Types of Investments

Discuss the types of investments, accounting for investments, economic entity concept and accounting standard.

As far as accounting is concerned, investment may be defined as an asset purchased with the assumption that it will generate income in the future. It generally involves a lump sum amount. An asset is supposed to give long term gains. It is not meant for short term use. For  example: A machinery to the worth of Rs. 1 million has been purchased by XYZ Ltd. The machinery is supposed to manufacture finished goods from processed items and is meant to be used in the future for a very long period of time (Zaremba, 2015). A car purchased for official purposes is also an investment. Investment can also be done in stocks and shares in the companies with the hope that the price will rise in future. Also, equity shares yield dividends when profits are earned by the companies.

Investing and speculating should not be confused. Investing leads to creation of wealth, speculating does not do so. They are highly liquid and posted on the asset side of balance sheet as current assets. There are certain investments which are acquired for the purpose of holding them (Calandro, 2005). The accounting depends on the intent of investment.

The investments can be classified by the following types:

Held to maturity

A bond may be defined as a promise to pay. A company purchases bonds sometimes. The bond is a promise to pay. The investment done with the objective of holding it to maturity is known as “held to maturity” investments. The amortized cost approach is used in this case.

Trading Security:

An investment is classified as trading security if the investor wants to sell it short term for a profit. Cost is taken as the basis of recording initially. At the end of the period, the investment is evaluated to its fair value. Operating income are any holding gains or losses (unrealized).

Available for sale:

The investments which are neither held to maturity or trading security are known as available for sale. It is initially recorded at cost. At the end of accounting period, the recorded investment is adjusted to its fair value.

Dividends are declared annually in the annual general meeting of a company. They are treated as in come in the final accounts. The entry will be as follows:

                                             Cash

                                                 To

Accounting for Investments

                                                       Dividend Income

On the balance sheet, the amount securities that is available for sale is shown as assets in the balance sheet.

When an individual wishes to borrow money, he approaches a bank or any other financial institution. However, a corporate house borrows large amounts and it often exceeds the lending capacity of the bank (Charpin and Lacaze, 2006). Therefore, a large borrower may issue bonds where the amount is broken up into many small units. Each bond has a face value and the number of bonds multiplied by the face value denotes the loan able amount. The issue price of the bond will depend on the issuer’s credit worthiness, the time to maturity and the market conditions. Bonds may be issued at a premium or even at a discount. Bonds  issued at a premium compels the investor to pay more than face value (Branch and Xu, 2014). Similarly, bonds issued at a discount enable the investor to pay less than   face value per bond. The journal entry will be as follows:

                                      Investment (in bonds)

                                              To

                                               Cash

The method applied to track amortized cost is known as straight line method.  A superior approach known as effective interest method is also applied sometimes. The investor makes the final entry on repayment of principal.

                                                Cash

                                                      To

                                              Investment (in bonds)

Enough ownership may be acquired by the owner in another company and can have significant influence in the matters of decision making in the company. Generally, this happens when the share is more than 20%.

A company which is controlled may continue to maintain its own legal entity. Suppose, A Ltd. has acquired shares in B Ltd. B will be part of the larger economic base (Pézier and White, 2008). Accounting rules require that parent companies bring to inclusion all the assets, liabilities and operating results of the subsidiaries in the balance sheet. There is one more concept of goodwill. Goodwill arises when one company acquires another. Whenever one company is in the process of buying another company and pays more than the net assets, the excess is termed as goodwill (Black, 2015). Another important concept occurs whether there is a realization of gain or loss. Gain or loss only occurs when the investment is sold. Similarly, change in the fair value gives unrealized gain or loss. In a held security, if there is a permanent loss, the entire investment is written off and is treated as realized loss (Mukherjee 2004). This occurs when the company goes bankrupt. Immediate taxation is not applied to any unrealized gain or loss. When the loss or gain is realized by the sale of security, then only it is subject to taxation. So, the basis of calculation of tax of securities and the  amount to be carried in the accounting records of the investor may have a  temporary difference (Calandro 2005).

Economic Entity concept

This particular standard deals with accounting for investments. There is no physical existence of some investments and are represented by certificates. The classification of investments is done with current investments and long term investments. Current investments resemble current assets. If issue of shares is used to acquire an investment, the cost is the  issued securities’ fair value. The fair value and the par value may not be equal. The given up fair value of assets determines the acquisition cost in case an investment is by exchange (Bodie, Kane and Marcus 2005). In some circumstances, income such as interest, dividends and rentals do not form part of income. If there is accrual of unpaid interest before the acquisition of an interest bearing investment, the subsequent receipt of interest happens between pre acquisition and post acquisition periods.  When equity dividends are declared from profits of pre acquisition, a  treatment which is similar applies. In case of rights shares, the carrying amount of the original holding adds the cost of the shares. If there is market sale of rights without subscribing, the sale proceeds are taken to the profit and loss statement (Mukherjee 2004). Where there is cum right basis acquiring and the investments market value immediately after  becoming ex-right is lower than the acquired cost , it is appropriate to apply the sales of rights to reduce the carrying amount of such investments to market value.

 Lower of cost or market value is the amount which is to be carried forward for current investments. Where there is an existence of an active market, the market value best provides fair value evidence. It is not appropriate to consider valuation of current investments on global basis. When there is a consideration of related current investments, there may be carriage of investments at lower of cost or market value. The profit and loss statement includes any fair value reduction and any reversals. Cost is the basis in which long term investments are usually carried. A fall in the  long term investment, value forces the carrying amount to recognize the decline. The lower of cost and fair value is taken as the basis for transfer when there is a reclassification of investments from current to long term.

Reference List

Black, Keith. 2015. ‘Defining Liquid Alternative Investments’. The Journal Of Alternative Investments17 (3): 6-25. doi:10.3905/jai.2014.17.3.006.

Bodie, Zvi, Alex Kane, and Alan J Marcus. 2005. Investments. Boston, Mass.: McGraw-Hill Irwin.

Branch, Ben, and Min Xu. 2014. ‘Hedge Fund Investments In Bankruptcy’. The Journal Of Alternative Investments, 140311050935003. doi:10.3905/jai.2014.2014.1.033.

Calandro, Joseph. 2005. ‘Super Cats As Alternative Investments’. The Journal Of Alternative Investments 7 (4): 42-49. doi:10.3905/jai.2005.491500.

Calandro, Joseph. 2005. ‘Super Cats As Alternative Investments’. The Journal Of Alternative Investments 7 (4): 42-49. doi:10.3905/jai.2005.491500.

Charpin, Françoise, and Dominique Lacaze. 2006. ‘Efficient Portfolios For Alternative Investments’.The Journal Of Alternative Investments 8 (4): 19-25. doi:10.3905/jai.2006.627847.

Mukherjee, Barsendu. 2004. ‘Current Research In Alternative Investments And Econometric Methods’.The Journal Of Alternative Investments 6 (4): 95-97. doi:10.3905/jai.2004.391068.

Mukherjee, Barsendu. 2004. ‘Current Research In Alternative Investments And Econometric Methods’.The Journal Of Alternative Investments 6 (4): 95-97. doi:10.3905/jai.2004.391068.

Pézier, Jacques, and Anthony White. 2008. ‘The Relative Merits Of Alternative Investments In Passive Portfolios’. The Journal Of Alternative Investments 10 (4): 37-49. doi:10.3905/jai.2008.705531.

Zaremba, Adam. 2015. ‘Is Financialization Killing Commodity Investments?’. The Journal Of Alternative Investments, 150609072048007. doi:10.3905/jai.2015.2015.1.042.