CH 17

AKUNTANSI KEUANGAN
MENENGAH
Chapter 17.
Investments
Minggu ke-12
Intermediate Accounting
IFRS Edition
Kieso, Weygandt, Warfield
Fourth Edition
Chapter 17
Investments
Prepared by
Coby Harmon
University of California, Santa Barbara
Westmont College
This slide deck contains animations. Please disable animations if they cause issues with your device.
Copyright ©2020 John Wiley & Sons, Inc.
Learning Objectives
After studying this chapter, you should be able to:
LO 1 Describe the accounting for debt investments.
LO 2 Explain the accounting for equity investments.
LO 3 Explain the equity method of accounting.
LO 4 Evaluate other major issues related to debt and equity
investments.
Copyright ©2020 John Wiley & Sons, Inc. 3

PREVIEW OF CHAPTER 17

Learning Objective 1
Describe the accounting for debt
investments.
LO 1 Copyright ©2020 John Wiley & Sons, Inc. 5

Debt Investments
Two Types of Financial Assets
• Debt investments.
• Equity investments.
Motivations for investing:
• Earn a high rate of return.
• To secure certain operating or financing arrangements
with another company (equity securities).

Debt Investments
Classification and Measurement of Financial Assets
Two criteria:
1. What is the company’s business model for managing its
financial assets?
2. What are the contractual cash flow characteristics of
the financial investment?

Classification and Measurement of
Financial Assets
Summary of the classification and measurement of debt and
equity investments.
ILLUSTRATION 17.1

A Closer Look at Debt Investments
Debt investments are characterized by contractual payments
on specified dates of
• principal and
• interest on the principal amount outstanding.
Companies group debt investments into three categories:
1. Held-for-collection
2. Held-for-collection and selling
3. Trading securities

A Closer Look at Debt Investments
Accounting for Debt Investments by Category
Companies group debt investments into three categories:
1. Held-for-collection
2. Held-for-collection and selling
3. Trading securities
ILLUSTRATION 17.2
Debt Investments—Held-for-Collection
Debt Investment at Amortized Cost
Illustration: 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 January 1, 2027 and yield
10 percent; interest is payable each July 1 and January 1.
Robinson records the investment as follows:
January 1, 2022
Debt Investments 92,278

Cash 92,278

Schedule of Interest Revenue and Bond Discount
Amortization—Effective Interest Method
ILLUSTRATION 17.3

Journal Entry to Record Receipt of First Semiannual
Interest Payment
ILLUSTRATION 17.3
Robinson records the receipt of the first semiannual interest

payment on July 1, 2022, as follows:
July 1, 2022
Cash 4,000
Debt Investments 614
Interest Revenue 4,614

Journal Entry to Record Accrued Interest and
Amortization of Discount
ILLUSTRATION 17.3
Robinson is on a calendar-year basis, it accrues interest and

amortizes the discount at December 31, 2022, as follows:
December 31, 2022
Interest Receivable 4,000

Reporting of Bond Investments at Amortized Cost
ILLUSTRATION 17.4

Amortization of Discount on November 1, 2024
Assume that Robinson sells its investment on November 1, 2024, at 99¾ plus
accrued interest. Robinson must record discount amortization from July 1, 2024,
to November 1, 2024.
ILLUSTRATION 17.3
November 1, 2024
Interest Revenue 522
(€783 × 4/6 = €522)
Computation of Gain on Sale of Bonds
ILLUSTRATION 17.5
Robinson records the sale of the bonds as follows.

November 1, 2024
Cash (€99,750 + €2,667) 102,417
Interest Revenue (4/6 × €4,000) 2,667
Gain on Sale of Investments 3,557

Debt Investments—Held-for-Collection and
Selling
Debt investments held-for-collection and selling 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
• Adjust the amortized cost to fair value.
• Any unrealized holding gain or loss is reported as part of
other comprehensive income rather than in the profit
and loss statement.

Debt Investments—Held-for-Collection and Selling
Single Security
Illustration: Graff plc purchases £100,000, 10 percent, five-

year bonds on January 1, 2022, with interest payable on July 1
and January 1. The bonds sell for £108,111, which results in a
bond premium of £8,111 and an effective-interest rate of 8
percent. Graff records the purchase of the bonds as follows.
January 1, 2022

Cash 108,111

Schedule of Interest and Bond Premium Amortization—
Effective-Interest Method
ILLUSTRATION 17.6

Journal Entry to Record Interest Revenue and Bond
Premium Amortization on July 1, 2022
ILLUSTRATION 17.6
Illustration (Single Security): The entry to record interest

revenue on July 1, 2022, is as follows.
July 1, 2022
Cash 5,000

Journal Entry to Record Interest Revenue and Bond
Premium Amortization on Dec. 31, 2022
ILLUSTRATION 17.6
Illustration (Single Security): At December 31, 2022, Graff

makes the following entry to recognize interest revenue.
December 31, 2022
Interest Receivable 5,000

Journal Entry to Apply Fair Value
ILLUSTRATION 17.6
Illustration (Single Security): To apply the fair value method to
these debt investments, assume that at December 31, 2022 the
fair value of the bonds is £105,000. Graff makes the following
entry.
December 31, 2022
Unrealized Holding Gain or Loss—Equity 1,732
Fair Value Adjustment 1,732

Computation of Fair Value Adjustment—HFCS (2022)
Illustration (Portfolio of Securities): Webb AG has two debt

securities classified as held-for-collection and selling. The following
illustration identifies the amortized cost, fair value, and the amount
of the unrealized gain or loss.
ILLUSTRATION 17.7

Journal Entry to Record Loss
ILLUSTRATION 17.7
Prepare the adjusting entry Webb would make on December

31, 2022 to record the loss.
December 31, 2022

Sale of HFCS Securities
If company sells bonds before maturity date:

• It must make entries to remove from the Debt Investments
account the amortized cost of bonds sold.
• Any realized gain or loss on sale is reported in the “Other
income and expense” section of the income statement.

Journal Entry to Record Sale of HFCS Securities
Illustration: Webb AG sold the Watson bonds (from Illustration
17.7) on July 1, 2023, for £90,000, at which time it had an
amortized cost of £94,214.
ILLUSTRATION 17.8
July 1, 2023
Cash 90,000
Loss on Sale of Investments 4,214

Computation of Fair Value Adjustment—HFCS (2023)
Illustration: Webb reports this realized loss in the “Other income

and expense” section of the income statement. Assuming no other
purchases and sales of bonds in 2023, Webb on December 31,
2023, prepares the information:
ILLUSTRATION 17.9

Adjusting Entry on December 31, 2023
Illustration: Webb records the following at December 31, 2023.
ILLUSTRATION 17.9
December 31, 2023


Reporting of HFCS Securities
ILLUSTRATION 17.10

Debt Investments—Trading
Companies often hold debt investments with the intention of
selling them in a short period of time. These debt investments
are often referred to as trading investments.
Companies report trading securities
• at fair value,
• with unrealized holding gains and losses reported as part
of net income.
A holding gain or loss is 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.

Computation of Fair Value Adjustment—Trading
Securities Portfolio (2022)
Illustration: Assume that on December 31, 2022, Western Publishing
determined the distribution of its trading securities portfolio to be as in
Illustration 17.10. At the date of acquisition, Western Publishing recorded these
trading securities at cost, in the account entitled Debt Investments. This is the
first valuation of this recently purchased portfolio.
ILLUSTRATION 17.11
Adjusting Entry on December 31, 2022
Illustration: At December 31, 2022, Western Publishing makes an
adjusting entry to the Fair Value Adjustment account, to record
both the increase in value and the unrealized holding gain.
ILLUSTRATION 17.11
December 31, 2022
Unrealized Holding Gain or Loss—Income 3,750

Fair Value Option
Companies have the option to report most financial assets at
fair value, with all gains and losses related to changes in fair
value reported in the income statement.
• Applied on an instrument-by-instrument basis.
• Generally available only at the time a company first
purchases the financial asset or incurs a financial liability.
• Company must measure this instrument at fair value until
the company no longer has ownership.

Fair Value Option
Journal Entry on December 31, 2022
Illustration: Hardy AG purchases bonds issued by the German

Central Bank. Hardy plans to hold the debt investment until it
matures in five years. At December 31, 2022, the amortized
cost of this investment is €100,000; its fair value at December
31, 2022, is €113,000. If Hardy chooses the fair value option
to account for this investment, it makes the following entry at
December 31, 2022.
December 31, 2022

Debt Investments (German bonds) 13,000

Fair Value Option (continued)
In this situation,
• Hardy uses the Debt Investment account to record the
change in fair value at December 31.
• It does not use the Fair Value Adjustment account.
• The unrealized gain or loss is recorded as part of net
income even though it is managing the investment on a
held-for-collection basis.
• Hardy must continue to use the fair value method to
record this investment until it no longer has ownership of
the security.

Describe the accounting for equity
investments.

Equity Investments
Equity investment represents
• ownership interest, such as ordinary, preference, or other
capital shares.
• rights to acquire or dispose of ownership interests at an
agreed-upon or determinable price, such as in warrants
and rights.
Cost includes
• Purchase price of the security.
• Broker’s commissions and fees are recorded as expense.

Equity Investments
Levels of Influence Determine Accounting Methods
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.
ILLUSTRATION 17.12

Equity Investments
Accounting and Reporting for Equity Investments
by Category
ILLUSTRATION 17.13

Equity Investments
Holdings of Less Than 20%
Under IFRS, the presumption is that equity investments are held-
for-trading.
General accounting and reporting rule:
• Investments valued at fair value.
• Record unrealized gains and losses in net income.
IFRS allows companies to classify some equity investments as non-
trading.
• General accounting and reporting rule:
• Investments valued at fair value.
• Record unrealized gains and losses in other comprehensive
income.
Equity Investments—Trading (Income)
Illustration: On November 3, 2022, Republic SA purchased

ordinary shares of three companies, each investment
representing less than a 20 percent interest. These shares are
held-for-trading.

Equity Investments —Trading (Income)
Journal Entries for Acquisition and Receipt of
Dividends
Republic records these investments on November 3, 2022 as follows:

November 3, 2022
Equity Investments 718,550
Cash 718,550
On December 6, 2022, Republic receives a cash dividend of €4,200 on
its investment in the ordinary shares of Nestlé.
December 6, 2022
Cash 4,200
Dividend Revenue 4,200
Computation of Fair Value Adjustment—Equity
Investment Portfolio (2022)
At December 31, 2022, Republic’s equity investment portfolio
has the carrying value and fair value shown.
ILLUSTRATION 17.14

Adjusting Journal Entry on December 31, 2022
ILLUSTRATION 17.14
On December 31, 2022, Republic prepares an adjusting entry to
record the decrease in fair value and to record the loss as follows.
December 31, 2022

Computation of Gain on Sale of Burberry Shares
On January 23, 2023, Republic sold all of its Burberry ordinary
shares, receiving €287,220.
ILLUSTRATION 17.15
January 23, 2023

Cash 287,220

Computation of Fair Value Adjustment—Equity
Investment Portfolio (2023)
In addition, assume that on February 10, 2023, Republic purchases €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, 2023 is as follows.
ILLUSTRATION 17.16
Adjusting Journal Entry on December 31, 2023
ILLUSTRATION 17.16
Republic records this adjustment on Dec. 31, 2023, as follows.
December 31, 2023

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.
Companies report the unrealized holding gain or loss as other
comprehensive income.

Purchase of Equity Investments
Illustration: On December 10, 2022, Republic SA 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, with unrealized gains and losses
recorded on other comprehensive income.
December 10, 2022
Equity Investments (Hawthorne) 20,750
Cash 20,750

Equity Investments—Non-Trading
Receipt of Cash Dividends
On December 27, 2022, Republic receives a cash dividend of

€450 on its investment in the ordinary shares of Hawthorne
Company. It records the cash dividend as follows.
December 27, 2022

Cash 450
Dividend Revenue 450

Computation of Fair Value Adjustment
At December 31, 2022, Republic’s investment in Hawthorne has the
carrying value and fair value shown.
ILLUSTRATION 17.17
Republic records this adjustment as follows.
December 31, 2022
Equity Investment (Hawthorne) 3,250
The Equity Investment account is used because the non-trading classification is

applied on investment by investment basis, rather than on a portfolio basis.

Financial Statement Presentation of Equity
Investments at Fair Value (2022)
ILLUSTRATION 17.18

Equity Investments—Non-Trading
Adjustment to Carrying Value of Investment
On December 20, 2023, Republic sold all of its Hawthorne
Company ordinary shares receiving net proceeds of €22,500.
ILLUSTRATION 17.19
Entry to adjust the carrying value of the non-trading investment.
December 20, 2023

Equity Investment (Hawthorne) 1,500

Journal Entry to Record Sale of Investment
On December 20, 2023, Republic sold all of its Hawthorne
Company ordinary shares receiving net proceeds of €22,500.
ILLUSTRATION 17.19
Entry to record the sale of the investment.
December 20, 2023
Cash 22,500

Explain the equity method of
accounting.

Equity Investments
Holdings Between 20% and 50%
An investment (direct or indirect) of 20 percent or more of

the voting shares of an investee should lead to a
presumption that in the absence of evidence to the
contrary, an investor has the ability to exercise significant
influence over an investee.
In instances of “significant influence,” the investor must
account for the investment using the equity method.

Holdings Between 20% and 50%
Equity Method
Record the investment at cost and subsequently adjust the
amount each period for changes in investee’s net assets.
• Investor’s proportionate share of the earnings (losses) of the
investee increases (decreases) the investment’s carrying
amount.
• Dividends received from the investee decrease the
investment’s carrying amount.
If investor’s share of investee’s losses exceeds the carrying amount
of the investment, the investor ordinarily should discontinue
applying the equity method and not recognize additional losses.

Comparison of Fair Value Method and
Equity Method
ILLUSTRATION 17.20

Equity Investments
Holdings of More Than 50%
Controlling Interest - When one company acquires a voting

interest of more than 50 percent in another company.
• Investor is referred to as the parent.
• Investee is referred to as the subsidiary.
• Investment in the subsidiary is reported on the parent’s
books as a long-term investment.
• Parent generally prepares consolidated financial
statements.

Evaluate other major issues related to debt
and equity investments.

Other Reporting Issues
Impairment of Value
A company should evaluate every debt investment accounted

for at amortized cost, at each reporting date, to determine if
it has suffered impairment—a loss in value such that the fair
value of the investment is below its carrying value.
If the company determines that an investment is impaired, it
writes down the amortized cost basis of the individual
security to reflect this loss in value.
The company accounts for the write-down as a realized loss,
and it includes the amount in net income.

Impairment of Value
Impairment—Investment Measured at Amortized
Cost
Illustration: At December 31, 2021, Mayhew Ltd. has a debt
investment in Bao Group, purchased at par for ¥200,000
(amounts in thousands). The investment has a term of four
years, with annual interest payments at 10 percent, paid at
the end of each year (the historical effective-interest rate is 10
percent). This debt investment is classified as held-for-
collection.
Use the information on the next slide to record the loss on
impairment.

Investment Cash Flows and Computation of
Impairment Loss
ILLUSTRATION 17.22
ILLUSTRATION 17.23
December 31, 2022
Loss on Impairment 12,680
Allowance for Impaired Debt Investments 12,680

Recovery of Impairment Loss
If subsequently the impairment loss decreases, some or all of
the previously recognized impairment loss shall be reversed
with a
• debit to the Allowance for Impaired Debt Investments
account and
• crediting Recovery of Impairment Loss.
Reversal of impairment losses shall not result in a carrying
amount of the investment that exceeds the amortized cost
that would have been reported had the impairment not been
recognized.

Recovery of Impairment Loss (continued)
For example, assume that on March 31, 2023, Mayhew
determines that Bao’s credit risk has declined significantly.
Mayhew therefore decides to reverse the impairment by
making the following entry.
March 31, 2023

Allowance for Impaired Debt Investments 12,680
Recovery of Loss on Impairment 12,680

Impairment of Value
Impairment—Debt Investments Measured at Fair
Value (HFCS)
Companies that have debt investments that are held-for-
collection and selling (HFCS) report the investment at fair
value, and any changes in fair value are reported in other
For these investments, companies use a different
impairment model.

Impairment—Debt Investments
Measured at Fair Value (HFCS)
Illustration: Assume that Alexander AG purchases a HFCS
debt investment on July 1, 2022, for €1,000,000 (its face
value). The debt investment has an interest rate of 7 percent
and a maturity date of July 1, 2027. At December 31, 2022,
the fair value of the investment has declined to €960,000,
due to an increase in market interest rates. The entries to
record this debt investment in 2022 are shown in Illustration
17.24.

Impairment—Debt Investments Measured
at Fair Value (HFCS)
HFCS Impairment Entries
ILLUSTRATION 17.24

Impairment—Debt Investments Measured
at Fair Value (HFCS)
Financial Statement Presentation
At December 31, 2022, Alexander AG’s financial statements are as
shown in below.
ILLUSTRATION 17.25

Impairment—Debt Investments (HFCS)
Additional Question
What happens if the €40,000 decline is caused by
1) a change of €10,000 due to market interest rate changes
and
2) an impairment of €30,000 due to credit risk?
In this case, the third entry in Illustration 17.24 changes
because the impairment loss of €30,000 is reported in the
income statement, not in other comprehensive income. The
entries to record the impairment and the change in fair value
and related closing entry are shown in Illustration 17.26.

Impairment Entries—Increase in Credit Risk
What happens if the €40,000 decline is caused by
1) a change of €10,000 due to market interest rate changes and
2) an impairment of €30,000 due to credit risk?
ILLUSTRATION 17.26

Financial Statement Presentation
At December 31, 2022, Alexander’s financial statements are as

shown.
ILLUSTRATION 17.27

Sale of Debt Investments
If we assume Alexander sells its debt investments on January
1, 2023, for €960,000 (its fair value at that time), the entries
are as follows.
January 1, 2023
Cash 960,000
Loss on Sale of Debt Investment 10,000
Allowance of Impaired Debt Investments 30,000
Debt Investments 1,000,000
Fair Value Adjustments 10,000

Accumulated Comprehensive Income 10,000

Journal Entry to Record Decrease in Credit Risk
What happens if Alexander decides to keep its debt
investment and later determines that its credit risk on this
investment has decreased by €15,000? In this case, it makes
the following entry.
Allowance of Impaired Debt Investments 15,000

Recovery of Impairment Loss 15,000

Impairment Model Summary
Asset Measurement Basis Impairment Model
Loans, receivables, and debt securities Expected credit losses recognized in net
measured at amortized cost. income.
Debt securities measured at fair value with Expected credit losses recognized in
gains and losses recorded in other income; remaining fair value change
comprehensive income. recorded in other comprehensive income.
Debt and equity securities measured at fair Impairment measured as the difference
value with gains and losses recorded in net between the lower-of-amortized-cost-or-
income. fair value (debt securities) or lower-of-cost-
or-fair value (equity securities).
ILLUSTRATION 17.28

Recycling Adjustments
Reporting Issues—Single-Period Example
To provide a single-period example of the reporting of

investment securities and related gain or loss on held-for-
collection and selling (HFCS) investments, assume that on
January 1, 2022, Hinges plc had cash and share capital—
ordinary of £50,000. At that date, the company had no other
asset, liability, or equity balances. On January 2, Hinges
purchased for cash £50,000 of debt securities classified as
HFCS. On June 30, Hinges sold part of the HFCS security debt
portfolio, realizing a gain as shown in Illustration 17.29.

Computation of Unrealized and Realized Gains
On June 30, Hinges sold part of the HFCS security debt portfolio,
realizing a gain as shown.
ILLUSTRATION 17.29
• Hinges did not purchase or sell any other securities during 2022.
It received £3,000 in interest during the year. At December 31,
2022, the remaining portfolio is as shown.
ILLUSTRATION 17.30
Income Statement and Statement of
Comprehensive Income
ILLUSTRATION 17.31
ILLUSTRATION 17.32

Statement of Changes in Equity and Comparative
Statement of Financial Position
ILLUSTRATION 17.33
ILLUSTRATION 17.34

Recycling Adjustments
Reporting Issues—Multi-Period Example
When a company sells securities during the year, double-

counting of the realized gains or losses in comprehensive
income can occur.
This double-counting results when a company reports
unrealized gains or losses in other comprehensive income in a
prior period and reports these gains or losses as part of net
income in the current period.
To ensure that gains and losses are not counted twice when a
sale occurs, a reclassification adjustment is necessary.

HFCS Investment Portfolio (2021)
To illustrate, assume that Open AG has the two HFCS debt
investments in its portfolio at the end of 2021 (its first year of
operations).
ILLUSTRATION 17.35

Journal Entry to Record Unrealized Holding Gain
ILLUSTRATION 17.35
The entry to record the unrealized holding gain in 2021 is as

follows.
December 31, 2021

Fair Value Adjustments 40,000

Statement of Comprehensive Income (2021)
If Open reports net income in 2021 of €350,000, it presents a
statement of comprehensive income as shown.
ILLUSTRATION 17.36

Entries on December 31, 2021 and August 10, 2022
The entry to transfer the unrealized holding gain—equity to
accumulated other comprehensive income is as follows.
December 31, 2021 (Closing Entry)

Accumulated Other Comprehensive Income 40,000
On August, 10, 2022, Open sells its Lehman Inc. bonds for
€105,000 and realizes a gain on the sale.
August 10, 2022
Cash 105,000

HFCS Investment Portfolio (2022)
This illustration shows the computation of the change in the Fair
Value Adjustment account (based on only the Woods Co.
investment).
ILLUSTRATION 17.37
The entry to record the unrealized holding gain or loss in 2022 is:
December 31, 2022
Fair value Adjustment 5,000

Statement of Comprehensive Income (2022)
Assume that Open reports net income of €720,000 in 2022,
including the realized sale on the Lehman bonds, its statement of
comprehensive income is presented as shown.
ILLUSTRATION 17.38

December 31, 2022 Closing Entry
At December 31, 2022, Open reports on its statement of

financial position debt investments of €155,000 (cost
€120,000 plus a fair value adjustment of €35,000) and
accumulated other comprehensive income in equity of
€35,000 (€40,000 − €5,000). The entry to transfer the
Unrealized Holding Loss—Equity to Accumulated Other
Comprehensive Income is as follows.
December 31, 2022 (Closing Entry)
Accumulated Other Comprehensive Income 5,000

Note Disclosure of Reclassification Adjustments
This reclassification adjustment may be made in the income
statement, in accumulated other comprehensive income or in a
note to the financial statements. The IASB prefers to show the
reclassification amount in accumulated other comprehensive
income in the notes to the financial statements. For Open AG, this
presentation is as shown.
ILLUSTRATION 17.39

Transfers Between Categories
Transferring an investment from one classification to another
• should occur only when the business model for managing
the investment changes.
• IASB expects such changes to be rare.
• Companies account for transfers between classifications
prospectively, at the beginning of the accounting period
after the change in the business model.

Transfers Between Categories Example
Illustration: British Sky Broadcasting Group plc (GBR) has a
portfolio of debt investments that are classified as trading; that is,
the debt investments are not held-for-collection but managed to
profit from interest rate changes. As a result, it accounts for these
investments at fair value. At December 31, 2021, British Sky has the
following balances related to these securities.

Transfers Between Categories
Journal Entry to Record Reclassification
Illustration: As part of its strategic planning process,
completed in the fourth quarter of 2021, British Sky
management decides to move from its prior strategy—which
requires active management—to a held-for-collection strategy
for these debt investments. British Sky makes the following
entry to transfer these securities to the held-for-collection
classification.
January 1, 2022

Describe the uses of and accounting for
derivatives.

Defining Derivatives
Financial instruments that derive their value from values of
other assets (e.g., ordinary shares, bonds, or commodities).
Three types of derivatives:
1. Financial forwards or financial futures.
2. Options.
3. Swaps.

Who Uses Derivatives, and Why?
• Producers and Consumers

• Speculators and Arbitrageurs

Basic Principles in Accounting for
Derivatives
• Recognize derivatives in the financial statements as assets
and liabilities.
• Report derivatives at fair value.
• Recognize gains and losses resulting from speculation in
derivatives immediately in income.
• Report gains and losses resulting from hedge transactions
differently, depending on the type of hedge.

Derivative Financial Instrument (Speculation)
Call Option
A call option gives the holder the right, but not the obligation, to buy
shares at a preset price. This price is often referred to as the strike price
or the exercise price.
Illustration: Assume a company purchases a call option contract on
January 2, 2022, when Laredo shares are trading at €100 per share. The
contract gives it the option to purchase 1,000 shares (referred to as the
notional amount) of Laredo shares at an option price of €100 per
share. The option expires on April 30, 2022. The company purchases
the call option for €400 and makes the following entry.
January 1, 2022
Call Option 400
Cash 400

Call Option
Intrinsic Value
The option premium consists of two amounts.
ILLUSTRATION 17A.1
Intrinsic value is the difference between the market price and the
preset strike price at any point in time. It represents the amount
realized by the option holder, if exercising the option immediately. On
January 2, 2022, the intrinsic value is zero because the market price
equals the preset strike price.

Call Option
Time Value
The option premium consists of two amounts.
ILLUSTRATION 17A.1
Time value refers to the option’s value over and above its intrinsic
value. Time value reflects the possibility that the option has a fair value
greater than zero. How? Because there is some expectation that the
price of Laredo shares will increase above the strike price during the
option term. As indicated, the time value for the option is €400. (as the
intrinsic value is zero).

Call Option
Additional Data
Additional data available with respect to the call option:
On March 31, 2022, the price of Laredo shares increases to

€120 per share. The intrinsic value of the call option contract is
now €20,000. That is, the company can exercise the call option
and purchase 1,000 shares from Baird Investment for €100 per
share. It can then sell the shares in the market for €120 per
share. This gives the company a gain of €20,000 (€120,000 -
€100,000) on the option contract.
Call Option
Journal Entries on March 31, 2022
On March 31, 2022, it records the increase in the intrinsic value of
the option as follows.
March 31, 2022
Call Option 20,000
A market appraisal indicates that the time value of the option at

March 31, 2022, is €100. The company records this change in
value of the option as follows.
March 31, 2022

Unrealized Holding Gain or Loss—Income 300
Call Option (€400 - €100) 300

Call Option
Effects on Financial Statements
At March 31, 2022, the company reports the
• call option in its statement of financial position at fair
value of €20,100.
• unrealized holding gain which increases net income.
• loss on the time value of the option which decreases net
income.

Call Option
Journal Entries on April 16, 2022
On April 16, 2022, the company settles the option before it
expires. To properly record the settlement, it updates the value
of the option for the decrease in the intrinsic value of €5,000
([€20 − €15]) × 1,000) as follows.
April 16, 2022
Call option 5,000
The decrease in the time value of the option of €40 (€100 − €60)
is recorded as follows.
April 16, 2022
Unrealized Holding Gain or Loss—Income 40
Call Option 40

Call Option
Journal Entry to Record Settlement of Option Contract
At the time of the settlement, the call option’s carrying value is as

follows.
Settlement of the option contract is recorded as follows.

April 16, 2022
Cash 15,000
Loss on Settlement of Call Option 60
Call Option 15,060

Call Option
Effect on Income—Derivative Financial Instrument
Summary effects of the call option contract on net income.
ILLUSTRATION 17A.2
The company records the call option in the statement of financial
position on March 31, 2022. Furthermore, it reports the call
option at fair value, with any gains or losses reported in income.

Differences Between Traditional and
Derivative Financial Instruments
A derivative financial instrument has the following three basic
characteristics.
1. Instrument has (1) one or more underlyings and (2) an
identified payment provision.
2. Instrument requires little or no investment at the
inception of the contract.
3. Instrument requires or permits net settlement.

Features of Traditional and Derivative
Financial Instruments
Feature Traditional Financial Instrument Equity Derivative Financial Instrument (Call
Investment (Trading) Option)
Value of the investment Share price times the number of Change in share price (underlying)
shares. multiplied by number of shares (notional
amount).
Initial investment Investor pays full cost. Initial investment is much less than full cost.
Settlement Deliver shares to receive cash. Deliver cash to receive shares at the option
price or receive the net cash amount, based
on changes in share price multiplied by the
number of shares.
ILLUSTRATION 17A.3

Explain the accounting for hedges.

Derivatives Used for Hedging
Hedging: The use of derivatives to offset the negative

impacts of changes in interest rates or foreign currency
exchange rates.
IFRS allows special accounting for two types of hedges—
• fair value and
• cash flow hedges.

Fair Value Hedge
A company uses a derivative to hedge (offset) the exposure
to changes in the fair value of a recognized asset or liability
or of an unrecognized commitment.

Fair Value Hedge Example
Illustration: On December 1, 2022, Hayward Tire Fabricators holds
an inventory of 1,000 tractor tires, with a cost of €200 per tire.
Hayward has been building an inventory of tractor tires in
anticipation of demand for these tires in the upcoming spring
planting season. Hayward records the inventory on its statement of
financial position at €200,000 (1,000 × €200), using lower-of-FIFO-
cost-or-net realizable value.
Until Hayward sells the tires, the company is exposed to the risk
that the value of the tire inventory will decline. Hayward wishes to
hedge its exposure to fair value declines for its tire inventory (the
inventory is pledged as collateral for one of its bank loans).

More Data
Illustration: To hedge this risk, Hayward locks in the value of its tire
inventory on January 2, 2023, by purchasing a put option to sell
rubber at a fixed price. Hayward designates the option as a fair
value hedge of the tire inventory. This put option (which expires in
nine months) gives Hayward the option to sell 4,000 pounds of
rubber at a price of €50 per pound, which is the current spot price
for rubber in the market. Since the exercise price equals the
current market price, no entry is necessary at inception of the put
option.

Journal Entries on March 31, 2023
Illustration: At March 31, 2023, the fair value of the inventory has
declined by 10 percent (€200,000 × 10% = €20,000 ) . Hayward
records the following entry for the tire inventory.
March 31, 2023
Allowance to Reduce Inventory to Fair Value 20,000
The following journal entry records the increase in value of the
put option to sell rubber, assuming that the spot price for rubber
declined by 10 percent.
March 31, 2023
Put Option 20,000

Statement of Financial Position and Income
Statement Presentation of Fair Value Hedge
ILLUSTRATION 17A.5
ILLUSTRATION 17A.6

Cash Flow Hedge
Used to hedge exposures to cash flow risk, which results

from the variability in cash flows.
Reporting:
• Fair value on the statement of financial position.
• Gains or losses in equity, as part of other comprehensive
income.

Cash Flow Hedge Example
Illustration: In September 2022 Allied Can Ltd. anticipates purchasing
1,000 metric tons of aluminum in January 2023. Concerned that prices of
aluminum will increase in the next few months, Allied wants to hedge the
risk that it might pay higher prices for inventory in January 2023. As a
result, Allied enters into an aluminum futures contract. The aluminum
futures contract gives Allied the right and the obligation to purchase
1,000 metric tons of aluminum for ¥1,550 per ton (amounts in
thousands). This contract price is good until the contract expires in
January 2023. The underlying for this derivative is the price of aluminum.
Allied enters into the futures contract on September 1, 2022. Assume
that the price to be paid today for inventory to be delivered in January—
the spot price—equals the contract price. With the two prices equal, the
futures contract has no value. Therefore no entry is necessary.

Journal Entry on December 31, 2022
Illustration: At December 31, 2022, the price for January delivery
of aluminum increases to ¥1,575 per metric ton. Allied makes the
following entry to record the increase in the value of the futures
contract.
December 31, 2022
Futures Contract 25,000
([¥1,575 - ¥1,550] x 1,000 tons)
Allied reports the futures contract in the statement of financial
position as a current asset and the gain as part of other

Journal Entries in January 2023
Illustration: In January 2023, Allied purchases 1,000 metric tons of
aluminum for ¥1,575 and makes the following entry.
January 2023
Aluminum Inventory 1,575,000
Cash (¥1,575 x 1,000 tons) 1,575,000
At the same time, Allied makes final settlement on the futures

contract. It records the following entry.
January 2023
Cash 25,000
Futures Contract (¥1,575,000 - ¥1,550,000) 25,000

Effect of Hedge on Cash Flows
ILLUSTRATION 17A.7
There are no income effects at this point. Allied accumulates in

equity the gain on the futures contract as part of other
comprehensive income until the period when it sells the
inventory.

