8.8. Investment income credits refer to the income accruing to Australian residents from the provision of financial capital to non-residents (evidenced by ownership of foreign financial assets). Investment income debits refer to the income accruing to non-residents from the provision of financial capital to Australian residents (evidenced by their ownership of Australian financial assets).
8.9. Investment income is primarily classified by direct, portfolio and other investment income (these terms are described in paragraph 3.17). The classification of direct investment income mirrors the classification for direction of investment (see paragraph 3.20) and the classification of portfolio and other investment income implicitly mirrors the asset and liability classification applied to the financial account transactions and international investment position. In turn, for direct and portfolio investment, separate data are provided for income on equity and income on debt. Within direct investment, income on equity is further divided into dividends and distributed branch profits, and reinvested earnings and undistributed branch profits. For portfolio investment, income on equity is synonymous with dividends. While financial derivatives are a type of financial instrument, they are created by the issuers without the provision of financial capital. Therefore there cannot, in concept, be any income accruing to the use of financial capital. Any capital gain or loss on these instruments, as with all other financial instruments, is included, when realised, in the financial account.
8.10. The direct investment credit entry represents income earned from direct investment enterprises abroad (foreign affiliates) less any income earned by foreign affiliates from their Australian direct investors (i.e. it is a net position). Similarly, the debit entry represents income earned by direct investors abroad from their Australian direct investment enterprises less income earned by those enterprises from their direct investors abroad. This netting process is shown explicitly in table 8.2 where the underlying income components for direct investment debt are shown separately. This netting process can result in the recording of a negative credit entry (income earned by Australian direct investors from their foreign affiliates is exceeded by income earned from the Australian direct investors by the foreign affiliates) and a positive debit entry (income earned by foreign direct investors from their Australian direct investment enterprises is exceeded by income earned by the Australian direct investment enterprises from their direct investors abroad).
8.11. Investment income is measured before the deduction of withholding taxes, which should be shown in current transfers. In Australian balance of payments statistics, this before tax measurement has been adopted since 1960-61 for income debits and since 1985-86 for income credits. For prior periods investment income was measured after deducting withholding taxes. Investment income, when denominated in foreign currency, is converted to Australian dollars by businesses and other entities reporting to the ABS, at the mid-point exchange rate at the time the income is earned. Holding gains and losses are not included in income. When holding gains and losses are realised they are included in the financial account, and when unrealised they are included in the price change component in the international investment position. From the September quarter 1998, the ABS plans to adjust interest income to take account of implicit financial services charges applicable to certain financial intermediation activities (see paragraph 2.26), and record the service flows separately in financial services.
Time of recording
8.12. Investment income is measured on an accrual basis. The earnings of direct investors from their ownership of direct investment capital are recorded in the period that the direct investment enterprises earned their operating and other current income. Dividends, in direct and portfolio investment, are measured in the period in which they are declared payable. Therefore reinvested earnings in direct investment enterprises are measured as the direct investors’ equity share of their current earnings less dividends declared payable and distributed profits of branches (i.e. withdrawals by the head office). Interest income is accrued in the period in which it is earned. For an explanation of the impact of accrued interest income on the financial account see box 11.1.
8.13. In the case of portfolio debt securities, a number of difficulties are encountered in collecting interest income accrued from liability issuers and asset holders. They occur because both issuers and holders may adopt historical cost accounting or include holding gains and losses which, in economic statistics, are excluded from measures of income and are included in the financial account. For these reasons, the ABS models income transactions on debt securities; this is referred to as the Accrued Income on Debt Securities Model.
8.14. For long-term debt securities (issued for twelve months or more), the approach used in the model is to take the average stock of securities for a quarter (i.e. half the opening plus half the closing stock), valued at market value, and apply market yields (interest earnings) appropriate to the security. This may be applied at an aggregate level, but preferably at an individual security level, as yields may vary for a number of reasons including credit worthiness of the issuer, the currency of denomination of the security, and the duration of the instrument. When average yields are applied to aggregate stocks, the model attempts to distinguish the sector of issuer, the market in which the issue is made and the currency of issue. In the longer term, the ABS hopes generally to move to a security-by-security model. For short-term securities, reported income is assumed to be a good proxy for accrued income because the very short duration of the instruments means that yield changes can have less impact; however, some smoothing of reported data is undertaken to take account of positions held across quarters. The methodology outlined here is not applied to Reserve Bank holdings, where the reported income on reserve assets is used directly in compiling investment income.
