Available for sale securities

Summary

This educational video script delves into the intricacies of available-for-sale debt securities, distinguishing them from held-to-maturity and trading securities. It explains the concept of reporting these investments at fair value, which leads to unrealized holding gains and losses recorded in other comprehensive income (OCI) as part of equity. The script provides a detailed example of bond amortization and the process of adjusting these securities to market value, emphasizing the importance of fair value adjustments. It also touches on the impact of selling these securities and the reclassification adjustments involved. The speaker encourages viewers to explore more resources for a comprehensive understanding of accounting topics.

Takeaways

• 📈 Available-for-sale securities are debt investments that are neither held to maturity nor intended for trading.
• 💼 These securities are reported at fair value, which can lead to unrealized holding gains or losses.
• 🔄 Unrealized gains or losses on available-for-sale securities are recorded in Other Comprehensive Income (OCI) and affect equity on the balance sheet.
• 📚 The adjustment process involves comparing the amortized cost of the security with its fair value to determine gains or losses.
• 📊 Fair Value Adjustment and Unrealized Gain/Loss accounts are used to record the necessary entries for these securities.
• 📋 An amortization schedule is created to account for the premium or discount on bonds and to calculate interest revenue.
• 💵 When bonds are sold, the realized gain or loss is recorded on the income statement, and a reclassification adjustment is made.
• 📅 Fair value adjustments are made at each reporting period to reflect the current market value of the securities.
• 🔑 The key to adjusting available-for-sale securities is understanding the difference between amortized cost and fair value.
• 🌐 For a portfolio of securities, the overall gain or loss is calculated and used to adjust the fair value and unrealized gain/loss accounts accordingly.

Q & A

What are available-for-sale securities?

Available-for-sale securities are debt investments that are not classified as held-to-maturity or trading securities. They are neither intended to be held until maturity nor are they bought with the intention of trading them in the near future. They are reported at fair value on the balance sheet.

How are unrealized gains and losses on available-for-sale securities reported?

Unrealized gains and losses on available-for-sale securities are reported in other comprehensive income (OCI) and are part of equity on the balance sheet. They do not affect the income statement until the securities are sold.

What is the difference between held-to-maturity and available-for-sale securities?

Held-to-maturity securities are debt investments that the company intends to hold until they mature, whereas available-for-sale securities are not intended to be held to maturity and can be sold if the price is right, but there is no immediate plan to do so.

Why are fluctuations in the value of available-for-sale securities not reflected in the income statement?

Fluctuations in the value of available-for-sale securities are not reflected in the income statement to avoid volatility that could result from changes in market conditions. Instead, these fluctuations are recorded in OCI to maintain a stable income statement.

How does amortization of a bond premium or discount affect the carrying value of the bond?

Amortization of a bond premium or discount affects the carrying value by reducing the premium or increasing the discount over time, which is reflected in the interest revenue calculation.

What is the process for adjusting the fair value of available-for-sale securities?

The adjustment process involves comparing the amortized cost of the securities with their fair value. If there is a difference, an entry is made to the fair value adjustment account and the unrealized gain or loss account to reflect the change in value.

What happens to the unrealized gains and losses when available-for-sale securities are sold?

When available-for-sale securities are sold, the unrealized gains or losses are reclassified from OCI to the income statement as realized gains or losses.

How are interest receivables recorded for bonds classified as available-for-sale securities?

Interest receivables for available-for-sale bonds are recorded as interest revenue and as interest receivable on the balance sheet, depending on whether the interest has been received in cash or is yet to be received.

What is the significance of the fair value adjustment account in the context of available-for-sale securities?

The fair value adjustment account is used to record the difference between the amortized cost and the fair value of available-for-sale securities. It is part of the process of adjusting these securities to their fair value on the balance sheet.

Can you provide an example of how to journalize the entries for available-for-sale securities?

Yes, an example would be receiving interest on a bond, which would involve debiting cash for the amount received, crediting the investment to reduce its carrying value, and crediting interest revenue for the amount earned.

What is the role of other comprehensive income (OCI) in reporting available-for-sale securities?

OCI is where unrealized gains and losses from available-for-sale securities are reported. It is a component of stockholders' equity and is used to record the changes in the fair value of these securities that have not been realized through a sale.

