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Chapter 12

Chapter 12. Investments. Objectives of the Chapter. 1.Classification and reporting of Investments: trading securities, available-for-sale securities and held-to-maturity securities. 2.Investments recorded and reported using the equity method.

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Chapter 12

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  1. Chapter 12 Investments

  2. Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and held-to-maturity securities. 2.Investments recorded and reported using the equity method. 3. The fair value option reporting for investments. Investments

  3. Securities for Investments • Investment in debt securities: include U.S. treasury securities, municipal securities, corporate bonds, commercial papers, pf stock with a mandatory redemption feature or redeemable at the option of the holder. • Investment in equity securities: include common stock, preferred stock, stock warrants, stock rights, call and put options. Investments

  4. Securities for Investments(cont.) • For reporting purposes, all investments must be classified into one of the following three categories at the reporting date: 1. Trading securities; 2. Available-for-sale securities; or 3. Held-to-maturity securities. Investments

  5. Classification of Investments 1.Trading securities: investments in debt and equity securities held for the purpose of selling them in the near future. 2. Available-for-sale securities: Including debt and equity securities that are not classified as trading securities and not classified as held-to-maturity securities. Investments

  6. Classification of Investments (cont.) 3.Held-to-maturity securities: investments in debt securities with positive intent and ability to hold these securities to maturity. Investments

  7. Classification of Investments (cont.) • Classifications of investments in securities into these three categories and the subsequent reclassification are based on management’s intent and judgment. Investments

  8. Investments - initial recording and end of period reporting (valuation) 1.Initial Recording of all investments: at cost. 2. End of Period Reporting (Valuation): a. Trading securities: reported at their fair market values on the B/S. The unrealized gains or losses are included in income of the current period. Investments

  9. Investments - initial recording and valuation (cont.) b. Available-for-sale securities: reported at their fair values on the B/S. The unrealized gains or losses are reported as a separate component of stockholders’ equity until realized. c. Held-to-maturity securities: reported at their amortized cost. Investments

  10. Investments - dividends and Interest revenue • Dividends, interest revenues of investments in securities and realized gains or losses from sale of investments are reported in the income statement. Investments

  11. Investments - other valuation methods • Other Valuation Methods: • a. Equity method: Applied when investments in equity securities with significant influence over the investee (usually owing 20% - 50% of the voting stock). No recognition of unrealized gains or losses. • Results in a partial consolidation statements for the investor. Investments

  12. Investments - other valuation methods (cont.) b. Consolidated financial statements Applied when the investor(the parent) controls the investee (the subsidiary) through an investment in equity securities (i.e., the investor owing over 50% of the voting common stock). Investments

  13. Investments - other valuation methods (cont.) • The investor has to issue the consolidated financial statements. No recognition of unrealized gains or losses. Investments

  14. Summary of Accounting for Investments Investments

  15. Example A:investments classified as available-for- sale securities (SAS) • The accounting treatment (SFAS 115) (a) initial recording: at cost; (b) end of period reported: at fair value; (c) unrealized holding gains or losses: reported as a separate component of stockholders’ equity on B/S; (d) interests, dividends, realized gains or losses reported on the I/S Investments

  16. Example A:(cont.): • Assume that Green Company acquires the following securities on 5/1/x5: Shares# per share A Company common stock 100 $50 B Company common stock 300 $80 C Company preferred stock 200 $120 D Company 10% bonds with a face value of $15,000 at par plus accrued interest (interests are paid on 5/31 & 11/30) Investments

  17. Example A:(cont.) 1. Initial recording on 5/1/x5: Investments in SAS 68,000* Invest. Rev. 625** Cash 68,625 • Cost = 100 x 50 + 300 x 80 + 200 x 120 + 15,000 = 68,000 ** Accrued interests = 15,000 x 10% x 5/12 = $625 Investments

  18. Example A: cont. • 5/31/x5 Cash 750 Invest. Revenue 750 (the net interest revenue = $750 -625= $125; the interest revenue for 5/1/95 ~ 5/31/95) • 11/30/x5 Cash 750 Invest. Revenue 750 Note: If the bonds were purchased at a discount or premium, the discount or premium needs to be amortized when interest revenue is recongized. Investments

  19. Example A: cont. • 12/31/x5 Invest. Receivable 125 Invest. Revenue 125 • Assuming Green received $3,000 for dividends in 20x5 Cash 3,000 Invest. Revenue 3,000 Investments

