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Chapter 9--Learning Objectives 1.Explain the recognition and measurement issues associated with investments.

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Presentation on theme: "Chapter 9--Learning Objectives 1.Explain the recognition and measurement issues associated with investments."— Presentation transcript:

1 Chapter 9--Learning Objectives 1.Explain the recognition and measurement issues associated with investments

2 The primary accounting standards for investments are: FASB SFAS No. 115 For all debt securities For equity investments of less than 20 percent APB Opinion No. 18 For equity investments of more than 20 percent

3 Major provisions of SFAS No. 115 Investments accounted for at fair value or amortized cost Investments classified as: 1.Trading securities 2.Available-for-sale 3.Held-to-maturity

4 Passive investments and significant influence A passive investment is one in which the investor has no ability to exercise significant influence over the investee Significant influence is presumed to exist with ownership of 20 percent to 50 percent of the voting stock of the investee

5 Investment classifications Trading securities Debt and equity securities bought and held principally for the purpose of sale in the near term Available-for-sale securities Debt and equity securities neither trading nor held-to-maturity Held-to-maturity securities Debt securities that the entity has the positive intent and ability to hold to maturity

6 Accounting requirements for Trading securities (investments less than 20 percent) Changes in market value recognized as gain or loss in current period income Securities reported at market value

7 Accounting requirements for Available-for-sale securities (investments less than 20 percent) Changes in market value recognized as separate component of shareholders equity until realized Securities reported at market value

8 Accounting requirements for Held-to-maturity securities (debt securities only) Changes in market value not recognized Securities reported at amortized cost

9 Major provisions of APB Opinion No. 18 Applies to ownership of equity securities greater than 20 percent For ownership of 20 to 50 percent, use the equity method For ownership of greater than 50 percent, use consolidated financial statements

10 The equity method (equity investments of 20 to 50 %) Investments recorded at cost Investment increased for proportionate share of net income Investment decreased for: 1.Dividends received 2.Extra depreciation 3.Amortization of goodwill

11 Consolidate financial statements (equity investments of more than 50 percent) This material is beyond the scope of our course (so much GAAP, so little time)

12 Chapter 9--Learning Objectives 2.Record and report transactions for debt-security investments and equity- security investments of less than 20%

13 Held to maturity debt securities Record acquisitions at cost Investment in Debt SecuritiesXXX CashXXX Record interest as income CashXXX Interest IncomeXXX

14 Held to maturity debt securities If purchased at premium, include in cost Investment in Debt SecuritiesXXX CashXXX Amortize by reducing investment value CashXXX Interest RevenueXXX Investment in Debt SecuritiesXXX

15 Held to maturity debt securities If purchased at discount, record at cost Investment in Debt SecuritiesXXX CashXXX Amortize by increasing investment value CashXXX Investment in Debt SecuritiesXXX Interest RevenueXXX

16 Held to maturity debt securities Ignore market value changes for held to maturity debt securities !

17 Sale of held to maturity debt securities before maturity Accrue interest as required Determine amortized cost Compare with selling price Recognize gain or loss based on difference between amortized cost (book value) and selling price

18 Available for sale debt securities Procedures for purchase, interest, and premium or discount amortization are same as for held to maturity debt securities Exception: Market value changes are adjusted for

19 Available for sale debt securities If market value is above amortized cost Adjustment to MarketXXX Unrealized Holding GainXXX Adjustment to Market is shown on the balance sheet along with the investment account Unrealized Gain is shown as a separate account in the equity section

20 Available for sale debt securities If market value is below amortized cost Unrealized Holding LossXXX Adjustment to MarketXXX Adjustment to Market is shown on the balance sheet along with the investment account as a reduction of value Unrealized Loss is shown as a separate negative account in the equity section

21 Debt Securities--Trading 4 Recorded at cost 4 Amortization ignored 4 Changes in fair value recorded in current income

22 Accounting for equity trading securities Record acquisitions at cost Investment in Trading SecuritiesXXX CashXXX Record dividends and interest as income CashXXX Dividend IncomeXXX

23 Accounting for equity trading securities If market value on reporting date is lower than original cost Loss on Holding Equity SecuritiesXXX Invest. in Trading SecuritiesXXX If market value is higher than cost Invest. in Trading SecuritiesXXX Gain on Holding Equity Sec.XXX

24 Available for sale equity securities Record acquisitions at cost Investment in AFS SecuritiesXXX CashXXX Record dividends and interest as income CashXXX Dividend IncomeXXX

