Lecture 4 - Investments (cont.)

Accounting for Investments (continued)

The valuation of market price of investment assets is difficult in these times when the market value of many securities has fallen dramatically and there is no liquid market. Some companies claim that the rules in FASB 157 (Fair Value Measurements) are not appropriate for this situation. Financial Accounting Foundation and FASB claims that there is too much pressure from Congress and other governmental agencies. See this article from the FASB web site: http://www.fasb.org/news/2008-FairValue.pdf

Long Term Investments

Available for Sale Securities (less than 20% interest) may be short-term or long-term. In either case, the rules are the same.

If you own more than 20% interest in the investee, you use the Equity Method. Record it at cost and every year, increase or decrease the carrying value by your share of the investees income.

If there's income, debit Investments and credit Income from Investment. If the investee has a loss, debit Loss from Investment and credit Investment.

If the investee pays a dividend, debit Cash and credit Investment.

If you own more than 50% interest in the investee, you treat the two companies as one consolidated whole and issue consolidated financial statement. (Some people say the 50% rule is too low and it shouldn't require consolidation until 60% or higher.) The same thing holds true if the investee is a non-US company. It needs to be consolidated. This is known as "worldwide consolidation". However, you can't consolidate foreign entities for tax accounting.

Debt Securities

There are three categories: trading, available for sale (both of which are treated exactly like equity securities), and held-to-maturity. For held-to-maturity securities, the market value is less relevant since they are going to be held to maturity.

Investment Quiz