ReSA - THE REVIEW SCHOOL OF ACCOUNTANCY

CPA Review Batch 43  May 2022 CPA Licensure Examination  Week No. 7

FINANCIAL ACCOUNTING & REPORTING C. UBERITA  J. BINALUYO  G. MACARIOLA

FAR-4309: INVESTMENT IN DEBT SECURITIES

Investment in debt securities – representing creditor’s claim with fixed amount and usually some
interest obligation (e.g. government securities, corporate bonds, convertible bonds, commercial paper, etc.).

Classification of debt securities: an entity shall classify financial assets as subsequently measured at amortized
cost, fair value through profit or loss or fair value through other comprehensive income on the basis of both:
a. The entity’s business model for managing the financial assets and
b. The contractual cash flow characteristics of the financial asset.

A financial asset shall be measured at amortized cost if both of the following conditions are met
a. The financial asset is held within a business model whose objective is to hold financial assets in order to collect
contractual cash flows and
b. The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments
of principal and interest on the principal amount outstanding.

A financial asset shall be measured at fair value through other comprehensive income if both of the
following conditions are met:
a. The financial asset is held within a business model whose objective is achieved by both collecting
contractual cash flows and selling financial assets and
b. The contractual terms of the financial asset give rise on specified dates to cash flows that are solely
payments of principal and interest on the principal amount outstanding.

A financial asset shall be measured at fair value through profit or loss unless it is measured at amortized
cost or at fair value through other comprehensive income.

Business model for managing financial assets (IFRS 9)

The business model approach is a fundamental building block of IFRS 9 and aligns the accounting with the way
that management deploys assets in its business while also considering the characteristics of assets. The business
model is determined by the company’s key management personnel and does not depend on management’s
intentions for an individual asset. It is instead determined at a higher level. A company could have more than
one business model for managing assets and may manage different portfolios of assets with different objectives.

Measurement at the date of acquisition (IFRS 9)

At amortized cost - is measured at the fair value of the financial instrument acquired plus any transaction costs
incurred in relation to its acquisition.

At fair value to profit or loss – is measured at the fair value of the security. Any transaction cost incurred is
recognized outright as an expense.

At fair value to other comprehensive income – is measured at fair value of the security plus any
transaction cost incurred in relation to its acquisition.

Measurement Subsequent to Date of Acquisition (IFRS 9)

At amortized cost -is re-measured at amortized cost

At fair value to profit or loss – is re-measured at fair market value with changes in fair value to be
recognized in the current year profit or loss

At fair value to other comprehensive income – is re-measured at the fair value of the security with
changes in the fair value included in part in the profit or loss and the other part in the other comprehensive
income.

Method of Amortization – Effective Interest Method (IFRS 9)

The effective interest method is a method of calculating the amortized cost of a financial asset or liability (or
group of financial assets or financial liabilities) and of allocating the interest income or interest expense over the
relevant period.

Reclassification (IFRS 9) -If entity reclassifies financial assets it shall apply the reclassification prospectively
from reclassification date. The entity shall not restate any previously recognized gains, losses (including
impairment gains or losses) or interest.

1. If an entity reclassifies a financial asset out of fair value through profit or loss measurement category
and into amortized cost measurement category, its fair value at the date of reclassification becomes its new
gross carrying amount. The effective interest rate is determined on the basis of the fair value on the date of
reclassification. The date of reclassification is treated as the date of initial recognition.

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FAR-4309
Week 7: INVESTMENT IN DEBT SECURITIES

2. If an entity reclassifies a financial asset out of fair value through profit or loss measurement category
and into fair value through other comprehensive income measurement category, the financial asset
continues to be measured at fair value.

3. If an entity reclassifies a financial asset out of amortized cost measurement category and into the fair value
through profit or loss measurement category, its fair value is measured at the reclassification date. Any
gain or loss arising from a difference between the previous amortized cost of the financial asset and fair value
is recognized in profit or loss.

4. If an entity reclassifies a financial asset out of the amortized cost measurement category and into the fair
value through other comprehensive income measurement category, its fair value is measured at the
reclassification date. Any gain loss arising from a difference between the previous amortized cost of the
financial asset and fair value is recognized in other comprehensive income. The effective interest rate and
the measurement of expected credit losses are not adjusted as a result of the reclassification. The recognition
of interest revenue will not change and therefore the entity continues to use the same effective rate. The
measurement of expected credit losses will not change because both measurement categories apply the same
impairment approach.

5. If an entity reclassifies a financial asset out of the fair value through other comprehensive income
category and into the Amortized cost measurement category, the financial asset is reclassified at its fair
value at reclassification date. However, the cumulative gain or loss previously recognized in other
comprehensive income is removed from equity and adjusted against the fair value of the financial asset at
the reclassification date. As a result, the financial asset is measured at the reclassification date as if it had
always been measured at amortized cost. This adjustment affects other comprehensive income but does not
affect profit or loss and therefore is not a reclassification adjustment. The effective interest rate and the
measurement of expected credit loss are not adjusted as a result of the reclassification.

6. If an entity reclassifies a financial asset out of the fair value through other comprehensive income
category and into the Fair value through profit or loss measurement category, the financial asset continues
to be measured at fair value. The cumulative gain or loss recognized in other comprehensive income is
reclassified from equity to profit or loss as a reclassification adjustment at the reclassification date.

PROBLEM SOLVING

Problem 1: On January 1, 2021, Snow Company purchased 2,000 of the P1,000 face value, 9%,
10-year bonds of White Company. Snow Company paid a broker’s fee of P100,000. The bonds
mature on January 1, 2031, and pay interest annually beginning December 31, 2021. Snow
Company purchased the bonds to yield 11% and classified this as Investment at Fair value through
Profit or Loss.

PV factor of 11% after 10 years 0.3522

PV factor of 9% after 10 years 0.4224
PV factor of annuity of 11% after 10 years 5.8890
PV factor of annuity of 9% after 10 years 6.4180

Market values of the bonds are as follows:

December 31, 2021 95
December 31, 2022 98

1. How much is the interest income for the year 2021?

a. 220,000 c. 158,798
b. 180,000 d. 194,086

2. How much is the carrying value of the investment that should be reported in the
Statement of Financial Position on December 31, 2022?
a. 1,900,000 c. 1,794,142
b. 1,676,199 d. 1,960,000

3. How much is the unrealized gain/loss that should be reported in the Profit or Loss
Statement for the year 2021?
a. 35,580 c. 135,580
b. 121,494 d. 221,494

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FAR-4309
Week 7: INVESTMENT IN DEBT SECURITIES

Problem 2: On May 1, 2021, Doc Company purchased a P2,000,000 face value 9% debt
instruments for P1,860,000 including the accrued interest. The debt instruments pay interest semi-
annually on January 1 and July 1. On December 31, 2021, the fair value of the instruments is
P1,940,000. The investment was designated as Investment at FVPL.

4. How much is the interest income for the year 2021?

a. 120,000 c. 162,000
b. 180,000 d. 108,000

5. How much is the unrealized gain or loss that should be taken to profit or loss for the
year 2021?
a. 80,000 c. 60,000
b. 140,000 d. 0

6. How much is the accrued interest/interest receivable on December 31, 2021?

a. 120,000 c. 180,000
b. 90,000 d. 0

Problem 3: On June 30, 2021, Grumpy Company purchased P4,000,000 of 16% bonds to yield
14% for P4,280,752. Interest is payable semiannually on June 30 and December 31. The bonds
mature in five years. Grumpy Company uses the calendar year and the effective interest method
of amortization. The investment was designated as Investment at FVOCI.

Market values of the bonds on different dates are as follows:

December 31, 2021 108

December 31, 2022 106

7. What amount of unrealized gain or loss shall be taken to OCI as a result of properly
measuring the investments on December 31, 2021?
a. 320,000 c. 59,595
b. 39,248 d. 20,347

8. How much is interest income for the year ended December 31, 2022?
a. 594,932 c. 296,704
b. 298,228 d. 596,457

9. How much is the unrealized gain or loss that should be presented in the Statement
of Financial Position on December 31, 2021?
a. 34,932 c. 59,595
b. 24,663 d. 45,068

Problem 4: Happy Company acquired on January 1, 2021 a 5 year, 10%, P5,000,000 face value
bonds, for P4,639,400 dated January 1, 2021. The bonds which pay interest every December 31
had a 12% prevailing interest rate on the date of acquisition. Happy’s business model is to collect
contractual cash flows and the cash flows are solely payment of principal and interest. The
prevailing interest rate on December 31, 2021 is at 9%.

10.How much is the correct interest income for the year 2022?
a. 500,000 c. 563,535
b. 556,728 d. 422,652

11.How much is the carrying value of the investment that should be reported in the
Statement of Financial Position on December 31, 2021?
a. 5,450,000 c. 4,759,663
b. 4,696,128 d. 5,161,850

12.How much is the amortized cost of the Investment on December 31, 2024?
a. 4,910,714 c. 4,759,817
b. 5,000,000 d. 4,830,995

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FAR-4309
Week 7: INVESTMENT IN DEBT SECURITIES

Problem 5: On January 1, 2021, Sleepy Company purchased P 1,000,000 12% bonds for
P1,063,394, a price that yields 10%. Interest on these bonds is payable every December 31. The
bonds mature on December 31, 2024. On April 1, 2022, Sleepy Company sold P600,000 face
value of the bonds at 101 plus accrued interest. Market values of the bonds on different dates are
as follows:

December 31, 2021 108

December 31, 2022 106

13.How much is the gain or loss on sale on April 1, 2022 assuming the bond investments
are classified as FVPL?
a. 42,000 gain c. 24,000 gain
b. 42,000 loss d. 24,000 loss

14.How much is the gain or loss on sale on April 1, 2022 assuming the bond investments
are classified as IAC?
a. 21,586 loss c. 3,586 loss
b. 21,586 gain d. 3,586 gain

Problem 6: Bashful Company acquired on January 1, 2021 a 5 year, 10%, P5,000,000 face value
bonds, for P4,639,400 dated January 1, 2021. The bonds which pay interest every December 31
had a 12% prevailing interest rate on the date of acquisition. Bashful’s business model is to collect
contractual cash flows and the cash flows are solely payment of principal and interest. On
December 31,2022, the P4,000,000 face value was disposed of when the market rate was 11%.
The management decided the that the business model is no longer appropriate and reclassified the
remaining investment to FVPL. The prevailing interest rate on December 31, 2023 is at 11.5%.

15.How much is the gain or loss on reclassification on January 1, 2023?

a.23,637 gain taken to P/L c. 23,637 gain taken to OCI
b.23,637 loss taken to P/L d. 23,637 loss taken to OCI

16.How much is the carrying value of the investment that should reported in the
Statement of Financial Position on December 31, 2023?
a.990,991 c. 982,143
b.986,547 d. 974,520

Problem 7: Sneezy Company acquired on January 1, 2021 a 5 year, 10%, P5,000,000 face value
bonds, for P4,639,400 dated January 1, 2021. The bonds which pay interest every December 31
had a 12% prevailing interest rate on the date of acquisition. Sneezy’s business model is to sell
the investment in the short-term to generate profits. The fair values of the investment on
December 31,2021 and December 31, 2022 are based on 11.5% and 11% respectively. On
December 31,2022, Sneezy Company decided the that investment is no longer for sale but now
held to collect contractual cash flow. The prevailing interest rate on December 31, 2023 is at
10.5%.

17.How much is the carrying value of the investment as of December 31, 2022?
a. 5,500,000 c. 4,877,850
b. 4,759,663 d. 5,550,000

18.How much is the interest income for the year 2023?

a. 500,000 c. 536,564
b. 571,160 d. 585,342

Problem 8: On January 2, 2019, Dopey Company invested in a 4-year 10% bond with a face value
of P6,000,000 in which interest is to be paid every December 31. The bonds have an effective
interest rate of 9% and was acquired for P6,194,383. The investment was designated as
Investment at FVOCI. The following information pertains to the debt security:
Date Fair Value*/Amortized cost at 9% Fair Value*/Amortized cost at 8.5%
01/01/19 P6,194,383 * None
12/31/19 P6,151,878 P6,229,862 *
12/31/20 P6,105,547 P6,159,400
12/31/21 P6,055,046 P6,082,949
12/31/22 P6,000,000 P6,000,000

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FAR-4309
Week 7: INVESTMENT IN DEBT SECURITIES

19.Assume the investment was reclassified on January 2, 2020 as Investment at Fair

Value to Profit or Loss wherein the prevailing rate of interest on January 2, 2020 is
8.5%, what amount of unrealized gain or loss reported in the equity that must be
reclassified to profit loss on the date of transfer/reclassification?
a none c. P 77,984
b P35,479 d. P113,373

20.Assume the investment was reclassified on January 2, 2020 as Investment at

Amortized Cost wherein the prevailing rate of interest on January 2, 2020 is 8.5%,
what amount should the investment account be reported in the Statement of
Financial Position on December 31, 2020?
a P6,105,547 c. P6,159,400
b P6,151,878 d. P6,229,862

THEORIES

1. Which of the following statements is true concerning recognition of unrealized gains and losses?
a. Unrealized gains and losses on financial assets held for trading shall be included in profit or loss.
b. Unrealized gains and losses on financial assets measured at amortized cost are not recognized.
c. Unrealized gains and losses on financial assets at fair value through other comprehensive income
are not recognized in the income statement.
d. All of the above statements are true.

