Chapter 12 Flashcards
Investment in debt securities are classified as _________ of the issuer.
Liabilities
What are the components of return of investment in debt securities?
Interest income and gains from changes in fair value.
This kind of investment is a contract usually available to the general public.
Investment in bonds
How can investment in debt securities be classified as?
FVTPL
FVTOCI
at Amortized Cost
Can an entity choose any of the three classifications, at its discretion, to account for each of its debt securities?
No.
What should be considered in classifying debt securities?
1.) The business model of managing the financial asset
2.) The contractual cash flow characteristics of the financial asset
This is how an entity manages its investments in debt securities to generate cash flows.
Business Model
This business model refers to holding debt securities until maturity in order to collect the contractual cash flows.
Held-to-maturity
This business model is the middle ground for debt securities.
Both held-to-maturity and held-for-selling
This business model is selling debt securities to receive cash flows.
Held-for-selling
This business model is evaluated in terms of performance based on interest income and credit quality of the securities.
Held-to-maturity
This business model is evaluated in terms of performance based on overall return or the credit quality plus the fair valuation of the securities.
Both held-to-maturity and held-for-selling
This business model is evaluated in terms of performance based on the realized and unrealized gains and losses and fair value of the securities.
Held-for-selling
What risk affects the performance of held-for-maturity securities?
Credit risk
What risk affects the performance of both held-for-maturity and held-for-selling securities?
Credit risk and market risk
What risk affects the performance of held-for-selling securities?
Market risk
True or False: The business model both held-to-maturity and held-for-selling possess the characteristics of both of the other business models.
True.
This is the risk that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation.
Credit Risk
This is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices.
Market Risk
This is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates.
Interest rate risk
This is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in foreign exchange rates.
Currency risk
True or False: The business model assessment shall be based on assertion or the intention of the management.
False. It should be based on facts.
True or False: The business model assessment is made on an investment-by-investment basis.
False. It should be made on portfolio basis.
This is defined as a collection of different financial assets for the purpose of managing investments.
Portfolio
True or False: An entity can utilize all of the different classifications at the same to account for debt securities.
True.
True or False: In assessing the business model, the worst case scenarios should be incorporated and considered.
False.
What is the SPPI test?
The test whether the contractual cash flows are solely payment of principal and interest.
How can an entity pass the SPPI test?
If it is consistent with a basic lending arrangement.
Illustrate the summary of classification of debt securities.
What are the circumstances that will fail the SPPI test?
1.) Leverage or the complex criteria in determining the amount of interest are considered as containing leverage.
2.) Excessive prepayment penalties
3.) Convertibility option on bonds
True or False: An entity cannot apply the fair value option or irrevocably designate a debt security at FVTPL even if doing so will eliminate or significantly reduce the accounting mismatch.
False. An entity may be able to do this.
When irrevocably designating a debt security, when is it made?
On the date of initial recognition
True or False: The irrevocable designation at FVTPL will disqualify a debt security to be subsequently reclassified to either FVTOCI or at amortized cost later on.
True
What rate should be used in the calculations of present values?
The market rate on the measurement date.
This determines the amount of interest that can be actually received from the debt security.
Stated rate
This is a type of debt security where there is a one-time principal payment on maturity date.
Term debt security
This is a type of debt security where there are periodic payments of principal.
Serial debt security
What PV factors are relevant for term debt securities?
Principal/Face amount: PV factor of single payment
Periodic interest payments: PV of ordinary annuity
What PV factors are relevant for serial debt securities?
series of PV factors of single payment
What are the other names for stated rate?
Nominal rate or interest rate
What are the other names for market rate?
Effective rate or discount rate
What is the effect of fair value > face amount?
Premium
What is the effect of fair value < face amount?
Discount
