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Trading – FVPL – Summary

  • Equity securities are represented by ownership shares as common stock or preferred stock, rights to acquire ownership shares such as stock warrants or rights, or call options. The category also includes rights to dispose of ownership in shares by way of put options.
  • Equity security is defined in FAS 115 as any security representing an ownership interest in an enterprise (for example, common, preferred, or other capital stock) or the right to acquire (for example, warrants, rights, and call options) or dispose of (for example, put options) an ownership interest in an enterprise at fixed or determinable prices. However, the term does not include convertible debt or preferred stock that by its terms either must be redeemed by the issuing enterprise or is redeemable at the option of the investor. The definition does not include redeemable preference shares.
  • Under the trade date accounting method, both the asset and the liability for the asset purchased are recognized on the date of trade and the payable is derecognized once the payment is made.
  • Under the settlement date accounting method, the entire transaction is recognized only on the date of settlement. While FAS 115 is silent as to the date on which the transaction should be recorded, the other levels of U.S. GAAP literature require trade date accounting to be followed for regular-way securities contracts, especially for broker-dealers and investment companies.
  • For regular-way contracts, the IASB gives the option to follow either trade date accounting or settlement date accounting, provided that one is followed consistently for purchases and sales of financial assets in the same category. However, the changes in the fair value of the asset should be treated properly depending upon the classification of the asset acquired.
  • Investments in equity securities that are purchased and held principally for the purpose of generating gains on resale are classified as trading securities. Investments in equity securities that are not trading securities are classified as available-for-sale (AFS) securities.
  • Trading securities are normally held by banks and other financial institutions that engage themselves in active buying and selling of securities with a view to make gains on trading. The mark-to-market process values the securities at market rates, recording the unrealized gains/loss on such securities.
  • When the investor invests in equity securities just to utilize the idle cash, without any intention to hold it for a long period or without any intention to generate gains on current resale, then such investments in equity securities are classified as available-for-sale securities.
  • Where the investor owns between 20 and 50 percent of the equity of the investee company, then the investor is presumed to have a significant influence in the operating and financial decisions of the investee company.
  • When the investor acquires more than 50 percent of the outstanding voting stock of the investee company, then the investor has controlling interest because of its majority ownership of the voting stock. Investments of this nature will necessitate the preparation of consolidated financial statements.
  • The currency of the primary economic environment in which the investor operates is the functional currency. The financial accounting records should be maintained in the functional currency and the investor is not free to choose the same. The investor’s investment activities and the currency in which the fund raises money from investors predominantly determine the functional currency. Presentation currency is the currency in which the financial statements are presented to the investors.
  • For assets and liabilities, the exchange rate at the balance sheet date is used to translate foreign currency statements into the functional currency.
  • For revenues, expenses, gains, and losses, the exchange rate at the dates on which such revenue or expense is recognized is used.
  • If the reporting currency is different from the trading currency, then every journal entry recorded is first revalued in the reporting currency, based on the market quote available for the trade currency.
  • On the reporting date, all the assets and liabilities of the investor that are designated in foreign currency should be converted into the functional currency based on the official FX conversion rates on the reporting date. This is achieved by the FX revaluation process.
  • As per the U.S. GAAP Statement of Position (SOP) 93-4, it is not mandatory to show the capital gains/loss due to change in the market rate of the asset and currency gains/loss due to change in the foreign exchange rate separately, even though the SOP indicates that such separate reporting would provide valuable information to the users of the financial statements.
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