ACCOUNTING FOR INVESTMENT in DEBT SECURITIES

Classifications of investment in debt securities:

a. Debt investment at Amortized cost or held to maturity securities (HTM)– Premium/discount is
amortized. ( need to prepare amortization table) The cost is purchase price plus transaction cost
directly attributable to acquisition. At each reporting the debt investment is reported at its
Carrying Value or Amortized cost.

b. Debt investment at FVPL- Premium/discount is NOT amortized. The cost is its purchase price.
Transaction cost is charged to expense. Reported at Fair Value

c. Debt investment at FVOCI- Premium/discount is amortized. (need to prepare amortization table)

The cost is purchase price plus transaction cost directly attributable to acquisition. Reported at Fair
Value

Comparison of the three types of debt investment

Classifications: At amortized cost FVPL FVOCI

Initial measurement Fair value (FV) + Fair Value FV + transaction
transaction cost cost
Treatment of transaction cost (broker’s fee) Capitalized Expensed Capitalized

Computation of interest income CV,beg. x effective Face value x CV,beg. x

interest rate stated interest effective interest
rate rate
Year- end valuation Carrying Value Fair Value Fair Value
Other
Reporting of changes in fair value N/A Profit or loss comprehensive
income
Financial statement classification Noncurrent asset Current asset Noncurrent asset
Upon sale of debt investment Gain/loss is Gain/loss is No gain/loss is to
recognized recognized be recognized.

Notes:
1. bonds purchased at a premium means that that stated interest rate is higher
than the effective interest rate/market interest rate.

2. bonds purchased at a discount means that the stated rate is lower than the
effective rate on interest.

3. bonds purchased at par means that the stated rate and effective rate are the
same.

Stated interest rate---10%

Market interest rate—12%
The bonds will be issued at a discount

Stated interest rate----15%

Market interest rate—12%
The bonds will be issued at a premium

HOW TO DETERMINE THE ISSUE PRICE/PURCHASE PRICE OF BONDS.

ILLUSTRATIONS:

1. bonds purchased at a premium

Face Value of bonds P1,000,000

Stated interest rate 12%
Effective(market) interest rate 10%
Term 5 years
Interest payment date Every December 31
Present value of 1 at 10% for 5 periods 0.620921
Present value of an ordinary annuity of 1 at 10% for 5 periods 3.790787
The bonds price is computed as follows:

Discounted value of Maturity value (P1M x 0.620921) P620,921

Discounted value of Interest payments (P1M x 12% x 3.790787) 454,894
Issue price/Purchase price of bonds P1,075,815

Since the stated interest rate of 12%, is higher than the effective rate of 10%, the issue price/purchase price
of the bonds would be at a premium.

Alternative computation:
Face value of bonds x difference in interest rate x present value factor:
P1,000,000 x 2% x 3.790787 = P75,815 premium (stated rate is > effective rate)
Face Value of bonds P1,000,000 + 75,815 premium = P1,075,815 Issue price of bonds

2. bonds purchased at a discount

Face Value of bonds P1,000,000

Stated interest rate 10%
Effective(market) interest rate 12%
Term 5 years
Interest payment date Every December 31
Present value of 1 at 12% for 5 periods 0.567427
Present value of an ordinary annuity of 1 at 12% for 5 periods 3.604776

The bonds price is computed as follows:

Discounted value of Maturity value (P1M x 0.567427) P567,427

Discounted value of Interest payments (P1M x 10% x 3.604776) 360,478
Issue price/Purchase price of bonds P927,905

Since the stated interest rate of 10%, is lower than the effective rate of 12%, the issue price/purchase price of
the bonds would be at a discount

Alternative computation:
Face value of bonds x difference in interest rate x present value factor:
P1,000,000 x 2% x 3.604776 = P72,095 discount (stated rate is < effective rate)
Face Value of bonds, P1,000,000 - 72,095 discount = P927, 905

ANSWERS TO:

3-2. ABU COMPANY –

1. Investment in Debt Securities classified as at amortized cost

Stated interest rate 15%

Effective interest rate or market rate/yield rate) 14%

ACQUISITION PRICE OF BONDS 8,274,646

FACE VALUE OF BONDS 8,000,000
Premium on bonds 274,646

TABLE OF PREMIUM AMORTIZATION

Interest
Date Received Interest
FV x stated Revenue
interest rate CV x effective Premium Carrying
(P8Mx15%) rate (14%) Amortization Value
01/01/Y1 8,274,646
12/31/Y1 1,200,000 1,158,450 41,550 8,233,096
12/31/Y2 1,200,000 1,152,633 47,367 8,185,729
12/31/Y3 1,200,000 1,146,002 53,998 8,131,731
12/31/Y4 1,200,000 1,138,442 61,558 8,070,173
12/31/Y5 1,200,000 1,129,827* 70,173* 8,000,000
*rounded off. 274,646

COMES DUE DATE OF THE BONDS, THE FACE VALUE AND CARRYING VALUE ARE EQUAL
 ENTRIES:
Y1
Jan. 1 Debt Investments at Amortized Cost 8,274,646
Cash 8,274,646
To record investment in 8M bonds purchased at a
premium
Dec. 31 Cash 1,200,000
Interest Revenue 1,200,000
To record interest received.

Dec. 31 Interest revenue 41,550

Debt Investments at Amortized Cost 41,550
To amortize premium on bonds.

Y2
Dec. 31 Cash 1,200,000
Debt Investments at Amortized Cost 47,367
Interest Revenue 1,152,633
To record interest received and amortization of
premium.

