Intermediate Accounting 1 Exploring Assets

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Intermediate Accounting 1: Exploring

Assets
A Learning Package for
AEAcc3, AEMA13, AEIA13, AEAIS13- Intermediate
Accounting 1
Janven A. Granfon
NOT INTENDED FOR PUBLICATION.

FOR CLASSROOM INSTRUCTION PURPOSES ONLY.
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Course Introduction
Intermediate Accounting 1 is a common course to all accounting related programs-
Bachelor of Science in Accountancy, Bachelor of Science in Management Accounting, Bachelor
of Science in Internal Auditing and Bachelor of Science in Accounting Information Systems. This
course introduces the nature, functions, scope, and limitations of the broad field of accounting
theory. It deals with the study of the theoretical accounting framework objectives of financial
statements, accounting conventions, and generally accepted accounting principles, standard
setting process for accounting practice, national as well as international principles relating to the
preparation and presentation of financial statements, the conditions under which they may be
appropriately applied, their impact or effect on the financial statements; and the criticisms
commonly levelled against them. The course covers the detailed discussion, appreciation, and
application of accounting principles covering the assets, financial and nonfinancial. Emphasis is
given on the interpretation and application of theories of accounting in relation to cash, temporary
investments, receivables, inventories, prepayments, long-term investments, property, plant and
equipment, intangibles, and other assets, including financial statement presentation and
disclosure requirements. The related internal control, ethical issues, and management of assets
are also covered. Exposure to computerized system in receivables, inventory, and lapsing
schedules is a requirement in this course.
This course will utilize a flexible learning package which include course introduction,
course syllabus, learning guide, learning contract, summative assessments are included that will
provide insights to the students as to what the course is all about, the course requirements, and
what are the activities and assessments to be accomplished.
This learning package is distinct from other books because it has the following major
parts:
Course Introduction –It presents the vital information about the course.
Course Syllabus-This provides vital information on the course outcomes, learning
outcomes, activities, assessments, grading system and the course requirements.
Learning Guide- This provides significant information as to the students’ schedules of
submitting the output and the course requirements, feedback modality, communication
mechanism, and the contact information of the instructor/professor and other authorities of the
University/Campus.
Learning Contract- It is a document which contains the commitment of the learners in
accomplishing the activities which includes also the Data Privacy Act, plagiarism rules, safety
reminders, and parents’ support.
Summative Assessments- These are forms which include the summative assessment
plan, summative assessment instructions, and assessment rubrics.
Flexible Learning Module- This is the meat of the package that contains the front
contents, module content (learning outcomes, pretest, content, learning activities, and
assessments), and the back contents.
Moreover, a flexible learning module is also included. It is a material which has a different
problem in any business settings for deeper understanding, with an appreciation for their
complexity and nuance, is selected. It aims to engage in richer discussions about different types

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of assets as well as strengthening the student’s analytical writing skills. Each reading will spark
discussions about topics ranging from current assets to noncurrent assets. This material will offer
variety of activities that will address the multiple intelligences and diversity of students and
worksheets will be provided. The use of computer aided communication like preparing financial
information through excel. Composed of 6 units, the flexible learning module is especially
designed in enhancing students’ enthusiasm and passion problem solving. It offers a basketful of
opportunities, extending activities, and interactive and innovative strategies towards the end of
the unit. It provides outcomes-based education model being implemented in both basic and higher
education institutes.
I hope that you will have a meaningful and fruitful learning in this course.
Spread the positivity in reading and creating fiction stories!
-The Author

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Course Syllabus

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Republic of the Philippines

JOSE RIZAL MEMORIAL STATE UNIVERSITY
The Premier University in Zamboanga del Norte
Main Campus, Dapitan City
College of Business and Accountancy
COURSE SYLLABUS
Course Title INTERMEDIATE ACCOUNTING 1 Instructor JANVEN A. GRANFON, CPA, MBA
Formative
Course Outcomes Learning Outcomes Topics References Learning Activities Learning Materials Assessment Summative Assessment
* Students will
Prepare Bank determine what to
Reconciliation and Proof of Accounting for Cash include and exclude
Cash Statement in cash using set
criteria.
*Solve Problems
related to cash
*Students wil
determine the
reconciling items
affecting the cash in
bank per ledger and
per bank statement
*Students will solve
Prepare Amortization Accounting for problems related to
Schedule of Receivables Receivable different types of
receivables
*Estimates the
allowance for doubtful
accounts using
different methods in
computing doubful
account expense.
*Solve problems in
Robles, N., and P. M. receivable financing
Empleo. (2021).
Intermediate *Students will
Prepare Inventory Accounting Volume III determine the value of
Accounting for
Valuations of different types (2021), Mandaluyong: Inventories using
Inventories
of inventories Millennium Books, Inc. different Inventory
Valix, C.T. and J. valuations.
Peralta. (2021).
*Solve problems
Intermediate
related to the
Develop financial reports Accounting Volume III
valuation of
by applying the different (Based on PAS,
inventories.
recognition and PFRS, IAS, IFRS).
measurement principles Manila: GIC Solve Problems Books, Module,
related to the Solve Problems Major Exam and Evaluation of
of asset elements in the Enterprises. Baysa, Calculator, Internet,
Inventory of an reflected in the Asset elements of a publicly
preparation and Gloria T., MC. Y. Laptop, Smart
agriculture type of module listed corporations
presentation of financial Lupisan, and E.F. Phones
statements in accordance Ledesma. (2021). business
*Students will
with accounting related Intermediate
determine diiferent
standards. Accounting 3.
types of investments
Prepare Investment Accounting for Mandaluyong:
and catgorized
Portfolio Investments Millenium Books, Inc.
current and
Weygandt, Kieso, and
noncurrent
Warfield, intermediate
Investments.
Accounting (2016)
*Prepare Amotization
11th Ed., Millennium
schedules of
Books, Inc., Shaw
Investment in Debt
Blvd., Mandaluyong
Securities
City
*Prepare Investment
in associates
accounts and
determine balances
in Investment
properties.
*Determine what to
Prepare Depreciation include and exclude
Accounting for Property,
Schedules and Revaluations costs as part of the
Plant and Equipment
of Assets cost of the Property,
Plant and Equipment.
*Conduct
Depreciations and
Revaluations of the
Value of the
Property, Plant and
Equipment.
Determine the
Impaiment of an
Assets.
*Determine what to
include and exclude
Prepare Depletion
costs as part of the
Schedules
Accounting for Intangible cost of the Intangible
Assets Assets
*Conduct Depletion
and Revaluations of
the Value of the
Intangible Assets.

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Republic of the Philippines

The Premier University in Zamboanga del Norte
Main Campus, Dapitan City
Course: INTERMEDIATE ACCOUNTING 1 Department College of Business and Accountancy
References:
Robles, N., and P. M. Empleo. (2021). Intermediate Accounting Volume I I (2021), Mandaluyong: Mil ennium Books, Inc.
Valix, C.T. and J. Peralta. (2021). Intermediate Accounting Volume I I (Based on PAS, PFRS, IAS, IFRS). Manila: GIC Enterprises.
Baysa, Gloria T., MC. Y. Lupisan, and E.F. Ledesma. (2021). Intermediate Accounting 3. Mandaluyong: Mil enium Books, Inc.
Weygandt, Kieso, and Warfield, intermediate Accounting (2016) 11th Ed., Mil ennium Books, Inc., Shaw Blvd., Mandaluyong City
Course learning rules:
Plagiarism is strictly prohibited. Be aware that plagiarism in this course would include not only using another’s words, but another’s specific intellectual posts in
social media. Assignments must be done independently and without reference to another student’s work. Any outside sources used in completing an assignment,
including internet references must be fully cited on any homework assignment or exercise.
Consulation hours are indicated at the learning package via email or text message on the contact information provided on the learning package.
Student shall give feedback to the instructor at least once every two weeks.
Grading Plan (you can be more specific on this based on your requirement)
Formative/student engagement 30%
Summative (Major output and requirements) 70%
TOTAL 100%
Prepared by: Checked by: Noted: Approved:
JANVEN A. GRANFON, CPA, MBA ANNA RHEA MICHELLE S. BUREROS, CPA AMIEL B. ANDIAS, DPA ALICE MAE M. ARBON, PhD
Instructor Program Chairperson, Accountancy Department Associate Dean OIC VPAA
Date: 02/02/2021 Date: Date:

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Learning Guide
The key to successfully finish this material lies in your perseverance to sincerely and
honestly perform the learning activities and accomplish the assessments. This flexible learning
package is developed with the aim to aid your learning for this course. Aside from meeting the
content and performance standards of this course in performing all the learning activities and
assessments, you will be able to learn the skills and values which are needed in achieving the
future skills and the graduate attributes to become globally competitive individuals.
To ensure an orderly, effective, and efficient conduct of the Flexible Learning System, please
observe the following general instructions:
Classroom Rules and Conduct

The following are the house rules which will help you to be on track and successfully finish
this course:
1. Schedule and manage your time to read and understand every component of this learning
package.
2. Study on how you can manage to perform all the learning activities in consideration with
your resources and accessibility to technology. Do not ask questions that are already
answered in the guide.
3. If you did not understand the readings and the other tasks, read again. If there are still
clarifications and questions, feel free to reach me through the contact information indicated
in this guide.
4. Do not procrastinate. As much as possible, follow the time table.
5. Read and understand the assessment and technology tools as indicated in the directions
in every assessment or activity.
6. Before the end of the midterms, you will be tasked to send back the material trough the
pigeon boxes in your department. For online learners, you will submit your output and
other tasks in the google classroom. While waiting for my feedback of your accomplished
module, you may continue on accomplishing the tasks in the succeeding units that are
scheduled for the finals.
7. Most importantly, you are the learner; thus, you do all the tasks in your own. You may ask
assistance and guidance from your parents, siblings or friends, but all the activities shall
be performed by you alone.
8. Course requirements must be submitted as to schedule.
9. Plagiarism is strictly prohibited. Be aware that plagiarism in this course would include not
only using another’s words, but another’s specific intellectual posts in social media.
Assignments must be done independently and without reference to another student’s
work. Any outside sources used in completing an assignment, including internet
references must be fully cited on any homework assignment or exercise.
10. All students should feel free to talk to the instructor face-to-face or through media during
office hours.
11. Academic accommodations are available for students with special needs. Students with
special needs should schedule an appointment with the instructor early in the semester to
discuss any accommodations for this course.

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Other Things to remember:

1. KEEP POSTED.
➢ Always keep posted on your Google classroom and email accounts, as all
announcements, activities, and class interactions shall be done through the above
platforms.
2. CLASS REPRESENTATIVE.
➢ Each section of our online classes shall nominate one (1) class liaison. It shall be the
duty of the class liaison to disseminate to the rest of the class announcements and other
communications which the Instructor will make from time to time.
3. MODULES
➢ You will be given modules for each course. These modules shall be in lieu of the traditional
in-house lectures and discussions. Give your utmost time and attention to completing
these modules by reading the discussions and answering the provided activities
wholeheartedly.
4. INTERACTIONS WITH INSTRUCTORS.

➢ Your Instructors will interact with you through the Google Classroom platform once a week.
This shall take place on the first scheduled class day of every week. (For example, if
Instructor A’s weekly schedule for his class is Tuesday/Thursday, 10-11:30am, he will
interact with you every Tuesday of the week, on the above-scheduled time.) The
interaction may be done via Google Meet or other means. During these interactions, your
Instructor will ask updates from you and check on your progress, and you may ask your
questions/clarifications on the scheduled topics in the module. However, this interaction is
not limited to google classroom only, you may also contact thru fb page, fb messenger or
mobile number.
➢ All the requirements given by the Instructor within a particular week may be submitted on
the next scheduled weekly interaction with him/her. (For example, if the same Instructor A
above gives out some requirements on Tuesday this week, the outputs shall be submitted
by the students no later than Tuesday next week, BEFORE the scheduled interaction at
10am.) However, the students may also send it collectively prior to the conduct of major
exams/assessments.
➢ Inquiries or concerns of the students shall be expressed only during the scheduled class
period. (For instance, if a student of the same Instructor A has a question on the topic,
he/she may only ask them every Tuesday/Thursday, 10-11:30am.)
5. KEEPING TRACK OF YOUR PROGRESS

➢ A progress matrix will be provided to you by the Instructor. For every lesson/topic that you
have completed in the module, place a check mark (✓) on the corresponding cell in your
matrix. This will help you keep track of your progress. Do your best to follow the timeline
provided in the matrix.

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These are truly challenging times which we are currently facing. In light of this, the University
faculty and administration are doing our best to adapt to the so-called “new normal.” Let us all
cooperate to ensure effective and responsive learning despite the less-than-ideal
circumstances.
Study Schedule
Week Unit Title Activities

August 30-September 3,
Orientation Distribution of FLPs
2021
Preparation of Bank
Reconciliation
September 6-17, 2021 Unit 1 Accounting for Cash
Multiple Choice (Theory)
Assessment
Situational Analysis
September 20-October 01, Unit 2 Accounting for
2021 Receivables Multiple Choice (Theory &
Problem)
Assessment
October 04-October 29, Unit 3 Accounting for Multiple Choice (Theory &
2021 Inventories Problem)
Assessment
(with Problem Solving)
November 3-4, 2021 Midterm Assessment
Submission of Midterm
Assessment
Unit 4 Accounting for Multiple Choice (Theory &
November 08- 26, 2021
Investments Problem)
Assessment
Unit 5 Accounting for
November 29- December Multiple Choice (Theory &
Property, Plant and
10, 2021 Problem)
Equipment
Assessment
December 13, 2021- Unit 6 Accounting for Multiple Choice (Theory &
January 11, 2022 Intangible Assets Problem)
Assessment
(with Problem Solving)
January 12-13, 2022 Final Assessment
Submission of Final
Assessment

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Evaluation
To pass the course, you must observe the following:

1. Read the course module and answer the pretest, quizzes, self-assessment
activities.
2. Write your thoughts and suggestions in the comment boxes.
3. Perform all the activities.
4. Accomplish the assessments.
5. Submit the course requirements.
6. Perform Summative Assessment.
Technology Tools
In order to perform all the learning activities and accomplish the assessment, you will need
these software applications: word processing, presentation, publication, and spreadsheet. These
are applications that are available in our desktop or laptop that will not require internet connection.
All activities will be submitted thru google classroom.
Feedback Modality and Communication Mechanisms
Feedback system will be facilitated through text messaging. If you need to call, send me
a message first and wait for me to respond. Do not give my CP number to anybody. I will not
entertain messages or calls from numbers that are not registered. You may send your
clarifications and questions through the google classroom.
Grading Plan
The term grade is computed using the formula:
30% - Formative Assessment/Student Engagement

70% - Summative Assessment (Major output and requirements)
Midterm Grade = 100% of the Midterm Grade

Final Grade = 50% of the Midterm Grade + 50% of the Final Grade
Contact Information
Person/Office Email address CP number

Instructor janvengranfon@jrmsu.edu.ph 09989515680
IMDO main.imd@jrmsu.edu.ph 09399168104
FLS
CBA main.cba@jrmsu.edu.ph 09534420897/09639612559
DSAS
Library
DRMMO

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LEARNING AGREEMENT
By signing this learning agreement, I commit to the following terms and

conditions of Jose Rizal Memorial State University in the implementation of
Flexible Learning System. Specifically, I commit to observe the following:
1. That I must observe all guidelines of the state pertaining to the

prevention of COVID, specifically to stay home, to observe physical
distancing and the use of face masks when interacting with others.
2. That I shall prioritize my health and safety while I comply with all
the necessary learning activities and assessments needed in my
enrolled courses.
3. That I will exhaust all means of complying the requirements at home or
in a less risky place and location that will not allow me to be exposed to
other people.
4. That I have already read and understood all instructions pertaining
to my enrolled courses.
5. That I commit to do all the learning activities diligently, following
deadlines and the learning guide enabling me to deliver the course
requirements.
6. That I commit to answer all forms of assessment in the learning package honestly.
7. That I shall initiate in giving feedback to my instructor at least once every two weeks.
8. That I shall not reproduce or publish any part of the learning package
content without the written consent of the University and the author/s.
9. That I shall not commit any form of plagiarism in all course requirements.
Conformed:
Name and signature of student Date signed
Name and signature of parent/guardian Date signed
Contact Number of Parent/Guardian
**Please email the signed copy of this learning agreement to your instructor as
soon as you have received the learning package.

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Jose Rizal Memorial State University

Form No. F16: Summative Assessment Plan
No. Course Title of Description Scoring/Grading Weight (%)

Outcomes Assessment Standard in final
grade
1 Develop Major Students will Rubric/point 70%
financial Exams/ take major System
reports by Develop examinations (Product-based
applying the Financial and develop Assessment)
different Report- a financial
recognition Asset Only report
and comprising
measurement an asset
principles of elements
asset only of
elements in financial
the statement
preparation
and
presentation
of financial
statements in
accordance
with
accounting
related
standards.

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Learner’s Timeline

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Unit 1-Accounting for Cash
From the point of view of a layman, “cash” simply means money. Money is the standard
medium of exchange in business transaction. It refers to the currency and coins which are
in circulation and legal tender.
Cash includes Money or its equivalent that is readily available for unrestricted use. Other
negotiable instruments that can be used to settle obligations and are readily available for
unrestricted use may form part of cash.
Topic 1-Cash and Cash Equivalents
Learning Outcomes
At the end of this topic, you will be able to:
• Define cash and identify the items that are included in the cash and cash
equivalents line item.
• Apply the concept of cash and cash equivalents.
• Solve problems related to cash
• Solve problems related to petty cash funds and cash shortages/overages.
Pretest
Identify which of the following items are disclosed as cash or cash equivalents on the balance
sheet. Put check in the box.
Items Cash Noncash

Checking accounts
Treasury stock
Treasury bills
Money market funds
Petty cash
Trading securities
Savings accounts
Sinking fund cash
Compensating balances against long-term borrowings
Cash restricted for new building
Postdated checks for customers
Available-for-sale securities
Thank you for answering. Proceed to another file for the answer. If you got less than 5
refer to the module in previous course for more readings.

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Content
Cash
The definition of cash includes both cash (cash on hand and demand deposits) and cash
equivalents (short-term, highly liquid investments).
Unrestricted cash
There is no specific standard dealing with “cash”. Accordingly, to be reported as “cash”, an item
must be unrestricted in use. This means that the cash must be readily available in the payment
of current obligations and not be subject to any restrictions, contractual or otherwise.
Cash items included in cash

a. Cash on hand- this includes undeposited cash as collections and other cash items awaiting
deposit such as customer’s checks, cashier’s or manager checks, traveler’s checks, bank drafts
and money orders.
b. Cash in bank- this includes demand deposit or checking account and saving deposit which are
unrestricted as to withdrawal.
c. Cash fund set aside for current purposes such as petty cash fund, payroll fund and dividend
fund.
In other words, cash includes:

1. Currency and coins
2. Checks and money orders held – not postdated/stale and defective (A/R)
3. Unrestricted Bank Deposits
4. Funds: Current use for current liability, taxes, dividends
5. Retained and recorded post-dated checks/undelivered- reversal to cash (entity issued)
Not included in cash:

1. Postdated Checks
2. IOUs or advances to employees
3. Cash funds not available for use in current operations, such as sinking fund, plant
expansion fund, depreciation fund, preference share redemption fund, contingency fund,
and insurance fund.
4. Postage stamps
Cash equivalents
PAS 7, paragraph 6, defines “cash equivalents” as short-term and highly liquid investment that
are readily convertible into cash and so near their maturity that they present insignificant risk of
changes in value because of changes in interest rates”.
Cash equivalents have to be readily convertible into cash and so near maturity that they carry
little risk of changing in value due to interest rate changes. Generally, this will include only those
investments with original maturities of three months or less from the date of purchase by the
enterprise.

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a. Common examples of cash equivalents include Treasury bills, commercial paper, and
money market funds. Unrestricted cash and cash equivalents available for general use
are presented as the first current asset.
In other words, Cash Equivalents are short term, highly liquid investment (low risk). 3 months or
less from DATE OF PURCHASE until DATE OF MATURITY.
Examples:
1. 3-month treasury bill, treasury bonds
2. Commercial paper
3. Money market placement
4. Time deposit (3 months)
Equity securities cannot qualify as cash equivalents because share do not have a maturity date.
However, preference shares with specified redemption date and acquired three months before
redemption date can qualify as cash equivalents.
Investment of excess cash

The control and proper use of cash is an important aspects of cash management. Basically, the
entity must maintain sufficient cash for use in current operations.
Classifications of investment of excess cash

Investments in time deposit, money market instruments and treasury bills should be classified as
follows:
a. If the term is more than three months or less, such instruments are classified as cash
equivalents and therefore included in caption “cash and cash equivalents”.
b. If the term is more than three months but within one year or twelve months, such
investments are classified as short-term financial assets or temporary investments and
presented separately as current assets.
c. If the term is more than one year, such investments are classified as noncurrent or long-
term investments.
Measurement of cash
Cash is measured at face value. Cash foreign currency is measured at the current exchange rate.
Financial statement presentation
The caption “cash and cash equivalents” should be shown as the first item among the current
assets.
Foreign currency
Cash in foreign currency should be translated to Philippines pesos using the current exchange
rate. Deposit in foreign countries which are not subject to any foreign exchange restriction are
included in “cash”.
Cash fund for a certain purpose

If the cash is set aside for use in current operations or for the payment of current obligation, it is
a current asset. It is included as part of cash and cash equivalent.

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Cash set aside for special uses is usually disclosed separately. The entry to set up a special fund
is
Special cash fund xx
Cash xx
Classification of cash fund

The classification of a cash fund as current or noncurrent should parallel the classification of the
related liability.
Cash restricted as to use (e.g., not transferable out of a foreign country) should be disclosed
separately, but not as a current asset if it cannot be used in the next year (this is true of special
funds also).
Bank overdraft
When the cash in the bank account has a credit balance, it is said to be an overdraft. The credit
balance in the cash in the bank account results from the issuance of checks in excess of the
deposits.
Exception to the rule on overdraft

When an entity maintains two or more accounts in one bank and one account results in an
overdraft, such overdraft can be offset against the other bank account with a debit balance in
order to show “cash, net of bank overdraft” or “bank overdraft, net of other bank account.”
Compensating balance
A compensating balance generally takes the form of minimum checking or demand deposit
account balance that must be maintained in connection with a borrowing arrangement with a
bank.
Classification of compensating balance

If the deposit is not legally restricted as to withdrawal by the borrower because of an informal
compensating balance agreement, the compensating is part of cash.
If the deposit is legally restricted because of a formal compensating balance agreement, the
compensating balance is classified separately as “cash held as compensating balance” under
current assets if the related loan is short- term.
Undelivered or unreleased check

An undelivered or unreleased check is one that is merely drawn and recorded but not given to the
payee before the end of the reporting period. Accordingly, an adjusting entry is required to restore
the cash balance and set up the liability as follows:
Cash xx
Accounts payable or appropriate account xx
Postdated check delivered

A postdated check delivered is a check drawn, recorded and already given to the payee but it
bears a date subsequent to the end of reporting period.

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Cash xx
Accounts payable or appropriate account xx
Stale check or check long outstanding

A stale check is a check not in cashed by the payee within a relatively long period of time.
If the amount of stale check is immaterial, it is simply accounted for as miscellaneous income as
follows:
Cash xx
Miscellaneous income xx
Accounting for cash shortage

Where the cash count shows cash, which is less than the balance per book, there is a cash
shortage to be recorded as follows:
Cash short or over xx
Cash xx
The cash short or over account is only a temporary or suspense account. When financial
statements are prepared the same should be adjusted. Hence, if the cashier or cash custodian is
held responsible for the cash shortage, the adjustment should be:
Due from cashier xx
However, if reasonable efforts fail to disclose the cause of the shortage, the adjustment is
Loss from cash shortage xx
Accounting for cash overage

Where the cash count shows cash, which is more than the balance per book, there is cash
overage to be recorded as follows:
Cash xx
Concealment of cash shortages

Cash shortages are fraudulently concealed in various ways.
Lapping
Occurs when the collection of the receivable from one customer is mis appropriated and
concealed by applying a subsequent collection from another customer. Lapping is made possible
when the incompatible duties of recording and cash custody are combined.
Illustration:
December 29 Cashier/Bookkeeper collects P20,000 from customer A, puts money in her
purse, and makes no journal entry.
December 31 Cashier/Bookkeeper goes on a date with a BBBoy security guard and
spends all the money.
January 1 Cashier/Bookkeeper collects P25,000 from customer, puts P5,000 in her
purse, and makes the following journal entry.

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Cash 20,000
Accounts Receivable- Mr. A 20,000
January 5 The Auditor comes to audit, confirms only “material” accounts, and won’t
detect lapping. The auditor is happy audit is finished. The
Cashier/Bookkeeper is happier and plans to date with another BBBoy
janitor.
Kiting
Occurs when cash shortage is concealed by overstating the balance of cash. Kiting is made
possible by exploiting the float period (the time it takes for a check to clear at the bank where it
was drawn).
Illustration:
December 23 Bookkeeper draws P20,000 check from BDO account for herself. No journal
entry is made.
December 25 Bookkeeper encashes check and spends all money shopping for BBBoy at
SM.
December 31 Fearing auditors will detect the fraud, the bookkeeper:
1. Draws unrecorded check of P100,000 from Metrobank accounts and
deposit it to BDO account. The shortage is concealed because BDO
increases the account balance upon deposit while the check drawn
does not yet clear at Metrobank (not yet deducted) until the following
month. No entry is made until after year-end.
2. Prepares bank reconciliation for Metrobank account showing no
outstanding check.
Window Dressing
A form of fraudulent financial reporting and not primarily a method of concealing cash shortages.
Window dressing occurs when books are not closed at year-end and transactions in the
subsequent period are deliberately recorded in the current period in order to improve the entity’s
financial performance or financial ratios.,
Accounting for Petty cash fund

The petty cash fund is money set aside to pay small expenses which cannot be paid conveniently
by means of checks.
There are two methods of handling the petty cash, namely:
a. Imprest fund system
b. Fluctuating fund system
Imprest (petty) cash funds are generally included in the total cash figure, but unreimbursed
expense vouchers are excluded.
Imprest system
The imprest system is a system of control of cash which requires that all cash receipts should be
deposited intact and all cash disbursements should be made by means of check.
Imprest fund system

The imprest fund system is the one usually followed in handling petty cash transactions.

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Accounting procedures
a. A check is drawn to establish the fund.
Petty cash fund xx
Cash in bank xx
b. Payment of expenses out of the fund.
c. Replenishment of petty cash payments.
d. At the end of the accounting period, it is necessary to adjust the unreplenished expenses in
order to state the correct petty cash balance as follows:
Expenses xx
Petty cash fund xx
e. An increase in fund is recorded as follows:
Petty cash fund xx
Cash in bank xx
f. A decrease in the fund is recorded as follows:
Cash in bank xx
Petty cash fund xx
Fluctuating fund system

The system is called “fluctuating fund system” because the check drawn to replenish the fund do
not necessarily equal the petty cash disbursements. Moreover, the petty cash disbursements are
immediately recorded thus resulting in a fluctuating petty cash balance per book from time to time.
Accounting procedures
a. Establishment of the fund
Petty cash fund xx
Cash in bank xx
b. Payments of expenses out of the petty cash fund:
Expenses xx
Petty cash fund xx
c. Replenishment or increase of fund:
Petty cash fund xx
Cash in bank xx
d. At the end of the reporting period, no adjustment is necessary because the petty cash
expenses are recorded outright.
e. Decrease of the fund is recorded as follows:
Cash in bank xx
Petty cash fund xx

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Assessment
General Instructions: Have your answers in a separate sheet, every topic must
have different sheets. Show your solutions to those items which required
solutions. In naming the file have this format “LastName_Unit#_TopicName”. You
may pass the assessments weekly based on your timeline or you may opt to pass
it collectively before the schedule of the major exams.
Activity 1
1. Which of the following is not considered cash for financial reporting purposes?
a. Petty cash funds and change funds
b. Money orders, certified checks, and personal checks
c. Coin, currency, and available funds
d. Postdated checks and I.O.U.'s
2. Which of the following may properly be included as part of cash to be reported in the December
31, 200A statement of financial position?
a. Treasury bills maturing on March 31, 200B, acquired on December 1, 200A.
b. Customer’s check dated January 1, 200B and sent to bank for deposit on December 31,
200A.
c. Shares of stocks to be sold on the first week of January 200B.
d. Preference shares with mandatory redemption and acquired three months prior to
redemption date.
3. Bank overdrafts, if material, should be
a. reported as a deduction from the current asset section.
b. reported as a deduction from cash.
c. netted against cash and a net cash amount reported.
d. reported as a current liability.
4. Deposits held as compensating balances
a. usually do not earn interest.
b. if legally restricted and held against short-term credit may be included as cash.
c. if legally restricted and held against long-term credit may be included among current assets.
d. none of these.
5. The effect of compensating balance is
a. to provide greater security for the borrower
b. to decrease the yield on the loan to the lender
c. to increase the yield on the loan to the borrower
d. to increase the yield on the loan to the lender.
6. Which of the following statements is incorrect?
a. Cash which is restricted and not available for use within one year of the reporting period
should be included in noncurrent assets.
b. Cash in a demand deposit account, being held specifically for the retirement of long-term
debts not maturing currently, should be excluded from current assets and shown as a
noncurrent investment.
c. Investments which can be liquidated at once and with little risk of loss of principal may be
classified as cash equivalent and included in the caption “Cash and Cash equivalents”
d. Compensating balances are cash amounts that are not immediately accessible by the
owner.

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e. Cash and cash equivalents is always presented first in statement of financial position when
presenting current and non-current classifications.
7. Alaking received cash to be held in trust for Ambit under an escrow agreement. Such cash
should be presented in Alaking’s financial statements as
a. part of cash
b. a liability
c. an asset and a liability
d. an off-balance sheet item but disclosed in the notes
8. These are short-term, highly liquid investments that are so near their maturity that they
represent insignificant risk of changes in value due to changes in interest rates.
a. Cash and Cash equivalents c. Treasury notes
b. Treasury bills d. Cash equivalents
9. When the bank receives cash from a depositor, the cash should be credited to
a. Cash c. Accounts payable
b. Cash in bank d. Deposit liability
10. Devin Co.'s cash balance in its balance sheet is P1,300,000, of which P300,000 is
identified as a compensating balance. In addition, Devin has classified cash of P250,000 that
has been restricted for future expansion plans as "other assets". Which of the following should
Devin disclose in notes to its financial statements?
(Item #1) Compensating balance; (Item #2) Restricted cash
a. Yes, Yes b. Yes, No c. No, Yes d. No, No
11. Which of the following is/are true about "compensating balances?"
I. They are reserve balances maintained for emergency spending requirements.
II. If compensating balances are legally restricted, they must be segregated on the balance
sheet.
III. Compensating balances are overstated if "floats" are included as part of the cash.
a. II only b. I & III c. I, II & III d. II & III
12. Which of the following best qualifies as a "cash equivalent?"
a. A firm's investment in "held to maturity" government treasury bonds that mature in 5 years.
b. A firm's equity investment in an unconsolidated subsidiary of a privately held firm.
c. A firm's investment in government treasury bills.
d. All of these answers.
13. Float refers to:
a. the number of days that a bank will allow a corporation to hold a negative balance in its
checking account before charging fees for the negative balance.
b. the companies bank balance in excess of its working capital needs.
c. the receivable balance on the books of the corporation.
d. checks issued but not yet paid by a bank.
14. On an entity’s December 31, 20x1 statement of financial position which of the following
items should be included in the amount reported as cash?
I. A check payable to the enterprise, dated January 2, 20x2, in payment of a sale made in
December 20x1.
II. A check drawn on the enterprise’s account, payable to a vendor, dated and recorded in the
company’s books on December 31, 20x1 but not mailed until January 10, 2002.
a. I only b. II only c. I and II only d. Neither I nor II
15. The amount reported as "Cash" on a company's balance sheet normally should exclude
a. postdated checks that are payable to the company
b. cash in a payroll account
c. undelivered checks written and signed by the company
d. petty cash

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16. Which of the following should be considered cash?

a. Certificates of deposits
b. Money orders
c. Money market savings certificates
d. Treasury bills
17. Travel advances should be reported as
a. Supplies
b. Cash because they represent equivalent of money
c. Investments
d. Receivables
18. In which account are postage stamps classified?
a. Cash
b. Supplies
c. Receivables
d. Inventory
19. Deposits held as compensating balance
a. Usually do not earned interest.
b. If legally restricted, and held against short-term credit may be included as cash.
c. If legally restricted, and held against long-term credit may be included among current
assets.
d. None of these.
20. Bank overdraft should be
a. Reported as a deduction from the current asset section
b. Reported as a deduction from cash
c. Netted against cash and net cash amount reported
d. Reported as current liability
21. What is the major purpose of an imprest petty cash fund?
a. To effectively plan cash inflows and outflows
b. To ease the payment of cash to vendors
c. To determine the honesty of the employees
d. To effectively control cash disbursements
22. Which of the following statements is incorrect in relation to imprest petty cash fund?
a. The imprest petty cash system in effect adheres to the rule of disbursement by check.
b. Entries are made to the petty cash account only to increase or decrease the size of the
fund or to adjust the balance if not replenished at year-end.
c. The petty cash account is debited when the fund is replenished.
d. The petty cash fund is reported as part of current assets.
23. Bank reconciliations are prepared monthly to identify adjustments in the depositor’s records
and to identify errors. Adjustments should be recorded by the depositor for
a. Bank errors, outstanding checks and deposits in transits
b. All items, except bank errors, outstanding checks and deposit in transit
c. Book errors and bank errors
d. Bank service charges, NSF checks, outstanding checks and deposit in transit
24. If the cash balance in an entity’s bank statement is less than correct cash balance and
neither the entity nor the bank has made errors, there must be
a. Deposits credited by the bank but not yet recorded by the entity
b. Outstanding checks
c. Bank charges not yet recorded by the entity
d. Deposits in transit

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25. If the cash balance in an entity’s accounting records is less than correct cash balance and
neither the entity nor the bank has made errors, there must be
a. Deposits credited by the bank but not yet recorded by the entity
b. Outstanding checks
c. Bank charges not yet recorded by the entity
26. Which of the following best qualifies as a "cash equivalent?"
a. A firm's investment in "held to maturity" government treasury bonds that mature in 5 years.
b. A firm's equity investment in an unconsolidated subsidiary of a privately held firm.
c. A firm's investment in government treasury bills.
d. All of these answers.
27. The amount reported as "Cash" on a company's balance sheet normally should exclude
e. postdated checks that are payable to the company
a. cash in a payroll account
b. undelivered checks written and signed by the company
c. petty cash
28. Which of the following would not be classified as cash?
a. Personal checks c. Cashier’s checks
b. Traveler’s checks d. Postdated checks
29. Cash in foreign currency is valued at
a. Face value
b. Current exchange rate
c. Current exchange rate reduced by allowance for expected decline in peso
d. Estimated realizable value
30. If material, deposit in foreign countries which are subject to foreign exchange restriction
should be shown separately as
a. Current asset with no disclosure of the restriction.
b. Non-current asset with no disclosure of the restriction.
c. Current assets with disclosure of the restriction.
d. Non-current asset with disclosure of the restriction.
31. Which of the following is least likely the purpose of preparing bank reconciliation?
a. to bring the cash in bank balance per books and per bank statement in agreement
b. as an internal control procedure for safeguarding assets
c. to detect fraud
d. to recognize items such as expenses and assets not recorded
32. Consider the following statements.
I. The voucher system refers to the complete use of the voucher check and of subsidiary
records of vouchers payable, voucher register and check register
II. The simplest and most satisfactory method of handling purchase discounts under the
voucher system is to deduct the purchase discount on the face of the voucher and enter
this discount in a special column in the check register
III. Entries in the voucher register are made in the same sequence as the numbering of the
checks – that is, in the order in which payments are made.
a. true, true, false c. false, false, false
b. true, false, false d. true, true, true
The next two questions are based on the following information:
The information below was taken from the bank transfer schedule prepared during the audit of
Fox Co.’s financial statements for the year ended December 31, 2001. Assume all checks are
dated and issued on December 30, 2001.

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Bank Accounts Disbursement date Receipt date

Check no. From To Per books Per bank Per books Per bank
101 National Federal Dec. 30 Jan. 4 Dec. 30 Jan. 3
202 County State Jan. 3 Jan. 2 Dec. 30 Dec. 31
303 Federal American Dec. 31 Jan. 3 Jan. 2 Jan. 2
404 State Republic Jan. 2 Jan. 2 Jan. 2 Dec. 31
33. Which of the following checks might indicate kiting?
a. #101 and #303. c. #101 and #404
b. #202 and #404 d. #202 and #303
34. Which of the following checks illustrate deposits/ transfers in transit at December 31,
2001?
a. #101 and #202. c. #202 and #404
b. #101 and #303 d. #303 and #404
35. This occurs when collection of receivables from one customer is misappropriated and then
concealed by applying a subsequent collection from another customer.
a. Lapping b. Kiting c. Window dressing d. Fraud
36. This occurs when cash shortage is concealed by overstating the balance of cash. This is
performed by exploiting the float period (the time it needs for a check to clear at the bank it was
drawn).
a. Lapping b. Kiting c. Window dressing d. Fraud
Activity 2
Answer as required the following problems.
1. The following items are obtained from the accounting records of PACERS Inc. as of December
31, 2020:
Coins and currency P150,000
IOU’s from company president 20,000
Money order 50,000
Postage stamps 30,000
Petty cash fund (inclusive of vouchers amounting to P20,000) 120,000
Payroll fund 30,000
Dividend fund 60,000
Tax fund 80,000
Bond sinking fund 200,000
Preference share redemption fund 100,000
Interest fund 10,000
Travel fund 20,000
Plant expansion fund 300,000
Stale check from a customer 20,000
Postdated check issued to a supplier of PACERS Inc. 20,000
What is the total cash and cash equivalents to be presented in the December 31, 2020 Statement
of Financial Position?
2. The following records are provided by the cash accountant of CAVS Inc. as of December 31,
2020:

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Coins P 100,000
Currency 300,000
Petty cash fund (P10,000 in IOUs and P20,000 in vouchers) 50,000
Foreign currency deposit (restricted) 200,000
RCBC Checking Account (overdraft) (200,000)
Postdated check from a customer of CAVS Inc. 30,000
Undelivered check for payment of accruals drawn by CAVS Inc. (PNB) 20,000
Savings Deposit in a bank closed by BSP 100,000
PNB Checking Account 500,000
What is the total cash and cash equivalents to be presented in the December 31, 2019 Statement
of Financial Position?
3. Abegail company reported the checkbook balance on December 31, 2020 at P8,000,000. In
addition, the entity held the following items in the safe on that date:
Check payable to Abegail, dated January 2, 2021 in payment of a sale,

not included in December 31 check book balance 1,000,000
Check payable to Abegail, deposited December 15 and included in
December 31 checkbook balance, but returned by bank on
December 30 stamped “NSF”. The check was redeposited on
January 2, 2020 and cleared on January 5, 2021 3,000,000
Check drawn on Abegail’s account, dated and recorded on
December 31, 2020 but not mailed until January 15, 2021 2,500,000
Coins and currencies 800,000
Three-month money market instruments 1,500,000
What is the correct amount of cash on December 31, 2020?
4. At year end, Dwayne Company reported cash and cash equivalents comprising cash on
hand P500,000, demand deposit P4 million, certificate of time deposit P2,000,000,
postdated customer check P300,000, petty cash fund P50,000, traveler’s check P200,000,
manager’s check P100,000 and money order P150,000. What amount of cash should be
reported at year-end?
5. On December 31, 2020, Salve Company had the following cash balances:
Cash in bank 5,000,000
Petty cash fund (all funds were reimbursed on December 31,2010 50,000
Treasury bills 1,500,000
Saving deposit 800,000
Cash in bank includes P500,000 of compensating balance against short-term borrowing

arrangement at December 31, 2020. The compensating balance is legally restricted as to
withdrawal by Salve. A check of P1,000,000 dated January 15, 2021 in payment of accounts
payable was recorded and mailed on December 31, 2020.

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In the December 31, 2020 statement of financial position, what amount should be reported as
“cash and cash equivalents”?
6. Marie Company had the following account balances on December 31, 2020.
Petty cash fund 50,000
Cash on hand 500,000
Cash in bank - current account 4,000,000
Cash in bank - payroll account 1,000,000
Cash in bank - restricted account for plant addition, expected to
be disbursed in 2021 500,000
Cash in sinking fund set aside for bond payable due June 30, 2021 1,500,000
The petty cash fund includes unreplenished December 2020 petty cash expense vouchers
of P5,000 and employee IOU of P5,000. The cash on hand includes a P100,000 check
payable to Marie dated January 15, 2021. In exchange for a guaranteed line of credit, Marie
has agreed to maintain a minimum balance of P200,000 in its unrestricted current bank
account.
What should be reported as “cash and cash equivalents” on December 31, 2020?
7. Mandy Company reported the following information at the end of the current year,
• Investment securities of P1,000,000. These securities are share investments in
entities that are traded in the Philippine Stock Exchange. As a result, the shares are
very actively traded in the market.
• Investment securities of P2,000,000. These securities are government treasury bills.
The treasury bills have a 10-year term and purchased on December 31 at which time
they had two months to go until they mature.
• Cash of P4,500,000 in the form of coin, currency, saving account and checking
account.
• Investment securities of Pl,500,000. These securities are commercial papers. The
term of the papers is nine months and they were purchased on December 31 at which
time they had three months to go until they mature
How much should be reported as cash and cash equivalents at the end of the current year?
8. The books of Kapiz Co. show the following balances at December 31, 20x1:
Cash on hand ₱ 400,000
Cash in Bank – current account 1,200,000
Cash in Bank – peso savings deposit 5,000,000
Cash in Bank – dollar deposit (unrestricted) $ 100,000
Cash in Bank – dollar deposit (restricted) 250,000
Cash in 3-month money-market account ₱ 500,000
3-month unrestricted time deposit $ 20,000
Treasury bill, purchased 11/1/20x1, maturing 2/14/20x2 ₱1,600,000
Treasury bond, purchased 3/1/20x1, maturing 2/28/20x2 1,000,000

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Treasury note, purchased 12/1/20x1, maturing 2/28/20x2 400,000

Unused Credit Line 4,000,000
Redeemable preference shares, purchased 12/1/20x1, 740,000
due on 3/1/20x2
Treasury shares, purchased 12/1/20x1, to be reissued on 200,000
1/5/20x2
Sinking fund 400,000
Additional information:
• Cash on hand includes a ₱40,000 check payable to Kapiz Co. dated December 29, 20x1.
• During December 20x0, check amounting to ₱30,000 was drawn against the Cash in bank -
current account in payment of accounts payable. The check remains outstanding as of
December 31, 20x1.
• The Cash in Bank – peso savings deposit includes ₱800,000 security bond on a pending labor
litigation, in favor of a previous employee. The establishment of the bond is mandated by a
court of law.
• The Cash in Bank – peso savings deposit also includes a compensating balance amounting to
₱500,000 which is not legally restricted.
• The Cash in Bank – dollar deposit (unrestricted) account includes interest of $4,000, net of tax,
directly credited to Kapiz Co.’s account. The exchange rate at year-end is $1 is to ₱45.
How much is the cash and cash equivalents to be reported in the 20x1 financial statements?
9. The following were the transactions involving an entity’s petty cash fund during the period.
July. 1, Established ₱30,000 petty cash fund.
20x1
July 1 Disbursements are made for the following:
through 21, - Groceries for use of employees in the pantry ₱4,200
20x1 - Transportation of Mang Benny, the messenger boy 1,500
- Snacks during meetings and conferences 3,000
- Gasoline for company vehicles 9,000
- Pedicure of Ms. Ana (secretary of the
boss) – authorized 9,000
Total ₱ 26,700
July 22, Total coins and currencies in the petty cash box is ₱1,500. Replenishment is
20x1 made.
Assuming that the petty cash fund is not replenished and financial statements are prepared on
July 31, 20x1, the month-end adjustment to the petty cash fund most likely does not include a:
a. debit to receivable from custodian for ₱1,800
b. credit to petty cash fund for ₱28,500
c. total debit to various expense accounts for ₱26,700
d. credit to cash in bank for ₱28,500

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10. As of December 31, 20x1, the petty cash fund of Kristelle Co. with a general leger balance of
₱15,000 comprises the following:
Coins and currencies 2,550
Petty cash vouchers:
Gasoline for delivery equipment 3,000
Medical supplies for employees 2,040 5,040
IOU’s:
Advances to employees 2,220
A sheet of paper with names of several employees
together with contribution to bereaved employee,
attached is a currency of 2,400
Checks:
Check drawn to the order of the petty cash custodian 3,000
Personal check drawn by the petty cash custodian 2,400
The entry to replenish the fund on December 31, 20x1 includes a
a. credit to cash shortage or overage for ₱2,190
b. debit to cash shortage or overage for ₱2,910
c. credit to cash in bank for ₱9,450
d. credit to petty cash fund for ₱9,450
Thank you for completing this activity. If you have not completed or have difficulty
in accomplishing the activities, don’t hesitate to contact me in our google
classroom with this code _______. Please follow strictly the given matrix
Now, you are ready for our next topic.

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Unit 1-Accounting for Cash
Topic 2- Bank Reconciliation and Proof of Cash
Bank Deposits
There are three kinds of bank deposit:
Demand deposit is the current account or checking account or commercial deposit
where deposits are covered by deposit slips and where funds are withdrawable on the
demand by drawing checks against the bank.
A demand deposit is non-interesting bearing.
Saving deposit
In a saving deposit, the depositor is given a passbook upon the initial deposit. The
passbook is required when making deposits and withdrawal.
A saving deposit is interest bearing.
Time deposit is similar to saving deposit in the sense that it is interest bearing.
Time deposit may be pre-terminated or withdrawn on demand or after a certain period
of time agreed upon.
Bank Reconciliation is necessary only for Demand deposit
Learning Outcomes

• Identify the reconciling items affecting the cash in bank per ledger and per bank
statement.
• Prepare Bank reconciliation.
• Prepare proof of cash.
Pretest
Before each statement, write TRUE if the statement is correct or FALSE if the statement is
incorrect.
______________1. NSF checks drawn and released to payee but are not yet encashed with the
banks.
______________2. Certified checks are already deducted from the account; thus, they are
excluded from outstanding checks.
______________3. Book errors are errors committed by the depositor.
______________4. Credit memos are deducted made by the bank to the depositor’s bank
account but not yet recorded by the depositor.

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______________5. A bank reconciliation statement is a report that is prepared for the purpose of
bridging the balances of cash per records and per bank statement into
agreement.
______________6. Bank reconciliation is prepared by the bank.
______________7. Deposits in transit often occur when deposits are mailed to the bank, placed
in an overnight depositary, made through check and the check has not yet
cleared, or made after the bank’s cut-off.
______________8. The amount of deposits in transit is deducted from the balance per bank
statement in preparing bank reconciliation.
______________9. The amount of the unadjusted balance appearing on the bank reconciliation
as of a given date is the amount that is shown on the balance sheet for that
date.
______________10. When business has more than one bank account, combined bank
reconciliations is made for made for all the accounts held.
Content
Bank reconciliation
A bank reconciliation is a statement which brings into agreement the cash balance per book and
cash balance per bank.
Bank reconciliations are prepared by bank depositors when they receive their monthly bank
statements. The reconciliation is made to determine any required adjustments to the cash
balance. Two types of reconciling items are possible.
The reconciliation is usually prepared monthly because the bank provides the depositor with the
bank statement at the end of every month.
A bank statement is a monthly report of the bank to the depositor showing:

a. The cash balance per bank at the beginning
b. The deposits made by the depositor and acknowledged by the bank
c. The checks drawn by the depositor and paid by the bank.
d. The daily cash balance per bank during the month
More specially, bank reconciliations are prepared to:

a. Explain the difference between the cash balance in the accounting records and the cash
balance reported on the bank statement;
b. Arrive at the adjusted (correct) cash balance to be shown in the financial statements; and
c. Provide information for reconciling journal entries.
Reconciling items

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At the end of every month, comparison between the cash records of the depositor and the bank
depositor and the bank statement received from the bank will yield the ff. reconciling items:
1. Book reconciling items:
a. credit memos
b. debit memos
c. errors
2. Bank reconciling items:
a. deposit in transit
b. outstanding checks
c. errors
Book Reconciling Items

Credit memos
Credit memos refer to items not representing deposits credited by the bank to the account of the
depositor but not yet recorded by the depositor as cash receipts.
Typical examples of credit memos are:
a. Notes receivable collected by bank in favor of the depositor and credited to the account of
the depositor.
b. Proceeds of bank loan credited to the account of the depositor
c. Matured time deposits transferred by the bank to the current account of the depositor.
Debit memos
Debit memos refer to items not representing checks paid by the bank which are charged or
debited by the bank to the account of the depositor but not yet recorded by the depositor as cash
disbursements. The debit memos have the effect of decreasing the bank balance.
Typical examples of debit memos:
a. NSF or no sufficient fund checks – These are checks deposited but returned by the bank
because of insufficiency of fund. The other name for NSF is DAIF or “drawn against
insufficient fund”.
b. Technically defective checks – these are checks deposited but returned by the bank
because of technical defects such as absence of signature or countersignature, erasures
not countersigned, mutilated checks, conflict between amount in words and amount in
figures.
c. Bank service charges – these include bank charges for interest, collection, checkbook and
penalty.
d. Reduction of loan – This pertains to amount deducted from current account depositor in
payment for loan which the depositor owes to the bank and which already matured.
Bank Reconciling Items

Deposits in transit
Deposits in transit are collections already recorded by the depositor as cash receipts but not yet
reflected on the bank statement.
Deposit in transit include:
a. Collections already forwarded to the bank for deposit but too late to appear in the bank
statement.
b. Undeposited collections or those still in the hands of the depositor. In effect, these are
cash on hand the awaiting delivery to the bank for deposit.
Outstanding checks
Outstanding checks are checks already recorded by the depositor as cash disbursements but not
yet reflected on the bank statement.

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Outstanding checks include:

a. Checks drawn and already given to payees but not yet presented for payment.
b. Certified checks – A certified check is one where the bank has stamped on its face the
word “accepted” indicating sufficiency of fund.
When the bank certifies a check, the account of the depositor is immediately debited or charged
to insure the eventual payment of the check. Certified checks should be deducted from the total
outstanding checks (if included therein) because they are no longer outstanding for bank
reconciliation purposes.
Forms of bank reconciliation

The ff. formats may be used in reconciling the book balance and the bank balance:
a. Adjusted balance method – Under this method, the book balance is brought to a correct cash
balance that must appear on the balance sheet.
b. Book to bank method – Under this method, the book balance is reconciled with the bank
balance or the book balance is adjusted to equal the bank balance.
c. Bank to book method - Under this method, the bank balance is reconciled with the book
balance or the bank balance is adjusted to the equal the book
balance.
Pro-forma of Adjusted balance method

BANK BOOK
(DR) CR (CR) DR
Balance xx xx
Reconciling Items:
Deposit in transit (DIT) xx
Outstanding Checks (xx)
Credit Memo (Collection, interest) (xx)
Debit Memo (charges, NSF) xx
Errors xx(xx) xx(xx)
Adjusted Balance xx xx
Pro-forma of Book to Bank method

Book Balance XX
Add: Reconciling Items:
Credit Memo (Collection, interest) XX
Outstanding Checks XX
Errors XX XX
Total XX
Less: Reconciling Items:
Debit Memo(charges, NSF) XX
Deposit in transit(DIT) XX
Errors XX XX
Bank Balance XX

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Pro-forma of Bank to Book Method

Bank Balance XX
Add: Reconciling Items:
Deposit in transit (DIT) XX
Debit Memo (charges, NSF) XX
Errors XX XX
Total XX
Less: Reconciling Items:
Outstanding Checks XX
Credit Memo (Collection, interest) XX
Errors XX XX
Book Balance XX
Illustrative Example:
Alpha Company provided the following information for the month of December:
Cash balance per ledger 5,000,000
Cash balance per bank statement 5,500,000
Proceeds of loan discounted on December 1 for one year at 14% 516,000
Undeposited collections on December 31 300,000
Check of Omega Company had been incorrectly deducted by bank from
Alpha Company Account 50,000
Check of Alpha Company in payment of an account payable had been
recorded by the depositor as P20,000. Correct amount is 200,000
The ledger account for cash was the only cash account kept by the entity.
It included a petty cash account comprised of the following items:
Coins and currency 4,000
Supplies 2,000
Transportation 3,000
Postage 1,000 10,000
Deposit of Omega Company credited by bank to the account of Alpha Comp. 130,000
Deposit of December 27 omitted form the bank statement 150,000
Outstanding Checks 544,000
Prepare a bank reconciliation od December 31.

Prepare on journal entry only necessary to adjust the cash account.

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Solution:
PROOF OF CASH
A proof of cash is an expanded reconciliation in that it includes proof of receipts and

disbursements.
The bank reconciliation is so-called “two-date” because it literally involves two dates. The
procedure followed for a one-date reconciliation are the same of two-date reconciliation. It
becomes complicated only when certain facts are omitted, hence the necessity for computing
them.
These are the some of the omitted information, any one or a combination of the following:
a. Book balance- beginning and ending
b. Bank balance- beginning and ending
c. Deposits in transit- beginning and ending
d. Outstanding checks- beginning and ending
The following formula may help in getting the omitted items:

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Computation of book balance
Computation of bank balance
Book debits refer to cash receipts or all items debited to the cash in the bank account.
Book credits refer to cash disbursements or all items credited to the cash in bank account.
Bank credits refer to all items credited to the account of the depositor which include deposits
acknowledge by bank and credit memos.
Bank debits refer to all items debited to the account of the depositor which include checks paid
by bank and debit memos.
Computation of deposit in transit
All items not representing checks credited to the cash in bank account should be deducted from
the book credits total to arrive at the checks drawn by the depositor. But as a rule, all book credits
in the absence of any statement to the contrary are assumed to be checks issued.

