Kế toán, kiểm toán - Chapter 012: Investments

InvestmentsChapter 12Nature of InvestmentsBonds and notes(Debt securities)Common and preferred stock(Equity securities)Investments can be accounted for in a variety of ways, depending on the nature of the investment relationship.Reporting Categories for InvestmentsInvestor Lacks Significant InfluenceSecurities to Be Held to MaturitySecurities are investments in bonds or other debt security that have a specified maturity date. The bonds or other debt are initially recorded at cost. The investor may have the “positive intent and ability” to hold the securities to maturity and can therefore be classified as held-to-maturity (HTM).They are reported on the balance sheet at “amortized cost.” Amortized cost (Face amount less unamortized discount, or plus unamortized premium).BalanceSheetTrading SecuritiesInvestments in debt or equity securities acquired principally for the purpose of selling them in the near term. Adjustments to fair value are recordedin a valuation account called fair value adjustment, or as a direct adjustment to the investment account.as a net unrealized holding gain/loss on the income statement.Unrealized Gain Unrealized Loss Income StatementFinancial Statement PresentationTrading securities are presented on the financial statement as follows: Income Statement and Statement of Comprehensive Income: Fair value changes are included in the income statement in the periods in which they occur, regardless of whether they are realized or unrealized. Investments in trading securities do not affect other comprehensive income. Balance Sheet: Securities are reported at fair value, typically as current assets, and do not affect accumulated other comprehensive income in shareholders’ equity. Cash Flow Statement: Cash flows from buying and selling trading securities typically are classified as operating activities, because the investors that hold trading securities consider them as part of their normal operations.Securities Available-for-SaleInvestments in debt or equity securities that are not for active trading and not to be held to maturity are classified as available-for-sale (AFS).Adjustments to fair value are recordedin a valuation account called fair value adjustment, or as a direct adjustment to the investment account.as a net unrealized holding gain/loss in other comprehensive income (OCI), which accumulates in accumulated other comprehensive income (ACOI).Unrealized Gain Unrealized Loss Other Comprehensive Income (OCI)Financial Statement PresentationAFS securities are presented on the financial statement as follows:Income Statement and Statement of Comprehensive Income: Realized gains and losses are shown in net income in the period in which securities are sold. Unrealized gains and losses are shown in OCI in the periods in which changes in fair value occur, and reclassified out of OCI in the periods in which securities are sold. Balance Sheet: Investments in AFS securities are reported at fair value. Unrealized gains and losses affect AOCI in shareholders’ equity, and are reclassified out of AOCI in the periods in which securities are sold.Cash Flow Statement: Cash flows from buying and selling AFS securities typically are classified as investing activities.U. S. GAAP vs. IFRSU.S. GAAP also allows transfers out of the trading security category.Reclassifications under U.S. GAAP are rare.Until recently, IFRS did not allow transfers out of their “Fair Value through Profit and Loss” (FVTPL) classification.IAS No. 39 now allows transfer of debt investments out of the fair value category into AFS or HTM in “rare circumstances.”The current financial crisis qualified as one of those circumstances.U. S. GAAP vs. IFRSU.S. GAAP permits classification as HTM, AFS, and TS.No significant tests are required to classify a debt investment.There is no comparable FVTPL or FVTOCI classification.IFRS No. 9 eliminates the HTM and AFS classifications, replaced by new classifications that are more restrictive. This has the general effect of pushing more investments into being accounted for at “Fair Value Through Profit & Loss” (FVTPL), and thus having unrealized gains and losses included in net income. Investments in debt securities are classified as either “Amortized Cost” or FVTPL.To be classified as a debt investment, two important tests must be met. The current financial crisis qualified as one of those circumstances.Investments in equity securities are classified as either “FVTPL” or “FVTOCI” (“Fair Value through Other Comprehensive Income).Transfers Between Reporting CategoriesAny unrealized holding gain or loss at reclassification should be accounted for in a manner consistent with the classification into which the security is being transferred. Securities are transferred at fair market value on the date of transfer.Impairment of InvestmentsOccasionally, an investment’s value will decline for reasons that are other-than- temporary (OTT).For HTM and AFS investments, a company recognizes an OTT impairment loss in earnings. Determining an “other than temporary” decline for debt securities can be quite complex. For both equity and debt investments, after an OTT impairment is recognized, the ordinary treatment of unrealized gains and losses is resumed.U. S. GAAP vs. IFRSU.S. GAAP has no prohibition against transfers between categories