302Chapter 14 notes

302Chapter 14 notes - CHAPTER 14 I Investments in Debt and...

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C HAPTER 14 I Investments in Debt and Equity Securities I L EARNING O BJECTIVES 1. Determine why companies invest in other companies. C Why do companies invest in debt and equity securities of other companies? < To earn a return on idle cash. < To establish a business relationship through ownership. < To diversify seasonal or industry risk. < To gain access to a company’s research or technology. C The intended outcome is to enhance the overall return to shareholders. 2. Understand the varying classifications associated with securities. C Securities are classified based on management’s intent in holding them. C If the intent is to influence or control the decisions and activities of that other company, the investment is accounted for using the equity method. C If the intent is to sell those securities should a need for cash arise or to take advantage of increases in value, they are classified as trading securities. C Debt securities that are intended to be held until they mature are classified as held-to-maturity securities. C All remaining investment securities are classified as available-for- sale. 3. Account for the purchase of debt and equity securities. C Debt and equity securities are accounted for at cost (including brokerage fees, taxes, and other charges incurred at acquisition). C With debt securities, interest accrued prior to the purchase date must be accounted for separately from the cost of the investment. 4. Account for the recognition of revenue from investments. 1
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C The method to recognize revenue from investments depends on how the investment was originally classified. C For debt securities, revenue recognized is termed interest revenue. C For trading and available-for-sale debt securities, the amount of interest revenue is a function of the stated rate of interest associated with the debt interest. C For held-to-maturity securities, any premium or discount associated with the initial purchase must be amortized and offset against interest revenue. C For equity securities classified as trading or available-for-sale, dividends declared by the investee are recorded as revenue. C If an investment is accounted for by using the equity method, the amount of revenue recognized is a function of the percentage of ownership. C The net income of the investee is multiplied by the ownership interest and recorded as revenue. 5. Account for the change in value of securities. C Temporary changes in the value of debt and equity securities classified as trading or available-for-sale are accounted for through the use of a market adjustment account (securities are then valued at fair market value on the balance sheet). C For trading securities, the increase/decrease in value is disclosed in the income statement. C
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302Chapter 14 notes - CHAPTER 14 I Investments in Debt and...

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