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AUDITING PROBLEMS BATCH 24 – MAY 2021

AP 02 – AUDIT OF INVESTMENTS IN DEBT SECURITIES

MY SAN INC’s portfolio of debt securities at December 31, 20x6 and December 31, 20x7 are shown below. All the bonds
were acquired by the company at the beginning of 20x6.

December 31, 20x6 December 31, 20x7

Gross Gross
Acquisition Carrying Carrying
Face value costs amount Fair values amount Fair values
12%, ABC Corp. 1,000,000 1,063,397 1,049,737 1,024,437 1,034,711 1,052,773
10%, DEF Inc. 2,000,000 1,903,926 1,932,398 1,965,750 1,964,286 2,018,348
12%, GHI Co. 3,000,000 3,190,191 3,149,211 3,073,311 3,104,132 3,158,320
TOTAL 6000000 6157514 12194844 6,063,498 6103129 6229441

ABC Corp. and GHI Co. bonds were acquired at prevailing market rate of interest at 10%, while DEF Inc. bonds were
acquired at an effective rate of 12%.

The prevailing market rate of interest at the end of 20x6 and 20x7 applicable to the bonds were at 11% and 9%,
respectively.

Note: For simplification, the ignore accounting for expected credit loss.

Case 1: Assuming that the above securities are Trading Securities:

1. How much is the gain or (loss) to be reported in the company’s income statements for 20x6 and 20x7?
A. (67,848); 126,312 C. (26,168); (28,217)
B. (94,016); 165,943 D. 0; 0

2. How much is the corresponding interest income to be reported in the company’s income statement for 20x6 and
20x7?
A. 680,000; 680,000 C. 585,984; 845,943
B. 653,832; 651,783 D. 0; 0
3. What is the carrying value of the investment in debt securities as of December 31, 20x6 and 20x7?
A. 6,000,000; 6,000,000 C. 6,157,514; 6,157,514
B. 6,131,346; 6,103,129 D. 6,063,498; 6,229,441
4. If the DEF Inc. bonds were sold at P2,000,000 on January 2, 20x8, how much realized gain or (loss) on the sale
should be recognized?
A. 35,714 C. (67,602)
B. 96,074 D. (18,348)
1. Case 2: Assuming the above debt securities are held within a business model whose objective is achieved by
collecting contractual cash flows:

1. How much is the gain or loss to be reported in the company’s income statements for 20x6 and 20x7?
A. (67,848); 126,312 C. (94,016); 165,943
B. (67,848); 194,160 D. 0; 0
2. How much is the corresponding interest income to be reported in the company’s income statement for 20x6 and
20x7?
A. 680,000; 680,000 C. 585,984; 845,943
B. 653,832; 651,783 D. 0; 0
3. What is the gross carrying value of the investment in debt securities as of December 31, 20x6 and 20x7?
A. 6,000,000; 6,000,000 C. 6,157,514; 6,157,514
B. 6,131,346; 6,103,129 D. 6,063,498; 6,229,441
4. If the DEF Inc. bonds were sold at P2,000,000 on January 2, 20x8, how much realized gain or (loss) on the sale
should be recognized?
A. 35,714 C. (67,602)
B. 96,074 D. (18,384)
Case 3: Assuming the above debt securities are held within a business model whose objective is achieved both by
collecting contractual cash flows and selling the debt securities.

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1. How much is the unrealized holding gain or loss should be shown as a component of other comprehensive income
for 20x6 and 20x7?
A. (67,848); 126,312 C. (94,016); 165,943
B. (67,848); 194,160 D. 0; 0
2. How much is the accumulated unrealized gain or loss shown in the statement of changes in equity for 20x6 and
20x7?
A. (67,848); 126,312 C. (94,016); 165,943
B. (67,848); 194,160 D. 0; 0
3. How much is the corresponding interest income to be reported in the company’s income statement for 20x6 and
20x7?
A. 680,000; 680,000 C. 585,984; 845,943
B. 653,830; 651,783 D. 0; 0

