Chapter 8

Chapter 8
Investment and
International
Operations
Main Points
1. Describe the accounting framework for financial assets as per the

IFRS.
2. Understand the accounting for debt investments at amortized cost.
3. Understand the accounting for debt investments at fair value.
4. Describe the accounting for the fair value option.
5. Understand the accounting for equity investments at fair value.
6. Understand consolidated financial statements.
7. Understand the accounting for international operations
ACCOUNTING FOR FINANCIAL ASSETS
Financial Asset
u Cash.
u Equity investment of another company (e.g., ordinary or

preference shares).
u Contractual right to receive cash from another party (e.g., loans,

receivables, and bonds).
IASB requires that companies classify financial assets into two

measurement categories—amortized cost and fair value—depending on
the circumstances.
Measurement Basis—A Closer Look

IFRS requires that companies measure their financial assets based
on two criteria:
u Company’s business model for managing its financial assets; and
u Contractual cash flow characteristics of the financial asset.
Only debt investments such as receivables, loans, and bond investments that meet
the two criteria above are recorded at amortized cost. All other debt investments
are recorded and reported at fair value.
Measurement Basis—A Closer Look

Equity investments are generally recorded and reported at fair
value.
DEBT INVESTMENTS
Debt investments are characterized by contractual payments on

specified dates of
u principal and
u interest on the principal amount outstanding.
Companies measure debt investments at

u amortized cost or
u fair value.
Debt Investments—Amortized Cost
Illustration: Robinson Company purchased €100,000 of 8% bonds of

Evermaster Corporation on January 1, 2015, at a discount, paying
€92,278. The bonds mature January 1, 2020 and yield 10%; interest is
payable each July 1 and January 1. Robinson records the investment
as follows:
January 1, 2015
Debt Investments 92,278

Cash 92,278
Robinson Company records the receipt of the first semiannual

interest payment on July 1, 2015, as follows:
Cash 4,000
Debt Investments 614
Interest Revenue 4,614
Because Robinson is on a calendar-year basis, it accrues interest and

amortizes the discount at December 31, 2015, as follows:
Interest Receivable 4,000

Interest Revenue 4,645
Reporting of Bond Investment at Amortized Cost

Assume that Robinson Company sells its investment on November 1,
2017, at 99¾ plus accrued interest. Robinson records this discount
amortization as follows:

Interest Revenue 522
(€783 x 4/6 = €522)

Computation Gain on Sale of Bonds
Cash 102,417
Interest Revenue (4/6 x €4,000) 2,667
Gain on Sale of Debt Investments 3,557
Debt Investments—Fair Value
Debt investments at fair value follow the same accounting

entries as debt investments held-for-collection during the
reporting period. That is, they are recorded at amortized cost.
However, at each reporting date, companies

u Adjust the amortized cost to fair value.
u Any unrealized holding gain or loss reported as part of net

income (fair value method).
Illustration: Robinson Company purchased €100,000 of 8 percent

bonds of Evermaster Corporation on January 1, 2015, at a discount,
paying €92,278. The bonds mature January 1, 2020, and yield 10
percent; interest is payable each July 1 and January 1.
The journal entries in 2015 are exactly the same as those for
amortized cost.
Entries are the same as those for amortized cost.

To apply the fair value approach, Robinson determines that, due to a

decrease in interest rates, the fair value of the debt investment
increased to €95,000 at December 31, 2015.
Fair Value Adjustment 1,463

Unrealized Holding Gain or Loss—Income 1,463
At December 31, 2016, assume that the fair value of the

Evermaster debt investment is €94,000.

