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    Inter ch.17

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    of 58
    CHAPTER 17 Investments LEARNING OBJECTIVES. Aer studying this chapter, you should be able to: 1. Describe the accounting for debt investments, 3. Explain the equity method of accounting 2, Describe the accounting for equity investments. 4, Evaluate other major issues related to debt and equity investments. PREVIEW OF CHAPTER 27 The The hope i that a relatively new standard (JFRS 9) will provide information on rec measurement, and disclosure of financial assets that w ser. This chapter discusses the key accounting issues related fo debt and equity Investments. Appendices to this chapter discuss the accounting for derivative instruments and fair value Aiclosures. The content and organization of the chapter are as INVESTMENTS Debt investments Equity investments Other Reporting Issues * Classification and measurement + Holdings of les than 20% + hwpsirroent of valve * Acoserlook at debtinvestments | |+ Holdings between 20% and 50% Miracrciee babaneses + Holdings of more than 50% + Transfers between categories + Summary of reporting treatment of investments Winners and Losers Maing nancial assets such as Joans, derivatives, and other debt investments, as well as ly investments is a challenge. The fundamental question (x: Should financial instru I be valued at amortized cont, fait value, or by other measures? As one writer noted, the ‘Plton that fie vatue accounting weakens financial and economic stability has persisted SS Scanned with CamScanner 17-2 CHAPTER 17 Investments among many companies, regulators, and poieians:On the other hang nea, believe that fair value is the right answer because it is more transparent information ~ todo? . Recently, the IASB has issued a standard on financial assets (IFRS 9) attribute approach. Some financial assets are valued at amortized cost Subsequently, a survey of accredited financial analysts on IFRS 9 c question on the standard: “Do you agree that the IASB's new stand: tion into amortized cost or fair value will improve the decision-useful instrument accounting?” The survey results indi that andor ontaned he ard requiring da ness of overal fing 4 te that just 47 percent believe the approach improves the decision usefulness of information This lukewarm supp rules is somewhat troubling given thatthe group surveyed is representa oft fp constituency——investors and creditors i Interestingly, the European Union initially refused t0 adopt the requiem JERS 9, arguing that ths standard requitesto@ meh far valu information en tess the standard was issued and, after some modifications by the IASB waren endorsed by the European Union. As a result, companies that comply with in Using this standard in 2018. tn the United States. a standard thats similar in many respects to JFRS 9 was alo nes adopted. Much like the reaction from the European Union, the US. respons hs tens, than favorable, Specifically, the requirement to report most investments in equtyat ben has not been well received. For example, Berkshire Hathaway (USA) posed Sissi, Sst quarter los in 2018 because of $62 billion losses on equity investments ht theca must now count in income as a result of the new standard. These losses reslted hee the following equity investments: shares of Wells Fargo (USA) lost 13.6 percent dure quarter, Coca-Cola (USA) shares lost 5.3 percent, and American Express (USA) vain 6.1 percent. ‘The CEO of Berkshire Hathaway, Warren Buffett, ws Fas not happy to have to report tse losses, indicating that this new measurement distorts Berkshire’s earnings. Speifiil, the investment gains and losses are often meaningless in terms of understanding out % results or evaluating our periodic economic performance.” He went on to note: "If yok the Figure of operating earnings—which we look at—we actually earned! record amt any quarter we've ever had.” AL the same time, other com panies benefited from the change in accounting fore investments. For example, Google's parent company Alphabet (USA), reported $8 Bain as a result of equity investments in Uber Technologies (USA) and o'er hot technod companies that are closely held -inancial Instrument Accounting Changs a7 nei Onlnztence November 2008); Rachel Sanderson and Jennifer Hughes “Carried ronvand” Fianbl Dense AP! 2,2010% and M. Rapoport. “Warren Buet's New Target Rale'That Cat 2 Sion Berkshire Earnings” WallStreet Journal (May 7, 2018), Review and Practice Goto the Review and Practice section Practice problem with solutior Additional exercises and practi atthe end ofthe chapter fora targeted soma . Multiplechoie questions with annotated slo ice problem with solutions, are also available online. Scanned with CamScanner = Debtinvestments 17-3 Debt Investments ING OBJECTIVE 1 {In Chapter 7, we discussed two types of financial assets—cash and receivables.' In this chap: ez, we discuss two other financial assets—debt investments and equity investments. Com- have different motivations for investing in debt or equity securities issued by other companies” One motivation is to earn a high rate of return. For example, Nokia (FIN) fan receive interest revenue from a debt investment or dividend revenue from an equity festment. In addition, it can realize capital gains on both types of securities. Another ‘motivation for investing (in equity securities) is to secure certain operating or {financing arrangements with another company. For example, Nokia may be able to ‘aercise some control over motherboard suppliers based on its significant (but not controlling) equity investments. Classification and Measurement of Financial Assets Financial assets include debt investments and equity investments. Two c determine how financial assets should be classified and measured. feria are used to 1. Whatis the company’s business model for managing its financial asset? That i, Isit the company’s business model to hold the financial asset to collect contractual cash flows rather than to sell the instrument prior to its contractual maturity to realize its fair value changes? 