Chapter 17 LO1

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Debt Securities

represents money that is borrowed and must be repaid, with terms that stipulates the size of the loan, interest rate, and maturity or renewal date.

The use of some simpler method that yields results similar to the effective-interest method is an application of what concept?

the materiality concept

Where do companies record changes in fair value related to available-for-sale securities?

the record these changes in an unrealized holding gains or losses account and subsequently these gains or losses are recorded in accumulated other comprehensive income in the equity section of the balance sheet for the period.

What effect do held-to-maturity bonds have on the volatility of reported earnings and reported capital?

Because companies do not adjust held-to-maturity securities to fair value, these securities do not increase the volatility of either reported earnings or reported capital.

Why do companies report some debt securities at fair value?

Not only is it relevant, but it is also representationally faithful

Amortized cost

The acquisition cost adjusted for the amortization of discount or premium

(T/F) Companies account for held-to-maturity securities at amortized cost, not fair value.

True

Assume that Firm A purchases $100,000, 10%, 5-year bonds on 1/1/19, with interest payable on 7/1 and 1/1. The bonds sell for 108,111 which results in a premium of 8,111 and an effective-rate of 8 percent. What is interest revenue for 2019?

$8,621 ($4,324 + $4,297)

Examples of Debt Securities

-US government securities -Municipal Securities -Corporate bonds -Convertible debt -Commercial paper

(calculation) Firm A purchases a $100,000 8% bond for $92,278 from Firm B on 1/1/19, the maturity date is 1/1/24, the effective interest rate is 10%, interest is semiannually paid on 7/1, and 1/1, what is the carrying amount of the bond on 7/1/19?

$92,892 ($92,278 + $614)

(calculation) Firm A purchases a $100,000 8% bond for $92,278 from Firm B on 1/1/19, the maturity date is 1/1/24, the effective interest rate is 10%, interest is semiannually paid on 7/1, and 1/1, what is the carrying amount of the bond on 1/1/22?

$96,454 ($95,671 + $783)

Assume that Firm A has purchased $100,000 of 8% bonds of Firm B on 1/1/19, at a discount, paying $92,278, What is the journal entry to record the initial investment?

(1/1/19) Debit- Debt Investment for 92,278 Credit- Cash for 92,278

To provide useful information, companies must account for investments based on what?

-Based on the type of security (debt/equity) -Based on their intent with respect to the investment.

Motivations companies have for investing in debt or equity securities issued by other companies

-Earn a high rate of return -To secure certain operating or financing arrangements with another company

3 categories of debt securities

-Held-to-maturity -Trading -Available-for-sale

Three characteristics of a security

-It either is represented by an instrument issued in bearer or registered form or, if not represented by an instrument, is registered in books maintained to record transfers by or on behalf of the issuer. -It is commonly traded on securities exchanges or markets or; when represented by an instrument, is commonly recognized in any area in which it is issued or dealt in as a medium for investment. -It either is one of a class or series or by its terms divisible into a class or series of shares, participation, interests, or obligations.

Companies should classify a debt security as held-to-maturity only if it has both...

-Positive Intent -The ability to hold those securities to maturity

Assume that on 12/31/2020, Firm A determined its trading securities portfolio at amortized cost of $314,450 and Fair value of $318,200; what is the net unrealized gain/loss?

A gain of $3,750 ($318,200 - $314,450) which means the Fair Value Adjustment is a Debit.

Security

A share or other interest in property or in an enterprise of the issuer or an obligation of the issuer

When is the Fair Value Adjustment account adjusted for the unrealized gains or losses on remaining trading securities in the trading investment portfolio?

After a trading security is sold, the reduction of that security's amortized cost and subsequent unrealized holding gain/loss is adjusted in the Fair Value Adjustment account at year-end.

Type of Security: Debt Management Intent: No plans to sell Valuation approach:

Amortized cost

How do firms report fair value adjustments on the balance sheet?