Outlines

00:00

📈 Understanding Available-for-Sale Debt Securities

This paragraph introduces the concept of available-for-sale debt securities, distinguishing them from held-to-maturity and trading securities. It explains that these securities are neither intended to be held indefinitely nor traded in the near future. The focus is on how these securities are reported at fair value, leading to unrealized holding gains and losses which are recorded in other comprehensive income (OCI) as part of equity. An example is used to illustrate the process, starting with Adam Corporation's purchase of a bond at a premium. The paragraph also discusses the importance of adjusting these securities to market value and amortizing any discount or premium on the bond.

05:01

📒 Journalizing Entries for Available-for-Sale Securities

The second paragraph delves into the process of journalizing entries for available-for-sale securities, emphasizing the importance of understanding fair value adjustments. It provides a detailed example of how to adjust the carrying value of a bond to its fair value, including the creation of necessary accounts such as 'Fair Value Adjustment' and 'Unrealized Holding Gain/Loss'. The paragraph explains how to handle the first journal entry when receiving interest and how to accrue interest before the receipt of payment. It also touches on the significance of fair value adjustments in reporting the true financial position of investments.

10:02

🔍 Adjusting Portfolio Securities to Fair Value

This section illustrates how to adjust a portfolio of securities to fair value, using examples to show how gains and losses are calculated and recorded. It explains the process of determining whether there is a gain or loss based on the fair value compared to the amortized cost, and how to adjust the 'Fair Value Adjustment' and 'Unrealized Holding Gain/Loss' accounts accordingly. The paragraph also discusses the concept of a timeline to track the portfolio's performance over time, including the sale of a bond and the recording of realized gains.

15:02

📉 Reflecting Changes in Unrealized Gains/Losses Over Time

The fourth paragraph continues the discussion on how unrealized gains and losses are reflected over time. It uses a scenario to show how the fair value adjustment and unrealized holding gain or loss are affected as the portfolio's value changes from year to year. The paragraph explains the journal entries required when there is an improvement in the portfolio's loss or an increase in gain, emphasizing the movement along the timeline from a negative balance to a positive one and vice versa.

20:03

📚 Resources for Further Learning on Securities Accounting

The final paragraph serves as a call to action for further learning, directing viewers to foreheadlectures.com for additional resources such as multiple choice questions and other study materials. It highlights the importance of understanding not only available-for-sale securities but also other types like held-to-maturity and trading securities. The paragraph encourages viewers to invest in their education and make use of the resources provided to enhance their knowledge and performance in accounting.

Keywords

💡Debt Investment

A debt investment refers to an investment where the investor lends money to a borrower, expecting to receive periodic interest payments and the return of principal at the end of the term. In the script, debt investments are one of the two types of investments a company can have, the other being equity investments. Debt investments are further divided into held-to-maturity and available-for-sale securities, which are the focus of this session.

💡Available-for-Sale Securities

Available-for-sale securities are debt or equity securities that are not classified as either held-to-maturity or trading securities. They are not intended to be held until maturity nor are they bought with the intention of selling them in the near future. In the script, these securities are described as being 'somewhere in between' and are reported at fair value, with gains or losses affecting other comprehensive income rather than the income statement.

💡Fair Value

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. In the context of the script, available-for-sale securities are reported at fair value, which is a critical concept because it determines the unrealized gains or losses that are recorded in other comprehensive income.

💡Unrealized Holding Gain/Loss

Unrealized holding gains or losses represent the change in the fair value of a security that has not been sold. In the script, these gains or losses are not recognized on the income statement but are instead recorded in other comprehensive income and affect the balance sheet through stockholders' equity.

💡Other Comprehensive Income (OCI)

OCI is a component of comprehensive income that includes all non-owner changes in equity except those resulting from investments by owners and distributions to owners. In the script, unrealized gains and losses on available-for-sale securities are reported in OCI, which is a part of the equity section on the balance sheet.

💡Amortization

Amortization refers to the process of allocating the cost of an intangible asset or a premium or discount on a bond over its useful life. In the script, amortization is used to describe how the premium paid on a bond is gradually reduced over time, affecting the carrying value of the bond and the amount of interest revenue recognized each period.

