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CH 17
CH 17
CH 17
Coby Harmon
University of California, Santa Barbara
Westmont College
17-1
CHAPTER 17
Investments
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Describe the accounting for 3. Explain the equity method of
debt investments. accounting.
2. Explain the accounting for 4. Evaluate other major issues
equity investments. related to debt and equity
investments.
17-2
PREVIEW OF CHAPTER 17
Intermediate Accounting
IFRS 3rd Edition
Kieso ● Weygandt ● Warfield
17-3
LEARNING OBJECTIVE 1
Debt Investments Describe the accounting for
debt investments.
17-4 LO 1
Debt Investments
17-5 LO 1
Classification and Measurement of
Financial Assets
ILLUSTRATION 17.1
Classification and Measurement
17-6 LO 1
A Closer Look at Debt Investments
17-7 LO 1
A Closer Look at Debt Investments
17-8 LO 1
Debt Investment at Amortized Cost
January 1, 2019
17-9 LO 1
Debt Investment at Amortized Cost
ILLUSTRATION 17.2
17-10 LO 1
Debt Investment at Amortized Cost
ILLUSTRATION 17.2
Cash 4,000
Debt Investments 614
Interest Revenue 4,614
17-11 LO 1
Debt Investment at Amortized Cost
ILLUSTRATION 17.2
17-12 LO 1
Debt Investment at Amortized Cost
ILLUSTRATION 17.3
17-13 LO 1
ILLUSTRATION 17.2
17-15 LO 1
Debt Investments—Held-for-Collection
and Selling (HFCS)
January 1, 2019
Debt Investments 108,111
Cash 108,111
17-17 LO 1
ILLUSTRATION 17.6
Schedule of Interest
Revenue and Bond
Premium Amortization—
17-18 Effective-Interest Method
ILLUSTRATION 17.6
Cash 5,000
Debt Investments 676
Interest Revenue 4,324
17-19 LO 1
Held-for-Collection and Selling (HFCS)
Interest
Revenue for
2019 = $8,621
ILLUSTRATION 17.6
ILLUSTRATION 17.6
17-21 LO 1
Held-for-Collection and Selling (HFCS)
ILLUSTRATION 17.7
17-22 Computation of Fair Value Adjustment—HFCS (2019) LO 1
Held-for-Collection and Selling (HFCS)
ILLUSTRATION 17.7
17-24 LO 1
Sale of HFCS Securities
Cash 90,000
Loss on Sale of Investments 4,214
Debt Investments 94,214
17-25 LO 1
Sale of HFCS Securities
ILLUSTRATION 17.9
Computation of Fair Value Adjustment—HFCS (2020)
17-26 LO 1
Sale of HFCS Securities
17-28 LO 1
Debt Investments—Trading
17-30 LO 1
Debt Investments—Trading
ILLUSTRATION 17.10
17-31
Unrealized Holding Gain or Loss—Income 3,750
Fair Value Option
17-32 LO 1
Fair Value Option
17-33 LO 1
Fair Value Option
In this situation,
Hardy uses the Debt Investment account to record the
change in fair value at December 31.
It does not use the Fair Value Adjustment account.
The unrealized gain or loss is recorded as part of net
income even though it is managing the investment on a
held-for-collection basis.
Hardy must continue to use the fair value method to record
this investment until it no longer has ownership of the
security.
17-34 LO 1
LEARNING OBJECTIVE 2
Equity Investments Describe the accounting for
equity investments.
17-35 LO 2
Equity Investments
ILLUSTRATION 17.12
Levels of Influence Determine Accounting Methods
17-36 LO 2
Equity Investments
ILLUSTRATION 17.13
Accounting and Reporting for Equity Investments by Category
17-37 LO 2
Equity Investments
17-38 LO 2
Equity Investments
17-39 LO 2
Equity Investments—Trading (Income)
Cash 4,200
Dividend Revenue 4,200
17-41 LO 2
Equity Investments—Trading (Income)
ILLUSTRATION 17.14
Computation of Fair Value Adjustment—
Equity Investment Portfolio (2019)
17-42 LO 2
ILLUSTRATION 17.14
Cash 287,220
Equity Investments 259,700
Gain on Sale of Investments 27,520
17-44 LO 2
Equity Investments—Trading (Income)
17-45
ILLUSTRATION 17.16
17-46 LO 2
Equity Investments—Non-Trading (OCI)
17-47 LO 2
Equity Investments—Non-Trading (OCI)
17-48 LO 2
Equity Investments—Non-Trading (OCI)
Cash 450
Dividend Revenue 450
17-49 LO 2
Equity Investments—Non-Trading (OCI)
ILLUSTRATION 17.21
Financial Statement Presentation of Equity Investments at Fair Value (2019)
17-51 LO 2
Equity Investments—Non-Trading (OCI)
ILLUSTRATION 17.19
Adjustment to Carrying Value of Investment
17-52 LO 2
Equity Investments—Non-Trading (OCI)
ILLUSTRATION 17.19
Adjustment to Carrying Value of Investment
17-53 LO 2
LEARNING OBJECTIVE 3
Equity Investments Explain the equity method of
accounting.
17-54 LO 3
Holdings Between 20% and 50%
Equity Method
Record the investment at cost and subsequently adjust the
amount each period for changes in investee’s net assets.
Investor’s proportionate share of the earnings (losses) of the
investee increases (decreases) the investment’s carrying
amount.
Dividends received from the investee decrease the
investment’s carrying amount.
17-57 LO 3
LEARNING OBJECTIVE 4
Other Reporting Issues Evaluate other major issues
related to debt and equity
investments.
Impairment of Value
A company should evaluate every debt investment accounted for
at amortized cost, at each reporting date, to determine if it has
suffered impairment—a loss in value such that the fair value of
the investment is below its carrying value.
17-58 LO 4
Impairment of Value
Impairment—Investment Measured at
Amortized Cost
Illustration: At December 31, 2018, Mayhew Ltd. has a debt
investment in Bao Group, purchased at par for ¥200,000
(amounts in thousands). The investment has a term of four years,
with annual interest payments at 10 percent, paid at the end of
each year (the historical effective-interest rate is 10 percent). This
debt investment is classified as held-for-collection.
Using the following information record the loss on impairment.
17-59 LO 4
Investment Measured at Amortized Cost
ILLUSTRATION 17.22
Investment Cash Flows
ILLUSTRATION 17.23
Computation of
Impairment Loss
17-61 LO 4
Recovery of Impairment Loss
17-62 LO 4
Impairment of Value
17-63 LO 4
Impairment—Debt Investments (HFCS)
17-64 LO 4
Impairment—Debt Investments (HFCS)
ILLUSTRATION 17.24
HFCS Impairment Entries
17-65 LO 4
Impairment—Debt Investments (HFCS)
ILLUSTRATION 17.25
Financial Statement Presentation
17-66 LO 4
Impairment—Debt Investments (HFCS)
17-67 LO 4
Impairment—Debt Investments (HFCS)
ILLUSTRATION 17.25
Impairment Entries—Increase in Credit Risk
17-68 LO 4
Impairment—Debt Investments (HFCS)
17-69 LO 4
Impairment—Debt Investments (HFCS)
Cash 960,000
Loss on Sale of Debt Investment 10,000
Allowance for Impaired Debt Investments 30,000
Debt Investments 1,000,000
17-70 LO 4
Impairment—Debt Investments (HFCS)
17-71 LO 4
Impairment—Debt Investments (HFCS)
ILLUSTRATION 17.28
Impairment Model Summary
17-72 LO 4
Recycling Adjustments
Reporting Issues
Single-Period Example. To provide an example of the reporting
of investment securities and related gain or loss on held-for-
collection and selling (HFCS) investments, assume that on
January 1, 2019, Hinges plc had cash and share capital—
ordinary of £50,000. At that date, the company had no other
asset, liability, or equity balance. On January 2, Hinges
purchased for cash £50,000 of debt securities classified as
HFCS. On June 30, Hinges sold part of the HFCS security debt
portfolio, realizing a gain as shown in Illustration 17.29.
