Chapter 2
Investments In Equity Securities
© 2008 Clarence Byrd Inc.
1
Chapter Objectives
► Classification
of equity
investments
► Accounting
for equity
investments
► Matching
classifications
with methods
© 2008 Clarence Byrd Inc.
2
Conceptual Basis For Classification
Held for
trading
Available
for sale
0%
© 2008 Clarence Byrd Inc.
Significantly
Influenced
companies
Joint
ventures
50%
Subsidiaries
100%
3
Classification
► Non-strategic
investments
 held-for-trading
 available-for-sale
► Strategic
investments
 Subsidiaries
 Significantly influenced companies
 Interests in joint ventures
© 2008 Clarence Byrd Inc.
4
Accounting Methods
► Cost
method
► Equity method
► Fair value method (changes in Net Income)
► Fair value method (changes in
Comprehensive Income)
► Full consolidation
► Proportionate consolidation
© 2008 Clarence Byrd Inc.
5
Held-For-Trading
► Defined
(Section 3855)
 Acquired principally for the
purpose of selling or
repurchasing in the short
term;
 A derivative; or
 Any financial asset or liability
that is so designated
© 2008 Clarence Byrd Inc.
6
Held-For-Trading
► Application
To Investments
 Equity securities held for short
term trading
 Other non-strategic holdings
that are designated as held
for trading
© 2008 Clarence Byrd Inc.
7
Held-For-Trading
► Accounting
Procedures
 Initial and subsequent
measurement at fair value
 Changes in fair value are
allocated to Net Income
 Transaction costs charged to
Net Income at acquisition
© 2008 Clarence Byrd Inc.
8
Held-For-Trading Example
EXAMPLE: On January 1, 2008, Holly Inc. acquires 1,000
shares of Helm Ltd. for $10 per share. The shares are
classified as held for trading.
On December 31, 2008, the Helm Ltd. shares are trading at
$12 per share. During 2008, Helm Ltd. declares and pays
dividends of $0.75 per share. On January 1, 2009, the
securities are sold for $13 per share.
© 2008 Clarence Byrd Inc.
9
Held-For-Trading Example
► Acquisition
Of Investment
January 1, 2008
Investments [(1,000)($10.00)]
Cash
© 2008 Clarence Byrd Inc.
Debit
Credit
$10,000
$10,000
10
Held-For-Trading Example
► Receipt
Of Dividends
During 2008
Cash [(1,000)($0.75)]
Investment Income (Net Income)
© 2008 Clarence Byrd Inc.
Debit
Credit
$750
$750
11
Held-For-Trading Example
► Year
End Adjustment
December 31, 2008
Investments [(1,000)($12.00 - $10.00)]
Investment Income (Net Income)
© 2008 Clarence Byrd Inc.
Debit
Credit
$2,000
$2,000
12
Held-For-Trading Example
► Sale
Of Investment
January 1, 2009
Cash [(1,000)($13.00)]
Debit
Credit
$13,000
Investments ($10,000 + $2,000)
$12,000
Investment Income (Net Income)
$1,000
© 2008 Clarence Byrd Inc.
13
Available-For-Sale
► Defined
(Section 3855)
 Non-derivative financial assets
that are designated as
available for sale, or that are
not classified as loans and
receivables, held-to-maturity,
or held-for trading
© 2008 Clarence Byrd Inc.
14
Available-For-Sale
► Would
include all equity
investments other than:
 Investments in subsidiaries
 Investments in significantly
influenced companies
 Investments in joint ventures
 Investments that are
classified as held for trading.
© 2008 Clarence Byrd Inc.
15
Available-For-Sale
► Accounting
Procedures
 Initial and subsequent
measurement at fair value
 Changes in fair value are allocated
to Comprehensive Income
 Transaction costs:
► charged
to Net Income at acquisition,
or added to the initial cost
© 2008 Clarence Byrd Inc.
