Strategic Accounting

1. Strategic Accounting ACCOUNTING FOR FINANCIAL ASSETS AND LIABILITIES

2. Securities available- for-sale are expected to be held for an unspecified period of time. Held-to-maturity securities are those where the investor intends and has the ability to hold the security to maturity date. Securities at FVTPL are bought and held primarily to be sold in the near term. Also includes investments reclassified from HTM or AFS categories under the FVO IFRS / U.S. GAAP DIFFERENCE Fair Value Option. U.S. GAAP refers to securities at fair value through profit and loss as “trading securities.”

3. Securities Available-for-Sale • All investments in debt and equity securities that don’t fit the definitions of the other reporting categories are classified as “available-for-sale.” • vSecurities available-for-sale are reported at the fair value of the investmentsecurities on the reporting date.

4. Securities Available-for-Sale Purchase of Investments November 18 Purchased ABM Corporation 10% bonds for $40 million. ($ in millions) Investment in ABM bonds 40 Cash 40 Investment Revenue November 30 Received cash interest of $2 million on the investment in ABM Corporation bonds. Cash 2 Investment revenue ($40 million x 10% x 1/2 year) 2 Sale of Investments December 1 Sold the ABM Corporation bonds for $43 million. Cash 43 Investment in ABM bonds 40 Gain on sale of investments 3

5. Securities Available-for-Sale Purchase of Investments December 21 Acquired two new investments costing: Millington Industries common shares $30 million Bartlett Corporation common shares 20 million ($ in millions) Investment in Millington shares 30Investment in Bartlett shares 20 Cash 50

6. ADJUSTING INVESTMENTS TO FAIR VALUE December 31 The market prices of the investments are: Millington Industries common shares $35 million Bartlett Corporation common shares 19 million ($ in millions) Fair Value Available-for-Sale Securities Cost Fair Value Adjustment Millington Industries shares $30 Bartlett Corporation shares 20 Totals $50

7. ADJUSTING INVESTMENTS TO FAIR VALUE December 31 The market prices of the investments are: Millington Industries common shares $35 million Bartlett Corporation common shares 19 million ($ in millions) Fair Value Available-for-Sale Securities Cost Fair Value Adjustment Millington Industries shares $30 $35 $5 Bartlett Corporation shares 20 19 (1) Totals $50 $54 $4 December 31 Fair value adjustment (calculated above) 4 Unrealized holding gain–other comprehensive income 4 Securities available-for-sale $50Plus: Fair value adjustment 4 $54

8. Other Comprehensive Income Holding gains and losses from retaining AFS securities during periods of price change are not included in the determination of income for the period. Instead, they are reported as Other Comprehensive Income on the Statement of Comprehensive Income. These amounts are accumulated over time and reported as a separate component of shareholders’ equity – Accumulated Other Comprehensive Income. (Often called “Investment Fair Value Reserve”)

9. Deferred losses (gains) from derivatives. Pensions: Losses (gains) Prior service cost. Losses (gains) from foreign currency translations. Comprehensive Income Comprehensive income includes losses and gains that traditionally havebeen excluded from net income. Gains or losses from changes in foreign currency exchange rates. The amount could be an addition to or reduction in shareholders’ equity. When a derivative designated as a cash flow hedge or foreign currency hedge is adjusted to fair value, the gain or loss is deferred as a component of OCI and included in earnings later, at the same time as earnings are affected by the hedged transaction. Increases (decreases) in the postretirement benefit obligation from changing assumptions as well as plan assets earning less or more than expected Cost of recalculating postretirement benefits in prioryears after amending a plan. From changes in the market value of securities available-for-sale Net holding losses (gains) on investments.

