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Accounting for Investments Debt Securities (Portfolio 5106)

Portfolio 5106-2nd, Accounting for Investments in Debt Securities (Accounting Policy and Practice Series), analyzes the accounting and reporting for investments in debt securities in accordance with generally accepted accounting principles. 

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DESCRIPTION

Portfolio 5106-2nd, Accounting for Investments in Debt Securities (Accounting Policy and Practice Series), analyzes the accounting and reporting for investments in debt securities in accordance with generally accepted accounting principles. This Portfolio also addresses hybrid securities that are treated as debt, but it does not discuss investments in equity securities or hybrid securities that are considered equity securities. Debt investments and hybrid securities treated as debt investments are financial instruments that embody a settlement obligation and do not convey either a direct or indirect ownership. This description of a debt investment is based on FASB discussions of financial instruments during their October 6, 2004 board meeting. Other portfolios address accounting for investments in equity securities.
This Portfolio principally addresses its subject from the standpoint of a holder or investor in debt securities.
This Portfolio analyzes in detail accounting for investments in debt securities by presenting, interpreting, and illustrating the accounting rules. Specifically, this Portfolio focuses on accounting practices and reporting as they relate to the acquisition of investments in debt securities, the recognition of interest income, disposition of investments, fair value adjustments, impairments, hedging, and transfers among investment classifications. Key audit considerations also are discussed.
This Portfolio provides numerous examples covering a variety of different debt securities and situations as topics are introduced. These examples illustrate the application of generally accepted accounting principles as reflected in journal entries and amounts reported in the financial statements. A comprehensive example combines most of the concepts presented in the Portfolio. The Worksheets include 1) amortization tables for the debt instruments included in the comprehensive illustration and 2) sample disclosures. Worksheet 1 defines abbreviations and acronyms that recur in the text. For the readers convenience the Worksheets also reproduce essential professional standards and implementation guidance.
This Portfolio may be cited as BNA Tax and Accounting Portfolio 5106-2nd, Kohlbeck, Accounting for Investments in Debt Securities (Accounting Policy and Practice Series).
Note: Various FASB documents, copyright by the Financial Accounting Standards Board, 401 Merritt 7, P.O. Box 5116, Norwalk, CT 06856-5116, U.S.A., are reprinted with permission.


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AUTHORS

MARK A. KOHLBECK, CPA, PH.D.
Mark A. Kohlbeck, Ph.D., The University of Texas at Austin; M.B.A., Southern Methodist University; B.B.A. (Accounting), The University of Wisconsin–Whitewater. Dr. Kohlbeck is a former auditor and management consultant for Deloitte & Touche. His practice experience includes restructuring troubled financial institutions, mergers and acquisitions, and litigation support.
Dr. Kohlbeck has written for numerous journals including Contemporary Accounting Research; Journal of Accounting, Auditing, and Finance; and Issues in Accounting Education. Dr. Kohlbeck is an assistant professor with the School of Accounting at Florida Atlantic University in Boca Raton, Florida, where he teaches financial accounting. He has taught financial accounting courses at the University of Wisconsin–Madison, Southern Methodist University, and The University of Texas at Austin. Dr. Kohlbeck is a member of Beta Alpha Psi, Beta Gamma Sigma, the AICPA, and the American Accounting Association.

