INVESTMENTS

Topic 6

Download Excel file Brief Exercises” in topic 6 area of Handouts

12-2

Nature of Investments

Bonds and notes

(Debt securities)

Bonds and notes

(Debt securities)

Common and preferred stock

(Equity securities)

Common and preferred stock

(Equity securities)

Investments can be accounted for in a variety of ways, depending on the nature

of the investment relationship.

12-3

Reporting Categories for Investments

Control Characteristics of the Investment Reporting Method Used by the InvestorThe investor lacks significant influence over the operating and financial policies of the investee:

Investment in debt securities for which the investor has the "positive intent and ability" to hold to maturity.

Held-to-maturity (HTM) - investment reported at amortized cost.*

Investment held in an active trading account.Trading securities (TS) - investment reported at fair value with unrealized holding gains and losses included in net income.

Other.

Securities available-for-sale (AFS) - investment reported at fair value with unrealized holding gains and losses excluded from net income and reported in other comprehensive income.*

The investor has significant influence over the operating and financial policies of the investee:

Typically the investor owns between 20% and 50% of the voting stock of the investee.

Equity method - investment cost adjusted for subsequent earnings and dividends of the investee.*

The investor controls the investee:The investor owns more than 50% of the voting stock of the investee.

Consolidation - the financial statements of the investor and investee are combined as if they are a single company.

Reporting Categories for Investments

* If the investor elects the fair value option , this type of investment also can be accounted for using the same approach that's used for trading securities, with the investment reported at fair value and unrealized holding gains and losses included in earnings.

12-4

Investor Lacks Significant Influence

Reporting ApproachTreatment of Unrealized Holding Gains and Losses

Investment Reported in the Balance Sheet at

Held-to-maturity (HTM): used for debt Not recognized Amortized Costthat is planned to be held for its entirelife

Trading (TS): used for debt or equity Recognized in net income Fair Valuethat is held in an active trading and therefore in retainedaccount for immediate resale, or for earnings as part ofwhich the fair value option had been stockholders' equityelected.

Available-for-sale (AFS): used for debt Recognized in other Fair Valueor equity that does not qualify as comprehensive income,held-to-maturity or trading. and therefore in

accumulated othercomprehensive incomein shareholders' equity

12-5

Securities to Be Held to MaturitySecurities are investments in bonds or other debt security that have a specified maturity date. The bonds or other debt are initially recorded at cost. The investor may have the “positive intent and ability” to hold the securities to maturity and can therefore be classified as held-to-maturity (HTM).They are reported on the balance sheet at “amortized cost.”

Amortized cost (Face amount less unamortized discount, or plus unamortized premium).

Amortized cost (Face amount less unamortized discount, or plus unamortized premium).

BalanceSheet

BalanceSheet

12-6

Securities to Be Held to MaturityOn January 1, 2013, Matrix Inc. purchased as an investment

$1,000,000, of 10%, 10-year bonds, interest paid semi-annually. The market rate for similar bonds is 12%. Let’s look

at the calculation of the present value of the bond issue.

Present Amount PV Factor Value Interest $ 50,000 × 11.46992 = $573,496 Principal 1,000,000 × 0.31180 = 311,805

Present value of bonds $885,301

PV of ordinary annuity of $1, n = 20, i = 6%

PV of $1, n = 20, i = 6%

12-7

Interest Interest Discount Unamortized CarryingDate Payment Revenue Amortization Discount Value

1/1/13 114,699$ 885,301$ 6/30/13 50,000$ 53,118$ 3,118$ 111,581 888,419

12/31/13 50,000 53,305 3,305 108,276 891,724 6/30/14 50,000 53,503 3,503 104,772 895,228

12/31/14 50,000 53,714 3,714 101,059 898,941

Securities to Be Held to MaturityPartial Bond Amortization Table

January 1, 2013Investment in bonds 1,000,000

Discount on bond investment 114,699Cash 885,301

June 30, 2013Cash (stated rate × face amount) 50,000Discount on bond investment 3,118

Investment revenue 53,118

12-8

Securities to Be Held to Maturity

June 30, 2013Investment in bonds 1,000,000$ Less: Discount on bond investment 111,581 Book value (amortized cost) 888,419$

$114,699 - $3,118 = $111,581 unamortized discount$114,699 - $3,118 = $111,581 unamortized discount

This investment would appear on the June 30, 2013, balance sheet as follows:

Unrealized holding gains and losses are not recognized for HTM investments.

Unrealized holding gains and losses are not recognized for HTM investments.

12-9

Interest Interest Discount Unamortized CarryingDate Payment Revenue Amortization Discount Value

1/1/13 114,699$ 885,301$ 6/30/13 50,000$ 53,118$ 3,118$ 111,581 888,419

12/31/13 50,000 53,305 3,305 108,276 891,724 6/30/14 50,000 53,503 3,503 104,772 895,228

12/31/14 50,000 53,714 3,714 101,059 898,941

Securities to Be Held to MaturityOn December 31, 2013, after interest is received by Matrix, all the bonds

are sold for $900,000 cash.

December 31, 2013Cash 50,000Discount on bond investment 3,305

Investment revenue 53,305

December 31, 2013Cash 900,000Discount on bond investment 108,276

Investment in bonds 1,000,000Gain on sale of investment 8,276

12-10

Brief Exercise 12-1Lance Brothers Enterprises acquired $720,000 of 3% bonds, dated July 1, on July 1, 2013, as a long-term investment. Management has the positive intent and ability to hold the bonds until maturity. The market interest rate (yield) was 4% for bonds of similar risk and maturity. Lance Brothers paid $600,000 for the investment in bonds and will receive interest semiannually on June 30 and December 31. Prepare the journal entries (a) to record Lance Brothers’ investment in the bonds on July 1, 2013, and (b) to record interest on December 31, 2013, using the effective (market) rate method.

12-11

Trading SecuritiesInvestments in debt or equity securities acquired principally for the purpose of selling them in the near term. Adjustments to fair value are recorded1.in a valuation account called fair value adjustment, or as a direct adjustment to the investment account.2.as a net unrealized holding gain/loss on the income statement.

Unrealized Gain Unrealized Gain

Unrealized Loss Unrealized Loss

Income Statement

Income Statement

12-12

Trading Securities

Matrix Inc. purchased securities classified as Trading Matrix Inc. purchased securities classified as Trading Securities (TS) on December 22, 2013. The fair value Securities (TS) on December 22, 2013. The fair value amounts for these securities on December 31, 2013, amounts for these securities on December 31, 2013,

are shown below. Prepare the journal entries for are shown below. Prepare the journal entries for Matrix Inc. to show the purchase of the securities, Matrix Inc. to show the purchase of the securities, and adjust the securities to fair value at 12/31/13.and adjust the securities to fair value at 12/31/13.

12/31/13 UnrealizedNo. of Unit Total Fair Gain or

Type Name Shares Cost Cost Value (Loss)TS Mining Inc 1,000 42.00$ 42,000$ 41,000$ (1,000)$ TS Toys and Things 1,500 15.00 22,500 20,000 (2,500)

Totals 64,500$ 61,000$ (3,500)$

12/22/13

12-13

Trading SecuritiesDecember 22, 2013Investment in Mining Inc. stock 42,000Investment in Toys and Things stock 22,500

Cash 64,500

December 31, 2013Net unrealized holding gains and losses – I/S 3,500

Fair value adjustment 3,500

Security Cost Fair Value AdjustmentMining Inc 42,000$ 41,000$ (1,000)$ Toys and Things 22,500 20,000 (2,500) Total 64,500$ 61,000$ (3,500)$ Existing balance in fair value adjustment -0-Change needed in fair value adjustment (3,500)$

Reported on the balance sheet asa adjunct account to the investment.Reported on the balance sheet asa adjunct account to the investment.

