SE SAN VA —. AA ws ~ oe rea setces __ Debt Investments outcomes Learning After reading this chapter, you should be able to: in debt securities and give examples; tments at the date of initial recognition; investments Miucting debt investments subsequent 0 invest transactions (a) define | (b) measure debt () account for acquisition: (a) measure Sept investments at the endo! (e) acquire proficiency and accuracy jnvestments in debt securities. f the reporting period; and ‘in solving problems relating to Definition and Nature a by an entity that typically instruments issue ‘and (c) a maturity date. (b) an interest rate > Investments in financial have (a) a maturity value: Classes of debt investments n of debt securities del for managin, aracteristics of the + hall be made on the basis of both (1) g the financial asseti and (2) the > The classificatio’ financial asset. Classification is > the business mo contractual cash flow chi as follows: 1s held to maturity «debt investments at amortized cost (called a securities or HTM under IAS 39) «debt investments at fair value through profit or loss + debt investments at fair value through other compre! hensive income d certificates and treasury notes issued by private ernment agency guaranteeing payment of a principal ecified future date. > Examples are bon enterprises or a g0V amount and interest at sp‘ ° ‘Accrued Interest on Debt. Securities at Time of Purchase in the accounts when debt securities are > Accrued interest arises the interest dates: purchased at any time between .d the bonds were july 1 an months + Assume interest dates are January 1 and J cae quired on March 1. Accrued interest is computed for two (January 1 to March 1).a Chapter 7 ep RNR a ee assume interest dates are January 1 and july 1 and the bonds were * ‘equired on September 1, Acery, r acer ths (July 1 to September 1). IMeFest is computed Tor two ed interest is excluded in the cos i t of t ed separately in an interest receivable or geese and is ‘cer able or interest revenue account. 7 secor termining Initial Cost/Purchase Price of Debe Securities ay quotation for the debt security is ex She Thus, if P1,000,000 bond is 790,000; if P1,000,000 bond is q 1,050,000. Pressed as a percentage of its face Quoted at 95, its bond price is luoted at 105, its bond price is purchase of debt investments at less than face value, resulting t discount, indicates that the bond's stated interest rate is less than the prevailing market rate; whereas purchase at more than face value resulting to a premium indicates that the bond’s stated interest rate is ater than the prevailing market rate. Apparently, the bonds are purchased at face value if the bond's stated interest rate and market rate are the same. > The bond price or market price is determined by discounting the maturity value of the bond and each remaining interest payments at the market rate of interest for similar debt on that date. Assume the following data Bond Corporation: Face value of bonds - P1,000,000; Statéd rate of interest - 12%; fifecive (market) rate of interest - 10%; Term~5 years; Date of purchase ~ January 1, 2016. Interest is payable every December 31 and the company uses the calendar year that ends on December 31. Present value of 1 at 10% for 5 periods (PVF) ~ 0.620921. Present value of an ordinary annuity of 1 at 10% for 5 periods (PVAF) - 3.790787. The bonds price is computed as follows Discounted value of maturity value i P1,000,000 x 0.620921 P 620,921 iscounted value of interest payments 454,894 P1,000, 3.790787 454.894 re 000 x 12% x3. Pitinis 169nail vais Debt Investassate, a i ° Alternative computation: Premium or Discount Face value of bonds x difference in periodic interes 1,000,000 x 2% x 3.790786 = 75,816 (premium, inet PVA rate is greater than market interest rate) "° *2ted inte, rest Bond Price Face value + Premium (or ~ discount) 1,000,000 + P75,816 = 1,075,816 (difference Is due to round unding ofp DEBT INVESTMENTS AT AMORTIZED COST Initial recognition > Debt investments at amortized cost are initially recognized at price which is the fair value at the date of acquisition plus tr costs that are directly attributable to their acquisition. Purchase ansaction Measurement After Initial Recognition > At interest dates and at reporting dates, any premium or discount amortized using the effective interest method. _ > Effective Interest Method of Amortization +” Amortization of premium decreases the carrying amount of the debt investment and the interest revenue (based on nominal rate) while amortization of discount increases the carrying amount of the debt investment and the interest revenue (based on nominal rate). * Effective interest method provides an increasing amount of amortization periodically. Likewise, it provides a constant rate of return on debt investment carrying amount from period to period. + If the securities are held until maturity, the carrying amount will be equal to its face value after appropriate amortizations are made. (Premium Situation) Using the given data for Bond Corporation, an amortization table is presented on the next page for the five-year term of the debt investment. Assume further that quotations for the bond on December 31, 2016 and December 31, 2017 are 105 and 104, respectively. The receipt of the first two annual interest and