Acc211 Week 1-3 Sim

College of Accounting Education
3F, Business & Engineering Building

Matina, Davao City
Phone No.: (082)300-5456 Local 13
Investment Property
Big Picture in Focus: ULOa. Discuss the nature and purpose of

investment; ULOb. Apply the measurement criteria of the investment
property; ULOc. Apply the recognition of transfers between investment
property and ULOd. Journalize transactions affecting investment
property.
Metalanguage
In this section, the most essential terms relevant to the study of Investment Property
is discussed as provided for in IAS 40 and explained and to demonstrate ULOa to d
will be operationally defined to establish a common frame of reference as to how the
texts work in your chosen field or career. You will encounter these terms as we go
through the study of Investments property. Please refer to these definitions in case
you will encounter difficulty in understanding accounting rules/concepts on investment
property.
IAS 40 provides for the following definitions:
a. Carrying Amount. It is the amount at which an asset is recognized in the statement of

financial position.
b. Cost. Is the amount of cash or cash equivalents paid or the fair value or other
consideration given to acquire an asset at the time of its acquisition or construction?
c. Fair value. Is the price that would be received to sell an asset or paid to transfer for a
liability in an orderly transaction between market participants at the measurement date.
d. Investment property. Is property (land or building – or part of a building or both) held
(by the owner or by the lessee as a right of use asset) to earn rentals or for capital
appreciation or both.
e. Owner-occupied property. Is property held (by the owner or by the lessee as a right of
use asset) for use in the production or supply of goods or services or for administrative
purposes.
To perform the aforesaid big picture (unit learning outcomes) for the first three (3)
weeks of the course, you need to fully understand the following essential knowledge
that will be laid down in the succeeding pages. Please note that you are not limited to
exclusively refer to these resources. Thus, you are expected to utilize other books,
research articles and other resources that are available in the university’s library e.g.
ebrary, search.proquest.com etc.
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Phone No.: (082)300-5456 Local 13
1. International Accounting Standards 40 Investment Property40 (IAS 40) replaces

IAS 40 Investment Property issued 2000. This standard shall be referred to in the
recognition, measurement and disclosures of investment property.
2. Investment Property. Investment properties per IAS 40 (IAS, 2003) refers to land
or buildings held primarily to earn rentals or for capital appreciation,are not used for
production or administrative purposes of the business, are not held for resale in the
ordinary course of business.It generates cash flows that are largely independent of
the other assets of the entity.
2.1 Examplesas enumerated in the standard paragraph 8 included the following:
a. Land held for long-term capital appreciation;

b. Land held for currently undetermined use;
c. Building owned by the reporting entity, or (a right of use asset relating to a building
held by the entity) and leased out under one or more operating leases;
d. Building that is vacant but is held to be leased out under one or more operating
leases; and
e. Property that is being constructed or developed for future use as investment
property.
Accordingly, the standard provides that an entity that owns a property leased to a
parent or subsidiary reports the property as investment property in its individual
financial statements.
However, in the consolidated financial statements the said property shall be reported
as an owner-occupied property.
On the other hand, an entity that owns a property which is used for earning rentals or
capital appreciation and also some portions for administrative purpose, the same
property shall be reported separately if it can be rented or sold separately. (IAS 40,
par.10)
If it cannot be rented or sold separately, it is reported as investment property, only if

the proportion used for administrative purpose is insignificant.
If there is more than an insignificant portion that is used as owner-occupied, then the
entire property is reported and accounted for under IAS 16 on property, plant and
equipment.
3. Recognition: IAS 40 paragraph 16 on Recognition states that “An owned

investment property shall be recognized as an asset when, and only when:
a. It is probable that the future economic benefits that are associated with the
investment property will flow to the entity; and
b. The cost of the investment property can be measured reliably.”
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Matina, Davao City
Phone No.: (082)300-5456 Local 13
4. Initial Measurement: IAS 40 par. 20 states that an investment property shall be

measured initially at cost.
Cost includes the purchase price, transaction costs and any directly attributable
expenditure such as professional fees, property transfer taxes, and other transaction
costs.
The cost of a self-constructed investment property is the cost at the date when the
construction or development is complete.
The standard in paragraph 24 further provides that if payment is deferred, the cost is
the cash price equivalent with the difference as interest expense over the credit
period.
In case of an exchange, paragraph 27 sets out the determination of the cost of the
investment which ismeasured at thefair valueunless the exchange transaction lacks
commercial substance.
If it lacks commercial substance or the fair value of neither the asset given up or asset
received is reliably measurable, this case, the investment in property is measured at
the carrying amount of the asset given up.
IFRS 16 applies the cost measurement for an investment property held by a lessee
as a right-of-use asset.
Costs excluded from cost of investment property as per IAS 40 par. 23 are as follows:
a. Start-up costs unless necessary to bring the property to the condition necessary
for its intended use,
b. operating losses incurred before the investment property achieves the planned
level of occupancy,
c. Abnormal amounts of wasted material, labor or other resources incurred in
constructing or developing the property.
5. Subsequent measurement of investment property: An entity shall choose either

of the following models as their accounting policy and shall apply that policy to all of
the investment property:
Fair value model – IAS 40 paragraph 33 states that an entity choosing the fair value
mode shall measure all of its investment property at fair value with any changes in fair
value included in profit or loss of the current year it has occur.
These changes in the fair value of investment property every end of the year is debited
as loss from change in fair value and is credited to gain from change in fair value
when the fair value of the investment property increased.
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Matina, Davao City
Phone No.: (082)300-5456 Local 13
Cost model – IAS 40 paragraph 56 states that an entity that chooses the cost model
shall measure investment property;
1.In accordance with IFRS 5 Non Current Asset held for sale and Discontinued
Operations if it meets the criteria to be classified as held for sale;
2 In accordance with IFRS 16 if it is held by a lessee as a right of use asset and is

not held for sale in accordance with IFRS 5;
3. In accordance with the requirements in IAS 16 for cost model in all other cases.
IAS 16 paragraph 30 provides that cost model carries asset at cost less accumulated
depreciation and accumulated impairment losses.
The discussion further provides that even if it carries investment property through the
cost model, fair value disclosure is still required and is necessary.
Illustration (Adapted) : Dao Ming Company engaged into construction of a Super

Mall for the purpose of earning rentals from tenants. The construction was completed
on January 1, 20A with total cost of 130,000,000. The property has a useful life of 10
years and residual value of 13,000,000.
An independent valuation was provided regarding fair value of the property at each
year end.
Dec. 31, 20A 156,000,000
Dec. 31, 20B 162,500,000
Dec. 31, 20C 149,500,000
The self-constructed property is recorded initially at the cost when the construction is
completed which is 130,000,000.
Subsequently, it will be measured either by cost model or revaluation model. The

following are the entries using the two methods for the three years.
Cost Model: Revaluation model:

Depreciation expense 11,700,000 Investment property 26,000,000
Acc. Depreciation 11,700,000 Gain from change in FV
26,000,000
Depreciation expense 11,700,000
Acc. Depreciation 11,700,000 Investment property 6,500,000
Gain from change in FV 6,500,000
Depreciation expense 11,700,000
Acc. Depreciation 11,700,000 Loss from change in FV 13,000,000
Investment property 13
,000,000
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Matina, Davao City
Phone No.: (082)300-5456 Local 13
6. Transfers of Investment Property IAS 40 provides that “transfers of Investment

Property to and from shall be made when and only when there is a Change of use
evidenced by:
a. Ccommencement of owner occupation

b. Commencement of development with a view to sale
c. End of owner-occupation
d. Ccommencement of an operating lease from owner-occupied property to
investment property.
Measurement of Transfers:
IAS 40 provides for the following guidelines in cases of transfers:
a. When fair value model is used, transfers from investment property to owner-
occupied or inventories, the deemed cost shall be made at fair value at the date of
change of use. (IAS 40, par. 60)
b. If owner-occupied property is to be transferred as investment property under fair

value model, the difference between the carrying amount and fair value shall be
treated as revaluation in accordance with IAS 16. (IAS 40, par. 61)
c. An inventory transferred to investment property to be carried at fair value, any

difference between the fair value and the previous carrying amount shall be included
in profit or loss. (IAS 40, par 63)
d. An investment constructed is completed which is to be carried at fair value, any

difference between fair value and carrying amount shall be included in profit or loss.
(IAS 40, par. 65)
7. Derecognition of Investment property: IAS 40 paragraph 66 provides the criteria

on derecognition of investment property. It states that an investment property shall
be derecognized on disposal, when permanently withdrawn from use or the moment
it no longer provides future economic benefits expected from its disposal.
It further provides that gain or loss from disposal of investment property shall be
determined as the difference between the net disposal proceeds and carrying amount
of the asset and shall be recognized in the profit or loss.
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Matina, Davao City
Phone No.: (082)300-5456 Local 13
Illustration (Adapted) : Continuing the first illustration, if the investment property was carried at
cost model and is sold for a selling price of 96,000,000 on Dec.31, 2019, what is the entry on the
disposal of investment property?
Investment property 130,000,000130,000,000-13,000,000/10*3

Depreciation expense for 3 years 35,100,000
Carrying amount 94,900,000
Selling price 96,000,000
Gain on disposal1,100,000 answer
Cash 96,000,000
Accumulated depreciation 35,100,000
Investment property 130,000,000
Gain on disposal 1,100,000
Assume further the same problem information, except that the revaluation model has been
used by the company, and the investment was sold for a selling price of 143,000,000, the
answer to the question and the entry upon sale of the investment property on Dec. 31, 20C
will be:
Selling price 143,000,000
Less: Fair value 12/31/19 149,500,000
Loss on sale of investment property 6,500,000 Answer
The 149,500,000 fair value is the carrying amount of the investment property on Dec. 31, 20C
since the model is revaluation model.
Year Account Titles F Debit Credit

Cash 143,000,000
Loss on sale of investment
property 6,500,000
Investment property 149,500,000
8. Disclosure Requirements: The following should be disclosed but not limited to:
a. Whether the fair value or cost model is used;
b. The extent whereby there is an independent valuation or the fact that there is
none;
c. The amount recognized in profit or loss for rental income on investment property,
direct operating expenses that generated and that does not generate rental income
during the period.
d. Obligations to purchase, construct or develop investment property or for repairs
or maintenance that is contract-based;
For disclosure not mentioned above and disclosures specific for companies using cost
model and revaluation model, please read on
https://www.iasplus.com/en/standards/ias/ias40#link8and
https://www.pkf.com/media/10031777/ias-40-investment-property-summary.pdf retrieved
May 27, 2020,be ready for an oral recitation.
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Matina, Davao City
Phone No.: (082)300-5456 Local 13
After your readings of these, please proceed to problem 1 and problem 2 and
answer. Your answers to these problems will be part of your assignments. For any
questions, you may raise it through LMS, my email, chat group or through a text. To
finally check your answers, I will post my solution to the problems including the
journal entries needed.
Please observe the deadline set for the activities as laid down at the end of this
coverage of week 1 to week 3 discussion.
KEYWORDS INDEX
This section lists down the keywords that help you for recall the discussions.
Investment Property Fair Value Cost model
Accumulated Carrying Amount Fair value model
Depreciation
Depreciation Gain or Loss on sale Loss on Sale
Owner-occupied Revaluation Model Cost
Self-Help: You can also refer to the sources below to help you
further understand the lesson:
*VALIX (2015). Financial Accounting: Volume 1. Manila, Philippines: GIC Enterprises & Co
International Accounting Standards. (2003b). IAS 40 – Investment Property. Retrieved from

http:www.iasplus.com/en/standards/ias/ias40
https://www.pwc.com/gx/en/audit-services/ifrs/publications/applying-ifrs-for-the-real-estate-
industry.pdf retrieved May 26, 2020
https://www.iasplus.com/en/standards/ias/ias40#link8 retrieved May 26, 2020
https://www.pkf.com/media/10031777/ias-40-investment-property-summary.pdf retrieved
May 27, 2020
Weydgant, J., kimmel P., Kieso D.- Fianncial Accounting IFRS.pdf
file:///C:/Users/canque%20evelyn/Downloads/Weygandt%20J.,%20Kimmel%20P.,%20Kies
o%20D.%20-%20Financial%20Accounting%20IFRS.pdf retrieved June 1, 2020
J. David Spiceland, Mark W. Nelson, Wayne B. Thomas Intermediate Accounting 10 th
edition, McGrawhill higher education 2019.pdf
https://drive.google.com/file/d/1bZ4wSMaqrIG8OTSwkAplJ2ehwk40MtBB/view retrieved
June 1, 2020
Q&A LIST
Do you have any questions for clarification?
Questions/Issues Answers
1. 1.
2. 2.
3. 3.
4. 4.
5. 5.
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Matina, Davao City
Phone No.: (082)300-5456 Local 13
Big Picture in Focus:

ULO e. Discuss the nature and purpose of fund;
ULO f. Apply the accounting for sinking fund and other funds;
ULO g. Apply the recognition of cash surrender value of life insurance
policy.
FUND AND OTHER INVESTMENTS

Metalanguage
In this section, the most essential terms relevant to the study of Fund and other
Investments is discussed and explained and to demonstrate ULOe to g will be
operationally defined to establish a common frame of reference as to how the texts
work in your chosen field or career. You will encounter these terms as we go through
the study of Fund and other Investments property. Please refer to these definitions in
case you will encounter difficulty in understanding accounting rules/concepts on fund
and other investments.
1. Fund. “Cash and other assets set aside for specific purpose whether for current (Petty
Cash, Dividend fund, Tax fund) or for non-current purpose (Plant expansion, Contingency,
Sinking Fund).
2. Sinking Fund. Is also termed as redemption fund for the purpose of liquidating long term
debts.
3. Preference share redemption fund. A fund set aside specifically for the redemption of
preference shares.
4. Contingency Fund. Is a fund set up for meeting obligations arising from contingencies
such as pending lawsuits or tax disputes?
5. Insurance fund. Set up to meet obligations from risk of loss from typhoons, explosions
and other similar events where the company has no insurance policies on kits assets.
6. Cash surrender value. “ Is the amount which the insurance firm will pay upon the
surrender and cancelation of the life insurance policy.”
7. Loan Value. “Is the amount which the insured can borrow from the insurance firm with
the cash surrender value as collateral security.
Essential Knowledge
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Phone No.: (082)300-5456 Local 13
1. Accounting for Fund under the administration of the entity:
Establishment of fund for different purposes is becoming very common more and
more now a days not only to business. Even in the households, it is often commonly
referred to.
Applied in an accounting entity, when the fund established is administered by the

entity because it does not want to hire the expertise of a trustee, emphasis on the
form of the fund whether it is in the form of cash, securities and other assets is very
important.
To establish the sinking fund, the company must transfer the cash from its general
cash account to a sinking fund account. The account title used is sinking fund cash.
The company may make appropriation of retained earnings equal to the amount of
cash transferred to the fund. Hence the entry requires the appropriation of retained
earnings by transferring said amount from unrestricted retained earnings to retained
earnings appropriated.

