1 Investments ACCTG 5120 David Plumlee. page2 Financial Instruments Any contract that Imposes on a 1st entity on potentially unfavorable terms with 2nd.
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page2 Financial Instruments Any contract that Imposes on a 1st entity on potentially unfavorable terms with 2nd entity an obligation to deliver cash or other financial instrument to the 2nd entity or to exchange financial instrument Conveys to 2nd entity at potentially favorable terms a contractual right to receive cash or other financial instrument from 1st entity or to exchange financial instruments
page3 Equity Investments 0%20%50% 100% What are the important “ownership” percentages when accounting for an investment in another entity? Significant influence No significant influence CONTROL
page4 Guidelines for Equity Investments 0%20%50% 100% cost or fair value (i.e. FASB 115) equity method consolidate How does “ownership percentage” affect accounting for an investment in another entity?
page5 Background - Pre-FASB 115 Inconsistencies – accounting for debt was either amortized cost or LCM, while equity as LCM Income manipulation (cherry picking) BV irrelevant Prior to FASB 115, what were the concerns about accounting treatment of investments?
page6 Scope of FASB 115 FASB 115 assumes that market value is readily available, what if its is not? Record at cost (equity) or amortized cost (debt) To what Investments does FASB 115 apply? equity securities with no significant influence debt securities
page7 Classifications Under FASB 115 Trading securities -- debt or equity securities intended to be actively traded Held-to-maturity-- debt securities where the entity has both the intent and ability to hold to maturity Available-for-sale all other debt or equity securities FASB 115 looks to the intent of management to classify investments, what are the 3 classifications?
page8 Held-to-Maturity Securities Interest including discount/premium amortization; no adjustment for FV How are held-to-maturity investments valued on the balance sheet? amortized cost using effective interest method to amortize premium/discount What is considered as income for held-to-maturity investments?
page9 Example - Held to Maturity Jan. 1, 2004: Acme Co. purchases $100,000 face amount, 7% bonds of Olsen Co. for $96,634, and it intends to hold to maturity, Dec. 31, 2007 Yielding 8% per year when purchased Interest paid June 30 and December 31 Acme uses effective interest rate method to amortize discount FV at December 31, 2004 is $98,000
page10 Journal Entries held to maturity 96,634 cash 96,634 JE to record purchase at January 1, 2004: cash (100,000 x 3.5%)3,500 held to maturity (plug) 365 interest income (96,634 x 4%)3,865 JE to record income at June 30, 2004:
page11 Journal Entries Unrealized gain at 12/31/04 not recorded! fair value 98,000 cost basis97,379 unrealized gain 621 cash (100,000 x 3.5%)3,500 held to maturity (plug) 380 interest income* 3,880 *(96,634 + 365) x 4% JE to record income at Dec. 31, 2004:
page12 Available for Sale Securities How are available for sale investments valued on the balance sheet? Record purchase at cost adjust to fair value at period end Include unrealized gain/loss in equity not in current year income
page13 Available for Sale Securities Dividend income Interest received adjusted by premium/discount amortization Upon sale, realized gains and/or losses proceeds - cost basis What is considered as income for available for sale investments?
page14 Example - Available for Sale Jan. 1, 2004: Acme Co. purchases the following: # Shares Price Total $ Red Co. stock 5,000 $12 $60,000 Blue Co. stock 1,000 $80 $80,000 March 1, 2004: $5,000 dividends received from Red. December 31, 2004 FV: Red Co. ($14 x 5,000)$70,000 Blue Co. ($75 x 1,000)$75,000
page15 Example - Available for Sale June 15, 2005: 2,500 shares of Red Co. stock sold for $9/share December 31, 2005 fair values: Red Co. ($9 x 2,500)$22,500 Blue Co. ($78 x 1,000)$78,000
page16 Journal Entries available for sale140,000 cash 140,000 JE to record purchase at January 1, 2004: cash 5,000 dividend income 5,000 JE to record income at March 1, 2004:
page17 Journal Entries December 31, 2004: adjust to FMV fair value 145,000 cost basis -140,000 unrealized gain 5,000 valuation allowance (AFS)5,000 unreal. gain/loss - B/S5,000 What is the adj. JE?
