Chapter 12
Investments
Copyright © 2015 McGraw-Hill Education. All rights reserved.
Investments
Financial instruments:
Equity securities
• Common stock
• Preferred stock
Debt securities
• Bonds
• Notes
• Purchased by individual investors, mutual funds, and
corporations
• Objective:
• To earn a return from the dividends or interest the
securities pay or from increases in the market prices
of the securities
• To develop ongoing affiliations with the companies
whose securities are acquired
Illustration: Reporting Categories for Investments
LO12-1
Investor Lacks Significant Influence
Purchasing the investment
Critical Events
that an
Investor
Experiences in
the Life of an
Investment
Recognizing investment revenue
• For debt: Interest
• For equity: Dividends
Holding the investment during periods
in which the investment’s fair value
changes
• Unrealized holding gains and losses
Selling the investment
Illustration: Accounting for Unrealized Holding
Gains and Losses When the Investor Lacks
Significant Influence
LO12-1
Key difference among the reporting approaches is how we
account for unrealized holding gains and losses
LO12-1
Illustration: Disclosure about Investments—
Bank of America
LO12-1
Securities to Be Held to Maturity (HTM)
• Investor has the “positive intent and ability” to hold
the securities to maturity
Securities
mature
Maturity date
Also called the
face amount
Principal
Paid to investors
Interest paid
to investors
Interest dates
LO12-1
HTM Investments: Premiums and Discounts
• Fair value of a bond changes when market interest
rates change
• Market value of a fixed-rate investment moves in
the opposite direction of market rates of interest
Interest rate
> Market rate
(stated rate)
sold at
Premium
Interest rate
(stated rate)
sold at
Discount
Market rate
>
Illustration: Bonds Purchased at a Discount (HTM)
LO12-1
On July 1, 2016, Masterwear Industries issued $700,000 of 12% bonds,
dated July 1. Interest of $42,000 is payable semiannually on June 30 and
December 31. The bonds mature in three years, on June 30, 2019. The
market interest rate for bonds of similar risk and maturity is 14%. The
entire bond issue was purchased by United Intergroup, Inc.
Calculation of the Price of the Bonds
Interest
$ 42,000 × 4.76654 = $200,195
Principal (face amount)
$700,000 × 0.66634 =
$666,633
Present value (price) of the bonds
Present value of $1 table:
n = 6, i = 7%
466,438
Present value of an ordinary annuity
of $1 table: n = 6, i = 7%
Journal Entry – July 1, 2016
Debit
Investment in Bonds
Discount on bond investment
Cash
700,000
Credit
33,367
666,633
Concept Check √
Chan Inc. purchased bonds for $800,000 that have a maturity value of
$900,000. Chan’s journal entry to record the purchase would include a:
a. Debit of $100,000 to Discount on bond investment.
b. Credit of $100,000 to Discount on bond investment.
c. Debit of $100,000 to Premium on bond investment.
d. Credit of $100,000 to Premium on bond investment.
Bond investment
900,000
Cash
Discount on bond investment
800,000
100,000
LO12-1
Bonds Purchased at a Discount (HTM)
(Illustration continued)
On July 1, 2016, Masterwear Industries issued $700,000 of 12% bonds,
dated July 1. Interest of $42,000 is payable semiannually on June 30 and
December 31. The bonds mature in three years, on June 30, 2019. The
market interest rate for bonds of similar risk and maturity is 14%. The
entire bond issue was purchased by United Intergroup, Inc.
Calculation of the Price of the Bonds
Interest
$ 42,000 × 4.76654 = $200,195
Principal (face amount)
$700,000 × 0.66634 =
$666,633
Present value (price) of the bonds
$666,633
Outstanding balance
×
[14% ÷ 2]
Effective rate
Journal Entry – December 31, 2016
Cash
Discount on bond investment
Investment revenue
466,438
=
$46,664
Effective interest
Debit
Credit
42,000
4,664
46,664
Concept Check √
Chan Inc. purchased bonds for $800,000 that have a maturity value of
$900,000. Which of the following is true about the first semi-annual
interest payment that Chan receives:
a. Chan will record interest revenue that is greater than cash received.
b. Chan will record interest revenue that is equal to cash received.
c. Chan will record interest revenue that is less than cash received.
d. Chan will not record interest revenue.
Chan will record interest revenue that is greater than cash received. It
paid less for the bond than its maturity value, so it must have done so
to achieve an effective interest rate that is greater than the stated rate
on the bond. The journal entry will have the form:
Cash
xx
Discount on bond investment
yy
Interest revenue
zz
with zz > xx.
Illustration: Amortization Schedule—Discount
LO12-1
On July 1, 2016, Masterwear Industries issued $700,000 of 12% bonds,
dated July 1. Interest of $42,000 is payable semiannually on June 30 and
December 31. The bonds mature in three years, on June 30, 2019. The
market interest rate for bonds of similar risk and maturity is 14%. The
entire bond issue was purchased by United Intergroup, Inc.
$700,000 × 6%
Date
Cash
Interest
$46,664 - $42,000
Effective
Interest
7/1/2016
12/31/2016
6/30/2017
$666,633 + $4,664
Increase in Outstanding
Balance
Balance
$666,633
$ 42,000 .07 (666,633) = $ 46,664
42,000 .07 (671,297) = 46,991
$ 4,664
4,991
671,297
676,288
12/31/2017
42,000 .07 (676,288) =
47,340
5,340
681,628
6/30/2018
12/31/2018
6/30/2019
42,000 .07 (681,628) =
42,000 .07 (687,342) =
42,000 .07 (693,456) =
47,714
48,114
48,544
5,714
6,114
6,544
687,342
693,456
700,000
$285,367
$33,367
$252,000
LO12-1
For HTM Investments, Do Not Recognize
Unrealized Holding Gains and Losses
Example:
The Wall Street Journal indicates that the fair value of
the Masterwear bonds on 12/31/2016 is $714,943. How
will United account for this increase in fair value?
• If viewed as an HTM investment:
• The change in fair value will be ignored so long as it is
viewed as temporary
• The investment simply will be recorded at amortized cost
• United will disclose the fair value of its HTM investments
in a note to the financial statements
• It will not recognize any fair value changes in the income
statement or balance sheet
LO12-1
Sell HTM Investments
(Illustration continued)
On July 1, 2016, Masterwear Industries issued $700,000 of 12% bonds,
dated July 1. Interest of $42,000 is payable semiannually on June 30 and
December 31. The bonds mature in three years, on June 30, 2019. The
market interest rate for bonds of similar risk and maturity is 14%. The
entire bond issue was purchased by United Intergroup, Inc.
