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In: Accounting

Maddow and Wells, Inc. purchased equity securities in 2018. The management of the company has decided...

Maddow and Wells, Inc. purchased equity securities in 2018. The management of the company has decided that the securities will not be sold immediately, but will be held for at least three years. This will allow MW to maximize the potential gains from holding the securities. The new accountant at the company wants to classify the securities as held-to-maturity because they will be held for three years; the company has never held securities for this long before. How would you advise the management of the company to classify the securities? At the end of each reporting year, how will the securities be recognized on the company’s books? Support your response with an appropriate ASC reference (ASC xxx-xx-xx-x) or ASU (accounting standard update).

Solutions

Expert Solution

The term 'Securities' refers to all kinds of negotiable financial instruments which is issued by the corporations, has some monetary value and can be traded in the market. Examples are shares, bonds etc. Majorly, securities are classified into two categories - Equities and Debt. Equity involves buying and selling of the stock or shares and gives ownership rights in the company to the shareholder. Debt represents the funds raised by a company by issuing bonds. Debt securities is a type of loan funds which needs to be repaid by the company.

Maddow and Wells, Inc. can classify their equity and debt securities into three categories :-

  • Held to Maturity securities
  • Trading securities
  • Available for Sale securities

Held to Maturity securities are the debt securities. These type of securities are purchased by the company with the intent of holding them till maturity. These are hold till maturity to realize a large capital gain. These are reported on the Asset side of the balance sheet at amortized cost i.e. these are recorded at their original purchase cost. Over the entire holding period, the value of security remains constant in company's balance sheet.

Trading securities are both debt and equity securities. These types of securities are purchased by the company for the purpose of trading in the market. Companies do not intend to hold such securities for a longer period of time. The main purpose is to make short term profit from these securities. Thus, they are quickly sold in the market whenever the rates are favorable. These securities are reported in Current Assets under Short Term Investments Account in the balance sheet.They are reported at fair value i.e. the current market value. An equivalent amount is recorded under the Unrealized Proceeds From Sale of Short Term Investments Account on the Liabilities side of the balance sheet.

Available for Sale securities - This is the default classification for all debt and equity securities if they don't fall into the above mentioned two categories. The main purpose of buying and selling these securities is not capital gain but to diversify company's investment portfolio risk. These securities are reported in Current Assets under Short Term Investments Account in the balance sheet.They are reported at fair value i.e. the current market value. Changes in the fair value are recorded under Unrealized Gain/Loss in other Comprehensive Income Account on the Liabilities side of the balance sheet.

ASC Reference (ASC 320-10) provides detailed information about the reporting of above mentioned securities.

https://www.fasb.org/home (Link to the FASB website, registration is required to study the complete report)


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