CHAPTER 17

Investments
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Describe the accounting for 3. Explain the equity method of
debt investments. accounting.
2. Explain the accounting for 4. Evaluate other major issues
equity investments. related to debt and equity
investments.

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 Investments LEARNING OBJECTIVE 1
Describe the accounting for
debt investments.

Two Types of Financial Assets

 Debt investments.
 Equity investments.

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 Investments

Invest in order to meet strategic goals

• Toyota owns between 5 and 49 percent of the equity of
its 10 largest Japanese suppliers.
 Encourage its suppliers to locate their manufacturing
plants to Toyota’s assembly plants.

 Large pharmaceutical companies, such as Merck and

Pfizer, own equity positions in start-up bio companies.

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 Financial Instruments in IRFS

2005: IAS 39 in its current form.

2008: Project “IFRS 9: Financial

Instruments (replacement of IAS 39)”

2018: IFRS 9 became effective!

17-4 Source: IFRS box

 Classification and Measurement of Financial Assets

Three ways to measure financial assets:

1. Amortized cost;

2. Fair value through other comprehensive income (FVOCI);

3. Fair value through profit or loss (FVPL).

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 Classification and Measurement of Financial Assets

Two criteria:
1. What is the company’s business model for managing its
financial assets?
• Hold to collect contractual cash flow (rather than sell before
maturity to realize fair value changes)?

2. What are the contractual cash flow characteristics of the

financial investment?
• Solely payments of principal and corresponding interest?

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 Source: faqifrs.com

But you DON’T need to memorize this chart….

It is easier to decide by looking at each type of the asset.

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 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.

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 A Closer Look at Debt Investments

Debt investments can be grouped into three categories:

1. Held-for-collection
• Hold the investment to receive cash flows over the life of it.

2. Held-for-collection and selling

• Something in between.

3. Trading
• Bought and held primarily for sale in the near term to generate
income on short-term price differences.

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 A Closer Look at Debt Investments

Accounting measurement for the three categories of debt

investments:

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 Debt Investments—Held-for-Collection

• Recorded at amortized cost.

• Amortization similar to bonds payable, but now it is the

company’s ASSET!

 Bond payable  Debt investment.

 Interest expense  Interest revenue.

 Interest payable  Interest receivable.

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 Question (Poll)

Patton Company purchased €400,000 of 10% bonds of Scott Co. on

January 1, 2019, paying €376,100. The bonds mature January 1,
2029; interest is payable each July 1 and January 1. The discount of
€23,900 provides an effective yield of 11%. Patton Company uses
the effective-interest method and holds these bonds for collection.

On July 1, 2019, Patton Company should increase its Debt

Investments account for the Scott Co. bonds by

a. €2,392.

b. €1,371.
376,100*11%/2-400,000*10%/2
c. €1,196.

d. €686.
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 Debt Investments—Held-for-Collection
and Selling (HFCS)

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.
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 Held-for-Collection and Selling (HFCS)

Illustration (single security): Robinson Company purchased

€100,000 of 8 percent bonds of Evermaster Corporation on
January 1, 2015, at a discount, paying €92,278. The bonds
mature January 1, 2020, and yield 10 percent; interest is
payable each July 1 and January 1.

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 Held-for-Collection and Selling (HFCS)

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 Held-for-Collection and Selling (HFCS)

First of all, we still need to record journal entries for

amortization and interests!!

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 Held-for-Collection and Selling (HFCS)

Then, we take care of the part that the investment is reported

at fair value!

Robinson determines that, the fair value of the debt investment

increased to €95,000 at December 31, 2015.

Fair Value Adjustment 1,463

Unrealized Holding Gain or Loss—Equity 1,463
This account helps adjust securities to
17-17 fair value, while allowing companies LO 3
to maintain records of amortized cost.
 Let’s keep going….

At December 31, 2016, assume that the fair value

of the Evermaster debt investment is €94,000.
First of all, we still need to record journal entries for amortization
and interests!! Then:

Unrealized Holding Gain or Loss—Equity 2,388

Fair Value Adjustment 2,388
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 Companies might manage a portfolio of Securities

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
17-19 Computation of Fair Value Adjustment—HFCS (2019) LO 1
 Held-for-Collection and Selling (HFCS)
ILLUSTRATION 17.7

Prepare the adjusting entry Webb would make on December 31,

2019 to record the loss.

Unrealized Holding Gain or Loss—Equity 9,537

Fair Value Adjustment 9,537
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 Held-for-Collection and Selling (HFCS)

Sale of HFCS Securities

If company sells the bond investment 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.

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 Sale of HFCS Securities

Illustration: Webb AG sold the Watson bonds (from Illustration

17.7) on July 1, 2020, for £90,000, at which time it had an
amortized cost of £94,214.

Cash 90,000
Loss on Sale of Investments 4,214
Debt Investments 94,214
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 Sale of HFCS Securities

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 2020, Herringshaw on December
31, 2020, prepares the information:

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 Debt Investments—Trading

If companies 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

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 Debt Investments—Trading

Accounting Treatment for Debt Investments - Trading

Everything is same as Held-for-Collection and Selling

(HFCS), except that:
 Unrealized holding gains and losses due to changes
in fair value are recorded and reported as part of net
income.

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 Fair Value Option

Companies have the option to report most financial assets at

fair value (Even for Debt Held-for-Collection!!), 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.

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 Fair Value Option

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, 2019, the amortized cost
of this investment is €100,000; its fair value at December 31,
2019, is €113,000. If Hardy chooses the fair value option to
account for this investment, it makes the following entry at
December 31, 2019.

Debt Investment (German bonds) 13,000

Unrealized Holding Gain or Loss—Income 13,000

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 Fair Value Option

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.

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 Mark-to-Market?
Always use fair value?
Yes No

 More relevant in helping  Many investments are not

investor assess the effect held for sale but rather for
of current economic the income they will
events on the future cash generate over the life of
flows of a financial asset. the investment.

 The use of a single  Fair value is unreliable

method promotes when markets are not
consistency in valuation functioning in an ordinary
and reporting on the fashion.
asset.

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 Mark-to-Market?

17-30
Baral, Tamrakar, Sherchan (2018) LO 1
 Let’s step back…

How do companies decide the fair value of securities?

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 Question (Poll)
Richman Co. purchased €300,000 of 8%, 5-year bonds from Carlin,
Inc. on January 1, 2018, with interest payable on July 1 and January
1. The bonds sold for €312,474 and are held-for-collection and
selling. Using the effective interest method, Richman Co. decreased
the Debt Investments account for the Carlin, Inc. bonds on July 1,
2018 and December 31, 2018 by the amortized premiums of €1,062
and €1,098, respectively.

At December 31, 2018, the fair value of the Carlin, Inc. bonds was
€318,000. What should Richman Co. report as other comprehensive
income and as a separate component of equity?
a. €0
b. €2,160
c. €5,526
17-32 d. €7,686 LO 1
 LEARNING OBJECTIVE 2
Equity Investments Describe the accounting for
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.

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 Equity Investments

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.

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 Equity Investments

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 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.

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 Equity Investments

Holdings of Less Than 20%

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.

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 Equity Investments—Trading (Income)

Illustration: November 3, 2019, Republic SA purchased

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

Republic records these investments as follows:

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 Equity
Investments
—Trading

Republic records these investments as follows:

Equity Investments 718,550
Cash 718,550

On December 6, 2019, Republic receives a cash dividend of

€4,200 on its investment in the ordinary shares of Nestlé.

Cash 4,200
Dividend Revenue 4,200
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 Equity Investments—Trading (Income)

At December 31, 2019, Republic’s equity investment portfolio has

the carrying value and fair value shown.

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 ILLUSTRATION 17.14

On December 31, 2019, Republic prepares an adjusting entry to

record the decrease in fair value and to record the loss as follows.

Unrealized Holding Gain or Loss—Income 35,550

Fair Value Adjustment 35,550
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 Equity Investments—Trading (Income)

On January 23, 2020, Republic sold all of its Burberry ordinary

shares, receiving €287,220.

Cash 287,220
Equity Investments 259,700
Gain on Sale of Investments 27,520

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 Equity Investments—Trading (Income)
Did we double count the gain??

January 23, 2020 458,850 408,000 (50,850)

Fair value adjustment (15,300)

(Implied Entry) to adjust the value of the investment portfolio.

Unrealized Holding Gain or Loss—Income 15,300
Fair Value Adjustment 15,300
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 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.

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 Question (Poll)
Dumar Corporation purchased 800 ordinary shares of Viking
Industries as a trading investment for €14,880. During the year,
Viking Industries paid a cash dividend of €3.20 per share. At
year-end, Viking’s shares were selling for €17.40 per share. On
the income statement for the year ended December 31, what is
the total amount of unrealized gain/loss and dividend revenue
reported by Dumar Corporation?

a. €1,600

b. €2,560

c. €960

d. €3,250
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 LEARNING OBJECTIVE 3
Equity Investments Explain the equity method of
accounting.

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.

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 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. Think about why.

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.
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 Equity Method

Rationales for equity method

 The equity method acknowledges the substantive economic

relationship between two entities.
 With a significant influence over another company's
operating and financial policies, the investor is basing its
investment value on changes in the value of that company's
net assets from operating and financial activities and the
resulting performances, including earnings and losses.

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 Dr equity investment 480,000
Cr cash 480,000

Dr equity investment 40,000

Cr investment income 40,000

No entry

Dr cash 20,000
Cr equity investment 20,000

Dr investment loss 10,000

Cr equity income 10,000

No entry

ILLUSTRATION 17.20
Comparison of Fair Value Method and Equity Method
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 CPA Question (Poll)
On January 1, 2019, Reston Co. purchased 25% of Ace Corp.'s
ordinary shares; no goodwill resulted from the purchase. Reston
appropriately carries this investment at equity and the balance in
Reston’s investment account was £720,000 at December 31,
2019. Ace reported net income of £450,000 for the year ended
December 31, 2019, and paid ordinary share dividends totaling
£180,000 during 2019. How much did Reston pay for its 25%
interest in Ace?

a. £652,500.

b. £765,000.

c. £787,500.

d. £877,500.
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 In practice, it could be more complicated
Especially for financial companies

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 Suggested End-of-Chapter Exercises

• E17.15
• P17.4
• P17.6

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