Equity and interest income
8.15. Dividends are earnings distributed to the shareholders of an incorporated enterprise. Dividends represent income that is declared payable without a binding agreement between the creditor and the debtor, i.e. dividends are regarded as discretionary. Stock dividends, i.e. shares issued in lieu of cash, are included in dividends with an offsetting equity investment in the financial account. Bonus shares issued, which represent the substitution of one type of equity for another (e.g. paid-up capital for reinvested earnings), or simply the division of shares, are not regarded as dividends. Income earned on non-participating preference shares, which are regarded as debt and not equity instruments, is excluded from dividends and included in interest. Liquidating dividends are regarded as a financial transaction and again are not recorded as dividends. Distributed branch profits refer to the distribution of income of branches and other unincorporated enterprises to their owners. As with dividends, income distributed in this way is at the discretion of the owners.
8.16. Reinvested earnings and undistributed branch profits refer to that part of the undistributed income of a direct investment enterprise that is attributable to direct investors in the enterprise. Undistributed income attributable to direct investors is included as investment income in the current account, with a corresponding offsetting entry in the financial account (see paragraph 2.25). This treatment is adopted because it is considered that direct investors, through their significant influence on the operations of the direct investment enterprise, are able to determine the level of distributed income and therefore the reinvested earnings of the direct investment enterprise. In the case of an incorporated direct investment enterprise, attribution of reinvested earnings to the direct investor is in the proportion of the direct investor’s holding of voting shares to the total voting shares issued by the direct investment enterprise. If the direct investment enterprise is unincorporated, the proportion used is that represented by the ownership interest of the direct investor. Attributing reinvested earnings to shareholders is not extended to portfolio investors because they are not able to influence the level of distributed and undistributed income.
8.17. Interest is measured through the return to the providers of financial capital, evidenced by holdings of debt (non-equity) instruments, such as non-participating preference shares, debentures, bonds, bills, notes, loans, deposits, financial leases and accounts receivable. It may be described as non-discretionary because it accrues on a continuous basis over the period of the provision of capital and is evidenced by a contractual agreement between creditor and debtor.
8.18. Within portfolio investment debt securities, separate components are shown for bonds and notes, including debentures (long-term instruments), and money market instruments (short-term instruments). However, separate details are not currently available in respect of income credits, for long- and short-term instruments. Portfolio investment income credits include income earned on official reserve assets. Portfolio investment income on equity and debt is classified by the four main institutional sectors: Reserve Bank (only applicable for investment income on debt, credit), general government (not applicable to equity income debit), depository corporations and other sectors.
8.19. Other investment income (i.e. other than from direct or portfolio investment) measures interest earned by residents from claims on non-residents and interest earned by non-residents on resident liabilities to non-residents. It includes interest earned from deposits, loans and trade credits. Interest earned on loans includes that part of financial lease payments construed to represent interest on loans, and in the past when the facility has been used, interest related to the use of IMF credit and loans. Other investment income also includes net charges on holdings of Special Drawing Rights and the imputed income earned by insurance policy holders (the offset to premium supplements). (Net charges on holdings of Special Drawing Rights are the charges by the IMF for the allocation of Special Drawing Rights to Australia, less the interest earned by Australia for the Special Drawing Rights held.)
8.20. As with portfolio investment income, other investment income is classified by the four main institutional sectors.
Measuring direct investment earnings
8.21. Direct investment equity earnings are measured on the basis of the direct investors’ equity share in the current operating performance and other current income and transfers of the direct investment enterprise. Operational earnings represent income from the normal operations of the enterprise and do not include holding gains and losses. (Such as gains and losses resulting from valuation changes (e.g. revaluation of fixed assets and investments, inventory write-offs), equipment sales due to business closure, write-off of intangibles (e.g. goodwill) because of unusual developments in a period, research and development expenditure write-offs, bad debt or expropriation write-offs, abnormal provisions on long-term contracts, and exchange rate losses.) Earnings of direct investment enterprises are measured after deducting provision for corporate taxes (considered to be payable by the enterprise and not the owners) and depreciation of fixed capital. Depreciation should be calculated at current replacement cost taking into account the expected life of the asset (based on normal wear and tear and foreseen obsolescence). Businesses in the Survey of International Investment are asked to report earnings on this basis, but many businesses have difficulties in calculating earnings strictly in accordance with the ideal measure, although the differences may not be material.
8.22. Direct investors’ share in net losses, other than holding gains and losses, of the direct investment enterprise, should be recorded as negative income. That is, for Australian investment abroad, losses are recorded as a negative credit, and for foreign investment in Australia, losses are reported as a positive (without sign) debit. This is to maintain the relationship that income on direct investment abroad is recorded as a net credit while income on direct investment in Australia is recorded as a net debit (see paragraph 8.10).