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INVESTMENTS

17-1

Investments
Investments

Debt Investments

Other Reporting
Issues

Amortized cost

Fair value

Impairment of value

Fair value

Equity method

Fair value option

Consolidation

Transfers between
categories

Summary of debt
investment accounting

17-2

Investments in
Equity Securities

Fair value controversy


Summary

Learning
Learning Objectives
Objectives
1.

Define Financial Instruments.

2.

Describe the accounting framework for financial assets.

3.

Define and discuss investments.

4.

Understand the accounting for equity investments at fair value.

5.

Understand the accounting for debt investments at fair value.

6.

Understand the accounting for debt investments at amortized cost.

7.

Describe the accounting for the fair value option.

8.

Explain the equity method of accounting and compare it to the fair value
method for equity investments.

9.

Discuss the accounting for impairments of debt investments.

10. Describe the accounting for transfer of investments between categories.


17-3

Financial
Financial Instruments
Instruments
Financial Instruments - definition on page 658

17-4

Financial Assets definition on page 659

Financial Liability definition on page 661

Equity Instrument of another entity definition on page


662

LO 1 Define financial instruments.

Accounting
Accounting for
for Financial
Financial Assets
Assets
Financial Asset

Cash.

Equity investment of another company (e.g., ordinary or


preference shares).

Contractual right to receive cash from another party (e.g.,


loans, receivables, and bonds).

Contractual right to exchange financial instruments with


another entity under conditions that are potentially favorable.

IASB requires that companies classify financial assets into two


measurement categoriesamortized cost and fair value
depending on the circumstances.
17-5

LO 2 Describe the accounting framework for financial assets.

Accounting
Accounting for
for Financial
Financial Assets
Assets
Measurement BasisA Closer Look
IFRS requires that companies measure their financial assets
based on two criteria:

Companys business model for managing its financial


assets; and

Contractual cash flow characteristics of the financial


asset.

Only debt investments such as receivables, loans, and bond investments


that meet the two criteria above are recorded at amortized cost. All other
debt investments are recorded and reported at fair value.
17-6

LO 2 Describe the accounting framework for financial assets.

Accounting
Accounting for
for Financial
Financial Assets
Assets
Measurement BasisA Closer Look
Equity investments are generally recorded and reported at
fair value.
Summary of Investment Accounting Approaches

17-7

Illustration 17-1

LO 2 Describe the accounting framework for financial assets.

Investments
Investments
Investments definition, examples and purpose on page 656 657

Presentation:
Balance Sheet as current or non-current assets.

17-8

Current Assets readily realizable and intended


to be held for not more than one (1) year.

Non-current Assets not expected to be realized


within 12 months and intended to be withheld for
more than 1 year.

LO 3 Define and discuss investments.

Equity
Equity Investments
Investments at
at Fair
Fair Value
Value
Equity investment represents ownership of ordinary, preference,
or other capital shares. (definition on page 662)
Designation of Equity Instrument:
- designate at initial recognition as investment at fair value
through profit or loss unless the entity made an irrevocable
election to designate the investment at fair value through other
comprehensive income (OCI).
- No transfer from other comprehensive income to profit or loss
(reclassification adjustment) once the equity investment has been
designated as fair value through profit or loss or fair value
through OCI.

17-9

LO 4 Understand the accounting for equity investments at fair value.

Equity
Equity Investments
Investments at
at Fair
Fair Value
Value
Measurement of Equity Investments (PFRS 9)
Designation

Initial Measurement

Subsequent Measurement

FV through profit or loss

Fair value*

Current fair value**

FV through OCI

Fair value plus transaction


cost

Current fair value**

*transaction costs are expensed outright


**without any deduction for transaction cost that it may incur on sale or other disposal.

Measurement of Equity Investments (PFRS 9)


Category

Initial Measurement

Subsequent
Measurement

Unrealized Holding
Gains or Losses

Trading Securities

Fair value

Current fair value

Recognized in net
income

Current fair value

Recognized in OCI
and as separate
component in
equity

Non-trading
Securities
17-10

Fair value plus


transaction cost

LO 4 Understand the accounting for equity investments at fair value.

