M i C P A R Review Center

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AUDITING PROBLEMS BATCH 24 – MAY 2021

AP 02 – AUDIT OF INVESTMENTS IN DEBT SECURITIES

MY SAN INC’s portfolio of debt securities at December 31, 20x6 and December 31, 20x7 are shown
below. All the bonds were acquired by the company at the beginning of 20x6.

December 31, 20x6 December 31, 20x7

Gross Gross
Face Acquisition Carrying Carrying
value costs amount Fair values amount Fair values
12%, ABC Corp. 1,000,000 1,063,397 1,049,737 1,024,437 1,034,711 1,052,773
10%, DEF Inc. 2,000,000 1,903,926 1,932,398 1,965,750 1,964,286 2,018,348
12%, GHI Co. 3,000,000 3,190,191 3,149,211 3,073,311 3,104,132 3,158,320
TOTAL 6000000 6157514 12194844 6,063,498 6103129 6229441

ABC Corp. and GHI Co. bonds were acquired at prevailing market rate of interest at 10%, while DEF
Inc. bonds were acquired at an effective rate of 12%.

The prevailing market rate of interest at the end of 20x6 and 20x7 applicable to the bonds were at
11% and 9%, respectively.

Note: For simplification, the ignore accounting for expected credit loss.

Case 1: Assuming that the above securities are Trading Securities:

1. How much is the gain or (loss) to be reported in the company’s income statements for 20x6 and
20x7?
A. (67,848); 126,312 C. (26,168); (28,217)
B. (94,016); 165,943 D. 0; 0

2. How much is the corresponding interest income to be reported in the company’s income
statement for 20x6 and 20x7?
A. 680,000; 680,000 C. 585,984; 845,943
B. 653,832; 651,783 D. 0; 0
3. What is the carrying value of the investment in debt securities as of December 31, 20x6 and
20x7?
A. 6,000,000; 6,000,000 C. 6,157,514; 6,157,514
B. 6,131,346; 6,103,129 D. 6,063,498; 6,229,441
4. If the DEF Inc. bonds were sold at P2,000,000 on January 2, 20x8, how much realized gain or
(loss) on the sale should be recognized?
A. 35,714 C. (67,602)
B. 96,074 D. (18,348)
1. Case 2: Assuming the above debt securities are held within a business model whose objective
is achieved by collecting contractual cash flows:

1. How much is the gain or loss to be reported in the company’s income statements for 20x6 and
20x7?
A. (67,848); 126,312 C. (94,016); 165,943
B. (67,848); 194,160 D. 0; 0

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2. How much is the corresponding interest income to be reported in the company’s income
statement for 20x6 and 20x7?
A. 680,000; 680,000 C. 585,984; 845,943
B. 653,830; 651,783 D. 0; 0
3. What is the gross carrying value of the investment in debt securities as of December 31, 20x6
and 20x7?
A. 6,000,000; 6,000,000 C. 6,157,514; 6,157,514
B. 6,131,346; 6,103,129 D. 6,063,498; 6,229,441
4. If the DEF Inc. bonds were sold at P2,000,000 on January 2, 20x8, how much realized gain or
(loss) on the sale should be recognized?
A. 35,714 C. (67,602)
B. 96,074 D. (18,384)
Case 3: Assuming the above debt securities are held within a business model whose objective is
achieved both by collecting contractual cash flows and selling the debt securities.

1. How much is the unrealized holding gain or loss should be shown as a component of other
comprehensive income for 20x6 and 20x7?
A. (67,848); 126,312 C. (94,016); 165,943
B. (67,848); 194,160 D. 0; 0
2. How much is the accumulated unrealized gain or loss shown in the statement of changes in
equity for 20x6 and 20x7?
A. (67,848); 126,312 C. (94,016); 165,943
B. (67,848); 194,160 D. 0; 0
3. How much is the corresponding interest income to be reported in the company’s income
statement for 20x6 and 20x7?
A. 680,000; 680,000 C. 585,984; 845,943
B. 653,830; 651,783 D. 0; 0

