INTERMEDIATE ACCOUNTING
TENTH CANADIAN EDITION
Kieso • Weygandt • Warfield • Young • Wiecek • McConomy
CHAPTER 9
Investments
Prepared by:
Dragan Stojanovic, CA
Rotman School of Management,
University of Toronto
CHAPTER 9:
INVESTMENTS
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.
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2
Investments
Understanding
Investments
•Types of investments
•Types of companies
that have investments
•Information for
decision-making
Measurement
•Cost / amortized
cost model
•Fair value through
net income model
•Fair value through
OCI model
•Impairment models
Presentation, IFRS / ASPE
Disclosure,
Comparison
•Investments in and Analysis •Comparison
Strategic
Investments
•Presentation
associates
•Investments in and disclosure
•Analysis
subsidiaries
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•Looking
ahead
3
Type of Investments
• Debt investments include investments in
government debt, corporate bonds,
convertible debt, and commercial paper
• Equity 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 strategy
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Measurement
• Method of accounting for a particular
investment can depend on:
– Type of instrument (debt vs. equity)
– Management’s intent
– Company strategy
– Ability to reliably measure instrument’s fair
value, or
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Accounting Models
• There are three main models of
accounting for investments:
– Cost/amortized cost model
– Fair value through net income model (FV-NI)
– Fair value through other comprehensive
income model (FV-OCI)
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Accounting Models: Summary
Cost/Amortized
Cost Model
At acquisition,
measure at:
FV-NI
FV-OCI
Cost (fair value +
transaction costs)
Fair value
Fair value
At each reporting Cost or amortized
date, measure at: cost
Fair value
Fair value
Unrealized
holding
gains/losses
reported in:
Net income
OCI
Realized holding
gains/losses
reported in:
Not applicable
Net income
income
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Transfer total
realized to net
income (recycling),
or to retained
earnings
7
Cost/Amortized Cost Model:
Investments in Shares
• Cost model for investments in shares of
another entity:
1. Recognize cost of investment at fair value
(plus direct transaction costs)
2. Report at cost (unless impaired)
3. Recognize dividend income when have
claim to dividend
4. When dispose of investment, derecognize
and report a gain/loss on disposal in net
income.
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Cost/Amortized Cost Model:
Investments in Debt Securities
• Amortized cost model for investments in debt
securities of another entity:
1. Recognize cost of investment at fair value (plus
direct transaction costs)
2. Report at amortized cost as well as interest
receivable (unless impaired)
3. Recognize interest income as earned, and also
amortize any discount/premium by adjusting
carrying amount of investment
4. 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.
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9
Amortized Cost Model: Example
Given:
Face amount:
$100,000
Purchase date:
January 1, 2014
Maturity date:
January 1, 2019
Interest paid:
July 1st and January
1st
Coupon (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 $92,278
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Amortized Cost Model: Example
The entry to record this purchase is:
Investment in Bonds
92,278
Cash
92,278
• Note the discount of $7,722 ($100,000 – 92,278) is
not recorded separately; it is amortized over the life
of the bond
• The effective interest method is used to amortize the
premium or discount (required under IFRS)
• ASPE also allows straight-line method of amortizing
premium or discount
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Bond Discount Amortization
Date
Cash
Received
(Dr. Cash)
Interest
Revenue
(Cr. Int.
