Theories of Accounts IACT1 (Financial Assets)
CHAPTER 24 FINANCIAL ASSETS AT FAIR VALUE
What are the classifications of financial assets?
Under PFRS 9, paragraph 4.1.1, financial assets are classified into two only, namely:
1. Financial assets at fair value
2. Financial assets at amortized cost
Financial assets at fair value include both equity securities and debt securities.
Financial assets at amortized cost include only debt securities.
Under PAS 39, financial assets are classified as follows:
1. Trading securities - whether debt and equity securities
2. Available for sale securities whether debt and equity securities
3. Held to maturity securities - debt securities only
4. Loans and receivables
The usual categories of financial assets under PAS 39, such. as available for sale, held to maturity,
and loans and receivables are now eliminated under PFRS 9.
PFRS 9 is intended to eventually supersede PAS 39 in its entirety.
At this stage, only the provisions on financial assets and financial liabilities are amended.
What is an equity security?
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The term "equity security" encompasses any instrument representing ownership shares and
right, warrants or options to acquire or dispose of ownership shares at a fixed or
determinable price.
In simple language, equity securities represent an ownership interest in an entity.
Ownership shares include ordinary, preference and other share capital.
Equity securities do not include redeemable preference shares, treasury shares and
convertible debt.
What is a debt security?
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A debt security is any security that represents a creditor relationship with an entity.
Examples of debt securities include corporate bonds, BSP treasury bills, government
securities, commercial papers, and preference shares with mandatory redemption date or
are redeemable at the option of the holder.
What financial assets are measured at "fair value through profit or loss"?
In accordance with PFRS 9, the following financial assets shall be measured at "fair value
through profit or loss":
1. Financial assets held for trading or popularly known as "trading securities".
These financial assets are measured at fair value through profit or loss "by requirement,"
meaning, required by the standard.
2. Financial assets that are irrevocably designated on initial recognition as at fair value
through profit or loss.
These financial assets are measured at fair value through profit or loss "by designation".
For example, investments in bonds and other debt. instruments can be designated as at fair
value through. profit or loss even if the financial assets satisfy the amortized cost
measurement.
This designation is in accordance with Paragraph 4.1.5 of PFRS 9.
3. All other investments in quoted equity instruments.
These financial assets are measured at fair value through profit or loss "by consequence" in
accordance with Application Guidance B5.4.14 of PFRS 9.
Define "financial asset held for trading".
Appendix A of PFRS 9 provides that a financial asset is held for trading when:
a. It is acquired principally for the purpose of selling or repurchasing it in the near term.
b. 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.
c. It is a derivative, except for a derivative that is a financial guarantee contract or a designated
and an effective hedging instrument.
 Stated differently, trading securities are debt and equity. securities that are purchased with
the intent of selling them in the "near term or very soon.
 These securities are generally purchased and sold in the exchange market to generate shortterm gains or profits. Trading securities are classified as current assets.
Explain the "initial measurement" of financial assets.
PFRS 9, paragraph 5.1.1 provides that when a financial asset is recognized initially, an entity shall
measure it at fair value plus transaction costs that are directly attributable to the acquisition.
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The fair value of a financial asset is usually the transaction price, meaning, the fair value of
the consideration given.
However, if the financial asset is held for trading or if the financial asset is measured at fair
value through profit or loss, transaction costs are treated as outright expense.
Transaction costs include fees and commissions paid to agents, advisers, brokers and
dealers, levies by regulatory agencies and securities exchanges, and transfer taxes and
duties.
Transaction costs do not include debt premiums or discounts, financing costs and internal
administrative or holding costs.
Explain the "subsequent measurement" of financial assets.
PFRS 9, paragraph 5.2.1, provides that after initial recognition, an entity shall measure a financial
asset either at fair valué or amortized cost.
An entity shall classify financial assets as subsequently measured at fair value or amortized cost
depending on the entity's business model for managing financial assets.
The business model for managing financial assets may be:
a. To hold investments in order to trade to realize fair value changes.
b. To hold investments in order to collect contractual cash flows.
Under the Application Guidance of PFRS 9, paragraph B4.1.1, the entity's business model is
determined by key management personnel.
Explain the measurement of financial asset 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:
a. The business model is to hold the financial asset in order to collect contractual cash flows on
specified dates.
b. The contractual cash flows are solely payments of principal and interest on the principal amount
outstanding.
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In other words, the business model is to collect contractual cash flows if the contractual
cash flows are solely payments of principal and interest. In such a case, the financial assets
shall be measured at amortized cost.
Explain the measurement of financial assets at fair value.
PFRS 9, paragraph 4.4, provides that by residual definition or by default, financial assets that do not
meet the conditions for amortized cost measurement shall be measured at fair value.
In other words, if the entity's business model is not to collect contractual cash flows or if the
contractual cash flows are not solely payments of principal and interest, the financial asset must be
measured at fair value.
PFRS 9, paragraph 4.1.5, further provides however, that at initial recognition, an entity may
irrevocably designate a financial asset as measured at fair through profit or loss even if the financial
asset satisfies the measurement at amortized cost.
Explain the measurement of financial asset "at fair value through other comprehensive income".
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At initial recognition, PFRS 9, paragraph 3.7.5, provides that an entity may make an
irrevocable election to present in other comprehensive income subsequent changes in fair
value of an investment in equity instrument that is not held for trading.
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In other words, if the investment in equity instrument is "held for trading, the election to
present unrealized gains and losses in other comprehensive income is not allowed.
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If the investment in equity instrument is held for trading, subsequent changes in fair value
are always included in profit or loss.
Explain the measurement of investment in unquoted equity instrument.
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Under the Application Guidance B5.4.14 of PFRS 9, all investments in equity instruments and
contracts on those instruments must be measured at fair value.
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However, in limited circumstances, cost may be an appropriate estimate of fair value.
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This may be the case if available recent information is insufficient to determine fair value or if
there is a wide range of possible fair value measurements, cost represents the best estimate of
fair value within that range.
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Simply stated, investments in unquoted equity instruments are measured at cost
What is "fair value"?
Fair value is the amount for which an asset could be exchanged, or a liability settled, between
knowledgeable and willing parties in an arm's length transaction.
Simply stated, fair value is defined as the price agreed upon by a willing buyer and a willing seller in an
arm's length transaction.
Most often, the fair value of securities is the quoted price in the securities market, for example, the
Philippine Stock Exchange
Thus, the fair value is synonymous with market value of the securities in the stock market
Explain the treatment of unrealized gains and losses on trading securities.
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Unrealized gains and losses on trading securities are included in profit or loss of the current
period. In other words, such unrealized gains and losses are shown in the income statement.
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Unrealized gains and losses arise from investments that are measured at fair value.
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If the fair value is higher than the carrying amount of securities, the difference is an unrealized
gain.
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If the fair value is lower than the carrying amount of the securities, the difference is an
unrealized loss.
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Gains and losses that result from actually selling the securities are known as realized gains and
losses.
Explain the determination of gain or loss on the derecognition of a financial asset.
PFRS 9, paragraph 3.2. 12, provides that on derecognition of a financial asset, "the difference between
the carrying amount and the consideration received, including any new asset obtained less any new
liability assumed, shall be recognized in profit or loss".
In other words, on disposal of a financial asset, the difference between the consideration received and
the carrying amount is recognized as gain or loss on disposal to be reported in the income statement.
Explain fully "reclassification" of financial assets.
PFRS 9, paragraph 4.4.1, provides that an entity shall reclassify financial assets only when it changes its
business model for managing the financial assets.
Where reclassification occurs, Paragraph 5.6.1 provides that an entity shall apply the reclassification
prospectively from the reclassification date.
The entity shall not restate any previously recognized gains, losses and interest.
As defined in 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.
This means that if the change in business model is in 2012, the reclassification date is January 1, 2013,
the first day of the next reporting period.
However, the entity must disclose the change in business model in the 2012 financial statements
because the change in the entity's business model is a significant and demonstrable event.
The Application Guidance B4.4.1 of IFRS 9 makes it clear that changes in an entity's business model in
managing its financial assets are expected to be infrequent.
Explain the reclassification of financial asset "from fair value to amortized cost".
PFRS 9, paragraph 5.6.3, provides that when an entity reclassifies a financial asset at fair value to
financial asset at amortized cost, the fair value at the reclassification date becomes the new carrying
amount of the financial asset at amortized cost.
The difference between the new carrying amount of the financial asset at amortized cost and the face
value of the financial asset shall be amortized through profit or loss over the remaining life of the
financial asset using the effective interest method.
Explain reclassification of financial asset "from amortized cost to fair value".
PFRS 9, paragraph 5.6.2, provides that when an entity reclassifies a financial asset at amortized cost to
financial asset at fair value, the fair value is determined at reclassification date.
The difference between the previous carrying amount and fair value is recognized in profit or loss.
Explain impairment of financial assets at fair value.
For financial assets measured at fair value, all gains and losses are either presented in profit or loss or in
other comprehensive income depending on whether the election to present gains and losses on equity
investments in other comprehensive income is taken or not.
Therefore, it is not necessary to assess Financial assets measured at fair value for impairment.
Explain impairment of financial assets at amortized cost.
Under PFRS 9, there is now only one impairment method for financial assets measured at amortized
cost.
PFRS 9, paragraph 5.2.2, provides that an entity shall apply the impairment requirements of paragraphs
58-65 and AG84-AG93 of PAS 39 to financial assets measured at amortized cost.
Paragraph 58 of PAS 39 provides that an entity shall assess at the end of each reporting period whether
there is any objective evidence that a financial asset or group of financial assets measured at amortized
cost is impaired.
Paragraph 63 of PAS 39 further provides that if there is objective evidence that an impairment loss on
financial assets measured at amortized cost has been incurred, the amount of the loss is measured as
the difference between the carrying amount and the present value of estimated future cash flows
discounted at the original effective interest rate.
The carrying amount of the asset shall be reduced either directly or through the use of an allowance
account. The amount of the loss shall be recognized in profit or loss.
What do you understand by the "tainting period"
Under paragraph 9 of PAS 39, if an entity sells or reclassifies more than an insignificant out of financial
asset at amortized cost, such sales or reclassifications normally will disqualify the entity from using the
"amortized cost" classification during the current year and the next two years.
This is understandable because sales of Financial asset at amortized cost call into question or "taint" the
entity's intention with respect to holding such investments.
Is "tainting" allowed under PFRS 9?
The IASB concluded that classification based on the entity's business model for managing financial assets
provides a clear rationale for measurement and therefore rejected totally the tainting provision in PAS
39.
The IASB stated further that the tainting provision would increase complexity of application of the
requirements of PFRS 9.
The Application Guidance of PFRS 9, paragraph B4.1.3, provides that although the business model may
be to hold financial assets in order to collect contractual cash flows, the entity need not hold all of those
instruments until maturity.
Thus, an entity's business model can be to hold financial assets to collect contractual cash flows, even if
sales of financial assets occur.
However, under the "Amendments to other PFRS and Guidance" of PFRS 9, PAS 1 was amended to
require an entity to present as a separate line item in the income statement all gains and losses from the
derecognition.
QUESTION 24-22 Multiple choice (PFRS 9)
1. Under PFRS 9, which of the following is not a category of financial assets?
a. Financial assets at fair value through profit or loss
b. Financial assets at fair value through other comprehensive income
c. Financial assets at amortized cost
d. Financial assets held for sale
2. All of the following financial assets shall be measured at fair value through profit or loss, except
a. Financial assets held for trading
b. Financial assets designated on initial recognition as at fair value through profit or loss
c. Investments in quoted equity instruments
d. Financial assets at amortized cost
3. A financial asset is held for trading if (choose the incorrect one)
a. It is acquired principally for the purpose of selling or repurchasing it in the near term.
b. On initial recognition, it is part of a portfolio of financial assets that are managed together and for
which there is evidence of a recent actual pattern of short-term profit taking.
c. It is a derivative that is not designated as an effective hedging instrument.
d. It is a derivative that is designated as an effective hedging instrument.
4. Transaction costs include
a. Fees and commission paid to agent, levies by regulatory authorities, transfer taxes and duties
b. Debt premiums or discounts
e. Financing costs
d. Internal administrative costs
5. Transaction costs that are directly attributable to the acquisition of a financial asset shall be
a. Capitalized as cost of the financial asset
b. Expensed when incurred
c. Charged to retained earnings
d. Included as a component of other comprehensive income 6. If the financial asset is held for trading or
if the financial asset is measured at fair value through profit or loss,
6. transaction costs directly attributable to the acquisition shall be
a. Capitalized as cost of the financial asset.
b. Expensed immediately when incurred
c. Deferred and amortized over a reasonable period
d. Included as component of other comprehensive income
7. Depending on the business model for managing financial assets, an entity shall classify financial
assets subsequent to initial recognition at
a. Fair value
b. Amortized cost
c. Either fair value or amortized cost
d. Neither fair value nor amortized cost
8. Under PFRS 9, a financial asset shall be measured subsequently at amortized cost when
I. The business model of the entity is to hold the financial asset in order to collect contractual cash flows
on specified dates.
II. The contractual cash flows are solely payments of principal and interest on the principal amount
outstanding.
a. I only
b. II only
c. Either I or II
d. Both I and II
9. Which statement is true concerning subsequent measurement of financial asset at fair value?
I. The financial asset shall be measured at fair value if the business model is not to collect contractual
cash flows on specified dates and the contractual cash flows are not solely payments of principal and
interest.
II. An entity may irrevocably designate a financial asset as measured at fair value through profit or loss
even if the financial asset satisfies the amortized cost measurement.
a. I only
b. II only
c. Both I and II
d. Neither I nor II
10. Which statement is true concerning recognition of unrealized gains and losses on financial assets?
I. Unrealized gains and losses on financial assets held for trading shall be included in profit or loss.
II. Unrealized gains and losses on financial assets measured at amortized cost shall be included as
component of other comprehensive income.
a. I only
b. II only
c. Both I and II
d. Neither I nor II
QUESTION 24-23 Multiple choice (PAS 39)
1. All of the following are characteristics of financial assets classified as held to maturity, except
a. They have fixed or determinable payments and a fixed maturity.
b. The holder can recover substantially all of its investment unless there has been credit deterioration.
c. They are quoted in an active market.
d. The holder has demonstrated a positive intention and ability to hold them to maturity.
2. Investments in equity instruments that do not have a quoted price in an active market and whose
fair value cannot be reliably determined are subsequently measured at
a. Cost
b. Amortized cost using the straight line method
c. Amortized cost using the effective interest method
d. Fair value
3. If as a result of a change in intention or ability, it is no longer appropriate to classify an investment
as held to maturity, it shall be reclassified as
a. Available for sale and remeasured at fair value and the difference between fair value and carrying
amount shall be accounted for as component of other comprehensive income.
b. Available for sale and remeasured at fair value and the difference between fair value and carrying
amount shall be accounted for as component of profit or loss.
c. Trading and remeasured at fair value and the difference between fair value and carrying amount shall
be included in profit or loss.
d. Nonmarketable investment and its carrying amount is the initial cost.
4. An entity acquired equity shares representing a small percentage of the issued ordinary shares of
another entity. The investee's shares are listed on a stock exchange. Which of the following categories
could this investment. in equity shares be classified?
a. Held to maturity
b. Available for sale
c. At fair value through profit or loss
d. Either as available for sale or at fair value through profit or loss
5. An entity acquired government bonds redeemable at the quoted market price. The entity has no
current intention to sell the bonds and has a policy to hold them as investments unless certain
corporate criteria are met and the bonds are sold to maintain liquidity. Which of the following is the
most appropriate classification for this investment in government bonds?
a. Held for trading
b. At fair value through profit or loss
c. Held to maturity
d. Available for sale
QUESTION 24-25 Multiple choice (AICPA Adapted)
1. Fair value of an asset should be based upon
a. The replacement cost of an asset.
b. The price that would be received to sell the asset at the measurement date.
c. The original cost of the asset plus an adjustment for obsolescence.
d. The price that would be paid to acquire the asset.
2. Which of the following describes a principal market for establishing fair value of an asset?
a. The market that has the greatest volume and level of activity for the asset.
b. Any broker or dealer market that buys or sells the asset.
c. The most observable market in which the price of the asset is minimized.
d. The market in which the amount received would be maximized.
3. Which of the following is true for measuring an asset at fair value?
a. The price of the asset should be adjusted for transaction cost.
b. The fair value of the asset should be adjusted for cost to sell.
c. The fair value is based upon an entry price to purchase the asset.
d. The price should be adjusted for transportation cost to transport the asset to its principal market.
4. Which of the following would meet the qualifications as market participants?
a. A liquidation market in which sellers are compelled to sell.
b. A subsidiary of the reporting unit interested in purchasing assets similar to those being valued.
c. An independent entity that is knowledgeable about the asset.
d. A broker or dealer that wishes to establish new market for the asset.
5. Which of the following is an assumption used in fair value measurement?
a. The asset must be in-use.
b. The asset must be considered in-exchange.
c. The most conservative estimate must be used.
d. The asset is in its highest and best use.
6. The fair value at initial recognition is
a. The price paid to acquire the asset.
b. The price paid to acquire the asset less transaction cost.
c. The price paid to transfer or sell the asset.
d. The carrying amount of the asset acquired.
7. Which of the following is not a valuation technique used in fair value measurement?
a. Income approach
b. Residual value approach
c. Market approach
d. Cost approach
8. Valuation techniques for fair value that include the Black-Scholes formula, a binomial model, or
discounted. cash flow are examples of which valuation technique?
a. Income approach
b. Market approach
c. Cost approach
d. Exit value approach
9. The market approach for measuring fair value requires which of the following?
a. Present value of future cash flows.
b. Prices and other relevant information of transactions from identical or comparable assets.
c. The price to replace the service capacity of the asset.
d. The weighted average of the present value of future
cash flows.
10. Which of the following are observable inputs used for fair value measurement?
I. Bank prime rate
II. Default rates on loans
III. Financial forecast
a. I only
b. I and II only
c. I and III only
d. I, II and III
ANSWER 24-25( QUESTION UP)
1. b
Fair value is the price that would be received to sell an asaet in an orderly transaction between market
participants at the measurement date. In other words, fair value is the "exit price".
2. a
The principal market is the market in which the entity would sell the asset with the greatest volume and
level of activity for the asset.
3. d
If location is an attribute of the asset, the price in the principal market should be adjusted for cost to
transport the asset to its principal market. The price of an asset is not adjusted for transaction cost, such
as selling cost.
4. C
Market participants are buyers and sellers in the principal market. Market participants should be
independent, knowledgeable, able and willing to transact, meaning motivated but not compelled to do
so.
5. d
A fair value measurement assumes the highest and best use of the asset that is physically possible,
legally permissible and financially feasible.
6. a
The fair value at initial recognition is the "entry price" or the price paid to acquire the asset.
7. b
The three valuation techniques for fair value. measurement are market approach, income approach and
cost approach. There is no technique called residual approach.
8. a
The income approach uses valuation technique to convert future amounts to single "present value
amount".
Black-Scholes formula, binomial model and other discounted cash flow models are examples of income
approach.
9. b
The market approach uses prices and other relevant information generated by market transactions
involving identical or comparable assets.
The present value of cash flows is an application of the income approach. The price to replace the
service capacity of an asset is a cost approach.
The weighted average of the present value of cash flows is not a valuation technique.
10. b
The bank prime rate and the default rates are both "observable" inputs. The financial forecast is
developed by the entity and therefore "unobservable".
CHAPTER 25 INVESTMENT IN EQUITY SECURITIES
When are dividends considered earned?
In this connection, three dates are important in accounting for dividends, namely.
1. Date of declaration is the date on which the payment of dividends is approved by the board of
directors.
2. Date of record is the date on which the stock and transfer book is closed for registration. Only those
shareholders registered as of this date are entitled to receive dividends.
3. Date of payment is the date on which the dividends declared shall be paid.
PAS 18, paragraph 29, provides that "dividends shall be recognized as revenue when the shareholder's
right to receive payment is established".
Accordingly, the dividends shall be recognized as revenue on the date of declaration.
Describe and discuss the accounting treatment of the following:
1. Cash dividends, as the title suggests, are in the form of cash. As a rule, such dividends are
treated as income but if the equity method is used, the same should be credited to the
investment account.
2. Property dividends or dividends in kind are dividends in the form of property or assets other
than cash.
 The property may be in the form of another entity's share, inventory, equipment
and other noncash asset.
 Property dividends are normally treated as income at the fair value of the property
received.
3. Liquidating dividends represent return of investment and therefore are not income.
4. Stock dividends are in the form of the issuing entity's earn shares. The IAS term for stock
dividend is "bonus issue".
 Stock dividends may be the same as those held or different from those held. Stock
dividends are not income.
 Stock dividends of the same kind are recorded only by means of a memorandum
entry on the part of the investor.
 Such stock dividends do not affect the total cost of the investment but reduce the
cost of the investment per share.
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Discuss the accounting treatment of stock dividends which are different from those held.
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As stated earlier, stock dividends are not income whether they are the same or different kind.
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When the stock dividends are of different kind, the procedure is to allocate the cost of the
original investment between the original shares and the "different" stock dividends on the basis
of fair value.
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For example, if the original investment is ordinary share and the investor receives preference
share as stock dividend, the stock dividend is recorded by debiting investment in preference
share and crediting investment in ordinary share for the amount allocated to the stock dividend.
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Accordingly, the stock dividends of different kind reduce the total cost of the original investment
because a new investment account is set up for the stock dividends received.
Discuss the accounting treatment for shares received in lieu of cash dividends.
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When cash dividends are declared and received, it is without a doubt that they are income.
A problem will arise when shares are received in lieu of cash dividends declared.
It is generally accepted that shares received in lieu of cash dividends are income at the fair value
of the shares received.
In the absence of the fair value of the shares received, the income is equal to the cash dividends