17-73 LO 4
Reporting Issues
On June 30, Hinges sold part of the HFCS security debt portfolio,
realizing a gain as shown. ILLUSTRATION 17.29
Computation of Realized Gain
Hinges did not purchase or sell any other securities during 2019. It
received £3,000 in interest during the year. At December 31, 2019,
the remaining portfolio is as shown ILLUSTRATION 17.30
Computation of Unrealized Gain
17-74 LO 4
ILLUSTRATION 17.31
ILLUSTRATION 17.32
17-75 LO 4
ILLUSTRATION 17.33
ILLUSTRATION 17.34
17-76 LO 4
Recycling Adjustments
Reporting Issues
Multi-Period Example. When a company sells securities during
the year, double-counting of the realized gains or losses in
comprehensive income can occur.
To ensure that gains and losses are not counted twice when a
sale occurs, a reclassification adjustment is necessary.
17-77 LO 4
Reporting Issues Multi-Period Example
ILLUSTRATION 17.35
HFCS Investment Portfolio (2018)
17-78 LO 4
Reporting Issues Multi-Period Example
ILLUSTRATION 17.35
ILLUSTRATION 17.36
Statement of Comprehensive Income (2018)
17-80 LO 4
Reporting Issues Multi-Period Example
On August, 10, 2019, Open sells its Lehman Inc. bonds for
€105,000 and realizes a gain on the sale.
Cash 105,000
Debt Investments 80,000
Gain on Sale of Investments 25,000
17-81 LO 4
Reporting Issues Multi-Period Example
ILLUSTRATION 17.37
HFCS Investment Portfolio (2019)
The entry to record the unrealized holding gain or loss in 2019 is:
ILLUSTRATION 17.38
Statement of Comprehensive Income (2019)
17-83 LO 4
Reporting Issues Multi-Period Example
17-84 LO 4
Reporting Issues Multi-Period Example
17-85
Transfers Between Categories
17-86 LO 4
Transfers Between Categories
17-87 LO 4
Transfers Between Categories
17-88 LO 4
APPENDIX 17A
Accounting for Derivative
Instruments
LEARNING OBJECTIVE 5
Describe the uses of and accounting for derivatives.
Defining Derivatives
Financial instruments that derive their value from values of
other assets (e.g., ordinary shares, bonds, or commodities).
2. Options.
3. Swaps.
17-89 LO 5
APPENDIX 17A
Accounting for Derivative
Instruments
17-90 LO 5
APPENDIX 17A
Accounting for Derivative
Instruments
17-91 LO 5
APPENDIX 17A
Accounting for Derivative
Instruments
17-93 LO 5
APPENDIX 17A
Accounting for Derivative
Instruments
Time value refers to the option’s value over and above its
intrinsic value. Time value reflects the possibility that the option
has a fair value greater than zero. How? Because there is some
expectation that the price of Laredo shares will increase above
the strike price during the option term. As indicated, the time
value for the option is €400.
17-94 LO 5
APPENDIX 17A
Accounting for Derivative
Instruments
On March 31, 2019, the price of Laredo shares increases to €120 per
share. The intrinsic value of the call option contract is now €20,000.
That is, the company can exercise the call option and purchase 1,000
shares from Baird Investment for €100 per share. It can then sell the
shares in the market for €120 per share. This gives the company a gain
€20,000
on the option contract of ____________. (€120,000 - €100,000)
17-95 LO 5
APPENDIX 17A
Accounting for Derivative
Instruments
17-97 LO 5
APPENDIX 17A
Accounting for Derivative
Instruments
The decrease in the time value of the option of €40 (€100 - €60)
is recorded as follows.
