Impairment Models ⢠Incurred Loss Model ⢠Expected Loss Model ...
Impairment Models Incurred Loss Model Expected Loss Model Fair Value Loss Model Summary of Impairment Models
Assume a company purchased an investment in AB Ltd. bonds for $100,000 at par value at the beginning of the year. The bonds pay interest on December 31 each year. AB Ltd. is experiencing financial difficulties. The company determines that the existence of financial difficulties provides objective evidence of impairment and represents a triggering or loss event. The present value of the discounted revised cash flows is $80,000 using the original effective interest rate and $70,000 using the current market interest rate (which is higher). The market value of the bonds is $70,000 less commissions. Accounting for Impairment under ASPE and IFRS
Strategic Investments Less than significant influence – less than 20% ownership Associate or significant influence – 20 – 50% ownership Subsidiary – more than 50% ownership Investments in Associates - equity method of accounting (IFRS) - equity or cost method (ASPE) - fair value approach if quoted in active market Significant influence - power to participate in the financial and operating policy decisions of an entity, but not control (IASB) Equity Method - initial measurement: cost of acquired shares - subsequent measurements: carrying amount adjusted each period for investor’s proportionate share of changes in investee’s net assets Assume that Maxi Corp. purchases a 20% interest in Mini Corp. and has the ability to exercise significant influence over Mini's financial and operating policies. 1. On January 2, 2013, Maxi Corp. acquires 48,000 shares (20% of Mini Corp. common shares) at a cost of $10 a share. ASPE/IFRS Equity Method: Investment in Associate (48,000 x $10) Cash
480,000
ASPE FV-NI: FV-NI Investments (48,000 x $10) Cash
480,000
ASPE Cost Model: Other Investments (48,000 x $10) Cash
480,000
480,000
480,000
480,000
2. For the year 2013, Mini Corp. reports net income of $200,000; Maxi Corp.'s share is 20%, or $40,000. ASPE/IFRS Equity Method: Investment in Associate Investment Income or Loss ASPE FV-NI: n/a ASPE Cost Model: n/a
40,000 40,000
3. At December 31, 2013, the 48,000 shares of Mini Corp. have a fair value of $12 a share, or $576,000. ASPE/IFRS Equity Method: n/a ASPE FV-NI: FV-NI Investments (576,000 – 480,000) Unrealized Gain or Loss
96,000 96,000
ASPE Cost Model: n/a 4. On January 28, 2014, Mini Corp. announces and pays a cash dividend of $100,000; Maxi Corp. receives 20%, or $20,000. ASPE/IFRS Equity Method: Cash Investment in Associate
20,000
ASPE FV-NI: Cash Investment Income or Loss
20,000
ASPE Cost Model: Cash Investment Income or Loss
20,000
20,000
20,000
20,000
5. For the year 2014, Mini Corp. reports a net loss of $50,000; Maxi Corp.'s share is 20%, or $10,000. ASPE/IFRS Equity Method: Investment Income or Loss Investment in Associate
10,000 10,000
ASPE FV-NI: n/a ASPE Cost Model: n/a 6. At December 31, 2014, the 48,000 Mini Corp. shares have a fair value of $11 a share, or $528,000. The investment value is not considered impaired. ASPE/IFRS Equity Method: n/a ASPE FV-NI: Unrealized Gain or Loss FV-NI Investments (576,000 – 528,000) ASPE Cost Model: n/a Additional Complexities in Application of Equity Method:
48,000 48,000
Differences between what was originally paid for the investment and the investor's share of the associate's book value need to be identified and accounted for according to the reason for the extra payment. o Any payment in excess of (or less than) the investor's share of book value is part of the cost of the investment, and after acquisition, it has to be accounted for appropriately The major classifications of the income reported by the associate are retained and reported in the same way on the investor's income statement. o portion that is the investor's share of the associate's discontinued operations is reported separately from the investor's share of income before discontinued operations o investor's portion of the associate's other comprehensive income, changes in accounting policy reported in retained earnings, and capital charges
Example: Assume that on January 1, 2014, Investor Company purchases 250,000 of Investee Company's one million outstanding common shares for $8.5 million. Investor has therefore acquired a 25% interest in Investee. The book value (net assets) of Investee Company on this date is $30 million and Investor's proportionate share is 25% of this, or $7.5 million. Investor Company therefore has paid $1 million in excess of its share of the book value. Assume that part of the reason is because Investee's depreciable assets are undervalued on the books by $2.4 million. This explains $600,000 (25% x $2.4 million) of the excess, because Investor would only pay more in proportion to its ownership interest. Investor Company estimates the remaining life of the depreciable assets to be eight years, so the $600,000 excess payment included in the Investment account will have to be amortized over this future period. The remaining $400,000 is unexplained and therefore is determined to be unrecorded goodwill. Investor will have to assess the carrying amount of the balance of the Investment account each year to determine whether there has been any impairment in its value. Analysis of Acquisition of Associate Company Cost of 25% investment in Investee Co. shares 25% of book value of Investee Co. represented by investment (25% x 30,000,000) payment in excess of share of book value fair value allocation to depreciable assets (25% x 2,400,000) unexplained excess assumed to be goodwill
8,500,000 7,500,000 1,000,000 600,000 400,000
annual amortization of excess payment for capital assets (600,000/8)
75,000
Investee Company later reports net income of $2.8 million for its 2014 fiscal year, including a loss on discontinued operations of $400,000. Income before discontinued operations, therefore, is $3.2 million. Dividends of $1.4 million are declared and paid by Investee Company on December 31, 2014. Jan 1/14
Dec 31/14
Investment in Associate Cash (To record acquisition of 25% of Investee Co.)
