ACCOUNTING FOR FINANCIAL ASSETS

Financial Asset
 Cash.
 Equity investment of another company (e.g., ordinary or
preference shares).
 Contractual right to receive cash from another party
(e.g., loans, receivables, and bonds).

IASB requires that companies classify financial assets into two

measurement categories—amortized cost and fair value—
depending on the circumstances.

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 ACCOUNTING FOR FINANCIAL ASSETS

Measurement Basis—A Closer Look

IFRS requires that companies measure their financial
assets based on two criteria:
 Company’s business model for managing its financial
assets; and
 Contractual cash flow characteristics of the financial
asset.

Only debt investments such as receivables, loans, and bond

investments that meet the two criteria above are recorded at amortized
cost. All other debt investments are recorded and reported at fair value.

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 ACCOUNTING FOR FINANCIAL ASSETS

Measurement Basis—A Closer Look

Equity investments are generally recorded and reported at
fair value.

ILLUSTRATION 17-1
Summary of Investment Accounting Approaches

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 DEBT INVESTMENTS

Debt investments are characterized by contractual

payments on specified dates of
 principal and
 interest on the principal amount outstanding.

Companies measure debt investments at

 amortized cost or
 fair value.

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 Debt Investments—Amortized Cost

Illustration: Robinson Company purchased €100,000 of 8%

bonds of Evermaster Corporation on January 1, 2015, at a
discount, paying €92,278. The bonds mature January 1, 2020
and yield 10%; interest is payable each July 1 and January 1.
Robinson records the investment as follows:

January 1, 2015

Debt Investments 92,278

Cash 92,278

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 Debt Investments—Amortized Cost
ILLUSTRATION 17-2

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 Debt Investments—Amortized Cost
ILLUSTRATION 17-2

Robinson Company records the receipt of the first semiannual

interest payment on July 1, 2015, as follows:

Cash 4,000
Debt Investments 614
Interest Revenue 4,614

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 Debt Investments—Amortized Cost
ILLUSTRATION 17-2

Because Robinson is on a calendar-year basis, it accrues

interest and amortizes the discount at December 31, 2015, as
follows:
Interest Receivable 4,000
Debt Investments 645
Interest Revenue 4,645
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 Debt Investments—Amortized Cost

Reporting of Bond Investment at Amortized Cost

ILLUSTRATION 17-3

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 ILLUSTRATION 17-2

Assume that Robinson Company sells its investment on

November 1, 2017, at 99¾ plus accrued interest. Robinson
records this discount amortization as follows:

Debt Investments 522

Interest Revenue 522
(€783 x 4/6 = €522)
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 Debt Investments—Amortized Cost

Computation Gain on Sale of Bonds

ILLUSTRATION 17-4

Cash 102,417
Interest Revenue (4/6 x €4,000) 2,667
Debt Investments 96,193
Gain on Sale of Debt Investments 3,557

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 Debt Investments—Fair Value

Debt investments at fair value follow the same

accounting entries as debt investments held-for-
collection during the reporting period. That is, they are
recorded at amortized cost.

However, at each reporting date, companies

 Adjust the amortized cost to fair value.
 Any unrealized holding gain or loss reported as part of
net income (fair value method).

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 Debt Investments—Fair Value

Illustration: Robinson Company purchased €100,000 of 8

percent bonds of Evermaster Corporation on January 1, 2015,
at a discount, paying €92,278. The bonds mature January 1,
2020, and yield 10 percent; interest is payable each July 1 and
January 1.

The journal entries in 2015 are exactly the same as those for
amortized cost.

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 Debt Investments—Fair Value

Entries are the same as those for amortized cost.

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 Debt Investments—Fair Value

To apply the fair value approach, Robinson determines that,

due to a decrease in interest rates, the fair value of the debt
investment increased to €95,000 at December 31, 2015.
ILLUSTRATION 17-5
Computation of Unrealized Gain on Fair
Value Debt Investment (2015)

Fair Value Adjustment 1,463

Unrealized Holding Gain or Loss—Income
1,463
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 Debt Investments—Fair Value

ILLUSTRATION 17-6
Financial Statement Presentation
of Debt Investments at Fair Value

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 Debt Investments—Fair Value

At December 31, 2016, assume that the fair value ILLUSTRATION 17-7
Computation of
of the Evermaster debt investment is €94,000. Unrealized Gain on
Debt Investment (2016)

Unrealized Holding Gain or Loss—Income 2,388

Fair Value Adjustment 2,388

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 Debt Investments—Fair Value

ILLUSTRATION 17-8
Financial Statement Presentation
of Debt Investments at Fair Value (2016)

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 Debt Investments—Fair Value

Assume now that Robinson sells its investment in Evermaster

bonds on November 1, 2017, at 99 ¾ plus accrued interest. The
only difference occurs on December 31, 2017. Since the bonds
are no longer owned by Robinson, the Fair Value Adjustment
account should now be reported at zero. Robinson makes the
following entry to record the elimination of the valuation account.

Fair Value Adjustment 925

Unrealized Holding Gain or Loss—Income 925

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 Debt Investments—Fair Value
Income
Effects on
Debt
Investment
(2015-2017)
Illustration 17-9

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 Debt Investments—Fair Value

Illustration (Portfolio): Wang Corporation has two debt

investments accounted for at fair value. The following illustration
identifies the amortized cost, fair value, and the amount of the
unrealized gain or loss. ILLUSTRATION 17-10
Computation of Fair Value Adjustment (2015)

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 Debt Investments—Fair Value

Illustration (Portfolio): Wang makes an adjusting entry at

December 31, 2015 to record the decrease in value and to
record the loss as follows.

Unrealized Holding Gain or Loss—Income 9,537

Fair Value Adjustment 9,537

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 Debt Investments—Fair Value

Illustration (Sale of Debt Investments): Wang Corporation

sold the Watson bonds (from Illustration 17-10) on July 1, 2016,
for ¥90,000, at which time it had an amortized cost of ¥94,214.
ILLUSTRATION 17-11
Computation of Loss
on
Sale of Bonds

Cash 90,000
Loss on Sale of Debt Investments 4,214
Debt Investments 94,214

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 Debt Investments—Fair Value

Wang reports this realized loss in the “Other income and

expense” section of the income statement. Assuming no other
purchases and sales of bonds in 2016, Wang on December 31,
2016, prepares the information:

ILLUSTRATION 17-12
Computation of Fair
17-24 Value Adjustment (2016) LO 3
 Debt Investments—Fair Value

Wang records the following at December 31, 2016.

ILLUSTRATION 17-12

Fair Value Adjustment 4,537

Unrealized Holding Gain or Loss—Income 4,537

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 Debt Investments—Fair Value

Financial Statement Presentation

ILLUSTRATION 17-13
Reporting of Debt
Investments at Fair Value
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 Fair Value Option

Companies have the option to report most financial assets at

fair value. This option
 is applied on an instrument-by-instrument basis and
 is generally available only at the time a company first
purchases the financial asset or incurs a financial liability.

If a company chooses to use the fair value option, it

measures this instrument at fair value until the company no
longer has ownership.

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 Fair Value Option

Illustration: Hardy Company purchases bonds issued by the

German Central Bank. Hardy plans to hold the debt investment
until it matures in five years. At December 31, 2015, the
amortized cost of this investment is €100,000; its fair value at
December 31, 2015, is €113,000. If Hardy chooses the fair value
option to account for this investment, it makes the following
entry at December 31, 2015.

Debt Investment (German bonds) 4,537

Unrealized Holding Gain or Loss—Income 4,537

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 Summary of Debt Investment Accounting

ILLUSTRATION 17-14
Summary of Debt
Investment Accounting

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 EQUITY INVESTMENTS

Equity investment represents ownership of ordinary,

preference, or other capital shares.
 Cost includes price of the security.
 Broker’s commissions and fees are recorded as
expense.

The degree 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.

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 EQUITY INVESTMENTS

ILLUSTRATION 17-15
Levels of Influence
Determine Accounting Methods

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 EQUITY INVESTMENTS

Illustration 17-16
Accounting and Reporting for Equity
Investments by Category

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 EQUITY INVESTMENTS

Holdings of Less Than 20%

Under IFRS, the presumption is that equity investments are
held-for-trading.

General accounting and reporting rule:

 Investments valued at fair value.
 Record unrealized gains and losses in net income.

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 EQUITY INVESTMENTS

Holdings of Less Than 20%

IFRS allows companies to classify some equity investments
as non-trading.

General accounting and reporting rule:

 Investments valued at fair value.
 Record unrealized gains and losses in other
comprehensive income.

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 Equity Investments—Trading (Income)

Illustration: November 3, 2015, Republic Corporation

purchased ordinary shares of three companies, each
investment representing less than a 20 percent interest. These
shares are held-for-trading.

Republic records these investments as follows:

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 Equity
Investments
—Trading

Republic records these investments as follows:

Equity Investments 718,550
Cash 718,550

On December 6, 2015, Republic receives a cash dividend of

€4,200 on its investment in the ordinary shares of Nestlé.

Cash 4,200
Dividend Revenue 4,200
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 Equity Investments—Trading (Income)

At December 31, 2015, Republic’s equity investment portfolio has

the carrying value and fair value shown.

ILLUSTRATION 17-17
Computation of Fair Value Adjustment—
Equity Investment Portfolio (2015)

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 Equity Investments—Trading (Income)

ILLUSTRATION 17-17

Unrealized Holding Gain or Loss—Income 35,550

Fair Value Adjustment 35,550
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 Equity Investments—Trading (Income)

On January 23, 2016, Republic sold all of its Burberry ordinary

shares, receiving €287,220. ILLUSTRATION 17-18
Computation of Gain on Sale of Burberry Shares

Cash 287,220
Equity Investments 259,700
Gain on Sale of Equity Investment 27,520

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 Equity Investments—Trading (Income)

In addition, assume that on February 10, 2016, Republic purchased

€255,000 of Continental Trucking ordinary shares (20,000 shares
€12.75 per share), plus brokerage commissions of €1,850.
Republic’s equity investment portfolio as of December 31, 2016.

ILLUSTRATION 17-19
Computation of Fair
Value Adjustment—
Equity Investment
Portfolio (2016)

17-40
 ILLUSTRATION 17-19

Republic records this adjustment as follows.

Fair Value Adjustment 101,650

Unrealized Holding Gain or Loss—Income
101,650
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 Equity Investments—Non-Trading (OCI)

The accounting entries to record non-trading equity

investments are the same as for trading equity investments,
except for recording the unrealized holding gain or loss.

Report the unrealized holding gain or loss as other

comprehensive income.

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 Equity Investments—Non-Trading (OCI)

Illustration: On December 10, 2015, Republic Corporation

purchased 1,000 ordinary shares of Hawthorne Company for
€20.75 per share (total cost €20,750). The investment represents
less than a 20 percent interest. Hawthorne is a distributor for
Republic products in certain locales, the laws of which require a
minimum level of share ownership of a company in that region.
The investment in Hawthorne meets this regulatory requirement.
Republic accounts for this investment at fair value.

Equity Investments 20,750

Cash 20,750

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 Equity Investments—Non-Trading (OCI)

On December 27, 2015, Republic receives a cash dividend of

€450 on its investment in the ordinary shares of Hawthorne
Company. It records the cash dividend as follows.

Cash 450
Dividend Revenue 450

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 Equity Investments—Non-Trading (OCI)

At December 31, 2015, Republic’s investment

in Hawthorne has the carrying value and fair ILLUSTRATION 17-20
Computation of Fair Value
value shown. Adjustment—Non-Trading Equity
Investment (2015)

Republic records this adjustment as follows.

