Question on Intercorporate Investment

CFA Level II FRA
#1

Hi,

Anyone studying from schweser material I have a doubt on the practice problem of Reading Intercorporate investments.

I could not understand which method to use for the Quaestion no. 3-6.

Can anyone please help. Thanks in advance.

#2

So, here is how you want to go about this problem set:

  • Does the investment indicate that the investor has “control” (loosely defined as 50% of voting shares)? No, so you know you don’t consolidate.
  • Does it indicate “significant influence” (loosely defined as 20-50% of voting shares)? No, so you know it isn’t an Equity Method Investment
  • So it must be a passive investment
  • From here, the answers to the questions are the same whether they hold the investment as a Trading Security or AFS. The carrying (book) value of the investment is the same for both of those classifications. The difference is just where the Unrealized G/L goes when there is a change in stock price. If a question asked for the P&L effect of a stock price change, you would not be able to answer with the info given.

Side note:. Companies generally would choose AFS to reduce volatitlity on their P&L. That is how AFS came to be.

#3

Everything mentioned is correct: except some additional comments by my side…

  • formally 50 % +1 vote is consolidation threshold but subsidiary can be consolidated if parent has no > 50% sharing votes if certain other conditions are met (parent can choose or revoke MBO, etc. we had such cases in real life), also

is mentioned in Curriculum.

  • threshold for sign. infulence is not 25 % +1 vote than 20 % + 1 voting power up to 50% acc. to IFRS

  • Exactly that’s not always true, there are many trading portfolios, it’s strongly depends on purpose of stock purchase. Once choosen category may be changed only under certain circumstances and certain category reclassification s not permitted by standards.

If subject has exact 50 % voting power (shares) in another subject, it is joint venture and equity method or proportionate consolidation method is applied.

#4

Thank you… you made it sound so simple…

but one question i have is yhy cant it be Held for maturity? why do we assume AFS or trading?

#5

Croatia, thaks for the post! I too have seen investments around the edgesof 20% and 50% be treated differently. No bright lines here. Other factors can override the explicit ownership percents. That is what I menat by “loosely defined”. The thee OCI components (AFS, Pension. FX) all developed under GAAP to reduce volatility on the P&L. I would expect the AFS choice to generally be driven by this, at least here in the US with our culture and norms. Ironically, perhaps, my employer has a fairly large AFS Bond portfolio and the decision was not due to volatility…hehe

The FASB just came out with ASU 2016-01 which will prohibit stocks being classified as AFS. it will all be Trading with unrealized g/l running through the P&L. it doesn’t become effective until 2017/2018, though.

Thaks for the 25% oversight. I will correct.

#6

shrutic, stocks don’t mature, thus no HTM classification.

#7

40yo

I supposed geo, tax impact and market preferences are crucial regarding decission to categorize to P/L or OCI (AFS). Of course, when market trend is strong bullish held-for trading is an attractive class, especially in a hyperinflationary environment and market bubbles which may be more frequent feature of emerging than developed markets.

IFRS 9 by IASB is also ready to come into force for less than 2 Y and as I’ve been informed this area should be even absolute converged with peer SFAS.

#8

Exactly HTM class is reserved for non-equity instruments, those which are supposed to mature in the future, (fixed income, receivables collections portfolio, etc.).

#9

oh yeah… how stupid of me…

thanks everyone for the explanantion!!!

#10

There is no shame do not know something and ask. It is a shame to persist in ignorance …

#11

Hi all, I have 1 question regarding EOC no 30 from curriculum (intercorp inv). It’s about comparison for Total Asset turnover (Equity method vs Consolidation) As we know Total asset TO = Revenue / Beg Total asset For equity method = P only / P only For Consol = P + S / P + S - NCI + 60 My question : what is number 60 in the denominator of consol method? P = parent S = subsidiary

#12

Indonesia, the $60 is licenses.

In an acquisition, the purchase price gets allocated to all identifiable assets/liabilities, with any excess going to goodwill. In this question, Boswell had BV of Assets/Liabilies = $580. Implied full Purchse Price $640 ($320 for 50%). Differeence equal $60. The background states “The excess of purchase price over FV of net assets was attributable to previoulsy unrecorded licenses.”

So on the consolidated Financials Statements you would see the $60 for Unrecorded Licenses.

#13

hi 40yo,

are you using Full Goodwill ? why not Partial ?

#14

There is no goodwill in this one.

#15

ok thanks