Accounting for Investments
Investments come in many forms. Companies purchase investments so that they can make a return (in the form of interest income, share price increases, etc.). Larger companies may have a treasury function that has a robust investment policy of what they can and cannot invest in based on the Company’s risk profile. Other companies may make riskier investments in private companies without knowing all the accounting implications.
Accounting for investments continues to be an area of complexity for preparers, with significant disclosure requirements. Each type of investment has its own accounting model. To properly account for investments, the investment needs to be appropriately classified, the strategy and rationale for the investment needs to be understood, and the appropriate model needs to be applied. Companies should have controls in place that assure all material investments are reviewed for appropriate classification and accounting.
Which guidance to apply?
Guidance | Scope | Examples |
ASC 320: Investments- Debt Securities | All investments in debt securities that represent a creditor relationship with an entity, including those resulting from the securitization of other financial instruments, and loans that meet the definition of a security
Excludes derivatives. | U.S. Treasury securities, municipal securities, corporate bonds, convertible debt, commercial paper, U.S. government agency securities, collateralized mortgage obligations, interest-only strips, preferred stock that is mandatorily redeemable or redeemable at the option of investor |
ASC 321: Investments- Equity Securities | All investments in equity securities and other ownership interests in an entity, including investments in partnerships, unincorporated joint ventures and limited liability companies. | Common, preferred, and other capital stock, or the right to acquire (e.g., warrants, rights, forward purchase contracts, call options) or dispose of (e.g., put options, forward sale contracts) an ownership interest in an entity at fixed or determinable prices |
ASC 323: Investments- Equity Method and Joint Ventures | Investments in either common stock and/or in-substance common stock of corporate entities, as well as investments in entities such as partnerships, unincorporated joint ventures, and limited liability companies and the investor can exert significant influence over the investee (i.e. When an investor or holding entity owns 20–50% of the voting stock). | Not within scope of this article |
This article only covers debt and equity securities under ASC 320 and ASC 321. To be a security, it must meet all the following 3 criteria:
- It is either represented by an instrument issued in bearer or registered form or, if not represented by an instrument, is registered in books maintained to record transfers by or on behalf of the issuer.
- It is of a type commonly dealt in on securities exchanges or markets or, when represented by an instrument, is commonly recognized in any area in which it is issued or dealt in as a medium for investment.
- It either is one of a class or series or by its terms is divisible into a class or series of shares, participations, interests, or obligations.
What are the accounting models?
Once an entity determines what type of investment it has and which guidance to apply, the entity will need to apply the accounting model under that guidance.
Accounting for Debt Securities
Debt securities fall into three main categories: Trading, Available-for sale, and Held-to-Maturity. The classification of the debt security needs to be determined at the time of acquisition and is primarily driven by management’s intent. In establishing intent, an entity should consider its historical experience. Each category has its own accounting for measurement and recognition. Therefore, it is critical to determine the appropriate classification upfront. The table below summarizes the measurement and recognition provisions under each category.
Classification | Criteria | Initial Measurement | BS Classification | Subsequent recognition |
Trading | Acquired with intent to sell in the near-term. | Fair value, generally transaction price | Current or noncurrent based on maturity and intent | Fair value with unrealized gains/losses recognized in earnings |
Available-for-sale | Not classified as trading or HTM | Fair value, generally transaction price | Current or noncurrent based on maturity or redemption date | Fair value with unrealized gains/losses recognized in OCI Entities should consider whether a decline in fair value below the amortized cost basis is other than temporary. |
Held-to-maturity | Acquired with both the positive intent and ability to hold to maturity | Amortized cost | Current or noncurrent based on maturity and intent | Amortization of premium/discount and interest income recognized in earnings. Entities should consider whether a decline in fair value below the amortized cost basis is other than temporary. |
The appropriateness of the classification of securities should be reassessed at each reporting date. If an entity no longer has the ability to hold securities to maturity, their continued classification as HTM would not be appropriate.
A debt security is considered impaired when the fair value of the security is less than its amortized cost (i.e. it is in an unrealized loss position). Further consideration is then required to determine if the impairment is an other than temporary impairment (OTTI) and recognized in the income statement. For available-for-sale securities, impairment is recognized in the income statement (rather than through OCI) in any one of the following circumstances): (1) management intends to sell the security, (2) it is more likely than not that the security will be required to be sold before its amortized cost basis is recovered and (3) a credit loss exists. If a credit loss exists, then it will need to be estimated and recorded. For held-to-maturity securities, impairment is recognized in the income statement when the investor does not expect to recover the entire amortized cost basis or a credit loss exists. An entity should assess whether an impaired debt security is other-than-temporarily impaired at every reporting period.
