ch 9 lecture notes

7/28/2019 Ch 9 Lecture Notes

1/14

CHAPTER 9

INVESTMENTS

CHAPTER TOPICS CROSS-REFERENCED WITH THECICA HANDBOOK, Part II and IFRS

Statement of Comprehensive Income PE GAAP N/A and IAS1/IFRS 7Business Combinations Section 1582 and IFRS 3Non-controlling interest Section 1602 and IFRS 3Consolidated Financial Statements Section 1601 and IAS 27Investments in Associates Section 3051 and IAS 28Financial Instruments Section 3856 and IFRS 9/IAS 39Recognition and MeasurementFinancial InstrumentsPresentation Section 3856 and IAS 32

Financial Instruments Disclosure Section 3856 and IFRS 7

LEARNING OBJECTIVES1. Explain and apply the cost/amortized cost model of accounting for investments in

debt and equity instruments, and identify how the investments are reported.

2. Explain and apply the fair value through net income model of accounting forinvestments in debt and equity instruments, and identify how the investments arereported.

3. Explain and apply the fair value through other comprehensive income model ofaccounting for investments in equity instruments, and identify how the investments

are reported.

4. Identify private entity GAAP and IFRS for investments in financial assets wherethere is no significant influence or control.

5. Explain and apply the incurred loss, expected loss, and fair value loss impairmentmodels, and identify private entity GAAP and IFRS requirements.

6. Explain the concept of significant influence and why the equity method isappropriate, apply the equity method, and identify private entity GAAP and IFRSrequirements.

7. Explain the concept of control, the basics of consolidated financial statements, andwhy consolidation is appropriate, and identify private entity GAAP and IFRSrequirements.

8. Explain the objectives of disclosure, and identify the major types of information thatare required to be reported for investments in other companies debt and equityinstruments.

9. Identify differences in accounting between private entity GAAP and IFRS, and what

ACCG21646 9-1


2/14

changes are expected in the near future.

10. Recognize the classifications of financial instruments under Canadian GAAP priorto 2011 (Appendix 9A).

This chapter focuses on the basic accounting models used to account forinvestments in debt and equity securities in general and which underlie currentinitiatives.

Financial Assets and Investments

A financial asset is defined as being any asset that is:

a. cash;b. an equity instrument of another entity; orc. a contractual right:

i. to receive cash or another financial asset from another party;or

ii. to exchange financial assets or liabilities with another partyunder conditions that are potentially favourable to the entity.

Debt instruments represent a creditor relationship with an enterprise and includedebt instruments such as investments in government securities, municipalsecurities, corporate bonds, convertible debt, and commercial paper.

Equity instruments represent ownership interest, such as common, preferred, orother capital stock and is any contract that is evidence of a residual interest in theassets of an entity after deducting all its liabilities.

A company will invest in debt and equity instruments issued by other companies tomake a return, such as interest, dividends, or capital appreciation, on excess cashnot needed for other purposes. The investment may be intended to generate short-term or long-term returns, depending on the companys goals and need for theexcess cash.

Acompany may also invest for strategic reasons. Strategic investments areentered into to give the investing company (the investor) significant influence orcontrol over the operating, investing, or financing decisions of the company in whichit has invested (the investee).

Accounting for the investments depends on the type of instrument (debt orequity), managements intent, the ability to reliably measure fair value, or theextent to which a company can influence the activities of the investee company.

Accounting for initial investments requires them to be measured on acquisition atfair value, which is generally the price paid. Transaction costs are added to theacquisition cost if the cost method is used and are expensed if the fair valuemethod is used.

ACCG21646 9-2


3/14

Subsequent to acquisition, the change in the fair value carrying amount offinancial instruments measure at fair value are called unrealized holding gainsor losses. These gains and losses are usually identified separately on thefinancial statements.

There are three accounting models used for the various non-strategic debt andequity investments. They include:

a. Cost/amortized cost model.

