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Investment Accounting in 2022: A New Perspective

What is Investment Accounting?

Investment accounting is a specialized part of the wider accounting field. Investment accountants are responsible for accounting for investment at asset and brokerage firms.

They process investments and monitor the activities of third parties. Investment accountants are responsible for managing client investments, keeping track of third-party activity and managing debt investments. We have listed five main tasks performed by investment accountants:

  • Monitor Client Investments: Investment accountants maintain & monitor client investments. They need to be familiar with their state's regulations regarding managing and reporting on investments.
  • Keep track of third party activity: Investment accountants keep track of third-party activity related to the investments of their clients or firms. Investment activity by others could impact a client's financial standing.
  • Manage Debt Investments. Another important responsibility of investment accountants is the management of debt investments. These investments are usually more stable and predictable than stocks. Bank loans and bonds are two examples of debt investments.
  • Financial Advice and Consulting: Some investment accounting professionals in managerial positions provide financial advice to asset managers and brokers. They can provide information about taxes, accounting activities, financial services, and products.
  • Prepare Tax Reports: This is another important task for investment accountants. They need to keep accurate and clear records of investments to create reports for government agencies.

Classification of investments

Investors report their balance sheets and classify them into current or non-current portions. Current investments (expected to mature in 12 months) are short-term investments, while non-current investments are long-term. Cash equivalents are investments that can be converted easily to cash and have negligible fluctuations in their value.

Principal types of investments are equity securities, debt securities, and derivative instruments.

  • Equity securities are financial instruments that represent residual interest (ownership) in a company, such as common stocks.
  • Debt securities are financial instruments that represent a right to a fixed stream of cash flows over a set period, like bonds.
  • Derivative securities refer to financial instruments that derive value from other financial instruments such as futures contracts, forward contracts, and options.

Accounting Classification of debt securities

IAS 32, IAS 39, the IFRS financial instrument accounting standards before IFRS 9, classified debt securities as:

  • held to maturity
  • sold
  • used for trading

The new standard, IFRS9, requires debt securities to be classified primarily into those at:

  • Amortized costs.
  • Fair value through profit or loss(FVTPL)
  • Fair value through other comprehensive income (FVOCI)

The legal form of an instrument is what dictates the classification under US GAAP. For many debt securities, the US GAAP preserves the legacy classification categories.

Classification under IFRS depends on (a) the instrument's business model and (b) its cash flow characteristics. First, an investor determines if the investor's business model is to either hold the asset to generate cash flows or sell it to make capital gains. The SPPI test is second. It determines whether cash flows of the asset consist of payments of only principal and interest. IFRS defines the following categories of debt securities:

  • Debt securities are classified at amortized cost if the company's business model calls for holding the asset to collect cash flow. These cash flows are only payments of principal and interest.
  • Debt securities are categorized at FVOCI(Fair value through other comprehensive income) when the investor's business model collects cash flows as well as sells the asset. The cash flows are purely payments of principal or interest.
  • Debt securities that do not meet the criteria for either FVTOCI or amortized cost are classified as FVTPL(Fair value through loss or profit).

Accounting Classification for equity securities

Accounting for Equity investments is based on the extent of ownership:

  • Controlling interest: If Company A has more than 50% of the equity in Company B, it is entitled to control Company B and has to prepare consolidated financial reports.
  • A significant influence: Company A can own anywhere from 20% to 50% of the equity of Company B. This gives it significant power over Company B. It is also required to account for any investments made in Company B by using the equity method.
  • There is no controlling interest or significant influence: If Company A holds less than 20% of Company B's equity, neither consolidation nor the equity method is required.

Previously, investment accounting standards such as IAS 39 or its U.S. GAAP equivalent allowed equity instruments to be classified as:

(a) held for trading

(b) designated at fair value through profit & loss

(c) available for sale

The new accounting standard, IFRS 9, fair value through loss (FVTPL), is preferred for all equity securities. This means equity security will be typically carried at fair value with any changes reflected into profit or loss.

