Explain the financial reporting implications of long-

LO 3 Explain the financial reporting implications of long-

As noted earlier, available-for-sale securities are debt or equity securities that term investments in stock and

cannot be classified as trading or held-to-maturity securities. When long-term the cost-adjusted-to-market and

equity securities are involved, a further criterion for classifying them as available equity methods used to account

for sale is that they be noninfluential and noncontrolling investments of less than for them.

20 percent of the voting stock. Accounting for long-term available-for-sale secu- rities requires using the cost-adjusted-to-market method. With this method, the securities are initially recorded at cost and are thereafter adjusted periodically for changes in market value by using an allowance account. 10

Available-for-sale securities are classified as long term if management intends to hold them for more than one year. When accounting for long-term available- for-sale securities, the unrealized gain or loss resulting from the adjustment is not reported on the income statement. Instead, the gain or loss is reported as a special item in the stockholders’ equity section of the balance sheet and in the disclosure of comprehensive income.

At the end of each accounting period, the total cost and the total market value of these long-term stock investments must be determined. If the total market value is less than the total cost, the difference must be credited to a contra-asset account called Allowance to Adjust Long-Term Investments to Market. Because of the long-term nature of the investment, the debit part of the entry, which rep- resents a decrease in value below cost, is treated as a temporary decrease and does not appear as a loss on the income statement. It is shown in a contra- stockholders’ equity account called Unrealized Loss on Long-Term Investments.* Thus, both of these accounts are balance sheet accounts. If the market value exceeds the cost, the allowance account is added to Long-Term Investments, and the unrealized gain appears as an addition to stockholders’ equity.

When a company sells its long-term investments in stock, the difference between the sale price and the cost of the stock is recorded as a realized gain or loss on the income statement. Dividend income from such investments is recorded by a debit to Cash and a credit to Dividend Income. For example, assume these facts about the long-term stock investments of Hoska Corporation:

June 1, 2010

Paid cash for the following long-term investments: 5,000 shares of Murcia Corporation common stock (representing 2 percent of outstanding stock) at $25 per share; 2,500 shares of Rava Corporation common stock (representing 3 percent of out-

Study Note

standing stock) at $15 per share.

Hoska’s sale of stock on April 1, Dec. 31, 2010 Quoted market prices at year end: Murcia common stock, $21; 2011, was the result of a

Rava common stock, $17.

change in policy. This illustrates

Change in policy required the sale of 1,000 shares of Murcia that intent is often the only

Apr. 1, 2011

common stock at $23.

difference between long-term investments and short-term

July 1, 2011

Received cash dividend from Rava equal to $0.20 per share. Dec. 31, 2011 Quoted market prices at year end: Murcia common stock, $24;

Long-Term Investments in Equity Securities

Entries in journal form to record these transactions are as follows: