INTERMEDIATE Intermediat ACCOUNTING Intermediat e e Accounting Accounting F I F T E E N T H E D I T I O N Prepared by Coby Harmon Prepared by Prepared by University of California, Barbara CobySanta Harmon Harmon Westmont College SantaCoby University of California, Barbara University of California, Santa Barbara 17-1 Westmont College kieso weygandt warfield team for success PREVIEW OF CHAPTER 17 Intermediate Accounting 15th Edition Kieso Weygandt Warfield 17-2 17 Investments LEARNING LEARNINGOBJECTIVES OBJECTIVES After studying this chapter, you should be able to: Identify the three categories of debt securities and describe the accounting and reporting treatment for each category Explain the equity method of accounting and compare it to the fair value method for equity securities Understand the procedures for discount and premium amortization on bond investments Describe the accounting for the fair value option and for impairments of debt and equity investments Identify the categories of equity securities and describe the accounting and reporting treatment for each category Describe the reporting of reclassification adjustments and the accounting for transfers between categories 17-3 Investment in Debt Securities Different motivations for investing: 17-4  To earn a high rate of return  To secure certain operating or financing arrangements with another company LO Investment in Debt Securities Companies account for investments based on  the type of security (debt or equity) and  their intent with respect to the investment Illustration 17-1 Summary of Investment Accounting Approaches 17-5 LO Investment in Debt Securities Debt securities represent a creditor relationship: Type  17-6 U.S government securities  Municipal securities  Corporate bonds  Convertible debt  Commercial paper Accounting Category  Held-to-maturity  Trading  Available-for-sale LO Investment in Debt Securities Debt Investment Classifications ILLUSTRATION 17-2 Accounting for Debt Securities by Category Amortized cost is the acquisition cost adjusted for the amortization of discount or premium, if appropriate 17-7 LO 17 Investments LEARNING LEARNINGOBJECTIVES OBJECTIVES After studying this chapter, you should be able to: Identify the three categories of debt securities and describe the accounting and reporting treatment for each category Explain the equity method of accounting and compare it to the fair value method for equity securities Understand the procedures for discount and premium amortization on bond investments Describe the accounting for the fair value option and for impairments of debt and equity investments Identify the categories of equity securities and describe the accounting and reporting treatment for each category Describe the reporting of reclassification adjustments and the accounting for transfers between categories 17-8 Investment in Debt Securities Held-to-Maturity Securities Classify a debt security as held-to-maturity only if it has both 1) the positive intent and 2) the ability to hold securities to maturity Accounted for at amortized cost, not fair value Amortize premium or discount using the effective-interest method unless the straight-line method yields a similar result 17-9 LO Held-to-Maturity Securities Illustration: Z-Smith Company purchased $100,000 of percent bonds of Bush Corporation on January 1, 2013, at a discount, paying $92,278 The bonds mature January 1, 2018 and yield 10%; interest is payable each July and January Z-Smith records the investment as follows: January 1, 2013 Debt Investments Cash 17-10 92,278 92,278 LO APPENDIX 17C FAIR VALUE DISCLOSURES Disclosure of Fair Value Information: Financial Instruments—No Fair Value Option Both the cost and the fair value of all financial instruments are to be reported in the notes to the financial statements FASB also decided that companies should disclose information that enables users to determine the extent of usage of fair value and the inputs used to implement fair value measurement 17-112 LO 12 APPENDIX 17C FAIR VALUE DISCLOSURES Disclosure of Fair Value Information: Financial Instruments—No Fair Value Option Two reasons for additional disclosure beyond the simple itemization of fair values are: Differing levels of reliability exist in the measurement of fair value information Changes in the fair value of financial instruments are reported differently in the financial statements, depending upon the type of financial instrument involved and whether the fair value option is employed 17-113 LO 12 APPENDIX 17C FAIR VALUE DISCLOSURES Levels of reliability fair value hierarchy  Level is the most reliable measurement because fair value is based on quoted prices in active markets for identical assets or liabilities  Level is less reliable; it is not based on quoted market prices for identical assets and liabilities but instead may be based on similar assets or liabilities  Level is least reliable; it uses unobservable inputs that reflect the company’s assumption as to the value