Handout 10 - INTRODUCTION TO FINANCIAL ACCOUNTING...

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Copyright © 2010 1 You may only share these materials with current term students. I NTRODUCTION TO F INANCIAL A CCOUNTING 33:010:272 S ECTIONS 08 09 |FALL 2011 PROFESSOR JULIAN YEO Class Notes 10: Investments in Securities, Shareholders’ Equity, and EPS In this document, we address the following issues: How to account for investments in debt securities? o Trading, held to maturity, available for sales How to account for short-term investments in equity securities? o Trading, available for sale How to account for long-term investments in equity securities o Fair market method and cost method o Equity Method o Consolidation Purchase Method Pooling Method What are components of shareholders’ equity accounts? o Contributed capital accounts o Treasury stock o Retained earnings o Comprehensive income accounts How to account for cash, property, stock dividends, stock splits, and stock options? How to calculate Earnings Per Share (EPS)? o Basic vs Diluted
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Copyright © 2010 2 You may only share these materials with current term students. Most companies invest in securities that were issued by governments (debt securities) or other corporations (debt and equity securities). This handout covers all investments in securities. We first discuss the accounting treatment for investments in debt securities and then for investments in equity securities. 1. Investments in debt securities: Investments in debt securities are classified as either Trading securities ” - if the securities were purchased with the purpose of generating profits from short-term price increases, Held to maturity securities ” - if the firm has the intent and ability to hold the securities to maturity, or Available for sale securities ” - otherwise. The accounting treatment for investments in debt securities that are classified as “held to maturity” is parallel to the accounting for issuance of long-term debt. Of course, investments in debt securities represent an asset and not a liability and thus generate interest revenue and not interest expense. But the amounts are calculated in the same way. The accounting treatment for the other two classifications is similar to that for “held to maturity” investments. The major difference is that at the end of each year, in addition to accruing interest revenue, the balance of the investment account is adjusted to reflect the securities’ market value on the balance sheet date. The unrealized gain/loss is reported on the income statement if the securities are classified as “trading,” or as a component of shareholders’ equity if the securities are classified as “available for sale” (part of “accumulated other comprehensive income”). When market prices are not available, estimates of fair value are used instead (typically based on discounted cash flow analysis). On the balance sheet, all “trading securities,” and “available for sale securities” that the firm
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Handout 10 - INTRODUCTION TO FINANCIAL ACCOUNTING...

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