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DISTANCE EDUCATION COURSE GUIDE USING OBTL DESIGN v1

MODULE 2: 12 hrs. Equity Investments and Investment in Associate

DISCUSSION

Let’s have a short review of the important concepts on the measurement of financial assets, but this
time, I want you to focus your attention on equity securities.

CLASSIFICATION INCLUSION INITIAL MEASUREMENT

Financial assets at fair value through profit or loss Equity securities
(FA@FVPL)
Debt securities Fair value
Financial assets at fair value through other
comprehensive income (FA@FVOCI) Equity securities
Financial assets at amortized cost Debt securities Fair value plus transaction costs

(FA@AC) Debt securities Fair value plus transaction costs

TYPE OF EQUITY INVESTMENT SUBSEQUENT MEASUREMENT Held for trading FVPL Not held for
trading (as a rule) FVPL Not held for trading (by irrevocable election) FVOCI All other investments in
quoted equity instruments FVPL Investments in unquoted equity instruments Cost

In this Module, it is assumed that you are already familiar with the concepts underlying the
measurement of equity securities. What we are about to discuss in this Module are the different
forms of equity investments and how it affects the other elements of financial statements.

Acquisition of Equity Investments

Equity investments can be acquired individually, by exchange, or on a lump sum basis. If the
equity investments are acquired individually, we initially measure it depending on this classification,
whether FA@FVPL or FA@FVOCI. However, if such investments are acquired by exchange, take
note that the acquisition cost is determined by reference to the following in the order of priority
(Meaning, if “a” is not given, proceed to “b”; if “b” is not given, that’s the time you go to option “c”): a.)
Fair value of asset given b.) Fair value of asset received c.) Carrying amount of asset given. Finally,
if two or more equity securities are acquired at a single cost or lump sum, the single cost is allocated
to the securities acquired on the basis of their fair value. If only one security has a known market
value, an amount is allocated to the security with a known market value equal to its market value.
The remainder of the single cost is then allocated to the other security with no known market value.
What if the fair value of the equity securities cannot be measured reliably? If this is the case,
the investment shall be measured at cost. We call this, investment in unquoted equity instruments.

SAMPLE PROBLEM:
Accessible Company purchased for a lump sum of P3,075,000 the following long-term investments:
A Corporation share capital 8,000 shares
B Corporation share capital 16,000 shares
C Corporation bond P1,000,000 face value
At the time of purchase, the securities were quoted at the following prices: A share, 100; B share,
150; and C bond, 90.

Required: Prepare journal entry to record the lump sum acquisition with proper allocation of the
single cost.

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SOLUTION:
 Fair value Total Ratio Allocated cost
A 8,000 100 800,000 800/4,100 600,000 B 16,000 150 2,400,000 2,400/4,100
1,800,000 C 1,000,000 90% 900,000 900/4,100 675,000 4,100,000 3,075,000

Investment in equity securities - A 600,000

Investment in equity securities - B 1,800,000
Investment in equity securities - C 675,000
Cash 3,075,000 Sale of Equity Securities

When equity securities are sold, the difference between the consideration received and the
carrying amount of the financial asset shall be recognized in profit or loss. But what if, the equity
shares of the same class were acquired on different dates at different costs, and only a portion is
subsequently sold? In such a case, the entity shall determine the cost of the shares sold using either
FIFO (if the problem is silent) or average cost approach.

SAMPLE PROBLEM:
Inane Company purchased shares to be measured at cost because the shares are unquoted.
Purchases were in the following order:
a. Purchased 1,000 ordinary shares of Star Company at P300 per share plus transaction costs
of P9,000.
b. Purchased 4,000 ordinary shares of Star Company at P250 per share plus transaction costs
of P30,000.
c. Sold 1,500 ordinary shares of Star Company at P280 per share minus transaction costs of
P15,000.

Required: 1.) Prepare journal entries to record transaction a and b. 2.) Prepare journal entry to
record transaction c under each of the following assumptions: 2a.) The shares sold are accounted
on FIFO basis. 2b.) The shares sold are accounted on an average basis.

SOLUTION:

1a) Investment in equity securities 309,000

Cash [(1,000x300)+9,000] 309,000
1b) Investment in equity securities 1,030,000
Cash [(4,000x250)+30,000] 1,030,000
2a) Cash [(1,500x280)-15,000] 405,000
Loss on sale of securities (squeeze) 32,750
Investment in equity securities* 437,750

2b) Cash 405,000

Gain on sale of securities (squeeze) 3,300 Investment in equity securities 401,700
(1,500x267.80)**

* Investment in equity securities (a) 309,000.00

Investment in equity securities (b) 128,750.00 [(500/4,000)x1,030,000] 437,750.00

** Investment in equity securities (a) 309,000.00

Investment in equity securities (b) 1,030,000.00
Total cost 1,339,000.00
Divided by: total number of shares 5,000.00
Average cost per share 267.80
OR
1,500/5,000 x 1,339,000

Dividends, Share Splits, Special Assessments, and Redemption of Shares

Since this is an investment in another company’s equity shares, the shareholder can receive
dividends out of his/her investment. This is thoroughly discussed in the book of Valix, Chapter 16.
Here is a summary of the journal entries under the different types of dividends. You might be asking
why I am showing you the journal entries? Because, the journal entries will

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clearly show us as to what account or element of financial statements will be affected by the
transaction. It will be easier for you to analyze the effects.

TYPE OF DIVIDEND PRO-FORMA JOURNAL ENTRY EFFECT ON INVESTMENT ACCT.

Cash dividend Cash XX

Dividend income XX No effect
Property dividend (except shares of another entity Dividend income XX No effect
declared as dividends)
Property dividend (in the form of shares of another entity Investment in shares XX
declared as dividends) Dividend income XX Increase
Liquidating dividend (except in the case of wasting asset
corp.) Cash or other appropriate acct. XX
Noncash assets XX
Investment in shares XX Decrease
Liquidating dividend (wasting asset Share/Stock dividend (issuing income XX
corp.) Cash or other appropriate acct. XX
Decrease (to the extent of liquidating
Investment in shares XX Dividend
dividends)

entity’s own shares as dividends) Investment in shares XX

Shares received in lieu of cash dividends (in effect:
Property dividend) Dividend income XX Increase
Cash XX
Cash received in lieu of share Loss on investment* XX
No entry No effect
dividends (“as if” approach – applied if Cash received in lieu of share is a gain/loss Cash XX
the problem is silent) Investment in shares XX Gain on Decrease
investment* XX *depends on whether it

dividends (BIR approach)

Dividend income XX No effect

Let’s now proceed to share split. I just like to reiterate that share split does not affect the total
cost of investment, only a decrease or increase in the cost per share and the number of shares.
Also, the ratio is always new for old. Meaning, for example, 4:1 share split. This means 4 new shares
for every share, hence, a split up.

As to special assessments, its effect is an increase in the investment account. The pro forma
journal entry is a debit to Investment in shares, and a credit to Cash. Lastly, for the redemption of
shares, the debit to Cash is computed by multiplying the selling price to the number of shares, then,
credit the cost of the Investment account; any difference goes to gain or loss on investment. That is,
if the balancing factor is on the debit side, it is a loss on investment, if it is on the credit side, it is a
gain on investment.

SAMPLE PROBLEM: Refer to Problem 16-3 on p.420 of Valix’s book – Effective Company

SOLUTION:
1) Investment in ANA ordinary shares 300,000 Cash 300,000
2) Investment in Benguet ordinary shares 120,000 Dividend income (2,000x60) 120,000
3) Investment in ANA ordinary shares 420,000 Cash 420,000
4) Cash 60,000 Dividend income (12%x200x5,000x(6/12)) 60,000
5) memorandum entry - ANA
"Received 20,000 new shares as a result of a 2-for-1 split of 10,000 original shares."
6) Cash [(8,000x85)*95%] 646,000 Gain on sale of ANA ordinary shares 358,000 Investment in
ANA ordinary shares (8,000x36)* 288,000

* Investment in ANA ordinary shares (1) 300,000

Investment in ANA ordinary shares (3) 420,000
Total cost 720,000
Divided by: total number of shares 20,000
Average cost per share 36
OR

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8,000/20,000x720,000

Investment No. of shares Cost

SMC preference shares 5,000 1,200,000 Benguet ordinary shares 12,000
1,120,000 ANA ordinary shares 12,000 432,000 Total investment in equity
securities 2,752,000

Share Right or Stock Right

Share rights can be accounted for separately or not accounted for separately. If the problem
is silent, our assumption is that, share rights are NOT accounted for separately. Refer to Chapter 16
of Valix for intensive discussion of this section.

