Intercorporate Investments

Question 1

Investment categories

Answer 1

1) No significant influence or control (less than 20%)
2) Significant influence but no control (20% to less than 50%)
3) Control is shared (joint venture)
4) Controlling interest is obtained (50% and more)

Question 2

Loan impairment approach

Answer 2

IFRS 9 - Expected credit loss model
IAS 39 - Incurred lost model

Question 3

Amortized cost approach criteria

Answer 3

Same for IFRS and IAS (hold-to-maturity classification)
(1) A business model test: The financial assets are being held to collect contractual cash flows; and

(2) A cash flow characteristic test: The contractual cash flows are solely payments of principal and interest on principal.

Question 4

Financial assets classification

Answer 4

Amortized cost
FVPL
— could include hold-to-collect and sell if accounting mismatch may arise
— include held-for-trading equity (required)
— include derivatives (excluding hedging instruments)
FVOCI
— include hold-to-collect and sell instruments (debt or equity)
— other equity apart from held-for-trading could be measured here (discretionary) but only the dividend income could be recognized in profit or loss

Investment reclassification is only allowed for debt instruments when business model significantly changed, and restatement is not required

Question 5

Accounting mismatch

Answer 5

Refers to an inconsistency resulting from different measurement bases for assets and liabilities, i.e., some are measured at amortized cost and some at fair value

Question 6

Joint venture characteristics

Answer 6

1) A contractual arrangement exists between two or more venturers, and 2) the contractual arrangement establishes joint control.

Required for both IFRS and US GAAP

Question 7

Equity method of accounting

Answer 7

Balance Sheet
Carrying cost of the joint venture
(+/-) earnings/losses
(-) dividend / capital distribution

Income Statement
Earnings and losses from the joint venture

Excess cost after fair value, if can no longer be allocated to specific assets, would be treated as goodwill.

Question 8

PPE method of accounting

Answer 8

IFRS - historical cost or fair value method (less accumulated depreciation)
US GAAP - historical cost only (less accumulated depreciation)

Question 9

Goodwill

Answer 9

any remaining difference between the acquisition cost and the fair value of net identifiable assets that cannot be allocated to specific assets is treated as goodwill and is not amortized

Allocated amounts are not reflected on the financial statements of the investee (associate), and the investee’s income statement will not reflect the necessary periodic adjustments. The investor must directly record these adjustment effects by reducing the carrying amount of the investment on its balance sheet and by reducing the investee’s profit recognized on its income statement.

Question 10

How to determine if there is goodwill or not?

Answer 10

Check if there is an excess purchase price. Check if cash paid vs. acquired net assets have a discrepancy. Check if PPE is over-valued or under-valued.

Question 11

How to determine value of investment in associate?

Answer 11

Purchase price
+ Net income
- Dividends received
- Amortized excess purchase price attributed to PPE

Remember to multiply net income / dividends / amortized excess purchase price attributable to PPE to the % stake.

Question 12

Equity method with fair value?

Answer 12

US GAAP - available for all Entities
IFRS - only for venture capital organizations, mutual funds, unit trusts, and similar entities, including investment-linked insurance funds

Election of use of fair value is irrevocable.
Gains, losses / dividends are reported in investor P&L.
Identifiable net assets and goodwill are not created nor recognized.

Question 13

Goodwill impairment

Answer 13

IFRS - the entire carrying amount of the equity method is tested for impairment if one or more loss event occurred which could impact investment’s future cash flow. Impairment is recognized in income statement and carrying amount is reduced through a contra-account.

US GAAP - if investment fair value falls below carrying value AND the decline is permanent, impairment loss is recognized, and carrying amount in balance sheet is reduced to the fair value.

Question 14

Equity method ratios impact

Answer 14

Net margin ratios could be overstated because income for the associate is included in investor net income but is not specifically included in sales

There can be significant assets and liabilities of the investee that are not reflected on the investor’s balance sheet, which will significantly affect debt ratios

Question 15

Business combinations

Answer 15

Mergers - acquirer absorbs the acquired
Acquisitions - acquired becomes the parent of the acquired
Consolidations - acquirer and acquired ceases to exist and a new entity arises
Special purpose or variable interest entities - consolidated if there is control exhibited by the sponsor

Question 16

Definition of control

Answer 16

UNDER IFRS
1) the investor has the ability to exert influence on the financial and operating policy of the entity; and 2) is exposed, or has rights, to variable returns from its involvement with the investee.

UNDER US GAAP
uses a two-component consolidation model that includes both a variable interest component and a voting interest (control) component.

Under the variable interest component, US GAAP19 requires the primary beneficiary of a variable interest entity (VIE) to consolidate the VIE regardless of its voting interests (if any) in the VIE or its decision-making authority. The primary beneficiary is defined as the party that will absorb the majority of the VIE’s expected losses, receive the majority of the VIE’s expected residual returns, or both.

pooling accounting method is NO LONGER allowed.

Question 17

Acquisition method

Answer 17

The fair value of the consideration given by the acquiring company is the appropriate measurement for acquisitions and also includes the acquisition-date fair value of any contingent consideration. Direct costs of the business combination, such as professional and legal fees, valuation experts, and consultants, are expensed as incurred.

PROs:
The recognition and measurement of the assets and liabilities of the combined entity;
Liability is recognized if 1) it is a present obligation that arises from past events, and
2) it can be measured reliably. IFRS include contingent liabilities if their fair values can
be reliably measured. US GAAP includes only those contingent liabilities that are
probable and can be reasonably estimated.

The initial recognition and subsequent accounting for goodwill; and
The recognition and measurement of any non-controlling interest.