Intermediate accounting IFRS 3rd ch17

Illustration Single Security: To apply the fair value method to these debt investments, assume that at December 31, 2019 the fair value of the bonds is £105,000.. Fair Value Adjustment 3

Prepared by Coby Harmon University of California, Santa Barbara

1. Describe the accounting for debt investments.

2. Explain the accounting for equity investments.

LEARNING OBJECTIVES

3. Explain the equity method of accounting.

4. Evaluate other major issues related to debt and equity investments.

After studying this chapter, you should be able to:

Investments

PREVIEW OF CHAPTER 17

Intermediate Accounting IFRS 3rd Edition

Debt Investments

Two Types of Financial Assets

 Debt investments.

 Equity investments.

Motivations for investing:

 Earn a high rate of return.

 To secure certain operating or financing arrangements with another company (equity

securities)

LEARNING OBJECTIVE 1

Describe the accounting for debt investments.

Classification and Measurement of Financial Assets

Two criteria:

1. What is the company’s business model for managing its financial assets?

2. What are the contractual cash flow characteristics of the financial investment?

Debt Investments

Summary of the classification and measurement of debt and equity investments.

Classification and Measurement of Financial Assets

ILLUSTRATION 17.1

Classification and Measurement

A Closer Look at Debt Investments

Debt investments are characterized by contractual payments on specified dates of

 principal and

 interest on the principal amount outstanding

Companies group debt investments into three categories:

1. Held-for-collection

2. Held-for-collection and selling

3. Trading

A Closer Look at Debt Investments

Companies group debt investments into three categories:

Illustration: Robinson SA purchased €100,000 of 8 percent bonds of Evermaster AG on January 1, 2019, at

a discount, paying €92,278 The bonds mature January 1, 2024 and yield 10 percent; interest is payable each July 1 and January 1 Robinson records the investment as follows:

Debt Investment at Amortized Cost

ILLUSTRATION 17.2

Cash 4,000Debt Investments 614

Interest Revenue 4,614Robinson records the receipt of the first semiannual interest payment on July 1, 2019, as follows:

Debt Investment at Amortized Cost

ILLUSTRATION 17.2

Interest Receivable 4,000Debt Investments 645

Reporting of Bond Investment at Amortized Cost

ILLUSTRATION 17.3

Debt Investment at Amortized Cost

Assume that Robinson sells its investment on November 1, 2021, at 99¾ plus accrued interest Robinson

records this discount amortization as follows:

Debt Investments 522

Interest Revenue 522

ILLUSTRATION 17.2

Computation Gain on Sale of Bonds

Cash (€99,750 + €2,667) 102,417

Interest Revenue (4/6 x €4,000) 2,667Debt Investments 96,193

Gain on Sale of Investments 3,557

ILLUSTRATION 17.4

Debt Investment at Amortized Cost

Debt investments held-for-collection and selling follow the same accounting entries as debt

investments held-for-collection during the reporting period That is, they are recorded at amortized

cost

However, at each reporting date, companies

 Adjust the amortized cost to fair value

 Any unrealized holding gain or loss is reported as part of other comprehensive income

rather than in the profit and loss statement

Debt Investments—Held-for-Collection and Selling (HFCS)

Illustration: Graff plc purchases £100,000, 10 percent, five-year bonds on January 1, 2019, with interest

payable on July 1 and January 1 The bonds sell for £108,111, which results in a bond premium of £8,111 and

an effective-interest rate of 8 percent Graff records the purchase of the bonds as follows

Held-for-Collection and Selling (HFCS)

January 1, 2019

Debt Investments 108,111

Cash 108,111

ILLUSTRATION 17.6

Schedule of Interest Revenue and Bond

Illustration (Single Security): The entry to record interest revenue on July 1, 2019, is as follows.

Cash 5,000

ILLUSTRATION 17.6

Illustration (Single Security): At December 31, 2019, Graff makes the following entry to recognize interest

Illustration (Single Security): To apply the fair value method to these debt investments, assume that at December

31, 2019 the fair value of the bonds is £105,000 Graff makes the following entry

Held-for-Collection and Selling (HFCS)

ILLUSTRATION 17.6

Illustration (Portfolio of Securities): Webb AG has two debt securities classified as held-for-collection and selling

The following illustration identifies the amortized cost, fair value, and the amount of the unrealized gain or loss

Held-for-Collection and Selling (HFCS)

Prepare the adjusting entry Webb would make on December 31, 2019 to record the loss.

ILLUSTRATION 17.7

Held-for-Collection and Selling (HFCS)

Sale of HFCS Securities

If company sells bonds before maturity date:

 It must make entries to remove from the Debt Investments account the amortized cost of bonds sold.

