Chapter 8 Slides for Class

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CHAPTER 8 INVESTMENTS
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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