premium amortization are recorded as follows (Please refer to the amortization table for the amounts): 170. eee Chapter 7 — Del ee 31,2016 ——Pebt Investments Cash Interest Revenue 12 0,008 Debt Investment at Amortizey Cah 0 a st é 12,419 per 31,2017 pee Cash Interest Revenue 120,009 Debt Investment at Amortizeg Cost 106,340 8 5 13,660 AMORTIZATION TABLE Interest Due 120,000 120,000 106.3. EL 120,000 047 120,000 | “i03.477 120,000 101,819 (Discount Situation) Assume the following data, face value of bonds ~ P1,000,000; sta i ted rate of i (market) rate of interest - 12%; Term rate of inter Test- 10%; Effective ; ~S years; D, 1.2016. Interest is payable every December 31 and terete lary lender year that ends on December 31, present value of 1 at 12% for S periods present value of an ordinary annui 3604776. (PVF) - 0.567427, ty of 1 at 12% for 5 periods (PvaF) - The bonds price is computed as follows: Discounted value of maturity value P 1,000,000 x 0.567427 Discounted value of interest payments P1,000,000 x 10% x 3.604776 Tol 927.905 Alternative computation: Premium or Discount Face value of bonds x difference in periodic interest rate x PVAF P1,000,000 x 2% x 3.604776 = 72,095 (discount, since stated interest rate is lesser than market interest rate) 171Chapter 7 ‘Debt Investments oe Can + premium (or re fas 000 P7299 927,905 jerest and discount amortizay on arg The rece! he firs! nual rst (wo anti hi iP ie {refer € the amor! ization table for the amounts); recorded as f° jows December 31, 2016 100,000 at 11,349 ee mvesiment or amortize Cost ae interest Revenue / pecember 31,2017 - Cash 100,000 asl : Debt snvesiment at amortized Cost 12,710 See Interest Revenue 2710 AMORTIZATION TABLE 1,000,000 interest Revenue estments at amortized cost is .d on debt inv tx effective rate) > The interest revenue earne represented by the effective interest (Carrying amoun pisposal/Derecognition een the sales price and for the difference betwé e debt investment d until the date of sale to u on the date of sale. s recognized pdate the amount of th should be recorde tof the investment sold. > Gain or loss i the carrying Amortization | carrying amoun! accrued interest is tween interest dates, to determine When the sale takes place be ind added to the sales price recorded as Interest Revenue a) the total proceeds from the sale. 172Chapter 7 —_ ———rbt lnvestments > Similar to equity im ot ee, Iovernets, debt investments at fair value through generally ite fair malty Fecorded at cost (purchase pri ; senerally its fair market Value atthe date of acastien). ee ost directly attributable to its acquisition doe De ee ment and Is recorded as an expense, "7 Pav ofthe costof On janua year borgtamuary 12016, A Corporation purchased P1,000,000, 12% 5- Hear bonds of Company B at 101 plus brokers commission of 2,000. vale of the bonds on Deceber a et ecenber 2. Market wassld ies pr ssapecembe! 31, 2018 P1:022.00. The invesimet The entity intends to ; speculate on fluctuations of interest rate designates the debt investment at fa value through profit os lus, ‘The entry is Debt Investments at Fair Value sat Fair Value through P&L Brokers Commission Se eae Cash 1,012,000 Interest Revenue > The interest revenue is represented by the amount of interest received or receivable. (Face value x nominal/stated rate of interest). Based on the data given for A Corporation, the annual interest revenue is P100,000 (PL million x 12%) recorded as Cash 120,000 Interest Revenue 120,000 ‘The discount or premium on investments classified as debt securities at > fair value through profit or loss is not subject to amortization. Measurement After Initial Recognition 1g date, the debt investments are measured at fair value and In the given > Atthe repo the unrealized gains and losses are taken to profit or loss. example for A Corporation, the entry to bring the debt investment to fair value on December 31, 2016 is Debt Investments at FVPL 12,000 Unrealized Gain/Loss on Debt Investments-P&L 12,000 ‘The unrealized gain/loss account is a nominal account reported in the entity’s profit or loss or income statement. 173a Chapter 7 . DebtInvestments Disposal/Derecognition the difference between the sales price ang n G ecognized for > Gain or loss is recogn c 3 ine riost recent measurement at the reporting date. ween interest dates, accrued interest ; is s place bett PI 1 d added to the sales price to determin, e Revenue ant m the sale. when the sale take: recorded as Interest the total proceeds fro! Using the data of A Corporation, the sale on January 31, 2017 is recorded as Cash (1,025,000 + 10,000) Debt Investment at FVPL Interest Revenue (1M x 12% x 1/12) Gain on Sale of Debt Investment 1,035,000 1,022,000 10,000 3,000 DEBT INVESTMENTS AT FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME (FVOCI) Initial Recognition > Debt investments designated as at fair value through other comprehensive income are initially recognized at purchase price plus transaction costs directly attributable to its acquisition. Interest Revenue > The interest revenue earned on debt investments at amortized cost is represented by the effective interest (Carrying amount x effective rate) Measurement After Initial Recognition At each interest date and at reporting dates, any premium or discount is > amortized using the effective interest method. At the reporting date, the debt investments are measured at fair value. The difference between the amortized cost and the fair value of debt investment is taken to equity under other comprehensive income. Assume the following data Bond Corporation: Face value of bonds - P1,000,000; Stated rate of interest - 12%; Effective (market) rate of interest - 10%; Term - 5 years; Date of purchase - January 1, 2016. Interest is payable every December 31 and the company uses the calendar year that ends on December 31. Assume further that quotations for the bond on December 31, 2016 and December 31, 2017 are 105 and 104, respectively. 