In some cases a Company may follow a policy of owning investments that may be converted to cash as needed and for purpose of earning a return on excess cash resources are characterized by their salability at a readily determinable price. Stocks and bonds not widely owned or frequently traded usually do no meet the marketability test. The Money market funds, commercial paper; treasury bills and certificate of deposit are considered as short-term investments.

At acquisition, short-term investments are recorded at cost, the price of the item in the market plus any costs incident to the acquisition, such as brokerage commission and transfer taxes.

 It is like commercial papers, treasury bills, certificate of deposits. Most of short-term investment has near term-maturity that premium and discount is probably negligible. The interest revenue earned on these investments is calculated by multiplying the interest rate by discounted amount. The interest revenue is accumulated in the short-term investments ledger account and recorded as interest revenue at the end of each account period during the stated term of the commercial paper or Treasury bills. The below accounting entries can clarify how the interest revenue is journalized.

1) When the commercial papers acquired, the below accounting entry at discounted amount will be as follow.

                Dr. Short-term Investments

                Cr. Cash

2) When the interest earned, the below accounting entry will be as follow

                Dr. Short-term Investments

                Cr. Interest Revenue

3) When the short-term investments reach to maturity date, the accounting entry will be as follow

                Dr. Cash

                Cr. Short-term Investments

4) When the short-term investments sold before maturity date, and the gain and loss is booked.

                Dr. Cash

                   Or Dr. Loss in market value of short-term investment

                Cr. Short-term Investments

                   Or Cr. Gain in market value of short-term investment

 

Bonds acquired between interest dates are traded on the basis of the market price plus the interest accrued since the most recent interest payment

Only debt securities and money market instruments can be classified as hold-to-maturity. Companies record held-to-maturity securities at amortized cost not fair value. The amortization is between the principal amount of bond and the value of the bonds. Principal of bond is the face value of bond, when bond matures; we receive both principal and interest. The value of bonds is the present value of bond which is calculated as below formula:

PV (Bond) = PV (Coupon payments) + PV (final payment)


If the coupon rate is lower than effective market rate , the bonds purchased at discount value as below example:

 

Discount Bonds

Effective Rate

5%

Nominal value

100,000

Coupon rate

4%

Period

Period interest
revenue earned

Present
Value of Amount

1

4,000

3,809.52

2

4,000

3,628.12

3

4,000

3,455.35

4

4,000

3,290.81

5

4,000

3,134.10

6

104,000

77,606.40

Discount bonds value

94,924.31

 

If the coupon rate is higher than effective market rate , the bonds purchased at premium value as below example:

Premium Bonds

Effective Rate

4%

Nominal Value

100,000

Coupon rate

5%

Period

Period interest
revenue earned

Present
Value of Amount

1

5,000

4,807.69

2

5,000

4,622.78

3

5,000

4,444.98

4

5,000

4,274.02

5

5,000

4,109.64

6

105,000

82,982.89

Premium bonds value

105,242.00

 

For calculating the bond discount amortization, see the below bond amortization schedule as an example..

 

Bonds input Data for discount amortization

Nominal Value:

100,000.00

Discount rate:

8%

Period per year

2

First interest revenue on

15/01/2010

Times of receiving interest

6

Effective Interest Rate

10%

Cash paid for bonds

94,924

8% bonds purchased to yield 10%

B

C

D

e

Bond

Carrying

Cash

Interest

Discount

Amount

Date

Received

Revenue

Amortization

of bonds

01/01/2010

94,924

15/01/2010

4,000

4,746

746

95,670

15/06/2010

4,000

4,784

784

96,454

15/01/2011

4,000

4,823

823

97,276

15/06/2011

4,000

4,864

864

98,140

15/01/2012

4,000

4,907

907

99,047

15/06/2012

4,000

4,952

952

100,000

24,000

29,076

5,076

Where:

b = Nominal Value x Discount Rate/period per year interest due

c = e * effective rate

d = c – b

E = (E in row-1)+ d

 

For calculating the bond premium amortization, see the below amortization schedule as an example.

