How to Show Investments on a Balance Sheet
The balance sheet for your company shows your assets, your liabilities and the owners’ equity. Investments are listed as assets, but they’re not all clumped together. Long-term investments on a balance sheet, for instance, are listed separately from short-term investments.
You show investments you plan to sell within a year as current assets on the balance sheet. Long-term investments are a separate account.
The Balance Sheet Equation
The balance sheet is an equation. On one side of the equals sign is your company’s total assets. Cash in the bank, inventory, accounts receivable and investments all go on the balance sheet as assets.
Company liabilities go on the other side of the equals sign. They include loans you have to pay back, wages you haven’t paid out and taxes and interest you owe.
Stockholders’ equity, the value of the company left if you paid off all your debts, goes on the same side as the liabilities. Equity plus liabilities always equal your assets.
Long-Term Investments: Balance Sheet
Short-term investments and long-term investments on the balance sheet are both assets, but they aren’t recorded together on the balance sheet. Investments can include stocks, bonds, real estate held for sale and part ownership of other businesses.
Whether you report, say, your shares of Dow Chemical and Amalgamated Solar Power as long-term investments on the balance sheet depends on your intentions. If you intend to keep them for more than a year, they’re long term. Otherwise, they’re short-term or temporary assets
Suppose you have to report a quoted investment on the balance sheet. A quoted investment is, for example, shares whose values are quoted on a stock exchange. If you plan to sell them in two months, they’re listed as current assets on the balance sheet. If it’s two years, they’d go in a separate category: investments.
About Valuing Stocks
The more your assets outweigh your liabilities, the larger your investors’ equity. It’s easy to inflate the value of assets by overestimating the value of your investments, so financial rules are strict on how to set their worth. For example, you report stocks on the balance sheet at the current fair-market value rather than how much you paid for them.
To consider one balance sheet example, suppose your company’s investments include $10,000 in stocks that you expect to sell within the year and $20,000 in stocks that you’re holding for the long term. You report the quoted investments in the balance sheet at their current value, not the price you paid for them.
If the stocks have changed in value since you bought them, you report the change as unrealized gain or loss in the owner’s equity section. Suppose they’ve gone up $3,000. You don’t actually get that money until you sell, so you don’t realize the profit until then. The same applies if the value drops.
The Cost Method
It’s easy to set the value of quoted investments in the balance sheet because you have the current sale price on the exchange with which to work. The rules change if the value of the investment is harder to determine. For example, if your company owns a stake in a privately held company, there are no exchange sales to generate a price.
If you have a small ownership stake and can’t exert any influence over the company, you report the value of your investment using the cost method — you report the value as the cost you paid for it. You don’t have to adjust that price unless you have evidence that the investment is worth less than you paid for it.
The Equity Method
If you own at least 20% of another company, it’s assumed that you have significant influence over it. In most cases, you’ll have to use the equity method to calculate the value of your investment. This is considerably more complicated, as you have to consider factors such as any dividend income you earn.
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- Accounting for Purchase of Business
- How to Calculate Initial Yield
- Factors That Contribute to Change.
- Accounting Treatment of Investments
- How to Calculate the Ownership.
- Accounting Consolidation Methods
- How Much Taxes Will I Pay When.
- What Is the Meaning of Biological.
- How Do I Post a Long-Term Capital.
- How to Calculate Cash Flow from.
- Presenting Stock Warrants on a.
- Equity Method of Accounting for.
- What is AOCI?
- The Anderson School at UCLA: How to Read a Balance Sheet
- Accounting Coach: Balance Sheet Example
- The Free Dictionary: Quoted Investments
- PrinciplesOfAccounting.com: Short-Term Investments
- AccountingTools: Equity Method
- AccountingTools: The Cost Method of Accounting For Investments
- Walmart. “2016 Annual Report,” page 37. Accessed July 30, 2020.
Fraser Sherman has written about every aspect of business: how to start one, how to keep one in the black, the best business structure, the details of financial statements. He’s also run a couple of small businesses of his own. He lives in Durham NC with his awesome wife and two wonderful dogs. His website is frasersherman.com
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Short-Term Investments
When a corporation purchases the stock of another corporation, the method of accounting for the stock investment depends on the corporation’s motivation for making the investment and the relative size of the investment. A corporation’s motivation for purchasing the stock of another company may be: (1) as a short or long-term investment of excess cash; (2) as a long-term investment in a substantial percentage of another company’s stock to ensure a supply of a required raw material (for example, Albemarle’s investment in the Wodgina project); or (3) as a long-term investment for expansion (when a company purchases another profitable company rather than starting a new business operation, as Facebook did when it purchased WhatsApp).
Reporting these investments on the balance sheet depends on management’s intent. If the investment is intended to be temporary, it is categorized as a current asset. If it intended to be long-term, it is a noncurrent asset.
Trading securities include both debt securities (bonds) and equity securities (stocks) an entity intends to sell in the short term for a profit that it expects to generate from increases in the price of the securities, so they are always considered current assets.Trading is usually done through an organized stock exchange, which acts as the intermediary between a buyer and seller, though it is also possible to directly engage in purchase and sale transactions with counterparties.