16
Available-For-Sale Example
EXAMPLE: On January 1, 2008, Holly Inc. acquires 1,000
shares of Helm Ltd. for $10 per share. The shares are
classified as available for sale.
On December 31, 2008, the Helm Ltd. shares are trading at
$12 per share. During 2008, Helm Ltd. declares and pays
dividends of $0.75 per share. On January 1, 2009, the
securities are sold for $13 per share.
© 2008 Clarence Byrd Inc.
17
Available For Sale Example
► Acquisition
Of Investment
January 1, 2008
Investments [(1,000)($10.00)]
Cash
© 2008 Clarence Byrd Inc.
Debit
Credit
$100,000
$100,000
18
Available For Sale Example
► Receipt
Of Dividends
During 2008
Cash [(1,000)($0.75)]
Investment Income (Net Income)
© 2008 Clarence Byrd Inc.
Debit
Credit
$750
$750
19
Available For Sale Example
► Year
End Adjustment
December 31, 2008
Investments [(1,000)($12.00 - $10.00)]
Other Comprehensive Income - Gain
© 2008 Clarence Byrd Inc.
Debit
Credit
$2,000
$2,000
20
Available For Sale Example
► Sale
Of Investment
January 1, 2009
Cash [(1,000)($13.00)]
Other Comprehensive Income – Reclassification
Investments ($10,000 + $2,000)
Investment Income (Net Income)
© 2008 Clarence Byrd Inc.
Debit
Credit
$13,000
2,000
$12,000
3,000
21
Cost Method
► Applicability
 Can be used when
available-for-sale
securities do not have
quoted market prices
► Procedures
 Investment at cost
 Earnings only when
received or receivable
© 2008 Clarence Byrd Inc.
22
Cost Method
► Return
of capital: Occurs when dividends
received exceed the investor’s share of
earnings since acquisition
© 2008 Clarence Byrd Inc.
23
Return Of Capital Example
EXAMPLE: On January 1, 2008, Norton Inc. acquires 10
percent of the voting shares of Montage Ltd. for $500,000.
During 2008, Montage has Net Income of $350,000 and pays
dividends of $250,000.
During 2009, Montage has Net Income of $100,000 and pays
dividends of $250,000.
© 2008 Clarence Byrd Inc.
24
Return Of Capital Example
► Acquisition
Of Investment
January 1, 2008
Investment In Montage
Cash
© 2008 Clarence Byrd Inc.
Debit
Credit
$500,000
$500,000
25
Return Of Capital Example
► Receipt
of 2008 dividends
During 2008
Cash [(10%)($250,000)]
Investment Income
© 2008 Clarence Byrd Inc.
Debit
Credit
$25,000
$20,000
26
Return Of Capital Example
► Receipt
of 2009 dividends
During 2009
Cash [(10%)($250,000)]
Investment Income
[(10%)($350,000 - $250,000 + $100,000)]
Investment In Montage
[(10%)($250,000 - $100,000 - $100,000)]
© 2008 Clarence Byrd Inc.
Debit
Credit
$25,000
$20,000
5,000
27
Subsidiaries
► Paragraph
1590.03(b) – A
subsidiary is an enterprise
controlled by another enterprise
(the parent) that has the right
and ability to obtain future
economic benefits from the
resources of the enterprise and is
exposed to the related risks.
© 2008 Clarence Byrd Inc.
28
The Concept Of Control
1590.03(b) Control of an
enterprise is the continuing power to
determine its strategic operating,
investing, and financing policies
without the co-operation of others.
© 2008 Clarence Byrd Inc.
29
The Concept Of Control
► In
general, based on ownership of more
than 50 percent of the outstanding voting
shares
► Exceptions
 Control may exist without majority ownership
 Control may not exist even with majority
ownership
© 2008 Clarence Byrd Inc.
30
The Concept Of Control
60%
P
© 2008 Clarence Byrd Inc.
55%
A
B
31
The Concept Of Control
70%
P
X
60%
30%
40%
Y
© 2008 Clarence Byrd Inc.