💡Yield

Yield in the context of bonds refers to the annual return on an investment, expressed as a percentage of the investment's cost. In the script, the example bond is yielding 8%, which means the market is earning 8% on the bond's cost, but it is paying 10%, hence it was purchased at a premium.

💡Premium

A premium in the context of bonds is the amount by which the issue price of a bond exceeds its face value. In the script, Adam Corporation paid a premium for a bond because the market yield was lower than the bond's coupon rate, indicating that the bond was considered a good investment at the time of purchase.

💡Carrying Value

Carrying value, also known as book value, is the value at which an asset is carried on a company's balance sheet. In the script, the carrying value of a bond is adjusted for any premium or discount and is used to calculate interest revenue and amortization.

💡Accrual Accounting

Accrual accounting is a method of accounting in which revenues and expenses are recorded when they are earned or incurred, not when cash is exchanged. In the script, the concept is applied when the script discusses accruing interest on a bond before the cash is received.

💡Realized Gain/Loss

A realized gain or loss is the profit or loss on a security that has been sold. In the script, when a bond is sold, any difference between the amortized cost and the selling price is a realized gain or loss, which is recorded on the income statement, as opposed to unrealized gains or losses.

Highlights

Introduction to available for sale securities, focusing specifically on debt investments.

Distinction between held to maturity, trading securities, and available for sale securities.

Available for sale securities are not held to maturity and not intended for immediate trading.

Reporting available for sale securities at fair value, leading to unrealized holding gains and losses.

Unrealized gains and losses are reported in other comprehensive income (OCI) rather than the income statement.

Importance of understanding how to adjust securities to market value.

Example of Adam Corporation purchasing a bond at a premium and the implications for accounting.

Creation of an amortization schedule for the bond purchased at a premium.

Calculation of cash received from bond interest payments based on stated rates.

Accrual of interest receivable and adjustments to the investment carrying value.

Fair value adjustments are crucial for accurately reflecting the investment's market value.

Process of determining gains or losses based on fair value versus amortized cost.

Detailed explanation of journal entries for recording interest revenue and fair value adjustments.

Impact of portfolio adjustments on overall financial reporting and equity.

Emphasis on the importance of understanding reclassification adjustments and impairment.

Encouragement to utilize additional resources for deeper understanding of available for sale securities.

