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Why does one company invest in another company? Investments can be equity securities (common stock, preferred stock) or debt securities (bonds) Investments can be short-term (current asset) or long-term
Control ability of an investing company to determine operating and financing policies of another company
The degree of influence and control an investing company has over the policies of the investee company determines how we account for the investment. Main Accounting Treatments
Control (Common stock ownership > 50%) => Consolidate Significant influence but not control (Common stock ownership between 20% and 50%) => Equity method No significant influence passive investment (Common stock < 20%, or preferred stock, or bonds) accounting treatment depends on how investment is classified
when less than 20% of the outstanding voting stock is held by the investor. Securities are classified as either:
Trading Securities (stock or bonds) Available-for-sale Securities (stock or bonds) Held-to-maturity Securities (bonds only)
Trading Securities
Held
primarily for the purpose of selling them in the near future Intent is to profit on short-term price differences Classified as Current Assets Accounted for using Market Value method (investment is "marked to market")
Available-for-Sale Securities
Securities
that are NOT held primarily for the purpose of selling them in the near future Intent is to earn a return on the funds invested Classified as Current or Noncurrent Assets depending on intent of management Accounted for using Market Value method (investment is "marked to market )
that company intends to hold until maturity Generally classified as Noncurrent Assets until year bond matures Typically accounted for using Historical Cost method (effectiveinterest method of recognizing interest revenue) but may use Market Value method
acquisition of investment is recorded at cost. In periods after acquisition, the securities are reported at market value.
Unrealized (holding) gains and losses related to changes in the market value of securities are recognized.
the gains or losses are unrealized because the stock has not yet been sold
the end of each accounting period, a journal entry is recorded to adjust the book value of the investment to equal the current market value The adjustment is recorded in an Allowance to adjust to market account
Example (investment declines in value by $1,000): Unrealized holding losses 1,000 Allowance to adjust investments to market 1,000
trading securities
are reported on the income statement.
3,000
Unrealized holding gains and losses from Available-For-Sale securities are typically part of comprehensive income and are reported in the equity section of the balance sheet (as part of Accumulated Other Comprehensive Income .
Allowance to adjust to market 200,000 Unrealized gain (income stmt) 200,000* *Market value (1,000,000) book value (800,000)
Available-for-Sale
Assume
Motorola classifies its Dell stock as Available-for-Sale. How would the journal entries differ?
Would
*Gain = Selling price (950,000) Cost (800,000) Unrealized holding gain (OCI) 100,000 Allowance to adjust to market
100,000
Bond book value on 12/31/Year 1? = $852,666 + $5,267 = $857,933 Entry on 12/31/Year 2: Cash Bond investment Interest revenue *$857,933 10%
It is presumed that the investment is made as a long-term investment Used when an investor can exert significant influence over an investee-- assumed when the investment is between 20% 50% of the total common stock outstanding Original acquisition of ownership interest is recorded at cost
value
Equity Method
Effect on Investment Account Reduce investment for dividends received. Investee Increase (decrease) Net Income investment by our (Loss) proportionate share. Adjusting Item Dividends
480,000*
report the financial information from two or more different companies as if they were one company
Dividend Income + Interest Income + Gains* !Losses* Fair Value of Investments at Beginning of Year**
* Include both Realized and Unrealized Gains and Losses ** The ratio represents an annual rate of return if proceeds from sales remain are reinvested