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INVESTMENTS IN DEBT SECURITIES DRILL

1. If the acquisition cost of investment in bonds is less than the face amount, there is
a. discount. b. premium. c. loss. d. gain.

2. The use of the effective-interest method in amortizing bond premiums and discounts results in
a. a greater amount of interest income over the life of the bond issue than would result from use of
the straight-line method.
b. a varying amount being recorded as interest income from period to period.
c. a variable rate of return on the book value of the investment.
d. a smaller amount of interest income over the life of the bond issue than would result from use
of the straight-line method.

3. If the effective interest rate is higher than the nominal rate, there is
a. discount. b. premium. c. loss. d. gain.

4. The true or actual rate of interest that a bondholder earns on the investment.
a. nominal rate c. effective interest rate
b. coupon rate d. stated rate

5. It is a type of serial bond wherein the holder is given the right to extend the initial maturity to a
longer maturity date.
a. extendible bond c. redeemable bond
b. retractable bond d. callable bond

6. Subsequent to their initial recognition, which financial assets with quoted market prices in an active
market are measured at fair value?
Financial assets Financial Assets with fair
at amortized cost values through profit or loss
a. Yes No
b. Yes Yes
c. No Yes
d. No No

7. On January 1, 20x1, Impressed Co. acquired 8%, ₱1,000,000 face amount, 4-year ‘term’ bonds for
₱936,603. The bonds are measured at amortized cost and have a yield rate of 10%. How much is the
carrying amount of the investment on December 31, 20x2?
a. 1,000,000 b. 950,263 c. 965,289 d. 981,818

8. On October 1, Dennis Company purchased ₱200,000 face value, 12% bonds at 98 plus accrued
interest and brokerage fees and classified them as amortized cost assets. Interest is paid
semiannually on January 1 and July 1. Brokerage fees for this transaction were ₱700. At what
amount should this acquisition of bonds be recorded?
a. 196,000 b. 196,700 c. 202,000 d. 202,700

9. On August 1, 2004, Bettis Company acquired ₱120,000 face value, 10% bonds of Hanson
Corporation at 104 plus accrued interest. The bonds were dated May 1, 2004, and mature on April
30, 2009, with interest payable each October 31 and April 30. The bonds are classified as
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subsequently measured at amortized cost. What entry should Bettis make to record the purchase of
the bonds on August 1, 2004?
a. Investment in bonds 124,800
Interest Revenue 3,000
Cash 127,800
b. Investment in bonds 127,800
Cash 127,800
c. Investment in bonds 127,800
Interest Revenue 3,000
Cash 124,800
d. Held-to-Maturity Securities 120,000
Premium on Bonds 7,800
Cash 127,800

10. On April 30, 20x1, Heidelberg Co. acquired ₱100,000 face amount, 10% bonds dated January 1, 20x1
at 102. The purchase price includes accrued interest. How much is the initial carrying amount of the
investment?
a. 102,000 b. 99,500 c. 98,667 d. 105,333

11. On January 1, 20x1, Honey Co. intends to buy 3-year, zero-coupon bonds with face amount of
₱3,000,000 and maturity value of ₱3,993,000. The effective interest rate is 16%. The bonds will be
measured at amortized cost. How much is estimated purchase price of the bonds on January 1,
20x1?
a. 2,299,341 b. 2,356,214 c. 2,558,146 d. 2,789,123

12. On January 1, 20x1, Santa Co. acquired 10%, ₱1,000,000 bonds at 92. Commission paid to brokers
amounted to ₱9,100. The bonds are classified as investment measured at amortized cost. Principal is
due on December 31, 20x3 but interest is due annually every December 31. The carrying amount of
the investment on December 31, 20x1 is most approximately equal to
a. 949,883. b. 958,364. c. 973,368. d. 938,341.

13. On January 1, 20x1, Solicit Co. acquired 12%, ₱1,000,000 bonds for ₱1,049,737. The principal is due
on January 1, 20x4 but interest is due annually every December 31. The bonds are classified as
investment measured at amortized cost. The yield rate on the bonds is 10%. On September 30, 20x2,
all the bonds were sold at 110. Commission paid to the broker amounted to ₱10,000. How much is
the gain (loss) on the sale?
a. (67,686) b. 77,686 c. (77,686) d. (22,314)

14. On January 1, 20x1, MX Co. purchased 10%, ₱3,000,000 bonds for ₱3,105,726. The bonds are
classified as financial asset measured at amortized cost. Principal on 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 is due annually at each year-end. The effective interest rate on the bonds is 8%. How much is
the current portion of the investment on December 31, 20x1?
a. 1,051,542 b. 1,035,665 c. 2,054,184 d. 1,018,519
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Use the following information for the next five questions:

On January 1, 20x1, NFCPAR, Inc. acquired 10%, ₱1,000,000 bonds for ₱827,135. The bonds mature on
December 31, 20x3 and pay annual interest every December 31. NFCPAR, Inc. incurred transaction
costs of ₱80,000 on the acquisition. The effective interest rate adjusted for the effect of the transaction
costs is 14%.

The bonds are to be held under a “hold to collect and sell” business model. Information on fair values is
as follows:
December 31, 20x1…………………………….98
December 31, 20x2……………………………102
December 31, 20x3……………………………100

15. How much is the carrying amount of the investment on December 31, 20x1?
a. 935,134 b. 1,002,000 c. 980,000 d. 965,443

16. How much is the unrealized gain (loss) recognized in other comprehensive income in 20x1?
a. 45,866 b. (45,866) c. (37,899) d. 0

17. How much is the interest income recognized in 20x2?

a. 126,999 b. 130,779 c. 135,088 d. 144,388

18. How much is the unrealized gain (loss) recognized in other comprehensive income on December
31, 20x2?
a. 9,221 b. 40,000 c. (7,219) d. 0

19. Disregard the previous questions. Assume the bonds were sold for ₱900,000 on July 1, 20x2. How
much is the total gain (loss) on the sale, including any reclassification adjustment to profit or loss?
a. (50,000) b. 50,000 c. (95,389) d. (99,523)

20. On January 1, 20x1, Staircase Glass Co. purchased 10%, ₱1,000,000 callable bonds for ₱966,199. The
bonds mature in 4 years’ time. Interest is due annually every Dec. 31. The investment is classified as
financial asset measured at amortized cost. The effective interest rate is 12%. If the carrying amount
of the investment on December 31, 20x1 is ₱982,143, what is the expected holding period for the
investment?
a. 4 years b. 3 years c. 2 years d. none of these

“Do nothing out of selfish ambition or vain conceit. Rather, in humility value others above
yourselves, not looking to your own interests but each of you to the interests of the others. In your
relationships with one another, have the same mindset as Christ Jesus.” (Philippians 2:3-5)
- END –

ANSWERS:
1. A
2. B
3. A
4. C
5. A
6. C
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7. C

Date Collections Interest income Amortization Present value

1/1/x1 936,603
12/31/x1 80,000 93,660 13,660 950,263
12/31/x2 80,000 95,026 15,026 965,289
12/31/x3 80,000 96,529 16,529 981,818
12/31/x4 80,000 98,182 18,182 1,000,000

8. B (200K x 98%) + 700 = 196,700

9. A

10. C
Purchase price of bonds including interest (100K x 102%) 102,000
Accrued interest purchased – Jan. to Mar. (100K x 10% x 4/12) (3,333)
Initial measurement of investment in bonds 98,667

11. C
Purchase price of bonds = ₱3,993,000 x PV of ₱1 @16%, n=3
Purchase price of bonds = (3,993,000 x 0.6406577) = 2,558,146

12. A
Acquisition cost (1M x 92%) 920,000
Transaction costs 9,100
Initial carrying amount 929,100

“Trial and error” approach:

Future cash flows x PV factor at x% = Present value
(1M x PV of ₱1 @ x%, n=3) + (1M x 10% x PV of an ordinary annuity of ₱1 @ x%, n=3) = 929,100

First trial: (using 13%)

Future cash flows x PV factor at x% = PV or initial carrying amount
➢ (1M x PV of ₱1 @ 13%, n=3) + (1M x 12% x PV of an ordinary annuity of ₱1 @ 13%, n=3) = 929,100
➢ (1M x 0.69305016227) + (100,000 x 2.36115259792) = 929,100
➢ (693,050 + 236,115) = 929,165 approximates 929,100

If the difference of ₱65 is deemed immaterial, the effective interest rate that will be used is 13%. The
amortization table using this rate is prepared as follows:

Date Collections Interest income Amortization Present value

1/1/x1 929,100
12/31/x1 100,000 120,783 20,783 949,883
12/31/x2 100,000 123,485 23,485 973,368
12/31/x3 100,000 126,538 26,538 999,906

13. D
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Solution:
Interest Present
Date Collections income Amortization value
1/1/x1 1,049,737
12/31/x1 120,000 104,974 15,026 1,034,711
9/30/x2 90,000 77,603 12,397 1,022,314

Sale price including purchased interest (1M x 110%) 1,100,000

Purchased interest (1M x 12% x 9/12) (90,000)
Transaction cost (10,000)
Net proceeds 1,000,000
Carrying amount (1,022,314)
Loss on sale (22,314)

14. B
Interest on outstanding principal
Date Principal Total collections
balance
A b c=a+b
Dec. 31, 20x1 1,000,000 (3,000,000 x 10%) = 300,000 1,300,000
Dec. 31, 20x2 1,000,000 (2,000,000 x 10%) = 200,000 1,200,000
Dec. 31, 20x3 1,000,000 (1,000,000 x 10%) = 100,000 1,100,000

Date Collections Interest income Amortization Present value

Jan. 1, 20x1 3,105,726
Dec. 31, 20x1 1,300,000 248,458 1,051,542 2,054,184
Dec. 31, 20x2 1,200,000 164,335 1,035,665 1,018,519
Dec. 31, 20x3 1,100,000 81,481 1,018,519 -

15. C – (1M x 98%) = 980,000

16. A (980,000 fair value - 934,134 amortized cost*) = 45,866 gain

*Amortization table:
Date Interest received Interest income Amortization Present value
1/1/x1 907,135
12/31/x1 100,000 126,999 26,999 934,134
12/31/x2 100,000 130,779 30,779 964,913
12/31/x3 100,000 135,088 35,088 1,000,000

17. B – see amortization table above

18. A
Fair value - 12/31/x2 1,020,000
Amortized cost - 12/31/x2 964,913
Cumulative balance of gain - 12/31/x2 55,087
Cumulative balance of gain - 12/31/x1 45,866
Unrealized gain - OCI in 20x2 9,221
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19. D
Solution:
Date Interest received Interest income Amortization Present value
1/1/x1 907,135
12/31/x1 100,000 126,999 26,999 934,134
7/1/x2 50,000 65,389 15,389 949,523

➢ (900,000 sale price – 50,000 accrued interest) – 949,523 amortized cost = (99,523) loss

Supporting journal entries:

7/1/x2
Interest receivable 50,000
Investment in bonds - FVOCI 15,389
Interest income 65,389
to record accrued interest as of date of sale

Unrealized loss – OCI 145,389*

Investment in bonds – FVOCI 145,389
to recognize the fair value change as of date of sale

*Net sale price - 7/1/x2 (900K – 50K receivable) 850,000

Amortized cost - 7/1/x2 949,523
Cumulative balance of loss - 7/1/x2 (99,523)
Cumulative bal. of gain - 12/31/x1 (see previous solutions) 45,866
Unrealized loss - OCI in 20x2 (145,389)

Cash 900,000
Investment in bonds – FVOCI 850,000
Interest receivable 50,000
to record the sale

Loss on sale – P/L 99,523

Unrealized loss – OCI 99,523*
to record the reclassification adjustment of the cumulative loss to profit or loss

20. C
Step 1: Place given information in pro-forma amortization table
Date Collections Interest income Amortization Present value
1/1/x1 966,199
12/31/x1
12/31/x2
12/31/x3
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12/31/x4

Step 2: Complete the amortization table until the present value equals the face amount
Date Collections Interest income Amortization Present value
1/1/x1 966,199
12/31/x1 100,000 115,944 15,944 982,143
12/31/x2 100,000 117,857 17,857 1,000,000
12/31/x3
12/31/x4

❖ The expected holding period is 2 years.