Question

What are the requirement(s) for an investment to be classified in each of the 3 categories (Held-to-Maturity securities, Trading Securities, and available for sale securities)? Also, that are the requirements for an investment to be accounted for using the equity method of accounting?

Answer 1

• Held-to-maturity:

These securities are investments made to be held till maturity. Normally these securities are Bonds .

Shares do not have a maturity date .Hence shares do not fall under this catagories.

Held to maturity securities are bonds purchased to be held till maturity. These securities are reported in balance sheet at amortized cost. Change in market values do not affect the valuation in balance sheet

• Held for trading : These securities are short term investments for trading. These are investments in bonds and shares held principally for selling them in near term. These are reported in the balance sheet at fair value. The unrealized gains or losses are included in income statement

• Available for sale

These are securities other than held to maturity and held for trading.

These are not purchased for trading, neither these are intended to be held till maturity.

These are investments in shares and bond which may be sold when required. These securities are also reported at fair value in the balance sheet. But unrealized gains or losses are not included in income statement. These appear in separate component of shareholders’ equity.

Equity method of accounting is required to be used if the firms investment in another company is more than 20% of that company’s total shares.

Suppose company A purchases shares of company B.

Assume ,company B has 100,000 common shares outstanding. If Company A purchased more than 20,000 hares of company B, equity method of accounting should be used by company A.

With more than 20% investment in company B, it is considered that company A has significant control over company B.

Under equity method ,share of the profit/ loss of company B will be treated as income/loss of company A.

If company B pays dividend to company A, the value of investment in Company A’s book is reduced.