cfa-level2-fra-intercorporate-investments-v2.pdf

7/25/2019 cfa-level2-fra-intercorporate-investments-v2.pdf

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CFA Level II Financial Reporting and Ana

Intercorporate Investments

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Graphs, charts, tables, examples, and figures are copyright 2012, CFA Institute. Reprod

and republished with permission from CFA Institute. All rights reserved.


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Contents and Introduction

1. Introduction

2. Basic Corporate Investment Categories

3. Investments in Financial Assets (IAS 39)

4. Investment in Financial Assets (IFRS 9)

5. Investments in Associates and Joint Ventures

6. Business Combinations

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2. Basic Corporate Investment Catego

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3. Investment in Financial Assets: IAS

Investor can not exert significant influence or control over the operations

investees

Four categories:

1. Held-to-maturity

2. Fair value through profit or loss

3. Available-for-sale

4. Loans and receivables

Reclassification of Investments

Impairments

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Financial Assets: Four Categories

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Held-to-Maturity Fair Value through Profit or Loss Available-for-Sale

Investments in financial assets with

fixed or determinable payments;

positive intent and ability to hold tomaturity

Initially report at fair value and

subsequently at amortized cost

Interest income and realized

gains/losses shown on Income

Statement

Unrealized gain/loss is ignored

Two sub-categories:

Held for trading: intent to sell in

the near term Designated at fair value

Shown at fair value on balance

sheet

Interest income, realized

gains/losses and unrealized

gains/losses shown on IncomeStatement

Investments not cate

HTM or FVPL

Shown at fair value o

sheet

Interest income and r

gains/losses shown o

Statement

Unrealized gain/loss s

of OCI

Loans and receivables are broadly defined as non-derivative financial assets

or determinable payments.


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Reclassifications and Impairments

Reclassification of Investments

Allowed but with restrictions

Example: HTM AFS if there is a change in intent or change in ability to hold

Impairments

Financial asset is impaired whenever its carrying amount is expected to permane

recoverable amount

IFRS: at the end of each reporting period, financial assets not carried at fair value

reviewed for any objective evidence that the assets are impaired; for HTM securi

difference between carrying value and PV of cash flows

U.S. GAAP: For AFS or HTM securities, determine whether decrease in value is tem

temporary, the cost base is written down and loss recognized in the income state

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Example 1

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How would this investment be r

balance sheet, income statemen

shareholders equity at 31 Dece

either IFRS or U.S. GAAP (accoun

same in this case), if Baxter desiinvestment as 1) held-to-maturi

3) available-for-sale, or 4) design

How would the gain be recogniz

securities were sold on 1 Januar

How would this investment app

sheet at 31 December 2012?

How would the classification an

Baxter had invested in Cartels e

instead of its debt securities?

k f l


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Working for Example 1

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i i i l


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4. Investments in Financial Assets: IFR

IFRS 9 will take effect by 2015 and will replace IAS 39

Significant convergence between IFRS and U.S. GAAP.

New approach considers the contractual characteristic of cash flows as

management of the financial assets. The portfolio approach of the curr

(i.e., designation of held for trading, available-for-sale, and held-to-ma

longer appropriate and the terms available-for-sale and held- to-maturappear in IFRS 9.

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l l f d


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Financial Assets Classification and Measuremen

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Reclassification of equity i

permitted because the init

FVPL and FVOCI is irrevoca

Reclassification of debt insFVPL to amortized cost (or

permitted if the business m

financial assets (objective

financial assets) has chang

significantly affects operat

the business model will re

are expected to be very in

5 I i A i d J i V


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5. Investments in Associates and Joint Ven

An investment is considered an Associate Company when the investor has (or can exe

significant influence, but not control, over the investees business activities. Significant

be evidenced by:

representation on the board of directors

participation in the policy-making process

material transactions between the investor and the investee

interchange of managerial personnel

technological dependency

Characteristics ofjoint ventures: 1) A contractual arrangement exists between two or mand 2) the contractual arrangement establishes joint control

Equity method of accounting is required for investment in associates and joint venture

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5.1 Equity Method of Accounting: Basic Pri