TABLE OF CONTENTS

Detailed Analysis

I. Introduction and Overall Scope of Portfolio

II. Overview of Current Practice

A. Organization

B. Historical Perspective

C. Current Practice and Philosophy

1. Major Authoritative Pronouncements

2. FAS 115 Summarized

a. Scope

b. Background

c. Classifications

D. Relationship of Current Practice to Conceptual Framework

E. Definitions

III. Historical Cost Accounting

A. Role and Relevance

B. Rules Summarized

C. Cross References

D. Types of Investments in Debt Securities

E. Accounting for Debt Investments Purchased at Par Value

1. Perspectives and Cross References

2. Three Illustrative Scenarios

a. Base Case

b. Purchased Interest

c. Interest Accruals

d. Interest Accruals and Reversing Entries

F. Accounting for Debt Investments Purchased With Discounts and Premiums

1. Investment in a Straight Bond Issued With a Discount (With Reversing Entries)

a. Acquisition of the investment on June 1, 2006

b. Quarter-end interest accrual on June 30, 2006

c. Reversing entry on July 1, 2006

d. Quarter-end interest accrual on September 30, 2006

e. Reversing entry on October 1, 2006

f. Receipt of interest payment on December 1, 2006

g. Year-end interest accrual on December 31, 2006

2. Investment in a Straight Bond Issued With a Discount (Without Reversing Entries)

a. Acquisition of the Investment on June 1, 2006 (No Reversing Entries)

b. Quarter-end Interest Accrual on June 30, 2006 (No Reversing Entries)

c. Quarter-end Interest Accrual on September 30, 2006 (No Reversing Entries)

d. Receipt of Interest Payment on December 1, 2006 (No Reversing Entries)

e. Year-end Interest Accrual on December 31, 2006 (No Reversing Entries)