At each reporting date, Firm A reports the bonds at fair value with an adjustment to the Unrealized Holding Gain or Loss - Equity account.

Assume that Firm A sold one of its bonds with an amortized cost of $94,214 for $90,000, it now only has bonds from Firm C with an amortized cost of $200,000 and a Fair Value of $195,000; If the previous fair value adjustment was a credit of $9,537; What are the 12/31/21 balances on the balance sheet and what is recorded on the income statement?

Balance Sheet -A balance for interest receivable is established (balance is unknown) -A balance for Debt Investments (available-for-sale) under the Investments category is $195,000 (fair value) -A balance for Accumulated Other Comprehensive Loss under the Stockholders' Equity category holds a balance of $5,000 Income Statement -Interest Revenue will be recorded for the same amount listed on the Interest Receivable account for the balance sheet. (amount still not determined) -Loss on the sale of the bond will be recorded for $4,214

Why is volatility of capital of concern to financial institutions?

Because regulators restrict financial institutions' operations based on their level of capital

Firm A purchases a $100,000 8% bond for $92,278 from Firm B on 1/1/19, the maturity date is 1/1/24, the effective interest rate is 10%, interest is semiannually paid on 7/1, and 1/1, how do you find the interest revenue?

By multiplying the discounted principal of the bond by the effective interest rate and multiplied by the amount of time elapsed if interest is payable multiple time a year. ($92,278 X 10% X 6/12 = $4,614)

Assume that Firm A sold bonds from Firm B on 7/1/21, for $90,000, at which time it had an amortized cost of $94,214; What does the journal entry to record the sale of bonds look like?

Dated 7/1/21 Debit -Cash for $90,000 (for the cash received from the sales price) -Loss on Sale of investments (to record an expense to account for difference between the fair value and book value of the asset) for $4,214 Credit -Debt Investments for $94,214 (this is the book value of the investments)

Assume that on 12/31/2020, Firm A creates an investment portfolio and determines its trading bonds have an unrealized gain of $3,750; What does the adjusting entry to Fair Value Adjustment account look like?

Debit -Fair Value Adjustment for $3,750 to recognize the overall increase in value of investments Credit -Unrealized Holding Gain or Loss - INCOME for $3,750 to record the potential increase in revenue

What is a fiscal benefit companies can receive from investment in securities?

Companies can receive interest (debt) revenue or dividend (equity) revenue, as well as capital gains from investments.

How long are Trading securities usually held for?

Companies generally hold trading securities for less than three months, some for merely days or hours.

How do companies report trading securities?

Companies report trading securities at fair value, with unrealized holding gains and losses reported as part of net income.

What affect does the "Fair Value Adjustment" account have if it has either a credit or debit balance?

Credit Balance -It is subtracted from the balance of debt investments Debit Balance -It is added to the balance of Debt Investments

Assume that Firm A sold one of its bonds, it now only has bonds from Firm C with an amortized cost of $200,000 and a Fair Value of $195,000; If the previous fair value adjustment was a credit of $9,537, what does the journal entry to record the reduction of the adjustment account balance look like?

Debit -Fair Value Adjustment for $4,537 ($9,537 - $5,000) Credit -Unrealized Holding Gain or Loss - Equity for $4,537

Assume that Firm A purchases $100,000, 10%, 5-year bonds on 1/1/19, with interest payable on 7/1 and 1/1. The bonds sell for 108,111 which results in a premium of 8,111 and an effective-rate of 8 percent. How do you record interest revenue at 12/31/19 in the journal?

Debit -Interest Receivable ($100,000 X .1 X 6/12) for $5,000 Credit -Debt Investment (used instead of bond premium amortization) ($5,000 - $4,297) for $703 -Interest Revenue ([Current carrying amount] $107,435 X .08 X 6/12) for $4,297

(calculation) Firm A purchases a $100,000 8% bond for $92,278 from Firm B on 1/1/19, the maturity date is 1/1/24, the effective interest rate is 10%, interest is semiannually paid on 7/1, and 1/1, what is the journal entry for the first interest payment?

