PRACTICAL ACCOUNTING | C.Uberita/C. EspenillaG, Macariola Investment in Debt Instruments Full Application of PERS 9 and PERS for SMEs in debt securities — representing creditor's claim with fixed amount and usually some interest obligation (e.g. government securities, corporate bonds, convertible bonds commercial paper, etc.) 2. Designation and Measurement: Full Application of the Standard (PFRS 9) and PFRS for SMEs Classification of debt securiies, the standard requires financial assets to be classified on initial recognition as measured at At amortized cost ~ A financial asset is measured at amortized cost when the entity has business model to hold assets in order to collect contractual cash flows, and the contractual terms give rise, on specified dates, to cash flows that are solely payments of principal and interest on the principal outstanding Fair value — @ financial asset is measured ut fair value to profit or loss when the entity has the objective of realizing cash flows through sale of assets, manage a portfolio of asses in order 10 realize fair value changes arising from changes in credit spreads and yield curves or when the entity's objective results in active buying and selling with the managing the instruments to realize fair value gains rather than collect the contractual cash flows Investment at fair value to profit or loss ~ measured initially at fair market value of the securities acquired, which is equal to the fair value of the consideration being used to acquire the debt instruments excluding transaction costs, are re-measured at fair value (transaction cost is not deducted) with changes in fair value taken to profit or loss. Premium or discount is not amortized. Investment at amortized cost — measured initially at fair market value of the securities acquired which is equal 1o the fair value of the consideration being sacrifice lo acquite the debt instruments plus transaction costs incurred. Premium or discount and any transaction cost are amortized. ‘Business model for managing financial asses The business model approach is a fundamental balding block of TERS: 9 and aligns the accounting with the wav that ‘management deploys assets in ts business while also considering the characteristics of asses. The business model 1s determined by the company’s hey management personne! and does 1 depend on management's intentions Jor a individual asset ts rslead determined ata higher level. A company could have more than one business mel for ‘managing assets and may manaye differen porvolios of aseis wth diferent objectives Note: Debt instruments bear interest, hence, it would be necessary to consider if the fair value of the consideration given or the cash paid includes or excludes any accrued interest. If interest were included because the instruments were acquired between interest dates, the interest should not be part of the historical cost of the instruments. 4, Reclassification of debt instrument: If entity's model objective changes. reclassification is permitted between Fair value through profit or loss (FVPL) or amortized cost (AC) oF vice versa. Such changes should be demonstrable to external parties and are expected to be very infrequent If an emity reclassifies financial assets it shall apply the reclassification prospectively from the reclassification date. The entity shall not restate any previously recognized gains, losses or interest. if an entity reclassifies a financial asset so that it is measured at fair value, its fair value is determined at the reclassification date Any ‘gain or loss arising from a difference between the previous carrying amount and fair value is recognized in profit (or loss. If un entity reclassifies a financial asset so that it is measured at amortized cost, its fair value at the reclassification date becomes its new carrying amount. z 5. Impairment of a debt instrument Impairment in value of amortized cost — the difference between the amortized costs of the debt instrument at the time impairment is deemed to exist and the revised cash Nlows discounted at the rate of initial recognition. aFinancial Instrument --Debt Instruments wv ‘On May 1.2014, Golden Company purchased a short-term P,000,000 fave vale 98% debt instruments for P3,720,000 excluding the accrued interest and classified Las a inygstoient (0 profit ar toss which is based on the business model of the entity to buy and sell porttolio at securities and to make profit for Shorterm movements in the market rate of interest. Golden Company incurred and paid’ ?20.000 {ransaction cost relaied to the acquisition of the instrument, The debt instruments mature on Jumuary ', 2017, and pay interest semi-annually on January | and July {On December 31, the fair market Value of the instruments is P3,880,000 On February 2, 2015, Graham Company sold the debt security for P3,960,000. At what amount should the investment be initially recorded” 3,720,000 ce. PR,R80,000 b. P3,740,000 @. P4,000,000 On October |, 2013, Graham Company, with a business model af trading debt securities, purchased a 2,000,000 face valuc 9% debt instruments for with at remaining form of 2years aid three months for 2,174,867... ‘The prevailing market rate of interest at the time of acquisition was H%, fnterest i being received every December 31, On December 31. the fair market value ot the instruments is P2,072.321 based on prevailing market rate of 7%... What amount of unrealized gain or toss should*Graham Company report in its