1. Investments and Financial Instruments
FA2 Module 8 - Chapter 11
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2. Expect to see 8 to 14% of the exam on this Module
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3. Introduction
Investments usually are purchased for cash and thus have a known cost which is recorded as an asset
The investment typically produces an annual cash flow of interest or dividends that can be recorded as investment revenue

4. Introduction
What is the nature of an investment in the securities of another corporation?
How can the investment be reported to reveal the economic impact of the investment rather than just its legal form?
Market value rather than cost of the securities might be a lot more important to the people who use the financial statements

5. Classification of Financial Asset Investments
Reasons corporations buy financial investments:
PASSIVE INVESTMENTS (to generate investment income)
1) Temporary investment of idle cash
2) Active trading investment portfolio
3) Long-term investments to generate earnings or fund longer-term goals
STRATEGIC INVESTMENTS (to enhance operations in some way)
4) Strategic alliances in/with other companies
5) Legal frameworks
Investments will either be debt investments, or equity investments.
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6. Passive & Strategic Passive Investment:
an intercorporate investment in which the investor cannot significantly influence or control the operations of the investee company (IAS 39)
Strategic Investment:
generally includes shares of other companies with the goal of a longer term relationship with that company, either in a working relationship or in an ownership position.
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7. Classification of Investments
AC = HTM , FVTPL = HFT,
FVTOCI = AFS

8. Classification of Investments
Classification depends on:
the presence of contractual cash flows generated by the investment,
the basis of the entity’s business model for managing the assets,
the availability of fair value information, and
the extent of ownership rights involved.
Initial Recognition
All investments are measured initially at fair value
Acquisition cost
Includes transaction costs

9. Subsequent Measurement For Investments
Different methods to account for investments:
Amortized cost method (AC) (for bonds)
aka* Held-to-Maturity HTM investments
Fair value through profit or loss (FVTPL)
aka Held-for-Trading HFT investments
Fair value through OCI (FVTOCI)
aka Available-for-Sale AFS investments
Cost method
Equity method
Consolidation method
*aka = also known as

10. Debt vs Equity Investments
(i.e. issuance of a corporate bond by Co. A, purchased as an investment by Co. B)
Equity – passive
(i.e. Issuance of common shares by Co. A, purchased by Co. B)
Equity – strategic
(i.e. purchase of another companies’ common shares)
Fair value through OCI (FVTOCI / AFS)
Control investment
Amortized Cost AC / Held-to-maturity (HTM)
Cost
Significant influence investment (SI)
FVTPL /
(held-for-trading HFT)
Trading investment
Joint venture (JV)
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11. Amortized Cost Amortized cost (AC) – if meet two criteria:
must be held and managed within a business model whose objective is to hold assets in order to collect contractual cash flows; and
must have contractual terms that give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount. Interest is defined as compensation for the time value of money and credit risk.
Can include: bonds and other money market instruments
Do not have to hold until maturity if objectives no longer being met
Excludes: common shares

12. Amortized Cost Method Used for bonds classified as AC investments
Original investment is recorded at cost (fair value at date of purchase) plus any transaction costs; and excludes any accrued interest at date of purchase
Interest recorded as investment income using the effective interest rate method, dividends recorded as investment revenue
If sold prior to maturity – gain or loss to net income

13. Fair value through Profit Loss (FVTPL) aka Held for Trading HFT
Fair value through profit or loss (FVTPL) – for debt & equity investments that:
are managed on a fair value basis; or
do not meet the criteria for an AC investment; or
were designated to this category by management to eliminate accounting mismatches – ex. Hedging
Purchased with the intent to hold for resale

14. Fair Value Through Profit or Loss Method
Investment is initially recorded at cost (fair value at purchase date)
Transaction costs are expensed
Interest based on effective interest rate and dividends are recorded as investment revenue
Investments are fair valued at end of each reporting period, with change flowing through net income
Unrealized and realized gains and losses are recorded to earnings

15. Fair Value Through Profit & Loss (FVTPL) Fair Value not Determinable
Fair Value not determinable because there is no active market and valuation models are not accurate (should be rare)
Cost be treated as though it were fair value
Not revalued at each reporting period
Need to consider a broad range of information to make this determination

16. Fair Value Through OCI (aka AFS)
Fair value through other comprehensive income (FVTOCI) – category is designated by management
Includes:
Only equity investments not held for trading;
Make the election when initially recognize the investment
Election is irrevocable
Change in fair value included in OCI, but do not cycle through net income (don’t go through retained earnings, but a separate equity reserve account)

17. Fair Value Through Other Comprehensive Income Method
Investment is initially recorded at cost (fair value at purchase date)
Transaction costs are capitalized as part of investment
Dividends are recorded as investment revenue
Investments are fair valued at end of each reporting period
Unrealized and realized gains and losses are recorded to OCI
When investment is sold, gains and losses may be recycled to retained earnings or left permanently in OCI

18. Cost Investments Cost – applies only to equity investments (not bonds)
Original investment is recorded at cost (fair value at date of purchase) plus any transaction costs;
Dividends recorded as investment revenue
When sold, gain or loss reported in earnings
Primarily applies to:
Investments in shares with no active market which are allowed to be carried at cost under ASPE
Investments in shares of subsidiary during the year - on non-consolidated basis
Investment in shares for which fair value cannot be established

19. Strategic Investments (type of Control)
Subsidiary (consolidate statements)
exists when the investor (parent) company has control over the investee
Control means that the investor has the power to govern the financial and operating policies of an entity so as to obtain benefits from its operations - consider
Percentage ownership - 50% plus one vote
Power to elect board members

20. Stategic Investments (type of control)
Associate (significant influence, use equity method)
exists when the investor company has the ability to exercise significant influence over the investee
Significant influence – the power to participate in financial and operating policy decisions of the investee although does not have control
Evidence includes:
Representation on board; participation in policy making decisions; material intercompany transactions; interchange of management personnel; provision of technical information
Ownership 20% - 50%

21. Strategic investment (type of control)
Joint venture (use equity method)
where an economic activity is undertaken by two or more investors and decision making is shared (regardless of ownership percentage)

22. Accounting for bonds using the Amortized Cost method (HTM)
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23. Amortized cost (HTM) investments
Usually bonds and money market instruments
Bonds typically offer interest payments annually or, more commonly, semi-annually, and repayment of the principal when the bond matures
Bond valuation is a present value exercise, where the interest payments are an annuity and the principal repayment is a lump sum; the discount rate is determined by the market as function of the risk-free rate and risk
Key bond data required -
Face value (or par value, principal value): amount payable when bond is due
Maturity date: end of bond term and due date for the face value
Stated interest rate (or coupon rate, nominal rate): rate that determines periodic interest payments
Interest payment dates: dates at which periodic interest payments are due

24. Bond characteristics determined by market
Market rate of interest (or bond yield): return required by investors, function of prevailing interest rates and bond risk
Market value: present value of cash flows implied by coupon rate and principal repayment, discounted at market rate
Bond discount/premium: difference between bond face value and market value, at date of issue

25. Market value of long term debt instruments
The market value of a long term instrument is the present value of its associated future cash flows, discounted at the market (or effective) rate or yield.
Cash flows associated with debt instruments are generally of two types:
Face value of instrument, payable at maturity date
Stream of interest payments ( = face value x stated interest rate): annuity

26. Accounting for bond investment
If the bonds are considered held-to-maturity (HTM) investments, the amortized cost method is appropriate.
Year-to-year fluctuations in the market value of the investment are ignored.
The investment is carried at amortized cost.
Investment revenue is (generally) equal to cash interest received, plus/minus amortization of any discount/premium, using effective interest method.

27. Accounting for initial bond investment
Dr. Investment in bonds Mkt
Cr. Cash Mkt +accrued int (if any)
Dr. Interest receivable Accrued int (if any)
Mkt = market value of bond at date of issue
Discount or premium (difference between face value and market value of bond) arises if market interest rate (yield) at date of investment differs from stated interest rate.

28. Accounting for AC/HTM bond investment
Initial cost excludes any accrued interest
Transaction costs (brokerage fees, commissions, etc.) are included as part of initial cost of investment
Interest income recorded using effective interest method (ASPE can use straight-line)
If investment sold before maturity (should be rare), there can be gain or loss on disposal
When investment matures, no gain or loss
See AC method – debt investment tab in Excel workbook

29. Amortization of discount/premium
Effective interest method
Interest received (cash) = face value X (stated interest rate / # of interest payments per year)
Interest revenue = market interest rate at date of bond issue X opening carrying value of bond (i. e., after last payment)
Adjustment to bond carrying value = difference between interest revenue and interest received (i. e., is a plug)
See Effective Interest rate tab in Excel workbook for example of debt instrument

30. Accounting for Other Investments using the Cost Method
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31. Accounting for other investments: Cost method
Used for equity investments when fair value is not available
Investment recorded at cost; transaction costs included in cost
Dividends declared are recorded as income
Any gain or loss on sale recorded in income
See example in ‘Cost method – shares’ tab in Excel workbook
Example: A (a)

32. Example: A11-14 (1a)
On April 30, 2012, Simon Company purchased 4,000 shares of Pine Ltd for $34/share plus $800 in commission.
In 2012, the company received a $1.30 per share dividend, and the shares had a fair value of $32 per share at the end of the year.
In 2013, the dividend was $2.10 per share, and the fair value was $38 per share at the end of the year.
In 2014, the shares were sold for $36 per share less a $750 commission.
AC Cost:
Show the amounts and accounts that would be reported in earnings and the Statement of Financial Position for 2012, 2013, and 2014 if the company uses the amortized cost method.
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33. Example A11-14 1(a) page 617 20x2 20x3 20x4 Earnings Dividend revenue
20x2
20x3
20x4
Earnings
Dividend revenue
$5,200
$8,400 $
Fees and commissions --
Gain on sale (1)
6,450
Statement of financial position
Investment (4,000 x $34) + $800
$136,800
OCI: Unrealized holding gain/(loss)
Cost method
(1) cost of $136,800 versus net proceeds $143,250 ((4,000 x $36) - $750)
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34. Cost method Acquisition Dr. Investment A+B Cr. Cash A+B
A = cost of shares B = transactions costs
Year-end (fair value has changed)
No entry
Sale of investment next year
Dr. Cash (Net proceeds) P
Cr. Investment A+B
Dr. Loss on sale (A+B)-P
Cr. Gain on sale P-(A+B)

35. Accounting for Investments at Fair Value through Profit & Loss (Held-for Trading investments)
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36. Accounting for other investments
Fair-value-through-profit-and-loss (FVTPL)
Used for held-for-trading (HFT) investments
Investment recorded at cost; transaction costs expensed immediately
Interest income on bonds recorded using effective interest method;
dividend income on shares recorded when declared
Investments revalued to fair value at end of each reporting period
Holding gains and losses recorded in income
Realized gains and losses (market less carrying value) recorded in income when sold
Also see ‘Fair Value Method – P&L’ tab in Excel workbook

37. Example: A11-14 (1b)
On April 30, 2012, Simon Company purchased 4,000 shares of Pine Ltd for $34/share plus $800 in commission.
In 2012, the company received a $1.30 per share dividend, and the shares had a fair value of $32 per share at the end of the year.
In 2013, the dividend was $2.10 per share, and the fair value was $38 per share at the end of the year.
In 2014, the shares were sold for $36 per share less a $750 commission.
FVTPL:
Show the amounts and accounts that would be reported in earnings and the Statement of Financial Position for 2012, 2013, and 2014 if the company uses the FVTPL method.
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38. Holding gains (losses)(1) (8,000) 24,000
20x2
20x3
20x4
Earnings
Dividend revenue
$5,200
$8,400 $
Fees and commissions
800
750
Holding gains (losses)(1)
(8,000)
24,000
Statement of financial position
Investment ($32; $38)
$128,000
$152,000 --
OCI: Unrealized holding gain/(loss)
FVTPL method
(1) 4,000 x ($34 - $32); ($32-$38); ($38-36)
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39. HFT/FVTPL investment (fair value increase)
Acquisition
Dr. Investment A
Dr. Commissions expense B
Cr. Cash A+B
A = cost of investment B = transaction costs
Year-end (fair value has increased to F)
Dr. Investment F-A
Cr. Unrealized holding gain (I/S) F-A
Sale of investment next year
Dr. Cash (Net proceeds) P
Cr. Investment F
Cr. Gain on sale (I/S) P-F
or Dr. Loss on sale F-P

40. HFT/FVTPL investment (fair value decrease)
Year-end (fair value has decreased to D)
Dr. Unrealized holding loss (I/S) A-D
Cr. Investment A-D
Sale of investment next year
Dr. Cash (Net proceeds) P
Cr. Investment D
Cr. Gain on sale (I/S) P-D
or Dr. Loss on sale D-P

41. Accounting for Investments at Fair Value through Other Comprehensive Income FVTOCI (Available for Sale AFS investments)
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42. Accounting for AFS investments
Fair-value-through-OCI (FVTOCI)
Available-for-sale (AFS); Designated by management; for equity investments only
Investment recorded at cost; transaction costs included in cost of investment
Dividend income on shares recorded when declared
Investments revalued to fair value at end of each reporting period
Holding gains and losses recorded in OCI; may be transferred into RE when realized or left in Accumulated OCI
Also see example in Excel workbook, ‘Fair Value Method – OCI’ tab

43. Example: A11-14 (1c)
On April 30, 2012, Simon Company purchased 4,000 shares of Pine Ltd for $34/share plus $800 in commission.
In 2012, the company received a $1.30 per share dividend, and the shares had a fair value of $32 per share at the end of the year.
In 2013, the dividend was $2.10 per share, and the fair value was $38 per share at the end of the year.
In 2014, the shares were sold for $36 per share less a $750 commission.
FVTOCI:
Show the amounts and accounts that would be reported in earnings and the Statement of Financial Position for 2012, 2013, and 2014 if the company uses the FVTOCI method.
Mona Basset Fall 2013

