After studying this chapter, you should be able to:
Identify the three categories of debt securities and describe the accounting and reporting treatment for each category. Understand the procedures for discount and premium amortization on bond investments. Identify the categories of equity securities and describe the accounting and reporting treatment for each category. Explain the equity method of accounting and compare it to the fair value method for equity securities.
Describe the accounting for the fair value option. Discuss the accounting for impairments of debt and equity investments. Explain why companies report reclassification adjustments. Describe the accounting for transfer of investment securities between categories.
What to Do?
Recently, a bank reported an $87.3 million write-down on its mortgage-backed securities for the third quarter of 2008; however, the bank stated that it expected its actual losses to be only $44,000. The loss of $44,000 was equal to a modest loss on a condo foreclosure. The bank’s regulator found “the accounting result absurd.” However, the rest of the story is that the bank, in the third quarter of 2009, raised its creditloss estimate by $263.1 million, quite a difference from its original loss estimate of $44,000. The discussion above highlights the challenge of valuing financial assets such as loans, derivatives, and other debt investments. The fundamental question that arose out of the example above and, more significantly, the recent financial crisis is: Should financial instruments be valued at amortized cost, fair value, or some other measure(s)? As one writer noted, the opinion that fair value accounting weakens financial and economic stability has persisted among many regulators and politicians, mostly in Europe but also in Asia. But some investors and others, particularly in the United States, believe that fair value is the right answer because it is more transparent information. OK, so what to do? Well, the FASB has issued a proposal to account for just about all financial assets at fair value with gains and losses recorded in income (amortized cost would be disclosed for some financial assets). The FASB believes this approach will provide the most relevant and transparent information about financial assets. In contrast, the IASB has issued a new standard on financial assets (IFRS 9) that uses a mixed-attribute approach. Some of the financial assets are valued at amortized cost and others at fair value. Thus, at this point the two bodies do not agree as to how these instruments should be accounted for and reported. A survey by the Chartered Financial Analysts association on IFRS 9 contained the following question on the IASB’s new standard: “Do you agree that the IASB’s new standard requiring classification into amortized cost or fair value will improve the decision-usefulness of overall financial instrument accounting?” The survey results indicate that just 47 percent believe the IASB’s approach improves the decision-usefulness of information. This less-than-strong support for the new rule is somewhat troubling, given that the group surveyed is representative of the IASB’s key constituency—investors and creditors.
Copyright © 2012 John Wiley & Sons, Inc.
Interestingly, the European Union refused to consider adopting the requirements of IFRS 9, arguing that it contained too much fair value information. Nevertheless, the standard was issued and other countries that follow IFRS will soon be implementing the new standard. At the same time, as soon as the FASB issues its new standard, the IASB has indicated that it may revisit the valuation issue once again. Thus, the early reaction to IFRS 9 indicates that, unfortunately, once again politics is raising its ugly head on an accounting issue. Some European regulators have suggested that the IASB’s future funding may even...
References: 8. On July 1, 2012, Wheeler Company purchased $4,000,000
of Duggen Company’s 8% bonds, due on July 1, 2019
1028 Chapter 17 Investments
report on its income statement for the year ended December 31, 2012.
9. If the bonds in question 8 are classified as available-forsale and they have a fair value at December 31, 2012, of $3,604,000, prepare the journal entry (if any) at December 31, 2012, to record this transaction.
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