of the financial instrument 17-114 LO 12 APPENDIX 17C FAIR VALUE DISCLOSURES Example of Fair Value Hierarchy Illustration 17C-1 17-115 LO 12 APPENDIX 17C Reconciliation of Level Inputs Illustration 17C-2 17-116 FAIR VALUE DISCLOSURES APPENDIX 17C FAIR VALUE DISCLOSURES Disclosure of Fair Values: Impaired Assets or Illustration 17C-4 Liabilities Disclosure of Fair Value with Impairment 17-117 RELEVANT FACTS - Similarities 17-118  GAAP and IFRS use similar classifications for trading investments  The accounting for trading investments is the same between GAAP and IFRS Held-to-maturity (GAAP) and held-for-collection (IFRS) investments are accounted for at amortized cost Gains and losses on some investments are reported in other comprehensive income  Both GAAP and IFRS use the same test to determine whether the equity method of accounting should be used, that is, significant influence with a general guideline of over 20 percent ownership LO 13 Compare the accounting for investments under GAAP and IFRS RELEVANT FACTS - Similarities 17-119  GAAP and IFRS are similar in the accounting for the fair value option That is, the option to use the fair value method must be made at initial recognition, the selection is irrevocable, and gains and losses are reported as part of income One difference is that GAAP permits the fair value option for equity method investments  The measurement of impairments is similar under GAAP and IFRS LO 13 RELEVANT FACTS - Differences 17-120  While GAAP classifies investments as trading, available-for-sale (both debt and equity investments), and held-to-maturity (only for debt investments), IFRS uses held-for-collection (debt investments), trading (both debt and equity investments), and non-trading equity investment classifications  The basis for consolidation under IFRS is control Under GAAP, a bipolar approach is used, which is a risk-and-reward model (often referred to as a variable-entity approach) and a voting-interest approach However, under both systems, for consolidation to occur, the investor company must generally own 50 percent of another company LO 13 RELEVANT FACTS - Differences 17-121  While the measurement of impairments is similar under GAAP and IFRS, GAAP does not permit the reversal of an impairment charge related to available-for-sale debt and equity investments IFRS allows reversals of impairments of held-for-collection investments  While GAAP and IFRS are similar in the accounting for the fair value option, one difference is that GAAP permits the fair value option for equity method investments; IFRS does not LO 13 ON THE HORIZON At one time, both the FASB and IASB have indicated that they believe that all financial instruments should be reported at fair value and that changes in fair value should be reported as part of net income However, the recently issued IFRS indicates that the IASB believes that certain debt investments should not be reported at fair value The IASB’s decision to issue new rules on investments, prior to the FASB’s completion of its deliberations on financial instrument accounting, could create obstacles for the Boards in converging the accounting in this area 17-122 LO 13 IFRS SELF-TEST QUESTION All of the following are key similarities between GAAP and IFRS with respect to accounting for investments except: a IFRS and GAAP have a held-to-maturity investment classification b IFRS and GAAP apply the equity method to significant influence equity investments c IFRS and GAAP have a fair value option for financial instruments d the accounting for impairment of investments is similar, although IFRS allows recovery of impairment losses 17-123 LO 13 IFRS SELF-TEST QUESTION Which of the following statements is correct? a GAAP has a held-for-collection investment classification b GAAP permits recovery of impairment losses c Under IFRS, non-trading equity investments are accounted for at amortized cost d IFRS and GAAP both have a trading investment classification 17-124 LO 13 IFRS SELF-TEST QUESTION IFRS requires companies to measure their financial assets at fair value based on: a the company’s business model for managing its financial assets b whether the financial asset is a debt investment c whether the financial asset is an equity investment d All of the choices are IFRS requirements 17-125 LO 13 Copyright Copyright © 2013 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein 17-126 ...PREVIEW OF CHAPTER 17 Intermediate Accounting 15th Edition Kieso Weygandt Warfield 17- 2 17 Investments LEARNING LEARNINGOBJECTIVES OBJECTIVES After studying this chapter, you should... investment Illustration 17- 1 Summary of Investment Accounting Approaches 17- 5 LO Investment in Debt Securities Debt securities represent a creditor relationship: Type  17- 6 U.S government securities... appropriate 17- 7 LO 17 Investments LEARNING LEARNINGOBJECTIVES OBJECTIVES After studying this chapter, you should be able to: Identify the three categories of debt securities and describe the accounting