MGAC01 Intermediate Accounting I

Transcription

1 MGAC01 Intermediate Accounting I S. Daga CLASS TOPIC: INVESTMENTS TEXT: E9-11, E9-16, E9-21, P9-11, CA9-3 LEARNING GOALS: 1. Be able to RECOGNIZE, MEASURE & PRESENT Non-Strategic investments. 2. Be able to RECOGNIZE, MEASURE & PRESENT Strategic investments. CLASS OUTLINE: Companies have different motivations for investing in securities issued by other companies. One motivation relates to the returns provided by investments and another motivation relates to strategy. Investments, which are financial instruments, can be either debt or equity. LEARNING GOAL 1: Be able to RECOGNIZE, MEASURE & PRESENT Non-Strategic investments. Non-strategic investments can be debt or equity instruments.

2 MEASUREMENT: There are three choices of accounting models for non-strategic debt and equity investments (1. cost/amortized cost model, 2. fair value through net income model, 3. fair value through other comprehensive income model) 1. Cost/Amortized Cost Model -Measured at cost on acquisition (equal to fair value + transaction costs) -At each reporting date, measure at cost or amortized cost -Unrealized holding gains and losses are not applicable as cost is not adjusted -Realized holding gains and losses are reported in net income -This is the method you are already familiar with 2. Fair Value through Net Income Model (FV-NI) -Measured at fair value on acquisition -At each reporting date, measure the investment at fair value -Transaction costs are expensed -Unrealized and realized holding gains and losses are reported in net income

3 3. Fair Value through Other Comprehensive Income Model (IFRS only) -At each reporting date, measure the investment at fair value _Transaction costs can be expensed or capitalized -Unrealized holding gains or losses reported in OCI -Realized holding gains or losses can be recycled to net income, or can be without recycling, going directly to retained earnings it s a company s choice which policy they are going to follow. Policy choice must be presented in the notes to the financial statements. Examples 1 and 2, Class Discussion Questions E9-11, E9-16 Class Note: GAAP Classifications and Impairment The standards are in a state of transition. Therefore, impairment models will not be part of the course materials. The text book describes the transition from IAS 39 to IAS9. You only need to know IAS9, the current materials used in our text.

4 Example 1: Non-strategic Investment, Cost Model -To illustrate accounting debt securities at Cost ABC Co. purchased bonds to be held to maturity. Face value $100, Coupon interest rate 7% Yield rate 10% Maturity date January 1, 2014 Date of purchase January 1, 2011 Interest receipts due Annually on Jan 1 Method of amortization Effective interest Purchase price $92, Required: 1. Prepare the journal entry for the purchase of the bond and all subsequent Journal entries for 2011 and 2012, assuming a December 31 year end and no reversing journal entries are used. 2.Prepare the journal entry to record the sale of the bonds, assuming they are sold January 1, 2013, for $102,000. Assume the sale occurs immediately after the annual interest receipt.

5 Example 2: Non- Strategic Investment, using FV-OCI -Illustrates accounting for equity investments under the FV-OCI without recycling model. As of December 31, 2013, Hastie Corporation had no investments. On November 15, 2014, Hastie purchases an equity investment for $346,800, and commission costs on the purchase amount to $3,200. At December 31, 2014, on Hastie s balance sheet date, fair value of the investment is $320,000. At December 31, 2015, the investment s fair value is $340,000. The investment is classified as FV-OCI without recycling, and Hastie Corporation prepares financial statements in accordance with IFRS. On January 15, 2016, the investment is sold for $428,000. REQUIRED: Prepare all relevant journal entries to record acquisition, subsequent measurement, and disposition of the investment. Ignore tax effects.

6 LEARNING GOAL 2: Be able to RECOGNIZE, MEASURE & PRESENT Strategic investments. Equity investments, when acquired, are recognized initially at the fair value of the consideration given. Investments by one corporation in the common shares of another can be classified according to percentage ownership. (Keep in mind that this percentage is just a guideline other factors, such as ability to have representation on the board of directors, play a part in determining whether any significant influence or control exists.) 1. Holdings less than 20% - cost or fair value method. 2. Holdings between 20% and 50% - equity method. 3. Holdings of more than 50% - consolidation. We will focus on strategic investments, with holding between 20% and 50%. For these, we use the equity method. The investment account is increased (decreased) by the investor s share of the earnings of the investee and decreased by all dividends received. The investor will also account for any fair value adjustments that were required when the investment was first acquired. The fair value adjustments are a result of the divergence between the carrying value of the investee on acquisition and the amount paid for the investment. Example 3, Class Discussion Questions E9-21, P9-11, CA9-3