2 What are the contractual cash flow characteristics of the financial investment? That is, do the contractual terms of the financial asset give rise on specified dates to fish flows that are solely payments of principal and interest on the principal amount ‘outstanding? Debt Investments Companies measure debt investments at amortized cost o Amortized Cost Debt investments that meet the two criteria described above (the com. Paty plans to hold them and to collect contractual cash flows), are measured at amortized {51 Amortized cost is the initial recognition amount of the debt investment minus repay- ‘ents plus or minus cumulative amortization and net of any reduction for uncollectibility, ‘Example, assume that Mitsubishi (JPN) purchases a bond investment that it intends to 9 fair value. lifferent ‘assets qualify as financial assets. These include cash, a contractual right to receive cash, (et nlc ume one re Sa nln cmt anel ney nes ae Baier te from their use in the business and do not arise from # toes PL Mixa sachs land and bigs comes Ril sim [ne he Aura Lites i trac pata, oterinterstin prope orinan eh sueroran ae Sng es chaacrisios (ile represented yan ine esa ha ene yon nrg in boks ransfers by or on behal Fae commonly taded on securities exchanges or markets See amy area in which tis issued or dealt in as terms is divisible into a class or Scanned with CamScanner AT-4 CHAPTER 17 carina td Fees Investments, ol rity, Mitsubishi's business model for this type of investment isto col, Ee rl re maturity date. The ena forthe interest and princi apy on the bond. In this case, Mitsubishi accounts for the investment at amortized cos yy. pusinese mode! is to hold the bond investment 10 maturity, and the contractual terms. cash flow payments of principal and interest over the bond investment term, [2} nts that do not meet one oF both of these to cits ay ipa alueis theamount for which an assetcould bees arm's length transaction. For exampje te on inerestrechan Fair Value Debt investme sured and reported at fair value. F between knowledgeable willing parties in an Mitsubishi purchased bonds as part of a trading strategy 10 specu saris ease, Mitsubishi is not intending to hold the bonds to maturity and threo Tete sell the bonds before maturity, When this situation occurs, then te, value. Various objectives may be consistent with jquidity, maintaining a particular interest yield pc Rann eagles ol bet ny se ness mode] investment is reported at fa model, for example, managing lis ‘matching the duration of financi Equity Investments Equity investments are generally recorded and reported at fair value. Equity imestnes hat have a maturity date and do not have a fixed interest and principal payment sched a result, reporting equity investments at far value is considered more relevant these investments at cost. IMustration 17.1 summarizes the classification and measure: of debt and equity investments Classification Rasessmentof Accounting Criteria === Mexenet Debt Meets business model (held-for-ollection) and Amore ‘contractual cashflow tests irae Does not meet the business model test trading. hele for-collection and selling) Equity Does not meet contractual cash flow test “For some uly ivesiment for which the investor exercises some contol over the invests Within this section, we explain the accounting for investments in deb’ securities later in the chapter. A Closer Look at Debt Investments Debt secu ties represent a creditor relationship with another compat: De® SS include goverment secures, municipal secures, company bonds ons as erage Ga investments are characterized by ‘contractual paymen's . ied dats of principal and interest on the principal amount outstani Ing ms at companies group investments in debt securities into three sepa" iccounting and reporting purposes. [4] ener ve of holding ase I" 1. Held-for-collection: Investments held with the obje collect contractual cash flows. a ‘ : ‘ial s of the financial a9" oe on seid dates eat Nowe tat are sey tapes tpl Principal amount outstanding, re solely payments of principal and ine" ash should be considered first and that the sonist a are eo Scanned with CamScanner Debt investments 17-5 eld for-collection and selling: Investments hold with the objective to both collect e ual cashflows and sell financial assets. The contract tere ofthe finan Gal aset give rise On specified dates to cash Nows that are solely payments of principal sat interest onthe principal amount outstanding, 4. Mrading: All debt investments not held-forcllection or held-orcolletion and selling Tse investments are bought and held primarily for sale inthe neat term to generate Jpeome on short-term price diferences, jon 17-2 identifies these categories, along with the accounting and reporting treat- mens required for each, ae Catesory Valuation _Unveaized Ga Festercollecion | Amortized cost Notrecognizea interestwhen earned: gains | Accounting for Debt Investments by Category ‘and loses from sale. Hastorcolection | Fairvalue ——_Recognizedaasother Interest when earned; gains andseling comprehensiveincomeand _andlosses rom sae. {3 separate component of equity Tratingsecurties | Fairvalue _Recognizedinnetincome _Interest when earned gains an losses trom sale. Debt Investments—Held-for-Collection (HFC) Only debt investments can be measured at amortized cost. If company like Carrefour (FRA) ‘makes an investment in the bonds of Nokia (FIN), it will receive contractual cash flows of interest over the life of the bonds and repayment ofthe principal at maturity. If itis Carrefour's Strategy to hold this investment in order to receive these cash flows over the life of the bond, it fsa held-for.collection (HFC) strategy and it will measure the investment at amortized cost Example: Debt Investment at Amortized Cost 10 illustrate the accounting fora debt (alates Sottion for livestment at amortized cost, assume that Robinson SA purchased €100,000 of 8 percent bonds of Evermaster AG on January 1, 2022, at a discount, paying €92,278. The bonds mature hae pacont Jantary 1,2027, and yield 10 percent; interest is payable each July 1 and January 1. Robinson ‘freords the investment as follows. January 1, 2022 Debt tmvestments ona78 ash aa Asindicated in Chapter 14, companies must amortize premiums or discounts using the “Interest method. They apply the effective-interest method to bond investments Way similar to that for bonds payable. To compute interest revenue, companies com: PMte the effective-interest rate or yield at the time of investment and apply that rate to the Iezinnng carrying amount (book value) for each interest period. The investment carrying Lis increased by the amortized discount or decreased by the amortized premium in ‘ch period, 3 Mlustration 17.3 shows the effect of the discount amortization on the interest revenue at Robinson records each period for its investment in Evermaster bonds, - Pte w het orcovecvon does ot mean the security must be eld 10 matury, For example, AenBP may sel an investment before maturity i (2) the security does not meet the company’s investment a a my AAA-rated bonds but the bond investment credit maturity aati aeeaments ona regula basis, it should assess whether such trading is ith the held for collection clasiiation, (8) Scanned with CamScanner 17-6 CHAPTER 17. Investments (OSCE ELe) Schedule of Interest Revenue and Bond Discount Amortization—Effective- Interest Method CS Reporting of Bond Investments at Amortized Cost ‘8% Bonds Purchased to Yield 10% % ond an cash Interest Discount oe ate Received om ae € 922 wae nna € 4000" ian rns on Me 7) vipa sau 74 = ans az 7s 61 1/6 an 71s mis ana os = eanara= 100 ze Robinson records the receipt of the first semiannual interest payment on July 1,2 (using the data in Illustration 17.3), as follows. July 1, 2022, Cash 4,000 Debt Investments, ola Interest Revenue 4014 Because Robinson is on a calendar-year basis, it accrues interest and amortizes the és count at December 31, 2022, as follows. December 31, 2022 Interest Receivable 4,000 Debt Investments. 645 Interest Revenue 4.645, Robinson reports its investment in Evermaster bonds in its December 31, 2 statements, as shown in Illustration 17.4.5 Statement of Financial Position Long-term investments Debtinvestments Currentassets Interest receivable ‘Income Statement Otherincome and expense Interest revenue (€4,614-+ €4,645) soc Astin # ay ond oes! eis may For eam five-year debt inven a tt fa change in its investment strategy to move 3) eae yinvestments like the Evermaster bonds, to Invest in shorter-term bonds 7 ore frequently in response 10 inst changes. Let's assume that Robinson sell, ls investment in Bvrmater bonson SO ™™ eit ‘than the individual security aaa atic paaating the investments) at a higher level of - pany May have more than one investment stratex ™ ch tractual cash hows 3 Scanned with CamScanner 99% plus accrued interest. The discount amortizat a Seana oleane I s22 (x73). odin eras ea aa to No int amortization as follows. November 1, 2024 ‘ Debt Investments Interest Revenue = “osrtion 175 shows the computation ofthe realized gain onthe sale price of bonds (exclusive of accrued interes) Book value of bonds on November 1, 2028 cost, July 1, 2028 Discount amortized forthe period July 2, 2026, ‘twNovember 1, 2024 yon sale of bonds ©3750 es5671 Peers he ae of tne bonds as otows : November 1,202 Cash (€99.750 + €2,567) 102,417 Interest Revenue (¥6 x €4,000) Debt Investments Gain on Sale of Investments, ‘The credit to Interest Revenue represents accrued interest for four months, for which the purchaser pays cash. The debit to Cash represents the selling price of the bonds plus accrued interest (€99,750 + €2,667). The credit to Debt Investments represents the book value of the bonds on the date of sale. The credit to Gain on Sale of Investments represents the excess of the selling price over the book value of the bonds. Debt Investments—Held-for-Collection and Selling (HFCS) Asindicated, ifthe objective of the business model isto hold a debt investment to collect its fontractual cashflows, the debt investment is measured at amortized cost. However, if the " dbjetive ofthe business model is not only to collect contractual cash lows but also to sell debt _ SSutes, then the debt investment is measured at fair value. For example, a company like " Garrefour (FRA) may wish to hold to collect but may also need to sell investments to manage Wauidty needs or maintain a yield profile This held-for-collection and selling (HIFCS) business model therefore recognizes fair “Talteon the statement of financial position because the companies may choose o sel the debt st, However, changes in far value are recognized in other comprehensive income Batherthan in the profit and fos statement o minimize the volatility of net income. [7] When investment is sold, then the company recognizes a gain or loss on the income state | Beni by recycling the amounts recorded in accumulated other comprehensive income into statement (see Underlying