CHAPTER 17 Investments ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC) Topics Questions Debt securities Brief Exercises Exercises 1, 2, 3, 13 Problems 2, 3, Concepts for Analysis 4, (a) Held-to-maturity 4, 5, 7, 8, 10, 13, 21 1, 1, (b) Trading 4, 6, 7, 8, 10, 21 (c) Available-for-sale 4, 7, 8, 9, 10, 11, 21 2, 10 1, 2, 3, 4, Bond amortization 8, 1, 2, 3, 4, 1, 2, 3 Equity securities 1, 12, 16 1, 1, 4, (a) Available-for-sale 7, 10, 11, 15, 21 5, 6, 8, 9, 11, 12, 16, 19, 20 5, 6, 8, 9, 10, 11, 12 1, 2, (b) Trading 6, 7, 8, 10, 14, 15, 21 6, 7, 14, 15 6, 1, (c) Equity method 16, 17, 18, 19, 20 12, 13, 16, 17 5, Comprehensive income 22 10 10, 12 Disclosures of investments 21 8, 5, 8, 9, 10, 11, 12 Fair value option 25, 26, 27 19, 20, 21 Impairments 24 Transfers between categories 23 *9 Derivatives *10 Variable Interest Entities 10 28, 29, 30, 31, 32, 33, 34, 35 18 1, 3, 22, 23, 24, 25, 26, 27 13, 14, 15, 16, 17, 18 36, 37 *This material is dealt with in an Appendix to the chapter Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 17-1 ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE) Brief Exercises Learning Objectives Exercises Problems Identify the three categories of debt securities and describe the accounting and reporting treatment for each category Understand the procedures for discount and premium amortization on bond investments 1, 2, 3, 2, 3, 4, 5, 21 1, 2, 3, 4, Identify the categories of equity securities and describe the accounting and reporting treatment for each category 5, 6, 1, 6, 7, 8, 9, 11, 12, 14, 15, 16, 19, 20, 21 3, 5, 6, 8, 9, 10, 11, 12 Explain the equity method of accounting and compare it to the fair value method for equity securities 12, 13, 16, 17 Describe the accounting for the fair value option 19, 20, 21 8, 9, 10, 12 Discuss the accounting for impairments of debt and equity investments 10 18 Explain why companies report reclassification adjustments 10 Describe the accounting for transfer of investment securities between categories *9 Explain who uses derivatives and why *10 Understand the basic guidelines for accounting for derivatives *11 Describe the accounting for derivative financial instruments 22, 26 13, 14, 15 *12 Explain how to account for a fair value hedge 23, 25 16, 18 *13 Explain how to account for a cash flow hedge 24, 27 17 17-2 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) ASSIGNMENT CHARACTERISTICS TABLE Item E17-1 E17-2 E17-3 E17-4 E17-5 E17-6 E17-7 E17-8 E17-9 E17-10 E17-11 E17-12 E17-13 E17-14 E17-15 E17-16 E17-17 E17-18 E17-19 E17-20 E17-21 *E17-22 *E17-23 *E17-24 *E17-25 *E17-26 *E17-27 P17-1 P17-2 P17-3 P17-4 P17-5 P17-6 P17-7 P17-8 P17-9 Description Investment classifications Entries for held-to-maturity securities Entries for held-to-maturity securities Entries for available-for-sale securities Effective-interest versus straight-line bond amortization Entries for available-for-sale and trading securities Trading securities entries Available-for-sale securities entries and reporting Available-for-sale securities entries and financial statement presentation Comprehensive income disclosure Equity securities entries Journal entries for fair value and equity methods Equity method Equity investment—trading Equity investments—trading Fair value and equity method compared Equity method Impairment of debt securities Fair Value measurement Fair Value measurement Fair value option Derivative transaction Fair value hedge Cash flow hedge Fair value hedge Call option Cash flow hedge Debt securities Available-for-sale debt securities Available-for-sale investments Available-for-sale debt securities Equity securities entries and disclosures Trading and available-for-sale securities entries Available-for-sale and held-to-maturity debt securities entries Fair value and equity methods Financial statement presentation of available-for-sale investments Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual Level of Difficulty Time (minutes) Simple Simple Simple Simple Simple Simple Simple Simple Simple 5–10 10–15 15–20 10–15 20–30 10–15 10–15 5–10 10–15 Moderate Simple Simple Moderate Moderate Moderate Simple Simple Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate 20–25 20–25 15–20 10–15 10–15 15–20 15–20 10–15 15–20 15–20 15–20 15–20 15–20 20–25 20–25 15–20 20–25 25–30 Moderate Moderate Moderate Moderate Moderate Simple Moderate Moderate Moderate 30–40 30–40 25–30 25–35 25–35 25–35 25–35 20–30 20–30 (For Instructor Use Only) 17-3 ASSIGNMENT CHARACTERISTICS TABLE (Continued) Item P17-10 P17-11 P17-12 *P17-13 *P17-14 *P17-15 *P17-16 *P17-17 *P17-18 CA17-1 CA17-2 CA17-3 CA17-4 CA17-5 CA17-6 CA17-7 17-4 Description Gain on sale of securities and comprehensive income Equity investments—available-for-sale Available-for-sale securities—statement presentation Derivative financial