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CPA PREP - Mod 5.1 - Intermediate Financial Reporting > Week 5 > Flashcards

Week 5 Flashcards

1
Q

What are passive investments and what are they governed by?

A

Investments held to enhance the value of excess cash by earning a return on that investment until the cash is needed.

  • < 20% ownership (?)
  • Governed by IFRS 9 Financial Instruments
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2
Q

What are the 4 categories of strategic investments?

A
  1. Subsidiary (control) - investor (parent) has control over the investee (subsidiary)
  2. Joint operations - joint control of assets and liabilities of the investee
  3. Joint venture - joint control of the net assets (equity)
  4. Associates - investor has significant influence over investee
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3
Q

What is control as defined by IFRS 10 (Consolidated Financial Statements)?

A

The investor’s (parent’s) ability to affect the returns of the investee (subsidiary) through its power to govern the policies of the investee.

  • Established by holding or having rights to hold greater than 50% of voting shares
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4
Q

What are 2 types of joint arrangements?

A
  1. Joint operations - joint control of assets and liabilities of the investee
  2. Joint ventures - joint control of the net assets (equity)

The rights and obligations of the parties determine which one it should be. These are assessed by looking at: the structure, legal form, contractual terms and other facts and circumstances.

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5
Q

Is a partnership a joint operation or joint venture?

A

Joint operation.

Partnerships give the joint operators rights to the joint arrangement’s assets and liabilities, rather than net assets. Therefore, a joint arrangement structured as a partnership is a joint operation.

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6
Q

Is an incorporated company a joint operation or joint venture?

A

Joint venture

Incorporated companies give the parties a claim on the net assets of the company, rather than specific assets therefore joint venture… unless there are contractual terms that say otherwise.

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7
Q

How are the joint arrangements accounted for?

A
  • Joint operations: using a modified form of proportionate consolidation
  • Joint venture: using equity method
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8
Q

What is significant influence with respect to associates?

A

The power to participate in the financial and operating policy decisions but not control (subsidiary) or jointly control (joint arrangement) those policies.

  • Investor holds 20-50% of voting stock
  • Representation on Board of Directors
  • Participation in policy making
  • Material transactions between investor and associate
  • Interchange of managerial personnel
  • Provision of technical information
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9
Q

What is another name for the equity method?

A

One-line consolidation

Because it essentially collapses income earned from the investment into one line itme in the statement of comprehensive income and similiarly reports the investors’ ownership interest in the individual assets and liabilities of the associate in one line on the statement of financial position.

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10
Q

What is initially recognized with the equity method?

A

Initially recognized at cost.

  • The fair value of consideration paid plus transaction costs.
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11
Q

How is investor’s interest in associates and joint ventures subsequently measured?

A

Recognize investor’s proportionate share of investee’s comprehensive income/loss for the year, adjusted for:

  • Amortization of acquisition differential
  • Impairment losses
  • Gains/losses from upstream and downstream sales
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12
Q

What are upstream and downstream sales?

A

Upstream sales: sales by investee to investor

Downstream sales: sales by investor to investee

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13
Q

What is a financial instrument?

A

Contract giving rise to:

  • financial asset of one enterprise; and
  • either a financial liability or equity instrument of another

Financial assets are financial instruments.

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14
Q

What is a bargain purchase?

A

Where the acquisition price is less than fair value of identifiable net assets.

  • Recognize difference in investor’s profit or loss
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15
Q

What to do if If the period-end statement date of the investee differs from that of the investor (contemporaneous period ends)?

A

Use interim reports or adjust for significant events

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16
Q

What to do if losses exceed investment balance?

A

Reduce investment account to zero

Only report additional losses (creating a liability) to extent that investor has an obligation.

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17
Q

What is a financial asset?

A

Any asset that is:

  • Cash
  • Equity instrument of another entity (e.g., investment in the shares of another company)
  • Contractual right to receive cash, or another financial asset from another enterprise
  • Contractual right to exchange financial instruments with another entity under conditions that are potentially favourable
  • Specified contracts that will or may be settled in the entity’s own financial instruments
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18
Q

Are property, plant and equipment a financial asset?

