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Investment in Debt and Equity Securities

chapter 14. Investment in Debt and Equity Securities. Learning Objectives. 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.

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Investment in Debt and Equity Securities

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  1. chapter14 Investment in Debt and Equity Securities

  2. Learning Objectives 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. Continued

  3. Learning Objectives 5. Account for the change in value of securities. 6. Account for the sale of investment securities. • Record the transfer of securities between categories. • Explain the proper classification and disclosure of investments in securities Continued

  4. Time Line of Business Issues Involved with Investment Securities • DETERMINE purpose of investment • CLASSIFY investments • PURCHASE securities • EARN AND RECOGNIZE a return • MONITOR changes in value • SELL securities • TRANSFER securities between categories • DISCLOSE status of portfolio at the end of the period

  5. Why Companies Invest in Other Companies • Safety Cushion • Cyclical Cash Needs • Investment for a Return • Investment for Influence • Purchase for Control

  6. Investment in Debt and Equity Securities—2001 Total Investment Percentage of Company (in billions) Total Assets Berkshire Hathaway $69.0 42.4% Microsoft 17.7 34.7 Coca-Cola 5.4 24.2 Citigroup 160.8 15.3 AT&T 24.5 14.8 Verizon 10.2 6.0

  7. Classification of Investment in Securities Debt securitiestypically have the following characteristics: 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.

  8. Classification of Investment in Securities • Equity securities have the potential for significant increases in price. Equity securitiesrepresent ownership in a company. • These shares of stock typically carry with them the right to collect dividends and vote on corporate matters.

  9. Classification of Investment in Securities Securities purchased for sale in the near future. Trading Securities purchased with the intent to hold until maturity. Held-to-Maturity Available-for-sale Securities not classified as trading or held-to-maturity. Debt/Equity Securities

  10. Classification of Investment in Securities Cost Method Debt Equity Held-to-maturity Available-for-sale Trading Equity Method

  11. Equity Method Securities 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. Even then, there may be evidence to support the fact that even a 20 percent investment does not have significant influence.

  12. Different Accounting Treatments Disclosure on the Balance Sheet Treatment of Temporary Changes in Value Classification of Securities Types of Securities Held to maturity Debt Amortized cost Not recognized Available 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

  13. 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. Accrued interest on May 1 is $3,000, calculated as follows: $100,000 x .09 x 4/12 = $3,000

  14. Purchases of Debt Securities Asset Approach Always includes brokerage fees Purchase date: May 1 Investment in Trading Securities 104,250 Interest Receivable 3,000 Cash 107,250 Continued

  15. Purchases of Debt Securities Revenue Approach Purchase date: May 1 Investment in Trading Securities 104,250 Interest Revenue 3,000 Cash 107,250 Continued

  16. Purchases of Debt Securities Asset Approach July 1 Cash 4,500 Interest Receivable 3,000 Interest Revenue 1,500 Revenue Approach July 1 Cash 4,500 Interest Revenue 4,500 Receipt of semiannual payment:

  17. Purchaseof Equity Securities - Available for Sale (AFS)/Trading Investment in Available-for-Sale*/Trading Securities - AB Company2,000 Cash 2,000 Purchased 1,000 shares of AB Company’s common shares at $2 per share. * - 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

  18. Purchaseof Equity Securities – Equity Method Citty Co. purchased 100,000 shares of AB Company common shares at $2 per share. 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.

  19. Purchaseof Equity Securities - – Equity Method Equity Method Securities Investment in AB Company Stock 200,000 Cash 200,000 Purchased 100,000 shares of Dave’s Deli common shares at $2 per share.

  20. Recognizing 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%.

  21. PV/Price of Debt Securities Present value of principal: FV = $100,000; N = 10; I = 4% $ 67,556 Present value of interest payments: PMT = $5,000; N = 10; I = 4% 40,554 Total present value of the bonds $108,110 Investment in Trading Securities 108,100 Cash 108,100 OR Investment in Held-to-Maturity Securities 108,100 Cash 108,100

  22. Interest Revenue for Debt Securities (Trading) When the first interest payment is received from Silmaril, the following entry would be made: July 1 Cash 5,000 Interest Revenue 5,000

  23. Interest Revenue for Debt Securities (Held-to-Maturity) $108,110 x .04 When the first interest payment is received from Silmaril, the following entry would be made: July 1 Cash 5,000 Interest Revenue 4,324 Investment in Held-to- Maturity Securities 676

  24. Recognizing Revenue for Equity Securities depends on the Appropriate Accounting Method Account for as trading or available-for-sale Equity method and consolidation procedures Equity method OwnershipPercentage No significant influence Significant influence Control 20% 50% 100% 0%

  25. Determining the Appropriate Accounting Method Control or Degree of Influence Ownership Interest Accounting Method Applicable Standard More than 50% Control Equity method APB Opinion #18 and consolidation FASB Exposure procedures Draft 20% to 50% Significant Equity method APB Opinion #18 influence Less than 20% No Account for as FASB Statement significant trading or No. 115 influence available for sale

  26. Revenue for Equity Securities Classified as Trading and AFS AB Company announces dividends of $0.25 per share. Assume that Citty Co. owns 10,000 of AB’s 200,000 shares (which represents 5%) Cash 2,500 Dividend Revenue 2,500

  27. Revenue for Equity Securities Classified as Equity Method Securities AB Company announces dividends of $0.25 per share. Assume that Citty Co. owns 100,000 which represents 50 % of the outstanding voting stock. Cash 25,000 Investment in AB Company Stock 25,000

  28. Revenue for Equity Securities Classified as Equity Method Securities AB Company reports an income of $250,000 for the year. Again, assume that Citty Co. owns 50 % of the outstanding voting stock. Investment in AB Company Stock 125,000 Income from Investment in AB Company Stock 125,000

  29. Classification of Security Available- Fair market Stockholder’s for-sale value equity Held-to- Amortized Not maturity cost recognized Accounting for TemporaryChanges in Value of Securities (an extract of slide 12) Disclosed at Report FMV Change On Fair market Income Trading value statement

  30. Accounting for TemporaryChanges in Value of Securities Eastwood Inc. bought the following securities on March 23, 2005.

  31. Accounting for TemporaryChanges in Value of Securities Initial Purchase Entry Investment in Trading Securities 11,000 Investment in Available-for-Sale Securities 17,000 Investment in Held-to-Maturity Securities 20,000 Cash 48,000 Continued

  32. Accounting for TemporaryChanges in Value of Securities By the end of the year, the value of the trading securities decreased from $11,000 to $10,500. December 31, 2005: Unrealized Loss on Trading Securities 500 Market Adjustment—Trading Securities 500 A contra account to the “investment account” Included in net income

  33. Accounting for TemporaryChanges in Value of Securities By the end of the year, the value of the available-for-salesecurities increased from $17,000 to $17,600. Included in stock holder’s equity => Comprehensive income December 31, 2005: Market Adjustment—Available-for-Sale Securities 600 Unrealized Increase/Decrease in Value of Available-for-Sale Securities 600

  34. Accounting for TemporaryChanges 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 17,600 Invest. in held-to-maturity sec. 20,000 $48,100 Stockholders’ Equity Add unrealized increase in available-for-sale securities $ 600

  35. Accounting for TemporaryChanges in Value of Securities Partial Income Statement for Eastwood Inc. Other expenses and losses: Unrealized loss on trading securities $500

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