Flashcards in Investments Deck (72)
FASB ASC 320-10-05-2 governs the accounting for all investments in debt securities and investments in equity securities that have readily determinable Fair Values except for what 4 items?
1. investments in equity securities accounted for under the equity method
2. investments in consolidated subsidiaries
3. not-for-profit organizations (however, it does apply to cooperatives and mutual enterprises, including credit unions and mutual insurance companies)
4. enterprises with specialized accounting practices relating to investments in debt and equity securities (i.e. brokers and dealers in securities)
Investments in equity securities that do not have readily determinable fair values, such as investments in closely held corporations are to be report at?
cost. Even though the FV of these securities may not be readily determinable, if there is evidence of an other-than-temporary decline in the value of the investments, the investment should be written down to a reasonable estimate of its FV
What are debt securities?
Debt securities include all securities representing a creditor relationship with an enterprise (i.e. Treasury securities, US Government agency securities, municipal securities, corporate bonds, convertible debt and commercial paper). It also includes preferred stock that, by its terms, either must be redeemed by the issuing enterprise or is redeemable at the option of the investor
What are equity securities?
Equity securities include all securities representing an ownership interest in an enterprise (i.e. common, preferred or other capital stock or the right to acquire (call options) or dispose (put options) an ownership interest in an enterprise at fixed or determinable prices). They do not include preferred stock that, by its terms, either must be redeemed by the issuing enterprise or is redeemable at the option of the investor
All investments in debt securities will be classified on the balance sheet in one of the following 3 categories. What are they?
1. held-to-maturity securities
2. trading securities
3. available-for-sale securities
Investments in equity securities that have a readily determinable fair value will be classified how?
either trading securities or available-for-sale securities
What are trading securities?
Trading securities include debt securities and readily marketable equity securities that are bought and held principally for the purpose of selling them in the near term. They generally reflect active and frequent buying and selling.
How are trading securities recognized on the balance sheet?
at fair value.
Unrealized holding gains and losses for trading securities are included in earnings.
What does the valuation allowance account represent?
it represents the difference between cost and fair value. A debt balance means that the FV is larger than cost, a credit balance means that the FV is less than cost.
What is the net unrealized holding gain or loss account?
It is a net income account that is a temporary account that reflects the change in the net unrealized gain or loss during the current period.
What is a financial instrument?
It is cash, evidence of an ownership interest in an enterprise, or a contract that both:
1) imposes on one entity a contractual obligation to deliver cash or another financial instrument to a second entity or to exchange financial instruments on potentially unfavorable terms with the second entity and
2) conveys to that second entity a contractual right to receive cash or another financial instrument from the first entity or to exchange other financial instruments on potentially favorable terms with the first entity
Some financial instruments are currently recognized as assets and the amount recognized reflects what?
the risk of accounting loss to the entity
Some financial instruments that are recognized as assets may expose the entity to a risk of accounting loss that exceeds the amount of currently recognize in the balance sheet. How is this shown?
off-balance sheet risk
Some financial instruments are currently recognized as liabilities, and the amount to settle the obligation cannot exceed what?
the amount recognized on the balance sheet
Some financial instruments that are recognized as liabilities may expose the entity to a risk of accounting loss that exceeds the amount of currently recognize in the balance sheet. How is this shown?
off-balance sheet risk
What 5 disclosures must be made regarding fair value?
1. FV of financial instruments for which it is practicable to estimate that value (either in the body of the FS or in the notes)
2. FV must be presented together with the related carrying amount, in a form that makes it clear whether the FV and carrying amounts represent assets or liabilities and how the carrying amounts relate to what is reported in the BS
3. the method or methods and significant assumptions used to estimate the FV
4. description of any changes in the methods and significant assumptions used to estimate FV of financial instruments during the period
5. the level of the FV hierarchy within which the FV measurements were categorized must be stated (level 1,2 or 3)
What is the best evidence of the FV of financial instruments?
quoted market prices, if available.
