Chapter 17: Investments Flashcards
Equity investments: Fair value method
Used when holdings are < 20%
- as long as market pricing is available
(practicability method = cost less impairment) - unrecognized holding gain or loss goes to income
- dividends recognized when received
- gains or losses recognized on sale of investment
no recognition of investee income other than dividends
FV adjustments done the same as with debt investments
Fair Value adjustment account debited if need to increase value of investment, credited if need to decrease)
then use unrealized holding gain or loss - income account
Treatment of Trading Debt securities
Debt securities bought and held primarily for sale to generate income on short term price differences
- valuation at fair value
- unrealized holding gains or losses recognized in net income
- any interest earned goes to gain or loss from sale of investments
Income effects of equity securities
Holdings < 20%:
- unrealized holdings gains or losses –> net income
- dividends and gains or losses from sale –> net income
Holdings 20%-50%;
- unrealized holding gains or losses NOT recognized in net income
- proportionate share of investee’s net income –> net income
- (dividends reduce investment)
Holdings >50%:
- consolidate statements
Valuation of lump sum security purchases
Ideally done by specific identification
if not, then average cost of FIFO is acceptable
Equity method for equity investments
IF proportion of loss is greater than carrying amount
If loss is limited to the investment amount:
- discontinue equity method and recognize no additional loss
If loss is not limited (investor guarantees investee’s obligations):
- loss should continue to be recognized
Accounting for investments
Depends on the type of security and management intent
Debt:
No plans to sell - record at amortized cost
Plans to sell - record at fair value
Equity:
Plans to sell - record at fair value
Exercise some control - use equity method
Recording debt securities
Held to maturity or AFS
Debit Debt Investments
Credit Cash
Could have a separate discount or premium amount but in practice generally don’t (still use amortization table)
Debits (discounts) or credits (premium) debt investment account for difference between cash received and interest revenue (based on carrying amount and effective rate)
Treatment of held-to-maturity debt securities
Debt securities ONLY, not equity
Company has to have positive intent AND ability to hold to maturity
Valued to amortized cost
- written down only if permanently impaired
- no recognition of unrealized holding gains or losses
Interest Revenue categorized under other revenue and gains
Consolidation
When one corporation (parent) owns more than 50% interest in another (subsidiary) = controlling interest
Parent prepares consolidated financial statements: parent and subsidiary as single method - use equity method
Accounting for ownership interest in another corporation
Holdings < 20% : passive interest
- use fair value method
Holdings 20% - 50%: significant influence
- use equity method
Holdings > 50%: controlling interest
- use consolidated statements
Sale of held-to-maturity debt NEAR maturity date
(sale within 3 months of maturity still considered sale at maturity)
1) record any amortization to date of sale
2) gain on sale = selling price (without interest) less FULLY amortized value of bonds to date
Debit Cash received
Credit Interest revenue (for accrued months)
Credit Debt investment
Credit gain on sale (selling price > book value)
Reporting other comprehensive income
Tracked and shown as separate component of stockholders’ equity until the relevant instrument is sold
only realization on sale goes into net income
Treatment of available-for-sale debt securities
Debt securities not classified as held-to-maturity or trading
- valuation at fair value
- unrealized holdings gains and losses recognized in other comprehensive inncome AND as a separate component of SE
- any interest earned goes to other revenues and gains
Reporting Fair Value adjustments
Available-for-sale and trading securities
Reported as an adjustment to the carrying amount of investment
Debit balance = increase
Credit balance = decrease
can report a portfolio as a lump sum
Available-for-sale securities in financial statements
Balance sheet
- interest receivable –> current assets
- debt investments (AFS) –> investments
- Accumulated other comprehensive income/ loss –> stockholders’ equity
Income statement
- interest revenue & loss or gain on investments –> other revenues and gains or other expenses and losses
Recording fair value adjustment for available-for-sale securities and trading securities
Loss:
Debit Unrealized holding gain or loss - equity
Credit Fair value adjustment
(reverse for gain)
Adjust balance of fair value adjustment account for correct affect on investment balance
goes for both AFS and Trading securities
Impairment of investment value of held-to-maturity debt
