Investments Flashcards
Grants the investor ownership rights?
An investment in the bonds of another entity does not give the investor an ownership interest, but an investment in the common stock of another entity does give the investor an ownership interest. An investment in the bonds of another entity establishes a debtor-creditor relationship, not an ownership relationship.
Not considered an equity investment for investment accounting purposes
Redeemable preferred stock is not considered an equity security for investment accounting purposes. Redeemable preferred stock, also known as callable preferred stock, may be reacquired by the issuing corporation under prescribed conditions.
FV Accounting for Investments
An investor may elect to use fair value to account for or measure some investments that otherwise would be accounted for using amortized cost or the equity method (Statement II). However, an investor is not required to use fair value to account for most investments (Statement I).
Levels of influence, that an investor may have over an investee, are identified?
Accounting identifies three levels of influence that an investor may have over an investee. Those levels are: (1) no significant influence, (2) significant influence, but not control, and (3) control.
Temporary Decline vs OTTI in AFS Security
A permanent decline in the value of an available-for-sale security is recognized as a loss in the Income Statement (whereas nonpermanent declines are treated as reductions in owners’ equity).
The security did not change in value during 2004 because the market value had not changed, thus there is no further reduction in assets. The owners’ equity account would be reclassified as a loss account; thus, only income is decreased.
Permanent vs Temp decline (FV<Cost) in AFS
Permanent losses on securities available-for-sale (SAS) are recognized in earnings as if they were realized. This is an example of conservatism. If the market value is not expected to recover, a loss is probable and therefore should be recognized in earnings.
This is in contrast to the treatment for temporary losses, which for SAS, are treated as direct reductions to owners’ equity. Thus, only the loss in I. (Knox) is recognized in earnings.
Compare Bond Investment Carrying Value to Cash Paid and Face.
When a bond is purchased at a discount, the price paid is less than face value. Any cash paid to the seller for accrued interest is debited to interest receivable, not to the bond investment. Thus, the carrying value is the portion of the total amount paid attributable to the total bond price, exclusive of accrued interest.
The carrying value must be less than the cash paid to the seller, which includes accrued interest.
KEYS to Bond Investment Qustions
- Watch Dates (Amort of Discount over 3 mos or 15 mos since asks for Balance at End of Year TWO)
- Purchase Price excludes Accrued Interest.
3.
HTM Investment and Prem / Discount
Held-to-maturity investments in bonds are reported at amortized cost. The discount or premium at purchase is amortized during the term of the bonds so that the carrying value is equal to face value at maturity. This is the amount to be received at maturity
The purchase price, exclusive of accrued interest, is $215,000 ($220,000-$5,000). Accrued interest is not included in the investment carrying value. The premium paid on the bonds is $15,000 because the face value of the bonds is $200,000 (200 x $1,000). The term of holding the bonds is from October 1, 2004 to January 1, 2011, a period of six years and three months or 75 months. The period from purchase to the December 31, 2005 Balance Sheet is 15 months. Amortization of the premium reduces the investment carrying amount because only face value, which is less than the amount paid for the investment, will be received at maturity.
HTM Bond Investment Carrying Value Example
Mkt = 10% and Cash = 8% and Jan 1 Purchase and Ann Interest Date.
The interest and amortization entries for the two years 2004 and 2005 lead to the correct ending balance at December 31, 2005 are:
December 31, 2004:
Interest receivable .08($500,000) 40,000
Investment in HTM bonds 5,620
Interest revenue .10($456,200)
45,620
December 31, 2005:
Interest receivable .08($500,000) 40,000 Investment in HTM bonds 6,182 Interest revenue .10($456,200 + $5,620)
46,182
AFS Security flow from OCI to I/S
The unrealized loss would be credited to the other comprehensive income account to reclassify the holding loss as a realized loss in the income statement for year 2. For purposes of illustration, assume the available for sale (AFS) securities were originally purchased for $5 and that the loss during year 1 was $1. The related entries would be:
Purchase: DR. AFS Securities $5
CR. Cash $5
Year 1 End: DR. OCI (holding loss) $1
CR. AFS Securities $1
Year 2: DR. Cash $4
CR. AFS Securities $4
DR. Loss on AFS Securities $1 (Income Statement)
CR. OCI (holding loss) $1 (B/S, Accumulated OCI)
The last entry (above) reclassifies the holding loss to recognize a realized loss on sale.
When investments are transferred between classifications, which one of the following valuation basis is most likely to be used when recording the investment in the new classification
Fair Value
Reclassifications between the two investment categories are always recorded at market value. The reclassification is treated as if the security in the old classification was sold, and the security in the new classification was purchased.
Market value reflects a brand new valuation and is treated as original cost from then on for the purpose of the annual year-end revaluation adjustment.
Reclass where no Net Income Impact
A transfer of an investment from held-to-maturity to available-for-sale would result in writing off the unamortized cost in the held-to-maturity classification and writing on the investment at fair value in the available-for-sale classification, with any difference being an unrealized gain or loss recognized in comprehensive income, not in current net income.
Trading Investments CF Classification
Operating if Current on B/S and Investment if Non-Current
If an investor properly switches from the fair value method to the equity method of accounting for an investment, the net income of prior periods must be adjusted.
True
An investor’s write-off of a portion of an excess payment (cost > book value) will reduce the amount of Investment (Equity) Revenue that would otherwise be recognized by the investor.
True