4. What is the carrying value of the investment in debt securities as of December 31, 20x6 and
20x7?
A. 6,000,000; 6,000,000 C. 6,157,514; 6,157,514
B. 6,131,346; 6,103,129 D. 6,063,498; 6,229,441
5. If the DEF Inc. bonds were sold at P2,000,000 on January 2, 20x8, how much realized gain or
(loss) on the sale should be recognized?
A. 35,714 C. (67,602)
B. 96,074 D. (18,384)

HARRIS CORP. acquired P2,000,000 face value bonds on March 31, 20x7 at P1,934,336. The 10 year,
10% bonds which are dated January 1, 20x0 pays annual interest every December 31 and were
classified as investment at fair value through profit or loss. The prevailing rate of interest of similar
security on the same date is at 12%. The company paid for broker’s fees and commissions
amounting to P100,000.
Interest collected at year-end were credited to the appropriate interest income account. Moreover,
the prevailing interest at year-end was at 14%, thus the market value of the bonds is at P1,814,269.

Requirements:
1. What is the unrealized holding gain or loss to be recognized in the company’s income statement
for the year?

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A. 70,067. C. 220,067.
B. 120,067. D. 0.
2. What is the investment account balance as of December 31, 20x7?
A. 1,884,336 C. 1,934,336
B. 1,984,336 D. 1,814,269
3. How much is the correct interest income to be recognized for the year 20x7?
A. 200,000 C. 163,284
B. 174,090 D. 150,000
4. Assuming that the investment was sold on July 1, 20x8 at P2,000,000, how much is the gain on
the sale?
A. 185,713 C. 85,731
B. 135,713 D. 65,664

Direct Corp. acquired a three-year, 12% bonds with a face value of P1,000,000 on January 1, 20x6.
The bonds which pay annual interest every December 31 had a 10% prevailing interest rate on the
date of acquisition. The acquisition was appropriately recorded by the company by debiting FVOCI
security, and crediting cash for the amount of the cash paid.

The present value factor of P1 at 10%, ordinary annuity, for 3 periods is at 2.486852 while the
present value factor of P1 at 10% for 3 periods is at 0.751315.
The applicable amortization schedule of any excess of acquisition cost over the investments’ face
value follows:
Interest
Interest income
received (CV*Eff
Date (P*Nom rate) rate) Amortization Balance
1/1/20x6 1,049,737
12/31/20x6 120,000 104,974 (15,026) 1,034,711
3/31 30,000 25,868 (4,132) 1,030,579
12/31/20x7 120,000 103,471 (16,529) 1,018,182
12/31/20x8 120,000 101,818 (18,182) 1,000,000

On December 31, 20x6, the prevailing interest for similar securities is at 11%, thus the fair market
value of the bonds is at P1,017,125 and the Loss Allowance was determined to be P125,000. The
only entry made at December 31, 20x6 the receipt of interest which was credited to Interest
Income.
Correct entry PC Entry
Cash 120,000 Cash 120,00
0
Interest income 104,974 Interest income 120,000
FVOCI 15,026
OCI-FV loss 17,586 No entry
FVOCI 17,586
Gross CA, 1,034,711 – FV 1,017,125
Credit Loss-P&L 125,000 No entry
OCI [Loss Allowance] 125,000
AJE:
Dr. RE (Interest income) 15,026
Cr. FVOCI 15,026
Dr. Revaluation Reserve (OCI ∆ in FV) 17,586
Cr. FVOCI 17,586
Dr. RE (Credit loss-P&L) 125,000
Cr. Revaluation Reserve (loss allowance) 125,000

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On March 31, 20x7, the bonds were sold at P1,250,000. The sale was recorded as follows:
Cash 1,250,000
FVOCI securities 1,049,737
Gain on sale-P&L 200,263

Correct entry PC Entry

Interest Receivable 30,000 No entry
Interest income 25,868
FVOCI 4,132
To update amortization