The Net Unrealized Holding Loss is reported on the Income Statement.The Net Unrealized Holding Loss is reported on the Income Statement.

12-14

Trading SecuritiesOn January 3, 2014, Matrix sold all trading securities for $65,000 cash. Let’s record the entry for the sale and the

adjustment to the fair value adjustment account.

January 3, 2014Cash 65,000

Investment in Mining, Inc. stock – T/S 42,000Investment in Toys and Things stock – T/S 22,500Gain on sale of investment 500

December 31, 2014Fair value adjustment 3,500

Net unrealized holding gains or losses – I/S 3,500

12-15

Financial Statement Presentation

Trading securities are presented on the financial statement as follows:

1. Income Statement and Statement of Comprehensive Income: Fair value changes are included in the income statement in the periods in which they occur, regardless of whether they are realized or unrealized. Investments in trading securities do not affect other comprehensive income.2. Balance Sheet: Securities are reported at fair value, typically as current assets, and do not affect accumulated other comprehensive income in shareholders’ equity.3. Cash Flow Statement: Cash flows from buying and selling trading securities typically are classified as operating activities, because the investors that hold trading securities consider them as part of their normal operations.

Trading securities are presented on the financial statement as follows:

1. Income Statement and Statement of Comprehensive Income: Fair value changes are included in the income statement in the periods in which they occur, regardless of whether they are realized or unrealized. Investments in trading securities do not affect other comprehensive income.2. Balance Sheet: Securities are reported at fair value, typically as current assets, and do not affect accumulated other comprehensive income in shareholders’ equity.3. Cash Flow Statement: Cash flows from buying and selling trading securities typically are classified as operating activities, because the investors that hold trading securities consider them as part of their normal operations.

12-16

Financial Statement Presentation

Presented below are the partial financial statements showing the accounting for TS owned by Matrix:

Income Statement 2013 2014Revenue t tExpenses t tOther income (expenses): Gain on sale of investment t 500 Realized and unrealized gains and losses on investments (3,500) 3,500 Total expenses t tNet income t tBalance SheetAssets: Trading securities 61,000 -0-Statement of Cash Flows (direct method)Operating Activities: Cash from investment revenue -0- -0- Purchase of trading securities (64,500) -0- Sale of trading securities -0- 65,000

12-17

Securities Available-for-SaleInvestments in debt or equity securities that are not for active trading and not to be held to maturity are classified as available-for-sale (AFS).Adjustments to fair value are recorded

1.in a valuation account called fair value adjustment, or as a direct adjustment to the investment account.

2.as a net unrealized holding gain/loss in other comprehensive income (OCI), which accumulates in accumulated other comprehensive income (ACOI).

Unrealized Gain

Unrealized Gain

Unrealized Loss

Unrealized Loss

Other Comprehensive Income (OCI)

Other Comprehensive Income (OCI)

12-18

Other Comprehensive Income (OCI)

Other comprehensive income:Foreign currency translation gains (losses) $ XX,XXXNet unrealized holding gains (losses) on investments -12,500Minimum pension liability adjustment XXXDeferred gains (losses) from derivatives XXX $ XX,XXXLess: aggregate income tax expense (benefit) X,XXX

Other comprehensive income $ XX,XXX

When we add other comprehensive income to net income we refer to the result as “comprehensive income.”

When we add other comprehensive income to net income we refer to the result as “comprehensive income.”

12-19Accumulated Other Comprehensive

Income

Unrealized holding gains and losses on available-for-sale securities are accumulated in the

shareholders’ equity section of the balance sheet. Specifically, the account is included in accumulated

other comprehensive income (AOCI).

Unrealized holding gains and losses on available-for-sale securities are accumulated in the

shareholders’ equity section of the balance sheet. Specifically, the account is included in accumulated

other comprehensive income (AOCI).

Shareholders’ EquityCommon stockPaid-in capital in excess of parAccumulated other comprehensive incomeRetained earningsTotal shareholders’ equity

Shareholders’ EquityCommon stockPaid-in capital in excess of parAccumulated other comprehensive incomeRetained earningsTotal shareholders’ equity

Net unrealizedholding gains and losses.

12-20

Securities Available for Sale Example

Assume the same information for our T/S example for Matrix Inc., except that the

investments are classified as available-for-sale securities rather than trading securities.

Security Cost Fair Value AdjustmentMining Inc 42,000$ 41,000$ (1,000)$ Toys and Things 22,500 20,000 (2,500) Total 64,500$ 61,000$ (3,500)$ Existing balance in fair value adjustment -0-Change needed (3,500)$

December 31, 2013Net unrealized holding gains and losses – OCIOCI 3,500

Fair value adjustment 3,500

12-21

Financial Statement Presentation

AFS securities are presented on the financial statement as follows:

1.Income Statement and Statement of Comprehensive Income: Realized gains and losses are shown in net income in the period in which securities are sold. Unrealized gains and losses are shown in OCI in the periods in which changes in fair value occur, and reclassified out of OCI in the periods in which securities are sold. 2.Balance Sheet: Investments in AFS securities are reported at fair value. Unrealized gains and losses affect AOCI in shareholders’ equity, and are reclassified out of AOCI in the periods in which securities are sold.3.Cash Flow Statement: Cash flows from buying and selling AFS securities typically are classified as investing activities.

AFS securities are presented on the financial statement as follows:

1.Income Statement and Statement of Comprehensive Income: Realized gains and losses are shown in net income in the period in which securities are sold. Unrealized gains and losses are shown in OCI in the periods in which changes in fair value occur, and reclassified out of OCI in the periods in which securities are sold. 2.Balance Sheet: Investments in AFS securities are reported at fair value. Unrealized gains and losses affect AOCI in shareholders’ equity, and are reclassified out of AOCI in the periods in which securities are sold.3.Cash Flow Statement: Cash flows from buying and selling AFS securities typically are classified as investing activities.

12-22

Brief Exercise 12-2 S&L Financial buys and sells securities

expecting to earn profits on short-term differences in price. On December 27, 2013, S&L purchased Coca-Cola common shares for $875,000 and sold the shares on January 3, 2014, for $880,000. At December 31, the shares had a fair value of $873,000.

What journal entries would S&L make in 2013 and 2014 as a result of this investment?

12-23

Brief Exercise 12-3 S&L Financial buys and sells securities with

the intent of holding for an extended period of time. Since this is their intent all securities are reported as available for sale.

On December 27, 2013, S&L purchased Coca-Cola common shares for $875,000 and sold the shares on January 3, 2014, for $880,000. At December 31, the shares had a fair value of $873,000.

What journal entries would S&L make in 2013 and 2014 as a result of this investment?

12-24

Brief Exercise 12-2 & 12-3 For trading securities, unrealized holding gains

and losses: are or are not

included in earnings.

For securities available-for-sale, unrealized holding gains and losses: are or are not

included in earnings.

12-25

BE 12-4 For several years Fister Links Products has

held shares of Microsoft common stock, considered by the company to be securities available-for-sale. The shares were acquired at a cost of $500,000. Their fair value last year was $610,000 and is $670,000 this year. At what amount will the investment be reported in this year’s balance sheet? What adjusting entry is required to accomplish this objective?

12-26Transfers Between Reporting

CategoriesAny unrealized holding gain or loss at reclassification should be accounted for in a manner consistent with the classification into which the security is being transferred. Securities are transferred at fair market value on the date of transfer.

Unrealized Gain or Loss fromTransfer from: To: Transfer at Fair Market ValueEither of the other Trading Include in current net income the total

unrealized gain or loss, as if it all occurred in the current period.

