Accounting Procedures on Writing off an Investment

It's an unfortunate fact that your company might make a bum investment. If you're holding stocks or bonds that have suffered a permanent loss of value, generally accepted accounting principles require you to write off the loss. The accounting procedures depend on the type and size of the investment.

You carry bonds you intend to hold to maturity at their purchase cost on the balance sheet. Normally, you do not change the value of held-to-maturity investments unless they suffer a permanent loss of value. The accounting entry is a debit to the loss on held-to-maturity investment account and a credit to the held-to-maturity investment account. The restated balance should equal the fair market value of the bond.

A trading security is one you intend to sell for a profit within a year. You carry this security at its fair market value and book any changes to value as a gain or loss to an operating income account. A special write-off for a loss in value is therefore not necessary. An available-for-sale security is one that is neither a trading security nor a held-to-maturity investment. You also carry these at fair market value but book changes to value as other comprehensive income until you sell the security, at which time you recognize the gain or loss to operating income.

If you hold more than 20 percent of another company's stock, you use the equity method to account for the investment. Under this method, you update the book value of the stock by your share of the investee's profits and losses. If the stock pays any dividends, deduct them from the carrying value. If the investee has a permanent loss of value, record the write-off as a debit to the loss on investment account and credit to the investment account. You can't write off more than the remaining value of the investment -- that is, you can't carry the investment as a negative number.

The fair value election is an alternative way to account for equity method investments. Under this option, you do not update the investment carrying value based on the investee's profits and losses. Instead, you adjust the carrying value based on the stock's fair market value. Another difference is that you don't subtract dividends from the carrying value. Under the fair value election, you don't have to write off the stock, because the fair market value will reflect the current value of the stock.