instrument Derivative financial instrument Free-standing derivative Fair value hedge interest rate swap Cash flow hedge Fair value hedge Level of Difficulty Moderate Complex Moderate Moderate Moderate Moderate Moderate Moderate Moderate Time (minutes) 20–30 35–45 20–30 20–25 20–25 20–25 30–40 25–35 25–35 Issues raised about investment securities Equity securities Financial statement effect of equity securities Equity securities Investment accounted for under the equity method Equity investment Fair value—ethics Moderate Moderate Simple Moderate Simple Moderate Moderate 25–30 25–30 20–30 20–25 15–25 25–35 25–35 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) SOLUTIONS TO CODIFICATION EXERCISES CE17-1 Master Glossary (a) Trading securities are securities that are bought and held principally for the purpose of selling them in the near term and therefore held for only a short period of time Trading generally reflects active and frequent buying and selling, and trading securities are generally used with the objective of generating profits on short-term differences in price (b) A holding gain or loss is the net change in fair value of a security The holding gain or loss does not include dividend or interest income recognized but not yet received or write-downs for otherthan-temporary impairment (c) A cash flow hedge is a hedge of the exposure to variability in the cash flows of a recognized asset or liability, or of a forecasted transaction, that is attributable to a particular risk (d) A fair value hedge is a hedge of the exposure to changes in the fair value of a recognized asset or liability, or of an unrecognized firm commitment, that are attributable to a particular risk CE17-2 According to FASB ASC 235-10-S99-1 (Notes to Financial Statements—SEC Materials): (n) Accounting policies for certain derivative instruments Disclosures regarding accounting policies shall include descriptions of the accounting policies used for derivative financial instruments and derivative commodity instruments and the methods of applying those policies that materially affect the determination of financial position, cash flows, or results of operation This description shall include, to the extent material, each of the following items: (1) A discussion of each method used to account for derivative financial instruments and derivative commodity instruments; (2) The types of derivative financial instruments and derivative commodity instruments accounted for under each method; (3) The criteria required to be met for each accounting method used, including a discussion of the criteria required to be met for hedge or deferral accounting and accrual or settlement accounting (e g., whether and how risk reduction, correlation, designation, and effectiveness tests are applied); (4) The accounting method used if the criteria specified in paragraph (n)(3) of this section are not met; (5) The method used to account for terminations of derivatives designated as hedges or derivatives used to affect directly or indirectly the terms, fair values, or cash flows of a designated item; Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 17-5 CE17-2 (Continued) (6) The method used to account for derivatives when the designated item matures, is sold, is extinguished, or is terminated In addition, the method used to account for derivatives designated to an anticipated transaction, when the anticipated transaction is no longer likely to occur; and (7) Where and when derivative financial instruments and derivative commodity instruments, and their related gains and losses, are reported in the statements of financial position, cash flows, and results of operations Instructions to paragraph 4-08(n) For purposes of this paragraph (n), derivative financial instruments and derivative commodity instruments (collectively referred to as “derivatives”) are defined as follows: (i) Derivative financial instruments have the same meaning as defined by generally accepted accounting principles (see Financial Accounting Standards Board (“FASB”), Statement of Financial Accounting Standards No 119, “Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments,” (“FAS 119”) paragraphs 5–7, (October 1994)), and include futures, forwards, swaps, options, and other financial instruments with similar characteristics (ii) Derivative commodity instruments include, to the extent such instruments are not derivative financial instruments, commodity futures, commodity forwards, commodity swaps, commodity options, and other commodity instruments with similar characteristics that are permitted by contract or business custom to be settled in cash or with another financial instrument For purposes of this paragraph, settlement in cash includes settlement in cash of the net change in value of the derivative commodity