Marketable Securities Flashcards
What are the types of marketable securities?
- Trading securities (HFT - Held for Trading)
- Available-for-sale securities (AFS/AVS)
- Held to maturity securities (HTM)
Assume you own 0-20% of stocks (Cost method of accounting)
Trading Securities (HFT)
HFT - Held for Trading; are investments in equity instruments, such as stocks, options, rights warrants or debt instruments, such as bonds, which the investor has acquired in an attempt to make profits by buying and selling within a short period of time. These are normally classified as current assets.
- recorded at cost when acquired
- purchased for the purpose of generating profits from resale, they are a form of inventory and transactions are normally reported in the operating activities of the statement of cash flows
- carrying values of the securities are adjusted to market price on a continuous basis.
- current asset on the B/S if operating and noncurrent if investing
- include both debt and equity securities (bonds & stocks)
- initially recorded at cost, but carried at FMV (ASC 320)
- any unrealized gains and losses (temporary) appear on the income statment
- realized gains and losses are always on the income statement along with interest and dividend income
- according to FASB ASC 320, trading securites can be classified as either operating or investing cash flows based on the nature and purpose for which the securities were acquired. If current, normally operating.
Class Example:
Purchase Price, 1/1/x1 $100
FMV, 12/31/x1 140
FMV, 12/31/x2 90
To Purchase:
Investment in trading securites $100
Cash $100
FMV at 12/31/x1
either increase investment account or set up valuation allowance account
Market Adjustment (B/S) 40
Unrealized Gain (I/S) 40
FMV at 12/31/x2
Unrealized Loss (I/S) 50
Market Adjustment (B/S) 50
NOTE: the I/S effect in x1 is $40 and in x2 is ($50). These amounts represent the current year effectsonly since they are both income statement items.
Available for Sale Securities (AFS/AVS)
- AFS securities are similar to trading securites in that they are likely to be sold some day, and since they are marketable, changes in market price are reflected on the B/S on a continuous basis.
- Since they were not, however, purchased primarily to gain short-term profits from resale, they are not considered to be inventory, and purchases and sales are reported in investing activites.
- Also fluctuations in price are not reported in net income until the securities are sold.
- Instead, they are considered part of OCI, and are reported directly in stockholders’ equity immediately below retained earnings in a section called “accumulated other comprehensive income.”
AFS securities are either debt or equity securites that don’t fall into the other two categories.
- current or noncurrent (if holding period is indefinite, assume noncurrent)
- include both debt and equity securites
- initially recorded at cost, but carried at FMV (ASC 320)
- any unrealized gains and losses appear on the balance sheet as part of Comprehensive income in the stockholder’s equity section. The cumulative amount is called accumulated other comprehensive income
- the acquisition and disposal of AFS investments is an investing activity on the statement of cash flow.
Class Example:
Purchase Price, 1/1/x1 $100
FMV, 12/31/x1 140
FMV, 12/31/x2 90
To Purchase:
Investment in AFS securites $100
Cash $100
FMV at 12/31/x1
either increase investment account or set up valuation allowance account
Market Adjustment (B/S) 40
Unrealized Gain (B/S) 40
UNREALIZED GAIN IS ON B/S NOT I/S AS FOR HTS
FMV at 12/31/x2
Unrealized Loss (B/S) 50
Market Adjustment (B/S) 50
UNREALIZED LOSS IS ON B/S NOT I/S AS FOR HTS
<strong>NOTE: The unrealized gain in x1 is $40 called OCI, and in x2 $(50), however, the net unrealized loss in x2 on the B/S is only $10. Since it is a B/S account, we are concerned with the cumulative balance; this amount is called “accumulated other comprehensive income”</strong>
Sale of Available for Sale (AFS) Security
When the investment in AFS is sold, the difference between the cost and the proceeds is treated as a realized gain/loss. Ignore the allowance account and adjust to the new target balance without the security that was just sold, unless it is the last investment, then the allowance and the unrealized gain/loss must both be eliminated.
