ACFAR 3134

Intermediate Accounting 3
Third Year: First Semester

Lesson 1  Lease incentives—payments by the lessor to the

CHAPTER 10: Lessee Accounting (Basic Principles)
Lease
 IFRS 16
 Definition
o Lease is a contract or part of a contract that
conveys the right to use the underlying asset
for a period of time in exchange for
consideration
 Conveyance of the right to control the use of an
identified asset
 An asset is typically identified by being explicitly
specified in a contract
Right to control the use of an asset
A contract conveys the right to control the use of an asset if
throughout the period of use, the customer has the right to:
a. Obtain substantially all of the economic benefits from
the use of the identified asset
b. Direct use of the identified asset
 All leases shall be accounted for by the lessee as a
finance lease under the new lease standard
 Underlying asset—the subject of a lease for which
the right to use that asset has been provided by the
lessor to the lessee.
lessee (reimbursements, assumption of costs by the
lessor)
 Initial direct costs—incremental costs of obtaining a
lease that would not have been incurred if the lease
had not been obtained
 Leasehold improvements—not IDC; separately
accounted for as PPE and depreciated over the shorter
between lease term and life of the improvements
Any refundable security deposit is accounted for as an asset by
the lessee
Other measurement models
 If a lessee applies FV model in measuring investment
property, the lessee shall also apply the FV model to
the right of use asset that meets the definition of
investment property
 If a lessee applies the revaluation model to a class of
PPE, the lessee may also elect to apply the
revaluation model to all the right of use assets that
relate to that class of PPE
Finance Lease Operating Lease
Permitted to be elected as an accounting policy
only when the lease is either a:
 Short-term lease
 Low value lease

 Class of underlying asset—a grouping of underlying Still, the operating lease is just an option even if
assets of similar nature and used in entity operations the lease is short-term or low-value.
A lease that
 Lessor vs. lessee transfers Recognized by a lessee
o Lessor—the entity that obtains the right to substantially all of  Rent expense (lease payments)
the risks and
use an underlying asset for a period of time
rewards incidental
in exchange for consideration Short-term lease
to ownership of an
underlying asset.  12 months or less from commencement date
o Lessee—the entity that provides the right to
 Election made by class of underlying asset
use an underlying asset for a period of time Recognized by a
in exchange for consideration lessee:
Low-value lease
 Right of use  Matter of professional judgment
 A lease with a purchase option is not a short-term asset
lease  Lease liability  No standard provision for a quantitative
threshold of “low-value”
Method required by  Standard only provides that lessee shall make
the lease standard an assessment based on the asset’s value when
it is new, regardless of age at lease
 Not qualified as LVL if asset is not of low
value when new (ex. car)
 Ex. PC, office furniture, eqpt
 Made on lease by lease basis

FINANCE LEASE Depreciation of ROUA

  Normal depreciation of ROUA over the shorter
between the lease term and the useful life of the asset
 Depreciation will be over the useful life of the asset
if:
o Ownership is transferred at lease term end
o Purchase option is reasonably certain to be
exercised
Measurement of lease liability
 Discounted using the implicit interest rate
 If IIR is not readily determined, incremental
borrowing rate of the lessee is used
 Implicit interest rate—the interest rate that causes
[PV of lease payments + unguaranteed residual
value] = [FV of the underlying asset + IDC of the
lessor]
 Lessee’s incremental borrowing rate—rate of interest
that the lessee has to pay to borrow funds necessary
to obtain a similar asset over a similar term and
similar security
Components of lease payments
 Fixed lease payments
o Payments made by the lessee to the lessor
for the right to use an underlying asset
during the lease term
o Lease payments that are variable in form but
fixed in substance:
 Payments made only if the asset is
proven to be capable of operating
during the lease
 Payments made only if an event
occurs with no genuine possibility
of not occurring
 Payments that are initially variable
but at some point becomes fixed in
substance
 Only the realistic set of payments
should be considered if there is
more than one set of payments
 Variable lease payments
o [ditto] that vary because of changes in facts
or circumstances occurring after the
commencement date other than passage of
time
o Accounted for depending on the nature of
variability
o Payments linked to consumer price index,
benchmark interest rate, or other index
o LL is remeasured and lease payments are
revised when the index or int. rate changes
o Payments based on passage of time or future
usage of the underlying asset are not
included in lease payments
 Purchase option—with reasonable certainty
 Residual value guarantee—amount expected to be
payable by the lessee
 Termination penalties—if the lease term reflects the
exercise of a termination option
Definitions
 RV guarantee—the guarantee made to the lessor by a
party unrelated to the lessor that the value of an
underlying asset at the end of the lease term will be at
least a specified amount
 Unguaranteed RV—the portion of the RV of the
underlying asset, the realization of which by the
lessor is not assured or guaranteed solely by a party
related to the lessor
 Executory costs—ownership expenses such as
maintenance, taxes, and insurance for the underlying
asset
o EXPENSED IMMEDIATELY
Lease term
 The noncancelable period for which the lessee has
the right to use the underlying asset together with
both of the following:
o Period of option to extend (if reasonably
certain)
o Period of option to terminate if reasonable
certain not to exercise the termination option
 Purchase option—UL always (basis for depreciation)
 Residual value guarantee—LT always (basis for
depreciation)
Disclosures—Lessee
1. Depreciation charge for ROUA by class of UA
2. Interest expense on LL
3. Expense related to short-term leases (excluding the
expense relating to leases with a term of one month
or less)
4. Expense related to low-value leases (excluding the
expense relating to leases with a term of one month
or less)
5. Expense relating to variable lease payments not
included in the measurement of LL
6. Income from subleasing ROUA
7. Total cash outflow for leases
8. Addition to ROUA
9. CA of ROUA at period end by class of UA
10. STL or LVL accounted for as operating lease
Additional Disclosures
Additional qualitative and quantitative information about Residual Value Guarantee
leasing activities necessary to help users of FS assess the  The underlying asset is simply transferred by the
effect of leases on SFP, IS, and CF. lessee to the lessor to satisfy the liability for the RV
1. Nature of lessee’s leasing activities guarantee
2. Future cash outflows to which the lessee is  There is no more purchase option if there is an RV
potentially exposed that are not reflected in the guarantee because the equipment will revert to the
measurement of lease liability lessor upon the expiration of the lease
a. Variable lease payments  The remaining CA of the asset should be equal to the
b. Extension and termination option RV guarantee
c. RV guarantee  If the FV < RV guarantee, a loss is reported for the
d. Leases not yet commenced to which the difference and the lessee must make up for the
lessee is committed difference with a cash payment
e. Restrictions or covenants imposed  Asset will be reverted to lessor
 Depreciation is based on lease term
Purchase Option
 Will only be recognized if the lessee is reasonably Unguaranteed Residual Value
certain to exercise the purchase option at the  Asset will be reverted to lessor
commencement date of the lease
 Even if it is an RV, unguaranteed RV is not
 Ownership is transferred considered in the computation of the depreciable
 Depreciation is based on useful life amount
Lesson 2 Terms
CHAPTER 11: Lessee Accounting (Other Accounting  Jan. 1, 2020—original commencement date
Issues)  Jan. 1, 2023—the exercise of extension option
Extension Option  Jan. 1, 2025—original end of lease
 An option that wasn’t reasonably certain on  Jan. 1, 2030—new end of lease
commencement date but decided on by the lessee in  5 year extension
the middle of the lease term
 New rate, new annual rental Amortization Table
 The Remeasurement of the LL Date Payment Interest Principal PV
1/1/2023 2 944 700
12/31/2023 500 000 235 576 264 424 2 680 276
Remeasurement of the lease liability 12/31/2024 500 000 214 422 285 578 2 394 698
12/31/2025 600 000 191 576 408 424 1 986 274
12/31/2026 600 000 158 902 441 098 1 545 176
Annual rental for remaining years of old lease term xxx 12/31/2027 600 000 123 614 476 386 1 068 790
12/31/2028 600 000 85 503 514 497 554 293
PV of OA of 1 for remaining years of old term at new rate 1.x
12/31/2029 600 000 45 707 55 923
PV—at the date the option was taken of the remaining rentals xxx

Annual rentals for extended period of new lease term xxx

PV of OA of 1 for extended period of option at new rate 1.x
PV—at the end of lease term (as if this was the original)
xxx
PV of 1 for remaining years of old term at new rate 0.x Journal Entries
PV—at the date the option was taken of the extended lease term xxx No changes other than that depreciation will be recomputed
for carrying amount divided by the remaining years.
PV of remaining rentals of old term xxx
PV of rentals of extended lease term xxx
Total PV—at the date the option was taken xxx Year Analysis
PV—or current CA of the old lease term (xxx)  The extended years will be added to the end of the
Increase in LL on the date the option was taken xxx
original lease term, not to the year the extension
Right of use—cost xxx option was taken
Accumulated depreciation (xxx)
Carrying amount xxx Variable Payments
Increase in LL xxx
New carrying amount xxx  Different payments on different years of the lease
term
Computation 1. Lease modification—increase and scope & current
market rent
Annual rental for first three years 300 000
a. Recognized as a new separate lease
PV of OA of 1 for 10% for 3 periods 2.487 2. Lease modification—extension of lease term
PV—Jan. 1, 2020 746 100 a. Different from extension option in that in
here, there was no option in the first place.
Annual rental for next five periods 400 000
PV of OA of 1 for 10% for 5 periods 3.791 The contract is simply in itself amended
PV—Jan. 1, 2023 1 516 400 b. Modified prospective amortization
PV of 1 for 10% for 3 periods 0.751 c. LL and ROUA CA increased
PV—Jan. 1, 2020 1 138 816
3. Lease modification—decrease in scope of lease
PV of annual rentals for 3 years 746 100 a. Modified prospective amortization
PV of annual rentals for next 5 years 1 138 816 b. Old LL and ROUA CA decreased by the
LL—Jan. 1, 2020 1 884 916 same percentage, but not the same amount
c. Termination gain—LL decrease > ROUA
dec.
Termination loss—ROUA decrease > LL
Amortization Table dec.
Date Payment Interest Principal PV d. Subsequent increase in LL and ROUA CA
1/1/2020 1 884 916 due to increase in rentals
12/31/2020 300 000 188 492 111 508 1 773 408
12/31/2021 300 000 177 341 122 659 1 650 749 4. Lease modification—change in rentals
12/31/2022 300 000 165 075 134 925 1 515 824 a. Modified prospective amortization
12/31/2023 400 000 151 582 248 418 1 267 406
b. Decrease in rentals decreases LL and ROUA
12/31/2024 400 000 126 741 273 259 994 147
12/31/2025 400 000 99 405 300 585 693 562 CA
12/31/2026 400 000 69 356 330 644 362 918
12/31/2027 400 000 37 082 362 918

Lease Modification
 Should be accounted for as a separate lease under the
following conditions
o The modification increases the scope of the
lease by adding the right to use an additional
underlying asset
o The rental for the lease modification
increases by an amount commensurate with
the increase in scope and equivalent to the
current market rental

***comprehensive note-taking has stopped here because of

time constraints for review***

Turn-around PVs
1. Extension option
2. Variable payments

No turn-around PVs, basic

 ACFAR 3134
Intermediate Accounting 3
Third Year: First Semester

Finance Lease
Lessee Perspective Lessor Perspective
Initial Right of use—at cost which include:
Measurement Lease liability xxx
Lease pmts made to lessor prior xxx
Lease incentives (xxx)
Initial direct costs xxx
Estimated cost of dismantling xxx
Right of use asset xxx

Lease liability—PV of lease payments

Periodic payment xxx
PV of 1 (OA of 1) x
PV of lease payments (LL) xxx
PV of purchase option (LL) xxx
PV of RV guarantee
xxx
Lease liability xxx

Subsequent COST MODEL—required by standard

Measurement
Cost xxx
Accumulated depreciation (xxx)
Increase in LL xxx
Decrease in LL (xxx)
Carrying amount xxx

Presentation As separate line item in the balance sheet

Alternative: ROUA included in the line item where the

underlying asset would be presented if owned (PPE. F&F)
It should be disclosed that such line item includes ROUA.

