Question

How to account for investments in equity papers with an investment rate ranging from 1% to 20%. and What are the international accounting standards used in this framework? What are the accounting methods stipulated by these standards? In summary, how are these accounting methods?

Answer 1

Meaning of Investment Account:

Investment means to spend money outside the business in order to earn some income which are non-trading in nature.

Usually, money is invested in Government Bonds, Securities, Shares and Debentures of companies etc.

Investments are made in two ways:

(a) As Trade Investments:

The investments which are made permanently for a regular income outside the business is known as Trade Investment. These are treated as fixed assets. That is why if this type of investments are sold at a profit, profit on such sale of investment is transferred to Capital Reserve Account and not to Profit and Loss Account.

(b) As Marketable Securities:

Sometimes a business wants to invest its idle cash purely on a temporary basis (of course, if the rate of earning is higher than cost of capital). This type of investment is known as Marketable Securities and is treated as Current Assets. That is why profit or sale of such investments is transferred to Profit and Loss Account and not to Capital Reserve.

Again, Marketable Securities are of two types:

A. Fixed Interest Bearing Securities,

B. Variable Interest Bearing Securities.

A. Fixed Interest Bearing Securities:

Fixed interest bearing securities mean where the rate of return is fixed, say 10%, 12% or 15%. The returns or income of such securities usually falls due on certain specific dates, as 30th June or 31st Dec. This is particularly appropriate in case of Govt. Bonds and Securities. For example, if we purchase 1,000, 10% Govt. Bonds @ Rs. 100 (interest is payable on 30th September or 31st March), we will have an income of Rs. 10,000; Rs. 5,000 falls due on 30th September and Rs. 5,000 on 31st March.

B. Variable Interest Bearing Securities: Variable Interest bearing securities means where the rate of return is not fixed, i.e., variable. It is applicable in case of shares. The rate of dividend on shares is not at all fixed,’ rather, it is fluctuating. In one year the return may be 10% whereas, in the next year, it may be 15%. Usually, shares are purchased as investment through brokers who charge a small rate of commission on both purchase and on sales.

Note: It must be remembered in this respect that in case of purchase of shares, brokerage or commissions will be added with the cost price of shares whereas, in case of sale, brokerage and commission will be deducted from sale price.

Transactions Relating to Investment Account:

Purchase and Sale of Investments:

It has been explained in an earlier paragraph that investments are made in various securities, e.g., Government, Semi-government, Corporation or Trust Securities, such as Shares, Bonds, Debentures, etc. in long or short-term. The long-term investment is normally made for earning interest or dividend whereas the short-term investment is meant for making profit by selling the same when market price becomes favourable.

The aforesaid investments are maintained in the General Ledger (since they are real accounts) when they are few in number. But when they are substantial, a separate ‘Investment Ledger’ is to be opened for each individual class of securities in addition to interest or dividend.

The Investment Account is maintained in a columnar form with three amount columns on each side—viz., Nominal, Interest/Income and Principal/Capital. The face value or nominal value of securities purchased or sold is recorded, however, in the ‘Nominal’ column. The accrued Interest/Dividend on purchase or sale of securities including the Interest/Dividend so received is recorded, however, in the ‘Interest/Income’ column. The third column, ‘Capital/Principal’, reveals the true cost or true sales consideration.

Brokerage and Other Expenses:

Generally, investment transactions are made through brokers. They charge a certain small commission against their services which is known as ‘Brokerage’. But the stamp duty at the prescribed rates is also to be paid in executing the transaction.

Since the brokerage and stamp duty are capital in nature, these are to be added with the cost price of the investments, i.e., brokerage will be added at the time of purchasing the securities and the same will be deducted from the sale price of the investment at the time of sale. As a result, only the net price is to be recorded in the ‘capital’ column of the Investment Account.

Accounting Treatment of Investment Account:

(a) Purchase of Investment:

When investment is purchased, its face value is recorded on the debit side of Investment Account and the actual cost (including brokerage, stamp duty, etc.) is recorded in the principal column. But if the same is purchased under cum-interest/dividend basis, the accrued interest must be recorded in ‘Interest’ column and will be deducted from the purchase price as the real cost is to be recorded in ‘Principal’ column.

But, if the investment is purchased under ex-interest/dividend basis, the quoted price—together with brokerage and stamp duty—will be recorded in the ‘Principal’ column. The accrued interest is, however, entered on the Interest/Income column.

(b) Sale of Investment:

When investment is sold, the same is recorded on the credit side of Investment Account, the face value being recorded in ‘Nominal’ column; the net selling price is entered, however, in the ‘Principal’ column. But if the investment is sold as cum-interest/dividend, the accrued interest will be recorded in ‘Interest/Income’ column and the net selling price (capital portion) on the ‘Principal’ column.

On the contrary, if the same is sold as ex- interest/dividend, the accrued interest/dividend is received by the seller in addition to quoted sale price. The accrued interest/dividend is entered on the ‘Interest/Income’ column and the quoted sale price in the ‘Capital’ column.

(c) Profit or Loss on Sale of Investment:

The difference between the capital cost of securities and the consideration received towards capital at the time of sale reveals the profit or loss on sale of investment. The profit or loss may be ascertained either for each individual sale or may be ascertained for all selling transactions at the end of the year—as a whole. And if the entire investments are sold, the difference between these two ‘Principal’ columns represents profit or loss, as the case may be.

But if a part of investments is sold, the balance of investments on hand should be ascertained first. Therefore, the balance is either valued at cost if the investment is treated as fixed asset, or the balance is valued at cost or market price, whichever is less if the investment is treated as current asset.

Naturally, the value of investments at hand is entered on the credit side of the Investment Account in ‘Principal’ column and the difference represents the profit or loss on sale of investment. The profit or loss on such sale is transferred to Profit and Loss Account if the investment is treated as a current asset or the profit or loss on such sale is treated separately if the investment is treated as a fixed asset.

(d) Balancing Investment Account:

The Balance of Investment account is ascertained at the end of the accounting period. The balance of ‘Nominal’ column reveals the face value of the investment in hand and— after recording the closing balance of investment in ‘Principal’ column—the profit or loss is to be ascertained (which has been explained earlier). And the difference between the two ‘Interest/Income’ columns represents income/interest from Investment Account which is, ultimately, transferred to Profit and Loss Account.

But, in the true sense of the term, Accounting Treatment depends on the date of purchase and sale of investment.

Cum-Interest or Cum-Dividend:

Where the right to receive interest or dividend from the issuer of security passes from the seller to the buyer, the transaction is known as ‘Cum-Interest’ or ‘Cum-Dividend’ purchase or sale. In other words, when the accrued interest or dividend from the last interest or dividend date up to the date of transaction is included in the quoted price, the capital cost of investment purchased or sold is ascertained by deducting the accrued interest/dividend from the quoted prices. And the difference between the quoted price and the actual cost may be represented as ‘Cum-Interest’ or ‘Cum-Dividend’.

Ex-Interest or Ex-Dividend:

When the seller retains the right to receive the interest/dividend, the transaction is called ‘Ex-Interest’ or ‘Ex-dividend’ purchase or sale. In other words, when the price quoted is exclusive of accrued interest/dividend, the price so quoted is treated as the capital cost of investment, i.e., the buyer has to pay accrued interest due from the last interest date to the date of transaction to the seller along with the cost price of investment.