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Financial asset at fair value

Definition: INVESTMENT
-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

Reasons why entities INVEST?


a. b. For accretion of wealth or regular income through interest, dividends, royalties and rentals. 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. For ownership control as in the case of investments in subsidiaries and associates. For meeting business requirements as in the case of sinking fund, preference share redemption, plant expansion fund and other noncurrent fund. For protection as in the case of interest in life insurance contract in the form of cash surrender value.

c. d. e.

Examples of investments
1. 2. 3. 4. 5. 6. 7. 8. Trading securities Investment in equity securities Investment in bonds Investment in associate Investment in subsidiary Investment property Investment in fund Investment in joint venture

Statement classification
Current=
by their very nature are readily realizable

AND are intended to be held for not more than one year Noncurrent /long term =
investments are intended to be held for more than one year

OR are not expected to be realized within twelve months after the end of the reporting period.

Noncurrent investments
-accumulation of funds for such purposes as plant expansion or liquidation of foreign debt -shareholdings acquired for the purpose of controlling another firm or creating good customer or supplier relationship -investment of land and buildings acquired for capital appreciation which are intended to be held for a number of years to generate income and capital gain

Financial instruments
Characteristics: -there must be a contract -at least two parties to the contract -contract shall give rise to a financial asset of one party AND financial liability or equity instrument of another party.

Examples of financial instruments:


Cash in the form of notes and coins: Financial asset of the holder or bearer Financial liability of the issuing government. ----------------------------------------------------------Cash in the form of checks: Financial asset of the payee Financial liability of the drawer or issuer ----------------------------------------------------------Cash in bank: Financial asset of the depositor Financial liability of the depository bank.

Definition financial asset


-cash -a contractual right to receive cash or another financial asset from another entity -a contractual right to exchange financial instrument with another entity under conditions that are potentially favorable -an equity instrument of another entity

What are conditions that are potentially favorable


Exchanges of financial instruments with another entity will result to a gain or additional cash inflow to the entity

Examples of financial assets


Cash or currency The following represent a contractual right to receive cash: Trade accounts receivable Notes receivable Loans receivable Bonds receivable An option held by the holder to purchase shares of another entity at less than market price.(potentially favorable)

Not considered as financial assets


The following do not give rise to a present right to receive cash or another financial asset. Physical assets: Inventory Property, plant and equipment Intangible assets: Patents Trademarks

Definition of financial liability


-any liability that is a contractual obligation: To deliver cash or other financial asset to another entity To exchange financial instruments with another entity under conditions that are potentially unfavorable.

Examples of financial liabilities


Obligation to deliver cash: -trade accounts payable -notes payable -loans payable -bonds payable - Redeemable preference sharefinancial liability on the part of the issuer -preference share that gives the holder the right to require the issuer to redeem the instrument at a particular datefinancial liability on the part of the issuer -an option written or issued by the issuer to sell shares in a specified company at less than market price (potentially unfavorable)

Not considered financial liabilities


Deferred revenue Warranty obligations
Associated with the delivery of goods and services rather than a contractual obligation to pay cash or another financial asset

Income taxes payablestatutory requirements imposed by government

Constructive obligationsthe obligation do not arise from contracts

Definition of equity instrument


Any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. Includes: Ordinary share capital Preference share capital Redeemable preference shareWarrants or written call options that allow the holder to subscribe for or purchase a fixed number of ordinary shares of the issuing entity in exchange for a fixed amount of cash or another financial asset.

Classification of financial assets


Financial assets at fair value Financial assets at amortized cost

Financial assets at fair value


-include BOTH equity securities and debt securities

Equity security
-any instrument represent an ownership interest in an entity -includes : ordinary shares preference share and other share capital rights, warrants or options -it does not include: redeemable preference shares treasury shares convertible debt

Debt security
-any security that represents a creditor relationship with an entity -has maturity date and maturity value -includes: corporate bonds BSP treasury bills government securities commercial papers preference share with mandatory redemption date at the option of the holder

Financial assets measured at fair value through profit and loss


By requirement (required by the standard)
trading securities =financial assets held for trading By designation on initial recognition investment in bonds other debt instruments By consequence all other investments in quoted equity instruments

Financial assets held for trading


It is acquired principally for the purpose of selling or repurchasing it in the near term. ( to generate short term gains or profits) 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. It is a derivative, except for a derivative that is a financial guarantee contract or a designated and an effective hedging instrument.