Retained earnings unappropriated XX
RE Approp. For fund XX
The entity is in charge with making the fund to raise earnings, therefore it is but
appropriate and necessary that the cash in the sinking fund is used to purchase
investment securities.
Reclassifying it from sinking fund cash is necessary. Hence the entry to classify it to
sinking fund securities shall be made while crediting/deducting it from sinking fund
cash account as follows:

Sinking Fund Securities XX
Singing Fund Cash XX
Any interest earned on the sinking fund securities mean recognition of sinking fund
income(credit) is made with a debit to sinking fund cash if it has been received, if not
yet received at the end of the period, then it is debited as accrued interest receivable
as follows:
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Phone No.: (082)300-5456 Local 13

Sinking Fund Cash XX
Sinking Fund XX
Income
To record Fund income received.
Accrued interest receivable XX

Sinking Fund Income XX
To record fund income
earned but not yet received.
At the end of the year, the total of the sinking fund shall be determined by adding its
components such as sinking fund cash, sinking fund securities and accrued interest
receivable and comparing it with the ledger balance of appropriated retained earnings.
The increase in the amount shall be made to increase appropriation of retained

earnings because the total sinking fund increased. The entry to record the increase
of the appropriation to retained earnings is as follows:

Retained earnings XX
Retained earnings Approp. XX
This means that after recording the additional appropriation the total of the sinking
fund and appropriated retained earnings must be equal or the same.
In a sale of sinking fund securities, the proceeds of the sale is debited to sinking fund
cash because it now becomes part of the sinking fund cash composition and no longer
as sinking fund securities.
Any difference in the selling price and cost of sinking fund securities is credited as
gain on sale.
The entry to record the sale of the fund securities will be as illustrated below:

Sinking Fund Securities XX
Gain on Sale of SF
securities.
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Phone No.: (082)300-5456 Local 13
If the sinking fund is used to retire a liability for which it was set up, example retirement
of a bond, then, the de-recognition/cancelation of the said liability is required and a
credit to sinking fund cash.
The entry in retiring the liability is:

Bonds payable XX
Retirement of
bonds.
Since the purpose of establishment of the fund has been made, any balance after
then shall be restored or returned to the general cash account;
Thus,
Cash XX
To transfer to
general cash.
As a result, the retained earnings appropriation is also released and shall be returned
to the unappropriated retained earnings; hence cancellation of retained earnings shall
be made as follows:
R/E- appropriated debit XX
To cancel
appropriation.
Summary:
To Establish the Sinking Fund: Transfer Sinking Fund Cash XX
cash to the fund account Cash XX
To record appropriation of Retained Retained earnings XX

Earnings: appropriate free retained Retained earnings App. XX
earnings equal to the fund initially
established.
To record purchase of fund securities: Sinking Fund Securities XX

Reclassify the amount used to purchase Sinking Fund Cash XX
securities from SF-cash to SF-
Securities.
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Phone No.: (082)300-5456 Local 13
Fund Income received Sinking Fund Cash XX

Sinking Fund Income XX
Fund income earned but not yet Accrued interest receivable XX

received Sinking Fund Income XX
End of the accounting period: Increase Retained Earnings XX

of the total fund requires additional Retained Earnings appropriated
appropriation of retained earnings. XX
Sale of Sinking Fund Securities at a gain Sinking Fund Cash

Sinking Fund Securities
Gain on sale of SF securities
Retirement of liability using the Fund Bonds payable XX

To record payment of liability
out of the fund.
Transferring back the excess Fund to Cash XX

the general cash account. Sinking Fund Cash XX
Release of the retained earnings Retained earnings appropriated XX

appropriated for the fund. Retained earnings XX
Accounting for Fund under the administration of the entity: The following
transactions are provided to facilitated discussion of Fund under the administration of
the entity:
The Problem: (Adapted) Isabella Company’s transactions on its sinking fund are as
follows and it also maintains retained earnings appropriation for that matter.
Dec.31,20A To record 4,000,000 of cash Sinking Fund Cash 4,000,000

transferred to the sinking fund. Cash
4,000,000
To record appropriation of retained

earnings to the fund. RE- unappropriated 4,000,000
RE- app. for SF 4,000,000
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Matina, Davao City
Phone No.: (082)300-5456 Local 13
The P4,000,000 sinking fund cash was

invested in 12% bonds, the purchase Sinking Fund securities 4,000,000
price equal to the face value of 4,000,000. Sinking Fund cash
The investment pays semi-annual 4,000,000
intereston April 1 and October 1. To record purchase of sinking
fund securities from the SF – cash.
October 1, 20AReceived the interest on

the SF securities.
Sinking fund cash 240,000
Sinking fund income 240,000
Dec. 31, 20A Transferred another
4,000,000 to the sinking fund.
Sinking fund cash 4,000,000
Cash
Dec. 31, 20AAccrual of interest for the 4,000,000
year end.
Accrued interest receivable

Dec. 31, 20A Appropriated RE equal to 120,000
the fund Sinking fund income
120,000
R/E- unappropriated 4,360,000

R/E- approp. for SF 4,360,000
The total Sinking fund amounted to 8,360,000 composed of SF Cash 4,240,000; SF

securities 4,000,000; Accrued interest of 120,000. Whereas the retained earnings
appropriated had a ledger balance of 4,000,000, therefore it requires an additional
appropriation of 4,360,000 to equate the amount of retained earnings with the Sinking
Fund balance.
- If a sale of SF securities at 105 is Sinking fund cash 4,200,000

later made, the entry would be: Sinking fund securities 4,000,000
Gain on sale of securities 200,000
- If the fund is used to retire a liability Bonds payable (face value) XX
for which it was set up example
Interest expense XX
retirement of a bond.
Sinking fund cash XX
- The entry to record the return of the
sinking fund cash to the general Cash XX
fund is: Sinking Fund XX
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- The release of the appropriated

retained earnings is: Retained earnings appropriated XX
RE unappropriated
XX
When the fund has been used for what it has been set up for, then the cash balance
should be returned back to the general cash account, while the retained earnings
appropriation must be cancelled.
To determine the balance of the Sinking Fund cash balance to be returned to the
general cash account, it is easier if the ledger or T-account is used.
2. Fund under the administration of a trustee:
Fund under the administration of a trustee maintains only one account title which is
Sinking Fund – trustee and does not need the details composing the fund.
Further, recording of the transaction about the fund can only be made when the
company receives the report from the trustee.
Such report includes purchase, sale of securities, earnings and expenses of the fund.
The following should be noted and applied in problem in connection with fund under
the administration of a trustee;
Establishing the fund by transferring cash from the general account to an account
debited as Sinking fund – trustee is required to separate it from cash which is not
restricted. The proforma entry is as follows:

Sinking Fund - Trustee XX
Cash XX
Hence, this cash fund is classified as noncurrent asset.
From the trustee’s report; the following are analyzed altogether to prepare one
compound entry regarding the effect of the report on the sinking fund – trustee;
a. When the trustee reports about fund expenses out of the fund; recording sinking
fund expense with the same deducted from sinking fund – trustee is done. Hence,
the entry will be as follows:
Sinking Fund - expense XX
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Sinking Fund – Trustee XX
b. The recognition of sinking fund income for interest received or earned with same
amount increases the sinking fund- trustee. The entry the is:

Sinking Fund - trustee XX
Sinking Fund – Income XX
c. Gain or loss on sale of securities is recognized when sale of securities above cost
or below cost is reported by the trustee. Gain on sale increases sinking fund - trustee
while loss on sale of securities decreases sinking fund –trustee.

Sinking Fund - trustee XX
Gain on Sale of Securities XX
Again, these entries are not individually recorded because the analysis of the trustee’s
report is done periodically and hence, from that report, a compound entry to take into
the effect of the transactions on the Sinking Fund on the hands of the trustee.
When the trustee reports that the fund has been used to pay off the liability for which
it was set up for,the entry will be:
Bonds payable XX
Sinking Fund – trustee XX
Since the sinking fund has been used to pay off the liability for which it has been
established, therefore the entity will now receive the remittance from the trustee of the
remaining balance of the sinking fund – trustee and the amount shall be reclassified
to the general cash account which is unrestricted.
Transactions/illustrations: (Adapted
Valix 2017)
a. Contributed 4,000,000 to the sinking Sinking fund – trustee 4,000,000
fund under a trustee. Cash 4,000,000
b. Trustee’s report contained the
following: cash 1,000,000, 2,000,000
No entry is necessary.
was invested in securities, 1,000,000
in money market placements.
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c. Received a periodic report from Sinkingfund - trustee(4560-

trustee: securities were sold for 4000)560,000
2,600,000 and interest received on Sinking fund expense
the money market placements was 140,000
100,000.
Sinking fund income
Trustee’s Report:
100,000
Sinking fund cash 1,000,000
Gain on sale of securities
Money market placement 1,000,000 600,000
Total 2,000,000
Receipts:
Sale of securities 2,600,000
Interest 100,000
2,700,000
Total 4,700,000
Disbursements:
Trustee’s fee 100,000
Admin. expense 40,000 140,000
Sinking fund balance
4,560,000
d. When a trustee pays a company’s

bond liability of 4,000,000 with
interest of 400,000 out of the fund,
the entry is: Bond’s payable 4,000,000
Interest expense 400,000
e. Received remittance from the trustee Sinking fund – trustee4,400,000
of the balance.
Cash 160,000
Sinking fund-trustee 160,000
To transfer back the fund to
the general cash account.
The gain on sale of securities is the difference in selling price of 2,600,000 and the
cost of the securities which is 2,000,000.
The amount credited for sinking fund income is self explanatory from the trustee’s
report and also the total expense of 140,000.
The cash remittance from the trustee amounting to 160,000 is the ledger posting
results with total debits to sinking fund trustee of 4,560,000 and total credits of
4,400,000, therefore a 160,000 ledger balance.
Since the purpose of the fund to retire a bond liability has been met, then the sinking
fund should be returned back to the general cash account.
20
Matina, Davao City
Phone No.: (082)300-5456 Local 13
To check your understanding of the above, please refer to Exercise 1 and 2 in the
Let’s Analyze portion and answer. Your answer form part only of the class
participation graded as assignments/seatwork. You may check the correctness of
your answer through LMS where I will be posting answer to the said problem. Had
no internet connection, you may contact me via text message.
Sinking Fund Contribution. Sinking fund contribution computation requires your

previous knowledge on the topic time value of money.
The amount of contribution to the fund can be voluntary or mandatory.
The annual contribution may be at the end of each year, in advance or can also be
made one time contribution.
To review your prior knowledge, you may as well click on this site https://www.business-
case-analysis.com/sinking-fund.html for computation of the amount of contribution
requiredto accumulate the funds needed at some certain future time.
When the annual contribution is at the end of each year, the amount to be
accumulated is to be divided by the future value factor in an annuity of 1 at a certain
percent for the many periods in order to get the annual contribution required.
When the annual contribution is made at the beginning of each year or in advance,
the amount to be accumulated is to be divided by the FV of an annuity of 1 in advance
at 12% for certain years to get the annual contribution required.
In case of a One time contribution, to get the one time contribution at the start of the
year, the amount to be accumulated shall be divided by the FV of 1 at 12% for certain
many years.
The preparation of the table of accumulating the fund, the first annual contribution is
multiplied to the rate(%) used to get the first year’s interest. To get the second year’s
interest, the fund balance of the first year is multiplied to the given rate (%).
Fund balance is the annual contribution plus interest.
Illustration: Date Interest Contribution Fund

Example 1:To accumulate 2,000,000 at balance
the end of year 4, what is the annual 12/31 418,471
contribution at the end of each year if it 418,471
is at the rate of 12% compounded 12/31 50,217 418,471
annually? 887,159
12/31 106,459 418,471
1,412,089
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Step 1:Get the future value factor of an 12/31 169,440 418,471

ordinary annuity 1 at 12% for 4 years. It 2,000,000
is 4.7793.
Step 2: Divide 2,000,000 by the FV
factor. It is 418,471.
Example 2: Same data as above except Date Interest Contribution Fund

that the annual contribution is made at balance
the beginning of each year or in 1/1 373,636
advance. 373,636
Step 1: Get the FV of an 1/1 44,836 373,636
annuity of 1 in advance at 792,108
12% for 4 years which is 1/1 95,053 373,636
5.3528. 1,260,797
Step 2. Divide 2,000,000 1/1 151,296 373,636
by 5.3528 which is 1,785,729
373,636. 12/31 214,271
2,000,000
Example 3: One time contribution. In Date Interest Contribution Fund

a one time contribution, get the FV of 1 balance
at 12% for 4 years which is 1.5735 and 1/1 1,271,052
divide 2,000,000 by that factor. 12/31 152,526 1,423,578
12/31 170,829 1,594,407
12/31 191,329
1,785,736
12/31 214,288 2,000,000
To check your understanding of the above points, please refer to exercise 3 in the
Let’s Analyze portion. Answering this problem facilitates your learning and will also
form part of your class participation/assignments. You may check the correctness of
your answer through LMS where I will be posting answer to the said problem. Had
no internet connection, you may contact me via text message.
3. Preference Share Redemption Fund, Contingency Fund and insurance fund.
Preference share redemption fund is among the non current assets of an entity in its
statement of financial position.
Thus, discussions on preference share redemption fund is simple. It involves two

accounting considerations;
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a. The setting up of the fund; and the

b. Redemption of the preference shares using the fund.
The journal entries involve on the above mentioned are provided for as follows:

