Chapter 12.

Intercorporate
Investments
1. Classification of investments
2. Accounting for non-strategic equity
investments
3. Accounting for strategic investments
4. The equity method
5. Consolidation
6. Consolidation (FV=BV)
7. Consolidation (FV~=BV)
8. Consolidation with Goodwill
9. Non-controlling interest
10. Consolidated income statement

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1. Classification of investments
Accountants distinguish two broad categories of
investments:
Non-strategic investments are made in order to
earn a return, either in the short or the long term,
with no view to control or influence the investee
(entity that issued the instrument).
 Typically, all short-term investments are Non-
strategic.
 Non-strategic investments can be voting or non-voting
instruments.
Strategic investments are made in order to
influence or control the investee company.
 Typically, these investments are in voting instruments.

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 Non-strategic investments: Equity
investments
1. Fair-value-through-profit-and-loss or FVTPL
investments (held-for-trading investments):
Held for the purpose of resale (so market value
is important); or subject to certain accounting
rules (e. g., hedges).
2. *Fair-value-through-other-comprehensive-
income or FVTOCI investments (also Available-
for-sale or AFS): irrevocably designated by
management at time of acquisition; not acquired
primarily for resale.
3. Cost investments: Investments for which fair
value cannot be reliably determined (e. g.,
shares in private corporations).
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Strategic investments (type of
control)
1. Controlled investments (subsidiaries): give
“continuing power to determine strategic
operating, investing and financing policies of
investee without cooperation of others.”
(usually, more than 50% of voting shares).
2. Significant influence investments (associates):
give influence over investee management but
not control (usually >= 20%, =<50% of
voting shares).
3. *Joint ventures: two or more venturers jointly
control the entity (one venturer cannot decide
without consent of other venturers).

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2. Accounting for non-strategic
equity investments
Realized vs. unrealized
Most investments have volatile values, that is,
their values will move up and down over time.
As long as the investor holds an investment, any
changes in value are unrealized. Gains and losses
are realized when the investments are sold.
In most cases, only realized gains and losses have
income tax consequences.
Methods of accounting for investments differ in
how they treat unrealized gains and losses.

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2. Accounting for non-strategic
equity investments
Current vs. non-current
The current vs. non-current classification of non-
strategic investments depends on the intentions of
management and the degree of liquidity of the
investments. However, the issue continues to
evolve under IFRS 9.
FVTPL investments are generally current assets
since they are liquid trading instruments (shares
or bonds) and held with the intention of earning a
short-term return, but companies can designate
FVTOCI investments for either current or non-
current investments.

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2. Accounting for non-strategic
equity investments
Cost Method
 Used for equity investments when fair value is
not available.
 Investment recorded at cost.
 Investment is carried at cost – no attempt to
revalue to fair value and no recognition of
unrealized gains or losses.
 Dividends declared are recorded as income.
 Any realized gain or loss on sale recorded in
income.

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Cost method bookkeeping
Acquisition
Dr. Investment, at cost A
Cr. Cash A
A = cost of shares
Dividend
Dr. Cash B
Cr. Dividend Income B
B = dividend received
Year-end (No Entry)

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Cost method bookkeeping
Sale of investment
P = net proceeds; A = cost of shares
If P > A
Dr. Cash (Net proceeds) P
Cr. Investment A
Cr. Gain on sale of investment P-A

Or, if P < A
Dr. Cash (Net proceeds) P
Dr. Loss on sale of investment A-P
Cr. Investment A

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Example: Granelli Corporation
Granelli Corp. purchased 1,000 common shares of
Term Ltd. $50 per share on January 1, Year 1. The
purchase represented 5% of Term’s outstanding
common stock. The intention of Granelli’s
management is to hold these shares as an investment
over a period of years. During the year, Term Ltd.
reported net income of $150,000 and paid cash
dividends of $6 per share. The market value of Term’s
shares at December 31, Year 1 was $52 per share.
Granelli sold the shares for $55,000 on January 4,
Year 2.
Required
Prepare journal entries to record these transactions.
What effect would these activities on the income
statement and balance sheet of Granelli Corporation
on December 31, Year 1? (assume cost method)
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Granelli (assume cost method)
January 1, Year 1

