Accy 432 CH 17 Day 1

17-1
PREVIEW OF CHAPTER
Intermediate Accounting
15th Edition
Kieso Weygandt Warfield
17
17-2
Lets say that Company B purchases 1,000 of
Company Zs common stock.
In this chapter, we are concerned with Company Bs
accounting for the investment.
Investment Accounting Approaches
Different motivations for investing:
To earn a high rate of return.
To secure certain operating or financing
arrangements with another company.
17-3
Companies account for investments based on
the type of security (debt or equity) and
their intent with respect to the investment.
Illustration 17-1
Summary of Investment
Accounting Approaches
Investment in Debt Securities
LO 1
17-4
Fair Value Definition
Fair value is the price that would be received to sell an
asset or paid to transfer a liability in an orderly
transaction between market participants at the
measurement date.
17-5
Is it a debt or equity security (from the investors
perspective)?
Important question because equity securities cannot be
held-to-maturity.
Convertible debt (think convertible bonds)
Debt
Mandatory redeemable preferred stock
Debt
17-6
Three classifications of debt securities
Held to maturity company (creditor) has the ability and
intent to hold the security until it matures (amortized cost)
Trading goal is to profit from short-term price differences
(fair market value)
General rule Held for 3 months or less
Available for sale everything not classified as trading or
held to maturity (fair market value)
For all three classifications record original purchase at
cost.
Classifying Debt Securities
17-7
Debt Investment Classifications
ILLUSTRATION 17-2
Accounting for Debt
Securities by Category
Amortized cost is the acquisition cost adjusted for the amortization of
discount or premium, if appropriate.
LO 1
17-8
Interest and Gains/Losses
Interest income on debt securities
Treat the same for all three classes recognize
in income as earned (this is different than as
received).
Gains/Losses from selling debt securities
Recognize in income as earned
17-9
Classify a debt security as held-to-maturity only if it has both
1) the positive intent and
2) the ability to hold securities to maturity.
Accounted for at amortized cost, not fair value.
LO 2
Held-to-Maturity Securities
Amortize premium or discount
using the effective-interest
method unless the straight-line
method yields a similar result.
See BE 17-1
17-10
LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Held-to-maturity Ignore holding gains /
losses (unless impaired)
Presented on balance sheet at amortized cost
(means we amortize premium or discount)
Impairments are discussed later in this chapter
Accounting for Investment in Bonds
We will not use a bond premium or discount
account
Any premium or discount will simply be included in the
amortized cost included in the Investment Account.
This means the Investment Account balance might change
over the life of the debt security
17-11
Illustration: Z-Smith Company purchased $100,000 of 8 percent
bonds of Bush Corporation on January 1, 2013, at a discount,
paying $92,278. The bonds mature January 1, 2018 and yield
10%; interest is payable each July 1 and January 1. Z-Smith
records the investment as follows:
January 1, 2013
Debt Investments 92,278
Cash 92,278
LO 2
*Journal entry to record purchase.
17-12
Illustration 17-3
Schedule of
Interest
Revenue and
Bond
Discount
Amortization
Effective-Interest
Method
LO 2
17-13
Illustration 17-3
Illustration: Z-Smith Company records the receipt of the first
semiannual interest payment on July 1, 2013, as follows:
Cash 4,000
Debt Investments 614
Interest Revenue 4,614
LO 2
*Journal entry to record interest revenue.
17-14
Illustration 17-3
Illustration: Z-Smith is on a calendar-year basis, it accrues
interest and amortizes the discount at December 31, 2013, as
follows:
Interest Receivable 4,000
LO 2
*Adjusting journal entry to recognize interest revenue.
17-15
Reporting of Held-to-Maturity Securities
Illustration 17-4
LO 2
17-16
Sale of Held-to-Maturity Securities
Record interest and amortization of premium
or discount up to sale date
After amortizing premium or discount,
compute gain or loss and record income
statement effect
NOTE: Sale of a held-to-maturity security
could bring into doubt the classification of any
remaining H-T-M securities why?
17-17
Illustration 17-3
Illustration:
Assume Z-Smith
sells its
investment in
Bush bonds on
November 1,
2017, at 99
plus accrued
interest. Z-Smith
records discount
amortization as
follows:
Interest Revenue 635
Calculation of amortization = $952 x 4/6 = $635
LO 2
*Journal entry to amortize discount up to the sale date.
17-18
LO 2
Computation of Gain on Sale of Bonds
Cash 102,417
Interest Revenue (4/6 x $4,000) 2,667
Gain on Sale of Securities 67
Illustration 17-5
