CHAPTER 17
Investments
LEARNING OBJECTIVES
1. Understand the accounting for debt investments.
2. Understand the accounting for equity investments.
3. Explain the equity method of accounting.
CHAPTER REVIEW
1. The problems of accounting for investments involve measurement, recognition, and
disclosure. Investments are generally classified as either debt securities or equity
Debt Investments
2. (L.O. 1) A financial asset is cash, an equity investment of another company (ordinary or
preference shares) or a contractual right to receive cash from another party (receivables).
3. IFRS requires a company to measure its financial assets based on (a) its business model
for managing financial assets and (b) the contractual cash flow characteristics of the
4. If a company’s business model for bond investments is to collect interest and then
principal at maturity, and if the company intends to hold a bond it purchases to maturity,
5. If these two criteria are not met, the debt investment is accounted for at fair value. Held-
for-collection and selling investments are held with intent to both collect contractual
cash flows and sell financial assets. Trading investments are those not classified as
Fair Value Method
6. In applying the fair value method, companies record an unrealized gain with the following
entry:
7. Companies have the option to report most financial instruments at fair value (even if the
company meets the criteria for accounting for debt instruments at amortized cost), with all
Equity Investments
8. (L.O. 2) Equity investments are described as securities representing ownership
9. The degree to which one corporation (investor) acquires an interest in the ordinary
shares of another corporation (investee) generally determines the accounting treatment
for the investment subsequent to acquisition. Investments by one corporation in the
Fair Value Method
10. When an investor has an interest of less than 20%, it is presumed that the investor has
little or no influence over the investee. If market prices are available, the investment is
valued and reported subsequent to acquisition using the fair value method. The fair value
11.When acquired, equity investments are recorded at their purchase price with broker’s fees
and other fees expensed as incurred. Cash dividends received are recorded as dividend
12. 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. For non-trading
Equity Method
13. (L.O. 3) When an investor has a holding interest between 20% and 50% in an investee
corporation, the investor is generally deemed to exercise significant influence over
14. Under the equity method the investment’s carrying amount is periodically increased
(decreased) by the investor’s proportionate share of the earnings (losses) of the investee
and decreased by all dividends received by the investor from the investee.
15. Under the equity method, if an investor’s share of the investee’s losses exceeds the
16. The following transactions illustrate the journal entries for an investment accounted for
under the equity method.
c. In early 2019, Wendy Company paid a €75,000 dividend. Workowski’s share is €19,500
(€75,000 X .26).
Consolidated Financial Statements
17. When one corporation (the parent) acquires a voting interest of more than 50% in another
corporation (the subsidiary), the investor corporation is deemed to have a controlling
interest. When the parent treats the subsidiary as an investment, consolidated financial
Other Reporting Issues: Fair Value Option
18. (L.O. 4) Companies have the option to report most financial assets at fair value. The
Other Reporting Issues: Impairment of Value
19. Every held-for-collection investment should be evaluated at each reporting date to
determine if it has suffered an impairment. An impairment occurs when the fair value of
20. Subsequent to recording an impairment, events and circumstances may change resulting
in a reversal of the impairment. In this case, some or all of the previously recognized
21. Transferring an investment from one classification to another should occur only very
rarely when the business model for managing the investment changes. Reclassifications
Accounting for Derivative Instruments
*22. (L.O. 5) In general, derivatives are a product that has been developed to manage the
risks due to changes in market prices and include such things as interest-rate swaps and
*23. Any individual or company that wants to insure against different types of business risks
often can use derivative contracts to achieve this objective. Producers and consumers
Basic Principles in Accounting for Derivatives
*24. Derivatives should be recognized in the financial statements as assets and liabilities and
should be reported in the statement of financial position at fair value. On the income
*25. When distinguishing between the differences of traditional and derivative financial
instruments, a derivative financial instrument has the following three basic characteristics:
Derivatives Used for Hedging—Fair Value Hedge
*26. (L.O. 6) In a fair value hedge, a derivative is used to hedge (offset) the exposure to
changes in the fair value of a recognized asset or liability or of an unrecognized
income.
Derivatives Used for Hedging⎯Cash Flow Hedge
*27. Cash flow hedges are used to hedge exposures to cash flow risk, which is exposure to
the variability in cash flows. In accounting for cash flow hedges, the derivative should be
Other Reporting Issues
*28. (L.O. 7) Hybrid securities have characteristics of both debt and equity and often are
a combination of traditional and derivative financial instruments. In some cases, a host
*29. For the special accounting of hedges to occur, certain criteria must first be met. The general
criteria relate to the following areas:
a. Designation, documentation, and risk management.