instrument (e g., net cash settlement based on changes in the price of the underlying commodity) For purposes of paragraphs (n)(2), (n)(3), (n)(4), and (n)(7), the required disclosures should address separately derivatives entered into for trading purposes and derivatives entered into for purposes other than trading For purposes of this paragraph, trading purposes has the same meaning as defined by generally accepted accounting principles (see, e g., FAS 119, paragraph 9a (October 1994)) For purposes of paragraph (n)(6), anticipated transactions means transactions (other than transactions involving existing assets or liabilities or transactions necessitated by existing firm commitments) an enterprise expects, but is not obligated, to carry out in the normal course of business (see, e g., FASB, Statement of Financial Accounting Standards No 80, “Accounting for Futures Contracts,” paragraph 9, (August 1984)) Registrants should provide disclosures required under paragraph (n) in filings with the Commission that include financial statements of fiscal periods ending after June 15, 1997 [45 FR 63669, Sept 25, 1980, as amended at 46 FR 56179, Nov 16, 1981; 50 FR 25215, June 18, 1985; 50 FR 49532, Dec 3, 1985; 51 FR 3770, Jan 30, 1986; 57 FR 45293, Oct 1, 1992; 59 FR 65636, Dec 20, 1994; 62 FR 6063, Feb 10, 1997] 17-6 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) CE17-3 According to FASB ASC 323-10-35-20 (Investments—Equity Method and Joint Ventures—Subsequent Measurement): The investor ordinarily shall discontinue applying the equity method if the investment (and net advances) is reduced to zero and shall not provide for additional losses unless the investor has guaranteed obligations of the investee or is otherwise committed to provide further financial support for the investee CE17-4 According to FASB ASC 815-10-45-4 (Derivatives and Hedging—Other Presentation Matters—Balance Sheet Netting); Unless the conditions in paragraph 210-20-45-1 are met, the fair value of derivative instruments in a loss position shall not be offset against the fair value of derivative instruments in a gain position Similarly, amounts recognized as accrued receivables shall not be offset against amounts recognized as accrued payables unless a right of setoff exists Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 17-7 ANSWERS TO QUESTIONS A debt security is an instrument representing a creditor relationship with an enterprise Debt securities include U.S government securities, municipal securities, corporate bonds, convertible debt, and commercial paper Trade accounts receivable and loans receivable are not debt securities because they not meet the definition of a security An equity security is described as a security representing an ownership interest such as common, preferred, or other capital stock It also includes rights to acquire or dispose of an ownership interest at an agreed-upon or determinable price such as warrants, rights, and call options or put options Convertible debt securities and redeemable preferred stocks are not treated as equity securities The variety in bond features along with the variability in interest rates permits investors to shop for exactly the investment that satisfies their risk, yield, and marketability desires, and permits issuers to create a debt instrument best suited to their needs Cost includes the total consideration to acquire the investment, including brokerage fees and other costs incidental to the purchase The three types of classifications are: Held-to-maturity: Debt investments that the enterprise has the positive intent and ability to hold to maturity Trading: Debt investments bought and held primarily for sale in the near term to generate income on short-term price differences Available-for-sale: Debt investments not classified as held-to-maturity or trading securities A debt investment should be classified as held-to-maturity only if the company has both: (1) the positive intent and (2) the ability to hold those securities to maturity Trading securities are reported at fair value, with unrealized holding gains and losses reported as part of net income Any discount or premium is amortized Trading and available-for-sale securities should be reported at fair value, whereas held-tomaturity securities should be reported at amortized cost $3,500,000 X 10% = $350,000; $350,000 ÷ = $175,000 Wheeler would make the following entry: Cash ($4,000,000 X 8% X 1/2) Debt Investments Interest Revenue ($3,500,000 X 10% X 1/2) 160,000 15,000 Fair Value Adjustment (Available-for-Sale) Unrealized Holding Gain or Loss—Equity [$3,604,000 – ($3,500,000 + $15,000)*] 89,000 175,000 89,000 *See number 10 17-8 Unrealized holding gains and losses for trading securities should be included in net income for the current period