174the journal entries for the first ents are as follows: (Figures table ae ri Clating pres tments at amortized ‘ake © the deb in 5 Cost - prem; n i lebt wae inve st ~ premium Situation) om the illustration 016 pave ne ebt Investment at FVOCI Cash 1,075,815 Jj peceber 31,2016 rss ash y Interest Revenue 120,000 Debt Investment at FVocl 107581 Ps 12, unrealized Gain/Loss on Debt Investment-Fvocy i Fair Value Adjustment - Debt Investm, 13,396 at —_(FVOCI) ae Fair value (1M x 1.05) 1,050,000 13,396 Amortized cost (see table) 063.396 : 4 Adjustment (Unrealized Loss) 13,396 pecember 31, 2017 Cash Interest Revenue 120,000 Debt Investment at FVOCI 106,340 13,660 Fair Value Adjustment - Debt Investment at peor : 3,660 Unrealized Gain/Loss on Debt Investment at : FVOCI 36 Fairvalue(1Mx 1.04) 1,040,000 eee Amortized cost (see table) 1,049,736 Cumulative unrealized loss 9,736 Equity balance before adj. 13,396 Unrealized gain 3,660 ‘The following amounts will appear in the financial statements for 2016 and 2017, Statement of Financial Position 2017 2016 Assets section: Debt Investment‘at FVOCI 1,040,000 — ‘P1,050,000 Equity section: ii Cumulative Unrealized Gain/Loss on Debt Investment at FVOCI (9,376) (13,396) 175Chapter 7 Debt Investments : ats are inclusive of t sets He alr Valyg wn as a mounts 3h? ce or deducte ar s added, if debit balance lucted, If cred, These a djustment that ade, 0 (04S 2017 P1,049,736 tized cost py Aare balance of FV adjustment oe Fair value p1,040,000 - 2016 Debt Other com asso Unrealized Gain/Lo: Investments at 3,660 13,396 pisposal/Derecognition » The debt investment account, together with the fair value adjustment account, are derecognized po” disposal. The cumulative balance of the : unt is transferred £0 Profit ot TOSS unrealized gain/los When the sale takes place between interest dates, accrued interest is recorded as Interest Revenue: v ‘Assume that the debt investment in the illustration is sold on January 1, 2018, at its market value (104). The journal entry to record the sale is: Cash 1,040,000 Fair Value Adjustment ~ Debt Investment at FVOCI 9,736 Loss on Sale of ‘Debt Investments 9,736 1,049,736 Debt Investments at FVOCI Unrealized Gain/Loss on Debt Investment at FVOCI 9,736 0 Reclassification of Debt Investments tion shall be made when and only when an entity changes its > Reclassificat business model for managing its financial assets. > Reclassification is prohibited (1) when there is change in management intention; (2) upon temporary disappearance of a particular market; and (3) when transfers of assets are made between existing models. > Reclassification shall be made prospectively from the date of reclassification. 176. ee Chapter 7 f Td _____ Debt Investments Ina reclassification to Fvpy, Pen mats » From amortized COSt, th » the ne fair value and the qi we bt inve, 4 ference Lo." ‘estment (PVP, taken to profit or loss,“ Detween faip value ) IS recorded at and amortized cost is From FVOCI, the New debt j t investm, and the cumulati i: ENE CFVPL) is rec i an Ve unrealized Baln/loge ) is recorded at fair value or loss, 'n OCl is transferred to profit y Inareclassification to Fvoc, + From amortized Cost, the ni fair value and the di taken to other co; used as debt inves| ew debt i ference is cen eaten (FVocr ) is recorded at N fair value mprehensive incom ent 4 mortized cost is : ' * the effective interest ment at amortized Cost remains the same, ae + From FVPL, the new debt in t vestment is and an effective inte Ee : 'STecorded at fai Maes {ate is calculated bas, i fisvalue the date of reclassific, ation, ed on the fair value on » Inareclassification to amortized cost, + From FVPL, the new d * From FVOCI, the accumu: Sain/loss and fair value adjustment balance (amo le), are eliminated in the accounts. The new debt investment (at amortized Cost) is recorded at the amount of the FVOCI, and the same effective interest rate is used, as if it had been designated at amortized cost from the date of initial recognition. lated unrealized unts are the sami + Impairment of Debt Investments Measured at Amortized Cost » When there is objective evidence of impairment, the amortized cost is adjusted to its impaired value and the ioss is taken to profit or loss, after which a new effective interest rate is used for subsequent amortization. » This impairment is recorded either by crediting directly the investment account or through the use of an allowance account. rryin > The impairment loss is measured as the difference meiner be ary eaearet the debt investment (including accrued ae A ee resent value of estimated future cash flows discount ae original effective rate at initial recognition. 177