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Computation of outstanding checks
All items debited to the account of the depositor not representing checks paid should be deducted
from the bank debits total to arrive at the checks paid by bank. But as a rule, all bank debits in the
absence of any statement to the contrary are assumed to be checks paid by bank.
There are three forms of proof cash, namely:

a. Adjusted balance method
b. Book to bank method
c. Book to book method
Pro-forma of a proof of Cash

Company XX
Proof of Cash
For the month ended XXX

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Illustrative Example
Fabulous Company provided the following data concerning cash on July 31:
Checks Drawn Bank Statement

No. 101 600,000 Balance, July 31 2,700,000
No. 102 700,000 Charges:
No. 103 300,000 Checks Paid 4,000,000
No. 104 400,000 Service Charge 20,000
No. 105 450,000 Credits:
No. 106 600,000 Deposits 3,500,000
No. 107 650,000 Note Collected 1,500,000
No. 108 500,000
Balance of cash per book on July 1, P1,270,000. Cash receipts per cash book for the month of
July P3,400,000. Checks paid by bank include all checks issued during the month of July except
No. 107 and No. 108. On July 31 cash received but not deposited in bank, P400,000.
Prepare a bank reconciliation on July 1 and July 31

Prepare adjusting entries on July 31.
Solution:

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Assessment
Activity 1
1. It is a report that is prepared for the purpose of bringing the balances of cash per records and
per bank statement into agreement.
a. Bank statement
b. Check Disbursement Voucher
c. Bank reconciliation
d. Bank deposit slip
2. These are deposits made but not yet credited by the bank to the depositor’s bank account.
a. Credit memos (CM)
b. Debit memos (DM)
c. Outstanding checks (OC)
d. Deposits in transit (DIT)
3. These are deductions made by the bank to the depositor’s bank account but not yet recorded
by the depositor.

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b. Debit memos (DM)
4. These are additions made by the bank to the depositor’s bank account but not yet recorded
by the depositor.
b. Debit memos (DM)
5. These are checks drawn and released to payees but are not yet encashed with the bank.
b. Debit memos (DM)
6. Which of the following is added to the cash balance per books when preparing a bank
reconciliation statement?
a. Credit memo
b. Debit memo
c. Outstanding check
d. Deposit in transit
7. Which of the following is added to the cash balance per bank statement when preparing a
bank reconciliation statement?
a. Credit memo
b. Debit memo
c. Outstanding check
d. Deposit in transit
8. Which of the following represents a debit memo?
a. Collections made by the bank on behalf of the depositor.
b. Interest income earned by the deposit.
c. Proceeds from loan directly credited or added by the bank to the depositor’s account.
d. Interest expense on a loan that is directly deducted from the depositor’s account.
9. Which of the following is not a debit memo?
a. Bank service charges
b. No sufficient funds checks (NSF)
c. Automatic debits representing payments of bills by the bank on behalf of the depositor
d. Direct deposits of customers to the depositor’s account
10. As an internal control, bank reconciliation statements are usually prepared
a. on a daily basis.
b. on a monthly basis.
c. annually every year-end.
d. whenever the accountant feels like it.
11. Adjusting and correcting entries in the books of the company are necessary for
a. Book reconciling items c. Errors committed by the bank
b. Bank reconciling items d. a and c
12. Bank reconciliations are normally prepared
a. on “as needed” basis
b. on a monthly basis
c. every time financial statements are prepared

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d. only at year-end
13. In preparing the bank reconciliation, certified checks should be excluded from outstanding
checks. The rationale for this treatment is
a. the bank, when certifying checks, draws the check in its account
b. the bank, when certifying checks, automatically debits the company’s account
c. the bank, when certifying checks, automatically credits the company’s account
d. the bank, when certifying checks, assumes the obligation to pay the drawee when the
check is presented for payment
14. Unless otherwise stated, reconciling items are presumed to have been taken up in the
books or taken up by the bank
a. during the month the bank statement is prepared
b. in the immediately following month
c. in the immediately preceding month
d. in the immediately following or preceding reporting period, on a case-to-case basis
15. In preparing the bank reconciliation using the adjusted balance method, the first item listed
in the bank reconciliation report for reconciling the balance of cash in bank per books to the
adjusted balance is the
a. balance of cash in bank per books as of the end of the month
b. balance of cash in bank per books as of the beginning of the month
c. balance of cash in bank per bank statement as of the end of the month
d. balance of cash in bank per bank statement as of the beginning of the month
16. In preparing the bank reconciliation using the adjusted balance method, the first item listed
in the bank reconciliation report for reconciling the balance of cash in bank per bank statement
to the adjusted balance is the
a. Balance of cash in bank per books as of the end of the month
b. balance of cash in bank per books as of the beginning of the month
c. balance of cash in bank per bank statement as of the end of the month
d. balance of cash in bank per bank statement as of the beginning of the month
17. In preparing the bank reconciliation using the adjusted balance method, errors to be
included in reconciling the balance per books to the adjusted balance include
a. only the errors committed by the company
b. only the errors committed by the bank
c. both the errors committed by the company and the bank
d. choice (c) if both errors affect the balance per books
18. Which of the following is deducted from the cash balance per bank when computing for
the cash balance reported in the books?
a. Deposit in transit c. Credit memo
b. Error d. Debit memo
19. When presenting a bank reconciliation statement prepared using the book to bank
method, which of the following is as a deduction in order to compute for the cash balance per
bank?
a. Deposit in transit c. Credit memo
b. Error d. Outstanding checks
20. In reconciling a business cash book with the bank statement, which of the following items
could require a subsequent entry in the cash book?
1. Checks presented after date.
2. A check from a customer which was dishonored.
3. An error by the bank.
4. Bank charges.
5. Deposits credited after date.

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6. Standing order entered in bank statement.

a. 2, 3, 4 and 6 b. 1, 2, 5 and 6 c. 2, 4 and 6 d. 1, 3 and 5
(ACCA)
21. A bank reconciliation is
a. A formal financial statement that list all of the bank account balances of an enterprise.
b. A merger of two banks that previously were competitors.
c. A statement sent by the bank to depositor on a monthly basis.
d. A schedule that accounts for the differences between an enterprise’s cash balance as
shown on its bank statement and the cash balance shown in its general ledger.
(AICPA)
22. If the balance shown on a company's bank statement is less than the correct cash balance,
and neither the company nor the bank has made any errors, there must be
a. deposits credited by the bank but not yet recorded by the company.
b. outstanding checks.
c. bank charges not yet recorded by the company.
d. deposits in transit.
(AICPA)
23. If the cash balance shown in a company's accounting records is less than the correct cash
balance, and neither the company nor the bank has made any errors, there must be
a. deposits credited by the bank but not yet recorded by the company.
b. deposits in transit.
c. outstanding checks.
d. bank charges not yet recorded by the company.
(Adapted)
24. Which of the following statements is false?
a. Certified check is a liability of the bank certifying it.
b. Certified check will be accepted by many persons who would not otherwise accept a
personal check.
c. Certified check is one drawn by the bank upon itself.
d. Certified check should not be included in the outstanding check.
(Adapted)
25. Bank statements provide information about all of the following except
a. checks cleared during the period c. bank charges for the period
b. NSF checks d. errors made by the company
(Adapted)
26. Which of the following items would be added to the book balance on a bank reconciliation?
a. Outstanding checks
b. A check written for P63 entered as P36 in the accounting records
c. Interest paid by the bank
(Adapted)
27. In preparing a bank reconciliation, interest paid by the bank on the account is
a. added to the bank balance c. added to the book balance
b. subtracted from the bank balance d. subtracted from the book balance
(Adapted)
28. In preparing a monthly bank reconciliation, which of the following items would be added
to the balance reported on the bank statement to arrive at the correct cash balance?
a. Outstanding checks
b. Bank service charge
c. Deposits in transit

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d. A customer's note collected by the bank on behalf of the depositor

29. Bank reconciliations are normally prepared on a monthly basis to identify adjustments
needed in the depositor's records and to identify bank errors. Adjustments should be recorded
for
a. bank errors, outstanding checks, and deposits in transit.
b. all items except bank errors, outstanding checks, and deposits in transit.
c. book errors, bank errors, deposits in transit, and outstanding checks.
d. outstanding checks and deposits in transit.
30. A reconciliation that includes proof of receipts and disbursements that is useful in
discovering possible discrepancies in handling cash over a certain period of time.
a. Bank statement c. Proof of cash
b. Bank reconciliation d. Cash requirements report
31. A device not normally prepared on a regular basis but is a very useful tool during fraud
audits regarding defalcation of cash
a. Lapping statement c. Proof of cash
b. Bank reconciliation d. Cash requirements report
32. Regarding the preparation of a proof of cash, an erroneous book credit committed in the
previous month which is corrected this month
a. is an addition to previous month's balance per books and a deduction to receipts in current
month
b. is a deduction to previous month's balance per books and a deduction to receipts in current
month
c. is an addition to current month's balance per books and a deduction to receipts in previous
month
d. is an addition to previous month's balance per bank statement and a deduction to receipts
in current month
33. When preparing a proof of cash, the correction for an overstatement of cash in the
previous month
a. is an addition to previous month's balance per books and a deduction to receipts in current
month
b. is a deduction to previous month's cash balance and a deduction to current month's
disbursements
c. is an addition to previous month's balance per bank statement and a deduction to receipts
in current month
d. is an addition to previous month's balance per bank statement and a deduction to current
month's disbursements
34. A proof of cash would be useful for
a. Discovering cash receipts that have not been recorded in the journal.
b. Discovering time lag in making deposits.
c. Discovering cash receipts that have been recorded but have not been deposited.
d. Discovering an inadequate separation of incompatible duties of employees.
(Adapted)
35. Del Co. prepares a four-column bank reconciliation. Check no. 8859 was written for
P5,670 on the books, but the check was written and cleared the bank for the correct amount,
P6,570. The correct treatment on the reconciliation would be:
a. on the bank side, deduct P900 from payments and add P900 to ending balance
b. on the book side, deduct P900 from payments and add P900 to ending balance
c. on the book side, add P900 to payments and deduct P900 from ending balance
d. on the bank side, add P900 to receipts and add P900 to ending balance
(Adapted)

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Activity 2
Answer as required
1. Jane Company provided the following information on December 31, 2020:
Cash in bank per bank statement P 8 million
DIT 1.2 million
O/C 1.3 million
Amount erroneously credited by bank to Jane’s account 150,000
Note collected by bank for the entity 1.1 million
Service Charge for December 20,000
NSF 500,000
Error in recording check in the book. Correct amount is
P100,000 instead of P200,000 as recorded 100,000
Saving deposit in other banks closed by BSP 1 million
Currency and coins on hand 900,000
Petty cash fund 50,000
What is the unadjusted cash in bank per ledger on December 31, 2020?
What is the adjusted cash in bank balance?
What is the total cash to be reported as current asset on December 31, 2020?
2.The accountant for the OppaHaeKo Company assembled the following data:
June 30 July 31
Cash account balance P 15, 822 P 39,745
Bank statement balance 107, 08 137, 817
DIT 8, 201 12, 880
O/C 27, 718 30, 112
BSC 72 60
Customer’s check deposited in July 10, returned
by bank on July 16 marked NSF, and redeposited
immediately; no entry on books for returned or redeposited 8, 250
Collection by bank of the company’s Note receivable 71, 815 80, 900
The bank statements and the company’s cash records show these totals:
Disbursements in July per bank statement P 218, 373
Cash receipts in July per OppaHaeKo’s books 236, 452
Based on the above data, you are provided to answer the following questions:
1. How much is the adjusted cash balance as of June 30?

2. How much is the adjusted bank receipts for July?
3. How much is the adjusted book disbursements for July?
4. How much is the adjusted cash balance for July?
5. How much is the cash shortage as of July 31?
3. Taken from the records of Girly Co. are the following:
Balance per books, October 31 4,440

Total Credits per books, November 8,320

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Balance per books, November 30 2,400

Balance per bank statement, October 31 5,520
Balance per bank statement, November 30 4,560
Total Debits per bank statement, November 2,800
Loan proceeds directly credited to Girly’s account in October 1,200
Collection of receivable directly credited to Girly’s
account in November – not yet recorded in the books 600
NSF checks returned in October 900
NSF checks returned in November - not yet recorded in the books 300
Check received from a customer amounting to ₱1,800
was recorded in the books in October as 180
Overstatement in book debit in October 800
Overstatement in book credit in November 300
Understatement in bank debit in October 290
Overstatement in bank credit in October 370
Deposit amounting to ₱1,050 was recorded by
the bank in November as 150
Deposits in transit – October 31 4,500

Outstanding checks – October 31 3,800
How much is the deposits in transit at November 30?
How much is the outstanding checks at November 30?
How much is the adjusted balance of cash at November 30?
4. Kriselda Co. has the following information for the months of June and July.
June 30 July 31
Book balance ? 9,300
Book debits 30,700
Book credits 27,000
Bank balance 10,200 16,800
Bank debits 21,300
Bank credits ?
Notes collected by bank 2,250 3,000
Bank service charge 20 100
NSF checks 880 1,400
Understatement of recorded cash
collections 1,900 1,200
Deposit in transit 6,000 11,250
Outstanding checks 9,750 17,850
Loan amortization of Kristeta
Corp. erroneously debited to
Kriselda Co.’s account 2,400 1,800
How much is the adjusted cash receipts in July?

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How much is the adjusted cash disbursements in July?
How much is the adjusted cash balance as of July 31?
classroom with this code _______. Please follow strictly the given matrix.
Reference List
Millan, Z. V. (2019). Intermediate Accounting 1 (2020 ed.). Bandolin Enterprise.
Millan, Z. V. (2019). Conceptual Framework and Accounting Standards (2020 ed.). Bandolin
Enterprise.
Philippine Accounting Standards Council. (2017). Philippine Accounting Standards. Board of

Accountancy.
Valix, C. T., Peralta, J. F., & Valix, C. A. M. (2020). Intermediate Accounting (2020 ed., Vol. 3).
GIC Enterprise.
Valix, C. T., Peralta, J. F., & Valix, C. A. M. (2020). Conceptual Framework and Accounting
Standards (2020 ed., Vol. 3). GIC Enterprise.

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Unit 2-Accounting for Receivables
Receivables are financial assets that represent a contractual right to receive cash or
another financial asset from another entity. For retailers or manufacturers, receivables are
classified into trade receivables and nontrade receivables.
Topic 1- Accounts Receivable and Estimation of doubtful Accounts
Learning Outcomes

• Determine the nature and composition of the accounts receivable.
• Identify and use the techniques in analyzing problems with regards to receivables.
• State the timing of recognition and measurement of trade receivables.
• Solve problems in accounts receivable
• Identify and apply methods of estimating doubtful accounts expense
Pretest
Sigma Corp. has the following information regarding its allowance for uncollectible accounts.
Balance December 31, year 1 P 28,000

Write-offs during year 2 (27,000)
Recoveries during year 2 7,000
Balance before year 2 provision 8,000
Required allowance at December 31, year 2 39,000
Year 2 Provision P 31,000
Prepare the journal entries for the write-offs and recoveries for year 2, and for the provision for
uncollectible accounts expense at December 31, year 2.
Write-offs
Allowance for uncollectible accounts
Accounts receivable
Recoveries
Accounts receivable
To reinstate the account receivable
Cash
Accounts Receivable
To show payment on the account

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Uncollectible accounts expense at December 31, year 2

Uncollectible accounts expense
Content
Trade and nontrade receivables

Trade receivables refer to claims arising from sale of merchandise or services in the ordinary
course of business. Trade receivables include accounts receivable and notes receivable.
Account receivable are open accounts arising from the sale of goods and services in the ordinary
course of business and not supported by promissory notes.
Notes receivable are those supported by formal promises to pay in the form of notes.
Nontrade receivables represent claims arising from sources other than the sale of merchandise
or services in the ordinary course of business.
For banks and other financial institutions, receivables result primarily from loans to customers.
Classification
Trade receivables which are expected to realize in cash within the normal operating cycle or one
year, whichever is longer, are classified as current assess.
Nontrade receivables which are expected to be realized in cash within one year the length of the
operating notwithstanding, are classified as current assets.
If collectible beyond one year, nontrade receivables are classified as noncurrent assets.
Financial Statement Presentation

Trade and nontrade receivables that are currently collectible are combined and presented on the
statement of financial position in a single item described as Trade and other receivables.
Customers’ credit balances

Customers’ credit balances are credit balances in accounts receivable resulting from
overpayments, returns and allowances, and advances payments from customers.
Measurement of accounts receivable

Initial measurement: Fair Value

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PFRS 9, paragraph 5.1.1 provides that financial asset be measured at fair value plus
transaction cost directly attributable to the acquisition. For short-term receivables, the fair
value is equal to the face amount. Accordingly, accounts receivable shall be measured initially
at face amount or original invoice amount.
Subsequent Measurement: Amortized cost

PFRS 9, paragraph 5.2.1 after initial recognition, accounts receivable shall be measured at
amortized cost. The amortized cost is actually the net realizable value (NRV) of accounts
receivable. The amortized cost is more relevant in long-term receivable. Thus, NRV is preferably
used in relation to accounts receivable.
The NRV is the amount of cash expected to be collected or estimated recoverable amount.
Net realizable Value

Initial amount recognized by A/R shall be reduced by adjustments which in the ordinary course of
business will reduce the amount recoverable from the customer. This is based on the established
basic principle that assets shall not be carried at above their recoverable amount.
Accordingly, in estimating the net realizable value of trade accounts receivable, the ff. deductions
as follows:
a. Allowance for freight charge
b. Allowance for sales return
c. Allowance for sales discount
d. Allowance for doubtful accounts
Terms of sale contract*

• FOB Destination
• FOB Shipping point
FOB stands for “free on board”
Accounting for freight charges*

• Freight Collect
• Freight Prepaid
*This has been discussed already in your Financial Accounting and Reporting course. Terms
related to the freight charges will be furtherly discuss in Inventory topic.
Sales Discount
Entities usually offer cash discounts to credit customers. A cash discount is a reduction from a n
invoice price by reason of prompt payment. A cash discount is known as sales discount on the
part of the seller and a purchase discount on the part of the buyer.
Methods of Recording Credit Sales

1. Gross method- the accounts receivable and sales are recorded at gross amount of the
invoice.
2. Net method- the accounts receivable and sales are recorded at net amount of the
invoice, meaning the invoice price minus the cash discount.
Illustration Assume that Go Enterprises sold merchandise to Wang Company at gross

sales of P200,000, terms: 2/10, n/30. The journal entries would be

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Illustration
Assume that Go Enterprises sold merchandise to Wang Company at gross sales of
P200,000, terms: 2/10, n/30. The journal entries would be
Books of Go Enterprises (Seller)
1. To record credit sales
Gross Method Net Method

Accounts Receivable 200,000 Accounts Receivable 196,000
Sales 200,000 Sales 196,000
*(200,000 x 98% =
196,000)
Note: Unlike the gross method, the net method initially records the sales reduced
by the cash discount even if no actual collection has been made yet. The
recording, however, does not reflect the sales discount account in the
books of accounts.
2. If collection is made within the discount period
Gross Net Method

Method
Cash 196,000 Cash 196,000
Sales Discounts 4,000 Accounts 196,00
Receivable 0
Accounts 200,00
Receivable 0
Note: The gross method records only the cash discount when actual collection was
made within the discount period.
3. If collection is made after the discount period.

Cash 200,000 Cash 200,000
Accounts 200,00 Accounts Receivable 196,000
Receivable 0
Sales discounts 4,000
forfeited
Note: Sales discount forfeited shall be treated as other operating income in the
income statement. Therefore, net profit is the same for both gross and
net methods.
Books of Wang Company (Buyer)
1. To record purchases on account

Purchases 200,000 Purchases 196,000
Accounts 200,000 Accounts Payable 196,00

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Payable 0
*(200,000 x 98% =
196,000)
2. If payment is made within the discount period.

Accounts Payable 200,000 Accounts 196,0
Payable 00
Cash 196,000 Cash 196,000
Purchase 4,000
Discounts
3. If payment is made after the discount period.

Accounts 200,000 Accounts Payable 196,000
Payable
Cash 200,000 Purchase Discount 4,00
Lost 0
Cash 200,00
0
Note: The purchase discount lost account shall be treated as other operating
expense (loss) in the income statement.
Therefore, net profit is the same for both gross and net methods.
Accounting for Bad Debts
Two Methods
1. Allowance Method
2. Direct Write-off Method
Allowance Method*
Requires recognition of bad debts loss if the accounts are doubtful of collection.
Direct write-off method

The direct write-off method requires recognition of a bad debt loss only when the accounts
proved to be worthless or uncollectible.
* Allowance Method is encouraged to use because it adheres to Matching Principles and

properly measured the NRV.
Illustration- Allowance Method

1. Accounts of P30,000 are considered doubtful of collection
Doubtful accounts 30,000
Allowance for doubtful accounts 30,000
2. The accounts are subsequently discovered to be worthless or uncollectible.
Accounts Receivable 30,000
3. The same accounts that are previously written off are unexpectedly recovered or collected

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Cash 30,000
Illustration- Direct write-off Method

1. Accounts of P30,000 are considered doubtful of collection
NO ENTRY is necessary.
2. The accounts proved to be worthless.

Bad Debts Expense 30,000
3. The same accounts that are previously written off are unexpectedly recovered or collected
Bad Debts Expense 30,000
Cash 30,000
Doubtful accounts in the income statement

1. Distribution cost
If the granting of credit and collection of accounts are under the charge of the sales manager,
doubtful accounts shall be considered as distribution cost.
2. Administrative expense
If the granting of credit and collection of accounts are under the charge of an officer other than
sales manager, doubtful accounts shall be considered as administrative expense.
T-Account for Accounts Receivable

This shows what accounts or transactions affect the accounts receivable account.
Accounts Receivable
Beginning balance Sales return and allowances
Recovery Sales discount
Sales on account Write off
Collection
Note receivable discounted
Ending balance
ESTIMATION OF DOUBTFUL ACOUNTS

Bad debts (doubtful accounts) expense is recognized when loss becomes probable and can be
measured reliably.
This is use on how you compute the NRV of the receivable by deducting the required allowance
for doubtful accounts.
T-Account for Allowance for doubtful accounts

This shows what accounts or transactions affect the accounts receivable account.

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Allowance for Doubtful Accounts

Write-off Beginning balance
Doubtful Expense
Recoveries
Ending balance
Methods of estimating doubtful accounts

There are three methods of estimating doubtful accounts, namely:
1. Aging the accounts receivable or “statement of financial
position approach”
2. Percent of account receivable or also “statement of
financial position approach”
3. Percent of sales or “income statement approach”
Aging of accounts receivable

The aging of accounts receivable involves an analysis where the accounts are classified into not
due or past due.
a. Not due e. 91 to 120 days past due
b. 1 to 30 days past due f. 121 to 180 days past due
c. 31 to 60 days past due g. 181 to 365 days past due
d. 61 to 90 days past due h. more than one year past due
This is a variation of the percentage of receivables method. However, under the aging of
receivables method, the required balance of allowance for doubtful accounts is computed by
applying various estimated percentages to the breakdown of the ending receivable according to
ages.
Based on the T-account of the allowance for doubtful accounts. The required allowance is the
ending balance.
Doubtful Expense
Recoveries
Ending balance
Required Allowance
Percent of accounts receivable
A certain rate is multiplied by the open accounts at the end of the period in order to get the required
allowance balance.
The rate use is usually determined from past experience of the entity.
This procedure has the advantage of presenting the accounts receivable at estimated net
realizable value.
Again, the amount that we can derive is the required allowance for doubtful accounts which is the
ending balance the same with aging of A/R. Based on the T-account of the allowance for doubtful
accounts.

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Doubtful Expense
Recoveries
Ending balance
Required Allowance
Percent of sales
The amount of sales for the year is multiplied by a certain rate to get the doubtful accounts
expense. The rate may be applied on credit sales or total sales. Theoretically, the rate to be used
is computed by dividing the bad debt losses in prior years by the charge sales of prior years.
In percent of sales the amount we can derive is the doubtful account Expense not the required
allowance.

Doubtful Expense Amount computed
Recoveries
Ending balance
Argument for percent of sales method

When the “percent of sales” method is used in computing doubtful accounts, proper matching of
cost against revenue is achieved. This is so because the debt loss is directly related to sales and
reported in the year of sale.
Thus, this method is an income statement approach because it favors the income statement. The
main argument against this method is that the accounts receivable may not be shown at estimated
realized value because the allowance for doubtful account accounts may prove excessive or
inadequate. Thus, it become necessary that from time to time the accounts should be “edge” to
ascertain the probable loss.
Correction in allowances for doubtful accounts

The percent of sells method of estimating doubtful accounts has the disadvantage the allowance
for doubtful accounts being inadequate or excessive. Aging the accounts is then necessary to test
reasonableness of the allowance. The correction is to be reported in the income statement ether
as an addition to or subtraction from doubtful accounts expense.
Impairment of accounts receivable
Many entities record allowance for doubtful accounts using edging of accounts receivable,
percentage of accounts receivable and percentage of sales.
The approach relatively direct and uncomplicated. Actually, accounts receivable considered
uncollectible redeem to be “impaired”.
PFRS 9, paragraph 5.5.1, provides that an entity shall recognize a loss allowance for expected
credit losses on financial asst measured at amortized cost.

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Paragraph 5.5.3 provides that an entity shall measure the loss allowance for a financial instrument
for a financial instrument at an amount equal to the lifetime expected credit losses if the credit
risk on that financial has increased significantly since initial recognition. Credit losses are the
percent value of all cash shortfalls. Expected credit losses are an estimate of credit losses over
the life of the financial instrument.
When measuring expected credit losses, an entity should consider:

a. The probability-weighted outcome
b. The time value of money
The expected losses should be discounted
c. Reasonable and supportable information that is available without undue cost or effort.
PFRS 9, does not prescribe particular method of measuring expected credit losses. An entity
may use various sources of data both internal or entity-specific and external in measuring
expected credit losses.
Impairment assessment
The following guideline may be of help in assessing weather accounts receivable should be
considered impaired.
a. Individually significant accounts receivable should be considered for impairment
separately and if impaired, the impairment loss is recognized.
b. Accounts receivable not individually significant should be collectively assessed for
impairment.
c. Accounts receivable not considered impaired should be included with other accounts
receivable with similar credit-risk characteristics and collectively assessed for
impairment.
T- Accounts for Receivables

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Assessment
Activity 1
1. Which of the following statements concerning the presentation of receivables are
incorrect?
a. Trade receivables which are expected to be realized in cash within the normal
operating cycle or one year, whichever is longer, are classified as current assets.
b. Nontrade receivables which are expected to be realized in cash within one year,
the length of the operating cycle notwithstanding, are classified as current assets.
c. Trade receivables and nontrade receivable which are currently collectible shall
be presented on the face of the statement of financial position as one line item
called trade and other receivables.
d. Trade and nontrade receivables which are currently collectible shall be
separately presented on the face of the statement of financial position.
2. The following non-trade receivables are generally classified as current, except
a. Advances to shareholders, employees or officers.
b. Advances to supplier for acquisition of merchandise.
c. Accrued income receivables such as dividends receivable, rent receivables and
royalty receivables.
d. Advances to affiliates and associates.
3. The following non-trade receivable may form part of the asset section, except
a. Claims receivable
b. Subscription receivable collectible beyond one year
c. Advances to subsidiary collectible beyond one year
d. Special deposits on contracts
4. Customer credit balances shall be presented as
a. Current asset as part of trade and other receivables by offsetting it customer
accounts with debit balances.
b. Current asset as part of short-term investment.
c. Current liability by removing it from the trade and other receivables
d. Both part of current asset and current liability
5. Accounts receivable shall be subsequently measured at
a. Face value
b. Present value
c. Amortized cost
d. Net realizable value
6. If the shipping term is FOB Shipping Point – Freight Collect, who shall pay and who
actually paid the freight, respectively?
a. Seller – Buyer
b. Seller – Seller
c. Buyer – Buyer
d. Buyer – Seller

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7. If the company uses the gross method of recording credit sales, which of the following
accounts shall not appear?
a. Accounts receivable
b. Sales discount
c. Sales discount forfeited
d. Sales
8. If the company uses the net method of recording credit sales, which of the following is
true?
a. The total sales may be recorded at gross amount.
b. The sales discount account may be presented in the Income Statements.
c. Sales discount forfeited is presented as a contra-sales account.
d. The total credit sales is always recorded at net amount.
9. Which of the following methods of recording bad debts does not conform to the
matching principle mandated by GAAP?
a. Direct write off method
b. Percent of sales method
c. Percent of accounts receivable method
d. Aging method
10. Which of the following methods of recording bad debts favors the income statement and
result to proper matching of expenses to revenue?
a. Direct write off method
b. Percent of sales method
c. Percent of accounts receivable method
d. Aging method
11. The amount initially computed under aging method of estimating bad debts is the
amount
a. Bad debt expense
b. Ending balance of allowance for bad debts
c. Written off accounts receivable
d. Beginning balance of accounts receivable
12. The following transactions will result to credit to allowance for bad debts account,
except
a. Bad debts expense
b. Recovery of accounts previously written off
c. Adjustment to increase the bad debts expense
d. Write off of accounts receivable
13. The following transactions decrease the accounts receivable account, except
a. Credit memo issued to customer
b. Credit sales
c. Sales discount
d. Factoring of accounts receivable
14. As a general rule, bad debts expense shall be classified in the Income Statement as
a. Selling Expense or Distribution Cost
b. Administrative expense
c. Finance cost
d. Other expense
15. Long-term notes receivable shall be subsequently measured at
a. Net realizable value
b. Amortized cost
c. Face value
d. Maturity value

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16. Which of the following is not a characteristic of receivables?

a. They have fixed or determinable payments.
b. The holder can recover substantially all of its investment (unless there has been
credit deterioration).
c. They are not quoted in an active market.
d. The holder has a demonstrated positive intention and ability to hold them to
maturity.
(Adapted)
17. Which of the following is not an acceptable balance sheet presentation of receivables?
a. the allowance for bad debts is not offset against the related receivables but rather shown
in a parenthetical notation as deduction to receivables
b. trade notes receivable are combined with trade accounts receivable
c. cash advances to officers which are due after one year but within the entity’s 18-month
operating cycle, are reported as current assets
d. unearned finance charges included in the face amount of receivables are presented as
deduction from the related receivables
(Adapted)
18. These receivables are classified as current or noncurrent based on the length of the
entity’s normal operating cycle
a. accounts receivables c. trade receivables
b. notes receivables d. nontrade receivables
19. Trade receivables are preferably presented on the face of the statement of financial
position
a. as a separate line item distinguished from other receivables
b. as part of one line item, included and undistinguished from other receivables
c. as part of current assets, included and undistinguished from other assets
d. as part of one line item but distinguished from other receivables
20. Which of the following statements is incorrect regarding recognition of receivables?
a. An entity shall recognize a receivable when the entity becomes party to the contractual
provisions of the instrument
b. Trade receivables are recognized simultaneously with the recognition of related revenue
when the criteria for revenue recognition are met.
c. Non-trade receivables are recognized when contractual rights over the future cash flows
of the receivables have been established and future economic benefits are both probable
and measurable.
d. Receivables are initially recognized at fair value
21. Receivables are initially recognized at
a. fair value c. net realizable value
b. amortized cost d. fair value plus direct costs
22. For trade receivables, the fair value is deemed equal to the
a. exchange price between a seller and a buyer after taking into account the amount of any
trade discounts and volume rebates allowed by the entity.
b. the amount due from the buyer without adjustment for any trade discounts allowed
c. the quoted price of the receivable in an active market
d. the price in a binding sale agreement
23. The entry to be made by the seller for a P10,000 freight on a sale transaction with terms
of FOB Shipping Point, Freight Collect is
a. Freight-in 10,000 c. Freight-in 10,000
Cash 10,000 Receivable 10,000
b. Freight-out 10,000 d. No entry

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Cash 10,000
of FOB Shipping Point, Freight Prepaid is
a. Payable 10,000 c. Freight-out 10,000
Cash 10,000 Cash 10,000
b. Receivable 10,000 d. Cash 10,000
of FOB Destination, Freight Prepaid is
b. Freight-out 10,000 d. Accounts receivable10,000
Cash 10,000 Cash 10,000
26. What is the effect upon the total assets of a business when an account receivable has
been collected?
a. increase total assets c. no change in total assets
b. decrease total assets d. decrease of receivable only
27. The value at which advances to subsidiaries and affiliates should be carried is
a. face amount
b. fair value
c. face amount less allowance for uncollectible accounts and impairment losses recognized
d. fair value with changes in fair values recognized in profit or loss
28. If it is known that sales are often recorded for merchandise that is shipped on approval
and available data suggests that a material proportion of such sales are returned by the
customers,
a. loss should be recognized under the immediate recognition principle
b. loss should be recognized under the matching concept
c. these estimated future returns must be accrued
d. future returns are ignored
29. Material amounts of anticipated discounts and allowances should be recorded
a. in the period of sale c. when the boss says so
b. when discounts are availed of d. they are not recorded
30. The “Allowance for sales discounts” account may be used under
a. Gross method c. Allowance method
b. Net method d. a or b
31. The “Allowance for sales returns” account may be used under
a. Gross method c. Allowance method
b. Net method d. a or b
32. If a company employs the gross method of recording accounts receivable from customers,
then sales discounts taken by customers should be
a. reported as a deduction from sales in the income statement.
b. reported as an item of "other expense" in the income statement.
c. reported as a deduction from accounts receivable in determining the net realizable value
of accounts receivable.
d. reported as sales discounts forfeited in the cost of goods sold section of the income
statement.

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33. An allowance for cash discounts that is presented in the financial statements as deduction
from accounts receivable and is based on an estimate of future cash discounts expected
to be taken is an effect of
a. consistency principle c. materiality principle
b. revenue principle d. conservatism principle
34. Poison Company sold merchandise on credit with a list price of P70,000. Terms were 2/10,
n/30. Given the indicated sales discounts methods in the responses, which entry is
correct?
a. Gross price method
Accounts receivable 63,000
Sales 63,000
b. Net price method
Sales 68,600
c. Net price method
Sales 40,000
d. Gross price method
Sales 68,600
35. The “Sales returns and allowances” account is reported as a:
a. contra-revenue account in the income statement
b. current liability on the balance sheet
c. deduction from accounts receivable on the balance sheet
d. selling expense on the income statement
36. Which of the following is a generally accepted method of determining the amount of the
adjustment to bad debt expense?
a. A percentage of net credit sales adjusted for the balance in the allowance
b. A percentage of net credit sales not adjusted for the balance in the allowance
c. A percentage of accounts receivable not adjusted for the balance in the allowance
d. An amount derived from aging accounts receivable and not adjusted for the balance in the
allowance
37. The advantage of relating a company's bad debt expense to its credit sale is that this
approach
a. gives a reasonably correct statement of receivables in the balance sheet.
b. best relates bad debt expense to the period of sale.
c. is the only generally accepted method for valuing accounts receivable.
d. makes estimates of uncollectible accounts unnecessary.
(AICPA)
38. Chris Co. prepares an accounts receivable aging schedule with a series of computation
as follows: 2% of the total peso balance of accounts from 1—60 days past due, plus 5%
of the total peso balance of accounts from 61—120 days past due and so on. How would
you describe the total of the, amounts determined in this series of computations?
a. it is the amount of bad debts expense for the year
b. it is the amount that should be added to the allowance for doubtful accounts at year end
c. it is the amount of the desired credit balance of the allowance for doubtful accounts to be
reported in the year-end financial statements
d. when added to the total of accounts written off during the year, this new sum is the desired
credit balance of the allowance account
(RPCPA)

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39. Ismael Co. recorded a bad debt recovery using the allowance method of accounting for
bad debts. Compare (X) the working capital before the recovery with (Y), the working
capital after the recovery.
a. X equals Y c. X is less than Y
b. X is greater than Y d. X is equal to or less than Y
(RPCPA)
40. Mr. Golf Champ maintains the accounts receivable records, authorizes the write-off of
uncollectible accounts, issues credit memoranda to customers, and handles cash receipts
from customers. When customers are late in paying their accounts, Mr. Golf Champ often
writes off the account as uncollectible and abstracts the cash received from the customer.
This fraud should come to light if an employee other than Mr. Golf Champ.
a. reconciles the bank statement to the accounting records
b. reconciles the accounts receivable subsidiary ledger to the controlling account
c. reconciles credit memoranda for sales returns to the returned merchandise accepted by
the receiving department
d. none of the above
(RPCPA)
41. Which of the following statements is correct?
a. The net realizable value of the total amount of accounts receivable is defined as the gross
amount billed to customers less any cash and trade discounts.
b. When a specified bad debt which has already been written off is later collected, sales
revenue is increased by the amount of the recovery.
c. The primary accounting principle supporting use of the allowance for doubtful accounts is
the cost principle.
d. An estimate of bad debt expense based upon credit sales rather than total sales will likely
be more in conformity with the matching principle.
42. Which of the following methods may not be appropriate for estimating bad debt expense?
a. Individual or collective assessment of outstanding receivables
b. Percentage of outstanding accounts receivable
c. Aging of accounts receivable
d. Percentage of sales
(Adapted)
43. Which of the following statements is incorrect?
a. If the estimate of bad debt expense is made on the basis of net credit sales, an entry is
made each period to the account, "Allowance for Doubtful Accounts," without regard to
the prior balance in that account.
b. If the allowance for doubtful accounts has been underestimated, a sale of the related
receivables to a factor is more likely to result in a gain than in loss.
c. If credit terms to customers were 2/10, n/30, a two percent discount will be granted if
payment is made within 10 days of the date of sale.
d. If the estimate of the bad debt expense is made on the basis of net realizable value of the
accounts receivable the balance of the account, "Allowance for Doubtful Accounts," is
adjusted so that the adjusted balance reflects the computed amount needed to properly
value the receivables.
(RPCPA)
44. Which of the following accounting principle primarily supports the use of allowance for
doubtful accounts?
a. continuity principle c. matching
b. full-disclosure d. cost principle
(RPCPA)

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45. The allowance method of recognizing bad debt expense can be applied in more than one
way. What two conditions must be met before the allowance method can be used?
a. bad debts must be expected and material
b. bad debts must be relevant and reliable
c. bad debts must be probable and estimable
d. bad debts must be consistent over time and the method used to estimate them must be
consistently applied
(RPCPA)
46. A company uses the allowance method to account for bad debts. Early 20x1, one of the
company's best customers went bankrupt. The customer owed for P6,570 of goods
purchased on credit. At the end of 20x1, this amount was considered uncollectible. What
entry should be made to reflect this information?
a. Loss of bad debts 6,570
b. Bad debt expense 6,570
c. Allowance for doubtful accounts 6,570
d. Loss on bad debts 6,570
(RPCPA)
47. When the allowance method of recognizing bad debt expense is used, the entry to record
the specific write-off of a specific customers’ account
a. decreases current assets c. has no effect on profit
b. decreases profit d. decreases working capital
48. When the allowance method of recognizing bad debt expense is used, the entry to record
the specific write-off of an uncollectible account would decrease
a. net accounts receivable c. profit
b. allowance for doubtful accounts d. working capital
49. When the percentage of credit sales method is used in determining doubtful accounts, the
amount computed represents the
a. required balance
b. bad debt expense
c. bad debt expense after adjustments for write-offs, recoveries and changes in the balance
of the allowance for doubtful accounts
d. required balance after adjustments for write-offs, recoveries and changes in the balance
of the allowance for doubtful accounts
50. In its December 31 balance sheet, Devin Co. reported trade accounts receivable of
P250,000 and related allowance for uncollectible accounts of P20,000. What is the total
amount of risk of accounting loss related to Devin's trade accounts receivable, and what
amount of that risk is off balance-sheet risk? (Item #1) Risk of accounting loss; (Item #2)
Off-balance-sheet risk
a. 0, 0 c. 230,000, 20,000
b. 230,000, 0 d. 250,000, 20,000
(AICPA)
Activity 2: PROBLEMS
Answer as required

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1. Koreko company provided the following data for 2019:

AR- January 1 2 million
Credit sales 10 million
Collection from customers 8.050 million
Accounts written off as worthless 100, 000
Sales returns 500, 000
Recovery 50, 000
Est. future sales returns on Dec. 31 150, 000
Est. uncollectible accounts on December 31 per aging 300, 000
What is the NRV of accounts receivable on Dec. 31, 2019?
2. KorekNapudKo company determined that the NRV of AR on December 31, 2019 based
on aging of AR was P3, 250, 000
ADA, January 1 300, 000
W/O during the year 180, 000
Recovery 20, 000
AR, December 31 3, 500, 000
What is the uncollectible accounts expense for the current year?
3. PasarKO company reported the following AR on December 31, 2019:

PaasaRaDiay company 1 million
PasarKoBasin company 1.5 million
PasarLageKO company 2 million
AmbotPasarBa company 2.5 million
All other accounts not individually significant 3.5 million
The entity determined that PaasaRaDiay company receivable is totally impaired and
PasarKoBasin Company receivable is impaired by 700, 000. The other receivables from
PasarLageKO and AmbotPasarBa are considered impaired. The entity determined that a
composite rate of 10% is appropriate to measure impairment on the remaining AR. What
is the total impairment of accounts receivable for 2019?
4. From inception of operations, HinaotLord Company provided for uncollectible accounts

expense under the allowance method and provisions were made montly at 2% of credit
sales. No year-end adjustments to the allowance account were made. The balance in the
allowance for doubtful accounts was P1,000,000 on January 1, 2019. During 2019, credit
sales totaled P20,000,000, interim provision for doubtful accounts were made at 2% of
credit sales, P200,000 of bad debts were written off, and recoveries of accounts previously
written off amounted to P50,000. And aging of accounts receivable was made for the first
time on December 31, 2019.
Classification Balance Uncollectible

November- December P 6,000,000 10%
July- October 2,000,000 20%
January- June 1,500,000 30%
Prior to January 1, 2019 500,000 50%

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Based on the review of collectability of the account balances in the prior to January 1,
2019 aging category, additional accounts totaling P100,000 are to be written off on
December 31, 2019. Effective December 31, 2019 the entity adopted aging for
estimating the allowance for doubtful accounts.
1. What is the required allowance for doubtful accounts on December 31, 2019?
2. What amount should be reported as doubtful account expense?
3. What is the year-end adjustment to the allowance for doubtful accounts on December
31, 2019?
4. What is the net realizable value of accounts receivable on December 31, 2016?
Gross method and Net method

Use the following information for the next two questions:
STALWART STRONG Co. sells inventory with a list price of ₱200,000 on account under credit
terms of 20%, 10%, 2/10, n/30.
1. If STALWART uses the gross method, how much is the debit to account receivable on initial
recognition?
2. If STALWART uses the net method, how much is the debit to account receivable on initial
recognition?
Allowance for sales return

5. The next two questions are based on the following information:
On December 31, 20x1, ABC Co. sold goods for ₱20,000 to XYZ, Inc. on account. To induce sale,
ABC Co. provides its buyers the right to return goods within 30 days upon purchase if the buyers
are not satisfied with the goods.
Case #1: Reliable estimate

1. ABC Co. can reliably estimate that 20% of the goods sold will be returned within the agreed
period of time. However, 25% of the goods are actually returned on January 5, 20x2. How
much is the net accounts receivable recognized on the date of sale?
Case #2: No reliable estimate

2. ABC Co. cannot reliably estimate future returns. much is the net accounts receivable
recognized on the date of sale?
Percentage of credit sales method

6. ABC Co. has the following information on December 31, 20x1 before any year-end adjustments.
Allowance for doubtful accounts, Jan. 1 30,400
Write-offs 19,000
Recoveries 3,800
Sales (including cash sales of ₱380,000) 2,280,000
Sales returns and discounts (including ₱3,800 sales returns 22,800

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on cash sales)
Accounts receivable, Dec. 31 570,000
Percentage of credit sales 3%
How much is the recoverable historical cost of accounts receivable?
Percentage of receivable method

7. Use the following information for the next two questions:
ABC Co. has the following information on December 31, 20x1 before any year-end adjustments.
Accounts receivable, Jan. 1 80,000
Net credit sales 270,000
Collections from customers (including recoveries) 140,000
Allowance for doubtful accounts, Jan. 1 10,000
Write-offs 5,000
Recoveries 1,000
Percentage of receivables 5%
1. How much is the bad debt expense?
2. How much is the recoverable historical cost of accounts receivable?
Computation of percentage
8. ABC Co. has been recognizing bad debt expenses based on the direct write-off method. In 20x4,
ABC Co. decided to change to the allowance method and that doubtful accounts shall be estimated
using the percentage of receivables method. The percentage is to be computed based on all
available historical data up to a maximum of four years. Information for five years is shown below:
Year Write-offs Recoveries Net credit sales
20x0 10,000 600 80,000
20x1 7,000 1,000 100,000
20x2 10,000 3,000 160,000
20x3 15,000 5,000 200,000
20x4 28,000 2,000 240,000
70,000 11,600 780,000
The balances of accounts receivables on January 1, 20x4 and December 31, 20x4 are ₱100,000
and ₱200,000, respectively.
How much is the doubtful accounts expense to be recognized in 20x4?
Aging based on days outstanding

9. ABC Co. has the following information:
Days outstanding Receivable balances % uncollectible
0 – 60 180,000 1%

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61 – 120 135,000 2%
Over 120 150,000 6%
Total accounts receivables 465,000
During the year, ABC Co. wrote off ₱10,500 receivables and recovered ₱6,000 that had been
written-off in prior years. The allowance for doubtful accounts has a beginning balance of ₱3,000.
How much is the doubtful accounts expense for the year?
Aging based on days past due

10. ABC Co. sells to wholesalers on terms of 2/15, net 30. An analysis of ABC Co.’s trade receivable
balances at December 31, 20x1, revealed the following:
Age in days Receivable balances
0 – 15 180,000
16 – 30 108,000
31 – 60 90,000
61 – 90 72,000
91 – 120 54,000
121 – 150 36,000
ABC Co. uses the aging of receivables method. The estimated percentages of collectibility based
on past experience are shown below.
Accounts which are overdue for less than 31 days 97%
Accounts which are overdue 31 – 60 days 90%
Accounts which are overdue for over 120 days 40%
The allowance for doubtful accounts has a balance of ₱18,000 as of January 1, 20x1. Write-offs
and recoveries during the year amounted to ₱6,000 and ₱3,000, respectively.
How much is the doubtful accounts expense for the year?
Combination of methods
11. Use the following information for the next two questions:
ABC Co. has the following information on December 31, 20x1 before any year-end adjustments.
Net credit sales 6,300,000
Accounts receivable, December 976,500
Allowance for doubtful accounts, Dec. 31 (before any
53,550
necessary year-end adjustments)
Percentage of credit sales 2%
The aging of receivables is shown below:

Days outstanding Receivable balances % uncollectible

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0 – 60 378,000 1%
61 – 120 283,500 2%
Over 120 315,000 6%
Additional information:
• ABC Co. uses the percentage of credit sales in determining bad debts in monthly financial
reports and the aging of receivables for its annual financial statements.
• Accounts written-off during the year amounted to ₱119,700 and accounts recovered amounted
to ₱28,350.
• As of December 31, ABC Co. determined that ₱63,000 accounts receivable from a certain
customer included in the “61-120 days outstanding” group is 95% collectible and a ₱31,500
account included in the “Over 120 days outstanding” group is worthless and needs to be written-
off.
1. How much is the balance of the allowance for doubtful accounts on January 1, 20x1?
2. How much is the adjusted bad debt expense to be reported in the year-end financial
statements?

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Topic 2- Notes Receivable and Loans Receivable
Notes receivable are claims supported by formal promises to pay usual in the form of
notes.
A negotiable promissory note is an unconditional promise in writing made by one person
to another, signed by the maker, engaging to pay on demand or at fixed determinable
future time a sum certain in money to order or to bearer.
Simply stated, a promissory note is a written contract I which one person, known as the
maker, promises to pay another person, known as the payee, a definite sum of money.
A loan receivable is a financial asset arising from a loan granted by a bank or other
financial institution to a borrower or client.
The term of the loan may be short-term but, in most cases, the repayment periods cover
several years.
Learning Outcomes

• Identify short-term and long-term notes.
• State the timing of recognition and measurement of note and loan receivables.
• Prepare amortization table of the note and loan.
Pretest
Feasible Company sold to another entity a tract of land costing P5,000,000 for P7,000,000 on
January 1, 2020. The buyer paid P1,000,000 down and signed a two-year promissory note for the
remainder of the purchase price plus 12% interest compounded annually. The note matures on
January 1, 2022.
Prepare journal entries for 2020, 2021 and 2022.
2020

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2021
2022
Nasty Bank granted a loan to a borrower on January 1, 2019. The interest on the loan is 10%
payable annually starting December 31, 2019. The loan matures in three years on December 31,
2021.
Principal Amount 4,000,000
Direct Origination Cost incurred 150,000
Origination fee received from the borrower 342,100
After considering the origination fee received from the borrower and the direct origination cost
incurred, the effective rate on the loan is 12%.
Prepare journal entries for 2019, 2020 and 2021.
2019
2020

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2021
Content
Notes Receivable
Notes receivable are claims supported by formal promises to pay usual in the form of notes. A
negotiable promissory note is an unconditional promise in writing made by one person to another,
signed by the maker, engaging to pay on demand or at fixed determinable future time a sum
certain in money to order or to bearer. Simply stated, a promissory note is a written contract I
which one person, known as the maker, promises to pay another person, known as the payee, a
definite sum of money.
Dishonored notes
When a promissory note measure and is not paid, it is said to be dishonored. The amount debited
to accounts receivable should include the face amount, interest and other charges. Such
approach is defended on the ground that the overdue note has lost part of its status as a
negotiable instrument and really represents only an ordinary claim against the maker.
Initial measurement of notes receivable

Conceptually, notes receivable shall be measured initially at present value*. However, short
term notes receivable shall be measured at face value.
*Present Value is the sum of all future cash flows discounted using the prevailing market interest
rate.
The initial measurement of long-term notes will depend on whether the notes are interest-bearing
or noninterest-bearing.

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Interest-bearing notes receivable

Interest bearing long-term notes are measured at face value which is actually the present value
upon issuance. In interest bearing notes, the interest is excluded in the face amount of the note.
Thus, in computing the interest of the note you simply follow the formula I=Prt.
Noninterest-bearing notes receivable

Noninterest-bearing long-term notes are measured at present value which is the discounted
value of the future cash flows using the effective interest rate.
Actually, the term “noninterest-bearing” is a misnomer because all notes implicitly contain interest.
It is simply case of the “interest bearing included in the face amount” rather than being stated as
a separate rate. Thus, in computing the interest for a noninterest-bearing note, you have to
compute the present value and deduct in in the face amount of the note.
Subsequent measurement
Subsequent to initial recognition, long-term notes receivable shall be measured at amortized
cost using the effective interest method. The amortized cost measurement is in accordance with
PFRS 9, paragraph 5.2.1.
Meaning of amortized cost

The “amortized cost” is the amount at which the note receivable is measured initially:
a. Minus principal repayment
b. Plus, or minus cumulative amortization of any difference between the initial carrying
amount and the principal maturity amount
c. Minus reduction for impairment or uncollectibility.
For long-term noninterest-bearing notes receivable, the amortized cost is the present value plus
amortization of the discount, or the face value minus the unamortized unearned interest income.
Accordingly, only long-term notes receivable will be discussed in conjunction with the present
value concept under the following situations:
a. Interest bearing note
b. Noninterest-bearing note
Amortization Table Pro-forma
Date Annual Interest Income Principal Present Value

Collection
Y0 XX
Y1 XX XX XX XX
Y2 XX XX XX XX
Y3 XX XX XX XX
The amount above is computed using the formula below:
Interest Income= PV/CV* x i
CV/PV (Y0) = Present Value Computed

CV/PV (Y1) = CV/PV (Y0) x (1+i) – Annual collection
CV/PV (Y2) = CV/PV (Y1) x (1+i) – Annual collection
CV/PV (Y3…) = CV/PV (Y2…) x (1+i) – Annual collection\

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Collection
Y0 XX
Y1 XX XX XX XX
Y2 XX XX XX XX
Y3 XX XX XX XX
Charge to Principal (Y1) = CV/PV (Y2) - CV/PV (Y1)

Charge to Principal (Y3…) = CV/PV (Y4…) - CV/PV (Y3…)
How to compute Present Value factors?

Using a scientific calculator:
PV of 1= (1+i)-n PV of OA*= (1+i)

-n
Using a Financial Calculator:
PV of 1= 1,+,i,÷,÷,=,=,=,…(number of periods).
PV of OA*= 1- (1,+,i,÷,÷,=,=,=,…(number of periods))÷ i
*Ordinary Annuity
*PV- Present Value *CV- Carrying Value *i- Interest rate *n- number of periods
When to use PV of 1 and PV of OA?

In note problem, PV of 1 is used when the note is paid lump sum or there is no installment. On
the other hand, PV of OA is used when there is an installment. You may use either PV of 1 of PV
of OA in note payable problems in getting the present value of the note depending on the given
data.
Amortization of the note

In amortization of the note, the present value is decreasing to zero if there is an annual installment.
However, if the payment is lump sum, the amortization is increasing until it is equal to the face
value.
Innovative Company manufactures and sells electrical generators. On January 1, 2019, the entity
sold an electrical generator costing P700,000 for P1,000,000. The buyer paid P100,000 down
and signed a P900,000 noninterest bearing note payable in three equal installments every
December 31. The prevailing interest rate for a note of this type is 12%.
Compute the present value factor (round off up to 4 decimal places) and the present value
of the note.
Prepare amortization table.
Prepare journal entries for the current year.
Solution:
1. Compute the present value factor (round off up to 4 decimal places) and the present
value of the note.

