Accounting for Investments

Related standards:
PFRS 9 Financial Instrument
PFRS 13 Fair Value Measurement
PAS 32 Financial Instrument: Presentation
Financial Instrument
- Is any contract that gives rise to a financial asset of oner entity and a financial liability or equity
instrument of another entity. (PAS 32.11)

Financial Asset – is any asset that is:

a. Cash;
b. An equity instrument of another entity;
c. A contractual right to receive cash or another financial asset from another entity;
d. A contractual right to exchange financial instruments with another entity under conditions that are
potentially favorable; or
e. A contract that will or may be settled in the entity’s own equity instruments and is not classified as the
entity’s own equity instrument.
Financial Liability – is any liability that is:
a. A contractual obligation to deliver cash or another financial asset to another entity;
b. A contractual obligation to exchange financial instruments with another entity under conditions that are
potentially unfavorable; or
c. A contract that will or may be settled in the entity’s own equity instruments and is not classified as the
entity’s own equity instrument.
Equity Instrument – is “any contract that evidences a residual interest in the assets of an entity after deducting
all of its liabilities.” (PAS 32.11)

Examples of financial assets

a. Cash and cash equivalents (e.g., cash on hand, cash in bank, short-term money placements, and cash
funds).
b. Receivables such as accounts, notes, loans, and finance lease receivables.
c. Investments in equity or debt instruments of other entities such as held for trading securities;
investments in subsidiaries, associates and joint ventures; investment in bonds; and derivative assets.
d. Sinking funds and other long-term funds composed of cash and other financial assets.
The following are not financial assets:
 a. Physical assets, such as inventories, biological assets, property, plant and equipment, and investment
property
b. Intangible assets
c. Advances to suppliers – these represent claims for the future delivery of goods rather than for cash or
other financial assets.
d. Prepaid assets
e. Prepaid interest – this is normally treated as a valuation account to the related financial liability (e.g.,
discount on note payable) rather than as a financial asset. Prepaid interest may only be disclosed as
financial asset if it is not related to any financial liability.
f. The entity’s own equity instrument (e.g., treasury shares)

Example of financial liabilities

a. Payables such as accounts, notes, loans and bonds payable
b. Lease liabilities
c. Held for trading liabilities and derivative liabilities
d. Redeemable preference shares issued
e. Security deposits and other returnable deposits
The following are not financial liabilities:
a. Unearned revenues and warranty obligations that are to be settled by future delivery of goods or
provision of services.
b. Constructive obligations
Items arising from statutory requirements (i.e., required by government) are not financial instruments because
these do not arise from contracts. The following are not financial assets or financial liabilities:
a. Prepaid tax, current tax, deferred tax asset/liability
b. SSS, PhilHealth, Pag-IBIG payables
Commodity contracts (e.g., contracts to buy or sell coffee beans, gold bullion, oil, and the like) are treated as
financial instrument only if the commodity contract can be settled net in cash or another financial instrument.
Such commodity contract is a financial asset to the party to whom conditions are potentially favorable, and a
financial liability to the party to whom conditions are potentially unfavorable.

Illustration 1: Financial asset

The following are taken from the records of Midas Co. as of year-end.
Cash and cash equivalent 13,000 Cash surrender value 12,000
Accounts receivable 15,000 Sinking fund 20,000
Allowance for bad debts (2,000) Investment in bonds 12,000
 Note receivable 5,000 Land 140,000
Interest receivable 2,000 Building 260,000
Claim for tax refund 12,000 Accumulated depreciation (65,000)
Advances to suppliers 6,000 Investment property 50,000
Inventory 75,000 Biological assets 30,000
Prepaid rent 5,000 Intangible assets 70,000
Investment in associate 20,000 Deferred tax assets 60,000
Investment in subsidiary 55,000 Prepaid insurance 6,000
Investment in equity instruments 13,000 Shares of stocks of Midas Co. 56,000

Requirement: Determine the financial assets to be disclosed in the notes to the financial statements.

Solution:
Cash and cash equivalent 13,000
Accounts receivable 15,000
Allowance for bad debts (2,000)
Notes receivable 5,000
Interest receivable 2,000
Investment in associate 20,000
Investment in subsidiary 55,000
Investment in equity instruments 13,000
Cash surrender value 12,000
Sinking fund 20,000
Investment in bonds 12,000
Total financial assets 165,000

Illustration 2: Financial liabilities

Accounts payable 2,000 SSS Contributions payable 6,000
Utilities payable 7,000 Cash dividend payable 4,000
Advances from customers 1,000 Property dividends payable 7,000
Accrued interest expense 6,000 Stock dividends payable 3,000
Unearned rent 9,000 Lease liability 35,000
Warranty obligations 5,000 Bonds payable 120,000
Unearned interest on receivables 3,000 Discount on bonds payable (15,000)
Income taxes payable 2,000 Security deposit 2,000

Requirement: Compute for the total financial liabilities.

Solution:
Accounts payable 2,000
Utilities payable 7,000
 Accrued interest expense 6,000
Cash dividends payable 4,000
Lease liability 35,000
Bonds payable 120,000
Discount on bonds payable (15,000)
Security deposit 2,000
Total financial liabilities 161,000

Initial recognition
Financial assets are recognized only when the entity becomes a party to the contractual provisions of the
instrument.

Classification of Financial Assets

Financial assets are classified as subsequently measure at:
a. Amortized cost
b. Fair value through other comprehensive income (FVOCI); or
c. Fair value through profit or loss (FVPL).

Basis of classification
Financial assets, except those that are designated, are classified on the basis of both:
a. The entity’s business model for managing the financial assets; and
b. The contractual cash flow characteristics of the financial asset.
Basis of Classification Classification
 Business model: ‘Hold to collect’  Amortized cost
Cash flow characteristics: ‘SPPI’ (e.g., debt instrument)
 Business model: ‘Hold to collect and sell’  FVOCI (mandatory)
Cash flow characteristics: ‘SPPI’ (e.g., debt instrument)
 Business model: Not defined  FVPL
Cash flow characteristics: Not defined (e.g., held for trading
securities and equity instrument)
 Exceptions:
1. Investment in equity securities  FVOCI (election)
2. Eliminates or significantly reduces “accounting
mismatch”  FVPL (designated)

Initial measurement
Financial assets are initially measured at fair value plus transaction costs, except FVPL. Financial
assets classified as FVPL are initially measured at fair value. Transaction costs are expensed immediately.
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. Appendix A)

Requirements on fair value measurement’

PFRS 13 Fair Value Measurement requires an entity to determine the following when measuring fair value:
a. The particular asset or liability being measured.
b. The market in which an orderly transaction would take place for the asset or liability.
c. The appropriate valuation technique(s) to be used in measuring fair value.
d. For non-financial asset, the highest and best use of the asset and whether the asset is used in
combination with other assets or on a stand-alone basis.

Fair Value Hierarchy

 Level 1 inputs – Quoted prices for identical assets or liabilities in active markets.
 Level 2 inputs – 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 inputs – Unobservable inputs (for example, an entity’s own data or assumptions).

Subsequent measurement
After initial recognition, financial assets are measured at
a. Amortized cost;
b. Fair value through other comprehensive income (FVOCI); or
c. Fair value through profit or loss (FVPL).
Gains and losses
 FVPL – profit or loss
 FVOCI (mandatory) – recognized in other comprehensive income, except for impairment and foreign
exchange gains and losses, until derecognized or reclassified. When the financial asset is derecognized,
the cumulative gains or loss previously recognized in OCI is reclassified from equity to P/L as a
reclassification adjustment.
 FVOCI (election) – gains and losses are recognized in OCI, however, when the financial asset is
derecognized, the cumulative gain or loss previously recognized in other comprehensive income is not
subsequently transferred to P/L, but the entity may transfer the cumulative gain or loss within equity, as
a direct transfer to retained earnings.
  Amortized cost – gain or losses on financial assets measured at amortized cost, such as those arising
from derecognition, reclassification, amortization, or impairment, are recognized in P/L. FV changes are
not recognized.

Investment
- Can be defined broadly as assets that are held for any of the following purposes:
1. To earn profit;
Examples: held for trading securities, investment in equity securities measured at FVOCI,
investment in debt securities mandatorily measured at FVOCI, investment in debt securities
measured at amortized cost, investment property.
2. To secure certain operating or financing arrangements or beneficial relationship with another
entity;
Example: investment in associate, investment in subsidiary, investment in joint venture.
3. To meet business requirements; or
Example: Investment in long-term funds.
4. To serve as protection for possible future loss.
Example: contingency or insurance fund and similar reserves, cash surrender value, certain
derivatives designated as hedging instruments.
Classificatio Composition Statement of Initial Subsequent Statement of
n of Financial Measurement Measurement comprehensive
investment Position income
1. FVPL Debt or equity Current Fair value Fair value Changes in FV are
securities assets recognize in P/L
2. FVOCI Equity Current or Fair value plus Fair value Changes in fair value
(election) securities noncurrent transaction costs are recognized in OCI
asset
3. FVOCI Debt securities Current or Fair value plus Fair value Changes in FV are
(mandatory) noncurrent transaction costs recognized in OCI
asset  Interest income
computed using
EIM is recognized
in P/L.
 Impairment
gains/losses are
recognized in P/L.
4. Amortized Debt securities Current or Fair value plus Amortized cost  Interest income
cost noncurrent transaction costs less computed using
asset impairment the EIM is
allowance recognized in P/L
 Impairment
gains/losses are
recognized in P/L.
Illustration 3: Held for trading securities – equity securities
On January 1, 20x1, ABC Co. purchased 12,000 shares of XYZ, Inc. for ₱100,000. Taxes and licenses incurred
amounted to ₱5,000. The equity securities meet the definition of held for trading securities. Accordingly, ABC
Co. classified the investment as subsequently measured at FVPL.

 Initial measurement:
To record the purchase:
Jan. 1, Held for trading securities 100,000
20x1 Taxes and licenses 5,000
Cash 105,000

 Subsequent measurement:
On December 31, 20x1, the shares are quoted at P10 per share. If the shares are sold on this date, the
transaction cost would be P0.50 per share.

To record the change in FV:

Dec. 31, Held for trading securities [(12,000 x 10) – 100k] 20,000
20x1 Unrealized gain – P/L 20,000

 Derecognition:
On January 3, 20x2, half of the investment was sold at P15 per share. Transaction costs incurred on the sale
amounted to P3,000.

