ch14(part1)
TRANSCRIPT
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Investment Investment in Debt and in Debt and
Equity Equity SecuritiesSecurities
chapterchapter 14
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1. Determine why companies invest in other companies.
2. Understand the varying classifications associated with securities.
3. Account for the purchase of debt and equity securities.
4. Account for the recognition of revenue from investments.
Learning Objectives
ContinuedContinuedContinuedContinued
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5. Account for the change in value of securities.
6. Account for the sale of investment securities.
7. Record the transfer of securities between categories.
8. Explain the proper classification and disclosure of investments in securities
Learning Objectives
ContinuedContinuedContinuedContinued
4Time Line of Business Issues Involved with Investment Securities
1. DETERMINE purpose of investment
2. CLASSIFY investments
3. PURCHASE securities
4. EARN AND RECOGNIZE a return
5. MONITOR changes in value
6. SELL securities
7. TRANSFER securities between categories
8. DISCLOSE status of portfolio at the end of the period
5Why Companies Invest in Other Companies
•Safety Cushion
•Cyclical Cash Needs
•Investment for a Return
•Investment for Influence
•Purchase for Control
6Investment in Debt and Equity Securities—2001
Total Investment Percentage ofTotal Investment Percentage ofCompany (in billions) Total AssetsCompany (in billions) Total Assets
Berkshire Hathaway $69.0 42.4%Microsoft 17.7 34.7Coca-Cola 5.4 24.2Citigroup 160.8 15.3AT&T 24.5 14.8Verizon 10.2 6.0
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1. A maturity value, representing the amount to be repaid to the debt holder at maturity.
2. An interest rate that specifies the periodic interest payments.
3. A maturity date, indicating when the debt obligation will be redeemed.
Classification of Investment in Securities
Debt securities typically have the following characteristics:
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These shares of stock typically carry with them the right to collect dividends and vote on corporate matters.
Equity securities represent ownership in a company.
Equity securities have the potential for significant increases in price.
Classification of Investment in Securities
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Debt/EquitySecurities
TradingTradingSecurities purchased for salein the near future.
Held-to-Maturity
Held-to-Maturity
Securities purchased with theintent to hold until maturity.
Available-for-sale
Available-for-sale
Securities not classified astrading or held-to-maturity.
Classification of Investment in Securities
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Available-for-sale
TradingHeld-to-maturity
DebtDebt
Equity Method
EquityEquity
Classification of Investment in Securities
Cost Method
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Equity Method Securities
These are securities purchased with the intent to control or significantly influence the operations of the investee.
These are securities purchased with the intent to control or significantly influence the operations of the investee.
At least 20 percent of the outstanding voting stock must be owned to have
this significant influence or control.
At least 20 percent of the outstanding voting stock must be owned to have
this significant influence or control.
Even then, there may be evidence to support the fact
that even a 20 percent investment does not have
significant influence.
Even then, there may be evidence to support the fact
that even a 20 percent investment does not have
significant influence.
12Different Accounting Different Accounting TreatmentsTreatments
Classification of Securities
Types of Securities
Disclosure on the
Balance Sheet
Treatment of Temporary Changes in
Value
Held to maturity Debt Amortized cost Not recognizedAvailable for sale Debt/equity Fair market value Reported in
stockholders’ equity
Trading Debt/equity Fair market value Reported on the income statement
Equity method Equity Historical cost Not recognized adjusted for changes in the assets of the investee
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Purchases of Debt Securities
On May 1, Douglas Company purchases $100,000 in U.S. Treasury notes at 104¼, including brokerage fees. Interest is 9%
payable semiannually on January 1 and July 1. The debt securities are classified by the
purchaser as trading securities.
On May 1, Douglas Company purchases $100,000 in U.S. Treasury notes at 104¼, including brokerage fees. Interest is 9%
payable semiannually on January 1 and July 1. The debt securities are classified by the
purchaser as trading securities.