4. What is the carrying value of the investment in debt securities as of December 31, 20x6 and 20x7?
A. 6,000,000; 6,000,000 C. 6,157,514; 6,157,514
B. 6,131,346; 6,103,129 D. 6,063,498; 6,229,441
5. If the DEF Inc. bonds were sold at P2,000,000 on January 2, 20x8, how much realized gain or (loss) on the sale
should be recognized?
A. 35,714 C. (67,602)
B. 96,074 D. (18,384)

HARRIS CORP. acquired P2,000,000 face value bonds on March 31, 20x7 at P1,934,336. The 10 year, 10% bonds which
are dated January 1, 20x0 pays annual interest every December 31 and were classified as investment at fair value
through profit or loss. The prevailing rate of interest of similar security on the same date is at 12%. The company paid
for broker’s fees and commissions amounting to P100,000.
Interest collected at year-end were credited to the appropriate interest income account. Moreover, the prevailing
interest at year-end was at 14%, thus the market value of the bonds is at P1,814,269.

Requirements:
1. What is the unrealized holding gain or loss to be recognized in the company’s income statement for the year?
A. 70,067. C. 220,067.
B. 120,067. D. 0.
P1,934,336 – AIR 50K = 1,884,336 vs FV P1,814,269 = 70,067
Answer: A

2. What is the investment account balance as of December 31, 20x7?

A. 1,884,336 C. 1,934,336
B. 1,984,336 D. 1,814,269
3. How much is the correct interest income to be recognized for the year 20x7?
A. 200,000 C. 163,284
B. 174,090 D. 150,000
4. Assuming that the investment was sold on July 1, 20x8 at P2,000,000, how much is the gain on the sale?
A. 185,713 C. 85,731
B. 135,713 D. 65,664
NET PROCEEDS – CA
Proceeds 2,000,000
Less: Accrued Interest (2m x 10% x 6/12) (100,000)
Proceeds applicable to principal 1,900,00
CV 1,814,269
Gain 85,731
Answer: C

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Direct Corp. acquired a three-year, 12% bonds with a face value of P1,000,000 on January 1, 20x6. The bonds which pay
annual interest every December 31 had a 10% prevailing interest rate on the date of acquisition. The acquisition was
appropriately recorded by the company by debiting FVOCI security, and crediting cash for the amount of the cash paid.
The present value factor of P1 at 10%, ordinary annuity, for 3 periods is at 2.486852 while the present value factor of P1
at 10% for 3 periods is at 0.751315.

The applicable amortization schedule of any excess of acquisition cost over the investments’ face value follows:
Interest Interest
received income
Date (P*Nom rate) (CV*Eff rate) Amortization Balance
1/1/20x6 1,049,737
12/31/20x6 120,000 104,974 (15,026) 1,034,711
12/31/20x7 120,000 103,471 (16,529) 1,018,182
12/31/20x8 120,000 101,818 (18,182) 1,000,000
On December 31, 20x6, the prevailing interest for similar securities is at 11%, thus the fair market value of the bonds is
at P1,017,125 and the Loss Allowance was determined to be P125,000. The only entry made at December 31, 20x6 the
receipt of interest which was credited to Interest Income.
On March 31, 20x7, the bonds were sold at P1,250,000. The sale was recorded as follows:
Cash 1,250,000
FVOCI securities 1,049,737
Gain on sale-P&L 200,263
Requirements:
1. What is the correct interest income to be reported in the 20x6 income statement?
A. 104,974. C. 15,026.
B. 120,000. D. 135,026.
2. What is the loss to be recognized on December 31, 20x6?
A. 0 C. 32,612
B. 17,586 D. 107,414
3. What is the balance of the Investment Revaluation Reserve on December 31, 20x6?
A. 0 C. 32,612
B. 17,586 D. 107,414
4. How much is the correct realized gain or loss on sale of the investment in 20x7?
A. 222,161. C. 189,421.
B. 192,161. D. 314,421

MC BEAN CORP. reported an investment in bonds amounting to P10,758,157 as of December 31, 20x7 and an interest
income for the year ended December 31, 20x7 at P1,200,000. The 10-year, 12% bonds, which were acquired on January
1, 20x6 had a face value of 10M are dated January 1, 20x1. The bonds were purchased at their prevailing interest rate of
10% and pays annual interest every December 31. The bonds were held to collect the contractual cash flows.
On December 31, 20x7, 60% of the investment was sold at its fair value of 110 and the company determined that the
bonds will now be held to collect the contractual cash flows and to sell.

Records reveal that the company accounted for the investment transactions as follows:
1/1/20x6 Investment in Bonds 10,758,157
Cash 10,758,157
To record acquisition of bonds.
12/31/20x6 Cash 1,200,000
Interest income 1,200,000
To record receipt of interest.
AJE Retained Earnings (Interest income) 124,184
Investment in Bonds 124,184
Retained Earnings (impairment loss) 150,000
Loss Allowance 150,000
12/31/20x7 Cash 1,200,000
Interest income 1,200,000
To record receipt of interest.
AJE Interest income 136,603
Investment in Bonds 136,603
Loss Allowance 50,000
Recovery of Impairment loss 50,000
12/31/20x7 Cash 6,600,000
Investment in Bonds 6,454,894

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Gain on Disposal 145,106

To record the sale of 60% of bonds.

For your reference:

(a) the partial amortization schedule of any excess of acquisition cost over the investments’ face value follows:
Interest @
Date Interest @ 12% 10% Amortization Balance
1/1/20x6 10,758,157
12/31/20x6 1,200,000 1,075,816 (124,184) 10,633,973
12/31/20x7 1,200,000 1,063,397 (136,603) 10,497,370
12/31/20x8 1,200,000 1,049,737 (150,263) 10,347,107
(b) it was determined that the investment’s credit has not increased significantly since initial recognition and the
appropriate amount of Loss Allowance at end of 20x6 and 20x7 are P150,000 and P60,000, respectively.

Requirements:
1. The entry to adjust the investment account for the error(s) in recording in 20x6 will include:
A. Debit to Retained Earnings for P124,184.
B. Debit to Retained Earnings for P274,184.
C. Credit to Investment account for P124,184.
D. Credit to Investment account for P274,184.
2. What is the correct interest income for 20x7?
A. 1,200,000. C. 1,075,816.
B. 1,063,397. D. 954,325.
3. What is the correct gain or loss on partial disposal of the investment?
A. 145,106 C. 301,578.
B. 246,472. D. 391,578.
4. What is the adjusted balance of the investment in bonds presented in the December 31, 20x7 SFP?
A. 4,400,000. C. 4,138,948.
B. 4,198,948. D. 4,000,000.
5. How much is the investment revaluation to be reported in the 20x7 SFP?
A. 0. C. 301,578.
B. 201,052. D. 502,630.

On January 2, 20x6, Plum Company purchased as a long-term investment a debt instrument with a three-year term at its
fair value of P1,425,394. The instrument has a principal amount of P1,500,000 and carries fixed interest of 8% annually.
The effective interest is determined to be 10%. The company’s management held the investment as measured at
amortized cost.
The accountant has prepared the following amortization schedule:
Interest Interest Gross Carrying
Year received 8% income 10% Amortization Amount
1,425,394
20x6 120,000 142,539 22,539 1,447,934
20x7 120,000 144,793 24,793 1,472,727
20x8 120,000 147,273 27,273 1,500,000

During 20x6, the issuer of the instrument suddenly came into financial difficulties and it becomes probable that the
issuer will be put into administration by a receiver. The fair value of the instrument is estimated to be P750,000 at the
end of 20x6, calculated by discounting the expected future cash flow at 10%. No cash flows are received in 20x7. At
the end of 20x7, the issuer is released from administration and Plum receives a letter from the receiver stating that the
issuer will be able to meet its remaining obligations, including interest and repayment of principal.
123120x6 impairment
Impairment Loss-P&L 697,934
Investment, net 697,934
123120x7 for recovery
Investment, net 647,727
Impairment recovery-P&L 647,727
Cash (PV of 120) 120,000
Interest income 120,000
Requirements:

1. What amount of impairment loss should be recognized in 20x6?

A. 697,932 C. 636,275

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B. 750,000 D. 675,393

2. How much interest should be recognized in 20x7?

A. 0 C. 75,000
B. 24,793 D. 120,000

3. What amount of impairment loss reversal should be recognized in 20x7?

A. 0 C. 697,932
B. 647,727 D. 756,818

4. How much interest revenue should be recognized in 20x8?

A. 147,273 C. 82,500
B. 27,275 D 120,000

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