1. Chapter 9--Learning Objectives
1. Explain the recognition and measurement issues associated with investments 1

2. The primary accounting standards for investments are:
FASB SFAS No. 115
For all debt securities
For equity investments of less than 20 percent
APB Opinion No. 18
For equity investments of more than 20 percent 2

3. Major provisions of SFAS No. 115
Investments accounted for at fair value or amortized cost
Investments classified as:
1. Trading securities
2. Available-for-sale
3. Held-to-maturity 3

4. Passive investments and significant influence
A passive investment is one in which the investor has no ability to exercise significant influence over the investee
Significant influence is presumed to exist with ownership of 20 percent to 50 percent of the voting stock of the investee 11

5. Investment classifications
Trading securities
Debt and equity securities bought and held principally for the purpose of sale in the near term
Available-for-sale securities
Debt and equity securities neither trading nor held-to-maturity
Held-to-maturity securities
Debt securities that the entity has the positive intent and ability to hold to maturity 12

6. Accounting requirements for Trading securities (investments less than 20 percent)
Changes in market value recognized as gain or loss in current period income
Securities reported at market value 4

7. Accounting requirements for Available-for-sale securities (investments less than 20 percent)
Changes in market value recognized as separate component of shareholders’ equity until realized
Securities reported at market value 5

8. Accounting requirements for Held-to-maturity securities (debt securities only)
Changes in market value not recognized
Securities reported at amortized cost 6

9. Major provisions of APB Opinion No. 18
Applies to ownership of equity securities greater than 20 percent
For ownership of 20 to 50 percent, use the equity method
For ownership of greater than 50 percent, use consolidated financial statements 7

10. The equity method (equity investments of 20 to 50 %)
Investments recorded at cost
Investment increased for proportionate share of net income
Investment decreased for:
1. Dividends received
2. Extra depreciation
3. Amortization of goodwill 8

11. (so much GAAP, so little time)
Consolidate financial statements (equity investments of more than 50 percent)
This material is
beyond the scope
of our course
(so much GAAP, so little time) 9

12. Chapter 9--Learning Objectives
2. Record and report transactions for debt-security investments and equity-security investments of less than 20% 10

13. Held to maturity debt securities
Record acquisitions at cost
Investment in Debt Securities XXX
Cash XXX
Record interest as income
Interest Income XXX 18

14. Held to maturity debt securities
If purchased at premium, include in cost
Investment in Debt Securities XXX
Cash XXX
Amortize by reducing investment value
Interest Revenue XXX
Investment in Debt Securities XXX 19

15. Held to maturity debt securities
If purchased at discount, record at cost
Investment in Debt Securities XXX
Cash XXX
Amortize by increasing investment value
Interest Revenue XXX 20

16. Held to maturity debt securities
Ignore market value changes for held to maturity debt securities ! 21

17. Sale of held to maturity debt securities before maturity
Accrue interest as required
Determine amortized cost
Compare with selling price
Recognize gain or loss based on difference between amortized cost (book value) and selling price 25

18. Available for sale debt securities
Procedures for purchase, interest, and premium or discount amortization are same as for held to maturity debt securities
Exception: Market value changes are adjusted for 22

19. Available for sale debt securities
If market value is above amortized cost
Adjustment to Market XXX
Unrealized Holding Gain XXX
“Adjustment to Market” is shown on the balance sheet along with the investment account
“Unrealized Gain” is shown as a separate account in the equity section 23

20. Available for sale debt securities
If market value is below amortized cost
Unrealized Holding Loss XXX
Adjustment to Market XXX
“Adjustment to Market” is shown on the balance sheet along with the investment account as a reduction of value
“Unrealized Loss” is shown as a separate negative account in the equity section 24

21. Debt Securities--Trading
Recorded at cost
Amortization ignored
Changes in fair value recorded in current income

22. Accounting for equity trading securities
Record acquisitions at cost
Investment in Trading Securities XXX
Cash XXX
Record dividends and interest as income
Dividend Income XXX 13

23. Accounting for equity trading securities
If market value on reporting date is lower than original cost
Loss on Holding Equity Securities XXX
Invest. in Trading Securities XXX
If market value is higher than cost
Invest. in Trading Securities XXX
Gain on Holding Equity Sec. XXX 14

24. Available for sale equity securities
Record acquisitions at cost
Investment in AFS Securities XXX
Cash XXX
Record dividends and interest as income
Dividend Income XXX 15

25. Available for sale equity securities
If market value on reporting date is lower than original cost
Unrealized Loss on AFS Sec. XXX
Investment in AFS Securities XXX
The “Unrealized Loss” account is shown as a separate component of stockholders’ equity (a reduction in this case)
It is NOT shown on the income statement 16

