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Lopez- Jobilleen-BSA-2106- Chapters-18-21-24-36-37
Intermediate Accounting 1 (AMA Computer University)
Studocu is not sponsored or endorsed by any college or university
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CHAPTER 18
INVESTMENT IN ASSCOIATES
QUESTIONS
1.
Define associate.
Associate is simply defined as an entity over which the investor has significant
influence.
2.
Define significant influence.
Significance influence is the power to participate in the financial and operating
policy decisions of the associate but not control or joint control over those policies.
3.
What is the practical guidance in determining significant influence?
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 and 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 an investor from having significant influence.
Beyond the mere 20% threshold of ownership, PAS 28, paragraph 6, provides that
the existence of significant influence is usually evidenced by the following factors:
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
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4.
Explain the equity method of accounting for share investment?
The investment in associate is measured using the equity method of accounting. It
is based on the economic relationship between the investor and investee whom are viewed
as a single economic unit. It is applicable when the investor has a significant influence over
the investee.
Accounting procedures – equity method
a. The investment is initially recognized at cost.
b. The carrying amount is increased by the investor’s share of the profit of the investee
and decreased by the investor’s share of the loss of the investee.
The investor’s share of the profit or loss of the investee is recognized as investment
income.
c. Dividends received from an equity investee reduce the carrying amount of the
investment.
d. Note that the investment must be in ordinary shares.
If the investment is in preference shares, the equity method is not appropriate regardless
of the percentage because the preference share is a nonvoting equity.
e. Technically, if the investor has significant influence over the investee, the investee is
said to be an associate. Accordingly, under equity method, the investment in ordinary
shares should be appropriately described as investment in associate.
f. The investment in associate accounted for using the equity method shall be reported as
noncurrent asset.
5.
What is the meaning of “excess of cost over carrying amount” with respect to
acquisition of share investment?
If the investor pays more than the carrying amount of the net assets acquired, the
difference is commonly known as "excess of cost over carrying amount" and may be
attributed to the following:
a. Undervaluation of the investee's assets, such as building, land and inventory.
b. Goodwill
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If the assets of the investee are fairly valued, the excess of cost over carrying
amount of the underlying net assets is attributable to goodwill.
If the excess is attributable to undervaluation of depreciable asset, it is amortized
over the remaining life of the depreciable asset.
If the excess is attributable to undervaluation of land, it is not amortized because
the land is nondepreciable. The amount is expensed when the land is sold.
If the excess is attributable to inventory, the amount is expensed when the inventory
is already sold.
If the excess is attributable to goodwill, it is included in the carrying amount of the
investment and not amortized.
However, the entire investment in associate including the goodwill is tested for
impairment at the end of each reporting period.
6.
Explain an impairment loss with respect to an investment in associate.
If there is an indication that an investment in associate may be impaired, an
impairment loss shall be recognized whenever the carrying amount of the investment in
associate exceeds recoverable amount.
The recoverable amount is measured as the higher between fair value less cost of
disposal and value in use.
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 the ultimate disposal.
Since goodwill is not separately recognized from the investment amount, the
impairment loss recognized is applied to the investment as a whole.
The recoverable amount of an investment in associate is assessed for each
individual associate.
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7.
Explain the accounting procedure if an associate has cumulative and noncumulative
preference shares.
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.
When an associate has outstanding noncumulative preference shares, the investor
shall compute its share of earnings after deducting the preference dividends only when
declared.
8.
Explain the discontinuance of the equity method.
In PAS 28, 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.
Consequently, the investor shall account for the investment as follows:
a. Financial asset at fair value through profit or loss.
b. Financial asset at fair value through other comprehensive income.
c. Nonmarketable investment at cost or investment in unquoted equity instrument.
In PAS 28, Basis for Conclusion 18, requires an investor that continues to have
significant influence over an associate to apply the equity method even if the associate is
operating under severe long-term restrictions that significantly impair the ability to transfer
funds to the investor.
Significant influence must be lost before the equity method ceases to be applicable.
9.
Explain the measurement of the investment in associate when significant influence is
lost.
In PAS 28, 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 fair value of the investment at the date it ceases to be an associate shall be regarded as
the fair value on initial recognition as a financial asset.
The difference between the carrying amounts of the retained investment at the date the
significant influence is lost and the fair value of the retained investment shall be included
in profit or loss.
Of course, the difference between the net proceeds from disposal of part of the investment
and the carrying amount of the investment sold is recognized as gain or loss on disposal of
investment
10.
