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Chapter 15: Investments and Fair Value Accounting

Companies invest cash in three ways:
1. Investing in current operations
2. Investing in temporary investments to earn additional revenue
3. Investing in long-term investments in stock of other companies for strategic reasons
To support its current level of operations, a company uses cash to pay:
1. Expenses
2. suppliers of merchandise/other assets
3. Interest to creditors
4. Dividends to stockholders
Companies will invest excess cash in temporary investments (securities):
1. Debt securities (notes and bonds that pay interest and have a fixed maturity rate)
2. Equity securities (preferred and common stock that do not have a fixed maturity date)
Primary goals of temporary investments
1. Earn interest revenues
2. Receive dividends
3. Realize gains from increase in the market price of all securities
Purpose of investing cash in long-term investments:
1. Reduction of costs
2. Replacement of management
3. Expansion
4. Integration
Accounting for bond investments includes recording the following:
1. Purchase of bonds
2. Interest revenue
3. Sale of bonds
Investment of less than 20% of the investee’s outstanding stock are accounted for using the….
Cost method
Entries for the cost method
1. Purchse of stock
2. Receipt of dividends
3. Sale of stock
Investments of between 20% and 50% of the outstanding stock are accounted for using the……..
Equity method
The equity method adjusts for
The investor’s share of the net income and dividends of the investee
Business combination
Purchase of more than 50% ownership of the investee’s stock
Trading securities
Debt and equity securities that are purchased to earn short-term profits from changes in their market prices

-Often held by banks, mutual funds, insurance companies, other financial institutions

-Valued as a portfolio using fair value (market price)

Available-for-Sale Securities
Debt and equity securities that are neither held for trading, held to maturity, not held for strategic reasons
Held-to-Maturity securities
Debt investments (e.g., notes and bonds) are a company intends to hold until their maturity date
Fair value accounting
Often book value differs greatly from fair value on property, plant, and equipment assets
Trends towards Fair Value Accounting
1. GAAP principles can be conflicting re: fair value vs. book value
2. A higher percentage of total assets of many companies consists of assets with readily available fair values
3. World economy compels a worldwide set of accounting standards and the U.S. is being pressured to conform. One major difference is the use of fair values
Disadvantages to fair value accounting
1. Fair values are not readily obtainable for some assets/liabilities
2. Makes it more difficult to compare companies that use different methods
3. Using fair value accounting causes more fluctuations in accounting reports because fair values change year to year
Dividend yield
Measures rate of return to stockholders based on cash dividends
Formula for dividend yield
Dividend Yield = Dividends per Share of Common Stock/Market price per share of common stock

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