Chapter 17: Investments

Question 1

Equity investments: Fair value method

Answer 1

Used when holdings are < 20%

• as long as market pricing is available
  (practicability method = cost less impairment)
• unrecognized holding gain or loss goes to income
• dividends recognized when received
• gains or losses recognized on sale of investment

no recognition of investee income other than dividends

FV adjustments done the same as with debt investments
Fair Value adjustment account debited if need to increase value of investment, credited if need to decrease)
then use unrealized holding gain or loss - income account

Question 2

Treatment of Trading Debt securities

Answer 2

Debt securities bought and held primarily for sale to generate income on short term price differences

• valuation at fair value
• unrealized holding gains or losses recognized in net income
• any interest earned goes to gain or loss from sale of investments

Question 3

Income effects of equity securities

Answer 3

Holdings < 20%:

• unrealized holdings gains or losses –> net income
• dividends and gains or losses from sale –> net income

Holdings 20%-50%;

• unrealized holding gains or losses NOT recognized in net income
• proportionate share of investee’s net income –> net income
• (dividends reduce investment)

Holdings >50%:
- consolidate statements

Question 4

Valuation of lump sum security purchases

Answer 4

Ideally done by specific identification

if not, then average cost of FIFO is acceptable

Question 5

Equity method for equity investments

IF proportion of loss is greater than carrying amount

Answer 5

If loss is limited to the investment amount:
- discontinue equity method and recognize no additional loss

If loss is not limited (investor guarantees investee’s obligations):
- loss should continue to be recognized

Question 6

Accounting for investments

Answer 6

Depends on the type of security and management intent

Debt:
No plans to sell - record at amortized cost
Plans to sell - record at fair value

Equity:
Plans to sell - record at fair value
Exercise some control - use equity method

Question 7

Recording debt securities

Answer 7

Held to maturity or AFS

Debit Debt Investments
Credit Cash

Could have a separate discount or premium amount but in practice generally don’t (still use amortization table)

Debits (discounts) or credits (premium) debt investment account for difference between cash received and interest revenue (based on carrying amount and effective rate)

Question 8

Treatment of held-to-maturity debt securities

Answer 8

Debt securities ONLY, not equity

Company has to have positive intent AND ability to hold to maturity

Valued to amortized cost

• written down only if permanently impaired
• no recognition of unrealized holding gains or losses

Interest Revenue categorized under other revenue and gains

Question 9

Consolidation

Answer 9

When one corporation (parent) owns more than 50% interest in another (subsidiary) = controlling interest

Parent prepares consolidated financial statements: parent and subsidiary as single method - use equity method

Question 10

Accounting for ownership interest in another corporation

Answer 10

Holdings < 20% : passive interest
- use fair value method

Holdings 20% - 50%: significant influence
- use equity method

Holdings > 50%: controlling interest
- use consolidated statements

Question 11

Sale of held-to-maturity debt NEAR maturity date

Answer 11

(sale within 3 months of maturity still considered sale at maturity)

1) record any amortization to date of sale
2) gain on sale = selling price (without interest) less FULLY amortized value of bonds to date

Debit Cash received
Credit Interest revenue (for accrued months)
Credit Debt investment
Credit gain on sale (selling price > book value)

Question 12

Reporting other comprehensive income

Answer 12

Tracked and shown as separate component of stockholders’ equity until the relevant instrument is sold

only realization on sale goes into net income

Question 13

Treatment of available-for-sale debt securities

Answer 13

Debt securities not classified as held-to-maturity or trading

• valuation at fair value
• unrealized holdings gains and losses recognized in other comprehensive inncome AND as a separate component of SE
• any interest earned goes to other revenues and gains

Question 14

Reporting Fair Value adjustments

Answer 14

Available-for-sale and trading securities

Reported as an adjustment to the carrying amount of investment

Debit balance = increase
Credit balance = decrease

can report a portfolio as a lump sum

Question 15

Available-for-sale securities in financial statements

Answer 15

Balance sheet

• interest receivable –> current assets
• debt investments (AFS) –> investments
• Accumulated other comprehensive income/ loss –> stockholders’ equity

Income statement
- interest revenue & loss or gain on investments –> other revenues and gains or other expenses and losses

Question 16

Recording fair value adjustment for available-for-sale securities and trading securities

Answer 16

Loss:
Debit Unrealized holding gain or loss - equity
Credit Fair value adjustment
(reverse for gain)

