Chapter 8: Intercorporate Investments Business LibreTexts

The criteria and accounting treatment for impairment vary depending on the type of investment. The question remained; how was it possible to lose 79% of Autonomy HP unit value in less than one year? HP claims to have discovered all kinds of intercorporate investments accounting irregularities which were denied by Autonomy’s founder and CEO, Mike Lynch. HP claimed that it would have paid half the purchase price, had it known what it later discovered about Autonomy’s true profitability and growth. HP alleged that the owners of Autonomy misrepresented their company’s financial position due to what HP referred to as serious accounting improprieties.

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• GAAP require the elimination of profits to the extent of the investor’s ownership of the investee.
• On the other hand, the investor’s proportionate ownership interest in the assets and liabilities of the investee is disclosed as a single line item (net assets) on its balance sheet.
• SPEs are non-operating entities created to meet the specific needs of the sponsoring entity.
• So the impairment charge more likely reflected a reassessment by HP of the future cash flows originally estimated, based on the financials, to be much less than anticipated.
• The ECL is adjusted up or down depending on if credit risk increasing or decreasing.
• Understand the criteria for choosing each method based on the level of influence or control over the investee, and how these methods impact financial statements.

The method of accounting for these investments depends on the level of influence or control the investing company (investor) has over the investee company. Proper accounting for intercorporate investments provides a realistic view of an investor’s financial position, and different accounting methods apply based on the extent of influence. Intercorporate Investments encompass the various methods by which one company can invest in another, impacting financial statements and valuation. This topic covers the classification and accounting treatment of investments, including equity method, consolidation, and fair value measurement. It also examines the effects of these investments on financial reporting and the implications for analyzing financial health and performance.

Legal or Contractual Rights

• It arises in business combinations where the parent company acquires a controlling interest in the subsidiary.
• Consider that software companies like Autonomy do not have much value in hard assets, so the impairment did not relate to a revaluation of assets.
• 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.
• There are also joint arrangements where two or more investors, through a contractual agreement, control a joint entity.
• This is backed up by Chief Executive Meg Whitman’s assertion that Autonomy’s real operating profit margin was closer to 30%, and not its reported 40 to 45%.
• Within the cost method, there can also be some further delineation of investments.

The fair value option is the option at the time of initial recognition to record an equity method investment at fair value. Additionally, IFRS 9 differs from IAS 39 in that companies are required to migrate from an actual loss model to an expected credit loss model. This implies that companies evaluate both historical and current information about loan performance and forward-looking information. With all the factors discussed above, it is possible that HP could allege and demonstrate that inappropriate reporting and valuation errors led to a discrepancy the size of which it purports. Autonomy HP unit CEO, Mike Lynch, denies all charges of reporting impropriety or error.

i. Amortized Cost

Consider that software companies like Autonomy do not have much value in hard assets, so the impairment did not relate to a revaluation of assets. Also, Autonomy did not have much in the way of outstanding invoices, so there was no large non-payment of amounts owed to trigger the drop in value and subsequent impairment write-down. At the end of 2020, the carrying value of Company B on Company A’s balance sheet will be $687,500, i.e., \(($593,750 + $150,000 – $56,250)\).

Investments in Financial Assets

For ASPE companies, there is a choice of using proportionate consolidation, equity, or cost. The mechanics of the proportionate consolidation method are similar to the consolidation method discussed above. Both IFRS and ASPE identify some percentage of ownership reference points as guidelines to help determine in which category to classify an investment. It is highly unlikely that this level of ownership would result in having any influence on a company’s decisions or operations.

Different accounting treatments are required depending on the type of intercorporate investment. For IFRS, impairment evaluations for AC investments are the same process as for FVOCI debt. Financial performance as measured by unconsolidated financial statements was possibly misleading. The sponsoring company would show improved asset turnover, lower operating and financial leverage, and higher profitability. For example, Enron used SPEs to obtain off-balance-sheet financing and artificially improve its financial performance. Its subsequent collapse was partly attributable to its guarantee of the debt of the SPEs it had created.

The value of the investment is adjusted based on the percentage of profit or loss for the owner. Rather, dividends increase cash and reduce the value of the investment for the investor. Joint ventures can be divided into jointly controlled operations, jointly controlled assets, and jointly controlled entities under IFRS. This method requires the venturer’s share of assets, liabilities, income, and the expenses of a joint venture to be combined on a line-by-line basis. The resulting standards have improved the relevance, transparency, and comparability of information provided in financial statements. Companies can also increase reported net income by inappropriately classifying certain current expenses as investments (assets), which are thereafter amortized over several years.

As the investor’s ownership level changes, the appropriate accounting method may need to be adjusted to reflect the new level of influence or control. Additionally, impairment assessments ensure that investments are accurately valued on the balance sheet, especially when market or operational factors reduce an investment’s fair value. When examining the financial statements of companies with intercorporate investments, it is important to watch for accounting treatments or classifications that do not seem to fit the actualities of the business relationship. While such instances shouldn’t automatically be looked at as “tricky accounting,” being able to understand how the accounting classification affects a company’s financial statements is an important part of financial analysis.

Investment decisions to buy or sell are based on this information so it is critical to be aware of any obscured data that could influence these decisions. Under IFRS 9, investments are divided into separate portfolios according to the way they are managed. That is not to say that investments classified as AC can never be sold, but sales in this classification would be incidental and made in response to some sort of change in the investment, such as an increase in investment risk. Both ASPE and IFRS allows companies to classify an investment as FVNI only at acquisition.

Finally, the non-controlling interests in the VIE are recorded in the consolidated balance sheet and income statement of the primary beneficiary. However, a joint venture refers to jointly controlled separate entities under U.S. On the other hand, the investor sells goods to the investee in a downstream sale.