Investments Flashcards
Accounting for investment in equity securities
Accounting for investments in equity securities depends upon the investor’s percentage of ownership in the investment
Accounting methods
investments in equity securities
FVTNI - fair value through net income
- no significant influence
- FV readily determinable
Equity method
- significant influence exists
FVTNI - fair value through net income
no significant influence
equity securities
Similar to the previous “cost method” under the old standard. Dividends and unrealized gains(losses) are booked to the income statement.
Requirement:
1) no significant influence on investee (generally less than 20% ownership)
2) FV is readily determinable
Under IFRS, this is called FVTPL, fair value through profit & loss. Exact same treatment, different name for IS. Under IFRS, can make irrevocable election to book through OCI.
FVTNI - accounting
no significant influence
equity securities
On acquisition: DR asset, CR cash
On dividend received: DR cash, CR dividend income (IS)
@ period end: book unrealized gain(loss) to income (IS; NOT OCI)
No significant influence, FV not determinable
no significant influence
equity securities
If no significant influence on investee, but FV is not readily determinable (normally unlisted investment companies):
Investment = investment value (cost) - impairment +/- observable price changes
Acquisition: DR asset, CR cash
Dividend received: DR cash, CR dividend income
@ period end: adjust for value
1) IMPAIRMENT:
- step 1 non discounted FCF, step 2 PV
- book adj: DR impairment; CR asset
2) observable price changes: e.g. co gets a fresh valuation to go through a round of funding
- calculate unrealized gain(loss) and book to IS
Equity method of accounting - requirements
equity securities
Significant influence exists (generally 20% - 50%)
if less than 20% influence but significant influence exists: EQUITY METHOD
- investor has definite intentions/plans to increase stock ownership to +20%
- investee has significant dependency on investor for technology or operational requirements
- investor has representation on investee BOD
if between 20%-50% ownership, but no significant influence: FVTNI
- investment is temporary
- bankruptcy of investee
- lawsuit against investor challenging significant influence
- investor has surrendered significant rights in the corp
- no representation on the BOD
Equity method accounting - acquisition
equity securities
think of this like partnership investment
acquisition: DR investment, CR cash
purchase price—FV net assets (%)—BV net assets
goodwill FV difference
(PPE, land, inv)
goodwill = purchase price - FV net assets (ownership%)
FV difference = FV net assets (%) - BV net assets (%)
Equity method accounting - investee records profit/loss
equity securities
think of it like partnership investment
PROFIT:
DR investment (% share of profits)
CR equity in earnings of investee (IS)
LOSS:
CR equity in earnings of investee (IS)
DR investment (% share of loss)
Equity method accounting - investee distribute dividend
equity securities
think of it like partnership investment
DR cash
CR investment
Equity method accounting - re-valuation
equity securities
Asset is recorded at fair value & must be adjusted to keep at fair value (as FV changes)
- impairment of goodwill
- depreciation on FV (already recorded on BV)
- disposal of inventory
Impairment of goodwill:
DR equity in earnings of investee (IS)
CR investment
Equity method accounting - year end
equity securities
INVESTMENT (BS): opening investment \+ % share of profits - % share of losses - dividends received - impairment and depreciation recorded on FV = closing investment
EQUITY IN EARNINGS (IS acct):
+ % share of profits
- % share of losses
- impairment, depreciation, or disposal recorded on FV
= equity in earnings
Equity method accounting - FV option
equity securities
Irrevocable election to record the investment at FV with unrecognized gains/losses recorded on the income statement
Change in ownership percentage
equity securities
If change in ownership method that would cross FTVNI / equity method….
treat is as a change in accounting method, APPLY PROSPECTIVELY from the date of the change
Control - more than 50% ownership
equity securities
consolidate books
Debt securities
accounting treatment depends upon how long you intend to hold the security
trading securities
available for sale
held to maturity
Trading securities (IFRS FVTPL)
debt securities
bought w/ intent to sell in near term, so booked as current asset w/ income/loss through income statement
reported at fair value, if readily determinable
unrealized gains(losses) booked to contra-asset account: trading valuation allowance account - same for AFS securities
cash in/out goes through operating section of cash flow statement
Available for sale (IFRS FVTOCI)
debt securities
not classified as either held-to-maturity or as trading debt securities
reported at FV, if readily determinable
unrealized gains(losses) booked through OCI
Available for sale - permanent decline in value
debt securities
If decline in FV (AFS and HTM) is determined to be other than temporary (aka permanent), then…
adjust the actual asset (not valuation account) down to FV and the REALIZED loss is reported in current earnings (IS)
Held-to-maturity securities - amortized cost
debt securities
Report at amortized cost, but disclose FV. No adjustment for unrealized gains(losses)
FV does not matter for HTM securities. Why? Because you will not be receiving the FV. You will be receiving the amortized cost.
