Financial Asset at Amortized Cost

By: Dr. Angeles A. De Guzman

Dean, College of Business Education
 Measurement at Amortized Cost
• PFRS 9 provides that a financial asset shall be
measured at amortized cost if both of the
conditions are met:
– The business model is to hold the financial asset in
order to collect contractual cash flows on specified
dates
– The contractual cash flows are solely payments of
principal and interest on the principal amount
outstanding
Financial Assets at Amortized Cost
• Investment in Bonds and other Debt
Instruments
• Classified as non current assets
• Financial assets that do not meet the
conditions for amortized cost measurement
shall be measured at fair value
 What is a Bond?
• A bond is a formal unconditional promise made under seal
to pay a specified sum of money at a determinable future
date, and to make priodic interest payments at a stated
rate until the principal sum is paid
• A bond is a contract of debt whereby one party called the
issuer borrows fund from another party called the investor
• A bond is a debt security because the bondholder is a
creditor and the issuer is a debtor
• An investor acquires a bond either as a temporary or
permanent investment and derives income in the form of
interest
 Classification of Bond Investment
• Financial assets held for trading or trading
securities
• Financial asset at amortized cost
 Initial Measurement
• Bond investment are recognized initially at fair value
plus transaction costs that are directly attributable
to the acquisition.
• Transactions costs include fees and commission paid
to agents, advisers, brokers and dealers, levies by
regulatory authorities and securities exchanges, and
transfer taxes and duties
• Transaction costs attributable to the acquisition of
trading bond investments are expensed immediately
 Subsequent Measurement
• Trading bond investments are measured at fair
value through profit or loss (not necessary to
amortize any premium or discount)
• Bond investments are classified as financial
assets measured at amortized cost using the
effective interest method
 Acquisition of Bond Investment
• Bonds acquired on interest date are initially
recognized at the acquisition cost
• Bonds acquired between interest dates
normally includes the accrued interest which
is charged either to accrued interest
receivable or interest income.
Investment in Bonds at Amortized Cost

• Bonds acquired as financial assets at

amortized cost are classified as noncurrent
investment
• “investment in bonds” or “financial asset at
amortized cost” is the account to be used in
recording investment in bonds classified as
financial asset at amortized cost
 Amortization of Premium or Discount
• Investment in bonds shall be measured subsequently at
amortized cost or any premium or discount must be
amortized
• Bond premium or discount is amortized over the life of the
bonds
• Amortization is done through the interest income account
– Amortization of bond discount
Investment in bonds
Interest Income
– Amortization of bond premium
Interest Income
Investment in bonds
 Philosophy on Amortization
• The reason for amortization of bond premium or discount is
to bring the carrying amount of the investment to face value
on the date of maturity
• Bond premium is a loss on the part of bondholder because
the bondholder paid more than what can be collected on the
date of maturity
• Bond discount is a gain on the part of bondholder because
the bondholder paid less than what can be collected on the
date of maturity
• Such gain or loss is being allocated over the life of the bonds
which is a process of amortization
 Sale of Bonds Prior to Maturity
• When investment in bonds is sold prior to the date of
maturity, it is necessary to determine the carrying
amount of the bond investment to be used as basis in
computing gain or loss on the sale
• Amortization of the premium or discount, if any,
should be recognized up to the date of sale
• The difference between the sale price, after deducting
the accrued interest, and the carrying amount of the
bond investment represents the gain or loss on the
sale of the investment
 Callable Bonds
• Bonds which may be called in or redeemed by
the issuing entity prior to their date of maturity
• Usually, the call price or redemption price is at a
premium or more than the face value of the
bonds
• The difference between the redemption price
and the carrying amount of the bond
investment on the date of redemption is
recognized in profit or loss
 Convertible Bonds
• Bonds which give the bondholders the right to
exchange their bonds for share capital of the issuing
entity at any time prior to maturity
• The equity conversion option is the embedded
derivative
• Convertible bonds are classified as financial assets
measured at fair value
• The existence of the conversion feature generally
precludes classification of the convertible bonds as
financial assets at amortized cost
 Other Kinds of Bonds
• Serial Bonds – those which have a series of
maturity dates or hose bonds which are
payable in installments
• Term Bonds are those that mature on a single
date
• Callable and convertible bonds can be
classified as term bonds despite their special
features
 Methods of Amortization
• Straight Line Method – provides for an equal
amount of premium or discount amortization
each accounting period
• Bond outstanding method – applicable to serial
bonds and provides for a decreasing amount of
amortization
• Effective interest method or simply “interest
method” or scientific method that provides for
an increasing amount of amortization
 Effective Interest Method
• Classification of interest rate
– Nominal or coupon rate or stated rate is the rate of
interest appearing on the face of the bonds. The
nominal rate multiplied by the face value of the bonds
gives the periodic interest received by the bondholder
– Effective or yield rate or market rate is the true or
actual rate of interest which bondholder earns on the
investment. The effective rate multiplied by the
carrying amount of the bond investment gives the
actual interest income
 Effective Interest Method
• The effective rate and the nominal rate are the same if the cost of the
bond investment is equal to the face value
• When bonds are acquired at a premium, the effective rate is lower than
the nominal rate.
• When bonds are acquired at a discount, the effective rate is higher than
the nominal rate
• The effective interest method simply requires the comparison between
the interest earned or interest income, and the interest received
• Interest earned or interest income is computed by multiplying the
effective rate by the carrying amount of the bond investment
• Interest received is computed by multiplying the nominal rate by the
face value of the bonds.