Investing activities are a crucial component of a company's financial strategy. These activities involve the acquisition and disposal of long-term assets and investments, such as property, equipment, and securities. Understanding cash flows from investing activities helps stakeholders gauge a company's growth potential and long-term value creation.
Accounting for investments in securities is a key aspect of investing activities. This involves classifying securities as debt or equity, determining their purpose as trading or available-for-sale, and valuing them appropriately. Proper accounting ensures accurate reporting of gains, losses, and fair value changes, providing insight into a company's investment performance and risk management.
Cash flows from investing activities
Investing activities are one of the three main categories of cash flows in the statement of cash flows, along with operating and financing activities
Cash flows from investing activities relate to the acquisition and disposal of long-term assets and investments, such as property, plant, and equipment, intangible assets, and investments in securities or other companies
Analyzing cash flows from investing activities helps users of financial statements understand how a company is investing in its future growth and generating long-term value
Accounting for investments in securities
Investments in securities are financial assets that a company holds for various purposes, such as generating income, realizing capital gains, or maintaining liquidity
Accounting for investments in securities involves classifying them based on their nature and intended use, measuring them at fair value or amortized cost, and recognizing gains and losses in the financial statements
Debt vs equity securities
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are investments in bonds, notes, or other debt instruments issued by governments or corporations, which provide a contractual right to receive cash flows in the form of interest and principal repayments
Equity securities are investments in shares of stock issued by other companies, which represent an ownership interest and a right to participate in the company's profits and assets
The classification of securities as debt or equity affects their accounting treatment, such as the recognition of interest income or dividend income and the measurement of fair value changes
Trading vs available-for-sale securities
are investments that a company holds primarily for the purpose of selling them in the near term to generate profits from short-term price fluctuations
are investments that a company does not intend to hold until maturity or trade actively, but may sell in response to changes in market conditions or liquidity needs
Trading securities are measured at fair value with unrealized gains and losses recognized in net income, while available-for-sale securities are measured at fair value with unrealized gains and losses recognized in other comprehensive income
Valuation of securities
The valuation of securities involves determining their fair value, which is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date
For actively traded securities, fair value is based on quoted market prices in active markets for identical assets or liabilities (Level 1 inputs)
For securities that are not actively traded, fair value may be estimated using valuation techniques such as discounted cash flow analysis or comparable company analysis (Level 2 or Level 3 inputs)
Gains and losses on securities
arise from changes in their fair value or from their sale or disposal
Realized gains and losses occur when securities are sold or otherwise disposed of, and are calculated as the difference between the proceeds received and the carrying amount of the securities
Unrealized gains and losses occur when the fair value of securities changes, but they have not yet been sold or disposed of
The recognition of gains and losses depends on the classification of the securities as trading, available-for-sale, or held-to-maturity
Accounting for investments in associates
Investments in associates are in companies over which the investor has significant influence, but not control or joint control
Significant influence is presumed to exist when the investor holds 20% to 50% of the voting rights of the investee, but it can also be demonstrated through other means such as representation on the board of directors or participation in policy-making processes
Equity method of accounting
The is used for investments in associates, whereby the investor initially records the investment at cost and subsequently adjusts the carrying amount for its share of the investee's post-acquisition profits or losses and other changes in equity
Under the equity method, the investor recognizes its share of the investee's net income or loss in its own income statement, and its share of the investee's other comprehensive income in its own other comprehensive income
The investor also adjusts the carrying amount of the investment for dividends received from the investee, as they represent a return of the investment rather than income
Adjustments for intercompany transactions
When the investor and the investee engage in transactions with each other, such as the sale of goods or services, the profits or losses arising from these transactions need to be eliminated to the extent of the investor's interest in the investee
The elimination of intercompany profits or losses ensures that the investor's financial statements reflect only its share of the investee's profits or losses from transactions with third parties
The adjustments for intercompany transactions are made to the carrying amount of the investment and to the investor's share of the investee's net income or loss
Impairment of investments in associates
Investments in associates are subject to impairment testing when there are indications that the carrying amount may not be recoverable, such as significant financial difficulty of the investee, adverse changes in the business environment, or a decline in the market value of the investment
Impairment testing involves comparing the carrying amount of the investment to its recoverable amount, which is the higher of its fair value less costs to sell and its value in use (the present value of its expected future cash flows)
If the recoverable amount is less than the carrying amount, an is recognized in the investor's income statement, and the carrying amount of the investment is reduced to the recoverable amount
Accounting for business combinations
Business combinations are transactions or events in which an acquirer obtains control of one or more businesses, such as through a merger, acquisition, or consolidation
