Learning Outcome

4.1 Characteristics of Short Term Investment

4.2 Accounting for Short Term Investments in Debt and Equity

Securities 4.2.1 Purchases, Disposals and Reclassification

4.2.2 Lower of Cost and Market (LCM)

What is a Short-term Investment ?

- An account in the current assets section of a company's balance sheet. - This account contains any investments that a company has made that will expire within one year.

- These accounts contain stocks and bonds that can be liquidated fairly quickly.

Types of short investment and their characteristics are as follows:

1. Money market fund

The money market fund is a way of pooling contributions from many small investors and managing them by a professional fund manager working for mutual fund companies with very low fees.

a) Money market fund can be liquid anytime. b) It is one of many saving vehicles because the interest paid by this fund is low, it cannot increase your investment wealth. c) Since the interest received is low, sometimes it may even fall below the inflation rate. d) If the money market fund is only an investment plan that is used to accumulate wealth for your retirement, you will eventually go broke because of today's low interest rate environment and heavy taxation.

e) Money in the money market fund is pooled and moves from lenders to borrowers through money markets, financial institutions, corporations, governments, and central bank.
f) The lenders are usually corporations or institutions with spare cash that can be invested for a short period; the borrowers are those who temporarily need extra funds.

g) Commercial paper and Treasury Bills are 2 widely used instruments in the money market.

2. Government saving bonds

Government saving bonds are issued by the government and sells directly to the citizen via some financial institutions.

a) They cannot be traded (but only redeemed), their value does not fluctuate. b) They are bought at the face value in the denominations of $100, $300, $500, $1000, $5000, and $10,000 from banks, trust companies, credit unions, and investment dealers.
c) Interest are taxed annually with no commission or fee.

3. Saving account
a) Putting your money into your savings account is considered as the easiest and simplest way to invest by lending your capital to financial institutions.

b) Daily savings account is the type of savings that interest is paid on the daily balance and is compounded monthly.
c) With regular savings accounts, interest is paid on the minimum monthly balance and is compounded every 6 months.

4.2 Accounting for Short Term Investments in :

- Debt Securities

- Equity Securities

What is Investment of Debt Securities?

- Involve activity of purchasing and selling debt equities. - Notes and bonds that pay interest and have a fixed maturity date.(1-5 years) - Example: Debentures, notes, bonds, bills, money market instrument. - The holder of debt securities entitled to earn interest/coupon on the instrument.

 Maturity - This is the date the issuer will make a lump sum payment to return the principal to the bondholder, which eliminates the debt.
Principal (referred to as par value, face value) - This the amount that will be returned to the holder of debt securities at maturity. Coupon - This is the interest payment that will be made to the holder of debt securities. A fixed percentage of the face value will represent the annual interest rate on the loan. The coupons are normally paid semi-annually.

What is Investment in Equity Securities?

Refers to activities of acquiring and disposing of common shares and preferred shares. Preferred and common stock that represent ownership in a company and do not have a fixed maturity date. Equity securities represent fractional ownership in a corporation. E.g. : Common share and preferred shares are equity securities. The holder of shares/investors entitled to earn dividend and he may sell them to achieve capital gains resulting from increase in the price of shares. Investor may have the rights to vote in the invested company.

4.2.1 Purchases, Disposals and Reclassification.

Purchases & Disposals on Debt Securities: Bond

Example 1 (Purchase of bonds):

1) Assume that Homer company purchases $ 18,000 of US Treasury bond at their par value at March 17 2012, plus accrued interest for 45 days. The bond have an interest of 6 %, payable on July 31 and Jan 31.(360 days) March 17 Dr Investment-Us Treasury Bonds $ 18,000 2012 Dr Interest Receivable $ 135 Cr Cash $ 18,135 (Purchased $18,000, 6% treasury bonds) Accrued interest= $18,000 x 6% x (45/360)= $ 135

Example 1.1 (Interest Revenue):