  20. Example A:(contd.) • The following info. is available on 12/31/x5: (Note: for investment in bonds, the cost is the amortized cost.) Investments

  21. Example A:(contd.):SAS • 12/31/x5 Adjusting entry (for valuation): • Fair Value Adjustment 3,000 Unrealized holding Gains** on investments-OCI 3,000 ** Reported in B/S as other comprehensive income of x5 Investments

  22. Balance Sheet Presentation :SAS Balance Sheet 12/31/x5 Assets Liabilities Inv. Sec. (at cost) $68,000 Fair Value Adjust. $3,000Stockholders’ Equity: Inv. Sec. ( at fair Value) $71,000 Accu. Other Comp. Income Unrealized holding gains (losses) on investment 3,000 Investments

  23. Example A: SAS(contd.) • The following info. is available on 12/31/x6: Investments

  24. Example A: (cont.):SAS • 12/31/x6 Adjusting entry (for valuation): Unrealized holding Gains (losses) on investment**-OCI 5,000 Fair Value Adjustment 5,000 • ** Other comprehensive income of x6 Investments

  25. Balance Sheet Presentation:SAS Balance Sheet 12/31/x6 Assets Liabilities Inv. Sec. (at cost) $68,000 Fair Value Adj. (2,000) Inv. Sec. (at fair value) $66,000 Stockholders’ Equity: Accu. Other Comp. Income Unrealized holding gains (losses) on investment(2,000) Investments

  26. Realized Gains and Losses from Sale of investments • Realized gains and losses are calculated as the difference between the selling price and the cost and is reported in the income statement. • This is due to the unrealized gain/loss of SAS is never recognized in the income statement. Investments

  27. Example B: SAS • In 20x7, Green sold 100 shares of A stock for $6,000. J.E. to record this transaction • Cash 6,000 Investments in SAS (at cost) 5,000 Gain on sale of investments 1,000 Investments

  28. Example B (cont.): SAS • Also in 20x7, Green sold 300 share of B for $22,000 J.E. to record this transaction Cash 22,000 Loss on sale of investments 2,000 Investments (at cost) 24,000 Investments

  29. Example B:(cont.) (with a fair value adjustment account) :SAS • Before the adjusting entry on 12/31/x7: Fair Value adjustment Investment (at cost) 1/1/x7 3,000 5,000 68,000 5,000a 24,000b 2,000 39,000 a. from sale of Stock A b. From sale of Stock B Investments

  30. Example B:(contd.):SAS • The following info. is available on 12/31/x7: Investments

  31. Example B:SAS • The Adjusting entry on 12/31/x7 Fair Value Adjustment 1,000 Unrealized Gains (Losses) on Investment** 1,000 Note: before the adjustment, the ending bal. of fair value adjustment and unrealized holding gain/loss equal $2,000 (credit) and $2,000 (debit), respectively. After the adjustment, the bal. of fair value adj. And unrealized holding G/L equal $1,000 (credit) and $1,000 (debit), respectively. Investments

  32. Balance Sheet Presentation:SAS Balance Sheet 12/31/x7 Assets Liabilities Investment Securities at Cost $39,000 Fair Value Adjus. (1,000)Stockholders’ Equity: Invest. Sec. (at fair) $38,000Accu. Other Comp. Income Unrealized holding gains (losses) on investment(1,000) Investments

  33. Impairment of Securities Available-for-Sale • If the decline in the fair value of securities available-for-sale is NOT temporary (i.e., a bankruptcy filing), the value of the securities should be written down to the fair value. • The amount of the write-down should be treated as a realized loss and is included in the income of the year. Investments

  34. Investments Classified as Trading Securities • The accounting treatment (SFAS 115) (a) initial recording: at cost; (b) end of period reported: at fair value; (c) unrealized holding gains or losses: reported in the income statement; (d) interests, dividends, realized gains or losses reported in the income statement Investments

  35. Investments Classified as Trading Securities (contd.) • Trading securities are held primarily by banks and stock brokers. FASB 115 applies to all specialized industries. • For trading securities, the realized gains and losses are computed as the difference of the selling price and the fair value (NOT the cost) recorded in the most recent balance sheet date. • This is due to the unrealized holding gain/loss for trading sec. is recognized in the previous income statement. Investments

  36. Example C: same infor. as in Example A on p20 but for Trading Securities Valuation on 12/31/x5 • 12/31/x5 Adjusting entry for valuation (a direct adjustment to the investment account): • Investment Securities* 3,000 Unrealized holding Gains** on investments-I/S 3,000 *the bal. of the investment securities account equals $71,000, the fair value, after the adjustment. ** Reported in the income statement of x5 and will be closed to income summary at the end of x5. Investments