Current expected credit loss model
- if probable that will not collect all amounts due
Debit Allowance for Doubtful Accounts
Credit Debt investments
No changes unless further impairment occurs
Fair value method for investment
once fair value option selected cannot switch back
- the choice is made for each investment, not for the entire portfolio
use accounts:
- unrealized holding gain or loss - income
- debt or equity investment (directly change to fair value)
Loss
Debit Unrealized holding gain or loss - income
Credit Debt or Equity Investment
Gain
Debit Debt or Equity Investment
Credit Unrealized holding gain or loss - income
Impairment of equity investments
Also trading debt
Decline in value reported via net income
Impairment of investment value of Available for sale debt securities
credit losses limited to amount fair value is less than amortized cost (b/c if more could sell security and avoid additional loss)
Debit Bad Debt Expense
Credit allowance for doubtful accounts
(may be refused but cannot exceed original amortized costs)
Sale of Available-for-sale securities
Amortized cost > selling price = loss (debit)
Amortized cost < selling price = gain (credit
Debit Cash
Debit Loss or Credit gain on sale of investments
Credit Debt investments
not using discount or premium accounts
shown on income statements in other revenue or gains or other expenses or losses
Holding gain or loss
Net change in the fair value of a security from one period to another
exclusive of dividend or interest revenue
Reporting unrealized holdings gains or losses trading securities
On income statement under other revenues and gains or other income and losses
only when securities are actively traded
FASB rulings re: recording investments
- loans reported at amortized costs (avoids volatility)
- equity investments mostly reported at fair value
Debt securities under IFRS
Held-for-collection debt securities : valued at amortized cost
Trading & AFS - held at fair value
Financial assets
Asset whose value comes from a contractual claim to to cash flows
Security
A share, participation, or other interest in property or in an enterprise of the issuer or an obligation of the issuer, with three characteristics:
1) represented by an instrument or in books
2) traded in securities exchange markets
3) one in a class or series or divisible into class/ series of shares etc…
Equity method for recording equity securities
Equity holdings of 20-50% (significant influence)
Original purchase = cost of shares acquired
Period adjustments for changes in proportionate shares of investees’ earnings
Debit Equity Investment (increases value directly)
Credit Investment income (or reversed for loss)
Receipt of dividends
Debit Cash (increase)
Credit Equity Investments (decrease)
No unrealized holding gain or loss
Debt investment
Creditor relationship with another entity involving a security
Types:
- held to maturity
- trading
- available for sale (not trading or held-to-maturity)
Equity Securities
Ownership interest: common, preferred, or other capital stock
- rights to acquire ownership interest (warrants, rights, call/put options)
(does not include convertible debt securities or redeemable preferred stock)
Cost = purchase price + broker’s commission and other fees
Impairment Models
Assessment measurement basis –> impairment model
Loans, receivables, and debt securities measured at amortized cost –> expected losses in net income
Debt securities measured at fair value, with gains and losses recorded in other comprehensive income (AFS) –> if fair value >= amortized cost, no expected credit loss recognized. if fair value < amortized cost, expected credit loss –> net income
Debt and equity securities measured at fair value with gains and losses recorded in net income (trading) –> debt securities: difference between lower of amortized cost or fair value or (equity securities) lower of cost or fair value
Reclassification Adjustment
Adjustment made to ensure gains and losses are not double counted when a security is sold but the unrealized gains or losses are already showing in a prior period comprehensive income (on the balance sheet)
FASB prefers it shown in notes to the financial statement
Transfers between categories of debt securities
At Fair value at date of transfer
Trading –> AFS: unrealized gain or loss –> SE & Income
AFS –> Trading: unrealized gain or loss –> SE & Income
Held-to-maturity –> AFS: SE increased or decreased by unrealized gain or loss
AFS –> held-to-maturity: unrealized gain or loss carried as separate component of SE and amortized over the life of the security
Comprehensive Income
Change in equity (net assets) of an entity during a period from transactions and other events and circumstances from non-owner sources
Investments
Financial assets held by an enterprise for earning income by way of dividends, interest, or capital appreciation, or for other benefits to the investing enterprise.