Unrealized holding gains and losses for available-for-sale securities should be reported as other comprehensive income and as a separate component of stockholders’ equity Unrealized holding gains and losses are not recognized for held-to-maturity securities Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) Questions Chapter 17 (Continued) 11 (a) Unrealized Holding Gain or Loss—Equity Fair Value Adjustment (Available-for-Sale) (b) Unrealized Holding Gain or Loss—Equity Fair Value Adjustment (Available-for-Sale) 60,000 60,000 70,000 70,000 12 Investments in equity securities can be classified as follows: (a) Holdings of less than 20% (fair value method)—investor has passive interest (b) Holdings between 20% and 50% (equity method)—investor has significant influence (c) Holdings of more than 50% (consolidated statements)—investor has controlling interest Holdings of less than 20% are then classified into trading and available-for-sale, assuming determinable fair values 13 Investments in stock not have a maturity date and therefore cannot be classified as held-tomaturity securities 14 Gross selling price of 10,000 shares at $27.50 Less: Brokerage commissions Proceeds from sale Cost of 10,000 shares Gain on sale of investments Cash Equity Investments Gain on Sale of Investments $275,000 (1,770) 273,230 (260,000) $ 13,230 273,230 260,000 13,230 15 Both trading and available-for-sale equity securities are reported at fair value However, any unrealized holding gain or loss is reported in net income for trading securities but as other comprehensive income and as a separate component of stockholders’ equity for available-forsale securities 16 Significant influence over an investee may result from representation on the board of directors, participation in policy-making processes, material intercompany transactions, interchange of managerial personnel, or technological dependency An investment (direct or indirect) of 20% or more of the voting stock of an investee constitutes significant influence unless there exists evidence to the contrary 17 Under the equity method, the investment is originally recorded at cost, but is adjusted for changes in the investee’s net assets The investment account is increased (decreased) by the investor’s proportionate share of the earnings (losses) of the investee and decreased by all dividends received by the investor from the investee 18 The following disclosures in the investor’s financial statements are generally applicable to the equity method: (a) (b) (c) (d) The name of each investee and the percentage of ownership of common stock The accounting policies of the investor with respect to investments in common stock The difference, if any, between the amount in the investment account and the amount of underlying equity in the net assets of the investee The aggregate value of each identified investment based on quoted market price (if available) Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 17-9 Questions Chapter 17 (Continued) (e) When investments of 20% or more interest are, in the aggregate, material in relation to the financial position and operating results of an investor, it may be necessary to present summarized information concerning assets, liabilities, and results of operations of the investees, either individually or in groups, as appropriate 19 Dividends subsequent to acquisition should be accounted for as a reduction in the investment in common stock account 20 Ordinarily, Raleigh Corp should discontinue applying the equity method and not provide for additional losses beyond the carrying value of $170,000 However, if Raleigh Corp.’s loss is not limited to its investment (due to a guarantee of Borg’s obligations or other commitment to provide further financial support or if imminent return to profitable operations by Borg appears to be assured), it is appropriate for Raleigh Corp to provide for its entire $186,000 share of the $620,000 loss 21 Trading securities should be reported at aggregate fair value as current assets Individual held-tomaturity and available-for-sale securities are classified as current or noncurrent depending upon the circumstances Held-to-maturity securities generally should be classified as current or noncurrent, based on the maturity date of the individual securities Debt securities identified as available-for-sale should be classified as current or noncurrent, based on maturities and expectations as to sales and redemptions in the following year Equity securities identified as available-for-sale should be classified as current if these securities are available for use in current operations 22 Reclassification adjustments are necessary to insure that double counting does not result when realized gains or losses are reported as part of net income but also are shown as