Marketable Securities, Time Value of Money 15.501/516 Accounting Spring 2004 Professor S. Roychowdhury Sloan School of Management Massachusetts Institute of Technology March 31, 2004  )  Marketable Securities Trading securities (debt and equityAcquired for short-term profit potential  Changes in market value reported in the income statement (net of taxes), investment marked to market in the balance sheet  Purchases and disposals reported in operating section of SCF  Held to maturity (debt only)  Acquired with ability and intent to hold to maturity  No changes in market value reported in the income statement, thus investment carried at historical cost in the balance sheet  Interest income reported in operating section of SCF  Available for sale (debt and equity)  Securities not classified as either of above  Changes in market value reported in “Other Equity” (net of taxes), instead of the income statement!  Purchases and disposals reported in investing section of SCF 2 What Is “Other Equity”?  lass?So far, what have we seen in c Stockholders’ Equity (SE) = Contributed capital (CC) + Retained Earnings (RE)  The above is a simplification! It is known as the “Clean Surplus Equation”.  In fact, Clean Surplus is often violated  SE = CC + RE + Other Equity  What causes changes in “Other Equity”?  Changes in the market value of AFS securities, for one! 1 3An Illustration: Acquisition and Dividends (2002) On Jan. 1, 2002, Ace acquired 500 common shares of security MITCo for $25/share. C MS adj+MS= DTL OE RE Trading: “Adjunct” AFS: account On Nov. 30, 2002, Ace received $625 in dividends ($1.25/share of MITCo) C MS +MSadj = DTL OE RE Trading: AFS: 4 An Illustration: Acquisition and Dividends (2002) On Jan. 1, 2002, Ace acquired 500 common shares of security MITCo for $25/share. C MS +MSadj = DTL OE RE Trading: (12,500) 12,500 AFS: Same as above On Nov. 30, 2002, Ace received $625 in dividends ($1.25/share of MITCo) C MS +MSadj = DTL OE RE Trading: AFS: 5 An Illustration: Acquisition and Dividends (2002) On Jan. 1, 2002, Ace acquired 500 common shares of security MITCo for $25/share. C MS +MSadj = DTL OE RE Trading: (12,500) 12,500 AFS: Same as above On Nov. 30, 2002, Ace received $625 in dividends ($1.25/share of MITCo) C MS +MSadj = DTL OE RE Trading: 625 625 AFS: Same as above “Investment income” on I/S 6Unrealized Gains and Losses (2002) On Dec. 31, 2002, MITCo is trading at $30/share. Ace elected to keep the shares, and has a tax rate of 30%. Trading: C BB: MS12,500 +MSadj = DTL OE RE EB: AFS: BB: C MS12,500 +MSadj = DTL OE RE EB: 7 Unrealized Gains and Losses (2002) On Dec. 31, 2002, MITCo is trading at $30/share. Ace elected to keep the shares, and has a tax rate of 30%. Trading: BB: C MS12,500 +MSadj 2,500 = DTL OE RE 2,500 EB: AFS: BB: C MS12,500 +MSadj = DTL OE ($30 – 25) x 500 “Investment income” on I/S RE EB: 8 Unrealized Gains and Losses (2002) On Dec. 31, 2002, MITCo is trading at $30/share. Ace elected to keep the shares, and has a tax rate of 30%. Trading: C MS +MSadj = DTL OE RE BB: 12,500 2,500 2,500 750 (750) 2,500 x 0.3 “Income tax expense” on I/S EB: AFS: C MS +MSadj = DTL OE RE BB: 12,500 EB: 9Unrealized Gains and Losses (2002) On Dec. 31, 2002, MITCo is trading at $30/share. Ace elected to keep the shares, and has a tax rate of 30%. Trading: BB: C MS12,500 +MSadj = DTL OE RE 2,500 2,500 750 (750) EB: 12,500 2,500 750 AFS: BB: C MS12,500 +MSadj = DTL OE RE EB: 10 Unrealized Gains and Losses (2002) On Dec. 31, 2002, MITCo is trading at $30/share. Ace elected to keep the shares, and has a tax rate of 30%. Trading: C MS +MSadj = DTL OE RE BB: 12,500 2,500 2,500 750 (750) EB: 12,500 2,500 750 AFS: C MS +MSadj = DTL OE RE BB: 12,500 2,500 750 1,750 No I/S effect EB: 11 Unrealized Gains and Losses (2002) On Dec. 31, 2002, MITCo is trading at $30/share. Ace elected to keep the shares, and has a tax rate of 30%. Trading: BB: C MS12,500 +MSadj 2,500 = DTL OE RE 2,500 750 (750) EB: 12,500 2,500 750 AFS: BB: C MS12,500 +MSadj 2,500 = DTL 750 OE 1,750 RE EB: 12,500 2,500 750 1,750 12C j = RE Unrealized Gains and Losses (2003) On Dec. 31, 2003, MITCo is trading at $27/share. Ace elected to keep the shares. Trading: MS +MSad DTL OEBB: 12,500 2,500 750 EB: AFS: BB: C MS12,500 +MSadj 2,500 = DTL750 OE1,750 RE EB: 13 C j = RE Unrealized Gains and Losses (2003) On Dec. 31, 2003, MITCo is trading at $27/share. Ace elected to keep the shares. Trading: MS +MSad DTL OEBB: 12,500 2,500 750 (1,500) (1,500) ($27 - $30) x 500 “Investment income” on I/S EB: AFS: C MS +MSadj = DTL OE RE BB: 12,500 2,500 750 1,750 EB: C j = RE Unrealized Gains and Losses (2003) On Dec. 31, 2003, MITCo is trading at $27/share. Ace elected to keep the shares. Trading: MS +MSad DTL OEBB: 12,500 2,500 750 (1,500) (1,500) (450) 450 EB: ($1,500) x 0.30 “Income tax benefit” on I/S AFS: C MS +MSadj = DTL OE RE BB: 12,500 2,500 750 1,750 EB: 15 14C j = RE Unrealized Gains and Losses (2003) On Dec. 31, 2003, MITCo is trading at $27/share. Ace elected to keep the shares. Trading: MS +MSad DTL OEBB: 12,500 2,500 (1,500) 750 (450) (1,500) 450 EB: 12,500 1,000 300 AFS: BB: C MS12,500 +MSadj 2,500 = DTL750 OE1,750 RE EB: 16 C j = RE Unrealized Gains and Losses (2003) On Dec. 31, 2003, MITCo is trading at $27/share. Ace elected to keep the shares. Trading: MS +MSad DTL OEBB: 12,500 2,500 750 (1,500) (1,500) (450) 450 EB: 12,500 1,000 300 AFS: C MS +MSadj = DTL OE RE BB: 12,500 2,500 750 1,750 (1,500) (450) (1,050) No I/S effect EB: 17 C j = RE Unrealized Gains and Losses (2003) On Dec. 31, 2003, MITCo is trading at $27/share. Ace elected to keep the shares. Trading: MS +MSad DTL OEBB: 12,500 2,500 750 (1,500) (450) (1,500) 450 EB: 12,500 1,000 300 AFS: BB: C MS12,500 +MSadj 2,500 (1,500) = DTL750 (450) OE1,750 (1,050) RE EB: 12,500 1,000 300 700 18C MS j = RE Realized Gains and Losses (2004) On Feb. 14, 2004, Ace sold all of its investment in MITCo, then trading at $36/share.