CHAPTER 20

EFFECTIVE INTEREST METHOD

Amortized cost, FVOCI and FVPL

TECHNICAL KNOWLEDGE
To apply the effective interest method of amortizing bond discount and premium.

To apply the measurement of bond investment at fair value through other comprehensive income.

To apply the fair value option of measuring bond investment.

To be able to determine the market price of bonds.

EFFECTIVE INTEREST METHOD

The effective interest or scientific 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.

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.

Interest received is computed by multiplying the nominal rate by the face amount of the bond.
The nominal rate is the coupon rate or stated rate appearing on the face of the bond.

The carrying amount of the bond investments is the initial cost gradually increase by periodic
amortization of discount or gradually reduced by periodic amortization of premium.
Effective rate versus nominal rate

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

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 - Discount
On January 1, 2021, an investor acquired P1,000,000 face amount bonds dated January 1, 2021. The
bonds mature on December 31. 2022.

The life of the bonds is 2 years and 8% interest is payable semiannually on June 30 and December 1 .

The cost of the bonds is P964, 540, a price which will yield a 10% effective rate per year.

Schedule of amortization

Date Interest Interest Discount Carrying amount

received income Amortization
Jan. 1, 2021 964,540
Jun. 30, 2021 40,000 48,227 8,227 972,767
Dec. 31, 2021 40,000 48,638 8,638 981,405
Jun. 30, 2022 40,000 49,070 9,070 990,475
Dec. 31, 2022 40,000 49,525 9,525 1,000,000
Interest received

Face amount of P1,000,000 times semiannual nominal rate of 4% or 40,000

Interest income

Carrying amount times semiannual effective rate.

Thus, for the period January 1 to June 30, 2021, the interest income is P964,540 times 5% or
48,227.

Discount amortization

Interest income minus interest received.

Thus, on June 30, 2021, the amortization is P48,227 minus P40,000 or P8,227
Carrying amount

Preceding carrying amount plus the discount amortization.

Thus, on June 30, 2021, the carrying amount is P964,540 plus P8,227 or P972,767.
Journal entries
2021
Jan. 1 Investments in bonds 964,540
Cash 964,540
Acquisition of the bonds.

Jun. 30 Cash 40,000

Interest income 40,000
Semiannual interest received.
Jun. 30 Investments in bonds 8,227
Interest income 8,227
Amortization of discounts for 6 months.
Dec. 31 Cash 40,000
Interest income 40,000

31 Investments in bonds 8,638

Amortization of discounts for the last 6 months. 8,638
continuation

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

2022
Jun. 30 Cash 40,000
Interest income 40,000
30 Investment in holds 9,070
Interest income 9,070

Dec 31 Cash 40,000

Interest income 40,000

31 Investment in bonds 9,525

Interest income 9,525

31 Cash 1,000,000
Investments in bonds 1,000,000
Full collection of face amount
Effective interest method - Premium

On January 1, 2021, an investor acquired P1,000,000 face amount bonds dated January 1, 2021. The
bonds mature on December 31, 2023.

The bonds mature in 3 years and bear 12% interest payable annually every December 31.

The cost of bonds is P1,049,740, a price which will yield an effective interest of 10%

Schedule of amortization

Date Interest Interest Premium Carrying

received income amortization amount
Jan. 1, 2021 1,049,740
Dec. 31, 2021 120,000 104, 974 15,026 1,034,714
Dec. 31, 2022 120,000 103,471 16,529 1,018,185
Dec, 31, 2023 120,000 101,815 18,185 1,000,000
Interest received

Face amount of P1,000,000 times annual nominal rate of 12% or P120,000.

Interest income

Carrying amount times annual effective rate.

Thus, for 2021, the interest income is P1,049,740 times 10% or P104,974.

Premium amortization

Interest received minus interest income

Thus, Decmber 31, 2021, the premium amortization is P120,000 minus P104,974 or P15,026.
Carrying amount

Preceding carrying amount minus premium amortization.

Thus, on December 31, 2021, the carrying amount is P1,049,740 minus P15,026
or P1,034,714.
Journal entries

2021
Jan. 1 Investments in bonds 1,049,740
Cash 1,049,740

Dec. 31 Cash 120,000

Interest income 120,000

31 Interest income 15,026

Investment in bonds 15,026

2022
Dec. 31 Cash 120,000
Interest income 120,000

31 Interest income 16,529

Investment in bonds 16,529
2022

Dec. 31 Cash 120,000

Interest income 120,000

31 Interest income 18,185

Investment in bonds 18,185

31 Cash 1,000,000
Investments in bonds 1,000,000
Effective interest method - Serial bonds

Face amount of bonds 4,000,000

Acquisition cost 4,171,810
Premium on the bonds 171,810
Annual installment on December 31, 2021
and every December 31 thereafter 1,000,000
Date of issue January 1, 2021
Nominal interest rate payable annually every December 31 10%
Effective interest rate 8%
Schedule of amortization
Date Interest Interest Premium Principal Carrying
received income amortization payment amount
1/1/2021 4,171,810
12/31/2021 400,000 333,745 66,255 1,000,000 3,105,555
12/31/2022 300,000 248,444 51,556 1,000,000 2,053,999
12/31/2023 200,000 164,320 35,680 1,000,000 1,018,319
12/31/2024 100,000 81,681 18,319 1,000,000 -

Interest received equals outstanding face amount times nominal rate.

Thus, on December 31, 2021, P4,000,000 times 10% equals P400,000, and on
December 31, 2022, P3,000,000 times 10% equals P300,000, and so on.
Interest income equals carrying amount times effective rate.
Thus, for 2021, P4,171,810 times 8% equals P333,745, and so on.

Premium amortization equals interest received minus interest income.

Thus, on December 31, 2021, P400,000 minus P333,745 equals P66,255, and so on.

Carrying amount equals preceding carrying amount minus principal payment and minus
Premium amortization.
Thus, on December 31, 2021, P4,171,810 minus P1,000,000 minus P66,255 equals P3,105,555.
Journal entries
2021
Jan, 21 Investments in bonds 4,171,810
Cash 4,171,810

Dec 31 Cash 1,400,000

Investment in bonds 1,000,000
Interest income 400,000

31 Interest income 66,255

Investments bonds 66,255

2022
Dec. 31 Cash 1,300,000
Investments in bonds 1,000,000
Interest income 300,000
continuation

31 Interest income 51,556

Investments in bonds 51,556
2023
Dec. 31 Cash 1,200,000
Investments in bonds 1,000,000
Interest income 200,000

31 Interest income 35,680

Investments in bonds 35,680
2024
Dec. 31 Cash 1,100,000
Investments in bonds 1,000,000
Interest income 100,000

31 Interest income 18,389

Investments in bonds 18,389
Bond investments - 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 or trading 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 or trading the financial asset in addition to collecting
contractual cash flows.

Interest income is recognized using the effective interest method as in amortized cost measurement.
On derecognition of the bond investment at FOVCI, the cumulative gain or loss previously
recognized in other comprehensive income shall be reclassified to profit or loss.

In contrast to derecognition of equity investment of FVOCI, the cumulative gain or loss

previously recognized in other comprehensive income shall be reclassified to retained earnings
 Illustration
On January 1, 2021, an entity purchased bonds with face amount of P5,000,000 for P4,760,000 including
transaction cost P160,000. The business model is to collect contractual cash flows and to sell the financial asset.

The bonds mature on December 31, 2023 and pay 10% interest annually on December 31 with a 12%
effective yield.

Financial asset - FVOCI 4,760,000

Cash 4,760,000

Note that unlike trading bond investments, transaction cost is included in the cost of financial asset
measured at fair value through OCI.
Journal entry to record the annual interest received

Cash (10% x 5,000,000) 500,000

Interest income 500,000

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.

Accordingly, this would require amortization of any discounts or premium on the bond
investment.

