10

Accounting for Investments

10.1 INTRODUCTION

An entity may invest in the financial instruments (e.g., shares and debentures) issued by another entity. These investments are not made for the purpose of manufacturing, administrative or marketing activities of the investors. Investment may be made with the intention to earn periodic income (dividend or interest) and/or to benefit from the appreciation in the value of these investments. Alternatively, these investments are for further business objectives, for example, investment made in a subsidiary or in joint venture. As we would discuss, the initial and subsequent measurement of investment is dependent upon the intended purpose for which it has been made.

10.2 CLASSIFICATION OF INVESTMENTS

As discussed in the Chapter 6, investments are classified as current and non-current based upon the intended time horizon. Current investments are intended by the company to be sold within twelve months or within the company’s operating cycle. This also includes investments which have a remaining maturity of less than twelve months or within the company’s operating cycle. All other investments are classified as non-current. Investments (both current and non-current) are required to be further classified as:

• Investments in equity instruments
• Investment in preference shares
• Investments in government or trust securities
• Investments in debentures or bonds
• Investments in mutual funds
• Investments in partnership firms
• Other investments (specify nature)

Under each of the above-mentioned category, investments made in subsidiaries, associates, joint ventures, or structured entities are separately identified. The aggregate amount of quoted investments (with market value) and unquoted investments are also required to be disclosed.

For subsequent measurement, investments are required to be classified based upon the entity’s business model for managing the investment and the contractual cash flow characteristics of the investment. As per Ind AS 109, investments are classified as:

• Subsequently measured at amortized cost (AC).
• Subsequently measured at fair value through other comprehensive income (FVTOCI).
• Subsequently measured at fair value through profit or loss (FVTPL).

The business model test considers the intention behind the investment—to collect contractual cash flows till maturity or to sell prior to maturity or both. The cash flow characteristics test considers the type of the instrument—certain interest and repayment of principal or not.

The above classification does not apply to the interest in associates and joint ventures that are accounted for using the equity method discussed later in this chapter.

10.2.1 Measured at Amortized Cost

For an investment to be classified in this category, the following conditions need to be satisfied:

1. Investment are held within a business model whose objective is to collect contractual cash flows.
2. Contractual terms of the financial asset give rise on (specified dates) to cash flows that are solely payments of principal and interest on the principal amount outstanding.

Investment in debt instruments which give rise to certain cash flows on specified dates, with the intention to hold them till maturity, will be classified in this category.

10.2.2 Measured at Fair Value Through Other Comprehensive Income

For an investment to be classified as FVTOCI, the following conditions need to be satisfied:

1. Investment are held within a business model whose objective is to collect contractual cash flows and sell financial assets.
2. Contractual terms of the financial asset give rise, on specified dates, to cash flows that are solely payments of principal and interest on the principal amount outstanding.

Investment in debt instruments which give rise to certain cash flows on specified dates with the intention to collect contractual cash flows and sell them before maturity to meet certain cash flow requirements will be classified as FVTOCI.

10.2.3 Measured at Fair Value ThroughProfit or Loss (FVTPL)

An investments which is neither classified as AC nor FVTOCI as aforesaid will be classified as measured at fair value through profit or loss (FVTPL). Investment in equity instruments will get classified under this category as it fails to meet the cash flow characteristics test.

 

An entity may make an irrevocable election at initial recognition for particular investments in equity instruments that would otherwise be measured at fair value through profit or loss to present subsequent changes in fair value in other comprehensive income. Likewise, an entity may make an irrevocable election at initial recognition to designate a particular investment as ‘measured at fair value through profit or loss.’ Such option is irrevocable and can be made if doing so eliminates or significantly reduces a measurement or recognition inconsistency.

The classification of debt instruments based upon the above discussion is presented in Figure 10.1.

In general, debt instruments that are intended to be held till maturity to collect contractual cash flows will be classified as ‘to be measured at amortized cost’. Debt instruments that are held for collecting contractual cash flows and by selling them before maturity will be classified as ‘to be measured at fair value through other comprehensive income’. Other debt instruments (which are held for trading or are irrevocably designated as such) will be classified as ‘to be measured through profit or loss’.

The classification of equity instruments is presented in Figure 10.2.

 

Equity does not generate contractual cash flows, and hence, fail the cash flow characteristics test. Therefore, equity instruments are classified as ‘to be measured through profit or loss’. However, at the time of the initial recognition, an entity may decide irrevocably to designate such investments as FVTOCI. Once the option to treat equity investments as FVTOCI is taken, it cannot be subsequently changed. Equity investment held for trading are not allowed to be designated as FVTOCI, and therefore, they would always be treated as FVTPL.

■ Illustration 10.1

Classify the following investments as ‘to be measured at amortized cost’, ‘to be measured at fair value through OCI’ or ‘to be measured at fair value through profit or loss’.

1. Investment made in 1,000 equity shares of an unlisted company.
2. Investment made in government securities with the intention to collect contractual cash flows.
3. Investment made in the equity shares of a listed company. The shares are regularly traded, but the company has no intention of trading.
4. Investment made in corporate debentures which are unlisted.
5. Investments made in a 10 years bond. The company intends to sell these bonds after three years to raise money for replacement of a machine.
6. Investments made in a 10 years bond to be held till maturity. However, the company may sell them if there is a significant decline in the market interest rate.
7. Investment made in listed corporate debentures with the intention to trade.

Solution:

1. To be measured at fair value through profit or loss, unless the company makes an irrevocable election to classify them as at fair value through OCI.
2. To be measured at the amortized cost as the intention is to collect contractual cash flows.
3. To be measured at fair value through profit or loss, unless the company makes an irrevocable election to classify them as at fair value through OCI.
4. To be measured at the amortized cost as the intention is to collect contractual cash flows.
5. To be measured at the fair value through OCI as the intention is to collect the contractual cash flows and selling the debentures.
6. To be measured at the amortized cost as the intention is to collect contractual cash flows.
7. To be measured at the fair value through profit or loss as the objective is trading.

10.3 MEASUREMENT

In this section, we will discuss the initial and subsequent measurement of investments classified as above.

10.3.1 Initial Measurement

Investments are initially measured at their fair value plus direct acquisition costs. Transactions costs that are directly attributable to the acquisition of investments are included. For example, registration and other regulatory fees, advisory fees to legal, accounting and other professionals, printing costs and stamp duties. Transaction costs are, however, not considered in the case of FVTPL investments.

10.3.2 Subsequent Measurement

Investments, after initial recognition, are measured based upon their classification. Investments that are classified as ‘measured at amortized cost’ are tested for impairment. The gain or loss on fair value measurement is recognized either in OCI or profit and loss, depending upon its classification. Table 10.1 summarizes rules for subsequent measurement.

 

10.3.3 Reclassification

An entity may subsequently reclassify investments from one category to another. Such a reclassification is permitted only if there is a change in the business model for managing its investments. For example, a portfolio which was earlier intended to be held till maturity (and hence measured at amortized cost) may be converted to trading portfolio (and hence measured at fair value through profit or loss). If there is a change in the business model, all the affected investments shall be reclassified. Reclassification will apply prospectively from the reclassification date, and therefore, previously recognized gains or losses (including impairment) will not be restated. Table 10.2 summarizes the impact of reclassification.

 

■ Illustration 10.2

How would you treat the following reclassification of investments consequent upon change in the business model of an entity?

1. Investment at amortized cost (₹30 million) to be reclassified as FVTPL. The fair value on the date of reclassification is ₹32 million.
2. Investment at FVTPL (₹35 million) to be reclassified as amortized cost.
3. Investment at amortized cost (₹30 million) to be reclassified as FVTOCI. The fair value on the date of reclassification is ₹28 million.
4. Investment at FVTOCI (₹35 million) to be reclassified as amortized cost. Accumulated gain, previously recognized in OCI as a part of other equity, amounts to ₹4 million.
5. Investment at FVTPL (₹35 million) to be reclassified as FVTOCI.
6. Investment at FVTOCI (₹35 million) to be reclassified as FVTPL. Accumulated loss, previously recognized in OCI as a part of other equity, amounts to ₹6 million

