Chapter 9

Investments

Prepared by:
Dragan Stojanovic, CA
Rotman School of Management, University of Toronto

Investments
Accounting Models
Introduction
Cost / amortized cost
model
Fair value through
net income model
Fair value through
OCI model
GAAP classifications

Presentatio
Strategic
Incurred loss model Investments n,
Disclosure,
Expected loss model Investments
and
in associates
Fair value loss
Investments
Analysis
model
Impairment

Accounting
standards for
impairment

in subsidiaries

Financial
statement
presentation
and disclosure
Analysis

IFRS /
Private Entity
GAAP
Comparison
Looking
ahead
Comparison

Investments
Accounting Models
Introduction
Cost / amortized cost
model
Fair value through
net income model
Fair value through
OCI model
GAAP classifications

Presentatio
Strategic
Incurred loss model Investments n,
Disclosure,
Expected loss model Investments
and
in associates
Fair value loss
Investments
Analysis
model
Impairment

Accounting
standards for
impairment

in subsidiaries

Financial
statement
presentation
and disclosure
Analysis

IFRS /
Private Entity
GAAP
Comparison
Looking
ahead
Comparison

Investments Recent
Changes
Due to the complexity of accounting for
investments, there are currently a number of
projects by IASB and FASB in this area:
1. Simplification of existing accounting
standards
2. Improved guidance on fair value
measurement

Financial Assets and

Investments
Debt investments include investments in
government debt, corporate bonds,
convertible debt, and commercial paper
Equity instruments represent ownership
interests in companies (e.g., common stock,
preferred stock)
Motivations for investments include: to obtain
short-term returns or long-term returns on
investments, and for corporate strategy
5

Financial Assets and

Investments
Method of accounting for a particular
investment can depend on:
Type of instrument (debt vs. equity)
Managements intent
Ability to reliably measure instruments fair
value, or
Extent of influence over the investee company

Fair Value Issues

Investments generally recognized at their fair
value at acquisition (usually purchase price)
Also, many investments are adjusted to fair
value at the balance sheet date
Unrealized holding gains or losses occur
when a financial instrument is adjusted to its
fair value

Accounting Models
There are three main models of accounting
for investments:
Cost/amortized cost model
Fair value through net income model (FV-NI)
Fair value through other comprehensive
income model (FV-OCI)

Accounting Models:
Summary
Cost/Amortized
Cost Model
At acquisition,
measure at:

FV-NI

FV-OCI

Cost (fair value +

transaction costs)

Fair value

Fair value

At each reporting Cost or amortized

date, measure at: cost

Fair value

Fair value

Unrealized
holding
gains/losses
reported in:

Net income

OCI

Net income

Transfer total
realized to net
income (recycling),
or to retained
9
earnings

Realized holding
gains/losses
reported in:

Not applicable

Net income

Cost/Amortized Cost Model:

Investments in Shares
Cost model for investments in shares of
another entity:
1. Recognize cost of investment at fair value
(plus direct transaction costs)
2. Report at cost (unless impaired)
3. Recognize dividend income when have claim
to dividend
4. When dispose of investment, derecognize
and report a gain/loss on disposal in net
income.
10

Cost/Amortized Cost Model:

Investments in Debt
Securities

Amortized cost model for investments in debt

securities of another entity:

1. Recognize cost of investment at fair value (plus

direct transaction costs)
2. Report at amortized cost as well as interest
receivable (unless impaired)
3. Recognize interest income as earned, and also
amortize any discount/premium by adjusting
carrying amount of investment
4. When dispose of investment, first bring accrued
interest and discount/premium amortization up to
date. Derecognize investment and report a
gain/loss on disposal in net income.
11

Amortized Cost Model:

Example
Given:
Face amount:
$100,000
Purchase date:
January 1, 2011
Maturity date:
January 1, 2016
Interest paid:
July 1st and January 1st
Coupon (stated) rate of interest: 8%
Market (effective) rate of interest: 10%
What is the approximate purchase price?
PV of $100,000 (n=10, i=5%) + PVA of ($100,000 X 4%)
where n=10, i = 5%
PV is approximately equal to $92,278
12

Amortized Cost Model:

Example
The entry to record this purchase is:
Investment in Bonds
Cash

92,278
92,278

Note the discount of $7,722 ($100,000 92,278)

is not recorded separately; it is amortized over
the life of the bond
The effective interest method is used to amortize
the premium or discount (required under IFRS)
Private entity GAAP also allows straight-line
method of amortizing premium or discount
13

Bond Discount Amortization

14

Reporting under Amortized

Cost Model
Balance Sheet
Current assets
Interest receivable (accrued interest
from investment)

