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.
