Special Lecture on PFRS 9:

Financial Instruments
University of Southern Philippines Foundation

By:
Remark M. Montalban
FINANCIAL
INSTRUMENTS
PAS 32/PFRS 9

Part 1 : Investment in
Equity Securities
Learning Objectives

After this session, you will know

• What financial instrument is
• The classification of equity securities
• The measurement of equity securities
• Accounting for investment in equity securities

3
Definition (PAS 32, paragraph 11)

Financial instrument is any contract that

gives rise to a financial asset of one entity
and a financial liability or an equity
instrument of another entity.

4
Characteristics of Financial Instruments

The characteristics of financial instrument

are:
• There must be a contract.
• There are at least two parties to the
contract.
• The contract shall give rise to a financial
asset of one party and financial liability or
equity instrument of another party.
5
Classifications of Financial Assets

PFRS 9, paragraph 4.1.1, financial assets are

classified into three, namely:
• Financial assets at fair value through profit or
loss – include both equity and debt securities.
• Financial assets at fair value through other
comprehensive income – include both equity
securities and debt securities.
• Financial assets at amortized cost – include
only debt securities.
6
Business Models for Managing Financial Assets

• To hold investments in order to realize

fair value changes.
• To hold investments in order to collect
contractual cash flows.

7
Financial Assets at Fair Value through Profit of Loss

Appendix A of PFRS 9 provides that a financial asset

is measured at fair value through profit or loss if:
• It is acquired principally for the purpose of selling or
repurchasing it in the near term.
• On initial recognition, it is part of a portfolio of
identified financial assets that are managed together
and for which there is evidence of a recent actual
pattern of short-term profit taking.
• It is a derivative, except for a derivative that is a
financial guarantee contract or a designated and an
effective hedging instrument.

8
Financial Assets at Fair Value through Profit of Loss

The following financial assets shall be measured at fair

value through profit or loss:
• Financial assets held for trading (trading securities) as required
by the standard.
• All other investments in quoted equity instruments by
consequence in accordance with the Application Guidance B5
of PFRS 9.
• Financial assets by irrevocable designation of fair value option
in accordance with Paragraph 4 of PFRS 9.
• All debt investments that do not satisfy the requirement
measurement at amortized cost and at fair value through other
comprehensive income by default in accordance with PFRS 9,
paragraph 4.

9
Irrevocable Designation

PFRS 9, paragraph 5.7.5., provides that an entity

may make irrevocable designation to present in
other comprehensive income subsequent changes
in fair value of an investment in equity instrument
that is not held for trading.

In this case, the financial instrument shall be

presented in accordance with paragraph 4.1.2A,
and measured in accordance with paragraph
5.1.1.
10
Financial Assets at Amortized Cost

PFRS 9, paragraph 4.1.2, provides that a

financial asset shall be measured at
amortized cost if both of the following
conditions are met:
• The business model is to hold the financial
asset in order to collect contractual cash flows
on specified date.
• The contractual cash flows are solely payments
of principal and interest on the principal
amount outstanding.
11
Financial Assets at Fair Value through OCI

PFRS 9, paragraph 4.1.2A, provides that a

financial asset shall be measured at fair value
through comprehensive income if both of the
following conditions are met:
• The business model is achieved both by
collecting contractual cash flows and by selling
the financial asset.
• The contractual cash flows are solely payments
of principal and interest on the principal
outstanding.
12
Initial Measurement of Financial Assets

PFRS 9, paragraph 5.1.1. provides that at

initial recognition, an entity shall
measure a financial asset at fair value,
plus in the case of financial asset not at
fair value through profit or loss,
transaction costs that are directly
attributable to the acquisition of financial
asset.
13
Illustration No. 1

On January 1, 2017, Shellah purchased 10,000

shares from Carpio Inc. for P15 per share, the
price as indicated in the PSE. In connection
to the purchase, Shellah paid the broker 10%
commission. What is the initial carrying
amount of the investment on January 1, 2017,
considering the following:
a) The financial asset is measured at FVPL
b) The financial asset is measured at FVOCI
14
Subsequent Measurement of Financial Assets

PFRS 9, paragraph 5.2.1, further provides

that after initial recognition, an entity
shall measure a financial asset at:
• Fair value through profit or loss
• Fair value through other comprehensive
income
• Amortized cost
15
Presentation of Financial Assets

• PFRS 9, paragraph 5.7.1, gain and loss on financial

asset measured at fair value shall be presented in
profit or loss, except:
• When the financial asset is part of a hedging
relationship.
• When the financial asset is an investment in nontrading
equity instrument and the entity has irrevocably
elected to present unrealized gain and loss in other
comprehensive income.
• When the financial asset is a debt investment that is
measured at fair value through other comprehensive
income.
16
Illustration No. 2 (Continuation)

On January 1, 2017, Shellah purchased 10,000 shares

from Carpio Inc. for P15 per share, the price as
indicated in the PSE. In connection to the purchase,
Shellah paid the broker 10% commission. On
December 31, 2017, the date of reporting, the closing
price in the PSE for this security is P15.50. What is the
book value of this investment if measured at the end
of the year using:
a) FVPL
b) FVOCI

17
Derecognition of Financial Assets measured at FVPL

Gain or loss on financial assets measured

at fair value through profit or loss on the
date of derecognition, sale or impairment
shall be recognized in profit or loss,
except as those set forth under paragraph
5.7.1 of PFRS 9 (OCI).

18
Derecognition of Financial Assets measured at AC

PFRS 9, paragraph 5.7.2, provides that

gain and loss on financial asset measured
at amortized cost and is not part of a
hedging relationship shall be recognized
in profit or loss when the financial asset
is derecognized, sold, impaired or
reclassified, and through amortization
process.
19
Derecognition of Financial Assets measured at FVOCI

Gain or loss on disposal of equity investment

measured at fair value through other
comprehensive income is recognized in
retained earnings in accordance with PFRS
9, paragraph 5, and any cumulative gain or
loss previously recognized in other
comprehensive income is also transferred to
retained earnings in accordance with PFRS 9
Application Guidance paragraph 5.
20
Measurement of Gain (Loss) on Sale

PFRS 9, paragraph 3, provides that on

derecognition of a financial asset, the
difference between the carrying amount
and the consideration received,
including new asset obtained less any
new liability assumed shall be recognized
in profit or loss, except those measured
at Fair Value through OCI.
21
Illustration No. 3

During 2017, Magic Company purchased 80,000

shares at P60 per share. The investment was
classified as FVPL. During the year, the entity sold
20,000 shares for P70 per share. On December 31,
2017, the market price per share is P55. What net
amount of gain or loss should be recognized for
2017 in profit or loss statement?

Answer: Loss of 100,000

22
Reclassification

PFRS 9, paragraph 4, provides that an entity

shall reclassify financial assets only when it
changes its business model for managing
financial assets.

Where reclassification occurs, paragraph

5.6.1 provides that an entity shall apply the
reclassification prospectively from the
reclassification date.
23
Reclassification

As defined by Appendix A of PFRS 9, the

reclassification date is the first day of the
reporting period following the change in
business model that results in an entity
reclassifying financial asset.

24
Reclassification as Presented by the Standard

Case A
When an entity reclassifies a financial
asset from amortized cost to fair value
through profit or loss, the fair value is
determined at reclassification date. The
difference between the previous carrying
amount and fair value is recognized in
profit or loss (par. 5.6.2)
25
Reclassification as Presented by the Standard

Case B
When an entity reclassifies a financial
asset from fair value through profit or
loss to amortized cost, the fair value at
the reclassification date becomes the new
carrying amount of the financial asset at
amortized cost (par. 5.6.3).
26
Reclassification as Presented by the Standard

Case C
When an entity reclassifies a financial asset
at amortized cost to fair value through other
comprehensive income, the fair value is
measured at reclassification date. Any gain
or loss arising from the difference between
the amortized cost carrying amount and fair
value is recognized in OCI (par. 5.6.4).

