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Investments
C O M PA N I E S M A K E I N V E S T M E N T S F O R T H R E E R E A S O N S .
F I R S T, C O M PA N I E S T R A N S F E R E X C E S S C A S H I N T O
INVESTMENTS TO PRODUCE HIGHER INCOME.
SECOND, SOME ENTITIES, SUCH AS MUTUAL FUNDS AND
PENSION FUNDS, ARE SET UP TO PRODUCE INCOME
FROM INVESTMENTS.
T H I R D , C O M PA N I E S M A K E I N V E S T M E N T S F O R S T R AT E G I C
REASONS. EXAMPLES ARE INVESTMENTS IN
COMPETITORS, SUPPLIERS, AND EVEN CUSTOMERS
Short Term versus Long Term Investments
 Short-Term Investments
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Investments that mature between 3 and 12 months are short-term
investments.
management intends to convert to cash within one year or the operating
cycle, whichever is longer
are readily convertible to cash
reported under current assets and are similar to cash equivalents
 Long-Term Investments
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not readily convertible to cash or are not intended to be converted into
cash in the short term
funds earmarked for a special purpose, such as bond sinking funds and
investments in land or other assets not used in the company's operations
reported in the noncurrent section of the balance sheet, often under
Long-Term Investments.
Debt Securities versus Equity Securities
 Debt securities reflect a creditor relationship such as
investments in notes, bonds, and certificates of deposit
and are issued by governments, companies, and
individuals.
 Equity securities reflect an owner relationship such as
shares of stock issued by companies.
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Recorded at cost plus broker’s fee
Five Classifications of Accounting Treatment
 Debt or Equity
 Short Term or Long Term
 Equity – Percentage of Ownership
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Trading Securities – Fair Value on Income Statement – Mark to Market Accounting
 Debt or Equity, Short Term, Non influential ownership (less than 20%)
Available for Sale – Fair Value on Balance Sheet
 Debt or Equity, Non influential ownership (less than 20%)
Significant Influence – Equity Method
 Equity only (Between 20% and 50%)
Held to Maturity – Amortized Cost – NOTE: Covered in Bonds Chapter
 Debt only to be held until maturity
Controlling Influence – Consolidation – NOTE: Covered in more advanced accounting
 Equity only (More than 50%)
Investments Account Titles
 Both Debt and Equity Investments are entitled either
 Short Term Investment –Trading
 Long-Term Investment – XX Company
 Debt investments yield interest revenue
 Equity investments yield dividend revenue
Trading Securities – Fair Value Changes Reported on Income Statement –
Deviation from historical cost allowed because there is an active market
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Debt and equity securities company intends to actively manage and trade for profit. Frequent purchases
and sales to earn profits on short-term price changes
Always reported as current assets. Short-Term Investments – Trading (Cost plus broker’s fee)
The entire portfolio reported at its fair value
Requires a “fair value adjustment” from the cost of the portfolio.
Any market changes are reported as an unrealized gain or loss because it is not yet confirmed by actual
sales. The fair value adjustment for trading securities is recorded with an adjusting entry at the end of
each financial statement period to equal the difference between the portfolio's cost and its fair value.
Purchase
Fair Value Adj
Short-Term Investment - Trading
Cash
11,500
Fair Value Adjustment - Trading
Unrealized Gain - Income
1,500
11,500
1,500
The original cost of the instrument is maintained in one balance sheet account and the adjustment to
fair value is reported in a separate balance sheet account—an adjunct account
 Any unrealized gain (or loss) from a change in the fair value of the portfolio of trading securities is
reported on the income statement in
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Other Revenues and Gains
Other Expenses and Losses
Trading Securities – Fair Value Changes Reported on Income Statement
 Selling trading securities.
 When individual trading securities are sold, the difference between
the cash received and the original cost of the individual trading
securities that are sold is recognized as a (realized) gain or a loss.
 Record cash received minus broker’s fee
 Any prior period fair value adjustment to the portfolio is not used to
compute the gain or loss from sale of individual trading securities.
Sale
Cash
10,000
Short-Term Investment - Trading
Gain on Sale of Short-Term Investments
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9,500
500
Note, income statement account is gain on sale not unrealized gain
When the period-end fair value adjustment for the portfolio of
trading securities is computed, it excludes the cost and fair value of
any securities sold.
Available-for-Sale Securities – Can be either Short or Long Term –
Fair Value Changes Recognized on Balance Sheet
 Purchased to yield interest, dividends, or increases in fair value. They are not
actively managed like trading securities. If the intent is to sell within the
longer of one year or operating cycle, they are classified as short-term
investments. Otherwise, they are classified as long-term.
 Valuing and reporting available-for-sale securities.
 As with trading securities, companies adjust the cost of the portfolio of AFS
securities to reflect changes in fair value.
