CHAPTER 11Investments in Debt and Equity Securities
CLASSIFICATION OF INTERCORPORATE INVESTMENTS
Companies invest in the securities ofother enterprises for a variety ofreasons.The invest-ment can be a
,meant primarily to increase investment income,or a
,meant to enhance operations in some way:
Investment ofIdle Cash.
Companies often have cash on hand that is not needed at presentbut will be needed in the future.Rather than allow the idle cash to remain in a low-inter-est bank account,companies find temporary investments with short terms that provide ahigher return.These investments typically have low risk and are easily converted to cash.Cash on hand can be invested in investments that may generate return through inter-est or dividends and also may be sold when market price has increased.These invest-ments will likely be ofhigher risk and/or a longer term,but the intent is to sell the invest-ment when money is needed for other activities and/or when the price is attractive.
Active Trading InvestmentPortfolio
.Some companies,primarily financial institutions,invest intrading portfolios.Securities in the portfolio are actively traded as part ofthe normal courseofbusiness,generally yielding a return because ofprice fluctuations or a dealer’s margin.
Long-Term Investments to Generate Earnings.
Cash on hand can be invested in less liq-uid securities in order to increase investment income.These investments are usually money market instruments (for example,bonds),and the intent is to keep the invest-ment until maturity.
An investment,especially in voting shares,may establish or cement abeneficial intercompany relationship that will increase the profitability ofthe investingcompany,both directly and indirectly.Strategic decisions may be made to invest in sup-pliers,customers,and even competitors.
Companies may choose to establish operations in one large company with numerous branches,or organize activities in a set ofsmaller companies,all or par-tially controlled by a central holding company.This may be done for tax reasons,toallow outside shareholders a small stake in particular operations,to satisfy legal require-ments in particular jurisdictions,and/or to limit potential liability claims to particularportions ofthe enterprise.
CLASSIFICATION OF INVESTMENTS
Many securities are
under the definitions established in Section 3860ofthe
.A financial instrument is any contract that gives rise to both a finan-cial asset ofone party and a financial liability or equity instrument ofanother party.In thecontext ofintercorporate investments,financial assets are defined as any contractual rightto receive cash or another financial asset from another company.Bonds and share invest-ment meet this definition.Investments that are financial instruments are classified according to the rules in propsosedSection 3855,“Financial Instruments—Recognition and Measurement.”These classifications andrules are brand new,effective in any fiscal year beginning after 1 October 2006—that is,in the2007 fiscal year.This chapter is based on the 2003 exposure draft in this area;
in shares are specifically excluded from the financial instruments sections ofthe
,but are accorded specific attention in other sections.For those interested in the rules in place upto 2006,refer to the superceded investments chapter available on the Online Learning Centre.This section explores the classification rules in depth.The classifications that follow aresummarized in Exhibit 11-1.
DEBT VERSUS EQUITY INVESTMENTS
An investment in a debt instrumentofanother entity can be classified as available for sale,held to maturity,or a trading investment.An investment in common shares may be available for sale,held to maturity,or a trading invest-ment,or,ifstrategic,a control investment,a significant influence investment,or a joint venture.It depends on intent and circumstances.We’ll define these terms in the sections that follow.
an intercorporate investmentin which the investor cannotsignificantly influence orcontrol the operations ofthe investee company
an investment in anothercompany for strategicpurposes; usually conveyscontrol or significant influenceor is a joint venture