Unrealized Holding Gain or Loss—Income 40
Call Option 40
17-98 LO 5
APPENDIX 17A
Accounting for Derivative
Instruments
17-101 LO 5
APPENDIX 17A
Accounting for Derivative
Instruments
ILLUSTRATION 17A.3
17-102 LO 5
APPENDIX 17A
Accounting for Derivative
Instruments
LEARNING OBJECTIVE 6
Explain the accounting for hedges.
17-103 LO 6
APPENDIX 17A
Accounting for Derivative
Instruments
17-104 LO 6
APPENDIX 17A
Accounting for Derivative
Instruments
17-105 LO 6
APPENDIX 17A
Accounting for Derivative
Instruments
17-106 LO 6
APPENDIX 17A
Accounting for Derivative
Instruments
ILLUSTRATION 17A.6
17-108 LO 6
APPENDIX 17A
Accounting for Derivative
Instruments
Reporting:
Fair value on the statement of financial position.
Gains or losses in equity, as part of other comprehensive
income.
17-109 LO 6
APPENDIX 17A
Accounting for Derivative
Instruments
17-111 LO 6
APPENDIX 17A
Accounting for Derivative
Instruments
Cash 25,000
Futures Contract (¥1,575,000 - ¥1,550,000) 25,000
17-112 LO 6
APPENDIX 17A
Accounting for Derivative
Instruments
There are no income effects at this point. Allied accumulates in equity the
gain on the futures contract as part of other comprehensive income until the
period when it sells the inventory.
17-113 LO 6
APPENDIX 17A
Accounting for Derivative
Instruments
Cash 2,000,000
Sales Revenue 2,000,000
17-114 LO 6
APPENDIX 17A
Accounting for Derivative
Instruments
July 2020
Unrealized Holding Gain or Loss—Equity 25,000
Cost of Goods Sold 25,000
The gain on the futures contract, which Allied reported as part of other
comprehensive income, now reduces cost of goods sold. As a result, the cost of
aluminum included in the overall cost of goods sold is ¥1,550,000.
17-115 LO 6
APPENDIX 17A
Accounting for Derivative
Instruments
Embedded Derivatives
A convertible bond is a hybrid instrument. Two parts:
1. a debt security, referred to as the host security, and
2. an option to convert the bond to shares of common stock,
the embedded derivative.
Accounted for as a single unit.
17-116 LO 7
APPENDIX 17A
Accounting for Derivative
Instruments
17-117 LO 7
APPENDIX 17A
Accounting for Derivative
Instruments
17-118 LO 7
APPENDIX 17A
Accounting for Derivative
Instruments
The most common type of swap is the interest rate swap. In this
type, one party makes payments based on a fixed or floating
rate, and the second party does just the opposite.
17-119 LO 7
APPENDIX 17A
Accounting for Derivative
Instruments
17-120 LO 7
APPENDIX 17A
Accounting for Derivative
Instruments
Cash 1,000,000
Bonds Payable 1,000,000
17-121 LO 7
Fair Value Hedge
Jones agrees to the following terms:
1. Jones will receive fixed payments at 8 percent (based on the
€1,000,000 amount).
2. Jones will pay variable rates, based on the market rate in
effect for the life of the swap contract. The variable rate at the
inception of the contract is 6.8 percent. ILLUSTRATION 17A.10
Interest Rate Swap
17-122 LO 7
Fair Value Hedge
Assuming that Jones enters into the swap on January 2, 2019 (the
same date as the issuance of the debt), the swap at this time has
no value. Therefore, no entry is necessary.
At the end of 2019, Jones makes the interest payment on the
bonds. It records this transaction as follows.
17-123 LO 7
Fair Value Hedge
At the end of 2019, market interest rates have declined
substantially. Therefore, the value of the swap contract increases.
Recall (see Illustration 17A.9) that in the swap, Jones receives a
fixed rate of 8 percent, or €80,000 (€1,000,000 × 8%), and pays a
variable rate (6.8%), or €68,000. Jones therefore receives €12,000
(€80,000 − €68,000) as a settlement payment on the swap contract
on the first interest payment date.
