Introduction - Equity and Debt Investments

Question 1

What are Equity Securities?

Answer 1

Securities representing ownership interest or right to acquire or dispose of ownership interest.

Ex. Common stock, preferred stock, stock warrants, call options. NOT debt securities, redeemable preferred stock and treasury stock

Question 2

What are debt securities?

Answer 2

Securities representing the right of buyer/holder (creditor) to receive from the issuer (Debtor) a principal amount at a specified future date and (generally) receive interest as payment for providing use of funds

Ex. bonds, notes, convertible bonds/notes, redeemable preferred stock. NOT futures/forward contracts

Question 3

What is a recognized gain or loss?

Answer 3

When a gain or loss related to an investment (or other item) is recorded in the financial statements, whether or not the investment has been sold.

Question 4

What is a realized gain or loss?

Answer 4

Occurs when an investment (or other item) is sold. The difference between the cash or other consideration received and the carrying value of the investment is a realized gain or loss

Question 5

What 3 things does the accounting and reporting of an investment in equity options depend on?

Answer 5

1. ) How much is owned
2. ) How long is it held
3. ) Whether the equity security is private or public

Question 6

If an investor has less than 20% ownership in an equity security how is it treated for accounting purposes?

Answer 6

Investor is considered to have NOMINAL influence over operating, investing and financing activity of Investee

• If investee is publicly traded and there is a readily determinable market value, the investment is classified as trading or investment for sale
• if investee is not publicly traded and no determinable market value, then investment is classified as a cost method investment
• Recorded on balance sheet as Investment-noncurrent or current depending on management’s intent

Question 7

What are the guidelines for determining no significant influence in an investment

Answer 7

Investment is:

1. )in Debt securities;
2. )in Non-voting stock;
3. )Temporary in nature;
4. )Less than 20% ownership of voting stock

Question 8

Identify the three possible levels of influence over an investee for accounting purposes.

Answer 8

1. ) Not significant;
2. ) Significant influence, but not control; and
3. ) Control

Question 9

What is the basis for general guidelines for determining the level of influence over an investee?

Answer 9

The nature and extent of ownership

Question 10

If investor owns between 20% and 50% in an equity security how is it treated for accounting purposes?

Answer 10

Investor is considered to have SIGNIFICANT INFLUENCE over the investee. It is accounted for using the equity method.

a. )If investee is public and has a readily determinable market value, investor can select Fair Value measurement.
b. ) Usually reported as noncurrent asset on BS because investments of this magnitude is relatively difficult to do.

Question 11

If investor uses Fair Value method for their investment how is it accounted for?

Answer 11

Investment is marked-to-market value with the unrealized gains and losses recorded in earnings. FV option is irrevocable

Question 12

If investor owns over 50% of of an investee how is it treated for accounting purposes?

Answer 12

Investor considered to have CONTROL over investee. Creates a parent/subsidiary relationship.

a. ) Recorded using the equity method
b. ) In some cases the parent can choose to use the cost method. Can be used by parent sometimes because the parent’s stand alone financials are typically not issued on a standalone basis.

Question 13

What does the accounting and reporting of an investment in debt securities depend on?

Answer 13

1. ) How long it is held

2. ) Whether the debt security is private or public.

Question 14

What is the first criterion for a debt security to be classified as Held to Maturity (HTM)?

Answer 14

An investor must have the positive ability and intent to hold the security to maturity.

a. ) Ability to hold may be evident in prior investments in debt securities
b. ) Intent to hold may be evident my demonstrating that the investor does not need cash associated with this investment.

Question 15

If debt security is publicly traded how is it accounted for?

Answer 15

Investor has option to value at amortized cost or FV

a. ) If investor intends to HTM, the security must be valued at amortized cost and classified as a noncurrent investment until it matures
b. )if the FV option is selected then records security at FV and classified as as trading or available-for-sale and presented as current or noncurrent depending on managements intent

Question 16

If a debt security is privately issued how is it accounted for?

Answer 16

Usually at amortized cost

a. ) If investor wants to HTM, must be valued at amortized cost, classified as noncurrent until it matures
b. ) If classified as trading or available for sale then should be recorded at FV

Question 17

When a bond is purchased for less than FV is effective rate lower or higher than stated rate?

Answer 17

It is greater and bond is purchased for a discount