13

Investments and Fair Value Accounting

Principles of Financial Accounting with Conceptual

Emphasis on IFRS
Reeve Warren Duchac Wang

©2011 Cengage Learning

 Learning
Investments Objective
and Fair 1
Value Accounting
3-1

After studying this chapter, you should be able to:

Describe why companies invest in debt

1 Insert Chapter Objectives
and equity securities.
Describe
2 the
Describe and nature
illustrate of the
the accounting for
debt investments.
adjusting process.
3 Describe and illustrate the accounting for
equity investments.

13-2
13-2
 Investments and Fair Value Accounting (continued)

4 Describe and illustrate valuing and

reporting investments in the financial
statements.

5 Describe fair value accounting and its

implications for the future.

13-3
13-3
 1

Describe why
companies invest in
debt and equity
securities.

13-4
13-4
 1

Investing Cash in Current Operations

Cash may be used to replace worn out
equipment or to purchase new, more efficient,
and productive equipment. Cash may be
reinvested in the company to expand its current
operations. Cash may be used to pay suppliers or
other creditors.

13-5
 1

Investing Cash in Temporary

Investments
Debt securities are notes and bonds that
pay interest and have a fixed maturity
date. Equity securities are preferred and
common stock that represent ownership
in a company and do not have a fixed
maturity date.

13-6
 1

Investing Cash in Temporary

Investments
These debt securities and equity
securities are termed Investments, or
Temporary Investments, and are
reported in the Current Assets section
of the statement of financial position.

13-7
 1

Investing Cash in Long-

Term Investments
Long-term investments often involve the
purchase of a significant portion of the stock
of another company. Such investments have a
strategic purpose:
1. Reduction of costs
2. Replacement of management
3. Expansion
4. Integration
13-8
 2

Describe and illustrate

the accounting for debt
investments.

13-9
13-9
 2

Purchase of Bonds
Homer Company purchases $18,000 of U.S. Treasury
bonds direct from a Federal Reserve Bank at their par
value on March 17, 2010 (45 days after the last interest
payment date). The bonds have an interest rate of 6%,
payable on July 31 and January 31.

$18,000 × 6% × (45/360)
13-10
 2

Interest Revenue
On July 31, Homer Company receives a semiannual
interest payment of $540 ($18,000 × 6% × ½).

($540 – $135) or [$18,000 × 6% × (135/360)]

13-11
 2

Accrued Interest
Homer Company’s accounting period ends on December
31. The following adjusted entry is required to record the
accrued interest:

Homer Company would report Interest Revenue on its

2010 statement of comprehensive income at $855 ($405
+ $450).

13-12
 2

Semiannual Receipt of Interest

Homer Company receives interest of $540 on
January 31, 2011. Notice that Interest Receivable is
credited for $450 to reflect this is a receivable from
2010. Interest Revenue of $90 is the interest earned
from January 1 through January 31, 2011.

13-13
 2

Sale of Bonds
On January 31, 2011, Homer Company sells Treasury
bonds at 98. The sale results in a loss of $360.
Proceeds from sale ($18,000 × 98%) $17,640
Less book value (cost) of the bonds 18,000
Loss on sale of bonds $(360)

Reported as part of Other Income

13-14 (Loss) on the statement of
comprehensive income
 2
Example Exercise 13-1

Bond Transactions
Journalize the entries to record the following selected
bond investment transactions for Tyler Company:
1. Purchased for cash $40,000 of Tyler Company 10%
bonds at 100 plus accrued interest of $320.
2. Received the first semiannual interest.
3. Sold $30,000 of the bonds at 102 plus accrued
interest of $110.

13-15
13-15
Example Exercise 13-1 (continued)
2
Follow My Example 13-1

1. Investments—Tyler Company Bonds…………………… 40,000

Interest Receivable…………………………………………. 320
Cash…………………………………………………….. 40,320
2. Cash ($40,000 × 10% × ½)………………………………….. 2,000
Interest Receivable…………………………………… 320
Interest Revenue……………………………………… 1,680
3. Cash [($30,000 × 102%) + $110 accrued interest]………. 30,710
Interest Revenue……………………………………… 110
Gain on Sale of Investments………………………... 600
Investments—Tyler Company Bonds……………... 30,000

For Practice: PE 13-1A, PE 13-1B

13-16
13-16
 3

Describe and illustrate

the accounting for
equity investments.

