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Lecture Financial accounting (10th edition): Chapter 8 - Pratt, Peters

Chapter 8 - Investments in equity securities. This chapter describe what an equity investment is and the criteria used to determine whether investments in securities should be classified as current or noncurrent on the balance sheet. | 2 Chapter 8: Investments in Equity Securities 2 3 Learning Objective 1 Describe what an equity investment is and the criteria used to determine whether investments in securities should be classified as current or noncurrent on the balance sheet. 4 What is an Equity Investment? An equity investment occurs when one company purchases another company’s outstanding common stock. To earn investment income Smaller and/or short-term investments Dividends Price appreciation To exert influence or control over the board of directors and management Larger and/or long-term investments 5 Equity Securities Classified as Current Two criteria must be met for an investment in a security to be considered current and thus warrant inclusion as a current asset: The investment must be readily marketable. Management must intend to convert the investment into cash within the time period of current assets (one year or the operating cycle, whichever is longer) 6 Concept Practice 1 7 Learning Objective 2 . | 2 Chapter 8: Investments in Equity Securities 2 3 Learning Objective 1 Describe what an equity investment is and the criteria used to determine whether investments in securities should be classified as current or noncurrent on the balance sheet. 4 What is an Equity Investment? An equity investment occurs when one company purchases another company’s outstanding common stock. To earn investment income Smaller and/or short-term investments Dividends Price appreciation To exert influence or control over the board of directors and management Larger and/or long-term investments 5 Equity Securities Classified as Current Two criteria must be met for an investment in a security to be considered current and thus warrant inclusion as a current asset: The investment must be readily marketable. Management must intend to convert the investment into cash within the time period of current assets (one year or the operating cycle, whichever is longer) 6 Concept Practice 1 7 Learning Objective 2 Describe mark-to-market accounting and how it is applied to passive investments in equity securities. 8 Passive Investment in Equity Securities Companies may purchase equity securities in small amounts to earn investment income and not exert influence. These are passive investments. Passive investments use the mark-to-market rule. Assets are carried at their current market value. Changes in value of securities are recorded as income or loss on the income statement. 9 Purchasing Passive Investments in Equity Securities Capitalized and recorded on the balance sheet at cost. Cost includes purchase price plus incidental acquisition costs. Assuming the security is readily marketable and the equity amount is small the journal entry is: Short-Term Equity Investment (+A) XXX Cash (-A) XXX Purchase passive equity securities 10 Declaration and Receipt of Cash Dividends The company has a legal right to declared dividends as a shareholder. A receivable and revenue are recorded. Dividend Receivable .