7 EXAMPLE 3: Strategic Investment Accounting - To illustrate the equity method of accounting for strategic investments in shares. Delight Corp. acquired 30% of the 1,000,000 outstanding shares of Treats Corp. on January 1, 2014 for $3,240,000 when the book value of the net assets of Treats totalled $9,600,000. At January 1, 2014, Treat s plant assets, having a remaining life of ten years, had a fair value which exceeded book value by $700,000. Treats Corp. reported net income of $1,600,000 for 2014 and $2,000,000 for Treats paid dividends of $400,000 on December 6, 2014, and $500,000 on December 5, Required: 1. Prepare all journal entries for Delight corp. for 2014 and 2015 that relate to this investment. 2. Calculate what should be shown as investment income on the income statement for 2014 and Calculate what should be shown as the balance of Delight s investment in Treats on the balance sheet for 2014 and 2015.

8 Presentation, Disclosure and Analysis (Illustration 9-23 in text) - Similar presentation requirements between ASPE and IFRS with some minor differences - IFRS requires quantitative measures of the investments risk exposures and concentrations, and information on how management manages these risks Analysis: Accounting standards require disclosures that make it possible for a reader to be able to: 1. Separate investment results from operating results 2. Understand the relationship between the investment asset and related returns (income) 3. Understand the effect of the accounting methods that are used.

9 Class Discussion Questions E9-11, E9-16, E9-21, P9-11, Case CA9-3 E9-11 (Equity Investment Entries FV-NI and FV-OCI) Arantxa Corporation made the following purchases of investments during 2014, the first year in which Arantxa invested in equity securities: 1. On January 15, purchased 9,000 shares of Nirmala Corp.'s common shares at $33.50 per share plus commission of $1, On April 1, purchased 5,000 shares of Oxana Corp.'s common shares at $52.00 per share plus commission of $3, On September 10, purchased 7,000 shares of WTA Corp.'s preferred shares at $26.50 per share plus commission of $2,910. On May 20, 2014, Arantxa sold 3,000 of the Nirmala common shares at a market price of $35 per share less brokerage commissions of $2,850. The year-end fair values per share were as follows: Nirmala $30; Oxana $55; and WTA $28. The chief accountant of Arantxa tells you that Arantxa Corporation holds these investments with the intention of selling them in order to earn short-term profits from appreciation in their prices and accounts for them using the fair value though net income model, with no separate reporting of dividends and other types of FV-NI investment income and losses. Assume that Arantxa Corporation follows IFRS, and specifically IAS 39. Instructions (a) Prepare the journal entries to record the three investments. (b) Prepare the journal entry(ies) for the sale of the 3,000 Nirmala shares on May 20. (c) Prepare the adjusting entries needed on December 31, (d) Repeat parts (a) to (c), assuming the investments are accounted for using the fair value through other comprehensive income model with recycling. Arantxa's policy is to capitalize transaction costs on the acquisition of FV-OCI investments and reduce the proceeds on disposal. (e) How would your entries in (d) change, if at all, if Arantxa adopted IFRS 9 in 2014 to account for its financial asset investments?

10 E9-16 (Impairment of FV-NI Investment and Subsequent Recovery in Value) On January 1, 2012, Mamood Ltd. paid $322, for 12% bonds of Variation Ltd. with a maturity value of $300,000. The bonds provide the bondholders with a 10% yield. They are dated January 1, 2012, mature on January 1, 2018, and pay interest each December 31. Mamood acquired the bond investment as part of its portfolio of trading securities. It accounts for the bonds at FV-NI and reports interest income separately from other investment gains and losses. At December 31, 2012, Mamood's year end, the bonds had a fair value of $320,700. Mamood applies IFRS. During 2013, the economic outlook related to Variation Ltd.'s primary business took a major downturn, so that Variation's debt was downgraded. By the end of 2013, the bonds were priced at 85.5, and at December 31, 2014, they were selling in the market at 87. Conditions reversed in 2015 and the outlook for Variation Ltd. significantly improved, leaving their bonds with a fair value at December 31, 2015, of Instructions (a) Prepare the entries to record Mamood's purchase of the bonds on January 1, 2012, the recognition of interest income and interest received on December 31, 2012, and the fair value adjustment required at December 31, (b) Prepare all entries required for 2013, including recognition of the impairment in value if necessary, and for (c) Prepare all entries required for 2015, including recognition of the recovery of the impairment in value, if necessary. (d) Identify the impairment loss model applied in this situation. If Mamood had accounted for this investment at amortized cost, identify and briefly describe the impairment model the company would have used if Mamood applied (1) IFRS using IAS 39, (2) IFRS using IFRS 9, and (3) ASPE.