Assume now that Robinson sells its investment in Evermaster bonds on

November 1, 2017, at 99 ¾ plus accrued interest. The only difference
occurs on December 31, 2017. Since the bonds are no longer owned by
Robinson, the Fair Value Adjustment account should now be reported at
zero. Robinson makes the following entry to record the elimination of the
valuation account.
Fair Value Adjustment 925

Unrealized Holding Gain or Loss—Income 925
Income
Effects on
Debt
Investment
(2015-2017)
Illustration (Portfolio): Wang Corporation has two debt investments

accounted for at fair value. The following illustration identifies the
amortized cost, fair value, and the amount of the unrealized gain or
loss.
Illustration (Portfolio): Wang makes an adjusting entry at December

31, 2015 to record the decrease in value and to record the loss as
follows.

Illustration (Sale of Debt Investments): Wang Corporation sold the

Watson bonds (from Illustration 17-10) on July 1, 2016, for ¥90,000, at
which time it had an amortized cost of ¥94,214.
Cash 90,000
Loss on Sale of Debt Investments 4,214
Wang reports this realized loss in the “Other income and expense”
section of the income statement. Assuming no other purchases and
sales of bonds in 2016, Wang on December 31, 2016, prepares the
information:
Wang records the following at December 31, 2016.

Financial Statement Presentation

Fair Value Option
Companies have the option to report most financial assets at fair

value. This option
u is applied on an instrument-by-instrument basis and
u is generally available only at the time a company first purchases

the financial asset or incurs a financial liability.
If a company chooses to use the fair value option, it measures this

instrument at fair value until the company no longer has ownership.
Fair Value Option
Illustration: Hardy Company purchases bonds issued by the German

Central Bank. Hardy plans to hold the debt investment until it matures
in five years. At December 31, 2015, the amortized cost of this
investment is €100,000; its fair value at December 31, 2015, is
€113,000. If Hardy chooses the fair value option to account for this
investment, it makes the following entry at December 31, 2015.
Debt Investment (German bonds) 4,537

Summary of Debt Investment Accounting
EQUITY INVESTMENTS
Equity investment represents ownership of ordinary, preference,

or other capital shares.
u Cost includes price of the security.
u Broker’s commissions and fees are recorded as expense.
The degree to which one corporation (investor) acquires an interest

in the common stock of another corporation (investee) generally
determines the accounting treatment for the investment subsequent
to acquisition.
EQUITY INVESTMENTS
EQUITY INVESTMENTS
EQUITY INVESTMENTS
Holdings of Less Than 20%

Under IFRS, the presumption is that equity investments are held-
for-trading.
General accounting and reporting rule:

u Investments valued at fair value.
u Record unrealized gains and losses in net income.

EQUITY INVESTMENTS
Holdings of Less Than 20%

IFRS allows companies to classify some equity investments as non-
trading.
General accounting and reporting rule:

u Investments valued at fair value.
u Record unrealized gains and losses in other comprehensive

income.
Equity Investments—Trading (Income)
Illustration: November 3, 2015, Republic Corporation purchased

ordinary shares of three companies, each investment representing less
than a 20 percent interest. These shares are held-for-trading.
Republic records these investments as follows:

Equity
Investments —
Trading
Republic records these investments as follows:

Equity Investments 718,550
Cash 718,550
On December 6, 2015, Republic receives a cash dividend of €4,200

on its investment in the ordinary shares of Nestlé.
Cash 4,200
Dividend Revenue 4,200
At December 31, 2015, Republic’s equity investment portfolio has the

carrying value and fair value shown.

On January 23, 2016, Republic sold all of its Burberry ordinary shares,
receiving €287,220.
Cash 287,220
Gain on Sale of Equity Investment 27,520
In addition, assume that on February 10, 2016, Republic purchased

€255,000 of Continental Trucking ordinary shares (20,000 shares €12.75
per share), plus brokerage commissions of €1,850. Republic’s equity
investment portfolio as of December 31, 2016.
ILLUSTRATION 17-19
Republic records this adjustment as follows.