Bonds input Data for premium amortization

Nominal Value:

100,000.00

Discount rate:

10%

Period per year

2

First interest revenue on

15/01/2010

Times of receiving interest

6

Effective Interest Rate

8%

Cash paid for bonds

105,242.00

10% bonds purchased to yield 8%

B

C

D

e

Bond

Carrying

Cash

Interest

Premium

Amount

Date

Received

Revenue

Amortization

of bonds

01/01/2010

105,242

15/01/2010

5,000

4,210

790-

104,452

15/06/2010

5,000

4,178

822-

103,630

15/01/2011

5,000

4,145

855-

102,775

15/06/2011

5,000

4,111

889-

101,886

15/01/2012

5,000

4,075

925-

100,961

15/06/2012

5,000

4,038

962-

100,000

30,000

24,758

5,242-

Where:

b = Nominal Value x Discount Rate/period per year interest due

c = e * effective rate

d = c – b

E = (E in row-1)+ d

 

For accounting treatments of held-to-maturity securities, please see the below template of accounting entries.

1) When debt securities acquired.

                Dr. Held-to-Maturity Securities                  94,924

                Cr. Cash                                                                                94,924

2) When interest earned

                Dr. Held-to-Maturity Securities                  746

                Dr. Cash                                                               4000

                Cr. Interest Revenue                                                      4746

3) When Held-to Maturity securities sold before maturity date, the accrued interest revenue should be recorded for the period past.

Selling price of bonds……………………………………………………………………..…xxxx

Less: Book value of bonds on the previous period………………….xxxx

Add: Discount amortized for the period past………………………….xxxx

                                                                                                                                     xxxxxx

Gain or Loss on sale of bonds ……………………………………………………………xxxxx

 

Dr. Cash

                Dr. Loss on sale of securities-Income Statement

                Cr. Interest Revenue – Income Statement

                Cr. Held-to-Maturity Securities – Long-term Investment

                Cr. Gain on Sale of Securities – Income Statement

 

Available-For-Sale securities are evaluated and reported at fair value. It records the unrealized gains and losses related to changes in the fair value of these securities in an unrealized holding gain or loss account that is reported in comprehensive income statement not income statement. The accounting entries are the same as Held-to-Maturity securities except for when fair value are changes, the following accounting entry will be as follow:

      Comprehensive income in equity

Dr. Unrealized Holding Gain or Loss

     Current Assets

Cr. Securities Fair Value Adjustment (Available-for sale)

Securities Fair Value Adjustments account is subtracted from balance of Available-For-Sale securities assets in the balance sheet. Means, the Available-For-Sale debt securities presented as net in the financial statements. The new fair value of such securities does not amortized. Also this adjustment accounts is becoming credit by decreasing the fair value and debit by increasing the fair value. The fair value change is not reported as part of net income until after selling the securities. The changes between opening and ending balances of AFS debt securities should be presented in cash flow under investing activities.

 Company reports trading securities at fair value, with unrealized holding gains and losses reported as part of net income. They are required to amortize any discount or premium such as Held-to-Maturity debt securities and Available-for-Sale debt securities. Recording the trading securities at cost, including brokerage commissions and taxes.

Trading debt securities has the same accounting entries such as Available-For Sale Securities.

The below computation is for calculating the cost of acquired short-term investment in bonds

                a-Market price of bonds (price x no. of bonds)……………………………..…………………… XXXXXX

                b-Add: Brokerage commission ……………………………………………………………………………….XXX

                c-            Total cost of bonds…………………………………………………………………………….…XXXXXX

                d-Add: Accrued interest for n months on amount in caption a, at x.x% a year ….…..XXX

                e- Total cash paid …………………………………………………………………………………………..XXXXXXX

The below computation is for calculating the cash received from sale of short-term investment in bonds

                a-Market price of bonds (price x no. of bonds)……………………………..…………………… XXXXX

                b-Less: Brokerage commission ……………………………………………………………………………….XXX

                c-            Net proceeds on sale of bonds……………………………………………………..…….…XXXXXX

                d-Add: Accrued interest for n months on amount in caption a, at x.x% a year ….…..XXX

                e- Total cash received ……………………………………………………………..……………………..XXXXXXX

 

The changes between opening and closing balances trade securities should be presented in cash flow statement under operating activities.

