(MODREV 2)

LECTURE AID

2020
Chapter 10 INVESTMENTS IN DEBT
SECURITIES
Learning Objectives

• Account for financial assets measured at amortized cost.

• Explain the accounting for discounts and premiums and their
relationships with the effective interest rate.
• Account for financial assets measured at FVOCI (mandatory).
• Account for regular way purchase or sale of financial assets.
• Account for the reclassification of financial assets.
• Account for the impairment of financial assets measured at FVOCI
(mandatory).
• State the revenue recognition of dividends received from investments.
• Account for stock rights.
• State the types of risks required by the standards to be disclosed in the
financial statements.
Bonds

• Bonds are long-term debt instruments similar to term

loans except that they are usually offered to the public
and sold to many investors.
• Bond indenture is the contractual arrangement between
the issuer and the bondholders. It contains restrictive
covenants intended to prevent the issuer from taking
actions contrary to the interests of the bondholders. A
trustee, often a bank, is appointed to ensure compliance.
 Types of bonds
• Term bonds – bonds maturing on a single date.
• Serial bonds – bonds having staggered or series of maturity dates.
• Registered bonds – bonds issued in the name of the holder (owner).
Interest payments are sent directly to the holder.
• Coupon (bearer) bonds – bonds that can be freely transferred and have
a detachable coupon for each interest payment.
• Zero-coupon bonds (strip bonds) – bonds that do not pay periodic
interests. Principal and compounded interest are due only at maturity date.
• Callable bonds – bonds containing call provisions giving the issuer
thereof the right to redeem the bonds prior to their maturity date.
• Convertible bonds – bonds giving the holder thereof the option of
exchanging the bonds for shares of stocks of the issuer.
 Accounting for investments measured at amortized cost

• The accounting for investments in bonds (measured at

amortized cost) is similar to the accounting for notes and
loans receivables. In the sense that, the accounting for
investment in bonds (measured at amortized cost) also
involves:
a. Present value computations; and
b. Preparation of amortization table (Effective interest
method)
Discount vs. Premium
• If the carrying amount is less than the face amount, the
difference represents a discount.
• If the carrying amount is more than the face amount,
the difference represents a premium.
• If there is a discount, the EIR is higher than the NIR.
• If there is a premium, the EIR is lower than the NIR.
• Discount or premium is amortized using the effective
interest method.
Effect of discount amortization
You have acquired a bond with face amount of ₱5,000 for ₱4,000.
 Would this be favorable or an unfavorable on your part?
 Favorable. Why? --- You will be collecting ₱5,000 (excldg. interest)
while your cash outflow is only ₱4,000.
 On acquisition date, it seems you have earned a “gain” of ₱1,000 right?
 Yes; however, PFRSs prohibit you from recognizing this “gain”
outright. You need to amortize it over the term of the bond.
 The “gain” represents the discount (Carrying amt. less than Face amt.).
 The effect of the amortization is an increase in interest income.
 Over the term of the bonds, total interest income will be greater than
total collections of interests by ₱1,000.
Transaction costs

• Transaction costs incurred in the acquisition of bonds to be

measured at amortized cost are included as part of the cost of the
investment.
Sale of bonds prior to maturity

• When bonds are sold prior to maturity, the difference between the
net disposal proceeds and the carrying amount of the bonds,
adjusted for any discount or premium amortization up to date of
disposal, is recognized as gain or loss in profit or loss.
Serial bonds

• Serial bonds are bonds having staggered or series of maturity dates.

Serial bonds are accounted for in much the same way as for term
bonds (i.e., bonds maturing on a single date such as those discussed
up to this point). However, the periodic collections on serial bonds
include not only collections for interests but also collections for
principal.
Zero-coupon bonds

• Zero-coupon bonds are bonds that do not pay periodic interests.

Both principal and interest are due only at maturity date.
Financial assets measured at FVOCI (mandatory)

• Initial measurement: Fair value + direct transaction costs.

• Subsequent measurement: Fair value
o Changes in fair value are recognized in OCI.
o Impairment losses and gains are recognized in profit or loss.
o Interest revenue is computed using the effective interest method and is
recognized in profit or loss.
• Derecognition: When the asset is derecognized, the cumulative balance of
gains and losses in equity are transferred to profit or loss as a
reclassification adjustment.
• The amounts recognized in profit or loss for a debt instrument measured at
FVOCI are the same as the amounts that would have been recognized in
profit or loss if the debt instrument had been measured at amortized cost.
Regular way purchase or sale of financial assets

• A regular way purchase or sale is a purchase or sale of a financial

asset under a contract whose terms require delivery of the asset
within the time frame established generally by regulation or
convention in the marketplace concerned.
• Trade date accounting vs. Settlement date accounting
a. Under trade date accounting, the financial asset purchased (s0ld) is
recognized (derecognized) at the trade date (i.e., the date the entity
commits to purchase or sell the financial asset).
b. Under settlement date accounting, the financial asset purchased
(s0ld) is recognized (derecognized) at the settlement date (i.e., the
date the ownership of the financial asset is transferred).
Reclassification
• After initial recognition, financial assets are reclassified only when
the entity changes its business model for managing financial
assets.

• Reclassification date is the first day of the first reporting period

following the change in business model that results in an entity
reclassifying financial assets.
Reclassification of debt-type financial assets
Reclassification of debt-type financial assets
Notes on reclassification

• Only debt instruments can be reclassified. Equity instruments

(e.g., investments in shares of stocks) cannot be reclassified.
• Financial assets cannot be reclassified into or out of the “designated
at FVPL” and “FVOCI - election” classifications.
• The initial measurement is fair value at reclassification date,
except for a reclassification from FVOCI to Amortized cost where the
fair value on reclassification date is adjusted for the cumulative
balance of gains and losses previously recognized in OCI.
Impairment

• The impairment requirements of PFRS 9 apply equally to debt-type

financial assets that are measured either at amortized cost or at
FVOCI.
• Impairment gains or losses on debt instruments measured at FVOCI
are recognized in profit or loss. However, the loss allowance shall
be recognized in other comprehensive income and shall not reduce
the carrying amount of the financial asset in the statement of
financial position.
Dividends

• Dividends received from equity securities measured at FVPL or

FVOCI (except share dividend) are recognized as dividend revenue.
Stock rights

• Stock rights, being equity instruments, are measured at fair value.

 Disclosure of Risks on financial instruments
1. Credit risk - The risk that one party to a financial instrument will cause a
financial loss for the other party by failing to discharge an obligation.
2. Liquidity risk - The risk that an entity will encounter difficulty in meeting
obligations associated with financial liabilities that are settled by delivering cash or
another financial asset.
3. Market risk - The risk that the fair value or future cash flows of a financial
instrument will fluctuate because of changes in market prices. Market risk
comprises the following.
a) Interest rate risk
b) Currency risk
c) Other price risk
 APPLICATION OF CONCEPTS
 

PROBLEM 2: FOR CLASSROOM DISCUSSION

OPEN FORUM
QUESTIONS????
REACTIONS!!!!!
END