1. RICHARD G. SCHROEDER MYRTLE W. CLARK JACK M. CATHEY
FINANCIAL ACCOUNTING
THEORY AND ANALYSIS: TEXT AND CASES
11TH EDITION
RICHARD G. SCHROEDER
MYRTLE W. CLARK
JACK M. CATHEY 4

2. LONG-TERM ASSETS II: INVESTMENTS AND INTANGIBLES
CHAPTER 10
LONG-TERM ASSETS II:
INVESTMENTS AND INTANGIBLES

3. Introduction
Reasons for making long-term investments in corporate securities – income, desirable relationships, control, new products
Classification as long-term is based on the concept of managerial intent
Intangibles

4. 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

5. Consolidation The concept of control
SFAS No. 94: Ownership of majority voting interest
Discussed in more detail in Chapter 16

6. The Equity Method The concept of significant influence
The twenty percent guideline
Other methods of determining
How to account for
Earnings
Dividends
SFAS No. 115 (FASB ASC 320)
Allows fair value method for some investments - discussed later in the chapter

7. 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

8. The Cost Method Lack of significant influence
Investment carried at historical cost
Dividends reported as revenue

9. The Lower Cost or Market Method
SFAS No. 12 (since superseded): LCM
Current and long-term portfolios
Conservatism
Criticism
Did not result in consistent treatment

10. The Fair Value Method: SFAS No. 115 (FASB ASC 320)
The concept of readily determinable fair value
Availability of information on current price in U. S. markets
Availability of information on current prices in a foreign market
Mutual fund information

11. The Fair Value Method Categories Rationale for the fair value method
Trading
Available-for-sale
Transfers between categories
Available-for-sale to trading
Trading to available-for-sale
Rationale for the fair value method

12. Market Value Method When to use Accounting treatment
Dividends recognized as income
Unrealized gains and losses recognized in earnings

13. Recent Developments
May 26, 2010: FASB issued proposed Accounting Standards Update
Classification to be determined at acquisition or issuance
Financial assets with variable cash flows to be accounted for at fair value
Changes in fair value of certain securities
Financial assets held for collection of cash
Both amortized cost and fair value presented on balance sheet
Some fair value changes to be recognized in net income
Other FV changes to be recognized in other comprehensive income

14. Accounting for Investments in Equity Securities
Percentage of
ownership 20 50
100
Accounting
Method
Equity Method
Fair Value
Method (if fair
value is readily
determinable)
Consolidation
Cost method (if
fair value is not
readily
determinable)
Market Value
Method (for certain
companies)

15. SFAS No. 159(FASB ASC 825) Deals with financial assets and liabilities
A financial asset is an asset that derives value because of a contractual claim. Examples include bank deposits, bonds, and stocks
A financial liability requires a debtor to make a payment, or payments, to a creditor in circumstances specified in a contract between them. For example, accounts payable, loans issued by an entity, and derivative financial liabilities.

16. SFAS No. 159 (FASB ASC 825)
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 gains and losses must be reported in earnings .

17. 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

18. Held-to-Maturity Criteria Initial measurement Subsequent accounting
Transfers
Trading
Available-for-sale
Problem - Criteria permit earnings management

19. 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

20. 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
Increases attributable to passage of time are reported as interest income
Balance is recorded as an adjustment to bad debt expense
Entire amount is recorded as an adjustment to bad debt expense

21. 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

22. Transfers of Financial Assets
Debt and equity securities
Accounting for financial assets was first outlined in SFAS No. 125
Recently replaced by SFAS No. 140.

23. 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:
The transferred assets have been isolated from the transferor
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.

24. Transfers of Financial Assets
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.

25. 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.

26. ™ © Intangibles Definition Classification by the APB Identifiability
Manner of acquisition
Expected period of benefit
Separability

27. Classifications VS VS Externally acquired Internally developed
Identifiable
Unidentifiable

28. Accounting Treatment Cost Subsequent amortization Factors to consider
Limited term of existence
No term of existence
Factors to consider

29. Goodwill The concept Accounting Theoretical value How to record?
How to amortize?
The cases for and against immediate write-off

30. SFAS No. 142 (FASB ASC 350): 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.

31. SFAS No. 142: Goodwill and Other Intangible Assets
Disclosure Requirements
Test for goodwill impairment is a two-step process that involves:
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.
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.