 Purchase recorded at cost plus broker’s fee and sale recorded at cost minus
broker’s fee
 Done with a fair value adjustment to its total portfolio cost
Fair Value Adj
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Fair Value Adjustment - Available for Sale
Unrealized Gain - Equity
2,250
2,250
Any unrealized gain or loss for the portfolio is not reported on the income
statement. Instead, it is reported in the equity section of the balance sheet
Purchase and Sale of Non Influential Investments
Purchase of Shares
Number of Shares
Price per Share
Total Share Cost
Broker's Fee
Total Paid
Purchaser's Price per Share
S-T Investment - AFS
Cash
Sale of Shares
Number of Shares
Price per Share
Total Share Cost
Broker's Fee
200
25
5,000
200
5,200
200
26
5,200
5,200
100
27
2,700
(125)
2,575
Cash
2,575
Loss on Sale of Investments
25
S-T Investment - AFS (100 shrs x $26)
2,600
Fair Value Determination
Fair Value Adjustment
Financial Statemement Date
Co A
Co B
Co C
Co D
Cost
162,000
15,800
14,660
8,540
201,000
Fair Value
165,400
25,000
13,250
7,000
210,650
Formula to determine loss or gain
(Analysis of entire portfolio)
Fair Value
Cost
Gain
Fair Value
Cost
Loss
210,650
201,000
9,650
197,650
201,000
(3,350)
Trading Securities
Fair Value Adjustment - Trading
Unrealized Gain - Income
9,650
9,650
Unrealized Loss - Income
3,350
Fair Value Adjustment - Trading
3,350
Available for Sale Securities
Fair Value Adjustment - AFS
Unrealized Gain - Equity
9,650
Unrealized Loss - Equity
Fair Value Adjustment - AFS
3,350
9,650
3,350
Investment in Securities with Significant Influence – Long-Term Investment –
Between 20% and less than 50% ownership
A long-term investment classified as equity securities with significant influence implies that the
investor can exert significant influence over the investee.
 The equity method of accounting and reporting is used
 Long-term investments in equity securities with significant influence are recorded at cost when
acquired.
 When the company invested in has earnings, the earnings are recorded by the investor based
upon the percentage owned by the investor. (The value of the investment is increased).
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Investment company
reports earnings
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Long-Term Investment - XX Company
Earnings from Long-Term Investment
150
150
Dividends require special mention. The receipt of cash dividends is not revenue under the equity
method because the investor has already recorded its share of the investee's earnings. Instead,
cash dividends received by an investor from an investee are viewed as a conversion of one asset
to another; that is, dividends reduce the balance of the investment account.
Investor company
receives dividends
Cash
Long-Term Investment - XX Company
260
260
Investment Purchase by Lucky Company
Dr Long-Term Invest Happy Cr
Long-Term Investment - Happy Co
540,000
Cash
(40,000 shares - Represents 40% owernship)
540,000
2014 - Happy Co reports earnings of $1,200,000. Lucky recognizes 40% of the earnings
Long-Term Investment - Happy Co
Earnings - Long-Term Investment
480,000
480,000
2014 - Happy Co declares dividends of $30,000. Lucky recognizes 40% of the dividends
Cash
Long-Term Investment - Happy Co
12,000
12,000
2015 - Happy Co reports earnings of $900,000. Lucky recognizes 40% of the earnings
Long-Term Investment - Happy Co
Earnings - Long-Term Investment
360,000
360,000
2015 - Happy Co declares dividends of $10,000. Lucky recognizes 40% of the dividends
Cash
Long-Term Investment - Happy Co
Purchase
2014 Earnings
2014 Dvds
2015 Earnings
2015 Dvds
4,000
4,000
2016 - Sale of 10,000 shares for $42 per share. Broker's fee of $150
(Cash received is 10,000 shares x $42 = $420,000 minus broker's fee of $150)
(Lucky's value per share is $1,364,000/40,000 shares or $34.10 x 10,000 = $341,000)
Cash
419,850
Long-Term Investment - Happy Co
Gain on Sale of Long -Term Investment
341,000
78,850
Balance
540,000
480,000
12,000
360,000
1,380,000
1,364,000
4,000
16,000
Investment in Securities with Controlling Influence
 A long-term investment classified as equity securities with controlling influence implies
that the investor can exert a controlling influence over the investee. An investor who owns
more than 50% of a company's voting stock has control over the investee. This investor can
dominate all other shareholders in electing the corporation's board of directors and has
control over the investee's management
 The equity method with consolidation is used to account for long-term investments in
equity securities with controlling influence. The investor reports consolidated financial
statements when owning such securities. The controlling investor is called the parent, and
the investee is called the subsidiary.
 A company owning all the outstanding stock of a subsidiary can, if it desires, take over the
subsidiary's assets, retire the subsidiary's stock, and merge the subsidiary into the parent.
However, there often are financial, legal, and tax advantages if a business operates as a
parent controlling one or more subsidiaries. When a company operates as a parent with
subsidiaries, each entity maintains separate accounting records. From a legal viewpoint, the
parent and each subsidiary are separate entities with all rights, duties, and responsibilities
of individual companies.
 Consolidated financial statements show the financial position, results of operations, and
cash flows of all entities under the parent's control, including all subsidiaries. These
statements are prepared as if the business were organized as one entity.