405ch17partii - Reporting Category: Held-to-maturity - Debt...

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Unformatted text preview: Reporting Category: Held-to-maturity - Debt securities only, investor has positive intent and ability to hold to maturity. 0 Holding gains or losses from market price Vchanges are ignored. As interest rates rise or fall, the fair value of the investment will decrease or increase. This movement in fair value is not relevant if the investment is to be held to maturity because investor receives same interest payments and principal at maturity, regardless of changes in fair value. Trading . - Investments in debt and equity securities acquired principally for the purpose of selling then in the near term. ' - Unrealized holding gains or losses are reported on the income statement as if they actually had been realized. 0 Relatively few investments are classified this way because only banks and other financial operations invest in securities in the manner and for the purpose necessary to be categorized as trading securities. - When securities are actively managed, as trading securities are, with the expressed intent of profiting from short term market price changes, the gains and losses that result from holding securities during market price changes are appropriate measures of success or lack of success - 9 1n that endeavor. - Trading Securities are reported a fair value on the balance sheet at the reporting date. Companies that invest in trading securities typically record fair value adjustments directly to ' '" the investments accounts because the investments turn over quickly. ‘ ' Available—for-Isale - Debt and Equity securities that don’t fit the definitions for the other reporting categories are classified as “available-for-sale.” Classified as current or noncurrent assets. 0 Securities available—for-sale are reported at fair value on the balance sheet at the reporting date. . - Unrealized holding gains or losses are notincluded in the determination of income for the period. (When sold, realized gains and losses are included in determination of income.) , - Unrealized holding gains or losses for the period are reported in Other Comprehensive Income as “net unrealized holdinggains (losses) on investments.” 0 The “net unrealized holding gains (losses) on investments” that is reported in comprehensive income is added to (subtracted from) accumulated other comprehensive income which is shown as a separate component of stockholders’ equity until realized. Investments in Debt Securities Debt securities include US. Government securities, municipal securities, corporate bonds, convertible debt, and commercial paper. (Trade accounts receivable and loans receivable are not debt securities.) Debt investments initially recorded at cost, then 3' Categories for reporting (Categories may be presented in note disclosure instead of balance sheet): Held-to-maturity Debt securities the company has the “positive intent and ability” to hold to scheduled maturity date. Trading Debt securities bought and held primarily for sale in the near term (days to a few months) to earn profits on short term price differences. Available-for sale ' Debt securities not classified as held-to-maturity or trading securities. Accounting and reporting requirements for the 3 categories of debt securities: Unrealized Holding Categog - Valuation . Gains or Losses Other income effects _ Held—to—maturity Amortized cost Not recognized . ' Interest when earned; Gains and losses from sale Trading securities Fair value Recognized in net income Interest when earned; (as if actually realized) Gains and losses from sale Available-for—sale Fair value Recognized in “other Interest when earned; comprehensive income” Gains and losses from sale and as separate component of stockholders equity Amortized cost is the acquisition cost adjusted for the amortization of discount or premium. (Cost plus any unamortized premium or less any unamortized discount.) Fair value is the amount at which ‘a company can exchange a financial instrument in a current transaction between Willing parties. Fair value is considered relevant and reliable. ' Investments in Equity Securities Equity securities represent ownership interests such as common, preferred, or other capital stock. Also includes rights to acquire or dispose of ownership interests at an agreed—upon price such as in warrants, rights, and call or put options. Convertible debt is not an equity security. Preferred stock redeemable for common stock is not an equity security. The cost of securities includes commissions and fees incidental to the purchase. I ' The reporting method for equity investments depends on the percentage of the voting stock held by the investor: Fair value method Investor owns less than 20% of voting stock and cannot influence operating and financial policies of the investee company. (Trading and available-for-sale categories may be presented in note disclosure instead of balance sheet) Equity method . Investor owns between 20% and 50% of voting stock and can significantly influence operating and financial policies 'of the investee company. Consolidated statements Investor owns more than 50% of the voting stock and therefore controls the investee company. ' Accounting and reporting for equity securities: Categog Holdings less than 20%: Trading Available-for- sale ‘ Holdings between 20% and 50% Holdings more than 50% Valuation Fair value Fair Value Equity Consolidation Unrealized Holding Gains or Losses Recognized in netiincome (as if actually realized). Recognized in “other comprehensive income” and as separate component of stockholders’ equity Not recognized Not recognized Other Income Effects Dividends declared; Gains and losses from sale Dividends declared; Gains and losses from sale Proportionate share of investee’s net income Not applicable THE EQUITY