*Journal entry to record sale of HTM.
17-19
Companies report available-for-sale securities at
fair value, with
unrealized holding gains and losses reported as part
of other comprehensive income (OCI) (equity).
Note 1: OCI flows to AOCI (like NI flows to RE)
Note 2: OCI + NI = Comprehensive Income
Book value = Investment Account + Securities Fair
Value Adjustment Account (VAA is a valuation
account)
Any discount or premium is amortized.
Available-for-Sale Securities
Debt
Securities
BE 17-2
17-20
Accounting for changes in FV of AFS debt securities
Use investment account to record amortized cost
i.e. continue to record interest income based
on amortization schedule
Use Securities Fair Value Adjustment account to
record holding gains and losses
Balance in this account should = Difference
between Investment Account balance and FV
Debt
Securities
17-21
Three levels for identifying fair value of a security:
Level 1
Quoted prices in active markets for identical
assets or liabilities
Level 2
Quoted prices in active markets for similar
assets or liabilities
Level 3
Unobservable inputs reflecting companys
assumptions (e.g. project cash flows)
Fair Value Hierarchy
Debt
Securities
17-22
Illustration (Single Security): Graffeo Corporation purchases
$100,000, 10 percent, five-year bonds on January 1, 2013, with
interest payable on July 1 and January 1. The bonds sell for
$108,111, which results in a bond premium of $8,111 and an
effective interest rate of 8 percent. Graffeo records the purchase of
the bonds on January 1, 2013, as follows.
Cash 108,111
Debt
Securities
LO 2
*Journal entry to record purchase.
17-23
Illustration 17-6
Schedule of
Interest
Revenue and
Bond
Premium
Amortization
Effective-Interest
Method
Debt
Securities
LO 2
17-24
Debt
Securities
Illustration 17-6
Illustration (Single Security): The entry to record interest
revenue on July 1, 2013, is as follows.
Cash 5,000
LO 2
*Journal entry to record interest revenue.
17-25
Debt
Securities
Illustration 17-6
Illustration (Single Security): At December 31, 2013, Graffeo
makes the following entry to recognize interest revenue.
Interest Receivable 5,000
Interest
Revenue for
2013 = $8,621
LO 2
*Adjusting journal entry to record interest revenue.
17-26
Illustration (Single Security): To apply the fair value method to
these debt securities, assume that at December 31, 2013 the fair
value of the bonds is $105,000. Graffeo makes the following entry.
Unrealized Holding Gain or LossEquity 1,732
Fair Value Adjustment (AFS) 1,732
Debt
Securities
Illustration 17-6
LO 2
Valuation account, permanent account so carry balance forward
*CV FV = Loss (106,732-105,000 = 1,732)
17-27
Illustration (Portfolio of Securities): Herringshaw Corporation
has two debt securities classified as available-for-sale. The
following illustration identifies the amortized cost, fair value, and the
amount of the unrealized gain or loss.
Illustration 17-7
Debt
Securities
LO 2
17-28
Prepare the adjusting entry Herringshaw would make on December
31, 2014 to record the loss.
Debt
Securities
Illustration 17-7
LO 2
*Adjusting journal entry to record change in fair value.
Herringshaw reports the unrealized holding loss of $9,537 as other
comprehensive income and a reduction of stockholders equity.
17-29
Sale of Available-for-Sale Securities
If company sells bonds before maturity date:
Must make entry to remove the,
Cost in Available-for-Sale Securities and
Securities Fair Value Adjustment accounts.
Any realized gain or loss on sale is reported in the
Other expenses and losses section of the income
statement.
Debt
Securities
17-30
Record interest and amortization of premium or discount
up to sale date
1. After amortizing premium or discount, compute gain or
loss and record realized gain or loss
2. Comprehensive income account and FV adjustment
account are adjusted at the end of the reporting period
Think of this as a 2-step approach (1. record realized
gain or loss; 2. adjust unrealized gains or loss acct.)
Debt
Securities
17-31
Illustration (Sale of Available-for-Sale Securities): Herringshaw
Corporation sold the Watson bonds (from Illustration 17-7) on July
1, 2015, for $90,000, at which time it had an amortized cost of
$94,214.
Cash 90,000
Loss on Sale of Investments 4,214
Illustration 17-8
Debt
Securities
LO 2
17-32
reports this realized loss in the Other expenses and losses
section of the income statement. Assuming no other purchases and
sales of bonds in 2015, Herringshaw on December 31, 2015,
prepares the information:
Illustration 17-9
Debt
Securities
LO 2
17-33
records the following at December 31, 2015. (Please note the
illustration below should read 12/31/15.)
Debt
Securities
LO 2
17-34
Financial Statement Presentation
Illustration 17-10
Reporting of Available-
for-Sale Securities
Debt
Securities
LO 2
17-35