Fair Value Disclosures
*30. (L.O. 8) The IASB requires the following disclosures regarding fair value information:
a. Both the cost and the fair value of all financial instruments must be reported in the
notes to the financial statements.
i. Quantitative information about significant observable inputs used for all Level
3 measurements.
ii. A qualitative discussion about the sensitivity of recurring Level 3
LECTURE OUTLINE
The material in this chapter can be covered in three class periods. Students will have some
A. (L.O. 1) Accounting for Debt Investments.
1. Debt investments are instruments representing a creditor relationship with an
enterprise.
4. Debt investments have contractual cash flows on specified dates, both principal and
interest.
a. Debt investments that the enterprise manages and evaluates on a fair value basis
are accounted for at fair value (Holding gains and losses reported in income).
b. IFRS requires companies to classify debt investments into three categories:
1) If a company’s business model for bond investments is to collect interest and
then principal at maturity, and if the company intends to hold a bond it
5. Debt investments are accounted for using the effective interest method, similar to the
method used to account for bonds payable.
a. Companies that account for and report debt investments at fair value follow the
b. However, at each reporting date, companies adjust the amortized cost to fair
value at the portfolio level for held-for-collection and sale and for trading
B. (L.O. 2) Equity Investments.
1. Equity investments are securities representing ownership interests such as ordinary,
preference, or other capital stock.
2. Investments by one corporation in the ordinary shares of another can be classified
according to percentage ownership.
3. Holdings of less than 20%. The cost of the equity investment is its purchase price
with broker’s and other fees expensed as incurred. Subsequent to acquisition, the
investment is valued and reported using the fair value method.
4. (L.O. 3) Holdings Between 20% and 50%. Use the equity method. The investment
account is increased (decreased) by the investor’s share of the earnings (losses) of the
C. Other Reporting issues
1. (L.O. 4) Fair Value Option. Companies can report most investments at fair value
using the fair value option, with unrealized gains and losses included in net income.
2. Impairment of Value. Companies evaluate held-for-collection investments at each
reporting date to determine if it is impaired. Impairment losses, which are calculated as
3. Transfers between categories. Transferring an investment from one classification to
another should occur only very rarely when the business model for managing the
E. Appendix 17A. (L.O. 5) Accounting for Derivative Investments.
1. Understanding derivatives.
2. Who uses derivatives?
3. Why use derivatives?
4. Accounting guidelines for derivatives.
a. Recognized as assets and liabilities.
5. Describe the accounting for derivatives—Example of derivative financial investment-
speculation.
b. Accounting entries:
(1) To record purchase price (option premium) of call option:
the market price will increase above the strike price.
(3) To record increase in intrinsic value of option:
Dr. Call Option
c. Financial statement reporting.
6. Derivative instruments have three basic characteristics.
(1) Interest rate risk is risk that changes in interest rates will negatively affect
b. Fair value hedge: a derivative used to hedge (offset) the exposure to changes in
the fair value of a recognized asset or liability, or of an unrecognized commitment.
(1) Interest rate swaps: used to hedge the risk that changes in interest rates
will have on fair value of debt obligations.
(3) Journal entries to account for a put option.
(a) To record a purchase, assuming no premium is paid: A memo entry only.
(4) Financial statement disclosure.
(a) On statement of financial position: both the investment security and the
8. Cash flow hedges: used to hedge cash flow risk.
a. Reported on the statement of financial position at fair value.
d. Spot price: price of an asset today, that will be delivered sometime in the future.
e. Journal entries:
(1) To record the signing of a futures contract (assuming spot price and contract
(3) To record settlement of futures contract (assuming spot price exceeded contract price):
(4) To record disposition of unrealized loss when goods are sold:
9. (L.O. 7) Other reporting issues.
a. Embedded derivatives:
(1) Bifurcation: separating the hybrid security from the host security. The IASB
b. Qualifying hedge criteria:
(1) Designation, documentation, and risk management.
10. (L.O. 8) Fair Value Disclosures. The following fair value information must be
disclosed:
b. Information that enables users to determine the extent of usage of fair value and the
inputs used to implement fair value (which level of fair value hierarchy was used).
c. Companies must provide the following (with a special emphasis on Level 3
measurements):
i. Quantitative information about significant observable inputs used for all Level
3 measurements.
