Ch8_3e_PPT.ppt investments chapter 8 acct

accounting

1. Investments Chapter 8

2. Nature of Investments Investments can be accounted for in a variety of ways, depending on the nature of the investment relationship. Bonds and notes (Debt securities) Ordinary and preference shares (Equity securities) Convertible bonds (Hybrid securities) Financial instrument under IFRS 9 Cost Equity method

3. Reporting Categories for Equity Instruments Relationship Accounting for the equity investment in the investor’s separate financial statements Accounting for equity investment in the consolidated financial statements Investor does not have “control”, “significant influence” or “joint control of the investee As a financial instrument under IFRS 9 As a financial instrument under IFRS 9 Investor has “control” o f the investee As cost, or as financial instrument under IFRS 9 or using the equity method Consolidation Investor has “significant influence” over the investee As cost, or as financial instrument under IFRS 9 or using the equity method Equity method Investor has “joint control” of the investee As cost, or as financial instrument under IFRS 9 or using the equity method Equity method

4. Accounting for Investments Under IFRS 9 Reporting approaches used for investments differ according to how the approaches account for one or more of the four critical events In the application of IFRS 9, companies have to determine if an investment falls in one of three categories: FVTPL Amortized cost FVOCI Holding the investment during periods in which investment’s fair value changes Recognizing investment revenue Purchasing the investment Selling the investment

5. Amortized Cost (AC) Basis On July 1, 2025, Masterwear Industries issued $700,000 of 12% bonds, dated July 1. Interest of $42,000 is payable semiannually on June 30 and December 31. The bonds mature in three years, on June 30, 2026. The market interest rate for bonds of similar risk and maturity is 14%. The entire bond issue was purchased by United Intergroup Ltd. Calculation of the Price of the Bonds       Present Values Interest $ 42,000 × 4.76654 = $200,195 Principal (face amount) $700,000 × 0.66634 =  466,438 Present value (price) of the bonds     $666,633 Purchase of AC Investment Journal Entry – July 1, 2025 Investment in bonds Discount on bond investment 700,000 33,367 Credit Debit Cash 666,633

6. Amortized Cost (AC) Basis (continued) Recognize Interest Revenue Journal Entry – Dec 31, 2025 Cash Discount on bond investment 42,000 4,664 Credit Debit Interest revenue 46,664

7. Amortized Cost (AC) Basis (concluded) Sell AC investments However, suppose that due to unforeseen circumstances the company decided to sell its debt investment for $725,000 on January 15, 2026. United would record the sale as follows (for simplicity we ignore any interest earned during 2028): Journal Entry – Jan 15, 2026 Cash Discount on bond investment 725,000 28,703 Credit Debit Investment in Masterwear bonds 700,000 Gain on sale of investments (to balance) 53,703 United would record this sale just like any other asset sale, with a gain or loss determined by comparing the cash received with the carrying value of the asset given up

8. Fair Value Through Profit or Loss (FVTPL) FVTPL securities are actively managed within a business model for the purpose of profiting from short-term price changes Accounting treatment for FVTPL investments FVTPL securities are initially recorded at the fair value paid for the securities Directly attributable transaction cost is expensed off immediately At financial year end, investment is written up or down to its fair with fair value changes taken to income statement

9. Fair Value Through Profit or Loss (FVTPL) United Intergroup actively buys and sells both debt and equity securities of other companies as investments. They are classified as FVTPL investments. United’s financial year-end is December 31. The following events during 2025 and 2026 pertain to the investment portfolio. Purchase Investments July 1, 2025 1. Purchased Masterwear Industries’ 12%, 3-year bonds for $666,633 to yield an effective interest rate of 14%. 2. Purchased $1,500,000 of Arjent equity shares. 3. Purchased $1,000,000 of Bendac equity shares. Receive Investment Revenue December 31, 2025 1. Received a semiannual cash interest payment of $42,000 from Masterwear. 2. Received a cash dividend of $75,000 from Arjent. (Bendac does not pay dividends) Adjust Investments to Fair Value December 31, 2025 1. Valued the Masterwear bonds at $714,943. 2. Valued the Arjent shares at $1,450,000. 3. Valued the Bendac shares at $990,000. Sell Investments January 15, 2026 1. Sold the Masterwear bonds for $725,000. 2. Sold the Arjent shares for $1,446,000. Adjust Remaining Investments to Fair Value December 31, 2026 1. Valued the Bendac shares at $985,000.

