UNIVERSITY OF SANTO TOMAS

ALFREDO M. VELAYO COLLEGE OF ACCOUNTANCY

CA5105 – Intermediate Accounting 1
Debt Securities

NATURE OF DEBT SECURITIES

• These are financial assets with the following characteristics: (1) Maturity Value; (2) Maturity Date
and; (3) Periodic Interest.
• Evidenced by Certificate of Bonds.
• Debtor (Investee) – Creditor (Investor) relationship is established and all agreements are
established in the Bond Indenture.
• May be sold in different denominations (P500, P1,000, P10,000)
• May be sold at a price different from the face value (value stated in the certificate of bonds) due
to existence of many factors such as: (1) Prevailing interest rates; (2) Market conditions; (3) Credit
rating of issuer of bonds; (4) Riskiness.
• The selling price of the bonds may be at a PREMIUM or at a DISCOUNT.

SOLD AT PREMIUM SOLD AT DISCOUNT

• Nominal Rate > Effective Rate • Nominal Rate < Effective Rate

• Results to a Premium on Selling Price – an • Results to a Discount on Selling Price – an

amount greater than the face value. amount less than the face value.

CLASSIFICATIONS OF DEBT SECURITIES

Using the entity’s business model of managing financial assets and characteristics of the contractual
cash flow of the financial assets, debt securities are classified as:

1. The management has the intention to hold

the securities until maturity and to receive
DEBT INVESTMENTS AT
cash flows from the investment as sole
AMORTIZED COST
payments for principal and interest (SPPI)
and does not exercise the fair value option.
2. The management has the intention to hold
the securities for “trading” purposes and to
DEBT INVESTMENTS AT FAIR
sell the financial asset when profit-taking
VALUE THROUGH PROFIT OR
opportunities arise due to changes in fair
LOSS
values and changes in fair values are taken to
profit or loss.
3. Both collecting cash flows that are payments
for principal and interest and selling the asset DEBT INVESTMENTS AT FAIR
when opportunity arises. The management VALUE THROUGH OTHER
has elected to show changes in fair value COMPREHENSIVE INCOME
through other comprehensive income.

RECOGNITION CRITERIA
An entity will recognize debt securities if and only if, they become party to the contractual provisions
of the contract (e.g. when they hold the bond certificate and is named under their entity, or if they
periodically receive the stipulated interest and the subsequent payment of the principal).
 DEBT INVESTMENT AT AMORTIZED COST
• Whether the debt security was sold at a premium or at a discount, at the end of the term of the
bonds, the carrying value of the investment must equal to the face value by amortizing the
excess between the selling price of the bonds and its face value to interest income (Effective
Interest Method).
• Initial acquisition cost of the investment is: Purchase Price + Directly Attributable Costs.

PROBLEM A – Debt Investments at Amortized Cost (DIAC)

On January 01, 2017, A Company acquired a 5 year, 10%, P10,000,000 face value bonds from B
Corporation. A has the ability to hold the investments until maturity and to receive contractual cash
flows as sole payments for principal and interest. Based on the contract, the interest is payable annually
every December 31, starting this year. The bonds were dated January 01, 2016. Round-off present
value factors to two (2) decimal places.

A. Discount scenario – Assuming that the market yield is 12%

1. What is the selling price of the bonds?
2. What is the interest income for the year 2017?
3. What is the carrying value at the end of 2017?
4. What is the premium/discount amortization for 2018?
5. What is the interest income for the year 2018?

B. Premium scenario – Assuming that the market yield is 8%

1. What is the selling price of the bonds?
2. What is the interest income for the year 2017?
3. What is the carrying value at the end of 2017?
4. What is the premium/discount amortization for 2018?
5. What is the interest income for the year 2018?

C. End of the reporting period does not coincide with interest payment dates – Assuming
that the end of the reporting period is every October 31 and using the discount scenario
1. What is the interest income for the year ended October 31, 2017?
2. What is the carrying value of the bonds for the year ended October 31, 2017?
3. What is the discount amortization for the year ended October 31, 2017?
4. What is the interest income for the year ended October 31, 2018?
5. What is the carrying value of the bonds for the year ended October 31, 2018?

D. Acquisition of the bonds in between interest payment dates – Assuming that the bonds
were acquired on March 31, 2017 and using the discount scenario and further assuming
that the extrapolated market rate is still 12%
1. How much is the total cash consideration to acquire the bond investment?
2. What is the interest income for the year ended December 31, 2017?
3. What is the carrying value of the bonds for the year ended December 31, 2017?
4. What is the carrying value of the bonds for the year ended December 31, 2018?

E. Disposal of the investment – Using the discount scenario and assuming that the bonds
were sold on April 30, 2019
1. What is the gain or loss from the sale if the bonds were sold at 105 plus accrued
interest?
2. What is the gain or loss from the sale if the bonds were sold at P11,500,000 which
includes the appropriate accrued interest?

