FAR-F4-M1-Financial Instruments

Question 1

How are equity securities typically valued?

Answer 1

Equity securities are valued at fair value. However, if the investor has significant influence over the investee, then the securities must be valued using the equity method.

Question 2

Where are unrealized gains and losses recorded for equity securities?

Answer 2

For equity securities, when reported under the fair value option, unrealized gains and losses are reported in net income as they occur

Question 3

What are the 3 types of debt securities?

Answer 3

Held to Maturity securities, available for sale securities and trading securities.

Question 4

For equity securities, how is impairment calculated?

Answer 4

Impairment loss is equal to the carrying value of the investment less the determined fair value.

Carrying value - fair value = the impairment loss

Question 5

For available for sale securities, where are unrealized gains and losses recorded?

Answer 5

For available for sale securities, unrealized gains and losses are recorded in OCI. Once they are realized, they are moved from OCI to net income in the income statement.

Question 6

How is impairment determined for Available for Sale securities?

Answer 6

For Available for sale securities, if the fair value of the security is below the present value of expected cash flows AND the PV is below the amortized cost, then loss is recorded. If the prompt specifically uses the Current Expected Credit Losses (CECL) the fair value of the security is compared against the amortized cost and if the fair value is below amortized cost, then asset should be written down to the lower fair value by recording a credit loss that is recognized on the income statement. (similar to HTM impairment)

Question 7

How are available for sale securities valued?

Answer 7

Available for sale securities are recorded at fair value.

Question 8

How are held to maturity securities recorded on the balance sheet?

Answer 8

Marketable securities that the company intends to hold to maturity both long term and short term are reported at carrying amount (amortized cost)

Question 9

Are unrealized gains and losses recorded for Held to maturity securities?

Answer 9

No, unrealized gains and losses are not recorded for held to maturity securities.

Question 10

For held to maturity securities, how is impairment evaluated?

Answer 10

If it is determined that all amounts due (principal and interest) will not be collected on a debt instrument reported at amortized cost, the investment should be reported at the present value of the principal and interest that is expected to be collected. Credit loss = PV - Amortized Cost.

If the problem is using the CECL method, then we compare present value of expected future cash flows OR fair value against the amortized cost. If fair value is below amortized cost and the decline is permanent, then impairment should be recorded.

Credit Loss Expense XXX
Allowance for Credit Loss (XXX)

Question 11

Generally speaking, what is the difference between realized gains and losses and unrealized gains and losses?

Answer 11

Realized gains and losses are those that have been actualized by selling an existing position for more or less than what it was worth. Unrealized gains and losses are “on paper” only and have not been actualized yet.

Question 12

What is a liquidating dividend?

Answer 12

A liquidating dividend is a distribution that exceeds the investor’s share of the investee’s retained earnings. A liquidating dividend is a return of capital that decreases the investor’s basis in the investment. The JE is
Dr. Cash XXX
Cr. Investment in Investee (XXX)

**The above JE is the same for a liquidating dividend under the fair value method and under the equity method, dividends received are considered a return of investment and lowers the investment account, so the JE would be the same regardless.

Where as a normal dividend would be
Dr. Cash XXX
Cr. Dividend Income (XXX)

Question 13

Is the following statement true or false? When transferring from one debt security to another, the transfer is accounted for using the fair value method.

Answer 13

True. When transferring from one debt security to another, the transfer is accounted for using the fair value method.

Question 14

How are trading securities reported on the balance sheet?

Answer 14

Trading securities are reported at fair value.

Question 15

How are unrealized gains and losses reported for trading securities?

Answer 15

Unrealized gains and losses are reported in net income for trading securities.

Question 16

Regardless of whether debt security (available for sale, trading or held to maturity) or equity securities, where are realized gains and losses recognized in the financial statements?

Answer 16

All realized gains and losses are recognized in net income. Realized gains and losses are recognized when a debt security is sold and when an Available for sale security is deemed to be impaired.

Question 17

Is the following statement true or false. Under the Current Expected Credit Losses (CECL) Model, AFS and HTM debt securities should be reported at the net amount expected to be collected using an allowance for expected credit losses.

Answer 17

True. Under the Current Expected Credit Losses (CECL) model, AFS and HTM debt securities should be reported at the net amount expected to be collected using an allowance for expected credit losses.

Question 18

Where is dividend income from equity securities reported?

Answer 18

Dividend income from equity securities are reported in the income statement.

Question 19

Where is interest income from trading securities, AFS securities or HTM investments reported in?

Answer 19

Interest income from all debt securities (trading, AFS and HTM) are reported in the income statement.

Dr. Cash XXX
Cr. Interest Income (XXX)

Question 20

Is restoration of credit losses (impairment) of held to maturity investments allowed under U.S. GAAP?

Answer 20

Yes, but only to the extent of previous write downs, similar to the restoration of impairment for PPE.

Question 21

Under the equity method, the receipt of dividends from COMMON STOCK OF INVESTEE reduces the investment in the investor’s books
Dr. Cash XXX
Cr. Investment in XYZ

What is the treatment if the dividends received came from preferred stock?

Answer 21

If the investor had preferred stock, dividends received from the preferred stock would be regular dividend income.

Dr. Cash XXX
Cr. Dividend Income (XXX)

Question 22

Regarding disclosures about financial instruments, is the disclosure of concentration of credit risk required?

Answer 22

Yes, disclosure of concentration of credit risk is required and included in the notes to the financial statements.

Question 23

Is the disclosure of market risk required?

Answer 23

No, the disclosure of market risk is encouraged but not required.

Question 24

Is the following statement true or false? Because equity securities, trading securities and available for sale securities are recorded at fair value and Held to maturity securities are held at carrying value, BOTH carrying value and fair value must be disclosed.

Answer 24

True. Because equity securities, trading securities and available for sale securities are recorded at fair value and Held to maturity securities are held at carrying value, BOTH carrying value and fair value must be disclosed.