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Since the problem states that there is an annual installment, we are going to use the PV
of OA formula, thus, PV factor is:
PV of OA*= (1+i)-n
I PV of OA= 2.4018
The present value is annual installment multiply by the PV factor. Thus:

PV= 300,000 x 2.4018
= P720,540
2. Prepare amortization table.
The figure above is computed using the formula in the discussion above.
3. Prepare journal entries for the current year.
Loans Receivable
A loan receivable is a financial asset arising from a loan granted by a bank or other financial
institution to a borrower or client. The term of the loan may be short-term but, in most cases, the
repayment periods cover several years.
Initial measurement of loan receivable

At initial recognition, an entity shall measure a loan receivable at fair value plus transaction
costs that are directly attributable to the acquisition of the financial asset. The fair value of
the loan receivable at initial recognition is normally the transaction price, meaning, the amount of
the loan granted.
Transaction costs that are directly attributable to the loan receivable include direct origination
costs. Direct origination costs should be included in the initial measurement of the loan receivable.
However, indirect origination costs should be treated as outright expense.

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Subsequent measurement of loan receivable

PFRS 9, paragraph 4.1.2, provides that if the business model in managing financial asset is to
collect contractual cash flows on specified dates and the contractual cash flows are solely
payments of principal and interest, the financial asset shall be measured at amortized cost.
Accordingly, a loan receivable is measured at amortized cost using the effective interest
method.
Meaning of amortized cost

The “amortized cost”* is the amount at which the loan receivable is measured initially.
a. Minus principal repayment
b. Plus or minus cumulative amortization of any difference between the initial carrying
amount and the principal maturity amount
c. Minus reduction for impairment or uncollectibility
*Observed that it is the same with the note receivable of amortization.
In other words, if the initial amount recognized is lower than the principal amount, the amortization
of the difference is added to the carrying amount. If the initial amount recognized is higher than
the principal amount, the amortization of the difference is deducted from the carrying amount.
Origination fees
Lending activities usually precede the actual disbursement of funds and generally include efforts
to identify and attract potential borrowers and to originate a loan. The fees charged by the
bank against the borrower for the creation of the loan are known as “origination fees”.
Origination fees include compensation for the following activities:
a. Evaluating the borrower’s financial condition
b. Evaluating guarantees, collateral and other security
c. Negotiating the terms of the loan
d. Preparing and processing the documents related to the loan
e. Closing and approving the loan transaction
Accounting for origination fees

The origination fees received from borrower are recognized as unearned interest income and
amortized over the term of the loan.
If the origination fees are not chargeable against the borrower, the fees are known as “direct
origination costs”. The direct origination costs are deferred and also amortized over the term of
the loan.
Preferably, the direct origination costs are offset directly against any unearned origination fees
received. If the origination fees receive exceed the direct origination costs, the difference is
unearned interest income and the amortization will increase interest income.
If the direct origination costs exceed the origination fees received, the difference is charge to
“direct origination costs” and the amortization will decrease interest income. Accordingly, the
origination fees received and the direct origination costs are included in the measurement of the
loan receivable.

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Date Interest Interest Income Principal Present Value

Received
Y0 XX
Y1 XX XX XX XX
Y2 XX XX XX XX
Y3 XX XX XX XX
Interest Received= Principal x i (nominal rate)

Interest Income= CV* x i (effective rate)
CV (Y0) = Carrying Amount/Value Computed

Initial Carrying amount of the loan (CV(Y0))
Principal amount XX
Origination fees received XX
Direct origination costs incurred XX
CV (Y0) XX
CV (Y1) = CV (Y0) x (1+i) – Interest Received

CV (Y2) = CV (Y1) x (1+i) – Interest Received
CV (Y3…) = CV (Y2…) x (1+i) – Interest Received

On January 1, 2019, Empress Bank granted a loan to a borrower. The interest on the loan is 10%
payable annually on December 31, 2019. The loan matures in three years on December 31, 2021.
Principal Amount 5,000,000
Direct origination costs incurred 457,500
Origination fee charged against the borrower 200,000
After considering the origination fee charged against the borrower and the direct origination cost
incurred, the effective rate on the loan is 8%.
Determine the carrying amount of the loan on January 1, 2019

Prepare a table of amortization of the direct origination cost.
Prepare journal entries for 2019, 2020 and 2020
Solution:
Determine the carrying amount of the loan on January 1, 2019

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Prepare a table of amortization of the direct origination cost.
Prepare journal entries for 2019, 2020 and 2020
Impairment of loan
PFRS 9, paragraph 5.5.1, provides that an entity shall recognized a loss allowance for expected
credit losses on financial asset measured at amortized cost. Paragraph 5.5.3 provides that an
entity shall measure the loss allowance for a financial instrument at an amount equal to the
lifetime expected credit losses if the credit risk on that financial instrument has increased
significantly since initial recognition.

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Credit losses are the present value of all cash shortfalls. Expected credit losses are an estimate
of credit losses over the life of the financial instrument.
Measurement of impairment
a. The probability-weighted outcome
The estimate should reflect the possibility that a credit loss occurs and the possibility that
no credit loss occurs.
The expected credit losses should be discounted.
c. Reasonable and supportable information that is available without undue cost or effort.
The amount of impairment loss can be measured as the difference between the carrying
amount and the present value of estimated future cash flows discounted at the original
effective rate.
The carrying amount of the loan receivable shall be reduced either directly or through the use of
an allowance account.
Meaning of credit risk

Credit risk is the risk that one party to a financial instrument will cause a financial loss for the other
party by failing to discharge on obligation. The risk contemplated is the risk that the issuer will fail
to perform a particular obligation. The risk does not necessarily relate to the credit worthiness of
the issuer.
Cozy Bank loaned a borrower P7,500,000 on January 1, 2017. The terms of the loan were
payment in full on January 1, 2022, plus annual interest payment at 12%. The interest payment
was made as scheduled on January 1, 2018. However, due to financial setbacks, the borrower
was unable to make the 2019 interest payment. The bank considered the loan impaired an
projected the cash flows from the loan on December 31, 2019. The bank accrued the interest on
December 31, 2018, but did not continue to accrue interest for 2019 due to the impairment of the
loan.
Projected cash flows

Date of cash flows Amount projected on December 31, 2019
December 31, 2020 500,000
December 31, 2021 1,000,000
December 31, 2022 2,000,000
December 31, 2023 4,000,000
Present value of 1 at 12%

For one period 0.89
For two periods 0.80
For three periods 0.71
For four periods 0.64
Compute the present value of the loan receivable on December 31, 2019.
Compute the impairment loss on the loan receivable.
Prepare Journal entries for 2019,2020 and 2021.

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Solution:
Compute the present value of the loan receivable on December 31, 2019.
Compute the impairment loss on the loan receivable.
Prepare Journal entries for 2019,2020 and 2021.

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Assessment
Activity 1
1. Which of the following statements correctly relate to accounting for loans and receivables?
I. Andres Company sold equipment to Bonifacio Company, taking in exchange a non-
interest bearing note, the face amount of which was in excess of the fair value of the
equipment. In a balance sheet prepared immediately after receipt of the note, Andres
Company should present the note at its face value plus the anticipated net earnings to the
note.
II. Receivables denominated in a foreign currency, when reported on the year-end statement
of financial position, should be translated to local currency at the rate of exchange at
acquisition.
III. The collection of an account which was previously written off through the allowance
method of recognizing bad debts would affect the total current assets.
IV. Significant amounts of installment receivables should be disclosed
V. Under PAS 1 trade receivables should be shown separately on the face of the balance
sheet. Notes receivable may either be combined with or separated from accounts
receivable.
a. IV, V b. II, IV, V c. I, III, IV, V d. IV
2. Which of the following statements is incorrect regarding the initial recognition of receivables?
a. On initial recognition, the fair value of a short-term receivable may be equal to its face
amount.
b. On initial recognition, the fair value of a long-term receivable bearing a reasonable interest
rate is deemed equal to its face amount.
c. On initial recognition, the fair value of a long-term noninterest bearing receivable is
deemed equal to the present value of future cash flows from the instrument discounted at
the effective interest rate on initial recognition.
d. On initial recognition, the fair value of all interest-bearing receivables is deemed equal to
their face amount.
3. If the gross amount of receivables includes unearned interest or finance charges
a. these should be presented in the statement of financial position as liability.
b. these should be deducted in arriving at the net amount to be presented in the statement
of financial position.
c. these should be added in arriving at the net amount to be presented in the statement of
financial position.
d. these should be ignored.
4. Loans and receivables are initially recognized at
a. fair value
b. face value
c. amortized cost
d. fair value plus transaction costs that are directly attributable to the acquisition
5. Loans and receivables are measured, subsequent to initial recognition, at

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a. historical cost c. amortized cost

b. fair value d. effective value
6. Jellyfish Co. lent P10,000 to a major supplier in exchange for a noninterest-bearing note due
in three years and a contract to purchase a fixed amount of merchandise from the supplier at
a 10% discount from prevailing market prices over the next three years. The market rate for a
note of this type is 10%. On issuing the note, Jellyfish should record
(Item #1) Deferred charge; (Item #2) Discount on note receivable
a. Yes, Yes b. Yes, No c. No, Yes d. No, No
7. On July 1, 2010, a company obtained a two-year 8% note receivable for services rendered.
At that time the market rate of interest was 10%. The face amount of the note and the entire
amount of the interest are due on June 30, 2012. Interest receivable at December 31, 2010,
was
a. 5% of the face value of the note.
b. 4% of the face value of the note.
c. 5% of the July 1,2010, present value of the amount due June 30, 2012.
d. 4% of the July 1,2010, present value of the amount due June 30, 2012.
8. Which of the following best describes the concept of time value of money?
a. interest is earned or incurred on debt instruments due to passage of time
b. interest is earned only on interest-bearing receivables
c. the amount debited to interest receivable is always equal to the interest income recognized
during the period
d. if no interest receivable is recognized, no interest income is also recognized
9. If the contractual cash flow from a debt instrument is due in lump sum, the appropriate present
value factor to be used is
a. PV of ₱1 c. PV of an annuity due of ₱1
b. PV of an ordinary annuity of ₱1 d. No one knows except the CPA
10. If the contractual cash flows from a debt instrument are due in installments with the first
installment due one period after initial recognition, the appropriate present value factor to be
used is
b. PV of an ordinary annuity of ₱1 d. Ask the auditor
11. If the contractual cash flows from a debt instrument are due in installments with the first
installment due immediately on initial recognition, the appropriate present value factor to be
used is
b. PV of an ordinary annuity of ₱1 d. Please don’t ask me
12. Which of the following is incorrect in relation to the concept of time value of money?
a. Present value is the exact opposite of Future value
b. If a noninterest-bearing note of ₱10,000 has a present value of ₱7,513 then the future
value of ₱7,513 is ₱10,000 using the same discount rate and period used in the present
value computation
c. If the contractual cash flows from a debt instrument are due in semi-annual installments,
the discount rate is divided by 2 and the period is multiplied by 2 in computing for the
present value factor.
d. The concept of time value of money means that the value of money decreases over time
due to inflation.
13. Which of the following is incorrect in relation to accounting for note receivables?

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a. a long-term note that is interest-bearing may nonetheless be discounted if it bears an

unreasonable interest rate.
b. the unearned interest income on a noninterest-bearing note receivable represents the total
interest income to be recognized over the life of the note.
c. the present value factor using a period (‘n’) of zero is 1
d. when accounting for noninterest-bearing note, the legal form of the instrument takes
precedence over its substance
14. If “PV” is the present value of an instrument, “CF” is the future cash flows, and “PVF” is the
present value factor, then future cash flows may be computed as
a. CF = PVF + PV c. CF = PVF ÷ PV
b. CF = PVF x PV d. CF = PV ÷ PVF
15. What is the effective interest rate of a bond or other debt instrument measured at amortized
cost?
a. The stated coupon rate of the debt instrument.
b. The interest rate currently charged by the entity or by others for similar debt instruments
(i.e., similar remaining maturity, cash flow pattern, currency, credit risk, collateral, and
interest basis).
c. The interest rate that exactly discounts estimated future cash payments or receipts
through the expected life of the debt instrument or, when appropriate, a shorter period to
the net carrying amount of the instrument.
d. The basic, risk-free interest rate that is derived from observable government bond prices.
16. Which of the following is true regarding non-interest bearing note receivables?
a. they are always discounted to their present value on initial recognition
b. they include a specified principal amount but an unspecified interest amount
c. they include a specified principal and specified interest
d. they cause no interest income to be recognized over their term
e. they include an unspecified principal and an unspecified interest
17. An entity received a 15-day non-interest bearing note receivable. The entity would most likely
recognize the note on initial recognition at
a. current value c. appraised value
b. maturity value d. present value
18. Which statement is not true?
a. Notes receivable initially should be recorded at the present value of the future cash
receipts on the date of issue.
b. All notes implicitly carry interest
c. Discount on notes receivable is a contra account frequently found with interest-bearing
notes
d. The Notes receivable dishonored account is an asset account
19. On March 1, 20x1, Nickelodeon Co. received a 12% note receivable dated January 1, 20x1.
Principal and interest on the note are due on July 1, 20x1. On initial recognition, which of the
following accounts increased?
a. Prepaid interest c. Unearned interest income
b. Interest receivable d. Interest revenue
20. Spongebob Squarepants lent ₱2,000 to Squidward for one year at 10% interest, all due at
maturity. He insisted the terms of the transaction be formalized in promissory note. In this
situation:
a. the maturity value of the note is ₱2,000
b. Spongebob Squarepants is considered the maker of the note and records the note as an
asset in his accounting records

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c. Spongebob Squarepants is considered the maker of the note and records the note as a
liability in his accounting records
d. Squidward is considered the maker of the note and records the note as a liability in his
accounting records
21. Sandy Company received a 12%, 3-year note receivable that is collectible in monthly
installments in exchange for services rendered. What is the note receivable’s carrying amount
one year after initial recognition?
a. Two-thirds of the billing price
b. Less than two-thirds of the net billing price
c. The present value of remaining future cash flows discounted at the current market rate as
of year-end
d. The present value of the remaining monthly payments discounted at 12%
22. Which of the following statements regarding interest methods of allocations is not true?
a. The term “interest methods of allocation” refers both to the convention for periodic
reporting and to the several approaches to dealing with changes in estimated future cash
flows.
b. Interest methods of allocation are reporting conventions that use present value techniques
in the absence of a fresh-start measurement to compute changes in the carrying amount
of an asset or liability from one period to the next.
c. Interest methods of allocation are grounded in the notion of current cost.
d. Holding gains and losses are generally excluded from allocation systems.
23. Which of the following is not an objective of using present value in accounting measurements?
a. To capture the value of an asset or a liability in the context of a particular entity.
b. To estimate fair value.
c. To capture the economic difference between sets of future cash flows.
d. To capture the elements that taken together would comprise a market price if one existed.
24. A company received two one-year notes in payment for merchandise sold. One note has a
face amount of P6,000 and was interest-bearing at an annual rate of 18 percent. The other
note has a face amount of P7,080 and was non-interest-bearing (its implied interest rate was
18 percent)
a. The total amount of cash ultimately to be received will be more for the interest-bearing
note.
b. Both notes will cause the same total interest to be recognized.
c. The amount of interest revenue which should be recognized is more for the interest-
bearing note.
d. The amount which should be credited to sales revenue is more for the noninterest-bearing
note
25. Gary Snail Inc., received a 3-year non-interest bearing trade note for ₱50,000 on January 1,
20x1. The current interest rate at that time was 15% for similar notes. Gary Snail recorded the
receipt of the note as follows:
(Dr) Notes receivable – trade ₱50,000
(Cr) Sales ₱50,000
The effect of this accounting for the notes receivable Gary Snail’s profit for years 20x1, 20x2 and
20x3 and retained earnings at the end of 20x3, respectively, shall to
a. overstate, overstate, understate, no effect
b. overstate, understate, understate, no effect
c. overstate, understate, understate, understate
d. no effect on any of these
Use the following data for the next three questions.

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On May 1, 20x1, Bikini Bottom Co. acquired a 16%, nine-month note receivable from a customer
in settlement of an existing account receivable of P120,000. Interest and principal are due at
maturity.
26. The proper adjusting entry at December 31,20x1, with regard to this note receivable includes
a:
a. credit to Interest Revenue of ₱12,800
b. debit to Notes Receivable of ₱19,200
c. debit to Cash of ₱12,800
d. debit to Interest Receivable of ₱14,400
27. Bikini's entry to record the collection of this note at maturity includes a (assume no reversing
entries were made):
a. credit to Interest Receivable of ₱12,800
b. credit to Interest Revenue of ₱14,400
c. credit to Interest Receivable of ₱1,600
d. credit to Notes Receivable of ₱134,400
28. Bikini's entry to record the collection of this note at maturity includes a (assume reversing
entries were made):
a. credit to Interest Receivable of ₱12,800
b. credit to Interest Revenue of ₱14,400
c. credit to Interest Receivable of ₱1,600
d. credit to Notes Receivable of ₱134,400
29. Chum Bucket Co. received a 60-day, 15% note for ₱3,000 on June 16. Which of the following
statements is true?
a. Chum Bucket will receive ₱3,000 plus interest of ₱450 at maturity
b. Chum Bucket should record a total receivable due of ₱3,075 on June 16
c. The principal of the note plus interest is due on August 15
d. The maturity value of this note is ₱3,000
30. If a 10%, 60-day note receivable is acquired from a customer in settlement of an existing
account receivable of ₱6,000, the accounting entry for acquisition of the note will:
a. include a debit to Notes Receivable for ₱6,600
b. include a debit to Notes Receivable for ₱6,100
c. include a credit to Interest Revenue for ₱100
d. include a debit to Notes Receivable for ₱6,000 and no entry for interest
Activity 2
Answer as required
1. An entity sells goods for ₱150,000 to a customer who was granted a special credit period of
1 year. The entity normally sells the goods for ₱120,000 with a credit period of one month or
with a ₱10,000 discount for outright payment in cash. How much is the initial measurement of
the receivable?
2. ABC Co. received the following note receivables on January 1, 20x1:

9-month, 10% note from Alpha Company. 15,000
6-month, noninterest bearing note from Beta, Inc. (the
effect of discounting is deemed immaterial) 20,000
14%, 3-year note from Charlie Corp. 30,000
Market rate of interest on January 1, 20x1 10%

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At what total net amount will the notes be initially recognized?
3. On August 1, 20x1, ABC Co. received a ₱1,200,000, 10%, 3-year note receivable in exchange
for a vacant lot carried in the books at ₱850,000. Principal, in three equal installments, plus
interest are due annually starting August 1, 20x2. Current market rates as of April 1, 20x1,
December 31, 20x1, and December 31, 20x2 are 10%, 12% and 13%, respectively. How much
interest receivable is recognized on December 31, 20x2?
4. On January 1, 20x1, ABC Co. extended a ₱1,200,000 loan to one of its officers as part of ABC
Co.’s car and housing assistance program. The note received is due on January 1, 20x4 and
bears 10% interest compounded annually. How much interest receivable is recognized on
December 31, 20x2 statement of financial position?
a. 132,000 b. 120,000 c. 168,000 d. 252,000

On January 1, 20x1, ABC Co. sold a transportation equipment with a historical cost of ₱1,000,000
and accumulated depreciation of ₱300,000 in exchange for cash of ₱100,000 and a noninterest-
bearing note receivable of ₱800,000 due on January 1, 20x4. The prevailing rate of interest for
this type of note is 12%.
5. How much is the interest income in 20x1?
6. How much is the carrying amount of the receivable on December 31, 20x2?
Use the following information for the next three questions:

On January 1, 20x1, ABC Co. sold transportation equipment with a historical cost of ₱20,000,000
and accumulated depreciation of ₱7,000,000 in exchange for cash of ₱500,000 and a noninterest-
bearing note receivable of ₱8,000,000 due in 4 equal annual installments starting on December
31, 20x1 and every December 31 thereafter. The prevailing rate of interest for this type of note is
12%.
8. How much is the current portion of the receivable on December 31, 20x1?
Noninterest-bearing note – installment in advance

On January 1, 20x1, ABC Co. sold transportation equipment with a historical cost of ₱12,000,000
and accumulated depreciation of ₱7,000,000 in exchange for cash of ₱100,000 and a noninterest-
bearing note receivable of ₱4,000,000 due in 4 equal annual installments starting on January 1,
20x1 and every January 1 thereafter. The prevailing rate of interest for this type of note is 12%.

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12. How much is the carrying amount of the receivable on January 1, 20x3?

On January 1, 20x1, ABC Co. sold machinery with historical cost of ₱3,000,000 and accumulated
depreciation of ₱900,000 in exchange for a 3-year, ₱2,100,000 noninterest-bearing note
receivable due in equal semi-annual payments every July 1 and December 31 starting on July 1,
20x1. The prevailing rate of interest for this type of note is 10%.
15. On January 1, 20x1, ABC Co. sold machinery costing ₱3,000,000 with accumulated
depreciation of ₱1,100,000 in exchange for a 3-year, ₱900,000 noninterest-bearing note
receivable due as follows:
Date Amount of installment
December 31, 20x1 400,000
December 31, 20x2 300,000
December 31, 20x3 200,000
Total 900,000
The prevailing rate of interest for this type of note is 10%. How much is the carrying amount
of the receivable on December 31, 20x1?

On January 1, 20x1, ABC Co. sold inventory costing ₱1,800,000 with a list price of ₱2,200,000
and a cash price of ₱2,000,000 in exchange for a ₱2,400,000 noninterest-bearing note due on
December 31, 20x3.
16. How much is the initial measurement of the receivable?
18. On January 1, 20x1, ABC Co. sold machinery with historical cost of ₱5,000,000 and
accumulated depreciation of ₱1,900,000 in exchange for a 3-year, 3%, ₱3,000,000 note
receivable. Principal is due on January 1, 20x4 but interest is due annually every December
31. The prevailing interest rate for this type of note is 12%. How much is the carrying amount
of the receivable on December 31, 20x1?
19. On July 1, 20x1, ABC Co. sold machinery costing ₱12,000,000 with accumulated depreciation
of ₱9,000,000 in exchange for a 3-year, 3%, ₱4,000,000 note receivable. Principal is due on
July 1, 20x4 but interests are due semiannually every July 1 and January 1. The prevailing
interest rate for this type of note is 12%. How much is the interest income in 20x1?
depreciation of ₱950,000 in exchange for a 3-year, 3%, ₱900,000 note receivable. Principal
is due in three equal annual installments. Interests on the outstanding principal balance are

88
also due annually and are to be collected together with the periodic collections on the principal.
The prevailing interest rate for this type of note is 12%. How much is the carrying amount of
the receivable on December 31, 20x1?
depreciation of ₱950,000 in exchange for a 3-year, ₱1,200,000 note receivable. Principal and
interest at 3% are due on January 1, 20x4. The prevailing interest rate for this type of note is
12%. How much is the carrying amount of the receivable on initial recognition date?
a. 1,311,272 b. 2,000,000 c. 933,337 d. 854,136
22. ABC Co. received a ₱1,000,000, 8%, 5-year note that requires five equal annual year-end
payments. The effective interest rate on the note is 9%. How much is total interest revenue
to be earned on the note?
a. 250,438 b. 278,074 c. 25,882 d. 225,882
23. On January 1, 20x1, ABC Co. sold a used equipment in exchange for a ₱1,200,000
noninterest-bearing note receivable due in three equal annual installments starting January 1,
20x4. The current market rate of interest on January 1, 20x1 is 12%. How much is the carrying
amount of the receivable on initial recognition date?
a. 890,365 b. 728,860 c. 765,890 d. 821,060
24. On January 1, 20x1, ABC Co. sold a used equipment in exchange for a ₱4,500,000 non-
interest-bearing note due in three annual installments as follows:
Jan. 1, 20x4 2,000,000
Jan. 1, 20x5 1,500,000
Jan. 1, 20x6 1,000,000
Total 4,500,000
The current market rate of interest on January 1, 20x1 is 12%. How much is the carrying amount
of the receivable on initial recognition date?
25. On March 1, 20x1, ABC Co. received a ₱1,000,000, 12%, one-year note dated January 1,
20x1 from XYZ, Inc. in exchange for a ₱1,000,000 past due account. How much interest
income is recognized in 20x1?
Activity 3
Problems solving
Problem 1
On December 31, 2019, Durable bank has a loan receivable of P4,000,000 from the borrower
that it is carrying at face amount and is due on December 31, 2024. Interest on the loan is payable
at 9% each December 31. The borrower paid the interest due on December 31, 2019 but informed
the bank that it would probably miss the next two years’ interest payments because of financial
difficulty. After that, the borrower is expected to resume the annual interest payment but it would
make the principal payment one year late, with interest paid for that additional year at the time of
principal payment.
Required:
1. Compute the present value of the loan receivable on December 31, 2019.

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2. Compute the impairment loss to be recognized on December 31, 2019.

3. Prepare journal entries for 2019 to 2025.
Problem 2
Gullible company is a dealer in equipment. On December 31, 2019, the entity sold an equipment
in exchange for a noninterest bearing note requiring five annual payments of P500,000. The first
payment was made on December 31, 2020. The market interest for similar notes was 8%.
Required:
1. Prepare journal entries for 2019 and 2020.
2. Determine the carrying amount of the note receivable on December 31, 2020.
3. Determine the interest income for 2021.
Problem 3
On January 1, 2019, allure company sold an equipment with a carrying amount of P800,000,
receiving a noninterest bearing note due in three years with a face amount of P1,000,000. There
is no established market value for the equipment. The interest rate on similar obligations is 12%
1. What is the present value of 1 at 12% for three periods?

2. What amount should be reported as gain or loss on sale of equipment in 2019?
3. What amount should be reported as interest income for 2019?
4. What is the carrying amount of note receivable on December 31, 2019?
5. What amount should be reported as interest income for 2020?

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Topic 3- Receivables Financing
Receivable financing is the financial flexibility or capability of an entity to raise money

out of its receivables.
During a general business decline, an entity may find itself in tight cash position because
sales decrease and customers are not paying their accounts on time. The entity would
be in financial distress as collections of receivables are delayed but cash payments for
obligations must be maintained.
Under these circumstances, if the situation becomes very critical, the entity may be
forced to look cash by financing its receivables.
Forms of receivable financing

The common forms of receivable financing are:
a. Pledge of accounts receivable
b. Assignment of accounts receivable
c. Factoring of accounts receivable
d. Discounting of notes receivable
Learning Outcomes
• Identify sources of financing through receivables.

• Distinguished forms of receivable financing from each other.
• Solve problems related to receivable financing
Pretest
Chester Company has transactions involving current assets and current liabilities. Complete the
various components of the simulation for Chester. Determine whether each statement is True or
False.
1. The balance in “factor’s holdback” (due from factor) is reported as an expense of the
period. ________________
2. In a specific assignment of receivables, collections on the assigned accounts are generally
remitted to the assignor. ________________
3. Factors are banks or finance companies that purchase receivables for a fee and then
collect the remittances directly from the selling company. ________________

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4. A transfer of receivables with recourse may be accounted for as a sale, provided the
transferee can require the transferor to repurchase the receivables. ________________
5. In a transfer of receivables with recourse accounted for as a borrowing, the difference
between the receivables and the total of the factor’s holdback plus the proceeds is a
financing cost that should be amortized to interest expense over the term of the
receivables. ________________
6. In pledging of accounts receivable, the loan is recorded by debiting cash and discount on
note payable if loan is discounted, and crediting note payable. ________________
7. Normally, the borrowing entity make the collections of the pledge accounts but may be
required to turn over the collections to the bank in satisfaction for the loan.
________________
8. In factoring arrangement, an entity sells accounts receivables to a bank or finance entity
called a factor. ________________
9. Endorsement may be with recourse which means that the endorser shall pay the endorsee
if the maker dishonors the note. ________________
10. If the entity has been transferred substantially all risks and rewards, the financial asset
shall be derecognized. ________________
Content
Pledge of accounts receivable

When loans are obtained from the bank or any lending institution, the accounts receivable may
be pledged as collateral security for the payment of the loan. The loan is recorded by debiting
cash and discount on note payable if loan is discounted, and crediting note payable.
Pledge does not qualify as transfer of financial assets for derecognition because the
pledgor/borrower retains control over the pledge receivables. Therefore, pledge receivables
neither derecognized nor specifically identified from other receivables. It is treated as secured
borrowing.
Key points to remember:

1. Pledge of AR
• All AR are collateral
• AR is served as collateral (Secure Bank Loan)
• Still recognized the Asset (same accounting procedure)
• Disclose in the notes – Total amount Pledge
illustrative Example
Pittance Company provided the following information in connection with a bank loan.

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March 1 Pittance Company borrowed P2,000,000 from bank on a six-month note

carrying an interest of 12% per annum. Accounts of P3,000,000 are pledge
to secure the loan.
April 1 Pledge accounts of P1,000,000 are collected minus 2% discount.
June 1 The remaining pledge accounts are collected.
September 1 The bank loan is repaid plus interest.
Prepare journal entries to record the transactions.
Assignment of accounts receivable

Assignment of accounts receivable means that a borrower called the assignor transfers rights in
some accounts receivable to a lender called the assignee in consideration in a loan.
Actually, assignment is a more formal type of pledging of accounts receivable. Assignment is

secured borrowing evidenced by a financing agreement and a promissory note both of which the
assignor signs.
However, pledging is general because all accounts receivable serve as a collateral security for
the loan. On the other hand, assignment is specific because specific accounts receivable serve
as collateral security for the loan.
Feature of assignment
Assignment may be done either on a non-notification or notification basis.
When accounts are assigned on a non-notification basis, as is usually the case, customers are
not informed that their accounts have been assigned. As a result, the customers continue to make
payments to the assignor, who in turn remits the collection to be assignee.
When accounts are assigned on a notification basis, customers are notified to make their
payments directly to the assignee.
Before entering into an assignment, the assignee, usually a bank or a finance entity, analyzes the
borrower accounts receivable.

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The assignee usually lends only a certain percentage of the face value of the accounts assigned
because the assign accounts may not fully realize by reason of such factors as sales discount,
sales return and allowances and uncollectible accounts.
The percentage maybe 70%, 80% or 90% depending on the quality of the accounts. The assignee
usually charges interest for the loan that it makes and requires a service or financing charge or
commission for the assignment agreement.

2. Assignment of AR
• Specific AR only
• Serve as Collateral
• Still recognized the Asset (same accounting procedure)
• Classified as:
• AR Assigned
• AR Assigned
• Notification Basis – the customer is informed that his AR is assigned.
- The customer paid directly to the Bank.
• Non-notification- In contrast to notification basis
Grateful Company provided the following transactions.
July 1 The company assigned P500,000 of accounts receivable to its bank on a
non-notification basis in consideration for a loan. On this date, the bank
advanced P400,000 less a service charge of 2% of the total accounts
assigned, and the entity signed a promissory note bearing interest of 1% per
month on the unpaid loan balance at the beginning of the month.
August 1 Collected P330,000 on assigned accounts. The entity remitted this amount
to the bank in payment first for the interest and the balance to the principal.
September 1 Collected the remaining balance of assigned accounts. The entity paid off
the remaining loan balance.

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Prepare journal entries to records the transactions.
Factoring
Factoring is a sale of accounts receivable on a without recourse, notification basis.
In a factoring agreement, an entity sells accounts receivable to a bank or finance entity called a
factor.
Factoring differs from an assignment in that an entity actually transfers ownership of the
accounts receivable to the factor.
In assignment, the assignor retains ownership of the accounts assigned.
Because of the nature of the transaction, the customers whose accounts are factored are
notified and required to pay directly to the factor.
Factoring may take the form of the following:
a. Casual factoring
If an entity finds itself in a critical cash position, it may be forced to factor some or all of its
accounts receivable at a substantial discount to a bank or a finance entity to obtained the much-
needed cash.
b. Factoring as a continuing agreement
Factoring may involve a continuing arrangement where a finance entity purchases all of the
accounts receivable of a certain entity.
In this setup, before a merchandise is shipped to a customer, the selling entity request the
factor’s approval.
If it is approved, the account is sold immediately to the factors after shipment to the goods.

3. Factoring of AR
• Transfer of an Asset
• Sale of AR
• Recognized G/L from Sale

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Zeus Company factored P6,000,000 of accounts receivable to a finance entity at the beginning of
current year. Control was surrendered by Zeus Company. The factor accepted the accounts
receivable subject to recourse for nonpayment. The fair value of the recourse obligation is
P100,000. The factor assessed a fee of 3% and retained holdback equal to 5% of the accounts
receivable. In addition, the factor charged 15% interest computed on a weighted average time to
maturity of the accounts receivable of 45 days.
What is the amount of cash initially received from the factoring?
If all accounts are collected, what is the loss on factoring the accounts receivable?
If all accounts are not collected, what is the loss on factoring?
Solutions:
What is the amount of cash initially received from the factoring?
If all accounts are collected, what is the loss on factoring the accounts receivable?
If all accounts are not collected, what is the loss on factoring?

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Discounting of notes receivable

Concept of discounting
As a form of receivable financing, discounting specifically pertains to note receivable.
In a promissory note, the original parties are the maker and payee.
The maker is the one liable and the payee is the one entitled to payment on the date of maturity.
When a note is negotiable, the payee may obtain cash before maturity date is discounting the at
a bank or other financing company.
To discount the note, the payee must endorse it. Thus, legally the payee becomes an endorser
and the bank becomes an endorsee.
Endorsement
Endorsement is the transfer of right to a negotiable instrument b simply signing at the back of the
instrument.
Endorsement may be with recourse which means that the endorser shall pay the endorsee if the
maker dishonors the note.
Endorsement may be without recourse which means that the endorser avoids future liability even
if the maker refuses to pay the endorsee on the date of maturity.
Terms related to discounting of note

1. Net proceeds refer to the discounted value of the note received by the endorser from the
endorsee.
Net proceeds = Maturity value minus Discount
2. Maturity value is the amount due on the note at the date of maturity. Principal plus interest
equals the maturity value.
3. Maturity date is the date on which the note should be paid.
4. Principal is the amount appearing on the face of the note. It is also referred to as face
value.
5. Interest is the amount of interest for the full term of the note. Interest is computed as
Principal x rate x time.
6. Interest rate is the rate appearing on the face of the note.
7. Time is the period within which interest shall accrue. For discounting purposes, it is the
period from date of note to maturity date.
In other words, the term “time” is the entire period “full term” of the note.
8. Discount is the amount of interest deducted by the bank in advance. Discount is equal to
maturity value times discount rate times discount period.
9. Discount rate is the rate used by the bank in computing the discount. The discount rate
should not be confused with the interest rate. The discount rate and the interest rate are
different from each other.
If the discount rate is given, the interest rate is safely assumed as the discount rate.
10. Discount period is the period of time from date of discounting to maturity date.

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Conditional sale or secured borrowing

PFRS 9, paragraph 3.2.3, provides that an entity shall derecognize a financial asset when either
one of the following criteria is mate:
a. The contractual rights to the cash flows of the financial asset have expired.
b. The financial asset has been transferred and the transfer qualifies for derecognition
based on the extent of transfer of risk and rewards of ownership.
The first criterion is usually easy to apply.

The contractual rights to the cash flows many expire, for example, when a note receivable from a
customer is fully collected.
The application of the second criterion is often complex.

It relies on the assessment of the extent of the transfer of risks and rewards of ownership.
PFRS 9, paragraph 3.2.6, provides the following guidelines for derecognition based on transfer
of risks and rewards:
1. If the entity has been transferred substantially all risks and rewards, the financial asset
shall be derecognized.
2. If the entity has retained substantially all risks and rewards, the financial asset shall not
be derecognized.
3. If the entity has neither transferred nor retained substantially all risks and rewards,
derecognition depends on whether the entity has retained control of the asset.
a. If the entity has lost control of the asset, the financial asset is derecognized in its
entirety.
b. If the entity has retained control over the asset, the financial asset is not
derecognized.
Evaluation
The contractual rights to the cash of the note receivable discounted with recourse have not yet
expired. Thus, this first criterion does not apply.
The discounting of note with recourse does not also fall squarely within a single guideline in the
second criterion of “transfer of risks and rewards of ownership”.
The discounting transaction is a combination of the guidelines in the second criterion as follows:
a. The entity has substantially transferred all “rewards”.
b. The entity has retained substantially all “risks”.
c. The entity has lost control of the note receivable.
Conclusion
Much debate on this accounting issue can go on among academicians and theoreticians until a
clear-cut interpretation of the standard is made by the Financial Reporting Standards Council.
The main justification is that upon discounting or endorsement of the note receivable, whether
with or without recourse, the transferor or endorser has lost control over the note receivable.

Discounting of Notes Receivable
• Discounting w/o recourse (Absolute Sale)

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– The note is in the bank, if mature the bank will collect the maker and if the maker
dishonors the note, the bank cannot collect from the company.
• Discounting w/ recourse
– in the event the maker dishonors the note the company is liable.
Conditional Sale w/ recognition of contingent liability

• Liable only when the note is dishonor
• Secondarily liable
Secured Borrowing
• the entity is primarily liable
• Recognize liability
1. MV = P + I
2. Proceeds= MV – Discount
3. Discount= MV x DR/ IR x Discount period (Unexpired period)
4. Interest= Prt
5. CA/CV= P + Accrued Interest (expired period)
6. G/L= Proceeds – CA
7. G/L= PV- CA
8. Collected amount= MV + Protest fee + Interest income
9. Interest Income = (MV + Protest fee) X DR
10. Unearned Interest Income = Principal – PV of note
* MV- Maturity Value *DR- Discount rate *P- Principal

* I- Interest *G/L- Gain/Loss *CA- Carrying Amount
*CV- Carrying value
Illustrative Examples:
1. Morale Company provided the following transactions:
March 14 Sale merchandise, P2,050,000 to a customer, FOB destination
2/10, n/30
April 7 Receipt of 60-day, 12% note dated April 5 from the customer, the
face of the note was the amount of the invoice minus freight charge
of P50,000 paid by the customer in connection with the March 14
sale.
20 The note of the customer was discounted with the bank at 15%.
June 4 Receipt of the notification from bank that the customer dishonored
to note. Accordingly, the entity paid the bank the amount due
including protest fee and other charges of P10,000.
July 4 Receipt of cash from the customer for the full amount of
indebtedness plus interest in the original face value.
Prepare journal entries to record the transactions assuming any discounting of the note
receivable is accounted for as a conditional sale with recognition of a contingent liability.

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2. On August 31, 2019, Stable Company discounted with recourse a customer’s note at the
bank at discount rate of 15%. The note was received from the customer on August 1, 2019, term
90 days, had a face value of P5,000,000, and carried an interest rate of 12%. The customer paid
the note to the bank on October 30, 2019, the date of maturity.
Prepare journal entries related to the discounting of note receivable, assuming the
discounting is accounted for as a secured borrowing.

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Assessment
Activity 1
1. Loans receivable are normally reported in the financial statements at
a. cost c. fair value
b. proceeds extended d. amortized cost
2. The following statements may be correctly stated as part of the acceptable accounting
principles for receivables:
I. Accounts receivable balances should be valued at their face amounts minus, if
appropriate, allowances set up for doubtful accounts and impairment in value
II. Receivable denominated in a foreign currency should be translated to local currency at
the rate of exchange at balance sheet date
III. If receivables are hypothecated against borrowings, the amount of receivables involved
should be disclosed in the financial statements or notes
IV. Unearned finance charges and interests included in the face amount of the receivables
are preferably shown as an addition to the related receivables
V. Significant amount of installment receivables should be stated separately
a. I, II, III, IV, and V c. I, II, III, and IV only
b. I, II, III, and V only d. I, II, and III only

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3. Which of the following is incorrect regarding the accounting for receivables?

a. The percentage-of- credit sales method is principally oriented toward achieving the best
possible matching of revenues and expenses. Aging the accounts is more oriented toward
the presentation of the correct net realizable value of the trade receivables in the
statement of financial position.
b. Impairment loss on note receivables may be recorded as a direct deduction to the impaired
asset’s account or through an allowance account.
c. Impairment testing on receivables is normally triggered by loss events.
d. Direct origination costs are deducted while direct origination fees are added to the carrying
amount of a loan receivable.
4. If a 12%, 3-month note receivable is acquired from a customer in settlement of an existing
account receivable of ₱10,000, the entry on initial recognition of the note receivable includes
a. debit to note receivable for ₱10,300
b. debit to note receivable for ₱11,200
c. credit to interest income for ₱300
d. debit to note receivable for ₱10,000 and no entry for interest
5. When testing loans and note receivables for impairment, the rate that should be used is
a. the current market rate as of date of impairment testing
b. the weighted average rate on the remaining term before maturity of note
c. the original effective rate of the note
d. the weighted average rate over the total life of the note
6. Immediately prior to recognition of impairment loss, the carrying amount of an impaired note
is
a. the future value of the note
b. the carrying amount of the note plus any accrued interest recorded prior to impairment
testing
c. the present value of the note discounted at the current market rate on the date of
impairment testing,
d. the total expected cash flows from the note
7. After impairment testing, the carrying amount of the impaired note is
a. the present value of the expected cash flows from the note, discounted at the original
effective rate.
b. the present value of the expected cash flows from the note, discounted at the current
market rate
c. the future value of the expected cash flows from the note
d. the amortized cost of the note ignoring impairment loss since the loss is only recognized
in profit or loss
8. After impairment testing, interest income on the impaired note is computed by
a. multiplying the present value of the note by the current market rate at year-end
b. multiplying the present value of the note by the rate used in impairment testing
c. multiplying the face value of the note by the rate used in impairment testing
d. no interest income will be recognized since the note is already impaired
9. Which of the following is not an objective evidence of impairment of a financial asset?
a. Significant financial difficulty of the issuer or obligor.
b. A decline in the fair value of the asset below its previous carrying amount.
c. A breach of contract, such as a default or delinquency in interest or principal payments.
d. Observable data indicating that there is a measurable decrease in the estimated future
cash flows from a group of financial assets although the decrease cannot yet be
associated with any individual financial asset.

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10. Impairment loss on financial assets may be recorded as a direct deduction to the impaired
asset’s account or through an allowance. If the entity uses an allowance account to record
impairment loss
a. the amount credited to the allowance account is equal to the impairment loss recognized
b. the amount credited to the allowance account is equal to the impairment loss recognized
if the carrying amount of the impaired financial asset immediately before impairment
testing does not include any accrued interest already recognized
c. the amount credited to the allowance account is equal to the impairment loss recognized
if the original effective interest rate is used in discounting the restructured future cash flows
from the instrument
d. in no case would the amount credited to the allowance account be equal to the impairment
loss recognized
11. Which of the following would indicate that a note receivable or other loan is impaired?
a. when it is written off
b. when it is probable that principal payments will be delayed
c. when the maker of the note experiences financial difficulties
d. when the market value of the note falls below its book value due to interest rate changes
12. If, in a subsequent period, the amount of the impairment loss decreases and the decrease
can be related objectively to an event occurring after the impairment was recognized
a. the previously recognized impairment loss shall be reversed in equity
b. the previously recognized impairment loss shall be reversed through an allowance
account
c. the previously recognized impairment loss shall be reversed either directly or by adjusting
an allowance account.
d. the previously recognized impairment loss shall not be reversed in profit or loss
13. Which of the following most likely would cause an impairment loss previously recognized to
be reversed to gain in profit or loss in the current period?
a. increase in the fair value of the receivable previously impaired
b. an improvement in the debtor’s credit rating
c. increase in current market interest rates
d. an improvement in the creditor’s credit rating
14. The reversal of impairment loss
a. shall not result in a carrying amount of the financial asset that exceeds what the amortized
cost would have been had the impairment not been recognized at the date the impairment
is reversed.
b. is recognized in profit or loss without any limit
c. is recognized in directly in equity
d. causes the debtor’s credit rating to increase
15. Where (X) is equal to the recoverable amount of a financial asset on impairment reversal date,
(Y) is equal to the carrying amount of a financial asset on impairment reversal date had no
impairment loss been recognized previously, and (Z) is equal to the carrying amount of a
financial asset on reversal date. The gain on reversal of impairment, assuming X is greater
than Y, is computed as
a. X minus Y b. Y minus Z c. X minus Z d. Z minus Y
16. The carrying value of an impaired note before recognizing a loan impairment:
a. includes accrued interest.
b. excludes accrued interest.
c. is the same as the carrying value after recognizing the impairment.
d. is less than the carrying value after recognizing the impairment.
17. Which of the following describes the carrying value of an impaired note immediately following
the recognition of the impairment?

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a. normal sum of the remaining cash flows to be received.

b. present value of remaining cash flows to be received, discounted at the current market
rate of interest.
c. present value of the remaining cash flows to be received, discounted at the original interest
rate implicit in the note.
d. the book value before the impairment is recognized less accrued interest.
18. Derecognition is the
a. inclusion of a financial asset or financial liability in the totals of the financial statements
through a journal entry.
b. exclusion of a financial asset or financial liability in the totals of the financial statements
through a memo entry.
c. removal of a previously recognized financial asset or financial liability from an entity’s
statement of financial position.
d. removal of a previously disclosed financial asset or financial liability from an entity’s notes.
19. An agreement to transfer a financial asset to another party in exchange for cash or other
consideration, with a concurrent obligation to reacquire the asset at a future date
a. firm purchase commitment c. recourse
b. repurchases agreement d. notification
20. Which of the following transfers of financial assets qualifies for derecognition?
a. A sale of a financial asset where the entity retains an option to buy the asset back at its
current fair value on the repurchase date.
b. A sale of a financial asset where the entity agrees to repurchase the asset in one year for
a fixed price plus interest.
c. A sale of a portfolio of short-term accounts receivables where the entity guarantees to
compensate the buyer for any losses in the portfolio.
d. A loan of a security to another entity (i.e., a securities lending transaction).
21. In which of the following circumstances is derecognition of a financial asset not appropriate?
a. The contractual rights to the cash flows of the financial assets have expired.
b. The financial asset has been transferred and substantially all the risks and rewards of
ownership of the transferred asset have also been transferred.
c. The financial asset has been transferred and the entity has retained substantially all the
risks and rewards of ownership of the transferred asset.
d. The financial asset has been transferred and the entity has neither retained nor transferred
substantially all the risks and rewards of ownership of the transferred asset. In addition,
the entity has lost control of the transferred asset.
22. Which of the following is not one of the conditions that must be met if a transfer of receivables
is to be accounted for as a sale?
a. The transferred assets have been isolated from the transferor.
b. The transferor's obligation under the recourse provisions can be reasonably estimated.
c. The transferee has the right to pledge or exchange the transferred assets.
d. The transferor does not maintain effective control over the assets through an agreement
to repurchase the assets before their maturity.
23. If financial assets are exchanged for cash or other consideration, but the transfer does not
meet the criteria for a sale, the transferor and the transferee should account for the transaction
as a (Item #1) Secured borrowing; (Item #2) Pledge of collateral
a. No, Yes b. Yes, Yes c. Yes, No d. No, No
24. Which one of the following sets correctly reflects whether the transfer of a financial asset
should be treated as a sale or as a borrowing when control over the transferred financial asset
has been surrendered and when control has not been surrendered? (Item #1) Control
Surrendered; (Item #2) Control Not Surrendered

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a. Sale, Sale c. Borrowing, Sale

b. Sale, Borrowing d. Borrowing, Borrowing
25. All but one of the following are required before a transfer of receivables can be recorded as a
sale.
a. The transferred receivables are beyond the reach of the transferor and its creditors.
b. The transferor has not kept effective control over the transferred receivables through a
repurchase agreement.
c. The transferor maintains continuing involvement.
d. The transferee can pledge or sell the transferred receivables.
26. Which of the following is not an objective for each entity accounting for transfers of financial
assets?
a. To derecognize assets when control is gained.
b. To derecognize liabilities when extinguished.
c. To recognize liabilities when incurred.
d. To derecognize assets when control is given up.
27. Which of the following is false?
a. A servicing asset shall be assessed for impairment based on its fair value.
b. A servicing liability shall be assessed for increased obligation based on its fair value.
c. An obligation to service financial assets may result in the recognition of a servicing asset
or servicing liability.
d. A servicing asset or liability should be amortized for a period of five years.
28. Which of the following is true?
a. A debtor may not grant a security interest in certain assets to a lender to serve as collateral
with recourse.
b. A debtor may not grant a security interest in certain assets to a lender to serve as collateral
without recourse.
c. The arrangement of having collateral transferred to a secured party is known as a pledge.
d. Secured parties are never permitted to sell collateral held under a pledge.
29. Larry has pledged financial assets as security for a loan from Lobster. Which of the following
statements concerning disclosure of the pledged assets is correct?
a. Larry is not required to separately disclose the assets pledged as security.
b. Larry must disclose the assets pledged as security on the face of its Balance Sheet.
c. Larry must disclose the assets pledged as security in the notes to its financial statements.
d. Larry may disclose the assets pledged as security either on the face of its Balance Sheet
or in the notes to its financial statements.
30. A transferor enterprise most likely should continue to recognize a transferred financial asset
if
a. The transferor may reacquire the asset, and the asset is readily obtainable in the market
b. The transferee may sell or pledge the full fair value of the asset.
c. The transferor may reacquire the asset, and the reacquisition price is fair value.
d. The transferor is entitled and obligated to repurchase the asset, and the transferee
receives a lender’s return.
31. Krabby Corp. transferred financial assets to Patty, Inc. The transfer meets the conditions to
be accounted for as a sale. As a transferor, Krabby should do each of the following, except
a. Remove all assets sold from the balance sheet.
b. Record all assets received and liabilities incurred as proceeds from the sale.
c. Measure the assets received and liabilities incurred at cost.
d. Recognize any gain or loss on the sale.
32. On April 9, 200A, Zyrus Co. purchased a financial asset from Dalome Co. During 200B, Zyrus
sold the financial asset to Didaco Co. at fair value. However, the sale was subject to an

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agreement that Zyrus Co. should repurchase the financial asset on February 10, 200C at face
amount plus 10% interest. Which of the following statements is correct?
a. Zyrus Co. should derecognize the financial asset.
b. Zyrus Co. should continue to recognize the financial asset.
c. Didaco should recognize interest income immediately
d. Dalome Co. should recognize the financial asset.
33. On July 10, 200A, Clifton Co. purchased a financial asset from Princess Co. During 200B,
Clifton sold the financial asset to Arnold Co. at fair value. However, the sale agreement gave
Clifton Co. the option to repurchase the financial asset in 200C at face amount plus 10%
interest. Which of the following statements is correct?
a. Clifton Co. should derecognize the financial asset.
b. Clifton Co. should continue to recognize the financial asset.
c. Arnold should derecognize the financial asset from Princess Co.
d. Princess Co. should not derecognize the financial asset.
34. Under PFRS 9 Financial Instruments, an entity shall derecognize a financial asset when
a. the contractual rights to the cash flows from the financial asset expire
b. it transfers the financial asset and such transfer qualifies for derecognition
c. a revenue recognition is permitted by a standard
d. a or b
35. An entity transfers a financial asset if, and only if, it
a. transfers the contractual rights to receive the cash flows of the financial asset
b. retains the contractual rights to receive the cash flows of the financial asset, but assumes
a contractual obligation to pay the cash flows to one or more recipients in an arrangement
that meets all the conditions required under PFRS 9 Financial Instruments
c. a or b
d. a and b
36. An entity transfers a financial asset if, and only if, it either transfers the contractual rights to
receive the cash flows of the financial asset; or retains the contractual rights to receive the
cash flows of the financial asset, but assumes a contractual obligation to pay the cash flows
to one or more recipients in an arrangement that meets which of the following conditions
I. If the entity is unable to collect on the financial instrument, it has no obligation to the
eventual recipient
II. The entity is prohibited from selling or pledging the financial instrument
III. Collections obtained from the financial instrument should be remitted to eventual
recipients without material delay
IV. The entity is not entitled to reinvest cash flows from the financial instrument, except for
investments in cash or cash equivalents during the short settlement period from the
collection date to the date of required remittance to the eventual recipients
V. Interest earned on temporary investments of collections is passed to the eventual recipient
a. I, II, III, IV c. any of the conditions stated
b. I, III, IV, V d. all of the conditions stated above
37. If the entity transfers substantially all the risks and rewards of ownership of the financial asset,
the entity
a. shall derecognize the financial asset
b. shall derecognize the financial asset and recognize separately as assets or liabilities any
rights and obligations created or retained in the transfer
c. shall continue to recognize the financial asset but also recognize as liabilities any rights
created or retained in the transfer
d. shall continue to recognize the financial asset

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38. If the entity retains substantially all the risks and rewards of ownership of the financial asset,
the entity
a. shall derecognize the financial asset
b. shall derecognize the financial asset and recognize separately as assets or liabilities any
rights and obligations created or retained in the transfer
c. shall continue to recognize the financial asset but also recognize as liabilities any rights
created or retained in the transfer
d. shall continue to recognize the financial asset
39. The process whereby financial assets are transformed into securities
a. equity set-off c. instrument modification
b. securitization d. instrument transformation
40. Offsetting financial assets and liabilities is permitted only when the entity
I. Has a legally enforceable right to set off the recognized amounts
II. Intends to settle the asset and liability on a net basis, or to realize the asset and settle the
liability simultaneously
a. I b. II c. I or II d. I and II
41. Girl Co. and Boy Co. regularly engage in transactions giving rise to both assets and liabilities
in each other’s statement of financial position. The companies thereby entered into a master
netting agreement on which a company’s payables may be offset from any receivables the
company has from the other company. At year-end, Boy Co. does not intend to settle its
receivables and liabilities on a net basis because of the timing of cash flows. Which of the
following is correct?
a. Boy Co. may present its receivables from Girl Co. and liabilities to Girl Co. separately and
at gross amounts in the financial statements
b. Boy Co. should present its receivables from Girl Co. net of any liabilities to Girl Co.
c. If Boy Co. is reluctant in offsetting its assets and liabilities, Girl Co. may report Boy Co. to
the Securities and Exchange Commission.
d. If Boy Co. is reluctant in offsetting its assets and liabilities, Girl Co. may report Boy Co. to
the Philippine Institute of Certified Public Accountants.
42. It is the process of using an asset as collateral security for borrowings. It generally refers to
borrowings secured by accounts receivable.
a. Factoring b. Pledging c. Discounting d. Financing
43. When accounts receivables are pledged,
a. a journal entry should be made to derecognize the accounts receivables pledged and to
record the pledge transaction. The loan transaction should be recorded separately.
b. the accounts receivables pledged should be separately presented in the face of the
statement of financial position separate from other receivables.
c. specific receivables are set up as collateral security for borrowings
d. the only accounting issue is that of adequate disclosure.
44. Which of the following is not a valid comparison between pledging and assignment of accounts
receivable?
a. Under pledge, all accounts receivables are set as collateral security for borrowings; under
assignment only specific receivables are set as collateral security.
b. In pledging, the lender has limited rights to inspect the borrower’s records to achieve
assurance that the receivables do exist; in assignment the lender will make an
investigation of the specific receivables that are being proposed for assignment and will
approve those that are deemed worthy to be held as collateral security.
c. No journal entry is made for the pledged receivables; an entry is made for the assigned
receivables.

