University:
Grand Rapids Community College
Course:
Financial and Managerial Accounting: Information for Decisions - John J. Wild
Academic year:

2024
Views:

490

Pages:

2
Author:

stud_ice13

To understand how companies classify and report investments, it’s important to distinguish between debt and equity securities as well as between short-term and long-term investments. Distinction between Debt and Equity Securities 1. Debt Securities: o Represent a creditor relationship. o Include investments in notes, bonds, and certificates of deposit. o Issued by governments, corporations, or individuals. o Investors in debt securities earn interest and are typically repaid their principal at maturity. o Examples: Government bonds, corporate bonds, and promissory notes. 2. Equity Securities: o Represent an ownership relationship in another entity. o Include investments in common and preferred stock. o Issued solely by companies, giving the investor ownership rights. o Equity securities may provide dividends if the company profits, but they do not have guaranteed payments like debt securities. o Examples: Shares of stock in publicly traded companies. Distinction between Short-Term and Long-Term Investments 1. Short-Term Investments: o Also known as marketable securities. o Must meet two criteria: (1) They are intended by management to be converted to cash within one year or the operating cycle, whichever is longer, and (2) they are readily convertible to cash. o They are classified as current assets. o Usually mature within 3 to 12 months. o Exclude cash equivalents, which typically mature in 3 months or less. 2. Long-Term Investments: o Not intended to be converted to cash within one year or the operating cycle. o Include investments that are not easily liquidated or are set aside for a specific purpose. o Classified as noncurrent assets. o Examples include investments in real estate, stocks, bonds, or assets designated for specific future use. Purposes and Types of Investments Companies invest for several reasons: • • • Income Generation: Companies invest surplus cash to earn returns, often choosing short-term investments. Investment Funds: Entities like mutual funds or pension funds are dedicated to generating income from investments. Strategic Purposes: Investments may also be strategic, such as acquiring stakes in suppliers or competitors. Classification and Reporting of Investments The accounting treatment for investments depends on: 1. Security Type (debt or equity), 2. Intent to Hold (short-term or long-term), and 3. Ownership Percentage (in the case of equity investments). Accounting for Debt Investments 1. Acquisition: Recorded at cost when purchased. For example, if Ling Co. buys $30,000 in bonds, it records the investment at that cost. 2. Interest: Recognized when earned. Interest income for debt investments is calculated as Principal × Interest Rate × Fraction of Year. 3. Maturity: At maturity, the proceeds are recorded, and any difference between purchase cost and maturity value (for long-term debt) is amortized over the security’s life as an adjustment to interest revenue. In summary, companies invest in both debt and equity securities, and these investments are classified by type, holding period, and ownership level, with differing accounting treatments for each. Debt investments yield interest and are often held to maturity, while equity securities provide potential dividends and ownership benefits.