SAMPLE PROBLEM: Refer to Problem 16-4 on p.421 of Valix’s book – Viable Company

SOLUTION:

1) Investment in equity securities 1,800,000

Cash 1,800,000 2) 10,000 stock rights (since the investor held 10,000 shares)
3) 100,000 (# of stock rights x fair value of rights; 10,000x10)
4) Stock rights 100,000
Investment in equity securities 100,000
5) Investment in equity securities (squeeze) 400,000
Cash [(10,000/5)*150] 300,000 Stock rights (at cost) 100,000
6) Cash (10,000x15) 150,000
Gain on sale of stock rights (squeeze) 50,000 Stock rights (at cost) 100,000
7) Loss on stock rights 100,000
Stock rights (at cost) 100,000

SAMPLE PROBLEM: Refer to Problem 16-5 on p.421 of Valix’s book – Vivacious Company

SOLUTION:
ACCOUNTED FOR SEPARATELY
1) Receipt of rights Stock rights 125,000 Investment in equity securities 125,000
[(125-100)/(4+1)]x25,000
Exercise of rights Investment in equity securities (squeeze) 750,000 Cash [(25,000/4)x100]
625,000
Stock rights (at cost) 125,000
2) Receipt of rights Stock rights 156,250 Investment in equity securities 156,250
[(125-100)/4]x25,000
Exercise of rights Investment in equity securities (squeeze) 781,250 Cash [(25,000/4)x100]
625,000
Stock rights (at cost) 156,250

NOT ACCOUNTED FOR SEPARATELY

1) Receipt of rights memorandum entry
"Received 25,000 stock rights to subscribe for new shares at P5
per share for every four rights held, or a total of 6,250 shares."
Exercise of rights Investment in equity secutities 625,000
Cash [(25,000/4)x100] 625,000

2) Receipt of rights memorandum entry

"Received 25,000 stock rights to subscribe for new shares at P6.25
per share for every four rights held, or a total of 6,250 shares."
Exercise of rights Investment in equity secutities 625,000
Cash [(25,000/4)x100] 625,000

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DISTANCE EDUCATION COURSE GUIDE USING OBTL DESIGN v1

Investment in Associate

The discussion and illustrations can be found in Chapters 17 and 18 of Valix’s book. Use it
as your reference for this topic. Below is the summary of concepts that you need to take note.

Methods – Initial recognition: at cost –

20% OR MORE
Increased by the investor’s share
• EQUITY in profit
– Decreased by the investor’s • FAIR VALUE
share in loss
– Affected by changes in FV –
– Cash dividends: reduce the
carrying amount of the Cash dividends: dividend income
– Stock

investment dividends: add to the total stocks

– Stock dividends: add to the total held
stocks held
– Investment must be in
• COST
ordinary shares (preference: – Not affected by changes in FV –
FVTPL/FVTOCI Cash dividends: dividend income
LESS THAN 20% – Stock dividends: add to the total
stocks held
 Excess of Cost Over Carrying
Amount
• Undervaluation of the investee’s assets –
Depreciable assets : amortized over the remaining
life
– Land: not amortized
– Inventory: the amount is expensed when the such is
already sold
– Investment income XX
Investment in associate XX
• Goodwill
– Not amortized
– Included in the carrying amount of the investment in
associate

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 Excess of Fair Value
Over Cost
• Included as income
– Investment in associate XX
Investment income XX • “negative
excess”
 Investee with Heavy
Losses
• The investor DISCONTINUES recognizing its
share of further losses if an investor’s share in
losses of an associate EQUALS OR EXCEEDS
the carrying amount of an investment
• Carrying amount of investment = balance of
“investment in associate” + long-term
receivables, loans and advances
• If the associate subsequently reports income,
the investor resumes including its share of such
income AFTER its share of the income equals
the share of losses not recognized.

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DISTANCE EDUCATION COURSE GUIDE USING OBTL DESIGN v1
 Investee with Preference

Shares

CUMULATIVE
• Share = Net income or
loss – preference
dividends (whether or not
such dividends are
declared)
NON-CUMULATIVE
• Share = Net income or
loss – preference
 dividends (only when

such dividends are

declared)

Upstream/Downstream
Transactions
• Investors share:
Net income – Unrealized profit on sale of
asset + Realized profit on sale of asset •
Unrealized profit : when the asset is not sold to
an unrelated party
• Realized profit:
– depreciation of the asset over its remaining
life
– When the asset is sold to an unrelated party
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Measurement
After
Loss of Significant Influence

Fair value

SAMPLE PROBLEMS:

Problem #1
Civility Company provided the following chronological transactions:
1. Purchased 20,000 ordinary shares of an investee for P2,400,000 representing 20% interest
on January 1, 2014. The net assets of the investee are fairly stated at P8,000,000.
2. The investee reported a net income of P1,500,000 for 2014.
3. Received a 10% stock dividend from the investee.
4. The investee reported a net loss of P300,000 for 2015.
 5. The investee paid a cash dividend of P500,000 to ordinary shareholders on December 31,
2015.
6. Sold 5,500 ordinary shares at P200 per share on December 31, 2015 resulting to loss of
significant influence.
7. The quoted market price of the investee’s share is P180 on December 31, 2015.

Required: Prepare journal entries to record the transactions under equity method and cost method.

SOLUTION – SAMPLE PROBLEM #1:

EQUITY METHOD
1.) Investment in associate 2,400,000 Cash 2,400,000
Cost 2,400,000
Net fair value (8,000,000x20%) 1,600,000
Excess of cost 800,000 (goodwill)
2.) Investment in associate 300,000 Investment income (1,500,000x20%) 300,000
3.) memo entry (total # of shares: 20,000+(20,000*10%) = 22,000)
4.) Loss on investment 60,000 Investment in associate (300,000x20%) 60,000
5.) Cash 100,000 Investment in associate (500,000x20%) 100,000
6.) Cash (5,500 x 200) 1,100,000 Gain on sale of investment 465,000 Investment in associate
(5,500/22,000 x 2,540,000) 635,000

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7.) Investment in associate (2,970,000-1,905,000) 1,065,000 Gain from remeasurement to fair

value 1,065,000
Number of shares (22,000 - 5,500) 16,500
Quoted market price per share 180
FV, 12/31/15 2,970,000
Investment in equity securities 2,970,000
Investment in associate 2,970,000

COST METHOD
1.) Investment in equity securities 2,400,000 Cash 2,400,000
2.) NO ENTRY
3.) memo entry (total # of shares: 20,000+(20,000*10%) = 22,000)
4.) NO ENTRY

5.) Cash 100,000 Dividend income 100,000

6.) Cash (5,500 x 200) 1,100,000 Gain on sale of investment 500,000 Investment in equity
securities (5,500/22,000 x 2,400,000) 600,000
7.) NO ENTRY

Problem #2
On January 1, 2015, Forensic Company acquired a 10% interest in an investee for P3,000,000. The
investment was accounted for at fair value through other comprehensive income. The fair value of
the investment was P3,500,000 on December 31, 2015 and P4,500,000 on December 31, 2016.

On January 1, 2017, the entity acquired a further 15% interest in the investee for P6,750,000. On
such date, the carrying amount of the net assets of the investee was P36,000,000. The fair value of
the net assets of the investee is equal to carrying amount, except for an equipment whose fair value
exceeds carrying amount by P4,000,000. The equipment has a remaining life of 5 years. The
investee reported net income of P8,000,000 for 2017 and paid dividend of P5,000,000 on December
31, 2017. No dividends were paid in 2015 and 2016 by the investee.