Preference Share redemption fund XX
Cash
To record establishment of fund.
Preference share capital (par XX

value)
Retained Earnings XX
P/S Redemption Fund XX
To record redemption of preference
shares.
Understanding the entry provided, the difference in redemption price and the par value
of the preference share is charged against retained earnings and not to be regarded
as loss because this is in equity.
On the other hand, Contingency Fund focuses upon its purpose which is for meeting
obligations arising from contingencies.
Hence, the two accounting considerations are as follows:
A. The establishment of the fund

B. The entry when the fund is used to pay for contingency.
For example, a company that has an expectation regarding an event(lawsuit in which

it is probable that the company may lose the suit) that has occurred having negative
impact on the company, establishes a fund for the matter. The purpose of which is
for the company to have readily available funds when the settlement is due. The
entries on the said events were as follows:
Contingency Fund XX
Cash XX
To establishment the contingency
fund.
Loss on lawsuit
XX
Contingency fund XX
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Settlement of the
lawsuit.
Insurance Fund arecash for purposes of meeting obligations arising from risks such
as fire, typhoon and other similar events from which the companies are not insured
to.
This is usually set up because the company has not taken an insurance policy for its
assets.
As the entity establishesthe fund, it simply must be debited to Insurance fund and
crediting cash because it is transferred to a cash fund for a long term purpose.
In the event of disaster or similar natural calamity, the entry to eliminate an asset that
has been destroyed is required.
The carrying amount of the asset is eliminated with the difference charged as a loss
from typhoon or appropriate account.
The insurance fund that is used for building up new facility is credited equal to its cost
with a corresponding debit to the appropriate asset account.
If the insurance fund runs short for the cost of the new facility, then the company
spends additional cash for it.
Illustration (Adapted) : A building with accumulated depreciation of 1,800,000 and a

historical cost of 4,800,000 has been completely destroyed by an explosion which is
currently under investigation. The owner entity of the said building has no insurance
for the building except that it created its own fund which it has annually contributed
240,000 for five years amounting to total of 1,200,000.
After sometime, the entity builds a new building using the fund. The total cost of the
building amounted to 6,000,000.
The following entries are prepared for the transaction above in connection with the
entity’s insurance fund.
To record the annual contribution to the fund, the entry is:

Insurance Fund 240,000
Cash 240,000
To establishment the insurance
fund.
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To record the building that has been destroyed by explosion:

Accumulated Depreciation 1,800,000
Loss on Fire
3,000,000
Building 4,800,000
To record the new building constructed:

Building 6,000,000
Insurance fund 1,200,000
Cash 4,800,000
To facilitate your learning and understanding on the following funds for different
purposes, please refer to problem 4 in the Let’s Analyze portion. Your answer is part
of the graded assignments, and of your accumulated class participation of 10%
equivalent of your grade. To see if your answer is correct, you may check the answer
from LMS forum or upload, group chat or via text in case you have no internet
connection.
4. Cash Surrender Value. Is the amount which the insurance firm will pay upon the
surrender and cancelation of the life insurance policy.
It only arises in a Life Insurance Policy, provided that premiums for three full years
were made and the policy is surrendered at the end of the third year or anytime
thereafter.
In the view point of the business, this is in connection with a company insuring its
officers and names itself as beneficiary to compensate for the loss of service from an
untimely death.
If the beneficiary is the officer insured or anyone but not the company, there is no
accounting complication, the entry for the payment of the premium is simply to debit
insurance expense and to credit cash.
If the company is the beneficiary, the following are the important considerations;
The insurance premiumpaid is accounted for in the same manner as you are taught
in your basic accounting. The amount paid is debited to insurance expense with
corresponding credit to cash.
Year end adjustment to recognize the prepaid portion of the insurance should be
prepared when the fund year does not coincide with the calendar year of the company.
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The preparation of reversing entry shall be made for the adjusting entry prepared at
the end of the accounting period.
Any amount of dividend received for by the entity in the fund is debited to cash and
reduces life insurance expense.
Over time, cash surrender value increases due to payments made and valuation
increases for the excess of payments and interest income over the cost of the
insurance.
The initial value of the cash surrender value at the end of the full 3 years should be
recognized with a debit to cash surrender value. The corresponding credit is life
insurance expense equivalent to the current year’s insurance expense while the prior
years is through retained earnings.
In the following year, the increase in cash surrender value should be recognized with
the effect of reducing life insurance expense during the period equal to the amount of
the increase in cash surrender value.
Upon the death of the officer, the company shall receive the cash equal to the value
of the policy.
It is to be noted that adjustment to record the increase in cash surrender value for the
portion from previous end of the year cash surrender value until the time of death shall
be taken by debiting Cash surrender value and a credit to life insurance expense.
The gain on life insurance is the difference between the policy proceeds and the sum
of the unexpired insurance and the balance of cash surrender value.
Thus creditsare insurance expense for the unexpired portion paid during the year and
cash surrender value for its balance as recorded.
Summary:
a. To record payment of the insurance Life insurance expense XX

premium. Cash XX
b. To record unexpired portion during Prepaid life insurance XX
the year.
Life insurance expense XX
c. To record dividends received on
the policy. Cash XX
d. To record initial recognition of CSV.
Cash Surrender Value XX
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The Cash surrender value applies to three years, so the current year is charged to life
insurance expense, while the prior year is through retained earnings.
e. To record CSV subsequent to Cash surrender value XX

third year. Life insurance expense XX
f. Entry upon the receipt of the life Cash XX
policy is recorded as:
Cash Surrender Value XX
Life insurance expense
XX
Gain on life insurance
settlementXX
Solve:
Face of Policy XX
Less: CSV XX
Unexpired premium XX XX
Gain on life insurance XX
Illustration 1 (Adapted) : Gabi Company insured the life of the president for
3,000,000, the entity being the beneficiary. The yearly premium is 90,000. The policy
was dated January 1, 20A and has the following cash surrender value:
End of policy year Cash surrender value
201A -
20B -
20C 90,000
20D 126,000
20E 174,000
The entity followed the calendar year as the accounting period. The president died
June 30, 20E and the policy was collected on July 31, 2021.
Applying the concepts above, the entries and amounts for this problem are presented
below:
201A Life Insurance expense 90,000

Cash 90,000
201B Life insurance expense 90,000
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Cash 90,000
20C Life insurance expense 90,000
Cash 90,000
Cash surrender value 90,000
Life insurance expense 30,000
Retained Earnings 60,000
201D Life insurance expense 90,000
Cash 90,000
201E Life insurance expense 90,000
Cash 90,000
Cash 3,000,000
Gain on settlement 2,805,000
Cash surrender value of 90,000 / 3 = 30,000 the amount for current year is credited
to life insurance expense while the previous years will be credited for retained
earnings.
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In 20E, the cash surrender value increase is equal to only one half of the
48,000(difference in 174,000 and 126,000) from Jan.1 20E to June 30, 20E because
the president died on this date and the policy is thus receivable this date. Life
insurance expense is credited for the amount which is unused from July 1, 20E to
Dec. 31, 20E.
When the policy year does not coincide with the accounting year, the entity’s
additional entry is the preparation of the adjusting entry to set up the prepaid
insurance expense at the end of December 31 of each year and also the preparation
of the reversing entry at the beginning of the next accounting period which is January
1.
To test your understanding of the above mentioned, please refer to Exercise 5 and 6
on the Let’s Analyze portion and answer. Your answer will be graded Assignment
and accumulated class participation. You may raise question and compare your
answers through LMS where I will upload the answer or directly via group chat or
through text.
Final Note: Since we have reached the end of the discussion on Fund and other
investments, please be reminded that submissions of all exercises will form part of
your graded quizzes. You may submit in accordance with the deadline set or earlier
The schedule is laid down at the end of the discussion of week one to week three
coverage. Late submission is equivalent to point deductions.
KEYWORDS INDEX
Cash Surrender value Fund Life Insurance policy
Sinking Fund Contingency Fund Fund Contribution
Insurance Fund Insurance premiums Life Insurance expense
*VALIX (2017). Financial Accounting: Volume 1. Manila, Philippines: GIC Enterprises

& Co
https://www.business-case-analysis.com/sinking-fund.html , retrieved May 26, 2020
https://www.accountingtools.com/articles/2017/5/5/cash-surrender-value, retrieved May 26,

2020
https://www.business-case-analysis.com/sinking-fund.html retrieved May 26, 2020
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ULO h. Discuss the nature, purpose, and types of derivatives;
ULOi. Apply recognition and measurement criteria in accounting for
derivative instruments.
Metalanguage
In this section, the most essential terms relevant to the study of Derivative instruments
is discussed and explained and to demonstrate ULOh to i will be operationally defined
to establish a common frame of reference as to how the texts work in your chosen
field or career. You will encounter these terms as we go through the study of Derivative
instruments. Please refer to these definitions in case you will encounter difficulty in
understanding accounting rules/concepts on derivatives.
The following are defined and described in the International Accounting Standards 39
paragraph 9 as follows:
1. Firm Commitment. A binding agreement for the exchange of a specified quantity

of resources at a specified price on a specified future date.
2. Forecast Transaction. An uncommitted but anticipated future transaction.
3. Hedged item is an asset, liability, firm commitment, highly probable forecast transaction
or net investment in a foreign operation.
4. Hedging instrument. A designated derivative or non derivative financial asset or
nonderivative financial liability whose fair value or cash flows are expected to offset
changes in the fair value or cash flows of a designated hedged item.
Essential Knowledge
Managing business involves the presence of a lot of risk. Different companies employ
different strategy to minimize some of the business risks that they are facing. Thus,
the relevance of accounting for hedging.
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Hedged items may include but not limited to the following examples:
a. A recognized asset or liability, firm commitment, highly probable transaction;
b. A portion of the cash flows or fair value of a financial asset or financial liability.
IAS 39 requires hedges to meet criteria for hedge accounting such as the formal
designation of the hedging relationships (formal documentation, the risk management
objective of the entity and hedging strategy.
Derivatives.Is a financial instrument whose value changes in response to the change

in an underlying variable; it requires no initial investment or a very small one and to
be settled at a future date. (iasplus.com)
Furthermore, it enumerates examples as follows:

A.Futures
b. Option
c. Forward
d. Interest Rate Swap
IAS 39.43 provides that all Financial Assets and financial Liabilities are initially
measured at fair value.
IAS 39 on Financial Instruments paragraph 86 enumerates hedging of three types:

a. fair value hedge;
b. cash flow hedge;
c. hedge of a net investment in foreign operation as defined in IAS 21.
Further, it describes the following as:
Fair value hedge - a hedge that could affect profit or loss attributable to a particular
risk of exposure to changes in fair value of a recognized asset or liability or an
unrecognized firm commitment.
Cash flow Hedge - a hedge that could affect profit or loss on the risk of exposure to
variability in cash flows attributable to a particular risk associated with a recognized
asset or liability or a highly probable forecast transaction and could affect profit or
loss.
Cash Flow hedge shall be accounted for in accordance with IAS 39 paragraph 95 as
follows:
a. Gain or loss – on effective hedge shall be recognized in other comprehensive income;
b. Gain or loss – on ineffective portion shall be through profit or loss.
IAS 39 par 97 provides that the recognized gains and losses through OCI associated
with a cash flow hedge recognizing financial asset or financial liability shall be
reclassified from equity to profit or loss as reclassification adjustment in the same
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period or periods during which the hedged forecast cash flows affect profit or loss
(such as the periods interest expense are recognized).
Interest Rate Swap (Cash Flow Hedge)
This transaction entered into give rise to interest rate swap receivable or payable and
an unrealized gain or unrealized loss representing increase or decrease in the fair
value of the swap receivable or payable and due to passage of time.
When the interest rate goes up or higher applicable for next period, what occurs is a
recognition of an asset and an unrealized gain.
When the prevailing interest rate is lesser than the agreed fixed rate, then what
occurred is an interest rate swap payable on the part of the company and the
recognition of the unrealized loss-interest rate swap is necessary.
The unrealized gain or unrealized loss is a component of other comprehensive income

because the derivative is a cash flow hedge( IAS 39 Paragraph 95).
The determination of the amount of swap receivable or swap payable at the end of
the current year is computed as the amount of difference between the fixed rate
agreed and the prevailing rate multiplied by the amount of the loan and the present
value factor of 1 for a number of periods from date today (usually the year end) ‘til its
final settlement.
The interest rate swap receivable will be received by the company at the end of the
next period.
On the reverse, the interest rate swap payable will be paid by the company at the end
of next period.
The net interest expense that must be reported is the amount so agreed which has
been fixed in the agreement.
Thus, the unrealized gain – interest rate swap or unrealized loss – interest rate swap
is closed to interest expense.
If it was Unrealized loss – interest rate swap increases recorded interest expense
based on prevailing rate and when it is unrealized gain – interest rate swap, it reduces
interest expense initially recorded based on prevailing rate.
Illustration 1 (Adapted) :
On Jan. 1, year 1, Hollow Company received a 5 year variable interest rate loan of
10,000,000 with interest payment at the end of each year and the principal to be
repaid on Dec. 31, year 5. The interest rate for year 1 is 10% and the rate in each
succeeding is equal to the market interest rate on Jan. 1 of each year. Hollow
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company entered into an interest rate swap agreement with another bank. Market
rates of interest: Jan. 1, year 1 at 10%, Jan. 1, year 2 at 11%, Jan. 1, year 3 at 8%,
Jan. 1, year 4 at 6% and Jan. 1, year 5 at 7%.
Journal entries:
Jan. 1, year 1 Solve: 10%-11%=1% * 10,000,000=
Cash 10,000,000 100,000*3.10 PV factor of 1 in an ordinary
Loans payable 10,000,000 annuity for 4 years = 310,000
Dec. 31, year 1

Interest expense(10,000,000*.10)1,000,000
Cash 1,000,000
Interest rate swap receivable 310,000

Unrealized gain – int. Rate swap 310,000
Dec. 31, year 2
Interest expense 1,100,000 (11%*10,000,000) = 1,100,000
Cash 1,100,000
To record interest payment.
Cash 100,000 1,100,000-1,000,000 = 100,000

Interest rate swap receivable
100,000
Collection of the interest swap payment
from the speculator bank.
Dec. 31, year 2

Unrealized gain – interest rate swap
100,000
Interest expense
100,000
Offset of the unrealized gain against
interest expense.
Unrealized gain – int. rate swap 210,00

Interest rate swap receivable
210,000
Cancelation of the balance of interest
swap receivable and related UG
because of reduced interest rate on Jan.
1, year 3. Solve: 10%-8%=2% * 10,000,000=
200,000 * 2.58 PV factor of 1 at 8% for 3
Dec. 31, year 2 periods = 516,000
Unrealized loss – interest rate swap (8%*10,000,000) = 800,000

516,000 Interest rate swap
payable 516,000
1,000,000-800,000 = 200,000
Dec. 31, year 3
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Cash 800,000
Note that the amount of interest expense to
Interest rate swap payable 200,000 be reported should be the hedged cash flow
Cash for interest which is 10*10,000,000 =
200,000 1,000,000
To record interest swap
payment to the speculator. Solve: 10%-
6%=4%*10,000,000=400,000*1.83 PVOA
Interest expense 200,000 at 6% for 2 periods
Unrealized loss –IR swap = 366,000- 316,000 UL balance per book
200,000 = 416,000 increase in UL
Dec. 31, year 4 (6%*10,000,000) = 600,000

Unrealized loss –interest rate swap
416,000
Interest rate swap payable
416,000
Dec. 31, year 4

Cash 600,000
To record payment of
interest. Solve: 10%-
7%=3%*10,000,000=300,000*.93 PV of 1 at
Interest rate swap payable 400,000 7% =279,000 – 332,000ULperbook=
Cash 400,000 53,000 decrease in unrealized Loss( UL)
To record interest rate swap payment to the
bank speculator.

Unrealized loss –IR swap
400,000
Interest rate swap payable 53,000

Unrealized loss – int. rate swap 53,000
Dec. 31, year 5

Interest expense (7%10,000,000)
700,000
Cash 700,000
Interest rate swap payable 279,000

Unrealized loss –IR swap 21,000
Cash 300,000

Unrealized loss –IR swap 300,000
Loans payable 10,000,000

Cash 10,000,000
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To self check your understanding of this cash flow value hedge, please refer to
Exercise 1 in the Let’s analyze portion. It is for your graded quiz. Please feel
comfortable to raise your concerns and questions Monday to Friday through LMS,
group chat or text. Submit photo upload of your answer which is handwritten. Late
submission is equivalent to point deduction.
In Fair value hedge: receive fixed, pay variable- Interest rate swap: IAS 39
paragraph 89(a) provides that gain or loss from remeasuring the hedging instrument
at fair value shall be recognized in profit or loss.
Hence, the Note payable is measured at fair value.Interest expense is initially

recorded at the amount paid.
At every year end any change in fair value of the note payable is recognized as gain
or loss on note payable through profit or loss.
There is gain when the fair value of the note payable decreases and a gain on note
payable when the fair value of the note payable is higher than the carrying amount in
which it is to be reported through profit or loss.
The fair value of the note is the sum of the present value of principal plus present
value of interest payments.
A loss on interest rate swap and interest rate swap payable is to be recognized when
the market rate is higher than the fixed rate computed as the difference between the
fixed rate and market rate multiplied to the face value of the note and multiplied to the
present value factor of 1 at the market rate appropriate for the periods.
The loss or gain on interest rate swap is reported immediately through profit or loss
because this is a fair value hedge.
IAS 39 paragraph 92 provides that when the fair value of the note is less than the face
value, the difference is amortized through interest expense by the effective interest
method at the end of next period.
Illustration (Adapted) :On January 1, 20A, Canque Company borrowed 3,000,000

from Alpas bank at a 10% fixed interest rate.
The interest is to be paid annually on December 31 of each year and the principal to
be repaid on December 31, 20C. The loan is evidenced by a promissory note.
On January 1, 20A, the entity entered into a “receive fixed, pay variable” interest rate
swap with a speculator and has designated the swap as a fair value hedge of the fixed
interest rate loan.
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The market rate of interest on January 1 of each year determines the interest swap
settlement to be made every December 31.
Market rates of interest:

January 1, 20A 10%
January 1, 20B 12%
January 1, 20C 14%
The present value of 1 at 12% for two periods is .7972 and the present value of an
ordinary annuity of 1 at 12% for two periods is 1.69.
The following are the entries in connection with the above problem:
January 1, 20A Cash 3,000,000

Note payable 3,000,000
To record the borrowing of
cash.
Dec. 31, 20A
Interest Expense 300,000
Cash 300,000
Note payable 101,400

Gain on note payable 101,400
To record change in fair value.
The carrying amount of the note payable at the beginning and fair value of the note payable
at the end of the year is compared because this is a fair value hedge.
Thus: Carrying amount on Jan. 1, 20A 3,000,000
Fair Value on Dec. 31, 20A PV of interest (3,000,000*.10*1.69) 507,000
PV of principal 3,000,000*.7972 2,391,600 2,898,600
Decrease in liability 101,400
Another entry is to recognize that the entity has a swap payable because the market rate is
higher than the agreed upon fixed rate of 10%.
Date Account Titles F Debiit Credit
12/31/A Loss on interest rate swap 101,400
Interest rate swap payable 101, 400
To record swap payable.
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12/31/20B Interest expense 2898,600(*.12) 347,832
Cash 300,000
Note payable 47,832
To record interest payment and

amortization of discount on note
payable.
The effective interest method is used whereby the difference between Face Amount*nominal
rate and Fair value *effective rate is the amount of amortization.
Hence, the entry above can be journalized separately as:
Cash 300,000
And: Interest expense 47,832

Note payable 47,832
The effect of amortization of discount on note payable where carrying amount is less than face
amount increases interest expense and note payable while the effect of amortization of
premium on note payable where carrying amount is higher than face amount is decreasing
interest expense and note payable.
Year-end comparison of note payable carrying amount and fair value to determine increase
or decrease in liability for recording fair value hedge;
Carrying amount of note payable December 31, 20B

FV 12/ 31, 20A 2,898,600
+ Amortization Dec. 31, 20B 47,832 = 2,946,432
Fair value of note payable Dec, 31, 20B
PV of interest 300,000*.8772 263,160
PV of principal 3,000,000*.8772 2,631,600 2,894,760
Decrease in liability 51,672

12/31/20B Note payable 51,672
Gain on note payable 51,672
To record decrease in
liability.
12/31/20B Interest rate swap payable 60,000

Cash (.02*3,000,000) 60,000
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The swap payment at the end of the year 20B is the difference between the 10% and 12%
multiplied to 3,000,000 principal loan.
The beginning balance of swap payable was 101,400, the cash paid for the swap payment is
60,000, so the balance per book is 41,400. The swap payable computed this year is actually
the ending balance of the swap payable computed as 3,000,000*.04* PV of .8772 amounting
to 105,264, and is to be settled next year. Therefore an increase of 63864 should be taken
up.
Swap payable 105,264
Less: swap payable per book 41,400
Increase in swap payable to be recorded 63,864
The 4% is the difference between the agreed upon 10% versus the 14% applicable rate for
year 20C.

Loss on interest rate swap 63,864
Interest rate swap 63,864
payable
To record the
increase in swap payable.
12/31, 20C Interest expense 405,240

Cash 300,000
Note payable 105,240
Fair value 20B * .14 2,894,760 * . 14 405,266

Face value * .10 3,000,000 *.10 300,000
Amortization in 20C 105,266 or 3,000,000- 2,894,760=
105,240
105,240 is used since it is the final year, just bring up the balance equal to the
3,000,000 face amount of the note payable.

12/31/20C Interest rate swap payable 120,000
Cash 120,000
To record swap payment
since market rate is higher.
The amount is the difference between 10% and 14% multiplied to the face amount of
3,000,000 which is 120,000.
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The final swap settlement requires the entry to recognize loss on interest rate swap since
200,000 cash payment is more than the interest rate swap payable balance which is

Loss on interest rate swap 14,736
Interest rate swap 14,736
Final cash payment of 120,000 less the carrying amount of the swap payable (120,000-
105,264)
Is the amount of additional loss on interest rate swap.
The final entry is the settlement of the note payable by simply debiting note payable at
3,000,000 and crediting cash at 3,000,000.
To self check your understanding of fair value hedge, please refer to Exercise 2 in the
Let’s analyze portion. It is for your practice to be able to answer the graded activity
in the exercise portion. Please feel comfortable to raise your concerns and questions
Monday to Friday through LMS, group chat or text.
Forward Contract
It is designated as a cash flow hedge; an agreement to purchase or sell a specified

commodity or a foreign currency at a specified price with settlement on a future date
at a specified price.
If the market price is higher than the underlying price, the company will record a
forward contract receivable and unrealized gain-forward contract.
On the date of the actual purchase, purchases is recorded equal to the market price
and the unrealized gain-forward contract is to be closed by crediting/deducting it from
purchases.
The unrealized gain-forward contract is recognized through other comprehensive

income because this is a cash flow hedge.
Illustration (Adapted) : On Jan. 1, 20A, Entries:

Gem company expects to make a Dec. 31, 20A
purchase of 100,000 kilos of a commodity Forward contract receivable 2,000,000
Unrealized gain –FC 2,000,000
on January 31, 20B at the prevailing
Jan. 31, 20B
market price. As protection against the Forward contract receivable 500,000
variability of market price, Gem company Unreal. gain –forward
entered into a forward contract with a contract500,000
speculator bank at 150 and the excess is
paid by the bank while if the market price Cash 2,500,000
drops, Gem company will pay the bank for Forward contract rec’ble 2,500,000
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the difference. Market price of the To record cash received

commodity on Dec. 31, 20A is at 170 and from the speculator.
on Jan. 31, 20B is at 175.
Purchases (175)(100,000)
175-170=5(100,000) = 500,000 17,500,000
Cash
17,500,000
To record the actual
purchase.
Unreal. gain – forward

contract2,500,000
Purchases 2,500,000
Futures Contract. Is similar to Forward contract however this one is traded in a

futures exchange market, so the parties do not know who is on the other side of the
contract.
Any unrealized gain – futures contract is through OCI because this is a cash flow
hedge.
Illustration (Adapted): Darna company Dec. 31. 20A

uses 150,000 kilos of a fruit juice Futures contract receivable
concentrate each month. On Dec. 31, 1,500,0000
20A, it entered into a futures contract to Unrealized gain –futures contract
purchase 50,000 kilos on Feb. 1, 20B at 1,500,00
a fixed price of 50 per kilo. The market Feb.1, 20B
prices on Dec. 31, 20A and Feb 1, 20B Purchases(150,000*52) 7,800,000
were 60 and 52 respectively. Cash 7,800,000
Unrealized gain – futures contract

Solve: 1,200,000
(60-52*150000)= 1,200,000 Futures contract receivable
1,200,000
Cash 300,000
Futures contract rec’ble 300,000
To record payment from the exchange
market speculator.
Unreal. gain – futures cont.

300,000
Purchases
300,000
Option
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Is a derivative investment whereby the price movements are based on an underlying

which is the price movement of another financial product.
An option is a right, call option on the part of the buyer to buy the product at the
predetermined price (strike price) before the option expiration.
It is to be paid for and that amount paid is called option premium.
The call option can be:

a. In the money when the underlying asset price is above the call strike price;
b. Out of the money when the underlying asset price is below the strike price;
c. At the money when both are the same.
The call option is a receivable from the speculator.
The difference between a futures contract and an option is that the holder is obliged
to fulfil the terms stated in the futures contract while option gives the holder the right
to buy or sell the underlying asset at expiration.
Any unrealized gainin an option is reported as component of OCI since it is designated

as a cash flow hedge.
After the actual purchase the unrealized gain is credited/deducted against purchases.
In the event that the actual market price on the date of actual purchase is lesser than
the strike price, the company may purchase at the lower price and losses the upfront
cash paid for the call option.
Thus the entry will involve a debit to loss on call option and unrealized gain with credit
of call option.
Illustration (Adapted) - Call option

On December 1, 20A, the expectation of Stanford company for a raw material is at
200,000 units scheduled to be purchased at the middle of 20B. In protection against
the movement of prices, Stanford entered into a call option contract with a
speculator by paying 100,000 for the option on Dec. 1, 20A. Market prices of the
commodity were as follows: Strike price – Dec. 1, 20A at 50, Dec. 31, 20A at 52
and July 1, 20B at 55.
Solve: 200,000*2(50-52)
= 400,000-100,000 payment for the option
= 300,000
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12/1/20A Call option 100,000
Cash 100,000
12/31, Call Option 300,000

20A
Unrealized gain – call option 300,000
7/ 1/ 20B Call option 600,000

= 200,000 * 5 (50-55)-
400,000 BV
Cash 1,000,000
Call option
1,000,000
Purchases 11,000,000
Cash
11,000,000
= 55*200,000

