## Learning Outcomes

- Explain the IFRS 9 default treatment for investments in equity instruments.
- Identify when the FVOCI election is available and why it is irrevocable.
- Account for fair value gains and losses on equity investments measured at FVTPL and FVOCI.
- Explain the treatment of dividends from equity investments.
- Apply the derecognition rules on disposal of equity instruments.
- Avoid common ACCA FR errors involving recycling gains from OCI to profit or loss.
- Recognise the IFRS 7 disclosure focus for FVOCI equity investments.

## ACCA Financial Reporting (FR) Syllabus

Equity investments are a common testing area within financial instruments because IFRS 9 gives a simple default rule but also an optional OCI presentation route. In ACCA FR, you may be asked to select the correct measurement category, calculate a carrying amount, decide whether a gain is reported in profit or loss or OCI, or explain the treatment on sale.

- Equity investments are measured at fair value after initial recognition.
- In the absence of an election at initial recognition, fair value changes go to profit or loss.
- The FVOCI election is available only for equity investments not held for trading.
- The FVOCI election is made at initial recognition and cannot be reversed.
- Dividends from equity investments are normally recognised in profit or loss.
- Gains and losses on FVOCI equity investments are not recycled to profit or loss on disposal.
- IFRS 7 requires extra disclosure for equity instruments designated at FVOCI.

## Test Your Knowledge

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, look more closely at that area during your revision._

1. What is the default IFRS 9 measurement category for an investment in ordinary shares if no OCI election is made?
2. When must an entity make the FVOCI election for an equity investment?
3. Where are dividends from FVOCI equity investments normally recognised?
4. On disposal of an equity investment designated at FVOCI, is the cumulative OCI gain transferred to profit or loss?
5. Why is an equity investment held for short-term trading not eligible for the FVOCI election?

## Introduction

IFRS 9 requires most financial assets to be classified and measured based on their nature and, for debt instruments, the business model and cash flow characteristics. Equity instruments are different. An investment in another entity’s ordinary shares does not have fixed contractual cash flows of principal and interest, so it is not measured at amortised cost. The main rule is fair value measurement.

For ACCA FR, the key issue is not usually whether an equity investment is measured at fair value. It is where the fair value gain or loss is reported. Unless the entity makes a valid election at initial recognition, fair value gains and losses on equity investments are recognised in profit or loss. If the FVOCI election is validly made, fair value gains and losses are presented in OCI, but they are not later recycled to profit or loss.

> **Key Term: Equity instrument**
> A contract that gives the holder a residual interest in the assets of another entity after deducting all of that entity’s liabilities.

### Default IFRS 9 treatment: equity investments at FVTPL

Under IFRS 9, investments in equity instruments are measured at fair value. The default category is fair value through profit or loss. This means that any gain or loss caused by remeasuring the investment to fair value is recognised in profit or loss.

> **Key Term: Fair value through profit or loss**
> A measurement basis under which the asset is carried at fair value and changes in fair value are recognised in profit or loss.

This default treatment applies when no valid FVOCI election has been made. It is also the required treatment for equity investments held for trading, because IFRS 9 does not allow the OCI election for trading investments.

For example, assume Kato Co buys listed shares for $80,000 and classifies them at FVTPL. At the reporting date, the shares are worth $92,000. Kato Co recognises a financial asset of $92,000 and a fair value gain of $12,000 in profit or loss. If, in the next period, the shares fall to $86,000, a $6,000 fair value loss is recognised in profit or loss.

Transaction costs also matter. For a financial asset measured at FVTPL, transaction costs are expensed in profit or loss when incurred. This is because the asset is initially measured at fair value and not at fair value plus transaction costs.

> **Test Tip:**
> If an ACCA FR question says an entity purchased shares and gives no evidence of an FVOCI election at initial recognition, use FVTPL. The investment is measured at fair value, and the gain or loss goes to profit or loss.

The default rule is often tested through objective test questions. A common format is a sentence completion question: “IFRS 9 requires investments in equity instruments to be measured at **_ with changes going through _** in the absence of any election at initial recognition.” The correct answer is fair value, with changes going through profit or loss.

This is a high-yield point because students sometimes confuse equity investments with debt instruments. A debt investment may be measured at amortised cost if the entity holds it to collect contractual cash flows consisting solely of principal and interest. That logic does not apply to ordinary shares. Shares do not give the holder a contractual right to fixed interest or repayment of principal. They give a residual ownership interest.

### The FVOCI election for non-trading equity investments

IFRS 9 allows an entity to make an irrevocable election to present fair value gains and losses on certain equity investments in OCI. This is usually called the FVOCI election for equity instruments.

> **Key Term: FVOCI election**
> An irrevocable choice made at initial recognition to present fair value gains and losses on a qualifying equity investment in OCI rather than in profit or loss.

