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Until recently, accounting for investments in debt securities dictated amortized historical cost as the carrying basis. The only concession to current value was a provision requiring a writedown if the fair value of the investment was significantly below book value and this decline in value was "other than temporary." Otherwise, fair values were ignored.
In response to the concerns of regulators and others about the recognition and measurement of investments in debt securities, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards 115, "Accounting for Certain Investments in Debt and Equity Securities." This Statement expands the use of fair value accounting for investments in debt securities. The FASB chose to say fair value (rather than market value) "...intending the term to be applicable whether the market for an item is active or inactive, primary or secondary" (par. 109).
SFAS 115 applies only to debt and equity securities held as investments and classes debt securities into three categories:
1. Trading Securities. Those held for current resale. Reported at fair value, with unrealized gains and losses included in earnings.
2. Held-to-Maturity. Those that the entity has the positive intent and ability to hold to maturity. Reported at amortized cost (identical to the manner in which debt securities were reported prior to Statement 115).
3. Available-for-Sale. Those not classified as either trading securities or as securities held to maturity. Reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity.
Because SFAS 115 applies only to investments in debt securities, accounting for bonds issued by a company continues to be based on historical values adjusted for the amortization of any discounts or premiums. No adjustments are made to reflect the fair value of bonds payable unless the debt is extinguished prior to maturity (by actual reacquisition or by in-substance defeasance).
We're going to discuss accounting for debt securities using a fair-value approach, emphasizing economic substance over form. First we'll contrast the historical cost and fair value accounting approaches. Then we'll address some implementation issues relating to measurement and reporting of debt securities under a fair-value approach. Our hypothetical example illustrates possible solutions to these problems.
Our discussion does not parallel the categories outlined by SFAS 115....