Spiceland, Chapter 12McGraw-Hill/Irwin
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Accounting for Investment Securities
Investments can be accounted for in six different ways, depending on the nature of the investment relationship.
Bonds and notes
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Debt
Investor has the positive intent and ability to hold to maturity
Held To Maturity
Securities Available-for-Sale
Fair Value (with unrealized gains and losses reported in shareholders' equity)
Debt or Equity
Trading Securities
Fair Value (with unrealized gains and losses included in earnings)
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Reporting Categories for Investments
Trading securities (TS) are bought and held primarily to be sold in the near term.
Securities available for sale (SAS) are expected to be held for an unspecified period of time.
Held to maturity (HTM) securities are those where the investor intends and has the ability to hold the security to maturity date.
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Debt
Investor has the positive intent and ability to hold to maturity
Held To Maturity
Securities Available-for-Sale
Fair Value (with unrealized gains and losses reported in shareholders' equity)
Debt or Equity
Trading Securities
Fair Value (with unrealized gains and losses included in earnings)
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Investments Held for an Unspecified Period of Time
When an investment is held for an unspecified period of time, it is reported at the fair value of the security on the reporting date.
Must be “readily determinable”
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a direct adjustment to the investment account, and
an allowance account in the equity section of the balance sheet called “Unrealized Holding Gains/Losses”.
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Securities Available for Sale Example
Foot, Inc. purchased the securities listed below in 2003. They are classified as Securities Available for Sale (SAS). Prepare the journal entries for Foot, Inc. to adjust the securities to fair value at Dec. 31, 2003.
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Securities Available for Sale Example
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Securities Available for Sale
Occasionally, an investment’s value will decline for reason’s that are “other than temporary”.
This is called . . .
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Securities Available for Sale
The new cost basis (the impaired fair value) is not changed for subsequent recoveries in fair value.
If the value is impaired . . .
. . . the recorded cost of the security is reduced to the impaired fair value, and the difference is included in the current period’s income.
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a direct adjustment to the investment account, and
a net unrealized holding gain/loss on the Income Statement.
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Trading Securities
Unrealized holding gains and losses from trading securities are reported on the income statement.
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Income from operations
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Example
Foot, Inc. purchased the addition securities classified as Trading Securities (TS) in 2003. Prepare the journal entries for Foot, Inc. to adjust the securities to fair value at 12/31/03.
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$ (1,500)
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Trading Securities & Securities Available for Sale - Example
The Net Unrealized Holding Loss is reported on the Income Statement.
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&A
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Transfers Between Reporting Categories
Transfers are accounted for at fair value on the transfer date.
Unrealized holding gains or losses at reclassification should be accounted for in a manner consistent with the classification into which the security is being transferred.
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Equity
Fair value not determinable and the equity method is not appropriate
Cost Method
The investor can "significantly influence" the operating and financial policies of the investee
Equity Method
Equity
Consolidation
Consolidated Financial Statements (as if they were a single company)
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When an investment results in the control of the investee (generally > 50%), the subsidiary is consolidated with the parent company.
The cost method is used for investments in equity securities when significant influence is not present.
The equity method is used for investments in equity securities resulting in significant influence (20%-50%).
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Equity
Fair value not determinable and the equity method is not appropriate
Cost Method
The investor can "significantly influence" the operating and financial policies of the investee
Equity Method
Equity
Consolidation
Consolidated Financial Statements (as if they were a single company)
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Original investment cost.
Dividends received.
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Equity Method
The investment account is reported on the balance sheet as a single amount.
The investor’s share of the investee’s earnings is reported as a single item on the investor’s income statement.
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Equity Method
If the investor acquires the equity securities of an investee by paying more than the fair value of net assets . . .
. . . the difference is allocated between GOODWILL and identifiable intangible assets.
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Example
Rings & More acquired 45% of the equity securities of Diamonds Galore for $1,350,000. On the acquisition date, Diamonds Galore’s net assets had a fair value of $3,000,000. During the year, Diamonds Galore paid dividends of $150,000 and net income of $1,750,000.
What amount will Rings & More report on the balance sheet as Investment in Diamonds Galore?
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45% Earnings 787,500
Reported Value 2,070,000
If the subsidiary had a loss, the investment account would have been reduced.
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The investment account is decreased.
When the Investment if Acquired in Mid-Year
The investment account is adjusted only for the income (loss) since the date of acquisition.
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Changing From Equity Method To Cost Method
At the transfer date, the carrying value of the investment under the equity method is regarded as cost.
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Changing From Equity Method To Cost Method
Any difference between cost and fair value is recorded in a valuation account and is recognized as an unrealized holding gain or loss.
After the transfer, the investment is treated as a trading security or a security available for sale, depending on management’s intent.
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Changing From Cost Method To Equity Method
When ownership level increases to a significant influence, the investor must change to the equity method.
At the transfer date, the recorded value is the initial cost of the investment adjusted for the investor’s equity in the undistributed earnings of the investee since the original investment.
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Changing From Cost Method To Equity Method
The original cost, the unrealized holding gain or loss, and the valuation account are closed.
A retroactive change is recorded to recognize the investor’s share of the investee’s earnings since the original investment.
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Contracts meeting certain conditions.
Derivatives:
Hedges created to offset risks created by other financial investments or transactions.
Value is derived from other securities.
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GENERAL JOURNAL
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Big Company
Income from
Net Unrealized Holding Gain2,500$
Big Company