Question

1. Under what circumstances is an investment is classified as

• Held to-maturity investment?
• Available-for-sale investment?

2. In the current year, a company sells all its held-to-maturity investments because the market values had appreciated significantly. Can other investments now be classified as held to maturity?

3. An investor owns 40% of the shares of another company. Is this evidence enough to conclude that significant influence exists?

4. What are bonds and why are they used?

5. An available-for-sale investment is bought for $10,000, and has a fair value of $14,000 at the end of the first year, $16,000 at the end of the second year, and is sold for $21,000 in the third year. What amount of gain is recorded in net income in the third year? 2. Assume that the same investment is classified as a trading investment. What gain is included in income in the third year?

Answer 1

1	Held to maturity Investment	Held to maturity securities are debt securities which the enterprise has the intent and ability to hold to maturity. These are reported at amortized cost. If an entity purchases a security and wanted to held it till maturity to earn intermediary cashflows then investment is classified as held for maturity.
	Available for sale security	Available for sale securities include all other debt and equity securities that are not classified as one of the following: Trading securities. This classification is assigned to investments where the intent is to sell them in the short term to earn a profit. Held-to-maturity securities. This classification is assigned to investments where the intent is to hold them until the maturity date. These are reported at fair value. Unrealized gains and losses are excluded from earnings and reported in a separate component of shareholders’ equity.
2		Even when a portion of held to maturity security is sold the remaining securities can still be classified as held for maturity security if the entity indents to hold the remaining security till the maturity.
3		Significant influence is the power to participate in the operating and financial policy decisions of an entity; it is not control over those policies. The concept is used in international financial reporting standards. If an investor holds at least 20 percent of the voting power of an investee, the investor is presumed to have significant influence. The assumption of influence can be reversed through a clear demonstration to the contrary. It is possible for an investor to not have significant influence, even with majority ownership of an investee. It is possible to lose significant influence over an investee even in the absence of a change in ownership. For example, an investee may become subject to the control of a court, regulator, or government, or loss of significant influence may be the result of a contractual agreement. Hence, if an entity has 40% interest on other entity it is not conclusive to say that there is significance influence.
4	Bond Definition	A bond is a loan to a company or government that pays investors a fixed rate of return over a specific timeframe. The company who issues bonds get money on behalf of such bonds.
	Why bonds are issued	i. Provides corporations with a way to raise capital without diluting the current shareholders' equity. ii. With bonds, corporations can often borrow at a lower interest rate than the rate available in banks. iii. By issuing bonds directly to the investors, corporations can eliminate the banks as "middlemen" in the transactions. Without the intermediaries, the borrowing process becomjes more efficient and less expensive.
5	Available-for-sale	Available for sale securities A/c(AFS) $4,000       Unrealized gain on AFS(OCI)     $4,000 (Entry passed in Year1 for fair value gain) Available for sale securities A/c $2,000       Unrealized gain on AFS(OCI)     $2,000 (Entry passed in Year2 for fair value gain) Cash    A/c                                         $21,000 Unrealized again on AFS(OCI)    $6,000    Available for sale securities             $16,000    Net income                                            $11,000 (entry in 3rd year)
		Hence Net income transfer = 11,000 in year 3
		If it is a trading investment then, also 11,000 will be transferred to PL