Equity
Equity Investments
Investments at
at Fair
Fair Value
Value
Measurement of Equity Investments (PAS 39)

17-11

Category

Initial Measurement

Subsequent
Measurement

Unrealized Holding
Gains or Losses

Trading Securities

Fair value

Current fair value

Recognized in net
income

Available for sale

Fair value plus


transaction cost

Current fair value

Recognized in OCI
and as separate
component in equity

Held to Maturity

Amortized cost

Amortized Cost
(carrying value)

NA

LO 4 Understand the accounting for equity investments at fair value.

Equity
Equity Investments
Investments at
at Fair
Fair Value
Value

17-12

Impairment:

Under PFRS, there is no more impairment loss

If decline in the value of financial assets at fair value


is non-temporary, the unrealized loss will continue to
be reported as component of other comprehensive
income rather than as an impairment loss.

LO 4 Understand the accounting for equity investments at fair value.

Equity
Equity Investments
Investments
Illustration 17-15
Levels of Influence
Determine Accounting Methods

17-13

LO 4 Understand the accounting for equity investments at fair value.

Equity
Equity Investments
Investments
Illustration 17-16
Accounting and Reporting for
Equity Investments by Category

17-14

LO 5 Understand the accounting for equity investments at fair value.

Equity
Equity Investments
Investments at
at Fair
Fair Value
Value
Under IFRS, the presumption is that equity investments
are held-for-trading.
General accounting and reporting rule:

17-15

Investments valued at fair value.

Record unrealized gains and losses in net income.

LO 4 Understand the accounting for equity investments at fair value.

Equity
Equity Investments
Investments at
at Fair
Fair Value
Value
IFRS allows companies to classify some equity
investments as non-trading.
General accounting and reporting rule:

17-16

Investments valued at fair value.

Record unrealized gains and losses in other


comprehensive income.

LO 4 Understand the accounting for equity investments at fair value.

Debt
Debt Investments
Investments
Debt investments are characterized by contractual
payments on specified dates of

principal and

interest on the principal amount outstanding.

Companies measure debt investments at

17-17

amortized cost or

fair value.

LO 5 Understand the accounting for debt investments at amortized cost.

Debt
Debt InvestmentsFair
InvestmentsFair Value
Value
Debt investments at fair value follow the same accounting
entries as debt investments held-for-collection during the
reporting period. That is, they are recorded at amortized
cost.
However, at each reporting date, companies

Adjust the amortized cost to fair value.

Any unrealized holding gain or loss reported as part of


net income (fair value method).

17-18

LO 3 Understand the accounting for debt investments at fair value.

Fair
Fair Value
Value Option
Option
Companies have the option to report most financial assets at
fair value. This option

is applied on an instrument-by-instrument basis and

is generally available only at the time a company first


purchases the financial asset or incurs a financial liability.

If a company chooses to use the fair value option, it


measures this instrument at fair value until the company no
longer has ownership.

17-19

LO 4 Describe the accounting for the fair value option.

Fair
Fair Value
Value Option
Option
Illustration: Hardy Company purchases bonds issued by the
German Central Bank. Hardy plans to hold the debt investment
until it matures in five years. At December 31, 2011, the
amortized cost of this investment is 100,000; its fair value at
December 31, 2011, is 113,000. If Hardy chooses the fair value
option to account for this investment, it makes the following
entry at December 31, 2011.
Debt InvestmentGerman Bonds

4,537

Unrealized Holding Gain or LossIncome

17-20

4,537

LO 4 Describe the accounting for the fair value option.

Summary
Summary of
of Debt
Debt Investment
Investment Accounting
Accounting
Illustration 17-14

17-21

LO 4 Describe the accounting for the fair value option.

Equity
Equity Method
Method
An investment (direct or indirect) of 20 percent or more of the
voting shares of an investee should lead to a presumption that
in the absence of evidence to the contrary, an investor has the
ability to exercise significant influence over an investee.
In instances of significant influence, the investor must
account for the investment using the equity method.

17-22

LO 6 Explain the equity method of accounting and compare it


to the fair value method for equity investments.

Equity
Equity Method
Method
Equity Method
Record the investment at cost and subsequently adjust
the amount each period for

the investors proportionate share of the earnings


(losses) and

dividends received by the investor.

If investors share of investees losses exceeds the carrying amount of


the investment, the investor ordinarily should discontinue applying the
equity method.
17-23

LO 6 Explain the equity method of accounting and compare it


to the fair value method for equity investments.

Equity
Equity Method
Method
Illustration 17-23

17-24

LO 6

Consolidation
Consolidation
Controlling Interest - When one corporation acquires a voting
interest of more than 50 percent in another corporation

Investor is referred to as the parent.