Purchases
900,000
To facilitate your learning and understanding of forward contract, futures contract and
option, please refer to Exercise 3, 4 and 5 and answer with solution. Submission,
inquiries and clarifications of the subject matter will part of your graded accumulated
10% class recitation and 10% quizzes.
Final Note: Since we have reached the end of the discussion on Derivatives, please
refer to Let’s Analyze, Nutshell and Let’s Check portion of the SIM and make sure to
answer everything.
Submissions will form part of your graded assignments. You may submit according
to the deadline set at the end of this SIM for week one to 3 cover period. Late
submission is equivalent to point deductions.
KEYWORDS INDEX
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PROPERTY, PLANT AND EQUIPMENT

ULO j. Explain the nature and characteristics of property, plant and
equipment;
ULO k. Identify the specific items of property, plant and equipment;
ULOl. Apply the recognition and measurement of property, plant and
equipment.
Metalanguage
In this section, the most essential terms relevant to the study of Property, plant and
equipment is discussed and explained and to demonstrate ULOh to i will be
operationally defined to establish a common frame of reference as to how the texts
work in the business field. You will encounter these terms as we go through the study
of property, plant and equipment. Please refer to these definitions in case you will
encounter difficulty in understanding accounting rules/concepts on property, plant and
equipment.
IAS 16 defines the following terms in the following manner:
1. Depreciable Amount. Is the cost of an asset, or other amount substituted for cost, less
its residual value.
2. Depreciation. Is the systematic allocation of the depreciable amount of an asset over its
useful life.
3. Entity specific - value. Is the present value of the cash flows an entity expects to arise
from the continuing use of an asset and from its disposal at the end of its useful life or
expects to incur when settling a liability.
4. Fair Value. Is the price that would be received to sell an asset or paid to transfer a liability
in an orderly transaction between market participants at the measurement date.
5. Impairment Loss. Is the amount by which the carrying amount of an asset exceeds its
recoverable amount.
6. Recoverable Amount.Is the higher of an asset’s fair value less costs to sell and value in
use.
7. Residual Value. The estimated amount that an entity would currently obtain from disposal
of the asset, after deducting the estimated costs of disposal, if the asset were already of
the age and in the condition expected at the end of its useful life.
8. Useful life. The period which an asset is expected to be available for use by an entity or
the number of production or similar units expected to be obtained from the asset.
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ESSENTIAL KNOWLEDGE
1. Property, Plant and Equipment.IAS 16.6 under IFRS property, plant and
equipment are the tangible items that are held for use in production or supply of
goods/services, for rental to others, for administrative purposes and are expected to
be used for more than one period (IAS 2003)
Examples include the following but not limited toland, Building, Machinery, Furniture
and Fixtures, Tools, Book plates, patterns and dies.
1.2 Recognition. IAS 16.7 recognition requirement of PPE states that when it is probable
that future economic benefits associated with the item will flow to the entity and the item’s
cost must be measured reliably (IAS, 2003a)
1.3 Initial Measurement. IAS 16 paragraph 15 provides that the Property, Plant and
equipment are measured at cost.In paragraph 16, the elements of cost are enumerated
as follows:
a. Purchase Price including all non recoverable tax and duties, net of discounts
b. Directly attributable costs to bringing the asset to the location and condition
necessary for its intended use.
c. Estimates of dismantling, removing and restoration costs when the company has
the obligation under criteria for recognition in IAS 37.
IAS 16 paragraph 17 laid down examples of directly attributable costs of the asset for
it to be capable of operating that will be part of the cost of the asset as follows:
a. Cost of employee benefits arising from construction and acquisition of property, plant
and equipment;
b. Delivery and handling
c. Cost of Site preparation
d. Installation and assembly costs
e. Cost of testing the asset for proper functioning
f. Professional fees directly attributable to the purchase
In paragraph 19 of IAS 16, the following costs do not form part of the cost of property,
plant and equipment:
a. Cost of opening new facility
b. Cost to advertise and promote new product
c. Cost of conducting business in new location
d. General and administrative costs
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In the book entitled “Intermediate Financial Accounting “ Volume 1, by Glenn Arnold

and Suzanne Kyle some examples of costs that should not be included in the initial
capitalized amount are as follows:
a. Initial operating losses
b. Training cost for employees
c. Other revenue or expenses that are incidental to the development of the property,
plant and equipment.
Subsequent measurement.
IAS 16 par. 29 on subsequent measurement provides that anentity may choose either
the cost model or revaluation model applied to the entire class of Property, Plant and
Equipment as its accounting policy.
Cost model (IAS 16 par. 30) After recognition at cost, property, plant and equipment
must be carried at cost less accumulated depreciation and accumulated impairment
losses.
Revaluation model (IAS 16 par.31) After initial recognition of the properties, shall be
carried at revalued amount less any subsequent accumulated depreciation and
subsequent impairment losses.
IAS 16 paragraph 43 provides further for the separate depreciation for an item of
Property, Plant and Equipment hat has a significant cost related to the total cost of
the item.
The charges for depreciation in each period shall be made through profit or loss. (IAS
16, par 48)
Depreciation method. The method to be used and selected by the entity shall be
that one reflective of the pattern of consumption of the asset’s future economic
benefits.
Any change to reflect such change in the consumption pattern shall be treated as a
change in accounting estimate and discussed in accounting changes IAS 8.
Derecognition. IAS 16 par. 67 applies to the derecognition of an asset on disposal

or when no expected future benefits can be derived from the asset.
The amount eliminated shall be equal to the carrying amount of the asset to be
derecognized.
Any gain or loss appertaining to de-recognition shall be included in the determination

of profit or loss at the time it was derecognized.
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The said gain or loss on de-recognition is computed as the difference between the
net disposal proceeds and its carrying amount.
Acquisition of property, plant and equipment.
MyLove Company had the following acquisitions of properties:

a. Purchased land and building for 6,000,000 lump sum price, and the building has a
fair value of 3,000,000 and land of 1,000,000
b. Purchased a machine at an invoice price of 1,000,000, 2/10, n/30.
The following acquisitions shall be recorded as follows in accordance with the

accounting concepts.
a. Cash basis. - Cost of asset is cash paid plus directly attributable costs.
In the case of a “lump sum price”, the price is to be allocated to each asset purchased
on the basis of fraction of their fair value.
Building (4/5*6,000,000) 4,500,000

Land (1/5*6,000,000) 1,500,000
Cash 6,000,000
b. Acquisition on account. Cost of the asset is equal to the invoice price less the
discount whether taken or not.
Discount taken is deducted from the cost of the property, so the asset purchased is
credited for the amount of the discount taken.
Discount not taken is still deducted from the cost of the property, and the asset
purchased is also credited equal the amount. In addition, a purchase discount lost is
debited.
The following are the entries under the gross method and net method:
Gross Method:
Machinery 1,000,000
Accounts payable 1,000,000
Accounts payable 1,000,000

Cash 980,000
Machinery
20,000
Payment within the discount period.
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Accounts payable
1,000,000
Purchase discount lost 20,000
Cash 1,000,000
Machinery 20,000
If payment is beyond discount period.
Net Method:
Machinery 980,000
Accounts payable 980,000

Cash 980,000
Payment within the discount period.

Purchase discount lost 20,000
Cash 1,000,000
If payment is beyond disc.
Period.
Installment basis. IAS 16.23 provides that when the property, plant and equipment
is on a deferred basis, the interest therein based on market rate is regarded as interest
over the credit period.
The cost is equal to the cash equivalent price, if and when there is cash price
available.
The difference between the cash price equivalent and the instalment price is regarded
as interest expense amortized over the credit period.
On the date of transaction, the note payable is credited at face amount and a discount
on note payable is debited, to reflect the initial carrying amount of the note payable.
The amortization of the discount on note payable increases interest expense and
reduces the balance of the discount on note payable.
The effect of amortization is increases the carrying amount of the note payable.
The illustration below uses the method of amortization which is outstanding balance
method.
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The preparation of the amortization per period is to add outstanding balance of note
payable per year and develop the fraction out of those amounts. Multiply each fraction
to the amount of discount on note payable to be amortized.
Illustration (Adapted) : The amortization is through

Geralene company bought a machine at an fraction of outstanding balance
instalment price of 700,000. A 100,000 down method as computed below:
payment is needed and the balance payable
BalanceFraction
thereafter in 3 equal annual instalments. The
1 600,000*6/12*120,000
cash price of the machine is 580,000. The
= 60,000
company issued a 600,000 promissory note for
2 400,000*4/12* 120,000
the balance.
= 40,000
3 200,000* 2/12 *120,000
= 20,000

1/1 Machinery 580,000
Discount on Note payable 120,000
Notes payable 600,000
Cash 100,000
To record
issuance of note.
12/31 Notes payable 200,000

Cash 200,000
First installment
payment.

Disc. on notes payable 60,000
Amortization of
Discount.
12/31/yr2 Notes payable 200,000

Cash 200,000
2nd installment.

Disc. on notes payable 40,000
Amortization of
Discount.
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Installment basis: no cash price available.
The cost of the asset is equal to the present value of all payments using an implied
interest rate.
The difference between the total present value versus the face amount of the note
payable is regarded as discount on note payable to be amortized as interest expense
over the credit period by the effective interest method.
Illustration: Ravena company purchased computer at an installment price of

1,680,000; down payment 240,000; balance payable in 3 equal annual instalments
and a promissory note has been issued by the company. The implied interest rate is
10%. The present value factor of 1 at 10% for 3 periods is 2.487.
Solve: 480,000 * 2.487=1,193,760

-1,440,000
246,240
The Table of Amortization is prepared by the effective interest method as follows:
Yearly Interest Principal Present value

payment
1,193,760
480,000 119,376 360,624 833,136
480,000 83,314 396,686 436,450
480,000 43,550 436,450 -
The entries on the date of transaction appears below:

Machinery 1,433,760
Discount on N/P 246,2
40
Cash 240,000
Notes Payable 1,440,0
00
12/31/yr1 Notes payable 480,000
Cash
480,000
First instalment.
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Discount on N/P
119,376
12/31/yr 2 Notes payable

480,000
Cash
480,000
nd
2 Installment.
Interest expense
83,314
Discount On N/P
83,314
12/31/yr 3 Notes payable

480,000
Cash
480,000
3rd Installment.
Interest expense
43,550
Discount On N/P
43,550
The table of amortization using the effective interest method computes the interest
expense for the period as:
Initial Present value of the note * rate = interest expense for the 1st year
For the second year, the carrying amount of the note multiply to the rate and so on for
the third year.
Whereas the carrying amount is computed as the initial present value minus the
amount in principal to get the next periods carrying amount.
To get the principal is to deduct from the annual cash payment the interest portion of
the payment.
To facilitate your learning and understanding of the above points, please refer to
problem 1 in the Let’s analyze portion and answer what is required. Any inquiries,
clarifications and submissions of answer to the problem will form part of your
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accumulated 10% class participation and grade quizzes/assignments. You may raise
your concerns through LMS, group chat or text message from Monday’s to Friday’s.
Acquisition by issuance of share capital.
The asset is recorded in an amount equal to the following order of priority:
a. Fair value of the property received;

b. Fair value of the share capital;
c. Par value or stated value of the share capital.
Share capital is credited at par and the excess is credited in the share premium
account.
The proforma entry to this transaction appear as follows:

Asset XX
Share capital XX
Share Premium XX
Acquisition by issuance of bonds payable.
The asset is measured in the following order of priority:

a. Fair value of bonds payable;
b. Fair value of asset received;
c. Face amount of bonds payable.
Bonds payable is credited at face amount and the excess is premium on bonds
payable.
When the carrying amount of the bonds is the measurement used, there is no
premium on bonds to be recognized.
The proforma entry of the above acquisition will be:

Asset XX
Bonds payable XX
Premium on Bonds XX
payable
Exchange. IAS 16.24 provides that the cost of an item of PPE acquired in an
exchange is measured at fair value as a general rule.
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Furthermore, the two instances wherein the general rule does not apply, is when the
assets fair value cannot be reliably measured and when the transaction lacks
commercial substance.
The recording then if it lacks commercial substance or in the absence of fair value
reliably measured, it is recorded at the carrying amount of the asset given up.
To have an understanding of commercial substance as against transaction that lacks

commercial substance, let us analyze it through the problem situation as adapted from
the book of Glenn Arnold and Suzanne Kyle.
Illustration: commercial substance (Adapted Suzanne Karl Intermediate

Financial Accounting vol.1)
“LinkedCompany decides to change its production process to accommodate a new

product that to be introduced next year. In connection with these,the company traded
a factory machine that is of no longer use for new machine useful to make the new
product. The machine to disposed of had an original cost of P78,000 and an
accumulated depreciation of P60,000. The fair value of the old machine at the time
of exchange was P22,000. The new machine being obtained has a list price of
P61,000. After a period of negotiation, the seller finally agreed to sell the new
machine to Linked Company for cash of P33,000 plus the trade in of the old machine.
As the old machine is essentially obsolete compared to the new one that can be used
to produce new products, then there is commercial substance.”