2. Under IFRS 9, the classification of debt investment shall be made on the basis of
a. The business model for managing the financial asset.
b. Contractual cash flow characteristics of the financial asset.
c. Management’s intention of holding the debt instruments.
d. Both the business model for managing the financial asset and contractual cash flow
characteristics of the financial asset.

3. An entity purchased government bonds. The entity’s business model in managing financial assets is
achieved by collecting cash flows that are solely for payment of principal and interest on the principal
amount outstanding and by selling the financial assets. Which of the following is the most appropriate
classification for the investment in bonds?
a. Held for trading
b. At fair value through profit or loss
c. At amortized cost
d. At fair value through other comprehensive income.

4. If the financial asset is measured at fair value through profit or loss, transaction costs directly
attributable to the acquisition shall be
a. Capitalized as cost of the financial asset.
b. Expensed immediately when incurred.
c. Deferred and amortized over a reasonable period
d. Included as component of other comprehensive income.

5. “Reclassification date” for purposes of reclassifying financial assets refers to

a. End of the current reporting period.
b. First day of the next reporting period following the change in business model.
c. Date when management decided to change the business model for managing financial assets
d. No definition of reclassification date as this would depend on the judgment of management.

6. Under IFRS 9, investments in debt securities that meet the business model test of collecting cash
flows and for which the enterprise does not exercise its option to measure at fair value shall be
initially recognized at
a. Purchase price
b. Fair value
c. Purchase price plus transaction cost
d. Purchase price plus transaction cost plus accrued interest.

7. Which of the following is true assuming the debt securities designated initially as FVPL was reclassified
to FVOCI?
a. Gain or loss on remeasurement on reclassification date is reported in profit or loss
b. Initial carrying value of FVOCI is the amortized cost on reclassification date
c. Interest income subsequent to reclassification date is the nominal interest
d. UG/UL taken to equity subsequent to reclassification date is the difference
between the amortized cost and fair value

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FAR-4309
Week 7: INVESTMENT IN DEBT SECURITIES

8. The bonds issued in June 1 of the current year have interest payment dates of April 1 and October 1.
Bond interest income for the current year ended December 31 is for a period of
a. 3 months
b. 4 months
c. 6 months
d. 7 months

9. An investor purchased debt investments at amortized cost on January 1. Annual interest was received
on December 31. The investor’s interest income for the year would be lower than the annual interest
received if the debt instrument was purchased at
a. A discount
b. A premium
c. Par
d. Face value

10. An entity made a year-end amortization for its only investment in bonds by debiting Investment at
amortized cost and crediting Interest income. The bond investment must have been purchased at
a. Premium.
b. Discount
c.. Face value
d. At middle of nowhere

11. If an entity failed to amortize the discount on its investment in bond classified as FVPL, this may result
to
a. Understatement of net income
b. Overstatement of net income
c. No effect on net income
d. Overstatement on investment account

12. For an investment in debt securities portfolio classified as Investment at Amortized Cost, which of the
following amounts should be included in the period profit or loss?
I. Unrealized temporary gains and losses during the period as a result of change in fair value
II. Amortization of discount or premium
III. Interest received and accrued

a. I and II
b. III
c. II and III
d. I and III

13. An entity made a year-end amortization for its only investment in bonds by debiting Investment at
amortized cost and crediting Interest income. The bond investment must have been purchased at
a. Premium.
b. Discount
c. Face value
d. At middle of nowhere

14. Subsequent to acquisition, these securities are generally reported in the statement of financial position
at AMORTIZED COST.
a. FVOCI only c. FVPL and FVOCI
b. Investment at Amortized cost d. FVOCI and Investment at Amortized cost
only

15. When an investor's accounting period ends on a date that does not coincide with an interest receipt
date for bonds held as an investment, the investor must
a. Make an adjusting entry to debit Interest Receivable and to credit Interest Revenue for the
amount of interest accrued since the last interest receipt date.
b. Notify the issuer and request that a special payment be made for the appropriate portion of the
interest period.
c. Make an adjusting entry to debit Interest Receivable and to credit Interest Revenue for the total
amount of interest to be received at the next interest receipt date.
d. Do nothing special and ignore the fact that the accounting period does not coincide with the bond's
interest period.

- END -

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