During the year

January 4, Year 2

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Granelli (assume cost method)
Income statement for the year ended
Dec. 31, Year 1

Balance sheet as at Dec. 31, Year 1

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2. Accounting for non-strategic
equity investments
Fair value through profit or loss (FVTPL)
method
 Used for trading investments.
 Investment initially recorded at cost.
 Dividend income on shares recorded when
declared.
 Investments revalued to fair value at end of
each reporting period and unrealized gains and
losses recorded in income.
 Realized gains and losses (market less carrying
value) recorded in income when sold.

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FVTPL bookkeeping
Acquisition
Dr. Investment A
Cr. Cash A
A = cost of investment
Dividend (same as Cost Method)
Year-end: If fair value has increased to F; F>A
Dr. Investment F-A
Cr. Unrealized gain (I/S) F-A
Or, If fair value has decreased to F; F<A
Dr. Unrealized loss (I/S) A-F
Cr. Investment A-F
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FVTPL bookkeeping
Sale of investment
P = net proceeds; F = fair value of shares
If P > F
Dr. Cash (Net proceeds) P
Cr. Investment F
Cr. Gain on sale of investment P-F

Or, if P < F
Dr. Cash (Net proceeds) P
Dr. Loss on sale of investment F-P
Cr. Investment F

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Example: Granelli Corporation
Granelli Corp. purchased 1,000 common shares of
Term Ltd. $50 per share on January 1, Year 1. The
purchase represented 5% of Term’s outstanding
common stock. The intention of Granelli’s
management is to hold these shares as an investment
over a period of years. During the year, Term Ltd.
reported net income of $150,000 and paid cash
dividends of $6 per share. The market value of Term’s
shares at December 31, Year 1 was $52 per share.
Granelli sold the shares for $55,000 on January 4, Year
2.
Required
Prepare journal entries to record these transactions.
What effect would these activities on the income
statement and balance sheet of Granelli Corporation on
December 31, Year 1? (Assume FVTPL Method)
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Granelli (assume FVTPL method)
January 1, Year 1

During the year

December 31, Year 1

*Closing entry

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Granelli (assume FVTPL method)
January 4, Year 2

Income statement for the year ended Dec. 31, Year 1

Balance sheet as at Dec. 31, Year 1

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 Granelli summary
Year 1 Method
Cost FVTPL Equity
Income statement
Dividend income
Unrealized gain
Investment income
Balance sheet
Assets
Cash

Investment
Shareholders’ Equity
Retained earnings
X = other Cash; Y = other Retained earnings
 Granelli summary
Year 2 Method
Cost FVTPL Equity
Income statement
Gain on sale
Loss on sale
Balance sheet
Assets
Cash

Investment
Shareholders’ Equity
Retained earnings
X = other Cash; Y = other Retained earnings
3. Accounting for strategic investments
The accounting method to be used for an investment in equity
securities depends on the amount of common shares owned. The
difference in accounting method arises from the nature of
influence that the investor has over the investee. In addition to the
level of voting share ownership, other factors that should be
considered in determining the level of influence that exists include:
1. The composition of the investee's Board of Directors,
including the extent to which the investor has any
representation thereon.
2. The composition of the senior management team, including
whether the investor and investee are sharing or otherwise
exchanging such personnel.
3. The extent to which material transactions are occurring
between the investor and the investee.
4. The extent to which the investor participates in the operating,
investing, and financing activities of the investee.
5. The extent to which there is an exchange of scientific,
technical, and special knowledge between the investor and the
investee.

