Financial 4 - Financial Instruments

Question 1

Bonds’ Market Value Causes and Effects

Answer 1

• If interest rates have increased, then the bonds’ interest rate would be less attractive to investors now than when the bonds were originally issued. This most likely would cause a decline in the bonds’ market value

Question 2

Purchasing a Bond

Answer 2

• Bond investments which are intended to be held until maturity date are classified as held-to-maturity securities and are reported at their amortized cost

1. At a DISCOUNT:
   - it is purchased for less than the face value of the bond
   - the gain on sale is determined by the difference between the proceeds received and the book value of the bonds

Question 3

Gain or Loss on Marketable Debt Securities

Answer 3

RULE:

• Unrealized gains and losses for marketable debt securities are reported as TRADING debt securities reported at fair value with unrealized gains and losses included in earnings.
• AVAILABLE-FOR-SALE debt securities are reported at fair value with unrealized gains and losses reported as a separate component of OCI (**PUFIER) (at the END OF THE REPORTING PERIOD). AFS securities are initially reported at cost when purchased

When market value of Marketable Debt Securities that the company has the intent and ability to hold to maturity EXCEED its carrying amount, BOTH long and short term, are reported at Carrying Amount (amortized cost).., unless there is a permanent decline in the market value

Question 4

Dividend Revenue Reporting

Answer 4

RULE: Dividend Revenue, under the fair value method, should be recognized to the extent of cumulative earnings since acquisition and return of capital beyond that point

• Receipt of a stock dividend is NOT income

Example’s correct answer: The amount of dividend revenue to be reported in the investor’s IS for the year would be the portion of the dividends received this year that were not in excess of the investor’s share of investee’s undistributed earnings since date of Investment

Question 5

How to Classify a Trading Security vs. Available for Sale Security

Answer 5

• Bond investments get classified as trading securities because the bonds are held for the purpose of selling them in the near term

Question 6

Disclosures About Risk on Financial Instruments

Answer 6

• Concentration of Credit Risk: Risk that the other part to the instrument will NOT perform = REQUIRED Disclosure (in the Notes to the Financial Statements)
• Market Risk: the risk of loss from changes in market prices = Encouraged disclosure, but NOT REQUIRED
• Both carrying value and fair value must be disclosed for most financial instruments (when practical to estimate FV)

Question 7

Fair Value Option Application

Answer 7

• Applies to Financial Assets (debt and equity securities) and liabilities (notes payable)
• EXCLUDED in Fair Value Option are investments in subsidiaries, pension benefit assets/liabilities and assets and liabilities recognized under leases