Accounting for business combinations involves identifying the acquirer, determining the acquisition date, measuring the consideration transferred, and recognizing and measuring the identifiable assets acquired, liabilities assumed, and any non-controlling interest in the acquiree
Acquisition method of accounting
The acquisition method of accounting is used for all business combinations, whereby the acquirer measures the identifiable assets acquired and liabilities assumed at their acquisition-date fair values, with limited exceptions
The acquirer recognizes goodwill as the excess of the consideration transferred plus any non-controlling interest in the acquiree over the net of the acquisition-date amounts of the identifiable assets acquired and liabilities assumed
If the net of the acquisition-date amounts of the identifiable assets acquired and liabilities assumed exceeds the consideration transferred plus any non-controlling interest in the acquiree, the acquirer recognizes a bargain purchase gain in net income
Goodwill vs bargain purchase
Goodwill is an intangible asset that represents the future economic benefits arising from the business combination that are not individually identified and separately recognized
Goodwill is not amortized but is tested for impairment at least annually or more frequently if events or changes in circumstances indicate that it might be impaired
A bargain purchase occurs when the net of the acquisition-date amounts of the identifiable assets acquired and liabilities assumed exceeds the consideration transferred plus any non-controlling interest in the acquiree
A bargain purchase gain is recognized immediately in the acquirer's net income and is not subsequently remeasured or amortized
Contingent consideration in acquisitions
Contingent consideration is an obligation of the acquirer to transfer additional assets or equity interests to the former owners of the acquiree if specified future events occur or conditions are met
Contingent consideration is measured at its acquisition-date fair value and is classified as a liability or equity based on its nature
Subsequent changes in the fair value of contingent consideration classified as a liability are recognized in net income, while changes in the fair value of contingent consideration classified as equity are not recognized
Acquisition-related costs
Acquisition-related costs are costs the acquirer incurs to effect a business combination, such as finder's fees, legal fees, due diligence costs, and other professional or consulting fees
Acquisition-related costs are expensed as incurred and are not included in the consideration transferred or the identifiable assets acquired and liabilities assumed
Debt or equity issuance costs are recognized as a reduction of the proceeds from the debt or equity issued and are not acquisition-related costs
Accounting for property, plant and equipment
Property, plant and equipment (PP&E) are tangible assets that are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes, and are expected to be used during more than one period
Accounting for PP&E involves initial recognition and measurement, subsequent measurement and depreciation, impairment testing, and derecognition and disposal
Initial recognition and measurement
PP&E are initially recognized at cost, which includes the purchase price, any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management, and the initial estimate of the costs of dismantling and removing the asset and restoring the site on which it is located
Directly attributable costs may include costs of employee benefits, site preparation, delivery and handling, installation and assembly, and testing of functionality
Borrowing costs that are directly attributable to the acquisition, construction, or production of a qualifying asset are capitalized as part of the cost of that asset
Depreciation methods and useful lives
Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life, which is the period over which an asset is expected to be available for use by an entity
The depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual value, which is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life
The depreciation method used should reflect the pattern in which the asset's future economic benefits are expected to be consumed by the entity, and may include the straight-line method, the diminishing balance method, and the units of production method
Impairment of long-lived assets
Long-lived assets, such as PP&E and intangible assets, are tested for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable, such as a significant decline in market value, adverse changes in the business environment, or physical damage or obsolescence of the asset
Impairment testing involves comparing the carrying amount of the asset to its recoverable amount, which is the higher of its fair value less costs of disposal and its value in use (the present value of its expected future cash flows)
If the recoverable amount is less than the carrying amount, an impairment loss is recognized in net income, and the carrying amount of the asset is reduced to the recoverable amount
Derecognition and disposal of assets
PP&E are derecognized upon disposal or when no future economic benefits are expected from their use or disposal
The gain or loss arising from the derecognition of an item of PP&E is included in net income when the item is derecognized, and is determined as the difference between the net disposal proceeds, if any, and the carrying amount of the item
If an entity rents out part of a property it owns and occupies another part, the portions are accounted for separately if they could be sold separately; otherwise, the property is PP&E only if an insignificant portion is held for rental to others
Accounting for intangible assets
Intangible assets are identifiable non-monetary assets without physical substance, such as patents, trademarks, copyrights, customer lists, and computer software
Accounting for intangible assets involves initial recognition and measurement, subsequent measurement and amortization, and impairment testing
Identifiable vs unidentifiable intangible assets
An intangible asset is identifiable if it is separable (capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged) or arises from contractual or other legal rights
Identifiable intangible assets are recognized separately from goodwill, which is an unidentifiable intangible asset that represents the future economic benefits arising from a business combination that are not individually identified and separately recognized
Internally generated intangible assets, such as research and development costs, are recognized only if they meet specific criteria, such as technical feasibility, intention and ability to complete and use or sell the asset, and probable future economic benefits