- subject to impairment loss
- they are impaired when there is a decline in value that is considered “other than temporary”
- although the investment will already be written down to its market value at the balance sheet date, the portion of the unrealized loss that represents the nontemporary decline will be recognized in income.
- The amount will be the difference between the investment’s original cost and the declined value from which it is not expected to recover.
- That amount will be reclassified out of other comprehensive income and recognized as a loss in calculating net income.
- Once written down, recoveries will not be recognized.
- The security is written down to FMV
- The loss is treated as a realized loss on the income statement and the remaining balance is considered to be the new cost.
- Loss (I/S) X
- Investment in AFS X
AFS – What does the 2 step process consist of?
A 2 step process is applied to determine if a decline in value is other than temporary, requiring an adjustment:
- Step 1 - Determine whether an investment is impaired
- If the Fair Value is less than its Cost, the investment is considered to be impaired
- Step 2 - Evaluate whether an impariment is Other-Than-Temporary
Approaches in determining if an impairment is Other - Than-Temporary is different for equity securites and debt securties.
- For Investments in equity securities, indications that an impairment is other than temporary include a series of operating losses, or the inability of an investee to maintain an earnings capacity that is sufficient to justify the carrying value.
- If the investor intends to sell the investment before it recovers in value, an imparitment is considered nontemporary and recognized in the period in which the decision is made to sell the investment
- If the investor does not intend to sell the investment, the loss is recognized in the period in which the loss that is considered nontemporary occurs.
- For Debt Securities: If the entity intends to sell the security, a nontemporary loss is considered to have occured
- If the entity does not intend to sell the secuirty, a nontemporary loss will be recognized if it is more likely than not that the entity will be equired to sell the security before the value is recovered or if the present value of the amount expected to be recovered is less than the carrying value.
If a decline is determined to be other than temporary, the amount of loss will be:
- For equity securites, the difference between the fair value at the balance sheet date and the cost of the investment.
- For debt securities
- If the investor expects to sell, or to be required to sell the security before recovery, the difference between the fair value at the balance sheet date and the amortized cost.
- If the investor does not expect to sell, or be required to sell the security before recovery, a portion of the loss attributable to credit factors will be recognized in earnings and the remainder, attributable to other factors, will be recognized in OCI.
To write down the investment for other than non-temporary:
Realized Loss 20
Investment 20
rather than Unrealized Loss and Allowance for investment…. Do not write up the investment if investment goes up just continue to do the FMV as discussed earlier.
Reclassifications between Trading and AFS
Securities may be reclassifed from one of the categories to another, and the accounting approaches vary depending on the old and new classifications. The approach is to treat the securities as if they are being sold from the portfolio they are leaving, then repurchased at the current market price into the portfolio they are entering. In other words, current market price is used to determine the transfer.
- Reclassify at FMV
- The difference is treated as a realized gain/loss on the income statement
- Eliminate any related valuation allowance accounts.
Reclassification between HTM and AFS
Securities may be reclassifed from one of the categories to another, and the accounting approaches vary depending on the old and new classifications. The approach is to treat the securities as if they are being sold from the portfolio they are leaving, then repurchased at the current market price into the portfolio they are entering. In other words, current market price is used to determine the transfer.
- Reclassify at FMV
- If HTM to AFS then record in OCI
- If AFS to HTM then the unrealized holding gain/loss is reported on the B/S as a part of Comprehensive Income and amortized over the remaining life of the security.
In some circumstances, an investment that may have been accounted for as AFS will qualify for accounting under the equity method.
For example, assume an investor has an ivestment in a marketable equity security that is accounted for as an available for sale security. The investment was obtained at a cost of $1,200,000 in 20x1 and had a fair value of $1,350,000 as of the end of 20x1. The increase in value of $150,000 represents an unrealized holding gain that will have been recognized with an increase or decrease to the investment and the recognition of a corresponding unrealized gain or loss in comprehensive income.
