HAND-OUT NO.

11: DEBT INVESTMENTS

Brian Christian S. Villaluz, CPA
FINANCIAL ACCOUNTING AND REPORTING
HAND-OUT NO. 11: Debt Investments

INTRODUCTION
A debt instrument is any contract that represents a right upon the holder to receive cash from the issuer thereof or an
obligation upon the issuer to pay cash to the holder thereof. It represents debtor-creditor relationship between entities.
On the other hand, an equity instrument represents ownership in another entity.

Initial Recognition
Financial assets are recognized only when the entity becomes a party to the contractual provisions of the instrument.

Classification of Financial Assets

Financial assets are classified as subsequently measured at
a. Amortized cost;
b. Fair value through other comprehensive income (FVOCI); or
c. Fair value through profit or loss (FVPL)

Basis of classification
Financial assets are classified on the basis of both:
a. The entity’s business model for managing the financial assets; and
b. The contractual cash flow characteristics of the financial asset.

Classification at amortized cost

A financial asset is measured at amortized cost if both of the following conditions are met:
a. The business model is to hold financial assets in order to collect contractual cash flows; and
b. The contractual cash flows are solely payments of principal and interest (SPPI).

Classification at fair value through other comprehensive income

A financial asset is measured at fair value through other comprehensive income (FVOCI) if both of the following
conditions are met:
a. The business model is achieved both by collecting contractual cash flows and by selling the asset; and
b. The contractual cash flows are solely payments of principal and interest (SPPI).

Classification at fair value through profit or loss

A financial asset that does not meet the conditions for measurement at amortized cost or FVOCI is measured at fair value
through profit or loss (FVPL).

Problem 1: (Debt investments at fair value through profit or loss; at Quoted Price)
On January 1, 2018, XYZ Co. purchased P100,000 bonds at 98. The bonds mature on December 31, 2021 and pay 12%
annual interest beginning December 31, 2018. Commission paid on the acquisition amounted to P10,000. The objective of
the entity’s business model is to sell such bonds in the near term to take advantage of fluctuations in fair value for short-
term profit taking.

On December 31, 2018, the bonds are quoted at 101. On January 2, 2019, the bonds were sold at 110.

1. Prepare the journal entries to record the foregoing.

2. At what amount should the debt investment be initially recognized?
3. How much is the unrealized gain or loss for the year ended 2018?
4. How much is the gain or loss on sale of bonds in 2019?

Problem 2: (Debt investments at fair value through profit or loss; Effective interest rate)
January 1, 2018, XYZ Co. purchased P100,000 bonds for P98,000. The bonds mature on December 31, 2021 and pay 12%
annual interest beginning December 31, 2018. Transaction costs are negligible. The bonds are classified as held for trading
securities.

On December 31, 2018, the bonds are selling at a yield rate of 10%.

1. Prepare the journal entries to record the foregoing.

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Brian Christian S. Villaluz, CPA
2. Compute the fair value of the bonds on December 31, 2018 (round off present value factors to four decimal places).
3. How much is the unrealized gain or loss for the year ended December 31, 2018?

Problem 3: (FVPL) [WITH ANSWERS] (Answers: C, A, A, B)

On January 1, 2019, Woot Company purchased 12% bonds with face amount of P5,000,000 for P5,500,000 including
transaction cost of P100,000. The bonds provide an effective yield of 10%.

The bonds are dated January 1, 2019 and pay interest annually on December 31 of each year.

The bonds are quoted at 115 on December 31, 2019. The entity has irrevocably elected the fair value option.

1. What amount of gain from change in fair value should be reported for 2019?
A. 750,000 B. 250,000
C. 350,000 D. -0-

2. What amount of interest income should be reported for 2019?

A. 600,000 B. 550,000
C. 660,000 D. 540,000

3. What is the carrying amount of the bond investment on December 31, 2019?
A. 5,750,000 B. 5,400,000
C. 5,500,000 D. 5,450,000

4. What total amount of income from the investment should be reported in the income statement for 2019?
A. 540,000 B. 950,000
C. 890,000 D. 900,000

Problem 4: (Initial Measurement)

On January 1, 2018, Dre Company purchased 5-year bonds with face amount of P8,000,000 and stated interest of 10% per
year payable semi-annually on June 30 and December 31.

The bonds were acquired to yield 8%.

PV of an annuity of 1 for 10 periods at 5% 7.72
PV of an annuity of 1 for 10 periods at 4% 8.11
PV of 1 for 10 periods at 5% 0.6139
PV of 1 for 10 periods at 4% 0.6756

1. What is the market price or purchase price of the bonds?

A. 7,382,400 B. 8,617,600
C. 8,648,800 D. 7,351,200

2. What is the carrying amount of the bond investment on December 31, 2018?
A. 8,594,752 B. 8,540,704
C. 8,538,542 D. 8,302,848

Problem 5: (Initial Measurement)

At the beginning of current year, JJ Company purchased ten-year bonds with a face amount of P1,000,000 and a stated
interest rate of 8% per year payable semi-annually June 30 and December 31.

