Investments are financial assets that represent a company’s right to receive cash from its stake fettered, shares, land, etc. The intent behind making such investments is to net investment income (interest and dividend) and to profit from expected financial gain.
Classification of investments
Investments are reported by the investor on their record and classified into current and non-current portions. Current investments (i.e. those expected to mature within 12 months) are called short-term investments while non-current investments are called long-term investments. Some investments which are are often easily converted to cash with negligible fluctuation in its value are classified as cash equivalents.
Major categories of investments include debt securities, equity securities, and derivative instruments.
Debt securities are financial instruments that represent a right to a determined stream of money flows for a particular period of your time, like bonds.
Equity securities are financial instruments that represent residual (ownership) interest during a company, for instance, shares of common shares, etc.
Derivative securities are financial instruments which ‘derive’ their value from other financial instruments, like forwarding contracts, futures contacts, options, etc.
Accounting classification of debt securities
IAS 32 and IAS 39, the previous IFRS financial instruments accounting standards, classified debt securities into held to maturity, available purchasable, and held for trading categories. IFRS 9, the new standard, requires debt securities to be classified mainly into those carried at (a) amortized cost, (b) fair value through profit or loss (FVTPL), and (c) fair value through other comprehensive income (FVOCI).
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Under US GAAP, the classification is dictated by the legal sort of the instruments. The US GAAP retains the legacy classification categories for several debt securities.
Under IFRS, classification depends on (a) the business model and (b) the income characteristics of the instrument. An investor first determines whether its business model is to carry the asset to gather cash flows or to sell it to understand financial gain.
Amortized cost: Debt securities are classified at amortized cost if the company’s business model is to carry the asset to gather cash flows, and people cash flows are solely payments of principal and interest.
Fair value through other comprehensive income (FVTOCI): Debt securities are classified at FVOCI if the investor’s business model is both to gather cash flows and sell the asset, and therefore the cash flows are solely payments of principal and interest.
Fair value through profit or loss (FVTPL): Debt securities that don’t qualify for classification at either amortized cost or FVTOCI are classified at FVTPL.
Accounting for equity securities
Accounting for equity investments depends on the extent of ownership:
Controlling interest: where Company A owns quite 50% equity of Company B, it’s control over Company B and is required to organize consolidated financial statements.
A significant influence: where Company A owns anywhere between 20% and 50% of the equity of Company B, it’s significant influence over Company B and is required to account for investments in Company B using the equity method.
No interest and no significant influence: if Company A owns but 20% of Company B’s equity, neither consolidation nor equity method is required.
Previous investment accounting standards, like IAS 39 and its US GAAP equivalent, allowed equity instruments to be classified as (a) held for trading, (b) designated at fair value through profit and loss, and (c) available purchasable.
Under the new accounting principle, IFRS 9, fair value through profit or loss (FVTPL) is the go-to category for all equity securities. It means equity securities would typically be carried at their fair value with any changes reflected in profit or loss.
However, under IFRS a corporation can irrevocably categorize equity investments (on an instrument-by-instrument basis) at fair value through other comprehensive income (FVOCI). It means the securities are carried at fair value, but the changes are reflected in other comprehensive income. just in case of such categorization, no reclassification to the FVTPL category is allowed in the future for such investments.
Similarly, under US GAAP there are some exceptions to the default fair value category. for instance, if the fair value can’t be determined, an equity investment is allowed to be carried at cost fewer impairment losses.
You are an Accountant at Flow, Inc., a futuristic technology-enabled financial services company. It’s cash and cash equivalents at 1 January 20X9 stood at $2.2 billion. A newly appointed Investment Manager began an aggressive investment spree. During the year, the corporate entered into the subsequent transactions:
1 January 20X9: obtained 60% holding in Dots, Inc. for $300 million.
1 February 20X9: purchased 18% of common shares of Air, Inc., a cutting-edge communication company for $450 million with intent to carry them for an indefinite period.
1 March 20X9: invested $55 million in an equity open-end fund with the intent to sell it in near future.
30 June 20X9: sold the equity open-end fund investment made on 1 March 20X9 for $60 million.
1 July 20X9: invested in plain-vanilla government bonds with a face value of $350 million due by the top of 5th year carrying a rate of interest of 8% at par. the corporate intends to carry them to maturity.
1 September 20X9: obtained 35% holding for $320 in Fiber, Inc.
At the year-end, i.e. 31 December 20X9, investment in Dots, Inc. dropped to $290 million, investment in Air, Inc. rose to $500 million while investment in Fiber, Inc. was valued at $350 million. the corporate earned dividends of $2 million from Dots, Inc., nothing from Air, Inc., nothing from the equity open-end fund, and zip from Fiber, Inc. Fiber, Inc. net for fiscal year 20X9 amounted to $15 million.
Classify the above investments into different investment categories and description the accounting treatment of related gains or losses.