Right of use xxx

Accumulated depreciation (xxx)
Carrying amount xxx

#1 (Default; fixed Commencement:

payments) Right of use asset xxx [@cost]
Lease liability xxx [@PV of
pmts.]
Cash xxx [@lease pmt.]
EL for restoration xxx [@pmt. val.]

Depreciation (with transfer of ownership):

Depreciation xxx [@DA ÷ useful life]
Accumulated depreciation xxx

Depreciation (no transfer of ownership):

Depreciation xxx [@DA ÷ shorter of
LT/UL]
Accumulated depreciation xxx

Lease payments (at year-end):

Interest expense xxx [@prev. PV x %]
Lease liability xxx [@pmt. – interest]
Cash xxx [@given]
 Interest accrual (at year-end):
Interest expense xxx [@prev. PV x %]
Accrued interest payable xxx

Lease payments (at year-end):

Accrued interest payable xxx [@prev. recognized]
Lease liability xxx [@pmt. – interest]
Cash xxx [@given]

Return of asset to lessor

(no more of this entry if there is transfer of ownership):
Accumulated depreciation xxx
Right of use asset xxx

#2 (With purchase No entry for return of asset to lessor since the asset is not
option) returned.

Exercise of purchase option

Lease liability xxx [@given]
Cash xxx

Non-exercise of purchase option

Accumulated depreciation xxx [@AD bal.]
Lease liability xxx [@purch. option]
Loss on finance lease xxx [@bal. fig.]
Right of use asset xxx [@cost]

#3 (Residual value Return of asset to lessor

guarantee) Accumulated depreciation xxx [@AD bal.]
Lease liability xxx [@RV guarantee]
Loss on finance lease xxx [@bal. fig.]
Right of use asset xxx [@cost]

If the FV of the UA is less than the RV guarantee

Loss on finance lease xxx [@RVG – FV]
Cash xxx

If the FV of the UA is more than the RV guarantee

No entry because there is no cash settlement
#4 (Unguaranteed Return of asset to lessor
residual value) Accumulated depreciation xxx [@AD bal.]
Lease liability xxx [@RV guarantee]
Loss on finance lease xxx [@bal. fig.]
Right of use asset xxx [@cost]

If the FV of the UA is less than the RV guarantee

Loss on finance lease xxx [@RVG – FV]
Cash xxx

If the FV of the UA is more than the RV guarantee

No entry because there is no cash settlement
Actual Purchase of Journal entry:
Underlying Asset Equipment xxx [@computed cost]
Accumulated depreciation xxx [@AD bal.]
Lease liability xxx [@LL bal.]
Right of use asset xxx [@ROUA bal.]
Cash xxx [@purch.
price]

Right of use asset xxx

Accumulated depreciation (xxx)
Carrying amount xxx
Cash payment xxx
Total consideration xxx
Lease liability (xxx)
Cost of equipment purchased xxx
Loss on finance Right of use asset xxx
 lease Accumulated depreciation (xxx)
Carrying amount xxx
Lease liability—purchase option (xxx)
Loss on finance lease xxx

Amortization Date Payment Interest Principal PV

Table 1/1 xxx
(Payment at year- 12/31 xxx xxx xxx xxx
end) xxx xxx xxx xxx xxx*

*xxx = 0 if there is no purchase option

= purchase option, if there is reasonable certainty
= residual value, guarantee
Amortization Date Payment Interest Principal PV
Table 1/1/20 xxx
(Payment in 1/1/20 xxx xxx xxx xxx
advance) 1/1/21 xxx xxx xxx xxx
…
1/1/24 xxx xxx xxx xxx
1/1/25* RVG xxx xxx -

*Maturity

 

Lesson 2 CHAPTER 13: Direct Financing Lease—Lessor

CHAPTER 11: Lessee Accounting (Other Accounting Handwritten notes. No digital notes.
Issues)
Handwritten notes. No digital notes. Lesson 5
CHAPTER 14: Sales Type Lease—Lessor
Lesson 3 Handwritten notes. No digital notes.
CHAPTER 12: Operating Lease—Lessor
Handwritten notes. No digital notes. Lesson 6
CHAPTER 15: Sale and Leaseback
Lesson 4 Handwritten notes. No digital notes.
Lesson 7  Deferred tax accounting
CHAPTER 16 (IA2): Accounting for Income Tax a. Applicable to all entities
Introduction b. Whether public or nonpublic
  Public entity—an entity whose equity and debt b. Dividends received
securities are: c. Life insurance premium
a. Traded in a stock exchange or over-the-  Nondeductible as expense if the
counter market entity is the beneficiary of a life
b. Registered with SEC in preparation for sale insurance policy on an officer or
of the securities employee (added back)
 Considered an expense for financial
Accounting Income (financial income) reporting
 Net income for the period before deducting income d. Tax penalties, surcharges, and fines are
tax expense nondeductible
 Charlotte’s Note:
Sales xxx a. Basically, permanent differences are those
COGS (xxx) items that are considered in the accounting
Gross profit xxx income, but not in the taxable income
Operating expenses (xxx) b. Such items are not included in the taxable
Net income before taxes xxx income since they are not taxed regularly
Tax expense (xxx)  Instead, they are subject to different
Net income after taxes xxx rates (FWTs, CWTs, OPTs, etc)
 Should be deducted from AI to get
 The income appearing on the traditional income TI
statement computed in accordance with accounting
standards Temporary Differences
 Items of income and expenses which are included in
Taxable Income both accounting income and taxable income but at
 The income for the period determined in accordance different time periods
with the rules established by the taxation authorities  Differences between the carrying amount of an asset
upon which income taxes are payable or recoverable or liability and the tax base
 Income appearing on ITR  Include timing differences
 Computed in accordance with income tax law a. Differences between accounting income and
 Excess of taxable revenue over tax deductible taxable income that originate in one period
expense and reverse in one or more subsequent
a. As defined by BIR periods
 For every temporary difference, eventually that
Differences between accounting and taxable income item’s treatment will be the same in accounting and
 Permanent differences taxable income
 Temporary differences  Gives rise to either of the following:
a. Deferred tax liability
b. Deferred tax asset
 Kinds of temporary difference
a. Taxable Temporary Difference
 The temporary difference that will
Permanent Differences result in future taxable amount in
 Items of revenue and expenses determining taxable income of
 Included either as accounting income or taxable future periods when the carrying
income amount of the asset or liability is
a. But will never be included in the other recovered or settled
 Nontaxable revenue and nondeductible expenses  Accrued income—income first
 Do not give rise to a deferred tax asset and liability earned but cash is not yet received
a. Because they have no future tax  Ex. revenue and gains included in
consequences the accounting income of the
current period but will only be
 Examples:
taxable in future periods
a. Interest income on deposits
 Overstated taxable expenses
  Understated taxable income tax base is zero since the EWC is a
 Late ang cash receipt future deductible amount.
 Early ang cash payment
b. Deductible Temporary Difference Tax Base of an Asset Tax Base of a Liability
 The temporary difference that will Zero Zero
result in future deductible amount The entire amount is Because some liabilities are
in determining taxable income of expensed in the current a future deductible amount.
year.
future periods when the carrying
amount of the asset or liability is If the amount is allowed as a It is deductible only when
recovered or settled one-time deduction. paid.
 Accrued liability—expense first
incurred but cash is not yet paid
 Items already deducted in the
accounting income but not yet in
taxable income
 Ex. expenses and losses deductible
for accounting purposes but
deductible for tax purposes in
future periods
 Understated taxable expenses
 Overstated taxable income
 Early ang cash receipt
 Lade ang cash payment

Tax Base
 The amount attributable to the asset or liability for
tax purposes
 Worded in another way, the tax base of an asset or a
liability is the amount of the asset or liability that is
recognized or allowed for tax purposes

Tax Base of an Asset

 The amount that will be deductible for tax purposes
against future income
 Example:
a. A software development cost capitalized as
1,000,000 will have a carrying amount of
1,000,000 for accounting purposes.
 However, if this amount is allowed
as a one-time deduction for tax
purposes, the tax base is zero since
the entire amount is expensed in the
current year.
Deferred Tax Liability (DTL)
 The amount of income tax payable in future periods
 With respect to a taxable temporary difference
 The deferred tax consequence attributable to a
taxable temporary difference or future taxable
amount
 A deferred tax liability arises from the following:
a. Accounting income > taxable income
 Because of timing differences
b. Asset: CA > tax base
c. Liability: CA < tax base

Tax Base of a Liability
 Normally the CA less the amount that will be
deductible for tax purposes in the future
 Example:
a. An estimated warranty liability recognized
at 500,000 will have a carrying amount of
500,000 for accounting purposes
 However, a EWC is deductible
only when actually paid. Thus, the
(DTL) Accounting Income Higher than Taxable Income
Temporary differences that result in accounting income higher
than taxable income include the following:
1. Revenues and gains
a. Included in current period accounting
income
b. Excluded in taxable income since taxable
only in future periods
c. Example:
 i. (Accrued income) An installment
sale is included in accounting
income at time of sale but included
in taxable income only when cash
is collected in future periods.
2. Expenses and losses
a. Excluded in current period accounting
income since deductible only in future
periods
b. Included in taxable income for tax purposes
in the current period
c. Example:
i. Accelerated depreciation for tax
purposes; straight line depreciation
for accounting purposes
ii. Development cost
 Capitalized and amortized
over future periods in
determining accounting
income
 Deducted in determining
taxable income in the
period in which it is paid
iii. Prepaid expense that has already
been deducted on a cash basis in
determining taxable income of the
current period
(DTL) Other Taxable Temporary Differences (TTD)
 Most TTD arise because of differences in the timing
of the recognition of the transaction for accounting
and tax purposes
 However, there are TTD that give rise to deferred tax
liability even for reasons that are technically not
timing differences.
 Such Other TTD are:
a. Upward revaluation of asset without an
equivalent adjustment made for tax purposes
b. The CA of investment in subsidiary,
associate, or joint venture is higher than the
tax base
 Because the subsidiary, associate,
or joint venture has not distributed
its entire income to the parent or
investor
c. The cost of a business combination that is
accounted for as an acquisition is allocated
to the identifiable assets and liabilities
acquired at fair value.
(DTL) Recognition of a Deferred Tax Liability
Recognized Not Recognized
For ALL taxable When the taxable temporary
temporary differences arise from:
differences  Goodwill resulting from a business
combination which is
nondeductible for tax purposes
 Initial recognition of an asset or
liability in a transaction that is not
a business combination and affects
neither accounting income nor
taxable income
 Undistributed profit of subsidiary,
associate, or joint venture when the
parent, investor, or venturer is able
to control the timing of the reversal
of the temporary difference
Deferred Tax Asset (DTA)
 The amount of income tax recoverable in future
periods
 With respect to deductible temporary difference
 The deferred tax consequence attributable to a future
deductible amount and operating loss carryforward
 A deferred tax asset arise from the following:
a. Taxable income > accounting income
 Because of timing differences
b. Asset: tax base > CA
c. Liability: tax base < CA
(DTA) Taxable Income Higher than Accounting Income
Temporary differences that result in taxable income higher
than accounting income include the following:
1. Revenues and gains
a. Included in current period taxable income
b. Excluded in accounting income since
included only in future periods
c. Example:
i. (Deferred income) Rent received in
advance is taxable at the time of
receipt but deferred in future
periods for accounting purposes
 2. Expenses and losses
a. Included (deducted) in current period
accounting income
b. Excluded from taxable income since
deducted only in future periods
(DTA) Future Deductible Temporary Differences
 A probable and measurable litigation loss
a. Accounting—recognized in the current
period
b. Taxation—deducted only when actually
incurred or paid
 Estimated product warranty cost
a. Accounting—recognized in the current
period
b. Taxation—deducted only when actually
incurred or paid
 Research cost
a. Accounting—recognized as expense
b. Taxation—deducted only at a later period
 Impairment loss
a. Accounting—recognized
b. Taxation—ignored until the asset is sold
 Doubtful accounts
a. Accounting—recognized as expense
b. Taxation—deductible only when written off
as worthless
(DTA) Other Deductible Temporary Differences (DTD)
 DTD that give rise to deferred tax asset even for
reasons that are technically not timing differences:
a. Downward revaluation of asset without an
equivalent adjustment made for tax purposes
b. The tax base of investment in subsidiary,
associate, or joint venture is higher than the
CA
 Because the subsidiary, associate,
or joint venture has suffered
continuing losses in current and
prior years
c. The cost of a business combination that is
accounted for as an acquisition is allocated
to the identifiable assets and liabilities
acquired at fair value.
(DTA) Recognition of Deferred Tax Asset
 Shall be recognized for ALL deductible temporary
differences and operating loss carryforward
a. When it is probable that taxable income will
be available against which the deferred tax
asset can be used
(DTA) Operating Loss Carryforward
 An excess of tax deductions over gross income in a
year
 May be carried forward to reduce taxable income in a
future year
 Certain entities registered with the Board of
Investments (BOI) are permitted to carry over net
operating loss for tax purposes subject to limitations
of the relevant law and implementing regulations of
the Board of Investments
Method of Accounting
1. Income statement approach
a. Focuses on timing differences only in the
computation of deferred tax asset or deferred
tax liability.
b. Timing differences affect the income
statement of one period and will reverse in
the income statement of one or more
subsequent periods
2. Statement of financial position approach
a. Considers all temporary differences
including timing differences
b. There are temporary differences that affect
the statement of financial position only and
therefore technically are not timing
differences but nonetheless are recognized in
computing deferred tax asset or liability
Accounting Procedures
The recognition of a deferred tax asset or deferred tax liability
is known as interperiod tax allocation.
1. Determine the taxable income
Income tax expense xxx
Income tax payable xxx
Current tax expense
= taxable income x tax rate
 Current tax expense
- The amount of income tax paid or payable
for a year as determined by applying the
provisions of the enacted tax law to the
taxable income

