F5 M1 Financial Instruments

financial assets

contractual right to receive cash or another financial instrument; cash (demand deposits and foreign currencies), evidence of ownership (stock investments, LL interests, etc.), debt investments (bonds or notes receivable), and derivative assets (favorable options, futures, or forward contracts)

financial liabilities

a contractual obligation to deliver cash or another financial instrument; delver cash or another financial instrument to a second entity (bonds & notes payable, accounts payable, loans payable, etc.); exchange other financial instruments on potentially unfavorable terms with second entity (stock options, other derivatives, etc.)

fair value option

allows an entity to elect FV measurement for an eligible financial asset or liability that would normally use another accounting method; unrealized gains/losses are recorded in earnings; it is irrevocable and is applied to individual financial instruments; the election is made on a specified election date

eligible financial instruments for FV option

recognized financial assets & liabilities and certain firm commitments & other eligible items; examples include an AFS investment measured at FV with changes directly going to earnings instead of OCI and when FV is selected for an equity-method investment and uses FV instead of equity method

non-eligible financial instruments for FV option

investment in subsidiaries or VIEs that must be consolidated, pension benefit assets & liabilities, financial assets or liabilities recognized under leases, deposit liabilities of financial institutions, and financial instruments classified as equity

FV option for instrument-specific credit risk

for financial liabilities, changes in FV are recognized in OCI; for derivative liabilities, changes in FV, including credit risk component, are recognized in net income; once the financial liability is derecognized, any accumulated gains/losses in OCI are recognized in earnings; due to fluctuation in credit risk of the customer

FV option election dates

can be applied on the date that the entity first recognizes an eligible financial instrument, the date that an investment becomes subject to equity method accounting, or the date that the entity ceases to consolidate an investment in subsidiary or VIE

debt security

is a financial instrument that represents a creditor relationship with another entity; holder generally has a contractual right to receive principal and interest

debt securities

corporate bonds, redeemable preferred stock, government securities, convertible debt, and commercial paper; do NOT include option contracts, leases, and notes/accounts receivable

trading security

debt securities bought primarily to sell in the near term and profit from short-term price changes; generally reflect active and frequent buying and selling with the objective of generating profits on short-term differences in price; generally current assets, reported at FV on balance sheet, unrealized gains/losses go direct to income statement (as well as realized gains/losses), and interest income is recognized in earnings; could be non-current on the off chance

available-for-sale (AFS) debt security

is a debt security that the entity does not intend to trade in near term and does not have positive intent or ability to hold until maturity; reported at FV on balance sheet, unrealized gains/losses go direct to OCI (net of tax), during selling process accumulated OCI amount is reclassified to earnings & realized gains/losses are recognized in net income, recognize credit loss expense when necessary (remainder to OCI0, interest income in net income, and either current or non-current

held-to-maturity (HTM) debt security

is a debt security where the investor has both the positive intent and ability to hold debt until maturity; reported at amortized cost; premiums, discounts, and transaction costs are amortized over security’s life; does not market-to-market, so no unrealized gains/losses; use CECL method for impairment losses

debt securities reported at FV

trading securities and AFS securities are recognized under these terms; this type represent the market price of the security or what a willing buyer or seller would pay and accept to exchange the security (changes are unrealized gains/losses)

unrealized gains/losses on FV securities

are changes in an investment’s FV while the investment is still held and has not been sold; for trading securities, these changes go to earnings and for AFS securities, these changes go to OCI

unrealized loss on trading security

a debit to unrealized loss for change in amount of PY FV to CY FV and a credit to the valuation account (FV adjustment); goes directly to net income

unrealized loss on AFS security

a debit to unrealized loss for change in amount of PY FV and CY FV and a credit to the valuation account (FV adjustment); goes directly to OCI

realized gains/losses

are recognized when a debt security is sold and when an AFS security is deemed impaired; are all recognized in net income

debt security reported at amortized cost

HTM securities are the only ones that are classified under this method (no market-to-market); unrealized gains/losses recognized here for HTM are not recognized in the financial statements (should not even occur because there is a positive intent and ability to hold until maturity)

debt securities cash flow statement

AFS securities and HTM securities are both classified as investing activities; trading securities are classified as operating activities when current and investing when non-current

transfer of a HTM security

transfer should be rare and should only be made when there is a change in the entity’s intent to hold a specific security to maturity that does not call into question the entity’s intent to hold other debt securities to maturity; accounted for at FV on reclassification date

transfer from a trading security

recorded at FV on the transfer date; the unrealized gains/losses at the date of transfer is already recognized in earnings and shall not be reversed

transfer to a trading security

recorded at FV on the transfer date; the unrealized gains/losses at that date of transfer shall be recognized in earnings immediately; when transferring to HTM, record difference between amortized cost and FV in net income on transfer date

