Question

(Issues Raised about Investment Securities) You have just started work for Warren Co. as part of the controller’s groupinvolved in current financial reporting problems. Jane Henshaw, controller for Warren, is interested in your accounting backgroundbecause the company has experienced a series of financial reporting surprises over the last few years. Recently, the controller haslearned from the company’s auditors that there is authoritative literature that may apply to its investment in securities. She assumesthat you are familiar with this pronouncement and asks how the following situations should be reported in the financial statements.

Situation 1: Trading debt securities in the current assets section have a fair value of \(4,200 lower than cost.

Situation 2: A trading debt security whose fair value is currently less than cost is transferred to the available-for-sale category.

Situation 3: An available-for-sale debt security whose fair value is currently less than cost is classified as noncurrent but is to bereclassified as current.

Situation 4: The company’s portfolio of held-to-maturity debt securities consists of the bonds of one company. At the end of theprior year, the fair value of the security was 50% of original cost, and this reduction in fair value was reported as an impairment.

However, at the end of the current year, the fair value of the security had appreciated to twice the original cost.

Situation 5: The company has purchased some equity securities that it plans to hold for less than a year. The fair value of the securitiesis \)7,700 below its cost.

Instructions

What is the effect upon carrying value and earnings for each of the situations above? Assume that these situations are unrelated

Short answer

When the fair value is less than the cost it is classified as unrealized holding loss

Step-by-step solution

Fair value is less than the cost

In this situation, the fair value is less than the cost value of the security. When the fair value is less than the cost value, it is known as the unrealized holding loss and posted under the head of the shareholder’s equity. This loss is adjusted as the fair value adjustment.

Transfer trading securities into available-for-sale securities.

Situation 2 does not affect earnings as it is already recognized.

Step 3:Reclassification of available-for-sale securities

In situation 3, available-for-sale securities are current, but it is recognized as a non-current asset, later reclassified as current. Hence, in this these securities comes under the head of current asset and the unrealized loss is Comes under

Treatment of held-to-maturity securities

In situation 4, as the value of the securities gets double, its means it is gain for the company, but in Held-to-maturity securities, change in fair value is only recognized at the time of maturity.

Securities held less than one year

In situation 5, Securities are classified as trading securities. The unrealized holding loss of these securities is put into OCI.