Required: 1.) Compute the goodwill on January 1, 2017. 2.) Prepare journal entries for 2015, 2016,
and 2017.

SOLUTION – SAMPLE PROBLEM #2:

2015 1/1/15 Financial asset - FVOCI 3,000,000 Cash 3,000,000

12/31/15 Financial asset - FVOCI 500,000
Unrealized gain - OCI 500,000
2016 12/31/16 Financial asset - FVOCI 1,000,000 Unrealized gain - OCI 1,000,000
2017 1/1/17 Investment in associate 6,750,000 Cash 6,750,000
Unrealized gain - OCI 1,500,000
 Retained earnings 1,500,000
Investment in associate 4,500,000
Financial asset - FVOCI 4,500,000
Cost of investment:
10% 4,500,000
15% 6,750,000 11,250,000
Carrying amount of net assets (36,000,000x25%) 9,000,000 Excess of cost
2,250,000 Attributable to:
Equipment (4,000,000 x 25%) 1,000,000 Goodwill (2,250,000 - 1,000,000)
1,250,000
12/31/17 Investment in associate 2,000,000
Investment income (8,000,000x25%) 2,000,000

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Cash (5,000,000x25%) 1,250,000

Investment in associate 1,250,000
Investment income 200,000
Investment in associate (1,000,000/5) 200,000

Problem #3
On January 1, 2015, Grand Company acquired 30% of East Company’s voting shares for
P8,000,000. During 2015, East earned P5,000,000 and paid dividends of P2,000,000. East reported
earnings of P6,000,000 for the 6 months ended June 30, 2016 and P8,000,000 for the year ended
December 31, 2016.

On July 1, 2016, Grand sold half of the investment in East for P6,000,000 cash resulting to loss of
significant influence. East paid dividends of P2,500,000 on October 1, 2016. Moreover, on July 1,
2016, the investment is measured at fair value through other comprehensive income. The fair value
of the retained investment is P6,500,000 on July 1, 2016, and P5,900,000 on December 31, 2016.

Required: Prepare journal entries for 2015 and 2016.

SOLUTION – SAMPLE PROBLEM #3:

2015 1/1/15 Investment in associate 8,000,000 Cash 8,000,000

12/31/15 Investment in associate 1,500,000 Investment income (5,000,000x30%) 1,500,000
Cash (2,000,000x30%) 600,000
Investment in associate 600,000
2016 6/30/16 Investment in associate 1,800,000 Investment income (6,000,000x30%) 1,800,000
7/1/16 Cash 6,000,000
Gain on sale of investment 650,000 Investment in associate (10,700,000/2)
5,350,000
Investment in associate 1,150,000
Gain from remeasurement to fair value (6,500,000-5,350,000) 1,150,000
Financial asset - FVOCI 6,500,000
Investment in associate 6,500,000
10/1/16 Cash 375,000
Dividend income (2,500,000x15%) 375,000
12/31/16 Unrealized loss - OCI 600,000 Financial asset - FVOCI (6,500,000-5,900,000)
600,000

Problem #4
At the beginning of the current year, Bridge Company purchased 25,000 shares of the 100,000
outstanding shares of an investee for P1,000,000. At the time of the purchase, the carrying amount
of the investee’s equity was P3,000,000. Assets having a market value greater than carrying amount
at the time of the acquisition were as follows:

Carrying Amount Market Value Remaining Life

Inventory 400,000 500,000 Less than 1 year
Equipment 2,000,000 2,500,000 5 years
Goodwill 0 400,000 Indefinite

The investee’s net income for the year was P700,000. Dividend per share paid by the investee
amounted to P3 at year-end.

Required: 1.) Prepare journal entries to record transactions. 2.) Compute the investment income for
the current year. 3.) Compute the carrying amount of the investment.

