Chapter 3: Investments in Equity and Debt Securities
3.1 EQUITY AND DEBT INVESTMENTS
companies record investments in debt securities when they purchase bonds, receive or accrue interest, and sell the bonds gains or losses are reported on the sale of bonds in the other revenues and gains or other expenses and losses sections in income statement equity or stock investments record investments in common stock when they purchase the shares, receive dividends and sell the shares when ownership is less than 20% and 50%, the equity method should be used when ownership is more than 50%, companies prepare consolidated financial statements company that owns more than 50% of common shares of another entity is called parent company company whose share the parent company owns is called subsidiary company, because of its shares ownership, parent company has a controlling interest in subsidiary when a company owns more than 50% of common shares of another company, it usually prepares consolidated financial statement these statements present the total revenues and expenses of the subsidiary companies it indicates the magnitude and scope of operations of the companies under common control 3.2 REPORTING INVESTMENTS trading securities o brought and held primarily for sale in the near term to generate income on short-term price differences available-for-Sale Securities o held with the intent of selling them sometime in the future held-to-maturity securities o debt securities that the investor has the intent and ability to hold to maturity 3.2.1 Trading Securities companies hold trading securities with the intention of selling them in a short period (usually less than a month) trading means frequent buying and selling companies report trading securities at fair value and report changes from cost as part of net income changes are reported as unrealised gains and losses because securities have not been sold unrealised gain or loss is the difference between total cost of trading securities and their total fair value companies classify trading securities as current assets if total cost of trading securities is greater than total fair value, an unrealised loss has occurred in this case, the adjusting entry is a debit to Unrealised Loss Income and a credit to market Adjustment Trading companies report the unrealised loss under other expenses and losses in income statement 3.2.2 Available-for-Sale Securities companies hold available-for-sale securities with the intention for selling these investments sometime in the future if the intent is to sell the securities within the next year or operating cycle, the investor classifies the securities as current assets in the balance sheet otherwise, it is classified as long term assets in the investments section of balance sheet companies report available-for-sale securities at fair value
3.2.3 Held-to-Maturity Securities
is the investment made by a company which it intends to hold till maturity while it has the capacity to honour such intention only debt securities can be classified as held-to-maturity because they have a definite maturity equity securities have no maturity and cannot be classified as held to- maturity a held-to-maturity investment is reported on balance sheet at its amortised cost interest income is recognised on held-to-maturity investments using the effective rate of interest method 3.3 SHORT-TERM INVESTMENT VERSUS LONG-TERM INVESTMENT 3.3.1 Short-term Investment short-term investments are securities held by a company that are readily marketable and intended to be converted into cash within the next year or operating cycle; whichever that does not meet both criteria is classified as long-term investments readily marketable o an investment is readily marketable when it can be sold easily whenever the need for cash arises intent to convert o management intends to sell the investment within next year or operating cycle, whichever longer SELF-CHECK 3. 3.3.2 Long-term Investment companies generally report long-term investments in a separate section of the balance sheet immediately below current asset long term investments in available-for-sale securities are reported at fair value investments in common shares accounted for under the equity method are reported at their equity value