2. Determine the taxable temporary differences

Income tax expense xxx

Deferred tax liability xxx

Deferred tax liability

Illustration 1—Deferred Tax Liability
= taxable temporary differences x tax rate
 When the accounting income > taxable income
= [(accounting income x %) + (taxable income x %)

Taxable temporary difference

= Total tax expense (accounting income)
– current tax expense (taxable income)
Journal entries
1. To record current tax expense
Income tax expense xxx
3. Determine the deductible temporary differences Income tax payable xxx
*[TI x %]*
Deferred tax asset xxx
Income tax benefit xxx 2. To record the deferred tax liability
Income tax expense xxx
Deferred tax payable xxx
Deferred tax asset *[TTD x %] or [(AI – TI) x %]*
= deductible temporary difference x tax rate
3. To decrease the tax liability
(In the following years where TI > AI)
Income tax benefit Deferred tax payable xxx
- Reduces the current tax expense for the year Income tax expense xxx
and is a deduction from current tax expense. *based on difference of AI and TI*
- May simply be a credited “income tax
expense”

(1)
4. Total Tax Expense
Income Statement Presentation (AI > TI)
a. The total tax expense for the year is equal to
Income before Income Tax (AI) xxx
the: Income Tax Expense:
i. Accounting income subject to tax Current tax expense (TI x %) xxx
multiplied by the tax rate, assuming Deferred tax expense (TTD x %) xxx (xxx)
there is no future enacted income Net income xxx
tax rate.
Income Statement Presentation (alternative)
Income before Income Tax (AI) xxx
Income Tax Expense (AI x %)
Current tax expense xxx (xxx)
Deferred tax expense xxx Net income xxx
Income tax benefit (xxx)
Total income tax expense xxx Income Statement Presentation (TI > AI; decrease)
Income before Income Tax (AI) xxx
Total income tax expense = Tax on accounting income Income Tax Expense:
Tax on accounting income = accounting income x % Current tax expense (TI x %) xxx
Decrease in DTL (TTD x %) (xxx) (xxx)
Net income xxx
Illustration 2—Deferred Tax Asset Illustration 3—Deferred Tax Asset & Deferred Tax
 When the taxable income > accounting income Liability
 Where an advance payment was subject to tax even if
it is to be reported as accounting income in another (1) Computation: Taxable Income
year Accounting income per book xxx
Permanent differences:
Journal entries Nondeductible expenses xxx
1. To record current tax expense Nontaxable revenue (xxx)
Accounting income subject to tax xxx
Income tax expense xxx
Deductible temporary differences:
Income tax payable xxx
Doubtful accounts xxx
*[TI x %]* Estimated warranty cost xxx
Taxable temporary differences:
2. To record the deferred tax asset Excess tax depreciation (xxx)
Deferred tax asset xxx Gross income on installment sale (xxx)
Income tax benefit/expense xxx
*[DTD x %] or [(TI – AI) x %]*

3. To decrease the tax liability

(In the following years where AI > TI) Journal entries
Income tax expense xxx 1. To record current tax expense
Income tax expense xxx Income tax expense xxx
*based on difference of TI and AI* Income tax payable xxx
*[TI x %]*

(1) 2. To record the deferred tax asset

Income Statement Presentation (TI > AI) Deferred tax asset xxx
Income before Income Tax (AI) xxx Income tax benefit/expense xxx
Income Tax Expense: *[DTD x %] or [(TI – AI) x %]*
Current tax expense (TI x %) xxx
Income tax benefit (DTD x %) (xxx)
3. To record the deferred tax liability
(xxx)
Net income xxx Income tax expense xxx
Deferred tax payable xxx
Income Statement Presentation (alternative) *[TTD x %] or [(AI – TI) x %]*
Income before Income Tax (AI) xxx
Income Tax Expense (AI x %)

(2) Income Statement Presentation (TI > AI)

Income before Income Tax (AI) xxx
Income Tax Expense:
Current tax expense (TI x %) xxx
Income tax benefit (DTD x %) (xxx)
Deferred tax expense (TTD x %) xxx (xxx)
Net income xxx

Income Statement Presentation (alternative)

Income before Income Tax (AI before PD adj.) xxx
Income Tax Expense (AI x %)
(xxx)
Net income xxx

(3) Basically
Accounting income xxx
Permanent differences
Nondeductible expenses xxx
Nontaxable revenue (xxx)
Deductible temporary differences xxx
Taxable temporary differences (xxx)
Taxable income xxx
Net Deferred Tax Expense or Income Tax Benefit
 The difference between the change in deferred tax
asset and the change in deferred tax liability is the net
deferred tax expense or benefit.
(4) Net deferred tax expense or benefit
Tax benefit from increase in deferred tax asset (xxx)
Tax expense from increase in deferred tax liability
xxx
Net deferred tax (benefit) expense
(xxx)/xxx
Basically
Current Tax Liability and Current Tax Asset
 Current tax liability
a. The current tax expense or the amount of
income tax actually payable
b. Basically, an income tax payable
c. Classified as current liability
 Current tax asset
a. If tax already paid for the current period >
amount actually payable, the excess
recognized is a current tax asset
b. Basically, a prepaid income tax
c. Classified as current asset
 In PH, income tax for corporations is payable every
quarter
 Current tax liability or current tax asset shall be
measured using the tax rate that has been enacted and
effective at the end of reporting period
Presentation of Deferred Tax Asset or Liability
 When an entity makes a distinction between current
and noncurrent assets and liabilities,
a. It shall NOT classify deferred tax assets as
current assets, and deferred tax liabilities as
current liabilities
b. Classification (regardless of reversal period)
 NONCURRENT ASSET—
deferred tax asset
 NONCURRENT LIABILITY—
deferred tax liability
c. A deferred tax asset or deferred tax liability
Offset or Deferred Tax Asset and Liability
 Under PAS 1 (Presentation of FS), assets and
liabilities SHALL NOT be offset unless required or
permitted by another standard
 Under PAS 12 (Income Taxes(, an entity shall offset
a deferred tax asset against a deferred tax liability
when:
a. The DTA and DTL relate to income taxes
levied by the same tax authority
b. The entity has a legal enforceable right to set
off a current tax asset against a current tax
liability
Measurement of Deferred Tax Asset or Liability
 A DTL or DTA shall be measured using
a. the tax rate that has been enacted by the end
of the reporting period and expected to apply
the period when the asset is realized or the
liability is settled
 For example:
a. 30% tax rate
 For the year 2020
 Will be used to measure current tax
asset and current tax liability
b. 25% enacted tax rate
 For the year 2021, declared on Dec.
31, 2020
 Will be used to measure deferred
tax asset and deferred tax asset
Intraperiod and Interperiod Tax Allocation
 Intraperiod tax allocation—the allocation of income
tax expense to the various revenues that brought
about the tax. Thus,
a. Total income tax expense—allocated to:
 Income from continuing operations
 Income from discontinued
operations
 Prior period errors
 Or items directly charged or
credited to retained earnings
Statement of Financial Position Approach
To account for a deferred tax asset or liability, an SFP that a. TAXABLE TEMPORARY DIFFERENCE
shows all the assets and liabilities at their carrying amount is  If a liability’s CA > tax
first prepared.

The following procedures are then prepared: (1) Computation: Deferred Tax Liability
 Determine the tax base of the assets and liabilities Asset 1 (CA – Tax Base) xxx
 Compare CAs with the tax base Asset 2 (CA – Tax Base) xxx
Total taxable temporary differences xxx
 Differences in CAs and tax baseDTA or DTL
 Permanent differences do not give rise to DTA or Deferred tax liability (total TTD x %) xxx
DTL
 Apply tax rate to temporary differences
 Determine beg. and end balances of DTA and DTL
 Recognize the net change between beg. and end (2) Computation: Taxable Income
balance of DTA or DTL Pretax accounting income xxx
Taxable temporary differences:
Development cost CA (entirely expensed) (xxx)
Excess tax depreciation (xxx)
Taxable income xxx

Current tax expense (TI x %) xxx

Journal entries:
1. To record the deferred tax liability
Income tax expense xxx
Deferred tax payable xxx
*[TTD x %] or [(AI – TI) x %]*

2. To record current tax expense

Income tax expense xxx
Income tax payable xxx
*[TI x %]*

(3) Income Statement Presentation

Income before Income Tax (AI) xxx
Income Tax Expense:
Current tax expense (TI x %) xxx
Deferred tax expense (TTD x %) xxx (xxx)
Net income xxx

Continuation (2021)
 If an asset’s CA > tax base
a. TAXABLE TEMPORARY DIFFERENCE
 If a liability’s CA > tax

Comprehensive Illustration (2020)

 If an asset’s CA > tax base
 Illustration—Revaluation
(1) Computation: Increase in Deferred Tax Liability
Replacemen Appreciatio
Deferred tax liability—Dec. 31, 2021 xxx Cost
t Cost n
(total TTD x %)
Deferred tax liability—Dec. 31, 2020 xxx Equipment xxx xxx xxx
Increase in deferred tax liability xxx AD (xxx) (xxx) (xxx)
CA/SV/RS xxx xxx xxx
Increase in deferred tax liability xxx

