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Transcript of INVESTMENT
What is Investment?
Investment are assets held by an entity for the accretion of wealth through distribution such as interest, royalties, dividends, and rentals, for capital appreciation or for other benefits to the investing entity such as those obtain through trading relationship.
Why Companies Invest?
Most companies generate cash from their operations that can be used for:
Investing Cash in Current Operations
Cash used to support the current operations activities of a company and it can be invested in the company to expand its current operations. To support it operation, a company used cash to pay:
b. Suppliers of merchandise and other assets.
c. Interest to creditors
d. Dividends to stockholders.
Investing Cash in Temporary Investments (to earn additional revenue)
A company may temporarily have excess that is not needed for used in its current operations and they usually invest their excess cash in temporary investments such as:
a. Debt securities- notes and bonds that pay interest and have a fixed maturity date.
b. Equity securities- preferred and common stock that represent
Investing Cash in Long-Term Investments (in stock f other companies for strategic reasons)
The company may invest cash in the debt or equity of another company as long-term investments that may be held for the same investment objectives as temporary investments. However, it often involves the purchase of a portion of the stock of another company.
Investments in debt and equity securities, termed Investments or Temporary Investments, are reported in the Current Assets section of the balance sheet. The primary objective of investing in temporary investments is to:
a. Earn interest revenue
b. Receive dividends
c. Realized gains from increases in the market price of the securities.
Such investments usually have a strategic purpose, such as:
a. Reduction of cost- The combined company may be able to reduce its administrative expenses.
b. Replacement of management- If the purchase company has been mismanage, the acquiring company may replace the management to improve operations and profits.
c. Expansion- one company can buy another company because it has a complementary product line, territory, or costume base and they serve the costumers better.
d. Integration- the company may integrate operations by acquiring supplier or/and costumers. Acquiring supplier may provide more stable or uninterrupted supply of resources while acquiring costumers may also provide market for the company’s products or services.
Accounting for Debt Investments
Companies invest excess cash in bonds as investments to earn interest revenue.
The account for bond investments includes recording the following:
Purchase of bonds
The purchase of bonds is recorded by delegating an investments account for the purchase price of the bonds, including any brokerage commissions. If the bonds are purchased between interest dates, the purchase price includes accrued interest since the last interest payment. This is because the seller has earned the accrued interest, but the buyer will receive the accrued interest when it is paid.
Accrued income is income which has been earned but not yet received. Accrued income must be recognized in the accounting period in which it earned regardless of when receive. As income will be credited to record the accrued income, a corresponding receivable must be created to account for the debit side of the transaction.
Sales of bonds
The sale of the bond investment results in gain or loss. If the proceeds from the sale exceed the book value of the bonds, then a gain is recorded. However, if the proceeds are less than the book value of the bonds, a loss is recorded.
Accounting for Equity Investments
A company may invest in the preferred or common stock of another company. Investors are the company’s investing in another company while investee is the company whose stock is purchased. The percent of the investee’s outstanding stock purchased by the investors determines the degree of control that the investors has over the investee.
Less than 20% ownership
If the investors purchase less than 20% of the outstanding stock of the investee, it is considered to have no control over the investee. It is assumed that the investor purchased the stock primarily to earn dividends or realize gains on price increase of the stock. Their investments are accounted for using the cost method.
Between 20%-%0% Ownership
The investor is considered to have a significant influence over the investee. Investors purchased the stock primarily for strategic reasons such as developing a supplier relationship. It is accounted for using the equity method where stocks is recorded initially at its cost, including any brokerage commissions and the investment account is adjusted for the investor’s share of the net income and dividends of the investee that serve as:
a. Net Income- investor records its share of the net income of the investees as an increase in the investment account. Its shares of any loss are recorded as a decrease in the investment account.
b. Dividends- Investors share of cash dividends receive from the investees decrease the investment account.
More than 50% Ownership
Investors are considered to have control over the investee. Investors purchased the stock of the investee primarily for strategic reasons. Purchasing of more than 50% stocks is a business combination.
Corporations owning all or a majority of the voting stock of another corporation is called parent company while the controlled company is called subsidiary company. Parent and subsidiary corp. maintain separate accounting records and prepare their own financial statements. At the end of the year the accounting record of both company are combined and reported as a single company and the combined financial statement is called solidated financial statements.
Valuing and Reporting Investments
Debt and equity securities are financial assets that are often traded on public exchanges. As a result, their market value can be observed and, thus, objectively determined. For purpose of valuing and reporting, debt and equity securities are classified as:
It’s the debt and equity securities that are purchased and sold to earn short-term profits from changes in their market prices. Trading securities are held as short-term investment and reported as current assets on the balance sheet. It valued as a portfolio (group) of securities using the securities’ fair value- the market prize that the company would receive for a security if it were sold. Changes in fair value of the portfolio are recognized as an unrealized gain or loss for the period.