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d. Pledged accounts receivable remain the assets of the borrower and continue to be
presented in its financial statements, with appropriate disclosure of the pledge transaction;
assigned receivables are assets of the lender/assignee but the assignment is disclosed in
the financial statements of the borrower/assignor.
e. In pledge, the amount borrowed is independent from the amount of accounts receivables
pledged; in assignment, normally only 70% to 90% of the amount of accounts receivables
assigned is advanced as a loan to the borrower.
45. The owner of the accounts receivable assigned in a notification basis is
a. assignee b. pledger c. assignor d. lender
46. If the records of an entity show a balance in a “Due from factor” or “Factor’s holdback” account,
it can be reasonably inferred that accounts receivables have been
a. pledged b. assigned c. factored d. discounted
47. The right of the transferee (factor) of accounts receivable to seek recovery for an uncollectible
account from the transferor
a. credit risk c. recourse
b. repurchase agreement d. notification
48. When accounts receivables are factored on a “with recourse” basis, the factoring is usually
treated as
a. a secured borrowing
b. an outright sale
c. a transfer of financial asset without recognition of liability created in the transfer.
d. derecognition of financial asset when the transferor neither transfers nor retains
substantially all the risks and rewards of ownership of the financial asset and has not
retained control. The transferor recognizes separately as assets or liabilities any rights
and obligations created in the transfer, such as the proceeds on the factoring and the
recourse obligation.
49. Jaco Co. had ₱3 million in accounts receivable recorded on its books. Jaco wanted to convert
the ₱3 million in receivables to cash in a more timely manner than waiting the 45 days for
payment as indicated on its invoices. Which of the following would alter the timing of Jaco's
cash flows for the ₱3 million in receivables already recorded on its books?
a. Change the due date of the invoice.
b. Factor the receivables outstanding.
c. Discount the receivables outstanding.
d. Demand payment from customers before the due date.
50. Which of the following is true when accounts receivable are factored without recourse?
a. The transaction may be accounted for either as a secured borrowing or as a sale,
depending upon the substance of the transaction.
b. The receivables are used as collateral security for a promissory note issued to the factor
by the owner of the receivables.
c. The factor assumes the risk of collectibility and absorbs any credit losses in collecting the
receivables.
d. The financing cost (interest expense) should be recognized ratably over the collection
period of the receivables.
51. Which of the following is used to account for probable sales discounts, sales returns, and
sales allowances? (Item #1) Due from factor; (Item #2) Recourse liability
a. Yes, No b. Yes, Yes c. No, Yes d. No, No
52. When accounts receivable are set aside as collateral security for a loan, and the borrower
continues to collect the receivables but collections are applied to the loan, the receivables are
a. factored b. pledged c. discounted d. assigned
53. If a company usually sells its accounts receivable, it records any factoring commission as a(n):

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a. loss b. expense c. receivable d. liability

54. Accounts receivable of a company sold outright to a financing company without recourse are
said to have been
a. pledged b. factored c. assigned d. collateralized
55. Dream Theater Co. accepted a ₱5,000, 8%, 90-day note receivable for services rendered to
a client. Thirty days later Dream Theater discounted the note at a bank at 10%. The entry to
record the proceeds from sales of the note would include a:
a. credit to notes receivable for ₱50,000
b. debit to cash for ₱51,000
c. credit to interest income for ₱33.33
d. debit to loss from discounting of note for ₱150
56. A note receivable that is sold (i.e., discounted) to obtain early cash must be:
a. retained in the accounts in the same manner as before discounting
b. reported as an extraordinary loss if it is dishonored
c. disclosed as a contingent liability if it is discounted without recourse
d. reported as sale or a loan
57. When a note receivable of an entity is sold to a non-bank financial institution on a with recourse
basis before maturity, the note receivable has been
a. pledged b. assigned c. discounted d. factored
58. When a company discounts its notes receivables at a bank, the common practice is to record
the discounted notes in a(n):
a. liability account c. asset account
b. contra-asset account d. expense account
59. When a company discounts its notes receivable at a bank and the discounting is treated as
secured borrowing, the discounting is recorded in a
a. liability account c. asset account
b. contra-asset account d. expense account
60. After being held for 30 days, a 90-day, 15% interest bearing note receivable was discounted
at a bank at 18%. The proceeds received from the bank upon discounting would be the:
a. face value less the discount at 18%
b. face value plus the discount at 18%
c. maturing value less the discount at 18%
d. maturing value plus the discount at 18%
Activity 2
Answer as required
ABC Co. transferred loans receivables with carrying amount of ₱900,000 and fair value of
₱1,000,000 to XYZ, Inc. for cash amounting to ₱1,000,000.
1. If ABC Co. transfers substantially all the risks and rewards of ownership of the loans
receivable, how much of the transferred receivables is derecognized?
2. If ABC Co. is obligated to repurchase the transferred loans at a future date for the fair market
value of the instrument at repurchase date plus 10% interest, how much of the transferred
receivables is derecognized?
3. If ABC Co. is obligated under the terms of the transfer to repurchase any individual loan but
the aggregate amount of loans that could be repurchased could not exceed ₱100,000, how
much of the transferred receivables is retained in the books and not derecognized?

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4. If ABC Co. retains only a right of first refusal to repurchase the transferred asset at fair value
if XYZ, Inc. subsequently sells it, how much of the transferred receivables is derecognized?
The next three questions are based on the following information:

ABC Co. factored ₱100,000 accounts receivable to XYZ Financing Corp. on a without recourse
basis on January 1, 20x1. XYZ charged a 4% service fee and retained a 10% holdback to cover
expected sales returns. In addition, XYZ charged a 12% interest computed on a weighted average
time to maturity of the receivables of 73 days based on 365 days.
5. How much proceeds is received from the factoring on January 1, 20x1?
6. How much is the cost of factoring assuming all of the receivables have been collected?
7. On April 1, the AIM Inc. assigned 800,000 of accounts receivable to a bank under a
nonnotifcation arrangement. The bank advances 80% less a service charge of 5,000. AIM Inc.
signed a promissory note that provides for interest of 1% per month on the unpaid balance. On
April 5, AIM Inc. issued a credit memo for sales return to a customer whose account was assigned
for 50,000. On April 10, the company collected 300,000 of the assigned accounts less 2%
discount. On April 30, AIM Inc. remitted the total collections to the bank plus interest for 1 month.
On May 7, 30,000 worth of assigned accounts proved to be worthless. On May 20, AIM Inc.
collected 300,000 of the assigned accounts. On May 30, the company remitted the total amount
due the bank to pay off the loan balance plus interest for one month. What is the remaining
balance of assigned accounts receivable to be transferred back to unassigned accounts
receivables?
8. BPI Inc. provides financing to other companies by purchasing their accounts receivable on a
non-recourse basis. BPI Inc. charges its clients a commission of 15% on all receivables factored.
In addition, BPI withholds 10% of receivables factored as protection against sales return and other
adjustments. BPI Inc. credits the 10% withheld to Clients Retainer Account and makes payments
to clients at the end of each month so that the balance in the retainer is equal to 10% of unpaid
receivables at the end of the month. Experience has led BPI Inc. to establish an allowance for
bad debts accounts of 4% of all unpaid receivables purchased. On December 31, 2014, BPI
purchased receivables from DLSL Inc. totaling 5,000,000. DLSL Inc. had previously established
an allowance for bad debts for these receivables at P200,000. By December 31, BPI Inc. had
collected 4,000,000 on these receivables.
What is the amount of cash received by DLSL Inc. as a result of factoring?
9. What is the gain/(loss) on factoring to be recognized by DLSL Inc.?

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10. On July 1, 2019, AWIT Inc. received a 180-day P1,000,000 note receivable from its customer
with 10% interest. Due to financial difficulties, AWIT Inc. discounted the said notes receivable to
RCBC Inc. on August 15, 2014 at a 15% discount rate. What is the net proceeds from the note
discounting to be received by AWIT Inc.? (Assume 360-day)
11. What is the gain/(loss) on note receivable discounting to be recognized by AWIT Inc.?
12. On December 1, 2019, SAYAW Inc. received a 2-year, P2,000,000 non-interest bearing note
from its customer. Due to financial difficulties, SAYAW Inc. discounted the said notes to UCPB
Inc. on December 31, 2019 at a 10% discount rate. The applicable discount rate for the similar
note is 12%. What is the net proceeds from the note discounting to be received by SAYAW
Inc.?(Assume 360-day)
13. On July 1, AIG Inc. assigned P2,000,000 of accounts receivable to a bank under a notification
arrangement. The bank loans 50% less 4% charge on the gross amount assigned. AIG Inc. signed
a promissory note that provides 2% interest per month on the unpaid loan balance. On July 31,
AIG Inc. received notice from the bank that P800,000 of the assigned accounts were collected
less 5% discount. A check was sent to the bank for the interest. On August 31, AIG Inc. received
notice from the bank that P500,000 of the assigned accounts were collected. Final settlement was
made by the bank for the excess collections together with uncollected assigned accounts of
P700,000. What is the amount of cash received from the bank in the final settlement?
14. On July 1, 20x1, ABC Co. discounted an ₱800,000, 90-day, 12% note, received from a
customer on June 1, 20x1, with a bank at 16% on with recourse basis. The discounting is
treated as conditional sale. The bank uses 365 days per year in computing for discounts. On
August 30, 20x1 (maturity date), the maker of the note defaulted and the bank charged ABC
Co. the maturity value of the note plus a ₱3,000 protest fee. How much is transferred to
accounts receivable due to the dishonor and before impairment testing?
15. On July 1, 20x1, ABC Co. discounted its own note of ₱200,000 to a bank at 10% for one year.
How much was the net proceeds received by ABC from the transaction?
Activity 3
Chameleon company provided the following data for the current year.
June 1 Received from Aye company a P5,000,000, 12% 90-day note for
merchandise sold.
July 1 Received from Bee company a P6,000,000, 10% 60-day note in full
payment of an account.
1 Discounted the Aye company note at the bank at 12%.
16 Discounted the Bee company note at the bank at 12%.
August 30 The bank notified Chameleon company that the Bee company note
was paid.

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30 The bank notified Chameleon company that the Aye company

defaulted on the note and charged the amount of principal, interest
and a fee of P20,000 against Chameleon’s bank account.
December 30 Received full payment from Aye company for the dishonored note plus
12% annual interest on the total amount due for four months.
Prepare journal entries to record the transactions on the assumption:
1. The discounting on the note receivable is accounted for as a secured borrowing.
2. The discounting on the note receivable is accounted for as a conditional sale with
recognition of contingent liability.
Reference List
Enterprise.

Accountancy.
GIC Enterprise.
Standards (2020 ed., Vol. 3). GIC Enterprise.

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Unit 3-Accounting for Inventories
Inventories are assets held for sale in the ordinary course of business, in the process of
production for such sale or in the form of materials or supply to be consumed in the
production process or in the rendering of services.
Inventories also encompass finished goods produced, goods in process and
materials and supplies awaiting use in the production process.
Topic 1- Inventory Cost Flow and LCNRV
Learning Outcomes
• Determine the nature, measurement and composition of the Inventories.

• Identify and use the techniques in analyzing problems with regards to Inventories.
• Solve problems in Inventories
• Identify and apply methods of Inventory cost flow and LCNRV.
Pretest
Indicate whether each of the following is included in the cost of inventory. Mark check in
the box.
Items Included Excluded

1. Merchandise purchased for resale
2. Freight-out
3. Direct materials
4. Sales returns
5. Packaging for shipment to customer
6. Factory overhead
7. Interest on inventory loan
8. Purchase discounts not taken
9. Freight-in
10. Direct labor

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Content
Overview
Inventory is defined as tangible personal property:
(1) held for sale in the ordinary course of business, (finished goods and merchandise inventory)
(2) in the process of production for such sale, or (work in process)
(3) to be used currently in the production of items for sale. (raw materials and manufacturing
supplies)
Classes of inventories
Inventories are broadly classified into two, namely inventories of a trading concern and inventories
of manufacturing concern. A trading concern is one that buys and sells goods in the same form
purchased. The term “merchandise inventory” is generally applied to goods held by a trading
concern.
A manufacturing concern is one that buys goods which are altered or converted into another form
before they are made available for sale.
The inventories of a manufacturing concern are:
1. Finished goods
2. Goods in process
3. Raw materials
4. Factory or manufacturing supplies
Definitions
Finished goods are completed products which are ready for sale.
Goods in process or work in process are partially completed products which require further
process or work before they can be sold.
Raw materials are goods that are to be used in the production process.
Factory or manufacturing supplies are similar to raw materials but their relationship to the end
product is indirect. Factory or manufacturing supplies may be referred to as indirect materials. It
is indirect because they are not physically incorporated in the products being manufactured.
Goods included in the inventory (Ownership over the inventories)

As a rule, all goods to which the entity has title shall be included in the inventory, regardless of
location. Passing of title is a legal language which means the point of time at which ownership
changes. Legal title normally passes when possession over the goods is transferred. However,
there may be cases where the transfer of control does not coincide with the transfer of physical
possession. Control may be transferred even before or after the transfer of physical possession.
The following items are to be included in the inventory:

1. Goods owned and on hand
2. Goods in transit purchased FOB shipping point
3. Goods in transit sold FOB destination
4. Goods out on consignment
5. Goods in the hands of salesmen or agents

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6. Goods held by customers on approval or on trial
Who is the owner of goods in transit?

This will depend on the terms, whether FOB destination or FOB shipping point. FOB means free
on board.
Under FOB destination, ownership of goods purchased is transferred only upon receipt of the
goods by the buyer at the point of destination. The goods in transit are still the property of the
seller.
Under FOB shipping point, ownership is transferred upon shipment of the goods and therefore,
the goods in transit are the property of the buyer.
SELLER
Seller delivers goods to carrier
for shipment to the buyer
LOGISTICS/CARRIER
If the Sale is FOB SHIPPING POINT,
ownership over the goods is transferred
here, on point of shipment.
BUYER
If the Sale is FOB DESTINATION,
Buyer receives the goods. ownership over the goods is transferred
here, the destination.

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Freight terms
Freight collect- this means that the freight charge on the goods shipped is not yet paid. The
common carrier shall collect the same from the buyer. Thus, under this, the freight charge is
actually paid by the buyer.
Freight prepaid- this means that the freight charge on the goods shipped is already paid by the
seller.
The term “FOB destination” and “FOB shipping point” determine ownership of the goods in transit
and the party who is supposed to pay the freight charge and other expenses from the point of
shipment to the point of destination.
The terms “freight collect” and “freight prepaid” determine the party who actually paid the freight
charge but not the party who is supposed to legally pay the freight charge.
Maritime shipping terms
FAS or free alongside – a seller who ships FAS must bear all expenses and risk involve in
delivering the goods to the dock next to or alongside the vessel on which the good are to be
shipped. This is the same as FOB Shipping point.
CIF or Cost, insurance and freight – under this shipping contract, the buyers agree to pay in a
lump sum the cost of the goods, insurance cost and freight charge. This is the same as FOB
Shipping point.
Ex-ship – a seller who delivers the goods ex-ship bears all expenses and risk of loss until the
goods are unloaded at which time title and risk of loss shall pass to the buyer. This is the same
as FOB Destination.
Consigned goods
A consignment is a method of marketing goods in which the owner called the consignor transfers
physical possession of certain goods to an agent called the consignee who sells them on the
owner’s behalf.
Statement Presentation
Inventories are generally classified as Current assets. It shall be presented as one-line item in
the statement of financial position but the details shall be disclosed in the notes to financial
statements.
Accounting for inventories

Two system are offered in accounting for inventories, namely periodic system and perpetual
system.
The periodic system calls for the physical counting of goods on hand at the end of the accounting
period to determine quantities.
The perpetual system requires the maintenance of records called stock cards that usually offer
a running summary of the inventory inflow and outflow.
Trade discounts and cash discounts

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Trade discounts are deduction from the list or catalog price in order to arrive at the invoice price
which is the amount actually charge to the buyer.
Cash discounts are the deductions from the invoice price when payment is made within the
discount period.
Purchase discount is deducted from the purchase to arrive at net purchases and sales discount
is deducted from sales to arrive at net sales revenue.
Illustration: Periodic vs. Perpetual (Journal Entries)

PERIODIC System PERPETUAL System
1. To record for purchased goods/merchandise
Purchases xx Merchandise Inventory xx
Cash/Accounts Payable xx Cash/Accounts Payable xx
2. To record for freight charges on merchandise purchased

Freight-in xx Merchandise Inventory xx
3. To record for goods/merchandise returned to supplier

Purchase Returns and Allowances xx Merchandise Inventory xx
4. To record for discount availed for early payment of merchandise purchased on credit
Accounts Payable xx Accounts Payable xx
Cash xx Cash xx
Purchase Discounts xx Merchandise Inventory xx
5. To record for sales to customers

Cash/Accounts Receivable xx Cash/Accounts Receivable xx
Sales xx Sales xx
Cost of Goods Sold xx
No Entry Merchandise Inventory xx
6. To record for goods/merchandise returned by the customer

Sales Returns and Allowances xx Sales Returns and Allowances xx
Cash/Accounts Receivable xx Cash/Accounts Receivable xx
Merchandise Inventory xx
No Entry Cost of Goods Sold xx
7. To record for discount given to customer for early collection of account

Cash xx
Sales Discounts xx Same Journal Entry
Accounts Receivable xx

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8. To record for freight charges on merchandise sold

Freight-out xx
Cash/Accounts Payable xx Same Journal Entry
Note: Under the Perpetual Inventory System, Merchandise Inventory account

was used to record for purchases, freight-in, purchase returns and
allowances, and purchase discounts.
For sales transaction, a second journal entry was made to update records
on outflow of merchandise or goods which is not present in the periodic
inventory system. Merchandise inventory account was credited to
decrease the inventory recorded and Cost of Goods Sold was debited to
increase the volume of merchandise sold.
For sales returns and allowances, Merchandise Inventory was debited to
record the increase of inventory as a result of goods returned by the
customer and a credit to Cost of Goods Sold as a decrease to goods sold.
This second journal entry does not exist in the periodic inventory system.
However, for sales discounts, there is no second journal entry under the
perpetual system since discounts does not affect the flow of merchandise
but only the amount of cash to be collected from the customer. Thus, it
has the same journal entry as with periodic system.
Moreover, under the perpetual inventory system, the use of stock cards is
a must. There is a continuous updating of the ins and outs in the stock card
every time there are purchases and sale of merchandise. The quantity
and amounts in the stock cards are being filled-up throughout the
accounting period or even the whole year round. It facilitates a better
control since it provides information of merchandise inventory on hand.
Merchandise Inventory account under Perpetual Inventory System as an

Asset with the following debit and credit postings:
Merchandise
Inventory
1. To record purchases 1. To record purchase returns and
allowances
2. To record freight-in 2. To record purchase discounts
3. To record actual cost of 3. To record actual cost of goods
merchandise returned 4. sold
by customer Excess of stock card against
actual inventory
4. Excess of actual inventory
against stock card

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PERPETUAL System PERIODIC System

• All increases and decreases in • Increases and decreases in inventory
inventory are recorded in the during the period are recorded in the
“Merchandise Inventory” account. “purchases”, “freight-in”, “purchase
returns and allowances”, and
“purchase discounts” accounts, as
appropriate.
• “Cost of Goods Sold” is debited when • “Cost of Goods Sold” is not recorded.
inventory is sold and credited for sales
returns.
• Physical count is performed only to • Physical count is necessary to

check the accuracy of the ledger determine the balances of inventory on
balances. hand and cost of goods sold.
• Does not require the use of any • Requires the use of the following
formula to determine cost of goods formula when determining cost of
sold because this information is readily goods sold:
available from the ledger.
Beginning Inventory Px
Add: Net Purchases:
Purchases Px
Freight-in x
Purchase Returns & Allowances (x)
Purchase Discount (x) x
Total Goods Available for Sale Px
Less: Ending Inventory (x)
Cost of Goods Sold Px
TRADE DISCOUNT VS. CASH DISCOUNT

Trade discount is referred to as a discount, given by the seller to the buyer at the time of purchase
of goods, as a deduction in the list price of the quantity sold. The trade discount is used by the
sellers to attract more customers and increase the quantity sales. There is no record maintained
in the books of both the buyer and seller for such a discount.
(Source: https://keydifferences.com/difference-between-trade-discount-and-cash-discount.html)
The following are examples of catalogue prices with trade discounts:
Product List Price Terms Items to purchase
1 P200,000 30, n/30 5 to 10 items
2 P200,000 30, 10, n/30 More than 10 to 20 items
3 P200,000 30, 10, 2/15, n/30 More than 20 items
The meaning of the pricing symbols stated is as follows:

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P200,000 – the list price. It is the suggested retail price.

30 – thirty percent (30%). It is the first trade discount deductible from the list price of P200,000.
10 – ten percent (10%). It is the second trade discount deductible from the balance net of the
first discount.
2/15 – two percent (2%) cash discount is given based on the invoice price if paid within fifteen
(15) days.
2/15, EOM – two percent (2%) cash discount is given based on the invoice price if paid within
fifteen (15) days from the end of the month.
n/30 – if not paid within 15 days, net amount (n) without the 2% discount must be paid within 30
days.
Cash Discount is referred to as a discount, allowed to customers by the seller at the time of
making the payment of purchases, as a reduction in the invoice price of the commodity. A cash
discount is used by the sellers to facilitate a prompt payment and thereby to avoid the credit risk.
Both the buyers and sellers keep a proper record of such discount in their books of accounts.
Therefore, unlike trade discounts, cash discounts are recorded in the books of the entity. It can
either be a purchase discount (on the buyer’s viewpoint) or a sales discount (on the seller’s
viewpoint).
(Source: https://keydifferences.com/difference-between-trade-discount-and-cash-discount.html)
Illustration
Based on the illustration above, assume that Burn Company paid within 10 days. The
computation of actual cash payment to the Barn Company would be:
Invoice Price P67,500

Less: Cash discount (P67,500 x 2%) 1,350
Actual cash payment P66,150
The appropriate journal entries would be – Periodic Inventory System:
• Books of Burn Company (Buyer)

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Apr 12 Accounts Payable 67,500
Cash 66,150
Purchase discounts 1,350
Payment within discount period
• Books of Barn Company (Seller)

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Apr 12 Cash 66,150

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Sales discounts 1,350

Collection within discount period
Gross method vs. net method

Net method represents the cash equivalent price on the date of payment and therefore the
theoretically correct historical cost.
Gross method violates the matching principle because discounts are recorded only when taken
or when cash is paid rather than when purchases that give rise to the discounts are made.
GROSS METHOD vs. NET METHOD OF RECORDING CASH DISCOUNTS

The issue in accounting is whether or not there would be a journal entry to be made for cash
discount not taken. The journal entry for cash discount not taken depends on whether the
method used in recording is gross method or net method.
The cost measured under the net method represents the cash equivalent price on the date of
payment and therefore the theoretically correct historical cost. However, in practice, most
entities record purchases at gross invoice amount.
Technically, the gross method violates the matching principle because discounts are recorded
only when taken or when cash is paid rather than when purchases that give rise to the discounts
are made. Despite its theoretical shortcomings, the gross method is supported on practical
grounds. It is more convenient than the net method from a bookkeeping standpoint.
Under the asset recognition principle, the net method is the current GAAP. Purchase discount
loss, being avoidable cost, should not be included in the cost of the asset. Asset should be
recognized net of discount.
Illustration
Assume that Go Enterprises sold merchandise to Wang Company at gross sales of P200,000,
terms: 2/10, n/30. The journal entries would be
Books of Go Enterprises (Seller)
1. To record credit sales

Sales 200,000 Sales 196,000
*(200,000 x 98% 196,000)

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Note: Unlike the gross method, the net method initially records the sales reduced by the cash
discount even if no actual collection has been made yet. The recording, however, does not
reflect the sales discount account in the books of accounts.
2. If collection is made within the discount period

Cash 196,000 Cash 196,000
Sales Discounts 4,000 Accounts Receivable 196,000
Note: The gross method records only the cash discount when actual collection was made within
the discount period.
3. If collection is made after the discount period.

Cash 200,000 Cash 200,000
Sales discounts forfeited 4,000
Note: Sales discount forfeited shall be treated as other operating income in the income
statement. Therefore, net profit is the same for both gross and net methods.
Books of Wang Company (Buyer)
1. To record purchases on account

Purchases 200,000 Purchases 196,000
Accounts Payable 200,000 Accounts Payable 196,000
*(200,000 x 98% = 196,000)
2. If payment is made within the discount period.

Cash 196,000 Cash 196,000
Purchase Discounts 4,000

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3. If payment is made after the discount period.

Cash 200,000 Purchase Discount Lost 4,000
Cash 200,000
Note: The purchase discount lost account shall be treated as other operating expense (loss) in
the income statement. Therefore, net profit is the same for both gross and net methods.
Cost of Inventories
The cost of inventories shall comprise:
a. Cost of purchase
b. Cost of conversion
c. Other cost incurred in bringing the inventories to their present location and
condition.
Cost of purchase
The cost of purchase of inventories comprises the purchase price, import duties and irrecoverable
taxes, freight, handling and other costs directly attributable to the acquisition of finished goods,
materials and services.
Cost of conversion
The cost of conversion of inventories includes cost directly related to the units of production such
as direct labor.
Allocation of variable production overhead

Variable production overhead is allocated to each unit of production on the basis of the actual
use of the production facilities.
Other cost
Other cost is included in the cost of inventories only to the extent that it is incurred in bringing the
inventories to their present location and condition.
INVENTORY COST FLOW

Cost formulas
PAS 2, paragraph 25, expressly provides that the cost of inventories shall be determine by
using either:
a. First in, First out (FIFO)
b. Weighted average (WA)
First in, First out (FIFO)

The FIFO method assumes that “the goods first purchased are first sold” and consequently the
goods remaining in the inventory at the end of the period are those most recently purchased or
produced.

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The rule is “first come, first sold”.
The inventory is thus expressed in terms of recent or new prices while the cost of the goods
sold is representative of earlier or sold prices.
Illustration – FIFO (Periodic/Perpetual)

The following data pertain to an inventory item:
Units Unit cost Total cost Sales (in units)

Jan. 1Beginning balance 800 200 160,000
8 Sale 500
18Purchase 700 210 147,000
22Sale 800
31Purchase 500 220 110,000
The ending inventory is 700 units.
FIFO
Units Unit cost Total cost

From Jan. 18 Purchase 200 210 42,000
From Jan. 31 Purchase 500 220 110,000
700 152,000 Ending inventory
Cost of Goods Sold
Inventory – January 1 160,000

Purchases (147,000 + 110,000) 257,000
Goods available for sale 417,00
Inventory – January 31 (152,000)
Cost of Goods Sold 265,000
Observed that the computation of the cost of goods sold and ending inventory is based on the
costs of the recent sold and unsold inventories. The cost of goods sold for periodic and perpetual
is the same under FIFO method.
Weighted average – periodic

The cost of the beginning inventory plus the total cost of purchases during the period is divided
by the total units purchased plus those in the beginning inventory to get awaited average unit cost
period.
WEIGHTED AVERAGE – PERIODIC
The cost of the beginning inventory plus the total cost of purchases during the period is divided
by total units purchased plus those in the beginning inventory to get weighted average unit cost.

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Such weighted average unit cost is then multiplied by the units on hand to derive the inventory
value.
In other words, the average unit cost is computed by dividing the total cost of goods available for
sale by the total number of units available for sale.
Formula:
Weighted average = Total goods available for sale *

unit cost Total no. of units available for sale*
* Total goods available for sale = Beg. Inventory + Purchases

* Total no. of units available for sale = Beg. Inventory (in units) + Purchases (in units)
Cost of Ending Inventory = Weighted average unit cost x Ending inventory (in units)
Illustration – Weighted Average (Periodic)
The preceding illustrative data are used.

Jan. 1 Beginning balance 800 200 160,000
18 Purchase 700 210 147,000
31 Purchase 500 220 110,000
Total goods available for sale 2,000 417,000
Weighted average unit cost (417,000 / 2,000) 208.50

Ending Inventory cost (700 x 208.50)145,950
Cost of Goods Sold

Inventory – January 1 160,000
Purchases 257,000
Goods available for sale 417,000
Inventory – January 31 (145,950)
Weighted average – perpetual

When used in conjunction with the perpetual system, the weighted average method is popularly
known as the moving average method.
PAS 2, paragraph 27, provides that the weighted average may be calculated on a periodic basis
or as each additional shipment is received depending upon the circumstances of the entity.

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WEIGHTED AVERAGE – PERPETUAL

When used in conjunction with the perpetual system, the weighted average method is popularly
known as the moving average method.
PAS 2, paragraph 27, provides that the weighted average may be calculated on a periodic basis
or as each additional shipment is received depending upon the circumstances of the entity. Under
this method, a new weighted average cost must be computed after purchase and purchase
return.
Thus, the total cost of goods available after every purchase and purchase return is divided by the
total units available for sale at this time to get a new weighted average unit cost. Such new
weighted average unit cost is then multiplied by the units on hand to get inventory cost.
This method requires the keeping of inventory stock card in order to monitor the “moving” unit
cost after every purchase.
Illustration – Weighted Average (Perpetual) or Moving Average

The preceding illustrative data are used.

Jan. 1 Beginning balance 800 200 160,000
8 Sale (500) 200 (100,000)
Balance 300 200 60,000
18 Purchase 700 210 147,00
Total 1,000 207 207,000
22 Sale (800) 207 (165,600)
Balance 200 207 41,400
31 Purchase 500 220 110,000
Total 700 216 151,400 Ending Inventory
Notes:
a. Unit cost will only change every purchase and purchase return
transaction.
b. Sales and sales return transactions will not affect the unit cost.
c. To compute for the new unit cost, divide total cost with the units available
for sale.
Cost of Goods Sold
Cost of goods sold under the moving average method can be computed by adding the cost of
sales.
Total cost
Jan. 8 Sale 100,000
22 Sale 165,600

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The argument for the weighted average method is that it is relatively easy to apply, especially with
computers. Moreover, the weighted average method produces inventory valuation that
approximates current value if there is a rapid turnover of inventory.
The argument against the weighted average method is that there may be a considerable lag
between the current cost and inventory valuation since the average unit cost involves early
purchases.
Last in, First out (LIFO)

The LIFO method assumes that “the goods last purchased are first sold” and consequently the
goods remaining in the inventory at the end of the period are those first purchased or produced.
This is not considered as inventory valuation under GAAP.
Specific identification
Specific identification means that specific costs are attributed to identified items of inventory.
PAS 2, paragraph 23, provides that this method is appropriate for inventories that are segregated
for a specific project and inventories that are not ordinarily interchangeable.
Standard costs
Standard costs are “predetermine product costs established on the basis of normal levels of
materials and supplies, labor, efficiency and capacity utilization”.
LOWER OF COST AND NET REALIZABLE VALUE

Measurement of inventory
Initially, inventory is measured at cost. Subsequently, PAS 2, paragraph 9, provides that
inventories shall be measured subsequently at the lower of cost and net realizable value
(LCNRV).
Net realizable value

Net realizable value or NRV is the estimated selling price in the ordinary course of business less
the estimated cost of completion and the estimated cost of disposal.
Cost of inventories may not be recoverable under the following circumstances:

1. The inventories are damaged.
2. The inventories have become wholly or partially obsolete.
3. The selling prices have declined.
4. The estimated cost of completion or the estimated cost of disposal has increased.
Determination of net realizable value

Inventories are usually written down to net realizable value on an item by item or individual basis.
Accounting for inventory write-down

If the cost is lower than net realizable value, there is no accounting problem because the inventory
is stated at cost and the increase in value is not recognized.
If the net realizable value is lower than cost, the inventory is measured at net realizable value.

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There are two methods of accounting for the inventory write-down, namely:
1. Direct method or cost of goods sold method
2. Allowance method or loss method
Direct method
The inventory is recorded at the lower of cost or net realizable value.
Allowance method
The inventory is recorded at the cost and any loss on inventory write-down is accounted for
separately.
PAS 2, paragraph 34, provides that “the amount of any reversal of any write-down of inventory
arising from an increase in net realizable value shall be recognized as a reduction in the amount
of inventory recognized as an expense in the period in which the reversal occurs”.
Purchase commitments
Purchase commitments are obligations of the entity to acquire certain goods sometime in the
future at a fixed price and fixed quantity.
Agricultural, forest and mineral products

PAS 2, paragraph 4, provides that inventories of agricultural, forest and mineral products are
measured at net realizable value at certain stages of production.
Commodities of broker-traders
PAS 2, paragraph 3, provides that commodities of broker-traders are measured at fair value less
cost of disposal. PFRS 13, paragraph 9, defines fair value as “the price that would be received
to sell an asset or paid to transfer a liability in an orderly transaction between market participants.”
Broker-traders those who buy and sell commodities for others.
RECAP.
Inventories are to be measured subsequently through LCNRV.
NRV > Cost = No Accounting problem.
NRV < Cost = Write-down Inventory
- recognized loss on inventory write-down

- loss on inventory write-down will be presented at COGS.
Purchase Commitment- committed to buy/sell goods at fixed price based on fixed quantity.
- same with LCNRV
Illustrative Examples:
1. The inventory of Horny Company at the end of the current year is to be recorded at the
lower of cost and net realizable value.

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Items Units Cost Estimated SP Cost of Sell

A 1,000 120 180 30
B 1,500 110 140 20
C 1,200 150 170 30
D 1,800 140 190 30
E 1,700 130 200 40
Determine the inventory value applying the LCNRV.
Solution:
2. Winter Company provided the following inventory data at the end of first year of operations:
Cost NRV
Skis 2,200,00 2,500,000
Boots 1,700,00 1,500,00
Ski Equipment 700,000 800,000
Ski Apparel 400,00 500,000
Prepare journal entries to adjust the ending inventory under

a. Direct method
b. Allowance method

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Assessment
Activity 1
1. A manufacturing concern would report the cost of units only partially processed as
inventory in the balance sheet.
2. Both merchandising and manufacturing companies normally have multiple inventory
accounts.
3. When using a perpetual inventory system, freight charges on goods purchased are
debited to Freight-In.
4. If a supplier ships goods f.o.b. destination, title passes to the buyer when the supplier
delivers the goods to the common carrier.
5. If ending inventory is understated, then net income is understated.
6. If both purchases and ending inventory are overstated by the same amount, net income
is not affected.
7. Freight charges on goods purchased are considered a period cost and therefore are not
part of the cost of the inventory.
8. Purchase Discounts Lost is a financial expense and is reported in the “other expenses
and losses” section of the income statement.
9. The cost flow assumption adopted must be consistent with the physical movement of the
goods.
10. In all cases when FIFO is used, the cost of goods sold would be the same whether a
perpetual or periodic system is used.
11. The change in the LIFO Reserve from one period to the next is recorded as an adjustment
to Cost of Goods Sold.
12. Many companies use LIFO for both tax and internal reporting purposes.
13. LIFO liquidation often distorts net income, but usually leads to substantial tax savings.
14. LIFO liquidations can occur frequently when using a specific-goods approach.
15. Dollar-value LIFO techniques help protect LIFO layers from erosion.
16. The dollar-value LIFO method measures any increases and decreases in a pool in terms
of total dollar value and physical quantity of the goods.
17. A disadvantage of LIFO is that it does not match more recent costs against current
revenues as well as FIFO.
18. The LIFO conformity rule requires that if a company uses LIFO for tax purposes, it must
also use LIFO for financial accounting purposes.
19. Use of LIFO provides a tax benefit in an industry where unit costs tend to decrease as
production increases.
20. LIFO is inappropriate where unit costs tend to decrease as production increases.

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21. A company should abandon the historical cost principle when the future utility of the
inventory item falls below its original cost.
22. The lower-of-cost-or-market method is used for inventory despite being less conservative
than valuing inventory at market value.
23. The purpose of the “floor” in lower-of-cost-or-market considerations is to avoid overstating
inventory.
24. Application of the lower-of-cost-or-market rule results in inconsistency because a
company may value inventory at cost in one year and at market in the next year.
25. GAAP requires reporting inventory at net realizable value, even if above cost, whenever
there is a controlled market with a quoted price applicable to all quantities.
26. A reason for valuing inventory at net realizable value is that sometimes it is too difficult to
obtain the cost figures.
27. In a basket purchase, the cost of the individual assets acquired is determined on the basis
of their relative sales value.
28. A basket purchase occurs when a company agrees to buy inventory weeks or months in
advance.
29. Most purchase commitments must be recorded as a liability.
30. If the contract price on a noncancelable purchase commitment exceeds the market price,
the buyer should record any expected losses on the commitment in the period in which
the market decline takes place.
31. When a buyer enters into a formal, noncancelable purchase contract, an asset and a
liability are recorded at the inception of the contract.
32. The gross profit method can be used to approximate the dollar amount of inventory on
hand.
33. In most situations, the gross profit percentage is stated as a percentage of cost.
34. A disadvantage of the gross profit method is that it uses past percentages in determining
the markup.
35. When the conventional retail method includes both net markups and net markdowns in
the cost-to-retail ratio, it approximates a lower-of-cost-or-market valuation.
36. In the retail inventory method, the term markup means a markup on the original cost of an
inventory item.
37. In the retail inventory method, abnormal shortages are deducted from both the cost and
retail amounts and reported as a loss.
38. The inventory turnover ratio is computed by dividing the cost of goods sold by the ending
inventory on hand.
39. The average days to sell inventory represents the average number of days’ sales for which
a company has inventory on hand.
40. The LIFO retail method assumes that markups and markdowns apply only to the goods
purchased during the period.
Activity 2
1. According to PAS 2, the primary issue in accounting for inventories is the determination of
I. cost to be recognized as asset in the statement of financial position.
II. the amount recognized as expense in the statement of profit or loss and other comprehensive
income when the related revenues are recognized.

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III. obsolete items that need to be written down to net realizable value.
IV. the point of sale where ownership is transferred from the seller to the buyer
a. I and II b. I, II, III c. I, II, IV d. I, II, III, IV
2. In which of the following shall PAS 2 Inventories be applied?
a. Buildings constructed and to be sold to third parties in the ordinary course of business under
specifically negotiated construction contracts.
b. Shares of stocks held for trading
c. Animals and plants that are managed and to be sold in the ordinary course of business
d. Inventory of a service provider consisting only of direct labor and overhead
3. PAS 2 Inventories shall not be applied to which of the following?
a. minor tools and spare parts
b. buildings being sold by a “buy and sell” real estate entity
c. obsolete inventory
d. assets held for use in the production or supply of goods or services
4. The measurement provisions of PAS 2 Inventories do not apply to which of the following?
I. Inventories of producers of agricultural, forest, and mineral products to the extent that they
are measured at net realizable value in accordance with well-established practices in those
industries.
II. Inventories of commodity broker-traders measured at fair value less costs to sell.
III. Inventories of a retail store.
IV. Inventories of a service concessionaire.
a. I, II b. I, II, III c. III, IV d. I, II, III, IV
5. PAS 2 Inventories may not be applied to which of the following?
a. inventories consisting of agricultural, mineral and forest products
b. minor spare parts, tools and lubricants
c. commodities of broker traders measured at fair value less costs to sell
d. unfinished products undergoing processing
6. Inventories of commodity broker-traders are measured at
a. fair value c. net realizable value
b. cost d. fair value less costs to sell
7. Which of the following is correct regarding the recognition of inventories?
a. Inventories are recognized only when legal title is obtained
b. Inventories are recognized only when they meet the definition of inventory and they qualify
for recognition as assets.
c. Inventories include only those that are readily available for sale in the ordinary course of
business.
d. Inventories are recognized only by entities engaged in trading or manufacturing operations.
8. Inventories are assets (choose the incorrect one)
a. Held for sale in the ordinary course of business.
b. In the process of production for sale.
c. In the form of materials or supplies to be consumed in the production process or in the
rendering of services.
d. Held for use in the production or supply of goods or services.
9. Ownership over inventories is normally transferred to the buyer
a. when legal title to the inventories is transferred
b. when the purchase price is fully paid

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c. upon shipment of the goods by the seller to the buyer

d. upon filling-up the sales order
10. Which of the following is incorrect regarding the accounting for inventories?
a. Legal title over inventories normally passes when possession over of the goods is transferred.
b. Transfer of ownership over inventories may precede, coincide with, or follow the transfer of
physical possession of the goods.
c. Ownership over inventories may be transferred to the buyer even when legal title to the goods
is retained by the seller.
d. Transfer of ownership over inventories may coincide with or follow but never precedes the
transfer of physical possession of the goods.
11. When accounting for inventories,
a. the form of the sales contract is more important than its substance
b. the agreement between the seller and the buyer shall be considered in determining the timing
of transfer of ownership over the goods
c. the sales contract is ignored since ownership over inventories are transferred only upon
receipt of delivery by the buyer
d. a journal entry is made only upon receipt of the delivery by the purchaser
12. Ownership over inventories is normally transferred from the seller to the buyer
I. When the significant risks and rewards of ownership are transferred to the buyer
II. The seller retains continuing managerial involvement to the degree usually associated with
neither ownership nor effective control over the goods sold
III. The seller retains neither continuing managerial involvement to the degree usually associated
with ownership nor effective control over the goods sold
13. In accounting for inventories, which of the following statements is incorrect?
a. In daily transactions, strict adherence to the passing of legal title is not practicable.
b. Regardless of location, an entity shall report in its financial statements all inventories over
which it holds legal title to or has gained control of the related economic benefits.
c. On inventory cut-off, an entity shall include in its inventory only those goods which are on
hand.
d. Goods that are in transit as of inventory cut-off date may be included as part of inventory.
14. Identify the incorrect statement regarding goods in transit.
a. Depending on the terms of sales contract, goods in transit may form part of the inventories
of the buyer or the seller or, in rare cases, both the buyer and the seller.
b. Accounting procedures for goods in transit are normally performed only on inventory cut-off.
c. Goods in transit form part of the inventory of the entity who holds legal title to the goods.
d. Accounting for goods in transit are normally performed by trading or manufacturing entities
but not by service oriented entities.
15. Who owns the goods in transit under FOB shipping point?
a. buyer b. seller c. either a or b d. none
16. Who owns the goods in transit under FOB destination?
17. Under this shipping cost agreement, freight is not yet paid upon shipment. The carrier collects
shipping costs from the buyer upon delivery.
a. freight collect c. FOB shipping point
b. freight prepaid d. FOB destination

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18. Under this shipping cost agreement, freight is paid in advance by the seller before shipment.
19. Under this shipping cost agreement, the buyer initially pays the freight of the goods delivered.
20. Under this agreement, the seller should pay for the freight of goods delivered.
21. Under a freight collect shipping cost agreement, who is supposed to pay for the freight?
22. Who should properly shoulder the freight of the goods shipped?
a. the entity who owns the goods c. the seller
b. the buyer d. the shipper
23. If the term of a sale or purchase transaction is FOB Shipping Point, ownership is transferred
a. upon shipment of the goods
b. after production is finished
c. when the buyer receives the goods
d. either a or c
24. If the term of a purchase transaction is FOB Shipping Point, liability is recognized
a. upon shipment of the goods
c. upon receipt of buyer of the goods shipped
d. either a or c
25. If the terms of a purchase or sale transaction is FOB Destination, ownership is transferred
a. upon the shipment of goods
c. when the buyer receives the goods
d. either a or c
26. If the term of a purchase transaction is FOB Destination, liability is recognized
a. upon the shipment of goods
c. upon receipt of buyer of the goods shipped
d. either a or c
27. If the term of a purchase transaction is FOB Shipping Point, Freight collect, the party who
finally shoulders the freight is the
a. buyer b. seller c. shipping company d. LBC
28. If the term of a purchase transaction is FOB Destination, Freight collect, the party who finally
shoulders the freight is the
a. buyer b. seller c. Air21 d. accountant
29. If the term of a purchase transaction is FOB Shipping Point, Freight prepaid, the party who
finally shoulders the freight is the
a. buyer b. seller c. FedEx d. auditor
30. If the term of a purchase transaction is FOB Shipping Point, Freight prepaid, the party who
initially shouldered the freight is the
a. buyer b. seller c. shipping company d. JRS

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31. The entry to record the P10,000 freight paid by the buyer on a purchase transaction with
terms of FOB Shipping Point, Freight Collect is
Cash 10,000 Accounts receivable 10,000
b. Freight-out 10,000 d. Freight-in 10,000
Accounts receivable 10,000 Accounts payable 10,000
32. The entry to record the settlement of P10,000 freight on a purchase transaction with terms of
FOB Shipping Point, Freight Prepaid is
a. Accounts payable 10,000 c. Freight-in 10,000
b. Freight-in 10,000 d. Answer not given
Accounts payable 10,000
33. The entry to record the P10,000 freight paid by the buyer on a purchase transaction with
terms of FOB Destination, Freight Collect is
b. Freight-out 10,000 d. Accounts payable 10,000
Cash 10,000 Cash 10,000
34. The entry to record the settlement of P10,000 freight on a purchase transaction with terms of
FOB Destination, Freight Prepaid is
b. Freight-out 10,000 d. None
35. The entry to record the payment of P10,000 freight on a purchase transaction with terms of
FOB Destination, Freight Collect is
Cash 10,000 Accounts payable 10,000
b. Freight-out 10,000 d. Answer not given
36. On January 1, an entity ordered goods under a purchase transaction with terms of FOB
Destination, Freight Collect. The goods were received on January 3 and freight of P10,000 was
paid to the shipper. What is the entry on January 5, when the entity settles the purchase?
a. Freight-in 10,000 c. Accounts payable 90,000
Accounts payable 100,000 Cash 90,000
Cash 110,000
b. Accounts payable 100,000 d. Freight-out 10,000
37. The entry to record the settlement of a purchase on account amounting to P100,000 and
freight of P10,000 on a purchase transaction with terms of FOB Destination, Freight Prepaid is
Cash 110,000

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b. Accounts payable 100,000 d. Freight-out 10,000

38. The entry to record the settlement of a purchase on account amounting to P100,000 and
freight of P10,000 on a purchase transaction with terms of FOB Shipping Point, Freight Prepaid
is
Cash 110,000 d. Freight-out 10,000
b. Accounts payable 110,000 Accounts receivable 10,000
Cash 110,000
39. On January 1, an entity ordered goods under a purchase transaction with terms of FOB
Shipping point, Freight Collect. The goods were received on January 3 and freight of P10,000
was paid to the shipper. What is the entry on January 5, when the entity settles the purchase?
Cash 100,000 d. Accounts payable 90,000
b. Accounts payable 110,000 Cash 90,000
Cash 110,000
40. When the buyer pays the freight on a sales transaction with terms of FOB Destination, Freight
Collect, the entry to record the payment for the freight is
a. Freight-out xx c. Accounts receivable xx
Cash xx Cash xx
b. Freight-in xx d. Accounts payable xx
Cash xx Cash xx
41. When the buyer settles the freight on a sales transaction with terms of FOB Destination,
Freight Prepaid, the entry to record the payment for the freight is
a. Freight-out xx c. Accounts payable xx
Cash xx Cash xx
b. Freight-in xx d. None of the choices
Cash xx
42. No special accounting treatment is necessary if the terms of purchase is

a. FOB Destination, Freight Collect
b. FOB Shipping point, Freight Prepaid
c. FOB Destination, Freight Unpaid
d. FOB Shipping point, Freight Collect
43. Which statement is true?

a. Until goods are sold by the consignee, the consignor includes the goods in his/her inventory
at cost, less handling and shipping costs incurred in the delivery and consignee.
b. When goods are sold on an installment plan, the seller retains title and continues to include
them on his/her balance sheet until full payment has been received.

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c. Title to goods cannot be transferred to the buyer before shipment occurs.

d. In accounting for inventory, economic substance should take precedence over legal form
44. Which of the following is incorrect regarding the accounting for consigned goods?
a. Consigned goods are properly included in the inventory of the consignor and not the
consignee.
b. Freight incurred by the consignor in delivering the consigned goods to the consignee forms
part of the cost of inventories
c. The consignee records consigned goods received from the consignor through journal entries.
d. The consignor should not recognize revenue until the consigned goods are sold by the
consignee to third parties.
45. Costs of delivering consigned goods to the consignee should be

a. expensed immediately
b. capitalized and included in the inventory of the consignee
c. capitalized and included in the inventory of the consignor
d. recorded be the consignor through memo entry
46. All of the following may properly be included in inventory, except

a. goods sold by an entity under a sale with repurchase agreement
b. goods pledged by an entity as security for a loan obtained
c. goods borrowed by an entity to be replaced with similar goods in the future
d. goods transferred by an entity to another entity to be replaced with similar goods in the future
47. Which of the following may properly be included in inventory?

a. goods sold by an entity under a sale with right of return and future returns can be reliably
estimated
b. goods sold by an entity on installment basis and possession over the goods is transferred to
the buyer but legal title is retained by the entity to protect collectibility of the amount due
c. goods sold by an entity under a sale that qualifies as “bill and hold” sale
d. goods sold by an entity under a sale that qualifies as “lay away sale” and amount due from
the buyer is not yet collected in full
48. It is a type of sale in which the buyer takes title and accepts billing but delivery of the goods
is delayed at the buyer’s request.
a. buy and hold sale c. cash and carry
b. lay away sale d. bill and hold
49. It is a type of sale in which goods are delivered only when the buyer makes the final payment
in a series of installments.
a. installment sale c. cash on delivery
b. lay away sale d. run away sale
50. The goods sold on a “bill and hold” sale is included in the inventory of the
a. buyer b. seller c. either a or b d. both a and b

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51. Prior to delivery, the goods sold on a “lay away” sale is included in the inventory of the
a. buyer b. seller c. either a or b d. both a and b
52. The goods sold under a bill and hold sale are excluded from the seller’s inventory and
included in the buyer’s inventory at the time of sale when title passes to the buyer and he accepts
billing, provided which of the following is met
a. Delivery is probable
b. Goods sold are on hand, identified, and ready for delivery to the buyer at the time of sale
c. The buyer specifically acknowledges the deferred delivery instructions
d. The usual payment terms apply
e. All of the choices
53. The goods sold under a lay away sale is included in the seller’s inventory until delivery is
made to the buyer except when
a. the term of the sale is freight prepaid
b. the title to the goods is retained by the seller solely to protect collectibility of the amount due
c. the purchase price is substantially paid
d. the goods are lost without the fault of the seller

54. The line-item “inventories” presented on the face of the statement of financial position of a
manufacturing entity is composed of all of the following, except
a. raw materials and manufacturing supplies c. finished goods
b. work-in-process d. office supplies
55. Inventories are classified on the statement of financial position as

a. current assets c. financial instruments
b. noncurrent assets d. intangible assets
56. Which of the following is not included as inventory?

a. raw materials and components c. work in-process
b. goods in-transit sold FOB destination d. long-term major spare parts
57. In a manufacturing company, inventory that is ready for sale is called

a. raw materials c. finished goods
b. work in process d. store supplies
58. The major objective of inventory accounting is

a. valuation of assets in the statement of financial position
b. proper matching of costs with related revenues
c. proper selection of appropriate cost flow formula
d. proper determination of periodic income and valuation of assets
59. Mr. Eugene Krab’s “buy and sell” business involves a large quantity of low-valued inventory.
Because of the fast turnover of inventory, it is often impracticable to perform periodic physical

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count of inventory. In fact, the cost of inventory is often approximated in Krab’s quarterly reports.
Which of the following inventory systems is most suitable for Krab’s business?
a. perpetual system c. plankton system
b. periodic system d. a or b
60. Spongebob Squarepants Co. utilizes an automated accounting system in which Spongebob
inputs the serial number of each item of inventory in the system. This enables Spongebob to track
the movement of each inventory. Which inventory system is most likely to be used by Spongebob?
a. perpetual system d. spatula system
b. periodic system e. a or b
c. patty system
61. The “inventory” account is updated for each purchase and sale of inventory under this type
of accounting system
a. respiratory system c. perpetual system
b. automatic system d. periodic system
62. Cost of goods sold is a residual amount under this system.

a. skeletal system c. perpetual system
b. endocrine system d. periodic system
63. Patrick Star uses the perpetual inventory system. During the period, Patrick Star returned
goods previously purchased for P300,000 to the seller. Ten percent of the goods returned were
purchased on cash basis. Which entry is most likely to have been made to record the transaction?
a. Accounts payable 270,000 c. Accounts payable 300,000
Purchases 270,000 Purchase return 300,000
b. Accounts payable 270,000 d. Accounts payable 270,000
Inventory 300,000 Purchase returns 300,000
64. In a perpetual inventory system, an inventory flow assumption is used primarily for
determining which cost to use in:
a. recording purchases of inventory
b. recording the cost of goods sold
c. recording sales revenue
d. forecasts of future operating results
65. Which of the following statements is incorrect regarding inventory systems?

a. An entity needs to have a ledger book in order to use the perpetual system.
b. Cost of goods sold is determined only periodically under the periodic system, whereas, cost
of goods sold can be determined at any given time under the perpetual system.
c. Physical count is performed basically as an internal control procedure under perpetual
system, whereas, physical count must be performed under periodic system in order to properly
compute for the profit or loss during the period.
d. Internal control is enhanced under periodic system.