The election is subject to strict conditions:

- it must relate to an investment in an equity instrument;
- the investment must not be held for trading;
- the election must be made at initial recognition;
- the election is made instrument by instrument; and
- once made, it cannot be changed later.

> **Key Term: Held for trading**
> A classification used where an asset is acquired mainly for selling in the near term, forms part of a trading portfolio, or is a derivative.

An entity may want the FVOCI election where it holds shares for a long-term strategic purpose rather than for short-term price movements. For instance, a manufacturer may hold a small shareholding in a supplier to strengthen a business relationship. If the shares are not held for trading, the entity may elect to present fair value gains and losses in OCI.

If the FVOCI election is made, transaction costs are included in the initial carrying amount because the asset is not measured at FVTPL. The financial asset is initially recognised at fair value plus directly attributable transaction costs. After initial recognition, the investment is remeasured to fair value at each reporting date, with fair value movements recognised in OCI.

> **Key Term: OCI**
> The part of total income and expense used for items that IFRS requires or permits to be presented outside profit or loss.

Consider this example.

> ** Question:** On 1 January 20X1, Arlen Co buys shares for $50,000 and pays broker fees of $1,000. The shares are not held for trading, and Arlen Co makes the FVOCI election at initial recognition. At 31 December 20X1, the shares have a fair value of $58,000. What is the carrying amount and where is the gain reported?

The initial carrying amount is $51,000: the $50,000 purchase price plus the $1,000 transaction cost. At the reporting date, the investment is carried at fair value of $58,000. The gain of $7,000 is recognised in OCI, not profit or loss.

This differs from FVTPL. If the same investment had been classified at FVTPL, the $1,000 transaction cost would be expensed immediately, and the fair value gain would be recognised in profit or loss.

> **Exam Warning:**
> Do not make the FVOCI election after seeing that the fair value has fallen. The election must be made at initial recognition. It is not a tool for moving losses out of profit or loss at the year end.

The election also cannot be applied to instruments that are not equity instruments under IAS 32. For example, redeemable preference shares may be financial liabilities from the issuer’s point of view if they contain an obligation to repay cash. The holder’s classification needs care, but the key FR exam point is that the OCI election is for equity instruments, not for all investments called “shares”.

### Dividends, impairment and profit or loss effects

Dividends from equity investments are normally recognised in profit or loss. This applies whether the equity investment is measured at FVTPL or designated at FVOCI.

> **Key Term: Dividend income**
> Income recognised when the investor’s right to receive a distribution from an equity investment is established, usually reported in profit or loss.

For example, if a company holds shares designated at FVOCI and receives a $3,000 dividend, the dividend is normally reported in profit or loss as investment income. The fact that fair value gains and losses go to OCI does not mean dividends also go to OCI.

There is one caution. A dividend is not treated as normal income if it clearly represents a recovery of part of the cost of the investment. ACCA FR questions usually keep this simple, so unless the facts state that the dividend is a recovery of cost, treat dividends as profit or loss income.

This creates a split treatment for FVOCI equity investments:

- fair value gains and losses go to OCI;
- dividends usually go to profit or loss;
- disposal gains and losses are not recycled to profit or loss;
- no separate impairment loss is recognised in profit or loss.

The no-impairment point is another area where errors occur. Under IFRS 9, FVOCI debt investments and FVOCI equity investments are not treated in the same way. Debt instruments measured at FVOCI are subject to expected credit loss impairment rules. Equity investments designated at FVOCI are not. If their fair value falls, the fall is recognised in OCI. There is no transfer of an impairment loss to profit or loss.

> **Test Tip:**
> In FR objective test questions, read whether the instrument is a debt instrument or an equity instrument. FVOCI debt instruments and FVOCI equity instruments have different rules, especially for impairment and recycling.

A simple calculation can show the exam effect.

> ** Question:** Bren Co buys non-trading shares for $100,000 and elects FVOCI. At the year end the shares are worth $76,000. What is the accounting treatment?

Bren Co recognises the investment at $76,000. The $24,000 fall is recognised in OCI. It is not an impairment expense in profit or loss.

If the shares were instead classified at FVTPL, the $24,000 fair value loss would be charged to profit or loss.

This difference affects ratios. FVTPL fair value gains and losses affect profit before tax and therefore measures such as profit margin and return on capital employed. FVOCI fair value movements bypass profit or loss, although they still affect total equity through OCI reserves.

### Derecognition and the no-recycling rule

Derecognition means removing the financial asset from the statement of financial position. For equity investments, this usually happens when the shares are sold, or when the contractual rights to cash flows from the asset expire.

> **Key Term: Derecognition**
> The removal of a financial asset or financial liability from the statement of financial position when the relevant IFRS criteria are met.

