FINANCIAL ACCOUNTING Tools for Business Decision-Making KIMMEL  WEYGANDT  KIESO  TRENHOLM  IRVINE CHAPTER 12: REPORTING AND ANALYZING INVESTMENTS

SO 1: Identify reasons to invest, and classify investments. SO 2: Account for non-strategic investments. SO 3: Account for strategic investments. SO 4: Explain how investments are reported in the financial statements. SO 5: Compare the accounting for a bond investment and a bond payable (Appendix 12A). STUDY OBJECTIVES

Classifying Investments Debt investments – Guaranteed investment certificates or term deposits, bonds, commercial paper and other debt securities – Earn interest over time – Borrower is usually obligated to return the original investment (principal) Equity investments – Preferred and common shares of other corporations – May or may not earn any revenue – No obligation to return principal

Classifying Investments (Cont’d) Non-strategic investments – To generate investment income Strategic investments – To influence or control the operations of another company

Non-Strategic Investments Reasons for purchasing non-strategic investments: – Excess cash – To earn capital gains – trading investments Further classified as short-term investments or long-term investments – Depends on liquidity of investment and how long management wishes to hold the investment

Strategic Investments Only equity securities can be considered a strategic investment – To influence the relationship between companies Usually classified as long-term investments

Accounting for Non-Strategic Investments Recorded at purchase cost at acquisition After acquisition, four alternate valuation models 1.Fair value through profit or loss model Adjust up or down to reflect fair value at end of period Causes an unrealized gain or loss, recorded in the income statement 2.Fair value through other comprehensive income model As above, except unrealized gain or loss is recorded in other comprehensive income 3.Amortized cost model Not adjusted to reflect fair value Any discount or premium on purchase is amortized over the remaining life of the investment

Accounting for Non-Strategic Investments (continued) 4.Cost model Used for equity investments when fair value not available No adjustment to record at fair value Fair value model is used unless: 1.Investment is held to earn cash flows with fixed payment dates (usually debt instruments) Use amortized cost method 2.Investment is not held to earn cash flows and does not trade in an active market Fair value model cannot be used

Using the Fair Value Model Any increase or decrease in market price changes the carrying amount on the statement of financial position – Corresponding unrealized gain or loss is recorded in: The income statement (through profit or loss model) Other comprehensive income (if this model, on an investment- by-investment basis) – Usually done via an adjusting journal entry at year end Any realized gains or losses on disposition are also reported on the same statement – No difference in reporting unrealized and realized gains and losses

Discussion Question What is the difference between unrealized gains and losses and realized gains and losses?

Accounting for Strategic Investments

Equity Method (More than 20%) Investor is considered to have significant influence over the investee (associate) Investment in common shares is initially recorded at cost – “Investment in Associates” account Investment account adjusted annually to show how the investor’s equity in the investee has changed – The investor’s share of associate’s profit or loss (increases or decreases investment account) – Record dividends received by investor (decreases investment account)

Cost Model Investment is recorded and cost and is not adjusted until the investment is sold – Any dividends received are recorded as revenue Used under certain circumstances

Reporting Investments: Income Statement / OCI

Reporting Investments: Statement of Financial Position Under IFRS Non-strategic investments – Investment purchased to earn contractual cash flows Amortized cost model; optional use of fair value through profit or loss Presentation: current or non-current presentation based on contract – Investment not purchased to earn contractual cash flows (example: trading investments) Fair value through profit or loss; some exceptions through OCI Presentation: Usually current assets (but not always) Strategic investments – Investor has control Consolidation – Investor has significant influence, but no control Equity method; non-current

Reporting Investments: Statement of Financial Position Under ASPE Non-strategic investments – Equity investments with quoted prices in active markets Fair value through profit or loss Presentation: current or non-current based on management intention – No active market or not an equity investment Amortized cost if debt or cost model if equity Presentation: current or non-current based on management intention Strategic investments – Investor has control Consolidation, or If fair value known, equity method or fair value through profit or loss – Investor has significant influence, but no control If fair value known, equity method or fair value through profit or loss If not known, equity method or cost model

Consolidated Financial Statements When one company controls the other company Consolidated statements show the combined assets and liabilities of both parent and subsidiary companies Prepared in addition to financial statements for individual parent and subsidiary companies

Appendix 12A: Investment in Bonds The recording of bonds as an investment is similar to recording a bond liability – Investor (purchaser of bonds) – Investee (issuer of bonds) Short-term investments in bonds accounted for using fair value Long-term investments use amortized cost model

Comparing IFRS and ASPE

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