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66. Prior to physical count, the balance of the inventory account of an entity using the periodic
system is
a. equal to the beginning balance of inventory plus net purchases less cost of goods sold
b. equal to the net purchases less cost of goods sold minus increase in inventory during the
period
c. equal to the beginning balance of inventory plus cost of goods sold less net purchases
d. equal to the beginning balance of inventory
67. Prior to physical count, cost of goods sold under the periodic system is equal to
a. net purchases plus increase in inventory during the period
b. net purchases minus increase in inventory during the period
c. net purchases plus decrease in inventory during the period
d. zero
68. The following account is affected when recording a return of inventory to the vendor under a
perpetual inventory system:
a. merchandise inventory c. accounts receivable
b. cash d. purchase returns and allowances
69. A perpetual inventory system would most likely be used by a(n)

a. automobile dealership c. drugstore
b. hardware store d. convenience store
70. Funk Co. is selecting its inventory system in preparation for its first year of operations. Funk
intends to use either the periodic weighted-average method or the perpetual moving-average
method, and to apply the lower of cost or market rule either to individual items or to the total
inventory. Inventory prices are expected to generally increase throughout 20x3, although a few
individual prices will decrease. What inventory system should Funk select if it wants to maximize
the inventory carrying amount at December 31, 20x3?
(Item #1) Inventory method; (Item #2) Cost or market application
a. Perpetual, Total inventory c. Periodic, Total inventory
b. Perpetual, Individual item d. Periodic, Individual item
71. If a company incorrectly includes consignment items in the ending inventory, the net effects
on the cost of goods sold and profit for the period, respectively, are
a. Overstatement, Understatment
b. Understatement, Overstatement
c. Overstatement, overstatement
d. The next period’s account will be correct
72. When the opening balance of inventory or net purchases during the period is overstated,
profit for the period is
a. understated b. overstated c. either a or b d. no effect
73. Cost of goods sold is understated if

a. beginning inventory is overstated c. ending inventory is understated

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b. net purchases is overstated d. ending inventory is overstated
74. If ending inventory is understated, (choose the incorrect statement)

a. cost of goods sold is overstated c. net purchases is unaffected
b. profit for the year is understated d. profit for the year is overstated
75. If purchase returns is understated,

a. profit for the period is understated c. ending inventory is overstated
b. cost of goods sold is understated d. profit for the period is overstated
76. Under the periodic system, which of the following statements is correct?
a. If purchase returns is understated, ending inventory is unaffected
b. If purchase returns is understated, cost of goods sold is understated
c. If purchase returns is understated, beginning inventory is understated
d. If purchase returns is understated, net purchases is unaffected
77. At each reporting period, inventories are measured at

a. cost c. cost plus direct acquisition costs
b. lower of cost or NRV d. fair value less cost to sell
78. The cost of inventories includes

I. Cost of purchase
II. Costs of conversion
III. Other costs necessary in bringing the inventory in its intended condition and location
a. I b. II c. I, II d. I, II, III
79. The purchase cost of inventories includes all of the following, except
a. purchase price
b. import duties and non-refundable taxes
c. freight cost incurred in bringing the inventory to its intended location
d. Value added taxes paid by a VAT registered payer
80. Which of the following costs is included as part of cost of inventories?

a. Abnormal amounts of wasted materials, labor or other production costs
b. Storage costs
c. Administrative overheads
d. Selling costs
e. None of the choices
81. When determining the unit cost of an inventory item, which of the following should be
included?
a. interest on loans obtained to purchase the item
b. advertising costs incurred to promote sale
c. freight cost on the item purchased
d. storage costs incurred prior to sale

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82. Which of the following is least likely to be included in determining the cost inventory?
a. Interest cost for amounts borrowed to finance the purchase of inventory
b. Purchasing costs
c. Receiving and unpacking costs
d. Freight costs
83. Which of the following costs of conversion cannot be included in cost of inventory?
a. Cost of direct labor.
b. Factory rent and utilities.
c. Salaries of sales staff (sales department shares the building with factory supervisor).
d. Factory overheads based on normal capacity.
84. The cost of inventory should not include

I. Purchase price.
II. Import duties and other taxes.
III. Abnormal amounts of wasted materials.
IV. Administrative overhead.
V. Fixed and variable production overhead.
VI. Selling costs.
a. II, III, IV, V b. III, IV, VI c. I, II d. II, III, IV, V, VI
85. Reporting inventory at the lower of cost or NRV is a departure from the accounting principle
of
a. Historical cost c. Conservatism
b. Consistency d. Full disclosure
86. When using the periodic inventory method, which of the following generally would not be
separately accounted for in the computation of cost of goods sold?
a. Trade discounts applicable to purchases during the period
b. Cash discounts taken during the period
c. Purchase returns and allowances of merchandise during the period
d. Cost of transportation-in (freight-in) for merchandise purchased during the period
Accounting for discounts

87. Accounts such as Purchase Returns, Sales Returns, Purchase Discounts, Freight-in and
Allowance for Purchase Discounts are used in
a. Perpetual Method and Gross Method
b. Perpetual Method and Net Method
c. Periodic Method and Net Method
d. Periodic Method and Gross Method
88. The use of Allowance for Purchase Discounts account is based on which accounting concept
a. matching c. net method
b. gross method d. periodic method
89. The Purchase Discounts Lost account is used under

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a. gross method c. perpetual system

b. net method d. periodic system
90. The Purchase Discounts account is used under

a. gross method c. perpetual system
b. net method d. periodic system
91. Theoretically, the net method should be used in recording purchases. Cash discounts not
availed of is preferably presented in the statement of profit or loss and other comprehensive
income as
a. cost of goods sold c. other expense
b. finance cost d. b or c
92. Theoretically, the net method should be used in recording purchases. Trade discounts taken
is preferably presented in the statement of profit or loss and other comprehensive income as
a. cost of goods sold c. other expense
b. operating expense d. not presented
93. Generally accepted accounting principles require the selection of an inventory cost flow
method which:
a. emphasizes the valuation of inventory for balance sheet purposes
b. most closely approximates lower of cost and net realizable value for the ending inventory
c. most clearly reflects the periodic income
d. matches the physical flow of goods from inventory with sales revenue
e. yields the most conservative amount of reported income
94. All of the following correctly describe the average cost inventory cost flow method except:
a. a moving average cost is used with a perpetual inventory system only.
b. the average cost methods are based on the view that the cost of inventory on hand and the
cost of goods sold during a period should be representative of all purchase costs available for the
period
c. a weighted-average unit cost is used with a periodic inventory system only
d. a moving average cost is used with either a periodic or a perpetual inventory system
95. The specific identification method can be used only:

a. in income tax returns
b. for financial reporting purposes(but not in income tax returns)
c. when the individual items in inventory are similar in terms of cost, function, and sales revenue
d. when the actual acquisition costs of individual units can be determined from the accounting
records
96. The average method of cost flow assumption, when used in a perpetual inventory system, is
called
a. moving average c. simple average
b. weighted average d. b or c

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97. Alcoholica Co. sells a wide variety of beverages. Because of the way Alcoholica stores its
inventory, the most recently purchased cases are usually the ones being sold first. Given these
circumstances, what flow assumption must Alcoholica use?
a. Specific identification c. Average cost
b. FIFO d. Any assumption it wishes
98. Which of the following methods of measuring the cost of goods sold most closely parallels
the actual physical flow of the merchandise?
a. LIFO b. FIFO c. Average cost d. Specific Identification
99. Cost of goods sold and ending inventory is the same under a periodic system as under a
perpetual system when the entity uses
a. FIFO b. LIFO c. Weighted average d. Specific identification
100. Which inventory costing method would not be appropriate for a manufacturer using a
perpetual inventory system?
a. FIFO
b. specific identification
c. simple weighted average
d. combination of FIFO and specific identification
101. When the FIFO method is used, ending inventory units are priced at the
a. most recent price c. earliest price
b. the average price d. none of choices
102. Which inventory cost flow formula is not permitted under PAS 2 Inventories?
a. Average cost b. LIFO c. FIFO d. All are permitted
103. The inventory cost flow assumption where the cost of the most recent purchase is matched
first against sales revenues is
a. FIFO b. Average c. Specific identification d. none
104. In a period of falling prices, the inventory method that gives the lowest possible value for
ending inventory is:
a. gross profit b. FIFO c. LIFO d. weighted average
105. A corporation entered into a purchase commitment to buy inventory. At the end of the
accounting period, the current market value of the inventory was less than the fixed purchase
price, by a material amount. Which of the following accounting treatments is most appropriate?
a. Describe the nature of the contract in a note to the financial statements, recognize a loss in
the income statement, and recognize a liability for the accrued loss
b. Describe the nature of the contract and the estimated amount of the loss in a note to the
financial statements, but do not recognize a loss in the income statement
c. Describe the nature of the contract in a note to the financial statements, recognize a loss in
the income statement, and recognize a reduction in inventory equal to the amount of the loss by
use of a valuation account

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d. Neither describes the purchase obligation nor recognize a loss on the income statement or
balance sheet
Lower of cost or net realizable value

106. Which of the following is not an acceptable basis for valuation of certain inventories in
published financial statements?
a. Historical cost
b. Current replacement cost
c. Prime cost
d. Current selling price less cost of disposal
107. The original cost of an inventory item is above the replacement cost and the net realizable
value. The replacement cost is below the net realizable value less the normal profit margin. As a
result, under the lower of cost or market method, the inventory item should be reported at the
a. Net realizable value
b. Net realizable value less normal profit margin
c. Replacement cost
d. Original cost
108. Under current standards, inventories of a trading entity should be measured at

a. Fair Value less cost to sell
b. the lower of Cost or Market, with ceiling on replacement cost
c. the lower of Cost or estimated selling price less and cost to sell
d. the lower of Cost or estimated selling price less cost of completion and cost to sell
109. Which statement is correct concerning the valuation of inventory at lower of cost or NRV?
I. Inventories are usually written down to net realizable value on an item by item basis.
II. It is not appropriate to write down inventories based on a classification of inventory, for
example, finished goods or all inventories in a particular industry or geographical segment.
a. I only b. II only c. Both I and II d. Neither I nor II
110. The costing of inventory must be deferred until the end of the accounting period under
which of the following method of inventory valuation?
a. Moving average c. LIFO perpetual
b. Weighted average d. FIFO
111. Which inventory costing method would a company that wishes to maximize profits in a
period of rising prices use?
a. FIFO c. Weighted average
b. Peso-value LIFO d. Moving average
112. Which of the following is/are true under PAS 2?

I. Inventories can only be "written down" but not "written up."
II. Inventories may be “written up” above their cost if it is clear that their values have increased
subsequent to previous write-down.

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III. Storage costs is included in the cost of inventory only when storage cost is necessary in
bringing the inventory to its intended condition and location.
a. II only b. I, II & III c. III only d. I & III
113. Which of the following are considered in determining the cost of an item of inventory?
I. Material wasted due to a machine breakdown
II. Import duties on shipping of inventory inwards
III. Storage costs of finished goods
IV. Trade discounts received on purchase of inventory
a. I, II b. III, IV c. II, IV d. I, II, III, IV
114. According to PAS 2 Inventories, which of the following costs should be included in
inventory valuations?
I. Transport costs for raw materials
II. Abnormal material usage
III. Storage costs relating to finished goods
IV. Fixed production overheads
a. I, II b. III, IV c. II, III d. I, IV
115. How should import duties be dealt with when valuing inventories at the lower of cost and
net realizable value (NRV) according to PAS 2 Inventories?
a. added to cost c. deducted in arriving at NRV
b. ignored d. deducted from cost
116. How should prompt payment discount not taken be dealt with when valuing inventories at
the lower of cost and net realizable value (NRV) using the gross method?
117. How should sales staff commission be dealt with when valuing inventories at the lower of
cost and net realizable value (NRV), according to PAS 2 Inventories?
118. How should trade discounts be dealt with when valuing inventories at the lower of cost
and net realizable value (NRV) according to PAS 2 Inventories?
119. Are the following statements true or false, according to PAS 2 Inventories?
I. Cost of factory management should be included in the cost of inventory.
II. Maintenance expenses for an item of equipment used in the manufacturing process should
be included in the cost of inventory.
a. False, false b. False, true c. True, false d. True, true

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120. The Hetfield Company has two products in its inventory which have costs and selling
prices per unit as follows:
Product X Product Y
Selling price 200 300
Materials and conversion costs 150 180
General administration costs 30 80
Selling costs 60 70
Profit/(loss) (40) (30)
At year-end, the manufacture of items of inventory has been completed but no selling costs have
yet been incurred. According to PAS 2 Inventories, how should Product X and Product Y carried
in Hetfield's statement of financial position, respectively?
a. NRV, NRV b. NRV, Cost c. Cost, NRV d. Cost, Cost
Activity 3
Answer as required
1. SUITS Inc. incurred the following costs related to its inventories:
List price P1,000,000
Trade discount and rebates 200,000
Purchase discount 100,000
Foreign exchange differences arising from acquisition 100,000
Finance cost on inventory loan 200,000
Irrecoverable import duties 300,000
Creditable value added taxes 200,000
Freight and handling costs 400,000
After-sales warranty cost 200,000
Sales commission paid to sales agents 100,000
Salary of inventory accountant 300,000
What is the total capitalizable cost of inventories of SUITS Inc.?
2. ARROW Inc. provided the following data concerning its inventories:

Finished goods of Arrow out on consignment to its customers P1,000,000
Raw materials held on consignment by Arrow from its suppliers 2,000,000
Goods in process in Arrow’s manufacturing plant 3,000,000
Raw materials in transit from a supplier with FOB Destination 1,000,000
Finished goods in transit to a customer with FOB Shipping point 3,000,000
Finished goods in retail store of Arrow 4,000,000
Finished good in shipping department of Arrow 2,000,000
Raw materials in receiving department of Arrow 3,000,000
Finished goods out to customer on approval 2,000,000
Finished goods out to customer on sale or return arrangement 1,000,000
Raw materials in transit from a supplier with FOB Shipping point 2,000,000
Finished goods in transit to a customer with FOB Destination 3,000,000
What is the total inventory to be presented in the Statement of Financial Position of ARROW Inc.?

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3. LENOVO produces laptops. The following costs are incurred by LENOVO for 2019:
Direct materials used in production P1,000,000
Salary of factory workers 2,000,000
Freight out or distribution cost 3,000,000
General administrative overhead 1,000,000
Indirect labor and indirect material laptop 2,000,000
Depreciation of machinery and equipment in factory 1,000,000
Salary of inventory accountant 2,000,000
Sales commission of sales agent 1,000,000
Utility costs in the factory 2,000,000
Abnormal waste of production 1,000,000
Storage cost of work in process and raw materials 2,000,000
Storage cost of finished goods 3,000,000
Advertising and marketing costs 1,000,000
What is the total inventoriable costs?
4. APPLE Inc. produces the following types of inventories with their corresponding relevant data:
Product Historical Cost Estimated Estimated
Estimated Estimated
Selling Price Gross Profit Cost to Complete Cost to Sell
IPOD P1,000,000 P2,000,000 P500,000 P200,000 P300,000
ITOUCH P2,000,000 P3,000,000 P1,000,000 P800,000
P400,000
IPAD P4,000,000 P5,000,000 P2,000,000 P800,000 P700,000
What is the total loss on inventory writedown to be presented as part of Cost of Sales of Apple?
5. SAMSUNG acquired A, B and C products at “basket price” of P3,000,000. The said products
have the following sales price: A – P500,000; B – P1,500,000; and C – P3,000,000.
What is the cost to be recognized on product C?
6. On January 1,2019, NOKIA entered into a purchase commitment for the acquisition of
microchips with contract purchase price of P500,000 to be delivered on April 30,2020. On
December 31,2019, the replacement cost of the microchips is P450,000 and on April 30,2020,
the replacement cost is P420,000.
What is the liability or asset to be recognized as a result of the purchase commitment on the part
of NOKIA as of December 31,2019?
7. The following data are extracted from the records of AIG Inc. relating to an inventory item.

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Units Unit Cost Total Cost

Jan. 1 Beginning balance 5,000 P200 P1,000,000
10 Purchase 5,000 P250 P1,250,000
15 Sale 7,000
16 Sale return 1,000
30 Purchase 16,000 P150 P2,400,000
31 Purchase return 2,000 P150 P 300,000
Under perpetual system-moving average method, what is the cost of goods sold for January?
8. CITI Company is a wholesaler of office supplies. The activity for inventory of calculators during
August is shown below:
Units Cost
August 1 Inventory 20,000 10.00
7 Purchase 30,000 12.00
12 Sale 10,000
21 Purchase 20,000 15.00
23 Purchase return 10,000 12.00
24 Sale 20,000
26 Sales return 5,000
29 Purchase 20,000 20.00
If CITI Company uses a Average periodic inventory system, what is the cost of goods sold for
August?
9. ESPN provided the following data concerning its inventory:

Units Cost
January1 Inventory 5,000 P5.00
5 Purchases 10,000 P6.00
6 Sales 8,000
8 Purchase 5,000 P8.00
10 Sales return 3,000
25 Purchase return 6,000 P6.00
30 Sales 5,000
31 Purchase 1,000 P10.00
If ESPN Co. uses FIFO perpetual inventory system, what is the cost of goods sold for January?
10. The following assets with their fair value less cost to sell are provided by FARMER Inc:
Carabaos P1,000,000
Plants 2,000,000
Trees 3,000,000
Horses 1,000,000
Agricultural land 2,000,000
Barn 2,000,000

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Leather shoes from Carabao 1,000,000

Harvested fruits from trees 1,000,000
Harvested vegetables 2,000,000
How much is the total biological assets to be presented on FARMER’s Statement of Financial
Position?
11. On January 1, 2019, SHEPERD Inc. purchased 100 cows which are 3-year old for P15,000
each for the purpose of producting milk for the local community. On July 1,2019, the cows gave
birth to 20 calves. The active market provided the fair value less cost to sell of the biological assets
as follows:
Newborh calf on July 1 4,000
Newborn calf on December 31 5,000
½ year old calf on December 31 7,000
3 years old cow on December 31 18,000
4 years old cow on December 31 24,000
What is the carrying value of biological assets on December 31,2019?
12. Using the same data in number 2, what is the gain due to price change for the year ended
December 31, 2019?
13. Using the same data in number 2, what is the gain due to physical change for the year ended
December 31, 2019 ?
14. The inventory on hand on December 31,2019 for FIRE company is valued at a cost of
P950,000. The following items were not included in this inventory amount:
Item 1: Purchased goods in transit, shipped FOB destination, invoice price P30,000 which
includes freight charge of P1,500.
Item 2: Goods held on consignment by Fair company at a sales price of P28,000, including sales
commission of 20% of the sales price.
Item 3: Goods sold to Grace company, under terms FOB Destination, invoiced for P18,500 which
includes P1,000 freight charge to deliver the goods. Goods are in transit. The entity’s selling price
is 140% of cost.
Item 4: Purchased goods in transit, terms FOB shipping point, invoice price P50,000, freight cost,
P2,500.
Item 5: Goods out on consignment to Manila Company, sales price P35,000 shipping cost of
P2,000. The entity’s selling price is 140% of cost.
What is the adjusted cost of the inventory on December 31,2019?
a. P1,040,000 b. P1,043,000 c. P1,042,000 d. P1,041,000
15. Zyron Company provided the following information relating to inventory for the month of
December:
Units Units Cost Unit SP

December 1, Beginning 10,000 52

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7, Purchase 30,000 50
12, Sale 20,000 90
17, Purchase 60,000 45
22, Purchase 20,000 43
28, Sale 70,000 90
Required:
Compute the December 31 inventory, cost of goods sold and gross income under:
1. FIFO
2. Weighted Average
- Periodic system
- Perpetual system

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Unit 3- Accounting for Inventories
Topic 2- Estimation of Inventory Valuation
Use of estimate in inventory valuation

In many causes, it is necessary to know the approximate value of inventory when it is
not possible to take a physical count.
The most common reasons for making an estimate of the cost of the goods on hand are:
a. The inventory is destroyed by fire and other catastrophe, of theft of the
merchandise has occurred and the amount of inventory is required for insurance
purposes.
b. A physical count of the goods on hand is made and it is necessary to prove the
correctness or reasonableness of such count by making an estimate.
This is known as the “gross profit test” in the accounting parlance.
c. Interim financial statements are prepared and a physical count of the goods an
hand is not necessary because it may take time to do the same.
Learning Outcomes
• Identify and use the techniques in analyzing problems with regards estimation of
inventory valuation.
• Identify and apply estimation of inventory valuation
Pretest
True or False. Write true if the statement is correct or false is the statement is wrong.
1. When a buyer enters into a formal, no cancelable purchase contract, an asset and a
liability are recorded at the inception of the contract. _______________
2. The gross profit method can be used to approximate the dollar amount of inventory on
hand. _______________
3. In most situations, the gross profit percentage is stated as a percentage of cost.
_______________
4. A disadvantage of the gross profit method is that it uses past percentages in determining
the markup. _______________
5. When the conventional retail method includes both net markups and net markdowns in
the cost-to-retail ratio, it approximates a lower-of-cost-or-market valuation.
_______________
6. In the retail inventory method, the term markup means a markup on the original cost of an
inventory item. _______________

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7. In the retail inventory method, abnormal shortages are deducted from both the cost and
retail amounts and reported as a loss. _______________
8. The inventory turnover ratio is computed by dividing the cost of goods sold by the ending
inventory on hand. _______________
9. The average days to sell inventory represents the average number of days’ sales for which
a company has inventory on hand. _______________
10. The LIFO retail method assumes that markups and markdowns apply only to the goods
purchased during the period. _______________
Content
GROSS PROFIT METHOD

The gross profit method is based on the assumption that the rate of gross profit remains
approximately the same from period to period and therefore the ratio of cost of goods sold to net
sales is relatively constant from period to period.
Cost of goods sold

The gross profit method is so called because the cost of goods sold is computed through the use
of the gross profit rate.
The cost of goods sold is computed as follows:

a. Net sales multiplied by cost ratio
This formula is used when the gross profit rate is based on sales.
b. Net sales divided by sales ratio

This formula is used when the gross profit rate is based on cost.
*Sales discount and Allowances are not deducted in getting NET SALES because there is no
actual inventory returned.
Karen Company reported the following information for the current year:
Beginning Inventory 5,000,000
Purchases 26,000,000
Freight in 2,000,000
Purchase returns and allowances 3,500,000
Purchase discounts 1,500,000
Sales 40,000,000
Sales returns 3,000,000
Sales allowances 500,000

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Sales discounts 1,000,000

A physical inventory taken at year-end resulted in an ending inventory costing P4,000,000. At
year-end, unsold goods out on consignment with selling price of P1,000,000 are in the hands of
consignee. The gross profit was 40% on sales.
What is the cost of goods available for sale?

What is the cost of goods sold?
What is the estimated cost of inventory shortage?
Solution:
What is the cost of goods available for sale?
What is the cost of goods sold?
What is the estimated cost of inventory shortage?
RETAIL INVENTORY METHOD

The retail inventory method is the other method of estimating the value of inventory. PAS 2,
paragraph 22, provides that this method is often used in the retail industry for measuring inventory

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of large number of rapidly changing items with similar margin for which it is impracticable to use
other costing method.
The retail inventory method came to its name because the selling price or retail price is tagged to
each item. The term “retail” simply means selling price.
Information required
The use of the retail inventory method requires that records be kept which must show the
following:
Beginning inventory at cost and at retail price
a. Purchases during the period at cost and at retail price
b. Adjustment to the original retail price such as additional markup, markup cancelation,
markdown and markdown cancelation
c. Other adjustments such as departmental transfer, breakage, shrinkage, theft, damaged
goods and employee discount
Treatment of items
1. Purchase discount – deducted from purchases at cost only
2. Purchase return – deducted from purchases at cost and at retail.
3. Purchase allowance – deducted from purchases at cost only.
4. Freight in – addition to purchases at cost only
5. Departmental transfer in or debit – addition to purchases at cost and at retail.
6. Departmental transfer out or credit – deduction from purchases at cost and retail.
7. Sales discount and sales allowance – disregarded, meaning, not deducted from sales.
8. Sales return – deducted from sales.
If the account is “sales return and allowance”, the same should be deducted from sales.
9. Employee discounts – added to sales.
Employee discount are special discounts usually not recorded because they are directly deducted
from the sales price. Only the net sales price is recorded.
10. Normal shortage, shrinkage, spoilage, breakage – this is deducted from goods available for
sale at retail.
Any normal shortage is usually absorbed or included in cost of goods sold.
11. Abnormal shortage, shrinkage, spoilage, breakage.
This is deducted from goods available for sale at both cost and retail so as not to distort the cost
ratio.
Items related to retail method

Accordingly, in the determination of the inventory at retail and for purposes of computing the cost
ratio, the ff. items should be considered:
The original sales price is frequently raised or lowered particularly at the end of the selling season
where replacement costs are changing.
1. Initial markup – original markup on the cost of goods.
2. Original retail – the sales price at which the goods are first offered for sale.
3. Additional markup – increase in sales price above the original sales price.
4. Markup cancelation – decrease in sales price that does not decrease the sales price below
the original sales price.

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5. Net additional markup or net markup – markup minus markup cancelation.

6. Markdown – decrease in sales price below the original sales price.
7. Markdown cancelation – increase in sales price that does not increase the sales price
above the original sales price.
8. Net markdown – markdown minus markdown cancelation.
9. Maintained markup – difference between cost and sales price after adjustment for all of
the above items.
10. Sometimes, maintained markup is referred to as “mark on”.
Approaches in the use of retail method

To obtained the appropriate inventory value under the retail inventory method, three approaches
are following namely
a. Conservative or conventional or lower of cost and net realizable value approach
b. Average cost approach
c. FIFO approach
Retail Method Formula:

TGAS @ Retail/Selling Price XX
Less: Net Sales XX
Employee Discounts XX
Normal Losses XX XX
Est. Ending Inventory @ Retail XX
X Cost Ratio %
Estimated Ending Inventory @ Cost XX
Cost Ratio:
TGAS @ Cost
TGAS @ Retail
*Sales discount and Allowances are not deducted in getting NET SALES because there is no
actual inventory returned.
**Conservative/Conventional Method- Include Mark-up only
***Average Method- Include both mark-up and mark down
FIFO retail approach

The FIFO retail approach is similar to the average cost approach in that it considers both net
markup and net markdown in computing the cost ratio. However, a “current” cost ratio is
determined every year considering the net purchases during the year and excluding the beginning
inventory.
The FIFO approach is based on the assumption that markup and markdown apply to goods
purchased during the year and not to beginning inventory.
Cynosure Company provided the following data:

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Cost Retail
Beginning Inventory 340,000 640,000
Purchases 4,500,000 7,300,000
Freight in 100,000
Purchase return 150,000 250,000
Purchase allowance 90,000
Departmental transfer in 100,000 160,000
Net Markup 150,000
Net Markdown 500,000
Sales 6,600,000
Sales Allowance 50,000
Employee Discount 100,000
Spoilage and breakage 200,000
What is the estimated cost of ending inventory using the conservative retail?
What is the estimated cost of ending inventory using the average cost retail?
Solution:
What is the estimated cost of ending inventory using the conservative retail?

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What is the estimated cost of ending inventory using the average cost retail?
Grotesque Company which employed the FIFO retail method provided the following inventory
data:
2019 Cost Retail
Beginning Inventory 420,000 600,000
Purchases 5,011,200 6,890,000
Net markup 160,000
Net markdown 90,000
Sales 6,839,000
2020
Purchases 4,970,000 7,110,000
Net markup 100,000
Net markdown 110,000
Sales 7,033,000
Determine the estimated cost of ending inventory in 2019 and 2020 using the FIFO retail
approach.

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Solution:
Assessment
Activity 1
Answer as Required
Problem 1
Sakura Company adopted a FIFO approach of Inventory pricing in connection with the use of
retail inventory method. The retail records showed the following
2019 Cost Retail

Beginning Purchases 556,800 928,000
Purchases 4,576,000 7,028,000
Net Markup 42,000
Net Markdown 30,000
Sales 6,840,000
2020
Purchases 4,760,000 6,812,000
Net Markup 56,000
Net Markdown 68,000

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Sales 6,928,000
Required:
a. What is the Cost ratio on 2019?

b. What is the Cost ratio on 2020?
c. Determine the estimated cost of Inventory on December 31, 2019?
d. Determine the estimated cost of Inventory on December 31, 2020?
Problem 2
Sasuke Company Provided the following data
Beginning Inventory
Cost 500,000
Selling Price 770,000
Purchases:
Cost 3,070,000
Selling Price 4,700,000
Transportation in 70,000
Purchase Discount 45,000
Purchase Return:
Cost 25,000
SP 40,000
Sales Return 80,000
Sales Discount 20,000
Markup 100,000
Markdown 350,000
Cancellation of markup 30,000
Cancelation of markdown 10,000
Sales 4,000,000
Required:
a. What is the cost ratio using LCNRV approach?

b. What is the cost ration using average cost approach?
c. What is the estimated cost of ending inventory using Conservative approach?
d. What is the estimated cost of ending inventory using average cost approach?
Problem 3
Doran Realty Company purchased a plot of ground for P800,000 and spent P2,100,000 in
developing it for building lots. The lots were classified into Highland, Midland, and Lowland
grades, to sell at P100,000, P75,000, and P50,000 each, respectively.
Instructions
Complete the table below to allocate the cost of the lots using a relative sales value method.
No. of Selling Total % of Apportioned Cost
Grade Lots Price Revenue Total Sales Total Per Lot
Highland 20 P P P P
Midland 40 P P

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Lowland 100 P P
160 P P
Problem 3
An inventory taken the morning after a large theft discloses P60,000 of goods on hand as of March
12. The following additional data is available from the books:
Inventory on hand, March 1 P 84,000

Purchases received, March 1 – 11 63,000
Sales (goods delivered to customers) 120,000
Past records indicate that sales are made at 50% above cost.
Instructions
Estimate the inventory of goods on hand at the close of business on March 11 by the gross profit
method and determine the amount of the theft loss. Show appropriate titles for all amounts in
your presentation.
Problem 3
On January 1, a store had inventory of P48,000. January purchases were P46,000 and January
sales were P90,000. On February 1 a fire destroyed most of the inventory. The rate of gross profit
was 25% of cost. Merchandise with a selling price of P5,000 remained undamaged after the fire.
Compute the amount of the fire loss, assuming the store had no insurance coverage. Label all
figures.
Problem 4
Utley Co. prepares monthly income statements. Inventory is counted only at year end; thus,
month-end inventories must be estimated. All sales are made on account. The rate of mark-up on
cost is 20%. The following information relates to the month of May.
Accounts receivable, May 1 P21,000

Accounts receivable, May 31 27,000
Collections of accounts during May 90,000
Inventory, May 1 45,000
Purchases during May 58,000
Instructions
Calculate the estimated cost of the inventory on May 31.
Problem 5
In the cases cited below, five different conditions are possible when X is compared with Y. These
possibilities are as follows:

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a. X equals Y d. X is equal to or greater than Y

b. X is greater than Y e. X is equal to or less than Y
c. X is less than Y
Instructions
In the space provided show the relationship of X and Y for each of the following independent
statements.
___ 1. "Cost or market, whichever is lower," may be applied to (1) the inventory as a whole
or to (2) categories of inventory items. Compare (X) the reported value of inventory
when procedure (1) is used with (Y) the reported value of inventory when procedure
(2) is used.
___ 2. Prices have been rising steadily. Physical turnover of goods has occurred
approximately 4 times in the last year. Compare (X) the ending inventory computed by
LIFO method with (Y) the same ending inventory computed by the moving average
method.
___ 3. The retail inventory method has been used by a store during its first year of operation.
Compare (X) markdown cancellations with (Y) markdowns.
___ 4. Prices have been rising steadily. At the beginning of the year a company adopted a
new inventory method; the physical quantity of the ending inventory is the same as
that of the beginning inventory. Compare (X) the reported value of inventory if LIFO
was the new method with (Y) the reported value of inventory if FIFO was the new
method.
___ 5. Prices have been rising steadily. Physical turnover of goods has occurred five times
in the last year. Compare (X) unit prices of ending inventory items at moving average
pricing with (Y) those at weighted average pricing.
Problem 6
On December 31, 2020 Felt Company's inventory burned. Sales and purchases for the year had
been P1,400,000 and P980,000, respectively. The beginning inventory (Jan. 1, 2020) was
P170,000; in the past Felt's gross profit has averaged 40% of selling price.
Instructions
Compute the estimated cost of inventory burned, and give entries as of December 31, 2020 to
close merchandise accounts.
Problem 7 (Pr. 9-150—Retail inventory method.)

When you undertook the preparation of the financial statements for Telfer Company at January
31, 2021, the following data were available:
At Cost At Retail
Inventory, February 1, 2020 P70,800 P 98,500

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Markdowns 35,000
Markups 63,000
Markdown cancellations 20,000
Markup cancellations 10,000
Purchases 219,500 294,000
Sales 345,000
Purchases returns and allowances 4,300 5,500
Sales returns and allowances 10,000
Instructions
Compute the ending inventory at cost as of January 31, 2021, using the retail method which
approximates lower of cost or market. Your solution should be in good form with amounts clearly
labeled.
Problem 7
The records of Lohse Stores included the following data:
Inventory, May 1, at retail, P14,500; at cost, P10,440
Purchases during May, at retail, P42,900; at cost, P31,550
Freight-in, P2,000; purchase discounts, P250
Additional markups, P3,800; markup cancellations, P400; net markdowns, P1,300
Sales during May, P46,500
Instructions
Calculate the estimated inventory at May 31 on a LIFO basis. Show your calculations in good
form and label all amounts.

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Unit 3- Accounting for Inventories
Topic 3- Biological Assets
The standard that covers biological assets is PAS 41 – Agriculture

PAS 41 shall be applied to account for the following when they relate to agricultural
activity:
a. Biological assets
b. Agricultural produce
c. Government grant related to a biological asset
Learning Outcomes
• Identify and use the techniques in analyzing problems with regards Biological
assets
• Identify and apply estimation of inventory valuation
• Apply the concept of recognition and measurement of biological assets.
• Solve problems related to biological assets
Content
Biological assets are “living animals and living plants”. Agricultural produce is the harvested
product of an entity’s biological assets.
Harvest is the detachment of produce from a biological asset or the cessation of a biological
assets life processes.
Examples of biological assets

Biological Agricultural Product
Asset Produce after Harvest
1. Sheep 1. wool 1. yarn, carpet
2. Trees in 2. felled trees 2. logs, lumber, plantation forest
3. Plant 3. harvested cane 3. sugar
4. Dairy cattle 4. milk 4. cheese
5. Pigs 5. carcass 5. sausage, cured ham
Agricultural activity or simply “agriculture”

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This is the management by an entity of the biological transformation and harvest of biological
assets for sale or for conversion into agricultural produce.
Features of agricultural activity

a. Capability to change
Living animals and plants are capable of biological transformation
b. Management of change
The agricultural activity must be “managed” to facilitate the biological transformation by enhancing
or at least stabilizing conditions necessary for the process to take place, for example, nutrient
levels, moisture, temperature, fertility and light.
c. Measurement of change
The change in quality or quantity brought about by biological transformation or harvest is
measured and monitored as a routine management function.
Biological transformation
Biological transformation comprises the process of growth, degeneration, production and
procreation that cause qualitative or quantitative changes in a biological asset.
Biological transformation results from the ff. types of outcome:
Asset changes through
a. Growth – an increase in quantity or improvement in quality of an animal or plant
b. Degeneration – a decrease in quantity or deterioration in quality of an animal and plant
c. Procreation – creation of additional living animal or plant.
Measurement
A biological asset shall be measured on initial recognition and at the end of each reporting period
at fair value less cost of disposal.
Agricultural produce shall be measured at fair value less cost of disposal at the point of harvest.
Cost of disposal
Cost of disposal is the incremental cost directly attributable to the disposal of an asset.
Fair value of biological asset

There is a presumption that fair value can be measured reliably for a biological asset.
Fair value of agricultural produce

In all cases, an entity shall measure agricultural produce at the point of harvest at fair value less
cost of disposal. The harvested product is recorded by debiting inventory and crediting gain from
change in fair value of agricultural produce
Definition of fair value

Under PFRS 13, fair value is defined as the price that would be received to sell an asset in an
orderly transaction between market participants at the measurement date.
PFRS 13, paragraph 72, enumerates the fair value hierarchy or best evidence of fair value as
follows:
1. Level 1 inputs are the quoted prices in an active market for identical assets

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An active market is a market in which transactions for the asset of liability take place with sufficient
regularity and volume to provide pricing information on an ongoing basis.
A principle market is the market with the greatest volume and level of activity for the asset or
liability
2. Level 2 inputs are inputs that are observable either directly or indirectly.
3. Level 3 inputs are unobservable inputs for the asset.
Unobservable inputs are usually developed by the entity using the best available information
from the entity’s own data.
Gain and loss

A gain or loss arising on initial recognition of a biological asset at fair value less costs of disposal
and any subsequent changes in fair value less costs of disposal shall be included in profit or
loss.
Agricultural land
Agricultural land is not deemed a biological asset. The principles espoused in PAS 41 for
biological assets and agricultural produce do not apply to agricultural land.
Biological assets attached to land

Biological assets are often physically attached to land, for example, trees in a plantation forest.
Government grant
An unconditional government grant related to a biological asset that has been measured at fair
value less cost of disposal shall be recognized as income when the grant becomes receivable.
Amendment for bearer plants

Prior to the IASB amendment, bearer plants are considered biological assets included within the
scope of IAS 41 and measured at fair value less cost of disposal. The IASB decide that bearer
plants should now be accounted for in the same way as property, plant and equipment in IAS 16
because the operation of bearer plants is similar to that of manufacturing.
Bearer plants are used solely to grow agricultural produce over several periods.
Agricultural produce growing on bearer plants

The agricultural produced growing on bearer plants remains within the scope of IAS 41.
In other words, the agricultural produce as it grows is measured at the end of each reporting
period prior to harvest at fair value less cost of disposal.
Ones harvested, the agricultural produce is measured at fair value less cost of disposal at the
point of harvest.
Definition of bearer plant

A bearer plant is a living plant that:
a. Is used in the production or supply of agricultural produce.
b. Is expected to bear produced for more than one period.
c. Has a remote likelihood of being sold as agricultural produced, except for incidental scrap
sales.

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Not considered bearer plants

a. Tress grown to be harvested and sold long or lumber are not bearer plants.
b. Annual crops which do not bear produce for more than one period and are held solely to
be harvested as agricultural produced such as corn and rice are not bearer plants.
Plant with dual use
A plant with dual use is reported as biological asset and not as bearer plant.
A plant may have a dual use, namely:
a. The plant is cultivated for bearing agricultural produce
b. The plant itself is being sold either as a living plant or an agricultural produce.
For example, rubber trees may be cultivated to grow rubber milk as agricultural produce and at
the same time, may be sold as living plant or cut down at the end of the productive life to be sold
as lumber or wood.
Separating bearer plant from agricultural produce

Before amendment, the bearer plant and the agricultural produce are considered to be one single
biological asset account presented as either current or noncurrent based on the asset’s useful
life. After amendment, the bearer plant and the agricultural produce are now reported as two
separate assets with different measurement model.
Measurement – immature bearer plants

Immature bearer plants similar to an item of property, plant and equipment being constructed
before the intended use. The IASB decide that bearer plants before maturity are measured at
accumulated cost in the same manner as self-constructed item of property, plant and equipment.
Measurement – mature bearer plants

There is no specific guidance on when a bearer plant reaches maturity
For example, a grape vine may take many years to produce the right quantity and quality of fruit
for a good wine.
Measurement of agricultural produce

a. Agricultural produce as it grows
Agricultural produce growing on bearer plant is measured at fair value cost of disposal
with changes recognized in profit or less as the produce grows.
In other words, agricultural produce is measured at the end of each reporting period prior to
harvest at fair value less cost of disposal.
b. Harvested produce
Harvested produce is measured at fair value less cost of disposal at the point of harvest
IAS 41 provides that the fair value of agricultural produce at the point of harvest can always be
measured reliably. The fair value less cost of disposal at the point of harvest is the deemed cost
of inventories on the date IAS 2 Inventories is applied.
Bearer animals

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However, bearer animals have been explicitly excluded from the IASB amendment and will
continue to be accounted for under IAS 41.
Assessment
Activity 1
1. Which of the following may be classified as a biological asset?
a. breast milk b. cheese curls c. mama monkey d. dead mama monkey
2. Which of the following may be classified as an agricultural produce?
a. duck b. table egg c. egg powder d. cake
3. Which of the following is not one of the common features of agricultural activities?
a. accounting change c. management of change
b. capability to change d. measurement of change
4. A biological asset is initially and subsequently measured at
a. fair value c. cost
b. fair value less costs to sell d. fair value less costs to complete
5. Which of the following is not a biological asset that is accounted for under IAS 41 Agriculture?
a. animals that are being grown to be butchered for their meat
b. animals held to produce milk
c. plants grown to produce fruit over a long period of time
d. plants grown to be harvested and sold
6. According to IAS 41, this refers to the management by an entity of the biological
transformation of biological assets for sale, into agricultural produce, or into additional
biological assets.
a. Agricultural activity c. Biological transformation
b. Agricultural management d. Biological activity
7. Agricultural activity covers a diverse range of activities. Such diverse range of activities have
common features which includes all of the following except
a. Capability to change c. Recognition of change
b. Management of change d. Measurement of change
8. It is the detachment of produce from a biological asset or the cessation of a biological asset’s
life processes.
a. Harvest b. Death c. Decease d. Cultivation
9. When there is a long aging or maturation process after harvest, the accounting for such
products should be dealt with by
a. IAS 41 b. IAS 2 c. IAS 16 d. IAS 40
10. According to IAS 41, which of the following would be classified as a product that is the result
of processing after harvest?
a. Cotton b. Wool c. Bananas d. Cheese

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11. Which of the following items would be classified as agricultural produce, according to IAS 41
Agriculture?
a. Tree b. Bush c. Butter d. Apple
12. According to IAS 41, which of the following items would be classified as biological assets?
I. Oranges
II. Chickens
III. Eggs
IV. Trees
a. I, II b. III, IV c. II, IV d. I, IV
13. Are the following statements about classification according to IAS 41 Agriculture true or false?
I. Sugar should be classified as agricultural produce.
II. Wool should be classified as agricultural produce.
a. False, False b. False, True c. True, False d. True, True
14. Which of the following is not dealt with by IAS 41?
a. The accounting for biological assets.
b. The initial measurement of agricultural produce harvested from the entity’s biological
assets.
c. The processing of agricultural produce after harvesting.
d. The accounting treatment of government grants received in respect of biological assets.
15. Which of the following is correct regarding the applicability of IAS 41?
a. IAS 41 applies to biological assets and agricultural produce at the point of harvest even if
they do not relate to agricultural activities.
b. IAS 41 applies to unconditional government grant related to biological assets measured
at cost.
c. IAS 41 applies to land on which tree recognized as biological assets are planted.
d. IAS 41 applies to living plants and animals only when such items relate to agricultural
activity.
16. IAS 41 applies to which of the following when they relate to agricultural activity
I. Biological assets
II. Agricultural produce after the point of harvest
III. Agricultural produce at the point of harvest
IV. An unconditional government grant related to a biological asset measured at its fair
value less costs to sell
V. An unconditional government grant related to a biological asset measured at cost
VI. Land related to agricultural activity
VII. Intangible assets related to agricultural activity
a. I, II, IV b. I, III, IV c. I, II, III, IV, V d. I, II, IV, VI, VII
17. According to IAS 41, this refers to the harvested product of the entity’s biological assets.
a. biological produce
b. agricultural products
c. agricultural produce
d. biological assets
18. It is a living animal or plant.
a. biological product b. biological asset c. agricultural product d. mutant assets
19. It comprises the processes of growth, degeneration, production, and procreation that cause
qualitative or quantitative changes in a biological asset.
a. agricultural activity
b. biological activity

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c. genetic mutation
d. biological transformation
20. Agricultural activity covers a diverse range of activities which includes all of the following
except
a. processing of grapes into wine by a vintner who has grown the grapes
b. raising livestock, forestry, and annual or perennial cropping
c. cultivating orchards and plantations
d. floriculture and aquaculture (including fish farming)
21. Agricultural activity may include
a. ocean fishing
b. deforestation
c. animal hunting in the forest
d. fish pond operation
22. According to IAS 41 Agriculture, which of the following criteria must be satisfied before a
biological asset can be recognized in an entity's financial statements?
I. The entity controls the asset as a result of past events
II. It is probable that economic benefits relating to the asset will flow to the entity
III. An active market for the asset exists
IV. The asset forms a homogenous biological group
a. I, II b. I, II, IV c. I, II, III d. I, II, III, IV
23. An entity had a plantation forest that is likely to be harvested and sold in 30 years. The income
should be accounted for in which of the following way?
a. No income should reported annually until first harvest and sale in 30 years
b. Income should be measured annually and reported using a fair value approach that
recognizes and measures biological growth.
c. The eventual sale proceeds should be estimated and matched to the profit and loss
account over the 30-year period.
d. The plantation forest should be valued every 5 years and the increase in value should be
shown in the statement of recognized gains and losses
24. When agricultural produce is harvested, the harvest should be accounted for by using PAS 2
Inventories, or another applicable PFRS. For the purpose of that Standard, cost at the date of
harvest is deemed to be
a. the fair value less cost to sell at point of harvest
b. the historical cost of the harvest
c. the historical cost less accumulated impairment losses
d. market value
25. A gain or loss arising on the initial recognition of a biological asset and from a change in the
fair value less costs to sell of a biological asset should be included in
a. The net profit or loss for the period
b. The statement of recognized gains and losses
c. A separate revaluation reserve
d. A capital reserve within equity
26. Land that is related to agricultural activity is valued
a. At fair value
b. In accordance with IAS 16, Property, Plant and Equipment, or IAS 40, Investment Property
c. At fair value in combination with the biological asset that is being grown on the land
d. At the resale value separate from the biological asset has been grown on the land
27. An unconditional government grant related to a biological asset that has been measured at
fair value less cost to sell should be recognized as
a. Income when the grant becomes receivable

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b. A deferred credit when the grant becomes receivable

c. Income when the grant application has been submitted
d. A deferred credit when the grant has been approved
28. Biological assets and agricultural produce are initially recognized at
a. cost c. fair value less costs to sell
b. fair value d. lower of cost or fair value less costs to sell
29. Biological assets are
a. Living animals only c. Both living animals and living plants
b. Living plants only d. Neither living animals nor living plants
30. Agricultural activity
a. is the aggregation of similar living animals or plants.
b. is the detachment of agricultural produce from a biological asset.
c. comprises the processes of growth, degeneration, production and procreation of a
biological asset.
d. is the management by an entity of the biological transformation and harvest of biological
asset or sale or for conversion into agricultural produce or additional biological asset.
31. The following provides examples of biological assets, agricultural produce and products that
are the result of processing after harvest. Which is an incorrect combination?
Biological asset Agricultural produce Product after harvest
a. Trees Felled trees Logs, lumber
b. Dairy cattle Cheese Milk
c. Pigs Carcass Sausage
d. Vines Grapes Wine
32. All of the following items are classified as biological assets, except
a. Dairy cattle b. Chickens c. Eggs d. Trees
33. All of the following are classified as agricultural produce, except
a. Sugar b. Wool c. Cotton d. Milk
34. Which of the following is classified as agricultural produce?
a. Tree b. Bush c. Butter d. Apple
35. Which of the following is classified as a product that is the result of processing after harvest?
a. Cotton b. Apple c. Bananas d. Cheese
36. Agricultural activity includes all of the following, except
a. Raising livestock c. Floriculture and aquaculture,
including fishing
b. Annual perennial cropping d. Ocean fishing
37. All of the following criteria must be satisfied before a biological asset can be recognized in an
entity's financial statements, except
a. The entity controls the asset as a result of past events.
b. It is probable that future economic benefits relating to the asset will flow to the entity.
c. An active market for the asset exists.
d. The fair value or cost of the asset can be measured reliably.
38. Biological assets are measured at
a. Cost c. Net realizable value
b. Lower of cost or net realizable value d. Fair value less cost to sell
39. Agricultural produce is harvested product of an entity’s biological asset and measured at
a. Fair value c. Net realizable value
b. Fair value less cost to sell at the point of harvest d. Net realizable value less normal
profit margin

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40. Costs to sell include all of the following, except

a. Commissions to brokers and dealers c. Transfer taxes and duties
b. Levies by regulatory agencies d. Transport costs
41. Where the fair value of the biological asset cannot be determined reliably, the biological asset
shall be measured at
a. Cost
b. Cost less accumulated depreciation
c. Cost less accumulated depreciation and accumulated impairment losses
d. Net realizable value
42. Which of the following statements in relation to agricultural produce is true?
I. In all cases, an entity shall measure agricultural produce at the point of harvest at fair
value less cost to sell.
II. The prevailing view is that the fair value of agricultural produce at the point of harvest can
always be measured reliably.
a. I only b. II only c. Both I and II d. Neither I nor II
43. A gain or loss arising on the initial recognition of biological asset and from a change in fair
value less cost to sell of a biological asset shall be included in
a. the profit or loss for the period c. a separate revaluation reserve
b. other comprehensive income d. a general reserve
44. When agricultural produce is harvested, the harvest should be accounted for as “inventory”.
For this purpose, the cost at the date of harvest is deemed to be the
a. Fair value less cost to sell at the point of harvest c. Historical cost less impairment
b. Historical cost of the harvest d. Market value
45. Land that is related to agricultural activity is measured
a. At fair value
b. At fair value in combination with the biological asset that is being grown on the land
c. At the resale value separate from the biological asset that is being grown on the land
d. In accordance with IAS 16 Property, plant and equipment or IAS 40 Investment property
Activity 2
Answer as required.
1. Aliyah Company has reclassified certain assets as biological assets. The total value of the
forest assets is P6,000,000 which comprises:
Freestanding trees 5,100,000
Land under trees 600,000
Roads in forest 300,000
In the statement of financial position, what total amount of the forest assets should be
classified as biological assets?
2. Andele Company provided the following data:

Value of biological asset at acquisition cost on December 31, 2019 6,000,000
Fair valuation surplus on initial recognition at fair value on December 31, 2019 500,000
Change in fair value on December 31, 2020 due to growth and price fluctuation 900,000
Decrease in fair value due to harvest 100,000
What is the net gain from the change in fair value of biological asset that should be reported
in 2020?
3. Anelia Dairy produces milk for local ice cream producers. The entity began operations on

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January 1, 2020 by purchasing milking cows for P2,000,000. The entity controller had the
following information available at year-end relating to the milking cows:
Carrying amount - January 1 2,000,000
Change in fair value due to growth and price changes 400,000
Decrease in fair value due to harvest 50,000
Milk harvested during the year but not yet sold 150,000
What amount of gain on biological asset should be reported in 2020?
What amount of gain on agricultural produce should be recognized in 2020?
4. Ambrosha Company is a producer of coffee. On December 31, 2019, the entity has harvested
coffee beans costing P3,000,000 and with fair value less cost to sell of P3,500,000 at the point
of harvest. Because of long aging and maturation process after harvest, the harvested coffee
beans were still on hand on December 31, 2020. On such date, the fair value less cost to sell
is P3,900,000 and the net realizable value is P3,200,000. What is the measurement of the
coffee beans inventory on December 31, 2020?
5. Amici Company has a herd of 100 2-year old animals on January 1, 2012. Ten animals aged
2.5 years were purchased on July 1, 2012 for P10,800 each and ten animals were born on
July 1, 2012. No animals were sold or disposed of during the year. The fair values less cost
to sell per unit were:
2-year old animal on January 110,000
2.5-year old animal on July 110,800
New born animal on July 17,000
2-year old animal on December 31 10,500
2.5-year old animal on December 31 11,100
Newborn animal on December 31 7,200
3-year old animal on December 31 12,000
0.5-year old animal on December 31 8,000
What is the carrying amount of the biological assets on December 31, 2020?
What is the gain from change in fair value that should be reported for 2020?

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Reference List
Enterprise.

Accountancy.
GIC Enterprise.
Standards (2020 ed., Vol. 3). GIC Enterprise

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Unit 4- Accounting for Investments
Definition of investment
The International Accounting Standards Board defines investment as follows:
“Investments are assets held by an entity for the accretion of wealth through distribution
such as interest, royalties, dividends and rentals, for capital appreciation or for other
benefits to the investing entity such as those obtained through trading relationship”.
Actually, investments are assets not directly identified with the operating activities of
an entity and occupy only an auxiliary relationship to the central revenue producing
activities of the entity.
Topic 1- Financial Assets and Investment in Equity Securities
Learning Outcomes
• Identify financial assets and financial liabilities.

• State the classifications of financial assets and their initial and subsequent
measurements.
• Apply the concept of recognition and measurement of Investments and .
• Explain how fair value is measured.
• Account for investments in equity securities.
Pretest
Answer page 501 and page 610 of your book.

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Content
Purposes of investment
Investment are held for diverse reason such as:
a. For accretion of wealth or regular income through interest, dividends, royalties and
rentals.
b. For capital appreciation as in the case of investments in land and real estate held for
appreciation and direct investment in gold, diamonds and other precious commodities.
c. For ownership control as in the case of investments in subsidiaries and associates.
d. For meeting business requirements as in the case of sinking fund, preference share
redemption fund, plant expansion fund and other noncurrent fund
e. For protection as in the case of interest in life insurance contract in the form of cash
surrender value.
Statement classification
Investments are classified either as current or noncurrent assets.
Current investments are investments that are by their very nature readily realizable and are
intended to be held for not more than one year.
Noncurrent or long-term investments are investments other than current investments.
This residual definition means that the noncurrent investments are intended to be held for more
than one year or are not expected to be realized within twelve months after the end of the reporting
period.
Financial instrument
PAS 32, paragraph 11, defines a financial instrument as any contract that gives rise to a financial
asset of one entity and a financial liability or an of another entity.
The characteristics of a financial instrument are:
a. There must be a contract.
b. There are at least two parties to the contract.
c. The contract shall give rise to a financial asset of one party and financial liability or equity
instrument of another party.
Financial assets
A financial asset is any asset that is:
a. Cash;
b. Equity instrument of another entity; or
c. Contractual right to receive cash or another financial asset or to exchange financial
instruments with another entity under conditions that are potentially favorable.

