F5 Investments, Statement of Cash Flows & Income Taxes

financial assets

cash, evidence of an ownership interest in an entity, a contract that conveys the right to receive cash or another financial instrument or exchange other financial instruments on potentially favorable terms

financial liability

contract that imposes on one entity an obligation to deliver cash or exchange other financial

fair value option

on certain election dates, companies can choose to measure instruments at FV that aren’t typically measured that way

under fair value, gains and losses are reported

in earnings

FV option is

irrevocable and applies to individual financial instruments in their entirety (not applied to specific risks)

eligible to be reported at FV

AFS debt securities, Not elEquity investment with significant influence (would typically use equity method)

not eligible for the fair value option

• consolidated investments

• pension benefit assets or liabilities

• leases

Fair Value changes attributable to instrument-specific credit risk

• For a financial liability designated under FVO (other than derivative liability), the change in FV attributable to instrument specific credit risk (your credit rating) is recognized in OCI (AKA direct to equity)

• Derivative liabilities recognize these changes in NI (NI→RE→E)

debt securities

financial instruments that represent a loan made by an investor to a borrower

lender debt securities

are assets

examples of debt securities

corporate bonds, redeemable PS, government securities, convertible debt,

commercial paper

classifications of debt securities

• trading security

• Available for sale

• Held to maturity

trading secuirty

bought to sell in the near term (can be debt or equity)

trading security valuation

fair value through profit/loss, unrealized gain/loss reported on income statement

trading security - cash flow

operating

available for sale

not trading securities or held to maturity

available for sale - valuation

fair value through OCI (initially recorded at FV on BS, unrealized g/l reported in OCI, when g/l is realized, remove from OCI and recognize on IS, interest income or dividends recorded on IS) UNLESS elected FV option

available for sale cash flow

investing

held to maturity

intent and ability to hold

held to maturity - valuation

fair value through OCI (initially recorded at FV on BS, unrealized g/l reported in OCI, when g/l is realized, remove from OCI and recognize on IS, interest income or dividends recorded on IS) UNLESS elected FV option

held to maturity - cash flow

Investing

disclosures on available for sale and held to maturity

• Aggregate FV

• Gross unrealized holding g/l

• Amortized cost basis by major security type

• Info about maturity date

trading security JE record loss in Net Income

Dr Unrealized loss on trading security

Cr Valuation account

Available for sale JE to record unrealized loss in OCI

Dr Unrealized loss in available for sale securities

Cr Valuation account

all realized gain/losses report to

Net Income

securities are recognized when

debt security sold or AFS impaired

purchase or sale of current asset

operating cash flow

purchase or sale of non-current asset

investing cash flow

reclassification

• Can only occur when justified

• Transfer from HTM

  • Only when there is change in intent that does not call into question other securities

• Transfer to and from trading → RARE

• Any transfer accounted for at FV

JE to record interest income in debt securities

Dr cash Cr interest Income

Impairment of Debt Securities

• Write down debt investment

• Record the loss

• Expected credit loss - estimate of potential loss that lender may face is borrow fails to repay loan

• CECL - current expected credit losses model states that AFS and HTM reported at net amount expected to be collected

current expected credit loss formula

= PVFCF - amortized cost

HTM Impairment

expected credit loss recognized on IS, write down the asset

JE HTM Impairment

Dr Credit Loss Cr Allowance for credit losses

AFS Impairment

• expected credit loss recognized on IS, any excess goes to OCI

• Investor has option to sell AFS security if the loss on sale will be less than the expected credit loss

  • Therefore, credit loss on AFS is limited to amortized cost minus fair value

  • Any additional loss goes to OCI

Sale of trading securities

realized gain/loss = adjusted cost (original cost ± unrealized gain/losses) - selling price

