AFA 400 Mid Term Exam

Type of Investments

Two main types of investments1. Debt instruments

When a company invests in a debt instrument, it is basically lending money to another company.

The investor becomes a creditor.

Examples of debt instruments:

• Bonds

• Notes receivable

• Loans

• Treasury bills

Simple meaning:
The company gives money now and expects to receive the money back later, usually with interest.

Example:
Company A buys Company B’s bond for $50,000.
Company A is lending money to Company B, so Company A is a creditor.

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2. Equity instruments

Equity instruments usually represent ownership in another company.

Examples:

• Common shares

• Preferred shares

Simple meaning:
The company buys shares and becomes a part-owner of the other company.

Example:
Company A buys shares of Company B.
Company A now owns part of Company B and may receive dividends.

Debt Instruments

ebt Instruments — Simple Explanation

A debt instrument is an investment where one company is basically lending money to another company or government.

The investor pays money upfront and gets the right to receive:

1. Interest payments

2. Repayment of the principal amount

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Examples of debt instruments1. Government bonds

A company lends money to the government.
The government pays interest and later repays the original amount.

2. Corporate bonds

A company lends money to another company.
The borrowing company pays interest and repays the principal later.

3. Convertible debt

This is debt that can sometimes be converted into shares.

Example:
You buy a bond, but later you may have the option to turn it into common shares.

4. Commercial paper

This is a short-term debt investment, usually issued by large companies to borrow money for a short time.

Equity Instruments

Equity Instruments — Simple Explanation

An equity instrument means the company is buying an ownership interest in another company.

Usually, this means buying:

• Common shares

• Preferred shares

• Other types of shares

So instead of lending money, the investor becomes an owner/shareholder.

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Main idea

Equity instrument = ownership investment

The company pays money upfront and receives ownership rights in return.

Example:
Company A buys common shares of Company B.
Company A now owns part of Company B.

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Equity instruments do not have a maturity date

Debt instruments usually have a repayment date.

But equity instruments usually do not mature.

That means there is no set date where the company must repay your investment.

IFRS and ASPE

FRS and ASPE — Simple Meaning

IFRS and ASPE are two sets of accounting rules used to prepare financial statements.

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IFRS

IFRS = International Financial Reporting Standards

These are accounting rules used by public companies and many large companies.

Public company meaning:

A company whose shares are traded on the stock market.

Example:
Banks, large corporations, companies listed on the TSX.

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ASPE

ASPE = Accounting Standards for Private Enterprises

These are accounting rules used by private companies in Canada.

Private company meaning:

A company not listed on the stock market.

Example:
Small or medium businesses owned by individuals or families.

IFRS = public companies = more detailed and complex

ASPE = private companies = simpler accounting rules

Subsidiaries

Subsidiaries — Simple Explanation

A subsidiary is a company that is controlled by another company.

The company that owns/controls it is called the parent company.

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Main idea

If Company A controls Company B, then:

Company A = parent
Company B = subsidiary

Example:
Rogers owns/control another smaller company.
That smaller company is Rogers’ subsidiary.

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What does “control” mean?

Control usually means the parent company has the power to make important decisions for the subsidiary.

This can happen when the parent owns more than 50% of the voting shares.

Company A owns 80% of Company B’s voting shares.
Company A controls Company B.
So, Company B is a subsidiary But control can also exist even with less than 50% ownership if the company still has power over decisions.

Cost / Amortized Cost

Fair Value through Net Income — FV-NI

Fair Value through OCI — FV-OCI

1. Cost / Amortized Cost

This means the investment is recorded at cost or amortized cost, not updated to fair value every time.

At acquisition:

You record it at:

Cost = fair value + transaction costs

Example:
You buy a bond for $10,000 and pay $200 transaction fees.

Dr Investment                 10,200
    Cr Cash                             10,200

At each reporting date:

You keep it at cost or amortized cost.

2. Fair Value through Net Income — FV-NI

This means the investment is measured at fair value, and changes in fair value go directly to net income.

At acquisition:

Record at fair value.

At each reporting date:

Update to fair value.

Unrealized gains/losses:

Reported in net income.

Example:
You bought shares for $10,000. At year-end, they are worth $10,800.

Dr Investment                  800
    Cr Unrealized Gain                   800

The $800 gain goes on the income statement.

3. Fair Value through OCI — FV-OCI

This means the investment is measured at fair value, but unrealized gains/losses go to OCI, not net income.

OCI = Other Comprehensive Income

OCI is like a separate section after net income. It records certain gains/losses that are not included in regular net income right away.

At acquisition:

Record at fair value.
Transaction costs usually get added to the investment cost.

At each reporting date:

Update to fair value.

Unrealized gains/losses:

Reported in OCI.

Example:
You bought shares for $10,000. At year-end, they are worth $10,800.

Dr Investment                  800
    Cr Unrealized Gain - OCI             800

The $800 does not go to net income. It goes to OCI.

Fair value

Fair value means the amount you could sell the investment for today in the market.

Simple meaning:

Fair value = current market value

Example:
You bought shares for $1,000.
At year-end, those shares are worth $1,200 in the market.

So the fair value is $1,200.

The $200 increase is an unrealized gain because you have not sold it yet.

Creditor

Contractual obligation

Creditor means the person or company that is owed money.

In investments:

When a company buys a debt instrument like a bond, it is basically lending money to another company.

So the investor becomes the creditor because the other company must pay them back.

Example:

Company A buys a bond from Company B for $10,000.

Company B now owes Company A:

• interest payments

• the $10,000 principal back later

So:

Company A = creditor
Company B = debtor

Easy way to remember:

Creditor = gets paid back
Debtor = owes money

Contractual obligation means a legal promise in a contract that someone must follow.

In simple words:

Contractual obligation = something you are required to do because the contract says so.

For debt instruments, the borrower has contractual obligations, such as:

• Paying interest on specific dates

• Repaying the principal amount at maturity

• Following the terms of the bond or loan agreement

cost model

The cost model means:

You record the investment at the amount you paid for it, and you keep it at that amount.

It does not get updated to market value every reporting date.

Think of it like this:

Cost model = “record it at cost”

Cost includes everything needed to buy the investment:

Purchase price + commission/transaction costs

The cost model means the investment is recorded at what it cost to buy, and you usually do not adjust it to fair value every period.

Simple meaning

Cost model = keep the investment at cost

Cost includes:

Purchase price + transaction costs

In your question:

Purchase price:        $13,200
Commission 1%:             132
Total cost:            $13,332

So the investment is recorded at $13,332.

Why use cost model here?

The question says the shares were not publicly traded.

That means there is no active market price available, so fair value is harder to measure. Because of that, Eastwind uses the cost model.

Journal entry

Dr Other Investments        13,332
    Cr Cash                          13,332

Easy way to remember

Fair value model = update to market value
Cost model = keep at what you paid