8,500,000
Cash
350,000
8,500,000
Investment in Associate (To record dividend from Investee Co. [25% x 1,400,000]) Dec 31/14
Investment in Associate Loss from Discontinued Operations (25% x 400,000)
350,000 700,000 100,000
Investment Income or Loss (25% x 3,200,000) 800,000 (To record investment income from Investee Co. [25% x Investee Co. income]) Investment Income or Loss 75,000 Investment in Associate (To record amortization of fair value difference, depreciable assets)
75,000
Analysis of Acquisition of Associate Company Acquisition Cost, January 1, 2014 Add: 25% of increase in investee’s net assets from earning net income Less: 25% of decrease in investee’s net assets from declaration/pmt of dividend Less: amortization of fair value difference related to capital assets Investment in Investee Co., December 31, 2014, at equity
8,500,000 700,000 (350,000) (75,000) 8,775,000
Impairment in Value, Equity Method - carrying amount > investment's recoverable amount: difference = impairment loss recognized in net income and the investment is written down directly - loss may be reversed if future events indicate that the recoverable amount has improved Disposal of Investment in Associate - statement of financial position Investment in Associates account and the Investment Income or Loss account are first brought up to date as at the date of sale o adjusting these accounts for the investor's share of the associate's earnings and changes in book value since the last reporting date - investment's carrying value is removed from the accounts and the difference between this and the proceeds on disposal is recognized in income as a gain or loss Example: Investor Company sells its investment in Investee Company on January 2, 2015 for $9 million. Cash Investment in Associate Gain on Sale of Investments
Investments in Subsidiaries
9,000,000 8,775,000 225,000
-
-
investment in the common shares of a subsidiary is presented as a long-term investment on the separate financial statements of the parent, usually accounted for by either the equity or cost method IFRS: consolidated financial statements for the group of companies under control - eliminates the investment account and instead reports all the assets and liabilities of the subsidiary on a line-byline basis ASPE: o consolidate all its subsidiaries o present all of its subsidiaries under either the equity method or cost model (except if quoted in active market – FV-NI) report 100% of the assets and liabilities and 100% of the revenues, expenses, gains, and losses under the parent's control even when the ownership is less than 100% o noncontrolling interest (minority interest accounts) – equity claims against parent (deducted)
Problem 9-2: Wedge Movers Incorporated has been growing quickly over the past several years due to its near perfect record in safely and quickly moving families across the country. In order to finance its recent growth it became a publicly listed company, and, as a result it must apply IFRS. The company has a December 31 year end. On January 1, 2014, Wedge purchased 20% of a company in Halifax, Nova Scotia that manufactures packing crates, PCM Inc., for a price of $300,000. Wedge considers this a significant influence investment, and has requested your help in accounting for it. At the time of purchase, the carrying amount and fair values of the packing company assets and liabilities are as follows.
Cash Accounts receivable Land Building (10-year life remaining; no residual value) Liabilities
Carrying Amount $ 50,000 100,000 200,000 350,000 (125,000) $575,000
Fair Value $ 50,000 100,000 250,000 500,000 (125,000) $775,000
During the year, PCM reported income of $200,000, and paid a dividend to its common shareholders of $100,000. The fair value of the investment in PCM shares at December 31, 2014 was $315,000. a. Prepare the journal entries for Wedge for 2014, assuming that Wedge cannot exercise significant influence over PCM. The securities are accounted for using the fair value through net income (FV-NI) model. Jan 1/14
FV-NI Investments Cash (To record purchase of 20% of PCM Inc.)