The entry to record the acquisition would be
20x1 Invest in AFS 1,200,000
Cash 1,200,000
At the end of 20x1, investment was worth $1,350,000
12/31/x1 Invest in AFS 150,000
Unrealized gain 150,000
unrealized gain would be reported as a component of OCI and closed in the equity account entitled accumulated other comprehensive income “AOCI”
12/31/x1 Unrealized Gain 150,000
AOCI 150,000
Assume that in 20x2 the investor become an member of the BOD and had ability to significantly influence the investee which allowed for equity method of accounting. Since no additional investment had been made, the investment would be reclassifed from and AFS to an equity investment. In addition, the unrealzied gain that had been recognized in the privous period would be reclassifed from AOCI and reported in current periods earnings.
20x2 AOCI 150,000
Gain due
to increase in value of investment 150,000
Held to Maturity (HTM)
- bonds the company has both the intent and ability to hold until maturity
- initially recorded at cost and the difference between the cost and maturity value is amoritized over the life of the security, using the effective rate method discussed in the bond section.
- straight-line method may be used if it doesn’t materially differ
- interest income is recognized in each period
Since HTM securities are not going to be sold, fluctuations in market price are ignored, and they are always carried at the amortized cost.
In the rare cases where these securites are not held to maturity (such as when the issuer exercises a call provision compelling the investor to redeem them early), an ordinary gain or loss on disposal results. Purchases and sales (redemptions) of these securites are investing activities on the statement of cash flows.
- non-current, unless maturity date is less than one year from the balance sheet date.
- bonds only (no stocks)
- record at cost
- Carry at amoritzed cost (face net of unamortized discount or premium)
- unrealized gain/losses - NA
- realized gains/losses shouldn’t happen but could
- report interest income net of amoritzaton on the income statement
- investing activity on the statement of cash flows
- considered HTM if sale occurs after at least 85% of principle has been collected.
Marketable Securites Overview
Fair Value Accounting Option (ASC 825)
- allows an entity to value various eligible items at fair value at certain dates, referred to as election dates
- fair value option can be elected on an instrument by instrument basis. Electing the fair value option for a particular instrument does not require elections for a similiar instruent held by the same entity.
- once the fair value option is elected, it is irrevocable until a subsequent election date
- some of the specific applications of the fair value option include the following:
- an investment accounted for under the equity method would be reported at fair value o each balance sheet date, increases or decreases will be recognized as unrealized gain/loss on I/S and dividends received will be recognized as income.
- AFS securities will be reported on the fair value on each balance sheet date, as already requried. Unrealzied gain/losses are reported as a component of net income, however, instead of OCI (so on I/S rather than B/S and treated as trading securities)
- Trading securites are not affected
- HTM securities continue to be accounted for at amortized cost, recognizing interest income unther the effective interest method. In addition the carrying value is adjusted to fair value on the B/S date with the increae recognized as a component of net income
ON TIDE N OC
Operating Income
Non-operating Income
Taxes
Income from continuing operations
Discontinued operations
Extradinory
Net Income
Other Comprehensive Income
Comprehensive Income
Reclass between HTM to AFS
Reclassify at FMV
If HTM to AFS then record in OCI
Reclass between AFS to HTM
- Reclassify at FMV
- If AFS to HTM then the unrealized holding gain/loss is reported on the B/S as a part of Comprehensive Income and amortized over the remaining life of the security.
Investments in Financial Instruments under IFRS
- IFRS doesn’t classify financial instruments as HTM, AFS,etc but rather as financial assets or financial liablities.
- IFRS defines a financial instrument as any contract that results in a financial asset of one entity and a financial liabiity or equity instrumet of another entity.
- Financial asset and liabilites are not recognized until an entity becomes a party to the contract that results in them.
- Financial assets are generally measured at fair value through profit or loss (FVTPL). When measured at FVTPL, increases or decreased in fair value are reported as gains or losses on the statment of operations (I/S).
Financial Assets (under IFRS)
A financial assets is
- Cash
- an equity instrument of another entity
- a contractual right:
- To receive cash or another finanical asset from another entity; or
- to exchange financial assets or financial liablities with another entity on potentially favorable terms
- a contract that will be settled in the entity’s own equity instruments