Solution

1. Investment will be shown at ₹32 million, i.e., the fair value on the date of reclassification. The gain of ₹2 million will be recognized in profit or loss.
2. The fair value on the reclassification date, i.e., ₹35 million will be the new carrying amount of the investment.
3. Investment will be shown at ₹28 million, i.e., the fair value on the date of reclassification. The loss of ₹2 million will be recognized in OCI.
4. The fair value on the reclassification date, i.e., ₹35 million will be the new carrying amount of the investment. Accumulated gain in other equity (₹4 million) will be adjusted from the fair value, as a result, the investment will be measured at there classification date at ₹31 million, as if it had always been measured at amortized cost.
5. No change. The investment will continue to appear at the fair value, i.e., ₹35 million.
6. No change. The investment will continue to appear at the fair value, i.e., ₹35 million. Accumulated loss of ₹6 million will be reclassified from other equity to profit or loss as a reclassification adjustment.

10.3.4 Derecognition

An investment is derecognized when the contractual rights to the cash flows from the investment expire or the rights to receive the contractual cash flows are transferred. On derecognition of an investment, the difference between the carrying amount and consideration received will be recognized in profit or loss. When an investment measured at FVTOCI is derecognized, the cumulative gain or loss previously recognized in OCI is reclassified from other equity to profit or loss as a reclassification adjustment.

10.4 INVESTMENT IN SUBSIDIARIES, ASSOCIATES AND JOINT VENTURE

Ind AS 28 defines an associate as an entity over which the investor has significant influence. The power to participate in the financial and operating policy decisions of the investee is indication of significant influence. Control or joint control over these policies is not a requisite condition for being an associate. In case of a joint venture, parties have joint control over the investee. Decisions about the relevant activities require the unanimous consent of the parties sharing control. The parties having joint control also have rights to the net assets of the arrangement. Subsidiary is an entity that is controlled by another entity due to voting rights, contractual rights, etc. (see Chapter 13 for details).

In the separate financial statements, Ind AS, 27 permits investments in subsidiaries, joint ventures and associates to be either accounted for at cost or in accordance with the classification prescribed under Ind AS, 109. The entity shall apply the same accounting for each category of investments.

Assignment Questions

1. Briefly explain the classification of investments as per Ind AS, 109.
2. What is the impact of subsequent measurement of investments on the financial statements of a company.
3. Is it possible to reclassify an investment from one class to another? What would be the impact of such reclassification on carrying amount and profit or loss.

Problems

1. Investment classification: PQR Limited invested ₹10 million in government bonds with coupon rate of 8% and maturity of 10 years. After one year, the fair value of the bonds has increased to ₹10.5 million. How would you classify the bonds and treat the increase in fair value if:
   1. The bonds are intended to be held for trading.
   2. The bond will be held till maturity.
   3. The company intends to sell the bonds only if the bond price significantly appreciates.
   4. The company intends to sell the bonds after three years to raise cash for replacement of a machine.
2. Treatment of fair value changes: ABC Limited invested ₹2 million in the equity shares of another company. The current market price of the investment is ₹1.7 million due to a fall in market. What are the options available to ABC Limited to classify these investments? How would you treat the fall in the market price under these alternatives.
3. Reclassification: Finvest Limited investments in corporate bonds amounting to ₹12 million. These investments were classified as FVTOCI in line with the business model of the company. With the change in the business model, the company would like to reclassify these investments. The carrying amount of this investment is ₹11 million and accumulated loss previously recognized in OCI as a part of other equity amounts to ₹1 million. What would be the impact of such reclassification in the following cases:
   1. Reclassify to ‘measured at amortized cost’.
   2. Reclassify to FVTPL.

Solutions to Problems

1. The classification of investments and treatment of fair value gain will be decided by the business model test and cash flow characteristics test as provided in Ind AS 109. Accordingly:
   1. Investment would be classified as FVTPL. The fair value gain would be recognized in profit or loss.
   2. Investments would be classified as ‘measured at amortized cost’. The fair value gain would be ignored.
   3. Investments would be classified as ‘measured at amortized cost’. The fair value gain would be ignored.
   4. Investment would be classified as FVTOCI. The fair value gain would be recognized in OCI.
2. ABL Limited has two alternatives to classify equity investments:
   1. FVTPL
   2. FVTOCI—For this option, the company has to irrevocably designate these investments in this category. If the investment is for trading, this option is not available.

