Intermediate Accounting - Chap012 pot

Investments Held for an Unspecified Period of Time When an investment is held for an unspecified period of time, it is reported at the fair value of the security on the reporting date.

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Investments

12

Accounting for Investment Securities

Bonds and

notes (Debt securities)

Bonds and

notes

(Debt securities)

Common and preferred stock

(Equity securities)

Common and preferred stock

(Equity securities)

Investments can be accounted for in a

variety of ways, depending on the nature

of the investment relationship.

Reporting Categories for Investments

Learning Objectives

Demonstrate how to identify and account for investments classified for reporting purposes

as held to maturity

Trading securities (TS) are bought and held primarily to be sold in the near term.

Trading securities (TS) are bought and held primarily to be sold in the near term.

Securities available for sale (SAS) are expected to be held for an unspecified period of time.

Securities available for sale (SAS) are expected to be held for an unspecified period of time.

Reporting Categories for Investments

Held-to-maturity (HTM) securities are investments in debt the investor intends and has the ability to hold until they mature.

Held-to-maturity (HTM) securities are investments in debt the investor intends and has the ability to hold until they mature.

Securities to Be Held to Maturity

On January 1, 2006, Matrix, Inc purchased as an investment

$1,000,000, of 10%, 10-year bonds, interest paid

semi-annually The market rate for similar bonds is 12%, so Matrix

paid $885,301 for the bonds Let’s look at the required

journal entries

$885,301 × (12% ÷ 2) = $53,118

$885,301 × (12% ÷ 2) = $53,118

Securities to Be Held to Maturity

$114,699 - $3,118 = $111,581 unamortized discount

On January 1, 2006, Matrix, Inc purchased as an investment

$1,000,000, of 10%, 10-year bonds, interest paid

semi-annually The market rate for similar bonds is 12%, so Matrix

paid $885,301 for the bonds Let’s look at the required

journal entries

Investments Held for an Unspecified Period of Time

When an investment is held for an unspecified

period of time, it is reported at the fair value of the

security on the reporting date.

When an investment is held for an unspecified

period of time, it is reported at the fair value of the

security on the reporting date.

Otherwise, the investment is reported at cost.

Learning Objectives

Demonstrate how to identify and account for investments classified for reporting purposes

as available-for-sale

Securities Available-for-Sale

Adjustments to fair value

are recorded as:

1. a direct adjustment to the

investment account, and

2. an allowance account in

the equity section of the

balance sheet called “Net

Unrealized Holding

Gains/Losses”.

Adjustments to fair value

are recorded as:

1. a direct adjustment to the

investment account, and

2. an allowance account in

the equity section of the

balance sheet called “ Net

Unrealized Holding

Gains/Losses

Securities Available for Sale Example

Matrix, Inc purchased the securities listed below in

2006 They are classified as Securities Available for Sale (SAS) The fair value of the securities

were determined on December 31, 2006 Prepare the journal entries for Matrix, Inc to adjust the

securities to fair value at December 31, 2006.

Matrix, Inc purchased the securities listed below in

2006 They are classified as Securities Available for Sale (SAS) The fair value of the securities

were determined on December 31, 2006 Prepare the journal entries for Matrix, Inc to adjust the

securities to fair value at December 31, 2006.

Securities Available for Sale Example

This net unrealized holding gain is reported as an allowance in the equity

section of the balance sheet.

This net unrealized holding gain is reported as an allowance in the equity

section of the balance sheet.

Other Comprehensive Income

When we add other comprehensive income to net income

we refer to the result as “comprehensive income.”

When we add other comprehensive income to net income

we refer to the result as “comprehensive income.”

Securities Available for Sale

Net unrealized holding gains and losses from securities

available-for-sale are reported in the equity section of

the balance sheet

Securities Available for Sale

This is called

Occasionally, an

investment’s value

will decline for

reasons that are

“other than temporary”.

Occasionally, an

investment’s value

will decline for

reasons that are

“other than temporary”.

Securities Available for Sale

The new cost basis (the impaired fair value) is not changed for subsequent recoveries in fair value.

The new cost basis (the impaired fair value) is not changed for subsequent recoveries in fair value.