  37. Example C(contd.): same as in Example A on p23 Except for Trading Securities Valuation on 12/31/x6 • 12/31/x6 Valuation adjusting entry (a direct adjustment): Unrealized holding Gains on investment * - I/S 5,000 Investment Securities** 5,000 • *Reported in the income statement of x6. • **The bal. of investment securities equals $66,000, the fair value, after the adjustment. Investments

  38. Example D: same as in Example B on p27 Except for Sale of Trading Securities • In 20x7, Green sold 100 shares of A stock for $6,000. J.E. to record this transaction • Cash 6,000 • Loss on Sale of Investment 100 Investments in Trading Sec. 6,100* *The investment account is at the fair value. Unlike the SAS, the unrealized Gains (Losses) of trading securities have been closed to the Income Summary at the end of 20x6. Investments

  39. Example D (contd.): same as in Example B on p28 Except for Sale of Trading Securities • Also in 20x7, Green sold 300 share of B for $22,000 J.E. to record this transaction Cash 22,000 Loss on sale of investments 700 Investments (at fair value) 22,700 * The investment account is at the fair value. Investments

  40. Example D (contd.): same as in Example B on p30 • The following info. is available on 12/31/x7: • 12/31/x6 12/31/x7 Change • cost Fair Value Fair Value in F.V • C $24,000 $23,200 $26,000 $2,800 ↑ • D $15,000 $14,000 $12,000 (2,000)↓ • $39,000 $37,200 $38,000 ($800)↓ Investments

  41. Example D (contd.) • The information on p40 indicates that the fair value of securities C and D equals $37,200 and $38,000 on 12/31/x6 and 12/31/x7, respectively. • Since the trading securities account balance is at the fair value (under the direct adjustment), the end of period valuation adjustment is to increase the trading securities investment account by $800. Investments

  42. Example D (Contd.) • The Adjusting entry on 12/31/x7 Investment in Trading Securities* 800 Unrealized Holding Gain**-I/S 800 • *The investment bal. equals $38,000, the fair value, after the adjustment. • **Reported in the income statement Investments

  43. Investments in Held to Maturity Securities (debt securities only) • The account treatment (SFAS No. 115): (a) Initial Recording: at cost*(not using a discount or a premium account); (b)End of Period Reporting: at amortized cost; (c)Unrealized Holding Gains or Losses:not recognized. (d)Interests and realized gains (Losses) on Sale : all included in income. * the present value Investments

  44. Investments in Held-to-Maturity(HTM) Securities • APB opinion No.21 recommends separate disclosure of face amount ($100,000) and the discount ($1,000). • However, most investors do not use separate accounts for face value and the unamortized discount (or premium). • The discount ($1,000) will be amortized to increase the interest revenue using the effective interest method. Investments

  45. 6 period 6 period ?% Example E: amortization of discount or premium of investments in held-to-maturity • Assume that Green acquires an investment in bonds that will be held to maturity with a face value of $100,000 for $102,458.71 on 1/1/x5. The stated interest rate is 13% and interests are paid on 6/30 and 12/31. The bonds mature on 12/31/x7. The effective interest rate is 12%* * 102,458.71 = 100,000 x 0.70496 + 6,500 x 4.91732 semiannual effective interest rate = 6% Investments

  46. Example E:(contd.) J.E • 1/1/x5 Investment in Bonds - held-to-maturity 102,458.71 Cash 102,456.71 • 6/10/x5 Cash 6,500 Interest Revenue* 6,147.52 Inv. in Bonds 352.48 Investments

  47. Example E: record the premium in a separate account (An alternative) J.E • 1/1/x5 Investment in Bonds 100,000 Prem. on Bond Inv. 2,458.71 Cash 102,456.71 • 6/10/x5 Cash 6,500 Interest Revenue* 6,147.52 Prem. on Bond Inv. 352.48 Investments

  48. Example E:(contd.) * Interest Rev. = Present Value x Effective Rate = 102,458.71 x 6% = 6,147.52 • Amortization of Premiums(discounts) on investments decreases (increases) interest revenue. Investments

  49. Bond Investment Interest revenue and Premium Amortization Schedule • Effective Interest Method Investments

  50. Bond Investment Interest revenue and Premium Amortization Schedule:(contd.) • Straight-Line Method Investments

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