Chapter 9 Investments Notes
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
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
Revenues, gains Opening balance,
Expenses, losses Retained earnings
Net income Net income + Net income
Retained earnings Retained earnings
Opening balance, AOCI
Other comprehensive income Other comprehensive income
for period for period
Comprehensive income Ending balance, AOCI AOCI
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