If the value is

impaired

the recorded cost of

the security is reduced

to the impaired fair

the recorded cost of

the security is reduced

to the impaired fair

value , and the difference is included in

the current period’s

income.

Learning Objectives

Demonstrate how to identify and account for investments classified for reporting purposes

as trading securities

Trading Securities

Matrix, Inc purchased the addition securities classified

as Trading Securities (TS) in 2006 The fair value

amounts were determined on December 31, 2006

Prepare the journal entries for Matrix, Inc to adjust

the securities to fair value at 12/31/06

Matrix, Inc purchased the addition securities classified

as Trading Securities (TS) in 2006 The fair value

amounts were determined on December 31, 2006

Prepare the journal entries for Matrix, Inc to adjust

the securities to fair value at 12/31/06

Transfers Between Reporting Categories

Unrealized holding gains or losses at reclassification should

be accounted for in a manner consistent with the classification into which the security

is being transferred

Unrealized holding gains or losses at reclassification should

be accounted for in a manner consistent with the classification into which the security

Disclosures

Learning Objectives

Explain what constitutes significant influence

by the investor over the operating and financial

policies of the investee

When an investment results

in the control of the investee

(generally > 50%), the

subsidiary is consolidated with the parent company

When an investment results

in the control of the investee

(generally > 50%), the

subsidiary is consolidated with the parent company

used for investments

in equity securities

when significant influence is not

The equity method is

used for investments in

equity securities resulting in significant

influence (20%-50%)

The equity method is

used for investments in

equity securities resulting in significant

influence (20%-50%)

Learning Objectives

Understand the way investments are recorded

and reported by the equity method

Equity Method

1. The investment account is increased

by:

 Original investment cost.

 Proportionate share of investee's

 Original investment cost.

 Proportionate share of investee's

earnings.

2. The investment account is

decreased by:

 Dividends received.

Equity Method

reported on the balance sheet

as a single amount.

investee’s earnings from date

of acquisition is reported as a

single item on the investor’s

income statement.

Equity Method

On January 1, 2006, Matrix, Inc acquired 45% of

the equity securities of Apex, Inc for

$1,350,000 On the acquisition date, Apex’s net

assets had a fair value of $3,000,000 During

2006, Apex cash paid dividends of $150,000

and reported net income of $1,750,000

What amount will Matrix, Inc report on the

balance sheet as Investment in Apex, Inc.?

On January 1, 2006, Matrix, Inc acquired 45% of

the equity securities of Apex, Inc for

$1,350,000 On the acquisition date, Apex’s net

assets had a fair value of $3,000,000 During

2006, Apex cash paid dividends of $150,000

and reported net income of $1,750,000

What amount will Matrix, Inc report on the

balance sheet as Investment in Apex, Inc.?

Equity Method

Equity Method

reduced.

Learning Objectives

Explain the adjustments made in the equity method when the fair value of the net assets underlying an investment exceeds their book

value at acquisition

Equity Method

If the investor acquires the equity securities of

an investee by paying more than the fair

value of net assets

the difference is allocated between

GOODWILL

GOODWILL and IDENTIFIABLE

ASSETS

ASSETS.

If the investor acquires the equity securities of

an investee by paying more than the fair

value of net assets

the difference is allocated between

GOODWILL and IDENTIFIABLE

ASSETS

Equity Method

On January 1, 2006, Matrix, Inc purchase 25% of the

common stock of Apex, Inc for $200,000 At the date of

acquisition, the book value of the net assets of Apex was

$480,000, and the net fair value of these assets is $600,000 During 2006, Apex paid cash dividends of $40,000, and

reported earnings of $100,000 Let’s prepare the journal

entries to reflect the acquisition and other events during 2006

Equity Method

Assume that of the $50,000 excess of purchase price over

fair value of the net asset acquired, 75% is attributable to

depreciable assets with a remaining life of 20 years and the

remainder is considered goodwill Matrix uses the straight-line

method of depreciation on similar owned assets

Equity Method

Remember, goodwill is not amortized

Changing From Equity To Cost

At the transfer date,

the carrying value

of the investment

under the equity method is regarded

as cost.

At the transfer date,

the carrying value

of the investment

under the equity

method is regarded

as cost.

When the investor’s level of influence changes, it

may be necessary to change from the equity

method to another method.

