Financial investments are becoming an increasingly important part of companies’ asset portfolios. Whether these include shares, bonds, fund units or derivatives, their correct accounting treatment is essential both for compliance with legislation and for ensuring reliable financial reporting.
What is a financial investment?
A financial investment is a company asset invested in another company, a financial instrument or another financially measurable right with the aim of earning income (e.g. interest, dividends, capital gains).
A financial investment is a financial asset acquired by a company with the intention to:
- hold it to generate returns;
- dispose of it later at a profit.
Basic principles of recognition
Financial investments must be accounted for in accordance with either:
- the Estonian financial reporting standard (RTJ), or
- International Financial Reporting Standards (IFRS).
A company may choose which framework to use when preparing its financial statements, unless legislation requires the use of IFRS (e.g. listed companies, credit institutions).
Initial recognition
All financial investments are initially recognised at acquisition cost, which includes the purchase price and transaction costs directly attributable to the acquisition. Subsequent accounting depends on the type of investment and the accounting policy chosen by the company.
Subsequent measurement methods
1. Cost method
- The investment remains on the balance sheet at purchase cost (subject to impairment where necessary).
- Suitable for smaller companies and micro-entities.
- The simplest and most conservative approach.
- Under the cost method, for example, shares and equity interests are recognised when fair value cannot be measured reliably.
2. Fair value method
- The investment is remeasured at market value as of the balance sheet date.
- Changes in value are recognised in the income statement.
- Suitable for actively traded securities (e.g. listed shares).
3. Amortised cost
- The financial investment is recognised on the balance sheet at its initial acquisition cost.
- To determine amortised cost, the difference between acquisition cost and redemption value is amortised over time.
- Suitable for financial investments held to maturity (e.g. listed bonds).
Short-term vs. long-term investments
- Short-term: investments intended to be sold within 12 months, typically for liquidity management or short-term returns.
- Long-term: investments intended to be held for a longer period, often with a strategic purpose.
For example, if a company purchases listed bonds that it plans to sell within a few months, these are recognised as short-term investments, even if the maturity date is several years away.
Specific considerations and observations
- Derivative instruments (options, futures) are always recognised at fair value.
- Investments recognised at fair value and denominated in foreign currency must be translated into euros.
Common errors in practice
Below are some of the most common mistakes in accounting for financial investments observed in practice:
- Ignoring changes in market value, even though these may be material for users of financial information.
- Failure to recognise impairment – if an investment has permanently lost value, an impairment loss should be recorded.
- Incorrect classification – recognising a long-term investment as short-term, or vice versa.
- Determining fair value without a reliable basis – for example, when there is no active market or independent valuation.
- Inconsistent application – using fair value for some investments but not for others under similar conditions.
- Excluding transaction costs from acquisition cost for financial investments that are subsequently measured at fair value.
- In a micro-entity’s abridged annual report, fair value measurement is not permitted and the cost method must be used.
Summary
Accounting for financial investments is not complex if you understand:
- the type of investment involved;
- which accounting method to apply;
- the size and needs of the company.
Correct recognition helps ensure reliable financial statements and avoids issues during audits or regulatory reviews.
