Chapter 14: Cash and Accrual Basis

CHAPTER 14: CASH AND ACCRUAL BASIS
Methods of accounting
Cash basis
Income is recognized when received regardless of when earned, and expense is recognized when
paid regardless of when incurred. In other words, this approach does not recognize accounts
receivable, accounts payable, accrued income, deferred income, accrued expense and prepaid
expense.
Accrual basis
Income is recognized when earned regardless of when received, and expense is recognized when
incurred regardless of when paid.
Thus, the essence of this approach is the recognition of accounts receivable, accounts payable,
accrued income, deferred income, accrued expense and prepaid expense.
Cash basis versus accrual basis
ITEM CASH BASIS ACCRUAL BASIS

Sales Cash sales plus collections Cash sales plus sales on
from customers account.
Purchases Cash purchases plus Cash purchases plus
payments to trade creditors. purchases on account.
Income other than sales Items received are considered Items earned are considered
as income regardless of when as income regardless of when
earned. received.
Expense, in general Items paid are treated as Items incurred are treated
expenses regardless of when regardless of when paid
expenses incurred.
Depreciation Depreciation is provided Depreciation is provided
normally. normally.
Bad Debts No bad debts are recorded Doubtful accounts are treated
because trades receivables are as bad debts.
not recognized.
Accounting problem
More often than not, accounting records are maintained on a cash basis.
At the end of the accounting period, adjustments are made for accruals and prepayments in order
to convert the records to accrual records.
To achieve the conversion from cash basis to accrual basis accounting, the following formulas
may be of help.
Normally, the data concerning the cash sales and the collections from customers are given. So,
the main problem in the formula is the computation of sales on account.
The substance of the formula is the reconstruction of the accounts and notes receivable because
the total accounts and notes receivable would represent the total sales on account. Thus, the
approach is to add back all items that decreased trade receivables to the ending balance of
accounts receivable and notes receivable.
The beginning balances of accounts receivable and notes receivable are deducted because these
items pertain to the preceding year and constitute sales of the prior year and that they might have
been collected during the current year or some may be the subject of returns, allowances and
discounts.
Normally, the data pertaining to cash purchases and payments of trade payables are given.
So the main problem is the computation of purchases on account.
The substance of the formula is the reconstruction of the accounts and notes payable because the
total accounts and notes payable would represent the total purchases on account.
Thus, the approach is to add back all items that decreased trade payables to the ending balance
of accounts payable and notes payable.
The items that decreased trade payables normally include:

a. Payment of accounts payable
b. Payment of trade notes payable
c. Purchase returns
d. Purchase allowances
e. Purchase discounts
The beginning balances of accounts and notes payable are deducted because these items pertain
to the preceding year and constitute purchases of the preceding year.
The beginning balances of accounts and notes payable might have been paid during the current
year or some may be the subject of discounts, returns and allowances.
Note that the formula involves deferred income and accrued income.
DEFERRED INCOME (pg 382)
Deferred income or unearned income or precollected income is income already received but not
yet earned.
Thus, deferred income is a liability account.
Examples are unearned rental income and unearned interest income.
The deferred income — beginning is added because this is received in the preceding year and
earned in the current year.
The deferred income — ending is deducted because this is received in advance in the current
year and to be earned only in the next year.
Accrued income
Accrued income is income already earned but not yet received. It is a receivable and therefore
an asset.
Examples are accrued interest receivable, accrued rental receivable or accrued royalties
receivable.
Accrued income — beginning is deducted because this is already recognized as income in the
preceding year although it is received only in the current year.
Accrued income — ending is added because this is already earned in the current year although
not yet received. It is to be received next year.
Note that the formula involves prepaid expenses and accrued expenses.
Prepaid expenses
Prepaid expenses are expenses paid in advance but not yet incurred and therefore are assets.
Examples are prepaid insurance, prepaid taxes, prepaid rent, prepaid interest and prepaid salaries.
Prepaid expense — beginning is added because this is paid in the preceding year and only
expensed in the current year.
Prepaid expense — ending is deducted because this is paid in the current year and to be expensed
next year.
Accrued expenses
Accrued expenses are expenses already incurred but not yet paid. These are liabilities.
Examples are accrued salaries payable, accrued interest payable and accrued rental payable.
Accrued expense — beginning is deducted because this is incurred in the preceding year
although only paid in the current year.
Accrued expense — ending is added because this is incurred in the current year and to be paid
next year.
Problem 14-32 Multiple choice (IAA)
1. Under accrual basis of accounting, cash receipts and disbursements may
a. Precede, coincide with, or follow the period in which revenue and expenses are
recognized.
b. Precede or coincide with but never follow the period in which revenue and expenses
are recognized.
c. Coincide with or follow but never precede the period in which revenue and expenses
are recognized.
d. Only coincide with the period in which revenue and expenses are recognized.
2. Which statement regarding accrual basis versus cash basis of accounting is true?
a. The cash basis is appropriate for smaller entities.

b. The cash basis is less useful in predicting the timing and amount of future cash
flows of an entity.
c. Application of the cash basis results in an income statement reporting. revenue and
expenses.
d. The cash basis requires a complete set of double entry records.
3. Under cash basis of accounting
a. Revenue is recorded when earned.

b. Accounts receivable would be recorded.
c. Depreciation is not recognized.
d. The matching principle is ignored.
4. Under the cash basis of accounting, revenue is recorded
a. When earned and realized

b. When earned and realizable
c. When earned
d. When realized
5. Total net income over the life of an entity is
a. Higher under the cash basis than under the accrual basis
b. Lower under the cash basis than under the accrual basis
c. The same under the cash basis as under the accrual basis
d. Not susceptible to measurement
6. Under International Financial Reporting Standards
a. The cash basis of accounting is accepted.

b. Events are recorded in the period the events occur.
c. Net income is lower under the cash basis than accrual basis.
d. All of the choices are correct.
7. Accrual accounting adheres to which of the following?
a. Matching principle
b. Historical cost principle
c. Matching principle and historical cost principle
d. Neither matching principle nor historical cost
8. Under accrual accounting, which of the following does not describe a deferral?
a. Deferral of revenue occurs when cash is received and recognized in financial

income.
b. Deferral typically results in the recognition of a liability or prepaid expense.
c. Cash collected in advance of services being rendered.
d. Cash paid up front for a one-year insurance policy.
9. Under accrual basis, a deferral is a transaction that impacts
a. Cash and the income statement at the same time

b. The income statement before impacting cash
c. Cash before impacting the income statement
d. The statement of financial position before impacting cash
10. Which statement is true about accrual and cash basis?
a. Under accrual, if the earning process is not complete, revenue is nevertheless recorded.
b. Under cash basis, if cash has been collected, revenue is recorded regardless of
earning process.
c. Under cash basis, revenue is recognized when the receivable is initially recorded.
d. All of these statements are true.
Problem 14-33 Multiple choice (AICPA Adapted)
1. The premium on a three-year insurance policy expiring on December 31, 2022 was paid
in total on January 1, 2020. If the entity has six-month operating cycle, then on December
31, 2020, the prepaid insurance reported as a current asset would be for
a. 6 months
b. 12 months
c. 18 months
d. 24 months
in total on January 1, 2020. The original payment was initially debited to a prepaid asset
account. The appropriate adjusting entry had been recorded on December 31, 2020. The
balance in the prepaid asset account on December 31, 2020 should be
a. Zero %
b. The same as it would have been if the original payment had been debited
initially to an expense account
c. The same as the original payment
d. Higher than if the original payment had been debited initially to an expense account
in total on January 1, 2020. If the original payment was recorded as a prepaid asset, how
would total assets and shareholders’ equity be affected during 2020?
a. Total assets would decrease and shareholders’ equity would increase

b. Both total assets and shareholders’ equity would decrease
c. Both total assets and shareholders’ equity would increase
d. Neither total assets nor shareholders’ equity would change
4. The premium on a four-year insurance policy expiring on December 31, 2023 was paid in
total on January 1, 2020. If the original payment was recorded as a prepaid asset, the
balance in prepaid asset on December 31, 2021 would be
a. Lower than the balance on December 31, 2020

b. Lower than the balance on December 31, 2022
c. The same as the balance on December 31, 2022
d. The same as the original payment
5. At the beginning of the current year, an entity signed a 5-year contract enabling it to use a
patented manufacturing process beginning in the current year. A royalty is payable for
each product produced, subject to a minimum annual fee. Any royalties in excess of the
minimum will be paid annually. On the contract date, the entity prepaid a sum equal to
two years’ minimum annual fees. In the current year, only minimum fees were incurred.
The royalty prepayment shall be reported in the current year-end financial statement as
a. An expense only
b. A current asset and an expense
c. A current asset and noncurrent asset
d. A noncurrent asset
CHAPTER 15: SINGLE ENTRY
Characteristics of single entry
The very heart of the accounting process is the analysis of the dual effect of each transaction on
the basic accounting model “Assets = Liabilities + Capital”.
All transactions are normally analyzed and recorded in terms of debits and credits.
This system is called the double entry system of bookkeeping.

A system of record keeping in which transactions are not analyzed and recorded in the double
entry framework is called a single-entry system.
Where the records are incomplete, they are said to be maintained on a single-entry basis.
Under the single-entry system, the records maintained are. represented only by the so-called
“bare essentials”.
Normally, the records include a record of cash, accounts receivable, accounts payable, property,
plant and equipment, and taxes paid.
The major record under the single-entry system is the cashbook.
The cashbook is maintained showing all receipts and disbursements.
And because in a single entry no specific accounts for the receipts and disbursements are debited
or credited, only a description thereof is made.
With respect to accounts receivable and accounts payable, only a list of customers and creditors
is made with their corresponding balances.
Single entry method
The computation procedure followed in determining net income or loss is simply to compare the
capital or retained earnings at the beginning of the year and capital or retained earnings at the
end of the same year after taking into consideration withdrawals. or dividends and additional]
investments.
The difference is either net income or net loss. Any increase in capital or retained earnings is net
income and any decrease in capital or retained earnings is net loss.
The single-entry method of determining net income or loss vs also known as “net assets
approach” or “capital maintenance approach”.
Thus, the procedure is to determine the effect of the changes in assets and liabilities on net assets
whether the change in the asset or liability increases or decreases the net assets.
Increases in assets and decreases in liabilities increase net assets while increases in liabilities
and decreases in assets decrease net assets.
The dividend paid is added back to net assets because it decreased net assets but not representing
profit or loss.
The increase in share capital and increase in share premium are deducted because they increased
net assets but not representing profit or loss.
Preparation of financial statements
The preparation of the income statement involves the computation of individual revenue and
expense balances by reference to the cash receipts and disbursements and the changes in assets
and liabilities.
The formulas used in converting cash basis to accrual basis of accounting are useful in this
case. These formulas involve the computation of:
a. Sales
b. Purchases
c. Income other than sales
d. Expenses in general
The preparation of the statement of financial position involves inventorying, counting and
verification procedures to determine the nature and amount of most of. the assets and liabilities.
For example, cash could be determined by count and by examining bank statements.
Accounts receivable and notes receivable could be summarized from unpaid sales invoices and
promissory notes.
Merchandise on hand, supplies and other inventories could be counted and their cost determined
from purchase invoices.
The cost of property, plant and equipment could be established by reference to deeds of sale and
other documents evidencing ownership of title.
Accounts payable and notes payable could be determined from purchase invoices, memoranda,
correspondence and even consultation with creditors.
Ownership equity or capital would be the difference between the value assigned to assets and
liabilities.
CHAPTER 16: ERROR CORRECTION

CHAPTER 16 ERROR CORRECTION
Errors can arise in respect of the recognition, measurement, presentation or disclosure of

elements of financial statements.
Potential current period errors discovered in that period are corrected before the financial
statements are authorized for use.
However, material errors are sometimes not discovered until a subsequent period, and these prior
period errors are corrected in the comparative information presented in the financial statements
for that subsequent period.
Prior period errors
Prior period errors are omissions and misstatements in the entity's financial statements for one or
more periods arising from a failure to use or misuse of reliable information that:
a. Was available when financial statements for these periods were authorized for issue.
b. Could reasonably be expected to have been obtained and taken into account in the preparation
and presentation of those financial statements.
Prior period errors include the effects of mathematical: mistakes, mistakes in applying
accounting policies, oversights or misinterpretation of facts, and fraud.
Treatment of prior period errors
An entity shall correct material prior period errors retrospectively in the first set of financial
statements authorized for issue after their discovery.
A prior period error shall be corrected by retrospective restatement, meaning, if comparative

statements are presented, the prior year statements. are restated to correct the error.
The correction of a prior period error is an adjustment of the beginning balance of retained
earnings of the earliest period presented.
Statement of financial position errors
Statement of financial position errors affect the statement of financial position or real accounts
only, meaning, the improper classification of an asset, liability and capital account.
In such a case, an entry is simply made to reclassify the account balances.
For example, if preference share capital is erroneously credited instead of ordinary share capital,
the reclassifying entry is debit preference share capital and credit ordinary share capital.
Income statement errors
Income statement errors affect the income statement or nominal accounts only, meaning, the
improper classification of revenue and expense accounts.
These errors have no effect on the statement of financial position and on net income.
Thus, a reclassifying entry is necessary only if the error is discovered in the same year it is
committed. Otherwise, if the error is discovered in a subsequent year, no reclassifying entry is
necessary because the nominal accounts for the current year are correctly stated.
For example, the entity erroneously debited purchases instead of office supplies during 2020.
If the error is discovered in 2020, the reclassifying entry is debit office supplies and credit
purchases.
If the error is discovered in 2021, no reclassifying entry is made.
The office supplies account and purchases account are already closed in 2020.
Combined statement of financial position and income statement errors
These errors affect both the statement of financial position and income statement because they
result in a misstatement of net income.
For example, if accrued salaries payable is overlooked, the effects are:
a. Salaries expense understated (income statement error).
b. Liability understated (statement of financial position error).
c. Net income overstated (income statement error).
d. Retained earnings overstated (statement of financial position error).
Combined statement of financial position and income statement errors are classified as
counterbalancing errors and noncounterbalancing errors.
Counterbalancing errors
Counterbalancing errors are errors which, if not detected, are automatically counterbalanced or
corrected in the next. accounting period.
In other words, these errors will be offset or corrected over two periods or these errors correct
themselves over two periods.
Effects of counterbalancing errors
a. The income statements for two successive periods are incorrect.

b. The statement of financial position at the end of the first period is incorrect.
c. The statement of financial position at the end of the second period is correct. :
Counterbalancing errors normally include the misstatement of the following:

a. Inventory, including purchases and sales
b. Prepaid expense.
c. Accrued expense
d. Deferred income
e. Accrued income
Overstatement of ending inventory
On December 31, 2019, the physical count was overstated by P50,000.
If the books for 2020 have not been closed, the entry on December 31, 2020 to correct the error
is:
Retained earnings 50,000

Inventory, January 1, 2020 50,000
The retained earnings account is debited because the net income of 2019 was overstated.
The inventory account is credited because the ending inventory on December 31, 2019 was
overstated.
If the books for 2020 have been closed, no entry is necessary because the error in 2019 is
counterbalanced in 2020.
In other words, the ending inventory in 2019 becomes the beginning inventory in 2020.
Thus, if the beginning inventory of 2020 is overstated, cost of goods sold would be overstated
with a consequent understatement of net income.
Understatement ending inventory
On December 31 2019, the physical count was understated by. P50,000.
If the books for 2020 have 1 not been closed, the entry to correct the error on December 31, 2020
is:

The inventory account is debited and the retained earnings account is credited because the ending
inventory of 2019 was understated with a consequent understatement of net income.
If the books for 2020 have been closed, no entry is necessary because the 2019 error is
Understatement of purchases
The entity failed to record a merchandise purchased in 2019, The same was recorded in 2020.
The physical inventory on December 31, 2019 was correctly stated.
If the books for 2020 have not been closed, the entry to correct the error on December 31, 2020
is:

Purchases 50,000
The retained earnings account is debited because net income of 2019 was overstated.
The purchases account is credited because the purchase pertains to 2019 and the same is
recorded in 2020, thus resulting to overstatement of 2020 purchases.
If the books for 2020 have been closed, no ‘entry is necessary because the 2019 error is
The purchases account in 2019 is understated while the purchases account in 2020 is overstated.
Thus, they equalize each other.
Overstatement of purchases and ending inventory

The entity recorded on December 31, 2019 P50,000 of purchases in transit to which the entity
had no title.
The same merchandise was included in the inventory of December 31, 2019.
If the books for 2020 have not been closed, the entries to correct the error on December 31, 2020
are:
1. Purchases 50,000
2. Retained earnings 50,000

In the first entry, the purchases account is debited because the purchase pertains to 2020 and was
erroneously recorded.in 2019.
The retained earnings account is credited because the net income of 2019 was understated by.
reason of overstated purchases.
In the second entry, the retained earnings account is debited and the inventory account is credited
because the ending inventory of 2019 was overstated resulting to overstatement of net income.
Actually, the net effect of the error is zero on net income and retained earnings.
The purchases account in 2019 is overstated and the purchases account in 2020 is understated.
The inventory on December 31, 2019 was overstated resulting to overstatement of net income.
The inventory on January 1, 2020 was also overstated and thus Overstating cost of goods sold
and understating net income.
Understatement of sales
The entity failed to record sales of F50, 000 in 2019. The same was recorded in 2020.
The physical inventory was correctly stated on December 31, 2019.

is:
Sales 50,000
The sales account is debited because the same pertains to 2019 and was recorded in 2020 thus
overstating 2020 sales.
The retained earnings account is credited because the 2019 net income was: understated.
The sales account of 2019 was understated and the sales account of 2020 was overstated.
Overstatement of sales Understatement of ending inventory
The entity recorded on December 31, 2019 P50,000 of sales in transit and to which the customer
had no title.
The cost of the merchandise was P30,000 and the same was excluded from the December 31,
2019 inventory. If the books for 2020 have not been closed, the entries to correct the error on
December 31, 2020 are:
1. Retained earnings 50,000

Sales 50,000
2. Inventory, January 1, 2020 30,000

In the first entry, the retained earnings account is debited because the 2019 net income was
overstated.
The sales account is credited because the sale pertains to 2020 and was erroneously recorded in
2019.
In the second entry, the inventory account is debited and the retained earnings account is credited
because the 2019 net income was understated by r reason of understatement of 2019 ending
inventory.
The sales account in 2019 was overstated and the sales account in 2020 was understated and thus
they counterbalance each other.
The understated ending inventory on December 31, 2019 becomes the beginning inventory in
2020.
Thus, they equalize the effect-on net-income.
Failure to record prepaid expense
On January 1, 2019, the entity purchased an insurance for two years for P50,000.
The payment was debited to an expense and no adjustment was made on December 31, 2019 for
the prepaid insurance.
is:
Insurance 25,000
The insurance account is debited because the prepaid insurance on December 31, 2019 becomes
an expense in 2020.
The retained earnings account is credited because the 2019 net income was understated.
If the books for 2020 have been closed, no entry is necessary because the error is
counterbalanced.
The net income of 2019 was understated by reason of overstatement of insurance expense while
the net income of 2020 was overstated by reason of understatement of insurance expense.
Failure to record accrued expense
On December 31, 2019, accrued rent expense of P50, 000 was not recorded.
is:

