Question

points 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, i.e., 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 assigns 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 (net income total stockholder' equity) b. return on assets (net income total assets)

Answer 1

AFS-

Available for sale are the securities which are intended to be sold before maturity.These securities may be either debt instrument or equity instrument.

In term of accounting,these securities will be shown as short term investment at fair value only.However difference in fair value will be reported in other comprehensive income section of equity.

In financial statements these securities must be reported as current asset and related gain or loss on securities will be shown in Equity section of balance sheet.

Impact on key ratio's of AFS securities-

These securities are likely to lower the return on equity ratio,if such security's fair value is increased in a particular period and vice versa.As increase in fair value will increase the stockholders equity section and net income will remain uneffected.

These securites are likely to lower the return on asset ratio,if the securities fair value is increased in a particular period and vice versa. As increase in fair value of underlying asset will increase the denominator (Total asset) and net income will be uneffected.

Trading securities (TS)-

These are the securites which are held with a primary purpose of trading only. As and when the price of security is looking higher then there should be immediate sale of such securities.

These assets are recognised on fair value,and resulted gain will be transferred to other income section of income statement.

These asset shall be reported as current asset in the balance sheet.

Imapct on ratio's-

These securities are likely to higher the return on equity ratio if the fair value increases and vice versa. As increase in fair value will increase the income.

These securites are likely to maintain the return on equity ratio on increase/decrease in fair value of underlying securities. It means that the ratio will remain unchanged. As increase in fair value will increase the net income with the same amount as the total assets have been increased.

Please comment for any explanation,

Thanks