Accrued interest on May 1 is $3,000, calculated as follows:
$100,000 x .09 x 4/12 = $3,000
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Purchases of Debt Securities
May 1 Investment in Trading Securities 104,250Interest Receivable 3,000
Cash 107,250
Purchase date:
Asset Approach
ContinuedContinuedContinuedContinued
Always includes
brokerage fees
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Purchases of Debt Securities
May 1 Investment in Trading Securities 104,250Interest Revenue 3,000
Cash 107,250
Purchase date:
Revenue Approach
ContinuedContinuedContinuedContinued
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Purchases of Debt Securities
Receipt of semiannual payment:
July 1 Cash 4,500Interest Receivable 3,000Interest Revenue 1,500
Asset Approach
July 1 Cash 4,500Interest Revenue 4,500
Revenue Approach
17Purchase of Equity Securities - Available for Sale (AFS)/Trading
Purchased 1,000 shares of AB Company’s Purchased 1,000 shares of AB Company’s common shares at $2 per share.common shares at $2 per share.
Purchased 1,000 shares of AB Company’s Purchased 1,000 shares of AB Company’s common shares at $2 per share.common shares at $2 per share.
Investment in Available-for-Sale*/Trading Securities - AB Company 2,000
Cash 2,000
* - would be so classified if management has no intention of holding them for a long period of time and will sell them as soon
as it is economically advantageous
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Citty Co. purchased 100,000 shares of AB Citty Co. purchased 100,000 shares of AB Company common shares at $2 per share.Company common shares at $2 per share.
Citty Co. purchased 100,000 shares of AB Citty Co. purchased 100,000 shares of AB Company common shares at $2 per share.Company common shares at $2 per share.
Purchase of Equity Securities – Equity Method
Assume that the 100,000 shares purchased represents 20 % of the outstanding voting stock of AB
Company. This investment gives the investor significant influence over AB
Company.
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Purchased 100,000 shares of Dave’s Deli Purchased 100,000 shares of Dave’s Deli common shares at $2 per share.common shares at $2 per share.
Purchased 100,000 shares of Dave’s Deli Purchased 100,000 shares of Dave’s Deli common shares at $2 per share.common shares at $2 per share.
Equity Method SecuritiesEquity Method Securities
Investment in AB Company Stock 200,000Cash 200,000
Purchase of Equity Securities - – Equity Method
20Recognizing Revenue from 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%.
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%.
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PV/Price of Debt SecuritiesPresent 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
$108,110Investment in Trading Securities 108,100
Cash108,100
Investment in Held-to-Maturity Securities 108,100
Cash108,100
OR
22Interest Revenue for Debt Securities (Trading)
When the first interest payment is received from Silmaril, the following
entry would be made:
When the first interest payment is received from Silmaril, the following
entry would be made:
July 1 Cash 5,000Interest Revenue 5,000
23Interest Revenue for Debt Securities (Held-to-Maturity)
When the first interest payment is received from Silmaril, the following
entry would be made:
When the first interest payment is received from Silmaril, the following
entry would be made:
July 1 Cash 5,000Interest Revenue 4,324Investment in Held-to- Maturity Securities 676
$108,110 x .04
24Recognizing Revenue for Equity Recognizing Revenue for Equity Securities depends on the Securities depends on the
Appropriate Accounting MethodAppropriate Accounting Method
0% 20% 50% 100%
No significantinfluence
Significantinfluence
Control
Ownership Percentage
Account for as trading or
available-for-saleEquity method
Equity method and consolidation
procedures
25Determining the Appropriate Determining the Appropriate Accounting MethodAccounting Method
Ownership Interest
Control or Degree of Influence
Accounting Method
Applicable Standard
More than 50% Control Equity method APB Opinion #18and consolidation FASB Exposureprocedures Draft
20% to 50% Significant Equity method APB Opinion #18influence
Less than 20% No Account for as FASB Statementsignificant trading or No. 115influence available for sale
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AB Company announces dividends of AB Company announces dividends of $0.25 per share. Assume that Citty Co. $0.25 per share. Assume that Citty Co. owns 10,000 of AB’s 200,000 shares owns 10,000 of AB’s 200,000 shares
(which represents 5%)(which represents 5%)
AB Company announces dividends of AB Company announces dividends of $0.25 per share. Assume that Citty Co. $0.25 per share. Assume that Citty Co. owns 10,000 of AB’s 200,000 shares owns 10,000 of AB’s 200,000 shares
(which represents 5%)(which represents 5%)
Cash 2,500Dividend Revenue 2,500
Revenue for Equity Securities Classified as Trading and AFS
27Revenue for Equity Securities Classified as Equity Method
Securities
AB Company announces AB Company announces dividends dividends of of $0.25 per share. Assume that Citty Co. $0.25 per share. Assume that Citty Co.
owns 100,000 which represents 50 % of owns 100,000 which represents 50 % of the outstanding voting stock.the outstanding voting stock.