as long as they can be reasonably justified.Until recently, IFRS did not allow transfers out of the “fair value through P&L” (FVTPL) classification (which is roughly equivalent to the trading securities classification in U.S. GAAP).Under IAS No. 39 transfers of debt investments out of the FVTPL category into AFS or HTM in “rare circumstances.”The 2008 financial crisis qualifies as one of those “rare circumstances.”Financial Statement Presentationand DisclosureAggregate Fair ValueMaturities of debt securitiesChange in net unrealized holding gains and lossesGross realized & unrealized holding gains & lossesAmortized cost basis by major security typeInputs to fair value estimatesInvestor Has Significant Influence Investor Has Significant InfluenceExtent of Investor InfluenceReporting MethodLack of significant influence(usually 50% equity ownership) ConsolidationWhat Is Significant Influence?If an investor owns 20% of the voting stock of an investee, it is presumed that the investor has significant influence over the financial and operating policies of the investee. The presumption can be overcome ifthe investee challenges the investor’s ability to exercise significant influence through litigation or other methods.the investor surrenders significant shareholder rights in a signed agreement.the investor is unable to acquire sufficient information about the investee to apply the equity method.the investor tries and fails to obtain representation on the board of directors of the investee.A Single Entity ConceptUnder the equity method . . .The investor recognizes investment income equal to its percentage share (based on stock ownership) of the net income earned by the investee rather than the portion of that net income received as cash dividends.Initially, the investment is recorded at cost. The carrying amount of this investment subsequently is:Increased by the investor’s percentage share of the investee’s net income (or decreased by its share of a loss).Decreased by dividends paid.Equity MethodOn January 1, 2013, Wilmer Inc. purchased 25% of the common stock of Apex Inc. for $180,000. At the date of acquisition, the book value of the net assets of Apex was $400,000, and the fair value of these assets is $600,000. During 2013, Apex paid cash dividends of $40,000, and reported earnings of $100,000.Changing From the Equity Method to Another Method At the transfer date, the carrying value of the investment under the equity method is regarded as cost.When the investor’s level of influence changes, it may be necessary to change from the equity method to another method.Changing from Another Method to the Equity MethodWhen the investor’s ownership level increases to the point where they can exert significant influence, the investor should change to the equity method.At the transfer date, the recorded value is the initial cost of the investment adjusted for the investor’s equity in the undistributed earnings of the investee since the original investment.Changing from Another Method to the Equity MethodThe original cost, the unrealized holding gain or loss, and the valuation account are closed.A retroactive change is recorded to recognize the investor’s share of the investee’s earnings since the original investment.Fair Value OptionGAAP allows companies to use a “fair value option” for HTM, AFS, and equity method investments. The investment is carried at fair value. Unrealized gains and losses are included in income.For HTM and AFS investments, this amounts to classifying the investments as trading.For equity method investments, the investment is still classified on the balance sheet with equity method investments, but the portion at fair value must be clearly indicated.The fair value option is determined for each individual investment, and is irrevocable.Financial Instruments andInvestment DerivativesFinancial Instruments:Cash.Evidence of an ownership interest in an entity.Contracts meeting certain conditions.Investment Derivatives:Value is derived from other securities.Derivatives are often used to “hedge” (offset) risks created by other investments or transactionsAppendix 12A – Other InvestmentsIt is often convenient for companies to set aside money to be used for specific purposes. In the short-term, funds may be set aside forPetty cash funds.Payroll accounts.In the long-run, funds are often set aside to:Pay long-term debt when it comes due.Acquire treasury stock.Special purpose funds set aside for the long-term are classified as investments.Appendix 12A – Other InvestmentsIt is a common practice for companies to purchase life insurance policies on key officers. The company pays the premium and is the beneficiary of the policy. If the officer dies, the company receives the proceeds from the policy. Some types of policies build a portion of each premium as cash surrender value. The cash surrender value of such a policy is classified as an investment on the balance sheet of the company.Appendix 12B – Impairment of InvestmentsIf the fair value of an investment declines to a level below cost, and that decline is not viewed as temporary, companies typically have to recognize an other-than-temporary (“OTT”) impairment loss in earnings.We use a three-step process to determine whether an OTT impairment loss must be recognized: (1) determine if the investment is impaired, (2) determine