Concepts). ‘Eample: Single Security _Toillustrate the accounting for HFCS securities, assume that ple purchases £100,000, 10 percent, five-year bonds on January 1, 2022, with interest fon July 1 and January 1. The bonds sell for £108,111, which results in a bond premium ill and an effective-interest rate of § percent. Graff records the purchase of the bonds as follows: January 1, 2022 108,111 Debt Investments Cash 10,111 si cot in purchasing eres. For investments accounted <2 jaires that these costs be expensed and reported in the "Other neat thee cant ae no ado 10 the cot ofthe nay incur brokerage and tran alu (both deb and equity) FRS re et epeme" secon ofthe nme tate Debt Investments 17-7 ‘Computation of Gain on. Sale of Bonds Underlying Concepts Recognizing unrealized tins and loses in equity isan application atthe concept of arapecictrs icons Cateltr Solution for ‘eed ce | a Bo 5.000 Scanned with CamScanner 17-8 CHAPTER 17 Investments Schedule of Interest Revenue and Bond Premium Amortization—Effective- Interest Method Mlustration 17.6 presents the effect of the premium amortization onthe inte TS eg Graff records each period using the effective-interest method. 10% Bonds Purchased to Vield 8% hq Caenjng cosh Interest Amount Date Received Revere of Bonds aaa 0602 Tz ESpoo ka 107,435 anes 5000 4237 106722 nn 5,000 4268 106,002 Ne a 2200 105241 yaa 5,000 4210 el ans 5,000 aan 103999 7ans 500 aus 10274 ans 5,000 an 101885 Tans 5000 4075 200.960 mp _ 500 4.040 too, Som tase ee es “15000 =110)000%.10%% “e576 = £5000 e424 Se4324= 08111 Ob “10735 Can 676 The entry to record interest revenue on July 1, 2022, i as follows July 1,2022 Cash > 5,000 Debt tnvestments 76 Interest Revenue 4324 ‘At December 31,2022, Graff makes the following entry to recognize interest revenue December 31, Interest Receivable = 5.000 Debt Investments ® Interest Revenue am Asa result, Graff reports interest revenue for 2022 of £8,621 (£4,324 + £4,297 se debt investments, assume that at year-end the frat she carrying amount ofthe investments i £106,732. CO=mS! ng Amount (amortized cost) of the bonds at December 37. lzed holding loss of £1,732 (£106,732 — £105,000. It income, Graff makes the following entry. December 31,2022 ‘Unrealized Holding Gain oF Loss—f i Fair Value Adjustment mia Fair Value Adjustment’ editing the Debt Investments account. The wie ; ‘the company to maintain a record 0! 8279 in this case, Graff sub arene A€e0unt to determine fair value. Graff repo Scanned with CamScanner ‘grample: Portfolio of Securities 1p il illustrate the accounting for a portfolio of securi- Mustration 17.7 identifies the amortized cost, fir value, and the amount of the unrealized The fair value of Webb's HFCS portfolio totals €284,000. The gross unrealized gains ate €10,063, and the gross unrealized losses are €19,600, resulting in a net unrealized loss (f €,537. That is, the fair value of HFCS securities is €9,537 lower than its amortized cost. Webb makes an adjusting entry to a valuation allowance to record the decrease in value and forecord the loss as follows. December 31,2022 Unrealized Holding Gain or Loss—Eauity 9337 Fair Value Adjustment 937 Webb reports the unrealized holding loss of €9,537 as other comprehensive income and Arsduction of equity Recall that companies exclude from net income any unrealized holding fins and losses related to HFCS securities. Unrealized Holding Gain or Loss—Equity is then ‘losed to Accumulated Other Comprehensive Income as shown in the following entry. December 31,2022 ‘Accumulated Other Comprehensive Income 981 nae Unrealized Holding Gain or Loss—Equity IAscotmolsted Other Comprehensive Income is reported as part of equityin the statement ffinancial position, Sale of HFCS Securities If comp” Tiles before the maturity date, it must ma _ €xountthe amortized cost of bonds sold. To {from tlustration 17.7) on July 1, 2023, 0 Of €94,214. Mustration 17.8 shows the comput 1 sels bonds carried as investments in HFCS secu: ie entries to remove from the Debt Investments illustrate, assume that Webb AG sold the Watson + €90,000, at which time it had an amortized tation of the realized loss. records the sale of the Watson bonds as follows: sly 12023, ‘Loss on Sale of Investments 94214 Debt Investments Debtinvestments 17-9 Computation of Fair Value Adjustment—HFCS (2022) Computation of Loss on Sale of Bonds Scanned with CamScanner 17-10 CHAPTER 17 Investments OTULEteY Computation of Fair Value Adjustment—HFCS (2023) Reporting of HFCS Securities 4 toss in the “Other income and expense” section of, “and sales of bonds in 2023, Webb on Denn Mlustration 17.9. * Webb re no other purchas tng he statement. —— ie pcs Debt Security Portfolio Sa Ee a ‘Amortized Fair Value Une eae oe Yaveatied canto Jnacorp Group a0 bonds total proto) emo ass00 9 Previous forvalue adjustment balancer, osm fairvalveaustinent-Dt us holding loss of 5,000. However, the Fair Value Adjusne, walance of €9,537. To reduce the adjustment account bane Webb has an unrealized account already has a credi £€5,000, Webb debits it for €4,537, as follows. December 31, 2023 Fair Value Adjustment 4337 ‘Unrealized Holding Gain or Loss— Equity 4337 ntation Webb's December 31, 2023, statement of fia items and amounts shown in Must Financial Statement Preset position and the 2023 income statement include the ion 17.0 (the Anacomp bonds are long-term investments but are not intended tobe eds maturity) cir Statement of Financial Position vestments ret : 413500 current assets = interest receivable a Equity vAccumulated other comprehensive loss ae Income Statement other income and ex ieee € | eee € 424 Ne ———— ex income ravers! Some favor including the unrealized holding gain or loss in 3 