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COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

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Presentation on theme: "COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license."— Presentation transcript:

1 COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Investments in Debt & Equity Securities Chapter 14 S t I c e | S t I c e | S k o u s e n Intermediate Accounting 16E Modified by A. Phassawan S.

2 Learning Objectives 1.Classifications of investment securities. 2.Purchase of investment securities. 3.Recognition of revenue from investment securities. 4.Change in value of investment securities. 5.Sale of investment securities.

3 Classifications of Investment Securities Available- for-sale Trading Held-to- maturity Debt Equity Method Equity Cost Method

4 Classifications of Investment Securities Equity Method Securities –Potentially purchased with the intent to control or significantly influence the operations of the investee. –Represents ownership in a company and includes rights to collect dividends and to vote on corporate matters.

5 Exhibit 14-8 Different Accounting Treatments ClassificationTypesDisclosure on B/S Changes in Value Held to MaturityDebtAmortized Cost Not Recognized Available for sale Debt/ Equity FMVReported in Equity TradingDebt/ Equity FMVReported in I/S Equity MethodEquityHistorical cost adjusted for changes in the net assets of investee Not recognized

6 Learning Objectives 1.Classifications of investment securities. 2.Purchase of investment securities. 3.Recognition of revenue from investment securities. 4.Change in value of investment securities. 5.Sale of investment securities.

7 Purchases of Debt Securities On May 1, ABC purchases $100,000 in U.S. Treasury notes at 104¼, including brokerage fees. Interest is 9% payable semiannually on Jan 1 & July 1. The debt securities are classified by the purchaser as trading securities. Asset Approach Inv. in Trading Security 104,250 Interest Receivable 3,000 Cash 107,250 Purchase date May 1 : Cash4,500 Interest Receivable 3,000 Interest Revenue 1,500 Receipt of semiannual payment July 1 : Inv. in Trading Security104,250 Interest Revenue 3,000 Cash 107,250 Cash4,500 Interest Revenue 4,500 Revenue Approach

8 Purchase of Equity Securities ABC Co. purchased 300 shares of Boro Co. stock as $75/share plus brokerage fees of $80 and 500 shares of Fara Inc. stock at $50/share plus brokerage fee of $30. The Boromir stock is classified as a trading security, but the Faramir stock is classified as available for sale. Investment in Trading Securities - Boro 22,580 Investment in Available-for- Sale Securities- Fara 25,030 Cash 47,610

9 Learning Objectives 1.Classifications of investment securities. 2.Purchase of investment securities. 3.Recognition of revenue from investment securities. 4.Change in value of investment securities. 5.Sale of investment securities.

10 Revenue from Debt Securities Debt Securities carry with them a stated rate of interest, indicating the amount of cash to be received in interest each year. When interest is received, CashXX Interest revenueXX

11 Revenue from Debt Securities When the debt security is issued at premium or discount and is classified at held-to-maturity, there is a need of periodic amortization of premium or discount with corresponding adjustments to interest revenue. Note that if the debt security is not classified as being held to maturity, the amortization process becomes less relevant.

12 Revenue from Debt Securities The debt security is issued at premium –a stated rate of interest > a market rate The debt security is issued at discount –a stated rate of interest < a market rate Note that to calculate the value of debt security at the time of purchase, the present value of debt security is required.

13 PV of 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%. 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

14 Debt Securities (Trading) The first receipt of interest on July 1 Cash5,000 Interest Revenue (100,000*0.05)5,000 Initial purchase of bonds on Jan 1 Investment in trading securities108,110 Cash108,110

15 Debt Securities (Held-to-Maturity) Initial purchase of bonds on Jan 1 Investment in held-to-maturity securities 108,110 Cash108,110 The first receipt of interest on July 1 Cash(100,000*0.05) 5,000 Interest Revenue (108,110*0.04)4,324 Investment in Held-to-Maturity Securities676 The second receipt of interest on Jan 1 Cash (100,000*0.05) 5,000 Interest Revenue (107,434*0.04)4,297 Investment in Held-to-Maturity Securities703

16 Premium Amortization Schedule (Effective-Interest Method) Interest Payment ABCDE Interest received (0.05* $100,000) Interest revenue (0.04*E) Premium Amort. (A-B) Unamort. Premium (D-C) Bond Carrying value ($100,000+D) 8,110108,110 15,0004, ,434107,434 25,0004, ,731106,731 35,0004, ,000106,000 ::::: ::::: 105,0004, ,000 Cash Interest Revenue Inv. in HTM securities

17 Discount Amortization Schedule (Effective-Interest Method) Interest Payment ABCDE Interest received (0.04* $100,000) Interest revenue (0.05*E) Discount Amort. (B-A) Unamort. Discount (D-C) Bond Carrying value ($100,000-D) 7,72392,277 14,0004, ,10992,891 24,0004, ,46493,536 34,0004, ,78794,213 ::::: ::::: 104,0004, ,000 Cash Interest Revenue Inv. in HTM securities

18 Revenue from Equity Securities 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

19 Revenue from Equity Securities (Trading and AFS) Deli Co. announces dividends of $0.25 per share. Assume that Citty Co. owns 1,000 shares Cash250 Dividend Revenue 250 Note that the dividend revenue is recognized when the dividend is declared or when it is received from the investee.

