F5 - M1 - Financial Instruments

Question 1

Give some examples of financial assets?

Answer 1

Cash

Ownership interest in an entity

Contract where the entity has the right to receive cash from a second entity

Exchange other financial instruments on potentially favorable terms with the second entity.

Question 2

What are some common examples of debt for investments in other companies stocks and bonds?

Answer 2

Trading Security

Available for Sale

Held to maturity

Question 3

What are some common examples of common equity for investments in other companies stocks and bonds?

Answer 3

Less than 20% ownership - No significant influence, trading security

20-50% - Significant influence (equity method)

Own > 50% - Acquisition (consolidate)

Question 4

What is a financial liability?

Answer 4

When you are borrowing and have to make payments, like most debt.

Question 5

For the trading security rules, what option do you use?

Answer 5

The fair value option

Question 6

When you use the fair value option, how does that work?

Answer 6

You report unrealized gains and losses in earnings. FMV from the beginning of the year and the end of the year.

The option is irrevocable, you can’t change.

Financial assets and financial liabilities have this option.

You can also this on equity investments.

Question 7

For any change in the financial liability is due to credit risk under the fair value option, where is this recognized?

Answer 7

Under other comprehensive income

Question 8

For derivative liabilities, where are those changes recognized?

Answer 8

Income statement

Question 9

For debt issued, how is this treated? What do these includes?

Answer 9

These are treated as assets, and there is no voting rights.

Corporate bonds

Redeemable preferred stock

Government securities and more

Question 10

For debt that you issue, how does the trading securities method work?

Answer 10

These are assets that will be sold in the near term.

You recorded unrealized gains and losses on the income statement.

Normally operating cash flows if they are classified as current assets.

Interest and unrealized gains and losses are on the income statement.

Question 11

For debt that you issue, how does the available for sale method work?

Answer 11

This is when you probably are not going to sell it right away, but won’t hold till maturity

If a non current asset, these are investing cash flows

Unrealized loss is on the income statement, unrealized gain goes direct to equity. Unrealized gain will be reported net of tax in OCI.

Interest goes on the income statement.

Question 12

For debt that you issue, how does the Held to maturity method work?

Answer 12

You plan to hold the asset to maturity, reported at amortized cost.

Do not plan on selling this.

Most likely investing cash flows if non current, no unrealized or realized gains and losses, and interest on the income statement.

Question 13

When debt securities are classified as trading or available for sale, what must they be valued at?

Answer 13

Fair value or market price of the security.

Unrealized gains or losses are fair value at the beginning and at the end of the year.

Question 14

What is the journal entry for a trading security unrealized gain or loss?

Answer 14

For Loss:

DR: Unrealized loss on trading security -xxx

CR: Valuation account (fair value adjustment) - xxx

Question 15

What is the journal entry for a trading security unrealized gain or loss?

Answer 15

For Loss:

DR: Unrealized loss on available for sale security -xxx (direct to equity) OCI.

CR: Valuation account (fair value adjustment) - xxx

Question 16

For both trading securities and available for sale securities, do realized gains and losses go to the income statement?

Answer 16

Yes, for realized the do, for unrealized it depends.

Question 17

When would you recognize a gain or loss?

Answer 17

When it is sold, or when there is an impairment.

Question 18

For held to maturity is there any unrealized or realized gains and losses?

Answer 18

No, because you are not supposed to sell these.

They are recorded at amortized cost.

Question 19

For held to maturity, trading, and available for sale, what is the cash flow recorded at?

Answer 19

Current asset - Operating

non-current - Investing

Question 20

Can you transfer between categories? At what value is the amount transferred for?

Answer 20

Yes, and it doesn’t matter where you are transferring to or from, it is always at fair value.

Question 21

When transferring from trading to any other method what happens to the unrealized holding gains and losses?

Answer 21

It has already been recognized as income so no adjustment is needed.

Question 22

When transferring from any other method to training d what happens to the unrealized holding gains and losses?

Answer 22

Unrealized holding gains and losses are recognized in the current earnings.

Question 23

When transferring from held to maturity to available for sale what happens to the unrealized holding gains and losses?

Answer 23

Record in OCI

Question 24

When transferring from available for sale to held to maturity what happens to the unrealized holding gains and losses?

Answer 24

Amortize gain or loss form OCI with any bond premium/discount amortization.

Question 25

What is the formula to calculate interest as held to maturity?

Answer 25

Beginning carrying value * Yield to maturity = Interest income

Question 26

What is the calculation for expected credit loss?

Answer 26

PV future cash flows - Amortized cost and this will be recorded on the income statement.

Question 27

What are expected credit losses determined by?

Answer 27

Current conditions, past experience, and future expectations.

Question 28

Where is the credit loss recognized?

Answer 28

On the income statement and write down the balance sheet balance.

Question 29

How do impairment of held to maturity securities work?

Answer 29

This is where you write down the asset to the present value of future cash flows, and you record the impairment on the income statement.

So for example, if you have a bond, but instead of collecting interest of 20,000 you think you are only going to collect 10,000. You would want to find the PV of the principal payment, and the present value of the ordinary annuity just like a normal bond.

The PV of the principle and the annuity minus the face value of the bond is what the credit loss would be. You would then record the following journal entry to recognize the loss.

DR: Credit loss -xxx
CR: Allowance for credit losses -xxx

Question 30

When an asset is impaired, when do you recognize the loss?

Answer 30

Right away.

Question 31

Impairment for available for sale securities, how are these handled?

Answer 31

When you calculate your expected credit loss, that is the maximum loss that will be recorded on the income statement. Any additional losses are reported as unrealized loss on OCI.

So lets say that the credit loss is 25,000 and the fair value is 20,000 less that the amortized cost of the bond. The full 20,000 would go on the income statement.

Now lets say the credit loss is 25,000 and the fair value is less than 50,000 of the amortized cost. 25,000 would go on the income statement, and the other 25,000 would go to OCI.

Question 32

What are the journal entries for available for sale securities?

Answer 32

Gain:

DR: Valuation account -xxx
CR: Unrealized gain on available for sale security -xxx

Loss:

DR: Credit Loss -xxx
CR: Allowance for credit losses -xxx

Loss when part is income statement, part is OCI

DR: Credit Loss -xxx
DR: Unrealized loss on available for sale security -xxx
CR: Allowance for credit loss -xxx
CR: Valuation account -xxx

Question 33

When you sell a trading security, what is the formula to recognize a gain or loss?

Answer 33

Adjusted Cost (Original cost plus or minus unrealized gains and losses) - Selling Price

DR: Cash
CR: Trading Security
CR: Realized gain on trading security