Investments are the portion of a company's assets that represent a stake or investment in the performance of another entity. They include investments in other enterprises, such as bonds and notes, which are debt investments, and stocks, which are equity investments. These investments create value for the investor through market appreciation, dividends, interest earnings, and even ownership rights. While all types of investments may involve a financial commitment to other entities, investment in the stock of other companies is unique because it creates a direct ownership interest in the investee. This type of direct ownership raises complex financial accounting issues for a company. To resolve these issues, there are different accounting methods used in different circumstances, depending on the ownership circumstance, such as the cost method, the equity method, and the consolidation method.
At A Glance
Companies invest available cash to generate maximum productivity of cash that would otherwise be idle. They invest to advance corporate strategies and to have a reserve against fluctuations or downturns in their business.
- One form of investment is debt investment, as in bonds or notes, which are short-term or long-term and return periodic interest to the owner.
- Journal entries for an initial bond investment and for the periodic interest payments for the bonds are made as the bonds are held to their maturity.
- Journal entries are made for the sale of a bond investment when that sale occurs before the bond's maturity date.
- If an investment bond is offered for sale at a specific interest rate but the market rate for interest drops before the bond is sold, the bond will be sold at a premium above the bond’s face value.
- A discount bond is priced below its original issuance price.
- Three methods to recognize equity investments, such as stocks that provide ownership interest in another entity, are cost, equity, and consolidation.
- The cost method for recognizing equity investments applies when a company owns less than 20% equity ownership in another company.
- Whenever a company holds between 20% and 50% ownership in another company, it must use the equity method to recognize the investment.
- When a company that is the investor owns or acquires more than 50% of an investee's stock, generally accepted accounting principles (GAAP) require the company to use the consolidation method to recognize the investment.
- For financial reporting purposes, passive investments are generally categorized into three well-defined groups: trading securities, available-for-sale securities, and held-to-maturity securities.
- Some investments affect net income directly, while others affect comprehensive income. Therefore, reporting other comprehensive income and comprehensive income discloses a company's financial status more fully.