Acct 351 Chapter 09

Question 1

Accumulated other comprehensive income (AOCI)

Answer 1

This is the balance of all past charges and credits to other comprehensive income to the balance sheet date

Question 2

amortized cost model

Answer 2

A model applied to investment in debt securities and long-term notes and loans receivable. The difference between the acquisition cost and maturity value is the discount or premium which is amortized over the term of the instrument

Question 3

associate

Answer 3

An entity that an investor has significant influence over that is neither a subsidiary or a joint venture

Question 4

Comprehensive income

Answer 4

An income measure that includes net income and all other changes in equity exclusive of owners’ investments and distributions

Question 5

consolidated financial statements

Answer 5

Financial statements that disregard the distinction between separate legal entities and treat the parent and subsidiary corporations as a single economic entity.

Question 6

consolidation

Answer 6

The process of treating both parent and subsidiary companies as a single economic entity for fnancial reporting purposes

Question 7

control

Answer 7

Definitions vary. Under PE GAAP, control is the continuing power to determine the strategic operating, financing, and investing policies of another entity without the cooperation of others. A new definition under IFRS refers to control as the power to direct the activities of another entity to generate returns, either positive or negative, for the investor

Question 8

cost model (CM)

Answer 8

A model that measures property, plant, and equipment assets after acquisition at their cost less accumulated depreciation and any accumulated impairment losses

Question 9

debt securities

Answer 9

An investment in government and/or corporate bonds

Question 10

derivative

Answer 10

A financial instrument or other contract that requires little or no initial net investment, that is settled at a future date, and the value of which is derived from the level of interest rates, commodity prices, exchange rates, or some other variable

Question 11

economic entity

Answer 11

When parent and subsidiary companies, for reporting purposes, are treated as a single company.

Question 12

effective interest method

Answer 12

The current market rate of interest at the time of invest

Question 13

Equity instruments

Answer 13

Any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities

Question 14

equity method

Answer 14

A method of accounting for investments where a substantive economic relationship is acknowledged between the investor and the investee. The investment is originally recorded at its cost, but is subsequently adjusted each period for changes in the investee’s net assets

Question 15

equity pickup

Answer 15

When an investor “picks up” its share of income or loss under the equity method. The investor increases/decreases the investment account for its share of the income/loss

Question 16

expected loss impairment model

Answer 16

A model of accounting for impairment where estimates of future cash flows used to determine the present value of the investment are made on a continuous basis and do not rely on a triggering event to occur. Cash flows are discounted at the historical effective interest rate.

Question 17

fair value loss impairment model

Answer 17

Where the impairment loss is the difference between the asset’s fair value and its current carrying amount assuming the fair value is less than the carrying amount. Fair value is based on expected future cash flows, discounted at the current interest rate

Question 18

fair value through net income (FV-NI)

Answer 18

A method of measuring the fair value of financial instruments where the carrying amount is adjusted to its current fair value at each reporting date such that all holding gains and losses are reported in net income along with any dividends or interest income earned

Question 19

fair value through other comprehensive income (FV-OCI)

Answer 19

A model where the carrying amount of each FV-OCI investment is adjusted to its current fair value at each reporting date, and the holding gains and losses are recognized in other comprehensive income

Question 20

fair value through profit or loss (FVTPL)

Answer 20

A method of measuring the fair value of financial instruments where the carrying amount is adjusted to its current fair value at each reporting date such that all holding gains and losses are reported in net income along with any dividends or interest income earned

Question 21

financial asset

Answer 21

A receivable that represents contractual rights to receive cash or other financial assets from another party

Question 22

incurred loss impairment model

Answer 22

A model where investments are recognized as impaired when there is no longer reasonable assurance that the future cash flows associated with them will be either collected in their entirety when due. It accounts for credit losses triggered by specific events that occurred by the balance sheet date

Question 23

investee

Answer 23

The company whose shares are bought

Question 24

investor

Answer 24

The individual or company that buys shares in another company

Question 25

Joint ventures

Answer 25

A type of equity investment characterized by joint control, rather than unilateral control by one party

Question 26

minority interest

Answer 26

Represents the percentage of the net assets not owned (reported as a liability on the balance sheet), or the percentage of the net income that does not accrue to the parent company (reported as a deduction from the combined net income on the income statement.) (Synonym: noncontrolling interest)