26. Available for sale equity securities
If market value on reporting date is higher than original cost
Investment in AFS Securities XXX
Unrealized Gain on AFS Sec. XXX
The “Unrealized Gain” account is shown as a separate component of stockholders’ equity (an increase in this case)
It is NOT shown on the income statement 17

27. Transfers between categories
Base classification on management intent
Transfer between categories based on fair market value at time of transfer
Recognize any unrealized holding gain or loss at time of transfer
Include in income for securities transferred into or from trading category
Show as separate stockholders’ equity item for securities transferred into available for sale category from held-to-maturity 26

28. Impairment of Securities
Permanent loss.Security written down to fair value
Loss included in earnings as realized

29. Chapter 9--Learning Objectives
3. Record and report equity-security investment transactions of greater than 20% 27

30. The equity method
Used for situations in which more than 20 percent of the voting stock is owned
If more than 50 percent is owned, consolidated financial statements are prepared
Thus, the equity method applies to situations of 20 to 50 percent 28

31. Equity method procedures
Record purchase of investment at cost
Investment in Other Company XXX
Cash XXX 29

32. Equity method procedures
Increase investment value on reported earnings
Investment in Other Company XXX
Investment Income XXX
Decrease investment value on reported losses
Investment Income (Loss) XXX
Investment in Other Company XXX 30

33. Equity method procedures
Decrease investment value on dividends
Cash XXX
Investment in Other Company XXX 31

34. Equity method procedures
Amortize differences between the book value and the fair market value of investee depreciable assets over the asset lives
Amortization of goodwill reduces investment income and investment value
Investor’s share of any extraordinary items or changes in accounting principle are shown as such (must be material) 32

35. Investments and cash flows
Cash flows from purchases, sales and maturities of trading securities are operating activities on the cash flow statement
Cash flows from purchases, sales and maturities of available for sale and held to maturity securities are investing activities on the cash flow statement 33

36. Chapter 9--Learning Objectives
4. Record and report transactions for funds and life insurance investments 34

37. Funds set aside for retirement of debts
Sinking funds
Funds set aside for retirement of debts 35

38. Accounting for funds Recording contributions to fund
Sinking Fund Cash XXX
Cash XXX
Recording purchase of fund investments
Sinking Fund Investments XXX
Sinking Fund Cash XXX 36

39. Accounting for funds Receipt of investment income
Sinking Fund Cash XXX
Sinking Fund Revenue XXX
Payment of expenses
Sinking Fund Expense XXX
Sinking Fund Cash XXX 37

40. Accounting for funds Sale of investments Sinking Fund Cash XXX
Sinking Fund Investments XXX
Gain on Sale of Inv. XXX 38

41. Accounting for funds Bond maturity and closing of fund
Bonds Payable XXX
Cash XXX
Sinking Fund Cash XXX 39

42. Cash surrender value of life insurance
Businesses frequently purchase life insurance policies on key personnel
Term life insurance is accounted for simply as an expense
Whole-life policies have cash surrender values and loan values
The increase in cash value is accounted for as an investment 40

43. Life insurance entries for policies with cash surrender value
Payment of premium
Life Insurance Expense XXX
Cash Surrender Value of LI XXX
Cash XXX 41

44. Life insurance entries for policies with cash surrender value
Death of key person, receipt of benefit
Cash XXX
Cash Surrender Value of LI XXX
Gain on Life Insurance XXX 42

45. Chapter 9--Learning Objectives
5. Analyze the impact of the different accounting methods for investments on profitability and liquidity measures 43

46. The differences between the methods of accounting for investments can affect income
Changes in market value are
included in income for trading securities
but not for others
Investee reported profits are included
in income under the equity method
but not under the cost method 44

47. The differences between the methods of accounting for investments can affect liquidity
Trading securities and some available
for sale securities are treated as
current assets
But other investments are not classified
as current assets 45

48. Chapter 9--Learning Objectives
6. Understand the concept and complexities associated with derivative financial instruments 46

49. What are derivatives ?
Financial instruments that provide the holder with the right or obligation to participate in the price changes of an underlying asset
Underlying assets may involve interest rates, price indexes, or other market indicators
Example 47

50. Derivative Financial Instruments
Manage financial risk due to changes in
Fair values
Cash flows
Foreign currency exchange rates

51. Derivatives as Hedges Fair value hedges Cash flow hedges
Foreign currency hedges

52. Accounting for gains & losses
Report gains & losses in income for
Hedges with no designation
Fair value hedges
Report gains & losses in other comprehensive income for
Effective cash flow hedges
Foreign currency hedges