Chapter 8 Slides for Class

TYPES OF INVESTMENTS Companies hold investments for two reasons: 1. To have the capital investment appreciate (increase in value). 2. To earn dividends, interest, and/or income. Two main types of investments: 3. Debt instruments 4. Equity instruments Why companies hold investments ?
TYPES OF INVESTMENTS Debt instruments- Bonds- ( Act like a creditor) "a contractual right to receive cash or another financial asset from another party" Debt instruments typically include: Bonds / Convertible debt / Commercial paper Return on investment typically takes the form of interest Equity instruments- Shares- ( Act like an owner) "ownership of a portion of another company" Typically represented by shares (Common / preferred) As an owner, you have a residual interest in the assets of a company after deducting all of its liabilities. Return on investment typically takes the form of dividends or an increase in value of the asset
ACCOUNTING FOR INVESTMENTS(NON - STRATEGIC) It depends on a number of factors: 1. The type of investment - Debt or Equity 2. Management's intention - Short-term or long-term? Hold to maturity or sell early? 3. Ability to reliably measure the fair value of the asset Accounting Methods (*) - Cost/amortized cost method Fair value through net income (FV-NI) Fair value through other comprehensive income (FV-OCI)
Recall - ACCT1011 Investing in bonds Investing in shares
COST/AMORTIZED COST METHOD When to use the cost/amortized method??? Usually used for investments shares (cost) or bonds (amortized cost) where there is a contractual agreement for cashflows and is intended to be held to maturity. Cost - Applies to equity- shares - investments. Amortized cost - Applies to debt- bonds investments, notes and loans receivable Original investment - recorded at its investment cost using present values Transaction costs - are included in the acquisition cost (aka commission)
COST/AMORTIZED COST METHOD Reporting date - reported at its original cost unless impaired, or its amortized cost if a debt instrument. Amortization method IFRS - Effective interest method (to amortize discount/premium) ASPE - Effective interest method or straight line amortization. Income recognition - recognize dividend income when the company has a right to it. Recognize interest income as its earned. Any interest earned but not received should be accrued. Gain or loss - may need to be recorded upon disposal of the asset
COST/AMORTIZED COST METHOD - BOND REVIEW Bonds are Debt Instruments (Amortized Cost or FV-NI) Basics covered earlier, but be aware of slightly different terms ! Yield Rate = Effective Rate/ Market Rate Bond Rate = Stated Rate Bonds can have implicit discounts or premiums If Bond is issued for more than face value = Premium If Bond is issued for less than face value = Discount The Premiums or Discount must be amortized over the life of the bond until maturity (using effective interest or straight line methods ) You can sell a bond anytime. The difference between carrying value at time of sale and sale amount is an investment gain/loss
FAIR VALUE THROUGH NET INCOME (FV-NI) Used for investments where 1. Fair value is readily available and reliable . 2. Management intends to hold investment for short-term for profit generating purposes. Original investment - recorded at its investment fair value (i.e. what you paid for it) Transaction costs - are expensed (not added to the investment)
FAIR VALUE THROUGH NET INCOME (FV-NI) Record purchase of investment at cost : Dr. FV-NI Investment Dr. Cash When interest or dividends are received: Cr. Cash Cr. Investment Income / Loss OR (interest/dividend income) On each reporting date, must adjust value to it's current fair value: Gain Loss Dr. FV-NI Investment Cr. Unrealized Gain or Loss Cr. FV-NI Investment Dr. Unrealized Gain or Loss Portfolio Recorded in a separate account .
When we sell the investment: Dr. Cash ( amount received) Cr. FV-NI Investment (Fair value on last reporting date) Cr. Investment Income or Loss( Difference) Dr. Investment Income or Loss( Difference- Loss) OR
FAIR VALUE THROUGH NET INCOME (FV- NI) Careful: watch for the statement "dividends and other investment income and losses are all reported in one investment income account". OR, if there is a portfolio of investments. Rather than using interest/dividend income, can use "Investment income or loss" In this case, changes in FV also flow through "Investment income or loss". When the investment is sold: Record gain or loss on disposal (based on current adjusted FV).
COMPARISON - FV-NI & COST/AMORTIZED COST What are the REAL differences? Name of the investment account (must be named correctly) FV-NI allows use of one 'Investment Income or Loss' account for all investment related income (i.e. use ONE account to record interest, dividends, realized/unrealized gains). NOTE - Do this ONLY if stated in the question. Under FV-NI, you must revalue the investment to the current fair-value at each financial reporting period.
