Chapter 1

Definition of Accountancy  Accounting process is the recognition or non-

recognition of business activities as
ACCORDING TO ACCOUNTING “ACCOUNTABLE” event
 Not all business activities are accountable (hiring of
STANDARDS COUNCIL: employees, death of the entity president, and entering
 The accounting function is to provide quantitative into a contract)
information primarily financial in nature, about  An event is accountable or quantifiable when it has
economic entities, that is intended to be useful in an effect on assets, liabilities and equity
making economic decision  The subject matter of accounting is economic
activity or the measurement of economic resources
ACCORDING TO COMMITTEE ON and economic liabilities (only economic activities
ACCOUNTING TERMINOLOGY OF THE are emphasized and recognized in accounting)
 Sociological and psychological matters are beyond
AMERICAN INSTITUTE OF CERTIFIED the province of accounting
PUBLIC ACCOUNTANT:
 Accounting is an art of recording, classifying and EXTERNAL & INTERNAL ACTIVITIES
summarizing in a significant manner and in terms of
money, transactions and events which are in part at EXTERNAL ACTIVITIES
least of a financial character and interpreting the
results thereof  Exchange transactions
 Economic events involving one entity and another
ACCORDING TO THE AMERICAN entity
ACCOUNTING ASSOCIATION IN ITS  Purchase of goods from a supplier
 Borrowing money from a bank
STATEMENT OF BASIC ACCOUNTING
 Sale of goods to a customer
THEORY  Payment of salaries to employees
 Accounting is the process of identifying, measuring,  Payment of taxes to the government
and communicating economic information to permit
informed judgment and decision by users of the INTERNAL ACTIVITIES
information  Economic events involving the entity only
 Economic activities that take place entirely within
Important points the entity
>>>EXAMPLE OF INTERNAL ACTIVITIES<<<
1. Accounting is about QUANTITATIVE information
a. PRODUCTION – process by which resources
2. The information is likely to be FINANCIAL IN are transformed into products
NATURE
b. CASUALTY LOSS - any sudden and
3. The information should be USEFUL IN unanticipated loss from fire, flood, earthquake
DECISION MAKING and other event ordinarily as an act of God.

The definition that has stood the test of time is the
definition given by the American Accounting
Association
 The very purpose of accounting is to provide
quantitative information to be useful in making
an economic decision
 Accounting has a number of components
 Identifying as the ANALYTICAL component
 Measuring as the TECHNICAL component
 Communicating as the FORMAL component
IDENTIFYING
measuring
 Assigning of peso amounts to the accountable
economic transactions and event
 If accounting information is to be useful, it must be
expressed in terms of a common financial
denominator or one unit of measure.
 A Financial Statement without monetary amounts
would be largely unintelligible or incomprehensible
 THE PHILIPPINE PESO – unit of measuring
accountable economic transactions
MEASUREMENT BASES
a. HISTORICAL COST – original acquisition
cost and the most common measure of financial
statement
b. CURRENT VALUE – includes fair value,
value in sue, fulfilment value and current cost

