Understand the nature of investments including which types of companies have significant investments Explain and apply the costamortized cost model of accounting for investments Explain and apply the fair value through net income model of accounting for investments ID: 648104
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After studying this chapter you should be able to:Understand the nature of investments including which types of companies have significant investments.Explain and apply the cost/amortized cost model of accounting for investments.Explain and apply the fair value through net income model of accounting for investments.Explain and apply the fair value through other comprehensive income model of accounting for investments.Explain and apply the incurred loss, expected loss, and fair value loss impairment models.Explain the concept of significant influence and apply the equity method.Explain the concept of control and when consolidation is appropriate.Explain how investments are presented and disclosed in the financial statements noting how this facilitates analysis.Identify differences in accounting between IFRS and ASPE, and what changes are expected in the near future.
Copyright John Wiley & Sons Canada, Ltd.
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INVESTMENTSSlide3
Copyright John Wiley & Sons Canada, Ltd.
3InvestmentsUnderstanding InvestmentsTypes of investmentsTypes of companies that have investmentsInformation for decision-makingMeasurementCost / amortized cost modelFair value through net income model
Fair value through OCI model
Impairment models
IFRS / ASPE Comparison
Comparison
Looking ahead
Strategic Investments
Investments in associates
Investments in subsidiaries
Presentation, Disclosure, and Analysis
Presentation and disclosure
AnalysisSlide4
Type of Investments
Debt investments include investments in government debt, corporate bonds, convertible debt, and commercial paperEquity instruments represent ownership interests in companies (e.g., common stock, preferred stock)Motivations for investments include: to obtain short-term returns or long-term returns on investments, and for corporate strategyCopyright John Wiley & Sons Canada, Ltd.4Slide5
Measurement
Method of accounting for a particular investment can depend on:Type of instrument (debt vs. equity)Management’s intentCompany strategyAbility to reliably measure instrument’s fair value, orCopyright John Wiley & Sons Canada, Ltd.5Slide6
Accounting Models
There are three main models of accounting for investments: Cost/amortized cost modelFair value through net income model (FV-NI)Fair value through other comprehensive income model (FV-OCI)Copyright John Wiley & Sons Canada, Ltd.6Slide7
Accounting Models: Summary
Copyright John Wiley & Sons Canada, Ltd.7Cost/Amortized Cost ModelFV-NIFV-OCI
At acquisition, measure at:
Cost (fair value + transaction costs)
Fair value
Fair value
At each reporting date, measure at:
Cost or amortized cost
Fair value
Fair value
Unrealized holding gains/losses reported in:
Not applicable
Net income
OCI
Realized holding gains/losses reported in:
Net income
Net income
Transfer total realized to net income (recycling), or to retained earningsSlide8
Cost/Amortized Cost Model: Investments in Shares
Cost model for investments in shares of another entity: Recognize cost of investment at fair value (plus direct transaction costs)Report at cost (unless impaired)Recognize dividend income when have claim to dividend When dispose of investment, derecognize and report a gain/loss on disposal in net income.Copyright John Wiley & Sons Canada, Ltd.8Slide9
Cost/Amortized Cost Model: Investments in Debt Securities
Amortized cost model for investments in debt securities of another entity: Recognize cost of investment at fair value (plus direct transaction costs)Report at amortized cost as well as interest receivable (unless impaired)Recognize interest income as earned, and also amortize any discount/premium by adjusting carrying amount of investment When dispose of investment, first bring accrued interest and discount/premium amortization up to date. Derecognize investment and report a gain/loss on disposal in net income.Copyright John Wiley & Sons Canada, Ltd.9Slide10
Amortized Cost Model: Example
Given:Face amount: $100,000Purchase date: January 1, 2014Maturity date: January 1, 2019Interest paid: July 1st and January 1stCoupon (stated) rate of interest: 8%Market (effective) rate of interest: 10%What is the approximate purchase price?PV of $100,000 (n=10, i=5%) + PVA of ($100,000 X 4%) where n=10, i = 5%PV is approximately equal to $92,278Copyright John Wiley & Sons Canada, Ltd.10Slide11
Amortized Cost Model: Example
Copyright John Wiley & Sons Canada, Ltd.11The entry to record this purchase is:Investment in Bonds 92,278 Cash 92,278Note the discount of $7,722 ($100,000 – 92,278) is not recorded separately; it is amortized over the life of the bondThe effective interest method is used to amortize the premium or discount (required under IFRS)ASPE also allows straight-line method of amortizing premium or discountSlide12
Bond Discount Amortization
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Reporting under Amortized Cost Model
