Presentation on theme: "Investment in Debt and Equity Securities"— Presentation transcript:
1Investment in Debt and Equity Securities chapter 14Investment in Debt and Equity Securities
2Learning Objectives1. Determine why companies invest in other companies.2. Understand the varying classifications associated with securities.3. Account for the purchase of debt and equity securities.4. Account for the recognition of revenue from investments.Continued
3Learning Objectives5. Account for the change in value of securities.6. Account for the sale of investment securities.Record the transfer of securities between categories.Explain the proper classification and disclosure of investments in securitiesContinued
4Time Line of Business Issues Involved with Investment Securities DETERMINE purpose of investmentCLASSIFY investmentsPURCHASE securitiesEARN AND RECOGNIZE a returnMONITOR changes in valueSELL securitiesTRANSFER securities between categoriesDISCLOSE status of portfolio at the end of the period
5Why Companies Invest in Other Companies Safety CushionCyclical Cash NeedsInvestment for a ReturnInvestment for InfluencePurchase for Control
6Investment in Debt and Equity Securities—2001 Total Investment Percentage ofCompany (in billions) Total AssetsBerkshire Hathaway $ %MicrosoftCoca-ColaCitigroupAT&TVerizon
7Classification of Investment in Securities Debt securities typically have the following characteristics:1. A maturity value, representing the amount to be repaid to the debt holder at maturity.2. An interest rate that specifies the periodic interest payments.3. A maturity date, indicating when the debt obligation will be redeemed.
8Classification of Investment in Securities Equity securities represent ownership in a company.These shares of stock typically carry with them the right to collect dividends and vote on corporate matters.Equity securities have the potential for significant increases in price.
9Classification of Investment in Securities Debt/EquitySecuritiesHeld-to-MaturitySecurities purchased with theintent to hold until maturity.TradingSecurities purchased for salein the near future.Available-for-saleSecurities not classified astrading or held-to-maturity.
10Classification of Investment in Securities DebtEquityHeld-to-maturityAvailable-for-saleTradingEquity MethodCost Method
11Equity Method Securities These are securities purchased with the intent to control or significantly influence the operations of the investee.At least 20 percent of the outstanding voting stock must be owned to have this significant influence or control.Even then, there may be evidence to support the fact that even a 20 percent investment does not have significant influence.
12Different Accounting Treatments Disclosure on the Balance SheetTreatment of Temporary Changes in ValueClassification of SecuritiesTypes of SecuritiesHeld to maturity Debt Amortized cost Not recognizedAvailable for sale Debt/equity Fair market value Reported in stockholders’ equityTrading Debt/equity Fair market value Reported on the income statementEquity method Equity Historical cost Not recognized adjusted for changes in the assets of the investee
13Purchases 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:$100,000 x .09 x 4/12 = $3,000
14Always includes brokerage fees Purchases of Debt SecuritiesAsset ApproachAlways includes brokerage feesPurchase date:May 1 Investment in Trading Securities 104,250Interest Receivable 3,000Cash 107,250Continued
15Purchases of Debt Securities Revenue ApproachPurchase date:May 1 Investment in Trading Securities 104,250Interest Revenue 3,000Cash 107,250Continued
17Purchase of Equity Securities - Available for Sale (AFS)/Trading Purchased 1,000 shares of AB Company’s common shares at $2 per share.Investment in Available-for-Sale*/TradingSecurities - AB Company 2,000Cash 2,000* - would be so classified if management has no intention of holding them for a long period of time and will sell them as soon as it is economically advantageous
18Purchase of Equity Securities – Equity Method Citty Co. purchased 100,000 shares of AB Company common shares at $2 per share.Assume that the 100,000 shares purchased represents 20 % of the outstanding voting stock of AB Company. This investment gives the investor significant influence over AB Company.
19Purchase of Equity Securities - – Equity Method Purchased 100,000 shares of Dave’s Deli common shares at $2 per share.Equity Method SecuritiesInvestment in AB Company Stock 200,000Cash 200,000
20Recognizing Revenue from Debt Securities On January 1, 2004, 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 bonds of similar quality and maturity is 8%.
