Electronic
Presentations
in Microsoft®
PowerPoint®
Prepared by
James Myers,
C.A.
University of
Toronto
© 2010 McGraw-Hill
Ryerson Limited
Chapter 2, Slide 1
© 2010 McGraw-Hill Ryerson Limited
Chapter 2
Investments in Equity Securities
Chapter 2, Slide 2
© 2010 McGraw-Hill Ryerson Limited
Learning Objectives
1.
2.
3.
4.
5.
To describe the broad relationship between all the
relevant standards from Part I of the CICA
Handbook that comprise the ‘big picture’
To distinguish between the various types of equity
investments
To evaluate relevant factors to determine whether
an investor has significant influence over an
investee
To prepare journal entries to account for
investments under the cost and equity methods.
To state the disclosure requirements related to an
investment in associate.
Chapter 2, Slide 3
© 2010 McGraw-Hill Ryerson Limited
Equity Investments: The Big Picture

Companies invest in the
shares of other companies for:



Strategic reasons: intending to
maintain a long-term
relationship, and
Non-strategic reasons:
intending to hold for profit
Starting January 1, 2013 IFRS
9 requires all nonstrategic
investments to be reported at
fair value including private
companies which do not have
a quoted market value.

IFRS is developing a standard
for fair value measurement.
LO 1, 2
Strategic
investments
Non-strategic
investments
Significant
influence
Fair value
through profit
and loss
(FVTPL)
Control
Available-forsale (AFS)
Joint control
-Market
value
available
--Market value not
available
Chapter 2, Slide 4
© 2010 McGraw-Hill Ryerson Limited
Equity Investments: The Big Picture
Reporting methods for investments in equity securities
Type
Reporting method
Reporting
unrealized gains
Significant influence
Equity method
Not applicable
Control
Full consolidation
Not applicable
Joint control
Proportionate consolidation or equity
Not applicable
FVTPL
Fair value method
In net income
Available-for-sale
- FMV available
- FMV not available
-
LO 1, 2
-
Fair value method
Cost method
In OCI
- Not applicable
-
Chapter 2, Slide 5
© 2010 McGraw-Hill Ryerson Limited
Equity Investments: The Big Picture


When IFRS 9 becomes mandatory in 2013, the
available-for-sale investment category disappears.
However an entity will still be able to elect to report fair
value changes on an equity investment that is not held
for short-term trading in other comprehensive income
(OCI)


LO 1
This is the same treatment presently allowed for AFS investments
However unlike current treatment, when such investments are
sold accumulated gains or losses in OCI are cleared directly to
retained earnings, not net income
Chapter 2, Slide 6
© 2010 McGraw-Hill Ryerson Limited
Equity Investments: The Big Picture
Directly related IFRSs
IFRS
IAS 27 – Consolidated and
Separate Financial Statements
Description
If J Company controls K Company
then J is the “parent” and must
consolidate K the “subsidiary” by
replacing J’s investment in K with
the assets and liabilities from K’s
balance sheet.
Control exists if J has the power
to direct the activities of K to
generate returns for J.
Refer to IAS 28, IAS 31, and IAS
39 if control does not exist.

LO 1, 2
Chapter 2, Slide 7
© 2010 McGraw-Hill Ryerson Limited
Equity Investments: The Big Picture
IFRS
IAS 28 – Investments in
Associates
Description
An associate is an investee over
which the investor exercises
significant influence and is
reported using the equity method.
Significant influence allows the
investor to affect the strategic
operating and financing policies of the
investee but does not convey control
or joint control
 An investment of between 20% and
50% of the voting shares, without
control being present, is presumed to
be significant influence in the absence
of contrary evidence

LO 1, 2
Chapter 2, Slide 8
© 2010 McGraw-Hill Ryerson Limited
Equity Investments: The Big Picture
IFRS
Description
IAS 31 – Joint Arrangements
Joint arrangements (“ventures”)
have two or more owners
(“venturers”) that have a
contractual arrangement among
themselves to exercise joint
control over the venture and
therefore no venturer can exercise
unilateral control. Report using
either proportionate consolidation
or the equity method
IFRS 9 – Financial Instruments –
Classsification and Measurement
Nonstrategic equity investments
are valued at fair value with
changes reported in profit or loss
LO 1, 2
Chapter 2, Slide 9
© 2010 McGraw-Hill Ryerson Limited
Equity Investments: The Big Picture
IFRS
IFRS 9 – Financial Instruments –
Classsification and Measurement
Description
Nonstrategic equity investments
are valued at fair value with
changes reported in profit or loss.
For equity instruments not held
for short-term trading an entity
can elect on initial recognition to
record fair value changes in OCI,
while recording dividends
received in income. Under this
election, gains and losses on sale
of the investment are cleared from
OCI directly to retained earnings
without being reported in profit or
loss.