Face amount 5,000,000

Acquisition cost 4,760,000
Discounts 240,000
Amortization of discount on December 31, 2021

Financial asset - FVOCI 71,200

Interest income 71,200

Date Interest Interest Discount Carrying

received income amortization amount
1/1/2021 4,760,000
12/31/2021 500,000 571,200 71,200 4,831,200
12/31/2022 500,000 579,744 79,744 4,910,944
12/31/2023 500,000 589,056 89,056 5,000,000
Explanation

Interest received equals face amount of P5,000,000 times the nominal rate of 10% or
P500,000.

Interest income equals carrying amount times the effective rate.

Thus, on December 31, 2021 P4,760,000 tomes 12% equals P571,200 and so on.

Discount amortization equals interest income minus interest received.

Thus, for 2021,, P571,200 minus P500,000 equals P71,200 and so on.

Carrying amount equals preceding carrying amount plus discount amortization.

Thus, on December 31, 2021, P4,760,000 plus P71,200 equals P4,831,200 and so on.
Measurement at fair value
On December 31,2021, the bond investment is measured at fair value through other comprehensive
income.

The bonds are quoted at 102 on December 31, 2021.

Market value December 31, 2021 (5,000,000 x 102%) 5,100,000

Carrying amount - December 31,2021 per table 4,831,200
Unrealized gain for 2021 - OCI 268,800

Financial asset - FVOCI 268,800

Unrealized gain - OCI 268,800
Subsequently, the entity must record discount amortization of P79,744 for 2022 and P89,056 for 2023
in accordance with the effective interest table of amortization regardless of the change in market
value.
The resulting carrying amount should then be adjusted to conform with the market value on December
31,2022 and 2023.
Continuation of illustration

The market value of the bonds on DEcember 31, 2022 and 2023 is 105 and the bonds are sold on June
30,2023 at 110 plus accrued interest.

Journal entries for 2022

1. To record the interest received:

Cash 500,000
Interest income 500,000
(10% x 5,000,000)

2. To record the discount amortization:

Financial asset - FVOCI 79,744
Interest income 79,744
 3. To record the change in market value:
Financial asset - FVOCI 70,256
Unrealized gain - OCI 70,256

Market value - December 31, 2025 (5,000,000 x 105) 5,250,000

Investment balance - December 31, 2022 per book
(5,100,000 + 79,744) 5,179,744
Increase in unrealized gain for 2022 70,256

Another Computation

Market value - December 31, 2022 5,250,000

Carrying amount per table - December 31, 2022
(see previous computation) 4,910,944

Cumulative unrealized gain - December 31, 2022 339,056

Unrealized gain - December 31, 2021 268,800
Increase in unrealized gain for 2022 70, 256
Journal Entries for 2023
1. To record the discount amortization from January 1 to June 30, 2023:
Financial asset - FVOCI 44,528
Interest income (89,056 x 6\12 44,528

2. To record the sale of the bonds on June 30, 2023:

Cash 5,750,000
Unearned gain - OCI 339,056
Financial asset - FVOCI 5,294,528
Gain on sale of financial asset 544,528
Interest income 250,000

Sale price (5,000,000 x 110) 5,500,000

Cumulative unrealized gain - OCI December 31,2022 339,056
Total 5,859,056
Investment balance per book - June 30,2023
(5,250,000 + 44,528) 5,294,528
Gain on sale of financial asset 544,528
Another computation
Sale price 5,500,000
Carrying amount per table - June 30, 2023
(4,910,944 + 44,528) 4,955,472
Gain on sale of financial asset 544,528

Sale price 5,500,000

Interest accrued from January 1, tot June 30, 2023
(5,000,000 x 10% x 6\12) 250,000
Total cash received 5,750,000

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 designated a
financial asset as measured at fair value through profit or loss even if the financial assets 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.

More over, the interest income is based on the nominal interest rate rather than the effective interest
rate.
Illustration
On January 1, 2021, an entity purchased bonds with face amount of P5,000,000 for P5,400,000 plus
broker commission of P100,000.

The stated interest rate is 8% payable annually every December 31, 2021 with an effective rate of 6%.