Due to unforeseen circumstances the company decided to sell its debt
investment for $725,000 on January 15, 2017
Journal Entry – January 15, 2017
Debit
Cash
Discount on bond investment
Investment in Masterwear bonds
Gain on sale of investments
725,000
28,703
($33,367 − $4,664)
Credit
700,000
53,703
Concept Check √
Williams has a HTM investment in bonds with a maturity value of $900,000
and a carrying value of $825,000. Due to unexpected cash flow needs,
Williams sold the bonds for $800,000. Williams’ journal entry to record the
sale would include a:
a. Credit to cash for $800,000.
b. Credit to discount on bond investment for $75,000.
c. Credit to gain for $25,000.
d. Debit to loss for $25,000.
Williams will record the following entry:
Cash
Loss (to balance)
Discount on bond investment
Bond investment
800,000
25,000
75,000
900,000
LO12-2
Trading Securities (TS)
• Investments in debt or equity securities acquired
principally for the purpose of selling them in the
near term
• Active buying and selling of securities
• Holding period generally is measured in hours and days
rather than months or years
• Typically reported among the investor’s current assets
• Fair value information is more relevant, so
• Carried at fair value on the balance sheet, and
• Unrealized holding gains and losses are included in net
income in the period in which fair value changes
Illustration: Purchase Investments (TS)
LO12-2
United Intergroup, Inc., buys and sells both debt and equity
securities of other companies as investments. United’s fiscal yearend is December 31. The following events during 2016 and 2017
pertain to the investment portfolio.
Purchase • Purchased Masterwear Industries’ 12%, 3-year bonds
Investments for $666,633 to yield an effective interest rate of 14%.
July 1, 2016 • Purchased $1,500,000 of Arjent, Inc., common stock.
• Purchased $1,000,000 of Bendac common stock.
Journal Entry – July 1, 2016
Investment in Masterwear bonds
Discount on bond investment
Cash
Investment in Arjent stock
Cash
Investment in Bendac stock
Cash
Debit
Credit
700,000
33,367
666,633
1,500,000
1,500,000
1,000,000
1,000,000
LO12-2
Recognize Investment Revenue (TS)
(Illustration continued)
United Intergroup, Inc., buys and sells both debt and equity
securities of other companies as investments. United’s fiscal yearend is December 31. The following events during 2016 and 2017
pertain to the investment portfolio.
Receive Investment • Received a semi-annual cash interest
payment of $42,000 from Masterwear.
Revenue
December 31, 2016 • Received a cash dividend of $75,000 from
Arjent. (Bendac does not pay dividends)
$666,633 × (14% ÷ 2)
Journal Entry – December 31, 2016
Cash (6% × $700,000)
Discount on bond investment (difference)
Investment revenue
Cash
Investment revenue
Debit
Credit
42,000
4,664
46,664
75,000
75,000
Adjust TS Investments to Fair Value (2016)
LO12-2
(Illustration continued)
United Intergroup, Inc., buys and sells both debt and equity
securities of other companies as investments. United’s fiscal yearend is December 31. The following events during 2016 and 2017
pertain to the investment portfolio.
Adjust Investments • Valued the Masterwear bonds at $714,943.
to Fair Value
• Valued the Arjent stock at $1,450,000.
December 31, 2016 • Valued the Bendac stock at $990,000.
December 31, 2016
Amortized
Fair Value
Security
Fair Value
Cost
Adjustment
Masterwear
$ 671,297
$ 714,943
$ 43,646
1,500,000
(50,000)
Arjent
1,450,000
Bendac
1,000,000
990,000
(10,000)
Total
$3,171,297
$3,154,943
$(16,354)
Existing balance in fair value adjustment:
–0–
Increase (decrease) needed in fair value adjustment: $(16,354)
Adjust TS Investments to Fair Value (2016)
LO12-2
(Illustration continued)
United Intergroup, Inc., buys and sells both debt and equity
securities of other companies as investments. United’s fiscal yearend is December 31. The following events during 2016 and 2017
pertain to the investment portfolio.
Adjust Investments • Valued the Masterwear bonds at $714,943.
to Fair Value
• Valued the Arjent stock at $1,450,000.
December 31, 2016 • Valued the Bendac stock at $990,000.
Face amount of the bond
Less: Discount on bond investment
$33,367 initial discount
(4,664) accumulated amortization
$28,703 discount at 12/31/2016
$700,000
Amortized cost of the bonds
+/- Fair value adjustment (plug)
Fair value of the bond at 12/31/2016
671,297
+ 43,646
$714,943
(28,703)
Adjust TS Investments to Fair Value (2016)
LO12-2
(Illustration continued)
United Intergroup, Inc., buys and sells both debt and equity
securities of other companies as investments. United’s fiscal yearend is December 31. The following events during 2016 and 2017
pertain to the investment portfolio.
Adjust Investments • Valued the Masterwear bonds at $714,943.
to Fair Value
• Valued the Arjent stock at $1,450,000.
December 31, 2016 • Valued the Bendac stock at $990,000.
Fair Value Adjustment
0
16,354
16,354
Journal Entry – December 31, 2016
Debit
Net unrealized holding gains and losses—I/S
Fair value adjustment
16,354
Credit
16,354
LO12-2
Sell TS Investments
(Illustration continued)
United Intergroup, Inc., buys and sells both debt and equity
securities of other companies as investments. United’s fiscal yearend is December 31. The following events during 2016 and 2017
pertain to the investment portfolio.
Sell Investments
• Sold the Masterwear bonds for $725,000.
January 15, 2017
• Sold the Arjent stock for $1,446,000.
Journal Entry – January 15, 2017
Cash
Discount on bond investment
Investment in Masterwear bonds
Gain on sale of investments
Cash
Loss on sale of investments
Investment in Arjent stock
Debit
Credit
725,000
28,703
700,000
53,703
1,446,000
54,000
($33,367 - $4,664)
1,500,000
Adjust TS Investments to Fair Value (2017)
LO12-2
(Illustration continued)
United Intergroup, Inc., buys and sells both debt and equity
securities of other companies as investments. United’s fiscal yearend is December 31. The following events during 2016 and 2017
pertain to the investment portfolio.
• Valued the Bendac stock at
Adjust Remaining
$985,000.
Investments to Fair Value
December 31, 2017
December 31, 2017
Amortized
Fair Value
Security
Fair Value
Cost
Adjustment
Masterwear
(sold)
–0–
–0–
Arjent
(sold)
–0–
–0–
Bendac
$1,000,000
$985,000
($15,000)
$1,000,000
$985,000
($15,000)
Total
Existing balance in fair value adjustment: ($16,354)
Increase (decrease) needed in fair value adjustment: $ 1,354
Adjust TS Investments to Fair Value (2017)
LO12-2
(Illustration continued)
United Intergroup, Inc., buys and sells both debt and equity
securities of other companies as investments. United’s fiscal yearend is December 31. The following events during 2016 and 2017
pertain to the investment portfolio.