Financial assets held for trading


Classification: CURRENT ASSETS Initial measurement: measured at fair value through profit and loss (required by the standard) (fair value=transaction price or fair value of the consideration given) transaction cost: EXPENSED OUTRIGHT fees and commissions paid to agents,etc
levies by regulatory agencies and security exchanges

transfer taxed and duties Pro-forma entry: Trading securities----------------xx Commission expenses---------xx Cash--------------------------------------xx

Subsequent measurement
Depends on the business model for managing financial assets, if financial assets are to be measured subsequently : at fair value or at amortized cost

business model for managing financial assets determined by key management personnel

-to hold investments in order to trade to realize fair value changes


(subsequently measured at FAIR VALUE)

-to hold investments in order to collect contractual cash flows (only principal and interest)
(subsequently measured at AMORTIZED COST)

FAIR VALUE-price in an arms length transaction Quoted price: pesos/share = equity security
percentage of the fair value of the bond= debt security Bid price= quoted market price for an asset held = price which a willing buyer wants to pay Asking price=quoted market price for an asset to be acquired =price which a willing seller wants to receive Use the most recent transaction price if bid and asking prices are not available

Unrealized gains and losses-trading securities


Arise from investments that are reported at fair value (fair value changes )
unrealized gain= fair value FV>carrying amount CA of securities unrealized loss= FV < CA proforma entry: Trading securities(increase in FV)-------------xx Unrealized gain-----------------------------------xx

Presented in profit and loss, hence, shown in INCOME STATEMENT as OTHER INCOME; OTHER EXPENSE

gains and losses= result from actually selling the securities


= CA consideration received
PRO-FORMA ENTRY:

Cash-----------------------------xx

Trading securities---------------------xx Gain on sale of trading securitiesxx

Unrealized gains and losses-trading securities

For more than one securities: Get the net amount of the unrealized gain or loss of the individual securities.

Subsequently measured at Amortized cost


to hold investments in order to collect contractual cash flows which are solely payments of principal and interest on the principal amount outstanding Unrealized gains and losses are not recognized because they are not reported at fair value Gains and losses are recognized when the financial assets are: derecognized impaired or reclassified through the amortization process

Financial assets not at fair value


Initial recognition: fair value plus transaction costs that are directly attributed to the acquisition of the financial asset proforma entry: investment in equity securities---xx cash---------------------------------xx

Financial assets not held for trading


May make an irrevocable election to present to OTHER COMPREHENSIVE INCOME (OCI) subsequent changes in fair value of an investment in equity instrument hence, unrealized gain/loss-OCI will be part of the statement of comprehensive income but not subsequently transferred to profit and loss thus, not part of Retained earnings but of reserves in the stockholders equity proforma entry: investment in equity securities----xx unrealized gain-oci-----------------xx

Cumulative unrealized gain


= original cost market value

Derecognition of a financial asset


Cash-----------------------------xx (consideration received) Loss on sale of securities--xx Investment in equity securities---------xx (carrying amount of the invesment) Gain on sale of securities----------------xx # Unrealized gain-OCI--------XX Retained earnings----------------xx to close since these are related to sold Investment in securities

RECLASSIFICATION either from fair value to amortized cost or vice versa


When it changes its business model for managing the financial assets
Applied prospectively from reclassification date Reclassification date- 1st day of the reporting period following the change in business model Not a change in business model: a. Change in intention related to the financial asset b. A temporary disappearance of a particualr market fro a financial asset c. A transfer of financial asset between parts of the entity with different business models

RECLASSIFICATION from fair value to amortized cost The fair value at the reclassification date becomes the new carrying amount of the financial asset at amortized cost.
New carrying amount of the financial asset at amortized cost

Less

face value of the financial asset amount is amortized over profit or loss over the remaining life of the financial asset using the effective interest method

Proforma entry: investment in bonds--------xx financial asset at fair value-------xx

RECLASSIFICATION from amortized cost to fair value Fair value is determined at reclassification date;
previous carrying amount

Less

fair value of the financial asset amount is recognized in profit or loss

Proforma entry:

financial assets at fair value------xx investment in bonds------------------xx

impairment
Financial assets at fair value: not necessary Financial assets at amortized cost:

tainting