© 2008 Clarence Byrd Inc. 1 Chapter 2 Investments In Equity Securities.

© 2008 Clarence Byrd Inc.© 2008 Clarence Byrd Inc. 11

Chapter 2Chapter 2

Investments In Equity Investments In Equity SecuritiesSecurities

© 2008 Clarence Byrd Inc. 2

Chapter ObjectivesChapter Objectives

►Classification of equity Classification of equity investmentsinvestments

►Accounting for equity Accounting for equity investmentsinvestments

►Matching Matching classifications with classifications with methodsmethods


Conceptual Basis For Conceptual Basis For ClassificationClassification

Held fortrading

Availablefor sale

50% 100%0%

Jointventures

SignificantlyInfluencedcompanies

Subsidiaries


ClassificationClassification

►Non-strategic investmentsNon-strategic investments held-for-tradingheld-for-trading available-for-saleavailable-for-sale

►Strategic investmentsStrategic investments SubsidiariesSubsidiaries Significantly influenced companiesSignificantly influenced companies Interests in joint venturesInterests in joint ventures


Accounting MethodsAccounting Methods

►Cost methodCost method►Equity methodEquity method►Fair value method (changes in Net Fair value method (changes in Net

Income)Income)►Fair value method (changes in Fair value method (changes in

Comprehensive Income)Comprehensive Income)►Full consolidationFull consolidation►Proportionate consolidationProportionate consolidation


Held-For-TradingHeld-For-Trading

►Defined (Section 3855)Defined (Section 3855)

Acquired principally for the Acquired principally for the purpose of selling or purpose of selling or repurchasing in the short repurchasing in the short term;term;

A derivative; orA derivative; or

Any financial asset or Any financial asset or liability that is so liability that is so designateddesignated



►Application To Application To InvestmentsInvestments Equity securities held for Equity securities held for

short term tradingshort term trading

Other non-strategic Other non-strategic holdings that are holdings that are designated as held for designated as held for tradingtrading



►Accounting ProceduresAccounting Procedures

Initial and subsequent Initial and subsequent measurement at fair valuemeasurement at fair value

Changes in fair value are Changes in fair value are allocated to Net Incomeallocated to Net Income

Transaction costs charged Transaction costs charged to Net Income at to Net Income at acquisitionacquisition


Held-For-Trading ExampleHeld-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.



► Acquisition Of Acquisition Of InvestmentInvestment

January 1, 2008January 1, 2008 DebitDebit CreditCredit

Investments [(1,000)($10.00)]Investments [(1,000)($10.00)] $10,000$10,000

CashCash $10,000$10,000



► Receipt Of DividendsReceipt Of Dividends

During 2008During 2008 DebitDebit CreditCredit

Cash [(1,000)($0.75)]Cash [(1,000)($0.75)] $750$750

Investment Income (Net Income)Investment Income (Net Income) $750$750



► Year End AdjustmentYear End Adjustment

December 31, 2008December 31, 2008 DebitDebit CreditCredit

Investments [(1,000)($12.00 - $10.00)]Investments [(1,000)($12.00 - $10.00)] $2,000$2,000

Investment Income (Net Income)Investment Income (Net Income) $2,000$2,000



► Sale Of InvestmentSale Of Investment


Cash [(1,000)($13.00)]Cash [(1,000)($13.00)] $13,000$13,000

Investments ($10,000 + $2,000)Investments ($10,000 + $2,000) $12,000$12,000

Investment Income (Net Income)Investment Income (Net Income) $1,000$1,000


Available-For-SaleAvailable-For-Sale

►Defined (Section 3855)Defined (Section 3855)

Non-derivative financial Non-derivative financial assets that are designated assets that are designated as available for sale, or as available for sale, or that are not classified as that are not classified as loans and receivables, loans and receivables, held-to-maturity, or held-held-to-maturity, or held-for tradingfor trading



►Would include all equity Would include all equity investments other than:investments other than: Investments in subsidiariesInvestments in subsidiaries

Investments in significantly Investments in significantly influenced companiesinfluenced companies

Investments in joint Investments in joint venturesventures

Investments that are Investments that are classified as held for trading.classified as held for trading.