Investee is referred to as the subsidiary.

Investment in the subsidiary is reported on the parents


books as a long-term investment.

Parent generally prepares consolidated financial


statements.

17-25

Impairment
Impairment of
of Value
Value
Impairment of Value
For debt investments, a company uses the impairment test to
determine whether it is probable that the investor will be unable
to collect all amounts due according to the contractual terms.
This impairment loss is calculated as the difference between the
carrying amount plus accrued interest and the expected future
cash flows discounted at the investments historical effectiveinterest rate.

17-26

LO 7 Discuss the accounting for impairments of debt investments.

Impairment
Impairment of
of Value
Value
Illustration: At December 31, 2010, Mayhew Company has a
debt investment in Bellovary Inc., purchased at par for $200,000.
The investment has a term of four years, with annual interest
payments at 10 percent, paid at the end of each year (the
historical effective-interest rate is 10 percent). This debt
investment is classified as held-for-collection. Using the following
information record the loss on impairment.

17-27

LO 7 Discuss the accounting for impairments of debt investments.

Impairment
Impairment of
of Value
Value
Illustration 17-24 & 25

Loss on Impairment
Debt Investments
17-28

12,688
12,688
LO 7

Transfers
Transfers Between
Between Categories
Categories
Transferring an investment from one classification to another

Should occur only when the business model for managing


the investment changes.

IASB expects such changes to be rare.

Companies account for transfers between classifications


prospectively, at the beginning of the accounting period
after the change in the business model.

17-29

LO 8 Describe the accounting for transfer of investments between categories.

Transfers
Transfers Between
Between Categories
Categories
Illustration: British Sky Broadcasting Group plc (GBR) has a
portfolio of debt investments that are classified as trading; that is,
the debt investments are not held-for-collection but managed to
profit from interest rate changes. As a result, it accounts for these
investments at fair value. At December 31, 2010, British Sky has
the following balances related to these securities.

17-30

LO 8 Describe the accounting for transfer of investments between categories.

Transfers
Transfers Between
Between Categories
Categories
Illustration: As part of its strategic planning process, completed
in the fourth quarter of 2010, British Sky management decides to
move from its prior strategywhich requires active management
to a held-for-collection strategy for these debt investments.
British Sky makes the following entry to transfer these securities
to the held-for-collection classification.
Debt Investments 125,000
Securities Fair Value Adjustment

17-31

125,000

LO 8 Describe the accounting for transfer of investments between categories.

Fair
Fair Value
Value Controversy
Controversy

17-32

Measurement Based on Business Model

Gains Trading

Liabilities Not Fairly Valued

Fair ValuesFinal Comment

LO 8 Describe the accounting for transfer of investments between categories.

Reporting
Reporting Treatment
Treatment of
of Investments
Investments
Illustration 17-26

17-33

LO 8 Describe the accounting for transfer of investments between categories.

17-34

U.S. GAAP classifies investments as trading, available for-sale (both


debt and equity investments), and held to-maturity (only for debt
investments). IFRS uses held-for-collection (debt investments), trading
(both debt and equity investments), and non-trading equity investment
classifications.

The accounting for trading investments is the same between U.S.


GAAP and IFRS. Held-to-maturity (U.S. GAAP) and held-for-collection
investments are accounted for at amortized cost. Gains and losses
related to available-for-sale securities (U.S. GAAP) and non-trading
equity investments (IFRS) are reported in other comprehensive income.

17-35

Both U.S. GAAP and IFRS use the same test to determine whether the
equity method of accounting should be usedthat is, significant
influence with a general guide of over 20 percent ownership.

The basis for consolidation under IFRS is control. Under U.S. GAAP, a
bipolar approach is used, which is a risk-and-reward model (often
referred to as a variable-entity approach) and a voting-interest
approach. However, under both systems, for consolidation to occur, the
investor company must generally own 50 percent of another company.

17-36

U.S. GAAP and IFRS are similar in the accounting for the fair value
option. That is, the option to use the fair value method must be made at
initial recognition, the selection is irrevocable, and gains and losses are
reported as part of income. One difference is that U.S. GAAP permits
the fair value option for equity method investments.

While measurement of impairments is similar, U.S. GAAP does not


permit the reversal of an impairment charge related to available-for-sale
debt and equity investments. IFRS allows reversals of impairments of
held-for-collection investments.

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