(1.5) Computation: Deferred Tax Asset (1) Net Revaluation Surplus

Deferred tax asset—Dec 31, 2021 xxx Revaluation Surplus—@ date of revaluation xxx
(total DTD x %) Deferred tax liability (RS x %) (xxx)
Net revaluation surplus xxx

The revaluation surplus is a future taxable amount and therefore,

(2) Computation: Taxable Income there is a deferred tax liability.
Pretax accounting income xxx
Taxable temporary differences:
Development cost CA (entirely expensed) (xxx) Journal entries:
Excess tax depreciation (xxx) 1. To record the revaluation
Taxable income xxx
Equipment xxx
Accumulated depreciation xxx
Current tax expense (TI x %) xxx
Revaluation surplus xxx

2. To recognize the deferred tax liability on the

Journal entries:
revaluation surplus
1. To record the increase in deferred tax liability
Revaluation surplus xxx
Income tax expense xxx
Deferred tax liability xxx
Deferred tax payable xxx
*[End DTL – Beg. DTL]*
3. To record depreciation
Depreciation xxx
2. To record the deferred tax asset
Accumulated depreciation xxx
Deferred tax asset xxx
Income tax benefit/expense xxx
4. To record the annual realization of the revaluation
*[DTD x %] or [(TI – AI) x %]*
surplus
Revaluation surplus xxx
3. To record current tax expense
Retained earnings xxx
Income tax expense xxx
Income tax payable xxx
Notes:
*[TI x %]*
 The deferred tax liability in the JE#2 is charged to
equity, meaning, revaluation surplus
(3) Income Statement Presentation
 Depreciation is based on the sound value or
Income before Income Tax (AI) xxx
depreciated replacement cost for accounting purposes
Income Tax Expense:
Current tax expense (TI x %) xxx  The revaluation surplus is a component of OCI and
Deferred tax expense (TTD x %) xxx subsequently reclassified through equity or retained
Deferred tax asset (DTD x %) (xxx) earnings
(xxx)
Net income xxx

(3) Net Deferred Tax

Deferred tax expense xxx
Income tax benefit (xxx)
Net deferred tax benefit xxx Current Tax Expense
 (2) Computation: Taxable Income Disclosures
Income before depreciation and tax xxx The disclosure requirements for income tax are quite
Tax depreciation (based on CA, not SV, over useful life) (xxx) extensive. However, the key elements are:
Taxable income xxx 1. Components of the total income tax expense
 Current tax expense
Current tax expense (TI x %) xxx  Deferred tax expense
 Deferred tax benefit
5. To record the current tax expense 2. An explanation of the relationship between total
Income tax expense xxx income tax expense and accounting profit.
Income tax payable xxx  This essentially discloses the accounting
profit subject to tax which is the accounting
Carrying Amount and Tax Base profit after considering permanent
differences
(2) Computation: Carrying Amount
3. The following:
Equipment at replacement cost xxx
Accumulated depreciation: (RC column)  Applicable tax rate
Jan. 1, 2020 xxx  Basis on which the tax rate has been applied
Depreciation on revalued amount xxx (xxx)  The explanation for any change in the
Carrying amount—Dec. 31, 2020 xxx applicable tax rate
4. The aggregate amount of current and deferred tax
(3) Computation: Tax Base
relating to items recognized directly in equity.
Equipment at cost xxx
5. The aggregate amount of temporary differences
Accumulated depreciation: (Cost column)
Jan. 1, 2020 xxx associated with investments in subsidiary, associate,
Depreciation on CA for 2020 xxx (xxx) and joint venture for which no deferred tax liability
Tax Base—Dec. 31, 2020 xxx has been recognized
6. Analysis of the beginning and ending balance of
deferred tax asset and deferred tax liability
Decrease in Deferred Tax Liability
Carrying amount xxx Problem Solving Notes
Tax base (xxx)  AI > TI—taxable temporary difference
Taxable temporary difference xxx  TI > AI—deductible temporary difference
 AI—income before tax
Deferred tax liability—Dec. 31 2020 (TTD x %) xxx
 TI—income before tax but with considerations for
Deferred tax liability—Jan. 1, 2020 xxx
Increase (decrease) in deferred tax liability xxx
temporary differences
 DTA (Dr), ITB (Cr)—increase
ITE (Dr), DTA (Cr)—decrease
6. To record the decrease in deferred tax liability  ITE (Dr), DTL (Cr)—increase
Deferred tax liability xxx DTL (Dr), ITE (Cr)—decrease
Income tax expense xxx  Income after temporary differences should be
adjusted for TI. Meaning, those items that are not
taxed, should be added back or removed if such are
(4) Income Statement Presentation not included in TI.
Income before depreciation and tax xxx  TTD
Depreciation on revalued amount (xxx) i. Gina-deduct sa pagcompute sa TI kay para
Income before tax xxx sa iya, mas gamay dapat ang AI
Income tax expense:
ii. Kay sa future niya singlon ang acctg.
Current tax expense xxx
Decrease in DTL (xxx) (xxx)
iii. Added sa pagcompute sa total tax expense
Net income xxx  DTD
Revaluation surplus realization xxx i. Gina-add sa pagcompute sa TI kay para sa
Total effect on retained earnings xxx iya, mas dako dapat ang AI, so dapat i-add
back tong expenses na gi minus
ii. Sa future sya mag give back sa acctg.
 iii. Deducted sa pagcompute sa total tax
expense
 (Accounting income – permanent differences) x %
i. For total income tax expense
 Tax exempt interest revenue
i. Not a temporary difference
ii. Ignored
 Future taxable amount
i. Deferred tax liability only
Lesson 8
CHAPTER 6 (IA3): Noncurrent Asset Held for Sale (PFRS
5)
Noncurrent Asset
 An asset that does not meet the definition of a current
asset
 May be:
i. Individual asset—like land or building
ii. Disposal group—a group of assets to be
disposed of, by sale or otherwise, together as
a group in a single transaction, and liabilities
directly associated with those assets that will
be transferred in the transaction
Noncurrent Asset Held for Sale
 A noncurrent asset or disposal group is classified as
held for sale if the CA will be recovered principally
through a sale transaction rather than continuing use
 Meaning that the entity does not intend to use the
asset as part of the on-going business
 Instead, the business intends to sell it and recover the
CA principally through sale
Conditions for Classification as Held for Sale
 A NCA or DG shall be classified as held for sale if
the following conditions are present:
i. The asset or DG is available for immediate
sale in the present condition
 Subject only to terms that are usual
and customary for sale of such
assets or disposal group
 In other words, the current
condition of the asset should be
adequate to be effectively sold as
seen
ii. The sale must be highly probable
Definition of Highly Probable
The following conditions must be met:
1. Management must be committed to a plan to sell the
asset of disposal group
2. An active program to locate a buyer and complete the
plan must have been initiated
 Future deductible amount
i. Deferred tax asset only
 Reported deferred tax expense for the current year
i. Net deferred tax expense
 Cumulative taxable temporary differences on Dec. 31
i. Basis of deferred tax liability
 Operating loss carryforward
 Considered only in the computation of deferred tax
asset
3. The sale should be expected to be a completed sale
within one year from the date of classification as held
for sale
 An extension of the one-year period does not
preclude the asset or DG from being
classified as held for sale if the delay is
caused by events or circumstances beyond
the entity’s control
4. The asset or DG must be actively marketed for sale at
a sale price that is reasonable in relation to the fair
value
5. Actions required to complete the plan indicate that it
is unlikely that the plan will be significantly changed
or withdrawn
Measurement of Asset Held for Sale
 A NCS or DG classified as held for sale shall be
measured at the lower of CA or FV less COD
 NCA classified as held for sale shall not be
depreciated
Writedown to FV less COD
 If FV less COD < CA of the asset or DG
o The writedown to FV less COD is treated as
an impairment loss
 If the NCA is a disposal group, the impairment loss is
apportioned across the assets based on CA after
writing off any goodwill first
Subsequent Increase in FV
 If there is an increase in FV less COD, an entity shall
recognize a gain
o But not in excess of any impairment loss
previously recognized
 Equipment held for sale xxx [@EHFS bal.]
Gain on sale of equipment xxx [@bal. figure]

Equipment held for sale is no longer depreciated

after reclassification!

Revalued Asset Classified as Held for Sale

Illustration #1 (FVLCD < CA)
1. To remove the equipment from PPE and classify it as held
for sale (on date of reclassification)
Equipment held for sale xxx [@CA, and CA only!]
Accumulated depreciation xxx [@AD bal.]
Equipment xxx [@cost]
2. To measure the equipment held for sale at the lower of
CA or FV less COD (on date of reclassification)
Impairment loss xxx [@CA less FVLCD]
Equipment xxx
This is if FV less COD < CA.
3. To record the sale of the equipment (on the date of sale)
Cash xxx [@selling price]
Loss on sale of equipment xxx [@bal. figure]
Equipment held for sale xxx [@EHFS bal.]
Equipment held for sale is no longer depreciated
after reclassification!
 When an entity adopts the revaluation model for the
measurement of assets
o Any asset classified as held for sale should
be revalued to fair value immediately prior
to the classification as held for sale
 The additional revaluation surplus is equal to:
o FV at classification date* – carrying amount
at classification date
o *not FVLCD!!
 Any cost of disposal at classification date should be
recognized as impairment loss for the period and
deducted from the asset held for sale
 At subsequent year-end, the revalued asset classified
as held for sale shall be measured at the lower of CA
and FV less COD
Illustration #3 (Revaluation Model)
1. To record acquisition of asset (at acquisition date)
Land xxx [@cost
Cash xxx [@cost]

2. To revalue asset at fair value (at year-end)

Illustration #2 (CA < FVLCD) Land xxx [@FV – cost]
1. To remove the equipment from PPE and classify it as held Revaluation surplus xxx [@FV – cost]
for sale (on date of reclassification)
Equipment held for sale xxx [@CA, and CA only!] 3. To revalue asset at fair value (at year-end)
Accumulated depreciation xxx [@AD bal.] Land xxx [@updated FV – previous FV]
Equipment xxx [@cost] Revaluation surplus xxx
2. To measure the equipment held for sale at the lower of
CA or FV less COD (on date of reclassification) 4. To remove land from PPE and classify it as held for sale
No entry. (at date of reclassification)
Land held for sale xxx
[@updated FV]
This is if CA < FV less COD. EHFS is already Land xxx
measured at CA.
5. To recognize the cost of disposal as impairment loss
FVLCOD xxx (on date of reclassification)
CA (xxx) Impairment loss xxx [@cost of disposal]
Expected gain xxx (different from gain on sale) Land held for sale xxx [@cost
of disposal]