Revenue)
Bond Discount
Amortization
(Dr. L/T
Investment)
01/01/2014
Amortized
Cost of
Bonds
92,278
01/07/2014
4,000
4614
614
92,892
01/01/2015
4,000
4645
645
93,537
01/07/2015
4,000
4677
677
94,214
01/01/2016
4,000
4711
711
94,925
01/07/2016
4,000
4746
746
95,671
01/01/2017
4,000
4783
783
96,454
01/07/2017
4,000
4823
823
97,277
01/01/2018
4,000
4864
864
98,141
01/07/2018
4,000
4907
907
99,048
01/01/2019
4,000
4952
952
100,000
40,000
47,722
7,722
Cash Received = interest payments of $100,000 x 4%
Interest Revenue =
Carrying amount of bonds x market rate of interest x 6/12 months
Bond Discount = Interest Revenue - Cash Received
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Reporting under Amortized Cost
Model
Balance Sheet
Current assets
Interest receivable (accrued interest
from investment)
$xx,xxx
Long-term investments
Investment, at amortized cost
$xx,xxx
Income Statement
Other revenue and gains
Interest income
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$x,xxx
13
Sale of Investments
• Discount (or premium) is amortized from last
date of amortization to the date of sale
• New carrying amount calculated, which is the
amortized cost balance plus the discount (or
minus the premium) amortized from last date
of amortization
• Gain (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 investment
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Fair Value through Net Income (FVNI) Model
• Fair value through net income (FV-NI) also
referred to as fair value through profit or loss
(FVTPL) in IFRS
• At acquisition, investment recorded at fair value
• Transactions costs are expensed
• At each reporting date, FV-NI investments are
adjusted to current fair value and any holding gain
or loss is reported in net income
• Any earned interest/dividend income and any
holding gain or loss on the investment may be
reported together as “Investment Income”
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FV-NI: An example
•
•
•
•
For non-interest bearing Treasury bill:
Purchase date: March 15
Maturity date: September 15
Pay = $19,231 for $20,000 six-month T-bill (8% yield)
Entry on March 15:
Temporary Investment in T-Bill
Cash
19,231
19,231
Entry on Sept 15:
Cash
Temporary Investment in T-Bill
Investment Income/Loss
20,000
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19,231
769
16
FV-NI: An example
A company reported on December 31, 2015:
• Investments
Carrying Amount
Fair Value
In various shares
$192,990
$191,200
Adjustment to fair value (192,990-191,200= $1,790)
Entry to record adjustment at year end:
Investment Income/Loss
FV-NI Investments
1,790
1,790
2015
Current assets:
FV-NI Investments
$191,200
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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 amount
• At 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’ Equity
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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/AOCI
• Under 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)
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FV-OCI: An Example
Given 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
Shareholders’ Equity
Accumulated other comprehensive income (loss)
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$ 275,000
$ 15,300
20
FV-OCI: An example
On January 23, 2014 sell investment for $287,220
Entry to record adjustment to fair value:
FV-OCI Investments ($287,220 - 275,000)
Unrealized Gain or loss – OCI
Entry to record sale and proceeds:
Cash
FV-OCI Investments
12,220
12,220
287,220
287,220
Entry to transfer holding gains:
Unrealized Gain or loss – OCI (15,300+12,220)
Gain on Sale of Investment
27,520
27,520
OR (if FV-OCI without recycling)
Retained Earnings
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27,520
21
ASPE Classifications
• ASPE generally relies on cost-based
model for equity investments, unless
active market prices are available
• FV-NI model is allowed as an option for
any financial instrument
• Under all models, interest earned and
dividends received are recognized in net
income
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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
dates
• If criteria for amortized cost do not apply, then
FV-NI is used.