Trading Either of the other Include in current net income any unrealized gain or loss that occurred in the current period prior to the transfer. (Unrealized gains and losses that occurred in prior periods already were included in net income in those periods.)

Held-to-maturity Available-for-sale No current income effect. Report total unrealized gain or loss as a separate component of shareholders’ equity (in AOCI

Available-for-sale Held-to-maturity No current income effect. Don’t write off any existing unrealized holding gain or loss in AOCI, but amortize it to net income over the remaining life of the security (fair value amount becomes the security’s amortized cost basis).

12-27Financial Statement Presentation

and Disclosure

Aggregate Fair ValueAggregate Fair Value

Maturities of debt securitiesMaturities of

debt securities

Change in net unrealized

holding gains and losses

Change in net unrealized

holding gains and losses

Gross realized & unrealized

holding gains & losses

Gross realized & unrealized

holding gains & losses

Amortized cost basis by major security type

Amortized cost basis by major security type

Inputs to fair value

estimates

Inputs to fair value

estimates

12-28

Impairment of Investments

Occasionally, an Occasionally, an investment’s value will investment’s value will

decline for reasons decline for reasons that are other-than- that are other-than- temporary (OTT).temporary (OTT).

For HTM and AFS investments, a company recognizes an impairment loss in earnings.

Determining an “other than temporary” decline for debt securities can be quite complex. For both

equity and debt investments, after an impairment is recognized, the ordinary treatment of unrealized

gains and losses is resumed.

12-29

Brief Exercise 12-13 LED Corporation owns 100,000 shares of

Branch Pharmaceuticals common stock and classifies its investment as securities available-for-sale. The market price of Branch’s stock fell over 30%, by $4.50 per share when the FDA banned one of the company’s principal drugs. What journal entry should LED record to account for the decline in market value? How should the decline be reported?

12-30

Investor Has Significant Influence

Control Characteristics of the Investment Reporting Method Used by the InvestorThe investor lacks significant influence over the operating and financial policies of the investee:

Investment in debt securities for which the investor has the "positive intent and ability" to hold to maturity.

Held-to-maturity (HTM) - investment reported at amortized cost.*

Investment held in an active trading account. Trading securities (TS) - investment reported at fair value with unrealized holding gains and losses included in net income.

Other. Securities available-for-sale (AFS) - investment reported at fair value with unrealized holding gains and losses excluded from net income and reported in Other Comprehensive income.*

The investor has significant influence over the operating and financial policies of the investee:

Typically the investor owns between 20% and 50% of the voting stock of the investee.

Equity method - investment cost adjusted for subsequent earnings and dividends of the investee.*

The investor controls the investee:The investor owns more than 50% of the voting stock of the investee.

Consolidation - the financial statements of the investor and investee are combined as if they are a single company.

Reporting Categories for Investments

* If the investor elects the fair value option, this type of investment also can be accounted for using the same approach that's used for trading securities, with the investment reported at fair value and unrealized holding gains and losses included in earnings.

12-31

Investor Has Significant Influence

Extent of Investor Influence Reporting MethodLack of significant influence

(usually < 20% equity ownership) Varies depending on classification

previously discussedSignificant influence

(usually 20% - 50% equity ownership) Equity method

Has control(usually > 50% equity ownership) Consolidation

12-32Criteria for Determining Whether There

is Influence FASC Sec 323

Representation on the investee’s Board of DirectorsRepresentation on the investee’s Board of Directors

Participation in the investee’s policy-making processParticipation in the investee’s policy-making process

Material intercompany transactions.Material intercompany transactions.

Interchange of managerial personnel.Interchange of managerial personnel.

Technological dependency.Technological dependency.

Extent of ownership in relationship to other ownership percentages.

Extent of ownership in relationship to other ownership percentages.

12-33

What Is Significant Influence?

If an investor owns 20% of the voting stock of an investee, it is presumed that the investor has significant influence over the financial and operating policies of the investee. The presumption can be overcome if1.the investee challenges the investor’s ability to exercise significant influence through litigation or other methods.

2.the investor surrenders significant shareholder rights in a signed agreement.

3.the investor is unable to acquire sufficient information about the investee to apply the equity method.

4.the investor tries and fails to obtain representation on the board of directors of the investee.

If an investor owns 20% of the voting stock of an investee, it is presumed that the investor has significant influence over the financial and operating policies of the investee. The presumption can be overcome if1.the investee challenges the investor’s ability to exercise significant influence through litigation or other methods.

2.the investor surrenders significant shareholder rights in a signed agreement.

3.the investor is unable to acquire sufficient information about the investee to apply the equity method.

4.the investor tries and fails to obtain representation on the board of directors of the investee.

12-34

Equity Method

1. The investment account is increased increased by: Original investment cost. Proportionate share of investee's

earnings.

2. The investment account is decreaseddecreased by: Dividends received.

1. The investment account is increased increased by: Original investment cost. Proportionate share of investee's

earnings.

2. The investment account is decreaseddecreased by: Dividends received.

12-35

Equity Method

The investment account is reported on the balance sheet as a single amount.

The investor’s share of the investee’s earnings from date of acquisition is reported as a single item on the investor’s income statement.

12-36

Equity Method

On January 1, 2013, Wilmer Inc. acquired 45% of the equity securities of

Apex Inc. for $1,350,000. On the acquisition date, Apex’s net assets had a fair value of $3,000,000. During 2013,

Apex paid cash dividends of $150,000 and reported net income of $1,750,000.

What amount will Wilmer Inc. report on the balance sheet as Investment in Apex Inc. on

December 31, 2013?

12-37

Equity Method

3,000,000$ Fair value of net assets× 45% Percentage ownership

1,350,000$ Fair value of assets purchased

January 1, 2013Investment in Apex Inc. stock 1,350,000

Cash 1,350,000

1,750,000$ Reported earnings× 45% Percentage ownership

787,500$ Share of earnings

2013Investment in Apex Inc. stock 787,500

Investment revenue 787,500

2013Cash 67,500

Investment in Apex Inc. stock 67,500150,000$ Dividends paid

× 45% Percentage ownership67,500$ Share of dividends

12-38

Equity Method

Investment in Apex Inc.

Investment 1,350,000 67,500 45% Dividends

45% Earnings 787,500

Reported amount 2,070,000

If the investee had a loss, the investment account

would have been reduced with a credit.

12-39

Equity MethodOn January 1, 2013, Wilmer Inc. purchased 25% of the common stock of Apex Inc. for $180,000. At the date of

acquisition, the book value of the net assets of Apex was $400,000, and the fair value of these assets is $600,000. During 2013, Apex paid cash dividends of $40,000, and

reported earnings of $100,000.

Fair value of assets 600,000$ Percentage ownership 25%Share of fair value of assets 150,000 Cost of investment in Apex 180,000 Excess of cost over fair value 30,000$

12-40

Equity MethodThe excess of the fair value of net assets over book value of

those net assets is 75% attributable to depreciable assets with a remaining life of 20 years and is 25% attributable to

land. Wilmer uses the straight-line depreciation.

Fair value of net assets 600,000$ Book value of net assets 400,000 Difference 200,000 Percentage of net assets acquired × 25%Excess 50,000 Amount attributable to land (25% or excess) 12,500 Amount attributable to depreciable assets 37,500 Remaining life of depreciable assets 20 yearsAdditional depreciation expense per year 1,875$

12-41

Equity Method

40,000$ Dividends paid× 25% Percentage ownership

10,000$ Share of dividends

100,000$ Reported earnings× 25% Percentage ownership

25,000$ Share of earnings

January 1, 2013Investment in Apex stock 180,000

Cash 180,000

2013Cash 10,000

Investment in Apex stock 10,000

Investment in Apex stock 25,000Investment revenue 25,000

December 31, 2013Investment revenue 1,875

Investment in Apex stock 1,875

12-42

Turner Company owns 10% of the outstanding stock of ICA Company. During the current year, ICA paid turner a $500,000 cash dividend.

