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Int. Acc. FA LECT 8: CH 19+17 part 4: Investments (Impairments of value(I)…
Int. Acc. FA LECT 8: CH 19+17 part 4: Investments
Impairments of value(I)
With amortized cost, this is not the case
If fair value falls significantly below amortized cost due to adverse circumstances (e.g., drop in value of Greek government bonds) --> Write down the amortized cost basis of the investment and recognize a
realized
loss in net income
With fair value measurement, the balance sheet value of the investment asset is adjusted to its fair value at the reporting period
Debt investments: use
impairment test
to determine “whether it is probable that the investor will not be able to collect all contractual amounts”
Debt investments-Fair value
The bonds are not held-to-maturity and are therefore accounted for at fair value. slide 22/34
Record the adjustment
Determine the unrealized holding gain or loss
Difference: At year-end, the carrying amount (or “book value”) is compared to the investment’s fair value
Recording of the investment and interest revenue in 2012: Same as for the amortized cost accounting
What if the bonds are sold before maturity?
Step 1-6: Same as for amortized cost method!
Realized
gain on sale of the debt investment is computed as the difference between the amount received (= fair value) and the carrying amount based on amortized cost
(the ’Fair value adjustment’ account is not used here)
Step 7: Eliminate (reverse) the valuation account:
Over the life of the bonds, the total net unrealized gains or losses net out to zero
--> Only difference between the two methods is that gains and losses are allocated to different time periods
Fair value optio
n
Companies have the option to report most financial assets at fair value. This option:
is applied on an instrument-by-instrument basis and
is generally available only at the time a company first purchases the
financial asset or incurs a financial liability
If a company chooses to use the fair value option, it measures this instrument at fair value until the company no longer has ownership
--> Switching between methods from period to period not possible
Example: slide 28/34
Note
: fair value changes under this FV option -> do not use the Fair value Adjustment account! (FV option is applied to an individual security, not entire portfolio)
Impairments of value (II)
Loss on impairment:
Recording of the impairment loss:
Discounted value of the expected future cash flows:
Impairments of value (III)-Reversal
Recording of the reversal:
What if economic conditions improve and the fair value of the investment increases?
--> Impairment loss decreases or disappears
Note: the reversal may never exceed the original amount written off from the debt investment account!
Summary
Two types of accounting:
Held-to-maturity --> Amortized cost
Held-for-trading --> Fair value
Main difference:
At the end of each year (or : reporting period), a fair value adjustment is made to account for the difference between carrying value and fair value of the debt investment
The fair value adjustment account is eliminated (reversed) when the bonds are sold
Two types of debt investments:
Held-to-maturity
Held-for-trading