DySAS Center for CPA Review (DCCPAR)

2nd Floor Mitra Bldg. (Mercury Drug)

San Pedro St., Davao City

FINANCIAL ACCOUNTING

Batch 19 May 2010

Review Material
MBA, CPA

Mr. John C. Frivaldo,

FINANCIAL INSTRUMENT - DEBT

DEFINITION
Bond

is a formal unconditional promise under seal to pay a specified

sum of money at a determinable future date, and to make
periodic interest payments at a stated rate until the principal
sum is paid.
is a contract of debt whereby one party called the issuer
(debtor) borrows fund from another party called the
bondholder (creditor).

CLASSIFICATION
A. Trading Securities are held with the intention of selling them in the near
future or very soon. They are normally classified as current assets for the
purpose of generating a profit. Any unrealized gains or losses are included in
the net income for the current period.
B. Available-for-Sale Securities are held indefinitely and will be available to
be sold in response to liquidity needs, reduction of legal reserves or allowable
alternative investments. They may be classified as current or noncurrent
assets depending on whether they are intended to be held within one year
or for more than one year. Any unrealized gains or losses are either included
in the equity.
C. Held-to-Maturity Securities are held with fixed or determinable
payments and fixed maturity that an enterprise has the positive intent and
ability to hold to maturity. They are normally classified as noncurrent
assets. Unrealized gains or losses are not recorded since they are recorded
at amortized cost, except when such are actually sold, impaired, or
amortized.
VALUATION
(1) Initial Measurement
Cost (fair value plus transaction costs*)
* outright expense for trading securities
(2) Subsequent Measurement
Fair Value (for Trading and Available-for-Sale)
Amortized Cost (for Held-to-Maturity Securities)
Method of Amortizing Premium or Discount on Bonds:
Scientific or Effective interest method (under PAS)
RECLASSIFICATIONS BETWEEN PORTFOLIOS OF SECURITIES
1. For a security transferred from or into trading securities, the
unrealized gain or loss at the date of transfer will be recognized as a
component of income. However, under the revised PAS 39, such transfer
is not allowable.
2. For a transferred from held to maturity into available for sale, the
unrealized gain or loss at the date of transfer shall be excluded from
income and reported as a separate component of stockholders equity.
3. For a transferred from available for sale securities into held to
maturity, the unrealized gain or loss at the date of transfer shall continue
to be reported as component of stockholders equity but shall be
amortized through interest income over the remaining life of the debt
security in a manner consistent with amortization of premium or discount.

FINANCIAL STATEMENT PRESENTATION

Current Assets:
Trading Securities
Available-for-Sale Securities
Non-Current Assets:
Available-for-Sale Securities
Held-to-Maturity Securities (amortized cost)
Stockholders Equity:
Unrealized gains Available-for-Sale Securities
Unrealized losses Available-for-Sale Securities
Income Statement:
Unrealized gains Trading Securities
Unrealized losses Trading Securities
Realized gains TS/AFS/HtM
Realized losses TS/AFS/HtM

Pxxx
Pxxx
Pxxx
Pxxx
Pxxx
(Pxx)
Pxxx
(Pxx)
Pxxx
(Pxx)

1. To be classified as trading securities, debt investments must be readily

marketable and be expected to be sold within:
(a) 3 months from date of purchase.
(b) the next year or operating cycle, whichever is shorter.
(c) the next year or operating cycle, whichever is longer.
(d) the next year.
D
2. What is the treatment of premium or discount on trading bond investment?
(a) as part of the cost of the bond investment until the investment is sold
(b) as part of the cost of the bond investment and amortized over 5 years
(c) as expense or revenue in the period the bond is purchased
(d) as part of the cost of the bond investment and amortized over the remaining
life of the bonds
A
3. If the acquisition cost of an available-for-sale (debt) securities bond
investment is more than the face value, the difference is:
(a) bond premium to be recognized as outright loss
(b) included as part of the carrying value of the bond investment but not
amortized
(c) included as part of the carrying value of the bond investment and
subsequently amortized over the remaining life of the bond using straight line
method
(d) included as part of the carrying value of the bond investment and
subsequently amortized over the remaining life of the bond using the
effective interest method. D
4. LMN Company did not amortize the premium on its available-for-sale (debt)
securities. What effect would this have on the carrying value of the investment
and on net income, respectively?
(a) overstated, overstated
(c) understated, understated
(b) understated, overstated
(d) no effect, no effect
A
5. On the derecognition of an available for sale security:
(a) the difference between the consideration received and the carrying amount
shall be recognized in profit and loss
(b) the difference between the consideration received and the carrying amount
shall be recognized as an adjustment to retained earnings
(c) the difference between the sum of the consideration received and any
cumulative gain or loss that has been recognized directly in equity and the
carrying amount shall be recognized in profit or loss.
(d) the difference between the sum of the consideration received and any
cumulative gain or loss that has been recognized directly in equity and the
carrying amount shall be recognized in retained earnings.
C
6. How is the premium or discount on debt securities purchased as held to
maturity securities generally reported in published financial statements?
(a) as an integral part of the cost of the asset acquired and amortized over the
remaining life of the bond issue
(b) as expense or revenue in the period the bonds are purchased
(c) as an integral part of the cost of the asset acquired and amortized over the
period the bonds are expected to be held
(d) as an integral part of the cost of the asset acquired until such time as the
investment is sold
A
7. An investor purchased a bond classified as held-to-maturity at a discount. At
the purchase date, the cash paid to the seller is:
(a) the same as the face amount of the bond
(b) the same as the face amount of the bond plus accrued interest
(c) more than the face amount of the bond
(d) less than the face amount of the bond
D

8. An investor purchased a long-term bond investment January 1. Annual

interest was received on December 31. The investors interest income for the
year would be higher if the bond was purchased at:
(a) discount
(c) face value
(b) premium
(d) current value
A
9. On both December 31 of the current year and prior year, an entitys marketable
equity security had the same market value which was below cost. The entity
considered the decline in value to be temporary in the prior year but
nontemporary in the current year. At the end of both years, the security was
classified as noncurrent available for sale security. What would be the effect of
the determination that the decline was nontemporary on the noncurrent assets
at current year-end and net income for the current year?
(a) no effect on both noncurrent assets and net income
(b) no effect on noncurrent assets and decrease in net income
(c) decrease in noncurrent assets and no effect on net income
(d) decrease in both noncurrent assets and net income
B
10.If there is objective evidence that the AFS security is impaired, the cumulative
loss that had been recognized directly in equity:
(a) shall not be removed from equity but amortized over a reasonable period
(b) shall not be removed from equity
(c) shall be removed from equity and recognized in profit or loss
(d) shall be removed from equity and recognized as an adjustment of the
beginning balance of retained earnings
C
11.A marketable debt security is transferred from AFS to HtM. At the transfer date,
the securitys carrying amount exceeds its market value. What amount is used
at the transfer date to record the security in the HtM portfolio?
(a) market value, regardless of whether the decline in market value below cost is
considered permanent or temporary
(b) market value, only if the decline in market value below cost is considered
permanent
(c) carrying amount, if the decline in market value below cost is considered
temporary
(d) carrying amount, regardless of whether the decline in market value below
cost is considered permanent or temporary
A
12.If as a result of a change in intention or ability, it is no longer appropriate to
classify an investment as held to maturity, it shall be reclassified as:
(a) AFS and remeasured at fair value and the difference between fair value and
carrying amount shall be accounted for as component of equity
(b) AFS and remeasured at fair value and the difference between fair value and
carrying amount shall be included in profit or loss
(c) TS and remeasured at fair value and the difference between fair value and
carrying amount shall be included in profit or loss
(d) Nonmarketable investment and its carrying amount is the initial cost
A
13.If as a result of a change in intention, it becomes appropriate to carrying a
financial asset with a fixed maturity at amortized cost rather than at fair value,
any previous gain or loss that has been recognized directly in equity shall be:
(a) recognized in profit or loss immediately
(b) included in equity and amortized to profit or loss over the remaining life of
the held to maturity security using straight line method
(c) included in equity and amortized to profit or loss over the remaining life of
the held to maturity security using effective interest method
(d) recognized as an adjustment of retained earnings
C
14.When interest payment dates of a bond are May 1 and November 1, and a bond
is purchased on June 1, the amount of cash paid by the investor will be:
(a) decreased by accrued interest from June 1 to November 1
(b) decreased by accrued interest from May 1 to June 1
(c) increased by accrued interest from June 1 to November 1

(d) increased by accrued interest from May 1 to June 1

D

15.A bond purchased on June 1, 2001 has interest payment dates of April 1 and
October 1. Bond interest income for the year ended December 31, 2001 is for:
(a) 3 months
(c) 6 months
(b) 4 months
(d) 7 months
D
16.How would the amortization of discount on bond investment affect each of the
following?
Carrying value
Net
Carrying value
Net
of bond
income
of bond
income
(a)
Decrease
Decrease
(c)
Increase
Decrease
(b)
Increase
Increase
(d)
Decrease
Increase
B
17.Which of the following is correct regarding the application of the scientific
method of amortization?
(a) The difference between interest earned and interest received represents the
discount or premium amortization.
(b) When bonds are acquired at a premium, the effective rate is higher than the
nominal rate.
(c) When bonds are acquired at a discount, the effective rate is lower than the
nominal rate.
(d) The effective rate and the nominal rate are the same if the cost of bond
investment is acquired at a premium.
A
18.The interest rate stated on the bonds is known as:
(a) effective rate
(c) nominal rate
(b) market rate
(d) real rate

19.Which of the following statements is true?

(a) The yield or effective interest rate on a bond is equal to the stated rate if the
bond premium or discount is amortized by using the straight line method.
(b) The terms yield rate, stated rate, and market rate are generally
interchangeable when referring to interest on bonds.
(c) Interest revenue and expense related to bonds are always computed using
the stated rate of interest.
(d) If a bond is sold at its face amount, the stated and effective interest rates are
the same.
20.The stated interest on the face of a debt instrument affects the issue price of
that instrument. If the instrument is issued at a premium (assuming no other
market place variable), the stated interest rate is:
(a) at the prevailing interest rate
(c) below the prevailing interest
rate
(b) above the prevailing interest rate
(d) not given
B
21.Under the PAS, bond issue cost is reported as:
(a) deferred charge
(c) adjunct account of bonds payable
(b) contra account of bonds payable
(d) either a or b
B
22.Under the current PAS, an entity shall measure all financial liabilities at
amortized cost after initial recognition using:
(a) straight line method
(c) bond outstanding method
(b) accelerated method
(d) scientific interest method
D
23.How would the carrying value of a bond payable be affected by amortization of
each of the following?
Premium
Discount
Premium
Discount
(a)
No effect
No effect
(c)
Increase
Decrease
(b)
Increase
No effect
(d)
Decrease
Increase
D

