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Long-Term Investments: Definition, Types & Examples

Instructor: Mark Koscinski

Mark has a doctorate from Drew University and teaches accounting classes. He is a writer, editor and has experience in public and private accounting.

In this lesson, you will learn to recognize and account for long-term investments. You will also learn when to use the equity method of accounting and consolidation accounting.

Why Own Long-Term Investments?

A company may hold long-term investments for many reasons. Perhaps it is to accumulate funds for a major expansion project or to repay a loan or bond principal coming due more than a year from now. Another reason to make a long-term investment in another company is for strategic reasons. For instance, the investor may intend to eventually acquire the second company. Whatever the reason, a company must analyze its investment portfolio, every balance sheet date, and determine how to classify each investment and how each security should be accounted for.

Trading Securities

Investment accounting considers the intent of management, the type of security being held, and the percentage of ownership for voting stock. Suppose your company owns a mix of stock and bond investments. You first must decide if you intend to actively manage (buy and sell) these securities for profit. If so, the securities are classified as trading securities and become current assets on the balance sheet. Trading securities are recorded at fair value, with any gain or loss reported in the income statement.

HTM Securities

You then look at the type of security in your portfolio. Debt securities that management intends to hold until maturity are called held-to-maturity (HTM) securities. Only debt securities can be HTM securities since equity securities do not mature. HTM securities can be classified as either short or long-term assets on the classified balance sheet, depending on the maturity date. They are accounted for at an amortized cost (The cost of acquiring the security plus any unamortized premium or less any unamortized discount).

AFS Securities

Any debt securities not classified as HTM, like preferred stock investments or common stock investments of less than 20% of the outstanding voting shares of another company, are reported as securities available-for-sale (AFS). These securities can be either short or long-term, depending on management's intent to hold the securities more or less than one year. AFS securities are recorded at fair value. Unlike the accounting for trading securities, the fair value adjustment is not recorded in current earnings but on the company's balance sheet in an equity account called other comprehensive income (OCI). Suppose your company holds AFS securities that have decreased in value by $10,000.

The journal entry is:

Dr. OCI--Change in AFS security value 10,000
Cr. AFS Securities 10,000

Fair Value Option

A recent change in accounting rules, known as the fair value option, allows companies to account for financial assets, such as investments at fair value. The fair value option requires any change in fair value to be recorded in the current earnings of the company and is available for both HTM and AFS securities.

Influential Securities

The Equity Method

If your company owns over 20% of the outstanding voting shares of a company, you are said to own influential securities. Influential securities are classified as long-term investments. The equity method of accounting and consolidation accounting rules then apply. If you own over 20% but less than 50% of the outstanding voting shares of another company, your company is said to have significant influence over the second company. As a result, you must use the equity method of accounting for the investment. This accounting records the investor company's pro-rata share of the income or loss of the owned company and reduces its investment in the owned company by any dividends received.

Suppose a company makes a $100,000 investment for a 25% ownership of a second company at the beginning of the year. The second company pays total dividends of $10,000 to all its shareholders and has net income of $20,000 for the year.

The equity method journal entries are:

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