INVESTMENTS

ZOE REGINA CASTRO

Financial instruments

• Financial instrument is “any contract that gives rise to a financial

asset of one entity and a financial liability or equity instrument of
another entity.” (PAS 32)
• Financial instruments include both financial assets and financial
liabilities.
• Financial instruments include equity instruments of another entity
but exclude an entity’s own equity instruments. An entity’s own
equity instruments are neither assets nor liabilities, but rather
equity.
 Financial assets

A financial asset is any asset that is:

a. Cash;
b. Equity instrument of another entity; or
c. Contractual right to receive cash or another financial asset or to
exchange financial instruments with another entity under
conditions that are potentially favorable.
Financial liabilities
A financial liability is any liability that is:
a. a contractual obligation to deliver cash or another financial
asset to another entity; or
b. a contractual obligation to exchange financial instruments with
another entity under conditions that are potentially unfavorable.
Initial recognition and Classification

• Financial assets are recognized only when the entity

becomes a party to the contractual provisions of the
instrument.
Basis of classification

Financial assets are classified based on:

1. the entity’s business model for managing the financial assets; and
2. the contractual cash flow characteristics of the financial asset.
Equity vs. Debt instruments

• Only debt instruments can be classified under the Amortized Cost or

FVOCI (mandatory) measurement categories.
• Equity instruments are measured at FVPL, unless the entity makes an
irrevocable election on initial recognition to measure them at
FVOCI.
• A debt instrument that is not measured at amortized cost or at
FVOCI is measured at FVPL.
Business models
Business models
Business models
Business models
Fair Value Measurement
• Fair value 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.” (PFRS 13)
• Fair value is based on the market price of the asset in a:
a. principal market; or
b. the most advantageous market (in the absence of a
principal
market)
• The market price used in measuring fair value is not adjusted for
any transaction costs, but is adjusted for any transport costs.
Formula

Market price (in ‘principal’ or ‘most

advantageous’ market) xx
Less: Transport costs (xx)
Fair value xx

INTERMEDIATE ACCTG 1A (by: MILLAN)

 Fair value hierarchy
Level 1 Observable inputs that reflect quoted prices
for identical assets or liabilities in active Most reliable
markets.

Level 2 Inputs other than quoted prices included in

Level 1 that are observable for the asset or
liability either directly or through
corroboration with observable data.

Level 3 Unobservable inputs (for example, an Least reliable

entity’s own data or assumptions).

INTERMEDIATE ACCTG 1A (by: MILLAN)

 INVESTMENT IN DEBTS
SECURITIES
Account for financial assets measured at amortized cost.
Explain the accounting for discounts and premiums.
Account for financial assets measured at FVOCI
(mandatory).
Bonds

• Bonds are long-term debt instruments similar to term loans

except that they are usually offered to the public and sold to
many investors.
• Bond indenture is the contractual arrangement between the
issuer and the bondholders. It contains restrictive covenants
intended to prevent the issuer from taking actions contrary to
the interests of the bondholders. A trustee, often a bank, is
appointed to ensure compliance.

INTERMEDIATE ACCTG 1A (by: MILLAN)

Types of bonds
• Term bonds – bonds that mature on a single date.
• Serial bonds – bonds that mature in a series of maturity dates.
• Registered bonds – bonds issued in the name of the holder (owner). Interest payments
are sent directly to the holder.
• Coupon (bearer) bonds – bonds that can be freely transferred and have a
detachable coupon for each interest payment.
• Zero-coupon bonds (strip bonds) – bonds that do not pay periodic interests. Principal
and compounded interest are due only at maturity date.
• Callable bonds – bonds containing call provisions giving the issuer thereof the right to
redeem the bonds prior to their maturity date.
• Convertible bonds – bonds giving the holder thereof the option of exchanging the
bonds for shares of stocks of the issuer.