that would have been received.
Shares received in lieu of cash dividends are recorded by debiting investment in shares and
crediting dividend income.
Discuss the accounting treatment for cash received in lieu of stock dividends.
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When stock dividends are declared and received, unquestionably they are not income.
A problem will arise when cash is received in lieu of stock dividends.
In this case, the "as if" approach is followed. This means that the stock dividends are assumed to
be received and subsequently sold at the cash received. Therefore, gain or loss may be
recognized.
Discuss share split and its accounting treatment.
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Share split may be split up or split down.
A share split up is 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.
A share split down is a transaction whereby the outstanding shares are called in and replaced by
a smaller number, accompanied by an increase in the par or stated value.
Share split does not affect the total cost of investment. But there is a decrease or an increase in
the cost per share because the total cost now will apply to a larger or smaller number of shares.
Only a memorandum entry is made to record the receipt of new shares by virtue of share split.
What is a stock right?
A stock right or preemptive right 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".
A stock right is inherent in every share. A shareholder receives one right for one share owned.
A stock right is valuable to an investor because the price at which the new shares are sold is generally
below the prevailing market price.
The purpose of the stock right is to enable the shareholders to preserve their equity or proportionate
interest in the corporation.
The ownership of stock right is evidenced by an instrument or a certificate known as share warrant.
Explain the procedure when stock rights are accounted for separately?
PAS 39 and PFRS 9 do not address this accounting issue categorically. But unquestionably, a stock right is
a form of a financial asset.
In this regard, there is a divergence of opinion among academicians and theoreticians. There are two
schools of thought on the matter, namely:
1. Stock rights are accounted for separately. 2. Stock rights are not accounted for separately.
Under PFRS 9, a financial asset is recognized initially at fair value plus transaction costs directly
attributable to the acquisition of the financial asset.
Accordingly, stock rights as a form of financial assets are measured initially at fair value.
In other words, a portion of the carrying amount of the original investment in equity securities is
allocated to the stock rights at an amount equal to the fair value of the stock rights at the time of
acquisition.
The reason for such an allocation is that stock rights are independent of the original shares from which
they are derived.
When stock rights are issued, the investor is now the owner of two financial assets, namely the original
shares and the related stock rights.
Stock rights are normally classified as current assets if the rights are accounted for separately.
Explain why stock rights are not accounted for separately.
Stock rights may be recognized as embedded derivative but not a "stand-alone" derivative. PAS 39,
paragraph 10, defines an embedded derivative as a "component of a hybrid or combined contract (host
contract) with the effect that some of the cash flows of the combined contract vary in a way. similar to a
stand-alone instrument".
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, PFRS 9, paragraph 4.3.3, further provides that 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.
This simply means that if the host contract is a financial asset, the embedded derivative is not separated.
Moreover, under PFRS 9, paragraph 4.3.3, if the host contract is measured at fair value through profit or
loss, the embedded derivative is not separated.
Accordingly, the stock right as an embedded derivative is not accounted for separately because the host
contract "investment in equity instrument" is a financial asset measured at fair value through profit or
loss.
Which approach is followed in accounting for stock rights?
Admittedly, this subject matter is not a well-settled issue.
In fact, PFRS 9, paragraph 4.3.4, states that "this standard. does not address whether an embedded
derivative shall be presented separately in the statement of financial position".
The authors strongly believe that the approach "not accounted for separately" stands on solid and
authoritative ground.
However, stay tuned and let us wait and see what the Financial Reporting Standards Council will say on
this accounting issue.
What is the meaning of "theoretical" or "parity" value of stock right? How is it computed?
The theoretical or parity value is the assumed fair value of the stock right that is derived from the
market value of the share.
QUESTION 25-12 Multiple choice (ACP)
1. It is the date on which the stock and transfer book of the entity is closed for registration. Only those
shareholders. registered as of this date are entitled to receive dividends.
a. Date of declaration
b. Date of record
c. Date of payment
d. Date of mailing the dividend check
2. At which of the following dates has the shareholder. theoretically realized income from dividend?
a. The date the dividend is declared
b. The date of record
c. The date the dividend check is mailed by the entity.
d. The date the dividend check is received by the shareholder.
3. Property dividends are recorded
a. As dividend income at carrying amount of the property
b. As dividend income at fair value of the property
c. As return of investment and therefore credited to investment account
d. By means of memorandum only
4. Liquidating dividends are credited to
a. Income
b. Retained earnings
c. Investment account
d. Share capital
5. What is the effect of stock dividend of the same class?
a. Increase in investment account and increase in cost per share
b. Decrease in investment account and decrease in cost per share
c. No effect on investment account but decrease in cost per share
d. No effect on investment account but increase in cost per share
6. When stock dividends of different class are received
a. No formal entry is made but only a memorandum
b. Cash is debited, and dividend income is credited
c. A new investment account is debited and dividend income is credited
d. A new investment account is debited and the original investment account is credited
7. Shares received in lieu of cash dividend are recorded as
a. Income at fair value of the shares received
b. Income at par value of the shares received
c. Income at the cash dividend that would have been received
d. Stock dividends
8. Cash received in lieu of stock dividends is accounted for
a. Dividend income
b. Return of investment
c. Partly dividend income and partly return of investment
d. If the stock dividends are received and subsequently sold at the cash received and gain or loss is
recognized
9. What is the effect of share split up?
a. Increase in number of shares and increase in cost per share
b. Decrease in number of shares and decrease in cost per share
c. Increase in number of shares and decrease in cost per share
d. Decrease in number of shares and increase in cost per share
10. An investor owns 10% of the ordinary shares of an investee throughout the year. The investee has
no preference shares outstanding. The investor's interest gives the right to
a. Be paid 10% of the investee's profits in cash each year.
b. Receive dividend equal to 10% of the par value each year.
c. Receive dividends equal to 10% of the total dividend paid by the investee for the year to shareholders.
d. Keep investee from issuing any additional shares unless the investor is willing to buy 10% of the newly
issued shares.
CHAPTER 26 INVESTMENT IN ASSOCIATE
Define significant influence, control, associate and subsidiary.
Significance influence is the power to participate in the financial and operating policy decisions of the
investee but not control or joint control over those policies.
Control is the power to govern the financial and operating policies of an entity so as to obtain benefits
from its activities.
Associate is an entity, including an unincorporated entity such as a partnership, over which the investor
has significant influence and that is neither a subsidiary nor an interest in a joint venture.
The amended PAS 28, paragraph 3, simply defines an associate as "an entity over which the investor
has significant influence"
Subsidiary is an entity including an unincorporated entity such as a partnership that is controlled by
another entity known as the parent.
Appendix A of PFRS 10 on consolidated financial statements simply defines a subsidiary as "an entity
that is controlled by another entity".
When does an investor have significant influence?
The assessment of significant influence is a matter of judgment. However, PAS 28, paragraph 5, provides
a practical
guidance to assist management in making such assessment.
If the investor holds, directly or indirectly through subsidiaries, 20% or more of the voting power of the
investee, it is presumed that the investor has significant influence, unless it can be clearly demonstrated
that this is not the case.
Conversely, if the investor holds, directly or indirectly through subsidiaries, less than 20% of the voting
power of the investee, it is presumed that the investor does not have significant influence, unless such
influence can be clearly demonstrated.
A substantial or majority ownership by another investor does not necessarily preclude an investor from
having significant influence.
PAS 28, paragraph 6, provides that the existence of significant influence by an investor is usually
evidenced in one or more of the following ways:
a. Representation in the board of directors
b. Participation in policy making process
c. Material transactions between the investor and the investee
d. Interchange of managerial personnel
e. Provision of essential technical information
Explain the treatment of potential voting rights in relation to having significant influence.
An entity may own share warrants, debt or equity instruments that are convertible into common shares
that have the potential, if exercised or converted, to give the entity. additional voting power.
PAS 28, paragraph 7, provides that the existence of such potential voting rights is considered in
assessing whether an entity has significant influence.
However, when potential voting rights exist, the investor's share of profit or loss of the investee and of
changes in the investee's equity is determined on the basis of "present ownership interest" and does not
reflect the possible exercise or conversion of potential voting rights.
When does an investor lose significant influence?
An entity loses significant influence over an investee when it loses the power to participate in the
financial and operating policy decisions of the investee.
The loss of significant influence can occur with or without change in the absolute or relative ownership
interest.
For example, the loss of significant influence could occur when an associate becomes subject to control
of a government, court, administrator or regulator.
The loss of significant influence could also occur as a result. of a contractual agreement.
Explain the equity method of accounting.
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The equity method is based on the economic relationship between the investor and the investee
The investor and the investee are viewed as a single economic
The equity method is applicable when the investor has a significance influence over the
investee.
Under the equity method, the investment is initially recorded at cost but it is subsequently increased by
the net income of the investee and decreased by the net loss and dividend payments of the investee
Note that the investment must be in ordinary shares. If the investment is in preferrence shares, the
equity method is not appropriate regardless of the percentage because the preference share is a
nonvoting equity.
The investment in preference shares may be accounted for as at fair value through profit or loss or at
fair value through other comprehensive income or nonmarketable investment.
Technically, if the investor has significant influence but not control over the investee, the investee is said
to be an associate or associated company.
The investment in associate accounted for using the equity method shall be classified as noncurrent
asset.
Accordingly, under the equity method, the investment in ordinary shares shall be appropriately
described as investment in associate.
If the investor has control over the investee, the investor is known as the parent and the investee is
known as the subsidiary.
In this case, the investment in ordinary shares is described as investment in subsidiary.
What do you understand by the "excess of cost over carrying amount" of interest acquired?
If the cost of an investment exceeds the carrying amount of the underlying net assets acquired, the
difference is termed as "excess of cost over carrying amount".
The excess of cost over carrying amount may be due to the following:
a. Goodwill
b. Undervaluation of the investee's depreciable assets
In practice, it is often difficult to determine which specific identifiable assets are undervalued.
If the assets of the investee are fairly valued, accountants frequently attribute the excess of cost over
carrying amount of the underlying net assets to goodwill.
If the excess is attributable to undervaluation of depreciable assets, it is amortized over the remaining
life of the depreciable assets.
The amortization of the excess of cost over carrying amount is recorded by debiting investment income
and crediting the investment account.
If the excess is attributable to goodwill, it is not amortized but the entire investment in associate is
tested for impairment at each reporting date.
What do you understand by "excess of net fair value over cost"?
If the investor pays less than the net fair value of underlying net assets acquired, the difference is known
as "excess of net fair value over cost".
As amended, PAS 28, paragraph 32, provides that the excess of the investor's share of the net fair value
of the associate's identifiable assets and liabilities over the cost of the investment is included as income
in the determination of the investor's share of the associate's profit or loss in the period in which the
investment is acquired.
Discuss the accounting procedure where the investment is accounted for by the equity method and
the investee is with "heavy losses".
Under the equity method, the amended PAS 28, paragraph 38, provides that if an investor's share of
