127. Mo Company acquired $500,000 face value of the outstanding bonds of Shemp Company on January 1,
2008. The bonds pay interest semiannually on June 30 and December 31 at an annual rate of 7% and mature on
December 31, 2010. The bonds were priced on the market on January 1, 2008, to yield 6% compounded
semiannually. Mo Company classifies these bonds as held to maturity.
a. Compute the amount that Mo Company paid for these bonds, excluding commissions and taxes.
b. Prepare an amortization table for these bonds.
c. Give the journal entries that Mo Company would make to account for these bonds during 2008.
d. Give the journal entries that Mo Company would make to account for these bonds on December 31, 2010.
(Mo Company, accounting for bonds held to maturity.)
b.See below.
Amortization Table for $500,000 Bonds with Interest Paid Semiannually at 7% and Priced to Yield 6%
Compounded Semiannually
Period
Balance at
Beginning
of Period
Interest
Revenue
for Period
Cash
Received
Portion of
Payment
Reducing
Carrying
Value
Balance
at End
of Period
(1)
(2)
(3)
(4)
(5)
(6)
1
$513,541
$15,406
$17,500
$(2,094)
$511,447
2
$511,447
$15,343
$17,500
$(2,157)
$509,291
3
$509,291
$15,279
$17,500
$(2,221)
$507,069
4
$507,069
$15,212
$17,500
$(2,288)
$504,781
5
$504,781
$15,143
$17,500
$(2,357)
$502,425
6
$502,225
$15,075a
$17,500
$(2,425)
$500,000
128. Joe Company
Information concerning Joe Company’s portfolio of debt securities at May 31, Year 6, and May 31, Year 7, is
presented below. All of the debt securities were purchased by Joe during June, Year 5. Prior to June, Year 5, Joe
had no investments in debt or equity securities.
As of May 31, Year 6
Fair Value
C3 Company bonds
$168,300
Julia Industry bonds
205,200
Brian Inc. bonds
285,200
$658,700
As of May 31, Year 7
Amortized Cost
Fair Value
C3 Company bonds
$152,565
$147,600
Julia Industry bonds
193,800
204,500
Brian Inc. bonds
289,130
291,400
$635,495
$643,500
a. Assuming that the above securities are properly classified as available-for-sale securities under U.S. GAAP,
how would the unrealized holding gain or loss as of May 31, Year 7, be recognized?
b. Assuming that the above securities are properly classified as held-to-maturity securities under U.S. GAAP,
how, if at all, would the unrealized holding gain or loss as of May 31, Year 7, be recognized?
129. Armageddon Insurance
Armageddon Insurance acquired shares of Anunnaki’s common stock on December 28, 2009, for $400,000 and
classified them as trading securities. The fair value of these securities on December 31, 2009, was $402,000.
Armageddon Insurance sold these shares on January 3, 2010, for $405,000.
a. What are the journal entries to record acquisition of trading securities on December 28, 2009?
b. What are the journal entries to measure trading securities at fair value and recognize unrealized holding gain
on December 31, 2009?
c. What are the journal entries to record the sale of trading securities at a gain on January 3, 2010?
d. What is the total income from the purchase and sale of the securities?
a. The journal entries to record acquisition of trading securities on December 28, 2009 are
130. Fishes Company acquires common stock of Chalice Enterprises for $400,000 on November 1, 2009, and
designates this investment as available-for-sale. The fair value of these shares is $435,000 on December 31,
2009. Fishes sells these shares on August 15, 2010, for $480,000.
a. What are the journal entries to record acquisition of securities available-for-sale on November 1, 2009?
b. What are the journal entries to measure securities available-for-sale on December 31, 2009.
c. What are the journal entries to record the sale of securities available-for-sale on August 15, 2010.
d. What is the total income from the purchase and sale of these securities reported in the year of sale.
a. The journal entries to record acquisition of securities available for sale on November 1, 2009.
131. How does U.S. GAAP and IFRS require firms to classify marketable securities?
The provisions of U.S. GAAP and IFRS require firms to classify marketable securities into three categories:
1. Debt securities held to maturity (U.S. GAAP) or held to maturity investments (IFRS) for which a firm has
both the intent and the ability to hold to maturity—shown on the balance sheet at an amount based on
132. How are securities measured at acquisition?
MEASUREMENT OF SECURITIES AT ACQUISITION
A firm initially records the purchase of marketable securities at acquisition cost, which includes the purchase
price plus any commissions, taxes, and other costs incurred. However, U.S. GAAP and IFRS exclude
transactions costs from the acquisition cost of trading securities, treating such costs as expenses of the period.
For example, if a firm acquires securities classified as marketable securities for $10,000, the entry is as follows:
133. How are securities measured after acquisition?
MEASUREMENT OF SECURITIES AFTER ACQUISITION
Debt Securities Held to Maturity
Firms sometimes acquire debt securities with the intention of holding these securities until maturity.
For example, an electric utility, has $100 million of bonds payable outstanding that mature in five years. The
utility acquires U.S. government securities whose periodic interest payments and maturity value exactly equal
The amortization procedure involves the following steps:
134. Discuss the accounting for debt securities held to maturity and arguments against this approach.
The accounting for debt securities held to maturity relies on the acquisition cost method in that both the initial
amount recorded and adjustments for amortization each period rely on the initial purchase price. The amount
that results from the application of this measurement approach is sometimes called amortized cost. U.S. GAAP
and IFRS require firms to account for debt securities designated as held to maturity at amortized cost, except
that they are also subject to impairment. That is, firms do not recognize increases in fair value (unrealized gains)
but might recognize decreases in fair value (unrealized losses). If a held-to-maturity security is deemed to be
impaired, the investor recognizes (debits) an impairment loss (included in net income) and reduces (credits) the
balance sheet carrying value of the investment.
