financial accounting dave ludwick, p.eng, mba, pmp, phd chapter 18 accounting for investments

Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD

Chapter 18Accounting for Investments

In this chapter…Balance Sheet

Current Assets

Cash

Chapter

10000

Current Liabilities

Accounts Payable 5000

Accounts Receivable 20000 Wages Payable 25000

Notes Receivable 15000 Utilities Payable 2000

Marketable Securities 18 25000 Long-Term Debt

Inventory 120000 Notes Payable 20000

Capital Assets Bonds Payable 600000

Equipment 250000 Owner’s Equity

Buildings 500000 Common Stock 300000

Goodwill 60000 Retained Earnings

48000

Total Assets 1000000 Total Liabilities + OE 1000000


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


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”


Accounting for Temporary Investments• When a company buys a temporary investment, the journal

entry looks like:

– 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 PR Debit Credit

Jan 1 Marketable Securities 25000

Cash 25000


Jan 1 Cash 27500

Gain on Marketable Securities

2500

Marketable Securities 25000Financial AccountingDave 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


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


Accounting for Temporary Investments• So, you bought 100 shares at $250 of XYZ Co.

– The purchasing journal entry is

– Lets say the shares drop to $240 by the time you prep the BS


Oct 11 Marketable Securities 25000

Cash 25000


Dec 31 Loss on Market Decline

of Marketable Securities

1000

Allowance to Reduce

Marketable Securities to FMV

1000


Accounting for Temporary InvestmentsBalance Sheet

Current Assets

Cash 10000

Current Liabilities

Accounts Payable 5000

AR 20000 Wages Payable 25000

Notes Receivable 15000 Utilities Payable 2000

Market Securities 25000 Long-Term Debt

Less: Allowance 1000 24000 Notes Payable 20000

Inventory 120000 Bonds Payable 600000

Capital Assets 750000 Owner’s Equity

Common Stock 300000

Goodwill 60000 Retained Earnings

47000

Total Assets 999000 Total Liabilities + OE 999000


Accounting for Temporary Investments• Or, you bought 100 shares at $250 of XYZ Co.

– And when you prepared the BS, they were up $10

– 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)


Dec 31 Allowance to Reduce Temp

Investments to Market

1000

Gain on Market Recovery

of Temp Investments

1000


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


Long-term Debt Investments• Say a company purchases some bonds of another company

• Then, the bonds earn, but not yet pay interest

• Then the company sells the bonds


Oct 11 Investment in Hydro Bonds 10000

Cash 10000


Dec 31 Interest Receivable 500

Interest Revenue 500


Mar11 Cash 10000

Investment in Hydro Bonds 10000Financial Accounting

Dave Ludwick, P.Eng, MBA, PMP, PhD

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.


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– 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


Oct 11 Investment in ABC Shares 30000

Earnings from ABC 30000Financial Accounting

Dave Ludwick, P.Eng, MBA, PMP, PhD

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.


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 chapter 18 accounting for investments

Documents

temporary investmentswhen

temporary investment

supply chain memberto

bonds receivable

purchase price

shortterm investments

journal entry

new asset