Adjust balance of fair value adjustment account for correct affect on investment balance

goes for both AFS and Trading securities

Question 17

Impairment of investment value of held-to-maturity debt

Answer 17

Current expected credit loss model

• if probable that will not collect all amounts due

Debit Allowance for Doubtful Accounts
Credit Debt investments

No changes unless further impairment occurs

Question 18

Fair value method for investment

Answer 18

once fair value option selected cannot switch back

• the choice is made for each investment, not for the entire portfolio

use accounts:

• unrealized holding gain or loss - income
• debt or equity investment (directly change to fair value)

Loss
Debit Unrealized holding gain or loss - income
Credit Debt or Equity Investment

Gain
Debit Debt or Equity Investment
Credit Unrealized holding gain or loss - income

Question 19

Impairment of equity investments

Answer 19

Also trading debt

Decline in value reported via net income

Question 20

Impairment of investment value of Available for sale debt securities

Answer 20

credit losses limited to amount fair value is less than amortized cost (b/c if more could sell security and avoid additional loss)

Debit Bad Debt Expense
Credit allowance for doubtful accounts

(may be refused but cannot exceed original amortized costs)

Question 21

Sale of Available-for-sale securities

Answer 21

Amortized cost > selling price = loss (debit)
Amortized cost < selling price = gain (credit

Debit Cash
Debit Loss or Credit gain on sale of investments
Credit Debt investments

not using discount or premium accounts

shown on income statements in other revenue or gains or other expenses or losses

Question 22

Holding gain or loss

Answer 22

Net change in the fair value of a security from one period to another

exclusive of dividend or interest revenue

Question 23

Reporting unrealized holdings gains or losses trading securities

Answer 23

On income statement under other revenues and gains or other income and losses

only when securities are actively traded

Question 24

FASB rulings re: recording investments

Answer 24

• loans reported at amortized costs (avoids volatility)

- equity investments mostly reported at fair value

Question 25

Debt securities under IFRS

Answer 25

Held-for-collection debt securities : valued at amortized cost

Trading & AFS - held at fair value

Question 26

Financial assets

Answer 26

Asset whose value comes from a contractual claim to to cash flows

Question 27

Security

Answer 27

A share, participation, or other interest in property or in an enterprise of the issuer or an obligation of the issuer, with three characteristics:

1) represented by an instrument or in books
2) traded in securities exchange markets
3) one in a class or series or divisible into class/ series of shares etc…

Question 28

Equity method for recording equity securities

Answer 28

Equity holdings of 20-50% (significant influence)
Original purchase = cost of shares acquired

Period adjustments for changes in proportionate shares of investees’ earnings
Debit Equity Investment (increases value directly)
Credit Investment income (or reversed for loss)

Receipt of dividends
Debit Cash (increase)
Credit Equity Investments (decrease)

No unrealized holding gain or loss

Question 29

Debt investment

Answer 29

Creditor relationship with another entity involving a security

Types:

• held to maturity
• trading
• available for sale (not trading or held-to-maturity)

Question 30

Equity Securities

Answer 30

Ownership interest: common, preferred, or other capital stock
- rights to acquire ownership interest (warrants, rights, call/put options)

(does not include convertible debt securities or redeemable preferred stock)

Cost = purchase price + broker’s commission and other fees

Question 31

Impairment Models

Answer 31

Assessment measurement basis –> impairment model

Loans, receivables, and debt securities measured at amortized cost –> expected losses in net income

Debt securities measured at fair value, with gains and losses recorded in other comprehensive income (AFS) –> if fair value >= amortized cost, no expected credit loss recognized. if fair value < amortized cost, expected credit loss –> net income

Debt and equity securities measured at fair value with gains and losses recorded in net income (trading) –> debt securities: difference between lower of amortized cost or fair value or (equity securities) lower of cost or fair value

Question 32

Reclassification Adjustment

Answer 32

Adjustment made to ensure gains and losses are not double counted when a security is sold but the unrealized gains or losses are already showing in a prior period comprehensive income (on the balance sheet)

FASB prefers it shown in notes to the financial statement

Question 33

Transfers between categories of debt securities

Answer 33

At Fair value at date of transfer

Trading –> AFS: unrealized gain or loss –> SE & Income

AFS –> Trading: unrealized gain or loss –> SE & Income

Held-to-maturity –> AFS: SE increased or decreased by unrealized gain or loss

AFS –> held-to-maturity: unrealized gain or loss carried as separate component of SE and amortized over the life of the security

Question 34

Comprehensive Income

Answer 34

Change in equity (net assets) of an entity during a period from transactions and other events and circumstances from non-owner sources

Question 35

Investments

Answer 35

Financial assets held by an enterprise for earning income by way of dividends, interest, or capital appreciation, or for other benefits to the investing enterprise.