Investments in Debt andEquity Securities

TEMPORARY INVESTMENTS

Use of idle cash Low risk investments Quickly and easily converted to

cash Securities of federal, state, and

local government agencies

LONG-TERM INVESTMENTS

Develops beneficial intercompany relationships.

May indirectly improve profitability of investing company.

May represent ownership interest.

ACCOUNTING ISSUES

Classification issues– Management’s intended holding

period for the security Valuation and investment income

measurement– Cost vs. fair value– Treatment of holding gains & losses

Disclosure issues

Invest. secur - 5

ACCOUNTING FOR VARIOUS INVESTMENTS

Classification Investment inDebt Securities

Investment inEquity Securities

Control-greater than 50%ownership of voting stock

Not applicable Consolidation

Significant influence - 20% to50% ownership of voting stock

Not applicable Equity method

Debt securities classified as heldto maturity, and equity securitiesfor which fair value is not readilydeterminable

Amortized cost method Cost method

Debt and equity securitiesclassified as trading securities

Fair value method, with unrealized holding gain or lossincluded in earnings

Debt and equity securitiesclassified as available for sale

Fair value method, with unrealized holding gain or lossincluded as a component of comprehensive income/stockholders’ equity

CLASSIFYING INVESTMENTS

Debt or equity security?

Fair value readily determinable?

Management’s intended holding period?

Influence or control over investee? Only for equity securitiesequity securities with voting rights

DEBT SECURITIES

Represent creditor relationship with an entity

– US Treasury securities, municipal securities, corporate bonds, convertible debt, commercial paper, and redeemable preferred stock

EQUITY SECURITIES

Represent ownership interest in an entity or the right to acquire or to dispose of an ownership right at a fixed price

– Capital stock (common and preferred), warrants, rights, and options

EQUITY SECURITIESCONTROLLING INTEREST

Investor (parent)(parent) owns more than 50% ofvoting stock in investee (subsidiary)(subsidiary).

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Consolidated financial statements

EQUITY SECURITIESSIGNIFICANT INFLUENCE

Investor holds 20% to 50%20% to 50% of voting stock

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Equity method

EQUITY METHOD

The investment account is increasedincreased by:– Original investment cost– Proportionate share of investee's earnings

The investment account is decreaseddecreased by:– Dividends received

EQUITY SECURITIESNO SIGNIFICANT INFLUENCE

Investor holds less than 20%less than 20% of voting stock

Measure carrying value of securities at fair valuefair value, ifreadily determinable.

If fair value is not readily determinable, use costmethod.

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DEBT SECURITIESCLASSIFICATION

Held to maturity (HTM)– Only for debtdebt securities– Investor intends and has the ability to hold security to maturity date.– Carry at amortized cost on balance sheet.

DEBT & EQUITY SECURITIESCLASSIFICATION

Trading securities (TS)– Debt or equity securities– Bought and held primarily to be sold in the near term– Current assets– Unrealized holding gains and losses included in earnings (net income)earnings (net income)

DEBT & EQUITY SECURITIESCLASSIFICATION

Securities available for sale (SAS)– Debt or equity securities– Investments expected to be held for an unspecified period of time– Typically noncurrent assets– Unrealized holding gains and losses reported as a separate component of stockholders’stockholders’ equityequity

TS AND SASACQUISITIONS

Recorded at cost when acquired.– Purchase price and incidental costs

Basket purchase requires allocation of the total cost to each class of security purchased.– Based on relative market values

TS and SAS are reported at fair valuefair value on the balance sheet.

The difference between the fair value and the carrying value from the previous balance sheet date (cost if acquisition occurred in the current period) is an unrealized holding gain unrealized holding gain or loss.or loss.

TS AND SASRECORDING AT FAIR VALUE

The unrealized holding gain or loss must be determined for individualindividual securities.

Each security has a valuation allowance valuation allowance account.account.

TS AND SASRECORDING AT FAIR VALUE

The individual unrealized holding gains and losses are added together to arrive at the

net portfolio unrealized holding gain or net portfolio unrealized holding gain or loss.loss.

Net unrealized holding gains and losses are calculated separately for the TS portfolio

and the SAS portfolio.

TS AND SASRECORDING AT FAIR VALUE

NET UNREALIZED HOLDING GAINS AND LOSSES

Trading securities:

The net unrealized holding gain or loss is treated as a component of

investment incomeinvestment income and is included on the income statementincome statement for the

period.

NET UNREALIZED HOLDING GAINS AND LOSSES

Securities available for sale:

The net unrealized holding gain or loss is notnot included in earnings for the period but rather is closed to a separately reported component of

stockholders’ equity.stockholders’ equity.

TS AND SASTRANSFERS

Transfers are accounted for at fair valuefair value on the transfer date.

Fair value at the reclassification date is regarded as cost of the security for

accounting purposes.

TS AND SASTRANSFERS

The entry will:– Remove the investments at cost.

– Record the investments with a carrying value equal to fair value.

– Remove the valuation accounts.

– Recognize the portion of unrealized holding gains or losses not previously included in income.

TS AND SASSALES

Sales are accounted for in a manner similar to transfers.

The only difference is that Cash is debited instead of the fair value of the

securities.

EQUITY INVESTMENTSSPECIAL ISSUES

Stock dividends and stock splits– Not included in investment revenue.– Increase in number of shares reduces

carrying value per share.

EQUITY INVESTMENTSSPECIAL ISSUES

Stock rights (Warrants)– Allocate investment cost between

stock and stock rights based on market value of stock and stock rights.

– Reported at fair market value.