On December 31,2021, the bonds had a fair value of P5,600,000.

Journal entries for 2021

1. Financial asset - FVPL 5,400,000
Commission expense 100,000
Cash 5,500,000
2. Cash (8% x 5,000,000) 400,000
Interest income 400,000
3. Financial asset - FVPL 200,000
Gain from exchange in fair value
(5,600,000 - 5,400,000) 200,000
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.
Illustration 1 - Discount

Face amount of bonds P3,000,000

Date of issue of bonds January 1, 2021
Nominal rate 6%
Effective rate 8%
Interest payable annually December 31
Date of maturity December 31, 2023

The present value of an ordinary annuity 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, then umber of interest period
is three.
The relevant present value factors are:

PV of an ordinary annuity of 1 at 8% for three periods 2.58

PV of 1 at 8% for three periods 0.79
PV of principal (3,000,000 x .79) 2,370,000
PV of future interest payments (180,000 x 2.58) 464,400
Market price bonds 2,834,400
Annual nomianl interest payment
(6% x 3,000,000) 180,000

The effective interest rate is higher than the nominal interest rate.
Thus, the difference between the face amount and present value is discount.

Face amount 3,000,000

Present value of market price of bonds 2,834,400
Discount 165,600
Illustration 2 - Premium

Face amount of bonds P3,000,000

Date of issue January 1, 2021
Nominal rate 8%
Effective rate 6%
Semiannual interest June 30 and December 31
Date of maturity December 31, 2022

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

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

The relevant present value factors are:

PV of an ordinary annuity of 1 at 3% for four periods 3.72

PV of 1 at 3% for four periods 0.89
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.

PV of principal (3,000,000 x 0.89) 2,670,000

PV of future interest payments (120,000 x 3.72) 446,400
Market price of bonds 3,116,400
Semiannual nominal interest payment
(4% x 3,000,000) 120,000

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

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

Face amount 3,000,000

Present value or market price of bonds 3,116,400
Premium 116,400
Market price of serial bonds
Face amount 6,000,000
Annual installment every December 31 2,000,000
Date of issue January 1, 2021
Nominal interest rate payable annually every December 31 12%
Effective interest rate 14%

Present value of 1 at 14%

One period 0.877
Two periods 0.770
Three periods 0.675

The simple approach is to compute the present value of the annual cash flows from the bonds.
Principal due on December 31, 2021 2,000,000
Interest received on 12/31/2021 (6,000,000 x 12%) 720,000
Total cash flows - December 31, 2021 2,720,000

Principal due on December 31,2022 2,000,000

Interest received on 12/31/2022 (4,000,000 x 12%) 480,000
Total cash flows - December 2022 2,480,000

Principal due on December 31, 2023 2,000,000

Interest received on 12/31/2023 (2,000,000 x 12%) 240,000
Total cash flows - December 31, 2023 2,240,000

The market price of the serial bonds is equal to the present value of the principal plus the present value of future
interest payments using the effective rate.
The market price of the serial bonds is computed by multiplying the total cash flows every December31
by the relevant present value factor.

December 31. 2021 (2,720,000 x .877) 2,385,440

December 31, 2022 (2,480,000 x .770) 1,909,600
December 31, 2023 (2,240,000 x .675) 1,512,200
Market price of serial bonds 5,807,040
QUESTIONS

1. Under IFRS, what method is required in amortizing bond discount and bond premium?
2. Define nominal rate and effective rate.
3. Which is higher between nominal rate and effective rate?
4. What is the formula for computing interest received?
5. What is the formula for computing interest earned and interest income?
6. Explain the effective interest method of amortizing bond discount and bond premium.
7. Explain the measurement of bond investment at fair value through other comprehensive income.
8. What are the conditions for the measurement of bond investment at fair value through other
comprehensive income?
9. What do you understand by the "fair value option" in relation to bond investment?
10. Explain the determination of the market price of bonds.
PROBLEMS

Problem 20-1 (IFRS)

On January 1, 2021, Charisma Company purchased bonds with face amount of P2,000,000 for
P1,900,500 including transaction cost of P100,500 to be held as financial assets at amortized cost.

