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.
Chapter 12 INVESTMENTS © 2013 The McGraw-Hill Companies, Inc Slide Nature of Investments Bonds Bonds and and notes notes (Debt (Debt securities) securities) Common Common and and preferred preferred stock stock (Equity (Equity securities) securities) Investments can be accounted for in a variety of ways, depending on the nature of the investment relationship Slide Reporting Categories for Investments Reporting Categories for Investments Control Characteristics of the Investment Reporting Method Used by the Investor in the Separate Financial Statements Reporting Method Used by the Investor in the Consolidated Financial Statements The investor lacks significant influence over the operating and financial policies of the investee: Investments in typically quoted or publicly traded debt securities for which the investor has the “positive intent and ability” to hold to maturity Investments in unquoted debt securities Investments held in an active trading account Other Heldtomaturity (“HTM”) — investment * reported at amortized cost Loans and receivables (“L&R”) — investments reported at amortized cost Trading securities (“TS”) — investment reported at fair value (with unrealized gains and losses included in net income) As in the separate financial statements Availableforsale securities (“AFS”) — investment reported at fair value (with unrealized gains and losses excluded from net income and * reported directly in shareholders’ equity) The investor has significant influence over the operating and financial policies of the investee: Equity method—investment cost Typically the investor owns between 20% and Investment reported at cost or as a financial adjusted for subsequent earnings and 50% of the ordinary shares of the investee asset dividends of the investee The investor controls the investee: Consolidation — the financial Typically the investor owns more than 50% of the Investment reported at cost or as a financial statements of the investor and investee investee asset 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 Slide 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 bond issue Present Value Amount PV Factor $ Interest 50,000 × 11.46992 = $573,496 Principal 1,000,000 × 0.31180 Present value of bonds = 311,805 $885,301 PV of ordinary annuity of $1, n = 20, i = 6% PV of $1, n = 20, i = 6% Slide Held-to-Maturity Securities Partial Bond Amortization Table Period Interest Payment 50,000 50,000 50,000 50,000 Date 1-1-12 6-30-12 Interest Revenue 53,118 53,305 53,503 53,714 Discount Amortization (3,118) (3,305) (3,503) (3,714) Description Investment in bonds Discount on bond investment Cash Cash Discount on bond investment Investment revenue Unamortized Discount 114,699 111,581 108,276 104,773 101,059 Debit 1,000,000 Carrying Value 885,301 888,419 891,724 895,227 898,941 Credit 114,699 885,301 50,000 3,118 53,118 Slide Held-to-Maturity Securities How would this investment appear on the statement of financial position after one period of discount amortization? Investment in bonds Less: Discount on bond investment Book value (amortized cost) $ 1,000,000 111,581 $ 888,419 $114,699 - $3,118 = $111,581 unamortized discount Slide Held-to-Maturity Securities Slide Held-to-Maturity Securities On December 31, 2012 after interest is received by Matrix, all the bonds are sold for $900,000 cash Period Interest Payment 50,000 50,000 50,000 50,000 Interest Revenue 53,118 53,305 53,503 53,714 Discount Amortization (3,118) (3,305) (3,503) (3,714) Date Description 12/31/12 Cash Discount on bond invetment Investment revenue 12/31/12 Cash Discount on bonds investment Investment in bonds Gain on sale of investment Unamortized Discount 114,699 111,581 108,276 104,773 101,059 Debit 50,000 3,305 Carrying Value 885,301 888,419 891,724 895,227 898,941 Credit 53,305 900,000 108,276 1,000,000 8,276 Slide Loans and Receivables Slide 10 Trading Securities Adjustments to fair value are recorded: in a valuation account called Fair Value Adjustment, or as a direct adjustment to the investment account as a net unrealized gain/loss on the Income Statement Unrealized Gain Unrealized Loss Income Income Statement Statement Slide 42 Changing From the Equity Method to Another Method The equity method is simply discontinued and the new method applied from then on For example, if there is a loss of significant influence, the investment is accounted for as a financial instrument under IAS 39 henceforth) Slide 43 Changing From Another Method to the Equity Method When the investor’s ownership level increases to the point where they can exert significant influence, the investor should change to the equity method The investment account would not be retroactively adjusted to the balance that would have existed if the equity method had always been used The equity method would be applied to the profits of the associate only from the date when the investor is able to exert significant influence over the investee Slide 44 Comparison of Cost, Fair Value, and Equity Method Separate Financial Statements Accounting method applied to investment in associate Sales proceeds Carrying amount Loss on sale Income previously recognized Total income Equity method 1,446,000 1,500,000 (54,000) Separate Financial Statements Fair value method for AFS securities 1,446,000 1,500,000 (54,000)* 75,000 75,000 120,000 21,000 21,000 21,000 Cost method Consolidated Financial Statements 1,446,000 1,545,000 (99,000) The difference in terms of income between the cost, fair value and equity methods lies in the timing at which gains or losses are recognized The higher income earned in an earlier period under the equity method is offset by a lower terminal profit (or higher terminal loss) at the date of sale Slide 45 Proportional Consolidation Slide 46 Financial Instruments & Derivatives Financial Financial Assets: Assets: 1 Cash Cash 2 Equity Equity instrument instrument in in another another entity entity 3 A A contractual contractual right right to to receive receive cash cash or or exchange exchange financial financial instruments instruments under under potentially potentially favorable favorable conditions; conditions; or or 4 A A contractual contractual right right to to receive receive aa variable variable number number of of the the entity’s entity’s own own equity equity instruments instruments Slide 47 Financial Instruments & Derivatives Financial Financial liabilities: liabilities: 1 A A contractual contractual obligation obligation to to pay pay cash cash or or exchange exchange financial financial instruments instruments under under potentially potentially unfavorable unfavorable conditions; conditions; or or 2 A A contractual contractual obligation obligation to to issue issue aa variable variable quantity quantity of of the the entity’s entity’s own own equity equity instruments instruments Derivatives: Derivatives: Financial Financial instruments instruments that that “derive” “derive” their their values values or or contractually contractually required required cash cash flows flows from from some some other other security security or or index index Slide 48 Appendix 12A – Other Investments It is a common practice for companies to purchase life insurance policies on key officers The company pays the premium and is the beneficiary of the policy If the officer dies, the company receives the proceeds from the policy Some types of policies build a portion of each premium as cash surrender value The cash surrender value of such a policy is classified as an investment on the statement of financial position of the company Slide 49 Appendix 12B – Impairment of a Receivable When the original terms of a debt agreement are changed as a result of financial difficulties experienced by the debtor, the new arrangement is referred to as debt modification Sometimes a troubled debt is settled in full when the debtor transfers assets or equities to the creditor The creditor usually recognizes a loss on the settlement Such a settlement is not considered unusual or infrequent Slide 50 Accounting for Financial Instruments Slide 51 IFRS – Equity Instruments Slide 52 IFRS Debt Instruments (1) Slide 53 IFRS Debt Instruments (2) Slide 54 IAS No 39 versus IFRS No Debt Instruments Slide 55 IAS No 39 versus IFRS No Equity Instruments End of Chapter 12 McGraw-Hill /Irwin © 2013 The McGraw-Hill Companies, Inc ... 6% Slide Held-to-Maturity Securities Partial Bond Amortization Table Period Interest Payment 50,000 50,000 50,000 50,000 Date 1-1 -1 2 6-3 0-1 2 Interest ... (amortized cost) $ 1,000,000 111,581 $ 888,419 $114,699 - $3,118 = $111,581 unamortized discount Slide Held-to-Maturity Securities Slide Held-to-Maturity Securities On December 31, 2012 after interest... included in net income Slide 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