Intercorporate Investments Notes & Practice Questions CFA

It is well-known that banks, insurance companies, and other financial institutions hold large portfolios of investments (financed by deposits and fees their customers paid to the banks) to increase their interest income. But it may also be the best way for companies in non-financial industry sectors to utilize excess cash and to strengthen relationships with other companies. If the intercorporate investments investments can earn a higher return compared to idle cash sitting in a bank account, then it may be in a company’s best interests to invest. The returns from these investments will be in the form of interest income, dividend income, or an appreciation in the value of the investment itself, such as the market price of a share.

If the fair value of the subsidiary falls below the carrying amount, including goodwill, an impairment loss is recognized. Intercorporate investment can occur when a company makes any investment in another company. These types of investments can be accounted for in a few different ways depending on the investment. United PLC has a contractual right to appoint three-quarters of the board of X Ltd and has used its voting rights to appoint all of the shareholders of Y Ltd. Company A employs the equity method to account for its investment in Company B.

Classification and Measurement of Financial Assets under IFRS 9

• 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.
• Held-to-maturity (HTM) refers to debt securities intended to be held till maturity.
• This is because United PLC controls the majority of the board of X Ltd and controls a majority of voting rights in Y Ltd.
• Such a position would be considered a “passive” investment because, in most cases, an investor would not have significant influence or control over the target firm.
• Other portfolios may be for longer-term investments such as bonds that will increase the company’s interest income.
• 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.

The equity method of accounting for joint ventures is required under both IFRS and U.S. This method results in a single line item on the income statement and a single line item on the balance sheet. HP also stated that the actual losses of Autonomy’s loss-prone hardware division were misclassified as “sales and marketing expenses” in the operating expenses section rather than as cost of goods sold in the gross profit section. Companies may form strategic alliances with other firms to collaborate on research and development, marketing, or production. For instance, two pharmaceutical companies might partner to develop a new drug, sharing research costs and resources.

About this chapter

• Joint ventures may be allowed to use proportionate consolidation under IFRS and US GAAP in rare cases.
• For example, how are investments to be classified and reported in order to provide relevant information about the investments to the stakeholders?
• The purchase price of the subsidiary is recorded at cost on the parent’s balance sheet, with any goodwill (purchase price over book value) being reported as an unidentifiable asset.
• The sponsoring company would show improved asset turnover, lower operating and financial leverage, and higher profitability.
• In 2011, Hewlett-Packard (HP) purchased approximately 87% of the share capital (213 million shares) of Autonomy Corporation plc.
• When an investor’s ownership interest in an investee changes, the method of accounting may also change.

Additionally, the investment must also be tested periodically for impairment. If the fair value of the investment falls below the recorded balance sheet value (and is considered permanent), the asset must be written down. A joint venture, whereby two or more firms share control of an entity, would also be accounted for using the equity method. 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.

Held-to-Maturity

In this light, apparently, some analysts questioned Autonomy’s acquisition accounting. 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.

Chapter 8: Intercorporate Investments

There is no single subsequent measurement for all investments for IFRS and ASPE. Below is a summary of the various classification alternatives for the two current standards for IFRS 9 and ASPE. This is because United PLC controls the majority of the board of X Ltd and controls a majority of voting rights in Y Ltd. In a case where one entity absorbs the majority of the VIE’s expected losses while the other entity receives a majority of the VIE’s expected profits, the entity absorbing a majority of the losses must consolidate the VIE. The primary beneficiary is identified as the entity expected to take up most of the VIE’s expected losses. Reversal of an impairment loss is prohibited under IFRS (except for non-goodwill impairment losses) or U.S.

7: Chapter Summary

However, the management may opt to use the fair value through profit and loss (FVPL) option to avoid an accounting mismatch. The consolidation method is required when the investor has control over the investee, usually indicated by ownership of more than 50% of voting shares or the ability to direct key management and financial policies. Available-for-sale securities are debt or equity securities purchased by a company with the intention of holding them for indefinite periods of time or selling them before they reach maturity.

When an investor’s ownership interest in an investee changes, the method of accounting may also change. The choice of method depends on the level of control or influence the investor has, which can vary as ownership percentages increase or decrease. The equity method is applied when the investor has significant influence over the investee, typically with ownership between 20% and 50%. Significant influence is characterized by the ability to affect management decisions, even without controlling the company. Within the cost method, there can also be some further delineation of investments.