1 Investments in Debts and Equity Securities

2  Determine why companies invest in other companies.  Understand the varying classifications associated with securities.  Account for the purchase of debt and equity securities.  Account for the recognition of revenue from investments. Learning Objectives

3  Account for the change in value of securities.  Account for the sale of securities.  Record the transfer of securities between categories.  Explain the proper classification and disclosure of investments in securities. Learning Objectives

4  Compare the accounting for securities under U.S. GAAP with the international standard in IAS 39. Learning Objectives EXPANDED MATERIAL  Account for changes to and from the equity method of accounting for securities. Account for the impairment of a loan receivable. 11

5 Time Line of Business Issues Involved with Investment Securities DETERMINE purpose of investment ?

6 Time Line of Business Issues Involved with Investment Securities CLASSIFY investments a, b, c

7 Time Line of Business Issues Involved with Investment Securities Cloud Corporation $100 par value xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxXxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxx. Cloud Corporation $100 par value xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxXxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxx. Good Buy Corporation $10 par value xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxXxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxx. PURCHASE securities

8 Time Line of Business Issues Involved with Investment Securities Cloud Corporation $100 par value xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxXxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxx. Cloud Corporation $100 par value xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxXxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxx. Good Buy Corporation $10 par value xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxXxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxx. EARN AND RECOGNIZE a return

9 Time Line of Business Issues Involved with Investment Securities Cloud Corporation $100 par value xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxXxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxx. Cloud Corporation $100 par value xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxXxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxx. Good Buy Corporation $10 par value xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxXxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxx. MONITOR changes in value

10 Time Line of Business Issues Involved with Investment Securities Cloud Corporation $100 par value xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxXxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxx. Cloud Corporation $100 par value xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxXxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxx. Good Buy Corporation $10 par value xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxXxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxx. SELL securities

11 Time Line of Business Issues Involved with Investment Securities TRANSFER securities between categories a b c

12 Time Line of Business Issues Involved with Investment Securities DISCLOSE status of portfolio at the end of the period

13  A maturity value, representing the amount to be repaid to the debt holder at maturity.  An interest rate that specifies the periodic interest payments.  A maturity date, indicating when the debt obligation will be redeemed. Classification of Securities Debt securities typically have the following characteristics:

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

15 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 Securities

16 Classification of Securities Available- for-sale Trading Held-to- maturity Debt Equity Method Equity

17 Purchases of Debt Securities On May 1, Douglas, Inc. 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

18 Purchases of Debt Securities May 1 Investment in Trading Securities104,250 Interest Receivable3,000 Cash107,250 Purchase date: Asset Approach

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

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

21 Interest Revenue for Debt Securities (Held-To-Maturity) On January 1, 2001, Silmaril Technologies purchases 5-year, 10% bonds with a face value of $100,000 for $108,115. The bonds pay interest on January 1 and July 1. The market rate (yield) is 8%. Jan. 1 Investment in Held-to- Maturity Securities108,115 Cash108,115 Click arrow to return to Slide 37

22 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 Revenue4,325 Investment in Held-to- Maturity Securities675 $108,115 x.08 x 6/12

23 Equity Securities Equity securities represent ownership in a company. These shares of stock typically carry with them the right to collect dividends and to vote on corporate matters.

24 Determining the Appropriate Securities 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 Purchase of Equity Securities Purchased 100 shares of Dave’s Deli common shares at $2 per share. Available-for-Sale Investment in Available-for- Sale Securities 200 Cash 200

26 (Representing a 20% ownership) (Representing a 20% ownership) Purchased 1,000 shares of Dave’s Deli common shares at $2 per share. Equity Method Investment in Dave’s Deli Common Stock 2,000 Cash 2,000 Purchase of Equity Securities

27 Available-for-Sale Cash80 Dividend Revenue80 Received $0.80 per share dividend. Equity Method Cash 800 Investment in Dave’s Deli Common Stock800 Purchase of Equity Securities

28 Dave’s Deli announces earnings for the year of $10,000. Dave’s Deli announces earnings for the year of $10,000. Available-for-Sale No Entry Equity Method Investment in Dave’s Deli Common Stock 2,000 Income from Investments2,000 Purchase of Equity Securities

29 Reporting Temporary Changes in Value 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

30 Example: Temporary Changes in Value Rocky’s Financial Corp. has the following securities in its portfolio: Trading securities: –Purchase price $ 8,000 –Value end of year$ 7,000 Available-for-sale securities: –Purchase price$ 5,000 –Value end of year$ 6,100 Held-to-maturity securities: –Purchase price$20,000 –Value end of year$23,000

31 Example: Temporary Changes in Value Assuming all securities were purchased on the same day, prepare Rocky’s journal entries for: –Purchase. –Year-end adjustments.

32 Example: Temporary Changes in Value (Solution) Date of Purchase: Investment in Trading Securities8,000 Investment in Available-for-Sale Securities5,000 Investment in Held-to-Maturity Securities20,000 Cash33,000

33 End of Year: Unrealized Loss on Trading Securities1,000 Market Adjustment--Trading Securities1,000 Market Adjustment--Available-for-Sale.1,100 Unrealized Increase/Decrease in Value Available-for-Sale Securities1,100 Example: Temporary Changes in Value (Solution) No entry is required for the held- to-maturity securities.

34 FASB No. 115 puts an end to “cherry-picking.” This is the practice of selectively selling securities whose prices have increased, while keeping those that have experienced losses or have maintained their historical cost.