INTERMEDIATE ACCTG 1A (by: MILLAN)

Accounting for investments measured at
amortized cost

• The accounting for investments in bonds that are measured at

amortized cost is similar to the accounting for notes and loans
receivables, in the sense that it also involves the following:
a. Present value computations
b. Preparation of amortization table (Effective interest method)

INTERMEDIATE ACCTG 1A (by: MILLAN)

Discount vs. Premium

• If the carrying amount is less than the face amount, the difference
represents a discount.
• If the carrying amount is more than the face amount, the difference
represents a premium.
• If there is a discount, the EIR is higher than the NIR.
• If there is a premium, the EIR is lower than the NIR.
• Discount or premium is amortized using the effective interest
method.

INTERMEDIATE ACCTG 1A (by: MILLAN)

Effect of discount amortization
You have acquired a bond with face amount of ₱5,000 for ₱4,000.
➢ Would this be favorable or an unfavorable on your part?
➢ Favorable. Why? --- You will be collecting ₱5,000 (excldg. interest) while your cash
outflow is only ₱4,000.
➢ On acquisition date, it seems you have earned a “gain” of ₱1,000 right?
➢ Yes; however, the PFRSs prohibit you from recognizing this “gain” outright. You need
to amortize it over the term of the bond.
➢ The “gain” represents the discount (Carrying amt. less than Face amt.).
➢ The effect of the amortization is an increase in interest income.
➢ Over the term of the bonds, total interest income will be greater than total
collections of interests by ₱1,000.

INTERMEDIATE ACCTG 1A (by: MILLAN)

Transaction costs

• Transaction costs incurred in the acquisition of bonds to be

measured at amortized cost are included as part of the cost of the
investment.

INTERMEDIATE ACCTG 1A (by: MILLAN)

Sale of bonds prior to maturity

• When bonds are sold prior to maturity, the difference between the
net disposal proceeds and the carrying amount of the bonds,
adjusted for any discount or premium amortization up to date of
disposal, is recognized as gain or loss in profit or loss.

INTERMEDIATE ACCTG 1A (by: MILLAN)

Serial bonds

• Serial bonds are bonds with series of maturity dates. Serial bonds
are accounted for similar to term bonds. However, the periodic
collections on serial bonds include not only collections for interests
but also collections for principal.

INTERMEDIATE ACCTG 1A (by: MILLAN)

Zero-coupon bonds

• Zero-coupon bonds are bonds that do not pay

periodic interests. Both principal and interest are due
only at maturity date.

INTERMEDIATE ACCTG 1A (by: MILLAN)

Financial assets measured at FVOCI (mandatory)

• Initial measurement: Fair value + Transaction costs.

• Subsequent measurement: Fair value
• Changes in fair value are recognized in OCI.
• Impairment losses and gains are recognized in profit or loss.
• Interest revenue is computed using the effective interest method and is
recognized in profit or loss.
• Derecognition: When the asset is derecognized, the cumulative
balance of gains and losses in equity are transferred to profit or loss
as a reclassification adjustment.
• The amounts recognized in profit or loss for a debt instrument
measured at FVOCI are the same as the amounts that would have
been recognized in profit or loss if the debt instrument had been
measured at amortized cost.
INTERMEDIATE ACCTG 1A (by: MILLAN)
 INVESTMENT – OTHER
CONCEPTS
Account for regular way purchase or sale of financial assets.
Account for the reclassification of financial assets.
Account for the impairment of financial assets measured at FVOCI
(mandatory).
Account for dividends received from investments.
Account for stock rights.
State the types of risks that are disclosed in the financial statements.
Regular way purchase or sale of financial assets

• A regular way purchase or sale is a purchase or sale of a financial

asset under a contract whose terms require delivery of the asset
within the time frame established generally by regulation or
convention in the marketplace concerned.
• Trade date accounting vs. Settlement date accounting
a. Under trade date accounting, the financial asset purchased (s0ld)
is recognized (derecognized) at the trade date (i.e., the date the
entity commits to purchase or sell the financial asset).
b. Under settlement date accounting, the financial asset purchased
(s0ld) is recognized (derecognized) at the settlement date (i.e., the
date the ownership of the financial asset is transferred).
Fair value change between trade date & settlement date