The bonds were acquired to yield 10%.

PV of 1 for 10 periods at 10% 0.386
PV of 1 for 20 periods at 5% 0.377
PV of an annuity of 1 for 10 periods at 10% 6.145
PV of an annuity of 1 for 20 periods at 5% 12.462

1. What is the market price of the bonds?

A. 1,124,620 B. 1,100,000
C. 1,000,000 D. 875,380
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Problem 6: (Initial Measurement)

On January 1, 2020, RC Company purchased serial bonds with face amount of P3,000,000 and stated 12% interest payable
annually every December 31.

The bonds are to be held as financial asset at amortized cost with a 10% effective yield.

The bonds mature at an annual installment of P1,000,000 every December 31. The present value of 1 at 10% for one period
is 0.91, for two periods is 0.83, and for three periods 0.75.

1. What is the present value of the serial bonds on January 1, 2020?

A. 3,106,800 B. 3,060,000
C. 3,045,000 D. 3,149,400

Problem 7: (Amortized Cost; Subsequent Measurement)

On January 1, 2018, NY Company purchased bonds with face amount of P8,000,000 for P7,679,000 as a long-term
investment.

The stated rate on the bonds is 10% but the bonds are acquired to yield 12%.

The bonds mature at the rate of P2,000,000 annually every December 31 and the interest is payable annually also every
December 31.

1. What is the interest for 2018?

A. 800,000 B. 921,480
C. 960,000 D. 767,900

2. What is the carrying amount of the investment in bonds on December 31, 2018?
A. 5,759,250 B. 7,759,250
C. 7,800,480 D. 5,800,480

Problem 8: (Amortized cost; Purchased between interest payment dates)

On July 1, 2018, Viva Company purchased as a long-term investment P1,000,000 of Vivo Company’s 8% bonds for
P946,000, including accrued interest. The bonds were purchased to yield 10% interest.

The bonds mature on January 2024 and pay interest annually on January 1. Viva Company used the effective interest
method of amortization.

1. What is the interest income for 2018?

A. 80,000 B. 90,600
C. 45,300 D. 40,000

2. On December 31, 2018, what is the carrying amount of the investment in bonds?
A. 911,300 B. 916,600
C. 953,300 D. 960,600

Problem 9: (FVOCI)
On January 1, 2018, KQ Company purchased bonds with face amount of P5,000,000. The entity paid P4,600,000 plus
transaction cost of P142,000.

The bonds mature on December 31, 2020 and pay 6% interest annually on December 31 of each year with 8% effective
yield.

The bonds are quoted at 105 on December 31, 2018 and 110 on December 31, 2019.

The business model in managing the financial asset is to collect contractual cash flows that are solely payments of principal
and interest and also to sell the bonds in the open market.

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Brian Christian S. Villaluz, CPA
1. What amount of unrealized gain should be reported as component of other comprehensive income for 2018?
A. 250,000 B. 400,000
C. 428,640 D. -0-

2. What cumulative amount of unrealized gain should be reported as component of other comprehensive income in
the statement of changes in equity for 2019?
A. 500,000 B. 592,931
C. 164,291 D. -0-

3. What is the interest income for 2019?

A. 300,000 B. 379,360
C. 385,709 D. 392,931

Problem 10: (FVOCI)

On January 1, 2018, Mars Company purchased bonds with face amount of P4,000,000 for P4,206,000.

The business model in managing the financial asset is to collect contractual cash flows that are solely payments of principal
and interest and also to sell the bonds in the open market.

The bonds mature on December 31, 2020 and pay 10% interest annually on December 31 each year with 8% effective
yield.

The bonds are quoted at 95 on December 31, 2018 and 90 on December 31, 2019.

1. What amount of unrealized loss should be reported as component of other comprehensive income in 2018?
A. 342,480 B. 406,000
C. 469,520 D. -0-

2. What amount of unrealized loss should be reported as component of other comprehensive income in 2019?
A. 473,878 B. 131,398
C. 200,000 D. -0-

3. What amount of cumulative unrealized loss should be reported in the statement of changes in equity for 2019?
A. 406,000 B. 606,000
C. 473,878 D. -0-

4. What is the carrying amount of the bond investment on December 31, 2019?
A. 4,206,000 B. 3,600,000
C. 3,800,000 D. 4,673,878

Problem 11: (FVOCI)

On January 1, 2019, NV Company purchased bonds with face amount of P5,000,000 for P4,760,000 including transaction
cost 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.

The bonds are quoted at 102 on December 31, 2019 and 105 on December 31, 2020. The bonds are sold on June 30, 2021
at 110 plus accrued interest.

1. What amount of unrealized gain should be reported as component of other comprehensive income for 2019?
A. 268,800 B. 100,000
C. 340,000 D. -0-

2. What amount of unrealized gain should be reported as component of other comprehensive income for 2020?
A. 339,056 B. 221,200
C. 70,256 D. -0-
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3. What amount should be recognized as gain on sale of the bond investment on June 30, 2021?
A. 544,528 B. 794,528
C. 250,000 D. 589,056

RECLASSIFICATION
After initial recognition, financial assets are reclassified only when the entity changes its business model for managing
financial assets.