The unrealized gain/loss for Available-For-Sale (AFS) and trade debt securities should consider the amortization, whereas, gain/loss compute as follow:

Unrealized gain/loss = Fair Value – Amortized carrying amount.

 Equity securities represent ownership interest such as common, preferred or other capital stock. They also include rights to acquire or dispose of ownership interests at an agreed upon or determinable price, such as in warrants, rights, and call or put options.

The classification of such securities depends on the percentage of the investee voting stock that is held by the investor.

1) Holding of less than 20%

2) Holdings between 20% and 50%

3) Holding of more than 50%

 When investor has an interest of less than 20%, it is presumed that the investor has little or no influence over the investee. If market prices are available subsequent to acquisition, the company values and reports that investment using the fair value method.


 The following accounting entries for acquisition, receiving dividends, changes in fair value and selling the securities

1) When the securities are acquired.

Dr. Available-For-Sale Securities

Cr. Cash

2) When dividends received.

Dr. Cash

Cr. Dividend Revenue

3) When fair value changes at year end.

Dr. Unrealized Holding Gain or Loss-Comprehensive income

Cr. Securities Fair Value Adjustments (Available-for-sale)

4) When securities sold

Dr. Cash

 Or Dr. Loss on Sale of Stocks

Cr. Available-For-Sale Securities

 Or Cr. Gain on Sale of stock

 The accounting treatments of trading equity securities are the same as for available-for-sale equity securities, except for reporting the unrealized holding gain or loss for trading securities which is reported in the income statement not in the comprehensive income statement

 Under the equity method. The investor records the investment at the cost of the shares acquired and adjusts the amount each period for change in the investee’s net income. The carrying amount of investment is increased or decreased when investee’s report income or loss.  Also, the dividends received by the investor from the investee leads to decrease the investment’s carrying amount. The accounting entries for such securities are as follow:

1) When securities are acquired at cost

Dr. Investment in xxxx

Cr. Cash

2) When investee Company reported the income or loss. The below entry for reporting income.

Dr. Investment in xxxx

Cr. Revenue from Investment

3) No accounting entry for changes in fair value of securities

4) When Investee Company announced and paid cash dividends

Dr. Cash

Cr. Investment in xxxx

 

 Notes on above debt and equity securities:

 a)      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.

b)      Liquidity dividends occur when accumulated dividends received exceed accumulated earnings. Liquidating dividend is treated as reduction in carrying amount of investment rather than dividend income, and it is reduced investment in both cost and equity methods.

c)      Goodwill is attributed to investor and when investor’s portion of fair value of investee’s net assets exceed the purchase price.

d)      The excess of investee’s asset fair value over its book value should be deducted/amortized from investee’s net income before applying the portion of investor’s except for goodwill.

Equity Method

Purchase Price of Investment                                                                                     xxxxx

Less : Investor’s portion of Fair Value of Investee’s net assets                      xxxxx

Goodwill (c)                                                                                                                        xxxxx

 

Fair Value of Investee’s net assets                            xxxx

Book value of investee’s net asset                            xxxx

Fair Value Difference                                                      xxxx

Investor’s portion                                                            xx%

Investor’s portion of fair value diff (d)                    xxxx

 

Carrying Amount of Investment = Purchase Price of Investment – Investee’s Net income – Amortization/depreciation of Undervalued (Fair Value difference) – Dividends

 

e)      Investor’s officers on investee’s board of directors and the volume of holding shares in comparison of other shareholders are considered large, even if the investor holds stocks less than 20%.

f)       The adoption of the equity must be retrospective based on previous percentage of holding investee’s share before the change. Retrospective adjustments for transfers from Fair Value Option to Equity Method will be through the following schedule and accounting entry.