NOTES:
1. The amortization of bond premium, decreases the carrying value of debt investment.
2. Likewise, the amortization of premium also decreases the interest revenue recognized by the investor

Questions:
1. At what amount should Abu Company report the bond investments on Dec. 31, year 1? 8,233,096
2. At what amount should Abu Company report the bond investments on Dec. 31, year 2? 8,185,729
3. How much interest income should the company report FY 1? 1,158,450
4. How much interest income should the company report FY 2? 1,152,633

2. Assuming the Investment in Debt Securities is classified as FVPL

No amortization table is to be prepared, because premium/discount is not amortized.
The debt investment is to be reported at FAIR VALUE.

ENTRIES:
Y1
Jan. 1 Debt Investments at FVPL 8,274,646
Cash 8,274,646
To record investment in bonds at a premium.

Dec. 31 Cash 1,200,000

Interest Revenue 1,200,000
To record interest received.

At the end of an accounting period, the FAIR Value of the investment is compared with the
previous Fair value. Any increase/decrease is recorded by preparing an adjusting entry.

Assume that the fair value of the bonds on Dec. 31, Y1 is 104

Fair value of debt investment at Dec. 31, year 1 (8M X 104)-----8,320,000

Fair value at Acquisition date---------------------------------------------8,274,646
Increase in fair value -------------------------------------------------------- 45,354
The Entry on Dec. 31, Y1 to record the increase in fair value is:
Debt Investments as at FVPL 45,3540
Unrealized gain/loss 45,3540
To take up increase in fair value of debt investment classified as at FVPL

If the fair value decreases, the entry would be:

Debit: Unrealized holding gain/loss------------------xxxx
Credit: Debt Investments as at FVPL---------------------------xxxx
Questions:
 1. At what amount should Abu Company report the bond investments on Dec. 31, year 1? 8,320,000
Computation: P8M x 104 fair value at Dec. 31, Y1 = 8,320,000
2. How much interest income should the company report FY 1? 1,200,000 (8M x 15% stated interest rate)
3. How much interest income should the company report FY 2? 1,200,000

3. Assuming the Investment in Debt Securities is classified as FVOCI

Amortization table is to be prepared for Debt Securities is classified as FVOCI

ENTRIES:
Y1
Jan. 1 Debt Investments at FVOCI 8,274,646
Cash 8,274,646
To record investment in bonds at a premium.

Dec. 31 Cash 1,200,000

Interest Revenue 1,200,000

To record interest received.

Interest revenue 41,550

Debt Investments at FVOCI 41,550
To amortize premium on bonds.

At the end of an accounting period, the FAIR Value of the investment is compared with its
carrying value. Any increase/decrease is recorded by preparing an adjusting entry.

Assume that the fair value of the bonds on Dec. 31, Y1 is 104

Fair value of debt investment at Dec. 31, year 1 (8M X 104)---------8,320,000

carrying Value at Dec. Y1-(Please refer to the amortization table --8,233,096
Increase in value ------------------------------------------------------------------- 86,904
The Entry on Dec. 31, Y1 to record the increase in fair value is:
Debt Investments at FVOCI-Fair value adjustment 86,904
Unrealized gain/loss-OCI 86,904
To take up increase in fair value of debt investment classified as at FVOCI.

Decrease in fair value would be recorded as follows:

Unrealized gain/loss-OCI xxxx
Debt Investments at FVOCI-Fair value adjustment xxxx

HOW TO COMPUTE GAIN/LOSS ON SALE OF DEBT INVESTMENT

a. For debt investment classified as at Amortized cost

Selling price ( assumed amt.) 1,200,000
Carrying value ( as of date of sale) 1,000,000
Gain on sale 200,000

b. For debt investment classified as at FVPL

Selling price ( assumed amt.) 1,000,000
Fair value 1,200,000
loss on sale 200,000

c. For debt investment classified as at FVOCI (no gain/ loss is recognized) because as of date of sale, the selling
price and fair value are equal.

MC 13- BONDS PURCHASED BETWEEN INTEREST PAYMENT DATE.

Notes:
1. bonds purchased between interest payment date carries with it an accrued interest
2. the accrued interest is from the last interest payment date up to date of purchase
3. the accrued interest paid by the investor is not part of the cost of debt investment. It is debited to
interest receivable or interest income.
Interest is payable every October 31 and April 30
The bonds were purchased on September 1, year 2
The accrued interest is from May 1 to August 31- 4 months

Face value of bonds—P1,000,000; acquired at 104

The acquisition cost is P1,000,000 x 104% = P1,040,000 Purchase price
The amount of accrued interest is-P1,000,000 x 12% x 4/12 =P40,000

Total amount to be paid upon acquisition of bonds on sept. 1, is

P1,040,000+40,000 accrued interest=P1,080,000

The entry to record the investment in debt securities on Sept. 1 is

Debt Investment at Amortized Cost 1,040,000
Interest Receivable 40,000
Cash 1,080,000
OR:
Debt Investment at Amortized Cost 1,040,000
Interest Income 40,000
Cash 1,080,000

Entry on Oct. 31, to record the receipt of semi-annual interest of bonds.

Cash (1,000,000 x 12% x 6/12) 60,000
Interest Receivable 40,000
Interest Income 20,000

Entry on Oct. 31, to record the receipt of semi-annual interest of bonds.( if interest income is debited on Sept.
1)
Cash (1,000,000 x 12% x 6/12) 60,000
Interest Income 60,000