Reclassification Date
Reclassifications of financial assets are applied prospectively from the reclassification date. 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.

Problem 12: (Reclassification date)

ABC Co. uses a calendar year period and reports only on an annual basis. If ABC Co. changes its business model on May
1, 2018, when is the reclassification date?

Problem 13:
On January 1, 2018, Von Company purchased bonds with face amount of P5,000,000. The company paid P4,500,000 plus
transaction cost of P168,600.

The bonds mature on December 31, 2021 and pay 6% interest annually on December 31 of each year with 8% effective
yield.

The bonds are quoted at 105 on December 31, 2018 and 110 on December 31, 2019.

The business model in managing the financial asset is to collect contractual cash flows and also to sell the bonds in the
open market.

The entity has not elected the fair value option.

On December 31, 2019, the entity changed the business model to collect only contractual cash flows.

On December 31, 2020, the bonds are quoted at 115 and the market rate of interest is 10%.

1. What amount of unrealized gain should be reported as component of OCI for 2018?
A. 250,000 B. 690,000
C. 507,912 D. -0-

2. What amount of cumulative unrealized gain should be reported as component of OCI in the statement of changes
in equity for 2019?
A. 500,000 B. 678,545
C. 250,000 D. 875,200

3. What amount of unrealized gain should be reported as component of OCI for 2019?
A. 500,000 B. 250,000
C. 170,633 D. 185,200

4. What is the interest income for 2020?

A. 300,000 B. 500,000
C. 385,716 D. 369,984

5. What is the carrying amount of the investment on December 31, 2020?

A. 4,694,784 B. 4,668,600
C. 4,907,171 D. 5,750,000

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Problem 14:
On January 1, 2018, SS Company purchased 10% bonds in the face amount of P3,000,000. The bonds mature on January
1, 2028 and were purchased for P3,405,000 to yield 8%.

The company used the effective interest method of amortization and interest is payable annually every December 31.

The business model for this investment is to collect contractual cash flows composed of interest and principal.

On December 31, 2019, the entity changed the business model for this investment to realize fair value changes.

On January 1, 2020, the fair value of the bonds was P2,845,000 at an effective rate of 11%.

1. What is the interest income for 2019?

A. 337,740 B. 300,000
C. 272,400 D. 270,192

2. What amount in profit or loss should be recognized in 2020 as a result of the reclassification?
A. 531,600 B. 502,592
C. 154,200 D. -0-

3. What is the interest income for 2020?

A. 300,000 B. 312,950
C. 267,807 D. 284,500

Problem 15:
On January 1, 2018, RR Company purchased 9% bonds in the face amount of P6,000,000. The bonds mature on January
1, 2023 and were purchased for P5,555,000 to yield 11%. The entity classified the bonds as held for trading and interest is
payable annually every December 31. The entity provided the following information about fair value of the bonds and
effective rate:

Fair value Effective rate

December 31, 2018 5,450,000 12%
December 31, 2019 6,155,000 8%

On December 31, 2019, the company changed the business model for this investment to collect contractual cash flows
composed of principal and interest.

On January 1, 2020, the fair value of the bonds remained unchanged.

1. What is the interest income for 2018?

A. 540,000 B. 610,922
C. 660,000 D. 661,918

2. What amount of unrealized should be recognized in profit or loss for 2018?

A. 500,000 B. 450,000
C. 105,000 D. -0-

3. What amount of unrealized gain should be recognized in profit or loss for 2019?
A. 155,000 B. 600,000
C. 705,000 D. -0-

4. What is the interest income for 2020?

A. 492,400 B. 540,000
C. 480,000 D. 677,050

FINANCIAL ACCOUNTING THEORIES

1. The amortization of a discount on an investment in bonds measured at amortized cost
A. Increases the carrying amount of the investment.
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Brian Christian S. Villaluz, CPA
B. Is the excess of interest income over interest received or receivable.
C. Is recorded directly to the investment account.
D. All of the foregoing

2. Depending on the business model for managing financial assets, a company shall classify financial assets
subsequent to initial recognition at
A. Fair value through profit or loss
B. Amortized cost
C. Fair value through other comprehensive income
D. All of these are used in measuring financial assets

3. A debt investment shall be measured subsequently at amortized cost

A. By irrevocable election
B. When the business model is to collect contractual cash flows that are solely payments of principal and interest
and also to sell the financial asset.
C. When the debt investment is held for trading
D. When the business model is to collect contractual cash flows that are solely payments of principal and interest.

4. Trading bond investments are reported at

A. Amortized cost B. Face amount C. Fair value D. Maturity value

5. Transaction costs on trading bond investments are

A. Accounted for separately as deferred charge.
B. Part of initial carrying value.
C. A component of OCI.
D. Expensed immediately.

END OF HANDOUT

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