8.1 & 8.2 Flashcards
Describe an investment in financial assets?
Where the investing firm has no control
Describe an investment in associates
Where the firm has significant influence, but not control
Describe a business combination
The investing firm has control over the operations of the investee firm
What is the ownership threshold for investments in associates?
Typically between 20% and 50% of the votes is considered a non-controlling interest
How is significant influence evidenced?
Seat on board
Involvement in policy making
Material intercompany transactions
Interchange of personnel
Dependence on technology
- Can you have significant ownership with <20% ownership? 2. Can you own between 20% and 50% and not have significant influence? How would you class these investments?
- Yes. An investment in associate
- Yes. An investment in financial assets
What is the threshold for business combinations?
Over 50%
What is a joint venture?
Control is shared by two or more investors
What accounting method is used for joint ventures?
Both IFRS and US GAAP require the equity method, although in rare cases both permit proportional consolidation
What is the accounting treatment for investments in financial assets?
Three options:
1. Amortised cost
2. Fair value through OCI
3. Fair value through P&L
What is the accounting treatment of investments in associates?
Equity method
.What is the accounting treatment for business combinations?
The acquisition method
What type of securities does amortised cost accounting apply to?
Only applies to debt securities where you must have the ability and intention to hold to maturity
What is the criteria test for amortised cost accounting?
Two criteria must be met:
1. Business model test: is the bond going to be held until maturity, firm will collect contractual cash flows?
2. Cash flow test: is it definitely debt e.g. the only payments should be coupon payments and principal repayment
What is amortised cost?
The original cost of the debt;
plus any discount OR;
minus any premium
….That has been amortised to date
What is the accounting treatment of amortised cost on the BS and IS
- Asset is carried on BS at amortised cost (original cost + discount - premium amortised to date)
- Interest income is recognised in the income statement, adjusted for any amortisation of premium/discount
- Subsequent changes in value are ignored because it will be held to maturity… UNLESS the asset is impaired
How do premiums/discounts impact asset values?
- Discounts/Premiums are amortised over the life of the bond
- Premium bonds will reduce the value of the asset over time
- Discount bonds will increase the value of the asset over time
What securities does FV through P&L apply to?
- Debt… if it is held for trading or amortised cost results in an accounting mismatch
- Equities held for trading, or designated as FVPL at purchase
- Derivatives not for hedging are always carried as FVPL
- If an asset has an embedded option, the whole asset is carried as FVPL
How are FVPL securities held on the balance sheet?
- They are reported at fair value
- Changes in fair value, realised and unrealised, are recognised in the income statement, alongside any dividend or interest income
How are FVOCI securities reported on the BS & IS?
- Carried at fair value on the balance sheet
- Unrealised gains and losses reported in OCI
- Dividend and interest income recorded in the income statement
- Realised gain/loss reported in income statement
Summary IS & BS treatment of amortised cost
BS = amortised cost = purchase cost + discount - premium amortised to date
IS = interest income including amortisation of discount/premium. Realised gains from sale
Summary IS and BS treatment of FVPL
BS = carried at FV
IS = realised & unrealised gains/losses, dividend and interest income
summary treatment of FVOCI
BS = carried at FV. Unrealised gain/loss recognised in OCI
IS = interest and dividend income. Realised gain/losses
How is interest income treated?
Always the same way whether it is amortised cost, FVPL or FVOCI…
Interest income + amortised discount - amortised cost
When is reclassification allowed?
- For equity… it is never allowed
- For debt, you can only reclassify if the business model has changed
What is the impact of loan impairment under IFRS 9?
- A new expected credit loss model has been introduced
- Need to look at historic loan performance but also use forward looking information
- It results in an earlier recognition of impairment; 12-month expected loss for performing loans and life-time expected loss for non-performing loans
How do you calculate unrealised gains/losses?
Equity = FV - purchase price = cumulative gain/loss
Debt = FV - amortised cost = cumulative gain/loss
How do you calculate the unrealised gain/loss for the period?
It is the change in the cumulative unrealised gain/loss
How do you calculate the amortisation amount?
Purchase price X initial YTM = interest payment
Interest payment - coupon payment = amortisation amount
