The final type of investment involves securities held to maturity. For obvious reasons, equity securities cannot fall under this category, as they have no maturity date. However, assets like bonds, mortgages, notes receivable, and other loans can all fall into this category.
These securities, because they are held until maturity at a given interest rate, experience no gains or losses in value, and thus are carried at the book value from the original transaction. Of course, these assets could have a premium or discount attached to them, depending on their interest rate relative to that of the market.
This extra premium (or less discount) would be amortized over the life of the security, being reduced with each receipt of interest revenue. State Street refers to these assets’ carrying value, or the net value of the investment and its corresponding premium or discount, as their amortized cost amount.
The amortized cost amount for State Street’s held to maturity securities is
$11.38 billion, while the market value for these same assets is $11.66 billion. The difference between these two values represents the gain that State Street would
incur if they were to sell these securities at fair value. This increase in price is likely derived from a decrease in interest rates, as the two have an inverse relationship.
In the case that State Street needs to increase their cash flows or liquidate entirely, these assets may be sold. However, it is generally in a company’s best interest to hold on to these investments and receive their interest payments, assuming major fluctuations in the market interest rate have not caused drastic price changes.
Statement of Cash Flows
When any of these securities are sold or purchased, the effects are generally seen on the statement of cash flows. Due to the nature of these assets, these corresponding cash flows can be found on the investing section of this statement. For most non- financial companies, the amount of cash used or provided by the sale of these investments might not be as significant as, say, selling old machinery. However, for State Street, a financial company, the transactions relating to investment securities are quite large. This can be seen through an analysis of this company’s Statement of Cash Flows. According to this statement, State Street purchased over $60 billion of available-for-sale investment securities in 2012. Below is the corresponding journal entry.
Investment Securities AFS 60,812,000,000
Cash 60,812,000,000
This is a major cash outflow proportional to the business, as total assets for State Street are around $222 billion. If these assets fail to meet their yield expectations, this could be devastating for the company.
In addition to this large purchase, State Street also sold around $5 billion in these types of securities. There are a couple of interesting elements involved with this journal entry, however. First, in order to sell these assets, they must be written back to original cost, or historical book value. Thus, the asset would need to be credited for its current fair value, and the unrealized holding gains account would need to be debited. This results in a net credit of the asset’s historical cost. Also, there will generally be cash associated with the purchase, unless it is traded for another asset, and there may be an additional gain or loss on the sale. The gain from sale would be included in net income for the period. The journal entry below will demonstrate the explanation above.
Cash 5,399,000,000
Unrealized Holding Gains 67,000,000 Investment Securities AFS 5,411,000,000 Gain from Sale of Securities 55,000,000
This entry depicts the investing activities providing cash flows in a very general sense. We can use this entry to determine the original cost of this asset. As mentioned above, if we take the net difference between the Investment Securities’
fair value at the time of the sale and its unrealized holding gain, we will find that the historical cost for this investment was $5,411,000,000 - $67,000,000 =
$5,344,000,000. (If the asset had a balance in unrealized holding losses, then the original cost would be found with the sum of the fair value and the amount in the loss account.) The $55 million gain from sale is derived from the difference between the cash received and the historical cost of this asset.
The following T account helps demonstrate State Street’s activity for 2012 regarding held-for-sale securities.
Net Unrealized Holding Gain (loss) on AFS Securities
181,000,000 67,000,000
1,367,000,000
1,119,000,000
This table can be explained with three events. The first, is that $181,000,000 simply comes from the ending balance in 2011. The debit of $67,000,000 was shown above during the sale of securities. The credit of $1,367,000,000 was done as an adjusting entry at year-end to bring the securities to fair value. The journal entry for this adjustment was as follows.
FV Adjustment AFS 1,367,000,000 Unrealized Holding Gain 1,367,000,000
Thus, the ending balance is $1,119,000,000, which can be reconciled with their notes on Investment Securities. This adjustment would have no effect on the Statement of Cash Flows. This is because changes in fair value for securities available-for-sale are reported as Other Comprehensive Income, not Net Income.
11. Revenue Recognition—Groupon
Executive Summary
In this analysis, we discuss the major implications of recognizing revenue and the risks associated with this topic. We assess these risks at an industry wide level for retail companies such as Walmart, Amazon, and Groupon. This involves comparing and contrasting their business models and experiences and how these differences affect the levels of risk they experience.
Furthermore, we delve into an analysis on revenues vs. stock prices and attempt to derive trends from Amazon’s financial position regarding these two items. Looking at over a decade of data, we draw a conclusion that stock prices tend to be more positively correlated with revenues than with net income. We further discuss possible reasons for this correlation.
Finally, we review some of the accounting errors that Groupon made during its first few years as a public company. We go into the criteria necessary for reporting gross revenue versus a simple reporting of net revenue. We then elaborate on the necessity for allowance accounts to bring revenue to a more accurate amount when accounting for risks of returned items. We show Groupon’s faulty reasoning relating to this topic and how it affected their financial statements.
Lastly, we discuss how it is possible for reporting corrections to significantly reduce a company’s revenue and net income, all while having zero effect on their statement of cash flows.