ch05&10s - 6A: 001 Fall 2010 Ch 5 & 10 Al Schepanski...

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Al Schepanski 6A: 001 – Fall 2010 – Ch 5 & 10 1 of 23 MIDTERM 1 IS TUEDAY October 5, 2010 Chapters 1- 5 &10 Chapters 5 & 10 (pp. 537-546) 1. Investments in the Securities of Other Organizations These securities, also called financial instruments, represent assets for the company acquiring the securities, are of 2 types: Debt securities: Ownership of promissory notes whereby one company (the borrower) promises to repay the amount borrowed, plus interest, to the lending company who acquires the note as an investment. Some debt securities are actively traded in debt markets and have a market price that might vary from day to day. Equity securities: Ownership of stock of another company that is actively traded in stock markets and has a market price that might vary from day to day. Equity securities may pay dividends to the owners of the securities. Companies acquire debt and equity securities of other organizations for a variety of reasons, e.g., to receive interest or dividends; to gain a degree of influence with another corporation to ensure a steady supply of raw materials; to gain operating control of another corporation, etc. All investments (debt or equity) are recorded at their acquisition cost on the date acquired. Following the acquisition date, how the investments are accounting for on the company’s accounting records and disclosed in its financial statements depends upon what management’s purpose was in acquiring the investment. These purposes are reflected in the following 3 classifications for all investments in the debt or equity securities of other organizations. 1. Held-to-maturity securities : Consist only of debt securities acquired for the purpose of earning interest where the company intends to keep the security until it matures (which may range from a few days to many years). These securities are initially recorded at there acquisition cost, but in subsequent periods are reported at their amortized cost . These securities can be classified as a current asset (if they mature within 1 year of the balance sheet date) or as a long-term investment (if they mature beyond 1 year from the balance sheet date). Notes Receivable is an example of a held-to-maturity security. One of the largest assets of banks are notes receivable. To illustrate, on March 31, US Bank loaned $1,500 to ABC Co., receiving a 2-month, 8%, $1,500 note receivable, with principal (the amount loaned, $1,500) and interest due on May 31. US Bank, which prepares monthly financial statements, would make the following journal entries:
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2 of 23 DR CR March 31: To record loan April 30: To record interest May 31: To record collection of note plus interest Nonbank companies also hold notes receivable, although less commonly than banks. In the above example, the acquisition cost of the note and its amortized cost were the same, because banks usually require that the market rate of interest be equal to the rate used in the note receivable. The following example illustrates an investment where acquisition cost and amortized cost are not the same.
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This note was uploaded on 09/26/2011 for the course 06A 001 taught by Professor Stuff during the Fall '10 term at University of Iowa.

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ch05&10s - 6A: 001 Fall 2010 Ch 5 & 10 Al Schepanski...

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