Chapter 18
Accounting for Investments
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
In this chapter…
Balance Sheet
Current Assets
Cash
Chapter
Current Liabilities
10000
Accounts Payable
Accounts Receivable
20000
Wages Payable
Notes Receivable
15000
Utilities Payable
Marketable Securities
Inventory
18
120000
2000
Notes Payable
20000
Bonds Payable
600000
Equipment
250000 Owner’s Equity
Buildings
500000
Total Assets
25000
25000 Long-Term Debt
Capital Assets
Goodwill
5000
60000
Common Stock
300000
Retained Earnings
48000
1000000 Total Liabilities + OE
1000000
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Purpose of Investments
• Why would a company invest in the ownership or debt of
another:
–
–
–
–
–
–
To earn income on available excess cash
To earn a capital gain
To participate in new technologies or markets
To build a favourable relationship with a supply chain member
To influence the operations of a supply chain member
To control the operations of a supply chain member
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Temporary vs. Long-term Investments
• Temporary Investments – aka, short-term investments or
marketable securities can be in the form of purchasing or
investing in debt or equity instruments.
• These are classified and reported as current assets if:
– Management intends to convert them to cash within a year
– They can be readily converted to cash
• These are classified as long-term investments if:
– They do not meet the requirements of the above
– They are not easily “marketable” (sellable)
• Long term assets are reported in their own section of the
asset side of the balance sheet usually under the heading
“Long-term Investments”
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Accounting for Temporary Investments
• When a company buys a temporary investment, the journal
entry looks like:
Date
Account Titles and explanation
Jan 1
Marketable Securities
PR
Debit
Credit
25000
Cash
25000
– The Temporary Investment account is created to hold the value of
the new asset. Other names could be used such as “Marketable
Securities” or “Bonds Receivable”.
• When the investment is sold, a journal entry could be:
Date
Account Titles and explanation
Jan 1
Cash
PR
Debit
Credit
27500
Gain on Marketable Securities
2500
Marketable Securities
25000
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Accounting for Temporary Investments
• When the investment (whether shares or bonds) are
purchased, the cost allocated to them are the purchase price
plus all costs necessary to acquire them (kind of like
Inventory)
– This includes purchase price, commissions
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Accounting for Temporary Investments
• When reporting the investment on the balance sheet, the
investment must be reported at the lower of cost or market
value
– So if you go off and buy 100 shares of WestJet at $100 in October,
then when you prepare the balance sheet in December and the
market value is only $90, you must report the shares as having a
value of $90
– If you hold a number of shares from a number of different
companies, you do this on an aggregate basis.
– When you go to report the shares, you will declare a Loss on
Market Decline of Temporary Investments, and write that loss into
a contra-account called Allowance to Reduce Temporary
Investments to Market
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Accounting for Temporary Investments
• So, you bought 100 shares at $250 of XYZ Co.
– The purchasing journal entry is
Date
Account Titles and explanation
PR
Oct 11 Marketable Securities
Debit
Credit
25000
Cash
25000
– Lets say the shares drop to $240 by the time you prep the BS
Date
Account Titles and explanation
PR
Dec 31 Loss on Market Decline
of Marketable Securities
Allowance to Reduce
Marketable Securities to FMV
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Debit
Credit
1000
1000
Accounting for Temporary Investments
Balance Sheet
Current Assets
Cash
Current Liabilities
10000
Accounts Payable
AR
20000
Wages Payable
Notes Receivable
15000
Utilities Payable
Market Securities
Less: Allowance
Inventory
Capital Assets
25000
1000
Total Assets
25000
2000
Long-Term Debt
24000
Notes Payable
20000
120000
Bonds Payable
600000
750000 Owner’s Equity
Common Stock
Goodwill
5000
60000
300000
Retained Earnings
47000
999000 Total Liabilities + OE
999000
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Accounting for Temporary Investments
• Or, you bought 100 shares at $250 of XYZ Co.
– And when you prepared the BS, they were up $10
Date
Account Titles and explanation
PR
Dec 31 Allowance to Reduce Temp
Investments to Market
–
–
–
–
Debit
Credit
1000
Gain on Market Recovery
1000
of Temp Investments
This either reduces or eliminates the loss.
If it eliminates the loss, or even now causes an overall gain, the
contra-account is removed and the investments are shown at the
lower of cost or market, which would now be cost.
The entries only affect the Allowance account, not the actual asset
Note: If you have a gain, you don’t report it as income until the
sale (conservative principal)
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Long-term Investments
• Long-term investments are recorded at total cost to acquire
the investment (purchase price plus commissions)
• There are 4 types of long term investments
– Debt investments to be held for a long time
– Share investments of less than 20% of the voting shares
– Share investments of more than 20% but less than 50% of the
voting shares
– Share investments of more than 50% of the voting shares
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Long-term Debt Investments
• Say a company purchases some bonds of another company
Date
Account Titles and explanation
PR
Oct 11 Investment in Hydro Bonds
Debit
Credit
10000
Cash
10000
• Then, the bonds earn, but not yet pay interest
Date
Account Titles and explanation
PR
Dec 31 Interest Receivable
Debit
Credit
500
Interest Revenue
500
• Then the company sells the bonds
Date
Account Titles and explanation
PR
Mar11 Cash
Debit
Credit
10000
Investment in Hydro Bonds
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
10000
Share Investments Less Than 20%
• Long-term investments in shares have the possibility of
offering the investing company an opportunity to affect the
operations of the purchased company.
• Significant Influence is the ability of the investor to
influence the investee even if the investor only owns less
than 50% of the shares of the investee
– As a general rule, significant influence does not exist if less than
20% of voting shares are owned.
– If this is the case the accounting for this condition is the same as
the accounting method used for short-term shares investments.
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Share Investments of 20% to 50%
• In this case, it is expected that significant influence could exist.
• The Equity Method of accounting and reporting is used for
long-term investments.
• The purchase is recorded in this situation (at cost) as it is in the
short-term investment scenario
• But, in addition, the investor company must record its portion
of a gain or loss of that of the investee
Date
– The gain is based on the investor’s % ownership of the investee
– The value of the investment is written up, and the Earnings noted as
Other Income
Account Titles and explanation
PR
Debit
Credit
Oct 11 Investment in ABC Shares
Earnings from ABC
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
30000
30000
Share Investments of more than 50%
• An investor who owns more than 50% of the voting shares
of the investee and intends to hold this position for the
long term has a Controlling Interest in the investee
• Control means the investor company dictates the
operations of the investee, not just influence
• To account for this situation, the parent reports consolidate
financial statements for it and all its subsidiaries.
– We won’t go into this.
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Reporting Long-term Investments
• Long-term Investments are reported in their own section of
the balance sheet
• They are reported at cost, even if market is below cost, so
long as this is a temporary dip. If it is expected to be
permanent, then the accountant must write down the value
of the investment.
– This is not done with an Allowance account, but rather by writing
down directly to the asset account of the investment.
– For the basis of future losses or gains, this new cost is now the
point from which to calculate
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD