CHAPTER 16

investments

CHAPTER STUDY OBJECTIVES

1. Identify reasons to invest, and classify investments. Companies purchase debt and equity securities of other companies for two main reasons: (1) for non-strategic reasons as a source of investment income, and (2) for strategic reasons, such as gaining control of a competitor, influencing strategic alliances, or moving into a new line of business. Non-strategic investments are debt and equity securities that are purchased for purposes of earning interest or dividend revenue or of selling them in the short term at a gain. Investments purchased for selling in the short term are called trading investments and are reported at fair value. Debt investments reported at amortized cost may be short-term or long-term. Strategic investments are always investments in equity securities and are classified as long-term investments.

2. Demonstrate the accounting for debt investments that are reported at amortized cost. Companies reporting under IFRS report debt investments purchased for the purposes of earning interest income at amortized cost. Companies reporting under ASPE may report all investments in debt instruments at amortized cost or at fair value if a fair value can be reliably determined. Debt investments include money-market instruments, bonds, and similar items. Entries are required to record the (1) acquisition, (2) interest revenue, and (3) maturity or sale. Interest revenue is recognized as it accrues and any discount or premium is amortized using the effective interest method under IFRS. Companies reporting under ASPE will use the effective-interest method but are permitted to use other methods.

3. Demonstrate the accounting for fair value investments. Under IFRS, debt and equity investments held for trading purposes and investments that do not meet the criteria for amortized cost or fair value through other comprehensive income are reported at fair value through profit or loss. Fair value through profit or loss is a “catch-all” category for investments. When using this measurement method, adjustments to the fair value of assets are included in the calculation of profit or loss on the income statement or statement of comprehensive income. Certain investments in equity may be categorized as fair value through other comprehensive income and are reported at fair value each reporting period. However, holding gains or losses from fair value adjustments are included in other comprehensive income on the statement of comprehensive income. Under ASPE, any investment that has a quoted market price may be accounted for using fair value through profit or loss; otherwise, cost or amortized cost is used. An equity investment may be in either preferred or common shares of another corporation. Entries are required to record the (1) acquisition, (2) investment revenue, (3) fair value adjustments, and (4) sale.

4. Explain how to account for strategic investments and demonstrate the accounting for strategic investments with significant influence. Strategic investments are long-term investments in common shares of another company. The accounting for strategic investments is based on how much influence the investor has over the operating and financial affairs of the issuing corporation (the investee). The investor company is usually considered not to have significant influence over the investee company when it owns less than 20% of the investee. In this case, the investor company reports the investment in the investee company at either fair value through profit or loss or, under IFRS, fair value through other comprehensive income. When there is significant influence (ownership is usually 20% or more), the investee is called an associate. The equity method is used to account for investments with significant influence. The equity method records investment revenue when profit is reported by the associate and increases the investor’s investment account accordingly. Dividends that are received reduce the value of the investment account. Under ASPE, companies can elect to report investments with significant influence at fair value if there is a quoted market price. In the absence of a quoted market price, significant influence investments may be reported using the equity method or cost. When a company controls the common shares of another company (that is, its ownership is usually greater than 50%), consolidation is required and consolidated financial statements are prepared.

5. Explain how investments are reported in the financial statements. Investments held for trading purposes and categorized as fair value through profit or loss are presented in the current assets section of the balance sheet. This includes equity investments and short- and long-term debt investments as long as they have been purchased with the intent to resell. Debt investments reported at amortized cost, maturing within 12 months of the balance sheet date, are also reported in current assets. Debt instruments reported at amortized cost with maturity dates of longer than 12 months from the balance sheet date and equity investments that are purchased for strategic purposes are reported in non-current assets. Gains and losses resulting from investments categorized as fair value through profit or loss are reported in the income statement and are presented in other revenues or other expenses. Gains and losses resulting from equity investments categorized as fair value through other comprehensive income are reported in other comprehensive income, then closed to accumulated other comprehensive income in the shareholders’ equity section of the balance sheet.

Exercises

Exercise 1

For each item listed below determine if it is a non-strategic investment (NS) or a strategic investment (S).

1. Bonds

2. Term deposits

3. Equity investment purchased to trade

4. Short-term debt instrument held to earn interest

5. Treasury bill

6. Preferred shares

7. Long-term debt instrument held to earn interest

8. Short-term debt instrument purchased to trade

9. 60% of the common shares of the investee

10. Money-market funds

Exercise 2

Following are four independent situations describing the investments of four businesses:

1. At the end August each year, Summer BBQ Sales (SBS) has excess cash on hand. Management purchases 180 day Term Deposits (TD), which earn interest at 4% and which will mature in late February, just in time to purchase inventory for the next barbeque season. However, if the cash is needed earlier, the TDs will be cashed in early. SBS has no other investments.