Gain is not recognized at this time because any gain 6. To record the sale of land (on date of sale)
should not be anticipated at the point of Cash xxx [@selling price]
classification as held for sale. Loss on sale of equipment xxx [@bal. figure]
Equipment held for sale xxx [@EHFS bal.]
3. To record the sale of the equipment (on the date of sale)
Cash xxx [@selling price] FVLCOD xxx
CA (xxx)
 Expected gain xxx (different from gain on sale)
7. To transfer the revaluation surplus to retained earnings
(on the date of sale)
Revaluation surplus xxx [@RS bal.]
Retained earnings xxx
Abandoned Noncurrent Asset
 An entity shall not classify as held for sale a NCA or
DG that is to be abandoned
 This is because the CA will be recovered principally
through continuing use, or the NCA is to be used
until the end of its economic life
Temporarily Abandoned
 An entity shall not account for a NCA that has been
temporarily taken out of use as if it had been
abandoned
 Ex. A plant temporarily abandoned because demand
for its product has declined
o However, the plant is maintained in
workable condition and it is expected that it
will be brought back into use if demand
picks up
Change in Classification
 Where NCA held for sale is no longer classified as
such
 Ex.
o Decision to no longer sell NCA
o Criteria for classification as HFS is no
longer met
 In such a case, the entity shall measure the NCA that
ceases to be classified as HFS at the lower of:
o CA before the asset was classified as HFS
 Adjusted for any depreciation,
amortization, or revaluation that
would have been recognized if the
asset had not been classified as
HFS
 Basically, the original CA that
could’ve been at the moment
o Recoverable amount at the date of the
subsequent decision not to sell
Illustration #4 (Decision Not to Sell)
1. To record acquisition of asset (at acquisition date)
Equipment xxx [@cost
Cash xxx [@cost]
2. To record depreciation (at year-end)
Depreciation xxx [@annual depreciation]
Accumulated depreciation xxx
3. To remove the equipment from PPE and classify it as held
for sale (on date of reclassification)
Equipment held for sale xxx [@CA, and CA only!]
Accumulated depreciation xxx [@AD bal.]
Equipment xxx [@cost]
4. To measure the equipment held for sale at the lower of
CA or FV less COD (on date of reclassification)
Impairment loss xxx [@CA less FVLCD]
Equipment xxx
This is if FV less COD < CA.
5. To measure the equipment that ceases as held for sale at
the lower of would’ve-been-CA and the recoverable
amount (on date of cessation of being held for sale)
Equipment held for sale xxx [@measurement – CA per book]
Gain on reclassification xxx
6. To reclassify the asset as PPE (on date of cessation of
being held for sale)
Equipment xxx [@measurement]
Equipment held for sale xxx
Presentation of Asset Classified as Held for Sale
 Assets classified as noncurrent shall not be
reclassified as current assets until they meet the
criteria to be classified as held for sale
 Simply stated, a NCA already classified as held for
sale shall be presented separately as current asset
 If the NCA is a DG classified as held for sale,
o The assets and liabilities of the group shall
be presented separately and cannot be offset
as a single amount
 Assets of the DG—shall be
described as “NCA classified as
HFS” presented separately as a
single amount under current assets
 Liabilities of the DG—“Liabilities
directly associated with NCA
classified as HFS” presented
separately as a single amount under
current liabilities
Change in Method of Disposal
 IASB amended IFRS 5 to clarify the accounting
treatment when an entity reclassifies an asset or DG
from “HFS” to “held for distribution to owners” or
vice versa without any time lag.
o The change in classification is considered a
continuation of the original plan of disposal
 o The entity shall continue to apply the “HFS”
or “held for distribution” accounting
 The asset shall be measured at the
lower of CA and FVLCD (disposal
or distribution)
o At the time of reclassification, the entity
shall recognize any impairment loss or
Lesson 9
CHAPTER 7 (IA3): Discontinued Operation (PFRS 5)
Discontinued Operation
 Defined as a component of an entity that either has
been disposed of or is classified as held for sale and:
o Represents a separate major line of business
or geographical area of operations
o Part of a single coordinated plan to dispose
of a separate major line of business or
geographical area of operations
o A subsidiary acquired exclusively with a
view to resale
Component classified as held for sale
 Discontinued operation is accounted for as a disposal
group classified as held for sale
 The component of an entity must be available for
immediate sale in the present condition and the sale
must be highly probable
Timing of reporting
A component of an entity is classified as discontinued
operation at the date of the ff. events:
 Actual disposition of the operation
 When the criteria to be classified as held for sale
The retroactive classification as a discontinued operation when
the discontinued criteria are met after the end of the reporting
period.
 If criteria are not met before end of reporting period,
do not classify such discontinued operation as held
for sale.
Component of an entity
 May be a:
o Subsidiary
o Major line of business
o Geographical segment
 Whose operations and cash flows can be clearly
distinguished, operationally and for financial
reporting purposes, from the rest of the entity
o This is if the assets, liabilities, revenue, and
expenses are directly attributable to the
business
subsequent increase in FVLCD (disposal or
distribution)
o The change in classification does not, in
itself, extend the period in which a sale has
to be completed
 ALRE are directly attributable to the component if
they would be eliminated when the component is
disposed of
 A discontinued operation occurs when the operations
and cash flows of that component have been or will
be eliminated from the ongoing operations of the
entity and the entity will have no significant
continuing involvement in that component after
disposal
Income statement presentation
 The income or loss from discontinued operation, net
of tax shall be presented as a single amount in the
income statement below the income from continuing
operations
Included in discontinued operation
 Amount of revenue, expenses, and income or loss
attributable to the discontinued operation during the
current period and the related income tax
 Impairment loss (if FVLCD of discontinued
operation < CA of net assets)
o If FVLCD is higher, expected gain is not
recognized
 Gain or loss from actual disposal of assets and
settlement of liabilities of a discontinued operation is
recognized on the date of sale or date of settlement
 Termination cost of employees and other costs which
are directly incurred as a result of the discontinuance
Statement of financial position presentation
An entity shall also present separately on the face of the
statement of financial position the following information:
 Assets of the component held for sale separately from
all other assets
 Assets of the component held for sale are measured at
lower of FVLCD and CA
 Liabilities of the component separately from all other
liabilities
 Nondepreciation—noncurrent assets of the
component held for sale shall be depreciated
Assets of the component—current assets
Liabilities of the component—current liabilities
  Assets and liabilities of the component cannot be
offset against the other
 If a disposal group is classified as held for sale in the
current year
o An entity shall not reclassify or represent the
assets and liabilities of the disposal group
for the prior period to reflect the “held for
sale” classification in the statement of
financial position as of the end of the current
reporting period
o In other words, the presentation of the assets
and liabilities of the disposal group in the
prior period is not changed
Cash flow presentation
 The net cash flows attributable to the operating,
investing, and financing activities of a discontinued
operation shall be separately presented in the
statement of cash flows or disclosed in the notes

Income Statement Presentation

Lesson 10 Change in accounting
Sales—continued estimate
operations xxx
CHAPTER 8 (IA3): Accounting Changes—Changes in  An adjustment of the CA of an asset or a liability, or
Cost of sales—continued operations (xxx)
Accounting Estimate (PAS 8) Gross income
the amount of the periodic consumption xxx
of an asset
Expenses—continued operations (xxx)
that results from the assessment of the present status
Accounting Change (Categories) Income before tax xxx
and expected future benefit and obligation associated
 Change in accounting estimate
with the asset and liability.
 Change in accounting policy
 Simply stated
Accounting changes can have a great impact on an entity’s
o A normal recurring correction or adjustment
reported earnings.
of an asset or liability which is the natural
result of the use of an estimate
 Use of reasonable estimate—an essential part of the
preparation of FS
 An estimate may need revision as a result of
o Newfrom
Disclosure—income information
discontinued operations
o More
Sales—discontinued experience
operations xxx
Cost of sales—discontinued
o Subsequent operations
development (xxx)
Gross income xxx
 Revision of the estimate
Expenses—discontinued operations (xxx)
o Does not relate to prior periods
Impairment loss (xxx)
o Not acost
Employee termination correction of an error (xxx)
 A
Income taxchange in measurement basis (xxx)
Income fromodiscontinued
A change operations
in accounting policyxxx
 When it is difficult to distinguish a change in
accounting estimate and a change in accounting
policy
o Treated as a change in accounting estimate,
Impairment loss with appropriate disclosure

Examples of accounting estimate

Estimation involves judgment based on the latest available and
reliable information
 Doubtful accounts
 Inventory obsolescence
 Useful life, residual value, and expected pattern of
consumption of benefit of depreciable asset
 Warranty cost
 FV of financial assets and financial liabilities
How to report change in accounting estimate
Currently and prospectively by including it in income or loss
of:
 The period of change if the change affects that period
only
 Period of change and future periods if the change
affects both
Lesson 11
CHAPTER 9 (IA3): Accounting Changes—
Change in accounting policy
Prior period errors (PAS 8)
Accounting Policies
 The specific principles, bases, conventions, rules, and
practices applied by an entity in preparing and
presenting financial statements.
 Same accounting policies each period to achieve
comparability of financial statements
Change in accounting policy
 Once selected, must be applied consistently for
similar transactions and events
 A change in accounting policy shall be made only
when:
o Required by an accounting standard or an
interpretation of the standard
o The change will result in more relevant and
faithfully represented information about the
financial position, financial performance,
and cash flows of the entity
 A change in accounting policy arises when an entity
adopts a GAAP which is different from the one
previously used by the entity.
Examples of change in accounting policy
 Change in method of inventory pricing
o FIFO to weighted average method
 Change in method of accounting for long term
construction contract
o Cost recovery method to percentage of
completion method
 Initial adoption of policy to carry assets at revalued
amount (PAS 16)
 Change from cost model to FV model in measuring
investment property
 Change to a new policy as required by PFRS
Not changes in accounting policy
A change in an accounting estimate shall not be accounted for
by restating amounts reported in the FS of prior periods.
Prospective recognition
 Change is applied to transactions, other events, and
conditions from the date of change in estimate
--
 Application of an accounting policy for events or
transactions that differ in substance from previous
events or transactions
 Application of new accounting policty for events or
transactions which did not occur previously or that
were immaterial
How to report a change in accounting policy
 Shall be applied in accordance with the transitional
provisions provided by a standard or an interpretation
 Shall be applied retrospectively or retroactively
o If the standard or interpretation contains no
transitional provision or if an accounting
policy is changed voluntarily
Retrospective application
 Adjustment to the opening balance of retained
earnings
 Comparative information should be disclosed
Journal Entry
Increase adjustment:
Retained earnings xxx
Balance sheet account xxx
Decrease adjustment:
Balance sheet account xxx
Retained earnings xxx
Limitation of retrospective allocation
 Not required if it is impracticable to determine the
cumulative effect of change
 For a particular prior period, it is impracticable to
apply a change in accounting policy when:
o Effects of the retrospective application are
not determinable
o If it requires assumptions about what
management’s intentions would have been at
that time
 o If it requires significant estimate, and it is
impossible to distinguish objectively
information about the estimate that:
 Provides evidence of circumstances
that existed at the time
 Would have been available at that
time.
Prospective application
 When it is impracticable for an entity to apply an
accounting policy retrospectively
o The entity shall apply the new policy
prospectively from the earliest period
practicable
 If the amount of the adjustment on the opening
balance of the RE cannot be determined
 No adjustments relating to prior periods are made
either to the opening balance of RE or other
component of equity
o This is because existing balances are not
recalculated
Change in reporting entity
 A change whereby entities change their nature and
report their operations in such a way that the financial
statements are in effect those of a different reporting
entity
 May result from
o Changing specific subsidiaries comprising
the group of entities for which consolidated
financial statements are presented
 A change in accounting policy
o Shall be treated retrospectively or
retroactively to disclose what the statements
would have looked like if the current entity
had been in existence in the prior year
 In other words, the FS of all prior periods shall be
restated to show financial information for the new
reporting entity
Absence of accounting standard
 In the absence of an accounting standard that
specifically applies to a transaction or event
o Management shall use judgment
o In selecting and applying an accounting
policy that results in information that is
relevant to the economic decision making
needs of users and fairly represented
Hierarchy of guidance for selecting accounting policies
1. Requirements of current standards dealing with
similar matters
2. Definition, recognition criteria, and measurement
concepts for assets, liabilities, income and expenses
in the Conceptual Framework for Financial Reporting
3. Most recent pronouncements of other standard-
setting bodies that use a similar Conceptual
Framework, other accounting literature and accepted
industry practices
Prior period errors
 Are omissions and misstatements in the FS for one or
more periods arising from a failure to use or misuse
of reliable information that:
o Was available when FS for those periods
were authorized for issue
o Could reasonably be expected to have been
obtained and taken into account in the
preparation and presentation of those FS
 Some errors may occur as a result of mathematical
mistakes, mistakes in applying accounting policies,
misinterpretation of facts, fraud, or oversight
How to treat prior period errors
 Retrospectively
o Adjustments to RE and affected assets and
liabilities
 If comparative statements are presented
o Retrospective restatement of prior period FS
 Correction of the recognition,
measurement, and disclosure of
amounts of elements of FS as if a
prior period error had never
occurred
 If the error occurred before the earliest prior period
presented
o The opening balances of assets, liabilities,
and equity for the earliest prior period
presented shall be restated
 When it is impracticable to determine the cumulative
effect at the beginning of the current period of an
error on all prior periods
o The entity shall restate the comparative
information to correct the error
prospectively from the earliest date
practicable
Disclosure of prior period errors
 Nature of the error
 Amount of correction for each prior period presented
to the extent practicable
o For each FS line item affected
 o For basic and diluted earnings per share  If retrospective statement is impracticable for a
 Amount of correction at the beginning of the earliest particular prior period, the circumstances that led to
prior period presented the existence of that condition and a description of
how and from when the error has been corrected
—
CHAPTER 14 (IA3): Cash and Accrual Basis
FORMULAS
Cash Basis Sales
 Income—recognized when received Sales = cash sales + sales on account
 Expense—recognized when paid Sales on account = TARNR, end + deductions – TARNR, beg
 None of the ff:
o AR Trade AR and NR
Trade AR and NR, beg Collections
o AP Sales on account SD, SRAA
o Accrued income Write-offs
o Deferred income TNR discounted
o Accrued expense Trade AR and NR, end
o Prepaid expense