AB Company announces AB Company announces dividends dividends of of $0.25 per share. Assume that Citty Co. $0.25 per share. Assume that Citty Co.
owns 100,000 which represents 50 % of owns 100,000 which represents 50 % of the outstanding voting stock.the outstanding voting stock.
Cash 25,000Investment in AB Company Stock 25,000
28Revenue for Equity Securities Classified as Equity Method
Securities
AB Company reports an AB Company reports an incomeincome of of $250,000 for the year. Again, assume $250,000 for the year. Again, assume
that Citty Co. owns 50 % of the that Citty Co. owns 50 % of the outstanding voting stock.outstanding voting stock.
AB Company reports an AB Company reports an incomeincome of of $250,000 for the year. Again, assume $250,000 for the year. Again, assume
that Citty Co. owns 50 % of the that Citty Co. owns 50 % of the outstanding voting stock.outstanding voting stock.
Investment in AB Company Stock 125,000
Income from Investment in AB Company Stock 125,000
29Accounting for TemporaryChanges in Value of Securities (an
extract of slide 12)
Classificationof Security
Disclosedat
Report FMV
TradingFair marketvalue
Incomestatement
Held-to-maturity
Amortizedcost
Notrecognized
Available-for-sale
Fair marketvalue
Stockholder’sequity
Change On
30Accounting for TemporaryChanges in Value of Securities
Security Classification Cost($) FMV 31/12/05($)
1 Trading 8,000 7,000
2 Trading 3,000 3,500
3 Available for Sale 5,000 6,100
4 Available for Sale 12,000 11,500
5 Held to Maturity 20,000 19,000
Eastwood Inc. bought the following securities on March 23, 2005.
31Accounting for TemporaryChanges in Value of Securities
Investment in Trading Securities 11,000Investment in Available-for-Sale Securities 17,000Investment in Held-to-Maturity Securities 20,000
Cash 48,000
Initial Purchase EntryInitial Purchase Entry
ContinuedContinuedContinuedContinued
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December 31, 2005:
Unrealized Loss on Trading Securities 500 Market Adjustment—Trading Securities 500
By the end of the year, the value of By the end of the year, the value of the the trading securitiestrading securities decreased from decreased from
$11,000 to $10,500.$11,000 to $10,500.
By the end of the year, the value of By the end of the year, the value of the the trading securitiestrading securities decreased from decreased from
$11,000 to $10,500.$11,000 to $10,500.
Accounting for TemporaryChanges in Value of Securities
Included in net income
A contra account to the “investment account”
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December 31, 2005:
Market Adjustment—Available-for-Sale Securities 600
Unrealized Increase/Decrease in Value of Available-for-Sale Securities
600
By the end of the year, the value of By the end of the year, the value of the the available-for-saleavailable-for-sale securitiessecurities
increased from $17,000 to $17,600.increased from $17,000 to $17,600.
By the end of the year, the value of By the end of the year, the value of the the available-for-saleavailable-for-sale securitiessecurities
increased from $17,000 to $17,600.increased from $17,000 to $17,600.
Accounting for TemporaryChanges in Value of Securities
Included in stock holder’s equity =>
Comprehensive income
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Partial Balance Sheet for Eastwood Inc.Assets
Invest. in trading securities $11,000 Market adjustment—trading sec. (500) $10,500Invest. in available-for-sale sec. $17,000 Market adjustment 600 17,600Invest. in held-to-maturity sec. 20,000$48,100
Stockholders’ EquityAdd unrealized increase in available-for-sale securities $ 600
Accounting for TemporaryChanges in Value of Securities
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Partial Income Statement for Eastwood Inc.
Other expenses and losses:Unrealized loss on trading
securities $500
Accounting for TemporaryChanges in Value of Securities