What's the best way to account for a risky investment - As an asset or an expense?

Question

We normally account for investments as a separate account in assets:

Assets:Banks:Bank ABC  =>  Assets:Risky Investments:Investment XYZ

which is consistent with the fact of having an asset that is no longer liquid. Sometimes those investments are too risky and results are only seen after a long number of years. Call it sunk shares, fallen companies, uncertain start ups,... In those cases, accounting for that money as an Investment seems odd to me, as the financial reports show the existence of value for assets that are really not there anytime soon, and are unlikely to be collected in a real certain date. Some of them may even fail to be recovered. I see reports "dirty" for a number of years.

QUESTION: I was wondering whether we can simply take a conservative approach and account for investments as expenses. If investment is never profitable, it was already accounted at the beginning. If the investment is profitable later, it is accounted as revenue (income). Is it accepted practice when dealing with foreseeable risky, long terms investments?

 Assets:Banks:Bank ABC  =>  Expenses:Risky Investments:Investment XYZ

On eventual return of funds in the future, we will account those as profits:

Income:Risky Investments:Investment XYZ =>  Assets:Banks:Bank ABC

Note: this question has nothing to do with tax, or tax implications of either. Treat the question just as a mere personal or bookkeeping approach .

Answer 1

I'm no accountant, but I think the way I'd want to approach this kind of thing in Gnucash would be to track it as an Asset, since it is. It sounds like your actual concern is that your tracked asset value isn't reflecting its current "market" value. Presumably because it's risky it's also illiquid, so you're not sure how much value it should have on your books. Your approach suggested here of having it as just as expense gives it a 0 value as an asset, but without tracking that there's something that you own.

The two main approaches to tracking an investment in Gnucash are:

1. Treat it as an Asset account, with subaccounts for your "Basis" and for "Unrealized Gains/Losses". Your initial purchase goes into the basis account, and as you come up with valuations for your asset you perform a transfer from income or expense accounts to the Unrealized Gains/Losses account. This is how I treat my house in Gnucash. Details for this approach are in the "GnuCash Tutorial and Concepts Guide chapter on Capital Gains".
2. Treat it as a Stock or Mutual Fund account, with an amount of "shares" that each have a value. Even if your investment isn't one usually denominated in shares, you could create your own custom Stock in Gnucash and track your initial investment as purchasing 1 share of it. As you come up with valuations for your asset, you update the share's price in the Price Editor. Details for this approach are in the "GnuCash Tutorial and Concepts Guide chapter on Investments".

Of course, both of these approaches do assume that you have some notion of your investment's "current value", which is what you're tracking. As the section on Estimating Valuation of the concepts guide says of valuing illiquid assets, "There is no hard rule on this, and in fact different accountants may prefer to do this differently." If you really think that the investment isn't worth anything at the moment, then I suppose you should track it at 0, but presumably you think it's worth something or you wouldn't have bought it, right? Even if it's just for your personal records, part of a regular (maybe annual?) review of your investments should include coming up with what you currently value that investment at (perhaps your best guess of what you could sell it for, assuming that you could find a willing buyer), and updating your records accordingly.

Of course, if you need a valuation for a bank or for tax purposes or the like, they have more specific rules about how they are tracking what things are worth, but presumably you're trying to track your personal assets for your own reasons to get a handle on what you currently own. So, do that! Take the time to get a handle on the worth of what you currently own. And don't worry about getting the value wrong, just take your best guess, since you can always update it later when you learn new information about what your investment is worth.