Fair value model

ACCOUNTING TREATMENT FOR FAIR VALUE DEBT

SECURITIES
1. Fair value asset through profit or loss
2. Fair value asset through other comprehensive income
ACCOUNTING TREATMENT FOR FAIR VALUE DEBT SECURITIES
1. Fair value asset through profit or loss
• Used when the entity held the investment for trading and irrevocably designates the
debt security as FVPL
• The debt instrument is recorded at fair value
• Any change in fair value will go directly to the profit or loss
Initial Recognition : Fair Value
Subsequent Measurement : Fair value
Note: The transaction cost is expense outright in the initial recognition
There is no amortization of discount and premium in the FVPL

The following are the indication of fair market value at year end
1. Total fair value
2. Quoted price
= Face value x Quoted price
3. Effective interest – used the effective interest to compute the fair market value
Interest income – computed using the formula Face value x Nominal rate
Problem 1: On January 1,2021, ABC Company purchased P1,000,000 bonds at 110. The bonds mature on
January 1,2024 and pay interest of 12% annually. Transaction cost at the purchased date amounts to P100,000. The entity
irrevocably designates the debt instrument as Financial asset at fair value through profit or loss. The following are the market
value of the bonds at year end
2021: 105
2022: 90
2023: 120
Compute the carrying amount and the unrealized gain or loss at year end.
Initial Recognition
Face value x Purchase price percentage = Fair value 2022
1,000,000 x 110% = 1,100,000 Face value x Quoted Price = Fair value
Journal Entry(To record the investment) 1,000,000 x 90% = 900,000 Interest income 2021 to 2023
Investment in bonds - FVPL 1,100,000 Fair value 2021 1,050,000 Face value x Nominal rate= Interest Income
Cash 1,100,000 Fair value 2022 900,000 1,000,000 x 12% = 120,000 interest per year
To record the transaction cost Unrealized loss 150,000
Transaction cost 100,000 Cash 120,000
Cash 100,000 Journal Entry Interest Income 120,000
2021 Unrealized loss 150,000
Face value x Quoted Price= Fair value Investment in bonds – FVPL 150,000
1,000,000 x 105% = 1,050,000 2023
Initial recognition 1,100,000 Face value x Quoted Price= Fair value
Fair value 2021 1,050,000 1,000,000 x 120% = 1,200,000
Unrealized loss 50,000 Fair value 2022 900,000
Fair value 2023 1,200,000
Journal Entry Unrealized gain 300,000
Unrealized loss 50,000
Investment in bonds – FVPL 50,000 Journal Entry
Investment in bonds – FVPL 300,000
Unrealized Gain 300,000
STEPS IN DERECOGNITION OF FVPL DEBT SECURITIES
Step 1: Compute the accrued interest as of the date of sale
Step 2: Compute the selling price
Step 3: Compare the selling price and the cost plus the accrued interest
Problem 1: On January 1,2021, ABC Company purchased P1,000,000 bonds at 110. The bonds mature on
January 1,2024 and pay interest of 12% annually. Transaction cost at the purchased date amounts to P100,000. The entity
irrevocably designates the debt instrument as Financial asset at fair value through profit or loss. The following are the market
value of the bonds at year end
2021: 105
2022: 90
On May 1,2023 the entity sold the investment for 130 including interest.
Compute the gain or loss on sale on May 1,2023.
Step 1: Compute the accrued interest
Face value x Nominal rate x time = Accrued Interest
1,000,000 x 12% x 4/12= 40,000 accrued interest

Step 2: Compute the selling price

Face value x quoted price = Selling price
1,000,000 x 130% = 1,300,000

Step 3: Compute the gain or loss

Selling price 1,300,000 Journal Entry
Less: Interest (40,000) Cash 1,300,000
Carrying amount of bonds (900,000) Investment in Bonds 900,000
Gain or loss on sale 360,000 Interest income 40,000
Gain on sale of investment 360,000
STEPS IN DERECOGNITION OF FVPL DEBT SECURITIES
Step 1: Compute the accrued interest as of the date of sale
Step 2: Compute the selling price
Step 3: Compare the selling price and the cost plus the accrued interest
Problem 1: On January 1,2021, ABC Company purchased P1,000,000 bonds at 110. The bonds mature on
January 1,2024 and pay interest of 12% annually. Transaction cost at the purchased date amounts to P100,000. The entity
irrevocably designates the debt instrument as Financial asset at fair value through profit or loss. The following are the market
value of the bonds at year end
2021: 105
2022: 90
On May 1,2023 the entity sold the investment for 130 plus interest.
Compute the gain or loss on sale on May 1,2023.
Step 1: Compute the accrued interest
Face value x Nominal rate x time = Accrued Interest
1,000,000 x 12% x 4/12= 40,000 accrued interest

