INTERMEDIATE ACCOUNTING

CHAPTER 19

Definition of a bond

A bond is a formal unconditional promise made under seal to pay a specified sum of money at a
determinable future date, and to make periodic interest payments at a stated rate until the principal
sum is paid.

In simple language, a bond is a contract of debt whereby one party called the issuer borrows fund from
another party called the investor.

Thus, a bond is a debt security because the bondholder is a creditor and the issuer is a debtor.

A bond is evidenced by a certificate and the contractual agreement between the issuer and investor is
contained in another document known as “bond indenture".

A bope is issued in small denomination of P100, P1,000 or P10,000 to enable more investors to purchase
the bond issue.

For example, a P50,000,000 bond issue may be issued in denomination of P1,000. Thus, there shall
50,000 bonds with face of P1,000 each.

An investor acquires a bond either as a temporary or permanent investment and derives regular income
in the form of interest.

Interest payment date

The interest on the bond investment is usually paid semiannually or every six months as follows:

a. January 1 and July 1

b. February 1 and August 1

c. March 1 and September 1

d. April 1 and October 1

e. May 1 and November 1

f. June 1 and December 1

Of course, there are certain bonds that pay interest annually or at the end of the bond year.
Classification of bond investments

Bonds may be acquired as current or noncurrent investment depending on the business model of
managing financial assets.

Accordingly, bond investments are classified and accounted for as follows:

a. Financial asset held for trading

b. Financial asset at amortized cost

c. Financial asset at fair value through other comprehensive income

d. Financial asset at fair value through profit or loss by irrevocable designation or by fair value option

Initial measurement

In accordance with PFRS 9, paragraph 5.1.1, bond investments are recognized initially at fair value plus
transaction costs that are directly attributable to the acquisition.

However, transaction costs attributable to the acquisition of bond investments held for trading or at fair
value through profit or loss are expensed immediately.

Subsequent measurement

Subsequent to initial recognition, bond investments are measured and accounted for as follows:

a. At fair value through profit or loss

b. At amortized cost

c. At fair value through other comprehensive income

Acquisition of bond investments

Bonds may be acquired on interest date or between interest dates. When bonds are acquired on
interest date, there is no accounting problem because the purchase price is initially recognized as the
acquisition cost.

When bonds are acquired between interest dates, meaning the date of acquisition is not any one of the
interest dates, the purchase price normally includes the accrued interest.

That portion of the purchase price representing accrued interest should not be reported as part of the
cost of investment but should be accounted for separately.

In effect, in this case, two assets are acquired, namely the bonds and the accrued interest. On the date
of acquisition, the accrued interest is charged either to accrued interest receivable or interest incomne.
When accrued interest receivable is debited, upon receipt of the first semiannual interest, the accrued
interest receivable account is closed and interest income is credited for the excess. When interest
income is debited, the receipt of the first semiannual interest is credited entirely to interest income.

The accrued interest purchased or paid is charged to “interest income” instead of accrued interest
receivable.

The subsequent collection of interest is simply credited to interest income.

When bond investment is held for “trading” or measured at fair value through profit or loss, it is not
necessary to amortize any premium or discount.

Investment in bonds at amortized cost

PFRS 9, paragraph 4.1.2, provides that a financial asset shall be measured at amortized cost if both of
the following conditions are met:

a. The business model is to hold the financial asset in order to collect contractual cash flows on specified
dates

b. The contractual cash flows are solely payments of principal and interest on the principal amount
outstanding.

Amortized cost is the initial recognition amount of the investment minus repayments, plus amortization
of discount, minus amortization of premium, and minus reduction for impairment or uncollectibility.

When bonds are acquired and classified as financial asset at amortized cost, the bond investments are
classified as noncurrent investments.

Amortization of premium or discount

Investment in bonds shall be measured subsequently at amortized cost.

This means that any premium or discount on the acquisition of long-term investment in bonds must be
amortized.

Bond premium or discount is amortized over the life of the bonds. On the part of the bondholder, the
life of the bonds is from the date of acquisition to the date of maturity.

Amortization is done through the interest incoine account.

Amortization may be made on interest dates or at the end of the reporting period. It is more convenient
to record amortization at the end of reporting period.
Philosophy on amortization

The reason for amortization of bond premium or discount is to bring the carrying amount of the
investment to face amount on the date of maturity.

When the bonds are redeemed on the date of maturity, the entry will simply be a debit to cash and a
credit to investment in bonds at face value.

The bondholder is a creditor and will collect on the date of maturity an amount equal only to the face
amount of the bonds no more and no less.