SOLUTION – SAMPLE PROBLEM #4:

Investment in associate 1,000,000 Investment income Cash 1,000,000 25,000 175,000 25,000
Cost 1,000,000 50,000 175,000 Carrying amount of investment (3,000,000x25%) 750,000 125,000

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Excess of cost over carrying amount 250,000

Attributable to: Investment in associate Inventory (100,000x25%) 25,000 1,000,000 75,000 Equipment
(500,000x25%) 125,000 175,000 25,000 Goodwill (400,000x25%) 100,000 25,000 1,175,000 125,000
Investment in associate 175,000 1,050,000 Investment income (700,000x25%) 175,000
Cash (25,000x3) 75,000
Investment in associate 75,000
Investment income 25,000
Investment in associate (inventory) 25,000
Investment income (125,000/5) 25,000
Investment in associate (equipment) 25,000

Problem #5 – Refer to Problem 17-5 on Valix’s book, found on p. 446. – Alpha Company

SOLUTION – SAMPLE PROBLEM #5:

20,000/80000 = 25% Investment inc., 2019 20,000 900,000

1/1/19 Investment in associate 2,400,000 880,000 Cash (20,000x120) 2,400,000
Investment inc., 2019
Cost 2,400,000 20,000 975,000 Carrying amount (8,000,000x25%) 2,000,000 955,000 Excess of cost
over carrying amount 400,000
Inv. in assoc., 12/31/20
Attributable to intangible asset 400,000 2,400,000 320,000 900,000 20,000
12/31/19 Investment in associate 900,000 975,000 400,000 Investment income (3,600,000x25%) 900,000 20,000
4,275,000 760,000
Cash (20,000x16) 320,000 3,515,000 Investment in associate 320,000

Investment income (400,000/20) 20,000

Investment in associate 20,000
12/31/20 Investment in associate 975,000
Investment income
(3,900,000x25%) 975,000
Cash (20,000x20) 400,000
Investment in associate 400,000
Investment income (400,000/20) 20,000
Investment in associate 20,000

Problem #6 – Refer to Problem 17-7 on Valix’s book, found on p. 447. – Bypass Company

SOLUTION – SAMPLE PROBLEM #6:

2016 Investment in associate 7,000,000 Investment in assoc. Cash 7,000,000 7,000,000 2,000,000
Dec. 2016 5,000,000
Loss on investment 2,000,000 2,800,000 Investment in associate 2,000,000 Dec. 2017
2,200,000 2,200,000
2017 Loss on investment 2,800,000 Dec.2018 - Investment in associate 2,800,000
2018 Advances to associate 2,000,000
Cash 2,000,000
Loss on investment 3,200,000
Investment in associate 2,200,000
Advances to associate 1,000,000
2019 Loss on investment 1,000,000
Advances to associate 1,000,000

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Problem #7 – Refer to Problem 18-2 on Valix’s book, found on p. 469. – Glorious Company

SOLUTION – SAMPLE PROBLEM #7:

1.) Investor's share in profit, 2019:

Profit 2,000,000 Less: Unrealized profit on sale of equipment - 1 (800,000-500,000)
300,000 Add: Realized profit on sale of equipment - 1 (300,000x10%) 30,000
Adjusted profit 1,730,000
Investor's share (1,730,000x40%) 692,000

2.) Investor's share in profit, 2020:

Profit 3,000,000 Less: Unrealized profit on sale of equipment - 2 (900,000-500,000) 400,000
Unrealized profit on sale of inventory (2,800,000-2,000,000) 800,000 1,200,000 1,800,000
Add: Realized profit on sale of equipment - 1 30,000 Realized profit on sale of equipment - 2
(400,000/5x6/12) 40,000 70,000 Adjusted profit 1,870,000
Investor's share (1,870,000x40%) 748,000

3.) 2019 1/1 Investment in associate 5,000,000 4.) Investment in assoc. Cash 5,000,000 5,000,000 320,000
692,000 400,000
12/31 Investment in associate 692,000 748,000
Investment income 692,000 6,440,000 720,000 5,720,000
Cash (800,000x40%) 320,000
Investment in assoc. 320,000
2020 12/31 Investment in associate 748,000
Investment income 748,000
Cash (1,000,000x40%) 400,000
Investment in assoc. 400,000

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