13-17
13-17
 3

Accounting for Equity

Investments
A company may invest in the preferred or
common stock of another company. The
company investing in another company’s
stock is the investor. The company whose
stock is purchased is the investee.

13-18
 3

Exhibit 1 Stock Investments

13-19
 3

Less Than 20% Ownership

Investments of less than

20% of the investee’s
outstanding stock are
accounted for using the cost
method.

13-20
 3

Purchase of Stock (Cost Method)

On May 1, Bart Company purchases 2,000 shares of Lisa
Company common stock at $49.90 per share plus a
brokerage fee of $200.

13-21
 3

Receipt of Dividends (Cost Method)

On July 31, Bart Company receives a dividend of $0.40
per share from Lisa Company.

Dividend Revenue is reported as part of Other Income on

Bart Company’s statement of comprehensive income.

13-22
 3

Sale of Stock (Cost Method)

On September 1, Bart Company sells 1,500 shares of Lisa
Company stock for $54.50 per share, less a $160
commission.

Proceeds from sale [(54.50 × 1,500 shares) – $160 $81,590

Book value (cost) of the stock ($100,000/2,000 shares) × 1,500 75,000
Gain on sale of investments $ 6,590

13-23
 3
Example Exercise 13-2

Stock Transactions
On September 1, 1,500 shares of Monroe Company
are acquired at a price of $24 per share plus a $40
brokerage fee. On October 14, a $0.60 per share
dividend was received on the Monroe Company
stock. On November 11, 750 shares (half) of Monroe
Company stock were sold for $20 per share, less a
$45 brokerage fee. Prepare the journal entries for the
original purchase, dividend, and sale.

13-24
13-24
 Example Exercise 13-2 (continued)
3
Follow My Example 13-2

Sept. 1 Investments—Monroe Company Stock……………. 36,040*

Cash…………………………………………………. 36,040
*(1,500 shares × $24 per share) + $40

Oct. 14 Cash……………………………………………………….. 900*

Dividend Revenue………………………………… 900
*$0.60 per share × 1,500 shares

Nov. 11 Cash……………………………………………………….. 14,955*

Loss on Sale of Investments………………………….. 3,065
Investments—Monroe Company Stock………. 18,020**
*(750 shares × $20) – $45
**$36,040 × 1/2

For Practice: PE 13-2A, PE 13-2B

13-25
13-25
 3

Between 20% and 50% Ownership

If the investor purchases between 20%
and 50% of the outstanding stock of the
investee, the investor is considered to
have significant influence over the
investee and the investment is accounted
for using the equity method.

13-26
 3

Purchase of Stock (Equity Method)

Simpson Inc. purchased a 40% interest in Flanders
Corporation’s common stock on January 2, 2010 for
$350,000.

13-27
 3

Recording Investee Net Income

(Equity Method)
For the year ending on December 31, 2010, Flanders
Corporation reported net income of $105,000.

Income of Flanders Corporation, if significant, is reported

as Other Income on Simpson Inc.’s statement of
comprehensive income.
13-28
 3

Recording Investee Dividends

(Equity Method)
During the year, Flanders declared and paid cash dividends
of $45,000.

13-29
 3

13-30
 3

Sale of Stock (Equity Method)

On January 1, 2011, Simpson Inc. sold Flanders
Corporation’s stock for $400,000 a gain of $26,000
calculated as follows:
Proceeds from sale $400,000
Book value of stock investment 374,000
Gain on sale $ 26,000

13-31
 3
Example Exercise 13-3

Equity Method
On January 2, Olson Company acquired 35% of the
outstanding stock of Bryant Company for $140,000.
For the year ending December 31, Bryant Company
earned income of $44,000 and paid dividends of
$20,000. Prepare the entries for Olson Company for
the purchase of the stock, share of Bryant income,
and dividends received from Bryant Company.

13-32
13-32
 Example Exercise 13-3 (continued)
3
Follow My Example 13-3

Jan. 2 Investment in Bryant Company Stock.……………. 140,000

Cash…………………………………………………. 140,000

Dec. 31 Investment in Bryant Company Stock………………. 15,400*

Income of Bryant Company……………………... 15,400
*Record 35% of Bryant income, 35% × $44,000

Dec. 31 Cash……………………………………………………….. 7,000*

Investment in Bryant Company Stock………… 7,000
*35% × $20,000

For Practice: PE 13-3A, PE 13-3B

13-33
13-33
 3

More Than 50% Ownership

If the investor purchases more than 50%
of the outstanding stock of the investee,
the investor is considered to have control
over the investee. The purchase is
termed a business consolidation.

13-34
 3

More Than 50% Ownership

A corporation owning all or a majority
of the voting stock of another
corporation is called a parent company.
The corporation that is controlled is
called the subsidiary company.

13-35
 4

Describe and illustrate

valuing and reporting
investments in the
financial statements.

13-36
13-36
 4

Trading Securities
Trading securities are debt and
equity securities that are purchased
and sold to earn short-term profits
from changes in their market prices.

13-37
 4

Maggie Company purchased a portfolio of trading

securities during 2009. On December 31, 2009, the
cost and fair values of the securities were as
follows:

13-38
 4

The adjusting entry on December 31, 2009, to

record the fair value of the securities is as follows:

The Unrealized Gain on Trading Investments, if

significant, is reported on the statement of
comprehensive income.
13-39
 4

13-40
 4

On September 10, 2010, Maggie Company

purchases 300 shares of Zane Inc. as a trading
security for $12 per share, including a brokerage
commission.

13-41
 4

On December 31, 2010, the cost and fair

valuation of the portfolio of trading securities
are as follows:

13-42
 4

Based on the above analysis, the adjusting entry

on December 31, 2010, is as follows:

13-43
 4

The valuation allowance for trading investments

account after the December 31, 2010 adjusting
entry, has a credit balance of $3,100.
Valuation Allowance for Trading Investments
2009
Dec. 31 Adj. 1,300
Dec. 31 Bal. 1,300
2010
Jan. 1 Bal. 1,300
2010
Dec. 31 Adj. 4,400
Dec. 31 Bal. 3,100

13-44
 4

13-45
 4
Example Exercise 13-4

Valuing Trading Securities at Fair Value

On January 1, 2010, Valuation Allowance for Trading
Investments has a debit balance of $23,500. On
December 31, 2010, the cost of the trading securities
portfolio was $79,200, and the fair value was
$95,000. Prepare the December 31, 2010, adjusting
journal entry to record the unrealized gain or loss on
trading investments.

13-46
13-46
 Example Exercise 13-4 (continued)
4
Follow My Example 13-4

2010
Dec. 31 Unrealized Loss on Trading Investments………….. 7,700
Valuation Allowance for Trading Investments 7,700*
To record decrease in fair value of
trading investments.
Valuation allowance for trading investments, January 1, 2010 $23,500 Dr.
Trading investments at cost, December 31, 2010 $79,200
Trading investments at fair value, December 31, 2010 95,000
Valuation allowance for trading investments, December 31, 2010 15,800 Dr.
*Adjustment $ 7,700 Cr.

For Practice: PE 13-4A, PE 13-4B

13-47
13-47
 4

Held-To-Maturity Securities

Held-to-maturity
securities are debt
investments, such as notes
or bonds, that a company
intends to hold until their
maturity date.

13-48
 4

Available-For-Sale Securities

Available-for-sale
securities are debt
and equity
securities that are
not classified as
trading or held-to-
maturity securities.

13-49
 4

Maggie Company purchased securities during

2009 as available-for-sale securities instead of
trading securities. On December 31, 2009, the
cost and fair values of the securities are as
follows:

13-50
 4

The adjusting entry on December 31, 2009, to

record the fair value of the securities is as follows:

13-51
 4

A credit balance in Unrealized

Gain (Loss) on Available-for-Sale
Investments is added to
stockholders’ equity, while a debit
balance is subtracted from
stockholders’ equity.

13-52
 4

13-53
 4

On September 10, 2010, Maggie Company

purchases 300 shares of Zane Inc. as an
available-for-sale security for $12 per share,
including brokerage commission.

13-54
 4

On December 31, 2010, the cost and fair

valuation of the portfolio of available-for-
sale securities are as follows:

13-55
 4

Calculating the Adjustment Amount for

the Valuation Account

13-56
 4

Based on the calculations on Slide 56, the

following December 31, 2010, adjusting entry
should be made:

13-57
 4

13-58
 4
Example Exercise 13-5

Valuing Available-for-Sale Securities at Fair Value

On January 1, 2010, Valuation Allowance for
Available-for-Sale Investments has a credit balance
of $9,000. On December 31, 2010, the cost of the
available-for-sale securities was $45,700, and the fair
value was $37,200.
Prepare the adjusting entry to record the unrealized
gain or loss for available-for-sale investments on
December 31, 2010.

13-59
13-59
 Example Exercise 13-5 (continued)
4
Follow My Example 13-5

2010
Dec. 31 Valuation Allowance for Available-for-Sale
Investments 500*
Unrealized Gain (Loss) on Available-for-
Sale Investments 500
To record increase in fair value of
available-for-sale securities.
Valuation allowance for available-for-sale investments,
January 1, 2010 $9,000 Cr.
Available-for-sale investments at cost, December 31, 2010 $45,700
Available-for-sale investments at fair value, December 31, 2010 37,200
Valuation allowance for available-for-sale investments,
December 31, 2010 8,500 Cr.
*Adjustment $ 500 Dr.

13-60 For Practice: PE 13-5A, PE 13-5B

13-60
 4
Exhibit 2 Summary of Valuing and Reporting of
Investments

13-61
 4

13-62
 4

13-63
 5

Describe fair value

accounting and its
implications for the
future.

13-64
13-64
 5

Fair Value Accounting

Fair value is the price that would be
received for selling an asset or paying
off a liability. Fair value assumes that
the asset is sold or the liability paid off
under normal rather than under
distressed conditions.

13-65
 5

Trends to Fair Value

Accounting
A current trend for the FASB and
other accounting regulators is to
adopt accounting principles using fair
values for valuing and reporting
assets and liabilities.

13-66
 5

Trends to Fair Value

Accounting
Factors contributing to this trend
include the following:
1. Current generally accepted accounting
principles are a hybrid of varying
measurement methods that often conflict
with each other.
(continued)

13-67
 5

2. A greater percentage of the total assets of

many companies consists of financial
assets such as receivables and securities.
3. The world economy has created pressure
on accounting regulators to adopt a
worldwide set of accounting principles
and standards.

13-68
 5

Disadvantages of Fair
Value Accounting
Several potential disadvantages
include the following:
1. Fair value may not be readily obtainable
for some assets or liabilities resulting in
subjectivity.
(continued)

13-69
 5

2. Fair values make it more difficult to

compare companies if companies use
different methods of determining
(measuring) fair values.
3. Using fair values could result in more
fluctuations in accounting reports
because fair values normally change
from year to year.

13-70
 5

Effect of Fair Value Accounting on the

Financial Statements
1. When an asset or liability is reported at
its fair value, any difference between
the asset’s original cost or prior
period’s fair value must be recorded.
2. The unrealized gain or loss on changes
in fair value must be recorded. One
method reports these as part of
stockholders’ equity.
13-71
 5

Effect of Fair Value Accounting on the

Financial Statements

Instead of recording the unrealized

gain or loss on changes in fair value
as part of stockholders’ equity, the
unrealized gains or losses may be
reported on the statement of
comprehensive income.

13-72
 5

Dividend Yield

The dividend yield indicates the rate of return to

stockholders in terms of cash dividends distributed.
Dividends per Share of Common Stock
Dividend Yield =
Market Price per Share of Common Stock
Mattel:
$0.75
Dividend Yield = = 3.93%
$19.09

13-73
 Appendix 1:
Accounting for Held-to-
Maturity Investments

13-74
13-74
 Prices of Bonds
1. If the coupon bond rate of interest is
more than the market rate of interest
for equivalent investments, bonds are
purchased at a premium.
2. If the coupon bond rate of interest is
less than the market rate of interest
for equivalent investments, bonds are
purchased at a discount.

13-75
 Amortization of a Premium on
a Bond Investment

13-76
 Amortization of a Discount on
a Bond Investment

13-77
 Purchase at a Discount
On April 1, 2010, Crenshaw Inc. purchases
$50,000 (face value) of 10-year, 8% bonds on
their issuance date directly from XPS
Corporation as a held-to-maturity investment.
The purchase price was $44,000; the bonds
pay interest semiannually.

