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Investments Flashcards

1
Q

Accounting for investment in equity securities

A

Accounting for investments in equity securities depends upon the investor’s percentage of ownership in the investment

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2
Q

Accounting methods

investments in equity securities

A

FVTNI - fair value through net income

  • no significant influence
  • FV readily determinable

Equity method
- significant influence exists

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3
Q

FVTNI - fair value through net income

no significant influence

equity securities

A

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.

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4
Q

FVTNI - accounting

no significant influence

equity securities

A

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)

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5
Q

No significant influence, FV not determinable

no significant influence

equity securities

A

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

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6
Q

Equity method of accounting - requirements

equity securities

A

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
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7
Q

Equity method accounting - acquisition

equity securities

A

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 (%)

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8
Q

Equity method accounting - investee records profit/loss

equity securities

A

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)

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9
Q

Equity method accounting - investee distribute dividend

equity securities

A

think of it like partnership investment
DR cash
CR investment

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10
Q

Equity method accounting - re-valuation

equity securities

A

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

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11
Q

Equity method accounting - year end

equity securities

A 
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

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12
Q

Equity method accounting - FV option

equity securities

A

Irrevocable election to record the investment at FV with unrecognized gains/losses recorded on the income statement

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13
Q

Change in ownership percentage

equity securities

A

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

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14
Q

Control - more than 50% ownership

equity securities

A

consolidate books

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15
Q

Debt securities

A

accounting treatment depends upon how long you intend to hold the security

trading securities
available for sale
held to maturity

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16
Q

Trading securities (IFRS FVTPL)

debt securities

A

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

17
Q

Available for sale (IFRS FVTOCI)

debt securities

A

not classified as either held-to-maturity or as trading debt securities

reported at FV, if readily determinable

unrealized gains(losses) booked through OCI

18
Q

Available for sale - permanent decline in value

debt securities

A

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)

19
Q

Held-to-maturity securities - amortized cost

debt securities

A

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.

20
Q

CECL model

debt securities

A

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

21
Q

CECL model - allowance account

debt securities

A

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

22
Q

CECL model - credit loss calculation

debt securities

A

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

23
Q

CECL model - AFS credit loss matrix

debt securities

A

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

24
Q

Transfers of securities between HTM, AFS, and trading securities

A

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

25
Q

Securities classifications - GAAP v IFRS

A

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

26
Q

Derivatives

A

financial instruments/contracts deriving value from underlying assets/instruments

27
Q

Defining characteristics of derivatives

A

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

28
Q

Main types of derivatives

A

options
forwards
futures
swaps

29
Q

Options contract

derivative

A

option - gives the RIGHT but not obligation

30
Q

Call option

derivative

A

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

31
Q

Put option

derivative

A

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

32
Q

Forwards

derivative

A

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

33
Q

Futures

derivative

A

forward contracts, but commercialized to mitigate risks of individual buyers/sellers. futures transacted through a clearing house

34
Q

Forwards - long position

derivative

A

LONG = buy (I long to buy a house)

you expect the value to go up in the future, so lock in the price today

35
Q

Forwards - short position

derivative

A

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

36
Q

Swaps

derivative

A

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.

37
Q

Derivative uses and accounting

A

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

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