27
Reclassification as Presented by the Standard

Case D
When an entity reclassifies a financial asset from
fair value through other comprehensive income
to amortized cost, the fair value at the
reclassification date becomes the new carrying
amount of the financial asset at amortized cost.
However, the cumulative gain or loss previously
recognized in other comprehensive income is
removed from equity and adjusted against the
fair value at reclassification date (par. 5.6.5).

28
Reclassification as Presented by the Standard

Case E
When an entity reclassifies a financial asset
from fair value through profit or loss to fair
value through other comprehensive income,
the financial asset continues to be measured
at fair value. The fair value at reclassification
date becomes the new carrying amount (par.
5.6.6).

29
Reclassification as Presented by the Standard

Case F
When an entity reclassifies a financial asset from
fair value through other comprehensive income
to fair value through profit or loss, the financial
asset continues to be measured at fair value. The
fair value at reclassification date becomes the
new carrying amount. The cumulative gain or
loss previously recognized in other
comprehensive income is reclassified to profit or
loss at reclassification date (par. 5.6.7).

30
Impairment of Financial Assets

PFRS 9, paragraph 5.5.1, provides that an

entity shall recognize a loss allowance for
expected credit losses on:
• Debt investment measured at amortized cost
• Debt investment measured at fair value through
other comprehensive income

31
Impairment of Financial Assets

Furthermore, paragraph 5.5.3 provides that an

entity shall measure the loss allowance for a
financial instrument at an amount equal to the
lifetime expected credit losses if the credit risk
on the financial instrument has increased
significantly since initial recognition. Credit
losses are the present value of all cash
shortfalls. PFRS 9 does not prescribe any
particular method of measuring credit losses.
32
Dividends

Dividends are distributions of a portion of a

company's earnings, declared by the board of
directors, paid to a class of its shareholders.

The main accounting problem concerning

dividends is the date when the dividends are
considered earned.

33
Important Dates in Dividend Distribution

• Date of declaration – the date on which the Board

approved the payment of dividends.
• Date of record – the date on which the stock and
transfer book of the corporation is closed for
registration.
• Date of payment – the date on which the dividend
declared shall be paid.

34
Dividends

If equity securities are measured at fair value

through profit or loss, other comprehensive income
or at amortized cost, dividends earned are
considered as income.
This recognition used the cost model. In other
words, dividend distribution does not affect the
investment account.

35
When to recognize dividend as income?

36
Types of Dividends

• Cash dividends
• Property dividends
• Liquidating dividends
• Stock dividends of the same class (bonus issue)
• Stock dividends of different class (bonus issue)
• Shares in lieu of cash dividends
• Cash received in lieu of stock dividends
37
Types of Dividends

• Cash dividends – dividend distribution is in

a form of cash. Dividends are measured at
face value.
• Property dividends – dividend distribution
is in a form of noncash assets. Otherwise
known as dividend in kind. These are also
considered as an income and recorded at fair
value.
38
Types of Dividends

• Liquidating Dividend – represent return of

invested capital, and therefore not an income.
The payment maybe in a form of cash or noncash
assets. However, in some instances for wasting
asset corporation, a portion may be distributed
as income.
• Stock dividends – are in the form of the issuing
entity’s own shares. This may be the same as
those held or different as those held. Stock
dividends are not income.
39
Types of Dividends

• Stock dividends on the same class – recorded

only by means of memorandum entry. Stock
dividends of this kind do not affect the total cost
of investment but reduce the cost of the
investment per share.
• Stock dividends of different class – the original
cost of the investment is apportioned between
the original shares and the stock dividends on
the basis of market value of each at the date of
receipt.
40
Types of Dividends

• Shares received in lieu of cash dividends – this

kind of dividend received are income at fair
value of the shares received. In the absence of
fair value, the income is equal to the cash
dividend that would have been received.
• Cash received in lieu of stock dividend – as if
the shares assumed to be received are
subsequently sold at the cash received.
Therefore, gain or loss may be recognized.

