ACNT 2304 CH 12 Investments
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Practice flashcards in question-and-answer format covering Chapter 12 lecture notes on investments, including debt classifications, equity method, and credit losses.
86 Terms
What are financial instruments?
Securities or contracts representing financial assets or obligations.
What are the two main types of investment securities?
Debt securities and equity securities.
What are examples of equity securities?
Common stock and preferred stock.
What are examples of debt securities?
Bonds and notes.
Who purchases financial instruments?
Individuals, mutual funds, and corporations.
Why do investors buy securities?
To earn interest, dividends, or price appreciation.
Why might a company buy another company’s securities?
To develop an ongoing affiliation.
What is the maturity date of a debt security?
The date the principal is due.
What is principal?
The amount repaid at maturity.
What are the two cash flows from a typical bond?
Periodic interest and repayment of principal.
What determines the present value of bond cash flows?
The prevailing market rate for similar risk and maturity.
What is the market annual rate in the example?
14%
When does a bond sell at a discount?
When the stated rate is below the market rate.
When does a bond sell at a premium?
When the stated rate exceeds the market rate.
How do fixed-rate bond prices move when market rates rise?
Prices fall.
How do bond prices move when market rates fall?
Prices rise.
What happens first in a debt investment’s life?
Purchase of the investment.
What periodic cash flow does a bond investor receive?
Interest payments.
What is an unrealized holding gain?
A value increase before sale.
How does a debt investment end?
Sale before maturity or principal repayment at maturity.
At what amount are purchased debt investments initially recorded?
Cost, including brokerage fees.
What is a bond discount account for the investor?
A contra-asset reducing the bond investment’s carrying amount.
Is a bond premium debited or credited at purchase?
Debited.
Is a bond discount debited or credited at purchase?
Credited.
How is cash interest calculated?
Face amount×stated rate per period
How is effective interest revenue calculated?
Beginning amortized cost×market rate per period
How does discount amortization affect carrying value?
It increases amortized cost.
What happens to a discount over the bond’s life?
It declines to zero.
What happens to a premium over the bond’s life?
It declines to zero.
What causes unrealized losses on fixed-rate bonds?
Rising market interest rates.
What causes unrealized gains on fixed-rate bonds?
Falling market interest rates.
What are the three debt investment classifications?
HTM, trading, and AFS.
Which debt category uses amortized cost?
Held-to-maturity.
Which debt category reports unrealized gains in net income?
Trading.
Which debt category reports unrealized gains in OCI?
Available-for-sale.
What qualifies a debt security as HTM?
Positive intent and ability to hold to maturity.
At what amount are HTM securities reported?
Amortized cost, less credit-loss allowance.
Where are HTM fair values disclosed?
In financial statement notes.
Does an HTM investment recognize fair value changes in net income?
No.
Which credit-loss model applies to HTM investments?
Current Expected Credit Loss (CECL).
Where is an HTM credit loss recognized?
Net income.
How is the HTM carrying amount reduced for expected credit losses?
Through an allowance for credit losses.
Where are realized HTM gains and losses reported?
Net income.
Do HTM unrealized holding gains affect OCI?
No.
How are HTM purchase and sale cash flows classified?
Investing activities.
Why are trading securities acquired?
To profit from near-term price changes.
How long are trading securities typically held?
Hours or days.
Where are trading securities usually classified on the balance sheet?
Current assets.
At what value are trading securities reported?
Fair value.
Where do trading unrealized gains and losses go?
Net income.
What is credited for the trading unrealized gain?
Gain on investments in net income.
Why is no separate sale gain recorded after updating trading securities to sale-date fair value?
The gain has already been recognized in net income.
What account is removed when a trading investment is sold?
The fair value adjustment, along with investment-related balances.
Where are trading security gains reported?
Net income.
Do trading security gains affect OCI?
No.
How are trading purchase and sale cash flows classified?
Operating activities.
What does AFS mean?
Available-for-sale.
When is debt classified as AFS?
When it is neither trading nor HTM.
How are AFS debt securities measured?
Fair value.
Where do AFS unrealized gains and losses go?
Other comprehensive income (OCI).
Where do realized AFS sale gains go?
Net income.
Where is the related AFS gain reported?
OCI, then accumulated in AOCI.
Why is an AFS reclassification adjustment needed on sale?
To remove gains from OCI/AOCI and prevent double counting.
When does an AFS impairment exist?
When fair value is below amortized cost.
What if management intends to sell an impaired AFS investment?
Write it down to fair value; recognize impairment in net income.
What if management does not expect to sell before recovery?
Recognize credit losses using an allowance; other declines go to OCI.
Where do AFS unrealized gains accumulate in equity?
Accumulated other comprehensive income (AOCI).
How are AFS purchase and sale cash flows classified?
Investing activities.
When is the fair value option elected?
At the purchase date.
Can the fair value option election be reversed?
No, it is irrevocable.
What does an equity investment represent?
An ownership interest in another company.
What are two common equity securities?
Common stock and preferred stock.
What ownership percentage typically indicates control?
More than 50%.
What accounting method is used for significant influence?
The equity method.
What percentage generally suggests significant influence?
20% to 50%, subject to facts and circumstances.
How is equity-method investment revenue recognized?
Investor ownership percentage×investee net income
Does investee income increase the investment account?
Yes.
How are equity-method dividends recorded?
As a reduction of the investment account.
Are equity-method dividends new investment revenue?
No.
Is an excess fair value assigned to land depreciated?
No.
Is equity-method goodwill amortized?
No.
What happens when an equity investment is acquired midyear?
Recognize only the investor’s share after acquisition.
How is a gain on sale of an equity-method investment determined?
Proceeds minus carrying amount.
What is a financial instrument?
Cash, an ownership interest, or a contractual right or obligation involving cash or another instrument.
What is a special purpose fund?
Assets set aside for a designated purpose.
What account offsets HTM expected credit losses?
Allowance for credit losses.