Accounting for Investments

Lecture 8
FINANCIAL STATEMENTS
Financial statements
Consolidated financial statements & Company financial statements
1. Balance sheet / Statement of financial position (IASB)
– Consolidated balance sheet
– Company balance sheet
2. Income statement or Statement of comprehensive income
– Consolidated statement of comprehensive income
– Company statement of income
3. Statement of cash flows
– Consolidated statement of cash flows
4. Statement of changes in equity
– Consolidated statement of changes in equity
FAR LEARNING OUTCOMES
FAR aims to train students as academic professionals in financial accounting and reporting.
At the end of this course, the students should be able to:
3. Describe and explain the accounting principles, including the principles for valuation and income
measurement for equity and debt investments allowed under IFRS.
4. Prepare a set of financial statements including a balance sheet (a statement of financial position), a
statement of cash flows, an income statement and a statement of comprehensive income, and a
statement of changes in equity.
5. Describe and explain the principles for valuation and income measurement for equity and debt
investments allowed under IFRS.
– Kieso et al. (2018/2020): CH17 Investments
6. Prepare a set of company and consolidated financial statements including a consolidated balance
sheet (a consolidated statement of financial position) and a consolidated income statement.

INVESTMENTS
Accounting for Equity investments: Levels of influence & Valuation methods
1. Accounting for equity investments
– Fair value measurement
– Equity method
– Consolidation

ACCOUNTING FOR EQUITY

INVESTMENTS
‘Mixed measurement approach’:
The degree (level of control) to which one corporation (investor) acquires an interest in the common stock of
another corporation (investee) generally determines the accounting treatment for the investment subsequent
to acquisition.

EQUITY INVESTMENTS HOLDINGS LESS THAN 20%

a) Under IFRS, the presumption is that equity investments are trading:
General accounting and reporting rule for trading investments:
– Dividends are recognized as revenue
– Investments valued at fair value & Unrealized gains and losses in included in net income:
Fair value adjustment
To Unrealized holding gain or loss - Income
b) IFRS allows companies to classify some equity investments as non-trading.
General accounting and reporting rule for non-trading investments:
– Dividends are recognized as revenue
– Investments valued at fair value & Record unrealized gains and losses in other comprehensive
income:
Fair value adjustment
To Unrealized holding gain or loss – Equity (OCI)
Fair value measurement: The total market value of all trading investments is compared to the most recent
market-to- market price [cost of the investments]

EXERCISE I: ACCOUNTING FOR TRADING AND NON-TRADING INVESTMENTS

EXERCISE II. PORTFOLIO OF TRADING INVESTMENTS
The following information is available for the trading investment portfolio of PLM company (amounts in €).
Fair value at 31 December

[1]: Shares of Company B were sold in May 2022 for €18.500. During the years 2910-2022, no dividends will be paid.
Questions
Financial calculations
1. Calculate PLM’s net income for the years 2019, 2020, 2021 and 2022 based on the information available.
Financial accounting
2. Prepare the journal entries for the years 2019, 2020, 2021 and 2022.
1. Financial calculations

*: Shares of Company B were sold in May 2022 for €18.500

∆: change in fair value
No dividend payments

HOLDINGS BETWEEN 20% AND 50% - MINORITY ACTIVE INVESTMENTS

An investment (direct and/or indirect) of 20 percent or more of the voting shares of an investee should lead to
a presumption that in the absence of evidence to the contrary, an investor has the ability to exercise significant
influence over an investee.
In instances of “significant influence,” the investor must account for the investment
using the equity method.

1. Holdings between 20% and 50%:

Investor can exert significant influence over the company
Ownership percentage equals or exceeds 20% is a guideline; it could be
less than 20%: Real criterium for significant influence:
The power to participate in the financial and operating policy decisions of the investee. However, no (legal)
control or joint control over those policies.
The key is the ability to influence management:
– Representation on the board of directors
– Participation in policy-making processes
– Material intercompany transactions
– Interchange of managerial personnel
– Provision of essential technical information

MINORITY ACTIVE INVESTMENTS: HOLDINGS BETWEEN 20% AND 50%: EQUITY METHOD
Equity method
Criteria:
– Holdings between 20% and 50%: Investor can exert significant influence over another
company (associate)
– The investment represents a continuing (“non-trading”) relationship between companies
1. Record the investment at cost
2. Subsequently, adjust the amount each period for the investor’s proportionate share of the earnings
(losses) & dividends received by the investor

– On 2 January 2022, Maxi Company acquired 48.000 shares, representing 20% of the (ordinary) shares of Mini Company, at a
cost of $10 a share.
– For the year 2022, Mini Company reported net income of $200.000; Maxi Company’s share is 20%, or $40.000.
– At 31 December 2022, the 48.000 shares of Mini Company have a fair value (market price) of $12 a share, or $576.000.
– On 28 January 2023, Mini Company announced and paid a cash dividend of
$100.000; The Maxi Company received 20%, or $20.000.
– For the year 2023, Mini Company reported a loss of $50.000; Maxi Company’s share is 20%, or $10.000.
– At 31 December 2023, the 48.000 shares of Mini Company have a fair value (market price) of $11 a share, or $528.000.
Questions
Prepare the journal entries for Maxi Company if this company has the ability to exercise significant influence over Mini Company.
Prepare the journal entries for Maxi Company if this company does not have the ability to exercise significant influence over Mini
Company. Maxi Company
classifies the investment in Mini Company as a trading investment.
Calculate Maxi Company’s net income for the years 2022-2023 under the equity
method.
Calculate Maxi Company’s net income for the years 2022-2023 under the fair value method.
Financial analysis
Maxi company’s net income for the years 2023-2024 under the equity method vs the fair value method