Conceptually, bond premium is a loss on the part of the bondholder because the bondholder paid more
than what can be collected on the date of maturity.

Such loss is not recognized outright but allocated over the life of the bonds to be offset against the
interest income to be derived from the bond investment.

On the other hand, bond discount is a gain on the part of the bondholder because the bondholder paid
less thân what can be collected on the date of maturity.

Such gain is not recognized outright but allocated over the life of the bonds to be added to the interest
income derived from the bond investment.

Such process of allocating the bond premium as deduction from the interest income and the bond
discount as addition to interest income is what is traditionally called amortization.

Note that when bonds are acquired between interest dates, it is more convenient to compute monthly
amortization rather than an annual amortization.

Sale of bonds prior to maturity

When investment in bonds is sold prior to the date of maturity, it is necessary to determine the carrying
amount of the bond investment to be used as basis in computing gain or loss on the sale.

In such a case, amortization of the premium or discount should be recogmized up to the date of sale.

If the sale is between interest dates, the sale price normally includes the accrued interest.

Accordingly, that portion of the sale price pertaining to the accrued interest should be credited to
interest income.

The difference between the sale price, after deducting the accrued interest, and the carrying amount of
the bond investment represents the gain or loss on the sale of the investment.

The accrued interest purchased is not part of cost. Thus, the same is deducted from the cash paid.
Callable bonds

Callable bonds are those which may be called in or redeemed by the issuing entity prior to their date of
maturity.

Usually, the call price or redemption price is at a premium or more than the face amount of the bonds.

The difference between the redemption price and the carrying amount of the bond investment on the
date of redemption is recognized in profit or loss.

Convertible bonds

Convertible bonds are those which give the bondholders the right to exchange their bonds for share
capital of the issuing entity at any time prior to maturity.

The existence of the conversion feature generally precludes classification of the convertible bonds as
financial assets at amortized cost because that would be inconsistent with paying for the conversion
feature, meaning the right to convert into equity shares before maturity.

Accordingly, investment in convertible bonds can be classified as financial assets measured at fair value.

Serial bonds

Serial bonds are those which have a series of maturity dates or those bonds which are payable in
installments.

Term bonds

Term bonds are those bonds that mature on a single date.

Callable and convertible bonds can be classified as term bonds despite their special features.

Methods of amortization

a. Straight line method - This method provides for an equal amount of premium or discount
amortization each accounting period.

b. Bond outstanding method - This method is applicable to serial bonds and provides for a decreasing
amount of amortization.

c. Efective interest method or simply “interest method" or scientitic method-This method provides for
an increasing, amount of amortization.

In accordance with PFRS 9, bond investments shall be classified as financial assets measured at
amortized cost using the effective interest method.
This means that any discount or premium must be amortized using the effective interest method.

The straight line method and bond outstanding method are acceptable only when the computation will
result in periodic interest income that is not materially different from the amount that would be
computed using the effective interest method.

The bond outstanding is determined every bond year.

The fractions are developed from the bond outstanding column.

The annual discount amortization is computed by multiplying the fractions by the amount of the
discount.

The annual premium amortization is computed by multiplying the fractions by the amount of the
premium.

CHAPTER 19 – MC

1. Trading bond investments are reported at

a. Amortized cost

b. Face amount

c. Fair value

d. Maturity value

2. Which statement is correct in regard to trading bond investments?

a. Trading bond investments are held with the intention of selling them in a short period of time.

b. Unrealized gains and losses are reported as part of net income.

c. Any discount or premium is not amortized.

d. All of these statements are correct.

3. Accrued interest on bonds that are purchased between interest dates

a. Is ignored by both the seller and the buyer.

b. Increases the amount a buyer must pay.

c. Is recorded as a loss on the sale of the bonds.

d. Decreases the amount a buyer must pay.

4. The interest income for the year would be higher if the bond was purchased at

a. Quoted price

b. Face amount

c. A discount

d. A premium

5. The interest income for the year would be lower if a bond is purchased at

a. Quoted price

b. Face amount

c. A discount

d. A premium
CHAPTER 20

Introduction

PFRS 9 requires that bond discount and bond premium shall be amortized using the effective interest
method.

The effective interest method is also known as scientific method or simply “interest method".

This method distinguishes two kinds of interest rate, namely nominal rate and effective rate.

The nominal rate is the coupon rate or stated rate appearing on the face of the bond.

The effective rate is the yield rate or market rate which is the actual or true rate of interest which the
bondholder earns on the bond investment.

The effective rate is the rate that exactly discounts estimated future cash payments through the
expected life of the bond or when appropriate, a shorter period to the net carrying amount of the bond.

Effective rate versus nominal rate

The effective rate and the nominal rate are the same if the cost of the bond investment is equal to the
face value.

When the bonds are acquired at a premium, the effective rate is lower than the nominal rate.

The reason is that the premium is a loss on the part of the bondholder.

On the other hand, when the bonds are acquired at a discount, the effective rate is higher than the
nominal rate.

The reason is that the discount is a gain on the part of the bondholder.

The effective rate and nominal rate are necessary in applying the effective interest method.

Effective interest method

The effective interest method simply requires the comparison between the interest earned or interest
income and the interest received.

The difference between the two represents the premium or discount amortization.

Interest earned or interest income is computed by multiplying the effective rate by the carrying amount
of the bond investment.

Interest received is computed by multiplying the nominal rate by the face amount of the bond.

The carrying amount of the bond investment is the initial cost gradually increased by periodic
amortization of discount or gradually reduced by periodic amortization of premium.
Effective interest method – Discount

Interest income – carrying amount times semiannual effective rate.

Discount amortization – interest income minus interest received.

Carrying amount – preceding carrying amount plus the discount amortization.

Note that the amortization is done on every interest date rather than at the end of the reporting period.

Effective interest method – Premium

Interest income – carrying amount times annual effective rate.

Premium amortization – interest received minus interest income.

Carrying amount – preceding carrying amount minus premium amortization.

Effective interest method – Serial bonds

Interest received – equals outstanding face amount times nominal rate.

Interest income – equals carrying amount times effective rate.

Premium amortization – equals interest received minus interest income.

Carrying amount – equals preceding carrying amount minus principal payment and minus premium
amortization.

Bond investment-FVOCI

PFRS 9, paragraph 4.1.2A, provides that a financial asset shall be measured at fair value through other
comprehensive income if both of the following conditions are met:

a. The business model is achieved both by collecting contractual cash flows and by selling the financial
asset.

b. The contractual cash flows are solely payments of principal and interest on the principal outstanding.

Note that the business model includes selling the financial asset in addition to collecting contractual
cash flows.

In this case, interest income is recognized using the effective interest method as in amortized cost
measurement.

On derecognition, the cumulative gain or loss recognized in other comprehensive income shall be
reclassified to profit or loss.
The business model is to collect contractual cash flows and to sell the financial asset.

Note that unlike trading bond investment, transaction cost is included in the cost of financial asset
measured at fair value through OCI.

PFRS 9, paragraph 4.1.2A, mandates that interest income for bond investment measured at fair value
through other comprehensive income must be calculated using the effective interest method and
included in profit or loss.

Note that for debt investment measured at fair value through other comprehensive income, the
cumulative gain or loss previously recognized in other comprehensive income is reclassified to profit or
loss on disposal of the investment.

Fair value option

PFRS 9, paragraph 4.1.5, provides that an entity at initial recognition may irrevocably designate a
financial asset as measured at fair value through profit or loss even if the financial asset satisfies the
amortized cost or FVOCI measurement.

In other words, investments in bonds can be designated without revocation as measured at fair value
through profit or loss even if the bonds are held for collection as a business model.

Under the fair value option, all changes in fair value are recognized in profit or loss. Accordingly, any
transaction cost incurred is an outright expense.

Moreover, the interest income is based on the nominal interest rate rather than the effective interest
rate.

MARKET PRICE OF BONDS

The market price of bonds is equal to the present value of the principal plus the present value of future
interest payments using the effective rate.

The present value of an ordinary annity of 1 is determined for the number of interest periods using the
effective rate.

Since the life of the bonds is three years and the interest is payable annually, the number of interest
periods is three.

The effective interest rate is higher than the nominal interest rate.

Thus, the difference between the face amount and present value is a discount.
Since the life of the bonds is 2 years and the interest is payable semiannually, the number of interest
periods is four.

The annual effective rate is 6% or a semiannually effective of 3%.

The market price of bonds is equal to the present value of the principal plus the present value of future
interest payments using the effective rate.

The effective interest rate is lower than the nominal interest rate.

Thus, the difference between the face amount and present value is a premium.

The simple approach is top compute the present value of the annual cash flows from the bonds.

The market price of the bonds is equal to the present value of the principal plus the present value of
future interest payments using the effective rate.

CHAPTER 20 – PROBLEM SOLVING

Problem 20-13

Hawk Company purchased 8,000, P1,000 face amount, 9% bonds to yield 10%. The carrying amount of
the bonds on January 1, 2020 was P7,800,000. The bonds mature on June 30, 2023 and pay interest
semiannually on June 30 and December 31. The entity sold 4,000 bonds on March 1, 2020 for
P3,920,000 after the interest has been received.