 

Period 1 Investment at cost                                                                                         xxxxx

      Equity Adjustment

          + Investor’s portion of investee’s net income                                             xxxx

          - Dividends received                                                                                              (xx)

          - Amortization of fair value difference                                                          (xx)

1) Balance of the investment under Equity                                                            xxxxx

2) Carrying amount of available-for-sale securities                                           xxxx

a) Adjustment to Equity (1-2)                                                                                     xxxx

b) Adjust the unrealized gain/(loss) on available-for-sale securities          +/-xxxx

c) Retrospective adjustment to opening retained earnings                            xxxx

 

Dr. Investment in xxxx                                   a

Cr. Retained earnings                                     c

Cr. Unrealized loss on AFS securities        b

If the shares are bought during the year, the fractional period should be considered for investee’s income not full year.

 When investor acquires a voting interest of more than 50% in investee. Means, the investor has controlling interest. The investor is considered as the parent and the investee is as the subsidiary present the investment in the common stock of the subsidiary as long-term investment on the separate financial statements of parent.

When the parent treats the subsidiary as an investment, the parent generally prepares consolidated financial statements. Consolidated financial statements treat the parent and subsidiary corporations as a single economic entity. When and how to prepare consolidated financial statements it will be discussed in Chapter 21: Consolidation.

Whether or not consolidated financial statements are prepared, the parent company generally accounts for the investment in the subsidiary using the equity method as explained in this section.

 

From

To

Measurement

Earning Recognition

Trading

Any

Fair Value

-       No need to reverse previous earning/loss

Any

Trading

Fair Value

-       Previous and current recognized unrealized gain/loss immediately

Available-for-sale

Held-to-maturity

Fair Value

-       Unrealized gain/loss recognized in OCI and reversed into retained earnings/investment if equity is used or

-       Unrealized gain/loss not reversed but amortized as premium/discount. The unrealized gain/loss should be amortized over the remaining life of security.

Held-to-maturity

Available-for-sale

Fair Value

-       Unrealized gain/loss should be reported in Other Comprehensive Income.

 Companies have different motivations for investing in securities issued by other companies, either plan to sell, no plan to sell or exercise some control. To provide useful information, companies account for investments based on the type of security, management intent with respect to investments. The below table summarize the financial reporting concepts and presentations as below table.

 

Types of Security

Management Intent

Valuation approach

Asset Presentation

Unrealized Holding Gains/Losses

Other Income Effects

Debt Securities

Trading securities

Fair value

Temporary Investments under current assets.

Interest receivables presented as current assets

Recognized in net income

Interest when earned; gains and losses from sale are Presented as other revenue or gain

 

Available for Sale

Fair value

Investment as current assets or as noncurrent assets , depends on maturities and expectations as to sales and redemptions in the follow year

Recognized as other comprehensive income and as separate component of stockholders’ equity

Interest when earned; gains and losses from sale are Presented as other revenue or gain

 

Held-to-maturity

Amortized Cost

Long-term Investments under noncurrent assets

Interest receivables presented as current assets

Not recognized

Interest when earned; gains and losses from sale are Presented as other revenue or gain

Equity Security

Holding less than 20% for Available-For-Sale

Fair Value

Investment as current assets or as noncurrent assets , depends on expectations as to sales in the follow year

Recognized as other comprehensive income and as separate component of stockholders’ equity

Dividends declared; gains and losses from sale

 

Holding less than 20% for trading

Fair Value

Temporary Investments under current assets.

