CFA2 FSA: SS6-Intercorporate Investments
Terms in this set (12)
Accounting for investments:
=> Less than 20% owned: Invest. in financial assets; -No significant influence;
-See Invest. in Financial assets (held-to-maturity, held-for-trading; held-for-sale, designated at FV)
=>20%-50% : (Investments in associates)
=>More than 50%: (Business combinations)
=>50% / 50%: (Joint venture)
-U.S. GAAP: Equity method
- IFRS: Proportionate consolidation preferred (Equity method permitted)
-Managmt has positive intent and abillity to hold to maturity
-B/S: Amortized cost.; Subseq. changes in FV ignored.
-I/S: Interest and any realized G/L reported
-IFRS same as US.GAAP
Held-for-trading securities (and desig. at FV)
-Acquired for the purpose of selling the near-term
-B/S: At FMV
-I/S: Dividends, Interest, Realized and Unrealized G/L
-IFRS same as US.GAAP
=>Desig. at Fair Value (treated as trading sec.)
-Management has the option to report the fin. assets and liab. that would otherwise be classified as Held-to-Maturity or Available for Sale at FV.
-May be sold to address liquidity
-B/S: At FMV; Unrealized G/L in Equity (OCI)
-I/S: Dividends, Interest, Realized G/L
-IFRS similar to US.GAAP, except Unrealized FX G/L which are recognized in I/S under IFRS and as OCI under US.GAAP.
Investments in associates
=>(20%-50%), sig. influence
-Equity method: same IFRS and US. GAAP
-B/S: Reported at cost + %Earnings - %Dividends
->%share of the investee's earnings
increase the investor's invest. account
->%share of dividends received reduce
the invest. account and increase the cash acct.
->No %dividend in I/S
-(>50% owned), control
-Acquisition method: same IFRS and US. GAAP
-Goodwill NOT amortized, subject to annual impairment test.
1-Eliminate Inv. acct of parent and Equity acct of sub.
2-Create Minority Interest (MI) (%equity not owned)
3) Combine the Assets and Liabilities of both firms
1-Eliminate Sub. earnings from parent
2-Substract minority share of earnings (%earnings not owned
3-Combine Revenues, and expenses of both firm
(net of intercompany transactions)
=>50% / 50%: Shared control
-U.S. GAAP: Equity method
-IFRS: Proportionate consolidation preferred; Equity method permitted)
->Proportionate consolidation is similar to a business combination, except the investor only includes the proportionate share of the assets, liabilities, revenues, and expenses of the joint venture. No minority owners' interest is required.
->Equity and NI are the same under prop.consol and Equity method, so ROE is the same but many ratios will change.
Effect of Choice of Method
Four important effects on B/S and I/S resulting from the choice of method on leverage and profitability:
1) All three methods report the same net income.
2) Sales: Highest under Acquisition; Lowest under the equity method; proportionate cons. is in-between.
->Higher under Acquisition by the amount of MI;
->Same under prop. cons. et Equity methods.
4) Assets and liabilities: Highest under the Acquisition and Lowest under the equity method; proportionate consolidation is in-between.
Effect of Choice of Method: Ratios
=>Leverage et Profitability ratios:
-Most favorable: Equity Method
-Least favorable: Acquisition Method
-In-between: Proportionate consolidation
E.M: Lower -> Liab. lower, equity same
=>Net profit margin: NI/Sales
E.M: Higher-> Sales lower, NI same
Equity Method: Higher -> equity lower, NI same Prop.Consol: Same as Equity Method
Equity Method: Higher -> assets lower, NI same Prop.Consol: In-between
Differences between IFRS and U.S. GAAP
=>Unrealized foreign exchange gains and losses on available-for-sale securities are recognized on the income statement under IFRS and as other comprehensive income under U.S. GAAP.
=>U.S. GAAP categorizes business combinations as mergers (acquired company ceases to exist), acquisitions (acquired company continues to exist as a subsidiary), or consolidations (new company is formed and both old companies cease to exist). IFRS does not distinguish between types of business combinations.
=>IFRS permits either the partial goodwill or full goodwill method to value goodwill and noncontrolling interest in business combinations. U.S. GAAP requires the full goodwill method.
=>U.S. GAAP requires equity method accounting for joint ventures. Under IFRS, proportionate consolidation is preferred but the equity method is permitted.
What is a Special purpose entity (SPE)?
->SPE is a legal structure created to isolate certain assets and liabilities of the sponsor.
->An SPE can take the form of a corporation, partnership, joint venture, or trust.
->Created to serve specific purpose: purchase asset, fund R&D, leas assets, enhance the balance sheet
->Typical motivation is to reduce risk and thereby lower the cost of financing.
Special purpose entity
IFRS continues to use the term special purpose entity. The sponsoring entity must consolidate if it controls, "in substance," the SPE. Indications of control include a sponsoring entity that:
-Benefits from the SPE's activities.
-Has decision-making rights to receive benefits from the SPE.
-Absorbs the risks and rewards of the SPE.
-Has a residual interest in the SPE.
Under U.S. GAAP rules, a VIE could include a SPE that has at-risk equity that is insufficient to finance the entity's activities without additional financial support.
If a SPE is considered a VIE, it must be consolidated by the primary beneficiary. The primary beneficiary is the entity that absorbs the majority of the risks OR receives the majority of the rewards.