Investment is initially recorded at cost

Share of income (not dividends) recorded in investors I/S

Investment account reflected as single line item on B/S

Value of investment = beginning value + share of profit share of dividends

Investment classified as noncurrent asset on B/S

One line consolidation

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E l 2 E it M th d B l i I t t A


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Example 2 Equity Method: Balance in Investment A

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5.2 Investment Costs That Exceed the Book Value of the

Value of investment (in proportion to investors stake) consists of:

Reported net asset value of investee (on investees B/S)

Fair value surplus/deficit relating to investees identifiable

assets/liabilities

Surplus is amortized over time

Goodwill = difference between purchase price and acquirers share offair value of investees net assets


E l 3 E it M th d I t t i E f B


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Example 3 Equity Method Investment in Excess of Bo

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5 3 Amortization of Excess Purchase Price


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5.3 Amortization of Excess Purchase Price

Excess amounts allocated to identifiable assets/liabilities of investee must be amortized

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Example 4

The plant and equipme

a straight-line basis andremaining life. Prince re

2011 of 100,000 and p

50,000. Calculate the

1. Goodwill included i

2. Investment in assoc

end of 2011.



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5 4 Fair Value Option & 5 5 Impairment


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5.4 Fair Value Option & 5.5 Impairment

Both IFRS and U.S. GAAP give the investor the option to account for the

method investment at fair value. Under U.S. GAAP, this option is availab

entities; however, under IFRS, its use is restricted to venture capital org

mutual funds, unit trusts, and similar entities, including investment-lininsurance funds.

Both IFRS and U.S. GAAP require periodic reviews of equity method inv

impairment. If the fair value of the investment is below its carrying valudecline is deemed to be other than temporary, an impairment loss mus

recognized.

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5 6 Transactions with Associates


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5.6 Transactions with Associates

Because an investor company can influence the terms

and timings of transactions with associates, profits

from such transactions cannot be realized until

confirmed through use of third party sale.

Investor companys share of any unrealized profit

must be deferred by reducing the amount recorded

under the equity method. This deferred profit is

added back to the equity income when confirmed.

Transactions may be upstream or downstream Upstream (associate to investor) profit recorded in

investees I/S.

Downstream (investor to associate) profit included in

investors I/S.


Example 5


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Example 5

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Example 6


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Example 6

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5 7 Disclosure & 5 8 Issues for Analy


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5.7 Disclosure & 5.8 Issues for Analy

Companies must disclose assets, liabilities and results of

equity method investments

Is the equity method appropriate? Investor may hold < 20% of investee but exercise significant influence

Investor may hold > 25 of investee but may not have significant

influence

Equity method is effectively one-line consolidation

Net margin may be overstated but debt ratios understated

Quality of equity method earnings

Assumes that a dollar earned by investee is a dollar received by the

investor company

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6 Business Combinations


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6. Business Combinations

Involve the combination of two or more organizations into a larger eco

IFRS: No distinction among business combinations; one party identified

US GAAP: Four types of business combinations

Merger

Acquisition

Consolidation Variable interest (special purpose) entity

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Accounting for Business Combinations


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Accounting for Business Combinations

Historically, two methods have been used:

Pooling of Interest

Purchase Method

Pooling of interest method has been discontinued:

US GAAP discontinued it in June 2001

IFRS discontinued it in 2004

Both U.S. GAAP and IFRS require use of acquisition method (replaces t

method)

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6 1 Pooling of Interests and Purchase Met


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6.1 Pooling of Interests and Purchase Met

Pooling of Interests

Combined companies portrayed as if they had always existed as one

Assets and liabilities of combined companies recorded at book values and pre-co

retained earnings are included in the balance sheet of the combined companies

Purchase Method

Net assets were recorded at fair values

For the same level of revenue, the purchase method results in lower reported inc

pooling of interests method

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6 2 Acquisition Method


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6.2 Acquisition Method

Recognition and measurement of identifiable assets and liabilities

Recognition and measurement of contingent liabilities

Recognition and measurement of indemnification assets

Recognition and measurement of financial assets and liabilities

Recognition and measurement of goodwill

Recognition and measurement acquisition price is less than fair value

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Example 7 Recognition and Measurement of G