Transcripts

hello and welcome to this session in

which we would look at available for

sales securities specifically debt

available for sale securities in the

prior sessions we looked at the type of

investments that a company could have

could be a debt investment or an equity

investment and now we are focusing on

the debt investments under the debt

investments we could have them as hell

to maturity and this is what we

discussed specifically in the previous

recording

in this recording would look at

available for sale and then in the next

recording we look at trading securities

so what are available for that

securities and specifically here we are

dealing with debt not equity well these

securities are either not held to

maturity and not for trading what does

that mean the two extreme of investment

in that is this you can either hold them

until to mature health to maturity this

is what we talked about in the prior

session is you hold them until they

mature until the bond mature means you

hold them till the end

or you can trade them pray that mean you

you plan to sell them in the near future

like flipping them well guess what

available for sale it's not trading it's

not held to maturity it's some someplace

in between i'm gonna hold it i might

sell it if the price is right but i have

no plan to hold it forever and i don't

i'm not intend to sell it in the near

future flipping it now how to report

these investments once you decide it's

available for sale you would report them

at fair value and the most important

thing we're going to be focusing on in

this session and i believe that's the

most important thing to learn is how to

make the adjustment how to adjust those

securities to market because they are

reported at fair value since they are

reported at fair value it means we're

going to have unrealized holding gainer

and losses and because we have

unrealized holding gain and losses those

will be reported in other comprehensive

income oci in other words they are

reported on the balance sheet as part of

equity now you might be asking why well

why is this available for sale you don't

plan to sell them in the near future it

means they should not be affecting your

income that's the purpose you're going

to hold them for multiple period

but through those multiple period they

may go up in value down in value up in

value again down in value more down so

on and so forth you don't want those

fluctuation to affect your income

statement as of yet so you park them in

oci and once you sell them well you'll

have to report them on the income

statement and make a reclassification

which we'll talk about in a separate

recording but the point to remember is

available for sale securities

adjustments are reported in other

comprehensive income just i want to make

sure you understand this and we're going

to actually work an example and since

it's a bond we're gonna amortize the

bond amortize any discount and any

premium the best way to illustrate this

concept is to take a look at an example

adam corporation purchase forehead

lectures one hundred thousand ten

percent five-year bond on january first

twenty x zero the bond pay interest on

july in january

semi-annually adam paid 108.11 to yield

eight percent simply put the bond was

sold at a premium because the face value

is a hundred thousand the bond is paying

10 percent but

10 percent it's yielding 8 percent what

does it mean to yield 8 percent it means

the market is earning eight percent

however the bond is paying 10 and that's

why you paid a premium so simply put

adam will debit that investment which is

an asset now remember we are dealing

from the investor's perspective not from

the issuer there's a one whole recording

about when a company issue a bond at a

premium or a discount go to my bonds

chapter and

adam will credit cash 108 111 what we

paid for the account what we paid for

the

what we paid for the investment now what

we will do next is create an

amortization schedule we have eight

thousand

and one hundred and eleven dollars as a

premium so we're gonna have the carrying

value of the bond 108 111

we're going to have a column for how

much cash we're going to be receiving

each period that's yielding 10 percent

annually

5 semi-annually

so the investor would receive 5 000

we have to compute interest revenue well

first let's compute the cash the cash is

taking the face value of the bond times

the stated rate times one half or six

divided by 12 because it pays interest

semi-annually that's where the cash 5000

is coming from interest revenue how do

we compute interest revenue we'll take

the carrying value of the bond as of the

beginning of the period times eight

percent times one half or six twelve so

the interest revenue is four thousand

three hundred and twenty four the

difference between those two is the

premium we are going to amortize this

period which is six hundred and seventy

dollars this is going to reduce the bond

carrying value to 107

435

the difference is 676 the difference

between the cash and the interest

revenue then we reduce the

carrying value because a premium bonds

starts above

above face value and it will go down as

we are amortizing the bond now the next

thing we're going to do we're going to

start to journalize the entries before

we generalize the entries i would like

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at the first journal entry when we

receive the first five thousand dollar

which will be july first acts zero so we

would receive five thousand dollar and

this is the information that we need to

journalize the entry we debit cash 5000

credit the investment

we don't credit the premium here we

credit the investment to reduce it and

we credit interest revenue for the 4324.

now on december 31st which is one day

before we receive the payment we have to

accrue the interest so what do we have

to do we have to accrue 5 000 worth of

cash as interest receivable we have to

credit the

debt investment reduce our debt

investment carrying value by 703 and we

record interest revenue of 42.97 simply

put the following day we would receive

the cash for this 5000 we debit cash

credit receivable but this jet journal

entry takes place december 31st

20 x 0 just to show you how we will

accrue the interest now it's very

important to understand how we make the

fair value adjustment extremely

important like what i'm going to be

doing now this is the important part

about fair value adjustment or adjusting

the fair value of the investment or

investing in the portfolio investment

the portfolio to fair value or reporting

things at fair value whatever you want

to call it there's a lot of fair value

terminology going on going on here

so this is

december 31st tx1 value of the bond on

the books 106 732

you are told the fair value of the bond

is 104 and these are available for sales

securities this this one is available

for sale security what do we have to do

now so i'm going to give you a few rules

please write them down please make sure

you are aware of this

okay so i'm going to show you how to

adjust your

investment or your portfolio to market

how do you do so well you're going to

have two accounts you're going to have

two related accounts one called

fare

value

adjustment and the other one it's going

to be called on

realized

gain slash loss

and specifically i'm going to call it

here equity and the word equity is

important because this is available for

sale and the adjustment goes to equity

so we're going to have those two

accounts what goes into those two

accounts please listen to me carefully

what you do first you compute whether

you have a loss or a gain and you should

be able to know whether you have a loss

or a gain based on what is your fair

value and what is the amortized cost

here the amortized cost is 106 732 but

if you want to sell your bond today

you're going to get 104. what does that

mean it means you have a loss

of 2732.

