CHAPTER 3

INVESTMENTS IN EQUITY AND DEBT SECURITIES

LEARNING OUTCOMES

Explain types and classification of investment Record the investment using various methods
a) Cost method b) Equity method

Account for changes in method Distinguish between share dividend, share split and share right Record investment in debt securities
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INVESTMENTS IN EQUITY SECURITIES

Investment assets owned to acquire additional income, increase capital and other benefits.

Types of investment: a) Short-term investment b) Long-term investment Classification of Investment: 1) Investment in Subsidiary 2) Invetment in Associate 3) Other Investment
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INVESTMENTS IN EQUITY SECURITIES

Each category of investment can use different accounting treatment in recording. 3 methods: Cost method Equity method Acquisition method (Consolidation/Purchase)

Investment in subsidiaries
(MFRS10 & 127)

Subsidiary - an entity that is controlled by another entity(parent)

Parent (investor) will record Investment in subsidiary Control (MFRS10 para 7):
a) power over the investee (see para 1014); ability to direct the relevant activities. b) exposure, or rights, to variable returns from its involvement with the investee (see para 15 and 16);and c) the ability to use its power over the investee to affect the amount of the investors returns (see para 17 and 18).
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Investment in subsidiaries
(MFRS 10)
Rights that can give an investor power include but are not limited to: (B15) (a) rights in the form of voting rights (or potential voting rights) of an investee (see paragraphs B34B50); Hold more than half of the voting power of the enterprise (b) rights to appoint, reassign or remove members of an investees key management personnel who have the ability to direct the relevant activities; (c) rights to appoint or remove another entity that directs the relevant activities; (d) rights to direct the investee to enter into, or veto any changes to, transactions for the benefit of the investor; and (e) other rights (such as decision-making rights specified in a management contract) that give the holder the ability to direct the relevant activities.

Investment in subsidiaries
(MFRS 127)

Parent should present 1) Its financial statement (MFRS 127) 2) a consolidated financial statement (parent and subsidiaries) (MFRS 10) In parents separate financial statements, it shall account for investments in subsidiaries either: (a) at cost, or (b) in accordance with MFRS 9. The entity shall apply the same accounting for each category of investments. Investments accounted for at cost shall be accounted for in accordance with MFRS 5 Non-current Assets Held for Sale and Discontinued Operations when they are classified as held for sale.
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Investment in Associate companies (MFRS 128)

Associate companies an enterprise in which the investor has significant influence

Significant influence - power to participate in the financial and operating policy

decisions of an investee but not control over those policies.

Ownership of voting share 20% - 50%

Investment in Associate companies (cont)

If investor does not present consolidated financial statement (CFS), it has to use equity method

If it prepare CFS, investor should not use equity method in its separate FS;

If use equity method in CFS, it should use cost method @ MFRS 139 in its FS; If use MFRS 5 (classified as held for sale) in CFS, it should use MFRS 5 in its FS; If use MFRS 139 (because of cease significant influence) in CFS, it should use MFRS 139 in its FS
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Cost method

Suitable for all categories of investment except current investment

the investment is recorded at cost,

the income statement reflects income from the investment only to the extent that the investor receives distributions from accumulated net profits of the investee arising subsequent to the date of acquisition.

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Cost method (cont..)

Cost of investment = Purchase price + all charges involved while acquiring (broker fees, bank charge) Share of investees earning (SIE) = % of holdings x profit

If dividend received < share of investees earning recorded as investment income / dividend
If dividend is received > share of investees earning

investee give dividends more than retained earnings they have. Recorded as declining in carrying amount of investment.
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Cost method (cont..)

Example:
P Company has 20% (5,000 out of 25,000 shares) shares in S Company. For 2011, S Company paid dividend RM0.80 per share. S Company declared a net income of RM60,000. Journal entries: Dividend = RM0.80 x 5,000 = RM4,000

SIE

= 20% x RM60,000 = RM12,000

Thus, Dividend < SIE Dr Cash Cr Investment Income 4,000 4,000

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Cost method (cont..)

