Accounting for Investments Quiz

Chapter 8: Investments

• This chapter covers various investment strategies and accounting practices.
• Investments involve financial instruments categorized as equity and debt securities.
• Equity securities include common stock and preferred stock, purchased by individuals, mutual funds, or corporations. Objective is to gain returns from dividends or appreciation in market prices.
• Debt securities like bonds and notes are also investment options. Investors purchase them to collect interest and achieve price appreciation.

Financial Instruments

• Financial instruments are the cornerstones of investments.
• Two main categories are equity securities and debt securities.

Equity Securities

• Common stock: Ownership shares in a company.
• Preferred stock: Stock with preferential rights compared to common stock (e.g., dividends).
• Purchased by individual investors, mutual funds, and corporations.
• Goal is to earn a return from dividends or increases in market price of securities.
• Also designed to build ongoing affiliations with affiliated companies.

Debt Securities

• Bonds: Issued by corporations and governments promising to pay principal and interest to bondholders.
• Notes: Similar to bonds but with shorter maturity periods.
• Individual investors, mutual funds, and corporations purchase debt securities.
• Objective is to earn a return from interest or accrued appreciation in market price.
• Establishing ongoing affiliations with the issuing companies is also a goal.

Accounting for Debt Investments

• Debt security accounting involves recording transactions at cost (including brokerage fees) and calculating maturity dates with interest payments.
• Investments are valued at cost.
• The face amount is recorded for investment in the bonds.
• The purchase price difference is recorded as Discount on bond investment.
• Recording interest revenue is also a critical component of accounting for debt investments.

Debt Investment: Bonds Discount

• Masterwear Industries issued $700,000 of 12% bonds in 2024, maturing in 2027.
• United Intergroup purchased the entire issue at a 14% market interest rate.
• Calculating the bonds' price involves discounting future interest and principal payments using the current market rate of 14% per year. The purchase price of the bonds was $666,633.

Bond Investments: Premiums and Discounts

• Bond fair values change with fluctuations in market interest rates.
• Prices of fixed-rate investments are influenced by changes in market interest rates.
• Prices of bonds are higher when the stated interest rate is greater than the market rate.
• When stated rates are less than market rate, bonds are cheaper.

Purchase of a Debt Investment

• When purchasing debt investments the total amount paid is recorded.
• Brokerage fees are also included in this total.
• Debt investments are recorded using the cost method.

Recording Interest Revenue

• Recording interest revenue involves determining the interest received.
• Determining the amount is done by multiplying the face amount of the bonds by the stated rate.
• The present values are calculated based on the market rate.

Amortization Schedule-Discount

• An amortization schedule details the period-wise distribution of a discount on bond investment.
• Amortization gradually reduces the discount on bond investment to zero when bonds mature.

Reporting Approach of Debt Investments

• Held-to-maturity (HTM) investments are intended for long-term holding until maturity. They do not recognize unrealized gains and losses.
• Trading (TS) investments are held for the near term and are recorded at fair value. Unrealized gains/losses are recognized.
• Available-for-sale (AFS) investments are held with potential for future sale. Unrealized gains and losses are not recognized in the income statement, instead are included in OCI.

Financial Statement Presentation—HTM

• Realized gains and losses are recorded in the income statement.
• Unrealized gains and losses are disclosed in footnotes.
• Financial statements do not reflect unrealized gains and losses.
• Investments are reported at amortized cost less allowances for credit losses.
• Cash flows from HTM securities are classified as investing activities.

Reporting Held-to-Maturity Investments

• Discloses revenues, expenses, other income, net income and other comprehensive income (OCI) in the statement of comprehensive income.
• Shows investments in bonds at amortized cost minus credit losses in the balance sheet.
• Shows cash flows from interest received and buying, selling HTM securities as investing activities in the statement of cash flows.

Reporting Trading Securities

• Includes realized gains/losses in the income statement, regardless of whether the gains/losses were realized or unrealized.
• Investments reported at fair value in the balance sheet.
• Cash flows from buying and selling trading securities are considered operating activities.

Debt Investments: Available-for-Sale Securities

• Available-for-sale (AFS) securities are not held for trading or designated as held-to-maturity.
• These securities are reported at fair value in the balance sheet.
• Unrealized holding gains and losses are not recorded in the income statement, but rather in other comprehensive income (OCI).

Adjusting AFS Investments to Fair Value

• Fair value adjustments are made for AFS securities when their market price differs from their carrying value. This is generally done annually, and any difference is recorded in other comprehensive income.