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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 acquisition
– Fair value option provides an opportunity to use
FV-NI accounting from acquisition if it corrects an
“accounting mismatch”
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IFRS Classifications
• Reclassification from one category to
another is not allowed, except under very
limited situations
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Impairment
• Investments must be reviewed for possible
impairment to ensure that future benefit
justifies the valuation on the balance sheet
• There are three different impairment
models:
1. Incurred loss model
2. Expected loss model
3. Full fair value model
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Impairment: Incurred Loss Model
• Impairment test carried out only if there is evidence of possible
impairment
• Indicators of possible impairment include:
– Significant financial difficulties
– Defaulting on interest/principal payments
– Major financial reorganization or bankruptcy
• Impairment loss is recognized in net income as difference
between carrying amount and revised present value of expected
cash flows
• Revised present value is calculated using discounted cash flow
(DCF) model (using either historic or current market rate as
discount rate)
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Impairment: Expected Loss Model
• Impairment test carried out continuously
• Impairment loss is recognized in net
income as difference between carrying
amount and revised present value of
expected cash flows
• Revised present value is calculated using
discounted cash flow (DCF) model (using
effective interest rate from time of
acquisition)
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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
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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 model
• IFRS proposals include:
– For instruments at amortized cost: expected loss
model
– For instruments at fair value: always adjust to FV
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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
model
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Strategic Investments
• As common shares carry voting rights,
extent of influence becomes a factor in
determining the appropriate accounting
treatment
• There are three levels of influence, each
with its own accounting treatment:
1. Little or no influence
2. Significant influence
3. Control
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Equity Investments:
Common Shares
%
Ownership
Level of
Influence
0%
Little or
none
Type of
Less than
Investment
significant
influence
20%
50%
Significant
Associate, or
significant
influence
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100%
Control
Subsidiary
33
Investment in Associates: Significant
Influence
•
•
Applies to equity investments of significant
influence (not control)
Significant influence deemed using the following
criteria:
1. Quantitative test: 20% to 50% ownership
2. Qualitative test:
•
•
•
•
•
Representation on Board of Directors
Participation in policy-making
Material intercompany transactions
Exchange of management personnel
Provision of technical information
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Investment in Associates
•
•
Under IFRS, investments in associates (i.e.
“significant influence”) are accounted for using the
equity method of accounting
ASPE, 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)
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Equity Method
• Investment recorded at cost of acquisition
• Investor takes into income its respective
share of the investee net income for the year
by debiting the Investment account and
crediting Investment Income
• Any dividends received are credited to the
Investment account
• The accrual basis of accounting is applied
Consider the following example of Maxi
Limited:
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Equity Method: Example
Given:
• Maxi Corp. purchases 20% of Mini Corp., and exercises
significant influence
• January 2, 2013 Maxi purchases 48,000 shares @ $10 per
share
• For the year 2013 Mini Corp. reports a net income of $200,000
• December 31, 2013 shares of Mini Corp. have a market price of
$12 per share
• January 28, 2014 Mini Corp. declared and paid a total cash
dividend of $100,000
• For the year 2014, Mini Corp. reports a net loss of $50,000
Prepare all necessary journal entries, using the Equity Method
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Equity Method: Example
January 2, 2013
Investment in Mini Corp. 480,000
Cash
480,000
(48,000 shares x $10)
December 31, 2013
Investment 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%)
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Equity Method
• Amounts paid in excess of (or less than) investee’s
book value becomes part of the cost of the
investment
– These amounts must be accounted for appropriately
after the acquisition
– For example, if the difference is due to long-lived
assets with fair values greater than book value, the
difference must be amortized
• Share of discontinued operations and other
comprehensive income of investee are reported in
the same way by the investor (major classifications
of income are retained)
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Equity Method: Impairment
• Investments with significant influence are
assessed at the end of each reporting period to
determine if there are indicators of impairment
• If there are indicators of impairment, the
impairment test is carried out
• Impairment 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 sell
• Impairment losses may be reversed
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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
income
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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 shares
• Control is defined as continuing power to
determine/direct the strategic operating,
financing, and investment policies/activities,
without the co-operation of others
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Investments in Subsidiaries
• Under IFRS, investments for subsidiaries are
accounted for preparation of consolidated financial
statements
– The two corporations are reported as a single
business entity
• Under ASPE, parent company has the
following options when accounting for
subsidiaries:
– Consolidate all subsidiaries
– Account 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)
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Consolidated Financial Statements
Parent Corporation
-Income Statement
-Balance Sheet
Subsidiary Corporation
-Income Statement
-Balance Sheet
Consolidated 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 statements
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Presentation and Disclosure
• For investments without significant influence
or control, key presentation issue is
classification of investment as current vs.
long-term
• Key disclosures include following types of
information:
– Carrying amount of investments
– Income statement effects
– Financial risk
• IFRS generally has more onerous disclosure
requirements than ASPE
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Investments – Recent Changes
• Due to the complexity of accounting for
investments, a number of proposals from
IASB and FASB relating to:
1. Simplification of existing accounting
standards
2. New model for impairments and use of
expected loss approach
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