Cash 1,250,000 Cash 1,250,000

Reclass from Reserve 107,414 FVOCI securities 1,049,737
[Dr 17,586; 125,000 Cr] Gain on sale-P&L 200,263
Interest Receivable 30,000
FVOCI securities 1,012,993
[P1,017,125 – 4,132]
Gain on sale-P&L 314,421
(1,250,000 – 30,000= Proceeds 1,220,000 – [1,030,579 – 125,000=] 905,579 = 314,421

AJE:
Dr. Interest receivable 30,000
Cr. Interest Income 25,868
Cr. FVOCI 4,132

Dr. Reclass from Reserve 107,414

Cr. Interest receivable 30,000
Dr. FVOCI 36,744
Cr. Gain on sale-P&L 114,158

Compound Adjusting Entry [12/31/20x7]

AJE:
Dr. RE (Interest income) 15,026
Cr. FVOCI 15,026
Dr. Revaluation Reserve (OCI) 17,586
Cr. FVOCI 17,586
Dr. RE (Credit loss-P&L) 125,000
Cr. Revaluation Reserve (Loss
125,000
Allowance)
Dr. Interest receivable 30,000
Cr. Interest Income 25,868
Cr. FVOCI 4,132
Dr. Reclass from Reserve 107,414
Cr. Interest receivable 30,000
Dr. FVOCI 36,744
Cr. Gain on sale-P&L 114,158
331,770 331,770

RE [15,026 + 125,000] 140,026

Interest income 25,868
Gain on sale-P&L 114, 158

Requirements:

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1. What is the correct interest income to be reported in the 20x6 income statement?
A. 15,026. C. 120,000.
B. 104,974. D. 135,026.
Answer: B EFF. INT see amortization table

2. What is the loss to be recognized on December 31, 20x6? Clear = OCI

A. 0 C. 32,612
B. 17,586 D. 107,414
Answer: B

3. What is the balance of the Investment Revaluation Reserve on December 31, 20x6?
A. 0 C. 32,612
B. 17,586 D. 107,414
Answer: D

4. How much is the correct realized gain or loss on sale of the investment in 20x7?
A. 222,161. C. 189,421.
B. 192,161. D. 314,421
Answer: D
NET PROCEEDS – AC
Check: if accounted as amortized cost:
3/31 AC = Gross 1,030,579 – Loss allowance 125,000 = 905,579 – Net proceeds 1,220,000 =
314,421

MC BEAN CORP. reported an investment in bonds amounting to P10,758,157 as of December 31,

20x7 and an interest income for the year ended December 31, 20x7 at P1,200,000. The 10-year,
12% bonds, which were acquired on January 1, 20x6 had a face value of 10M are dated January 1,
20x1. The bonds were purchased at their prevailing interest rate of 10% and pays annual interest
every December 31. The bonds were held to collect the contractual cash flows.
On December 31, 20x7, 60% of the investment was sold at its FV of 110 plus accrued interest and
the company determined that the bonds will now be held to collect the contractual cash flows and
to sell.

Records reveal that the company accounted for the investment transaction as follows:
1/1/20x6 Investment in Bonds 10,758,157
Cash 10,758,157
To record acquisition of bonds.
12/31/20x6 Cash 1,200,000
Interest income 1,200,000
To record receipt of interest.
AJE Retained Earnings (Interest income) 124,184
Investment in Bonds 124,184
Retained Earnings (impairment loss) 150,000
Loss Allowance 150,000
12/31/20x7 Cash 1,200,000
Interest income 1,200,000
To record receipt of interest.
AJE Interest income 136,603
Investment in Bonds 136,603
Loss Allowance 50,000
Recovery of Impairment loss 50,000
12/31/20x7 Cash 6,600,000
Investment in Bonds 6,454,894
Gain on Disposal 145,106

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To record the sale of 60% of bonds.

