F5 - M1 - Financial Instruments Flashcards
Give some examples of financial assets?
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.
What are some common examples of debt for investments in other companies stocks and bonds?
Trading Security
Available for Sale
Held to maturity
What are some common examples of common equity for investments in other companies stocks and bonds?
Less than 20% ownership - No significant influence, trading security
20-50% - Significant influence (equity method)
Own > 50% - Acquisition (consolidate)
What is a financial liability?
When you are borrowing and have to make payments, like most debt.
For the trading security rules, what option do you use?
The fair value option
When you use the fair value option, how does that work?
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.
For any change in the financial liability is due to credit risk under the fair value option, where is this recognized?
Under other comprehensive income
For derivative liabilities, where are those changes recognized?
Income statement
For debt issued, how is this treated? What do these includes?
These are treated as assets, and there is no voting rights.
Corporate bonds
Redeemable preferred stock
Government securities and more
For debt that you issue, how does the trading securities method work?
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.
For debt that you issue, how does the available for sale method work?
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.
For debt that you issue, how does the Held to maturity method work?
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.
When debt securities are classified as trading or available for sale, what must they be valued at?
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.
What is the journal entry for a trading security unrealized gain or loss?
For Loss:
DR: Unrealized loss on trading security -xxx
CR: Valuation account (fair value adjustment) - xxx
What is the journal entry for a trading security unrealized gain or loss?
For Loss:
DR: Unrealized loss on available for sale security -xxx (direct to equity) OCI.
CR: Valuation account (fair value adjustment) - xxx
For both trading securities and available for sale securities, do realized gains and losses go to the income statement?
Yes, for realized the do, for unrealized it depends.
When would you recognize a gain or loss?
When it is sold, or when there is an impairment.
For held to maturity is there any unrealized or realized gains and losses?
No, because you are not supposed to sell these.
They are recorded at amortized cost.
For held to maturity, trading, and available for sale, what is the cash flow recorded at?
Current asset - Operating
non-current - Investing
Can you transfer between categories? At what value is the amount transferred for?
Yes, and it doesn’t matter where you are transferring to or from, it is always at fair value.
When transferring from trading to any other method what happens to the unrealized holding gains and losses?
It has already been recognized as income so no adjustment is needed.
When transferring from any other method to training d what happens to the unrealized holding gains and losses?
Unrealized holding gains and losses are recognized in the current earnings.
When transferring from held to maturity to available for sale what happens to the unrealized holding gains and losses?
Record in OCI
When transferring from available for sale to held to maturity what happens to the unrealized holding gains and losses?
Amortize gain or loss form OCI with any bond premium/discount amortization.
What is the formula to calculate interest as held to maturity?
Beginning carrying value * Yield to maturity = Interest income
What is the calculation for expected credit loss?
PV future cash flows - Amortized cost and this will be recorded on the income statement.
If the amortized cost is greater than PV of future cash flows, then you would want to record a loss.
What are expected credit losses determined by?
Current conditions, past experience, and future expectations.
Important to note, if the fair value of the investment is greater than the amortized cost, that is a gain for available for sale. So if your PV of future cash flows is less than the amortized cost, but the amortized cost is less than the FV, then you would not record any loss on the income statement.
Where is the credit loss recognized?
On the income statement and write down the balance sheet balance.
How do impairment of held to maturity securities work?
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
When an asset is impaired, when do you recognize the loss?
Right away.
Impairment for available for sale securities, how are these handled?
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.
What are the journal entries for available for sale securities?
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
When you sell a trading security, what is the formula to recognize a gain or loss?
Adjusted Cost (Original cost plus or minus unrealized gains and losses) - Selling Price
DR: Cash
CR: Trading Security
CR: Realized gain on trading security