300,000
Cash
20,000
300,000
Investment Income or Loss (To record receipt of dividend.) Dec 31/14
FV-NI Investments 15,000 Investment Income or Loss (To record change in fair value of PCM shares using FV-NI)
20,000
15,000
b. Prepare the journal entries for Wedge for 2014, assuming that Wedge can exercise significant influence over PCM. Jan 1/14
Investment in Associate Cash (To record purchase of 20% of PCM Inc.)
300,000
Investment in Associate (200,000 x 20%) Investment Income or Loss (To record investment income from PCM Inc.)
40,000
300,000
40,000
Investment Income or Loss ([150,000 x 20%]/10) 3,000 Investment in Associate (To record amortization of fair value difference, building) Cash
3,000
20,000
Investment in Associate (To record receipt of dividend.)
20,000
c. At what amount is the investment in securities reported on the statement of financial position under each of these methods at December 31, 2014? What is the total investment income reported in 2014 under each of these methods? No significant influence
Significant influence
WEDGE MOVERS INCORPORATED Statement of Financial Position December 31, 2014 Investment in PCI Inc.
315,000
Investment in PCI Inc.
317,000
WEDGE MOVERS INCORPORATED Income Statement December 31, 2014 Investment Income (Loss)
35,000 Investment Income (Loss)
37,000
d. Prepare the journal entries for Wedge for 2014, assuming that Wedge cannot exercise significant influence over PCM and that the securities are eligible for the special election to be accounted for using the fair value through other comprehensive income (FV-OCI) model. Jan 1/14
FV-OCI Investments Cash (To record purchase of 20% of PCM Inc.)
300,000
Cash
20,000
300,000
Dividend Income (To record receipt of dividend.) Dec 31/14
FV-OCI Investments Unrealized Gain or Loss
20,000 15,000 15,000
(To record change in fair value of PCM shares using FV-OCI) e. Assume that Wedge is a private company and has decided instead to apply ASPE. Identify which, if any, of the previous answers will change under this assumption. Can the company choose which standards to follow, or is it restricted by the type of company it is? Explain briefly. If Wedge Movers Incorporated was a private entity following ASPE, then the PCM Inc. common shares would have to be accounted for using fair value through net income (since ASPE does not have an FVOCI option). A public company must follow IFRS. However, a private company can choose to follow either IFRS or ASPE. A Comparison of IFRS and ASPE
Assume a company purchased an investment in AB Ltd. bonds for $100,000 at par value at the beginning of the year. The bonds pay interest on December 31 each year. AB Ltd. is experiencing financial difficulties. The company determines that the existence of financial difficulties provides objective evidence of impairment and represents a triggering or loss event. The present value of the discounted revised cash flows is $80,000 using the original effective interest rate and $70,000 using the current market interest rate (which is higher). The market value of the bonds is $70,000 less commissions. Accounting for Impairment under ASPE and IFRS
Strategic Investments Less than significant influence – less than 20% ownership Associate or significant influence – 20 – 50% ownership Subsidiary – more than 50% ownership Investments in Associates - equity method of accounting (IFRS) - equity or cost method (ASPE) - fair value approach if quoted in active market Significant influence - power to participate in the financial and operating policy decisions of an entity, but not control (IASB) Equity Method - initial measurement: cost of acquired shares - subsequent measurements: carrying amount adjusted each period for investor’s proportionate share of changes in investee’s net assets Assume that Maxi Corp. purchases a 20% interest in Mini Corp. and has the ability to exercise significant influence over Mini's financial and operating policies. 1. On January 2, 2013, Maxi Corp. acquires 48,000 shares (20% of Mini Corp. common shares) at a cost of $10 a share. ASPE/IFRS Equity Method: Investment in Associate (48,000 x $10) Cash
480,000
ASPE FV-NI: FV-NI Investments (48,000 x $10) Cash
480,000
ASPE Cost Model: Other Investments (48,000 x $10) Cash
