 Hello and welcome to the session in which we'll discuss accounting for investments. Well, we're talking about accounting for investments in other companies. So when one company buys stocks in another company, so why do companies invest in another company? Well, there are many reasons why you would do it, but it's very important to get the big picture. Why do they do it? Well, one reason is to invest in a startup. Maybe it's a new company, maybe they have a new product, new promising product you want to buy into that company or enter a new market. For example, Microsoft, when they wanted to have a social network, what they did rather than starting one, they bought LinkedIn. And I'm sure you're both most likely a user of Microsoft and LinkedIn. Diversify your risk. So if you're a software company, you may want to buy some stocks in a construction company. Maybe you want to buy some stocks in companies that's not related to you, maybe retails. Why? Now you have some cash on the side and you don't have any investment in your company itself, you diversify your risk. In case your business went down, your investments will do well. To earn a high rate of return, cash gives you the lowest return, practically zero because with cash, you take no risk. So what you want to do, if you want to earn more, you would have to make an investment. Investment taken risk, you'll invest in other companies. You would also invest to secure what's called operating arrangement. Sometime you might be relied on one supplier, on one important supplier. For example, specialized industries like the electric cars, they might have very unique products, very unique parts that they need to secure from one supplier. For example, if you're producing an electric car, you might need that battery. So what's going to happen is you will buy, you will invest in your supplier. You'll buy some of those stocks. You will be an owner. That's why you would invest to secure operating arrangement. Now you are part of the company. You know what's going on? You have a saying. And some companies exist to invest in other companies. That's their job. Like Berkshire Hathaway, the CEO Warren Buffett, their company, that's all what they do. They take money and they invest that money in other companies. That's their business. And it could be many other reasons why company invests in other companies. For the sake of intermediate accounting, financial accounting, or the CPA exam, we're going to break investments into two types. So we're going to keep it simple. Debt and equity. And what we mean by that bond, it's when you lend money to another company, buy their bond. And what we mean by equity is stocks. Now bear in mind, those are not the only two types of investments. You can invest in gold. You can invest in real state. You can invest in cryptocurrency. It doesn't matter. Once you understand how bonds and equity work, you'll be able to do accounting for investments for any other investments. So what do we need to know about the types of investments? If we are dealing with that, the first thing we have to determine is what is the intent of the company, the intent of the management. When they buy this bond, and hopefully you know what a bond is, bond is when you lend money to the company. When you buy someone's bond, if you're given the money and in return, they're giving you a piece of paper. They're going to give you this money back plus interest. The question is, you made these investments. What is your intent? Well, it is if you're intent, no plan to sell the bond. Well, eventually you're going to have to give it back to the company, but you have no plan to sell it. In other words, you bought that bond and you're going to hold it to maturity. Guess what? You classify it as held to maturity. So held to maturity is the first classification. So when you make an investment in a bond, you can classify it as held to maturity. When do you do so? When you have no plan to sell it. Also, how do you report this? You would report it at amortized cost. What does amortized cost mean? It means wherever you bought it at, then you amortize the premium or the discount. What does that mean? It means you ignore any fair value fluctuation. Bonds go up and down in value. If you plan, if you have no plan to sell it, if you plan to hold it until it mature, it's held to maturity. Therefore, there is no reason to look at fair value fluctuation. Why not? Because if we know anything about bonds from the bonds chapter, bonds at the end of their life, they mature at face value. Therefore, if you keep bringing it up and down constantly and you're going to hold it forever, forever it's going to be the face value. So why waste your time and waste your effort knowing you're going to get the face value at the end of the day? So this is the first classification of debt securities. Now we're going to have more classification. And by the way, we're going to have a whole session dealing with health to maturity. In the next session, we would look at the journal entries when we buy them, when we sell them, if they earn us interest, so on and so forth. Now we're going to look at other categories of debt investments. Before we look at the other categories, I would like to remind you whether you are a student or a CPA candidate to take a look at my website, farhatlectures.com. I don't replace your CPA review course nor your accounting course. My motto is saving accounting students and CPA candidate one at a time. How? I provide you additional resources to complement and supplement your CPA review course as well as your accounting courses. This is a list of all the accounting courses that I offer. My CPA supplemental material is aligned with your Roger, Becker, Gleam, and Wiley. So any course you are taking, you can use my resources because it's aligned. I organize it the same way as your main course to go ahead to go along your course. I also give you access to 1500 previously released AI CPA questions, actual CPA questions. I kept them in their original format plus detailed solution in addition to thousands of multiple choice. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation. Like this recording, it helped me tremendously. Connect with me on Instagram. I'm trying to grow my Instagram following Facebook, Twitter, and Reddit. So what happened if you plan is to sell the bond? So you make an investment, you bought the bond, but your plan is to sell it. Well, what does that mean? Well, under those circumstances, you have to report the investment and bond at fair value. What does fair value mean? Fair value mean you're going to get unrealized gains and losses. Well, under unrealized gain and losses, if it's fair value, you're going to have two categories. You're going to have either trading or available for sale category. So notice we have health to maturity one category trading is to available for sale is straight. So those are the three categories when you have a bond bond investment or a debt investment. What is trading? What's health to maturity trading? As the word trading suggests, you plan to sell it in the near future trading, flipping it. That's that's what that's what trading is. Well, what is available for sale? Well, if we think HTM is on one end trading on the other trading a short term HTM hold it forever, available for sale will be some someplace in between. You're not you don't plan to hold it forever, and you don't plan to flip it in the near future. Well, if the price is right, you might sell it. That's available for sale. Now let's talk about the type of debt securities that you could have. You can have many. You could have US government securities. Those are bonds, debt securities, municipal securities, corporate bonds, convertible debt, commercial paper. Now, for our purposes, as an accounting students, we will deal with corporate bonds. On the other hand, if you buy a stock or equity, how do you account for that investment? Well, it all depends on the degree of ownership, degree of ownership. It means how much do you control? How much do you control of the company that you purchased? Well, you might own stocks, I own stocks, but what is our control degree of control practically zero? Because public companies are extremely, extremely large. So you need billions of dollars to have a saying in those companies and those major companies that I have right here on this slide, not Bitcoin, Bitcoin is not a company, but Apple, Nestle, Procter and Gamble, so on and so forth. So if you own, if a company owns between zero to 20% of the company, we consider this investment to be basically minor, or you are a passive investor. Passive, that means you have no saying in the company. If you own up to 20% from an accounting perspective, you have no saying. No injury word in some companies, if you own 5%, you could have a major state, but that's beside the point. From an accounting perspective, you're a passive investor. How do you account for your equity investment? If that's the case, fair value. What does fair value mean? It means you're going to have unrealized holding gains and losses. We'll talk about this in the next session because we're going to have a session for each of these categories. This is just an introduction. What happened if you own more than 20% but up to 50%? Under those circumstances, we assume that the investor has significant influence. What is significant influence? Significant influence means you have a saying in that company. Why? Because you have enough shares to maybe vote yourself or someone, your friend or an ally on the board of directors. And once you are a part of the board of directors, you control the company. You have some control. You have some saying. Therefore, you have a significant influence. How do we account for these investments? We account for these investments under a method called the equity method. And guess what? To be discussed, this is going to be one whole session about the equity method. What happened if you own more than 50%, 50% plus? Well, once you own more than 50% of a public company for financial accounting purposes, not for tax purposes, for financial accounting purposes, you are in control. You own more than 50%. You own the company. You're the party in charge. Under those circumstances, you have to consolidate. We have to use the consolidation method. Now, how does the consolidation method works? Well, there's one whole course called advanced accounting, and you'll have to learn how to do the consolidation. So we don't discuss consolidation for the purpose of intermediate accounting. You need to know that more than 50% gives you control. If you have control, you have to consolidate the investor and the investee. Investor, it's mean or sometimes it's the parent company. The investor is the parent company. And the investee is the subsidiary. So you'll have to, the subsidiary will be part of the parent company over all financial statement. So this is what I wanted to discuss at the beginning of this introductory session. What type of investments you could have? Debt and equity. And how do you classify them? Well, that could be health to maturity one, trading two. Let me just health to maturity one, trading two available for sale three. Equity, if you're less than 20%, you're a passive investor. We use the fair value method. If you own between 20 to 50, we use the equity method. If you have more than 50%, we use the control. You have control. We use the consolidation. What should you do now? Go to farhatlectures.com. Work multiple choice questions. Look at additional resources to understand how to account for investments. Don't take your accounting education lightly. Invest in yourself. Learn it. Practice. If you're studying for the CPA exam, invest in my resources. Your CPA is a long-term investment. Don't shortchange yourself. Good luck. Study hard. And of course, stay.