Corporate Investment Categories and Accounting Methods

Posted on Jan 26, 2025 in Economy

Goal 1: Understand the Three Major Categories of Corporate Investment

  • Three Categories of Investments in Securities
    • Passive Investments
    • Investments Made with the Intention to Exercise Significant Influence Over Another Corporation
      • Significant influence may be indicated by:
        • Joining the Board
        • Participating in Policy Formulation and Decision Making
        • Transactions Between the Two Companies
        • Exchange of Personnel Management
        • Technological Dependence
      • In the absence of a clear distinction based on these factors, it is assumed that there is significant influence if the investor owns between 20% and 50% of the outstanding voting shares of another company.
    • Investments Made with the Intent to Exercise Control Over Another Company
  • Accounting Methods Used for the Registration of Investments
    • Directly related to the purpose of investment
    • Determining the purpose of investment determines the appropriate method for registration of investment

Objective 2: Analyze and Report on Passive Investments in Securities Using the Market Value Method

  • Securities Held as a Passive Investment
    • This is presumed when the investor company holds less than 20% of the outstanding shares entitled to vote.
    • These are reported using the market value method.
      • Market Value Method: Values are reported at market value at the end of the period. Gains and losses are reported based on changes in stock prices that are maintained.
  • Prices to be Considered in the Valuation
    • The market value approach is a departure from the principle of cost and is supported by two reasons:
      • Relevance: Analysts often try to project future cash flows of a company.
        • One source is the sale of the passive investment portfolio.
        • Another source is that the best estimate of cash that could be generated by the sale of these securities is their current market value.
      • Measurability: Accountants can only register items that can be measured (in $, Bs, €, etc.) with a high degree of reliability.
        • Determining the fair market value for most assets is problematic.
  • Determining the fair market value of these investments is easy (special publications, The Wall Street Journal, Caracas Stock Exchange, etc.).
    • Accounts affected when the value of a passive investment is adjusted to reflect changes in the fair market value:
      • The allowance is adjusted to market value (added to the investment account, which is held at cost in order to report the market value).
      • Gains and losses from holding (not performed because no sale has taken place).
  • Sorting Passive Investments
    • Short Term: The purpose is to earn a return on the funds that may be required for operational purposes in the near future, classified as current assets on the balance sheet.
      • To Market Values: Investment in stocks or bonds that are maintained primarily for the purpose of marketing (buying and selling) in the near future, are recorded at the market value method and are classified as current assets.
      • Securities Available for Sale: All other passive investments, other than those recorded at market value, are recorded at the market value method and are classified as current assets or noncurrent assets.
    • Securities Available for Sale Long Term: These funds are not needed for operational purposes, but may be needed long-term for certain purposes, are classified as long-term assets on the balance sheet, based on the intention of management.
  • Critical Concept to Check: Purchases of Securities
    • Receipt of Dividends: The dividends earned are recorded as investment income and are reported as part of net income in the statement.
  • Critical Concept to Check: Valuation at the End of the Year
    • As you can see, and considering that this is a value available for sale, the account “Unrealized Holding Loss” is reported in the Heritage section (other comprehensive income) of the balance sheet.
      • Gains or losses associated with holding securities available for sale are not reported as part of net profit.
      • When the value is sold, any gain or loss realized will be included in net profit.
  • Sale of Securities Available for Sale
    • If the securities available for sale are sold, three cash accounts are affected:
      • Investment Account (Securities Available for Sale)