What are the circumstances when the equity method is not applicable?
In 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 the other owners do not object to investor not applying the equity method.
b. The investor’s debt and equity instruments are not traded in a public market or “over
the counter” market.
c. The investor did not file or it is not in the process of filing 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 follow:
a. Financial asset at fair value through profit or loss.
b. Financial asset at fair value through other comprehensive income.
c. Nonmarketable investment at cost or investment in unquoted equity instrument.
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MULTIPLE CHOICE
Problem 18-1 (ACP)
Camia Company provided the following chronological transactions:
1. Purchased 20,000 ordinary shares of an investee for P2,400,000 representing 20% interest
on January 1, 2020. The net assests of the investee are fairly stated at P8,000,000.
2. The investee reported net income of P1,500,000 for 2020.
3. Received a 10% share dividend from the investee.
4. The investee reported net loss of P300,000 for 2021.
5. The investee paid a cash dividend of P500,000 to ordinary shareholders on December 31,
2021.
Required:
a. Prepare journal entries to record the transactions under equity method.
b. Compute the implied goodwill.
c. Compute the carrying amount of the investment on December 31, 2021.
Solutions:
a.
Investment in associate
P2,400,000
Cash
P2,400,000
To record sold ordinary shares to an investor.
Investment in associate
300,000
Investment Income
To record the share share of the investee’s income.
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300,000
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Loss on investment
60,000
Investment in associate
60,000
To record the share share of the investee’s loss.
Cash
100,000
Investment in associate
100,000
To record receipt of 20% of dividends paid by the investee.
b.
Acquisition Cost
P2,400,000
Carrying amount of net assets acquired
(20% x P8,000,000)
Excess of cost over carrying amount – goodwill
1,600,000
P 800,000
c.
Acquisition Cost
P2,400,000
Investment Income (P8,000,000 x 20%)
1,600,000
Cash Dividend (P500,000 x 20%)
(100,000)
Carrying amount of the investment on December 31, 2021
P3,900,000
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Problem 18-2 (IAA)
At the beginning of current year, Marion Company acquired 25% of the outstanding shares
of an investee at a total cost of P7,000,000.
At the time, the carrying amount of the net assets of Marion Company totaled P24,000,000
which is equal to fair value.
The investee earned net income of P5,000,000 during the current year.
The investee declared and paid a cash dividend of P3,000,000 to shareholders at year-end.
Required:
a. Prepare journal entries relating to the investment for the current year.
b. Compute the goodwill.
c. Compute the carrying amount of the investment at year-end.
Solutions:
A.
Investment in associate
7,000,000
Cash
7,000,000
Investment in associate
1,250,000
Investment Income (5,000,000 x 25%)
Cash
1,250,000
750,000
Investment in associate (3,000,000 x 25%)
750,000
B.
Acquisition cost
P7,000,000
Carrying amount of net assets acquired (25% x 24,000,000)
(6,000,000)
Excess of cost over carrying amount – goodwill
P1,000,000
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C.
Acquisition cost
P7,000,000
Investment income
1,250,000
Share in cash dividend
(750,000)
Carrying amount at year end
P7,500,000
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Problem 18-3 (AICPA Adapted)
At the beginning of current year, Sam Company purchased 20% of another entity’s
ordinary shares outstanding for ₱6,000,000.
The acquisition cost is equal to the carrying amount of the net assets acquired.
During the current year, the investee reported net income of ₱7,000,000 and paid cash
dividend of ₱4,000,000.
What is the carrying amount of the investment in associate at year-end?
a. 5,200,000
b. 6,000,000
c. 6,600,000
d. 7,400,000
Solution:
₱ 6,000,000
Acquisition Cost
Investment Income (₱7,000,000 x 20%)
1,400,000
Cash Dividend (₱4,000,000 x 20%)
(800,000)
Investment in Associate
₱ 6,600,000
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Problem 18-4 (AICPA Adapted)
At the beginning of current year, Farah Company acquired 20% of the outstanding ordinary
shares of another entity for P8,000,000.
This investment gave Farah the ability to exercise significant influence over the investee.
The carrying amount of the acquired shares was P6,000,000.
The excess of cost over carrying amount cannot be attributed to any particular identifiable
asset.
The investee reported net income of P1,800,000 and paid cash dividend of P400,000 and
thereafter issued 5% share dividend during the current year.
What is the carrying amount of the investment in associate at year-end?
a. 6,280,000
b. 7,800,000
c. 8,000,000
d. 8,280,000
Solution:
₱ 8,000,000
Acquisition Cost
Investment Income (P1,800,000 x 20%)
360,000
Cash Dividend (P400,000 x 20%)
(80,000)
Investment in Associate
₱ 8,280,000
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Problem 18-5 (AICPA Adapted)
At the beginning of current year, Diana Company as a long-term investment a 20%
ordinary share in East Company.
Diana paid P7, 000,000 for this investment when the fair v of the investee's net assets
was P35, 000,000.
The investee reported net income of P4, 000, 000 for current year and declared and paid
cash dividend of P1, 600,000.
What amount of revenue from the investment should be reported for the current year?
a. 400,000
b. 480,000
с. 800,000
d. 320,000
Solution:
Investment Revenue (P1, 600,000 x 20%) = P800, 000
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Problem 18-6 (AICPA Adapted)
On July 1, 2020, Diamond Company paid P1,000,000 for 100,000 outstanding shares
which represent 40% of Silver Company.
At that date, the net assets of Silver totaled P2,500,000 and the fair values of all Ashley’s
identifiable assets and liabilities were equal to their carrying amount.
The investee reported net income of P500,000 for 2020, of which P300,000 was for the six
months ended December 31, 2020. The investee paid cash dividend of P250,000 on September
30, 2020.
What amount of income should be reported from the investment in associate?
a. 200,000
b. 100,000
c. 120,000
d. 80,000
Solution:
Cash Dividend
P250,000
Shares (in percentage)
40%
Share in cash dividend
P100,000
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Problem 18-7 (AICPA Adapted)
On July 1, 2020, Denver Company purchased 30,000 shares of Eagle Company’s 100,000
outstanding shares for P200 per share representing 30% interest.
On December 15, 2020 the investee paid P400,000 in cash dividends to the ordinary
shareholders.
The investee’s net income for the year ended December 31, 2020 was P1,200,000 earned
evenly throughout the year.
What amount of income from the investment should be reported in 2020?
a. 360,000
b. 180,000
c. 120,000
d. 60,000
Solution:
December 31, 2020 Investee’s net income
Interest rate
P1,200,000
30%
P1,200,000 x 30% =
P360,000
Under equity method, dividend is not an income but a reduction of investment.
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Problem 18 – 8 (AICPA Adapted)
On April 1, 2020, Ben Company purchased 40% of the outstanding ordinary shares of Clarke
Company for P10, 000,000.
On the date, Clarke’s net assets were P20, 000,000 and Ben cannot attribute the excess of the
cost of its investment in Clarke over its equity in Clarke’s net assets to any particular factor. The
investee’s net income of P5,000,000 for 2020.
What is the maximum amount which could be included in 2020 income before tax to reflect the
equity in net income of investee?
a. 1,400,000
b. 1,500,000
c. 2,000,000
d. 1,850,000
Solution:
Share in net from April 1 to December 31, 2020
(5,000,000 x 9/12 x 40%)
1,500,000
Acquisition cost
10.000.000
Carrying amount of net assets (40% x 20,000,000)
(8,000,000)
Goodwill – not amortized
2,000,000
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Problem 18-9
2) C
3) D
4) B
5) B
6) D
7) D
8) A
9) B
10) C
Problem 18-10
1) D
2) D
3) C
4) A
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CHAPTER 21
INVESTMENT PROPERTY
QUESTIONS
1.
Define an investment property.
Investment property is defined as a property (land or building or part of a building
or both) held by an owner or the lessee under a finance lease to earn rentals or for capital
appreciation or both. In other words, only land and building can qualify as investment
property. An equipment or any movable property cannot qualify as investment property.
2.
Define an owner-occupied property.
Investment property is a property held by an owner with the intention of earning
through rental income, future resale of the property due to capital appreciation, or both. It
is not a movable property.
3.
Give examples of investment property.
Examples of investment property a. Land held for long-term capital appreciation.
b. Land held for a currently undetermined use. For example, if an entity has not determined
that it will use the land either as owner-occupied property or for short-term sale in the
ordinary course of business, the land is considered to be held for capital appreciation and
therefore investment property. C. Building owned by the reporting entity leased out under
an operating lease. d. Building that is vacant but is held to be leased out under an operating
lease. e. Property that is being constructed or developed for future use as investment
property.
4.
What is the treatment of property that is partly investment and partly owneroccupied?
The treatment of property for partly investment and partly owner-occupied depends
on how the portions can be sold or leased out separately or not. If a part can be sold / leased
out separately then an entity shall account the portions separately as investment property
and owner-occupied property. Meanwhile, if the portions could not be sold separately, the
property is investment property if only an insignificant portion is held for manufacturing
or administrative purposes.
In addition, when ancillary services are provided by the entity to the occupants of
the property and these services are a relatively insignificant component of the arrangement,
the property is treated as investment property. However, if the services provided are a more
significant component of the arrangement, the property is treated as owner-occupied
property.
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5.
What is the treatment of property leased to an affiliate?
From the perspective of the individual entity that owns it, the property leased to
another subsidiary or its parent is considered an investment property. However, from the
perspective of the group as a whole and for purposes of consolidated financial statements,
the property is treated as owner-occupied property.
6.
When is an investment property recognized?
A property will be recognized as Investment Property if it meets the following
criteria: The definition of Investment Property. It is probable that the future economic
benefits that are associated with the investment property will flow to the entity. • Its cost is
reliably measurable.
7.
Explain the initial measurement of investment property.
An investment property is initially measured at cost, including transaction costs.
The cost of a purchased investment property comprises the purchase price and any directly
attributable expenses such as professional fees for legal services, property transfer taxes
and other transactions. Such cost should not include start-up costs unless necessary to bring
the property on its intended use, abnormal waste of material, labor or other resources
incurred in creating the property or initial operating losses incurred before the investment
property achieves the planned level of occupancy.
8.
What is the measurement of investment property subsequent to initial recognition?
IAS 40 permits entities to choose between: the fair value model, and the cost model.
One method must be adopted for all of an entity's investment property. Change is
permitted only if this results in a more appropriate presentation. IAS 40 notes that this is
highly unlikely for a change from a fair value model to a cost model.
9.
Explain the cost model and fair value model of measuring investment property.
Fair Value Model in the investment property is carried at the fair value with changes
in fair value included in profit or loss. There is no depreciation recorded for the investment
property. Investment property is remeasured at fair value, which is the price that would be
received to sell an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date. Gains or losses arising from changes in the
fair value of investment property must be included in net profit or loss for the period in
which it arises. While Cost Model in the investment property is carried at cost less any
accumulated depreciation and any accumulated impairment loss. Fair value of investment
property must be disclosed.
10.
Explain the fair value of investment property.
The fair value of investment property is the price at which the property could be
exchanged between knowledgeable and willing parties in an arm's length transaction. In
determining the fair value, there should not contain a deduction for transaction cost it may
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incur on sale or other disposal. The fair value of an investment property shall reflect market
conditions at the end of reporting period. Furthermore, we should always keep in mind that
fair value is time-specific as of a given date, as the market condition change rapidly due to
different factors. Dwelling more on what may be considered to be included in the fair value
of an investment property, equipment that are an integral part of a building such as lift or
air-conditioning are included. As well as when an property shall reflect market conditions
at the end of reporting period. Meanwhile, the fair value of investment property excludes
prepaid or accrued operating lease income.
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MULTIPLE CHOICE
Problem 21-1
1. A
2. C
Problem 21-2 (IFRS)
1. B
2. A
Problem 21-3 (IFRS)
1. B
Problem 21-4 (IFRS)
1. B
Problem 21-5 (IFRS)
1. A
Problem 21-6 (IFRS)
1. A
Problem 21-7 Multiple Choice (PAS 40)
1.
2.
3.
4.
5.
6.
7.
8.
9.
C
D
D
B
A
C
B
A
A
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CHAPTER 24
FINANCIAL INSTRUMENTS - PRESENTATION
QUESTIONS
1.
Define a financial instrument.
According to PAS 32, paragraph 11, financial instrument is any contract that gives
rise to both a financial asset of one entity and a financial liability or equity instrument of
another entity. It is simple encompasses a financial asset, a financial liability and an equity
instrument. In addition, financial instruments are assets that can be traded, or they can also
be seen as packages of capital that may be traded. Most types of financial instruments
provide efficient flow and transfer of capital all throughout the world's investors. These
assets can be cash, a contractual right to deliver or receive cash or another type of financial
instrument, or evidence of one's ownership of an entity.
2.
Define a financial asset.
A financial asset is a liquid asset that gets its value from a contractual right or
ownership claim. Cash, stocks, bonds, mutual funds, and bank deposits are all are examples
of financial assets. Unlike land, property, commodities, or other tangible physical assets,
financial assets do not necessarily have inherent physical worth or even a physical form.
Rather, their value reflects factors of supply and demand in the marketplace in which they
trade, as well as the degree of risk they carry.
3.
Give examples of financial assets.
Financial asset is a non-physical asset, it does not have physical form or have
inherent physical worth and whose value is derived from a contractual claim. An example
of this is the bank deposits, bonds, and stocks. Also, the cash or currency since it is more
liquid and is the basis of measurement of all transactions.
4.
Define a financial liability.
Financial liability is any liability that is contractual obligation to deliver cash or
other financial asset to another entity and to exchange financial instruments with another
entity under conditions that are potentially unfavorable.
5.
Give examples of a financial liability.
• Payables such as accounts, notes, loans and bonds payable.
• Lease liabilities
• Held for trading liabilities and derivative liabilities
• Redeemable preference shares issued
• Security deposits and other returnable deposits
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6.
Define an equity instrument.
Equity instrument reflects the basic accounting equation that equity equals assets
minus liability. It is any contract that evidences a residual interest in the assets of an entity
after deducting all of the liabilities. In addition to, it includes ordinary share capital,
preference share capital and warrants or option.
7.
What is the guideline in determining whether a financial instrument is a financial
liability or an equity instrument?
• PAS 32, paragraph 15, provides that the issuer of a financial instrument shall
classify the instrument as a financial liability or equity instrument in accordance with the
substance of the contractual arrangement and the definition of a financial liability, financial
asset and equity instrument.
• Paragraph 16 provides that to determine whether a financial instrument is an
equity instrument rather than a financial liability, the instrument is an equity instrument if
the instrument includes no contractual obligation to deliver cash or another financial asset.
8.
Explain a redeemable preference share
. • A preference share that provides for mandatory redemption by the issuer for a
fixed or determinable amount at a future date is a financial liability of the issuer because
the issuer has a contractual obligation to pay cash at some future time.
• A preference share that gives the holder the right to require the issuer to redeem
the instrument at a particular date for fixed or determinable amount is also a financial
liability because the issuer has a contractual obligation to pay cash at some future time.
9.
Explain the accounting for a compound financial instrument.
A compound financial instrument, as defined by PAS 32, paragraph 28, it is a
financial instrument that has the characteristics of both an equity and liability from the
perspective of the issuer. Meaning, one component of the financial instrument meets the
definition of financial liability while the other component of financial instrument meets the
definition of an equity instrument.
10.
Explain the accounting for bonds payable issued with share warrants and convertible
bonds.
Accounting for bonds payable issued with share warrants
When the bonds are sold with share warrants, the bondholders are given the right
to acquire shares of the issuing equity at a specified price at some future time.
Actually, when bonds are sold with the share warrants two securities are sold-the
bonds and the share warrants.
Share warrants attached to bond may be detachable or non-detachable.
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Detachable share warrants can be traced separately from the bond while nondetachable share warrants cannot be traded separately.
Accordingly, the proceeds from the issuance of the bonds payable with share
warrants shall be accounted for as partly liability and partly equity.
PAS 32 does differentiate whether the equity component is detachable or nondetachable.
Whether detachable or non-detachable, share warrants have a value and therefore
shall be accounted for separately.
PAS 32, paragraph 31, provides the equity instruments are instruments that
evidence a residual interest in the assets of an entity after deducting all of its liabilities.
Therefore, the bonds are assigned an amount equal to the “market value of the
bonds of the ex-warrant”, regardless of the market value of the warrants.
The residual amount or remainder of the issue price shall then be allocated to the
share warrants.
Accounting for convertible bonds
An entity frequently makes its bond issue more attractive to investors by making
the bonds convertible.
Generally, an entity can obtain financing at a lower interest rate by issuing
convertible bond.
Convertible bonds give the holders the right to convert their bond holdings into
share capital of the issuing entity within a specified period of time.
Convertible bonds are conceived as compound financial instruments.
Accordingly, the issuance of convertible bonds shall be accounted for as partly
liability and partly equity.
In other words, the issue price of the convertible bonds shall be allocated between
the bonds payable and the conversion privilege.
The bonds are assigned an amount equal to the market value of the bonds without
the conversion privilege.
The residual amount or remainder of the issue price shall then be allocated to the
conversion privilege or equity component.
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MULTIPLE CHOICE
Problem 24-1 (AICPA Adapted)
1.
What is the carrying amount of the bonds payable?
B. 4,750,000
2.
What amount of the proceeds from the bond issue should be recognized as an increase in
shareholder’s equity?
D. 400,000
Problem 24-2 (IAA)
Marion Company issued Php 5,000,000 face amount 12% convertible bonds at 110 at the
beginning of current year. The bonds pay interest semiannually on January 1 and July 1.
It is estimated that the bonds would sell only at 102 without the conversion feature. Each
Php 1,000 bond convertible into 10 ordinary shares with Php 100 par value.
What is the increase in shareholders’ equity arising from the original issuance of the
convertible bonds payable?
A. 400,000
Problem 24-3 (PAS 32)
1.
A financial instrument is any contract that gives rise to
D. A financial asset of one entity and a financial liability or equity instrument
of another equity.
2.
Which is not classified as a financial instrument?
B. Foreign currency contract
3.
Which cannot be considered a financial asset?
B. A contractual right to exchange financial instruments with another entity
under conditions that are potentially unfavorable.
4.
Which should be classified as financial asset?
A. Patent
5.
A financial liability
B. Is a contractual obligation to deliver cash or another financial asset to
another entity.
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6.
Financial liabilities include all of the following except
D. Income Tax Payable
7.
It is any contract that evidences residual interest in the assets of an entity after deducting
all of the liabilities
A. Equity instrument
8.
How should preference shares that are redeemable mandatorily be presented in the
statement of financial position?
D. Either current or noncurrent liability depending on redemption date.
9.
What is the presentation of preference dividend on mandatorily redeemable preference
shares?
C. Interest expense
10.
Which is not an equity instrument?
B. Bonds Payable
Problem 24-4 (IFRS)
1.
What is the principal accounting for a compound instrument?
B. The issuer shall classify the liability and equity components of a compound
instrument separately as liability or equity.
2.
How are the proceeds from issuing a compound instrument allocated between the liability
and equity components?
A. First, the liability component is measured at fair value, and then the
remainder of the proceeds is allocated to the equity component.
3.
When bonds are issued with share warrants, the equity component is equal to
B. The excess of the proceeds over the face amount of the bonds
4.
When bonds are issued with share warrants, a portion of the proceeds should be allocated
to equity when the bonds are issued with
A. Detachable share warrants
5.
The proceeds from an issue of bonds payable with share warrants should not be allocated
between the liability and equity components when
C. The warrants issued are nondetachable
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Problem 24-5 (IAA)
1.
A bond convertible by the holder into a fixed number of ordinary shares of the issuer is
A. A compound financial instrument
2.
Convertible bonds
D. May be exchanged for shares of the issuer.
3.
Convertible bonds
B. Allow an entity to issue debt financing at lower rate.
4.
What is the accounting for issued convertible bond?
D. The instrument should be recorded as part bond and part equity.
5.
Issued convertible bonds are
D. Recorded at par value of the share.
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CHAPTER 36
FINANCIAL INSTRUMENT – MEASUREMENT OF FINANCIAL ASSET
QUESTIONS
1.
Explain the initial measurement of financial asset.
PFRS 9, paragraph 5.1.1, provides that the initial measurement of financial asset is
at fair value plus, in the case of financial asset not at fair value through profit or loss,
transaction cost that are directly attributable to the acquisition of the financial asset.
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 expensed outright.
2.
Explain the subsequent measurement of financial asset.
As provided by the PFRS 9, paragraph 5.2.1, after initial recognition, an entity shall
measure a financial asset at:
▪ Fair Value through Profit or Loss (FVPL)
▪ Fair Value through Other Comprehensive Income (FVOCI)
▪ Amortized Cost
In subsequent measurement, it depends on the category of financial instrument.
Some categories are measured at amortized cost, and some at fair value. In limited
circumstances, other measurement bases apply. All current instruments are measured at
undiscounted cash or consideration to be received and all non-current instruments shall be
measured at amortized cost using the effective interest method. In this measurement,
transactions costs will stay the same and they are not deducted anymore.
3.
What are the financial assets 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 measures 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 and loss even if the financial assets satisfy
the amortized cost measurement. This designation is in accordance with Paragraph
4.1.5 of PFRS 9.
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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.
4.
Explain financial asset held for trading.
Financial assets at fair value through profit or loss. One of its two subcategories is
Held for trading. The second category includes financial assets that are held for trading.
All derivatives (except those designated hedging instruments) and financial assets acquired
or held for the purpose of selling in the short term or for which there is a recent pattern of
short-term profit taking are held for trading. [IAS 39.9]
5.
Explain measurement of equity investment at fair value through other comprehensive
income.
Gain or loss on disposal of equity investment measured at fair value through other
comprehensive income is recognized directly in retained earnings in accordance with PRFS
9, paragraph 5.7.1b.
Moreover, the cumulative gain or loss previously recognized in other
comprehensive income is also transferred to retained earnings in accordance with PRFS 9
Application Guidance, paragraph 5.7.1.
Accumulated other comprehensive income (OCI) includes unrealized gains and
losses reported in the equity section of the balance sheet that are netted below-retained
earnings. Other comprehensive income can consist of gains and losses on certain types of
investments, pension plans, and hedging transactions. It is excluded from net income
because the gains and losses have not yet been realized. Investors reviewing a company's
balance sheet can use the OCI account as a barometer for upcoming threats or windfalls to
net income.
6.
Explain measurement of debt investment at amortized cost.
PFRS 9, paragraph 4.1.2, provides that a financial asset shall be measured at
amortized cost if the two conditions were met. First condition is that the business model is
to hold the financial asset in order to collect contractual cash flows on specified date. The
second condition is that contractual cash flows are solely payments of principal and interest
on the principal amount outstanding. To summarize, the financial asset shall be measured
at amortized cost if the business model is to collect contractual cash flows if that cash flows
are solely payments of principal and interest.
7.
Explain measurement of dept investment at fair value through other comprehensive
income.
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PFRS 9, paragraph 4.1.2A, provides that a financial asset shall be measured at their
fair value through other comprehensive income if both of the following conditions are met;
if the business model is achieved both by collecting contractual cash flows and by selling
the financial asset and if the contractual cash flow are solely payments of principal and
interest on the principal outstanding.
8.
Explain the treatment of unrealized gain and loss on financial asset at fair value
through profit or loss.
Unrealized gain or unrealized loss are recognized on the Profit and Loss Statement
and impact the net income of the company although these securities have not been sold to
realize the profits. Securities held as trading securities reported at fair value in the financial
statements. The gains increase in earnings per share and retained earnings. There is no
impact such gains on the cash flow statement. Due to fair value treatment for available for
sale securities the unrealized gains or losses are included in the balance sheet on the asset
side. However, such gains do not impact the net income of the company. The unrealized
gains on such securities are not recognized in the net income until they are sold and profit
is realized.
An unrealized gain is an increase in the value of the investment due to the increase
in its market value. Such a gain is recorded in the balance sheet before the asset has been
sold, and thus the gains are called unrealized because no cash transaction happened. For
securities except for trading securities, the unrealized gains do not impact the net income.
The gains are realized only after selling the asset for cash because it is only when the
transaction has materialized.
9.
Explain the derecognition of financial asset at fair value through profit or loss.
Derecognition is the removal of a previously recognized financial asset from an
entity’s statement of Financial Position. PFRS 9, paragraph 3.2.3, provides that an entity
shall derecognize a financial asset when either one of these criteria is met: the contractual
rights to the cash flows of the financial asset have expired; or the financial asset has been
transferred and the transfer qualifies for derecognition based on the extent of transfer of
risks and rewards of ownership.
10.
Explain the derecognition of equity investment at fair value through other
comprehensive income.
Derecognition is the removal of a previously recognized financial asset from an
entity’s statement of financial position. In general, IFRS 9 criteria for derecognition of a
financial asset aim to answer the question whether an asset has been effectively ‘sold’ and
should be derecognized or whether an entity obtained a kind of financing against this asset
and simply an additional financial liability should be recognized.
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As per Philippine Accounting Standard 9, On derecognition of equity investment
at fair value through other comprehensive income, the amount may be transferred to
retained earnings.
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MULTIPLE CHOICE
1. D
2. D
3. C
4. D
5. A
6. B
7. B
8. B
9. C
10. D
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Chapter 37
Fair Value Measurement
Questions
1.
Define Fair Value.
Fair Value of an asset is the price that would be received to sell an asset in an
orderly transaction between market participants. Fair value of liability is the price that
would be paid to transfer a liability in an orderly transaction between market participant.
2.
What is an orderly transaction?
An orderly transaction is a transaction that allows for normal marketing activities
that are usual and customary.
3.
Explain Market Participants.
The market participants are the buyers and sellers in the principal market who are:
a. Independent or unrelated parties
b. Knowledgeable of having a reasonable understanding of the transaction
c. Willing or motivated but not forced and compelled to enter into the transaction
4.
Define Active market.
PFRS 13 defines an active market as a market in which transactions for the asset
or liability take place with sufficient frequency and volume to provide pricing information
on an ongoing basis.
5.
Define Principle Market.
A principal market is the market with the greatest volume and level of activity for
the asset or liability.
6.
Define most advantageous market.
The most advantageous market is the market that maximizes the amount that would
be received to sell the asset or minimizes the amount that could be paid to transfer a
liability. Generally, the market that an entity enters when it sells an asset or transfers a
liability is the principal market or the most advantageous market.
7.
Explain the valuation premise in measuring fair value.
The valuation premise in measuring or determining the fair value (e.g asset or
liability), an entity may refer to information that is directly observable or readily available.
The entity can also estimate the fair value by using a valuation method. The fair value shall
not be adjusted for transaction cost. If location is a characteristic of an asset, the fair value
shall be adjusted for transport cost that would be incurred to transport the asset from its
current location to the principal or most advantageous market.
In use, select if the asset would provide maximum value to market participants
principally through its use in combination with other assets as a group as installed or
otherwise configured for use. When using an in-use valuation premise, the fair value of the
asset is determined based on the price that would be received in a current transaction to sell
the asset assuming that the asset would be used with other assets as a group and that those
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8.
assets would be available to market participants. On the other hand, in exchange, select if
the asset would provide maximum value to market participants principally on a standalone
basis.
Explain the highest and best use of an asset.
In measuring the fair value or nonfinancial asset, an entity must take into
consideration the highest and best use of the asset.
Highest and best use is defined as the use of nonfinancial asset by market
participants that would maximize the value of asset.
The highest and best use of the asset should possess the following:
a. Physically possible, meaning, it reflects the physical characteristics of an
asset.
b. Legally permissible, meaning, it reflects any legal restrictions on the use of
the asset.
c. Financially feasible, meaning, it reflects whether the use would generate
sufficient income or cash flows.
The highest and best use of the asset might provide maximum value either on a
stand-alone basis, or as a group in combination with other asset and liability.
9.
Explain the three valuations technique in measuring fair value.
a. Market Approach- uses prices and relevant information for market transactions for
identical and comparable asset and liability
b. Income Approach- Focuses on converting future amounts into discounted cash
flows.
c. Cost Approach- relies on the current replacement cost to replace the asset with a
comparable asset.
10.
Explain the fair value hierarchy.
PFRS 13 seeks to increase consistency and comparability in fair value
measurements and related disclosures through a 'fair value hierarchy'. The hierarchy
categorizes the inputs used in valuation techniques into three levels. The hierarchy gives
the highest priority to (unadjusted) quoted prices in active markets for identical assets or
liabilities and the lowest priority to unobservable inputs. Level 1 inputs are quoted prices
in active markets for identical assets or liabilities that the entity can access at the
measurement date. A quoted market price in an active market provides the most reliable
evidence of fair value and is used without adjustment to measure fair value whenever
available, with limited exceptions. If an entity holds a position in a single asset or liability
and the asset or liability is traded in an active market, the fair value of the asset or liability
is measured within Level 1 as the product of the quoted price for the individual asset or
liability and the quantity held by the entity, even if the market's normal daily trading
volume is not sufficient to absorb the quantity held and placing orders to sell the position
in a single transaction might affect the quoted price. On the other hand, Level 2 inputs are
inputs other than quoted market prices included within Level 1 that are observable for the
asset or liability, either directly or indirectly. It includes (a) quoted prices for similar assets
or liabilities in active markets and (b) quoted prices for identical or similar assets or
liabilities in markets that are not active inputs other than quoted prices that are observable
for the asset or liability, for example interest rates and yield curves observable at
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commonly, quoted intervals, implied volatilities, and credit spreads. Lastly, Level 3 inputs
are unobservable inputs for the asset or liability. Unobservable inputs are used to measure
fair value to the extent that relevant observable inputs are not available, thereby allowing
for situations in which there is little, if any, market activity for the asset or liability at the
measurement date. An entity develops unobservable inputs using the best information
available in the circumstances, which might include the entity's own data, considering all
information about market participant assumptions that is reasonably available.
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MULTIPLE CHOICE
1. B
2. A
3. D
4. D
5. C
6. C
7. B
8. A
9. B
10. B
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