Question 27

non-controlling interest

Answer 27

Represents the percentage of the net assets not owned (reported as a liability on the balance sheet), or the percentage of the net income that does not accrue to the parent company (reported as a deduction from the combined net income on the income statement.) (Synonym: minority interest)

Question 28

on margin

Answer 28

Investments in shares where the investor pays only part of the purchase price to acquire the shares, and the broker covers the difference

Question 29

Other comprehensive income (OCI)

Answer 29

Comprises revenues, expenses, gains and losses that are required by primary sources of GAAP (see Generally Accepted Accounting Principles, Section 1100) to be included in comprehensive income, but excluded from net income

Question 30

parent

Answer 30

A company that acquires more than 50% voting interest in another company

Question 31

realized

Answer 31

Revenue from assets received or sold can be readily converted into cash or claims to cash.

Question 32

reclassification adjustment

Answer 32

This is necessary to ensure gains and losses are not counted twice when investments are sold. Double counting results when realized gains or losses are reported as part of net income but were previously reported as other comprehensive income in the current period or previous periods

Question 33

regular-way purchase or sale

Answer 33

This occurs when the period between the trade date (the date when the commitment to purchase or sell the security is made) and the settlement date (the date when the delivery occurs and the title is transferred) is short

Question 34

significant influence

Answer 34

When an investor owns roughly 20-50% of a company and there is investor representation on the Board of Directors, participation in policy-making processes, material intercompany transactions, interchange of managerial personnel, or provision of technical information

Question 35

straight-line method

Answer 35

The amount of the bond discount or premium is amortized on a constant basis over the life of the bond

Question 36

subsidiary

Answer 36

A corporation that is being controlled by another corporation

Question 37

transaction costs

Answer 37

Costs associated with the acquisition of financial instruments, such as fees, commissions, or transfer taxes

Question 38

unrealized holding gains or losses

Answer 38

The difference between the fair value and cost (carrying amount) of an investment still held (owned) by the investor

Question 39

variable interest entity

Answer 39

Is an entity created by a company to perform a special project or function e.g. access financing. (Synonym: Special purpose entity)

Question 40

Explain and apply the cost/amortized cost model of accounting for investments in debt and equity instruments, and identify how the investments are reported

Answer 40

At acquisition, the cost of the investment is recognized as its fair value plus transaction costs. If the investment is a debt instrument, any premium or discount is amortized to interest income. Holding gains are recognized only when realized, as are holding losses, unless the investment is impaired. The investment is reported at its cost or amortized cost as either a current asset or a long-term investment, depending on its maturity and management’s intention to hold it.

Question 41

Explain and apply the fair value through net income model of accounting for investments in debt and equity instruments, and identify how the investments are reported

Answer 41

At acquisition, the investment is recognized at its fair value, with transaction costs being expensed. At each reporting date, the investment is revalued to its current fair value, with holding gains and losses recognized in net income. Dividend and interest income is also recognized in net income. If the investment is not held for trading purposes, any interest income is reported separately and is adjusted for discount or premium amortization. If held for trading or other current purposes, the investment is reported as a current asset

Question 42

Explain and apply the fair value through other comprehensive income model of accounting for investments in equity instruments, and identify how the investments are reported

Answer 42

At acquisition, the investment is recognized at fair value plus transaction costs. At each reporting date, the investment is revalued to its current fair value with the holding gains or losses reported in other comprehensive income. On disposal, the accumulated holding gains or losses are either recycled to net income or transferred directly to retained earnings. Investments are reported as current or long-term assets, depending on marketability and management intent

Question 43

Identify private entity GAAP and IFRS for investments in financial assets where there is no significant influence or control

Answer 43

Under private entity GAAP, all financial instrument investments are accounted for at fair value through net income or cost/amortized cost with transaction costs expensed unless using a cost-based measure. The FV-NI approach is used for equity instruments with prices quoted in an active market but there is an FV option that can be used for any other instrument. For both models, all interest and dividend income is reported in net income as are all holding gains and losses, whether realized or not. Under IFRS, the two major models are amortized cost and fair value through net income. Transaction costs for FV-NI investments are expensed. To use amortized cost, the investment must have characteristics of a basic loan with contractual cash flows and be managed on a yield to maturity basis. A company can opt to report equity instruments that are not held for trading as FV-OCI without recycling realized gains and losses back through net income. In addition, if there would otherwise be an accounting mismatch, investments ordinarily classified at amortized cost may be designated at FV-NI. All interest and dividend income is recognized in net income, with the effective interest method used for determining interest income, unless not separately reported, such as for those investments held for trading purposes