Purchases
Accrual Basis
Purchases = cash purchases + purchases on account
 Income—recognized when earned
Purchases on acct = TAPNP, end + deductions – TAPNP, beg
 Expense—recognized when incurred
 Recognizes: Trade AP and NP
o AR Trade AP and NP, beg AP payments
o AP Purchases on account Trade NP payments
o Accrued income PRAA, PD
o Deferred income Trade AP and NP, end
o Accrued expense
o Prepaid expense
Income other than Sales
Income received—cash basis xxx
Items Cash basis Accrual basis Add: Deferred income, beg. xxx
Cash sales Cash sales Accrued income, end xxx
Sales + collection from + sales on Total xxx
customers account Less: Deferred income, end xxx
Cash purchases Cash purchases Accrued income, beg. xxx (xxx)
Purchases + payments to + purchases on Income for the current year—accrual basis xxx
creditors account
Income other than
Received Earned
sales Deferred income = received, not yet earned
Expenses, in
Paid incurred  Beg.— added since it will be earned in the current
general
year
Provided Provided
Depreciation  End—deducted since though it will be earned in the
normally normally
No bad debts next year
Doubtful
Bad debts since there are no
accounts
trade receivables Accrued income = earned, not yet received
 Beg.—deducted since earned only in previous period
 End—added since earned in current period

Accounting Problem
 In cash basis recording
o Adjustments are made for accruals and
prepayments, to convert cash basis records
to accrual records
Income other than Sales  Beg.—added since it will be incurred in the current
Expenses paid—cash basis xxx year
Add: Prepaid expenses, beg. xxx  End—deducted since though it will be incurred in the
Accrued expense, end xxx next year
Total xxx
Less: Prepaid expenses, end xxx
Accrued expenses, beg. xxx (xxx) Accrued expense = incurred, not yet paid
Income for the current year—accrual basis xxx  Beg.—deducted since incurred only in previous
period
 End—added since incurred in current period
Prepaid expense = paid, not yet incurred __

CHAPTER 15: Single Entry

Single Entry System
 Double entry system—debits and credits
 Singe entry system
o Transactions are not analyzed and recorded
in a double entry framework
Preparation of Financial Statements
 Where the records are incomplete
 Preparation of income statement
 Records maintained are represented only by the so-
o Involves computation of individual revenue
called “bare essentials”
and expense balance by reference to cash
 Cashbook—the major record
receipts and disbursements
o Shows all receipts and disbursements
o Formulas used in converting cash basis to
 No specific accounts are debited and credited
accrual basis
o Only a description thereof is made
 Sales, purchases, income other than
 List of customers and creditors for
sales, expenses in general
AR and AP
 Preparation of statement of financial position
 Net income or loss
o Involves
o Capital or retained earnings (beg) vs capital
 Inventorying
or retained earnings (end) – withdrawals +
 Counting
dividends + additional investments
 Verification procedures to
determine amount and nature of
Formula for proprietorship or partnership
assets and liabilities
Capital, end xxx
o For example
Add: Withdrawals xxx
Total xxx  Cash—by count and examination
Less: Capital, beg. xxx of bank statements
Addt’l investments xxx (xxx)  AR and NR—based on unpaid sales
Net income (loss) xxx invoices and promissory notes
 Merchandise, supplies, inventories
—count, cost from purchase
Formula for corporation invoices
RE, end xxx  PPE—by reference to deeds of
Add: Dividends declared/paid xxx
sales and other documents
Items that decrease RE (not P/L) xxx
Total xxx evidencing ownership
Less: RE, beg. xxx  AP and NP—purchase invoices,
Items that increase RE (not P/L) xxx (xxx) memoranda, correspondence,
Net income (loss) xxx consultation with creditors
 Ownership equity or capital—A –
L

CHAPTER 16: ERROR CORRECTION  Treatment—retrospective

  SFP errors  If books for 2020 not closed
o Reclassification entry RE xxx
o No effect on net income Inventory xxx
 Income errors  If books for 2020 closed
o Reclassification entry—if same year No entry, counterbalanced
o No reclassification entry—if not same year in 2020.
 If books are not closed yet—adjust to RE
 Combined SFP and income errors
If books are already closed—no need for adjustment
o Misstates net income
 To know if to debit or credit RE, ask yourself if the
net income during the year the error occurred was
Counterbalancing errors
understated or overstated.
 Errors that will be offset or corrected over two
 If overstated, debit RE.
periods
 If understated, credit RE.
 Correct themselves over two periods
 Year 1 = net income is under/overstated
Non-counterbalancing errors
Year 2 = net income is over/understated
 If not detected, are not automatically counterbalanced
Offsetting effect
or corrected in the next accounting period
 Effects
 Year 1 = net income is under/overstated
o After 1st period—IS and FS incorrect
Year 2 = net income is unaffected
o After 2nd period—IS incorrect, FS correct
 If books are not closed yet—adjust
 Example
If books are already closed—adjust still since there is
o Dec. 31, 2019—overstated
no automatic offset effect
o Dec. 31, 2020
CHAPTER 17: STATEMENT OF CASH FLOWS Operating Activities (Cash transactions that affect net
Statement of Cash Flows (SCF) income)
 Primary purpose  Cash flows derived primarily from the principal
o Provides information about cash receipts and revenue-producing activities of the entity
cash payments  Transactions that enter into the determination of net
 Designed to provide information about the change in income or loss
an entity’s cash and cash equivalents (CCE) Trading securities
 Strictly a cash concept  Classified as operating activities
 Basically a conversion from the accrual basis to the  Purchase transactions TS
cash basis of accounting  Sale transactions of TS

Cash and Cash Equivalents Investing Activities (Cash effects on non-operating assets)
 Cash—cash on hand and demand deposits  Cash flows derived from the acquisition and disposal
 Cash equivalents of long-term assets and other investments not
o Short term included in cash equivalent
o Highly liquid  Investments not for trading
o Matures three (3) months from date of
Financing Activities (Cash effects on nontrade liabilities &
acquisition
equity)
 Does not include equity securities
 Cash flows derived from the equity capital and
o Equity securities do not have a maturity date
borrowings of the entity
 Includes bank overdrafts
 Cash flows that result from the ff. transactions:
o Equity financing—entity x owners
Classification of Cash Flows
o Debt financing—entity x creditors
 Operating activities
 Investing activities
Operating Investing Financing
 Financing activities + Sale of goods Sale of PPE Issuance of shares or
other equity
Royalties Sale of intangibles instruments—
ordinary and
Rentals Sale of long-term preference shares
 assets o Conversion of bonds payable to share capital
Fees Issuance of
Repayment of adv. debentures o Conversion of PS to OS
Commissions And loans made to
other parties Issuance of loans
Other revenue Interest
Derivative receipts: Issuance of notes  In general, operating activities (especially for
Other insurance Future contract
policy benefits Forward contract Issuance of bonds financial institutions) because it enters into the
Option contract determination of net income/loss
Receipt of interest Swap contract Issuance of
mortgages  Alternatively:
Receipt of dividends o Financing—cost of obtaining financial
Short/long term
borrowings resources
Purchased G&S Acquired PPE Acquisition or o Investing—return on investment
redemption of issued
Selling exp. Acquired intangibles shares  Disclosed separately whether it has been recognized
in P/L or capitalized
Admin. exp. Acquired long-term Payment for treasury
assets shares
Other expenses Dividends
Acquired equity or Payment for Dividend received
Insurance premiums debt instruments of amounts borrowed
other entities and  Operating activities because it enters into the
Insurance annuities interests in joint Payment by a lessee determination of net income/loss
venture for the reduction of
Settlement of the outstanding  Alternatively:
-
obligations Cash advances and principal lease o Investing—return on investment
loans to other parties liability
Payment of trade AR (other than CA and
loans made by FI) Payment of Dividend paid
Payment of trade NR dividends
Derivative  Financing activity because it is a cost of obtaining
Payment of income payments: financial resources
tax payable Future contract
Forward contract  Alternatively:
Payment of accrued Option contract o Operating—to determine
expenses Swap contract

Payment of interest Income Taxes

Income taxes, unless
specifically  Operating activities
identified with  Separately disclosed as cash flows from operating
financing and
investing activities activities
 Classified as OA since most of the time, all tax cash
For securities held
o
for trading
flows are often difficult to match to the originating
underlying transaction
Cash advances and
loans of a financial
institution whose
business is security
trading