Remember: Unrealized gains/losses on AFS securities
hit comprehensive income (not the income statement)

Key point: Gains or losses on AFS securities do not
affect net income until the AFS securities are sold.
Debt
Securities
17-36
LO 2
17-37
Trading Securities
Companies report trading securities at
fair value on balance sheet,
use a valuation account to record balance sheet
effects of holding gains and losses
continue to use effective interest method to amortize
discount or premium
recognize unrealized holding gains and losses
reported in net income.

Debt
Securities
17-38
Illustration: On December 31, 2012, Koopmans Publishing
Corporation determined its trading securities portfolio to be as follows:
At December 31, Koopmans Publishing makes an adjusting entry:
Fair Value Adjustment (Trading) 3,750
Unrealized Holding Gain or LossIncome 3,750
Trading Securities
Debt
Securities
LO 2
17-39
Illustration: (Trading Securities) Hendricks Corporation
purchased trading investment bonds for $50,000 at par. At
December 31, Hendricks received annual interest of $2,000, and
the fair value of the bonds was $47,400.
Instructions:
a) Prepare the journal entry for the purchase of the
investment.
b) Prepare the journal entry for the interest received.
c) Prepare the journal entry for the fair value adjustment.
Trading Securities
Debt
Securities
LO 2
17-40
Illustration: (Trading Securities) Hendricks Corporation
purchased trading investment bonds for $50,000 at par. At
December 31, Hendricks received annual interest of $2,000, and
the fair value of the bonds was $47,400.
Trading Securities
Debt
Securities
(a) Debt investments 50,000
Cash 50,000
LO 2
(b) Cash 2,000
(c) Unrealized Holding Loss Income 2,600
Fair Value Adjustment (Trading) 2,600
17-41
Trading Securities
Sale of debt classified as Trading Securities
Record interest and amortization of premium or
discount up to sale date
After amortizing premium or discount, compute gain or
loss and record income statement effect (realized gain
or loss)
Unrealized holding gain or loss and FV adjustment
account are adjusted at the end of the reporting period
Net effect on income statement during period
of sale = Realized gain or loss Unrealized
holding gain or loss recorded to date

Debt
Securities
17-42
Trading Securities
Why do we continue to amortize the bond premium or
discount on AFS and trading securities? Wouldnt a
single adjustment to FMV be just as good?
Answer: No.
There are two sources of changes in the FV of debt
securities held as investments.
Change in discount or premium
We want this component of the change to be part
of interest income
Change in FV due to market conditions
We want this to be part of unrealized gain/loss

Debt
Securities

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