If quoted market prices are not available, management's best estimate of FV may be based on the quoted market price of a financial instrument with similar characteristics or on appropriate valuation techniques
What does "practicable" mean in reference to FV?
It means that an estimate of FV can be made without incurring excessive costs. It is a dynamic concept. What is practicable for one entity might not be for another.
If it is not practicable to estimate the FV of a financial instrument or class of financial instruments, what 2 things must be disclosed?
1. information pertinent to estimating FV of that instrument or class of instruments, such as the carrying amount, effective interest rate and maturity
2. the reasons why it is not practicable to estimate FV
What are the disclosure requirements for the FV for trade receivables and payables?
There are none if their carrying amount approximated their FV
What are the 4 required disclosures regarding credit risk?
1. information about the (shared) activity, region, or economic characteristics that identifies the concentration
2. the maximum amount of loss due to credit risk that, based on the gross FV of the financial instrument, the entity would incur if parties to the financial instruments that make up the concentration failed completely to perform according to the terms of the contracts and collateral or other security, if any, for the amount due proved to be no value to the entity
3. the entity's policy of requiring collateral or other security support financial instruments subject to credit risk, information about the entity's access to that collateral or other security, and the nature and a brief description of the collateral or the other security supporting those financial instruments
4. the entity's policy of entering into master netting arrangements to mitigate the credit risk of financial instruments, information about the arrangements for which the entity is a party, and a brief description of the terms of those arrangements, including the extent to which they would reduce the entity's maximum amount of loss due to credit risk
Must an entity disclose quantitative information about the market risks of financial instruments?
An entity is encouraged but not required
What are available-for-sale securities?
Investments in debt securities and readily marketable equity securities that are not classified as held-to-maturity securities or as trading securities
How are available-for-sale securities recognized?
On the balance sheet at FV. However, any related unrealized holding gains/losses are excluded from net income and reported as other comprehensive income
Transfers between categories shall be accounted for at FV. Transfers from trading securities to either available-for-sale or held-to-maturity securities are accounted for how?
the unrealized holding gain or loss will already have been recognized in earnings and shall not be reversed
Transfers between categories shall be accounted for at FV. Transfers into trading securities from either available-for-sale or held-to-maturity securities are accounted for how?
the unrealized holding gain or loss shall be recognized in earnings immediately
Transfers between categories shall be accounted for at FV. Transfers into the available-for-sale category from the held-to-maturity category are accounted for how?
the unrealized holding gain or loss shall be recognized as other comprehensive income
Transfers between categories shall be accounted for at FV. Transfers into the held-to-maturity category from the available-for-sale category are accounted for how?
the unrealized holding gain or loss at the time of transfer shall continue to be reported as accumulated other comprehensive income in SH's equity but shall be amortized over the remaining life of the security as an adjustment of yield in a manner consistent with the amortization of any premium or discount
Individual securities classified as either available-for-sale or held-to-maturity shall be evaluated to determine whether a decline in FB below the amortized cost basis is other than temporary. If so, what should be done?
the cost basis of the individual security should be written down to FV and the amount of the write-down included in earnings. For a debt security, the amount recognized in earnings depends on whether the entity intends to sell the security or more likely than not will be required to sell it prior to recovery of its amortized cost basis less any current-period credit loss.
In a classified BS, where should trading securities be presented?
in the current assets section
What section of the cash flow statement should cash flows from purchases, sales and maturity of available-for-sale securities and held-to-maturity securities be classified?
investing activities and reported gross for each security classification
What section of the cash flow statement should cash flows from purchases, sales and maturity of trading securities be classifies?
as cash flows from operating activities
How does FASB ASC 320-10-35 require that unrealized gains/losses occurring during the year related to available-for-sale securities be recognized?
in other comprehensive income. It also requires that reclassification adjustments be recognized in other comprehensive income.
For debt securities classified as available-for-sale and separately for all securities classified as held-to-maturity, an enterprise must disclose what 4 things?