41
Illustration No. 10

A shareholder owns 10,000 shares costing

P1,100,000. Subsequently, the shareholder
receives P150,000 cash in lieu of 1,000 shares
originally declared as 10% stock dividend.
What is the gain on investment?

Ans: 50,000
42
Share Split

Is the restructuring of the corporation of its capital by

effecting a change in the number of shares without
capitalizing retained earnings or changing the
amount of its legal capital. Which may be either:
• Split up, a transaction whereby the outstanding shares
are called in and replaced by a larger number,
accompanied by a reduction in the par or stated value of
each share.
• Split down, the reverse of split up.

Only memorandum entry is prepared.

43
Special Assessments

Additional capital contribution of the

shareholders. On the part of the shareholders,
special assessments are recorded as additional
cost of investment and on the part of the
entity as share premium.

44
Illustration No. 11

A shareholder owns 10,000 shares costing

P500,000. Subsequently, the directors pass a
resolution to the effect that the shareholders shall
contribute P5 each per share held to the
corporation. What is the increase in the investment
in equity securities account of the shareholder?

Ans: P50,000
45
Stock Rights

Is a legal right granted to shareholders to

subscribe for new shares issued by a
corporation at a specified price during a
definite period. The IAS term for stock right is
right issue.

46
Accounting for Stock Rights

Case A
Application Guidance B5.4.14 of PFRS 9
provides that all investments in equity
instruments and contracts on those
instruments must be measured at fair value.
Stock rights are equity instruments, therefore
should be measured at fair value. This calls
that a portion of the investment should be
allocated to stock rights.
47
Illustration No. 12

A shareholder acquired 10,000 shares costing P1,800,000. Subsequently,

the shareholder received 10,000 stock rights to subscribe for new shares
at P100 per share for every five rights held. The market value of the
share is P150 and the market value of the right is P10.
• What is the value assigned to stock rights?
• What is the balance of investment in equity securities account?
• What is the cost of the new investment if the stock rights are
exercised?
• What is the gain on sale if stock rights are sold for P150,000?

Ans: 100,000; 1,700,000; 300,000; 50,000

48
Accounting for Stock Rights

Case B
PFRS 9 paragraph 4.3.3. provides that an
embedded derivative shall be separated from
the host contract and accounted for separately
under certain conditions. However if the host
contract is within the scope of PFRS 9, the
classification requirements of PFRS 9 are
applied to the combined host contract in its
entirety.
49
Illustration No. 13

A shareholder acquired 10,000 shares for P1,500,000. Subsequently, the

shareholder received 10,000 stock rights to subscribe for new shares at
P100 per share for every five rights held. The market value of the share
is P140, and the market value of the right is P10. The stock rights are all
exercised by the shareholder.
• What is the value of stock rights?
• What is the balance of investment in equity securities account before
the rights are exercised?
• What is the cost of the new investment through the exercise of the
stock rights?

Ans: 0; P1,500,000; 200,000

50
Theoretical/Parity Value of Stock Rights

The theoretical or parity value is the assumed

fair value of the right that is derived from the
market value of the share when no known
market value is assigned to stock rights.

51
Theoretical/Parity Value of Stock Rights

Two formulas may be used in the computation:

When the share are selling right-on:
Value of one right = Market value of share right-on minus
subscription price divided by number of rights to purchase one plus 1

When the share are selling ex-right:

Value of one right = Market value of share ex-right minus
subscription price divided by number of rights to purchase

52
Illustration No. 14

A shareholder acquired 10,000 shares costing P2.5

million. Subsequently, the shareholder received stock
rights to subscribe for new shares at P150 per share
for every five rights held. The market value of the
share is P210 per share. The right has no known
market value. Compute for the value of one right if:
a. The market value per share is selling right-on.
b. The market value per share is selling ex-right.