480,000
480,000
480,000
480,000
2. For the year 2013, Mini Corp. reports net income of $200,000; Maxi Corp.'s share is 20%, or $40,000. ASPE/IFRS Equity Method: Investment in Associate Investment Income or Loss ASPE FV-NI: n/a ASPE Cost Model: n/a
40,000 40,000
3. At December 31, 2013, the 48,000 shares of Mini Corp. have a fair value of $12 a share, or $576,000. ASPE/IFRS Equity Method: n/a ASPE FV-NI: FV-NI Investments (576,000 – 480,000) Unrealized Gain or Loss
96,000 96,000
ASPE Cost Model: n/a 4. On January 28, 2014, Mini Corp. announces and pays a cash dividend of $100,000; Maxi Corp. receives 20%, or $20,000. ASPE/IFRS Equity Method: Cash Investment in Associate
20,000
ASPE FV-NI: Cash Investment Income or Loss
20,000
ASPE Cost Model: Cash Investment Income or Loss
20,000
20,000
20,000
20,000
5. For the year 2014, Mini Corp. reports a net loss of $50,000; Maxi Corp.'s share is 20%, or $10,000. ASPE/IFRS Equity Method: Investment Income or Loss Investment in Associate
10,000 10,000
ASPE FV-NI: n/a ASPE Cost Model: n/a 6. At December 31, 2014, the 48,000 Mini Corp. shares have a fair value of $11 a share, or $528,000. The investment value is not considered impaired. ASPE/IFRS Equity Method: n/a ASPE FV-NI: Unrealized Gain or Loss FV-NI Investments (576,000 – 528,000) ASPE Cost Model: n/a Additional Complexities in Application of Equity Method:
48,000 48,000
Differences between what was originally paid for the investment and the investor's share of the associate's book value need to be identified and accounted for according to the reason for the extra payment. o Any payment in excess of (or less than) the investor's share of book value is part of the cost of the investment, and after acquisition, it has to be accounted for appropriately The major classifications of the income reported by the associate are retained and reported in the same way on the investor's income statement. o portion that is the investor's share of the associate's discontinued operations is reported separately from the investor's share of income before discontinued operations o investor's portion of the associate's other comprehensive income, changes in accounting policy reported in retained earnings, and capital charges
Example: Assume that on January 1, 2014, Investor Company purchases 250,000 of Investee Company's one million outstanding common shares for $8.5 million. Investor has therefore acquired a 25% interest in Investee. The book value (net assets) of Investee Company on this date is $30 million and Investor's proportionate share is 25% of this, or $7.5 million. Investor Company therefore has paid $1 million in excess of its share of the book value. Assume that part of the reason is because Investee's depreciable assets are undervalued on the books by $2.4 million. This explains $600,000 (25% x $2.4 million) of the excess, because Investor would only pay more in proportion to its ownership interest. Investor Company estimates the remaining life of the depreciable assets to be eight years, so the $600,000 excess payment included in the Investment account will have to be amortized over this future period. The remaining $400,000 is unexplained and therefore is determined to be unrecorded goodwill. Investor will have to assess the carrying amount of the balance of the Investment account each year to determine whether there has been any impairment in its value. Analysis of Acquisition of Associate Company Cost of 25% investment in Investee Co. shares 25% of book value of Investee Co. represented by investment (25% x 30,000,000) payment in excess of share of book value fair value allocation to depreciable assets (25% x 2,400,000) unexplained excess assumed to be goodwill
8,500,000 7,500,000 1,000,000 600,000 400,000
annual amortization of excess payment for capital assets (600,000/8)
75,000
Investee Company later reports net income of $2.8 million for its 2014 fiscal year, including a loss on discontinued operations of $400,000. Income before discontinued operations, therefore, is $3.2 million. Dividends of $1.4 million are declared and paid by Investee Company on December 31, 2014. Jan 1/14
Dec 31/14
Investment in Associate Cash (To record acquisition of 25% of Investee Co.)
8,500,000
Cash
350,000
8,500,000
Investment in Associate (To record dividend from Investee Co. [25% x 1,400,000]) Dec 31/14
Investment in Associate Loss from Discontinued Operations (25% x 400,000)
350,000 700,000 100,000
Investment Income or Loss (25% x 3,200,000) 800,000 (To record investment income from Investee Co. [25% x Investee Co. income]) Investment Income or Loss 75,000 Investment in Associate (To record amortization of fair value difference, depreciable assets)
75,000
Analysis of Acquisition of Associate Company Acquisition Cost, January 1, 2014 Add: 25% of increase in investee’s net assets from earning net income Less: 25% of decrease in investee’s net assets from declaration/pmt of dividend Less: amortization of fair value difference related to capital assets Investment in Investee Co., December 31, 2014, at equity
8,500,000 700,000 (350,000) (75,000) 8,775,000
Impairment in Value, Equity Method - carrying amount > investment's recoverable amount: difference = impairment loss recognized in net income and the investment is written down directly - loss may be reversed if future events indicate that the recoverable amount has improved Disposal of Investment in Associate - statement of financial position Investment in Associates account and the Investment Income or Loss account are first brought up to date as at the date of sale o adjusting these accounts for the investor's share of the associate's earnings and changes in book value since the last reporting date - investment's carrying value is removed from the accounts and the difference between this and the proceeds on disposal is recognized in income as a gain or loss Example: Investor Company sells its investment in Investee Company on January 2, 2015 for $9 million. Cash Investment in Associate Gain on Sale of Investments
Investments in Subsidiaries
9,000,000 8,775,000 225,000
-
-
investment in the common shares of a subsidiary is presented as a long-term investment on the separate financial statements of the parent, usually accounted for by either the equity or cost method IFRS: consolidated financial statements for the group of companies under control - eliminates the investment account and instead reports all the assets and liabilities of the subsidiary on a line-byline basis ASPE: o consolidate all its subsidiaries o present all of its subsidiaries under either the equity method or cost model (except if quoted in active market – FV-NI) report 100% of the assets and liabilities and 100% of the revenues, expenses, gains, and losses under the parent's control even when the ownership is less than 100% o noncontrolling interest (minority interest accounts) – equity claims against parent (deducted)
Problem 9-2: Wedge Movers Incorporated has been growing quickly over the past several years due to its near perfect record in safely and quickly moving families across the country. In order to finance its recent growth it became a publicly listed company, and, as a result it must apply IFRS. The company has a December 31 year end. On January 1, 2014, Wedge purchased 20% of a company in Halifax, Nova Scotia that manufactures packing crates, PCM Inc., for a price of $300,000. Wedge considers this a significant influence investment, and has requested your help in accounting for it. At the time of purchase, the carrying amount and fair values of the packing company assets and liabilities are as follows.
Cash Accounts receivable Land Building (10-year life remaining; no residual value) Liabilities
Carrying Amount $ 50,000 100,000 200,000 350,000 (125,000) $575,000
Fair Value $ 50,000 100,000 250,000 500,000 (125,000) $775,000
During the year, PCM reported income of $200,000, and paid a dividend to its common shareholders of $100,000. The fair value of the investment in PCM shares at December 31, 2014 was $315,000. a. Prepare the journal entries for Wedge for 2014, assuming that Wedge cannot exercise significant influence over PCM. The securities are accounted for using the fair value through net income (FV-NI) model. Jan 1/14
FV-NI Investments Cash (To record purchase of 20% of PCM Inc.)
300,000
Cash
20,000
300,000
Investment Income or Loss (To record receipt of dividend.) Dec 31/14
FV-NI Investments 15,000 Investment Income or Loss (To record change in fair value of PCM shares using FV-NI)
20,000
15,000
b. Prepare the journal entries for Wedge for 2014, assuming that Wedge can exercise significant influence over PCM. Jan 1/14
Investment in Associate Cash (To record purchase of 20% of PCM Inc.)
300,000
Investment in Associate (200,000 x 20%) Investment Income or Loss (To record investment income from PCM Inc.)
40,000
300,000
40,000
Investment Income or Loss ([150,000 x 20%]/10) 3,000 Investment in Associate (To record amortization of fair value difference, building) Cash
3,000
20,000
Investment in Associate (To record receipt of dividend.)
20,000
c. At what amount is the investment in securities reported on the statement of financial position under each of these methods at December 31, 2014? What is the total investment income reported in 2014 under each of these methods? No significant influence
Significant influence
WEDGE MOVERS INCORPORATED Statement of Financial Position December 31, 2014 Investment in PCI Inc.
315,000
Investment in PCI Inc.
317,000
WEDGE MOVERS INCORPORATED Income Statement December 31, 2014 Investment Income (Loss)
35,000 Investment Income (Loss)
37,000
d. Prepare the journal entries for Wedge for 2014, assuming that Wedge cannot exercise significant influence over PCM and that the securities are eligible for the special election to be accounted for using the fair value through other comprehensive income (FV-OCI) model. Jan 1/14
FV-OCI Investments Cash (To record purchase of 20% of PCM Inc.)
300,000
Cash
20,000
300,000
Dividend Income (To record receipt of dividend.) Dec 31/14
FV-OCI Investments Unrealized Gain or Loss
20,000 15,000 15,000
(To record change in fair value of PCM shares using FV-OCI) e. Assume that Wedge is a private company and has decided instead to apply ASPE. Identify which, if any, of the previous answers will change under this assumption. Can the company choose which standards to follow, or is it restricted by the type of company it is? Explain briefly. If Wedge Movers Incorporated was a private entity following ASPE, then the PCM Inc. common shares would have to be accounted for using fair value through net income (since ASPE does not have an FVOCI option). A public company must follow IFRS. However, a private company can choose to follow either IFRS or ASPE. A Comparison of IFRS and ASPE
