Intermediate accounting 17e stice skousen cengage chapter 14

Purchase of Debt SecuritiesAsset Approach May 1 Investment in Trading Securities 104,250 Interest Receivable 3,000 Interest Receivable 3,000 Interest Revenue 1,500... Purchase of Debt

Intermediate Accounting,17E

Stice | Stice | Skousen

PowerPoint presented by: Douglas Cloud Professor Emeritus of Accounting, Pepperdine

University

Investments in Debt and

Equity Securities

Why Companies Invest in

Other Companies

• Safety cushion

• Cyclical cash needs

• Investment for a return

• Investment for

influence

Classifications of Investment Securities

• Debt securities are financial

instruments issued by a company

that (1) have a maturity value, (2)

have a fixed or variable interest rate that specifies the periodic interest

payments, and (3) a maturity date.

• Equity securities represent

ownership in a company.

Held-to-Maturity Securities

• Held-to-maturity securities are debt

securities purchased by a company with the intent to hold those securities until they

mature.

• This category includes only debt securities

because equity securities typically do not

mature.

Available-for-Sale Securities

• Available-for-sale securities are

equity securities that are not

considered trading securities and are not accounted for using the equity

method.

• Debt securities that are not being held

until maturity and are not classified as

Trading Securities

Trading securities are debt and

equity securities purchased with

the intent of selling them in the

near future.

Equity Method Securities

• Equity method securities are

equity securities purchased with the intent of being able to control or

significantly influence the operations

of the investee

• A large block of stock (presumably

at least 20% of the outstanding stock) must be owned to be

Classification of Investment Securities According to IFRS

• The classification of investment

securities under IFRS, specifically IAS

39 , is essentially the same as under

U.S GAAP.

for derivatives and accounting for loans and receivables.

Purchase of Debt Securities

On May 1, Douglas Company purchases

$100,000 in U.S Treasury notes at 104¼,

including brokerage fees Interest is 9%

payable semiannually on January 1 and

July 1 The debt securities are classified by the purchaser as trading securities

Accrued interest on May 1 is $3,000, calculated

as follows:

Purchase of Debt Securities

Asset Approach

May 1 Investment in Trading

Securities 104,250 Interest Receivable 3,000

Interest Receivable 3,000 Interest Revenue 1,500

Purchase of Debt Securities

Revenue Approach

May 1 Investment in Trading

Securities 104,250 Interest Revenue 3,000

Interest Revenue 4,500

Purchase of Equity Securities

Gondor Enterprises purchased 300 shares

of Boromir Co stock at $75 per share plus brokerage fees of $80 (as trading

securities) and 500 shares of Faramir Inc stock at $50 per share plus brokerage fees

of $30 (as available-for-sale securities)

Investment in Trading Securities—

Investment in Available-for-Sale

Securities—Faramir Inc 25,030

Recognition of Revenue from

Debt Securities

• Assume that on January 1, 2010,

Silmaril Technologies purchased

5-year, 10% bonds with a face value of

$100,000 and interest payable

semiannually on January 1 and July 1 The market rate on similar bonds is

8%.

Present value of principal:

FV = $100,000; N = 10; I = 4% $ 67,556 Present value of interest payments:

Total present value of the bonds $108,110

Investment in Trading Securities 108,110

When trading securities are purchased:

Interest Revenue for Debt Securities (Held-to-Maturity)

The initial purchase:

Investment in Held-to-Maturity Securities 108,110

Interest Revenue for Debt Securities (Held-to-Maturity)

When the first interest payment is received:

Investment in Held-to-Maturity Securities 676

(continues)

Interest Revenue for Debt Securities (Held-to-Maturity)

When the second interest payment is

Investment in Held-to-Maturity Securities 703

Recognition of Revenue from

Equity Securities

In those instances where the level of

ownership in the investee is such that the

investor is able to control or significantly

influence decisions made by the investee, the use of the equity method is appropriate.

Recognition of Revenue from

 Interchange of management personnel

 Technical dependency of investee on investor

 Percentage of outstanding voting stock owned

Determining the Appropriate

Accounting Method

No significant

Revenue for Equity Securities Classified as Trading and Available for

Sale

The journal entry to record receipt of the

dividends would be:

Revenue for Securities Classified

As Equity Method Securities

BioTech Inc purchased 40% of the

outstanding stock of Medco Enterprises on January 1 of the current year by paying

$200,000 During the year, Medco reported net income of $50,000 and paid dividends

of $10,000

(continues)

Investment in Medco Enterprise Stock:

Investment in Medco Enterprise Stock 200,000

To record the purchase of 40% of Medco stock.

