Long-Term Investments
Definition and importance
Long-term investments are assets a company intends to hold for more than one year. Common examples include equity stakes in other companies, bonds, and real estate. These investments appear on the noncurrent (asset) side of the balance sheet and are used to diversify holdings, generate steady income (dividends, interest, rent), and support long-term strategic goals.
Classification and accounting treatment
How an investment is classified affects its valuation on the balance sheet and the timing of gains or losses on the income statement.
Explore More Resources
- Held-to-maturity (HTM)
- Debt securities that the company intends and is able to hold until maturity.
- Recorded at amortized cost (purchase price adjusted for premiums or discounts amortized over the life of the instrument).
- Impairment write-downs may be required if value is permanently impaired.
-
Equity securities cannot be classified as HTM.
-
Available-for-sale (AFS)
- Securities not classified as HTM or trading and not expected to be sold within 12 months.
- Recorded at fair value; unrealized gains or losses are reported in other comprehensive income (OCI) until realized.
-
When sold, accumulated OCI amounts are reclassified into net income.
-
Trading securities
- Held for short-term profit; typically classified as current assets.
-
Measured at fair value, with unrealized and realized gains or losses flowing through net income each reporting period.
-
Investments with significant influence (equity method)
- When an investor has significant influence over another company (commonly presumed with 20–50% ownership), the investment is typically accounted for using the equity method.
- The investor records its share of the investee’s profits or losses in its income statement and adjusts the carrying amount of the investment accordingly.
Key examples
- Real estate: Land or buildings held for rental income and capital appreciation are typical long-term investments. They provide cash flow and potential capital gains.
- Equity stakes: Long-term holdings in other companies can yield dividends and capital appreciation and may grant strategic influence or synergies (for example, a parent or strategic investor maintaining a long-term stake in a partner or supplier).
- Bonds: Long-term bonds produce interest income and may be classified as HTM, AFS, or trading depending on intent and ability to hold.
Financial effects and strategic considerations
- Liquidity: Long-term investments are generally less liquid than current assets. Heavy investment in noncurrent assets can reduce a company’s ability to meet short-term cash needs.
- Income and profitability: Many long-term assets generate ongoing income (interest, dividends, rent) that can improve profitability and help meet financial obligations.
- Creditworthiness: A strong portfolio of long-term assets can enhance a company’s balance-sheet strength and may support better credit ratings, since such assets can be used as collateral or liquidated if necessary—though liquidation may not be quick or at full market value.
- Financial strategy and capital budgeting: Long-term investments are part of capital budgeting decisions and should align with a firm’s strategic objectives, risk tolerance, and cash-flow projections.
Practical note on valuation and reporting impact
The choice among HTM, AFS, and trading classifications affects reported earnings volatility:
* Trading securities → immediate recognition of fair-value changes in net income (greater earnings volatility).
* AFS → fair-value changes flow through OCI until realized (less immediate effect on net income).
* HTM → reported at amortized cost, so fair-value fluctuations generally do not affect reported earnings unless impairment occurs.
Bottom line
Long-term investments are a key component of corporate financial strategy. Held properly, they can stabilize income, diversify risk, and support long-term growth. Their classification and accounting treatment determine how value changes affect reported financial results and should reflect management’s intent and ability to hold the investments.