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Chapter 3: Investments in Equity and Debt Securities

3.1 EQUITY !D DE"T I!#EST$E!TS

• 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 0%, the equity method should be used

• when ownership is more than 0%, companies prepare consolidated financial statements

• company that owns more than 0% 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 0% 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.% &E'(&TI!) I!#EST$E!TS

• trading securities

o  brought and held primarily for sale in the near term to generate income on short!term

 price differences

• available!for!"ale "ecurities

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.%.1 Tradin* 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 adusting entry is a debit to &nrealised 'oss ( )ncome and a credit to market

*dustment ( +rading

• companies report the unrealised loss under “other expenses and losses” in income statement

3.%.% vai+ab+e,-r,Sa+e 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

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3.%.3 /e+d,t,$aturity 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 S/(&T,TE&$ I!#EST$E!T #E&SUS 0(!),TE&$ I!#EST$E!T

3.3.1 Shrt,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 marketableo 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 

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3.3.% 0n*,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 theirequity value