1. Investments In Equity Securities
Chapter 2
Investments In Equity Securities
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2. Chapter Objectives Classification of equity investments
Accounting for equity investments
Matching classifications with methods
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3. Conceptual Basis For Classification
Control
Held for
trading
Available
for sale
Significantly
Influenced
companies
Joint
ventures
Subsidiaries 0%
50%
100%
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4. Classification Non-strategic investments Strategic investments
held-for-trading
available-for-sale
Strategic investments
Subsidiaries
Significantly influenced companies
Interests in joint ventures
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5. Accounting Methods Cost method Equity method
Fair value method (changes in Net Income)
Fair value method (changes in Comprehensive Income)
Full consolidation
Proportionate consolidation
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6. Held-For-Trading Defined (Section 3855)
Acquired principally for the purpose of selling or repurchasing in the short term;
A derivative; or
Any financial asset or liability that is so designated
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7. Held-For-Trading Application To Investments
Equity securities held for short term trading
Other non-strategic holdings that are designated as held for trading
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8. Held-For-Trading Accounting Procedures
Initial and subsequent measurement at fair value
Changes in fair value are allocated to Net Income
Transaction costs charged to Net Income at acquisition
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9. Held-For-Trading Example
EXAMPLE: On January 1, 2008, Holly Inc. acquires 1,000 shares of Helm Ltd. for $10 per share. The shares are classified as held for trading.
On December 31, 2008, the Helm Ltd. shares are trading at $12 per share. During 2008, Helm Ltd. declares and pays dividends of $0.75 per share. On January 1, 2009, the securities are sold for $13 per share.
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10. Held-For-Trading Example
Acquisition Of Investment
January 1, 2008
Debit
Credit
Investments [(1,000)($10.00)]
$10,000
Cash
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11. Held-For-Trading Example
Receipt Of Dividends
During 2008
Debit
Credit
Cash [(1,000)($0.75)]
$750
Investment Income (Net Income)
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12. Held-For-Trading Example
Year End Adjustment
December 31, 2008
Debit
Credit
Investments [(1,000)($ $10.00)]
$2,000
Investment Income (Net Income)
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13. Held-For-Trading Example
Sale Of Investment
January 1, 2009
Debit
Credit
Cash [(1,000)($13.00)]
$13,000
Investments ($10,000 + $2,000)
$12,000
Investment Income (Net Income)
$1,000
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14. Available-For-Sale Defined (Section 3855)
Non-derivative financial assets that are designated as available for sale, or that are not classified as loans and receivables, held-to-maturity, or held-for trading
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15. Available-For-Sale Would include all equity investments other than:
Investments in subsidiaries
Investments in significantly influenced companies
Investments in joint ventures
Investments that are classified as held for trading.
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16. Available-For-Sale Accounting Procedures
Initial and subsequent measurement at fair value
Changes in fair value are allocated to Comprehensive Income
Transaction costs:
charged to Net Income at acquisition, or added to the initial cost
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17. Available-For-Sale Example
EXAMPLE: On January 1, 2008, Holly Inc. acquires 1,000 shares of Helm Ltd. for $10 per share. The shares are classified as available for sale.
On December 31, 2008, the Helm Ltd. shares are trading at $12 per share. During 2008, Helm Ltd. declares and pays dividends of $0.75 per share. On January 1, 2009, the securities are sold for $13 per share.
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18. Available For Sale Example
Acquisition Of Investment
January 1, 2008
Debit
Credit
Investments [(1,000)($10.00)]
$100,000
Cash
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19. Available For Sale Example
Receipt Of Dividends
During 2008
Debit
Credit
Cash [(1,000)($0.75)]
$750
Investment Income (Net Income)
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20. Available For Sale Example
Year End Adjustment
December 31, 2008
Debit
Credit
Investments [(1,000)($ $10.00)]
$2,000
Other Comprehensive Income - Gain
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21. Available For Sale Example
Sale Of Investment
January 1, 2009
Debit
Credit
Cash [(1,000)($13.00)]
$13,000
Other Comprehensive Income – Reclassification
2,000
Investments ($10,000 + $2,000)
$12,000
Investment Income (Net Income)
3,000
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22. Cost Method Applicability Procedures
Can be used when available-for-sale securities do not have quoted market prices
Procedures
Investment at cost
Earnings only when received or receivable
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23. Cost Method
Return of capital: Occurs when dividends received exceed the investor’s share of earnings since acquisition
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24. Return Of Capital Example
EXAMPLE: On January 1, 2008, Norton Inc. acquires 10 percent of the voting shares of Montage Ltd. for $500,000.