part of other comprehensive income in the current period or in previous periods 23 When a security is transferred from one category to another, the transfer should be recorded at fair value, which in this case becomes the new basis for the security Any unrealized gain or loss at the date of the transfer increases or decreases stockholders’ equity The unrealized gain or loss at the date of the transfer to the trading category is recognized in income 24 A debt security is impaired when “it is probable that the investor will be unable to collect all amounts due according to the contractual terms.” When an impairment has occurred, the security is written down to its fair value, which is also the security’s new cost basis The amount of the writedown is accounted for as a realized loss 25 Fair value is now defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” Fair value is therefore a market-based measure 26 The fair value option gives companies the option to report most financial instruments at fair value with all gains and losses related to changes in fair value reported in the income statement This option is applied on an instrument by instrument basis The fair value option is generally available only at the time a company first purchases the financial asset or incurs a financial liability If a company chooses to use the fair value option, it must measure this instrument at fair value until the company no longer has ownership 27 No The fair value option is generally available only at the time a company first purchases the financial asset or incurs a financial liability If a company chooses to use the fair value option, it must measure this instrument at fair value until the company no longer has ownership 17-10 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued) Equity Investment (Slobbaer) Revenue from Investments (To record income on the equity method, $300,000 X 25% = $75,000) 75,000 Cash Equity Investments (Slobbaer) (To record dividends received from equity-method investee, $100,000 X 25% = $25,000 25,000 75,000 25,000 Analysis The total effect on net income is $120,000 – $150,000 + $75,000 = $45,000 Note that the gain on the available-for-sale securities is a component of other comprehensive income, not net income reported on Instar’s income statement Note also that the equity method dividends received reduce the balance sheet value of the investment and are not recorded as revenue or income Principles The rationale for reporting held-to-maturity securities at amortized cost is that if management intends to hold the securities to maturity, fair values are not relevant for evaluating the cash flows associated with these securities On the other hand, if the securities are trading or available-for-sale, they may be sold before maturity or have such short maturities that information on their fair value is relevant for determining future cash flows When a company exercises significant influence over the operations of another company, it is argued that the investor company should use the equity method of accounting The rationale for this measurement basis is that the investor company should report the net income at the time the investee company earns it Under the fair value method for available-forsale securities, the company does not report income until it receives a dividend or sells the security (although it can increase or decrease other comprehensive income) 17-84 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) PROFESSIONAL RESEARCH (a) According to FASB ASC 320-10: 15-5 The guidance in the Investments—Debt and Equity Securities Topic establishes standards of financial accounting and reporting for both of the following: a Investments in equity securities that have readily determinable fair values b All investments in debt securities, including debt instruments that have been securitized Readily Determinable Fair Value (FASB ASC 320-10-20 Glossary) An equity security has a readily determinable fair value if it meets any of the following conditions: a The fair value of an equity security is readily determinable if sales prices or bid-and-asked quotations are currently available on a securities exchange registered with the U.S Securities and Exchange Commission (SEC) or in the over-the-counter market, provided that those prices or quotations for the over-the-counter market are publicly reported by the National Association of Securities Dealers Automated Quotations systems or by Pink Sheets LLC Restricted stock meets that definition if the restriction terminates within one year b The fair value of an equity security traded only in a foreign market is readily determinable if that foreign market is of a breadth and scope comparable to one of the U.S markets referred to above c The fair value of an investment in a mutual