2) On July 31, Homer company receives a semi-annual interest payment of $540($18,000x6%x1/2). The $540 interest includes the $135 accrued interest that Homer company purchased with bonds on march 17. Thus, Homer company has earned $405($540-$135) of interest revenue.
July 31 Dr Cash 2012 Cr Interest Receivable Cr Interest Revenue ( Received semi-annual interest ) $ 540 $135 $405

3) Homer companys accounting period ends on Dec 31. Thus, an adjusting must be made to a accrued interest for 5 months(August 1- Dec 31) of $450 ($18,000x6%x5/12). The adjusting entry to record the accrued interest is as follows:
Dec 31 Dr Interest Receivable 2012 Cr Interest Revenue (Accrued interest) $450 $450

4) For the year ended Dec 31, 2012, Homer company would report interest revenue of $855($405+$450) as part of other income in Income Statement. The receipt of the semi-annual interest of $540 on Jan 31, 2013 is recorded as follows: Jan 31 Dr Cash $540 2012 Cr Interest Revenue $90 Cr Interest Receivable $450 (Received interest on Treasury bond)

Example 1.3 ( Sales of Bond/Disposals):

5) On Jan 31, 2013, Homer company sells the Treasury Bonds at 98, which is a price equal to 98% of par value. The sales results in a loss of $360, as shown below. Proceeds from sale($18,000x98%) $17,640 Less: Book Value(Cost) of the bonds $(18,000) Loss on sales of bonds $ (360) Jan 31 Dr Cash 2013 Dr Loss on sale of investment Cr Investmests- US Treasury Bonds (Sale of US Treasury Bonds) $ 17,640 $ 360

$ 18,000

Purchases & Disposals on Equity Securities: Stock/Share

Types of Investment in Equity Securities

% of ownership of shares will determine the degree of control of investor:
% of ownership Accounting Method Degree of control of investor over investee Control Significant influence No control

> 50% 20% - 50% ownership < 20%

Consolidation Equity method

Cost Method

Accounting Method
Cost Method

Description
Item includes: Purchase of stock Dividend receipt Sale of stock
The stock is recorded initially at its cost including any brokerage commissions. Combined financial statement of the parent company and subsidiary company. (Consolidated Financial Statement)

Equity Method

Consolidation

Less than 20% Ownership

Example 2 ( purchase of stock ):
1) Assume that on May 1, Bart company purchases 2,000 shares of Lisa company common stock at $49.90 per share plus a brokerage fee of $200. The entry to record the purchase of the stock is as follows:
May 1 Dr Investment-Lisa company stock Cr Cash (purchased 2,000 of shares of Lisa company common stock) [($49.90x2,000)+$200] $100,000 $100,000

Example 2.1 ( receipt of dividends ):

2) On July 31, Bart company receives a dividend of $0.40 per share from Lisa company. The entry to record the receipt of dividend is as follows: July 31 Dr Cash Cr Dividend revenue (receipt dividend on Lisa company common stock) (2,000x$0.40) $800
$800

Example 2.2 (sale of stock):

3) On September 1, Bart company sells 1,500 shares of Lisa company stock for $54.50 per share, less a $160 commission. The sale results in a gain of $6.590 as shown below. Proceeds from sale $ 81,590* Book value (cost) of the stock $ (75,000)** Gain on sale $ 6,590
*[($54.50x1,500 shares)-$160] **[($100,000/2,000 shares)x1,500 shares] Sept 1 Dr Cash $ 81,590 Cr Gain on sale of investment $ 6,590 Cr Investment-Lisa company $ 75,000 (Sale of 1,500 shares of Lisa company common stock)

Between 20%-50% Ownership

Example 3 (purchase of stock):
1) Assume that Simpson Inc. purchased its 40% interest in Flanders Corporations common stock on January 2, 2012, for $ 350,000. The entry to record the purchase is as follows: Jan 2 Dr Investment in Flanders Corporation $ 350,000 2012 Cr Cash $ 350,000 (Purchased 40% of Flanders Corporation stock)

Example 3.1 (recording investee net income):