1. aggregated FV
2. gross unrealized holding gains
3. gross unrealized holding losses
4. amortized cost basis by major security type as of each date for which a BS is presented
For investments in debt securities classified as available-for-sale and separately for all securities classified as held-to-maturity, an enterprise must disclose what 4 things?
1. information about the contractual maturities of those securities as of the date of the most recent BS presents
2. It must disclose the FV and the amortized cost of debt securities based on at least 4 maturity groupings:
a) within 1 year
b) after 1 year through 5 years
c) after 5 years through 10 years
d) after 10 years
For any sales of or transfers from securities classified as held-to-maturity, what 3 things must be disclosed?
1. the amortized cost amount of the sold or transferred security
2. the related realized or unrealized gain or loss
3. the circumstances leading to the decision to sell or transfer the security
For each period for which the results of operations are presented, an enterprise must disclose what 5 things?
1. the proceeds from the sale of available-for-sale securities and the gross realized gains and gross realized losses on those sales
2. the basis on which cost was determined in computing realized gain or loss (ie - specific identification, average cost or method)
3. the gross gain and gross losses included in earnings from transfers of securities from the available-for-sale category into the trading category
4. the change in net unrealized holding gain or loss on available-for-securities that has been included in the separate component of SH's equity during the period
5. the change in net unrealized holding gain or loss on trading securities that has been included in earnings during the period
What types of security will be classified in the held-to-maturity category?
1. investments in debt securities. (equity securities are not included because they have no maturity date)
2. the reporting enterprise must have the positive intent and ability to hold the debt security to maturity (if the intent to hold the security is indefinite, it should NOT be included here)
How are investments classified as held-to-maturity measured?
At amortized cost.
acquisition cost adjusted for any amortized premium or discount
The accounting method that should be used by an investor to account for the investment in an investee depends on what 2 things?
1. the nature of the stock of the investee
2. the degree of influence or control the investor exercises over the investee
Long-term investments in stocks other than common stock are accounted for using what method?
fair value if the stock qualifies as a marketable equity security; otherwise the cost method should be used
If an investor owns a controlling interest in the voting stock of an investee, how should this be accounted?
normally the investor (parent) should prepare consolidated financial statements and include the accounts of the investee (subsidiary) in those statements
How should investments in voting stock of investee be accounted for when the investor does not own a controlling interest?
equity method if the investor has the ability to exercise significant influence over the operating and financial policies of the investee. If the investor does not have the ability to do this, then the fair value, cost or lower of cost or market method should be used
Generally, what percentage of ownership leads to the presumption that an investor does not have the ability to exercise significant influence?
20% or less
20% or less ownership of voting stock of investee can demonstrate significant influence over investee if what 5 things can be demonstrated?
1. representation on the investee's board of directors
2. participation in the investee's policy-making processes
3. material intercompany transactions with the investee
4. interchange of managerial personnel
5. technological dependency of the investee on the investor
Generally, ownership of 20% or more of the voting stock of the investee leads to the presumption of the ability to exercise significant influence over the investee unless evidence to the contrary be shown. What 5 things can do this?
1. opposition by the investee, such as litigation, challenges the investor's ability to exercise significant influence
2. investor and investee sign an agreement under which the investor surrenders significant rights as shareholder
3. majority ownership of the investee is concentrated among a small group of SH who operate the investee without regard to the views of the investor
4. investor needs or wants more financial information to apply the equity method than is available to the investee's other SH, tries to obtain that info and fails
5. investor tries and fails to obtain representation on the investee's board of directors
What is the cost method of accounting for investments?
The investor records and maintains the investment account at cost. Earnings are recognized as income only as accrued by the investor in the form of dividends
What is the equity method of accounting for investments?
The investor initially records the investment at cost. Subsequent to acquisition, investor adjusts the carrying amount of the investment to recognized investor's share of earnings or losses after the date of acquisition
Under the equity method of accounting for investments, when the carrying amount of the investment is adjusted, where is the adjustment included?
in net income of the investor and reflects adjustments similar to those made in preparing consolidated statements
What 3 types of adjustments are made in consolidated statements and adjustments to investments using the equity method?
