ACCOUNTING FOR INVESTMENT in DEBT SECURITIES

Classifications of investment in debt securities:

a. Debt investment at Amortized cost or held to maturity securities (HTM)– Premium/discount is

amortized. ( need to prepare amortization table) The cost is purchase price plus transaction cost
directly attributable to acquisition. At each reporting the debt investment is reported at its
Carrying Value or Amortized cost.

b. Debt investment at FVPL- Premium/discount is NOT amortized. The cost is its purchase price.
Transaction cost is charged to expense. Reported at Fair Value

c. Debt investment at FVOCI- Premium/discount is amortized. (need to prepare amortization table)

The cost is purchase price plus transaction cost directly attributable to acquisition. Reported at Fair
Value

Notes:
1. bonds purchased at a premium means that that stated interest rate is higher
than the effective interest rate.

2. bonds purchased at a discount means that the stated rate is lower than the
effective rate on interest.

3. bonds purchased at par means that the stated rate and effective rate are the
same.

ANSWERS TO:

Problem 3-3

1. Assuming the investment in debt securities is classified as at amortized cost

Face value of debt securities P4,000,000

Acquisition cost 3,691,500
Discount 308,500

The discount of P308,500 will be recognized as interest revenue through amortization.

investment in debt securities

at Amortized Cost
Partial Amortization table

A B C D E
Interest Revenue Discount
Date Interest Received (amortized cost x Amortization Amortized Cost
(4M x 8%) yield rate) ( B-C ) (E–D)
June 1, Year 1 3,691,500
Dec. 1, Year 1 160,000 184,575 24,575 3,716,075
June 1, Year 2 160,000 185,804 25,804 3,741,879
Dec. 1, Year 2 160,000 187,094 27,094 3,768,973
June 1, Year 3 160,000 188,449 28,449 3,797,422
Dec. 1, Year 3 160,000 189,871 29,871 3,827,293
June 1, Year 4 160,000 191,365 31,365 3,858,658
Dec. 1, Year 4 160,000 192,933 32,933 3,891,591

a) Entries:
Year 1:

June 1
Debt Investments at Amortized Cost 3,691,500
Cash 3,691,500
To record investment in debt securities classified as at amortized cost.
Dec. 1
Cash 160,000
Interest revenue 160,000
To record interest received.

Debt Investments at Amortized Cost 24,575

Interest revenue (pls. see table above) 24,575
To amortize discount on debt investment classified as at amortized cost.

The Dec. 1, entry may be compounded as follows:

Cash 160,000
Debt Investments at Amortized Cost 24,575
Interest Revenue (see above table) 184,575
To record interest on debt investment and to amortize the discount on debt securities

Dec. 31
Interest receivable ( 160,000 x 1/6) 26,667
Interest revenue 26,667
To take up accrued interest for the month of December.

Debt Investments at Amortized Cost 4,301

Interest revenue (25,804 x 1/6 ) 4,301
To amortize discount for the month of December.

Compound Entry

Interest receivable ( 160,000 x 1/6) 26,667

Debt Investments at Amortized Cost 4,301
Interest revenue 30,968
To take up accrued interest and to amortize discount.

Entries:
Year 2:
June 1

Cash 160,000
Interest Revenue 160,000
To record interest received.

Debt Investments at Amortized Cost 25,804 x 5/6) 21,503

Interest Revenue 21,503
to amortize the discount from January to June 1, year 2. ( 5 months)

Dec. 1
Cash 160,000
Interest revenue 160,000
To record interest received.

Debt Investments at Amortized Cost 27,094

Interest revenue (pls. see table above) 27,094
To amortize discount on debt investment classified as at amortized cost.

Dec. 31
Interest receivable ( 160,000 x 1/6) 26,667
Interest revenue 26,667
To take up accrued interest for the month of December.

Debt Investments at Amortized Cost 4,516

Interest revenue (27,094 x 1/6 ) 4,516
To amortize discount for the month of December.

Note: If the debt investment is classified as at amortized cost, increase/decrease in FV is ignored.

b) Entry to record the sale of debt investment on November 1, year 4
Debt Investments at Amortized Cost 27,444
Interest Receivable (4M x 8% x 5/6)- June 1 to Nov. 1 133,333
Interest revenue 160,777
To update the amortization of discount as of date of sale and to take up accrued
interest.

Cash 3,925,000
Loss on Sale of Debt Investments 94,435
Interest Receivable 133,333
Debt Investments at Amortized Cost 3,886,102
To record sale of debt investment.

Computation of loss on sale of debt investment:

Amount received from sale (includes accrued interest) 3,925,000
Less: accrued interest (4M x 8% x 5/6)- June 1 to Nov. 1 (133,333)
Selling price of debt investment 3,791,667
CV of debt investment, date of sale (which is the amortized
cost as of date of sale) 3,886,102
Loss on sale 94,435

Note: the accrued interest in not part of the selling price.