Ans: P10; P12

53
FINANCIAL
INSTRUMENTS
PAS 32/PFRS 9

Part 2 : Investment in
Bonds
What is a bond?

Bond is a formal unconditional promise

made under seal to pay a specified sum
of money at a determinable future date
and to make periodic interest payments
at a stated rate until the principal sum is
paid.

55
Characteristics of a bond

1) Bond is evidenced by a certificate and the

contractual agreement between the issuer and
investor is contained in another document called
bond indenture.
2) A bond is issued in small denomination of P100,
P1,000 or P10,000 to enable more investors to
purchase the bond issue.
3) An investor may acquire a bond either as
temporary or permanent investment and derives
regular income in the form of interest, maybe
paid semiannually or annually.
56
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).
• Coupon (bearer) bonds – bonds that can be
freely transferred and have a detachable
coupon for each interest payment.
57
Types of Bonds

• Zero-coupon bonds (strip bond) – bonds that do

not pay periodic interest. However, they sell at a
deep discount from their face amount. Principal and
compounded interests 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 the
option of exchanging bonds for shares of stocks of
the issuer.
58
Let’s take a look at the past a little bit…

Classification of Financial Assets

(1)Financial assets at fair value through
profit or loss (FVPL)
(2)Financial assets at fair value through
other comprehensive income (FVOCI)
(3)Financial assets at amortized cost
59
Let’s take a look at the past a little bit…

Business Models:
(1)To hold investments in order to realize
fair value changes
(2)To hold investments in order to collect
contractual cash flows

60
Let’s take a look at the past a little bit…

Initial Measurement
Fair value plus transaction costs
only if NOT:
Financial asset at fair value through
profit or loss

61
Let’s take a look at the past a little bit…

Subsequent Measurement
(1) Fair value through profit or loss
(2) Fair value through other comprehensive income
(3) Amortized cost

62
Overview of Investment in Bonds

Classification of Investment in Bonds

• Financial asset held for trading
• Financial assets at fair value through other
comprehensive income
• Financial assets at amortized cost
• Financial asset at fair value through profit
or loss by irrevocable designation or by fair
value option
63
Measurement of Investment in Bonds

• Held for trading – at fair value through profit or loss

• Held for collection of contractual cash flows – at
amortized cost
• Held for collection of contractual cash flows – at fair
value through profit or loss by irrevocable designation
• Held for collection of contractual cash flows and for sale
of the financial asset –at fair value through other
comprehensive income
• Held for collection of contractual cash flows and for sale
of the financial asset – at fair value through profit or loss
by irrevocable designation
64
Investment in Bonds measured at FVPL

Appendix A of PFRS 9 provides that a financial

asset is held for trading if:
• It is acquired principally for the purpose of selling
or repurchasing it in the near term.
• On initial recognition, it is part of a portfolio of
identified financial assets that are managed
together and for which there is evidence of a
recent actual pattern of short-term profit taking.
• It is a derivative, except for a derivative that is a
financial guarantee contract or a designated and
an effective hedging instrument.
65
Investment in Bonds measured at FVPL

• In, short these securities are held with the

intent of selling them in the very near term.
Also known as, “Trading Securities” under IAS
39 (old standard).
• Any transaction cost, is an expense outright.
• When bonds are classified as held for “trading”
or measured at fair value through profit or loss,
it is not necessary to amortize any premium or
discount. Which means that interest income is
computed based on the nominal interest rate
multiplied by the face amount.
66
Illustration No. 1

On January 1, 2016, an entity acquired 12%

bonds with face amount of P2,000,000 for
P2,200,000. Commission expense related to
the acquisition amounts to P15,000. The
bonds are held for trading. Interests are paid
semi-annually. What amount should this
bond be recorded at the date of acquisition?

Ans: 2,200,000
67
Illustration No. 1 (Cont..)

Use the same information in No. 1, what

is the interest income to be recognized on
July 1, 2016?