Recognize a percentage of net income:

Investment in Medco Enterprise Stock 20,000

Income from Investment in Medco

Investment in Medco Enterprises Stock 4,000

Revenue for Securities Classified

As Equity Method Securities

Equity Method: Purchase for

More than Book Value

The net assets of Stewart Inc was

$500,000 at the time Phillips Manufacturing

Co purchased 40% of the common shares for $250,000 Based on the ownership

interest, the market value of the net assets

of Stewart Inc would be $625,000, which is

$125,000 more than the book value Only

$50,000 of this is attributed to depreciable assets The remaining $75,000 is attributed

to a special operating license

(continues)

Equity Method: Purchase for

More than Book Value

The average remaining life of the

depreciable assets is 10 years and the

license is to be amortized over 20 years

Phillips Manufacturing Co would adjust its share of Stewart Inc.’s net income as

follows:

Additional depreciation ($50,000 × 0.40)/10 $2,000 License amortization ($75,000 × 0.40)/20 1,500

$3,500

Equity Method: Purchase for

More than Book Value

Each year for the first 10 years, Phillips

would make the following entry in addition

to entries made to recognize its share of

Stewart’s income and dividends

Income from Investments in Stewart Inc.

Investment in Stewart Inc Stock 3,500

To adjust share of income on Stewart Inc common stock for proportionate depreciation on excess of market value

of depreciable property, $2,000, and for amortization of the unrecorded license,

$1,500.

Equity Method: Purchase for

More than Book Value

• After the 10th year, the adjustment would be for

$1,500 until the license amount is fully

amortized.

• Stewart Inc declared and paid dividends of

$70,000 during 2011 and reported net income of

$150,000 for the year The investment would be shown on Philip’s balance sheet as follows:

Equity Method: Joint Venture

• A joint venture is a form of

off-balance-sheet financing.

• Joint ventures are accounted for using the

equity method.

• Even if the joint venture does not have a

50–50 ownership structure, the minority

interest will still account for the joint

venture using the equity method.

Eastwood Incorporated purchased the following securities on March 23, 2011 Their fair value is shown as of December 31, 2011.

Accounting for the Change in

Value of Securities

Initial Purchase Entry—2011

Investment in Trading Securities 11,000

By the end of 2011, the value of the trading securities decreased from

$11,000 to $10,500.

December 31, 2011:

Unrealized Loss on Trading Securities 500

Market Adjustment—Trading Securities 500

Trading Securities—2011

Accounting for the Change in

Value of Securities

By the end of 2011, the value of

the available-for-sale securities

Accounting for the Change in

Accounting for the Change in

Value of Securities

The adjusting entry is as follows:

Market Adjustment—Trading Securities 800

Unrealized Gain on Trading Securities 800

Trading Securities—2012

Accounting for the Change in

Value of Securities

Available-for-Sale Securities—2012

(continues)

At the end of 2011, available-for-sale

securities had a fair value of $17,600 At the end of 2012, the fair value is $17,200

Accounting for the Change in

Value of Securities

The adjusting entry is as follows:

Unrealized Increase/Decrease in Value of

Available-for-Sale Securities ($17,600 ─ $17,200) 400

Market Adjustment—Available-for-Sale Securities 400

Available-for-Sale Securities—2012

Held-to-Maturity Securities—2012

By the end of 2012, Security 5 had

increased in value from $19,000 to $20,700 Recall in Slide 14-51 that no loss was

recorded when the fair value dropped to

$19,000.

Accounting for the Change in

Value of Securities

Held-to-Maturity Securities—2012

• The fair value of the held-to-maturity

securities of $20,700 would not be used to adjust the reported balance sheet amount.

• The $20,700 fair value would be disclosed

in the notes to the financial statements.

Accounting for the Change in

Value of Securities

Determining Whether a Decline in Fair

Value is Other Than Temporary

In SAB No 59, the SEC staff suggests that one consider the following in determining whether

a decline in fair value is other than temporary:

 How long has the fair value of the security

been below its original cost?

 What is the current financial condition of the investee and its industry?

 Will the investor’s plans involve holding the security long enough for it to recover its

value?

Sale of Securities

For Silmaril Technologies (from Slide 14-14 ), assume that the debt

securities are sold on April 1, 2012,

for $103,000, which includes accrued interest of $2,500 The carrying value

of the debt security on January 1,

2012, is $105,240.