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d. An equity instrument of another entity.

Financial liabilities
A financial liability is any liability that is:
a. a contractual obligation to deliver cash or another financial asset to another entity; or
b. a contractual obligation to exchange financial instruments with another entity under
conditions that are potentially unfavorable.
Only financial asset is discussed in this financial accounting volume one.
Examples of financial assets
Cash or currency is a financial asset because it represents the medium of exchange and is
therefore the basis on which all transactions are measured and recognized in financial
statements.
A deposit of cash with a bank or similar financial institution is a financial asset because it
represents the contractual right of the depositor to obtain cash from the bank or to draw a check
against the balance in favor of a creditor in payment of a financial liability.
But a gold bullion deposited in a bank is not a financial asset because although it is very precious
the gold is a commodity.
Financial assets representing a contractual right to receive cash in the future include:
a. Trade accounts receivable
b. Notes receivable
c. Loans receivable
d. Bonds receivable
Not considered financial assets

Intangible assets are not financial assets.
Physical assets, such as inventory and property, plant and equipment are not also financial
assets.
Prepaid expense for which the future economic benefit is the receipt of goods or services rather
than the right to receive cash or another financial asset are not also financial assets.
Leased assets are not also financial assets because control of such assets does not give rise to
a present right to receive cash or another financial asset.
Classification of financial assets
Under PFRS 9, paragraph 4.1.1, financial assets are classified into three namely:
1. Financial assets at fair value through profit or loss – include both equity securities and
debt securities.
2. Financial assets at fair value through other comprehensive income – include both equity
securities and debt securities.
3. Financial assets at amortized cost – include only debt securities.

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The classification depends on the business model for managing financial assets which may be:
a. To hold investments in order to realize fair value changes.
b. To hold investments in order to collect contractual cash flows.
Basis of classification
Financial assets are classified based on:
1. the entity’s business model for managing the financial assets; and
2. the contractual cash flow characteristics of the financial asset.
Equity security
The term “equity security” encompasses any instrument representing ownership shares and right,
warrants or options to acquire or dispose of ownership shares at a fixed or determinable price.
Equity securities do not include redeemable preference shares, Debt security
A debt security is any security that represents a creditor relationship with an entity.
A debt security has a maturity date and a maturity value:
a. Corporate bonds
b. BSP treasury shares
c. Government securities
d. Commercial papers
e. Preference shares with mandatory redemption date or are redeemable at the option of the
holder.
Initial recognition
Financial assets are recognized only when the entity becomes a party to the contractual
provisions of the instrument.
Initial measurement of financial assets
PFRS 9, paragraph 5.1.1, provides that at initial recognition, an entity shall measure a financial
asset at fair value plus, in the case of financial asset not at fair value through profit or loss,
transaction costs that are directly attributable to the acquisition of the financial asset.
PFRS 9, paragraph 5.2.1, provides that after recognition, an entity shall measure a financial asset
at:
a. Fair value through profit or loss (FVPL)
b. Fair value through other comprehensive income (FVOCI)
c. Amortized cost
Financial assets at fair value through profit or loss

The ff. financial assets shall be measured at “fair value through profit or loss”:
1. Financial assets held for trading or popularly known as “trading securities”.
2. All other investments in quoted equity instrument.

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3. Financial assets that are irrevocably designated on initial recognition as at fair value
through profit or loss.
4. All debt investments that do not satisfy the requirements for measurement at amortized
cost and at fair value through other comprehensive income.
Financial asset held for trading
Appendix A of PFRS 9 provides that a financial asset is held for trading if:
a. It is acquired principally for the purpose of selling or repurchasing it in the near term.
b. On initial recognition, it is part of a portfolio of identified financial assets that are managed
together and for which there is evidence of a recent actual pattern of short – term profit
taking.
c. It is a derivative, except for a derivative that is a financial guarantee contract or a
designated and an effective hedging instrument.
Equity instrument at fair value through OCI
At initial recognition, PFRS 9, paragraph 5.7.5, provides that an entity may make an irrevocable
election to present in other comprehensive income or OCI subsequent changes in fair value of
an investment in equity instrument that is not held for trading.
Debt investment at amortized cost
PFRS 9, paragraph 4.1.2, provides that a financial asset shall be measured at amortized cost if
both of the following conditions are met:
a. The business model is to hold the financial asset in order to collect contractual cash flows
on specified date.
b. The contractual cash flows are solely payments of principal and interest on the principal
amount outstanding.
Debt investment at fair value through OCI
PFRS 9, 4.1.2A, provides that a financial asset shall be measured at fair value through other
comprehensive income if both of the following conditions are met:
a. The business model is achieved both by collecting contractual cash flows and by selling
the financial asset.
outstanding.
Note that the business model includes selling the financial asset in addition to collecting
contractual cash flows.
In this case, interest income is recognized using the effective interest method as in amortized cost
measurement.

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Measurement of equity investment

1. Held for trading – at fair value through profit or loss
2. Not held for trading – as a rule, at fair value through profit or loss
3. Not held for trading – at fair value through other comprehensive income by irrevocable
election
4. All other investments in quoted equity instruments – at fair value through profit or loss
5. Investments in unquoted equity instruments – at cost
6. Investments of 20% to 50% - equity method of accounting
7. Investments of more than 50% - consolidation method to be taken up in an advanced
accounting course.
Measurement of debt investments
1. Held for trading – at fair value through profit or loss
2. Held for collection of contractual cash flows – at amortized cost
3. Held for collection of contractual cash flows – at fair value through profit r loss by
irrevocable designation or fair value option
4. Held for collection of contractual cash flows and for sale of the financial asset – at fair
value through other comprehensive income
5. Held for collection of contractual cash flows and for sale of the financial asset – at fair
value through profit or loss by irrevocable designation or fair value option

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Equity vs. Debt instruments

➢ Only debt instruments can be classified under the Amortized Cost or FVOCI (mandatory)
measurement categories.
➢ Equity instruments are measured at FVPL, unless the entity makes an irrevocable
election on initial recognition to measure them at FVOCI.
➢ A debt instrument that is not measured at amortized cost or at FVOCI is measured at
FVPL.
Business models

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Fair value
appendix a of PFRS 9 in conjunction with PFRS 13 provides a new definition of fair value. Fair
value of an asset is the price that would be received to sell an asset in an orderly transaction
between market participants at the measurement date.
Gain and loss – financial asset at fair value
Under PFRS 9, paragraph 5.7.1, gain and loss on financial asset measured at fair value shall be
presented in profit or loss, except:
a. When the financial asset is part of a hedging relationship
b. When the financial asset is an investment in nontrading equity instrument and the entity
has irrevocably elected to present unrealized gain and loss in other comprehensive
income
c. When the financial asset is a debt investment that is measured at fair value through
other comprehensive income
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.” (PFRS 13)
Fair value is based on the market price of the asset in a:
a. principal market; or
b. the most advantageous market (in the absence of a principal
market)
The market price used in measuring fair value is not adjusted for any transaction costs, but is
adjusted for any transport costs.
Formula:

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Regular way purchase or sale of financial assets

• A regular way purchase or sale is a purchase or sale of a financial asset under a contract
whose terms require delivery of the asset within the time frame established generally by
regulation or convention in the marketplace concerned.
• Trade date accounting vs. Settlement date accounting
a. Under trade date accounting, the financial asset purchased (s0ld) is recognized
(derecognized) at the trade date (i.e., the date the entity commits to purchase or sell the
financial asset).
b. Under settlement date accounting, the financial asset purchased (s0ld) is recognized
(derecognized) at the settlement date (i.e., the date the ownership of the financial asset is
transferred).
Fair value change between trade date & settlement date
• For purchases of FVPL and FVOCI assets (but not amortized cost), the buyer recognizes
the change in fair value between the trade date and the settlement date.
• For sale transactions, the seller does not recognize the change in fair value between the
trade date and the settlement date.
Gain and loss – financial asset at amortized cost

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Unrealized gain and loss on financial asset at amortized cost are not recognized simply because
such investments are not reported at fair value.
PFRS 9, paragraph 5.7.2, provides that gain and loss on financial asset measured at amortized
cost and is not part of a hedging relationship shall be recognized in profit or loss when the
financial asset is derecognized, sold, impaired or reclassified, and through the amortization
process.
Reclassification
• After initial recognition, financial assets are reclassified only when the entity changes its
business model for managing financial assets.
• Reclassification date is the first day of the first reporting period following the change in
business model that results in an entity reclassifying financial assets.
PFRS 9, paragraph 4.4.1, provides that an entity shall reclassify financial assets only when it
changes its business model for managing the financial assets.
Where reclassification occurs, paragraph 5.6.1, provides that an entity shall apply the
reclassification prospectively from the reclassification date.
The PFRS 9 Application Guidance B4.4.1 makes it clear that changes in the business model in
managing financial assets are expected to be infrequent.
Reclassification from FVPL to amortized cost
PFRS 9, paragraph 5.6.3, provides that when an entity reclassification a financial asset from fair
value through profit or loss to amortized cost, the fair value at the reclassification date becomes
the new carrying amount of the financial asset at amortized cost.
The difference between the new carrying amount of the financial asset at amortized cost and the
face value of the financial asset shall be amortized through profit or loss over the remaining life
of the financial asset using the effective interest method.
Reclassification from amortized cost of FVPL
PFRS 9, paragraph 5.6.2, provides that when an entity reclassifies a financial asset from
amortized cost to fair value through profit or loss, the fair value is determined at reclassification
date.
The difference between the previous carrying amount and fair value is recognized in profit or loss.
Reclassification from amortized cost to FVOCI
PFRS 9, paragraph 5.6.4, provides that if an entity reclassifies a financial asset at amortized cost
to fair value through other comprehensive income, the fair value is measured at reclassification
date.
Any gain or loss arising from the difference between the amortized cost carrying amount and fair
value is recognized in other comprehensive income.
Reclassification from FVOCI to amortized cost

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PFRS 9, paragraph 5.6.5, provides that if an entity reclassifies a financial asset from fair value
through other comprehensive income to amortized cost, the fair value at reclassification date
becomes the new amortized cost carrying amount.
Reclassification from FVPL to FVOCI
PFRS 9, paragraph 5.6.6, provides that an entity reclassifies a financial asset from fair value
through profit or loss to fair value through other comprehensive income, the financial asset
continues to be measured at fair value.
Reclassification from FVOCI to FVPL
PFRS 9, paragraph 5.6.7, provides that if an entity reclassifies a financial asset from fair value
through profit or loss, the financial asset continues to be measured at fair value.
Reclassification of debt-type financial assets

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Notes on reclassification
• Only debt instruments can be reclassified. Equity instruments (e.g., investments in
shares of stocks) cannot be reclassified.
• Financial assets cannot be reclassified into or out of the “designated at FVPL” and “FVOCI
- election” classifications.
• The initial measurement is fair value at reclassification date, except for a reclassification
from FVOCI to Amortized cost where the fair value on reclassification date is adjusted for
the cumulative balance of gains and losses previously recognized in OCI.
Impairment
• The impairment requirements of PFRS 9 apply equally to debt-type financial assets that
are measured either at amortized cost or at FVOCI.
• Impairment gains or losses on debt instruments measured at FVOCI are recognized in
profit or loss. However, the loss allowance is recognized in OCI and does not reduce the
carrying amount of the financial asset in the statement of financial position.
Impairment – Equity investments at fair value
For financial assets measured at fair value, all gains and losses are either presented in profit or
loss or in other comprehensive income depending on whether the election to present gains and
loss on equity investments in other comprehensive income is taken or not.
Impairment – Debt investments

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PFRS 9, paragraph 5.5.1, provides that an entity shall recognized a loss allowance for expected
credit losses on:
a. Debt investment measured at amortized cost
b. Debt investment measured at fair value through other comprehensive income
Paragraph 5.5.3, provides that an entity shall measure the loss allowance for a financial
instrument at an amount equal to the lifetime expected credit losses if the credit risk on that
financial instrument has increased significantly since initial recognition.
Credit losses are the present value of all cash shortfalls.
Expected credit losses are an estimate of credit losses over the life of the financial instrument.
Measurement of impairment
a. The probability – weighted outcome
c. Reasonable and supportable information that is available without undue cost of effort.
PFRS 9 does not prescribe particular method of measuring expected credit losses.
An entity may use various source of data both internal or entity-specific and external in measuring
expected credit losses.
The amount of impairment loss can be measured as the difference between the carrying amount
and the present value of estimated future cash flows discounted at the original effective rate.
INVESTMENT IN EQUITY SECURITIES
Acquisition of equity investment
The Application Guidance of PFRS 9 provides that when a financial asset is recognized initially,
an entity shall measure it at fair value plus transaction costs that are directly attributable to the
acquisition.
The fair value is usually the transaction price, meaning the fair value of the consideration given.
As a rule, transaction costs that are directly attributable to the acquisition of the financial asset
shall be capitalized as cost of the financial asset.
However, transaction costs directly attributable to the acquisition of financial asset held for
trading or financial asset at fair value through profit or loss shall be expensed immediately.
Acquisition by exchange
If the equity securities are acquired in an exchange, the acquisition cost is determined by
reference to the following in the order of priority:
a. Fair value of asset given
b. Fair value of asset received
c. Carrying amount of asset given

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Lump sum acquisition

If two or more equity securities are acquired at a single cost or lump sum, the single cost is
allocated to the securities acquired on the basis of their fair value.
The remainder of the single cost is then allocated to the other security with no known market
value.
Investment categories
Investment in equity securities are accounted for as one of the following categories:
a. Trading securities or financial assets at fair value through profit or loss
b. Financial assets at fair value through other comprehensive income
c. Investment in associate
d. Investment in subsidiary
e. Investment in unquoted equity instruments
Investment in unquoted equity instruments
Under the Application Guidance B5.4.14 of PFRS 9, all investments in equity instrument must
be measured at fair value. However, unquoted equity instruments are measured at cost if FV
cannot be determined.
Sale of equity securities
PFRS 9, paragraph 3.2.12, provides that on derecognition of a financial asset measured at fair
value through profit or loss, the difference between the consideration received and the carrying
amount of the financial asset shall be recognized in profit or loss.
Dividends
If the equity securities are measured at fair value through profit or loss, or at fair value through
other comprehensive income or at cost, dividends earned are considered as income.
Only cash and property dividends received from equity securities may be recognized as
dividend revenue.
Dividends considered earned when:
a. Date of declaration – this is the date on which the payment of individuals is approved by
the Board of Directors.
b. Date of record – this is the date on which the stock and transfer book of the corporation is
closed for registration.
Only those shareholders registered as of this date are entitled to receive dividends.
c. Date of payment – this is the date on which the dividends declared shall be paid.
Between the date of declaration and the record date, the shares are selling “dividend-on”.
Recording of the dividend income is always made at the date of declaration.
When to recognize dividends as income

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Dividends shall be recognized as revenue when the shareholder’s right to receive payment is
established.
Accordingly, the dividends shall be recognized as revenue on the date of declaration.
The reason is that when dividends are declared, the shareholder has already acquired the right
there to so much so that if the shares are subsequently sold, the sale price normally includes the
accrued dividends.
When shares are sold “dividend-on” and the dividend accrued is specifically included in the sale
price, that portion of the sale price pertaining to the accrued dividend should be credited to
dividend income.
Only the remainder of the sale price should be used as basis for determining gain or loss on the
sale of the investment.
TYPES OF DIVIDENDS
Property dividends
Property dividends or dividends in kind are dividends in the form of property or noncash assets.
Liquidating dividends
Liquidating dividends represent return of invested capital, and therefore, are not income. The
payment may be in the form of cash or noncash assets.
Stock dividends
Stock dividends are in the form of the issuing entity’s own shares. The IAS term for stock dividend
is “bonus issue”.
Kinds of stock dividends
Stock dividends may be the same as those held or different from those held.
Stock dividends whether of the same class or different are not income. The reason is that there
is no distribution of the assets of the entity.
The assets of the entity are the same before and after the issuance of the stock dividends.
The shareholder receives additional shares but still has the same proportionate equity interest
in the entity. The shareholder may have more shares but at reduced market value.
Shares of another entity declared as dividends are not stock dividends but property dividends.
Stock dividends of same class
Stock dividends of the same class are recorded only by means of a memorandum entry on
the part of the shareholder.
Stock dividends different from those held
A shareholder may receive a stock dividend which is different from the original shares.
Again, stock dividends of different class are not income.
However, the original cost of the investment is apportioned between the original shares and
the stock dividends on the basis of market value of each at the date of receipt.

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Shares received in lieu of cash dividends

it is generally accepted that shares received in the lieu of cash dividends are income at fair
value of the shares received. The reason is that such shares are in effect property dividends.
Cash received in lieu of stock dividends
When stock dividends are declared and received, unquestionably, they are not income. A
problem will arise when cash is received in lieu of stock dividends.
BIR approach
Under the ruling of the Bureau of Internal Revenue, all cash received, whether originally
designated as cash dividends or stock dividend, is recognized as income.
Share split
A corporation may restructure its capital by effecting a change in the number of shares without
capitalizing retained earnings or changing the amount of its legal capital.
Split up is a transaction whereby the outstanding shares are called in and replaced by a larger
number, accompanied by a reduction in the par or stated value of each share.
Split down is the reverse of the split up. Split down is a transaction whereby the outstanding
shares are called in and replaced by smaller number, accompanied by an increase in the par
or stated value.
Share split does not affect the total cost of investment. But there is a decrease or an increase
in the cost per share because the total cost now will apply to a larger or smaller number of
shares.
Only a memorandum entry is made to record the receipt of new shares by virtue of share split.
Special assessments
Special assessments are additional capital contribution of the shareholders. On the part of the
shareholders, special assessments are recorded as additional cost of the investment and on
the part of the entity as share premium.
Redemption of share
Shares, particularly preference shares, may be called in for redemption and cancelation by the
entity issuing them.
On the part of the shareholder, the redemption of share is recorded in the same manner as a
sale of shares. The redemption price is treated as the sale price.
Stock right or share right
A stock right or preemptive share right is a legal right granted to shareholders to subscribe for
new shares issued by a corporation at a specified price during a definite period.
The IAS term for stock right is “right issue”
A stock right is inherent in every share. A shareholder receives one right for every share owned.

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A stock right is valuable to a shareholder because the price at which the new shares are sold
is generally below the prevailing market price. The purpose of the stock right is to give the
shareholders the chance to preserve there equity interest in the corporation.
The ownership of stock right is evidenced by instruments or certificate called share warrants.
Accounting for stock rights
PFRS 9, does not address this accounting issue categorically. But unquestionably, a stock
right is form of a financial asset.
Accounted for separately
Under the Application Guidance B5.4.14 of PFRS 9, all investment in equity instruments and
contracts on those instruments must be measured at fair value.
Undoubtedly, stock rights are a form of equity instruments and therefore shall be measured
initially at fair value.
In other words, a portion of the carrying amount of the original investment in equity securities
is allocates to the stock rights at an amount equal to the fair value of the stock rights at the
time of acquisition.
Not accounted for separately
Stock rights are recognized as embedded derivative but not a “stand-alone” derivative.
PFRS 9, paragraph 4.3.3, provides that an embedded derivative shall be separated from the
host contract and accounted for separately under certain conditions.
Paragraph 4.3.3, further provides that if the host contract is within the scope of PFRS 9, the
classification requirements of PFRS 9 are applied to the combined host contract in its entirety.
This simply means that if the host contract is a financial asset, the embedded derivative is
not separated.
Approach to be followed
Admittedly, this subject matter is not a well-settled issue. In fact, PFRS 9, paragraph 4.3.4,
states that “this standard does not address whether an embedded derivative shall be presented
separately in the statement of financial position”.
The authors strongly believe that the second approach “not accounted for separately” stands
on solid and authoritative ground.
However, stay tuned and let us wait and see what the Financial Reporting Standards Council
and the IASB will say on this accounting issue.
Between the date of declaration and date of record
During this period the shares are considered to be selling right-on. This means that the share
and the right are inseparable and are treated as one.
In other words, the share cannot be sold without also selling the right or vise versa.
Exercise of stock rights

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When stock rights are exercised, the cost of the new investment includes the subscription price
ant the cost of the stock rights exercised.
Sale of stock rights
The stock rights are financial assets separate from the original shares. Accordingly, the stock
rights can be sold independently of the original investment.
Expiration of stock rights
Stock rights can be exercised only up to a certain date after which the stock rights become
worthless.
Theoretical or parity value of stock right
The theoretical or parity value is the assumed fair value of the right that is derived from the
market value of the share.
Two formulas may be used in the computation of the theoretical or parity value of the stock
right.
Disclosure of Risks on financial instruments
1. Credit risk - The risk that one party to a financial instrument will cause a financial loss for
the other party by failing to discharge an obligation.
2. Liquidity risk - The risk that an entity will encounter difficulty in meeting obligations
associated with financial liabilities that are settled by delivering cash or another financial
asset.
3. Market risk - The risk that the fair value or future cash flows of a financial instrument will
fluctuate because of changes in market prices. Market risk comprises the following.
a) Interest rate risk
b) Currency risk
c) Other price risk
Assessment
Activity 1
1. According to PFRS 9, a financial instrument is recognized
a. when the instrument has probable economic benefits that can be measured reliably.
b. only when the entity becomes a party to the contractual provisions of the instrument.
c. when the entity enters into a binding contract to deliver a variable number of its own equity
instrument.
d. only when the instrument requires receipt of another financial instrument under conditions
that are potentially favorable.

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2. Which of the following is a financial liability?

a. Income tax payable
b. Unearned revenue
c. Warranty obligation
d. Lease liability
3. During the period, an entity acquires an investment. The entity has a “hold to collect and sell”
business model. The investment should be classified as
a. investment measured at fair value through other comprehensive income.
b. investment measured at amortized cost.
c. investment measured at fair value through profit or loss.
d. any of these
4. Which of the following is measured at fair value with fair value changes recognized in profit or
loss?
a. Held to maturity investments
b. Financial assets designated at FVPL
c. FVOCI
d. All of these
5. If an entity’s business model’s objective is to hold investments in order to collect contractual

cash flows that are solely payments for principal and interests, then investments should be
classified as
a. subsequently measured at fair value through other comprehensive income.
b. subsequently measured at amortized cost.
c. subsequently measured at fair value through profit or loss.
d. any of these
6. Under PFRS 9, financial assets are classified

a. on the basis of the entity’s business model only.
b. based on the nature of the financial assets, i.e., debt or equity instrument.
c. as financial assets subsequently measured at FVPL, FVOCI (election), FVOCI
(mandatory) or Amortized cost.
d. all of these
7. According to PFRS 9, if an asset or a liability measured at fair value has a bid price and an
ask price, the price within the bid-ask spread that is most representative of fair value in the
circumstances is used to measure fair value. Bid price is
a. the maximum price at which market participants are willing to sell an asset.
b. the maximum price at which market participants are willing to buy an asset.
c. the minimum price at which market participants are willing to sell an asset.
d. the price that an entity will incur to bid farewell to an asset.
8. The following are taken from the records of Lunch Co. as of year-end.
Cash 10,400 Investment in 44,000
subsidiary
Accounts receivable 12,000 Treasury shares 44,800
Allowance for bad (1,600) Investment in 9,600
debts bonds

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Note receivable 4,000 Land 112,000

Interest receivable 1,600 Building 208,000
Claim for tax refund 9,600 Accum. (52,000)
depreciation
Advances to 4,800 Investment 40,000
suppliers property
Inventory 60,000 Biological assets 24,000
Prepaid expenses 4,000 Intangible assets 56,000
Petty cash fund 800 Deferred tax 48,000
assets
Investment in equity Cash surrender 9,600
securities 10,400 value
Investment in 16,000 Sinking fund 16,000
associate
How much are the total financial assets disclosed in the notes?
a. 142,400 b. 132,000 c. 132,800 d. 92,800

On January 1, 20x1, ABC Co. purchased 1,000 shares of XYZ, Inc. for ₱250,000. Commission
paid to broker amounted to ₱10,000. The equity securities were designated by management to
be measured at fair value through profit or loss. On December 31, 20x1, the shares are quoted
at ₱200 per share. It was estimated that transaction cost of ₱20 per share will be incurred if the
shares were sold on that date.
9. How much is the unrealized gain (loss) on change in fair value recognized in the 20x1 profit
or loss?
a. (70,000) b. (50,000) c. (40,000) d. 60,000
10. On January 3, 20x2, all the shares were sold at ₱300 per share. Commission paid for the sale
amounted to ₱60,000. How much is the realized gain (loss) from the sale?
a. 60,000 b. (10,000) c. 40,000 d. (40,000)
11. If ABC Co. uses an allowance account to account for changes in fair values, how much is the
balance of this account on December 31, 20x1?
a. 70,000 debit c. 40,000 credit
b. 50,000 debit d. 50,000 credit

On Jan. 1, 20x1, Three Co. purchased 10,000 shares of AM, Inc. for ₱1,000,000. Three Co.
paid broker’s commission of ₱15,000 on the acquisition. Three Co. made an irrevocable choice
to subsequently measure the shares at fair value through other comprehensive income. The
quoted prices per share on Dec. 31, 20x1 and Dec. 31, 20x2 were ₱90 and ₱108, respectively.
On Jan. 3, 20x3, Three Co. sold all the shares at ₱105 per share. Three Co. paid broker’s
commission of ₱16,000 on the sale.
12. How much is the unrealized gain (loss) recognized in Three Co.’s 20x1 profit or loss?

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a. 115,000 b. (115,000) c. (85,000) d. 0
13. How much is the unrealized gain (loss) recognized in Three Co.’s 20x2 other comprehensive
income?
a. 180,000 b. 65,000 c. (115,000) d. 0
14. How much is the cumulative gain (loss) transferred to retained earnings on Jan. 3, 20x3?
a. 19,000 b. 34,000 c. (19,000) d. (34,000)
15. On January 1, 20x1, ABC Co. purchased ₱1,000,000 bonds at a price that reflects a yield rate
of 14%. The bonds mature on January 1, 20x4 and pay 12% annual interest. The bonds are
classified as held for trading securities. On December 31, 20x1, the bonds are selling at a
yield rate of 10%. How much is the unrealized gain (loss) on the change in fair value
recognized in ABC’s 20x1 profit or loss?
a. 78,336 b. 83,561 c. 81,144 d. 0
16. It refers to purchase or sale of a financial asset under a contract whose terms require delivery
of the asset within the time frame established generally by regulation or convention in the
marketplace concerned.
a. normal way c. special way
b. regular way d. no way
17. According to PFRS 9, which of the following represents a commencement of a financial

asset’s impairment accounting?
a. Reclassification of the financial asset from Amortized cost to FVPL
b. Reclassification of the financial asset from FVPL to Amortized cost
c. Reclassification of the financial asset from Amortized cost to FVOCI
d. Reclassification of the financial asset from FVOCI to Amortized cost

On December 29, 20x1, an entity commits itself to purchase a financial asset for ₱10,000. The
transaction will be settled on January 4, 20x2. On December 31, 20x1 and on January 4, 20x2,
the fair value of the asset is ₱12,000 and ₱15,000, respectively.
18. If the financial asset is measured at fair value through profit or loss and that the entity uses
the settlement date accounting, on what date and at what amount is the financial asset initially
recognized?
a. December 29, 20x1, ₱10,000
b. January 4, 20x2, ₱10,000
c. January 4, 20x2, ₱12,000
d. January 4, 20x2, ₱15,000
19. If the financial asset is measured at fair value through other comprehensive income and that
the entity uses the trade date accounting, what amount of gain (loss) on fair value change is
recognized on December 31, 20x1 and how is that gain (loss) recognized?
a. ₱2,000 gain in other comprehensive income
b. ₱3,000 gain in other comprehensive income

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c. ₱2,000 gain in profit or loss

d. zero gain or loss

On Jan. 1, 20x1, Cloudy Day Co. acquires ₱2,000,000 face amount, 10% bonds for ₱1,903,927.
The bonds are due on Jan. 1, 20x4 but pay annual interest every Dec. 31. The yield rate is 12%.
Cloudy changes its business model for managing financial assets on Sept. 1, 20x2. Cloudy only
reports annually every Dec. 31. The bonds are quoted at 101 on Sept. 1, 20x2, 103 on Dec. 31,
20x2 and 104 on Jan. 1, 20x3.
20. The bonds are reclassified from amortized cost to fair value through profit or loss. How much
is the gain (loss) on reclassification and where is that amount presented?
a. 128,471 in P/L c. 115,714 in P/L
b. (143,292) in OCI d. 115,714 in OCI
21. The bonds are reclassified from fair value through profit or loss to amortized cost. What is the
amount of premium or discount to be amortized over the remaining life of the bonds
subsequent to the reclassification date?
a. 80,000 discount c. 115,714 discount
b. 80,000 premium d. 115,714 premium
22. On March 31, 20x1, Likkig, Inc. declares cash dividends of ₱40 per share to shareholders of
record on April 15, 20x1, to be distributed on April 30, 20x1. On April 9, 20x1, Ceecee Co.
purchases 10,000 Likkig shares for ₱400 per share. The investment is classified as
investment in equity securities measured at FVOCI. How much is the initial carrying amount
of the investment?
a. 4,000,000 b. 4,400,000 c. 3,600,000 d. 3,890,664
23. Devin Co holds 10,000 shares of Eureka, Inc. as investment in equity securities. On April 1,
20x1, Devin receives shares with fair value of ₱520,000 and aggregate par value of ₱400,000
as share dividend. How much is the dividend income?
a. 520,000 b. 400,000 c. 120,000 d. 0
24. On April 1, 20x1, Jean Co. received ₱480,000 cash dividends, one-third of which represents
liquidating dividends. How much is the dividend revenue?
a. 160,000 b. 320,000 c. 80,000 d. 0
25. On March 31, 20x1, Bogart Co. received from its investment in equity securities 10,000 stock
rights to subscribe to new shares at ₱60 per share for every 4 rights held. Immediately after
issuance of stock rights, the shares were selling at ₱80 per share. How much is the initial
carrying amount of the stock rights?
a. 20,000 c. 50,000
b. 40,000 d. cannot be determined

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Activity 2
Show your Solution and answer as required.
1. In your books, answer problem 5 and problem 6 found in pages 510 to 515.
2. In your books, answer problem 5 found in pages 618 to 622.
Reference List
Enterprise.

Accountancy.
GIC Enterprise.

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Topic 2- Investments in Debt Securities
Financial Asset at Amortized Cost

Definition of a bond
A bond is a formal unconditional promise made under seal to pay a specified sum of
money at a determinable future date, and to make periodic interest payments at a stated
rate until the principal sum is paid.
In simple language, a bond is a contract of debt whereby one party called the issuer
borrows fund from another party called the investor. Thus, a bond is a debt security
because the bondholder is a creditor and the issuer is a debtor.
A bond is evidenced by a certificate and the contractual agreement between the issuer
and the investor is contained in another document known as “bond indenture”.
Learning Outcomes
• Apply the concept of recognition and measurement of Investments in Bonds

• Apply methods of amortizing bond discount and premium.
• Solve problems about bonds.
Pretest
Answer page 550 of your book Intermediate Accounting 1 A.
Content
Types of bonds
• Term bonds – bonds that mature on a single date.

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• Serial bonds – bonds that mature in a series of maturity dates.

• Registered bonds – bonds issued in the name of the holder (owner). Interest payments
are sent directly to the holder.
• Coupon (bearer) bonds – bonds that can be freely transferred and have a detachable
coupon for each interest payment.
• Zero-coupon bonds (strip bonds) – bonds that do not pay periodic interests. Principal and
compounded interest are due only at maturity date.
• Callable bonds – bonds containing call provisions giving the issuer thereof the right to
redeem the bonds prior to their maturity date.
• Convertible bonds – bonds giving the holder thereof the option of exchanging the bonds
for shares of stocks of the issuer.
Interest payment date
The interest on the bond investment is usually paid semiannually or every six months as follows:
a. January 1 and July 1
b. February 1 and August 1
c. March 1 and September 1
d. April 1 and October 1
e. May 1 and November 1
f. June 1 and December 1
Of course, there are certain bonds that pay interest annually or at the end of the bond year.
Classification of bond investment

Bonds may be acquired as current or noncurrent investment depending on the business model of
managing financial assets.
Accordingly, bond investments are classified and accounted for as follows:
a. Financial asset held for trading
b. Financial asset at amortized cost
c. Financial asset at fair value through other comprehensive income
d. Financial asset at fair value through profit or loss by irrevocable designation or by fair
value option.
Accounting for investments measured at amortized cost
The accounting for investments in bonds that are measured at amortized cost is similar to the
accounting for notes and loans receivables, in the sense that it also involves the following:
a. Present value computations
b. Preparation of amortization table (Effective interest method)
Initial measurement
In accordance with PFRS 9, paragraph 5.1.1, bond investments are recognized initially at fair
value plus transaction costs that are directly attributable to the acquisition.

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However, transaction costs attributable to the acquisition of bond investments held for trading or
at fair value through profit or loss are expensed immediately.
Subsequent to initial recognition, bond investments are measured and accounted for as follows:
a. At fair value through profit or loss
b. At amortized cost
c. At fair value through other comprehensive income
Acquisition of bond investment
Bonds may be acquired on interest date or between interest dates. When bonds are acquired
on interest date, there is no accounting problem because the purchase price is initially recognized
as the acquisition cost.
When bonds are acquired between interest dates, meaning the date of acquisition is not any
one of the interest dates, the purchase price normally includes the accrued interest.
In effect, in this case, two assets are acquired, namely the bonds and the accrued interest. On
the date of acquisition, the accrued interest is charged either to accrued interest receivable or
interest income.
When accrued interest receivable is debited, upon receipt of the first semiannual interest, the
accrued interest receivable account is closed and interest income is credited for the excess. When
interest income is debited, the receipt of the first semiannual interest is credited entirely to interest
income.
Investment in bonds at amortized cost
PFRS 9, paragraph 4.1.2, provides that a financial asset shall be measured at amortized cost if
both of the following conditions are met:
a. The business model is to hold the financial asset in order to collect contractual cash flows
on specified dates.
amount outstanding.
Amortized cost is the initial recognition amount of the investment minus repayments, plus
amortization of discount, minus amortization of premium, and minus reduction for impairment or
uncollectibility.
When bonds are acquired and classified as financial asset at amortized cost, the bond
investments are classified as noncurrent investments.
Amortization of premium or discount
Investment in bonds shall be measured subsequently at amortized cost.
This means that any premium or discount on the acquisition of long-term investment in bonds
must be amortized.
Bond premium or discount is amortized over the life of the bonds. On the part of the bondholder,
the life of the bonds is from the date of acquisition to the date of maturity.

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Amortization may be made on interest dates or at the end of the reporting period. It is more
convenient to record amortization at the end of the reporting period.
Philosophy on amortization
The reason for amortization of bond premium or discount is to bring the carrying amount of the
investment to face value on the date of maturity.
When the bonds are redeemed on the date of maturity, the entry will simply be a debit to cash
and a credit to investment in bonds at face value.
The bondholder is a creditor and will collect on the date of maturity an amount equal only to the
face value of the bonds no more and no less.
Conceptually, bond premium is a loss on the part of the bondholder because the bondholder paid
more than what can be collected on the date of maturity.
On the other hand, bond discount is a gain on the part of the bondholder because the bondholder
paid less than what can be collected on the date of maturity.
Such gain is not recognized outright but allocated over the life of the bonds to be added to interest
income derived from the bond investment.
Such process of allocating the bond premium as deduction from the interest income and the bond
discount as addition to interest income is what is traditionally called amortization.
Discount vs. Premium
• If the carrying amount is less than the face amount, the difference represents a
discount.
• If the carrying amount is more than the face amount, the difference represents a
premium.
• If there is a discount, the EIR is higher than the NIR.
• If there is a premium, the EIR is lower than the NIR.
• Discount or premium is amortized using the effective interest method.
Sale of bonds prior to maturity

When investment in bonds is sold prior to the date of maturity, it is necessary to determine the
carrying amount of the bond investment to be used as basis in computing gain or loss on the sale.
In such a case, amortization of the premium or discount should be recognized up to the date of
sale.
Effect of discount amortization
You have acquired a bond with face amount of ₱5,000 for ₱4,000.
➢ Would this be favorable or an unfavorable on your part?
➢ Favorable. Why? --- You will be collecting ₱5,000 (excluding interest) while your cash
outflow is only ₱4,000.
➢ On acquisition date, it seems you have earned a “gain” of ₱1,000 right?
➢ Yes; however, the PFRSs prohibit you from recognizing this “gain” outright. You need to
amortize it over the term of the bond.
➢ The “gain” represents the discount (Carrying amt. less than Face amt.).
➢ The effect of the amortization is an increase in interest income.

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➢ Over the term of the bonds, total interest income will be greater than total collections of
interests by ₱1,000.
*On the other hand, the effect of the acquisition of bond in premium is in contrast with the
acquisition in discount.
Bullish Company had the following transactions in bond investment held as trading for the current
year.
March 1 Purchased 2,000, P1,000,12%bonds of long company at 93 excluding
accrued i9nterest. Interest is payable on February 1 and August 1.
April 1 Purchased 4,000, P1,000,12% bonds of National Corporation at 95 plus
accrued interest. Interest is payable March 1 and September 1.
October 1 Sold 1,000 of the National bonds at 105 excluding accrued interest.
December 1 Sold all of the Long Bonds at 100 plus accrued interest.
31 The market value of the National bonds is 90.
Required:
a. Prepare journal entries to record the transactions including receipt and accrued of interest.
b. Statement presentation of the bond investment on December 31.
Solutions:

203
Methods of amortization
a. Straight line method – this method provides for an equal amount of premium or discount
amortization each accounting period.
b. Bond outstanding method – this method is applicable to serial bonds and provides for a
decreasing amount of amortization.
c. Effective interest method or simply “interest method” or scientific method – this method
provides for an increasing amount of amortization.
This means that any discount or premium must be amortized using the effective interest
method.
The straight-line method and bond outstanding method are acceptable only when the computation
will result in periodic interest income that is not materially different from the amount that would
be computed using the effective interest method.
Effective Interest Method
PFRS 9 requires that bond discount and bond premium shall be amortized using the effective
interest method. The effective interest method is also known as scientific method or simply
“interest method”.
This method distinguishes two kinds of interest rate, namely nominal rate and effective rate.
The nominal rate is the coupon rate or stated rate appearing on the face of the bond.
The effective rate is the yield rate or market rate which is the actual or true rate of interest which
the bondholder earns on the bond investment.
The effective rate is the rate that exactly discounts estimated future cash payments through the
expected life of the bond or when appropriate, a shorter period to the net carrying amount of the
bond.
Effective rate versus nominal rate

The effective rate is and nominal rate are the same if the cost of the bond investment equal to the
face value.
When the bonds are acquired at a premium, the effective rate is lower than the nominal rate.
The reason is that the premium is a loss on the part of the bondholder.
On the other hand, when the bonds are acquired at a discount, the effective rate is higher than
the nominal rate.
The reason is that the discount is a gain on the part of the bondholder.
The effective rate and nominal rate are necessary in applying the effective interest method.
Effective interest method
The effective interest method simply requires the comparison between the interest earned or
interest income and the interest received.

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Interest earned or interest income is computed by multiplying the effective rate by the carrying
amount of the bond investment.
Interest received is computed by multiplying the nominal rate by the face amount of the bond.
The carrying amount of the bond investment is the initial cost gradually increased by periodic
amortization of discount or gradually reduced by periodic amortization of premium.
Table 1
Date Interest Interest Discount/Premium Present Value/

Received Income Amortization Carrying
amount
Y0 XX
Y1 XX XX XX XX
Y2 XX XX XX XX
Y3 XX XX XX XX
Interest Received= Face Value x i (Nominal Rate)

Interest Income= PV/CV* x i (Effective Rate)
Discount/Premium Amortization= Interest received – Interest income
CV/PV (Y0) = Present Value Computed

CV/PV (Y1) = CV/PV (Y0) x (1+i) – Interest Received
CV/PV (Y2) = CV/PV (Y1) x (1+i) – Interest Received
CV/PV (Y3…) = CV/PV (Y2…) x (1+i) – Interest Received

Collection
Y0 XX
Y1 XX XX XX XX
Y2 XX XX XX XX
Y3 XX XX XX XX

How to compute Present Value/Carrying Value?

Face Value x PV of 1 = XX
Interest Received x PV of OA = XX
PV/CA (Y0) XX
How to compute Present Value factors?

Using a scientific calculator:
PV of 1= (1+i)-n PV of OA*= (1+i)

-n

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Using a Financial Calculator:
PV of 1= 1,+,i,÷,÷,=,=,=,…(number of periods).
PV of OA*= 1- (1,+,i,÷,÷,=,=,=,…(number of periods))÷ i
*Ordinary Annuity
*PV- Present Value *CV- Carrying Value *i- Interest rate *n- number of periods
In the computation of present value factors, take caution on the interest rate that you are
using, if the payment is semi-annual, use semi-annual rate, if it is annually paid, use the
annual rate.
Nominal rate will be used once only. It is only use in computing the Interest received.
When to use PV of 1 and PV of OA?

Unlike in the note receivable problems, PV of 1 and PV of OA are used together in getting the
present value of the Carrying amount of the loan.
Amortization of the bond

In amortization of the bond the following shall be observed:
Serial Bond: The PV/CV is decreasing until it reached to zero in the due date.
Term Bond: The PV/CV can either be decreasing or increasing depending if it is bought by
discount or premium. It will be decreasing if it is a premium and increasing if it is at discount. Until
it will be equal to its face value at due date.
On January 1, 2019, Labyrinth Company purchased serial bonds with face amount of P3,000,000
and stated 12% interest payable annually every December 31. The bonds are to be held as a
financial asset at amortized costs with a 10% effective yield. The bonds mature at an annual
installment of P1,000,000 every December 31.
Required:
1. Compute the market price of the bonds
2. Prepare journal entries for 2019. The effective interest method of amortization is used.
3. Compute the carrying amount of the bond investment on December 31, 2019.
Solution:
1. Compute the market price of the bonds
In computing for the present value of a serial bonds. You have to compute the present value factor
of 1 in each period. The basis of the present value in each period will be principal payment plus
Interest payment in each period based on the balance. The computation is shown in next page.

206
2. Prepare journal entries for 2019. The effective interest method of amortization is used.
3. Compute the carrying amount of the bond investment on December 31, 2019.

207
Another Illustrative Example

On January 1, 2019, Agusan Company purchased bonds with face amount of P5,000,000. The
entity paid P4,600,000 plus transaction cost of P142,000 for the bond investment. The business
model of the entity in managing financial asset is to collect contractual cash flows solely payment
of principal and interest and also to sell the bonds in the open market. The entity has not elected
the fair value option of measuring financial asset. The bonds mature on December 31 each year
and pay 6% interest annually on December 31 each year with 8% effective yield. The bonds are
quoted at 105 on December 31, 2019 and 110 on December 31, 2020. The bonds are redeemed
at face amount on December 31, 2021.
Required:
a. Prepare an amortization table.
b. Prepare journal entries for 2019, 2020 and 2021.
Solution:
a. Prepare an amortization table.
b. Prepare journal entries for 2019, 2020 and 2021.

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Assessment
Activity 1
Answer Problems 2 and 3 of the Chapter 10 of your book Intermediate Accounting 1 A.
Activity 2
Answer Problem 4 and Problem 5- Activity 1 only of the Chapter 10 of your book Intermediate
Accounting 1 A.

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210
Topic 3- Derivatives
Introduction
Derivatives are becoming increasingly common but very complicated. Huge losses may
be suffered by banks and other financial institutions because of too much exposure in
derivative financial instruments.
Trading in derivatives has been likened to a wild frontier where adventure and danger
are constant companion.
Potential huge and losses may arise from their settlement.
Learning Outcomes
• Apply the concept of the nature and purpose of derivatives

• Apply the concept of recognition and measurement of a derivative.
• Solve problems about derivatives.
Pretest
Answer page 677 of your book Intermediate Accounting 1 A.
Content
Purpose of derivatives
Entities use derivatives financial instruments to manage financial risk. Financial risk originates
from sources, such as change in commodity price, change in cash flows and foreign currency
exposure.

211
In other words, its purpose is:

1. to speculate (incur risk); or
2. to hedge (avoid or manage risk).
Types of financial risk

Price risk is the uncertainty about the future price asset.
Entities are exposed to a price risk with respect to existing assets such as investments in trading
securities and assets to be acquired in the future such as purchase commitments and equipment
to be imported at a future date.
Credit risk is the uncertainty over whether a counterparty or the party on the other side of the
contract will honor the terms of the contract.
Interest rate risk is the uncertainty about future interest rates and their impact on cash flows and
fair value of the financial instruments.
Foreign currency risk is the uncertainty about future Philippine peso cash flows stemming from
assets and liabilities denominated in foreign currency.
The peso equivalent of the foreign currency loan the date of maturity will differ from the peso
equivalent of the foreign currency loan when it was obtained.
What is derivatives?
A derivative is simply a financial instrument that derives its value from the movement in
commodity price, foreign exchange rate and interest rate of an underlying asset or financial
instrument.
Actually, a derivative is an executory contract, meaning, it is not a transaction but an exchange
of promises about future action.
On inception, derivative financial instruments give one party a contractual right to exchange
financial asset or financial liability with another party under conditions that are potentially
favorable.
On the other hand, the other party has a contractual obligation to exchange under potentially
unfavorable conditions.
Expressed in the simplest terms, parties to the derivative financial instrument are taking bets on
what will happen to the “underlying” financial instrument in the future.
Characteristics of a derivative
A derivative is a financial instrument with all three of the following characteristics:
1. The value of the derivative changes in response to the change in an “underlying
variable”.
An underlying is a specified interest rate, commodity price, foreign exchange rate, price
index and other variable.
Although not mentioned specially, a derivative must contain a national which could an
amount of currency, number of units or volume.

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2. The derivative requires ether no initial net investment or an initial small net investment.
In other words, there is no payment or there is only a small payment for the derivative on
the date of contract.
3.The derivative is readily settled at a future date by a net cash payment.
Fair Value hedging in a Derivative
Fair value hedge is a derivative that offsets in whole or in part the change in the fair value of an
asset or a liability.
a. The derivative or hedging instrument is measured at fair value.
b. The hedging item is also measured at fair value in contrast with a cash flow hedge where
the hedge item is not adjusted.
c. The changes in fair value are recognized in profit or loss.
Common types of derivatives
1. Forward contract – is an agreement between two parties to exchange a specified amount of
a commodity, security, or foreign currency at a specified date in the future at a pre-agreed price.
2. Futures contract – is a contract traded on an exchange that allows an entity to buy or sell a
specified quantity of commodity or a financial security at a specified price on a specified future
date.
Quezon Company requires 50,000 kilos of soya beans each month in the manufacturing
operations. To eliminate the price risk associated with the purchase of soya beans, on December

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1, 2019, the entity entered into a futures contract as a cash flow hedge to buy 50,000 kilos of soya
beans at P150 per kilo on February 1, 2020
Required:
Prepare the journal entries for 2019 and 2020 assuming:
1. The market price per kilo of soya beans is P160 on December 31, 2019 and P165 on
February 1, 2020.
2. The market price per kilo of soya beans on December 31, 2019 on February 1, 2020 is
P145.
Solution:

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3. Option – is a contract giving the holder the right, but not the obligation, to buy or sell an asset
at a specified price any time during a specified period in the future. When the holder exercises his
right, the writer of the option is obligated to perform his obligation on the option contract.
An option is a right and not an obligation to purchase or sell.
Types of options as to right of holder:
1. Call option – an option to buy
2. Put option – and option to sell
A call option gives the holder the right to purchase an asset, and a put option gives the holder the
right to sell an asset.
Unlike an interest rate swap, forward contract and futures contract, an option must be paid for.
This is a derivative that requires an initial small payment for the protection against unfavorable
movement in price.
This payment is commonly known as the “option premium”.
➢ At the money – holder may or may not exercise option; no gain or loss in exercising
➢ In the money – holder should exercise; gain in exercising
➢ Out of the money – holder should not exercise; loss in exercising
Legaspi Company produces colorful 100% cotton T-Shirt that are very popular among the youth.
The entity uses 150,000 kilos of cotton each month in the production process. On December 1,
2019, the entity purchased a call option to buy 150,000 kilos of cottons on July 1, 2020. The call
option price per kilo is P30. The entity paid P50,000 for the call option which was designated as
a cash flow hedge.
Required:
Prepare journal entries for 2019 and 2020 assuming:
1. The market price of the cotton on December 31, 2019 is P32 and the market price on July
1, 2020 is P35 per kilo.
2. The market price of the cotton on December 31, 2019 is P32 and the market price on July
1, 2020 is P28 per kilo.

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Solution:
4. Swap – is a contract in which two parties agree to exchange payments in the future based on
the movement of some agreed-upon price or rate. Common examples include:
• Interest rate swap – is a contract between two parties who agree to exchange future
interest payments on a given loan amount. Usually, one set of interest payments in based
on a fixed interest rate and the other is based on a variable interest rate.
The contract of loan is the primary financial instruments and the interest rate swap
agreement is the derivative financial instrument.

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On January 1, 2019, Tenable Company borrowed P5,000,000 from a bank at a variable rate of
the interest for 4 years. Interest will be paid annually to the bank on December 31 and the principal
is due on December 31, 2022. Under the agreement, the market rate of interest every January 1
resets the variable rate for that period the amount of interest to be paid on December 31. In
conjunction with the loan, the entity entered into a “received variable, pay fixed” interest rate swap
agreement with another bank speculator. The interest rate swap agreement was designated as a
cash flow hedge.
Market rates of interest
January 1, 2019 10%
January 1, 2020 14%
January 1, 2021 12%
January 1, 2022 11%
Present Value of an ordinary annuity of 1
At 14% for three periods 2.32

At 12% for two periods 1.69
At 11% for one period 0.90
Required:
Prepare journal entries for 2019, 2020, 2021 and 2022 to recognize all transactions relating to the
contract of loan and the derivative contract.
Solutions:

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• Foreign currency swap – is a contract between two parties who agree to exchange sum
of money in one currency for another currency.
When foreign loans are obtained or when an asset is purchase from abroad by an entity,
must often than not, the loan or obligation is denominated in foreign currency.
This means that the obligations are expressed in foreign currency, for example, dollars
and not in pesos.
When foreign loans or obligations must be repaid in foreign currency, a foreign currency
risk always arises by reason of the volatility of the exchange rate of the peso in relation to
the foreign currency.
As a protection against this foreign currency risk, the entity enters into a contract with a
bank or any financial institution to the effect that if the exchange rate proves unfavorable
to the entity because the exchange rate of the peso increases, the bank shall pay the
entity for the difference in the exchange rate.
Conversely, if the exchange rate of the peso decreases, the entity shall pay the bank for
the difference in the exchange rate.
5. Caps, floors and collars – are essentially options designed to shift the risk of an upward
and/or downward movement in variables, such as interest rates. These are normally linked to a
notional amount and a reference rate.

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6. Swaption – is an option on a swap. The option provides the holder with the right to enter into
a swap at a specified future date at specified terms. This derivative has characteristics of an option
and a swap.
7. Weather derivative – a contract that requires payment based on climatic, geological or other
physical variables.
Embedded derivative
An embedded derivative is a component of a hybrid or combined contract with the effect that
some of the cash flows of the combined contract vary in a way similar to a stand-alone derivative.
This simply means that there is a basic contract known as the “host contract” that has an
embedded derivative.
The interest rate swap, forward contract, futures contract and option are stand-alone derivative
contracts separate from the primary contract.
However, an embedded derivative Is not a separate contract. Both the embedded derivative and
the host contract are contained in one combined contract.
Examples of embedded derivative
1. Equity conversion option in a convertible bond instrument that allows the holder to convert
the bond into shares of the issuer.
The convertible bond instrument is the host contract and the equity conversion feature are
the embedded derivative.
2. Redemption option in an investment in redeemable preference share that allows the issuer
to purchases the preference share.
The investment in redeemable preference share is the host contract and the redemption
option feature are the embedded derivative.
3. An investment in bond whose interest or principal payment is linked to the price of gold or
silver.
The investment in bond is the host contract and the embedded derivative is the payment
of interest or principal based on the price of gold or silver.
The embedded derivative is a commodity derivative.
Embedded derivative accounted for separately.
Bifurcation is the process of separating and embedded derivative from the host contract.
PFRS 9, PARAGRAPH 4.3.3, provides that an embedded derivative shall be separated from the
host contract and accounted for as if it were a stand-alone derivative if the following conditions
are met:
1. A separate instrument with the same terms as the embedded feature would meet the
definition of a derivative.
2. The combined contract is not measured at fair value through profit or loss.

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If the combined contract is measured at fair value through profit or loss, there is no
need to separate the embedded feature because the combined contract is already
accounted for similar to a derivative.
3. The economic characteristics and risks of the embedded feature are not closely related
to the economic characteristics and risks of the host contract.
Simply stated, the embedded derivative and the host contract do not have the same
economic characteristics.
4. The host contract is outside the scope of PFRS 9.
If separated, the embedded derivative is accounted for at fair value and the host contract
is accounted for in accordance with appropriate PFRS.
PFRS 9, paragraph 4.3.4, provides that this PFRS does not address whether an
embedded derivative shall be presented separately in the statement of financial position.
Host contract within scope of PFRS 9
PFRS 9, paragraph 4.3.3, provides that if the has contract is within the scope of PFRS 9, the
classification requirements of PFRS 9 are applied to the combined contract in its entirety.
Simply stated, if the host contract is a financial asset, thing e embedded derivative is not
separated.
Depending on the business model of managing financial asset, the host contract in its entirety
is measured at:
a. Amortized cost
b. Fair value through profit or loss
c. Fair value through other comprehensive income.
These derivatives are often designated as hedging instruments.
Note that derivatives are financial instruments separate from the primary financial instruments,
meaning, “stand-alone” derivatives.
In fact, these derivatives financial instruments would not exist in their own right but have been
created solely to hedge against financial risks crated by other primary financial instruments or by
transaction that have yet to occur but are anticipated.
Assessment

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Activity 1
Answer Problems 2 and 3 of the Chapter 13 of your book Intermediate Accounting 1 A.
Activity 2
Answer Problem 4 of the Chapter 13 of your book Intermediate Accounting 1 A.

