Investments and Financial Instruments
What this domain tests
This domain covers classification and measurement of debt and equity investments, the fair value hierarchy, the equity method, and impairment under ASC 320, ASC 321, ASC 323, ASC 820, IFRS 9, and IAS 28.
Classification and measurement
US GAAP debt securities are held-to-maturity at amortized cost, trading at fair value through net income, or available-for-sale at fair value through OCI, with credit losses recognized through an allowance. Equity securities with readily determinable fair value are measured at fair value through net income. Equity securities without readily determinable fair value may use the measurement alternative: cost minus impairment plus observable price changes.
IFRS 9 classifies debt at amortized cost if the business model is hold-to-collect and the cash flows are solely payments of principal and interest; at FVOCI if hold-to-collect-and-sell; otherwise at FVTPL. Equity investments are FVTPL unless an irrevocable FVOCI election is made.
The equity method applies when an investor has significant influence, presumed at 20% or more ownership. The investment starts at cost, increases for the investor's share of investee income, and decreases for dividends and share of losses. Basis differences are amortized. Impairment is recognized when fair value falls below carrying amount and the decline is other than temporary. The fair value hierarchy ranks Level 1 quoted prices, Level 2 observable inputs, and Level 3 unobservable inputs.
Worked example
An investor buys 25% of an investee for $200,000. The investee reports net income of $80,000 and pays dividends of $20,000. The investment carrying amount is $200,000 + $20,000 - $5,000 = $215,000. Dividends are not revenue under the equity method; they reduce the investment. If fair value is $190,000 and the decline is other than temporary, an impairment loss is recognized.
Traps
Putting available-for-sale unrealized gains in net income; treating equity-method dividends as income; treating 20% as a strict cutoff; classifying a security as held-to-maturity while intending to sell it; using Level 3 inputs as a default; and ignoring CECL on held-to-maturity debt.