simply put the difference between what

you can sell the bond for what you have

it reported on the books

how do you adjust this bond well you

have those two accounts

if you have an overall a loss

listen to me carefully if you have an

overall a loss

fair value adjustment should have a

credit balance

and i said balance not adjustment a

credit balance

and the credit balance should be for the

amount of the loss how much is the lost

loss losses 2732 simply put you would

say my balance

not my entry

my balance should be

a credit balance of 27

27 32. this should be my balance now

what should be my entry well my entry

depending on what is my pr prior balance

is because fair value adjustment could

be either a contra asset it could be

reducing your asset it could be an

adjunct asset sometime it's going to

increase your investment sometimes it's

going to reduce your investment but the

balance should be 27.32 now for this

example we assume that our prior balance

is zero because this is year one

the so first you start with your fair

value then from your fear value after

you input whatever you need to do in

fair value you will determine your the

other corresponding entry whether it's a

debit or a credit let's do the fair

value first well if you need a balance

of 2732

okay and you have a zero balance in that

account from the beginning so you need

to credit

27.32 so you need to credit 27.32

because you have a prior zero balance

you will come up with 27.32 as a credit

balance which is because it's a loss

the the corresponding debit or credit to

this adjustment is to the unrealized

gain now remember losses unrealized gain

slash losses losses will have a debit

balance so if you

credited fair value you're going to

debit unrealized loss 2732 and your

balance will be

27.32 so this is the balance

you should put the balance in a

different color

just to kind of illustrate the word

balance because that's important

so this is the balance 2732 this is your

balance

and in green is your entry therefore i

will

credit

fair value adjustment 2732 debit

unrealized holding gain or loss 27.32

now this is easy because i had no prior

balance

okay now we're going to work few

examples that i'm going to show you when

you have a prior balance especially when

you have a complete portfolio let's take

a look at an adjustment for a portfolio

of that securities portfolio means more

than one security whether you have and

happens to be two securities here but

whether you have two two hundred or two

thousand it all work the same way

we have an economic integration bond and

a youtube core bond the economic

integration bond has a cost amortized

cost of

500 the fair value of 101 300 the

youtube

has a cost of 200 000 fair value of 175

so we have a gain on the economic

integration forum a loss on the youtube

overall we have a portfolio loss of

fourteen thousand two hundred and we're

going to assume this is a first-year

adjustment so the there's no prior

balance it means we have to have

remember this is a loss what did i tell

you i told you we have a fair value

adjustment account and we have

uh unrealized

gain slash loss equity account so since

we have a loss of 14 14 200

we should have a credit of 14 200 as a

balance

then what do we have to do we have to

determine the adjustment well since we

have a zero balance the adjustment will

be a credit of fourteen thousand two

hundred a debit of fourteen thousand two

hundred to have a loss of 14 200. okay

so this is just basically like the prior

example that i just showed you so notice

we credited uh we debited a loss of

14200 credited fair value adjustment now

make a note of this

but let me show you on a timeline what

does it look like simply put on a

timeline

if if your portfolio is zero it means

you have no gain and no loss now you are

standing at negative

14 200. so make a note of this and

write jot this down that you are on the

timeline you are negative 14

200.