whether any impairment is OTT, and (3) determine where to report the OTT impairment.Appendix 12B – Impairment of InvestmentsAppendix 12B – Impairment of InvestmentsInvestments:A Chapter SupplementSupplement to Chapter 12GAAP vs. Proposed Accounting Standard UpdateAccounting for Equity InvestmentsDetermining how to account for equity investments in stock under the proposed ASU is easy. If the investor does not have “significant influence” over the investee, the equity investment is accounted for as FV-NI. If the investor has significant influence over the investee, but lacks control, the equity method is used. If the investor has control, the investment is consolidated. Under current GAAP, the investor accounts for the equity investment as a trading or as an AFS security.Under the ASU an equity investment always is treated as FV-NI (equivalent to being accounted for as a trading security). Accounting for Debt InvestmentsDetermining how to account for debt investments under the proposed ASU is more complicated than accounting for equity investments. Under the proposed ASU we base classification of debt investments on two criteria: The characteristics of the debt instrument.The business activity in which the instrument is used. We discuss each of the criteria in turn.Characteristics of a Simple Debt Instrument An amount is transferred to the borrower (debtor) when the debt instrument is issued that will be returned to the lender (creditor) when the debt matures or is settled. The amount is the principal or face amount of the debt adjusted for any discount or premium.The debt cannot be prepaid or settled in such a way that the lender does not recover substantially all of its original investment, unless the lender chooses to allow it.The debt instrument is not a derivative.Accounting for Debt InvestmentsCharacteristics of a Complex Debt InstrumentDebt that lacks one or more of the characteristics of simple debt is considered complex. Under the proposed ASU, debt that is complex always is classified as fair value in net income. Business Purpose of a Debt InstrumentFor simple debt, we next must consider the business activity that motivates the investor to hold the debt. The proposed ASU identifies three primary business activities aslending, long-term investing, or held for sale. The debt holder’s purpose is lending or customer financing with a focus on collecting cash flows (interest and principal). The debt holder must have the ability to renegotiate, sell, or settle the debt to minimize losses due to a borrower's deteriorating credit. The appropriate accounting approach is amortized cost.Business Purpose of a Debt InstrumentFor simple debt, we next must consider the business activity that motivates the investor to hold the debt. The ASU identifies three primary business activities aslending, long-term investing, or held for sale. The debt holder may choose to hold on to the debt investment or sell it as a way of either (a) maximizing its return on investment or (b) managing risk. The appropriate accounting approach is Fair Value – Other Comprehensive Income (FV-OCI)Business Purpose of a Debt InstrumentFor simple debt, we next must consider the business activity that motivates the investor to hold the debt. The ASU identifies three primary business activities aslending, long-term investing, or held for sale. For the business purpose to be classified as held for sale, the debt instrument is either (a) held for the purpose of being sold or (b) actively managed internally on a fair value basis. The appropriate accounting approach is Fair Value – Net Income.Summary of Classification CriteriaThe proposed ASU does not allow transfers of debt from one category to another. After the debt is initially classified, reclassifications are not permitted.Impairments When the Investor Does Not Exercise Significant InfluenceBecause equity investments are reported at FV-NI, no impairment guidance is necessary. The same is true for debt investments recorded at FV-NI. Declines in fair value always are reported in net income. However, for debt investments reported at amortized cost or at FV-OCI, impairment losses are possible. Let’s look at the “three-bucket” approach currently under consideration.Investments not affected by observed events.Investments affected by observed events (but individual defaults have not been identified).Individual debt investments suffering credit losses.123Debt Impairment (continued)Objective: Use expected value (probability-weighted average) of losses of principal and interest on a discounted basis.Time horizon of estimated losses: Bucket 1: over near term (say, 1-2 years). Buckets 2 and 3: over remaining life of investment. No impairment upon acquisition of distressed debt (interest based on expected cash flows rather than contractual cash flows). Equity MethodThe criteria for applying the equity method are the same in the ASU as in current GAAP. If a company is holding an investment for sale that normally would qualify for the equity method, the investment is accounted for as FV-NI.If facts indicate an impairment in value of an equity method investment, the investor recognizes an amount equal to the difference between the investment’s carrying value and its fair value. If fair value increases in the future, the impairment cannot be reversed.End of Chapter 12