SUPPLEMENTARY LEARNING MATERIALS IN ACCOUNTING 3

(Prepared by Dr. Lily P. Custodio, CPA)

D.1 – Financial Asset at Fair Value

I. Discussion of Accounting Principles

1. The International Accounting Standards Board defines investments as “assets held by an entity
for the accretion of wealth through distribution such as interest, royalties, dividends and rentals,
for capital appreciation or for other benefits to the investing entity such as those obtained
through trading relationships”.

Investments are assets not directly identified with the operating activities of an entity and occupy
only an auxiliary relationship to the central revenue producing activities of the entity.

2. Investments are held for diverse reasons such as:

a. For accretion of wealth or regular income through interest, dividends, royalties and rentals.
b. For capital appreciation as in the case of investments in land and real estate held for
appreciation and direct investments in gold, diamonds and other precious commodities.
c. For ownership control as in the case of investments in subsidiaries and associates.
d. For meeting business requirements as in the case of sinking fund, preference share
redemption fund, plant expansion fund and other noncurrent fund.
e. For protection as in the case of interest in life insurance contract in the form of cash
surrender value.

3. Examples of investments

1. Trading securities or financial assets held for trading

2. Financial asset at fair value through other comprehensive income
3. Nontrading equity investment
4. Investment in bonds or financial asset at amortized cost
5. Investment in associates
6. Investment in subsidiary
7. Investment property
8. Investment in fund
9. Investment in joint venture
10. Cash surrender value of life insurance

4. A financial asset is any asset that is:

a. Cash
b. A contractual right to receive cash or another financial asset from another entity.
c. A contractual right to exchange financial instrument with another entity under conditions that
are potentially favorable.
d. An equity instrument of another entity or shares issued by another entity.

6. Examples of financial assets

a. Cash or currency is the best example of financial asset because it represents the medium of
exchange for the measurement of financial transactions.
b. A deposit of cash with a bank is a financial asset because it represents the contractual right
of the depositor to obtain cash from the bank.

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 However, a gold bullion deposited in a bank is not a financial asset because it is a
commodity.

c. Trade accounts receivable, notes receivable, loans receivable and bond investment.

d. An option to purchase shares at less than market price.

e. Investment in shares, such as trading and nontrading equity investment, investment in

associate and investment in subsidiary.

7. Examples of nonfinancial assets

a. Intangible assets such as patent and trademark

b. Physical assets, such as inventory and property, plant and equipment
c. Prepaid expenses for which the future economic benefit is the receipt of goods or services
rather than the right to receive cash or another financial asset
d. Right of use asset or leased asset

8. What is an equity security?

a. It encompasses any instrument representing ownership shares and right, warrants or options
to acquire or dispose of ownership shares at a fixed or determinable price. Simply put, it
represents an ownership interest in an entity.

b. Ownership shares include ordinary shares, preference shares and rights or options to secure
ownership shares.

The owners of equity securities are legally known as shareholders.

c. A share is the ownership interest or right of a shareholder in an entity. The share is

evidenced by an instrument called share certificate.

The right pertains to share in earnings, election of directors, subscription for additional shares
and share in net assets upon liquidation.

d. Equity securities do not include redeemable preference shares, treasury shares and
convertible stock.

9. What is a debt security?

a. A debt security is any security that represents a creditor relationship with an entity.

b. A debt security has a maturity date and a maturity value.

c. Examples of debt securities:

a. Corporate bonds
b. BSP treasury bills
c. Government securities
d. Commercial papers
e. Preference shares with mandatory redemption date or are redeemable at the option of
the holder

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10. Classification of financial assets

1. Financial assets at fair value through profit or loss – include both equity securities and debt
securities.

2. Financial assets at fair value through other comprehensive income – include both equity
securities and debt securities.

3. Financial assets at amortized cost – include only debt securities.

11. The classification depends on the business model for managing financial assets which may
be:

a. To realize fair value changes.

b. To collect contractual cash flows.
c. To collect contractual cash flows and sell the investment.

12. Initial measurement of financial asset

 At initial recognition, an entity shall measure a financial asset at fair value plus, in the case
of financial asset not at fair value through profit or loss, transaction cost that are directly
attributable to the acquisition of the financial asset.

 Accordingly, transaction costs that are directly attributable to financial asset measured at
fair value through other comprehensive income shall be capitalized as cost of the financial
asset.

