ACCOUNTING THEORY I

(70-351)
CASE ANALYSIS # 2

Submitted By:

Abdul Qadir
Student # 101684280
 OVERVIEW

Investment Company Limited is a Private Company which manages the

owner’s investment portfolios. Company has its board of directors
which consists of ten Doctors who owns equal shares of the company.
The company employees two full time Managers to look after the
investment business and day-to-day activities. The average earnings
per year after tax are $1.5 Million. In the past the company has
invested mainly in private companies but now they are planning to
invest more in public companies because the stock market is expected
to perform better. For the purpose of investment they want to borrow
money from bank, therefore, the bank is the main user of this
information. The most important information for the banker is the
ability to repay the loan and a successful business.GAAP is a constraint
since the bank will likely to see the information which is reliable and
relevant. Main issues in the case study are identification of each
category of investment and accounting and reporting treatment for
each category.
ANALYSIS AND RECOMMENDATIONS:
INVESTMENT A (IA):
ICL has purchased common shares of IA for $1,000,000 which
represents 15% of the total outstanding common shares of the
company. While an equity of less than 50% of an investee corporation
does not give an investor legal control, it could give the investor the
ability to exercise significant influence over the strategic policies of the
investee.To provide a guide for accounting for investors who held 50%
or less of the voting common shares and to develop an operational
definition of “significant influence” the AcSB of the CICA noted in CICA
handbook Section 3050 that the ability to exercise influence over
another company’s operating,investing,and financing activities may be
indicated in several ways. For instance: representation on the board of
directors, participation in policy-making processes, material
intercompany transactions, interchange of managerial personnel, or
provision of technical information.
In the transaction IA, we have significant influence because we
have one member on the Board of Directors out of three and one of
the owner of ICL is a consultant of the IA to advise them on the
acquisitions of equipment or he’s providing technical information to
IA.Since we have not designated these shares as trading and the
company is not sure as to how long we’ll keep them, we will classify
them as Available for Sale-Equity Securities with significant influence.
Accordingly these will be valued by using Equity method.

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INVESTMENT B(IB):
A preferred stock, also known as a preferred share or simply a
preferred, is a type of stock. It typically gives the owner the right to
collect a fixed dividend from the firm when funds are available for
distribution, with higher priority than regular stock owners, hence the
“preferred”name.However,it, it generally does not give the owner any
voting power in the decisions of the firm. In that sense it has a lower
ranking than regular stock, and hence is more similar to debt. Also,
the dividend owed to preferred shareholders is generally fixed and
therefore they do not benefit from large dividend payouts, as regular
stock holders do.
Although we have 25% shares of IB but since these are
“preferred” shares we don’t have any control in this company. Now the
issue is how to classify this investment as per CICA guide lines. It is
likely that we’ll sell these shares within two months but there is no
clear cut decision about it. We’ll classify these shares as trading
securities or held-for-trading investments. The investments under this
classification are acquired with the intention of being sold in a short
period of time. These securities are reported at fair value, with
unrealized gains and losses reported as part of net income.
INVESTMENT C(IC):
We purchased 25% common shares two years ago of IC.As we know,
common shares carry voting rights in a company, which means more
shares held, the more votes and therefore the more say the investor
has in the decisions made by the company invested in. Accounting for
investments in common shares of another company is depends on the
relationship between the investor and the investee.This relationship is
classified by the level of influence which in turn generally related to
degree of share ownership. As per accounting guide lines since we
have 25% shares we can classify this investment as with significant
influence with the assumption that other shares are not held by few
entities. Equity method is used to valuate investments with significant
influence. Under the equity method, a substantive relationship is
acknowledged between the investor and the investee.Originally, the,
the investment is recorded at the cost of the shares acquired but is
subsequently adjusted each period for changes in the net assets of the
investee.Since, the carrying value of these shares has decreased to
$950,000 from $1 Million we have to adjust this loss in our financial
statements.
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