Intermediate Accounting II

ACC 307

Handout 4

Investment
This Hand Out intended to achieve the following learning outcomes No 3
Describe the categories of debt and equity securities and examine the accounting and
reporting treatments for each category.

Source: https://lms.ectmoodle.ae/

17-1
 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 (consolidation).
2. Explain the accounting for 4. Evaluate other major issues
equity investments. related to debt and equity
investments.

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 PREVIEW OF CHAPTER 17

Intermediate Accounting
IFRS 3rd Edition
Kieso ● Weygandt ● Warfield
17-3
 LEARNING OBJECTIVE 1
Debt Investments Describe the accounting for
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).

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 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? (future cash flow the company will
expect from the invetsment)

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 Classification and Measurement of
Financial Assets

Summary of the classification and measurement of debt

and equity investments.

ILLUSTRATION 17.1
Classification and Measurement

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 A Closer Look at Debt Investments

Debt investments (bonds) are characterized by contractual

payments on specified dates of
 principal and
 interest on the principal amount outstanding (carrying
amount).

Companies group debt investments into three categories:

1. Held-for-collection (held to maturity: long term)
2. Held-for-collection and selling (available for sale)
3. Trading securities

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 A Closer Look at Debt Investments

Companies group debt investments into three categories:

1. Held-for-collection (held to maturity: long term bonds)
2. Held-for-collection and selling (available for sale)
3. Trading securities ILLUSTRATION 17.2
Accounting for Debt Investments
by Category

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 1. Debt Investment at Amortized Cost
(held for collection)
Illustration: Robinson SA purchased (chapter 1 issued :
sells) €100,000 of 8 percent bonds of Evermaster AG on
January 1, 2019, at a discount, paying €92,278 (present
value). The bonds mature January 1, 2024 (5 years) and yield
10 percent; interest is payable each July 1 and January 1
(semi-annual). Robinson records the investment as follows:

January 1, 2019

Debt Investments + (pv) 92,278

Cash - 92,278
(to purchase debt securities I = 4 % = 8% 2 , n = 10 = 5*2
17-9 semi annual) LO 1
 Debt Investment at Amortized Cost
ILLUSTRATION 17.2

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 Debt Investment at Amortized Cost
ILLUSTRATION 17.2

Robinson records the receipt of the first semiannual interest

payment on July 1, 2019, as follows:

Cash + (interests paid) 4,000

Debt Investments (discount amortization ) 614
Interest Revenue (received) 4,614
(to receive the first payment)
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 Debt Investment at Amortized Cost
ILLUSTRATION 17.2

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

amortizes the discount at December 31, 2019, as follows:

Interest Receivable 4,000

Debt Investments 645
Interest Revenue 4,645

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 Debt Investment at Amortized Cost

Reporting of Bond Investment at Amortized Cost

93,537 : PV carrying value at 31/12/2019

Interest receivable (current assets) 4000

Interest revenues both SEMI ANNUAL 1/7/2019 + 31/12/2019

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 ILLUSTRATION 17.2

Assume that Robinson sells its investment on November 1,

2021, at 99¾ ( 99,750 ) plus accrued interest (2667).
Robinson records this discount amortization as follows:

Debt Investments 522

Interest Revenue 522
(€783 x 4/6 = €522) to complete 4 months amortization
17-14 Amortization of July + august + September + October 4/6 LO 1
 Debt Investment at Amortized Cost

Computation Gain on Sale of Bonds

ILLUSTRATION 17.4

Cash (€99,750 + €2,667) selling price + accrued interests 102,417

Interest Revenue (4/6 x €4,000) 2,667
Debt Investments 95,671 + 522 (cost + unamortized ) 96,193
Gain on Sale of Investments 3,557

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 2. Debt Investments—Held-for-Collection
and Selling (available for sale)

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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 2. Held-for-Collection and Selling (HFCS)

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

year bonds on January 1, 2019, with interest payable on July 1
and January 1 (semi annual) . The bonds sell for £108,111 (fair
value), 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, 2019
Debt Investments (fair value) 108,111
Cash - 108,111

(to purchase bonds with a premium)

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 ILLUSTRATION 17.6
Schedule of Interest
Revenue and Bond
Premium Amortization—
17-18 Effective-Interest Method
 ILLUSTRATION 17.6

Illustration (Single Security): The entry to record interest revenue

on July 1, 2019, 2020, 2021 ,2022, 2023, 2024 is as follows.

Cash (interests received) 5,000

Debt Investments (premium amortization) 676
Interest Revenue (effective) 4,324

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 Held-for-Collection and Selling (HFCS)

Interest
Revenue for
2019 = $8,621

ILLUSTRATION 17.6

Illustration (Single Security): At December 31, 2019, Graff makes

the following entry to recognize interest revenue.

Interest Receivable 5,000

Debt Investments 703
Interest Revenue 4,297
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 Held-for-Collection and Selling (HFCS)

ILLUSTRATION 17.6

Illustration (Single Security): To apply the fair value method to

these debt investments, assume that at December 31, 2019 the fair
value of the bonds is £105,000. Graff makes the following entry.