• Valued the Bendac stock at
Adjust Remaining
$985,000.
Investments to Fair Value
December 31, 2017
Fair Value Adjustment
16,354
1,354
15,000
Journal Entry – December 31, 2017
Debit
Fair value adjustment
1,354
Net unrealized holding gains and losses—I/S
Credit
1,354
Concept Check √
The Bali Company has trading securities that cost $200,000. At the
beginning of 2016 those securities had a fair value of $220,000, and at the
end of 2016 they had a fair value of $190,000. Bali’s journal entry to record
unrealized gains and losses for 2016 would include a:
a. Debit to Fair value adjustment for $30,000.
b. Credit to Fair value adjustment for $30,000.
c. Credit to Fair value adjustment for $10,000.
d. Debit to Fair value adjustment for $10,000.
Bali’s fair value adjustment needs to change from a debit of $20,000 to a
credit of $10,000. Therefore, it will record the following entry:
Net unrealized holding gains and losses—I/S
$30,000
Fair value adjustment
30,000
LO12-2
Financial Statement Presentation: TS
• Income Statement and Statement of Comprehensive
Income:
• Fair value changes affect net income in the period in
which they occur
• Do not affect other comprehensive income (OCI)
• Balance Sheet:
• Reported at fair value
• Do not affect accumulated other comprehensive income
(AOCI)
• Cash Flow Statement:
• Cash flows from buying and selling trading securities are
classified as operating activities
LO12-2
Illustration: Reporting Trading Securities
LO12-3
Securities Available-for-Sale (AFS)
• Investment that is acquired by a company neither
for an active trading account nor to be held to
maturity (so AFS defined as not HTM or TS)
• Reported in the balance sheet at fair value
• Unrealized holding gains and losses on AFS
securities:
• are not included in net income
• are included in other comprehensive income (OCI)
• Realized gains and losses are included in net
income (so have to be backed out of OCI in the
period the investment is sold)
LO12-3
Rationale for AFS Treatment of Unrealized
Holding Gains and Losses
Why use an approach for accounting for AFS securities
that differs from that used for trading securities?
Including unrealized holding gains and losses on AFS
investments in net income might make income
appear more volatile than actually is the case.
Many companies purchase AFS investments:
• as long term investments, so fluctuations in their fair value aren’t that
informative about current operations.
• to hedge liabilities, so changes in fair value of investments offset changes
in the fair value of liabilities. Hedging insulates the company from risk,
but can make earnings appear volatile if changes in the fair value of the
investment are included in earnings but changes in the fair value of the
liability are not.
Illustration: Purchase Available-for-Sale Investments
LO12-3
United Intergroup, Inc., buys and sells both debt and equity
securities of other companies as investments. United’s fiscal yearend is December 31. The following events during 2016 and 2017
pertain to the investment portfolio.
• Purchase Masterwear Industries’ 12%, 3-year bonds
Purchase
Investments for $666,633 to yield an effective interest rate of
14%.
July 1, 2016
• Purchased $1,500,000 of Arjent, Inc., common stock.
• Purchased $1,000,000 of Bendac common stock.
Journal Entry – July 1, 2016
Investment in Masterwear bonds
Discount on bond investment
Cash
Investment in Arjent stock
Cash
Investment in Bendac stock
Cash
Debit
Credit
700,000
33,367
666,633
1,500,000
1,500,000
1,000,000
1,000,000
LO12-3
Recognize Investment Revenue
United Intergroup, Inc., buys and sells both debt and equity
securities of other companies as investments. United’s fiscal yearend is December 31. The following events during 2016 and 2017
pertain to the investment portfolio.
Receive Investment • Received a semi-annual cash interest
payment of $42,000 from Masterwear.
Revenue
December 31, 2016 • Received a cash dividend of $75,000 from
Arjent. (Bendac does not pay dividends)
Journal Entry – December 31, 2016
Cash
Discount on bond investment
Investment revenue
Cash
Investment revenue
Debit
Credit
42,000
4,664
46,664
75,000
75,000
Adjust AFS Investments to Fair Value (2016)
LO12-3
United Intergroup, Inc., buys and sells both debt and equity
securities of other companies as investments. United’s fiscal yearend is December 31. The following events during 2016 and 2017
pertain to the investment portfolio.
Adjust Investments • Valued the Masterwear bonds at 714,943.
to Fair Value
• Valued the Arjent stock at $1,450,000.
December 31, 2016 • Valued the Bendac stock at $990,000.
December 31, 2016
Amortized
Fair Value
Security
Fair Value
Cost
Adjustment
Masterwear
$ 671,297
$ 714,943
$ 43,646
Arjent
1,500,000
1,450,000
(50,000)
Bendac
1,000,000
990,000
(10,000)
Total
$3,171,297
$3,154,943
$(16,354)
Existing balance in fair value adjustment:
–0–
Increase (decrease) needed in fair value adjustment: $(16,354)
LO12-3
Adjust AFS Investments to Fair Value (2016) (Continued)
United Intergroup, Inc., buys and sells both debt and equity
securities of other companies as investments. United’s fiscal yearend is December 31. The following events during 2016 and 2017
pertain to the investment portfolio.
Adjust Investments • Valued the Masterwear bonds at $714,943.
to Fair Value
• Valued the Arjent stock at $1,450,000.
December 31, 2016 • Valued the Bendac stock at $990,000.
Fair Value Adjustment
0
16,354
16,354
Journal Entry – December 31, 2016
Net unrealized holding gains and losses—OCI
Fair value adjustment
Debit Credit
16,354
16,354
LO12-3
Sell AFS Investments
United Intergroup, Inc., buys and sells both debt and equity
securities of other companies as investments. United’s fiscal yearend is December 31. The following events during 2016 and 2017
pertain to the investment portfolio.
Sell Investments
• Sold the Masterwear bonds for $725,000.
January 15, 2017
• Sold the Arjent stock for $1,446,000.
Journal Entry – January 15, 2017
Cash
Discount on bond investment
Investment in Masterwear bonds
Gain on sale of investments
Cash
Loss on sale of investments
Investment in Arjent stock
Debit
Credit
725,000
28,703
700,000
53,703
1,446,000
54,000
1,500,000
Adjust AFS Investments to Fair Value (2017)
LO12-3
United Intergroup, Inc., buys and sells both debt and equity
securities of other companies as investments. United’s fiscal yearend is December 31. The following events during 2016 and 2017
pertain to the investment portfolio.