Accounti ng for debt investments

– Amortized cost measurement
– Fair value measurement
A CLOSER LOOK AT DEBT INVESTMENTS
Debt investments are characterized by contractual payments on specified dates of
principal and interest on the principal amount outstanding.
IFRS 9 Financial instruments: ‘Business model approach’ Companies group debt investments into three
categories: 1.Held-for-collection
2. Held-for-collection and selling
3. Trading (including: Held-for-collection and trading)
Debt investments
Debt investments are characterized by contractual payments on specified dates of
principal and interest on the principal amount outstanding.
IFRS 9 Financial instruments: ‘Business model approach’
1. Held-for-collection
– Company has a business model whose objective is to hold assets in order to
collect contractual cash flows.
– 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.
2. Held-for-collection and selling
– Investments held with the objective to both collect contractual cash flows and sell financial assets.
3. Trading (including: Held-for-collection and trading)
– Company has a business model whose objective is to hold debt investments (bonds) as a trading investment.
– Active trading strategy for investments in debts (bonds)
DEBT INVESTMENTS
IFRS 9 Financial instruments: ‘Business model approach’:
Two criteria for companies to determine how to measure their financial assets:
1. The company's business model for managing its financial assets
2. The contractual cash flow characteristics of the financial asset

Debt investments
Companies group debt investments into three categories:
1. Held-for-collection
2. Held-for-collection and selling
3. Trading

EXERCISE IV. DEBT INVESTMENTS – AMORTIZED COST & FAIR VALUE

On the 31 December 2021, RLP Company purchased a 3-year €1.000.000 bond with 7% interest rate and 5% yield for €1.054.465. The
bonds pay interest on 31 December 2022, 2023 and 2024. RLP’s business model is to hold these bonds to collect contractual cash flows.
For this reason, the bonds are classified as held-for collection.
Questions
Financial calculations
1. Prepare the bond investment amortization schedule.
Financial accounting
2. Prepare the journal entry at the date of the bond purchase.
3. Prepare the journal entries to record the interest revenues and the amortization for the years 2022-2024.
Assume the same information except that RLP has an active trading strategy for these bonds. The fair value of the bonds at 31 December
of each year-end is as follows:
2022 €1.030.000
2023 €1.025.000
2024 €1.000.000
4. Prepare the journal entries to record the interest revenues and the amortization for the years 2022-2024 if the debt security is
classified as a trading investment.
EFFECTIVE-INTEREST METHOD
CH14 Non-Current Liabilities
Effective-interest method produces a periodic (bond) interest revenue (expense) equal to a constant
percentage of the carrying value of the bonds.
— Bond interest revenue (expense)
= Carrying value of bonds at beginning of period x effective interest rate
— Bond interest paid = Face amount of bonds x Stated interest rate
— Amortization amount = Bond interest expense - Bond interest paid

DEBT INVESTMENTS – AMORTIZED COST

Effective-interest method produces a periodic (bond) interest revenue equal to a constant percentage of the
carrying value of the bonds.
— Cash received = (Bond) interest paid = Face amount of bonds x stated interest rate
— Interest revenue = Carrying value of bonds at beginning of period x effective interest rate
— Amortization amount = (Bond) interest received – (Bond) interest revenue

Effective-interest method produces a periodic (bond) interest revenue equal to a constant percentage of the carrying value of the bonds.
€1.054.464,96 = €70.000/1,05 + €70.000/1,052 + (€70.000 + €1.000.000)/1,053
Cash received = (Bond) interest paid = Face amount of bonds x stated interest rate (7%):
€70.000 = €1.000.000 * 0,07
Interest revenue = Carrying value of bonds at beginning of period x effective interest rate (5%):
€52.527,25 = €1.054.464,96 * 0,05
Amortization amount = (Bond) interest received – (Bond) interest revenue:
€17.276,75 = €70.000 - €52.723,25
€1.037.188,21 = €1.054.464,96 - €17.276,7

Fair Value Option

Companies have the option to report most financial assets at
fair value, with all gains and losses related to changes in fair
value reported in the income statement.
– Applied on an instrument-by-instrument basis.
– Generally available only at the time a company first
purchases the financial asset or incurs a financial
liability.
 – Company must measure this instrument at fair value until the company no longer has
ownership.
EXERCISE IV. DEBT INVESTMENTS – AMORTIZED COST & FAIR VALUE
On the 31 December 2021, RLP Company purchased a 3-year €1.000.000 bond with 7% interest rate and 5% yield for €1.054.465. The
bonds pay interest on 31 December 2022, 2023 and 2024. RLP’s business model is to hold these bonds to collect contractual cash flows.
For this reason, the bonds are classified as held-for collection.
Questions
Financial calculations
1. Prepare the bond investment amortization schedule.
Financial accounting
2. Prepare the journal entry at the date of the bond purchase.
3. Prepare the journal entries to record the interest revenues and the amortization for the years 2022-2024.
Assume the same information except that RLP has an active trading strategy for these bonds. The fair value of the bonds at 31 December
of each year-end is as follows:
2022 €1.030.000
2023 €1.025.000
2024 €1.000.000
4. Prepare the journal entries to record the interest revenues and the amortization for the years 2022-2024 if the debt security is
classified as a trading investment.