8.2.2: Fair Value Through OCI Investments (FVOCI); (IFRS only)

Types of Investments	Accounting Treatment
Debt (bonds)	Interest and dividends through net income as earned/declared.
Debt (bonds) Equities (shares) by special irrevocable election only at acquisition	Remeasure investment to fair value at each reporting date through OCI. Can be recorded directly to investment or through an asset valuation account. Upon sale, remeasure investment sold to its fair value with gains/losses through OCI. Reclassify the OCI for the debt investment sold to net income (FVOCI with recycling), and to retained earnings for equities investments (FVOCI without recycling).

Looking at the table above, one cannot help but notice how the FVOCI debt investments are recycled through net income when sold in contrast to the FVOCI equities investments which are not recycled, and are reclassified to retained earnings instead, bypassing net income altogether. Originally, the FVOCI classification was without recycling for both debt and equity. This was done to lessen the instances of "earnings management" which is the manipulation of earnings due to bias. By timing the most opportune time to sell, a company could suddenly boost net income resulting from the reclassification of OCI from AOCI to net income of the unrealized gains dating back to when the investment was purchased. However, it appears that an exception has now been made to allow FVOCI debt investments to recycle through net income. FVOCI investments in equities continue to be classified as FVOCI without recycling.

FVOCI debt and equity investments are reported at their fair value at each balance sheet date with fair value changes recorded in Other Comprehensive Income (OCI). Unlike FVNI investments, transaction costs are usually added to the carrying amount of the FVOCI investment, and are usually reported as long-term assets unless it is expected they will be sold within twelve months or the normal operating cycle.

The fair value measurement at each reporting date is recorded to the investment asset account (or an asset valuation account). The unrealized holding gain (loss) is recorded to unrealized gain (loss) OCI and reported in OCI (net-of-tax). When the investments are sold, a remeasure to fair value can precede the entry for the sales proceeds, or alternatively, any gains (losses) resulting from the sale are reported in net income as a realized gain (loss) on sale of investment.

This is the point where FVOCI investments in debt differ from FVOCI investments in equity.

For FVOCI, debt investment sold:

• any unrealized gain (loss) in AOCI at the time of the sale is reclassified from AOCI to net income (with recycling).

For FVOCI, equity investment sold:

• any unrealized gain (loss) in AOCI at the time of the sale is reclassified from AOCI to retained earnings (without recycling).

Recall from the chapter on Statement of Income and Statement of Changes in Equity, that OCI is not included in net income, and is reported in a separate statement called the Statement of Comprehensive Income. This means that any unrealized gains (losses) from holding FVOCI investments will not be reported as net income until the debt investment is sold or impaired as will now be discussed. Students are encouraged to review the material regarding the topic of OCI.

Impairment of Investments with no recycling (Equity)

For FVOCI in equity investments, there is no need for impairment tests because equities are continually re-measured to their fair value based on the readily available market prices and these changes in value are not reported in net income, so impairment testing is not done. For FVOCI investments in debt, impairments will be discussed in detail in the FVOCI with recycling (debt) section later in this chapter.

FVOCI (without recycling) – Investments in Shares

The similarities and differences between FVNI and FVOCI investments journal entries will be examined next, since both apply fair value remeasurements, but differ in how these are recorded and reported. Using the same example for Lornelund Ltd. used in the FVNI investments above, a comparison between the entries required for FVNI and FVOCI is shown below. The transactions are repeated below but now include another fair value change at the end of 2021.

Lornelund Ltd. – Non-Strategic Equity Investments
Dates		# of	Price per	Total
in 2020	Transaction Detail	Shares	Share	Amount
June 1	Purchased Symec Org. shares for $150 per share (transaction costs were an additional $1.25 per share)	1,000	$150.00	$150,000
Aug 15	Purchased Hemiota Ltd. shares	2,500	84.00	210,000
Nov 30	Dividends for Symec declared and received	1,000	6.10	6,100
Dec 31	Market price for Symec shares at year-end		165.00
Dec 31	Market price for Hemiota shares at year-end		82.00
Dates
in 2021
Jan 10	Sold Symec shares	500	165.70	82,850
Dec 31	Market price for Symec shares at year-end		$167.00
Dec 31	Market price for Hemiota shares at year-end		$75.00