10. Statement of Comprehensive Income ($ in millions) Net income $xxx Other comprehensive income: Net unrealized holding gains (losses) on investments $ 4 Pensions and other postretirement plans: ØGains (losses) due to revising assumptions used to estimate liability or the return on plan assets differing from expected x (x) ØPrior service cost (x) Deferred gains (losses) from derivatives x Gains (losses) from foreign currency translation xxx Comprehensive income $xxx

11. As an expanded version of the income statement. As a separate statement. Comprehensive Income Other comprehensive income (a) is reported periodicallyas it is created and (b) also is reported as a cumulative amount. There are 2 options for reporting comprehensive income created during the reporting period. The statement of comprehensive income can be presented: The accumulated amount of comprehensive income is reported as a separate item of SE in the balance sheet. IFRS / U.S. GAAP DIFFERENCE U.S. GAAP allows a third alternative: reporting other comprehensive income in the statement of shareholders’ equity. The accumulated amount of comprehensive income often is referred to as a “reserve.”

12. REPORTING INVESTMENTS IN SECURITIES AVAILABLE-FOR-SALE INCOME STATEMENT($ in millions) Revenues $  Expenses () Other Income (Expense): Investment revenue 2 Gain on sale of investments 3 Net Income $  STATEMENT OF COMPREHENSIVE INCOME-OCI Unrealized holding gain on investments $ 4 BALANCE SHEET Assets Securities available-for-sale $50 Plus: Fair value adjustment 4 $54 Liabilities Not affected Shareholders’ Equity Accumulated other comprehensive income Net unrealized holding gain (loss) $ 4

13. SELLING SECURITIES PREVIOUSLY ADJUSTED TO FAIR VALUE Sale of Investments June 9 Sold the Millington shares for $36 million. ($ in millions) Cash 36 Investment in Millington shares (cost) 30 Gain on sale of investments (difference) 6 Purchase of Investments October 7 Purchased shares of Eads Industries for $45 million. Investment in Eads shares 45 Cash 45

14. ADJUSTING INVESTMENTS TO FAIR VALUE December 31 The market prices of the investments are: Bartlett Corporation common shares $16 million Eads Industries common shares 46 million ($ in millions) Fair Value Securities Available-for-Sale Cost Fair Value Adjustment Bartlett Corporation shares $20 Eads Industries shares 45 Totals $65

15. ADJUSTING INVESTMENTS TO FAIR VALUE December 31 The market prices of the investments are: Bartlett Corporation common shares $16 million Eads Industries common shares 46 million ($ in millions) Fair Value Securities Available-for-Sale Cost Fair Value Adjustment Bartlett Corporation shares $20 $16 $(4) Eads Industries shares 45 46 1 Totals $65 $62 $(3) Moving from a positive $4 (last yr) to a negative $3 requires a reduction of $7: --^-----------^----------^---------------------------------- -3 0 +4 <-------------------------- -7 Unrealized holding loss–OCI ($4 credit to $3 debit) 7 Fair value adjustment ($4 debit to $3 credit) 7 Balance from last period

16. RECLASSIFICATION ADJUSTMENT Bartlett: Cost FV (last yr) FV (this yr) $20 $19 $16

17. Other comprehensive income for the year also includes: RECLASSIFICATION ADJUSTMENT

18. AND, Other comprehensive income for the year includes: RECLASSIFICATION ADJUSTMENT Millington: Cost FV (last yr) Sold (this yr) $30$35 $36 Cash 36 Investment in Millington shares 30 Gain on sale of investments 6

19. RECLASSIFICATION ADJUSTMENT v Components one and two represent a change in the fair value while holding securities during the current year. v The third component reduces this year’s comprehensive income by the amount that was reported last year to keep it from being reported twice. v This adjustment is automatically accomplished each period when we compare the cost of the portfolio with its fair value. OTHER COMPREHENSIVE INCOME Unrealized holding gains (losses) on investments $ (2) Reclassification adjustment of last year’s unrealized gain included in this year’s net income (5) Net unrealized holding gains (losses) $ (7)

20. Fair Value Option IAS 39 gives a company the option to value some financial assets and liabilities at fair value with unrealized gains and losses recognized in net income in the period in which they occur. To avoid misuse, the fair value option is limited to only those financial instruments falling into one of the following categories. • a group of financial assets, financial liabilities, or both is managed and its performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, or • the fair value option designation eliminates or significantly reduces an “accounting mismatch” that would otherwise arise from measuring assets or liabilities or recognizing the gains and losses on them on different bases

21. IFRS / U.S. GAAP DIFFERENCE • Fair Value Option. International accounting standards are more restrictive than U.S. standards for determining when firms are allowed to elect the fair value option. Under IFRS No. 39, companies can elect the fair value option only in specific circumstances. • Although SFAS No. 159 indicates that the intent of the fair value option under U.S. GAAP is to address these sorts of circumstances, it does not require that those circumstances exist.

