Question

In a continuation of their efforts to explore the financial condition of ABC Company, the Board of Directors has now started to explore the various investment strategies of the company. They would like to understand more about the differences between debt versus equity investments. They also wish to learn more about the various types of investments reported on the Balance Sheet. Using your text and outside sources, explain the following:

(1) debt versus equity securities;

(2) various types of investments such as those listed in Exhibit 15-2; and

(3) how to account for these investments (refer to Exhibit 15-8 as a guide). Keep in mind the intended audience of the memo.

Accounting for investments in securities depends on three factors: (1) security type, either debt or equity; (2) the company's intent to hold the security either short term or long term; and (3) the investor's percentage of ownership in the other company's (investee’s) equity securities. Q Exhibit 15.2 identifies six classes of securities using these three factors. EXHIBIT 15.2 Investments in Securities Debt Investments Equity Investments Significant Influence Held-to-Maturity Available-for-Sale Insignificant Influence Debt securities intended to be held until maturity Trading Debt securities that are actively traded Debt securities that are not HTM or Trading Equity securities with insignificant influence Equity securities with significant influence Controlling Influence Equity securities with controlling influence

Answer 1

1) Debt Vs Equity Securities

Debt securities are investments into debt instruments. They are safer than equity securities.

Equity securities represent a claim on the assets and earning of a company. They are more risky than debt securities.

2) Debt investment:

Held to maturity- It is a financial asset that has either fixed payments and fixed maturity or company has intention of holding them to maturity.

Trading - These are financial instruments which are bought for the purpose of selling them in a short period of purchase.

Available for sale- These are the securities that company decide to invest for the purpose of benefiting their financial position.

Equity Investment:

Insignificant influence: When an investor doesnt have significant influence over the investee, holding less than 20% shares.

Significant influence: When an investor has significant influence over the investee, holding 20%- 50% shares.

Controlling influence : When an investor has significant influence over the investee, holding more than 50% shares.

3. Held to maturity: these securities are valued at cost. No unrealized gains or losses are recognised in the fiancial statements.

Trading : These securities are valued at fair value. Changes in fair value will be reflected in financial statemnts. Fair values will be adjusted in the income of the company.

Available for sale:  These securities are valued at fair value. Changes in fair value will be reflected in financial statements. Fair values will be adjusted in the equity of the company.

Insignificant influence: These securities are valued at fair value. Changes in fair value will be reflected in financial statemnts. Fair values will be adjusted in the income of the company.

Significant influence:- These securities are valued by equity method. No unrealized gains or losses are recognised in the fiancial statements.

Controlling method: These securities are valued by controlling method. No unrealized gains or losses are recognised in the fiancial statements.