It’s the debt and equity securities that are neither held for trading, held to maturity, or held for strategic reasons.. It is similar to the accounting for trading securities except for the reporting of changes in fair values. Specifically, changes in the fair values of trading securities are reported as an unrealized gain or loss. Changes in fair values are recorded as part of stockholders’ equity and excluded in the income statement.
It’s the debt investments, such as notes and bonds that a company intends to old until their maturity date. It is primary purchased to earn interest revenue.
Fair Value Accounting
It is the price that would be received for selling an assets or paying off a liability. Fair value assume that the assets is sold or the liability paid off under normal rather than under distressed comditions.
Trend to Fair Value Accounting
A current trend is to adopt accounting principles using fair values for valuing and reporting assets and liabilities.
Effect of Fair Value Accounting on the Financial Statements
The use of fair values for valuing assets and liabilities affects the financial statement specifically; the balance sheet and income statement could be affected.
Financial analysis and interpretation: Dividend Yield
It measures the rate of return to stockholders based on cash dividends. To compute dividend yield, divide “Dividends per share of common stock” by “Market price per share of common stock”-
Dividends per share of common stock/
Market price per share of common stock
It was defined as all changes in stockholders’ equity during a period, except those resulting from dividends and stockholders’ investments. Comprehensive income is computed by adding or subtracting other comprehensive income from net income. Other comprehensive income items include unrealized gains and losses on available-for-sale securities as well as other items. It is reported on the balance sheet, as accumulated other comprehensive income.
Different forms of investments
Investing in equity securities
Investing in bonds
Investment in associate
Investment in subsidiary
Investment in property
Investment in funds
Investment in joint venture
Purposes of investments
Accretion of wealth
regular income through interest, dividends, royalties, and rentals
in the case of investment of land and real estate held for appreciation and direct investments in gold, diamonds, and other precious commodities
the case of investment in subsidiaries and associates
Meeting business requirements
in the case of sinking fund, preference share redemption fund, plant expansion fund, and other non current funds
in the case of interest in life insurance contract in the form of cash surrender value
Statement Classification of Investments
investments that are by their very nature readily realizable and are intended to be held for
not more than one year
Non- Current Investment
investments that are intended to be held for
more than one year
or are not expected to be realized within twelve months after the end of the reporting period
PAS 32- financial instrument is any contract that gives rise to financial assets of one entity and a financial liability or an equity instrument of another entity
characteristics of financial instrument
- there must be a contract
- there must be at least two parties in the contract
- the contract shall give rise to a financial asset of one party and financial liability or equity instrument o another party
Common example of financial instrument
Cash in a form of notes and coins
this is a financial asset of the holder or bearer and a financial liability of the issuing government
Cash in the form of checks
this is a financial asset of the payee and a financial liability of the drawer or issuer
Cash in Bank
this is the financial asset of the depositor and financial liability of the depository bank
this is a financial asset of the seller as accounts receivable and a financial liability of the customer or buyer as accounts payable
Notes and Loans
this is a financial asset of the lender or creditor as notes receivable or loans receivables and a financial liability of the borrower or debtor as notes payable or loans payable
this is the financial asset of the investor and the financial liability of the issuer
this is the financial asset of the investor and an equity of the issuer
Definition of financial asset
financial asset is any asset that is:
- a contractual right to receive cash or any financial asset from another entity
- a contractual right to exchange financial instrument with another entity under condition that are potentially favorable
- any equity instrument of another entity
Examples of financial asset
Cash or currency
it represents the medium of exchange and is therefore the basis on which all transaction are measured and recognized in financial statement
Deposit of cash
it represents the contractual right of the depositor to obtain cash from the bank or to draw a check against the balance in favor of a creditor in payment of a financial liability
Financial assets representing a contractual right to receive cash
-Trade accounts receivable
Definition of Financial liability
any liability that is contractual obligation:
- to deliver cash or other financial asset to another entity
- to exchange financial instrument with another entity under condition that are potentially unfavorable
Financial liabilities representing a contractual obligation to deliver cash in future
- Trades accounts payable
- Notes payable
- Loans payable
encompasses any instrument representing ownership shares and right, warrants or options to acquire or dispose of ownership shares at a fixed or determinable price.
in simple language, equity security represent an ownership interest in an equity
ownership shares includes ordinary shares, preference share and other share capital
is any security that represents a creditor relationship with an entity. a debt security has a maturity date and maturity value
example of debt security
- corporate bonds
- BSP treasury bills
- government securities
- commercial papers
-preference share with mandatory redemption date
is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at a measurement date.
simply stated, fair value is the price agreed upon by a buyer and a seller in an arms length or orderly transaction
Unrealized gain and losses
gain and losses on financial assets measured at a fair value shall be represented in profit or loss, unless:
- part of hedging relationship
- an investment in equity instrument and the entity has irrevocably elected to present unrealized gain and losses in other comprehensive income
Gain and losses- financial assets at amortized cost
Unrealized gain and losses on financial assets at amortized cost are not recognized simply because such investments are not reported at fair value
Deo jansen Calano
thank you for watching
Hope you learn a lot