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1 Investment in Debt and Equity Securities chapter chapter 14.

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Presentation on theme: "1 Investment in Debt and Equity Securities chapter chapter 14."— Presentation transcript:

1 1 Investment in Debt and Equity Securities chapter chapter 14

2 2 1.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. Learning ObjectivesContinuedContinued

3 3 5.Account for the change in value of securities. 6.Account for the sale of investment securities. 7. Record the transfer of securities between categories. 8. Explain the proper classification and disclosure of investments in securities Learning ObjectivesContinuedContinued

4 4 Time Line of Business Issues Involved with Investment Securities 1.DETERMINE purpose of investment 2.CLASSIFY investments 3.PURCHASE securities 4.EARN AND RECOGNIZE a return 5.MONITOR changes in value 6.SELL securities 7.TRANSFER securities between categories 8.DISCLOSE status of portfolio at the end of the period

5 5 Why Companies Invest in Other Companies Safety Cushion Cyclical Cash Needs Investment for a Return Investment for Influence Purchase for Control

6 6 Investment in Debt and Equity Securities2001 Total Investment Percentage of Company (in billions) Total Assets Berkshire Hathaway$ % Microsoft Coca-Cola Citigroup AT&T Verizon

7 7 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. Classification of Investment in Securities Debt securities typically have the following characteristics:

8 8 These shares of stock typically carry with them the right to collect dividends and vote on corporate matters. Equity securities represent ownership in a company. Equity securities have the potential for significant increases in price. Classification of Investment in Securities

9 9 Debt/Equity Securities Trading Securities purchased for sale in the near future. Held-to- Maturity Securities purchased with the intent to hold until maturity. Available- for-sale Securities not classified as trading or held-to-maturity. Classification of Investment in Securities

10 10 Available- for-sale Trading Held-to- maturity Debt Equity Method Equity Classification of Investment in Securities Cost Method

11 11 Equity 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.

12 12 Different Accounting Treatments Classification of Securities Types of Securities Disclosure on the Balance Sheet Treatment of Temporary Changes in Value Held to maturityDebtAmortized costNot recognized Available for saleDebt/equityFair market valueReported in stockholders equity TradingDebt/equityFair market valueReported on the income statement Equity methodEquityHistorical cost Not recognized adjusted for changes in the assets of the investee

13 13 Purchases 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

14 14 Purchases of Debt Securities May 1 Investment in Trading Securities104,250 Interest Receivable3,000 Cash107,250 Purchase date: Asset Approach ContinuedContinued Always includes brokerage fees

15 15 Purchases of Debt Securities May 1 Investment in Trading Securities104,250 Interest Revenue3,000 Cash107,250 Purchase date: Revenue Approach ContinuedContinued

16 16 Purchases of Debt Securities Receipt of semiannual payment: July 1 Cash4,500 Interest Receivable3,000 Interest Revenue1,500 Asset Approach July 1 Cash4,500 Interest Revenue4,500 Revenue Approach

17 17 Purchase of Equity Securities - Available for Sale (AFS)/Trading Purchased 1,000 shares of AB Companys common shares at $2 per share. Investment in Available-for-Sale*/Trading Securities - AB Company 2,000 Cash 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

18 18 Citty Co. purchased 100,000 shares of AB Company common shares at $2 per share. Purchase of Equity Securities – Equity Method 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.

19 19 Purchased 100,000 shares of Daves Deli common shares at $2 per share. Equity Method Securities Investment in AB Company Stock 200,000 Cash 200,000 Purchase of Equity Securities - – Equity Method

20 20 Recognizing 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%.

21 21 PV/Price of Debt Securities Present value of principal: FV = $100,000; N = 10; I = 4%$ 67,556 Present value of interest payments: PMT = $5,000; N = 10; I = 4% 40,554 Total present value of the bonds$108,110 Investment in Trading Securities 108,100 Cash108,100 Investment in Held-to-Maturity Securities 108,100 Cash108,100 OR

22 22 Interest Revenue for Debt Securities (Trading) When the first interest payment is received from Silmaril, the following entry would be made: July 1 Cash5,000 Interest Revenue5,000

23 23 Interest Revenue for Debt Securities (Held-to-Maturity) When the first interest payment is received from Silmaril, the following entry would be made: July 1 Cash5,000 Interest Revenue4,324 Investment in Held-to- Maturity Securities676 $108,110 x.04

24 24 Recognizing Revenue for Equity Securities depends on the Appropriate Accounting Method 0% 20%50%100% No significant influence Significant influence Control Ownership Percentage Account for as trading or available-for-sale Equity method Equity method and consolidation procedures

25 25 Determining the Appropriate Accounting Method Ownership Interest Control or Degree of Influence Accounting Method Applicable Standard More than 50%ControlEquity methodAPB Opinion #18 and consolidationFASB Exposure proceduresDraft 20% to 50%SignificantEquity methodAPB Opinion #18 influence Less than 20%No Account for asFASB Statement significanttrading or No. 115 influenceavailable for sale

26 26 AB Company announces dividends of $0.25 per share. Assume that Citty Co. owns 10,000 of ABs 200,000 shares (which represents 5%) Cash 2,500 Dividend Revenue2,500 Revenue for Equity Securities Classified as Trading and AFS

27 27 Revenue 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 25,000 Investment in AB Company Stock25,000

28 28 Revenue 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 Company Stock 125,000 Income from Investment in AB Company Stock125,000

29 29 Accounting for Temporary Changes in Value of Securities (an extract of slide 12) Classification of Security Disclosed at Report FMV Trading Fair market value Income statement Held-to- maturity Amortized cost Not recognized Available- for-sale Fair market value Stockholders equity Change On

30 30 Accounting for Temporary Changes in Value of Securities SecurityClassificationCost($)FMV 31/12/05($) 1Trading8,0007,000 2Trading3,0003,500 3Available for Sale5,0006,100 4Available for Sale12,00011,500 5Held to Maturity20,00019,000 Eastwood Inc. bought the following securities on March 23, 2005.

31 31 Accounting for Temporary Changes in Value of Securities Investment in Trading Securities11,000 Investment in Available-for-Sale Securities17,000 Investment in Held-to-Maturity Securities20,000 Cash48,000 Initial Purchase Entry ContinuedContinued

32 32 December 31, 2005: Unrealized Loss on Trading Securities500 Market AdjustmentTrading Securities500 By the end of the year, the value of the trading securities decreased from $11,000 to $10,500. Accounting for Temporary Changes in Value of Securities Included in net income A contra account to the investment account

33 33 December 31, 2005: Market AdjustmentAvailable-for-Sale Securities600 Unrealized Increase/Decrease in Value of Available-for-Sale Securities600 By the end of the year, the value of the available-for-sale securities increased from $17,000 to $17,600. Accounting for Temporary Changes in Value of Securities Included in stock holders equity => Comprehensive income

34 34 Partial Balance Sheet for Eastwood Inc. Assets Invest. in trading securities$11,000 Market adjustmenttrading sec. (500) $10,500 Invest. in available-for-sale sec.$17,000 Market adjustment ,600 Invest. in held-to-maturity sec. 20,000 $48,100 Stockholders Equity Add unrealized increase in available-for-sale securities $ 600 Accounting for Temporary Changes in Value of Securities

35 35 Partial Income Statement for Eastwood Inc. Other expenses and losses: Unrealized loss on trading securities$500 Accounting for Temporary Changes in Value of Securities


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