losses of an associate equals or exceeds the carrying amount of an investment, the investor discontinues
recognizing its share of further losses.
The investment is reported at nil or zero value.
The carrying amount of the investment in associate is not just the balance of the account "investment in
associate",
The carrying amount of the investment in associate also includes other long-term interests in an
associate, such as long-term receivables, loans and advances.
However, trade receivables and any long-term receivables for which adequate collateral exists, such as
secured loans, are excluded from the carrying amount of an investment in associate.
Additional losses are provided for or a liability is recognized to the extent that the investor has incurred
legal or constructive obligations or made payments on behalf of the associate.
If the associate subsequently reports income, the investor resumes including its share of such income
after its share of the income equals the share of losses not recognized.
Explain the impairment of an investment in associate.
If there is an indication that an investment in associate may be impaired, PAS 28, paragraph 40 in
conjunction with PAS 36 on "impairment of assets" requires that an impairment loss shall be recognized
"whenever the carrying amount of the investment in associate exceeds its recoverable amount".
The recoverable amount is measured as the higher between fair value less cost to sell and value in use.
Fair value less cost to sell is the amount obtainable from the sale of the asset in an arm's length
transaction between knowledgeable willing parties less disposal cost.
Value in use is the present value of the estimated future cash flows expected to arise from the
continuing use of an asset and from its ultimate disposal.
The value in use of an investment in associate is the investor's share in either of the following:
a. Present value of estimated future cash flows expected to be generated by the investee,
including cash flows from operations of the investee and the proceeds from the ultimate
disposal of the investment.
b. Present value of the estimated future cash flows expected to arise from dividends to be received
from the investment and from its ultimate disposal.
Under appropriate assumptions, both methods give the same result.
Any resulting impairment loss for the investment is allocated first to any remaining goodwill
Explain the treatment when the investee has an outstanding preference shares.
a. When an associate has outstanding cumulative preference shares, the investor shall compute its
share of earnings or losses after deducting the preference dividends, whether or not such dividends are
declared.
b. When an associate has outstanding noncumulative preference shares, the investor shall compute its
share of earnings after deducting the preference dividends only when declared.
Explain the treatment of "other changes in the equity of the invested" that have not been recognized
in profit or loss.
ANSWER 26-11
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Adjustments to the carrying amount of the investment in associate may be necessary for
changes in the investor's proportionate interest in the investee arising from changes mi
investee's equity that have not been recognized in the investors profit or loss.
Such changes include those arising from revaluation of property, plant and equipment and from
foreign exchange translation differences.
The investor's share of those changes is recognized directly in equity of the investor.
What are some adjustments in the investee's operations before an investor computes its share in the
investee's profits or losses?
1. The most recent available financial statements of the associate are used by the investor in applying
the equity method.
 When the reporting dates of the investor and the investee are different, the associate shall
prepare for the use of the investor financial statements as of the same date as the financial
statements of the investor unless it is impracticable to do so.
 In any case, the difference between the reporting date of the associate and that of the investor
shall be no more than three months.
2. If an associate uses accounting policies other than those of the investor, adjustments shall be made
to conform the associate's accounting policies to those of the investor.
3. Profits and losses resulting from upstream and downstream transactions between an investor and
an associate are recognized in the investor's financial statements only to the extent of the
unrelated investors' interest in the associate.
 "Upstream" transactions are sales of assets from an associate to the investor.
 "Downstream" transactions are sales from the investor to the associate.
 The investor's share in the associate's profits and losses resulting from these transactions is
eliminated.
In other words, the unrealized profit and loss from upstream and downstream transactions must be
eliminated in determining the Investor’s shares in the profit or loss of the associate
When shall an investor discontinue the use of the equity method?
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PAS 28 as amended, paragraph 22, provides that an investor shall discontinue the use of the
equity method from the date that it ceases to have significant influence over an associate
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Consequently, the investor shall account for the investment as financial asset at fair through
profit or loss, or financial assets at fair value through other comprehensive income or
nonmarketable investment.
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However, PAS 28 does not permit an investor that continues to have significant influence over
an associate not to apply equity method even if the associate is operating under severe longterm restrictions that significantly impair its ability to transfer funds to the investor
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Significant influence must be lost before the equity method ceases to be applicable.
What is the measurement of the investment in associate on the date significant influence is lost?
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PAS 28 as amended, paragraph 22, provides that on the date the significant influence is lost, the
investor shall measure any retained investment in associate at fair value.
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The difference between the carrying amount of the investment at the date the significant
influence is lost, and the fair value of the retained investment plus any proceeds received from
disposal of any part interest in the associate, shall be included in profit or loss.
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Paragraph 22 further provides that the fair value of the investment at the date it ceases to be an
associate shall be regarded as its fair value on initial recognition as a financial asset.
What is the treatment of "other comprehensive income" of an associate when the investor loses
significant influence over the associate?
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PAS 28, paragraph 22, provides that if an investor loses significant influence, the investor shall
account for all amounts recognized in other comprehensive income by the associate on the
same basis as would be required if the associate had directly disposed of the related assets.
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In other words, if the gain or loss previously recognized in other comprehensive income by the
associate would be reclassified to profit or loss upon disposal of the related assets, the investor
shall reclassify such gain or loss to profit or loss when the investor loses significant influence
over the associate.
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For example, if an associate has cumulative exchange difference relating to a foreign operation
and the investor loses significant influence over the associate, the investor shall reclassify to
profit or loss any gain or loss previously recognized in other comprehensive income
What are the specific circumstances when an investment in associate shall not be accounted for using
the equity method?
The amended PAS 28, paragraph 17, provides that an investment in associate shall not be accounted for
using the equity method if the investor is a parent that is exempt from preparing consolidated financial
statements or if all of the following apply:
a. The investor is a wholly-owned subsidiary, or a partially-owned subsidiary of another entity and
its other owners do not object to the investor not applying the equity method.
b. The investor's debt and equity instruments are not traded in a public market, meaning domestic
or foreign stock exchange or "over the counter" market.
c. The investor did not file or it is not in the process of filing its financial statements with the SEC
for the purpose of issuing any class of instruments in a public market.
d. The ultimate or any intermediate parent of the investor produces consolidated financial
statements available for public use that comply with Philippine Financial Reporting Standards.
In these circumstances, the investment is accounted for as at fair value through profit or loss, or at fair
value through other comprehensive income or nonmarketable investment.
Explain the treatment of an investment in associate that is "classified as held for sale".
PAS 28, paragraph 20, provides that if the investment in associate is classified as held for sale, it is
accounted for in accordance with PFRS 5 which specifically mandates that any noncurrent asset
classified as "held for sale" shall be measured at the lower of carrying amount and fair value less cost to
sell.
Paragraph 21 provides that when an investment in associate previously classified as held for sale no
longer meets the criteria to be so classified, the investment shall be accounted for using the equity
method retrospectively as from the date of classification as held for sale.
Financial statements for the periods since classification as held for sale shall be amended accordingly.
What is the method of accounting for an investment of less than 20%?
If the investor holds, directly or indirectly, through subsidiaries less than 20% of the voting power of the
investee, it is presumed that the investor does not have significant influence, unless such influence can
be clearly demonstrated.
In this case, the investment is accounted for as financial asset at fair value through profit or loss or
financial asset at fair value through other comprehensive income or nonmarketable investment.
Explain the "cost method" of accounting for investment in equity instrument.
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The cost method is a method of accounting for an investment whereby the investment is
recognized at cost.
The cost method is usually applied with respect to investment in unquoted equity instrument or
nonmarketable equity security.
The investor does not share in the profit or loss of the investee because this method is based on
the legal relationship between the investor and the investee.
The investor and the investee are independent of the other.
Accordingly, dividends received by the investor from the investee are accounted for as dividend
income.
Explain the treatment of cash dividend from preacquisition retained earnings.
There is no longer a distinction between preacquisition dividends and postacquisition dividends.
In applying the cost method, dividends received from an associate are recognized as dividend income,
regardless of whether the dividends originated from preacquisition retained earnings or postacquisition
retained earnings.
Explain a change from cost or fair value method to equity method.
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An investor may acquire an ownership interest in an investee on a certain date but the investee
may not be classified as an associate until a later date.
For example, an investor holds a 10% interest in an investee on January 1, 2012. The investor
acquires additional 10% interest in the same investee on January 1, 2013 enabling the investor
to exercise significant influence over the investee.
In 2012, the investment is accounted for under the cost or fair value method.
However, in 2013, the investment is to be accounted for under the equity method because the
investee is now an associate.
If subsequent acquisitions increase the ownership interest to 20% or more, a change must be
made to the equity method.
This scenario is known as "investment in associate achieved in stages."
Explain the accounting for "investment in associate achieved in stages".
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The investment in associate achieved in stages is not covered by PAS 28.
This investment in associate is parallel to business combinations achieved in stages.
Accordingly, the principles for business combinations achieved in stages should be applied.
PFRS 3, paragraph 42, provides that in a business. combination achieved in stages, the acquirer
shall remeasure the previously held equity interest at fair value and recognize the resulting gain
or loss in profit or loss.
By inference, the investor shall remeasure the previously held interest in an investee using the
equity method.
The remeasured equity amount is considered the fair value of the investment in associate.
The difference between the remeasured equity amount and the carrying amount of the
investment shall be recognized in profit or loss.
Actually, the difference between the remeasured equity amount and the carrying amount of the
investment is the same as the difference between the income previously reported and the
income that would have been reported under the equity method.
QUESTION 26-23 Multiple choice (PAS 28).
1. It is an entity, including an unincorporated entity such as a partnership over which the investor has
significant. influence and that is neither a subsidiary nor an interest in joint venture.
a. Associate
b. Investee
c. Venture capital organization
d. Mutual fund
2. Which of the following statements best describes the term "significant influence"?
a. The holding of a significant proportion of the share capital in another entity
b. The contractually agreed sharing of control over an economic entity
c. The power to participate in the financial and operating policy decisions of an entity.
d. The mutual sharing in the risks and benefits of a combined entity
3. Which of the following statements is true concerning significant influence?
I. If an investor holds, directly or indirectly, less than 20% of the voting power of the investee, it is
presumed that the investor does not have significant influence, unless such influence can be clearly