JE Sale for trading securities

Dr Cash

Cr Trading security

Cr Gain/Loss

Sale of AFS securities

any unrealized gain/loss in AOCI must reversed at the time of sale

realized gain/loss = original cost - selling price

JE Sale of AFS

Dr Cash

Dr unrealized gain

Cr AFS security

Cr Gain/Loss

equity security

represent an ownership interest in a company (common stock, preferred estock, convertible securities, warrants and options)

equity securities does not include

Redeemable preferred stock, treasury stock, convertible bonds

common stock own < 20%

No significant influence, trading security (fair value through net income)

common equity 20%-50%

significant influence (equity method)

common stock own >50%

acquisition method (consolidate)

equity securities disclosures

Disclose portion of unrealized g/l for period on ES held at end of period

unrealizes gain/loss still held formula

= net g/l during period - net g/g sold during period

Fair value

• All entities must disclose on BS or in notes

  • All financial assets grouped by measurement category (FVTNI, OCI, or amortized cost)

  • Provide level in measurement hierarchy

  • If measured at amortized cost, disclose FV at exit price

equity securities reported at fair value through net income

• Practicability exception for privately held - allows entity to measure investments at cost - impairment +/- observable price changes of identical/similar investments from same issuer

• Applicable for equity investments that do not have readily available determinable FV (private)

JE to record loss in net income equity security valuation

Dr Unrealized loss on ES

Cr Valuation account

dividend income recognized in net income unless

• liquidating dividend

• stock dividend

• commin equity accounted for using equity method

JE record normal dividend income

Dr Cash

Cr Dividend income

liquidating dividend

distribution that exceeds investors' share of investees RE. Return of capital that reduces investors' basis in investment

JE to record liquidating dividend

Dr Cash

Cr Investment in investee

formula for current expected credit losses

= present value of future cash flows - amortized cost

based on rule of conservatism, where is impairment loss recorded

on the income statement

factors when determining impairment

• Going concern issues.

• Violating debt covenants.

• Deficiencies in working capital.

• Negative Operating Cash Flow (OCF).

• Adverse changes in the industry.

• Decline in earnings/growth or credit rating.

realized gain/loss when selling a secuirty

= selling price - carrying value

JE with no gain or loss on sale of security

Dr Cash

Cr Equity secuirity

JE for sale of equity security with a gain

Dr Cash

Cr Equity Security

Cr Gain

If an equity security is recorded with a valuation account, how does the credit entry change during a sale?

You credit the Equity Security at cost and credit the Valuation Account, rather than using a single carrying value line.

under the equity method, how are dividends treated

as a return of capital and reduce the investment account balance.

Situations where the equity method is NOT appropriate, even with 20%-50% ownership

• Bankruptcy of the subsidiary.

• The investment is temporary.

• A "standstill" agreement is in place.

• Another small group has significant influence instead.

• You cannot obtain necessary financial information

initial investment formula

= cash paid + debt issued + FMV of stock issued + lawyer fees

investment account adjusted over time

Increase by the investor's share of the investee’s income.

Decrease by the investor's share of the investee’s dividends.

can the investment account balance be negative?

No, it cannot be negative, it is brought down to zero

income available to common shareholder formula

= net income - preferred dividends

equity earnings formula

= income available to common shareholder * ownership %

JE to record investment at cost

Dr Investment in investee

Cr Cash

JE to record increase in investment investors' share of earnings

Dr investment in investee

Cr Equity in earnings/investee income

JE to record decrease in investment by investors share of dividends

Dr Cash

Cr investment in investee

What causes the need for "additional adjustments" when using the equity method?

The difference between the Purchase Price paid and the Net Book Value (NBV) of the investee’s assets.

how is the "identifiable excess" (Fair Value > Book Value) of an asset handled?

amortized over the life of the asset

JE to account for asset fair value difference

Dr equity in investee income

Cr Investment in investee income

how is goodwill treated differently

Goodwill is not amortized and is not individually subject to an impairment test.

under the equity methid, how is impairment tested regarding goodwill

you don't test goodwill alone; instead, the entire investment (including the goodwill portion) is analyzed for impairment annually.

equity method impairment

• Recognize impairment if FV less than CV and decline is not temporary

• If both true, report impairment loss on IS and CV of investments reduced on BS

• Can’t reverse

if transitioning to the equity method, on date of change

• Add incremental cost of acquiring additional interest to CV of investment

• Adopt EM going forward

• No retroactive adjustment

• Any goodwill created in an investment under equity method is ignored. Do not amortize or impair. The entire investment is subject to impairment test under equity method

voting interest model

It determines if consolidated financial statements must be prepared once a parent-subsidiary relationship (control over 50%) is formed.

