Investment Accounting Methods under US GAAP Explained 2025

If an entity determines an other than temporary impairment (OTTI) has occurred, the accounting for the OTTI depends on whether the entity intends to sell (or not sell) the security prior to recovery of its amortized cost basis. This accounting treatment for impairments is the same for both available-for-sale and held-to-maturity classified securities. The accounting and financial reporting requirements for investments in debt and equity securities under US GAAP continues to be an area of focus and complexity for preparers and users of financial statements.

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An example of a physical investment is a building purchased to be a rental property. The property is a fixed asset acquired for the purpose of providing rental income to the owner. Examples of nonphysical investment include the investment securities mentioned above but can also include derivatives or investments in companies. You have probably heard of stock investments, and the term “investment” may lead you to immediately envision stocks, bonds, and mutual funds. While this line of thinking is correct, accountants view investments as this and much more. Specifically, from an accounting perspective an investment is an asset acquired to generate income.

• Understand the core principles of FASB 115, which established how a company’s intent for its investments directly shaped their financial statement reporting.
• Investing in equity securities can be a lucrative venture, but it comes with its own set of accounting challenges.
• FASB 115 required that upon acquisition, an entity must classify its debt and equity securities into one of three categories.
• They can be in the form of common stock, preferred stock, or other instruments that convey ownership rights.

Classifying Investments Under GAAP

The Held-to-Maturity (HTM) category is for investments that the company has the positive and demonstrated intent and ability to hold until the security’s contractual maturity date. This classification cannot be used if a company might sell the investment to manage interest rate risk or meet liquidity needs. All entities that are not public business entities may adopt the amendments in this Update earlier as of the fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Changes in equity investments will generally be reflected in net income as they occur–even before the equity investments are sold.

Observable price changes

At acquisition, and at each reporting date thereafter, an entity must classify each acquired debt security into one of three categories as summarized below. The classification decision should consider the entity’s intent and all facts and circumstances of the entity Accounting For Equity Securities when making the election. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. Receive the latest financial reporting and accounting updates with our newsletters and more delivered to your inbox.

Accounting for Investments in Equity Securities (ASC : Measurement Alternative

The above entry is based on the assumption that Legg declared and paid a $4,000 dividend. This treats dividends as a return of the investment (not income, because the income is recorded as it is earned rather than when distributed). In the case of dividends, consider that the investee’s equity reduction is met with a corresponding proportionate reduction of the Investment account on the books of the investor. Common stock represents ownership with voting rights, while preferred stockholders have higher claims on assets and fixed dividends. It is appropriate to use the equity method when the investor exercises significant influence over the operating and financial policies of the investee.

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• The classification decision should consider the entity’s intent and all facts and circumstances of the entity when making the election.
• DisclaimerThis post is for informational purposes only and should not be relied upon as official accounting guidance.
• In this comprehensive guide, we will walk you through the intricacies of accounting for investments in equity securities.
• Nearly 30 years later, some of those requirements and concepts are still present – including the core principles for classification and accounting for debt securities.

Trading Securities (TS) included both debt and equity securities bought and held principally for the purpose of selling them in the near term. The objective was to generate profits from short-term fluctuations in market prices, which resulted in frequent buying and selling. This July 2025 edition adds guidance related to investments in debt and equity securities. It clarifies the accounting for forward contracts and purchased options to acquire securities that, once settled or exercised, will be accounted for under the equity method. Before this ASU, there was uncertainty about whether these instruments should be treated as derivatives under Topic 815.

In general, a controlling financial interest means the parent owns more than 50% of the subsidiary. However, a parent company with a lesser ownership percentage may also have a controlling interest in another legal entity if they have significant control over key decisions and the right/obligations to significant income/loss of the investee. Investing in equity securities can be a lucrative venture, but it comes with its own set of accounting challenges.

Generally Accepted Accounting Principles (GAAP) provides a framework for transparently reporting investment activities. The correct accounting treatment depends on the investment’s classification, which is based on the security’s type and management’s strategic intent. This initial classification dictates all subsequent measurement and reporting, ensuring financial statements accurately reflect an investment’s value and performance. Additionally, ASC 321 provides for a measurement alternative if the fair value of the equity security is not readily determinable. When a parent company has a controlling financial interest over a subsidiary (investee) company, the parent company will account for the investment, or ownership, in the subsidiary by consolidating, or combining their financial statements into one report.

The measurement alternative is not required; entities are always permitted to account for such investments at fair value with changes in fair value reported in earnings. However, if elected, an entity shall continue to apply the measurement alternative until the investment no longer qualifies for its use. Each reporting period, an entity is required to reassess whether the investment’s fair value becomes readily determinable or whether it now qualifies for use of NAV as a practical expedient.

In fact, KPMG LLP was the first of the Big Four firms to organize itself along the same industry lines as clients. KPMG has market-leading alliances with many of the world’s leading software and services vendors.