• lntercorporate

Study Session I
Investments
1. lntercorporate Investments

EXAMPLE 1

• Accounting for Investments in Debt Securities

• In this example, two fictitious companies are used. On 1 January 2011, Baxter Inc. invested £300,000 in
Cartel Co. debt securities (with a 6% stated rate on par value, payable each 31 December). The par value
of the securities was £275,000. On 31 December 2011, the fair value of Baxter's investment in Cartel is
£350,000.
• Assume that the market interest rate in effect when the bonds were purchased was 4.5%. If the
investment is designated as held-to-maturity, the investment is reported at amortized cost using the
effective interest method. A portion of the amortization table is as follows:
• The effective interest rate method applies the market rate in effect when the bonds were purchased to the current amortized cost
(book value) of the bonds to obtain interest income for the period. Assume that the debt securities' contractual cash flows are
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equal to estimated cash flows and that its contractual life is equal to its expected life.
•lntercorporate
Study Session I Investments
1. lntercorporate Investments

- EXAMPLE 1

• Accounting for Investments in Debt Securities

End of year Interest Interest Income Amortization Amortized cost
Payement
0 300,000

1* 16,500 13,500 3,000 297,000

2 16,500 13,365 3,135 293,865

3 16,500 13,224 3,276 290,589

2
*(6% * par value of £ 275,000 = £16,500) and (4,5% * carrying value of £300,000 =£ 13,500)
• lntercorporate
Study Session I
Investments
1. lntercorporate Investments

-
EXAMPLE 1

• Accounting for Investments in Debt Securities

• 1. How would this investment be reported on the balance sheet, income statement, and statement of
shareholders' equity at 31 December 2011, under either IFRS or US GAAP (accounting is essentially the
same in this case), if Baxter designated the investment as 1) held-to-maturity, 2) held for trading, 3)
available-for-sale, or 4) designated at fair value?
• 2. How would the gain be recognized if the debt securities were sold on 1 January 2012 for £352,000?
• 3. How would this investment appear on the balance sheet at 31 December 2012?
• 4. How would the classification and reporting differ if Baxter had invested in Cartel's equity securities
instead of its debt securities? 3
• lntercorporate
Study Session I Investments
1. lntercorporate Investments

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Solution to 1

• The amount received each period (£16,500) is based on the par value (£275,000) and the
stated 6% rate. The interest income is calculated using the effective interest method
(4.5% market rate times the beginning amortized cost each period). The difference
between the amount received and the interest income is the amortization.
• The initial fair value (£300,000) is reduced by amortization resulting in a £297,000
amortized cost. This represents the carrying value reported on the balance sheet if the
security is classified as held-to-maturity. If the security is reported at fair value,
remeasurement to fair value (£350,000 at the end of Year 1) results in an unrealized gain
of £53,000 (£350,000 - £297,000). 4
 Income statement Balance sheet Statement of
•lntercorporate Investments shareholders’ Equity
Held-to - Maturity Interest income of £13,500 Reported at
3. Investments in(£16,500
Financial Assets:
-£ 3,000 or £Standard IAS 39cost
amortized (asofof December 2012)
300,000*4,5%) £ 297,000
-

Held for trading Interest income of £13,500 Reported at fair

security £ 53,000 unrealized gain is value £ 350,000
recognized through profit

Designated at fair Interest income of £13,500 Reported at fair

value £ 53,000 unrealized gain is value £ 350,000
recognized through profit
Available-for-sale Interest income of £13,500 Reported at fair £ 53,000 unrealized gain
value £ 5350,000 (net of tax) is reported as
other comprehensive
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income
•lntercorporate
Study Session I Investments
1. lntercorporate Investments

Solution to 2

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• If the debt securities were sold on 1 January 2012 for £352,000, the amount of the realized gain would be
as follows:

■ Held-to-maturity: The selling price less the carrying value results in a gain on income statement of
£55,000 (£352,000 - £297,000).

■ Assets held for trading and designated fair value through profit or loss:

• The security is fair valued on the balance sheet at 31 December 2011 at £350,000. The appreciation was
previously recognized in profit and loss. The gain on income statement (profit and loss) of £2,000
(£352,000 - £350,000) reflects the difference between the selling price and the recorded fair value.
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•lntercorporate
Study Session I Investments
1. lntercorporate Investments

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Solution to 2

• Available-for-sale: The security is fair valued on the balance sheet at 31

December 2011 at £350,000. Because it is designated as available-for-sale, the
appreciation was reflected in other comprehensive income in the equity section of
the balance sheet. Upon sale in 2012, the cumulative unrealized gain or loss is
removed from other comprehensive income and the entire gain is recognized in
the profit and loss statement £55,000 = (£352,000 - £350,000) + £53,000
(removed from other comprehensive income).
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•lntercorporate
Study Session I Investments
1. lntercorporate Investments

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Solution to 3

If the investment was classified as held-to-maturity, the reported amount at

amortized cost at the end of Year 2 on the balance sheet would be £293,865. If the
investment was classified as either held for trading, available-for-sale, or designated
at fair value, it would be measured at its fair value at the end of Year 2.

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•lntercorporate
Study Session I Investments
1. lntercorporate Investments

- Solution to 4

If the investment had been in Cartel Co. equity securities rather than debt securities, the analysis
would change in the following ways:

• There would not be a held-to-maturity option.

• Dividend income (if any) would replace interest income and there would be no amortization.