BUS 343 Chapter 7

  1. amortized cost
    a method of accounting where the balance sheet amount equals the purchase cost of the investment adjusted for amortization of any premium or discount on the investment
  2. associate
    an entity over which the investor has significant influence and that is neither a subsidiary nor an interest in a joint venture
  3. available for sale (AFS)
    a category of financial investments, excluding derivatives, that an entity has designates as available for sale, or that has not been otherwise classified as one of the other 6 categories of financial assets
  4. financial asset
    an asset arising from contractual agreements on future cash flows

    not equipment, land, buildings, or inventory which are  ''real'' assets
  5. financial instrument
    • and contract that gives rise to
    • –(i) a financial asset for one
    • entity and

    • – (ii) a financial liability or equity
    • instrument for another entity
  6. equity instrument
    a contract that gives the holder of the residual interest in an entity after deducting all of its liabilities, such as a common share

    can be: subsidiary, joint venture, associate, HFT, AFS
  7. derivative
    • a financial instrument with all of the three characteristics
    • i) its value changes according to a specified variable such as stock price
    • ii) it requires no initial net investment or a small investment relative to a non-derivative contracts with similar exposure to the specified variable
    • iii) it is settled at a future date

    are only HFT
  8. debt instrument
    • any financial instrument that is not an equity instrument or a derivative
    • ex. Bonds

    can be: HFT, AFS, HTM, loans & receivables
  9. parent
    • - an entity that controls another entity
    • - the investor
    • - controls the subsidiary
  10. subsidiary
    • an entity that is controlled by another entity
    • - controlled by the parent
    • - accounting treatment - consolidation
  11. control
    • power to govern the financial and operating policies
    • - presume control if investor holds more than 50% of voting power
  12. consolidation accounting
    • a method of combining the financial statements of two or more companies that are controlled by the same owners, reporting one set of financial statements
    • - 100% of the assets, liabilities, revenues, and expenses or each subsidiary are added to the parent company's accounts

    - eliminate: investment in subsidiary on the parent's books, shareholders equity on the subsidiary's books, intercompany transaction such as loans or sales
  13. joint venture
    • contractual arrangement whereby two or more parties undertake and economic activity
    • - subject to joint control

    • accounting treatment
    • - proportionate consolidation
    •         where you only consolidate your percentage of the joint ventures assets and liabilities
    • -equity methoed
  14. joint control
    • contractually agreed sharing of control over any economic activities
    • - strategic decisions require unanimous consent
  15. significant influence
    power to participate in financial and operating policy decisions of investee
  16. associate
    • entity over which investor has significant influence
    • - presumed significant if holding 30-50% of voting power
  17. equity method
    • –Balance sheet value = cost + investor’s share
    • of post-acquisition change in net assets of associate

    • –Income = investor’s share of associate’s
    • income

    • •The initial investment is
    • recorded at cost.

    •Adjustments are made to the investment account for the investor’s pro rata share of income or loss.

    • •Dividends decrease the investee’s owners’ equity and so it also reduces the
    • investor’s investment
  18. Book value of investment
    purchase + share of income - share of dividends
  19. Held for Trading (HFT)
    •Acquired for purpose of selling in the near term

    •Management intends to trade and make profit

    •Derivatives are only treated as HFT investments

    –Are high risk and speculative

    •Accounting treatment – fair value through profit or loss (part of net income)

    •Report at fair value on the balance sheet

    •Any changes reported in the income statement

    –Unrealized gain and losses

    • –Trading activity part of regular operating
    • activities

    –Part of net income (not OCI)

    •Fair value the relevant measure

    –An active market supports fair value
  20. Available for Sale (AFS)
    • •Entity has designated investments
    • as available for sale (AFS)

    –But no active intention to sell unlike in HFT

    • –Might sell them soon, might hold them for
    • quite awhile

    •Investment accounted for as AFS by default

    • –An investment not classified as one of the
    • other six categories of financial assets

    A catch all category

    •Accounting treatment—fair value through other comprehensive income (OCI)

    •Report at fair value on the balance sheet

    –Same as HFT investments

    •Any changes reported in the income statement

    –Unrealized gain and losses part of OCI (not net income)

    –Trading activity not part of regular operating activities

    –When sold…

    •Unrealized gain and losses in OCI need to be reversed

    Realized gains and losses are part of net income (not OCI
  21. Held to Maturity
    •xed or determinable payments

    •Fixed maturity

    •Entity intends to hold to maturity

    •Accounting treatment – amortized cost

    • –the purchase cost of the investment is
    • adjusted for amortization of any premium or discount on the purchase of the investment

    –At maturity, the book value = maturity value
  22. Loans & Receivables
    •Applies to investments in debt instruments only

    •Fixed or determinable payments

    –Fixed maturity not required

    •No active market       no readily obtainable price


    • –intends to sell in the near term which should
    • be classified as HFT

    –has designated as AFS when first acquired

    •Accounting treatment— amortized cost (Ch. 5)
  23. Effective Interest Method
    • •Effective interest method - calculates the present
    • value of the asset’s cash flows discounted at the effective (market) interest rate or yield
  24. Bond Premium
    • when the bond price (market value) is higher than the face
    • value
  25. Bond Par
    • when the bond price (market value) exactly equals the face or
    • par value
  26. Bond Discount
    • when the bond price (market value) is
    • lower than the face value
Card Set
BUS 343 Chapter 7
Chapter 7