Lecture Intermediate accounting (IFRS/e) - Chapter 12: Investments

In this chapter, you will learn that investments that companies make in the stock and debt securities of other companies are accounted for differently depending on the nature of the investments. For instance, you''ll see that investment securities categorized as securities held-to-maturity are reported at amortized cost, while securities available-for-sale and trading securities are reported at their fair values.

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Nature of Investments

Bonds and

notes

(Debt securities)

Bonds and

notes (Debt securities)

Common and preferred stock

(Equity securities)

Common and preferred stock

(Equity securities)

Investments can be accounted for in a

variety of ways, depending on the nature

of the investment relationship.

Reporting Categories for Investments

Reporting Method Used by the Investor in the Separate Financial Statements

Reporting Method Used by the Investor in the Consolidated Financial Statements

Investments in typically quoted or publicly traded 

debt securities for which the investor has the 

“positive intent and ability” to hold to maturity

Held­to­maturity (“HTM”) — investment reported at amortized cost*

Investments in unquoted debt securities Loans and receivables (“L&R”) — 

investments reported at amortized costInvestments held in an active trading account Trading securities (“TS”) — investment 

reported at fair value (with unrealized gains and losses included in net income)

Other

Available­for­sale securities (“AFS”) — investment reported at fair value (with unrealized gains and losses excluded from net income and reported directly in shareholders’ equity)*

Typically the investor owns between 20% and 

50% of the ordinary shares of the investee

Investment reported at cost or as a financial asset

Equity method—investment cost adjusted for subsequent earnings and dividends of the investee

Typically the investor owns more than 50% of the 

investee

Investment reported at cost or as a financial asset

Consolidation — the financial statements of the investor and investee are combined as if they are a single company

*If the investor elects the fair value option, this type of investment also can be accounted for using the same approach that’s used for trading securities, with the investment reported at fair value through profit or loss (FVTPL) and unrealized holding gains and losses included in net income

Reporting Categories for Investments Control Characteristics of the Investment

The investor controls  the investee:

The investor has  significant influence  over the operating and financial policies of the investee:

The investor lacks  significant influence  over the operating and financial policies of the investee:

As in the separate financial statements

Held-to-Maturity Securities

On January 1, 2012, Matrix Ltd purchased as an

investment $1,000,000, of 10%, 10-year bonds, interest paid semi-annually The market rate for similar bonds is 12% Let’s look at calculation of the present value of the

PV of ordinary annuity of $1, n = 20, i = 6%

PV of $1, n = 20, i = 6%

Partial Bond Amortization Table

Date Description Debit Credit

Held-to-Maturity Securities

Investment in bonds $ 1,000,000

Less: Discount on bond investment 111,581

Book value (amortized cost) $ 888,419

$114,699 - $3,118 = $111,581 unamortized discount

How would this investment appear on

the statement of financial position after

one period of discount amortization?

Held-to-Maturity Securities

Held-to-Maturity Securities

On December 31, 2012 after interest is received by

Matrix, all the bonds are sold for $900,000 cash.

Date Description Debit Credit

Period Payment Interest  Revenue Interest  Amortization   Discount  Unamortized  Discount Carrying         Value

Loans and Receivables

Trading Securities

Adjustments to fair value are recorded:

1 in a valuation account called Fair Value in a valuation account called Fair Value

investment account.

2. as a net unrealized gain/loss on the Income as a net unrealized gain/loss on the Income

Statement .

Unrealized Gain

Unrealized Gain Unrealized Loss

Unrealized Loss

Income Statement

Income Statement

Trading Securities

Matrix Ltd purchased additional securities classified as Trading Securities (TS) at the end of 2012 The fair value amounts for these securities on December 31, 2012, are shown below Prepare the journal entries for Matrix Ltd to

adjust the securities to fair value at 12/31/12.

No of Unit Total Fair Gain or Type Name Shares Cost Cost Value (Loss)

TS Mining, Inc 1,000 $ 42.00 $ 42,000 $ 41,000 $ (1,000)

TS Ford Motor 1,500 15.00 22,500 20,000 (2,500)

Net Unrealized Holding Loss for TS $ (3,500)

12/31 Net unrealized holding gains and losses-IS 3,500

Fair value adjustment 3,500

Trading Securities

On January 3, 2013, Matrix Ltd sold all trading

securities for $65,000 cash.