CHAPTER 9 - INVESTMENTS Fair Value through Other Comprehensive Income (FV - OCI)
FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME (FV-OCI) - Other Comprehensive Income (OCI) - revenues, gains, losses, expenses that are part of "comprehensive income" but not normal net income. Unrealized gains and losses fall into this category. Accumulated Other Comprehensive Income (AOCI) - separate item under Shareholder's Equity - balance of all past charges and credits to OCI Original investment - recorded at its fair value Transaction costs - are capitalized under IFRS
FV-OCI - RECYCLING FV OCI - Without Recycling When an investment is sold - any gain or loss flows through retained earnings (bypassing N/I) - AOCI to R/E directly - Used for Equity\ shares Investments FV OCI - With Recycling When an investment is sold - flow through net income - AOCI to Net Income and then closed to R/E - Used for Debt/ bonds Investments "Recycling" only applies to debt instruments not equity
FV-OCI Record purchase of investment at cost : Dr. FV-OCI Investment (company name) Cr. Cash Dr. Cash When dividends are received: Gain Loss Dr. FV-OCI Investment (company name) Cr. Unrealized gain/loss Cr. FV-OCI Investment(company name) Dr. Unrealized gain/ loss On each reporting date, must adjust value to it's current fair value: Cr. Investment Income / Loss OR (interest/dividend income) Portfolio Recorded in a separate account .
FV-OCI When sold: Receive cash (Dr. Cash) Sell the investment (Cr. FV-OCI Investment) Watch recycling! Clear Accumulated Other Comprehensive Income - Unrealized Gain or Loss - OCI
COMPARE FV-OCI & FV-NI What are the REAL differences? Name of the investment account (must be named correctly) FV-OCI - "Recycling " option when certain investment is sold. Under FV-OCI, the fair-value adjustment gets reported in Other Comprehensive Income (not Net Income).
SUMMARY OF THREE MAJOR MODELS OF ACCOUNTING FOR INVESTMENTS Cost/Amortized Cost Model Fair Value through Net Income Model (FV-NI) Fair Value through OCI Model (FV- OCI) At acquisition, measure at: Cost (equal to fair value + transaction costs) Fair value Fair value (transactions costs tend to be added at acquisition) At each reporting date, measure at: Cost or amortized cost Fair value Fair value Report unrealized holding gains and losses (changes in fair value): N/A In net income In OCI Report realized holding gains and losses: In net income In net income Transfer total realized gains/losses to net income (recycling) or directly to retained earnings (no recycling)
IMPAIRMENT Items on balance sheet must be reviewed to ensure that amounts do not exceed the future benefits to the organization Since FV assets are already measured at their current FV it is only cost/amortized cost assets that we have to test for impairment (Remember with NI and OCI - we are adjusting the value of our investment as the FV changes). We have to adjust for impairment for each individual asset at each reporting date unless the information is not readily available.
STRATEGIC INVESTMENTS Why would a company invest in another company? To earn a return To have a special relationship with a supplier or customer (e.g. to gain access to certain shipping channels or markets). To be able to exercise rights to influence or control the investee (e.g. to establish a long term relationship)
STRATEGIC INVESTMENT - EQUITY METHOD "Equity Method" - Basic principles The original investment is recorded at it's acquisition cost (i.e. what you paid for it) The investor recognizes a portion of the investee's net income equal to it's % ownership. The net income recognized increases book value of the investment. Dividends received decreases the book value of investment .
EQUITY METHOD - GOODWILL - Excess payments upon acquisition The carrying value vs. fair value of the investee's assets must be considered under the equity method. Any payment in excess of (or less than) the investors share of book value is part of the cost of investment: Capital assets Difference between investee's book value and fair value of capital assets. Must be amortized annually Goodwill Any additional unexplained amount paid above fair value of all net assets (i.e. assets - liabilities )
DISCLOSURE For investments without significant influence or control , key presentation issue is classification of investment as current vs. long-term Key disclosures include the following types of information: o Carrying amount of investments and any impaired investments o Income statement effects o Risk exposures (emphasized by I F R S) o Fair value information (I F R S) o Reconciling opening and closing balances in impairment accounts (I F R S)
DISCLOSURE - CONTINUED Investments in associates are classified as non- current assets (unless they are held for sale), and income from these significantly influenced companies is reported according to its nature in the associate's financial statements Requirements for those using the equity method: o Investment category and accounting method used o FV of investments quoted in active market o Separate disclosure of income from investments o Different year ends for associates
QUESTIONS FOR PRACTICE Exercise 8-1 Exercise 8-4 Exercise 8-5 Exercise 8-6 Exercise 8-7 Exercise 8-10 Exercise 8-11 Exercise 8-13 Exercise 8-14 Exercise 8-19
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