Fair Value Adjustment 3,250

Unrealized Holding Gain or Loss—Equity
3,250
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 Equity Investments—Non-Trading (OCI)

ILLUSTRATION 17-21
Financial Statement Presentation

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 Equity Investments—Non-Trading (OCI)

On December 20, 2016, Republic sold all of its Hawthorne

Company ordinary shares receiving net proceeds of €22,500.

ILLUSTRATION 17-22
Adjustment to Carrying Value of Investment

Entry to adjust the carrying value of the non-trading investment.

Unrealized Holding Gain or Loss—Equity 1,500
Fair Value Adjustment 1,500

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 Equity Investments—Non-Trading (OCI)

On December 20, 2016, Republic sold all of its Hawthorne

Company ordinary shares receiving net proceeds of €22,500.

ILLUSTRATION 17-22
Adjustment to Carrying Value of Investment

Entry to record the sale of the investment.

Cash 22,500
Equity Investments 20,750
Fair Value Adjustment 1,750
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 Holdings Between 20% and 50%

An investment (direct 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.

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 Holdings Between 20% and 50%

Equity Method (IAS 28)

Record the investment at cost and subsequently adjust
the amount each period for
 the investor’s proportionate share of the earnings
(losses) and
 dividends received by the investor.

If investor’s share of investee’s losses exceeds the carrying

amount of the investment, the investor ordinarily should discontinue
applying the equity method.

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 ILLUSTRATION 17-23
Comparison of Fair Value Method and Equity Method
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 Holdings of More Than 50%

Controlling Interest - When one corporation acquires a

voting interest of more than 50 percent in another
corporation.
 Investor is referred to as the parent.
 Investee is referred to as the subsidiary.
 Investment in the subsidiary is reported on the parent’s
books as a long-term investment.
 Parent generally prepares consolidated financial
statements.

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 OTHER REPORTING ISSUES

Impairment of Value
For debt investments, a company uses the impairment test to
determine whether “it is probable that the investor will be unable
to collect all amounts due according to the contractual terms.”
This impairment loss is calculated as the difference between the
carrying amount plus accrued interest and the expected future
cash flows discounted at the investment’s historical effective-
interest rate.

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 Impairment of Value

Illustration: At December 31, 2014, Mayhew Company has a

debt investment in Bao Group, purchased at par for ¥200,000
(amounts in thousands). The investment has a term of four years,
with annual interest payments at 10 percent, paid at the end of
each year (the historical effective-interest rate is 10 percent). This
debt investment is classified as held-for-collection.
Using the following information record the loss on impairment.

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 Impairment of Value ILLUSTRATION 17-24
Investment Cash Flows

ILLUSTRATION 17-25
Computation of
Impairment Loss

Loss on Impairment 12,680

Debt Investments 12,680
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 Recovery of Impairment Loss

If subsequently the impairment loss decreases, some or all of

the previously recognized impairment loss shall be reversed
with a
 debit to the Debt Investments account and
 crediting Recovery of Impairment Loss.
Reversal of impairment losses shall not result in a carrying
amount of the investment that exceeds the amortized cost that
would have been reported had the impairment not been
recognized.

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 Transfers Between Categories

Transferring an investment from one classification to another

 Should occur only when the business model for managing
the investment changes.
 IASB expects such changes to be rare.
 Companies account for transfers between classifications
prospectively, at the beginning of the accounting period
after the change in the business model.

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 Transfers Between Categories

Illustration: British Sky Broadcasting Group plc (GBR) has a

portfolio of debt investments that are classified as trading; that is,
the debt investments are not held-for-collection but managed to
profit from interest rate changes. As a result, it accounts for these
investments at fair value. At December 31, 2014, British Sky has
the following balances related to these securities.

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 Transfers Between Categories

Illustration: As part of its strategic planning process, completed

in the fourth quarter of 2014, British Sky management decides to
move from its prior strategy—which requires active management
—to a held-for-collection strategy for these debt investments.
British Sky makes the following entry to transfer these securities
to the held-for-collection classification.

Debt Investments 125,000

Fair Value Adjustment 125,000

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 Reporting Treatment of Investments

ILLUSTRATION 17-26
Summary of Investment Accounting Approaches
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