 Hello and welcome to this session. This is Professor Farhad and this session would look at investment in debt securities. This topic is covered in financial accounting, the CPA exam far section, and in my intermediate accounting course. In my intermediate accounting, I covered this session in a little bit more in depth, actually much more in depth. So if this session does not satisfy your need, please visit my intermediate accounting. As always, I would like to remind you to connect with me only then if you haven't done so. YouTube is where you would need to subscribe. I have 1700 plus accounting, auditing, finance, and tax lectures. This is a list of all my courses. If you like my lectures, please like them, share them, put them in playlists. If they benefit you, they might benefit other people, subscribe, connect with me on Instagram. On my website, you will find additional resources such as PowerPoint slides through false multiple choice. If you're studying for your CPA exam, additional resources, if you're studying for your CMA, EA, or if you're trying to supplement your accounting education, I strongly suggest you check out my website. In the prior session, we looked at the classification and reporting, which is we had an intro session. If you did not look at this intro session, please check the description for the link. So classification and reporting, as we mentioned in the prior session, when we invest, we have to determine what type of investments we have. Is it debt or equity? So we have three factors. The first one to determine is whether the investment is a debt investment or an equity investment. And in this session, we will only focus on debt investments. Therefore, I'm going to take the equity out. The second thing we have to answer, whether we are planning to hold this investment a short term or long term. And the third category is the percentage ownership in the company's equity securities. We don't have to worry about this. Why? Because we're dealing with debt in this session. So in this session, we have to determine whether we plan to hold it short term or long term or guess what, in between. So let's look at debt investments. One classification for debt investments is health to maturity. And we're going to define it. Another classification is trading. We're going to define it, which is we're going to actively trade, which is basically short term, health to maturity, usually long term, we hold it until it mature. And if it's not trading or health to maturity, we're going to call it available for sale. Now we're going to dig deep into each of these sections, each of these sections, starting with held to maturity. So we skip the equity investment for this session. In the next session, we would look at the equity investments. So health to maturities, they can only have debt securities because equity securities don't mature. Equity securities stocks don't have maturity date. That will have a maturity date. A bond will have a maturity date. We intend to hold it until it mature. We report it as current asset if the maturity is within one year. So it's in the last year of its life, it's going to be current. Otherwise, it's a noncurrent if the maturity is longer than a year. Usually it's noncurrent until the last year. The portfolio of health to maturity securities reported at amortized cost. Now what is amortized cost? If you remember when we looked at bonds, we amortized the bond, same concept. And what's important about health to maturity? No fair value adjustment. It doesn't mean we don't have to worry whether the bond went up or the bond went down in value. Why? Well, because we're going to be holding it until it mature. So we don't have to worry about those fluctuations because bonds do fluctuate up and down. So initially, when we buy the bond, the bond is recorded at cost. And this should be no surprise. All investments are recorded initially at cost. So let's assume on July 1st, Ling paid $30,000 to buy Dell's 7% two-year bond with a $30,000 power value. Well, what does that mean? It means we bought a bond for $30,000 and it has a power value of $30,000. The bond pays interest semi-annually on December 31st and June 31st. Well, we're going to buy the bond first. We're going to debit debt investment, which is an asset, $30,000 and we're going to credit cash. This is on July 1st. Now, what's going to happen? The bond will pay interest. So interest revenue is recorded when earned. So after six months, we're going to take $30,000, the power value times the stated value, 7% times one half. And the interest earned from July till December is $1,050. Now, well, what's the journal entry by December 31st? Well, the bond pays interest December 31st. So on December 31st, we will debit cash $1,050 and we credit interest revenue $1,050. This is what we do. Then what's going to happen is this. On the income statement, we're going to show the interest revenue that was booked from the journal entry on December 31st. And on the balance sheet, we will show the debt investment at $30,000. This is the presentation on the balance sheet. And basically every six months, we'll get the revenue. And at the end of the year, we'll report the bond at the amortized cost. Then once the bond mature, guess what? We get our money back. And how much do we get back? We get the power value. And how much is the power value for this bond? $30,000. So we credit debt investments and we debit cash for the bond value. So this is one category. The second category for bonds is trading. What does it mean? It means you bought the bond, but your planning is to sell it in the near future. Also, trading is a debt investment. Again, when we say debt investments, we are dealing with bonds. Those you are actively managed for profit. You're trying to buy and sell on a regular basis. It's always