Noncash transactions COMPUTATION

Operating Activities (the ff. methods are only for OA)
 Investing and financing transactions that do not
1. Direct method—default method
require use of CCE shall be excluded from the SCF
a. Shows in detail or itemizes the major classes
o Disclosed either in:
of gross cash receipts and gross cash
 Notes to FS
payments
 Separate schedule
b. “Cash basis” income statement
 Noncash transactions
o Acquisition of asset by assuming directly
Receipts xxx
related liability
Payments (xxx)
o Acquisition of asset by means of issuing
Cash generated from operations xxx
share capital Interest paid (xxx)
 Income tax paid (xxx) Depreciation xxx
Net cash provided by OA xxx Amortization xxx
Other noncash expenses/loss xxx
Cash payments/receipts are computed via the usual Gain on disposal of property (xxx)
T-account. Considers noncash P/L items—such as Gain on early retirement of
depreciation and amortization. nontrade liabilities (xxx)
Loss on disposal of property xxx
2. Indirect method Loss on early retirement of
a. Net income or loss is adjusted for the effects nontrade liabilities xxx
of transactions of a noncash nature Other noncash income/gain xxx
b. Begins with accrual basis net income and Net cash provided by OA xxx
applies a series of adjustments to convert the
income to a cash basis No need to compute for cash receipts/payments.
Simply use the increases and decreases but with
Net income xxx consideration of additional information.
Increases in trade noncash CA (xxx)
Decreases in trade noncash CA xxx Expenses, if silent, are paid by cash. Except
Increases in trade CL xxx depreciation and amortization—obviously noncash.
Decreases in trade CL (xxx) —
ACADSFEST REVIEW o The uncertainty over whether a counterparty
CHAPTER 12 (IA3): Derivatives (Interest rate swap) or the party on the other side of the contract
Purpose of Derivatives will honor the terms of the contract
 Derivative financial instruments are used to manage o This risk is against the possibility of
financial risk nonpayment of loans
 Financial risk may originate from the following  Interest rate risk
sources: o The uncertainty about future interest rates
o Change in commodity price and their impact on cash flows and the fair
o Change in cash flows value of the financial instruments
o Foreign currency exposure  Foreign currency risk
 The reduction of financial loss stemming from the o The uncertainty about future PH peso cash
financial risk is the motivating factor in trading in flows stemming from assets and liabilities
derivatives denominated in foreign currency
 Derivative financial instruments create rights and o The peso equivalent of the foreign currency
obligations that have the effect of transferring loan on the date of maturity will differ from
between the parties to the instrument the financial the peso equivalent of the foreign currency
risks inherent in an underlying primary financial loan when it was obtained
instruments
Definition of Derivative
Types of Financial Risk  A financial instrument that derives its value from the
 Price risk movement in commodity price, foreign exchange
o The uncertainty about the future price of an rate, and interest rate of an underlying asset or
asset financial instrument
o Entities are exposed to a price risk with  An executory contract
respect to: o Not a transaction but an exchange of
 Existing assets such as investments promises about future action
in trading securities  On inception, derivative financial instruments give
 Assets to be acquired in the future one party a contractual right to exchange financial
such as purchase commitments asset or financial liability with another party under
 Equipment to be imported at a conditions that are potentially favorable
future date  On the other hand, the other party has a contractual
 Credit risk obligation to exchange under potentially unfavorable
condition
  Expressed in the simplest terms, parties to the
derivative financial instrument are “taking bets” on Measurement of Derivatives
what will happen to the underlying financial  Recognized and measured as either asset or liability
instrument in the future at fair value
 Both FV and notional shall be fully disclosed
Characteristics of a Derivative  Unrealized gain or loss—recognized when there is
Three characteristics: change in FV
1. Its value changes in response to the change in an  Recognition of change in FV in P/L or OCI depends
underlying variable on whether the derivative is:
a. Underlying—a specified interest rate, o Not designated as a hedging instrument
commodity price, foreign exchange rate,  Derivative can be thought of as a
price index, and other variable speculation
b. Although not mentioned specifically, a o Designated as a cash flow hedge
derivative must contain a notional which  Measured at FV
could be an amount of currency, number of  A derivative that offsets in whole
shares, or number of units of volume or in part the variability in cash
2. Requires either no initial net invest or an initial small flows from a probable forecast
net investment transaction
a. In other words, there is no payment or there  Probable forecast transaction—an
is only a small payment for the derivative on uncommitted but anticipated future
the date of contract transaction
3. Readily settled at a future date by a net cash payment o Designated as a FV hedge
 Measured at FV
Hedging  A derivative that offsets in whole
 Hedging—designating one or more hedging or in part the change in the FV of
instruments so that the change in FV or cash flows is an asset or a liability
an offset, in whole or in part, to the change in FV or
CF of a hedged item
 Simply, hedging is a means of protecting a financial No hedging designation P/L
loss or the structuring of a transaction to reduce risk OCI—effective portion
Cash flow hedge
 Derivatives are often used for hedging P/L—ineffective portion
 Three types of hedging relationship Fair value hedge P/L
o FV hedge
o Cash flow hedge (only type to be discussed Examples of Derivatives
in this chapter)  Derivatives that are often designated as hedging
o Hedge of a net investment in a foreign instruments:
operation o Interest rate swap
 Two components of a hedge or hedging relationship o Forward contract
o Hedging instrument o Futures contract
o Hedged item o Option
 These derivatives are financial instruments separate
Hedging Instrument from the primary financial instruments—
 The derivative whose FV or cash flows would be STANDALONE DERIVATIVES
expected to offset changes in the FV or cash flows of  In fact, these derivative financial instruments would
the hedged item not exist in their own right but have been created
solely to hedge against financial risks created by
Hedged Item other primary financial instruments or by transactions
 An asset, liability, firm commitment, highly probable that have yet to occur but are anticipated
forecast transaction or net investment in a foreign
operation Interest Rate Swap
 Designated as a hedged item only when it exposes the
entity to risk of changes in FV or future CF
  A contract where two parties agree to exchange cash
Variable rate (for year of variation) 12%
flows for future interest payments based on a contract Underlying interest rate (10%)
of loan Variable rate more than underlying rate 2%
 Designation
Contract of loan
Primary Financial Instrument Net cash settlement—receipt (5,000,000 x 2%) 100,000
(creditor-debtor)
Derivative Financial Instrument
Interest rate swap
(debtor-speculator)
Second bank pays 100 000 to Easy Company at settlement.
 Usually designated as a cash flow hedge against a
variable interest rate which may be increasing over
Interest Payments to First Bank
the term of the loan. Ex. Dec. 31, 2020 Dec. 31, 2021
o Receive variable, pay fixed interest rate (10%) (12%)
Variable interest paid to
swap agreement with a Second Bank First Bank
500,000 600,000
 The fixed rate is the underlying interest rate Net cash settlement with
- (100,000)
First Bank—receipt
Net interest expense 500,000 500,000

The entity incurs a uniform or fixed interest of 500,000 on a

variable-rate loan.

Illustration #1—Interest Rate Swap (VIRs not lower than Journal Entries
UIR) 2020
Terms Jan. 1 Cash 5 000 000 [@principal]
 10% underlying interest rate Loan payable 5 000 000
 5,000,000 notional amount
 Actual interest rates on loan: Dec. 31 Interest expense 500 000 [@principal x VIR]
o Jan. 1, 2020—10% Cash 500 000
o Jan. 1, 2021—12%
 Derivative FI term
o Receive variable if interest rate is > 10% Dec. 31 IRS receivable 89 300 [@FV x PV of 1]
o Pay fixed if interest rate < 10% Unrealized gain—IRS 89 300

Computation of Net Cash Settlement  FV is the PV of 100,000 to be received in 2021

 PV of 1 for one period since it is still one year from
(The difference between variable interest to be
12/31/20 that such amount will be received
received and fixed interest to be paid)
 PV of 1 for 12% at n=1
 The unrealized gain on the interest rate swap is part of
Interest Rate Swap with Second Bank OCI since it is designated as a cash flow hedge
Dec. 31, 2020 Dec, 31, 2021  Such unrealized gain is recognized P/L in the period
(10%) (12%)
that such cash flow occurs
Receive variable 500,000 600,000
Pay 10% fixed (500,000) (500,000)
Net cash settlement—receipt - 100,000 2021
Dec. 31 Interest expense 600 000 [@principal x VIR]
Cash 600 000
Another Computation
Dec. 31 Cash 100 000 [@net settlement]
IRS receivable 89 300 Interest Payments to First Bank
Dec. 31, 2020 Dec. 31, 2021
UG-IRS 10 700 [@ bal. fig.] (10%) (7%)
Variable interest paid to
 Unrealized gain of 10 700 represents the increase in the 500,000 350,000
First Bank
FV of the IRS receivable due to passage of time. From Net cash settlement with
- 150,000
89 300 to 100 000. First Bank—receipt
Net interest expense 500,000 500,000

Dec. 31 Loan payable 5 000 000 [@principal]

The entity incurs a uniform or fixed interest of 500,000 on a
Cash 5 000 000
variable-rate loan.

Dec. 31 UG-IRS 100 000 [@ net settlement]

Interest expense 100 000

 Because of the hedging effect, the net interest expense

for 2021 if 500 000.
 The UG-IRS is all cancelled out.

Illustration #2—Interest Rate Swap

Journal Entries
(VIR for Year 2 is lower than UIR)
2020
Terms
Jan. 1 Cash 5 000 000 [@principal]
 10% underlying interest rate
Loan payable 5 000 000
 5,000,000 notional amount
 Actual interest rates on loan:
Dec. 31 Interest expense 500 000 [@principal x VIR]
o Jan. 1, 2020—10% Cash 500 000
o Jan. 1, 2021—7%
 Derivative FI term
o Receive variable if interest rate is > 10% Dec. 31 Unrealized loss-IRS 140 250 [@FV x PV of 1]
o Pay fixed if interest rate < 10% IRS payable 140 250

 FV is the PV of 150,000 to be paid in 2021

Computation of Net Cash Settlement
(The difference between variable interest to be
received and fixed interest to be paid)
Variable rate (for year of variation)
Underlying interest rate
Variable rate less than underlying rate
 PV of 1 for one period since it is still one year from
12/31/20 that such amount will be received
 PV of 1 for 7% at n=1
 The unrealized loss on the interest rate swap is part of
7% OCI since it is designated as a cash flow hedge
(10%)  Such unrealized loss is recognized P/L in the period that
( 3%) such cash flow occurs

Net cash settlement—payment (5,000,000 x -3%) (150,000) 2021

Dec. 31 Interest expense 350 000 [@principal x VIR]
Cash 350 000
Easy Company pays 150 000 to Second Bank at settlement.
Dec. 31 IRS payable 140 250
UL-IRS 9 750 [@ bal. fig.] Jan. 1, 2021 (11%)
Cash 150 000 [@sttlmnt.] Variable rate (for year of variation) 11%
Underlying interest rate (10%)
 Unrealized loss of 9 750 represents the increase in the
Variable rate more than underlying rate 1%
FV of the IRS payable due to passage of time. From
140 250 to 150 000.
Net cash settlement—receipt (5,000,000 x 1%) 50,000
The entity will receive 50 000 at the end of 2021, 2022, 2023,
Dec. 31 Loan payable 5 000 000 [@principal] and 2024. Accrued at PV on Dec. 31, 2020.
Cash 5 000 000
Jan. 1, 2022 (8%)
Dec. 31 Interest expense 150 000 [@ net settlement] Variable rate (for year of variation) 8%
UL-IRS 150 000 Underlying interest rate (10%)
Variable rate less than underlying rate ( 2%)
 Because of the hedging effect, the net interest expense
for 2021 if 500 000. Net cash settlement—payment (5,000,000 x -2%) (100,000)
 The UG-IRS is all cancelled out. The entity will pay 100 000 at the end of 2022, 2023, and 2024.
Accrued at PV on Dec. 31, 2021.

Jan. 1, 2023 (6%)

Variable rate (for year of variation) 6%
Underlying interest rate (10%)
Variable rate less than underlying rate ( 4%)

Net cash settlement—receipt (5,000,000 x -4%) (200,000)

The entity will pay 200 000 at the end of 2023 and 2024.
Accrued at PV on Dec. 31, 2022.

