Accounting for investment

Hospitality firms invest in the securities of other companies for one of two reasons

  • To earn a good return on excess on cash held for the short term
  • To exercise influence or control

If the securities are purchased for the short term to obtain a favorable return on excess cash, they are not listed under investments. Instead, a current asset account, short-term investments, is debited for the purchase price. The investments must be immediately convertible at the market price of the securities to be included in the short-term investments account. The method of accounting used for the current asset short-term investment depends on whether a debt or equity security is involved.

Investment in debt securities

The accounting for short-term and long-term debt securities is basically the same. When a hospitality firm invests in bonds, it expects to receive interest semiannually on its investment.

Short-term equity investments

Accounting for short-term equity investments is simpler than accounting for short-term debt investment. Recall that invests investments in stocks yields dividends rather than interest. Dividends are typically paid quarterly. Companies that have investments in the stocks of other companies do not accrue the dividends. Instead, dividend income is recorded when received.

Realized gains or losses from the sales of short-term equity investments. When these securities are sold, the cost of the securities should be written off the books and the gain or loss on the sale recognized. The gain or loss should be closed into the income summary account at the end of the fiscal period.

Long-term equity investments

The following sections focuses on accounting for long-term equity investments. The cost method, the equity method, and the consolidated statement method are discussed.

The cost method

When the investment in the stock of another company is less than 20 percent of the investee’s stock, the cost method is used to account for the investment. Under the cost method, long-term investments are put on the books at cost, gains or losses are recognized as of the sale date, and income is recorded when received.

The equity method

In the equity method of accounting for investments, the investor records the original investment at the cost, and then adjusts the value of the investment over time. The investor increases the value of the investment as the investee generates income and decreases the value of the investment if the investee loses money. When the investee pays the investor dividends, the value of the decreases, and the investor records the decrease as dividends.

The consolidated statement method

In this method one company owns more than 50 percent of a second company, the first company is said to control the second, the purchaser is called the parent company and the purchased company is called the subsidiary company. When this occurs, consolidated financial statements normally are prepared for the one entity. In this statement there are three simple subsidiary book values they are

  • The purchase of 100 percent of a subsidiary at book value
  • The purchase of 100 percent of a subsidiary at a price above book value
  • The purchase of less than 100 percent of subsidiary at book value

Reference

This article information is taken from the book “Hospitality Industry Financial Accounting” Raymond S. Schmidgall and James W. Damitio writes this book.