Communicating
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 Process of preparing and distributing accounting
reports to potential users of accounting information
 Identifying and measuring are pointless if the
information contained in the accounting records cannot
be communicated in some form to potential users
 Reason why accounting has been called the
“universal language of business”
 Implicit in communicating process:
 RECORDING (JOURNALIZING)
 is the process of systematically maintaining a
record of all economic business transactions
after they have been identified and measured
 CLASSIFYING
 sorting or grouping of similar and interrelated
economic transactions into their perspective
classes (accomplished by posting to the ledger)
 THE LEDGER – group of accounts which
are systematically categorized into asset,
liability, equity, revenue and expense
account
 SUMMARIZING
 preparation of financial statements
 Statement of financial position (Balance
Sheet)
 Income statement
 Statement of comprehensive income
 Statement of changes in equity
 Statement of cash flows
o Notes to Financial Statement
(supplementary)
ACCOUNTING AS INFORMATION
SYSTEM
 Measures business activities, processes information
into reports and communicates the reports to decision
makers
 FINANCIAL STATEMENTS
 Key product of information system
 Documents that report financial information about
an entity to decision makers
 Financial reports tell us how well an entity is
performing in terms of profit and loss and where
it stands in financial terms
OVERALL OBJECTIVE OF ACCOUNTING
 To provide quantitative financial information about
a business that is useful to statement users
particularly owners and creditors in making economic
decisions
 Accountant’s primary task is to supply financial
information so that the statement users could make
informed judgment and better decisions
 The essence of accounting is decision-usefulness
The accountancy profession
 REPUBLIC ACT NO. 9298
 The la[w regulating the practice of accountancy in
the Philippines.
 the law is known as the Philippine Accountancy
Act of 2004
In the Philippines, in order to qualify to practice the
accountancy profession, a person:
 Must finish a degree in Bachelor of Science in
Accountancy
 Pass a very difficult government examination given
by the Board of Accountancy
 BOARD OF ACCOUNTANCY
 body authorized by law to promulgate rules and
regulations affecting the practice of the
accountancy professions in the Philippines
 responsible for preparing and grading the
Philippine CPA examination
 The computer-based examination is offered twice
a year (May and October), in authorized testing
centers around the country.
LIMITATION OF THE PRACTICE OF
PUBLIC ACCOUNTANCY
 single practitioners and partnerships for the practice of
the public of accountancy shall be registered certified
public accounts in the Philippines
 A certificate of accreditation shall be issued to
certified public accountants in public practice upon
showing in accordance with rules and regulations
promulgated by the BOA and approved by the PRC
that such registrant has acquired a minimum of 3
years of meaningful experience in any areas of public
practice (including taxation)
 Security and Exchange Commission shall not register
any corporation organized for the practice of public
accountancy
ACCREDITATION TO PRACTICE OF
PUBLIC ACCOUNTANCY
 CPAs, firms and partnership of certified public
accountants (partners & staff members) are
required to register with BOA and PRC for the
practice of public accountancy
 The PRC upon favorable recommendation of the BOA
shall issue the Certified of Registration to practice
accountancy which shall be valid for 3 years and
renewable every 3 years upon payment of required
fees
3 Main Areas cpa can Practice Their
Profession
1. PUBLIC ACCOUNTING
 Composed of individual practitioners, small
accounting firms and large multinational
organizations that render independent and expert
financial services to the public
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 Public accountants usually offer three kinds of
services:
a. AUDITING
 Has traditionally been the primary service
offered by most public accounting practitioners
 Or external auditing is the examination of
financial statements by independent CPA for the
purpose of expressing an opinion as to the
fairness with which the financial statements are
prepared
 External auditing is the at least function of
independent CPAs
 The BIR requires audited financial statements to
accompany the filing of annual income tax return
b. TAXATION
 Includes the preparation of annual income tax
returns and determination of tax consequences of
certain proposed business endeavors.
 To offer this service effectively and efficiently,
the public accountant must be thoroughly
familiar with the tax laws and regulations and
updated with changes in taxation law and court
cases concerned with interpreting taxation law
c. MANAGEMENT ADVISORY SERVICE
 Has no precise coverage but is used generally to
refer to services to clients on matters of
accounting, finance, business policies,
organization procedures, product costs,
distribution and many other phases of business
conduct and operations.
 Specifically it includes:
 Advice on installation of computer system
 Quality control
 Installation and modification of accounting
system
 Budgeting
 Forward planning and forecasting
 Design and modification of retirement plans
 Advice on mergers and consolidations
2. PRIVATE ACCOUNTING
 Accounting staff, chief accountant, internal auditor,
and controller
 CONTROLLER – the highest accounting
officer in an entity
 MAJOR OBJECTIVE OF PRIVATE
ACCOUNTANT:
 To assist management in planning and
controlling the entity’s operation
 Private accounting includes:
 maintaining the records
 producing the financial reports
 preparing the budgets
 controlling and allocating the resources of an
entity
 the private accountant has also the responsibility for
the determination of the various taxes the entity is
obliged to pay
3. GOVERNMENT ACCOUNTING
 Encompasses the process of analysing, classifying,
summarizing and communicating all transactions
involving the receipt and disposition of government
funds and property and interpreting the results
thereof.
 Focus of government accounting:
a) Custody
b) Administration of public funds
 CPAs that are employed in many branches of the
government more particularly:
 Bureau of Internal revenue
 Commission on Audit
 Department of Budget and Management
 Securities and Exchange Commissions
 Bangko Sentral ng Pilipinas
CONTINUING PROFESSIONAL
DEVELOPMENT (CPD)
 REPUBLIC ACT NO 10912 is the law mandating and
strengthening the continuing professional development
program for all regulated profession including
accountancy profession
 All certified public accountants shall abide by the
requirements, rules and regulations on continuing
professional development to be promulgated by the
BOA, subject to the approval of the PRC, in
coordination with the credited national professional
organization of CPAs or any duty accredited
educational institutions
 CPD refers to the inculcation and acquisition of
advanced knowledge, skill, proficiency, and ethical and
moral values of the initial registration of the CPA for
assimilation intro professional practice and lifelong
learning
 raises and enhances the technical skill and
competence of the CPA
CPD CREDIT UNITS
 Refer to the CPD credit hours required for the renewal
of CPA license and accreditation of a CPA to practice
the accountancy profession every 3 years
 Under the BOA Resolution, all CPAs regardless of area
or sector of practice shall be required to comply with
120 CPD credit units
 CPD is required for the renewal of CPA license and
accreditation of CPA to practice the accountancy
profession
 Only 15 CPD credit units are required for the renewal
of CPA license
 120 CPD credit units are required for accreditation of
a CPA to practice the accountancy profession
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 Excess credit units earned shall not be carried over to the recording of business preparation of financial
the next 3-year period, except credit units earned for transactions and the reports for INTERNAL
masteral and doctoral degrees. eventual preparation of USERS only.
 MANDATORY for CPAs. financial statements
Focuses on general purpose It is the area of accounting
reports known as financial that emphasizes
statements intended for developinh accounting
INTERNAL and information for use
EXTERNAL USERS. within an entity.
Exemption from CPD
GENERALLY ACCEPTED
 CPA shall be permanently exempted from CPD ACCOUNTING PRINCIPLES
requirements upon reaching the age of 65 years.
 Accounting rules, procedures, and practices known as
 Applied only to the renewal of CPA license and NOT
GAAP
for the purpose of accreditation to practice the
 The principles have developed o the basis of
accountancy profession.
experience, reason, custom, usage and practical
necessity.
Accounting vs Auditing  GAAP represent the rules, procedures, practice, and
standards followed in the preparation and presentation
Accounting Auditing
of financial reporting.
(broad sense) (broad sense) Auditing is
 GAAP are like laws that must be followed in financial
Accounting embraces one of the areas of
reporting.
Auditing accounting specialization.
 The process of establishing GAAP is a political
(Limited Sense) (Limited Sense)
process which incorporates political actions of a
-Accounting is essentially -Auditing is analytical.
various interested user groups as well as professional
constructive in nature. -The work of an auditor
judgement, logic, and research.
-It ceases when financial begins when the work of
statements are already the accountant ends. (After
prepared. the FS are prepared) Purpose of Accounting Standards
The Auditor examines the  The overall purpose of accounting standards is to
FS to ascertain whether identify proper accounting practices for the
they are in conformity with preparation and presentation of financial statements.
generally accepted  Accounting standards create a common
accounting principles. understanding between preparers and users of FS
particularly the measurement of assets and liabilities.
Accounting vs bookkeeping  A Set of high-quality accounting standards is a
Accounting bookkeeping necessity to ensure comparability and uniformity in
Conceptual Procedural element of financial statements based on the same financial
accounting information.
Concerned with the why, Largely concerned with
reason or justification for development and
any action adopted. maintenance of accounting
Financial Reporting Standards council
records (FRSc)
“WHY” “HOW” of the accounting
 In the Philippines, the development of GAAP is
Accounting vs accountancy formalized initially through the creation of the
Accounting accountancy Accounting Standards Council or ASC.
Broadly speaking, the two terms are synonymous  The FRSC now replaces the ASC
because they both refer to the entire field of accounting  The FRSC is the accounting setting body created by
theory and practice. Professional Regulation Commission (PRC) upon
Technically speaking recommendation of the BOA to assist the BOA in
Accounting is used in Accountancy refers to carrying out its powers and functions provided under
reference only to a the profession of R.A Act. No 9298.
particular field of accounting practice.  The main function is to establish and improve
accountancy such as accounting standards that will be generally accepted
public, private, and in the Philippines.
government accounting.  The accounting standards promulgated by the FRSC
council constitute the “highest hierarchy” of GAAP in
the Philippines.
 The approved statements of the FRSC are known as
Financial Accounting vs managerial Accounting Philippine Accounting Standards (PAS) and
Financial Accounting managerial Accounting Philippine Financial Reporting Standards (PRFS)
Primarily concerned with It is the accumulation and
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 Composition of FRSC
 FRSC is composed of 15 members
 with a chairman who had been or is presently a
senior accounting practitioner and
 14 representatives.
 The chairman and members of the FRSC shall have a
term of 3 years renewable for another term.
 Any member of the ASC shall not be disqualified from
being appointed to the FRSC.
Philippine Interpretations Committee (PIC)
 The PIC was formed by the FRSC in August 2006 and
has replaced the Interpretation Committee or IC formed
by the Accounting Standards Council in May 2000.
 ROLE of PIC:
 prepare interpretations of PFRS for approval by
the FRSC
 provide timely guidance on financial reporting
issues not specifically addressed in current PFRS
 Interpretations are intended to give authoritative
guidance on issues that are likely to receive divergent
or unacceptable treatment because the standards do not
provide specific and clearcut rules and guidelines.
International Accounting Standards
Committee (IASC)
 The IASC is an interdependent private sector body,
 Objective is to achieve uniformity in the accounting
principles which are used by business and other
organizations for financial reporting around the world.
 IT was formed in June 1973 through an agreement.
Objectives of IASC
 To formulate and publish in the public interest
accounting standards to be observed in the
presentation of financial statements and to
promote their worldwide acceptance and
observance/
 To work generally for the improvement and
harmonization of regulations, accounting standards
and procedures relating to the presentation of
financial statements.
International Accounting Standards Board
(IASB)
 The IASB now replaces the international Accounting
Standards Committee.
 The IASB publishes standards in a series of
pronouncements called International Financial
Reporting Standards or IFRS.
 However, the IASB has adopted the body of standards
issued by the IASC
 The pronouncements of the IASC continue to be
designated “International Accounting Standards” or
IAS
 The IASB standard-setting process includes in the
correct order research discussion paper, exposure draft
and accounting standard.
Move toward IFRS
 In developing accounting standards that will be
generally accepted in the Philippines, standards issued
by other standard-setting bodies such as the USA
Financial Accounting Standards Board (FASB) and
the IASB are considered.
 In the past years, most of the Philippine standards
issued are based on American Accounting Standards.
 The move toward IFRS is essential to achieve the goal
of one uniform and globally accepted financial
reporting standards.
 The Philippines is fully compliant with IFRS effective
January 2005, a process which was started back in
1997 in moving from USA GAAP to IFRS
Factors considered in deciding to move totally to
international accounting standards.
a) Support of international accounting standards by
Philippine organizations, such as the Philippine SEC,
BOA and PICPA
b) Increasing internalization of business which has
heightened interest in a common language for
financial reporting
c) Improvement of international accounting standards or
removal of free choices of accounting treatments.
d) Increasing Recognition of international Accounting
standards by the World Bank, Asian Development
Bank and World Trade Organization.
Philippine Financial Reporting Standards
(PFRS)
The Financial Reporting Standard Council issues standards
in a series of pronouncements called PFRS.
The PFRS collectively include all of the following:
a) PFRS which correspond to IFRS
 The PFRS are numbered the same as their
counterpart in IFRS
b) PAS which correspond to IAS
 The PFRS are numbered the same as their
counterpart in IAS
c) Philippine Interpretations which correspond to
interpretation of the IFRIC and the Standing
Interpretations Committee, and Interpretations
developed by the Philippine interpretations
Committee.
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 Chapter 2
Objective of Financial Reporting
The Conceptual Framework for Financial
Reporting
 is a complete, comprehensive and single document
promulgated by the IASB.
 It is also the summary of terms and concepts that
underlie the preparation and presentation of financial
statement for external users.
 Describes the concepts for general purpose financial
reporting.
 To provide an overall theoretical foundation for
accounting
 To guide standard setter, preparers and user of
financial information in the financial statements.
 This will be used for the future accounting standards
without changing the current IFRS
THE CONCEPTUAL FRAMEWORK
PROVIDES THE FOUNDATION FOR
STANDARDS THAT:
a. CONTRIBUTE TO TRANSPARENCY
 By enhancing international comparability and
quality of financial information
b. STRENGTHEN ACCOUNTABILITY
 By reducing information gap between the
providers of capital and the people to whom they
have entrusted their money
c. CONTRIBUTE TO ECONOMIC EFFICIENCY
 By helping investors to identify opportunities and
risks across the world.
PURPOSES OF REVISED
CONCEPTUAL FRAMEWORK
 To assist IASB to develop IFRS standards based
on consistent concepts.
 To assist prepares of financial statements to
develop consistent accounting policy when no
Standard applies to a particular transaction.
 To assist preparers of financial statements to
develop accounting policy
 To assist all parties to understand and interpret
the IFRS standards.
AUTHORITATIVE STATUS OF
CONCEPTUAL FRAMEWORK
 When there are no specific standard or an
interpretation that applies to a transaction, the
management shall consider the applicability of the
conceptual framework
 It is to be stated that the conceptual framework is
not an IFRS. Nothing in the Conceptual Framework
overrides any specific IFRS.
 If there is conflict between CF and IRFS, IFRS shall
prevail.
USERS OF FINANCIAL INFORMATION
1. PRIMARY USERS
 Are the parties whom general purpose financial
reports are primarily directed. They can’t require
the reporting entity to provide all of the information
they want.
a. EXISTING AND POTENTIAL
INVESTORS
 They are concerned with the risk inherent in and
rerun provided by their investments.
 Shareholders are also interested in information
which enables them to assess the ability and
 the entity to pay dividends
b. LENDERS AND OTHER
CREDITORS
 They are interested in information which enables
them to determine whether their loans, interest
thereon and other amounts owning to them will
be paid when due.
2. OTHER USERS
 Are users of financial information other than the
existing and potential users.
 They are parties that may find the general purpose of
financial report such as she reports are not directed
primarily.
a. EMPLOYEES
 are interested in information about the stability
and profitability of the entity.
 They are interested in the information in order to
assess the ability of the entity to provide
remuneration, retirement benefits and
employment opportunities.
b. CUSTOMERS
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  They are interested in the information especially
when they have a long-term involvement with or
are dependent on the entity.
c. GOVERNMENT AND THEIR
AGENCIES
 They are interested because of the allocation of
resources and activities of the entity.
 They also need financial information in order to
provide taxation policies and as basis of national
income and similar statistics.
d. PUBLIC
 They are interested in financial information
because entities make substantial contribution to
the local economy in many ways including the
rate of employment and their patronage to certain
local suppliers and in order for them to know the
trend and range of its activities.
SCOPE OF REVISED CONCEPTUAL
FRAMEWORK:
a. Objective of Financial Reporting
b. Qualitative characteristics of useful financial
information
c. Financial Statements and reporting entity
d. Elements of Financial Statements
e. Recognition and derecognition
f. Measurement
g. Presentation and Disclosure
h. Concepts of Capital and Capital Maintenance.
OBJECTIVE FINANCIAL REPORTING
 The objective financial reporting forms the foundation
of Conceptual Framework
 Overall objective of financial reporting:
 To provide financial information about the
reporting entity that is useful to existing and
potential investors, lenders and other creditors
in making decisions about providing resources to
the entity.
 It is the “why” of the Accounting
 FINANCIAL REPORTING
 is the provision of Financial information about an
entity to external users that is useful to them in
making economic decisions and for assessing the
effectiveness of the entity’s management.
 Encompasses not only financial statements but also
other information such as financial highlights,
summary of important financial figures, analysis of
financial statements and significant ratios.
 ANNUAL FINANCIAL STATEMENTS
 principal way of providing financial information to
external users.
 FINANCIAL REPORT
 also include nonfinancial information such as
description of major products and a listing of
officers and directors
TARGET USERS
 financial reporting information is directed primarily to
the existing and potential Investors, lenders and other
creditors (primary users)
 reason: they are the most critical and immediate need
for the information.
 The primary users of financial information are the
parties that provide resources to the entity.
 Information that meets the needs of the specifies
primary users is likely to meet the needs of the other
users such as employees, customers, governments and
their agencies
 MANAGEMENT is also interested in the financial
information but they only need it in order to obtain or
access additional information financial information
internally.
SPECIFIC OBJECTIVE OF FINANCIAL
REPORTING
The Conceptual Framework places more emphasis
on the importance of providing information needed to
assess the management stewardship of the entity’s
economic resources
a. To provide information useful in making
decisions about providing resources to the entity
b. To provide information useful in assessing the
cash flow prospects of the entity
(investing/financing/operating)
c. To provide information about entity resources,
claims and changes in resources and claims
(financial statement)
ECONOMIC DECISIONS
 Existing and potential investors need general purpose
financial reports in order to enable them in making
decisions whether to buy, sell or hold equity
investments
 While other existing and potential lenders and other
creditors need general purpose financial reports In
order to enable them in making decisions whether to
provide or settle loans and other forms of credit
ASSESSING CASH FLOW PROSPECTS
 Decisions of the primary users depend on the
RETURNS that they expect from the investment or
called as DIVIDENDS.
 It is also depend on the PRINCIPAL and
INTEREST PAYMENTS on the side of the creditor
 Financial Reporting should provide information
useful in assessing the amount, timing and uncertainty
of prospects for the future net cash inflows of the
entity
Economic Resources & Claims
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  General purpose financial reports provide information
about the financial position of a reporting entity
 FINANCIAL POSITION
 is information about the entity’s economic resources
(ASSETS) and the claims (LIABILITY AND
EQUITY) against the reporting entity
 comprises the assets, liabilities and equity of an
entity at a particular moment in time.
 Information about Financial Position can help users
to assess the strength and weakness of the entity.
Also, the liquidity, solvency and the need for
additional financing.
 LIQUIDITY – is the availability of cash
in the near future to cover currently maturing
obligations (short-term)
 SOLVENCY – is the availability of cash
over a long term to meet financial
commitments when they fall due
Changes in Economic Resources and
Claims
 Financial reports provide information about the effects of
transactions and other events that changes the economic
resources and claims
 Changes in economic resources and claims result from
financial performance and from other events or
transactions such as issuing debt or equity instruments
 Financial performance comprises revenue, expenses and
net income or loss for a period of time. In other words, it
is the level of income earned by the entity through the
efficient and effective use of its resources.
 The FINANCIAL PERFORMANCE is also
known as THE RESULTS OF THE
OPERATIONS and is portrayed in the Income
Statement and Statement of the Comprehensive Income.
USEFULNESS OF FINANCIAL
PERFORMANCE
 Information about the past financial performance is
usually helpful in predicting the future returns on the
entity’s economic resources
 Information about the return the entity has produced
provide an indication of how well management has
discharged its responsibilities to make efficient and
effective use of the entity’s economic resources
 Information about financial performance during a
period is useful to assess the entity’s ability to
generate future cash inflows from the normal
operation.
Chapter 3
Qualitative characteristics
QUALITATIVE CHARACTERISTICS
 Qualitative characteristics are the qualities or
attributes that make financial accounting information
useful to the users.
 In deciding which information to include in financial
statements, the objective is to ensure that the
ACCRUAL ACCOUNTING
 Depicts the effect of transactions and other events and
circumstances on an entity’s economics resources and
claims even if the cash receipts occur in different
period of time
 ACCRUAL BASIS: The effects of transactions and
other events are recognized when they occur and not
as cash is received or paid
 INCOME recognized when earned regardless of
when it is received and EXPENSES are recognized
when they have incurred regardless of when it is paid
 provides a better basis for assessing past and future
performance rather than information that is solely
about cash basis during a period.
LIMITATIONS OF FINANCIAL
REPORTING
a. General Purpose Financial Reports DO NOT and
CANNOT provide all of the information that existing
and potential investors and other creditors need
 These users need to consider pertinent
information from other sources (general
economic conditions, political events and
industry outlook)
b. General Purpose Financial reports are not designed
to show the value of the entity but they provide
information for the users to assess and estimate the
value of the entity.
c. General Purpose Financial Reports are intended to
provide common information to users and cannot
accommodate every request for information.
d. To a large extent, reports are based on estimate and
judgment rather than exact depiction
MANAGEMENT STEWARDSHIP
 Information about how efficiently and effectively
management has used its responsibilities to use the
entity’s economic resources helps the users to assess
the management stewardship.
 Such information is also useful for predicting how
management will use the economic resources in the
future
 Can be useful in assessing the entity’s prospects for the
future net cash flows.
 For example, management can decide not to
dispose or sell investments when prices are
declining in order to avoid realizing losses.
information is useful to the users in making economic
decisions.
 Under the Conceptual Framework for Financial
Reporting, qualitative characteristics are classified
into fundamental qualitative characteristics and
enhancing qualitative characteristics
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 FUNDAMENTAL QUALITATIVE
CHARACTERISTICS
 The fundamental qualitative characteristics relate to
the content or substance of financial information.
 The fundamental qualitative characteristics are
RELEVANCE and FAITHFUL PRESENTATION
and information must be both relevant and faithfully
represented if it is to be useful
APPLICATION OF QUALITATIVE
CHARACTERISTICS
The most efficient and effective process of
applying the fundamental qualitative characteristics would
usually be:
1) Identify an economic phenomenon that has the
potential to be useful
2) Identify the type of the information about the
phenomenon that would be most relevant and can
be faithfully represented
3) Determine whether the information is available
RELEVANCE
 capacity of information to influence a decision.
 To be relevant, the financial information must be
capable of making a difference in the decisions made
by users.
 It requires that the financial information should be
related or pertinent to the economic decision
 Information that does not bear on an economic
decision is useless.
For example:
 The statement of financial position is relevant in
determining financial position and the income
statement is relevant in determining performance
 The earnings per share information is more relevant
than book value per share in determining the
attractiveness of an investment.
INGREDIENTS OF RELEVANCE
Financial information is capable of making
difference in a decision if it has predictive value and
confirmatory value
1. PREDICTIVE VALUE
 Financial information has predictive value if it can
be used as an input to processes employed by users
to predict future outcome.
 If it can help users increase the likelihood of
correctly or accurately predicting or forecasting
outcomes of events
For Example:
 Information about financial position and past
performance is frequently used in predicting
dividend and wage payments and the ability of
the entity to meet maturing commitments
2. CONFIRMATORY VALUE
 Financial information has confirmatory value if it
provides feedback about previous evaluations.
 When it enables users confirm or correct earlier
expectations
MATERIALITY
 Practical rule in accounting which dictates that strict
adherence to GAAP is not required when the items
are not significant enough to affect the evaluation,
decision and fairness of the financial statements
 The materiality concept is also known as the doctrine
of convenience.
 Really a quantitative “threshold” linked very closely
to the quantitative characteristics of relevance
 The relevance of information is affected by its
nature and materiality.
 Materiality is a subquality of relevance based on the
nature or magnitude or both of the items to which the
information relates.
MATERIALITY IS A RELATIVITY
 Materiality of an item depends on relative size rather
than absolute size.
WHEN IS AN ITEM MATERIAL?
 Dependent on good judgement, professional expertise
and common sense
NEW DEFINITION OF
MATERIALITY
 Information is material if omitting, misstating or
obscuring it could reasonably be expected to influence
the economic decisions that primary users of general
purpose financial statements make on the basis of
those statements which provide financial information
about a specific reporting entity.
 An information is material if the omission,
misstatement and obscuring of the information could
reasonably affect the economic decision of primary
users
Important aspects:
a. Could reasonably be expected to influence
b. Obscuring information
c. Primary users
COULD RESONABLY BE EXPECTED
TO INFLUENCE
9|Mikee P.
  Threshold adds an element of reasonability of
financial information on which economic decision is
based.
 Material information shall be limited to the
economic decision of primary users rather than to
all users which is too broad in scope
 Insures that information capable to influence
economic decision of the primary users shall be
included in the financial statements.
OBSCRUBING INFORMATION
 Is a new concept added to the new definition of
materiality
 Information is obscured if presenting or
communicating it would have similar effect as
omitting or misstating the information
 Means the presentation of financial information not
readily understood or not clearly expressed
 May be characterized by deliberate vagueness,
ambiguity and abstruseness
Examples:
 The language is vague or unclear
 The information is scattered throughout the financial
statements
 Dissimilar items are aggregated inappropriately
 Similar items are disaggregated inappropriately
PRIMARY USERS
 Narrows the definition to primary users who are
primarily affected by general purpose financial
statements
 Includes existing and potential investors, lenders and
other creditors.
 New definition specifies that only primary users of
financial statements are considered because these
groups are the users to whom general purpose
financial statements are primarily directed
FACTORS OF MATERIALITY
 Materiality depends on the magnitude and nature of
the financial information
 Relative size and nature of an item are considered
 The size of the item in relation to the total of the
group to which the item belongs is taken into account
 The nature of the item may be inherently material
because by its very nature it affects economic decision
FAITHFUL REPRESENTATION
 Financial representation means the financial reports
represent the economic phenomena or transactions in
words and numbers.
 Faithful representation means that the actual effects
of the transactions shall be properly accounted for
and reported in the financial statements.
INGREDIENTS OF FAITHFUL
REPRESENTATION
 Completeness
 Neutrality
 Free from error
1. COMPLETENESS
 Completeness requires that relevant information
should be presented in a way that facilitates
understanding and avoids erroneous application.
 Completeness is the result of the adequate
disclosure standard or the principle of full
disclosure.
 A complete depiction includes all information
necessary for a user to understand the phenomenon
being depicted
STANDARD OF ADEQUATE
DISCLOSURE
 Means that all significant and relevant information
leading to the preparation of financial statements
shall be clearly reported
 Does not mean disclosure of just any data
NOTES TO FINANCIAL STATEMENTS
 The financial statements shall be accompanied by
“notes to financial statements”
 To provide necessary disclosures required by
Philippine Financial Reporting Standards
 It provides narrative description or disaggregation
of the items presented in the financial statements
and information about items that do not qualify for
recognition
2. NEUTRALITY
 A neutral depiction is without bias in the preparation
or presentation of financial information.
 Neutral depiction is not slanted, weighted,
emphasized, de-emphasized or otherwise
manipulated to increase the probability that financial
information will be received favorably or
unfavorably by users
 To be neutral, the information contained in the
financial statements must be free from bias.
 Financial information should not favor one party to
the detriment of another party
 The information is directed to the common needs of
many users and not be particular needs of specific
users
 Neutrality is synonymous with the all-encompassing
principle of fairness
 To be neutral is to be fair
PRUDENCE
 The exercise of care and caution when dealing
with the uncertainties in the measurement process
10 | M i k e e P .
 such that assets or income are not overstated and
liabilities or expenses are not understated
 neutrality is supported by the exercise of prudence
CONSERVATISM
 synonymous with prudence
 means that when alternatives exist, the alternative
which has the least effect on equity should be
chosen
 means “in case of doubt, record any loss and do not
record any gain”
 Contingent loss is recognized as a “provision” if the
loss is probable and the amount can be reliably
measured
 Contingent gain is not recognized but disclosed
only
3. FREE FORM ERROR
 Free from error means there are no errors or
omissions in the description of the phenomenon or
transaction.
 Free from error does not mean perfectly accurate in
all respects.
MEASUREMENT UNCERTAINTY
 Arises when monetary amounts in financial reports
cannot be observed directly and must be estimated
 Can affect faithful representation if the level of
uncertainty in providing an estimate is high
 The use of reasonable estimate is an essential part
of providing financial information and does not
undermine the usefulness of the financial
information
SUBSTANCE OVER FORM
 It is necessary that the transaction and events are
accounted in accordance with their substances and
reality and not merely their legal form
 Usually emphasized when economic substance
differs from legal form
 is not considered a separate component of faithful
representation because it would be redundant
 faithful representation inherently represents the
substance of an economic phenomenon or
transaction rather than merely representing the
legal form
Enhancing Qualitative
Characteristics
 The enhancing qualitative characteristics relate to the
presentation or form of the financial information.
 The enhancing qualitative characteristics are intended
to increase the usefulness of the financial information
that is relevant and faithfully represented
 The enhancing qualitative characteristics are
COMPARABILITY, UNDERSTANDABILITY,
VERIFIABILITY and TIMELINESS.
 Relevant and faithfully represented financial
information is useful but the information would be
most useful if it is comparable, understandable,
verifiable, and timely
1. COMPARABILITY
 Comparability means the ability to bring together
for the purpose of noting points of likeness and
difference.
 Enables users to identify and understand
similarities and dissimilarities among items
 May be made within an entity or between and
across entities
 Comparability within an entity is also known as
horizontal comparability or intracomparability
 Comparability across entities is also known as
intercomparability or dimensional comparability.
 Comparability between and across entities is the
quality of information that allow comparisons
between two or more entities engaged in the same
industry (uniform application)
CONSISTENCY
 Refers to the use of the same method for the same
item, either from period to period within an entity or
in a single period across entities
 Comparability is the goal and consistency help to
achieve that goal
 Consistency is the uniform application of accounting
method from period to period within an entity
2. UNDERSTANDABILITY
 Understandability requires that financial information
must be comprehensible or intelligible if it is to be
most useful.
 The information should be presented in a form and
expressed in terminology that a user understands.
 Classifying, characterizing and presenting
information “clearly and concisely” makes it
understandable
 Financial statements should be readily
understandable by users
 The users shall have an understanding of the
complex economic activities, the financial
accounting process and the terminology in the
financial statements
 Financial statements cannot realistically be
understandable to everyone
 Financial reports are prepared for users who have
reasonable knowledge of business and economic
activities and who review and analyze the
information diligently
 Understandability is very essential because a
relevant and faithfully represented may prov useless
if it is not understood by users
3. VERIFIABILITY
 Verifiability means that different knowledgeable and
independent observers could reach consensus,
although not necessarily complete agreement, that a
particular depiction is a faithful representation
 Implies consensus
11 | M i k e e P .
  Verifiable financial information provides results that
would be substantially duplicated y measurers using
the same measurement method
 It helps assure users that information represents the
economic phenomenon or transaction it purports to
present
TYPES OF VERIFICATION
a. DIRECT VERIFICATION – means verifying
an amount or other representation through direct
observation, for example, by counting cash.
b. INDIRECT VERIFICATION – means
checking the inputs to a model, formula or other
technique and recalculating the inputs using the
same methodology
4. TIMELINESS
Chapter 4
Financial Statements and Reporting Entity Underlying Assumptions
GENERAL OBJECTIVE OF
FINANCIAL STATEMENTS
FINANCIAL STATEMENTS
 provide information about economic resources of
the reporting entity, claims against the entity and
changes in the economic resources and claims
 provide financial information about an entity’s
assets, liabilities, equity, income and expenses
useful to users of financial statements in:
a. Assessing future cash flows to the reporting
entity.
b. Assessing management stewardship of the
entity’s economic resources.
The financial information is provided in the
following:
1. Statement of financial position, by recognizing
assets, liabilities and equity
2. Statement of financial performance, by recognizing
income and expenses
3. Other statements and notes by presenting and
disclosing information about:
(a) Recognized assets, liabilities, equity, income
and expenses
(b) Unrecognized assets and liabilities
(c) Cash flows
(d) Contribution from equity holders and
distribution to equity holders
(e) Method, assumption and judgment in
estimating amount presented
Types of financial statements
1) CONSOLIDATED FINANCIAL
STATEMENTS
 Timeliness means that financial information must be
available or communicated early enough when a
decision is to be made.
 The older the information, the less useful
 Timeliness enhances the truism that without
knowledge of the past, the basic for prediction will
usually be lacking and without interest in the future,
knowledge of the past is sterile
 What happened in the past would become the basis
of what would happen in the future
Cost constraint on useful information
 Cost is a pervasive constraint on the information that
can be provided by financial reporting
 The benefit derived from the information should exceed
the cost incurred in obtaining the information
 The evaluation of the cost constraint is substantially a
judgmental process
 These are the financial statements prepared when the
reporting entity comprises both the parents and its
subsidiaries.
 Provide information about the assets, liabilities,
equity, income and expenses of both the parent and
its subsidiaries as a single reporting entity.
 The parent is the entity that exercises control over
the subsidiaries
 It is useful for existing and potential investors,
lenders and other creditors of the parent in their
assessment of future net cash inflows to the parent
 Are not designed to provide separate information
about the assets, liabilities, equity, income and
expenses of a particular subsidiary
 A subsidiary’s own FS are designed to provide such
information.
2) UNCONSOLIDATED FINANCIAL
STATEMENTS
 These are the financial statements prepared when the
reporting entity is the parent alone.
 Are designed to provide information about the
parent’s assets, liabilities, income and expenses and
not about those of subsidiaries.
 It is useful for existing and potential investors,
lenders and other creditors because a claim against
the parent typically does not give the holder of that
claim against subsidiaries
 Information provided is typically not sufficient to
meet the requirement needs of primary users
 Note: when consolidated financial statements are
required, unconsolidated financial statements cannot
serve as substitute for consolidated financial
statements
3) COMBINED FINANCIAL
STATEMENTS
12 | M i k e e P .
  These are the financial statements when the
reporting entity comprises two or more entities that
are not linked by a parent and subsidiary
relationship
 Combined financial statements provide financial
information about the assets, liabilities, equity,
income and expenses of two or more entities not
linked with parent and subsidiary relationship.
Reporting entity
 A reporting entity is an entity that is required or
chooses to prepare financial statements.
 The reporting entity can be a single entity or a
portion of an entity, or can comprise more than one
entity.
 A reporting entity is not necessarily a legal entity.
The following can be considered a reporting entity:
a. Individual corporation, partnership or
proprietorship
b. The parent alone
c. The parent and its subsidiaries as single entity
d. Two or more entities without parent and subsidiary
relationship as a single entity
e. A reportable business segment of an entity
Reporting period
 The reporting period is the period when financial
statements are prepared for the purpose of general
purpose financial reporting
 Financial statements may be prepared on an interim
basis (3/6/9 months)
 INTERIM FINANCIAL STATEMENTS ARE NOT
REQUIRED BUT OPTIONAL
 Financial statements must be prepared on an annual
basis or a period of twelve months.
 Financial statements are prepared for a specified
period of time and provide information about:
a. Assets, liabilities, equity and the end of the
reporting period
b. Income and expenses during the reporting
period
 Financial statements also provide comparative
information for at least one preceeding reporting
period
 FS may include information about transactions and
other events that occurred after the end of reporting
period
Underlying Assumptions
 Accounting assumptions are the basic notions or
fundamental premise on which the accounting process
is based.
 Accounting assumptions are also known as
postulates.
 Accounting assumptions serve as the foundation of
bedrock of accounting in order to avoid
misunderstanding but rather enhance the
understanding and usefulness of the financial
statements
 The Conceptual Framework for Financial Reporting
mentions only one assumption, namely going
concern.
 However, IMPLICIT in accounting are the basic
assumptions of ACCOUNTING ENTITY, TIME
PERIOD and MONETARY UNIT.
GOING CONCERN
 The going concern or continuity assumption means
that in the absence of evidence to the contrary, the
accounting entity is viewed as continuing in
operation indefinitely.
 Financial Statements are normally prepared on the
assumptions that the entity will continue in
operations for the foreseeable future
 The going concern postulate is the very foundation
of the COST PRINCIPLE
 The going concern assumption is ABANDONED
 If the there is an evidence that the entity would
experience large and persistent losses or entity’s
operations are to be terminated.
ACCOUNTING ENTITY
 In financial accounting, the accounting entity is the
specific business organization, which may be a
proprietorship, partnership or corporation.
 Under this assumption, the entity is separate from the
owners, managers, and employees who constitute the
entity.
 The transaction of the entity shall not be merged with
the transactions of the owners
 The reason of the entity assumption is to have a fair
presentation of financial statements
 Each business is an independent accounting entity
 The shareholder is not the corporation and the
corporation is not the shareholder
 However, when parent and subsidiary relationship
exists, consolidated statements for the affiliates are
usually made because for practical and economic
purposes, the parent and the subsidiary are a “single
economic entity”
TIME PERIOD
 The time period assumption requires that indefinite life
of an entity is subdivided into accounting periods which
are usually of equal length for the purpose of
preparing financial reports on financial position,
performance and cash flows.
 A completely accurate report on the financial position
and performance of an entity cannot be obtained until
the entity is finally dissolved and liquidated
 Users of financial information need timely
information for making an economic decision. It
becomes necessary therefore to prepare periodic reports
on financial position, performance and cash flows of an
entity
 By convention, the accounting period or fiscal period is
one year or a period of twelve months
13 | M i k e e P .
  The “one-year period” is traditionally the
accounting period because usually it is after one
year that government reports and required