reporting tas other comprehensive income, However, some companies, particulate institutions, note that recognizing gains and losses on assets, but not lablites 1 tubstantal volatility in net income. They argue that hedges often exist beiveet 2 Tiabilities so that gains in assets are offset by losses in liabilities, and vice ‘ognize gains and losses only on the asset side is unfair and not repress activities ofthe company. ao “This argument convinced the IASB, Asa result, companies do not ini INMC these unrealized gains and loses on debt investments classified as eldfo" etn ing. However, even this approach solves only some of the problems bec: volatility ital still results. This is of concern to financial institutions because regs institutions’ operations based on their level of capital. However comp" their net income by engaging in gains trading (i.e. selling the wines “ont oe mais nc etsy comprehensive Incime, Thc ajouen ccs at yearend when he em ‘valve adjustment, = C Scanned with CamScanner pebt Invest ments—Trading tnsome cases, companies both manage and evaluate investment performance on a fair value juss In these situations, these investments are managed and evaluated based on a docu- mented risk-management or investment strategy based on fair value information. For exam: plesome companies often hold debt investments with the intention of selling them in a short fered of time. These debt investments are often referred to as trading investments because fompanies frequently buy and sell these investments to generate profits from short-term dif- ferences in price. ‘Companies report trading securities at fair value, with unrealized holding gains and losses reported as part of net income. Similar to held-for-collection or HFCS invest penis, companies are required to amortize any discount or premium. A holding gain or Jossis the net change in the fair value of a security from one period to another, exclusive of dividend or interest revenue recognized but not received. In short, the IASB says to adjust the trading securities to fair value, at each reporting date. In addition, companies report the ‘change in value as part of net income, not other comprehensive income. {po illustrate, assume that on December 31, 2022, Western Publishing determined the Aistubution of its trading securities portfolio, as shown in Mustration 17.11. (Assume that ‘022s the first year that Western Publishing held trading securities.) At the date of acquisi tion, Western Publishing recorded these trading securities at cost, in the account entitled Debt Investments. This is the first valuation of this recently purchased portfolio. ‘Trading Debt Security Portfolio December 31,2022 Amortized Cost FairValue Northern 63s bonds € 43,860 € 51,500, 184.230 ‘Communications 8% bonds 5360 Total of portotio Giaso Previous sir value ‘adjustment balance Fairvalue adjustment Dr. The total cost of Western Publishing's trading portfolio is €314,450. The gross unrealized {Bins are €12,780 (€7,640 + €5,140), and the gross unrealized losses are €9,030, resulting in ‘(net unrealized gain of €3,750. The fair value of trading securities is €3,750 greater than its cost. At December 31, Western Publishing makes an adjusting entry to the Fair Value Adjust "ent account, to record both the increase in value and the unrealized holding gain December 31, 2022 Fair Value Adjustment Unrealized Holding Gain or Loss—Income 3,750 Because the Fair Value Adjustment account balance isa debit, Western Publishing adds it "othe cost of the Debt Investments account to arrive ata fair value for the trading securities. "stern Publishing reports this fair value amount on the statement of financial positio swith other debt investments, when a trading investment is sold, the Debt Investments nt is reduced by the amount of the amortized cost of the bonds. Any realized gain or {s recorded in the “Other income or expense” section of the income statement. The Fair Mae Adktment nconss ten ajsed mt eure fo the unread sins or lesen maining securities in the trading investment portfolio. securities are actively traded, the IASB believes that the investments should be at fair value on the statement of financial position. In addition, changes in fair value Bains and losses--income) should be reported in the “other income and expense” of the income statement. Such reporting on trading securities provides more relevant mn 0 existing and prospective shareholders. Debt Investments 17-11 Computation of Fair Value Adjustment—Trading Securities Portfolio (2022) Scanned with CamScanner 37-12 CHAPTER 17 Investments Fair Value Option In some situ: ns, a company meets the criteria for accounting for a debt inves, tized cost, but it would rather account for the investment at fair value, with losses related to changes in fair value reported in income. The most common address a measurement or recognition “mismatch. purchases debt investments that it plans to manage on a held-for-collection basis for at amortized cost). Pirelli also manages and evaluates this investment in related liability that is measured at fair value. Pirelli has a mismatch on these rel, cial assets because, even though the fair value of the investment may chia MED tay, ‘or example, assume that Pips (nang ction ate fw NE, No ign losses are recognized, while gains and losses on the liability are recorded in income ‘Toaddress this mismatch, companies have the option to report mos nancial aug at fair value. This option is applied on an instrument-by- available only at the time a company first purchases the financial ass. to use the fair value option, it measures this instrument at fair value longer has ownership. [9] By choosing the fair value option