22. FVO for Investment Securities • Securities classified as FVTPL already are accounted for at fair value, so there is no need to choose the fair value option for them. • Choosing the fair value option for HTM and AFS investments just requires reclassifying those investments as FVTPL

23. FVO - Investments Illustration Buyer, Inc. chooses the fair value option for its investments. On July 1, it bought $200,000 of Seller, Inc.’s 8% bonds, priced to yield 10%, and issued for $180,000. Their fair value was $183,000 on December 31. Buyer recorded the Dec. 31 interest with the following entry: Cash ($200,000 x 8% x 6/12) 8,000 Discount on investment 1,000 Interest revenue ($180,000 x 10% x 6/12) 9,000  Amortizing the discount in this entry increased the book value of the investment by $1,000 to $181,000.  Comparing that amount with the fair value of the bonds on that date provides the amount needed to adjust the bonds to their fair value. Dec. 31 fair value $183,000 Dec. 31 book value (amortized initial amount) 181,000 Fair value adjustment needed $ 2,000  Rather than increasing the investment account itself, though, we instead increase it indirectly with a valuation allowance (or contra) account: Fair value adjustment ($183,000 – 181,000) 2,000 Unrealized holding gain 2,000  Buyer, Inc. must recognize the unrealized holding gain in the income statement. Unpaid interest Face amt. x stated rate Balance x effective rate Bond investment $200,000less: Discount (19,000)Book Value$181,000FV adjustment 2,000 Fair value $183,000 Bonds Payable  less: Discount Book Value

24. TRANSACTION COSTS Transaction costs incurred in connection with investments are recorded as an addition to the cost of the investment.  An exception is when the investment is classified as at FVTPL. in that case transaction costs are expensed immediately.

25. IFRS / U.S. GAAP DIFFERENCE Equity Method.Like international accounting standards, U.S. GAAP requires the equity method for use with significant influence investees (referred to as “associates”), but unlike IFRS 28, U.S. GAAP has no such requirement. Equity Method

26. No FVO for Investments Otherwise Accounted For by the Equity Method IFRS 28 does not allow for equity method investments to be reclassified to FVTPL. IFRS / U.S. GAAP DIFFERENCE • Equity Method.Like international accounting standards, U.S. GAAP requires the equity method for use with significant influence investees (referred to as “associates”), but unlike IFRS 28, U.S. GAAP has no such requirement.

27. Impairment Losses  The classification of the investment determines how we record an impairment loss. Securities at FVTPL. Impairment rules do not apply. HTM Securities. Loss is the difference between the carrying amount and the PV of estimated future cash flows. The loss is reported in NI. Impairment losses can be reversed (through NI). Securities AFS. The cumulative loss that has been reported in OCI is removed from equity (AOCI) and reported in NI. Reversals are permitted for debt investments only, not for equity investments.

28. Impairment Losses IFRS / U.S. GAAP DIFFERENCE International standards allow the reversal of some impairment losses through net income. U.S. GAAP does not permit such reversals.

29. Fair Value Option for Non-Financial Assets IAS 16 allows a company to value PP&E at (1) cost less accumulated depreciation or (2) fair value (revaluation). If revaluation is chosen, all assets within a class of PP&E must be revalued on a regular basis. Also permitted to value an intangible asset at FV if FV can be determined by reference to an active market. Since few intangibles are traded on an active exchange, few intangible assets are accounted for under the FVO.

30. Fair Value Option for Non-Financial Assets IFRS / U.S. GAAP DIFFERENCE International standards allow the revaluation of P,P,&E and for some intangible assets. U.S. GAAP does not permit revaluation.