INSIGHTS

The accounting for investments is discussed in IAS 27 (“Consolidated and Separate Financial Statements”), IAS 28 (“Accounting for Investments in Associates”), IAS 39 (“Financial Instruments: Recognition and Measurement”), and IFRS 9 (“Financial Instruments”). Until recently, when the IASB issued IFRS 9, the accounting and reporting for investments under IFRS and GAAP were for the most part very similar. However, IFRS 9 introduces new investment classifications and increases the situations when investments are accounted for at fair value, with gains and losses recorded in income.

RELEVANT FACTS

Following are the key similarities and differences between GAAP and IFRS related to investments.

Similarities

• GAAP and IFRS use similar classifications for trading investments.
• The accounting for trading investments is the same between GAAP and IFRS. Held-to-maturity (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.
• Both 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.
• 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.
• The measurement of impairments is similar under GAAP and IFRS.

Differences

• While GAAP classifies investments as trading, available-for-sale (both debt and equity investments), and held-to-maturity (only for debt investments), IFRS uses held-for-collection (debt investments), trading (both debt and equity investments), and non-trading equity investment classifications.
• The basis for consolidation under IFRS is control. Under GAAP, a bipolar approach is used, which is a risk-and-reward model (often referred to as a variable-entity approach, discussed in Appendix 17B) and a voting-interest approach. However, under both systems, for consolidation to occur, the investor company must generally own 50 percent of another company.
• While the measurement of impairments is similar under GAAP and IFRS, GAAP does not permit the reversal of an impairment charge related to available-for-sale debt and equity investments. IFRS allows reversals of impairments of held-for-collection investments.
• While GAAP and IFRS are similar in the accounting for the fair value option, one difference is that GAAP permits the fair value option for equity method investments; IFRS does not.

ABOUT THE NUMBERS

Accounting for Financial Assets

A financial asset is cash, an equity investment of another company (e.g., ordinary or preference shares), or a contractual right to receive cash from another party (e.g., loans, receivables, and bonds). The accounting for cash is relatively straightforward and is discussed in Chapter 7. The accounting and reporting for equity and debt investments, as discussed in the opening story, is extremely contentious, particularly in light of the credit crisis in the latter part of 2008.

IFRS requires that companies determine how to measure their financial assets based on two criteria:

• The company's business model for managing its financial assets; and
• The contractual cash flow characteristics of the financial asset.

If a company has (1) a business model whose objective is to hold assets in order to collect contractual cash flows and (2) the contractual terms of the financial asset provides specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding, then the company should use amortized cost.

For example, assume that Mitsubishi purchases a bond investment that it intends to hold to maturity. Its business model for this type of investment is to collect interest and then principal at maturity. The payment dates for the interest rate and principal are stated on the bond. In this case, Mitsubishi accounts for the investment at amortized cost. If, on the other hand, Mitsubishi purchased the bonds as part of a trading strategy to speculate on interest rate changes (a trading investment), then the debt investment is reported at fair value. As a result, only debt investments such as receivables, loans, and bond investments that meet the two criteria above are recorded at amortized cost. All other debt investments are recorded and reported at fair value.

Equity investments are generally recorded and reported at fair value. Equity investments do not have a fixed interest or principal payment schedule and therefore cannot be accounted for at amortized cost. In summary, companies account for investments based on the type of security, as indicated in Illustration IFRS17-1.

Debt Investments

Debt Investments—Amortized Cost

Only debt investments can be measured at amortized cost. If a company like Carrefour makes an investment in the bonds of Nokia, it will receive contractual cash flows of interest over the life of the bonds and repayment of the principal at maturity. If it is Carrefour's strategy to hold this investment in order to receive these cash flows over the life of the bond, it has a held-for-collection strategy and it will measure the investment at amortized cost.⁴⁴

Example: Debt Investment at Amortized Cost. To illustrate the accounting for a debt investment at amortized cost, assume that Robinson Company purchased $100,000 of 8 percent bonds of Evermaster Corporation on January 1, 2014, at a discount, paying $92,278. The bonds mature January 1, 2019, and yield 10 percent; interest is payable each July 1 and January 1. Robinson records the investment as follows.