Accounting for Equity Securities
In 2016, the FASB issued ASU 2016-01 to address recognition and measurement of financial assets and financial liabilities. One of the primary impacts of this ASU was the model for equity securities. Equity securities are now generally required to be measured at fair value, with changes in fair value recognized through earnings, with certain exceptions.
Under ASC 321, equity investments with readily determinable fair values are required to be measured at fair value at inception and subsequently, with unrealized holding gains and losses for these securities recorded in earnings.
An equity security has a readily determinable fair value if it meets any of the following conditions:
- If sales prices or bid-and-asked quotations are currently available on a securities exchange registered with the SEC or in the over-the-counter market if publicly reported by the National Association of Securities Dealers Automated Quotations systems or by OTC Markets Group Inc.
- If the foreign market is of a breadth and scope comparable to one of the U.S. markets referred to above.
- If the mutual fund, or a structure similar to a mutual fund, has a fair value per share (unit) that is determined and published and is the basis for current transaction.
For equity securities that do not have readily determinable fair values, entities can elect a measurement alternative for equity investments or the NAV per share practical expedient. The scope of the NAV practical expedient is limited to investments in entities that calculate NAV per share (or its equivalent, such as member units or an ownership interest in partners’ capital) consistently with the measurement principles of ASC 946, Financial Services — Investment Companies. Entities must first determine if the NAV practical expedient is applicable. Only if it is not applicable, may the measurement alternative be applied. Under the measurement alternative, the investments are measured at cost, less any impairment. Entities are also required to reassess at each reporting period whether an investment qualifies for the alternative.
Entities that measure their equity securities at fair value through net income do not need to assess whether those securities are impaired. If an entity uses the measurement alternative to measure an equity investment without a readily determinable fair value, it is required to make a qualitative assessment of impairment at each reporting date. Impairment indicators that an entity considers include, but are not limited to, the following:
- A significant deterioration in the earnings performance, credit rating, asset quality, or business prospects of the investee
- A significant adverse change in the regulatory, economic, or technological environment of the investee
- A significant adverse change in the general market condition of either the geographical area or the industry in which the investee operates
- A bona fide offer to purchase, an offer by the investee to sell, or a completed auction process for the same or similar investment for an amount less than the carrying amount of that investment
- Factors that raise significant concerns about the investee’s ability to continue as a going concern, such as negative cash flows from operations, working capital deficiencies, or noncompliance with statutory capital requirements or debt covenants.
If a qualitative assessment indicates that the investment is impaired, the entity is required to estimate the investment’s fair value. If the fair value is less than the investment’s carrying value, then an impairment loss is recognized in earnings equal to the difference between the carrying value and fair value.
Disclosures
Investments in Debt Securities
There are many disclosure requirements related to investments in debt securities, including the following:
- For securities classified as available-for-sale an entity must disclose the following summarized by major security type as of each balance sheet date presented:
- Amortized cost basis
- Aggregate fair value
- Total OTTI recognized in accumulated other comprehensive income
- Total gains for securities with net gains in accumulated other comprehensive income
- Total losses for securities with net losses in other comprehensive income
- Information about the contractual maturities of those securities as of the most recent balance sheet date presented
- For securities classified as held-to-maturity an entity must disclose the following summarized by major security type as of each balance sheet date presented:
- Amortized cost basis
- Aggregate fair value
- Gross unrealized holding gains
- Gross unrealized holding losses
- Net carrying amount
- Total OTTI recognized in accumulated other comprehensive income
- Information about the contractual maturities of those securities as of the date of the most recent statement of financial position presented.
- For investments in an unrealized loss position but don’t have OTTI, the following must be disclosed by major security type as of each balance sheet date presented (segregated by those investments with continuous unrealized loss position for less than 12 months and those for 12 months or longer):
- Aggregate related fair value
- Aggregate amount of unrealized losses
- Additional information in narrative form that provides sufficient information to all the users to understand the information that the entity considered in reaching the conclusion that the impairment is not OTTI.
- For each interim and annual reporting period presented, an entity shall disclose a tabular rollforward of the amount related to credit losses recognized in earnings
- For PBEs, the fair value of financial instruments measured at amortized cost (either on the balance sheet or in the notes to the financial statements.
- Information about transfers between categories and sales of debt securities
Investment in Equity Securities
For all equity investments, entities need to disclose the portion of unrealized gains and losses recognized during the period for equity investments held at the reporting date for each period for which results of operations are presented.
For equity securities without readily determinable fair values, the following should be disclosed:
- Carrying amount of investments
- Amount of impairments or downward adjustments (both annual and cumulative)
- Amount of upward adjustments (both annual and cumulative)
- Additional information to allow users to understand how the entity determined the carrying amounts and upward or downward adjustments
An entity must also provide the nonrecurring fair value measurement disclosures required under ASC 820 in its interim and annual financial statements whenever it adjusts the carrying amount of an investment measured using the measurement alternative (i.e. when the investment is impaired).