Debit Cash for 4,000 (the 8% interest) Debt Investments for 614 (the discount amortization) Credit Interest Revenue for 4,614 (Effective interest rate by initial carrying amount by half-year)

(calculation) Firm A purchases a $100,000 8% bond for $92,278 from Firm B on 1/1/19, the maturity date is 1/1/24, the effective interest rate is 10%, interest is semiannually paid on 7/1, and 1/1, what is the journal entry for the interest payment on 7/1/21?

Debit Cash for 4,000 (to record actual interest payment) Debt Investment for 746 (to record the discount amortization) Credit Interest Revenue for 4,746 (to record the effective interest)

Trading

Debt securities bought and held primarily for sale in the near term to generate income on short-term price differences.

To compute interest revenue, companies compute the _____ rate or yield at the time of investment and apply that rate to the _________________ for each interest period.

Effective-interest, beginning carrying amount (book value)

Type of Security: Equity Management Intent: Exercise some control Valuation approach:

Equity Method

Type of Security: Debt Management Intent: Plan to sell Valuation approach:

Fair Value

Type of Security: Equity Management Intent: Plan to sell Valuation approach:

Fair Value

When securities are actively traded, the FASB believes that the investment should be reported at ______ on the balance sheet. In addition, changes in fair value (unrealized gains and losses) should be reported in ______.

Fair value; Income

(T/F) Trade accounts receivable and loans receivable are considered debt securities because they technically meet the definition of a security.

False

(T/F) Both debt and equity securities can be classified as held-to-maturity.

False, Equity has no maturity

(T/F) Companies report available-for-sale securities at fair value on the balance sheet and also report changes in fair value as part of net income.

False, companies don't record changes in fair value as part of net income until after selling the security. This approach reduces the volatility of net income.

Firm A purchases a $100,000 8% bond for $92,278 from Firm B on 1/1/19, the maturity date is 1/1/24, the effective interest rate is 10%, interest is semiannually paid on 7/1, and 1/1, how do you find the bond discount amortization?

Find the difference between the cash received and the interest revenue. ($4,614 - $4,000 = $614)

Assume that on 12/31/2020, Firm A creates an investment portfolio and determines its bonds from: Firm B to be at an Amortized cost of $43,860 and Fair Value of $51,500 Firm C to be at an Amortized Cost of $184,230 and Fair Value of $175,200 Firm D to be at an Amortized Cost of $86,360 and Fair Value of $91,500 What is Firm A's gross unrealized gains?

Firm A has gross unrealized gains of $12,780 (Firm B bonds gain of $7,640 + Firm D bonds gain of $5,140)

Assume that on 12/31/2020, Firm A creates an investment portfolio and determines its bonds from: Firm B to be at an Amortized cost of $43,860 and Fair Value of $51,500 Firm C to be at an Amortized Cost of $184,230 and Fair Value of $175,200 Firm D to be at an Amortized Cost of $86,360 and Fair Value of $91,500 What is Firm A's gross unrealized loss?

Firm A's unrealized gross losses are $9,030 (comprised of the deficit of Firm C's bonds at amortized cost and fair value [184,230 - 175,200])

Assume that Firm A has 2 debt securities classified as available-for-sale, Firm B bonds at amortized cost of $93,537 and Firm C bonds at amortized cost of $200,000; the fair values of each respective bonds is 103,600 and 180,400; what are the unrealized holding gains or losses for each debt security?

Firm B bonds experience an unrealized holding GAIN ($93,537<$103,600) of $10,063 (103,600 - 93,537) Firm C bonds experience an unrealized holding LOSS ($200,000 > $180,400) of $19,600 (200,000 - 180,400)

Assume that Firm A purchases $100,000, 10%, 5-year bonds on 1/1/19, with interest payable on 7/1 and 1/1. The bonds sell for 108,111 which results in a premium of 8,111 and an effective-rate of 8 percent. How do you calculate interest revenue for 7/1/19?