25 Available for sale equity securities If market value on reporting date is lower than original cost Unrealized Loss on AFS Sec.XXX Investment in AFS SecuritiesXXX The Unrealized Loss account is shown as a separate component of stockholders equity (a reduction in this case) It is NOT shown on the income statement

26 Available for sale equity securities If market value on reporting date is higher than original cost Investment in AFS SecuritiesXXX Unrealized Gain on AFS Sec.XXX The Unrealized Gain account is shown as a separate component of stockholders equity (an increase in this case) It is NOT shown on the income statement

27 Transfers between categories Base classification on management intent Transfer between categories based on fair market value at time of transfer Recognize any unrealized holding gain or loss at time of transfer Include in income for securities transferred into or from trading category Show as separate stockholders equity item for securities transferred into available for sale category from held-to-maturity

28 Impairment of Securities 4 Permanent loss.Security written down to fair value 4 Loss included in earnings as realized

29 Chapter 9--Learning Objectives 3.Record and report equity-security investment transactions of greater than 20%

30 The equity method Used for situations in which more than 20 percent of the voting stock is owned If more than 50 percent is owned, consolidated financial statements are prepared Thus, the equity method applies to situations of 20 to 50 percent

31 Equity method procedures Record purchase of investment at cost Investment in Other CompanyXXX CashXXX

32 Equity method procedures Increase investment value on reported earnings Investment in Other CompanyXXX Investment IncomeXXX Decrease investment value on reported losses Investment Income (Loss)Investment Income (Loss)XXX Investment in Other CompanyXXX

33 Equity method procedures Decrease investment value on dividends CashXXX Investment in Other CompanyXXX

34 Equity method procedures Amortize differences between the book value and the fair market value of investee depreciable assets over the asset lives Amortization of goodwill reduces investment income and investment value Investors share of any extraordinary items or changes in accounting principle are shown as such (must be material)

35 Investments and cash flows Cash flows from purchases, sales and maturities of trading securities are operating activities on the cash flow statement Cash flows from purchases, sales and maturities of available for sale and held to maturity securities are investing activities on the cash flow statement

36 Chapter 9--Learning Objectives 4.Record and report transactions for funds and life insurance investments

37 Sinking funds Funds set aside for retirement of debts

38 Accounting for funds Recording contributions to fund Sinking Fund CashXXX CashXXX Recording purchase of fund investments Sinking Fund InvestmentsXXX Sinking Fund CashXXX

39 Accounting for funds Receipt of investment income Sinking Fund CashXXX Sinking Fund RevenueXXX Payment of expenses Sinking Fund ExpenseXXX Sinking Fund CashXXX

40 Accounting for funds Sale of investments Sinking Fund CashXXX Sinking Fund InvestmentsXXX Gain on Sale of Inv.XXX

41 Accounting for funds Bond maturity and closing of fund Bonds PayableXXX CashXXX Sinking Fund CashXXX

42 Cash surrender value of life insurance Businesses frequently purchase life insurance policies on key personnel Term life insurance is accounted for simply as an expense Whole-life policies have cash surrender values and loan values The increase in cash value is accounted for as an investment

43 Life insurance entries for policies with cash surrender value Payment of premium Life Insurance ExpenseXXX Cash Surrender Value of LIXXX CashXXX

44 Life insurance entries for policies with cash surrender value Death of key person, receipt of benefit CashXXX Cash Surrender Value of LIXXX Gain on Life InsuranceXXX

45 Chapter 9--Learning Objectives 5.Analyze the impact of the different accounting methods for investments on profitability and liquidity measures

46 The differences between the methods of accounting for investments can affect income Changes in market value are included in income for trading securities but not for others Investee reported profits are included in income under the equity method but not under the cost method

47 The differences between the methods of accounting for investments can affect liquidity Trading securities and some available for sale securities are treated as current assets But other investments are not classified as current assets

48 Chapter 9--Learning Objectives 6.Understand the concept and complexities associated with derivative financial instruments

49 What are derivatives ? Financial instruments that provide the holder with the right or obligation to participate in the price changes of an underlying asset Underlying assets may involve interest rates, price indexes, or other market indicators Example

50 Derivative Financial Instruments 4 Manage financial risk due to changes in –Fair values –Cash flows –Foreign currency exchange rates

51 Derivatives as Hedges 4 Fair value hedges 4 Cash flow hedges 4 Foreign currency hedges

52 Accounting for gains & losses 4 Report gains & losses in income for –Hedges with no designation –Fair value hedges 4 Report gains & losses in other comprehensive income for –Effective cash flow hedges –Foreign currency hedges


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