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Topic 4- Investment in Associate
Introduction
An Investment in associate is a from of an intercorporate share investment.
Intercorporate share investment

An intercorporate share investment is the purchase of the equity securities of one entity
by another entity.
Most intercorporate investments are acquired simply as a means of accruing regular
income in the form of dividend and investment appreciation.
Learning Outcomes
• Apply the concept of the accounting for an investment in associate.

• Apply the concept of recognition and measurement of an investment in
associate.
• Solve problems about investment in associate.
Pretest
Answer page 37 of your book Intermediate Accounting 1 B.
Content
An investment in associate a type of investment which has significant influence. Significant

influence distinguishes this investment from all other types of investment. Shown on the table are
the types of investment and how it distinguishes from all other types of investments.

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Type of Investment Nature of Applicable Percentage of

Relationship with standards ownership
investee
Financial Asset at Regula Investor PFRS 9 Less than 20%
Fair Value
Investment in Significant PAS 38 20% to 50%
Associate Influence
Investment in Control PFRS 3 and PFRS 51% to 100%
Subsidiary 10
Investment in Joint Joint Control PFRS 11 and PAS Contractually agreed
Venture 38 sharing of control
Definitions
Significance influence is the power to participate in the financial and operating policy decisions
of the investee but not control or joint control over those policies.
Control is the power over the investee or the power to govern the financial and operating
policies of an investee so as to obtain benefits.
Associate is simply defined as an entity over which the investor has significant influence.
Subsidiary is simply defined as an entity that is controlled by another entity.
Significant influence
The assessment of significant influence is a matter of judgment.
However, PAS 28, paragraph5, provides a practical guidance to assist management in making
such assessment.
Significant influence is presumed to exist if the investor holds, directly or indirectly (e.g. through
subsidiaries), 20% or more of the voting power of the investee, unless it can be clearly
demonstrated that this is not the case.
Evidence of existence of significant influence by an investor
The following may provide evidence of significant influence even if the percentage of ownership
interest is less than 20%.
a) Representation on the board of directors or equivalent governing body of the investee;
b) Participation in policy-making processes, including participation in decisions about
dividends or other distributions;
c) Material transactions between the investor and the investee;
d) Interchange of managerial personnel; or
Provision of essential technical information.
For significant influence to exist, the investment should provide the investor voting rights. Thus,
investment in preference shares, regardless of the percentage of ownership, is not accounted
for under PAS 28 because preference shares do not give the investor voting rights.
Potential voting rights

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An entity may own share warrant, debt or equity instruments that are convertible into ordinary
shares that have the potential, if exercised or converted, to give the entity additional voting power
over the financial and operating policies of another entity.
PAS 28, paragraph 7, provides that the existence of such potential voting rights is considered in
assessing whether an entity has significant influence.
The potential voting rights should be currently exercisable or convertible.
Potential voting rights are not currently exercisable or convertible when the rights cannot be
exercised or converted until a future date or until the occurrence of a future event.
Loss of significant influence
An entity loss significant influence over an investee when it losses the power to participate in the
financial and operating policy decisions of the investee.
The loss of significant influence can occur with or without change in the absolute or relative
ownership interest.
The loss of significant influence could also occur as a result of a contractual agreement.
Equity method
The equity method is based on the economic relationship between the investor and the investee.
The investor and the investee are viewed as a single economic unit. The investor and the investee
are one and the same.
The equity method is applicable when the investor has a significance influence over the investee.
Under the equity method, the investment is initially recognized at cost and the carrying amount is
increased by the investor’s share of the profit of the investee and decreased by the investor’s
share of the loss of the investee.
Thus, investments in associates or joint ventures are accounted for using the equity method.
Under this method, the investment is initially recognized at cost and subsequently adjusted for
the investor’s share in the changes in the EQUITY of the investee.
Excess of net fair value over cost
PAS 28, paragraph 32, provides that any excess of the investor’s share of the net fair value of
the associate’s identifiable assets and liabilities over the cost of the investment is included as
income in the determination of the investor’s share of the associate’s profit or loss in the period in
which the investment is acquired.
Investee with heavy losses
PAS 28, paragraph 38, provides that if an investor’s share of losses of an associate equals or
exceeds the carrying amount of an investment, the investor discontinues recognizing its share of
further losses.
The investment is reported at nil or zero value.
The carrying amount of the investment in associate is not just the balance of the account
“investment in associate”.

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The carrying amount of the investment in associate also includes other long-term interests in an
associate, such as long-term receivables, loans and advance.
However, trade receivables and any long-term receivables for which adequate collateral exists,
such as secured loans, are excluded from the carrying amount of an investment in associate.
Impairment loss
If there is an indication that an investment in associate may be impaired, PAS 28, paragraph 40,
in conjunction with PAS 36 on “impairment of assets” requires that an impairment loss shall be
recognized “whenever the carrying amount of the investment in associate exceeds its recoverable
amount”.
The recoverable amount is measured as the higher between fair value less cost of disposal and
value in use.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an
Value in use is the present value of the estimated future cash flows expected to arise from the
continuing use of an asset and from its ultimate disposal.
The value in use of an investment in associate is the investor’s share in either of the following:
a. Present value of estimated future cash flows expected to be generated by the investee,
including cash flows from operations of the investee and the proceeds on the ultimate
disposal of the investment.
b. Present value of the estimated future cash flows expected to arise from dividends to be
received from the investment and from its ultimate disposal.
Again, under Equity Method, the investment is initially recognized at cost and
subsequently adjusted for the investor’s share in the investee’s changes in equity. The
table below shows the effects of the transactions to the investment in associate and investment
income account.
Share in Associate’s Effect on investment in Effect on investment
associate income
Profit or Loss Increase for share in profit; Increase for share in profit;
Decrease for share in loss Decrease for share in loss
Dividends Decrease No effect
OCI Increase for share in gain; No effect; the share in OCI is
decrease for share in loss included in the Investor’s OCI
Undervaluation/ Decrease for undervaluation Decrease for undervaluation
Overvaluation of Assets of assets; Increase for of assets; Increase for
overvaluation of assets overvaluation of assets

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T-Accounts
Investment in Associate
Beginning Balance XX Share in loss XX
Share in Profit XX Share in OCI (loss) XX
Share in OCI (gain) XX Share in Dividends XX
Overvaluation of Assets XX Undervaluation of Assets XX
Ending Balance XX
Share in P/L of an Associate

Share in Loss XX Share in profit XX
Undervaluation of Assets XX Overvaluation of Assets XX
Unrealized Profit XX Realized Profit XX
Share in Loss XX Share in Profit XX
Illustrative Example 1
At the beginning of the current year, Disgust Company purchased 30,000 shares of an investee’s
200,000 outstanding ordinary shares for P6,000,000. On that date, the carrying amount of the
acquired shares was P4,000,000. The entity attributed the excess of the cost over the carrying
amount to patent with remaining useful life of 10 years.
During the year, Disgust Company’s officers gained a majority on the investee’s board of
directors. The investee reported earnings of P5,000,000 for the year and paid dividend of
P3,000,000 at year-end.
Required:
a. Prepare journal entries to record the transactions for the current year.
b. Compute the investment income for the current year.
c. Compute the carrying amount of the investment at year-end.
Solution:
a. Prepare journal entries to record the transactions for the current year.

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b. Compute the investment income for the current year.

Interest Acquired is 15% computed as 30,000 shares/ 200,000 shares, although the
quantitate threshold (20%) did not met, it is clearly stated in the problem that the company
has gained majority on the investee’s board of directors. Thus, equity method shall apply.
Share in Loss - Share in Profit (5M x 15%) 750,000
Undervaluation of Asset (2M/10) 200,000 Overvaluation of Assets -
Unrealized Profit - Realized Profit -
Share in Profit 550,000
a. Compute the carrying amount of the investment at year-end.

Beginning Balance 6,000,000 Share in loss -
Share in Profit 550,000 Share in OCI (loss) -
Share in OCI (gain) - Share in Dividends (3M x 15%) 450,000
Overvaluation of Assets - Undervaluation of Assets 200,000
Ending Balance 5,900,000
Alpha Company acquired 20,000 shares of Beta Company on January 1, 209 at P120 per share.
Beta company had 80,000 shares outstanding with a carrying amount of P8,000,000. The
difference between the carrying amount and the fair value of Beta Company on January 1, 2019
is attributable to a broadcast license intangible asset. Beta company recorded earnings of
P3,600,000 and P3,900,000 for 2019 and 2020, respectively, and paid per-share dividend of P16
in 2019 and P20 in 2020. Alpha company has a 20-year straight line amortization policy for the
broadcast license.
Required:
a. Compute for the investment income for 2019.
b. Compute for the investment income for 2020.
c. Determine the carrying amount of the investment in associate on December 31, 2020.
Solution:
a. Compute for the investment income for 2019.
Share in Loss - Share in profit (3.6M X 25%) 900,000
Undervaluation of Assets (400K/20) 20,000 Overvaluation of Assets -

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Acquisition Cost (20,000 X 120) 2,400,000 Interest Acquired = 20,000/80,000= 25%

Net Assets Acquired (25% X 8M) 2,000,000
Excess of Cost 400,000
b. Compute for the investment income for 2020.

Share in Loss - Share in profit (3.9M X 25%) 975,000
Undervaluation of Assets (400K/20) 20,000 Overvaluation of Assets -
c. Determine the carrying amount of the investment in associate on December 31, 2020.
Beginning Balance 2,400,000 Share in loss -
2019
Share in Profit 900,000 Share in OCI (loss) -
Share in OCI (gain) - Share in Dividends (20K x 16) 320,000
Overvaluation of Assets - Undervaluation of Assets 20,000
Ending Balance, 2019 2,960,000
Share in Profit 975,000 Share in loss -
Share in OCI (gain) - Share in OCI (loss) -
2020
Overvaluation of Assets - Share in Dividends (20K x 20) 400,000
Undervaluation of Assets 20,000
Preference shares issued by an associate

If an associate has outstanding preference shares that are held by parties other than the
investor, the investor computes its share of profits or losses after making the following
adjustments.
Preference share is Preference share is Preference share is
cumulative noncumulative redeemable
 Deduct one-year  Deduct dividends only  No dividend is

dividend, whether when declared before deducted when
declared or not computing share in computing share in
before computing associate’s profit or loss. associate’s profit or
share in associate’s loss.
profit or loss.

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Investee with cumulative preference shares

When an associate has outstanding cumulative preference shares, the investor shall compute its
shares of earnings or losses after deducting the preference dividends, whether or not such
dividends are declared.
Investee with noncumulative preference shares
When an associate has outstanding noncumulative preference shares, the investor shall compute
its share of earnings after deducting the preference dividends only when declared.
Other changes in equity
Adjustments to the carrying amount of the investment in associate may be necessary for changes
in the investor’s proportionate interest in the investee arising from changes in the investee’s equity
that have not been recognized in the investee’s profit or loss.
Adjustment of investee’s operations
1. The most recent available financial statements of the associate are used by the investor in
applying the equity method.
In any case, the difference between the reporting date of the associate and that of the investor
shall be no more than three months.
2. If an associate uses accounting policies other than those of the investor, adjustments shall be
made to conform the associate’s accounting policies to those of the investor.
3. Profits and losses resulting from upstream and downstream transactions between an investor
and an associate are recognized in the investor’s financial statements only to the extent of the
unrelated investor’s interests in the associate.
The investor’s share in the associate’s profits and losses resulting from these transactions is
eliminated.
Upstream transactions
Upstream transactions are sales of assets from an associate to the investor.
For example, the associate sells the inventory or noncurrent asset to the investor.
The unrealized profit from these transactions must be eliminated in determining the investor’s
share in the profit or loss of the associate.
Downstream transactions
Downstream transactions are sales of assets from the investor to an associate.
For example, the investor sells inventory or noncurrent asset to an associate.
Unquestionably, the unrealized profit from these transactions must be also eliminated as
prescribed by paragraph 28 of PAS 28.
Accounting issue
The accounting issue is how to eliminate the unrealized profit from downstream transactions.
Unfortunately, PAS 28 does not offer a crystal-clear guidance on the accounting issue.

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Actually, this issue is still the subject of discussion paper for an IFRIC interpretation.
Discontinuance of equity method – change from equity
PAS 28, paragraph 22, provides that an investor shall discontinue the use of the equity method
from the date that it ceases to have significant influence over an associate.
• An investor starts to apply the equity method on the date it obtains significant influence
and ceases to apply the equity method on the date it loses significant influence.
• On the loss of significant influence, the investor shall measure at fair value any investment
the investor retains in the former associate. The investor shall recognize in profit or loss
any difference between:
a. The fair value of any retained investment and any proceeds from disposing
of the part interest in the associate; and
b. The carrying amount of the investment at the date when significant
influence is lost.
The investor shall account for the investment as follows:
a. Financial asset at fair value through profit or loss.
b. Financial asset at fair value through other comprehensive income.
c. Nonmarketable investment at cost or investment in unquoted equity instrument.
PAS 28, basis for conclusion 18, requires an investor that continues to have significant influence
over an associate to apply the equity method even if the associate is operating under severe long-
term restrictions that significantly impair the ability to transfer funds to the investor.
Significant influence must be lost before the equity method ceases to be applicable.
Measurement after loss of significant influence
PAS 28, paragraph 22, provides that on the date the significant influence is lost, the investor shall
measure any retained investment in associate at fair value.
The difference between the carrying amount of the retained investment at the date the significant
influence is lost and the fair value of the retained investment shall be included in profit or loss.
Paragraph 22 further provides that the fair value of the investment at the date ceases to be an
associate shall be regarded as the fair value on initial recognition as a financial asset.
Classification of retained interest
Following the discontinuance of equity method, the retained interest shall be classified as follows:
Loss of significant influence due to Accounting treatment
• Decrease of ownership interest below ➢ Financial asset at fair value under

20%. PFRS 9
• Increase of ownership above 50% ➢ Investment in subsidiary under PFRS 3

and PFRS 10

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Reclassification of cumulative OCI

If an investor loses significant influence over an associate, all amounts recognized in other
comprehensive income in relation to the associate shall be accounted on the same basis as
would be required if the associate had directly disposed of the related assets or liabilities.
Change to equity method - Gain of significant influence
Significant influence may be achieved from additional purchase of shares resulting to an increase
in ownership interest. Although, not specifically addressed in PAS 28, this type of acquisition may
be accounted for by reference to PFRS 3 Business Combinations particularly on the accounting
for business combination achieved in stages.
“In a business combination achieved in stages, the acquirer shall remeasure its previously held
equity interest in the acquiree at its acquisition-date fair value and recognize the resulting gain
or loss, if any, in profit or loss or other comprehensive income, as appropriate.” (PFRS 3.42)
Equity method not applicable
PAS 28, paragraph 17, provides that an investment in associate shall not be accounted for using
the equity method if the investor is a parent that is exempt from preparing consolidated financial
statements or if all of the following apply:
a. The investor is a wholly-owned subsidiary, or a partially-owned subsidiary of another entity
and the other owners do not object to the investor not applying the equity method.
b. The investor’s debt and equity instruments are not traded in a public market or “over the
counter” market.
c. The investor did not file or it is not in the process of filing financial statements with the SEC
for the purpose of issuing any class of instruments in a public market.
d. The ultimate or any intermediate parent of the investor produces consolidated financial
statements available for public use that comply with Philippine Financial Reporting
Standards.
In these circumstances, the investment is accounted for as follows:
a. Financial asset at fair value through profit or loss.
b. Financial asset at fair value through other comprehensive income.
c. Nonmarketable investment at cost or investment in unquoted equity instrument.
Associate held for sale
PAS 28, paragraph 20, provides that if the investment in associate is classified as held for sale, it
is accounted for in accordance with PFRS 5.
This means that the investment in associate classified as “held for sale” shall be measured at the
lower of carrying amount and fair value less cost of disposal.
Investment of less than 20%
If the investor holds, directly or indirectly, through subsidiaries less than 20% of the voting power
of the investee, it is presumed that the investor does not have significant influence, unless such
influence can be clearly demonstrated.

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Accounting for investment of less than 20%

a. Fair value method – this is applicable to financial asset measured at fair value through
profit or loss and financial asset measured at fair value through other comprehensive
income.
b. Cost method – the cost method is usually applied with respect to investment in unquoted
equity instrument or nonmarketable equity investment.
PFRS 3, paragraph 42, provides that in a business combination achieved in stages, the acquirer
shall remeasure the previously held equity interest at fair value and recognize the resulting gain
or loss in profit or loss.
Dividend from pre-acquisition retained earnings
There is no longer a distinction between pre-acquisition dividends and post-acquisition dividends.
In applying the fair value and cost method, dividends received from an investee are recognized
as dividend income, regardless of whether the dividends originated from pre-acquisition retained
earnings or post-acquisition retained earnings.
Fair value approach
a. The existing interest in the associate is remeasured at fair value with any change in fair value
included in profit or loss.
b. However, if the existing interest is accounted for at fair value through other comprehensive
income, any unrealized gain or loss at the date the investee becomes an associate is reclassified
to retained earnings.
c. The fair value of the existing interest plus the cost of the additional interest acquired constitutes
the total cost of the investment for the initial application of the equity method.
d. The total cost of the investment for the initial application of the equity method minus the
carrying amount of the net assets acquired at the date significant influence is obtained equals
excess of cost over carrying amount or excess net fair value.
Glorious Company acquired 40% interest in an associate, Alta company, for P5,000,000 on
January 1, 2019. At the acquisition date, there were no difference between fair value and carrying
amount of identifiable assets and liabilities.
Alta company reported net income of P2,000,000 for 2019 and P3,000,000 for 2020. On
December 31, 2019 and 2020, Alta company paid cash dividend of P800,000 and P1,000,000,
respectively.
a. On January 1, 2019, Alta company sold an equipment costing P500,000 to Glorious
company for P800,000. Glorious company applies a 10% straight line depreciation.
b. On July 1, 2020, Alta Company sold an equipment for P900,000 to Glorious company. The
carrying amount of the equipment is P500,000 at the time of sale. The remaining life of
the equipment is 5 years and Glorious company uses straight line depreciation.
c. On December 1, 2020, Alta company sold an inventory to Glorious company for
P2,800,000. The inventory had a cost of P2,000,000 and was still on hand on December
31, 2020.

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Required:
1. Determine the investor’s share in the profit of the associate for 2019.
3. Prepare journal entries on the books of Glorious company for 2019 and 2020 in relation to
the investment in associate.
4. Determine the carrying amount of the investment in associate on December 31, 2020.
Solution:
Share in P/L of an Associate*
Loss - Profit 2,000,000
Undervaluation of Asset - Overvaluation of Assets
Unrealized Profit (800K-500K) 300,000 Realized Profit (300K X 10%) 30,000
Adjusted Profit 1,730,000

Share in Profit (1,730,000 X 40%) 692,000
*This is also one way of computing the share of the Investor in the Profit of the Investee
wherein you are going to adjust first the profit of the investee and multiply with the interest
of the investor.
Loss - Profit 3,000,000
Undervaluation of Asset - Overvaluation of Assets
Unrealized Profit (900K-500K) 400,000 Realized Profit (300K X 10%) 30,000
Unrealized Profit (2.8M-2M) 800,000 Realized Profit (400K/5 X1/2) 40,000
Adjusted Profit 1,870,000
Share in Profit (1,870,000 X 40%) 748,000
3. Prepare journal entries on the books of Glorious company for 2019 and 2020 in relation to the
investment in associate.

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4. Determine the carrying amount of the investment in associate on December 31, 2020.
Beginning Balance,2019 5,000,000 Share in loss -
Share in Profit (2019) 692,000 Share in OCI (loss) -
Share in Profit (2020) 748,000 Share in Dividends,2019 (800K x 40%) 320,000
Share in OCI (gain) - Share in Dividends,2020 (1M x 40%) 400,000
Overvaluation of Assets - Undervaluation of Assets -
Assessment
Activity 1
Answer Problems 2 and 3 of the Chapter 14 of your book Intermediate Accounting 1 B.
Activity 2

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Topic 5 - Investment Property
Investment property
• Investment property is “property (land or a building – or a part of a building – or
both) held (by the owner or by the lessee under finance lease) to earn rentals or
for capital appreciation or both, rather than for:
a. use in the production or supply of goods or services or for administrative
purposes; or
b. sale in the ordinary course of business.”
(PAS 40)
Learning Outcomes
• Apply the nature and purpose on Investment property.

• Apply the concept of recognition and measurement of an Investment property.
• Solve problems about Investment property.
Pretest
Content
PAS 40 prescribes the accounting treatment for investment property and related disclosure
requirements.
Investment property is defined as property (land or building or the part of a building or both) held
by an owner or by the lessee under a finance lease to earn rentals or for capital appreciation or
both.
An equipment or any movable property cannot qualify as investment property.

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An investment property is not held:

a. For use in the production or supply of goods or services or for administrative purposes.
b. For sale in the ordinary course of business.
The property held by an owner or lessee under a finance lease for use in the production or supply
of goods or services, or for administrative purposes is known as owner-occupied property.
Examples of investment property
a. Land held for long-term capital appreciation.
b. Land held for a currently undetermined use.
c. Building owned by the reporting entity, or held by the entity under a finance lease, and
leased out under an operating lease.
d. Building that is vacant but is held to be leased out under an operating lease.
e. Property that is being constructed or developed for future use as investment property.
PAS 40 has been amended to bring property that is being constructed or developed for future use
as investment property.
Items not considered investment property
a. owner-occupied property or property held for use in the production or supply of goods or
services or for administrative purposes.
b. Property held for future use as owner-occupied property.
c. Property held for future development and subsequent use as owner-occupied property.
d. Property occupied by employees, whether or not the employees pay rent at market rate.
e. Owner-occupied property awaiting disposal.
f. Property held for sale in the ordinary course of business or in the process of construction
or development for such sale.
g. Property being constructed or developed on behalf of third parties.
h. Property that is leased to another entity under a finance lease.
Property interest held by lessee
A property interest that is held by a lessee under an operating lease may be classified and
accounted for as investment property provided:
a. The property meets the definition of investment property.
b. The operating lease is accounted for as if it were a finance lease.
c. The lessee uses the fair value model in measuring the property interest.
This classification alternative is available on a property by property basis.

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Investment property vs. Owner-Occupied Property (PPE)

Investment property Owner-occupied property
• Held to earn rentals or for capital • Held for use in the production or supply
appreciation or both. of goods or services or for
administrative purposes.
• Generates cash flows largely • Generates cash flows in conjunction

independently of the other assets held with the other assets held by an entity.
by an entity
• Includes only land and building • May include assets other than land and
building
• Accounted for under PAS 40 • Accounted for under PAS 16
Property that is partly investment property and partly owner-occupied

Certain properties may include a portion that is held to earn rentals or for appreciation and another
portion that is held for manufacturing or administrative purposes.
• If the portions could be sold separately (or leased out separately under a finance lease),
an entity accounts for the portions separately. The portion being rented out under
operating lease is classified as investment property and the portion used as owner-
occupied is classified as property, plant, and equipment.
• If the portions could not be sold separately, the property is investment property only if
an insignificant portion is held for use in the production or supply of goods or services
or for administrative purposes. If the owner-occupied portion is significant, the entire
property is classified as property, plant, and equipment.
Property leased to an affiliate
From the perspective of the individual entity that owns it, the property leased to another
subsidiary or its parent is considered an investment property.
However, from the perspective of the group as a whole and for purposes of consolidated financial
statements, the property is treated as owner-occupied property.
Recognition of investment property
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.
b. The cost of the investment property can be measured reliably.
Initial measurement of investment property
An investment property shall be measured initially at its cost. Transaction costs shall be included
in the initial measurement. the cost of a purchased investment property comprises the purchase
price and any directly attributable expenditure.

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Directly attributable expenditure includes professional fees for legal services, 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.
If the payment for an investment property is deferred, the cost is the cash price equivalent.
The difference between this amount and the total payments is recognized as interest expense
over the credit period.
Costs excluded from cost of investment property
a. Startup costs, unless they are 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.
Subsequent measurement of investment property
a. Fair value model
The investment property is carried at fair value.
b. Cost model
The investment property is carried at cost less any accumulated depreciation and any
accumulated impairment losses.
Fair value of the investment property shall be disclosed.
Property interest in operating lease
If a property interest in an operating lease is classified as investment property, all items of
investment property shall be measured under the fair value model.
Change in accounting policy
• A change from the cost model to the fair value is accounted for prospectively.
• A change from the fair value model to the cost model is not permitted.
Fair value of investment property
Fair value of an asset is the price that would be received to sell an asset in an orderly transaction
between market participants at the measurement date.
The price in the principal market used to measure fair value shall not be adjusted for transaction
costs.
Transaction costs are directly attributable to the disposal of an asset and would not have been
incurred had the decision to sell the asset not been made.
The fair value of investment property excludes prepaid or accrued operating leased income.
Overserve the Fair value hierarchy

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PFRS 13, paragraph 72, enumerates the fair value hierarchy or best evidence of fair value as
follows:
1. Level 1 inputs are the quoted prices in an active market for identical assets.
2. Level 2 inputs include quoted prices for similar assets in an active market and quoted
prices for identical or similar assets in a market that is not active.
3. Level 3 inputs are unobservable inputs for the asset.
Unobservable inputs are usually developed by the entity using the best available information
from the entity’s own data.
Active market ad principal market
An active market is a market in which transactions for the asset or liability take place with
sufficient regularity and volume to provide pricing information on an ongoing basis.
A principal market is the market with the greatest volume and level of activity for the asset or
liability.
The market participants are the buyers and sellers in the principal market who are:
a. Independent or unrelated parties
b. Knowledgeable or having a reasonable understanding of the transaction
c. Willing or motivated but not forced and compelled
Inability to determine fair value reliably
There is a rebuttable presumption that an entity can reliably determine the fair value of an
investment property on a continuing basis.
However, in exceptional cases, when an entity first acquires an investment property, or when an
existing property becomes investment property because there has been a change of use, there
may be clear evidence that the fair value of the investment properly cannot be determined reliably
on a continuing basis.
Moreover, under such exceptional cases only, the residual value of the investment property shall
be assumed to be zero.
Transfers of investment property
Transfers to and from investment property shall made when and only when there is a change of
use evidenced by:
a. Commencement of owner occupation – transfer from investment property to owner-
occupied property.
b. Commencement of development with a view to sale – transfer from investment property
to inventory.
c. End of owner occupation – transfer from owner-occupied property to investment property.
d. Commencement of an operating lease to another entity – transfer from owner-occupied
property to investment property.
Measurement of transfers

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1. When the entity uses the cost model, transfers between investment property, owner-
occupied property and inventory shall be made at carrying amount.
2. A transfer from investment property carried at fair value to owner-occupied property or
inventory shall be accounted for at fair value which becomes the deemed cost for
subsequent accounting.
3. If owner-occupied property is transferred to investment property that is to be carried at
fair value, the difference between the fair value and the carrying amount of the property
shall be accounted for as revaluation of property, plant and equipment.
4. If an inventory is transferred to investment property that is to be carried at fair value, the
remeasurement to fair value shall be included in profit or loss.
5. When an investment property under construction is completed and to be carried at fair
value, the difference between fair value and carrying amount shall be included in profit or
loss.
Derecognition of investment property
An investment property shall be derecognized:
a. On disposal.
b. When the investment property is permanently withdrawn from use.
c. When no future economic benefits are expected from the investment property.
Disposal of investment property
Gain or loss from disposal of investment property shall be determined as the difference between
the net disposal proceeds and the carrying amount of the asset and shall be recognized in profit
or loss.
Disclosures related to investment property
The general disclosures are:
1. Whether the entity uses the cost model or fair value model of measuring investment
property.
2. The amount of rental income for the period along with the related expense.
3. Restrictions on the investment property either through rentals or sale proceeds.
4. Contractual obligations to purchase or construct investment property.
When the fair value method is used, the disclosures are:
1. Detailed reconciliation, showing all movements, between carrying amount of investment
property at the beginning and end of the period.
2. The method of determining the fair value of investment property and whether the valuation
is carried out by an independent qualified valuer.
3. net gains or losses from fair value adjustments.
4. Whether significant fixtures, such as lift and office furniture, within an investment property,
have been separately recognized.

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When the cost method is used, the disclosures are:

1. The depreciation method or rate and useful life.
2. Detailed reconciliation of the gross cost of investment property and the related
accumulated depreciation showing all movements during the year.
3. Fair value of the investment property where possible. If it is not possible, such fact shall
be explained.
Classic Company and its subsidiaries own the following properties that are accounted for in
accordance with international accounting standards:
Land held by the parent for undetermined use 5,000,000
A vacant building owned by the parent and to be leased out under an operating 3,000,000
lease
Property held by a subsidiary, a real estate firm, in the ordinary course of the 2,000,000
business
Property held by the parent for use in production 4,000,000
Building owned by a subsidiary and for which the subsidiary provides security and 1,500,000
maintenance services to the lessees
Land leased by the parent to a subsidiary under an operating leased 2,500,000
Property under construction for use as investment property 6,000,000
Land held for future factory site 3,500,000
Machinery leased out by the parent to an unrelated party under an operating 1,000,000
leased
Required:
1. Compute the total investment property that should be reported in the consolidated
statement of financial position of Classic Company and its subsidiaries.
2. Indicate the classification of the assets that are excluded from investment property.
Solution:
1. Compute the total investment property that should be reported in the consolidated statement
of financial position of Classic Company and its subsidiaries.
2. Indicate the classification of the assets that are excluded from investment property.

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Galore Company ventured into construction of a condominium in Makati which is rated as the
largest state-of-the-art structure. The board of directors decided that instead of selling the
condominium, the entity would hold this property for purposes of earning rentals by letting out
space to business executives in the area. The construction of the condominium was completed
and the property was placed in serviced on January 1, 2019. The cost of the construction was
P50,000,000. The useful life of the condominium is 25 years and the residual value is P5,000,000.
An independent valuation expert provided the following fair value at each subsequent year-end:
December 31, 2019 55,000,000
December 31, 2020 53,000,000
December 31, 2021 60,000,000
Required:
Prepare journal entries for 2019, 2020 and 2021:
a. The investment property is accounted for under the cost method.
b. The investment property is accounted for under the fair value method.
Solutions:
a. The investment property is accounted for under the cost method.

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b. The investment property is accounted for under the fair value method.
*Observed that the journal entries of each model differ, it has been discussed above.
Assessment
Activity 1
Activity 2

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Unit 5- Accounting for Property, Plant and Equipment
Topic 1- Land, Building and Machinery
Property, Plant and Equipment

Property, plant and equipment are tangible assets that use in production of goods and
services, or for administrative purposes and expected to be used over a period of more
than one year.
(PFRS 16)
Examples are but not limited to the following:

Land; Land improvements; Building; Machinery; Ship; Aircraft; Motor vehicle; Furniture
and fixtures; Office equipment; Patterns, molds, and dies; Tools; Book plates
Learning Outcomes
• Apply the nature and characteristics of property, plant and equipment.

• Apply the concept of recognition and measurement of property, plant and
equipment specifically the land, building and machinery.
• Solve problems about land, building and machinery.
Pretest
Content
Characteristics of PPE
a. Tangible assets – items of PPE have physical substance
b. Used in normal operations – items of PPE are used in the production or supply of goods
or services, for rental, or for administrative purposes

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c. Long-term in nature – items of PPE are expected to be used for more than a year
Recognition
The cost of an item of property, plant and equipment shall be recognized as an asset only if:
a. it is probable that future economic benefits associated with the item will flow to the entity;
and
b. the cost of the item can be measured reliably.
Initial measurement
• An item of PPE is initially measured at its cost.
• Cost – is the amount of cash equivalent paid and the fair value of the other consideration
given to acquire an asset at the time of acquisition or construction. If payment is deferred
beyond normal credit terms, the difference between the cash price equivalent and the total
payment is recognized as interest over the period of credit unless such interest is
capitalized in accordance with PAS 23 Borrowing Costs.
Elements of Cost
1. Purchase price, including non-refundable purchase taxes, after deducting trade discounts
and rebates.
2. Costs directly attributable to bringing the asset to the location and condition necessary for
it to be capable of operating in the manner intended by the management.
3. Present value of decommissioning and restoration costs to the extent that they are
recognized as obligation
Directly attributable costs
Examples:
*Cost of employee benefits arising directly from the construction
* Cost of site preparation
* Initial delivery and handling cost
* Installation an assembly cost
* Professional fees
* Cost of testing whether the asset is functioning properly
Cessation of capitalizing costs to PPE
• Recognition of costs in the carrying amount of an item of PPE ceases when the item is in
the location and condition necessary for it to be capable of operating in the manner
intended by management.
Acquisition of Property
There are many ways of acquiring property and each presents a costing problem for accounting
purposes only, namely:
1. Cash basis

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2. On account subject to cash discount

3. Installment basis
4. Issuance of Share capital
5. Issuance of Bonds Payable
6. Exchange
7. Donation
8. Government Grant
9. Construction
Acquisition on Cash basis
-is the cash price equivalent at the recognition date.
- simply includes cash paid plus directly attributable costs such as freight, installation cost and
other cost necessary in bringing asset to the location and condition for the intended use.
Acquisition on account subject to cash discount
-when asset is acquired on account subject to cash discount, the cost of the asset is equal to
the invoice price minus the discount, regardless of whether the discount is taken or not.
Cash discount are generally considered as a reduction of cost and not as income.
Acquisition on Installment basis
- when payment for item of property, plant and equipment is deferred beyond normal credit
terms, the cost is the cash price equivalent. The excess of installment price over the cash
price is treated as an interest to be amortized over the credit period.
- If there is no cash price available, the asset is recorded at an amount equal to the Present
Value of all payments using an implied interest rate.
Acquisition through Issuance of share capital
-where a property is acquired through the issuance of share capital
-property shall be measured at an amount equal to the following: (In order of priority, when
on is not present, proceed to the other recognition.)
a. Fair value of the property
b. Fair value of the share capital
c. Par value or stated value of the share capital
Acquisition through Issuance of bonds payable
- asset acquired by issuing bonds payable is measured: (In order of priority, when on is not
present, proceed to the other recognition.)
a. Fair value of bonds payable
b. Fair value of asset received
c. Face amount of bonds payable

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Acquisition by Exchange
PAS 16, paragraph 24, provides that the cost of an item of property, plant and equipment acquired
in exchange for a nonmonetary asset an is measured at fair value.
Commercial substance – is a new notion and is defined as the event or transaction causing the
cash flows of an entity to change significantly by reason of the exchange.
• If the exchange has commercial substance, the asset received from the exchange is
measured using the following order of priority:
a. Fair value of asset Given up Plus cash Paid/ minus cash received
b. Fair value of asset Received
c. Carrying amount of asset Given up Plus cash Paid/ minus cash received
• If the exchange lacks commercial substance, the asset received from the exchange is
measured at (c) above.
Trade in
• is a form of exchange.
• involves a nondealer acquiring the asset from a dealer.
• involves significant amount of cash
• transaction has commercial substance.
Donation
At present, IFRS does not address donation or contribution. However, IFRS explicitly addresses
government grant.
Philippine GAAP provides that contributions received from shareholders shall be recorded at fair
value with the credit going to donated capital.
Expenses incurred in connection with the donation, like payment of registration fees and legal
fees shall be charged to the donated capital account.
Thus, Items of PPE received as donation are measured at fair value and accounted for as:
a. Income – if the donor is an unrelated party.
b. Donated capital – if the donor is an owner (shareholder).
c. Government grant, in accordance with PAS 20 Accounting for Government Grants and
Disclosure of Government Assistance. Accounting (see Topic 2) – if the donor is the
government.
Construction
cost of self-constructed asset is determined using the same principles as for an acquired asset.
Shall include:
1. Direct cost of material
2. Direct cost of labor
3. Indirect cost and incremental overhead

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Derecognition
– the cost of the property, plant and equipment together with the related accumulated depreciation
shall be removed from the accounts.
Fully depreciated property
- when the carrying amount is equal to zero or equal to residual value.
1. Nutty Company made the following individual cash purchases:
Land and Building 6,000,000
Machinery and Office Equipment 1,800,000
Delivery Equipment 500,000
An appraisal disclosed the following fair value:
Land 1,000,000
Building 3,000,000
Machinery 800,000
Office Equipment 400,000
Delivery Equipment 350,000
2. Nutty company acquired the assets of another entity with the following fair value:
Land 1,000,000
Building 5,000,000
Machinery 2,000,000
The entity issued 60,000 shares with P100 par value in exchange. The share had a quoted
price of P150 on the date of purchase of the property.
3. Received a parcel of land located in Dapitan City from a philanthropist as an inducement
to locate a plant in the city. The land has a fair value of P1,500,000.
4. The entity paid cash for a machinery, P900,000 subject to 2% cash discount, and freight
on machinery. P35,000.
5. The entity acquired furniture and fixtures by issuing a P400,000 two-year non-interesting
bearing note. In similar transactions, the entity has paid12% interest. The present value
of 1 at 12% for 2 years is .797, and the present value of an annuity of 1 at 12% for 2 years
is 1.69
Required:
Prepare the journal entries to record the transactions.
Solution:

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Explanation:
1. The land and building as well as the machinery and office equipment are purchased
in lump sum, thus it needs to be pro- rated using the relative sales price method by
getting the ratio based on its fair value.
2. The cost that has been used is the fair value of the property because it is clearly
identifiable, however if that is not present, we will be using the fair value of the
shares or the par value as presented in the order of priority.
3. Income for donation is credited because it is received from unrelated party.
4. Discount is deducted in the purchase price whether taken of not and freight is
capitalizable as part of the machine purchased.
5. Cash price equivalent is not present; thus, it requires the computation of the
present value of the note which eventually equals to the cost of the property being
purchased.
Cherish Company provided the following transactions:

1. Exchanged a car from inventory for a computer to be used as a long-term asset
Carrying amount of the car 300,000
Listed Selling price of the car 450,000
Fair Value of the computer 430,000
Cash difference paid by Cherish Company 50,000
2. Exchanged an old packaging machine which cost P240,000 and was 50% depreciated,
for a new machine and paid a cash difference of P30,000. The fair value of the old
packaging machine is determined to be P110,000 and the list price of the new machine is
P150,000.
3. Exchanged an old equipment costing P3,000,000 with accumulated depreciation of
P1,800,000 and fair value of P1,000,000 for another used equipment with fair value of
P1,200,000. The exchange is nonmonetary.

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Required:
Prepare the journal entries to record the transactions.
Solution:
Explanation:
1. Based on the data, Fair value of asset Given up is not available, thus, we used the
fair value of the asset received as the second priority as our measurement on the
asset received through exchange.
2. The Fair value of asset Given up Plus is available here, and there is cash involved,
the company paid cash thus it will be added to the fair value of the asset that has
been given up. A loss is also being recorded.
3. Since the transaction is nonmonetary, we just simply recorded it by recognizing the
new asset and derecognized the asset that has been subject to exchange.
LAND ACCOUNT
Statement of classification
Depends on the nature and purpose of the land.
➢ use as a plant site, treated as property, plant and equipment.
➢ held for a currently undetermined use is treated as an investment property.
➢ held for long-term capital appreciation is treated as an investment property.
➢ held for current sale by a real estate developer as in the case of subdivided lots is treated
as current asset as part of inventory.
Cost chargeable to Land (Property)
1. Purchase price including other necessary costs such as broker’s commissions.
2. Closing costs, such as titling costs, attorney’s fees, and recording fees.

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3. Costs incurred in getting the land in the condition for its intended use, such as surveying,
grading, filling, draining, and clearing.
4. Unpaid taxes prior to date of acquisition assumed by the buyer.
5. Assumption of any liens, mortgages, or encumbrances on the property
6. Special assessments for local government-maintained improvements, such as
pavements, street lights, sewers, and drainage systems.
7. Option paid to acquire the land.
8. Costs incurred to induce tenants to vacate premises and costs of relocating and
reconstructing property belonging to others.
9. Initial estimate of restoration costs for which the entity has a present obligation
10. Any additional land improvements that have indefinite useful life such as costs of
draining, clearing, grading, leveling and filling, surveying, subdividing, and other
permanent improvements.
Land improvement
• Land improvements are enhancements to the land which have definite useful life, such
as private driveways, walks, fences, parking lots, drainages and water systems, and cost
of trees, shrubs, plants and other landscaping.
• not subject to depreciation are charged to the land account.
• Part of the cost of building if included in the blueprint.
Special assessments
➢ are taxes paid by the landowner as a contribution to the cost of public improvements.
Real property taxes
➢ treated as outright expense. However, if unpaid real property taxes are assumed by the
buyer in acquiring the land, the taxes are capitalized but only up to the date of acquisition.
BUILDING ACCOUNT
Cost of building when purchased
The following expenditures are normally charge to the building account when building is acquired
by purchased:
1. Purchase price including other necessary costs such as broker’s commissions and legal
fees.
2. Assumption of any liens, mortgages, or encumbrances on the property
3. Option paid to acquire the building.
4. Unpaid taxes prior to date of acquisition assumed by the buyer.
5. Costs incurred to induce tenants to vacate premises.
6. Costs of getting the building in the condition for its intended use, such as remodeling,
renovation, and other repairs prior to occupancy.

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Costs of building when constructed

1. Materials, labor, and overhead costs incurred during construction.
2. Architectural costs, supervision costs, and costs of building permit
3. Excavation costs
4. Insurance costs and safety inspection fees
5. Costs of temporary structures built during construction
6. Interest on borrowings made to finance construction (Borrowing costs are discussed in
Topic 2)
The following costs are not included in the cost of a self-constructed building:
1. Internal profits or savings on self-construction
2. Cost of abnormal amounts of wasted material, labor, or other resources due to
inefficiencies
3. Costs of uninsured hazards or claims for uninsured accidents
4. Costs of private driveways, walks, permanent fences, parking lots, and drainages and
water systems that are not included in the building’s blueprint
Claims for damages
Where insurance is taken during the construction of a building, the cost of insurance is charged
to the building because it is a necessary and reasonable cost of bringing the building into
existence.
To charge the damages to the building would be tantamount to concealment of the management
failure or negligence.
Building Fixtures
Expenditures for shelves, cabinets and partitions may be charge to the building or furniture and
fixture depending upon the nature of the expenditures.
If such expenditures are immovable in the sense that these are attached to the building in such
manner that the removal thereof may destroy the building, these are charged to the building
account.
Ventilating system, lighting system, elevator
a. If installed during construction, the ventilating system, lighting system and elevator are
charged to the building account.
b. Otherwise, these are charged to building improvements and depreciated over their useful
life or remaining life of the building, whichever is shorter.
Building improvement
Building improvements refer to costs incurred subsequent to occupancy of a purchased building
or subsequent to completion of a self-constructed building that either increase the useful life of
the building or improve its current state.

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PIC Interpretations on Land and Building

1. Land and old building are purchased at a Single cost:
a. If the old building is reusable, the cost is allocated to land and building based on
relative fair value.
b. If the old building is unusable, the cost is allocated to land only.
2. The old building is demolished immediately to make room for construction of a new
building:
a. The carrying amount of the usable old building is recognized as loss if the new
building is accounted for as PPE or Investment property.
b. The carrying amount of the usable old building is capitalized as cost of the new
building if the new building is accounted for as Inventory.
c. The demolition cost minus salvage value is capitalized as cost of the new
building whether the new building is PPE, Investment property, or Inventory.
d. Demolition cost is capitalized as cost of the land if the old building is
demolished to prepare the land for the intended use but not to make room of
new building.
3. A building is acquired and used in a prior period but demolished in the current period to
make room for the construction of a new building:
a. The carrying amount of the old building is recognized as loss, whether the new
building is PPE, Investment property or Inventory.
b. The demolition cost minus salvage value is capitalized as cost of the new
building whether the new building is PPE, Investment property, or Inventory.
c. If the old building is subject to a contract of lease, any payments to tenants to
induce them to vacate the old building shall be charge to the cost of the new
building.
MACHINERY ACCOUNT
Cost of machinery
when purchased, the cost normally includes the following:
a. Purchased price
b. Freight, handling, storage and other cost related to the acquisition.
c. Insurance while in transit.
d. Installation cost, including site preparation an assembling.
e. Cost of testing and trial run, and other cost necessary in preparing the machinery for its
intended use.
f. Initial estimate of cost of dismantling and removing the machinery and restoring the site
on which it is located, and for which the entity has a present obligation.
g. Fee paid to consultants for advice on the acquisition of the machinery.
h. Cost of safety rail and platform surrounding machine.
i. Cost of water device to keep machine cool.

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The value added tax or VAT on the purchased of machinery is not capitalizable but charged to
input tax to be offset against output tax.
Lump-sum purchase
• The acquisition cost of a group of items of PPE acquired on a lump-sum price (basket
price) is allocated to the individual assets based on their relative fair values at the date of
purchase. It is also called the relative sales price method.
Demolition costs
• The accounting treatment for demolition costs depends on the reason for the demolition.
Example:
Case: An old structure is demolished to make way for the construction of a new building.
Accounting: The demolition costs are considered as costs of site preparation under PAS 16.; and
therefore, capitalized as cost of the new building.
❖ Any proceeds from sale of salvaged materials from the demolition are deducted from the
demolition cost that is capitalized to the new building.
Tools
➢ are classified as machine tools and hand tools. Machine tools include drills and punches.
Hand tools include hammer and saws. Tools should be segregated from the machinery
account.
Patterns and dies
➢ used in designing or forging out a particular product.
➢ used for the regular product are recorded as assets.
➢ depreciated over the useful life
➢ used for specially ordered product from part of the cost of the special product.
Equipment
➢ includes delivery equipment, store equipment, office equipment and furniture and fixtures.
Cost of such equipment includes the purchase price, freight, and other handling charges,
insurance while in transit, installation cost and other costs necessary in preparing them
for the intended use.
Delivery equipment includes cars, trucks, and other vehicles used in business operations.
Store and office equipment include computers, typewriters, adding machines, cash register and
calculator.
Furniture and Fixtures include showcases, counters, shelves, display fixtures, cabinets, partitions,
safe, desks and tables.
In a broad sense, furniture and fixtures may include store and office equipment.
Returnable containers

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Includes bottles, boxes, tanks, drums and barrels which are returned to the seller by the buyer
when the contents are consumed or used.
Capital expenditure and revenue expenditure
An expenditure that benefits only the current period is a revenue expenditure and therefore
reported as an expense.
An expenditure that benefits the current period and future periods is a capital expenditure and
therefore reported as an asset.
Additions
These are modifications or alterations which increase the physical size or capacity of the asset.
Such expenditures are of two types, namely:
a. An entirely new unit
b. An expansion, enlargement or extension of the old asset
Improvements or betterments
Are modifications or alternations which increase the service life or the capacity of the asset.
Replacements
Also involve substitution but the new asset is not better than the old asset when required.
Classified into three:
a. Replacement of the old asset by a new one.
b. Replacement of major parts or extraordinary repairs
c. Replacement of minor parts or ordinary repairs
Repairs
These are those expenditures used to restore assets to good operating condition upon their
breakdown or replacement of broken parts. May be classified as extraordinary or ordinary repairs
Extraordinary repairs are material replacement of parts involving large sums and normally extend
the useful life of the asset. This is usually capitalized.
Ordinary repairs are minor replacement of parts, involving small sums and are frequently
encountered.
Repair and maintenance
Repair is different from maintenance in that repair restores the asset in good operating condition
while maintenance keeps the asset in good condition.
Rearrangement cost is the relocation or redeployment of an existing property, plant and
equipment.
Accounting for major replacement
An important consideration in determining the appropriate accounting treatment for a replacement
is whether the original part of an existing asset is separately identifiable

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Facetious Company incurred the following expenditures related to the construction of the new
home office:
Purchased price of land and an old apartment building 2,000,000
Fair value of land 1,800,000
Legal fees, including fee for title search 10,000
Payment of land mortgage and related interest due at the time of sale 50,000
Payment of delinquent property taxes assumed 20,000
Cost of razing the apartment building 30,000
Grading and drainage of land site 15,000
Architect fee on the new building 200,000
Payment to building contractor 8,000,000
Interest cost to specific borrowing during construction 300,000
Payment of medical bills of the employees accidentally injured while inspecting 10,000
building construction
Cost of paving driveways and parking lot 40,000
Cost of trees, shrubs and other landscaping 55,000
Cost of installing lights in parking lot 5,000
Premium for insurance on building during construction 25,000
Cost of open house party to celebrate opening of building 60,000
Required:
1. What is the cost of land?
2. What is the cost of new building?
3. What is the cost of land improvements?
Solution

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In auditing the records of Tormentor Company for the year ended December 31, 2019, the
following data are discovered;
1. Machine A listed at P4,500,000 was acquired on April 1, 2019 in exchange for P5,000,000
face value bonds maturing on April 1, 2029. The accountant recorded the acquisition by a
debit to machinery and a credit to bonds payable for P5,000,000. The bonds are unquoted
Straight-line depreciation was recorded based on a five-year life and amounted to
P600,000 for 9 months.
2. Machine B listed at P3,200,000 was purchased on January 1, 2019. The entity paid
P500,000 down and P250,000 per month for 12 months. The last payment was made on
December 30, 2019. Straight-line depreciation based on a five-year life and no residual
value was recorded at P700,000 for the year. Freight of P150,000 on Machine B was
charged to freight on account.
3. Machine C was recorded at P3,000,000 which included the carrying amount of P540,000
of a machine accepted as a trade in. the list price of Machine C was P2,610,000 and the
trade in allowance was P150,000. This transaction took place on December 22, 2019.
4. Machine D was acquired on January 10, 2019in exchange of a past due account
receivable of P4,200,000 on which an allowance of 20% was established at the end of the
prior year. The fair value of the machine on January 10 was estimated at P3,300,000. The
machine was recorded by a debit to machinery and credit to accounts receivable for
P4,200,000. No depreciation was recorded on Machine D because it was never installed
for use. In March, the machine was exchange for 30,000 shares of the entity having a
market value of P120 per share. The treasury shares account was debited for P4,200,000,
the carrying amount of the Machine D.
Required:
Prepare the adjusting entries on December 31, 2019.
Solution

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Assessment
Activity 1
Activity 2

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Topic 2- Government Grants and Borrowing Costs
Government Grants
PAS 20, paragraph 3, defines as “as assistance by government in the form of transfer of
resources to an entity in return for part or future compliance with certain conditions
relating to the operating activities of the entity”.
Borrowing Costs
PAS 23, paragraph 5, borrowing cost are defined as “interest and other costs that an
entity incurs in connection with borrowing of funds”.
Learning Outcomes
• Apply the accounting treatment of a government grants.

• Apply the concept of recognition and measurement of borrowing costs.
• Solve problems about government grants and borrowing costs.
Pretest
Answer page 265 and page 294 of your book Intermediate Accounting 1 B.
Content
Government Grant definition

• Government grants are assistance by government in 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. They exclude those forms of government assistance
which cannot reasonably have a value placed upon them and transactions with

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government which cannot be distinguished from the normal trading transactions of the
entity.
• Other terms for government grants include subsidies, subventions, or premiums.
The following are not government grants:
a. Tax benefits,
b. Free technical or marketing advice,
c. Provision of guarantees,
d. Government procurement policy that is responsible for a portion of the entity’s
sales, and
e. Public improvements that benefit the entire community.
Recognition
• Government grants, including non-monetary grants at fair value, shall not be recognized
until there is reasonable assurance that:
a. the entity will comply with the conditions attaching to them; and
b. the grants will be received
Classifications of government grants according to attached condition

a. Grants related to assets – grants whose primary condition is that an entity qualifying for
them should purchase, construct or otherwise acquire long-term assets.
b. Grants related to income – grants other than those related to assets.
Initial measurement
• Monetary grants are measured at the
a. amount of cash received; or
b. the fair value of amount receivable; or
c. carrying amount of loan payable to government for which repayment is forgiven;
or
d. discount on loan payable to government at a below-market rate of interest.
• Non-monetary grants (e.g., land and other resources) are measured at the
a. fair value of non-monetary asset received.
b. alternatively, at nominal amount or zero, plus direct costs incurred in preparing the
asset for its intended use.
Accounting for Government Grants

• The main concept in accounting for gov’t. grants is the MATCHING CONCEPT.
• This means that the gov’t. grant is recognized as income as the entity recognizes as
expense the related cost for which the grant is intended to compensate.
Presentation of Government grant

1. related to asset, including nonmonetary grant at fair value, presented in the statement of
financial position in two ways:
a. by setting the grant as deferred income
b. by deducting the grant in arriving at the carrying amount of the asset

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2. related to income, presented as follows:

a. presented in the income statement, separately or under the general heading “other
income”.
b. the grant is deducted from the related expense.
Presentation of Government grants related to assets

• Government grants related to assets are presented in the statement of financial position
either by:
a. Gross presentation –the grant is presented as deferred income (liability); or
b. Net presentation – the grant is deducted when computing for the carrying
amount of the asset
Presentation of Government grants related to income

• Grants related to income are sometimes presented in the income statement either by:
a. Gross presentation – the grant is presented separately or under a general
heading such as “Other income”, or
b. Net presentation – the grant is deducted in reporting the related expense
Repayment of Gov’t. Grants

• A government grant that becomes repayable is accounted for as a change in accounting
estimate that is treated prospectively under PAS 8.
Government assistance
This is different from government grants because government assistance is an action by the
government design to provide an economic benefit specific to an entity or range of entities
qualifying under certain criteria:
a. free technical or marketing advice
b. provision of guarantee
c. government procurement policy
Core principle of borrowing costs

• “Borrowing costs that are directly attributable to the acquisition, construction or production
of a qualifying asset form part of the cost of that asset. Other borrowing costs are
recognized as an expense.” (PAS 23.1)
Zephyr Company is provided a grant by a foreign government for the purpose of acquiring land
for a building site. The grant is zero-interest loan for 5 years evidenced by a promissory note. The
loan was granted on January 1, 2019 for P8,000,000. The market price rate of interest is 6%. The
present value for five periods at 6% is .7473.
Required:
Prepare journal entries for 2019 and 2020.

