Slide 1

Investments in EquitySecurities(Text, Chapter 2 and pp 427-431)PresenterChuck Campbell

UNIVERSITY OF BRITISH COLUMBIA Copyright hereChapter 2 Learning ObjectivesDistinguish between the various categories of intercompany equity investments.Prepare journal entries to account for investments carried at fair value with revaluation gains/losses through net income.Prepare journal entries to account for investments carried at fair value with revaluation through other comprehensive income.Prepare journal entries to account for investments accounted for using the equity method.Prepare journal entries to account for investments accounted for using the cost method.Identify some of the differences between IFRSs and ASPE for accounting for investments in equity securities.

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereIntroduction to intercorporate investmentsUNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereTypes of equity investmentsNon-strategic investmentsfair value through profit and loss (FVTPL)fair value through OCI (FVTOCI)

Strategic investmentswith significant influence significantly influenced investment or associated companywith joint control joint operation or joint venturewith control subsidiary

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereClassification of Investments

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereReporting methodsNon-strategic investmentsfair value method (with changes to net income)fair value method (with changes to other comprehensive income) cost method

Strategic investmentsequity method (significant influence investments and joint ventures)proportionate consolidation (joint operations)full consolidation (subsidiaries)

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereAccounting (recording) methodscost methodequity methodfair value method (with changes to net income)fair value method (with changes to other comprehensive income)

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereImpact of IFRS 9IFRS 9, introduces three significant changes:the default classification for non-strategic investments changes from FVTOCI to FVTPL;all non-strategic investments must be valued at fair value (cost method not permitted);realized gains and losses on FVTOCI investments go directly from AOCI to retained earnings without going through net income.Although the date for mandatory implementation of IFRS 9 has been deferred indefinitely, early adoption is encouraged (and will be assumed for all questions in this course.)UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereAccounting for investments at fair value through profit and loss (FVTPL)UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereFVTPL (held-for trading) investmentsThis terminology has changed from held-for-trading investments to investments valued at fair value through profit and loss (FVTPL).

This recognizes that the valuation of such investments will be at fair value with the unrealized revaluation gains and losses being accounted for in net income as they occur.

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereFVTPL investmentsWith the implementation of IFRS 9, all nonstrategic investments must be valued at fair value, including investments in non-traded private companies.On initial recognition, an entity can elect to present the fair value changes on an equity investment that is not held for short-term trading in other comprehensive income (OCI).If this election is not made, revaluation gains and losses on all non-strategic investments will be reported in net income.

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereFVTPL investmentsThey are initially recorded at fair value.Transaction costs must be charged to net income at acquisition.Dividends are taken to income as declared.They are revalued to fair value at each financial statement date.Changes in value are recorded in net income as they occur.Effectively, revaluations are considered as realized as they occur.

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereFVTPL investmentsInvestorco acquired 2,000 shares of A Company on January 1, 2012, at a cost of $20.00 per share plus a 2% brokerage charge. (This was 10% of the outstanding shares of A Company). At the close of business on December 31, 2012, the shares were trading at $18.00 per share and at the close of business on December 31, 2013, were trading at $21.00 per share. On October 1, 2014, Investorco sold 50% of the shares for proceeds of $22,250. The share price at December 31, 2014 was $22.50. The investment was considered to be a fair value through profit and loss investment throughout the period during which it was held. A Company earned income of $50,000 per year and paid dividends of $0.50 per share on June 30 and December 31 each year.

What journal entries would be required to account for this investment (and the income from it) from Jan 1, 2012 to Dec 31, 2014?

