 Hello and welcome to this session. This is Professor Farhad and this session we would look at introduction to investments. This topic is covered in financial accounting, the CPA exam, as well as intermediate accounting. As always, I would like to remind you to connect with me on LinkedIn. If you haven't done so, YouTube is where you would need to subscribe. I have 1,700 plus accounting, auditing, finance and tax lectures. This is a list of all the courses that I cover, including many CPA questions if you are studying for your CPA. If you like my lectures, please like them, share them, put them in playlists, subscribe to the channel, connect with me on Instagram and on my website. You will find additional resources to supplement your accounting education, study for your CPA exam, study for your CMA exam, study for your enrolled agent exam. What are the motivations for investment? Why do people invest? Well, one reason is people or companies invest to produce higher income. So if you have some extra money, sitting down with nothing, you don't want it to be there. You wanted it to be invested somewhere, so it would produce income for you. So what you will do is you will buy stocks or bonds to produce that income. So that's one reason, whether you are a company or an individual, that's why we invest. Another reason we invest for some companies is that's what they do for a living. They invest in other companies to produce income. A case in point, a company called Berkshire Hathaway, and not sure if you know who this person is, this is Warren Buffett, the legendary investor, and that's what he does. His company buys, takes money, takes the money from the investors, and they don't do anything with it except allocate that money to different investments. So that's all what they do. That's why they invest. The third reason is companies make investments for strategic reasons. For example, Amazon bought Whole Foods. Why? Because they want to get into this business for strategic reasons, they bought this company. So that's why we invest. Now, our investments can be separated into short-term investments and long-term investments. We're going to talk about short-term investments first. Short-term investments are securities that management intend to convert to cash within one year. Or the company's operating cycle, we're going to assume it's one year. What does that mean? It means we bought some stocks, some bonds, we made an investment, and our intent is to sell it and change it to cash within one year. And we can do so. We have the ability and we are ready to convert it. Like what? If you bought Apple stocks, you bought Microsoft stocks, or the stocks of any company, or the bonds of any company, and you can sell it in the near, and you plan to sell it in the near future, you intend to sell it within one year, then this is considered a short-term investment. Now, also, we need to understand that short-term investments do not include cash equivalent. Now, what are cash equivalents? Well, we talked about cash equivalent and the cash flow chapter. These are investments that are both readily convertible to a known amount of cash and mature within three months. An example will be a T-bill from the government. When you lend money to the government, what's going to happen? You may lend it at a short-term basis. And as a result, it's called cash equivalent. Why? Because when you lend the money, you can get your money back within three months, within three months, and there's no risk of change in the value. So that's why it's called cash equivalent. Another example of cash equivalent is something called commercial paper, is when large companies borrow money on a short-term basis. Now, long-term investments, obviously, they are not readily convertible into cash, and we plan to hold them, are not converted into short-term. We plan to hold them longer than one year. That's basically, that's why they are called noncurrent. They are reported in the noncurrent or long-term section. And what are we talking about here? We're talking about Apple and Microsoft, same companies. So these could be short-term and these could be long-term investments. What does it depend on? It depends on your intention. It depends on your intention. Also, long-term investments, like Microsoft, when they purchase LinkedIn, that's a long-term investment. The reason they bought LinkedIn is to have LinkedIn as part of their company. So that's why it's a long-term investment. They did not buy it to sell it in the near future. And this is a breakdown of sample companies as per percent of their short-term versus long-term investments. If we look at Coca-Cola, 9% of their investments of their total assets is short-term, 18% is long-term. We look at Microsoft, they have a lot of short-term investments because what they do is they buy Treasury Bill with their cash and 7% long-term. So this is part of LinkedIn, will be part of this long-term investment section. This is just an idea. Now, when we, just a picture of the short-term versus long-term in the real world. Now, when we invest in the real world, we could invest in two things. We separate our investments into either debt securities or equity securities. So what are debt securities? For the purpose of this course, once I say debt securities, just say, think of bonds when we buy bonds. What are bonds? Bonds reflect a creditor relationship. It means you are lending money to the company. That's what a bond, that's what bondholders do. They lend money to the company. So investments in notes, when you lend money, bonds and CDs, certificate of deposit. CDs is certificate of deposit. So when you deposit the money in the bank, that's what you are doing. You are making an investment. You are making an investment and it's a debt investment. Why? Because you're going to get your money back plus the interest, maybe issued by government, companies or individual. So anyone can issue debt securities, sell you the debt securities. You can buy it from the government. You can buy it from companies. So we're going to be dealing with companies. So in this chapter, we're going to be saying, well, you bought the corporate bond of XYZ company. Okay, so we're looking at corporate bond. That's what you want to think of