• Valued the Bendac stock at
Adjust Remaining
$985,000.
Investments to Fair Value
December 31, 2017
December 31, 2017
Amortized
Fair Value
Security
Fair Value
Cost
Adjustment
Masterwear
(sold)
–0–
–0–
Arjent
(sold)
–0–
–0–
Bendac
$1,000,000
$985,000
($15,000)
$1,000,000
$985,000
($15,000)
Total
Existing balance in fair value adjustment: ($16,354)
Increase (decrease) needed in fair value adjustment: $ 1,354
LO12-3
Adjust AFS Investments to Fair Value (2017) (Continued)
United Intergroup, Inc., buys and sells both debt and equity
securities of other companies as investments. United’s fiscal yearend is December 31. The following events during 2016 and 2017
pertain to the investment portfolio.
• Valued the Bendac stock at
Adjust Remaining
$985,000.
Investments to Fair Value
December 31, 2017
Fair Value Adjustment
16,354
1,354
15,000
Journal Entry – December 31, 2017
Debit Credit
Fair value adjustment
1,354
Net unrealized holding gains and losses—OCI
1,354
Concept Check √
Singapore Associates has AFS securities that cost $100,000. At the
beginning of 2016 those securities had a fair value of $88,000, and at the
end of 2016 they had a fair value of $110,000. Singapore’s journal entry to
record unrealized gains and losses for 2016 would include a:
a. Debit to Net unrealized holding gains and losses—OCI for $12,000.
b. Credit to Net unrealized holding gains and losses—OCI for $22,000.
c. Credit to Net unrealized holding gains and losses—OCI for $10,000.
d. Debit to Net unrealized holding gains and losses—OCI for $22,000.
Bali’s fair value adjustment needs to change from a debit of $20,000 to a
credit of $10,000. Therefore, it will record the following entry:
Fair value adjustment
22,000
Net unrealized holding gains and losses—OCI
$22,000
LO12-3
Adjust AFS Investments to Fair Value (2017) (Continued)
($5,000) to add 2017 unrealized loss associated with investments not sold
6,354 to remove 2016 net unrealized loss that’s no longer unrealized
$1,354 2017 adjustment to OCI
New changes in the fair value of investments held
$1,000,000
(985,000)
$ 15,000
(10,000)
$
5,000
initial cost of Bendac stock
fair value at the end of 2017
balance needed at end of 2017
balance at end of 2016
new unrealized loss in 2017
Journal Entry – December 31, 2017
Net unrealized holding gains and losses-OCI
Fair value adjustment
Debit
Credit
5,000
5,000
LO12-3
Adjust AFS Investments to Fair Value (2017) (Continued)
($5,000) to add 2017 unrealized loss associated with investments not sold
6,354 to remove 2016 net unrealized loss that’s no longer unrealized
$1,354 2017 adjustment to OCI
Reclassification adjustment
$50,000
2016 unrealized loss for the Arjent stock
43,646
2016 unrealized gain for the Masterwear bonds
$6,354
net unrealized loss in 2016
• If only the net unrealized loss on the Arjent and Masterwear
investments is included:
• Entry at the end of 2016
Journal Entry – December 31, 2016
Net unrealized holding gains and losses-OCI
Fair value adjustment
Debit
Credit
6,354
6,354
LO12-3
Adjust AFS Investments to Fair Value (2017) (Continued)
Reclassification adjustment: reverses previously recorded
unrealized gain or loss:
• Entry at the end of 2017
Journal Entry – December 31, 2017
Fair value adjustment
Net unrealized holding gains and losses-OCI
The 2017 FV adjustment
combines the two parts:
Debit
Credit
6,354
6,354
$6,354 − 5,000
Journal Entry – December 31, 2017
Fair value adjustment
Net unrealized holding gains and losses-OCI
Debit
Credit
1,354
1,354
LO12-3
Financial Statement Presentation
• Income Statement and Statement of Comprehensive
Income:
• Realized gains and losses are shown in net income in the
period in which securities are sold
• Unrealized gains and losses are shown in OCI in the
periods in which changes in fair value occur
• Reclassified out of OCI in the periods in which securities are sold
• Balance Sheet:
• Investments are reported at fair value
• Unrealized gains and losses affect AOCI in shareholders’
equity
• Reclassified out of AOCI in the periods in which securities are
sold
LO12-3
Financial Statement Presentation (Continued)
• Cash Flow Statement:
• Cash flows from buying and selling AFS securities typically
are classified as investing activities
LO12-3
Illustration: Reporting Available-for-Sale Securities
LO12-3
Illustration: Investments in Securities Availablefor-Sale—Cisco Systems
LO12-3
Illustration:
Comparison of HTM, TS, and AFS Approaches
LO12-3
Transfers between Investment Categories
At each reporting date, the appropriateness of the
classification is reassessed
Example:
If the investor no longer has the ability to hold
certain securities to maturity and will now hold
them for resale, those securities would be
reclassified from HTM to AFS.
Transfer of a security between reporting categories is
accounted for at fair value and in accordance with
the new reporting classification
Disclosure notes should describe the circumstances
that resulted in the transfer
LO12-3
Illustration: Transfer between Investment Categories
Concept Check √
Which of the following is true? Note: there may be more than one correct
answer.
a. TS and AFS both are shown at fair value on the balance sheet.
b. Unrealized gains and losses are included in OCI for TS investments and in
net income for AFS investments.
c. The same basic journal entry is used to record purchase and sale of
HTM, TS, and AFS investments.
d. The same basic journal entry is used to record changes in unrealized
gains and losses for HTM and AFS investments.
Answer b is not correct because unrealized gains and losses are included in
OCI for AFS investments and in net income for TS investments.
Answer d is not correct because changes in unrealized gains and losses are
not recognized for HTM investments.
LO12-7
Fair Value Option
• Trading securities are accounted for at fair value, so
there is no need to choose the fair value option for
them
• Choosing the fair value option for HTM and AFS
investments means reclassifying these investments
as TS investments
• Electing the fair value option is irrevocable
• Why allow the fair value option?
• To avoid excess earnings volatility
OTT Impairments of Investments
• Declines or increases in the fair value of some
investments are always reported in earnings
• Trading Securities
• Securities for which the fair value option has been elected
• For HTM and AFS investments, declines in fair value
normally are only recognized when the investment is
sold.
• However, an “other-than-temporary” impairment loss is
recognized in net income, even if the security is not sold
• The process for determining whether an investment has
an OTT impairment differs between equity and debt
investments
• Equity: recognize if company doesn’t have the intent and
ability to hold the investment until fair value recovers.
• Debt: more complicated.