Trading securities are recorded in the balance sheet of the investor at their fair value as of the balance sheet date. If there is a change in the fair value of such an asset from period to period, this change is recognized in the income statement as a gain or loss.
Other investments in marketable securities are classified as either available-for-sale or held-to-maturity.
- Held-to-maturity investments are usually bonds (loans to other companies) held until they come due, which may be years in the future.
- Available-for-sale securities don’t fit in the other two categories, and so may be classified as current or noncurrent, depending on the facts and circumstances.
In this section, we’ll focus on trading securities. Think of trading securities as your on-line brokerage account where you put a few extra dollars trying to earn a quick profit instead of letting that money sit in a savings account that pays very little. Available-for-sale securities and held-to-maturity securities are more like your 401(k) retirement plan, where you set it aside and leave it.
For example, Facebook, Inc. had almost $20 billion in cash and cash equivalents at the end of 2019 (see below) which may seem like a lot of cash sitting idle and not earning much return on investment (because cash and cash equivalents are invested in short-term, low-risk and therefore low-return but highly liquid securities). However, with annual operating expenses of almost $50 billion in 2019, plus cash needed for capital investments, $20 billion in the bank is not unreasonable. Imagine if your annual household expenses were $50,000 and you had $20,000 in the bank—that wouldn’t be unreasonable.
However, there is another $36 billion in marketable securities on the balance sheet (trading securities and short-term available-for-sale securities). Equate that to you personally having another $36,000 invested in the stock market. One question you might have is: where is all that cash coming from? In a later module, you’ll study the statement of cash flows, which may answer that question, but for now, we are just analyzing the balance sheet. It is clear though that Facebook has a lot of cash and liquid assets.
Investors in common stock can use two methods to account for their investments. The purchaser’s level of ownership determines whether the investment is accounted for by (a) the cost method or (b) the equity method.
Under both methods, the purchaser initially records the investment at cost (price paid at acquisition). Under the cost method, the investor company does not adjust the investment account balance subsequently for its share of the investee’s reported income, losses, and dividends. If the investor company receives dividends, it debits whatever money market or savings or checking account the dividend was deposited to and credits an income statement account called Dividend Revenue or something similar. That account is usually reported “below the line” (after operating income but before taxable income).
For example, YourCompany buys, via an EFT from the general checking account to a broker, 100 shares of Public, Inc. at $55 per share, and intends to sell it within six months, or as soon as it hits $60, whichever is sooner. The intent is to hold it short-term, and it is unlikely that YourCompany owns any significant portion of ownership. This is called a trading security and will be categorized as short-term, and we will use the cost method to account for such investments.
| Date | Description | Post. Ref. | Debit | Credit |
|---|---|---|---|---|
| Marketable Securities | $5,500 | |||
| Checking Account | $5,500 | |||
| To record the purchase of 100 shares of Public, Inc. |
When a dividend is deposited into our brokerage money market account, we record it as follows:
| Date | Description | Post. Ref. | Debit | Credit |
|---|---|---|---|---|
| Money Market Account | $5 | |||
| Dividend Revenue | $5 | |||
| To record receipt of Public, Inc. dividend. |
At year-end, companies adjust the book value of trading securities (and available-for-sale securities, covered in the next section) to fair market value. Fair market value is considered to be the market price of the securities or what a buyer or seller would pay to exchange the securities. An unrealized holding gain or loss will usually result in each portfolio.
To illustrate the application of the fair market value to trading securities, assume YourCompany only has that 100 shares of Public, Inc. stock in the trading securities portfolio. At year-end, based on the closing value from the stock market listing, the trading price is now $50. The journal entry required at the end of the year is:
| Date | Description | Post. Ref. | Debit | Credit |
|---|---|---|---|---|
| Dec 31 | Unrealized loss on trading securities | 500 | ||
| Dec 31 | Trading securities | 500 | ||
| Dec 31 | To record unrealized loss from market decline of trading securities. |
Note that the debit is to the Unrealized Loss on Trading Securities account. This loss is unrealized because the securities have not been sold. However, the loss is reported in the income statement as a deduction in arriving at net income. The credit in the preceding entry is to the Trading Securities account so as to adjust its balance to its fair market value. An unrealized holding gain would be an addition to net income. In addition, some companies may post the unrealized gains and losses to a contra or companion account. That is a bookkeeping decision.
If YourCompany sold the 100 shares of Public, Inc. in January of the next year at $60 per share, the company would receive $6,000. The gain on sale entry would be:
| Date | Description | Post. Ref. | Debit | Credit |
|---|---|---|---|---|
| Jan 1 | Checking Account | 6,000 | ||
| Jan 1 | Trading securities | 5,000 | ||
| Jan 1 | Gain on sale of trading securities | 1,000 | ||
| Jan 1 | To record the sale of YourCompany stock. |
No adjustment needs to be made to the unrealized loss account previously debited because the unrealized loss recorded last year has flowed through the income statement and been closed to retained earnings through the closing process.
Obviously, there would be a subsidiary ledger tracking the individual stocks, which could be as simple as the brokerage statement, as long as the amounts tie to the general ledger control account (trading securities).
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