TOPIC 5A

ACCOUNTING
FOR
INVESTMENT
INSTRUMENTS
COURSE FACILITATOR

ABDIFATAH MAYGAG
TOPIC 5 ACCOUNTING FOR
A INVESTMENT INSTRUMENTS

Contents
1. Investment Types
2. Accounting for Short-term Investments
3. Accounting for Equity Investments
4. Accounting for Fixed Income Securities
RECAP – FINANCIAL INTERMEDIATION

Surplus Units Bank Deficit Units

“Deposits” “Financing”

Bank’s Liabilities Bank’s Assets

Uses of of funds

Denotes flow of funds

INVESTMENT TYPES
 INVESTMENT TYPES

 Banks engage a variety of investment types.

 Typically, it can be categorized into the following broad areas:
 Short-Term Investments
• Treasury Bills (Short)
• Certificate of Deposit (CD)
• Commercial Paper
 Fixed Income Securities
• Corporate Bonds
• Treasury Bills (Long-term)
• Municipal Bonds
 Stocks and Equities
ACCOUNTING FOR SHORT-TERM
INVESTMENTS
ACCOUNTING FOR SHORT-TERM INVESTMENTS

Money Market
 The money market refers to trading in very short-term debt
investments.
 The money market involves the purchase and sale of large volumes of
very short-term debt products.
 At the wholesale level, it involves large-volume trades between
institutions and traders.
 At the retail level, it includes money market mutual funds bought by
individual investors and money market accounts opened by bank
customers.
 Money market investments are characterized by safety and liquidity.
ACCOUNTING FOR SHORT-TERM INVESTMENTS

Money Market Instruments:

 Because of their short terms to maturity.
 Undergo the least price fluctuations and so are the least risky
investments.
 Principle money market instruments include:
• U.S. Treasury Bills
• Negotiable Bank Certificates of Deposit
• Commercial Paper
• Repurchase Agreements
• Federal (Fed) Funds
ACCOUNTING FOR SHORT-TERM INVESTMENTS

Accounting for Debt Securities: Treasury Bills

Example:
Consider the purchase of a two year Treasury bill for $907, which has
a face value of $1,000. The prevailing market rate at the time of
issuance is 5% (compounded annually).

Journal entry to record the initial purchase:

Dr. Investment in Securities (T-Bills) $907
Cr. Cash $907
ACCOUNTING FOR SHORT-TERM INVESTMENTS

Accounting for Debt Securities: Treasury Bills

Example:

Journal entry to record the accrued interest at the end of year 1:

Dr. Investment in Securities (T-Bills) $45

Cr. Interest Income $45

Interest Rate Calculation:

Period Beginning Balance Interest Income Ending Balance

1 $907 $45 $952

2 $952 $48 $1,000
ACCOUNTING FOR SHORT-TERM INVESTMENTS

Accounting for Debt Securities: Treasury Bills

Example:

At the end of the first year assume interest rates have increased and
the market value for one year Treasury bill is now $934. After the
first year the book value of the Treasury bill purchased is $952
(purchase price of $907 plus year 1 accrued interest of $45),
producing an unrealized loss of $18.
Journal entry to record the Unrealized loss on the T-Bill:

Dr. Unrealized Loss $18

Cr. Investment In T-Bill $18
ACCOUNTING FOR SHORT-TERM INVESTMENTS

Accounting for Debt Securities: Treasury Bills

Example:

Journal entry to record the accrued interest at the end of year 2:

Dr. Investment in Securities (T-Bills) $48

Cr. Interest Income $48

Journal Entry to record receipt of face value at maturity (Year 2

End)
Dr. Cash $1,000
Cr. Investment in Securities (T-Bills) $982
Cr. Realized Gain $18
ACCOUNTING FOR EQUITY INSTRUMENTS
 ACCOUNTING FOR EQUITY INVESTMENTS

Equity investment represents ownership of ordinary, preference, or

other capital shares.
 Cost includes price of the security.
 Broker’s commissions and fees are recorded as expense.

The degree to which one corporation (investor) acquires an interest

in the common stock of another corporation (investee) generally
determines the accounting treatment for the investment subsequent
to acquisition.
 ACCOUNTING FOR EQUITY INVESTMENTS

Levels of Influence Determine Accounting Methods

 ACCOUNTING FOR EQUITY INVESTMENTS

Accounting and Reporting for Equity Investments by

Category
ACCOUNTING FOR EQUITY INVESTMENTS

Holdings of Less Than 20%

Under IFRS, the presumption is that equity investments are held-
for-trading.