To record the sale:

Jan. 3, Cash [(6,000 x P15)-P3,000] 87,000
20x2 Held for trading securities (120k x 0.50) 60,000
Realized gain on sale (87,000 – 60,000) 27,000

As of Dec. 31, 20x1, the investment is disclosed in the notes as follows:

Held for trading securities 100,000

Accumulated fair value changes (debit) 20,000
Carrying amount, Dec. 31, 20x1 120,000

Illustration 4: Held for trading securities – portfolio

On January 1, 20x1, ABC Co. purchased the following marketable securities to be held for trading. Transaction
costs are negligible.
Cost Fair value Fair value
12/31/x1 12/31/x2
Apple Co. preference shares P50,000 P40,000 P55,000
Boy Co. ordinary shares 40,000 15,000 20,000
Cat. Co. bonds 30,000 35,000 30,000
TOTALS P120,000 P90,000 P105,000

 Initial Measurement:
Jan. 1, Held for trading securities 120,000
20x1 Cash 120,000

 Subsequent measurement:
Jan. 1, Unrealized loss – P/L (90k-120k) 30,000
20x1 Held for trading securities 30,000
 The change in fair value is computed as follows:

Fair value – Dec. 31, 20x1 90,000

Unadjusted CA – Dec. 31, 20x1 (initial cost) (120,000)
Net decrease in fair value – unrealized loss (30,000)

 Subsequent measurement:
Jan. 1, Held for trading securities 15,000
20x1 Unrealized gain – P/L (105k – 90k) 15,000

Illustration 5: Held for trading securities – debt securities

On January 1, 20x1, ABC Co. purchased P100,000 bonds at 98. The bonds mature on January 1, 20x5 and pay
12% annual interest beginning January 1, 20x2. Commission paid on the acquisition amounted to P10,000. The
objective of ABC Co.’s business model is to sell investment in the near term to take advantage of fluctuations in
fair values for short-term profit taking. Accordingly, the bonds are classified as held for trading securities.

To record the purchase:

Jan. 1, Held for trading securities (100k x 98%) 98,000
20x1 Commission expense 10,000
Cash 108,000
 On December 31, 20x1, the bonds were quoted at 101.

The change in fair value is computed as follows:

Fair value – Dec. 31, 20x1 (100k x 101%) P101,000

Unadjusted CA – Dec. 31, 20x1 (initial cost) (98,000)
Net increase in fair value – Unrealized gain P 3,000

To record the fair value change:

Dec. 31, Held for trading securities 3,000
20x1 Unrealized gain – P/L 3,000

To record accrued interest in 20x1:

Dec. 31, Interest receivable (100,000 x 12%) 12,000
20x1 Interest income 12,000

To record the receipt of interest:

Jan. 1, Cash (100,000 x 110%) 110,000
20x2 Held for trading securities 101,000
Gain on sale of securities 9,000

Illustration 6: Held for trading securities – debt securities

On January 1, 20x1, ABC Co. purchased P100,000 bonds for P98,000. The bonds mature on January 1, 20x5
and pay 12% annual interest beginning January 1, 20x2. Transaction costs are negligible. The bonds are
classified as held for trading securities.

To record the purchase:

Jan. 1, Held for trading securities (100k x 98%) 98,000
20x1 Cash 98,000

 On Dec. 31, 20x1, the bonds were selling at a yield rate of 10%.
 The fair value of the bonds is computed as follows:

Future cash flows PV @10%, n=3 PV factors Present value

Principal 100,000 PV of P1 0.751315 75,132
Interest (100K x 12%) 12,000 PV of ordinary annuity 2.486852 29,842
Fair value as of Dec. 31, 20x1 104,974

To record the fair value change:

Dec. 31, Held for trading securities 6,974
20x1 Unrealized gain – P/L 6,974

To record accrued interest:

Dec. 31, Interest receivable (100,000 x 12%) 12,000
20x1 Interest income 12,000

Illustration 7: FVOCI (election)

On January 1, 20x1, ABC Co. purchased 12,000 shares of XYZ, Inc. for P100,000. Commission paid to broker
amounted to P5,000. The shares do note meet the definition of held for trading. ABC Co. made an irrevocable
choice to subsequently measure the shares at fair value through other comprehensive income.

 Initial measurement:
Transaction price 100,000
Add: Transaction cost 5,000
Initial carting amount 105,000

To record the purchase:

Jan. 1, Investment in equity securities - FVOCI 105,000
20x1 Cash 105,000

 Subsequent measurement:
On December 31, 20x1, the shares were quoted at P10 per share.

The change in fair value is computed as follows:

Fair value – Dec. 31, 20x1 (12K shares x P10) 120,000

Unadjusted CA – Dec. 31, 20x1 (initial CA on Jan. 1, 20x1) (105,000)
Increase in fair value – unrealized gain 15,000

To record the fair value change:

Dec. 31, Investment in equity securities - FVOCI 15,000
20x1 Unrealized gain – OCI 15,000

 Derecognition:
On January 3, 20x2, all shares were sold for P174,000.

The Journals entries are as follows:

Jan. 3, Investment in equity securities – FVOIC 54,000
20x2 Unrealized gain – OCI (174K – 120K) 54,000
To recognize the change in FV
Jan. 3, Cash 174,000
20x2 Investment in equity securities – FVOCI 174,000
 To derecognize the investment
Jan. 3, Unrealized gain – OCI (15K+54K) 69,000
20x2 Retained earnings 69,000
To derecognize the cumulative FV gains

Illustration 8: Investment measured at FVOCI – portfolio

On January 1, 20x1, ABC Co. purchased equity securities for a total amount of P90,000. ABC Co. elected to
measure the equity securities at FVOCI.
Cost Fair value Fair value
12/31/x1 12/31/x2
Apple Co. preference shares P50,000 P40,000 P55,000
Boy Co. ordinary shares 40,000 15,000 20,000
TOTALS P120,000 P90,000 P105,000

Requirements:
a. Compute for the gain (loss) recognized in OCI in 20x1 and 20x2, respectively.
b. Compute for the cumulative balances of gains (losses) presented in equity on Dec. 31, 20x1 and 20x2,
respectively.
c. Provide the journal entries.

Solutions:
Requirement a: Gains (loss) presented in OCI
20x1 20x2
Fair value – Dec 75,000 100,000
Unadjusted carrying amount – Dec. 31 (90,000) (75,000)
Gain (Loss) in OCI (15,000) 25,000

Requirement b: Cumulative Gain (loss) presented in Equity

20x1 20x2
Fair value Dec. 31 75,000 100,000
Carrying amount on initial recognition (90,000) (90,000)
Cumulative bal. of gain (loss) in equity (15,000) 10,000

Requirement c: Journal Entries

Jan. 1, Investment in equity securities – FVOCI 90,000
20x1 Cash 90,000
To record the purchase of investment
Dec. 31, Unrealized gain (loss) – OCI 15,000
20x1 Investment in equity securities – FVOCI 15,000
To record the fair value change in 20x1
Dec. 31, Investment in equity securities – FVOCI 25,000
20x2 Unrealized gain (loss) – OCI 25,000
To record the fair value change in 20x2
 Investment in Debt Securities

Investment in bonds measured at amortized cost

Investment in bonds may be classified as FVPL, FVOCI (mandatory) or at amortized cost.
 Amortized cost is “the amount at which the financial asset or financial liability is measured at initial
recognition minus principal payments plus or minus the cumulative amortization using the effective interest
method of any difference between that initial amount and the maturity amount and, for financial assets
adjusted for any loss allowance.”

Discount Acquisition cost is less than Effective interest rate is

Face amount higher than Nominal rate
Premium Acquisition cost is more Effective interest rate is
than Face amount lower than Nominal rate

Interest income = Effective interest rate x Present Value

Interest receivable = Nominal interest rate x Face amount

Illustration 9: Acquisition at a discount

On Jan. 1, 20x1, ABC Co. acquired P1,000,000 face amount, 10% bonds of XYZ, Inc. for P951,963. The
principal is due on Jan. 1, 20x4 but interest is due annually every Jan. 1 The yield rate on the bonds is 12%.
ABC Co. classified the bonds as amortized cost financial asset.

Solution:
 The bonds are acquired at a discount because the acquisition cost is less than face amount. The discount is
determined as follows:

Acquisition cost 951,963

Face amount (1,000,000)
Discount – January 1, 20x1 (48,037)

To record the acquisition:

Jan. 1, Investment in bonds at amortized cost 951,963
20x1 Cash 951,963

Amortization table:
Date Interest Received Interest Income Amortization Present value
Jan. 1, 20x1 951,963
Jan. 1, 20x2 100,000 114,236 14,236 966,199
Jan. 1, 20x3 100,000 115,944 15,944 982,124
Jan. 1, 20x4 100,000 117,857 17,857 1,000,000

To record the accrued interest:

Dec. Interest receivable 100,000
31, Investment in bonds at amortized cost 14,236
20x1 Interest income 114,236

To record the collection of interest:

Jan. 1, Cash 100,000
20x2 Interest receivable 100,000
 Unamortized bond discount/premium

Present value – Dec. 31, 20x1 966,199

Face amount (1,000,000)
Unamortized discount – Dec. 31, 20x1 (33,801)

Other entries:
Dec. 31, Interest receivable 100,000
20x2 Investment in bonds at amortized cost 15,944
Interest income 115,944
Jan. 1, Cash 100,000
20x3 Interest receivable 100,000
Dec. 31, Interest receivable 100,000
20x3 Investment in bonds at amortized cost 17,857
Interest income 117,857
Jan. 1, Cash 100,000
20x4 Interest receivable 100,000
Jan. 1, Cash 1,000,000
20x4 Investment in bonds at amortized cost 1,000,000

Illustration 10: Acquisition at a premium

On Jan. 1, 20x1, ABC Co. acquired P1,000,000, 12% bonds for P1,049,737. The principal is due on Dec. 31,
20x3 but interest is due annually every Dec. 31. The effective interest rate is 10%. The bonds are measured at
amortized cost.
 The bonds are acquired at a premium because the acquisition cost id more than the face amount. The
premium is determined as follows:

Acquisition cost 1,049,737

Face amount (1,000,000)
Premium – Jan. 1, 20x1 49,737

To record the acquisition:

Jan. 1, Investment in bonds at amortized cost 1,049,737
20x1 Cash 1,049,737

Amortization table:
Date Interest received Interest income Amortization Present value
Jan. 1, 20x1 1,049,737
Dec. 31, 20x1 120,000 104,974 15,026 1,034,711
Dec. 31, 20x2 120,000 103,471 16,529 1,018,182
Dec. 31, 20x3 120,000 101,818 18,182 1,000,000

To record the collection of interest:

Dec. Cash 120,000
31, Interest income 104,974
20x1 Investment in bonds at amortized cost 15,026

The unamortized premium on Dec. 31, 20x1 is determined as follows:

Present value -Dec. 31, 20x1 1,034,711
Face amount (1,000,000)
Premium – Dec. 31, 20x1 34,711
Other entries:
Dec. 31, Cash 120,000
20x2 Interest income 103,471
Investment in bonds at amortized cost 16,529
Dec. 31, Cash 120,000
20x3 Interest income 101,818
Investment in bonds at amortized cost 18,182
Dec. 31, Cash 1,000,000
20x3 Investment in bonds at amortized cost 1,000,000

Acquired interest
Bonds may be purchased in between scheduled interest payment dates. When unpaid interest has accrued before
the acquisition, the subsequent receipt of interest is allocated between the pre-acquisition and post-acquisition
periods. Only the post-acquisition portion is recognized as interest income.

