bg financial accounting 2 chapter 10 5488

Chapter 10 Investments LEARNING OBJECTIVES After studying this chapter, you should be able to  Describe debt investments and equity investments  Understand the accounting for debt investments  Unde[.]

Chapter 10: Investments

LEARNING OBJECTIVES

After studying this chapter, you should be able to:

 Describe debt investments and equity investments

 Understand the accounting for debt investments

 Understand the accounting for equity investments

 Understand how to presentation and Disclosure

10.1 Overview of investments

10.1.1 Introduction to investments

10.1.2 Types of investments

10.2 Investments in Debt Securities

10.2.1 Debt investment classifications 10.2.2 Accounting for Debt Securities

10.3 Investments in Equity Securities

10.1 Overview of investments

10.1.1 Introduction to investments

Investments are assets which represent a company’s right to receivecash from its stake in another company, government, etc Investmentsare made through purchase of bonds or shares or other financialinstruments of the investee The intent behind making such investments

is to generate investment income (interest and dividend) and to benefitfrom expected capital gain

10.1 Overview of investments

10.1.2 Types of investments

Investments are reported by the investing company on its SOFP,classified into current and non-current portion Investments which areexpected to be sold within next 12 months are called short-terminvestments while investments other than short-term investments arecalled long-term investments Some investments, which are can beeasily converted to cash with negligible fluctuation in its value, areclassified as cash equivalents

10.1 Overview of investments

10.1.2 Types of investments

Investments can be made in debt securities, equity securities

 Debt securities are financial instruments that represent right to adetermined stream of cash flows for a definite period of time Forexample, government bonds, corporate bonds, municipal bonds,notes receivable, etc all have a pre-determined payout for a specificperiod

 Equity instruments are securities that represent residual (ownership)interest in a company, for example, shares of common stock, etc

10.2 Investments in Debt Securities

10.2.1 Debt investment classifications

Companies group investments in debt securities into three separate categories for accounting and reporting purposes:

Held-to-maturity: Debt securities that the company has the positive intent and ability to hold to maturity

Trading: Debt securities bought and held primarily for sale in the near term to generate income on short-term price differences

Available-for-sale: Debt securities not classified as held-to-maturity

or trading securities

10.2.2 Accounting for Debt Securities

DOUBLE ENTRY FOR DEBT SECURITIES

• PRINCIPLE:

DEBT SECURITIES ACCOUNT

• An increase of Debt Securities is a debit entry in the Debt Securities account

• An decrease of Debt Securities is a credit entry in the Debt Securitiesaccount

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(1) Purchased Debt Investments

Dr Debt Investments

Cr Cash; payables, …

Accounting entries for several major transactions 10.2 Investments in Debt Securities

(2) Recording Debt Investments Interest

+ To record receipt of interest

Dr Cash

Cr Interest Revenue + To accrue interest

Dr Interest Receivable

Cr Interest Revenue

Accounting entries for several major transactions 10.2 Investments in Debt Securities

(2) Recording Debt Investments Interest

+ To record receipt of accrue interest

Dr Cash

Cr Interest Receivable

Accounting entries for several major transactions 10.2 Investments in Debt Securities

(3) Recording Sale of Debt Investments

+ If gain on Sale of Debt Investments

Dr Cash

Cr Debt Investments

Cr Gain on Sale of Debt Investments

Accounting entries for several major transactions 10.2 Investments in Debt Securities

(3) Recording Sale of Debt Investments

+ If loss on Sale of Debt Investments

10.3 Investments in Equity Securities

Equity securities represent ownership interests such as common, preferred, orother capital stock They also include rights to acquire or dispose of ownershipinterests at an agreed-upon or determinable price, such as in warrants, rights, andcall or put options Companies do not treat convertible debt securities as equitysecurities Nor do they treat as equity securities redeemable preferred stock (whichmust be redeemed for common stock) The cost of equity securities includes thepurchase price of the security plus broker’s commissions and other fees incidental

to the purchase

10.3 Investments in Equity Securities

All the definitions relating to Investments in Equity Securities are extremelyimportant You must learn them and understand their meaning andapplication

 Control An investor controls an investee when the investor is exposed, orhas rights, to variable returns from its involvement with the investee andhas the ability to affect those returns through power over the investee.(IFRS 10: App A)

 Power Existing rights that give the current ability to direct the relevantactivities of the investee (IFRS 10: App A)

 Subsidiary An entity that is controlled by another entity (IFRS 10: App A)

10.3 Investments in Equity Securities

 Parent An entity that controls one or more subsidiaries (IFRS 10: App A)

 Group A parent and all its subsidiaries (IFRS 10: App A)

 Associate An entity over which an investor has significant influence andwhich is neither a subsidiary nor an interest in a joint venture (IFRS 10:App A)

 Significant influence The power to participate in the financial and operatingpolicy decisions of an investee but it is not control or joint control over thosepolicies (IAS 28: para 3)

10.3.1 Investment in Subsidiary

Control can usually be assumed to exist when the parent owns more

than half (ie over 50%) of the voting power of an entity unless it can be clearly shown that such ownership does not constitute control (these situations will be very rare) What about situations where this

ownership criterion does not exist?

The following situations show where control exists, even when the

parent owns only 50% or less of the voting power of an entity

 (a) The parent has power over more than 50% of the voting rights by virtue of agreement with other investors

10.3.1 Investment in Subsidiary

 (b) The parent has power to govern the financial and operating

policies of the entity by statute or under an agreement

 (c) The parent has the power to appoint or remove a majority of members of the board of directors (or equivalent governing body)

 (d) The parent has power to cast a majority of votes at meetings of the board of directors

10.3.1 Investment in Subsidiary

Power can be obtained directly from ownership of the majority of voting rights

or can be derived from other rights, such as:

+ Rights to appoint, reassign or remove key management personnel who candirect the relevant activities

+ Rights to appoint or remove another entity that directs the relevant activities+ Rights to direct the investee to enter into, or veto changes to, transactions forthe benefit of the investor

+ Other rights, such as those specified in a management contract

DOUBLE ENTRY FOR INVESTMENTS IN SUBSIDIARIES

• PRINCIPLE:

INVESTMENTS IN SUBSIDIARIES ACCOUNT

• Debit: Increases in actual value of investments in subsidiaries

• Credit: Decreases in actual value of investments in subsidiaries

• Debit balance: Actual value of existing investments in subsidiaries of the parent company

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 Companies present the investment in the common stock of the subsidiary as

a long-term investment on the separate financial statements of the parent.When the parent treats the investment as a subsidiary, the parent generallyprepares consolidated financial statements Consolidated financialstatements treat the parent and subsidiary corporations as a single economicentity

 The parent company generally accounts for the investment in the subsidiaryusing the equity method

10.3.1 Investment in Subsidiary

The parent company generally accounts for the investment in the subsidiary using the equity method.

(1) When a parent company invests money in subsidiaries

Dr Investments in subsidiaries

Cr Cash

Accounting entries for several major transactions

10.3.1 Investment in Subsidiary

(2) When a parent company invests non-monetary assets in subsidiaries

In case the book value or the residual value of the contributed asset is smaller than re-evaluated value

Dr Investments in subsidiaries

Dr Accumulated Depreciation of fixed assets

Cr fixed assets

Cr inventories

Cr Other income (increase in difference of evaluation)

Accounting entries for several major transactions

10.3.1 Investment in Subsidiary

(2) When a parent company invests non-monetary assets in subsidiaries (In

case the book value or the residual value of the contributed asset is greater than re-evaluated value)

Dr Investments in subsidiaries

Dr Accumulated Depreciation of fixed assets

Dr Other expenses (decrease in difference of evaluation)

Cr fixed assets

Cr inventories

Accounting entries for several major transactions

10.3.1 Investment in Subsidiary

(3) Recording dividend received

When receiving notification of dividends received

Dr receivables

Cr Financial income

Accounting entries for several major transactions

10.3.1 Investment in Subsidiary

(3) Recording dividend received

Dr Investments in subsidiaries

Cr Finacial income (investments in subsidiaries)

Accounting entries for several major transactions

10.3.1 Investment in Subsidiary

10.3.2 Investment in Assosiation

When an investor company owns only a small portion of the shares ofstock of another company, the investor cannot exercise control over theinvestee But, when an investor owns between 20% and 50% of thecommon stock of a corporation, it is presumed that the investor has

significant influence over the financial and operating activities of the

investee The investor probably has a representative on the investee’sboard of directors, and through that representative, may exercise somecontrol over the investee The investee company in some sensebecomes part of the investor company

10.3.2 Investment in Assosiation

Under the equity method, the investor company initially records the investment

in common stock at cost After that, it adjusts the investment account annually

to show the investor’s equity in the investee Each year, the investor does thefollowing:

(1) It increases (debits) the investment account and increases (credits) revenue

for its share of the investee’s net income

(2) The investor also decreases (credits) the investment account for the amount

of dividends received The investment account is reduced for dividendsreceived, because payment of a dividend decreases the net assets of theinvestee

(2) RECORDING REVENUE

Dr Investments in assosiation

Cr Revenue from Investments in assosiation

Accounting entries for several major transactions

10.3.3 Other investment

 In accounting for stock investments of less than 20%, companies usethe cost method Under the cost method, companies record theinvestment at cost, and recognize revenue only when cash dividendsare received

DOUBLE ENTRY FOR OTHER INVESTMENT

• PRINCIPLE:

OTHER INVESTMENT ACCOUNT

• Debit: Increases in actual value of other investmentCredit: Decreases in actual value of other investment

• Debit balance: Actual value of existing other investment130

(1) RECORDING ACQUISITION OF OTHER INVESTMENT

At acquisition, the cost principle applies Cost includes all expendituresnecessary to acquire these investments, such as the price paid plus anybrokerage fees (commissions)

• Dr other investment

Cr Cash

Accounting entries for several major transactions

(2) RECORDING DIVIDENDS OF OTHER INVESTMENT

Dr Cash

Cr Dividend Revenue

Accounting entries for several major transactions

(3) RECORDING SALE OF OF OTHER INVESTMENT

When a company sells a other investment, it recognizes as a gain or a loss the difference between the net proceeds from the sale (sales price less brokerage fees) and the cost of other investment

Accounting entries for several major transactions

(3) RECORDING SALE OF OF OTHER INVESTMENT

+ If Loss on Sale of other investment

10.4 Presentation and Disclosure

Companies generally report investments in a separate section of thebalance sheet

Companies must present in the financial statements gains and losses oninvestments, whether realized or unrealized: Interest Revenue;Dividend Revenue; Gain on Sale of Investments; Loss on Sale ofInvestments