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Example 7 Recognition and Measurement of G

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6.3 Impact of the Acquisition on Financ


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6.3 Impact of the Acquisition on FinancStatements and Post-Acquisition

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Example

Jefferson haintangible a

balances in

combinatio

using the ac



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6 4 The Consolidation Process


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6.4 The Consolidation Process Combine assets, liabilities, revenues and expenses of subsidiary with p

Intercompany transactions are eliminated

For business combination with less than 100% acquisition show non-co

(minority) interests on balance sheet

Difference between IFRS and U.S. GAAP in terms of how minority intere

measured U.S. GAAP says use Full Goodwill method

IFRS says either Full Goodwill or Partial Goodwill methods can be used

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Example 9 Non-controlling Asset Valuatio


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p g

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1. Calculate the value o

consolidated balance

IFRS and U.S. GAAP.


value of the non-cont

the acquisition date u

goodwill method.


value of the non-cont

the acquisition date u

goodwill method.

Example 9 - Working


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Example 9 Working

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Income Statement Impact


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p

Non-controlling (minority) interests are presented as a line item reflecting the allocation

loss for the period. Intercompany transactions, if any, are eliminated in full.

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Goodwill Impairment


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p

Goodwill is not amortized, it must be tested for impairment at least annually. Once writt

goodwill cannot be restored.

IFRS

Goodwill is allocated to acquirers cash generating units

Goodwill impairment testing is done using a one-step approach

Impairment loss is based on difference between carrying value and recoverable amount

U.S. GAAP

Goodwill is allocated to acquirers reporting units

Goodwill impairment testing is done using a two-step approach

1. Identify impairment possibility by comparing carrying value and fair value

2. Determine implied fair value of goodwill: fair value of reporting unit fair value of n

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Examples 10 and 11 Goodwill Impairmen


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p p

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6.5 Financial Statement Presentation Subsequen


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q

Business Combination

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IFRS and U.S. GAAP have similar formats for consolidated income statements.Each line item (e.g., turnover [sales], cost of sales, etc.) includes 100% of the

parent and the subsidiary transactions after eliminating any upstream (subsidiary

sells to parent) or downstream (parent sells to subsidiary) intercompany

transactions. The portion of income accruing to non-controlling shareholders is

presented as a separate line item on the consolidated income statement.

6.6 Variable Interest and Special Purpose Ent


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Special purpose entities (SPEs) are created to accommodate specific needs of the sponso

The sponsoring entity frequently transfers assets to the SPE, obtains the right to use ass

SPE, or performs services for the SPE, while other parties provide funding to the SPE. SP

legitimate financing mechanism for a company to segregate certain activities and thereb

SPEs may take the form of a limited liability company (corporation), trust, partnership, ounincorporated entity.

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Variable Interest Entity


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y

VIE is a U.S. GAAP concept and refers to an entity that is financially controlled

by one or more parties that do not hold a majority voting interest.

A SPE is a VIE if:1. Total equity at risk is insufficient to finance activities without financial

support from other parties

2. Equity investors lack any one of the following:

a. the ability to make decisions

b. the obligation to absorb losses

c. the right to receive returns

The primary beneficiary of a VIE must consolidate it as its subsidiary regardless

of how much of an equity investment it has in the VIE.

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Example 12 Receivables Securitizatio


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p

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Example 12 - Working


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p g

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6.7 Additional Issues in Business Combination


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Impair Comparability

Contingent Assets and Liabilities

Contingent Considerations

In-Process R&D

Restructuring Costs

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Summary


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y

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Investments in Financial

Assets

Investment in

Associates

Joint Ventures Bus

Com

Description No significant influence Significant influence Shared control Con

Accounting HTM, FVPL, AFS Equity Equity Acq

Assets

Liabilities

Equity

Revenue

Net Income

Leverage

NPM

ROE

ROA

Conclusion


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Read the summary

Review learning objectives

Examples

Practice problems

Practice questions from other sources

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