Wecker is the controller for Wildcat Company, which has numerous long-term inves

Question

Wecker is the controller for Wildcat Company, which has numerous long-term investments in debt securities. Wildcat's investments are mainly in 10-year bonds.Wecker is preparing its year-end financial statements. In accounting for long-term debt securities, she knows that each long-term investment must be designated as a held-to-maturity or an available-for-sale security. Interest rates rose sharply this past year causing the portfolio's market value to substantially decline. The company does not intend to hold the bonds for the entire 10 years.
Wecker also earns a bonus each year which is computed as a percent of net income.

Questions:
2 pts 1. Will Wecker's bonus depend in any way on the classification of the debt securities? Explain?
3 pts 2. What criteria must Wecker use to classify the securities as held-to-maturity or available-for-sale.?

Explanation / Answer

1.Held-to-maturity investments are bought at par or at premium or at discount. The premium or discounted will be transferred to income or expenditure along with the interest received at agreed periods. Interest will be received at agreed rate and at fixed interevals. The principal amount will be received at the end of maturity and it will be the fixed amount on which interest is calculated. So, in this case the variation in market rates of maturity bonds need not be accounted for. In the present case the interest rates are raising and naturally the held to maturity type bonds will be sold at discount in the market as the market rate of interest is higher than the held for maturity interest. By continuing to classify as bonds held for maturity By this option Wecker can avoid booking loss in market value of bonds to income statement and there by avoid fall in net income which is basis for her bonus calculation. These assets are treated as non-current assets.

Available For Sale securities are carried at readily available fair value on the balance sheet, and unrealized holding gains and losses are excluded from earnings and recognized as a separate component of equity in Accumulated other comprehensive income.

Since the company does not intend to hodl the securities for maturity it is advisable to classify them as Available for Sale which classification is not impacting Wecker's bonus as net income is not affeced immediately. However, on sale the profit or loss will affect the net income affecting bonus calculation. Investment is shown in current or long term investment depending on intention to sell in next 12 months or more.

2. Since classification of securities is an accounting policy matter where intention at the time of purchase is primary for classifying asset as trading security or held for sale or held for maturity, it is advisable that assets be classified as for sale when there is no intention to hold for maturity. Again, when the decision at the time of investment is to hold a particular security for maturity the same be classified accordingly and shown as non-current asset unless maturity is below 12 months. The accounting standaards are very clear that intention at the time of purchase be basis for classification and since the company does not intend to hold to maturity they need to be classified as available for sale since fair value must be readiy available.

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