 If the financial asset is held for trading of if the financial asset is measured at fair value
through profit or loss, transaction cost are expensed outright.

Transaction costs include fees and commissions paid to agents, advisers, brokers and
dealers, levies by regulatory agencies and securities exchanges, and transfer taxes and
duties.

Transaction cost do not include debt premiums or discounts, financing cost and internal
administrative or holding costs.

13. Subsequent measurement or after initial recognition, an entity shall measure a financial asset
at:

a. Fair value through profit or loss (FVPL)

b. Fair value through other comprehensive income (FVOCI)
c. Amortized cost

14. Financial assets at fair value through profit or loss

 Financial assets held for trading or popularly known as trading securities.

 These financial assets are measured at fair value through profit or loss by requirement,
meaning, required by the standard.

 All other investments in quoted equity instruments.

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  These financial assets are measured at fair value through profit or loss by consequence
in accordance with Application Guidance B5. 1.14 of PFRS 9.

 Financial assets that are irrevocably designated on initial recognition as at fair value
through profit or loss.

 These financial assets are measured at fair value through profit or loss “by irrevocable
designation” or “by option”.

 This fair value option is applicable to investment in bonds and other debt instruments
which can be irrevocably designated as at fair value through profit or loss even if the
financial assets satisfy the amortized cost or fair value through other comprehensive
income measurement.

This irrevocable designation is the fair value option allowed in accordance with
Paragraph 4.1.5 of PFRS 9.

 All debt investments that do not satisfy the requirements for measurement at amortized cost
and at fair value through other comprehensive income.

 These financial assets are measured at fair value through profit or loss by default in
accordance with PFRS 9, paragraph 4.1.4.

15. Appendix A of PFRS 9 provides that a financial asset is held for trading if:

a. It is acquired principally for the purpose of selling or repurchasing it in the near term.

b. On initial recognition, it is part of a portfolio of identified financial assets that are managed
together and for which there is evidence of a recent actual pattern of short-term profit taking.

c. It is a derivative, except for a derivative that is a financial guarantee contract or a designated

and an effective hedging instrument.

 Trading securities are debt and equity securities that are purchased with the intent of
selling them in the “near term” or very soon.

 Trading securities are normally classified as current assets.

16. Equity investment of fair value through OCI

 At initial recognition, an entity may make an irrevocable election to present in other

comprehensive income or OCI subsequent changes in fair value of an investment in equity
instrument that is not held for trading (see PFRS 9, paragraph 5.7.5).

The irrevocable election to measure equity investment at FVOCI is applicable to nontrading

equity investment.

This irrevocable approach is designed to impose discipline in accounting for nontrading

equity investment.

The amount recognized in other comprehensive income is not reclassified to profit or loss
under any circumstances.

On derecognition, however, the amount may be transferred to equity or retained earnings.

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  If the investment in equity instrument is “held for trading”, the election to present gain and
loss in other comprehensive income is not allowed.

 If the investment in equity instrument is held for trading, subsequent changes in fair value are
always included in profit or loss.

17. Debt investment at amortized cost

 A financial asset shall be measured at amortized cost if both of the following conditions are
met (PFRS 9, paragraph 4.1.2):

a. The business model is to hold the financial asset in order to collect contractual cash flows
on specified date.

b. The contractual cash flows are solely payments of principal and interest on the principal
amount outstanding.

 This means that the business model is to collect contractual cash flows if the contractual
cash flows are solely payments of principal and interest.

 In such a case, the financial asset shall be measured at amortized cost.

18. Debt investment at fair value through OCI

 A financial asset shall be measured at fair value through other comprehensive income if both
of the following conditions are met (PFRS 9, paragraph 4.1.2A):

a. The business model is achieved both by collecting contractual cash flows and by selling
or trading the financial asset.

b. The contractual cash flows are solely payments of principal and interest on the principal
outstanding.

 The business model includes selling or trading the financial asset in addition to collecting
contractual cash flows.

 Interest income is recognized using the effective interest method as in amortized cost
measurement.

 On derecognition of debt investment at FVOCI, the cumulative gain and loss recognized in
other comprehensive income shall be reclassified to profit or loss in contrast to derecognition
of equity investment at FVOCI which is reclassified to retained earnings.

19. Summary of Measurement Rules

 Measurement of equity investments

1. Held for trading – at fair value through profit or loss

2. Not held for trading – as a rule, at fair value through profit or loss

3. Not held for trading – at fair value through other comprehensive income by irrevocable
election

4. All other investment is quoted equity instruments – at fair value through profit or loss
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 5. Investment is unquoted equity instruments – at cost

6. Investment of 20% to 50% - equity method of accounting

7. Investment of more than 50% - consolidation method to be taken up in advanced

accounting course.

 Measurement of debt investments

1. Held for trading – at fair value through profit or loss

2. Held for collection of contractual cash flows – at amortized cost

3. Held for collection of contractual cash flows – at fair value through profit or loss by
irrevocable designation or fair value option

4. Held for collection of contractual cash flows and for sale of the financial asset – at fair
value through other comprehensive income

5. Held for collection of contractual cash flows and for sale of the financial asset – at fair
value through profit or loss by irrevocable designation or fair value option

20. The Fair Value of an asset refers to the price that would be received to sell an asset in an
orderly transaction between market participants at the measurement date.

 Best evidence of the fair value in descending hierarchy

a. Quoted price of identical asset in an active market

b. Quoted price of similar asset in an active market
c. Quoted price of identical and similar asset in an inactive market

An active market is a market in which transactions take place with sufficient regularity and
volume to provide pricing information on an ongoing basis.

The fair value is the price agreed upon by a buyer and a seller in an arm’s length or orderly
transaction.

The buyer and seller who are the market participants must be independent, knowledgeable
and willing, meaning not forced or not compelled to enter into the transaction.

21. Quoted price

 Most often, the fair value of securities is the quoted price in the securities market, for
example, the Philippine Stock Exchange.

If the quoted price pertains to a share of equity security, it means pesos per share.

For example, if the investment in 10,000 shares of an entity costing P800,000 is quoted at
90, the market value thereof is P900,000, computed by multiplying 10,000 shares by P90 per
share.

 If the quoted price pertains to a bond or debt security, it means percent of the face amount of
the bond.

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 For example, if the investment in bonds with face amount of P2,000,000 costing P1,700,000
is quoted at 90, the market value is P1,800,000, computed by multiplying the face amount of
P2,000,000 by 90%.

22. Gain and loss on financial asset measured at fair value shall be presented in profit or loss,
except (see PFRS 9, paragraph 5.7.1):

a. When the financial asset is an investment in nontrading equity instrument and the entity has
irrevocably elected to present unrealized gain and loss in other comprehensive income

b. When the financial asset is a debt investment that is measured at fair value through other
comprehensive income

 Unrealized gain and loss on financial asset held for trading and other financial asset
measured at fair value are reported in profit or loss.

Unrealized gain and loss arise from investments that are reported at fair value.

 In determining fair value, no deduction is made for transaction cost that may be incurred on
disposal of the financial asset.

If the fair value is higher than carrying amount, the difference is an unrealized gain.

If the fair value is lower than carrying amount, the difference is an unrealized loss.

 Gain and loss that result from actually selling the investments are known as realized gain
and realized loss.

23. Gain and loss – Financial asset at amortized cost

 Unrealized gain and loss on financial asset at amortized cost are not recognized simply
because such investments are not reported at fair value.

 Gain and loss on financial asset measured at amortized cost shall be recognized in profit
or loss when the financial asset is derecognized, sold, impaired or reclassified, and through
the amortization process (PFRS 9, paragraph 5.7.2).

24. Sale of trading securities

 On December 31, 2023, the trading securities are sold for P5,200,000. The sale is simply
recorded as follows:

Cash 5,200,000
Trading securities 4,500,000
Gain on sale of trading securities 700,000

On derecognition of a financial asset the difference between the carrying

amount and the consideration received shall be recognized in profit or loss
(see PFRS 9, paragraph 3.2.12).

On disposal of a trading investment, the difference between the cash received and the
carrying amount is recognized as gain or loss on disposal to be reported in profit or loss.

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25. Equity statement at fair value through OCI

 As emphasized earlier, at initial recognition, an entity may make an irrevocable election to

present in other comprehensive income subsequent changes in value of an investment in
nontrading equity instrument.

26. Sale of equity investment – FVOCI

 On July 1, 2023, the securities are sold for P2,000,000. The journal entry to record the sale
is:

Cash 2,000,000
Financial asset – FVOIC 1,600,000
Retained earnings 400,000

Gain or loss on disposal of equity investment measured at fiar value through

otehr comprehensive income is recognized in retained earnings in
accordance with PFRS 9, oaragraph 5.7.1b.

 The cumulative gain or loss previously recognized in other comprehensive income is also
transferred to retained earnings in accordance with PFRS 9 Application Guidance,
paragrtaph 5.7.1.

 The amount recognized in OCI is not reclassified to profit or loss under any circumstances.

27. Impairment – Equity investments at fair value

 For financial assets measured at fair value, all gains and losses are either presented in profit
or loss or in otehr comprehensive income depending on whether the election to present gains
and losses on equity investments in other comprehensive income is taken or not.

 It is not necessary, therefore, to assess financial assets measured at fair value through profit
or loss and equity investments measured at fair value through other comprehensive income.

28. Impairment – Debt investments

An entity shall recognize expected credit loss on (see PFRS 9, paragraph 5.5.1):

a. Debt investment measured at amortized cost

b. Debt investment measured at fair value through other comprehensive income

29. Credit loss is the present value of all cash shortfalls.

 Expected credit loss is an estimate of credit loss over the life of the financial instrument.

The amount of impairment loss can be measured as the difference between the
carrying amount and the present value of estimated future cash flows
discounted at the original effective rate.

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 II. Application Exercises

You are provided with exercises that will demonstrate the application of accounting principles
discussed for financial assets at fair value using appropriate analysis in solving the exercises
correctly and accurately.

Five application exercises are provided in this lesson.

Exercise 1

ABC Company provided the following with respect to marketable equity securities held as “trading”.

1. The entity carried the following securities on December 31, 2023:

Cost Market
A ordinary – 4,000 shares 330,000 300,000
B ordinary – 1,000 shares 200,000 160,000
C preference – 2,000 shares 300,000 310,000
830,000 770,000

2. On June 30, 2024, the entity sold all the B ordinary shares for Ᵽ140,000.

3. On December 31, 2024, the securities are qouted as follows:

A Ordinary 80
C Preference 180

Required: Prepare journal entries to record the transactions.

Solution to Exercise 1

1. Unrealized loss – Trading Securities 60,000

Trading securities 60,000

Cost Market Difference

A ordinary – 4,000 shares 330,000 300,000
B ordinary – 1,000 shares 200,000 160,000
C preference – 2,000 shares 300,000 310,000
830,000 770,000 (60,000)

2. Cash 140,000
Loss on sale of trading securities 20,000
Trading securities 160,000

Carrying amount Market Difference

A Ordinary (4,000 x P80) 300,000 320,000
C Preference (2,000 x P180) 310,000 360,000
Total 610,000 680,000 70,000

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 3. Trading securities (680,000 – 610,000) 70,000
Unrealized gain – Trading Securities 70,000

Exercise 2

On January 1, 2022, CBA Company purchased the following trading securities:

Fair value
Cost December 31, 2023
Cong Company ordinary 600,000 650,000
Bong Company preference 350,000 200,000
Ang Company bonds 500,000 400,000

On October 1, 2023, the entity sold one-half of Cong Company ordinary for Ᵽ375,000.

On December 31, 2023, the fair value of the remaining securities was Ᵽ800,000.

Required:

Prepare journal entries to record the transactions.

Solution to Exercise 2

Dec. 31, 2022 - Unrealized loss – Trading securities 200,000

Trading securities 200,000

Cost Market Difference

Cong Company ordinary 600,000 650,000
Bong Company preference 350,000 200,000
Ang Company bonds 500,000 400,000
1,450,000 1,250,00 (200,000)
0

Oct. 1, 2023 - Cash 375,000

Gain on sale of trading securities 50,000
Trading securities (650,000 x ½ ) 325,000

Dec. 31, 2023 - Unrealized loss – Trading secutities 125,000

Trading securities 125,000

Carrying amout Market Difference

Bong Company 200,000
Ang Company 400,000
Cong Company 325,000
Total 925,000 800,000 (125,000)

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 Exercise 3

PRIMA Company purchased equity securities during 2023 to be held as investments. The cost and
market value of the investment are:

December 31, 2023 Cost Market

Trading securities 2,000,000 2,500,000
Securities not held for trading 3,000,000 2,900,000

December 31, 2022

Trading securities 2,000,000 2,200,000
Securities not held for trading 3,000,000 2,300,000

The securities not held for trading are measured at fair value through other comprehensive income
by irrevocable election.

Required:
Prepare journal entries for 2023 and 2024.

Solution to Exercise 3

Dec. 31, 2023:

Trading securities 500,000
Unrealized gain – Trading securities 500,000
(2,000,000 – 2,000,000)

Unrealized loss – OCI 100,000

Financial asset – FVOCI 100,000
(2,900,000 – 3,000,000)

Dec. 31, 2024

Unrealized loss – TS 300,000
Trading securities 300,000
(2,500,000 – 2,200,000)

Unrealized loss – OCI 600,000

Financial asset – FVOCI 600,000
(2,900,000 – 2,300,000)

Exercise 4

CAS Company acquired the following equity securities:

December 31, 2023 Cost Market

ES Company 200,000 120,000
Bio Company 400,000 280,000
Env Company 600,000 650,000

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 December 31, 2024
ES Company 200,000 220,000
Bio Company 400,000 300,000
Env Company 600,000 580,000

The equity securities do not qualify as held for trading.

The equity has elected irrevocably to present changes in fair value in other comprehensive income.

Required:
Prepare journal entries on December 31, 2023 and December 31, 2024.

Solution to Exercise 4

Dec. 31, 2023 Unrealized loss – OCI 150,000

Financial asset – FVOCI 150,000

Dec. 31, 2023 Cost Market Difference

ES Company 200,000 120,000
Bio Company 400,000 280,000
Env Company 600,000 650,000
1,200,000 1,050,000 150,000

Dec. 31, 2024 Financial asset – FVOCI 50,000

Unrealized gain – OCI 50,000

Dec. 31, 2024 Carrying amount Market Difference

ES Company 120,000 220,000
Bio Company 280,000 300,000
Env Company 650,000 580,000
1,050,000 1,100,000 50,000

Exercise 5

GLEZA Company reported the following accounts in the statement of financial position on January 1,
2023:
Noncurrent assets
Financial asset – FVOCI 4,000,000
Market adjustment for unrealized loss ( 500,000)
Market value 3,000,000
Other comprehensive income
Unrealized loss ( 500,000)

An analysis of the investment portfolio revealed the following on December 31, 2023.
Cost Market
GGG ordinary share 1,000,000 1,200,000
EZA ordinary share 2,500,000 2,000,000
GLZ preference share 500,000 200,000
4,000,000 3,400,000

On July 1, 2024, the EZA ordinary share was sold for Ᵽ2,100,000.

On December 31, 2024, the remaining investments have the following market value:
GGG ordinary share 1,000,000
GLZ preference share 150,000
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Required:
1. Prepare journal entry to recognize the decrease in value on December 31, 2023.
2. Prepare journal entry to record the sale of PRI ordinary share on July 1, 2024.
3. Prepare journal entry on December 31, 2024 to recognize the change in fair value.

Solution to Exercise 5

Requirement 1: Journal Entry on Dec. 31, 2023

Unrealized loss – OCI 100,000

Financial asset – FVOCI 100,000

Dec. 31, 2023 Carrying amount Market Difference

GGG ordinary shares 1,200,000
EZA ordinary shares 2,000,000
GLZ preference shares ________ 200,000
Total 3,500,000 3,400,000 100,000

Requirement 2: Journal Entry on July 1, 2024

Cash 2,100,000
Retained earnings 100,000
Financial asset – FVOCI 2,000,000

The cumulative unrealized loss of P500,000 is charged to Retained Earnings:

Retained earning 500,000
Unrealized loss 500,000

Requirement 3: Journal Entry on Dec. 31, 2024 to recognize change in fair value

Unrealized loss – OCI 250,000

Financial asset – FVOCI 250,000

Carrying amount Market Gain (Loss)

GGG 1,200,000 1,000,000 (200,000)
GLZ 200,000 150,000 (50,000)
Total 1,400,000 1,150,000 (250,000)

Further analysis:

Unrealized loss – December 31, 2023 (100,000)

Unrealized gain realted to EZA which were sold 100,000
Adjusted balance -
Unrealized loss in 2024 (250,000)
Unrealized loss as reflected on Dec. 31, 2024 (250,000)

*****

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