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FAR: Balance Sheet, EPS and Cash Flows: Accounting for Marketable Securities - YouTube
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All right guys, here we go, accounting for
marketable securities. What type of
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investment do I have? Okay. So let's
review. As I mentioned in the intro, it
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could be common stock. We're going to
focus in on situations where there's no
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significant influence, okay? No
significant influence, fair value through
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net income is what we're going to do. You
will see with Gearty, situations where
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you have significant influence, generally
between 20 and 50 percent ownership, and
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then you'll use the equity method of
accounting, or the third situation with
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common stock is where you have control,
where you're going to have to
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consolidate. All right. But what we're
going to focus in on here is the common
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stock, no significant influence. Okay.
Remember, if you buy preferred stock or
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debt, since neither one of those has
voting rights, generally with the
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preferred equity as well, preferred stock
and debt, same thing, no significant
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influence. So the equity method of
accounting and consolidations only
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applies to investments in common equity.
We're focusing again on the common equity
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with no significant influence, you
generally own 10 or 15 percent, less than
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20. All right. Now, let's talk about a
bond. With a bond, we have three
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different options in accounting for that
investment in the bond. It's either
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going to be a trading security,
available-for-sale, or held-to-maturity.
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Now remember, whether it's a current or
non-current asset is dependent upon the
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buyers, the investors' holding period,
their expecting holding period, okay?
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Trading security, available-for-sale,
held-to-maturity. More likely than not,
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the available-for-sale, held-to-maturity
probably going to be a non-current asset,
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trading could be a current asset. Now,
what makes bonds unique, they have a
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maturity date. So held-to-maturity,
obviously, is something that would apply
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to a bond only, right? Because only
bonds mature. So the trading security,
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the available-for-sale, held-to-maturity,
are three different options when
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accounting for a bond. Okay. So now we
have a bond, let's figure out how we're
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going to account for it. Let's say for
example, it's HTM, held-to-maturity. Now
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look, we do not mark it to fair market
value. So it's very, very simple. We do
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not mark it to fair market value.
Held-to-maturity, it stays on the balance
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sheet at amortized cost. And the only
thing we're going to have on the income
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statement generally is our interest
income. Okay. So held-to-maturity is on
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the books when you see that on the exam
at amortized cost. Whether the value
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goes up or down, as a general rule of
thumb, we ignore that. We do not mark it
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to market value, stays on the books at
amortized cost. And there shouldn't be
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any sales, there should not be any
realized gains and losses. Why? Because
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held-to-maturity, you're supposed to be
holding this security to maturity. So
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for our purposes, that means it's not
going to be sold. Any change in value,
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we totally ignore it. Now, there's one
major exception with the amortized cost,
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if it's impaired. If it's
held-to-maturity and it's impaired, we
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have to calculate what's called an
expected credit loss. What's the
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expected credit loss? Well, we're going
to review. You're going to calculate the
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present value of the principal and
interest you think you're going to
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receive. Okay. That's going to be our
present value. You're going to compare
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that to our amortized cost. Okay. If
the present value of what you expect to
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collect in the future is less than the
amortized cost, well, then that means
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we're going to have an expected credit
loss and that's our impairment. We have
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to get that loss on the income statement.
Okay. So we're going to record a loss
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on the income statement, and we're going
to have a special offsetting account
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allowance, that we're going to reflect
the credit loss, and that will reduce the
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carrying value of that bond, okay? Down
to its present value of future cash flows
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we expect to collect. So
held-to-maturity, general rule of thumb,
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do not mark it to market value,
distractor information. Held-to-maturity
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is on the books at amortized cost. There
should not be any sales, there shouldn't
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be any unrealized gains or losses. The
one exception is the expected credit loss
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it's impaired. We have to calculate
present value of the cash flows we expect
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to collect, and then we're going to write
down that asset from its amortized cost
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down to that present value. That loss
will go on the income statement, it's a
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credit loss and then there will be an
offsetting credit to an allowance for
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that credit loss that will reduce
amortized cost down to that new present
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value. Okay. We have a bond now, but now
we're going to account for it as
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available-for-sale. Okay. Now, we are
going to mark it to market value. So now
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fair market value is very important. So
available-for-sale, we're going to mark
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it to fair market value. If the value
goes up, we'll have an unrealized gain.
