Chapter-15-Financial-Asset-at-Fair-Value.pptx

The financial asset to fair value

1. CHAPTER 15 Financial Asset At Fair Value

2. Technical Knowledge To define a financial asset. To know the classification of financial assets based on the business model of managing financial assets. To know the initial and subsequent measurement of financial assets. To identify the financial assets that can be measured at fair value through profit or loss. To understand the measurement of equity investment at fair value through the comprehensive income . To understand the measurement of debt investment at amortized cost. To understand the measurement of debt investment at fair value through other comprehensive income.

3. FINANCIAL ASSET A financial asset is any asset that is: Cash A contractual right to receive cash or another financial asset from another entity favorable . A contractual right to exchange financial instrument with another entity under conditions that are potentially An equity instrument of another entity or shares issued by another entity. Examples of financial assets Cash or currency is the best example of financial asset because it represents the medium of exchange for the measurement of financial transactions. 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. But a gold bullion deposited in bank is not a financial asset because although it is very precious the gold is a commodity. Trade accounts receivable, notes receivable, loans receivable and bond investment. An option to purchase shares at less than market price. Investment in shares, such as trading and nontrading equity investment, investment in associate and investment in subsidiary.

4. Nonfinancial assets a. Intangible assets such as patent and trademark. b. Physical assets , such as inventory and property, plant and equipment are not also financial assets. 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 are not also financial assets. d. Right of use asset or leased asset What is an equity security? An equity security encompasses any instrument representing ownership shares and right, warrants or options to acquire or dispose of ownership shares at a fixed or determinable price. In simple language, equity securities represent an ownership interest in an entity. Ownership shares include ordinary shares , preference shares and rights or options to acquire ownership shares. The owners of equity securities are legally known as shareholders. A share is the ownership interest or right of a shareholder in an entity. The share is evidenced by an instrument called share cerificate . The right pertains to the share in earnings, election of directors, subscription for additional shares and share in net assets upon liquidation

5. What is an equity security? The right pertains to the share in earnings, election of directors, subscription for additional shares and share in net assets upon liquidation Equity securities do not include redeemable preference shares, treasury shares and convertible debt. What is a debt security? A debt security is any security that represents a creditor relationship with an entity. A debt security has a maturity date and a maturity value. Examples of debt securities include the following: 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

6. Classification of financial assets Financial assets at fair value through profit or loss-include both equity securities and debt securities . Financial assets at fair value through other comprehensive income - include both equity securities and debt securities. Financial assets at amortized cost - include only debt securities. The classification depends on the business model for managing financial assets which may be: To realize fair value changes. To collect contractual cash flows. To collect contractual cash flows and sell the investment. 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 costs that are directly attributable to the acquisition of the financial asset. Accordingly, transaction costs directly attributable to financial asset measured at fair value through other comprehensive income shall be capitalized as cost of the financial asset. However, if the financial asset is held for trading or if the financial asset is measured at fair value through profit or loss, transaction costs are expensed outright.

7. Initial measurement of financial asset 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 costs do not include debt premium or discount, financing cost and internal administrative cost. Subsequent measurement 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

8. Financial assets at fair value through profit or loss The following financial assets shall be measured at fair value through profit or loss : 1. Financial assets held for trading or popularly known as trading securities . Financial assets held for trading are measured at fair value through profit or loss by requirement , meaning required by the Standard. 2. All other investments in quoted equity instruments . 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. 3. 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. Under IFRS, the fair value option is applicable to investments in bonds and other debt instruments which can be irrevocably designated as at fair value through profit or loss. 4. 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. The irreversible designation or fair value option is allowed even if the financial assets satisfy the amortized cost or fair value through other comprehensive income measurement.

9. Financial asset held for trading A financial asset is held for trading if: It is acquired principally for the purpose of selling or repurchasing it in the near term. 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. Stated differently, financial assets held for trading are debt and equity securities that are purchased with the intent of selling them in the "near term" or very soon. Financial assets held for trading or trading securities are normally classified as current assets. Equity investment at fair value through OCI At initial recognition, PFRS 9, paragraph 5.7.5, provides that 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. In other words, 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 other comprehensive income is not reclassified to profit or loss under any circumstances.

10. Equity investment at fair value through OCI The amount recognized other comprehensive income is not reclassified to profit or loss under any circumstances. However, on derecognition , the amount should be transferred to retained earnings. 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 recognized and presented in the income statement. Debt investment at amortized cost PFRS 9 . paragraph 4. 1.2. provides that a financial asset shall be measured at amortized cost if both of the following conditions are met: 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 In other words, 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.

11. Debt investment at fair value through OCI PFRS 9. paragraph 4.1.2.A. provides that a financial asset shall be measured at fair value through other comprehensive income if both of the following conditions are met: 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. Note that the business model includes selling or trading the financial asset in addition to collecting contractual cash flows. In this case, 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. The measurement of debt investment at amortized cost or at fair value through other comprehensive income is discussed extensively in Chapter 20.

12. SUMMARY OF MEASUREMENT RULES Measurement of equity investments 1. Held for trading - at fair value through profit or toss 2. Not held for trading - as a rule, at four value through profit or loss 3. Not held for trading - at fair value through other comprehensive income by irrevocable election 4. All other investments in quoted equity instruments - of fair value through profit or loss 5. Investments in unquoted equity instruments - at cost 6. Investments of 20% to 50% - equity method of accounting 7. Investments of more than 50% consolidation method to be taken up in an 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

13. Fair value Appendix A of PFRS 9 in conjunction with PFRS 13 provides the definition of fair value. Fair value of an asset is the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date. Best evidence of fair value in descending hierarchy Quoted price of identical asset in an active market 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. Simply stated, 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.

14. 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 or equity security , it means pesos per share. For example, if the investment in 10,000 shares costing P800,000 is quoted at 90, the market value 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. For example, if the investment in bond 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%. Gain and loss - Financial asset at fair value Under PFRS 9 , paragraph 5.7.1 , gain and loss on financial asset measured at fair value shall be presented in profit or loss except : 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 When the financial asset is a debt investment measured at fair value through other comprehensive income

15. Gain and loss - Financial asset at fair value In other words, unrealized gain and loss on financial asset held for trading and other financial asset measured at fair value are reported in the income statement. Unrealized gain and loss arise from investments that are reported at fair value. In determining fair value, no deduction is made for transaction costs 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. 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. PFRS 9 , paragraph 5.7.2 , provides that 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.

16. Illustration - Trading securities (TS) On January 1, 2024, an entity purchased marketable equity securities for P5,000,000. The equity securities qualify financial asset held for trading. The entity also paid P50,000 a commission to the broker. Trading securities 5,000,000 Commission expense 50,000 Cash 5,050,000 The acquisition may be debited to "Financial asset - FVPL " or "Financial asset held for trading". FVPL means that the financial asset is measured at fair value through profit or loss. Observe that the commission paid to the broker is not capitalized as cost of the investment but treated as outright expense.

17. Illustration - Trading securities (TS) On December 31, 2024 , the trading securities have a fair value of P6,000,000. The increase in value is recorded as unrealized gain at year-end. Trading securities 1,000,000 Unrealized gain – TS 1,000,000 The unrealized gain is classified in the income statement as other income. On December 31, 2024, the statement of financial position will report the trading securities at fair value of P6,000,000 with a disclosure of the cost of P5,000,000. On December 31, 2025 , the trading securities have a fair value of P4,500,000. The decrease in fair value is recorded as unrealized loss at year-end. Unrealized loss – TS 1,500,000 Trading securities 1,500,000 The unrealized loss is reported in the income statement as other expense. On December 31, 2025, the trading securities will be carried at P4,500,000, with disclosure of the cost of P5,000,000.

18. Another illustration - Trading securities On January 1, 2024, an entity acquired trading securities with the following market value on December 31, 2024: Cost Market Gain (loss) ABC preference share 200,000 150,000 (50,000) XYZ ordinary share MNO bonds 800,000 950,000 150.000 RST ordinary share MNO bonds 1,000,000 1,100,000 100,000 MNO bonds 3,000,000 2,500,000 (500,000) 5,000,000 4,700,000 (300,000) The acquisition on January 1, 2024 is normally recorded. Trading securities 5,000,000 Cash 5,000,000 On December 31, 2024, the net decrease in market value is recorded as unrealized loss. Unrealized loss – TS 300,000 Trading securities 300,000

19. Another illustration - Trading securities Observe that the unrealized gain and unrealized loss are offset against the other and only the net amount is recorded. The offsetting is permitted by IFRS. On December 31, 2024, the trading securities shall be reported at fair value of P4,700,000. However, the notes to financial statements shall disclose the individual securities with their corresponding carrying amount and market value. On January 15, 2025, the ABC preference share is sold for P80,000. The sale is normally recorded as disposal of asset. Cash 80,000 Loss on sale of trading securities 70,000 Trading securities 150,000 PFRS 9, paragraph 3.2.12, provides that on derecognition of a financial asset, the difference between the carrying amount and the consideration received shall be recognized as gain or loss on disposal of asset The carrying amount of ABC preference share is equal to the market value of P150,000 on December 31, 2024.

20. Equity investment at fair value through OCI 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 instrument. Illustration and On January 1, 2023, an entity purchased marketable equity securities for P1,000,000. The entity paid commission equity taxes of P100,000. The equity securities do not qualify as financial asset held for trading. The entity made an irrevocable election to present unrealized gain and loss in other comprehensive income. The acquisition on January 1, 2024 is normally recorded. Financial asset-FVOCI 1,100,000 Cash 1,100,000 FVOCI means the financial asset is measured at fair value through other comprehensive income. Under IFRS, a financial asset measured at fair value through other comprehensive income shall be recognized initially at fair value plus transaction cost directly attributable to the acquisition. Thus, the commission and taxes of P100,000 are capitalized as cost of the investment.

21. Equity investment at fair value through OCI On December 31, 2024 , the securities have a market value of P1,300,000. The increase in market value is recorded as unrealized gain at year-end. Financial asset – FVOCI 200,000 Unrealized gain – OCI 200,000 The unrealized gain is presented as component of other comprehensive income in the 2024 statement of comprehensive income. The financial asset - FVOCI on December 31, 2024 is carried at the market value of P1,300,000 with disclosure of the cost of P1,100,000. The financial asset noncurrent asset. - FVOCI is normally classified as noncurrent asset.

22. December 31, 2025 On December 31, 2025, the securities have a market value s unrealized gain at year-end. The increase in market value is recorded of P1,600,000. Financial asset - FVOCI 300,000 Unrealized gain-OCI 300,000 At this point, the financial asset - FVOCI is carried at the market value of P1,600,000, and the cumulative unrealized gain is P500,000 (P200,000+ P300,000). However, only P300,000 shall be reported in the 2025 statement of comprehensive income. The cumulative amount of P500,000 shall be reported in the 2025 statement of changes in equity. Sale of equity investment - FVOCI On July 1, 2026, the securities are sold for P2,000,000. The sale is normally recorded as disposal of asset: Cash 2,000,000 Financial asset – FVOCI 1,600,000 Retained earnings 400,000

23. Sale of equity investment – FVOCI Gain or loss on disposal of equity investment measured at fair value through other comprhensive income is recognized directly in retained earnings in accordance with PFRS 9, paragraph 5.7.1b . Moreover, the cumulative gain or loss previously recognized in other comprehensive income is also transferred to retained earnings in accordance with PFRS 9 Application Guidance, paragraph 5.7.1. Accordingly, the cumulative unrealized gain of P500,000 is transferred to retained earnings. Unrealized gain – OCI 500,000 Retained earnings 500,000 The cumulative credit to retained earnings of P900,000 is actually the difference between the sale price of P2,000,000 and historical cost of P1,100,000. The cumulative amount recognized in other comprehensive income is not reclassified to profit or loss under any circumstances.

24. Another illustration On January 1, 2024, an entity purchased equity securities not qualifying as financial asset held for trading. The entity elected to present changes in fair value as component of other comprehensive income. On December 31, 2024, the securities have the following cost and market value: Cost Market Gain (loss) Security A 1,000,000 900,000 (100,000) Security B 2,000,000 1,700,000 (300,000) Security C 3,000,000 2,800,000 (200,000) 6,000,000 5,400,000 (600,000) Obviously, the net decrease in market value is P600,000. and recorded as unrealized loss. Unrealized loss – OCI 600,000 Financial asset-FVOCI 600,000

25. Sale of individual security On July 1, 2025, Security A was sold for P700,000. Cash 700,000 Retained earnings 200,000 Financial asset-FVOCI 900,000 The carrying amount of Security A is the market value of P900,000 on December 31, 2024. The carrying amount of Security A is the market value of P900,000 on December 31, 2024. The unrealized loss of P100,000 related to Security A on December 31, 2024 is transferred to retained earnings. Retained earnings 100,000 Unrealized loss – OCI 100,000 The cumulative debit to retained earnings of P300,000 is actually the difference between sale price and historical cost. Sale price 700,000 Historical cost-Security A 1,000,000 Total loss - directly debited to retained earnings (300,000)

26. Remaining securities On December 31, 2025 , the remaining securities have the following carrying amount and market value: Carrying amount Market Gain (loss) Security B 1,700,000 1,500,000 (200,000) Security C 2,800,000 2,700,000 (180,000) 4,500,000 4,200,000 (300,000) The net decrease in market value on December 31, 2025 is recorded as unrealized loss. Unrealized loss – OCI 300,000 Retained earnings 300,000 Unrealized loss- December 31, 2024 (600,000) Unrealized loss related to Security A that was sold (100,000) Adjusted balance - December 31, 2024 (500,000) Unrealized loss in 2025 (300,000) Cumulative unrealized loss - December 31, 2025 (800,000)

27. Remaining securities Actually, the cumulative unrealized loss is always the difference between the original cost and current market value. Security B 2,000,000 Security C 3,000,000 Total original cost 5,000,000 Market value - December 31, 2025 4,200,000 Cumulative unrealized loss - December 31, 2025 (800,000) The unrealized loss of P300,000 in 2025 is presented in the statement of comprehensive income for 2025. However, the cumulative unrealized loss of P800,000 is presented in the statement of changes in equity for 2025.

28. 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 other comprehensive income depending on whether election to present gains and losses on equity investments in other comprehensive income is taken or not. Therefore, it is not necessary to assess financial asset measured at fair value through profit or loss and equity investments measured at fair value through profit or loss and comprehensive income for impairment. Impairment - Debt investments PFRS 9, paragraph 5.5.1, provides that an entity shall recognize expected credit loss on: a. Debt investment measured at amortized cost b. Debt investment measured at fair value through other comprehensive income Paragraph 5.5.3 provides that an entity shall measure the loss allowance for a financial instrument at an amount equal to the lifetime expected credit loss if the credit risk on that financial instrument has increased significantly since initial recognition. 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 excess of the carrying amount over the present value of estimated future cash flows discounted at the original effective rate.

29. THANK YOU Prof. Justiniano L. Santos, CPA , MBA