 CALENDAR YEAR – 12-month period that

ends on December 31
 NATURAL BUSINESS YEAR – 12-month
period that ends on any month when the business is at
the lowest or experiencing slack season

MONETARY UNIT
 The monetary unit assumption has two aspects, namely
quantifiability and stability of the peso.
 The QUANTIFIABILITY aspect means
that assets, liabilities, equity, income and
expenses should be stated in terms of a unit of
measure which is the peso in the Philippines.
 The STABILITY OF THE PESO
ASSUMPTION means that the purchasing power
of the peso is stable or constant and that its instability
is insignificant and therefor may be ignored.
 The STABLE PESO POSTULATE is actually
an amplification of the going concern
assumption so that adjustments are unnecessary
to reflect any changes in purchasing power
 The accounting function is to account for NOMINAL
PESOS ONLY and not for constant pesos or changes
in purchasing power

Chapter 5
Elements of Financial Statements

14 | M i k e e P .
 ELEMENTS OF FINANCIAL Rights that have the potential to produce economic
benefits may take the following forms:
STATEMENTS
1. RIGHTS THAT CORRESPOND TO AN
 Financial statements portray the financial effects of the OBLIGATION OF ANOTHER ENITY
transactions and other events by grouping them into a. Right to receive cash
broad classes according to their economic b. Right to receive goods or services
characteristics c. Right to exchange economic resources with
 The elements of FS refer to quantitative information another party on favorable terms
reported in SFP and Income Statement. d. Right to benefit from an obligation of another
 Are the “building blocks” from which financial party if a specified uncertain future event
statements are constructed occurs
 The preparation of these involves process of 2. RIGHTS THAT DO NOT CORRESPOND
classification and subclassification TO AN OBLIGATION OF ANOTHER
 The Conceptual Framework identifies no elements that ENTITY
are unique to the statement of changes in equity
a. Right over physical objects, such as property,
because such statement comprises items that appear in
plant and equipment or inventories
the statement of financial position and the income
b. Right to intellectual property
statement
o EQUITY 3. RIGHTS TO ESTABLISHED BY
– residual interest in the assets of the entity after CONTRACT OR LEGISLATION SUCH
deducting all of the liabilities
AS OWNING A DEBT INSTRUMENT OR
ELEMENTS DIRECTLY RELATED TO AN EQUITY INSTRUMENT OR OWNINF
THE MEASUREMENT OF FINANCIAL A REGISTERED PATENT
POSITION: POTENTIAL TO PRODUCE ECONOMIC
 Asset BENEFITS
 Liability
 Equity  An economic resource is a right that has the potential
to produce economic benefits
ELEMENTS DIRECTLY RELATED TO  It does not need to be certain or even likely that the
THE MEASUREMENT OF FINANCIAL right will produce economic benefits
 It is only necessary that the right already exists
PERFORMANCE:  The economic resource is the present right that
 Income contains the potential and not the future economic
 Expense benefits may produce

ASSET An economic resource could produce economic

 Under the Revised Conceptual Framework, an asset is
defined as a present economic resource controlled
by the entity as a result of past events.
 An ECONOMIC RESOURCE is a right that has the
potential to produce economic benefits.
 The new definition clarifies that an asset is an
economic resource and that the potential economic
benefits no longer need to be expected to flow to the
entity
benefits if an entity is entitled:
 To receive contractual cash flows
 To exchange economic resources with another party
on favorable terms
 To produce cash inflows or avoid cash outflows
 To receive cash by selling the economic resource
 To extinguish a liability by transferring an economic
resource

ESSENTIAL CHARACTERISTICS Control of an economic resource

OF AN ASSET  An entity controls an asset if it has the present
ability to direct the use of the asset and obtain the
a. The asset is a present economic resource
economic benefits that flow from it
b. The economic resource is a right that has the potential
to produce economic benefits.  Control also includes the ability to prevent others
c. The economic resource is controlled by the entity as a from using such as asset and therefore preventing
result of past events others from obtaining the economic benefits from
the assets
RIGHT  Control may arise if an entity enforces legal
rights

15 | M i k e e P .

LIABILITY
 Under the Revised Conceptual Framework, a liability
is defined as present obligation of an entity to transfer
an economic resource as a result of past events.
 The outflow of economic benefits no longer needs to
be expected similar to the definition of an asset.
 A liability is the obligation to transfer an economic
resource and not the ultimate outflow of economic
benefits
ESSENTIAL CHARACTERISTICS OF
LIABILITY
a. The entity has an obligation
 The entity liable must be identified. It is not
necessary that the payee or the entity to whom
the obligation is owed be identified
b. The obligation is to transfer an economic resource
c. The obligation is a present obligation that exists as
a result of past event
 This means that a liability is not recognized
until it is incurred
Obligation
 An obligation is a duty or responsibility that an
entity has no practical ability to avoid.
 Obligation can be either be legal or constructive
 Obligations may be LEGALLY ENFORCEABLE
as a consequence of a binding contract or statutory
equipment
 CONSTRUCTIVE OBLIGATIONS arise from
normal business practice, custom and a desire to
maintain good business relations or act in an
equitable manner.
Transfer of an economic resource
a. Obligation to pay cash
b. Obligation to deliver goods or noncash resources
c. Obligation to provide sevices at some future time
d. Obligation to exchange economic resources with
another party on unfavorable terms
e. Obligations to transfer an economic resource if
specified uncertain future event occurs
Past event
An obligation exists as a result of past event if both of the
following conditions are satisfied:
a. An entity has already obtained economic benefits
b. An entity must transfer an economic resource
INCOME
 Income is defined as increases in assets or decreases
in liabilities the result in increases in equity, other
than those relating to contributions from equity holders
 The definition of income encompasses both revenue
and gains:
REVENUE
 – arises in the course of the
ordinary regular activities and is referred to by
variety of different names including sales, fees,
interest, dividends, royalties and rent
 the essence of revenue is regularity
 GAINS – represent other items that meet the
definition of income and do not arise in the course
of the ordinary regular activities
 Include gain from disposal of noncurret
asset, unrealized gain on trading investment
and gain from expropriation
Statement of financial performance
 The Revised Conceptual Framework introduces the
term statement of financial performance
 This statement refers to the statement of profit or loss
and a statement presenting other comprehensive income
 Statement of profit or loss is the primary source of
information about an entity’s financial performance.
 GENERAL RULE: all income and expense are
included in profit or loss
 Recycling is permitted as long as it would result to
relevant and faithfully represented information about
financial performance.
EXPENSE
 Expense is defined as decreases in assets or
increases in liabilities that result in decreases in
equity, other than those relating to distributions to
equity holders.
 Expenses encompass losses as well as those expenses
that arise in the course of the ordinary regular
activities:
 EXPENSES that arise in the course of
ordinary regular activities include cost of
goods sold, wages and depreciation
 LOSSES do not arise in the course of the
ordinary regular activities and include losses
resulting from disasters
 Examples include losses from fire,
flood, storm surge, tsunami and
hurricane, as well as those arising
from disposal of noncurrent assets.
16 | M i k e e P .
 CHAPTER 6
Recognition and Measurement

Recognition criteria
RECOGNITION
 Only items that meet the definition of an asset, a
 The Revised Conceptual Framework defines
liability or equity are recognized in the statement of
recognition as the process of capturing for inclusion in
financial position.
the financial statements an item that meets the
 Similarly, only items that meet the definition of income
definition of an asset, liability, equity, income or
or expense are recognized in the statement of financial
expense
performance.
 The amount at which an asset, a liability or equity is
 Items are recognized only when their recognition
recognized in the statement of financial position is
provides users of financial statements with information
reported as carrying amount
that is both relevant and faithful represented
 Recognition links the elements to the statement of
 Recognition does not focus anymore on how probable
financial position and statement of financial
economic benefits will flow to or from the entity and
performance
that the cost can be measured reliably
 The recognition of an item is one statement
requires the recognition of the same item in  An asset or liability and any corresponding income or
another statement expense can exist even if the probability of inflow or
 The recognition of the expense happened outflow of the benefits is low
simultaneously with the recognition of a decrease in
asset or decrease in liability Point of sale income recognition
17 | M i k e e P .
 The BASIC PRINCIPLE OF INCOME recognition
is that income shall be recognized when earned.
 Legal title to the goods passes to the buyer at the point
of scale
 However, under certain conditions, income may be
recognized at the point of production, during
production and at the point of collection.
EXPENSE RECOGNITION
 The BASIC EXPENSE RECOGNITION means
that expenses are recognized when incurred
 The expense recognition principle the application of
the matching principle
 “There is no gain of there is no pain.”
 The MATCHING PRINCIPLE requires that those
costs and expenses incurred in earning a revenue shall
be reported in the same period.
Thematching principle has THREE
APPLICATIONS namely:
1) Cause and effect association
2) Systematic and rational allocation
3) Immediate recognition
Cause and effect association
 Under this principle, the expense is recognized when
the revenue is already recognized.
 The reason is the presumed direct association of the
expense with specific items of income. This is actually
the “STRICT MATCHING CONCEPT”
 This process, commonly referred to as the matching of
cost with revenue, involves simultaneous or combined
recognition of revenue and expenses that result
directly and jointly from the same transactions or
events.
Example:
 Cost of merchandise inventory
 Doubtful accounts
 Warranty expense
 Sales commissions
 The historical cost or original acquisition cost of an asset is
Systematic and rational allocation
 Under this principle, some costs are expensed by
simply allocating them over periods benefitted
 The cost incurred will benefit future periods
and that there is an absence of a direct or clear
association of the expense with specific
revenue
 When economic benefits are expected to arise over
several accounting periods and the association with
income can only be broadly or indirectly determined,
expenses are recognized on the basis of systematic and
allocation procedures.
Examples:
 Depreciation of property, plant and equipment
 Amortization of intangibles
 Allocation of prepaid rent, insurance and other
prepayments
Immediate recognition
 Under this principle, the cost incurred is expensed
outright because of uncertainty of future economic
benefits or difficulty of reliably associating certain
costs with future revenue.
An expense is recognized immediately:
a. When an expenditure produces no future economic
benefit.
b. When cost incurred does not qualify or ceases to
qualify for recognition as an asset.
DERECOGNITION
 Removal of all or part of a recognized asset or
liability from the statement of financial position.
 Normally occurs when an item no longer meets
the definition of an asset or a liability
 DERECOGNITION OF AN ASSET
occurs when the entity losses control of all or part
of the asset
 DERECOGNITION OF A LIABILITY
occurs when the entity no longer has a present
obligation for all or part of the liability
MEASUREMENT
 Measurement is defined as quantifying in monetary
terms the elements in the financial statements.
The revised Conceptual Framework mentions TWO
CATEGORIES.
1. Historical cost
2. Current value
1) HISTORICAL COST
the cost incurred in acquiring or creating the asset
comprising the consideration paid plus transaction cost.
 The historical cost of a liability is them consideration
received to incur the liability minus transaction cost.
 Historical cost is the entry price or entry value to
acquire an asset or to incur a liability
 An application of this is to measure financial asset and
financial liability at amortized cost
 The amortized cost reflects the estimate of
future cash flows discounted at a rate
determine at initial recognition
HISTORICAL COST UPDATED
18 | M i k e e P .
1. HISTORICAL COST OF AN ASSET IS (c) FULFILLMENT VALUE
UPDATED BECAUSE OF:  Fulfillment value is the present value of cash that
a. Depreciation and amortization an entity expects to transfer in paying or settling
b. Payment received as a result of disposing part a liability.
or all of the asset  Does not include transaction cost on incurring a
c. Impairment liability but includes transaction cost on fulfillment
d. Accrual of interest to reflect any financing of a liability
component of the asset  Is an exit price of exit value
e. Amortized cost measurement of financial
asset
(d) CURRENT COST
 Current cost of an asset is the cost of an
2. HISTORICAL COST OF A equivalent asset at the measurement date
LIABILITY IS UPDATED BECAUSE comprising the consideration paid and transaction
OF: cost.
a. Payment made or satisfying an obligation to  CURRENT COST OF A LIABILITY is the
deliver goods consideration that would be received less any
b. Increase in value of the obligation to transfer transaction cost at measurement date.
economic resources such that the liability  Current cost is also based on the entry price or
becomes onerous entry value but reflects market conditions on
c. Accrual of interest to reflect any financing measurement date
component of the liability
d. Amortized cost measurement of financial Selecting a measurement basis
liability
 It is necessary to consider the nature of the information
that the measurement basis will produce
2) CURRENT VALUE  No single factor will determine which measurement basis
Current value includes: should be selected
 The information must be both relevant and faithfully
a. Fair value
represented
b. Value in use for asset
 HISTORICAL COST is the measurement basis most
c. Fulfillment value for liability commonly adopted in preparing financial statements
d. Current cost  generally well understood and verifiable

(a) 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 measurement date.
 FAIR VALUE OF A LIABILITY is the price
that would be paid to transfer a liability in an
orderly transaction between market participants at
measurement date
 Fair value is an exit price or exit value
 Can be observed directly using market price of the
asset or liability in an active market
 In cases where fair value cannot be directly
measured, an entity can use present value of cash
flows.
 Fair value is not adjusted for transaction cost.
 Cost is a characteristic of the
transaction and not of the asset or
liability

(b) VALUE IN USE

 Value in use is the present value of the cash
flows that an entity expects to derive from the use
of an asset and from the ultimate disposal
 Does not include transaction cost on acquiring the
asset but includes transaction cost on the disposal
of the asset
 Is an exit price or exit value

19 | M i k e e P .
 CHAPTER 7
Presentation and Disclosure Concepts of Capital
Presentation & Disclosure
 Can be an effective communication tool about the
information in financial statements.
 A reporting entity communicates information about its
assets, liabilities, equity, income and expense by
presenting and disclosing information in the FS.
 Effective communication in FS is supports by not
duplicating information in different parts of the FS.
 DUPLICATION is usually unnecessary and can make
FS less understandable.
CLASSIFICATION
 Classification is the sorting of assets, liabilities,
equity, income, and expense on the basis of shared or
similar characteristics.
 Classifying dissimilar assets, liabilities, equity,
income and expense can:
 Obscure relevant information,
 Reduce understandability and comparability;
 may not provide a faithful representation of
financial information
 It may be necessary to classify components of equity
separately if such components are subjects to legal,
regulatory and other requirements.
 Should be disclosed separately:
 Ordinary share capital,
 Preference share capital,
 Share premium
 Retained earnings
Classification of
income and expense
 Income and expense are classified as components of
profit, loss and components of other comprehensive
income
 The Revised Conceptual Framework has introduced the
term statement of financial performance to refer to the
statement of profit or loss together with the statement
presenting other comprehensive income
 The statement of profit or loss is the primary source of
information about an entity’s financial performance for
the reporting period.
 All income and expense should be appropriately
classified and included in the statement of profit or loss
 Certain items of income and expense that are presented
outside of profit or loss but included or retained
earnings.
Aggregation
 Aggregation is the adding together assets, liabilities,
equity, income and expense that have similar or shared
characteristics and are included in the same
classification
 Makes information more useful by summarizing a large
volume of detail (however, aggregation may conceal
some of the detail.)
 Balance should be made so that relevant information is
not obscured either by a large amount of insignificant
detail or by excessive aggregation.
 Typically, the statement of financial position and the
statement of financial performance provide
summarized or condensed information.
 More detailed information is provided in the notes to
financial statement.
Capital maintenance
The financial performance of an entity us determined using
two approaches namely:
1) TRANSACTION APPROACH
 The traditional preparation of an income
statement
2) CAPITAL MAINTENANCE APPROACH
 Net income occurs only after the capital used
from the beginning of the period is maintained.
 NET INCOME is the amount of the entity can
distribute to its owners and be as “well-off” at the end
of the year as at the beginning
 The distinction between return of capital and return on
capital
o RETURN ON CAPITAL or an amount in excess
of their original investment
o RETURN OF CAPITAL – is an erosion of the
capital invested in the entity
20 | M i k e e P .
 The Conceptual Framework considered two concepts
of capital maintenance namely:
1) Financial capital
2) Physical capital
FINANCIAL CAPITAL
 Under financial capital concept, such as invested ILLUSTRATION:
money or invested purchasing power, capital is
synonymous with net assets or equity Assume in the previously given illustration, the net assets
 of the entity of P500,000 on January 1 had a current cost of P800,000
 Financial capital is the monetary amount of the net by reason of inflationary condition
assets contributed by shareholders and the amount of
the increase in net assets resulting from earnings Net assets – Dec 31 1,300,000
retained by the entity Add: Dividends paid 300,000
 Traditional concept based on historical cost and Total 1,600,000
adopted by most entities Less: Net assets – Jan 1 800,000
Additional Investments 400,000 1,200,000
ILLUSTRATION: Net income 400,000
Jan 1 Dec 31
Total assets 1,500,000 2,500,000
Total liabilities 1,000,000 1,200,000
Additional investments during the yr 400,000
Dividends paid during the year 300,000

Computation of Net Income

Net assets – Dec 31 1,300,000

Add: Dividends paid 300,000
Total 1,600,000
Less: Net assets – Jan 1 500,000
Additional Investments 400,000 900,000
Net income 700,000

NET ASSETS APPROACH: Note that the amount

of net assets is “the excess of total assets over the
total liabilities”
physical capital
 Is the quantitative measure of the physical productive
capacity to produce goods and services
 The physical productive capacity may be based on units
of output per day or physical capacity of productive
assets to produce goods and services
 Productive assets be measure at CURRENT COST,
rather than historical cost
 Productive assets:
 Inventories
 PPE
 The current cost of this these must be maintained
in order that physical capital is also maintained
 Physical capital is equal to the net assets of the entity
expressed in terms of current cost
 This concept should be adopted if the main concern of
users is the operating capability of the entity – the
resource or fund needed to achieve that operating
capability or capacity
 Net income occurs “when the physical productive
capital at the beginning of the period, also after
excluding distributions to and contributions from
owners during the period”