a current asset because your intent is to sell it in the near future. Here, the portfolio is reported at fair value. What does that mean? It means when they go up in value, when they go down in value at the end of the period, you have to report those gains, those unrealized gains. And where do you report them? You report them in the income statement. So trading securities are reported in the income statements. The best way to illustrate this is to look at an example. Techcom portfolio of trading securities has a total cost of $11,500. This is how much we paid for them and a fair value cost of $13,000. Well, they're worth $13,000. We bought them at $11,500. What does that mean? It means we have a gain. So there's a difference of $1,500 between the cost and the fair value. What do we do? Well, here's what we do. Here's what we do. If there is a gain, let's work this, there's a gain, what's going to happen is this. We're going to be dealing with two accounts. One account is called fair value adjustment and another account we're going to be calling unrealized holding gain slash loss. So those are the two account that we use to adjust our portfolio. Now the portfolio here, we have a gain of $1,500. Here are the rules that you need to know for the gains. When you have a gain, when you have a gain, when you have a gain, what's going to happen? Every time you have a gain, it means you should have a balance, debit balance to be more specific, debit balance in fair value adjustment. What's the fair value adjustment right here? Fair value adjustment. Do we have a gain here? Yes, we have a gain. So what does that mean? It means the balance in this account should be a debit balance of $1,500. Now once you know the balance, once you know what the fair value balance should be, so it should be debit balance because we have a gain because we have an overall gain. Now if we have overall a loss, then the balance, notice the balance, not the entry, the balance should be a credit balance. Okay, the balance should be a credit balance. So simply put here, how do we come up with a balance of $1,500? Well, we have to work these two accounts. Those two accounts are involved. So I need to have $1,500 debit. It means I'm going to have a $1,500 credit unrealized holding gain. Now it's a holding gain, although the account that's called holding gain or loss, it's unrealized holding gain and we have to be very clear here, this unrealized holding gain is an income statement account. So this is how I adjust my portfolio. So how do we show things on the financial statements when we do so? So the fair value adjustment trading debit $1,500 unrealized holding gain $1,500. Now let me switch this and make this a loss. So let's assume the fair value was $10,000. What entry do we make? Well, under those circumstances, we have unrealized loss-income $1,500 fair value adjustment $1,500. So it will be a loss and this will be a credit balance. Okay, now what happened? How do we present those things on the balance sheet? On the balance sheet, we would still have the investment at cost $11,500. Then since we have a gain, we add fair value adjustment $1,500, then we reported this is reported at fair value or we could report it simply at fair value by saying that investment trading at fair value $11,500, which is the cost is $11,500 fair value at $13,000. So this is basically how we account for it at the end of the period. Now what's going to happen sometime? We are going to sell those trading securities. So assume TechCom sells trading securities that has a cost of $100,000 for $120,000 in cash. So we sold them for $120,000. It means we have a gain. Now this gain is, since we sold them, it's called realized gain. So the gain is reported in the other revenue and gain section. So it's not with revenue. There's a section on the income statement called other revenues and other gains. It's reported there. The loss would be reported in a section called other expenses and other losses. What's the journal entry? We received cash $120, debit cash $120, remove the investment for $100, and book the gain for $20. So this is the journal entry for the debt investment. Now the third category is that that's available for sale. Remember that available for sale. It's not held to maturity. We're not going to hold it forever. We're not going to sell it in the near future. So it's someplace in between. So it's not classified as trading or held to maturity. That's what it is. It's reported as short-term investment if it's intended to be sold within one year or the company's operating cycle or long-term if the securities do not meet the short-term criteria. Now the company will have an idea whether they want to sell it in the near future or keep it a little bit longer. It's valued at fair value. What does that mean? It means we have to write it up. We have to write it down. Hold on a second. This sounds like trading well with a minor difference. Any unrealized holding gain or loss is reported in the equity section of the balance sheet as part of comprehensive income. So the difference between this and the trading is the unrealized holding gain or loss. And the unrealized holding gain or loss for trading securities, we booked it an income. We're going to see the unrealized holding gain or loss for the available for sale. We're going to book it in the equity section. So let's assume we had no prior investments in the current period. We acquired two available for sale securities and at December 31st, this is what they're showing. So we have two securities, Apple bonds and Intax notes. So we paid for the bonds 73,000. The value today is 74,550. So we have a gain. Remember, if we have a gain, it means we have to have a balance of fair value balance. Remember, fair value adjustment balance of 1,550. So what does that mean? It means I