As indicated in Chapter 14, companies must amortize premiums or discounts using the effective-interest method. They apply the effective-interest method to bond investments in a way similar to that for bonds payable. To compute interest revenue, companies compute the effective-interest rate or yield at the time of investment and apply that rate to the beginning carrying amount (book value) for each interest period. The investment carrying amount is increased by the amortized discount or decreased by the amortized premium in each period.

Illustration IFRS17-2 shows the effect of the discount amortization on the interest revenue that Robinson records each period for its investment in Evermaster bonds.

Robinson records the receipt of the first semiannual interest payment on July 1, 2014 (using the data in Illustration IFRS17-2), as follows.

Because Robinson is on a calendar-year basis, it accrues interest and amortizes the discount at December 31, 2014, as follows.

Again, Illustration IFRS17-2 shows the interest and amortization amounts. Thus, the accounting for held-for-collection investments in IFRS is the same as held-to-maturity investments under GAAP.

Debt Investments—Fair Value

In some cases, companies both manage and evaluate investment performance on a fair value basis. In these situations, these investments are managed and evaluated based on a documented risk-management or investment strategy based on fair value information. For example, some companies often hold debt investments with the intention of selling them in a short period of time. These debt investments are often referred to as trading investments because companies frequently buy and sell these investments to generate profits in short-term differences in price.

Companies that account for and report debt investments at fair value follow the same accounting entries as debt investments held-for-collection during the reporting period. That is, they are recorded at amortized cost. However, at each reporting date, companies adjust the amortized cost to fair value, with any unrealized holding gain or loss reported as part of net income (fair value method). An unrealized holding gain or loss is the net change in the fair value of a debt investment from one period to another.

Example: Debt Investment at Fair Value. To illustrate the accounting for debt investments using the fair value approach, assume the same information as in our previous illustration for Robinson Company. Recall that Robinson Company purchased $100,000 of 8 percent bonds of Evermaster Corporation on January 1, 2014, at a discount, paying $92,278.⁴⁵ The bonds mature January 1, 2019, and yield 10 percent; interest is payable each July 1 and January 1.

The journal entries in 2014 are exactly the same as those for amortized cost. These entries are as follows.

Again, Illustration IFRS17-2 shows the interest and amortization amounts. If the debt investment is held-for-collection, no further entries are necessary. To apply the fair value approach, Robinson determines that, due to a decrease in interest rates, the fair value of the debt investment increased to $95,000 at December 31, 2014. Comparing the fair value with the carrying amount of these bonds at December 31, 2014, Robinson has an unrealized holding gain of $1,463, as shown in Illustration IFRS17-3.

Robinson therefore makes the following entry to record the adjustment of the debt investment to fair value at December 31, 2014.

Robinson uses a valuation account (Fair Value Adjustment) instead of debiting Debt Investments to record the investment at fair value. The use of the Fair Value Adjustment account enables Robinson to maintain a record at amortized cost in the accounts. Because the valuation account has a debit balance, in this case the fair value of Robinson's debt investment is higher than its amortized cost.

The Unrealized Holding Gain or Loss—Income account is reported in the other income and expense section of the income statement as part of net income. This account is closed to net income each period. The Fair Value Adjustment account is not closed each period and is simply adjusted each period to its proper valuation. The Fair Value Adjustment balance is not shown on the statement of financial position but is simply used to restate the debt investment account to fair value.

Robinson reports its investment in Evermaster bonds in its December 31, 2014, financial statements as shown in Illustration IFRS17-4.

As you can see from this example, the accounting for trading debt investments under IFRS is the same as GAAP.

Equity Investments

As in GAAP, under IFRS, the degree to which one corporation (investor) acquires an interest in the shares of another corporation (investee) generally determines the accounting treatment for the investment subsequent to acquisition. To review, the classification of such investments depends on the percentage of the investee voting shares that is held by the investor:

1. Holdings of less than 20 percent (fair value method)—investor has passive interest.
2. Holdings between 20 percent and 50 percent (equity method)—investor has significant influence.
3. Holdings of more than 50 percent (consolidated statements)—investor has controlling interest.