Step 2: Compute the selling price

Face value x quoted price = Selling price
1,000,000 x 130% = 1,300,000

Step 3: Compute the gain or loss

Selling price 1,300,000 Journal Entry
Less: Carrying amount of bonds (900,000) Cash 1,340,000
Gain or loss on sale 400,000 Investment in Bonds 900,000
Interest income 40,000
Gain on sale of investment 400,000
ACCOUNTING TREATMENT FOR FAIR VALUE DEBT
SECURITIES
2. Fair value asset through other comprehensive income
• Used when the entity holds the debt securities for both of the following reasons
i. The entity holds the debt securities for collection of interest and principal and,
ii. The entity holds the debt securities to realize gains from changes in market value
• Any change in fair value will go directly to the other comprehensive income
and in the shareholder’s equity
Steps in accounting the Debt Instrument under FVOCI
Step 1: Compute the amortization using the effective interest method
Step 2: Compute the carrying amount using the effective interest method and
compare it to the current fair value, the difference is the cumulative gain or loss
Step 3: Compare the cumulative gain or loss this period versus the last period, the
difference is the current unrealized gain or loss
Problem 1
Sample Problem: On January 1, 2021, Fancy Company acquired P1,000,000 12% bonds to be held as financial assets at fair value
through other comprehensive income. Interest is payable annually on December 31. The bonds mature on January 1, 2024.
The effective interest method of amortization is used. The bonds have a 10% effective yield.
The market value of the investment at year end are as follows
2021 : 105 2022: 90 2023: 110
Step 1 and 2 : Compute for the amortization and carrying amount using the effective interest method
Date Interest Received Interest Income Amortization Present Value
Jan. 1,2021 1,049,440
Dec.31,2021 120,000 104,944 15,056 1,034,384
Dec.31,2022 120,000 103,438.4 16,561.6 1,017,822.4
Dec.31,2023 120,000 102,177.6 17,822.24 1,000,000

SHORT CUT FORMULA

Present value of Principal payment
Add: Present value of Interest payment
Total present value

Present value at the end of 2021

Present value of Principal payment 1,000,000 x 0.826 = 826,400 Present value at the end of 2022
Add: Present value of Interest payment 120,000 Present value of Principal payment 1,000,000 x 0.909 = 909,000
x 1.736 = 208,320 = 109,080
Total present value Add: Present value of Interest payment 120,000 x 0.909
1,034,720 Total present value 1,018,080
Problem 1
Sample Problem: On January 1, 2021, Fancy Company acquired P1,000,000 12% bonds to be held as financial assets at fair value
through other comprehensive income. Interest is payable annually on December 31. The bonds mature on January 1, 2024.
The effective interest method of amortization is used. The bonds have a 10% effective yield.
The market value of the investment at year end are as follows
2021 : 105 2022: 90 2023: 110

Date Interest Received Interest Income Amortization Present Value

Jan. 1,2021 1,049,440
Dec.31,2021 120,000 104,944 15,056 1,034,384
Dec.31,2022 120,000 103,438.4 16,561.6 1,017,822.4
Dec.31,2023 120,000 102,177.6 17,822.24 1,000,000

