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CHAPTER 19
FINANCIAL ASSET AT
AMORTIZED COST
Bond investment
Definition
A bond is a formal unconditional promise made under the law to pay a specified sum of money at a determined future date, and make a periodic interest payment at a stated rate until the principal amount is paid. A bond is evidenced by a certificate and an agreement between the issuer and the investor.
Interest payment date
The interest on bond investments is usually paid every six months or semi- annually. The dates are as follows: a. January 1 and July 1 d. April 1 and October 1 b. February 1 and August 1 e. May 1 and November 1 c. March 1 and September 1 f. June 1 and December 1 Note: There are interests that is only paid every annually or once a year.
Classifications of bond investments
Bonds can be a current or a noncurrent investment depending on the model of business. Accordingly, bond investments are classified and accounted for as follows:
a. Financial asset held for trading b. Financial asset at amortized cost c. Financial asset at fair value through other comprehensive income d. Financial asset at fair value through profit or loss by irrevocable designation or by fair value option Initial measurement PFRS 9, paragraph 5.1.1, bond investments are recognized initially at fair value plus transactions costs that are directly attributable to the acquisition. On the other hand, in cases of bond investments held for trading, transaction costs must be expensed immediately. Subsequent measurement Subsequent to initial recognition, bond investments are measured and accounted for as follows: a. At fair value through profit or loss b. At amortized cost c. At fair value through other comprehensive income Acquisition of bond investment Bonds may be acquired on interest date or between interest dates. The two dates differ greatly in terms on recognizing the carrying amount of the bonds acquired. When bonds are acquired on interest date , there is no accounting problem since the entity will recognize the purchase price as the acquisition cost. When bonds are acquired between interest dates , meaning the date of acquisition is not any one of the interest dates, therefore, the purchase price includes the accrued interest.
Investment in bonds 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. Amortized cost is the initial recognition amount of the investment acquired less repayments, plus amortization of discount, minus amortization of premium, and minus reduction for impairment or the amount that cannot be collected.
Amortization of premium or discount
Amortized cost shall be used in measuring the investment in bonds. This simply means that the discount and premium on the acquisition long-term investment in bonds shall be amortized. The premium or discount is amortized over the life of the bonds. Amortization is done through the interest income account. a. Amortization of bond premium: Interest income x x Investment in bonds x x b. Amortization of bond discount: Investment in bonds x x Interest income x x
Note: Amortization may be made on interest dates stated in the contract or at the end of the entity’s reporting period. It is more convenient to record amortization at the end of the reporting period.
Why do we amortize?
The reason bond premium or discount is amortized is to bring the carrying amount of the investment to face amount on the date of maturity.
Sale of bonds prior to maturity
When investments in bonds are sold before the date of maturity, the entity is required to determine the carrying amount that will be used in determining whether there is a gain or loss on the sale. In these cases, amortization of the premium or discount should be recognized up to the date of sale. If the sale is made in between the interest dates, like explained in previous pages, the sale price normally includes the accrued interest. Accordingly, the portion of the sales intended to cover for the accrued interest shall be recorded as interest income.
Callable Bonds
Callable bonds are those which may be called in or redeemed by the issuing entity prior to their date of maturity. Usually, the call price of the said bonds is at a premium or greater than the face amount of the bonds.
TRUE OR FALSE (THEORIES)
- A bond is a formal unconditional promise made under the law to pay a specified sum of money at a determined future date.
- A bond is evidenced by a certificate and an agreement between the issuer and the investor.
- Semiannual means every 3 months.
- When bonds are acquired between interest dates, there is no accounting problem since the entity will recognize the purchase price as the acquisition cost.
- When bonds are acquired on interest date, meaning the date of acquisition is not any one of the interest dates, therefore, the purchase price includes the accrued interest.
- When bonds are acquired between interest dates, meaning the date of acquisition is not any one of the interest dates, therefore, the purchase price includes the accrued interest.
- Instead of recording the interest as accrued interest receivable, the entity can record it simply as interest income.
- Amortized cost is the initial recognition amount of the investment acquired plus repayments, less amortization of discount, minus amortization of premium, and minus reduction for impairment or the amount that cannot be collected.
- When investments in bonds are sold before the date of maturity, the entity is required to determine the carrying amount that will be used in determining whether there is a gain or loss on the sale. 10.If the sales are made between interest dates. The interest must not be included in the sales price. 11.These bonds are those which give the bondholders the right to exchange their bonds for shares of the issuing entity at any time before the maturity of the bond. 12.Serial bonds are similar to installments. 13.Term bonds mature on a single date. 14.Straight line method uses a decreasing amount of amortization at every accounting period. 15.Effective interest method Provides an increasing amount of amortization.
Problem 19-
On January 1, 2018, Luffy Company paid P2,470,000 of 10% 20-year bonds with a face amount of 2,000,000. The bonds were purchased to yield 4%. The effective interest method is used to recognize interest income from this long-term investment. What is the carrying amount of the investment in bonds on December 31, 2018? a. 2,477, b. 2,368, c. 2,670, d. 2,272,
Problem 19-
On January 1, 2019, Celebi Company purchased bonds with face amount of P9,000,000 for 8,540,000 as long-term investment. The stated rate on the bonds is 10% but the bonds are acquired to yield 12% The bonds mature at the rate of P2,000,000 annually every December 31 and the interest are payable annually at the same date. The entity used effective interest method of amortizing discount. What is the interest income for 2018? a. 900, b. 1,080, c. 980, d. 1,024,