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If the value goes down, we'll have an
unrealized loss. The big difference
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between available-for-sale and trading
securities, is where do we put that
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unrealized gain or loss? And for an
available-for-sale security, the major
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thing to remember is unrealized gains and
losses go direct to equity, part of other
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comprehensive income, all right? So
unrealized gains and losses, direct to
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equity. We will mark it up or down to
fair market value depending upon what
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happens. And remember, that's a holding
gain or loss. We haven't sold it, so
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it's unrealized. If you look at when we
actually sell it, that's going to cause
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an actual realized gain or loss. And
you'll see when it's available-for-sale,
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and you calculate your realized gain or
loss, it's going to be selling price
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minus your original cost. That's how you
calculate your gain or loss. And then
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any unrealized gains and losses that went
direct to equity, well, upon the sale of
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that security, that's going to have to be
reversed. Okay. The only other issue we
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have with an available-for-sale security
is that it could be impaired. Okay. It
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could be impaired. What do we do if we
have a bond, and it's available-for-sale,
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and it's impaired? Well, just like we did
with the held-to-maturity, we have to
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calculate our expected credit loss. The
expected credit loss, the first thing we
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need is the present value of the future
principal and interest we expect to
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collect, and then we compare that to the
amortized cost. The difference between
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that present value and that amortized
cost, that's going to to be the expected
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credit loss. Now, with
available-for-sale securities though, the
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accounting for that impairment loss is a
little bit different when it's considered
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available-for-sale. So with the
available-for-sale securities, what we
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want to do is get some of that loss on to
the income statement. Normally, when we
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have an available-for-sale security, an
unrealized gain or loss goes direct to
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equity but not when it's impaired. So
we're going to calculate that change in
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value and if we have a loss, some of that
loss is going to go on the income
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statement. The maximum loss that will go
on the income statement is that expected
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credit loss. If there's any additional
loss, we have a big reduction in the fair
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market value to the extent of the
expected credit loss, that portion of the
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loss will go on the income statement, the
balance of the loss will go to OCI. Woo,
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baby. Are you getting all this? All
right. A bond, now we classify it as a
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trading security. Again, like the
available-for-sale, we mark it to fair
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market value. All right? So unrealized
gains and losses, the major difference,
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that's going to go on the income
statement, okay? So unlike the
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available-for-sale, unrealized gains and
losses go on the income statement. And
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we don't have to sweat the expected
credit loss. Why? Because any
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unrealized loss would already go on the
income statement anyway. So it's a moot
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point. So trading like,
available-for-sale, mark it to fair
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market value. Major differences,
unrealized gains and losses go on the
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income statement rather than direct to
equity. When you sell a trading
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security, the way you calculate your gain
or loss is different. And since you've
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already marked it to market value, and
gains and losses have already flowed
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through the income statement. When you
sell an available-for-sale, it's selling
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price minus your original cost. When you
sell a trading security, it's selling
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price minus the carrying value on the
balance sheet at the time of sale, and
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that'll be a realized gain or loss. And
realized gains and losses go where? On
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the income statement. Woo, baby. Okay.
Now we got stock. Beautiful. We've
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already covered stock. Okay. So with
common stock, we're going to be dealing
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specifically where we have no significant
influence, okay? Remember, if it's
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preferred stock, you definitely have no
voting rights, so no significant
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influence. Common stock could be no
significant influence, equity method or
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consolidation, we're focusing on the no
significant influence. For the most part
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unless you're told otherwise, it's
publicly traded. So if it's publicly
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traded, we can mark it to fair market
value, it's pretty simple. So we're
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going to use fair value through net
income. If it's publicly traded, it's
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easy, we mark it to fair market value,
fair value through net income. All gains
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and losses realized or unrealized,
they're going to flow through the income
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statement. There's one exception though
where we have nonpublic. An investment in
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stock, but it's nonpublic, it's a
practicability exception where the entity
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can measure the equity investment at cost
because we can't mark it to market value
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because it's nonpublic, then it would be
cost minus impairment. Okay. So here's
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the stock, fair value through net income.
It's on the balance sheet of what
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amount? Fair market value. So if it's
unsold, any unrealized gain or loss is
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going to go where? On the income
statement, okay? On the income
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statement, just like a trading security
for a bond. Unrealized gains and losses
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go on the income statement. If we have a
situation with a practicability exception
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applied, equity investments look, what it
says, where we had no readily
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determinable fair value. That's the one
major exception where the equity will be
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on the books at cost less impairment,
okay? Costs less impairment. All right.
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So that's a major difference. If the
practicability exception applies, then
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its cost minus impairment. If you sell
your stock, any gain or loss will now be
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considered realized. It's your selling
price minus your carrying value at the
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time of sale. So really, the fair value
through net income for equity and the
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trading security rules for debt are
basically identical. Okay. They're
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almost identical. You mark it to market,
fair market value, unrealized gains and
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losses flow through the income statement,
realized gains and losses flow through
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the income statement. The one thing with the equity is, when you can't mark it to
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market value, then it's on the books at
cost minus any impairment. Woo, baby. I
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don't know about you man, but I'm ready
to jump in and do some math. So let's
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move on, let's bang out a math problem.
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