► Accounting ProceduresAccounting Procedures

Initial and subsequent Initial and subsequent measurement at fair valuemeasurement at fair value

Changes in fair value are Changes in fair value are allocated to Comprehensive allocated to Comprehensive IncomeIncome

Transaction costs:Transaction costs:

►charged to Net Income at charged to Net Income at acquisition, or added to the initial acquisition, or added to the initial costcost


Available-For-Sale ExampleAvailable-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.


Available For Sale ExampleAvailable For Sale Example



Investments [(1,000)($10.00)]Investments [(1,000)($10.00)] $100,000$100,000

CashCash $100,000$100,000



► Receipt Of DividendsReceipt Of Dividends


Cash [(1,000)($0.75)]Cash [(1,000)($0.75)] $750$750

Investment Income (Net Income)Investment Income (Net Income) $750$750



► Year End AdjustmentYear End Adjustment

December 31, 2008December 31, 2008 DebitDebit CreditCredit

Investments [(1,000)($12.00 - $10.00)]Investments [(1,000)($12.00 - $10.00)] $2,000$2,000

Other Comprehensive Income - GainOther Comprehensive Income - Gain $2,000$2,000





Cash [(1,000)($13.00)]Cash [(1,000)($13.00)] $13,000$13,000

Other Comprehensive Income – Other Comprehensive Income – ReclassificationReclassification

2,0002,000

Investments ($10,000 + $2,000)Investments ($10,000 + $2,000) $12,000$12,000

Investment Income (Net Income)Investment Income (Net Income) 3,0003,000


Cost MethodCost Method

► ApplicabilityApplicability Can be used when Can be used when

available-for-sale available-for-sale securities do not securities do not have quoted market have quoted market pricesprices

► ProceduresProcedures Investment at costInvestment at cost Earnings only when Earnings only when

received or received or receivablereceivable


Cost MethodCost Method

► Return of capital: Occurs when Return of capital: Occurs when dividends received exceed the dividends received exceed the investor’s share of earnings since investor’s share of earnings since acquisitionacquisition


Return Of Capital ExampleReturn 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.





Investment In MontageInvestment In Montage $500,000$500,000

CashCash $500,000$500,000



► Receipt of 2008 Receipt of 2008 dividendsdividends


Cash [(10%)($250,000)]Cash [(10%)($250,000)] $25,000$25,000

Investment IncomeInvestment Income $20,000$20,000



► Receipt of 2009 Receipt of 2009 dividendsdividends


Cash [(10%)($250,000)]Cash [(10%)($250,000)] $25,000$25,000

Investment Income Investment Income [(10%)($350,000 - $250,000 + $100,000)][(10%)($350,000 - $250,000 + $100,000)] $20,000$20,000

Investment In Montage Investment In Montage [(10%)($250,000 - $100,000 - $100,000)][(10%)($250,000 - $100,000 - $100,000)] 5,0005,000


SubsidiariesSubsidiaries

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


The Concept Of ControlThe 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.



► In general, based on ownership of In general, based on ownership of more than 50 percent of the more than 50 percent of the outstanding voting sharesoutstanding voting shares

►ExceptionsExceptions Control may exist without majority Control may exist without majority

ownershipownership

Control may not exist even with majority Control may not exist even with majority ownershipownership



P A B60% 55%



P

Y Z

X70%

40%

30%60%


SubsidiariesSubsidiaries

►Accounting ProceduresAccounting Procedures Paragraph 1590.16 Paragraph 1590.16 An enterprise An enterprise

should consolidate all of its should consolidate all of its subsidiaries. (January, 1992)subsidiaries. (January, 1992)

Consolidation procedures will be Consolidation procedures will be covered in Chapters 4, 5, and 6covered in Chapters 4, 5, and 6


Significantly Influenced Significantly Influenced CompaniesCompanies

►DefinedDefined IAS 28 IAS 28 Significant influence is the power Significant influence is the power

to participate in the financial and to participate in the financial and operating policy decisions of the investee, operating policy decisions of the investee, but is not control over those policiesbut is not control over those policies

