Investments in Debt and Equity Securities. TEMPORARY INVESTMENTS Use of idle cash Low risk...
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Transcript of Investments in Debt and Equity Securities. TEMPORARY INVESTMENTS Use of idle cash Low risk...
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Investments in Debt andEquity Securities
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TEMPORARY INVESTMENTS
Use of idle cash Low risk investments Quickly and easily converted to
cash Securities of federal, state, and
local government agencies
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LONG-TERM INVESTMENTS
Develops beneficial intercompany relationships.
May indirectly improve profitability of investing company.
May represent ownership interest.
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ACCOUNTING ISSUES
Classification issues– Management’s intended holding
period for the security Valuation and investment income
measurement– Cost vs. fair value– Treatment of holding gains & losses
Disclosure issues
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Invest. secur - 5
ACCOUNTING FOR VARIOUS INVESTMENTS
Classification Investment inDebt Securities
Investment inEquity Securities
Control-greater than 50%ownership of voting stock
Not applicable Consolidation
Significant influence - 20% to50% ownership of voting stock
Not applicable Equity method
Debt securities classified as heldto maturity, and equity securitiesfor which fair value is not readilydeterminable
Amortized cost method Cost method
Debt and equity securitiesclassified as trading securities
Fair value method, with unrealized holding gain or lossincluded in earnings
Debt and equity securitiesclassified as available for sale
Fair value method, with unrealized holding gain or lossincluded as a component of comprehensive income/stockholders’ equity
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CLASSIFYING INVESTMENTS
Debt or equity security?
Fair value readily determinable?
Management’s intended holding period?
Influence or control over investee? Only for equity securitiesequity securities with voting rights
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DEBT SECURITIES
Represent creditor relationship with an entity
– US Treasury securities, municipal securities, corporate bonds, convertible debt, commercial paper, and redeemable preferred stock
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EQUITY SECURITIES
Represent ownership interest in an entity or the right to acquire or to dispose of an ownership right at a fixed price
– Capital stock (common and preferred), warrants, rights, and options
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EQUITY SECURITIESCONTROLLING INTEREST
Investor (parent)(parent) owns more than 50% ofvoting stock in investee (subsidiary)(subsidiary).
=
Consolidated financial statements
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EQUITY SECURITIESSIGNIFICANT INFLUENCE
Investor holds 20% to 50%20% to 50% of voting stock
=
Equity method
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EQUITY METHOD
The investment account is increasedincreased by:– Original investment cost– Proportionate share of investee's earnings
The investment account is decreaseddecreased by:– Dividends received
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EQUITY SECURITIESNO SIGNIFICANT INFLUENCE
Investor holds less than 20%less than 20% of voting stock
Measure carrying value of securities at fair valuefair value, ifreadily determinable.
If fair value is not readily determinable, use costmethod.
=
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DEBT SECURITIESCLASSIFICATION
Held to maturity (HTM)– Only for debtdebt securities– Investor intends and has the ability to hold security to maturity date.– Carry at amortized cost on balance sheet.
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DEBT & EQUITY SECURITIESCLASSIFICATION
Trading securities (TS)– Debt or equity securities– Bought and held primarily to be sold in the near term– Current assets– Unrealized holding gains and losses included in earnings (net income)earnings (net income)
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DEBT & EQUITY SECURITIESCLASSIFICATION
Securities available for sale (SAS)– Debt or equity securities– Investments expected to be held for an unspecified period of time– Typically noncurrent assets– Unrealized holding gains and losses reported as a separate component of stockholders’stockholders’ equityequity
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TS AND SASACQUISITIONS
Recorded at cost when acquired.– Purchase price and incidental costs
Basket purchase requires allocation of the total cost to each class of security purchased.– Based on relative market values
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TS and SAS are reported at fair valuefair value on the balance sheet.
The difference between the fair value and the carrying value from the previous balance sheet date (cost if acquisition occurred in the current period) is an unrealized holding gain unrealized holding gain or loss.or loss.
TS AND SASRECORDING AT FAIR VALUE
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The unrealized holding gain or loss must be determined for individualindividual securities.
Each security has a valuation allowance valuation allowance account.account.
TS AND SASRECORDING AT FAIR VALUE
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The individual unrealized holding gains and losses are added together to arrive at the
net portfolio unrealized holding gain or net portfolio unrealized holding gain or loss.loss.
Net unrealized holding gains and losses are calculated separately for the TS portfolio
and the SAS portfolio.
TS AND SASRECORDING AT FAIR VALUE
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NET UNREALIZED HOLDING GAINS AND LOSSES
Trading securities:
The net unrealized holding gain or loss is treated as a component of
investment incomeinvestment income and is included on the income statementincome statement for the
period.
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NET UNREALIZED HOLDING GAINS AND LOSSES
Securities available for sale:
The net unrealized holding gain or loss is notnot included in earnings for the period but rather is closed to a separately reported component of
stockholders’ equity.stockholders’ equity.
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TS AND SASTRANSFERS
Transfers are accounted for at fair valuefair value on the transfer date.
Fair value at the reclassification date is regarded as cost of the security for
accounting purposes.
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TS AND SASTRANSFERS
The entry will:– Remove the investments at cost.
– Record the investments with a carrying value equal to fair value.
– Remove the valuation accounts.
– Recognize the portion of unrealized holding gains or losses not previously included in income.
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TS AND SASSALES
Sales are accounted for in a manner similar to transfers.
The only difference is that Cash is debited instead of the fair value of the
securities.
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EQUITY INVESTMENTSSPECIAL ISSUES
Stock dividends and stock splits– Not included in investment revenue.– Increase in number of shares reduces
carrying value per share.
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EQUITY INVESTMENTSSPECIAL ISSUES
Stock rights (Warrants)– Allocate investment cost between
stock and stock rights based on market value of stock and stock rights.
– Reported at fair market value.