Illustration 11: Purchased accrued interest

On April 1, 20x1, ABC Co. acquires P1,000,000, 12% bonds dated January 1, 20x1 at 98 including interest.

Journal Entry:
Apr. 1, Investment in bonds at amortized cost(a) 950,000
20x1 Interest income (1M x 12% x 3/12) 30,000
Cash 980,000
(a)
(1M x 98% including interest) – 30,000 interest = 950,000 initial carrying amount of bonds

To record the subsequent collection of interest:

Dec. 31, Cash (1M x 12%) 120,000
20x1 Interest income 120,000
Note: The discount amortization is ignored to simplify the illustration.

Illustration 12: Purchased accrued interest

On April 1, 20x1, ABC Co. acquires P1,000,000, 12% bonds dated January 1, 20x1 at 98 excluding interest.

Journal Entry:
Apr. 1, Investment in bonds at amortized cost(b) 980,000
20x1 Interest income (1M x 12% x 3/12) 30,000
Cash 1,010,000
(b)
(1M x 98% excluding interest) = 980,000 initial carrying amount of bonds

Transaction costs
Amortized cost financial assets are initially measured at fair value plus transaction costs. When transaction costs
are incurred, the effective interest rate is adjusted in order to exactly discount the cash flows of the instrument
equal to its initial carrying amount. The adjusted effective interest rate can be determined using the “trial and
error” approach.

Illustration 13: Adjustment to effective interest rate

On Jan. 1, 20x1, ABC Co. acquired P1,000,000, 12% bonds at 98. ABC Co. paid transaction costs of P51,000.
The bonds are due on Dec. 31, 20x4 but pay annual interest every Dec. 31. The bonds are measured at
amortized cost.

 The bonds are initially measured as follows:

Purchase price (1M x 98%) 980,000
Transaction costs 51,000
Initial carrying amount 1,031,00

Journal entry:
Jan. 1, Investment in bonds at amortized cost 1,031,000
20x1 Cash (1M x 98% +51,000) 1,031,000

Trial and Error Approach

Our working equation is as follows:

o Future cash flows x PV Factor at x% = Present value

o (1M x PV factor of P1 @ x%, n=4) + (1M x 12% x PV of an ordinary annuity of P1 @ x%, n=4) =
1,031,000

 First trial
o (1M x PV factor of P1 @ 10%, n=4) + (1M x 12% x PV of an ordinary annuity of P1 @ 10%, n=4)
= 1,031,000
o (1M x 0.683013) + (120,000 x 3.169865) =
o (683,013 + 380,384) = 1,063,397 is not equal to 1,031,000

 Second trial
o (1M x PV factor of P1 @ 11%, n=4) + (1M x 12% x PV of an ordinary annuity of P1 @ 11%, n=4)
= 1,031,000
o (1M x 0.658731) + (120,000 x 3.102446) = 1,031,000
o (658,731 + 372,294) = 1,031,025 approximates 1,031,000

Amortization table:
Date Interest received Interest income Amortization Present Value
Jan. 1, 20x1 1,031,000
Dec. 31, 20x1 120,000 113,410 6,590 1,024,410
Dec. 31, 20x2 120,000 112,685 7,315 1,017,095
Dec. 31, 20x3 120,000 111,880 8,120 1,008,975
Dec. 31, 20x4 120,000 111,025 8,975 1,000,000

Illustration 14: Sale of bonds

On Jan. 1, 20x1, ABC Co. acquired P1,000,000 face amount, 10% bonds of XYZ, Inc. for P951,963. The
principal is due on Jan. 1, 20x4 but interest is due annually every Jan. 1. The yield rate on the bonds is 12%.
ABC Co. classified the bonds as amortized cost financial asset.

Case 1: Sale on interest payment date

On Jan. 1, 20x3, ABC Co. sold all the bonds at 110. ABC Co. incurred transaction costs of P10,000 on the
sale.

Requirement: Compute for the gain (loss) on the sale.

Solution:
Date Interest received Interest income Amortization Present value
Jan. 1, 20x1 951,963
Jan. 1, x0x2 100,000 114,236 14,236 966,199
Jan. 1, 20x3 100,000 115,944 15,944 982,143
 Jan. 1, 20x4 100,000 117,857 17,857 1,000,000
Sale price (1M x 110%) 1,100,000
Transaction costs (10,000)
Net disposal proceeds 1,090,000
Carrying amount on date of sale (982,143)
Gain on sale 107,857

Jan. Cash [(1M x 110%) – 10K] 1,090,000

1, Investment in bonds at amortized cost 982,143
20x3 Gain on sale 107,857

Case 2: Partial sale on interest payment date

On Jan. 1, 20x3, ABC Co. sold half of the bonds at 110. ABC Co. incurred transaction costs of P10,000 on
sale.

Requirement: Compute for the gain (loss) on the sale.

Solution:
Jan. Cash [(1M x 110% x 0.50) – 10K] 540,000
1, Investment in bonds at amortized cost (982,143 x 0.50) 491,072
20x3 Gain on sale 48,928

Case 3: Sale in between interest payment dates

On Jul. 1, 20x3, ABC Co. sold half of the bonds at 112. ABC Co. incurred transaction costs of P10,000 on the
sale.

Requirement: Compute for the gain (loss) on sale.

Solution:
The bonds are amortized up to the date of sale.
Date Interest received Interest income Amortization Present value
Jan. 1, 20x1 951,963
Dec. 31, 20x1 100,000 114,236 14,236 966,199
Dec. 31, 20x2 100,000 115,944 15,944 982,143
Dec. 31, 20x3 50,000(a) 58,929(b) 8,929 991,072
(a)
(1,000,000 x 10% x 6/12) = 50,000
(b)
(982,143 x 12% x 6/12) = 58,929

Sale price including accrued interest (1M x 112%) 1,120,000

Accrued interest (50,000)
Sale price excluding accrued interest 1,070,000
Transaction costs (10,000)
Net disposal proceeds 1,060,000
Carrying amount on date of sale (991,072)
Gain on sale 68,928

July Interest receivable 50,000

1, Investment in bonds at amortized cost 8,929
20x3 Interest income 58,929
To record the discount amortization
July Cash (1M x 112% - 10K) 1,110,000
 1, Investment in bonds at amortized cost 991,072
20x3 Interest receivable 50,000
Gain on sale 68,928
To record the sale

Purchase price of bonds

The purchase price of a bond can be estimated by discounting the future cash flows using the current rate.

Illustration 15: Purchase price of bonds

ABC Co. is contemplating on investing in P1,000,000, 3-year bonds that pay 12% annual interest. The current
market rate on Jan. 1, 20x1 is 10%.

Case 1: Acquisition on interest payment date

What is the estimated purchase price of the bonds on Jan. 1, 20x1?

Solution:
Purchase price of bonds = Cash flows x PV factors

Future cash flows PV @ 10%, n=3 PV factors Present value

Principal 1,000,000 PV of P1 0.751315 751,315
Interest 120,000 PV of OA of P1 2.486852 298,422
Estimated purchase price of the bonds on Jan. 1, 20x1 1,049,737

Case 2: Acquisition in between interest payment dates

How much nis the total cash outlay if the bonds were to be acquired on April 1, 20x1?

Solution:
Date Interest received Interest income Amortization Present value
Jan. 1, 20x1 1,049,737
Apr. 1, 20x1 30,000(a) 26,243(b) 3,757 1,045,980
(a)
(1M x 12% x 3/12)
(b)
(1,049,737 x 10% x 3/12)

The estimated purchase cost of the bonds on April 1, 20x1 is P1,045,980. However, since the bonds are to be
acquired in between interest payment dates, the total cash outlay in the acquisition necessarily includes the
payment for the accrued interest. This is computed by simply adding back the accrued interest to the present
value on April 1, 20x1.

Present value on Apr. 1, 20x1 1,045,980

Add: Accrued interest 30,000
Total cash outlay on the acquisition 1,075,950

Serial bonds
- Are bonds that mature in installments.
- The periodic collections include not only interest but also a portion of the principal.

Illustration 16: Serial bonds

On Jan. 1, 20x1, ABC Co. purchased P3,000,000, 10% bonds for P2,900,305. The bonds mature as follows:
December 31, 20x1 1,000,000
December 31,20x2 1,000,000
December 31, 20x3 1,000,000
 Total 3,000,000

Interest on the outstanding bonds is also due annually. The effective interest rate is 12%. The bonds are
measured at amortized cost.

Requirements:
a. Provide journal entries.
b. Determine the current and noncurrent portions of the investment on Dec. 31, 20x1.

