Trading securities are investments that were made with the intent of reselling them in the very near future, hopefully at a profit. Such investments are considered highly liquid and are classified on the balance sheet as current assets. They are carried at fair market value, and the changes in value are measured and included in the operating income of each period.
However, not all investments are made with the goal of turning a quick profit. Many investments are acquired with the intent of holding them for an extended period of time. The appropriate accounting methodology depends on obtaining a deeper understanding of the nature/intent of the particular investment. You have already seen the accounting for "trading securities" where the intent was near future resale for profit. But, many investments are acquired with longer-term goals in mind.
For example, one company may acquire a majority (more than 50%) of the stock of another. In this case, the acquirer (known as the parent) must consolidate the accounts of the subsidiary. At the end of this chapter we will briefly illustrate the accounting for such "control" scenarios.
Sometimes, one company may acquire a substantial amount of the stock of another without obtaining control. This situation generally arises when the ownership level rises above 20%, but stays below the 50% level that will trigger consolidation. In these cases, the investor is deemed to have the ability to significantly influence the investee company. Accounting rules specify the "equity method" of accounting for such investments. This, too, will be illustrated within this chapter.
Not all investments are in stock. Sometimes a company may invest in a "bond" (you have no doubt heard the term "stocks and bonds"). A bond payable is a mere "promise" (i.e., bond) to "pay" (i.e., payable). Thus, the issuer of a bond payable receives money today from an investor in exchange for the issuer's promise to repay the money in the future (as you would expect, repayments will include not only amounts borrowed, but will also have added interest). In a later chapter, we will have a detailed look at Bonds Payable from the issuer's perspective. In this chapter, we will undertake a preliminary examination of bonds from the investor's perspective. Although investors may acquire bonds for "trading purposes," they are more apt to be obtained for the long-pull. In the latter case, the bond investment would be said to be acquired with the intent of holding it to maturity (its final payment date) -- thus, earning the name "held-to-maturity" investments. Held-to-maturity investments are afforded a special treatment, which is generally known as the amortized cost approach.
By default, the final category for an investment is known as the "available for sale" category. When an investment is not trading, not held-to-maturity, not involving consolidation, and not involving the equity method, by default, it is considered to be an "available for sale" investment. Even though this is a default category, do not assume it to be unimportant. Massive amounts of investments are so classified within typical corporate accounting records. We will begin our look at long-term investments by examining this important category of investments.
The following table recaps the methods you should be familiar with.
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