Copyright John Wiley & Sons Canada, Ltd.13Balance SheetCurrent assetsInterest receivable (accrued interest from investment) $xx,xxxLong-term investmentsInvestment, at amortized cost $xx,xxxIncome StatementOther revenue and gains
Interest income $x,xxxSlide14
Sale of Investments
Discount (or premium) is amortized from last date of amortization to the date of saleNew carrying amount calculated, which is the amortized cost balance plus the discount (or minus the premium) amortized from last date of amortizationGain (or loss) calculated as the difference between selling price and carrying amount Any accrued interest income is calculated (and received) over and above the selling price of the investmentCopyright John Wiley & Sons Canada, Ltd.14Slide15
Fair Value through Net Income (FV-NI) Model
Fair value through net income (FV-NI) also referred to as fair value through profit or loss (FVTPL) in IFRSAt acquisition, investment recorded at fair valueTransactions costs are expensedAt each reporting date, FV-NI investments are adjusted to current fair value and any holding gain or loss is reported in net incomeAny earned interest/dividend income and any holding gain or loss on the investment may be reported together as “Investment Income”Copyright John Wiley & Sons Canada, Ltd.15Slide16
FV-NI: An example
Copyright John Wiley & Sons Canada, Ltd.16For non-interest bearing Treasury bill:Purchase date: March 15Maturity date: September 15Pay = $19,231 for $20,000 six-month T-bill (8% yield)Entry on March 15:Temporary Investment in T-Bill 19,231 Cash 19,231Entry on Sept 15:
Cash 20,000
Temporary Investment in T-Bill
19,231
Investment Income/Loss
769Slide17
FV-NI: An example
Copyright John Wiley & Sons Canada, Ltd.17A company reported on December 31, 2015:Investments Carrying Amount Fair Value In various shares $192,990 $191,200Adjustment to fair value (192,990-191,200= $1,790)Entry to record adjustment at year end:Investment Income/Loss 1,790
FV-NI Investments 1,790
2015
Current assets:
FV-NI
Investments
$191,200Slide18
Fair Value through Other Comprehensive Income (FV-OCI)
At acquisition, investments are recorded at fair value Transaction costs tend to be added to investment’s carrying amountAt each reporting date, FV-OCI investments are adjusted to current fair value and any holding gain or loss is reported in other comprehensive income (OCI)Accumulated holding gains/losses are reported in AOCI, which is a separate item under Shareholders’ EquityCopyright John Wiley & Sons Canada, Ltd.18Slide19
Fair Value through Other Comprehensive Income (FV-OCI)
When investments are disposed, previously unrealized holding gains or losses need to be transferred out of OCI/AOCIUnder FV-OCI with recycling, unrealized holding gains or losses are transferred (i.e. “recycled”) into net income (and as part of net income, closed into retained earnings)Under FV-OCI without recycling, unrealized holding gains or losses are transferred directly into retained earnings (bypassing net income)Copyright John Wiley & Sons Canada, Ltd.19Slide20
FV-OCI: An Example
Copyright John Wiley & Sons Canada, Ltd.20Given share investment accounted for at FV-OCI: Fair value at Dec. 31, 2013 $275,000 Carrying amt. at Dec. 31, 2013 259,700 Unrealized Holding Gain
$ 15,300
Entry to Record:
FV-OCI Investments
15,300
Unrealized Gain or loss – OCI
15,300
Long-term investments (assumed)
FV-OCI
Investments
$ 275,000Shareholders’ Equity
Accumulated other comprehensive income (loss) $ 15,300Slide21
FV-OCI: An example
Copyright John Wiley & Sons Canada, Ltd.21On January 23, 2014 sell investment for $287,220Entry to record adjustment to fair value:FV-OCI Investments ($287,220 - 275,000) 12,220 Unrealized Gain or loss – OCI 12,220Entry to record sale and proceeds:Cash 287,220 FV-OCI Investments 287,220
Entry to transfer holding gains:
Unrealized Gain or loss –
OCI
(15,300+12,220
)
27,520
Gain on Sale of Investment
27,520
OR (if FV-OCI without recycling)
Retained Earnings
27,520Slide22
ASPE Classifications
ASPE generally relies on cost-based model for equity investments, unless active market prices are availableFV-NI model is allowed as an option for any financial instrumentUnder all models, interest earned and dividends received are recognized in net incomeCopyright John Wiley & Sons Canada, Ltd.22Slide23
IFRS Classifications
Amortized cost used only if both of following conditions are satisfied:Business model: investment managed on contractual yield basis (and cash flows best assessed relative to contractual cash flows specified by instrument)Contractual cash flow characteristics: cash flows represent only payments of principal and interest on principal outstanding, and occur at specified datesIf criteria for amortized cost do not apply, then FV-NI is used.Copyright John Wiley & Sons Canada, Ltd.23Slide24
IFRS Classifications
IFRS standard effective 2015 (with early adoption possible) includes two additional options: Investments held for longer term strategic reasons (without control or significant influence) may be accounted for under FV-OCI without recycling if such choice is made on acquisitionFair value option provides an opportunity to use FV-NI accounting from acquisition if it corrects an “accounting mismatch”Copyright John Wiley & Sons Canada, Ltd.24Slide25
