Reading 07 - Intercorporate Investments

Question 1

What are the 3 ways Intercorporate Investments can be categorised?

+ explain this in terms of influence and control

Answer 1

1. investments in financial assets ( the investing firm has no significant control over the operations of the investee firm)
2. investments with associates (investment firm has signficant influences, but not control)
3. business combinations (when the investing firm has control over the operations of the investee firm)

Question 2

What are the % of ownership under Financial Assets, Investments in Associates and Business Combinations of Intercorporate Investments?

Answer 2

• Financial Assets < 20%
• Investments in Associates > 20% & < 50%
• Business Combination > 50%

Question 3

What are some ways an Investments in Associates can have significant influence in the investee firm?

Answer 3

1. Board of Directors representation
2. Involvement in policy making
3. Material intercompany transactions
4. Interchange of managerial personnel
5. Dependence on technology

Question 4

What is the accounting treatment for Investments in Financial Assets, Investment in Associates and Business Combinations?

Answer 4

• Investments in Financial Assets :
  Held to maturity/Amortised cost,
  Available for sale/FV through OCI,
  FV through profit or loss
• Investment in Associates:
  Equity Method
• Business Combinations:
  Acquisition Method

Question 5

How are held to maturity/held at amortised cost financial assets reported in:
* the balance sheet?
* the income statement?

Answer 5

• Balance sheet:
  carried on the balance sheet at amortised cost
• Income statement:
  interest income
  realised gain/loss

NOTE: changes in market value NOT recognised unless impaired

Question 6

If a Financial Asset is classified as Held-to Maturity and its fair value changes, how is this handled in the financial statements?

Answer 6

Fair value changes are ignored.

Question 7

How are fair value through OCI/available for sale financial assets reported in:
* the balance sheet?
* the income statement?

Answer 7

• Balance sheet:
  carried on the balance sheet at fair value
• Income statement:
  interest income
  dividend income

Gains/losses from changes in FV reported directly in equity

Question 8

How are fair value through profit or loss/trading securities financial assets reported in:
* the balance sheet?
* the income statement?

Answer 8

• Balance sheet:
  carried on the balance sheet at fair value
• Income statement:
  interest income
  dividend income
  realised gains/losses
  unrealised gains/losses

Question 9

Equity Method:
What effect does this method have on the balance sheet and income statement?

Specify the balance sheet line affected and how dividends are treated

Answer 9

The balance sheet investment account and income statement increase by the pro rata share of the investees earnings.
Dividends received decrease the investment account.

Question 10

Under GAAP, what are the 3 ways business combinations are categorized?

Answer 10

1. Merger -> (Company A + Company B = Company A)
2. Acquisition -> Company A + Company B = (Company A + Company B)
3. Consolidation -> Company A + Company B = Company C

Question 11

What is the only allowable accounting method for Business Combinations?

Answer 11

The Acquisition Method

All of the assets, liabilities, revenues and expenses of the subsidiary are combined with the parent. Intercompany transactions are excluded.

Question 12

Acquisition method:
How is goodwill impaired? How is goodwill amortised?

Answer 12

Goodwill is subject to annual impairments tests. It is not amortised.

Question 13

Acquisition method:
What aspects are combined with the parent company? What aspects is excluded?

Combined - 4
Excluded - 1

Answer 13

Combined:
* assets of subsidiary
* liabilities of subsidiary
* revenue of subsidiary
* expenses of subsidiary

Excluded:
* intercompany transfers

Question 14

Acquisition method:
When is minority interest accounted for? What financial statement is it found in?

Answer 14

If less than 100% of company is acquired, minority interest in the balance sheet accounts for the share not owned by the parent.

Question 15

What % of control or influence triggers a joint venture? What method is used to account for JVs?

Answer 15

50% shared control.
Equity method

Question 16

Equity, acquisition & proportionate consolidation:
How do all 3 methods affect net income?

Answer 16

All three methods report the same net income.

Question 17

Acquisition method vs. equity method:
How are assets, liabilities, equity, revenues and expenses affected under acquisition method compared with the equity method?

Answer 17

Assets, liabilities, equity, revenues and expenses are higher under the acquisition method v.s. equity method.

Question 18

IFRS vs. US GAAP:
Under which accounting standards is fair value accounting primarily applied to financial instruments held by venture capital organizations and mutual funds, and which standards allow for a broader range of entities?

Answer 18

IFRS primarily applies fair value accounting to financial instruments held by venture capital organizations, mutual funds, and similar entities.

US GAAP allows for fair value accounting for a broader range of entities and financial instruments.