 Any realized gain or loss on sale is reported in the “Other income and expense” section of the income

statement

Held-for-Collection and Selling (HFCS)

Illustration: Webb AG sold the Watson bonds (from Illustration 17.7) on July 1, 2020, for £90,000, at which time it

had an amortized cost of £94,214

Cash 90,000Loss on Sale of Investments 4,214

Illustration: Webb reports this realized loss in the “Other income and expense” section of the income statement

Assuming no other purchases and sales of bonds in 2020, Herringshaw on December 31, 2020, prepares the

information:

Sale of HFCS Securities

Illustration: Webb records the following at December 31, 2020.

ILLUSTRATION 17.9

Sale of HFCS Securities

Financial Statement Presentation ILLUSTRATION 17.10Reporting of HFCS Securities

Held-for-Collection and Selling (HFCS)

Companies often hold debt investments with the intention of selling them in a short period of time

These debt investments are often referred to as trading investments

Companies report trading securities

 at fair value,

 with unrealized holding gains and losses reported as part of net income.

A holding gain or loss is the net change in the fair value of a security from one period to another,

exclusive of dividend or interest revenue recognized but not received

Debt Investments—Trading

Illustration: Assume that on December 31, 2019, Western Publishing determined its trading securities portfolio to be

as shown At the date of acquisition, Western Publishing recorded these trading securities at cost in the account

entitled Debt Investments This is the first valuation of this recently purchased portfolio

Debt Investments—Trading

ILLUSTRATION 17.10

Computation of Fair Value Adjustment—Trading Securities Portfolio (2019)

Fair Value Adjustment 3,750

Debt Investments—Trading

Illustration: At December 31, Western Publishing makes an adjusting entry to the Fair Value Adjustment account, to

record both the increase in value and the unrealized holding gain

ILLUSTRATION 17.10

Companies have the option to report most financial assets at fair value, with all gains and losses related to

changes in fair value reported in the income statement

 Applied on an instrument-by-instrument basis

 Generally available only at the time a company first purchases the financial asset or incurs a financial

liability

 Company must measure this instrument at fair value until the company no longer has ownership.

Fair Value Option

Illustration: Hardy AG purchases bonds issued by the German Central Bank Hardy plans to hold the debt

investment until it matures in five years At December 31, 2019, the amortized cost of this investment is €100,000; its fair value at December 31, 2019, is €113,000 If Hardy chooses the fair value option to account for this

investment, it makes the following entry at December 31, 2019

Debt Investment (German bonds) 13,000

Unrealized Holding Gain or Loss—Income 13,000

Fair Value Option

In this situation,

 Hardy uses the Debt Investment account to record the change in fair value at December 31

 It does not use the Fair Value Adjustment account.

 The unrealized gain or loss is recorded as part of net income even though it is managing the investment

on a held-for-collection basis

 Hardy must continue to use the fair value method to record this investment until it no longer has

ownership of the security

Fair Value Option

Equity Investments

Equity investment represents

 ownership interest, such as ordinary, preference, or other capital shares

 rights to acquire or dispose of ownership interests at an agreed-upon or determinable price, such as

in warrants and rights

Cost includes

 Purchase price of the security.

 Broker’s commissions and fees are recorded as expense.

LEARNING OBJECTIVE 2

Describe the accounting for equity investments.

ILLUSTRATION 17.12

Levels of Influence Determine Accounting Methods

The degree to which one corporation (investor) acquires an interest in the common stock of another

corporation (investee ) generally determines the accounting treatment for the investment subsequent to

acquisition.

Equity Investments

ILLUSTRATION 17.13

Accounting and Reporting for Equity Investments by Category

Equity Investments

Under IFRS, the presumption is that equity investments are held-for-trading

General accounting and reporting rule:

 Investments valued at fair value

 Record unrealized gains and losses in net income.

Equity Investments

Holdings of Less Than 20%

Equity Investments

Holdings of Less Than 20%

IFRS allows companies to classify some equity investments as non-trading.

General accounting and reporting rule:

 Investments valued at fair value

 Record unrealized gains and losses in other comprehensive income.

Illustration: November 3, 2019, Republic SA purchased ordinary shares of three companies, each

investment representing less than a 20 percent interest These shares are held-for-trading

Equity Investments—Trading (Income)

At December 31, 2019, Republic’s equity investment portfolio has the carrying value and fair value shown.

Equity Investments—Trading (Income)

ILLUSTRATION 17.14

Unrealized Holding Gain or Loss—Income 35,550

Fair Value Adjustment 35,550

On December 31, 2019, Republic prepares an adjusting entry to record the decrease in fair value and to record the loss

as follows

On January 23, 2020, Republic sold all of its Burberry ordinary shares, receiving €287,220.