11 E9-21 (Long-Term Equity Investments, Equity Method, and Impairment) On January 1, 2014, Rae Corporation purchased 30% of the common shares of Martz Limited for $196,000. Martz Limited shares are not traded in an active market. The carrying amount of Martz's net assets was $520,000 on that date. Any excess of the purchase cost over Rae's share of Martz's carrying amount is attributable to unrecorded intangibles with a 20-year life. During the year, Martz earned net income and comprehensive income of $75,000 and paid dividends of $15,000. The investment in Martz had a fair value of $201,000 at December 31, During 2015, Martz incurred a net loss and comprehensive loss of $80,000 and paid no dividends. At December 31, 2015, the fair value of the investment was $140,000 and the recoverable amount was $149,000. Assume that Rae follows IFRS. Instructions (a) Prepare all relevant journal entries related to Rae's investment in Martz for 2014 and 2015, assuming this is its only investment and Rae cannot exercise significant influence over Martz's policies. Rae accounts for this investment using the fair value through net income model and separately records and reports each type of income (loss) separately. Illustrate how the statement of comprehensive income is affected in 2014 and (b) Prepare all relevant journal entries related to Rae's investment in Martz for 2014 and 2015, assuming this is its only investment and Rae exercises significant influence over its associates' policies. Illustrate how the statement of comprehensive income is affected in 2014 and Briefly explain. (c) How would your answer to part (b) be different if you were told that Martz's 2014 statement of comprehensive income included a loss from discontinued operations of $20,000 (net of tax)?

12 P9-11 On January 1, 2014, Melbourne Corporation, a public company, acquired 15,000 of the 50,000 outstanding common shares of Noah Corp. for $25 per share. The statement of financial position of Noah reported the following information at the date of the acquisition: Assets not subject to depreciation $290,000 Assets subject to depreciation 860,000 Liabilities 150,000 Additional information: 1. On the acquisition date, the fair value is the same as the carrying amount for the assets that are not subject to depreciation and for the liabilities. 2. On the acquisition date, the fair value of the assets that are subject to depreciation is $960,000. These assets had a remaining useful life of eight years at that time. 3. Noah reported 2014 net income of $100,000 and paid dividends of $5,000 in December Noah's shares are not actively traded on the stock exchange, but Melbourne has determined that they have a fair value of $24 per share on December 31, Melbourne Corporation accounts for its FV-NI and FV-OCI investments under the provisions of IFRS 9. Instructions (a) Prepare the journal entries for Melbourne Corporation for 2014, assuming that Melbourne cannot exercise significant influence over Noah and accounts for the investment at fair value through other comprehensive income. (b) Prepare the journal entries for Melbourne Corporation for 2014, assuming that Melbourne can exercise significant influence over Noah's operations. (c) How would your answers to parts (a) and (b) change if Melbourne had acquired the Noah shares on July 2 instead of January 1? (d) Prepare the 2014 journal entries if Melbourne Corporation were a private company applying ASPE, clearly identifying the methods of accounting you have chosen. (e) For your answers to (d), prepare a table of the investment amount reported on the statement of financial position and the amount reported on the income statement under each approach identified. As a shareholder of Melbourne Corporation, which method of accounting do you think provides better information? Explain briefly.

13 CA9-3 Impaired Investments Limited (IIL) is in the real estate industry. Last year, the company divested itself of some major investments in real estate and invested the funds in several instruments as follows: 1. Investments in 5% bonds: currently carried at amortized cost 2. Investments in common shares (no significant influence or control and not held for trading) Company A: currently carried at fair value with gains and losses booked to income 3. Investments in common shares Company B: currently carried at fair value with gains and losses booked to other comprehensive income During the current year, similar bonds available in the marketplace are yielding 6%. Although the company is not certain, the controller feels this may be due to greater perceived risk associated with changes in the economy and specifically the real estate industry. The investment in Company A shares is significantly below cost at year end according to market prices at year end (Company A's shares trade on a stock exchange). The investment in Company B shares is also below cost but the controller feels that this is just a temporary decline and not necessarily an impairment. The shares of Company B also trade on a stock exchange. IIL is currently a private entity but has recently considered going public, perhaps in the next five years, and plans to adopt IFRS this year. It will also adopt IFRS 9. Instructions Adopt the role of the controller and discuss the financial reporting issues related to the IIL financial statements.