Equity Investments—Non-Trading (OCI)
The accounting entries to record non-trading equity investments are

the same as for trading equity investments, except for recording the
unrealized holding gain or loss.
Report the unrealized holding gain or loss as other comprehensive

income.
Illustration: On December 10, 2015, Republic Corporation purchased

1,000 ordinary shares of Hawthorne Company for €20.75 per share (total
cost €20,750). The investment represents less than a 20 percent interest.
Hawthorne is a distributor for Republic products in certain locales, the
laws of which require a minimum level of share ownership of a company
in that region. The investment in Hawthorne meets this regulatory
requirement. Republic accounts for this investment at fair value.

Cash 20,750
On December 27, 2015, Republic receives a cash dividend of €450 on its

investment in the ordinary shares of Hawthorne Company. It records the
cash dividend as follows.
Cash 450
Dividend Revenue 450
At December 31, 2015, Republic’s investment in

Hawthorne has the carrying value and fair value
shown.
Republic records this adjustment as follows.

Unrealized Holding Gain or Loss—Equity 3,250
On December 20, 2016, Republic sold all of its Hawthorne Company

ordinary shares receiving net proceeds of €22,500.
Entry to adjust the carrying value of the non-trading investment.
Unrealized Holding Gain or Loss—Equity 1,500

On December 20, 2016, Republic sold all of its Hawthorne Company

ordinary shares receiving net proceeds of €22,500.
Entry to record the sale of the investment.
Cash 22,500
Consolidated Subsidiaries
Investor controls investee
Owns more than 50% of investee’s voting shares
Investor can elect majority of board members
Investor is called the parent company
Investee is called the subsidiary
51
Many investors (the shareholders)
own
The parent corporation
who
owns
The subsidiary
Copyright ©2014 Pearson Education.
Consolidation Accounting
Method of combining financial statements of all
companies controlled by same shareholders
Results is a single set of statements as if parent and its

subsidiaries are one company
Gives better perspective on total operations than

individual statements
Worksheet is used to combine parent and sub accounts
Intercompany accounts are eliminatedY

53
Goodwill and Non-
controlling Interest
Goodwill Non-controlling interest
•Arises when parent pays •Arises when parent company

more to acquire a subsidiary owns less than 100% of
than the fair value of its net subsidiary stock
assets •Recorded as a separate
•Recorded as an intangible account in the shareholders’
asset equity section
Income of Consolidated
Entity
Parent’s
income
Consolidated 20% Non-

Income 80% controlling
Subsidiary’s interest’s
income
Foreign Currencies &
Exchange Rates
International business often results in companies
receiving or paying in a foreign currency
Measure of one nation’s currency against another:
Foreign currency exchange rate
Conversion of an item in one currency to another:
Translation
Factors Affecting Exchange
Rates
Ratio of imports to Rate of return on
exports capital markets
•If exports exceed •If high, increases
imports, increase in international
demand drives up investments and
price of currency demand for
•If imports exceed currency
exports, supply •Currencies are
increases and described as strong
currency price falls or weak
Example
Qian Hu’s sale of ornamental fish and aquariums to Fishy
Tales, a pet store in Europe, on a 30-day credit term, on June
10, 20X6. Fishy Tales would like to pay in euros and Qian
Hu agrees to receive euros instead of Singapore dollars of
EUR 1,000. Suppose that the exchange rate on June 10, 20X6,
the day of the sale, is 1 EUR for 2.00 SGD. Qian Hu would
thus record:
When Qian Hu receives payment of EUR 1,000 from Fishy

Tales on July 10, 20X6, the exchange rate is 1 EUR for 2.10
SGD (in other words, the euro has strengthened against the
Singapore dollar).
Suppose the exchange rate on July 10 was 1 EUR = 1.95

