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Chapter 9

Chapter 9 Notes

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Department
Financial Accounting
Course
MGAC01H3
Professor
Daga
Semester
Winter

Description
Chapter 9 Investments Notes Accounting Models Introduction Financial Assets and Investments companies that invest in debt instruments of another entity are creditors of the issuing company debt instruments include debt securities, whose prices are normally quoted in an active market, such as investments in government and corporate bonds, convertible debt, and commercial paper; on the other hand, equity instruments represent ownership interests typical examples are common, preferred, or other capital stock or shares and also include rights to acquire or dispose of ownership interests at an agreed-upon or determinable price, such as warrants, rights, and call or put options an equity instrument is any contract that is evidence of a residual interest in the assets of an entity after deducting all of its liabilities Prices and Fair Values it is logical to capitalize the transaction costs associated with an investment that is accounted for using a cost-based model because transaction costs are a necessary cost of acquiring the asset alternatively, for assets accounted for using a fair value model, it makes more sense to expense the transaction costs regardless of how transaction costs are accounted for at acquisition, they are not included in fair value at later balance sheet dates when a financial instrument is measured at fair value, changes in fair value carrying amount are unrealized holding gains or losses the change in value is unrealized because it has not been converted to cash or a claim to cashthe asset is still held by the entity such gains or losses are only realized when the asset is disposed of Cost/Amortized Cost Model Fair Value Through NI Model Fair Value Through OCI Model At acquisition, measure Cost (equal to fair value + Fair value Fair value at: transaction costs) At each reporting date, measure at: Cost or amortized cost Fair value Fair value Report unrealized holding gains and Not applicable In net income In OCI losses (changes in FV): Report realized Transfer total realized gains/losses holdings gains and In net income In net income to net income (recycling) or losses: directly to retained earnings Cost/Amortized Cost Model the amortized cost model applies only to investments in debt instruments and long-term notes and loans receivable, while the cost model may be applied to investments in equity instruments (shares) of other companies Investments in Shares of Other Entities application of the cost model to the investment one company makes in another entitys shares is straightforward: 1) Recognize the cost of the investment at the fair value of the shares acquired (or the fair value of what was given up to acquire them, if more reliable). Add to this any direct transaction costs (such as commissions) incurred to acquire the shares. 2) Unless impaired, report the investment at its cost at each balance sheet date. 3) Recognize dividend income when the entity has a claim to the dividend. 4) When the shares are disposed of, derecognize them and report a gain or loss on disposal in net income. The gain or loss is the difference between the investments carrying amount and the proceeds on disposal. Investments in Debt Securities of Other Entities when cost model is applied to investment in debt securities (and long-term notes and loans receivable), it is referred to as amortized cost model because any difference between acquisition cost recognized and FV of security is amortized over period to maturity amortized cost is amount recognized at acquisition reduced by principal repayments, where applicable, plus or minus the cumulative amortization of any discount or premium; i.e., the difference between the initial amount recognized and the maturity value the following statements describe this method: 1) Recognize cost of investment at the fair value of the debt instrument acquired (or the fair value of what was given up to acquire it, if more reliable a measure). Add to this any direct transaction costs, such as commissions, incurred to acquire the investment. 2) Unless impaired, report investment at amortized cost as well as any outstanding interest receivable at each balance sheet date. 3) Recognize interest income as it is earned, amortizing any discount or premium at the same time by adjusting the carrying amount of the investment. 4) When the investment is disposed of, first bring the accrued interest and discount or premium amortization up to date. Derecognize the investment, reporting any gain or loss on disposal in net income. The gain or loss is the difference between the proceeds received for the security and the investments amortized cost at the date of disposal. Fair Value through Other Comprehensive Income (FV OCI) Model comprehensive income is the change in equity (or the net assets) of an entity during a period from non-owner source transactions and events; it is the total of net income and other comprehensive income other comprehensive income (OCI) is made up of revenues, gains, expenses, and losses that accounting standards say are included in comprehensive income, but excluded from net income accumulated other comprehensive income (AOCI) is the balance of all past charges and credits to OCI to the balance sheet dateStatement of Comprehensive Statement of Changes in Shareholders Equity End of Income Statement Income Shareholders Equity Period Share capital Revenues, gains Opening balance, Expenses, losses Retained earnings Net income Net income + Net income Dividends Ending balance, Retained earnings Retained earnings Opening balance, AOCI Other comprehensive income Other comprehensive income for period for period Comprehensive income Ending balance, AOCI AOCI Shareholders equity GAAP Classifications under ASPE, the cost-based model is generally applied for equity investments except when active market prices are available because investment portfolios are usually made up of a mix of debt and equity instruments that are managed on a fair value basis, PE GAAP allows entities to choose the FV-NI model for any financial instrument regardless of which method is used, all interest earned and dividends received are recognized in net income the IASBs underlying philosophy is that the amortized cost classification decision should be based on an entitys business model for managing its financial assets as well as on the contractual cash flow characteristics of the instrument 1) Business model for managing the instrument: The amortized cost classification does not depend on managements intent for a specific instrument, but instead, is based first on how it, or more likely, a portfolio of such instruments, is managed. If investments are managed on a contractual yield basis, changes in its fair value are not relevant. If the prospects for future cash flows are best assessed by reference to the contractual cash flows specified by the instrument, the amortized cost method is the more appropriate method of accounting for and reporting the asset. 2) Contractual cash flow characteristics: The instrument should have only basic loan features. This means that the financial asset has contractual terms that give rise to cash flows on specified dates that are solely payments of principal and interest on the principal outstanding. if an investment does not meet both of these conditions, it is accounted for at fair value through income while the two main IFRS classifications are a
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