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Investments - Alternative accounting Options for Managing a substantial Balance Sheet Item

Investments - Alternative accounting Options for Managing a substantial Balance Sheet Item. Accounting for Investments. A credit union may invest any of its funds: in securities in which trustees are authorised by law to invest shares deposits or loans to another credit union

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Investments - Alternative accounting Options for Managing a substantial Balance Sheet Item

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  1. Investments - Alternative accounting Options for Managing a substantial Balance Sheet Item

  2. Accounting for Investments • A credit union may invest any of its funds: • in securities in which trustees are authorised by law to invest • shares deposits or loans to another credit union • shares of Industrial and Provident Societies • other investments as may be prescribed by the central Bank • Other funds on current account with a credit institution • Other non-permitted investments to be disposed of within 2 years

  3. Accounting for Investments • Investment prescribed by Central Bank: • Irish and EMU State Securities • Accounts in Authorised Credit Institutions (Irish and Non-Irish based). • Bank Bonds • Investment in Equities • Collective Investment Schemes

  4. Realised profits The Credit Union Act “…only surpluses realised at the balance sheet date shall be included in the income and expenditure account…” “all income and charges … shall be taken into account without regard to the date of receipt of payment..”

  5. Realised profits The Guidance • Realised means received in: • Cash • An asset that is readily convertible to cash (traded in an active market) • accrual of investment income in 2

  6. Realised profits – Practical examples • Short term deposits – all realised • Long term deposits – encashment value – realised • Long term deposits – nominal value - unrealised • Government bonds - realised (active market) • Bank bonds - active market - realised • Bank bonds – in-active market - not realised • Bank bonds – encashment value – realised • Equities – realised • Collective Investment Schemes - encashment value – realised • Collective Investment Schemes - nominal value – not realised

  7. Spanish Government Bonds – Extract from investor analysis “At a current price of c. 100.45, the bond yields c. 2.95% and matures in January 2016. • As a comparison, three year Irish Government bonds yield c. 2.10% and a three year deposit with AIB will pay c. 2.05%. • This bond pays a coupon of 3.15% annually which can be distributed. This will diversify counterparty exposure to sovereign risk and reduce the pressure on domestic bank counterparty exposures Over the life of the investment investing in this Spanish Government bond will generate additional income versus a similar 3 year deposit with AIB yielding 2.05% of c. €13.6k”

  8. Accounting for Investments 1/5 • Irish and EMU State Securities - criteria • Maturity not more than 10 years • 30% max in 7+ year bonds • Not more than 70% of CU portfolio • Amortised Cost • Yield = profit • Capital gains and losses booked • Held to maturity • Yield = profit • Capital gains and losses ignored • Check for impairment • Fair value • Yield = profit • Capital gains and losses booked

  9. Accounting for Investments Irish and EMU State Securities - amortised accounting cost model Issued €0.95 Redeemed €1 Yield = coupon + (1-0.95)/6 periods

  10. Accounting for Investments Irish and EMU State Securities - amortised accounting cost model Redeemed €1 Issued €0.95 Credit downgrade Held to maturity: ignore downgrade (but consider impairment) Cost and fair value: book downgrade – increased yield in future years

  11. Accounting for Investments • Irish and EMU State Securities - purchase at a premium • Nominal value €1.0m • Coupon 5.5% • Yield 2.556% (monthly yield) • Cost to purchase (@111.6) €1,111,600 • Redeemed in 2017 for €1m

  12. Accounting for Investments • Irish and EMU State Securities - purchase at a premium • Nominal €1.0m, Coupon 5.5%, Yield 3.8% (simple) • Cost €1,111,600 Redeemed in 2017 for €1m *2 month to coupon date

  13. Accounting for Investments Irish and EMU State Securities Redeemed €1 2014 Credit downgrade 2013 2016 Issued €1.11 2015 Held to maturity: ignore downgrade (but consider impairment) Cost and fair value: book downgrade – increased yield in future years