The accounting and reporting for equity investments therefore depend on the level of influence and the type of security involved, as shown in Illustration IFRS17-5.

Equity Investments at Fair Value

When an investor has an interest of less than 20 percent, it is presumed that the investor has little or no influence over the investee. As indicated in Illustration IFRS17-5, there are two classifications for holdings less than 20 percent. Under IFRS, the presumption is that equity investments are held-for-trading. That is, companies hold these securities to profit from price changes. As with debt investments that are held-for trading, the general accounting and reporting rule for these investments is to value the securities at fair value and record unrealized gains and losses in net income (fair value method).⁴⁶

However, some equity investments are held for purposes other than trading. For example, a company may be required to hold an equity investment in order to sell its products in a particular area. In this situation, the recording of unrealized gains and losses in income, as is required for trading investments, is not indicative of the company's performance with respect to this investment. As a result, IFRS allows companies to classify some equity investments as non-trading. Non-trading equity investments are recorded at fair value on the statement of financial position, with unrealized gains and losses reported in other comprehensive income.

Example: Equity Investment (Income). Upon acquisition, companies record equity investments at fair value. To illustrate, assume that on November 3, 2014, Republic Corporation purchased ordinary shares of three companies, each investment representing less than a 20 percent interest.

Republic records these investments as follows.

On December 6, 2014, Republic receives a cash dividend of $4,200 on its investment in the ordinary shares of Nestlé. It records the cash dividend as follows.

All three of the investee companies reported net income for the year, but only Nestlé declared and paid a dividend to Republic. But, recall that when an investor owns less than 20 percent of the shares of another corporation, it is presumed that the investor has relatively little influence on the investee. As a result, net income of the investee is not a proper basis for recognizing income from the investment by the investor. Why? Because the increased net assets resulting from profitable operations may be permanently retained for use in the investee's business. Therefore, the investor recognizes net income only when the investee declares cash dividends.

At December 31, 2014, Republic's equity investment portfolio has the carrying value and fair value shown in Illustration IFRS17-6.

For Republic's equity investment portfolio, the gross unrealized gains are $15,300, and the gross unrealized losses are $50,850 ($13,500 + $37,350), resulting in a net unrealized loss of $35,550. The fair value of the equity investment portfolio is below cost by $35,550.

As with debt investments, Republic records the net unrealized gains and losses related to changes in the fair value of equity investments in an Unrealized Holding Gain or Loss—Income account. Republic reports this amount as other income and expense. In this case, Republic prepares an adjusting entry debiting the Unrealized Holding Gain or Loss—Income account and crediting the Fair Value Adjustment account to record the decrease in fair value and to record the loss as follows.

On January 23, 2015, Republic sold all of its Burberry ordinary shares, receiving $287,220. Illustration IFRS17-7 shows the computation of the realized gain on the sale.

Republic records the sale as follows.

As indicated in this example, the fair value method accounting for trading equity investments under IFRS is the same as GAAP for trading equity investments. As shown in the next section, the accounting for non-trading equity investments under IFRS is similar to the accounting for available-for-sale equity investments under GAAP.

Example: Equity Investments (OCI). The accounting entries to record non-trading equity investments are the same as for trading equity investments, except for recording the unrealized holding gain or loss. For non-trading equity investments, companies report the unrealized holding gain or loss as other comprehensive income (OCI). Thus, the account titled Unrealized Holding Gain or Loss—Equity is used.

To illustrate, assume that on December 10, 2014, Republic Corporation purchased $20,750 of 1,000 ordinary shares of Hawthorne Company for $20.75 per share (which represents less than a 20 percent interest). Hawthorne is a distributor for Republic products in certain locales, the laws of which require a minimum level of share ownership of a company in that region. The investment in Hawthorne meets this regulatory requirement. As a result, Republic accounts for this investment at fair value, with unrealized gains and losses recorded in OCI.⁴⁷ Republic records this investment as follows.