• For purchases of FVPL and FVOCI assets (but not amortized cost),
the buyer recognizes the change in fair value between the trade
date and the settlement date.
• For sale transactions, the seller does not recognize the change in
fair value between the trade date and the settlement date.
Reclassification

• After initial recognition, financial assets are reclassified only when

the entity changes its business model for managing financial
assets.

• Reclassification date is the first day of the first reporting period

following the change in business model that results in an entity
reclassifying financial assets.
Reclassification of debt-type financial assets
Reclassification of debt-type financial assets
Notes on reclassification

• Only debt instruments can be reclassified. Equity instruments (e.g.,

investments in shares of stocks) cannot be reclassified.
• Financial assets cannot be reclassified into or out of the “designated
at FVPL” and “FVOCI - election” classifications.
• The initial measurement is fair value at reclassification date, except
for a reclassification from FVOCI to Amortized cost where the fair
value on reclassification date is adjusted for the cumulative
balance of gains and losses previously recognized in OCI.
Impairment

• The impairment requirements of PFRS 9 apply equally to debt-type

financial assets that are measured either at amortized cost or at
FVOCI.
• Impairment gains or losses on debt instruments measured at FVOCI
are recognized in profit or loss. However, the loss allowance is
recognized in OCI and does not reduce the carrying amount of the
financial asset in the statement of financial position.
Dividends

• Only cash and property dividends received from equity

securities may be recognized as dividend revenue.
Stock rights
• Stock rights, being equity instruments, are measured at
fair value.
 Disclosure of Risks on financial instruments

1. Credit risk - The risk that one party to a financial instrument will cause a
financial loss for the other party by failing to discharge an obligation.
2. Liquidity risk - The risk that an entity will encounter difficulty in meeting
obligations associated with financial liabilities that are settled by delivering
cash or another financial asset.
3. Market risk - The risk that the fair value or future cash flows of a financial
instrument will fluctuate because of changes in market prices. Market risk
comprises the following.
a) Interest rate risk
b) Currency risk
c) Other price risk
OTHER LONG TERM
INVESTMENTS
Give examples of other long-term investments.
Account for cash surrender value.
Other long-term investments
Other long-term investments include investments in funds set
aside for specific and long-term purpose and cash surrender
value.

Examples of other long-term investments

a. Sinking fund
b. Preference share redemption fund
c. Asset replacement fund
d. Expansion fund
e. Contingency fund
f. Insurance fund
g. Cash surrender value
Cash surrender value

• A cash surrender value accumulates when

premiums and interest paid on a whole life insurance
exceed the cost of insurance.
Accounting for cash surrender value
INITIAL RECOGNITION:
• On initial recognition, the cash surrender value is allocated over the
required holding period necessary for it to accumulate (e.g., 3
years). The amount allocated to the current year is recognized as a
deduction from insurance expense while the amount allocated to
prior years is credited to retained earnings. The cash surrender value
is classified as noncurrent investment.
• Pro-forma entry:

Cash surrender value xx

Retained earnings xx
Insurance expense xx

INTERMEDIATE ACCTG 1A (by: MILLAN)

Accounting for cash surrender value
SUBSEQUENT PERIODS:
• Subsequent to initial recognition, increases in cash surrender value are
treated as deduction from the insurance expense recognized during the
period.
• Pro-forma entry:
Cash surrender value xx
Insurance expense xx

• Cash dividends received from the insurance are not recognized as

income but rather as deduction from the insurance expense recognized
during the period.
• Pro-forma entry:
Cash xx
Insurance expense xx
Accounting for cash surrender value
SETTLEMENT:
• When the insured key employee dies during the year, the increase
in cash surrender value is recognized up to the date of death. The
difference between (a) the insurance proceeds received or
receivable and (b) the sum of cash surrender value and any
unexpired portion of prepaid insurance is recognized as gain on life
insurance settlement.
• Pro-forma entry:
Cash xx
Cash surrender value xx
Insurance expense/ Prepaid insurance xx
Gain on settlement xx
BASIC DERIVATIVES
Definition of a derivative

A derivative is a financial instrument or other

contract that derives its value from the
changes in value of some other underlying
asset or other instrument.
Characteristics of a derivative

1. Its value changes in response to the change in an

underlying;
2. It requires no initial net investment or only a very minimal
initial net investment; and
3. It is settled at a future date.
Common types of derivatives

1. Forward contract – is an agreement between two parties to

exchange a specified amount of a commodity, security, or
foreign currency at a specified date in the future at a pre-
agreed price.

2. Futures contract – is a contract traded on an exchange that

allows an entity to buy or sell a specified quantity of commodity
or a financial security at a specified price on a specified future
date.
Common types of derivatives (Continuation)
3. Option – is a contract giving the holder the right, but not
the obligation, to buy or sell an asset at a specified price
any time during a specified period in the future. When the
holder exercises his right, the writer of the option is
obligated to perform his obligation on the option contract.

• Types of options as to right of holder:

1. Call option – an option to buy
2. Put option – and option to sell
➢ At the money – holder may or may not exercise
option; no gain or loss in exercising
➢ In the money – holder should exercise; gain in
exercising
➢ Out of the money – holder should not exercise; loss in
exercising
Common types of derivatives (Continuation)

4. Swap – is a contract in which two parties agree to exchange

payments in the future based on the movement of some
agreed-upon price or rate. Common examples include:
• Interest rate swap – is a contract between two parties who
agree to exchange future interest payments on a given loan
amount. Usually, one set of interest payments in based on a
fixed interest rate and the other is based on a variable interest
rate.
• Foreign currency swap – is a contract between two parties
who agree to exchange sum of money in one currency for
another currency.
Common types of derivatives (Continuation)
5. Caps, floors and collars – are essentially options designed
to shift the risk of an upward and/or downward movement in
variables, such as interest rates. These are normally linked to
a notional amount and a reference rate.

6. Swaption – is an option on a swap. The option provides the

holder with the right to enter into a swap at a specified future
date at specified terms. This derivative has characteristics of
an option and a swap.

7. Weather derivative – a contract that requires payment

based on climatic, geological or other physical variables.
Purpose of derivatives

1. to speculate (incur risk); or

2. to hedge (avoid or manage risk).
 Measurement of derivatives

• All derivatives are measured at fair value. The accounting for fair
value changes depends on whether the derivative is:
1. Not designated as a hedging instrument;
2. Designated as fair value hedge; or
3. Designated as cash flow hedge.
No hedging designation (held for speculation)

• Derivatives that are not designated as hedging instruments are

accounted for as held for trading securities. Accordingly, fair value
changes are recognized in profit or loss (i.e., FVPL).
INVESTMENT IN
ASSOCIATES
 Definition of terms

• Associate – an entity, including an unincorporated entity such as a

partnership, over which the investor has significant influence.
• Significant influence – the power to participate in the financial
and operating policy decisions of the investee but is not control or
joint control over those policies.
(PAS 28)
Significant influence

• Significant influence is presumed to exist if the investor holds, directly

or indirectly (e.g. through subsidiaries), 20% or more of the voting
power of the investee, unless it can be clearly demonstrated that
this is not the case.

• For significant influence to exist, the investment should provide the

investor voting rights. Thus, investment in preference shares,
regardless of the percentage of ownership, is not accounted for
under PAS 28 because preference shares do not give the investor
voting rights.
Evidence of existence of significant influence by
an investor

The following may provide evidence of significant influence even if

the percentage of ownership interest is less than 20%.
a) Representation on the board of directors or equivalent
governing body of the investee;
b) Participation in policy-making processes, including participation
in decisions about dividends or other distributions;
c) Material transactions between the investor and the investee;
d) Interchange of managerial personnel; or
e) Provision of essential technical information.
Equity method
• Investments in associates or joint ventures are accounted for using
the equity method. Under this method, the investment is initially
recognized at cost and subsequently adjusted for the investor’s
share in the changes in the EQUITY of the investee.
 T-accounts

Investment in associate Sh. In P/L of associate

beg. xx
Sh. in profit xx xx Sh. in loss Sh. in loss xx xx Sh. in profit
Sh. in (Cr.) OCI xx xx Sh. in (Dr.) OCI
xx Sh. in dividends
Undervaluation Undervaluation
xx of asset of asset xx
xx end. xx
Preference shares issued by an associate
If an associate has outstanding preference shares that are held by parties other
than the investor, the investor computes its share of profits or losses after making
the following adjustments.
Preference share is Preference share is Preference share is
cumulative noncumulative redeemable
 Deduct one-  Deduct dividends  No dividend is
year dividend, only when deducted when
whether declared before computing share
declared or not computing share in in associate’s
before associate’s profit or profit or loss.
computing loss.
share in
associate’s
profit or loss.
Discontinuance of the use of equity method
• An investor starts to apply the equity method on the date it
obtains significant influence and ceases to apply the equity
method on the date it loses significant influence.
• On the loss of significant influence, the investor shall measure
at fair value any investment the investor retains in the former
associate. The investor shall recognize in profit or loss any
difference between:
a. The fair value of any retained investment and any proceeds from disposing of
the part interest in the associate; and
b. The carrying amount of the investment at the date when significant influence
is lost.
Classification of retained interest
Following the discontinuance of equity method, the
retained interest shall be classified as follows:

Loss of significant influence due to Accounting treatment

• Decrease of ownership ➢ Financial asset at fair value

interest below 20%. under PFRS 9
• Increase of ownership ➢ Investment in subsidiary
above 50% under PFRS 3 and PFRS 10
Reclassification of cumulative OCI

• If an investor loses significant influence over an associate, all

amounts recognized in other comprehensive income in
relation to the associate shall be accounted on the same
basis as would be required if the associate had directly
disposed of the related assets or liabilities.
Change to equity method - Gain of significant
influence
• Significant influence may be achieved from additional purchase of
shares resulting to an increase in ownership interest. Although, not
specifically addressed in PAS 28, this type of acquisition may be
accounted for by reference to PFRS 3 Business Combinations
particularly on the accounting for business combination achieved
in stages.

• “In a business combination achieved in stages, the acquirer shall

remeasure its previously held equity interest in the acquiree at its
acquisition-date fair value and recognize the resulting gain or loss, if
any, in profit or loss or other comprehensive income, as
appropriate.” (PFRS 3.42 )
Share in losses of associate
If an investor’s share of losses of an associate equals or exceeds
its interest in the associate, the investor discontinues recognizing
its share of further losses.

Interest in the associate includes the following:

1. Investment in associate measured under equity method
2. Investment in preference shares of the associate
3. Unsecured long-term receivables or loans

Interest in the associate does not include the following:

1. Trade receivables and payables
2. Secured long-term receivables or loans
Share in losses of associate - continuation
After the investor’s interest in the associate is reduced to zero,
additional losses are provided for, and a liability is recognized, only
to the extent that the investor has incurred
a. Legal or constructive obligations or
b. Made payments on behalf of the associate.

• Any other losses are not recognized.

• If the associate subsequently reports profits, the investor resumes

recognizing its share of those profits only after its share of the
profits equals the share of losses not recognized.

INTERMEDIATE ACCTG 1B (by: MILLAN)

THANK YOU!!!!