BUSA 101-SCHMIDT

CHAPTER 12: INVESTMENTS IN STOCK (aka EQUITY SECURITIES)  

Why would one company want to buy another company’s stock?

  ·       To generate additional income

·       To use excess cash to generate higher returns

·       To develop a business relationship

·       To try and gain control (i.e. Hostile takeover)  

 

                                         Two Classifications  

 

     Trading Securities                                              Avail. For Securities  

 

This is where management actively buys & sells stocks for profit.  These would be stockbrokers, brokerage firms, banks, etc.

Management casually invests money and plans to sell stocks when money is needed…not the primary business of the firm.

 

(Another Class)                                             (This Class)

 
 

SHORT TERM INVESTMENTS

HOW TO ACCOUNT FOR “AVAILABLE FOR SALE” SECURITIES:

 

 

 

Temporary Investments or Marketable Securities—These are investments that can be quickly sold and converted to cash when needed.  Two conditions to be met:

 

1.    They must be readily marketable (i.e.-they can be sold at any time without restriction)

2.    Management INTENDS to sell when cash is needed

 

If they meet this criterion, then they are classified (at cost) as a marketable security…a current asset that’s very liquid.  (usually shown right below cash)

 

(If they don’t, they are classified as an “investment”, like patents or trademark)

 

Adjustments to market:

·       At the balance sheet date, stocks are adjusted to their FMV (fair market value) as quoted in the Wall Street Journal.

·       Any difference between their cost and their FMV gets recorded to “unrealized holding gain or loss”.

·       “Unrealized” means “on paper only” because no actual sale has taken place.

·       This account is not used in determining traditional GAAP net income but is used in the computation of “comprehensive net income”

·       Gains and losses are only REALIZED when an actual sale takes place.

LONG TERM INVESTMENTS

 

When a company invests in stocks with the INTENT to hold it long term, then they are not classified as marketable securities.  They are classified as an Investment, or a long term asset.

 

There are two GAAP methods used to account for long term Investments, depending upon how much stock is purchased.

 

GAAP METHODS
EQUITY METHOD		COST METHOD
“significant influence” can be exercised		No significant influence
≥ 20% ownership		< 20%
·       Cost of stock gets debited to investment account		·       Same
·       Record portion of NI as an increase to investments		·       Dividends are recorded as Dividend income
·       Record dividends as a decrease to investment ·       No adjustment to FMV at Balance sheet date		·       Show at FMV at Balance sheet date with any unrealized gain or loss as part of comprehensive income