Journal Entries in July 2023
Illustration: Assume that Allied processes the aluminum into
finished goods (cans). The total cost of the cans (including the
aluminum purchases in January 2023) is ¥1,700,000. Allied
sells the cans in July 2023 for ¥2,000,000, and records this
sale as follows.
July 2023
Cash 2,000,000
Sales Revenue 2,000,000
Cost of Goods Sold 1,700,000
Inventory (Cans) 1,700,000

Another Journal Entry in July 2023
Illustration: Since the effect of the anticipated transaction has
now affected earnings, Allied makes the following entry related to
the hedging transaction.
July 2023
Cost of Goods Sold 25,000
The gain on the futures contract, which Allied reported as part of

other comprehensive income, now reduces cost of goods sold. As
a result, the cost of aluminum included in the overall cost of
goods sold is ¥1,550,000.

Identify special reporting issues related
to derivative financial instruments that
cause unique accounting problems.

Embedded Derivatives
A convertible bond is a hybrid instrument. Two parts:

1. a debt security, referred to as the host security, and
2. an option to convert the bond to shares of common stock,
the embedded derivative.
Accounted for as a single unit.

Qualifying Hedge Criteria
Criteria that hedging transactions must meet before

requiring the special accounting for hedges.
1. Documentation, risk management, and designation.
2. Effectiveness of the hedging relationship.
3. Effect on reported earnings of changes in fair values or
cash flows.

Summary of Derivative Accounting
ILLUSTRATION 17A.8

Comprehensive Hedge Accounting Example
Many companies popular type of derivative called a swap.
A swap is a transaction between two parties in which the
1. first party promises to make a payment to the second
party.
2. Similarly, the second party promises to make a
simultaneous payment to the first party.
The most common type of swap is the interest rate swap. In
this type, one party makes payments based on a fixed or
floating rate, and the second party does just the opposite.

Swap Transaction
In most cases, large money-center banks bring together the two
parties.
ILLUSTRATION 17A.9

Fair Value Hedge
Illustration: Assume that Jones AG issues €1,000,000 of five-year,
8 percent bonds on January 2, 2022. Jones records this transaction
as follows.
January 2, 2022
Cash 1,000,000
Bonds Payable 1,000,000
To protect against the risk of loss, Jones hedges the risk of a

decline in interest rates by entering into a five-year interest rate
swap contract.

Fair Value Hedge
Interest Rate Swap
Jones agrees to the following terms:
1. Jones will receive fixed payments at 8 percent (based on the
€1,000,000 amount).
2. Jones will pay variable rates, based on the market rate in effect for
the life of the swap contract. The variable rate at the inception of the
contract is 6.8 percent.
ILLUSTRATION 17A.10
Fair Value Hedge
Journal Entry to Record First Interest Payment
Assuming that Jones enters into the swap on January 2, 2022

(the same date as the issuance of the debt), the swap at this
time has no value. Therefore, no entry is necessary.
At the end of 2022, Jones makes the interest payment on the
bonds. It records this transaction as follows.
December 31, 2022

Interest Expense 80,000
Cash (8% × €1,000,000) 80,000

Fair Value Hedge
Journal Entry to Record Settlement Payment
At the end of 2022, market interest rates have declined
substantially. Therefore, the value of the swap contract
increases. Recall (see Illustration 17A.10) that in the swap,
Jones receives a fixed rate of 8 percent, or €80,000
(€1,000,000 × 8%), and pays a variable rate (6.8%), or
€68,000. Jones therefore receives €12,000 (€80,000 −
€68,000) as a settlement payment on the swap contract on
the first interest payment date.
Jones records this transaction as follows.
December 31, 2022
Cash 12,000
Interest Expense 12,000

Fair Value Hedge
More Journal Entries on December 31, 2022
In addition, a market appraisal indicates that the value of the

interest rate swap has increased €40,000. Jones records this
increase in value as follows.
December 31, 2022
Swap Contract 40,000
Because interest rates have declined, the company records a loss

and a related increase in its liability as follows.
December 31, 2022
Bonds Payable 40,000
Fair Value Hedge
Statement of Financial Position and Income
Statement Presentation of Fair Value Hedge
ILLUSTRATION 17A.11
ILLUSTRATION 17A.12

Describe required fair value
disclosures.

Disclosure of Fair Value Information:
Financial Instruments
Both
• cost and
• fair value
of all financial instruments must be reported in the notes to
the financial statements.

Disclosure of Fair Value Information
Fair Value Hierarchy
Three broad levels related to the measurement of fair values.

• Level 1 is the most reliable measurement because fair value is
based on quoted prices in active markets for identical assets or
liabilities.
• Level 2 is less reliable; it is not based on quoted market prices
for identical assets and liabilities but instead may be based on
similar assets or liabilities.
• Level 3 is least reliable; it uses unobservable inputs that reflect
the company’s assumption as to the value of the financial
instrument.

Required Disclosures of Fair Value
Information
Companies must provide the following (with special emphasis on
Level 3 measurements):
1. Quantitative information about significant unobservable inputs
used for all Level 3 measurements.
2. A qualitative discussion about the sensitivity of recurring Level
3 measurements to changes in the unobservable inputs
disclosed, including interrelationships between inputs.
3. A description of the company’s valuation process.

