Chapter 2: Investments in Equity Securities

Topic 1: Significant Influence and Controlled Investments

Objectives:
By the end of this topic you will be able to:

• Define and distinguish significant influence and controlled investments

• Prepare journal entries to account for investments when recording investments
under the cost and equity methods

Readings: Please read pages 56 – 64 (up to but not including “acquisition costs greater
than carrying amounts” but no harm to read this now if you wish; we will cover acquisition
costs greater than carrying amounts later in our course); pages 67 (presentation and
disclosure requirements) - 71

Summary Notes:

Define and distinguish significant influence and controlled investments

Equity investments are investments in shares of another company.

There are two main categories of equity investments: strategic and nonstrategic. For
strategic investments, the investor intends to establish or maintain a long-term operating
relationship with the entity in which the investment is made and has some level of influence
over the strategic decisions of the investee company. The level of influence varies between
full control, joint control, or significant influence. For nonstrategic investments, the
investor is hoping for a reasonable rate of return without having the ability to play an active
role in the strategic decisions of the investee company.

As of January 1, 2016, there are five different types of share investments classified as either
a strategic investment, or a nonstrategic investment. The following chart displays the
reporting methods for investments in equity securities.

REPORTING METHODS FOR INVESTMENTS IN EQUITY SECURITIES

Type of Investment Reporting Method Reporting of Unrealized
Gains
Strategic investments*
• Significant influence Equity method Not applicable
• Control Full consolidation Not applicable
*Also includes joint
controlled investments
Nonstrategic investments
• Fair value through profit or Fair value method In net income
loss (FVTPL)
• Other — elect fair value Fair value method In other comprehensive income
through OCI (FVTOCI)

When investments are not reported at fair value (such as the strategic investments noted
above), they are usually reported using the cost method or the equity method.

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Under IFRS 9, we use fair value accounting for nonstrategic investments to report any
unrealized gains or losses as follows:
a) If the investment is FVTPL: record unrealized gains and losses in net income
b) If the investment is FV-OCI, report the unrealized gain or loss on the investment in
OCI (note: an investment is classified as FV-OCI if when purchased, the company
designates it as such)

The cost method of reporting an equity investment is used under IFRSs in certain
circumstances. Under the cost method, the investment is initially recorded at cost. The
investor’s share of the dividends declared is reported in net income. The investment is
reported at original cost at each reporting date unless the investment becomes impaired.
Impairment losses are reported in net income. When the investment is sold, the realized
gains or losses are reported in net income. The cost method is allowed under ASPE for
equity investments that are not quoted in an active market.

An investment where the investor is able to significantly influence the operations of the
investee is called an investment in associate and under IFRS, must be accounted for using
the equity method. This requires the investor to record its share of all increases in the
shareholders’ equity of the investee. In later chapters we will discuss further adjustments
to the investee’s equity picked up by the investor in chapters 4 and 5.

Recording SI investments: Under ASPE, investors can account for SI investments using
the cost, equity or fair value methods (text page 71). Under IFRS, we use the equity
method to account for SI investments (if the Associate trades publicly, we also quote the
associate’s fair value in the notes).

An associate is an entity over which the investor has significant influence. Significant
influence allows the investor to influence the operating, I vesting and financing decisions of
the investee (associate). The following conditions are possible indicators that significant
influence is present and that the investee is an associate:

(a) Representation on the board of directors or equivalent governing body of the

investee;
(b) Participation in policy-making processes, including participation in decisions about
dividends or other distributions;
(c) Material transactions between the investor and the investee;
(d) Interchange of managerial personnel; or
(e) Provision of essential technical information.

A guideline (not a rigid rule) in determining whether there is significant influence is

20% to 50% of voting shares. Ownership in excess of 50% of voting shares is said to
be a controlled investment.

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Prepare journal entries to account for investments when recording investments
under the cost and equity methods

When an investor has significant influence, the investment should be reported by the
equity method. The basic concept behind the equity method is that the investor records its
proportionate share of the associate’s income as its own income and reduces the investment
account by its share of the associate’s dividends declared. Under the equity method, the
investor’s investment account changes in direct relation to the changes taking place in the
investee’s equity accounts. The equity method reflects the accrual method of income
measurement. As the investee earns income, the investor accrues its share of this income.
The associate is not obligated to pay out this income as a dividend on an annual basis.

TIPS:

- Review the example on pages 60 – 63 so you can see the differences between the cost
and equity methods

- Read the section on pages 63 – 64 “other changes in Associate’s Equity” so you can see
how Associate’s OCI impacts the Investors entry for the SI investment

Investments in associates shall be classified as noncurrent assets. The investor’s share of

the profit or loss of such associates, and the carrying amount of these investments, must be
separately disclosed.

Let’s Practice: Try the sample problem postings in this module for chapter 2; also review
the self study problem #1 in the course text for chapter 2. Compare your solutions to those
provided. Compare your response to the solution provided.