CICA has a 20 percent guidelineCICA has a 20 percent guideline Judgment would have been betterJudgment would have been better Key is the ability to elect directorsKey is the ability to elect directors



►Required Accounting Required Accounting Procedures:Procedures: Section 3051 requires Section 3051 requires the use of the equity methodthe use of the equity method


Equity Method ProceduresEquity Method Procedures

►Accounting for the investment assetAccounting for the investment asset Investment is recorded at costInvestment is recorded at cost Adjusted each year for the investor’s Adjusted each year for the investor’s

shares of the investee’s change in shares of the investee’s change in Retained EarningsRetained Earnings


Equity Method ProceduresEquity Method Procedures

►Accounting for investment incomeAccounting for investment income

Investment income is equal to the Investor’s share of the reported Net Income of the Investee.


Equity Method ExampleEquity 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.





Investment In BeauchampInvestment In Beauchamp $800,000$800,000

CashCash $800,000$800,000



► 2008 Income And Dividends2008 Income And Dividends

Year Ending December 31, 2008Year Ending December 31, 2008 DebitDebit CreditCredit

Cash [(25%)($180,000)Cash [(25%)($180,000) $45,000$45,000

Investment In Beauchamp Investment In Beauchamp [(25%)($300,000 - $180,000)][(25%)($300,000 - $180,000)] 30,00030,000

Investment Income [(25%)($300,000)]Investment Income [(25%)($300,000)] $75,000$75,000



Year Ending December 31, 2009Year Ending December 31, 2009 DebitDebit CreditCredit

Cash [(25%)($150,000)]Cash [(25%)($150,000)] $37,500$37,500

Investment Loss [(25%)($100,000)]Investment Loss [(25%)($100,000)] 25,00025,000

Investment In Beauchamp Investment In Beauchamp [(25%)(- $100,000 – $150,000)][(25%)(- $100,000 – $150,000)] $62,500$62,500

► 2009 Income And Dividends2009 Income And Dividends





CashCash $1,200,00$1,200,0000

Investment In Beauchamp Investment In Beauchamp ($800,000 + $30,000 - $62,500)($800,000 + $30,000 - $62,500) $767,500$767,500

Gain On Investment SaleGain On Investment Sale 432,500432,500


Equity MethodEquity Method

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



► EIC No.8: negative EIC No.8: negative balance can be shown balance can be shown if:if: Investor has guaranteed Investor has guaranteed

obligations of the obligations of the investeeinvestee

The investor is committed The investor is committed to provide further to provide further financial supportfinancial support

The investee seems The investee seems assured of returning to assured of returning to profitabilityprofitability



► Significant Influence To ControlSignificant Influence To Control Consolidation is requiredConsolidation is required



► Significant Influence To No InfluenceSignificant Influence To No Influence Will become held-for-trading or available-for-saleWill become held-for-trading or available-for-sale The “new cost” will be the equity value at the The “new cost” will be the equity value at the

time of the changetime of the change



►Consolidation AdjustmentsConsolidation Adjustments All of the adjustments that would be All of the adjustments that would be

required in preparing consolidated required in preparing consolidated statements are required here.statements are required here.

See Chapters 5 and 6 for illustrations of See Chapters 5 and 6 for illustrations of these procedures.these procedures.



► DisclosureDisclosure Basis of valuationBasis of valuation Separate disclosure of the Separate disclosure of the

class in both the Balance class in both the Balance Sheet and the Income Sheet and the Income StatementStatement

Treatment of the difference Treatment of the difference between the cost of the between the cost of the investment and the investment and the underlying book value of the underlying book value of the investee’s assets at the date investee’s assets at the date of acquisition.of acquisition.