What amount should be recognized as gain on sale of bonds?

a. 25,000

b. 20,000

c. 15,000

d. 0

Problem 20-14

Oblivion Company purchased bonds at a discount of P100,000. Subsequently, the entity sold these
bonds at a premium of P140,000. During the period that the entity held this investment, amortization of
the discount amounted to P20,000.

What amount should be reported as gain on sale of bonds?

a. 120,000

b. 220,000

c. 240,000

d. 260,000
Problem 20-15

On January 1, 2020, Mirage Company acquired P4,000,000 of 12% face amount bonds for P3,767,000 to
be held as financial assets at amortized cost with a 14% effective yield. Interest on bonds is payable
annually on December 31 and the bonds mature on January 1, 2024. The effective interest method of
amortization is used.

What is the carrying amount of the bond investment on December 31, 2020?

a. 3,814,380

b. 3,767,000

c. 4,000,000

d. 3,719,620

Problem 20-16

On January 1, 2020, Paradox Company purchased 9% bonds with a face amount of P4,000.000 for
P3,756,000 to yield 10%. The bonds are dated January 1, 2020, mature on December 31, 2029, and pay
interest annually on December 31. The bonds are measured at amortized cost.

What amount should be reported as interest revenue for 2020?

a. 400,000

b. 344,400

c. 360,0000

d. 375,600

Problem 20-17

On July 1, 2020, Quagmire Company purchased P5,000,000 face amount, 8% bonds for P4,615,000 to
yield 10% per year to be held as financial assets at amortized cost. The bonds pay interest semiannually
on January 1 and July 1.

On December 31, 2020, what amount should be reported as interest receivable?

a. 184,600

b. 250,000

c. 230,750

d. 200,000
Problem 20-18

On July 1, 2020, Conair Company paid P1,198,000 for 10% bonds with a face amount of P1,000,000 to be
held as financial assets at amortized cost. Interest is paid on June 30 and December 31. The bonds were
purchased to yield 8%. The entity used the effective interest method.

What is the carrying amount of the bond investment on December 31, 2020?

a. 1,207,900

b. 1,198,000

c. 1,195,920

d. 1,193,050

Problem 20-19

On July 1, 2020, Vicar Company purchased P1,000,000 of 8% bonds for P946,000, including accrued
interest ofP40,000. The bonds were purchased to yield 10% interest. The bonds mature on January 1,
2026, and pay interest anually on January 1. The bonds are measured at amortized cost.

On December 31, 2020, what is the carrying amount of the bond investment?

a. 911,300

b. 916,600

c. 953,300

d. 960,600

Problem 20-20

On January 1, 2020, Pearl Company purchased P5,000,000 face amount 8% bonds for P4,562,000 to be
held as financial assets at amortized cost. The bonds were purchased to yield 10% interest. The bonds
mature on January 1, 2026 and pay interest annually on December 31. The interest method of
amortization is used.

What is the carrying amount of the bond investment on December 31, 2021?

a. 4,680,020

b. 4,662,000

c. 4,618,200

d. 4,562,000
Problem 20-21

On July 1, 2020, Scheme Company purchased ten-year, 8% bonds with a face amount of P5,000,000 for
P4,200,000 to be held as financial assets at amortzed cost. The bonds mature on June 30, 2028 and pay
interest semiannually on June 30 and December 31. Using the interest method, the entity recorded
discount amortization of P18,000 for the six months ended December 31, 2020.

What amount should be reported as interest income for 2020?

a. 168,000

b. 182,000

c. 200,000

d. 218,000

Problem 20-22

On January 1, 2020, Dumaguete Company purchased bonds with face amount of P4,000,000 for
P4,206,000. The business model of the entity in managing the financial asset is to collect contractual
cash flows that are solely payment of principal and interest and also to sell the bonds in the open
market. The entity has not elected the fair value option of measuring financial asset. The bonds mature
on December 31, 2022 and pay 10% interest annually on December 31 each year with 8% effective yield.
The bonds are quoted at 95 on December 31, 2020 and 90 on December 31, 2021.