Otherwise, if S Company paid dividend of RM2.50 per share:

Dividend = RM2.50 x 5,000 = RM12,500 SIE = 20% x RM60,000 = RM12,000 Dividend > SIE
Dr Cash Cr Investment Income Cr Investment in shares 12,500 12,000 500

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Cost Method (cont.)

If there is a decline in the value of investment (not temporary in nature), the cost of the investment will also be declined and the loss is charged to the Income Statement. Dr Loss of declining in investment value Cr Investment in shares XX XX

If there is a sale of investment in shares, gain or loss on disposal should be recognized (Difference between selling price and cost of investment)

Dr. Cash Dr. Loss on securities sold Cr. Investment in shares Cr. Gain on Securities sold 14

XX XX
XX XX

Equity method

Used in the preparation of the Consolidated Financial Statement the investment is initially recorded at cost and adjusted thereafter for the post-acquisition change in the investors share of net assets of the investee.

The Income Statement reflects the investors share of the results of operations of the investee.

Carrying Amount of Investment = Cost (+) Allocation of income in SIE, @ (-) Allocation of loss (-) Dividend received from investee
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Equity method (cont..)

Adjustments are also needed to be made for:

eliminating gain / loss from the transactions between companies difference in amortization of goodwill between original investors cost (purchase price) and investees net book value at the date of acquisition extraordinary items

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Equity method (cont..)

Example: On January 2012, Firdaus Company owns 25% shares of Idani Company at a price of RM700,000. At the date of the ownership, fair value of the depreciable assets is RM100,000, and yearly depreciation of RM12,500. The followings are the information taken from Idani Company in 2000: Net Income declared Dividend issued RM 90,000 RM 70,000

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Equity method (cont..)

Solution:
Dr Investment in shares 700,000 Cr Cash 700,000 (to record the acquisition/ownership of shares 25%) Dr Investment in shares Cr Investment Income (to record SIE 25% x 90,000) Dr Cash (25% x 70,000) Cr Investment in shares (to record the dividend received) 22,500 22,500

17,500 17,500

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Equity method (cont..)

Solution (cont..): Dr Investment Income 3,125 Cr Investment in shares 3,125 (to record the amortization of the depreciable assets) (25% x 12,500) Thus; Carrying amount of investment in shares: = RM700,000 + RM22,500 RM17,500 RM3,125 = RM701,875
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Acquisition method

MFRS 3 (para1) specifies that all business combinations should be accounted for by applying the acquisition method. Views a business combination from the perspective of the acquirer.

The acquirer is the combining entity that obtains control of the other combining entities or businesses. The acquirer purchases net assets and recognizes the assets acquired and liabilities and contingent liabilities assumed, including those not previously recognized by the acquiree. The acquirer records the assets and liabilities at fair values. 20

Acquisition method (cont..)

cost of the business combination - the fair values of assets given, liabilities incurred or assumed, and equity instruments issued by the acquirer, in exchange for control of the acquiree; any cost directly attributable to the business combinations (accounting, legal, consulting) should be expensed when incurred (para 53) allocating, at the acquisition date, the cost of the business combination to the assets acquired and liabilities and contingent liabilities assumed.

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Acquisition method (cont..)

Example:

ABC acquired a 100% interest in the equity capital of WXY SB on 1 January 2012. The purchased consideration was satisfied as follows: An immediate cash payment of RM1,000,000 An amount of RM2,000,000 to be paid on 1 January 2005 An issue of RM1,000,000 ABCs ordinary shares of RM1.00 each. These shares have been valued at RM4.00 each by Merchant Bank Bhd., the advisor to the acquisition and agreed upon by the regularity authorities.
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Acquisition method (cont..)

Example (cont..)

Cost incurred that were directly attributable to the acquisition totaled RM500,000 and these have not been paid. The cost of registration for issuing shares is RM100,000 paid by cash. ABCs incremental borrowing cost was 8% per annum.

Required: Calculate the COI and record the related journal entry.

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Acquisition method (cont..)

