CHAPTER 9

Investments
Part 1

Investments
Firms can make investments in
debt securities (e.g. investments in government debt, corporate bonds,
convertible debt, and commercial paper) or
equity securities (buying common stock or preferred shares in another
company)
Benefits to the firm
Higher rate of return than bank savings or current accounts
short-term returns (interest or dividend payments
long-term returns (stock price appreciation)
corporate strategy

Investments are accounted for based on :

Type of instrument (debt vs. equity)
Managements intent (e.g. Investing for short vs long term)
Ability to reliably measure instruments fair value, or
Extent to which firm has control over investee
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Accounting Models
There are four main models of accounting for investments:
Cost model (investment in other firms shares)
Amortized cost model (investment in other firms debt security)
Use if being held to maturity
Fair value through net income model (FV-NI or FVTPL)
Use if held to sell in near term or to generate profit through fluctuations in price
Fair value through other comprehensive income model (FV-OCI)
Use if investments in equity that are not held for trading purposes

Under all models, interest earned and dividends received are

recognized in net income

Accounting Models: Summary

Cost Model

Amortized
Cost Model

FV-NI

FV-OCI

Transaction
costs

Capitalized

Capitalized

Expensed

Expensed or
Capitalized

At
acquisition,
measure at:

Cost (fair
value +
transaction
costs)

Cost (fair
value +
transaction
costs)

Fair value

Fair value

End of Period
measure at:
Cost

Amortized
cost

Fair value

Fair value

Unrealized
holding
gains/losses
reported in:

Not applicable

Net income

OCI

Net income

Net income
(recycling), or
retained
earnings

Realized
holding
gains/losses
reported in:

Not applicable

Net income

Net income

IFRS Requirements (IAS 39)

Amortized cost used only if
The firms business model is to manage the instrument as if held
to maturity
AND
Contractual cash flow can be characterised as the payments of
principal and interest on principal outstanding at specified dates
Otherwise use FV-NI.
IFRS proposed draft standard includes two additional

options:
Equity Investments held for longer term strategic reasons

(without control or significant influence) may be accounted for

under FV-OCI without recycling if such choice is made on
acquisition.
Fair value to correct an accounting mismatch
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Cost Model: Equity Investment

Changes in investments market value have no effect on

balance sheet or income statement until sold

1. At acquisition recognize the cost of investment at
fair value (plus direct transaction costs)
2. In subsequent periods report at cost (unless
impaired)
3. Receipts of dividend recognized as dividend
income
4. When investment is sold, the difference between
original cost and final market value is called a
realized gain/loss which is reported in net income.

Amortized Cost Model

Used for investments in another firms debt security

1.At acquisition recognize the cost of investment at

fair value (plus direct transaction costs)

2.In subsequent periods report at amortized cost
(unless impaired)

recognize interest receivable

recognize interest income as earned

amortize any discount/premium by adjusting carrying

amount of investment

3.When investment is sold

first bring accrued interest and discount/premium

amortization up to date.

Derecognize investment and report a gain/loss on

disposal in net income.
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Sale of Investments
Discount (or premium) is amortized from last date of

amortization to the date of sale

New carrying amount calculated, which is the
amortized cost balance plus the discount (or minus
the premium) amortized from last date of
amortization
Gain (or loss) calculated as the difference between
selling price and carrying amount
Any accrued interest income is calculated (and
received) over and above the selling price of the
investment
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BE9-7 Amortized Cost

On September 1, Louisa Ltd. purchased $80,000 of five-year, 9%

bonds for $74,086, resulting in an effective (yield) rate of 11%. The

bonds pay interest each March 1 and September 1. Louisa Ltd.
applies ASPE, accounts for the investment under the amortized cost
approach using the effective interest accounting policy, and has a
December 31 year end. The following March 1, after receiving the
semi-annual interest on the bonds, Louisa sells the bonds for
$75,100. Prepare Louisas journal entries for:
(a) the purchase of the investment,
(b) any adjusting entry(ies) needed at December 31,
(c) the receipt of interest on March 1, and
(d) the sale of the bond investment on March 1.