Question 19

IFRS vs. US GAAP:
Under which accounting standards is partial and full good will permitted, and which standards only allow for full good will?

Answer 19

IFRS: Partial and full goodwill permitted

US GAAP: Full goodwill only

Question 20

Under GAAP, how is goodwill determined?

Answer 20

The Goodwill

is the amount by which the fair value of the subsidiary is greater than the fair value of the acquired company’s net identifiable assets

Question 21

What is partial goodwill, how is it calculated and what accounting standards allow it?

Answer 21

Is the excess of the purchase price over the fair value of the acquiring company’s proportion of the acquired company’s identifiable assets.
It involves measuring the goodwill attributable only to the controlling interest acquired by the parent company, rather than the entire goodwill of the acquired entity.

**Allowed under IFRS but not GAAP**

Question 22

IFRS vs. US GAAP:
How does the goodwill impairment process differ under IFRS vs. US GAAP?

Answer 22

IFRS:
* 1 STEP - recoverable amount v.s. carrying value

US GAAP:
* 2 STEP - identify if impairment, then measure the amount to be impaired.

Question 23

IFRS vs. US GAAP:
Under the acquisition method, how are contingent assets recognised?

Answer 23

IFRS:Contingent assets are not recognised
US GAAP: Recognised, recorded at FV.

Question 24

IFRS vs. US GAAP:
How are prior service costs reported in financial statements?

Answer 24

IFRS:Recognised as an expense in the I/S
US GAAP: Reported in OCI, amortised in I/S

Question 25

IFRS vs. US GAAP: How are actuarial gains/losses reported in financial statements?

Answer 25

**IFRS:**Remeasurements in OCI, not amortised **US GAAP:** OCI, amortised with corridor approach

Question 26

IFRS vs. US GAAP: How are dividend/interest income and interest expenses cash flows classified in financial statements?

Answer 26

**IFRS:**Operating or financial cash flows **US GAAP:** Operating cash flow

Question 27

Are ROA and ROE higher or lower for the full goodwill method than under the partial goodwill method? And why?

Answer 27

Lower b/c the full goodwill method results in higher total assets and higher total equity

Question 28

Are Net Profit Margin, ROA and ROE higher under the Equity Method or Acquisition Method?

Answer 28

All higher under the Equity Method

Question 29

Are you able to reclassify an asset under IFRS 9 (New Standards)?

Answer 29

**_Equities:_** No, the initial designation is irrevocable **_Debt:_** Yes, but only if the business model has changed.

Question 30

What are the kinds of loss events are necessary under IFRS for a **debt security** to be considered impaired?

Answer 30

1. Default of payments of principal or interest 2. Likely bankruptcy or reorganization **\*\*\*A credit downgrade or lack of a liquid market are not reasons to be considered impaired\*\*\***

Question 31

What are the 2 criterias for using **Amortized Cost Accounting **for debt securities under IRFS 9?

Answer 31

1. **_Business Model Test _** - Debt securities are being held to collect contractual cash flows 2. **_Cash Flow Characteristic Test -_** The contractual cash flows are either principal , or interest on principal, only

Question 32

How do you calculate goodwill? \*\*\*\*Research this formula further\*\*\*\*\*\*\*\*\*

Answer 32

Purchase Price Less : Pro-rata book value of net assets Less : Excess allocated to PP&E = Goodwill

Question 33

What is an **upstream transaction **?

Answer 33

Transactions flowing from the parent to the subsidiary

Question 34

What is a **downstream transaction **?

Answer 34

transactions from the subsidiary to the parent

Question 35

What happens using the **acquisition method ** when the parent owns less than 100% of the subsidiary?

Answer 35

It is necessary to create a noncontrolling (**minority**) interest account for the proportionate share of the subsidiary's net assts that are not owned by the parent **\*\*UPDATE CARD TO REFLECT WHERE THE MINORITY ASSET GOES ON BALANCE SHEET**

Question 36

What is a VIE?

Answer 36

**_V_**ariable **_I_**nterest **_E_**ntity Is a term used by FASB to describe a Special Purpose Entity (SPE) **\*\*\*\*If the SPE is considered a VIE, it must be consolidated by the primary beneficiary\*\*\***

Question 37

What are the characterstics that would classify an SPE as a VIE?

Answer 37

**Only one of the 2 is neccessary to be a VIE** 1. At-risk equity that is insufficient to finance the entity's activities without additional financial support 2. Equity investors that lack any one of the following: * Decision making rights * The obligation to absorb expected losses * The right to receive expected residual returns