Case Study is attached below Answer each and every highlighted question listed below
case study "An Exercise in Accounting for Marketable Securities" (Lynch, 2007). Next, using outside sources that you may seek and your professional experience,develop and write a 3- to 4-page paper concisely answering the following questions:
(A1.1) What might the company's financial reporting objective(s) be with respect to the marketable securities?
(A1.2) What potentially constrains management from meeting the objective(s)?
(A1.3) How can management meet the objective(s) given the constraint(s)?
(A1.4) What is the process used by accountants to consider such objectives and constraints when advising management?
(A1.5) How should accountants communicate their advice to management and what should be included in that communication?
Accounting for Marketable Securities UV1132 This technical note was prepared by Professor Mark Haskins and Associate Professor Luann J. Lynch. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright 2008 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to sales@dardenbusinesspublishing.com. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means— electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation. ACCOUNTING FOR MARKETABLE SECURITIES Managers invest in securities of other companies for a variety of reasons. First, a company may have cash it would like to invest in the stocks or bonds of another company simply to generate a return. Second, a company may invest in another company so that it can influence that company’s policies and performance. Third, a company may invest in another company with the objective of obtaining control of that company. From a financial reporting perspective, these diverse reasons result in three broad investment categories: (1) passive investments, (2) investments that result in significant influence, and (3) investments that result in control. Passive Investments Passive investments are investments in securities of another company simply for the purpose of earning a rate of return. They can include investments in debt and equity securities. All debt securities (e.g., bonds) are considered passive investments—they generally do not result in the investing company having any significant influence or control of the company whose securities it has purchased. Although there are exceptions, investments in equity securities (e.g., stocks) are considered passive investments if the investing company owns less than 20% of the outstanding voting shares of the investee. Note that since preferred stock is typically nonvoting stock, it is usually considered a passive investment. The accounting for a passive investment depends on management’s intent with respect to that investment. Management’s intent is generally classified into one of three categories: (1) hold-to-maturity investments—investments in bonds that management intends to hold until the maturity date of the bonds;1 (2) trading securities—investments in either bonds or stocks that management intends to actively trade with the objective of generating profits from short-term changes in the prices of those securities; or (3) available-for-sale securities—investments in either bonds or stocks that are not classified as hold-to-maturity or trading. Management will sell them “if the time is right,” but it does not intend to actively trade them for short-term profits. 1 Note that stocks do not have a maturity date, so investments in stocks cannot be classified as hold-to-maturity. This document is authorized for use only by Jennifer Robinson in ACCT-6140-1,Current Trends Acct Standards.2020 Summer Sem 05/04-08/23-PT2 at Laureate Education - Walden University, 2020. -2- UV1132 Investments in bonds classified as hold-to-maturity investments are accounted for at amortized cost. Investments in bonds or stocks classified as either available-for-sale or trading securities are accounted for using the market value method of accounting. Investments in Stock for Significant Influence Investments in the stock of another company that give the investing company a significant influence over the policies (operating, investing, and financing) and performance of the company it has invested in require a method of accounting different from that for passive investments. Although there are exceptions, investments in stock are considered investments for significant influence if the investing company owns 20% to 50% of the outstanding voting shares of the investee. Other factors may lead to the investing company having significant influence over the other company’s policies, such as other contractual arrangements, cross-border restrictions, and legal restrictions associated with electing members of the board of directors. These investments are accounted for using the equity method of accounting. Investments in Stock for Control Investments in the stock of another company that give the investing company control over the policies (operating, investing, and financing) of the company it has invested in require yet a third type of accounting. Although there are exceptions, investments in stock are considered investments for control if the investing company owns more than 50% of the outstanding voting shares of