Question 44

Explain and apply the incurred loss, expected loss, and fair value loss impairment models, and identify private entity GAAP and IFRS requirements

Answer 44

The three impairment loss models differ in the timing of the recognition of impairment losses and the discount rate used. Under the incurred loss approach, a triggering event is required before a loss is recognized and measured, and the revised cash flows are discounted using either the historical or a current market rate. Under the expected loss approach, no triggering event is required, and revised cash flows and impairment losses are determined on a continual basis. The discount rate is the historical or original rate. Using the fair value loss model, the expected future cash flows anticipated by the market are discounted, using a current market discount rate. Private entity GAAP applies the incurred loss model, with the cash flows discounted using a current market rate of interest. Existing IFRS use a variety of approaches, with different methods required for investments according to how they are classified, even for equity investments at FV-OCI. An exposure draft on impairment, favouring the expected loss model for amortized-cost-classified investments, was being prepared as this text went to print. No impairment model was anticipated for instruments measured at fair value.

Question 45

Explain the concept of significant influence and why the equity method is appropriate, apply the equity method, and identify private entity GAAP and IFRS requirements

Answer 45

Significant influence is the ability to have an effect on strategic decisions made by an investee’s board of directors, but not enough to control those decisions. The equity method, sometimes referred to as one-line consolidation, is used because income is recognized by the investor as it is earned. The investor’s income statement will reflect the performance of the investee company. Under this method, the investment account is adjusted for all changes in the investee’s book value and for the amortization of any purchase discrepancy. IFRS requires use of the equity method for its associates (investees a company can significantly influence), while PE GAAP provides a policy choice: either the equity method or the cost method, except that associates with a quoted price in an active market cannot be accounted for at cost. Instead, the FV-NI model can be used

Question 46

Explain the concept of control, the basics of consolidated financial statements, and why consolidation is appropriate, and identify private entity GAAP and IFRS requirements

Answer 46

Control relates to the ability to direct the strategic decisions of another entity and to generate returns for your own benefit or loss. When one company controls another, it controls all the net assets of that entity and is responsible for all its revenues and expenses. Therefore, all of the subsidiary’s assets and liabilities, and revenues and expenses, on a line-by-line basis, are reported by the parent investor in consolidated financial statements. The interests of the non-controlling shareholders in the subsidiary company are reported separately as non-controlling interest. Under IFRS, all subsidiaries are consolidated. PE GAAP, on the other hand, allows consolidation or a choice of the equity or cost method. Investments in companies with shares traded in an active market cannot be reported using the cost method, but may use FV-NI

Question 47

Explain the objectives of disclosure, and identify the major types of information that are required to be reported for investments in other companies’ debt and equity instruments

Answer 47

The objectives of disclosure are to provide information so users can assess the significance of the financial asset investments to the entity’s financial position and performance, the extent of risks to which the company is exposed as a result, and how those risks are managed. As a result, the investments are identified on the balance sheet according to how they are classified for accounting purposes, with the income statement reporting information on the returns by method of classification. Extensive disclosure is required, particularly under IFRS, on the risk exposures of the entity and how the entity manages those risks

Question 48

Identify differences in accounting between private entity GAAP and IFRS, and what changes are expected in the near future

Answer 48

Both PE GAAP and IFRS choose from the same accounting models, with PE GAAP allowing more cost-based measures as the first choice and IFRS using FV-NI as the default category. The effective interest method is required by IFRS when calculating interest income, but PE GAAP does not require this method. Both require all realized gains and losses to be recognized in net income; however, under IFRS, they could be recognized in OCI if using FV-OCI. Different impairment models are used. PE GAAP is based on an incurred loss model, while IFRS is moving toward an expected loss model. Under IFRS, the equity method and consolidation are required for investments in associates and subsidiaries, respectively. Under PE GAAP, the same two methods are allowed; however, for investments in significantly influenced companies, entities may choose to use the cost method, and for subsidiaries, they have a choice of the equity method or cost method. In either case, if the investee’s shares are traded in an active market, the cost method cannot be used