2) On Dec 31, 2012 Flanders corporation reported net income of $ 105,000. Under the equity method, Simpson Inc. (the investor) records its shares of Flanders net income as follows: Dec 31 Dr Investment in Flanders Corporation $ 42,000 2012 Stock Cr Income of Flanders Corporation $ 42,000 (Record 40% of share of Flanders Corporation net income) (105,000x40%)

Example 3.2 (recording investee dividends):

3) During the year, Flanders declared and paid cash dividends of $ 45,000. Under the equity method, Simpson Inc. (the investor) records its share of Flanders dividends as follow:

Dec 31 Dr Cash Cr Investment in Flanders Corporation stock (Record 40% of share of Flanders Corporation dividends) ($45,000x40%)

$ 18,000
$ 18,000

Example 3.3 (Sale of stock):

4) If Simpson Inc. sold Flanders Corporations stock on January 1, 2013 for $ 400,000, a gain of $ 26,000 would be reported, as shown below. Proceeds from sale $ 400,000 Book value of stock investment $ (374,000) Gain on sale $ 26,000 Jan 1 Dr Cash Cr Investment in Flanders Corporation Stock Cr Gain on sale (sale of Flanders Corporation stock) $ 400,000 $ 374,000 $ 26,000

VALUING AND REPORTING INVESTMENT

What is trading securities ?

-Trading Securities are debt and equity securities that are purchased and sold to earn short-term profits from changes in their market prices.

- Trading securities are often held by banks, mutual funds, insurance companies, and other financial institutions.
- Since trading securities are held as a short term investment, they are reported as a current asset on the balance sheet. -Trading securities are valued as portfolio (group) of securities using securities fair value - Fair value is the market price that the company would receive for a security if it were sold. - Changes in fair value of the portfolio of trading securities are recognized as an unrealised gain or loss for the period.

TRADING SECURITIES
Assume Maggie Company purchased a portfolio of trading securities during 2012. On December 31, 2012, the cost and fair values of the securities were as follows :
Name
Armour Company Maven , Inc Polaris co Total

Number Of Shares
400 500 200 1100

Total Cost Value

$ 5000 11000 8000 $24000

Total Fair Value

$ 7200 7500 10600 $25300

The portfolio of trading securities is reported at fair value of $25300. An adjusting entry is made to record the increase in fair value of $1300 ($25300-$24000. The adjusting entry on December 31, 2012, to record the fair value of the portfolio of trading securities is as shown below.

2012 Dec 31 Dr Valuation Allowance for trading investments Cr Unrealised Gain on trading Investments

1300 1300

( To record increase in fair value of trading securities)

*unrealised gain on trading investments is reported on the income statement as other income. *valuation allowance for trading investment will be recorded in balance sheet under current assets

What is available for sale securities?

-Available for sale securities are debt and equity securities that
are neither held for trading, held to maturity, or held for a strategic reason
- Accounting for available for sale securities is similar to the accounting for trading securities except for the reporting of changes in fair value. -Specifically, changes in the fair value of trading securities are reported as unrealized gain or loss on the income statement. In contrast, changes in the fair values of available for sale securities are reported as part of stockholders equity and thus excluded from the income statement.

AVAILABLE FOR SALE SECURITIES

To illustrate , assume that Maggie Company purchased the three securities during 2012 as available for sale securities instead of trading securities . On December 31, 2012 the cost and fair values of the securities were as follows:

The portfolio of available for sale securities is reported at its fair value of $25300. An adjusting entry is made to record the increase in fair value of $1300 ($25300-24000). Unlike trading securities , the december 31 2012 adjusting entry credits a stockholders equity account instead of an income statement account .
2012 Dec 31 Dr Valuation Allowance for available for sale investment Cr Unrealised Gain on Available for Sale investment

1300 1300

*credit balance in unrealised gain added to stockholder equity while debit balance is subtracted from stockholder equity

The valuation allowance and the unrealized gain are reported on the december 31, 2012, balance sheet as follows: Maggie Company Balance Sheet December 31, 2012

Current Asset : Cash Available for sale investment (at cost) Plus Valuation Allowance for available for sale investments(at fair value)

$120000
$24000 1300 25300

Stockholders equity : Common Stock Paid in capital in excess of par value Retained earnings Unrealised gain on available for sale investment Total Stockholders equity $ 10,000 150,000 250,000 1,300 $ 411,300

HELD TO MATURITY SECURITIES

- Held to maturities securities are debt investments, such as notes or bonds, that a company intends to hold until their maturity date. Held to maturity securities are primarily purchased to earn interest revenue.