fund is readily determinable if the fair value per share (unit) is determined and published and is the basis for current transactions Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 17-85 PROFESSIONAL RESEARCH (Continued) (b) See FASB ASC 320-10-35 35-18 For individual securities classified as either available for sale or held to maturity, an entity shall determine whether a decline in fair value below the amortized cost basis is other than temporary Providing a general allowance for unidentified impairment in a portfolio of securities is not appropriate 35-30 If the fair value of an investment is less than its amortized cost basis at the balance sheet date of the reporting period for which impairment is assessed, the impairment is either temporary or other than temporary In addition to the guidance in this Section, an entity shall apply other guidance that is pertinent to the determination of whether an impairment is other than temporary, such as the guidance in Section 325-40-35, as applicable Other than temporary does not mean permanent (c) See FASB ASC 320-10-25 25-14 Sales of debt securities that meet either of the following conditions may be considered as maturities for purposes of the classification of securities and the disclosure requirements under this Subtopic: The sale of a security occurs near enough to its maturity date (or call date if exercise of the call is probable) that interest rate risk is substantially eliminated as a pricing factor That is, the date of sale is so near the maturity or call date (for example, within three months) that changes in market interest rates would not have a significant effect on the security’s fair value The sale of a security occurs after the entity has already collected a substantial portion (at least 85 percent) of the principal outstanding at acquisition due either to prepayments on the debt security or to scheduled payments on a debt security payable in equal installments (both principal and interest) over its term For variable-rate securities, the scheduled payments need not be equal 17-86 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) PROFESSIONAL RESEARCH (Continued) (d) See FASB ASC 320-10-50 50-10 For any sales of or transfers from securities classified as heldto-maturity, an entity shall disclose all of the following in the notes to the financial statements for each period for which the results of operations are presented: The net carrying amount of the sold or transferred security The net gain or loss in accumulated other comprehensive income for any derivative that hedged the forecasted acquisition of the held-to-maturity security The related realized or unrealized gain or loss The circumstances leading to the decision to sell or transfer the security (Such sales or transfers should be rare, except for sales and transfers due to the changes in circumstances identified in paragraph 320-10-25-6(a) through (f).) Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 17-87 PROFESSIONAL SIMULATION Journal Entries (a) Debt Investments (Available-for-Sale) Interest Revenue ($50,000 X 12 X 4/12) Investments 187,400* 2,000 189,400 *($37,400 + $100,000 + $50,000) (b) December 31, 2012 Interest Receivable Interest Revenue **Accrued interest: $50,000 X 12 X 10/12 = Accrued interest: $100,000 X 11 X 3/12 = 7,750 7,750** $5,000 2,750 $7,750 Measurement 17-88 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) PROFESSIONAL SIMULATION (Continued) Explanation If Powerpuff owns 30%, it will use the equity method to account for the investment As a result, this investment would not be reported at fair value and there would be no unrealized holding gains or losses Under the equity method, the investment carrying amount is periodically increased (decreased) by the investor’s proportionate share of the earnings (losses) of the investor and decreased by all dividends received by the investor from the investee Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 17-89 IFRS CONCEPTS AND APPLICATION IFRS17-1 The accounting for investment securities is discussed in IAS 27 (“Consolidated and Separate Financial Statements”), IAS 28 (“Accounting for Investments in Associates”), IAS 39 (“Financial Instruments: Recognition and Measurement”), and IFRS (“Financial Instruments”) IFRS17-2 GAAP classifies investments as trading, available-for-sale (both debt and equity investments), and held-to-maturity (debt investments) IFRS uses heldfor-collection (debt investments), trading (both debt and equity investments), and non-trading equity investment classifications The accounting for trading investments is the same between GAAP and IFRS Held-to-maturity (GAAP) and held-for-collection (IFRS) investments are accounted for at amortized cost Gains and losses related to available-for-sale (GAAP) and non-trading