Page 560 - Accounting Principles (A Business Perspective)

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Accounting for short-term stock investments and for long-term stock investments of less than
20 per cent
Accountants use the cost method to account for all short-term stock investments. When a company owns less
than 50 per cent of the outstanding stock of another company as a long-term investment, the percentage of

ownership determines whether to use the cost or equity method. A purchasing company that owns less than 20 per
cent of the outstanding stock of the investee company, and does not exercise significant influence over it, uses the
cost method. A purchasing company that owns from 20 per cent to 50 per cent of the outstanding stock of the
investee company or owns less than 20 per cent, but still exercises significant influence over it, uses the equity
method. Thus, firms use the cost method for all short-term stock investments and almost all long-term stock
investments of less than 20 per cent. For investments of more than 50 per cent, they use either the cost or equity
method because the application of consolidation procedures yields the same result.

Cost method for short-term investments and for long-term investments of less than 20 per
cent
When a company purchases stock (equity securities) as an investment, accountants must classify the stock
according to management's intent. If management bought the security for the principal purpose of selling it in the
near term, the security would be a trading security. If the stock will be held for a longer term, it is called an
available-for-sale security. Trading securities are always current assets. Available-for-sale securities may be
either current assets or noncurrent assets, depending on how long management intends to hold them. Each

classification is accounted for differently. This topic will be discussed later in this chapter.
Securities can be transferred between classifications; however, there are specific rules that must be met for these
transfers to be allowed. These rules will be addressed in intermediate accounting. Under the cost method, investors
record stock investments at cost, which is usually the cash paid for the stock. They purchase most stocks from other
investors (not the issuing company) through brokers who execute trades in an organized market, such as the New
York Stock Exchange. Thus, cost usually consists of the price paid for the shares, plus a broker's commission.
For example, assume that Brewer Corporation purchased as a near-term investment 1,000 shares of Cowen

Company's USD 10 par value common stock at USD 14.22 per share, plus a USD 180 broker's commission. Brokers
quote most stock prices in dollars and cents. Brewer's entry to record its investment is:
Trading securities [(1,000 shares x $14.22) + $180 14,400
commission] (-SE)
Cash (-A) 14,400
Purchased 1,000 share of Cowen common stock as a near-
term investment at 14.22 plus commission.
Accounting for cash dividends received Investments in stock provide dividends revenue. As a general rule,

investors debit cash dividends to Cash and credit Dividends Revenue. The only exception to this general rule is
when a dividend declared in one accounting period is payable in the next. This exception allows a company to
record the revenue in the proper accounting period. Assume that Cowen declared a USD 1 per share cash dividend
on 2010 December 1, to stockholders of record as of December 20, payable on 2011 January 15. Brewer should
make the following entry in 2010:
2010
Dec. 1 Dividends receivable (+A) 1,000
Dividends revenue (+SE) 1,000
To record $1 per share cash dividend on
Cowen common stock, payable 2010 January
15.

Accounting Principles: A Business Perspective 561 A Global Text