The bonds mature on December 31, 2023 and pay interest of 8% annually every December 31 with a 10%
effective yield.

Required:

1. Prepared a table of amortization of the discounts.

2. Prepare journal entries for 2021,2022 and 2023.
Problem 20-2 (IFRS)

On January 1, 2021, Demeanor Company purchased bonds with face amount of P5,000,000 to be held
as financial assets at amortized cost. The entity paid P4,600,000 plus transaction cost of P142,000.

The bonds mature on December 31, 2023 and pay interest of 6% annually every December 31 of each
year with a 8% effective yield.

The bonds are quoted at 105 on December 31, 2021.

The bonds are sold at 110 on December 31, 2022.

Required:

1. Prepared a table of amortization of the discounts.

2. Prepare journal entries for 2021,2022 and 2023.
Problem 20-3 (IAA)

Enormous Company acquired P6,000,000 12%bonds on February 1, 2021 for P5,486,000 to be held as
financial asset at amortized cost.

The bonds pay interest annually on February 1 and matures on February 1, 2025. The bonds are
acquired to yield a 15% effective rate.

The fiscal period for the entity is the calendar period. Amortization is done following the effective
interest method.

On May 1, 2022, Enormous Company sold all the bonds at 105 plus accrued interest.

Required:
1. Prepare journal entries for 2021.
2. Prepare journal entries to update the amortization and record the sale of the bonds on May 1, 2022.
Problem 20-4 (IAA)

On January 1, 2021, Fancy Company acquired P8,000,000 12% bonds to be held as financial asset at
amortized cost for P8,400,000 plus transaction cost of P198,400.

Interest is payable annually on December 31. The bonds mature on January 1, 2016.

The effective interest method of amortization is used. The bonds have a 10% effective yield.

Required:

Prepare journal entries for 2021.

Problem 20-5 (ACP)

On January 1, 2021, Flexible Company acquired for P5,241,500 the entire P5,000,000 12% bond issue of
another entity to be held as financial asset at amortized cost.

Bonds of P1,000,000 mature at annual interval beginning December 31, 2021.

Interest is payable annually on December 31. The bonds have a 10% effective rate.

Required:

Prepare journal entries for 2021, and 2022 using the effective interest method.
Problem 20-6 (IAA)

On January 1, 2021, Portugal Company purchased bonds with face amount of P8,000,000 for
P7,679,000 to be measured at amortized cost.

The stated rate on the bonds is 10% but the bonds are acquired to be yield 12%.

The bonds mature at the rate of P2,000,000 annually every December 31 and the interest is payable
annually also every December 31.

The entity used the effective interest method of amortizing discount.

Required:

a. Prepare journal entries for 2021.

b. Compute the carrying amount of the bond investment on December 31, 2021.
Problem 20-7 (IFRS)

On January 1, 2021, Michelle Company purchased bonds with face amount of P5,000,000. The entity
paid P4,600,000 plus transaction cost of P142,000 for the bonds investments.

The business model of the entity in managing the financial asset if 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, 2023 and pay 6% interest annually on December 31 each year with
8% effective yield.

The bonds are quoted at 105 on December 31, 2021 and 110 on December 31, 2022
The bonds are redeemed at face amount on December 31, 2023.

Required:

a. Prepare an amortization table for the discount.

b. Prepare journal entries for 2021, 2022 and 2023.
Problem 20-8 (IAA)

On January 1, 2021, Reign company purchased 12% bonds with face amputh pf P5,000,000 for
P5,380,000. The bonds provide n effective yield of 10%.

The bonds are dated January 1, 2021, mature on January 1, 2026 and pay interest annually on December
31 of each year.

The bonds are quoted at 120 on December 31, 2021 and 115 on December 31, 2022.

The entity has elected the fair value option for the bond investment.

Required:

Prepare journal entries for 2021 and 2023.

Problem 20-9 (ACP)

At the beginning of the current year, Havoc Company purchased ten-year bonds with a face amount of
P5,000,000.