LO 1, 2
Chapter 2, Slide 10
© 2010 McGraw-Hill Ryerson Limited
Equity Investments: The Big Picture
Other Related IFRSs
IAS 39 – Financial Instruments –
Recognition and Measurement
Indicates how and when hedge accounting
standards can be applied to report gains
and losses on hedged and hedging items
in the same period.
IFRS 3 – Business Combinations
A business can obtain control either by
investing in voting shares or purchasing
the net assets of another business.
IFRS 8 – Operating Segments
Disclosure of operating segments within
consolidated financial statements.
IAS 1 – Presentation of Financial
Statements
Financial statements include balance
sheet (statement of financial position), and
statements of comprehensive income,
changes in equity, and cash flows
IFRS 12 – Income Taxes
Refer to Chapters 6 and 9.
LO 1, 2
Chapter 2, Slide 11
© 2010 McGraw-Hill Ryerson Limited
Equity Investments: The Big Picture
Other Related IFRSs
IAS 21 – The Effects of Changes
in Foreign Exchange Rates
Addresses translation of the financial
statements of foreign investees,
subsidiaries, and joint arrangements.
(Chapters 10 and 11)
IAS 36 – Impairment of Assets
Applies impairment tests to all assets
including investments in associates,
goodwill, and intangibles. (Chapter 5)
IFRIC 16 – Hedges of a Net
Investment in a Foreign Operation
Refer to Chapter 11.
SIC 12 – Consolidation – Special
Purpose Entities
Refer to Chapter 9.
SIC 13 – Jointly Controlled
Entities – Non-monetary
Contributions by Venturers
Guidance in determining the gain that a
venturer can recognize when contributing
non-monetary assets to a joint
arrangement (Chapter 9)
LO 1, 2
Chapter 2, Slide 12
© 2010 McGraw-Hill Ryerson Limited
Investments Valued at Fair Value
Fair Value Through Profit and Loss (FVTPL) investments
 Include investment held for short-term trading and any other
investments the reporting entity wishes to designated as
FVTPL
 Classified as current assets since they actively trade and are
intended to be sold within one year.
 Recorded at fair value. Unrealized gains and losses as well
as dividends received or receivable are reported in income.
Available for sale investments
 Classified as current or noncurrent assets depending on how
long management intends to hold on to these shares.
 Unrealized gains/losses are recorded in other comprehensive
income (OCI). Dividends are recorded in income.
 When sold, previously unrealized gains and losses are
removed from OCI and reported in net income.
 Account at cost if market value is not available.
LO 1, 2
Chapter 2, Slide 13
© 2010 McGraw-Hill Ryerson Limited
Investments Valued at Fair Value

Other comprehensive income can be presented
either at the end of one single statement of
comprehensive income, or on a separate
statement of other comprehensive income (OCI).


In either case, both statements show “comprehensive
income” as the last line on the statement.
Net income is added to retained earnings and
OCI is added to “Cumulative Other
Comprehensive Income” which is a separate
component of shareholders’ equity.
LO 1, 2
Chapter 2, Slide 14
© 2010 McGraw-Hill Ryerson Limited
Investments Not Valued at Fair Value


Reported using either the cost or equity method.
Cost method:






Used for available-for-sale investments when market value is not
reliably measurable
Can be used to report control investments in non-consolidated
separate entity financial statements (Chapter 5)
Can be used to record control investments (Chapter 5)
Impairment losses are reported in net income.
Dividends are reported in income.
Cumulative dividends received in excess of net income since
acquisition (“liquidating dividends”) are reported in income
LO 1, 2
Chapter 2, Slide 15
© 2010 McGraw-Hill Ryerson Limited
Investments Not Valued at Fair Value

Equity method applies to investments in associates,
where the investee has the ability to exercise significant
influence. Indications of significant influence include:







Representation on board of directors
Participation in policy-making processes or decisions about
dividends and distributions
Material transactions between investor and investee
Exchange of management personnel
Exchange of essential technical information
Generally holding between 20% and 50% of voting
shares indicates the presence of significant influence,
which can also exist with less than 20%.
Determination of significant influence requires the
application of judgment.
LO 3
Chapter 2, Slide 16
© 2010 McGraw-Hill Ryerson Limited
Investments Not Valued at Fair Value


When one investor has control, other
investors usually do not have significant
influence
The equity method records the investor’s
share of the changes in the associate’s
shareholders’ equity


Adjustments are made for acquisition costs greater
than book value, unrealized intercompany profits,
impairment losses, and other factors.
The equity method provides information on
the potential for future cash flows
LO 1, 3
Chapter 2, Slide 17
© 2010 McGraw-Hill Ryerson Limited
Investments Not Valued at Fair Value

Using the equity method, the investor:





LO 4
records its proportionate share of the investee’s
operating income as its own operating income
reduces the investment account by its share of
investee dividends received
Records its proportionate share of the investee’s nonoperating income (e.g. discontinued operations,
extraordinary items) separately
Amortizes acquisition costs greater than book value of
investee (“acquisition differential”)
Eliminates after-tax unrealized intercompany profits
Chapter 2, Slide 18
© 2010 McGraw-Hill Ryerson Limited
Equity Method Accounting

Initial investment is recorded at cost
EXAMPLE
On January 1, 2010, New Inc. buys 20% of Newer
Co. for $1,000,000 cash.
Prepare the journal entry to record the acquisition
on New’s books.
LO 4
Chapter 2, Slide 19
© 2010 McGraw-Hill Ryerson Limited
Equity Method Accounting
•
Each investment has a unique account
GENERAL JOURNAL
Date
Description
1-Jan. Investment in Newer Co.
Cash
to record investment in Newer
LO 4
Page
1
Debit
Credit
$ 1,000,000
$ 1,000,000
Chapter 2, Slide 20
© 2010 McGraw-Hill Ryerson Limited
Equity Method Accounting

Investor recognizes its share of investee’s net
operating income (loss) on the income
statement

Based on percentage ownership
EXAMPLE
For all of 2010, Newer’s net operating income was
$400,000.
Prepare the journal entry for New.
LO 4
Chapter 2, Slide 21
© 2010 McGraw-Hill Ryerson Limited
Equity Method Accounting
New’s ownership percentage × Newer’s net
income = 20% × $400,000 = $80,000
GENERAL JOURNAL
Date
Description
31-Dec. Investment in Newer Co.
$
Income on equity investment
to record equity in Newer net
operating income
LO 4
Page
100
Debit
Credit
80,000
$
80,000
Chapter 2, Slide 22
© 2010 McGraw-Hill Ryerson Limited
Equity Method Accounting

Dividends paid by the investee are treated
as a reduction of the investor’s investment
account
EXAMPLE
Also in 2010, Newer paid $70,000 of dividends to
its shareholders.
Prepare the journal entry to record New’s receipt
of the its portion of the dividends from Newer.
LO 4
Chapter 2, Slide 23
© 2010 McGraw-Hill Ryerson Limited
Equity Method Accounting

New’s ownership percentage × Newer’s
dividend = 20% × $70,000 = $14,000
GENERAL JOURNAL
Date
Description
31-Dec. Cash
Investment in Newer Co.
to record receipt of dividend
from Newer Co.
LO 4
$
Page
100
Debit
Credit
14,000
$
14,000
Chapter 2, Slide 24
© 2010 McGraw-Hill Ryerson Limited
Equity Method Accounting:



The initial investment is recorded at cost
The investee’s net income (loss) results in a proportional
increase (decrease) in the investor’s investment account
The investor’s investment account is reduced by the
amount of the dividends it receives from the investee.
Investment in Newer
$ 1,000,000
80,000
$ 14,000
$ 1,066,000
LO 4
Chapter 2, Slide 25
© 2010 McGraw-Hill Ryerson Limited
Equity Method Accounting

Investee records its share of investee’s
non-operating income/loss
EXAMPLE
Also in 2010, Newer recorded an discontinued
operations loss of $100,000.
Prepare the journal entry to record New’s portion
of this extraordinary loss.
LO 4
Chapter 2, Slide 26
© 2010 McGraw-Hill Ryerson Limited
Equity Method Accounting

New’s ownership percentage × Newer’s
discontinued operations loss = 20% ×
$100,000 = $20,000
GENERAL JOURNAL
Date
Description
31-Dec. Investment loss, extraordinary
Investment in Newer Co.
to record extraordinary loss
from Newer Co.
LO 4
$
Page
100
Debit
Credit
20,000
$
20,000
Chapter 2, Slide 27
© 2010 McGraw-Hill Ryerson Limited
Equity Method Accounting

Investor amortizes acquisition costs paid in
excess of book value (“acquisition differential”)

EXAMPLE
When New paid $1,000,000 for Newer on January 1, 2010
Newer’s net book value was $4,000,000 (New’s 20%
share = $800,000). New’s $200,000 acquisition
differential was attributable entirely to a building owned
by Newer, with a 20-year remaining life, the fair value of
which was $1,000,000 greater than its book value.
Prepare the journal entry to amortize the acquisition
differential on New’s books for 2010.
LO 4
Chapter 2, Slide 28
© 2010 McGraw-Hill Ryerson Limited
Equity Method Accounting

New’s ownership percentage × acquisition
differential allocated to building / remaining life
= 20% × $1,000,000 / 20 = $10,000
GENERAL JOURNAL
Date
Description
31-Dec. Investment income
Investment in Newer Co.
to amortize purchase
discrepancy re Newer Co.
LO 4
$
Page
100
Debit
Credit
10,000
$
10,000
Chapter 2, Slide 29
© 2010 McGraw-Hill Ryerson Limited
Equity Method Accounting

Investor eliminates unrealized profits on
intercompany transactions until the assets are
sold to outsiders or consumed by the purchaser.
EXAMPLE
In 2010 New sold inventory for $100,000 to Newer and
recorded a 40% gross profit on the transaction. Newer’s
inventory still contains these items on December 31,
2010. New pays income tax at a rate of 30%
Prepare the journal entry to eliminate the unrealized
intercompany profit on New’s books for 2010.
LO 4
Chapter 2, Slide 30
© 2010 McGraw-Hill Ryerson Limited
Equity Method Accounting

Downstream sale (investor selling to investee,
investor’s books reflect profit)  eliminate 20% x
$100,000 x 40% gross profit x (1-30% tax rate) =
$5,600
GENERAL JOURNAL
Date
Description
31-Dec. Investment income
Investment in Newer Co.
to eliminate unrealized
downstream profit on sale to
Newer Co.
LO 4
$
Page
100
Debit
Credit
5,600
$
5,600
Chapter 2, Slide 31
© 2010 McGraw-Hill Ryerson Limited
Other Equity Accounting Considerations


Change from FVTPL to equity method: once
significant influence is achieved on an
investment previously reflected as FVTPL, begin
using equity method.
Change from equity method to FVTPL: if
significant influence is lost, begin using fair value
method prospectively; adjust investment to
market value at date of change and at each
reporting date and report adjustments to market
value in profit and loss.
LO 1, 2
Chapter 2, Slide 32
© 2010 McGraw-Hill Ryerson Limited
Other Equity Accounting Considerations

Losses Exceeding Investment Account Balance (IAS 28):




if investor has guaranteed investee’s obligations or is committed to
providing additional financial support, continue recording losses and
reflect negative investment balance as a liability.
If there are no such guarantees or commitments, leave investment
balance at nil and begin recording future share of investee profits only
after they exceed the investor’s share of previous losses not recognized.
Impairment losses (IAS 36): Compare the investment’s recoverable
amount (higher of fair value less costs of selling and value in use) to
its carrying amount and if recoverable amount < carrying amount,
then write down to recoverable amount. Write down can be
reversed if recoverable amount increases in future.
Gains and Losses on Sale of Investments: When a portion of shares
held are sold, gain or loss is calculated based on average cost of
shares sold, not FIFO, LIFO, or specific identification.
LO 1
Chapter 2, Slide 33
© 2010 McGraw-Hill Ryerson Limited
GAAP for Private Enterprises

CICA Handbook Part II Sections 3051 and 3856:





LO 1
Permits use of either equity or cost method to account for all
significant influence investments that are not publicly traded on
the same basis.
Investments in and income from cost-accounted investments
should be reported separately, net of any impairment losses
which are reported in net income.
Allows investors to elect to report any equity investment at fair
value.
Prohibits use of the cost method to account for publicly traded
investments, which must be reported at fair value with changes
reflected in profit and loss
Does not require amortization of the acquisition differential
Chapter 2, Slide 34
© 2010 McGraw-Hill Ryerson Limited