Financial Statement Presentation and Disclosure
• On the statement of cash flows, inflows and outflows
of cash from buying and selling trading securities are
considered operating activities.
• Cash flows from the purchase, sale, and maturity of
HTM or AFS securities are considered investing
activities.
• Cash flows of HTM or AFS securities for which the fair
value option has been selected (and so are treated as
trading securities) may be classified as investing.
Financial Statement Presentation and Disclosure
(Continued)
• The information to be disclosed in the disclosure
notes for every year it is presented includes:
• Aggregate fair value
• Gross realized and unrealized holding gains
• Gross realized and unrealized holding losses
• Change in net unrealized holding gains and losses
• Amortized cost basis by major security type
• Total gains or losses for the period (realized and
unrealized)
• Purchases, sales, issuances and settlements
Illustration: Fair Value Disclosure of Investment
Securities—General Electric
Investor Has Significant Influence
Illustration: Reporting Classifications for Investment
Relationships
LO12-4
What Is Significant Influence?
• Significant influence is assumed to exist if the
investor owns between 20% and 50% of the
investee’s voting shares
• Absence of control (not > 50% ownership)
• Significant influence over the operating and financial
policies of the investee
• Decisions often can be swayed in the direction the
investor desires
• Investment is accounted for by the equity method
How the Equity Method Relates to Consolidated
Financial Statements
• Consolidate if the investor has a controlling interest:
• Company owns more than 50% of the voting stock of
another company
• The investor is referred to as the parent and the investee is termed the
subsidiary
• The parent and subsidiary are considered to be a single reporting
entity
• Consolidated financial statements:
• Combine the individual elements of the parent and
subsidiary statements into a single financial statement
• Goodwill:
• Difference between the acquisition price and the sum
of the fair values of the acquired net assets
• Recognized as an asset
LO12-5
Equity Method: A Single Entity Concept
• Equity method views the investor and investee
collectively as a special type of single entity
• The investor’s ownership interest in individual assets
and liabilities of the investee is represented by a
single investment account
• Referred to as a one-line consolidation
• Initial investment is recorded at cost. The carrying
amount of this investment subsequently is:
• Increased by the investor’s percentage share of the
investee’s net income
• Decreased by dividends paid by investee to investor
Illustration: Equity Method—Purchase of Investment
LO12-5
United Intergroup purchased 30% of Arjent, Inc.’s, common stock for
$1,500,000 cash.
Book Value on Arjent’s Fair Value at Time of
Financial Statement
United’s Investment
Account
Buildings (10-year remaining
useful life, no salvage value)
$1,000,000
$2,000,000
Land
500,000
1,000,000
Other net assets
600,000
600,000
Net assets
2,100,000
3,600,000
Goodwill
1,400,000 (to balance)
Total fair value of Arjent $5,000,000
× 30% purchased
Other information:
$1,500,000 purchase
price
Arjent’s 2016 net income:
$500,000
Arjent’s 2016 dividends:
$250,000
Journal Entry
Investment in Arjent stock
Cash
Debit
1,500,000
Credit
1,500,000
Equity Method—Recognizing Investment Income
LO12-5
(Illustration continued)
United Intergroup purchased 30% of Arjent, Inc.’s, common stock for
$1,500,000 cash.
Book Value on Arjent’s Fair Value at Time of
Financial Statement
United’s Investment
Account
Buildings (10-year remaining
useful life, no salvage value)
$1,000,000
$2,000,000
Land
500,000
1,000,000
Other net assets
600,000
600,000
Net assets
2,100,000
3,600,000
Goodwill
1,400,000 (to balance)
Total fair value of Arjent $5,000,000
× 30% purchased
Other information:
$1,500,000 purchase
price
Arjent’s 2016 net income:
$500,000
Arjent’s 2016 dividends:
$250,000
30% × 500,000
Journal Entry
Investment in Arjent stock
Investment revenue
Debit
150,000
Credit
150,000
Equity Method—Receiving Dividends
LO12-5
(Illustration continued)
United Intergroup purchased 30% of Arjent, Inc.’s, common stock for
$1,500,000 cash.
Book Value on Arjent’s Fair Value at Time of
Financial Statement
Account
United’s Investment
Buildings (10-year remaining
useful life, no salvage value)
$1,000,000
$2,000,000
Land
500,000
1,000,000
Other net assets
600,000
600,000
Net assets
2,100,000
3,600,000
Goodwill
1,400,000 (to balance)
Total fair value of Arjent $5,000,000
× 30% purchased
Other information:
$1,500,000 purchase
price
Arjent’s 2016 net income:
$500,000
Arjent’s 2016 dividends:
$250,000
30% × 250,000
Journal Entry
Cash
Investment in Arjent stock
Debit
75,000
Credit
75,000
Concept Check √
Scotts purchased 40% of the stock of Yonkers, Inc. for $500,000 on
1/1/2016, and accounts for the investment using the equity method. In
2016, Yonkers earned net income of $150,000, and paid dividends of
$50,000. As of 12/31/16, Scotts’ Yonkers investment account should have a
balance of:
a. $650,000
b. $600,000.
c. $540,000.
d. $500,000.
$500,000 + (40% x $150,000) – (40% x $50,000) = $540,000.
LO12-6
Further Adjustments Under the Equity Method
• Occur when investor’s expenditure to acquire an
investment exceeds the book value of the underlying
net assets acquired
• Purpose:
• To approximate the effects of consolidation, without
actually consolidating financial statements
• Amortizing the differential between purchase price
and book value:
• Adjust investment account and investment revenue to
act as if consolidation procedures had been followed
• If assets would have been written up to fair value, act as if that
happened
• Impute higher expenses in subsequent periods when those assets are
expensed, such that
• Earnings are lower by the investor’s share in that additional expense
LO12-6
Illustration: Source of Differences between the
Investment and the Book Value of Net Assets Acquired
($ in thousands)
Investee Net Net Assets
Assets
Purchased
Cost
$5,000 × 30% =
Difference
Attributed to:
$1,500
Goodwill:
Fair value
$3,600 × 30% =
$420
$1,080
Undervaluation of:
Book value $2,100 × 30% =
$630
Buildings
$300
Land
$150
LO12-6
Equity Method—Adjustments for Additional Depreciation
United Intergroup purchased 30% of Arjent, Inc.’s, common stock for
$1,500,000 cash.
Book Value on Arjent’s Fair Value at Time of
United’s Investment
Financial Statement
Account
Buildings (10-year remaining
useful life, no salvage value)
$1,000,000
$2,000,000
Land
500,000
1,000,000
Other net assets
600,000
600,000
Net assets
2,100,000
3,600,000
Goodwill
1,400,000 (to balance)
Total fair value of Arjent $5,000,000
× 30% purchased
Other information:
$1,500,000 purchase
price –
Arjent’s 2016 net income:
$500,000
30% × [$2,000,000
Arjent’s 2016 dividends:
$250,000
1,000,000] ÷ 10 yrs.