IFRS Classifications
Reclassification from one category to another is not allowed, except under very limited situationsCopyright John Wiley & Sons Canada, Ltd.25Slide26
Impairment
Investments must be reviewed for possible impairment to ensure that future benefit justifies the valuation on the balance sheetThere are three different impairment models: Incurred loss modelExpected loss modelFull fair value modelCopyright John Wiley & Sons Canada, Ltd.26Slide27
Impairment: Incurred Loss Model
Impairment test carried out only if there is evidence of possible impairmentIndicators of possible impairment include: Significant financial difficultiesDefaulting on interest/principal paymentsMajor financial reorganization or bankruptcyImpairment loss is recognized in net income as difference between carrying amount and revised present value of expected cash flowsRevised present value is calculated using discounted cash flow (DCF) model (using either historic or current market rate as discount rate)Copyright John Wiley & Sons Canada, Ltd.27Slide28
Impairment: Expected Loss Model
Impairment test carried out continuouslyImpairment loss is recognized in net income as difference between carrying amount and revised present value of expected cash flowsRevised present value is calculated using discounted cash flow (DCF) model (using effective interest rate from time of acquisition)Copyright John Wiley & Sons Canada, Ltd.28Slide29
Impairment: Fair Value Loss Model
Impairment loss is recognized in net income as difference between carrying amount and fair value Where fair value is determined using the discounted cash flow (DCF) model, using the current interest rate at time of impairment test Copyright John Wiley & Sons Canada, Ltd.29Slide30
Impairment: Accounting Standards
IFRS currently uses the following models: For all financial asset investments accounted for at cost or amortized cost: incurred loss model (with original discount rate)For FV-NI instruments: full fair value modelIFRS proposals include: For instruments at amortized cost: expected loss modelFor instruments at fair value: always adjust to FVCopyright John Wiley & Sons Canada, Ltd.30Slide31
Impairment: Accounting Standards
ASPE has following requirement: For financial asset investments accounted for at cost or amortized cost: incurred loss model (using current market rate)For equity instruments (with market values) and derivative instruments, use fair value modelCopyright John Wiley & Sons Canada, Ltd.31Slide32
Strategic Investments
As common shares carry voting rights, extent of influence becomes a factor in determining the appropriate accounting treatmentThere are three levels of influence, each with its own accounting treatment:Little or no influenceSignificant influenceControlCopyright John Wiley & Sons Canada, Ltd.32Slide33
Equity Investments:
Common SharesCopyright John Wiley & Sons Canada, Ltd.33%Ownership0%20%50%100%
Level of
Little or Significant Control
Influence
none
Type of
Less than Associate, or Subsidiary
Investment
significant significant
influence influenceSlide34
Investment in Associates: Significant Influence
Applies to equity investments of significant influence (not control)Significant influence deemed using the following criteria:Quantitative test: 20% to 50% ownershipQualitative test:Representation on Board of DirectorsParticipation in policy-makingMaterial intercompany transactionsExchange of management personnelProvision of technical informationCopyright John Wiley & Sons Canada, Ltd.34Slide35
Investment in Associates
Under IFRS, investments in associates (i.e. “significant influence”) are accounted for using the equity method of accountingASPE, investors can choose from following options for all “significant influence” investments: Equity method, or Cost method (unless associate shares are quoted in active market, in which case FV-NI model is used)Copyright John Wiley & Sons Canada, Ltd.35Slide36
Equity Method
Investment recorded at cost of acquisitionInvestor takes into income its respective share of the investee net income for the year by debiting the Investment account and crediting Investment IncomeAny dividends received are credited to the Investment accountThe accrual basis of accounting is appliedConsider the following example of Maxi Limited:Copyright John Wiley & Sons Canada, Ltd.36Slide37
Equity Method: Example
Copyright John Wiley & Sons Canada, Ltd.37Given:Maxi Corp. purchases 20% of Mini Corp., and exercises significant influenceJanuary 2, 2013 Maxi purchases 48,000 shares @ $10 per shareFor the year 2013 Mini Corp. reports a net income of $200,000December 31, 2013 shares of Mini Corp. have a market price of $12 per shareJanuary 28, 2014 Mini Corp. declared and paid a total cash dividend of $100,000For the year 2014, Mini Corp. reports a net loss of $50,000Prepare all necessary journal entries, using the Equity MethodSlide38
Equity Method: Example
Copyright John Wiley & Sons Canada, Ltd.38January 2, 2013Investment in Mini Corp. 480,000 Cash 480,000(48,000 shares x $10)December 31, 2013Investment in Mini Corp. 40,000 Investment Income 40,000($200,000 net income x 20%)
December 31, 2013
No entry required to reflect market price (or fair value). Investment is not impaired.