Z
32
Subsidiaries
► Accounting
Procedures
 Paragraph 1590.16 An enterprise should
consolidate all of its subsidiaries. (January,
1992)
 Consolidation procedures will be covered in
Chapters 4, 5, and 6
© 2008 Clarence Byrd Inc.
33
Significantly Influenced Companies
► Defined
 IAS 28 Significant influence is the power to
participate in the financial and operating policy
decisions of the investee, but is not control over
those policies
 CICA has a 20 percent guideline
 Judgment would have been better
 Key is the ability to elect directors
© 2008 Clarence Byrd Inc.
34
Significantly Influenced Companies
► Required
Accounting Procedures:
Section 3051 requires the use of the
equity method
© 2008 Clarence Byrd Inc.
35
Equity Method Procedures
► Accounting
for the investment asset
 Investment is recorded at cost
 Adjusted each year for the investor’s shares of
the investee’s change in Retained Earnings
© 2008 Clarence Byrd Inc.
36
Equity Method Procedures
► Accounting
for investment income
Investment income is equal to
the Investor’s share
of the reported Net Income
of the Investee.
© 2008 Clarence Byrd Inc.
37
Equity Method Example
EXAMPLE: On January 1, 2008, Fortin Inc. pays $800,000 for
a 25 percent interest in the voting shares of Beauchamp Ltd.
This investment gives Fortin Inc. significant influence over
Beauchamp Ltd.
During the year ending December 31, 2008, Beauchamp Ltd.
has net income of $300,000 and pays dividends of $180,000.
During the year ending December 31, 2009, Beauchamp Ltd.
has a net loss of $100,000 and pays dividends of $150,000.
On January 1, 2010, Fortin’s holding of Beauchamp securities
is sold for $1,200,000.
© 2008 Clarence Byrd Inc.
38
Equity Method Example
► Acquisition
Of Investment
January 1, 2008
Investment In Beauchamp
Cash
© 2008 Clarence Byrd Inc.
Debit
Credit
$800,000
$800,000
39
Equity Method Example
► 2008
Income And Dividends
Year Ending December 31, 2008
Cash [(25%)($180,000)
Investment In Beauchamp
[(25%)($300,000 - $180,000)]
Investment Income [(25%)($300,000)]
© 2008 Clarence Byrd Inc.
Debit
Credit
$45,000
30,000
$75,000
40
Equity Method Example
► 2009
Income And Dividends
Year Ending December 31, 2009
Cash [(25%)($150,000)]
Investment Loss [(25%)($100,000)]
Investment In Beauchamp
[(25%)(- $100,000 – $150,000)]
© 2008 Clarence Byrd Inc.
Debit
Credit
$37,500
25,000
$62,500
41
Equity Method Example
► Sale
Of Investment
January 1, 2010
Cash
Debit
Credit
$1,200,000
Investment In Beauchamp
($800,000 + $30,000 - $62,500)
Gain On Investment Sale
© 2008 Clarence Byrd Inc.
$767,500
432,500
42
Equity Method
►
© 2008 Clarence Byrd Inc.
Results of discontinued
operations and
extraordinary items of the
investee must be shown in
the investor’s Statement
Of Net Income as separate
line items after Income Or
Loss Before Discontinued
Operations And
Extraordinary Items.
43
Equity Method
► EIC
No.8: negative
balance can be shown if:
 Investor has guaranteed
obligations of the investee
 The investor is committed
to provide further financial
support
 The investee seems
assured of returning to
profitability
© 2008 Clarence Byrd Inc.
44
Equity Method
► Significant
Influence To Control
 Consolidation is required
© 2008 Clarence Byrd Inc.
45
Equity Method
► Significant
Influence To No Influence
 Will become held-for-trading or available-for-sale
 The “new cost” will be the equity value at the time
of the change
© 2008 Clarence Byrd Inc.
46
Equity Method
► Consolidation
Adjustments
 All of the adjustments that would be required in
preparing consolidated statements are required
here.