First you take the current Carrying amount of the Bonds at premium (108,111) then multiply that amount by the effective interest rate (8% or .08) then take that amount and divide it in half because of semi-annual payments (or multiply by 6/12) the result should be around $4,324

Assume that Firm A purchases $100,000, 10%, 5-year bonds on 1/1/19, with interest payable on 7/1 and 1/1. The bonds sell for 108,111 which results in a premium of 8,111 and an effective-rate of 8 percent. How do you calculate the new carrying amount of the bond for 7/1/19?

First you take the initial carrying amount (108,111) and subtract from it (because amortizing a premium reduces carrying value to original face value) the bond premium expense (676) and the resulting new carrying amount should be 107,435.

Assume that Firm A sold bonds from Firm B on 7/1/21, for $90,000, at which time it had an amortized cost of $94,214; What is the realized gain or loss?

First, take the amortized cost of the Firm B bonds ($94,214) and then deduct the selling price of those bonds ($90,000) and the result should be a net loss on sale of bonds for $4,214

If Firm A sells its $100,000 of Firm B bonds for 99.75 on 11/1/23 what is the gain or loss on that sale assuming the bonds amortized cost on 7/1/23 is $99,048 and the discount amortized on the date of sale is 635?

First, take the selling price of the bonds which is $99,750 ($100,000 X .9975) and subtract away the combined amortized cost of the bonds and discount amortized up to the date of sale, the current book value should be $99,683 ($99,048 + 635). The resulting difference should come to a gain on the sale of bonds for 67$.

Assume that Firm A purchases $100,000, 10%, 5-year bonds on 1/1/19, with interest payable on 7/1 and 1/1. The bonds sell for 108,111 which results in a premium of 8,111 and an effective-rate of 8 percent. How do you calculate bond premium expense for 7/1/19?

First, you take the Cash Received ($5,000 which is the normal semi-annual interest) and subtract away the interest revenue ($4,324 which is the semi-annual interest you would get when you apply the current carrying amount of the Bonds [108,111] to the effective-interest rate [8%]) the total should be $676

Why should banks be careful when engaging in shifting their debt the held-to-maturity?

If the bank has liquidity problems, it may have to sell these held-to-maturity securities for a large loss at inopportune times. Given the 2008 financial crisis, the process of trying to hype capital and maintain less volatile earnings may backfire if investors believe that shenanigans are taking place in the financial institution area.

Fair Value Adjustment

It is a valuation account used instead of crediting Debt investments and it enables a company to maintain a record of the amortized cost of its debt investment.

When there is a Unrealized Holding Gain or Loss in relation to trading securities, where is it recorded?

It is recorded in the income statement under "Other revenues and gains" or "Other expenses and losses."

When a trading security is sold, what happens to the Debt Investments account?

It is reduced by the Amortized cost of the bonds and any realized gain or loss is recorded in the "Other revenues and gains" or the "Other expenses and losses" section of the income statement.

Many banks have shifted their debt investment portfolios into the "held-to-maturity" category from trading or available-for-sale; For example, in a recent 18-month period, banks have moved $293 billion of their investments to the held to maturity category; What does this mean for the marketability for these investments?

It means that about $640 billion, or one in five dollars in the banks' portfolios, cannot be sold easily.

If a company sells bonds carried as investments in available-for-sale securities before the maturity date, how must it address the removal from the Debt Investments account?

It must make entries to remove from the Debt Investments Account the amortized cost of bonds sold, usually accounting for Cash, Gains or Losses on sale of investments, and crediting debt investments.

Firm A purchases a $100,000 8% bond for $92,278 from Firm B on 1/1/19, the maturity date is 1/1/24, the effective interest rate is 10%, interest is semiannually paid on 7/1, and 1/1, how do you find the cash received?

