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Chapter 2

Chapter 2. Investments In Equity Securities. Chapter Objectives. Classification of equity investments Accounting for equity investments Matching classifications with methods. Conceptual Basis For Classification. Control. Held for trading Available for sale. Significantly Influenced

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Chapter 2

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  1. Chapter 2 Investments In Equity Securities

  2. Chapter Objectives • Classification of equity investments • Accounting for equity investments • Matching classifications with methods

  3. Conceptual Basis For Classification Control Held for trading Available for sale Significantly Influenced companies Joint ventures Subsidiaries 100% 0% 50%

  4. Classification • Non-strategic investments • held-for-trading • available-for-sale • Strategic investments • Subsidiaries • Significantly influenced companies (Associates) • Joint ventures

  5. Accounting Methods • Cost method • Equity method • Fair value method (changes in Net Income) • Fair value method (changes in Comprehensive Income) • Full consolidation • Proportionate consolidation

  6. Held-For-Trading • Defined (Section 3855) • Acquired principally for the purpose of selling or repurchasing in the short term; • A derivative; or • Any financial asset or liability that is so designated

  7. Held-For-Trading • Application To Investments • Equity securities held for short term trading • Other non-strategic holdings that are designated as held for trading

  8. Held-For-Trading • Accounting Procedures • Initial and subsequent measurement at fair value • Changes in fair value are allocated to Net Income in the period they occur • Transaction costs charged to Net Income at acquisition

  9. Held-For-Trading Example EXAMPLE: On January 1, 2008, Holly Inc. acquires 1,000 shares of Helm Ltd. for $10 per share. The shares are classified as held for trading. On December 31, 2008, the Helm Ltd. shares are trading at $12 per share. During 2008, Helm Ltd. declares and pays dividends of $0.75 per share. On January 1, 2009, the securities are sold for $13 per share.

  10. Held-For-Trading Example • Acquisition Of Investment

  11. Held-For-Trading Example • Receipt Of Dividends

  12. Held-For-Trading Example • Year End Adjustment

  13. Held-For-Trading Example • Sale Of Investment

  14. Available-For-Sale • Defined (Section 3855) • Non-derivative financial assets that are designated as available for sale, or that are not classified as loans and receivables, held-to-maturity, or held-for trading

  15. ________ __ ___ Available-For-Sale • Would include all equity investments other than: • Investments in subsidiaries • Investments in significantly influenced companies • Investments in joint ventures • Investments that are classified or designated as held for trading.

  16. Available-For-Sale • Accounting Procedures • Initial and subsequent measurement at fair value • Changes in fair value are allocated to Comprehensive Income • Transaction costs: • charged to Net Income at acquisition, or added to the initial cost

  17. Available-For-Sale Example EXAMPLE: On January 1, 2008, Holly Inc. acquires 1,000 shares of Helm Ltd. for $10 per share. The shares are classified as available for sale. On December 31, 2008, the Helm Ltd. shares are trading at $12 per share. During 2008, Helm Ltd. declares and pays dividends of $0.75 per share. On January 1, 2009, the securities are sold for $13 per share.

  18. Available For Sale Example • Acquisition Of Investment

  19. Available For Sale Example • Receipt Of Dividends

  20. Available For Sale Example • Year End Adjustment *After being included on the statement of comprehensive income this will be disclosed tothe balance sheet account Accumulated Other Comprehensive Income.

  21. Available For Sale Example • Sale Of Investment

  22. Cost Method • Applicability • Can be used when available-for-sale securities do not have quoted market prices • Procedures • Investment at cost • Earnings only when received or receivable

  23. Cost Method • Return of capital: Occurs when dividends received exceed the investor’s share of earnings since acquisition. These are regarded as a recovery of investment (return of capital)

  24. Return Of Capital Example EXAMPLE: On January 1, 2008, Norton Inc. acquires 10 percent of the voting shares of Montage Ltd. for $500,000. During 2008, Montage has Net Income of $350,000 and pays dividends of $250,000. During 2009, Montage has Net Income of $100,000 and pays dividends of $250,000.