21 | M i k e e P .
 Chapter 8
Presentation of Financial Statements
(Statement of Financial Position) - PAS 1
FINANCIAL STATEMENTS  When an entity’s end of reporting period changes and
financial statements are presented for a period longer or
 Are the means by which the information accumulated shorter than one year, an entity shall disclose:
and processed in financial accounting is periodically a. The period covered by the financial
communicated to the users statements
 Are the end product of main output of the financial b. The reason for using a longer or shorter
accounting process period
 A structured financial representation of the financial c. The fact that amounts presented in the
position and financial performance of an entity financial statements are not entirely
comparable
GENERAL PURPOSE FINANCIAL
STATEMENTS Statements of Financial
 An entity shall prepare and present general purpose Position
financial statements in accordance with the  Is a formal statement showing the three elements
International Financial Reporting Standards comprising financial position:
 Simply referred to financial statements – intented to  Assets, liabilities, and equity
meet the needs of users who are not in a position to  Investors, creditors and other statement users analyze
require an entity to prepare reports tailored to their the statement of financial position to evaluate such
particular information needs factors as:
 Are directed to all common users and not to specific
 Liquidity, solvency, and the need of the entity
users
for additional financing
COMPONENTS OF FINANCIAL
STATEMENTS ASSET
1. Statement of Financial Position (SFP)  an asset is an economic resource controlled by an entity
2. Income Statement (IS) as a result of past event
3. Statement of Comprehensive Income (SCI)  an economic resource is a right that has the potential to
4. Statement of Changes in Equity (SCE) produce economic benefits
5. Statement of Cash Flow (SCF)
6. Notes to Financial Statement CLASSIFICATION OF ASSETS
 Comprising a summary of significant
accounting policies and other explanatory notes  classified into two – current and noncurrent assets
 when an entity supplies goods or services within a
OBJECTIVE OF FINANCIAL clearly identifiable operating cycle, the separate
STATEMENTS classification of current and noncurrent assets is a
useful information by distinguishing between net assets
 To provide information about the financial position, that are continuously circulating as working capital
financial performance and cash flows of an entity that is from the net assets used in long-term operation
useful to a wide range of users in making economic  the operating cycle of an entity is the time between the
decisions acquisition of assets for processing and their realization
 Also show the results of the management’s stewardship in cash or cash equivalent
of the resources entrusted to it  when the entity’s normal operating cycle is not
clearly identifiable, the duration is assumed to be 12
Financial statements provide information about:
months
a. Assets
b. Liabilities
c. Equity
d. Income and expenses, including gains and losses  CURRENT ASSETS
e. Contributions by and distributions to owners in their
capacity as owners PAS 1, paragraph 66 provides that an entity shall classify
f. Cash flows an asset as current when:

Frequency of Reporting a. the asset is cash or cash equivalent unless the asset is
 Financial statements shall be presented at least restricted to settle a liability for more than 12 months
annually after the reporting period
b. the entity holds the asset primarily for the purpose of
trading
22 | M i k e e P .
 c. the entity expects to realize the asset within 12  The IASC defines investment as” an asset held by
months after the reporting period an entity for the accretion of wealth through capital
d. the entity expects to realized the assets of intends to distribution, such as interest, royalties, dividends,
sell or consume it within the entity’s normal operating and rentals, for capital appreciation or for other
cycle benefits to the investing entity such as those
obtained through trading relationships”
PRESENTATION OF CURRENT ASSETS
Current assets are usually listed in the order of (c) INTANGIBLE ASSETS
liquidity. PAS 1, paragraph 54, provides the MINIMUM  An identifiable nonmonetary asset without
LINE ITEMS UNDER CURRENT ASSETS: physical substance
 Patent
a. cash and cash equivalents  Franchise
b. financial assets at fair value such as trading  Copyright
securities and other investments in quoted
 Lease right
equity instruments
 Trademark
c. trade and other receivables
d. inventories  Computer software
e. prepaid expenses
(d) OTHER NONCURRENT
 NONCURRENT ASSETS ASSETS
 Is a Residual definition  Those assets that do not fit into the definition of
 PAS1, paragraph 65, states that “an entity shall the previously mentioned noncurrent assets.
classify all other assets not classified as current as  Long term advances to officers
noncurrent”  Directors
 What is not included in the definition of current  Shareholders and employees
assets is deemed excluded. All others are classified  Abandoned property
as noncurrent assets
 Long-term refundable deposit
NONCURRENT ASSETS INCLUDE THE
FOLLOWING: LIABILITY
 Is a present obligation of an entity to transfer an
a. Property, plant and equipment economic resource as a result of past event.
b. Long-term investments  An obligation is a duty or responsibility that an
c. Intangible assets entity has no practical ability to avoid.
d. Deferred tax assets  Obligation can either be legal or
e. Other noncurrent assets constructive
 Liability is classified as current and noncurrent
(a) PROPERTIES, PLANT AND liability
EQUIPMENT
 Pas 16, paragraph 6, defines PPE as “tangible  CURRENT LIABILITIES
assets which are held by an entity for use in PAS 1, paragraph 69, provides that an entity shall classify
production or supply of goods and services, for a liability as current when:
rental to other, or for administrative purposes,
and are expected to be used during more than a. The entity expects to settle the liability within
one period” the entity’s normal operating cycle
 Most PPE, except land, are presented at cost less b. The entity holds the liability primarily for the
accumulated depreciation. purpose of trading
c. The liability is due to be settled within 12
 Examples of PPE
months AFTER the reporting periods
 Land d. The entity does not have an unconditional right
 Building to defer settlement of the liability for at least 12
 Machinery months after the reporting period.
 Equipment
 Furniture Presentation of current liabilities
 Fixtures
 Patterns PAS 1, paragraph 54, provides that as a minimum, the face
 Molds of the statement of financial position shall include the
 Dies following MINIMUM line items for current
 Tools liabilities:
(b) LONG-TERM INVESTMENTS a. Trade and other payables
 accounts payable,
23 | M i k e e P .
  notes payable,
 accrued interest on note payable,
 dividends payable,
 accrued expense
b. Current provisions
c. Short-term borrowing
d. Current portion of long-term debt
e. Current tax liability
 No objection can be raised if the trade accounts and
notes payable are separately represented
 NONCURRENT LIABILITEIS
The term “noncurrent liabilities” is also a residual
definition
PAS 1, paragraph 69, provides that all liabilities not
classified as current are classified as noncurrent.
a. Noncurrent portion of long-term debt
b. Finance lease liability
c. Deferred tax liability
d. Long-term obligations to company officers
e. Long-term deferred revenue
Currently maturing long-term debt
A liability which is due to be settled within 12 months
after the reporting period is classified as current, even if:
a. The original term was for a period longer than 12
months.
b. An agreement to refinance or to reschedule a
payment on a long-term basis is completed after
the reporting period and before the financial
statements are authorized for issue.
However, if the refinancing on a long term basis is
completed on or before the end of the reporting period,
the refinancing is an adjusting event and therefore the
obligation is classified as noncurrent.
Discretion to Refinance
 If the entity has the discretion to refinance or roll over
an obligation for at least 12 months after the reporting
period under an existing loan facility, the obligation is
classified as NONCURRENT even it would otherwise
be due within a shorter period
 The reason for this treatment is that such
obligation is considered to form part of the
entity’s long-term refinancing because the
entity has an unconditional right under the
existing loan agreement to defer payment for at
least 12 months after the end of the reporting
period.
 Note that the refinancing or rolling over is must be at
the discretion of entity.
 Otherwise, if the refinancing or rolling over is
not at the discretion of the entity, the obligation
is classified as a current liability.
Covenants
 Covenants are often attached to borrowing agreements
which represents undertaking by the borrower.
 Covenants are actually restrictions on the borrower
as to:
 Undertaking further borrowings,
 Paying dividends,
 Maintaining specified level of working capital
 and so forth
 Under these covenants, if certain conditions relating
to the borrower’s financial situation are breached =
the liability becomes payable on demand.
Effects of breach of covenants
 PAS 1, paragraph 74, provides that the liability is
classified as current even if the lender has agreed, after
the reporting period and before the statements are
authorized for issue, not to demand payment as a
consequence of the breach.
 This liability is classified as current because at
reporting date the borrower does not have an
unconditional right to defer payment for at least
12 months after the reporting period.
 Paragraph 75, provides that the liability is classified as
noncurrent if the lender has agreed on or before the
end of the reporting period to provide a grace period
ending at least 12 months after the end of the reporting
period.
LIABILITY
 The term EQUITY is the residual interest in the
assets of the entity after deducting all of its liabilities
 Equity means “net assets” or total assets minus
liabilities
 The terms used in reporting the equity of an entity
depending on the form of the business organization are:
a. Owner’s equity in a proprietorship
b. Partners’ equity in a partnership
c. Stockholders’ equity or shareholders’ equity
in a corporation
 The term “equity” may simply be used for all business
entities
 Under PAS 1, paragraph 7, the holders of the
instruments classified as equity are simply known as
owners
24 | M i k e e P .
 Notes to
Financial Statements
 Provide narrative description or disaggregation of
items presented in the financial statements and
information about items that do not qualify for
recognition
 Are used to report information that does not fit into the
body of the financial statements in order to enhance the
SHAREHOLDER’S understandability of the financial statements
 It contains information in addition to that presented in
EQUITY the statement of financial position, income statement,
statement of comprehensive income, statement of
 Is the residual interest of owners in the net assets of a changes in equity and statement of cash flows
corporation measured by the excess of assets over  PURPOSE: to provide the necessary disclosures
liabilities required by the Philippine Financial Reporting
 The elements constituting shareholders’ equity with Standards (PFRS)
their equivalent IAS Term are:

Philippine term IAS Term FORMS OF STATEMENT OF

 Capital stock  Share capital
 Subscribed capital stock  Subscribed share capital FINANCIAL POSITION
 Preferred stock  Preference share capital There are two customary forms in presenting the statement
 Common stock  Ordinary share capital of financial position namely:
 Additional paid capital  Share premium (a)REPORT FORM
 Retained earnings  Accumulated profit (losses)  This form sets forth the three major sections in a
(Deficit)  Revaluation reserve downward sequence of assets, liabilities and equity
 Retained earnings  Treasury share
appropriated (b)ACCOUNT FORM
 Revaluation surplus  The presentation follows that an account – the
 Treasury stock assets are shown on the left side and the liabilities
and equity on the right side of the statement of
financial position
Chapter 9
Presentation of Financial Statements
(statement of comprehensive income) – pas 1

INCOME STATEMENT A. COMPONENTS OF PROFIT OR LOSS

 Is a formal statement showing the financial
performance of an entity for a given period of time
 The financial performance of an entity is primarily
measured in terms of the level of income earned by the
entity through the effective and efficient utilization of
its resources
 Financial performance is also known as results of
operations of the entity
 The transaction approach is the traditional preparation
of the income statement in conformity with accounting
standards
 The income statement for a period presents the income,
expenses, gains, losses and net income or loss
recognized during the period
 Information about financial performance is useful in
predicting future performance and ability to generate
future cash flows
COMPREHENSIVE INCOME
Is the change in equity during a period resulting from
transactions and other events, other than changes resulting
from transactions with owners in their capacity as owners
It includes:
 The term profit or loss is the total of income less
expenses (excluding the components of OIC)
 The bottom line in the traditional income statement
 Entity may use “net income” or “net loss” to
describe profit or loss
B. COMPONENTS OF OTHER
COMPREHENSIVE INCOME
 Comprises items of income and expenses including
reclassification adjustments that are not recognized
in profit or loss as required or permitted by PFRS
The components of OCI include the following:
1) Unrealized gain or loss on equity investment
measured at fair value through other comprehensive
income
2) Unrealized gain or loss on debt investment
measured at fair value through other comprehensive
income
3) Gain or loss from translation of the financial
statements if a foreign operation
4) Revaluation surplus during the year

25 | M i k e e P .
 PRESENTATION OF
5) Unrealized gain or loss from derivative contracts
designated as cash flows hedge COMPREHENSIVE INCOME
6) “Remeasurements” of defined benefit plan,
including actual gain or loss 1) TWO STATEMENTS
7) Change in fair value attributable to credit risk of a (a) An income statement showing the
financial liability designated at fair value through comprehensive components of profit or loss
profit or loss (b) A statement of comprehensive income
beginning with profit or loss shown in the
PRESENTATION other income statement plus or minus the
components if other comprehensive income.
COMPREHENSIVE INCOME
2) SINGLE STATEMENT OF
PAS 1, paragraph 82A, provides that the statement COMPREHENSIVE INCOME
of comprehensive income shall present line items for
amounts of other comprehensive income during the period
 Combined statement showing the
classified by nature components of profit or loss and components
of other comprehensive income in a single
The line items for amounts of OIC shall be grouped as statement.
follows:  The revised con. Framework calls this as
A. OCI that will be RECLASSIFIED statement of financial performance
SUBSEQUENTLY TO PROFIT OR LOSS
when specific conditions are met Source of income
(a) Unrealized gain or loss on debt investment a) SALES OF MERCHANDISE TO CUSTOMERS
measured at fair value through other  Income from sales shall include all sales to
comprehensive income customers during the period
(b) Gain or loss from translating financial  Sales return, allowances and sicounts shall be
statements of a foreign operation deducted from gross sales to arrive at net sales
(c) Unrealized gain or loss on derivative contracts b) RENDERING OF SERVICES
designated as cash flow hedge  Income from rendering of services, among others,
B. OCI that will not be RECLASSIFIED includes
subsequently to profit or loss but RETAINED  professional fees,
 media advertising commissions,
EARNINGS
 insurance agency commissions,
 Unrealized gain or loss on equity investment  admission fees for artistic dividend income
measured at fair value through other c) USE OF ENTITY RESOURCES
comprehensive income  Income category includes interest, rent, royalty
 The Application Guidance of PFRS, and dividend income
paragraph B5.7.1, provides that such d) DISPOSAL OF RESOURCES OTHER THAN
unrealized gain or loss is reclassified to PRODUCTS
retained earnings upon disposal of the  gain on sale of investments,
investments
 gain on sale of property, plant and equipment
 Revaluation surplus during the year  gain on sale of intangible assets.
 The realization of the revaluation surplus is
through retained earnings
 “Remeasurements” of defined benefit plan, Components of expense
including actual gain or loss  Cost of goods sold or cost of sales
 The remeasurements are not classified  Distribution costs or selling expenses
subsequently but are permanently excluded  Administrative expenses
from profit or loss  Other expenses
 The measurements, may be transferred within  Income tax expense
equity or retained earnings
 Change in fair value attributable to credit risk of a Cost of goods sold of merchandising
financial liability designated at fair value through
profit or loss
concern
Beg. Inventory 500,000
 Such gain or loss from change in fair value
Net Purchases 2,000,000
attributable to credit risk of a financial liability
Goods available for sale 2,500,000
may be transferred within equity or retained
Ending inventory (300,000)
earnings
COGS 2,220,000
26 | M i k e e P .
 Gross profit 1,900,000 other expenses
Freight in 50,000
Total 2,050,000  Are those expenses which are not directly related to
Purchase returns allowances & discounts(50,000) the selling and administrative function
Net purchases 2,000,000 a. Loss on sale of trading investments
b. Loss on disposal of PPE
c. Loss on sale of noncurrent investment
d. Casualty loss – flood, earthquake, fire
Cost of goods sold of manufacturing
concerns
Beg. Raw materials 500,000 No more extraordinary income
Net purchases 2,000,000 PAS 1, paragraph 87, specifically mandates that on entity
Raw materials available for use 2,500,000 shall not present any items of income and expenses as
Ending raw materials (300,000) extraordinary either on the face of the income statement or
Raw materials used 3,200,000 statement of comprehensive income or in the notes
Direct labor 3,000,000
Factory overhead 1,300,000
Total manufacturing cost 6,500,000
Line items
Beg. Goods in process 900,000 PAS 1, paragraph 82, provides that as a minimum, the
Total cost of goods in process 7,400,000 income statement and statement of comprehensive
Ending goods in process (1,000,000) income shall include the following:
Cost of goods manufactured 6,400,000
Beg. Finished goods 1,600,000 a. Revenue
Goods available for sale 8,000,000 b. Gain and loss from the depreciation of financial asset
Ending finished goods (1,500,000) measured at amortized cost as required by PFRS 9.
COGS 6,500,000 c. Finance cost
d. Share in income or loss of associate and joint
Classification of expenses venture accounted for using the equity method
e. Gain of loss on the reclassification of financial asset
DISTRIBUTION COSTS constitute costs which are from amortized cos to fair value profit or loss
directly related to selling, advertising and delivery of goods f. Gain of loss on the reclassification of financial asset
to customers from fair value other comprehensive income to fair
value profit or loss
Distribution costs ordinary include: g. Income tax expense
h. A single amount comprising discontinued operations
a. Salesmen’s salaries i. Profit or loss for the period
b. Salesmen’s commissions j. Total other comprehensive income
c. Traveling and marketing expenses k. Comprehensive income for the period being the total
d. Advertising and publicity of profit or loss and other comprehensive income
e. Freight out
f. Depreciation of delivery equipment and store The following items shall be disclosed on the face of
equipment the income statement and statement of comprehensive
income
ADMINISTRATIVE EXPENSES a. Profit or loss for the period attributable to non-
 Administrative expenses constitute costs of controlling interest and owners of the parent
administering the business b. Total comprehensive income for the period
 Ordinarily include all operating expenses not related to attributable to non-controlling interest and owners
selling and cost of goods sold of the parent

a. Doubtful accounts Forms of income statement

b. Office salaries
c. Expenses of general executives  PAS 1, paragraph 99, provides that an entity shall present
d. Expenses of general accounting and credit an analysis of expenses recognized in profit or loss using
department a classification based on either the function of expenses
e. Office supplies used or their nature within the entity, whichever provides
f. Certain taxes information that is reliable and more relevant
g. Contribution  The income statement may be presented in two ways:
h. Professional fees a. FUNCTIONAL PRESENTATION
i. Depreciation of office building and office  Classifies expenses according to their functions as
equipment part of goods sold, distribution costs,
j. Amortization of intangible assets administrative expenses and other expenses

27 | M i k e e P .
  Also known as the cost of goods sold method
 An entity classifying expenses by function shall
disclose additional information on the nature of
expenses, including depreciation, amortization and
employee benefit costs
b. NATURAL PRESENTATION
 Referred to as the nature of expense method
 Expenses are aggregated according to their nature
and not allocated among the various functions
within the entity
 Expenses are no longer classified as cost of goods
sold, distribution costs, administrative expenses
and other expenses
 the expenses which are the same nature are
grouped or aggregated and presented as one item

28 | M i k e e P .
 Chapter 10
STATEMENT OF CASH FLOW – PAS 7
STATEMENT OF CASH FLOWS
 A component of financial statements summarizing
the operating, investing and financing activities of
an entity
 PRIMARY PURPOSE: Provides information about
the cash receipts and cash payments of an entity
during a period
 An entity shall prepare a statement of cash flows and
present it as an integral part of the financial
statements for each period for which financial
statements are presented
CASH AND CASH EQUIVALENTS
 CASH – comprises cash on hand deposits
 CASH EQUIVALENTS – short-term
highly liquid investments that are readily convertible
to known amount of cash and which are subject to
an insignificant risk of change in value
 PAS 7, paragraph 7, provides that an investment
normally qualifies as a cash equivalent only when it
has a short maturity of three months or less from
date of acquisition
 The investments must be acquired three months or
less before the date of acquisition
EXAMPLES
a. Three-month BSP treasury bill
b. Three-year BSP treasury bill purchased three
months before date of maturity
c. Three-month time deposit
d. Three-month money market instrument or
commercial paper
classification of cash flows
 Cash flows are inflows outflows of cash and cash
equivalents
 The statement of cash flows shall report cash flows
during classified as operating, investing and
financing
Operating activities
 are the cash flows derived primarily from the
principal revenue producing activities of an entity
 operating activities generally result from and other
events that enter into the determination of net income
or loss
EXAMPLES:
a. Cash receipts from sale of goods and rendering of
services
b. Cash receipts from royalties, rental, fees,
commissions and other revenue
c. Cash payments to suppliers for goods and
d. Cash payments for selling, administrative and
other expense
e. Cash receipts and cash payments of an insurance
entity for premiums and claims, annuities and
other policy benefits
f. Cash payments or refunds of income taxes unless
specifically identified with financing and investing
activities
g. Cash receipts and payments for securities held for
trading
Trading securities
 PAS 7, paragraph 15, provides that cash flows arising
from the purchase and sale of dealing or trading
securities are classified as OPERATING
ACTIVITIES
 Cash advances and loans made by a financial
institution are usually classified as operating
activities since they relate to the main revenue
producing activity of that entity.
investing activities
 are the cash flows derived from the acquisition and
disposal of long-term assets and other investments not
included in cash equivalent.
 investing activities include transactions involving
non-operating assets.
EXAMPLES:
a. Cash payments to acquire property, plant and
equipment, intangibles and other long-term assets
b. Cash receipts from sales of property, plant and
equipment, intangibles and other long-term assets
c. Cash payments to acquire equity or debt
instruments of other entities (current and long-term
investments)
d. Cash receipts from sales of equity or debt
instruments of other entities
e. Cash advances and loans to other parties other
than advances and loans made by financial
institution
f. Cash receipts from repayment of advances and
loans made to other parties
g. Cash payments for futures contract, forward
contract, option contract and swap contract
h. Cash receipts from futures contract, forward
contract, option contract and swap contract
Financing activities
 are the cash flows derived from the equity capital and
borrowings of the entity
 are the cash flows that result from transaction
a) Between the entity and the owners –
EQUITY FINANCING
b) Between the entity and the creditors – DEBT
FINANCING
29 | M i k e e P .
 financing activities include the cash flows transactions
involving nontrade liabilities and equity of an entity
EXAMPLES:
a. Cash receipts from issuance of ordinary and
preference shares
b. Cash payments to acquire treasury shares
c. Cash receipts from issuing debentures, loans,
notes, bonds, mortgages, and other short or long-
term borrowings
d. Cash payments for amounts borrowed
e. Cash payments by a lessee for the reduction of
the outstanding principal lease liability
Cash payments to settle such obligations as
trade accounts and notes payable, income tax
payable, accrued expenses are operating activities,
not financing activities.
Noncash transactions
 PAS 7, paragraph 43, provides that investing and
financing transactions that do not require use of
cash or cash equivalents shall be excluded from the
statement of cash flows
 Noncash investing and financing transactions shall
be disclosed elsewhere in the financial statements
either in the notes to financial statements or in a
separate schedule or in a way that provides all
relevant information about these transactions.
 The statement of cash flows is strictly a cash
concept.
THE FOLLOWING NONCASH TRANSACTIONS
ARE DISCLOSED SEPARATELY:
a. Acquisition of asset by assuming directly related
liability
b. Acquisition of asset by issuing share capital
c. Acquisition of asset by issuing bonds payable
d. Conversion of bonds payable into share capital
e. Conversion of preference shares into ordinary shares
Interest
Chapter 11
Accounting Policies, Estimate and Errors (PAS 8)
Accounting Policies
 Are the specific principles, bases, conventions,
rules and practices applied by am entity in
preparing and presenting financial statements
 Essential for a proper understanding of the
information contained in the financial
statements
 An entity is required to outline all significant
accounting policies applied in preparing
financial statements
 Under accounting standards, alternative
treatments are possible
 PAS 7, paragraph 33, provides that interest paid and
interest received shall be classified as operating cash
flows because such items enter into the
determination of net income or loss
 Alternatively, interest paid may be classified as
financing cash flow because it is a cost of obtaining
financial resources.
 Alternatively, interest received may be classified as
investing cash flow because it is a return on
investment.
 For a financial institution, interest paid and interest
received are usually classified as operating cash
flows.
Dividends
 PAS 7, paragraph 33, provides that dividend
received shall be operating cash flow because it
enters into the determination of net income.
 Alternatively, dividend received may be
classified as investing cash flow because it is a
return on investment.
 PAS 7, paragraph 34, provides that dividend paid
shall be financing cash flow because it is a cost of
obtaining financial resources.
 Alternatively, dividend paid may be classified as
operating cash flow in order to assist users to
determine the ability of the entity to pay dividends
out of operating cash flows.
Income taxes
 PAS 7 paragraph 35, provides that cash flows
arising from income taxes shall be separately
disclosed as cash flows from operating activities
unless they can be specifically identified with
investing and financing activities.
 Tax cash flows are often difficult to match to the
originating underlying transaction, so most of the
time all tax cash flows are classified as arising
from operating activities.
 It becomes all the more important for an entity
to clearly state the accounting policies used in
preparing financial statements
 The entity shall select and apply the same
accounting policies each period in order to
achieve comparability of financial statements
or to identify trends in the financial position,
performance and cash flows of the entity
Change in accounting policy
Accounting policies must be applied consistently for
similar transactions and events
30 | M i k e e P .
 A change accounting policy shall be made only when:
a. Require by an accounting standard
b. The change will result in more relevant and
faithfully represented information about the
financial position, financial performance and cash
flows of the entity
EXAMPLES OF CHANGE IN ACCOUNTING
POLICY
A change in accounting policy arises when an
entity generally adopts a accepted accounting principle
which is a the one previously used by the entity.
a. Change in the method of inventory pricing from FIFO
to weighted average method.
b. Change in the method of accounting for long term
construction contract from cost recovery method to
percentage of completion method.
c. The initial adoption of policy to carry assets at revalue
amount is a change in accounting policy to be dealt
with as revaluation.
d. Change from cost model to fair value model in
measuring investment property.
e. Change to a new policy resulting from the
requirement of a new PFRS.
How to report a change in accounting
policy
A change in accounting policy required by a
standard or an interpretation shall be applied in
accordance with the transitional provisions therein.
If the standard or interpretation contains no
transitional provisions or if an accounting policy is
changed voluntarily, the change shall be applied
retrospectively or retroactively.
Retrospective application
 means that any resulting adjustment from the change
in accounting policy shall be reported as an
adjustment to the opening balance of retained
earnings.
 The amount of the adjustment is determined as of the
beginning of the year of change
 If comparative information is presented, the
financial statements of the prior period presented shall
be restated to conform with the new accounting
policy.
Absence of accounting standard
 PAS 8, paragraph 10. provides that in the absence of
an accounting standard that specifically applies to a
transaction event, management shall use judgment in
selecting and applying an accounting policy that
results in information that is relevant to the economic
decision-making need of users and faithfully
represented.
Paragraphs 11 & 12 specify the following hierarchy of
guidance which management may use when selecting
accounting policies in such circumstances:
a. Requirements of current standards dealing with
similar
b. matters
c. Definition, recognition criteria and measurement
concepts for assets, liabilities, income and expenses
in the Conceptual Framework for Financial Reporting
d. Most recent pronouncements of other standard-
setting bodies that use a similar Conceptual
Framework, other accounting literature and accepted
industry practices.
ACCOUNTING ESTIMATE
 A change in accounting estimate is a normal
recurring correction or adjustment of an asset or
liability which is the natural result of the use of an
estimate.
 An estimate may need revision if changes occur
regarding the circumstances on which the estimate
was based or as a result of new information, more
experience or subsequent development
 By very nature, the revision of the estimate does not
relate to prior periods and is not a correction of an
error
 Sometimes it is difficult to distinguish a change in
accounting estimate and a change in accounting
policy.
 The change is treated as a change in accounting
estimate, with appropriate disclosure.
EXAMPLES OF ACCOUNTING ESTIMATE
 As a result of the uncertainties in business activities,
many items in financial statements cannot be
measured with precision but can only be estimated
 Estimation involves judgment based on the latest
available and reliable information.
ESTIMATES MAY BE REQUIRED FOR THE
FOLLOWING:
a. Doubtful accounts
b. Inventory obsolescence
c. Useful life, residual value and expected pattern of
consumption of benefit of depreciable asset
d. Warranty cost
e. Fair value of asset and liability
How to report change in accounting
estimate
The effect of a change in accounting estimate shall be
recognized currently and prospectively by including it
in income or loss of:
a. The period of change if the change affects that
period only
b. The period of change and future periods if the
change affects both.
31 | M i k e e P .
 A change in an accounting estimate shall not be
accounted for by restating amounts reported in
financial statements of prior periods.
 Changes in accounting estimates are to be handled
currently and prospectively, if necessary,
 Prospective recognition of the effect of a change in
accounting estimate means that the change is applied
to transactions, her events and conditions from the
date of change in estimate.
Illustration
For example, a depreciable asset costing P500,000 is
estimated to have a life of 5 years. At the beginning of
the third year, the original life is changed to 8 years.
Thus, the asset has a remaining life of 6 years.
The procedure is not to correct past depreciation.
Instead, the remaining carrying amount of P300,000
(P500,000 minus P200,000 depreciation for 2 years) is
now allocated over 6 years or a subsequent annual
depreciation of P50,000.
Thus, the entry to record the annual depreciation, starting
the third year is:
Chapter 12
Events After the Reporting Period (PAS 10)
 PAS 10, paragraph 3, defines events after the
reporting period favorable or unfavorable, that
occur between the end of reporting period and the
date on which the financial statements are
authorized for issue.
 Events after reporting period are also known as
subsequent events.
 Such events may require either adjustment or
disclosure
TYPES OF EVENTS AFTER THE
REPORTING PERIOD
a. Adjusting events after the reporting period are those
that provide evidence of conditions that exist at the
end of reporting period
b. Nonadjusting events after reporting period are those
that are indicative of conditions that arise after the end
of reporting period.
 It is appropriate to adjust the financial statements for
all events that offer clarity concerning the conditions
that existed at the end of reporting period and that
occur prior to the date the financial statements are
authorized for issue.
 an entity must adjust the amounts recognized in the
financial statements for adjusting events that provide
evidence of conditions that existed at the end of
reporting period.
Depreciation 50,000
Accumulated depreciation 50,000
PRIOR PERIOD ERRORS
are omissions and misstatements in the financial
statements for one or more periods arising from a
failure to use or misuse of reliable information.
Errors may occur as a result of mathematical mistakes,
mistakes in applying accounting policies,
misinterpretation of facts, fraud or oversight.
How to treat prior period errors
Prior period errors shall be corrected retrospectively by
adjusting the opening balances of retained earnings
and affected assets and liabilities.
If comparative statements are presented, the financial
statements of the prior period shall be restated so as to
reflect the retroactive application of the prior period
errors as a retrospective restatement.
 an entity does not recognize events after the reporting
period that relate to conditions that only arose after
the reporting period.
 The entity is required only to disclose significant
nonadjusting events.
ADJUSTING EVENTS
Examples of adjusting events after the reporting
period which require the entity to adjust the financial
statements are:
a. Settlement after the reporting period of a court case
because it confirms that the entity already had a
present obligation at the end of reporting period.
b. Bankruptcy of a customer which occurs after the
reporting period.
c. Sale of inventories after the reporting period may
give evidence about the net realizable value at
reporting date.
d. The determination after the reporting period of the
cost of asset purchased or the proceeds from asset
sold before the end of reporting period.
e. The determination after the reporting period of the
profit sharing or bonus payment if the entity has the
present obligation at the end of reporting period to
make such payment.
f. The discovery of fraud or errors that show the
financial statements were incorrect.
NONADJUSTING EVENTS
32 | M i k e e P .
1. Business combination after the reporting period
2. Plan to discontinue an operation
3. Major purchase and disposal of asset or expropriation
major asset by government
4. Destruction of a major production plant by a fire after
the reporting period
5. Major ordinary share transactions and potential
ordinary share transactions after the reporting period
6. Announcing or commencing the implementation of a
major restructuring
7. Abnormally large changes after the reporting period
in asset prices or foreign exchange rates
8. Entering into significant commitments or contingent
liabilities, for example, by issuing guarantees
9. Commencing major litigation arising solely from
events that occurred after the reporting period
CHAPTER 13
Related Party Disclosures - PAS 24
RELATED PARTY
Parties are considered to be related if one party
has:
 The ability to control the other party.
 The ability to exercise significant influence over
the other party.
 Joint control over the reporting entity.
CONTROL
 Is the power over the investee or the power to
govern the financial and operating policies of an
entity so as to obtain benefits.
 is ownership directly or indirectly through
subsidiaries of more than half of the voting power
of an entity.
SIGNIFICANT INFLUENCE
 is the power to participate in the financial and
operating policy decision of an entity, but not
control of those policies.
 may be gained by share ownership of 20% or
more.
 If an investor holds, directly or indirectly through
subsidiaries, 20% or more of the voting power of
the investee, it is presumed that the investor has
significant influence, unless it can be dearly
demonstrated that this is not the case.
 Beyond the mere 20% threshold of ownership, the
existence of significant influence is usually evidenced
by the following factors:
a. Representation in the board of directors
b. Participation in policy making process
c. Material transactions between the investor
and the investee
d. Interchange of managerial personnel
e. Provision of essential technical information
10. Change in tax rate enacted or announced after the end
of reporting period that has a significant effect on
current and deferred tax asset and liability
Financial statements authorized for
issue
 Financial statements are authorized for issue when
the board of directors reviews the financial
statements and authorizes them issue.
 In some cases, an entity is required to submit the
financial statements to the shareholders for approval
after the financial statements have been issued.
 In such cases, the financial statements are authorized
for issue on the date of issue by the board of
directors and on the date when shareholders approve
the financial statements.
JOINT CONTROL  is the contractually agreed
sharing of control over an economic activity.
Examples of related parties
1) AFFILIATES
 meaning the parent, the subsidiary and fellow
subsidiaries
2) ASSOCIATES
 meaning the entities over which one party
exercises significant influence
 The term "associate" includes the subsidiary or
subsidiaries of the associate.
3) VENTURER in a joint venture
 A joint venture includes the subsidiary or
subsidiaries of the joint venture.
4) Key management personnel - are those
persons having authority and responsibility for
planning, directing and controlling the activities of the
entity, directly or indirectly, any executive director or
nonexecutive director.
5) Close family members of an individual
are those family members who may be expected to
influence or be influenced by that individual in their
dealings with the entity.
Close family members of an individual include:
 The individual's spouse and children
 Children of the individual's spouse
 Dependents of the individual or the
individual's spouse.
6) Individuals owning directly or indirectly an
interest in the voting power of the reporting entity that
gives them significant influence over the entity, and
close family members of such individuals.
7) Postemployment benefit plan for the benefit
of employees.
33 | M i k e e P .
 Examples of
related party transaction
A RELATED PARTY TRANSACTION is a
transfer of resources or obligations between related
parties, regardless of whether a price is charged.
PAS 24, paragraph 20, provides the following
examples of related party transaction:
 Purchase and sale of goods
 Purchase and sale of property and other asset.
 Rendering or receiving services
 Leases
 Transfer of research and development
 License agreement 7. Finance arrangements, including
loans and equity contributions in cash or in kind
 Guarantee and collateral
 Settlement of liabilities on behalf of the entity or by the
entity on behalf of another party.
Related party disclosures
● PAS 24, paragraph 12, requires disclosure of related
party relationships where control exists irrespective
of whether there have been transactions between the
related parties.
● In other words, relationships between parents and
subsidiaries shall be disclosed regardless of whether
there have been transactions between those related
parties.
● An entity shall disclose the name of the entity's parent
and if different, the ultimate controlling party.
● If neither the entity's parent nor the ultimate
controlling party produces financial statements
available for public use, the name of the next most
senior parent that does so shall also be disclosed.
Disclosures of related party transaction
● PAR 24, paragraph 17, provides that if there have
been transactions between related parties, an entity
shall disclose the nature of the related party
relationship as well as information about the
transactions and outstanding balances necessary for
an understanding of the financial statements.
● As a minimum, the disclosures of related party
transaction shall include:
 The amount of the transaction
 The amount of outstanding balance, terms and
conditions, whether secured or unsecured, and
nature of consideration to be provided in
settlement.
 The allowance for doubtful accounts related to
the outstanding balance.
 The doubtful accounts expense recognized during
the period in respect of amount due from related
parties.
Key management personnel compensation
PAS 24, paragraph 16, provides that an entity
shall disclose key management personnel
compensation in total and for each of the following
categories:
 Short-term employee benefits
 Postemployment benefits, for example, retirement
pensions
 Other long-term benefits
 Termination benefits
 Share based payment transactions, for example,
share options
RELATED PARTY DISCLOSURES
NOT REQUIRED
● PAS 24, paragraph 3, requires disclosure of related
party transactions and outstanding balances in the
separate financial statements of a parent, subsidiary,
associate or venturer.
● However, Paragraph 4 provides that intragroup related
party transactions and outstanding balances are
eliminated in the preparation of consolidated financial
statements of the group.
UNRELATED PARTIES
Unrelated parties include the following:
 Two entities simply because they have a director
or key management personnel in common.
 Providers of finance, trade unions, public utilities
and government agencies in the course of their
normal dealings with an entity by virtue only of
those dealings.
 A single customer, supplier, franchisor or general
agent with whom an entity transacts a significant
volume of business merely by virtue of the
resulting economic dependence
 Two venturers simply because they share joint
control over a joint venture.
34 | M i k e e P .
 CHAPTER 14
Inventories ( PAS 2)
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 supplies to be
consumed in the production process or in the
rendering of services.
 Inventories encompass goods purchased and held for
resale, for example:
 Merchandise purchased by a retailer and
held for resale
 Land and other property held for resale by a
subdivision entity and real estate developer.
 Inventories also encompass finished goods
produced, goods in process and materials and
supplies awaiting use in the production process.
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:
 Finished goods
 Goods in process
 Raw materials
 Factory or manufacturing supplies
COST OF INVENTORIES
1) Cost of purchase
2) Cost of conversion
3) Other cost incurred in bringing the inventories to
their present location and condition
1) 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.
 Trade discounts, rebates and other similar items
are deducted in determining the cost of purchase.
2) COST OF CONVERSION
 The cost of conversion of inventories includes
cost directly related to the units of production
such as direct labor.
 It also includes a systematic allocation of fixed
and variable production overhead that is incurred
in converting materials into finished goods.
 FIXED PRODUCTION OVERHEAD is the
indirect cost of production that remains relatively
constant regardless of the volume of production.
 Examples are depreciation and
maintenance of factory building and
equipment, and the cost of factory
management and administration.
 VARIABLE PRODUCTION OVERHEAD
is the indirect cost of production that varies
directly with the volume of production.
 Examples are indirect labor and indirect
materials.
3) 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.
 For example, it may be appropriate to
include the cost of designing products for
specific customers in the cost of
inventories.
 excluded from the cost of inventories and
recognized as expenses in the period when.
incurred:
(a) ABNORMAL amounts of wanted
materiale, labor and other production
costs.
(b) STORAGE COSTS, unless necessary
in the production process prior to a
further production stage. Thus, storage
costs on goods in process are capitalized
but storage costs on finished goods are
expensed.
(c) ADMINISTRATIVE OVERHEADS
(d) DISTRIBUTION OR SELLING
COSTS
35 | M i k e e P .
 COST OF INVENTORIES OF A SERVICE Goods Avail for Sale 417,000
PROVIDER Inventory - Jan 31 (152,000)

 The cost of inventories of a service provider UNITS UNIT TOTAL TOTA

consists primarily of the labor and other costs of COST COST L
personnel directly engaged in providing the COST
service, including supervisory personnel and
Jan. 1 Beg. Bal
attributable overhead. 800 200 160,000
 Labor and other costs relating to sales and general
administrative personnel are not included but are Sale 500
recognized as expenses in the period in which they 8
incurred. Purchase
700 210 147,000
18
Cost formulas

PAS 2, paragraph 25, expressly provides that Sale 800

22
the cost of inventories shall be determined by using
either: Purchase 500 220 110,000
a. First in, First out 31
b. Weighted average COGS 265,000
 The standard does not permit anymore the use of the
last in, first out (LIFO) as an alternative formula in Jan 18 Purchases 147,000
measuring cost of inventories. 31 Purchases 110,000
Total Purchases 157,000
1)FIRST IN, FIRST OUT (FIFO)
 The FIFO method assumes that "the goods first
purchased are first sold" and consequently the 2)WEIGHTED AVERAGE
goods remaining in the inventory at the end of the  The cost of the beginning inventory plus the total
period are those most recently purchased or cost of purchases during the period is divided by
produced. the total units purchased plus those in the
 In other words, the FIFO is in accordance with the beginning inventory to get a weighted average unit
ordinary merchandising procedure that the goods cost.
are sold in the order they are purchased.  Such weighted average unit cost is then multiplied
 The rule is "first come, first sold". by the units on hand to derive the inventory value.
 The inventory is thus expressed in terms of recent In other words, the average unit cost is computed
or new prices while the cost of goods sold is by dividing the total cost of goods available for
representative of earlier or old prices. sale by the total number of units available for
 This method favors the statement of financial sale
position in that the inventory is stated at current
replacement cost.
 The objection to the method is that there is
improper matching of cost against revenue because
the goods sold are stated at earlier or older prices
resulting in understatement of cost of goods sold.
 Accordingly, in a period of inflation or rising
prices, the FIFO method would result to the
highest net income.
 However, in a period of deflation or declining
prices, the FIFO method would result to the lowest
net income.

