Chapter 12 Investments

(1) What is the valuation of Held-to-maturity? (2) How is it recognized in unrealized holding gains or losses?

(1) Amortized Cost (2) Not recognized

Balance sheet presentation for equity securities

-Short term (i.e. Trading & some AFS): Current Assets -Long Term (i.e. some AFS): Noncurrent Assets

Available for sale securities aren't held for trading or designated as held to maturity. The investment is just available to be sold, so how is it reported on the balance sheet?

AFS is reported on the balance sheet at fair value. Unrealized gains and losses are reported in statement of comprehensive income (for debt securities) as "other comprehensive income/loss (OCI)". For equity securities, Unrealized gains and losses are reported on the income statement in net income

Amortized cost

Amortized cost is the acquisition cost adjusted for the amortization of discount or premium (assuming that it was purchased at other than "par value".)

Available for Sale reported on the Cash flow statement?

Cash flows from buying and selling AFS securities are classified as investing activities

Trading Securities on Cash Flow statements

Cash flows from buying and selling trading securities are classified as operating activities (WHY? - because trading securities are classified as current assets)

For changes in the fair value of trading securities, how are they recognized?

Changes in "fair value" are recognized as "unrealized holding gain/loss" in the Income Statement 1. The cost of the "investment" is recorded as an "investment" account in the B/S (this doesn't change until the trading security is sold) 2. Changes in the fair value of the investment are recorded in a "Fair Value Adjustment" account in the B/S

Consolidated financial statements

Combine the individual elements of the parent and subsidiary statements into a single financial statement

Trading

DEBT SECURITIES and EQUITY SECURITIES held primarily for sale in the near term to generate income on short-term price differences.

Held-to-maturity (HTM)

DEBT SECURITIES that a company has the positive intent and ability to hold to maturity

How would we record interest revenue (income) using the effective interest method now that we are the ones purchasing the bonds?

Dr. Cash Dr. Disc. on Bond Inv Cr. Interest Revenue OR Dr. Cash Cr. Premium on Bond Inv Cr. Interest Revenue

HTM in the Income Statement and Statement of Comprehensive Income

For REALIZED gains and losses on a HTM security, it is shown in net income in the period in which the securities are sold. However, UNREALIZED gains and losses on a HTM security (difference between amortized cost and fair value) are only disclosed in the notes and are NOT recorded.

Trading Securities on Income Statement

Gains and losses are included in the income statement in the periods which the fair value changes, regardless of whether they are realized or unrealized

Goodwill in Consolidation

Goodwill is recognized for the difference on the date of acquisition between the acquisition price and the sum of the fair values of the acquired net assets. Recognized as an asset

Equity Method

Investment reported at cost adjusted for investor's share of subsequent earnings and dividends of the investee

Available for sale reported on the balance sheet?

Investments in AFS securities are reported at fair value. Unrealized holding gains and losses become part of AOCI (accumulated OCI) in shareholders equity, and are reclassified out of AOCI in the periods which securities are sold (it then goes to the income statement)

Trading Securities (TS)

Investments in debt or equity securities acquired principally for the purpose of selling them in the near term.

Trading Securities on the Balance Sheet

Investments in trading securities are reported at fair value, classified as current assets

Cash Flow Statement for Equity Securities

Short term (i.e. Trading & some AFS): Operating Activities Long Term (i.e. some AFS): Investing activities

What does "significant influence" mean? How would it be accounted for?

Significant influence means decisions can be swayed in the direction the investor desires. It is accounted for by the Equity Method

Fair Value Option for HTM & AFS

The election is OPTIONAL BUT IRREVOCABLE on the date of investment purchase. Under the Fair Value Option: -HTM and AFS investments are shown in the B/S at fair value -Unrealized gains and losses are recognized in net income in the income statement in the period in which they occur -Purchases and sales of investments are classified as INVESTING activities in cash flow statement

Why would individual investors, mutual funds, and corporations invest in equity and debt securities?

To earn a return from the dividends (equity securities) or to earn a steady flow of interest income (debt securities). Also, to realize gains from increases in the market prices which would affect equity more than it would debt.

Fair value information for Trading Securities

Trading securities are carried at fair value on the balance sheet, and Unrealized holding gains or losses are included in net income in the period which the fair value CHANGES.

Available for sale reported on Income statement and statement of comprehensive income?

Unrealized gains and losses are shown in other comprehensive income in the periods in which fair value changes. Those same amounts are taken out of OCI and recognized as a realized gain or loss and are put in net income, at the period they are sold.

If you own more than 20% of another company's stock (equity), what happens?

You have significant influence and you use the equity method of accounting

Available-for-sale securities (AFS)

all other DEBT SECURITIES and EQUITY SECURITIES that are not classified in trading or HTM. It is basically the catch all class. If we get the right price, we will sell it.

Investments in HTM securities are reported at ________ _________. Where are the fair values of these investments disclosed?

amortized cost In the Notes of the financial statement

All trading securities are classified as _________ assets on the balance sheet

current This is because you plan to sell them in the next 12 months, it doesn't mean this always happens

Cash flows from buying and selling HTM securities are classified as ____________ __________

investing activities

When we determine present value...

its always determined by using the market rate

If a company is consolidated, the investor is referred to as the __________ and the investee is termed the ___________

parent; subsidiary The parent and subsidiary are considered to be a single reporting entity

Consolidation

the financial statements of the investor and investee are combined as if they are a single company

(1) What is the valuation of Available-for-sale? (2) How is it recognized in unrealized holding gains or losses?

(1) Fair Value (2) Recognized as other comprehensive income and as a separate component of stockholders equity (DOES NOT GET REPORTED ON INCOME STATEMENT LIKE TRADING)

(1) What is the valuation of Trading? (2) How is it recognized in unrealized holding gains or losses?

(1) Fair value (2) Recognized in net income on the income statement

Impairment of Investments

-Companies are required to use the Current Expected Credit Loss (CECL) model to account for impairments of all investments. This model uses the Allowance method -An impairment is when the fair value declines below its recorded cost

Notes in Financial Statements for Equity Securities

-Disclose the portion of unrealized gains and losses for the period -Disclose how carrying value was calculated when/if fair value is not readily determinable

Where are Impairment losses recognized for each investment category?

-HTM Debt Securities: Investment loss recorded in the Income Statement -Trading Debt or Equity Securities: Investment loss recorded in the Income Statement -AFS Equity Securities: Investment loss recorded in the Income Statement -AFS Debt Securities: Other Comprehensive income -- Loss recorded in Accumulated OCI (component of shareholders equity).

Objectives of purchasing life insurance on executives:

-To compensate the company for the untimely loss of a valuable human resource in the event the office dies -When the insured is still alive, life insurance policy can be surrendered in exchange for a determinable amount of money (called the Cash Surrender Value, which is classified as an Investment)

Types of Debt Securities

-US Government Securities -Municipal Securities -Corporate bonds -Convertible debt or Convertible bonds -Commercial Paper

Investments in Equity Securities. Ownership Percentages?

0-20%: Investor has passive interest and investment is valued using fair value method 20-50%: Investor has significant influence and investment is valued using Equity Method 50-100%: Investor has controlling interest. Investment valued on parent's books using Cost Method or Equity Method (investment eliminated in Consolidation)

Two types of financial instruments held as investments

1. Equity Securities -Common Stock -Preferred Stock 2. Debt Securities -Bonds -Notes

Debt Securities are classified into 3 categories according to accounting purposes. What are they?

1. Held-to-maturity 2. Trading 3. Available-for-sale