HTM transferred to AFS

transferred at FV on reclassification date; unrealized gains/losses at date of transfer shall be reported in OCI (difference between amortize cost and FV); transfer should be based on a change in intent and ability, not simply to manage earnings

AFS transferred to HTM

transfer it at FV on transfer date; unrealized gains/losses at date of transfer is already reported in OCI; the unrealized gains/losses should be amortized over the remaining life of security as an adjustment of yield in a manner consistent with the amortization of any premium or discount

interest income for trading or AFS securities

recorded on the income statement; a debit to cash and a credit to interest income

*state coupon rate x face value

interest income for HTM securities

recorded on the income statement; calculated using the effective interest method; a debit to cash for coupon payment, a credit to HTM investment for discount, and a credit to interest income for coupon payment minus discount

*beginning carrying value x effective interest rate

impairment of debt securities

under the CECL method, AFS and HTM should be reported at net amount expected to be collected using allowance for expected credit losses; determined based on current conditions, past experiences, and future expectations; trading securities are already reported at FV, with all changes going to net income, so CECL is generally no applied

impairment of HTM securities

investment should be reported at the PV of the principal and the interest that is expected to be collected, discounted at effective interest rate at time of purchase

credit loss in AFS & HTM impairment

*((PV of $1 using annual interest, remaining years, & face (par) value) + (PV of an ordinary annuity using annual interest, remaining years, & new interest to be collected)) - purchase price
*face (par) value x (market rate/2, semiannual) = original interest
*original interest - less amount believed to be collected = new interest to be collected

HTM impairment entry

a debit to credit loss expense and a credit to allowance for credit losses for the credit loss amount

impairment of AFS securities

credit loss expense is reported in net income (CECL method) and the security is limited to the amount by which FV is below amortized cost; any additional loss is reported as an unrealized loss in OCI

AFS security gain

a debit to the valuation account (FV adjustment) and a credit to unrealized gain for the difference between amortized cost and CY FV

AFS security impairment loss within credit loss

a debit to credit loss expense and a credit to allowance for credit losses for the difference between amortized cost and CY FV (as long as it does not exceed the credit loss cap)

AFS security impairment loss beyond credit loss

a debit to credit loss expense for total credit loss amount, a debit to unrealized loss (OCI) for the difference between credit loss and total loss, and a credit to allowance for credit losses, and a credit to valuation account (FV adjustment)

selling of a trading security

recorded at its carrying value, which equals FV immediately before the sale a debit to cash for FV at time of sale (selling price), a credit to trading security at its current carrying value (± any unrealized gains/losses are already included), and a credit to realized gain on trading security for the realized gains/losses amount

*selling price - current carrying value = realized gains/losses

selling of an AFS security

any unrealized gains/losses in AOCI must be reversed at the time of sale; the realized gains/losses goes directly to net income

*selling price - original cost = realized gains/losses
*FV before sale (current carrying value) ± unrealized gains/losses = original cost
*original cost ± unrealized gains/loss = FV before sale (current carrying value)

AFS sale security

a debit to cash for selling price, a debit to unrealized gain at time of sale (reversal), a credit to AFS security for FV before sale (current carrying value), and a credit to realized gain for realized gain amount

equity security

is an ownership interest in another company, or the right to acquire or dispose of ownership interest in an enterprise at fixed or determinable prices; ownership interest is usually represented by common or preferred stock; for the investor, it is an asset; if has less than 20% ownership, it is accounted as similar rules to a trading security

equity securities

ownership shares (common, preferred, and other forms of capital stock), rights to acquire ownership shares (stock warrants, rights, or call options), and rights to dispose of ownership shares (put option); do NOT include redeemable preferred stock, treasury stock, and convertible bonds

fair value through net income

equity securities are generally carried at this; reported at FV on the balance sheet, adjusted for unrealized gains/losses (changes reporting in net income), and dividend & interest income goes into net income; does apply to equity securities when investor does not have significant influence, trading securities, and eligible investments for which FV option is elected

practicability exception for equity securities

applicable to equity securities that do not have a readily determinable FV; impairment is recognized in net income & observable price changes are recognized as an adjustment to the investment’s carrying amount, goes into net income; most commonly applies to an investment in a private company (no market-to-market)