Illustration - FIFO

The ending inventory is 700 units

UNITS UNIT TOTAL
COST COST
Cost of Good Sold Fr. Jan 18 200 210 42,000
Purchase
Inventory - Jan 1 160,000 Fr. Jan 31 500 220 110,000
Purchases 257,000 Purchase
36 | M i k e e P .
700 152,000
 The preceding illustrative data are used.  In a period of DECLINING PRICES, the LIFO
method would result to the highest net income.
INVENTOR TOTAL UNIT NRV
UNIT LCRNV
TOTAL Illustration - LIFO
Y ITEM COST S COST COST
UNITS UNIT TOTAL
A Beg. Bal
Jan. 2,000,000 8001,900,000
200 1,900,000
160,000 COST COST
1
B 1,500,000 1,550,000 1,500,000
From Jan 1 balance 700 200 140,000
Purchase 700 210 147,000
C
18 2,500,000 2,100,000 2,100,000
Inventory - Jan 1 160,00
D Purchase
3,000,000 5003,200,000
220 3,200,000
110,000 Purchases 257,00
31
Total 9,000,000 8,750,000 8,500,000 Goods Avail for Sale 417,000
Total Goods 2,000 417,000
Available for Sale Inventory - Jan 31 (140,000)

Weighted average unit cost (417,000 / 2,000) COGS 227,000

= 208.50

Inventory cost (700 x 208.50) Specific identification

= 145, 950
● means that specific costs are attributed to identified
items of inventory.
Cost of Good sold ● The cost of the inventory is determined by simply
multiplying the units on hand by the actual unit
Inventory - Jan 1 160,000
cost.
Purchases 257,000
● PAS 2, paragraph 23, provides that this method is
Goods Avail for Sale 417,000
appropriate for inventories that are segregated for a
Inventory - Jan 31 (145,950)
specific project and inventories that are not
COGS 271,050
ordinarily interchangeable.
 The argument for the weighted average method is that
it is relatively easy to apply, especially with Measurement of inventory
computers.
 Moreover, the weighted average method produces ● PAS 2, paragraph 9, provides that inventories shall
inventory valuation that approximates current be measured at the lower of cost and net realizable
value if there is a rapid turnover of inventory. value.
 The argument against the weighted average method is ● The cost of inventory is determined using either
that there may be a considerable lag between the FIFO cost or average cost.
current cost and inventory valuation since the average ● The measurement of inventory at the lower of cost
unit cost involves early purchases. and net realizable value is known as LCNRV.

LAST IN, FIRST OUT (LIFO)

Net realizable value
 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.
 The inventory is thus expressed in terms of
earlier/old prices and the cost of goods sold is
representative of recent/new prices.
 The LIFO favors the income statement because
there is matching of current cost against current
revenue, the cost of goods sold being expressed in
terms of current or recent cost
 The objection of the LIFO is that the inventory is
stated at earlier or older prices and therefore there
may be a significant lag between inventory valuation
and current replacement cost.
 In a period of RISING PRICES, the LIPO method
would result to the lowest net income.
● 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.
The cost of inventories may not be recoverable under
the following circumstances:
a. The inventories are damaged
b. The inventories have become wholly or partially
obsolete.
c. The selling prices have declined
d. The estimated cost of completion or the
estimated cost of disposal has increased.
 Inventories are usually written down to net realizable
value on an item by item or individual basis.
Accounting for inventory writedown

37 | M i k e e P .
 ● If the cost is lower than net realizable value, The measurement of the inventory at LCNRV is applied
there is no accounting problem because the on an item by item or individual basis or P8,500,000
inventory is stated at cost and the increase in
value is not recognized. Total Cost 9,000,000
● If the net realizable value is lower than cost, the LCNRV 8,500,000
inventory is measured at net realizable value. Inventory Writedown 500,000
● In this case, the problem is the proper treatment
of the writedown of the inventory to net Journal Entries
realizable value.
● The writedown of inventory to net realizable The inventory on December 31, 2020 is recorded at cost.
value is accounted for using the allowance
Inventory-December 31, 2020 9,000,000
method.
Income summary 9,000,000
Allowance method The loss on inventory writedown is accounted for
separately.
 The inventory is recorded at cost and any loss on
inventory writedown is accounted for separately. Loss on inventory write down 500,000
 This method is also known as loss method because Allowance for inventory writedown 500,000
 a loss account "loss on inventory writedown" is
debited &  The loss on inventory write down is included in the
 a valuation account "allowance for inventory computation of cost of goods sold.
writedown" is credited.
 In subsequent years, this allowance account is The allowance for inventory write down is presented
adjusted upward or downward depending on the as a deduction from the inventory.
difference between the cost and net realizable value Inventory- December 31, 2020, at cost 9,000,000
of the inventory at year-end Allowance for inventory writedown (500,000)
 If the required allowance increases, an Net realizable value 8,500,000
additional loss is recognized.
 If the required allowance decreases, a gain on
reversal of inventory writedown is recorded.
 However, the gain is limited only to the extent of the
allowance balance.
 The allowance method is used in order that the
effects of writedown and reversal of writedown can
be clearly identified.
 As a matter of fact, PAS 2, paragraph 36, requires
disclosure of the amount of any inventory writedown
and the amount of any reversal of inventory
writedown.
Illustration - Inventory Data on Dec. 31, 2020

Chapter 15
Property, Plant, and Equipment (pas 16)

Property, Plant and Equipment Examples of PPE:

 Are intangible assets that are held for used in 1. Land
production or supply of goods or services, for 2. Land improvements
rental to others, or for administrative purposes; 3. Building
 are expected to be used during more than one 4. Machinery
period. 5. Ship
6. Aircraft
Major characteristics of PPE: 7. Motor vehicle
8. Furniture and fixtures
 The PPE are intangible assets with physical substance 9. Office equipment
 The PPE are used in business (use in production or 10. Pattern, molds and dies
supply of goods or services, for rental to others, & for 11. Tools
administrative purposes) 12. Bearer plants
 The PPE are expected to be used over a period or
more than 1 year. Recognition of PPE
An item of PPE shall be recognized as an asset when:
38 | M i k e e P .
  It is probable that future economic benefits
associated with the asset will flow to the entity
 The cost of the asset can be measured reliably
MEASUREMENT AT RECOGNITION
An item of PPE that qualifies for recognition as an asset
shall be measured at cost.
● COST is the amount of cash or cash equivalent
paid and the fair value of the other consideration
given to acquire an asset at the time of
acquisition or construction
Elements of Cost
 Purchase price, including imp[ort duties and
nonrefundable purchase taxes, after deducting trade
discounts and rebates
 Cost directly attributable to bringing the assets to the
location and condition necessary for it to be capable
of operating in the manner intended by management.
 Initial estimate of the cost of dismantling and
removing the item and restoring the site on which it is
located for which an entity has a present obligation.
Directly attributable costs that qualify for
recognition
a. Cost of employee benefit arising directly from
the construction or acquisition of the item of PPE
b. Cost of site preparation
c. Initial delivery and handling cost
d. Installation and assembly cost
e. Professional fee
f. Cost of testing whether the asset is functioning
properly.
Cost not qualifying for recognition
- Costs that are expensed rather than recognized as
element of PPE
a. Cost of opening a new facility
b. Cost of introducing a new product of service,
including cost of advertising and promotion
c. Cost of conducting business in a new location or
with a new class of customer, including cost of
staff training
d. Administration and other general overhead cost
e. Cost incurred while an item capable of operating
in the manner intended by management has yet
be brought into use of is operated less than full
capacity
f. Cost of relocating or recognizing aprt or all of an
entity’s operations.
MEASUREMENT AFTER RECOGNITION
➢ After initial recognition, an entity shall choose either
the cost model or the revaluation model as the
accounting policy for PPE
➢ The entity shall apply such accounting policy to an
entire class of PPE
❖ The cost model means that PPE are carried at
cost less any accumulated depreciation & any
accumulated impairment loss.
❖ The revaluation model means that PPE are
carried at revalued carrying amount
➔ REVALUED CARRYING AMOUNT -
is the fair value at the date of revaluation
less any subsequent accumulated
impairment loss
Acquisition on a cash basis
 The cost of an item of PPE is the cash price
equivalent at the recognition date.
 The cost of asset acquired on a cash basis simply
includes the cash paid + directly attributable
costs (as freight, installation cost and other cost
necessary in bringing asset to the location and
condition for the intended use.)
Acquisition on account
 When an asset is acquired on account subject to a
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 discounts are generally considered as
reduction of cost and not as income.
Acquisition on installment basis
 When payment for item of PPE is deferred beyond
normal credit terms, the cost is the cash price
equivalent.
 In other words, if an asset is offered at a cash price
and at an installment price and is purchased at the
installment price, the asset shall be recorded at
the cash price.
 The excess of the installment price over the cash
price is treated as an interest to be amortized over
the credit period.
Issuance of share capital
 Philippine GAAP provides that if shares are issued
for consideration other than actual cash, the
proceeds shall be measured by the fair value of the
consideration received.
 Accordingly, where a property is acquired through
the issuance of share capital, the property shall be
measured at an amount equal to the following in
the order of priority:
a. Fair value of the property received
b. Fair value of the share capital
c. Par value or stated value of the share
capital
Issuance of bonds payable
PFRS 9, paragraph 5.1.1, provides the asset acquired by
issuing bonds payable is measured in the following order:
39 | M i k e e P .
 a. Fair value of bonds payable
b. Fair value of asset received
c. Face amount of bonds payable
Exchange
➢ PAS 16, paragraph 24, provides that the cost of an
item of PPE acquired in exchange for a
nonmonetary asset or a combination of monetary
and nonmonetary asset is measured at fair value
plus any cash payment.
➢ However, the exchange is recognized at carrying
amount if the exchange transaction lacks
commercial substance.
● Commercial substance is a new notion and
is defined as the event or transaction causing
the cash flows of the entity to change
significantly by reason of the exchange.
➔ An exchange transaction has
commercial substance when the cash
flows of the asset received differ
significantly from the cash flows of the
asset transferred.
Construction
The cost of self-constructed asset is determined using
the same principles as for an acquired asset.
1) Direct cost of materials
2) Direct cost of labor
3) Indirect cost and incremental overhead
specifically identifiable or traceable to the
construction.
PAS 16, paragraph 22, provides that the cost of abnormal
amount of wasted material, labor or overheard incurred in
the production of self-constructed asset is not included
in the cost of the asset.
Derecognition
➢ means that the cost of the PPE together with the
related accumulated depreciation shall be removed
from the statement of financial position.
➢ PAS 16, paragraph 67, provides that the carrying
amount of an item of PPE shall be derecognized on
disposal or when no future economic benefits are
expected from the use or disposal.
➢ The gain or loss from the derecognition of an item of
PPE shall be included in profit or loss.
➔ Gains shall not be included in revenue but
treated as other income.
➢ The gain or loss arising from the derecognition of an
item of PPE shall be determined as the difference
between the net disposal proceeds and the carrying
amount of the item.
Fully Depreciated Property
➢ A property is said to be fully depreciated when the
carrying amount is equal to zero, or the carrying
amount is equal to the residual value.
➢ In such a case, the asset account and the related
accumulated depreciation account are closed and the
residual value is set up in a separate account.
➢ However, it is not uncommon for an entity to
continue to use an asset after it has been fully
depreciated.
➢ The cost of fully depreciated asset remaining in
service and the related accumulated depreciation
ordinarily shall not be removed from the accounts.
➢ However, entities are encouraged but not required to
disclose fully depreciated property.
Concept of depreciation
 defined as the systematic allocation of the
depreciable amount of an asset over the useful life.
 not so much a matter of valuation.
 is a matter of cost allocation in recognition of the
exhaustion of the useful life of an item of PPE.
 OBJECTIVE: to have each period benefiting from
the use of the asset bear an equitable share of the
asset cost.
DEPRECIATION IN THE FINANCIAL
STATEMENTS
➢ Depreciation is an expense.
➢ Depreciation may be a part of the cost of goods
manufactured or an operating expense.
➢ The depreciation charge for each period shall be
recognized as expense unless it is included in the
carrying amount of another asset.
DEPRECIATION PERIOD
➢ The depreciable amount of an asset shall be
allocated on a systematic basis over the useful life.
➢ Depreciation of an asset begins when it is available
for use, meaning, when the asset is in the location
and condition necessary for the intended use by
management.
➢ Depreciation ceases when the asset is derecognized.
➔ Therefore, depreciation does not cease when
the asset becomes idle temporarily.
➔ Temporary idle activity does not preclude
depreciating the asset as future economic
benefits are consumed not only through usage
but also through wear and tear and
obsolescence.
Factors of depreciation
➢ In order to properly compute the amount of
depreciation, 3 factors are necessary, namely
depreciable amount, residual value and useful life.
1. DEPRECIABLE AMOUNT
➔ is the cost of an asset or other amount
substituted for cost, less the residual value.
40 | M i k e e P .
 ➔ 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.
★ For example, it may be appropriate to
depreciate separately the airframe,
engines, fittings (seats and floor
coverings) and tires of an aircraft.
➔ The entity also depreciates separately the
remainder of the item and the remainder
consists of the parts of the item that are
individually not significant.
2. RESIDUAL VALUE
➔ is the estimated net amount currently
obtainable if the asset is at the end of the
useful life.
➔ The residual value of an asset shall be
reviewed at least at each financial year-end
and if expectation differs from previous
estimate, the change shall be accounted for as
a change in an accounting estimate.
➔ The residual value of an asset may increase to
an amount equal to or greater than the
carrying amount.
➔ If it does, the depreciation charge is zero
unless and until the residual value
subsequently decreases to an amount below
the carrying amount.
➔ Depreciation is recognized even if the fair
value of the asset exceeds the carrying
amount as long as the residual value does not
exceed the carrying amount.
3. 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.
Factors in determining useful life
A. EXPECTED USAGE OF THE ASSET - Usage 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:
● no. of shifts the asset is used,
● the repair and maintenance
program, &
● the care and maintenance of the
asset while idle.
C. TECHNICAL OR COMMERCIAL
OBSOLESCENCE - This arises from changes or
improvements in production, or change in the market
demand for the product output of the asset.
D. LEGAL LIMITS for the use of the asset, such as the
expiry date of the related lease.
Depreciation method
➢ The depreciation method shall reflect the pattern in
which the future economic benefits from the asset are
expected to be consumed by the entity.
➢ The depreciation method shall be reviewed at least at
every year-end.
➢ If there has been a significant change in the expected
pattern of economic benefits, the method shall be
changed to reflect the changed pattern.
➔ Such change shall be accounted for as a change
in accounting estimate.
➢ A variety of depreciation methods can be used.
➢ Depreciation methods include straight line, production
method and diminishing balance method.
 STRAIGHT LINE METHOD
➔ Under the straight line method, the annual
depreciation charge is calculated by allocating
the depreciable amount equally over the number
of years of useful life.
➔ In other words, straight line depreciation is a
constant charge over the useful life of the asset.
➔ 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.
 PRODUCTION METHOD
➔ The production or output method assumes that
depreciation is more a function of use rather
than passage of time.
➔ The useful life of the asset is considered in terms
of the output it produces or the number of hours
it works.
 Thus, depreciation is related to the
estimated production capability of the
asset and is expressed in a rate per unit of
output or per hour of use.
➔ The production method is adopted if the principal
cause of depreciation is usage
 DIMINISHING BALANCE METHOD
(accelerated methods)
➔ provide higher depreciation in the earlier years
and lower depreciation in the later years of the
useful life of the asset.
 Thus, these methods result in a
decreasing depreciation charge over the
useful life.
➔ The accelerated depreciation is on the philosophy
that new assets are generally capable of
producing more revenue in the earlier years than
in the later years.
➔ The accelerated methods include sum of years'
digits method and double declining balance
method.
41 | M i k e e P .
 CHAPTER 16
Government Grant (PAS 20)

GOVERNMENT GRANT Journal entries-first year

 PAS 20, paragraph 3, defines government grant as Cash 15,000,000

assistante by government in the form of transfer of Deferred grant income 15,000,000
resources to an entity in return for part or future
compliance with certain conditions relating to the Deferred grant income 3,000,000
operating activities of the entity. Grant income 3,000,000

Recognition and measurement Environmental expenses 2,000,000

Cash 2,000,000
Government grant shall be recognized when there is
reasonable assurance that: First year (2/10 x 15,000,000) 3,000,000
 The entity will comply with the conditions Second year (3/10 x 15,000,000) 4,500,000
attaching to the grant. Third year (5/10 x 15,000,000) 7,500,000
 The grant will be received. 15,000,000

Government grant shall not be recognized: Illustration 2

 on a cash basis -- as this is not consistent with An entity received a grant of P50,000,000 from the
generally accepted accounting practice. Australian government for the acquisition of a chemical
facility with an estimated cost of P80,000,000 and useful
Classifications of government grant life of 6 years.
a. GRANT RELATED TO ASSET  Grant related to depreciable asset shall be
➢ This is a government grant whose primary recognized as income over the periods and in
condition is that an entity qualifying for the grant proportion to the depreciation of the related asset
shall purchase, construct or otherwise acquire  Accordingly, the grant of P50,000,000 is allocated
long-term assets. an income over 5 years depending on the method of
b. GRANT RELATED TO INCOME depreciation.
➢ By residual definition, this is government grant  The straight line method is used.
other than grant related to asset.
Journal entries for first year
Accounting for government grant
1. Cash 50,000,000
● Government grant shall be recognized as income on Deferred grant income 50,000,000
a systematic basis over the periods in which an
entity recognizes as expenses the related costs for 2. Building 80,000,000
which the grant is intended to compensate. Cash 80,000,000
● In other words, the grant is taken to income over one
or more periods in which the related cost is incurred 3. Depreciation 16,000,000
Accumulated depreciation 16,000,000
Illustration 1 (80,000,000/5)

An entity received a grant of P15,000,000 from the 4. Deferred grant income 10,000,000
national government for the purpose of defraying safety Grant income 10,000,000
and environmental expenses over the period of three (50,000,000/5)
years.