Journal Entry
Investment revenue
Investment in Arjent stock
Debit
30,000
Credit
30,000
LO12-6
No Adjustments for Land or Goodwill
• Land:
• Land is not depreciated
• Difference between the fair value and book value of
the land would not cause higher expenses
• Goodwill:
• Unlike most of the other intangible assets, goodwill
is not amortized
• Acquiring goodwill will not cause higher expenses
Concept Check √
KB purchased 40% of the stock of RiteCo, Inc. for $500,000 on 1/1/2016,
and accounts for the investment using the equity method. At 1/1/2016,
40% of the fair value of Rite Co's net assets is $500,000, and 40% of the
book value of RiteCo's net assets is $200,000. One half of the difference is
attributable to land, and the other half to a building being depreciated over
10 years. To account for this difference, during 2016 KB would reduce its
investment in RiteCo by:
a. $300,000.
b. $150,000.
c. $15,000.
d. $6,000.
½ x ($500,000 - $200,000) ÷ 10 = $15,000.
LO12-6
Adjustments for Other Assets and Liabilities
• If the fair value of purchased inventory exceeds its
book value, the period in which that inventory is
sold should be identified
• Inventory is usually sold in the next year
• Investment revenue and its investment in the stock
is reduced in the next year by the amount of the
differential attributable to inventory
Reporting the Investment
LO12-6
(Illustration continued)
• The fair value of the investment shares at the end of the
reporting period is not reported when using the equity
method
• Instead, the investment account is reported at:
Investor’s share
The portion of the
Original
of the investee’s
earnings received
Cost
net income
as dividends
The balance of United’s 30% investment in Arjent at
December 31, 2016 is calculated as:
Investment in Arjent Stock
Cost
1,500,000
Share of income
150,000
30,000 Depreciation adjustment
75,000 Dividends
1,545,000
LO12-6
Reporting the Investment
(Illustration continued)
• When the Investee Reports a Net Loss:
• The investment account would be decreased by the
investor’s share of the investee’s net loss
• When the Investment is Acquired in Mid-year:
• Only recognize the investor’s share of the year’s activity
• Example: If United purchased 30% of Arjent on October 1:
Cost
Share of income
(3/12 × $150,000)
Investment in Arjent Stock
1,500,000
37,500
Depreciation adjustment
7,500
(3/12 × $30,000)
Dividends
18,750
1,511,250
(3/12 × $75,000)
LO12-6
Illustration: Equity Method Investments on the
Balance Sheet—AT&T
LO12-6
What If Conditions Change?
• A change from the equity method to another
method
• No adjustment is made to the remaining carrying
amount of the investment
• Equity method is discontinued and the new method
applied from then on
• The balance in the investment account would serve
as the new cost basis for writing the investment up or
down to fair value on the next set of financial statements
LO12-6
What If Conditions Change?
A change from another method to the equity method
• The investment account should be retroactively adjusted to
the balance that would have existed if the equity method
always had been used
• As income also would have been different, retained
earnings would be adjusted as well
Example:
It is determined that an investor’s share of investee net
income, reduced by dividends, was $4,000,000 during a
period when the equity method was not used, but
additional purchases of shares cause the equity method to
be appropriate now.
Journal Entry
Investment in equity securities
Retained earnings
Debit
Credit
4,000,000
4,000,000
LO12-6
If an Equity Method Investment is Sold
• When an investment reported by the equity method is
sold:
Selling price
> Book (carrying) value
Gain is recognized
Selling price
>
Loss is recognized
Book (carrying) value
Example:
The balance of United’s 30% investment in Arjent at
December 31, 2016 is $1,545,000. United sells its
investment in Arjent on January 1, 2017, for $1,446,000.
Journal Entry – January 1, 2017
Cash
Loss on sale of investment
Investment in Arjent stock
Debit
1,446,000
99,000
Credit
1,545,000
LO12-6
Illustration: Comparison of Fair Value and the
Equity Methods
Fair Value Option
LO12-7
• Irrevocable decision about whether to elect the fair value
option or not is made by the company
• Company carries the investment at fair value in the balance
sheet and unrealized gains and losses are included in
earnings
• Investments are shown on their own line in the balance
sheet or are combined with equity method investments
with the amount at fair value shown parenthetically
(1) Investment is accounted for using
entries similar to those that would be used
to account for trading securities
Alternatives
for
(2) Record all the accounting entries during
bookkeeping
the period under the equity method, and
then record a fair value adjustment at the
end of the period
Differences between IFRS and U.S. GAAP
IFRS
LO12-8
U.S. GAAP
Accounting for Investments When Investor Lacks Significant Influence
The primary categories under IAS No.
39 consists of “Fair Value through
Profit & Loss” (“FVPL,” similar to TS),
HTM, and AFS.
The primary categories are
same as IFRS.
Investments in debt securities are
classified either as amortized cost, fair
value through other comprehensive
income (“FVOCI”), or fair value
through profit or loss (“FVPL”).
Investments in debt securities
are classified either as HTM
investments, AFS investments,
or trading securities.
Under the FVOCI category, realized
gains and losses associated with a
sold equity investment is transferred
from AOCI to retained earnings
without passing through the income
statement.
Under AFS, realized gains and
losses on equity investments
are reclassified out of OCI and
into net income when the
investment is later sold.
LO12-8
Differences between IFRS and U.S. GAAP (Continued)
IFRS
U.S. GAAP
Transfer Between Investment Categories
Allows transfers of debt
investments out of the FVPL
category into AFS or HTM in “rare
circumstances,” and indicated that
the financial crisis qualified as one
of those circumstances.
Allows transfers out of the trading
security category, but
reclassifications under this
continue to be rarer events than
that occurred under IFRS with this
change.
Fair Value Option
It is more restrictive than U.S.
standards for determining when
firms are allowed to elect the fair
value option. Under both IAS No.
39 and IFRS No. 9, companies can
elect the fair value option only in
specific circumstances.
Less restrictive than IFRS. It
indicates that the intent of the fair
value option is to address specific
circumstances. But it does not
require that those circumstances
exist.
LO12-8
Differences between IFRS and U.S. GAAP (Continued)
IFRS
U.S. GAAP
Cost Method
Under IAS No. 39, equity
This method is more prevalent
investments typically are
than under IFRS.
measured at fair value, even if they
are not listed on an exchange or
over-the-counter market. The cost
method is used only if fair value
cannot be measured reliably.
