Auditing Problems – Investment Lord Gen A.

Rilloraza, CPA

INVESTMENTS

DISCUSSION
PFRS 9 – Financial Instruments
 Specifies how an entity should classify and measure financial assets, financial liabilities, and some contracts to
buy or sell non-financial items.
 Mandatory application starting January 1, 2018

INITIAL MEASUREMENT OF FINANCIAL INSTRUMENTS

 At fair value plus or minus the transaction costs, except if the investment is carried at Fair Value through Profit
or Loss (i.e. transaction costs for financial assets at fair value through profit or loss are expensed)

SUBSEQUENT MEASUREMENT OF FINANCIAL INSTRUMENTS

 See discussions below on specific classifications of financial instruments

INVESTMENT IN EQUITY SECURITIES

General Application
 If investor has CONTROL over the investee, or if the investor holds more than 50% interest in the investee, the
investment is accounted for as Investment in Subsidiary (PAS 27 – Separate Financial Statements; PFRS 10 –
Consolidated Financial Statements)
 If investor has SIGNIFICANT INFLUENCE over investee, or if the investor holds 20% or more interest in the
investee, the investment is accounted for as Investment in Associate (PAS 28 – Investment in Associates and
Joint Ventures)
 If investor has no control nor significant influence over the investee, or if the investor has less than 20%
interest in the investee (i.e. nominal interest), account for under PFRS 9

Classifications
 Investment in equity securities can be accounted for as follows:
o Financial asset at fair value through profit or loss (FVPL)
o Financial asset at fair value through other comprehensive income (FVOCI)
 Investor has an irrevocable option to carry the investment as FVOCI at initial recognition

FVPL
 Initially measured at fair value; transaction costs are expensed
 Subsequently measured at fair value; changes in the fair value are recognized through profit or loss
 Dividends are recorded as income
 Reclassification to FVOCI is NOT ALLOWED, since the option to classify as FVOCI only exists at initial
recognition
 Upon disposal, difference between selling price and carrying value is presented in profit or loss

FVOCI
 Initially measured at fair value, plus or minus transaction costs
 Subsequently measured at fair value; changes in the fair value are recognized as a component of other
comprehensive income
 Dividends are recorded as income
 Reclassification to FVPL is NOT ALLOWED, since the option to classify as FVOCI at initial recognition is
IRREVOCABLE
 Upon disposal, adjust first the carrying value of the shares sold to their fair value, with the difference closed to
unrealized gain(loss) – OCI. Upon disposal, the related cumulative unrealized gain(loss) – OCI of the shares sold
should remain within equity

INVESTMENT IN DEBT SECURITIES

Classifications
 Investment in debt securities can be accounted for as follows:
o Financial asset at amortized cost (FAAC)
o Financial asset at fair value through other comprehensive income (FVOCI)
o Financial asset at fair value through profit or loss (FVPL)
 Basis of classification is the entity’s BUSINESS MODEL

Business Models and the Investments’ Classifications

Business Model Classification
Collect contractual cash flows (principal and interest at specified dates) FAAC
Collect contractual cash flows and sell the financial assets FVOCI
If not held in one of the business models above or if the entity exercised
its option to present as FVPL FVPL

FAAC
 Initially measured at fair value, plus or minus transaction costs
 Subsequently measured at amortized cost
 Interest income is based on the carrying value multiplied by the effective rate
 Difference in the interest income and interest received is the amortization
 Upon disposal, difference between selling price and carrying value is recognized in profit or loss

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Auditing Problems – Investment Lord Gen A. Rilloraza, CPA

 If there is partial disposal, the instrument is NOT RECLASSIFIED to FVOCI since the basis of accounting for such
is the business model

FVOCI
 Initially measured at fair value, plus or minus transaction costs
 Subsequently measured at fair value
 Amortization is the same as that of FAAC, however, the amortized cost shall be increased or decreased to
match the fair market value; the difference is presented as unrealized holding gain or loss – OCI at the
statement of financial position
 The increase or decrease in the unrealized holding gain or loss – OCI at the statement of financial position,
shall be presented as a component of other comprehensive income
 Upon disposal, difference between selling price and carrying value is recognized in profit or loss; cumulative
gain or loss previously recognized in OCI is likewise transferred to profit or loss

FVPL
 Initially measured at fair value; transaction costs are expensed
 Subsequently measured at fair value; changes in the fair value are recognized through profit or loss
 Interest income is based on the principal amount of the security multiplied by the stated or nominal rate for
simplicity (theoretically, it should be at effective rate)
 Upon disposal, difference between selling price and carrying value is recognized in profit or loss

Reclassification
 Reclassification of investment in debt securities is allowed; this happens when the entity changes its business
model
 Reclassification shall be done on the FIRST DAY OF THE NEXT PERIOD FOLLOWING THE CHANGE IN BUSINESS
MODEL (e.g. if entity changed its business model on November 3, 2018, reclassification shall be made on
January 1, 2019)

Summary
TO
FAAC FVOCI FVPL
  Reclassify to FVOCI at Reclassify to FVPL at
fair value; difference fair value; difference
between fair value between fair value
FAAC and previous carrying and previous carrying
value is recognized in value is recognized in
OCI profit or loss

Reclassify to FAAC at   Simply transfer from

amortized cost; FVOCI to FVPL since
cumulative gain or both are measured at
loss previously fair value; cumulative
recognized in OCI is gain or loss previously
FVOCI adjusted against the recognized in OCI is
FROM
fair value of the recognized in profit or
financial asset; loss as reclassification
effective rate is not adjustment
changed

The fair value at The fair value at  

reclassification date reclassification date
becomes the new becomes the new
carrying amount; carrying amount;
FVPL effective interest rate effective interest rate
is computed based on is computed based on
that amount that amount

PROBLEMS
PROBLEM 1
Out of the 200,000 outstanding shares of LLB Company, CPA Corporation purchased 10,000 shares for P50 per share
on July 5, 2017. CPA incurred P25,000 as broker’s fees. The fair market value of the shares at the end of 2017, 2018,
2019, and 2020, are P52/sh, P58/sh, P60/sh, and P55/sh, respectively. LLB declared dividends for P200,000 on 2018,
and P500,000 on 2020.

Requirements:
Case 1
If the investment is accounted for under PFRS 9, and the entity did not exercise the option to carry the investment
through other comprehensive income or loss,
1. At how much shall the investment be initially recognized?
2. What is the net income(loss) related to the investment to be recognized in the income statement for 2017,
2018, 2019, and 2020?
3. What is the carrying value of the investment at the end of 2017, 2018, 2019, and 2020?

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Auditing Problems – Investment Lord Gen A. Rilloraza, CPA

4. Provided that the entity sold the investment on November 2, 2020 for P56 per share, what is the gain(loss) to
be recognized from the disposal?
Case 2
If the investment is accounted for under PFRS 9, and the entity exercised the option to carry the investment through
other comprehensive income or loss,
1. At how much shall the investment be initially recognized?
2. What is the net income(loss) related to the investment to be recognized in the income statement for 2017,
2018, 2019, and 2020?
3. What is the unrealized holding gain(loss) to be recognized as part of other comprehensive income for 2017,
2018, 2019, and 2020?
4. What is the unrealized holding gain(loss) to be presented in the statement of financial position as of December
31, 2017, 2018, 2019, and 2020?
5. What is the carrying value of the investment at the end of 2017, 2018, 2019, and 2020?
6. Provided that the entity sold the investment on November 2, 2020 for P56 per share, what is the gain(loss) to
be recognized from the disposal?

PROBLEM 2
Feelings Corporation purchased shares from different companies at different dates during 2017. The summary is
presented below:

FMV per FMV per FMV per FMV per

No. of Cost per Share Trans. share at share at share at share at
Company Shares at Acq. Date* Cost 12/31/17 12/31/18 12/31/19 12/31/20
Andrew Inc. 20,000 5 10,000 7 8 3 4
Billy Corp. 10,000 18 20,000 15 17 19 22
Cathy Inc. 5,000 310 53,000 305 322 310 320
Debbie Co. 100,000 2 12,500 4 3 4 6
*The cost per share at acquisition date does not include the transaction costs.

Feelings accounted for all investments under PFRS 9 and opted to present its investments in Billy and Cathy through
other comprehensive income or loss.

The entity sold half of its investment in Andrew shares for P5 per share on April 4, 2019; and half of its investment in
Billy shares for P20 per share on October 10, 2019.

Dividends per share declared by the investees by the end of each year are summarized below:

Company 2017 2018 2019 2020

Andrew Inc. 0.70 0.82 0.85 1.00
Billy Corp. 2.00 2.10 2.15 2.35
Cathy Inc. 36.00 37.40 37.00 38.50
Debbie Co. 0.20 0.19 0.24 0.40

By June 30, 2021, Feelings decided to dispose all of its investments. The shares of Andrew, Billy, Cathy, and Debbie
were sold for P2/share, P38/share, P335/share, and P5/share, respectively.

Requirements:
1. What is the total initial cost of the investments?
2. What amount of unrealized holding gain(loss) should be presented in the income statement for 2017, 2018,
2019, and 2020?
3. What amount of net income(loss) related to all investments should be presented in the income statement for
2017, 2018, 2019, and 2020?
4. What amount of unrealized holding gain(loss) should be presented as part of other comprehensive income or
loss for 2017, 2018, 2019, and 2020?
5. What amount of unrealized holding gain(loss) should be presented in the statement of financial position as of
December 31, 2017, 2018, 2019, and 2020?
6. What is the carrying value of the investments as of December 31, 2017, 2018, 2019, and 2020?
7. How much realized gain(loss) from disposal should be presented in the income statement for 2021?

PROBLEM 3
You were engaged by Move-On Company to audit their financial statements as of and for the period ended December
31, 2017. The investments of the entity are currently held by Investorama, a third party custodian. Based from the
confirmation response of Investorama, the investment portfolio of Move-On included the following:
 10,000 ordinary shares of DiKoKaya Inc., purchased for P32 per share on August 8, 2014.
 30,000 ordinary shares of SigeNaNga Co., purchased for P11 per share on September 9, 2014.

The working trial balance of Move-On for the current period presented the balances of the investments in DiKoKaya
and SigeNaNga at P320,000 and P330,000, respectively.

From your audit procedures, you were able to gather the following facts:
 The entity applied PFRS 9 in accounting for their investments. Only the investment in SigeNaNga is accounted
for through other comprehensive income or loss.
 The accountant of the entity resigned on November 13, 2014; a new accountant was hired on November 15,
2014.
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Auditing Problems – Investment Lord Gen A. Rilloraza, CPA

 The new accountant was not able to account for the changes in the fair market values of the investments,
hence, the investments are still carried at their initial costs.
 The fair market values of DiKoKaya shares and SigeNaNga shares as of December 31, 2016 are P35/share and
P8.50/share, respectively.
 The fair market values of DiKoKaya shares and SigeNaNga shares as of December 31, 2017 are P29/share and
P12/share, respectively.

Requirements:
1. What is the correct carrying value of the investments as of December 31, 2017?
2. What amount of unrealized gain(loss) must be presented in the income statement for 2017?
3. What amount of unrealized gain(loss) must be presented as part of other comprehensive income for 2017?
4. What amount of unrealized gain(loss) must be presented in the statement of financial position as of December
31, 2017?
5. How much would be the retrospective adjustment to the retained earnings of the entity from the omissions?
6. How much would be the retrospective adjustment to the unrealized gain(loss) in the statement of financial
position?
7. Prepare a compound adjusting journal entry to reflect the correction for the errors in the previous years.

PROBLEM 4
On January 2, 2017, Single Corporation purchased 5-year 10% bonds of Taken Co., with face value totalling to
P5,000,000, at 92. Single incurred an additional P39,500 as direct costs, resulting to a yield rate of 12%. Interest is
paid by Taken every December 31.

The bonds are quoted on December 31, 2017 and 2018, at 95 and 91, respectively. The entity sold the bonds on
January 3, 2019 at 92.

Case 1
The company has a business model of holding the financial asset to collect contractual cash flows consisting of
principal payments and interest payments on the outstanding principal.
1. What is the initial cost of the investment?
2. How much income related to the investment must be presented in the 2017 income statement?
3. What is the carrying value of the investment as of December 31, 2018?
4. How much is the gain or loss on disposal?
Case 2
The company has a business model of holding the financial asset to collect contractual cash flows consisting of
principal payments and interest payments on the outstanding principal, and to sell the financial asset.
5. What is the initial cost of the investment?
6. What is the carrying value of the investment as of December 31, 2017?
7. How much unrealized gain or loss must be presented as a component of other comprehensive income for
2017?
8. How much unrealized gain must be presented in the statement of financial position as of December 31, 2018?
9. How much is the gain or loss on disposal?

Case 3
The company carried the financial asset at fair value through profit or loss.
10. What is the initial cost of the investment?
11. How much income related to the investment must be presented in the 2017 income statement?
12. How much income related to the investment must be presented in the 2018 income statement?
13. What is the carrying value of the investment as of December 31, 2018?
14. How much is the gain or loss on disposal?

PROBLEM 5
On January 1, 2018, Baby Co. purchased a 10-year 9% P1,000,000 bonds of Lakay Inc. for an amount resulting to a
yield rate of 10%. Interest is collected by Baby every December 31.

The effective rate of the bonds on December 31, 2018 is 8%; 12% on December 31, 2019; and 11% on December 31,
2020.

Note: use four decimal places for PV factors (i.e. x.xxxx)

Case 1
The company carried the investment at amortized cost, then subsequently reclassified the investment at fair value
through other comprehensive income on December 31, 2019.
1. What is the interest income for 2019?
2. What is the carrying value of the investment as of December 31, 2019?
3. What is the carrying value of the investment as of January 1, 2020? How much is the gain or loss on
reclassification to be presented in the income statement?
4. How much is the unrealized gain or loss to be presented as a component of other comprehensive income for
2020?
5. How much is the unrealized gain or loss to be presented in the statement of financial position as of December
31, 2020?
6. What is the carrying value of the investment as of December 31, 2020?

Case 2
The company carried the investment at amortized cost, then subsequently reclassified the investment at fair value
through profit or loss on December 31, 2019.
7. What is the carrying value of the investment as of December 31, 2019?
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Auditing Problems – Investment Lord Gen A. Rilloraza, CPA

8. How much is the gain or loss on reclassification to be presented in the income statement?
9. How much is the interest income for 2020?
10. How much is the unrealized gain or loss to be presented in the income statement for 2020?
11. What is the carrying value of the investment as of December 31, 2020?

Case 3
The company carried the investment at fair value through other comprehensive income, then subsequently
reclassified the investment at amortized cost on December 31, 2019.
12. What is the carrying value of the investment as of December 31, 2019?
13. What is the carrying value of the investment as of January 1, 2020?
14. How much is the gain or loss on reclassification to be presented in the income statement?
15. How much is the interest income for 2020?
16. What is the carrying value of the investment as of December 31, 2020?

Case 4
The company carried the investment at fair value through other comprehensive income, then subsequently
reclassified the investment at fair value through profit or loss on December 31, 2019.
17. What is the carrying value of the investment as of January 1, 2020
18. How much is the gain or loss on reclassification to be presented in the income statement?
19. How much is the interest income for 2020?
20. How much is the unrealized gain or loss to be presented in the income statement for 2020?
21. What is the carrying value of the investment as of December 31, 2020?

Case 5
The company carried the investment at fair value through profit or loss, then subsequently reclassified the investment
at fair value through other comprehensive income on December 31, 2019.
22. What is the interest income for 2019?
23. What is the carrying value of the investments as of January 1, 2020?
24. How much is the gain or loss on reclassification to be presented in the income statement?
25. How much is the interest income for 2020?
26. What is the carrying value of the investment as of December 31, 2020?
27. How much is the unrealized gain or loss to be presented as a component of other comprehensive income for
2020?

Case 6
The company carried the investment at fair value through profit or loss, then subsequently reclassified the investment
at amortized cost on December 31, 2019.
28. What is the carrying value of the investments as of January 1, 2020?
29. How much is the gain or loss on reclassification to be presented in the income statement?
30. How much is the interest income for 2020?
31. What is the carrying value of the investment as of December 31, 2020?