When consolidating, what percentage of the subsidiary's assets, liabilities, and expenses does the parent report?

100%, even if the parent owns less than 100% of the subsidiary

If a subsidiary is acquired during the year, how much of its income is reported in the consolidated statements?

Only the income earned for the portion of the year after the acquisition date

noncontrolling interest

The portion of a subsidiary's equity/assets that is not owned by the parent company

Where and at what value is Noncontrolling Interest (NCI) reported on the Balance Sheet?

in the equity section, reported at fair value

pushdown accounting

• Elective, entity-level choice that allows the acquired company report FS using stepped-up basis associated with acquirer’s purchase price allocation

• Subsidiary remeasures all identifiable A+L to same acquisition date FV recognized by new parent

• Any resulting goodwill is recorded directly on sub’s books (goodwill = purch price > FV assets)

  • If purch price is less than FV of assets, record as APIC

In the Acquisition Method, at what value are 100% of the acquired net assets reported?

fair value

CAR - CAR IN BIG

Common Stock, APIC, and Retained Earnings of the subsidiary. These are eliminated (debited) during consolidation.

IN - CAR IN BIG

I: Investment in subsidiary is eliminated (credited).

N: Noncontrolling Interest is created/recorded (credited) at Fair Value.

BIG - CAR IN BIG

B: Balance Sheet adjustments to Fair Value.

I: Identifiable intangible assets recorded at Fair Value.

G: Goodwill (or Gain).

Goodwill calculated in a consolidation

It is the excess of the Fair Value of the sub (Acquisition Price + NCI) over the Fair Value of the net assets acquired. It acts as the "plug" (debit) in the entry.

What happens if the acquisition price is less than the Fair Value of the net assets acquired?

A Gain is recorded (credited) because the company got a "bargain purchase."

At what percentage are the subsidiary's Balance Sheet accounts adjusted to Fair Value?

100%, even if the parent owns less than 100% of the subsidiary.

Elimination Journal Entry

Dr CS - Sub

Dr APIC - Sub

Dr RE - sub

Cr Investment in sub

Cr Noncontrolling interest

Dr Balance sheet adjustemnts to FV

Dr identifiable intangible assets to FV

Dr Goodwill (plug)

Why must 100% of intercompany transactions be eliminated during consolidation?

a company cannot report a profit by "selling" to itself.

What are common types of Intercompany Transactions that need to be eliminated?

• Payables and receivables.

• Bond interest income and expense.

• Sale of PP&E.

• Sale of inventory.

three elements to reversing intercompany transactions

1. Reverse intercompany sales and intercompany COGS.

2. Account for profit on the sale (correct COGS or write down Ending Inventory).

3. Eliminate intercompany profit from prior periods (Beginning Inventory) from Retained Earnings (RE).

If intercompany inventory was sold to a third party, how is the internal profit corrected?

reducing COGS

If intercompany inventory is still on hand, how is the internal profit corrected?

writing down ending inventory to its orgiinal cost

JE for eliminating Intercompany Inventory transactions

Debit: Intercompany Sales

Debit: Retained Earnings (for profit in Beginning Inventory)

Credit: Intercompany COGS

Credit: COGS (to reduce COGS sold to 3rd party)

Credit: Ending Inventory (to write down to cost)

intercompany bonds

• if a company acquires affiliated companies bonds, bond is considered retired and g/l is recognized on consolidated IS

• Not initially recorded on either companies books, but recorded in EJE on consolidation