03/01/13 Cash 65,000

Investment in Ford Motor – TS 22,500 Investment in Mining, Inc – TS 42,000 Gain on sale of investment 500

12/31/13 Fair value adjustment 3,500

Net unrealized gain or loss – I/S 3,500

Available-for-Sale Securities

Adjustments to fair value are recorded:

1 in a valuation account called Fair Value Adjustment in a valuation account called Fair Value Adjustment ,

or as a direct adjustment to the investment account.

2 as a net unrealized gain/loss in Other

Comprehensive Income (OCI), which accumulates in separate OCI components in equity.

Unrealized Gain

Unrealized Gain Unrealized Loss

Unrealized Loss

Other Comprehensive

Income

Other Comprehensive

Income

Other Comprehensive Income (OCI)

Other comprehensive income:

Foreign currency translation gains (losses) $ XX,XXX

Net unrealized gains (losses) on AFS investments -3,500

Minimum pension liability adjustment XXX

Deferred gains (losses) from derivatives XXX $ XX,XXX

Less: aggregate income tax expense (benefit) X,XXX

Other comprehensive income $XX,XXX

When we add other comprehensive income to net income

we refer to the result as “comprehensive income.”

When we add other comprehensive income to net income

we refer to the result as “comprehensive income.”

Accumulating Other Comprehensive Income

Unrealized gains and losses on

available-for-sale securities are accumulated in separate

OCI components of the shareholders’ equity

section of the statement of comprehensive

income.

Unrealized gains and losses on

available-for-sale securities are accumulated in separate

OCI components of the shareholders’ equity

section of the statement of comprehensive

income .

Shareholders’ Equity Ordinary shares

Unrealized gains on AFS instruments Retained earnings

Total Shareholders’ Equity

Cumulative

net unrealized

gains

and losses

Example of Available-for-sale securities

Now assume the same facts for our Matrix Ltd

example, except that the investment is for available-for-sale securities rather than trading

securities

Now assume the same facts for our Matrix Ltd

example, except that the investment is for available-for-sale securities rather than trading

Example of Available-for-sale securities

The net unrealized gain is reported in other comprehensive income.

The net unrealized gain is reported in other comprehensive income.

Date Description Debit Credit

12/31 Net unrealized holding gains and losses-OCI 3,500

Fair value adjustment 3,500

Investments are Sold

Event Effect on Comprehensive Income Effect on Shareholders' Equity

Period 1: hold AFS investment

and

experience net unrealized loss. OCI for unrealized loss.

 Equity

Period 2: sell AFS investment and

realize loss on sale

 OCI to back out previously recognized

 Net income for realized

loss  Retained earnings

On January 3, 2013, Matrix Ltd sold all

available-for-sale securities for $65,000 cash.

03/01/13 Cash 65,000

Investment in Ford Motor – TS 22,500 Investment in Mining, Inc TS 42,000 Gain on sale of investment 500

12/31/13 Fair value adjustment 3,500

Net unrealized gain or loss – OCI 3,500

Available-for-Sale Securities

Impairment of Investments

Fair Value Option

* U.S GAAP allows for the unconditional use of the fair value option

Transfers Between Reporting Categories

Unrealized gains or losses at

reclassification should be accounted for in a manner

consistent with the classification into which the security is being transferred

Unrealized gains or losses at

reclassification should be accounted for in a manner

consistent with the classification into which the security is being transferred

Transfers Between Reporting Categories

Transfer from: To: Permitted/required classification

Derivative securities 

(FVTPL) Others Not permitted

Designated as FVTPL

(“Fair value option”) Others Not permitted

Nonderivative TS AFS Permitted if change in intention to trade (rare)

Nonderivative TS L&R Permitted if meets the definition of L&R*

AFS L&R Permitted if meets the definition of L&R*

HTM AFS Required if intention or ability is tainted

AFS HTM Permitted if no further breaches of tainting rules in current  year and preceding two years

Disclosures of financial instruments (FI)

Investor Has Significant Influence

Investments in typically quoted or publicly traded 

debt securities for which the investor has the 

“positive intent and ability” to hold to maturity

Held­to­maturity (“HTM”) — investment reported at amortized cost*

Investments in unquoted debt securities Loans and receivables (“L&R”) — 

investments reported at amortized costInvestments held in an active trading account Trading securities (“TS”) — investment 

reported at fair value (with unrealized gains and losses included in net income)

Other

Available­for­sale securities (“AFS”) — investment reported at fair value (with unrealized gains and losses excluded from net income and reported directly in shareholders’ equity)*

