Investments in securities and minority, passive investments

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Firms also may invest in the securities of other firms, such as common stock and longterm debt, thus acquiring claims to the returns from other firms’ operations. In computations of ROA, financial assets increase the ROA denominator, and profits from the investments increase both the denominator (assets) and numerator (net income). This section examines the accounting, reporting, and analysis issues surrounding investments in securities.  Firms invest in the securities of governments, corporations, variable-interest entities, joint ventures, and partnerships for a variety of reasons, including to

•  earn interest or dividends.
•  speculate on potential price appreciation of the securities.
•  lock in high yields on long-term debt securities.
•  provide financial support to, exert significant influence over, or gain control of an important raw materials supplier, customer, technological innovator, or other valued entity
•  achieve other strategic purposes

The appropriate accounting for investments depends on the level of ‘‘controlling financial interest’’ by the firm making the investment, determined by:

•  the degree of influence and control one firm has over another entity, which may be: • minority, passive. • minority, active. • majority, active.
• whether the reporting firm is deemed the primary beneficiary of the investment it has made in a VIE (variable-interest entity

Minority, Passive Investments
Firms often invest in the debt securities, preferred stock, or common stock of another corporation for the anticipated interest or dividends and capital gains. These investments are deemed minority, passive investments when the percentage that a firm owns of another corporation’s voting shares is relatively small (less than 20%) and the investing firm is not deemed the VIE’s primary beneficiaryTo account for minority, passive investments:

•  firms initially record investments at acquisition cost
•  revenues each period equal interest and dividends received or receivable the accounting at the end of each period and at time of sale depends on the type of security and the firm’s ability and intent to hold it, as follows: 
• • Firms must account for debt securities theyexpect to hold to maturity atamortized acquisition cost.

• Firms must account for trading securities at fair value. These are securities a firm actively buys and sells to take advantage of short-term differences or changes in  market values. They are reported as a current asset on the balance sheet and are marked to market at the end of each period. Broker/dealers, banks, and insurers, for example, often trade securities in different capital markets worldwide to take advantage of temporary differences in market prices. Manufacturers, retailers, and other nonfinancial firms occasionally invest funds for trading purposes, but such situations are unusual. Firms include unrealized holding gains and losses on trading securities in net income each period. When a firm sells a trading security, it recognizes the difference between the selling price and the book value (that is, the market value at the end of the most recent accounting period prior to sale) as a realized gain or loss in net income

Firms must account for available-for-sale securities at fair value, reporting them as either current or noncurrent assets, depending on the expected holding period. These are all other minority, passive investments that do not fit into one of the first  two categories. Unrealized holding gains or losses on securities available for sale are not included in net income each period; instead, they appear as a component of other comprehensive income, labeled Unrealized Holding Gain or Loss on Securities Available for Sale. The cumulative unrealized holding gain or loss on securities available for sale appears in the shareholders’ equity section of the balance sheet as part of accumulated other comprehensive income. When a firm sells an available-for-sale security, it recognizes the difference between the selling price and the acquisition cost (or amortized cost if it is a bond) as a realized gain or loss on the income statement. At the time of sale, the firm must remove any unrealized gain or loss from accumulated other comprehensive income and the full amountof the realized gain or loss is then recognized in net income and retained earnings.

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