New machine 55,000
Accumulated depreciation 60,000
Old machine
78,000
Cash 33,000
Gain on exchange 4,000
To record the exchange.
Illustration (AdaptedGlenn Arnold and Suzanne Kyle): no commercial

substance
“LinkedCompany has a delivery truck purchased one year ago for P32,000.
Depreciation of P5,000 has been recorded to date on this asset. The company
decides to trade this for a new delivery truck in a different colour. Bothassets have
the same functionality and expected life. The only difference is the colour. No
identifiable cash flows can be associated with the effect of this exchange. The fair
value of the old truck at the time of the trade was P28,000. The seller of the new truck
agrees to take the old truck in trade, but requires Linked Company to pay an additional
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P5,000 in cash. This has no commercial substance because after the exchange
transaction, the economic position of the company has not been materially affected.”
New Truck 32,000
Accumulated Depreciation 5,000
Old Truck 32,000
Cash 5,000
The following order of priority in an exchange should then be observed:
a. Fair value of property given;

b. fair value of property received;
c. carrying amount of property given
The difference between the fair value of the property given or property received versus
the carrying amount of the asset given up is gain on exchange.
When carrying amount is the measurement base, there is no gain on exchange arising
from the transaction.
When there is cash involve, the asset acquired is recorded equal to

a. FV of asset given plus cash payment (payor);
b. FV of asset given minus cash received (recipient).
Lllustration (Adapted) : With cash involveMira and Lira exchanged machinery with
the following information:
Mira Lira
Machinery 800,000 1,000,000
Accumulated depreciation 450,000 675,000
Carrying Amount 350,000 325,000
Fair value 300,000 400,000
Cash paid by Mira to Lira 100,000 100,000
Books Of Mira:
Account Titles F Debit Credit
Equipment – new 400,000
Accum. Dep. 450,0
00
Loss on exchange 50,0
00
Equipment-old
800,000
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Cash 100,000
Books of Lira:
Account Titles F Debit Credit
Equipment – new 300,000
Cash
100,000
Accumulated Dep. 675,0
00
Equipment-old
1,000,000
In the books of Mira:
The new equipment is recorded at 400,000 which is the sum of the cash payment plus the
fair value of the old machine of 300,000.
The loss on exchange is the difference between fair value of 300,000 and the carrying
amount of the old machine which is 350,000.
Accumulated depreciation of 450,000 and the cost of the old equipment of 800,000 are
simply eliminated.
In the books of Lira:
The new equipment is recorded at 300,000 which is the sum of the fair value of Lira’s old
machine of 400,000 minus the cash received of 100,000 from Mira.
The accumulated depreciation of 675,000 and old equipment at cost are simply eliminated.
The gain on exchange is the difference between of 400,000 versus carrying amount of the
asset of 325,000 (1,000,000-675,000).
When the exchange lacks commercial substance, the property is measured at the
carrying amount of the asset given and no gain or loss to be recognized.
Trade In
Is a way to acquire an asset whereby it involves a significant amount of cash from

anon dealer acquiring the asset from a dealer of the asset.
It is accounted for under the following order of priority:
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Fair value approach – whereby cost is equal to FV of asset given plus cash payment
Trade in value approach – whereby cost is equal to trade in value plus cash
payment.
In fair value approach, the new equipment is recognized at an amount equal to the
fair value of asset given up plus the cash payment.
Accumulated depreciation and old equipment are simply eliminated.Cash is credited

because the company made payment of significant cash.
Loss on exchange is recognized as the difference between the fair value of asset
given versus the carrying amount of the asset given up.
If fair value is higher than the carrying amount, gain on exchange; if fair value is lower
than the carrying amount, loss on exchange.
In Trade in value approach, the new equipment is recognized at a cost equal to cash
payment plus the trade in value.
The carrying amount (accumulated depreciation and cost of the old equipment)of the
old equipment is simply eliminated.
The cash payment is recorded as credit to cash.
The difference between the trade-in value versus the carrying amount of the asset is
recorded as either gain or loss on exchange.
If trade in value is higher than carrying amount there is gain on exchange.If trade in
value is lowerthan carrying amount there is loss on exchange.
Illustration: An entity traded its old equipment for a new one. The following data
relates to the old and the new.
OldEquipment New Equipment
Cost 2,800,000 List price
4,000,000
Accumulated Dep. 2,000,000 Trade in value of old
(1,000,000)
Carrying amount 800,000 Cash payment
3,000,000
Fair value 700,000
Trade in value 1,000,000
Fair Value Approach:

Date Account Titles F Debit Credit
Equipment – new 3,700,000
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Accum. Dep. 2,000,00

0
Loss on exchange 100,00
0
Equipment-old
2,800,000
Cash
3,000,000
Trade In Value Approach:

Date Account Titles F Debit Credit
Equipment – new 4,000,000
Accum. Dep. 2,000,00
0
0
Equipment-old
2,800,000
Cash
3,000,000
To self assess your understanding of the above discussion on acquisition through

issuance of shares, bonds payable, trade in and exchange, please refer to problem 2
and 3 in the Let’s analyze portion and answer what is required. Any inquiries and
clarifications regarding the problem will form part of your accumulated 10% class
participation. You may raise your concerns through LMS, group chat or text message
from Monday’s to Friday’s.
All activities at the end of this discussion shall be submitted following the deadline set
for each topic laid down at the end of this whole coverage for first exam.
h. Donation.
In Philippine GAAP, contributions received from shareholders shall be recorded at the
fair value and credited to donated capital.
Any expenses in relation to the donated asset is charged or deducted from the
donated capital account.
i. Construction of building. Cost of constructed asset includes the following:

a. Direct cost of materials;
b. Direct cost of labor;
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c. Indirect cost and incremental overhead specifically identifiable or traceable to the

construction.
In the event that overhead is not specifically identifiable, it can be allocated on the basis of
direct labor cost as illustrated:
Liyanne had constructed an asset with following costs incurred:

Materials (Normal 2,500,000) 3,250,000
Labor (Normal 2,000,000) 2,500,000
Manufacturing overhead 2,250,000
The computation for the cost of building and finished goods will be:
Finished goods Building
Materials 2,500,000 750,000
Labor 2,000,000 500,000
overhead 1,800,000 450,000
6,300,000 1,700,000
In additionCost of Building Constructedalso includes the following:

a. cost of building permit/license;
b. Architect, fee;
c. superintendent fee;
d. cost of excavation;
e. cost of temporary buildings used construction offices and tools or material shed;
f. expenditures incurred during the construction period such as interest on
construction loans and insurance.
g. Expenditures for service equipment and fixtures made a permanent part of the
structure.
h. Cost of temporary safety fence around construction site and cost of subsequent
removal thereof. If the permanent fence is constructed after the completion of the
building, it is debited to land improvement.
i. Safety inspection fee
j. Sidewalks, pavements, parking lot, driveways should be charged to building if it is
part of the blueprint, if not then it is debited to land improvement.
k. Cost of insurance taken is charged to the building, if no insurance was taken and
something has happened, the cost for damages is expensed immediately and not to
be capitalized.
l. Building fixtures if immovable are charged to building, if movable it is charged to
furniture and fixtures.
m. Ventilating system, lighting system, elevator if installed during construction, it is
charged to the building. However if not, it is charged to building improvements and
depreciated to over their useful life or remaining life of the building whichever is
shorter.
Any miscellaneous amounts earned from the building during construction such as
rental of a portion completed, reduces the cost of the building.
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Cost of interest during construction is capitalized as cost of the property, however

computation is discussed in detailed in Borrowing Cost topic of this SIM.
Cost of property, plant and equipment is the cost and directly attributable cost to
make it available for its intended use.
Cost of Building purchased:

a. Purchase price
b. Cost to remodel and repair building acquired
c. assumed unpaid taxes
d. legal costs
e. real estate commissions
Cost of land purchase includes:

a. real estate commissions, legal fees, title search fees and similar fees
b. demolition cost of an old building
c. Draining and clearing
d. Filling
e. Grading
f. Encumbrances such as unpaid taxes
g. Local assessments for streets and sidewalks
Permanent landscaping and leveling
Land and building at a single cost. The land and building being purchased at a
single cost is determined as follows:
When the building is usable, the cost is allocated between land and building on the
basis of their fair value.
If the building is not usable, the full cost is charged to land including the cost of
removing the building less any salvage proceeds..
When a land with a building is purchased and the building is immediately demolished,
any allocated carrying amount of the usable building is charged to loss account if the
new building is accounted for a PPE or investment property.
If the new building is accounted for as inventory, the usable building carrying amount
that is immediately demolished is charged to the new building.
The demolition cost minus salvage value is capitalized as cost of the building if the
purpose to demolish is to give room for construction of a new building.
If the purpose to demolish is to prepare the land for the intended use but not to make
room for construction of a new building, the net demolition cost is charged to the land
account.
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To self assess your understanding of the above discussion, please refer to problem 6
and 7 in the Let’s analyze portion and answer what is required. Any inquiries,
accumulated 10% class participation and quizzes/assignments. You may raise your
concerns through LMS, group chat or text message from Monday’s to Friday’s.
j. Machinery. The following costs but not limited to are included in the cost of
machinery:
a. Purchase price including any irrecoverable or non refundable purchase tax (net of
discount whether taken or not)
b. Transportation fees, handling, storage and other cost related to the acquisition
c. Insurance while on shipment
d. Installation cost
e. Cost of testing and trial run
f. Assembly
g. Initial estimate of cost of dismantling and removing and restoring the site required
under IAS 37 on provision.
h. Fee paid to consultants
I. Other costs to make it ready for use in its intended location
The cost to dispose and remove old property is part of its loss on disposal of the old
machine and not capitalizable cost of the new one.
Asset Recognition Criteria sets out that subsequent cost is recognized and capitalized
if it will increase the future service potential of the asset (extends the life, increase the
capacity, improves the efficiency and safety) as there will be expected future benefits.
Spending for maintaining the current level performance does not result to
capitalization of the subsequent cost because there is no additional expected future
benefits. Therefore, it is to be expensed immediately.
Examples of subsequent costs includes:

a. Additions;
b. Improvements;
c. Replacements;
d. Repairs;
e. Rearranging cost.
Additions are of two types; an entirely new unit or expansion/enlargement/extension.
If it is an entirely new unit, the cost is depreciated over its useful life. If it’s not an
entirely new unit rather an expansion only, the subsequent cost is depreciated over
whichever is shorter between the useful life of the expansion or the remaining useful
life of the asset which it’s a part of.
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Improvements or betterments increase the service life or capacity of the asset such
as in improving a wooden shingle and substituted by a tile roof. Such expenditure is
capitalized as cost of the asset.
a. Replacements. It may be required for some properties at regular intervals. The

cost may be included in the carrying amount when it meets the criteria for recognition
as capitalizable subsequent cost as provided for in IAS 16.7.
IAS 16.13 provides for the derecognition provision of the carrying amount of the parts
replaced.
Replacements by a new one and replacement of major parts are subsequent costs
that are to be capitalized. Minor replacements are ordinary repairs to be expensed
immediately since it does not meet the criteria for recognition as an asset.
b. Repairs and maintenance. When extraordinary, it is capitalized while if it is

ordinary, tehnexpensed immediately.
c. Rearranging Costoccurs when the property is being moved from one place and is
installed to another place or location. It only maintains the existing level of standard
performance of the asset and thus expensed as incurred.
To self assess your understanding of the above discussion, please refer to problem
6, and 7 in the Let’s analyze portion and answer what is required. Any inquiries,
accumulated 10% class participation. You may raise your concerns through LMS,
group chat or text message from Monday’s to Friday’s.
Accounting for replacement – separate identification possible
To record the elimination of asset replaced, the carrying amount of the asset is
cancelled. The amount of difference is charged to loss on retirement of the old asset.
The recording of the New asset replaced at cost by recognizes the asset and a credit
to cash or other appropriate account.
To record the subsequent annual depreciation, the assets carrying amount including
the replacement is depreciated over the remaining useful life.
Replacement in which separate identification is impracticable:
Accounting process requires discounting at an appropriate discount rate.
The cost of replacement is multiplied at the present value of 1 of the appropriate

discount rate to get the amount to be eliminated as cost of the portion of building
replaced .
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The discounted amount is then credited as cost of the asset eliminated and
accumulated depreciation equal to percent depreciated with the amount of difference
charged as loss on retirement of the old asset.
The cost of the newly replaced asset is then recorded by a debit to asset and credit
to cash or other appropriate account.
The carrying amount of the asset including the replacement is then depreciated over
the remaining useful life.
Accounting for replacement – separate identification possible.
Illustration: Assume that a company has a Loss on ret.- building

building having a useful life of 20 years at a 100,000
cost of 2,500,000. After 10 years, the roof is Acc. Depreciation 100,000
replaced with a concrete roofing for a cost of Building 200,000
250,000. Separate identification reveals that To eliminate building roof
200,000 is an accurate estimate of the original replaced.
cost of the original wooden roof.
Cost (2500,000-200,000+250,0000) Building 250,000
2,550,000 Cash 250,000
A/D (1,250,000-100,000) (1150,000) To record cost of replacement
Carrying amount 1400,000/10 roof.
Subsequent depreciation 140,000
Depreciation 140,000
Acc. depreciation140,000
To record subsequent annual
depreciation.
Replacement – separate identification impracticable.The process requires

discounting at an appropriate discount rate. Using the same data above in 3.2, and
6% as discount rate appropriate, the entries would be:
Cost of replacement 250,000
PV factor of 1 at 6% for 10 years .558
Amount 139,500
The entry:
Loss on retirement of building 69,750
Accumulated depreciation 69,750
Building 139,500
Building 500,000
Cash 500,000
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To record
replacement.
Depreciation expense 143,025

Accumulated 143,025
depreciation
Year end
depreciation.
Building 2,500,000 + 250,000 – 139,500= 2,610,500

Accum dep. 1,250,000- 69,750= 1,180,250
Divide by remaining life 10
Annual depreciation 143,025
Disclosure Requirements:
a. Basis for measurement at carrying amount
b. Depreciation method used
c. Useful life
d. Reconciliation of carrying amount at the beginning and at the end of the period;
For details and additional disclosure requirements, please click on this link for further
reading: https://www.iasplus.com/en/standards/ias/ias16.
Since we have finished the coverage, please refer to the Let’s check portion and Let’s
Analyze and the “In a Nutshell” portion and answer. Submissions must be within the
deadline set at the end of this coverage for 1 st exam. Please observe that I will only
accept hand written uploaded photo of your answers with complete solution through
LMS. This is a graded quiz.
For your 10% project grade, answer the problems presented on this site and submit
your answers through LMS; https://www.accaglobal.com/us/en/student/exam-support-
resources/fundamentals-exams-study-resources/f7/technical-articles/ppe.html
KEYWORDS INDEX
Carrying Amount Accumulated Depreciation Revaluation model
Depreciation Donation Exchange
Fair Value Trade in value Capital expenditure
Cost Cost Model Depreciable Amount
Replacement Installment Construction
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Big Picture in Focus: ULOm. Explain the nature of depreciation; n.