 See Chapters 5 and 6 for illustrations of these
procedures.
© 2008 Clarence Byrd Inc.
47
Significantly Influenced Companies
► Disclosure
 Basis of valuation
 Separate disclosure of the class
in both the Balance Sheet and
the Income Statement
 Treatment of the difference
between the cost of the
investment and the underlying
book value of the investee’s
assets at the date of
acquisition.
© 2008 Clarence Byrd Inc.
48
Joint Venture Arrangements
► Paragraph
3055.03(c)
A joint venture is an
economic activity
resulting from a
contractual arrangement
whereby two or more
venturers jointly control
the economic activity
© 2008 Clarence Byrd Inc.
49
Joint Venture Arrangements
►
Current accounting rules
require the use of
proportionate consolidation
►
Proportionate consolidation
will be covered in Chapter 8
►
IASB will eliminate
proportionate consolidation
and require the equity method
© 2008 Clarence Byrd Inc.
50
Impairment Of
Significantly Influenced Companies
►
Paragraph 3051.18
When there has been a
loss in value of an
investment that is other
than a temporary decline,
the investment should be
written down to recognize
the loss. The write-down
should be included in the
determination of net
income and may or may
not be an extraordinary
item.
© 2008 Clarence Byrd Inc.
51
Impairment Of
Significantly Influenced Companies
► Indicators
Depressed market prices
Severe or continued losses
Suspension of trading
Liquidity or going concern
problem
 Current fair value less than
carrying value




© 2008 Clarence Byrd Inc.
52
Impairment Of
Significantly Influenced Companies
► Subsequent
recoveries
 Write downs cannot be reversed
© 2008 Clarence Byrd Inc.
53
Impairment – Other Investments
► Held
for trading
Already at fair value
► Available
for sale at fair value
► Available
for sale at cost
If impaired, transfer from comprehensive to net income
Same rules as significantly influenced companies
► Subsidiaries
and Joint Ventures
Subject to provisions that relate to specific assets
(e.g., 3063 deals with impairment of plant)
© 2008 Clarence Byrd Inc.
54
Differential Reporting Options
► Subsidiaries
 Qualifying enterprises may elect
to use either the cost method or
the equity method for these
investees
► Additional
procedures and
disclosures are required
© 2008 Clarence Byrd Inc.
55
Differential Reporting Options
► Significantly
Influenced Companies
 Qualifying enterprises may elect to use the cost
method for these investees
► Additional
required
© 2008 Clarence Byrd Inc.
procedures and disclosures are
56
Differential Reporting Options
► Joint
Ventures
 Qualifying enterprises may elect to use either the
cost method or the equity method for these
investees
► Additional
required
© 2008 Clarence Byrd Inc.
procedures and disclosures are
57
International Convergence
► Held-for-trading
and
available-for-sale
investments: covered
in IAS 39
© 2008 Clarence Byrd Inc.
58
IAS 39 Differences
► “Held-for-trading”
replaced by “financial asset at
fair value through profit or loss”
► Generally doesn’t allow arbitrary designation as
held for trading
► Allows cost when fair value “not readily
determinable” as opposed to no quoted market
value
► Does not provide an optional treatment of
transaction costs
► Requires the reversal of impairment write downs
when there is a recovery
© 2008 Clarence Byrd Inc.
59
International Convergence
► Significantly
influenced
companies: covered in
IAS 28
© 2008 Clarence Byrd Inc.
60
IAS 28 Differences
► Uses
the term “associated companies” rather than
“significantly influenced companies”
► Impairment
when recoverable amount is less than
the carrying amount. Recoverable amount based
on present value of future cash flows
► IAS
28 requires the reversal of an impairment loss
when a recovery has occurred
© 2008 Clarence Byrd Inc.
61
International Convergence
► Subsidiaries
and joint
ventures – Differences
will be covered in later
chapters
© 2008 Clarence Byrd Inc.
62
© 2008 Clarence Byrd Inc.
63