INVESTMENTS

The form of investments can vary considerably. The investments may be in debt (T-bills, commercial
paper, bonds) or equity (common stock, preferred stock) securities; the securities may be marketable or
long-term, as investment in stocks of subsidiary or affiliated companies. Also investment may be in
pension funds, cash surrender value of the life insurance, real estate, or loan or advance rather than a
security. However, the primary distinction between long-term investment and investment classified as
current assets is management’s intention and ability to hold the investment for longer than one year.

Review: Accounting for Investments

Nature and Categories of Financial Assets

Financial asset – is any asset that is: a. cash b. a contractual right to receive cash or another financial
asset from another enterprise (e.g., debt securities such as bonds, loans) c. a contractual right to
exchange financial instruments with another enterprise under conditions that are potentially favorable
(e.g., derivatives) d. an equity instrument of another enterprise (e.g., common stocks).

For the purpose of measuring a financial asset subsequent to initial recognition, SFAS 39/IAS 39
classifies financial assets into four categories: a. financial assets held for trading b. held-to-maturity
investments c. loans and receivables originated by the enterprises and not held for trading and d.
available-for-sale financial assets.
a. Financial assets held for trading-are those acquired principally for the purpose of generating a
profit from short-term fluctuations in price or dealer’s margin.
b. Available-for-sale financial assets-are those financial assets that are not a) loans and receivables
originated by the enterprise, b) held-to-maturity investment, or c) financial assets held for trading.
c. Held-to-maturity investments are financial assets with fixed or determinable payment and fixed
maturity that an enterprise has a positive intent and ability to hold to maturity other than loans
and receivables originated by the enterprise.
d. Loans and receivables originated by the enterprise are financial assets that are created by the
enterprise by providing money, goods, or services directly to debtor, other than those that are
originated with the intent to be sold immediately or in the short-term, which should be classified
as held for trading. Loans and receivables which are acquired from others, however, are
accounted for in the same manner as other debt securities (i.e., they may be classified as held-for-
trading, available-for-sale or held-to-maturity and accounted for accordingly.)

Valuation
SFAS 39/IAS 39 requires that all financial assets and financial liabilities should be recognized on the
balance sheet including derivatives. They should be initially measured at cost, which is the fair value of
the consideration given or received to acquire the financial asset or liability (plus certain hedging gains or
losses).
Subsequent to initial recognition, all financial assets should be remeasured to fair value, except
for the following, which should be carried at amortized cost subject to a test for impairment:
a. loans and receivables originated by the enterprise and not held for trading;
b. other fixed maturity investments, such as debt securities and mandatorily redeemable preferred
shares, that the enterprise intends and is able to hold to maturity; and
c. financial assets whose fair value cannot be reliably measured (limited to some equity securities
with no quoted market price and some derivatives that are linked to and must be settled by
delivery of such unquoted equity instruments).
Accounting for Investment
Investment-is an asset held by an enterprise for purposes of accretion of wealth through distributions of
interest, royalties, dividends, and rentals or for capital appreciation or other benefits to be obtained.

Many companies purchase securities issued by other companies to earn a return on temporarily
idle cash, or to gain influence, control, business expansion or some other business advantages.
Accounting for such investments depends on the nature and classification of the invested securities.

Investment in Equity Securities

Equity security-is defined as any instrument representing ownership interest in an entity (e.g., a common
stock or a preferred stock) or the right to acquire ownership interest (e.g., stock warrants, stock options,
etc.). This term, however, does not encompass callable or redeemable preferred stock, treasury stock and
convertible bonds. Investments in equity securities are classified as follows:
a. Controlling interest: A controlling interest exists when the investor company owns enough of the
voting stock (common stock) of an investee company to determine its operating and financial
policies. Ownership over 50% of the investee’s outstanding voting stock usually would assure
control.
b. Significant influence: Investor’s ability to affect, to an important degree, the operating and
financial policies of the investee indicates a significant influence. In the absence of evidence to
the contrary, significant influence should be presumed if an investor holds 20% or more of the
investee’s voting stock.
c. Other equity securities: Any investments in the investee’s stock without controlling interest or
significant influence are considered as small investment, which are subdivided into the following:
a. Nonmarketable- Equity securities without readily determinable fair value.
b. Marketable- Equity securities with readily determinable fair value:
a. Trading securities (TS) – Held for current sale.
b. Securities available-for-sale (SAS) – May or may not be held for current sale.