1. What amount of unrealized loss should be reported as component other comprehensive income in
2020?

a. 342,480

b. 406,000

c. 469,520

d. 0

2. What amount of unrealized loss should be reported as component of other comprehensive income in
2021?

a. 473,878

b. 131,398

c. 200,000

d. 0
3. What amount of cumulative unrealized loss should be reported in the statement of changes in equity
on December 31, 2021?

a. 406,000

b. 606,000

c. 473,878

d. 0

4. What is the carrying amount of the bond investment to be reported on December 31, 2021?

a 4,206,000

b. 3,600,000

c. 3,800,000

d. 4,673,878

Problem 20-23

On January 1, 2020, Gelyka Company purchased 12% bonds with face amount of P5,000,000 for
P5,500,000 including transaction cost of P100,000. The bonds provide an effective yield of 10%. The
bonds are dated January 1, 2020 and pay interest annually on December 31 of each year. The bonds are
quoted at 115 on December 31, 2020. The entity has irrevocably elected to use the fair value option.

1. What amount of gain from change in fair value should be reported for 2020?

a. 750,000

b. 250,000

c. 350,000

d. 0

2. What amount of interest income should be reported for 2020?

a. 600,000

b. 550,000

c. 660,000

d. 540,000
3. What is the carrying amount of the bond investment on December 31, 2020?

a. 5,750,000

b. 5,400,0000

c. 5,500,000

d. 5,450,000

4. What total amount ot income from the investment should be reported in the income statement for
2020?

a. 540,000

b. 950, 000

c. 890,000

d. 900,000

CHAPTER 20 – MC

1. The actual interest earned by the bondholder is

a. Effective rate

b. Yield rate

c. Market rate

d. Effective rate, yield rate or market rate

2. The interest rate written on the face of bond is known as

a. Nominal rate

b. Coupon rate

c. Stated rate

d. Nominal rate, coupon rate or stated rate

3. To compute the price to pay for a bond, what present value concept is used?

a. The present value of 1

b. The present value of an ordinary annuity of 1

c. The present value of 1 and present value of an ordinary annuity of 1

d. The future value of 1

4. Bonds usually sell at a discount when investors are willing to invest in bonds

a. At the stated interest rate.

b. At rate lower than the stated interest rate.

c. At rate higher than the stated interest rate.

d. Because a capital gain is expected.

5. Bonds usually sell at a premium

a. When market rate is greater than stated rate.

b. When stated rate is greater than market rate.

c. When the price of the bonds is greater than maturity amounat.

d. In none of these cases.

6. The effective interest rate on bond is lower than the stated rate when bond sells

a. At maturity value

b. Above face amount

c. Below face amount

d. At face amount

7. The effective interest rate on bond is higher than the stated rate when bond sells

a. At face amount

b Above face amount

c. Below face amount

d. At maturity value
8. The interest method of amortizing discount provides for

a. Increasing amortization and increasing interest income

b. Increasing amortization and decreasing interest income

c. Decreasing amortization and increasing interest income

d. Decreasing amortization and decreasing interest income

9. The interest method of amortizing premium provides for

a. Increasing amortization and increasing interest income

b. Increasing amortization and decreasing interest income

c. Decreasing amortization and decreasing interest income

d. Decreasing amortization and increasing interest income

10. When the interest payment dates of a bond are May 1 and November 1, and a bond is purchased on
June 1, the cash paid by the investor would be

a. Decreased by accrued interest from June 1 to November 1.

b. Decreased by accrued interest from May 1 to June 1.

c. Increased by accrued interest from June 1 to November 1.

d. Increased by accrued interest from May 1 to June 1.

CHAPTER 22

Definition

Investment property is defined as property (land or building or part of a building or both) held by an
owner or by the lessee under a finance lease to earn rentals or for capital appreciation or both.

In other words, only land and building can qualify as investment property.

An equipment or any movable property cannot quality as investment property.

An investment property is not held:

a. For use in the production or supply of goods or services or for administrative purposes.

b. For sale in the ordinary course of business.

The property held by an owner for use in the production or supply of goods or services, or for
administrative purposes is known as owner-occupied property.

Examples of investment property

a. Land held for long-term capital appreciation

b. Land held for a currently undetermined use

For example, if an entity has not determined that it will use the land either as owner-occupied property
or for short-term sale in the ordinary course of business, the land is considered to be held for capital
appreciation and therefore investment property

c. Building owned by the reporting entity leased out under an operating lease

d. Building that is vacant but is held to be leased out under an operatimg lease

e. Property that is being constructed or developed for future use as investment property

Items not considered investment property

a. Owner-occupied property or property held for use in the production or supply of goods or services or
for administrative purposes.

b. Property held for future use as owner-occupied property.

c. Property held for future development and subsequent use as owner-occupied property.

d. Property occupied by employees, whether or not the employees pay rent at market rate.

e. Owner-occupied property awaiting disposal.

f. Property held for sale in the ordinary course of business or in the process of construction or
development for such sale.
g. Property being constructed or developed on behalf of third parties.

h. Property that is leased to another entity under a finance lease.

