Investments in Debt & Equity Securities

Question 1

What is Market Risk?

Answer 1

The risk that market interest rates will rise, making the lower rate on the receivable less desirable and reducing its value.

Also, could be that other investments will become available that offer a greater return, also diminishing value

Question 2

What is Performance Risk?

Answer 2

The risk that the debtor will not perform, which could mean that some or all payments will be missed or late.

Question 3

Examples of debt securities:

Answer 3

a. Preferred stock that by its terms must be redeemed or is redeemable at the option of the investor
b. A collateralized mortgage obligation that is used in equity form but is required to be accounted for as a nonequity instrument regardless of how that instrument is classified (that is where equity or debt) in the issuer’s statement of financial position (B/S)
c. US Treasury securities
d. US gov’t agency securities
e. Municipal securities
f. corporate bonds
g. convertible debt
h. commercial paper
i. All securitized debt instruments (collateralized mortgage obligations and real estate mortgage investment conduits)
j. Interest- only and principal-only strips

Question 4

Debt securities exclude all of the following:

Answer 4

a. Option contracts
b. Financial futures contracts
c. Forward contracts
d. Lease contracts
e. Trades Account Receivables arising from sales on credit by industrial or commercial entities
f. Loans receivable arising from consumer, commercial and real estate lending activities of lending institutions

Question 5

Name the ASC which relates to investments in debt

and equity securities.

Answer 5

ASC 320

Question 6

Name the ASC which relates to the equity method of accounting for certain equity securities and joint ventures

Answer 6

ASC 323

Question 7

Name the ASC which relates to other investments such as investments in insurance contracts and beneficial interests in securitized financial assets

Answer 7

ASC 325

Question 8

ASC 320

Answer 8

The Accounting Standards Codification related to investments in debt and equity securities.

Question 9

What are Trading Securities?

Answer 9

Investments in debt and equity securities, such as stocks and bonds, which the investor has acquired in an attempt to make profits by buying and selling within a short period of time.

Question 10

What are Available-for-Sale securities?

Answer 10

All investments in marketable debt instruments that do not fit the definitions of HTM or Trading Securities. These may be classified as current or non current, depending on expected date of sale.

Question 11

What are Held-To-Maturity Securities?

Answer 11

Investments in bonds and other debt instruments that the investor has the ability and intent to hold until the due date for repayment. (if principal is paid in installments, the principal that will be paid within the next year or operating cycle, is classified as a current asset)

Question 12

Which section do Trading Securities fall on the Statement of Cash Flows?

Answer 12

Operating activities (purchase or sale)

Question 13

Where on the Balance Sheet are Trading Securities reported?

Answer 13

Usually as a current assets under temporary term investments (trading securities) - Initially recorded at cost, but carried at Fair Market Value

Question 14

Where do you recognize unrealized or realized gains/loss including any dividends or interest income for Trading Securities?

Answer 14

On the income statement as a part of non-operating income under Interest Income which is a component of income from continuing operations

Question 15

Which section do Trading Securities fall on the Statement of Cash Flows?

Answer 15

Operating activities (purchase or sale)

Question 16

Where on the Balance Sheet are Available for Sale Securities reported?

Answer 16

Current/non current and at FMV

Question 17

Where do you recognize unrealized gains/loss for Available for Sale Securities?

Answer 17

In the Stockholder’s Equity section under Accumulated Other Comprehensive Income on the Balance Sheet

Question 18

Where do you recognize realized gains/loss for Available for Sale Securities?

Answer 18

On the income statement as a part of non -operating income under Interest Income

Question 19

Which section do Available for Sale Securities fall on the Statement of Cash Flows?

Answer 19

Investing activities

Question 20

Where on the Balance Sheet are Held-To-Maturity Securities reported?

Answer 20

On the Balance Sheet as a non current asset at amortized cost
* would move to current asset section the year that it matures

Question 21

Where do you recognize realized gains/loss for Held-To-Maturity Securities?

Answer 21

On the income statement as a part of non -operating income under Interest Income which is a component of income from continuing operations

Question 22

Which section do Held-To-Maturity Securities fall on the Statement of Cash Flows?

Answer 22

Investing activities

Question 23

How should you handled any Reclassifications between Trading securities to AFS?

Answer 23

Reclassify at FMV and the difference will be classified as a realized gain/loss. You must eliminate any related valuation allowance account.

Question 24

How should you handle any re-classifications between HTM to AFS securities?

Answer 24

Reclassify to FMV and record in Other Comprehensive Income

Question 25

What happens when an AFS investment is sold?

Answer 25

The difference between the cost and the proceeds is treated as a realized gain/loss. Any allowance account is ignored and adjusted to the new target balance without the security that was just sold, unless it is the last investment, in which case the allowance account and the unrealized gain/loss must be eliminated.

Question 26

True of False: HTM investments are subject to impairment loss?

Answer 26

True.

HTM investments are subject to impairment loss if the investor has reason to believe that the issuer of the debt security would not make all principal and interest payments as scheduled.

Question 27

True of False: AVS investments are subject to impairment loss?

Answer 27

True.

They are impaired when there is a decline in value that is considered other than temporary (permanent).

Although the investment will already be written down to its market value at the B/S date, the portion of the unrealized loss that represents the non temporary decline will be recognized in income.

Question 28

When is an AVS security considered impaired?

Answer 28

They are impaired when there is a decline in value that is considered other than temporary (permanent).

Question 29

When is an investment considered to be impaired?

Answer 29

If the Fair value is less than its cost

Question 30

What is the 2-step process to determine if a decline in value is other than temporary?

Answer 30

1. Determine whether an investment is impaired.

2. Evaluate whether an impairment is other than temporary (permanent).

Question 31

If an entity elects to use fair value option for AFS security then where should any unrealized gains/losses be recognized?