1. recognized the investor's share of the investee's reported earnings or losses
2. eliminate intercompany gains and losses, and
3. amortize any differences between cost of the investment and the investor's equity in the net assets of the investee. (note: goodwill may not be amortized)
Under the equity method, how are dividends received from the investee recognized?
it reduces the carrying cost of the investment but are not included in the income of the investor
The investor's ownership is based on what type of voting stock?
common or preferred
The investor's share of investee's earnings or losses is based on what type of voting stock?
How should the investment using the equity method be shown on the investor's balance sheet?
as a single amount
How should the investor's share of earnings and losses from continuing operations in an investee be shown?
as a single amount on the income statement
When should an investor discontinue applying the equity method?
When the investment account is reduced to zero unless the imminent return to profitable operations by the investee appears to be assured. If the investee subsequently reports net income, the investor should resume applying the equity method only after its share of that net income equals the share of net losses not recognized during the period the equity method was suspended
The investor's ownership percentage may decrease below the level required for the equity method to be used. In such cases, the investor should switch to what method?
cost method (or LCM if a marketable equity security) on a prospective basis. The balance in the investment account at the time of the switch would be considered to be cost for purposes of applying the cost method
An investment previously accounted for by other than the equity method may become qualified for use of the equity method by an increase in the investor's ownership percentage. When this occurs, the investor should switch to the equity method using what basis?
retroactive. The investment, results of operations (current and prior periods), and retained earnings of the investor should be adjusted retroactively
How do stock dividends affect the investor?
1. It is not income to the investor
2. the carrying amount per share is affected
A stock dividend takes nothing from the property of the corp and adds nothing to the interests of the SH.
Corporations sometimes issue certificates known as warrants, what do these warrants do?
1. gives the holder the right to purchase a specified number of shares of stock at a specified price within a specified time period
In some cases, warrants are issued to existing stockholders as a means of what?
1. complying with any preemptive right associated with that class of stock OR
2. aiding the sale of additional shares of stock
In such cases, the stockholder is entitled to one right for each new share of the stock owned but more than one right may be required to purchase one new share of stock
The recipient of stock rights has the following 3 alternative courses of action, what are they?
1. exercise the right in purchasing shares of stock
2. sell the right
3. allow the right to expire
When a corporation issues stock right, it has not distributed any assets. The recipient of the rights should be treated in what manner?
similar to stock dividends
When stock rights are received, how should the investor (recipient) allocate the carrying cost?
it should allocate the carrying amount of the stock already owned between the stock and the rights. Allocation should be on the basis of relative fair values
Stock rights are included in the definition of equity securities. How should they be classified?
As either trading securities or available-for-sale
Allocation of carrying amount "to rights" formula (stock rights)
(MV of one right/(MV of one share of stock ex-rights + MV of one right)) X carrying amount of stock before rights received
Allocation of carrying amount to "Old shares of stock" (stock rights) formula
( MV of one share of stock ex-rights/(MV of one share of stock ex-rights + MV of one right)) X Carrying amount of stock before rights received
What is the formula for the "Theoretical MV of one right" as ex-rights?
(MV of one share of stock ex-rights - exercise price per share for new stock)/number of rights to buy one share
What is the formula for the "Theoretical MV of one right" as rights-on?
(MV of one share of stock rights on - exercise price per share for new stock)/(number of rights to buy one share +1)
Investments in debt securities shall be classified as held-to-maturity securities if the enterprise has the positive intent and ability to hold those securities to maturity. Otherwise, how should they be classified?
As trading securities or available-for-sale securities and reported on balance sheet at FV
How are held-to-maturity securities accounted for?
using the amortized cost method. Carried at original cost adjusted for the amortization of any discount or premium. A single account is more of tradition than requirement, discount or premium could be set up in a separate account