for the de strument bss and spree ompany chi the compag vestment, records gains and losses in income, which will offset the gains and loss recorded eat liability, thereby providing more relevant information about these relates! »ancial ase’ To illustrate, assume that Hardy AG purchases bonds issued by 0h» German Genet Bank. Hardy plans to hold the debt investment until it matures in five yea At December: 2022, the amortized cost of this investment is €100,009; its fair value at De. ember 31,2025 €113,000, If Hardy chooses the fair value option to account for this investment, it males following entry at December 31, 2022. December 31, 2022 Debt Investment (German bonds) 13,000 Unrealized Holding Gain or Loss—Income 30 In this situation, Hardy uses the Debt Investment account to record the cha in irae December 31. It does not use the Fair Value Adjustment account because the sccountng i fair value option is on an investment-by-investment basis rather than on a portfolios Hardy selected the fair value option, the unrealized gain or loss is recorded as part of tine even though it is managing the investment on a held-for-collection basis. Hardy mustcoom==" se fair value to record this investment until it no longer has ownership of these curity. What Do the Numbers Mean? _ What Is Fair Value? In a letter to market regulators, the International Accounting ‘Standards Board (IASB) said some European financial institutions should have booked bigger losses on their Greek government bond holdings. The IASB criticized inconsistencies in the way financial institutions wrote down the value of their Greek sovereign debt in their quarterly earnings. The IASB said “some companies” were not using market ga wide angel 68 holdings a> | results varied from 21 to 50 percent, showin ‘on what they expect to get back from thei head of J. Chahine Capital (LUX) whsh TOS" ew billion in assets, noted that “the Greek debt issve hs lightly. And i's not just Greek debt—all of it nests down, including Spain, Italy.” nwo Especially egregious, stated one accounting Pe" prices to calculate the far value of their Greek bond holdings, findings that companies use their own more OPUS Paying insead on internal models While some claimed this was thns in some instances asa substitute for exs791 ey Tecause the market for Greck debt had become ilquid he TASB “What that is saying is: ‘air value is what you 8a agreed. “Although the level of trading activity in Greek gov: be. Pick a number... That especially trouble Cerment bonds has decreased, transactions are sil taking place,” 2 TASB chair Hans Hoogervors! wrote, Sources: Susanne Crag and Jonathan Wel, “SEC PAS ‘roropean banks, which had taken 3 billion hit on their Staley Values” Wal iret Journal (November ® 24. Greck bond holdings, employed markedly diflerent approaches “Accounting Board Criticizes European Banks 08 © crtuing the det. The write-downs disclosed in thir quarterly The Now York Times (August, 2012) nn * Companies may also use the fair value option for investments hektforcoletion ans ‘unrealized holding guns and loses on the deb investment are recorded i OOM: pet, ps discuss in Chapter 14, companies may elect theft value option an reer DES nt {n fair valve reported in income. An exception to this guideline is when a potion of To due 10 change in a company's own credit isk; {n that case, the Some (with mo recyeling). ge sre Scanned with CamScanner Equityinvestments 17-13 Equity Investments i Sea en cer Se ROU LEARNING OBJECTIVE 2 " pescribe the accounting for equity investments. nequity investment represents ownership interest, such as ordinary, preference, or other capital shares It also includes rights to acquire or dispose of ownership interests at an agreed. upon or determinable price, such as in warrants and rights. The cost of equity investments is ‘measured at the purchase price of the security: Broker's commissions and other fees incidental tothe purchase are recorded as expense. [10] ‘The degree to which one company (investor) acquiresan interest in the shares of another ‘company (Investee) generally determines the accounting treatment for the investment subse- quent to acquisition. The classification of such investments depends on the percentage of the imvestee voting shares that is held by the investor: 4 Holdings of less than 20 percent (fair value)—investor has passive interest, 2. Holdings between 20 percent and 50 percent (equity method) —investor has significant influence. 3. Holdings of more than S0 percent (const interest. lated statements) investor has controlling IMlustration 17.12 lists these levels of interest or influence and the corresponding valua: tion and reporting method that companies must apply to the investment. , >) *Iamm Percentageot | Omnertio | om ——> 20% —— som —— 100 Levels of Influence Determine Level of | Tinieor Significant. Contra | Accounting Methods influence | None Valuation ir Faulty Consolidation | method Valve Method | rents therefore depend on the level of influ The accounting and reporting for equity invests Ree ei ion 17.23. ‘nce and the type of security involved, as shown in Ilustrat Unease ling = ILLUSTRATION 3 on Gansortoses otherincemettiects | Accounting and Reporting aie for Equity Investments by Category necopinedinnet ivdends declared: parece income gains and losses tomate 5 necogisdin “Other ivdends declared: pe ‘comprehensive gains and losses sreomeond35 from sate Sepontecomponen. ofeauty Fo eaital recognised Proportarae share a ‘of investee’s net Income, gis ant ones rom ae Corvoiimin ——_pexreconnd ot ppbeabe Scanned with CamScanner 17-14 CHAPTER 17 Investments Holdings of Less Than 20% When an investor has an interest of less than 20 percent, itis