Ch.

8: Part A

Investments:
Textbook pages 509 – 535 (Covered in 3 parts: Part A, B, and C)

Intermediate Accounting I

Dr. Charles Kang

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 Slide 2

Accounting for Investments Under IFRS 9

Reporting approaches used for investments differ

according to how the approaches account for one or more
of the four critical events

Holding the
investment during
Purchasing the Recognizing Selling the
periods in which
investment investment revenue investment
investment’s fair
value changes

In the application of IFRS 9, companies have to determine if an

investment falls in one of three categories:

Amortized FVOCI
FVTPL
Cost (AC)

only applicable to Investments

in Debt Security 2
 Slide 3

Decision Flow Under IFRS 9--Debts

Accounting for instruments under IFRS 9
follows two critical tests

Contractual Cash Flow Business Model (BM) test

(CCF) test

Are the contractual cash What is the objective of

flows from the instrument the business model in
solely principal and interest managing the contractual
on principal outstanding? cash flows of the
instrument?

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 Slide 4

Decision Flow
Under IFRS 9:
Debt
Security
Key points:
1. If held to collect CCF,
then AC method;
2. If Non-AC, then usually
FVOCI;
3. If Non-AC, only under
special “accounting
mismatch” term, it could
be FVTPL.

No Worries: In this course,

the question will tell you if the
investments are AC, FVOCI,
or FVTPL  4
 Slide 5

Contractual Cash Flow Test

Are contractual cash flows from the instrument solely
repayment of principal and interest on principal?
Yes No

Business model test Is the instrument

equity in nature

Element of Interest

Time Basic Profit

Credit risk
value of lending margin for Interest
premium
money costs lending

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 Slide 6

Business Model Test—Debt Securities

Business Measurement
Prerequisite
model basis

Hold to collect
Amortized cost
CCF

Must have
Hold to collect
passed the CCF FVOCI
CCF and to sell
test

All others
FVTPL
(Hold to sell)*
*Implied

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 Slide 7

1. Amortized Cost Investments

• Bonds
• Unquoted Securities
• Loans
• Notes Receivables, etc.
For this course, we will mainly focus on bonds.

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 Slide 8

Debt Securities (e.g., bonds)

At Debt Issuance Date
Company Selling Price Investor
Issuing Debt Buying Debt
Securities Certificate Securities

Subsequent Periods
Company Interest Payments Investor
Issuing Debt (1) Principal Payment at Buying Debt
Maturity
Securities
(2) Sell debt
Other securities
Investors before maturity 8
 Bonds [Amortized Cost Method]
Bonds are a special type of loans. The issuing company issues a bond
at a certain Face Value.

At the maturity date, the issuing company pays the bond

holders the Face Value.

The bond-holders also receive semi-annual coupon (interest)

payments.

PV{all the expected coupon payments} + PV{the Face Value to be

received at the maturity date} is the price of the bond today. This is
the price that an investor/bond-holder needs to pay.

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 Bonds at Par, Discount Bond, Premium Bond
If bond’s coupon rate is the same as the required market interest
rate, then bond’s current price is exactly equal to the bond’s Face
Value. The bond is sold at Par. The semi-annual coupon payments
cover the interest rate required by the investors.

If bond’s coupon rate is lower than the required market rate, then
bond’s current price is lower than the bond’s Face Value. The bond
is sold at a discount.

If bond’s coupon rate is higher than the required market rate, then
the bond is more attractive to the investors. So the bond’s current
price is higher than the bond’s Face Value. The bond is sold at a
premium.
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 Interest receipt, interest revenue, and
amortization of discount /premium
Conditions Interest revenue (i.e., accrued interest)
= YTM × [1/2] × Carrying value at the start of
a period
YTM = Coupon rate Interest receipt (i.e., cash interest)
YTM > Coupon rate Interest receipt + Amortization of discount
YTM < Coupon rate Interest receipt – Amortization of premium

1) YTM = Yield to maturity = Effective interest rate = Market

interest rate for similar bonds
2) Amortization of discount = The unreceived portion of
interest revenue (i.e., a reinvestment in the investment)
3) Amortization of premium = The unaccrued portion of
interest receipt (i.e., an early realization of the investment)
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Realized vs. unrealized gains (losses)
• Gains (losses) on the sale of investment
– Gains (losses) = selling price – amortized cost
– Recorded in the income statement

• Unrealized holding gains (losses)

– Not recorded in the income statement for AC
securities.
– Rationale:
• AC classification presumes that an entity does not
intend to sell the bonds before maturity; therefore,
• Unrealized changes in market prices before maturity
are irrelevant to the entity’s performance 12
 Slide 13

Example: Bond Securities (AC)

On Jan. 1, 2012, Matrix Ltd purchased a bond with $1,000,000
face value, 10% coupon rate, 10-year maturity, and interest paid
semi-annually. The market interest rate for similar bonds is 12%.
Matrix decided to hold the bond to maturity. In December 2012,
the credit rating of the issuer was dropped from BBB+
(investment grade) to BB (speculative grade). To avoid further
credit losses, Matrix sold the bond for $800,000 of cash on Dec.
31, 2012.
Required:
1) Determine the price of the bond issue on Jan. 1, 2012. Use
relevant present value tables in our textbook.
2) Prepare journal entries during 2012.

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 Slide 14

Example: Bond Securities (AC)

Required 1) Determine the price of the bond issue on
Jan. 1, 2012.

$1M*10%*[1/2] Amount PV Factor Present

Value
Interest $ 50,000 × 11.46992 = $573,496
Principal 1,000,000 × 0.31180 = 311,805
Bond price $885,301

PV of an ordinary annuity of $1, PV of $1, n = 10×2 = 20,

n = 10×2 = 20, i = 12%/2 = 6% i = 12%/2 = 6%
(Table 4, Appendix) (Table 2, Appendix) 14
 Slide 15

Example: Bond Securities (AC)

Required 2) Prepare journal entries during 2012.

(a) Record the acquisition of the bond on Jan. 1, 2012

• Carrying value of the bond at the date of purchase
= $885,301
• Discount on the bond
= $1,000, 000 (Face Value) – $885,301 (Carrying amount)
= $114,699

Dr. Investment in bonds 1,000,000

Cr. Discount on bond Investment 114,699
Cr. Cash 885,301
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 Slide 16

Example: Bond Securities (AC)

(b) Record investment revenues on 6/30 and 12/31

Interest Interest Discount Unamortized Carrying

Date receipt Revenue Amortization Discount amount

1/1 114,699 885,301

6/30 50,000 53,118 (3,118) 111,581 888,419

Interest receipt = $1,000,000 x 10% (coupon rate) x ½ = 50,000

Interest revenue = 885,301 (1/1 carrying value) x 12%
(yield-to-maturity) x ½ = 53,118
Discount amortization = 53,118 – 50,000 = 3,118
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 Slide 17

Example: Bond Securities (AC)

(b) Record investment revenues on 6/30 and 12/31

Interest Interest Discount Unamortized Carrying

Date receipt Revenue Amortization Discount amount
1/1 114,699 885,301

6/30 50,000 53,118 (3,118) 111,581 888,419

12/31 50,000 53,305 (3,305) 108,276 891,724

Interest receipt = $1,000,000 x 10% (coupon rate) x ½ = 50,000

Interest revenue = 888,419 (7/1 carrying value) x 12%
(yield-to-maturity) x ½ = 53,305
Discount amortization = 53,305 – 50,000 = 3,305
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 Slide 18

Example: Bond Securities (AC)

6/30/2012: Record investment revenue
Dr. Cash 50,000
Dr. Discount on bond Investment 3,118
Cr. Investment revenue 53,118

12/31/2012: Record investment revenue

Dr. Cash 50,000
Dr. Discount on bond Investment 3,305
Cr. Investment revenue 53,305

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 Slide 19

Example: Bond Securities (AC)

(c) Record gain (loss) on the sale of investment on
12/31/2012
Gain (loss) on the sale of bond at 12/31/2012
= $800,000 (selling price) – $891,724* (amortized cost)
* 1,000,000 (face value) – 108,276 (unamortized discount)
= $(91,724)

12/31/2012: Record gain (loss) on sale of investment

Dr. Cash 800,000
Dr. Discount on bond Investment 108,276
Dr. Loss on sale of bond investment 91,724
Cr. Investment in bond 1,000,000
This example is a rare case. Generally, AC securities are NOT sold before
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maturity.
Example: Bond Discount Amortization Schedule
To solve questions about AC investments, you need to know how to prepare a
discount/ premium amortization schedule. Financial calculators do not really help
here. It is tedious work. Hopefully, you will only need to write out the first few lines.
Here is an example of a complete amortization schedule of Discount on Bond.

KC Company purchased $100,000 of 8 percent bonds of Evermaster

Corporation on January 1, 2009, at a discount, paying $92,278. The
bonds mature January 1, 2014 and yield 10%; interest is payable each
July 1 and January 1. KC records the investment as follows:

January 1, 2009

Investment in bonds 100,000

Discount on bond investment 7,722
Cash 92,278
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Schedule of Interest Revenue and Bond Discount Amortization:
Effective-Interest Method
July 1, 2009 Journal Entry: Cash 4000
Discount on Bond 614
Interest Revenue 4614

(M/D/Y)

The value of bond investment is

increasing with time. It will
become $100,000 at maturity. 21
 Amortized Cost (AC) Investments:
Do-It-Yourself-Exercise (Solutions provided separately)
Tanner-UNF Corporation acquired as a long-term investment $240 million of quoted 6% bonds,
dated July 1, on July 1 2012. Company management has the positive intent and ability to hold
the bonds until maturity. The market interest rate (Yield) was 8% for bonds of similar risk and
maturity. Tanner-UNF paid $200 million for the bonds. The company will receive interest
semiannually on June 30 and December 31. As a result of changing market condition, the fair
value of the bonds at December 31, 2012, was $210 million.
Requirement #1: Prepare the journal entry to record Tanner-UNF’s investment in
bonds on July 1, 2012.
Requirement #2: Prepare the journal entry to record interest payment on December
31, 2012, at the effective interest rate.
Requirement #3: At what amount will Tanner-UNF report its investment in the
December 31, 2012, statement of financial position (i.e., Balance Sheet)? Why?

Requirement #4: Due to an unexpected credit-rating downgrade, Tanner-UNF sells the

investment on January 2, 2013 for $190 million. Prepare the journal entry.

Requrement#4.2: Suppose the selling price was $203 million instead of $190 million.
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Prepare the journal entry for selling the bond investments for $203 million.