General accounting and reporting rule:

 Investments valued at fair value.
 Record unrealized gains and losses in net income.
ACCOUNTING FOR EQUITY INVESTMENTS

Holdings of Less Than 20%

IFRS allows companies to classify some equity investments as
non-trading.

General accounting and reporting rule:

 Investments valued at fair value.
 Record unrealized gains and losses in other comprehensive
income.
ACCOUNTING FOR EQUITY INVESTMENTS

Equity Investments – Trading (Income)

Illustration: November 3, 2015, Republic Corporation purchased
ordinary shares of three companies, each investment representing less
than a 20 percent interest. These shares are held-for-trading.

Republic records these investments as follows:

Equity
Investments
—Trading

Republic records these investments as follows:

Equity Investments 718,550

Cash 718,550

On December 6, 2015, Republic receives a cash dividend of €4,200 on its

investment in the ordinary shares of Nestlé.

Cash 4,200
Dividend Revenue 4,200
ACCOUNTING FOR EQUITY INVESTMENTS

Unrealized Holding Gain or Loss—Income 35,550

Fair Value Adjustment 35,550
ACCOUNTING FOR EQUITY INVESTMENTS

On January 23, 2016, Republic sold all of its Burberry ordinary shares,
receiving €287,220. ILLUSTRATION 17-18
Computation of Gain on Sale of Burberry Shares

Cash 287,220
Equity Investments 259,700
Gain on Sale of Equity Investment 27,520
ACCOUNTING FOR EQUITY INVESTMENTS
Equity Investments—Non-Trading (OCI)

Equity Investments: Non-trading

 The accounting entries to record non-trading equity
investments are the same as for trading equity investments,
except for recording the unrealized holding gain or loss.
 Report the unrealized holding gain or loss as other
comprehensive income.
 ACCOUNTING FOR EQUITY INVESTMENTS
Equity Investments—Non-Trading (OCI)
Equity Investments: Non-trading
 On December 10, 2015, Republic Corporation purchased 1,000 ordinary
shares of Hawthorne Company for €20.75 per share (total cost €20,750).
 The investment represents less than a 20 percent interest. Hawthorne is a
distributor for Republic products in certain locales, the laws of which
require a minimum level of share ownership of a company in that region.
 The investment in Hawthorne meets this regulatory requirement.
Republic accounts for this investment at fair value.

Equity Investments $20,750

Cash $20,750
ACCOUNTING FOR EQUITY INVESTMENTS
Equity Investments—Non-Trading (OCI)

On December 27, 2015, Republic receives a cash dividend of €450 on

its investment in the ordinary shares of Hawthorne Company. It records
the cash dividend as follows.

Cash 450
Dividend Revenue 450
ACCOUNTING FOR EQUITY INVESTMENTS
Equity Investments—Non-Trading (OCI)

At December 31, 2015, Republic’s investment in Hawthorne has the

carrying value and fair value shown.
Computation of Fair Value Adjustment—Non-Trading Equity Investment
(2015)

Republic records this adjustment as follows.

Fair Value Adjustment 3,250

Unrealized Holding Gain or Loss—Equity
3,250
 ACCOUNTING FOR EQUITY INVESTMENTS
Equity Investments—Non-Trading (OCI)

Financial Statement Presentation

 ACCOUNTING FOR EQUITY INVESTMENTS
Equity Investments—Non-Trading (OCI)

On December 20, 2016, Republic sold all of its Hawthorne Company

ordinary shares receiving net proceeds of €22,500.

Adjustment to Carrying Value of Investment

Entry to adjust the carrying value of the non-trading investment.

Unrealized Holding Gain or Loss—Equity 1,500
Fair Value Adjustment 1,500
 ACCOUNTING FOR EQUITY INVESTMENTS
Equity Investments—Non-Trading (OCI)

On December 20, 2016, Republic sold all of its Hawthorne Company

ordinary shares receiving net proceeds of €22,500.

Adjustment to Carrying Value of Investment

Entry to record the sale of the investment.

Cash 22,500
Equity Investments 20,750
Fair Value Adjustment 1,750
ACCOUNTING FOR EQUITY INVESTMENTS

Holdings Between 20% and 50%

An investment (direct or indirect) of 20 percent or more of the
voting shares of an investee should lead to a presumption that in
the absence of evidence to the contrary, an investor has the ability
to exercise significant influence over an investee.
In instances of “significant influence,” the investor must account
for the investment using the equity method.
ACCOUNTING FOR EQUITY INVESTMENTS

Holdings Between 20% and 50%

Equity Method
Record the investment at cost and subsequently adjust the
amount each period for
 the investor’s proportionate share of the earnings (losses)
and
 dividends received by the investor.