A

No

As they do not give a right to receive cash or another financial asset, though it would be expected that they would ultimately generate cash. Similarly, intangible assets, such as brands and patents, are not financial assets.

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19
Q

What are the 3 classes of financial instruments?

A
  1. Financial assets measured at amortized cost
  2. Financial assets measured at fair value through other comprehensive income (FVOCI)
  3. Financial assets measured at fair value through profit or loss (FVPL)
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20
Q

When can you measure financial assets at amoritized cost?

A

When:

  • The objective of the business model is to collect contractual cash flows (by holding the asset); and
  • The contractual cash flows are paid on specified dates and are solely of principal and interest (such as loans receivable, bonds and mortgage investments).
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21
Q

When can you measure financial assets at fair value through OCI (FVOCI)?

A

When:

  • The objective of the business model is to collect contractual cash flows and to sell the asset; and
  • The contractual cash flows are paid on specified dates and are solely of principal and interest (such as loans receivable, bonds and mortgage investments).
22
Q

When do you classify financial assets through profit or loss (FVPL)?

A

When:

  • Assets are not measured at amortized cost or at FVOCI (for example, investment in equities).
  • Any securities that are held for trading are automatically classified as FVPL.
  • An entity can classify any item as FVPL.
23
Q

What is held for trading?

A

An asset that is acquired principally for the purpose of selling in the near term

24
Q

What is an exception to FVPL for equity instruments?

A

Entity may make an irrevocable election to classify as fair value through OCI, provided the asset is not held for trading (FVOCI-elect).

  • Applied on an investment by investment basis.
  • Dividends from these investments are recognized in profit or loss.
25
Q

How are financial assets initially measured?

A
  • Amortized cost = FV + TC
  • FVOCI = FV + TC
  • FVPL = FV (transaction costs are immediately expensed)

Where FV = fair value, TC = transaction costs

26
Q

How are financial assets subsequently measured on statement of financial position?

A
  • Amortized cost: at amortized cost
  • FVOCI: at fair value
  • FVPL: at fair value
27
Q

Where are interest income and earned dividends recognized for subsequent measurement using FVPL?

A

In profit or loss

(notes p.25)

28
Q

With FVPL, do you use the stated rate or effective rate of interest to determine the interest revenue?

A

Stated rate

  • Interest income for all others (i.e., not FVPL) uses the effective interest method
29
Q

What is the effective interest method?

A

Method that is used in the calculation of amortized cost of a financial asset or liability and in the allocation and recognition of the interest revenue or interest expense in a profit or loss over the relevant period.

30
Q

What is the effective interest rate?

A

That which exactly discounts the estimated future cash payments or receipts through the expected life of the financial asset or financial liability to the gross carrying amount of a financial asset or to the amortized cost of a financial liability.

  • If transaction costs = 0, then effective rate = market rate on the date the asset was acquired.
  • If transaction costs <> 0, then financial calculator is required.
31
Q

What to punch into the calculator to get the effective interest rate?

A
  • PV = net price paid for the investment inclusive of transaction costs. Enter as a negative.
  • FV = principal sum to be received at maturity (the amount of the bond)
  • N = number of payment periods to maturity.
  • PMT = payment to be received per period. Face value x state (coupon) rate on the bond / # of compounding periods.
  • I = SOLVE FOR THIS. This is the effective interest rate per period.
32
Q

How to calculate interest revenue once the effective rate is known?

A

Interest Revenue

= net book value (carrying value) of the investment at the beginnng of the period x the effective interest rate per period

  • If investment was acquired at a discount to the maturity amount, interest revenue will increase each period
  • If at a premium, interest revenue will decrease each period.
33
Q

How is impairment handled for debt instruments?

A
  • Amortized cost: must recognize credit loss in P&L where there is significant increase in credit risk. Allowance for losses is netted against amortized balance.
  • FVOCI: must recognize credit loss in OCI where there is significant increase in credit risk. Expected 12-month impairment losses are recognized annually in P&L
  • FVPL: when adjusted to fair value, the credit losses are already reported in P&L.
34
Q

What can investments in equity be reclassifed to?

