9 - Intent-Based Accounting [MUSIC] LARRY WALTHER: I'm Larry Walther. This is principles of accounting.com chapter nine. This is the first module in chapter nine, and it speaks to the influence of intent on determining how to account for long-term investments. So first of all, recall from an earlier chapter, trading securities. Those were investments that were made with the intent of buying and selling in the very near term with the goal, primarily, of making a profit on the trade. And those were classified on the balance sheet as current assets, adjusted to fair value at each financial statement date, and the changes in value were reported and captured in the income statement for each period's change in value. Not all investments are acquired with the intent for trading with a quick profit, However, and that drives the accounting considerations. The accounting is going to be dependent upon the intent and nature of the investment. A company might make an investment with the intent of acquiring control over another company. That usually happens when a company buys more than 50% of the stock of another company with the intent of holding it on a continuing basis. In that case, the acquirer must consolidate all of the accounts of the subsidiary into the acquirers book's. This term consolidation, it's the subject of a subsequent module in this chapter. A company may simply acquire a substantial amount of the stock of another company however, without obtaining control. It usually happens when a company buys 20 to 50% of the stock of another company, investors thereby deem of significant influence over the investee company. Now, in that case, the investor is going to use the equity method of accounting that we'll look at in a subsequent module. The company may buy a bond type investment, a promise from another company, to repay cash over time. The issue over bond payable receives money today from an investor in exchange for a promise to repay that money in the future, and it includes accrued interest. It's really just debt. Investors usually acquire those investments with the intent of holding them to maturity to collect the interest and the principal at maturity, and that requires another method, typically the amortized cost approach of accounting. Finally, anything that doesn't meet one of these other categories like trading or held to maturity or equity method or consolidation, those are accounted as available-for-sale securities. So you see we're growing a fairly complicated scenario. To review here, trading securities are those investments that we have bought with the intent to buy and sell for short-term profits. The basic accounting approach is fair value accounting, and gains and losses are recognized in operating income. In contrast, available-for-sale securities, it's the default category. It's carried at fair value on the balance sheet, gains and losses are recognized, but to a unique other comprehensive income account that we'll be exposed to. Held-to-maturity securities, those are where we buy a security that has a fixed future maturity date, and our goal was to hold it to that maturity date, typically accounted for by the amortized cost method. The equity method is appropriate for those investments where we have the ability to exercise significant influence, generally 20 to 50% ownership, but that's not absolute. The real test is significant influence. And lastly, if we buy the stock of another company with the intent of controlling them, we'll then consolidate that particular scenario. These approaches apply to investments that continue to be held when any type of investment is sold. The realized gain or loss is then measured and included in operating income. So these accounting methods are sort of overridden at the point of sale. Any gain or loss is reported in income when the investment's actually sold. Companies do have a fair value option that overrides this entire structure. Companies may elect to use fair value accounting for financial assets and financial liabilities. So this could be applicable to available-for-sale types securities, eligible maturity investments, any of those can instead be measured at fair value. The change in value, the gains and losses as they accrue would be recognized in earnings. This is very similar to the approach that's used for trading securities that you've seen from an earlier chapter. If a company elects to apply the fair value option to a particular investment, that decision is irrevocable. You'll be using that method going forward from that date. [MUSIC]