Investments

Key Things To Know

Investors make investments for three primary reasons:

1) appreciation in market value
2) income from interest and dividends
3) significant influence and control

Investments are made in bonds (debt) and equities (stocks)

The journal entry to record all types of investments is:

Investment         $$cost
              Cash               $$cost

Cost includes commissions

Two methods to report investments
Fair Market Value Method and Equity Method

Method depends on the purpose of making the investment  

Fair Market Value Method:

Records investments made for appreciation and income

Use this method when:

1)  You have no significant influence or control (own < or equal to 20%)
2)  The market price is reliable – 

Reliable: has a bid ask quote, traded on an exchange

3 categories of investments under this method:

1)  Held to Maturity: Intend to hold bonds to maturity
Investments in Bonds only

2)  Trading Securities: Intend to hold for less than one year
All equity investments are now trading securities

3)  Available for Sale: Intend to hold bonds for one year or more 
Investments in Bonds only

Held to maturity:

Do not adjust to fair market value.
Adjust the cost of the bond investment each period for interest using the amortization schedule, as interest is earned and received

Trading Securities:

Adjust the investment to fair market value at the end of each period if fair market value is reliable (bid ask quote)

The change in fair market value is reported on the income statement under “other” revenues and expenses (Unrealized holding gain/loss account) 

Record dividends received as dividend income

Available for Sale:

Adjust the investment to fair market value at the end of the period if fair market value is reliable

The change in fair market value is reported on the balance sheet as part of owner’s equity in the “unrealized holding gain/loss” owner’s equity account

Record dividends received as dividend income

Journal entries:  Record 2 things each period

1)  Adjust to fair market value 

Trading – change is reported on the income statements
Available for sale – change is reported in owners’ equity

2)  Record dividends received

Accounts used for the entry:

Adjustment to FMV:

Investment

and

Unrealized Holding Gain/Loss (either equity or income statement account)

The investment account will be a debit when the investment goes up
The investment account will be a credit when the investment goes down

The other account is the opposite, debit or credit, unrealized holding gains or losses
(IS or OE) for the same amount

Receive Dividends:

Cash
         Dividend Income

Important to notice:  The only difference in trading and available for sale is the account that is used to adjust to fair market value.  Trading uses unrealized gain/loss-IS which is reported on the income statement. Available for sale uses unrealized gain/loss-OE which is reported on the balance sheet in owner’s equity.

Equity Method:  

Use when you own an equity investment in a company and have significant influence

Significant influence exists when you own > 20%, and you have
Access to financial information
Seat(s) on the board of directors
Influence company policies and procedures

The objective of the equity method is to show the investment as if it represents the owner’s equity in the company you purchased.  When the company’s owner’s equity increases (earn income), your investment balance should increase. When the company’s owner’s equity decreases (losses and dividends paid), your investment balance should decrease.

The company’s owner’s equity changes with income and loss and dividends paid.
These things also change your investment balance.  

Journal entries are:

Profits

Investment in “X”                
            Investment Income       

Losses

Investment Expense
            Investment in “X”

Dividends

Cash
            Investment in “X”

When you sell your investment (FMV and Equity methods):

1)  Record the cash you get as a debit

2)  Take the investment off your books at the current balance in your 
Investment “T” account times the % you are selling (credit investment)

3) If held AFS – remove the unrealized holding gain/loss-OE balance

4)  Plug to realized gain (credit) or realized loss (debit) to balance the entry

Cash (db)
Realized loss (db) or realized gain (cr)
Unrealized holding loss (cr) or gain (db)-OE
            Investment (cr)

Accounts reported on the income statement – current year only:

Unrealized Gain/Loss – IS (holding the investment)

Realized Gain/Loss (when sold)

Dividend Income (for equities only)
Interest Income (for bonds only)

Accounts reported on the balance sheet – cumulative balance:

Investment

Unrealized Gain/Loss – OE (holding the investment)