Intermediate accounting IFRS 3rd ch17

Prepared by Coby Harmon University of California, Santa Barbara 17-1 Westmont College CHAPTER 17 Investments LEARNING OBJECTIVES After studying this chapter, you should be able to: Describe the accounting for debt investments Explain the equity method of accounting Explain the accounting for equity investments Evaluate other major issues related to debt and equity investments 17-2 PREVIEW OF CHAPTER 17 Intermediate Accounting IFRS 3rd Edition Kieso ● Weygandt ● Warfield 17-3 LEARNING OBJECTIVE Debt Investments Describe the accounting for 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) 17-4 LO Debt Investments Classification and Measurement of Financial Assets Two criteria: 17-5 What is the company’s business model for managing its financial assets? What are the contractual cash flow characteristics of the financial investment? LO Classification and Measurement of Financial Assets Summary of the classification and measurement of debt and equity investments ILLUSTRATION 17.1 Classification and Measurement 17-6 LO 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: 17-7 Held-for-collection Held-for-collection and selling Trading LO A Closer Look at Debt Investments Companies group debt investments into three categories: Held-for-collection Held-for-collection and selling Trading ILLUSTRATION 17.2 Accounting for Debt Investments by Category 17-8 LO Debt Investment at Amortized Cost Illustration: Robinson SA purchased €100,000 of 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 and January Robinson records the investment as follows: January 1, 2019 Debt Investments Cash 17-9 92,278 92,278 LO Debt Investment at Amortized Cost ILLUSTRATION 17.2 17-10 LO Fair Value Hedge Assuming that Jones enters into the swap on January 2, 2019 (the same date as the issuance of the debt), the swap at this time has no value Therefore, no entry is necessary At the end of 2019, Jones makes the interest payment on the bonds It records this transaction as follows Interest Expense 80,000 Cash (8% × €1,000,000) 17-123 80,000 LO Fair Value Hedge At the end of 2019, market interest rates have declined substantially Therefore, the value of the swap contract increases Recall (see Illustration 17A.9) that in the swap, Jones receives a fixed rate of percent, or €80,000 (€1,000,000 × 8%), and pays a variable rate (6.8%), or €68,000 Jones therefore receives €12,000 (€80,000 − €68,000) as a settlement payment on the swap contract on the first interest payment date Jones records this transaction as follows Cash 12,000 Interest Expense 17-124 12,000 LO Fair Value Hedge In addition, a market appraisal indicates that the value of the interest rate swap has increased €40,000 Jones records this increase in value as follows Swap Contract 40,000 Unrealized Holding Gain or Loss—Income 40,000 Because interest rates have declined, the company records a loss and a related increase in its liability as follows Unrealized Holding Gain or Loss—Income Bonds Payable 17-125 40,000 40,000 LO ILLUSTRATION 17A.11 ILLUSTRATION 17A.12 17-126 LO APPENDIX 17B Fair Value Disclosures LEARNING OBJECTIVE Describe required fair value disclosures Disclosure of Fair Value Information: Financial Instruments Both  cost and  fair value of all financial instruments must be reported in the notes to the financial statements 17-127 LO APPENDIX 17B Fair Value Disclosures Disclosure of Fair Value Information Three broad levels related to the measurement of fair values  Level is the most reliable measurement because fair value is based on quoted prices in active markets for identical assets or liabilities  Level is less reliable; it is not based on quoted market prices for identical assets and liabilities but instead may be based on similar assets or liabilities  Level is least reliable; it uses unobservable inputs that reflect the company’s assumption as to the value of the financial instrument 17-128 LO APPENDIX 17B Fair Value Disclosures Disclosure of Fair Value Information Companies must provide the following (with special emphasis on Level measurements): Quantitative information about significant unobservable inputs used for all Level measurements A qualitative discussion about the sensitivity of recurring Level measurements to changes in the unobservable inputs disclosed, including interrelationships between inputs 17-129 A description of the company’s valuation process LO APPENDIX 17B Fair Value Disclosures Disclosure of Fair