Professional Documents
Culture Documents
Chapter 11
Valuation Adjustments
TABLE OF CONTENTS
Overview
Available-for-sale Securities
Trading Securities
Held-to-maturity Securities
Tax Consequences
A Closer Look at the Key Concepts
Example
5
6
6
Assumptions
8
10
Example
10
11
Exercise 11.01
12
Exercise 11.02
13
Exercise 11.03
14
Exercise 11.04
16
Navigating Accounting
Exercise 11.05
17
Exercise 11.06
18
Exercise 11.07
19
Exercise 11.08
20
Exercise 11.09
21
Exercise 11.10
22
Exercise 11.11
23
OVERVIEW
This chapter examines how investments (also called marketable securities)
affect financial statements and footnote disclosures under US GAAP.
This chapter has two sections: (1) this overview, which summarizes the
key concepts and links them to those you learned in other chapters, and
(2) A Closer look at the Key Concepts, which uses an example and
Intel disclosures to develop and illustrate the concepts in the overview.
Skim the overview the first time through the chapter and then reread it
more carefully after you have read A Closer Look at The Key Concepts.
One of the learning objectives is to help you better understand the
difference between realized and unrealized gains and losses. Realized
gains and losses arise from selling investments or other assets.
Unrealized gains and losses arise from revaluing unsold investments or
other assets to their fair value at the end of the reporting period.
If you purchase shares of stock in Intel and the value of your shares
increases, you have an unrealized gain. If you sell the shares, you have
a realized gain. Determining unrealized gains and losses on marketable
securities is relatively straightforward. You simply check the price
of recent trades versus the price you paid for your shares. However,
determining the fair values of other assets not traded regularly are more
difficult to assess. Thus, estimating their unrealized gains and losses
reliably is more problematic.
Navigating Accounting
Available-for-sale Securities
Available-for-sale securities are recognized at their fair values. Valuation
adjustments are recorded at the end of the period, ensuring the securities
are stated at their fair values.
Here is how these adjustments affect the balance sheet equation:
Assets
The securities values increase (decrease) by the adjustment needed to
state them at their fair values.
Equities
If the adjustment increases (decreases) the value of the securities,
a deferred tax liability (asset) is recognized to reflect the tax
consequences that would occur if the securities were sold at their
current values in the future.
If the adjustment increases (decreases) the value of the securities,
other comprehensive income (OCI) reflects the after-tax gain (loss) that
would accrue to owners if the securities were sold at their current
values. OCI is closed to accumulated OCI at the end of the reporting
period.
Trading Securities
The accounting for trading securities is similar to available-for-sale
securities except the after-tax effects of valuation adjustments effect net
income rather than OCI. Thus, unrealized gains and losses associated with
trading securities are recognized in income.
Held-to-maturity Securities
Held-to-maturity securities are not adjusted for increases in fair value but,
like all other assets, are adjusted for impairments (significant declines)
based on the lower of cost or market principle.
Tax Consequences
Realized gains and losses affect the current provisions of tax expenses, just
as they do for PP&E disposals. Thus, these tax effects are included in the
entry recording the tax expense.
Unrealized gains and losses also have tax effects that depend on the way
the investments are classified. As indicated earlier, unrealized gains and
losses of investments classified as trading assets are recognized in financial
reporting income. Generally, these unrealized gains and losses are not
recognized for tax reporting until they are realized. Thus, unrealized gains
and losses on trading assets recognized in financial reporting income
generally affect the deferred tax provision.
Unrealized gains and losses on available-for-sale investments are not
recognized in financial reporting income, but they are recognized in
owners equity. Intel mentions the tax consequences of these unrealized
gains and losses in the Investments section of the Accounting Policies
footnote (underline added for emphasis):
Investments designated as available-for-sale are recorded at fair
value, with unrealized gains and losses, net of tax, recorded in
accumulated other comprehensive income.
Page 54, Intels 2006 Annual Report
Navigating Accounting
Example
Assumptions
XYZ Company buys a share of another companys stock for $1 at the
start of XYZs first year of operations.
XYZ classifies the stock as available-for-sale.
The market value of the share is $4 at the end of the first year.
XYZ sells the stock for $5 one month into its second year.
Navigating Accounting
Unrealized gains
Unrealized losses
Net gains
$178
$164
$14
($1)
($5)
$4
$177
$159
$18
End of 2006
End of 2005
Increase (decrease)
$62.30
$57.40
$4.90
($0.35)
($1.75)
$1.40
Subtracting the table above from the earlier one yields the after-tax
consequences for accumulated other comprehensive income associated
with Intels available-for-sale investments:
Intel's Net of Taxes
Available-for-Sale Unrealized Gains/Losses
End of 2006
End of 2005
Increase (decrease)
Unrealized gains
Unrealized losses
$115.70
$106.60
$9.10
($0.65)
($3.25)
$2.60
Accumulated other
comprehensive
income
$115.05
$103.35
$11.70
10
Navigating Accounting
company had sold its marketable security just before the close of the
first year, and in particular, before recording unrealized gains and losses.
XYZ would have recorded: (a) a $4 increase in cash, (b) a $1 decrease in
marketable securities at cost, and (c) a $3 realized gain.
12
Navigating Accounting
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Balance Sheets
Income Statements
Operating
Assets
Investing
Liabilities
Expenses
Financing
Owners' Equity
Revenue
Exercise 11.01
Record events MMS 7, 48-51 and 56 and explain how these events affect
the three financial statements.
How do these events relate to Intel?
Net Income
Cash change
Reconciliations
Net Income
Adjustments
Operating Cash
Where would you search for related disclosures in Intels 2006 Annual
Report?
Record Keeping
and Reporting
Icon
This exercise helps
you meet the insider
record keeping and
reporting challenge.
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Zero
Balance Sheets
Income Statements
Operating
Assets
Investing
Liabilities
Expenses
Financing
Owners' Equity
Revenue
Net Income
Cash change
Reconciliations
Exercise 11.02
The goals of this exercise are: (1) to give you an opportunity to practice
the entries discussed in the text from the perspective of an insider, and (2)
introduce a template we will modify slightly in the next exercise to reverse
engineer entries from the perspective of an outsider.
Net Income
Adjustments
Operating Cash
Record Keeping
and Reporting
Icon
This exercise helps
you meet the insiders
record keeping and
reporting challenge.
You will need to open the following Excel file to complete this exercise:
Ex_11.02.xls.
Required
Given the assumptions below, complete the entries and year-end balances
in the Insiders_Val_Adj_ Template worksheet of Ex_11.02.xls.
Assumptions for years 1 and 2
14
Navigating Accounting
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Cls RE
End Bal
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ssets
Beg Bal
Zero
Balance Sheets
Income Statements
Operating
Assets
Investing
Liabilities
Expenses
Financing
Owners' Equity
Revenue
Net Income
Cash change
Reconciliations
Net Income
Adjustments
Operating Cash
Record Keeping
and Reporting
Icon
This exercise
helps you meet the
outsiders record
keeping and reporting
challenge reverse
engineering entries.
Exercise 11.03
The goal of this exercise is to introduce a template we will use to reverse
engineer available-for-sale-investments entries from the perspective of an
outsider.
You will need to open the following Excel file to complete this exercise:
Ex_11.03.xls.
Template Modifications
As indicated below, the events here are the same as those in Exercise
11.02. However, the outsider template introduced here combines some
of the accounts and entries we used in Exercise 11.02. Specifically, the
template:
Has 14 unknown items, X1-X14, and contains a general structure
for available-for-sale-investments valuation adjustments based on the
entries in Exercise 11.02.
Records securities sales in one entry rather than three.
Nets the deferred tax assets and liabilities into a single net deferred tax
liability account: NetDTL = DTL - DTA.
Nets unrealized gains and losses into a single net unrealized gains
account: Neturg = Msurg - Msurl.
Assumptions
The assumptions are the same as those in Exercise 11.02:
Assumptions for years 1 and 2
Sell several securities during the year with a total historical cost
of $250 for $400. Some of these securities had a total of $120
unrealized gains, others had a total of $20 of unrealized losses,
and the remainder had no previously recorded unrealized gains or
losses.
