8.7 Chapter Summary

LO 1: Describe intercorporate investments and their role in accounting and business.

Non-strategic intercorporate investments exist when companies invest in other companies’ equity (shares or derivatives) or debt (bonds or convertible debt) to earn a better return on their idle cash. These returns will take the form of interest income, dividend income, or capital appreciation of the security itself.

Strategic intercorporate investments are voting shares purchased by the investor company to enhance its own operations. The goal is to either influence the investee’s board of directors (share holdings 20% or greater) or to take control over the company (share holdings 50% or greater). This is undertaken in order to guarantee a source of scarce materials or services or to increase sales and hence profit. There are also joint arrangements where two or more investors, through a contractual agreement, control a joint entity.

Intercorporate investments are financial assets because the investor’s contractual rights to receive cash or other assets of the investee company result in a financial liability or equity instrument of the investee. They are reported as either current or long-term investments depending on the investments business model and if management intends to hold and collect interest and dividends or to realize changes in their value through selling them.

For all investments, the initial measurement is the acquisition price (which is equal to the fair value) in Canadian funds. For equity investments this would likely be the market price and for debt investments such as bonds, it would be the future cash flows discounted using the market interest rate (net present value). Subsequent measurement will depend on the category of the investment. For non-strategic investments, IFRS has three categories: a) FVNI for trading and measured at fair value through net income; b) AC to hold and collect cash flows and measured at amortized cost; and c) FVOCI to collect cash flows and to sell, measured at fair value through OCI with recycling (debt) or without recycling (equities). ASPE has two categories: a) investments for trading purposes (FVNI); and b) all other investments at cost or amortized cost. Strategic investments have three categories: a) holdings of 20% or greater (associate or significant influence) which uses the equity method (IFRS); b) holdings of 50% or greater (subsidiary or control) which uses consolidation (IFRS); and c) joint arrangements made up of various percentages, using the equity method for joint ventures or a form of proportionate consolidation for joint operations. ASPE allows some other choices of methods for its strategic investments and permits straight-line amortization of its debt instruments. The ownership percentages are guidelines only and there can be exceptions to these.

LO 2: Identify and describe the three types of non-strategic investments.

Held-for-trading (FVNI) investments in debt, equity, or derivatives are held for short periods of time. For ASPE companies, these are for equities trading in an active market, debt, or most derivatives under the fair value option (classification irrevocable, once made). FVNI investments are reported as current assets at fair value through net income at each balance sheet date. Transaction costs are expensed. Gains (losses) upon sale are reported in net income. Since they are reported at fair value, no separate impairment tests or charges are required. Investor companies often use an asset valuation allowance ac- count (contra account to the investment asset) to record changes in fair value to preserve the original cost information for the investment. For debt instruments such as bonds, any amortization is calculated using the effective interest method for IFRS. ASPE companies can also elect to use straight-line method for its amortization.

FVOCI investments in debt or equity are for sale, but also for the purpose of collecting the cash flows of interest and dividends. This classification is only available for IFRS companies. They are reported as long-term assets (until within twelve months of the intention to sell them) at fair value through OCI at each balance sheet date until sold. Transactions costs are capitalized. For FVOCI investments in debt, gains/losses upon sale are transferred from OCI to net income. For FVOCI investments in equities, gains/losses upon sale are reclassified from AOCI to retained earnings. Impairment evaluations begin as soon as the investment is acquired and estimated costs regarding potential defaults (expected credit losses or ECL) are calculated and reported at the first reporting date after acquisition. The ECL is adjusted up or down depending on if credit risk increasing or decreasing.

For IFRS, AC investments in debt are reported at amortized cost at each balance sheet date. ASPE companies can also classify equity securities not traded in an active market to this category at cost. Transaction costs are capitalized. AC investments are reported at their carrying value as long-term assets, unless they are expected to mature within twelve months of the balance sheet date. Interest earned on investments in debt (bonds), and dividends earned on equity securities measured at cost, are reported in net income. Any bond premium or discount amortization is calculated using the effective interest rate method for IFRS companies. ASPE can choose to use either the effective interest or the straight-line method. For ASPE, if a loss event occurs, any impairment is calculated as the difference between the carrying value and the present value of the impaired cash flows using the current market rate. Any gain (loss) due to impairment or upon sale is reported in net income. An asset valuation allowance can be used for either standard and any of the classifications.