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 Accounting for investments
Nature of Control/influence Accounting
investment exerted (assuming method
absence of other
indicators)

< 20 % of voting
None Cost or FVTPL
shares

≥ 20%, but ≤ 50%

Influence Equity Method
of voting shares

> 50% of voting

Control Consolidation
shares

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4. The equity method
This is used for investments in which the investor has
influence, but not control, over the investee.
 Investment is initially recorded at cost.
 When investee reports income, investor recognizes
portion of it as investment income and increases
balance of investment account (decrease in case of
investee loss).
 Dividends from investee are recorded as decrease in
investment account (treated as return of
investment); dividends have no effect on the
income statement.
 Investment is carried at equity value = Cost +
share of investee income recognized as investment
– dividends received.
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Equity method bookkeeping
Acquisition
Dr. Investment, at cost A
Cr. Cash A
A = cost of shares
Dividend
Dr. Cash B
Cr. Investment B
B = dividend declared

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Equity method bookkeeping
Year-end
Dr. Investment A
Cr. Investment Income A
A = B * Investor’s % of common shares
B = Investee’s reported net income

Or
Dr. Investment Loss A
Cr. Investment A
A = B * Investor’s % of common shares
B = Investee’s reported net loss

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Equity method bookkeeping
Sale of investment
P = net proceeds; F = fair value of shares
If P > F
Dr. Cash (Net proceeds) P
Cr. Investment F
Cr. Gain on sale of investment P-F

Or, if P < F
Dr. Cash (Net proceeds) P
Dr. Loss on sale of investment F-P
Cr. Investment F

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Example: Granelli Corporation
Granelli Corp. purchased 1,000 common shares of Term
Ltd. $50 per share on January 1, Year 1. The purchase
represented 25% of Term’s outstanding common stock.
The intention of Granelli’s management is to hold these
shares as an investment over a period of years. During
the year, Term Ltd. reported net income of $150,000
and paid cash dividends of $6 per share. The market
value of Term’s shares at December 31, Year 1 was $52
per share. Granelli sold the shares for $55,000 on
January 4, Year 2.
Required
Prepare journal entries to record these transactions.
What effect would these activities on the income
statement and balance sheet of Granelli Corporation on
December 31, Year 1?

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Granelli (Equity method)
January 1, Year 1

Dividends paid in year 1

Term net income announced in Year 1

*Closing entry

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Granelli (Equity method)
January 4, Year 2

Income statement for the year ended Dec. 31, Year 1

Balance sheet as at Dec. 31, Year 1

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5. Consolidation
When one company (the “parent”) obtains control of
another (the “subsidiary”) by (usually) purchasing more
than 50% of the voting shares, the financial statements
of the two companies are combined and presented as
consolidated statements.
Legally, the parent and subsidiary are separate entities,
but economically, they are a single unit. As always, the
accounting treatment aims to capture and present the
economic reality, rather than the legal fiction.
The two companies continue to keep separate
accounting records. Consolidation only occurs when
financial statements are prepared.

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5. Consolidation
Preparing consolidated statements using the
acquisition method:
The consolidated balance sheet is essentially the
same as the parent's balance sheet, except the
parent's “investment in subsidiary” account is
replaced by the subsidiary's assets and liabilities.
The consolidated income statement is essentially
the parent's income statement, except the parent's
“investment income from subsidiary” is replaced by
the subsidiary's revenues and expenses.

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 Consolidation example
On Jan. 1, Year 1, Parent purchases a controlling interest
in Sub. The book values of Sub assets and liabilities are
equal to their fair market values. The balance sheets
immediately before the share purchase were:
Parent Co. Balance Sheet as at Jan. 1, Year 1
Cash $200 Liabilities $270
Inventory 180 Common shares 150
Plant (net) 220 Retained earnings 180
Total assets $600 Total liab + Sh. Eq. $600

Sub Co. Balance Sheet as at Jan. 1, Year 1

Cash $10 Liabilities $80
Inventory 80 Common shares 60
Plant (net) 90 Retained earnings 40
Total assets $180 Total liab + Sh. Eq. $180

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6. Consolidation (FV=BV)
Parent acquires 100% of the shares of Sub
for $100 cash (the fair value of Sub
identifiable assets and liabilities equal to its
book value).
Procedure
1. Starting point: Unadjusted balance sheets of
Parent and Subsidiary.
2. Eliminate Parent’s investment in Sub.
3. Eliminate Sub’s Shareholders’ equity.
4. Combine remaining accounts to get
consolidated accounts.