Fair Value through Net Income (FVNI) Model

At acquisition record investment at fair value
Expense transactions costs
At end of period, adjust investments to the current

fair value
The resulting unrealised holding gain or loss is
reported in net income
Interest or dividend income plus holding gain or
loss reported as Investment Income

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11

BE9-8 FV-NI
Abdul Corporation purchased 400 common shares of

Sigma Inc. for trading purposes for $13,200 on September

8 and accounted for the investment under ASPE at FV-NI.
In December, Sigma declared and paid a cash dividend of
$1.75 per share. At year end, December 31, Sigma shares
were selling for $35.50 per share. In late January, Abdul
sold the Sigma shares for $34.95 per share. Prepare
Abdul Corporations journal entries to record
(a) the purchase of the investment,
(b) the dividends received,
(c) the fair value adjustment at December 31, and
(d) the January sale of the investment.

Fair Value through Other Comprehensive

Income (FV-OCI)
At acquisition record investments at fair value
Transaction costs are usually added to investments

carrying amount
At end of period adjust investments to current fair
value
The resulting unrealised holding gain or loss is
reported in other comprehensive income (OCI)
Accumulated holding gains/losses are reported in
AOCI, which is a separate item under Shareholders
Equity

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Fair Value through Other Comprehensive

Income (FV-OCI)
When investments are sold the balance of the

unrealized holding gains or losses are transferred from

OCI/AOCI
Under FV-OCI with recycling, unrealized holding gains
or losses are transferred into net income
Under FV-OCI without recycling, unrealized holding
gains or losses are transferred directly into retained
earnings bypassing net income

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14

E9-11 FV-NI and FV-OCI

Arantxa Corp made the following cash purchases of investments
during 2011:
1.Jan 15 purchased 10,000 shares of Nirmala Corp.s common
shares at $33.50 per share plus commission of $1,980.
2.April 1 purchased 5,000 shares of Oxana Corp.s common
shares at $52.00 per share plus commission of $3,370
3.September 10 purchased 7,000 shares of WTA Corp.s
preferred shares at $26.50 per share plus commission of $4,910
On May 20, 2010 Aranxa sold 4,000 of the Nirmala common
shares at a market price of $35/share less brokerage
commisions of $3,850. The year-end fair values/share were as
follows: Nirmala $30, Oxana $55, and WTA $28.

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E9-11 FV-NI and FV-OCI cont.

In addition the CFO told you that Arantxa Corp holds these investments
with the intention of selling them in order to earn short-term profits from
appreciation in their prices and accounts for them using the FV-NI
model.
Assume that Arantxa follows IFRS and dividend and interest income is
not reported separately.
a)Prepare the j/e to record the three investments
b)Prepare the j/e for the sale of the 4,000 Nirmala shares on May 20
c)Prepare the adjusting entries needed on Dec. 31, 2011
d)Repeat a) b) and c) assuming the investments will be accounted for
using the fair value through other comprehensive income model.
Arantxas policy is to capitalize transaction costs on the acquisition of
FV-OCI investments and reduce the proceeds on disposal.

Reclassifications
Firms are not allowed to reclassify investment from

one category to another, unless there is a change in

business model in relation to investments
If reclassification is to a FV-based model, then revalue
at FV and recognize gain/loss in income
If reclassification is from FV-based model to another,
then FV at time of reclassification becomes the new
carrying amount

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Impairment
In some instances the value carried for investments

may be overstated on the balance sheet

Firms must periodically test for impairment of
investments using one of three models:
1.
2.
3.

Incurred loss model

Expected loss model
Full fair value model

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Impairment: Incurred Loss Model

Impairment test is done only if there are indications that

impairment has occurred e.g.

Severe financial problems
The firms has defaulted on interest/principal payments
Significant financial reorganization or bankruptcy
Impairment loss is defined as the difference between the carrying

amount and revised present value of expected cash flows using

discounted cash flow method.
Discount rate for present value calculations is current or historical
market rate
Impairment loss is recognized in net income.
Any subsequent changes in value are adjustments to the
impairment loss.
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Impairment: Expected Loss Model

Firm must continually do impairment testing
Impairment loss is defined as difference between

carrying amount and revised present value of

expected cash flows
Discount rate used is the effective interest rate
from time of acquisition
Impairment loss is recognized in net income.

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Impairment: Full Fair Value Loss

Model

Impairment loss is defined as the difference

between carrying amount and fair value

Fair value is determined using the discounted
cash flow model, using the current interest rate
at time of impairment test
Impairment loss is recognized in net income

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Impairment
IFRS 9 requirement:
Incurred loss model for all financial investments

accounted for using cost/amortized cost model using

original discount rate. May be reversed for debt
instruments
Full fair value model for FV-NI instruments
IAS 39 requirement:
Incurred loss model also used for FV-OCI where trigger event has

occurred.