Multiply the stated value of the bond by the stated interest rate and then multiplied by the amount of time elapsed if interest is payable multiple time a year. ($100,000 X 8% X 6/12 = $4,000)

If management intends to hold certain securities to maturity and has no plans to sell them, is fair value relevant?

No, because the ultimate purpose of holding the bond is to see it through maturity and that means there's no need to keep track of its market price.

Assume that Firm A purchases $100,000, 10%, 5-year bonds on 1/1/19, with interest payable on 7/1 and 1/1. The bonds sell for 108,111 which results in a premium of 8,111 and an effective-rate of 8 percent. What would the journal entry to record the first interest payment of the bonds look like?

On 7/1/19 Debit - Cash for 5,000 This represents semi-annual 10% interest payment on the original principal of the bond ($100,000 X .1 X 6/12) Credit - Debt Investments for 676 This represents the premium amortization on the bond ([$108,111 X .8 X 6/12] - $5,000 [normal interest]) Credit - Interest Revenue for 4,324 This represent the difference between the Cash received from the bond and premium amortization recorded in the Debt Investments account.

When a "loss/gain on sale of investments" occurs, where is it recorded?

On the "Other Expenses and Losses" section of the income statement

Firm A purchases a $100,000 8% bond for $92,278 from Firm B on 1/1/19, the maturity date is 1/1/24, the effective interest rate is 10%, interest is semiannually paid on 7/1, and 1/1, how does Firm A report its investment in their financial statements at 12/31/19?

On the Balance Sheet -In current assets "interest receivable" will have a balance of $4,000 to record the interest to collected on 1/1/20. -In long-term investments "Debt Investment (held-to-maturity)" account will hold a balance of $93,537 to record the up-to-date carrying amount of the bond. On the Income Statement -Other revenues and gains will report "interest revenue" of $9,259 to record the amount of effective interest earned this year ($4,614 + $4,645).

Why is there this massive shift in banks to convert major portions of their investment portfolio's to held-to-maturity?

One major reasons is that banks recognize when securities are classified as held-to-maturity, they are carried at their original cost, typically face value. Declines in market values of HTM bonds hit neither the book value or earnings. Their value is written down only if they are considered to be permanently impaired. If long-term interest rates are expected to rise, then bond prices will drop. If bond prices drop, banks that hold trading or available-for-sale securities will have their earnings and capital drop. As a result, the shift to held-to-maturity portfolios provides protection from this level of volatility.

What's the difference between physical assets and financial assets?

Physical assets (land and buildings) derive their value from their use in the business and not from a contractual claim.

Assume that Firm A sold one of its bonds, it now only has bonds from Firm C with an amortized cost of $200,000 and a Fair Value of $195,000; If the previous fair value adjustment was a credit of $9,537, what is the Fair Value adjustment for this year?

Right now, there is a total Unrealized Holding Loss of $5,000 which is $4,537 less than the previous loss of $9,537. This means that a Debit of $4,537 to Fair Value Adjustment is necessary in order to offset the previous years balance.

What are the arguments against including unrealized holding gains or losses in net income instead of other comprehensive income?

Some companies, particularly financial institutions, note that recognizing gains and losses on assets, but not liabilities, introduces substantial volatility in net income. They argue that hedges often exist between assets and liabilities so that gains in assets are offset by losses in liabilities, and vice versa. In short, to recognize gains and losses only on the asset side is unfair and not representative of the economic activities of the company.

How does the FASB recommend companies adjust trading securities to fair value and report the change in value?

The FASB says to adjust the trading securities to fair value, at each reporting date. In addition, companies report the change in value as part of net income, not other comprehensive income.

When a security is sold, when do changes in unrealized gains/losses get recorded?

The adjustment to accumulated other comprehensive income occurs at year-end when the entire portfolio is evaluated for fair value adjustment.

If a company INTENDS to hold a debt security for an indefinite period of time should the company classify this debt as held-to-maturity?

The company should not classify this security as held-to-maturity.