*original cost - impairment ± observable price changes

observable price changes

are changes in the estimated value of an equity investment based on an orderly transaction involving an identical or similar investment from same issuer

not allowed to use practicability exception

entities that are broker-dealers in securities, investment companies, and postretirement benefit plans

equity security valuation

are generally reported at FV through net income; unrealized gains/losses on equity securities are included in earnings as they occur; if no FV, use practicability exception when allowed

unrealized loss on an equity security

a debit to unrealized loss and a credit to valuation account (FV adjustment) for the PY FV minus the CY FV (goes directly to net income)

dividend income equity security

generally recognized in net income when the dividend is declared, not when cash is received (does not apply to a liquidating dividend); a debit to cash and a credit to dividend income

*total dividend declared - liquidating dividend = dividend income

liquidating dividend

is a distribution that exceeds the investor’s share of the investee’s retained earnings; is a return of capital that decreases the investor’s basis in the investment; a debit to cash and a credit to investment in investee

*total dividend received - dividend income = liquidating dividend

liquidating dividend on investment

a debit to cash for dividend paid times percentage owned, a credit to dividend income for dividend income times percentage owned, and a credit to investment in investee for the difference between dividend received and dividend income

impairment with the practicability exception

apply a qualitative assessment that considers going-concern problems such as noncompliance with debt requirements & insufficient working capital, significant adverse changes such as technological developments & investee’s industry declining, significant declines in earnings & credit ratings, and an offer to purchase the same or similar investment for less than its carrying value

qualitative assessment indicates impairment

write-down the investment to FV and recognize a realized loss in net income to represent the write-down; the write-down is not reversed if the value later increases

sale of equity security measure at FV through net income

update the investment to FV immediately before the sale and if all FV changes were already recorded, the sale itself produces no additional gain or loss because all the unrealized gains/losses are already in net income; a debit to cash and a credit to equity security when carrying amount equals selling price, any valuation account would also be removed when security is sold

sale of equity security when there were no FV changes previously recorded

a gain or loss is recorded at the time of sale equal to difference between adjusted cost and the selling price; a debit to cash for selling price, a credit to equity security for adjusted cost, and a credit to gain for the gain amount

*original cost ± unrealized gains/losses = adjusted cost
*selling price - adjusted cost = gain/loss

AFS and HTM disclosures

the aggregate FV, gross unrealized gains/losses, amortized cost basis by major security type, and information about the contractual maturities of debt securities

net unrealized gains/losses recognized during the period on equity securities still held at year-end

*net gains/losses recognized during period on equity securities - net gains/losses recognized during the period on equity securities sold during the period

financial assets and liabilities disclosed by measurement category

FV through net income (trading securities and equity securities that do not have significant influence, FV through OCI (AFS), and amortized cost (HTM)

disclosure for form of financial assets

equity & debt securities, loans or receivables, and cash

public business entities (PBEs) disclosures

FV amount reported on balance sheet or in notes; FV hierarchy classification, Level 1 (most reliable), Level 2 (reliable), and Level 3 (least reliable)

disclosures for assets and liabilities measured at amortized cost

FV should be disclosed in accordance with the exit price (selling price)

FV disclosure exceptions

not required for payables & receivables due within one year, deposit liabilities with no defined maturities, and equity investments reported under the practicability exception

disclosures for practicability exception

carrying amount of all investments without readily determinable FV, impairment charges recognized during the reporting period, and upward or downward adjustments to the carrying amount from observable price changes in orderly transactions involving identical or similar investments from same issuer

concentration of credit risk disclosure

occur when an entity has significant financial instruments exposed to the possibility that one party, or a group of similar parties, will fail to perform under the contract; applies to all entities except nonpublic entities that have less than $100 million and have no instruments that are accounted for as derivatives; include parties with same industry, same geographic region, etc.

credit risk

is the possibility of a loss from the failure of another party to perform according to the terms of a contract (ex: a borrower defaulting on a loan, etc.)

market risk disclosure

is the possibility of a loss from changes in market value (economic circumstances); disclosure of this is encouraged but not required, may disclose quantitative information about market risk of financial instruments that is consistent with the way it manages or adjusts those risks