During 2008, Montage has Net Income of $350,000 and pays dividends of $250,000.
During 2009, Montage has Net Income of $100,000 and pays dividends of $250,000.
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25. Return Of Capital Example
Acquisition Of Investment
January 1, 2008
Debit
Credit
Investment In Montage
$500,000
Cash
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26. Return Of Capital Example
Receipt of 2008 dividends
During 2008
Debit
Credit
Cash [(10%)($250,000)]
$25,000
Investment Income
$20,000
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27. Return Of Capital Example
Receipt of 2009 dividends
During 2009
Debit
Credit
Cash [(10%)($250,000)]
$25,000
Investment Income [(10%)($350,000 - $250,000 + $100,000)]
$20,000
Investment In Montage [(10%)($250,000 - $100,000 - $100,000)]
5,000
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28. Subsidiaries
Paragraph (b) – A subsidiary is an enterprise controlled by another enterprise (the parent) that has the right and ability to obtain future economic benefits from the resources of the enterprise and is exposed to the related risks.
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29. The Concept Of Control
(b) Control of an enterprise is the continuing power to determine its strategic operating, investing, and financing policies without the co-operation of others.
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30. The Concept Of Control
In general, based on ownership of more than 50 percent of the outstanding voting shares
Exceptions
Control may exist without majority ownership
Control may not exist even with majority ownership
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31. The Concept Of Control Indirect Control P A B P Controls B 60% 55%
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32. The Concept Of Control Indirect Control P X Y Z P Controls Z 70% 60%
30% Y
40% Z
P Controls Z
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33. Subsidiaries Accounting Procedures
Paragraph An enterprise should consolidate all of its subsidiaries. (January, 1992)
Consolidation procedures will be covered in Chapters 4, 5, and 6
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34. Significantly Influenced Companies
Defined
IAS 28 Significant influence is the power to participate in the financial and operating policy decisions of the investee, but is not control over those policies
CICA has a 20 percent guideline
Judgment would have been better
Key is the ability to elect directors
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35. Significantly Influenced Companies
Required Accounting Procedures: Section 3051 requires the use of the equity method
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36. Equity Method Procedures
Accounting for the investment asset
Investment is recorded at cost
Adjusted each year for the investor’s shares of the investee’s change in Retained Earnings
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37. Equity Method Procedures
Accounting for investment income
Investment income is equal to the Investor’s share of the reported Net Income of the Investee.
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38. Equity Method Example
EXAMPLE: On January 1, 2008, Fortin Inc. pays $800,000 for a 25 percent interest in the voting shares of Beauchamp Ltd. This investment gives Fortin Inc. significant influence over Beauchamp Ltd.
During the year ending December 31, 2008, Beauchamp Ltd. has net income of $300,000 and pays dividends of $180,000.
During the year ending December 31, 2009, Beauchamp Ltd. has a net loss of $100,000 and pays dividends of $150,000.
On January 1, 2010, Fortin’s holding of Beauchamp securities is sold for $1,200,000.
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39. Equity Method Example Acquisition Of Investment January 1, 2008 Debit
Credit
Investment In Beauchamp
$800,000
Cash
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40. Equity Method Example 2008 Income And Dividends
Year Ending December 31, 2008
Debit
Credit
Cash [(25%)($180,000)
$45,000
Investment In Beauchamp [(25%)($300,000 - $180,000)]
30,000
Investment Income [(25%)($300,000)]
$75,000
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41. Equity Method Example 2009 Income And Dividends
Year Ending December 31, 2009
Debit
Credit
Cash [(25%)($150,000)]
$37,500
Investment Loss [(25%)($100,000)]
25,000
Investment In Beauchamp [(25%)(- $100,000 – $150,000)]
$62,500
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42. Equity Method Example Sale Of Investment January 1, 2010 Debit Credit
Cash
$1,200,000
Investment In Beauchamp ($800,000 + $30,000 - $62,500)
$767,500
Gain On Investment Sale
432,500
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43. Equity Method Intra Statement Disclosure
Results of discontinued operations and extraordinary items of the investee must be shown in the investor’s Statement Of Net Income as separate line items after Income Or Loss Before Discontinued Operations And Extraordinary Items.