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 Consolidation worksheet
Parent acquires 100% of the shares of Sub for $100.
Parent Sub Adj. Consol.
Assets
Cash $100 $10
Inventory 180 80
Plant (net) 220 90
Investment in Sub 100
$600 $180

Liabilities + Sh. Eq.

Liabilities $270 $80
Common shares 150 60
Retained earnings 180 40
$600 $180

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7. Consolidation (FV~=BV)
Parent acquires 100% of the shares of Sub
for $110 cash (the fair value of Sub
identifiable assets and liabilities equal to its
book value, except for Plant (net) with fair
value of $100).
Procedure
1. Starting point: Unadjusted balance sheets of
Parent and Subsidiary.
2. Eliminate Parent’s investment in Sub.
3. Eliminate Sub’s Shareholders’ equity.
4. Revalue Sub’s Plant (net) based on FV.
5. Combine remaining accounts to get
consolidated accounts.

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 Consolidation worksheet
Parent acquires 100% of the shares of Sub for $110.
Parent Sub Adj. Consol.
Assets
Cash $90 $10
Inventory 180 80
Plant (net) 220 90
Investment in Sub 110
$600 $180

Liabilities + Sh. Eq.

Liabilities $270 $80
Common shares 150 60
Retained earnings 180 40
$600 $180

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8. Consolidation with Goodwill
Goodwill arises when the investor pays a price greater
than the fair value of investee net assets, i. e., the
value of Sub as a whole is greater than the sum of its
identifiable parts. This implies that there is some
unidentifiable asset (e. g., good reputation, valued
employees) which warrants the additional cost.
For many companies, goodwill is perhaps their most
important asset. Because of difficulties in measuring
goodwill, however, it is only recognized when purchased
in a takeover transaction.
Goodwill is a non-current asset.
Goodwill is not amortized but is tested for impairment
annually.

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Consolidation with Goodwill
Parent acquires 100% of the shares of Sub for
$120 (the fair value of Sub identifiable assets and
liabilities equal to its book value).
Procedure
1. Starting point: Unadjusted balance sheets of
Parent and Subsidiary.
2. Eliminate Parent’s investment in Sub.
3. Eliminate Sub’s Shareholders’ equity.
4. Establish goodwill account = value of Sub as a
whole – (fair value of identifiable Sub assets
less liabilities).
Goodwill = $120 – (180 – 80) = $20
5. Combine remaining accounts to get
consolidated accounts.

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 Consolidation worksheet: Goodwill
Parent acquires 100% of the shares of Sub for $120.
Parent Sub Adj. Consol.
Assets
Cash $80 $10
Inventory 180 80
Plant (net) 220 90
Investment in Sub 120
Goodwill
$600 $180
Liabilities + Sh. Eq.
Liabilities $270 $80
Common shares 150 60
Retained earnings 180 40
$600 $180

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9. Non-controlling interest
Sub shareholders other than Parent are called
non-controlling interest. This is a type of
equity holding in the consolidated entity, but not
provided by Parent.
Non-controlling interest arises when Parent
acquires control of Sub but does not acquire
100% of the voting shares. All of Sub’s assets
and liabilities appear on the consolidated balance
sheet, but some of the assets and liabilities are
provided by Sub’s shareholders other than parent
– non-controlling shareholders.
NCI appears only on the consolidated balance
sheet, as a Shareholders’ Equity item.

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10. Consolidated income statement
Like the consolidated balance sheet, the income
statements of Parent and Sub are combined to
become the consolidated income statement.
Possible complications:
 Intercompany transactions (sales between
Parent and Sub) are treated as internal
transfers and must be removed from
consolidated income statement (advanced
accounting course topic).
 Must present clearly any part of consolidated
net income that “belongs” to non-controlling
interest.

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 Consolidated income statement
Parent holds 100% of the shares of Sub. Parent
and Sub income statements one year after
Parent’s acquisition are presented below:
Parent Sub Consol.
Revenue $210 $50
Investment Income 20
Expenses 130 30
Net income $100 $20

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