Solution:
Cost of Investment: Immediate cash consideration PV of deferred consideration (2,000/(1.08)^2) Fair value of shares issued (1,000 x 4) COI
Investment in Subsidiary Cash Deferred liability Share capital Share premium 6,715 1,000 1,715 1,000 3,000
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1,000 1,715 4,000 6,715

Changes in Method
Changes from equity method to cost method
Changes of method when percentage of ownership decline. Carrying amount of investment at the date of changing the method will be a base for the investment cost.

Amortization of the excess ownership costs on net book value of depreciable assets need not to be done again.
Not retroactive in nature (prior period adjustment)

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Changes in Method (Cont..)

Example:

On January 1, 2010, Alma Company purchased 250,000 unit shares of Berjaya Company at the cost of RM8,500,000. Total shares of Berjaya Company are 1,000,000 units.

Assume that on 1/1/2011, Berjaya Company issued 1,500,000 ordinary shares to the public. This has caused percentage of ownership of Alma Company reduced from 25% (250,000 / 1,000,000) to 10% (250,000 / 2,500,000). Carrying value of investment of Alma Company in Berjaya Company at 31/12/2010 is RM8,924,000.
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Changes in Method (Cont..)

Example (cont) The followings are the net income (loss) and dividend of Berjaya Company (investee) from year 1996 1998.
Investors position in investees Net Income Dividend received by investor

2011 2012 2013

RM600,000 RM350,000 -

RM400,000 RM400,000 RM210,000

Assume that a change from equity method to the cost method is effective at 1/1/2011.
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Changes in Method (Cont..)

Solution:

Calculation of cumulative net income on the investors dividend

2011 RM600,000 RM400,000

2013 (RM0 RM210,000) + RM150,000

RM200,000
(RM60,000)

2012 (RM350,000 RM400,000) + RM200,000 RM150,000

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Changes in Method (Cont..)

Journal entries of recording dividend received:

2011
Dr Cash Cr Dividend Income
2012 Dr Cash Cr Dividend Income

400,000 400,000

400,000 400,000

2013 Dr Cash 210,000 Cr Investment in shares 60,000 Cr Dividend Income 150,000

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Changes in Method (Cont..)

Changes from cost method to equity method:
Retroactive in nature, i.e. prior period adjustment should be made.
Unrealized profit / loss account and adjustment of the fair value securities should be eliminated

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Issues in Investment in equity securities

1.
2. 3.

Share Dividends Share split Share rights

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Share Dividends

Dividend received by investor in terms of shares not cash. Implications: Number of shares increased % of ownership maintained Total cost of investment as a whole remained Carrying amount of shares per unit declined If the shares are sold, profit / loss is recognized but the carrying amount of shares per unit after the sale is similar. Journal not required for the investor
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Share Dividends (Cont..)

Example:

A corporation with 50,000 shares of RM5 par, gives a 100% share dividends to existing shareholders. Below is the shareholders equity before share dividends distribution.

Ordinary shares: RM5 par, 50,000 shares outstanding Premium share Retained earnings

250,000 400,000 300,000 950,000

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Share Dividends (Cont..)

Below is the shareholders equity after dividends shares distribution.

Ordinary shares:

RM5 par,100,000* shares outstanding Premium share Retained earnings

500,000 150,000 300,000 950,000

Solution: Dr Premium share Cr Ordinary shares

250,000

250,000
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Exercise:
Dividend Received in Shares

On 2 Feb 2010, Eagle Co. purchased 1,000 unit shares of Tiger Co. at RM7,500. In the beginning of 2011, Tiger Co. paid dividend in shares to Eagle Co. totaling 20% of its ordinary shareholders.
On 1 June 2011, Eagle Co. retired 300 unit shares of Tiger Co. at RM2,000

Prepare the entries for Eagle Co.

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Solution for Exercise

Eagle Co.
2 Feb 2010; Dr Investment in shares Cr Cash (to record purchase of investment in share) 7,500 7,500

Jan 2011; -no journalmemo: No. of additional shares = 20% x 1,000 = 200 Cost per unit share = RM7,500/(1,000 + 200) = RM6.25 per unit 1 June 2011 Dr Cash 2,000 Cr Investment in shares (6.25 x 300) 1,875 Cr Gain on sale 125
(to record sale of investment in shares)
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Share Split

Made when fair value of shares are too high. Implications: Number of shares increased Cost of investment for each unit of share reduced Total cost of investment as a whole does not change % interest does not change
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Share Split (Cont..)