   If ABC Limited irrevocably decides to classify these investments as FVTOCI, the fair value loss of ₹0.3 million will be recognized in OCI and accumulate in other equity. If ABC Limited does not use this option, investment will be classified as FVTPL and the fair value loss of ₹0.3 million will be recognized in profit or loss.

3. The reclassification is permitted if there is a change in the business model. The impact of the reclassification would be:
   1. The accumulated loss of ₹1 million will be adjusted against the carrying amount of the investment and the carrying amount will increase to 12 million, as if these investments had always been measured at amortized cost.
   2. No change. The investment will continue to appear at the fair value, i.e., ₹11 million. Accumulated loss of ₹1 million will be reclassified from other equity to profit or loss as a reclassification adjustment.

Try It Yourself

1. Investment classification: Super Invest Limited invested ₹15 million in government bonds with coupon rate of 8% and maturity of five years. After one year, the fair value of the bonds has declined to ₹1 million. How would you classify the bonds and treat the increase in fair value if:
   1. The bonds are intended to be held for trading.
   2. The bond will be held till maturity.
   3. The company intends to sell the bonds only if the bond price significantly appreciates.
   4. The company intends to sell the bonds after three years to raise cash for expansion project.
2. Classification of equity investment: Starfin Limited invested ₹1 million in the equity shares in the stock market. The management wants this investment to be measured at amortized cost as this is intended to be held for long-term. Please advise options available to the company for classification.
3. Reclassification: XXX Investment Limited invested ₹10 million in corporate bonds. These investments were classified as FVTPL in line with the business model of the company. With the change in the business model, the company would like to reclassify these investments. The carrying amount of these bonds currently is ₹11 million. What would be the impact of such reclassification in the following cases:
   1. Reclassify to ‘measured at amortized cost’.
   2. Reclassify to FVTOCI.
4. Reclassification of investments: YYY Investment Limited invested ₹6 million in corporate bonds. These investments were initially classified as ‘measured at the amortized cost’ in line with the business model of the company. With the change in the business model, the company would like to reclassify these investments. The fair value these bonds is ₹6.4 million. What would be the impact of such reclassification in the following cases:
   1. Reclassify to FVTPL.
   2. Reclassify to FVTOCI.
5. Derecognition of investments: Pee Cee Limited sold some of its investments for a consideration of ₹40,00,000. These investments were purchased at ₹32,00,000 and initially were classified as FVTOCI. The carrying amount of this investment is ₹38,00,000 million and the cumulative gain previously recognized in the OCI amounted to ₹6,00,000. What would be the impact of this sale on financial statements of the company?

Cases

Case 10.1: Investment Classification by Hero Moto Corp Limited

Hero Moto Corp Ltd. (Formerly Hero Honda Motors Ltd.) is the world’s largest manufacturer of two-wheelers, based in India. In 2001, the company had achieved the coveted position of being the largest two-wheeler manufacturing company in India and also the ‘World No.1’ two-wheeler company in terms of unit volume sales in a calendar year. Hero Moto Corp Ltd. continues to maintain this position till date. It derives its income from manufacturing and sale of motorcycles.

The company invests its surplus cash primarily in mutual funds and bonds & debentures. The company has invested in subsidiaries and associate companies for business purposes. As on 31st March 2017, the carrying amounts of current and non-current investments was reported at 4,540.85 crore and 1,349.00 crore, respectively. The break-up of these investments is given below:

 

During the year 2016–17, the other income relating to investments, recognized by the company in the statement of profit and loss, included:

 

Questions for Discussion

1. How are current investments different from non-current investments?
2. Hero Motocorp Limited has classified its investments in bonds and debentures as ‘measured at amortized cost’, whereas investment in mutual funds is classified as ‘measured at fair value through profit or loss’. What are the conditions to be met for such classification?
3. Why is the investment in subsidiaries and associates carried at cost? How would you treat impairment in their value, if any?
4. The company has carried its equity investment at fair value through profit or loss. Is it possible to classify equity investments as FVTOCI?
5. Is it possible for the company to reclassify its investment in bonds/debentures to FVTPL? If yes, how would it impact the financial statements of the company?