The safety and environmental expenses will be incurred

by the entity as follows:
First year 2,000,000
Illustration 3
Second year 3,000,000
Third year 5,000,000 An entity is granted a large tract of land in Mindanao by
10,000,000 the national government.
 Grant in recognition of specific expenses shall be
recognized as income over the period of the related  The fair value of the land is P60,000,000.
expense.  The grant requires that the entity shall construct a
 Accordingly, the grant of P15,000,000 is allocated as refinery on the site.
income over three years in proportion to the costs
incurred.
42 | M i k e e P .
  The cost of the refinery is estimated to be  Alternatively, the grant is deducted from the
P100,000,000 and the useful life is 20 years. related expense.
 Grant related to nondepreciable asset requiring
fulfillment of certain conditions shall be Illustration
recognized as income over the periods which bear
the cost of meeting the conditions. ● At the beginning of current year, an entity purchased
 Accordingly, the grant of P60,000,000 is allocated an equipment for P5,000,000 and received a
over 20 years. government grant of P500,000 with respect to this
asset.
Journal entries in the first year ● The equipment is to be depreciated on a straight line
basis over5 years. The estimated residual value of
1. Land 60,000,000 the equipment is P200,000.
Deferred grant income 60,000,000
Deferred income approach
2. Refinery 100,000,000
Cash 100,000,000 1. To record the acquisition of the equipment:
3. Depreciation 5,000,000 Equipment 5,000,000
Accumulated depreciation 5,000,000 Cash 5,000,000
(100,000,000/20)
2. To record the government grant as deferred
4. Deferred grant income 3,000,000 income:
Grant income 3,000,000
(60,000,000/20) Cash 500,000
Deferred grant income 500,000
Illustration 4
3. To record annual depreciation:
An entity received grant of P50,000,000 from the USA
government to compensate for massive losses incurred Depreciation 960,000
because of a recent earthquake.. Accumulated depreciation 960,000

A government grant that becomes receivable as

compensation for expenses or losses already incurred or Cost of equipment 5,000,000
for the purpose of giving immediate financial support to Residual value (200,000)
the entity with no further related costs shall be Depreciable amount 4,800,000
recognized as income of the period in which it becomes
receivable. Annual depreciation 960,000
(4,800,000 / 5 years)
Accordingly, the grant of P50,000,000 is recognized as
income immediately. 4. To recognize the income from government grant
for the current year:
Cash 50,000,000
Grant income 50,000,000 Deferred grant income 100,000
Grant income
100,000
(500,000/5 years)

Deduction from asset approach

Presentation of government grant
1. To record the acquisition of the equipment:
 Government grant related to asset shall be presented in
the statement of financial position in either of two Equipment 5,000,000
ways: Cash 5,000,000
 By setting the grant as deferred income. 2. To record the government grant as a deduction from
 By deducting the grant in arriving at the the cost of the asset:
carrying amount of the asset.
Cash 500,000
 Government grant related to income is presented as Equipment 500,000
follows:
 The grant is presented in the income statement, 3. To record the annual depreciation:
either separately or under the general heading
Depreciation 860,000
"other income."
43 | M i k e e P .
 Accumulated depreciation 860,000 forms of government assistance from which the entity
has directly benefited.
Acquisition cost 5,000,000  Unfulfilled conditions and other contingencies
Government grant ( 500,000) attaching to government assistance that has been
Net cost 4,500,000 recognized.
Residual value ( 200,000)
Depreciable amount 4,300,000  It is not required to disclose the name of the
government agency that gave the grant along with the
Annual depreciation 860,000
date of sanction of the grant by such government
(4,300,000/5 years)
agency and the date when cash was received in case
of monetary grant.
Government assistance
● Government assistance is action by government
designed to provide an economic benefit specific to
an entity or range of entities qualifying under certain
criteria. The essence of government assistance is
that no value can reasonably be placed upon it

Examples of government assistance are:

 Free technical or marketing advice
 Provision of guarantee
 Government procurement policy that is responsible
for a portion of the entity's sales.

Government assistance does not include the following

indirect benefits or benefits not specific to an entity:

 Infrastructure in development areas such as

improvement to the general transport and
communication network.
 Imposition of trading constraints on competitors.
 Improved facilities such as irrigation for the benefit
of an entire local community.

Disclosures about government grant

 The accounting policy adopted for government grant,
including the method of presentation adopted in the
financial statements.
 The nature and extent of government grant recognized
in the financial statements and an indication of other

Chapter 17
Borrowing Cost (PAS 23)

BORROWING COSTS b. Finance charge with respect to a finance

➢ (Under PAS 23, prg 5) borrowing costs are defined
as interest and other costs that an entity incurs in
connection with borrowing of funds.
➢ Parag 6 provides that borrowing costs specifically
include:
a. Interest expense calculated using the
effective interest method.
lease.
c. Exchange difference arising from foreign
currency borrowing to the extent that it is
regarded as an adjustment to interest cost.
QUALIFYING ASSETS

44 | M i k e e P .
➢ A qualifying asset is an asset that necessarily takes a Asset financed by specific borrowing
substantial period of time to get ready for the
intended or sale. ➢ PAS 23, paragraph 12, provides that if the funds are
borrowed specifically for the purpose of acquiring a
Examples include the following: qualifying asset, the amount of capitalizable
a. Manufacturing plant borrowing cost is the actual borrowing cost incurred
b. Power generation facility during the period less any investment income from the
c. Intangible asset temporary investment of those borrowings.
d. Investment property Illustration

At the beginning of the current year, an entity obtained a

Excluded from capitalization loan of P4,000,000 at an interest rate of 10%,
specifically to finance the construction of new building.
- PAS 23 does not require capitalization of borrowing The building was completed at the current year-end.
costs relating to the following:
Availments from the loan were made quarterly in equal
A. Asset measured at fair value, such as biological amounts. Total borrowing cost incurred amounted to
asset P250,000 for the current year.
B. Inventory that is manufactured in large quantity
on a repetitive basis, such as maturing whisky,
even if it takes a substantial period of time to get
ready for sale
C. Asset that is ready for the intended use or sale
when acquired.

Accounting for borrowing cost

- PAS 23, paragraph 8, mandates the following rules

on borrowing cost:

1. If the borrowing is directly attributable to the

acquisition, construction or production of a
qualifying asset, the borrowing cost is required to be
capitalized as cost of the asset.
 In other words, the capitalization of
borrowing cost is mandatory for a qualifying
asset.
 Borrowing cost can be capitalized when the
asset is a qualifying asset and it is probable
that the borrowing cost will result to future
economic benefit and the cost can be
measured reliably.

2. All other borrowing costs shall be expensed as

incurred
 In other words, if the borrowing is not
directly attributable to a qualifying asset, the
borrowing cost is expensed immediately.

45 | M i k e e P .
 Prior to their disbursement, the proceeds of the  The amount of capitalizable borrowing cost is the
borrowing were temporarily invested and earned interest
income of P40,000. (b)
(a)
MONTHS
date EXPENDITUR (a x b) AMOUNT
OUTSTANDI
Actual borrowing cost 250,000 ES
NG
Interest income from investment of proceeds (40,000)
Capitalizable borrowing cost 210,000 Jan.1 400,000 12 4,800,000

Asset financed by general borrowing March 31 1,000,000 9 9,000,000

➢ PAS 23, paragraph 14, provides that if the funds are June 30 1,200,000 6 7,200,000
borrowed generally and used for acquiring a
Sept. 30 1,000,000 3 3,000,000
qualifying asset, the amount of capitalizable
borrowing cost is equal to the average carrying Dec. 31 400,000 0 –
amount of the asset during the period multiplied by
a capitalization rate or average interest rate. 24,000,000
- However, the capitalizable borrowing cost
shall not exceed the actual interest incurred. Average carrying amount 2,000,000
➢ The capitalization rate or average interest rate is equal (24,000,000 / 12)
to the total annual borrowing cost divided by the total
general borrowings outstanding during the period. average carrying amount of the building multiplied by
➢ No specific guidance is provided for general the capitalization rate.
borrowing with respect to investment income. (a) (b) (a x b)
➢ Accordingly, any investment income from general date
EXPENDITURES FRACTION AMOUNT
borrowing is not deducted from capitalizable
borrowing cost. Jan. 1 400,000 12 / 12 400,000

Illustration March 31 1,000,000 9 / 12 750,000

An entity had the following borrowings on January 1 of June 30 1,200,000 6 / 12 600,000
the current year. The borrowings were made for general
purposes and the proceeds were partly used to finance the Sept. 30 1,000,000 3 / 12 250,000
construction of a new building.
Dec.31 400,000 – –
Principal Borrowing cost
10% bank loan 3,000,000 300,000 Average carrying amount 2,000,000
12% short-term note 1,500,000 180,000
8% long-term loan 3,500,000 280,000 . - Thus, P2,000,000 x 9.5% equals P190,000.
8,000,000 760,000
 The capitalizable borrowing cost shall not exceed the
The construction of the building was started on January 1 actual borrowing cost.
and was completed on December 31 of the current year.  The amount of P190,000 is the proper capitalizable
borrowing cost because it is less than the actual
January 1 400,000
March 31 1,000,000 borrowing cost of P760,000.
June 30 1,200,000  The excess of P760,000 over P190,000 or P570,000 is
September 30 1,000,000 charged to interest expense.
December 31 400,000
Total expenditures on the building 4,000,000

Asset financed both by specific and general borrowing

At the beginning of the current year, an entity borrowed

Average carrying amount of the building
>>> Another Approach <<<
 The capitalization rate is computed by dividing the total
annual borrowing cost by the total general borrowings.
- Thus, P760,000 divided by P8,000,000 equals
9.5%.
P1,500,000 at an interest of 10% specifically for the
construction of a new building. The actual borrowing
cost on this loan is P150,000.
The entity had also outstanding during the year a 5-year
8% general borrowing of P7,000,000.
The construction of the building started on January 1 and
was completed on December 31 of the current year.
46 | M i k e e P .
 January 1 500,000 ➢ The activities necessary to prepare the asset for the
April 1 1,000,000 intended use or sale encompass more than the
May 1 1,500,000 physical construction of the asset.
September 1 1,500,000
➢ These include technical and administrative work
December 31 500,000 .
Total Cost 5,000,000 prior to the commencement of physical construction,
such as drawing up plans and obtaining permits for a
date (a) (b) (A x B) building.
EXPENDITURE FRACTION AMOUNT
S
➢ However, merely holding assets for use or
development without any associated development
Jan. 1 500,000 12 / 12 500,000 activity does not qualify for capitalization.
★ For example, borrowing costs incurred while
April 1 1,000,000 9 / 12 750,000
land is under development are capitalized
May 1 1,500,000 8 / 12 1,000,000 during the period in which development
activities are being undertaken.
Sept.1 1,500,000 4 / 12 500,000 ➢ But borrowing costs incurred while land acquired
for building purposes is held without any associated
Dec. 31 500,000 – –
development activity do not qualify for
Average carrying amount 2,750,000 capitalization.

Specific borrowing (1,500,000) Suspension of capitalization

Applicable to general borrowing 1,250,000
➢ Capitalization of borrowing costs shall be suspended
during extended periods in which active
CAPITALIZABLE INTEREST development is interrupted
 However, capitalization of borrowing costs is
not normally suspended during a period when
substantial technical and administrative work
is being carried out.
➢ Capitalization of borrowing costs is not also
suspended when a temporary delay is a necessary
part of the process of getting an asset ready for its
COMMENCEMENT OF intended use or sale.
CAPITALIZATION ★ For example, capitalization continues during
the extended period that high water levels
The capitalization of borrowing costs as part of the cost delay the construction of a bridge, if such
of a qualifying asset shall commence when the following high water levels are common during the
three conditions are present: construction period in the georgraphical
region involved.
A. When the entity incurs expenditures for the asset.
B. When the entity incurs borrowing costs.
C. When the entity undertakes activities that are
Cessation of capitalization
Specific Borrowing 150,000 ➢ Capitalization of borrowing costs shall cease when
(10% X 1,500,000)
substantially all the activities necessary to prepare
General Borrowing 100,000 the qualifying asset for the intended use or sale are
(8% X 1,250,000) complete.
➢ An asset is normally ready for the intended use or
TOTAL CAPITALIZABLE 250,000
INTEREST sale when the physical construction of the asset is
complete even though routine administrative work
necessary to prepare the asset for the intended
might still continue.
use or sale.

ACTIVITIES NECESSARY TO Disclosures related to borrowing

PREPARE costs
47 | M i k e e P .
  The amount of borrowing costs capitalized during
the period.
 The capitalization rate used to determine the
amount of borrowing costs eligible for
capitalization.

~ Segregation of assets that are "qualifying assets" from

other assets in the statement of financial position is not
required to be disclosed.

CHAPTER 18
Investment in Associates (PAS 28)

ASSOCIATE  However, PAS 28, paragraph 5, provides a practical

 Associate is simply defined as an entity over which
the investor has significant influence.
 Significance influence is the power to participate in
the financial and operating policy decisions of the
associate but not control or joint control over those
policies.
 The assessment of significant influence is a matter
of judgment.
guidance to assist management in making such
assessment.
 If the investor holds, directly or indirectly through
subsidiaries, 20% or more of the voting power of
the investee, it is presumed that the investor has
significant influence, unless it can be clearly
demonstrated that this is not the case.
 Conversely, if the investor holds, directly or
indirectly through subsidiaries, less than 20% of the
voting power of the investee, it is presumed that the

48 | M i k e e P .
 investor does not have significant influence, unless
such influence can be clearly demonstrated.
 A substantial or majority ownership by another
investor does not necessarily preclude an investor
from having significant influence
Beyond the mere 20% threshold of ownership, PAS
28, paragraph 6, provides that the existence of significant
influence is usually evidenced by the following factors:
➢ Accordingly, under the equity method, the
investment in ordinary shares should be
appropriately described as investment in
associate.
(f) The investment in associate accounted for using the
equity method shall be reported as noncurrent
asset.

a. Representation in the board of directors

b. Participation in policy making process
c. Material transactions between the investor and
the investee
d. Interchange of managerial personnel.
e. Provision of essential technical information
Illustration - equity method
1) On January 1, 2020, an investor purchased 20,000
shares of the 100,000 outstanding ordinary shares of
another entity at P200 per share
The investment represents a 20% equity interest and
the investor has a significant influence over the
investee.

Investment in associate 4,000,000

Cash 4,000,000

2) The investee reported net income of P5,000,000 for

2020.
Measurement of investment in
The investor recognized a share of the net income of
associate the investee equal to 20% of P5,000,000 or
P1,000,000.
● The investment in associate is measured using the
equity method of accounting. Investment in associate 1,000,000
● The equity method is based on the economic Investment income 1,000,000
relationship between the investor and the investee.
● The investor and the investee are viewed as a single 3) Received a 25% share dividend from the investee on
economic unit. The investor and the investee are one December 31, 2020
and the same.
● The equity method is applicable when the investor Memo-Received 5,000 ordinary shares as 25% share
has a significance influence over the investee. dividend on 20,000 original shares. Shares now
held, 25,000 shares
ACCOUNTING PROCEDURES -
Note that the 20% equity interest is not affected by the
EQUITY METHOD - share dividend. The equity interest is the same before
and after the share dividend
(a) The investment is initially recognized at cost.
(b) The carrying amount is increased by the investor's
sharo of the profit of the investee and decreased by
4) The investee reported a net loss of P1,000,000 for
the investor's share of the loss of the investee.
2021
➢ The investor's share of the profit or loss of the
The investor recognized a share in the net loss of the
investee is recognized as investment income. investee equal to 20% of P1,000,000 or P200,000.
(c) Dividends received from an equity investee reduce
the carrying amount of the investment. Loss on investment 200,000
(d) Note that the investment must be in ordinary shares Investment in associate 200,000
➢ If the investment is in preference shares, the 5) The investee declared and paid a cash dividend
equity method is not appropriate regardless of the P2,500,000 on ordinary shares on December 31, 2021.
percentage because the preference share is a
nonvoting equity. The investor recognized a share in the cash dividend
(e) Technically, if the investor has significant influence paid by the investee equal to 20% of P2,500,000 or
over the investee, the investee is said to be an P500,000.
associate Cash 500,000
49 | M i k e e P .
 Investment in associate 500,000
Under the equity method, cash dividend is not an income
but a REDUCTION OF INVESTMENT.
Excess of cost over carrying amount
● An accounting problem arises if the investor pays
more or less for an investment than the carrying
amount of underlying net assets.
● For example, if the earning potential of the investee
is: abnormally high, the current value of the
investee's net assets is frequently higher than their
carrying amount.
If the investor pays more than the carrying amount of the
net Assets acquired, the difference is commonly known
as "excess of cost over carrying amount" and may be
attributed to the following:
a. Undervaluation of the investee's assets, such
as building land and inventory.
b. Goodwill
● If the assets of the investee are fairly valued, the
excess of cost over carrying amount of the
underlying net assets is attributable to goodwill
● If the excess is attributable to undervaluation of a
depreciable asset, it is amortized over the remaining
life of the depreciable asset.
● If the excess is attributable to undervaluation of
land, it is not amortized because the land is
nondepreciable
● The amount is expensed when the land is sold
● If the excess is attributable to inventory, the amount
is expensed when the inventory is already sold
● If the excess is attributable to goodwill, it is
included in the carrying amount of the investment
and not amortized
● However, the entire investment in associate
including the goodwill is tested for impairment at
the end of each reporting period.
Illustration
At the beginning of the current year, an investor
purchased 20% of the outstanding ordinary shares of an
investee for P5,000,000.
● The net assets of the investee on the date of
acquisition are fairly valued. Any excess is
attributable to goodwill.
● The carrying amount of the investeo's not assets
was P20.000.000 equal to fair value. The investor
therefore paid P1,000,000 in excess of the carrying
amount of net assets.
Acquisition cost 5,000,0000
Carrying amount of net assets acquired
(20% x 20,000,000) 4,000,000
Excess of cost over carrying 1,000,000
amount - goodwill
Excess of 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.
Illustration
At the beginning of the current year, an investor
purchased 40% of the ordinary shares outstanding of an
investee for P10,000,000 when the net assets of the
investee amounted to P30,000,000.
At acquisition date, the carrying amounts of the
identifiable assets and liabilities of the investee were
equal to fair value.
Acquisition cost 10,000,000
Fair value of net assets acquired
(40% x 30,000,000) 12,000,000
Excess fair value 2,000,000
The excess fair value is included in investment income of
the investor on the date of acquisition.
Investment in associate 2,000,000
Investment income
Impairment loss
 If there is an indication that an investment in associate
may be impaired, an impairment loss shall be
recognized whenever the carrying amount of the
investment in associate exceeds 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 in an orderly transaction between market
participants at the measurement date.
 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 the ultimate
disposal.
 Since goodwill is not separately recognized from the
investment amount, the impairment loss recognized is
applied to the investment as a whole.
 The recoverable amount of an investment in an
associate is assessed for each individual associate.
 Investee with cumulative preference shares
➢ When an associate has outstanding cumulative
preference shares, the investor shall compute its
share of earnings or losses after deducting the
preference dividends, whether or not such
dividends are declared
 Investee with noncumulative preference shares
50 | M i k e e P .
 ➢ When an associate has outstanding noncumulative
preference shares, the investor shall compute its
share of earnings after deducting the preference
dividends only when declared.
Discontinuance of equity method
● 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,
Consequently, the investor shall account for the
investment as follows:
 Financial asset at fair value through profit or loss
 Financial asset at fair value through other
comprehensive income.
 Nonmarkeble investment at cost or investment in
unquoted equity instrument.
 The investor did not file or 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.
 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.

