Discussion Question 1: Veritae, Inc. maintains an investment portfolio for liquidity and to enhance earnings. Included in the investment portfolio is $500,000 in bonds of D'Elegant Home Construction. The company's chief financial officer (CFO), Gaylord Kwame read in yesterday's Wall Street Journal that Moody's just downgraded D'Elegant's bonds because of the slowdown in the housing market. Gaylord wants you to research the current accounting requirements related to declines in the value of investment securities.
Research about accounting requirements of investment securities. Based on your research and understanding, answer the following questions:
- How would you account for the decline of the value of the investment securities required by GAAP?
- Does the treatment of the decline in value differ depending on whether the investment is accounted for as held-to-maturity, available-for-sale, or trading securities? Why or why not?
- If the investment was an equity investment in D'Elegant, how would your answer change?
Discussion Question 2: The decline and fall of Enron and its auditors were well publicized. Enron used special purpose entities (SPEs) to keep from reporting certain liabilities on their balance sheet. You may be surprised to know that their reporting of these entities was consistent with GAAP at that time.
Subsequently, Financial Accounting Standards Board (FASB) Interpretation Number 46 (revised December 2003), or FIN 46(R), was issued to address reporting of these types of entities, which are now referred to by the more general name of variable-interest entities (VIEs). This standard requires companies to consolidate VIEs based on risks and rewards rather than percentage ownership.
Research about Enron. Based on your research and understanding, respond to the following:
- Analyze and evaluate whether these guidelines will increase the quality of information investors receive about risks related to VIEs.
- Rationalize and justify your position using Enron or any other company—that either uses or has used SPEs or VIEs—as an example.
If there is a decline in the value of investment securities, the decline is written off. This is the general rule. Since the portfolio is $500,000 in bonds of D'Elegant Home Construction, the downgrading by Moody's means that there is a decline in the value of investment.
The treatment of the decline in value differs depending on whether the investment is reported as held-to-maturity, available-for-sale, or trading securities. The first requirement is that the company has to judge if the decline in value is not temporary. If the decline in value is considered not temporary, the difference between the cost and fair value of the investment at the balance sheet date is reporting in earnings.
If the investment is in trading securities, these are measured at fair value in the financial statements, and unrealized holding gains and losses are included in earnings. If the securities are available for sale, that have readily determinable fair values are measured later at fair value in the statement of financial position. The unrealized holding gains and losses are excluded from earnings and reported in other comprehensive income until realized. If the securities are held to maturity, they are measured subsequently at amortized cost in the ...
The solution to this problem provides a clear explanation on the subject of variable interest entity. This solution has been completed in over 700 words and includes four references.