20 Revenue from Equity Securities (Equity Method Security) Assume that Biotech Inc. purchased 40% of outstanding shares of Medco Enterprises on Jan 1 by paying 200,000. Investment in Medco Stock 200,000 Cash 200,000 To record the purchase of 40% of Medco stock

21 Revenue from Equity Securities (Equity Method Security) During the year, Medco reported (1) Net Income of $50,000 and paid (2) dividends of $10,000. Biotech would make the following journal entries. Cash(10,000*0.4) 4,000 Investment in Medco Stock 4,000 Investment in Medco Stock20,000 Income from Investment in Medco Stock (50,000*0.4) 20,

22 Learning Objectives 1.Classifications of investment securities. 2.Purchase of investment securities. 3.Recognition of revenue from investment securities. 4.Change in value of investment securities. 5.Sale of investment securities.

23 Accounting for the Change in Value of Securities 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 Stockholder’s equity Change On

24 Accounting for the Change in Value of Securities Eastwood Inc. purchased the following securities on March 23, Trading securities: FV, Dec 31 Purchase price (#1) $ 8,000 $7,000 Purchase price (#2) $ 3,000 $3,500 Available-for-sale securities: Purchase price (#3) $ 5,000 $6,100 Purchase price (#4) $12,000 $11,500 Held-to-maturity securities: Purchase price (#5) $20,000* $19,000 *purchased at face value, otherwise, the amortization is needed.

25 Accounting for the Change in Value of Securities Initial Purchase Entry Investment in Trading Securities11,000 Investment in Available-for-Sale Securities17,000 Investment in Held-to-Maturity Securities20,000 Cash 48,000

26 Accounting for the Change in Value of Securities 1)Unrealized loss on trading securities would be reported on I/S under Other Expenses and Losses 2)Market adjustment-Trading security is combined with Investment in Trading Securities and reported on the B/S By the end of the year, the value of the trading securities decreased from $11,000 to $10,500. December 31, 2008: Unrealized Loss on Trading Securities500 Market Adjustment—Trading Securities500

27 Accounting for the Change in Value of Securities December 31, 2008: Market Adjustment—Available-for-Sale Securities 600 Unrealized Increase in Value of Available-for-Sale Securities 600 By the end of the year, the value of the available-for-sale securities increased from $17,000 to $17,600. Increase the amount of stockholder’s equity

28 Accounting for the Change in Value of Securities Partial Balance Sheet for Eastwood Inc. Assets Invest. in trading securities$11,000 Market adjustment—trading 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 Total capital paid-in and retained earning XX Add unrealized increase in available-for-sale securities $ 600

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

30 Learning Objectives 1.Classifications of investment securities. 2.Purchase of investment securities. 3.Recognition of revenue from investment securities. 4.Change in value of investment securities. 5.Sale of investment securities.

31 Sale of Investment Securities When an investment security is sold, its carrying value is removed. –For trading and AFS securities, the carrying value will equal to the securities’ original cost. –For held-to-maturity security, the carrying value will change as any premium or discount is amortized. –For equity method security, the carrying value will change when the BV of the investee change. The different between carrying value and the cash received is recorded as a realized gain or loss.

32 Sale of Securities Assume that the debt securities are sold on April 1, 2009 for $103,000, which includes accrued interest of $2,500. The carrying value of on Jan 1, 2009 is 105,240. Apr. 1 Interest Receivable (100,000*0.1*3/12) 2,500 Investment in Held-to Maturity Securities 395 Interest Revenue (105,240*0.08*3/12)2,105 To record accrued revenue and amortize premium:

33 Sale of Securities Entry to record sale: Apr. 1 Cash 103,000 Realized Loss on Sale of Securities 4,353 Interest Receivable2,500 Investment in Held-to Maturity Securities(105, )104,845 Assume that the debt securities are sold on April 1, 2009 for $103,000, which includes accrued interest of $2,500. The carrying value of on Jan 1, 2009 is 105,

34 QUESTIONS


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