Chapter 2 - Investments in Equity Securities

Under the equity method of accounting for investments, how are the following transactions accounted for: 1) Income from the associate company (investee) 2) Dividends declared

1) Income from the associate company -> These are treated as increases or reductions to the investment account proportional to the % ownership in the investee (Ie. 10% investment would equate to 10% of the investee net income) 2) Dividends declared -> These decrease the investment account to the extent of the dividend declared Note, the overall accounting objective here is to reflect the accrual of income from this investment (Ie. Dividends aren't always paid out periodically, but can be accrued into the investment income account)

If an investment is deemed to be impaired, what two valuation methods can an investor employ the estimate it's value?

1) It's share of the present value of the estimated future cash flows expected to be generated by the associate (including the cash flows from operations AND the proceeds of the ultimate disposal of the investment) OR 2) The present value of the estimate future cash flows expected to arise from dividends to be received and from the disposal of the investment

What are six key disclosures required by IFRS 12 for investments in associates?

1) Nature of the entity's relationship with the associate and the proportion of ownership interest or participating shares held by the entity 2) Fair value of investments in associates for which there are published price quotations 3) Summarized financial information of associates, including the aggregated amounts of assets, liabilities, revenues, and profit or loss 4) Unrecognized share of losses of an associate, both for the period and cumulatively, if an investor has discontinued recognition of its share of losses of an associate. 5) Nature and extent of any significant restrictions on the ability of associates to transfer funds to the entity in the form of cash dividends, or to repay loans or advances made by the entity 6) Contingent liabilities incurred relating to its interests in associates

What are five possible indicators that would suggest an investee is an associate in the company they are investing in (Ie. Significant influence investments/strategic investment)?

1) Representation on the board of directors or equivalent governing body of the investee 2) Participation in policy-making processes, including participation in decisions about dividends or other distributions 3) Material transactions between the investor and the investee 4) Interchange of managerial personnel 5) Provision of essential technical information

Under what two circumstances would an investor company recognize liabilities from an investee company after the associate's losses exceed the carrying amount of the investment?

1) The investor has a legal obligation as a guarantor of the investee's liability 2) The investor has a constructive obligation, which can occur if it has always bailed out an associate for certain liabilities in the past even though it had not agreed, in writing, to do so.

What is an unrealized profit? How are these handled under the equity method?

An unrealized profit occurs when, during an inter-company transfer of assets, a profit is achieved. Given that you can not achieve a profit from selling to yourself, the equity method dictates that these profits must be held back on an after-tax basis in the investor's equity method journal entires. When the asset is sold outside or consumed by the purchaser, the after-tax profit is realized.

How should an investment that has previously been accounted for under FVTPL be handled if circumstances result in this investment becoming one of significant influence? Are these changes made retroactively or prospectively?

If this occurs, the carrying value of the FVTPL investment (essentially the fair value of the investment) would become the new cost. Any changes are made on a prospective basis given that the circumstances that warranted the adjustment were not present in prior periods.

When determining the gain (loss) on the income statement, how would the calculation differ in the following two scenarios: 1) All of the shares are sold 2) Some of the shares are sold

In scenario #1, the gain (loss) would be calculated as the difference between the sale proceeds and the carrying amount of the investment. In scenario #2, the gain (loss) would be calculated using the average carrying amount of the investment would be applied to the above calculation.

How should an investment that has previously been accounted for under the equity method be handled if significant influence is lost?

In this instance, the equity method would cease to be appropriate and FVTPL would take its place on a prospective basis. On this date, the investor measures any investments the investor retains in the former associate at fair value. The investor also recognizes in net income any difference between: 1) The fair value of any retained investment and any proceeds from disposing of the part interest in the associate and 2) The carrying amount of the investment at the date when significant influence is lost

What is a liquidating dividend and how is this handled under the cost method?

Liquidating dividends occur when the cumulative amount paid out as dividends exceeds the cumulative net income earner by the investee (company that is invested in since the initial investment. Since dividends are substantively a method of distributing earnings to owners and it follows that you can't distribute more than you've earned, this traditionally was treated as a reduction in investment accounts. However, this has since been streamlined under the cost method to still be treated as dividend income regardless..

What are the two main categories of equity investments?

Strategic -> The investor intends to establish/maintain a long-term operating relationship with the entity and has some level of influence over strategic decisions Non-strategic -> Investor is looking for a reasonable rate of return without wanting or having the ability to play an active role in the strategic decisions of the entity

Can the percentage of voting shares be used to determine whether an equity investment involves significant influence?

The % of voting shares in an entity can often be segregated into three general ranges: • Greater than 50% -> The investor objectively has significant influence • Between 20-50% -> The investor may or may not have significant influence. This depends on a variety of qualitative and quantitative indicators, including how the remainder of the voting shares are distributed (Ie. Does someone else have majority shares?) • Below 20% -> The investor usually does not have significant influence

What criteria must be met in order for an investment to be classified as "Held for sale"? How would these investments be valued and classified?

The criteria for being classified as "Held for Sale" are as follows: • The asset must be available for immediate sale in its present condition • The sale must be highly probable (management must be committed to a plan to sell and have an active program locate a buyer) These investments would be valued at the lower of carrying amount and fair value less costs of disposal and should be classified as current assets.

According to IFRS 9, how must all non-strategic equity investments be measured? How should unrealized gains/losses in these investments be recorded, what types of investments fall into each category, and how are dividends handled?

These investments must be recorded at fair value. In terms of recognizing gains and losses, there are two methods: • FVTPL -> Unrealized gains and losses are recycled through net income. This is used for investments held for short-term trading (current assets). Dividends go through net income too. • Other- Elect FVTOCI -> Unrealized gains are recognized through OCI. Once the equity instrument is sold, the accumulated OCI is cleared directly into retained earnings (never touches the income statement). Management makes this irreversible election upon initial acquisition, regardless of whether they classify it as current or non-current. Dividends are reported through net income.

Under the equity method, how are the following income items from an associate company accounted for by the investor: • Income from continuing operations • Income from discontinued operations • Other comprehensive income

These items are all separated out as follows: • Income from continuing operations -> Increases or reduces the investment account • Income from discontinued operations -> Increases or reduces "Discontinued operations - investment" account • Other comprehensive income -> Increases or reduces "Other comprehensive income - related to associate" Note that any difference from these items are closed out into the investment account.

What is an acquisition differential? Generally speaking, how is this differential handled?

This is the difference between the investor's cost of an equity investment and the investor's percentage of the carrying amount of the identifiable net assets. The investor would then allocate this differential to specific assets/liabilities of the associate and either depreciate the allocated component over its useful life or write it down when there's been an impairment.

Under what circumstances would the cost method of reporting an equity investment be used under IFRS? What about ASPE?

Under IFRS, the cost method of reporting would be used in the following situations: • For investments in controlled entities -> This is an option when the reporting entity prepares separate-entity financial statements • For a parent company's internal accounting records prior to preparing consolidated financial statements Under ASPE, this method is used when equity investments are not quoted in an active market.

For the cost method of accounting for equity investments, how is the equity investment valued in the financial statements? How are dividends handled?

Under this method, the investment is initially recorded at cost. At each subsequent reporting date, the investment is reported at that same value unless it becomes impaired, in which case the investment is written down and the impairment loss is reported through net income. Dividends declared (doesn't matter if it's received or receivable) are funnelled through net income in this method.