(Posted September 2024)
Candidates often struggle to understand how to deal with the accounting for various types of investments in other companies on the CPA Canada Common Final Examination (CFE). This blog summarizes the key technical you need to know when addressing investment issues on the CFE and considerations for your writing approach.
Investments
Whether you are under IFRS or ASPE, there are a number of different investments in other companies that can be tested.
Control
One type of investment is where the investor has control over the investee. This typically exists when the investor owns more than 50% of the investee but can also exist when the investor has the power and ability to determine the strategic, operating, investing, and financing policies of the investee. ASPE 1591 and IFRS 10 have different guidelines regarding how to determine whether control exists.
If control does exist, IFRS 10 requires that consolidation is used to account for the investment. ASPE 1591 provides a policy choice between consolidation, the equity method, or cost.
Significant Influence
Another type of investment is where the investor holds significant influence over the investee. This typically exists when the investor owns between 20% and 50% of the investee. However, other qualitative factors also need to be considered, such as board representation, participation in policymaking processes, material intercompany transactions, interchange of managerial personnel, or provision of key technical information. The existence of one or more of these factors can cause there to be significant influence, even if ownership falls below the 20% guideline. Conversely, there may not be significant influence even if ownership is more than 20%.
When significant influence exists, IAS 28 requires the equity method to be applied. ASPE 3051 provides a policy choice between the equity method or cost.
Joint Control
Joint control exists when unanimous consent of all owners is required for any decisions to be made. This could occur with equal share ownership by each owner, or contractual requirements for unanimous consent of all decisions made. When joint control exists, there is a joint arrangement.
Under IFRS 11, there are two types of joint arrangements:
- Joint operations exist when the parties have rights to the assets and obligations for the liabilities and are accounted for by recording the investor’s share of the assets, liabilities, revenues, and expenses of the joint operation.
- Joint ventures exist when the parties have rights to the net assets of the arrangement and are accounted for using the equity method.
Under ASPE 3056, there are three types of joint arrangements:
- Jointly controlled operations exist when the operation uses the assets and resources of the investors, rather than the establishment of a separate structure, and are accounted for by recording the assets the investor controls, liabilities it incurs, and its share of revenue and expenses.
- Jointly controlled assets exist when there is joint control or ownership of one or more assets dedicated to purposes of joint arrangement where each investor may take a share of the benefits and shares expenses incurred. These are accounted for by recording the investor’s share of jointly incurred assets, liabilities, revenues, and expenses.
- Jointly controlled enterprises exist when a corporation, partnership or other structure is established in which each investor has an interest. There is a policy choice for the accounting for these investments of either the equity method, cost, or the investor’s share of assets, liabilities, revenues, and expenses.
Other
If control, joint control, or significant influence does not exist, the investment would be considered a financial instrument. For more information on how to account for financial instruments, see our financial instruments technical spotlight blog.
How to Write on the CFE
Investments are a commonly tested topic on the CFE. The CFE will test your ability to identify which type of investment is presented and how to account for it. While you must adapt to the issue and case facts presented to you, there is a common approach that can often be taken to develop sufficient depth in your analysis.
Step 1: Use case facts to assess the type of investment
Use the specific case facts regarding the investor’s ownership in the investee, and any other considerations that would identify whether there is control, significant influence, or joint control that can be applied to the relevant technical under ASPE or IFRS to determine what type of investment exists. Once you have applied the case facts to the technical, conclude on the type of investment.
Step 2: Discuss valid methods to record the investment
Once you have concluded which type of investment exists, discuss the options surrounding recording the investment (where they exist under ASPE). Consider any user needs to determine which method would be most beneficial for the investor. For example, if the business is looking to maximize assets, then the equity method would be preferred over the cost method because the value of the investment would increase if the investment is profitable.
Step 3: Explain how the method works
Once you determine which method should be used to record the investment, explain how the method works, supported by the relevant case facts.
For example, when explaining the equity method, you would consider the following components:
- The investment is recorded on the balance sheet at its cost plus the investor’s percentage (%) share of net income (loss) less any dividends received.
- Investment income is recorded as the investor’s % share of net income (loss), which includes the amortization of any purchase price discrepancy.
- The investment must be assessed for impairment at the end of each reporting period.
Step 4: Other considerations
When given numbers, quantify the impact of the investment on the investor’s financial statements. For example, if you are given the details on investment cost, net income, and dividends, you should calculate how the investment would be recorded at year-end under the equity method. You may also need to integrate your results into a summary calculation, such as revised financial statements, a materiality calculation, or financial ratios. You also may need to consider any impact of the changes in ownership or control at a subsequent date.
More detailed technical and information on how to write for investments are included in our Scenario Flowcharts Workbook, which is included in our CFE Prep courses, and in our Competency Map Study Notes publication.