For an equity investment measured at FVTPL, the asset is remeasured to fair value, and gains or losses are recognised in profit or loss. On sale, any difference between sale proceeds and the carrying amount is also recognised in profit or loss. In many exam questions, if the asset has already been adjusted to fair value immediately before disposal, the disposal gain or loss may be small or nil.

For an equity investment designated at FVOCI, the disposal treatment is the main exam trap. The cumulative gain or loss recorded in OCI is not recycled to profit or loss. IFRS 9 allows the cumulative balance to be transferred within equity, for example from an FVOCI reserve to retained earnings, but it must not pass through profit or loss.

> **Key Term: Recycling**
> The later transfer of a gain or loss previously recognised in OCI into profit or loss.

Consider this example.

> ** Question:** Corda Co buys shares for $40,000 and makes a valid FVOCI election. By 31 December 20X3, the shares have a fair value of $55,000, so a cumulative OCI gain of $15,000 has been recorded. On 10 January 20X4, Corda Co sells the shares for $57,000. How is the disposal accounted for?

The financial asset is removed from the statement of financial position. The extra $2,000 increase from $55,000 to $57,000 is recognised in OCI, not profit or loss. The total cumulative gain of $17,000 may be transferred within equity, such as to retained earnings, but it is not reported in profit or loss.

This is very different from the treatment of many other gains. Students often assume that when an investment is sold, the total gain becomes “realised” and should be reported in profit or loss. IFRS 9 does not permit that for equity investments designated at FVOCI.

> **Exam Warning:**
> Do not recycle FVOCI equity gains to profit or loss on sale. The cumulative OCI balance may move within equity, but profit or loss is not affected by the disposal gain.

A fuller example brings the rules together.

> ** Question:** Derran Co purchased 20,000 shares for $3 each on 1 April 20X1. Transaction costs were $800. The investment was not held for trading, and Derran Co elected FVOCI at initial recognition. At 31 March 20X2, the shares were worth $3.60 each. During the year, Derran Co received dividends of $2,400. On 30 April 20X2, Derran Co sold the shares for $3.75 each. Explain the treatment.

Initial carrying amount is $60,800, made up of the $60,000 purchase price plus $800 transaction costs. At 31 March 20X2, fair value is $72,000, so the gain is $11,200 and is recognised in OCI. The dividend of $2,400 is recognised in profit or loss. On disposal for $75,000, the further $3,000 gain is recognised in OCI. The cumulative OCI gain is $14,200. It may be transferred within equity but must not be taken to profit or loss.

### IFRS 7 disclosure focus for FVOCI equity investments

IFRS 7 requires disclosure that helps users understand financial instruments and their effect on performance, position and risk. For equity instruments designated at FVOCI, the disclosures aim to explain what has been designated, why, and what the financial effects are.

> ** Key Term: IFRS 7 disclosure **
> Information required in the notes to help users understand the significance and risks of financial instruments.

For FVOCI equity investments, disclosure may include:

- which equity investments have been designated at FVOCI;
- the reasons for using the FVOCI presentation election;
- the fair value of the investments at the reporting date;
- dividends recognised during the period;
- any transfers of cumulative gains or losses within equity; and
- for investments disposed of, the fair value at the date of disposal and the cumulative gain or loss.

In ACCA FR, detailed note drafting is less common than recognition and measurement questions. However, disclosure knowledge can help in written parts, especially where a question asks for explanation of accounting treatment. If a company has elected FVOCI for strategic shareholdings, a short answer can refer to the fact that IFRS 7 requires transparent disclosure of the designation and related gains, losses and dividends.

Do not overcomplicate this area. For exam purposes, focus first on the core accounting entries and where each item appears in the financial statements. Disclosure points are useful supporting marks but rarely replace the need to get the measurement and profit or loss treatment correct.

## Key Point Checklist

_This article has covered the following key knowledge points:_

- Equity investments are measured at fair value under IFRS 9.
- The default treatment for equity investments is FVTPL.
- If no valid OCI election is made at initial recognition, fair value gains and losses go to profit or loss.
- The FVOCI election is available only for equity investments not held for trading.
- The FVOCI election is irrevocable and made instrument by instrument.
- FVTPL transaction costs are expensed immediately.
- FVOCI transaction costs are included in the initial carrying amount.
- Dividends from equity investments are normally recognised in profit or loss.
- FVOCI equity investments do not have impairment losses recognised in profit or loss.
- On disposal of an FVOCI equity investment, cumulative OCI gains or losses are not recycled to profit or loss.
- A cumulative FVOCI balance may be transferred within equity, such as to retained earnings.
- IFRS 7 requires disclosure of FVOCI designations, fair values, dividends and disposal effects.

## Key Terms and Concepts

- Equity instrument
- Fair value through profit or loss
- FVOCI election
- Held for trading
- OCI
- Dividend income
- Derecognition
- Recycling
- IFRS 7 disclosure


Subsequent measurement and derecognition - Equity instruments and OCI election