ACC 310 ch 12

Define a financial instrument. Provide three examples of current liabilities that represent financial instruments.

A financial instrument is defined as cash, evidence of an ownership interest in an entity, or contracts.

What is "comprehensive-income?" Its composition varies from company to company, but may include which investment-related items that are not included in net income?

Changes in shareholder equity that consists of net income and all other changes in equity that do not arise from transactions with owners (OCI). All-for-sale securities gains and losses are included in OCI

All investments in debt securities and investments in equity securities for which the investor lacks significant influence over the operation and financial policies of the investee are classified for reporting purposes in one of three categories, and can be accounted for differently depending on the classification. What are these three categories?

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

Does GAAP distinguish between fair values that are readily determinable from a securities exchange versus those needing to be calculated based on the company's own assumptions? Explain how a user will know about the reliability of the inputs used to determine fair value.

If the fair value of an equity security is not readily determinable, GAAP requires that companies use the cost method. A user will know about the reliability of the inputs used to determine fair value if the security is traded on particular securities exchanges or over-the-counter markets.

Why are holding gains and losses treated differently for trading securities and securities available-for-sale?

Including in net income unrealized holding gains and losses on AFS investments make income appear more volatile than it is.

Is it necessary for an investor to report individual amounts for the three categories of investments - held-to-maturity, available-for-sale, or trading - in the financial statements? What information should be disclosed about these investments?

No, but they should be disclosed in the disclosure notes. The aggregate fair value, gross realized and unrealized gains and losses, change in net unrealized holding gains and losses, and amortized cost basis by major security type should be disclosed for each of these investments.

When market rates of interest rise after a fixed-rate security is purchased, the value of the now-below-market, fixed-interest payments decline, so the market value of the investment falls. On the other hand, if market rates of interest fall after a fixed-rate security is purchased, the fixed-interest payments become relatively attractive, and the market value of the investment rises. Assuming these price changes are not viewed as giving rise to an other-than-temporary impairment, how are they reflected in the investment account for a security classified as held-to-maturity?

The changes in fair value are not reported in the income statement or balance sheet, but are disclosed.

Sometimes an investor's level of influence changes, making it necessary to change from the equity method to another method. How should the investor account for this change in accounting method?

The current carrying value is not adjusted. The method of accounting is simply switched from the equity method to another method at that point.

What is the effect of a company electing the fair value option with respect to a held-to-maturity investment or an available-for-sale investment?

The effect is that they are reclassified as trading securities.

What is the effect of a company electing the fair value option with respect to an investment that otherwise would be accounted for using the equity method?

The investments are shown on their own line in the balance sheet or are combined with equity method investments with the amount at fair value.

The equity method has been referred to as a one-line consolidation. What might prompt this decision?

The investor reports its equity interest in the investee as a single investment account while at the same time having the same effect as a consolidation would on total income and shareholders' equity.

In the application of the equity method, how should dividends from the investee be accounted for? Why?

The investor's investment in the investee's net assets is reduced. Recognizing dividends both directly and indirectly would be double counting.

when an investment is acquired to be held for an unspecified period as opposed to being held to maturity, it is reported at the fair value of the investment securities on the reporting date. Why?

The securities must be ready to be traded at any time. To trade, the security must be adjusted to fair value.

Reporting an investment at its fair value means adjusting its carrying amount for changes in fair value after its acquisition (or since the last reporting date if it was held at that time.) Such changes are called unrealized holding gains and losses because they haven't yet been realized through the sale of the security. If the security is classified as available-for-sale, how are unrealized holding gains and losses reported if they are not viewed as giving rise to an other-than-temporary impairment?

They are reported as OCI.

Some financial instruments are called derivatives. Why?

They derive their values from some other security or index.

Under what circumstances is the equity method used to account for an investment in stock?

When the investor cannot control, but significantly influence the investee.