Required Disclosures of Fair Value
Information (continued)
Companies must provide the following (with special emphasis on
Level 3 measurements):
4. Any transfers between Levels 1 and 2 of the fair value
hierarchy.
5. Information about non-financial assets measured at fair value
at amounts that differ from the assets’ highest and best use.
6. The proper hierarchy classification for items that are not
recognized on the statement of financial position but are
disclosed in the notes to the financial statements.

Compare the accounting for
investments under IFRS and U.S. GAAP.

Global Accounting Insights
Until recently, when the IASB issued IFRS 9, the accounting
and reporting for investments under IFRS and U.S. GAAP
were, for the most part, very similar. While IFRS 9 introduces
new investment classifications relative to U.S. GAAP, both IFRS
and U.S. GAAP have increased situations when investments
are accounted for at fair value, with gains and losses recorded
in income.

Similarities
• U.S. GAAP and IFRS use similar classifications for financial assets: cash, loans
and receivables, investments, and derivatives.
• Both IFRS and U.S. GAAP require that financial assets be sorted into specific
categories for measurement and classification purposes.
• Held-to-maturity (U.S. GAAP) and held-for-collection (IFRS) investments are
accounted for at amortized cost. Gains and losses on some investments are
reported in other comprehensive income.
• Amortized cost or fair value is used depending upon the classification of the
financial instrument.
• The definitions of amortized cost and fair value are the same.

More Similarities
• Both U.S. GAAP and IFRS use the same test to determine whether the equity
method of accounting should be used, that is, significant influence with a
general guideline of over 20 percent ownership.
• U.S. GAAP and IFRS are similar in the accounting for the fair value option.
That is, the option to use the fair value method must be made at initial
recognition, the selection is irrevocable, and gains and losses are reported
as part of income.
• Under both U.S. GAAP and IFRS, credit losses are recognized in income.

Differences
• While U.S. GAAP classifies debt investments as trading, available-for-sale,
and held-to-maturity, IFRS classifies debt investments as held-for-collection,
held-for-collection and selling, and trading.
• U.S. GAAP requires that all changes in fair value for all equity securities be
reported as part of income. IFRS requires that changes in fair value for non-
trading equity securities be reported as part of other comprehensive
income.
• While the measurement of impairments is similar under U.S. GAAP and IFRS,
U.S. GAAP measures impairments based on lifetime expected credit losses.
IFRS uses lifetime expected losses for financial assets that have experienced
a significant increase in credit risk since initial recognition (otherwise, the
credit loss allowance is based on 12-month expected credit losses).

More Differences
• U.S. GAAP generally does not permit the reversal of an impairment charge
related to held-to-maturity debt investments and equity investments. IFRS
allows reversals of impairments of held-for-collection investments.
• While U.S. GAAP and IFRS are similar in the accounting for the fair value
option, one difference is that U.S. GAAP permits the fair value option for all
financial assets; IFRS allows the fair value option if doing so reduces an
accounting mismatch.

On the Horizon
At one time, both the FASB and IASB indicated that they believed that all
financial instruments should be reported at fair value and that changes in fair
value should be reported as part of net income. Through recent standards in this
area, the Boards continue to move toward that goal. U.S. GAAP and IFRS are
substantially converged, except for non-trading equity investments and the
measurement of credit losses.

Copyright
Copyright © 2020 John Wiley & Sons, Inc.
All rights reserved. Reproduction or translation of this work beyond that

permitted in Section 117 of the 1976 United States Copyright Act without the
express written permission of the copyright owner is unlawful. Request for
further information should be addressed to the Permissions Department, John
Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use
only and not for distribution or resale. The Publisher assumes no responsibility
for errors, omissions, or damages, caused by the use of these programs or from
the use of the information contained herein.

DISKUSIKAN DI KELAS
Mengapa perusahaan melakukan investasi dalam surat utang?

REFERENSI
Kieso, Weygandt and warfield (2020). Intermediate Accounting, 4th

Edition, IFRS Edition. New Jersey: John Wiley & Sons, Inc.

CH 17

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

CH 17

Uploaded by

Copyright:

Available Formats

AKUNTANSI KEUANGAN

Copyright ©2020 John Wiley & Sons, Inc. 3

Copyright ©2020 John Wiley & Sons, Inc. 4

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 5

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 6

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 7

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 8

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 9

Debt Investments 92,278

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 11

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 12

Robinson records the receipt of the first semiannual interest

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 13

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

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 14

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 15

Robinson records the sale of the bonds as follows.

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 17

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 18

Illustration: Graff plc purchases £100,000, 10 percent, five-

Debt Investments 108,111

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 19

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 20

Illustration (Single Security): The entry to record interest

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 21

Illustration (Single Security): At December 31, 2022, Graff

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 22

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 23

Illustration (Portfolio of Securities): Webb AG has two debt

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 24

Prepare the adjusting entry Webb would make on December

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 25

If company sells bonds before maturity date:

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 26

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 27

Illustration: Webb reports this realized loss in the “Other income

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 28

Illustration: Webb records the following at December 31, 2023.

Fair Value Adjustment 4,537

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 29

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 30

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 31

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 33

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 34

Illustration: Hardy AG purchases bonds issued by the German

December 31, 2022

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 35

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 36

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 37

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 38

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 39

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 40

Illustration: On November 3, 2022, Republic SA purchased

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 42

Republic records these investments on November 3, 2022 as follows:

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 44

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 45

January 23, 2023

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 46

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 48

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 49

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 50

On December 27, 2022, Republic receives a cash dividend of