Chapter 12 Notes

Realized gain or loss

A _____ for the difference between carrying value and the cash received from selling an equity investment is included in net income.

Concern

A _____ with fair value accounting is that management has much discretion over fair values and may not be able to estimate fair values accurately.

Fair value

A benefit of _____ accounting is that it prevents managers from timing the sale of investments to recognize gains or losses in particular accounting periods.

Note

A transfer of a security between reporting categories is accounted for at fair value and in accordance with the new reporting classification.

Trading securities

Actively managed in a trading account for the purpose of profiting from short-term price changes

Equity

All _____ investments are recorded initially at cost.

Cost

All investment securities are initially recorded at _____

"Other-than-temporary"

An _____ impairment loss is recognized in net income even though the security hasn't been sold.

Investee

As the _____ earns additional net assets, the investor's investment in those net assets increases.

Dividends

As the investee distributes net assets as _____, the investor does not recognize revenue. Rather, the investor's investment in the investee's net assets is reduced.

Fair Value

Available-for-sale (AFS) are carried in Balance Sheet at

Effective Interest Method

Calculates interest revenue as the market rate of interest multiplied by the outstanding balance of the investment

Fair value option

Choosing the _____ for HTM and AFS investments means accounting for them like trading securities.

Discount on bond investments

Contra-asset account; reduces the carrying value of the bond to its cost at date of purchase

Other comprehensive income

Current period holding gains or losses

OTT - Other than temporary

Debt impairments are OTT if the investor: (A) intends to sell the investment, or (B) believes it is more likely than not that they will sell the investment prior to fair value recovery, or (C)has suffered a credit loss.

Higher than

During the current period, Muenster Company amortized $5,000 of discount relating to its investment in debt securities. The company's amortization next period should be _____ the current period

Lower than

During the current period, Muenster Company amortized $5,000 of premium relating to its investment in debt securities. The company's amortization next period should be _____ the current period

Note

For AFS investments, unrealized holding gains and losses from fair value changes are recorded up to the date an investment is sold

Equity method

For an equity investment, when an investor owns enough stock to "significantly influence" an investee but does not control it, the investor uses the __________ of accounting, which ignores fair value changes but includes a portion of the investee's income in the investor's income

Note

For trading securities, unrealized holding gains and losses from fair value changes are recorded up to the date an investment is sold.

Amortized Cost

Held-to-maturity is carried in Balance Sheet at

Debt Investments

Held-to-maturity, trading, or available-for-sale

OTT - Other than temporary

If a debt impairment is OTT: • Investment is written down to fair value. • If OTT because of 2a or 2b, all of the OTT impairment loss is recognized in net income. • If OTT because of 2c, only the credit loss is recognized in net income; noncredit loss in OCI.

Unrealized holding gains or losses

If all of the _____ have been included in net income, no additional gain or loss is recognized.

Fair value option

If the _____ is chosen for investments otherwise accounted for by the equity method, the amount that is reported at fair value is clearly indicated.

Fair value

If the _____ of purchased inventory exceeds its book value, we usually assume the inventory is sold in the next year and reduce investment revenue in the next year by the entire difference.

Discount

If the bond's stated rate is lower than the market rate, then investors are willing to purchase the bond only at an amount less than its maturity value (so it's sold at a _____)

Premium

If the interest rate paid by the bond (the stated rate) is higher than the market rate, investors are willing to purchase the bond for more than its maturity value (so it's sold at a _____)

An unrealized holding gain

If the market rate of interest decreased after a bond is purchased, the bond incurs...

Rises; Unrealized holding gain

If the market rate of interest falls after a bond is purchased, the market will calculate the present value of the cash flows provided by the bond using that lower rate, so the fair value of the bond _____ (aka _____).

Falls; Unrealized holding loss

If the market rate of interest rises after a bond is purchased, the market will compute the present value of the cash flows provided by the bond using that higher discount rate, so the fair value of the bond _____ (aka _____).

Held-to-maturity

Ignore most fair value changes

Available-for-sale investments

Include fair value changes only in other comprehensive income until the debt investment is sold

Trading securities appear in the financial statements as follows:

Income Statement and Statement of Comprehensive Income: For trading securities, gains and losses are included in the income statement in the periods in which fair value changes, regardless of whether they are realized or unrealized. Investments in trading securities do not affect other comprehensive income. Balance Sheet: Investments in trading securities are reported at fair value, typically as current assets. Cash Flow Statement: Cash flows from buying and selling trading securities typically are classified as operating activities, because the financial institutions that routinely hold trading securities consider them as part of their normal operations.

AFS securities appear in the financial statements as follows:

Income Statement and Statement of Comprehensive Income: Gains and losses are shown in OCI in the periods in which changes in fair value occur. Those amounts are reclassified out of OCI and recognized in net income in the periods in which securities are sold. Balance Sheet: Investments in AFS securities are reported at fair value. Unrealized holding gains and losses become part of AOCI in shareholders' equity, and are reclassified out of AOCI in the periods in which securities are sold. Cash Flow Statement: Cash flows from buying and selling AFS securities typically are classified as investing activities.

HTM securities appear in the financial statements as follows:

Income Statement and Statement of Comprehensive Income: Realized gains and losses are shown in net income in the period in which securities are sold. Unrealized holding gains and losses are disclosed in the notes to financial statements. Investments in HTM securities do not affect other comprehensive income. Balance Sheet: Investments in HTM securities are reported at amortized cost. Fair values of those investments are disclosed in the notes to financial statements. Cash Flow Statement: Cash flows from buying and selling HTM securities typically are classified as investing activities.

