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INVESTMENTS AT FAIR VALUE (Equity securities, less than 20% of voting power)
FAIR VALUE THROUGH PROFIT FAIR VALUE THROUGH OTHER
OR LOSS COMPREHENSIVE INCOME
A.) Initial recognition Purchase price xx Purchase price xx
Less: Dividends-on* (xx) Add: Transaction costs xx
Note: Items with no available Cost of investment xx Total xx
fair value data are Less: Dividends-on (xx)
appropriately classified as *Dividends that have accrued Cost of investment xx
nonmarketable securities, on the investment because the
having the same initial purchase of the same was Examples of transaction costs
recognition as FA-OCI. made between the date of are brokerage fees and
declaration and date of record. commission expenses.
*Notes on disposal:
- For FA-OCI, the gain or loss on disposal shall be charged directly to RE. Furthermore, the related
unrealized gain or loss previously recognized in OCI shall also be charged or credited to RE, as the
case may be. Recall that the unrealized gain or loss presented in OCI is the net amount. Suppose
that the total investments of the company has a net unrealized gain, but for a specific investment,
the corresponding change is an unrealized loss. If such specific investment shall be disposed of,
the related loss now becomes realized, and accordingly, a debit to RE is necessary. However, since
an unrealized gain was presented in the OCI, the same shall be credited, and not unrealized loss.
2.) Exchange
- The initial valuation of the asset received (or debited) shall be, in order of priority:
a.) Fair value of the asset given up, plus any cash payment
b.) Fair value of the asset received, minus any cash payment
c.) Carrying amount of the asset received
- So, if the shares were exchanged for, say, a land, the land shall be valued at the fair value of
the shares (the asset given up) at the time of exchange, if available.
- In the settlement date, the investment must be valued at the fair value on such date. Thus,
under trade accounting, the change in fair value must be accounted for, while under settlement
date accounting, the investment is directly credited to its fair value. Regardless of the method
used, the cash paid must be fixed at its cost on the date of commitment.
- If the investment is a financial asset at amortized cost, then no changes in fair value must be
accounted for and the purchase is recorded in the usual manner (i.e. recorded at commitment
date under trade date accounting as a payable, and at settlement date under settlement date
accounting as direct cash payment)
2. Sale transaction: On December 1, 2016, the company committed to sell investment worth 10 000.
Its fair value on the commitment date is 10 100, at year-end, 10 200, while on January 5, 2016,
settlement date, 10 400.
- Watch out on investments at FVTOCI! Upon disposal, its related unrealized gain or loss shall be
credited or charged to retained earnings.
- For investments at amortized cost, the sale is recorded in the usual manner, depending on the
method used (i.e. recorded at commitment date under trade date accounting as receivable, and at
settlement date under settlement date accounting as direct cash received)
DIVIDENDS
1.) Dividends out of earnings
a. Share or stock dividends
- If the shares received as dividends are of the same class with the shares owned, then this is
recorded as a memorandum entry only. Total cost remains the same, but unit cost decreases
while the number of shares increases.
- If the shares received as dividends are of a different class with the shares owned, then the
shares dividends of a different class will be valued using the relative fair value method. The
cost of the investment owned is prorated using the fraction from the fair values of both the
shares owned and share dividends. This is basically a reclassification from the class of the
shares owned to the class of the shares received as dividends.
- If the corporation is not a wasting asset company, then one-time liquidation should be done.
Upon receipt of cash from the investee company, the entire investment is derecognized and a gain
or loss on liquidation is recognized.
STOCK SPLIT
- A memorandum entry is sufficient
SPECIAL ASSESSMENT
- These are additional capital contribution of the shareholders. Accordingly, this needs a debit to
investment and credit to cash. The cost of the investment is increased but the number of shares
remains the same. It follows that cost per share also increases.
STOCK RIGHT
Fair value thru P/L Fair value thru OCI
Accounting Not accounted for separately, Accounted for separately
treatment
Issuance Memorandum entry Stock rights are recognized thru debit
to stock rights and credit to the
investment account*
Upon exercise Debit investment and credit cash, The total investment to be debited
(credit to cash is valued at the subscription price shall be the subscription price paid
the same) and the cost of stock rights exercised
Upon expiration No entry Debit loss on stock rights and credit
stock rights
*Note that the cost of the investment account shall be decreased by the value of the stock rights
issued. The valuation of the stock rights upon their issuance shall be dependent on the following info:
1.) If the market value per right is given, use it!