demonstrated.
II. If an investor holds, directly or indirectly, 20% or more of the voting power of the investee, it is
presumed that the investor does have significant influence, unless it can be clearly demonstrated that
this is not the case.
III.A substantial or majority ownership by another investor does not necessarily preclude an investor from
having significant influence
a. I, II and III
b. I and II only
c. III only
d. II only
4. Which of the following statements is incorrect concerning the equity method?
a. The investment in associate is initially recorded at cost.
b. The investment in associate is increased or decreased by the investor's share of the profit or loss of
the investee after the date of acquisition.
c. The investor's share of the profit or loss of the investee is not recognized in the investor's profit or
loss.
d. Distributions received from the investee reduce the carrying amount of the investment.
5. Goodwill arising from an investment in associate is
a. Included in the carrying amount of the investment and amortized over the useful life.
b. Included in the carrying amount of the investment and not amortized.
c. Excluded from carrying amount of the investment but charged to retained earnings.
d. Excluded from carrying amount of the investment but charged to expense immediately.
6. If an associate has outstanding cumulative preference shares, held by outside interests, the investor
computes its share of profits or losses
a. After adjusting for preference dividends which were actually paid during the year.
b. Without regard for preference dividends.
c. After adjusting for the preference dividends only when declared.
d. After adjusting for the preference dividends, whether or not the dividends have been declared.
7. An investor shall discontinue the use of the equity method from the date
I. The investor ceases to have significant influence over an associate.
II. The associate operates under severe long-term restrictions that significantly impair its ability to
transfer funds to the investor.
a. I only
b. II only
c. Both I and II
d. Neither I nor II
8. If under the equity method, an investor's share of losses of an associate equals or exceeds the
carrying amount of an investment, which of the following is incorrect?
a. The investor ordinarily discontinues its share of further losses.
b. Additional losses are provided or a liability is recognized to the extent that the investor has incurred
legal or constructive obligations or made payments on behalf of the associate.
c. If the associate subsequently reports profits, the investor resumes its share of those profits without
regard to the share of net losses not previously recognized.
d. The investment is reported at NIL value.
9. When the investor discontinues the use of the equity method because significant influence is lost,
the investment in associate retained by the investor shall be measured at
a. Fair value
b. Carrying amount
c. Amortized cost
d. Original cost
10. When an entity increases its interest in an investment in equity securities accounted for by the fair
value method, and changes to the equity method, what is the initial carrying amount for purposes of
subsequent application of the equity method?
a. Carrying amount at the date of change.
b. Original cost plus or minus the net fair value change since acquisition.
c. Fair value at the date of change.
d. The amount that would be reflected in the investment account had equity method been in use
continually since the purchase of the investment.
QUESTION 26-24 Multiple choice (IFRS)
1. The equity method is not required to be applied when the associate has been acquired and held
with a view to its disposal within a certain time period. What is the period within which the associate
must be disposed of?
a. Six months from the end of reporting period
b. Twelve months from the end of reporting period
c. Twelve months from date of classification as held for sale
d. In the near future
2. How is goodwill arising on the acquisition of an associate dealt with in the financial statements?
a. It is amortized.
b. It is impairment tested individually.
c. It is written off against profit or loss.
d. Goodwill is not recognized separately within the carrying amount of the investment
3. How is the impairment test carried out for an investment in associate?
a. The goodwill is separated from the rest of the investment and is impairment tested individually.
b. The entire carrying amount of the investment is tested for impairment by comparing the recoverable
amount with carrying amount.
c. The carrying amount of the investment shall be compared with the market value.
d. The recoverable amounts of all investments in associates shall be assessed together to determine
whether there has been an impairment on all investments.
4. What should happen when the financial statements of an associate are not prepared as of the same
date as the financial statements of the investor?
a. The associate shall prepare financial statements for the use of the investor at the same date as that of
the investor.
b. The financial statements of the associate prepared up to a different date shall be used as normal.
c. Any major transactions between the date of the financial statements of the investor and that of the
associate shall be accounted for.
d. As long as the gap is not greater than three months, there is no problem.
5. If there is any excess of the investor's share of the net fair value of the associate's identifiable
assets and liabilities over the cast of the investment, that is, "bargain purchase", how should that
excess be treated?
a. It should be included in other comprehensive income.
b. It should be included in retained earnings.
c. It should be included as income in the determination of the investor's share of the associate's profit or
loss for the period.
d. It should be disclosed separately as part of the investor's equity.
QUESTION 26-25 Multiple choice (AICPA Adapted)
1. An investor uses the equity method to account for an investment in ordinary shares. After the date
of acquisition, the investment account of the investor would
a. Not be affected by its share of the earnings or losses of the investee
b. Not be affected by its share of the earnings of the investee but be decreased by its share of the losses
of the investee
c. Be increased by its share of the earnings of the investee, but not be affected by its share of the losses
of the investee
d. Be increased by its share of the earnings of the investee, and decreased by its share of the losses of
the investee
2. Under the equity method of accounting for investments, an investor recognizes its share of the
earnings in the period in which the
a. Investor sells the investment
b. Investee declares a dividend
c. Investee pays dividend
d. Earnings are reported by the investee in its financial statements
3. When an investor uses the equity method to account for investment in ordinary shares, the
investment account will be increased when the investor recognizes
a. A proportionate interest in the net income of the investee
b. A cash dividend received from the investee
c. Periodic amortization of the goodwill related to the purchase
d. Depreciation related to the excess of market value over book value of the investee's depreciable
assets at the date of purchase by the investor.
4. When an investor uses the equity method to account for investment in ordinary shares, cash
dividends received by the investor from the investee shall be recorded as
a. Dividend income
b. A deduction from the investor's share of the investee's profits
c. A deduction from the investment account
d. A deduction from the shareholders' equity account, dividends to shareholder.
5. An investor uses the equity method to account for investment in ordinary shares. The purchase
price implies a fair value of the investee's depreciable assets in excess of the investee's net asset
carrying amount. The investor's amortization of the excess
a. Decreases the investment account
b. Decreases the goodwill account
c. Increases the investment revenue account
d. Does not affect the investment account.
6. An investor uses the equity method to account for its 30% investment in ordinary shares of an
investee. Amortization of the investor's share of the excess of fair value over carrying amount of
depreciable assets at the date of the purchase should be reported in the investor's income statement
as part of
a. Other expense
b. Depreciation expense
c. Equity in earnings of investee
d. Amortization of goodwill
7. An investor uses the equity method to account for its purchase of another entity's ordinary shares.
On the date of acquisition, the fair value of the investee's inventory and land exceeded their carrying
amount. How do these excesses of fair value over carrying amount affect the investor's reported
equity in earnings of the investee for the current year?
Inventory excess
Land excess
a.
Decrease
Decrease
b.
Decrease
No effects
c.
Increase
Increase
d.
Increase
No effect
8. In its financial statements, an investor uses the equity. method of accounting for its 30% ownership
in an investee. At year-end, the investor has a receivable from the investee. How should the
receivable be reported in the investor's financial statements for the current year?
a. None of the receivable should be reported, but the entire receivable should be offset against
investee's payable to the investor.
b. Seventy percent of the receivable should be separately reported, with the balance offset against 30%
of investee's payable to the investor.
c. The total receivable should be disclosed separately.
d. The total receivable should be included as part of the investment in associate, without separate
disclosure
9. When an investor purchases sufficient ordinary shares to gain significant influence over the
investee, what is the proper accounting treatment of any excess of cost over the carrying amount of
the net assets acquired?
a. The excess remains in the investment account until it is sold
b. The excess is immediately expensed in the period in which the investment is made.
c. The excess is amortized over the time period that is reasonable in the light of the underlying cause of
the excess.
d. The excess is charged to retained earnings at the time the investor resells the investment.
10. At the beginning of the current year, an investor acquired 30% of the ordinary shares of another
entity. In the current year, the investee has net earnings which exceeded dividends paid. The investor
mistakenly recorded these transactions using the cost method instead of the equity method of
accounting. What effect would this have on investment account, net earnings and retained earnings,
respectively?
a. Overstate, overstate, overstate
b. Overstate, understate, understate
c. Understate, overstate, understate
d. Understate, understate, understate
QUESTION 26-26 Multiple choice (AICPA Adapted)
1. When an investor uses the cost method to account for investment in ordinary shares, cash
dividends received by the investor from the investee should be recorded as
a. Dividend income
b. An addition to the investor's share of the investee's profit
c. A deduction from the investor's share of the investee's profit
d. A deduction from the investment account
2. An investor uses the cost method to account for an investment in ordinary shares. A portion of the
dividends received this year were in excess of the investor's share of investee's earnings subsequent
to the date of investment. The amount of dividend revenue that should be reported in the investor's
income statement for this year would be
a. Zero
b. The total amount of dividends received this year
c. The portion of the dividends received this year that were in excess of the investor's share of investee's
earnings subsequent to the date of investment
d. The portion of the dividends received this year that were not in excess of the investor's share of
investee's earnings subsequent to the date of investment.
3. An investor uses the cost method to account for investment in ordinary shares. Dividends received
in excess of the investor's share of investee's earnings subsequent to the date of investment
a. Increase other comprehensive income.
b. Decrease the investment account
c. Increase the investment account
d. Increase dividend revenue
4. An investor uses the cost method of accounting for its 15% ownership in an investee. At year-end,
the investor has a receivable from the investee. How should the receivable be reported?
a. The total receivable should be reported separately.
b. The total receivable should be included as part of the investment, without separate disclosure.
c. Eighty-five percent of the receivable should be reported separately, with the balance offset against
the investee's payable to the investor.
d. The total receivable should be offset against the investee's payable to the investor.
5. On January 1 of the current year, an entity purchased 10% of another entity's ordinary shares. The
entity. purchased additional shares bringing its ownership up to 40% of the investee's ordinary shares
outstanding on August 1 of the current year. During October of the current year, the investee declared
and paid a cash dividend on all of its outstanding ordinary shares. How much income from the
investment should be reported for the year?
a. 10% of investee's income from January 1 to July 31, plus 40% of investee's income from August 1 to
December 31
b. 40% of investee's income from August 1 to December 31 only
c. 40% of investee's income for the current year
d. Amount equal to dividends received from the investee
CHAPTER 27 FINANCIAL ASSET AT AMORTIZED COST
Explain the measurement of financial asset 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:
a. The business model is to hold the financial asset in order to collect contractual cash flows on
specified dates.
b. The contractual cash flows are solely payments of principal and interest on the principal amount
outstanding.
 In other words, the business model is to collect contractual cash flows if the contractual cash
flows are solely payments of principal and interest. In such a case, the financial asset shall be
measured at amortized cost.
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Financial assets measured at amortized cost include investments in bonds and other debt
instruments.
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Financial assets at amortized cost are classified as noncurrent assets.
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PFRS 9, paragraph 4.1.4, further provides that by residual. definition or by default, financial
assets that do not meet the conditions for amortized cost measurement shall be measured at
fair value.
What is a bond?

A 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.

In simple language, a bond is a contract of debt whereby one party called the issuer borrows
fund from another party called the investor
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.
Thus, a bond is a debt security because the bondholder is a creditor and the issuer is a debtor.
A bond is evidenced by a certificate and the contractual agreement between the issuer and
investor is contained in another document known as "bond indenture".
What is the purpose of acquiring bond investment?
An investor acquires a bond either as a temporary or permanent investment and derives regular income
in the form of interest.
The interest is usually paid semiannually or every six months as follows:
a.
b.
c.
d.
e.
January 1 and July 1
February 1 and August 1
March 1 and September 1
April 1 and October 1
May 1 and November 1 f. June 1 and December 1
Of course, there are certain bonds that pay interest annually or at the end of the bond year.
Explain the classification of bond investments.
Bonds may be acquired as current or noncurrent investment depending on the business model of
managing financial assets.
Accordingly, bond investments are classified and accounted for as follows:
a. Financial assets held for trading or trading securities
b. Financial assets at amortized cost
Explain the "initial measurement" of bond investment.

In accordance with PFRS 9, paragraph 5.1.1, bond investments are recognized initially at fair
value plus transaction costs that are directly attributable to the acquisition.

The fair value of the bond investment is usually the transaction price, meaning the fair value of
the consideration given.