Measured at cost on acquisition (equal to fair value + transactioncosts)

At each reporting date, measure at cost or amortized cost

Unrealized holding gains or losses are not applicable

Realized holding gains and losses are reported in net income

b. Fair value through net income model (FV-NI).

Measured at fair value on acquisition

At each reporting date, measure at fair value

Unrealized holding gains or losses reported in net income

Realized holding gains and losses are reported in net income

c. Fair value through other comprehensive income model (FV-OCI).

Measured at fair value on acquisition

At each reporting date, measure at fair value

Unrealized holding gains or losses reported in othercomprehensive income (OCI)

Realized holding gains and losses are transferred to net incomeor directly to net income

Cost/Amortized Cost ModelA cost-based model is applicable to both debt and equity investments.However as shares are not amortized, the term cost is applicable forinvestments in equity investments. The amortized cost model applies only toinvestments in debt instruments and long-term notes and loans receivable.

Application of the cost model for an equity investment is as follows:o Cost of the investment = fair value of the shares acquired (or fair value of

what was given up to acquire them if more reliable) plus any transactioncosts on acquisition

o Unless impaired, investment reported at its cost each balance sheet dateo Recognize dividend income when the entity has a claim to the dividendo When the shares are disposed of, derecognize them and report a gain or

loss on disposal in net income. Gain or loss is the difference between theinvestments carrying amount and the proceeds on disposal.

ACCG21646 9-3


4/14

Application of the Cost model to debt investments is as follows:o Cost of the investment = fair value of the debt instrument acquired (or fair

value of what was given up to acquire them if more reliable) plus anytransaction costs on acquisition

o Unless impaired, investment reported at its amortized cost plus any

outstanding interest each balance sheet dateo Recognize interest income as it is earned, amortizing any premium or

discount at the same time by adjusting the carrying amount of theinvestment.

o When the investment is disposed of, first bring the accrued interest anddiscount or premium amortization up to date. Derecognize theinvestment, reporting any gain or loss on disposal in net income. Gain orloss is the difference between the investments amortized costs at thedate of disposal and the proceeds received for the security.

IFRS requires that the bond premium or discount use the effective interestmethod. Private entity GAAP allows the straight line method. In practice, the

discount or premium on a bond investment is not usually recognized and reportedseparately, though it could be.

ACCG21646 9-4


5/14

Fair Value through Net Income (FV-NI) ModelThe Fair Value through Net Income (FV-NI) model is also applicable to both debtand equity investments. This model is also referred to as fair value through profit orloss (FVTPL) in International Standards.

Application of the FV-NI model is as follows:

o Measurement at acquisition = fair value of the investment acquired (orfair value of what was given up to acquire them if more reliable).Transaction costs are expensed.

o Carrying amount of each FV-NI investment is adjusted to its fair value ateach reporting date with all resulting unrealized holding gains andlosses reported in net income along with any dividends or interestincome earned.

o For FV-NI investments held for trading purposes (i.e. held to sell in thenear term or to generate a profit from short-term fluctuations in price)both interest and dividend income need not be reported separately fromthe holding gains or losses, but rather accounted for and reportedtogether to mirror how such investments are managed.

o When the entity holding the investment needs to or wants to track theholding gains and losses separately, the dividend is recognized in anaccount such as Dividend income, and the adjustment to fair value ateach reporting date is recognized in a separate account such as Gain(or Loss) on FV-NI Investment in Shares.

o For debt investments, separate reporting is more complex because therecognition of the interest income separately requires that the discount

ACCG21646 9-5


6/14

or premium be amortized before the change in fair value is recognized.The amortization of the discount/premium changes the investmentscarrying amount so the fair value adjustment entry has to take this intoaccount. There are several ways the bookkeeping for this can behandled, but the text takes the approach that maintains the investmentaccount at fair value and the necessary amortized cost information is

kept in supplementary records.The steps are as follows:

Recognize the interest as Interest Income on FV-NI Debt Investments:as it is earned, adjusting the book value of the investment by theamount of any discount or premium amortization

The change arising from the adjustment of the investment to its currentfair value at each reporting date is recognized as Gain (or Loss) on FV-NI Debt Investments.

