8.2.3: Amortized Cost Investments (AC)

For ASPE companies, either debt or equities that are not traded in an active market are reported at amortized cost or cost respectively. Unlike investments acquired for short-term profit such as FVNI investments, shares or bonds may be purchased as AC investments for other reasons, such as to strengthen relationships with a supplier or an important customer.

For IFRS companies, if the investment business model is to acquire investments to collect the contractual cash flows of principal and interest, and there is no intention to sell, investments in debt securities such as bonds are reported at their amortized cost at each balance sheet date. Management intent is to hold these investments until maturity, so debt instruments are included in this category. Equity investments have no set maturity dates, therefore they are not classified as an AC investment. Even if equities such as shares are not part of a quoted market system, IFRS states that fair values are still normally determinable, making FVOCI equities (without recycling) the more appropriate classification for unquoted equities.

Transactions costs are added to the investment (asset) account. AC investments are reported as long-term assets unless they are expected to mature within twelve months of the balance sheet date or the normal operating cycle.

To summarize the initial and subsequent measurements used for AC investments:

• Initial purchase is at cost (purchase price) which is also fair value on the purchase date. Unlike FVNI investments, transaction fees are added to the investment (asset) account. This is because AC investments are cost-based investments, so any fees paid to acquire the asset are to be capitalized like property, plant, and equipment, which are also cost-based purchases.

• Bond interest and share dividends declared are reported in net income as realized. Any premium or discount is amortized to the investment asset using the effective interest rate method (IFRS). For ASPE companies, they can choose between the effective interest rate method and the straight-line method.

• If the investment is impaired, determine the impairment amount. For ASPE the impairment amount is the higher of: a) the present value of impaired future cash flows at the current market interest rate, and b) net realizable value through sale (or sale of collateral). ASPE allows for reversals of impairment. For IFRS, refer to the Impairment section above in the FVOCI debt (with recycling).

• Report the investment at its carrying value at each reporting date, net of any impairment. As asset valuation account can be used instead of recording the impairment loss directly to the investment account.

• When the investment is sold, remove the related accounts from the books. For debt instruments, ensure that any interest, amortization or possible impairment recovery is updated before calculating the gain/loss on sale prior to its removal from the books. The difference between the carrying value and the net sales proceeds is reported as a gain/loss on sale (including full or partial recovery of a previous impairment, if applicable) and reported in net income.

AC Investments in Debt 

In the previous sections discussing FVNI and FVOCI investments, Osterline purchased Waterland bonds on the January 1, 2020, the interest payment date. Assume now that Osterline classified this as an AC investment. The entries would be the same as illustrated earlier for the FVNI category, except to exclude any fair value adjustments.

Note that the entry to the investment account for the sale of Waterland bonds for the FVNI or FVOCI methods shown earlier is $508,027 compared to AC method above for $515,577. The reason for this difference is due to the fair value adjustment for $7,550 for the FVNI and FVOCI methods (both fair-value based) but not done for AC method which is based on amortized cost.

 

 

AC Investments in Bonds – Between Interest Dates 

 

What if the debt investment is purchased in between interest payment dates? Below is an example of the accounting treatment for an AC investment in bonds that is purchased between interest payment dates.

On March 1, 2020, Trimliner Co. purchases 6%, 5-year bonds of Zimmermann Inc. with a face value of $700,000. Interest is payable on January 1 and July 1. The market rate for a bond with similar characteristics and risks is 6.48%. The bond is purchased for $685,843 cash. Stated another way, the bond is purchased at 98 () on March 1, 2020. On December 31, 2020 year-end, the fair value of the bond at year-end is $710,000. Trimliner follows IFRS and intends to hold the investment to collect the contractual cash flows of principal and interest and to hold until maturity (AC classification).

Note that the purchase date of March 1 falls in between interest payments on January 1 and July 1. The business practice regarding bond interest payments is for the bond issuer to pay the full six months interest to the bond holder throughout the life of the bond. This creates a much simpler bond interest payment process for the bond issuer, but it creates an issue for the purchaser since they are only entitled to the interest from the purchase date to the next interest date, or four months in this case, as illustrated below.

This issue is easily resolved. The purchaser includes in the cash paid any interest that has accrued between the last interest payment date on January 1 and the purchase date on March 1, or two months. In other words, the purchaser adds to the cash payment any interest that they are not entitled to receive. Later, when they receive the full six months of interest on July 1 for $21,000, the net amount received will be for the four-month period that was earned, which was from the purchase date on March 1 to the next interest payment on July 1 as shown above.

In this example, the purchase price of $685,843 is lower than the face value of $700,000, so the bonds are purchased at a discount.

The entry to record the investment for Trimliner, including the interest adjustment on March 1, 2020 and the first interest payment on July 1, 2020, is shown below. Note that the discount is also amortized from the date of the purchase of bonds to the end of the interest period.

The net interest income recorded by Trimliner is $14,814 on July 1 (), which represents the four months interest earned from the March 1 purchase date to the first interest payment date on July 1. The interest receivable is now eliminated.

Note that for AC bonds, there are no entries to adjust the AC investment to fair value at year-end. The fair value information of $710,000 on December 31, 2020, that was provided in the question data is not relevant for AC investments.

When the bonds mature at the end of five years, the entry to record the proceeds of the sale is shown below.

As previously stated, ASPE companies can choose to use either the effective interest or the straight-line method to amortize premiums or discounts. If straight-line method is used, the discount for $14,157 () will be amortized over five years. The amortization amount for the July 1 entry would be for four months or $944 (). After that, the amortization will be for every six months or $1,416 ().

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AC Impairment 

 

For IFRS companies, the process to evaluate and measure impairments was already discussed in FVOCI debt (with recycling). The accounting treatment for impairments (IFRS) is the same for both FVOCI debt with recycling and AC.

This section will now discuss impairment for ASPE companies with AC investments.

Since AC investments are measured at amortized cost for bonds and cost for shares, there is always the possibility of an impairment loss since fair values are not used. For this reason, investments should be assessed at the end of each reporting period to see if there has been a loss event. Investment assets should be evaluated on both an individual investment and portfolio (grouped) investment basis to minimize any possibilities of hidden impairments within a portfolio of investments with similar risks. Below are details regarding how impairments for AC investments are measured:

ASPE—reduce the investment carrying value to the higher of:

• the present value of impaired future cash flows using the current market interest rate and

• the net realizable value either through sale or by exercising the entity's rights to sell any collateral.

The loss is reported in net income and the investment (or an asset valuation allowance) is reduced accordingly. These impairments may be reversed.

For example, assume that Vairon Ltd. purchased an investment in Forsythe Ltd. bonds for $200,000 at par value on January 1 and intends to hold them until maturity. The bonds pay interest on December 31 of each year. At year-end, Forsythe experiences cash flow problems that are considered by the investor as a loss event that triggers an impairment evaluation. The following cash flows are identified:

 

 

Changes in Classifications 

 

Changes in management's intention to sell or hold to maturity can result in a change in classification. However, earlier in this chapter some significant impacts in net income and investment asset values were illustrated between FVNI, FVOCI, and AC methods. It is easy to see how this might lead to manipulation of net income or asset values by management. To minimize this possibility, for ASPE, no reclassification is permitted unless there's a change in the company's business model, which happens very rarely. For IFRS, there is the fair value option discussed earlier for FVOCI equities, which is irrevocable.