- If held to maturity securities will mature in a year, it is reported as a current asset on the balance sheet. Held to maturity securities maturing beyond a year are reported as a noncurrent asset.
-eg : corporate notes and bonds (with maturity dates) - equity securities are not held to maturity securities because they have no maturity date.

TRADING SECURITIES

AVAILABLE FOR SALE SECURITIES

Valued at

Fair Value Unrealized gain or loss is reported on income statement as other income Cost of investment plus or minus valuation allowance

Fair Value Accumulated unrealized gain or loss is reported in stockholders equity on the balance sheet Cost of investments plus or minus valuation allowance Either as current or noncurrent asset, depending on managements intention

Changes in Valuation are reported as

Reported on the balance sheet as

Classified on balance sheet as

A current assets

4.2.2. LOWER OF COST AND MARKET (LCM)

VALUATION OF TEMPORARY INVESTMENTS

Valued using LCM (Lower of Cost or Market) Applied to:

portfolio as a whole; or individual item basis

Application of LCM must then be consistently applied

Investment Allowance account used to capture valuation write-downs Reported net balance cannot be below cost

APPLICATION OF LCM
Apply LCM on an Individual Security Basis.

Given for Western Publishing Corp. on December 31, 2002:

Investments Fair Value $ 43,860 $ 51,500 184,230 175,200 86,360 91,500 $314,450 $318,200 Cost

Air Canada shares CIBC shares Magna shares Portfolio Total

APPLICATION OF LCM
Western Publishing Corporation Security Portfolio December 31, 2001

Investments

Air Canada shares CIBC shares Magna shares Portfolio Total

Fair Unrealized Value Gain (Loss) $ 43,860 $ 51,500 $ 7,640 184,230 175,200 (9,030) 86,360 91,500 5,140

Cost

$314,450

318,200

$ 9,030

Note: Gains will not be recorded.

APPLICATION OF LCM
We will now apply the LCM valuation based on the portfolio as a whole.

To record the the LCM rule, the journal entry at December 31, 2002 will be:
Unrealized Loss on Investment 9,030

Investment Allowance

9,030

APPLICATION OF LCM
Western Publishing Corporation Security Portfolio December 31, 2001

Investments

Air Canada shares CIBC shares Magna shares Portfolio Total

Fair Unrealized Value Gain (Loss) $ 43,860 $ 51,500 $ 7,640 184,230 175,200 (9,030) 86,360 91,500 5,140

Cost

$314,450 $318,200

$ 3,750

Note: The total historical cost is lower than total fair value. Gain is not recorded.

If total fair value < Total Cost

Total fair value (TFV) = RM310,000 Total Cost (TC) = RM314,450 the difference will be recognized as unrealized loss on marketable equity security (MES).
Journal entry: DR Unrealized loss on MES 4,450 CR Investment allowance

4,450

The loss will be recorded in the Statement of profit and loss and other comprehensive income under the heading of the other expenses. Statement of profit or loss and other comprehensive income
Other Expenses Unrealized loss on MES

XX

Investment allowance will be shown in the Statement of Financial Position as shown below:Current Asset Marketable equity security RM 314,450

(-) Investment allowance

(4,450)
310,000

*NOTE:-Investment allowance account is a contra asset account deducted from marketable equity security.

 If the total fair value for the next period is higher than the carrying amount, Recoverable Unrealized Loss will be recognized. The maximum recoverable amount should be the balance of investment allowance account. From the previous example the maximum recoverable amount is RM4,450.

Total Fair Value increases from RM310,000 to RM313,000

E.g. for the next period, the total fair value of portfolio is RM313,000.