Answer 31

Income Statement

Question 32

In the accounting treatment (debit/credit to what accounts) for unrealized gains on AFS securities, how are the gains recognized?

Answer 32

Unrealized gains are recognized with a debit (increase) to the investment and a credit (increase) to other comprehensive income (OCI).

OCI is closed into accumulated other comprehensive income (AOCI), a stockholders’ equity account on the balance sheet, which has a balance equal to the cumulative net unrealized gain or loss on the securities since acquisition.

Question 33

In the accounting treatment (debit/credit to what accounts) for unrealized losses on AFS securities, how are the losses recognized?

Answer 33

Unrealized losses are recognized with an entry crediting the investment and debiting OCI.

OCI is closed into accumulated other comprehensive income (AOCI), a stockholders’ equity account on the balance sheet, which has a balance equal to the cumulative net unrealized gain or loss on the securities since acquisition.

Question 34

A marketable debt security is transferred from trading securities to securities available for sale. At the transfer date, the security’s cost exceeds its market value. What amount is used at the transfer date to record the security in securities available for sale?

Answer 34

When investments in marketable debt securities are transferred between the trading and available for sale categories, the transfer is always recorded at the fair market value of the securities on the date of the transfer

Question 35

In 20X2, Gem Corp, which prepares its financial statements in accordance with IFRS, made a $125,000 investment in marketable equity securities. The securities are not held for trading and Gem has elected to recognize changes in fair value in other comprehensive income rather than profit or loss. At December 31, 20X2, the investment had a fair value of only $95,000 and it was determined that it was required to recognize an impairment loss in income. At December 31, 20X3, the investment had a market value of $140,000. At what amount will the investment be reported on the balance sheet and how will the change be recognized by Gem?

Answer 35

The investment will be reported at $140,000 and $30,000 will be recognized in profit or loss and $15,000 will be reported in other comprehensive income.

When an investment for which changes are recognized in OCI increases in fair value, any previously recorded impairment losses are reversed. Any remaining increase is reported in OCI. Gem would have recognized an impairment loss of $30,000 in 20X2. In 20X3, the investment would be increased to its fair value of $140,000, representing a $45,000 increase. The loss of $30,000 would be reversed, resulting in a $30,000 gain in profit or loss. The remaining $15,000 is recognized in OCI.

Question 36

In year 1, a company reported in other comprehensive income an unrealized holding loss on an investment in available-for-sale securities. During year 2, these securities were sold at a loss equal to the unrealized loss previously recognized. The reclassification adjustment should include which of the following?

Answer 36

The unrealized loss should be credited to the other comprehensive income account.

When an available-for-sale investment is sold, the net amount of any unrealized gains and losses that had been reported in other comprehensive income must be eliminated. Since there had been an unrealized loss, which would result in a debit balance in accumulated other comprehensive income, it is eliminated with a credit to other comprehensive income.

Question 37

What is the amount paid for a bond that is purchased between interest dates?

Answer 37

It is the FMV which is the carrying value at the purchase date, plus interest accruing from the last interest date to the date of purchase.

When a bond is purchased between interest dates, the amount paid will be the fair market value of the bond, (which will be the carrying value at the purchase date, plus interest accruing from the last interest date to the date of purchase). The CARRYING amount excludes the interest and will be lower than the amount of cash paid.

Question 38

What is the carrying amount (more or less) of a bond that is purchased at a discount?

Answer 38

The carrying value would be LESS that the face value of the bond.

When a bond is purchased at a discount, the carrying value will be lower than the face amount of the bond.

Question 39

Is the CARRYING amount more or less of the amount paid to a seller, if the bond was purchased between interest dates and at a discount?

Answer 39

The carrying amount would be LESS than the cash paid to a seller and LESS than the face amount of the bond.

Question 40

nformation regarding Pinn, Inc.’s noncurrent investments in marketable debt securities available for sale at December 31, 20X1 and 20X0, follows:

20X1 20X0
Cost  $275,000  $350,000
Allowance for decline in value  $37,000  $25,000
 

What amount should Pinn report in its December 31, 20X1, balance sheet as the net unrealized loss on noncurrent marketable debt securities?

Answer 40

The net unrealized loss to be reported on the balance sheet is the same amount as the allowance for decline in value ($37,000 for 12/31/20X1).

Question 41

A marketable debt security is transferred from trading securities to securities available for sale. At the transfer date, the security’s cost exceeds its market value. What amount is used at the transfer date to record the security in securities available for sale?

Answer 41

When investments in marketable debt securities are transferred between the trading and available for sale categories, the transfer is alwasy recorded at the FMV of the securities on the date of the transfer. Any difference is treated as a REALIZED gain/loss.

Question 42

Antonio Corp. has a portfolio of marketable debt securities that it does not intend to sell in the near term. Antonio elects the fair value option for reporting its financial assets in accordance with ASC 825 (SFAS 159). How should Antonio classify these securities, and how should it report unrealized gains and losses?

Answer 42

Classify as AFS, report as a component of income from continuing operations on the I/S

Question 43

Reconciliation for Bank statement balance to book balance:

Answer 43

Bank Balance
+ Deposits in Transit
- Outstanding Checks
+/- Errors made by the bank

= Corrected Book Balance

Question 44

Reconciliation for book balance to Bank statement balance:

Answer 44

Book Balance
+ Amounts collected by bank
- Unrecorded bank charges
+/- Errors made by the bank

= Corrected Bank Balance

Question 45

How should you handle any re-classifications between AFS to HTM securities?

Answer 45

Unrealized holding gain/loss is reported on the B/S as part of comprehensive income and amortized over the remaining life.

***The difference between the cost of the investment and the FMV at the date the security is reclassified is what gets recorded