Accounting Principles II – Investments | Accounting

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Study GuideAccounting PrinciplesII–Investments1.Introduction to InvestmentsCompanies often have more cash on hand than they need for their day-to-day operations. Instead ofletting this extra money sit unused, they may choose to invest it. Investing allows a company to earnadditional income, such asinterestordividends, while the cash is not immediately needed.1.Why Do Companies Invest?There are a few common reasons companies invest their excess cash:•To earn income:Short-term investments can generate interest or dividend revenue.•For strategic goals:A company might invest in another business, for example by buying itsstock, to support long-term plans such as expansion or partnerships.No matter the reason, once a company invests its cash, that investment must be reported in thecompany’sfinancial statements.2.How Investments Appear on the Balance SheetInvestments are shown on thebalance sheet, but they are usually listed separately from cash. Thishelps users of financial statements clearly see how much money is tied up in investments rather thanavailable for immediate use.Investments are classified as:•Short-term assetsif the company plans to sell or use them soon.•Long-term assetsif the company intends to hold them for a longer period.The classification depends on both the type of investment and management’s plan for how long it willbe held.

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Study Guide3.Types of Investments Companies Can ChooseCompanies have many investment options, including:•Certificates of deposit (CDs)•U.S. Treasury bills•Bonds and notes•Mutual funds•Bonds issued by other companies•Stock of other companiesEach type of investment has different risks and returns, so companies choose based on their financialgoals and needs.4.Accounting for Different InvestmentsIt’s important to know thatinvestments in bonds and investments in stocks are accounted fordifferently. Because these investments work in different ways, the accounting entries used to recordthem are not the same. This chapter will explore those differences in more detail.Overall, investments help companies put unused cash to work while supporting both short-termincome and long-term strategies.2. Accounting for Debt SecuritiesDebt securities are a common type of investment for companies. Let’sbreak this topic down step bystep so it’s clear, logical, and easy to follow.What Is a Debt Security?Adebt securityis an investment inbondsissued by:•The government, or•A corporationWhen a company buys bonds, it is essentially lending money and earninginterestin return.

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Study Guide1.Recording the Purchase of BondsWhen a company purchases bonds, the totalcost of the investmentis recorded in an asset accountcalledDebt Investments.What counts as acquisition cost?The acquisition costincludes:•Theprice paid for the bonds, and•Anyinvestment fees or broker’s commissionsThese costs are combined and recorded together because they represent the total amount invested.Example: Buying BondsSupposeComputers Galorebuys:•Fivebonds with a face value of $1,000 each•Interest rate of 10%•On July 1•Purchase price: $5,500•Broker’s fees: $50Total acquisition cost = $5,550

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Study GuideJournal Entry on July 1•DebitDebt Investments for $5,550•CreditCash for $5,550This entryshows that cash was used to acquire the bond investment.2.Recording Interest RevenueBonds usually pay interest on specific dates. In this case, the bonds pay interesttwice a year:•June 30•December 31Calculating InterestFor December 31:•Principal: $5,000 (5 bonds × $1,000)•Interest rate: 10%•Time: 6 months (6/12 of a year)

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Study GuideJournal Entry on December 31•DebitCash for $250•CreditInterest Revenue for $250This records the interest income earned from the bonds.3.Holding orSelling BondsAfter purchasing bonds, a company can either:1.Hold them until maturity, or2.Sell them before maturityEach option is handled differently in accounting.Bonds Held to MaturityIf the company plans to keep the bonds until theymature:•They are classified as along-term investment•Any difference between:○The bond’smaturity value, and

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Study Guide○Thecost of the bonds○isamortizedover the life of the bonds and reported on the income statement.4.Selling Bonds Before MaturityIf the company plans to sell the bonds:•Their value changes with the market•Again or lossis recorded at the time of saleCalculating Gain or LossA gain or loss is the difference between:•Book valueof the bond, and•Cash receivedfrom the saleExample: Selling One Bond at a LossTotal acquisition cost was $5,550 for five bonds.If one bond is sold on June 1 for$1,050:

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