CE Cash 6,600,000
Loss Allowance [100,000 x 60%] 60,000
Investment in Bonds (10,497,370x 60%) 6,298,422
Gain on disposal 361,578
AJE Investment in Bonds 156,472
Loss Allowance [100,000 x 60%] 60,000
Gain on disposal 216,472

For your reference:

(a) the partial amortization schedule of any excess of acquisition cost over the investments’ face
value follows:
Interest @ Interest @
Date 12% 10% Amortization Balance
1/1/20x6 10,758,157
12/31/20x6 1,200,000 1,075,816 (124,184) 10,633,973
12/31/20x7 1,200,000 1,063,397 (136,603) 10,497,370
12/31/20x8 1,200,000 1,049,737 (150,263) 10,347,107
(b) it was determined that the investment’s credit has not increased significantly since initial
recognition and the appropriate amount of Loss Allowance at end of 20x6, 20x7 and 20x8 are
P150,000, P100,000 (entire bond) and P60,000 (remaining 40%), respectively.

Requirements:
1. The entry to adjust the investment account for the error(s) in recording in 20x6 will include:
A. Debit to Retained Earnings for P124,184.
B. Debit to Retained Earnings for P274,184.
C. Credit to Investment account for P124,184. Also correct
D. Credit to Investment account for P274,184.
Answer: B

2. What is the correct interest income for 20x7?

A. 1,200,000. C. 1,324,184.
B. 1,063,397. D. 954,325.
Answer: B

3. What is the correct gain or loss on partial disposal of the investment?

A. 0. C. 502,630.
B. 301,578. D. 201,057. 361,578
4. What is the adjusted balance of the investment in bonds as of December 31, 20x7?
A. 4,198,948. C. 4,000,000.
B. 4,400,000. D. 0.
10,497,370 x 40% – 60,000 Loss Allowance = 4,138,948
5. How much is the investment revaluation to be reported in the 20x7 balance sheet?
A. 0. C. 301,578.
B. 201,052. D. 502,630.

On January 2, 20x6, Plum Company purchased as a long-term investment a debt instrument with a
three-year term at its fair value of P1,425,394. The instrument has a principal amount of
P1,500,000 and carries fixed interest of 8% annually. The effective interest is determined to be 10%.
The company’s management held the investment as measured at amortized cost.
The accountant has prepared the following amortization schedule:
Year Interest Interest Amortization Gross Loss Amortized
received income Carrying Allowance Cost

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8% 10% Amount
1,425,394
20x6 120,000 142,539 22,539 1,447,934 697,934 750,000
20x7 120,000 144,793 24,793 1,472,727
20x8 120,000 147,273 27,273 1,500,000
P 1,500,000 + 2 x 120,000 = 1,740,000 / 1.1 = 1,581,818
P 1,500,000 + 120,00 / 1.1 =1 ,472,727
120,000/1.1 = 109,091
Dr. Int recel 109,091
Dr. Investment 647,727
Cr. Recovery 756,818

Interest Interest
received income Carrying
Year 8% 10% Amortization Amount
1,425,394 Gross
20x6 120,000 142,539 22,539 1,447,934 Gross
impairmen Amortized
t (697,934) 750,000
20x7 0 75,000 825,000
recovery 647,727 1,472,727
1,581,818 756,818
20x8 120,000 147,273 27,273 1,500,000
During 20x6, the issuer of the instrument suddenly came into financial difficulties and it becomes
probable that the issuer will be put into administration by a receiver. The fair value of the
instrument is estimated to be P750,000 at the end of 20x6, calculated by discounting the expected
future cash flow at 10%. No cash flows are received in 20x7. At the end of 20x7, the issuer is
released from administration and Plum receives a letter from the receiver stating that the issuer will
be able to meet its remaining obligations, including interest and repayment of principal.
Requirements:

1. What amount of impairment loss should be recognized in 20x6?

A. 697,932 C. 636,275
B. 750,000 D. 675,393

2. How much interest should be recognized in 20x7?

A. 0 C. 75,000
B. 24,793 D. 120,000

3. What amount of impairment loss reversal should be recognized in 20x7?

A. 0 C. 697,932
B. 647,727 D. 756,818

4. How much interest revenue should be recognized in 20x8?

A. 147,273 C. 82,500
B. 27,275 D 120,000

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