COMPARISON OF FVNI TO FVOCI (without recycling)
		(FVNI)		(FVOCI)
2020
June 1	Investments – Symec shares	150,000		151,250
	Transactions fees expense	1,250
	Cash		151,250		151,250
Aug 15	Investments – Hemiota shares	210,000		210,000
	Cash		210,000		210,000
Nov 30	Cash (or dividend receivable if declared but not paid)	6,100		6,100
	Dividend income		6,100		6,100
Dec 31	Investments – Symec shares	15,000		13,750
	Unrealized gain (loss) on FVNI investments (NI)		15,000
	()
	Unrealized gain (loss) on FVOCI investments (OCI)				13,750
	()
NOTE – Both FVNI and FVOCI shares carrying values for Symec are .
Dec 31	Unrealized gain (loss) on FVNI investments (NI)	5,000
	(()
	Unrealized gain (loss) on FVOCI investments (OCI)			5,000
	Investments – Hemiota shares		5,000		5,000
NOTE – Both FVNI and FVOCI shares carrying values for Hemiota are $82 per share 2,500 = $205,000
2021
Jan 10	Cash	82,850		82,850
	Investments – Symec shares		82,500		82,500
	Gain (loss) on sale of investments (NI)		350
	Gain (loss) on sale of investments (OCI)				350
	For Cash: (), For Investments: ()
Jan 10	AOCI			7,050
	Retained earnings				7,050
	()
	To reclassify unrealized gains from AOCI to retained earnings for 500 Symec shares sold.
Dec 31	Investments – Symec shares	1,000		1,000
	Unrealized gain (loss) on FVNI investments (NI)		1,000
	Unrealized gain (loss) on FVOCI investments (OCI)				1,000
	()
Dec 31	Unrealized gain (loss) on FVNI investments (NI)	17,500
	Investments – Hemiota shares		17,500
	()
	Unrealized gain (loss) on FVOCI investments (OCI)			17,500
	FVOCI Investments – Hemiota shares				17,500

Note that the transaction fees are expensed for FVNI investments but are added to the carrying value for FVOCI investments. At December 31 year-end, Lornelund makes two end-of-period adjusting entries to record the latest fair values changes for each investment. The fair value for Symec shares increased FVOCI $150 to $165 per share resulting in an increase in the investment value by $15,000 and $13,750 for FVNI and FVOCI categories respectively. These amounts are different due to the transaction costs originally recorded to the investment asset of the FVOCI investment. The fair value for Hemiota shares decreased from $84 to $82 per share resulting in a decrease in the investment value of $5,000 for both FVNI and FVOCI investments.

Ignoring taxes for simplicity, below are the financial statements for 2020 under FVNI and FVOCI:

Lornelund Ltd.
Balance Sheet
December 31, 2020
Current assets:			FVNI			FVOCI
FVNI investments (at fair value)*		$	370,000
Long-term assets:
Long-term investment (at fair value)					$	370,000
Equity:
Accumulated other comprehensive income **					$	8,750

* FVNI (); FVOCI ()
** AOCI ()

There is no difference in the ending balances of the investment asset accounts under the FVNI and FVOCI methods on December 31, 2020, because both are reported at fair value at each reporting date. Even though the transaction costs were initially capitalized under the FVOCI method, the year-end fair value adjustment entry for both FVNI and FVOCI investments resulted in equalizing the investments balances.

Lornelund Ltd.
Income Statement and Comprehensive Income Statement (partial)
For the Year Ended December 31, 2020
		FVNI			FVOCI
Dividend income		$	6,100		$	6,100
Unrealized gain ()			10,000
Transaction fees expense			(1,250)
Net income		$	14,850		$	6,100
Other Comprehensive Income:
Items that may be reclassified
subsequently to net income or loss:
Unrealized gain from FVOCI investments ()
					$	8,750
Total comprehensive income		$	14,850		$	14,850

At December 31, 2021 year-end, 50% of the Symec shares have been sold in January and the fair values are once again adjusted for both Symec and Hemiota investments at year-end.

Below is a partial balance sheet and income statement reporting the investment at December 31, 2021.

Lornelund Ltd.
Balance Sheet
December 31, 2021
Current assets:			FVNI			FVOCI
FVNI investments (at fair value)*		$	271,000
Long-term assets:
Long-term investment (at fair value)					$	271,000
Equity:
Retained earnings					$	7,050
Accumulated other comprehensive income/loss **						(14,500)

* FVNI (); FVOCI ()
** AOCI ()

Lornelund Ltd.
Income Statement and Comprehensive Income Statement (partial)
For the Year Ended December 31, 2021
		FVNI			FVOCI
Gain on sale of shares		$	350		$
Unrealized loss			(17,500)
Net income/(loss)		$	(16,150)
Other Comprehensive Income:
Items that may be reclassified
subsequently to net income or loss:
Unrealized gain/loss from FVOCI investments		$				(16,150)*
Total comprehensive income/(loss)		$	(16,150)		$	(16,150)

* ()

As can be seen from the illustrations above, there are significant differences in net income, due to the accounting treatments between FVNI and FVOCI investments. This could lead to earnings management, if care is not taken to ensure that these differences are considered solely for the purpose of managing net income to get higher bonuses, or fall under the radar regarding any restrictive covenants (for example, net income minimum thresholds set by creditors as performance targets). These differences also have to be taken into account when analyzing investment portfolio performance.

FVOCI (with recycling) – Investments in Debt

FVOCI investments for IFRS companies can also be debt, such as bonds. FVOCI shares (no recycling) reports dividends in net income and unrealized gains in OCI until sold, at which time the OCI corresponding to the shares sold are reclassified from OCI/AOCI to retained earnings. FVOCI debt (with recycling) reports interest in net income and unrealized gains in OCI until sold. As the "with recycling" name suggests, when the debt securities are sold, the corresponding OCI is recycled through net income.

Using the same example as for FVNI investments in bonds discussed earlier, where Osterline Ltd. purchased 7%, 5-year Waterland bonds with a face value of $500,000. On July 1, 2021, just after receiving the interest, Osterline sells the bonds at the market rate of 107. Osterline's journal entries from Jan 1, 2020 to July 1, 2021 classified as FVNI are repeated below and compared with debt investments classified as FVOCI.

Osterline Ltd.
COMPARISON OF FVNI TO FVOCI debt (with recycling)
		(FVNI)		(FVOCI)
2020
Jan 1	Investments – Waterland bonds	521,326		521,326
	Cash		521,326		521,326
Jul 1	Cash	17,500		17,500
	Investments – Waterland bonds		1,860		1,860
	Interest income		15,640		15,640
	For Cash: (), for Interest income: ()
Dec 31	Interest receivable	17,500		17,500
	Investments – Waterland bonds		1,916		1,916
	Interest income		15,584		15,584
	For Interest receivable: (), for Interest income: ()
Dec 31	Unrealized loss on FVNI investment (NI)	7,550
	Unrealized gain (loss) on investments (OCI)			7,550
	Investments – Waterland bonds		7,550		7,550
	For NI: ()
2021
Jan 1	Cash	17,500		17,500
	Interest receivable		17,500		17,500
Jul 1	Cash	17,500		17,500
	Investments – Waterland bonds		1,973		1,973
	Interest income		15,527		15,527
	For Cash: (), for Interest income: ()
Jul 1	Cash	535,000		535,000
	Gain on sale of Waterland bonds		26,973
	Gain on sale of Waterland bonds (OCI)				26,973
	Investments – Waterland bonds		508,027		508,027
	For Cash: (), for Investments: ()
Jul 1	OCI – removal of gain due to sale			19,473
	Gain from sale of investment (NI)				19,473
	()

Note the similarities in accounting treatment between the FVNI and FVOCI classifications for bonds. As was the case for the FVNI investment in shares, the investment is adjusted to fair value at the reporting date. The difference between the two methods is the account used for the fair value adjustment. For FVNI, the unrealized gain/loss is reported in net income, whereas for FVOCI, the unrealized gain/loss is reported as Other Comprehensive Income which is closed at each year-end to the AOCI account (an equity account), until the investment is sold. Once sold, any unrealized gains/losses that relate to the sale of this investment are now realized and are transferred from OCI to net income. This is referred to as "with recycling" (through net income). Recall that FVOCI in equities do not recycle through net income. It is for this reason that FVOCI investments in debt with recycling must be evaluated for impairment which is discussed next.

Also note the order of the entries upon sale. The July 1 sales is comprised of two entries above. The first entry is a combined entry that records the cash proceeds, removal of the investment sold and any realized gain/loss through OCI. This is the same as the method used for FVOCI equities. The second entry is a transfer of the OCI related to the sale from OCI to net income. For FVOCI equities this entry is a reclassification from OCI to retained earnings. This is an important distinction regarding the accounting treatment for the FVOCI investments.

Because the entire investment was sold, the net income differed in the first and second year between FVNI and FVOCI with recycling, but over two years, the net income was the same for both. If only part of the investment been sold, the differences would be similar to the example regarding FVOCI equities, with regard to balances in the OCI/AOCI account compared to FVNI where all the gains/losses are reported through net income.

Impairment of Investments – FVOCI with recycling (Debt)

For FVOCI in debt investments, an evaluation is done starting at its acquisition date. Under IFRS 9, impairment evaluation and measurement is based on expected losses, and must now reflect the basic principles below:

• An unbiased evaluation over a range of probability-based possible outcomes
• Estimated revised cash flows are discounted to reflect time value of money
• The evaluation and measurements are based on data from past, current and estimated future economic conditions, using reasonable and supportable information without undue cost or effort at the reporting date

The last point suggests that a company does not need to identify every possible scenario when risks are low, and companies are encouraged to use modelling techniques to simplify evaluations and impairment measurements of large low-risk portfolios.

Essentially how it works is that for each investment at acquisition, various potential default scenarios (where the debt owing is not paid when due) are identified. Expected future cash flows are estimated for each scenario, which is multiplied by its probability of occurring. These probability-based cash flows are summed, and the total is deemed as the expected credit loss (ECL) for that investment. This is a separate evaluation and measurement of impairment losses than fluctuations in the market.

These estimated cash flows can either be based on scenarios and probabilities of default over the investment's next 12 months (12-month ECL) from acquisition, if risk of default is low, or over the investment's lifetime (Lifetime ECL), if risk of default is higher. IFRS 9 identifies three approaches for receivables and investments:

• Credit adjusted approach – for investments that are impaired at acquisition, such as deeply discounted investments from high risk investee companies. This approach will apply only rarely. Evidence of high risk could be due to significant financial difficulties or potential bankruptcy, a history of defaults, a history of concessions granted by creditors on previous debt, or economic downturns in the investee company's industry sector. This approach uses the cumulative change in Lifetime ECL.
• Simplified approach – this approach is intended specifically for trade receivables, IFRS 15 contract assets and lease receivables where the financial instrument does not contain a significant interest component. It is based on Lifetime ECL
• General approach – this approach applies to all other financial instruments not covered in the first two approaches. It is based on a 12-month ECL unless the credit risk increases significantly.

If the credit risk is high at the investment's acquisition, the credit adjusted approach with Lifetime ECL will apply, otherwise the general approach would be used with the shorter 12-month ECL. The end-result is that every investment will have an ECL amount associated with it. These risk-based cash flows are discounted using the historic interest rate at acquisition, and compared to the carrying value of the debt investment at the evaluation date. The carrying value of the investment (or an asset valuation account) is reduced by the loss amount and recorded to net income. Below is a schedule that illustrates a simple ECL calculation:

Investment in Bonds – Emil Ltd. Investee
Expected Credit Loss Calculation
	Scenario 1			Scenario 2			Scenario 3			Total
Estimated future cash flows at
acquisition assuming no risk of
default, discounted @ effective
interest rate	$	500,000		$	500,000		$	500,000
Future cash flows if default
occurs, discounted @ historic
effective rate at acquisition		450,000			400,000			350,000
Cash flow shortage		50,000			100,000			150,000
Probability of default		2.0%			1.5%			0.5%
Expected Credit Loss (ECL)	$	1,000		$	1,500		$	1,750		$	4,250

Management can include as many default scenarios as is appropriate. In this case, there are three scenarios where management has identified potential defaults for this investment. If at the first reporting date after acquisition the fair value of the investment is $480,000, the entry to record the fair value change would be:

The unrealized loss of $15,750 is to adjust for changes in the market fluctuations that is not due to an impairment, so it is recorded to OCI. The loss on impairment resulting from the ECL calculation must be reported through net income. Compared to the previous accounting standard (IAS 39), this results in an earlier recognition of an impairment loss because it is recorded at the first reporting period after the investment acquisition. This clearly could create more volatility in the income statement.

After the initial recognition, the ECL is adjusted up or down, through net income at each reporting date as the probabilities of default change. Once the investment is collected, the ECL will be reduced to zero and impairment recoveries will be reported through net income. If default risk increases due to adverse changes in business conditions, not only will the estimated cash flow shortages and probabilities increase, the increased credit risk could result in a change from the simpler 12-month ECL to the Lifetime ECL if risk becomes too high. If a default does occur, the ECL amount will equal the actual cash flow shortage. In IFRS 9, there is a presumption that credit/default risk significantly increases if contractual payments from the investee are more than 30 days past due.

To summarize, assessing credit risk is only required for amortized cost and FVOCI debt (with recycling). FVNI and FVOCI equities do not need to be evaluated for impairment because they are always remeasured to fair value each reporting date. Evaluating and measuring impairments requires considerable judgement and companies are encouraged to establish an accounting policy regarding factors to consider when determining if increases in credit risk (ECL) is to be deemed as significant or not.