Investment property held by lessee

IFRS 16, the new standard on leases, requires a lessee to recognize a right of use asset and a lease
liability.

The “right of use" asset is initially recognized at cost which includes the following:

a. The present value of the lease payment

b. Lease payment made to the lessor at or before commencement date less any lease incentive

c. Initial direct cost incurred by the lessee

d. Estimate of cost of dismantling and restoring the underlying asset for which the lessee has a present
obligation

Subsequent measurement

IFRS 16, paragraph 34, provides that if a lessee applies the fair value model in measuring investment
property, the lessee shall also apply the fair value model to the right of use asset that meets the
definition of investment property.

Partly investment and partly owner-occupied

Certain properties may include a portion that is held to earn rentals or for appreciation and another
portion that is held for manufacturing or administrative purposes.

If these portions could be sold or leased out separately, an entity shall account the portions separately
as investment property and owner-occupied property.

If the portions could not be sold separately, the property is investment property if only an insignificant
portion is held for manufacturing or administrative purposes.

When ancilliary services are provided by the entity to the occupants of the property and these services
are a relatively insignificant component of the arrangement, the property is treated as investment
property.

An example would be where the owner of an office building provides security and maintenance services
to the lessees. The building being leased out as offices is investment property.

However, if the services provided are a more significant component of the arrangement, the property is
treated as owner-occupied property.
For example, if an entity owns and manages a hotel, services provided to guests are a significant
component of the arrangement as a whole.

Therefore, the owner-managed hotel is treated as owner-occupied property, rather than investment
property.

Property leased to an affiliate

From the perspective of the individual entity that owns it, the property leased to another subsidiary or
its parent is considered an investment property.

However, from the perspective of the group as a whole and for purposes of consolidated financial
statements, the property is treated as owner-occupied property.

Recognition of investment property

Investment property shall be recognized as an asset when and only when:

a. It is probable that the future economic benefits that are associated with the investment property will
flow to the entity.

b. The cost of the investment property can be measured reliably.

Initial measurement of investment property

An investment property shall be measured initially at its cost. Transaction costs shall be included in the
initial measurement.

The cost of a purchased investment property comprises the purchase price and any directly attributable
expenditure.

Directly attributable expenditure includes professional fees for legal services, property transfer taxes
and other transaction costs.

Costs excluded from cost of investment property

a. Start up costs, unless necessary to bring the property to the condition necessary for its intended use

b. Operating losses incurred before the investment property achieves the planned level of occupancy

c. Abnormal amounts of wasted material, labor or other resources incurred in constructing or

developing the property
Subsequent measurement of investment property

An entity shall choose either of the following models as the accounting policy and shall apply that policy
to all of the investment property:

a. Fair value model-The investment property is carried at fair value.

b. Cost model-The investment property is carried at cost less any accumulated depreciation and any
accumulated impairment loss.

Fair value of investment property

Fair value of an asset is the price that would be received to sell an asset in an orderly transaction
between market participants at the measurement date.

The price in the principal market used to measure fair value shall not be adjusted for transaction cost.

Equipment such as lift or air-conditioning is often an integral part of a building and is generally included
in the fair value of the investment property.

If an office is leased on a furnished basis, the fair value of the office generaly includes the fair value of
the furniture because the rental income relates to the furnished office.

The fair value of investment property excludes prepaid or accrued operating lease income.

Inability to determine fair value reliably

In exceptional cases, when an entity first acquires an investment property, or when an existing property
becomes investment property because there has been a change of use, there may be clear evidence
that the fair value of the investment property cannot be determined reliably on a continuing basis.

Under such exceptional cases, PAS 40, paragraph 53, mandates that the entity shall measure such
investment property using the cost method until the disposal of the investment property.

Moreover, under such exceptional cases only, the residual value of the investment property shall be
assumed to be zero.

PAS 40, paragraph 54, states that an entity that uses the fair value model shall continue to measure
other investment property at fair value, notwithstanding the fact that one investment property is
carried using the cost model due to exceptional cases.

The entity shall select either the cost model or the fair value model in measuring such investment
property because the fair value of the investment property can be determined reliably.
Cost model

If the entity decides to measure the investment property under the cost model, the asset shall be
carried at cost less accumulated impairment loss.

Fluctuations in the fair value of the investment property from year to year are not recognized.

Instead, the annual depreciation of the investment property is the charge against profñt or loss for the
year.

Any change in fair value is not recognized. However, the fair value of the investment property is
disclosed at every year-end.