Rent expense 50,000
The retained earnings account is debited because the net income of 2019 was overstated.
The rent expense is credited because the accrual of 2019 necessarily was paid in 2020 and the
same was debited to rent expense, thus overstating the rent expense of 2020.
The net income of 2019 was overstated by reason of understatement of rent expense while the
2020 net income was understated by reason of overstatement of rent expense.
Failure to record a deferred income
On January 1, 2019, the entity received rent for two years in the amount of P50,000. The same
was credited to rent income and no adjustment was made on December 31, 2019.
is:

Rent income 25, 000
The retained earnings account is debited because the 2019 net income was overstated.
The rent income is credited because the unearned rent income on December 31, 2019 becomes
an income of 2020.
counterbalanced in 2020. The 2019 rent income was overstated while the 2020 rent income was
understated. Thus, they counterbalance each other.
Failure to record accrued income
On December 31, 2019, accrued interest receivable of P50,000 was not recorded. If the books for
2020 have not been closed, the entry to correct the error on December 31, 2020 is:
Interest income 50,000
The interest income is debited because the interest accrual of 2019 necessarily was received in
2020 and the same was credited to interest income, thus overstating the 2020 interest income.
The retained earnings account is credited because the 2019 income was understated.
The 2019 interest income was understated while the 2020 interest income was overstated. Thus,
they equalize each other.
Noncounterbalancing errors
Noncounterbalancing errors are errors which, if not detected, are not automatically
counterbalanced or corrected in the next accounting period.
In other words, if the net income of one year is understated or overstated, the net income of
subsequent year is not affected.
Effects of noncounterbalancing errors
1. The income statement of the period in which the error is committed is incorrect but the
succeeding income statement is not affected.
2. The statement of financial position of the year of error and succeeding statement of financial
position are incorrect until the error is corrected.
The best example of a noncounterbalancing error is the misstatement of depreciation.
1. If ending inventory is understated, the effect is to
a. Overstate the net purchases

b. Overstate the gross margin
c. Overstate the cost of goods available for sale
d. Overstate the cost of goods sold
2. If beginning inventory is overstated, the effect is to

a. Overstate net purchases
b. Overstate gross margin
c. Overstate cost of goods available for sale
d. Understate cost of goods sold
3. The overstatement of ending inventory in the current year will cause
a. Retained earnings to be understated in the current year-end statement of financial

position.
b. Cost of goods sold to be: understated in the income statement of next year.
c. Cost of goods sold to be overstated in the income statement of the current year.
d. Statement of financial position not to be misstated in the next year-end.
4. At the middle of the year, an entity paid for insurance premium for the current year and
debited the amount to prepaid insurance. At year-end, the bookkeeper forgot to record
the amount expired. In the financial statements prepared at year-end, the omission
a. Overstates owners’ equity

b. Understates assets
c. Understates net income
d. Overstates liabilities
5. If at end of current reporting period, an entity erroneously excluded some goods from
ending inventory and also erroneously did not record the purchase of these goods, these
errors would cause
a. The ending inventory to be overstated

b. The retained earnings to be understated
c. No effect on net income, working capital and retained earnings
d. Net income to be understated
6. When the current year’s ending inventory is overstated
a. The current year’s cost of goods sold is overstated.

b. The current year’s total assets are understated.
c. The current year’s net income is overstated.
d. The next year’s net income is overstated.
7. An overstatement of ending inventory in the current period would result in income of

the next period being
a. Overstated
b. Understated
c. Correctly stated
d. The answer cannot be determined from the information
8. Which would result if the current year’s ending inventory is understated in the cost of
goods sold calculation?
a. Cost of goods sold would be overstated

b. Total assets would be overstated
c. Net income would be overstated.
d. Retained earnings would be. Overstated
9. If the beginning inventory in the current year was overstated, the income for the current
year would be
a. Understated and assets are correctly stated.

b. Understated and assets are overstated.
c. Overstated and assets are overstated.
d. Understated and assets are understated.
10. Which of the following would cause income to be overstated in the period of occurrence?
a. Overestimating bad debt expense

b. Understating beginning inventory
c. Overstated purchases
d. Understated ending inventory
Problem 16-20 Multiple Choice (IAA)
1. Failure to record the expired amount of prepaid rent would not
a. Understate expense
b. Overstate net income
c. Overstate Owners’ equity
d. Understate liabilities
2. Failure to record accrued salaries at year-end results in

a. Overstated retained earnings
b. Overstated assets
c. Overstated liabilities
d. Understated retained earnings
3. Failure to record depreciation at year-end results in
a. Understated income
b. Understated assets
c. Overstated expenses
d. Overstated assets
4. Which of the following is a counterbalancing error?
a. Understated depletion expense

b. Bond premium under-amortized
c. Prepaid expense adjusted incorrectly
d. Overstated depreciation expense
5. Which error will not self-correct next year?

a. Accrued expense not recognized at year-end
b. Accrued revenue not recognized at year-end
c. Depreciation expense overstated for the year
d. Prepaid expense not recognized at year-end
CHAPTER 18: BOOK VALUE PER SHARE
Book value per share is the amount that would be paid on each share assuming the entity is
liquidated and the amount available to shareholders is exactly the amount reported as
shareholders’ equity.
Where there is only one class of share capital, the formula for the computation of book value per
share is:
Book value per share = Total shareholders’ equity

Number of shares outstanding
Where there are two classes of share capital, it is necessary to apportion the shareholders’ equity
between the preference share and ordinary share.
The book value per share should then be computed as follows:
Book value per preference share = Preference shareholders’ equity

Number of preference shares outstanding
Book value per ordinary share = Ordinary shareholders’ equity

Number of ordinary shares outstanding
Accounting procedures
For purposes of apportionment between the preference share and ordinary share, the following
procedures should be observed:
1. An amount equal to the par or stated value is allocated to the preference share and
ordinary share.
2. Any balance of the shareholders’ equity in excess of the par or stated value is then
apportioned taking into account the liquidation value and dividend rights of the
preference shareholders.
For book value purposes, the following are assumed to be available for dividends:
a. Retained earnings
b. Share premium
c. Revaluation surplus
Where there are treasury shares and subscribed share capital, the amount of par or stated
value to be assigned to the pertinent share capital is computed as follows:
Shares Amount
Share capital issued XX XX
Add: Share capital subscribed XX XX
Total XX XX
Less: Treasury shares at par XX XX
Amount and shares outstanding XX XX
For purposes of book value computation, treasury shares shall be treated as retired.
Accordingly, any gain on retirement is credited to share premium, and any loss on retirement is
charged first to share premium and then to retained earnings.
Liquidation value of preference share

The liquidation value is the amount which the preference shareholders normally receive upon the
liquidation of the corporation. The liquidation value may be more than the par value.
In the absence of a liquidation value, the preference shareholders shall receive an amount equal
to the par or stated value.
However, if there is a deficit the preference shareholders would share on a pro rata basis with
the: ordinary shareholders.
The preference share may have a call price but this is ignored for book value computation.
The call price is the amount paid to preference shareholders upon redemption of preference share
during the lifetime of the corporation.
Preference as to assets
When preference as to assets, the preference shareholders are entitled to payment not only for the
liquidation value but also for dividends in arrears.
Preference as to dividends
Preference as to dividends does not mean that the preference shareholders have an absolute right
to dividends.
The preference simply means that if dividends are declared, the preference shareholders have the
right to receive dividends first before the ordinary shareholders are paid a dividend.
In the absence of any statement to the contrary, the preference share has preference as to
dividends.
When preference share has preference as to dividends, the dividend right may be:
a. Noncumulative
b. Cumulative
c. Nonparticipating
d. Participating
Definitions
A noncumulative preference share is one on which the right to receive dividends is forfeited in
any one year in which the dividends are not declared. Thus, the preference share is entitled only
to current year dividends.
A cumulative preference share is one on which any undeclared dividends accumulate each year
until paid. Thus, the cumulative preference share is entitled to all dividends in arrears.
A nonparticipating preference share is one that is entitled to receive only the dividends equal to
the fixed rate.
A participating preference share is one which is entitled to receive dividends in excess of the
basic or fixed rate.
Participating preference share may be fully participating with ordinary share on a pro data basis
or participating only to a certain amount or percentage.
However, before the preference share can participate, the ordinary share should receive first an
amount equal to the basic preference rate, meaning preference rate times the par value of the
ordinary share outstanding.
Special notes
a. In the absence of specific designation, preference share is assumed to be noncumulative
and nonparticipating.
b. Dividends in arrears usually include current dividends. Dividends in arrears in prior years
shall be specifically disclosed, otherwise, there are no arrearages.
c. In case where there are two classes of preference shares with different dividend rates and
both are participating the lower rate shall be the basis for allocation to the ordinary
shares.
If only one preference share is participating, the ratio of the participating preference share shall
be used as basis for ordinary share dividend.
CASE 1. Preference share is noncumulative and nonparticipating.
The “excess over par” is the sum of the shareholders’ equity accounts other than the par or stated
value of share capital.
CASE 2. Preference share is cumulative and nonparticipating

