FAR CPA Lessons 107-120 Flashcards
Define Equity Security
Securities that represent ownership interest or the right to acquire or dispose of ownership interest.
- Includes common stock, preferred stock (except redeemable preferred stock), stock warrants, call options/rights, put options.
- Excludes debt securities (including convertible debt), redeemable preferred stock, written equity options, cash settled options, and treasury stock.
Define Debt Securities
Securities that represent the right of buyer/holder (creditor) to receive from the issuer (debtor) a principal amount at a specified future date and (generally) to receive interest as payment for providing use of funds. (Debt securities do not give the investor any influence over the investee)
- Includes bonds, notes, convertible bonds/notes, redeemable preferred stock.
- Excludes common/preferred stock, stock warrants/options/rights, futures/forward contracts.
Explain Recognition
Recognition is an accounting concept—it means that we have reported the item on the financial statements.
A recognized gain/loss occurs when a gain or loss related to an investment (or other item) is recorded (recognized) in the financial statements, regardless of whether the investment has been sold.
Explain Realization
Realization is an economic concept; it means that there is a culmination of the earnings process, and cash or other consideration is given or received.
A realized gain/loss occurs when the investment (or any other item) is sold (or otherwise disposed of).
How are nominal equity securities recorded?
At fair value and as either a current or noncurrent asset - changes in fairvalue are recorded in net income
How is and investment in the equity security recorded?
Can elect to record at fair value or by using the equity method
What are the ownership percentage cut offs for:
- Nominal
- Significant
- Control
Nominal - <20%
Significant - >=20% - 50%
Control - >50%
How are Significant control equity securities recorded?
Record using the equity method unless the fair value method is elected and record as an investment (Typically noncurrent) - If using FV - changes in FV are recorded in earnings
How are controlling securities recorded?
Record using the equity method or cost method and record in the consolidated financial statements
How are Trading debt securities recorded?
Valued using fair value - unrealized gains or loss are recorded in earnings - Dividend/Interest income is recorded in earnings
Typically a current asset
How are available-for-sale debt securities recorded?
Valued using fair value - unrealized gains or loss are recorded in other comprehensive income - Dividend/Interest income is recorded in earnings
Could be a current or noncurrent asset
How are held to maturity debt securities recorded?
Valued using Amortized cost - Do not record unrealized gains or losses - Dividend/Interest income is recorded in earnings
Define “readily determinable fair value.
An equity security has readily determinable fair value if it meets any of the following conditions:
- Sales prices or bid-and-ask quotations are currently available on a securities exchange registered with the U.S. Securities and Exchange Commission (SEC) or in the over-the-counter (OTC) market if the OTC prices are publicly reported.
- Prices or quotations are in a foreign market that has the breadth and scope of the U.S. markets.
- Prices or quotations for investments in mutual funds (or structures similar to mutual funds, such as a limited partnership or venture capital entity) when the fair value per share is published based on current transactions.
Distinguish when an equity investment must be accounted for at fair value
Equity investments are not required to be reported at fair value in the following circumstances:
- The equity investment is accounted for under the equity method
- The equity investment is controlled and will be consolidated with the investee
- The equity investment does not have readily determinable fair value
How do you determine the fair value of an equity security?
The fair value of an equity security is the price that would be received to sell the security in an orderly transaction between market participants.
How do you determine the initial equity investment amount?
Cost includes purchase price and includes any costs directly related to the purchase such as brokerage fees, transfer fees, etc.
Describe when an investor in an equity security may use the practicability exception
An entity can elect a practicability exception to fair value measurement for investments in an equity security when there is no readily determinable fair value.
In most cases, the investor uses the practicability exception because the investee is a privately held company.
Describe the factors that must be considered when determining if the equity investment may be impaired
- A significant deterioration in the earnings performance, credit rating, asset quality, or business outlook of the investee
- A significant adverse change in the regulatory, economic, or technological environment of the investee
- A significant adverse change in the general market condition of either the geographical area or the industry in which the investee operates
- A bona fide offer to purchase, an offer by the investee to sell, or a completed auction process for the same or similar investment for an amount less than the carrying amount of that investment
- Factors that raise significant concerns about the investee’s ability to continue as a going concern
Complete an impairment calculation and adjustment for an investment in an equity security carried at cost
The impairment loss is measured as the amount that the carrying value exceeds the fair value of the equity security.
The impairment loss is recorded in net income
An impairment loss cannot be reversed unless there are observable price changes in a similar or identical security, as described in the next section.
Identify when an adjustment to an investment in an equity security may occur based on observable factors
Changes in the observable prices in similar or identical securities may indicate that the investor should make an adjustment to the equity security being held as an investment. - The investor should make an effort to monitor observable price changes in transactions of the same issuer for any security that is similar or identical to the equity security being held.
Describe the accounting when all or part of an equity method investment is disposed of.
first update the equity method accounts to date of sale by recording:
- Investor's share of the investee's income or loss to date of sale. - Investor's share of the investee's dividends declared or paid to the date of sale. - Investor's depreciation or amortization on of the excess cost over book value to date of sale.
The gain or loss on the sale is the difference between selling price (SP) and book (carrying) value (BV) of the equity investment sold.
If the sale is not for entire investment and results in the investor losing significant influence over the investee (e.g., < 20% ownership), the remaining investment should be accounted for at fair value
What are the factors that indicate the investor has significant influence even though ownership is less than 20%
- The investor has representation on the investee’s board of directors;
- The investor participates in investee’s policy making;
- There are material transactions between the investor and the investee;
- There is technological dependence on the investor; or
- No other single investor has a material voting ownership in the investee.
Describe the required disclosures for the equity method of accounting.
- The name of each equity method investee and the percentage of ownership.
- The breakout of which are less then 20%, between 20-50% that are accounted for using the equity method and why they are using the equity method
- Any difference between the carrying amount of the investment and the investor’s share of the underlying claim to net assets and how that difference is treated.
- When a bargain purchase gain is recognized, the amount of the gain recognized, the line item where the gain is recognized and a description of the transaction that resulted in the gain.
- When there is a quoted market price for the common stock, the market value of each investment.
- When the equity method is used for investments in corporate joint ventures that are material to the investor, summary information about the assets, liabilities, and results of operation of those joint venture investees.
- Possible effects of conversion or exercise of outstanding securities (e.g., options, convertible securities, etc.) on the investor’s ownership claim.
Items of other comprehensive income that might change equity would include:
- Unrealized gains/losses on available-for-sale debt securities;
- Foreign currency items; and
- Pension and postretirement benefit items not recognized in period cost.
