Investments are classified on the balance sheet into two types: short-term investments and long-term investments. Companies have different motivations for investing in other companies (i) motivation is to earn a high rate of return, (ii) motivation for investing is to secure certain operating or financing arrangements with another company.
Definition of Short-Term Investments
A short-term investment is an investment that is by its nature readily realizable and is intended to be held for not more than one year.
To be classified as a short-term investment, security must meet the following tests:
- The security must be readily marketable i.e., it must be regularly traded on a security exchange market.
- The investor intends to convert the security to cash within the current operating cycle or one year, whichever is longer.
Types of short-term investments
2 types of short-term investments are:
- Investments in Equity Securities,
- Investments in Debt Securities,
Investments in Equity Securities
Equity securities are securities representing ownership interests, such as shares of common and preferred stock.
Investments in Debt Securities
Debt securities are instruments representing a creditor relationship with an enterprise, such as government securities, municipal securities, corporate bonds, convertible debt, and commercial paper.
Accounting For Short-Term Investments at the Acquisition Date
Short-term investments are recorded at cost on the acquisition date in conformity with the Equity method.
Under the equity method, the investment in an associate is initially recognized at cost and the carrying amount is increased or decreased to recognize the investor’s share of the investee’s profit or loss after the acquisition date.
Acquisition cost is the cash equivalent price paid: it includes the purchase cost plus all incidental acquisition costs.
The cost of an investment includes acquisition charges such as brokerages, fees, duties and bank fees.
Accounting For Short-term Investments After the Acquisition Date
Investments classified as current assets should be carried in the balance sheet at either:
- Market value; or
- The lower cost and market.
Suppose current investments are carried at a lower cost and market value. In that case, the carrying amount should be determined either on an aggregate portfolio basis, in total or by category of investment, or on an individual investment basis.
FASB Statement-12 requires that LCM be applied to short-term equity investments. It also requires maintaining a clear distinction between realized and unrealized losses and gains.
These if requirements are implemented as follows;
Portfolio Basis
at the end of each reporting period, group the short-term equity investments into one aggregate portfolio to determine total original cost and market value.
Measure any unrealized loss.
At the end of each reporting period. Compare the total portfolio cost with the total market; if the market is less than the cost.
The entry will be;
| Unrealized loss on short term Investment | Debit | – |
| Allowance to reduce short term investment to market | – | Credit |
Measure any unrealized loss recoveries
At the end of each reporting period, the balance in the allowance account must be readjusted to reflect LCM.
If a total market value has continued decline, in the allowance account must be increased.
In the other hand, if the total market value of the portfolio has increased, the balance in the allowance account must be decreased and give an unrealized loss recovery entry
| Allowance to reduce short term investment to market | Debit | – |
| Unrealized loss recovery on S.T | – | Credit |
Accounting for Disposals of Short-term investments
Disposal of a short-term investment the difference between net disposal proceeds and the carrying amount should be recognized as gain or loss.
If the investment was a current asset carried on a portfolio basis at the lower of cost and market value, the gain or loss on sale should be based on cost.
If sales value more than the lower of cost and market value, this entry would be recorded as follows:
| Cash | Debit | – |
| Investment in equity securities S.T | – | Credit |
| Realized gain on sale of investment | – | Credit |
If sales value lower than the lower of cost and market value, this entry would be recorded as follows;
| Cash | Debit | – |
| Realized loss on the sale of investment | Debit | – |
| Realized loss on the sale of investment | – | Credit |
Investments re-classified from current to long-term should be each transferred at the lower of cost and market value, or market value if they were previously stated at that value.
This transaction would be recorded as follows:
| Investment in Equity Securities – Long term | Debit | – |
| Investment in equity securities – Short-term | – | Credit |
Important Journal for Short Term Investments | |||
| 1 | Purchased equity securities | ||
| Investment in equity securities. S.T | Debit | ||
| Cash | Credit | ||
| 2 | Received cash dividend | ||
| Cash | Debit | ||
| Investment revenue | Credit | ||
| 3 | Sales more than the lower of cost and market price | ||
| Cash | Debit | ||
| Investment in equity securities. S.T | Credit | ||
| Realized gain on sale of investment | Credit | ||
| 4 | Sales less than the lower of cost and market price | ||
| Cash | Debit | ||
| To Specific Assets A/C | Debit | ||
| Investment in equity securities. S.T | Credit | ||
| 5 | At the end of the year, if the market is less than the cost | ||
| Unrealized loss on short term Investment | Debit | ||
| Allowance to reduce S.T to market | Credit | ||
| 6 | Transfer to Long term investment, more than the lower of cost and market price: | ||
| Investment in equity securities. L.T | Debit | ||
| Investment in equity securities. S.T | Credit | ||
| Realize gain on S.T investment | Credit | ||
| 7 | Purchased bonds plus accrued interest | ||
| Investment in debt securities. S.T | Debit | ||
| Interest revenue/receivable | Debit | ||
| Cash | Credit | ||
| 8 | End of the period for accrued interest | ||
| Accounts Receivable-Name of debtor A/C | Debit | ||
| To Specific Assets A/C | Credit | ||
| 9 | Interest received with accrued interest: | ||
| Purchased A/C | Debit | ||
| Interest receivable | Credit | ||
| Interest revenue | Credit | ||
| 10 | Sold bonds plus accrued interest: | ||
| Notes Receivable AC | Debit | ||
| Investment in debt securities, S.T | Credit | ||
| Interest revenue | |||