CASE 3. Preference share is cumulative and participating
Inasmuch as the preference shareholders are participating, the ordinary shareholders get the
current year dividend using the preference rate in the absence of an ordinary dividend rate.
The balance is allocated to the preference and ordinary share on a prorata basis
The fractions are developed from the aggregate par value of share capital.
CASE 4. Preference share is cumulative and participating up to 14%
CASE 5. Preference share is cumulative, nonparticipating and with liquidation value of P106 per
share
CASE 1B. Preference share has preference as to assets (dividends in arrears are fully payable)
Note that if the preference share has preference as to assets, the dividends in arrears are fully
payable.
CASE 2B. Preference share has preferences as to dividends
Note that the deficit is apportioned on a prorata basis between the ordinary share and preference
share notwithstanding the fact that the preference share has preference as to dividends.
As stated earlier, preference as to dividends does not mean absolute right to dividends.
The preference simply means that the preference shareholders will receive first dividends if and
when dividends are declared.
But no. dividends can be declared because there is a deficit.
The right therefore becomes academic.
Note that the subscription receivable should not be deducted from subscribed share capital.
As stated earlier, the treasury shares for book value purposes are treated as retired.
Note that in the absence of an ordinary dividend rate, the ordinary shareholders get the current
year dividend using the preference rate if the preference share is fully participating.
1. Which of the following shareholder rights is most commonly enhanced in an issue of

preference shares?
a. The right to vote for the board of directors.

b. The right to maintain one's proportional interest.
c. The right to receive a full cash dividend before dividends are paid to other
classes of share capital.
d. The right to vote on major corporate issues.
2. Preference shares participate ratably with the ordinary shareholders in any profit
distribution beyond the prescribed preference rate.
a. Cumulative feature
b. Participating feature
c. Callable feature
d. Redeemable feature
3. Which feature of preference share would most likely be opposed by ordinary

shareholders?
a. Convertible
b. Callable
c. Redeemable
d. Participating
4. Noncumulative preference dividends in arrears
a. Are not paid and not disclosed.

b. Must be paid before any other cash dividends can be distributed.
c. Are disclosed as liability until paid.
d. Are paid to preference shareholders if sufficient funds remain after payment of
ordinary dividend.
5. How should cumulative preference dividends in arrears be reported?
a. Note disclosure
b. Increase in shareholders’ equity
c. Increase in current liabilities
d. Increase in noncurrent Liabilities
CHAPTER 19: BASICS EARNING PER SHARE
EARNINGS PER SHARE
The earnings per share figure is the amount attributable to every ordinary share outstanding
during the period.
Ordinary share is an equity instrument that is subordinate to all-other classes of equity
instruments.
Thus, the earnings per share information pertains only to ordinary share.
It is not necessary for preference share because there is a definite rate of return for such share.
The computation of earnings per share is covered by PAS 33 which requires two presentations of
earnings per share, namely:
a. Basic earnings per share
b. Diluted earnings per share
The presentation of earnings per share is required for:

a. Entities whose ordinary shares are publicly traded.
b. Entities that are in the process of issuing ordinary shares or potential ordinary shares in the
public securities market.
In other words, public entities are required to present earnings per share.
Nonpublic entities are not required but are encouraged to present earnings per share.
Uses of earnings per share
a. It is a determinant of the market price of ordinary share, thus indicating the attractiveness of
the ordinary share as an investment.
b. It is measure of performance of management in conducting operations.
c. It is the basis of dividend policy of an entity.
Presentation
An entity shall present on the face of the income. statement; basic and diluted earnings per share
for income or loss from continuing operations.
An entity that reports a discontinued operation shall disclose the basic and diluted amounts per
share for the discontinued operation either on the face of the income statement or in the notes to
the statements.
An entity shall present basic and diluted earnings per share even if the amounts are negative, for
example, basic loss per share.
When an entity presents both consolidated financial statements and separate financial statements,
the disclosures required by the standard need be presented only on the basis of the consolidated
information.
Basic earnings per share
Basic EPS = Net Income

Ordinary shares outstanding
The net income is equal to the amount after deducting dividends on preference share.
If the preference share is cumulative, the preference dividend for the current year only is
deducted from the net income, whether such dividend is declared or not.
If the preference share is noncumulative, the preference dividend for the current year is deducted
from net income only if there is declaration.
If there is a significant change in the ordinary share capital during the year, the weighted average
number of ordinary shares outstanding during the period should be used as denominator.
The "participating" preference share can be treated as a special ordinary share.
Determination of weighted average
Shares are usually included in the weighted number of shares from the date consideration is
receivable, which is usually the date of their issue.
a. Ordinary shares in exchange for cash are included when cash is receivable.
b. Ordinary shares issued as a result of the conversion of a debt instrument to ordinary
shares are included from the date that interest ceases to accrue.
c. Ordinary shares issued in place of interest or principal on other financial instruments are
included from the date that interest ceases to accrue.
d. Ordinary shares issued in exchange for the settlement of a liability of the entity are
included from the settlement date.
e. Ordinary shares. issued as consideration for the acquisition of an asset other than cash are
included as of the date on which the acquisition is recognized.
f. Ordinary shares issued for the rendering of services to the entity are included as the
services are rendered.
g. Ordinary shares issued as part of the purchase consideration of a business combination
that is an acquisition are included in the weighted average number of shares from the date
of the acquisition.
h. Ordinary shares that will be issued upon the conversion of a mandatory convertible
instrument are included in the calculation of basic earnings per share from the date the
contract is entered into.
i. Under IFRS, subscribed ordinary shares or partly paid shares are included in EPS to the
extent that they are entitled to participate in dividends.
Under Philippine jurisdiction, subscribed shares are entitled to participate fully in dividends.
Where share dividends or share splits create a change in the capital structure, the increase or
decrease in the number of shares shall be recognized retroactively.
In other words, the share dividends or share split shall be treated as a change from the date the
original shares were issued.
Bonus issue
In a bonus issue, ordinary shares are issued to existing shareholders for no consideration.
Therefore, the number of ordinary shares is increased without increase in resources.

A bonus issue is actually a share dividend.
The number of ordinary shares outstanding is adjusted for the proportionate change in the
number of ordinary shares outstanding as if the bonus issue has occurred at the beginning of the
earliest period presented.
Rights issue
When rights are issued to shareholders most often the exercise price is less than the fair value of
the shares.
Accordingly, such a rights issue includes a bonus element, meaning shares issued for no
consideration.
Application Guidance 2 of PAS 33 provides that “the number of ordinary shares to be used in
calculating basic earnings per share for all periods prior to’ the rights issue is the number of
ordinary shares outstanding prior to the rights issue ‘multiplied by an adjustment factor”.
The adjustment factor is the ratio of the market value of the share right-on to the market value of
the share ex-right.
The market value of the share right-on is actually the market value of the share immediately
prior to the exercise of rights.
The market value of the share ex-right is equal to the market value of the share right-on minus
the theoretical value of right.
The problem is the determination of the theoretical market value of the right.
Formula - Theoretical value of right
Thankfully, the mathematician invented a formula for the computation of theoretical value of a
right.
Market value of share right-on minus subscription price = Value of one right
Number of rights to purchase one share plus 1
Observe that if the preference share is cumulative, the preference dividend is added to the net
loss to get total loss to the ordinary shareholders.
However, if the preference share is noncumulative, the preference dividend is ignored because
presumably there is no declaration since there is a net loss.
Problem 19-29 Multiple choice (PAS 33)
1. EPS disclosures are required for
a. Entities whose ordinary shares and potential ordinary shares are publicly traded.
b. Entities that are in the process of issuing ordinary shares in the public market.
c. All entities.
d. Entities whose ordinary shares and potential ordinary ‘shares are publicly
traded and entities that are in the process of issuing ordinary shares in public
market.
2. EPS disclosures are
a. Required for all public and nonpublic entities

b. Required for public entities and encouraged for nonpublic entities
c. Encouraged for public entities and required for nonpublic entities
d. Encouraged for all entities
3. When an entity issues both consolidated and separate financial statements, the EPS
information is required
a. For both sets of financial statements

b. In neither set of financial statements
c. Only for consolidated financial statements
d. Only for separate financial statements
4. Earnings per share shall be computed on the basis of
a. The number of shares outstanding at the end of the year

b. A weighted average of the number of shares outstanding during the year regardless
of. the extent of fluctuations
c. A weighted average of the number of shares outstanding during the year except
that minor fluctuations in the number of shares may be disregarded
d. The number of shares outstanding at the middle of year
5. Earnings per share shall be reported for all of the following, except
a. Continuing operations
b. Discontinued operations
c. Net income
d. Gross income
6. In computing basic earnings per share, if the preference shares are cumulative, the
amount that should be deducted as an adjustment to the numerator is the
a. Preference dividends in arrears
b. Preference dividends paid during the year
c. Annual preference dividend
d. Annual ordinary dividend
7. In computing basic earnings per share, the amount of preference dividends on

noncumulative preference shares should be
a. Deducted from net income whether declared or not

b. Deducted from net income only when declared
c. Added to net income only when declared
d. Ignored
8. In computing basic earnings per share, the full amount of the required preference
dividends on cumulative preference shares for the period should be
a. Ignored
b. Deducted from net income only when declared
c. Deducted from net income whether declared or not
d. Added to net income whether declared or not
9. In computing basic loss per share, the annual preference dividend on cumulative
preference shares should be
a. Ignored
b. Deducted from the net loss whether declared or not
c. Added to the net loss whether declared or not
d. Added to the net loss only when declared
10. In the computation of weighted average number of shares when there is a share split, the
additional shares are
a. Weighted by the number of days outstanding.
b. Weighted by the number of months outstanding.
c. Considered outstanding at the beginning of the year.
d. Considered outstanding at the beginning of the earliest year reported.
Problem 19-30 Multiple choice (IFRS)
1. Earnings per share information is calculated before accounting for which of the
following?
a. Preference dividend for the period

b. Ordinary dividend
c. Taxation
d. Minority interest
2. Which figure for earnings does EPS information use?
a. Net income attributable to ordinary equity holders and preference shareholders of the
parent
b. Net income before taxation.
c. Net income from operations
d. Net income attributable to ordinary equity holders of the parent
3. When an entity issues a share split
a. The previous year's EPS is not adjusted for the issue.

