Reinvesting Profits in Long-Term Securities

An important accounting function is tracking cash flow.This involves the inflow of cash through sales, services and investment interest and the outflow of cash in the form of expenses and other financial activities. Investing excess cash in securities, either short-term or long-term, is beneficial to the company.

Long-Term Investments

Long-term investments are defined as investments made to earn income. Or, investments made in order to exert significant influence on another company.

  • Available-for-Sale Securities

These include debt and equity securities. Because these securities are held until maturity and are normally for a time period exceeding a year, they are classified as noncurrent on the balance sheet. They are reported at fair value and as a separate component of stockholders’ equity under Other Comprehensive Income. This entry is below the Retained Earnings line on the balance sheet.

Even though the available-for-sale securities experience changes in market value, these changes are considered an unrealized gain or loss. This means that a security can gain or lose market value but this is not accounted for because the security hasn’t yet been sold.

  • Investment in Equity Securities to Gain Control & Influence

A company may seek to influence another company’s policy by purchasing a large quantity of long-term investments in the form of equity in that company. The Financial Accounting Standards Board (FASB) has created guidelines to define this type of control sought by an investing company.

The company with the investment has…

    • Little Influence: With holdings of less than 20%. Account for these using the fair value similar to available-for-sale securities.
    • Significant Influence: With holdings between 20% to 50%. Account for these using the equity method. The investor records the initial investment at cost and includes a proportional share of the investee’s income on its income statement each period.
    • Controlling Interest: With holdings of more than 50%.  The financial statements of the investee are consolidated with those of the owner-investor because of their large portion of stock ownership.