However, under IFRS, a company can irrevocably categorize equity investments (on an instrument-by-instrument basis) at fair value through other comprehensive income (FVOCI). This means that securities are carried at fair values, but changes are reflected in other comprehensive Income. This categorization does not allow future reclassifications to the FVTPL category for such investments.

The US GAAP also allows for exceptions to the default value category. If fair value cannot be determined, equity investments can be made at fewer impairment losses.

Classification example

You are an accountant at Glow, Inc., a future-oriented technology-enabled financial service company. The company's newly appointed Investment Manager embarked upon an aggressive investment spree. The company's cash and cash equivalents stood at $2.2 billion at the beginning of 20X7. The following are the company's transactions during the year:

  • 1 January 20X7 - acquired 60% holdings of Kits, Inc. for $300 Million.
  • 1 February 20X7: Purchased 18% of common stock of Flair, Inc., a cutting-edge communications company, for $450 million with intent to hold them for an indefinite period.
  • 1 March 20X7 - Invested $55 million in an Equity Mutual Fund intending to sell it within the next few months.
  • 30 June 20X7 - Sold the equity mutual fund investment made on 1 March 20X7 for $60 million.
  • 1 July 20X7: Invested in plain vanilla government bonds of face value $350 million due by the end of the 5th Year with an interest rate of 8% at par. The company intends to hold them up to maturity.
  • 1 September 20X7 - acquired 35% Holding for $320 in Cable, Inc.

At the year-end, i.e. 31 December 20X7, Kits, Inc. investment dropped to $290m, while Flair, Inc. investment rose to $500m, and Cable, Inc. investment was valued at $350m. Dividends of $2 million were earned from Kits, Inc. and nothing from Air, Inc., the equity mutual fund, and Cable, Inc. Cable, Inc.'s net income for the financial year 20X7 was $15 million.

Identify the investment categories and outline the accounting treatment of related gains or losses.

Solution

  • Since it represents control, the 60% stake in Kits, Inc. needs to be consolidated in the financial reports of Glow, Inc.
  • The 18% stake in Flair, Inc. should be classified at FVTPL, and a gain of $50 million ($500 million - $450 million) should be reported in the income statement.
  • The investment of $55million in equity mutual funds should be classified as FVTPL. The realized gain of $5million ($60 million - $55million) should be added to the income statement.
  • The investment in government securities is to be carried out at amortized cost. We need to recognize interest income in the income statement. This is due to the company's business model of 'hold the asset to collect' cash flows that meet the SPPI test.
  • The 35% stake in Cable, Inc. resulted in significant influence and should be accounted for using the equity method.
  • The company has an option to designate the investments in Flair, Inc. and the equity mutual fund at FVOCI on initial recognition, in which case the unrealized gains will be reported in other comprehensive income.

TOP TRENDS IN INVESTMENT ACCOUNTING

The COVID-19 pandemic, adoption of digital technologies, and the government's expanding role in the economy have accelerated key global trends. Here are the top trends that can potentially change the perception of the global market's winners and losers.

1. Cloud-based accounting: A Digital Revolution

Investment accounting software manages the accounting processes associated with investments. These solutions handle the multiple types of accounting required of investment income, including equity method, trading security, available for sale, and more. With the rise in digitization, these solutions are being adopted as a norm as they simplify and streamline otherwise time-consuming tasks and processes. Solutions like Altair and backstop solutions enable their clients to quickly and easily access, share, and manage critical knowledge to their day-to-day business success. Backstop Solutions raised $20m in funding, which is only a start to the digital revolution in investment accounting technology.

About 67% of accountants believe cloud technology can simplify their jobs (Sage, 2018). Sage conducted a survey that found 53% of respondents used cloud-based solutions to manage client communications and project management. This could be due to the increased demand for technological solutions in various industries. The accounting industry is one of them and is making significant strides in achieving more accurate and comprehensive financial reporting.