METHOD “ .30 We use, the equity method when the investor owns less than 51% of the voting shares; and therefore can’t control I the investee, but can exercise “significant influence” over the operating and financial policies of an investee. ‘ 02' It should be presumed, in the absence of evidence to the contrary, that the investor exercises significant influence over the inveStee with it owns between 20% and 50% of the 'investee's voting shares. * .10 Initially, the investment is recorded at cost. - The carrying 4 amount of this investment subsequently is: ’ > Increased by the investor's percentage share of the investee’s net income (or decreased by its share of a loss). ' > Decreased by dividends declared. Summary of Reporting Treatment of Securities: Category Held-to-maturity (debt securities) Trading (debt and equity securities) Available—for-sale (debt and equity securities) Equity method and/or consolidation (equity securities) Balance Sheet Investments shown at amortized cost. Current or long term asset Investments shown at fair value CUrrent assets .r Investments shown at fair value Current 'or long term assets. Unrealized holding gains and losses are a separate component Of stockholders’ equity. Investments are originally carried at cost, are periodically adjusted by the investor’s share of the investee’s earnings or losses, and are decreased by dividends received from the investee. Classified as long-term. Income Statement Interest is recognized as revenue Interest and dividends are recognized as revenue. Unrealized holding gains and losses are included in net income. ‘ Interest and dividends-are recognized as revenue. Unrealized holding gains and losses are not included in net income but in “other comprehensive income.” Revenue is recognized to the extent of the investee’s earnings or losses reported subsequent to the date of investment. Generally an investment of 20 % or more gives an investor the ability to exercise significant influence over the investee company. The following example compares the fair value method to the equity method of accounting for an investment. For the equity part of the example, assume the 20 % investment permits Harper Company to exercise significant influence. All the following entries are made by Harper: ' Fair Value Method Equity Method ‘ On January 2, 2005, Harper Company purchased 50,000 shares (20% of ABC Co. stock) at a cost of $12 a share. Investment securities (A-F-S) , 600,000 Investment in ABC stock 600,000 Cash 600,000 Cash 600,000 For 2005, ABC Co. reported net income of $400,000. Harper’s share is 20% or $80,000. Investment in ABC stock 80,000 Gash IAN/ES rméwr Aéyr 80,000 At 12-31-05, the 50,000 shares of ABC Co. have a market Investment‘securities (A-F-S) market adjustment 100,000 Unrealized holding gain , on investments 100,000 rice (fair value) of $14 a share. On March 17, 2006, ABC Co. declared and paid a cash dividend of $100,000. Harper received 20%. Cash . ' Cash , 20,000 Dividend revenue Investment in ABC stock 20,000 For 2006, ABC Co. Reported a net loss of $50,000. H er’s share is 20% or $10,000. Loss on Investment 10,000 Investment in ABC stock 10,000 At 12-31-06, the 50,000 shares of ABC Co. have a market Unrealized holding loss on investments 50,000 Investment securities (A-F—S) rice (fair value) of $13 a share. market adjustment ' 50,000 PiTING CATEGORIES When a security is reclassified between two reporting categories, . the security is transferred at its fair value at the date of transfer. v‘ Any unrealized holding gain or loss should be accounted for in a manner consistent with “the classification into which the'security is ‘ being transferred. ' Transfer To: Unrealized gain or loss from transfer at i from: . fair market Value I Either of the Trading - Include in current earnings » ' - other . ' ‘ Trading, Either of There is none (already recognized in t ' the other earnings) ' Held-to— Available— Report as a separate component of maturity for-sale shareholders’ equity (in Other Comprehensive Income) Don’t write-off any existing unrealized holding gain or loss, but amortizelit to ‘ earnings over the remaining life of the security (fair value amount becomes the security’s amortized cost basis). Held—to— V maturity ~ ' .Availableefor- sale A CHANGE _ TO OTHER‘METHOD > When the investor changes from the equity method to another method, the equity method is simply discontinued and the new ' method applied from then on. ' ~ ' W A CHANGE FROM ANOTHER METHoD A > When a change to the equity method is appropriate, the investment account should be retroactively adjusted to the balance that would have existed if the equity method always had been used. - 5 0.9 PRESENTATION AN ISCLOSURE Trading securities are current assets by definition. ' Individual held-to-maturity and available-for-sale securities are either current or noncurrent depending on when they are expected to be sold. ' ' It’s not necessary that a company report individual amounts for the three categories of investments — held—to—maturity, - available-for-sale, or trading — on the face of the balance sheet as long as that information is presented in the disclosure notes. Investors should disclose the following in the disclosure notes: ' > aggregate fair value ' > gross realized and unrealized holding gains 1 > gross" realized and unrealized holding losses ' > the change in net unrealized holding gains and losses, and > amortized cost basis by major security type Information about maturities should be reported for debt securities, by disclosing the fair value and cost for at least 4 maturity groupings: (a) within 1 year, (b) after 1 year through 5 years, (c) after 5 years through 10 years, and (d) after 10 years. ...
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405ch17partii - Reporting Category: Held-to-maturity - Debt...

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