Questions:

1. What is the amortized cost/ carrying value of the debt investment at December 31, year 1? Answer-
3,740,650

Computation:
Amortized cost or carrying value on Dec. 1, year 1 (pls refer to amortization table) 3,716,075
Add: Amortization of discount for the month of December 24,575
CV, Dec. 31, year 1 3,740,650

2. How much is the interest revenue for year 1? Answer – 215,542

Computation:
Interest from June 1, to Dec. 1, year 1 (pls see table) 184,575
Add: Interest for the month of December (185,804 x 1/6) 30,967
Total interest revenue for year 1 215,542

2. Assuming the investment in debt securities is classified as at FVPL

Note: the discount is not amortized. So, no amortization table is to be prepared

a) Entries:
Year 1:

June 1
Debt Investments as at FVPL 3,691,500
Cash 3,691,500
To record investment in debt securities.

Dec. 1
Cash 160,000
Interest revenue 160,000
To record interest received.

Dec. 31
Interest receivable ( 160,000 x 1/6) 26,667
Interest revenue 26,667
To take up accrued interest for the month of December.
 At December 31, year 1, Additional entry is prepared to take up increase/decrease in fair value of
debt investment. The increase/ decrease is determined as follows:

Fair value of debt investment at Dec. 31, year 1 (4million x .97)—P 3,880,000
Fair Value at acquisition date-----------------------------------------------3,691,500
Increase in fair value ------------------------------------------------------P 188,500

Dec. 31
Debt Investments as at FVPL 188,500
Unrealized holding gain/loss 188,500
To take up increase in fair value of debt investment classified as at FVPL

Year 2 Entries:

June 1 – to record the receipt of P160,000 interest- Same entry.

Dec. 1 -- to record the receipt of P160,000 interest -Same entry.
Dec. 31 -- to record accrued interest – same entry
Dec. 31 -- to take up increase/decrease in FV

Fair value of debt investment at Dec. 31, year 2 (4million x .99)—P 3,960,000
Fair Value at December 31, year 1 ((4million x .97)----------------- -- 3,880,000
Increase in fair value-----------------------------------------------------------P 80,000

Entry: Dec. 31, year 2

Debt Investments as at FVPL 80,000
Unrealized holding gain/loss 80,000
To take up increase in fair value of debt investment classified as at FVPL

b) Entry to record the sale of debt investment on November 1, year 4

Cash 3,925,000
Loss on Sale of Debt Investments-FVPL 128,333
Interest Revenue (4M x 8% x 5/12) 133,333
Debt Investments -FVPL (FV at Dec.31, yr 3) 3,920,000
To record sale of debt investment.

Computation of loss on sale of debt investment-FVPL

Amount received from sale (includes accrued interest) 3,925,000
Less: accrued interest (4M x 8% x 5/6)- June 1 to Nov. 1 (133,333)
Selling price of debt investment 3,791,667
CV of debt investment, date of sale (the FV at Dec. 31, year 3) 3,920,000
Loss on sale 128,333

Questions:
1. What is the carrying value of the debt investment at Dec. 31, year 1? 4M x 97 = 3,880,000
2. What is the carrying value of the debt investment at Dec. 31, year 2? 4M x 99 = 3,960,000
3. What is the carrying value of the debt investment at Dec. 31, year 3? 4M x 98 = 3,920,000

4. How much is the interest revenue for year 1? Answer-P P186,667

Computation:
Interest from June 1 to December 31, year 1 (4million x 8% x 7/12)- P186,667

5. How much is the interest revenue for year 2? Answer-P P320,000

Computation:
Interest from January 1 to December 31, year 2 (4million x 8%)- P320,000

6. How much is the interest revenue for year 2? Answer-P P320,000 (same of year 2)
3. Assuming the investment in debt securities is classified as at FVOCI
Note: the discount is to be amortized. Amortization table is to be prepared.

a) Entries:
Year 1:

June 1 – the entry to record the investment is same with the other classification
Dec. 1 – the entry to record the receipt of P160,000 interest is also same.
Dec. 1 – the entry to record the amortization of discount is same with as at amortized cost classification
Dec. 31, year 1- the entry to amortize the discount for the month of December- same
Dec. 31, year 1- the entry to take up accrued interest- same

Additional entry on Dec. 31 year 1, is to be prepared to take up the increase in FV of debt

investment classified as at FVOCI. The increase/decrease is determined as follows:

FV December 31, year 1 ( 4,000,000 x .97) ----------- P3,880,000

Amortized Cost, Dec. 31, year 1:
Amortized cost -Dec.1, yr. 1 (see table)------ 3,716,075
Add: amortization Dec. 1 to 31 --------------- 4,301 3,720,376
Unrealized holding gain-FVOCI 159,624

Entry:
Debt Investment-FVOCI 159,624
Unrealized Gain on Debt Investments - FVOCI 159,624

Year 2 Entries:
Dec. 1 – the entry to record the receipt of P160,000 interest is also same.
Dec. 1 – the entry to record the amortization of discount is same with as at amortized cost classification
Dec. 31, year 2- the entry to amortize the discount for the month of December- same
Dec. 31, year 2- the entry to take up accrued interest- same

