1. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD Chapter 18 Accounting for Investments

2. In this chapter… Balance Sheet Current Assets Cash Chapter 10000 Current Liabilities Accounts Payable5000 Accounts Receivable20000 Wages Payable25000 Notes Receivable15000 Utilities Payable2000 Marketable Securities1825000Long-Term Debt Inventory120000 Notes Payable20000 Capital Assets Bonds Payable600000 Equipment250000Owner’s Equity Buildings500000 Common Stock300000 Goodwill60000 Retained Earnings48000 Total Assets1000000Total Liabilities + OE1000000 Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

3. Purpose of Investments Why would a company invest in the ownership or debt of another: –To earn income on available excess cash –To earn a capital gain –To participate in new technologies or markets –To build a favourable relationship with a supply chain member –To influence the operations of a supply chain member –To control the operations of a supply chain member Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

4. Temporary vs. Long-term Investments Temporary Investments – aka, short-term investments or marketable securities can be in the form of purchasing or investing in debt or equity instruments. These are classified and reported as current assets if: –Management intends to convert them to cash within a year –They can be readily converted to cash These are classified as long-term investments if: –They do not meet the requirements of the above –They are not easily “marketable” (sellable) Long term assets are reported in their own section of the asset side of the balance sheet usually under the heading “Long-term Investments” Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

5. Accounting for Temporary Investments When a company buys a temporary investment, the journal entry looks like: –The Temporary Investment account is created to hold the value of the new asset. Other names could be used such as “Marketable Securities” or “Bonds Receivable”. When the investment is sold, a journal entry could be: DateAccount Titles and explanationPRDebitCredit Jan 1Marketable Securities25000 Cash25000 DateAccount Titles and explanationPRDebitCredit Jan 1Cash27500 Gain on Marketable Securities2500 Marketable Securities25000 Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

6. Accounting for Temporary Investments When the investment (whether shares or bonds) are purchased, the cost allocated to them are the purchase price plus all costs necessary to acquire them (kind of like Inventory) –This includes purchase price, commissions Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

7. Accounting for Temporary Investments When reporting the investment on the balance sheet, the investment must be reported at the lower of cost or market value –So if you go off and buy 100 shares of WestJet at $100 in October, then when you prepare the balance sheet in December and the market value is only $90, you must report the shares as having a value of $90 –If you hold a number of shares from a number of different companies, you do this on an aggregate basis. –When you go to report the shares, you will declare a Loss on Market Decline of Temporary Investments, and write that loss into a contra-account called Allowance to Reduce Temporary Investments to Market Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

8. Accounting for Temporary Investments So, you bought 100 shares at $250 of XYZ Co. –The purchasing journal entry is –Lets say the shares drop to $240 by the time you prep the BS DateAccount Titles and explanationPRDebitCredit Oct 11Marketable Securities25000 Cash25000 DateAccount Titles and explanationPRDebitCredit Dec 31Loss on Market Decline of Marketable Securities 1000 Allowance to Reduce Marketable Securities to FMV 1000 Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

9. Accounting for Temporary Investments Balance Sheet Current Assets Cash 10000 Current Liabilities Accounts Payable5000 AR20000 Wages Payable25000 Notes Receivable15000 Utilities Payable2000 Market Securities25000Long-Term Debt Less: Allowance100024000 Notes Payable20000 Inventory120000 Bonds Payable600000 Capital Assets750000Owner’s Equity Common Stock300000 Goodwill60000 Retained Earnings47000 Total Assets999000Total Liabilities + OE999000 Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

10. Accounting for Temporary Investments Or, you bought 100 shares at $250 of XYZ Co. –And when you prepared the BS, they were up $10 –This either reduces or eliminates the loss. –If it eliminates the loss, or even now causes an overall gain, the contra-account is removed and the investments are shown at the lower of cost or market, which would now be cost. –The entries only affect the Allowance account, not the actual asset –Note: If you have a gain, you don’t report it as income until the sale (conservative principal) DateAccount Titles and explanationPRDebitCredit Dec 31Allowance to Reduce Temp Investments to Market 1000 Gain on Market Recovery of Temp Investments 1000 Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

11. Long-term Investments Long-term investments are recorded at total cost to acquire the investment (purchase price plus commissions) There are 4 types of long term investments –Debt investments to be held for a long time –Share investments of less than 20% of the voting shares –Share investments of more than 20% but less than 50% of the voting shares –Share investments of more than 50% of the voting shares Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

12. Long-term Debt Investments Say a company purchases some bonds of another company Then, the bonds earn, but not yet pay interest Then the company sells the bonds DateAccount Titles and explanationPRDebitCredit Oct 11Investment in Hydro Bonds10000 Cash10000 DateAccount Titles and explanationPRDebitCredit Dec 31Interest Receivable500 Interest Revenue500 DateAccount Titles and explanationPRDebitCredit Mar11Cash10000 Investment in Hydro Bonds10000 Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

13. Share Investments Less Than 20% Long-term investments in shares have the possibility of offering the investing company an opportunity to affect the operations of the purchased company. Significant Influence is the ability of the investor to influence the investee even if the investor only owns less than 50% of the shares of the investee –As a general rule, significant influence does not exist if less than 20% of voting shares are owned. –If this is the case the accounting for this condition is the same as the accounting method used for short-term shares investments. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

14. Share Investments of 20% to 50% In this case, it is expected that significant influence could exist. The Equity Method of accounting and reporting is used for long-term investments. The purchase is recorded in this situation (at cost) as it is in the short-term investment scenario But, in addition, the investor company must record its portion of a gain or loss of that of the investee –The gain is based on the investor’s % ownership of the investee –The value of the investment is written up, and the Earnings noted as Other Income DateAccount Titles and explanationPRDebitCredit Oct 11Investment in ABC Shares30000 Earnings from ABC30000 Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

15. Share Investments of more than 50% An investor who owns more than 50% of the voting shares of the investee and intends to hold this position for the long term has a Controlling Interest in the investee Control means the investor company dictates the operations of the investee, not just influence To account for this situation, the parent reports consolidate financial statements for it and all its subsidiaries. –We won’t go into this. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

16. Reporting Long-term Investments Long-term Investments are reported in their own section of the balance sheet They are reported at cost, even if market is below cost, so long as this is a temporary dip. If it is expected to be permanent, then the accountant must write down the value of the investment. –This is not done with an Allowance account, but rather by writing down directly to the asset account of the investment. –For the basis of future losses or gains, this new cost is now the point from which to calculate Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD