"Every year gives us another chance, chance to change, to hope and wish for the better. That betterment will surely come. Wishing You all a Very Energetic, Healthy n Fulfilling New Year!
Since, I have fairly talked about Bonds, I would like to shift to "Investments" which is a closely related topic. It is a pretty interesting area, frequently used and easy to absorb.
The Authoritative Pronouncement on Investments, Codification 320 (formerly known as FASB Statement 115) discusses accounting treatment for following Investment types:-
a. Held-to-Maturity Securities (HTM) comprising only Debt securities with the management's ability and intent to hold until maturity. These are carried at amortized cost i.e acquisition cost is adjusted for amortization of premium or discount. Unrealized holding loss is not reported unless the decline in FV is permanent.
b. Trading Securities comprising of both debt and equity securities held with the purpose of selling in the short run. These are carried at Fair Value and unrealized holding gain/loss is reported on the income statement.
c. Available-for-Sale Securities (AFS) also includes both debt and equity securities which are not actively traded but not necessarily held to maturity. These are also carried at fair value and unless the decline in FV is permanent the unrealized holding gain/loss is reported under other comprehensive income (OCI).
Note:-In case of equity securities this codification is applicable only if significant influence does not exist (i.e. investment in equity securties is less than 20%).
On the Statement of Cash Flows both HTM and AFS securities are classified as cash flow from investing activity. Trading securities are, however, classified as cash flow from operating actitvity.
In the Balance Sheet, HTM and AFS securities may be classified as current or non-current where as Trading securities are short-term investments.
If there is a permanent decline in Fair Value of HTM and AFS securities, investment is written down to fair value, thus, becoming a new cost basis and unrealized loss is taken to earnings.
Decline in FV
Decline in FV
Sale of securities
Premature sale of HTM securities is considered as a sale at maturity in either of two cases:-
1. The sale occurs so close to maturity that interest rate risk is virtually eliminated; or
2. Sale occurs after 85% of principal is recovered.
Realized gain/loss on sale of HTM securities is recognized in accordance with its amortized cost method (either staright line or effective interest).
When AFS securities are sold, the proportionate amount of unrealized gain/loss in OCI is reclassified and becomes part of realized gain/loss. The realized gain/loss on sale is then the difference between original cost and the selling price.
Since unrealized gain/loss on Trading securities is included in earnings in the period they occur, the realized gain/loss on sale of such securities is the amount not already recognized as unrealized.
Transfer of Securities between Categories
When the securities are transferred between the categories i.e from HTM to AFS or Trading or vice versa, such transfers are recorded at FV with adjustment to unrealized gain/loss and recognized gain/loss. This is summarized in the chart which can be viewed by following the link below.
In the next post I will continue with this topic and talk about investment in equity securities when siginificant influence does exist.
Thank you and Good bye