Fair value model

If the entity decides to measure the investment property under the fair value model, the changes in fair
value from year to year are recognized in profit or loss.

No depreciation is recorded for the investment property.

The net gains and losses from fair value adjustments shall be disclosed.

Transfers of investment property

Transfers to and from investment property shall made when and only when there is a change of use
evidenced by:

a. Commencement of owner occupation or development with view to owner-occupation - transfer from

investment property to owner-occupied property.

b. Commencement of development with a view to sale - transfer from investment property to inventory.

c. End of owner occupation - transfer from owner-occupied property to investment property.

d. Inception of an operating lease to another entity transfer - from owner-occupied property to

investment property.

Measurement of transfers

1. When the entity uses the cost model, transfers between investment property, owner-occupied
property and inventory shall be made at carrying amount.

2. A transfer from investment property carried at fair value to owner-occupied property or inventory
shall be accounted for at fair value which becomes the deemed cost for subsequent accounting.
3. If owner-occupied property is transferred to investment property that is to be carried at fair value, the
difference between the fair value and the carrying amount of the property shall be accounted for as
revaluation of property, plant and equipment.

4. If an inventory is transferred to investment property that is to be carried at fair value, the

remeasurement to fair value shall be included in profit or loss.

5. When an investment property under construction is completed and to be carried at fair value, the
difference between fair value and carrying amount shall be included in profit or loss.

Derecognition of investment property

An investment property shall be derecognized:

a. On disposal.

b. When the investment property is permanently withdrawn from use.

c. When no future economic benefits are expected from the investment property.

Disclosures related to investment property

The general disclosures are:

a. Whether the entity uses the cost model or fair value model

b. The amount of rental income with the related expense

c. Restrictions on the investment property

d. Contractual obligations to purchase or construct investment property

When the fair value model is used, the disclosures are:

a. Detailed reconciliation between carrying amount of investment property at the beginning and end of
the period

b. The method of determining the fair value of investment property and whether the valuation is carried
out by an independent qualified valuer

c. Net gains or losses from fair value adjustments

d. Whether significant fixtures, such as lift and office furniture, within an investment property, have
been separately recognized
When the cost model is used, the disclosures are:

a. The depreciation method or rate and useful life.

b. Detailed reconciliation of the gross cost of investment property and the related accumulated
depreciation

c. Fair value of the investment property where possible. If it is not possible, such fact shal be explained.

CASH SURRENDER VALUE

The entity may insure the life of its officers and name itself as beneficiary.

The accounting for the payment of the insurance premiums will depend on whether the beneficiary is
the entity itself or the officer insured.

If the beneficiary is the officer insured or any person other than the entity like the wife of the officer, no
accounting problem is encountered because the payment of the premium is simply charged to insurance
expense.

An accounting problem will arise when the beneficiary is the entity itself. It is on this assumption that
the following discussion is geared.

Under our law, a life insurance policy has a cash surrender value and loan value.

Cash surrender value is the amount which the insurance firm will pay upon the surrender and
cancelation of the life insurance policy. Cash surrender value arises if the following requisites are
present:

a. The policy is a life policy. There is no cash surrender value in fire, accident and other nonlife policies.

b. Premiums for three full years must have been paid.

c. The policy is surrendered at the end of the third year or anytime thereafter.

Thus, a cash surrender value legally commences to accrue at the end of the third year.

However, there are certain insurance firms which sell life insurance policies that grant cash surrender
value even at the end of the second year only.

The cash surrender value is classified as noncurrent investment.

On the other hand, a loan value is the amount which the insured can borrow from the insurance firm
with the cash surrender value as collateral security.

The loan shall not be deducted from the cash surrender value but accounted for as an ordinary
obligation.
Theory on the cash surrender value

The cash surrender value of a life policy arises from the fact that the fixed annual premium is much in
excess of the annual risk during the earlier years of the policy.

The excess is necessary in order to balance the deficiency of the same premium to meet the annual risk
during the later years of the policy.

Such excess in the premium paid over the annual cost of insurance, with accumulated interest,
constitutes the cash surrender value.

Accounting procedures

The accounting procedures concerning the cash surrender value are as follows:

a. Payment of the insurance premium

Life insurance expense

Cash

b. Adjustment of the unexpired premium at the end of the period:

Prepaid life insurance

Life insurance expense

c. Dividends received on the life policy are not income but a reduction of life insurance expense.

