Investments
ACCOUNTING FOR INVESTMENT SECURITIES
There are two potential types of investments that a corporation might hold: investments in equity
securities and investments in debt securities. The type of investment has an impact on the
accounting treatment. In addition, management’s intent with respect to the holding of the
investment affects how the investment is accounted for in the financial statements. The following
is a schedule of the accounting treatment based on the type of investment and management’s
intentions.
Control
< 20%
< 20%
< 20%
20% - 50%
> 50%
Reporting
Category
Management Intent
Held-to-Maturity Positive intent and ability to hold
Available-for-Sale Sale subject to market factors and
company financial requirements
Trading
Subject to immediate sale
Equity Method Significant influence
Consolidation Control
Type of Security
Debt
Debt or Equity
Debt or Equity
Equity
Equity
Securities to Be Held to Maturity
Debt securities that are classified as held-to-maturity indicate that the company has both the
ability and intent to hold the securities until maturity. The investor company does not have any
influence over the operating or financial policies of the investee company. The investment in
debt securities that are held-to-maturity are recorded at the market value (original cost) on the
date of acquisition.
Example: Spencer Company purchased $40,000 of the 8%, 5-year bonds of Alexander
Company for $43,412, which provides a 6% return. The bonds pay interest semiannually.
Spencer Company has both the ability and intent to hold the securities until the maturity date.
The journal entry to record the investment would be as follows:
Date
1/1/00
Account
Debit
Investment in bonds
$40,000
Premium on bonds
3,412
Cash
To record the purchase of held-to-maturity bonds
Credit
$43,412
The following amortization table has been prepared to assist in the discussion related to the
recording of interim interest revenue and reporting the investment on the balance sheet at the end
of the accounting period.
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Investments
Amortization Schedule, 8% 5-Year Bonds to Yield 6%
Amortization
Carrying
Amount
Date
Payment
Interest
of Premium
1/1/00
$43,412
6/30/00
$1,600
$1,302
$298
43,114
12/31/00
1,600
1,293
307
42,807
6/30/01
1,600
1,284
316
42,491
12/31/01
1,600
1,275
325
42,166
6/30/02
1,600
1,265
335
41,831
12/31/02
1,600
1,255
345
41,486
6/30/03
1,600
1,245
355
41,131
12/31/03
1,600
1,234
366
40,765
6/30/04
1,600
1,223
377
40,388
12/31/04
1,600
1,212
388
40,000
We are assuming that the first interest payment will be received on June 30, 2000. The bond is
scheduled to pay $1,600 but the company paid a premium so the effective interest earned is
$1,302, the cash received net the amortization of the premium. The following journal entry
would be recorded to reflect this transaction.
Date
6/30/00
Account
Debit
$1,600
Credit
Cash
Premium on bonds
$298
Interest revenue
1,302
To record interest received, amortization of premium, and interest rearned
on the first payment
The debt securities classified as held-to-maturity are carried in the accounting records at
amortized cost (face amount plus premium/less discount). No interim unrealized gains or losses
are recognized. If Spencer Company prepares financial statements at December 31, 2001 the
investment would be reported on the balance sheet as follows:
Held-to-Maturity Investments
Corporate bonds
Plus: unamortized premium
Book value (amortized cost)
$40,000
2,166
$42,166
Available-For-Sale Securities
Equity or debt securities that are classified as available-for-sale indicate that the company is
holding these securities for some purpose other than short-term trading. The timing of the
disposition of such securities would be dictated by changes in the market for the securities or
changes in the cash flow requirements of the investor company. At the end of each accounting
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Investments
period these securities are marked-to-market. Because the securities are held for an unspecified
period, the resulting gain or loss is recorded in a special equity account, Unrealized holding
gain/loss on investments-Equity. When a company has a portfolio of investments it can be
difficult to keep track of the original or amortized cost of investments. To maintain a clean
record a separate account is established to record the resulting adjustment to the asset account,
Available-for-Sale Investments. This is an accretion or contra-asset account, Available-forSale Securities Fair Value Adjustment, depending on whether the adjustment increases or
decreases the carrying amount of the investment.
Example: Spencer Company purchased $50,000 of the 9%, 5-year bonds of Alexander
Company $46,304, which provides an 11% return. Management intends to hold this debt
security until there is a change in interest rates or the company requires the cash. The fair value
of the bonds at year-end is $47,200. To record the original purchase the company would prepare
the following journal entry.
Date
1/1/00
Account
Debit
Investment in bonds
$50,000
Discount on bonds
Cash
To record the purchase of available-for-sale bonds
Credit
$3,696
46,304
The following amortization table has been prepared to assist in the discussion related to the
recording of interim interest revenue, recording unrealized gains (or losses) at the end of the
accounting period, reporting the investment at market on the balance sheet at year-end.
