Accounting for Investments (Equity and Debt Securities)

an agent who arranges a transaction between a buyer and a seller of equity securities is called a:
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in this video were going to talk about how to account for investments so the accounting for an investment depends on whether its a debt investment like for example of your company were to purchase a government bond or a corporate bond or an equity investment for example of your company were to buy stock in another company and then they have ownership shares of that company so whether its a debt investment or equity investment is going to matter because its going to affect the accounting for example one way that you can classify a debt investment is as held to maturity so held to in charity you have to have two things to classified as it you have to have the intent and you have to have the ability to hold the debt investment to maturity so for example if it was a thirty-year government bond that you purchased you have to be able to show that okay we intend to hold this bond for the next thirty years until it matures and we have the ability to do so were not going to go bankrupt or something next year and not be able to hold this to maturity so when you hold it to maturity then were going to have it on the balance sheet at whats called amortized cost and I have an hour video talking about that so you can learn more about that there so we can have it at amortized cost which is not fair value thats thats the key point here if you just want to get the key takeaway its not fair value for Helda maturity securities okay so any unrealized gains or losses on hell the maturity security it is not going to go to the income statement its not going to affect that okay and like I said we talked about that later equity investments cannot be held or cannot be classified as held in maturity its not applicable and the reason is if you think about it lets say you bought stock at another company its not like that stock matures at some point in time so hell the maturity really only makes sense when thinking about a debt investment so it doesnt qualify for an equity investment now you can also have a debt investment characterized as something called available for sale so available for sale basically means its not a held a maturity security right so youve bought this government bond and youre not going to hold it to maturity or maybe youre not sure if you are youre going to be able to but you dont intend to sell it either you dont youre not wheeling and dealing in debt investments its not like you bought it and said okay next month Im selling it you dont really know what youre going to do with this debt investment and so you classify it as available for sale so its not held to maturity but by the same token youre not sure if youre going to sell it anytime soon you dont know what youre going to do with it so you classify it

as available for sale now available for sale is going to be marked a market on the balance sheet so its going to be classified at fair value and then any unrealized gains or losses are going to go to an account called other comprehensive income which is going to bypass the income statement so its not going to affect net income now when I say unrealized that that means that the fair value of this government bond changed but you hadnt sold the bond yet once you actually sell an available for sale debt investment then you could ever realize gain or loss because now youve sold it and that would affect net income but unrealized gains and losses on available for sale debt investments bypass the income statement go to this other comprehensive income account which increases stockholders equity now equity investments until 2018 before 2018 equity investments in the you up for US GAAP equity investments could be held at also available for sale however from 2018 going forward at the Financial Accounting Standards Board they passed this new rule basically ASU 2016 – oh one that said that okay you cannot have equity investments they cant be available for sale any longer okay so what are equity investments at generally well if you own less than 20% cents so when you purchase that stock and another company if you buy stock in another company you own less than 20% which is usually the case right if you if users buy a small position two percent one percent less than 1% its classified as trading okay and trading could be either equity investment or actually debt investments could also be trading okay so what trading is is that its going to be marked a market at fair value okay and again this applies for both debt investment and equity they could both be classified as trading so trading is saying that its going to be classified at fair values can be marked a market on the balance sheet but any unrealized gains or losses are going to flow through net income okay so thats different than available for sale developer for sale they go to that OCI account but with trading they flow through net income okay so debt investments can be classified as held to maturity right they can be classified as held to maturity they can be classified as trading okay and they could also be classified as available for sale so theres really three different classifications and so think about it like this for debt investments if you intend and have the ability to hold it to maturity its held to maturity if you intend to sell it in the near future lets say you intend to sell it in a month or two its trading if you dont know what youre going to do with it with the debt investments available for sale with an equity investment you dont have much choice if you own less than 20% of the company that you invested in it has to be trading there is an exception there is an exception its called the

practicability exception it basically means that if for some reason you cant figure out the fair value its too difficult or whether theres some kind of issue may resign you bought stock and some startup that is not publicly traded right so you dont know what the fair value is you dont have any idea and so what you would do is you would record this investment at cost minus any impairment so if theres some kind of impairment you would write the asset value down now all that being said so this trading is if you own less than 20% of the equity of the firm that you invested in if you own between 20 to 50 percent we say that you have significant influence and youre going to be governed by the equity method okay so youre going to use this equity method were base used you get a proportionate share of the investees net income okay I have an hour video that talks about that more depth okay but but basically youre not going to recognize dividend revenue when you get a dividend if youre using the equity method now there is an option to use this this trading method which for equity investments I know this is confusing but they actually call this trading method they call this the fair value method so this would be the fair value method for less than 20% you can elect since if you have it between 20 and 50 percent ownership you could say you know I dont want to use the equity method I have to I want to use the fair value method okay and but its a vocable or irrevocable election so once you made it thats it now if you want more than 50% of the company that you purchased a position in you have to do whats called consolidation right so basically their assets and their liabilities become the parents assets and the parents liabilities its not as easy its just adding the two balance sheets together because that could result in double counting and well talk a lot about consolidation and how its done in future videos but just suffice it to say that its a lot different than the equity method in trading and you cannot you cannot if you have to consolidate the firmest or the investi you cant elect to do this fair value method so its not like the equity method where you could say you know what I dont want to do the equity method I want to do the fair value method you cant do that now there are exceptions theres caveat to everything in accounting and so in some cases when you dont own more than 50% you might still be required to do a consolidation there are these things called variable interest entities which you might also heard of it special purpose entities SPE s and so forth so in some cases you might actually be required to consolidate a VI e even though you might not own more than 50% of that and well talk about that in the videos to come

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investment, equity, debt, fair value, fair value method, equity method, consolidation, trading security, available for sale, available-for-sale, held to matu…
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