page18 Calculation for each asset.. Red stock Cost $12/share 60,000 FMV$14/share70,000 Valuation allowance $10,000 DR Blue stock Cost$80/share80,000 FMV$75/share75,000 Valuation allowance $ 5,000 CR Net valuation 5,000 DR
page19 Balance sheet presentation Current assets Investments AFS,at fair value (net)145,000 PPE etc. XXXX Total Assets XXX,XXX Total Liabilities XXXX Stockholders’ Equity Unrealized gain on AFS securities 5,000 Total stockholders equity XXXX Total Liabilities and S EquityXXX,XXX
page20 Journal Entries JE to record sale of shares at June 15, 2005: sale proceeds (2,500 x $9)22,500 cost basis (2,500 x $12)30,000 realized loss on sale (7,500) cash22,500 loss on sale 7,500 available for sale30,000 What is the JE for the sale?
page21 Journal Entries JE to adjust to FMV at December 31, 2005: fair value 100,500 cost basis (2,500@$12; 1,000@$80) 110,000 unrealized loss (9,500) unreal. gain/loss - B/S 14,500 valuation allowance (AFS)14,500 change in valuation allowance: current balance$5,000 debit required balance$9,500 credit What is the adj. JE?
page22 Calculation for each asset.. Red stock Cost $12/share 30,000 FMV @ 12/31/04 $14/share 70,000 FMV @ 12/31/05 $9/share 22,500 Valuation allowance $ 7,500 CR Blue stock Cost $80/share 80,000 FMV @12/31/04 $75/share 75,000 FMV @ 12/31/05 $78/share 78,000 Valuation allowance $ 2,000 CR Net valuation 9,500 CR compare
page23 Balance sheet presentation Current assets Investments AFS sec,at fair value (net) 100,500 PPE etc. XXXX Total Assets XXX,XXX Stockholders’ Equity Unrealized gain(loss) on AFS securities (9,500) Total stockholders equity XXXX Total Liabilities and S Equity XXX,XXX
page24 Trading Securities How are Trading Securities investments valued on the balance sheet? Record purchase at cost adjust to fair value at period end
page25 Trading Securities Dividend income (equity) or interest received (debt) NOT adjusted by premium/discount amortization Unrealized gains/losses Upon sale, realized gains and/or losses proceeds - cost basis What is considered as income for Trading Securities investments?
page26 Journal Entries The JE are identical to entries for available for sale securities except Unrealized gains/losses are taken to the income statement No adjustment to amortize bond discount/premium
page27 Equity method Situations where the investor has “significant influence,” but not control (>20% and < 50% ownership). When do we account for investments using the equity method? Dividends paid by investee is recorded as reduction of asset account Income earned by investee is recorded as income by investor What are the important differences in the way we account for these investments?
page28 Journal Entries Investment in Red Co.60,000 cash 60,000 JE to record purchase at January 1, 2004: cash 5,000 Investment in Red Co.5,000 JE to record income at March 1, 2004:
page29 Journal Entries Investment in Red Co. 15,000 Revenue from investment15,000 Assume Acme has a 30% ownership and Red’s reported income is $50,000 What is the JE to record Acme’s investment income in 2004? No entry for FMV adjustment!!
page30 Current assets Long term investments Inv in Red Co 70,000 PPE etc. XXXX Total Assets XXX,XXX Stockholders’ Equity Total stockholders equity XXXX Total Liabilities and S Equity XXX,XXX Balance sheet presentation Original investment $60,000 Dividends (5,000) Pro Rata Income 15, 000
page31 Equity Method Stock Sale Acme sold 1/2 of its investment in Red Company for $25,000. What is the JE to record Acme’s investment sale? Cash 25,000 Loss on sale 10,000 Investment in Red 35,000
page32 Transfers from one category to another FV at date of transfer--new cost basis Unrealized gains/losses are recognized How to you account for transfers from Trading to AFS? FV at date of transfer--new cost basis Unrealized gains/losses are recognized How to you account for transfers from AFS to Trading? Cannot avoid gains/losses by transferring!
page33 Transfers from one category to another AFS to HTM FV at date of transfer Unrealized gain/loss is amortized over life of security How to you account for transfers from Hold to Maturity to AFS? FV at date of transfer Unrealized gain/loss effective at date of transfer How to you account for transfers from AFS to Hold to Maturity?