Unrealized Holding Loss—Equity 1,732

Fair Value Adjustment 1,732
(to adjust the value of securities to fair value 106,732 – 105,000
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loss)
 Held-for-Collection and Selling (HFCS)

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
17-22 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 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.

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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.
ILLUSTRATION 17.8
Computation of Loss on Sale of Bonds

Cash (sales price) 90,000

Loss on Sale of Investments (-) 4,214
Debt Investments (amortized cost) 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:

ILLUSTRATION 17.9
Computation of Fair Value Adjustment—HFCS (2020)
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 Sale of HFCS Securities

Illustration: Webb records the following at December 31, 2020.

ILLUSTRATION 17.9

Fair Value Adjustment 4,537

Unrealized Holding Gain or Loss—Equity 4,537
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 Held-for-Collection and Selling (HFCS)

Financial Statement Presentation

ILLUSTRATION 17.10
Reporting of HFCS
Securities

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 3. Debt Investments—Trading securities

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
17-29 dividend or interest revenue recognized but not received. LO 1
 Debt Investments—Trading

Illustration: Assume that on December 31, 2019, Western

Publishing determined its trading securities portfolio to be as shown.
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 17.10
Computation of Fair Value
Adjustment—Trading
Securities Portfolio (2019)

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 Debt Investments—Trading

Illustration: At December 31, 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 17.10

Fair Value Adjustment 3,750

17-31
Unrealized Holding Gain—Income 3,750
 LEARNING OBJECTIVE 2
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: parent

company) acquires an interest in the common stock of another
corporation (investee: subsidairy) generally determines the
accounting treatment for the investment subsequent to
acquisition.

ILLUSTRATION 17.12
Levels of Influence Determine Accounting Methods

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 Equity Investments

ILLUSTRATION 17.13
Accounting and Reporting for Equity Investments by Category

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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
(to purchase equity investments)
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
17-38
(to receive cash dividend) LO 2
 Equity Investments—Trading (Income)

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

the carrying value and fair value shown.

ILLUSTRATION 17.14
Computation of Fair Value Adjustment—
Equity Investment Portfolio (2019)
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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 Loss— 35,550

Fair Value Adjustment + (trading ) 35,550
17-40
(to recognize unrealized gains and losses in net income) LO 2
 Equity Investments—Trading (Income)

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

shares, receiving €287,220. ILLUSTRATION 17.15
Computation of Gain on Sale of Burberry Shares

Cash (sales price) 287,220

Equity Investments (purchase price) 259,700
Gain on Sale of Investments (-) 27,520
(sales of shares investment with gain)

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 ILLUSTRATION 17.16

Republic records this adjustment on Dec. 31, 2020, as follows.

Fair Value Adjustment – (trading) 101,650

Unrealized Holding Gain +Income 101,650

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 Equity Investments—Non-Trading (OCI)

Illustration: On December 10, 2019, 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.

Equity Investments (Hawthorne) 20,750

Cash 20,750

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 Equity Investments—Non-Trading (OCI)

On December 27, 2019, Republic receives a cash dividend of

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

Cash + 450
Dividend Revenue + 450

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 Equity Investments—Non-Trading (OCI)

At December 31, 2019, Republic’s investment in Hawthorne has

the carrying value and fair value shown. ILLUSTRATION 17.17
Computation of Fair Value Adjustment

Republic records this adjustment as follows.

Equity Investment (non trading) 3,250

Unrealized Holding Gain—Equity 3,250

The Equity Investment account is used because the non-trading

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

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.
17-47 LO 3
 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.

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 LEARNING OBJECTIVE 4
Other Reporting Issues Evaluate other major issues
related to debt and equity
investments.

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.

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 Impairment of Value

Impairment—Investment Measured at
Amortized Cost
Illustration: At December 31, 2018, 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.
Using the following information record the loss on impairment.

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 Investment Measured at Amortized Cost
ILLUSTRATION 17.22
Investment Cash Flows

ILLUSTRATION 17.23
Computation of
Impairment Loss

Loss on Impairment of investments + 12,680

Allowance for Impaired Debt Investments 12,680
17-51
 Impairment—Debt Investments (HFCS)

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.

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 Reporting Issues

On June 30, Hinges sold part of the HFCS security debt portfolio,
realizing a gain as shown. ILLUSTRATION 17.29
Computation of Realized Gain

Hinges did not purchase or sell any other securities during 2019. It
received £3,000 in interest during the year. At December 31, 2019,
the remaining portfolio is as shown ILLUSTRATION 17.30
Computation of Unrealized Gain

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 ILLUSTRATION 17.31

ILLUSTRATION 17.32

17-54 LO 4
 ILLUSTRATION 17.33

ILLUSTRATION 17.34

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 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.

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 Transfers Between Categories

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, 2018, British Sky has
the following balances related to these securities.

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 Transfers Between Categories

Illustration: As part of its strategic planning process, completed

in the fourth quarter of 2018, 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.

Debt Investments 125,000

Fair Value Adjustment 125,000
(to record the increase in fair value due to transfer).

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