  14. Accounting for Investments 2/5 • Irish and EMU State Securities - purchase at a premium • Lets be really clear • Purchase a €1m bond for €1.1m • Investment is €1.1m (not €1m) • There is not an expenses of €100k • Coupon is a cash flow number and irrelevant to the income statement • Yield (to maturity) is the key number

  15. Spanish Government Bonds – Extract from investor analysis “At a current price of c. 100.45, the bond yields c. 2.95% and matures in January 2016. • As a comparison, three year Irish Government bonds yield c. 2.10% and a three year deposit with AIB will pay c. 2.05%. • This bond pays a coupon of 3.15% annually which can be distributed. This will diversify counterparty exposure to sovereign risk and reduce the pressure on domestic bank counterparty exposures Over the life of the investment investing in this Spanish Government bond will generate additional income versus a similar 3 year deposit with AIB yielding 2.05% of c. €13.6k”

  16. Accounting for Investments 2/5 • Accounts in Authorised Credit Institutions • Maturity not more than 10 years • 50% max in 5+ year deposits • 20% max in 7+ year deposits • Credit rating of A • Not more than 25% of CU portfolio

  17. Accounting for Investments Accounts in Authorised Credit Institutions • Cost and fair value - short term • Interest is income • Held to maturity • Interest is income • Early encashment penalty is non distributable • Check for impairment • Cost - long term deposits • Interest less encashment penalty as income • Fair value - long term deposits • Interest = income + gains and losses due to credit risk changes

  18. Accounting for Investments 3/5 • Bank Bonds • Traded on a regulated market • Maturity not more than 10 years • 30% max in 7+ year deposits • Credit rating of A (institute not bond) • Not more than 70% of CU portfolio

  19. Accounting for Investments Bank bonds – active market • Held to maturity • Book yield as profit • Capital gains and losses ignored • Check for impairment • Amortised Cost + Fair value • Book yield as profit • Capital gains and losses booked Must have an “active market” for gains to be realised

  20. Accounting for Investments Bank bonds – inactive market • Held to maturity • Book yield as profit • Encashment value in excess of cost = realised income, balance = unrealised • Check for impairment • Amortised Cost • Encashment value in excess of cost = income • Fair value • Yield + capital gains and losses = income • Only encashment excess is distributable Possibly Illegal

  21. Accounting for Investments 4/5 • Investment in equities • Euro denominated, traded on regulated EU market • Market capitalisation of €.5bln • Not more than 5% of CU portfolio (total) • Not more than 1% of CU portfolio (any one share)

  22. Accounting for Investments 4/5 • Investment in equities Cost and fair value Dividend and gains + losses as profit (gains not distributable) Held to maturity n/a

  23. Accounting for Investments 5/5 • Collective Investment Schemes • No property schemes • Financial Regulator Authorised schemes only • Underlying investments meet requirements in 1-4

  24. Accounting for Investments 5/5 • Collective Investment Schemes • Held to maturity • Book yield as profit • Encashment value in excess of cost = realised income, balance = unrealised • Check for impairment • Amortised Cost • Encashment value in excess of cost = income • Fair value • Yield + capital gains and losses = income • Only encashment excess is distributable Possibly Illegal

  25. Investments - key questions • Is it on the list of authorised investments for credit unions • Is there a deep and liquid market for the product • Credit rating of the issuer • Credit rating of the bond • Will this product be accounted for as a simple financial instrument under Chapter 11 of FRS 102 • Or Will this product be accounted for as an other financial instrument under Chapter 12 of FRS 102

  26. Investments - myths debunked • Spanish Government bonds are allowed • (2.9% yield but be careful of volatility and default) • Junk/subordinated bonds from an A credit rated bank are allowed • (10% yield but good chance of default) • When referring to investment products, the word “guaranteed” is an single word oxymoron

  27. CONTACT aidan.clifford@accaglobal.com 01 4988907 www.accaglobal.com

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