Cash

Life insurance expense

d. Initial recognition of the cash surrender value at the end of the third year:

Cash surrender value

Life insurance expense

Retained earnings

The initial cash surrender value is regarded as applicable to three years of the life policy. That portion of
the cash surrender value applicable to the current year is credited to life insurance expense and that
portion applicable to the prior years is credited to retained earnings.
e. Recognition of cash surrender value subsequent to the third year:

Cash surrender value

Life insurance expense

f. Receipt of the proceeds of the life policy:

Cash

Cash surrender value

Life insurance expense

Gain on life insurance settlement

The amount to be credited to the cash surrender value should be the adjusted balance at the time of
death of the insured.

The life insurance expense account is credited for the unexpired premium at the time of death.

CHAPTER 22 – MC

Problem 22-16

1. Which statement best describes investment property?

a. Property held for sale in the ordinary course of business

b. Property held for use in the production and supply of goods or services and property held for
administrative purposes

c. Property held to earn rentals or for capital appreciation

d. Property classified as held for sale

2. Which of the following statements best describes owner-occupied property?

a. Property held for sale in the ordinary course of business

b. Property held for use in the production and supply of goods or service and property held for
administrative purposes

c. Property held to earn rentals

d. Property held for capital appreciation

3. Investment property includes all of the following, except

a. Land held for long-term capital appreciation

b. Land held for currently undetermined use

c. Building owned by the reporting entity leased out under an operating lease.

d. Property held for sale in the ordinary course of business.

4. Which of the following is an investment property?

a. Property being constructed or developed on behalf of third party

b. Property being constructed and developed as investment property

c. Property held for future development and subsequent use as owner-occupied property

d. Owner-occupied property awaiting disposal

5. Which statement is true if the property is partly investment and partly owner-occupied?

I. If the investment and owner-occupied portions could be sold or leased out separately, the portions
shall be accounted for separately as investment property and owner-occupied property.

II. If the investment and owner-occupied portions could not be sold or leased out separately, the
property is investment property if only an insignificant portion held for manufacturing or administrative
purposes.

a. only

b. II only

c. Both I and II

d. Neither I nor II

6. If an entity owns and manages a hotel and services provided to guests are a significant component of
the arrangement as a whole, the hotel is classified as

a. Investment property

b. Owner-occupied property

c. Partly investment property and partly owner-occupied property

d. Neither investment property nor owner-occupied property

7. Which statement is true concerning property leased to an affiliate?

I. From the perspective of the individual entity that owns it, the property leased to an affiliate is
considered an investment property.

II. From the perspective of the affiliates as a group and for purposes of consolidated financial
statements, the property is treated as owner-occupied property.

a. Both I and II

b. Neither I nor II

c. I only

d. II only

8. Directly attributable expenditures related to investment property include

a. Professional fees for legal services, property transfer taxes and other transaction cost.

b. Start up costs

c. Initial operating loss incurred before the investment property achieves the planned level of
occupancy.

d. Abnormal amount of wasted material, labor and other resources incurred in constructing or
developing the property.

9. Which statement is incorrect in determining the fair value of an investment property?

a. An entity shall determine the fair value of investment property by deducting transaction cost that
may be incurred upon disposal.

b. The fair value of investment property shall reflect market conditions at the end of the reporting
period.

c. If an office is leased on a furnished basis, the fair value of the office generally includes the fair value of
the furniture because the rental income relates to the furnished office.

d. The fair value of investment property excludes prepaid or accrued operating lease income.
10. An investment property is derecognized when

a. lt is disposed to a third party.

b. It is permanently withdrawn from use.

c. No future benefits are expected from the disposal.

d. In all of these cases.

Problem 22-17

1. Subsequent to initial recognition, the investment property shall be measured using

a. Fair value model or revaluation model

b. Fair value through profit or loss model

c. Cost model or fair value model

d. Cost model or revaluation model

2. If the entity uses the fair value model for investment property, changes in fair value are reported

a. In profit or loss in the current period.

b. As an extraordinary gain.

c. In other comprehensive income for the period.

d. As deferred revenue for the period.

3. If the entity uses the fair value model for investment property, which statement is true?

a. The entity should value the property at cost less accumulated depreciation and impairment.

b. The entity depreciates the equipment.

c. The entity does not record depreciation.

d. All of these statements are true.

4. Which disclosure shall be made when the fair value model has been adopted?

a. Depreciation method used

b. The amount of impairment loss recognized

c. Useful life

d. Net gain or loss from fair value adjustments

5. Transfers from investment property to property, plant and equipment are appropriate

a. When there is change of use.

b. Based on the discretion of management.

c. Only when the entity adopts the fair value model.

d. The entity can never transfer property into another classification once it is classified as investment
property.