Private entity GAAP requirement:

Incurred loss model for financial investments accounted for at
cost/amortized cost using current market rate
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Reclassifications
Firms are not allowed to reclassify investment from

one category to another, unless there is a change in

business model in relation to investments
If reclassification is to a FV-based model, then revalue
at FV and recognize gain/loss in income
If reclassification is from FV-based model to another,
then FV at time of reclassification becomes the new
carrying amount

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Strategic Equity Investments

The accounting treatment for equity investments

varies with the level of influence the firm has over the
firm it is investing in:
Three levels of the type of investment
1.

Little or no influence

2.

Significant influence - Associate

3.

Control - Subsidiary

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1. Less than Significant Influence

1.

Typically 0-20% ownership

2.

Little or no influence on the firms financial or operating policy

3.

Accounted for using the cost/amortized cost, FV-NI or FVOCI models learned before

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2. Determination of Significant
Influence
Significant influence is defined as the power to
participate in the financial and operating policy
decisions of an entity, but not control over those
policies.
2 criteria for significant influence are:

1.
2.

Quantitative test: 20% to 50% ownership

Qualitative test. Examples are:

Whether the firm is represented on the Board of

Directors
The existence of material intercompany transactions
Exchange of management personnel
Provision of technical information
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2. Associate or Significant
Influence

If firm has significant influence in another firm then

the type of investment is that of an Associate or
Significant Influence
Under IFRS, investments in associates/significant
influence are accounted for using the equity
method of accounting
Under private entity GAAP, investors can use
either

Equity method, or

Cost method (However, if the associate shares are

traded in an active market the FV-NI model is used)

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2. Associate or Significant Influence Equity Method

At acquisition, the investment is recorded at cost

Investor reports in net income its share of the investee

net income for the year

Dr: Investment account
Cr: Investment Income
Any dividends received are credited to the Investment
account
Use accrual accounting

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2. Associate or Significant Influence Equity Method

The difference between the amounts paid for the

investment and the investees book value is part of

the cost of the investment
If this difference is due to long-lived assets with fair

values greater than book value, the difference must

be amortized

The investor keeps the major income

classifications that the investee used

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2. Associate or Significant Influence Equity Method: Example

Given:

Maxi Corp. purchases 20% of Mini Corp., and exercises

significant influence
January 2, 2010 Maxi purchases 48,000 shares @ $10 per
share
For the year 2010 Mini Corp. reports a net income of $200,000
December 31, 2010 shares of Mini Corp. have a market price of
$12 per share
January 28, 2011 Mini Corp. declared and paid a total cash
dividend of $100,000
For the year 2011, Mini Corp. reports a net loss of $50,000

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2. Equity Method: Impairment

The investment is assessed at the end of each

reporting period to determine if there are indicators

of impairment and impairment test done
Impairment loss is recognized in income and
measured as the carrying amount in excess of
investments recoverable amount
Investments recoverable amount is measured as
the higher of value in use and fair value less cost
to sell
Impairment losses may be reversed

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2. Associate or Significant Influence Equity Method: Disposal

When investment is sold, both investment account

and investment income accounts are brought up to

date (i.e. adjusted for investors share of
associates income and changes in book value up
to date of sale)
Investments carrying value is removed and any
gains/losses are recognized in net income

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3. Investments in Subsidiaries
A corporation (the parent) controls another corporation

(the subsidiary)
Control is generally acquired through purchasing 50%
or more voting shares
Control is defined as continuing power to
determine/direct the strategic operating, financing, and
investment policies/activities, without the co-operation
of others

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3. Investments in Subsidiaries
Under IFRS, investments for subsidiaries are

accounted for using consolidated financial

statements where the two corporations are reported

as a single business entity

Under private entity GAAP, the parent can either
Consolidate all subsidiaries, or

Account for all subsidiaries under FV-NI or cost

method (cant use if active market exists)

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Consolidated Financial Statements

Consolidated Statements are reported by Parent

Combined Balance Sheet, line-by-line (100%)

Combined Income Statement, line-by-line (100%)
Eliminate any unrealized inter-company gains and losses
Eliminate any inter-company balances
Parent eliminates the investment in the subsidiary company
Non-controlling interest reported (the percent of the
subsidiary not owned by the parent) on both balance sheet
and income statements

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