Example:

On 1/1/2010, Syarikat Malim owns 10,000 unit shares in Syarikat Kundang at a cost of RM9 per unit. At 31/12/2011, Syarikat Kundang split the shares, 3 for 1.

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Share Split (Cont..)

Solution:

New number of shares = 3 x 10,000 = 30,000 units

Cost of share per unit = RM90,000/30,000 = RM3/share

In Syarikat Malims book:
1/1/2010 31/12/2011 Effect

Cost of share per unit

No. of shares Total costs

RM9
1,000

RM3
30,000

Decline
Increase

RM90,000 RM90,000 unchanged

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Share Right

Investee offers additional shares to the existing shareholders in accordance to the % of ownership. Certificate of warrant will be issued to buy the right share. Warrant - stating the number of shares that the holder of the right may purchase and also the price of the right share at which they may purchase (normally lower than the fair value).

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Share Right (Cont..)

Before the maturity date, shares and right can be sold separately. Investor has 3 choices: Purchased additional shares (use right) Sold right to other parties Unused (purchased) or sold right until the maturity date

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Share Right (Cont..)

Investor need to record this as Investment in right.

Investor need to allocate the cost of investment in shares to cost of investment in right share

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Share Right (Cont..)

Example:

100 shares had been acquired before the issuance of the right. Original cost is RM50 per share. Issuance of right: one share for each share held. Two rights are needed to buy one additional share at a price of RM50. Fair value of share = RM60 / share Fair value of right = RM3 / right

Prepare the journal entries relating to the issuance of the right share.
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Share Right (Cont..)

Solution:

Total fair value of shares (100 x 60) = RM6,000 Total fair value of right = RM 300 RM6,300 Costs allocated to shares: 6,000 / 6,300 x RM5,000 = RM4,762 Cost per unit = RM4,762 / 100 = RM47.62

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Share Right (Cont..)

Costs allocated to the right: = 300 / 6,300 x RM5,000 = RM238 Cost per unit = RM238 / 100 = RM2.38 Dr Investment in right Cr Investment in shares 238 238

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Share Right (Cont..)

If 10 out of the original shares are sold at RM58 per share: Dr Cash (10 x 58) 580 Cr Investment in shares [(4,762 / 100) x 10] 476.2 Cr Gain from disposal of investment 103.8

If 40 units right (can buy 20 shares) are sold at a price of RM3.00 / right: Dr Cash (3 x 40) 120 Cr Investment in right (238 / 100) x 40 95.24 Cr Gain from disposal of right 24.76
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Share Right (Cont..)

If the right is used to buy 20 additional shares at an offered price of RM50 per share:

Dr Investment in share 1,095.24 Cr Cash (20 x 50) Cr Investment in right share (40 rights x 2.38)

1,000 95.24

If 20 rights (the remaining balance) are kept until the maturity date this amount should be eliminated from the account.

Dr Loss of right share (20 x RM2.38) Cr Investment in right share (to record the unused right @ unsold)

47.6
47.6
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INVESTMENTS IN DEBT SECURITIES

A debt security is an investment in bonds issued by the government or a corporation Bond a certificate issued to the public whereby the company who issued the bonds (issuer) agreed to pay the bonds holder (investor) the face value of the bonds at a certain maturity date including the interest at the agreed rate. Characteristics: nominal value or face value of the bond normally stated at RM1,000. is the value that can be repaid at the maturity date. maturity date date whereby the issuer of the bonds has to pay back the face value of the bond to the investor.
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INVESTMENTS IN DEBT SECURITIES (CONT..)

coupon rate (fixed interest rate) interest rate fixed by the issuer of the bond for the payment of interest to the investor.

Can be issued at par, discount or premium

Bond issuer company is the owner of the bond and when the bond is issued recorded as bonds payable
Buyer of bond (investor) recorded as investment in bond

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Types of Debt Securities

Terms v. Serial Bond Terms bonds issued and will mature at the same date. Issuer of the bond has to pay certain amount of money at the maturity date for all bonds issued.