Intra Statement
Disclosure
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44. Equity Method Losses Exceed Investment Balance
EIC No.8: negative balance can be shown if:
Investor has guaranteed obligations of the investee
The investor is committed to provide further financial support
The investee seems assured of returning to profitability
Losses
Exceed
Investment
Balance
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45. Equity Method Loss Of Significant Influence
Significant Influence To Control
Consolidation is required
Loss Of
Significant
Influence
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46. Equity Method Loss Of Significant Influence
Significant Influence To No Influence
Will become held-for-trading or available-for-sale
The “new cost” will be the equity value at the time of the change
Loss Of
Significant
Influence
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47. Equity Method Consolidation Adjustments
All of the adjustments that would be required in preparing consolidated statements are required here.
See Chapters 5 and 6 for illustrations of these procedures.
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48. Significantly Influenced Companies
Disclosure
Basis of valuation
Separate disclosure of the class in both the Balance Sheet and the Income Statement
Treatment of the difference between the cost of the investment and the underlying book value of the investee’s assets at the date of acquisition.
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49. Joint Venture Arrangements
Paragraph (c) A joint venture is an economic activity resulting from a contractual arrangement whereby two or more venturers jointly control the economic activity
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50. Joint Venture Arrangements
Current accounting rules require the use of proportionate consolidation
Proportionate consolidation will be covered in Chapter 8
IASB will eliminate proportionate consolidation and require the equity method
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51. Impairment Of Significantly Influenced Companies
Paragraph When there has been a loss in value of an investment that is other than a temporary decline, the investment should be written down to recognize the loss. The write-down should be included in the determination of net income and may or may not be an extraordinary item.
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52. Impairment Of Significantly Influenced Companies
Indicators
Depressed market prices
Severe or continued losses
Suspension of trading
Liquidity or going concern problem
Current fair value less than carrying value
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53. Impairment Of Significantly Influenced Companies
Subsequent recoveries
Write downs cannot be reversed
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54. Impairment – Other Investments
Held for trading Already at fair value
Available for sale at fair value If impaired, transfer from comprehensive to net income
Available for sale at cost Same rules as significantly influenced companies
Subsidiaries and Joint Ventures Subject to provisions that relate to specific assets (e.g., 3063 deals with impairment of plant)
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55. Differential Reporting Options
Subsidiaries
Qualifying enterprises may elect to use either the cost method or the equity method for these investees
Additional procedures and disclosures are required
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56. Differential Reporting Options
Significantly Influenced Companies
Qualifying enterprises may elect to use the cost method for these investees
Additional procedures and disclosures are required
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57. Differential Reporting Options
Joint Ventures
Qualifying enterprises may elect to use either the cost method or the equity method for these investees
Additional procedures and disclosures are required
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58. International Convergence
Held-for-trading and available-for-sale investments: covered in IAS 39
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59. IAS 39 Differences
“Held-for-trading” replaced by “financial asset at fair value through profit or loss”
Generally doesn’t allow arbitrary designation as held for trading
Allows cost when fair value “not readily determinable” as opposed to no quoted market value
Does not provide an optional treatment of transaction costs
Requires the reversal of impairment write downs when there is a recovery
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60. International Convergence
Significantly influenced companies: covered in IAS 28
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61. IAS 28 Differences
Uses the term “associated companies” rather than “significantly influenced companies”
Impairment when recoverable amount is less than the carrying amount. Recoverable amount based on present value of future cash flows
IAS 28 requires the reversal of an impairment loss when a recovery has occurred
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62. International Convergence
Subsidiaries and joint ventures – Differences will be covered in later chapters
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63. The End!
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