let's assume

on march 1st 20 x1

um we sold this bond

the amortized cost was 91 200 we sold it

for 94 000. we actually sold this bond

so we removed one bond from our

portfolio well what do we do we received

cash 94 000 we removed the bond at

amortized cost 91 400 and we sold it 2

500 more than the amortized cost

therefore we have an actual gain this is

a realized gain this is different than

this gain okay now later on in another

session we would learn something about

reclassification adjustment but we'll

talk about that later simply put the

gain on the sale goes on the

income statement versus unrealized gain

for available for sale securities goes

on the equity section of the balance

sheet now let's go to year two in year

two here's what's going to happen we

still have only one bond and that's the

youtube bond they have an amortized cost

of two hundred thousand fair value of

193 so overall for that year we have a

real unrealized loss of seven thousand

remember what we have in the prior year

in the prior year we have available i'm

sorry fair value adjustment with a

balance of 14 200 from the prior year

and we had the unrealized

gain slash loss equity and that had a

fourteen thousand two hundred

our portfolio has a loss of exactly

seven thousand what does that mean if we

have a loss of seven thousand it means

we have to adjust our portfolio to show

a loss of seven thousand what does that

mean once again it means our fair value

should have a balance of seven thousand

this is what we're saying exactly this

is what we're saying we should have a

balance of seven thousand well what did

we have in the prior year let's go back

to that

time

uh the line uh

line numbers we had negative fourteen

thousand two hundred negative as a

balance fourteen thousand two hundred

what happened now we we still have a

loss but our loss did improve so we were

at negative

fourteen thousand two hundred now our

loss is

seven thousand

simply put we move to the right we move

to the right

7200 unit what does that mean it means

we have to debit our fair value

adjustment let me put the adjustment and

adjustment in a different color we have

to debit our fair value adjustment seven

thousand two hundred the credit goes to

the unrealized holding gain or loss when

we do that we have a balance of seven

thousand and fair value and we have a

balance of seven thousand

under unrealized holding gain or loss

what we did on the on the number line we

move to the right every time we move to

the right

we are going to debit fair value

adjustment in credit unrealized holding

gain or loss simply put we still have a

loss we are still below zero this is

negative seven thousand but we moved

from negative fourteen thousand two

hundred to negative seven thousand

therefore when we move to the right okay

it it this this is not this is not

anywhere in your textbook we debit fair

value adjustment we credit unrealized

holding gain or loss now let me make

another scenario let's assume in here

this is x1 let's assume in here x 2

x 2

our portfolio has a cost of

a million dollar worth of portfolios and

a fair value of one million

and i'm gonna make it one thousand

dollar

what does that mean why did i use large

numbers because large numbers are

useless what you're looking for you're

looking for the difference in the

overall portfolio the difference is

i have a gain

of 1000 this is what i'm trying to show

you

what does that mean if i have a gain of

1000 in the following year here x2 it

means i moved from

i move from negative seven thousand i

move to the right

to positive

one thousand

okay what does that mean from a journal

entry perspective so i'm gonna again do

the fair value adjustment here from the

prior year i had 7000 as my balance so

i'm gonna remove this this is the

balance just it's the same thing i just

keep it up seven thousand is the balance

and unrealized gain and loss i have a

debit of seven thousand this is from the

prior year so the corresponding

other account unrealized holding gain or

loss

equity i have a debit balance of seven

thousand now what do i have to do since

i have a gain remember if i have a gain

i have to have a debit balance and fair

value it means my debit balance should

be a thousand

okay in my if the debit balance is a

thousand the credit balance here should

be a thousand okay

what is the entry that i need to make

and want the x2

to make that

balance a thousand here what i have to

do i'm moving more to the right i'm

going to have to debit

fair value 8 000

and credit unrealized holding gain eight

thousand simply put in year x two

eight thousand

and eight thousand what happened if i do

debit fair value eight thousand i'm

gonna be left with a thousand debit

balance which is it's reflecting my gain

of a thousand and if i credited

unrealized holding gain or loss eight

thousand i'm gonna have an eight one

thousand credit balance which is this is

what i need to show i have a one

thousand of a gain

then again in year x three

you look at your total portfolio cost

total portfolio fair value

you might in x3 you might go further to

the right if your portfolio you have

more than a thousand in gain

or you might go for example from a

thousand back to 200 you would still be

positive but you are worse off than the

prior year then you will debit

unrealized holding in or lost credit

fair value for 800 for that example

how do you report things on the

income statement and balance sheet

on the balance sheet we're going to

accrue any interest receivable if

there's any interest receivable on the

bond we're going to report the

investment at fair value for example 193

000

and we're also going to have under

stockholders equity the

other com other comprehensive loss which

happens to be in our example

seven thousand

seventh out um sorry

it should be not seven thousand two

hundred it should be

the unrealized loss should be seven

thousand not seven thousand two hundred

seven thousand the adjustment is seven

thousand two hundred

on the income statement we will show any

interest received whether it's cash or

recruit and remember we sold the

economic integration for an economic

integration bond and we had the realized

gain of 2500 this is not all about

available for sale securities for

available for sale securities you also

need to learn about reclassification

which is have a separate recording for

this and we need to talk about

impairment when those securities are

impaired how do we record for impairment

what should you do now you should go to

forehead lectures.com and work mcq's

multiple choice questions look at

additional resources to learn more

available for sale help to maturities

trading securities don't shortchange

yourself

my resources will help you do better

give me a try give me a month

give it a try you like it you keep it

you don't you cancel that's your risk

invest in yourself this is a long-term

investment good luck study hard and of

course stay safe