2. Miller Distributors is active in a number of industries. Recently, Miller purchased 10% of the voting shares of Helen’s Home Decorating Supplies, with the intention that if additional shares of Helen’s become available, Miller will purchase enough shares to exercise voting control over Helen’s and will then merge the two companies. Consequently, Miller’s management has elected to exclude gains and losses on this investment from profit or loss.

3. Cole’s Computers will invest excess cash by making private loans to employees up to $ 2,000 in order to generate interest income while assisting employees. The employees sign two-year interest bearing promissory notes and make monthly instalments including interest. At Cole’s year end, total notes receivable from employees were $ 8,950. Unless the loans are in default, Cole does not expect to collect the loans before their maturity date.

4. Joudrey Holdings has accounts with several online brokers, and frequently buys and sells public company securities in an attempt to generate extra income. At Joudrey’s year end, it owned shares in Big Rock Brewing Inc., Home Depot Canada, and Rogers Communications Inc.

Instructions

a) For each situation indicate if the investment is a strategic or non-strategic investment.

b) For each situation indicate if the investment should be reported at amortized cost, fair value, or reported using the equity method.

c) For each situation indicate if the investment should be reported in current assets or long-term assets.

Exercise 3

Assuming that none of these are cash equivalents, for each of the following investments owned by Kowanda Industries, use the table provided to indicate whether it is most likely to be

a) A non-strategic or a strategic investment;

b) Classified as current assets or non-current assets; and

c) measurement Method.

Exercise 4

On July 2, 2021, Algoma Corp. purchased at 101, $ 100,000 of 6%, 10 year bonds issued by Shield Inc., with the intention of holding the bonds to earn interest income. The bonds pay interest semi-annually on January 1 and July 1. Both companies have December 31 year ends. The relevant amortization amount for the period ending December 31, 2021 is $ 50.

Instructions

a) Record the purchase of the bond by Algoma and record any entries it will make related to this investment for the year end December 31, 2021.

b) Record the issue of the bond by Shield and record any entries they will make related to this liability for the year end December 31, 2021.

c) Record the receipt of interest by Algoma on January 1, 2022.

d) Record the payment of interest by Shield on January 1, 2022.

Exercise 5

Hidden Village Inc. had the following transactions during the year ended December 31, 2021. The debt investments were purchased to earn interest income.

Jan 1 Invested $ 10,000 in a money-market fund.

Mar 31 Notified by fund manager that interest of $ 125 had been added to the money-market fund.

Apr 1 Purchased a 180 day treasury bill maturing on September 30 for $ 58,600.

Jun 30 Notified by fund manager that interest of $ 125 had been added to the money-market fund.

Jul 31 Cashed the money-market fund and received $ 10,290.

Aug 1 Purchased a 6 month, 3% term deposit for $ 15,000.

Sep 30 Received $ 59,500 at maturity of treasury bill.

Instructions

Record the transactions and prepare any December 31, 2021 adjusting entries.

Exercise 6

The Old Country Company purchased the following instruments during the year. Assume the company’s fiscal year end is January 31, 2022.

Dec 1 2021 Purchased a $ 5,000 120 day treasury bill for $ 4,935. The treasury bills are trading at a market rate of interest of 4% annually.

Feb 1, 2022 Purchased at 101 a $ 15,000, 5% 5 year Laurentian Bank of Canada bond. Interest is paid semi-annually. The market rate of interest was 3.5%. The bonds were purchased to trade.

Mar 30, 2022 Treasury bill matured.

Aug 1, 2022 Received interest on the Laurentian Bank of Canada bond.

Aug 2, 2022 Sold the Laurentian Bank of Canada bond at 99.

Instructions

Record the above transactions and any necessary adjusting entries for The Old Country Company required at January 31, 2022.

Exercise 7

On January 1, 2021, Space Sports Inc. purchased a 10 year, $ 100,000 bond, paying interest of 7% semi-annually every January 1 and July 1. The market rate of interest for similar bonds is 6%. Space has the intention of holding the bonds to maturity and earning interest income. The company follows IFRS and has a December 31 year end.

Instructions

a) Record the purchase of the bonds on January 1, 2021.

b) Record the first interest payment on July 1, 2021.

c) Prepare the necessary journal entry at year end to accrue interest income.

d) Record the interest payment on January 1, 2022.