b. The previous year's EPS is adjusted for the issue.
c. Only a note of the effect on the previous year’s EPS is made.
d. Only the diluted EPS for the previous year is adjusted.
4. If-a bonus issue occurs between the year-end and the date that the financial statements are
authorized
a. The EPS both for the current and the previous year are adjusted
b. The EPS for the current year only is adjusted
c. No adjustment is made to EPS
d. Diluted EPS only is adjusted
5. If a new issue of shares for cash is made between the year-end and the date that the
financial statements are authorized
a. The EPS both for the current and the previous year are adjusted.
b. The EPS for the current year only is adjusted.
c. No adjustment is made to EPS.
d. Diluted EPS only is adjusted.
6. The weighted average number of shares outstanding during the period for all periods
should be adjusted for
a. Any change in the number of ordinary shares without a change in resources.

b. Any prior period adjustment.
c. Any new issue of shares for cash.
d. Any convertible instruments settled in cash.
7. Ordinary shares issued as part of a business combination are included in the EPS
calculation from
a. The beginning of the accounting period.

b. The date of acquisition.
c. The end of the accounting period.
d. The midpoint of the accounting year.
8. Shares issued to settle a liability are included in the EPS calculation from
a. Date of the contract for services.

b. Halfway through the rendering of services
c. The completion of services
d. The settlement date
9. Shares to be issued upon the conversion of a mandatorily convertible instrument are

included in the calculation of basic earnings per share from
a. The date of the contract for the shares

b. Halfway through the period
c. The date of conversion
d. The issue of the share certificate
10. Under IFRS, where ordinary shares are issued but not fully paid, the ordinary shares are
treated in EPS
a. In the same way as fully paid ordinary shares.

b. As a fraction of an ordinary share to the extent that the subscribed shares are
entitled to participate in dividends.
c. In the same way as warrants or options.
d. Are ignored.
CHAPTER 20: DILUTED EARNINGS PER SHARE
Introduction
When the capital structure of an entity is simple in the sense that it consists only of ordinary share
capital and nonconvertible securities, the computation of the earnings per share is relatively easy.
The net income minus the preference dividends is simply divided by the number of ordinary shares
outstanding or by the average shares outstanding, whichever is appropriate.
But where the capital structure of an entity is complex in the sense that it consists of ordinary shares
and potential ordinary shares or potential diluters, the computation of the earnings per share becomes
a little complicated.
Potential ordinary share
A potential ordinary share is a financial instrument or other contract that may entitle the holder to
ordinary shares.
In other words, a potential ordinary share is a financial instrument that represents future issuance of
ordinary shares. The three major types of potential ordinary shares are:
a. Convertible bond payable

b. Convertible preference share
c. Share option and warrant
Dilution and antidilution
Dilution arises when the inclusion of the potential ordinary shares decreases the basic earnings per
share or increases the basic loss per share. In this case, the potential ordinary shares are dilutive
securities.
Antidilution arises when the inclusion of the potential ordinary shares increases basic earnings per
share decreases basic loss per share. In this case, the potential ordinary shares are antidilutive and
ignored in computing diluted earnings per share.
Diluted earnings per share
The computation of the diluted earnings per share is based on the “as if” scenario:
a. “As if” the convertible bond payable is converted into» ordinary share
b. “As if” the convertible preference share is converted into ordinary share.
c. “As if” the share options and warrants are exercised.
Convertible bond payable
The computation of diluted earnings per share assumes that the bond payable is converted into
ordinary share.
Accordingly, adjustments shall be made both to net income and to the number of ordinary shares
outstanding.
The net income is adjusted by adding back the interest expense on the bond payable, net of tax.
The number of ordinary shares outstanding is increased by the number of ordinary shares that would
have been issued upon conversion of the bond payable.
Observe that if a convertible bond payable is outstanding during the entire year, it is assumed that the
conversion takes place at the beginning of the year.
Bond payable issued during the year

Assume that the convertible bond payable is issued on April 1 of the current year. In this case, all
conversion computations will be made for nine months only, from April 1 to December 31 of the
current year.
Accordingly, the diluted earnings per share would be modified.
Needless to say, the basic earnings per share would remain the same.
Convertible preference share
If there is a convertible preference share, the computation of diluted earnings per share also assumes
that the preference share is converted into ordinary share.
Accordingly, the net income is not reduced anymore by the amount of preference dividend.
The number of ordinary shares outstanding is increased by the number of ordinary shares that would
have been issued — upon conversion of the preference share.
Observe that the conversion is assumed to be made at the _ beginning of the year because the
convertible preference share is: outstanding during the entire year.
Preference share issued during the year
If the convertible preference share is issued on September 1 of the current year, the conversion
computation will only be for four months, from September 1 to December 31 of the current year.
The basic earnings per share would remain the same.
Note that the preference dividends are deducted from net income because the preference dividends
were paid in full before the actual conversion. Otherwise, the preference dividends are ignored
Whether the preference dividends were paid or not before the actual conversion, the diluted earnings
per share would be the same.
Options and warrants
Share options are granted to employees enabling them to acquire ordinary shares of the entity at a
specified price during a definite period of time.
Share warrants are granted to shareholders enabling them to acquire ordinary shares of the entity at
a specified price during a definite period of time.
By definition, options and warrants have no cash yield-but they derive their value from the right to
obtain ordinary shares at a specified price that is usually lower than the prevailing market price.
Options and warrants are dilutive if the exercise price or option price is less than the average market
price of the ordinary share.
However, for employee share options, the exercise price or option price shall include the fair value
of any services to be supplied to the entity in the future under the option plan.
Treasury share method
Options and warrants are included in the EPS computation through the treasury share method.
However, this does not imply that the entity has entered into a transaction to purchase treasury
shares.
The treasury share method is used to simplify the computation of incremental ordinary shares that
are assumed to be issued for no consideration as a result of options and warrants.
The following procedures shall be followed in the. computation of incremental ordinary shares
arising from issuance of options and warrants:
a. The options and warrants are assumed to be exercised at the beginning of the current year or
at the date issued during the current year.
b. The proceeds from the exercise of the options and warrants are assumed to be used to acquire
treasury shares at average market price.
c. The number of incremental ordinary shares is equal to the option shares minus the assumed
treasury shares acquired. The incremental ordinary shares represent the issue of ordinary
shares for no consideration.
Accordingly, these are the potential ordinary shares that are included in the computation of diluted
earnings per share.
The assumed proceeds from the options and warrants shall be considered to have been received from
issue of shares at fair value or average market price.
Note that the total option price for employee share options shall include the fair value of share option
in accordance with paragraph 47A of PAS 33.
Options issued during the year

Note that if the options are outstanding during the entire year, these are assumed to be exercised at
the beginning of the current year.
If the options are issued on March 1 of the current year, the incremental ordinary shares would be
for ten months
Needless to say, the basic earnings per share would remain the same.
Actual exercise of options and warrants
The computation procedures with respect to the option shares or shares "covered" by warrants are:
a. The option shares or covered shares actually issued are “averaged from the date of exercise to the
end of the current year.
b. The incremental ordinary shares are “averaged” from the beginning of the current year to the date
of exercise of options and: warrants.
Note that the market price on the "date of actual exercise” is used in computing the assumed
treasury shares.
If the entity has a net loss, only the basic loss per share is computed and reported.
The diluted loss per share is the same as the basic loss per share but not reported anymore.
The reason is that the potential ordinary shares would always decrease the loss per share and
therefore the effect of the assumed conversion is always antidilutive.
PROBLEM 20-27 Multiple Choice (PAS 33)
1. The calculation of diluted EPS assumes that share options were exercised and that the
proceeds were used to
a. Buy ordinary shares as an investment

b. Retire preference shares
c. Buy treasury shares
d. Increase net income
2. Options and warrants are dilutive if
a. The exercise price is lower than the average market price.

b. The exercise price is higher than the average market price.
c. The exercise price is equal to the average market price
d. The option shares represent 20% of ordinary shares
3. When applying the treasury share method for diluted EPS, the market price of the ordinary
share used for the assumed acquisition of treasury shares is the
a. Market price at the end of the year

b. Average market price during the year
c. Market price at the beginning of the year
d. Average market price over a two-year period
4. In applying the treasury share method of computing diluted earnings per share, when is it
appropriate to use the average market price of ordinary share during. the year as the assumed
repurchase price?
a. Always.
b. When the average market price is higher than the exercise price
c. Never
d. When the average market price is lower than the exercise price
5. Under the treasury share method, the number of potential ordinary shares is equal to
a. Option shares
b. Option shares minus assumed treasury shares
c. Assumed treasury shares
d. Option shares actually issued during the year
1. All of the following must be disclosed in relation to earnings per share, except
a. Forecast earnings per share for the following year.