Typically the investor owns between 20% and 

50% of the ordinary shares of the investee

Investment reported at cost or as a financial asset

Equity method—investment cost adjusted for subsequent earnings and dividends of the investee

Typically the investor owns more than 50% of the 

investee

Investment reported at cost or as a financial asset

Reporting Categories for Investments Control Characteristics of the Investment

The investor controls  the investee:

The investor has  significant influence  over the operating and financial policies of the investee:

The investor lacks  significant influence  over the operating and financial policies of the investee:

As in the separate financial statements

Investor Has Significant Influence

Extent of Investor Influence Reporting Method

Lack of significant influence

(usually < 20% equity ownership)

Varies depending on

classification previously discussed

What Is Significant Influence?

If an investor owns 20% of the voting rights of an investee,

it is presumed that the investor has significant influence

over the financial and operating policies of the investee

The presumption can be overcome if, for example:

1 the investee challenges the investor’s ability to

exercise significant influence through litigation or

other methods.

2 the investor surrenders significant shareholder rights

in a signed agreement.

3 the investor is unable to acquire sufficient information

about the investee to apply the equity method.

4 the investor tries and fails to obtain representation on

the board of directors of the investee.

If an investor owns 20% of the voting rights of an investee,

it is presumed that the investor has significant influence

over the financial and operating policies of the investee

The presumption can be overcome if, for example:

1 the investee challenges the investor’s ability to

exercise significant influence through litigation or

other methods.

2 the investor surrenders significant shareholder rights

in a signed agreement.

3 the investor is unable to acquire sufficient information

about the investee to apply the equity method.

4 the investor tries and fails to obtain representation on

the board of directors of the investee.

Equity Method and Consolidation

The equity method is used when an investor can’t control,

but can “significantly influence” the investee:

Control has two key features in IAS No 27

1 The power to govern the operating and financial

policies of the investees, and

2 The rights to the benefits from the investee’s

activities

• Although the concept of control is qualitative in nature,

an entity is “presumed” to have control if it owns more

than 50% of an investee’s issued or partial ordinary

shares.

• Departure from this qualitative threshold is allowed, but it

must be disclosed and explained

The equity method is used when an investor can’t control,

but can “significantly influence” the investee:

Control has two key features in IAS No 27

1 The power to govern the operating and financial

policies of the investees, and

2 The rights to the benefits from the investee’s

activities

• Although the concept of control is qualitative in nature,

an entity is “presumed” to have control if it owns more

than 50% of an investee’s issued or partial ordinary

Equity Method and Consolidation

A “parent” and “subsidiary” relationship exists when a

investor controls an investee.

1.The parent and subsidiary are considered a single

reporting entity

Consolidated financial statements combine the

separate financial statements of the parent and

subsidiary each period into a single aggregate set

of financial statements.

2 The equity method is sometimes referred to as a

“one line consolidation,” because it shows the

investor’s income and investment as increasing by

their portion of the investee’s income.

A “parent” and “subsidiary” relationship exists when a

investor controls an investee.

1.The parent and subsidiary are considered a single

reporting entity

Consolidated financial statements combine the

separate financial statements of the parent and

subsidiary each period into a single aggregate set

of financial statements.

2 The equity method is sometimes referred to as a

“one line consolidation,” because it shows the

investor’s income and investment as increasing by

their portion of the investee’s income.

Equity Method

by:

earnings.

Equity Method – Example 1

On January 1, 2012, Matrix Ltd acquired 45% of the

equity securities of Apex Ltd for $1,350,000 On the

investment date, Apex’s net assets had a fair value of

$3,000,000 During 2012, Apex paid cash dividends of

$150,000 and reported net income of $1,750,000

What amount will Matrix Ltd report on the statement of financial

position as Investment in Apex Ltd? Ignore taxes.

Equity Method

Investment in Apex Ltd.

Investment 1,350,000 67,500 45% Dividends 45% Earnings 787,500

Reported amount 2,070,000

If the investee had a loss, the investment account would have been reduced.

Equity Method - Example 2

On January 1, 2012, Matrix Ltd purchase 25% of the

ordinary shares of Apex Ltd for $180,000 At the date of

investment, the book value of the net assets of Apex was

$400,000, and the net fair value of these assets is

$600,000 During 2012, Apex paid cash dividends of

$40,000, and reported earnings of $100,000.