$xx,xxx

Long-term investments
Investment, at amortized cost

$xx,xxx

Income Statement
Other revenue and gains
Interest income

$x,xxx
15

Sale of Investments
Discount (or premium) is amortized from last date
of amortization to the date of sale
New carrying amount calculated, which is the
amortized cost balance plus the discount (or minus
the premium) amortized from last date of
amortization
Gain (or loss) calculated as the difference between
selling price and carrying amount
Any accrued interest income is calculated (and
received) over and above the selling price of the
investment
16

Fair Value through Net

Income (FV-NI) Model
Fair value through net income (FV-NI) also
referred to as fair value through profit or loss
(FVTPL) in IFRS
At acquisition, investment recorded at fair value
Transactions costs are expensed
At each reporting date, FV-NI investments are
adjusted to current fair value and any holding
gain or loss is reported in net income
Any earned interest/dividend income and any
holding gain or loss on the investment may be
reported together as Investment Income

17

FV-NI: An example

For non-interest bearing Treasury bill:

Purchase date: March 15
Maturity date: September 15
Pay = $19,231 for $20,000 six-month T-bill (8% yield)

Entry on March 15:

Temporary Investment in T-Bill
Cash

19,231
19,231

Entry on Sept 15:

Cash
Temporary Investment in T-Bill
Investment Income/Loss

20,000
19,231
769
18

FV-NI: An example
A company reported on December 31, 2012:
Investments
Carrying Amount
Fair Value
In various shares
$192,990
$191,200
Adjustment to fair value (192,990-191,200= $1,790)

Entry to record adjustment at year end:

Investment Income/Loss
Investments

1,790
1,790
2012

Current assets:
Temporary investments, at fair value

$191,200
19

Fair Value through Other

Comprehensive Income (FV-OCI)
At acquisition, investments are recorded at
fair value
Transaction costs tend to be added to
investments carrying amount
At each reporting date, FV-OCI investments
are adjusted to current fair value and any
holding gain or loss is reported in other
comprehensive income (OCI)
Accumulated holding gains/losses are
reported in AOCI, which is a separate item
under Shareholders Equity
20

Fair Value through Other

Comprehensive Income (FV-OCI)
When investments are disposed, previously
unrealized holding gains or losses need to be
transferred out of OCI/AOCI
Under FV-OCI with recycling, unrealized
holding gains or losses are transferred (i.e.
recycled) into net income (and as part of net
income, closed into retained earnings)
Under FV-OCI without recycling, unrealized
holding gains or losses are transferred
directly into retained earnings (bypassing net
income)
21

FV-OCI: An Example
Given share investment accounted for at FV-OCI:
Fair value at Dec. 31, 2010 $275,000
Carrying amt. at Dec. 31, 2010
259,700
Unrealized Holding Gain
$ 15,300

Entry to Record:
Investment
15,300
Holding Gain (OCI)

15,300

Long-term investments (assumed)

Investment, at fair value with gains/losses in OCI
Shareholders Equity
Accumulated other comprehensive income (loss)

$ 275,000
$ 15,300
22

FV-OCI: An example
On January 23, 2011 sell investment for $287,220
Entry to record adjustment to fair value:
Investment ($287,220 - 275,000)
12,220
Holding Gain on Investment (OCI)
12,220
Entry to record sale and proceeds:
Cash
Investment

287,220
287,220

Entry to transfer holding gains:

Holding Gain on Investment (OCI)
(15,300+12,220)
27,520
Gain on Sale of Investment
27,520
OR (if FV-OCI without recycling)
Retained Earnings
27,520
23

GAAP Classifications: PE GAAP

Private entity GAAP generally relies on costbased model for equity investments, unless
active market prices are available
FV-NI model is allowed as an option for any
financial instrument
Under all models, interest earned and
dividends received are recognized in net
income

24

GAAP Classifications: IFRS

Amortized cost used only if both of following
conditions are satisfied:
Business model: investment managed on
contractual yield basis (and cash flows best
assessed relative to contractual cash flows
specified by instrument)
Contractual cash flow characteristics: cash
flows represent only payments of principal and
interest on principal outstanding, and occur at
specified dates

If criteria for amortized cost do not apply, then

FV-NI is used.
25

GAAP Classifications: IFRS

IFRS proposed draft standard includes two
additional options:
Investments held for longer term strategic
reasons (without control or significant
influence) may be accounted for under FV-OCI
without recycling if such choice is made on
acquisition
Fair value option provides an opportunity to
use FV-NI accounting from acquisition if it
corrects an accounting mismatch
26

GAAP Classifications: IFRS

Reclassification from one category to another
is not allowed, except when there is a change
in business model in relation to investments
If reclassify to FV-based model, then revalue
at FV and recognize gain/loss in income
If reclassify from FV-based model to another,
then FV at time of reclassification becomes
the new carrying amount