If investor’s share of investee’s losses exceeds the carrying amount of the

investment, the investor ordinarily should discontinue applying the equity
method.
Comparison of Fair Value Method and Equity Method
ACCOUNTING FOR EQUITY INVESTMENTS

Holdings of More Than 50%

Controlling Interest - When one corporation acquires a voting
interest of more than 50 percent in another corporation.
 Investor is referred to as the parent.
 Investee is referred to as the subsidiary.
 Investment in the subsidiary is reported on the parent’s
books as a long-term investment.
 Parent generally prepares consolidated financial
statements.
ACCOUNTING FOR FIXED INCOME
SECURITIES
 ACCOUNTING FOR DEBT INVESTMENTS

Debt investments are characterized by contractual payments on

specified dates of
 principal and
 interest on the principal amount outstanding.

Companies measure debt investments at

 amortized cost or
 fair value.
 ACCOUNTING FOR DEBT INVESTMENTS

Debt Investments—Amortized Cost

Illustration: Robinson Company purchased €100,000 of 8% bonds
of Evermaster Corporation on January 1, 2015, at a discount, paying
€92,278. The bonds mature January 1, 2020 and yield 10%; interest
is payable each July 1 and January 1. Robinson records the
investment as follows:

January 1, 2015

Debt Investments 92,278

Cash 92,278
ACCOUNTING FOR DEBT INVESTMENTS
 ACCOUNTING FOR DEBT INVESTMENTS

ILLUSTRATION 17-2

Robinson Company records the receipt of the first semiannual

interest payment on July 1, 2015, as follows:

Cash 4,000
Debt Investments 614
Interest Revenue 4,614
 ACCOUNTING FOR DEBT INVESTMENTS

Because Robinson is on a calendar-year basis, it accrues interest and

amortizes the discount at December 31, 2015, as follows:

Interest Receivable 4,000

Debt Investments 645
Interest Revenue 4,645
 ACCOUNTING FOR DEBT INVESTMENTS

Reporting of Bond Investment at Amortized Cost

 ILLUSTRATION 17-2

Assume that Robinson Company sells its investment on

November 1, 2017, at 99¾ plus accrued interest. Robinson
records this discount amortization as follows:

Debt Investments 522

Interest Revenue 522
(€783 x 4/6 = €522)
 ACCOUNTING FOR DEBT INVESTMENTS

Debt Investments—Fair Value

Debt investments at fair value follow the same accounting entries
as debt investments held-for-collection during the reporting period.
That is, they are recorded at amortized cost.

However, at each reporting date, companies

 Adjust the amortized cost to fair value.
 Any unrealized holding gain or loss reported as part of net
income (fair value method).
 ACCOUNTING FOR DEBT INVESTMENTS

Debt Investments—Fair Value

Illustration: Robinson Company purchased €100,000 of 8
percent bonds of Evermaster Corporation on January 1, 2015,
at a discount, paying €92,278. The bonds mature January 1,
2020, and yield 10 percent; interest is payable each July 1 and
January 1.
The journal entries in 2015 are exactly the same as those for
amortized cost.
 ACCOUNTING FOR DEBT INVESTMENTS

Debt Investments—Fair Value

Entries are the same as those for amortized cost.
 ACCOUNTING FOR DEBT INVESTMENTS

Debt Investments—Fair Value

To apply the fair value approach, Robinson determines that, due to a
decrease in interest rates, the fair value of the debt investment
increased to €95,000 at December 31, 2015.
Computation of Unrealized Gain on Fair Value Debt Investment (2015)

Fair Value Adjustment 1,463

Unrealized Holding Gain or Loss—Income 1,463
 ACCOUNTING FOR DEBT INVESTMENTS

Debt Investments—Fair Value

Financial Statement Presentation of Debt Investments at Fair Value

LO 3
 ACCOUNTING FOR DEBT INVESTMENTS

Debt Investments—Fair Value

At December 31, 2016, assume that the fair value of the Evermaster
debt investment is €94,000.

Unrealized Holding Gain or Loss—Income 2,388

Fair Value Adjustment 2,388
LO 3
 ACCOUNTING FOR DEBT INVESTMENTS

Debt Investments—Fair Value

Financial Statement Presentation of Debt Investments at Fair Value
(2016)

LO 3