Cash 287,220

Equity Investments 259,700Gain on Sale of Investments 27,520

Equity Investments—Trading (Income)

ILLUSTRATION 17.15

Computation of Gain on Sale of Burberry Shares

In addition, assume that on February 10, 2020, Republic purchased €255,000 of Continental Trucking ordinary shares (20,000 shares €12.75 per share), plus brokerage commissions of €1,850 Republic’s equity investment portfolio as of December 31, 2020.

Equity Investments—Trading (Income)

Fair Value Adjustment 101,650

Unrealized Holding Gain or Loss—Income 101,650

ILLUSTRATION 17.16

Republic records this adjustment on Dec 31, 2020, as follows

The accounting entries to record non-trading equity investments are the same as for trading equity

investments, except for recording the unrealized holding gain or loss

Companies report the unrealized holding gain or loss as other comprehensive income

Equity Investments—Non-Trading (OCI)

Illustration: On December 10, 2019, Republic SA purchased 1,000 ordinary shares of Hawthorne Company for

€20.75 per share (total cost €20,750) The investment represents less than a 20 percent interest Hawthorne is a

distributor for Republic products in certain locales, the laws of which require a minimum level of share ownership

of a company in that region The investment in Hawthorne meets this regulatory requirement Republic accounts

for this investment at fair value

Equity Investments (Hawthorne) 20,750

Cash 20,750

Equity Investments—Non-Trading (OCI)

On December 27, 2019, Republic receives a cash dividend of €450 on its investment in the ordinary shares of

Hawthorne Company It records the cash dividend as follows

Cash 450

Dividend Revenue 450

Equity Investments—Non-Trading (OCI)

At December 31, 2019, Republic’s investment in Hawthorne has the carrying value and fair value shown.

Equity Investment (Hawthorne) 3,250

Unrealized Holding Gain or Loss—Equity 3,250

Equity Investments—Non-Trading (OCI)

ILLUSTRATION 17.17

Computation of Fair Value Adjustment

Republic records this adjustment as follows

The Equity Investment account is used because the non-trading classification is applied on investment by investment basis,

rather than on a portfolio basis.

ILLUSTRATION 17.21

Financial Statement Presentation of Equity Investments at Fair Value (2019)

Equity Investments—Non-Trading (OCI)

On December 20, 2020, Republic sold all of its Hawthorne Company ordinary shares receiving net proceeds of

€22,500

Unrealized Holding Gain or Loss—Equity 1,500

Equity Investment (Hawthorne) 1,500

Equity Investments—Non-Trading (OCI)

ILLUSTRATION 17.19

Adjustment to Carrying Value of Investment

Entry to adjust the carrying value of the non-trading investment

On December 20, 2020, Republic sold all of its Hawthorne Company ordinary shares receiving net proceeds of

Adjustment to Carrying Value of Investment

Entry to the sale of the investment

An investment (direct or indirect) of 20 percent or more of the voting shares of an investee should lead to a

presumption that in the absence of evidence to the contrary, an investor has the ability to exercise

significant influence over an investee.

In instances of “significant influence,” the investor must account for the investment using the equity

method.

Equity Investments

LEARNING OBJECTIVE 3

Explain the equity method of accounting.

Holdings Between 20% and 50%

Equity Method

Record the investment at cost and subsequently adjust the amount each period for changes in investee’s net assets

 Investor’s proportionate share of the earnings (losses) of the investee increases (decreases) the

investment’s carrying amount

 Dividends received from the investee decrease the investment’s carrying amount.

Holdings Between 20% and 50%

If investor’s share of investee’s losses exceeds the carrying amount of the investment, the investor ordinarily should

discontinue applying the equity method and not recognize additional losses.

Controlling Interest - When one company acquires a voting interest of more than 50 percent in another company.

 Investor is referred to as the parent

 Investee is referred to as the subsidiary.

 Investment in the subsidiary is reported on the parent’s books as a long-term investment.

 Parent generally prepares consolidated financial statements.

Equity Investments

Holdings of More Than 50%

A company should evaluate every debt investment accounted for at amortized cost, at each reporting date, to

determine if it has suffered impairment—a loss in value such that the fair value of the investment is below its

carrying value

If the company determines that an investment is impaired, it writes down the amortized cost basis of the

individual security to reflect this loss in value

The company accounts for the write-down as a realized loss, and it includes the amount in net income

Illustration: At December 31, 2018, Mayhew Ltd has a debt investment in Bao Group, purchased at par for

¥200,000 (amounts in thousands) The investment has a term of four years, with annual interest payments at 10

percent, paid at the end of each year (the historical effective-interest rate is 10 percent) This debt investment is