Apply the proper accounting treatment of recognizing depreciation.
Metalanguage and Essential Knowledge

In this section, the most essential terms relevant to the study of Depreciation are
discussed and to demonstrate ULOm will be operationally defined to establish a
common frame of reference as to how the texts work in your chosen field or career.
You will encounter these terms as we go through the study of depreciation. Please
refer to these definitions in case you will encounter difficulty in the in understanding
accounting concepts.
To perform the aforesaid big picture (unit learning outcomes) for these weeks of the
course, you need to fully understand the following essential knowledge that will be laid
down in the succeeding pages. Please note that you are not limited to exclusively refer
to these resources. Thus, you are expected to utilize other books, research articles
and other resources that are available in the university’s library e.g. ebrary,
search.proquest.com etc.
1. Depreciation: Depreciation is used to account for ordinary, typical wear and tear of fixed
assets over time.
Depreciation has been defined as the systematic process of allocating the depreciable
amount over the useful life of the asset.
The amount periodically allocated is reported as expenses presented in the income

statement whether as general and administrative or part of selling expenses or
manufacturing overhead in case of manufacturing equipment.
The accumulated depreciation is a contra-asset account of the appropriate property, plant

and equipment.
In the definition of account titles, a contra asset is a deduction from the related account
title to arrive at its carrying amount.
The entry to recognize depreciation as part of year-end adjusting entry is:

Depreciation Expense XX
Accum. Depreciation – Asset XX
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IAS 16.50 indicates depreciable amount of an asset to be allocated on a systematic

basis over its useful life.
2. Depreciation Methods used:

A. Straight Line
B. Sum of the years digit
C. Double declining balance method
D. Output method
Straight line method:

a. Annual Depreciation = Depreciable Cost/Economic or useful life.
b. Depreciable cost = Cost - Residual value
c. Carrying amount = Historical cost less accumulated depreciation
d. Accumulated depreciation = The sum of depreciation expense over the period.
Example (Adapted) A machine is purchased on Jan. 1, 2017 costing 1,000,000 with
useful life of 5 years and a residual value of 100,000. The Depreciation table will
appear as follows:
Year Annual Depreciation Carrying Amount

1/1/2017 1,000,000
12/31/2017 180,000 820,000
12/31/2918 180,000 640,000
12/31/2019 180,000 460,000
12/31/20 180,000 280,000
12/31/20 180,000 100,000 Residual value
The entry to recognize depreciation expense for the year is to debit depreciation
expense with a corresponding credit to accumulated depreciation of 180,000.
At end of year 1, the Statement of Financial Position shall report accumulated

depreciation of 180,000 and a carrying amount of 820,000. In the Income statement,
depreciation expense reported is 180,000.
Sum of the years digit method:
SYD = ( life in years +1)*life in years

2 which is constant
Year 1 depreciation is computed as Depreciable amount * remaining life in year

1/SYD, in year 2 is Depreciable amount * remaining life in year 2/SYD and so on.
Example (Adapted) : On January 1, 2017, a machine costing 6,000,000 was

purchased and the SYD method is used. The useful life of the machine was 10 years
with a residual value of 500,000.
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Thus: The SYD = 55
The table of depreciation is presented below:
Date Annual Depreciation Accumulated Carrying

Depreciation Amount
1/1/2017 6,000,000
12/31/2017 10/55*5,500,000=1,000,000 1,000,000
5,000,000
12/31/2018 9/55*5,500,000=900,0000 1,900,000
4,100,000
12/31/2019 8/55*5,500,000= 800,000 2,700,000 3,300,000
12/31/2020 7/55*5,500,000=700,000 3,400,000
2,600,000
12/31/2021 6/55*5,500,000=600,000 4,000,000
2,000,000
12/31/2022 = 500,000 4,500,000 1,500,000
12/31/2023 = 400,000 4,900,000
1,100,000
12/31/2024 = 300,000 5,200,000
800,000
12/31/2025 = 200,000 5,400,000
600,000
12/31/2026 = 100,000 5,500,000 500,000
The year 2 Income statement shall report depreciation expense amounting to 900,000, accumulated
depreciation of 1,900,000 (year 1 plus year 2 depreciation expense) and a carrying amount at the end
of year 2 of 4,100,000.
3. Double declining Balance Method.
Annual depreciation = Carrying amount * double declining rate
Double declining rate = Straight line rate*2
Straight line rate = 100%/life in years
Illustration: (Adapted from Intermediate Accounting by Glenn Arnold & Suzanne

Kyle)
On January 1, 2017, Loverei company purchased for a packaging machine for

4,800,000 used in a factory with a useful life of 10 years and a residual value of
200,000. The machine was depreciated by the double declining balance method..
Thus: The double declining rate is 1/10=10%*2 = 20% or 100%/10*2= 20%
The depreciation table follows:
Year Annual Depreciation Accumulated Carrying Amount

Dep.
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1/1/2017 4,800,000
12/31/2017 4800,000 *20%=960,000 960,000
3,840,000
12/31/2018 3840,000*20%=768,000 1,728,000 3,072,000
12/31/2019 3072,000*20%=614,400 2,342,400 2,457,600
12/31/2020 2,457,600*20%=491,520 2,833,920 1,966,080
12/31/2021 1,966,080*20%=393,216 3,227,136 1,572,864
12/31/2022 1,572,864*20%=314,573 3,541,709 1,258,291
12/31/2023 1,258,291*20%=291,658 3,833,367 966,633
12/31/2024 966,633*.20 =193,327 4,026,694 773,306
12/31/2025 773,306*20% =154,661 4,181,355 618,645
12/31/2026 618,645-200,000=418,645 4,600,000 200,000
The Income statement of year 3 (2019) shall report depreciation expense amounting
to 614,400, accumulated depreciation of 2,342,400 (the sum of depreciation for year
1, 2 and 3) and presents the carrying amount at 2,457,600.
The final year’s depreciation is just getting the difference between the previous year’s
carrying amount and the residual value at the end of the life of the asset.
4. Output Method and production method.

Depreciation rate = Depreciable cost/total number of units
Or = Depreciable cost/total number of hours
Annual Depreciation = Depreciation rate * number of units produced during the year
Or= Depreciation rate * number of hours used during the year
Illustration (Adapted) : Assume that a machine purchased for P8,000,000 has a

production capacity over its economic life of 4,000,000 in terms of units of products and
3,040,000 in terms of service hours available for production. The residual value amounted
to 400,000. Units produced per year in terms of units and service hours worked are shown
below: Units produced Service
Hours worked
Year 1 900,000 750,000
Year 2 800,000 640,000
Year 3 700,000 620,000
Year 4 750,000 635,000
Year 5 650,000 345,000
Year 6 200,000 50,000
The depreciation table will be: Units of production method
Year Annual depreciation Accumulated Carrying Amount

Depreciation
7,600,000/4,000,000=1.9 8,000,000
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1 1.9 * 900,000=1,710,000 1,710,000 6,290,000

2 1.9 * 800,000= 1,520,000 3,230,000 4,770,000
3 1.9* 700,000=1,330,000 4,560,000 3,440,000
4 1.9* 750,000=1,425,000 5,985,000
2,015,000
5 1.9*650,000=1,235,000 7,220,000
780,000
6 1.9*200,000=380,000 7,600,000 400,000 RV
The amount of depreciation expense to be reported in the Income statement of year 2

is 1,710,000 while the statement of financial position shall present accumulated
depreciation at the end of year 2 for 3,230,000 and a carrying amount of the asset at
4,770,000.
The depreciation table under Working Hours method will be:
Year Annual depreciation Accumulated Carrying Amount

dep.
7,600,000/3,040,000=2.5 8,000,000
1 2.5 * 750,000 = 1,875,000 1,875,000 6,125,000
2 2.5 * 640,000 = 1,600,000 3,475,000 4,525,000
3 2.5 * 620,000 = 1,550,000 5,025,000 2,975,000
4 2.5 * 635,000 = 1,587,500 6,612,500 1,387,500
5 2.5 * 345,000 = 862,500 7,475,000 525,000
6 2.5 * 50,000 = 125,000 7,600,000 400,000
To check if you can prepare a depreciation table under each of the 5 methods using
the guide above, please refer to problem 1 in Let’s check portion.
Composite and group method. Is used by large entities as it is not so practical to

depreciate each asset individually.
Composite method is used for dissimilar assets to be grouped together and

depreciated as a single unit.
Dissimilar assets refers to assets having different characteristics and even vary in their
useful life.
In group method, similar assets are taken and depreciated as one unit. The purpose
of which is to simplify accounting for depreciating individually low value assets.
Illustration (Adapted) : Composite Method

MieLove Company had the following items in its property, plant and equipment:
Cost Residual Depreciable Cost Life Depreciation
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Building 1,170,000 90,000 1,080,000 15 72,000

Machinery 396,000 36,000 360,000 8 45,000
Equipment 234,000 54,000 180,000 4 45,000
1,800,000 180,000 1,620,000 162,000
At the end of 4th year, the equipment is retired for a consideration of 36,000.
It uses the composite method of depreciation.

To compute depreciation, the composite life and composite rate are computed using the
formula.
Composite life = Total Depreciable amount/ Total depreciation
=1,620,000/162,000
= 10 years
Composite rate = Total depreciation/ Total Cost
= 162,000/1,800,000
= 9%
Hence, the entry to recognize depreciation is

To record annual dep.
Upon the retirement of the equipment after 4 years for a proceeds of 36,000, simply eliminate
the cost of the equipment, receive the cash and the excess is charged or debited against
accumulated depreciation as follows:

Cash 36,000
Equipment 234,000
If on the other hand there were no proceeds received from the equipment, the entry will
involve the elimination of the cost of the equipment and the same amount is charged or
debited against accumulated depreciation as shown below:

Equipment 234,000
To record
Retirement.
On the fifth year, the annual depreciation will be computed as 9% (1,566,000) resulting to
140,940. The 1,566,000 is the balance of 1,800,000 less the equipment retired of 234,000.
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Had the asset retired been replaced by another asset costing 288,000, then the annual
depreciation would be computed as 9% (1,854,000) which is 166,860. The 1,854,000 is
computed as follows:
Total assets 1,800,000
Equipment retired (234,000)
Add: newly purchased 288,000
Balance 1,854,000 * 9% = 166,860
Illustration (Adapted) : Group method

William Company purchased 100 similar machines on January 1, year 1 at a total cost of
1,500,000 or at an average cost of 15,000 per machine.
The machines have an average useful life of 5 years or an annual depreciation rate of 20%.
The machine are retired as follows:
Date Number of Machines Salvage proceeds
Dec. 31, year 4 30 None
Dec. 31, year 5 40 15,000
Dec. 31, year 6 30 30,000
The annual depreciation is simply computed as 20% multiplied by the total cost of 1,500,000.
The journal entry to record the annual depreciation from year 1 to year 6 is the same as follows:

12/31/1 Depreciation expense 300,000
Accumulated 300,000
Depreciation

Accumulated 300,000
Depreciation

Accumulated 300,000
Depreciation

Accumulated 300,000
Depreciation
Accumulated depreciation
450,000
Machinery
450,000
Cost of machines retired is computed as: 30 machines (15,000) = 450,000

There is no cash receive therefore no cash is debited and the full cost of the machines
retired is then charged to the accumulated depreciation.
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To get the following year’s amount of depreciation, simply get the balance of total cost and
multiply to 20%. Thus, 1,500,000 less 450,000 equals 1,050,000 balance in total cost then
multiplied to 20% is 210,000, the amount of depreciation for the next period.

Cash 15,000
Accumulated Depreciation
585,000
Machinery 600,000
Upon the retirement of the 40 machines, the accumulated depreciation is charged for the
excess of cost over the cash received since there is a cash proceeds.
The determination of the next period’s depreciation expense requires the following
computation:
a. carrying amount per book

b. Difference between carrying amount and salvage proceeds
Cost as of Dec. 31, 2017 1,050,000

Retired 40 (15,000) 2018 600,000
Cost balance 450,000
Accumulated dep. (375,000) (300,000 * 4) + 210,000 - 450,000- 585,000
Carrying amount per book 75,000
Less Salvage proceeds 30,000

Cash 30,000
Accumulated Depreciation
420,000
Machinery 450,000
To record the retirement of the 30
machines.
The retirement of the machines eliminates the cost of the machines and the accumulated
depreciation is debited for an amount in excess of the cost over the cash proceeds.
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We just had the end of this chapter, please answer the Let’s analyze and Nutshell portion as
part of your accumulated graded assignment which is 5% of your final grade. You may submit
your work through LMS and may raise your questions and clarifications via LMS, group chat
and text message.
KEYWORDS INDEX
Cost Residual Value Cost model
Accumulated Carrying Amount Composite rate
Depreciation
Depreciation Dissimilar Assets Depreciable amount
& Co
Intermediate Financial Accounting Volume 1, Glenn Arnold & Suzanne

Kylehttps://lifa1.lyryx.com/textbooks/ARNOLD_2/marketing/ArnoldKyle-IntermFinAcct-
Vol1-2020A.pdf
https://www.profitbooks.net/what-is-depreciation/retrieved May 27, 2020

https://corporatefinanceinstitute.com/resources/knowledge/accounting/types-depreciation-
methods/retrieved May 27, 2020
http://investment_terms.enacademic.com/11948/Retirement_Method_of_Depreciationretrieve
d May 27, 2020
http://www.accioneduca.org/admin/archivos/clases/material/depreciation_1564412042.pdfret
rieved May 27, 2020
https://www.playaccounting.com/explanation/exp-oa/composite-depreciation/retrieved May
27, 2020

https://drive.google.com/file/d/1bZ4wSMaqrIG8OTSwkAplJ2ehwk40MtBB/view retrieved
June 1, 2020
Q&A LIST
Do you have any questions for clarification?
Questions/Issues Answers
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GOVERNMENT GRANT