need to debit my fair value because we have no prior balance, no prior balance and fair value. So simply put, fair value adjustment has a balance of zero and I need the balance of 1550. Why did I say zero? Because it says here you have no prior investment. So we don't know whether we have a gain or a loss from the prior year because it does make a difference whether we have a gain or a loss. And if you have a subsequent here, I suggest you check out my, well, we're going to look at subsequent here so it doesn't matter or you can check out my intermediate accounting, but we're going to work with subsequent here adjustment in this session. So we're going to debit fair value adjustment available for sale 1550, credit unrealized gain equity 1550. So what I want you to do is to put down this T account fair value adjustment 1550. So this is the year of 2019. So let's take a look at year 20 and this is the presentation. This is how we presenting on 2019. Again, that investments is showing at cost of 73,000. This is the fair value adjustment. This is that at fair value 74,550. And under the equity section, we would report the 1550 of unrealized gain. Now the following year, we will extend the example. And in year 2020, a year later, we have a portfolio of securities. Now we have a cost of 81,000 and a fair value of 82,000. You take the difference. And now I have a gain of 1000. Okay, I still have a gain, but at 1000. Now, remember what I did. I told you, keep track of fair value adjustment. If you remember fair value adjustment was 1550 from the prior year. This is 2019. Now the fair value adjustment supposed to be 1000. Why? Because my gain is 1000. So now I need to make an adjustment. What adjustment do I need to make? Well, I need to credit fair value of 1550. So this is the adjustment. Okay, now to credit fair value, you remember the corresponding entry goes to unrealized holding gain slash loss equity. And remember in that account, I had 1550, let me put it in red first. I had 1550 balance. I'm sorry. I had, yes, I had 1550 credit balance. This is unrealized gain 1550 credit balance from the prior year, 1550. Now what I do is since I credited this account, I'm going to debit, debit 1550. The difference between them now is 1000. Notice I have 1000 in both. Now my unrealized gain is 1000. My fair value adjustment, a debit 1000, which makes sense because I have a gain of 1000. My balance should be 1000. Okay, I'm going to take this one more year. Just kind of make sure we can do this one more year. Let's assume in year 2020, 21. So we're done with 2020. I just made the adjustment. And now the balance is 1000 and 1000. And here's what you're looking at. In these examples, what's helpful is to use the, this timeline zero. So in 2019, we were at 1550. Then this is, this was in 2019. In 2020, we went down to 1000. So we reduce our gain by 550. Now in 2021, in 2021, here we go. I have a portfolio with a cost of a million and fair value, fair value of 999,000. Okay, so if I paid for, now my new portfolio has a cost of a million and fair value of 999,000, I have a loss of 1000. That's what I have. I have a loss of 1000. Well, if I have a loss of 1000, what does that mean? It means I'm moving from, oh, I had a gain of 1000. So I'm moving from a gain of 1000. This is zero to a loss negative 1000. So I'm moving 2000 units to the left. It means in my fair value, it means in my fair value, I'm supposed to have a balance of 2000. Because remember, if it's a loss, I have to have a balance. Well, to have a, I'm sorry, balance of 1000, I apologize, balance of 1000. Well, to have a balance of 1000, I have to credit this account 2000. Well, for every credit, I need, yes, for every credit, because I need 2000 to eliminate the 1000 and keep 1000. For every credit, I need a debit. So for every credit, I need a debit. So I'm sorry, this, I mean, sorry, this was a mistake. I made a mistake. This 1000 is supposed to be on this end from the prior year. So sorry, maybe you already kind of noticed that. So this 1000 on this end. So now I need to credit this account 2000. And now I have a balance of 1000. This is a debit. A debit means a loss. And 1000 credit and fair value means a loss. So in 2021, I am reporting a loss. Now 2022, you would look at your portfolio, determine whether you have a loss. You might move a little bit further down. You might move backward, depending on whether you have a loss or a gain. So this is how you adjust your portfolio. So for year 2020, notice you had fair value adjustment of 1550, but you needed 1000 because the loss was 1000. So you needed to credited 550. Then for year, for the same year, you credited, you debited unrealized gain to make it a balance. Now let me go a step further. What I did redo this one more time because I don't want to confuse you. Remember in 2021, we said assume a loss of 1000. A loss of 1000 means I'm supposed to have a credit of 1000 and fair value. To have a credit of 1000, I need to credit this account 2000. And for every credit, I need to debit. This is 2000. So this is 1000 loss. It becomes unrealized loss. And now this is good credit balance and fair value means I have a loss of 1000. In the next session, we would look at investment and equity securities. And although if you had any problem with the fair value adjustment, fair value adjustment, don't worry, we're going to look at the fair value adjustment again when we look at equity securities. Just in case you're like, I'm not really sure, or you can go to my intermediate accounting. As always, please like the recording, share it. And if you're interested in additional material, please visit my website, especially if you're studying for your CPA exam, and you want to get those extra five to 10, seven or 15 points, I can help you with that. Good luck, study hard and stay safe.