Amortization Schedule, 9% 5-Year Bonds to Yield 11%
Amortization Carrying
Amount
Date
Payment
Interest
of Discount
1/1/00
$46,304
1/1/01
$4,500
$5,093
$593
46,897
1/1/02
4,500
5,159
659
47,556
1/1/03
4,500
5,231
731
48,287
1/1/04
4,500
5,312
812
49,099
1/1/05
4,500
5,401
901
50,000
We are assuming that the first interest payment will be made on January 1, 2001. In order to
prepare the year end financial statements for December 31, 2000 the company will have to
accrue the interest that will be received on the first day of 2001. The following journal entry will
accomplish this.
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Investments
Date
Account
Debit
Credit
12/31/00 Interest receivable
$4,500
Discount on bonds
593
Interest revenue
$5,093
To record interest receivable, amortization of discount, and interest rearned
on the first payment at December 31, 2000.
Available-for-sale securities are marked-to-market for financial reporting purposes. If we
assume that the fair value of the bonds at year-end are $47,200 then the following journal entry
needs to be made in order to properly reflect the fair value of the securities for financial reporting
purposes.
Date
Account
Debit
Credit
12/31/00 Unrealized holding loss on AFS investments
$303
FVA, AFS investments
$303
To mark-to-market the available-for-sale securities at year-end
Analysis of unrealized holding gain (loss)
Market value, December 31, 2000
$47,200
Carrying value
46,897
Unrealized holding gain (loss)
T-Account: Fair value adjustment, AFS debt securities
Date
Description
Debit
1/1/00 Beginning balance
$0
12/31/00 Required AJE
303
12/31/00 Ending balance
$303
T-Account: Unrealized holding (gain) loss, equity
Date
Description
Debit
1/1/00 Beginning balance
12/31/00 Required AJE
12/31/00 Ending balance
$303
Credit
Credit
0
$303
$303
To calculate this year-end adjustment, refer to the amortization table above. The carrying
amount of the investment is $46,897 and the fair market value is $47,200. The difference of
$300 increases the carrying value of the investment and end up separately stated in the equity
section of the balance sheet as presented below:
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Investments
ASSETS
Available-for-Sale Debt Securities:
Corporate bonds
Less: unamortized discount
Carrying value (amortized cost)
Fair value adjustment, AFS investments
Investment at fair value
$50,000
3,103
46,897
303
$47,200
SHAREHOLDERS' EQUITY
Unrealized holding gain on AFS investments
$303
If the ownership of available-for-sale investments continues for several accounting periods the
accounting for unrealized gains or losses becomes a little more complicated. The change in
market value is recorded from the end of the previous accounting period.
Example: At December 31, 2000, Spencer Company had the following balances in its availablefor-sale investment account and the related available-for-sale securities adjustment, and
unrealized holding gain accounts.
Available-for-Sale Equity Securities:
Baker Equipment, common stock
Sizemore Corporation, common stock
Totals
Unrealized
Original
Cost
Fair Value Gain (Loss)
$103,000
$101,000
($2,000)
45,000
51,000
6,000
$148,000
$152,000
$4,000
T-Account: Fair value adjustment, AFS equity securities
Debit
Credit
Date
Description
$0
1/1/00 Beginning balance
4,000
12/31/00 Required AJE
$4,000
12/31/00 Ending balance
T-Account: Unrealized holding (gain) loss, equity
Debit
Credit
Date
Description
$0
1/1/00 Beginning balance
4,000
12/31/00 Required AJE
$4,000
12/31/00 Ending balance
The journal entry to record this fair value adjustment is as follows:
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Investments
Date
Account
Debit
Credit
12/31/00 Fair value adjustment, AFS equity securities
$4,000
Unrealized holding gain, AFS equity securities
$4,000
To mark-to-market the available-for-sale securities at December 31, 2000
No available-for-sale investments have been purchased or sold during 2001. As of December 31,
2001 the fair market values of the two equity investments are as follows:
Baker Equipment, common stock
Sizemore Corporation, common stock
Total market value
$97,500
44,000
$141,500
In order to prepare the December 31, 2001 financial statements the available-for-sale
investments account and related available-for-sale securities adjustment and unrealized holding
gain accounts need to be adjusted to reflect the new fair values of the equity investments. The
following provides such an analysis:
Available-for-Sale Equity Securities:
Baker Equipment, common stock
Sizemore Corporation, common stock
Totals
Unrealized
Original
Cost
Fair Value Gain (Loss)
$103,000
$97,500
($5,500)
45,000
44,000
(1,000)
$148,000
$141,500
($6,500)
T-Account: Fair value adjustment, AFS equity securities
Debit
Date
Description
$4,000
1/1/01 Beginning balance
12/31/01 Required AJE
12/31/01 Ending balance
T-Account: Unrealized holding (gain) loss, equity
Debit
Date
Description
1/1/01 Beginning balance
$10,500
12/31/01 Required AJE
$6,500
12/31/01 Ending balance
Credit
$10,500
$6,500
Credit
$4,000
The required adjusting journal entry at the end of December 31, 2001 is as follows:
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Date
Account
Debit
Credit
12/31/01 Unrealized holding loss, AFS equity securities
$10,500
Fair value adjustment, AFS equity securities
$10,500
To mark-to-market the available-for-sale securities at December 31, 2001
If an available-for-sale security has been marked-to-market and then subsequently sold the sale
must be recorded by removing the marked-to-market amounts in the available-for-sale securities
adjustment and unrealized holding gains/losses accounts. For example, if on January 1, 2002
Spencer Company sold the stock in Baker Equipment for $100,000 the following journal entry
would be prepared to record the transaction.
