INTRODUCTION TO INVESTMENTS
INVESTMENTS OF AN ENTITY
The goal of almost every business entity is to earn profit, and they can supplement this by
investing its excess cash to earn additional income. Examples of short-term investments: time
deposits, money market placement, commercial papers.
An entity may also invest for long-term purposes such as investments in facilities. Examples:
stock market, investments in debt securities (bonds and loans) and investments in lands.
Earnings are in the form of dividends, interest, and/or capital appreciation.
The choice of what investment outlet an entity should choose mainly depends on the following:
a. Core activities – an entity will most likely invest its cash on the facilities related to its
operations. b. Availability of excess funds-if funds re available for a short period of time before
its eventual use, an entity may put them in short-term investments. If funds are available for
long-term use or commitments, an entity may invest in long-term investments.
c. risk appetite –every investment entail risk (possibility that the investments may or may not
provide returns to an entity or worse, diminish the amount invested due to losses. The higher
the risk, the higher the return. An entity is called risk-averse if it willing to accept a lower level
of risk while risk-seeking if it is willing to accept a higher level of risk.
FINANCIAL INSTRUMENTS, FINANCIAL ASSETS, AND FINANCIAL LIABILITIES
Financial instrument – is any contract that gives rise to a financial asset of one entity and a
financial liability or equity instrument of another entity.
Financial asset-is any asset that is: cash, an equity instrument of another entity, a contractual
right to receive cash or another financial asset from another entity or exchange financial assets
or financial liabilities with another entity under conditions that are potentially favorable to the
entity or a contract that will or may be settled in the entity’s own equity instruments (derivatives).
Financial liability- is any liability that is a. a contractual obligation to deliver cash or another
financial asset to another entity or to exchange financial assets or financial liabilities with
another entity. b. a contract that will or may be settled in the entity’s own equity instruments and
is a non-derivative for which the entity is or may be obliged to deliver a variable number of the
entity’s own equity instruments; or a derivative that will or may be settled other than by the
exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s
own equity instruments.
Characteristics of financial assets and their corresponding financial liabilities:
a. arise from contractual rights and obligations b. for financial assets, there would be a present
right to receive cash or other financial assets, and for financial liabilities, there would be a
present obligation to pay cash or other financial assets.
The following items are not financial instruments: inventories, prepaid expenses, PPE,
intangible assets, unearned income, warranty liability, tax items, constructive obligations.
Illustrations 1: DONNA Company reported the following information:
Cash P600,000 Investment in equity securities P1,000,000
Accounts receivable 2,000,000 Biological assets 800,000
Notes receivable 500,000 Land 1,800,000
Inventory 5,000,000 Building 3,000,000
Loans receivable 6,000,000 Intangible assets 1,200,000
Investment in bonds 10,000,000 Goodwill 870,000
Prepaid expenses 400,000 Accounts payable 1,850,000
Equipment 4,500,000 Notes payable
615,000
Deferred tax asset 600,000 Bonds payable 8,000,000
Prepaid taxes 150,000 Income tax liability 700,000
Advances to suppliers 325,000 Loans payable 1,100,000
Investment properties 2,700,000 Advance payments from customers 100,000
Derivative assets 350,000 Derivative liabilities 750,000
Required: Classify and determine the total amount as to financial assets, nonfinancial assets,
financial liabilities and nonfinancial liabilities.
BROAD CLASSIFICATIONS OF FINANCIAL ASSETS
a. Investments in debt securities – these include but are not limited to loans receivable,
notes receivables, investments in bonds, and investments in redeemable preference shares.
These are basically the financial liabilities of another entity in the form of loans payable, notes
payable, and bonds payable. Normally, these investments are interest-bearing.
b. Investments in equity securities – these include but are not limited to investments in
common shares or preference shares.
c. Derivatives – are usually classified into those held for speculation and those that are used in
hedging. Derivatives “derive” their value from changes in the specified underlying. Examples of
derivatives are forwards, futures and options. Examples of underlying: interest rate, commodity
price, foreign exchange rate, or other variables.
CLASSIFICATIONS OF FINANCIAL ASSETS
1. Fair value through profit or loss (FVTPL)
a. by default (for both debt and equity securities) or by
b. irrevocable designation on initial recognition (for both debt and equity securities)
2. Fair value through other comprehensive income (FVTOCI)
a. by meeting certain conditions (for debt securities only); or
b. by irrevocable designation on initial recognition (for equity securities only)
3. Amortized cost
a. by meetings certain conditions (for debt securities)
Note: Investments in equity securities cannot be classified at amortized cost. Unlike
investments in equity securities, investments in debt securities cannot be irrevocably designated
at FVTOCI, but need to meet certain conditions to be classified at FVTOCI.
Classifications of Financial Assets:
1. Investments in Equity Securities – FVTPL/FVTOCI (irrevocable designation only)
2. Investments in Debt Securities – FVTPL/Amortized cost/FVTOCI (by meeting certain
conditions only)
3. Derivatives (used for speculation) – FVTPL (by default)
BASIS FOR THE CLASSIFICATION OF FINANCIAL ASSETS
a. the entity’s business model for managing financial assets;
b. the contractual cash flow characteristics of the financial asset
WHEN TO RECOGNIZE FINANCIAL ASSETS? When the entity becomes party to the
contractual provisions of the instrument. Planned future transactions are not assets and
liabilities.
INITIAL MEASUREMENT OF FINANCIAL ASSETS (depends on the related classification)
FVTPL Financial Assets All others (FVTOCI and Amortized Cost)
At fair value (i.e., transaction costs are At fair value plus transaction costs (i.e.,
expensed outright) transaction costs are capitalized)
Fair value – 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. FV = transaction
price paid in obtaining the financial asset. FV is not necessarily equal to the par value of equity
securities or the face amount of debt securities.
Transaction costs are incremental costs that are directly attributable to the acquisition, issue,
or disposal of a financial asset or financial liability. Incremental cost is one that would not have
been incurred if the entity had not acquired, issued, or disposed of the financial instrument. TC
include fees and commission paid to agents, advisers, brokers and dealers, levies by regulatory
agencies and security exchanges, and transfer taxes and duties. TC do not include debt
premiums or discounts, financing costs or internal administrative or holding costs.
Illustration 2. An entity acquired a financial asset for P700,000 which is equal to its fair value on
that date. In addition, the entity also incurred P12,000 transaction costs of the acquisition.
Required: Under each of the following independent scenarios, determine the journal entry to
record the acquisition of the financial asset:
1. The financial asset is accounted as FVTPL.
2. The financial asset is accounted as FVTOCI.
Scenario 1: Since the financial asset is measured at FVTPL, the transaction costs are expensed
outright:
Financial asset at FVTPL 700,000
Transaction costs (expense) 12,000
Cash 712,000
Scenario 2: Since the financial asset is measured at FVTOCI, the transaction costs are
included in the initial measurement (i.e., capitalized):
Financial asset at FVTPL 712,000
Cash 712,000
METHODS OF COMPUTING THE AMOUNT OF FAIR VALUE
Depending on the financial asset, the following are the applicable methods of computing the fair
value:
Approaches Description
Quoted price Applicable to both investments in equity securities and debt securities
approach wherein the fair value is determined using the quoted price of the
financial asset.
For investments in equity securities, it is usually stated as the quoted
price per share.
For investments in debt securities, it is usually stated as a percentage
of face amount.
Present value This approach is primarily applicable to investments in debt securities.
approach Fair value is determined by obtaining the present value of contractual
cash flows (principal + interest) discounted using the market yield
rate as of the measurement date.
WHEN THE TRANSACTION PRICE IS NOT EQUAL TO FAIR VALUE
There are circumstances wherein transaction price is different from the amount of fair value.
For example, transaction price might be lower than the fair value if the seller is forced to accept
the transaction price due to financial difficulty (e.g. rush sale).
Regardless of the difference between transaction price fair value, a financial asset shall
always be initially measured equal to its fair value, with the difference accounted for as
follows:
Scenario Accounting for the difference
Transaction price < Fair value Unrealized gain
Transaction price > Fair value Unrealized Loss
Illustration 3: An entity acquired a financial asset to be measured at FVTPL for P1,000,000.
Required: Under each of the following independent scenarios, determine the journal entry to
record the acquisition:
1. Financial asset’s fair value amounted to P1,100,000.
2. Financial asset’s fair value amount to P985,000.
Solution?
BASKET PURCHASE OF FINANCIAL ASSETS
Traditional Approach Contemporary Approach
The transaction price is allocated between or The transaction price is not allocated but the
among the covered financial assets based on financial assets are measured at their fair
their relative fair values. values.
There is no gain or loss to be recognized on Any difference between the transaction price
initial recognition. paid and the total fair value shall be
This approach is a relic from the past recognized as unrealized gain or loss in
generally accepted accounting. profit or loss. This is similar to the recognition
of day 1 gain or loss. (According to PFRS)
Illustration 4. On January 1, 2023, KNOWLEDGE Company acquired from another investor
ordinary shares of AAA Company and ordinary shares of BBB Company at a single price of
P9,500,000, both to be accounted for at FVTPL. As of the same date, the acquired shares of
AAA Co. had fair value of P4,000,000 while the acquired shares of BBB Co had a fair value of
P6,000,000. Record the transaction using the a) traditional approach and contemporary
approach.
Solution?