DR. Investment allowance

3,000

CR. Recoverable unrealized loss on MES 3000 Statement of Financial Position MES RM314,450

(-) Investment allowance*

*(RM4,450-RM3,000)

(1,450)
313,000

RECLASSIFICATION OF MARKETABLE EQUITY SECURITY

If management intent changes and does not plan to hold the investment for temporary purposes, the investment is to be reclassified as a long term investment. The amount at which investment is transferred depends upon the accounting basis for short term investment. If the lower of cost or market was the accounting basis, LCM would be the new cost. The difference between the cost and market value will be treated same as for sales of short term MES, i.e. either realized profit or loss will arise.

EXAMPLE

Current investments of X Bhd as at 31/12/2012 are as follows:

Investments CIBC shares Magna shares Portfolio Total Cost(RM) 25,000 17,500 42,500 FV (Cost) 21,000 16,000 37,000

On 31/12/2012 X Bhd reclassified investment in Magna as long term investment.

Example o Journal entry: DR MES in Magna (long term) 16,000 Loss on reclassification* 1,500 17,500

CR MES in Magna
*(17500-16000)

o If the unrealized loss and allowance account had a balance

of RM 5,500.
o It should be reduced by RM1,500 (realized loss from reclassification) of MES. This will make the new balance of RM4,000.

Marketable Debt Security (MDS)

Previously MDS was recorded at cost. However, MDS now can be recorded using LCM method. The journal entries are same as for MES. Purchase of MDS is recorded at cost. But when purchase between interest payment dates, the accrued interest is recorded at the date of

purchase ( the company has to pay the MDS cost plus accrued interest.)
However, the extra charge (interest portion) will not be included as part of

MDS cost but will be recorded as accrued interest.

Marketable debt security (MDS)

On 1/4/2011 AA Bhd bought bonds at the rate of 86%, 100

units of BBB Bhds bond with face value of RM1,000 and

interest rate is 10%. Interest is payable on 1 July and 1 January. Brokers cost and commission is RM 1,720.

Calculation:
Purchase price(1000x100x0.86) Commission Bonds cost Accrued interest ( 1/1-1/4)
(RM 100,000x10%x3/12)

86,000 1,720 87,720

2,500
90,220
87,720
2,500 90,220

Cash disbursement
Journal entries:-

DR MDS Bond
Accrued interest CR Cash

MARKETABLE DEBT SECURITY (MDS)

Discounts or premium on bond will not be recorded separately for short term investment.
1 July, interest earned journal entry: Cash 5,000 Interest Revenue 2,500 Accrued Interest 2,500 When the MDS is disposed , the difference between cost and selling price will be recorded as gain or loss. E.g. (use the previous example) On 1/11/2011, AAA Bhd sold investment in BBBs bond at the rate of 98% with accrued interest. Related commission and tax expense is RM 1,870.

MARKETABLE DEBT SECURITY ( MDS)

Calculation: Bonds selling price (100x1000x0.98) Less: Commission and tax Net proceed Carrying amount of bond(cost) Gain from disposal of bond

98,000 (1,870) 96,130 (87,720) 8,410

Gain from disposal will be illustrated in the income statement under the item of other income. Journal entries: Cash 96,130 MDS Bond 87,720 Gain on disposal 8,410

MARKETABLE DEBT SECURITY(MDS)

Journal entries: 1/11/2011 Interest receivable Interest revenue

3,333 3,333

Calculation: 100,000x10%x4/12=3,333

DISCLOSURE

Temporary investment is classified as current asset in the Statement of Financial Position. Disclosure required are : 1) Accounting policies i. The determination of carrying amount of investment. ii. The treatment of changes in market value of current investments carried at market value. iii. The treatment of a revaluation surplus on the sale of revalued investments.

DISCLOSURE
2) The significant amounts included in income for :

i. Interest, royalties, dividends and rentals on long term and current investments. ii. Profit and losses on disposal of current investments and changes in value of such investments. 3) The market value of marketable investments if they are not carried at market value. 4) The fair value of investment properties if they are accounted for as long term investments and not carried at fair value.

DISCLOSURE

5) Significant restrictions on the reliability of investments or the

remittance of income and proceeds of disposal.