presumed that the ing, has little or no influence over the investee. As indicated in Illustration 17.13, there an. classifications for holdings less than 20 percent. Under IFRS, the presumption is that investments are held-for-trading. That is, companies hold these securities to profit fam © changes. As with debt investments that are held-for-trading, the general accounting se reporting rule for these investments is to value the securities at fair value and record uae. ized gains and losses in net income (fair value)."" However, some equity investments are held for purposes other than trading For ean ple, a company may be required to hold an equity investment in order to sel is producs¢ particular area, In this situation, the recording of unrealized gains and losses in income a required for trading investments, is not indicative of the company’s perforrsance with rape to this investment. As a result, IFRS allows companies to classify some equity investors as non-trading. Non-trading equity investments are recorded at fair ‘luc on the sie ‘ment of financial position, with unrealized gains and losses reported in otler comprehensie income. [12] Equity Investments—Trading (Income) Upon acquisition, companies record equity investments at fair value. To ills that on November 3, 2022, Republic SA purchased ordinary shares of three companies ex investment representing less than a 20 percent interest. These shares are held-fortrading cost Burberry 259,700 Nestlé 317,500 ‘St. Regis Pulp Co. 141,350 Total cost 718,550 Republic records these investments as follows. November 3, 2022 Equity Investments 718,550 ash 718,850 am On December 6, 2022, Republic receives a cash dividend of €4,200 on its invest™="" ordinary shares of Nestlé. It records the cash dividend as follows. December 6, 2022 oe 4,200 Dividend Revenue 4.200 "Far value at intial recognition isthe transact ascii transaction price (exclusive of brokerage and het Way nese fale measuremenis should be based on market ies ale Whe F®S et of tue? ‘hat all equity investments be measured a far vo ‘equity Investment in certain imited canes. (14) "Companies should record equity investment opr or servis tet aos ‘Otherwise, the value ofthe exchange can hea Cost may be an appropriate estimate ie sulted in exchange for non-cash consideP\ sideration given ie value can be mess ie, thea ae ad a ree ts Wels the dates of purchases and sles atone lM, same class of security The flestin, lestoue jena everaBs cost etd fr LDN PA pew tale fu also acceptable and n roe 'method of assigning costs to invest Scanned with CamScanner All three of the investee companies reported net income for the year, but only Nestlé alae and paid a dividend to Republic. But recall that when an inoeter oe es has agpercent of the shares of another company, itis presumed that the investor has relatively lit tiinluence on the investee. Asa result, net income earned by the investee is not a proper basis for recognizing income from the investment by the investor. Why? Because the increased net assets resulting from profitable operations may be permanently retained for swe in the investee’s business. Therefore, the investor earns net income investee declares cash dividends, ‘AtDecember 31, 2022, Republic's equity inve: fairvalue shown in Mustration 17.14, only when the tment portfolio has the carrying value and Equity investment Portfolio. December 21,2022 ‘carrying Fair Unrealized “Nalue Value Gain (Loss) 255,700 €27500-—€ 15300 (23,500) St Regis Pulp Co. Total of portato e7sss0 Previous fairvalve adjustment balance Fair value adjustment—Cr. For Republic's equity investment portfolio, the gross unrealized pains are €15,300,and the fos unrealized losses are €50,850 (€13,500 + €37,350), resulting in a net unrealized loss of ©5550, The far value of the equity investment portfolio is below cost by €35,550, Republic records the net unrealized gains and losses related to changes in the fair value ‘quity investments in an Unrealized Holding Gain or Loss—Income account. Republic ‘Por this amount as “Other income and expense." In this case, Republic prepares an adjust- Hngeniry debiing the Unrealized Holding Gain oF Loss—Income account and crediting the an Adjustment account to record the decrease in fair value and to record the loss as December 31, 2022 Unrealized Holding Gain or Loss—Income Fair Value Adjustment 35,550 35,550 ‘OnJanuary 23, 2023, Republic sels all ofits Burberry ordinary shares, receiving €287,220, 17.15 shows the computation of the realized gain on the sale. from sale 287220 Net proceeds 012 Cost of Burberry shores Gain onsale of shares Republic records the sal as follows ary 23,2023 Cash 2s a 287,220 aly resineos 2070 Glin on Sao vesimens vary 10,202, Republepushases 255 00of Continental Ae Tatler uaeaan ecient sp8ition, assume tht on Febr Ordinary shares (20,000 shares x €12.75 Equity Investments 17-15 ILLUSTRATION 17.44 Computation of Fair Value Adjustment—Equity Investment Portfolio (2022) ‘Computation of Gain on: ‘of Burberry Shares Scanned with CamScanner AT-1G CHAPTER 17 Investments RATION 17.16 Computation of Fair Value Adjustment—Equity Investment Portfolio (2023) Ilustration 17.16 lists Republic’s equity investment portfolio as of December’, Equity Investment Portfolio, ‘December 31, 2023 Carrying Fair Unrated lavestments Value Valve Gain oss) Continental Trucking €255,000°—€278,350 € 2350 Nestlé 317,500 362,550 5059 St. Regis Pulp Co. 141/350 139,050, 2,00) Total of portfolio Previous fair value adjustment balancer. (25.550) Fair value adjustment-or. a "The brokerage commisions ae expensed At December 31, 2023, the fair value of Republic's equity investment portfolio carrying value by €56,100 (unrealized gain). The Fair Value Adjustment acount hada balance of €35,550 at December 31, 2023. To adjust its December 31 ity invest portfolio to fair value, the company debits the Fair Value Adjustment account for 10.69 (€35,550 + €66,100). Republic records this adjustment as follows, December 31, 2023 Fair Value Adjustment 101,650 Unrealized Holding Gain or Loss—Income Equity Investments—Non-Trading (OC!) The accounting entries to record non-trading equity investments are the samme 81 equity investments, companies report the unrealized holding gain or loss 808%" 5 prehensive income. Thus, the account titled Unrealized Holding Gain ot Les at 0 os ‘To illustrate, assume that on December 10, 2022, Republic SA purchases shares of Hawthorne Company for €20.75 per share (total cost €20,750). The ine" resents less than a 20 percent interest. Hawthorne is a distributor for Republi 0, certain locales, the laws of which require a minimum level of share owner in that region. The investment in Hawthorne meets this regulatory require Republic accounts for this investment at fair value, with unrealized gains 1 ; ent as fol in other comprehensive income (OCI)."” Republic records this investment # | December 10, 2022 Equity Investment (Hawthorne) 20,750 cash a gst” ‘The Equity Investment (Hawthorne) account is used because the non-teadingHS applied on an investment by investment basis rather than on a portfolio PIS. yal! (On December 27,2022, Republic receives a cash dividend of €480 02 181° ordinary shares of Hawthorne Company. It records the cash dividend as (1! Dovember 27,2022 Cash 450 450 Dividend Revenue "The IASB provided the fair value through other comprehensive income Of ‘some investments are made primarily for now financial reasons (estate to define sirateyic alllances ora general principal for identifying such ase te FVOCT optional. The classification of an equity investment as non-trading is ITEC ‘designed 10 provide some discipline to the application ofthe now-trading option: ‘puns and losses 1 bypass net income [13] Scanned with CamScanner to the accounting for trading investments, when pe ordinary shares of another company. itis p eijeinfloence onthe investee. The ‘cash dividends. ‘At December 31, 2022, Republic’ investment in Hawthorne has the carrying value and sgrvalue shown in IMustration 17.17, an investor owns less than 20 percent imed that the investor has relatively efore, the investor earns income when the investee Unrealized Non-Trading Equity Investment carey Gain (Loss) Hawthorne Company €20,750 6250 For Republic's non-trading investment, the unrealized gain is €3,250. That is, the fair vale ofthe Hawthorne investment exceeds cost by €3,250, Because Republic has classified thisinvestment as non-trading, Republic records the unrealized gains and losses related to changes in the fair value of this non-trading equity investment in an Unrealized Holding Gain or Loss—Equity account. Republic reports this amount as a part of other compre- hensive income and as a component of accumulated other comprehensive income (Geported in equity). In this case, Republic prepares an adjusting entry crediting the Unre alized Holding Gain or Loss—Equity account and debiting the Equity Investment account 10 trord the increase in fair value and to record the gain as follows. Equity Investment (Hawthorne) Unrealized Holding Gain or Loss—Eauity 3.280 Asindicated, the Equity Investment (Hawthorne) account is used to record the change in fuirvalue because the non-trading classification is applied on investment by investment basis, rater than on a portfolio basis. Republic reports its equity investments in its December 31 Shown in tustration 17.18 2022, financial statements as Statement of Financial Posi iene CaultymestentHawthors) e400 ny € 3,250 | "accumulated other comprehensive gin ‘Statement of Comprehensive Income Ctherincome and expense € 450 Dividend revenue Other comprehensive income eee Unrealized holding 219 7 ywthorne as a distributor did not meet, c products through Hawt! ym these markets. On December 20, sMent's goals, As a result, Republic withdrew from these mark yecem 2 er ad al of Hate Cam eo he te | Before Republic records the sale» A eae eerie Ronan ety mesmo ava engi a nt lized gain oF loss as sh ition 17.19. During 2023, sales of Repub! _Non Trading Equity Investment Equity Investments 17-17 Computation of Fair Value ‘Adjust ment—Non-Trading Equity Investment (2022) Statement Presentation of Equity Investments at Fair Value (2022) Adjustment to Carrying Value fof Investment Scanned with CamScanner AT-IB CHAPTER 17 Investments Republic makes the following entry to reduce the equity investment and r unrealized holding loss for Hawthorne as follows, Oona December 20, 2023 Unrealized Holding Gain or Loss—Equity 1,500 Equity Investment (Hawthorne) mete ‘The following entry is then made to record the sale of the investment. December 20, 2023 Cash 22,500 uity Investment (Hawthorne) 00 As indicated, recognition of the sale does not result in a gain or loss because the ui ‘ment is stated at fair value, Note that all gains and losses on the non-trading investinen recorded in equity.'* In summary, the accounting for non-trading equity investments deviates from the gn provisions for equity investments, The LASB noted that while fair value pr ful information about equity investments, recording unrealized gains or loss in otherconge hensive income is more representative for non-trading equity investments. the mos. ue [ What Do the Numbers Mean? The Fair Value Challenge ther illustration of fair value measurement challenges—this graphs show the wide range of valuations for C!_

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