Available-for-Sale Equity Securities:
Sizemore Corporation, common stock
Date
1/1/02
Date
1/1/02
Date
1/1/02
Unrealized
Original
Cost
Fair Value Gain (Loss)
$45,000
$44,000
($1,000)
T-Account: FVA, Available-for-Sale Securities
Debit
Description
Beginning balance
$5,500
Required AJE
Ending balance
T-Account: Unrealized Holding Gain, Equity
Debit
Description
$6,500
Beginning balance
Required AJE
$1,000
Ending balance
Account
Cash
FVA, available-for-sale securities
Loss on sale of investments
Investment in AFS, Baker Equipment
Unrealized holding loss on AFS securities
Debit
$100,000
5,500
3,000
Credit
$6,500
$1,000
Credit
$5,500
Credit
$103,000
5,500
To record the sale of Baker Equipment stock and remove the allocation of
unrealized holding losses from the FVA, available-for-sale securities and
the unrealized holding loss on AFS equity accounts on January 1, 2002.
As with impairment losses on plant, property and equipment or intangible assets, if the decline in
value of an available-for-sale investment is other than temporary, it is considered an impairment
and must be recognized in the accounting period discovered. The carrying value of the asset is
written down to the market value and recorded in the income statement.
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Trading Securities
Equity and debt securities that are classified as trading securities indicate that the company has
purchased the securities for the purposes of making a short term profit. These securities are not
being held for interest income but rather for short-term appreciation on the market price of the
security. At the end of each accounting period the securities are marked-to-market with the
resulting gains and losses reported in the income statement. A nominal account is used to report
such gains and losses, Unrealized holding gain/loss on investments-Income. Unlike the
available-for-sale investments the carrying value of the trading securities are actually written up
or down to their new market values, therefore there is no need for an accretion or contra-asset
account.
The purchase of trading securities is record at net cost. At the end of each accounting period the
market value is determined and the carrying value of the securities is marked-to-market.
Example: Spencer Company purchased the following securities during 2000.
Supreme Products, 490 shares stock
Alexander Company, 5,200 shares stock
Total cost of trading securities
$240,000
132,800
$372,800
At December 31, 2000 management determined that the fair market values of the trading
securities were as follows.
Trading Securities:
Supreme Products, 490 shares stock
Alexander Company, 5,200 shares stock
Totals
Unrealized
Original
Cost
Fair Value Gain (Loss)
$245,000
$240,000
($5,000)
130,000
132,800
2,800
$375,000
$372,800
($2,200)
T-Account: FVA, Trading Securities
Debit
Date
Description
$0
1/1/00 Beginning balance
12/31/00 Required AJE
12/31/00 Ending balance
Credit
$2,200
$2,200
The company will record an adjusting journal entry to reflect this unrealized loss. The loss will
be reported on the income statement and the carrying value of the investments will be adjusted to
market value at December 31, 2000. Any realized gain or loss on the subsequent sale of the
investments will be based on the carrying value as of December 31, 2000. The journal entry
would be as follows:
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Investments
Date
Account
Debit
Credit
12/31/00 Unrealized holding loss, income
$2,200
FVA, trading securities
$2,200
To record the unrealized holding loss on trading securities at December 31,
2000.
Transfers between Reporting Categories
If management decides to transfer an investment security from one category to another the
resulting unrealized gain or loss is recognized or deferred based on the follow schedule:
Transfer
From
Held-to-Maturity
Held-to-Maturity
Available-for-Sale
Available-for-Sale
Trading
Trading
To
Available-for-Sale
Trading
Held-to-Maturity
Trading
Available-for-Sale
Held-to-Maturity
Unearlized Gain or Loss from Transfer
Unrealized Gain/Loss, Equity
Unrealized Gain/Loss, Income
Amortize over remaining life of security
Unrealized Gain/Loss, Income
None, already at FMV
None, already at FMV
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