27

Investments
Accounting Models
Introduction
Cost / amortized cost
model
Fair value through
net income model
Fair value through
OCI model
GAAP classifications

Presentatio
Strategic
Incurred loss model Investments n,
Disclosure,
Expected loss model Investments
and
in associates
Fair value loss
Investments
Analysis
model
Impairment

Accounting
standards for
impairment

in subsidiaries

Financial
statement
presentation
and disclosure
Analysis

IFRS /
Private Entity
GAAP
Comparison
Looking
ahead
Comparison

28

Impairment
Investments must be reviewed for possible
impairment to ensure that future benefit
justifies the valuation on the balance sheet
There are three different impairment models:
1. Incurred loss model
2. Expected loss model
3. Full fair value model

29

Impairment: Incurred Loss

Model
Impairment test carried out only if there is evidence of possible
impairment
Indicators of possible impairment include:

Significant financial difficulties

Defaulting on interest/principal payments
Major financial reorganization or bankruptcy
Impairment loss is recognized in net income as difference
between carrying amount and revised present value of expected
cash flows
Revised present value is calculated using discounted cash flow
(DCF) model (using either historic or current market rate as
discount rate)
30

Impairment: Expected Loss

Model
Impairment test carried out continuously
Impairment loss is recognized in net income as
difference between carrying amount and revised
present value of expected cash flows
Revised present value is calculated using
discounted cash flow (DCF) model (using
effective interest rate from time of acquisition)

31

Impairment: Fair Value Loss

Model
Impairment loss is recognized in net income as
difference between carrying amount and fair
value
Where fair value is determined using the
discounted cash flow (DCF) model, using the
current interest rate at time of impairment test

32

Impairment: Fair Value Loss

Model
Impairment loss is recognized in net income as
difference between carrying amount and fair
value
Where fair value is determined using the
discounted cash flow (DCF) model, using the
current interest rate at time of impairment test

33

Impairment: Accounting
Standards
IFRS currently uses the following models:
For all financial asset investments accounted for at
cost or amortized cost: incurred loss model (with
original discount rate)
For FV-OCI instruments: full fair value model (with no
reversals of impairments on equity instruments
recognized in net income; such reversals are
recognized in OCI)

IFRS proposals include:

For instruments at amortized cost: expected loss
model
For instruments at fair value: always adjust to FV

34

Impairment: Accounting
Standards
Private entity GAAP has following requirement:
For financial asset investments accounted for at
cost or amortized cost: incurred loss model
(using current market rate)

35

Investments
Accounting Models
Introduction
Cost / amortized cost
model
Fair value through
net income model
Fair value through
OCI model
GAAP classifications

Presentatio
Strategic
Incurred loss model Investments n,
Disclosure,
Expected loss model Investments
and
in associates
Fair value loss
Investments
Analysis
model
Impairment

Accounting
standards for
impairment

in subsidiaries

Financial
statement
presentation
and disclosure
Analysis

IFRS /
Private Entity
GAAP
Comparison
Looking
ahead
Comparison

36

Strategic Investments

As common shares carry voting rights, extent

of influence becomes a factor in determining
the appropriate accounting treatment
There are three levels of influence, each with
its own accounting treatment:
1. Little or no influence
2. Significant influence
3. Control
37

Equity Investments:
Common Shares
%
Ownership

0%

20%

50%

100%

Level of
Influence

Little or
none

Significant

Control

Type of
Investment

Less than
significant
influence

Associate, or
significant
influence

Subsidiary

38

Investment in Associates:
Significant Influence

Applies to equity investments of significant

influence (not control)
Significant influence deemed using the following
criteria:
1. Quantitative test: 20% to 50% ownership
2. Qualitative test:
Representation on Board of Directors
Participation in policy-making
Material intercompany transactions
Exchange of management personnel
Provision of technical information
39

Investment in Associates

Under IFRS, investments in associates (i.e.

significant influence) are accounted for using the
equity method of accounting
Under private entity GAAP, investors can choose
from following options for all significant influence
investments:

Equity method, or
Cost method (unless associate shares are quoted in
active market, in which case FV-NI model is used)

40

Equity Method
Investment recorded at cost of acquisition
Investor takes into income its respective share
of the investee net income for the year by
debiting the Investment account and crediting
Investment Income
Any dividends received are credited to the
Investment account
The accrual basis of accounting is applied

Consider the following example of Maxi Limited:

41

Equity Method: Example

Given:
Maxi Corp. purchases 20% of Mini Corp., and exercises
significant influence
January 2, 2010 Maxi purchases 48,000 shares @ $10 per
share
For the year 2010 Mini Corp. reports a net income of $200,000
December 31, 2010 shares of Mini Corp. have a market price of
$12 per share
January 28, 2011 Mini Corp. declared and paid a total cash
dividend of $100,000
For the year 2011, Mini Corp. reports a net loss of $50,000
Prepare all necessary journal entries, using the Equity Method
42

Equity Method: Example

January 2, 2010
Investment in Mini Corp. 480,000
Cash
480,000
(48,000 shares x $10)
December 31, 2010
Investment in Mini Corp. 40,000
Investment Income 40,000
($200,000 net income x 20%)
December 31, 2010
No entry required to reflect market
price (or fair value). Investment is not
impaired.