Transaction costs include fees and commission paid to agents, advisers, brokers and dealers,
levies by regulatory authorities and securities exchanges, and transfer taxes and duties.

However, transaction costs attributable to the acquisition of "trading" bond investments are
expensed immediately.
Explain the "subsequent measurement" of bond investments.
Subsequent to initial recognition, bond investments are measured and accounted for as follows:
1. Trading bond investments are measured at fair value through profit or loss.
 When bond investment is held for "trading", it is not necessary to amortize any premium or
discount.
2. Bond investments are classified as financial assets measured at amortized cost using the
effective interest method.
Discuss a bond premium and bond discount.

If the acquisition cost of the bonds is different from the face value, the bonds are said to be
acquired at a premium or discount.

If the acquisition cost is more than the face value, the difference is a bond premium.

If the acquisition cost is less than the face value, the difference is a bond discount.

If the bond investments are classified as financial assets at amortized cost, the bond premium or
discount is amortized over the life of the bonds.

On the part of the bondholder, the life of the bonds is from the date of acquisition to the date of
maturity.
Why amortize bond premium or bond discount?

The reason for amortization of bond premium or discount is to bring the carrying amount of the
investment to face value on the date of maturity.

When the bonds are redeemed on the date of maturity, the entry will simply be a debit to cash
and a credit to investment in bonds at face value.

The bondholder is a creditor and will collect on the date of maturity an amount equal only to the
face value of the bonds no more and no less.

Conceptually, bond premium is a loss on the part of the investor because the investor paid more
than what can be collected on the date of maturity which is equal to the face value.

Such loss is not recognized outright but allocated or amortized over the life of the bond to be
deducted from the interest income derived from the bond investment.

Thus, the periodic amortization of bond premium is recorded by debiting interest income and
crediting the investment account.

On the other hand, bond discount is a gain on the part of the investor because the investor paid
less than what can be collected on the date of maturity.

Such gain is not recognized outright but allocated or amortized over the life of the bond to be
added to the interest income derived from the bond investment.

Thus, the periodic amortization of the bond discount is recorded by debiting the investment
account and crediting interest income.
What are callable bonds?