24.On January 1 of the current year, an entity issued bonds at a discount. The
entity incorrectly used the straight line method instead of the effective interest
method to amortize the discount. How were the following amounts, as of
December 31 of the current year affected by the error?
Bond carrying
Retained
Bond carrying
Retained
amount
earnings
amount
earnings
(a) Overstated
Overstated
(c) Overstated
Understated
(b) Understated
Understated
(d) Understated
Overstated C
25.On January 1, 2009, an entity issued bonds at a discount. The bonds mature on
December 31, 2014. The entity incorrectly used the straight line method instead
of the effective interest method to amortize the discount. How is carrying
amount of the bonds affected by the error?
At December 31, 2009
At December 31, 2014
(a)
Overstated
Understated
(b)
Overstated
No effect
(c)
Understated
Overstated
(d)
Understated
No effect
B
26.The proceeds from a bond issued with detachable stock purchase warrants
should be accounted for:
(a) entirely as bonds payable
(b) entirely as stockholders equity
(c) partially as unearned revenue, and partially as bonds payable
(d) partially as stockholders equity, and partially as bonds payable
D
27.Cash proceeds from the issuance of the convertible bonds should be reported as:
(a) contributed capital for the entire proceeds
(b) liability for the fair value of the bond and the balance for the portion of the
proceeds attributed to the conversion feature
(c) a liability for the face amount of the bond and contributed capital for the
premium over the face amount
(d) a liability for the entire proceeds
B
28.A 10-year term bond was issued at a discount with a call provision to retire the
bonds. When the bond issuer exercised the call provision on an interest date,
the carrying amount of the bond was less than the call price. The amount of
bond liability removed from the accounts should have equaled the:
(a) call price
(c) face amount less unamortized discount
(b) call price less unamortized discount
(d) face amount plus unamortized
discount
C
29.On July 2, 2008, Dream Company purchased as a trading security a P1,000,000
face value 8% bond for P910,000 plus accrued interest. The bonds mature on
January 1, 2012, and pay interest annually on January 1. On December 31,
2008, the bonds had a market value of P945,000. On February 13, 2009, Dream
sold the bonds for P920,000. In its December 31, 2008 balance sheet, what
amount should Dream report for short-term investment in debt securities?
(a) P950,000
(b) P920,000
(c) P945,000
(d)
P910,000
C
30.On January 1, 2009, Pie Company purchased available-for-sale debt securities
with face value of P2,000,000 for P1,900,500 including transaction costs of
P100,500. The bonds mature on December 31, 2011 and pay interest of 8%
annually every December 31 with a 10% effective yield. On December 31, 2009,
the bonds are quoted at 105. What amount of unrealized gain on these bonds
should be reported on the 2009 statement of changes in equity?
(a) P169,450
(b) P199,500
(c) P300,000
(d) P179,500A

31.On January 1, 2008, Vex Company purchased available-for-sale debt securities

with face value of P5,000,000 for P5,100,000 plus transaction costs of P148,000.
The bonds mature on December 31, 2010 and pay interest of 12% interest
annually every December 31 with a 10% effective yield. The bonds are quoted
at 98 on December 31, 2008 and at 94 on December 31, 2009. What amount of
unrealized loss on these bonds should be reported on the 2009 statement of
changes in equity?
(a) P272,800
(b) P117,280
(c) P390,080
(d) P211,000C
32.Jet Company acquired bonds at a discount of P100,000. Subsequently, Jet sold
these bonds at a premium of P140,000. During the period that Jet held the
investment, amortization of the discount amounted to P20,000. What amount
should Jet report as gain from sale of bonds?
(a) P120,000
(b) P220,000
(c) P240,000
(d) P260,000B
Premium on sale of bonds
P140,000
Unamortized discount (100,000 20,000)
80,000
Gain on sale of bonds
P220,000
33.On January 1, 2006, E-Bank purchased 5,000 of the P1 ,000 face value 12%
bonds for P5,500,000. The bonds mature on January 1, 2011 and pay interest
annually on December 31. The bonds are intended to be held to maturity and
appropriately classified as part of the banks investments in bonds and other
debt instruments. On December 31, 2008, the bank decided to reclassify the
bond investment to available for sale securities in response to legal or liquidity
reserves, security deposits and allowable alternative investments. The market
value of the bond investment on December 31, 2008 was P6,000,000. In its
December 31, 2008 balance sheet, what should it report as unrealized gain on
these debt securities?
(a) P800,000
(b) P500,000
(c) P300,000
(d) P 0
A
Cost
P5,500,000
Amortization of premium from 1/1/2002 to
12/31/2004 (500,000 / 5 years x 3)
300,000
Book value of investment 12/31/2004
P5,200,000
Market value 12/31/2004
6,000,000
Unrealized gain
P 800,000
Items 34 and 35:
On October 1, 2008, Yost Company purchased 4,000 of the P1,000 face value,
10% held-to-maturity bonds of Pile Inc. for P4,400,000 which includes accrued
interest of P100,000. The bonds, which mature on January 1, 2015, pay interest
semiannually on January 1 and July 1. Yost uses the straight line method of
amortization and appropriately recorded the bonds as a long-term investment.
34.In its December 31, 2009 balance sheet, Yost should report the bond investment
at:
(a) P4,284,000
(b) P4,288,000
(c) P4,300,000
(d)
P4,400,000 B
35.In its income statement for the year 2009, Yost should report interest income on
the bonds at:
(a) P400,000
(b) P352,000
(c) P448,000
(d) P88,000 D
36.On January 1, 2009, Ward Company purchased 5,000 of the P1,000 face value,
8% bonds of Dwight Corporation for P4,614,000 to yield 10% per annum. The
bonds, which mature on January 1, 2014, pay interest semiannually on January 1,
and July 1. Ward uses the interest method of amortization and the bonds are
appropriately recorded as a long-term investment. What is the interest income
for 2009?

(a) P462,935

(b) P230,700

(c) P477,200

(d) P400,000A

37.Cone Company acquired long term 12% bonds, P2,000,000 face value for
P2,192,000 including accrued interest and brokerage of P92,000 on January 1,
2003. The bonds pay semiannual interest and mature May 1, 2009. On
December 31, 2003, Cone sold all bonds for P2,300,000 excluding accrued
interest. What is the gain on sale of bonds?
(a) P172,000
(b) P108,000
(c) P148,000
(d) P300,000A
Purchase price
P2,192,000
Less: Accrued interest from 11/1/2002
to 1/1/2003 (2M x 12% x 2/12)
40,000
Adjusted cost
P2,152,000
Face value
2,000,000
Premium
P 152,000
Monthly amortization 1/1/2003 to 5/1/2009
(152,000 / 76 months)
P2,000
Original cost
P2,152,000
Amortization of premium for 2002
(2,000 x 12)
( 24,000)
Book value 12/31/2003
P2,128,000
Sales price
P2,300,000
Less: Book value of bonds
(2,128,000)
Gain on sale of bonds
P 172,000
38.Wise Company purchased P2,000,000 12 % face value bonds, 5 years, on June 1,
2005 for P1,710,000 plus accrued interest to be held to maturity. The bonds are
dated April 1, 2005 with interest payable April 1 and October 1. Bond discount is
amortized semi-annually following the straight line method.
On April 1, 2006, all of the bonds were converted into 20,000 shares of
common stock. At the time of the conversion, the accrued interest was received
in cash, the common shares sell at P110 and the bonds are quoted at 99.
What is the gain on the exchange of the bonds on April 1, 2006?
(a) P220,000
(b) P490,000
(c) P270,000
(d) P440,000
39.On January 1, 2004, Pike Company purchased at par 5,000 of the P1,000 face
value 8% bonds of Kite Company to be held as long-term investment. The bonds
mature on January 1, 2014 and pay interest semiannually on July 1 and January
1. Kite incurred heavy losses from operations for several years and defaulted on
the July 1, 2008 and January 1, 2009 interest payments. Because of the
permanent decline in market value of Kites bonds, Pike wrote down its
investment to P4,000,000 at December 31, 2008. Pursuant to Kites plan of
reorganization effected on July 1, 2009, Pike received 50,000 shares of P100 par
value 8% cumulative preferred stock of Kite in exchange for the P5,000,000 face
value bond investment. The quoted market value of preferred stock was P70 per
share on July 1, 2009. What amount of loss should be included in the
determination of Pikes net income for 2009?
(a) P1,500,000
(b) P1,000,000
(c) P500,000
(d) P 0
C
1/1/2004

Investment in bonds
P5,000,000
Cash
P5,000,000
12/31/2008 Impairment loss
1,000,000
Investment in bonds
1,000,000
7/1/2009
Investment in stock
3,500,000
Loss on exchange
500,000
Investment in bonds
4,000,000
Fair value of asset received
(50,000 x 70)
3,500,000
Book value of asset given (4,000,000)
Loss on exchange
( 500,000)

40.On January 1, 2009, Sweet Company purchased 5-year bonds with face value of
P8,000,000 and stated interest of 10% per year payable semi-annually January 1
and July 1. The bonds acquired to yield 8%. What is the purchase price of the
bonds?
(a) P7,382,400
(b) P8,617,600
(c) P8,648,800
(d)
P7,351,200 C