the investee. Other factors may lead to the investing company having control over the other company’s policies, similar to those mentioned above with respect to investments for significant influence. These investments are accounted for using the consolidation method of accounting. Table 1 and Table 2 summarize: Table 1. Investment in debt securities. Management intent: Hold-to-maturity Actively trade or available for sale Accounting method: Amortized cost method Market value method This document is authorized for use only by Jennifer Robinson in ACCT-6140-1,Current Trends Acct Standards.2020 Summer Sem 05/04-08/23-PT2 at Laureate Education - Walden University, 2020. -3- UV1132 Table 2. Investment in equity securities. Ownership % of outstanding voting shares:< 20%="" 20%="" to="" 50%=""> 50% Category: Passive Significant influence Control Management intent: Actively trade or available for sale N/A N/A Accounting method: Market value method Equity method Consolidation method This note discusses the accounting for passive investments in equity and debt securities (heretofore called “marketable securities”). Statement of Financial Accounting Standard No. 115, Accounting for Certain Investments in Debt and Equity Securities (SFAS No. 115), addresses the accounting and reporting for marketable securities. However, because SFAS No. 115 is complex in its original form, this reading provides a simplified explanation of how to apply it. Marketable Equity Securities When management invests in marketable equity securities, it classifies those securities as either trading securities or available-for-sale securities, depending on its intent with respect to those investments. Trading securities are securities a company intends to actively trade with the objective of generating short-term profits from short-term changes in prices of the securities. They are almost always classified as current assets on the balance sheet. Available-for-sale securities are securities a company does not intend to actively trade, but in which a company invests to generate a return to use to support company operations on an ongoing basis. This classification does not mean that the company cannot sell the investment; it simply means that management’s intent is simply not to actively trade the security to generate short-term profits from short-term fluctuations in the security’s price. They are classified as current assets if management expects to sell them in the upcoming year, or noncurrent assets if not. Table 3 shows an example investment portfolio and provides data for all subsequent illustrations. This document is authorized for use only by Jennifer Robinson in ACCT-6140-1,Current Trends Acct Standards.2020 Summer Sem 05/04-08/23-PT2 at Laureate Education - Walden University, 2020. -4- UV1132 Table 3. Example investment portfolio. Year 1 Year 2 Cost Market Difference Cost Market Difference Security #1 $20,000 $22,000 $2,000 $20,000 $23,000 $3,000 Security #2 30,000 25,000 (5,000) 30,000 27,000 (3,000) Security #3 $25,000 $24,000 $(1,000) $25,000 $19,000 $(6,000) The flowchart in Exhibit 1 portrays a series of pertinent issues and queries to be considered with respect to equity securities in the application of SFAS No. 115. Assume (as is often the case) that these queries are made as of year end. Securities classified both as available- for-sale and trading face the same set of questions; only the required accounting entries differ. Temporary changes in value—Trading securities Let’s examine trading securities first. The initial step, as we see on our flowchart in Exhibit 1, is to compare the current market value of each separate equity security with its recorded cost. If the market value is equal to the original cost of the investment, no accounting entry is required. If the market value is less than the original cost, management must determine whether the decline is permanent or temporary—an important determination that will affect the way the decline is handled. Temporary declines are short-term fluctuations that are expected to reverse themselves (e.g., a general decline in the stock market). If management decides that the decline in the value of an individual security is temporary, an accounting transaction must be recorded to reflect the decline in value. If the security has been classified as a trading security, this is accomplished by decreasing the security asset account and by reducing income statement profits (a retained earnings account) for the “unrealized holding loss.”2 In the Table 3 year 1 example, the market value of security #2 is $25,000, as compared with a cost of $30,000. Assuming that management judged the decline in the value to be temporary, the following accounting entry would be made: Retained earnings (OE) (unrealized holding loss) (dec.) $5,000 Investment in trading securities–Security #2 (A)3 (dec.) $5,000 The rationale for decreasing retained earnings in this way (i.e., recording an unrealized loss on the income statement) is that management expects to hold its trading securities only for a short time, trading them frequently to generate profits from short-term fluctuations in their prices; therefore, it is assumed that a portfolio market decline below cost is unlikely to reverse