2.5. Short-term investments in bonds

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Do curso por Moscow Institute of Physics and Technology

Core Concepts of Accounting – Numbers and People

5 classificações

Moscow Institute of Physics and Technology

Core Concepts of Accounting – Numbers and People

5 classificações

Curso 3 de 5 em Specialization Understanding Modern Finance

Whenever the word “accounting” is pronounced, it is immediately associated with the need to memorize endless boring numbers. However, it is the common financial statements that contain important information that provides inputs for valuation of investment projects. The only challenge is how to properly extract them. Accounting and finance are indeed intertwined. Sometimes people that are not experienced in the area even mix them up. But most often emphasis in accounting is on numbers. Still, the deep understanding of key accounting concepts helps reveal the interests and actions of people behind these numbers. And the human dimension of accounting adds invaluable insight in the potential of successful project implementation. This Course discusses core ideas and concepts of both financial and managerial accounting. It by no means pretends to be comprehensive to any extent. But, being rather an accounting overview, it focuses on the issues that are most relevant and important for effective valuation of investment projects. The learners will gain insight into the essence of accounting. They will be able to use the obtained knowledge and skills to successfully advance in their career at a financial institution, as well as in the area of financial management at non-financial businesses. To pursue a career in accounting, a more detailed study is strongly recommended.

Na lição

Operational Assets. Depreciation. Short-Term Investments. Long-Term Liabilities. Shareholders’ Equity. Some Tax Issues

Week 2 is devoted to long-term assets and liabilities. We start with operational assets and see the role of depreciation and amortization in financial accounting and compare it to the way depreciation is used in valuation of investment projects. Then we discuss how financial investments in securities – stocks and bonds – are treated in accounting dependent upon goals and time horizon of holding and/or issuing of these securities. You will see how financial concepts (present values) are used in accounting for bond premium/discount amortization. Finally, an overview of the accounting approach to taxes is provided. On an example, you will study the core idea of deferred taxes.

2.1. Operational assets – types and accounting approach13:17

2.2. Depreciation11:14

2.3. Depreciation tax shield8:53

2.4. Intangible assets – accounting and amortization7:22

2.5. Short-term investments in bonds10:19

2.6. Short-term investments in stocks12:33

2.7. Bonds (1) – parameters and accounting approach10:31

2.8. Bonds (2) – amortization of premium/discount13:34

2.9. Equity (1) – accounting for common and preferred stock11:37

2.10. Equity (2) – treasury stock and stock dividends12:15

2.11. Accounting for taxes – an overview9:11

2.12. Deferred taxes – an example8:32

Conheça os instrutores

Konstantin Kontor
Director and Professor of Finance and Strategy
American Institute of Business and Economics (AIBEc)

Now, I'll say few words about marketable securities.

Well, we could have talked about that in quite some detail but we've done so already.

We spent quite a few episodes in our capital markets course.

We talked about that in the corporate finance course.

So, by that time, hopefully,

you all have an idea of what these securities are.

Now for us here,

the important breakdowns will be only by the term, short-term versus long-term.

And again, strictly speaking,

we can say that they may be both assets

and liabilities, because, for example,

if we buy them and keep in the hope of receiving some gain or some interest,

then this is an asset,

while we are issuing them to raise capital,

this is clearly a liability.

So for now, I am just pronouncing in this episode some ways that we

treat short-term investments in bonds in our accounting approach.

Again, for short-term, we have to say that this is liquid,

it can be easily converted to cash,

and then the time horizon is here less than one year.

Other than that, if not,

then we come here.

So, we will analyze some most simplistic cases of short-term investments in bonds,

and we would say that this is a bond that the overall face value will be $100,000.

So, basically, these are 100 of

normal bonds because you remember that the normal face value of bond is $1,000.

And then, the cost at which we will buy it will be 96,000.

So we will buy them with a discount.

Now, they will all carry at

six percent annual, six percent coupon.

So, basically, a six percent semi-annual coupon.

So you can say that in an year,

you will have made $6,000 from that,

and then we will see how that proceeds.

Now, case one, how do we record the acquisition?

Well, first of all,

we have to record the acquisition at cost.

And again, this cost,

what does it include?

Well, purchase price clearly,

but also all other commissions and fees,

because we do that through a broker,

and maybe even some taxes here.

Now, what accounts do we use?

We have the following account.

First of all, this is short-term investments,

and we debit that by 96,000 because this is at the cost,

and then we have

collegially cash that we credit by the same amount because we paid out cash.

So this is the acquisition phase.

Well, what do we have as an income from this investment?

We receive interest, and them we may sell this bond,

hopefully at a price that is higher than 96.

Let's see how that proceeds.

So, case two,

interest accrued.

Well, let's say in half a year,

we will have 3,000 because 6,000 that's over a year.

So in half a year,

so we open up interest receivable

and then here, interest revenue.

Now, the important thing is that in,

not in the next episode,

but in the one that after the next one,

we'll talk about a long-term investments in bonds,

and we will see that an important thing is

the amortization of the bond discount or the bond premium.

Here, for short-term investments,

we ignore that altogether because this is a short period of time and

its effect is sort of not very significant.

Now, again, like I said,

we now move to a third case,

the disposal, the sale of the security.

And again, let me remind you that the face value is $100,000,

then the coupon is six percent,

and then the cost is 96,000.

And then, we will study two cases.

In one case, we will sell that at a premium,

we will sell it at 97 and then the other will sell that at a gain,

that what we say, and then, in reality,

and the last, we'll sell it only for 94,000.

Then also, to make a story more realistic, we will say,

we have to take into account accrued interest for two months

because we do not sell it at the moment of the payment of interest.

So, how much is this?

For two months, this is one sixth of the year, so 6,000.

So this is $1,000.

Equipped with all that,

we'll flip over the page and

do case three sale.

So here, I will open up the following T accounts,

that will be cash,

this will be the short-term investments as we made before,

then we also have interest revenue,

and then the important one,

this is realized gain or loss.

And again, there will be two cases, like I said,

one is 97, the other is 94.

So, first of all,

let's start the case 3A.

3A will be in black.

So here, I'll put it

3A sold at $97,000.

And case 3B will be in

red sold at $94,000.

So how much money do we have here?

So we sold it 97, but we also have accrued interest of 1,000 below cases.

So the amount here is 98.

Well, we dispose of the investment.

So here, we credit short-term investment by 96.

Here, I'll put sort of in brackets.

But before, it was 96 here.

So now it will be nothing.

Well, then we have interest revenue of $1,000.

This is also a 3A,

and this is 3A, and this is the same for both.

Now, see what happens.

So you know that all ends should meet.

So here we're debited 98.

And on the credit side, we have 96, one.

So we have one missing.

So, in this case, here comes $1,000,

and that will be a realized gain.

Well, why is it the gain? Because we sold at the higher amount,

and that comes at this gain lost.

This is sort of a revenue account.

Now let's see what happens in part 3B.

In this case, how much do we have it collect?

We collect 95 because this is this plus this.

For interest, we have exactly the same story.

Here, we have exactly the same story because we have to just write this off.

See what happens.

Now, in order to make ends meet,

we have to have a loss of $2,000 here,

which is clearly from our calculations because

96 was the cost and the sales price was 94.

So this is how it normally is recorded.

And, like I said,

the approach is the same for both short-term and long-term bonds.

But as we will see in the episodes to follow,

when we account for a longer term investments in fixed income securities,

we will see a much more important component that will be

the amortization of the bond, premium or discount.

In the next episode,

we will do the same exercise for a short-term investment in equity securities.

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