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Solution
2020
Preposterous Company received a government grant of P2,000,000 related to a factory building
that is purchased in January 1, 2019 from an industrialist identified by the government. If the entity
did not purchase the building which was located in the slums of the city, it would have been
repossessed by the government agency. The entity purchased the building for P12,000,000. The
useful life of the building is 5 years with no residual value. On January 1, 2020, the entire amount
of the government grant become repayable by reason of noncompliance with conditions attached
to the grant.
Required:
Prepare journal entries assuming the government grant is accounted for using:
a. Deferred income approach
b. Deduction from asset approach
Solution
a.

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b.
Borrowing costs
Borrowing costs are interest and other costs incurred by an entity in connection with the borrowing
of funds. Borrowing costs may include:
1. Interest expense calculated using the effective interest method
2. Finance charges in respect of finance leases
3. Exchange differences arising from foreign currency borrowings to the extent that they are
regarded as an adjustment to interest costs.
Qualifying asset
• Qualifying asset is an asset that necessarily takes a substantial period of time to get
ready for its intended use or sale. Depending on the circumstances, any of the following
may be qualifying assets:
a. Inventories (building)

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b. Manufacturing plants
c. Power generation facilities
d. Intangible assets
e. Investment properties measured under cost model
• The following are not qualifying assets

a. Financial assets, and inventories that are manufactured, or otherwise produced,
over a short period of time.
b. Assets that are ready for their intended use or sale when acquired are not
qualifying assets.
c. Assets that are routinely manufactured or otherwise produced in large
quantities on a repetitive basis.
d. assets measured at fair value.
* Borrowing costs may be capitalized only for a QUALIFYING ASSET.
Commencement of capitalization
• The capitalization of borrowing costs as part of the cost of a qualifying asset commences
on the date when all of the following conditions are met:
a. The entity incurs expenditures for the asset;
b. The entity incurs borrowing costs; and
c. It undertakes activities that are necessary to prepare the asset for its intended use
or sale.
Suspension of capitalization
• Capitalization of borrowing costs shall be suspended during extended periods of
suspension of active development of a qualifying asset.
Cessation of capitalization
• An entity shall cease capitalizing borrowing costs when substantially all the activities
necessary to prepare the qualifying asset for its intended use or sale are complete.
Determining borrowing costs eligible for capitalization

Asset financed by “specific borrowing”
PAS 23, paragraph 12, if the funds are borrowed specifically for the purpose of acquiring a
qualifying asset, the amount of capitalizable borrowing cost is the actual borrowing cost incurred
during the period less any investment income from the temporary investment of those borrowings.
1. Qualifying assets financed through Specific borrowing

Interest expense on specific borrowing ₱ xx
Less: Investment income earned on specific borrowing xx
Borrowing cost eligible for capitalization ₱ xx

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Asset financed by “general borrowing”

PAS 23, paragraph 14, if the funds are borrowed generally and used for acquiring a qualifying
asset, the amount of capitalizable borrowing cost is equal to the average carrying amount of the
asset during the period multiplied by a capitalization rate or average interest rate.
2. Qualifying assets financed through General borrowing

Total interest expense on general borrowings ₱ xx
Divide by: Total general borrowings xx
Capitalization rate %
Average expenditure on the asset ₱ xx

Multiply by: Capitalization rate %
Borrowing cost that may be eligible for capitalization* ₱ xx
*The amount computed in the formula above shall be compared with the actual borrowing costs
incurred during the period. The amount to be capitalized is the lower amount.
3. Qualifying assets financed through both Specific & General borrowing

3.1 Average accumulated expenditure method (Traditional)
Specific Borrowing:
Borrowing cost from specific borrowing xx
General Borrowing:
Average expenditures xx
Less: Specific borrowing xx
Expenditures financed by general borrowing xx
Borrowing cost from general borrowing xx
Total* ₱ xx
*Again, the amount computed in the formula is compared with the actual borrowing costs incurred
during the period. The borrowing cost to be capitalized is the lower amount.
3.2 Avoidable interest method (Contemporary)

Specific Borrowing:
Borrowing cost from specific borrowing xx
General Borrowing:
Average expenditures xx
Borrowing cost from general borrowing xx
Total* ₱ xx

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*Again, the amount computed in the formula is compared with the actual borrowing costs incurred
during the period. The borrowing cost to be capitalized is the lower amount.

• Qualifying assets are not segregated from other assets in the financial statements. They
are presented as regular assets under their normal classification as provided under other
standards.
Molave Company had the following outstanding loans during 2019 and 2020:
Specific Construction Loan 3,000,000 10%

General Loan 25,000,000 12%
The entity began self-construction of a new building on January 1, 2019 and the building was
completed on June 30, 2020. The following expenditures were made:
January 1, 2019 4,000,000

April 1, 2019 5,000,000
December 1, 2019 3,000,000
March 1, 2020 6,000,000
Required:
1. Compute the cost of the new building on December 31, 2019 and June 30, 2020.
2. Compute the interest expense for 2019 and 2020.
Solution:

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On January 1, 2019, Gemini Company contracted with a contractor to construct a building for
P20,000,000. The entity is required to make five payments in 2019 with the last payment
scheduled on the date of completion. The building was completed on December 31, 2019. The
entity made the following payments during 2019:
January 1 2,000,000
March 31 4,000,000
June 30 6,100,000
September 30 4,400,000
December 31 3,500,000
20,000,000
The entity had the following debt outstanding on December 31, 2019:
12% 4-year note dated January 1, 2019, with interest compounded quarterly, 8,500,000
both principal and interest due December 31, 2022, relating specifically to the
building project. The future value of 1 at 3%for four periods is 1.1255
10% 10-year note dated December 31, 2018 with simple interest payable 6,000,000
annually on December 31
12% 5-year note dated December 31, 2017 with simple interest payable 7,000,000
annually on December 31

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Required:
1. Determine the average expenditures on the building.
2. Determine the capitalizable borrowing cost.
3. Determine the total cost of the building on December 31, 2019
4. Compute the interest expense for 2019.
Solution:

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Assessment
Activity 1
Answer Problems 2, 5 and 6 of the Chapter 18 of your book Intermediate Accounting 1 B.
Activity 2

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Topic 3- Depreciation, Depletion and Revaluation
Depreciation
Depreciation is the systematic allocation of the depreciable amount of an asset over its
estimated useful life.
Depletion
Depletion is the systematic allocation of the depletion base of a natural resource over
the period the natural resource is extracted.
Revaluation
After recognition as an asset, an item of property, plant and equipment whose fair value
can be measured reliably can be carried at a revalued amount.
Learning Outcomes
• Apply the accounting treatment of Depreciation.

• Apply the accounting treatment of Depletion.
• Apply the accounting treatment of Revaluation.
• Solve problems Depreciation, Depletion and Revaluation.
Pretest
Answer page 178 and page 232 of your book Intermediate Accounting 1 B.
Content
Subsequent to initial recognition, an entity shall choose either:
(a) the cost model or
(b) the revaluation model

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as its accounting policy and shall apply that policy to an entire class of PPE.
Cost Model
• After recognition, an item of PPE is measured at its cost less any accumulated
depreciation and any accumulated impairment losses.
Property, plant and equipment, except land, normally are usable for a number of years after which
the assets have relatively little value either for service or for sale.
Three different terms namely:
a. Depreciation
b. Depletion
c. Amortization
Technically, depreciation refers to property, plant and equipment, depletion to wasting assets and
amortization to intangible assets.
Concept of Depreciation
• Depreciation is the systematic allocation of the depreciable amount of an asset over its
estimated useful life.
• When computing for depreciation, each part of an item of PPE with a cost that is
significant in relation to the total cost of the item shall be depreciated separately
• Depreciation is a matter of cost allocation in recognition of the exhaustion of the useful life
of an item of property, plant and equipment.
• The objective of depreciation is to have each period benefiting from the use of the asset
bear an equitable share of the asset cost.
• Depreciation is an expense account.
• Depreciation begins when the asset is available for use, i.e., when it is in the location
and condition necessary for it to be capable of operating in the manner intended by
management.
• Depreciation ceases when the asset is derecognized or when it is classified as “held for
sale” under PFRS 5, whichever comes earlier.
Kinds of Depreciation
Physical depreciation - is related to the depreciable asset's wear and tear and deterioration over
a period.
May be caused by:

a. Wear and tear due to frequent use
b. Passage of time due to nonuse
c. Action of the elements such as wind, sunshine, rain or dust
d. Casualty or accident such as fire, flood, earthquake and
other
e. Disease or decay - This physical cause is applicable to
animals and wooden buildings.
Functional or economic depreciation arises from inadequacy, supersession and

obsolescence. Inadequacy arises when the asset is no longer useful to the entity because of an
increase in the volume of operations. Supersession arises when an asset becomes available and
the new asset can perform the same function more efficiently and economically or for substantially
less cost. Obsolescence is the catchall for economic or functional depreciation.

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Factors of depreciation
In order to properly compute the amount of depreciation, three factors are necessary, namely
depreciable amount, residual value and useful life.
Depreciable amount
Depreciable amount or depreciable cost is the cost of an asset or another amount substituted for
cost, less the residual value.
Residual value
It is the estimated amount that an entity would currently obtain from disposal of an asset, after
deducting the estimated cost of disposal, if the asset were already of the age and condition
expected at the end of the useful life. It is also the estimated net amount currently obtainable or
the asset is at the end of the useful life.
Useful life
Useful life is either the period over which an asset is expected to be available for use by the
entity, or the number of production or similar units expected to be obtained from the asset by the
entity.
It is expressed as follows:
a. Time periods as in years
b. Units of output or production
c. Service hours or working hours
Factors in determining useful

a. Expected usage of the asset - is assessed by reference to the asset's expected capacity
or physical output.
b. Expected physical wear and tear - This depends on the operational factors
c. Technical or commercial obsolescence - This arises from changes or improvements in
production
d. Legal limits for the use of the asset, such as the expiry date of the related lease.
Service life is the period of time an asset shall be used by an entity.

Physical life refers to how long the asset shall last.
Methods of depreciation
1. Equal or uniform charge methods
a. Straight line
b. Composite method
c. Group method
2. Variable charge or use-factor or activity methods
a. Working hours or service hours
b. Output or Production method
3. Decreasing charge or accelerated or diminishing balance methods
a. Sum of years' digits
b. Declining balance method
c. Double declining balance

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4. Other methods
a. Inventory or appraisal
b. Retirement method
c. Replacement method
Selection of depreciation method

• There are various methods of depreciation as shown above. The entity shall select the
method that most closely reflects the expected pattern of consumption of the future
economic benefits embodied in the asset.
• However, a depreciation method that is based on revenue that is generated by an activity
that includes the use of an asset is not appropriate.
Common types of depreciation methods

1. Straight line method – depreciation is recognized evenly over the life of the asset by dividing
the depreciable amount by the estimated useful life. It is calculated by allocating the depreciable
amount equally over the number of years of estimated useful life.
Depreciation = (Historical cost – Residual value) ÷ Estimated useful life
Straight line rate
The straight-line rate is determined by dividing 100% by the life of the asset in years.
Rationale for straight line

The straight-line method is adopted when the principal cause of depreciation is passage of time.
The straight-line approach considers depreciation as a function of time rather than as a function
of usage. The carrying amount is the amount at which an asset is recognized in the statement of
financial position after deducting any accumulated depreciation and accumulated impairment
loss. Large entities find more practical to compute depreciation by treating many individual assets
as though they were a single asset. Composite method that are dissimilar in nature or assets that
have different physical characteristics and vary widely in useful life are grouped and treated as a
single unit. Group method all assets that are similar in nature and in estimated useful life are
grouped and treated as a single unit.
2. Sum-of-the-years’ digits (SYD) depreciation – depreciation is computed by applying a series
of fractions to the depreciable amount of the asset. It provides for depreciation that is computed
by multiplying the depreciable amount by a series of fractions whose numerator is the digit in the
useful life of the asset and whose denominator is the sum of digits in the useful life of the asset.
Depreciation = (Historical cost – Residual value) x Fraction
SYD Life + 1
= Life x
denominator 2
Or you can compute manually like if the useful life is 5 years, SYD denominator may be computed
like “1+2+3+4+5” by adding all the number of years together.

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3. Declining balance method – depreciation is computed by applying a fixed rate on the carrying
amount of the asset at the end of each period. Unlike for other depreciation methods, the residual
value is initially ignored when computing depreciation under the double declining method. The
common application of the declining balance method is the “double declining balance”.
Depreciation = Carrying amount x Rate
2
Double declining rate =
Life
4. Units of production method (Activity method or Variable-charge method)

The units-of-production method relates depreciation to the estimated production capability of an
asset and is expressed in a rate per unit of output or per hour of input.
Depreciation = (Historical cost – Residual value) x Rate
This assume that depreciation is more a function of use rather than passage of time.
Two Variable methods
a. Working hours method - a depreciation rate per hour is computed by dividing the depreciable
amount by the estimated useful life in terms of service hours.
b. Output or production method - results in a charge based on the expected use or output. A
depreciation rate is computed by dividing the depreciable amount by estimated useful life in terms
of units of output.
Leasehold improvements
• Leasehold improvements are depreciated over the useful life of the improvements or the
remaining lease term, whichever is shorter.
• An option to renew the lease is considered when determining the shorter between the
useful life and the remaining lease term if it is probable that the renewal option will be
exercised.
Retirement and replacement method
➢ No depreciation is recorded until the asset is retired.
The amount of depreciation is equal to the original cost of the asset retired minus salvage
proceeds.
➢ No depreciation is recorded until the asset is retired and replaced.
The amount of depreciation is equal to the replacement cost of the asset retired, minus salvage
proceeds.
Such method is suitable when large number of similar items are employed by the entity the
items are constantly being retired and replaced. These are frequently used by public utility entities
which have a large number or virtually identical items that are being installed, retired an replaced
such as poles
➢ The cost of the replacement part is recognized while the carrying amount of the replaced
part is derecognized.

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➢ If the carrying amount of the replaced part is indeterminable, the entity may use the cost
of the replacement as an indication of what the cost of the replaced part was at the time it
was acquired or constructed.
Changes in depreciation method, useful life, and residual value

Change in useful life
Unexpected physical deterioration or technological improvement may indicate that the useful life
of the asset is less than that originally estimated. The depreciation charge for the current an future
periods shall be adjusted.
Change in depreciation method

Depreciation method use shall reflect the pattern in which the asset’s economic benefits are
expected to be consumed by the entity. This is to be reviewed at least at each financial year-end
and if there has been a significant change in the expected pattern of economic benefits embodied
in the asset, the method shall be changed to reflect the new pattern.
• A change in depreciation method, useful life, or residual value is a change in accounting

estimate accounted for prospectively.
• Prospective accounting means the change affects only the current period and/or future
periods. The change does not affect past periods.
Amicable Company purchased a machine at a cost of P635,000 on January 1, 2019. It was
estimated that the machine would have a residual value of P35,000. The estimated useful life is
5 years, 60,000 service hours and 150,000 production units.
Actual Operations Service hours Unit Produced

2019 14,000 34,000
2020 13,000 32,000
2021 10,000 25,000
2022 11,000 29,000
2023 12,000 30,000
Required:
Prepare a depreciation table for the following methods
a. Straight-line
b. Service hours
c. Production method
Solution:

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Happy company owned a power plant which consisted of the following assets all acquired at the
beginning of the current year:
Cost Residual Value Useful life in years

Building 6,100,000 100,000 20
Machinery 2,550,000 50,000 5
Equipment 1,030,000 30,000 10
Required:
a. Compute the composite rate
b. Compute the composite life
c. Prepare the journal entry to record the depreciation for the current year following the
composite method.
d. Prepare the journal entry to record the retirement of the machinery at the end of the fifth
year assuming the proceeds from retirement amount to P40,000.
e. Prepare journal entry to record the depreciation for the sixth year following the
composite method.

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Solution:
Bitter Company acquired a machinery on April 1, 2019.
Cost 1,200,000
Residual Value 120,000
Estimated Useful Life 8 years
Required:
a. What is the depreciation for 2019 using SYD?
b. What is the depreciation for 2020 using SYD?
c. What is the depreciation for 2019 using double declining balance?
d. What is the depreciation for 2020 using double declining balance?
Solution:

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a. What is the depreciation for 2019 using double declining balance?

b. What is the depreciation for 2020 using double declining balance?
Vicious Company reported the following PPE and Accumulated depreciation on January 1,
2019:
Cost Accumulated Depreciation

Land 350,000
Land Improvements 180,000 45,000
Building 4,500,000 1,050,000
Machinery and Equipment 1,160,000 405,000
Automobiles 1,800,000 1,344,000
Land Improvements - Straight-line, 15 years

Building - 150% declining balance, 20 years
Machinery and Equipment - Straight-line, 10 years
Automobiles - 150% declining balance, 3 years
➢ On January 1, 2019, machinery and equipment were purchased at a total invoice cost of
P260,000, which included a P10,000 charge of freight. Installation cost of P40,000 was
incurred.
➢ On June 30, 2019, a machine purchased for P60,000 on January 1, 2018 was sold for
P36,000.
➢ On December 31, 2019, the entity purchased a new automobile for P460,000 cash and
trade-in of an automobile purchased for P540,000 on January 1, 2018. The new
automobile has a cash price of P570,000.
Required:
Determine the following for the year ended December 31, 2019.
1. Depreciation of Land Improvements
2. Depreciation of Building
3. Depreciation of Machinery and Equipment
4. Depreciation of Automobiles

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Solution:
Revaluation Model
After recognition as an asset, an item of PPE whose fair value can be measured reliably shall be
carried at a revalued amount, being its fair value at the date of the revaluation less any
subsequent accumulated depreciation and subsequent accumulated impairment losses.
Revaluation of all items in an entire class

• When property, plant and equipment are revalued, the entire class of property, plant and
equipment should be revalued.
• The items within a class of PPE are revalued simultaneously to avoid selective
revaluation of assets and the reporting of amounts in the financial statements that are a
mixture of costs and values as at different dates.
A class of property, plant and equipment is a grouping of assets of a similar nature and use in an
entity’s operation.
Examples of separate classes are:
a. Land
b. Land and Buildings
c. Machinery
d. Ships
e. Aircraft
f. Motor vehicles
g. Furniture and fixtures
h. Office equipment
Basis of revaluation
a. Fair Value – The fair value is determined by appraisal normally undertaken by professional
qualified valuers.
b. Depreciated replacement cost – Where market value is not available, depreciated
replacement cost shall be used.

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Definition of terms
Revalued amount is the fair value or depreciated replacement cost of the item of property, plant
and equipment.
Fair Value is the price that would be received to sell an asset or paid to transfer a liability in an
Depreciated replacement cost is the replacement cost of the property, plant and equipment minus
the corresponding accumulated depreciation. This amount is actually the sound value of the
asset.
Replacement cost is the current “purchase price” of the property, plant and equipment.
Carrying amount is equal to historical cost minus the corresponding accumulated depreciation.
Revaluation surplus is equal to the fair value or depreciated replacement cost (sound value) minus
the carrying amount of the property, plant and equipment. This amount is also known as
revaluation increment.
Appreciation or revaluation increase is the excess of the revalued amount over the historical cost.
Revaluation surplus
Fair value* xx
Less: Carrying amount (xx)
Revaluation surplus – gross of tax xx
*The fair value is determined using an appropriate valuation technique, taking into account the
principles set forth under PFRS 13.
The Cost Approach of fair value measurement

• Total economic life = Effective life + Remaining eco. Life
• Percentage depreciation = Effective life ÷ Total eco. life
• Depreciation = Percentage dep’n. x Replacement cost
• Fair value = Replacement cost - Depreciation
Methods of recording revaluation

Two approaches in recording the revaluation
1. Proportional approach – The accumulated depreciation at the date of revaluation is
restated proportionately with the change in the gross carrying amount of the asset so that
the carrying amount of the asset after revaluation equals the revalued amount. In other
words, the gross carrying amount is adjusted proportionately to the change in the carrying
amount.

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2. Elimination approach – The accumulated depreciation is eliminated against the gross

carrying amount of the asset and the net amount restated to the revalued amount of the
asset.
Frequency of revaluation
• For items with significant and volatile changes in fair value, annual revaluation is
necessary. For items with insignificant changes in fair value, revaluation may be made
every 3 or 5 years.
Subsequent accounting for revaluation surplus

• Revaluation is initially recognized in other comprehensive income unless the
revaluation represents impairment loss or reversal of impairment loss, in which case it is
recognized in profit or loss.
• Subsequently, the revaluation surplus is accounted for as follows:
1. If the revalued asset is non-depreciable, the revaluation surplus accumulated in
equity is transferred directly to retained earnings when the asset is
derecognized.
2. If the revalued asset is depreciable, a portion of the revaluation surplus may be
transferred periodically to retained earnings as the asset is being used.
Derecognition
The carrying amount of an item or PPE shall be derecognized:
a. on disposal; or
b. when no future economic benefits are expected from its use or disposal
Ignito Company provided the following data:
Cost Replacement Cost

Equipment 3,000,000 4,800,000
Accumulated Depreciation 750,000
Age of Asset 5 Years
Required:
1. What is the original useful life of the equipment?
2. Prepare journal entry to record the revaluation
3. Prepare journal entry to records the annual depreciation after revaluation.
4. Prepare journal entry to records the piecemeal realization of the revaluation surplus.
Solution

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On January 1 2016, Epitome Company acquired the following PPE:
Cost Useful Life

Land 5,000,000
Building 25,000,000 25
Machinery 10,000,000 5
Equipment 3,000,000 10
At the beginning of 2019, a revaluation of PPE was made professionally qualified valuers. While
no change in the useful life of the assets was indicated, it was ascertained that replacement cost
of the assets had increased by the following percentage:
Land 100%
Building 80%
Machinery 50%
Equipment 40%
It was authorized that such evaluation be recorded in the accounts and that depreciation be
recorded on the basis of revalued amount.
Required:
1. Prepare journal entry to record the revaluation on January 1, 2019.
2. Prepare journal entry to record the depreciation for the current year.
3. Prepare journal entry to record the piecemeal realization of the revaluation surplus.
4. Present the assets in the statement of financial position on December 31, 2019.
Solution:

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Exploration and evaluation expenditures

(PFRS 6 Exploration for and Evaluation of Mineral Resources)
• Exploration for and evaluation of mineral resources is the search for mineral
resources, including minerals, oil, natural gas and similar non-regenerative resources
after the entity has obtained legal rights to explore in a specific area, as well as the
determination of the technical feasibility and commercial viability of extracting the mineral
resource.
• Exploration and evaluation expenditures are expenditures incurred by an entity in
connection with the exploration for and evaluation of mineral resources before the
technical feasibility and commercial viability of extracting a mineral resource are
demonstrable.
Accounting for exploration and evaluation expenditures

• PFRS 6 permits entities to develop their own accounting policy for exploration and
evaluation assets which results in relevant and reliable information based entirely on
management’s judgment and without the need to consider the hierarchy of standards
in PAS 8.
• This means that the entity may recognize exploration and evaluation expenditures either
as expense or asset depending on the entity’s own accounting policy.
Measurement at recognition
• If the entity opts to capitalize exploration and evaluation expenditures as assets, it shall
measure them at cost.

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• Subsequent to recognition, the exploration and evaluation assets shall be measured using
the cost model or the revaluation model.
Natural resources
Natural resources, often called wasting assets, include petroleum, minerals, and timber.
Wasting assets
➢ are material objects of economic value and utility to an produced by nature.
➢ are natural resources: usually include coal, oil, precious metals like gold and silver and
timber.
➢ are so called because these are physical consumed an once consumed, the assets
cannot be replaced anymore.
Characterized by two main features

a. The wasting assets are physically consumed.
b. The wasting assets are irreplaceable.
Cost of wasting asset

At present, IFRS does not address wasting assets.
There is no comprehensive standard that is applicable to the extractive or mining industry.
In general, the cost of wasting asset can be divided into four categories, namely:
a. Acquisition cost – is the price paid to obtain the property containing the natural
resources.
b. Exploration cost – is the expenditure incurred before the technical feasibility an
commercial viability of extracting a mineral resource are demonstrated.
-the cost incurred in an attempt to locate the natural resource that can economically be
extracted or exploited.
2 methods of accounting for exploration cost
1. Successful effort method- The exploration cost directly related to the discovery of
commercially producible natural resources is capitalized as cost of the resource
property.
2. Full cost method- All exploration cost, whether successful or unsuccessful, are
capitalized as cost of the successful resource discovery.
c. Development cost- is the cost incurred to exploit or extract the natural resource that has
been located through successful exploration. May be in the form of intangible equipment and
tangible development cost.
d. Estimated Restoration cost- Is the cost to be incurred in order to bring the property to its
original condition. There must be an existing present obligation required by law or contract.
Depletion
• Depletion is the systematic allocation of the depletion base of a natural resource over
the period the natural resource is extracted.
• Depletion base is the capitalized cost of the natural resource less its residual value.
• Depletion is normally computed using the units-of-production method (activity method
or variable-charge method).

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• The depletable amount of the wasting asset is divided by the units estimated to be
extracted to obtain a depletion rate per unit. The depletion rate per unit is then multiplied
by the units extracted during the year to arrive at the depletion for the period.
Depreciation of mining equipment
a. Movable tangible equipment includes those that can be used from one extracting site to
another (e.g., heavy equipment, transportation equipment). Movable tangible equipment
is depreciated separately over its useful life using normal depreciation policy.
b. Immovable tangible equipment includes those that cannot be used in other extracting
sites after the reserves in one site are fully depleted (e.g., drilling rig foundation).
Immovable tangible equipment is depreciated separately over its useful life or the life of
the resource, whichever is shorter.
➢ When the useful life of immovable tangible equipment is shorter than the economic
useful life of the natural resource, the immovable equipment is depreciated using the
straight-line method.
➢ When the useful life of immovable tangible equipment is longer than the economic useful
life of the natural resource, the immovable equipment is depreciated using the units-of-
production method.
Reliable Company purchased a tract of resource land in 2019 for P3,960,000. The content of the
tract was estimated at P120,000 units. When the resource has been exhausted, it is estimated
that the land will be worth P120,000. Building was set up at a cost of P960,000 and heavy
equipment was purchased in early January 2019 for P1,240,000. The useful life of the building is
8 years and the useful life of the equipment is 4 years. In 2019, 12 units have been extracted.
This was one half of the annual extraction which can be expected following the first year of
operations. In 2020, 25 units were extracted.
Required:
Prepare journal entries to record the transactions relating to the resource property for 2019 and
2020.
Solution:

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In 2016, Sunflower Company acquired a silver mine in Eastern Mindanao. Because the mine is
located deep in the Mindanao frontier, Sunflower Company was able to acquire the mine for the
low price of P50,000.
In 2017, Sunflower Company constructed a road to the silver mine costing P5,000,000.
Improvements and other development costs made in 2015 cost P750,000. Because of the
improvements of the mine and to the surrounding land, it is estimated that the mine can be sold
for P600,000 when mining activities are complete.
During 2018, five buildings were constructed near the mine site to house the mine workers and
their families. The total cost of the five buildings was P2,000,000. Estimated residual value is
P200,000.
In 2019, geologists estimated that P4,000,000 tons of silver ore could be removed from the mine
for refining. During 2019, the first year of operations, only 500,000 tons of silver ore were removed
from the mine.
However, in 2020, workers mined 1,000,000 tons of silver. During that same year, geologist
discovered that the mine contained 3,000,000 tons of silver ore in addition to the original
4,000,000 tons. Development costs of P1,300,000 were made to the mine early in 2020 to
facilitate the removal of the additional silver. Early in 2020, and additional building was
constructed at a cost of P375,000 to house the additional workers needed to excavate the added
silver. This building is not expected to have any residual value.

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Required:
1. Compute the depletion for 2019 and 2020.
2. Compute the depreciation for 2019 and 2020.
Solution:

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Assessment
Activity 1
Activity 2
Answer Problems 2, 3, 5 and 6 of the Chapter 17 of your book Intermediate Accounting 1 B.

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Topic 4- Impairment of Assets
Related standard: PAS 36 Impairment of Assets
Impairment
Impairment is a fall in the market value of an asset so that the “recoverable amount” is now
less than the carrying amount in the statement of financial position.
Learning Outcomes
• Apply the accounting treatment of Impairment

• Solve problems about Impairment.
Pretest
Content
Core Principle
• If the carrying amount of an asset is greater than its recoverable amount, the asset is
impaired. The excess is impairment loss.
• The carrying amount is the amount at which an asset is recognized in the statement of
financial position after deducting accumulated depreciation and accumulated impairment
loss.

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PAS 36
The recognition of an impairment loss is covered by PAS 36 which squarely deals with impairment
of assets. If the carrying amount is higher than the recoverable amount, the asset is judged to
have suffered an impairment loss.
Accounting for impairment

Three main accounting issues to consider, namely:
a. Indication of possible impairment
b. Measurement of the recoverable amount
c. Recognition of impairment
Computation of Impairment loss

Recoverable amount xx
Less: Carrying amount (xx)
Impairment loss xx
Measurement of recoverable amount

• Recoverable amount is the amount to be recovered through use or sale of an asset. It is
the higher of an asset’s:
a. Fair value less costs of disposal, and
b. Value in use
• However, if there is no reason to believe that an asset’s value in use materially exceeds
its fair value less costs of disposal, the asset’s fair value less costs of disposal may be
used as its recoverable amount. This will often be the case for an asset that is held for
disposal.
Fair value less cost of disposal

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an
Cost of disposal is an incremental cost directly attributable to the disposal of an asset or cash
generating unit, excluding finance cost and income tax expense.
Active market and principal market
Active market is a market in which transactions for the asset or liability take place with sufficient
regularity and volume to provide pricing information on an ongoing basis. Principal market is the
market with the greatest volume and level of activity for the asset or liability.
Market participants are the buyers and sellers in the principal market who are:
a. Independent
b. Knowledgeable
c. Willing
Value in Use
Value in use as the present value or discounted value of future net cash flows (inflows minus
outflows) expected to be derived from an asset or cash-generating unit. The cash flows are pretax
cash flows and pretax discount rate is applied in determining the present value.

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• Value in use is the present value of the future cash flows expected to be derived from an
asset or cash-generating unit.
✓ Any residual value of the asset and disposal costs should be included in
estimating future cash inflows and outflows.
✓ Cash flow projections shall cover a maximum period of 5 years.
✓ Projections beyond 5 years are extrapolated.
✓ The discount rate to be used shall be a pre-tax rate
 When making estimates of future cash flows for purposes of computing value in use:
Identifying an asset that may be impaired

• An entity shall assess at the end of each reporting period whether there is any indication
that an asset may be impaired. If any such indication exists, the entity shall estimate the
recoverable amount of the asset.
• If there is no indication that an asset may be impaired, an entity is not required to
estimate the recoverable amount of the asset.
Indication of impairment
An entity shall assess at each reporting date whether there is any indication that an asset may be
impaired. If any such indication exists, the entity shall estimate the recoverable amount of the
asset.
I. External sources of information
a. Significant decline in the asset’s value more than what is expected as a result of passage
of time of normal use.
b. Significant changes in technological, market, economic or legal environment in which the
entity operates or in the market to which an asset is dedicated.
c. Increase in market interest rates or other market rates of return on investments which are
likely to affect discount rates used in calculating asset’s value in use and decrease asset’s
recoverable amount materially.
d. Carrying amount of the net assets is more than its market capitalization.
II. Internal sources of information
a. Evidence of obsolescence or physical damage
b. Significant change with adverse effect to the entity has taken place or will take place,
which will affect expected use of asset, e.g., discontinuance, disposal, restructuring plans.

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c. Evidence is available from internal reporting that indicates that the economic performance
of an asset is, or will be, worse than expected.
Required testing for impairment

• The following assets are required to be tested for impairment at least annually, whether
or not there are indications for impairment:
a. Intangible asset with indefinite useful life
b. Intangible asset not yet available for use
c. Goodwill acquired in a business combination
Recognizing and measuring an impairment loss

Impairment loss is recognized in profit or loss, unless the asset is carried at revalued amount,
in which case revaluation surplus is decreased first and any excess is recognized in profit or loss.
The decrease in the revaluation surplus is recognized in other comprehensive income.
Depreciation after impairment

After the recognition of an impairment loss, the depreciation (amortization) charge for the asset
shall be adjusted in future periods to allocate the asset’s revised carrying amount, less its
residual value (if any), on a systematic basis over its remaining useful life.
Cash-generating unit (CGU)

Cash-generating unit (CGU) is the smallest identifiable group of assets that generates cash
inflows that are largely independent of the cash inflows from other assets or groups of assets.
As a basic rule, the recoverable amount of an asset shall be determined for the asset individually.
The cash generating unit must be the smallest aggregation of assets for which cash flows can
be identified and which are independent of cash flows from other assets or group of assets.
Impairment of individual assets included in a CGU

• Assets whose recoverable amount can be determined reliably are tested for impairment
individually.
• Assets whose recoverable amount cannot be determined reliably (e.g., assets that do not
generate their own cash flows) are included in a CGU. The CGU is the one tested for
impairment.
Cash generating unit with goodwill

Goodwill does not generate cash flows independently from other assets or group of assets, and
therefore, the recoverable amount of goodwill as an individual asset cannot be determined. For
purposes of impairment testing, goodwill acquired in a business combination shall be allocated
to each of the acquirer’s CGU in the year of business combination.
PAS 36, paragraph 104, provides that when an impairment loss is recognized for a cash
generating unit, this loss shall be allocated to the assets of the in the following order:
a. First, to the goodwill, if any.
b. Then, to all other noncash assets of the unit prorate based on their carrying amount.

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Corporate assets
Corporate assets are assets other than goodwill that contribute to the future cash flows of both
the cash generating unit under review and other cash generating units.
Corporate assets are group or divisional asset such as head office building, EDP, equipment or
a research center.
Reversal of Impairment loss
• (d) – (c) = Reversal of impairment loss recognized in other comprehensive income

• (c) – (b) = Reversal of impairment loss recognized in profit or loss
In January 2017, Wine Company purchased equipment at a cost on P2,500,000. The equipment
has a residual value of P500,000, a useful life of 8 years and is depreciated by the straight-line
method. Two years later, it became apparent that this equipment suffered permanent impairment
in value. In January 2019, management determined the recoverable amount of the equipment to
be only P875,000 with a 2-year remaining useful life and residual value of P125,000.
Required:
1. Prepare journal entry to record the impairment loss on January 1, 2019.
2. Prepare journal entry to record the depreciation for 2019.
3. Determine the carrying amount of the equipment on December 31, 2019.
Solution

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On January 1, 2019, Brandy Company owned a group of machine with the following aggregate
cost and accumulated depreciation:
Machinery 90,000,000
Accumulated Depreciation 25,000,000
The machines have an average remaining useful life of 4 years and it has been determined that
this group of machines constitutes a cash generating unit. The fair value less cost of disposal of
this group of machines in an active market is determined to be P4,800,000. Based on supportable
and reasonable assumptions, the financial forecast for this group of machines reveals the
following cash inflows and cash outflows for the next four years:
Cash Inflows Cash Outflows

2019 30,000,000 12,000,000
2020 32,500,000 17,500,000
2021 27,500,000 12,500,000
2022 16,000,000 4,000,000
It is believed that a discount rate of 8%is reflective of time value of money. The table of PV shows
the following PV of 1 at 8%
Period PV of 1
1 .930
2 .857
3 .794
4 .735
Required:
1. Determine the value in use
2. Determine the recoverable amount
3. Prepare journal entry to record the impairment loss, if any
4. Prepare journal entry to records the depreciation for the current year
Solution

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One of the cash generating units of Severe Company is the production of liquor. At year-end, the
entity believed that the assets of the CGU are impaired based on an analysis of economic
indicators. The assets and liabilities of the CGU at carrying amount at year-end are:
Cash 4,000,000
Accounts Receivable 6,000,000
Allowance for doubtful accounts 1,000,000
Inventory 7,000,000
Property, plant and Depreciation 22,000,000
Accumulated depreciation 4,000,000
Goodwill 3,000,000
Accounts Payable 2,000,000
Loans Payable 1,000,000
The entity determined that the value in use of the CGU is P30,000,000. The accounts receivable
is considered collectible, except those considered doubtful.
Required:
1. Determine the carrying amount of the CGU.
2. Determine the impairment loss, if any, of the CGU
3. Prepare journal entry to record the impairment loss
Solution

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Assessment
Activity 1
Activity 2

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Unit 6- Accounting for Intangible Assets
Topic 1- Identifiable Intangible Assets
PAS 38, paragraph 8, simply defines an intangible asset as an identifiable nonmonetary

asset without physical substance.
Paragraph 8 further states that “the intangible asset must be controlled by the entity as a
result of past event and from which future economic benefits are expected to flow to the
entity.”
Learning Outcomes
• Apply the initial and subsequent measurement of intangible assets

• Apply the accounting treatment of Intangible assets
• Solve problems about Intangible assets
Pretest
Content
Intangible assets
• An intangible asset is an identifiable non-monetary asset without physical substance.
• Goodwill acquired in a business combination is outside the scope of PAS 38 because it
is unidentifiable. Goodwill is accounted for under PFRS 3 Business Combinations and
PAS 36 Impairment of Assets.
Essential criteria in the definition of intangible assets
1. Identifiability – separable or arises from contractual rights

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2. Control – power to obtain (or restrict others from obtaining) the economic benefits from
an asset.
3. Future economic benefits – may include revenue from the sale of products or services,
cost savings, or other benefits resulting from the use of the asset by the entity.
Identifiability
That an intangible asset must be identifiable in order to distinguish it clearly from goodwill.
With nonphysical items, an asset is identifiable when:
a. It is separable.
This means that the asset is capable of being separated from the entity and sold,
transferred, licensed, rented or exchanged, either individually or together with a related asset or
liability.
b. It arises from contractual or other legal rights.
This is regardless of whether these rights are transferable or separable from the entity or
from other rights and obligations.
Control
Control is the power of the entity to obtain the future economic benefits flowing from the intangible
asset and restrict the access of others to those benefits.
The entity must be able to enjoy the future economic benefits from the asset and prevent others
from enjoying the same benefits.
Future economic benefits
Future economic benefits may include revenue from the sale of products or services, cost savings
or other benefits resulting from the use of the asset by the entity.
Recognition
An intangible asset shall be recognized if management can demonstrate that:
1. The item meets the definition of intangible asset;
2. It is probable that the expected future economic benefits will flow to the entity; and
3. The cost of the asset can be measured reliably.
Judgment is usually exercised in assessing the degree of certainty of the future economic
benefits. The judgment is based on external evidence.
Initial measurement
An intangible asset shall be measured initially at cost. Measurement of cost depends on how the
intangible asset is acquired. Intangible assets may be acquired through:
1. Separate acquisition
2. Acquisition as part of a business combination
3. Acquisition by way of a government grant
4. Exchanges of assets
5. Internal generation

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Separate acquisition
The cost of a separately acquired intangible asset comprises:
1. Its purchase price, including import duties and non-refundable purchase taxes, after
deducting trade discounts and rebates; and
2. Any directly attributable cost of preparing the asset for its intended use.
Acquisition as part of a business combination
The cost of intangible asset acquired in a business combination is its fair value at the acquisition
date.
Acquisition by way of a government grant
Intangible assets acquired by way of government grant may be recorded at either:
1. fair value
2. alternatively, at nominal amount or zero, plus direct costs incurred in preparing the asset
for its intended use
Exchanges of assets
If the exchange has commercial substance, the intangible asset is initially recognized using the
following order of priority:
a. Fair value of the asset Given up (Plus cash Paid or minus cash received)
b. Fair value of the asset Received
c. Carrying amount of the asset Given up (Plus cash Paid or minus cash received)
If the exchange has lacks commercial substance, the intangible asset is initially recognized using
(c) above.
An exchange transaction has a commercial substance if the expected future cash flows from
the asset received significantly differ from those of the asset given up.
Internally generated intangible assets
The costs of self-creating an intangible asset are classified into:
a. Research costs – include costs of searching new knowledge and identifying and
selecting possible alternatives.
b. Development costs – include costs of designing from selected alternative and using
knowledge gained from research.
If an entity cannot identify in which phase a cost is incurred, the cost is regarded as incurred in
research phase.
Examples of identifiable intangible asset are:
a. Patent
b. Copyright
c. Franchise
d. Trademark or brand name

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e. Leasehold or lease right

f. Computer software
g. Broadcasting license, airline right and fishing right
Items not recognized as intangible assets

The cost of internally generated brands, mastheads, publishing titles, customer lists, goodwill and
items similar in substance are expensed when incurred.
Subsequent expenditure
Subsequent expenditures on an intangible asset are generally recognized as expense.
Reinstatement of costs in subsequent period
Expenditure on an intangible item that was initially recognized as an expense shall not be
recognized as part of the cost of an intangible asset at a later date.
Measurement after recognition
An entity shall choose either the cost model or revaluation model as an accounting policy.
1. Cost model – An intangible asset shall be carried at cost, less any accumulated
amortization and any accumulated impairment loss.
2. Revaluation model – An intangible asset shall be carried at a revalued amount, less any
subsequent amortization and any subsequent accumulated impairment loss.
Amortization
Intangible assets with finite useful life are amortized over the shorter of the asset’s useful life
and legal life.
Intangible assets with indefinite useful life are not amortized but tested for impairment at least
annually.
The default method of amortization is the straight-line method.
Impairment of intangible assets
Intangible assets with finite useful life are tested for impairment whenever there is an indication
of impairment at the end of reporting period.
Intangible assets with indefinite useful life are tested for impairment at least annually and
whenever there is an indication of impairment.
An impairment loss on an intangible asset is recognized if the recoverable amount is less than
the carrying amount.
Fair value is the price that would be received to sell an asset or paid to transfer liability in an
Value in use is the present value of future cash flows expected to be derived from an asset.
Definition of amortization
Amortization is the systematic allocation of the amortizable amount of an intangible asset over
the useful life. The amortizable amount is the cost of the intangible asset less residual value.

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Useful life
The useful life of an intangible asset must be assessed as either indefinite or finite.
Factors affecting useful life
a. Technical, technological, commercial or other type of obsolescence
b. Expected action by competitors or potential competitors
c. Expected usage of the asset by the entity
d. Typical product life cycle for the asset
e. Stability of the industry in which the asset operates
f. Level of maintenance expenditure required to obtain the expected future economic
benefits from the asset
g. The useful life of the asset may be dependent on the useful life of other assets of the entity
h. Period of control over the asset and legal or similar limits on the use of the asset, such as
expiry dates of related leases.
Amortization method
The method of amortization shall reflect the pattern in which the future economic benefits from
the asset are expected to be consumed by the entity.
Residual value
The residual value of an intangible asset shall be presumed to be zero, except:
a. When a third party is committed to buy the intangible asset at the end of the useful life.
b. When there is an active market for the intangible asset.

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304

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At the beginning of the current year, Erudite Company acquired three patents.
Cost Remaining Useful Remaining Legal Life
Life
Patent X 1,200,000 10 8
Patent Y 2,000,000 5 10
Patent Z 3,000,000 6 15
Patent Z is believed to be uniquely useful as long as the entity retains the right to use it. The entity
successfully defended the right to Patent Y at the middle of the year. Legal fees of P450,000 were
incurred in this action.
Required:
Prepare journal entries for the current year.
Solution:
Sanity Company acquired a copyright to a best seller novel for P285,000 on January 1, 2019. The
copyright has a remaining legal life of 20 years. Sales of the novel are estimated as:
2019 50,000 copies
2020 30,000 copies
2021 10,000 copies
2022 5,000 copies
Required:
Prepare journal entries for 2019 and 2020.

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Solution
At the beginning of the current year, Outlandish Company entered into a franchise agreement
with Jollibee Company to sell Jollibee products for an indefinite period. The agreement provides
for an initial fee of P20,000,000, P5,000,000 down upon signing of the contract and the balance
in four equal annual payments every year-end. The entity signed a 10% interest-bearing note for
the balance. The collection of the note is reasonably assured. The agreement further provides
that the franchisor will assist in the site location, make a survey potential market and provide
training of management and employees. Jollibee Company has already performed all initial
services required under the agreement.
Required:
Prepare journal entries for the current year on the books of the franchisee.
Solution

307
Assessment
Activity 1
Answer Problems 2: numbers 1, 2, 8 to 20 ; and Problems 3: numbers 1,2, 3, 8 to 13 of the
Chapter 22 of your book Intermediate Accounting 1 B.

308
Unit 6- Accounting for Intangible Assets
Topic 2- Research and Development Cost
PAS 38, paragraph 52, provides that to assess whether an internally generated intangible
assets meets the criteria for recognition, an entity classifies the generation of the asset
into a research phase and a development phase.
PAS 38, paragraph 53, provides that if an entity cannot distinguish the research phase
from the development phase, the entity treats the expenditure as if it were incurred in the
research phase only.
Learning Outcomes
• Apply the accounting treatment of Research and Development

• Solve problems about Research and Development
Content
Internally generated intangible assets

The costs of self-creating an intangible asset are classified into:
a. Research costs – include costs of searching new knowledge and identifying and
selecting possible alternatives.
b. Development costs – include costs of designing from selected alternative and using
knowledge gained from research.
If an entity cannot identify in which phase a cost is incurred, the cost is regarded as incurred in
research phase.
Definition of research
Research is original and planned investigation undertaken with the prospect of gaining scientific
or technical knowledge and understanding.
Definition of development cost
Development is the application of research findings or other knowledge to a plan or design for the
production of new or substantially improved material, device, product, process, system or service,
prior to the commencement of commercial production.
A development activity involves the application of research findings to develop a new product.

309
Examples of research activities

a. Laboratory research aimed at obtaining or discovering new knowledge.
b. Searching for application of research finding and other knowledge.
c. Conceptual formulation and design of possible product or process alternative.
d. Testing in search for product or process alternative.
Examples of development activities
a. Design, construction, and testing of preproduction prototype and model.
b. Design of tools, jigs, molds, and dies involving new technology.
c. Design, construction and operation of a pilot plant that is not of a scale economically
feasible to the entity for commercial production.
d. Design, construction and testing of a chosen alternative for new or improved product or
process.
Accounting for research cost
PAS 38, paragraph 54, provides that expenditures on research or on the research phase of an
internal project shall be recognized as expense when incurred.
American standard
The AICPA Financial Accounting Standards Board stipulated that expenditures for research and
development which have alternative future use, either in additional research project or for
productive purposes, can be capitalized.
R&D Costs
1. Costs incurred in research phase are expensed immediately.
2. Costs incurred in development phase are expensed immediately, unless they meet all
of the following conditions for capitalization:
(1) Technical feasibility,
(2) Intention to complete,
(3) Ability to use or sell,
(4) Probable economic benefits,
(5) Availability of adequate resources, and
(6) Measured reliably.
The following are not R&D expenses but rather regular expenses.
a. Costs incurred during commercial production:
i. Trouble-shooting during commercial production
ii. Periodic or routine design changes to existing products
iii. Modification of design for a specific customer

310
iv. Design, construction and operation of plant that is feasible for commercial production
v. Engineering follow through in an early phase of commercial production
vi. Quality control during commercial production
b. Advertising and other marketing expenses
c. Training costs
(HINT: R&D expense relates to something that is still in the process of being invented. It does
not relate to periodic changes to an existing product. The following terms generally indicate that
a cost is not an R&D expense: ‘commercial,’ ‘customer, ’advertising’ and ‘market’.)
Items of PPE used in R&D activities
• If the item of PPE can be used in various R&D activities or other purposes, the cost of the
PPE is capitalized and depreciated. The amount of depreciation is included as R&D
expense.
• If the item of PPE is can only be used on one specific R&D project, the cost of the PPE
is expensed immediately in its entirety as R&D expense.
Amortization of computer software
The amortization method for a computer software shall reflect the pattern in which the future
economic benefits are expected to be consumed by the entity.
Impairment of computer software
Since the computer software is an intangible asset with finite useful life, the cost is amortized at
the end of reporting period over the useful life.
Classification of computer software
a. As a rule, computer software is classified as an intangible asset.
b. Computer software purchased for resale shall be treated as inventory.
c. A computer software purchased as an integral part of a computer-controlled machine tool
that cannot operate without the specific software shall be treated as property, plant and
equipment.
Alexandria Company started a research and development project on a new product on January
1, 2019. Total cost incurred before reaching technological feasibility amounted to P4,000,000
while development cost after reaching technological feasibility amounted to P5,000,000 before
year-end. Prior to commercial production, the entity paid legal and registration fees amounting to
P1,000,000 in filing for a patent on the new product on July 1, 2019. Early in January 2020, and
additional amount of P2,000,000 was incurred to develop the project to full manufacturing stage.
The patent was approved in early January 2020 and valid for 20 years. However, the entity
expected technological advancements will render the new product virtually obsolete by December
31. 2020. The entity decided to account separately any capitalized development cost.
Required:
1. What amount should be capitalized as cost of the patent?

311
2. What amount should be capitalized as development cost?

3. What total amount should be reported as amortization of intangible assets for 2020?
Solution
Question 1
Cost of patent – legal and registration fee P1,000,000
Question 2
Question 3
Assessment
Activity 1
Answer Problems 2: numbers 4 to 7, 12; and Problems 3: numbers 4 to 7 of the Chapter 22 of
your book Intermediate Accounting 1 B.
Activity 2
Answer problems 5 and 6 of the Chapter 22 of your book Intermediate Accounting 1 B.

312
Reference List
Enterprise.

Accountancy.
GIC Enterprise.

313
GLOSSARY
accounting: It is the art of recording, classifying and summarizing in a significant manner and in
terms of money, transactions and events which are in part at least of a financial character
and interpreting the results thereof. (Accounting Standards Council)
agricultural activity: It is the management by an entity of the biological transformation and

harvest of biological assets for sale or for conversion into agricultural produce or into
additional biological assets.
agricultural produce: It is the harvested produce of the entity’s biological assets.
agriculture: It means farming or the process of producing crops and raising livestock.
amortization: It is the systematic allocation of the depreciable amount of an intangible asset over
its useful life.
asset: A resource controlled by the entity as a result of past events and from which future
economic benefits are expected to flow to the entity.
associate: It is an entity over which the investor has significant influence.
auditing: It is a systematic process of objectively obtaining and evaluating evidence regarding

assertions about economic actions and events to ascertain the degree of correspondence
between these assertions and established criteria and communicating the results to
interested users.
bearer plant: It is a living plant that is used in the production or supply of agricultural produce; is
expected to bear produce for more than one period; and has a remote likelihood of being
sold as agricultural produce, except for incidental scrap sales.
biological asset: It is a living animal or plant.
biological transformation: It comprises the processes of growth, degeneration, production, and

procreation that cause qualitative or quantitative changes in a biological asset.
borrowing costs: These are interest and other costs that an entity incurs in connection with the
borrowing of funds.
communicating: It is the process of transforming economic data into useful accounting

information such as financial statements and other accounting reports for dissemination
to users.
costs to sell: These are the incremental costs directly attributable to the disposal of an asset,
excluding finance costs and income taxes.
equity: The residual interest in the assets of the entity after deducting all its liabilities.
expense: Decreases in economic benefits during the accounting period in the form of outflows or
depletions of assets or incurrences of liabilities that result in decreases in equity, other
than those relating to distributions to equity participants.

314
fair value: It 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.
fulfilment value: It is the present value of the cash, or other economic resources, that an entity
expects to be obliged to transfer as it fulfils a liability.
government grants: These are assistance received from the government in the form of transfers
of resources in exchange for compliance with certain conditions.
harvest: It is the detachment of produce from a biological asset or the cessation of a biological
asset’s life processes.
identifying: It is the process of analyzing events and transactions to determine whether or not
they will be recognized in the books.
income: Increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities that result in increases in equity, other
than those relating to contributions from equity participants.
intangible asset: It is an identifiable nonmonetary asset without physical substance.
inventories: These are assets that are held for sale in the ordinary course of business; in the
process of production for such sale; or in the form of materials or supplies to be consumed
in the production process or in the rendering of services.
investment property: This is land and/or building held to earn rentals or for capital appreciation
or both.
liability: A present obligation of the entity arising from past events, the settlement of which is
expected to result in an outflow from the entity of resources embodying economic benefits.
measuring: It is the process of assigning numbers, normally in monetary terms, to the economic
transactions and events.
net realizable value: It is the estimated selling price in the ordinary course of business less the
estimated costs of completion and the estimated costs necessary to make the sale.
organizational costs: (start-up costs) are costs incurred in establishing a new business.
property, plant and equipment: These are tangible items than are held for use in the production
or supply of goods or services, for rental to others, or for administrative purposes and are
expected to be used during more than one period.
qualifying asset: It is an asset that necessarily takes a substantial period of time to get ready for
its intended use of sale.
recognition: It is the process of incorporating in the balance sheet or income statement an item
that meets the definition of an element and satisfies the following criteria for recognition.
related party transaction: The transfer of resources, services or obligations between a reporting
entity and a related party, regardless of whether a price is charged.

315
related party: It is a person or entity that is related to the entity that is preparing its financial
statements (in this Standard referred to as the ‘reporting entity’).
retrospective application: - It is the application of a new accounting policy to transactions, other

events and conditions as if that policy had always been applied.
significant influence: It is the power to participate in the financial and operating policy decisions
of the investee but is not control or joint control of those policies.
value in use: It is the present value of the cash flows, or other economic benefits, that an entity
expects to derive from the use of an asset and from its ultimate disposal.

316
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Intermediate Accounting 1: Exploring

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