3. Investment in a Straight Bond Issued With a Premium

a. Acquisition of the Investment on June 1, 2006

b. Quarter-end Interest Accrual on June 30, 2006

c. Reversing Entry on July 1, 2006

d. Quarter-end Interest Accrual on September 30, 2006

e. Reversing Entry on October 1, 2006

f. Receipt of Interest Payment on December 1, 2006

g. Year-end Interest Accrual on December 31, 2006

4. Investment in a Zero Coupon Bond

a. Acquisition of the Investment on June 1, 2006

b. Recognition of Interest Revenue for the Quarter Ended June 30, 2006

c. Recognition of Interest Revenue for the Quarter Ended September 30, 2006

d. Year-end Interest Accrual on December 31, 2006

5. Investment in a Self-Amortizing Bond

a. Acquisition of the Investment on June 1, 2006

b. Quarter-end Interest Accrual on June 30, 2006

c. Reversing Entry on July 1, 2006

d. Quarter-end Interest Accrual on September 30, 2006

e. Reversing Entry on October 1, 2006

f. Receipt of Principal and Interest Payment on December 1, 2006

g. Year-end Interest Accrual on December 31, 2006

6. Investment in a Serial Bond

a. Acquisition of the Investment on June 1, 2006

b. Quarter-end Interest Accrual on June 30, 2006

c. Reversing Entry on July 1, 2006

d. Quarter-end Interest Accrual on September 30, 2006

e. Reversing Entry on July 1, 2006

f. Receipt of Payment on December 1, 2006

g. Year-end Interest Accrual on December 31, 2006

G. Investments in Hybrid Debt Securities

1. Structured Notes

2. Contingent and Convertible Debt

3. Beneficial Interests

4. Mandatorily Redeemable Preferred Stock

H. Maturities, Sales, and Conversions

1. Perspective

2. Maturities

3. Sales and Other Dispositions of Debt Securities Prior to Maturity

I. Trading Securities -A Special Situation

J. Determination of Effective Yield

IV. Fair Value Accounting

A. Summary

B. Trading Securities

1. Overview

2. Accounting

3. Illustration

C. Held to Maturity Securities

1. Overview

a. Intent

b. Ability

2. Accounting

D. Available-for-Sale Securities

1. Overview

2. Accounting

3. Illustration

E. Tax Effects of Fair Value Adjustments

1. Overview and Accounting

2. Illustrations

F. Estimating Fair Values

1. Traditional Discounted Cash Flow Approach

a. Discount Rate Build-Up

b. Comparison Discount Rate

c. Illustration

2. Accounting Approach

V. Impairments

A. Overview of Impairments

1. Reasons for Impairments

2. Identifying and Accounting for Impairments

a. Step 1: Determine Whether an Impairment Has Occurred

b. Step 2: Determine Whether the Impairment is Other-Than-Temporary

(1) Debt Securities Outside the Scope of EITF Issue 99-20

(2) Beneficial Interests in Securitized Financial Assets Under EITF Issue 99-20

c. Step 3: Account for the Impairment

B. Accounting for Impairments

C. Impairment Illustrations

VI. Transfers Among Categories

A. Overview

B. Accounting for Transfers Among Classifications

C. Illustrations

1. Trading to Held-to-Maturity

2. Trading to Available-for-Sale

3. Held-to-Maturity to Trading

4. Available-for-Sale to Trading

5. Held-to-Maturity to Available-for-Sale

6. Available-for-Sale to Held-to-Maturity

VII. Hedging Investments in Debt Securities

A. Overview

1. Definition of a Derivative

2. Definition of a Hedge

3. Hedge Accounting Summarized

B. Fair Value Hedges

1. Accounting

2. Fair Value Hedge Example - Swap Agreement (Receive Variable, Pay Fixed)

3. Fair Value Hedge Example - Put Option

C. Cash-Flow Hedges

1. Accounting

2. Cash-Flow Hedge Example - Swap Agreement (Receive Fixed, Pay Variable)

VIII. Presentation and Disclosures

Introductory Material

A. GAAP Requirements

1. Balance Sheet

2. Income Statement

3. Statement of Cash Flows

4. Accompanying Notes

B. SEC Requirements

C. Illustrations

1. Balance Sheet

2. Income Statement

3. Statement of Stockholders' Equity

4. Statement of Cash Flows

5. Notes to the Financial Statements

a. Accounting Policies

b. Investments - Trading

c. Investments - Held-to-Maturity and Available-for-Sale

IX. Auditor Considerations

Introductory Material

A. Fair Values

B. Classifications

C. Impairments

D. Hedging

X. Comprehensive Illustration

Introductory Material

A. Background Information

B. Base Illustration

1. First Quarter 2006

2. Second Quarter 2006

3. Third Quarter 2006

4. Fourth Quarter 2006

C. Impairments and Hedges

1. Third Quarter 2006

2. Fourth Quarter 2006

XI. Concluding Thoughts

Working Papers


WORKING PAPERS

TABLE OF WORKSHEETS

Worksheet 1 Principal Abbreviations Used in Portfolio

Worksheet 2 Summary of Intent-Based Accounting

Worksheet 3 Common Types of Debt Investments

Worksheet 4 Comparison of Debt Investment Cash Flows

Worksheet 5 Amortization Tables for Comprehensive Illustration

Worksheet 6 Disclosure Examples, Bed Bath & Beyond (2005 Form 10-K)

Worksheet 7 Disclosure Examples, Circuit City Stores, Inc. (2005 Form 10-K)

Worksheet 8 Disclosure Examples, Compuware Corp. (2005 Form 10-K)

Worksheet 9 FAS 115, Accounting for Certain Investments in Debt and Equity Securities (May 1993)

Worksheet 10 Q& A 115-A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities: Questions and Answers

Worksheet 11 FSP FAS 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (November 3, 2005)

Worksheet 12 List of Significant Accounting Pronouncements Principally Discussed

Bibliography

OFFICIAL

American Institute of Certified Public Accountants Materials:

Accounting Principles Board Opinions

AICPA Statement on Auditing Standards

AICPA Statements of Positions

Committee on Accounting Procedures

Financial Accounting Standards Board Materials:

FASB Financial Accounting Standards

FASB Financial Accounting Concepts:

FASB Implementation Guides

FASB Technical Bulletins

FASB Staff Positions

FASB Emerging Issues Task Force (EITF) Abstracts

FASB Meeting Minutes

International Accounting Standards Board:

Securities and Exchange Commission Materials:

Securities Act Industry Guide

Staff Accounting Bulletins

SEC Publications and Speeches

UNOFFICIAL

Books

Articles