equity investments (IFRS) are reported in other comprehensive income Both GAAP and IFRS use the same test to determine whether the equity method of accounting should be used—that is, significant influence with a general guide of over 20 percent ownership The basis for consolidation under IFRS is control Under GAAP, a bipolar approach is used, which is a risk-and-reward model (often referred to as a variable-entity approach) and a voting interest approach However, under both systems, for consolidation to occur, the investor company must generally own 50 percent of another company GAAP and IFRS are similar in the accounting for the fair value option That is, the option to use the fair value method must be made at initial recognition, the selection is irrevocable, and gains and losses are reported as part of income One difference is that GAAP permits the fair value option for equity method investments While measurement of impairments is similar, GAAP does not permit the reversal of an impairment charge related to available-for-sale debt and equity investments IFRS allows reversals of impairments for held-for-collection investments 17-90 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) IFRS17-3 The two criteria for determining the valuation of financial assets are the (1) company’s business model for managing their financial assets and (2) contractual cash flow characteristics of the financial asset IFRS17-4 Only debt investments such as loans and bond investments are valued at amortized cost A company should use amortized cost if it has a business model whose objective is to hold assets in order to collect contractual cash flows and the contractual terms of the financial asset gives specified dates to cash flows IFRS17-5 Lady Gaga should classify this investment as a trading investment because companies frequently buy and sell this type of investment to generate profits in short term differences in price IFRS17-6 If Lady Gaga plans to hold the investment to collect interest and receive the principal at maturity, it should account for this investment at amortized cost IFRS17-7 Unrealized holding gains and losses for trading investments should be included in net income for the current period Unrealized holding gains and losses are not recognized for held-for-collection investments IFRS17-8 (a) Under U.S GAAP, Ramirez makes no entry, because impaired investments may not be written up if they recover in value (b) Under IFRS, Ramirez makes the following entry: Debt Investments Recovery of Impairment Loss Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual 300,000 300,000 (For Instructor Use Only) 17-91 IFRS17-9 (a) Debt Investments Cash 65,118 (b) Cash ($60,000 X 08 X 6/12) Debt Investments Interest Revenue ($65,118 X 06 X 6/12) 2,400 65,118 446 1,954 IFRS17-10 (a) Equity Investments Cash 13,200 (b) Cash Dividend Revenue (400 X $3.25) 1,300 (c) Fair Value Adjustment Unrealized Holding Gain or Loss—Income [(400 X $34.50) – $13,200] 600 13,200 1,300 600 IFRS17-11 (a) Equity Investments Cash 13,200 (b) Cash Dividend Revenue (400 X $3.25) 1,300 (c) Fair Value Adjustment Unrealized Holding Gain or Loss— Equity [(400 X $34.50) – $13,200] 600 17-92 Copyright © 2011 John Wiley & Sons, Inc 13,200 Kieso, Intermediate Accounting, 14/e, Solutions Manual 1,300 600 (For Instructor Use Only) IFRS17-12 (a) January 1, 2012 Debt Investments Cash (b) 537,907.40 537,907.40 Schedule of Interest Revenue and Bond Premium Amortization 12% Bonds Sold to Yield 10% Date 1/1/12 12/31/12 12/31/13 12/31/14 12/31/15 12/31/16 Cash Received — $60,000 60,000 60,000 60,000 60,000 Interest Revenue — $53,790.74 53,169.81 52,486.80 51,735.48 50,909.77* Premium Amortized — $6,209.26 6,830.19 7,513.20 8,264.52 *9,090.23 Carrying Amount of Bonds $537,907.40 531,698.14 524,867.95 517,354.75 509,090.23 500,000.00 *Rounded by 75¢ (c) December 31, 2012 Cash Debt Investments Interest Revenue (d) 60,000.00 6,209.26 53,790.74 December 31, 2013 Cash Debt Investments Interest Revenue 60,000.00 6,830.19 53,169.81 IFRS17-13 (a) January 1, 2012 Debt Investments Cash Copyright © 2011 John Wiley & Sons, Inc 537,907.40 Kieso, Intermediate Accounting, 14/e, Solutions Manual 537,907.40 (For Instructor Use Only) 17-93 IFRS17-13 (Continued) (b) December 31, 2012 Cash Debt Investments Interest Revenue ($537,907.40 X 10) 60,000.00 Fair Value Adjustment Unrealized Holding Gain or Loss— Income ($534,200.00 – $531,698.14) 2,501.86 (c) 6,209.26 53,790.74 2,501.86 December 31, 2013 Unrealized Holding Gain or Loss—Income Fair Value Adjustment Amortized Cost Debt investments Previous fair value adjustment—Dr Fair value adjustment—Cr 12,369.81 12,369.81 Fair Value Unrealized Holding Gain (Loss) $524,867.95 $515,000.00 $ (9,867.95) 2,501.86 $(12,369.81) IFRS17-14 (a) December 31, 2012 Unrealized