Step 3: Compute for the market value and compare it to the carrying amount

2021
Face value x Quoted price = Fair market value 2021 Journal Entry Carrying amount of Bonds,2021
1,000,000 x 105% = 1,050,000 To record the change in market value Beginning CA 1,049,440
Investment in Bonds – FVOCI 15,616 Amortization (15,056)
Present value at the end of 2021 1,034,384 Unrealized gain – OCI 15,616 Change in fair value 15,616
Market value, 2021 1,050,000 Carrying amount, 2021 1,050,000
Cumulative Unrealized gain or loss 15,616 cumulative unrealized gain To record the receipt of interest
2021 Cumulative gain or loss Cash 120,000
15,616
Less: Previous cumulative gain or loss Interest Income 120,000
0
Current Unrealized gain or loss 15,616 current unrealized gain
To record the amortization
Interest Income 15,056
Bonds Receivable 15,056
Problem 1
Sample Problem: On January 1, 2021, Fancy Company acquired P1,000,000 12% bonds to be held as financial assets at fair value
through other comprehensive income. Interest is payable annually on December 31. The bonds mature on January 1, 2024.
The effective interest method of amortization is used. The bonds have a 10% effective yield.
The market value of the investment at year end are as follows
2021 : 105 2022: 90 2023: 110

Date Interest Received Interest Income Amortization Present Value

Jan. 1,2021 1,049,440
Dec.31,2021 120,000 104,944 15,056 1,034,384
Dec.31,2022 120,000 103,438.4 16,561.6 1,017,822.4
Dec.31,2023 120,000 102,177.6 17,822.24 1,000,000

Step 3: Compute for the market value and compare it to the carrying amount

2022
2021 Journal Entry Carrying amount of Bonds,2022
Face value x Quoted price = Fair market value
To record the change in market value Beginning CA 1,049,440
1,000,000 x 90% = 900,000
Unrealized Loss 133,438.4 Cummulative Amortization (31,617.6)
Present value at the end of 2022 1,017,822.4 Investment in Bonds – FVOCI 133,438.4 Cum. Change in fair value (117,822.4)
Market value, 2022 900,000.00 Carrying amount, 2022 900,000
Cumulative Unrealized gain or loss 117,822.4 cumulative unrealized loss
To record the receipt of interest Carrying amount of Bonds,2022
2022 Cumulative gain or loss 117,822.4 loss CA, 2021 1,050,000
Cash 120,000
Less: Previous cumulative gain or loss 15,616 gain Current Amortization (16,561.6)
Interest Income 120,000
Current Unrealized gain or loss 133,438.4 current unrealized loss Current Change in fair value (133,438.4)
To record the amortization Carrying amount, 2022 900,000
Interest Income 16,561.6
Bonds Receivable 16,561.6
Problem 1
Sample Problem: On January 1, 2021, Fancy Company acquired P1,000,000 12% bonds to be held as financial assets at fair value
through other comprehensive income. Interest is payable annually on December 31. The bonds mature on January 1, 2024.
The effective interest method of amortization is used. The bonds have a 10% effective yield.
The market value of the investment at year end are as follows
2021 : 105 2022: 90 2023: 110

Date Interest Received Interest Income Amortization Present Value

Jan. 1,2021 1,049,440
Dec.31,2021 120,000 104,944 15,056 1,034,384
Dec.31,2022 120,000 103,438.4 16,561.6 1,017,822.4
Dec.31,2023 120,000 102,177.6 17,822.4 1,000,000

Step 3: Compute for the market value and compare it to the carrying amount

2023
2021 Journal Entry Carrying amount of Bonds,2023
Face value x Quoted price = Fair market value
To record the change in market value Beginning CA 1,049,440
1,000,000 x 110% = 1,100,000
Investment in Bonds – FVOCI 217,822.4 Cummulative Amortization (49,440)
Present value at the end of 2023 1,000,000 Unrealized gain - OCI 217,822.4 Cum. Change in fair value 100,000
Market value, 2023 1,100,000 Carrying amount, 2023 1,100,000
Cumulative Unrealized gain or loss 100,000 cumulative unrealized gain To record the receipt of interest
Cash 120,000 Carrying amount of Bonds,2023
2023 Cumulative gain or loss 100,000 gain CA, 2022 900,000
Interest Income 120,000
Less: Previous cumulative gain or loss 117,822.4 loss Current Amortization (17,822.4)
Current Unrealized gain or loss 217,822.4 current unrealized gain To record the amortization Current Change in fair value 217,822.4
Interest Income 17,822.4 Carrying amount, 2023 1,100,000
Bonds Receivable 17,822.4