Investments in Debt and
Equity Securities
TEMPORARY INVESTMENTS
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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 in
Debt Securities
Investment in
Equity Securities
Control-greater than 50%
ownership of voting stock
Not applicable
Consolidation
Significant influence - 20% to
50% ownership of voting stock
Not applicable
Equity method
Debt securities classified as held
to maturity, and equity securities
for which fair value is not readily
determinable
Amortized cost method
Cost method
Debt and equity securities
classified as trading securities
Fair value method, with unrealized holding gain or loss
included in earnings
Debt and equity securities
classified as available for sale
Fair value method, with unrealized holding gain or loss
included 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 securities with voting rights
DEBT SECURITIES
n Represent creditor relationship with an entity
– US Treasury securities, municipal securities,
corporate bonds, convertible debt, commercial
paper, and redeemable preferred stock
EQUITY SECURITIES
n 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 SECURITIES
CONTROLLING INTEREST
Investor (parent) owns more than 50% of
voting stock in investee (subsidiary).
=
Consolidated financial statements
EQUITY SECURITIES
SIGNIFICANT INFLUENCE
Investor holds 20% to 50% of voting stock
=
Equity method
EQUITY METHOD
The investment account is increased by:
– Original investment cost
– Proportionate share of investee's earnings
The investment account is decreased by:
– Dividends received
EQUITY SECURITIES
NO SIGNIFICANT INFLUENCE
Investor holds less than 20% of voting stock
Measure carrying value of securities at fair value, if
readily determinable.
=
If fair value is not readily determinable, use cost
method.
DEBT SECURITIES
CLASSIFICATION
Held to maturity (HTM)
– Only for debt securities
– Investor intends and has the ability to hold
security to maturity date.
– Carry at amortized cost on balance sheet.
DEBT & EQUITY SECURITIES
CLASSIFICATION
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)
DEBT & EQUITY SECURITIES
CLASSIFICATION
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’
equity
TS AND SAS
ACQUISITIONS
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
RECORDING AT FAIR VALUE
TS and SAS are reported at fair 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 or loss.
TS AND SAS
RECORDING AT FAIR VALUE
The unrealized holding gain or loss must be
determined for individual securities.
Each security has a valuation allowance
account.
TS AND SAS
RECORDING AT FAIR VALUE
The individual unrealized holding gains and
losses are added together to arrive at the net
portfolio unrealized holding gain or loss.
Net unrealized holding gains and losses are
calculated separately for the TS portfolio and
the SAS portfolio.
NET UNREALIZED HOLDING
GAINS AND LOSSES
Trading securities:
The net unrealized holding gain or loss is
treated as a component of investment
income and is included on the income
statement for the period.
NET UNREALIZED HOLDING
GAINS AND LOSSES
Securities available for sale:
The net unrealized holding gain or loss is
not included in earnings for the period
but rather is closed to a separately
reported component of stockholders’
equity.
TS AND SAS
TRANSFERS
Transfers are accounted for at fair value on the
transfer date.
Fair value at the reclassification date is
regarded as cost of the security for
accounting purposes.
TS AND SAS
TRANSFERS
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 SAS
SALES
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 INVESTMENTS
SPECIAL ISSUES
Stock dividends and stock splits
– Not included in investment revenue.
– Increase in number of shares reduces
carrying value per share.
EQUITY INVESTMENTS
SPECIAL 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.