Investment in Debt Securities

A debt security is an instrument representing creditors’ claim with a fixed amount and usually some
interest obligation (e.g., government securities, corporate bonds, convertible bonds, commercial paper,
etc.). Investments in debt securities are classified as follows:
a) Held to maturity (HTM) – Management has positive intent and ability to hold the security to
maturity.
b) Not held to maturity – Management does not have positive intent and ability to hold the security
to maturity:
1) Nonmarketable – Debt securities without readily determinable fair value.
2) Marketable – Debt securities with readily determinable fair value.
a) Trading securities (TS) – held for current resale.
b) Securities available-for-sale (SAS) – may or may not be held for current resale.

Summary of Accounting Methods Used and Balance Sheet Presentation for Different Types of
Securities Investment
Classification
A. Debt & Equity Securities classified Account Title: Investment in Trading Securities (TS)
as Trading Securities Accounting Method: Fair value method
(Marketable securities held for with unrealized holding gain or loss included in
current sale) earnings; presented among current assets.
B. Debt & Equity Securities classified Account Title: Investment in Securities Available
as Available for Sale for Sale (SAS)
(Marketable securities held for Accounting Method: Fair value method
Unspecified period of time such as with unrealized holding gain or loss included as a
those that might be sold to meet component of stockholders’ equity or as part of
liquidity needs or sold in earnings for the period; presented as current or
implementing a company’s risk mgt. noncurrent assets as appropriate.
Program)
C. Debt securities classified as Held Account title: Investments in securities Held to
To Maturity or for which fair Maturity
Value is not readily determinable. Accounting Method: Amortized Cost Method;
Presented as noncurrent assets.
D. Equity securities for which fair value Account title: Investment in Equity Securities
is not readily determinable and in Accounting Method: Cost Method; presented
which investor company does not as noncurrent assets.
have significant influence (less than
20% of the voting stock of the investee)
E. Equity securities in which investor Account title: Investment in Equity Securities
holds 20% - 50% of the voting Accounting method: Equity method; presented
stock of the investee as noncurrent assets.
F. Equity securities in which investor Account title: Investment in Equity Securities/
owns more than 50% of the voting Subsidiary Company
stock of the investee Accounting method: Consolidation; presented
as noncurrent assets.

Fair value Method. Fair value is the amount for which an asset could be exchanged, or a liability
between knowledgeable, willing parties in an arm’s length transaction.
The fair value of securities may be determined by one or several generally accepted methods:
1. Published price quotation in the stock exchange
2. Rating by an independent agency
3. Other valuation model using data inputs from active markets.

Exercise 1. Match the following by entering appropriate letters to the left.

Method :
a. Equity b. Cost c. Consolidated statement basis d. Fair value e. None of these

Investor’s Situation
_____1. Owns 30 percent of the common stock (voting) of another corporation
_____2. Owns 15 percent of the preferred stock (nonvoting) and 10 percent of the common stock
(nonvoting) of another corporation. The common is really marketable.
_____3. Owns 100 percent of the preferred stock (nonvoting( of another corporation. The stock is
readily marketable.
_____4. Owns 5 percent of the common stock (voting) of another corporation. The stock is not readily
marketable.
_____5. Owns 25 percent of the outstanding bonds payable of another corporation.
_____6. Owns 51 percent of the common stock (voting) of another corporation.
_____7. Owns 20 percent of the preferred stock (nonvoting)

Exercise 2. Match the different securities listed below with their usual classification as investments by
entering the appropriate letter in each blank space:
A. Investment in trading securities
B. Investment in securities available for sale
C. Investment in equity-basis securities
D. Investment in securities held to maturity
E. Investment in equity securities to be consolidated
F. None of the above

Typical securities
____1. Liberty common stock, no par, acquired to use temporarily idle cash.
____2. Land acquired for short-term speculation.
____3. National Bank Treasury bills, mature in six months.
____4. AB preferred stock, par 100 birr; mandatory redemption within next 12 months.
____5. Platinum common stock, par 5 birr; thereby acquiring a controlling interest.
____6. Alpha bonds, 9 percent, mature at the end of 10 years; intended to be held for 10 years.
____7. Aspen Corporation, common stock, a 30 percent interest acquired, but difficulties encountered in
withdrawing cash earned.
____8. Certificates of deposit (CDs); mature at end of one year.
____9. Savings certificate at local savings and loan association, mature in one year.
____10. Silver common stock, par 1 birr; acquired as an investment that management plans to hold
indefinitely.