On December 27, 2014, Republic receives a cash dividend of $450 on its investment in the ordinary shares of Hawthorne Company. It records the cash dividend as follows.

Similar to the accounting for trading investments, when an investor owns less than 20 percent of the ordinary shares of another corporation, it is presumed that the investor has relatively little influence on the investee. Therefore, the investor earns income when the investee declares cash dividends.

At December 31, 2014, Republic's investment in Hawthorne has the carrying value and fair value shown in Illustration IFRS17-8.

For Republic's non-trading investment, the unrealized gain is $3,250. That is, the fair value of the Hawthorne investment exceeds cost by $3,250. Because Republic has classified this investment as non-trading, Republic records the unrealized gains and losses related to changes in the fair value of this non-trading equity investment in an Unrealized Holding Gain or Loss—Equity account. Republic reports this amount as a part of other comprehensive income and as a component of other accumulated comprehensive income (reported in equity) until realized. In this case, Republic prepares an adjusting entry crediting the Unrealized Holding Gain or Loss—Equity account and debiting the Fair Value Adjustment account to record the decrease in fair value and to record the loss as follows.

Republic reports its equity investments in its December 31, 2014, financial statements as shown in Illustration IFRS17-9.

During 2015, sales of Republic products through Hawthorne as a distributor did not meet management's goals. As a result, Republic withdrew from these markets and on December 20, 2015, Republic sold all of its Hawthorne Company ordinary shares, receiving net proceeds of $22,500. Illustration IFRS17-10 shows the computation of the realized gain on the sale.

Republic records the sale as follows.

Because Republic no longer holds any equity investments, it makes the following entry to eliminate the Fair Value Adjustment account.

In summary, the accounting for non-trading equity investments deviates from the general provisions for equity investments. The IASB noted that while fair value provides the most useful information about investments in equity investments, recording unrealized gains or losses in other comprehensive income is more representative for non-trading equity investments.

Impairments

A company should evaluate every held-for-collection investment, 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.⁴⁸ For example, if an investee experiences a bankruptcy or a significant liquidity crisis, the investor may suffer a permanent loss. If the company determines that an investment is impaired, it writes down the amortized cost basis of the individual security to reflect this loss in value. The company accounts for the write-down as a realized loss, and it includes the amount in net income.

For debt investments, a company uses the impairment test to determine whether “it is probable that the investor will be unable to collect all amounts due according to the contractual terms.” If an investment is impaired, the company should measure the loss due to the impairment. This impairment loss is calculated as the difference between the carrying amount plus accrued interest and the expected future cash flows discounted at the investment's historical effective-interest rate.

Example: Impairment Loss

At December 31, 2013, Mayhew Company has a debt investment in Bellovary Inc., purchased at par for $200,000. 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. Unfortunately, Bellovary is experiencing significant financial difficulty and indicates that it will be unable to make all payments according to the contractual terms. Mayhew uses the present value method for measuring the required impairment loss. Illustration IFRS17-11 shows the cash flow schedule prepared for this analysis.

As indicated, the expected cash flows of $264,000 are less than the contractual cash flows of $280,000. The amount of the impairment to be recorded equals the difference between the recorded investment of $200,000 and the present value of the expected cash flows, as shown in Illustration IFRS17-12.

The loss due to the impairment is $12,680. Why isn't it $16,000 ($280,000 − $264,000)? A loss of $12,680 is recorded because Mayhew must measure the loss at a present value amount, not at an undiscounted amount. Mayhew recognizes an impairment loss of $12,680 by debiting Loss on Impairment for the expected loss. At the same time, it reduces the overall value of the investment. The journal entry to record the loss is therefore as follows.

Recovery of Impairment Loss

Subsequent to recording an impairment, events or economic conditions may change such that the extent of the impairment loss decreases (e.g., due to an improvement in the debtor's credit rating). In this situation, some or all of the previously recognized impairment loss shall be reversed with a debit to the Debt Investments account and a credit to Recovery of Impairment Loss. Similar to the accounting for impairments of receivables shown in Chapter 7, the reversal of impairment losses shall not result in a carrying amount of the investment that exceeds the amortized cost that would have been reported had the impairment not been recognized.