What journal entry is made for the dividend Turner receives in the current year?

Brief Ex 12-8

12-43

Brief Ex 12-8 ExplanationTurner should account for the dividends as trading or available for sale investments, unless they have the ability to exercise significant influence, then Turner would account for the investment using the equity method as investment revenue. Since Turner holds only 10% of ICA stock, it’s assumed that it does not have significant influence over the company.

12-44

Brief Exercise 12-7Turner Company owns 40% of the outstanding stock of ICA Company. During the current year, ICA paid a $2 million cash dividend to Turner.

What journal entry is made for the dividend Turner receives in the current year?

12-45

Brief Exercise 12-7 ExplanationTurner is presumed to have the ability to exercise significant influence over ICA based on the 40% ownership.Turner should account for ICA’s dividends as a reduction in its Investment in ICA account. Since investment revenue is recognized as ICA earns it, it would be inappropriate to again recognize revenue when earnings are distributed as dividends. Instead, the dividend distribution is considered to be a reduction of the investment in ICA’s net assets, reflecting the fact that the Turner’s ownership interest in those net assets declined proportionately.

12-46

Brief Ex 12-9The fair value of Wallis, Inc.’s depreciable assets exceeds their book value by $50 million. The assets have an average remaining useful life of 15 years and are being depreciated by the straight-line method. Park Industries buys 30% of Wallis’s common shares. When Park adjusts its investment revenue and the investment by the equity method, what adjusting journal entry will be made?

12-47

Brief Ex 12-9 ExplanationThe equity method reports acquired net assets at their fair values. Both the accounts Equity Income and Investment in Wallis would be reduced by the “extra depreciation” the higher fair value. This would equal 30% x $50 million ÷ 15 years = ?each year for fifteen years.

12-48

End of Required Course Material The following will be covered in Advanced

Accounting Will not be tested on final.

12-49

Fair Value Option

GAAP allows companies to use a “fair value option” for HTM, AFS, and equity method investments.

The investment is carried at fair value.Unrealized gains and losses are included in income.

For HTM and AFS investments, this amounts to classifying the investments as trading.

For equity method investments, the investment is still classified on the balance sheet with equity method investments, but the portion at fair value must be clearly indicated.

The fair value option is determined for each individual investment, and is irrevocable.

GAAP allows companies to use a “fair value option” for HTM, AFS, and equity method investments.

The investment is carried at fair value.Unrealized gains and losses are included in income.

For HTM and AFS investments, this amounts to classifying the investments as trading.

For equity method investments, the investment is still classified on the balance sheet with equity method investments, but the portion at fair value must be clearly indicated.

The fair value option is determined for each individual investment, and is irrevocable.

12-50Financial Instruments and

Investment Derivatives

Financial Instruments:Financial Instruments:1.1.Cash.Cash.

2.2.Evidence of an Evidence of an ownership interestownership interest in an in an entity.entity.

3.3.Contracts meeting Contracts meeting certain conditions.certain conditions.

Financial Instruments:Financial Instruments:1.1.Cash.Cash.

2.2.Evidence of an Evidence of an ownership interestownership interest in an in an entity.entity.

3.3.Contracts meeting Contracts meeting certain conditions.certain conditions.

Investment Derivatives:Investment Derivatives:1.1. Value is derived from Value is derived from

other securities.other securities.

2.2. Derivatives are often Derivatives are often used to “hedge” (offset) used to “hedge” (offset) risks created by other risks created by other investments or investments or transactionstransactions

Investment Derivatives:Investment Derivatives:1.1. Value is derived from Value is derived from

other securities.other securities.

2.2. Derivatives are often Derivatives are often used to “hedge” (offset) used to “hedge” (offset) risks created by other risks created by other investments or investments or transactionstransactions