10. Fair Value Through Profit or Loss (FVTPL) Purchase Investments Journal Entry – Jul 1, 2025 Cash 666,633 Credit Debit Investment in Masterwear bonds 666,633 Cash 1,500,000 Investment in Arjent shares 1,500,000 Cash 1,000,000 Investment in Masterwear bonds 1,000,000 FVTPL investment securities are recorded initially at fair value. Any transaction costs attributable to the acquisition of the securities would be expensed off.

11. Fair Value Through Profit or Loss (FVTPL) Recognize Investment Revenue Journal Entry – Dec 31, 2025 Cash (6% x $700,000) Investment in Masterwear bonds 42,000 4,664 Credit Debit Interest revenue (7% x $666,633) 46,664 Cash 75,000 Investment revenue (dividends received) 75,000 Dividend and interest income is included in net income

12. Fair Value Through Profit or Loss (FVTPL) Adjust Trading Security Investments to Fair Value (2025) December 31, 2025 Security Carrying amount Fair Value Fair Value Adjustment Masterwear $ 671,297 $ 714,943 $ 43,646 Arjent 1,500,000 1,450,000 (50,000) Bendac  1,000,000   990,000  (10,000) Total $3,171,297 $3,154,943 $(16,354) Journal Entry – Dec 31, 2025 Net fair value gains and losses (Income Statement) Investment in Masterwear bonds 16,354 43,646 Credit Debit Investment in Arjent shares 50,000 Invest in Bendac shares 10,000 $666,633 + 4,664

13. Fair Value Through Profit or Loss (FVTPL) Sell FVTPL Investments Cash (amount received) Investment in Masterwear bonds (account balance) 725,000 714,943 Credit Debit Gain on sale of investment (to balance) 10,057 Cash (amount received) Loss on sale of investments (to balance) 1,446,000 4,000 Investment in Arjent shares (account balance) 1,450,000 All gains or losses from FVTPL investments is included in net income. Journal Entry – Jan 15, 2026

14. Fair Value Through Other Comprehensive Income A debt investment is an FVOCI security when it passes both the CCF test and that investment must be held within a business model that is held to both collect contractual cash flows and to sell Accounting Treatment for FVOCI Debt Instruments FVOCI securities are initially recorded at the fair value paid for the securities Upon sale of FVOCI securities, cumulative gains or losses in OCI are “recycled” to income statement At financial year end, investment is written up or down to its fair with fair value changes taken to OCI

15. Accounting for Equity Investments Under IFRS 9 Equity instruments are always carried at fair value hence measured at either FVTPL or FVOCI Three critical questions to be answered in IFRS 9 for classification Is the instrument equity in nature? Does the investor wish to elect the option to recognize non-trading equity instrument at FVOCI? Is the equity instrument held for trading?

16. Accounting for Equity Investments Under IFRS 9

17. Accounting for Equity Investments Under IFRS 9 Is the instrument equity in nature? Investors of equity instruments do not have a contractual right to a fixed or determinable amount of cash. Is the equity instrument held for trading? If any one of the three tests under IFRS 9 are met, instrument is held for trading acquired primarily for purposes of selling in the near term; Ii part of and managed within a larger portfolio of identified financial instrument where there is evidence of recent and actual pattern of short-term profit taking; or is a derivative Does the investor elect the option to recognize non-trading equity instrument at FVOCI? Election is irrevocable. Gains or losses on FVOCI equity investments are not permitted to be reclassified to income statement.

18. Impairment of Debt Investments Impairment test to be applied to financial assets that pass CCF test and carried at amortized cost or FVOCI. Impairment losses are recognized in income statement immediately! FVOCI equity investment need not be tested for impairment!