Value Information Companies must provide the following (with special emphasis on Level measurements): Any transfers between Levels and of the fair value hierarchy Information about non-financial assets measured at fair value at amounts that differ from the assets’ highest and best use The proper hierarchy classification for items that are not recognized on the statement of financial position but are disclosed in the notes to the financial statements 17-130 LO GLOBAL ACCOUNTING INSIGHTS LEARNING OBJECTIVE Compare the accounting for investments under IFRS and U.S GAAP Until recently, when the IASB issued IFRS 9, the accounting and reporting for investments under IFRS and U.S GAAP were for the most part very similar While IFRS introduces new investment classifications relative to U.S GAAP, both IFRS and U.S GAAP have increased situations when investments are accounted for at fair value, with gains and losses recorded in income 17-131 LO GLOBAL ACCOUNTING INSIGHTS Relevant Facts Following are the key similarities and differences between U.S GAAP and IFRS related to investments Similarities • U.S GAAP and IFRS use similar classifications for financial assets: cash, loans and receivables, investments, and derivatives • Both IFRS and U.S GAAP require that financial assets be sorted into specific categories for measurement and classification purposes • Held-to-maturity (U.S GAAP) and held-for-collection (IFRS) investments are accounted for at amortized cost Gains and losses on some investments are reported in other comprehensive income 17-132 LO GLOBAL ACCOUNTING INSIGHTS Relevant Facts Similarities • Amortized cost or fair value is used depending upon the classification of the financial instrument • The definitions of amortized cost and fair value are the same • Both U.S 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 guideline of over 20 percent ownership • U.S 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 • 17-133 Under both U.S GAAP and IFRS, credit losses are recognized in income GLOBAL ACCOUNTING INSIGHTS Relevant Facts Differences • While U.S GAAP classifies debt investments as trading, available-for-sale, and held-to-maturity, IFRS classifies debt investments as held-for-collection, held-for-collection and selling (debt investments), and trading • U.S GAAP requires that all changes in fair value for all equity securities be reported as part of income IFRS requires that changes in fair value for non-trading equity securities be reported as part of other comprehensive income 17-134 LO GLOBAL ACCOUNTING INSIGHTS Relevant Facts Differences • U.S GAAP measures impairments based on lifetime expected credit losses IFRS uses lifetime expected losses for financial assets that have experienced a significant increase in credit risk since initial recognition (otherwise, the credit loss allowance is based on 12-month expected credit losses) • U.S GAAP generally does not permit the reversal of an impairment charge related to held-to-maturity debt investments and equity investments IFRS allows reversals of impairments of held-for-collection investments • In the accounting for the fair value option, one difference is that U.S GAAP permits the fair value option for all financial assets; IFRS allows the fair value option if doing so reduces an accounting mismatch 17-135 LO GLOBAL ACCOUNTING INSIGHTS On the Horizon At one time, both the FASB and IASB indicated that they believed that all financial instruments should be reported at fair value and that changes in fair value should be reported as part of net income Through recent standards in this area, the Boards continue to move toward that goal U.S GAAP and IFRS are substantially converged, except for non-trading equity investments and the measurement of credit losses 17-136 LO Copyright Copyright © 2018 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein 17-137 ... investments 17-2 PREVIEW OF CHAPTER 17 Intermediate Accounting IFRS 3rd Edition Kieso ● Weygandt ● Warfield 17-3 LEARNING OBJECTIVE Debt Investments Describe the accounting for debt investments Two... studying this chapter, you should be able to: Describe the accounting for debt investments Explain the equity method of accounting Explain the accounting for equity investments Evaluate other major... three categories: Held-for-collection Held-for-collection and selling Trading ILLUSTRATION 17.2 Accounting for Debt Investments by Category 17-8 LO Debt Investment at Amortized Cost Illustration: