Reading 14: Intercorporate investments
what is upstream
(Associate to investor) A transaction between two related companies, an investor company (or a parent company) and an associate company (or a subsidiary company) such that the associate company records a profit on its income statement. An example is a sale of inventory by the associate to the investor company or by a subsidiary to a parent company.
what is downstream
(investor to associate) A transaction between two related companies, an investor company (or a parent company) and an associate company (or a subsidiary) such that the investor company records a profit on its income statement. An example is a sale of inventory by the investor company to the associate or by a parent to a subsidiary company.
what are the 4 basic classifications of investments in financial assets under IFRS
1) held-to-maturity, 2) fair value through profit or loss, 3) available-for-sale, and 4) loans and receivables. Under IFRS, financial assets classified as fair value through profit or loss includes both financial assets held for trading and financial assets specifically designated as through profit or loss by management.
After IFRS 9 what are the criteria to use amortized cost
A business model test: The financial assets are being held to collect contractual cash flows; and A cash flow characteristic test: The contractual cash flows are solely payments of principal and interest on principal.
how are held to maturity investments reported/initially recognized
At each reporting date (subsequent to initial recognition), IFRS and US GAAP require that held-to-maturity securities are reported at amortized cost using the effective interest rate method,4 unless objective evidence of impairment exists. IFRS require that held-to-maturity securities be initially recognized at fair value, whereas US GAAP require held-to-maturity securities be initially recognized at initial price paid.
what are the 4 different ways US GAAP allows reclassification of securities
If a security initially classified as held for trading is reclassified as available-for-sale, any unrealized gains and losses (arising from the difference between its carrying value and current fair value) are recognized in profit and loss. If a security is reclassified as held for trading, the unrealized gains or losses are recognized immediately in profit and loss. In the case of reclassification from available-for-sale, the cumulative amount of gains and losses previously recognized in other comprehensive income is recognized in profit and loss on the date of transfer. If a debt security is reclassified as available-for-sale from held-to-maturity, the unrealized holding gain or loss at the date of the reclassification (i.e., the difference between the fair value and amortized cost) is reported in other comprehensive income. If a debt security is reclassified as held-to-maturity from available-for-sale, the cumulative amount of gains or losses previously reported in other comprehensive income will be amortized over the remaining life of the security as an adjustment of yield (interest income) in the same manner as a premium or discount.
how would you measure the financial assets under IFRS 9
If the financial asset meets the criteria above but may be sold, a "hold-to-collect and sell" business model, it may be measured at fair value through other comprehensive income (FVOCI). However, management may choose the "fair value through profit or loss" (FVPL) option to avoid an accounting mismatch.10 An "accounting mismatch" refers to an inconsistency resulting from different measurement bases for assets and liabilities.
how are ratios impacted from IFRS and GAAP from partial/full goodwill
Net income to parents shareholders are the same since depreciation is the same under both methods, but since shareholders equity is lower the ratios higher for ROA/ROE
who allows partial goodwill
Only IFRS allows partial goodwill
how do you amortize excess purchase price
The excess purchase price allocated to the assets and liabilities is accounted for in a manner that is consistent with the accounting treatment for the specific asset or liability to which it is assigned. Usually PPE is amortized over useful life, but land and goodwill are not amortized. Annual amortization would reduce the investor's share of the investee's reported income (equity income) and the balance in the investment account
transactions with associates
Transactions between the two affiliates may be upstream (associate to investor) or downstream (investor to associate). In an upstream sale, the profit on the intercompany transaction is recorded on the associate's income (profit or loss) statement. The investor's share of the unrealized profit is thus included in equity income on the investor's income statement. In a downstream sale, the profit is recorded on the investor's income statement. Both IFRS and US GAAP require that the unearned profits be eliminated to the extent of the investor's interest in the associate.