January 28, 2011

Cash
20,000
Investment in Mini Corp. 20,000
($100,000 Dividend x 20%)
December 31, 2011
Investment Loss
10,000
Investment in Mini Corp. 10,000
($50,000 net loss x 20%)

43

Equity Method
Amounts paid in excess of (or less than)
investees book value becomes part of the cost of
the investment
These amounts must be accounted for
appropriately after the acquisition
For example, if the difference is due to long-lived
assets with fair values greater than book value, the
difference must be amortized

Share of discontinued operations and other

comprehensive income of investee are reported
in the same way by the investor (major
classifications of income are retained)
44

Equity Method: Impairment

Investments with significant influence are
assessed at the end of each reporting period to
determine if there are indicators of impairment
If there are indicators of impairment, the
impairment test is carried out
Impairment loss is recognized in income and is
measured as carrying amount in excess of
investments recoverable amount
Investments recoverable amount is measured as
the higher of value in use and fair value less cost
to sell
Impairment losses may be reversed
45

Equity Method: Disposal

On disposal of the investment, both investment
account and investment income accounts are
brought up to date (i.e. adjusted for investors
share of associates income and changes in book
value up to date of sale)
Investments carrying value is removed and any
gains/losses are recognized in net income

46

Investments in Subsidiaries
A corporation (the parent) can acquire control
of another corporation (the subsidiary)
Control is generally acquired through
purchasing 50% or more voting shares
Control is defined as continuing power to
determine/direct the strategic operating,
financing, and investment policies/activities,
without the co-operation of others

47

Investments in Subsidiaries
Under IFRS, investments for subsidiaries are
accounted for preparation of consolidated
financial statements
The two corporations are reported as a single
business entity

Under private entity GAAP, parent company

has the following options when accounting for
subsidiaries:
Consolidate all subsidiaries
Account for all subsidiaries under either equity or
cost method (cost method cannot be used if
shares are traded in an active market, and FV-NI is
used instead)
48

Consolidated Financial
Statements
Parent Corporation
-Income Statement
-Balance Sheet

Subsidiary
Corporation
-Income Statement
-Balance Sheet

Consolidated Entity

(Reported by Parent Corporation)

Combined Balance Sheet, line-by-line (100%)
Combined Income Statement, line-by-line (100%)
Eliminate any unrealized inter-company gains and losses
Eliminate any inter-company balances
Parent eliminates the investment in the subsidiary company
Non-controlling interest reported (the percent of the
subsidiary not owned by the parent) on both balance sheet
and income statements
49

Investments
Accounting Models
Introduction
Cost / amortized cost
model
Fair value through
net income model
Fair value through
OCI model
GAAP classifications

Strategic
Presentatio
Incurred loss model Investments n,
Disclosure,
Expected loss model Investments
in associates
and
Fair value loss
Investments
Analysis
model
Impairment

Accounting
standards for
impairment

in subsidiaries

Financial
statement
presentation
and disclosure
Analysis

IFRS /
Private Entity
GAAP
Comparison
Looking
ahead
Comparison

50

Presentation and Disclosure

For investments without significant influence or
control, key presentation issue is classification of
investment as current vs. long-term
Key disclosures include following types of
information:
Carrying amount of investments
Income statement effects
Financial risk

IFRS generally has more onerous disclosure

requirements than private entity GAAP
51

Investments
Accounting Models
Introduction
Cost / amortized cost
model
Fair value through
net income model
Fair value through
OCI model
GAAP classifications

Presentatio
Strategic
Incurred loss model Investments n,
Disclosure,
Expected loss model Investments
and
in associates
Fair value loss
Investments
Analysis
model
Impairment

Accounting
standards for
impairment

in subsidiaries

Financial
statement
presentation
and disclosure
Analysis

IFRS /
Private Entity
GAAP
Comparison
Looking
ahead
Comparison

52

Looking Ahead
Area of accounting for financial assets in general is
undergoing significant change
IASB and FASB are currently working on
simplifying accounting for financial instrument
(especially ones without significant influence or
control)
Additional changes expected from IASB include:
New impairment standard
New financial instrument derecognition standard
Revisions to conceptual frameworks (IASB and
FASB)
53

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54