Joint Venture ArrangementsJoint Venture Arrangements

► Paragraph Paragraph 3055.03(c)3055.03(c) A joint A joint venture is an venture is an economic activity economic activity resulting from a resulting from a contractual contractual arrangement whereby arrangement whereby two or more venturers two or more venturers jointly control the jointly control the economic activityeconomic activity


Joint Venture ArrangementsJoint Venture Arrangements

► Current accounting rules Current accounting rules require the use of require the use of proportionate proportionate consolidationconsolidation

► Proportionate Proportionate consolidation will be consolidation will be covered in Chapter 8covered in Chapter 8

► IASB will eliminate IASB will eliminate proportionate proportionate consolidation and require consolidation and require the equity methodthe equity method


Impairment Of Impairment Of Significantly Influenced Significantly Influenced

CompaniesCompanies► Paragraph 3051.18Paragraph 3051.18

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



CompaniesCompanies► IndicatorsIndicators

Depressed market pricesDepressed market prices Severe or continued lossesSevere or continued losses Suspension of tradingSuspension of trading Liquidity or going concern Liquidity or going concern

problemproblem Current fair value less than Current fair value less than

carrying valuecarrying value



CompaniesCompanies

► Subsequent recoveriesSubsequent recoveries Write downs cannot be Write downs cannot be

reversedreversed


Impairment – Other Impairment – Other InvestmentsInvestments

►Held for tradingHeld for tradingAlready at fair valueAlready at fair value

►Available for sale at fair valueAvailable for sale at fair valueIf impaired, transfer from comprehensive to net If impaired, transfer from comprehensive to net incomeincome

►Available for sale at costAvailable for sale at costSame rules as significantly influenced companiesSame rules as significantly influenced companies

►Subsidiaries and Joint VenturesSubsidiaries and Joint VenturesSubject to provisions that relate to specific assets Subject to provisions that relate to specific assets (e.g., 3063 deals with impairment of plant)(e.g., 3063 deals with impairment of plant)


Differential Reporting Differential Reporting OptionsOptions

► SubsidiariesSubsidiaries Qualifying enterprises may Qualifying enterprises may

elect to use either the cost elect to use either the cost method or the equity method or the equity method for these investeesmethod for these investees

► Additional procedures and Additional procedures and disclosures are requireddisclosures are required



► Significantly Influenced CompaniesSignificantly Influenced Companies Qualifying enterprises may elect to use the Qualifying enterprises may elect to use the

cost method for these investeescost method for these investees

► Additional procedures and disclosures Additional procedures and disclosures are requiredare required



► Joint VenturesJoint Ventures Qualifying enterprises may elect to use Qualifying enterprises may elect to use

either the cost method or the equity method either the cost method or the equity method for these investeesfor these investees

► Additional procedures and disclosures Additional procedures and disclosures are requiredare required


International ConvergenceInternational Convergence

►Held-for-trading and Held-for-trading and available-for-sale available-for-sale investments: investments: covered in IAS 39covered in IAS 39


IAS 39 DifferencesIAS 39 Differences

► ““Held-for-trading” replaced by “financial Held-for-trading” replaced by “financial asset at fair value through profit or loss”asset at fair value through profit or loss”

►Generally doesn’t allow arbitrary Generally doesn’t allow arbitrary designation as held for tradingdesignation as held for trading

► Allows cost when fair value “not readily Allows cost when fair value “not readily determinable” as opposed to no quoted determinable” as opposed to no quoted market valuemarket value

►Does not provide an optional treatment of Does not provide an optional treatment of transaction coststransaction costs

► Requires the reversal of impairment write Requires the reversal of impairment write downs when there is a recoverydowns when there is a recovery



► Significantly Significantly influenced influenced companies: companies: covered in IAS 28covered in IAS 28


IAS 28 DifferencesIAS 28 Differences

► Uses the term “associated companies” rather Uses the term “associated companies” rather than “significantly influenced companies”than “significantly influenced companies”

► Impairment when recoverable amount is less Impairment when recoverable amount is less than the carrying amount. Recoverable than the carrying amount. Recoverable amount based on present value of future cash amount based on present value of future cash flowsflows

► IAS 28 requires the reversal of an impairment IAS 28 requires the reversal of an impairment loss when a recovery has occurredloss when a recovery has occurred



► Subsidiaries and Subsidiaries and joint ventures – joint ventures – Differences will be Differences will be covered in later covered in later chapterschapters


© 2008 Clarence Byrd Inc. 1 Chapter 2 Investments In Equity Securities.

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