A

FVPL only

Investments in debt can be reclassified to other.

35
Q

When do reclassifications of debt instruments occur?

A

When there are changes in the business model.

  • These should be infrequent
  • Usually only occur when entity has acquired, disposed of or terminated a business line
36
Q

What happens when you reclassify debt instrument from AC to FVOCI?

A

Gain or loss adjustment to OCI

37
Q

What happens when you reclassify debt instrument from FVOCI to FVPL?

A

Adjust cumulative OCI to P&L

38
Q

What happens when you reclassify debt instrument from FVPL to AC?

A

Fair value at reclassification date is amortized cost.

New effective interest rate is calculated based on new fair value.

39
Q

When should financial assets be derecognized?

A
  • The contractual rights to the cash flows from the financial asset expire
  • The entity transfers substantially all the risks and rewards of ownership.
40
Q

Where is the gain or loss on derecognition recognized?

A

Recognized in profit or loss

  • Calculated as the difference between the carrying amount and the consideration received.
  • For FVOCI-elect for an equity instrument, cumulative gains or losses previously recognized in other comprehensive income is recognized in OCI. May transfer remaining amount to retained earnings.
41
Q

Where are gains and losses reporting in ASPE?

A

P&L

No such thing as other comprehensive income (OCI).

42
Q

What is a debt instrument?

A

A debt instrument is a paper or electronic obligation that enables the issuing party to raise funds by promising to repay a lender in accordance with terms of a contract.

Examples: notes, bonds, certificates, mortgages, leases or other agreements between a lender and a borrower.

43
Q

What is the coupon rate?

A

The actual interest rate of the bond. It determines the amount of interest the borrower pays.

Also called the ​stated rate.

44
Q

What is the effective interest rate?

A

The rate that investors demand for the loan.

Also called the market interest rate.

45
Q

For effective interest amortization of bonds, what is the calculation for interest payments?

A

Interest payment = (maturity value x stated rate)/# of interest payments per year

46
Q

What is the journal entry for interest revenue and cash received for a bond discount using the effective interest method (for the investor)?

A

Dr Cash

Dr Investment in bond

Cr Interest Expense

47
Q

What is the journal entry for interest revenue and cash received for a bond premium using the effective interest method (for the investor)?

A

Dr Cash

Cr Interest revenue

Cr Investment in bond

(Confirm the above)

48
Q

What is the equity method?

A

A method used to account for an organization’s investment in another entity (the investee). This method is only used when the investor has significant influence over the investee.

  • Investor recognizes its share of the profits and losses of the investee in the periods when these profits and losses are also reflected in the accounts of the investee.
  • Any profit or loss recognized by the investing entity appears in its income statement.
  • Any recognized profit increases the investment recorded by the investing entity, while a recognized loss decreases the investment.
49
Q

If the market rate > coupon rate, will the bond rise or fall in value?

A

Fall in value.

  • If Market rate > Coupon Rate you will expect the bond to fall in value
  • If Market Rate < Coupon Rate you will expect the bond value to rise

When a bond is created the preparer uses the interest rate at that time in the market. For example if it is 3% right now they use 3% to calculate the payments. Hence we call this the coupon rate. By the time they are in the market the rates will go up and down causing the values to increase or decrease.

Response from Supinder on discussion board.

50
Q

With ASPE, how are equity instruments measured?

A
  • Quoted in an active market, at fair value
  • Not quoted in an active market, cost less impairment losses
    • or may irrevocably elect to be at fair value
51
Q

With ASPE, how are equity instruments measured?

A

Measure at amortized cost

  • may use the effective interest rate method or straight-line method to amortize the premium or discount
  • or may irrevocably elect to be at fair value
52
Q

What is the journal entry, if the bonds are classified as amortized cost and the fair value of the bond changes in the future?

A

Nothing.

Under amortized cost, the investments are not adjusted to fair value at year end.

Practice Problem 6

CPA PREP - Mod 5.1 - Intermediate Financial Reporting (6 decks)

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