2.) If no market value per right is available, use the theoretical value of the rights.
a.) When the stock is selling right-on (between the date of declaration or approval of the
issuance of the stock rights and the date of record or the actual issuance of the stock rights)
Value of one right = Market value of stock right-on minus subscription price
Number of rights to purchase one share PLUS 1
b.) When the stock is selling ex-right (between the date of record or the actual issuance of the
stock rights and the date of their expiration)
Value of one right = Market value of stock right-on minus subscription price
Number of rights to purchase one share
2. INVESTMENT IN ASSOCIATE (Equity securities, More than 20% but less than 50%)
Default presumption: Investors holding 20% or more of the voting power of the investee company are
deemed to have significant influence, and their investments shall be accounted for under the equity
method of accounting.
*The fair value of the net assets of the investee company shall be multiplied by the
percentage ownership of the investor to get the share of the latter in the fair value. The
goodwill and any under- or overvalued items are not recognized separately.
Note: If the cost of the investment is less than the share in the fair value of the net assets,
the resulting negative goodwill shall be treated as excess of net fair value over cost, which
shall be accounted for as an increase in both the investment account and the investment
income for the period (i.e. debit investment, credit investment income)
B. Subsequent to acquisition
Note: Formulas labelled with share imply that the overall amount of the item is multiplied by the
applicable percentage ownership of the investor.
Notes:
1.) Adjustments to net income of investee
- For depreciable assets, the under- or overvaluation, not the entire fair value, shall be
amortized over the remaining useful life of the asset, or liability.
- Inventory is assumed to have been sold within the year, and thus, the entire under- or over-
valuation is deducted or added, respectively, from net income.
- For non-depreciable items (e.g. land), the entire under- or over-valuation shall only be
deducted or added from net income when they are sold to third parties. Note that the related
gain or loss on sale is ignored since it was already considered in the computation of net
income of the associate/investee.
- If the preference shares are treated as a financial liability (as in the case of redeemable
preference shares), the related dividends are NOT ANYMORE deducted from net income, since
it is already deducted as interest expense.
Notes:
1.) Common adjustments
- The net investment computed above shall be added to the cost of the investment.
- Dividends are viewed as a return of investment, and thus it decreases the investment
account. Note that the dividends attributable to the investor shall be deducted.
2.) PPE
A.) Unrealized gain: This is the entire difference between the cost on the books of the seller
and the selling price. The unrealized gain shall only affect net income on the year when the
upstream sale happened. On subsequent years, this unrealized gain is now irrelevant, and
does not affect the net income anymore. This is applicable both to depreciable and non-
depreciable assets.
B.) Realized gain: This is the portion of the unrealized gain which is amortized.
- Depreciable assets: Unrealized gain is amortized over the remaining useful life of the
asset sold. This affects net income throughout the useful life of the asset, compared to
unrealized gain which affects net income only on the year of sale.
- Non-depreciable assets: The entire unrealized gain is realized only when this is sold to
third parties. This is not amortized. As long as this remains in the ownership of the
purchaser, this does not affect the net income of the subsequent years.
D. Special cases
1.) Investment in associate achieved in stages (e.g. investor initially purchases 10% of the voting
power of the investee, and then purchases another 20% interest. Since the total interest is 30%, it
should now be accounted for under equity method)
Note: Upon reclassification, the excess of cost over book value (attributed to under- or overvalued
assets and goodwill) is computed as follows:
Fair value of the original investment (e.g. 10%) xx
Cost of the additional investment (e.g. 20%) xx
Total investment in associate xx
Less: Book value of the net assets acquired (e.g. at 30%) (xx)
Excess attributable to under- or overvalued assets and goodwill xx
Notes:
- The investment in associate must be updated as of the date of sale. Accordingly, all net
income accrued and the amortization of the excess (which are prorated) shall be adjusted to the
carrying amount of the investment.
- If there is no available market value on the securities, then the remaining investment shall
be accounted for under the cost method. Accordingly, the reclassification shall yield NO gain or
loss on reclassification. Changes in fair value are ignored!
- Exhaust first the balance of the investment in associate, and then the investment in preference
shares, and lastly the long-term unsecured receivables. Charge share in the net loss to loss from
investment account.
- Suppose that the share of the investor of the loss for the period is 300 000, but the remaining
interest is only 100 000, then the loss recorded shall only be for 100 000, and the remainder shall be
disclosed as an unrecorded loss. This unrecorded loss shall be accumulated until such time that the
investor will report any profits.
- If the associate subsequently reports profits, then the investor resumes recognizing its share of the
profits, only after deducting all unrecorded loss from the share in profit. The first amount to be
recovered (i.e. account to be debited concurrent with the credit to investment income) shall be the
last amount deducted when there was a share in the net loss: (a) first to long-term receivables, (b)
then investment in preference shares, (c) and lastly investment in associate.
Debt securities can be accounted for thru fair value thru profit or loss or at amortized cost.
1.) AT FAIR VALUE THRU P/L (e.g. trading bond investments, or irrevocably designated at FVTPL)
Salient points to remember.
- Investment in bonds may be acquired (a) on or (b) between interest dates.
(a) On interest date: the bonds are recorded initially at its quoted price (usually shown as a
percentage of the face amount, e.g. 98 or 102)
(b) Between interest date: the bonds are recorded at its quoted price LESS any accrued
interest income from the date when interest are paid to the date when the bonds are acquired.
Note: Under both dates, the cash received shall always be equal to the quoted price.
Suppose on April 1, 12% bonds w/ face amount of 10 000 were acquired at 120. Interest is
paid annually on Dec. 31. The accrued interest on the date of acquisition may be debited as:
*If the investment is sold in between interest dates (there is an accrual of interest
income), this shall be deducted from the consideration received, and is separately
recognized as a credit to interest income or receivable in the journal entry. Suppose,
interest payment is made at year-end. If the investment is sold during the year, say on
July 1, interest income from January to June should be recognized.
2.) AT AMORTIZED COST
Under PFRS 9, bond investments shall be classified as financial assets at amortized cost using the
effective interest method.
Term bonds
Date Int. received Int. income Amortization Carrying amount
1/1 This is nominal This is the This is the If this is lower than the face
rate multiplied by effective rate difference (i.e. discount), amortization
the face of the multiplied by the between interest increases the value. If greater
bonds carrying amount received and (i.e. premium), amortization
investment. of the bonds. interest income. decreases the value.
Technique: Nominal rate: 10%, Effective rate: 12%. To arrive at the carrying amount of the next
period: [Carrying amount current period x 1.12 (Face amount x 0.10) (Principal collection, for
serial bonds)]. This is applicable whether the acquisition resulted to a bond discount or bond premium.
b.) For serial bonds (bonds payable in installment) The total collection per year (principal
and interest, which is decreasing since principal is decreasing) shall be discounted using the
effective interest rate
B. Subsequent recognition
- Construct the table above for ease and convenience in computing this. The entries to record interest
income may be compounded as follows:
DISOCUNT PREMIUM
Cash xx Cash xx
Investment in bonds xx Interest income xx
Interest income xx Investment in bonds xx
Notes:
- Refer always to the table. The cash is debited based on the amount of interest received. The
interest income is credited based on the interest income. The debit or credit to investment in bonds is
the amortization, or simply, a balancing figure.
*The carrying value of the bonds sold shall be updated as of the date of the sale. Thus, the
related amortization shall be prorated and is added if discount or deducted if premium on the
carrying amount as of the last interest date (i.e. date of payment of interest).
COMPREHENSIVE ILLUSTRATION
Jan. 1, 2016: 5 000 000 face value. 6% nominal interest, 8% effective yield. Carrying amount on Jan.
1 is 4 742 000.
Dec. 31, 2016: The bonds are quoted at 105.
October 1, 2017: 1/2 of the investment were sold at 110 plus accrued interest.
Dec. 31, 2017: The bonds are quoted at 112.
Notice that the differences between the plus and the including are the figures for cash and gain
or loss on sale. Nothing more, nothing less!
Illustration. Date of sale, Jan. 1, 2016. Face amount, 5 000 000. Selling price, 4 760 000, including
transaction costs of 160 000. Term, 3 years. Nominal rate, 10%. Effective rate, 12%. Interest is paid
every Dec. 31. The bonds are quoted at 102 and 105 on Dec. 31, 2016 and 2017. The bonds are sold
on June 30, 2018 at 110.
1/1/16 FA-FVTOCI 4 760 000 Note: Transaction costs are always capitalized under
Cash 4 760 000 fair value thru other comprehensive income.
12/31/16 Cash 500 000 Note: Interest income under FVTOCI shall be
FA-FVTOCI 71 200 recognized using the effective interest method.
Int. income 571 200 After, the change in fair value shall also be
accounted for.
FA-FVTOCI 268 800 FV, 12/31/16 5 100 000
UG OCI 268 800 CA, 12/31/16 4 831 200
Unrealized gain 268 800
12/31/17 Cash 500 000 Note: Even with the change in the carrying amount
FA-FVTOCI 79 744 of the bonds to 5.1M, the amortization shall still be
Int. income 579 744 based on the table originally constructed.
FV, 12/31/17 5 250 000
FA-FVTOCI 70 526 CA per table 4 910 944
UG OCI 70 526 Cumulative UG 339 056
Less: UG last year 268 800
Unrealized gain 70 526