19. Expected Loss Model Expected credit loss is present value of the probability-weighted difference between contractual cash flows and expected cash flows in different scenarios Expected loss model anticipates the impairment loss (what is traditionally described as “bad debt”) on a debt or receivable. Expected credit loss = Present value of probability-weighted credit loss Credit loss = Contractual cash flows at contractual dates – Expected cash flows on those dates Discounted at the effective interest rate

20. Expected Loss Model IFRS 9 adopts a three-stage model that requires the investor or lender to evaluate expected credit loss over different time horizons

21. Expected Loss Model On July 16, 2023, Sure-Win purchased 1 million units of 5-year bonds of Good Books at $1.00 per bond unit. The effective interest rate is 5% per annum. Due diligence showed that Good Books is of high credit standing. Good Books, a traditional book publisher, is however most vulnerable to the threat of digital publishing. After assessing the developments in digital publishing, Sure-Win assesses that there is a probability of 1% and 5% that Good Books Co will fail within 12 months from initial recognition and within 5 years respectively. Recovery in the event of default is expected to be $10,000. On December 31, 2023, the probabilities were revised to 2.5% and 8% for 12 months and remaining period to maturity.   Since the probabilities of default are low on July 16, 2023, and December 31, 2023, the loss allowance is equal to 12-months expected credit loss. We also apply the effective interest rate on the gross carrying amount of $1,000,000 (i.e., the balance before deducting the loss allowance).     Probability of loss 12 months Lifetime Initial recognition 1% 5% Year end 2.5% 8% Credit loss $990,000 $990,000 Expected credit loss on July 16, 2023 $9,900 $49,500 Expected credit loss on December 31, 2023 $24,750

22. Expected Loss Model Given the short time horizon of the expected credit loss, we ignore discounting in the accounting entries above. Expected credit loss on Stage 1 bonds Journal Entry — Jul 16, 2023 Investment in Good Books Impairment Loss — (I/S) 1,000,000 9,900 Credit Debit Loss Allowance 9,900 1,000,000 Cash Journal Entry — Dec 31, 2023 Impairment Loss — (I/S) 14,850 Credit Debit Loss Allowance 14,850 Interest receivable 50,000 Interest revenue 50,000

23. Equity Method Much like consolidation, the equity method views the investor and investee collectively as a special type of single entity. The investor doesn’t include separate financial statement items of the investee on an item-by-item basis as in consolidation. The investment account is increased by: Original investment cost + Proportionate share of investee's earnings. The investment account is decreased by: Dividends received.

24. Equity Method — Example 1 On January 1, 2025, Matrix Ltd acquired 45% of the equity securities of Apex Ltd. for $1,350,000. On the investment date, Apex’s net assets had a fair value of $3,000,000. During 2025, Apex paid cash dividends of $150,000 and reported net income of $1,750,000. What amount will Matrix Ltd. report on the statement of financial position as Investment in Apex Ltd? Ignore taxes.

25. Equity Method Do note that the investor paid fair value for the net assets acquired.

26. Equity Method Investment in Apex Ltd. Investment 1,350,000 67,500 45% Dividends 45% Earnings 787,500 Reported amount 2,070,000 If the investee had a loss, the investment account would have been reduced.

27. Equity Method — Example 2 On January 1, 2025, Matrix Ltd. purchase 25% of the ordinary shares of Apex Ltd. for $180,000. At the date of investment, the book value of the net assets of Apex was $400,000, and the net fair value of these assets is $600,000. During 2025, Apex paid cash dividends of $40,000 and reported earnings of $100,000. “Implicit” Goodwill

28. Equity Method Assume that of the $50,000 excess of the fair value of net assets acquired ($600,000 × 25% = $150,000) over the book value of those net assets on Apex’s statement of financial position ($400,000 × 25% = $100,000), 75% is attributable to depreciable assets with a remaining life of 20 years and the remainder is attributable to land. Matrix uses the straight-line method of depreciation on similar owned assets.

29. Equity Method Goodwill is “implicit” or embedded in the investment To adjust for additional depreciation

30. Equity Method — Other issues When investor’s proportionate share of investee losses could exceed the carrying amount of the investment Investor should discontinue applying the equity method until the investor’s share of subsequent investee earnings equals to losses not recognized during the time equity method was discontinued When Investment is acquired mid-year Changes in the investment account the first year are adjusted for the fraction of the year the investor has owned the investment.

31. End of Chapter 8