44. Holding gains (losses)(2)
20x2
20x3
20x4
Earnings
Dividend revenue
$5,200
$8,400 $
Fees and commissions --
Holding gains (losses)(2)
Statement of financial position
Investment ($32; $38)
$128,000
$152,000
OCI: Unrealized holding gain/(loss)(1)
(8,800)
15,200
6,450
Transfer to RE
(6,450)
FVTOCI method
(1) 2012: $136,800 - $128,000 = 8,800 loss ;
2013: ($152,000 - $128,000) = $24,000 + ($8,800);
2014: ($143,250 - $152,000) = ($8,750) + $15,200
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45. FVTOCI/AFS investments with fair value increase
Acquisition
Dr. Investment A+B
Cr. Cash A+B
A = cost of shares B = transaction costs
Year-end (fair value increases)
Dr. Investment F-(A+B)
Cr. Unrealized holding gain (OCI) F-(A+B)
Sale of investment next year (fair value increases)
Dr. Cash (Net proceeds) P
Cr. Investment F
Cr. Realized holding gain (OCI) P-F

46. FVTOCI/AFS (continued)
Net holding gains transferred to RE (optional)
Dr. OCI: Holding gains P–(A+B)
Cr. Retained earnings P-(A+B)
With Fair Value decrease
Year-end (fair value decreases)
Dr. Unrealized holding loss (OCI) A+B-D
Cr. Investment A+B-D
Sale of investment next year (fair value decreases)
Dr. Cash (Net proceeds) P
Cr. Investment D
Dr. Realized holding loss (OCI) D-P
Net holding losses transferred to RE (optional)
Dr. Retained earnings (A+B)-P
Cr. OCI: Holding losses (A+B)-P

47. Accounting for Investments using the Equity Method For Significant Influence investments (20 to 50% ownership, and Joint Ventures
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48. Equity Method – Significant Influence (SI) Investments
The equity method is used for significant influence investments.
Under the equity method:
the original investment is recorded at its acquisition cost; this is initial book value
the investor’s proportionate share of the investee’s net income (subject to certain adjustments) is recognized on the investor’s income statement as revenue and on the balance sheet as an increase in the book value of the investment
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49. Equity Method
dividends are recorded as a decrease in the investment account rather than as investment revenue
when the investment is sold, the difference between proceeds and book value is recorded as a gain or loss on sale
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50. Equity Method
At any point in time, the equity method investment account on the balance sheet consists of:
The investment’s cumulative historical cost, plus
The investor’s cumulative share of the investee’s adjusted earnings since the investment was made (net income of investee), minus
The investor’s cumulative share of dividends of the investee since the shares were purchased
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51. Equity Method
The difference between the investor’s share of the investee’s net income and the dividends received (#2-#3, from previous slide) is called unremitted earnings and increases book value above cost
This method is sometimes called ‘one-line consolidation’ because all relevant values are combined into the investor’s investment account:
Original cost of investment
Proportionate share of investee’s net income
Dividends received from investee (reduction in investment)
Investor’s share of investee’s income is reduced by appropriate amounts of amortization on fair values of depreciable assets, and any write-down caused by impairment of good will.
Adjustments will be made for unrealized intercompany profits (not confirmed by a third party)
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52. Consolidation – Control Investment (Parent & subsidiary) learn in FA4
A parent company is required to consolidate its financial statements with those of its subsidiaries when it issues general purpose financial statements
The parent company uses the cost or equity method to account for its investment during the year, but at the end of the reporting period, must prepare consolidated financial statements for reporting to its shareholders and other financial statement users
Consolidated statements are prepared by combining the sets of financial statements into one, which is intended to portray the activities of the whole enterprise
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53. Proportionate Consolidation Method (learn in FA4)
Joint ventures are reported by means of proportionate consolidation or the equity method
Proportionate consolidation: combining the financial statements of an investor company and a joint venture enterprise; only the investor’s proportionate share of the financial elements of the joint venture are included
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54. Reclassification Should be rare
Reclassification of AC investments only appropriate when objective of business mode for managing these assets has changed
Classification of FVTOCI investment can only be made on initial recognition and is irrevocable
Investments may move from FVTPL to being strategic investments if control or significant influence is established.
Strategic investments may move into FVTPL if control or influence is lost

55. Reclassification

56. Classification and Disclosure
Adoption of IFRS 9 – must be adopted by 2013 or earlier
Report an investment as:
Current if classified as cash equivalent or expected to be realized in the next 12 months or company’s normal operating period
Current would include: FVTPL investments; FVTOCI investments and AC investments about to mature
Investments in associates are long-term

57. The End
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