Amortization of intangible assets
Amortization is the systematic allocation of the depreciable amount of an intangible asset over its useful life, which is the period over which the asset is expected to contribute directly or indirectly to the future cash flows of the entity
The depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual value, which is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life
Intangible assets with finite useful lives are amortized on a systematic basis over their useful lives, while intangible assets with indefinite useful lives are not amortized but are tested for impairment at least annually
Impairment testing for intangible assets
Intangible assets with finite useful lives are tested for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable, such as a significant decline in market value, adverse changes in the business environment, or technological obsolescence
Intangible assets with indefinite useful lives and intangible assets not yet available for use are tested for impairment at least annually, and whenever there is an indication that the asset may be impaired
Impairment testing involves comparing the carrying amount of the asset to its recoverable amount, which is the higher of its fair value less costs of disposal and its value in use (the present value of its expected future cash flows)
If the recoverable amount is less than the carrying amount, an impairment loss is recognized in net income, and the carrying amount of the asset is reduced to the recoverable amount
Accounting for investment property
is property (land or a building, or part of a building, or both) held to earn rentals or for or both, rather than for use in the production or supply of goods or services or for administrative purposes, or for sale in the ordinary course of business
Accounting for investment property involves initial recognition and measurement, subsequent measurement using the or the , and transfers to and from investment property
Initial recognition and measurement
Investment property is initially recognized at cost, which includes the purchase price and any directly attributable expenditure, such as professional fees for legal services, property transfer taxes, and other transaction costs
If payment is deferred beyond normal credit terms, the cost is the present value of all future payments
If an investment property is acquired through a non-exchange transaction (such as a donation), its cost is measured at its fair value as at the date of acquisition
Fair value vs cost model
After initial recognition, an entity may choose as its accounting policy either the fair value model or the cost model for all of its investment property
Under the fair value model, investment property is measured at fair value, with changes in fair value recognized in profit or loss for the period in which they arise
Under the cost model, investment property is measured at cost less accumulated depreciation and accumulated impairment losses, with fair value disclosed in the notes to the financial statements
The chosen policy must be applied to all investment property and cannot be changed unless the change will result in a more appropriate presentation
Transfers to and from investment property
Transfers to or from investment property are made only when there is a change in use, evidenced by end of owner-occupation (for a transfer from owner-occupied property to investment property), commencement of owner-occupation (for a transfer from investment property to owner-occupied property), or commencement or end of development with a view to sale (for a transfer from investment property to inventories or vice versa)
For a transfer from investment property carried at fair value to owner-occupied property or inventories, the property's deemed cost for subsequent accounting is its fair value at the date of change in use
For a transfer from owner-occupied property to investment property carried at fair value, the property is accounted for as property, plant and equipment up to the date of change in use, and any difference at that date between the carrying amount and the fair value is treated as a revaluation surplus or deficit
For a transfer from inventories to investment property carried at fair value, any difference between the fair value at the date of transfer and the previous carrying amount is recognized in profit or loss
Disclosures for investing activities
Entities are required to disclose information that enables users of their financial statements to evaluate the nature and extent of their investing activities and the related cash flows
Disclosures for investing activities include a reconciliation of cash flows from investing activities, significant non-cash investing transactions, and restrictions on investments and assets
Reconciliation of cash flows from investing activities
Entities should provide a reconciliation of the amounts of cash flows from investing activities reported in the statement of cash flows to the related items in the statement of financial position
The reconciliation should separately disclose the cash receipts and payments for each major class of investing activities, such as purchases and sales of property, plant and equipment, investments in securities, and investments in associates and joint ventures
The reconciliation should also explain the reasons for any significant differences between the cash flows and the related changes in the statement of financial position
Significant non-cash investing transactions
Entities should disclose significant non-cash investing transactions that are not included in the statement of cash flows, such as the acquisition of assets by assuming directly related liabilities or by means of a lease, and the conversion of debt to equity
Non-cash investing transactions are excluded from the statement of cash flows because they do not require the use of cash or cash equivalents, but they are relevant to understanding an entity's investing activities and its ability to generate future cash flows
Disclosures of non-cash investing transactions may include a description of the nature and amount of the transactions, and their effect on the entity's financial position and performance
Restrictions on investments and assets
Entities should disclose the existence and amounts of restrictions on the realizability of investments or on the remittance of income and proceeds of disposal
Restrictions on investments may arise from legal or contractual arrangements, such as pledges of assets as collateral for liabilities, or from the terms of the investments themselves,