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereFVTPL investmentsJan 1, 2012 Investment in A Co 40,000Investment expenses 800Cash 40,800

June 30, 2012 Cash 1,000Dividend income 1,000

Dec 31, 2012 Cash 1,000Dividend income 1,000

Investment revaluation loss 4,000Investment in A Co 4,000

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereFVTPL investmentsJune 30, 2013 Cash 1,000Dividend income 1,000

Dec 31, 2013 Cash 1,000Dividend income 1,000

Investment in A Co 6,000 Investment revaluation gain 6,000UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereFVTPL investmentsJune 30, 2014 Cash 1,000Dividend income 1,000

Oct 1, 2014 Cash 22,250Gain on sale of shares 1,250 Investment in A Co 21,000

Dec 31, 2014 Cash 500Dividend income 500

Investment in A Co 1,500Investment revaluation gain 1,500

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereFVTPL investments

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereFVTPL investments -- summaryThey are recorded at cost when acquired.Dividend income is recorded as dividends are declared by investee. They are revalued at each financial statement date with revaluation gains or losses included in net income. A gain or loss will be recorded on disposal. All entries go through net income.

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereAccounting for INVESTMENTS VALUED AT FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME (FVTOCI)UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereFVTOCI investmentsPrior to the implementation of IFRS 9, this classification was called available for sale investments.Until IFRS 9 is implemented, this is the default category for non-strategic investments; with the implementation of IFRS 9, the default will be FVTPL and investments may only be accounted for as FVTOCI if an election is made at the time of initial recognition.Revaluation gains are recorded in OCI as they occur.UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereFVTOCI investmentsGains and losses may be transferred from accumulated OCI to retained earnings at any time (generally, this would be done when the investment was sold and the revaluation gains or losses realized).With the introduction of IFRS 9, such balances must be transferred directly to retained earnings without being recycled through net income.

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereFVTOCI investmentsTheir initial and subsequent measurement is at fair value.Under IFRS, transactions costs are usually included in the initial value of the investment, although they may be expensed at the option of the investor.Changes in value are recorded in other comprehensive income as they occur.Effectively, revaluations are considered as unrealized until the investments are sold.

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereFVTOCI investmentsInvestorco acquired 2,000 shares of A Company on January 1, 2012, at a cost of $20.00 per share plus a 2% brokerage charge. (This was 10% of the outstanding shares of A Company). At the close of business on December 31, 2012, the shares were trading at $18.00 per share and at the close of business on December 31, 2013, were trading at $21.00 per share. On October 1, 2014, Investorco sold 50% of the shares for proceeds of $22,250. The share price at December 31, 2014 was $22.50. Investorco elected to account for this investment through OCI. A Company earned income of $50,000 per year and paid dividends of $0.50 per share on June 30 and December 31 each year. The company included brokerage and other acquisition costs in the cost of the investment. Revaluation gains and losses are transferred to retained earnings when realized.

What journal entries would be required to account for this investment (and the income from it) from January 1, 2012 to December 31, 2014?

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereFVTOCI investmentsJanuary 1, 2012 Investment in A Co40,800 Cash 40,800

June 30, 2012 Cash 1,000Dividend income 1,000

Dec 31, 2012 Cash 1,000Dividend income 1,000

Inv revaluation loss (OCI) 4,800Investment in A Co 4,800

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereFVTOCI investmentsJune 30, 2013 Cash 1,000Dividend income 1,000

Dec 31, 2013 Cash 1,000Dividend income 1,000

Investment in A Co 6,000 Inv revaluation gain (OCI) 6,000

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereFVTOCI investmentsJune 30, 2014 Cash 1,000Dividend income 1,000

Oct 1, 2014 Investment in A Co 2,500 Inv revaluation gain (OCI) 2,500

Cash 22,250Investment in A Co 22,250Accumulated OCI 1,850Retained earnings 1,850

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereFVTOCI investmentsDec 31, 2014 Cash 500Dividend income 500

Investment in A Co 250 Inv revaluation gain (OCI) 250

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereFVTOCI investments

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereFVTOCI investmentsThey are recorded at cost when acquired.Dividend income is recorded as dividends are declared by investee; They are revalued at each financial statement date with revaluation gains/losses included in OCI; A gain/loss is recorded on disposal. Under IFRS 9, gains/losses are transferred from accumulated OCI directly to retained earnings (usually on disposal). This is the only investment category using OCI.