(continued)
13-78
 Purchase of bonds on April 1, 2010.

Receipt of semiannual interest on October 1.

(continued)
13-79
Adjusting entry for 3 months of accrued interest on December 31.

(continued)
13-80
The bonds on April 1, 2020.

13-81
 Appendix 2:
Comprehensive Income

13-82
13-82
 Comprehensive Income
• Comprehensive income is defined as all
changes in stockholders’ equity during a
period, except those resulting from
dividends and stockholders’ investments.
• Other comprehensive income items include
unrealized gains and losses on available-for-
sale securities as well as other items such as
foreign currency and pension liability
adjustments.
13-83
13-84
13-85
 Spotlight on IFRS
Financial Instruments

13-86
 IFRS Standards on Financial
Instruments
• IAS 32 Financial Instruments: Presentation,
• IAS 39 Financial Instruments: Recognition
and Measurement,
• IFRS 7 Financial Instruments: Disclosure.
• IFRS 9 will cover the four issues on
classification and measurement, impairment,
hedge accounting, and offsetting for financial
instruments.
13-87
 Definition
• A financial instrument
– Is a contract that gives rise to a financial asset of
one entity and a financial liability or equity
instrument of another entity.
– include financial assets, financial liabilities and
equity, all specified in contracts.
• A financial instrument is
– a financial asset (an investment) to its or holders;
– a financial liability, or equity to its issuer or writer.
13-88
 Financial Assets

• IFRS defines Financial Assets as:

– cash;
– an equity instrument of another entity (the
issuer);
– a contractual right (a) to receive cash or another
financial asset from another entity; or (b) to
exchange financial assets or financial liabilities
with another entity under conditions that are
potentially favorable to the entity; or
13-89
 Financial Assets
• a contract that will or may be settled in the entity's own
equity instruments and is:
(a) a non-derivative for which the entity is or may be obliged to
receive a variable number of the entity's own equity
instruments; or
(b) a derivative that will or may be settled other than by the
exchange of a fixed amount of cash or another financial asset
for a fixed number of the entity's own equity instruments

13-90
 Financial Liabilities
• IFRS defines a financial liability as:
– a contractual obligation:
(a) to deliver cash or another financial asset to another
entity; or
(b) to exchange financial assets or financial liabilities
with another entity under potentially unfavorable
conditions to the entity; or
– a contract that will or may be settled in the
entity's own equity instruments and is

13-91
 Financial Liabilities
(a) a non-derivative for which the entity is or may be
obliged to deliver a variable number of the entity's
own equity instruments; or
(b) a derivative that will or may be settled other than
by the exchange of a fixed amount of cash or another
financial asset for a fixed number of the entity's own
equity instruments.

13-92
 Financial Assets

• IAS 39 Financial Instruments: Recognition

and Measurement specifies four categories of
financial assets:
(1) Financial assets at fair value through profit or
loss (FVTPL)
(2) Loans and receivables (LR)
(3) Available-for-sale financial assets (AFS)
(4) Held-to-maturity investments (HTM)
13-93
 Type of instrument
Classification Investment in a Investment in an Derivatives
debt security equity security for and
which fair value can embedded
be reliably measured derivatives

FVTPL      
 Held for
trading √ √ √

 Designated as
at FVTPL √ √  

Loans and
receivables √    

Held-to-maturity √    
Available-for-sale √ √  
13-94
 A History of IFRS 9 Financial
Instruments
• To improve the decision usefulness for users
of financial statements by simplifying the
classification and measurement requirements
for financial instruments, IASB initiates a
project for the replacement of IAS 39 with
IFRS 9.

13-95
 The main stages
• The project consists of three main stages:
– Stage 1: Classification and measurement
– Stage 2: Impairment methodology
– Stage 3: Hedge accounting 

13-96
 Initial measurement and
recognition
• All financial instruments are initially measured
at fair value plus or minus, in the case of a
financial asset or financial liability not at fair
value through profit or loss, transaction costs.