how do IFRS and US GAAP differ on the treatment of foreign exchange gains and losses on available for sale debt securities
Under IFRS the foreign exchange gain/loss is recognized in the income statement but under US GAAP it is included in other comprehensive income along with the change in fair value
how is goodwill impairment calculated in IFRS
Under IFRS, at the time of acquisition, the total amount of goodwill recognized is allocated to each of the acquirer's cash-generating units that will benefit from the expected synergies resulting from the combination with the target. A cash-generating unit represents the lowest level within the combined entity at which goodwill is monitored for impairment purposes. Goodwill impairment testing is then conducted under a one-step approach. The recoverable amount of a cash-generating unit is calculated and compared with the carrying value of the cash-generating unit. An impairment loss is recognized if the recoverable amount of the cash-generating unit is less than its carrying value. The impairment loss (the difference between these two amounts) is first applied to the goodwill that has been allocated to the cash-generating unit. Once this has been reduced to zero, the remaining amount of the loss is then allocated to all of the other non-cash assets in the unit on a pro rata basis.
how is non controlling interest calculated differently under partial goodwill and total goodwill method?
Under IFRS, the parent can measure the non-controlling interest at either its fair value (full goodwill method) or at the non-controlling interest's proportionate share of the acquiree's identifiable net assets (partial goodwill method). Under US GAAP, the parent must use the full goodwill method and measure the non-controlling interest at fair value.
how is goodwill impairment calculated in US GAAP
Under US GAAP, at the time of acquisition, the total amount of goodwill recognized is allocated to each of the acquirer's reporting units. A reporting unit is an operating segment or component of an operating segment that is one level below the operating segment as a whole. Goodwill impairment testing is then conducted under a two-step approach: identification of impairment and then measurement of the loss. First, the carrying amount of the reporting unit (including goodwill) is compared to its fair value. If the carrying value of the reporting unit exceeds its fair value, potential impairment has been identified. The second step is then performed to measure the amount of the impairment loss. The amount of the impairment loss is the difference between the implied fair value of the reporting unit's goodwill and its carrying amount. The implied fair value of goodwill is determined in the same manner as in a business combination (it is the difference between the fair value of the reporting unit and the fair value of the reporting unit's assets and liabilities). The impairment loss is applied to the goodwill that has been allocated to the reporting unit. After the goodwill of the reporting unit has been eliminated, no other adjustments are made automatically to the carrying values of any of the reporting unit's other assets or liabilities.
Basic principles of equity method of accounting
Under the equity method of accounting, the equity investment is initially recorded on the investor's balance sheet at cost. In subsequent periods, the carrying amount of the investment is adjusted to recognize the investor's proportionate share of the investee's earnings or losses, and these earnings or losses are reported in income. Dividends or other distributions received from the investee are treated as a return of capital and reduce the carrying amount of the investment and are not reported in the investor's profit or loss. The equity method is often referred to as "one-line consolidation" because the investor's proportionate ownership interest in the assets and liabilities of the investee is disclosed as a single line item (net assets) on its balance sheet, and the investor's share of the revenues and expenses of the investee is disclosed as a single line item on its income statement.
can you reclassify debt/equity instruments under new method?
Under the new standard, the reclassification of equity instruments is not permitted because the initial classification of FVPL and FVOCI is irrevocable. Reclassification of debt instruments is only permitted if the business model for the financial assets (objective for holding the financial assets) has changed in a way that significantly affects operations. Changes to the business model will require judgment and are expected to be very infrequent.
how are available for sale investments classified
debt and equity securities not classified as held-to-maturity or fair value through profit or loss. Under both IFRS and US GAAP, investments classified as available-for-sale are initially measured at fair value. At each subsequent reporting date, the investments are remeasured and recognized at fair value. Unrealized gain or loss at the end of the reporting period is the difference between fair value and the carrying amount at that date. Other comprehensive income (in shareholder's equity) is adjusted to reflect the cumulative unrealized gain or loss
how do you find goodwill
goodwill is the residual of the excess purchase price after your take out the portion attributable to net assets such as plant and equipment and land. These are excess of book value and fair value and takes the percentage of ownership.
how do you calculate excess purchase price
purchase price - % of book value of investment
what are the 2 classifications for financial assets in IFRS 9
those measured at amortized cost and those measured at fair value. All financial assets are measured at fair value when initially acquired. Subsequently, financial assets are measured at either fair value or amortized cost.