Answer: 120,000

68
Illustration No. 2

On April 1, 2016, Heart purchased P1,000,000, 12%

bonds at 96 plus accrued interest. Interest is payable
January 1 and July 1. The bonds are held for trading
investment. On October 31, bonds with face value of
P600,000 are sold for 101 plus accrued interest. At the
end of the year bonds are quoted at 120. What
amount is to be recognized as unrealized gain on
bond investment classified as FVPL in the income
statement?

Ans: 96,000
69
Illustration No. 2 (Cont…)

Use the same information in No. 3, what is the interest

income to be recognized on December 31, 2016?
Answer : 78,000
Interest Income
(1,000,000 x 12% x 7/12) 70,000
Interest Income
(400,000 x 12% x 2/12) 8,000
Total Interest Income 78,000

70
Investment in Bonds measured at FVOCI

PFRS 9, par. 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:
• The business model is achieved by both
collecting contractual cash flows and by selling
the financial asset.
• The contractual cash flows are solely payments
of principal and interest on the principal
outstanding.
71
Investment in Bonds measured at FVOCI

• If debt investment is measured at FVOCI, transaction cost is

added to the cost of investment.
• PFRS 9, par. 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
and included in the profit or loss.
• Subsequently, the entity must record discount amortization 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.
• Unlike equity securities, investment in bonds measured through
other comprehensive income, the cumulative gain or loss
previously recognized in OCI shall be reclassified to PROFIT
OR LOSS on the date of disposal or derecognition. 72
Illustration No. 3

On January 1, 2017, an entity purchased

bonds with face value of P5,000,000 for
P4,600,000, incurring transaction costs of
P160,000. The business model is to collect
contractual cash flows and to sell the
financial asset. The bonds mature on
December 31, 2019 and pay 10% interest
annually on December 31 with a 12%
effective yield. What is the initial
measurement of investment in bonds?
73
Illustration No. 3

ANSWER : 4,760,000

Financial Asset – FVOCI 4,760,000

Cash 4,760,000

74
Illustration No. 3 (Cont…)

Using the same information in No. 1,

what is the carrying amount of bond
investment on December 31, 2018?

Ans: 4,910,944, determined using the

amortization table.

75
Illustration No. 3 (Cont…)

Assuming that on December 31, 2017, the

bonds are quoted at 102, what is the
unrealized gain to be recognized in profit or
loss?

Ans : zero (0), unrealized gain is recognized

in other comprehensive income not in profit
or loss.
76
Illustration No. 3 (Cont…)

Computation for the unrealized gain - OCI

Market Value (5,000,000 x 102) 5,100,000
Carrying Amount – 12/31/17 4,831,200
Unrealized gain – OCI 268,800

Entry:
Financial Asset – FVOCI 268,800
Unrealized gain – OCI 268,800
77
Illustration No. 3 (Cont…)

Assume further that the market value of the

bonds on December 31, 2018 is 105. What
amount is to be recognized as unrealized
gain (loss) in other comprehensive income
on December 31, 2018?

Ans: 70,256
78
Illustration No. 3 (Cont…)

Solution to the problem:

Market Value (5,000,000 x 105) 5,250,000
Investment Bal. – 12/31/18* 5,179,744
Unrealized gain – OCI 70,256
*(5,100,000 + 79,744)

79
Illustration No. 3 (Cont…)

Another Solution to the problem:

Market Value 5,250,000
Carrying Amount per table – 12/31/18 4,910,944
Cumulative Unrealized Gain – 12/31/18 339,056
Unrealized Gain – 12/31/17 268,800
Increase in Unrealized Gain 70,256

80
Illustration No. 3 (Cont…)

What cumulative unrealized gain (loss)

shall be recognized on December 31,
2018?

Ans: 339,056, see previous computations

81
Illustration No. 3 (Cont…)

The bonds are sold on June 30, 2019 at

110 plus accrued interest. What is the
gain on sale of bonds to be recognized in
profit or loss on June 30, 2019?