The stated interest rate is 8% per year payable semiannually June 30 and December 31. The bonds were
acquired to yield 10%.

Present value of 1 for 10 periods at 10% .386

Present value of 1 for 20 periods at 5% .377
Present value of an annuity of 1 for 10 periods at 10% 6.145
Present value of an annuity of 1 for 20 periods at 5% 12.462
Required:

a. Compute the market price of the bonds.

b. Prepare journal entries for the current year.

Problem 20-10 (ACP)

At the beginning of current year, Impasse Company acquired P4,000,000 16% face amount bonds. The
interest is payable annually every December 31.

The bonds are expected to yield a 12% interest and mature in five years.

Present value of 1 for 5 periods at 12% .567

Present value of 1 for 10 periods at 6% .558]
Present value of an annuity of 1 for 5 periods t 12% 3.605
Present value of an annuity of 1 for 10 periods at 6% 7. 360
Required:

a. Compute the market price of the bonds.

b. Prepare journal entries for the current year.

Problem 20-11 (IAA)

At the beginning of the current year, Jest Company purchased 5-year bonds with face amount of P8,000,000
and stated interest of 10% per year payable semiannually January 1 and July 1. The bonds were acquired to
yield 8%.

Present value of an annuity of 1 for 10 periods at 5% 7.72

Present value of an annuity of 1 for 10 periods at 4 % 8.11
Present value of 1 for 10 periods at 4% 0.6756

Required:
a. Compute the market price of the bonds C. Compute the carrying amount of the bond investment year-end.
b. prepare journal entries for the current year. The effective interest method of amortization is used
Problem 20-12 (IAA)

On January 1, 2021, Labyrinth Company purchased serial bonds with face amount of P3,000,000 and
stated 12% interest payable annually every December 31.

The bond are to be held as financial assets at amortized cost with a 10% effective yield. The bonds
mature at an annual installment of P1,000,000 every December 31.

Present value of 1 at 10% for one period 0.91

Present value of 1 at 10% for two periods 0.83
Present value of 1 at 10% for three periods 0.75

Required:
1. Compute the market price of the bonds.
2. Prepare for journal entries for 2021. The effective interest method of amortization is used.
3. Compute the carrying amount of the bond investment on December 31, 2021.
Problem 20-13 (IAA)

Hawk Company purchased 8,000, P1,000 face amount, 9% bonds to yield 10%. The carrying amount of
the bonds on January 1, 2021 was P7,800,000. The bonds mature on June 30, 2024 and pay interest
semiannually on June 30 and December 31.

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

a. 25,000
c. 15,000
b.20,000
d. 0
Problem 20-14 (AICPA Adapted)

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 (IAA)

On January 1, 2021, Mirage Company acquired P4,000,000 of 12% face amount bonds for P3,767,000 to
be held s financial asset at amortized cost with a 14% effective yield.

Interest on bonds is payable annually on December 31 and the bonds mature on January 1, 2025. The
effective interest method of amortization is used.

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

a. 3,814,380
b. 3, 767,000
c.4,000,000
d.3,719,620
Problem 20-16 (AICPA Adapted)

On January 1, 2021, Paradox Company Purchased 9% bonds with a face mount of P4,000,000 for
P3,756,000 to yield 10 %.

The bonds are dated January 1, 2021, mature on December 31, 2030, and pay interest annually on
December 31. The bonds are measured at amortized cost.

What amount should be reported as interest revenue for 2021?

a. 400,0000
b.344,400
c.360,000
d.375,600
Problem 20-17 (AICPA Adapted)

On July 1, 2021, East 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, 2021, what amount should be reported as interest receivable?

A. 184,600
B. 250,000
C. 230,750
D. 200,000
Problem 20-18 (AICPA Adapted)

On July 1, 2021, Conair company paid P1,198,000 for 10% bonds with a face amount of P1,000,00 to be
held as financial assets at amortized cost.

Interest is paid on June 30 and December 1. 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, 2021?