ULO o. Explain the nature and purpose of government grant;
p. Apply the proper accounting treatment of government grant.
Metalanguage
In this section, the most essential terms relevant to the study of Government grant is
discussed and explained and to demonstrate ULOoto p will be operationally defined
to establish a common frame of reference as to how the texts work in the business
field. You will encounter these terms as we go through the study of government grant.
Please refer to these definitions in case you will encounter difficulty in understanding
accounting rules/concepts on government grant. The IAS 20 specifically defines the
following as:
1. Government. Refers to government, government agencies and similar bodies whether
local, national or international.
2. Government Assistance. An action by the government to provide economic benefit
specific to an entity or range of entities qualifying under certain criteria.
3. Government Grants. Are assistance by government if the form of transfers of resources
to an entity in return for past or future compliance with certain conditions relating to the
operating activities of the entity.
4. Grants related to Assets. Are government grants whose primary condition is that entities
qualified should purchase, construct or acquire long term assets.
5. Grants related to income. Are government grants other than those related to assets.
6. Forgivable loans. Are loans which the lender undertakes to waive repayment of under
certain prescribed condition.
Essential Knowledge
IAS 20. The International Accounting Standards 20 is the Accounting for Government
grants and Government Assistance.
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Government Grants.Isoftentimes called subsidy, subvention or premium. PAS 20

refers to it as assistance by government.
Recognition and measurement.IAS 20 paragraph 7 provides the recognition of

Government grants when there is reasonable assurance that conditions attaching to
the grant will be complied and that the grant will be received.
Examples of government grant. The following are different government grants:

A. Grants related to asset;
B. Grants related to income;
C. Grants with no further related costs
The key notes are as follows:
Grants with no further related costs shall be recognized as income of the period in
which it becomes receivable such as grants related to financial support for massive
losses on earthquake, etc. (IAS 20 par. 20)
Government grant is recognized as income on a systematic basis over the periods in

which an entity recognizes as expenses the related costs for which the grant is
intended to compensate (IAS 20-12).
IAS 20 par 29; grants related to income is presented in the following manner:
a. In the income statement as other income or
b. Deducted from the related expense.
Upon the receipt of the grant, it is initially credited to deferred grant income account.
The deferred grant income is recognized as earned in proportion to the fraction

developed from the related expense per year for which the grant is connected to or
the conditions attached to the grant.
The related expense is recognized immediately at the time it is incurred.
Illustration 1 (Adapted) Government Grant Galendez company received a grant of

7,500,000 from the national government for the purpose of defraying safety and
environmental expenses over the period of 3 years. The safety expenses will be
incurred by Galendez Co. as follows:
1st year 1,000,000
2nd year 1,500,000
3rd year 2,500,000
Thus the grant is recognized as income on the basis of related expense as computed
below:
1 - 1,000,000/5,000,000 *7,500,000 = 1,500,000
2 - 1,500,000/5,000,000 *7,500,000 = 2,250,000
3 - 2,500,000/5,000,000 * 7,500,000 = 3,750,000
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1 Cash 7,500,000
Deferred grant income 7,500,000

Grant income 1,500,000
Environmental expense 1,000,000

Cash 1,000,000
Grants related to depreciable asset. IAS 20 par. 24 provides that grants related to
asset shall be recognized by setting up deferred grant or deducting the grant from the
asset.
Presented below are the 2 approaches on presenting the grant:

Illustration: Adapted
Matinee Ltd. purchases a new factory machine for P100,000. This machine will help the
company manufacture a new, energy-saving product. The company receives a government
grant of P20,000to help offset the cost of the machine. The machine is expected to have a
five-year useful life with no residual value.
Deferred Method:
Machine 100,000
Deferred grant 20,000
Cash 80,000
Depreciation expense
20,000
Accumulated Dep’n 20,000
Deferred grant
4,000
Grant Income 4,000
Offset Method:
Machine 80,000
Cash 80,000
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Depreciation expense
16,000
Accumulated Dep’n
16,000
Grants related to non depreciable asset.IAS 20 par. 24 provides that grants related
to asset shall be recognized by setting up deferred grant or deducting the grant from
the asset.
The deferred Income approach is used. The grant shall be recognized as income
over the periods which bear the cost of meeting the conditions.
Recording the grant received by debiting the non depreciable asset received as grant
and crediting deferred grant income.
Recording the cost of building the asset which bears the condition attached to the
receiving of the grant at cost will have an equivalent credit to cash.
Normal depreciationof the asset build by the company over the useful life is taken as
it is.
Recognize the grant as income over the useful life of the asset that is built in the non
depreciable asset – land.
Illustration (Adapted) :
For example,Faith Company received a grant, a tract of land in Davao Region with a
fair value of 24,000,000 by the national government. The grant requires Faith to
construct a refinery on the site estimated at a cost of 40,000,000, the useful life of
which is 20 years.
Land 24,000,000
Refinery 40,000,000
Cash 40,000,000
Depreciation Expense 2,000,000

Accumulated 2,000,000
depreciation
Deferred grant income

1,200,000
Grant income 1,200,000
93
Matina, Davao City
Phone No.: (082)300-5456 Local 13
Third and 4th entry will be done for 20 years.
The deferred grant income is to be recognized as earned over 20 years, the useful
life of the refinery.
Repayment of government grant. A government grant becomes repayable

because conditions were not complied.
IAS 20 par 32 clearly stated it to be accounted for as a change in accounting estimate.
It shall be applied first to the unamortized deferred income and the excess recognized
immediately as an expense.
Repayment of a grant related to asset shall be recognized by increasing the carrying

amount of the asset or reducing the deferred income balance by the amount
repayable.
In the first approach (deferred income approach) the difference between the deferred
grant income balance to be eliminated and the amount of cash to be paid/repayable
is charged to loss.
Whereas in deduction from the asset approach, the company pays the cash, debit the
asset to increase the carrying amount of the asset.
The depreciation for the year is equal to the sum of the original depreciation plus the
depreciation charge on the increase due to the repayment equal to the depreciation
not taken for previous years including this year.
Further, the subsequent year’s depreciation is computed as carrying amount divided

by the remaining useful life.
Illustration (Adapted) : Racquel Company purchased a machine for 3,000,000 on January
1, 20A. The entity received a government grant of 500,000 in respect of this asset. The
policy is to depreciate the asset over 5 years on a straight line basis and to treat the grant as
deferred income. On Jan. 1, 20C, the grant became fully repayable because of non
compliance with conditions.
Deferred Income Method:
1/1/20A Machine 3,000,000
Cash 3,000,000
Cash 500,000
Deferred Gov’t grant 500,000
12/31/20A Depreciation Expense 600,000
94
Matina, Davao City
Phone No.: (082)300-5456 Local 13
Accumulated 600,000
depreciation
Deferred Gov’t grant
100,000
Grant income
100,000
12/31/20B Dep’n expense

600,000
Accum. Depreciation
600,000

100,000
Grant income
100,000
1/1/20C Deferred grant income

300,000
Loss
200,000
Cash
500,000
12/31/20C Dep’n expense

600,000
Accum. Depreciation
600,000
Deduction from asset approach:

1/1/20A Machine 2,500,000
Cash 2,500,000
12/31/20A Depreciation Expense 500,000

Accumulated 500,000
depreciation
12/31/20B Dep’n expense

500,000
Accum. Depreciation
500,000
95
Matina, Davao City
Phone No.: (082)300-5456 Local 13
1/1/20C Machinery
500,000
Cash
500,000
12/31/20C Dep’n expense

800,000
Accum. Depreciation
800,000
Deduction from asset approach:

Machinery 2,500,000
Less Accumulated depreciation 1,000,000
Increase in carrying amount 500,000
New carrying amount 2,000,000
Depreciation in 2019 ( 800,000)
Carrying amount in 12/31/2019 1,200,000
The depreciation in 20C is the original depreciation of 500,000 plus the 3 years of
depreciation based on the 500,000 adjustment increase in carrying amount which was
not depreciated.
Note that the two approaches will have the same carrying amount of the asset on
December 31, 20C.
On Grant of interest-free loan.
The interest free loan which is the difference between the face value of the loan and
the present value of the loanis discount on the loan.
The discount on the note is to be amortized as interest expense over the period of the
loan.
The same amount of difference also is the amount of the deferred grant income to be
amortized as grant income over the period of the loan.
The pro forma entry to amortize discount is:

Interest expense XX
Discount on note payable XX
The amount of grant income recognized is equal to the amount of interest expense
recognized for each period.
The pro forma entry to recognize grant income for the period is:
Deferred grant income XX
Grant income XX
96
Matina, Davao City
Phone No.: (082)300-5456 Local 13
The table of amortization computed uses the effective interest method.
Illustration: (Adapted Valix 2017), a 4,000,000 interest free loan is granted to a

company for a period of three years evidenced by a promissory note. The market
rate for similar not is 5% and the present value of 1 at 5% for 3 periods is 0.8638.
Table of amortization:
Year Amortization Discount On N/P Present Value
1/1 544,800 3,455,200
12/31 172,760 372,040 3,627,960
12/31 181,398 190,642 3,809,358
12/31 190,642 - 4,000,000
The entries:
1/1 Cash 4,000,000
Disc. On N/P
544,800
Deferred grant income 544,800
12/31 Interest expense

172,760
Disc. On N/P 172,760

172,760
Grant income 172,760
12/31/2 Interest expense 181,398


12/31/3 Interest expense 190,642


97
Matina, Davao City
Phone No.: (082)300-5456 Local 13

Cash 4,000,000
Note that in the table of amortization, the amount of interest expense amortization will
also be the amount of deferred grant income to be recognized as earned grant income
for the period.
Disclosure of Government Grants: IAS 20.39 provides that the company should
disclose the accounting policy adopted and the method of presentation used in the
balance sheet; the recognition in the financial statements of the nature and extent of
grants and the conditions not fulfilled and the contingencies attached to the grant.
To check your learning and understanding on the following discussions, please refer
to the Let’s Check portion, Let’s Analyze and In a Nutshell.Your answer will be graded
as assignments and as part of your accumulated 10% class participation. Inquiries
and clarifications may be done through LMS forum, group chat, or text Monday’s to
Friday’s. Submissions can only be done through LMS. Please observe deadline of
submissions at the end of this 1st exam coverage discussion.
KEYWORDS INDEX
Government Grants related to income Deferred Income
Approach
Government Grant Grants related to asset Deduction from asset
approach
Deferred Grant Income Grant Income Discount on note
payable

& Co
International Accounting Standards. IAS 20 –Accounting for Government Grants and

disclosure of government assistance. Retrieved
fromhttp:www.iasplus.com/en/standards/ias/ias20
https://www.iasplus.com/en/standards/ias/ias20 retrieved May 27, 2020
https://www.ifrsbox.com/ias-20-government-grants/ retrieved May 27, 2020
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College of Accounting Education

3F, Business & Engineering Building

Big Picture in Focus: ULOa. Discuss the nature and purpose of

IAS 40 provides for the following definitions:

a. Carrying Amount. It is the amount at which an asset is recognized in the statement of

1. International Accounting Standards 40 Investment Property40 (IAS 40) replaces

2.1 Examplesas enumerated in the standard paragraph 8 included the following:

a. Land held for long-term capital appreciation;

If it cannot be rented or sold separately, it is reported as investment property, only if

3. Recognition: IAS 40 paragraph 16 on Recognition states that “An owned

4. Initial Measurement: IAS 40 par. 20 states that an investment property shall be

5. Subsequent measurement of investment property: An entity shall choose either

2 In accordance with IFRS 16 if it is held by a lessee as a right of use asset and is

Illustration (Adapted) : Dao Ming Company engaged into construction of a Super

Subsequently, it will be measured either by cost model or revaluation model. The

Cost Model: Revaluation model:

6. Transfers of Investment Property IAS 40 provides that “transfers of Investment

a. Ccommencement of owner occupation

b. If owner-occupied property is to be transferred as investment property under fair

c. An inventory transferred to investment property to be carried at fair value, any

d. An investment constructed is completed which is to be carried at fair value, any

7. Derecognition of Investment property: IAS 40 paragraph 66 provides the criteria

Investment property 130,000,000130,000,000-13,000,000/10*3

Year Account Titles F Debit Credit

International Accounting Standards. (2003b). IAS 40 – Investment Property. Retrieved from

Big Picture in Focus:

FUND AND OTHER INVESTMENTS

1. Accounting for Fund under the administration of the entity:

Applied in an accounting entity, when the fund established is administered by the

Year Account Titles F Debit Credit

Year Account Titles F Debit Credit

Year Account Titles F Debit Credit

Accrued interest receivable XX

The increase in the amount shall be made to increase appropriation of retained

Year Account Titles F Debit Credit

Year Account Titles F Debit Credit

The entry in retiring the liability is:

To record appropriation of Retained Retained earnings XX

To record purchase of fund securities: Sinking Fund Securities XX

Fund Income received Sinking Fund Cash XX

Fund income earned but not yet Accrued interest receivable XX

End of the accounting period: Increase Retained Earnings XX

Sale of Sinking Fund Securities at a gain Sinking Fund Cash

Retirement of liability using the Fund Bonds payable XX

Transferring back the excess Fund to Cash XX

Release of the retained earnings Retained earnings appropriated XX

Dec.31,20A To record 4,000,000 of cash Sinking Fund Cash 4,000,000

To record appropriation of retained

The P4,000,000 sinking fund cash was

October 1, 20AReceived the interest on

Accrued interest receivable

R/E- unappropriated 4,360,000

The total Sinking fund amounted to 8,360,000 composed of SF Cash 4,240,000; SF

- If a sale of SF securities at 105 is Sinking fund cash 4,200,000

- The release of the appropriated

2. Fund under the administration of a trustee:

Year Account Titles F Debit Credit

Hence, this cash fund is classified as noncurrent asset.

Sinking Fund – Trustee XX

Year Account Titles F Debit Credit

Year Account Titles F Debit Credit

c. Received a periodic report from Sinkingfund - trustee(4560-

d. When a trustee pays a company’s