Question

You just got hired as a staff accountant at a reputational company. One of your job duties is to prepare memos to help with decision-making, especially when it involves different accounting choices a company could have made Recently the company is contemplating purchasing bonds as an investment, due to the downturn of stock market. The company does NOT want to hold them until maturity date, it is unsure how long it will hold these bonds. Your supervisor notices that FASB allows two other categories, ie, available for sale (AFS) versus trading securities (TS), to classify these bonds investment in. However, their accounting procedure and impact on financial statement seem to share some similarities and differences Your supervisor asigns you to explore about this further in your memo, analyze the similarities and differences between AFS and TS in the following aspects 1. Accounting procedures during the year and at year-end 2. Financial statement presentation 3. Impact on the company's key ratio such as a. return on equity income total stockholder' equity) b.return on asets (net income total assets)

Answer 1

1. Accounting procedures at year end

Both Available for sale and Trading securities are classified as assets in the Balance Sheet. Also losses and gains are recognised in the financial statements but the way they are shown is different at the end of the year. The difference between fair value and carrying value of Available for sale securities is shown in Comprehensive other income. There are not accounted for in Income Statement. The comprehensive other income is part of stockholders’ equity. In case of trading securities the difference between fair value and carrying value of securities are recognised in Income statement immediately at the end of the year. Fair value of securities usually refer to the market value of the securities

2. Financial Statement Presentation

Available for sale securities are classified as current assets if they are if they are to be liquidated in next one year else as long term investment if they are to be liquidated beyond one year. Trading securities are current assets since they are held with intention to buy and sell and make profit in the short term

3. Impact on ratios

Return on equity – In case of available for sale securities, the stockholders’ equity is affected. The gains increase other comprehensive income and losses reduce other comprehensive income and hence the equity changes since other comprehensive income are part of stockholders’ equity. Trading securities losses reduce the net income and gains increase the net income and they affect the net profit available to shareholders. It affects the stockholders’ equity since net profit or loss is transferred to Retained earnings

Return on assets – The gains or losses on account of available for sale securities do not affect the net income in Income statement. But the assets value will decrease or increase. The loss on account on trading securities decreases the total net income and total assets. The gains on account of trading securities increase the total net income and total assets.