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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
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.
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
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.
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
Revenue from Debt Securities
• 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.
Revenue from Debt Securities
• 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
Investment in Medco Stock 4,000
Investment in Medco Stock 20,000
Income from Investment
in Medco Stock (50,000*0.4) 20,000
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2
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.
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
Accounting for the Change in Value of Securities
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.
Accounting for the Change in Value of Securities
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
Accounting for the Change in Value of Securities
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
Accounting for the Change in Value of Securities
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
Accounting for the Change in Value of Securities
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
Accounting for the Change in Value of Securities
Partial Income Statement for Eastwood Inc.
Other expenses and losses:Unrealized loss on trading
securities $500
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.
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