Ans: 544, 528

82
Illustration No. 3 (Cont…)

Solution to the problem

Sales Price (5,000,000 x 110) 5,500,000
Unrealized Gain – OCI 339,056
Total 5,839,056
Investment Bal. – 6/30/19* 5,294,528
Gain on Sale 544,528

*(5,250,000 + 44,528)
83
Illustration No. 3 (Cont…)

Another solution to the problem

Sales Price 5,500,000
Carrying Amount per table – 6/30/19 4,955,472
Gain on Sale 544,528

Sales Price 5,500,000

Accrued Interest (5M x 10% x 6/12) 250,000
Total Cash Received 5,750,000

84
Investment in Bonds measured at FVPL by
irrevocable designation (fair value option)

PFRS 9, par. 4.1.5 provides that an entity at initial

recognition may irrevocably designate a
financial asset as measured at FVPL even if the
financial asset satisfies the amortized cost
measurement.

Therefore; all changes in fair value are

recognized in profit or loss, transaction costs are
outright expense and interest income are based
on nominal rate rather than effective interest
rate.
85
Illustration No. 4

On January 1, 2017, an entity purchased bonds

with face value of P5,000,000 for P5,400,000 plus
broker commission of P100,000. The stated rate
is 8% payable annually every December 31. The
bonds are acquired to yield an effective rate of
6%. On December 31, 2015, the bonds had a fair
value of P5,600,000. What is the initial
recognition of this bond investment?

Ans: 5,400,000
86
Investment in Bonds measured at Amortized Cost

PFRS 9, par. 4.1.2, provides that a financial

asset shall be measured at amortized cost, if
both of the following conditions are met:
• The business model is to hold the financial
asset in order to collect contractual cash flows
on specified date.
• The contractual cash flows are solely payments
of principal and interest on the principal
outstanding.
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Methods for Amortization

• Straight line method – provides for equal

amount of premium and discount
amortization each accounting period.
• Bond outstanding method – is applicable
to serial bonds and provides for a
decreasing amount of amortization.
• Effective interest method – or interest
method or scientific method, this provides
for an increasing amount of amortization.
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What method to use?

In accordance with PFRS 9; investment in

bonds shall be classified as financial
assets measured at amortized cost using
effective interest method.

Therefore, straight-line method and bond

outstanding method are to be used only
when the difference is immaterial.
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Amortization

Amortization is the difference between

interest income and interest received.
This is done through the interest income
account while increasing or decreasing
the investment account depending
whether the investment is made resulting
to a discount or premium.
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Amortization

Amortization of bond discount:

Investment in bonds xxx
Interest Income xxx

Amortization of bond premium:

Interest Income xxx
Investment in bonds xxx
91
Relationship of Interest Received and Interest Income

• If Discount: Interest received < interest

income
• If Premium: Interest received > interest
income

92
Illustration No. 5

On January 1, 2017, an entity acquires bonds

with face amount of P2,000,000 for 1,850,000,
due on January 1, 2020. Interest in of 12% is
payable semiannually on June 30 and
December 31. What is the carrying amount of
the investment in bonds on December 31,
2018, if the company uses straight line
method for amortization?

Answer: 1,950,000
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Illustration No. 5

Solution to the problem:

Acquisition Cost 1,850,000
Amortization:
2017 50,000
2018 50,000 100,000
Carrying Amount – 12/31/18 1,950,000

94
Illustration No. 6

On January 1, 2017, an entity acquires bonds

with face amount of P4,000,000 for
P4,200,000. Principal of P1,000,000 and
interest of 12% is payable annually every
December 31. What is the carrying amount of
investment in bonds on December 31, 2017,
using the bond outstanding method?

Ans: 3,120,000
95
Illustration No. 6

Solution to the problem:

Carrying Amount – 1/1/17 4,200,000
First Installment (1,000,000)
Amortization of Premium – 12/31 ( 80,000)
Carrying Amount – 12/31/17 3,120,000

96
Effective Interest Method

PFRS 9 requires that bond discount and

bond premium shall be amortized using
the effective interest method.

