💸Firms can invest in other companies and organizations’ Debt or Equity.
💵 Debt investments usually correspond to (corporate or government) Bonds.
⌛If a Debt investment is supposed to last till maturity, Amortization Cost Method is used to valuate the related Asset in the Balance Sheet.
With the Amortization Cost Method:
• at the beginning of holding period, an Asset of the Bond’s Price amount is recorded; at the end of holding period, the Asset Balance will equal to the Face Value (the cash to be received at the end, besides all the previous interests paid);
• every (interest) payment received during the holding period is equal to = (Interest Rate * the Face Value) / (number of payments in 1 year)
• the Interest Revenue that is recorded in the income statement every time an interest payment occurs is equal to = (Asset Balance at the beginning of the current year * the Yield to Maturity) / (number of payments in 1 year)
• the balance of the Asset throughout the holding period (the “Carrying Amount” of the Security) will have a floating value that is equal to = (Asset Balance Value at the Beginning of the current year + Interest Revenue in the current year – the interest payment received)
🛒 If a Debt Asset is planned to be sold before maturity, Fair Value Method is used to determine its value in the balance sheet, so each year this value is updated to the Debt’s actual worth and simultaneously a Gain or Loss is recorded in the income statement.
🌘 Fair Value is also used when a company invests in Equity, holding a lower-than-20% ownership.
🌗 If the ownership is more than the percentage above, Equity Method is used following these steps:
• the original investment is recorded at cost;
• at the end of each year, the investment account is increased/decreased by a proportionate share of the investee’s earnings/losses (and respectively crediting/debiting an income statement account);
• the investment account is also decreased when dividends are received, since this kind of earning is actually being paid now and reduces the carrying amount of the asset.
🌖 If the ownership is more than 50%, Cost Method can be used as well: either way, the investment value is eliminated when financial statements are consolidated.
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