Chapter 17 Flashcards
How are investment categories described under SFAS 115?
1) Debt Securities and Equity Securities, 2) Types of Debt Securities: Trading, Available for Sale, and Held to Maturity, 3) Types of Equity Securities: Trading and Available for Sale
To what kind of securities does SFAS 115 apply to?
marketable securities, those that are traded on an exchange with observable values
Why would investors choose to own debt securities?
because of interest payments
Why would investors choose to own equity securities?
for ownership
When is the equity method used to account for equity securities?
If own 20-50% of the voting stock
When is the consolidation method used to account for equity securities?
If own more than 50% of the voting stock
How are trading debt securities accounted for?
recorded at fair value and the market value changes are recorded as part of income (mark to market), gains and losses are recorded and impounded into EPS
What classifies a debt security as trading?
based on management intent to sell in less than 1 year (more like 3 months)
How are available for sale debt securities accounted for?
recorded at fair value and market value changes are recorded as part of equity, do not effect EPS
How are held to maturity debt securities accounted for?
recorded at amortized cost and market value changes are not recognized
What are the problems with the way debt securities are currently accounted for?
can tweak income by cherry picking which securities to put in which categories and determining management intent
What classifies a debt security as held to maturity?
positive intent to hold the securities and the ability to hold them to maturity
How is intent to hold a debt security as held to maturity determined?
through paper trails
What are held to maturity debt securities recorded at?
amortized cost, not fair value
What are available for sale debt securities recorded at?
fair value in the balance sheet with differences between the fair value and amortized cost reported as unrealized holding gains and losses (part of equity)
How are gains and losses on available for sale securities reported when realized?
reported as part of net income
What makes a gain/loss unrealized?
if the security has not been sold yet
What are trading debt securities used for?
to generate profits from short-term differences in prices
What is the holding period of a trading security?
usually less than 3 months
What are trading debt securities recorded at?
fair value and unrealized gains and losses are reported as part of net income, any discount or premium is not amortized
Why are trading debt securities unamortized?
because amortization is usually immaterial in practice, if held for year, must be amortized
What are equity securities?
represent ownership interests such as common, preferred, stock options, warrants, or other capital stock
What rights are included in equity securities?
rights to buy and sell ownership interest
Are convertible debt and redeemable preferred stock considered equity securities?
no because convertible debt is a debt security and redeemable preferred stock has a maturity date so is considered debt
What determines the accounting treatment for equity securities?
extent of ownership in common stock by an investor in an investee
What are the levels of influence in equity interests?
1) 0-20% = little or none influence, 2) 20-50% = significant influence, 3) 50-100% control
Where do most companies investments fall?
Below 20%
What are some cases in which significant influence may not exist?
1) Investee opposes investor’s acquisition of stock, 2) Investor surrenders significant shareholder rights, 3) Investor is unable to obtain needed financial information from investee, 4) Investor is unable to obtain representation on investee’s board of directors
When is the equity method used to account for equity securities?
when the investor has significant influence over the investee
How is a significant security investment initially accounted for under the equity method?
recorded at cost
How is the investment’s carrying value increased?
by investor’s proportionate share of earnings
How is the investment’s carrying value decreased?
1) by investor’s proportionate share of losses, 2) dividends declared by the investee
When is consolidation used to account for equity securities?
when there is a voting interest of more than 50% that results in a controlling interest
What is the relationship between the investor and investee in a controlling interest relationship?
investor is parent corporation and investee is subsidiary corporation
What is the result of the parent-subsidiary relationship?
investor prepares consolidated financial statements for the parent and subsidiary
How are securities presented on the financial statements?
amounts must be reported for each category of investment
How are trading securities recorded?
Reported at aggregate fair value as current assets
How are available-for-sale securities recorded?
reported at aggregate fair value and either current or noncurrent assets, usually noncurrent
How are held-to-maturity securities recorded?
reported at amortized cost and either current or noncurrent assets, always noncurrent except in year of maturity
When is a bond sold at a discount or premium?
Premium = stated rate higher than yield rate, Discount = yield rate higher than stated rate
When is the PV of 1 table used?
when calculating the PV of a lump sum (use yield rate)
When is the annuity table used?
when calculating the value of interest payment
How are the values of an amortization table calculated?
1) Cash = face value x stated rate, 2) Interest Revenue = carrying value x yield rate, 3) face value = final carrying value
When is a unrealized holding gain/loss credited?
when a gain occurs
When is the fair value adjustment account debited?
when the fair value increases
What is a derivative?
type of financial instrument that derives its value from some asset
What accounting standard applies to derivatives?
SFAS 113
What are types of derivatives?
Hedge, Speculate, and arbitrage
What is a hedge?
the goal is to budget, control cost, set prices, and manage cash flows in order to lower risk (jet fuel, commodities)
What is speculation?
taking a risk but can make lots of profit
What is arbitrage?
insider information used to buy and sell and make a profit, informational advantage
How are derivatives accounted for on the balance sheet?
fair value
How are derivatives accounted for on the income statement?
fair value with the gain/loss to income
What are derivatives treated similarly to?
trading securities