IFRS No. 9 does not allow the cost
method, but may allow cost as an
estimate of fair value in some
circumstances.
LO12-8
Differences between IFRS and U.S. GAAP (Continued)
IFRS
U.S. GAAP
IAS No. 28 governs application of
the equity method and requires
that the accounting policies of
investees be adjusted to
correspond to those of the
investor when applying the equity
method.
It has has no such requirement.
It does not provide the fair value
option for most investments that
qualify for the equity method.
It provides the fair value option for
all investments that qualify for the
equity method.
Financial Instruments and Investment
Derivatives
• A financial instrument is defined as:
• Cash
• Evidence of an ownership interest in an entity
• A contract that
• Imposes on one entity an obligation to deliver cash or
another financial instrument
• Conveys to the second entity a right to receive cash
• A contract that
• Imposes on one entity an obligation to exchange
financial instruments on potentially unfavorable
terms
• Conveys to a second entity a right to exchange other
financial instruments on potentially favorable terms
Financial Instruments and Investment
Derivatives (Continued)
• Derivatives
• Instruments that “derive” their values from some
other security or index
• Complex class of financial instrument
• Created solely to hedge against risks created by:
• other financial instruments or
• by transactions that have yet to occur but are anticipated
Derivatives
Financial
Futures
Interest Rate
Swaps
Forward
Contracts
Options
Financial Instruments and Investment
Derivatives (Continued)
• FASB
• Wants to provide a consistent framework for
resolving financial instrument accounting issues,
including those related to derivatives and other offbalance-sheet instruments
• The financial instruments project has three separate
but related parts: disclosure, recognition and
measurement, and distinguishing between liabilities
and equities
• To help fill the disclosure gap, the FASB has offered a
series of temporary, “patchwork” solutions in the form of
additional disclosures for financial instruments
APPENDIX 12A
Other Investments
• Special Purpose Funds
• Amount set aside by companies to be used for specific
purposes
• A special purpose fund can be established for virtually
any purpose
• Fund is established to accumulate money to expand
facilities, provide for unexpected losses, buy back shares
of stock
• Noncurrent special purpose funds are reported within
the category investments and funds
• Investments in Life Insurance Policies
• Objective:
• To compensate the company for the untimely loss of a
valuable resource in the event the officer dies
• When the insured is still alive, life insurance policy can be
surrendered in exchange for a determinable amount of
money (called the cash surrender value). That’s an
investment
APPENDIX 12A
Illustration: Cash Surrender Value
Several years ago, American Capital acquired a $1 million
insurance policy on the life of its chief executive officer,
naming American Capital as beneficiary. Annual premiums
are $18,000, payable at the beginning of each year. In 2016,
the cash surrender value of the policy increased according to
the contract from $5,000 to $7,000. The CEO died at the end
of 2016.
$7,000 − $5,000
Journal Entry
Insurance expense
Cash surrender value of life insurance
Cash (2016 premium)
Debit
Credit
16,000
2,000
18,000
APPENDIX 12A
Illustration: Cash Surrender Value (Continued)
Several years ago, American Capital acquired a $1 million
insurance policy on the life of its chief executive officer,
naming American Capital as beneficiary. Annual premiums
are $18,000, payable at the beginning of each year. In 2016,
the cash surrender value of the policy increased according to
the contract from $5,000 to $7,000. The CEO died at the end
of 2016.
Journal Entry
Debit
Credit
Cash
1,000,000
7,000
Cash surrender value of life insurance
993,000
Gain on life insurance settlement
Concept Check √
RangeCo insured its CFO for $2,000,0000, and the CFO died at a time when
the cash surrender value of the insurance policy had grown to $100,000.
The journal entry to record RangeCo’s receipt of cash from the insurance
company would include a:
a. Debit to Cash for $1,900,000.
b. Credit to Surrender value of $100,000.
c. Debit to Insurance investment of $1,900,000.
d. Credit to Cash for $2,000,000.
RangeCo’s journal entry would be:
Cash
2,000,000
Surrender value
100,000
Gain on life insurance settlement
1,900,000
APPENDIX 12B
Temporary v. OTT Impairment of Investments
• Impairment: The fair value of an investment declines to
a level below cost
• If the impairment is temporary, it is:
• Recognized in earnings for TS investments
• Recognized in earnings for investments for which fair
value option has been elected
• Ignored for HTM investments
• Recorded in OCI for AFS investments
• But what if the decline is OTT (other than temporary)?
OTT Impairment of Investments
OTT Impairments of
Equity Investments
OTT Impairments of Debt
Investments
APPENDIX 12B
OTT Impairments of Equity Investments
1. Is the investment impaired?
• Impairment occurs when fair value has declined to a level
below the investment’s cost
• Investment’s cost equals the investment’s purchase price
less previously recognized impairments and other
adjustments
2. Is any impairment other-than-temporary (OTT)?
• Equity impairments are OTT if the investor cannot assert it
has the intent and ability to hold the investment until fair
value recovers
3. Where is the OTT impairment reported?
• The investor recognizes the loss in the income statement,
just as if the loss had been realized by selling the investment
• Must reclassify amounts out of OCI that were recorded
previously as unrealized gains or losses
APPENDIX 12B
Illustration: Disclosure about OTT Impairments
of Equity Investments—Bank of America
APPENDIX 12B
Illustration: OTT Impairment of an Equity Investment
United Intergroup, Inc., buys and sells both debt and equity securities of
other companies as investments. United’s fiscal year-end is December
31. The following events during 2016 and 2017 pertain to the
investment portfolio.
Purchase Investments - July 1, 2016
• Purchased $1,000,000 of Bendac common stock.
Adjust Investments to Fair Value
• Dec. 31, 2016 - Valued the Bendac stock at $990,000 and determined
that the decline in FV should not be treated as an OTT impairment.
• Dec. 31, 2017 - Valued the Bendac stock at $985,000 and determined
that the decline in FV should be treated as an OTT impairment.
Journal Entry – December 31, 2016
Net unrealized holding gains and losses-OCI
Fair value adjustment
Debit Credit
10,000
$1,000,000 − $990,000
10,000
APPENDIX 12B
OTT Impairment of an Equity Investment
(Illustration continued)
United Intergroup, Inc., buys and sells both debt and equity securities of
other companies as investments. United’s fiscal year-end is December
31. The following events during 2016 and 2017 pertain to the
investment portfolio.
$1,000,000 − $985,000
Purchase Investments - July 1, 2016
• Purchased $1,000,000 of Bendac common stock.
$1,000,000 − $990,000
Adjust Investments to Fair Value
• Dec. 31, 2016 - Valued the Bendac stock at $990,000 and determined
that the decline in FV should not be treated as an OTT impairment.
• Dec. 31, 2017 - Valued the Bendac stock at $985,000 and determined
that the decline in FV should be treated as an OTT impairment.
Journal Entry– December 31, 2017
Other-than-temporary impairment loss-I/S
Investment in Bendac
Fair value adjustment
Net unrealized holding gains and losses-OCI
Debit Credit
15,000
15,000
10,000
10,000
Concept Check √
Criterion Inc. has an AFS investment in Skinner Co.’s equity for which fair
value is $100,000 but cost is $150,000. The investment currently has a fair
value adjustment account with a credit balance of $10,000. Criterion
concludes that the impairment is OTT. Criterion’s journal entry to record
the OTT impairment would include a:
a. Debit to OTT impairment loss—OCI of $50,000.
b. Debit to OTT impairment loss—N/I of $40,000.
c. Credit to Skinner AFS investment of $50,000.
d. Credit to OTT impairment loss—OCI of $10,000.
Criterion’s journal entry would be:
OTT impairment loss—I/S
50,000
Skinner AFS investment
50,000
Note: Criterion also would have to reclassify the previously recognized
unrealized loss out of OCI:
Fair value adjustment
10,000
Net unrealized holding gains and losses—OCI
10,000
OTT Impairments of Debt Investments
APPENDIX 12B
1. Is the investment impaired?
• Total amount of impairment is split into:
• Credit losses: occur due to anticipated reductions in cash
flows from the debt investment
• Noncredit losses: it captures other reductions in fair value
such as those due to changes in general economic conditions
2. Is any impairment other-than-temporary (OTT)?
• Debt impairment is viewed as OTT if the investor:
a) Intends to sell the investment
b) Believes it is more likely than not that they will sell the
investment prior to fair value recovery
c) Determines that a credit loss exists on the investment
3. Where is the OTT impairment reported?
• Investment is written down to fair value in the balance sheet
• Amount included in net income or OCI depends on the
reason that:
• If OTT is because of 2(a) or 2(b), all of the OTT impairment
loss is recognized in net income
• If OTT is because of 2(c), only the credit loss is recognized in
net income; noncredit loss in OCI
APPENDIX 12B
Illustration: Disclosure about OTT Impairments
of Debt Investments—Bank of America
Illustration: OTT Impairment of Debt Investment
APPENDIX 12B
United Intergroup, Inc., buys and sells both debt and equity
securities of other companies as investments. United’s fiscal yearend is December 31. The following events occurred during 2017
Purchase Investments - July 1, 2016
• Purchased $1,000,000 of Bendac bonds, maturing on December
31, 2022.
Adjust Investments to Fair Value - December 31, 2017
• Valued the Bendac bonds at $950,000. Of the $50,000
impairment, $30,000 is credit loss and $20,000 is noncredit loss.
Case 1: United either plans to sell the investment or believes it is
more likely than not that it will have to sell the investment
before fair value recovers.
$1,000,000 − $950,000
Journal Entry– December 31, 2017
OTT impairment loss – I/S
Discount on bond investment
Debit
50,000
Credit
50,000
OTT Impairment of Debt Investment
(Illustration continued)
APPENDIX 12B
United Intergroup, Inc., buys and sells both debt and equity
securities of other companies as investments. United’s fiscal yearend is December 31. The following events occurred during 2017
Purchase Investments - July 1, 2016
• Purchased $1,000,000 of Bendac bonds, maturing on December
31, 2022.
Adjust Investments to Fair Value - December 31, 2017
• Valued the Bendac bonds at $950,000. Of the $50,000
impairment, $30,000 is credit loss and $20,000 is noncredit loss.
Case 2: United does not intend to sell the investment and does
not believe it is more likely than not that it will have to sell the
Bendac investment before fair value recovers, but estimates that
$30,000 of credit losses have occurred.
Journal Entry– December 31, 2017
Debit Credit
OTT impairment loss – I/S
30,000
30,000
Discount on bond investment
20,000
OTT impairment loss – OCI
Fair value adjustment-Noncredit loss
20,000
Concept Check √
AB&C has an AFS investment in Bacon, Inc. debt for which fair value is
$200,000 but cost is $500,000. The present value of expected future
principal and interest payments is $400,000. AB&C has a credit loss of:
a. $100,000.
b. $200,000.
c. $300,000.
d. $400,000.
AB&C’s credit loss is $500,000 — $400,000 =
The noncredit loss is $400,000 — $200,000 =
The total OTT impairment is $500,000 — $200,000 =
$100,000
200,000
$300,000
APPENDIX 12B
Income Statement Presentation of
OTT Impairment of Debt Investment
Income Statement Presentation,
December 31, 2017
OTT impairment of AFS investments:
Total OTT impairment loss
Less: portion recognized in OCI
Net impairment loss recognized in net income
(Illustration continued)
Case 1
Case 2
$50,000 $50,000
–0– 20,000
$50,000 $30,000
APPENDIX 12B
Illustration: Other-Than-Temporary Impairment of
Equity Investments and Debt Investments Compared
LO12-8
Differences between IFRS and U.S. GAAP (Continued)
IFRS
U.S. GAAP
Accounting for OTT impairments
For an HTM investment, the
impairment is calculated as the
difference between the amortized
cost of the asset and the present
value of expected future cash
flows, estimated at the asset’s
original effective rate.
For an HTM investment, the
impairment is calculated as the
difference between the amortized
cost of the asset and the present
value of expected future cash
flows, estimated at the asset’s
original effective rate. So, the
impairment is essentially equal to
the amount that would be
considered a credit loss.
Allows recoveries of impairments
to be recognized in earnings for
debt investments, but not for
equity investments.
Does not allow recoveries of any
OTT impairment of equity or debt
(other than debt that is classified
as a loan).
LO12-8
Differences between IFRS and U.S. GAAP (Continued)
IFRS
U.S. GAAP
Impairments
Impairment of debt investments is
calculated using the expected
credit loss (“ECL”) model.
Impairment of debt investments is
calculated using CECL model.
IFRS ECL model calculates the
expected credit losses over the
remaining life of the investment if
there has been a significant
increase in credit risk. If the credit
risk of a debt investment has not
increased, the estimate of credit
losses only considers credit losses
that result from default events that
are possible within the next twelve
months. Accrues very little credit
loss, because the credit risk of the
investment hasn’t changed.
U.S. CECL model calculates the
expected credit losses over the
remaining life of the investment if
there has been or has not been a
significant increase in credit risk.
Because of this, it tends to
recognize impairment losses
earlier, and in higher amounts,
than are recognized under IFRS.
End of Chapter 12