F. Impairment of Debt Investment at Amortized Cost – Using the discount scenario and
assuming that B is suffering from financial difficulties and on the brink of bankruptcy and that
after payment of interest by B Company on December 31, 2017, B negotiated for a restructuring
of its debt such that the new stated interest is 5%:
1. What is the present value of the cash flows from the investment using the new
agreement?
2. What is the impairment loss recognized by A Company on December 31, 2016?
3. What is the interest income of the year ended December 31, 2017?
4. What is the carrying value of the bond for the year ended December 31, 2018?
 DEBT INVESTMENTS AT FAIR VALUE THROUGH PROFIT OR LOSS

• Using the business model of managing financial assets and the characteristics of the contractual
cash flows, the debt investment is classified at profit or loss if the investment is held for trading,
speculating only in changes in the fair value of the investment.

• No premium or discount amortization of the excess between the selling price and the face value
of the bonds.

• Adjustments to fair value are taken to profit or loss.

• Initial cost of the investment: Purchase price.

PROBLEM A – Debt Investments at Fair Value through profit or loss

On January 01, 2017, ABC Company purchased 5,000 of the P1,000 face value, 10% bonds of DEF
Corporation. The bonds will mature after 5 years and pay interest every December 31, starting this
2017. The bonds were purchased to yield 12%.

Market values of the bonds at the end of each reporting period were as follows:

December 31, 2017 – 99

December 31, 2018 – 106
December 31, 2019 – 110

1. Journal entries to record the foregoing.

2. What total amount shall be taken to profit or loss for 2017, 2018 and 2019?
3. What is the carrying value of the investment for December 31, 2017, December 31, 2018
and December 31, 2019?

PROBLEM B – Debt Investments at Fair Value through profit or loss (disposal of investment)
On January 01, 2017, ABC Company acquired a 5-year, 15%, P10,000,000 face value bonds of DEF
Company. Based on the business model and contractual cash flow characteristics of this instrument,
ABC classified the investment at fair value through profit or loss. The interest on the bonds is payable
every December 31, starting 2017. The bonds were acquired to yield 10%.

Market values of the bonds at the end of each reporting period were as follows:

December 31, 2017- 110

December 31, 2018 – 112
December 31, 2019 – 109
December 31, 2020 - 108

On April 01, 2020, because of a currently maturing obligation, ABC Company decided to sell half of
its investment. The bonds were sold at P5,250,000 which includes the appropriate accrued interest.

1. Journal entries to record the foregoing.

2. What total amount shall be taken to profit or loss for 2017, 2018, 2019 and 2020?
3. What is the carrying value of the investment for December 31, 2017, December 31, 2018,
December 31, 2019 and December 31, 2020?
4. What is the gain or loss from the disposal of the investment?
 DEBT INVESTMENT AT FAIR VALUE THROUGH OTHER COMPREHENSIVE
INCOME

• Using the business model of managing financial assets and the characteristics of the contractual
cash flows, a debt investment is classified at fair value through other comprehensive income when
the entity intends to hold the investment until maturity and to receive cash flows as sole payments
for principal and interest, and to sell the investment when profit-taking opportunity arises.
• The difference between the selling price of the bonds and its face value is amortized to interest
income using the effective interest method.
• Adjustments to fair value are taken to other comprehensive income.
• Unrealized holding gains and losses is transferred to profit or loss upon disposal.
• Initial cost of the investment: Purchase price + directly attributable costs.

PROBLEM A – Debt Investments at Fair Value through Other Comprehensive Income

On January 01, 2017, ABC Corporation purchased P1,000,000, 10%, 5-year bonds of DEF
Corporation. The bonds were acquired to yield 8%. Interest is payable annually starting December 31,
2017. ABC Corporation appropriately classified the investment at fair value through other
comprehensive income.

Fair values of the investment at the end of each reporting period were as follows:

December 31, 2017 – 112

December 31, 2018 – 113
December 31, 2019 – 107
December 31, 2020 – 106

1. Journal entries to record the foregoing.

2. What total amount shall be taken to profit or loss for 2017 to 2021?
3. What total amount shall be taken to other comprehensive income for 2017 to 2021?
4. What amount shall be presented in the statement of financial position for the years ended
December 31, 2017 to December 31, 2021?

PROBLEM B – Debt Investments at Fair Value through Other Comprehensive Income

(Disposal of Investment)
On January 01, 2017, ABC Company acquired 1,000 of the P1,000, 10% face value bonds of DEF
company at a price that yields 7%. The interest is payable annually every December 31, starting this
year. The bonds mature on December 31, 2021. ABC appropriately classified the investment at fair
value through other comprehensive income.

On March 31, 2019, all of the bonds were sold at 110 plus accrued interest.

Fair values of the bonds at the end of each of the reporting period were as follows:

December 31, 2017 – 101

December 31, 2018 – 102
December 31, 2019 – 103
December 31, 2020 – 104

1. Journal entries to record the foregoing.

2. Selling price of the bonds.
3. What total amount shall be taken to profit or loss from 2017 to 2021?
4. What total amount shall be taken to other comprehensive income from 2017 to 2021?
5. What amount shall be presented as the carrying value of the bonds at the end of each
reporting period from 2017 to 2021?
6. What is the balance of the UGL account at the end of each year from 2017 to 2021?

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