Investments and Fair Value Accounting LO 1 – Company Investment Options

Investing Cash in Current Operations LO 1 Investing Cash in Current Operations Cash may be used to replace worn-out equipment or to purchase new, more efficient, and productive equipment. Cash may be reinvested in the company to expand its current operations. Cash may be used to pay suppliers or other creditors. A company that is performing well normally creates net cash flow from its operations. This excess cash can be used for expansion to buy additional assets, to generate revenue, or for strategic purposes.

Investing Cash in Temporary Investments LO 1 Investing Cash in Temporary Investments Instead of letting excess cash remain idle in a checking account, most companies invest this cash in securities such as: Debt securities, which are notes and bonds that pay interest and have a fixed maturity date. Equity securities, which are preferred and common stock that represent ownership in a company and do not have a fixed maturity date. To survive and prosper, a company must create sufficient cash to pay bills and, hopefully, have cash left over. This cash can be invested in operations or in other types of investments in assets. Investing in operations usually involves the purchase of long-term tangible assets. That topic was covered in the eLectures from Chapter 10. This chapter focuses on investments in securities. A business may purchase temporary investments as a means of earning a return on excess cash that is not needed for operations. Businesses may invest excess cash in the debt or equity securities of other companies.

Investing Cash in Temporary Investments LO 1 Investing Cash in Temporary Investments These debt securities and equity securities are termed investments, or temporary investments, and are reported in the Current Assets section of the balance sheet. The primary objective of investing in temporary investments is to: earn interest income receive dividends realize gains from increases in the market price of the securities Instead of letting excess cash remain idle in a checking account, most companies invest in temporary investments in order to: Earn interest revenue. Receive dividends. Realize gains from increases in the market price of securities.

Investing Cash in Long-Term Investments Long-term investments often involve the purchase of a significant portion of the stock of another company. Such investments have a strategic purpose: Reduction of costs Replacement of management Expansion Integration A company may invest in the debt or equity securities of another company as a long-term investment. Long-term investments may be held for the same objectives as temporary investments. However, most long-term investments have a strategic objective. Long-term investments are not intended as a source of cash in the normal operations of the business. Rather, such investments are often held for their income, long-term gain potential, or influence over another business entity. One of the reasons for investing for strategic purposes is to reduce costs. This can happen when one company buys another company; the combined company may be able to reduce redundant administrative functions and expenses. A second strategic reason could be to replace management. If a purchased company was mismanaged, the acquiring company may be able to improve operations and profits by replacing the management. A third strategic reason for long-term investing is expansion. A company may acquire another company to acquire a territory, product line, or customer base. Finally, integration could be a strategic reason for investment. A company may integrate operations by acquiring another supplier or customer. An acquired supplier may provide a more stable supply of resources. A major customer may also provide an additional market for the acquiring company’s products or services.

Investing Cash in Long-Term Investments Long-term investments are reported in the balance sheet under the caption Investments, which usually follows the Current Asset section. Long-term investments are reported in non-current assets, under the heading “Investments.” This section is reported directly after Current Assets and before Fixed Assets.