Long-Term Investments: Stocks

By Winicur, Barbara | The National Public Accountant, February 1994 | Go to article overview

Long-Term Investments: Stocks


Winicur, Barbara, The National Public Accountant


In last month's column, we looked at the methods of accounting for short term investments in marketable securities. These assets allowed management to put idle cash to work earning a return until it was needed elsewhere and were defined as "short term" largely because of the investor's intent to keep them for less than a year.

Management may later decide that these securities are too good to dispose of and can reclassify them as long-term investments. Reasons for this decision might include the desire to gain some measure of control over another firm. By purchasing stock in another firm, one might be able to expand business operations without starting another business from scratch. Management may simply wish to prolong the period during which they benefit from the stream of interest payments made on a bond issue or they may hope for gain from anticipated increases in stock value. All of these reasons might motivate an investor to hang on to these promising investments.

Long-term investments in the stocks or bonds of other firms are initially recorded at cost, just as short-term investments are recorded. Because such long-term investments can have very different characters, however, the subsequent treatment differs. Let's look at investments in stock first.

DETERMINING DEGREE OF INFLUENCE

When stock in another company is purchased, it gives the purchaser a degree of ownership in the purchased firm. The accounting treatment for such an investment depends on the degree of influence or control over the firm's policies and finances achieved by the purchase. Ownership of less than 20% of the stock is considered "non-influential and non-controlling," and the cost method is used to account for post-purchase activity. Dividend checks are recorded as income. At the balance sheet date, investments are shown at "lower of cost or market" in accordance with the conservatism concept, with an allowance account used to record any decline in market value.

If we purchase between 20% and 50% of a firm's stock, we are said to be "influential but non-controlling" and the equity method is required. This method mandates that we adjust our investment account to reflect the activity of the investee firm. Our share of the firm's net income is shown as an increase in the investment account, since income increases the value of the firm itself and thus our share of it. …

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