ON THE HORIZON

At one time, both the FASB and IASB have indicated that they believe that all financial instruments should be reported at fair value and that changes in fair value should be reported as part of net income. However, the recently issued IFRS indicates that the IASB believes that certain debt investments should not be reported at fair value. The IASB's decision to issue new rules on investments, prior to the FASB's completion of its deliberations on financial instrument accounting, could create obstacles for the Boards in converging the accounting in this area.

IFRS SELF-TEST QUESTIONS

1. All of the following are key similarities between GAAP and IFRS with respect to accounting for investments except:

   (a) IFRS and GAAP have a held-to-maturity investment classification.

   (b) IFRS and GAAP apply the equity method to significant influence equity investments.

   (c) IFRS and GAAP have a fair value option for financial instruments.

   (d) the accounting for impairment of investments is similar, although IFRS allows recovery of impairment losses.

2. Which of the following statements is correct?

   (a) GAAP has a held-for-collection investment classification.

   (b) GAAP permits recovery of impairment losses.

   (c) Under IFRS, non-trading equity investments are accounted for at amortized cost.

   (d) IFRS and GAAP both have a trading investment classification.

3. IFRS requires companies to measure their financial assets at fair value based on:

   (a) the company's business model for managing its financial assets.

   (b) whether the financial asset is a debt investment.

   (c) whether the financial asset is an equity investment.

   (d) All of the choices are IFRS requirements.

4. Select the investment accounting approach with the correct valuation approach:

   

5. Under IFRS, a company:

   (a) should evaluate only equity investments for impairment.

   (b) accounts for an impairment as an unrealized loss, and includes it as a part of other comprehensive income and as a component of other accumulated comprehensive income until realized.

   (c) calculates the impairment loss on debt investments as the difference between the carrying amount plus accrued interest and the expected future cash flows discounted at the investment's historical effective-interest rate.

   (d) All of the above.

IFRS CONCEPTS AND APPLICATION

IFRS17-1 Where can authoritative IFRS be found related to investments?

IFRS17-2 Briefly describe some of the similarities and differences between GAAP and IFRS with respect to the accounting for investments.

IFRS17-3 Describe the two criteria for determining the valuation of financial assets.

IFRS17-4 Which types of investments are valued at amortized cost? Explain the rationale for this accounting.

IFRS17-5 Lady Gaga Co. recently made an investment in the bonds issued by Chili Peppers Inc. Lady Gaga's business model for this investment is to profit from trading in response to changes in market interest rates. How should this investment be classified by Lady Gaga? Explain.

IFRS17-6 Consider the bond investment by Lady Gaga in IFRS17-5. Discuss the accounting for this investment if Lady Gaga's business model is to hold the investment to collect interest while outstanding and to receive the principal at maturity.

IFRS17-7 Indicate how unrealized holding gains and losses should be reported for investments classified as trading and held for-collection.

IFRS17-8 Ramirez Company has a held-for-collection investment in the 6%, 20-year bonds of Soto Company. The investment was originally purchased for $1,200,000 in 2013. Early in 2014, Ramirez recorded an impairment of $300,000 on the Soto investment, due to Soto's financial distress. In 2015, Soto returned to profitability and the Soto investment was no longer impaired. What entry does Ramirez make in 2015 under (a) GAAP and (b) IFRS?

IFRS17-9 Carow Corporation purchased, as a held-for-collection investment, $60,000 of the 8%, 5-year bonds of Harrison, Inc. for $65,118, which provides a 6% return. The bonds pay interest semiannually. Prepare Carow's journal entries for (a) the purchase of the investment, and (b) the receipt of semiannual interest and premium amortization.

IFRS17-10 Fairbanks Corporation purchased 400 ordinary shares of Sherman Inc. as a trading investment for $13,200. During the year, Sherman paid a cash dividend of $3.25 per share. At year-end, Sherman shares were selling for $34.50 per share. Prepare Fairbanks' journal entries to record (a) the purchase of the investment, (b) the dividends received, and (c) the fair value adjustment.

