CHAPTER 10

LONG-TERM ASSETS II:

INVESTMENTS AND INTANGIBLES
 Introduction
 Reasons for making long-term investments in
corporate securities
 Classification as long-term
is based on the concept of
managerial intent
 Intangibles
 Investments in Equity
Securities
 What are equity securities?
 Methods of accounting
 Consolidation
 The equity method
 The cost method
 The fair value method
 The market value method
 Consolidation
 The concept of control
 Discussed in more detail in Chapter 16
The Equity Method
 The concept of significant
influence
 The twenty percent guideline
 Other methods of determining
 How to account
 Earnings
 Dividends
 The Equity Method
 Circumstances which limit significant influence
when holding a 20 percent investment
 Opposition by the investee
 Surrender of significant rights
 Majority ownership by small group
 Inability to obtain the financial information
to apply the equity method
 Failure to obtain representation on the
Board of Directors
 The Cost Method

 Lack of significant influence

 How to account
The Lower Cost or Market Method
 The requirements of SFAS No. 12
 Criticism
 The Fair Value Method
 The concept of readily determinable fair
value
1 Availability of information on current price in U. S. markets
2 Availability of information on current prices in a foreign
market
3 Mutual fund information
 The Fair Value Method
 Categories
1 Trading
2 Available-for-sale
3 Transfers between categories
 Available-for-sale to trading
 Trading to available-for-sale
 Rationale for the fair value method
 Market Value Method

 When to use
 Accounting treatment
 The methods of accounting for
investments in equity securities
are summarized in the following
graph
 Accounting for Investments
in Equity Securities
Percentage of 0 20 50 100
ownership

Accounting Fair Value Equity Method Consolidation

Method Method (if fair
value is readily
determinable)

Cost method (if

fair value is not
readily
determinable)

Market Value
Method (for certain
companies)
SFAS No. 159
 Most financial assets &
liabilities may be measured at
fair value.
 Measured using exit prices on
balance sheet date.
 Fair value is price a company
would receive to sell an asset or
pay to transfer a liability.
 Unrealized holding costs most
be reported.
 Investment in Debt Securities
 Trading
 Available-for-sale
 Held-to-maturity
 Trading and available-for-sale accounted for
in a manner similar to equity securities - fair
value
 Held-to-Maturity
 Criteria
 Initial measurement
 Subsequent accounting
 Transfers
 Trading
 Available-for-sale
 Problem - Criteria permit earnings
management
Permanent Decline in Value of Available-for-
Sale and Held-to-Maturity Securities

 Write-down to fair value

 Loss included in earnings
and a new cost basis is
established
 No future recovery included
in cost
 Impairment of Investments in
Unsecuritized Debt

 Impairment is based on the

present value of expected future
cash flows
 In subsequent periods, impairment is remeasured and
may be accounted for by one of the following procedures
1 Increases attributable to passage of time are reported as interest
income
 balance is recorded as an adjustment to bad debt expense
2 Entire amount is recorded as an adjustment to bad debt expense
 Impairment of Investments in
Unsecuritized Debt
 Critics have argued that impairment
reflects a change in the character of the
loan
 interest should reflect the fair value
associated with risk
 Allows earnings management
 Transfers of Financial Assets

 Financial assets:
debt and equity securities
 Accounting for financial assets was first
outlined in SFAS No. 125
 Recently replaced by SFAS No. 140.
Transfers of Financial Assets
 According to SFAS No. 140, the
investor transfers or surrenders control
over transferred assets if and only if all
of the following 3 conditions are met:
1. The transferred assets have been isolated from
the transferor
2. Each transferee has the right to pledge or
exchange the assets it received
 no condition both constrains the transferee from
taking advantage of its right to pledge or
exchange and provides more than a trivial benefit
to the transferor.
 Transfers of Financial Assets

3. The transferor does not

maintain effective control
over the transferred asset

 by having an agreement that obligates it to

repurchase or redeem the asset before maturity
 or by having an agreement that allows it to
repurchase or redeem assets that are not readily
obtainable.
 Transfers of Financial Assets
 A transfer of financial assets
 accounted for as a sale
 to the extent that consideration other than beneficial interests in the
transferred asset is received in exchange.

 Liabilities and derivatives incurred in a

transfer of financial assets
 initially measured at their fair market values.

 Servicing assets and liabilities

 measured by amortization over the period of servicing income or loss
 assessment for asset impairment or increased obligation based on their fair
market values.
 Liabilities are derecognized
 only when repaid or when the debtor is legally relieved of the obligation.
 In-substance defeasance is not permitted.
 Intangibles
™
 Definition
 Classification by the APB
©
 Identifiability
 Manner of acquisition
 Expected period of benefit
 Separability
Classifications