Recognized in net income

Dividends declared; gains and losses from sale

 

Holding between 20% and 50%

Equity

Long-term Investments

Not recognized

Proportionate share of investee’s net income

 

Holding more than 50%

Consolidation

 

Not recognized

Not Applicable

 Note for financial reporting:

 

  1. Whatever the purpose of using temporary investments e.g. to be used for purchasing fixed assets, temporary investments should be presented as current assets. If the fixed assets such as building or cars are purchased and intend to sell it within operating cycle, such fixed assets should be reported as investments and should not be depreciated.
  2. Permanent decline not temporary decline in stock price lead to impairment that should be presented as earnings in income statement whichever the classification of securities (Available-For-Sale or Trade securities)
  3. If the company owns less than 20% of outstanding voting stocks, but has convertible loans to investee that result in ownership of 20% or more, and the board seats allow the investor company to significantly influence the voting at meetings of investee’s board of directors. The overall impact of such transaction could demonstrate that the company has the ability to exercise significant influence over the investee. Therefore, equity method should be followed in accounting for the investments or consolidation method if the investor has over 50% of outstanding shares.
  4. IFRS 9: Financial instrument indicate that financial assets in form of debt instrument is measured at amortized cost if it meets the business model test and cash flow tests. Also, under IFRS, the financial assets that are not at fair value through profit or loss is measured initially at fair value plus transaction cost.

The following disclosure requirements in the investor’s financial statements generally apply to the equity method;

1.       The name of each investee and the percentage of ownership of common stock

2.       The accounting policies of the investor with respect to investment in common stock.

3.       The difference, if any, between the amount in the investment account and the amount of underlying equity in the net assets of the investee.

4.       The aggregate value of each identified investment based on quoted market price (if available)

5.       When equity-method investments are, in the aggregate, material in relation to the financial position and operating results of an investor, the company may need to present summarized information concerning assets, liabilities, and results of operations of the investees, either individually or in groups, as appropriate.

To ensure that gains and losses are not counted twice when a sale occurs, reclassification adjustment is necessary in the financial statements as follow:

Net income (include realized gain or loss)                                                                             xxxxx

Other Coprehensive income

The holding gains or loss arising during the year (Realized+Unrealized)   xxxx

Less: Reclassification adjustment for gains or loss included                           xxxx       xxxxx

Comprehensive income                                                                                                                                xxxxx

Company should evaluate every investment at each reporting date, to determine if it has suffered impairment- permanent loss that is other than temporary. For example, if an investee experiences a bankruptcy or a significant liquidity crisis, the investor may suffer a permanent loss, company writes down the cast basis of the individual security to a new cost basis. The company accounts for the write-down as realized loss that is included in the net income.

For debt securities, company uses the impairment test to determine whether it is probable that the investor will be unable to collect all amounts due according to the contractual terms.

For equity securities, the guideline is less precise. Any time realizable value is lower than the carrying amount of the investment, a company must consider impairment.

Any transfer between the category of the securities should be measured at fair value at transfer date.

The unrealized gain or loss should be disclosed for marketable securities under current assets as follow:

The gross unrealized gain/loss on December 31, 20xx was $xx,xxx. On December 31, 20xx, the gross unrealized gain/loss on was $xx,xxx.

 

Issues

IFRS

U.S GAAP

Available-For-Sale Securities

-       Unrealized gain/loss of Debt securities are recognized under OCI except for their foreign exchange gains/loss that should be reported in income statements

-       Unrealized gain/loss of equity securities and their foreign exchange difference are reported in OCI

All unrealized gain/loss are recognized in OCI

Impairments of securities

-       It is allowable to use either direct (cost) method or indirect (Valuation allowance) Method to book the impairment. The impairment should be reported to income statement.

-       Whatever the classification of securities (AFS or HTM), the impairment should be reversed by the amount of the increase of fair value in subsequent period. For Held-to-maturity (HTM) securities the reversal should not exceed the amortized costs.

-       Impairment losses are recognized in income statement by using cost basis not valuation allowance (Direct method) and not reversed due to increase of fair value in subsequent period if the security classified as held-to-maturity.

-       For the Available-for-sale securities, the increase of fair value of security in subsequent period should be recognized in OCI