A. 1,207,900
B. 1,198,000
C. 1,195,920
D. 1,193,050
Problem 20-19 (AICPA Adapted)

On July 1, 2021, Vicar company purchased P1,000,000 of 8% bonds for P946,000, including accrued
interest of P40,000. The bonds were purchased to yield 10% interest. The bonds mature on January 1,
2027, and pay interest annually on January 1. The bonds are measured at amortized cost.

On December 31, 2021, what is the carrying amount of the bond investment?

A.911,300
B.916,600
C.953,300
D.960,600
Problem 20-20 (AICPA Adapted)

On January 1, 2021, Pearl company purchased P5,000,000 Face amount 8% bonds for P4,562,00 to be
held as financial assets at amortized cost. The bonds were purchased to yield 10% interest.

The bonds mature on January 1, 2027 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, 2022?

A. 4,680,020
B. 4,662,000
C. 4,618,200
D. 4,562,000
Problem 20-21 (AICPA Adapted)

On July 1, 2021, Pell 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 amortize cost. The bonds mature on June 30, 2029 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, 2021.

What amount should be reported as interest income for 2021?

A.168,000 B.182,000
C.200,000 D.218,00
Problem 20-22 (IFRS)

On January 1, 2021, 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 assets 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, 2023 and pay 10% interest annually on December 31 each year with
8% effective yield.

The bonds are quoted at 95 on December 31, 2021 and 90 on December 31, 3022.

1. What amount of unrealized loss should be reported as component other comprehensive income in
2021?
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
2022?

A.473,878 c. 200,000
B.131,398 D.0

3.What amount of cumulative unrealized loss should be reported in the statement of changes in equity
on December 31,2022?

A.406,000
B.606,000
C.473,878
D.0
4. What is the carrying amount if the bond investment on December 31, 2022?

A. 4,206,000
B. 3,600,000
C. 3,800,000
D. 4,673,878
Problem 20-23 (IAA)

On January 1, 2021, 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 1,2021 and pay interest annually on December 31 of each year .

The bonds are quoted at 115 on December 31, 2021.

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 2021?

A.750,000 B.250,000
C.350,000 D. 0
2. What amount of interest income should be reported for 2021?

A.600,000 B.550,000
C.660,000 D.540,000

3. What is carrying amount of the bond investment on December 32, 2021?

A.5,750,000 B.5,400,000
C.5,500,000 D,5,450,000

4.What total amount of income from the investment should be reported in the income statement for
2021?

A.540,000 B.950,000
C.890,000 D.900,000
Problem 20-24 Multiple choice (IAA)

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 the bond is know 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 id used?

A. The present value of 1 D. The future 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
4. Bond usaully 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. Bond usually sell at a premium

A. When market rate is greater than stated rate

B. When stated rate is greater tan market rate
C. When the price of the bonds is greater than maturity amount.
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 the face amount.

C. below the 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 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. Increaser by accrued interest from May 1 to June 1.
Problem 20-25 Multiple choice (IAA)

1. Which statement is true about the interest method?

A. The interest method does not use a constant rate.

B. Amortization of discount decreases each period
C. Amortization of premium decreases each period
D.The interest method applies the effective interest rate to the beginning carrying amount.

2. The fair value of option

A. Must be applied to all debt instruments.

B. May be selected as a valuation method at any time.
C. Reportd all gains and losses in income.
D. all of the choices are correct
3. The fair value option allows an entity to

A. Record income when the fair value increases

B. Measure bond investment at fair value in some years.
C. Report most financial instrument at fair value.
D. All of these statements are correct.

4. A bond investments that satisfies the amortized cost measurement may be designated

A. Irrevocably at fair value through profit or loss

B. Revocably at fair value through profit or loss
C. Irrevocably at fair value through OCI
D. Irrevocably at amortized cost
5. Under what condition can an entity classify financial asset that meets the amortized cost criteria at
FVPL?

A. Where the instruments is held to maturity

B. Where the business mode; approach is adopted
C. Where the financial asset passes the contractual cash flow characterstics test
D. Id doing so eliminates or reduces an accounting mismatch.