For IFRS, impairment evaluations for AC investments are the same process as for FVOCI debt. To summarize, impairment evaluations begin as soon as the AC investment is acquired and estimated costs regarding potential defaults (expected credit losses or ECL) are calculated and reported at the first reporting date after acquisition. The ECL is adjusted up or down depending on if credit risk increasing or decreasing.

LO 3: Identify an describe the three types of strategic investments.

Investments in the voting shares of an investee company are undertaken to influence or take over control of the board of directors. The degree of ownership defines the level of influence and the classification.

Associate (Significant Influence) investments of 20% or greater voting shares are re- ported using the equity method for IFRS. For ASPE, management can choose the equity method, the fair value method through net income if traded in an active market, or the cost method if no market exists. Transaction costs are expensed for the equity and fair value methods and added to the investment (asset) account for the cost method. Investments in associates are reported as long-term investments and income from associates is to be separately disclosed on the income statement. The equity method is based on a reflection of ownership in the investee company. Dividends received are treated as a return of some of the investment asset and are recorded as a reduction in the value of the investment. Conversely, the investor company’s share of an associate’s reported net income is added to the value of the investment. Included in the journal entries are also any excess amount paid that is attributable to the investee’s net identifiable assets amortized over the remaining life of the assets. Any remaining excess is usually attributable to unrecorded goodwill. Any impairment charge other than those attributed to unrecorded goodwill is recoverable, but limited.

Investments in subsidiaries (Control) for greater than 50% of the voting shares in another company are reported using the consolidation method for IFRS. For ASPE companies, there is a choice of consolidation, equity, or cost methods. Transaction costs are expensed for the consolidation and equity methods and added to the investment (asset) account for the cost method. Consolidation involves the elimination of the investment account, and 100% of each asset and liability of the subsidiary is incorporated on a line-by-line basis with the assets and liabilities of the parent company’s balance sheet. As well, 100% of the revenues, expenses, gains, and losses are also incorporated on a line-by-line basis in the parent company’s consolidated statement of income. If the parent company owns less than 100%, then a minority interest held by other shareholders exists. This is reported as a single line called non-controlling interest in the parent company’s consolidated balance sheet and consolidated income statement.

The investments in joint arrangements classification is used when there are multiple investors each having direct rights to the assets and obligations of the joint arrangement. The degrees of ownership can be varying percentages, and are reported in each investor company using the proportionate consolidation method for IFRS. For ASPE companies, there is a choice of using proportionate consolidation, equity, or cost. The mechanics of the proportionate consolidation method are similar to the consolidation method discussed above.

LO 4: Explain disclosures requirements for intercorporate investments.

The various classifications and accounting treatments can significantly impact the asset values and net income of investor companies. Accounting methods in this chapter can obscure some of the key data and stakeholders may have difficulty distinguishing between performance of the investor’s core operations and those of its investments. Investment decisions to buy or sell are based on this information so it is critical to be aware of any obscured data that could influence these decisions.

LO 5: Identify the issues for stakeholders regarding investment analyses of performance.

Analyzing the performance of a company’s portfolio of intercorporate investments is a critical process. The most significant hurdle to good investment management is to en- sure that the information used to assess performance is clearly understood by those performing the analysis and interpreting the results, since some of the critical data can be obscured by the choice of accounting treatment. Investments have three potential accounting categories for both non-strategic (FVNI, FVOCI, AC) and strategic (associate, control, joint arrangements) investments. As well, accounting treatments can also vary between debt instruments and equity securities within a specific classification, making comparisons with other benchmark data (e.g., historic or industry ratios) difficult, and hence performance assessment challenging as well. The result is that both net income and investment accounts balances can differ widely at each reporting date depending on the category classification chosen to account for the investment(s).

LO 6: Discuss the similarities and differences between IFRS and ASPE for the three non-strategic investment classifications.

A decision map assists in determining the proper treatment for various types of investment decisions.