INVESTMENT IN DEBT SECURITIES:

2 classifications of Financial Assets

1. Financial Assets at Fair Value

2. Financial Assets at Amortized Cost

Financial Assets @ Amortized cost generally refer to investment in bonds which are neither designated at FVPL nor
held for trading.

Investment in bonds may be classified as:

1. FA at FVPL ( Designated or Held For Trading) accounted for the same way as investment in equity
securities at FVPL
2. Financial Assets at Amortized Cost
Note: It cannot be classified as FA at FVOCI

Bond investment

1. Treasury-Bonds ( Government Bonds)

2. Corporate Bonds ( Private Bonds)

This are disclosed in the notes to assessed related risk on such investment

Bond issuer vs Bond holder

 Bond Issuer is a borrower (debtor) Till the maturity of the bond, the bond issuer pays periodic (can be
annual/ semi-annual) interest to the bondholders, and upon maturity, the issuer returns the principal
amount borrowed to the holder of the bond.
 Bond holder is the lender ( creditor)
What is a Bond?

 Long term debt instrument

 Usually offered to the public and sold to many investors

What id bond indenture?

 Contractual agreement
 Restrictive covenants to protect the bondholder
 A trustee, often a bank is appointed to ensure compliance

Accounting for Investment in Bonds at amortized cost

 Similar to the accounting for notes and loans receivable

What is amortized cost?

 The amount at which a financial asset or financial liability is measured at initial recognition
minus principal repayments, plus or minus the cumulative amortization using the effective
interest method of any difference between initial amount and the maturity amount and minus
any reduction ( directly or through the use of an allowance account) for impairment or
uncollectibility

Note: Amortized cost of the investment in bonds is determined using effective interest method.

What is effective interest method?

 Method in calculating the amortized cost of a financial asset or financial liability and of allocating
the interest income or interest expense over the relevant period

What is effective interest rate?

 Rate that exactly discounts estimated future cash payments or receipts though the expected life
of the financial instrument or when appropriate, a shorter period to the net carrying amount of
the financial asset or financial liability.
 Other terms: yield rate, market rate, imputed rate

What is nominal rate?

 Nominal interest rate is the annual interest rate (per year) for a certain compounding period.
 Other terms: stated rate, coupon rate, annual percentage rate

When accounting for investment in bonds we must consider the following:

1. Discount or premium
2. Recognition of interest income
3. Acquired interest
4. Adjustment to effective interest due to transaction costs
5. Sale of bonds prior to maturity

1. DISCOUNT or PREMIUM

 Bonds are acquired at discount if the acquisition cost (including transaction cost) is less than the
face amount.
o Acquisition cost plus transaction cost < face amount is equal to the discount.
o Effective interest rate is greater than Nominal Rate
 Bonds are acquired at premium if the acquisition cost (including transaction cost) is greater
than the face amount.
o Acquisition cost plus transaction cost > face amount is equal to the premium
o Effective interest rate is less than Nominal Rate

Example:
1. On January 1, 2001. BTS Co. acquired 10%, P1,000,000 bonds for P951,963. The principal is
due on January 1, 2004 but interest is due annually every January 1. The yield rate on the
bonds is 12%, The bonds are classified as amortized cost.

2. On January 1, 2001. BTS Co. acquired 12%, P1,000,000 bonds for P1,049,737. The principal
is due on January 1, 2004 but interest is due annually every January 1. The yield rate on the
bonds is 10%, The bonds are classified as amortized cost

2. Amortization of discount or premium.

 Any discount or premium is included in the carrying amount of the bonds and amortized using
effective interest method
 No separate account is needed to record any discount or premium
 At maturity date, amortizing discount or premium will bring the carrying amount of the bonds
equal to the face value at maturity date

Bonds acquired at discount Bonds acquired at premium

In effect there is gain ( the bonds are
acquired lower than the face amount)
This gain is deferred and amortized as
addition to interest income
Amortization of bond discount
increases interest income over the
period bonds are held
Affects only interest income and not
interest receivable
In effect there is loss ( the bonds are acquired
higher than the face amount)
This loss is deferred and amortized as
reduction to interest income
Amortization of bond premium decreases
interest income over the period bonds are
held
Affects only interest income and not interest
receivable
 Recognition of interest income/investment income

How to compute interest income?

 Interest income on bonds is computed using effective interest method
 Interest income = Present value of the bonds x original effective interest rate
 Interest income already includes the amortization of any premium or discount during the period

How to compute interest receivable?