When the investment is disposed of, the realized gain or loss ondisposal is equal to the fair value at the last measurement date and theproceeds of disposal.

ACCG21646 9-6


7/14

Fair Value through Other Comprehensive Income (FV-OCI) ModelChapter 4 introduced the concept of other comprehensive income (OCI). To recapthe terms associated with OCI:

o Comprehensive income change in equity (or net assets) of an entityduring a period from non-owner source transactions and events. It isthe total of net income and other comprehensive income.

o Other comprehensive income (OCI) made up of revenues, gains,expenses, and losses that accounting standards say are included incomprehensive income, but excluded from net income.

o Accumulated other comprehensive income (AOCI) the balance of allpast charges and credits to other comprehensive income to thebalance sheet date.

Example of a combined income and comprehensive income statement:

Sales $800,000Cost of goods sold (600,000)

Gross profit 200,000Operating expenses 90,000Net income 110,000Other comprehensive income

Unrealized holding gain, net of tax 30,000Comprehensive income $140,000

The Fair Value through Other Comprehensive Income (FV-OCI) modelunder IASB proposals for financial instruments normally will be limited to equityinvestments in other companies, though this is not finalized and so may extend todebt securities.

Application of the model is as follows:o Measurement at acquisition = fair value of the investment acquired (or

fair value of what was given up to acquire them if more reliable). UnlikeFV-NI investments, transaction costs tend to be added to the carryingamount of the investment. When the investment is adjusted at the firstreporting date, the transaction costs will automatically become part ofthe holding gain or loss recognized in OCI.

o Carrying amount of each FV-OCI investment is adjusted to its fairvalue at each reporting date with all resulting unrealized holding gainsand losses reported in other comprehensive income.

o Any dividend or interest income earned is reported in net income.o When the investment is disposed of, there are two versions of how the FV-

OCI model can be applied the when holding gains and losses are realized: FV-OCI with recycling previously unrealized gains and losses to

the date of disposal are transferred (recycled) into net income FV-OCI without recycling - previously unrealized gains and losses to

the date of disposal are transferred directly into retained earnings

ACCG21646 9-7


8/14

ACCG21646 9-8


9/14

Impairments

Review for impairment is generally only applicable to investments valued atcost/amortized cost because fair value investments would automatically reflect any

impairment. Both IFRS and private entity GAAP require entities adjust forimpairment at each reporting date, preferably on an individual investment basisunless doing so would not be timely, in which case investment portfolios with similarcharacteristics could be grouped and assessed. Impairments on investments arerecognized when there is no longer reasonable assurance that the future cash flowsassociated with them will be either collected in their entirety or when due.

Three models could be used to calculate and record the losses. A loss assessedunder all models would be recognized in net income and reversals are generallypermitted up to amortized cost, though there are some limitations on reversals.These models are:

Incurred loss model Expected loss model

Fair value loss model

ACCG21646 9-9


10/14

Below is a summary that can be used to compare the differences and similaritiesbetween the impairment loss models.

Strategic InvestmentsThere are two ways that strategic investments are classified as:

Significant influence investments bought to give the holder significant influenceover the operating, financing, and investing decisions of the investee.

Control investments bought to give the holder control over the operating,financing, and investing decisions of the investee.

The degree to which one corporation (investor) acquires an interest in the commonstock of another corporation (investee) generally determines the accounting treatmentfor the investment subsequent to acquisition. Investments by one corporation in thecommon share of another and the accounting method to be used can be classifiedaccording to the percentage of the voting share of the investee held by the investor(however this is only a guideline and other factors need to be considered):

Holding Method

a Less than 20%-investor has passive interestFair Value Method Fair Value

b Between 20% and 50%- investor has significant interest Equity Methodc More than 50%-investor has controlling interest Consolidation

Other factors in addition to percentage ownership would include representation onthe board of directors, participation in policy-making processes, materialintercompany transactions, interchange of managerial personnel, or provision oftechnical information.