If Fair Value Option (irrevocable), cumulative unrealized gains(losses) @ election date shall be included in the cumulative adjustment, and must be disclosed.
CECL model
debt securities
current economic loss credit model
under this model, credit losses expected over the life of HTM and AFS securities are to be recognized upon the initial recognition of the asset
much like booking allowance for doubtful accounts for accounts receivable
CECL model - allowance account
debt securities
Allowance account for expected losses based on
- historical trends
- current market conditions
- other reasonable assumptions
expected credit losses are booked to the credit loss expense account on the IS
CECL model - credit loss calculation
debt securities
HTM securities:
credit loss = amortized cost - PV
AFS securities:
credit loss = amortized cost - FV
bc holding period for AFS securities is unknown, we
cannot calculate the PV. so use FV instead.
AFS credit losses are limited to the maximum loss (using the defined expectations) as if it were HTM. any losses beyond that would be booked as unrealized
said otherwise, if the security has a 200 loss in the
short-term, but if you hold to maturity only a 150 loss,
then you would not dispose in the short-term. the 50
balance would be booked to unrealized losses OCI
CECL model - AFS credit loss matrix
debt securities
FV > CV no credit loss
FV < CV credit loss
FV < HTM PV < CV….
CV - HTM PV = credit loss write-down
HTM PV - FV = unrealized loss OCI
Transfers of securities between HTM, AFS, and trading securities
trading - all through income statement
AFS - valuation account and OCI for unrealized G(L)
HTM - impairments booked to valuation acct and losses on IS
for all transfers, first make sure security is at FV
from TRADING to AFS / HTM: - any unrealized G(L) already recog'd on IS. no adjustment needed. reclass to new investment acct
from AFS / HTM to TRADING:
- AFS: unrealized G(L) parked in OCI s/b moved to IS
- HTM: value at FV and book G(L) to IS
from HTM to AFS:
- value at FV, book unrealized G(L) to OCI
from AFS to HTM:
- for the unrealized G(L) parked in OCI, amortize it over the remaining life of the asset
Securities classifications - GAAP v IFRS
GAAP IFRS
trading FVTPL (FVOCI option)
AFS FVTOCI (FVTPL option)
HTM amortized cost (FVTPL option)
for IFRS alternative valuation options available but they are irrevocable elections
Derivatives
financial instruments/contracts deriving value from underlying assets/instruments
Defining characteristics of derivatives
settled net: provision for a net cash settlement
- instead of physical delivery of the asset, can just take the amount over/under the market
underlying and notional amount: value is based on an underlying or notional amount
no or negligible initial net investment: requires no or little initial investment
Main types of derivatives
options
forwards
futures
swaps
Options contract
derivative
option - gives the RIGHT but not obligation
Call option
derivative
option to BUY at a predetermined price in the future
(you CALL the market for the asset you want to buy)
for a call, you want the strike price to be lower than the future market price
Put option
derivative
option to SELL at a predetermined price in the future
(you PUT your asset on the market)
for a put option, you want the strike price to be higher than the future market price
Forwards
derivative
agreement between two parties to buy/sell an item in the future for a price agreed upon today. both right and obligation. you must execute
customized to the needs of the parties. not traded on an exchange
Futures
derivative
forward contracts, but commercialized to mitigate risks of individual buyers/sellers. futures transacted through a clearing house
Forwards - long position
derivative
LONG = buy (I long to buy a house)
you expect the value to go up in the future, so lock in the price today
Forwards - short position
derivative
SHORT - sell (i think the price will be SHORTer in the future so i want to sell it)
you expect the value to go down in the future, so lock in selling a higher price today
Swaps
derivative
right and obligation to exchange cash flows of one party’s instrument with the other party’s instrument
A has a fixed rate loan at 10%
B has floating rate loan
A thinks rates will go down in the future
B thinks rates will go up in the future
They swap their rates.
If rates go up to 12%, then A pays the 2% differential to B.
If rates go down to 7%, then B pays the 3% differential to A.
Derivative uses and accounting
speculation - speculate in attempt to make profit from market changes
- report gains/losses on income statement
fair value hedge - hedge against risk from changes in FV of a recognized asset/liability, or of an unrecognized firm commitment.
- report gains/losses on income statement
cash flow hedge - hedge against risk of variability of cash flows of a recognized asset/liability, or planned/forecasted future transaction
- park gains/losses in OCI. when transaction occurs, then book to income statement