32. Research and Development Costs
Definition
Research
Development
Expense as incurred

33. International Accounting Standards
The IASB has issued pronouncements on the following issues:
Accounting for investments in associates  in a revised  IAS No. 28, “Accounting for Investments in Associates.”
Accounting for financial assets in IAS No. 32, “Financial Instruments: Presentation.”
Accounting for intangibles in IAS No. 38, “Intangible Assets.”
The recognition and measurement of financial assets in a reissued IAS No. 39, “Financial Instruments: Recognition and Measurement.”

34. International Accounting Standards
Accounting for goodwill  in SFRS No. 3, “Business  Combinations,” which replaced IAS No. 22.
The disclosure of information on financial instruments in IFRS No. 7, “Financial Instruments: Disclosures.”
Accounting for financial assets in IFRS No. 9, “Financial Instruments,” as a first step in its project  to replace  IAS No. 39.

35. 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

36. 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

37. IAS No. 32: Financial Instruments:
Disclosure and Presentation
Financial asset
Cash
Right to receive cash
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

38. IAS No. 38: Intangible Assets
Applies to purchased and internally developed intangible assets.
Recognize an intangible asset only if
The asset is identifiable
The future economic benefits specifically attributable to the asset will flow to the enterprise, and
Cost is reliably measurable.
Recognition criteria apply to both purchased and internally generated intangibles. ™ ™ ™ ™

39. 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:
Benchmark treatment: historical cost less any amortization and impairment losses; or
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 $ ™ ™ $ ™ $

40. 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 useful life and:
Test the intangible asset for impairment at least annually in accordance with IAS 36, Impairment of Assets
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. $ ™ ™ $ ™ $

41. IAS No. 39 Financial Instruments: Recognition and Measurement
Main objective of IASB in reissuing IAS No. 39:
To provide additional guidance on selected matters such as:
When financial assets and financial liabilities may be measured at fair value
How to assess impairment
How to determine fair value
Some aspects of hedge accounting.
IAS No. 39 indicates that an entity should recognize a financial asset or its statement of financial position when, and only when, the entity becomes a party to the contractual provisions of the instrument.

42. IAS No. 39 Financial Instruments: Recognition and Measurement
All financial assets are initially measured at cost:
Fair value of whatever was paid or received to acquire the financial asset.
Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s-length transaction.
Subsequently, most financial assets and liabilities are to be measured at fair value, except for the following, which should be carried at amortized cost:
Loans and receivables originated by the enterprise and not held for trading
Other fixed maturity investments, such as debt securities and mandatorily redeemable preferred shares, that the enterprise intends, and is able, to hold to maturity
Financial assets whose fair value cannot be reliably measured (generally limited to some equity securities with no quoted market price and forwards and options on unquoted equity securities)

43. IAS No. 39 Financial Instruments: Recognition and Measurement
Additionally, an entity is required to assess, at each balance sheet date, whether there is objective evidence of asset impairments.
Any impairment losses are measured as the difference between the asset’s carrying amount and the present value of estimated cash flows discounted at the financial asset’s original effective interest rate.
If, in a subsequent period, the amount of the impairment loss relating to a financial asset carried at amortized cost or a debt instrument carried as available for sale decreases owing to an event occurring after the impairment was originally recognized, the previously recognized impairment loss is reversed; however, impairments relating to investments in available-for-sale equity instruments are not reversed.

44. IAS No. 39 Financial Instruments: Recognition and Measurement
If an asset is to be derecognized, the entity must first determine whether the asset under consideration for derecognition is:
An asset in its entirety
Specifically identified cash flows from an asset
A fully proportionate share of the cash flows from an asset
A fully proportionate share of specifically identified cash flows from a financial asset

45. 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.”

46. IFRS No. 7
Requires disclosures of risks arising from financial instruments
Requires quantitative disclosures based on internal information

47. IFRS No. 9 November 12, 2009 First step to replace IAS No. 39
New requirements for classifying and measuring financial assets
All financial assets initially measured at fair value plus, in some cases transaction costs
All financial assets divided into
Those measured at amortized cost
Those measured at fair value

48. IFRS No. 9
Financial asset debt instrument that meets following 2 requirements is measured at amortized cost
Business model test
Cash flow characteristics test
All other debt instruments measured at fair value through profit or loss (FVTPL)

49. IFRS No. 9
Equity assets that fall under scope of IFRS No. 9 measured at fair value.
All derivatives are to be measured at fair value.

50. End of Chapter 10 Prepared by Kathryn Yarbrough, MBA
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