Chapter 17 Quiz

equity method is intended for what type of shares?

shares that will be held indefinitely

How to record sale of investment

(1) Accrue Interest; (2) Get the asset and related account off the books; (3) Get the unrealized gain or loss off the books; and (4) Record any necessary realized gain or loss from the sale. You can do this in two entries (like the book) or as one entry.

equity method

20-50% where the firm holds significant influence over the firm whose shares they own. No fair value adjustments, but rather use income to change the value of the investment.

things to consider in balance sheet

A L E

Neither HTM nor T. This means the firm is not sure what it will do, or it (at least) plans to hold it beyond the near term.

Available for Sale

For a firm to impair an investment, it must conclude that the change in what?

fair value has PERMANENTLY fallen below the carrying value

no intent to sell before maturity

Held-to Maturity

Similarities between IFRS and U.S. GAAP (4)

IFRS and U.S. GAAP similarly classify financial assets, including investments. HTM debt securities (held-for-collection under IFRS) are both accounted for using amortized cost. Both IFRS and GAAP allow amortized cost and fair value accounting depending on the investment classification. Their definitions are the same. Both IFRS and GAAP require the equity method with a general guideline of 20 percent ownership.

Differences between IFRS and U.S. GAAP

IFRS does not include an available-for-sale classification for debt investments. They only permit held for collection (similar to HTM) and trading. Under GAAP, changes to fair value for equity securities are reported under net income. IFRS permits non-trading equity securities to report changes in fair value under other comprehensive income.

passive def

Less than 20% of outstanding shares where the firm may actively trade the shares. Fair value adjustments where gains and losses go on the income statement.

Does the firm's assumption affect the "real" profits the firm is able to earn from its investing activities?

No; real profits are cash transaction

consolidation

Over 50% where the firm controls the investee. The firm consolidates all financial statement items from the subsidiary into its own financial statements. We will not cover this type of investment in this class.

the only negative is PV

PV

Why do you think something like AOCI causes debate amongst accountants?

The debate revolves around what makes accounting information "useful." Since AOCI is largely misunderstood some argue that including makes accounting information less useful... while others, prefer AOCI because when properly understood makes accounting information more useful.

Held primarily with the intent to sell in the near term

Trading (T)

Does the equity method allow (or force depending on your thought) firms to accurately reflect the change in the value of the investment?

Yes. It does because the value lies in the influence and the ability to pay a dividend.

the only thing that increases the value of the investment is the investees

ability to pay a dividend

why is it easier to impair equity securities than debt securities?

b/c the criteria is less stringent. And debt securities the company would have top conclude that the investee is going to default on the debt which is unusual.

Companies may transfer securities from one what?

category to another - most often between HTM, AFS, and Trading.

unrealized holding gain or loss is a permanent what account?

equity

Why don't we have HTM securities for equity investments?

equity maturities do not mature

How do we measure influence under GAAP? Do you think this is appropriate?

idk yet

things to consider in income statement

op non op OCI

2 types of categories that exist for equity securities

passive equity method

AFS securities are those investments that are neither HTM nor trading. We do make fair value adjustments to AFS securities, however, the unrealized gains and losses do not show up on the income statement. Instead, they show up as part of accumulated other comprehensive income (part of the firm's earned equity, but not part of retained earnings).

true

As the book points out, when a firm has significant influence (but not control) over another company through its equity holdings, GAAP requires that the firm uses the equity method.

true

HTM securities are those debt securities with intent to hold the security until it matures. The firm does not use fair value for these securities, but rather uses amortized cost, which is very similar to how a firm accounts for bonds that it issues.

true

If a firm sells shares, it should consider reclassifying the investment to either AFS or Trading.

true

In some ways equity securities are much easier to account for than debt securities. You don't have to worry about amortization or recording an interest expense (Nice!). However, unlike debt securities, the relative influence a firm has through its equity investment will determine how the firm accounts for the investment.

true

Just like HTM and AFS securities, trading securities are amortized while they are held. They are typically held for a very short amount of time, so many times this amortization is short-lived. However, unlike HTM and AFS securities, any unrealized gains and losses are reported on the firm's income statement. Other than that, the treatment is very similar.

true

Passive equity securities include fair value adjustments where unrealized gains and losses are captured as part of net income (similar to trading debt securities).

true

Regardless of your like or dislike of AOCI, it is used as part of our accounting for AFS securities Unlike HTM securities, the firm must do FYE fair value adjustments as necessary.

true

Temporary fluctuations in price do not require an impairment and should not be recorded as an impairment.

true

You should also note that periodic fair value adjustments do partially alleviate the need for any large impairments. This may not be the case with HTM securities or investments where the equity method is being used.

true

debt securities are what the firm BUYS, not debt the firm issues.

true

for equity method there's no FVA adjustments only investment income adjustments. And when a supplier declare and pays a cash dividend you don't record dividend revenue, you record equity investment in the credit slot.

true

remember there's a gain or loss/ and record Int Rev when you sale stuff

true

trading securities unrealized holding gain or loss is an income account, and only shows up on the income statement non op section ALSO when you sell trading securities you don't record an unrealized holding gain or loss- income either ALSO for portfolios problems remember to look at the table displaying the numbers to get the right journal entries

true

when looking at a portfolio, record Equity investments at cost not FVA

true

when you sell trade securities, you have to remember if time has passed in order to get the Int Rev you have to multiply the bond yield by the previous CV of the DI times the amount of months that has passed

true

work all the problems

true

Ultimately, the firm's assumption about real profit only determines what?

when gains and losses are recorded and how they are classified and they affect timing/classification.

what does the equity method focus on?

• Income increases the value of the investment since the book value of the shares owned by the firm increase. The firm recognizes the income when the ability to pay a dividend changes. • Dividends decrease the value of the investment since the book value of the shares owned by the firm decrease. The firm has already recorded the "income" before. The firm has not incurred a loss b/c they received cash. However, the value of the investment is lower b/c the investee is now less able to pay a future dividend. The firm simply exchanged one type of asset (investment) for another (cash).

impairment highlights

• It is "easier" to impair equity securities than debt securities b/c the criteria is less stringent. For debt securities the company would have to conclude that the investee is going to default on the debt. This is unusual. • For a firm to impair an investment, it must conclude that the change in fair value has PERMANENTLY fallen below the carrying value. Temporary fluctuations in price do not require an impairment and should not be recorded as an impairment. • You should also note that periodic fair value adjustments do partially alleviate the need for any large impairments. This may not be the case with HTM securities or investments where the equity method is being used.

Transfers key ideas

• Record the new category at the current fair value. • Remove the old category using the carrying value. • Record any necessary unrealized gains or losses for the difference.

HTM steps

• The firm records the investment at the acquisition cost. If acquired above the face value, there is an implicit premium (although not a separate account). If acquired below face value, there is an implicit discount (although not a separate account). • The firm amortizes the premium or discount (directly to the debt security account) as there is a difference between cash received and interest revenue. • If the security is sold before it matures, the firm may record a gain or loss.