This method is also known as, scientific

method or simply, “interest method”.

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Effective Interest Method

Two kinds of interest rates:

• Nominal rate – is the coupon rate or
stated rate appearing on the face of the
bond.
• Effective rate – yield rate or market rate
which is the actual or true rate of
interest which the bondholder earns on
the bond investment.
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Effective Interest Method

Effective Interest Method:

Requires the difference between interest earned
or interest income and interest received.

Interest Income = Carrying Amount of the Loan

x effective interest rate

Interest Received = Face Amount of Loan x

coupon rate
99
Effective Interest Method

If Discount : Interest received < interest income

: Nominal Rate < Effective Rate
: Acquisition Cost < Face Amount

If Premium : Interest received > interest income

: Nominal Rate > Effective Rate
: Acquisition Cost > Face Amount
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Effective Interest Method

If effective interest rate is not given:

Effective interest rate can be computed using several methods.
However, we will use the TRIAL AND ERROR approach combined
with INTERPOLATION when needed.

TRIAL AND ERROR:

Future cash flows x PV factor @ x% = Present value of BONDS

INTERPOLATION:
𝑃𝑉𝑙𝑟−𝑃𝑉𝑏𝑜𝑛𝑑𝑠
Exact Rate = 𝐿𝑅 + [ 𝐻𝑅 − 𝐿𝑅 𝑋 ( )]
𝑃𝑉𝑙𝑟−𝑃𝑉ℎ𝑟

101
Illustration No. 8

On January 1, 2011, the entity acquired 10%,

P1,000,000 bonds for P951,963. The principal
is due on January 1, 2014 but interest is due
annually every January 1. The yield rate on
the bonds is 12%. The bonds are classified as
investment measured at amortized cost.
What is the carrying amount of the
investment on January 1, 2013?

Ans: 982,143
102
Illustration No. 9

On January 1, 2016, an entity acquired 12%,

P1,000,000 bonds for P1,049,737. The
principal is due on December 31, 2018. The
effective interest rate on the bonds is 10%.
What is the carrying amount of the
investment in bonds on December 31, 2017?

Ans: 1,018,182
103
Illustration No. 10

On April 1, 2016, the entity acquired 12%,

P1,000,000 bonds dated January 1, 2016 at
98 excluding interest. The bonds mature
on December 31, 2018 but pays annual
interest at each year-end. What is initial
cost of the investment?

Ans: 980,000
104
Illustration No. 11

On April 1, 2016, the entity acquired 12%,

P1,000,000 bonds dated January 1, 2016 at
98 including interest. The bonds mature
on December 31, 2018 but pay annual
interest each year-end. What is the initial
cost of investment in bonds?

Ans: 950,000
105
Sale/Disposal of Bonds Prior to Maturity

If bonds are sold prior to maturity, it is

necessary to determine the carrying
amount of the bond up to the date of sale
to determine the gain or loss on sale.

If the sale is between interest dates, the

sales price normally includes the accrued
interest.
106
Sale/Disposal of Bonds Prior to Maturity

If partial derecognition or sale:

When there is partial sale of financial
assets at amortized cost prior to maturity,
the unsold portion may still continue to
be measured at amortized cost.

107
Illustration No. 15

On January 1, 2016, the entity acquired 10%,

P1,000,000 bonds for P951,963. The principal is
due on January 1, 2019 but interest is due
annually starting December 31, 2016. The yield
rate on the bonds is 12%. On January 1, 2018, the
entire bonds were sold at 110. Commission paid
to broker amounted to P10,000. What is the gain
on sale of investment?

Ans: 107,858 108

Illustration No. 16

Use the same information in No.15, but

assume that only half of the bonds were sold
at 110 on January 1, 2018. Commission paid to
broker amounted to P10,000. What is the gain
(loss) on sale?

Ans: 48,928
109
“So far, you’ve survived 100% of your
worst days. This too shall pass!”
Thank you!

110