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Callable bonds are those which may be called in or redeemed by the issuer prior to the date of
maturity.
Usually, the call price or redemption price is at a premium or more than the face value of the
bonds.
The difference between the redemption price and the carrying amount, of the bonds on the
date of redemption is recognized in profit or loss.
What are convertible bonds?
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Convertible bonds are those which give the bondholders the right to exchange their bonds for
share capital of the issuing entity at any time prior to maturity.
This subject matter will be discussed more in detail in a later chapter because convertible bonds
involve an embedded derivative. The equity conversion option is the embedded derivative.
The existence of the conversion feature generally precludes classification of the convertible
bonds as financial assets at amortized cost because that would be inconsistent with paying for
the conversion feature, meaning the right to convert into equity shares before maturity.
Accordingly, investment in convertible bonds can be classified as financial asset at fair value.
What are serial bonds?
Serial bonds are those which have a series of maturity
What are term bonds?


Term bonds are those bonds that mature on a single date.
Callable and convertible bonds can be classified as term bonds despite their special features.
What are the three methods of amortizing bond premium or bond discount?



The straight line method provides for an equal or uniform amount of premium or discount
amortization each accounting period.
The bond outstanding method is applicable to serial bonds. and provides for decreasing amount
of amortization.
The effective interest method or simply "interest method" or scientific method provides for an
increasing amount of amortization.
In accordance with PFRS 9, bond investments shall be classified as financial assets measured at
amortized cost using the effective interest method.


This means that any discount or premium must be amortized using the effective interest
method.
The straight line method and bond outstanding method are acceptable only when the
computation will result in periodic interest income that is not materially different from the
amount that would be computed using the effective interest method.
What is the market price of bonds?
The market price of the bonds is equal to the sum of the following:
a. Present value of principal
Principal multiplied by the "PV of 1 factor" for the number of interest periods using the "effective rate".
b. Present value of interest payments
Periodic interest payment multiplied by the "PV of an ordinary of 1 factor" for the number of interest
periods using the "effective rate".
Distinguish effective rate and nominal rate.
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Nominal or coupon or stated rate is the rate of interest appearing on the face of the bonds.
The nominal rate multiplied by the face of the bonds gives the periodic interest received by the
bondholder.
Effective or yield or market rate is the true or actual rate of interest which bondholder earns on
the investment.
The effective rate multiplied by the carrying amount of the bond investment gives the actual
interest earned or interest income.
The effective interest method simply requires the comparison between the interest earned or
interest income and the interest received.
The difference between the interest income and interest received represents the premium or
discount amortization.
The carrying amount of the bonds is the initial cost gradually increased by periodic amortization
of discount or gradually reduced by periodic amortization of premium.
The effective rate and the nominal rate are the same if the cost of the bond investment is equal
to the face value.
When the bonds are acquired at a premium, the effective rate is lower than the nominal rate.
The reason is that the premium is a loss on the part of the bondholder.
On the other hand, when the bonds are acquired at a discount, the effective rate is higher than
the nominal rate.
The reason is that the discount is a gain on the part of the bondholder.
QUESTION 27-16 Multiple choice (IAA)
1. The contractual agreement between an investor and the bond issuer is contained in a formal
document known as
a. Contract of debt
b. Bond indenture
c. Bond certificate
d. Bond agreement
2 Accrued interest on bonds that are purchased between. interest dates.
a. Is ignored by both the seller and the buyer.
b. Increases the amount a buyer must pay to acquire the bonds.
c. Is recorded as a loss on the sale of the bonds.
d. Decreases the amount a buyer must pay to acquire the bonds
3. If a 5-year bond matures on October 1, 2012 and interest is payable semiannually, the interest
dates are
a. April 1 and October 1
b. January 1 and July 1
c. May 1 and November 1
d. Not determinable
4. The effective interest method of amortizing bond. discount provides for
a. Increasing discount amortization and increasing interest income.
b. Increasing discount amortization and decreasing interest income
c. Decreasing discount amortization and increasing interest income.
d. Decreasing discount amortization and decreasing interest income
5. The interest rate written on the face of bond is known as
a. Nominal rate
b. Coupon rate
c. Stated rate
d. Nominal rate, coupon rate or stated rate
6. To compute the price to pay for a bond, what present value concept is used?
a. Only the present value of 1 concept
b. Only the present value of an annuity of 1 concept
c. Both the present value of 1 concept and present value of an annuity of 1 concept
d. Neither the present value of 1 concept nor the present value of annuity of 1 concept
7. Bonds usually sell at a discount when
a. Investors are willing to invest in the bonds at the stated interest rate.
b. Investors are willing to invest in the bonds at rates that are lower than the stated interest rate.
c. Investors are willing to invest in the bonds only at rates that are higher than the stated interest rate.
d. An unrealized gain is expected.
8. Bonds usually sell at a premium
a. When the market rate of interest is greater than the stated rate of interest on the bonds.
b. When the stated rate of interest on the bonds is greater than the market rate of interest.
c. When the price of the bonds is greater than their maturity value.
d. In none of the above cases
9. The effective interest rate on bonds is lower than the stated rate when bonds sell
a. At maturity value
b. Above face value
c. Below face value
d. At face value
10. The effective interest rate on bonds is higher than the stated rate when bonds sell
a. At face value
b. Above face value
c. Below face value
d. At maturity value
QUESTION 27-17 Multiple choice (AICPA Adapted)
1. How is the premium or discount on bonds purchased as a "trading" investment reported in financial
statements?
a. As an integral part of the cost of the asset acquired and amortized over the remaining life of the bond
issue.
b. As an integral part of the cost of the asset acquired until such time as the investment is sold.
c. As expense or revenue in the period the bonds are purchased.
d. As an integral part of the cost of the asset acquired and amortized over the period the bonds are
expected to be held.
2. An entity did not amortize the discount on its "trading" bond investment. What effect would this
have on the carrying amount of the investment and on net income, respectively?
a. Overstated, overstated
b. Understated, overstated
c. Understated, understated
d. No effect, no effect
3. An investor purchased a bond classified as a long-term investment between interest dates at a
premium. At the purchase date, the carrying amount of the bond is more than the
I. Cash paid to seller
II. Face value of bond
a. Both I and II
b. I only
c. II only
d. Neither I nor II
4. An investor purchased a bond as a long term investment between interest dates at a premium. At
the purchase date, the cash paid to the seller is
a. The same as the face amount of the bond
b. The same as the face amount of the bond plus accrued interest
c. More than the face amount of the bond
d. Less than the face amount of the bond
5. An investor purchased a bond as a long-term investment on January 1. Annual interest was received
on December 31. The investor's interest income for the year would be lower if the bond was
purchased at
a. A discount
b. A premium
c. Par
d. Face value
6. An investor purchased a bond as a long-term investment on January 1. Annual interest was received
on December 31. The investor's interest income for the year would be higher if the bond was
purchased at
a. Par
b. Face value
c. A discount
d. A premium
7. When the interest payment dates of a bond are May 1 and November 1, and a bond is purchased on
June 1, the amount of cash paid by the investor would be
a. Decreased by accrued interest from June 1 to November 1.
b. Decreased by accrued interest from May 1 to June 1.
c. Increased by accrued interest from June 1 to November 1.
d. Increased by accrued interest from May 1 to June 1.
8. In the prior year, an entity acquired at a premium 10-year bond as a long-term investment. At the
end of the current year, the bond is quoted at a small discount. Which of the following situations is
the most likely cause of the decline in the bond's market value
a. The bond issuer issued a stock dividend.
b. The bond issuer is expected to call the bond at a premium, which is less than the investor's carrying
amount.
c. Interest rates have declined since the investor purchased the bond.
d. Interest rates have increased since the investor purchased the bond.
9. A bond purchased on June 1 of the current year has interest payment dates of April 1 and October
1. Bond interest income for the current year ended December 31 is for
a. 3 months
b. 4 months
c. 6 months
d. 7 months
10. The effective interest method of amortizing bond premium or bond discount
a. Is too complicated for practical use.
b. Uses a constant rate of interest.
c. Is another name for the straight line method.
d. Is needed to determine the amount of cash to be paid to bondholders at each interest date.
EQUITY SECURITIES
Investments in Debt Securities
Investment Associate