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FAR - Fact Nuggets > Investments & Derivatives > Flashcards

Investments & Derivatives Flashcards

1
Q

How are transfers between debt security classifications treated?

A
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2
Q

What is an equity security?

A

Securities that represent ownership rights.

Includes: common stock, preferred stock (NOT redeemable preferred), written equity options, treasury stock

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3
Q

What is a debt security?

A

Securities that represent the right of the buyer/holder (creditor) to receive from the issuer (debtor) principal at future date and receive interest as payment for providing use of funds.

Includes: bonds, notes, convertible bonds, redeemable preferred stock. Does not include: stock warrants, futures/forwards

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4
Q

What factors determine how an investment in debt or equity security are accounted for and reported?

A
  • -The nature of the investment (debt or equity security)
  • -The portion of the investment securities acquired
  • -Management’s intent on how long the investment will be held -If fair value is readily determinable
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5
Q

What is on the balance sheet for Equity Investment?

A
    • Original cost
  • +Pro-rata share of investee income
  • -Pro-rata share of investee dividends
    • Amortization of FV>BV
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6
Q

What is on the income statement for Equity Income from Investee?

A

CR: Pro-rata share of investee income

DR: Amortization of FV>BV

Note: No dividends on income statement

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7
Q

What determines significant influence over investees?

A

Presumed if there is 20-50% ownership.

Factors: 1) representation on Board

2) participates in policy making
3) material transactions between investor/investee
4) technological dependence on investor OR
5) no single other investor has voting ownership

*comprehension, not memorization*

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8
Q

What factors are indicators the investor does not have significant influence?

A

1) Investee opposes investment
2) Standstill - investor not able to acquire more shares
3) Significant influence by other party ( other investors, bankruptcy, foreign govt)
4) Cannot get representation on the board

*comprehension, not memorization*

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9
Q

What is the effect of Fair Value of Assets more than Book Value under Equity method?

A

Assets in investment are marked up to Fair Value, and difference is amortized over useful life.

DR: Income in Investee

CR: Investment in Income

Both entries REDUCE accounts since it is amortization

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10
Q

What is the application of equity method on investments which were not previously under significant influence?

A

Equity method is applied with PROspective application.

EX: Owned 10% in year 1, bought 20% more in year. Investment account should only include the cost of investment, plus future earnings, no income from Y1

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11
Q

Where should decline in FV of AFS investment below amortized cost due to credit decline (credit loss) be classified?

A

Earnings section of income statement

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12
Q

How are changes in Fair Value recognized through FVTPL?

A

An asset that is classified as FVTPL is remeasured to fair value each period, and the profit or loss is recognized in income for the period

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13
Q

If a firm elects to use the Fair Value Option to report investments, where are unrealized gains and losses reported?

A

Income statement for all classifications

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14
Q

What are the classification of debt securities and how are they determined?

A

Determined by management’s intent, Must have ability to hold to maturity.

Trading - Intent to sell in near term

Held to Maturity - Ability and intent to hold to maturity Available for Sale - not trading or HTM

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15
Q

What is the treatment of Trading Debt securities?

A
  • Recognized at cost (purchase price + direct acquisition costs).
  • Recognized at FV at year end through direct to adjustment to investment account, difference reported on I/S as unrealized gain/loss.
  • Classified as current asset.
  • Dividends or interest earned reported as income.
  • Operating or Investing section of Stmt Cash Flow.
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16
Q

What is the entry to record decline in FV of trading debt security?

A

Investment originally recorded at cost

DR: Invest. in Debt - Trading $1000 (CR Cash)

Fair Value decline to $900

DR: Unrealized loss (I/S) $100

CR: Invest in Debt - Trading $100

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17
Q

What is the treatment of Available for Sale Debt Securities?

A
  • Recognized at cost (purchase price + direct acquisition costs).
  • Recognized at FV at year end through adjustment to valuation account, difference reported in OCI as unrealized gain/loss (U in PUFIER).
  • Any permanent value decline is reported on I/S.
  • Classified as current or non current asset.
  • Dividends or interest earned reported as income.
  • Investing section of Stmt Cash Flow.
18
Q

What is the entry to record increase in FV of AFS debt security?

A

Investment originally recorded at cost

DR: Invest. in Debt - AFS$5,000 (CR Cash)

Fair Value rise to $5,500

DR: FV Adjustment - AFS $500 (B/S valuation)

CR: Unrealized gain (OCI) $500

Doesn’t hit investment directly, adjusted through valuation account.

19
Q

What is the treatment of AFS losses related to credit losses?

A
  • Any permanent losses would go to Income (instead of OCI).
  • Losses due to credit worthiness of investee also go to Income with a separate credit loss allowance account . Credit losses can be recovered, but not more than balance in allowance account.
  • If credit loss is determined not to be recoverable, allowance can be written off, and investment value reduced.
  • Total loss = Amortized Cost - FV of security
  • I/S loss= Amortized cost - PV
  • OCI loss = Total loss - I/S loss
20
Q

What is the treatment of HTM debt securities?

A
  • Recognized at cost (purchase price + direct acquisition costs).
  • Recognized at amortized value at year end..
  • Any permanent value decline is reported on I/S.
  • Classified as non current asset.
  • Dividends or interest earned reported as income, recognized through effective interest method.
  • Investing section of Stmt Cash Flow.
21
Q

What is the Current Expected Credit Loss Model? (CECL)

A

Allowance for credit loss on HTM debt securities. Based on historical experience, current conditions, and reasonable forecasts. Reduces net investment on B/S.