Sale of AFS Investments

• If an AFS investment is sold, the adjustment is reversed, and the gain or loss on sale is recognized in the income statement.

Impairment of AFS Investments

• Companies need to recognize impairments when the fair value of AFS investments falls below the carrying value.
• The recognition of impairment loss depends on management's intention to sell the investment.

Financial Statement Presentation: AFS

• Gains and losses from fair value changes are reported in other comprehensive income (OCI).
• Investments are reported at fair value in the balance sheet.
• Cash flows from buying and selling AFS securities are reported in investing activities.

Investments in Securities Available-for-Sale—Cisco Systems

• This note provides a breakdown of various types of available-for-sale securities, including their amortized cost, gross unrealized gains, gross unrealized losses, and fair values in millions of dollars.

Comparison of HTM, TS, and AFS Approaches

• Summarizing different accounting methods for investments.
• Providing a quick comparison of investment accounting methods.

Transfers between Reporting Categories

• When transitioning between investment accounting categories, unrealized gains or losses are treated differently depending on the category transitioning to.
• Unrealized holding gains and losses are not recognized in the income statement during the transfer if one investment category transfers to a different category.

Fair Value Option (FVO-HTM & AFS)

• An optional accounting method for HTM and AFS investments to value them at fair value rather than amortized cost.
• Unrealized gains and losses are reported in the income statement.

Financial Statement Presentation and Disclosure

• Investors must disclose specific investment data in financial statements, including aggregated fair value, realized gains/losses, and their change in net unrealized gains/losses.

Fair Value Disclosures of Investment Securities

• Providing a snapshot of fair values for specific investments for HP Incorporated as of October 31, 2020.

Accounting for Equity Investments

• Explains how equity investments are accounted for, from purchasing them to holding them, and eventually selling them.

Reporting Categories for Equity Investments

• Discusses different investor influence levels and how these influence reporting methods for equity investments.

Investor Lacks Significant Influence

• This section details the accounting treatment for an investor who has less than a 20% ownership stake in another company's stock (lacks significant influence).
• Purchase, recognizing investment revenue, adjusting fair value, and recording sales are explained.

Adjustments for Other Assets and Liabilities

• Addresses the accounting treatment of unrealized gains or losses when inventory purchased by an investor is sold and when the fair value of purchased inventory exceeds its original book value.

Reporting the Investment

• In the equity method, the investor's share of the investee's undistributed earnings gets recorded in the investment account. However, the fair value of the investment shares is not reported annually.

Reporting the Investment: Losses & Mid-Year

• Explaining accounting for equity investments bought during the middle of the year.
• Provides examples for understanding the proportion of income/losses in relation to the timeframe the investment was held.

Equity Method Investments: AT&T

• Presenting a summary of equity investments for AT&T, broken down by category (current and noncurrent assets) as of December 31, 2018 and 2019.

Impairment of Equity Method Investments

• Outlines and describes the accounting procedures to be followed if the fair value of an equity investment falls below its carrying value.

What If Conditions Change?

• If the circumstances surrounding investment change, accounting treatment can shift from an equity method to another approach, though no adjustments are made to the current investment balance.

If an Equity Method Investment is Sold

• Provides a summary of the accounting treatment when an equity investment that has been valued using the equity method is sold.
• Explains the journal entries for such events in a straightforward manner.

Comparison of Fair Value and Equity Methods

• Explains how accounting differs for evaluating investments under fair value method vs. equity method.

Fair Value Option: Equity Method

• Clarifies how the fair value option affects accounting for investments using the equity method.

Credit Losses for Held-to-Maturity Investments

• Defines credit losses for held-to-maturity (HTM) investments.
• Explains how credit losses are estimated and calculated.

Credit Losses for Available-for-Sale Investments

• Covers the process of calculating credit losses for investments that are classified as available-for-sale (AFS).

Account for Impairment of AFS Investments

• Presents a decision tree to illustrate recognizing or not recognizing impairment for AFS investments.

Impairment of AFS Investments (Case 1)

• Explains the journal entry for impairment cases when the investor intends to sell the investment before fair value recovers to amortized cost.

Impairment of AFS Investments (Case 2)

• Explains the journal entry process, when the investor doesn't intend to sell the AFS investment and doesn't see it likely that the fair value will recover.

Test your knowledge on accounting for investments, including the effects of discount rates, amortization, and equity valuations. This quiz covers essential concepts like credit losses, significant influence, and the consolidation method of accounting. Perfect for finance students and professionals.