Com 202 - Chapter 12
Using the Fair Value Model?
- Any increase or decrease in market price changes the carrying amount on the statement of financial position - Corresponding unrealized gain or loss is recorded in: 1) The income statement (through profit or loss model) 2) Other comprehensive income (if this model, on an investment-by-investment basis) - Usually done via an adjusting journal entry at year end - Any realized gains or losses on disposition are also reported on the same statement - No difference in reporting unrealized and realized gains and losses, except for fair value through OCI debt investments
Reasons for purchasing non-strategic investments?
- Effective use of excess cash. Generally invest in debt securities that have low risk and high liquidity. - To earn capital gains: invest in debt and equity securities with the hope of selling them later at a higher price and benefiting from their price appreciation. The resulting gain is called a capital gain, which receives preferential income tax treatment in Canada because only half of the gain is usually taxed. - held for trading investments: Non-strategic investments that are held for the purpose of earning capital gains are called held for trading investments.
Reporting Investments: Statement of Financial Position Under ASPE - Non-strategic investments?
- Equity investments with quoted prices in active markets 1) Fair value through profit or loss 2) Presentation: current or non-current based on management intention - No active market or not an equity investment 1) Amortized cost if debt or cost model if equity 2) Presentation: current or non-current based on management intention
Debt investment?
- Guaranteed investment certificates or term deposits, bonds, commercial paper and other debt securities - Earn interest over time - Borrower is usually obligated to return the original investment (principal)
The fair value model is used unless..?
- Investment is held to earn cash flows with fixed payment dates (usually debt instruments). Use amortized cost method - Investment is not held to earn cash flows and does not trade in an active market. Fair value model cannot be used.
Cost Model?
- Investment is recorded and cost and is not adjusted until the investment is sold - When investee declares a dividend, investor records dividend revenue - Used under certain circumstances
Reporting Investments: Statement of Financial Position Under IFRS - Non-strategic investments?
- Investment purchased to earn contractual cash flows. 1) Amortized cost model; optional use of fair value through profit or loss 2) Presentation: current or non-current presentation based on contract - Investment not purchased to earn contractual cash flows (example: trading investments) 1) Fair value through profit or loss; some exceptions through OCI 2) Presentation: Usually current assets (but not always)
Reporting Investments: Statement of Financial Position Under ASPE - Stre
- Investor has control 1) Consolidation, or 2) If fair value known, equity method or fair value through profit or loss - Investor has significant influence, but no control 1) If fair value known, equity method or fair value through profit or loss 2) If not known, equity method or cost model
Reporting Investments: Statement of Financial Position Under IFRS - Strategic investments?
- Investor has control: Consolidation - Investor has significant influence, but no control: Equity method; non-current
Equity Method? (More than 20%)
- Investor is considered to have significant influence over the investee (associate) - Investment in common shares is initially recorded at cost "Investment in Associates" account - Investment account adjusted annually to show how the investor's equity in the investee has changed - The investor's share of associate's net income or loss (increases or decreases investment in associate's account) - Dividends earned (decreases investment in associate's account)
Strategic Investments?
- Only equity securities (normally common shares) can be considered a strategic investment - To influence the relationship between companies - Usually classified as long-term investments
Equity investment?
- Preferred and common shares of other corporations - May or may not earn any revenue - No obligation to return principal - Unlike debt investments, equity investments are riskier because they have no requirement to receive any form of revenue through dividends over time or to receive a return of the original amount invested.
Accounting for Non-Strategic Investments?
- Recorded at purchase cost at acquisition. - After acquisition, four alternate valuation models 1. Fair value through profit or loss model: - Investments are adjusted up or down to reflect fair value at end of period - Causes an unrealized gain or loss, recorded in the income statement 2. Fair value through other comprehensive income (OCI) model - As above, except unrealized gain or loss is recorded in other comprehensive income 3. Amortized cost model (applies only to debt investments - Not adjusted to reflect fair value - Any discount or premium on purchase is amortized over the remaining life of the investment 4. Cost model - Used for equity investments when fair value not available - No adjustment to record at fair value - this investment does not give rise to a discount or premium the concept of amortization does not apply to this model
What is the difference between unrealized gains and losses and realized gains and losses?
- Unrealized gains/losses are the different between an investment's fair value and carrying amount. - Realized gains/losses differ as they are based upon the amount the investment is actually sold for.
When investing excess cash for short periods of time?
- When investing excess cash for short periods of time, corporations generally invest in debt securities that have low risk and high liquidity. - Examples include guaranteed investment certificates, bankers' acceptances, term deposits, and treasury bills. - It is usually not wise to invest short-term excess cash in equity securities such as common shares of other companies because share prices can fluctuate significantly over the short term
Non-strategic investments can be further classified as?
- as short-term investments or long-term investments. - depends on liquidity of investment and how long management wishes to hold the investment
Accounting for Strategic Investments - percentage of ownership? ?
- if the investor owns less than 20% of the investee's common shares, then they are unable to influence or control the investee. In this case, the investment is accounted for using one of the fair value models - When an investor owns 20% or more of the common shares of another company but does not have control (less than 50% of the common shares), the investor is generally presumed to have a significant influence over the decisions of the investee company. When an investee can be significantly influenced, it is known as an associate. - If the investor has more than 50% of the investee's voting shares, it is assumed that the investor controls the investee. In this case, the investee is considered to be a subsidiary company of the investor or parent company. Even though the investee is a separate legal entity, it is part of a group of corporations controlled by the parent company.
If a company has excess cash for a prolonged period of time?
-if a company has excess cash for a prolonged period of time, and wants a low-risk investment, bonds or preferred shares may be purchased because their values do not fluctuate very much. - Although a company is not required to pay out a dividend, as discussed in Chapter 11, it is common to do so for preferred shares. Investments of this nature usually generate steady amounts of dividend revenue over time.
First Classification of Investments ?
1) Debt investment 2) Equity investment
Classifying Investments?
1) Non-strategic investments To generate investment income. Often made to earn income from interest, dividends, and gains upon the sale of the investment. 2) Strategic investments To influence or control the operations of another company