 Interest receivable = Outstanding face amount x nominal rate

How to compute discount or premium amortization

 Interest receivable - Interest income= Discount/ Premium Amortization

How to compute for unamortized discount discount/premium?

 Present value – face amount= unamortized discount/premium

Sample Problem:
1. On January 1, 2001. BTS Co. acquired 10%, P1,000,000 bonds for P951,963. The principal is
due on January 1, 2004 but interest is due annually every January 1. The yield rate on the
bonds is 12%, The bonds are classified as amortized cost.

Date Interest Interest Income Amortization Present Value

Receivable ( EIR x PV)
( Nominal rate x
Face amount)
January 1, 2001 951,963
January 1, 2002 100,000 114,236 14,236 966,199
January 1, 2003 100,000 115944 15,944 982,143
January 1, 2004 100,000 117,857 17,857 1,000,000

1. On January 1, 2001. BTS Co. acquired 12%, P1,000,000 bonds for P1,049,737. The principal
is due on January 1, 2004 but interest is due annually every January 1. The yield rate on the
bonds is 10%, The bonds are classified as amortized cost

Date Interest Interest Income Amortization Present Value

Receivable
January 1, 1,049,737
2001
 January 1,2002 120,000 104,974 15,026 1,034,711
January 1,2003 120,000 103,471 16,529 1,018,182
January 1,2004 120,000 101,818 18,182 1,000,000

Discount vs Premium

DISCOUNT PREMIUM
Discount amortization increases interest Premium amortization decreases interest
income income
Discount amortization increases present Premium amortization decreases present
value value
Interest Income, Amortization and Present Amortization Column on the amortization
Value columns increase over the life of the table increases over the life of the bonds
bonds

Acquired Interest
 Bonds may be purchased in between scheduled interest payment dates
 When unpaid interest has accrued before acquisition date of bonds, subsequent receipt of
interest is allocated between pre-acquisition and post-acquisition periods.

60,000 60,000
Debit to Interest Recognize as
Receivable/
Interest income
Interest income

January 1 July 1 December 31

ACQUISITION DATE

 Only post acquisition portion is recognized as interest income.

 Accrued interest during the period the bonds were not held should not be recognized as interest
income.
 Usually accrued interest prior to the acquisition is sold to the investor. However this should not
be included as part of the cost of the investment. It is debited to interest receivable or interest
income. Purchased accrued interest increases cash outlay on acquisition but does not affect cost
of investment.
Sample:
On April 1, 20x1 BTS Co. Acquired 12% P1,000,000 bonds dated January 1, 2021 at 98 excluding
interest. The bonds mature on December 31, 20x3 but pay annual interest at each year end.

Journal entry at acquisition date:

April 1, 20x1 Investment in bonds @amortized cost 980,000

Interest Receivable 30,000
Cash in bank 1,010,000
Acquisition of Investment in Bonds at amortized cost
Dec 31, 20x1 Cash in bank 120,000
Interest Receivable 30,000
Interest Income 90,000
Receipt of interest

April 1, 20x1 Investment in bonds @amortized cost 980,000

Interest Income 30,000
Cash in bank 1,010,000
Acquisition of Investment in Bonds at amortized cost
Dec 31, 20x1 Cash in bank 120,000
Interest Income 120,000
Receipt of interest

On April 1, 20x1 BTS Co. Acquired 12% P1,000,000 bonds dated January 1, 2021 at 98 including
interest. The bonds mature on December 31, 20x3 but pay annual interest at each year end.

Journal entry at acquisition date:

April 1, 20x1 Investment in bonds @amortized cost 950,000

Interest Receivable 30,000
Cash in bank 980,000
Acquisition of Investment in Bonds at amortized cost
Dec 31, 20x1 Cash in bank 120,000
Interest Receivable 30,000
Interest Income 90,000
Receipt of interest

April 1, 20x1 Investment in bonds @amortized cost 950,000

Interest Income 30,000
Cash in bank 980,000
Acquisition of Investment in Bonds at amortized cost
Dec 31, 20x1 Cash in bank 120,000
 Interest Income 120,000
Receipt of interest

On August 1, 20x1 BTS Co. Acquired 12% P1,000,000 bonds dated January 1, 2021 at 98
including interest. The bonds mature on December 31, 20x3 but pays semi- annual interest at
every January 1 and July 1

Journal entry at acquisition date:

April 1, 20x1 Investment in bonds @amortized cost 970,000

Interest Receivable 10,000
Cash in bank 980,000
Acquisition of Investment in Bonds at amortized cost
Dec 31, 20x1 Cash in Bank 60,000
Interest Receivable 10,000
Interest Income 50,000
Receipt of interest