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereOther comprehensive incomeOther comprehensive income is a relatively new term in accounting and consists of revenues, expenses, gains and losses that are required to be included in comprehensive income, but excluded from net income, and includes such items as:gains and losses on revaluation of investments valued at fair value through OCI;gains on revaluation of capital assets (losses generally are charged against net income); unexpected valuation gains and losses from accounting for defined benefit pension plans;gains and losses on derivatives designated as cash flow hedges;unrealized gains and losses on translating the financial statements of self-sustaining foreign operations.OCI is part of IFRS but is not part of ASPE.UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereOther comprehensive incomeComprehensive income for the year is made up of two elements net income and other comprehensive income. At the end of the year, net income is transferred to retained earnings and other comprehensive income is generally transferred to a separate account in shareholders equity called accumulated other comprehensive income.

Net income and other comprehensive income may be reported on a single statement of comprehensive income (ending with comprehensive income for the year) OR reported separately in an income statement (concluding with net income for the year) and a separate statement of comprehensive income. The sources of the changes in other comprehensive income must be disclosed. (The sources are listed on the previous slide.)

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereAccounting using the cost and equity methodsUNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereCost method of accounting -- IFRSIFRS currently permits the cost method to be used to report investments when investments accounted for at fair value through OCI do not have a reliable market value. This will be changed with the implementation of IFRS 9 to require that all available-for-sale securities be valued at fair value.

The cost method may also used to account for (but not report) other investments such as subsidiaries.

The cost method may be used to report investments in subsidiaries where the parent prepares single entity (unconsolidated) financial statements under IFRS.

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereCost method of accounting -- ASPEUnder ASPE, the cost method may be used to report a number of investments, including non-strategic investments without a reliable market value, investments with significant influence, joint operations and subsidiaries.ASPE does not permit the cost method to be used for any investment which is traded on an exchange and has a reliable market value.

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereCost method of accountingThe investment is recorded at cost and is not revalued unless there is a permanent decline in value.Dividends are recorded when received or receivable.Prior to 2009, when dividends exceeded the investors share of earnings since acquisition, this was considered to be a return of capital (liquidating dividend). These were regarded as a recovery of investment and credited to the investment account.Since 2009, all dividends from investments accounted for using the cost method are taken to income when received or receivable.

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereCost method of accountingOn January 1, 2013, Holding Company Inc. paid $100,000 for 10% of the outstanding shares of Cougar Inc. During 2013, Cougar Inc. had a net income of $150,000 and paid dividends of $100,000 at the end of that year. During 2014, Cougar Inc. had a net income of $50,000 and paid dividends of $120,000 at the end of that year. Holding Company reports under ASPE and has elected to account for this investment using the cost method.What journal entries would have been required to account for the investment in Cougar Inc. and the receipt of the dividends from Cougar for the years 2013 and 2014?

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereCost method of accountingAt acquisition: Dr. Investment in Cougar Inc. $100,000 Cr.Cash $100,000

No entry is made to record Holding Companys share of Cougar Inc.s income for 2013.

On receipt of the 2013 dividend: Dr. Cash$ 10,000Cr. Investment income (Cougar Inc.) $10,000

On receipt of the 2014 dividend: Dr. Cash $12,000Cr. Investment income (Cougar Inc.) $12,000

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereCost method of accountingThey are recorded at cost when acquired.Dividend income is recorded as dividends are declared by investee. They are not revalued unless there is a permanent decline in value.A gain or loss recorded on disposal. All transactions are recorded in net income.

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereThe concept of controlControl is the ability of an investor to use its power over the investee to affect variable returns from its investment in the investee. This is usually achieved by owning a majority of the voting shares of the investee.

Significant influence is the ability to influence the strategic operating, investing and financing activities of an investee. This is usually achieved by owning at least 20% (but less than a majority) of the voting shares of the investee.

No influence is no ability to influence the strategic operating, investing and financing activities of an investee. This is usually considered to be the case where the investor owns less than 20% of the voting shares of the investee.

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereThe concept of controlControl may exist without majority ownership.Control may not exist even with majority ownership.Professional judgement must be used to determine whether control (or significant influence) exists.Control will be assumed where majority ownership exists. UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereSubsidiariesA subsidiary is defined as an enterprise controlled by another enterprise (the parent) that has the right and ability to obtain future economic benefits from the resources of the enterprise and is exposed to the related risks.UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereSignificant influenceLike control, significant influence is a matter of determination by applying professional judgement in each case.

Indicators of significant influence include:representation on the board of directors;participation in policy-making processes;material intercompany transactions;exchange of management personnel;exchange of essential technical information.UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereThe equity method of accountingIFRS requires the use of the equity method to report investments where significant influence exists and also for joint ventures.The initial investment is recorded at cost.The investment account is adjusted each period for the investors share of the investees change in retained earnings (i.e., net income less dividends).

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereThe equity method of accountingInvestment income is equal to the investors share of the reported net income of the investee. An entry is made to debit the investment account and credit investment income for that amount.Gains or losses on discontinued operations, other comprehensive income, etc., must be separately reported by the investor.Dividends are credited to the investment account (not income) when received or receivable.

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereThe equity method of accountingOn January 1, 2014, Holding Company Inc. paid $125,000 for 25% of the outstanding shares of Puma Inc. On that date, Puma had net assets of $500,000. During 2014, Puma Inc. had a net income of $100,000 and paid dividends of $80,000 at the end of that year.

Required: Prepare the journal entries to record Holding Companys acquisition of the shares in Puma Inc. and its investment income for the year 2014 if the investment in Puma is recorded using the equity method.

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereThe equity method of accountingAt acquisition:Dr.Investment in Puma Inc. $125,000 Cr.Cash $125,000.

On notification of Puma Inc.s net income for 2014:Dr.Investment in Puma Inc. $ 25,000Cr. Investment income (Puma Inc.) $25,000

On receipt of the dividend:Dr.Cash $ 20,000Cr.Investment in Puma Inc. $20,000

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereThe equity method of accountingIt is possible for the investment account to go into a negative balance. A negative balance can be shown if:the investor has guaranteed obligations of the investee,the investor is committed to provide further financial support, orthe investee seems assured of returning to profitability (not permitted by IFRS but allowed by both ASPE and US GAAP).

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereThe equity method of accountingWhen using the equity method (within IFRS), all of the adjustments that would be required in preparing consolidated statements are also required in determining the investment income of the investor.

These relate primarily to the amortization of components of the difference between the purchase price and net book value at acquisition (the acquisition differential or purchase discrepancy) and the elimination of unrealized gains and losses arising from intercompany transactions.

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereThe equity method of accountingIf there is a loss of value, other than a temporary decline, the investment must be written down with the write-down included in the determination of net income.

Indicators of impairment of an investment include depressed market prices, severe or continued losses, suspension of trading, and liquidity or going concern problems.UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereThe equity method of accountingInvestments are recorded at cost when acquired.The investors share of the income of the investee is recorded as investment income when earned.Dividends are not taken to income but reduce the investment account. Investments are not revalued unless there is a permanent decline in value.A gain or loss is recorded on disposal. All transactions are recorded in net income.

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereChanges in ClassificationWhen the classification of an investment changes, usually due to the purchase or sale of shares in the investee, the accounting must change (prospectively) to conform to the new classification.The investment account balance, on the date of the transaction causing the change in classification, must be updated to that transaction date using the method previously used.When control is initially achieved, any previous investment holding must be revalued to fair value at the date that control is first achieved.UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright hereASPE ProvisionsThe default category for equity investments is fair value through profit and loss.Any equity investment may be reported at fair value.ASPE permit either the equity or the cost method to be used to account for all significant influence investments that are not publicly traded.Investments in and income from cost-accounted investments should be separately reported, net of any impairment losses.The cost method is not permitted for publicly traded investments which must be accounted for at FVTPL.ASPE does not require amortization of any purchase differential when reporting using the equity method.

UNIVERSITY OF BRITISH COLUMBIA#UNIVERSITY OF BRITISH COLUMBIA Copyright here