  25. Return Of Capital Example • Acquisition Of Investment

  26. Return Of Capital Example • Receipt of 2008 dividends

  27. Return Of Capital Example • Receipt of 2009 dividends

  28. Subsidiaries • Paragraph 1590.03(a) – A subsidiary is an enterprise controlled by another enterprise (the parent) that has the right and ability to obtain future economic benefits from the resources of the enterprise and is exposed to the related risks.

  29. The Concept Of Control 1590.03(b) Control of an enterprise is the continuing power to determine its strategic operating, investing, and financing policies without the co-operation of others.

  30. The Concept Of Control • In general, based on ownership of more than 50 percent of the outstanding voting shares • Exceptions • Control may exist without majority ownership • Control may not exist even with majority ownership

  31. The Concept Of Control Indirect Control P A B 60% 55% P Controls B

  32. The Concept Of Control Indirect Control 70% P X 60% 30% 40% Y Z P Controls Z

  33. Subsidiaries • Accounting Procedures • Paragraph 1590.16 An enterprise should consolidate all of its subsidiaries. (January, 1992) • Consolidation procedures will be covered in Chapters 4, 5, and 6

  34. Significantly Influenced Companies • Defined • IAS 28 Significant influence is the power to participate in the financial and operating policy decisions of the investee, but is not control over those policies • CICA (section 3051) has a 20 percent guideline • Judgment would have been better • Key is the ability to elect directors

  35. Significantly Influenced Companies • Required Accounting Procedures: Section 3051 requires the use of the equity method

  36. Equity Method Procedures • Accounting for the investment asset • Initial investment is recorded at cost • Adjusted each year for the investor’s shares of the investee’s change in Retained Earnings

  37. Equity Method Procedures • Accounting for investment income Investment income is equal to the Investor’s share of the reported Net Income of the Investee.

  38. Equity Method Example EXAMPLE: On January 1, 2008, Fortin Inc. pays $800,000 for a 25 percent interest in the voting shares of Beauchamp Ltd. This investment gives Fortin Inc. significant influence over Beauchamp Ltd. During the year ending December 31, 2008, Beauchamp Ltd. has net income of $300,000 and pays dividends of $180,000. During the year ending December 31, 2009, Beauchamp Ltd. has a net loss of $100,000 and pays dividends of $150,000. On January 1, 2010, Fortin’s holding of Beauchamp securities is sold for $1,200,000.

  39. Equity Method Example • Acquisition Of Investment

  40. Equity Method Example • 2008 Income And Dividends

  41. Equity Method Example • 2009 Income And Dividends

  42. Equity Method Example • Sale Of Investment

  43. Results of discontinued operations and extraordinary items of the investee must be shown in the investor’s Statement Of Net Income as separate line items after Income Or Loss Before Discontinued Operations And Extraordinary Items. Equity Method Intra Statement Disclosure

  44. EIC No.8: negative balance can be shown if: Investor has guaranteed obligations of the investee The investor is committed to provide further financial support The investee seems assured of returning to profitability Equity Method Losses Exceed Investment Balance

  45. Significant Influence To Control Consolidation is required Equity Method Loss Of Significant Influence

  46. Significant Influence To No Influence Will become held-for-trading or available-for-sale The “new cost” will be the equity value at the time of the change Equity Method Loss Of Significant Influence

  47. Equity Method • Consolidation Adjustments • All of the adjustments that would be required in preparing consolidated statements are required here. • See Chapters 5 and 6 for illustrations of these procedures.

  48. Significantly Influenced Companies • Disclosure • Basis of valuation • Separate disclosure of the class in both the Balance Sheet and the Income Statement • Treatment of the difference between the cost of the investment and the underlying book value of the investee’s assets at the date of acquisition.

  49. Impairment Of Significantly Influenced Companies • Paragraph 3051.18 When there has been a loss in value of an investment that is other than a temporary decline, the investment should be written down to recognize the loss. The write-down should be included in the determination of net income and may or may not be an extraordinary item.

  50. Impairment Of Significantly Influenced Companies • Indicators • Depressed market prices • Severe or continued losses • Suspension of trading • Liquidity or going concern problem • Current fair value less than carrying value

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