FINANCIAL ACCOUNTING & REPORTING 1

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Accounting for Investments in Equity and Debt Instruments

Module 011 Investment in equity instruments

There are a variety of reasons why companies choose to invest in other

companies rather than buy back their own shares or dividend excess cash to
shareholders. The accounting for such transactions is frequently as simple as
doing basically the opposite of what was done by the company issuing the
securities. But there are some major exceptions and issues to be explored in
this session.
At the end of this module, you will be able to:
1. Know the accounting standards for equity investments
2. Define equity investment and know the different types of investments an
investor can make
3. Measure equity investments
4. Classify equity investments
Under this module, the common applications are proper measuring and
classifying of equity investments.
Investment in equity instruments
Investment in equity instruments means the acquisition of equity securities for the purpose
of accruing income through dividends and increase in market value or controlling another
entity.
Equity securities represent ownership shares such as ordinary shares, preferences shares,
and other share capital. This may also represent rights and options to acquire own shares.

Categories:

• Control exists(50% equity in voting shares, that is, ordinary shares)- Investment in
Subsidiary.

• Significant influence exists(20%-50% in voting shares, that is, ordinary shares)-

Investment in Associate(Equity Method) <to be discussed in succeeding sessions>

• No control nor significant influence- Financial asset at Fair Value (PAS 39 or PFRS 9)

✓ Financial asset at fair value through profit or losses <discussed in the

previous session>

✓ Financial asset at fair value through other comprehensive income <discussed

in the previous session>

• Investment in unquoted equity instruments

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Accounting for Investments in Equity and Debt Instruments

Investment in unquoted equity instruments

Under PFRS 9, all investments in equity instruments must be measured at fair value.
However, investments in unquoted equity instruments are measured at cost if the
fair value cannot be measured reliably.

Measurement of equity securities

PFRS 9 – When a financial asset is recognized initially, an entity shall measure it a fair value
plus transaction costs that are directly attributable to the acquisition.
The fair value is usually the transaction price, meaning the fair value of the consideration
given.
As a rule, transaction costs that are directly attributable to the acquisition of the financial
asset shall be capitalized as the cost of the financial asset.
However, transaction costs directly attributable to the acquisition of financial assets held
for trading or financial asset at fair value through profit or loss shall be expensed
immediately.
Acquisition by exchange
If the equity securities are acquired in exchange, the acquisition cost is determined
by reference to the following in the order of priority:
a. Fair value of the asset given
b. Fair value of the asset received
c. Carrying amount of assets given
Lump sum acquisition
If two or more securities are acquired at a single cost or lump sum, the single cost is
allocated to the securities acquired on the basis of their fair value.
If only one security has a known market value, an amount is allocated to the security
with a known market value equal to its market value.
The remainder of the single cost is then allocated to the other security with no
known market value.
Sale of equity instruments
PFRS 9, paragraph 3.2.12, provides that in the derecognition of a financial asset
measured at fair value through profit or loss, the difference between the
consideration received and the carrying amount of the financial asset shall be
recognized in profit or loss.
When equity securities are of the same class acquired on different dates at different
costs, a problem will arise as to the determination of the cost of securities sold when
only a portion of the securities is subsequently sold.
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Accounting for Investments in Equity and Debt Instruments

In such a case, the entity shall determine the cost of the securities sold using the
FIFO or average cost approach.
When are dividends considered earned?
a. Date of declaration- This is the date on which the payment of dividends is
approved by the BOD
b. Date of record- Date in which the stock and transfer book of the corporation is
closed for registration. Only those shareholders registered as of this date are
entitled to receive dividends.
c. Date of payment- this is the date on which the dividends declared shall be paid.
Between the date of declaration and the record date, the shares are selling
"dividend-on." This means that when shares are sold after the date of the
declaration but prior to the record date, they carry with them the right to receive
the dividends.
Between the date of record and the date of payment, the shares are selling "ex-
divided," which means that the shares can be sold, and still the original shareholder
has the right to receive the dividends on the payment date.
When to recognize dividends as income?
Dividends shall be recognized as revenue when the shareholder’s right to receive
payment is established.
Accordingly, the dividends shall be recognized as revenue on the date of
declaration.
Once a dividend has been declared, a legal liability binding on the corporation is
created.
Accounting for dividends on equity instruments
Cash dividends
Measured at the face amount of dividend
a. When the cash dividends are earned but not received:
Dividends receivable xx
Dividend income xx
b. When the cash dividends are subsequently received:
Cash xx
Dividend receivable xx
The cash dividend does not affect the investment account.
Property dividends
Property dividends or dividends in kind are dividends in the term of property or
noncash assets. This is recorded at the fair value of the property.

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Accounting for Investments in Equity and Debt Instruments

Noncash assets xx
Dividend income xx
For example, X Company distributed its holding of P10,000 shares in Y Company as
a property dividend. The shares of Y Company have a market value of P100 per
share. A shareholder receives 500 shares of Y Company as a property dividend from
X Company.
The property dividend is recorded as follows:
Investment in equity securities (500x100) 50,000
Dividend Income 50,000
Another example of a property dividend is when an entity declares P100 worth of
merchandise for every one share. If a shareholder owns 500 shares, the dividend in
the form of merchandise would be P50,000.
The journal entry to record the property dividend is:
Merchandise inventory 50,000
Dividend income 50,000

Liquidating dividends
Liquidating dividends represent the return of invested capital and therefore, are not
income. The payment may be in the form of cash or noncash assets.
Normally, liquidating dividends are paid when a corporation is dissolved and
liquidated.
However, in the case of wasting assets, corporations or mining entities liquidating
dividends may be paid even before dissolution and liquidation.
Accordingly, when dividends are received from a wasting asset corporation, the
dividends are designated as partly income and partly return of capital. That portion
representing a liquidating dividend should be credited to the investment account.
For example, a shareholder receives a P100,000 dividend, designated as income,
P60,000, and liquidates P40,000.
The journal entry to record the dividend is:
Cash 100,000
Dividend income 60,000
Investment in equity securities 40,000
When liquidating dividends exceeds the cost of investment, the difference is
credited to gain on investment. On the other hand, when liquidation is completed,
and the carrying amount of the investment is not fully recovered, the balance is
written off as a loss.
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Accounting for Investments in Equity and Debt Instruments

Stock Dividends
These are in the form of the issuing entity's own shares. The IAS term for the stock
dividend is "bonus issue."
No amount of income is recognized, and only memorandum entry is required to
acknowledge the receipt of new shares.
Kinds of stock dividends
a. Stock dividends of the same class
✓ Recorded only by means of a memorandum entry.
✓ Do not affect the total cost of the investment but reduce the cost per
share.
b. Stock dividends are different from those held.
✓ If received, these are not income. However, the original cost of the
investment is apportioned between the shares and the stock dividends on
the basis of the market value of each at the date of receipt.
Cash received in lieu of stock dividends.
When stock dividends are declared and received, unquestionably, they are not
income. A problem will arise when cash is received in lieu of stock dividends.
For example, a shareholder owns 10,000 shares costing P1,100,000. Subsequently,
the shareholder receives P150,000 cash in lieu of P1,000 shares originally declared
as a 10% stock dividend.
In this case, the “as if” approach is followed. This means that the stock dividends are
assumed to be received and subsequently sold at the cash received. Therefore, a
gain or loss may be recognized.

As if approach and BIR approach

As if approach
The original cost of P1,100,000 applies now to 11,000 shares which is the sum of the
original 10,000 shares and the 1,000 shares assumed to be received as stock
dividends. The cost per share would then be P100.
The 1,000 shares representing stock dividends are assumed to be sold for the cash
received.
Cash 150,000
Investment in equity securities(1,000 shares x 100) 100,000
Gain on investment 50,000
BIR approach
Under the ruling of the BIR, all cash received, whether originally designated as a
cash dividend or stock dividend, is recognized as income. Thus, under the "BIR"
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Accounting for Investments in Equity and Debt Instruments

approach, the cash received of P150,000 is simply debited to cash and credited to
dividend income. However, the "as if" approach is theoretically sound and should be
followed for accounting purposes.
Shares received in lieu of cash dividends.
It is generally accepted that shares received in lieu of cash dividends are income at
the fair value of the shares received. The reason is that such shares are, in effect,
property dividends.
In the absence of fair value of the shares received, the income is equal to the cash
dividends that would have been received.
For example, a shareholder owns 10,000 shares costing P1,000,000. Subsequently,
the shareholder receives 1,000 shares in lieu of a cash dividend of P10 per share.
The market value per share is P150.
The receipt of the P1,000 shares is recorded as follows:
Investment in equity securities 150,000
Dividend income 150,000
If there is no market value, the journal entry is:
Investment in equity securities 100,000
Dividend income(10,000 x 10) 100,000

Share split
A corporation may restructure its capital by effecting a change in the number of
shares without capitalizing on retained earnings or changing the amount of its legal
capital. This restructuring is known as a share split. This may be split up or split
down.
Split up is a transaction whereby the outstanding shares are called in and replaced
by a larger number, accompanied by a reduction in the par or stated value of each
share.
For example, if a shareholder owns 10,000 shares and the share is split-up 5-for-1,
the shareholder receives 50,000 new shares in exchange for the 10,000 original
shares.
Split down is the reverse of the split up. Split down is a transaction whereby the
outstanding shares are called in and replaced by a smaller number, accompanied by
an increase in par or stated value.
For example, if a shareholder owns 10,000 shares and the share is split down 5-for-
1, the shareholder receives 2,000 new shares in exchange for the 10,000 old shares.
Share split does not affect the total cost of investment. But there is a decrease or an
increase in the cost per share because the total cost now will apply to a larger or
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Accounting for Investments in Equity and Debt Instruments

smaller number of shares. Only a memorandum entry is made to record the receipt
of a new share by virtue of a share split.

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Accounting for Investments in Equity and Debt Instruments

Special assessments
Special assessments are the additional capital contribution of the shareholders. On
the part of the shareholders, special assessments are recorded as the additional cost
of the investment and on the part of the entity as share premium.
Redemption of share
Shares, particularly preference shares, may be called in for redemption and
cancellation by the entity issuing them. On the part of the shareholder, the
redemption of a share is recorded in the same manner as the sale of a share. The
redemption price is treated as the sale price.
For example, if a shareholder acquires 10,000 preference shares per P100 per share,
the entry is:
Investment in preference share 1,000,000
Cash 1,000,000
If, subsequently, the preference shares are called in by the issuing entity at P110 per
share, the entry to record the redemption is:
Cash (10,000 shares x 110) 1,100,000
Investment in preference share 1,000,000
Gain on investment 100,000

Stock right
A stock right or preemptive right is a legal right granted to shareholders to
subscribe to new shares issued by a corporation at a specified price during a definite
period.
The IAS term for stock right is "right issue."
A stock right is inherent in every share. A shareholder receives one right for every
share owned. Thus, if a shareholder owns 10,000 shares, the shareholder will
receive 10,000 stock rights.
The ownership of stock rights is evidenced by instruments or certificates called
share warrants.
PFRS 9 does not address this accounting issue categorically. But unquestionably, a
stock right is in the form of a financial asset. In this regard, there is a divergence of
opinion among academicians and theoreticians.
There are two schools of thought on the matter, namely:
✓ Stock rights are accounted for separately
✓ Stock rights are not accounted for separately
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Accounted for separately

Under the Application Guidance B5.4.14 of PFRS 9, all investments in equity
instruments and contracts on those instruments must be measured at fair value.
Undoubtedly, stock rights are a form of an equity instrument and, therefore, shall be
measured initially at fair value. In other words, a portion of the carrying amount of
the original investment in equity securities is allocated to the stock rights at an
amount equal to the fair value of the stock rights at the time of acquisition.
The reason for such an allocation of stock rights is that stock rights are independent
of the original shares from which they are derived. When stock rights are issued, the
investor is now the owner of two financial assets, namely the original shares and the
related stock rights. Stock rights are normally classified as current assets if the
rights are accounted for separately.
Not accounted for separately
Stock rights are recognized as embedded derivatives but not a "stand-alone"
derivative.
An embedded derivative is a "component of a hybrid or combined contract (host
contract) with the effect that some of the cash flows of the combined contract vary
in a way similar to a stand-alone derivative."
PFRS 9, paragraph 4.3.3, provides that an embedded derivative shall be separated
from the host contract and accounted for separately under certain conditions
Paragraph 4.3.3 further provides that if the host contract is within the scope of PFRS
9, the classification requirements of PFRS 9 are applied to the combined host
contract in its entirety.
This simply means that if the host contract is a financial asset, the embedded
derivative is not separated.
Moreover, if the host contract is measured at fair value through profit or loss, the
embedded derivative is not separated.
Accordingly, the stock right as an embedded derivative is not accounted for
separately because the host contract “investment in equity instrument” is a financial
asset. Embedded derivatives are discussed more extensively in subsequent
chapters.
Approach to be followed
Admittedly, this subject matter is not a well-settled issue. In fact, PFRS 9, paragraph
4.3.4, states that "this standard does not address whether an embedded derivative
shall be presented separately in the statement of financial position.

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Glossary
Equity instruments: Documents that serve as legally enforceable evidence of the
ownership of the firm.
Cash dividends: Money given/paid to stockholders
Property dividends: Distribution of assets to stockholders
Stock dividends: Dividend payment in the form of shares
Share split: The number of shares increases, but the total value of the shares remains the
same

References and Supplementary Materials

Books and Journals
1. Cabrera, M. B., & Ocampo, R. R. (n.d.). Financial Accounting & Reporting - Standards &
Application (2014-2015 ed., Vol. 2). Manila, Philippines.
2. Robles, N. S., & Empleo, P. M. (2014). Intermediate Accounting (2014 ed., Vol. 1).
Manila, Philippines.
3. Valix, C. T., Peralta, J. F., & Valix, C. M. (2017). Financial Accounting (2017 ed., Vol.
2).Manila, Philippines.
4. IFRS 9, Financial Instruments
5. IAS 39, Financial Instruments: Recognition and Measurement
6. IAS 32 Financial Instruments: Presentation
Online Supplementary Reading Materials
1. When to account for dividends?; https://www.accountingweb.co.uk/any-
answers/when-to-account-for-dividends; October 23, 2017
2. IFRS 9 — Financial Instruments; http://www.ifrs.org/issued-standards/list-of-
standards/ifrs-9-financial-instruments/; October 23, 2017
3. IAS 39 — Financial Instruments: Recognition and Measurement;
http://www.ifrs.org/issued-standards/list-of-standards/ias-39-financial-
instruments-recognition-and-measurement/; October 23, 2017
Online Instructional Videos
Not applicable.