copyright © 2007 thomson south-western, a part of the thomson corporation. thomson, the star logo,...

COPYRIGHT © 2007Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are

trademarks used herein under license.

Investments in Debt & Equity Securities

Chapter 14

S t I c e | S t I c e | S k o u s e n

Intermediate Accounting

16E

Modified by A. Phassawan S.

Learning Objectives

1. Classifications of investment securities.

2. Purchase of investment securities.

3. Recognition of revenue from investment securities.

4. Change in value of investment securities.

5. Sale of investment securities.

Classifications of Investment Securities

Available-for-sale

TradingHeld-to-maturity

DebtDebt

Equity Method

EquityEquity

Cost Method

Classifications of Investment Securities

• Equity Method Securities– Potentially purchased with the intent to

control or significantly influence the operations of the investee.

– Represents ownership in a company and includes rights to collect dividends and to vote on corporate matters.

Exhibit 14-8 Different Accounting Treatments

Classification Types Disclosure on B/S

Changes in Value

Held to Maturity Debt Amortized Cost

Not Recognized

Available for sale

Debt/ Equity

FMV Reported in Equity

Trading Debt/ Equity

FMV Reported in I/S

Equity Method Equity Historical cost adjusted for changes in the net assets of investee

Not recognized

Learning Objectives






Purchases of Debt Securities

On May 1, ABC purchases $100,000 in U.S. Treasury notes at 104¼, including brokerage fees. Interest is 9% payable

semiannually on Jan 1 & July 1. The debt securities are classified by the purchaser as trading securities.

Asset ApproachAsset Approach

Inv. in Trading Security 104,250Interest Receivable 3,000 Cash 107,250

Purchase date May 1 :

Cash 4,500 Interest Receivable 3,000 Interest Revenue 1,500

Receipt of semiannual payment July 1 :

Inv. in Trading Security104,250Interest Revenue 3,000 Cash 107,250

Cash 4,500 Interest Revenue 4,500

Revenue ApproachRevenue Approach

Purchase of Equity Securities

ABC Co. purchased 300 shares of Boro Co. stock as $75/share plus brokerage fees of $80 and 500 shares of

Fara Inc. stock at $50/share plus brokerage fee of $30. The Boromir stock is classified as a trading security, but the

Faramir stock is classified as available for sale.

Investment in Trading Securities - Boro 22,580 Investment in Available-for- Sale Securities- Fara 25,030

Cash 47,610

Learning Objectives






Revenue from Debt Securities

• Debt Securities carry with them a stated rate of interest, indicating the amount of cash to be received in interest each year.

• When interest is received,

Cash XXInterest revenue XX


• When the debt security is issued at premium or discount and is classified at held-to-maturity, there is a need of periodic amortization of premium or discount with corresponding adjustments to interest revenue.

• Note that if the debt security is not classified as being held to maturity, the amortization process becomes less relevant.


• The debt security is issued at premium– a stated rate of interest > a market rate

• The debt security is issued at discount – a stated rate of interest < a market rate

Note that to calculate the value of debt security at the time of purchase, the

present value of debt security is required.

PV of Debt Securities

On January 1, 2004, Silmaril Technologies purchased 5-year, 10% bonds with a face value of

$100,000 and interest payable semiannually on January 1 and July 1. The market rate on bonds of

similar quality and maturity is 8%.

Present value of principal:FV = $100,000; N = 10; I = 4%

$ 67,556Present value of interest payments:

PMT = $5,000; N = 10; I = 4%

40,554Total present value of the bonds

$108,110

Debt Securities (Trading)

The first receipt of interest on July 1

Cash 5,000 Interest Revenue (100,000*0.05) 5,000

Initial purchase of bonds on Jan 1

Investment in trading securities108,110 Cash 108,110

Debt Securities (Held-to-Maturity)

Initial purchase of bonds on Jan 1 Investment in held-to-maturity securities 108,110 Cash 108,110

The first receipt of interest on July 1Cash (100,000*0.05) 5,000 Interest Revenue (108,110*0.04) 4,324 Investment in Held-to-Maturity Securities 676

The second receipt of interest on Jan 1Cash (100,000*0.05) 5,000 Interest Revenue (107,434*0.04) 4,297 Investment in Held-to-Maturity Securities 703

Premium Amortization Schedule (Effective-Interest Method)Interest Payment

A B C D E

Interest received(0.05*

$100,000)

Interest revenue (0.04*E)

Premium Amort.(A-B)

Unamort. Premium

(D-C)

Bond Carrying

value($100,000+D)

8,110 108,110

1 5,000 4,323 676 7,434 107,434

2 5,000 4,297 703 6,731 106,731

3 5,000 4,269 731 6,000 106,000

: : : : :

: : : : :

10 5,000 4,041 959 0 100,000

Cash Interest Revenue Inv. in HTM securities

Discount Amortization Schedule (Effective-Interest Method)Interest Payment

A B C D E

Interest received(0.04*

$100,000)

Interest revenue (0.05*E)

Discount Amort.(B-A)

Unamort. Discount

(D-C)

Bond Carrying

value($100,000-D)

7,723 92,277

1 4,000 4,614 614 7,109 92,891

2 4,000 4,645 645 6,464 93,536

3 4,000 4,677 677 5,787 94,213

: : : : :

: : : : :

10 4,000 4,952 952 0 100,000

Cash Interest Revenue Inv. in HTM securities

Revenue from Equity Securities

0% 20% 50% 100%

No significantinfluence

Significantinfluence Control

Ownership Percentage

Account for as trading or

available-for-saleEquity method

Equity method and consolidation

procedures

Revenue from Equity Securities (Trading and AFS)

Deli Co. announces dividends of $0.25 per share. Assume that Citty Co. owns 1,000

shares

Cash 250

Dividend Revenue 250

Note that the dividend revenue is recognized when the dividend is declared or when it is received from the investee.

Revenue from Equity Securities (Equity Method Security)

Assume that Biotech Inc. purchased 40% of outstanding shares of Medco Enterprises on

Jan 1 by paying 200,000.

Investment in Medco Stock 200,000

Cash 200,000

To record the purchase of 40% of Medco stock

Revenue from Equity Securities (Equity Method Security)

During the year, Medco reported (1) Net Income of $50,000 and paid (2) dividends of $10,000. Biotech would make the following

journal entries.

Cash (10,000*0.4) 4,000



Income from Investment

in Medco Stock (50,000*0.4) 20,000

1

2

Learning Objectives






Accounting for the Change in Value of Securities

Classification

of Security

Disclosedat

Report FMV

TradingFair marketvalue

Incomestatement

Held-to-

maturity

Amortized

cost

Not

recognized

Available-for-sale

Fair marketvalue

Stockholder’sequity

Change On


Eastwood Inc. purchased the following securities on March 23, 2008.

Trading securities: FV, Dec 31

Purchase price (#1) $ 8,000 $7,000

Purchase price (#2) $ 3,000 $3,500

Available-for-sale securities:Purchase price (#3) $ 5,000 $6,100Purchase price (#4) $12,000 $11,500

Held-to-maturity securities: Purchase price (#5) $20,000* $19,000

*purchased at face value, otherwise, the amortization is needed.


Initial Purchase EntryInitial Purchase Entry

Investment in Trading Securities 11,000Investment in Available-for-Sale Securities 17,000Investment in Held-to-Maturity Securities 20,000

Cash 48,000


1) Unrealized loss on trading securities would be reported on I/S under Other Expenses and Losses

2) Market adjustment-Trading security is combined with Investment in Trading Securities and reported on the B/S

By the end of the year, the value of the trading securities decreased from $11,000 to $10,500.

December 31, 2008:Unrealized Loss on Trading Securities 500

Market Adjustment—Trading Securities 500


December 31, 2008:Market Adjustment—Available-for-Sale

Securities 600 Unrealized Increase in Value of Available-for-Sale Securities 600

By the end of the year, the value of the By the end of the year, the value of the available-for-sale securities increased from available-for-sale securities increased from

$17,000 to $17,600.$17,000 to $17,600.

By the end of the year, the value of the By the end of the year, the value of the available-for-sale securities increased from available-for-sale securities increased from

$17,000 to $17,600.$17,000 to $17,600.

Increase the amount of stockholder’s equity


Partial Balance Sheet for Eastwood Inc.Assets

Invest. in trading securities $11,000 Market adjustment—trading sec. (500) $10,500 Invest. in available-for-sale sec. $17,000 Market adjustment 600 17,600Invest. in held-to-maturity sec. 20,000

$48,100Stockholders’ Equity Total capital paid-in and retained earning XX

Add unrealized increase in available-for-sale securities $ 600


Partial Income Statement for Eastwood Inc.

Other expenses and losses:Unrealized loss on trading

securities $500

Learning Objectives






Sale of Investment Securities

• When an investment security is sold, its carrying value is removed.

– For trading and AFS securities, the carrying value will equal to the securities’ original cost.

– For held-to-maturity security, the carrying value will change as any premium or discount is amortized.

– For equity method security, the carrying value will change when the BV of the investee change.

• The different between carrying value and the cash received is recorded as a realized gain or loss.

Sale of Securities

Assume that the debt securities are sold on April 1, 2009 for $103,000, which includes accrued interest of $2,500. The carrying value of on Jan 1, 2009 is 105,240.

Apr. 1Interest Receivable (100,000*0.1*3/12) 2,500

Investment in Held-to Maturity Securities 395

Interest Revenue (105,240*0.08*3/12)2,105

To record accrued revenue and amortize premium:

Sale of Securities

Entry to record sale:Apr. 1 Cash 103,000Realized Loss on Sale of Securities 4,353

Interest Receivable 2,500Investment in Held-to

Maturity Securities(105,240-395)104,845

Assume that the debt securities are sold on April 1, 2009 for $103,000, which includes accrued interest of $2,500. The carrying value of on Jan 1, 2009 is 105,240.

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QUESTIONS

copyright © 2007 thomson south-western, a part of the thomson corporation. thomson, the star logo,...

Documents

sale of investment securities

value of investment

purchases of debt securities

sale securities fara

trading securities boro

debt equity securities

revenue approach slide

sale debt equity fmvreported