Accounting concepts and applications

Noninfluential Securities

Accounting

Identify and explain three out of four types of classifications for non-influential investments in securities.

Regarding the reporting of non-influential investments, the first and most common type of such investments are frequently-purchased trading securities called debt and equity securities. "Debt securities get their measure of safety by having a principal amount that is returned to the lender at the maturity date or upon the sale of the security. They are typically classified and grouped by their level of default risk, the type of issuer and income payment cycles" (Debt securities, 2012, Investopedia). In contrast, equity securities confer proportional ownership and lack such security. "The entire portfolio of trading securities is reported at its market value; this requires a 'market adjustment' from the cost of the portfolio of securities. Any unrealized gain or loss from a change in the market value of the portfolio of trading securities is reported in the income statement" (Chapter 15 PowerPoint, 2009: Slide 7). These securities can be traded at any time, depending on the will of the holder, and are thus volatile and unpredictable in nature, particularly equity securities.

Unlike traded securities, a held-to-maturity (HTM) security is designed to be held to maturity, or to a specific date. "They are reported in the current assets if their maturity dates are within one year or the operating cycle, whichever is longer. The securities are classified as noncurrent investments if their maturity dates are longer than one year or the normal operating cycle, whichever is longer" (Chapter 15 PowerPoint, 2009: Slide 9). No temporary price changes need to be shown, in contrast to debt or equity securities which lack a maturity date. "Interest income received from a held-to-maturity security is run through the income statement, however the gains and losses go through comprehensive income until it is realized" (Held to maturity securities, 2012, Investopedia). HTM is thus predictable and relatively easy to account for on a balance sheet.

A third type is available-for-sale (AFS) securities. These securities are not actively managed like traded securities, along the lines of debt and equity types. However, they are available to sell, "given the right combination of market factors" and the cash situation of the company (Securities available for sale, 2012, McGraw-Hill.). Sales are dependent upon contingent market factors. From an accounting standpoint, "like trading securities, we report investments in AFS securities in the balance sheet at fair value. Unlike trading securities, though, unrealized holding gains and losses on AFS securities are not included in net income. Instead, they are reported in the statement of comprehensive income as other comprehensive income (OCI). Also, "if the intent is to sell the securities within the longer of one year or the normal operating cycle, the securities are classified as short-term investment. Otherwise, they are classified as long-term investments" (Chapter 15 PowerPoint, 2009: Slide 10).