Accounting for Investments

Approaches in Recording Investments in Equity Securities (Common Stocks):

1. Fair value method – if the acquired stocks is less than 20% of the total outstanding stocks of the
investee corporation, the investment will be recorded at cost and subsequently adjusted to fair value if
Fair market value is readily determinable, otherwise the investment remains at cost.
Entry:
1. Investment Investment in X Co. - xxx (at cost)
Cash - xxx
2. Dividends Cash - xxx
Dividend Income - xxx
3. Net Profit No Entry
4. Adjustment to FMV Investment in X Co. - xxx
Unrealized Gains/losses - xxx
5. Closing of UG/Loss Unrealized gains/losses - xxx
Income Summary (TS) - xxx
Or Unrealized gains/losses - xxx
Stockholders’ Equity (SAS) - xxx
2 Types of Short-term Equity Securities:

1. Trading securities (TS)- are those acquired principally for the purpose of generating profit
from short-term fluctuations in prices or dealer’s margin.
 2. Available-for-sale securities (SAS) – are those financial assets that are not a) loans and
receivables originated from the enterprise or b) held-to-maturity investment or c) held for
trading.

2. Equity Method – when significant influence is exercised by the acquiring company due to the
acquisition of more than 20% of the common stock of the investee corporation but not more than 50%.
Significant influence exist when the acquiring company purchased 20% - but not more than 50% of the
voting stock (common stock) of the investee corporation.
Entry:
1. Investment Investment in X Co. - xxx (at cost)
Cash - xxx
2. Adjustment for amortization Equity in Investee Income - xxx
Investment in X Co. - xxx
3. Dividends Cash - xxx
Investment - xxx
4. Share in Net profit Investment in X Co. - xxx
Equity in Investee Income – xxx

3. Consolidation Method– is used when 50% of the common stock of the investee corporation is
acquired by the acquiring company (controlling interest). Controlling interest exist when the acquiring
company purchased more than 50% of the voting stock.

Audit Objectives and Procedures

Assertions Audit Objectives Audit Procedures
1. Existence or Occurrence A. To determine that investments in 1. Obtain or prepare a listing
securities (stocks, bonds, notes) of securities and investments
physically exist and in loans and owned by the company and
advances exist. related revenue accounts and
reconcile to the general ledger
2. Inspect securities on hand.
3. Obtain confirmation of
securities held by others.
2. Completeness B. To determine that investments 4. In addition to 2 And 3,
vouch selected purchases
and sales transactions of
securities during the year.
3. Rights and Obligation C. To determine that the company 5. In addition to 2 and 3.
owns or has ownership rights verify the client’s cutoff
to all investments included in the of securities transactions.
balance sheet. 6. Perform analytical procedure
7. Compute independently
revenue from securities.
4. Valuation D. To determine that investments are 8. Determine market value of
valued properly in accordance securities at balance sheet
with GAAP. Date.
 9. Evaluate the method of
accounting for securities.
5. Presentation and E. Investments are properly 10. Evaluate financial statement
described and classified in the presentation and related
balance sheet and related revenue or loss accounts.
disclosures are adequate.
Illustrative Audit Case 1: Analysis of Investment in Equity Securities
As auditor for the Abysinia Company, you are to prepare the following:
Working papers for the securities and for security transactions for the year ended December 31, 2014,
including columns for the following:
1. Securities inventory at December 31, 2013, divided into security name, number of shares, cost, and
average cost per share.
2. Security purchases in 2014, divided into date, shares, and amount.
3. Security sales in 2014, divided into date, shares, and amount, and average cost of shares sold, and
profit or loss on sales.
4. Securities inventory at December 31, 2014, divided into name of security, shares, and cost.
5. Dividends received in 2014.
Marketable securities owned by the Abysinia Company at December 31, 2014:
Security A, 1,500 shares, at a cost of………………………………..120,000 birr
Security B, 1,200 shares, at a cost of ………………………………. 84,000
Security C, 1,000 shares, at a cost of………………………………..130,000
Security D, 800 shares, at a cost of……………………………….. 85,000
Security E, 1,000 shares, at a cost of……………………………….. 70,000
489,000
======
Security transactions for 2014 are as shown in the two tables following:
Purchases Shares Cost
April 5 500 A 50,000 birr
April 25 200 F 15,000
July 15 300 G 40,000
July 25 200 D 20,000
August 15 200 D 25,000
September 15 1,000 G 90,000

Sales Shares Selling Price

March 10 200 C 30,000 birr
April 10 1,200 B 110,000
June 15 300 C 50,000
August 20 1,000 E 30,000
September 30 1,000 A 125,000
Other data are as follows:
1. Cash dividends received, 2014: A, 12,000 birr; C, 6,000 birr; D, 5,000 birr; and F, 1,000 birr.
2. Stock dividend received on June 15, 2014; E, 100 percent.
3. Market price of securities at December 31, 2014: 565,000 birr.