DR: Reclassification adjustment - OCI CR: Fair value adjustment (account balance)

Journal entry to - Step 2 Reverse Previous Fair Value Adjustments for AFS investments

DR: Fair value adjustment CR: Unrealized holding gain on AFS investments - OCI

Journal entry to record change in fair value adjustment and corresponding unrealized holding gain for AFS securities

DR: Fair value adjustment CR: Unrealized holding gain on trading securities - NI

Journal entry to record the fair value adjustment and the corresponding unrealized holding gain - Step 1 Adjust Trading Securities to Fair Value

DR: Fair value adjustment CR: Unrealized holding gain on AFS investments - OCI

Journal entry to record the gain on AFS investments - Step 1 Adjust AFS Investments to Fair Value

Structure

Managers may _____ equity investments to qualify for their preferred accounting approach.

Accumulated other comprehensive income

Net fair value adjustments to date - net holding gains and losses to date

Net income

Realized gains and losses from the sale of AFS securities

DR: Cash DR: Discount on bond investment (account balance) CR: Investment in bonds (account balance) CR: Fair value adjustment (account balance)

Record Sale of Trading Security Transaction

DR: Cash DR: Discount on bond investment (account balance) CR: Investment in bonds (account balance) CR: Gain on AFS investments - NI (to balance)

Record the Sale Transaction of an AFS investment

DR: Investment in bonds (face amount) CR: Discount on bond investment (difference) CR: Cash (Price paid for the bonds)

Recording the Purchase of a Debit Investment with Discount

DR: Investment in bonds (face amount) DR: Premium on bond investment (difference) CR: Cash (Price paid for the bonds)

Recording the Purchase of a Debit Investment with Premium

DR: Cash (Stated rate x face amount) DR: Discount on bond investment (difference) CR: Interest revenue (market rate x outstanding balance)

Recording the interest received on an investment with discount

DR: Cash (Stated rate x face amount) CR: Premium on bond investment (difference) CR: Interest revenue (market rate x outstanding balance)

Recording the interest received on an investment with premium

Carrying amount

The _____ of the investment is its initial cost plus the investor's equity in the undistributed earnings of the investee.

FASB's

The _____ ongoing financial instruments project is expected to lead to a consistent framework for accounting for all financial instruments.

Equity method

The ______ is used when an investor can't control, but can significantly influence, the investee.

Opposite

The fair value of a fixed-rate investment moves in the _____ direction of market interest rates.

Present value of future cash receipts

The price of a bond is equal to the _________ of future cash receipts.

Accounted for

The way an investment is _____ affects net income, investment book value, and the amount of gain or loss recognized when the investment is sold.

Fair value

Trading securities are adjusted to their _____ in each reporting period

Fair Value

Trading securities are carried in Balance Sheet at

Differences between trading securities and HTM investments

Trading securities are written up or down to their fair value, or "marked to market", in the balance sheet. (HTM securities are kept at amortized cost.) Corresponding unrealized holding gains and losses on trading securities are included in net income in the income statement. (HTM securities do not include unrealized holdings gains and losses in net income.)

Recognized in other comprehensive income, and therefore in accumulated other comprehensive income in shareholders' equity

Treatment of Unrealized Holding Gains and Losses for Available-for-sale (AFS)

Not recognized

Treatment of Unrealized Holding Gains and Losses for Held-to-maturity (HTM)

Recognized in net income, and therefore in retained earnings as part of shareholder's equity

Treatment of Unrealized Holding Gains and Losses for Trading Securities

Equity method

Under the _____, the investor recognizes on its own income statement its proportionate share of the investee's income.

Effective Interest Method

Under the __________, interest for a period equals the market rate of interest when the debt was purchased multiplied the outstanding balance of the debt at the beginning of the period

Net income

Unrealized holding gains and losses for trading securities are included in _____ in the period in which fair value changes

Held-to-maturity (HTM)

Used for debt for which the investor has the "positive intent and ability" to hold to maturity

Available-for-sale (AFS)

Used for debt that does not qualify as held-to-maturity or trading

Trading (TS)

Used for debt that is held in an active trading account for immediate resale

Control

Usually an investor can _____ the investee if it owns more than 50% of the investees voting shares.

Significant influence

Usually an investor can exercise _____ over the investee when it owns at least 20% of the investee's voting shares.

Notes

When a trading security is sold, all of the gain or loss already has been included in net income, so no additional gain or loss is recognized.

Note

When an AFS investment is sold, accumulated unrealized gains and losses are removed from AOCI using a reclassification entry

Note

When an AFS investment is sold, realized gains and losses are included in net income

Equity investments

_____ are adjusted to their fair value at each reporting date.

Derivatives

_____ are financial instruments that "derive" their values from some other security or index.

Debt impairments

_____ can be divided into credit losses and noncredit losses

Consolidated financial statements

_____ combine the individual elements of the parent and subsidiary statements.

Dividends

_____ received for equity investments are included in income.

Depreciation

_____: The investor adjusts its share of the investee's net income to reflect revenues and expenses associated with differences between the fair value and book value of the investee's assets and liabilities that existed at the time the investment was made.

Credit losses

______ are due to anticipated reductions in cash flows from the debt investments; all other are noncredit losses.