ACCG21646 9-10


11/14

Equity Method

When an investor can exercise significant influence over operating and financialpolicies of the investee company they are considered to have "significantinfluence," and is required to account for the investment using the equity method.

Under the equity method the investment's carrying amount is periodicallyincreased (decreased) by the investor's proportionate share of the earnings(losses) of the investee and decreased by all dividends received by the investorfrom the investee. The adjustments made to the carrying amount will also result inincreases or decreases to investment income.

When the investment is originally purchased, the difference between the bookvalue of the company being purchased and the actual amount paid is allocated tothe appropriate assets and liabilities purchased. These may be tangible assets(such as inventories), intangible assets (such as patents), or unrecorded assets(such as a customer base). Any excess amount that cannot be allocated to anidentifiable tangible or intangible asset/liability as a fair value adjustment is

allocated to goodwill. The subsequent accounting for the excess fair value orgoodwill follows accounting procedures that would normally be followed for theseassets and recognized as either decreases or increases in the investment income.

ACCG21646 9-11


12/14

Under both IFRS and private entity GAAP, impairments in value are assessed ateach balance sheet date and a loss is recorded if the carrying amount is morethan the investments recoverable amount. The loss may be reversed if futureevents indicate that the recoverable amount has improved.

On disposal of investment in an associate, the investment account and investment

account are brought up to date as at the date of sale and the investment carryingamount is removed from the books through the recording of a gain or loss on thesale.

Consolidation

When one corporation (the parent) acquires a voting interest of more than 50% inanother corporation (the subsidiary), the investor corporation is deemed to have acontrolling interest.When the parent treats the subsidiary as an investment,consolidated financial statements are generally prepared instead of separatefinancial statements for the parent and the subsidiary. If the parent and the

subsidiary prepare separate financial statements, the investment in the commonstock of the subsidiary is presented as a long-term investment on the financialstatements of the parent under the equity method. The equity method issometimes called one line consolidation because the results for net income andretained earnings will be the same whether financial statements are preparedusing the equity method or prepared using consolidation.

ACCG21646 9-12


13/14

Presentation, Disclosure, and Analysis

Investments presentation and disclosure are similar under IFRS and privateentity GAAP with some differences, but generally will be:

Current Assetso Classification: under IFRS, if it is expected to be sold or otherwise

realized with the entitys normal operating cycle or within 12 monthsfrom the balance sheet date, held primarily for trading, or is a cashequivalent. Under private entity GAAP, if it is usually realizable within12 months from the balance sheet date (or operating cycle if longer)and it can be readily converted into cash).

o Could include debt and equity instruments measured at cost oramortized cost and those at FV-NI.

o Disclosure: under both IFRS and private entity GAAP, the carryingamount of investments and the method used; net gains or lossesrecognized by method of accounting; interest income, impairment

losses and reversalso Under IFRS, need to provide quantitative measures of their riskexposures and concentrations, and information on how managementmanages these risks.

Noncurrent assetso Could include investments held at cost or amortized cost or FV-NI if

they dont meet the requirement to be classified as current, and FV-OCI investments as they are usually held for long-term strategicpurposes

o Investments in Associates (unless held for sale). Income is reported as income before discontinued operations,

discontinued operations, or other comprehensive income,according to its nature in the associates financial statements. Disclosure for associates accounted for under the equity

method include disclosure of the investment category,method of accounting used, fair value of any of theseinvestments if they have an active market, separatedisclosure of the income from investments under the equitymethod, and information about the associates year ends thatare different than the investors.

ACCG21646 9-13


14/14

IFRS and Private Entity GAAP Comparison

ACCG21646 9-14

ch 9 lecture notes

Documents