Solutions:
Jan. 1, Investment in bonds at amortized cost 2,900,305
20x1 Cash 2,900,305

 The total annual collections are computed as follows:

Date Principal Interest on outstanding Total collections
principal balance
Dec. 31, 20x1 1,000,000 (3M x 10%) = 300,000 1,300,000
Dec. 31, 20x2 1,000,000 (2M x 10%) = 200,000 1,200,000
Dec. 31, 20x3 1,000,000 (1M x 10%) = 100,000 1,100,000

Amortization table:
Date Collections Interest income Amortization Present value
Jan. 1, 20x1 2,900,305
Dec. 31, 20x1 1,300,000 348,037 951,963 1,948,342
Dec. 31, 20x2 1,200,000 233,801 966,199 982,143
Dec. 31, 20x3 1,100,000 117,857 982,143 0

Dec. 31, Cash 1,300,000

20x1 Interest income 348,037
Investment in bonds at amortized cost 951,963
Dec. 31, Cash 1,200,000
20x2 Interest income 233,801
Investment in bonds at amortized cost 966,199
Dec. 31, Cash 1,100,000
20x3 Interest income 117,857
Investment in bonds at amortized cost 982,143

Current portion of investment in serial bonds = 966,199

Noncurrent portion of investment in serial bonds = 982,143

Financial Assets measured at FVOCI (mandatory)

Illustration 17: Financial assets measured at FVOCI

On Jan. 1, 20x1, ABC Co. acquired P1,000,000, 10% bonds for P951,963. The principal is due on Jan. 1, 20x4
but interest is due annually every Jan. 1. The effective interest rate is 12%. The bonds are measured at fair value
through other comprehensive income. Information on fair values is as follows:
Dec. 31, 20x1 . . . . . . . . . . . . . . . . . . . . . . 98
Dec. 31, 20x2 . . . . . . . . . . . . . . . . . . . . . . 103

 Initial recognition:
Jan. 1, Investment in bonds – FVOCI 951,963
 20x1 Cash 951,963

 Subsequent measurement (Dec. 31, 20x1):

Although the bonds are reported at fair value, interest income is computed using the effective interest
method. Accordingly, an amortization table is prepared:
Date Interest received Interest income Amortization Present value
Jan. 1, 20x1 951,963
Jan. 1, 20x2 100,000 114,236 14,236 966,199
Jan. 1, 20x3 100,000 115,944 15,944 982,143
Jan. 1, 20x4 100,000 117,857 17,857 1,000,000

The interest is accrued as follows:

Dec. Interest receivable 100,000

31, Investment in bonds – FVOCI 14,236
20x1 Interest income 114,236

After recording the interest revenue, the gain (loss) on the change in fair value is computed as follows:

Fair value – 12/31/x1 (1M x 98%) 980,000

Amortized cost – 12/31/x1 966,199
Unrealized gain – OCI 13,801

Dec. Investment in bonds – FVOCI 13,801

31, Unrealized gain (loss) – OCI 13,801
20x1

 Subsequent measurement (Dec. 31, 20x2):

The interest is accrued as follows:
Dec. Interest receivable 100,000
31, Investment in bonds – FVOCI 15,944
20x2 Interest income 115,944
The gain (loss) on the change in fair value is computed as follows:

Fair value – 12/31/x2 (1M x 103%) 1,030,000

Amortized cost – 12/31/x2 982,143
Cumulative balance of gain in equity – 12/31/x2 47,857
Cumulative balance of gain in equity – 12/31/x1 13,801
Unrealized gain – OCI (20x2) 34,056

The gain is recorded as follows:

Dec. Investment in bonds – FVOCI 34,056
31, Unrealized gain (loss) - FVOCI 34,056
20x2

The gain in 20x2 can also be reconciled as follows:

Fair value – 12/31/20x1 (1M x98%) 980,000
Fair value – 12/31/20x2 (1M x 103%) 1,030,000
Gross change in fair value 50,000
Amortization in 20x2 (15,944)
Net change in fair value – gain 34,056
  Derecognition:
On Jan. 1, 20x3, ABC Co. sold all the bonds at 104.

The journal entries are as follows:

Jan. Investment in bonds – FVOCI 10,000
1, Unrealized gain (loss) – OCI 10,000
20x3 To recognize the change in fair value
Jan. Cash 1,040,000
1, Investment in bonds – FVOCI 1,040,000
20x3 To derecognize the investment
Jan. Unrealized gain (loss) – OCI 57,857
1, Gain on sale – P/L 57,857
20x3 To derecognize the cumulative fair value gains

Net proceeds (1M x 104%) 1,040,000

Amortized cost – 1/1/x3 982,143
Cumulative gain in equity/reclassification adjustment – 1/1/x3 57,857

Concept:
PFRS 9 states that 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.

Puttable financial assets

- Is one that give the holder the right to return (put back) the instrument to the issuer in exchange for cash
or another financial asset or is automatically put back to the issuer upon the occurrence of a specified
future event, e.g., death of the holder.
- Examples of puttable financial assets:
a. Extendible and Retractable bonds
i. Extendible bonds – bonds that give holders the right to extend the initial maturity to a
longer maturity date.
ii. Retractable bonds – bonds that give holders the right to advance the return of principal
to an earlier date than the original maturity.
b. Investment in redeemable preference shares – can be classified as either amortized cost or
FVOCI depending on the entity’s business model.

Illustration 18: Investment in redeemable preference shares

On January 1, 20x1, ABC Co. purchased 6% redeemable preference shares with aggregate par value of
P1,000,000 for P850,000. Transaction costs amounted to P12,609. The preference shares can be redeemed at
any time beginning Jan. 1, 20x3. The investment qualified under the ‘hold to collect’ business model and ‘SPPI’
test; hence, ABC Co. expects to hold the investment for the next five years. The effective interest rate is 3%.

 Initial measurement:
Transaction price 850,000
Transaction costs 12,609
Initial carrying amount 862,609

Jan. 1, Investment in debt securities 862,609

20x1 Cash 862,609
 Subsequent measurement:
 Date Interest income (PV x 3%) Present Value (PV)
Jan. 1, 20x1 862,609
Dec. 31, 20x1 25,878 888,487
Dec. 31, 20x2 26,655 915,142
Dec. 31, 20x3 27,454 942,596
Dec. 31, 20x4 28,278 970,874
Dec. 31, 20x5 29,126 1,000,000

Dec. 31, Investment in debt securities 25,878

20x1 Interest income 25,878

 ABC Co. received one-year dividends on March 31, 20x2.

Mar. 31, Cash (1M x 6%) 60,000
20x2 Interest income 60,000
Notice that the dividend is recognized as interest income.

Case 1: The investment is held up to December 31, 20x5 and is redeemed at a premium of P100,000.

Dec. 31, Cash (1M par + 100K premium) 1,100,000

20x5 Investment in debt securities 1,000,000
Gain on redemption of investment 100,000

If not redeemed after 5 years, the investment may need to be discounted yet again depending on the expected
extension of holding period and the effect of time value of money even if the carrying amount is equal to par
value.

Case 2: The investment is redeemed on December 31, 20x3 at a premium of P200,000.

Dec. 31, Cash (1M + 200K premium) 1,200,000

20x3 Investment in debt securities 942,596
Gain on redemption of investment 257,404

The P942,596 credit to the investment account is the carrying amount of the investment on the
redemption date.

Regular way purchase or sale of financial assets

- 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.
- Are recognized and derecognized, as applicable, using trade date accounting or settlement date
accounting. An entity applies the same method consistently for all purchases and sales of financial
assets with same classification.

Trade date accounting Settlement date accounting

 Purchase transaction:  Purchase transaction:
The financial asset acquired and the associated The financial asset acquired and the associated
liability to pay for it are recognized on the trade liability to pay for it are recognized only on the
date (the date of commitment to purchase). settlement date (the date the purchased asset is
received
 Sale transaction:  Sale transaction:
The financial asset sold is derecognized on the the financial asset sold is derecognized on the
 trade date (the date of commitment to sell). The settlement date (the date the asset sold is
receivable from the sale is recognized on the delivered to the buyer). Th sale proceeds and any
trade date. gain or loss on the sale are recognized on the
settlement date.

Fair value changes between Trade date and Settlement date

Purchase transaction Sale transaction
An entity accounts for the change in fair value of the An entity does not account for the change in the fair
purchased asset during the period between the trade value of the asset sold during the period between the
date and settlement date (under both trade date and trade date and the settlement date (under both trade
settlement date accounting) in the same way as it date and settlement date accounting) because the
accounts for the acquired asset (i.e., in profit or loss if seller’s right to the changes in the fair value of the
the purchased asset is classified as FVPL; in OCI if asset sold ceases on the trade date.
classified as FVOCI; and ignored if classified as
Amortized cost).

Illustration 19:
On December 29, 29x1 (trade date), an entity commits to purchase a financial asset (a debt instrument) for
P1,000, the fair value on this date. On December 31, 20x1 and January 4, 20x2 (settlement date), the fair values
of the asset are P1,002 and P1,003, respectively.

Requirements: Provide the journal entries under (1) trade date accounting and (2) settlement date accounting
assuming the financial asset purchased is measured at: (a) FVPL; (b) FVOCI (mandatory); and (c) amortized
cost.

Solutions:

(a) FVPL
Date Trade date accounting Settlement date accounting
Dec. 29, FVPL asset 1,000
20x1 Payable 1,000 NO ENTRY
To record the purchase of investment
Dec. 31, FVPL asset 2 Receivable 2
20x1 Unrealized gain – P/L 2 Unrealized gain – P/L 2
To record fair value change To record the fair value change
Jan. 4, FVPL asset 1 FVPL asset 1,003
20x2 Payable 1,000 Receivable 2
Unrealized gain – P/L 1 Unrealized gain – P/L 1
Cash 1,000 Cash 1,003
To record the settlement of the To record the purchase of investment
purchase transaction

(b) FVOCI (mandatory)

Date Trade date accounting Settlement date accounting
Dec. 29, FVOCI asset 1,000
20x1 Payable 1,000 NO ENTRY
To record the purchase of investment
Dec. 31, FVOCI asset 2 Receivable 2
20x1 Unrealized gain – OCI 2 Unrealized gain – OCI 2
To record fair value change To record the fair value change
Jan. 4, FVOCI asset 1 FVOCI asset 1,003
20x2 Payable 1,000 Receivable 2
 Unrealized gain – OCI 1 Unrealized gain – OCI 1
Cash 1,000 Cash 1,003
To record the settlement of the To record the purchase of investment
purchase transaction

(c) Amortized cost

Date Trade date accounting Settlement date accounting
Dec. 29, Amortized cost asset 1,000
20x1 Payable 1,000 NO ENTRY
To record the purchase of investment
Dec. 31, NO ENTRY
20x1 NO ENTRY
Jan. 4, Payable 1,000 FVPL asset 1,001
20x2 Cash 1,000 Cash 1,001
To record the settlement of the To record the purchase of investment
purchase transaction

Reclassification of debt-type financial assets

Type of Initial Accounting
Reclassification recognition
1. Amortized cost  Fair value on reclassification date  Difference between Carrying amount and
to FVPL Fair value is recognized in P/L.
2. FVPL to  Fair value on reclassification date  Fair value on reclassification date
amortized cost becomes the new gross carrying amount of
the financial asset and the basis for
computing the effective interest rate and
the discount or premium.
3. Amortized cost  Fair value on reclassification date  Difference between Carrying amount and
to FVOCI Fair value is recognized in OCI.
(mandatory)
4. FVOCI  Fair value adjusted for the  The cumulative balance of gain or loss
(mandatory) to cumulative balance of gain or previously recognized in OCI is
Amortized cost loss previously recognized in OCI. derecognized as an adjustment to the
measurement of the financial asset on
reclassification date (i.e., as if the financial
asset had always been measured at
amortized cost.)
5. FVPL to FVOCI  Fair value on reclassification date  Update the carrying amount of the FVPL
(mandatory) on reclassification date. Any adjustment is
recognized in profit or loss. Subsequent
fair value changes will be recognized in
OCI.
6. FVOCI  Fair value on reclassification date  The cumulative balance of gain or loss
(mandatory) to previously recognized in OCI is
FVPL transferred to P/L as a reclassification
adjustment.