Jones records this transaction as follows.
Cash 12,000
Interest Expense 12,000
17-124 LO 7
Fair Value Hedge
In addition, a market appraisal indicates that the value of the
interest rate swap has increased €40,000. Jones records this
increase in value as follows.
17-125 LO 7
ILLUSTRATION 17A.11
ILLUSTRATION 17A.12
17-126 LO 7
APPENDIX 17B Fair Value Disclosures
LEARNING OBJECTIVE 8
Describe required fair value disclosures.
17-129 LO 8
APPENDIX 17B Fair Value Disclosures
17-130 LO 8
GLOBAL ACCOUNTING INSIGHTS
LEARNING OBJECTIVE 9
Compare the accounting for investments under IFRS and U.S. GAAP.
Until recently, when the IASB issued IFRS 9, the accounting and reporting for
investments under IFRS and U.S. GAAP were for the most part very similar.
While IFRS 9 introduces new investment classifications relative to U.S. GAAP,
both IFRS and U.S. GAAP have increased situations when investments are
accounted for at fair value, with gains and losses recorded in income.
17-131 LO 9
GLOBAL ACCOUNTING INSIGHTS
Relevant Facts
Following are the key similarities and differences between U.S. GAAP and
IFRS related to investments.
Similarities
• U.S. GAAP and IFRS use similar classifications for financial assets: cash,
loans and receivables, investments, and derivatives.
• Both IFRS and U.S. GAAP require that financial assets be sorted into
specific categories for measurement and classification purposes.
• Held-to-maturity (U.S. GAAP) and held-for-collection (IFRS) investments
are accounted for at amortized cost. Gains and losses on some investments
are reported in other comprehensive income.
17-132 LO 9
GLOBAL ACCOUNTING INSIGHTS
Relevant Facts
Similarities
• Amortized cost or fair value is used depending upon the classification of the
financial instrument.
• The definitions of amortized cost and fair value are the same.
• Both U.S. GAAP and IFRS use the same test to determine whether the
equity method of accounting should be used, that is, significant influence
with a general guideline of over 20 percent ownership.
• U.S. GAAP and IFRS are similar in the accounting for the fair value option.
That is, the option to use the fair value method must be made at initial
recognition, the selection is irrevocable, and gains and losses are reported
as part of income.
• Under both U.S. GAAP and IFRS, credit losses are recognized in income.
17-133
GLOBAL ACCOUNTING INSIGHTS
Relevant Facts
Differences
• While U.S. GAAP classifies debt investments as trading, available-for-sale,
and held-to-maturity, IFRS classifies debt investments as held-for-collection,
held-for-collection and selling (debt investments), and trading.
• U.S. GAAP requires that all changes in fair value for all equity securities be
reported as part of income. IFRS requires that changes in fair value for non-
trading equity securities be reported as part of other comprehensive
income.
17-134 LO 9
GLOBAL ACCOUNTING INSIGHTS
Relevant Facts
Differences
• U.S. GAAP measures impairments based on lifetime expected credit losses.
IFRS uses lifetime expected losses for financial assets that have
experienced a significant increase in credit risk since initial recognition
(otherwise, the credit loss allowance is based on 12-month expected credit
losses).
• U.S. GAAP generally does not permit the reversal of an impairment charge
related to held-to-maturity debt investments and equity investments. IFRS
allows reversals of impairments of held-for-collection investments.
• In the accounting for the fair value option, one difference is that U.S. GAAP
permits the fair value option for all financial assets; IFRS allows the fair
value option if doing so reduces an accounting mismatch.
17-135 LO 9
GLOBAL ACCOUNTING INSIGHTS
On the Horizon
At one time, both the FASB and IASB indicated that they believed that all
financial instruments should be reported at fair value and that changes in fair
value should be reported as part of net income. Through recent standards in
this area, the Boards continue to move toward that goal. U.S. GAAP and IFRS
are substantially converged, except for non-trading equity investments and the
measurement of credit losses.
17-136 LO 9
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17-137