ACG2021 Chapter 10 (Principles of Financial Accounting)

The investor is the one that bought the bond or stock from a corporation

The investee is the one that issued the bond or stock

A security is a share or interest representing financial value.

Investment in notes or bonds payable issued by another company

An equity security is an investment in stock ownership in another company and sometimes pays cash dividends or issues stock dividends.

1. The company has short-term excess cash that they do not need for business operations and want to make the most of that cash

2. The company may invest for “certain business strategies”, such as buying stock of a vendor to strengthen their relationship with them.

Short-term investment: Investments in debt or equity securities that the investor intends to sell in one year or less.

Long-term investment: Are all investments that are not short-term. (So, the investor intends to no longer hold in over a year)

1. Trading Debt Investments: Are debt securities that investors intend to sell in the very near future - days, weeks, and only a few months - with the intent of generating a quick profit.

2. Held-to-Maturity (HTM) debt investments: Are debt securities that the investor intends to hold and has the ability to hold until it matures.

3. Available-for-sale (AFS) debt investments: Are all debt securities that are not trading debt investments or HTM debt investments. AFS debt investments are either reported as current assets (intend to no longer hold in a year or less) or as long-term assets (intend to no longer hold in over a year).

-The classification is based on how much influence the investor has over the investee’s company

1. No Significant Influence Equity Investments: An equity investment in which the investor lacks the ability to participate in the decision of the investee’s company.

2. Significant Influence Equity Investments: An equity investment in which the investor has the ability to exert influence over operational and financial decisions of the investee company.

3. Controlling Interest Equity Investments: An equity investment in which the investor owns more than 50% of the investee’s stock.

DEBT SECURITIES

*Is the same for Trading Debt Investments & AFS debt investments, just a different account name.

*Is the same for Trading Debt Investments & AFS debt investments, just a different account name.

Next 4 slides are how to record debit securities

At the end of each year, the company has to make an adjustment entry to report the fair value of the security. Fair value is the price the company would receive if the company were to sell their investment.

The adjustment entry is shown in the image. The ‘Unrealized Holding Loss - Trading’ is an expense. The ‘Fair Value Adjustment - Trading” is a contra-account to the Trading Securities asset (used on the balance sheet to report the fair value).

-If the business intends to no longer hold in 1 year or less, then it's a current asset. Anything else is a long-term asset.

-At the end of each year, the company has to make an adjustment entry to report the fair value of the security. Fair value is the price the company would receive if the company were to sell their investment. (Just like Trading Debt Investments)

-The adjustment entry is shown in the image. This is the same as the Trading Debt Investment except that there is a gain so it's backwards. So, ‘Fair Value Adjustment

-Available for Sale” is a contra-asset account for AFS securities. "Unrealized Holding Gain - Available for sale” (however is different from trading in that it is not an revenue/expense) is an Equity account under ‘Other Comprehensive Income’.

(PS: Also, in the financial statements, you can see the contra-asset account be subtracted by the asset account to get the fair value for the balance sheet. Then, you can see the equity account under ‘Other Comprehensive income’)

You also will use the ‘Unrealized Holding Gain/Loss - AFS’ account in a Comprehensive Income Statement, which is the company’s change in total stockholders’ equity from all sources other than the owner’s investments and dividends.

NEED TO KNOW

-Comprehensive Income includes

1. Unrealized holding gain/loss for AFS debt securities
2. Foreign Currency translation adjustment
3. Gain or losses from post retirement benefit plan
4. Deferred gains or losses from derivatives.

-HTM Debt Investments are reported at amortized costs.

-Interest Revenue earned from the HTM debt investment is reported on the income statement in ‘Other Income and (Expense)’ Section.



(They don’t really explain it, just remember whats above)

EQUITY SECURITIES

The next three slides are for Journal Entries for Equity Securities with no Influence.

(Also known as the Fair Value Method)

*It could also be a “Loss on Disposal" and be debited since it is an expense.

So, you increase / decrease the equity security.

The next four slides are for Journal Entries for Equity Securities with significant Influence (with 20% - 50% of the companies shares)

(Also known as the Equity Method)

*PS: Unlike ‘no influence’, getting dividends decreases Equity Investments since part of the value of the company is taken out of the investee company and paid to you in cash.

*PS: The investor debits the Equity Investments account and credits Revenue from Investments when the investee reports income

Book Value: Original Cost + your share of investee income - dividends received

The next 5 slides are for Equity Securities when you control more than 50% of the company

Consolidation Method

The corporation that owns enough to control decisions in another company.

A company that is controlled by another corporation

The way to combine the financial statements of two or more companies that have the same owners

Combining the financial statements (such as income statement, balance sheet, etc) of the parent company with its controlling interest affiliation

PS: “Controlling Interest”: enough ownership to control decisions

Rate of Return of Total Assets = (Net Income + Interest Expense) / Average Total Asset

A percentage that shows how much profit the company makes for every dollar of assets it owns.

(For every \$1.00 of total assets Pepsico owns, it earns \$0.102 in profit.