At year-end, management concluded part of the portfolio had
a $40 other-than-temporary loss. Managements policy is to
charge other-than-temporary losses directly to the historical cost
securities account.
At year end, the investment portfolio has $430 of unrealized gains
and $150 of unrealized losses.
Required
The template in Ex_11.03.xls has 14 variables X1-X14 in cells related to
available-for-sale investments entries or balances. An outsiders challenge
in reverse engineering entries is to locate or estimate as many of these
variables as possible. This following questions aim to prepare you for this
challenge.
(a) Record entries into the template by replacing variables with numbers
determined by the above assumptions.
(b) Determine the beginning and ending balances by replacing variables
with numbers.
(c) If you were an outsider who did not know the assumptions behind
the entries, what variables or combinations of variables in the
template might you expect to find in a companys annual report and
where would you expect to find them?
16
Navigating Accounting
Exercise 11.04
This exercise pertains to investments and valuation adjustment questions
on the 2007 final exam, which was based on a supplement from
Motorolas fiscal 2006 annual report.
Search Icon
This exercise
requires you
to search for
information.
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End Bal
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Required
Zero
Balance Sheets
Income Statements
Operating
Assets
Investing
Liabilities
Expenses
Financing
Owners' Equity
Revenue
Net Income
Cash change
Reconciliations
Net Income
Adjustments
Operating Cash
Record Keeping
and Reporting
Icon
This exercise
helps you meet the
outsiders record
keeping and reporting
challenge reverse
engineering entries.
Usage Icon
This exercise helps
you learn how
accounting reports
are interpreted and
used by outsiders.
Exercise 11.05
This exercise pertains to investments and valuation adjustment questions
on the 2006 final exam, which was based on a supplement from HewlettPackards (HPs) fiscal 2005 annual report. HPs fiscal 2005 year started
on November 1, 2004 and ended on October 31, 2005.
Search Icon
This exercise
requires you
to search for
information.
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Tr Bal
Cls IS
Cls RE
End Bal
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=L
Required
Zero
Balance Sheets
Income Statements
Operating
Assets
Investing
Liabilities
Expenses
Financing
Owners' Equity
Revenue
Net Income
Cash change
Reconciliations
Net Income
Adjustments
Operating Cash
Record Keeping
and Reporting
Icon
This exercise
helps you meet the
outsiders record
keeping and reporting
challenge reverse
engineering entries.
Usage Icon
This exercise helps
you learn how
accounting reports
are interpreted and
used by outsiders.
18
Navigating Accounting
Exercise 11.06
This exercise pertains to questions involving investments and
comprehensive income on the 2005 final exam, which was based on a
supplement from Boston Scientifics fiscal 2004 annual report.
Search Icon
This exercise
requires you
to search for
information.
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Answer final exam 2005 question 1c, 1d, 1i, 4e, 4h, and 5a. Be sure to
read the directions for question 4 on the top of page 8, which specifies
how account names should be chosen.
Tr Bal
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Cls RE
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Required
Zero
Balance Sheets
Income Statements
Operating
Assets
Investing
Liabilities
Expenses
Financing
Owners' Equity
Revenue
Net Income
Cash change
Reconciliations
Net Income
Adjustments
Operating Cash
Record Keeping
and Reporting
Icon
This exercise
helps you meet the
outsiders record
keeping and reporting
challenge reverse
engineering entries.
Usage Icon
This exercise helps
you learn how
accounting reports
are interpreted and
used by outsiders.
Exercise 11.07
This exercise pertains to questions involving investments and
comprehensive income on the 2004 final exam, which was based on a
supplement from AMDs fiscal 2003 annual report.
Search Icon
This exercise
requires you
to search for
information.
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temporary OE
Answer question final exam 2004 1b, 1d, 4b, and 4g. Be sure to read
the directions for question 4 on the top of page 8, which specifies how
account names should be chosen.
Zero
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Required
Zero
Balance Sheets
Income Statements
Operating
Assets
Investing
Liabilities
Expenses
Financing
Owners' Equity
Revenue
Net Income
Cash change
Reconciliations
Net Income
Adjustments
Operating Cash
Record Keeping
and Reporting
Icon
This exercise
helps you meet the
outsiders record
keeping and reporting
challenge reverse
engineering entries.