13-97
 Subsequent measurement of
financial assets
• For accounting purposes, all financial assets
(debts and equity instruments, currently in the
scope of IAS 39) are classified into two
categories:
– those measured at amortized cost and those
measured at fair value.
– Classification is made at initial recognition, when
the entity becomes a party to the contractual
provisions of the instrument.
13-98
Accounting for investment in debt
instruments
1. Amortized cost method (AC)
– A debt instrument that meets the following two
conditions can be measured at amortized cost
(net of any writedown for impairment):
• Business model test;
• Cash flow characteristics test. All other debt
instruments must be measured at fair value through
profit or loss (FVTPL).
2. Fair value option (FVO).
13-99
Accounting for investment in debt
instruments
– Even if the above two conditions are met,
companies are allowed to choose to FVTPL if
application of FVTPL eliminates or significantly
reduces a measurement or recognition
inconsistency (accounting mismatch).
3. Available-for-sale (AFS) and held-to-
maturity (HTM) categories under IAS 39 no
longer exist under IFRS 9.

13-100
 Investment in equity instruments

• FVTPL--Measured at fair value in the statement

of financial position and changes in fair value
are recognized in profit or loss.
• FVTOCI--An equity investment is not held for
trading, an entity can make an irrevocable
option at initial recognition to measure it at fair
value through other comprehensive income
(FVTOCI) with only dividend income
recognized in profit or loss.
13-101
 Investment in equity instruments

• There is no “cost exception” for unquoted

equities. However, there are cases that costs
can be the best estimates of fair value.

13-102
   IFRS 9

IAS 39
FVTPL AC FVTOCI

FVTPL
√    

LR
√ √  

HTM
√ √  

AFS
     

 Debts instruments
√ √  

 Equity instruments
13-103 √   √
 Subsequent measurement of
financial liabilities
• IFRS 9 inherits the basic accounting model for
financial liabilities from IAS 39.
• Similar to investment in debt instruments, two
measurement categories of IAS 39 remain—
fair value through profit or loss (FVTPL) and
amortized cost:
– Financial liabilities held for trading are measured at
FVTPL, and all other financial liabilities are
measured at amortized cost unless the entity
exercises the fair value option (FVO).
13-104
 Fair value option (FVO)
• Even if the conditions for AC are met, an entity
can choose to use FVTPL in the following two
situations:
1. The liability is part or a group of financial
liabilities, or financial assets and financial
liabilities that is managed with its performance
evaluated on a fair value basis, in accordance with
a documented risk management or investment
strategy, and information about the group is
provided internally on that basis to the entity's key
13-105 management personnel.
 Fair value option (FVO)
2. Application of fair value accounting eliminates
or significantly reduces a measurement or
recognition inconsistency (accounting
mismatch).
3. A financial liability which does not meet any of
these criteria may still be designated as measured
at FVTPL when it contains one or more
embedded derivatives that would require
separation.

13-106
 Fair Value Option (FVO)
• IFRS 9 is carried over from IAS 39, with a
change in the fair value option related to own
credit risk.
• FVO
– the liability is reported at its full fair value.
– Gains and losses on financial liabilities
designated as at fair value through profit or loss
should be split into two amounts and presented in
two different ways:
13-107
 Fair Value Option (FVO)
(1) The amount of change in the fair value attributable to
changes in the credit risk should be presented in other
comprehensive income (OCI), and
(2) The remaining amount of change in the fair value
should be presented in profit or loss.
(3) That choice should be made at initial recognition and a
subsequent change in recognition is not allowed.
(4) Subsequently, an entity may only transfer the
cumulative gain or loss within the equity section.
Transferring amounts presented in OCI to profit or loss is
not allowed.
13-108
 Fair value guidance
• IAS 39 provides a priority to be used in
determining the fair value of a financial
instrument:
– Quoted market prices in an active market;
– Entity-established fair value, estimated using a
valuation technique with maximum use of market
information inputs.
– Cost less impairment.