Externally Internally
acquired developed

Identifiable Unidentifiable
 Accounting Treatment
 Cost
 Subsequent amortization
 Limited term of existence
 No term of existence
 Factors to consider
 Goodwill
 The concept
 Theoretical value
 Accounting
 How to record?
 How to amortize?
 The cases for and against
immediate write-off
 SFAS No. 142: Goodwill and
Other Intangible Assets
 Changes accounting for goodwill
 from an amortization period not to exceed 40
years
 to an approach that requires, at a minimum,
annual testing for impairment.
 The goodwill impairment test is
to be performed at the reporting
unit level.
SFAS No. 142: Goodwill and Other
Intangible Assets
 Disclosure Requirements
 test for goodwill impairment is a two-step
process that involves:
1. A comparison of the fair value of the reporting
unit to its carrying value.
 In the event fair value exceeds carrying value, no
further testing is required.
 If the carrying value of the reporting unit exceeds
its fair value, step two is required.
2. A calculation of the implied fair value of goodwill
by measuring the fair value of the net assets
other than goodwill and subtracting this amount
from the fair value of the reporting unit.
Research and Development Costs

 Definition
 Research
 Development
 Accounting
 International Accounting Standards

 The IASC has issued pronouncements

on the following issues:
1. Accounting for investments in associates in a revised IAS
No. 28, “Accounting for Investments in Associates.”
2. Accounting for goodwill in SFRS No 3 "Business
Combinations," which replaced IAS No. 22
3. Accounting for intangibles in IAS No. 38 "Intangible
Assets."
International Accounting Standards

4. The recognition and measurement of

financial assets in a reissued IAS No. 39,
“Financial Instruments: Recognition and
Measurement.”
 IAS No. 28: Accounting for
Investments in Associates
 Revised IAS No. 28
 IASB did not change the fundamental accounting for
accounting for associates in using the equity
method.
 Main objective for the revision was to reduce
alternatives.
 Equity investments may be
carried at
 cost
 revalued amounts
 or lower of cost or market
 If carried at revalued amount
 must frequently revalue and revalue on, at
least
an investment category basis
IAS No. 28: Accounting for Investments
in Associates
 Revaluation increases
 recorded in stockholders’ equity, decreases
in income unless they are recoveries
 Recognize non-temporary declines in
value
 SFRS No 3: Business Combinations
 IASB indicated that goodwill
 should be recognized by the acquirer as an asset from the acquisition
date
 and be initially measured
 as the excess of the cost of the business
combination over the acquirer's share of
the net fair values of the acquiree's
identifiable assets, liabilities and
contingent liabilities.
 Prohibits the amortization of goodwill.
 Goodwill must be tested for impairment
at least annually in accordance with
IAS No. 36, “Impairment of Assets.”
IAS No. 38: Intangible Assets
 The original exposure draft was withdrawn
and a new ED was issued in August, 1997. ©
 Applies to purchased and internally developed
intangible assets. ™
Recognize an intangible asset only if
©

a)

b)
the asset is identifiable
the future economic benefits specifically attributable
™
c)
to the asset will flow to the enterprise, and
cost is reliably measurable. ™
Recognition criteria apply to both purchased
©

and internally generated intangibles.
©
™
 IAS No. 38: Intangible Assets
©  After initial recognition in the financial statements, an
intangible asset should be measured under one of the
following two treatments:
$
™
1. Benchmark treatment: historical cost less any amortization
and impairment losses; or

© 2. Allowed alternative treatment: revalued amount (based on

fair value) less any subsequent amortization and
impairment losses.

™ The main difference from the treatment for revaluations of


property, plant and equipment under IAS 16:
$  revaluations for intangible assets are permitted only if fair
value can be determined by reference to an active market.
©  Active markets are expected to be rare for intangible assets

$
™
 IAS No. 38: Intangible Assets

©  The statement requires intangible assets to be amortized over

the best estimate of their useful life
$ includes the presumption that the useful life of an intangible


™
asset will not exceed 20 years from the date when the asset
is available for use.

© 


In rare cases, where persuasive evidence suggests that the
useful life of an intangible asset will exceed 20 years
amortize the intangible asset over the best estimate of its

$ ™ 1.
useful life and:
Test the intangible asset for impairment at least annually in
accordance with IAS 36, Impairment of Assets
2. Disclose the reasons why the presumption that the useful life of

© an intangible asset will not exceed 20 years is rebutted and also

the factor(s) that played a significant role in determining the
useful life of the asset.

$
™
 IAS No. 9
 Research
 ongoing investigations with the prospect of
gaining new knowledge
 Development
 applications of research findings to a plan of
production
 Research costs are recognized as expenses
 Development costs may be capitalized if
certain criteria are met
 If capitalized - amortized to reflect pattern of
benefits
 IAS No. 22
 Outlined accounting treatment
for investments with the ability to
significantly influence.
 Requirements similar to U. S.
GAAP
 IAS No. 32: Financial Instruments:
Disclosure and Presentation
 Financial asset
a) Cash
b) Right to receive cash
c) Right to exchange financial
asset under
favorable conditions or equity

 Must disclose how financial assets might affect the

amount, timing and certainty of future cash flows,
associated accounting policies and measurement
bases.
 Must also disclose exposure to credit risk and fair
value
 IAS No. 36
 Requires an impairment loss to be
recognized on investments and
intangibles whenever the
recoverable amount of an asset is less
than its book value
 The recoverable amount is the higher of
the asset’s selling price, or value in use
(present value of future cash flows)
 An impairment loss is recognized as an
expense on the income statement
 IFRS No. 7

 Requires disclosures of risks arising

from financial instruments
 Requires quantitative disclosures
based on internal information
 Prepared by
Kathryn Yarbrough, MBA

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