21PV/Price of Debt Securities Present value of principal:FV = $100,000; N = 10; I = 4% $ 67,556Present value of interest payments:PMT = $5,000; N = 10; I = 4% ,554Total present value of the bonds $108,110Investment in Trading Securities ,100Cash 108,100ORInvestment in Held-to-Maturity Securities 108,100Cash 108,100
22Interest Revenue for Debt Securities (Trading) When the first interest payment is received from Silmaril, the following entry would be made:July 1 Cash 5,000Interest Revenue 5,000
23Interest Revenue for Debt Securities (Held-to-Maturity) When the first interest payment is received from Silmaril, the following entry would be made:July 1 Cash 5,000Interest Revenue 4,324Investment in Held-to-Maturity Securities 676$108,110 x .04
24Recognizing Revenue for Equity Securities depends on the Appropriate Accounting Method Account for as trading or available-for-saleEquity method and consolidation proceduresEquity methodOwnership PercentageNosignificantinfluenceSignificantinfluenceControl0%20%50%100%
25Control or Degree of Influence Determining the Appropriate Accounting MethodControl or Degree of InfluenceOwnership InterestAccounting MethodApplicable StandardMore than 50% Control Equity method APB Opinion #18 and consolidation FASB Exposure procedures Draft20% to 50% Significant Equity method APB Opinion #18 influenceLess than 20% No Account for as FASB Statement significant trading or No influence available for sale
26Revenue for Equity Securities Classified as Trading and AFS AB Company announces dividends of $0.25 per share. Assume that Citty Co. owns 10,000 of AB’s 200,000 shares (which represents 5%)Cash 2,500Dividend Revenue 2,500
27Revenue for Equity Securities Classified as Equity Method Securities AB Company announces dividends of $0.25 per share. Assume that Citty Co. owns 100,000 which represents 50 % of the outstanding voting stock.Cash 25,000Investment in AB CompanyStock 25,000
28Revenue for Equity Securities Classified as Equity Method Securities AB Company reports an income of $250,000 for the year. Again, assume that Citty Co. owns 50 % of the outstanding voting stock.Investment in AB CompanyStock 125,000Income from Investmentin AB Company Stock 125,000
29Accounting for Temporary Changes in Value of Securities (an extract of slide 12) Classificationof SecurityDisclosedatReport FMVChange OnFair marketIncomeTradingvaluestatementAvailable-for-saleFair marketvalueStockholder’sequityHeld-to-maturityAmortizedcostNotrecognized
30Accounting for Temporary Changes in Value of Securities Eastwood Inc. bought the following securities on March 23, 2005.SecurityClassificationCost($)FMV 31/12/05($)1Trading8,0007,00023,0003,5003Available for Sale5,0006,100412,00011,5005Held to Maturity20,00019,000
31Accounting for Temporary Changes in Value of Securities Initial Purchase EntryInvestment in Trading Securities 11,000Investment in Available-for-SaleSecurities 17,000Investment in Held-to-MaturitySecurities 20,000Cash 48,000Continued
32A contra account to the “investment account” Accounting for Temporary Changes in Value of SecuritiesBy the end of the year, the value of the trading securities decreased from $11,000 to $10,500.A contra account to the “investment account”December 31, 2005:Unrealized Loss on Trading Securities 500Market Adjustment—Trading Securities 500Included in net income
33Included in stock holder’s equity => Comprehensive income Accounting for Temporary Changes in Value of SecuritiesBy the end of the year, the value of the available-for-sale securities increased from $17,000 to $17,600.Included in stock holder’s equity => Comprehensive incomeDecember 31, 2005:Market Adjustment—Available-for-SaleSecurities 600Unrealized Increase/Decrease in Valueof Available-for-Sale Securities 600
34Accounting for Temporary Changes in Value of Securities Partial Balance Sheet for Eastwood Inc.AssetsInvest. in trading securities $11,000Market adjustment—trading sec (500) $10,500Invest. in available-for-sale sec. $17,000Market adjustment ,600Invest. in held-to-maturity sec ,000$48,100Stockholders’ EquityAdd unrealized increase inavailable-for-sale securities $ 600
35Accounting for Temporary Changes in Value of Securities Partial Income Statement for Eastwood Inc.Other expenses and losses:Unrealized loss on tradingsecurities $500