December 31, 2013. profit or toss? none ©, PIO. B P32.454 d PL3S,000 On January 1, 2014, Sun Company purchased the debt instruments of Sik Company with a face value of P5,000,000 bearing interest rate of 8% for P4,621,006 to yield (O"® interest per year. The bonds mature on January 1, 2019 and pay interest annually on December W.On December 31, 2014 the fair value of the investment is 4,838,014 which is based on the prevailing market rate ofY%e? If the company’s business model has the objective of trading and making a profit from changes in the fair value of the securities, what amount of unrealized gain or loss should the company disclose in their December 31, 2014 profit or loss? a. None PLS4.907 anreatized gain b. P26,559 unrealized gain PP P2008 unrealized gain Question 2: 1f the company’s business model has the objective of collecting all the contractual cash flows including interest and principal. at what amount should the investment be reported in the ‘company’s statement of financial position for the year ended December 31, 201 a. P4.621,006 P® P4683,107 d. PA838,018 On January 2, 2013, Saint Company invested in a 4-year 10% bond with a face value of P6,000,000 in which interest is to be paid every December 31. The bonds hits an effective interest rate of 9% and was acquired for P6,194.383. Saint Company has a portolio of commercial loans that it holds to sell in’the short term, On December 31, 2013, the security has a fair value of P6,229,862 which is based ‘on the prevailing market rate of 8.5%. On December 31, 2013, Saint Company acquires Joseph Company that manages commercial loans and hhas a business model that holds the loans in order to collect the contractual eash flows, Saint Company original portfolio of commercial loans is no longer for sale, and the porttolio is now managed together with the acquired commercial loans and all are held to collect the contractual cash flows. On December 31. 2014, the debt investment has a fair value of P6,SS0,000. What amount should the debt investment be reported in the December 31, 2014 statement of financi a. 76,082,949 ©, P6,229,862 de 6.159.400 d, P6,550,000 ‘On January 2, 2013, Saint Company invested in a 4-year 10% bond with a face value of 76,000,000 in which interest fs to be paid every December 31. ‘The bonds has an effectiv rate of 9% and was acquired for P6,194.383, On December 31, 2014, the management of Saint Company decided to dispose P4,000,000 face value debt instrument which will be used to settle an obligation and to finance: o706. ee eet Accounting Debt ‘Some of its operating costs. “The company has a business model of collecting the contractual cash flows for all their debt security investments, however due to frequent sale and disposal of investments the management has decided that the business model is no longer appropriate. On December 31, 2014, the four million face value debt instrument was disposed of when the market rate of similar instrument was 11%, “PV factor of 11% after 2 years 0.8116 PV factor of annuity of 11% after 2 years 1.7125 Question 1; What is the amortized cost of the debt instrument on December 31, 2014? a. P6,055,046 ©. P6151,877 % P6,105,547 d. P6,194,383 Question 2: If the remaining debt securities were redesignated on January 1, 2015 when the market rate of interest has yet to change, what is the amount of gain or loss should the company recognize in its 2014 profit or loss as a result of the redesignation? ya a. none ©. P138,865 ye P69,432 + d. P208,298 ‘On December 31, 2009, Outer Company invested in the S-year bonds of Inner Corporation. The bonds have a face value of P3,000,000 with 8% interest payable per year. Outer Company paid P2,772,552 to acquire the instruments and intends to hold until maturity. “The effective interest rate for the same instrument at the time of acquisition is 10%, \ ry During 2011, Inner Corporation's business deteriorated due to political instability and faltering global economy. After reviewing all available evidence at December 31, 2011, Outer Company determined that it was probable that Inner would pay back only P2,600,000 at maturity. As a result, Outer Company decided that the investment in bonds was impaired, and that a loss should be recorded immediately. Question_1: What amount of impairment toss should Outer Company recognize on its debt instruments? none ©. 747,127 b. 247,934 (A. 897,370 Question 2: Assume that on December 31, 2012, Inner Company’s financial condition had improved and informed Outer Company to pay back P2,900,000 on maturity instead of the promised amount of 2,600,000 in December 31, 2011, what amount of impairment recovery should Outer Company report in its 2012 income statement? ™& None Let coe ¢. 747,127 BAT S34 (F002 0b = Hoh) 4. 897,370 On January 2, 2009, Holy Company invested in a 4-year 10% bond with a face value of P3,000,000 in which interest is to be paid every December 31. The bonds has an effectiye interest rate of 8% and twas acquired for P3,198,650. Holy Company classified the bonds a8 aailabictor oh RAC. ‘On December 31, 2011, Holy Company sold the bonds at the prevailing rate of 12% and incurred total transaction cost of P45,000. ‘Question 1: What amount of gain or loss should Holy Company recognize on the sale ofthe security? & 109,030 ey ©, 205,447 AY 154,030 7. 4. 250,477 Question 2: What amount of interest income should Holy Company report in its 2011 statement of income? a, 244,437 ¢. 252,363 7. 248,552 HAS: 4. 300,000