January 28, 2014
Cash 20,000
Investment in Mini Corp. 20,000
($100,000 Dividend x 20%)
December 31, 2014
Investment Loss 10,000
Investment in Mini Corp. 10,000
($50,000 net loss x 20%)Slide39
Equity Method
Amounts paid in excess of (or less than) investee’s book value becomes part of the cost of the investmentThese amounts must be accounted for appropriately after the acquisitionFor example, if the difference is due to long-lived assets with fair values greater than book value, the difference must be amortizedShare of discontinued operations and other comprehensive income of investee are reported in the same way by the investor (major classifications of income are retained)Copyright John Wiley & Sons Canada, Ltd.39Slide40
Equity Method: Impairment
Investments with significant influence are assessed at the end of each reporting period to determine if there are indicators of impairmentIf there are indicators of impairment, the impairment test is carried outImpairment loss is recognized in income and is measured as carrying amount in excess of investment’s recoverable amount Investment’s recoverable amount is measured as the higher of value in use and fair value less cost to sellImpairment losses may be reversedCopyright John Wiley & Sons Canada, Ltd.40Slide41
Equity Method: Disposal
On disposal of the investment, both investment account and investment income accounts are brought up to date (i.e. adjusted for investor’s share of associate’s income and changes in book value up to date of sale)Investment’s carrying value is removed and any gains/losses are recognized in net incomeCopyright John Wiley & Sons Canada, Ltd.41Slide42
Investments in Subsidiaries
A corporation (the parent) can acquire control of another corporation (the subsidiary)Control is generally acquired through purchasing 50% or more voting sharesControl is defined as continuing power to determine/direct the strategic operating, financing, and investment policies/activities, without the co-operation of othersCopyright John Wiley & Sons Canada, Ltd.42Slide43
Investments in Subsidiaries
Under IFRS, investments for subsidiaries are accounted for preparation of consolidated financial statementsThe two corporations are reported as a single business entityUnder ASPE, parent company has the following options when accounting for subsidiaries: Consolidate all subsidiariesAccount for all subsidiaries under either equity or cost method (cost method cannot be used if shares are traded in an active market, and FV-NI is used instead)Copyright John Wiley & Sons Canada, Ltd.43Slide44
Consolidated Financial Statements
Copyright John Wiley & Sons Canada, Ltd.44Parent CorporationIncome StatementBalance SheetSubsidiary CorporationIncome StatementBalance SheetConsolidated Entity (Reported by Parent Corporation)
Combined Balance Sheet, line-by-line (100%)
Combined Income Statement, line-by-line (100%)
Eliminate any unrealized inter-company gains and losses
Eliminate any inter-company balances
Parent eliminates the investment in the subsidiary company
Non-controlling interest reported (the percent of the subsidiary not owned by the parent) on both balance sheet and income statementsSlide45
Presentation and Disclosure
For investments without significant influence or control, key presentation issue is classification of investment as current vs. long-termKey disclosures include following types of information: Carrying amount of investmentsIncome statement effectsFinancial riskIFRS generally has more onerous disclosure requirements than ASPECopyright John Wiley & Sons Canada, Ltd.45Slide46
Investments – Recent Changes
Due to the complexity of accounting for investments, a number of proposals from IASB and FASB relating to: Simplification of existing accounting standardsNew model for impairments and use of expected loss approachCopyright John Wiley & Sons Canada, Ltd.46Slide47
COPYRIGHT
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