SGD instead of 2.10 SGD.
Accounting for Foreign
Currency Transactions
JOURNAL
Date Accounts and explanation Debit Credit
Jun 10 Accounts receivable 2,000
Sales Revenue 2,000
Sale on account (€1,000 x 2.00)
Jul 10 Cash 2,100
Accounts receivable 2,000
Transaction gain 100
Collection on account (€1,000 x 2.10)
Jul Cash 1,950
Translation Loss 50
Accounts receivables 2,000
Collection on account (€1,000 x 1.95)
Short Exercise 8.9
JOURNAL
Date Accounts and explanation Debit Credit
9-12 Accounts receivable (500,000 x .36) 180,000
Sales 180,000
10-18 Cash (250,000 x .33) 82,500
Foreign currency transaction loss 7,500
Accounts receivable (1/2 x 180,000) 90,000
10-1 Cash (250,000 x .39) 97,500
Accounts receivable (1/2 x 180,000) 90,000
Foreign currency transaction gain 7,500

Foreign Currency Gains and
Losses
Gains and losses are netted and reported in the
“Other” category on the Income Statement
Losses can be avoided by:
Only accepting or paying in local currency
Hedging
Purchasing futures contracts

Consolidation of Foreign
Subsidiaries
Two challenges:
Foreign subsidiary uses different accounting

principles
Subsidiary’s statements expressed in foreign

currency
Foreign currency translation adjustment needed
Reported as other comprehensive income

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Chapter 8

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Chapter 8

1. Describe the accounting framework for financial assets as per the

u Equity investment of another company (e.g., ordinary or

u Contractual right to receive cash from another party (e.g., loans,

IASB requires that companies classify financial assets into two

Measurement Basis—A Closer Look

u Contractual cash flow characteristics of the financial asset.

Measurement Basis—A Closer Look

Debt investments are characterized by contractual payments on

Companies measure debt investments at

Illustration: Robinson Company purchased €100,000 of 8% bonds of

Debt Investments 92,278

Robinson Company records the receipt of the first semiannual

Because Robinson is on a calendar-year basis, it accrues interest and

Interest Receivable 4,000

Reporting of Bond Investment at Amortized Cost

Debt Investments 522

(€783 x 4/6 = €522)

Computation Gain on Sale of Bonds

Debt investments at fair value follow the same accounting

However, at each reporting date, companies

u Any unrealized holding gain or loss reported as part of net

Illustration: Robinson Company purchased €100,000 of 8 percent

Entries are the same as those for amortized cost.

To apply the fair value approach, Robinson determines that, due to a

Fair Value Adjustment 1,463

At December 31, 2016, assume that the fair value of the

Unrealized Holding Gain or Loss—Income 2,388

Assume now that Robinson sells its investment in Evermaster bonds on

Fair Value Adjustment 925

Illustration (Portfolio): Wang Corporation has two debt investments

Illustration (Portfolio): Wang makes an adjusting entry at December

Unrealized Holding Gain or Loss—Income 9,537

Illustration (Sale of Debt Investments): Wang Corporation sold the

Wang records the following at December 31, 2016.

Fair Value Adjustment 4,537

Financial Statement Presentation

Companies have the option to report most financial assets at fair

u is generally available only at the time a company first purchases

If a company chooses to use the fair value option, it measures this

Illustration: Hardy Company purchases bonds issued by the German

Debt Investment (German bonds) 4,537

Equity investment represents ownership of ordinary, preference,

u Cost includes price of the security.

u Broker’s commissions and fees are recorded as expense.

The degree to which one corporation (investor) acquires an interest

Holdings of Less Than 20%

General accounting and reporting rule:

u Record unrealized gains and losses in net income.

Holdings of Less Than 20%

General accounting and reporting rule:

u Record unrealized gains and losses in other comprehensive

Illustration: November 3, 2015, Republic Corporation purchased

Republic records these investments as follows:

Republic records these investments as follows:

On December 6, 2015, Republic receives a cash dividend of €4,200

At December 31, 2015, Republic’s equity investment portfolio has the

Unrealized Holding Gain or Loss—Income 35,550

In addition, assume that on February 10, 2016, Republic purchased

Republic records this adjustment as follows.

Fair Value Adjustment 101,650

The accounting entries to record non-trading equity investments are

Report the unrealized holding gain or loss as other comprehensive

Illustration: On December 10, 2015, Republic Corporation purchased