13-109
 Accounting for Amortized cost method
• Under IAS 39,
– financial liabilities are classified into FVTPL and
AC;
– financial assets are classified into FVTPL, LR,
HTM, and AFS.
• Under IFRS 9,
– For financial assets covered by IAS 39 are
classified into FVTPL and AC.
• Amortized cost (AC) is applied to financial
assets classified as LR or HTM and financial
13-110
liabilities not at FVTPL.
 Amortized cost calculation
• Amortized cost is calculated using the
effective interest method.
• The effective interest rate is the discount rate
at which that the present value of estimated
future cash payments or receipts through the
expected life of the financial instrument
equals the net carrying amount of the
financial asset or liability.
13-111
 Discount and Premium
• On acquisition of a financial instrument (asset
or liability), the discount to or premium on the
instrument is the difference between the
maturity amount and initial fair value, minus
reduction due to impairment or
uncollectability.
• The discount or premium is amortized, using
effective interest rate, as interest income or
expense to profit and loss until the maturity of
the instrument.
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 Discount and Premium
• The effective interest rate method separates the
periodical payments of the instrument into
interest income/expenses and principal
repayment (discount/premium amortization).
• The subsequent carrying amortized cost is
equal to the initial fair value minus cumulative
principal repayment and any reduction for
impairment or uncollectability.
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 Derecognition of financial assets
• Under IFRS 9 (carried over from IAS 39),
accounting for derecognition follows the
following four steps:
1. Determine the asset to be derecognized:
2. Determine whether or not the entity has
transferred the asset.
3. Determine whether or not the entity has
transferred substantially all of the risks and
rewards of ownership of the asset.
13-114
 Derecognition of financial assets
• If the entity has neither retained nor transferred
substantially all of the risks and rewards of the
asset, then the entity must assess whether it has
relinquished control of the asset or not.
– If the entity does not control the asset then
derecognition is appropriate;
– If the entity has retained control of the asset, then
the entity continues to recognize the asset to the
extent to which it has a continuing involvement in
the asset.
13-115
 Derecognition of financial liabilities

• A financial liability should be removed from

the statement of financial position when, and
only when the obligation specified in the
contract is discharged, cancelled, or expires.

13-116
 Derecognition and Recognition
If a transaction substantially changes the terms of an
existing financial liability either through exchange or
contract modification, the transaction should be
accounted for as:
1. An extinguishment of the original financial
liability and
2. A recognition of a new financial liability.
3. A gain or loss from extinguishment of the
original financial liability is recognized in profit
or loss.
13-117
 Derivatives
• All derivatives are measured at fair value.
• Value changes are recognized in profit or loss
unless the entity has elected to treat the
derivative as a hedging instrument in
accordance with IAS 39.

13-118
 Embedded derivatives
• An embedded derivative (e.g., the call option
in a convertible bond) is a component of a
hybrid contract (e.g., a convertible bond).
• The hybrid contract includes a non-derivative
host (e.g., the straight debt of a convertible
bond), with the effect that some of the cash
flows of the combined instrument vary in a
way similar to a stand-alone derivative.

13-119
 Embedded Derivative-Characteristics

• A component of a hybrid security that is embedded in

a non-derivative instrument.
• An embedded derivative can modify the cash flows of
the host contract because the derivative can be related
to an exchange rate, commodity price or some other
variable which frequently changes.

13-120
 Embedded Derivative-Example
• A German company might enter into a sales contract
with a Chinese company, creating a host contract. If
the contract is denominated in the U.S. dollar, an
embedded foreign currency derivative is created.
• IFRS requires that the embedded derivative has to be
separated from the host contract and accounted for
separately unless the economic and risk
characteristics of both the embedded derivative and
host contract are closely related.

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 Transferable Derivatives
A derivative that is attached to a financial
instrument is not an embedded derivative, but
a separate financial instrument, if it
1. is contractually transferable independently of
that instrument, or
2. has a different counterparty.

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 IAS 39 and IFRS 9
• Under IAS 39, embedded derivatives that were not
closely related to the financial host asset are
separately accounted for at FVTPL.
• However, under IFRS 9, the contractual cash flows
of the financial asset are assessed in their entirety. In
addition, the asset as a whole should be measured at
FVTPL if any of its cash flows do not represent
payments of principal and interest.

13-123
 The Status of IFRS 9
• IFRS 9 introduces new requirements for the
classification and measurement of financial assets,
effective from 1 January 2013 and with early
adoption permitted.
• New requirements for classification and
measurement of financial liabilities, derecognition of
financial instruments, impairment and hedge
accounting are to be added to IFRS 9.