IFRS17-11 Use the information from IFRS17-10 but assume the shares were purchased to meet a non-trading regulatory requirement. Prepare Fairbanks' journal entries to record (a) the purchase of the investment, (b) the dividends received, and (c) the fair value adjustment.

IFRS17-12 On January 1, 2014, Roosevelt Company purchased 12% bonds, having a maturity value of $500,000, for $537,907.40. The bonds provide the bondholders with a 10% yield. They are dated January 1, 2014, and mature January 1, 2019, with interest receivable December 31 of each year. Roosevelt's business model is to hold these bonds to collect contractual cash flows.

Instructions

(a) Prepare the journal entry at the date of the bond purchase.

(b) Prepare a bond amortization schedule.

(c) Prepare the journal entry to record the interest received and the amortization for 2014.

(d) Prepare the journal entry to record the interest received and the amortization for 2015.

IFRS17-13 Assume the same information as in IFRS17-12 except that Roosevelt has an active trading strategy for these bonds. The fair value of the bonds at December 31 of each year-end is as follows.

Instructions

(a) Prepare the journal entry at the date of the bond purchase.

(b) Prepare the journal entries to record the interest received and recognition of fair value for 2014.

(c) Prepare the journal entry to record the recognition of fair value for 2015.

IFRS17-14 On December 21, 2014, Zurich Company provided you with the following information regarding its trading investments.

During 2015, Carolina Company shares were sold for $9,500. The fair value of the shares on December 31, 2015, was Stargate Corp. shares—$19,300; Vectorman Co. shares—$20,500.

Instructions

(a) Prepare the adjusting journal entry needed on December 31, 2014.

(b) Prepare the journal entry to record the sale of the Carolina Company shares during 2015.

(c) Prepare the adjusting journal entry needed on December 31, 2015.

IFRS17-15 Komissarov Company has a debt investment in the bonds issued by Keune Inc. The bonds were purchased at par for $400,000 and, at the end of 2014, have a remaining life of 3 years with annual interest payments at 10%, paid at the end of each year. This debt investment is classified as held-for-collection. Keune is facing a tough economic environment and informs all of its investors that it will be unable to make all payments according to the contractual terms. The controller of Komissarov has prepared the following revised expected cash flow forecast for this bond investment.

Instructions

(a) Determine the impairment loss for Komissarov at December 31, 2014.

(b) Prepare the entry to record the impairment loss for Komissarov at December 31, 2014.

(c) On January 15, 2015, Keune receives a major capital infusion from a private equity investor. It informs Komissarov that the bonds now will be paid according to the contractual terms. Briefly describe how Komissarov would account for the bond investment in light of this new information.

Professional Research

IFRS17-16 Your client, Cascade Company, is planning to invest some of its excess cash in 5-year revenue bonds issued by the county and in the shares of one of its suppliers, Teton Co. Teton's shares trade on the over-the-counter market. Cascade plans to classify these investments as trading. They would like you to conduct some research on the accounting for these investments.

Instructions

Access the IFRS authoritative literature at the IASB website (http://eifrs.iasb.org/). (Click on the IFRS tab and then register for free eIFRS access if necessary.) When you have accessed the documents, you can use the search tool in your Internet browser to respond to the following questions. (Provide paragraph citations.)

(a) Since the Teton shares do not trade on one of the large securities exchanges, Cascade argues that the fair value of this investment is not readily available. According to the authoritative literature, when is the fair value of a security “readily determinable”?

(b) How is an impairment of a debt investment accounted for?

(c) To avoid volatility in their financial statements due to fair value adjustments, Cascade debated whether the bond investment could be classified as held-for-collection; Cascade is pretty sure it will hold the bonds for 5 years. What criteria must be met for Cascade to classify it as held-for-collection?

ANSWERS TO IFRS SELF-TEST QUESTIONS

1. a
2. d
3. a
4. c
5. c

Remember to check the book's companion website to find additional resources for this chapter.