35 Financial Statement Disclosure of Securities Partial Balance Sheet for Rocky’s Assets Invest. in trading securities$8,000 Market adjustment (1,000) $ 7,000 Invest. in available-for-sale sec.5,000 Market adjustment 1,100 6,100 Invest. in held-to-maturity sec. 20,000 Stockholders’ Equity Add unrealized increase in available-for-sale securities $ 1,100

36 Partial Income Statement for Rocky’s Other Expenses and Losses Unrealized loss on trading securities$1,000 Financial Statement Disclosure of Securities

37 Sale of Securities On April 1, 2003, the investment in Silmaril’s debt securities is sold for $103,000, which includes accrued interest of $2,500. Interest revenue of $2,105 ($105,248 x.08 x 3/12) would be recorded. On January 1, the debt securities had a carrying value of $105,248. The required amortization for the three-months’ premium between January 1 and April 1 is $395. To review the purchase transaction, click on the green dot.

38 Sale of Securities Entry to record accrued revenue and to amortize premium: Apr. 1Interest Receivable2,500 Investment in Held-to Maturity Securities395 Interest Revenue2,105 Entry to record sale: Apr. 1 Cash103,000 Realized Loss on Sale of Securities4,353 Interest Receivable2,500 Investment in Held-to Maturity Securities104,853

39 Transferring Securities Between Categories Transferred Treatment of Change in Value From “Trading”1. Recognize any previously unrecognized changes. 2. Do not reverse previously recognized changes.

40 Example: From “Trading” Assume: Cost of trading security$1,000 Fair market value, end of Year 11,600 Fair market value at transfer in Year 21,800 Proper adjusting entries were made at end of Year 1 Record a transfer to “Available-for-Sale” category.

41 Example: From “Trading” Investment in Available-for-Sale Securities1,800 Market Adjustment--Trading Securities 600 Unrealized Gain on Transfer of Securities 200 Investment in Trading Securities1,000 Record a transfer to “Available-for-Sale” category.

42 Transferring Securities Between Categories Transferred Treatment of Change in Value From “Trading”1. Recognize any previously unrecognized changes. 2. Do not reverse previously recognized changes. To “Trading”Recognize any previously unrecognized changes.

43 Example: To “Trading” Assume: –Cost of Available-for-Sale Sec.$10,000 –Fair market value, end of Year 1 8,700 –Fair market value at Transfer in Year 2 8,300 –Proper adjusting entries were made at End of Year 1 Record a transfer to “Trading” classification.

44 Example: To “Trading” Investment in Trading Securities 8,300 Market Adjustment--Available-for- Sale Securities 1,300 Unrealized Loss on Transfer of Securities700 Unrealized Increase/Decrease in Value of Available-for-Sale Securities1,300 Investment in Available-for-Sale Securities 10,000

45 Transferring Securities Between Categories Transferred Treatment of Change in Value From “Trading”1. Recognize any previously unrecognized changes. 2. Do not reverse previously recognized changes. To “Trading”Recognize any previously unrecognized changes. From “Held-to-Maturity” to “Available-for-Sale” Recognize any unrealized changes in value.

46 Example: From “Held-to- Maturity” to “Available for Sale” Assume: Cost of Held-to-Maturity Security $40,000 FMV End of Year 1 40,700 FMV at Transfer in Year 2 40,400 Proper adjusting entries were made at End of Year 1 Record a transfer from “Held- to-Maturity” to “Available-for- Sale” classification.

47 Example: From “Held-to- Maturity” to “Available for Sale” Investment in Available-for-Sale Securities 40,400 Unrealized Increase/Decrease in Value of Available-for- Sale Securities 400 Investment in Held-to-Maturity Securities40,000

48 Transferring Securities Between Categories Transferred Treatment of Change in Value From “Trading”1. Recognize any previously unrecognized changes. 2. Do not reverse previously recognized changes. To “Trading”Recognize any previously unrecognized changes. From “Held-to-Maturity” to “Available-for-Sale” Recognize any unrealized changes in value. From “Available-for-Sale” to “Held-to-Maturity” Amortize any recognized unrealized change using the effective-interest method.

49 Example: From “Available-for- Sale” to “Held-to-Maturity” Assume: Cost of Available-for-Sale securities$6,000 Fair market value, end of Year 17,500 Fair market value at Transfer in, Year 26,900 Proper adjusting entries were made at end of Year 1 Record a transfer from “Available- for-Sale” to “Held-to-Maturity”

50 Example: From “Available-for- Sale” to “Held-to-Maturity” Investment in Held-to-Maturity Securities 6,900 Unrealized Increase/Decrease in Value of Available-for-Sale Securities600 Investment in Available-for- Sale Securities6,000 Market Adjustment--Available- for-Sale Securities 1,500

51 Additional Disclosures Required by FASB 115 Trading securities –The change in net unrealized holding gain or loss that is included in the income statement. Available-for-sale securities –Aggregate fair value, gross unrealized holding gains and gross unrealized holding losses, and amortized cost basis by major security type. –The proceeds from sales of available-for-sale securities and the gross realized gains and losses on those sales and the basis on which cost was determined in computing realized gains and losses.

52 Additional Disclosures Required by FASB 115 Available-for-sale securities (continued): –The change in net unrealized holding gain or loss on available-for-sale securities that has been included in stockholders’ equity during the period. Held-to-maturity securities: –Aggregate fair value, gross unrealized holding gains and gross unrealized holding losses, and amortized cost basis by major security type. –The company should disclose information about contractual maturities.

53 Additional Disclosures Required by FASB 115 Transfers of securities between categories: –Gross gains and losses included in earnings from transfers of securities from available-for- sale into the trading category. –For securities transferred from held-to-maturity, the company should disclose the amortized cost amount transferred, the related realized or unrealized gain or loss, and the reason for transferring the securities.

54 The End