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 The Status of IFRS 9
Early adoption of the standard is a major step for any
entity, because an early adopter of IFRS 9 continues
to apply IAS 39 for other accounting requirements
for financial instruments that are not covered by
IFRS 9, that is:
– classification and measurement of financial liabilities,
recognition;
– derecognition of financial assets and financial liabilities;
– impairment of financial assets;
– hedge accounting.
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 Reclassification
• An entity may change the business model
objective for its financial asset management.
In this case, the entity should reclassify its
financial assets between FVTPL and AC if
and only if its previous model assessment
would no longer apply.

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 Reclassification
• Classification of financial assets involves different
recognition of gains, losses, or interest.
• Reclassification of financial assets is prospective
rather than retrospective from the reclassification
date.
• Therefore, an entity should not restate any
previously recognized gains, losses, or interest.

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 Reclassification
• Reclassification is prohibited in the
following two cases:
1. the ”other comprehensive income” option
(OCIO) has been exercised for a financial asset,
or
2. the fair value option (FVO) has been exercised
in any circumstance for a financial assets or
financial liability.

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 Available-for-Sale Option (AFSO) for
Loans and Receivables
• IAS 39 permits entities to designate, at the
time of acquisition, any loan or receivable as
available-for-sale. In this case, loan and
receivable is measured at fair value with
changes in fair value recognized in equity.
• IFRS eliminates the AFS category.

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 Impairment—recognition and
reversal
• At each statement of financial position date, an entity should
assess whether there is any objective evidence of impairment
for a financial asset or group of financial assets.
• Once there is objective evidence as a result of one or more
events occurring after the initial recognition, the entity should
do a detailed impairment calculation to determine whether an
impairment loss should be recognized.
• The amount of the impairment loss is measured as the
difference between the asset's carrying amount and the
present value of estimated cash flows under the financial
asset's original effective interest rate.
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 Impairment—recognition and
reversal
• Assets that are individually assessed and for which no
impairment exists should be grouped with financial assets
with similar credit risk statistics and collectively assessed for
impairment.
• If, in a subsequent period, the amount of the impairment loss
related to a financial asset carried at amortized cost or a debt
instrument carried as available-for-sale decreases due to an
event occurring after the impairment was originally
recognized, the previously recognized impairment loss is
reversed through profit or loss.
• Impairments related to investments in available-for-sale
equity instruments are not reversed through profit or loss.
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 Hedging accounting
• Hedging accounting is IASB’s third stage of
replacing IAS 39 with IFRS 9.
• IAS 39 is unable to adequately reflect the risks an
entity faces, what management is doing to manage
those risks, and how effective those risk management
strategies are.
• In December 2010, the IASB publishes exposure
draft to propose significant changes to the general
hedge accounting requirements in IAS 39 in order to
provide more useful hedge accounting information.
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 Hedge Accounting
• Hedge accounting will address the following issue:
(a) what financial instruments qualify for designation as
hedging instruments;
(b) what items qualify for designation as hedged items;
(c) an objective-based hedge effectiveness assessment;
(d) how an entity should account for a hedging
relationship--fair value hedge, cash flow hedge or a
hedge of a net investment in a foreign operation;
(e) hedge accounting presentation and disclosures. It also
proposes application guidance for the proposed hedge
accounting model.
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 Accounting for fair value hedges
• The gain or loss on the hedging instrument
and the hedged item should be recognized in
other comprehensive income (OCI).
• The ineffective portion of the gain or loss
shall be transferred to profit or loss (PL). In
addition, the gain or loss on the hedged item
shall be presented as a separate line item in
the statement of financial position.
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 Linked presentation
• Linked presentation is a way to present
information together in the statement of
financial position to show how a particular
asset and liability is related.
• Linked presentation is not the same as
offsetting. This is because linked
presentation displays the gross amounts
together in the statement of financial
position.
13-135
 Discontinuation of Hedge Accounting
An entity should discontinue hedge accounting
prospectively only when the hedging
relationship (or a part of a hedging relationship)
ceases to meet the qualifying criteria.
– This includes when the hedging instrument
expires or is sold, terminated or exercised.
– This may affect the entire hedging relationship or
a part of it.

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