Jan. 1, 2024 (7%)

Variable rate (for year of variation) 7%
Illustration 3—Interest Rate Swap Underlying interest rate (10%)
Variable rate less than underlying rate ( 3%)
Terms
 10% underlying interest rate
Net cash settlement—receipt (5,000,000 x -3%) (150,000)
 5,000,000 notional amount The entity will pay 150 000 at the end of 2024.
 Actual interest rates on loan: Accrued at PV on Dec. 31, 2023.
o Jan. 1, 2020—10%
o Jan. 1, 2021—11%
Journal Entries
o Jan. 1, 2022—8% 2020
o Jan. 1, 2023—6% Jan. 1 Cash 5 000 000 [@principal]
o Jan. 1, 2024—7% Loan payable 5 000 000

Computation of Net Cash Settlement Dec. 31 Interest expense (10%) 500 000 [@principal x VIR]
(The difference between variable interest to be Cash 500 000
received and fixed interest to be paid)

Dec. 31 IRS Receivable (11%) 155 000 [@FV x PV of OA of

1]
UG-IRS 155 000

 FV is the PV of 50,000 to be received in 2021, 2022,

2023, and 2024
 PV of OA 1 for four periods since the entity will
receive such amount every year for 4 years.
 PV of OA 1 for 11% at n=4
 The unrealized gain on the interest rate swap is part of
OCI since it is designated as a cash flow hedge
  Such unrealized gain is recognized P/L in the period Dec. 31 Interest expense (6%) 300 000 [@principal x VIR]
that such cash flow occurs
Cash 300 000
2021
Dec. 31 IRS Payable (6%) 200 000 [@receipt
Dec. 31 Interest expense (11%) 550 000 [@principal x VIR]
from 8%]
Cash 550 000 Cash 2080000

Dec. 31 Cash (11%) 50 000 [@receipt from 11%] Dec. 31 Interest expense (6%) 200 000[@receipt from 8%]
IRS Receivable 50 000
UL-IRS 200 000

Dec. 31 UG-IRS (11%) 50 000 [@receipt from 11%]

Dec. 31 IRS Payable (7%) 26 500 [@adj. to
Interest expense 50 000 UL]
UL-IRS 26500
Dec. 31 UG-IRS (11%) 105 000 [@rem. 11% balance]
IRS Receivable 105 000  The interest swap receivable and related unrealized gain
is not cancelled because the interest rate is still below
 Cancellation of the balance of the interest swap the underlying interest rate.
receivable and related unrealized gain because of the  Computed FV x PV of OA of 1 is already the UL req.
reduced interest rate on Jan. 1, 2022 for the year. Only the adj. of the current bal. is
recorded
Dec. 31 UL-IRS (8%) 258 000 @[FV x PV of OA of
1] 2024
IRS Payable 258 000 Dec. 31 Interest expense (7%) 350 000 [@principal x VIR]
Cash 350 000
2022
Dec. 31 Interest expense (8%) 400 000 [@principal x VIR] Dec. 31 IRS Payable (7%) 139 500
Cash 400 000 UL-IRS 10 500
Cash 150 000
Dec. 31 IRS Payable (8%) 100 000 [@receipt
from 8%]  UL-IRS and IRS Payable are completely closed at
Cash 100 000 period of settlement.

Dec. 31 Interest expense (8%) 100 000 [@receipt from 8%] Dec. 31 Interest expense 150 000
UL-IRS 100 000 UL-IRS 150 000

Dec. 31 UL-IRS (6%) 208 000 [@adj. to UL] Dec. 31 Loan payable 5 000 000
IRS Payable 208 000 Cash 5 000 000

 The interest swap receivable and related unrealized gain

is not cancelled because the interest rate is still below Remember:
the underlying interest rate.
 Accrued at Dec. 31 of previous year
 Computed FV x PV of OA of 1 is already the UL req.
for the year. Only the adj. of the current bal. is  Given in the problem at Jan. 1 of the year
recorded  Settled at Dec. 31 of the year
2023
ACADSFEST REVIEW  The objective is to assure that the buyer who entered
CHAPTER 13 (IA3): Derivatives (Interest rate swap) into a purchase commitment shall pay only the
Forward Contract underlying prevailing market price on the specified
 An agreement between two parties to exchange a date in the future
specified amount of commodity, security, or foreign  Designation
currency on a specified date in the future at a The highly
Primary Financial Instrument
probable forecast
specified price or exchange rate (seller-buyer)
purchase
 Simply stated, a forward contract is a commitment to Forward contract
Derivative Financial Instrument
(buyer-speculator)
purchase or sell a specified commodity on a future
date at a specified price
 Buyer-speculator
 Journal Entries
2020
Dec. 31 FCR 1 000 000 [@FCR]
UG-FC 1 000 000

2021
Jan. 31 FCR 250 000 [@increase in FCR]
UG-FC 250 000

Jan. 31 Cash 1 250 000 [@FCR bal.]

FCR 1 250 000

Jan. 31 Purchases (50 000 x 175) 8 750 000

Cash 8 750 000

Jan. 31 UG—FCR 1 250 000

Purchases 1 250 000

 Unrealized gain can be credited to gain on forward

contract which is an offset against the cost of goods of
sold.
Futures Contract
 A contract to purchase or sell a specified commodity
at some future date at a specified price
 Same definition with a forward contract
 Difference from a forward contract:
Illustration #1—Forward Contract
o A futures contract is traded in a futures
(for a purchase commitment)
exchange market in much the same manner
Terms
as debt and equity securities being traded in
 50 000 kilos of tobacco
the stock market
 Prices
o A forward contract is a private contract
o 150—underlying market price
between two parties who know each other
o 170—Dec. 31, 2020 market price
very well
o 175—Jan. 31, 2021
 A standard contract traded in a futures exchange
 Dates market and one party will never know who is on the
o Jan. 1, 2020—decision to purchase other side of the contract
o Jan. 31, 2021—specified purchase date  All cash settlements are made through the exchange
market

Market price—Dec. 31, 2020 (50 000 x 170) 8 500 000

Underlying price (50 000 x 150) (7 500 000)
Forward contract receivable—Dec. 31, 2020 1 000 000

Market price—Jan. 31, 2020 (50 000 x 175) 8 750 000

Underlying price (7 500 000)
Forward contract receivable—Jan. 31, 2020 1 250 000

Current FCR 1 250 000

Previous FCR (1 000 000)
Increase in FCR 250 000

This means that the entity shall receive from the bank a total of
1 250 000 on Jan. 31, 2021.
 Jan. 31 UG-FC 400 000 [@decrease in FCR]
FCR 400 000

Jan. 31 Cash 100 000 [@FCR bal.]

FCR 100 000

Jan. 31 Purchases (50 000 x 52) 2 600 000

Cash 2 600 000

Jan. 31 UG—FCR 100 000

Purchases 100 000

 Unrealized gain can be credited to gain on forward

contract which is an offset against the cost of goods of
sold.

Option
Illustration #2—Futures Contract
 A contract that gives the holder the right (not
(for a purchase commitment)
obligation) to purchase or sell an asset at a specified
Terms
price during a definite period at some future time
 50 000 kilos of apple juice
 A right, not an obligation to purchase or sell
 Prices
 Two types of option
o 50—underlying market price
o Call option—on the part of the buyer
o 60—Dec. 31, 2020 market price
o Put option—on the part of the seller
o 52—Feb. 1, 2021
 Call option
 Dates o Gives the holder the right to purchase an
o Dec. 1, 2020—decision to purchase
asset
o Feb. 1, 2021—specified purchase date
 Put option
o Gives the holder the right to sell an asset
Market price—Dec. 31, 2020 (50 000 x 60) 3 000 000  Unlike an interest rate swap, forward contract and
Underlying price (50 000 x 50) (2 500 000) future contracts, an option must be paid for.
Forward contract receivable—Dec. 31, 2020 500 000  This is a derivative that requires an initial small
payment for the protection against unfavorable
Market price—Feb. 1, 2020 (50 000 x 52) 2 600 000 movement in price
Underlying price (2 500 000)  The payment is commonly known as the “option
Forward contract receivable—Jan. 31, 2020 100 000
premium”
Current FCR 100 000
 Designation
The highly
Previous FCR ( 500 000) Primary Financial Instrument
probable forecast
Decrease in FCR ( 400 000) (seller-buyer)
purchase
Call option Derivative Financial Instrument
This means that the entity shall receive from the bank a total of contract (buyer-speculator)
100 000 on Feb. 1, 2021.
 The underlying is also known as the strike or exercise
price
Journal Entries  “In the money”
2020 o If the market price is greater than the strike
Dec. 31 FCR 500 000 [@FCR] or exercise price
UG-FC 500 000  “Out of the money”
o If the market price is lower than the strike or
2021 exercise price
  The call option is classified as current asset. Cash 5 500 000
 The call option is not exercised if the market price is
lower than the strike price. Jul. 1 UG-CO 450 000
 Remember that a call option is a right and not an Purchases 450 000
obligation to buy the raw material
 Unlike future and forward contracts, no liability is
recognized if the call option is out of the money.
(UL-FCR, forward/future contracts payable)

Illustration #2—Call option

Illustration #1—Call option (With final market price lower than the call option price)
(No market price lower than the call option price) Terms
Terms  100 000 units of raw material
 100 000 units of raw material  P50 000—option premium
 P50 000—option premium  Prices
 Prices o 50—underlying market price
o 50—underlying market price o 52—Dec. 31, 2020 market price
o 52—Dec. 31, 2020 market price o 45—Jul. 1, 2021
o 55—Jul. 1, 2021  Dates
 Dates o Dec. 1, 2020—decision to purchase
o Dec. 1, 2020—decision to purchase o Middle of 2021—specified purchase date
o Middle of 2021—specified purchase date
Journal Entries
Journal Entries 2020
2020 Dec. 1 Call option 50 000 [@option premium]
Dec. 1 Call option 50 000 [@option premium] Cash 50 000
Cash 50 000
Dec. 31 Call option 150 000 [@increase in FV]
Dec. 31 Call option 150 000 [@increase in FV] UG-CO 150 000
UG-CO 150 000
 FV of call option (100 000 x 2) 200 000
Payment for CO (50 000)
 FV of call option (100 000 x 2) 200 000
Increase in FV 150 000
Payment for CO (50 000)
 UG-CO (CF hedge)—recognized as component of OCI
Increase in FV 150 000
 UG-CO (CF hedge)—recognized as component of OCI
2021
2021 Jul. 1 Purchases 4 500 000
Jul. 1 Call option 300 000 [@increase in FV] Cash 4 500 000
UG-CO 300 000
Jul. 1 Loss on call option 50 000
 Increase from 200 000 to 500 000. UG-CO 150 000
Call option 200 000
Jul. 1 Cash 500 000 [@call option bal.]
Call option 500 000

Jul. 1 Purchases 5 500 000

 Embedde
Payment of interest or principal based
d
on the price of gold or silver
derivative

Embedded derivative accounted for separately

 Bifurcation—the process of separating an embedded
derivative from the host contract
 An embedded derivative shall be accounted for
separately if the following conditions are met:
o A separate instrument with the same terms
as the embedded feature would meet the
definition of a derivative
o The combined contract is measured at FVPL
 If measured at such, there is no
need to separate the embedded
feature since the combined contract
is already accounted for similar to a
Embedded Derivative
derivative
 A component of a hybrid or combined contract with o The economic characteristics and risks of
the effect that some of the cash flows of the
the embedded feature are not closely related
combined contract vary in a way similar to a stand-
to the economic characteristics and risks of
alone derivative
the host contract
 This means that there is a basic contract known as the  Simply stated, the embedded
“host contract” that has an embedded derivative derivative and the host contract do
 Separate, stand-alone contracts (not embedded) not have the same economic
o Interest rate swap characteristics
o Forward contract o The host contract is outside the scope of
o Futures contract PFRS 9 (Financial Instruments)
o Options  If separated, the ff. will be measured at:
 An embedded derivative is combined with the host o Embedded derivative—FV
contract to form one combined contract o Host contract—in accordance with
appropriate PFRS
Examples of Embedded Derivative  There is no explicit statement in the standard on
 Equity conversion option whether an embedded derivative shall be presented
o In a convertible bond instrument that allows separately in the statement of financial position.
holders to convert the bond into shares of
the issuer Host Contract within Scope of PFRS 9
Host Convertible bond instrument  If the host contract is within the scope of PFRS 9, the
Embedde
d Equity conversion feature classification requirements of PFRS 9 are applied to
derivative the combined contract in its entirety
 Simply stated, if the host contract is a financial asset,
 Redemption option
the embedded derivative is not separated.
o In an investment, in redeemable preference
share that allows the issuer to repurchase the
preference share
Investment in redeemable preference
Host
share
Embedde
d Redemption option feature
derivative

 An investment in bond whose interest or principal

payment is linked to the price of gold or silver
o A commodity derivative
Host Investment in bond