Illustration 20: Reclassification of financial assets

ABC Co. changed its business model for managing financial assets. Information on a debt-type financial asset is
as follows:
Carrying amount under previous classification 80,000
Fair value on reclassification date (Jan. 1, 20x3) 100,000
Case 1: reclassification from amortized cost to FVPL
Jan. FVPL asset 100,000
1, Amortized cost asset 80,000
20x3 Gain on reclassification – P/L (squeeze) 20,000

Case 2: Reclassification from FVPL to Amortized cost

Jan. FVPL asset 20,000
1, Unrealized gain – P/L 20,000
20x3 To record the fair value change on
reclassification date
Jan. Amortized cost asset 100,000
1, FVPL asset 100,000
20x3 To record the reclassification

Case 3: Reclassification from Amortized cost to FVOCI

Jan. FVOCI asset 100,000
1, Amortized cost asset 80,000
20x3 Gain on reclassification – OCI (squeeze) 20,000

Case 4: Reclassification from FVOCI to Amortized cost

Additional information: the cumulative balance of gain previously recognized in OCI and accumulated in equity
is P5,000.
Jan. FVOCI asset 20,000
1, Unrealized gain – OCI 20,000
20x3 To record the fair value change on
reclassification date
Jan. Amortized cost asset (squeeze) 75,000
1, Unrealized gain – OCI (5K + 20K) 25,000
20x3 FVOCI asset 100,000
To record the reclassification

Case 5: Reclassification from FVPL to FVOCI

Jan. FVPL asset 20,000
1, Unrealized gain – P/L 20,000
20x3 To record the fair value change on
reclassification date
Jan. FVOCI asset 100,000
1, FVPL asset 100,000
20x3 To record the reclassification

Case 6: Reclassification from FVOCI to FVPL

Additional information: The cumulative balance of gain previously recognized in OCI and accumulated in
equity is P5,000.
Jan. FVOCI asset 20,000
1, Unrealized gain – OCI 20,000
20x3 To record the fair value change on
reclassification date
Jan. FVPL asset 100,000
1, FVOCI asset 100,000
20x3 To record the reclassification
 Jan. Unrealized gain – OCI (5k + 20K) 25,000
1, Gain on reclassification – P/L 25,000
20x3 To record the reclassification adjustment to P/L

Dividends
1. Cash dividends – dividend in the form of cash
2. Property dividends – dividends in the form of non-cash assets.
3. Share dividends (stock dividends or bonus issue) – dividends in the form of the investee’s own equity
securities.

Recognition of dividend revenue

Only cash dividends and property dividends are recognized as “dividend revenue” (dividend income). Share
dividends are nor recognized as dividend revenue.

Dates relevant to the accounting for dividends

1. Date of declaration – the date when the board of directors formally announces the distribution of
dividends.
2. Date of record – the date on which the stock and transfer book of the corporation is closed for
registration. Only those who are registered as of this date are entitled to receive dividends.
 Ex – dividend date – to provide shareholders ample time to register, they are normally allowed
to register about three to five days prior to the date of record. The day shareholders can start
registering before the date of record is referred to as the ex-dividend date.
3. Date of distribution – the date when the dividends declared are distributed to the shareholders.

Dividend-on and Ex-dividend

 After the date of declaration but before the date of record, shares are said to be selling dividend
on, meaning the purchase price includes the dividends.
 After the date of record but before the date of distribution, shares are said to be selling ex-
dividend, meaning the purchase price excludes the dividends.

Illustration 21: Dividend-on and Ex-dividend

On March 31, 20x1, XYZ, Inc. declares P10 cash dividend per share. The date of record is April 15, 20x1. The
date of distribution is April 30, 20x1.

Case 1: Dividend-on
On April 9, 20x1, ABC Co. purchases 10,000 XYZ, Inc. shares at P100 per share. ABC Co. classifies the shares
as FVOCI asset.

Analysis:
The share as purchased dividend-on because the acquisition date is after the date of declaration (March 31,
20x1) but before the date of record (April 15, 20x1). Consequently, the purchase price includes the dividends.
The initial measurement of the investment is computed as follows:

Total purchase price (10,000 x P100 per sh.) 1,000,000

Less: Purchased dividends (100,000)
Initial measurement of investment 900,000

The entry to record the purchase:

Apr. Investment in stocks – FVOCI 900,000
9, Dividend income 100,000
20x1 Cash 1,000,000
The entry to record the receipt of dividends:
Apr. Cash 100,000
30, Dividend income 100,000
20x1

Case 2: Ex-dividend
On April 16, 20x1, ABC Co. purchases 10,000 XYZ, Inc. shares at P100 per share. ABC Co. classifies the
shares as FVOCI asset.

Analysis:
The share is purchased ex-dividend because the acquisition date is after the date of record (April 15, 20x1) but
before the date of distribution (April 30, 20x1). Consequently, the purchase price excludes the dividends. There
is no accounting problem here. The initial measurement of the investment is equal to the purchase price.

The entry to record the purchase:

Apr. Investment in stocks – FVOCI 1,000,000
26, Cash 1,000,000
20x1

Measurement of dividends
1. Cash dividends – are recognized as dividend revenue at the amount of cash received or receivable.
2. Property dividends – are recognized as dividend revenue at the fair value of the non-cash assets
received or receivable, determined as of the date of declaration.
3. Share dividends (stock dividends or bonus issue) – are not recognized as dividend revenue. Instead, the
shares received are recognized at fair value and a corresponding gain is recognized (a) in profit or los if
the shares are measured at FVPL or (b) in other comprehensive income if the shares are measured at
FVOCI.
4. Liquidating dividends – liquidating dividends represent return of capital. Therefore, liquidating
dividends are nor recognized as dividend revenue but rather deducted from the carrying amount of the
investment. Liquidating dividends are received when the investee is undergoing liquidation or is a
wasting asset corporation.

Illustration 22: Cash dividends

ABC Co. holds 10,000 shares of XYZ, Inc. as investment in equity securities. On April 1, 20x1, ABC Co.
receives notice of declaration of cash dividend of P10 per share. ABC Co. collects the dividend on April 20,
20x1.

Journal entries:
Apr. 1, Dividend receivable (10,000 sh. X P10) 100,000
20x1 Dividend income 100,000
Apr. Cash 100,000
20,20x Dividend receivable 100,000
1

Illustration 23: Property dividends

On April 1, 20x1, ABC Co. receives from an investee inventory with a cost of P130,000 and fair value of
P120,000 as property dividend.

Journal entry:
Apr. 1, Inventory 120,000
20x1 Dividend income 120,000
Illustration 24: Share dividends
On April 1, 20x1, ABC Co. receives 10,000, P1 par value, shares from an investee representing share dividend.
The quoted price on this date is P13 per share.

Case 1: FVPL
The investment from which the share dividend is received is classified as held for trading securities.

Journal entry:
Apr. 1, Held for trading securities 130,000
20x1 Unrealized gain – P/L 130,000

Case 2: FVOCI
The investment from which the share dividend is received is classified as FVOCI asset.

Journal entry:
Apr. 1, Investment in stock – FVOCI 130,000
20x1 Unrealized gain – OCI 130,000

Illustration 25: Liquidating dividends

On April 1, 20x1, ABC Co. received P120,000 cash dividends, one-third of which represents liquidating
dividends.

Journal entry:
Apr. 1, Cash 120,000
20x1 Investment account (120,000 x 1/3) 40,000
Dividend account (120,000 x 2/3) 80,000

Dividends settled at the option of holder

There may be instances where the investor is given an option to receive dividend that is different from what is
declared. For example, share dividend is declared but the holder is given the option to receive cash instead, or
vice versa. In determining whether the dividend is received is revenue or not, reference is made to the dividend
that is originally declared.

Share in lieu of Cash dividend

If cash dividend is declared but the investor opts to receive shares instead, the shares received are recognized
as dividend revenue at fair value.
However, if the related investment is measured at cost, the shares received are recognized as dividend
revenue at the amount of cash dividend that would have been received if the investor did not opt to receive
shares.
This dividend scheme is also called dividend reinvestment program/plan (DRIP). It allows shareholders
to immediately reinvest their dividend to the investee.

Illustration 26:
ABC Co. holds 10,000 shares XYZ, Inc. as investment in equity securities. XYZ, Inc. declares cash dividends
of P8 per share. However, ABC Co. opted to receive 1,000 shares instead.

Case 1: The investment is measured at FVOCI and fair value of the shares received is P10 per share.
The entry to record the receipt of the share is as follows:
Apr. 1, Investment in equity securities – FVOCI (1,000 x 10) 10,000
20x1 Dividend income 10,000
 Case 2: The investment is measured at cost.

The entry to record the receipt of the shares is as follows:

Apr. 1, Investment in equity securities at cost (1,000 x 8) 8,000
20x1 Dividend income 8,000

Cash in lieu of Share dividend

If share dividend is declared but the investor opts to receive cash instead, no dividend revenue is recognized.
The investor records the transaction “as if” the share dividends have been received but were subsequently sold
at a price equal to the cash received. The difference between the cash received and the allocated cost of the
shares assumed to have been sold is recognized as gain or loss.

Illustration 27:
ABC Co. holds 10,000 shares of XYZ, Inc. as investment in equity securities measured at cost. The investment
has a carrying amount of P110,000. On April 1, 20x1, ABC Co receives P12,000 cash in lieu of 1,000 share
dividends.

 The cost allocated to the shares “assumed to have been received and subsequently sold” is computed as
follows:

Carrying amount of investment measured at cost P110,000

Divide by: (10K sh. Held + 1K sh. Dividend assumed received) 11,000
Cost per share P 10
Multiply by: No. of shares “Assumed received and sold” 1,000
Cost allocated to the shares “assumed received and sold” P 10,000

Journal entry:
Apr. 1, Cash 12,000
20x1 Investment in equity securities at cost 10,000
Gain on investment – P/L (squeeze) 2,000

The “as if” method above is based on the notion that by opting to receive cash instead of shares, the
investor fails to maintain his original interest in the corporation; therefore, a portion of his investment is
realized.

Share split
A share split (stock split) occurs when the investee calls in issued shares and replaces them with new shares that
are either:
a. A large number of shares but with a decrease par value per share (split-up); or
b. A smaller number of shares but with an increased par value per share (split-down).

The aggregate par value of the shares remains the same before and after the share split.

Example 1: Split-up
ABC Co. holds 10,000 shares of XYZ, Inc. with par value of P10 per share. XYZ, Inc. declares a 2-for-1 split.
ABC Co. surrenders the 10,000 shares and receives 20,000 new shares with reduced par value of P5 per share.
The aggregate par value of the shares held by ABC Co. remains the same before and after the share split:
 Before share split: (10,000 shares x P10 par value) P100,000
 After share split: (20,000 shares x P5 par value) P100,000
Accounting for share split
 If share split is received from an investment measure at fair value, any change in fair value brought
about by the share split is recognized as unrealized gain or loss in profit or loss for FVPL and in other
comprehensive income for FVOCI.
 If share split is received from an investment in unquoted equity securities measured at cost, only a
memo entry is needed.

Special assessments
When an entity is undergoing financial distress, its shareholders may be required to provide additional
contribution. This additional contribution is called special assessment. Special assessments are accounted for as
additional cost of investment for the investor and as an increase in share premium for the investee.

Stock rights
When a corporation issues new shares, the existing shareholders have the right to purchase from the new issue,
in proportion to their current holdings, before the shares are offered to other potential investors. This privilege,
referred to as a stock right (preemptive right or right of preemption), protects existing shareholders from equity
dilution without their consent.
 Equity dilution – is the decrease in existing shareholders’ ownership percentage as a result of the
corporation issuing new shares.
 Share warrant – evidence of stock rights.

Accounting for stock rights

Stock rights, being equity instruments, are measured at fair value. Just like with dividends, the accounting for
stock rights depends on the following important dates:
1. Date of declaration – the date the entity declares its intention to issue stock rights to existing
shareholders.
2. Date of record – the last day of registration in the entity’s stock and transfer books. Only those
registered as of this date are entitled to receive stock rights.
3. Date of issuance – the stock rights are issued to the registered shareholders.
4. Exercise period – the period over which the holder can exercise the stock rights.
5. Date if expiration – the last day the stock rights can be exercised, after which the stock rights are
forfeited.

Rights-on
 After the date of declaration but before the date of record, shares are said to be selling rights-on,
meaning the shares are sold together with the stock rights. Neither one of them can be sold separately.
 The buyer will be entitled to stock rights.
 During this period, stock rights are considered embedded derivatives.
 An embedded derivative is a component of a hybrid contract that is attached to a non-derivative host
contract. The host contract is the shares held from which the stock rights are received. The stock rights
are not accounted for separately during this period because PFRS 9 does not require stock rights
attached to share that are selling rights-on to be separated from the host contract (most especially if the
host contract is measured at FVPL).

Ex-rights
 After the date of record but before the date of expiration, shares are said to be selling ex-rights,
meaning the shares are sold separately form the stock rights.
 The seller will be entitled to stock rights.
 During this period, the stock rights lose their status as embedded derivatives. PFRS 9 states that “a
derivative that is attached to a financial instrument but is contractually transferable independently of the
instrument, or has a different counterparty, is not an embedded derivative, but a separate financial
instrument.”
  Since the stock rights can now be sold separately, much like any other security, they are now accounted
for separately. Stock rights are accounted for as FVPL asset because they qualify as derivatives and
also because of their short duration.

Stock rights received from investment measured at cost

Stock rights received from investments in unquoted equity securities measured at cost are not accounted for
separately. No asset is recognized for the stock rights received because they cannot be measured reliably (i.e.,
fair value is not available). If the fair value of the shares from which the stock rights are received cannot be
determined reliably (which is why shares are measured at cost in the first place), so is the case for the stock
rights because the value of stock rights is dependent on the value of the shares. Stock rights received from
investments measured at costs are accounted for as follows:
 Upon receipt, only a memo entry is made.
 When exercised, the investment account is debited for the acquisition cost.
 When sold, the investment account is credited for the net disposal proceeds. No gain or loss is
recognized.
 Upon expiration, only a memo entry again is made.

Illustration 28: Accounting for stock rights

ABC Co. receives 12,000 stock rights to subscribe for new shares at P6 per share for every 4 rights held. (For
the ‘fair value’ scenario, assume the fair value per stock right is P2).

 Initial recognition:
The related investment from which the stock rights are received is measured:
at FVOCI at cost
Stock rights (12K x P2) 24K MEMO ENTRY
Unrealized gain – P/L
24K

 Exercise of stock rights:

Four thousand (4,000) stock rights are exercised.

The related investment from which the stock rights are received is measured:
at FVOCI at cost
(a)
FVOCI asset 6K Investment in stocks (@ cost) 6K
Cash 6K Cash 6K
To record the acquisition of new To record the acquisition of new
shares using 4,000 stock rights shares using 4,000 stock rights
(b)
Unrealized loss – P/L 8K
Stock rights 8K
To derecognize the 4,000 stock
rights exercised
(a)
(4,000 stock rts. / 4 rts. Per sh.) x P6 exercise price per sh. = 6,000
(b)
(24,000 initial carrying amt. x 4,000 / 12,000 total stock rights received) = 8,000

 Sale of stock rights:

Five thousand (5,000) stock rights are sold at P1.50 per right.
The related investment from which the stock rights are received is measured:
at FVOCI at cost
Cash (5,000 x P15) 7.5K Cash (5,000 x P1.50) 7.5K
Loss on sale 2.5K Investment in stocks (@ cost) 7.5K
Stock rights 10K(c)
 (c)
(P24,000 initial carrying amt. x 5,000 sold / 12,000 total stock rights received) = 10,000

 Expiration of stock rights:

The remaining 3,000 stock rights have expired.
The related investment from which the stock rights are received is measured:
at FVOCI at cost
Loss on expiration 6K MEMO ENTRY
Stock rights 6K(d)
(d)
(24,000 initial carrying amount x 3,000 expired /12,000 total stock rights received) = 6,000

Estimating the fair value of the stock rights

The fair value of stock right can be estimated as the difference between (a) the fair value of the shares
selling right-on and (b) the fair value of the shares selling ex-right.
 Fair value of share selling right-on – refers to the fair value of the shares before issuance date. This
includes both the fair value of the share and the fair value of the stock right.
 Fair value of share selling ex-right – refers to the fair value of the shares after issuance date. This
includes only the fair value of the share.

Fair value of share selling right-on (FV share + FV of right) xx

Fair value of share selling ex-right (FV of share only) (xx)
Estimated fair value of stock right xx

Illustration 29:
ABC Co. received 10,000 stock rights from its investment in equity securities. Prior to the issuance of the
stock rights, the shares were selling at P20 per share. After the issuance, the shares were quoted at P17 per
share.

Journal entry:
Mar. 31, Stock rights [(20 rt. on – 17 ex-rt.) x 10,000 rts.] 30,000
20x1 Unrealized gain – P/L 30,000

Theoretical or parity value of stock rights

Another approach in estimating the value of stock rights is by considering the relationship between the FV
of the shares and the exercise price suing the following formulas:

a. Share are selling rights-on:

TP value of 1¿=¿ No. of rightsneeded ¿ purchase one share+1 ¿Fair value of share ¿−on−Subscription price ¿
b. Share are selling ex-right:
TP value of 1¿=¿ No. of rightsneeded ¿ purchase one share ¿Fair value of share ex−¿ – Subscription price

Illustration 30: Theoretical or parity value

ABC Co. received 10,000 stock rights to subscribe for new shares at P15 per share for every 4 rights held.

Case 1: Right-on
Prior to the issuance of the stock rights, the shares were selling at P20 per share.

TP value of 1¿=¿ No. of rightsneeded ¿ purchase one share+1 ¿Fair value of share ¿−on−Subscription price ¿

20−15
T/P of value of 1 right =
4+ 1
T/P of value of 1 right = 1.00
Journal entry:
Date Stock rights (10,000 x P1) 10,000
Unrealized gain – P/L 10,000

Case 2: Ex-right
After to the issuance of the stock rights, the shares were selling at P20 per share.

TP value of 1¿=¿ No. of rightsneeded ¿ purchase one share ¿Fair value of share ex−¿ – Subscription price

20−15
T/P value of 1 right =
4
T/P value of 1 right = 1.25

Journal entry:
Date Stock rights (10,000 x P1.25) 12,500
Unrealized gain – P/L 12,500

Date Stock rights (10,000 x P1) 10,000

Unrealized gain – P/L 10,000

Investment in bonds with detachable warrants

When an entity acquires bonds with detachable warrants, the entity acquires two instruments – (1) the bonds
and (2) the warrants. The bonds by themselves are debt instrument and therefore classified either as amortized
cost or FVOCI (mandatory). The detachable warrants are equity instruments. Detachable warrants can normally
be sold separately and therefore normally classified as held for trading securities (FVPL).

Illustration 31:
ABC Co. acquires bonds with detachable warrants for P1,050,000. The bonds have a face amount of
P1,000,000. Without the detachable warrants, the bonds are selling at P950,000. The detachable warrants have a
fair value of P100,000. ABC Co.’s business model for managing financial assets requires debt instruments to be
measured at amortized cost and equity instruments at fair value.

 Initial recognition:
Date Investment in bonds (amortized cost) 950,000
Share warrants 100,000
Cash 1,050,000

Case 1: exercise of warrants

Assume the detachable warrants are subsequently exercised. The shares are acquired for P1,000,000 and are
classified as held for trading securities.

Date Held for trading securities 1,000,000

Cash 1,000,000
To recognize the newly acquired investment
Date Loss on derecognition of asset – P/L 100,000
Share warrants 100,000
To derecognize the share warrants exercised

Case 2: sale of warrants

Assume the detachable warrants are subsequently sold for P120,000.
 Date Cash 120,000
Share warrants 100,000
Gain on sale 20,000

Case 3: expiration of warrants

Assume the detachable warrants expired.
Date Loss on expiration of share warrants 100,000
Share warrants 100,000

Investment in associates
 An associate is “an entity over which the investor has significant influence.”

Nature of relationship with

Types of investment Applicable reporting standard
investee
 Investment measured at fair Regular investor PFRS 9
value
 Investment in associate Significant influence PAS 28
 Investment in subsidiary Control PFRS 3 and PFRS 10
 Investment in joint venture Joint control PFRS 11 and PAS 28

 Significant influence is the power to participate in the financial and operating policy decisions of the
investee but is not control or joint control of those policies.”
Percentage of ownership interest Type of investment
Less than 20% Financial assets at fair value
20% to 50% Investment in associate
51% to 100% Investment in subsidiary
Contractually agreed sharing of control Investment in joint venture

The existence of significant influence arising from “20% or more” ownership is just a presumption,
meaning this is generally held true in the absence of evidence to the contrary. An investor may have significant
influence even if it has less than 20% voting power, and oppositely may not have significant influence even if it
has more than 20% voting power, if this is clearly the case.

Other evidences of significant influence

Any of the following may provide evidence of the existence of significant influence even if the ownership is
less than 20%:
a. Representation on the BOD 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 entity and its investee;
d. Interchange managerial personnel; or
e. Provision of essential technical information.

Voting rights
Usually obtained from holding ordinary shares. Thus, investments in preference shares¸ regardless
of the percentage of ownership, are not accounted for under PAS 28 because preference shares do not give the
investor voting rights. An interest in a partnership (unincorporated entity) is accounted for under PAS 28 if it
gives the investor significant influence over the partnership.

Equity method
Investments in associates are accounted for using the equity method.
Under the equity method, the investment is initially recognized at cost and subsequently adjusted for
the investor’s share in the investee’s change in equity.

Illustration 32: Equity method

On Jan. 1, 20x1, ABC Co. purchased 20,000 shares out of the 100,000 total outstanding shares of XYZ, Inc. for
P1,000,000.

Journal entry:
Jan. 1, Investment in associate 1,000,000
20x1 Cash 1,000,000
To record the purchase of investment

In 20x1, XYZ Inc. reported profit of P3,000,000 and declared and paid cash dividends of P200,000.

Journal entries:
Dec. 31, Investment in associate 600,000
20x1 Share in profit of associate (3M x 20%*) 600,000
Dec. 31, Cash (200,000 x 20%) 40,000
20x1 Investment in associate 40,000
*Ownership interest = (20,000 shares acquired / 100,000 shares outstanding) = 20%

The carrying amount of the investment on December 31, 20x1 is determined as follows:

Acquisition cost 1,000,000

Sh. In profit – 20x1 600,000
Cash dividends – 20x1 (40,000)
Investment in associate, 12/31/20x1 1,560,000

Continuation of illustration:
In 20x2, XYZ, Inc. reported loss of P2,000,000, declared and issued 10% stock dividends, and recognized gain
on property revaluation of P500,000 and loss on exchange differences on translation of foreign operations of
P100,000 in other comprehensive income.

Journal entries:
Dec. 31, Share in loss of associate (2M x 20%) 400,000
20x2 Investment in associate 400,000
To record the share in the loss of the associate
Dec. 31, Investment in associate (500K x 20%) 100,000
20x2 Share in OCI of associate – revaluation surplus 100,000
To record the share in the gain on property
valuation of the associate
Dec. 31, Share in OCI of associate – translation of foreign operation 20,000
20x2 Investment in associate (100K x 20%) 20,000

Application of the Equity method

An investor starts applying the equity method from the date it obtains significant influence over an investee. On
acquisition, the difference between the cost of the investment and the entity’s share in the net fair value of the
investee’s identifiable assets and liabilities is accounted for as follows:
 If the cost is greater than the fair value of the interest acquired, the excess is goodwill.
 If the cost is less than the fair value of the interest acquired, the deficiency (negative goodwill) is included
as income in determining the entity’s share in the investee’s profit or loss in the period of acquisition.
 Share in undervaluation of asset  Deduction to both:
a. Share in the profit of associate (investment
income); and
b. Investment in associate account

Illustration 33: Purchase cost exceeds fair value of interest acquired

On January 1, 20x1, ABC Co. purchased 25% interest in the ordinary shares of XYZ Inc. for P2,000,000.
XYZ’s assets and liabilities approximate their fair values except for the following:
a. Inventories with a carrying amount of P500,000 have a fair value of P100,000.
b. A depreciable asset with carrying amount of P3,000,000 has a fair value of P5,000,000. The asset has a
remaining useful life of 10 years.

XYZ’s net assets have a book value of P5,000,000.

The entry to record the purchase is as follows:

Jan. 1, Investment in associate 2,000,000
20x1 Cash 2,000,000

 The goodwill is computed as follows:

Purchase cost 2,000,000

Less: fair value of net assets acquired (1,650,000)(a)
Goodwill 350,000
(a)
the fair value of the net assets acquired is computed as follows:
Book value (carrying amount) of the net assets 5,000,000
Overvaluation of inventory (500K – 100K) (400,000)
Undervaluation of depreciable asset (5M – 3M) 2,000,000
Fair value of net assets 6,600,000
Multiply by: Interest acquired 25%
Fair value of net assets acquired 1,650,000

On December 31, 20x1, XYZ reported P1,200,000 profit and declared and paid dividends of P500,000.

Journal entries:
Dec. Investment in associate 300,000
31, Share in profit of associate (1.2M x 25%) 300,000
20x1 To record the share in the associate’s profit
Dec. Cash (500,000 x 25%) 125,000
31, Investment in associate 125,000
20x1 To record the cash dividends
Dec. Investment in associate (400K x 25%) 100,000
31, Share in profit of associate 100,000
20x1 To account for the overvaluation of inventory
Dec. Share in profit of associate [(2M x 25%) / 10 yrs.] 50,000
31, Investment in associate 50,000
20x1 To depreciate the undervaluation of asset

Discontinuance of Equity method

An entity stops applying the equity method from the date it loses significant influence over the investee.
The loss of significant influence can occur with or without a change in the percentage of ownership,
for example:
a. When an associate becomes subject to the control of a government, court, administrator or regulator; or
b. As a result of a contractual agreement.

Loss of significant influence due to Accounting treatment

 Decrease of ownership interest below 20%.  Financial asset at fair value under PFRS 9
 Increase of ownership above 50%  Investment in subsidiary under PFRS 3 and
PFRS 10
 The discontinuance of equity method is accounted for prospectively.

Illustration 34: Loss of significant influence

On January 1, 20x1, ABC Co. acquired 30,000 ordinary shares of XYZ, Inc., representing 30% interest, for
P3,000,000. On this date, XYZ’s net assets have carrying amount of P8,000,000 and a fair value of
P10,000,000. The difference is attributable to an undervalued building with a remaining useful life of 10 years.
XYZ uses the straight-line method of depreciation.

In 20x1, XYZ reported profit of P1,000,000 and paid cash dividends of P600,000.

On July 1, 20x2, ABC sold 60% of its investment in XYZ shares at the prevailing market price of P120 per
share. XYZ reported interim profit of P500,000 for the six months ended June 30, 20x2.

On December 31, 20x2, XYZ reported total profit of P1,200,000 for the year and declared P1,000,000 cash
dividend. The shares are quoted at P135 per share at year-end.

 Journal entries in 20x1:

Jan. 1, Investment in associate 3,000,000
20x1 Cash 3,000,000
To record the purchase of investment
Dec. Cash (600K x 30%) 180,000
31, Investment in associate (squeeze) 120,000
20x1 Share in profit of associate (1M x 30%) 300,000
To record the cash dividends and the share in
the associate’s profit
Dec. Share in profit of associate [(10M – 8M) / 10 yrs.] x 30% 60,000
31, Investment in associate 60,000
20x1 To record the depreciation of the undervaluation
of the associate’s building

 Journal entries on July 1, 20x2:

The carrying amount of the investment is adjusted prior to the sale as follows:

July 1, Investment in associate (500K x 30%) 150,000

20x2 Share in profit of associate 150,000
To record the share in associate’s profit for the
six months ended June 30, 20x2
July 1, Share in profit of associate 30,000
20x2 Investment in associate (60K x 6/12) 30,000
To record the depreciation of undervaluation of
building for the six months ended June 30, 20x2
  The carrying amount of the investment on the date of sale is computed as follows:

Investment in associate:
Beginning balance, Jan. 1, 20x1 3,000,000
Add: share in profit – 20x1 300,000
Less: Cash dividends – 20x1 180,000
Undervaluation – 20x1 60,000
Ending balance, 20x1 3,060,000
Add: Share in profit – 6/30/x2 150,000
Less: Undervaluation – 20x2 30,000
Ending balance – 07/01/20x2 3,180,000

July 1, Cash (30,000 sh. X 60% x 120) 2,160,000

20x2 Investment in associate (3.18M x 60%) 1,908,000
Gain on sale of investment (squeeze) 252,000
To record the partial sale of investment
July 1, Held for trading securities(a) 1,440,000
20x2 Investment in associate (3.18M x 40%) 1,272,000
Gain on reclassification 168,000
To reclassify the remaining investment
(a)
(30,000 sh. Originally held x 40%) =12,000 remaining sh. X P120 fair value on July 1, 20x2 = 1,440,000 fair
value on reclassification date

Dec. 31, Dividend receivable (1M x12%(b)) 120,000

20x2 Dividend income 120,000
To record the dividends
Dec. 31, Held for trading securities 180,000
20x2 Unrealized gain – P/L (c) 180,000
To record the gain on the change in fair value
(b)
(30% previous interest x 40% unsold portion) = 12% retained interest
(c)
(P135-120) x 12,000 sh. = 180,000

 Total investment-related income recognized in profit or loss in 20x2 is computed as follows:

Share in profit of associate, net – 01/01 – 06/30 (150K-30K) 120,000

Gain on sale 252,000
Gain on reclassification 168,000
Dividend income 120,000
Unrealized gain on change in fair value 180,000
Total income recognized in profit or loss – 20x2 840,000

Reclassification of cumulative other comprehensive income

When the equity method is discontinued, all amounts previously recognized in OCI in relation to the investment
are either (a) reclassified to profit or loss as a reclassification adjustment or (b) transferred directly to retained
earnings, in accordance with the provisions of other PFRSs.
If ownership interest is reduced but significant influence is not lost, only a proportionate amount of
the OCI relating to the reduction of interest is reclassified to profit or loss or transferred directly to retained
earnings, as appropriate.

Illustration 35: Reclassification adjustment for OCI

ABC Co. owns 30% of XYZ, Inc,’s ordinary shares. On July 1, 20x2, ABC Co. sold half of its investment for
P400,000. The adjusted balances of the related accounts immediately before the sale are as follows:
 Investment in associate 1,200,000
 Cumulative share in associate’s exchange
Differences on translation of foreign operation 500,000 Cr

Case 1: Significant influence is lost

The remaining 15% ownership (30% x ½) does not give ABC significant influence over XYZ.

Journal entries:
July 1, Cash 400,000
20x2 Loss on sale of investment 200,000
Investment in associate (1.2M x ½) 600,000
To record the sale
July 1, Translation of foreign operation 500,000
20x2 Gain on reclassification – P/L 500,000
To record the reclassification adjustment of OCI to
profit or loss

Case 2: Significant influence is not lost

The remaining 15% ownership still gives ABC significant influence over XYZ.

Journal entries:
July 1, Cash 400,000
20x2 Loss on sale of investment 200,000
Investment in associate (1.2M x ½) 600,000
To record the sale
July 1, Translation of foreign operation 250,000
20x2 Gain on reclassification (500K x ½) 250,000
To record the reclassification adjustment of the OCI to
profit or loss

Case 3: Transfer of OCI directly to retained earnings

Use the fact pattern above except that the cumulative OCI represents share in the associate’s revaluation
increment on property. The remaining 15% ownership does not give ABC significant influence over XYZ.

Journal entries:
July 1, Cash 400,000
20x2 Loss on sale of investment 200,000
Investment in associate (1.2M x ½) 600,000
To record the sale
July 1, Revaluation surplus – associate 500,000
20x2 Retained earnings 500,000
To record the transfer of OCI arising from
property revaluation directly to retained earnings

Intercompany transactions with an associate

Gains and losses resulting from “downstream” and “upstream” transactions between an entity and its associate
are recognized in the entity’s financial statements only to the extent of unrelated investors’ interests in the
associate.
 If the seller is the investor, the transaction is downstream.
  If the seller is the investee (associate), the transaction is upstream.

The investor’s share in the unrealized profit or loss resulting from a downstream or upstream
transaction is eliminated, except when the asset to be sold or purchased is impaired, in which, in a downstream
transaction, the investor recognizes the loss in full, while in an upstream transaction, the investor recognizes its
share in the loss.

Illustration 36: Downstream sale

ABC Co. owns 20% of XYZ Inc.’s voting shares. On December 31, 20x1, ABC sold equipment with historical
cost of P150,000 and accumulated depreciation of P50,000 to XYZ inc. for P120,000. The equipment has a
remaining useful life of 10 years. Both ABC and XYZ use the straight-line method of depreciation.

The downstream sale is recorded as follows:

Dec. 31, Cash 120,000
20x1 Accumulated depreciation 50,000
Equipment 150,000
Gain on sale 20,000

The gain is eliminated up to extent of the entity’s interest as follows:

Dec. 31, Gain on sale (20,000 x 20%) 4,000
20x1 Investment in associate 4,000

The result of the elimination is that the gain recognized in ABC Co.’s financial statements is only to
the extent of unrelated investors’ interest in the associate.

Illustration 37: Upstream sale

Use the information in ‘Illustration 35’ except that the sale is upstream.

ABC Co. records the purchase as follows:

Dec. 31, Equipment 120,000
20x1 Cash 120,000

ABC Co. eliminates its share in the associate’s gain as follows:

Dec. 31, Share in profit of associate (20K x 20%) 4,000
20x1 Investment in associate 4,000

Share in losses of an associate

The investor shares in the investee’s losses only up to the amount of its interest in the associate.

 Interest in the associate includes the following:

a. Carrying amount of the investment in associate
b. Investment in preference shares of the associate
c. Unsecured, long-term receivables or loans
Illustration 38: share in losses of associate
ABC Co. owns 20% of the ordinary shares of XYZ, Inc. ABC ‘s records on December 31, 20x1 show the
following information begore any necessary year-end adjustments:
Investment in associate 200,000
Trade accounts receivable – XYZ 300,000
Investment in preference shares – XYZ 100,000
Advances to associate – XYZ 50,000
Loans receivable, secured – XYZ 120,000
  XYZ reported loss of P1,400,000 in 20x1.

 The interest in the associate as of Dec. 31 20x1 before adjustment is computed as follows:
Investment in associate 200,000
Investment in preference shares – XYZ 100,000
Advances to associate – XYZ 50,000
Interest in the associate – before the adjustment 350,000

The P350,000 balance of the “interest in the associate” is the threshold in determining the share in
the losses of the associate.

 The share in the loss of the associate in 20x1 is computed as follows:

Share in the loss of associate (1.4M x 20%) (280,000)

The share in the loss of associate is charged first to the balance of the investments in associate. The
excess loss is charged to the other components of the interest is the associate in the reverse order of
liquidation or to the preference shares first then to the advances to associate (unsecured long-term
receivable).

 The entry to recognize the share in the loss is as follows:

Dec. Share in loss of associate 280,000
31, Investment in associate 200,000
20x1 Investment in preference shares 80,000

 After posting the entry above, the balances of the relevant accounts are as follows:
Investment in associate (200K – 200K) 0
Investment in preference shares – XYZ 20,000
Advances to associate – XYZ 50,000
Interest in the associate – after adjustment 70,000

The remaining threshold for recognizing further losses is P70,000.

 XYZ reported loss of P500,000 in 20x2.

Share in loss of associate (500K x 20%) (100,000)

The computed amount of P100,000 exceeds the P70,000 threshold. Thus, only P70,000 will be
recognized as share in the associate ‘s loss in 20x2. The excess of P30,000 is disclosed as “loss not
recognized.”

 The entry to recognize the share in the loss is as follows:

Dec. Share in loss of associate 70,000
31, Investment in preference shares 20,000
20x2 Advances to associate 50,000

After making the entry above, the interest in the associate has a zero balance.

 XYZ reported loss of P100,000 in 20x3. In addition, ABC incurred constructive obligation of P120,000
in favor of XYZ and made payments of P80,000 on behalf of XYZ.
  ABC will not recognize any share in the P100,000 loss because the balance of the “interest in associate”
is already reduced to zero. The ‘should have been’ share of P20,000 (P100,000 loss in 20x3 x20%) is
disclosed as “loss not recognized.” The cumulative balance of “losses not recognized is P50,000
(P30,000 in 20x2 + 20,000 in 20x3).
However, ABC co. recognizes the P120,000 constructive obligation and the P80,000 payments made
on behalf of the associate as additional losses. The entry is as follows:

Dec. Loss on associate (120K + 80K) 200,000

31, Liability incurred on behalf of associate 120,000
20x3 cash 80,000

 In 20x4, XYZ reported profit of P1,000,000.

 ABC Co. resumes recognizing its share in the associate’s profits only after its share in the profit equals
the share in the losses not recognized. The share in the profit is computed as follows:

Share in profit of associate before adjustment (1M x 20%) 200,000

Cumulative losses not recognized (50,000)
Share in profit of associate -adjusted 150,000

Impairment losses
The investment in associate is tested for impairment under PAS 36 Impairment of Assets by comparing the
investment’s carrying amount (which includes the goodwill) with the investment’s recoverable amount. Any
resulting impairment loss is not allocated to any asset, even to goodwill. Instead, the total impairment loss is
treated as a decrease in the carrying amount of the investment, to which the goodwill is included.
Any reversal of impairment loss is recognized in accordance with PAS 36 to the extent that the
recoverable amount of the investment subsequently increases.

Recoverable amount is the amount to be recovered through use or sale of an asset. It is higher of an asset’s:
a. Fair value less costs of disposal; and
b. Value in use.

 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.”
 Costs of disposal – are “incremental costs directly attributable to the disposal of an asset or cash-
generating unit, excluding finance costs and income tax expense.”
 Value in use is “the present value of the future cash flows expected to be derived from an asset or cash-
generating unit.”

Impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount.

Illustration 39: Impairment of investment in associate

On December 31, 20x1, ABC Co. determined that its investment in associate is impaired. Information on
investment is as follows:

Carrying amount of investment (including P70,000 goodwill) 1,000,000

Fair value less costs of disposal (FVLCD) 800,000
Value in use 790,000

a. The impairment loss is computed as follows:

Recoverable amount (FVLCD – higher) 800,000
 Carrying amount of investment (1,000,000)
Impairment loss (200,000)

Journal entry:
Dec. 31, Impairment loss 200,000
20x1 Investment in associate 200,000

Joint arrangements
Joint arrangement is “an arrangement of which two or more parties have joint control.”

Essential elements in the definition of joint arrangement:

a. Contractual arrangement
b. Joint control

Types of joint arrangement

a. Joint operation – is “a joint arrangement whereby the parties that have joint control of the arrangement
have rights to the assets and obligations for the liabilities of the arrangement. Those parties are called
joint operators.”

b. Joint venture – is “a joint arrangement whereby the parties that have joint control of the arrangement
have rights to the net assets of the arrangement. Those parties are called joint venturers.”

Joint operations
A joint operator recognizes its own assets, liabilities, income and expenses plus its share in the joint operation’s
assets, liabilities, income and expenses.

Illustration 40:
A and B agreed to combine their operations, resources and expertise to jointly manufacture and sell a particular
product. The joint operators will individually carry out different parts of the manufacturing process, bearing
their own costs but will share equally in the revenues. The joint operation was completed, and thus
terminated, during the year. The following were the transactions:

 A had sales of P200 and expenses of P100

 B had sales of P150 and expenses of P80.

 Financial reporting:
The individual statements of comprehensive income of the entities will show the following:
Entity A Entity B
Sales [(200 +150) x 50%] 175 Sales [200 + 150 x 50%] 175
Expenses (100) Expenses (80)
Profit 75 Profit 95

Joint Ventures
An entity first applies PFRS 11 to determine the type of arrangement it is involved in. if the arrangement is a
joint venture, the entity recognizes its interest as an investment and account for it using the equity method
under PAS 28 Investment in associates and Joint Ventures.
Under the equity method, the investment is initially recognized at cost and subsequently adjusted for
the investors share in the investee’s change in the equity such as (1) profit or loss, (2) other comprehensive
income, (3) dividends, and (4) results of discontinued operations.
Illustration 41: Equity method
On Jan. 1, 20x1, ABC Co. entered into a joint arrangement classified as a joint venture. ABC acquired its 30%
interest in Joint venture, Inc (JV Inc.) for P500,000. During the year, JV Inc. reported P1,000,000 profit and
P200,000 other comprehensive income, i.e., a total comprehensive income of mP1,200,000. JV Inc. declared
dividends of P600,000.

Requirement: Compute for the carrying amount of ABC’s investment on Dec. 31, 20x1.

Solution:

Initial investment, 1/1/x1 500,000

Sh. In profit (1M x 30%) 300,000
Share in OCI (200K x 30%) 60,000
Dividends (600K x 30%) 180,000
Investment in Joint Venture 12/31/x1 680,000