If a company anticipates that a SALE may be necessary due to changes in interest rates, foreign currency risk, liquidity needs, or other asset-liability management reasons, should it classify this debt as held-to-maturity?

The company should not classify this security as held-to-maturity.

How is the investment carrying amount affected by bond discounts and premiums?

The investment carrying amount is increased by the amortized discount or decreased by the amortized premium in each period.

If Firm A sells its $100,000 of Firm B's 8% bonds for 99.75 on 11/1/23 what is the journal entry to record the sale assuming the bonds amortized cost on 7/1/23 is $99,048, interest is payable on 7/1 and 1/1, and the discount amortized on the date of sale is 635?

The journal would be recorded on 11/1/23 Debit - Cash for 102,417 this represents the selling price of the bonds ($99,750 [$100,000 X .9975]) plus the accrued interest ($2,667[$100,000 X 8% X 6/12 X 4/6) Credit - Interest Revenue for 2,667 This represents accrued interest for the partial half-year Credit - Debt Investment for 99,683 This represents the book value of the bonds on the date of sale (99,048 + 635) Credit - Gain on sale of investments for 67 This represents the excess of the selling price over the book value of the bonds (99,750 - 99,683).

Effective-Interest Method

The method used by a bond buyer to account for accretion of a bond discount as the balance is moved into interest income or to amortize a bond premium into an interest expense.

Holding Gain (or Loss)

The net change in the fair value of a security form one period to another, exclusive of dividend or interest revenue recognized but not received.

Fair Value

The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date

To apply the fair value method to debt investments, assume that at year-end the value of some bonds are $105,000 and that the carrying amount of the investments is $106,732; what is the result of this discrepancy and how is it recorded in the journal and other financial statements?

The result of this discrepancy is a Unrealized Holding Loss because because the fair value is less than book value. EFFECT ON JOURNAL Debit -Unrealized Holding Gain or Loss - Equity for $1,732 (105,000 - 106,732) Credit -Fair Value Adjustment (Used instead of crediting Debt Investments for clarification) for $1,732

What happens if company sells a held-to-maturity debt security prematurely?

The sale may "taint" the entire held-to-entry portfolio and therefore management's statement regarding "intent" is no longer credible and the company may have to reclassify the securities.

Assume that Firm A has 2 debt securities classified as available-for-sale, Firm B bonds at amortized cost of $93,537 and Firm C bonds at amortized cost of $200,000; the fair values of each respective bonds is 103,600 and 180,400; what is the Unrealized holding gain or loss on total portfolio and how does this get recorded?

There are many ways to determine the total unrealized holding gain or loss on total investments; The simplest method is to take the amortized total cost of the debt investments ($293,527) and find the difference between the total fair value of the bonds ($284,000) which should result in a deficit of 9,537. This deficit is recorded as "Fair Value Adjustment" of $9,537 and a Debit to Unrealized Holding Gain or Loss - Equity for the same amount.

How do companies record investments acquired at par, discount, or premium in the accounts?

They generally record them at cost, including brokerage and other fees but excluding the accrued interest. They don't generally record investments at maturity value or use a separate discount or premium account as a valuation account..

How do companies generate profits from trading securities?

They generate profits by selling the securities at an advantage in short-term differences in price.

Why do companies hold trading securities?

They have the intention of selling them in a short period of time.

What is the FASB's stance on recording unrealized gains/losses in income?

They recommend that companies keep the recognition of such gains/losses restricted to the equity section of the balance sheet.

Why is an unrealized holding gain or loss recorded in Equity?

This is because companies exclude from net income any unrealized holding gains and losses related to available-for-sale securities and instead reports this information as other comprehensive income.

Gains Trading

This is the practice of purchasing securities and then selling those that subseuently appreciate in value while retaining as investment portfolio assets those that cannot be sold at a profit. Accounting and banking regulators have repeatedly and strongly criticized this practice. Rules related to the transfer of securities from trading portfolios to available-for-sale or held-to-maturity portfolios are specifically designed to prohibit gains trading.

In recent times, many banks have entered into long-term relationships with their securities portfolio, promising hundreds of billions of dollars of assets will be "held-to-maturity;" What does this mean for the value of these banks' books and their value to their regulators?

This means that banks' books will yield higher values and be better capitalized by their regulators even if the value of their securities declines.

(T/F) Companies must amortize a premium or discount using the effective-interest method unless some other method - such as the straight-line method - yields a similar result

True

(T/F) Similar to HTM or AFS investments, companies are required to amortize any discount or premium on trading securities.

True

(T/F) Some companies are able to exercise some control over intermediary companies based on their significant (but not controlling) equity investments in that company

True

Assume that Firm A its investment in Firm B's bonds on 11/1/23, at 99.75 plus accrued interest. What is the discount amortization from 7/1/23 to 11/1/23 and the journal entry to record that amortization if the current carrying amount at 7/1/23 is 99,048 and the effective interest is 10%?

Usually, the amortization amount would be 952 (99,048 X .1 X 6/12). However only 4 months pass between 7/1 and 11/1 so that means the amortization is about 635 (952 X 4/6). The journal entry would Debit- "Debt Investments" 635 and Credit - "Interest Revenue" 635.

Category: Held-to-Maturity Valuation: Unrealized Holding Gains or Losses: Other Income Effects:

Valuation: Amortized Cost Unrealized Holding Gains or Losses: Not Recognized Other Income Effects: Interest when earned; gains and losses from sale

Category: Available-for-Sale Valuation: Unrealized Holding Gains or Losses: Other Income Effects:

Valuation: Fair Value Unrealized Holding Gains or Losses: Recognized as other comprehensive income and as separate component of stockholders' equity Other Income Effects: Interest when earned; Gains and Losses from sale

Category: Trading Securities Valuation: Unrealized Holding Gains or Losses: Other Income Effects:

Valuation: Fair Value Unrealized Holding Gains or Losses: Recognized in net income Other Income Effects: Interest when Earned; Gains and Losses from sale

How do companies record available-for-sale debt securities?

at fair value

What situation in where a company sells a debt security before it matures, is that company not violating the held-to-maturity requirement in the eyes of the FASB?

When a company sells a security close enough to maturity to where interest rate risk is no longer an important pricing factor.

Can a company sell a hold-to-maturity security and not compromise it's original intent to hold that maturity?

Yes, so long as the company sells it so close to the maturity date that a change in the market interest rate would not significantly affect the security's fair value. Such a sale would be considered a sale at maturity.

Assume that Firm A purchases $100,000, 10%, 5-year bonds on 1/1/19, with interest payable on 7/1 and 1/1. The bonds sell for 108,111 which results in a premium of 8,111 and an effective-rate of 8 percent. How do you get the cash received for each interest payment date?

You can get this by taking the unamortized face of the bonds ($100,000) and multiplying that by the original interest percentage (10%) and then dividing that in half due to semi-annual payments (or multiply by 6/12) the result should be $5,000.

What is a financial asset?

a financial assets is an asset whose value comes from a contractual claim to cash flows.

Available-for-sale

debt securities no classified as held-to-maturity or trading securities.

Held-to-maturity

debt securities that the company has positive intent and ability to hold to maturity.

What are examples of financial assets?

in addition to cash and receivables - equity investments in another company (common or preferred stock) - a contractual right to receive cash from another party (loans and bonds)

Assume that Firm A purchases $100,000, 10%, 5-year bonds on 1/1/19, with interest payable on 7/1 and 1/1. The bonds sell for 108,111 which results in a premium of 8,111 and an effective-rate of 8 percent. What would the journal entry to record the purchase of the bonds look like?

on 1/1/19 Debit - Debt Investments for 108,111 This represents the current carrying value of the bonds Credit - Cash for 108,111 This represents the face amount of money given for the bonds.


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