CHAPTER 12 Accounting for Investment Securities

CHAPTER 12 Accounting for Investment Securities -...

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Investments ACCOUNTING FOR INVESTMENT SECURITIES There are two potential types of investments that a corporation might hold: investments in equity securities and investments in debt securities. The type of investment has an impact on the accounting treatment. In addition, management’s intent with respect to the holding of the investment affects how the investment is accounted for in the financial statements. The following is a schedule of the accounting treatment based on the type of investment and management’s intentions. Control Reporting Category Management Intent Type of Security < 20% Held-to-Maturity Positive intent and ability to hold Debt < 20% Available-for-Sale Sale subject to market factors and company financial requirements Debt or Equity < 20% Trading Subject to immediate sale Debt or Equity 20% - 50% Equity Method Significant influence Equity > 50% Consolidation Control Equity Securities to Be Held to Maturity Debt securities that are classified as held-to-maturity indicate that the company has both the ability and intent to hold the securities until maturity. The investor company does not have any influence over the operating or financial policies of the investee company. The investment in debt securities that are held-to-maturity are recorded at the market value (original cost) on the date of acquisition. Example: Spencer Company purchased $40,000 of the 8%, 5-year bonds of Alexander Company for $43,412, which provides a 6% return. The bonds pay interest semiannually. Spencer Company has both the ability and intent to hold the securities until the maturity date. The journal entry to record the investment would be as follows: Date Account Debit Credit 1/1/00 Investment in bonds $40,000 Premium on bonds 3,412 Cash $43,412 To record the purchase of held-to-maturity bonds The following amortization table has been prepared to assist in the discussion related to the recording of interim interest revenue and reporting the investment on the balance sheet at the end of the accounting period. F:\Teaching\3321\web\module3\c12\tnotes\c12a.doc 2/19/2007 1
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Investments Date Payment Interest Amortization of Premium Carrying Amount 1/1/00 $43,412 6/30/00 $1,600 $1,302 $298 43,114 12/31/00 1,600 1,293 307 42,807 6/30/01 1,600 1,284 316 42,491 12/31/01 1,600 1,275 325 42,166 6/30/02 1,600 1,265 335 41,831 12/31/02 1,600 1,255 345 41,486 6/30/03 1,600 1,245 355 41,131 12/31/03 1,600 1,234 366 40,765 6/30/04 1,600 1,223 377 40,388 12/31/04 1,600 1,212 388 40,000 Amortization Schedule, 8% 5-Year Bonds to Yield 6% We are assuming that the first interest payment will be received on June 30, 2000. The bond is scheduled to pay $1,600 but the company paid a premium so the effective interest earned is $1,302, the cash received net the amortization of the premium. The following journal entry would be recorded to reflect this transaction.
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CHAPTER 12 Accounting for Investment Securities -...

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