Intermediate Accounting

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14 Investments in Debt and Equity Securities Overview There are a variety of reasons why companies choose to invest in other companies rather than buy back their own shares or dividend excess cash to shareholders. The accounting for such transactions is frequently as simple as doing basically the opposite of what was done by the company issuing the securities which you learned in the prior two chapters. But there are some major exceptions and issues to be explored. Based on the kind of security (debt or equity) purchased, the amount of securities held (as a percentage of the available equity securities outstanding in a single company), and the intent with which the security is held, the accounting can defer. Debt securities can basically be thought of as loaning the issuer money, even when they are purchased on the open market and not directly from the issuer. The number of debt securities held in a single company does not change the accounting, because ownership of the company does not take place by merely loaning money to another company. What can change the accounting with debt securities is intent. Are the held debt securities going to be sold in the near future? Are they not going to be sold in the near future but before maturity? Or are they going to be held until the issuer pays back the face amount? The accounting varies based on which of those three questions gets the “yes.” A similar process is undertaken for equity securities but with an added wrinkle and a key difference. The difference is that equity securities can not be held until maturity because equity securities never mature. There is no fixed date in which a company must buy back common stock from shareholders, unlike the terms with a bond issuance which always have such a date. But there is another question that takes the place of the “Will it be held to maturity?” question, which is, “How much of the other company is owned?” The accounting will differ at three levels: less than 20 percent ownership, 20 percent to 50 percent ownership (significant influence), and over 50 percent ownership (control).
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14-2 Chapter 14 Significant influence requires the use of the equity method to account for those securities. Control requires consolidated financial statements for the companies. In any event, companies with investments in other companies must disclose significant information about them in notes to the financial statements so that readers of the statements can better understand the composition of the investments listed on the face of them. Learning Objectives Refer to the Review of Learning Objectives at the end of the chapter. It is crucial that this section of the chapter is second nature to you before you attempt the homework, a quiz, or exam. This important piece of the chapter serves as your CliffsNotes or “cheat sheet” to the basic concepts and principles that must be mastered. If after reading this section of the chapter you still don’t feel comfortable with all of the
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This note was uploaded on 12/22/2010 for the course ACCOUNTING 564 taught by Professor Ahmadali. during the Fall '08 term at American Dubai.

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032459237X_176353 - 14 Investments in Debt and Equity...

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