b. Instruments that could potentially dilute basic earnings per share in the future but not
included in the diluted EPS because they are antidilutive in the current period.
c. The weighted average number of ordinary shares used.
d. The earnings figures used in calculating EPS.
2. Dilution of EPS is defined as
a. Decrease in earnings per share when any financial instrument is converted to any form of
share capital.
b. Decrease in share capital
c. Decrease in earnings per share when convertible instruments are converted to
ordinary shares.
d. Decrease in earnings per share when share capital is converted to debt capital.
3. If a share option is converted on March 31
a. The potential ordinary shares are included in diluted EPS up to March 31, and in
basic EPS from the date converted to the year-end, both weighted accordingly.
b. The ordinary shares are not included in diluted EPS.
c. The ordinary shares are not included in basic EPS.
d. The effects of the share option are included only in previous year’s EPS calculation.
4. In calculating whether potential ordinary shares are dilutive, the income figure used as the
control number is
a. Net income including discontinued operations

b. Income from continuing operations
c. Income before tax including discontinued operations
d. Retained earnings for the year after dividends
5. The nature of diluted earnings per share involving adjustment for share options can be
described as
a. Historical because earnings are historical

b. Historical because it indicates an entity's valuation
c. Proforma because it indicates potential changes in number of shares
d. Proforma because it indicates potential changes in earnings
1. Antidilutive securities
a. Should be included in the computation of diluted earnings per share but not basic
earnings per share.
b. Are those whose inclusion in earnings per share computation would cause basic earnings
per share to exceed diluted earnings per share.
c. Include share options and warrants whose option price is less than the average market
price.
d. Should be disregarded in all EPS computations.
2. The purpose of diluted earnings per share is to

a. Provide a comparison figure for debt holders.
b. Indicate earnings shareholders shall receive in future periods.
c. Distinguish between entities with a complex capital structure and entities with a simple
capital structure.
d. Show the maximum possible dilution of earnings.
3. What is the justification underlying the concept of potential ordinary shares in a diluted EPS
computation?
a. Form over substance

b. Substance over form
c. Form and substance considered equally
d. Accounting practice
4. In calculating diluted earnings per share, which of the following should not be considered?
a.The weighted average number of ordinary shares outstanding

b.The amount of dividends declared on cumulative preference shares
c.The amount of cash dividends declared on ordinary shares
d.The number of ordinary shares resulting from the assumed conversion of bonds payable
outstanding
5. Which statement is correct in relation to EPS?
a. If preference share is outstanding, dividend declared on the preference share is always

deducted from net income in calculating EPS.
b. EPS can never be negative.
c. If income from continuing operations is less than zero, potentially dilutive securities
are antidilutive.
d. All issues convertible to ordinary shares must be included in the calculation of diluted
EPS.
6. An entity already has calculated the basic earnings per share. In determining diluted earnings
per share, the annual dividend on convertible cumulative preference share which is dilutive
should be
a. Added back to the numerator of basic EPS whether declared or not.

b. Deducted from the numerator of basic EPS only if declared.
c. Added back to the numerator. of basic EPS only if declared.
d. Deducted from the numerator of basic EPS whether declared or not.
7. In determining diluted earnings per share, dividends on nonconvertible cumulative preference
shares should be
a. Disregarded
b. Added back to net income whether declared or not
c. Deducted from net income only if declared
d. Deducted from net income whether declared or not
8. The “if converted” method of computing earnings per share assumes conversion of
convertible bonds payable at
a. Beginning of the earliest period reported or at time of issuance, if later

b. Beginning of the earliest period reported regardless of time of issuance.
c. Middle of the earliest period reported regardless of the time issuance
d. Ending of the earliest period reported regardless of the time of issuance
9. In determining diluted earnings per share, interest expense, net of income tax, on dilutive
convertible bond payable should be
a. Added back ‘to weighted average. shares outstanding for diluted earnings per share.
b. Added back to net income for diluted earnings per share.
c. Deducted from net income for diluted earnings per share.
d. Deducted from weighted average shares outstanding for diluted earnings per share
10. When dilutive convertible bonds are the only potential ordinary shares
a. Diluted EPS will be greater if the bonds are actually converted than not converted
b. Diluted EPS will be smaller if the bonds are actually converted than not converted
c. Diluted EPS will be the same whether or not the bonds are converted.
d. The effect of conversion on diluted EPS cannot be determined without additional
information.
CHAPTER 21 – DILUTED EARNINGS PER SHARE

Multiple Potential Ordinary Shares
If there is only one dilutive potential ordinary share, there is no accounting problem.
A problem arises where the entity has two or more dilutive potential ordinary shares.
In considering whether potential ordinary shares are dilutive or antidilutive, each issue or series
of potential ordinary shares shall be considered separately or individually, rather than in the
aggregate.
In order to maximize the dilution of the basic earnings per share, each issue is considered in
sequence from the most dilutive to the least dilutive.
In other words, the potential ordinary shares shall be ranked based on their contribution in terms
of incremental EPS.
The potential ordinary share with the lowest incremental EPS is ranked first.
TEST FOR DILUTIONS
Options and warrants e options and warrants are dilutive if the option price or exercise price is
lower than the average market price.
The options and warrants are the most dilutive because options and warrants have no impact on
net income.
Thus, the options and warrants are ranked first in computing diluted earnings per share.
Convertible preference share
The contribution of the preference share to net income is the amount of preference dividend that
is avoided because of the conversion.
The incremental EPS for convertible preference share is equal to the amount of annual
preference dividend divided by the number of ordinary shares into which the preference share is
convertible.
If this incremental EPS is lower than the basic EPS, the convertible preference share is probably
dilutive.
If this incremental EPS is higher than the basic EPS, the preference share is antidilutive.
Convertible bond payable
The contribution of the bond payable to net income is the amount of interest expense that is
avoided because of the conversion.
The incremental EPS for the convertible bond payable is equal to the interest expense, net of tax
divided by the number of ordinary shares into which the bond payable is convertible.
Written put options
Put options on ordinary shares are contracts that give the holder the right to sell ordinary shares
at a specified price for a given period.
Contracts that require the entity to repurchase its own shares, such as written put options and
forward purchase contracts are reflected in the calculation of diluted earnings per share if the
effect is dilutive.
If these contracts are in the money, meaning the exercise or settlement price is higher than the
average market price, the potential dilutive effect on earnings per share shall be calculated as
follows:
a. It is assumed that at the beginning of the period sufficient ordinary shares will be issued at the
average market price.
b. It is assumed that the proceeds from the issue are used to satisfy the contract or buy back the
ordinary shares covered by the written put options.
c. The difference between the number of ordinary shares assumed issued and the number of
ordinary shares repurchased under. the written put options represents the incremental ordinary
shares.
d. The incremental ordinary shares shall be included in the calculation of diluted earnings per
share.
Contingent ordinary shares
Contingent ordinary shares are ordinary shares issuable for little or no cash or other
consideration upon satisfaction of specified conditions in a contingent share agreement.
A contingent share agreement is an agreement to issue ordinary shares that is dependent o on \

the satisfaction of specified conditions.
Contingent ordinary shares are treated as outstanding and included in the computation of both
basic and diluted earnings per share if the conditions are satisfied.
The difference lies in the number of contingent shares that would be included in the computation
of earnings per share.
Contingent ordinary shares are included in the calculation of basic earnings per share from the
date the condition is satisfied.
Contingent ordinary shares are included in the computation of diluted earnings per share from
the beginning of the period or from the date of the contingent agreement, if later.
Note that the second condition about earnings contingency has no effect on basic earnings per
share because it is not certain that the condition is satisfied until the end of the contingency
period on December 31, 2021.
Diluted Earnings per share
As stated earlier, contingent ordinary shares are included in the computation of diluted earnings
per share from the beginning of the period or from the date of agreement, if later.
Thus, the full ordinary shares from the retail site condition and earnings condition are
recognized.
Note that the earnings condition must be satisfied on December 31, 2021 but already
considered in computing diluted earnings per share.
PAS 33, paragraph 53, provides that if a specified amount of earnings is a condition for a
contingent issue and that amount is already attained at the end of the current period, the
contingent ordinary shares are included in the computation of the diluted earnings per share.
It is as if the amount of earnings at the end of the current period is the amount of earnings at the
end of the contingency period.
Restatement is not permitted if the conditions are not met when the contingency expire on
December 31 2021.
Convertible bonds settled in shares or cash
When an entity has issued bonds payable that may be settled in ordinary shares or cash at the
issuer's option, the entity shall presume that the bonds will be settled in ordinary shares.
The resulting potential ordinary shares shall be included in the calculation of diluted earnings per
share if the effect is dilutive.
Convertible bonds are compound instrument and accounted for as partly liability and partly
equity.
The interest expense, net of tax, on the liability component _ is added back to the net income.
CHAPTER 22: HYPERINFLATION
PAS 29 on financial reporting in a hyperinflationary economy does not establish an absolute

rate at which hyperinflation is deemed to arise.
Hyperinflation is a matter of judgment.
Hyperinflation is indicated by characteristics of the economic environment of a country which