DR: Credit loss expense

CR: Allowance for credit loss

Reassessed each period, if deemed permanent, can write off and revise amortized cost.

22
Q

How are common dividends treated under the Equity Method of Investments?

A

Reduction of investment account (credit) NOT income

23
Q

How are preferred dividends treated under the Equity Method?

A

Interest Income to investor

24
Q

When should the equity method be used?

A

When an investor has the ability to exercise significant influence over the investee, and consolidation is not appropriate. Between 21-50% of ownership of stock with voting rights

25
Q

What is included in the I/S for HTM debt securities? (not using fair value option)

A
  • -Gains/Losses on securities sold during the period
  • -Permanent decline in value

Current year gains included in the disclosures, but are only recognized when realized (sold).

26
Q

What is readily determined Fair Value (Investments)?

A

It meets any of these conditions:

1) Sales prices or bid-and-ask quotes are available on securities exchange
2) Price or quotes are in a foreign market
3) Prices or quotes for mutual funds when FV per share is published If none of these conditions exist, consider recording investment using cost method

27
Q

How are dividends received treated? FV, Cost, and Equity Method

A

*Fair Value* - Dividends are income, Investment is measured on published prices

*Cost* - Dividend Income, investment recorded at cost when FV not available, impaired if needed

*Equity* - Dividends reduce the carrying amount of investment.

28
Q

What is the Cost Method for reporting an investment?

A
  • When no fair value is readily determinable, use the cost method.
  • Records investment at cost.
  • Record dividends received as income.
  • If impairment is required, expense is reported in current earnings.
29
Q

What are derivatives?

A

A derivative is a financial instrument or other contract that derives its value from the movement of prices, interest rates, or foreign exchange rates associated with an underlying asset or financial instrument.

A notional amount is a number of currency units, shares, bushels, pounds, or other units specified in the contract. The notional amount is called a face amount in some contracts. A payment provision specifies a fixed or determinable settlement to be made if the underlying behaves in a specified manner. Derivatives are the only financial instruments to have such notional amounts or payment provisions based on underlying variables.

30
Q

What is a notional amount in a derivative instrument?

A

A notional amount is a number of currency units, shares, bushels, pounds, or other units specified in a derivative instrument.

31
Q

What are three main features of derivatives?

A
  • The requirement of a very small or negligible investment fee
  • Option to settle the transaction at a net amount
  • An underlying asset that decides the settlement amount of the derivative
32
Q

How should preferred convertable stock not intended to be sold in the near term be classified?

A

Fair Value through net income

33
Q

Which exchange rate is used to convert operating transactions denominated in a foreign currency??

A

Current exchange rate

F/X gains / losses are reported as part of income from continuing operations and are remeasured at period end

34
Q

What is a direct exchange rate of US dollars ?

A

When it is proportionate dollars to buy ONE Foreign currency

EX $1.32 dollars = 1.00 YEN

35
Q

What types of rates should be used to translate foreign currency financials?

A
  • all assets and liabilities at the current exchange rate at the balance sheet date;
  • revenues and expenses at the e_xchange rate at the time the revenue or expense was recognized_, however, due to the impracticability of this where rates change frequently, a weighted-average exchange rate for the period may be used;
  • contributed capital at the historical exchange rate; and
  • retained earnings at the translated amount of retained earnings for the prior period, plus (less) net income(loss) at the weighted-average rate, less dividends declared during the period at the exchange rate when declared.
  • The weighted average exchange rate would be an appropriate exchange rate for salaries expense and sales to external customers.
36
Q

What is the difference between a Forward Contract and and Option Contract?

A
  • Forward - Establishes an obligation to buy or sell FC at a price determined today, but to be performed in the future. This contract requires performance.
  • Option - establishes the right, rather than an obligation to buy or sell foreign currency at a price determined today, but performance is not required. Option would expire.
37
Q

What is the difference between the functional, recording, and reporting currencies ?

A
  • Functional - currency of the primary economic environment in which the foreign company transacts (important - will be used to determine conversion)
  • Recording - currency which the entity’s general ledger is maintained ( may or may not be same as functional)
  • Reporting - currency of US parent company
38
Q

How are foreign subsidiaries converted to USD when functional currency is the same as local currency?

A
  • When the local currency is the functional currency, the conversion process is translation aka current rate method .
  • Foreign currency translation gains and losses are recorded in OCI
  • Income statement - at weighted average rate
  • current assets & liabilities - year end rate
  • stock and APIC - historic rate
  • dividends - exchange rate at date of declarations
    *
39
Q

How are foreign subsidiaries converted when the local currency is not the functional currency?

A
  • Remeasurement aka temporal- for example, the subsidiary is highly integrated with US operations
  • Monetary assets (cash, receivables, bonds) - current rate at year end date
  • non monetary assets (inventory, PPE)- historical rate
  • Income statement - weighted average
  • depreciation - historic rate of fixed asset
  • Gain/loss is recorded in Net Income (Not OCI)

Think about it this way, many the transactions were already based around the USD, so remeasure based on historic rate - non monetary assets, depreciation,

40
Q

What type of foreign currency conversion goes to OCI? Translation or remeasurement?

A

Translation goes to OCI

Remeasurement goes to IS

41
Q

What are the criteria for being classified as a hedged item?

A
  • The hedged item is specifically identified as either all or a specific portion of a recognized asset or liability or of an unrecognized firm commitment.
  • The hedged item is a single asset or liability (or a specific portion thereof) or is a portfolio of similar assets or a portfolio of similar liabilities.
  • The hedged item presents an exposure to changes in fair value attributable to the hedged risk that could affect reported earnings.

FAR - Fact Nuggets (17 decks)

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