Changing From Equity To Cost

Any difference between cost and fair

value is recorded in a valuation

account and is recognized as an

unrealized holding gain or loss.

After the transfer, the investment is

treated as a trading security or a

security available for sale, depending on management’s intent.

Any difference between cost and fair

value is recorded in a valuation

account and is recognized as an

unrealized holding gain or loss.

After the transfer, the investment is

treated as a trading security or a

security available for sale, depending on management’s intent.

Changing From Cost To Equity

When ownership level increases to a

significant influence, the investor may

change to the equity method.

At the transfer date, the recorded value is the

initial cost of the investment adjusted for

the investor’s equity in the undistributed

earnings of the investee since the original

investment.

When ownership level increases to a

significant influence, the investor may

At the transfer date, the recorded value is the

initial cost of the investment adjusted for

the investor’s equity in the undistributed

earnings of the investee since the original

investment.

Changing From Cost To Equity

The original cost, the unrealized holding

gain or loss, and the valuation account

are closed.

A retroactive change is recorded to recognize the investor’s share of the investee’s earnings since the original

investment.

The original cost, the unrealized holding

gain or loss, and the valuation account

are closed.

A retroactive change is recorded to

recognize the investor’s share of the investee’s earnings since the original

investment.

Financial Instruments & Derivatives

Financial Instruments:

2. Value is derived from

2. Value is derived from

other securities.

Appendix 12AOther Investments

Special Purpose Funds

It is often convenient for companies to set aside money to

be used for specific purposes In the short-term funds

may be set aside for

1 Petty cash funds

2 Payroll accounts

In the long-run funds are often set aside to:

1 Pay long-term debt when it comes due

2 Acquire treasury stock

Special purpose funds set aside for the long-term are

classified as investments

Investment in Life Insurance Policies

It is a common practice for companies to purchase

life insurance policies on key officers The

company pays the premium and is the beneficiary

of the policy If the officer dies the company

receives the proceeds from the policy Some types

of policies build a portion of each premium as cash surrender value The cash surrender value of such

a policy is classified as an investment on the

balance sheet of the company.

Appendix 12B

Impairment of a Receivable Due to a Troubled Debt

Restructuring

When the Receivable is Settled Outright

When the original terms of a debt agreement are changed

as a result of financial difficulties experienced by the

debtor, the new arrangement is referred to as a troubled troubled

debt restructuring

Sometimes a troubled debt is

settled in full when the debtor

transfers to the creditor assets

or equities The creditor

usually recognized a loss on

the settlement Such a

settlement is not considered

unusual or infrequent and is

not an extraordinary item

When the Receivable is Settled Outright

Creditor, Inc is owed $1,000,000 by Debtor Company

Because of financial difficulties, Debtor Company is unable

to pay the $1,000,000 due or the accrued interest of

$42,500 Creditor, Inc agrees to accept a parcel of land

with a fair market value of $615,000 in full settlement of

the debt and the accrued interest

Creditor, Inc is owed $1,000,000 by Debtor Company

Because of financial difficulties, Debtor Company is unable

to pay the $1,000,000 due or the accrued interest of

$42,500 Creditor, Inc agrees to accept a parcel of land

with a fair market value of $615,000 in full settlement of

the debt and the accrued interest

Modified Terms

Creditor, Inc is owed $1,000,000 by Debtor Company

Because of financial difficulties, Debtor Company is unable

to pay the $1,000,000 due or the accrued interest of

$42,500 Creditor, Inc agrees to forgive the accrued interest

of $42,500, and reduce the principal amount to $800,000

Interest of $40,000 is due at the end of each year and the

principal amount is due in full at the end of five years

Creditor discounts future cash inflows at 6%

Creditor, Inc is owed $1,000,000 by Debtor Company

Because of financial difficulties, Debtor Company is unable

to pay the $1,000,000 due or the accrued interest of

$42,500 Creditor, Inc agrees to forgive the accrued interest

of $42,500, and reduce the principal amount to $800,000

Interest of $40,000 is due at the end of each year and the

principal amount is due in full at the end of five years

Creditor discounts future cash inflows at 6%

Modified Terms

The journal entry to record the forgiveness of principal

and accrued interest and record the new note is:

End of Chapter 12