2. Data Analytics: The Key to Success

The accounting industry is shifting its focus to data analysis as technology makes specific accounting tasks more manageable. Businesses can gain valuable insight by analyzing numbers, which allows them to identify potential process improvements and improve efficiency. With unique skills that revolve around data analysis, accountants are taking on roles as advisors & consultants.

Analytics as part of accounting services are not new. However, they are now more powerful and present financial performance in new ways for better actionable insights. Prominent accounting firms use data analytics in auditing, tax, consulting, and risk management. Whereas CPAs are utilizing the best data analysis solutions to meet industry-specific requirements.

3. Outsourcing Accounting Functions

Many companies are now turning towards outsourcing for accounting functions. Outsourcing accounting functions is a popular option for businesses, which reaps many benefits. Outsourcing allows companies to focus their scarce resources on crucial tasks and increase profitability. It also helps companies save money on employment costs such as payroll, taxation, salary, benefits, and training.

Accounting is becoming a highly respected career, particularly in business processing outsourcing(BPO) companies. This has led to an increase in outsourcing accounting service providers and is one of the fastest-growing areas in the accounting industry. CPA firms are increasingly relying on outsourcing to provide efficient services to clients. They analyze their business operations and add value to their business. Most businesses are satisfied with the quality and results of their outsourced accounting services every year.

4. More emphasis on employee satisfaction

Accounting firms are not the only ones that have picked up employee satisfaction as a critical priority. Organizations have had to reevaluate their employee benefits, pay, culture and work environment in light of the "Great Resignation" this year.

Employers also examine employee satisfaction levels to prevent them from leaving their organizations. This includes examining how to resolve employee dissatisfaction, especially those that include the desire to leave the organization.

These retention strategies are expected to continue through 2022 and give job applicants an advantage. Candidates may be more likely to get what they want when negotiating a job offer.

5.Blockchain

Blockchain technology is essential for the accounting industry. Blockchain technology is already changing the accounting industry by lowering the costs of reconciling, and maintaining ledgers. It provides accurate information about ownership and the history of assets. Blockchain technology gives accountants a clearer view of their company's obligations and available resources. It's not surprising that there are a lot of blockchain wallets created each month, with a large portion belonging to companies. According to data (Statista 2020), US firms will spend $1.1 billion on blockchain technology by the end of 2022.

The Big Four accounting firms, Price Waterhouse, Ernst Young, Deloitte and KPMG, have joined the blockchain trend by having their employees work in distributed ledger labs. This is being done, hoping that immutable distributed ledgers will become a reality. Their accounting and audit divisions will likely become obsolete in that scenario.

6. Advisory Services

Experts predict a hybrid approach that will briefly combine financial advisor input and accounting technology. The new analytics solutions have allowed accountants to concentrate more on decoding data and providing more profound insights. Decision-making, unlike other tasks in accounting, will always be left to human professionals and experts. Therefore, complete automation cannot be achieved in the accounting sector.

Accounting firms can now focus on quality and innovation in their advisory services thanks to the increasing use of advanced technology within the industry. The quality of services such as growth profitability strategies and business intelligence is improving and increasing. Accounting firms can spend more time analyzing data providing insights and advice, particularly in disruptive times like the COVID-19 pandemic.

Automation of accounting processes reduces errors and increases client confidence in the data. This improves the quality of the advice they receive. Investment Accounting professionals can also rely on robotic process automation (RPA) to understand client intent and base its current actions on past data (Bernard Marr & Co).

Ending Notes:

The current accounting trends show us that digitization is just as prevalent in the accounting industry as anywhere else. However, human roles are still relevant. Remote work is another significant development that will change how accounting works in the future. It is already a big trend in other industries, and it will continue to be a significant part of accounting practice in the future.

The latest developments in accounting provide many benefits. These include time savings, more efficient tasks, and more accurate analytics. Companies and accounting firms can also enjoy significant cost savings by embracing the latest technology to optimize their processes. As the world struggles to navigate the economic chaos caused by the COVID-19 epidemic, we must reduce our costs.