135. What is the accounting treatment for trading securities?
Trading Securities
Firms sometimes purchase and sell debt and equity securities for the short-term profit potential—some would
say for speculation. The term trading implies active and frequent buying and selling with the objective of
136. What is the accounting treatment for securities available for sale?
Firms initially record investments in securities available for sale at acquisition cost, including transaction costs.
If a firm classifies debt securities as available for sale, it must amortize any difference between the purchase
price and the maturity value of the debt over the remaining term to maturity, the same as if the firm classified
137. What disclosures about marketable securities are required by U.S. GAAP?
DISCLOSURES ABOUT MARKETABLE SECURITIES
U.S. GAAP and IFRS require disclosures about marketable securities each period. The following disclosures
reflect U.S. GAAP requirements. IFRS requirements are similar but can result in less detailed disclosures.
138. What are derivative instruments and how are they used?
DERIVATIVE INSTRUMENTS
Firms engage in transactions that subject them to specific financial risks. Most firms face risks—that is,
variability of outcome—from changes in interest rates, foreign exchange rates, and commodity prices. Firms
can purchase financial instruments to reduce these business risks, that is, to reduce the volatility of certain
outcomes. Some of these instruments trade in relatively active markets, like marketable securities, while others
have specialized terms and do not trade at all. The general term used for the types of financial instruments that
firms might buy to mitigate the risks is a derivative. The accounting for derivative financial instruments follows
139. What are elements of a derivative?
Consider the following elements of a derivative:
140. Describe the accounting for derivatives.
ACCOUNTING FOR DERIVATIVES
A firm must recognize derivatives on its balance sheet as assets or liabilities, depending on the rights and
obligations under the contract. Firms must remeasure derivatives to fair value each period. The change in fair
value either increases or decreases the balance sheet carrying value of the derivative asset or liability, and also
derivative as either a fair value hedge or a cash flow hedge, authoritative guidance requires that the firm account
for the derivative as if it were a trading security (U.S. GAAP) or a security at fair value through profit and loss
(IFRS). Firms measure derivatives that they do not designate as hedges at fair value each period and include the
resulting gain or loss in net income.
Fair Value Hedges
Derivative instruments acquired to hedge exposure to changes in the fair values of assets or liabilities are fair
141. How are hedging gains and losses treated?
TREATMENT OF HEDGING GAINS AND LOSSES
U.S. GAAP and IFRS allow firms to choose whether to designate a particular derivative as a hedge, and
therefore eligible for hedge accounting. Firms remeasure derivatives not designated as a hedge to fair value at
every balance sheet date and include changes in fair value in net income. For a derivative designated as a hedge,
The matching convention provides both the basis for hedge accounting, as well as the logic for the treating
gains and losses from changes in fair value of fair value hedges differently from cash flow hedges. In a fair
value hedge of a recognized asset or liability, both the hedged asset (or liability) and its related derivative
(hedging instrument) appear on the balance sheet. Remeasuring both the hedged asset (or liability) and its
related derivative to fair value each period and including the gain or loss on the hedged asset (or liability) and
142. Describe the accounting for a fair value hedge of a recognized asset or liability.
Accounting for a Fair Value Hedge of a Recognized Asset or Liability
The following summarizes the accounting for a fair value hedge of a recognized asset or liability.
1. A firm recognizes the hedged asset or liability, even in the absence of hedge accounting. In the absence of
hedge accounting, the measurement of the hedged item depends on the required accounting for that item (for
example, lower of cost or market for inventories, present value of future cash flows for long-term receivables
and payables).
143. U.S. GAAP and IFRS require firms to disclose the fair value of financial instruments in a note to the
financial statements. What should such a note include?
DISCLOSURES RELATED TO DERIVATIVE INSTRUMENTS
U.S. GAAP and IFRS require firms to disclose the fair value of financial instruments in a note to the financial
statements. U.S. GAAP also requires firms to disclose the following information (among others) with respect to
derivatives (IFRS requires similar but not identical disclosures).
1. A description of the firm’s risk management strategy and how particular derivatives help accomplish the
firm’s hedging objectives. The description should distinguish among derivative instruments designated as fair
value hedges, cash flow hedges, and all other derivatives. This disclosure helps the user of the financial
144. Describe the fair value option applied to marketable securities and derivatives.
THE FAIR VALUE OPTION APPLIED TO MARKETABLE SECURITIES AND DERIVATIVES
Both U.S. GAAP and IFRS provide for the option of reporting selected financial assets and financial liabilities
at fair value and recognizing gains and losses in net income as fair values change. Firms can apply the fair value
option on an instrument-by-instrument basis, when the firm first adopts the standard that provides for the fair
value option, when the firm acquires an eligible instrument, and at certain remeasurement events, such as
business combinations. Once elected, the fair value option is irrevocable (for the instrument to which the firm
Accounting Method Applicable To:
Method 1: Amortized Acquisition Cost Debt Securities Held to Maturity
Method 2: Fair Value with Unrealized Gains and Marketable Securities
Classified as Available for Sale