Impact of Sale of Securities on Unrealized Gains and Losses

At the beginning of Year 1, Levi Company

purchased trading securities for $10 At

the end of Year 1, the securities had a

value of $12 At the end of Year 2, the

same securities are sold for $9

Unrealized Loss—

Trading 2 Market Adjust-

Impact of Sale of Securities on Unrealized Gains and Losses

When the securities are sold at the

end of Year 2 for $9, the entry will

reflect only a $1 loss.

Year 2

Realized Loss—Trading 1

Investment Securities—Trading 10

Bank A has the following balance

sheet:

Bank A is required by government

regulation to maintain equity of at

As an option, Bank A can set up a

service entity called QSPE

(qualifying special purpose entity)

Under the supervision of Bank A,

QSPE raises $100 cash by

borrowing $90 and receiving $10 as

an investment from Bank A QSPE

After Bank A “sells” the $100

mortgage receivable asset to QSPE, the balance sheet appears as

follows:

The process described in

Slides14-46 through 14-49 is called

derecognition

According to SFAS No 140, a transfer of a financial asset is accounted for as a sale (resulting in derecognition) when the

transfer satisfies the following three

conditions:

up legal claim to the assets meaning that even if it declares bankruptcy its

prevent the transferee from using the transferred assets however desired, such as selling them or pledging them

as collateral for a loan

not have the right to force the transferee to return the assets, such as with a repurchase agreement

Transferring Securities Between Categories

The Eastwood Inc example used earlier

will serve to demonstrate transferring

securities between categories As of

December 31, 2012, Eastwood Inc had

the following securities:

Transferring Securities Between Categories

During 2013, Eastwood Inc elects to

reclassify certain of its securities as

shown below

(continues)

From the Trading Security

Category

Eastwood Inc elects to reclassify

security 2 from a trading security to

Into the Trading Security Category

Eastwood Inc elects to reclassify

security 4 from an available-for-sale

security to a trading security.

Investment in Trading Securities 10,300

Market

Unrealized Loss on Transfer of Securities 1,700

Unrealized Increase/Decrease in Value

From the Held-to-Maturity to

the Available-for-Sale

Category

Eastwood Inc elects to reclassify

security 5 from a security being held

until maturity to one that is available

Eastwood Inc elects to reclassify

security 3 from one that is available

to be sold to a security that will be

held until maturity.

Investment in Held-to-Maturity Securities 5,900

Unrealized Increase/Decrease in Value

Cash Flows from Gains and Losses

Purchases of investment securities (600)

Sale of investment securities (costing $200) 170

The market value of the remaining securities was $500 on December 31, 2011

(continues)

Cash Flows from Gains and Losses

on Available-for-Sale Securities

Caesh Company’s net income for 2011

can be computed as follows:

The statement of cash flows for Caesh

Company for 2011 can be prepared as

follows:

Cash Flows from Gains and Losses

on Available-for-Sale Securities

If the investment securities purchased by

Caesh Company are classified as trading

securities and are deemed to have been

acquired for operating purposes, the unrealized gain appears in the operating activities section.

Cash Flows from Gains and Losses

on Trading Securities

Required Additional Disclosures

 The change in net unrealized holding gain or loss that is included in the income statement.

 Aggregate fair value, gross unrealized holding gains and gross

unrealized holding losses, and amortized cost basis by major security type.

 The proceeds from sales of available-for-sale securities and the

gross realized gains and losses on those sales and the basis on which cost was determined in computing realized gains and losses.

Available-for-sale securities (continues):

 The change in net unrealized holding gain

or loss on available-for-sale securities that has been included in stockholders’ equity during the period.

3 Held-to-maturity securities:

 Aggregate fair value, gross unrealized

holding gains and gross unrealized holding losses, and amortized cost basis by major

Required Additional Disclosures

4 Transfer of securities between categories:

 Gross gains and losses included in earnings from transfers of securities from available- for-sale into the trading category.

 For securities transferred from maturity, the company should disclose the amortized cost amount transferred, the

held-to-related realized or unrealized gain or loss, and the reason for transferring the security.

Required Additional Disclosures

Accounting for the Impairment of a Loan

• A loan is impaired when, based on

current information and events, it is

probable that a creditor will be unable to collect all amounts due according to the

contractual terms of the loan agreement

• For loans with no market value,

impairment is measured by comparing

the present value of expected future cash

Accounting for the Impairment of a Loan

Malone Enterprises reports a loan

receivable from Stockton Co in the amount

of $500,000 The repayment terms include

a 10% interest rate plus annual principal

payments of $100,000 on January 1 of each year The loan was made on January 1,

2009 Stockton made the $50,000 interest payment in 2009 but did not make the

$100,000 principal payment nor the

$50,000 interest payment in 2010

(continues)