(F5) Debt & Equity Securities

fair value option

• Under this option, unrealized G/Ls ar reported in earnings.

• This option is irrevocable

• Applied to individual financial instruments

Financial instruments not eligible for the fair value option:

1. Investments in subsidiaries of variable interest entities that an entity is required to consolidate

2. Pension benefit assets or liabilities

3. Financial assets/liabilities recognized under leases

4. Deposit liabilities of financial institutions

5. Financial instruments classified as equity

debt securities

• any security representing a creditor relationship with an entity

• an asset to the lender

3 types:

1. Trading

2. Available-for-sale

3. Held to maturity

Trading debt securities

debt securities bought & held principally for the purpose of selling them in the near term

*fair value goes to the income statement

Available-for-sale debt securities

securities not meeting the definitions of trading or held to maturity

*FV goes through other comprehensive income (OCI) → remember PUFI

held to maturity debt securities

security with the intent and ability to be held to its maturity

*reported @ amortized cost, do not mark to market value

How are unrealized G/Ls for trading securities reported?

on the income statement

How are unrealized G/Ls for available-for-sale securities reported?

in other comprehensive income (OCI)

How are realized G/Ls reported?

in net income for all types

How are unrealized G/Ls reported for held to maturity securities?

not recognized because they are not marked to market value. They are intended to not be sold.

reclassification

very rare and must be justified

• trading → any other: already recognized in income, no adjustment necessary

• any other → trading: recognize in net income

• held to maturity → available for sale: record in OCI

• available for sale → held to maturity: amortize G/L from OCI w/ any bond premium/discount amortization

impairment

under the CECL model, AFS and HTM should be reported @ the net amount expected to be collected using an allowance for credit losses.

credit loss is recognized on the income statement

expected credit loss

PV of future cash flows - amortized cost

sale of a debt security

• results in a realized G/L through net income for any category of security

Amount to recognize on sale of a trading security

G/L = selling cost - CV @ time of sale

Amount to recognize on sale of an available for sale security

G/L = selling price - original cost

equity security

security that represents an ownership interest in an enterprise or the right to acquire or dispose of an ownership interest in an enterprise at fixed or determinable prices

liquidating dividends are:

not income

How are equity securities with no significant influence (<20%) reported?

at fair value

• unrealized G/Ls included on the income statement as they occur

equity method

used to account for investments if significant influence can be exercised by the investor over the investee (between 20%-50% ownership)

• dividends on common stock aren’t income

• don’t mark to FMV