This chapter covers accounting for investments including trading securities, available for sale held to maturity and equity method.
Trading Securities, Available-for-Sale, Held-to-Maturity (HTM) |Debt Securities
Held-to-Maturity (HTM) | Investment in Debt Securities
Available-for-Sale (AFS) | Debt Securities
Trading Securities | Debt Investment
Investment in Equity Securities
Equity Method of Investment (New FASB)
Fair Value Option for Investments
Impairment of Value for Debt Investments
Accounting for Derivatives: Speculation (Appendix 17A)
Accounting for Derivatives: Fair Value Hedge (Appendix 17A)
Accounting for Derivatives: Cash Flow Hedge (Appendix 17A&B
Example: Fair Value Hedge--Interest Rate Swap
Example: Cash Flow Hedge--Interest Rate Swap
Example: Interest Rate Swap With Journal Entries
Example: Investment in Debt Securities Held to Maturity
Example: Available-for-Sale Securities
The problems of accounting for investments involve measurement, recognition, and disclosure. Investments are generally classified as either debt securities or equity securities and may be either temporary or long-term investments. The first section presents accounting for debt securities; the second section covers accounting for equity securities; and the remainder of the chapter presents the equity method of accounting, disclosure requirements, impairments, and accounting for the transfer of investment securities between categories.
Debt securities are instruments representing a creditor relationship with an enterprise. Debt securities include U.S. government securities, municipal securities, corporate bonds, convertible debt, commercial paper, and all securitized debt instruments.
Debt securities are grouped into the following three separate categories:
Held-to-maturity: Debt securities that the enterprise has the positive intent and ability to hold to maturity.
Trading: Debt securities bought and held primarily for sale in the near term to generate income on short-term price differences.
Available-for-sale: Debt securities not classified as held-to-maturity or trading securities.
Held-to-Maturity Debt Securities
Held-to-maturity debt securities are accounted for at amortized cost, not fair value. A company should classify a debt security as held-to-maturity only if it has both (1) the positive intent and (2) the ability to hold those securities to maturity.
The effective-interest method is required to amortize premium or discount unless some other method—such as the straight-line method—yields a similar result. The effective-interest method is applied to bond investments in a fashion similar to that described for bonds payable. The effective-interest rate or yield is computed at the time of investment and is applied to its beginning carrying amount (amortized cost) for each interest period to compute interest revenue. The investment carrying amount is increased by the amortized discount or decreased by the amortized premium in each period.
Available-for-sale debt securities are reported at fair value. After a company recognizes interest revenue and bond investment amortization, it adjusts the carrying value of the portfolio of debt securities to fair value. The unrealized gains and losses related to changes in the fair value of available-for-sale debt securities are recorded in an unrealized holding gain or loss account. This account is reported as other comprehensive income and as a separate component of stockholders’ equity until realized. A valuation account called “Fair Value Adjustment” is used for the portfolio of debt investments instead of debiting or crediting the Available-for-Sale Securities account to enable the company to maintain a record of the securities’ amortized cost.
When an available-for-sale debt security is sold, the realized gain or loss is reported in the Other Revenues and Gains section or the Other Expenses and Losses section of the income statement. The unamortized cost of the bond investment is removed from the investment account.
When an investor has a holding interest of between 20% and 50% in an investee corporation, the investor is generally deemed to exercise significant influence over operating and financial policies of the investee. Other factors to consider in determining whether an investor can exercise “significant influence” over an investee include representation on the board of directors, participation in policy-making processes, material company transactions, interchange of managerial personnel, or technological dependency. In instances of “significant influence,” the investor is required to account for the investment using the equity method.
Under the equity method, the investment’s carrying amount is periodically increased (decreased) by the investor’s proportionate share of the earnings (losses) of the investee and decreased by dividends received by the investor from the investee.
Under the equity method, if an investor’s share of the investee’s losses exceeds the carrying amount of the investment, the investor should discontinue applying the equity method and not recognize additional losses (unless the investor’s loss is not limited or if return to profitability appears to be assured).