Holding Gain or Loss—Income Fair Value Adjustment 1,400 (b) During 2013 Cash Loss on Sale of Investments Equity Investments 9,500 500 17-94 Copyright © 2011 John Wiley & Sons, Inc 1,400 Kieso, Intermediate Accounting, 14/e, Solutions Manual 10,000 (For Instructor Use Only) IFRS17-14 (Continued) (c) December 31, 2013 Investments Stargate Corp shares Vectorman Co shares Total of portfolio Previous fair value adjustment balance—Cr Fair value adjustment—Dr Cost $20,000 20,000 $40,000 Fair Value $19,300 20,500 $39,800 Fair Value Adjustment Unrealized Holding Gain or Loss— Income Unrealized Gain (Loss) $ (700) 500) (200) (1,400) $ 1,200 1,200 1,200 IFRS17-15 (a) Contractual cash flow [($400,000 X 10 X 3) + $400,000] Expected cash flow Cash flow loss Recorded investment Less: Present value of €350,000 due in years at 10% (€350,000 X 75131) Present value of €35,000 annual interest for years at 10% (€35,000 X 2.48685) Impairment loss (b) Loss on Impairment Debt Investments $520,000 (455,000) $ 65,000 $400,000 $262,959 87,040 349,999 $ 50,001 50,001 50,001 (c) Since Komissarov will now receive the contractual cash flow ($520,000) there is no cash flow loss Therefore Komissarov must reverse the impairment loss by debiting Debt Investments and crediting Recovery of Impairment Loss Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 17-95 IFRS17-16 (a) According to IAS 39, paragraph AG71, “A financial instrument is regarded as quoted in an active market if quoted prices are readily and regularly available from an exchange, dealer, broker, industry group, pricing service or regulatory agency, and those prices represent actual and regularly occurring market transactions on an arm’s length basis.” (b) According to IAS 39, paragraph IN22, “The Standard requires that impairment losses on available-for-sale equity instruments cannot be reversed through profit or loss, i.e any subsequent increase in fair value is recognised in other comprehensive income.” Also, according to paragraph 58, “An entity shall assess at the end of each reporting period whether there is any objective evidence that a financial asset or group of financial assets is impaired If any such evidence exists, the entity shall apply paragraph 63 (for financial assets carried at amortised cost), paragraph 66 (for financial assets carried at cost) or paragraph 67 (for available-for-sale financial assets) to determine the amount of any impairment loss.” (c) According to IFRS 9, paragraph B4.3, Although the objective of an entity’s business model may be to hold financial assets in order to collect contractual cash flows, the entity need not hold all of those instruments until maturity Thus an entity’s business model can be to hold financial assets to collect contractual cash flows even when sales of financial assets occur For example, the entity may sell a financial asset if: the financial asset no longer meets the entity’s investment policy (e.g., the credit rating of the asset declines below that required by the entity’s investment policy); an insurer adjusts its investments portfolio to reflect a change in expected duration (i.e., the expected timing of payouts); or an entity needs to fund capital expenditures However, if more than an infrequent number of sales are made out of a portfolio, the entity needs to assess whether and how such sales are consistent with an objective of collecting contractual cash flows 17-96 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) IFRS17-17 (a) M&S reports both current and non-current “other financial assets,” along with both current and non-current derivative financial instruments These investments are reported on the statement of financial position and in the notes to the financial statements (b) M&S’s investments are valued at fair value for trading and non-trading, while held-for-collection investments are valued at amortized cost If there is no quoted price in an active market for a security, and the fair value can’t be reliably measured, then the security is held at cost Derivatives are reported at fair value (c) M&S uses derivatives to manage its exposure to fluctuations in interest rates and exchange rates Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 17-97 ... E17-11 E17-12 E17-13 E17-14 E17-15 E17-16 E17 -17 E17-18 E17-19 E17-20 E17-21 *E17-22 *E17-23 *E17-24 *E17-25 *E17-26 *E17-27 P17-1 P17-2 P17-3 P17-4 P17-5 P17-6 P17-7 P17-8 P17-9 Description Investment... Use Only) 17- 3 ASSIGNMENT CHARACTERISTICS TABLE (Continued) Item P17-10 P17-11 P17-12 *P17-13 *P17-14 *P17-15 *P17-16 *P17 -17 *P17-18 CA17-1 CA17-2 CA17-3 CA17-4 CA17-5 CA17-6 CA17-7 17- 4 Description... Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) ASSIGNMENT CHARACTERISTICS TABLE Item E17-1 E17-2 E17-3 E17-4 E17-5 E17-6 E17-7 E17-8 E17-9 E17-10 E17-11 E17-12 E17-13