Serial bonds has more than one maturity date (i.e. mature according to levels).

Registered v. Bearer (Coupon Bonds) Registered bonds payment of interest and principal of the bond matured will be paid to the owner of the bond according to the name listed in the record of the trustee holder.

Coupon bonds payment of interest will be paid to the person who submitted the coupon interest to the issuer company.

Junk Bond High-risk bond. Thus, high return.

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Types of Debt Securities (Cont..)

Convertible Bond Bonds which can be converted to the shares within a certain period of time. Callable Bond Bonds which can be settled before the maturity date. Issuer of the bond has option whether to settle the bonds at a fixed maturity date or earlier than the date. Zero-interest Bond Bonds which has no coupon rate or a very low coupon rate. Normally issued at discount or lower price.

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Determining and Recording Initial Cost for Bonds Purchased

Purchase price/selling price of the bond is determined by calculating: a) Present Value of the bond b) Amount at the issuance rate given Example: ABC Bhd issues RM300,000 of 9% bonds, due in 10 years, with interest payable semiannually. At the time of issue, the market rate for such bonds is 10%. Compute the issue price of the bonds.

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Determining and Recording Initial Cost for Bonds Purchased (Cont..)

Solution:
n = 10 x 2 PV of the principal: 300,000 x 0.37689 PVOA of interest payable: [(9% x 300,000)/2] x 12.46221 Price f bond i = 10%/2

113,067 168,240 281,307

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Determining and Recording Initial Cost for Bonds Purchased (Cont..)

The price of a bond is determined by the interaction between the bond's stated interest rate and its market rate. A bond's price is equal to the sum of the present value of the principle and the present value of the periodic interest.

If the stated rate = the market rate, the bond will sell at par. If the stated rate < the market rate, the bond will sell at a discount. If the stated rate > the market rate, the bond will sell at a premium.

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Example:
ABC Bhd issued RM200,000 of 8% bonds on 1 Jan 2010. The bonds are due on 1 Jan 2015, with interest payable each 1 July and 1 Jan. Compute the issue price at a)100 b) 97 c) 105

Prepare journal entries for investor.

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Solution:

a) At 100: Dr Investment in Bonds Cr Cash b) At 97: Dr Investment in Bonds Cr Cash c) At 105: Dr Investment in Bonds Cr Cash

200 200

194 194

210 210
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Amortization of Premiums and Discounts

Two methods:
1. Straight-line method
l

may be used if the results are not materially different from those produced by the effective interest method. is the preferred procedure used to calculate periodic interest expense. The carrying amount of the bonds at the start of the period is multiplied by the effective interest rate to determine the interest expense.

2. Effective interest method

l

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Amortization of Premiums and Discounts (Cont..)

Interest Revenue (Effective interest method) = Effective Interest Rate x Carrying Value of Bonds. Journal entry: If a premium exists: Dr Cash/interest receivable Dr Interest Revenue Cr Investment in Bonds If a discount exists: Dr Cash/interest receivable Dr Investment in Bonds Cr Interest Revenue

XX XX XX

XX XX XX
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Amortization of Premiums and Discounts (Cont..)

Example (straight-line method):

ABC Bhd issued RM600,000 of 10%, 20-year bonds on 1 Jan 2012, at 102. Interest is payable semiannually on 1 July and 1 Jan. ABC Bhd uses straight-line method of amortization for bond premium/discount. Prepare the journal entries to record: a) The issuance of the bonds b) The payment of interest on 1 July c) The accrual of interest on 31 Dec

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Amortization of Premiums and Discounts (Cont..)

Solution (straight-line method):
a)

Issuance of bonds: Dr Investment in Bonds Cr Cash (600,000 x 1.02)

612,000 612,000

b)

Receive of interest on July 1: Dr Cash 30,000 Dr Interest Revenue Cr Investment in Bonds Accrual interest on 31 Dec Dr Interest Receivable 30,000 Dr Interest Revenue Cr Investment in Bonds

29,700 300

c)

29,700 300

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Amortization of Premiums and Discounts (Cont..)

Example (effective interest method):

XYZ Bhd issued RM600,000 of 10%, 20-year bonds on 1 Jan 2012. Interest is payable semiannually on 1 July and 1 Jan. XYZ Bhd uses effective interest method of amortization for bond premium/discount. Assume an effective rate yield of 11.5%

Prepare the journal entries to record: a) The issuance of the bonds b) The payment of interest on 1 July c) The accrual of interest on 31 Dec
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Amortization of Premiums and Discounts (Cont..)

Solution (effective interest method):

a)

Issuance of bonds:

i=11.5/2, n=20x2
PV 600,000 x 0.10685 PVOA 30,000 x 15.5330 Price on 1 Jan Dr Investment in Bond Cr Cash = 64,110 = 465,990 = 530,100 530,100 530,100

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Amortization of Premiums and Discounts (Cont..)

Cash Interest exp.
30,481a 30,508 30538

Amort. Disc

Balance of Bonds
530,100 530,581c 531,089 531,627

1/7/12 1/1/13 1/7/13

30,000 30,000 30,000

481b 508 538

a: 11.5% x 530,100 x 6/12 = 30,481 b: 30,481 30,000 = 481 c: 530,100 + 481 = 530,581
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Amortization of Premiums and Discounts (Cont..)

b)

Interest expense on 1 July:

Dr Cash Investment in Bonds Cr Interest Revenue 30,000 481 30,481

c)

Accrual interest on 31 Dec:

Dr Cash Investment in Bonds Cr Interest Revenue 30,000 508
30,508

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Bonds Acquired between Interest Dates

Adjustment for accrued interest should be done. Accrued interest is calculated for the period in between of the date of previous interest payment with date of bond is sold. Cash paid by buyer is the price of the bonds together with the accrued interest. Price of bonds is the present value of the bond at the date of selling/buying.

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Bonds Acquired between Interest Dates (Cont..)

Example:

Berdesup Cahaya Bhd purchased bond from Sakinah Bhd. The following is the information on the bond.
Date of bond Maturity date June 30, 2009 June 30, 2014

Date of selling the bond

Date of interest payment Stated interest rate Face value of bond

Sept 1, 2009
Dec 31 and June 30 9% RM200,000

Prepare journal entries on 1 Sept and 31 Dec

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Bonds Acquired between Interest Dates (Cont..)

Issued at discount Effective interest rate = 11% Price of bond at 30/6/09 Face value [PV5.5%, 10 200,000 = 0.58543 x 200,000] Interest [PVOA5.5%, 10 9,000 = 7.53763 x 9,000] Present Value (+) Increment of bonds value from 30/6 1/9 [184,925 x 11% x 2/12] Cash (-) Cash paid for interest from 30/6 1/9 [200,000 x 9% x 2/12] PRICE OF BOND AT 1/9/09

117,086 67,839 184,925

3,390 188,315
(3,000) 185,315

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Bonds Acquired between Interest Dates (Cont..)

Journal Entries
Issuer:
Sept 1 Dr Cash 188,3151 Disc on Bond 14,6852 Cr Interest Payable 3,0003 Bonds Payable 200,000

Buyer: Sept 1 Dr Investment Bonds 185,315 Interest Receivable 3,000 Cr Cash 188,315

185,315 + 3,000 (interest) 2. 200,000 185,315 3. 200,000 x 9% x 2/12

1.

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Bonds Acquired between Interest Dates (Cont..)

Amortization of discount schedule:
Date 1/6 31/12 30/6 Cash Paid 9,000 9,000 Interest Expense 10,171 10,235 Amortization Carrying amount of discount of bond 1,171 1,235 184,925 186,096 187,331

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Bonds Acquired between Interest Dates (Cont..)

Journal Entries
Dec. 31 Dr Interest Expense 6,7811 Interest Payable 3,000 Cr Disc on Bonds 7812 Cash 9,000 10,171 x 4/6 2. 1,171 x 4/6
1.

Dec. 31 Dr Investment in Bonds 781 Cash 9,000 Cr Interest Revenue 6,781 Interest Receivable 3,000

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End of the Chapter

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