Usage Icon
This exercise helps
you learn how
accounting reports
are interpreted and
used by outsiders.
20
Navigating Accounting
Exercise 11.08
This exercise pertains to questions involving investments and
comprehensive income on the 2003 final exam, which was based on a
supplement from Gateways fiscal 2002 annual report.
Search Icon
This exercise
requires you
to search for
information.
R
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C
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K
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P
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ssets
iabilities
+O
wners'
Beg Bal
quities
temporary OE
Zero
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Tr Bal
Cls IS
Cls RE
End Bal
R
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=L
Required
Zero
Balance Sheets
Income Statements
Operating
Assets
Investing
Liabilities
Expenses
Financing
Owners' Equity
Revenue
Net Income
Cash change
Reconciliations
Net Income
Adjustments
Operating Cash
Record Keeping
and Reporting
Icon
This exercise
helps you meet the
outsiders record
keeping and reporting
challenge reverse
engineering entries.
Usage Icon
This exercise helps
you learn how
accounting reports
are interpreted and
used by outsiders.
Exercise 11.09
This exercise pertains questions involving investments and comprehensive
income on the 2000 final exam, which was based on a supplement from
Ciscos fiscal 2000 annual report.
Search Icon
This exercise
requires you
to search for
information.
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Cls RE
End Bal
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Required
Zero
Balance Sheets
Income Statements
Operating
Assets
Investing
Liabilities
Expenses
Financing
Owners' Equity
Revenue
Net Income
Cash change
Reconciliations
Net Income
Adjustments
Operating Cash
Record Keeping
and Reporting
Icon
This exercise
helps you meet the
outsiders record
keeping and reporting
challenge reverse
engineering entries.
Usage Icon
This exercise helps
you learn how
accounting reports
are interpreted and
used by outsiders.
22
Navigating Accounting
Exercise 11.10
Search Icon
This exercise requires you
to search for information.
R
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ssets
iabilities
+O
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quities
Zero
Required
Tr Bal
Cls IS
Cls RE
End Bal
Zero
Balance Sheets
Income Statements
Operating
Assets
Revenue
Investing
Liabilities
Expenses
Financing
temporary OE
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Beg Bal
This goal of this exercise is to help you learn how to reverse engineer as
many entries and related information about available-for-sale investments
as possible from Intels 2004 annual report, using the outsiders template
developed in Exercise 11.03. A copy of this template is included in
Ex_11.08.xls, which you will use for this exercise.
Owners' Equity
Net Income
Cash change
Reconciliations
Net Income
Adjustments
Operating Cash
Record Keeping
and Reporting
Icon
This exercise
helps you meet the
outsiders record
keeping and reporting
challenge reverse
engineering entries.
Usage Icon
This exercise helps
you learn how
accounting reports
are interpreted and
used by outsiders.
Exercise 11.11
Search Icon
This exercise requires you
to search for information.
R
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C
O
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D
K
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P
I
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ssets
iabilities
+O
wners'
quities
temporary OE
Zero
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s
Tr Bal
Cls IS
Cls RE
End Bal
R
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P
O
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I
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=L
Beg Bal
Zero
Balance Sheets
Income Statements
Operating
Assets
Investing
Liabilities
Expenses
Financing
Owners' Equity
Revenue
This goal of this exercise is to help you learn how to reverse engineer as
many entries and related information about available-for-sale investments
as possible from Ciscos fiscal 2000 annual report using the outsiders
template developed in Exercise 11.03. A copy of this template is included
in Ex_11.09.xls, which you will use for this exercise.
Required
Locate or estimate as many of the 14 unknowns in the outsiders
valuation adjustment template in Ex_11.09.xls as you can. Replace the
template variables with the numbers you estimate or locate.
Net Income
Cash change
Reconciliations
Net Income
Adjustments
Operating Cash
Record Keeping
and Reporting
Icon
This exercise
helps you meet the
outsiders record
keeping and reporting
challenge reverse
engineering entries.