Dec. 31, year 2- Entry to take up increase/decrease in FV

Entry:
Debt Investment-FVOCI 26,661
Unrealized Gain on Debt Investments - FVOCI 26,661

Computation of unrealized/holding gain to be recorded at Dec. 31, year 2

FV December 31, year 2 ( 4,000,000 x .99) -------------------------------------- P3,960,000

Amortized Cost, Dec. 31, year 2:
Amortized cost -Dec.1, yr. 2 (see table)---------------------- 3,768,973
Add: amortization Dec. 1 to 31 ------------------------------- 4,742 3,773,715
Unrealized gain-FVOCI- accumulated balance, Dec. 31, year 2 186,285
Less: Unrealized Gain on Debt Investments – FVOCI bal. Dec. 31,yr 1 159,624
Fair value adjustment- Dec. 31, year 2 26,661

b) Entry to record the sale of debt investment-FVOCI on November 1, year 4

1. Entry to update amortization of discount as of date of sale

Debt Investment-FVOCI 27,444
Interest revenue 27,444

2. Entry to take up accrued interest from June 1 to Nov. 1

Interest receivable (4,000,000 x 8% x 5/12) 133,333
Interest revenue 133,333

3. to adjust the FV of debt investment –FVOCI as of date of sale

FV date of sale (selling price w/o the accrued interest) 3,791,667
CV as of date of sale: 3,886,102
Decrease in value- Unrealized loss-FVOCI 94,435

Entry to adjust the FV of debt investment-FVOCI

Unrealized gain/loss-FVOCI 94,435
Debt Investment-FVOCI 94,435
4. to record the sale
Cash 3,925,000
Interest receivable 133,333
Debt Investment-FVOCI 3,791,667

5. to transfer to retained earnings the unrealized gain/loss-FVOCI, relating to the investment

sold
Retained Earnings 94,435
Unrealized Gain/Losses on Debt Investments-FV OCI 94,435

HOW TO DETERMINE THE ISSUE PRICE/PURCHASE PRICE OF BONDS.

ILLUSTRATIONS:

1. bonds purchased at a premium

Face Value of bonds P1,000,000

Stated interest rate 12%
Effective(market) interest rate 10%
Term 5 years
Interest payment date Every December 31
Present value of 1 at 10% for 5 periods 0.620921
Present value of an ordinary annuity of 1 at 10% for 5 periods 3.790787

The bonds price is computed as follows:

Discounted value of Maturity value (P1M x 0.620921) P620,921

Discounted value of Interest payments (P1M x 12% x 3.790787) 454,894
Issue price/Purchase price of bonds P1.075,815

Since the stated interest rate of 12%, is higher than the effective rate of 10%, the issue price/purchase
price of the bonds would be at a premium.

Alternative computation:
Face value of bonds x difference in interest rate x present value factor:
P1,000,000 x 2% x 3.790787 = P75,815 premium (stated rate is > effective rate)

Face Value of bonds P1,000,000 + 75,815 premium = P1,075,815

2. bonds purchased at a discount

Face Value of bonds P1,000,000

Stated interest rate 10%
Effective(market) interest rate 12%
Term 5 years
Interest payment date Every December 31
Present value of 1 at 12% for 5 periods 0.567427
Present value of an ordinary annuity of 1 at 12% for 5 periods 3.604776

The bonds price is computed as follows:

Discounted value of Maturity value (P1M x 0.567427) P567,427

Discounted value of Interest payments (P1M x 10% x 3.604776) 360,478
Issue price/Purchase price of bonds P927,905

Since the stated interest rate of 10%, is lower than the effective rate of 12%, the issue price/purchase
price of the bonds would be at a discount

Alternative computation:
Face value of bonds x difference in interest rate x present value factor:
P1,000,000 x 2% x 3.604776 = P72,095 discount (stated rate is < effective rate)

Face Value of bonds P1,000,000 - 72,095 discount = P927, 905

MC 13- BONDS PURCHASED BETWEEN INTEREST PAYMENT DATE.

Notes:

1. bonds purchased between interest payment date carries with it an accrued interest
2. the accrued interest is from the last interest payment date up to date of purchase
3. the accrued interest paid by the investor is not part of the cost of debt investment. It is debited to
interest receivable or interest income.

Interest is payable every October 31 and April 30

The bonds were purchased on September 1, year 2
The accrued interest is from May 1 to August 31- 4 months

Face value of bonds—P1,000,000; acquired at 104

The acquisition cost is P1,000,000 x 104% = P1,040,000
The amount of accrued interest is-P1,000,000 x 12% x 4/12 =P40,000

Total amount to be paid upon acquisition of bonds on sept. 1, is

P1,040,000+40,000 accrued interest=P1,080,000

Please Answer the following problems:

a. 3-1
b. 3-2

for 3-2 also prepare entries for year 1 and 2

assuming the debt investment is classified as at FVPL
and assuming the debt investment is classified as at FVOCI

Additional information:
Market value of the debt securities, Dec. 31, year 1-104: Dec. 31, year 2-105