when you think of debt investments. And in contrast to that investments, we have equity investments. When we say equity investments, think of stocks. What do stocks represent? An ownership relationship. Reflect an owner relationship. You own the stocks. An example will be investments in stocks issued by companies. Who should stocks companies? Government don't issue stocks. You don't own the government. They're issued by companies. And here we think about Apple and Microsoft. Now, so again, our investments are separated into two classification, either short-term, long-term, and within debt and equities, they could be long-term or short-term investments. Now, we need to properly learn how to classify the investments. And this is an important slide that's going to set the ground for the remainder of this chapter. Okay, so as we said, securities, we have two types of securities, either debt or equity, either bonds or stocks. The classification depends on our intent to hold them. Is it short-term or long-term? And the third factor that determines how to account for investments is our ownership level. The percentage ownership in another company's equity. Do we own 10%, do we own 25%, do we own 4%. So that matters. Why? Well, depending on if you own 10%, it means you have no influence. If you own 25%, it means you have significant influence. 40%, you have significant influence. And if you have 55%, you have a controlling influence. And there is a percentage that we're going to be looking at down the road, not down the road, fairly, shortly, determine which category it is. So the type of the security. So one is the type, two is the intent, either short-term or long-term. And the third one is how much do you own in that equity security. So let's take a look at debt. Debt, the third component is not relevant for that because it doesn't matter how much debt you own. But for debt securities, you could have the security. So if you own, let's talk about now debt, only debt. So we're going to look at debt separately from equity. And remember, that doesn't matter what is your ownership in debt. So if you own debt securities, you could held that to maturity. Okay. What does it mean held to maturity? Held to maturity means you bought the bond and you're going to wait until the bond mature. What does the bond mature? It means you're going to wait until they pay you back the money. So after you lend them the money, you have no plan, you have no plan on reselling those bond until the bond mature and you will get your money back. So that's one category. You know, if you have held to maturity, you have to account for it using the what we call the amortized cost. Now, what is the amortized cost? We're going to see later. The second category is trading. So you could buy a debt security and it could be for trading. When we say for trading, generally it's shorter, shorter. And the third category is available for sale. What is available for sale? Available for sale is not shorter and not held to maturity. Because held to maturity, you're going to wait all the way till the end, all the way until the bond mature. You're not waiting for that and you're not going to sell it in the near future. So someplace in between is called available for sale. That's what we mean by available for sale. So those are the three categories or the three classification of debt. Either you're going to held it to maturity, you're going to trade it and you're going to trade it or it's going to be available for sale. It's available for sale. I will trade it if the price is right, basically. Okay, that's basically what we are saying for available for sale. Now for equity investments, now again, now we're going to be looking at equity investments and now number three, now matters a lot how much do you own? Well, you could have unsignificant influence. It means you own some stocks, but really they're unsignificant. What are we looking at here? We're looking at zero up to 20%. If you own between zero to 20% of any particular company, you are assumed to have no significant influence in that investment. Simply put, you own that percentage, but really it doesn't represent any power to you. Under those circumstances, we're going to be using the fair value and we'll see how we account for that later. If you own between 20% to 50%, now this is important. Notice here your percentage, your percent is important. If you own between 20% to 50%, we're going to be using something called the equity method. Now what is the equity method? Don't worry about it now. Once we get to the equity method section, we're going to have one whole section about that. We'll talk about the equity section in the tails. The point is there's one whole category called the equity section. The third category is called the controlling. When do you use the controlling? It's when you own more than 50%. And what is controlling? Controlling means if you own more than 50%, that means you own everything for the company. Sorry, you own the whole company because you own more than 50%. You could vote yourself as the CEO, as the CFO, as on the board of, not the CFO, but you could vote yourself to the board of directors then assign yourself because you are in charge. So this is when you own 50% plus, you have a controlling influence. We don't work with controlling influence in this course. There's a course called advanced accounting. And I do have that course on my website. So you can look at it if you'd like to, if you're interested, but we don't cover advance, we don't cover, we don't cover consolidation. That's what the topic is called. So we're going to look at insignificant influence as well as significant influence. If you like this recording, please like it, share it, put it in playlist, subscribe to the channel. And in the next session, what I'm going to look at is investment in debt security. So I'm going to go back and start working with those categories. When you have investments and that investment is in debt. So I will start with the slide. Once again, don't shortchange yourself. If you want to pass your CPA exam, go ahead with your courses, be successful in your courses, subscribe, study hard, accounting is worth it, and especially stay safe during those coronavirus days. Good luck.