CHAPTER

BLUE NOTES
13 S
L
A financial asset shall be measured at amortized cost if both of the following conditions are met: ( PFRS 9, par.4.1.2)
1. The business model is to hold the financial asset in order to collect contractual cash flows on specified
dates.
2. The contractual cash flows are solely payments of principal and interest on the principal amount
outstanding.

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

Classifications
1. Financial assets held for trading or trading securities
2. Financial assets at amortized cost

Measurement
Financial Assets Held for Trading or Financial Assets at Amortized Cost
Trading Securities

Initial Measurement At fair value At fair value plus transaction costs

Note: Transaction cost are expensed that are directly attributable to the
immediately acquisition

Subsequent Measurement At fair value through profit or loss. No At amortized cost using effective
amortization of premium or discount interest method
is needed

Kinds of Bonds
1. Callable bonds – bonds that may be called or redeemed by the issuing entity prior to their maturity date.
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.
2. Convertible bonds – bonds that give the bondholder the right to exchange their bonds for share capital of
the issuing entity at any time prior to maturity.
3. Serial bonds – bonds that have a series of maturity dates or those bonds which are payable in installments.
4. Terms bonds – bonds that mature on a single date. Callable and convertible bonds can be classified as term
bonds despite their special features.

Acquisition of Bonds
Bonds acquired: On interest date Between interest dates
Purchase price Acquisition cost Includes accrued interest
Journal entry Trading securities/Bond investment xxx Trading securities/Bond investment xxx
Cash xxx Accrued interest receivable xxx
Cash xxx

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Chapter 13 – Financial Asset at Amortized Cost USL Blue Notes 47

Sale of Bonds Prior to Maturity

Sales price (net of accrued interest, if any) minus the carrying amount of the bond investment equals gain/loss on
the sale of investment

Amortization of Premium or Discount

Bond premium Bond discount
Definition A loss on the part of the bondholder A gain on the part of the bondholder
because the bondholder paid more because the bondholder paid less
than what can be collected on the than what can be collected on the
date of maturity. date of maturity.
Pro-forma entry of amortization Interest income xxx Investment in bonds xxx
Investment in bonds xxx Interest income xxx
Methods of Amortization
a. Straight line method – provides for an equal amount of premium or discount amortization each accounting
period.
b. Bond outstanding method – this method is applicable to serial bonds and provides for a decreasing amount of
amortization.
c. Effective interest method (or simply interest method or scientific method) – provides for an increasing amount
of amortization.
Note: PFRS 9 requires the use effective interest method in amortizing premium or discount.

Illustrative Problems

Methods of Amortization

1. Straight Line Method

Face value of bonds P 2,000,000

Acquisition cost (January 1, 2012) 1,800,000
Discount on bonds 200,000
Date of bonds January 1, 2012
Date of maturity January 1, 2016
Interest payable annually on December 31 12%

Yearly Amortization: 200,000/4 = 50,000

2. Bond Outstanding Method

Face value of bonds P 2,000,000
Acquisition cost (January 1, 2012) 2,200,000
Premium on bonds 200,000
Annual installment every December 31 500,000
Date of bonds January 1, 2012
Interest payable annually on December 31 12%

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48 USL Blue Notes Chapter 13 – Financial Asset at Amortized Cost

Schedule of annual amortization:

Year Bond outstanding Fraction Premium amortization

2012 2,000,000 2/5 80,000
2013 1,500,000 1.5/5 60,000
2014 1,000,000 1/5 40,000
2015 500,000 .5/5 20,000
5,000,000 200,000

3. Effective interest method

Key terms:
i. Nominal rate/coupon rate/stated rate – the rate of interest appearing on the face of the bonds. Nominal
rate multiplied by the face value of the bonds gives the periodic interest received by the bondholder.
ii. Effective rate/yield rate/market rate – the true or actual rate of interest which the bondholder earns on
investment. Effective rate multiplied by the carrying amount of the bond investment gives the actual
interest income.
iii. Carrying amount of the bond investment – is the initial cost gradually increased by periodic amortization of
discount or gradually reduced by periodic amortization of premium.
Note!
i. Effective rate = nominal rate  cost of bond investment = face value
ii. Effective rate  nominal rate  cost of bond investment  face value (bond premium)
iii. Effective rate  nominal rate  cost of bond investment  face value (bond discount)

Face value of bonds P 1,000,000

Acquisition cost (January 1, 2012) 964,540
Discount on bonds 35,460
Effective interest rate 10%
Nominal rate (Interest payable
semiannually on December 31) 8%
Maturity date January 1, 2014

Amortization schedule:

Date Interest received Interest income Discount amortization Carrying amount

Jan. 1, 2012 964,540
Jun. 30, 2012 40,000 48,227 8,227 972,767
Dec. 31, 2012 40,000 48,638 8,638 981,405
Jun. 30, 2013 40,000 49,070 9,070 990,475
Dec. 31, 2013 40,000 49,525 9,525 1,000,000

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Chapter 13 – Financial Asset at Amortized Cost USL Blue Notes 49

Interest received = face value x semiannual nominal rate (4%)

Interest income = carrying amount x semiannual effective rate (5%)
Discount amortization = interest income – interest received
Carrying amount = preceding carrying amount + discount amortization

4. Computing Effective Rate

Face value of bonds P 5,000,000

Acquisition cost (January 1, 2012) 4,650,000
Maturity date January 1, 2017
Nominal rate (Interest payable annually
every December 31) 10%

Since the acquisition cost is at discount, the effective rate must be higher than nominal rate of 10%.
By interpolation, using a rate of 11%, the PV of 1 for 5 periods is 0.5935 and the PV of an ordinary annuity of 1
for 5 periods is 3.6959.

PV of principal (5,000,000 x .5935) 2,967,500

PV of future interest payments (500,000 x 3.6959) 1,847,950
Total present value of cash flows 4,815,450

The acquisition cost is still lower than the present value of the bonds. This means that the effective rate must
be higher than 11%.
Another interpolation is made using another rate of 12 %. The PV of 1 for 5 periods is .5674 and the PV of an
ordinary annuity of 1 for 5 periods is 3.6048.

PV of principal (5,000,000 x .5674) 2,837,000

PV of future interest payments (500,000 x 3.6048) 1,802,400
Total present value of cash flows 4,639,400

The acquisition cost is now higher than the present value of bonds. This means that the effective rate must be
lower than 12%.
Thus, the effective rate must between 11% and 12%. The differential between 11% and 12% is interpolated as
follows:
X – 11%
12% - 11%
Then, the present values applicable to the rates are substituted as follows:
4,650,000 – 4,815,450
4,639,400 – 4,815,450

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50 USL Blue Notes Chapter 13 – Financial Asset at Amortized Cost

165,450
= .94
176,500
This differential of .94 between 11% and 12% is added to 11% to get an effective rate of 11.94%.

5. Computing the Purchase Price or Market Price of Bonds

The market price or purchase price of bonds is equal to the present value of the principal plus the present
value of future interest payments using the effective rate.

Face value of bonds P 3,000,000

Date of issue of bonds January 1, 2012
Nominal rate 8%
Effective rate 6%
Semiannual interest January 1 and July 1
Date of maturity January 1, 2014

PV of 1 at 3% for 4 periods 0.8885

PV of an ordinary annuity of 1 at 3% for 4 periods 3.7171

The market price of bonds is computed as follows:

PV of principal (3,000,000 x .8885) 2,665,500

PV of future interest payments (120,000 x 3.7171) 446,052
Total market price/purchase price 3,111,542

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