include but are not limited to. the following:
a. The general population prefers to keep its wealth in nonmonetary assets or in relatively
stable foreign currency.
Accordingly, amounts held in local currency are immediately invested in nonmonetary
assets or stable foreign currency to maintain purchasing power.
b. The general population regards monetary amounts not in terms of local currency but in
terms of a relatively stable foreign currency.
c. Sales and purchases on credit take place at prices that compensate for the expected loss of
purchasing power during the credit period even if the period is short.
d. Interest rates, wages and prices are linked to a price index.
e. The cumulative rate over 8 years is approaching or exceeds 100%.
Although PAS 29 sets out the characteristics that may indicate hyperinflationary economy, it also
states that judgment may be used in determining whether restatement of financial statements is
required.
Financial reporting in hyperinflationary economy
PAS 29, paragraph 8, provides that the financial statements of entity that reports in the currency
of a hyperinflationary economy, whether they are based on historical cost approach or a current
cost approach, shall be stated in terms of the measuring unit current at the end of reporting
period.
Presentation of the information required under PAS 29 as a supplement to unrestated financial

statements is not permitted.
The restatement of financial statements of an entity that reports in the currency of a
hyperinflationary economy is accomplished by means of constant peso accounting and current
cost accounting.
Constant peso accounting
Constant peso accounting is the restatement of conventional or historical financial statements in

terms of the current purchasing power of the peso through the use of index number.
Constant peso accounting also known as purchasing power or price level accounting.
The traditional concept of preparing financial statements based on historical cost is known as
nominal peso accounting.
Monetary items
PAS 21 defines monetary items as money held and assets and liabilities to be received or paid in
fixed or determinable amount of money.
The essential feature of a monetary item is a right to receive or an obligation to deliver a fixed
or determinable amount of money.
In simple language, monetary items refer to cash and assets that represent a fixed amount of
pesos to be received, or obligations that represent a fixed amount of pesos to be paid.
Monetary assets and liabilities remain the same regardless of the change in the general price
level.
Nonmonetary items
Nonmonetary items, by the process of exclusion, may be defined as those items that cannot be
classified as monetary.
These items are so called nonmonetary because their peso amounts reported in the financial
statements differ from the amounts that are ultimately realizable or payable.
The essential feature of a nonmonetary item is the absence of a right to receive or an obligation
to deliver a fixed or determinable amount of money.
What items are restated?

Only nonmonetary items are restated when preparing constant peso financial statements.
Monetary items are not restated anymore because they are automatically stated in terms of
current purchasing power of the peso.
The objective of constant peso accounting is to report elements of the financial statements in
terms of pesos that have the same purchasing power.
Formula for restatement
Index number at end of reporting period x Historical

Index number on acquisition date
Examples of Monetary and nonmonetary items (refer to page 675, ka stress mag type)
General Price Index
The index number used for restatement is known as genera| price index constructed by the
Bangko Sentral ng Pilipinas.
Such an index is designed to show how much the overall level of prices in the economy has
changed over time.
An increase in the general price index means that the purchasing power of money has decreased.
This is popularly known as inflation.
A decrease in the general price index means that the purchasing power of money has increased.
This is known as deflation.
Specific price index
A specific price index is the change in the price of a specific good | or service, such as food,
clothing and car.
Specific price change occurs primarily because of change in supply and demand for a particular
good or service. The law of supply and demand is in operation in the case of a specific price
change.
For example, if there is an increase in demand for cars, then the specific price of cars will tend to
increase.
The specific price of a good or service may change at a different rate and even in the opposite
direction from the general price change in the overall economy.
Gain or loss on purchasing power
Purchasing power means the goods and services that money can buy.
In a period of inflation or rising prices, a purchasing power loss is incurred on monetary assets
and purchasing power gain is realized on monetary liabilities.
In a period of deflation or falling prices, a purchasing power gain is realized on monetary assets
and a purchasing power loss is incurred on monetary liabilities.
Procedures for restatement
1. The items in the financial statements are classified into monetary and nonmonetary.
2. Monetary items are not restated because these are already expressed in terms of the
monetary unit current at this end of reporting period.
3. Nonmonetary items are restated by applying the genera] price index from the date of
acquisition to the end of reporting period. Some nonmonetary items are carried at
amounts current at end of reporting period, such as net realizable value and fair value.
4. Some nonmonetary items are carried at amount current at date other than acquisition date,
for example, property, plant and equipment are revalued. In such case, the carrying
amounts are restated from the date of revaluation.
5. All items in the income statement are restated by applying the change in the general price
index from the dates when the items of income and expenses were initially recorded.
However, for practical purposes, the average index may be used.
6. The general purchasing power gain or loss is computed.
This pertains only to monetary items. The gain or loss on purchasing power is included in
profit or loss.
7. The restated amount of property, plant and equipment, goodwill and other intangible
asset is reduced when it exceeds the recoverable amount.
8. Any revaluation surplus recognized previously is eliminated.
9. Retained earnings would be the balancing figure in the restated statement financial
position.
10. When comparative statements are prepared, the monetary items of the preceding year are
expressed in terms of the index number at the end of the current year.
Observe that the computation of gain or loss on purchasing | power requires only the comparison
of net monetary assets at the end of reporting period at historical cost and net monetary assets
at the end of reporting period restated at current or constant pesos.
Gain or loss on purchasing power
If the net monetary assets at historical cost exceed the net monetary assets at current pesos, there
is a gain on purchasing power.
On the other hand, if the net monetary assets at historical cost are less than the net monetary
assets at current pesos, there is loss on purchasing power.
The rule is the reverse for net monetary liabilities.
The following formula may be used in computing the “constant peso” net monetary assets at the
end of current year:
Monetary assets, beginning, restated xx

Less: Monetary liabilities, beginning, restated xx
Net monetary assets, beginning, restated xx
Add: Increase in net monetary assets, restated xx
Total ~ xx
Less: Decrease in net monetary assets, restated xx
Net monetary assets, end, restated xx
Economy ceasing to be hyperinflationary
Judgment shall also be exercised whether an economy is no longer hyperinflationary.
The criterion is that whether the cumulative inflation rate drops below 100% in a three-year
period.
When an economy ceases to be hyperinflationary, an entity shall discontinue the preparation and
presentation of financial statements under a condition of hyperinflationary economy.
The amounts expressed in the measuring unit current at the end of the previous reporting period
shall be the carrying amounts in subsequent financial statements.
Disclosures for hyperinflationary financial statements

a. The fact that the financial statements have been restated for changes in the general purchasing
power of the reporting currency.
b. Whether the financial statements are based on historical cost approach or current cost
approach.
c. The nature and level of the price index at the end of reporting period and the movement in the
index during the current and previous reporting period.
1. Hyperinflation is indicated by all of the following, except
a. The general population prefers to keep its wealth in nonmonetary assets.

b. Interest rates, wages and prices are linked to a price index.
c. The cumulative inflation rate over three years is approaching or exceeds 100%.
d. All of these indicate hyperinflation.
2. All would indicate that hyperinflation exists, except
a. The general population regards monetary amounts in terms of relatively stable foreign
currency.
b. The cumulative inflation rate over three years is approaching or exceeds 100%.
c. Inflation rates have exceeded interest rates in three successive years.
d. The general population prefers to keep its wealth in nonmonetary assets.
3. Which would indicate that hyperinflation exists?
a. Sales on credit are at lower prices than cash sales

b. Inflation is approaching or exceeds 20% per year.
c. Monetary items do not increase in value.
d. People prefer to keep their wealth in nonmonetary assets or a stable foreign
currency.
4. An entity that wishes to present information about the effect of changing prices in a
hyperinflationary economy should report this information in
a. The body of the financial statements

b. The notes to the financial statements
c. Supplementary schedule
d. Management's report to shareholders
5. In a hyperinflationary economy, monetary items
a. Are not restated because they are already expressed in terms of the measuring
unit current at year-end.
b. Are measured at fair value.
c. Are restated applying the general price index.
d. Are restated applying the specific price index.
6. For purpose of adjusting financial statements for changes in the general price level,
monetary items consist of
a. Assets and liabilities whose amounts are fixed by otherwise in terms of pesos
b. Assets and liabilities classified as current.
c. Cash and cash equivalents plus all receivables.
d. Cash, other assets expected to be converted into cash, and current liabilities.
7. All of the following are monetary items, except
a. Accounts payable
b. Accounts receivable
c. Administration costs paid in cash
d. Loan repayment at face value
8. The financial statements of an entity that reports in the currency of a hyperinflationary

economy shall be stated in terms of
a. Historical cost
b. Current cost
c. Fair value
d. Measuring unit current at the end of reporting period
9. The gain or loss on the net monetary position in a hyperinflationary economy shall be
included in
a. Profit or loss and separately disclosed

b. Retained earnings
c. Equity
d. Other comprehensive income
10. In a hyperinflationary economy, amounts not expressed in the measuring unit current at
the end of reporting period are restated by applying
a. General price index
b. Specific price index.
c. Both general price index and specific price index
d. Either general price index or specific price index
1. When of the following is classified as nonmonetary?
a. Allowance for doubtful accounts

b. Accumulated depreciation
c. Premium on bonds payable
d. Advances to unconsolidated subsidiaries
2. Which of the following is classified as nonmonetary?

