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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