a. Warranty liability
b. Accrued expense
c. Unamortized discount on bonds payable
d. Refundable deposit
3. Which of the following is classified as nonmonetary?
a. Cash surrender value

b. Long-term receivable
c. Accrued lability on firm purchase commitment
d. Inventory
4. Which of the following is classified as monetary?
a. Goodwill
b. Equipment
c. Patent
d. Allowance for doubtful accounts
5. Purchasing power gain or loss results from
a. Monetary asset only

b. Monetary liability only
c. Both monetary asset and monetary liability
d. Nonmonetary asset and nonmonetary liability
6. During a period of inflation, an account balance remains constant. With respect to this
account, a purchasing power loss will be recognized if the account is a
a. Monetary asset
b. Monetary liability
c. Nonmonetary asset
d. Nonmonetary liability
7. During a period of inflation, an account balance remains constant. With respect to this
account, a purchasing power gain will be recognized if the account is a
a. Monetary liability
b. Monetary asset
c. Nonmonetary liability
d. Nonmonetary asset
8. During a period of deflation in which a liability account balance remains constant, which
of the following occurs?
a. A purchasing power loss if the item is a nonmonetary liability.

b. A purchasing power gain if the item is a nonmonetary liability.
c. A purchasing power loss if the item is a monetary liability.
d. A purchasing power gain if the item is a monetary liability.
9. During a period of inflation in which a liability account balance remains constant, which
of the following occurs?
a. A purchasing power loss if the item is a nonmonetary liability

b. A purchasing power gain if the item is a nonmonetary liability
c. A purchasing power loss if the item is a monetary liability.
d. A purchasing power gain if the item is a monetary liability.
10. During a period of deflation, an entity would have the greatest gain in general purchasing
power by holding
a. Cash
b. Property, plant and equipment
c. Finance lease liability
d. Mortgage payable
Problem 22-19 (AICPA Adapted)

1. Financial statements that are expressed under a stable monetary unit are a
a. Constant peso financial statements

b. Nominal peso financial statements
c. Current cost financial statements
d. Fair value financial statements
2. A general price level statement of financial position is prepared and presented in terms of
a. The general purchasing power of the peso at the latest end of reporting period.
b. The general purchasing power of the peso in the base period.
c. The average general ‘purchasing power of the peso.
d. The general purchasing power of the peso at the time the financial statements are
issued.
3. Which method of reporting attempts to eliminate the - effect of the changing value of the
peso?
a. Discounted net present value of future cash flows
b. Historical cost restated for change in the general price level
c. Replacement cost
d. Exit value
4. The restatement of historical peso financial statements to reflect the general price level
change results in presenting assets at
a. Lower of cost or net realizable value

b. Fair value
c. Cost adjusted for purchasing power change
d. Current replacement cost
5. Which argument in favor of price level adjusted financial statements is not valid?
a. Price level financial statements use historical cost.

b. Price level financial statements compare uniform purchasing power among various
periods.
c. Price level financial statements measure current value.
d. Price level financial statements measure earnings in terms of a common peso.
CHAPTER 23: CURRENT COST ACCOUNTING

Current cost accounting is a method of measuring assets, liabilities, income and expenses at
current cost at the end of reporting period.
In other words, current cost accounting is the restatement of historical cost in terms of current
replacement cost.
Current replacement cost is the estimated cost to acquire a similar asset at current purchase
price.
The essence of current cost accounting is the recognition of a holding gain or holding loss.
If the replacement cost. is higher than historical cost, the difference is a holding gain.
If the replacement cost is lower than historical cost, the difference is a holding loss.
Holding gain or holding loss may be classified as realized and unrealized.
If the asset is still unsold or unused, the holding gain or loss is said to be unrealized.
If the asset is already sold or used during the year, the shading gain or loss is said to be realized.
Realized holding gain or loss
Realized holding gain or loss is the difference between the current cost and historical cost of
assets sold or used the year.
For inventory sold

Cost of sales at average current cost xx
Less: Cost of sales at historical cost xx
Realized holding gain(loss) xx
For depreciable property

Depreciation based on average current cost xx
Less: Depreciation based on historical cost xx
Realized holding gain (loss) xx
For nondepreciable property (land)

Current cost at the time of sale xx
Less: Historical cost xx
Realized holding gain (loss) xx
Unrealized holding gain or loss
Unrealized holding gain or loss is the difference between the current cost and historical cost of
the assets still on hand or unsold at the end of the year.
For ending inventory

Current cost at end of year xx
Unrealized holding gain (loss) xx
For depreciable property

Net current cost (current cost minus accumulated depreciation) xx
Less: Carrying amount xx
For nondepreciable property (land)

Current cost at end of year xx
Preparation of current cost income statement
Sales
Sales are made at current selling prices throughout the period and therefore not restated.
Cost of goods sold
In current cost accounting, cost of goods sold equals the current cost of the units sold at the time
of sale.
In practice, cost of goods sold i is equal to the average unit cost multiplied by the units sold
during the period.
Operating expenses
Operating expenses are measured at current cost when incurred.

Accordingly, these expenses are already stated on a current. cost basis.
Depreciation
Depreciation is based on average current cost of the property, plant and equipment.
Income tax
Income tax is already on a current cost basis.
However, the income tax is computed on the basis of the income under historical cost.
Current cost statement of financial position
Cash and receivables
These items are already reported on a current cost basis in conventional statements and are
therefore not restated.
Inventory
Inventory is stated at current. cost at end of reporting period.
Property, plant and equipment
Land is stated at current cost at end of reporting period.

Depreciable property, plant and equipment are shown at current cost minus accumulated
depreciation based on current cost at year-end.
Payables
Payables are conventionally reported on a current basis and therefore do not require restatement.
Share capital and share premium
These items are not restated
Retained earnings
The balance of retained earnings is obtained from the current cost statement of retained earnings.
Current cost retained earnings ~ January 1 xx
Add: Current cost net income xx
Total xx
Less. Dividends declared or paid xx
Current cost retained earnings - December 31 xx
1. In current cost financial statements
a. General price level gains or losses are recognized.

b. Amounts are always stated in common purchasing power.
c. All items are different from what they would be in g historical cost statement of
financial position.
d. Holding gains are recognized.
2. When an entity adjusted the historical cost income statement by applying specific price
index to depreciation, the income statement is prepared according to
a. Fair value accounting

b. Purchasing power accounting
c. Current cost accounting
d. Nominal peso accounting
3. When an entity prepares financial statements on a current cost basis, how is the cost of
goods sold computed?
a. Number of units sold times average current cost

b. Number of units sold times current cost at year-end
c. Number of units sold times beginning current cost
d. Beginning inventory at current cost plus cost of goods purchased less ending inventory at
current cost
4. In a period of inflation, an entity discloses income on a current cost basis. Compared to

historical cost income, which condition increases the current cost income?
a. Current cost is the same as historical cost.

b. Current cost of land is less than historical cost.
c. Current cost of goods sold is less than historical cost.
d. Ending net monetary assets are less than beginning.
5. Could current cost financial statements report holding gains during the period for which
of the following?
a. Goods sold
b. Inventory
c. Goods sold and inventory
d. Neither goods sold nor inventory
WHOOOOOO TAPOS EON.

Chapter 14: Cash and Accrual Basis

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Chapter 14: Cash and Accrual Basis

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CHAPTER 14: CASH AND ACCRUAL BASIS

Cash basis versus accrual basis

ITEM CASH BASIS ACCRUAL BASIS

So the main problem is the computation of purchases on account.

The items that decreased trade payables normally include:

DEFERRED INCOME (pg 382)

Thus, deferred income is a liability account.

Examples are unearned rental income and unearned interest income.

Problem 14-32 Multiple choice (IAA)

1. Under accrual basis of accounting, cash receipts and disbursements may

a. The cash basis is appropriate for smaller entities.

a. Revenue is recorded when earned.

4. Under the cash basis of accounting, revenue is recorded

a. When earned and realized

5. Total net income over the life of an entity is

6. Under International Financial Reporting Standards

a. The cash basis of accounting is accepted.

7. Accrual accounting adheres to which of the following?

a. Deferral of revenue occurs when cash is received and recognized in financial

9. Under accrual basis, a deferral is a transaction that impacts

a. Cash and the income statement at the same time

10. Which statement is true about accrual and cash basis?

Problem 14-33 Multiple choice (AICPA Adapted)

a. Total assets would decrease and shareholders’ equity would increase

a. Lower than the balance on December 31, 2020

CHAPTER 15: SINGLE ENTRY

Characteristics of single entry

This system is called the double entry system of bookkeeping.

The major record under the single-entry system is the cashbook.

The cashbook is maintained showing all receipts and disbursements.

Single entry method

Preparation of financial statements

CHAPTER 16: ERROR CORRECTION

Errors can arise in respect of the recognition, measurement, presentation or disclosure of

Prior period errors

Treatment of prior period errors

A prior period error shall be corrected by retrospective restatement, meaning, if comparative

Statement of financial position errors

Income statement errors

If the error is discovered in 2021, no reclassifying entry is made.

Combined statement of financial position and income statement errors

Effects of counterbalancing errors

a. The income statements for two successive periods are incorrect.

Counterbalancing errors normally include the misstatement of the following:

Overstatement of ending inventory

On December 31, 2019, the physical count was overstated by P50,000.

Retained earnings 50,000

On December 31 2019, the physical count was understated by. P50,000.

Inventory, January 1, 2020 50,000

The physical inventory on December 31, 2019 was correctly stated.

Retained earnings 50,000

Overstatement of purchases and ending inventory

2. Retained earnings 50,000

The physical inventory was correctly stated on December 31, 2019.

Thus, they equalize each other.

Overstatement of sales Understatement of ending inventory

1. Retained earnings 50,000

2. Inventory, January 1, 2020 30,000

Thus, they equalize the effect-on net-income.

Failure to record prepaid expense

Failure to record accrued expense

Retained earnings 50,000

Failure to record a deferred income