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 fair value of the investment at the date it ceases
to be an associate shall be regarded as the fair value
on initial recognition as a financial asset.
● 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.
● Of course, the difference between the net proceeds
from disposal of part of the investment and the
carrying amount of the investment sold is recognized
as gain or loss on disposal of investment.

Equity method not applicable

PAS 28, paragraph 17, provides that an investment in
associato 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:

 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
 The investor's debt and equity instruments are not
traded in a public market or "over the counter"
market.
51 | M i k e e P .
 CHAPTER 19
Impairment of Assets (PAS 36)
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.
● 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.
Core principle of impairment
● The basic principle underlying impairment of asset is
relatively straightforward.
● There is an established principle that an asset shall
not be carried at above the recoverable amount.
● An entity shall write down the carrying amount of an
asset to the recoverable amount if the carrying amount
is not recoverable in full.
● If the carrying amount is higher than the recoverable
amount, the asset is judged to have suffered an
impairment loss.
● The asset shall therefore be reduced by the amount of
the impairment loss.
ACCOUNTING FOR
IMPAIRMENT
In this regard, there are three main accounting issues to
consider, namely:
 Indication of possible impairment
 Measurement of the recoverable amount
 Recognition of impairment loss
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.
 However, irrespective of whether there is any
indication of impairment, an entity shall test an
intangible asset with an indefinite useful life or an
intangible asset not yet available for use for
impairment annually by comparing the carrying
amount with the recoverable amount.
 The events and changes in circumstances that lead to
an impairment of assets may be classified as external
and internal sources of information.
EXTERNAL SOURCES
a. Significant decrease or decline in the market value of
the asset as a result of passage of time or normal use
or a new competitor entering the market.
b. Significant change in the technological, market, legal
or economic environment of the business in which the
asset is employed.
➢ This could be as simple as a change in
customer taste.
c. An increase in the interest rate or market rate of return
on investment which will likely affect the discount
rate used in calculating the value in use.
d. The carrying amount of net assets of the entity is more
than the "market capitalization."
➢ In other words, the carrying amount exceeds
the fair value of the net assets.
➢ The market capitalization simply means the
fair value of the net assets of the entity.
INTERNAL SOURCES
a. Evidence of obsolescence or physical damage of an
asset.
b. Significant change in the manner or extent in which
the asset is used with an adverse effect on the entity.
For example, the asset is part of a restructuring or
held for sale or the asset is idle.
c. Evidence that the economic performance of an asset
will be worse than expected.
 For example, the undiscounted not cash flows
from the asset are significantly worse than
those budgeted.
 The external and internal sources of information
are not exhaustive. An entity may identify other
indications that an asset may be impaired.
Measurement of recoverable amount
● After establishing evidence that an asset has been
impaired, the next step is to determine the recoverable
amount preparatory to the recognition of an
impairment loss.
52 | M i k e e P .
 ● The recoverable amount of an asset is the fair value d. Income tax receipts or payments.
less cost of disposal or value in use, whichever is
higher. RECOGNITION OF IMPAIRMENT LOSS
Fair value less cost of disposal
● If the recoverable amount of an asset is less that the
● FAIR VALUE is the price that would be received carrying amount, an impairment loss has occurred.
to sell an asset in an orderly transaction between ● The impairment loss shall be recognized
market participants at the measurement date. immediately by reducing the asset's carrying amount
● Cost of disposal is an incremental cost directly to its recoverable amount.
attributable to the disposal of an asset, excluding ● The impairment loss is recognized in profit or loss
finance cost and income tax expense. and presented separately in the income statement.
 Examples of cost of disposal include legal
Illustration
cost, stamp duty and similar transaction tax,
cost of removing the asset, and direct cost in At year-end, an entity has a machinery with the following
bringing the asset into condition for sale. cost and accumulated depreciation:
● In simple terms, fair value less cost of disposal is
equal to the exit price or selling price of an asset Machinery 5,000,000
minus cost of disposal. Accumulated depreciation 2,000,000
(5-year life, 2 years expired)
VALUE IN USE Carrying amount 3,000,000
● Value in use is measured as the present value or Due to obsolescence and physical damage, the machinery
discounted value of future net cash flows expected is found to be impaired.
to be derived from an asset.
● The cash flows are pretax cash flows and pretax The entity has determined the following information with
discount rate is applied in determining the present respect to the machinery at year-end:
value.
Fair value less cost of disposal 2,400,000
Calculation of value in use Value in use 2,200,000

Calculating a value in use calls for estimates of future Journal entry

cash flows and there is the possibility that an entity might
come up with "overoptimistic" estimates of cash flows. Impairment loss 600,000
Accumulated depreciation 600,000
a. Cash flow projections shall be based on
reasonable and supportable assumptions. Carrying amount 3,000,000
b. Cash flow projections shall be based on the most Fair value less cost of disposal 2,400,000
recent budgets on financial forecasts, usually up to (recoverable amount)
a maximum period of 5 years, unless a longer Impairment loss 600,000
period can be justified.
c. The discount rate used in estimating future cash Note that the fair value less cost of disposal is considered
flows is the current pretax rate. the recoverable amount and used in computing the
impairment loss because it is higher than the value in
Composition of estimates of future cash use.
After the recognition of an impairment loss, the
flows includes depreciation charge for the asset shall be adjusted in
a. Projections of cash inflows from the continuing future periods to allocate the revised carrying amount
less residual value on a systematic basis over the
use of the asset.
remaining useful life.
b. Projections of cash outflows necessarily incurred
to generate the cash inflows from the continuing Another illustration
use of the asset.
c. Net cash flows received or paid on the disposal of On December 31, 2020, an entity has a machinery with
the asset at the end of its useful life in an arm's the following cost and accumulated depreciation:
length transaction. Machinery 60,000,000
Estimates of future cash flows do not Accumulated depreciation 20,000,000
Carrying amount 40,000,000
include:
a. Future cash flows relating to restructuring to which
the entity is not yet committed.  The entity believes that there has been an impairment
b. Future costs of improving or enhancing the asset's of the machinery and accordingly determines the fair
performance. value less cost of disposal and value in use.
c. Cash inflows or outflows from financing activities.
53 | M i k e e P .
 The fair value cost of disposal is determined to be reverses a previous revaluation decrease and any
P33,000,000. excess credited directly to revaluation surplus.
 The machinery has a remaining life of 5 years and is
expected to generate an annual undiscounted net cash Illustration
inflow of P9,000,000,
 The appropriate discount rate is 8%. The present On December 31, 2020, the statement of financial
value of an ordinary annuity of 1 at 5% for 5 periods position shows the following balances:
is 3.99. Machinery 8,000,000
 The value in use is the discounted net cash inflow Accumulated depreciation 1,000,000
computed by multiplying the annual undiscounted (10-year life, 2 years expired)
cash inflow of P9,000,000 by the present value factor Carrying amount 6,400,000
of 3.99 or P35,910,000.
 The value in use is the recoverable amount because it  On the same date, the recoverable amount of the
is higher than the fair value less cost of disposal. machinery is determined to be P5,200,000,

Computation of Impairment Loss Journal entry to record impairment loss

Carrying amount 40,000,000 Impairment loss 1,200,000
Recoverable amount 35,910,000 Accumulated depreciation 1,200,000
Impairment loss 4,090,000 (6,400,000 - 5,200,000)
Journal entries ➢ On December 31, 2021, the recoverable amount of
the machinery is P6,000,000, indicating a reversal of
1. To record the impairment loss on December 31, impairment loss.
2020: ➢ In this case, the "maximum" carrying amount of the
machinery should be equal to the carrying amount
Impairment loss 4,090,000
that would have been determined had there been no
Accumulated depreciation 4,090,000
impairment.
2. To record depreciation for 2021:

Depreciation 7,182,000
Accumulated depreciation 7,182,000
Would have been carrying amount on December
(35,910,000/5 years)
31, 2021
Machinery 8,000,000
Accumulated depreciation 2,400,000
(8,000,000 / 10 x 3 years)
Carrying amount - 5,600,000
December 31, 2021, no impairment
Reversal of an Impairment Loss ➢ Accordingly, the carrying amount of the machinery
cannot exceed P5,600,000.
● PAS 36, paragraph 114, provides that an impairment
➢ Therefore, the carrying amount of P5,600,000 is the
loss recognized for an asset in prior years shall be
basis of the impairment reversal and not the
reversed if there has been a change in the estimate of
recoverable amount of P6,000,000
the recoverable amount.
➢ As a simple guide, the increased carrying amount is
● In other words, if the recoverable amount of an asset
the carrying amount assuming there was no
that has previously been impaired turns out to be
impairment or the recoverable amount, whichever is
higher than the current carrying amount, the carrying
lower.
amount of the asset shall be increased to new
recoverable amount. Carrying amount with impairment on December
● However, PAS 36, paragraph 117, provides that the
31, 2021
increased carrying amount of an asset due to a
reversal of an impairment loss shall not exceed the Machinery 8,000,000
carrying amount that would have been determined, Accumulated depreciation-Dec. 31, 2010 2,800,000
had no impairment loss been recognized for the asset (1,600,000 + 1,200,000)
in prior years. Adjusted carrying amount-Dec. 31, 2020 5,200,000
● The reversal of the impairment loss shall be Depreciation for 2021 (5,200,000 / 8) 650,000
recognized immediately in the income statement as Carrying amount-Dec. 31, 2021 per book 4,550,000
gain on reversal of impairment loss. with Impairment
● But any reversal of an impairment loss on a revalued
asset shall be credited to income to the extent that it Journal entries on December 31, 2021

54 | M i k e e P .
 1. An entity has determined that a cash generating unit is
CARRYING FRACTIO LOSS T impaired. The assets of the cash generating unit at
AMOUNT N
carrying amount are:
Building 2,400,000 24/60 600,000
Building 2,100,000
Land 1,800,000 18/60 450,000 Land 1,800,000
Equipment 1,500,000
Equipment 1,500,000 15/60 375,000 Inventory 300,000
Carrying amount of CGU 6,000,000
Inventory 300,000 3/60 75,000
 Most often, the recoverable amount of a cash
6,000,000 1,500,000 generating unit. is equal to the value in use because
the unit is not to be disposed of.
o record the depreciation for 2021:  The entity calculated the value in use of the cash
generating unit to be P4,500,000.
Depreciation 650,000
Accumulated depreciation 650,000
Computation of Impairment Loss
2. To record the impairment reversal: Carrying amount of CGU 6,000,000
Accumulated depreciation 1,050,000 Value in use 4,500,000
Impairment loss 1,500,000
Gain on reversal of impairment 1,050,000

Carrying amount-no impairment
Carrying amount- with impairment
Gain on reversal of impairment
3. To record depreciation for 2022:
Depreciation
Accumulated depreciation
Adjusted carrying amount- Dec. 31, 2021
Divide by remaining life
5,600,000 PAS 36, paragraph 104, provides that when an
impairment loss is recognized for a cash generating
4,550,000 unit, this loss shall be allocated to the assets of the
1,050,000 unit in the following order:
a. First, to the goodwill, if any.
b. Then, to all other noncash assets of the unit pro
800,000 rata based on their carrying amount.
800,000
Since there is no goodwill, the impairment loss is
5,600,000 allocated across the assets based on carrying amount.
7 years

Annual depreciation for 2022 800,000

Journal entry to record an Impairment

Loss
Impairment loss 1,500,000
Accumulated depreciation - bldg. 600,000
Land 450,000
Cash generating unit (CGU) Accumulated depreciation – equip 375,000
Inventory 75,000
● A cash generating unit is the smallest identifiable
group of assets that generate cash inflows from Cash generating unit with goodwill
continuing use that are largely independent of the
cash inflows from other assets or group of assets ● Goodwill does not generale cash flows independently
● Simply stated, a cash generating unit is a segment of from other assets or group of assets, and therefore, the
business that generates revenue and cash inflows recoverable amount of goodwill as an individual asset
independently. cannot be determined.
● In practice, a cash generating unit may be a ● As a consequence, if there is an indication that
department, a product line or a segment of business. goodwill may be impaired, a recoverable amount is
● As a basic rule, the recoverable amount of an asset determined for the cash generating unit to which
shall be determined for the asset individually. goodwill belongs.
● However, if it is not possible to estimate the
recoverable amount of the individual asset, an entity DETERMINATION OF IMPAIRMENT
shall determine the recoverable amount of the cash
generating unit to which the asset belongs. PAS 36, paragraph 90, provides that a cash generating
unit to which goodwill has been allocated shall be tested
Illustration for impairment at least annually by comparing the
carrying amount of the unit, including the goodwill,
with the recoverable amount.

55 | M i k e e P .
 a. If the recoverable amount of the unit exceeds the ALLOCATION OF IMPAIRMENT LOSS
carrying amount of the unit, the unit and the
goodwill allocated to that unit shall be regarded Impairment loss 1,500,000
as not impaired. Applicable to goodwill 1,000,000
b. If the carrying amount of the unit exceeds the Excess impairment loss 500,000
recoverable amount of the unit, the entity must
recognize an impairment loss. The excess impairment loss is allocated to the other
noncash assets pro rata based on carrying amount.
Carrying Amount Fraction Loss
PPE 3,000,000 ⅗ 300,000
Patent 2,000,000 ⅖ 200,000
5,000,000 500,000

Journal entry to recognize the impairment loss

Illustration Impairment loss 1,500,000
A cash generating unit reported the following assets at Goodwill 1,000,000
carrying amount at year-end: Accumulated depreciation. 300,000
Patent 200,000
Property, plant and equipment 3,000,000
Patent 2,000,000  PAS 36, paragraph 105, provides that the carrying
Goodwill 1,000,000 amount of an asset shall not be reduced below the
Carrying amount of CGU 6,000,000 highest of fair value less cost of disposal, value in use
and zero.
 An annual impairment review is required as the cash  The amount of impairment loss that would otherwise
generating unit contains goodwill. have been allocated to the asset shall be allocated
 The most recent review assesses the value in use of prorata to the other assets of the cash generating
the cash generating unit to be P4,500,000. unit.

Carrying amount of CGU 6,000,000 Reversal of impairment loss on goodwill

Value in use – recoverable amount
Impairment loss
4,500,000 ● PAS 36, paragraph 124, explicitly provides that
1,500,000 an impairment loss recognized for goodwill shall
not be reversed in a subsequent period.
CHAPTER 20
Intangible Assets (PAS 38)

INTANGIBLE ASSET b. It arises from contractual or other legal rights.

➢ An intangible asset is simply defined as an
identifiable nonmonetary asset without physical
substance.
➢ 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.
3 ESSENTIAL CRITERIA OF AN INTANGIBLE
- Identifiability, Control, & Future Economic benefits
(ICFe)
A. IDENTIFIABILITY
➢ The definition of an intangible asset requires that an
intangible asset must be identifiable in order to
distinguish it clearly from goodwill.
➢ With nonphysical items, there may be a problem
with identifiability.
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.
➔ This is regardless of whether these rights are
transferable or separable from the entity or
from other rights and obligations.
B. CONTROL
➢ Another element in the definition of an intangible
asset is that it must be under the control of the entity
as a result of a past event.
➢ 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.
- In other words, the entity must be able to enjoy
the future economic benefits from the asset and
prevent others from enjoying the same benefits.
➢ The capacity of an entity to control the future
economic benefits from an intangible asset normally
would stem from legal rights that are enforceable in
a court of law.
➢ The capacity to control future economic benefits is
much pronounced in the case of trademark,
copyright and patent.
➢ In the absence of legal rights, it is more difficult to
demonstrate control.
56 | M i k e e P .
C. 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.
★ For example, the use of intellectual property
in a production process or the legal right to
use a new technology, may reduce future
production costs rather than increase future
revenue.
Recognition of an intangible asset
An intangible asset shall be recognized if the following
conditions are present:
a. It is probable that future economic benefits
attributable to the asset will flow to the entity.
b. The cost of the intangible asset can be measured
reliably.
Initial measurement of intangible asset
PAS 38, paragraph 24, provides that an intangible asset
shall be measured initially at cost.
➢ If an intangible asset is acquired separately, the
cost of the intangible asset can be measured
reliably, particularly so if the purchase
consideration is in the form of cash or other
monetary asset.
The cost of a separately acquired intangible asset
comprises:
a. Purchase price
b. Import duties and nonrefundable purchase tax
c. Directly attributable costs of preparing the asset
for the intended use
Directly attributable costs include the following:
a. Cost of employee benefit arising directly from
bringing the asset to its working condition.
b. Professional fee arising directly from bringing the
asset to its working condition.
c. Cost of testing whether the asset is functioning
properly
Costs which are not capitalizable
Examples of costs that are not included in the cost of an
intangible asset but expensed immediately are:
● Cost of introducing a new product or service,
including cost of advertising and promotional
activity
● Cost of conducting business in a new location or
with a new class of customer, including cost of staff
training
● Administration and other general overhead cost
● Cost incurred while an asset capable of operating in
a manner intended by management has yet to be
brought into use
● Initial operating loss
Internally generated intangible asset
➢ The cost of an internally generated intangible asset
comprises all directly attributable costs necessary to
create, produce and prepare the asset to be capable
of operating it in the manner intended by
management.
Examples of directly attributable costs are:
● Cost of materials and services used or consumed in
generating the intangible asset.
● Cost of employee benefit arising from the
generation of the intangible asset.
● Fee to register a legal right.
● Amortization of patent used to generate the
intangible asset.
Expenditures that are not components of the cost of
an internally generated intangible asset:
● Selling, administrative and other general overhead
● Clearly identified inefficiency and initial operating
loss
● Expenditure on training staff to operate the asset
❖ PAS 38, paragraph 63,
 explicitly provides that internally generated brand,
masthead, publishing title, customer list and other
items similar in substance shall not be recognized
as intangible assets.
 Such items cannot be identified separately from
the cost of developing the business as a whole.
- Instead, such items are seen as being
component of internally generated goodwill.
❖ PAS 38, paragraph 48,
 provides that internally generated goodwill shall
not be recognized as an asset.
 Accordingly, such expenditures shall be expensed
when incurred.
Recognition as an expense
1. An expenditure on an intangible item that does not
meet the recognition criteria for an intangible asset
shall be expensed when incurred.
2. Examples of expenditures that are expensed when
incurred include:
● Start up costs
➔ Start up costs may consist of organization
costs such as legal and secretarial costs
incurred in establishing a legal entity.
➔ Start up costs also include preopening
costs or expenditures to open a new
facility or business, and preoperating costs
or expenditures for commencing new
operation or launching new product.
● Training costs
● Advertising and promotional costs
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 ● Business relocation or reorganization costs
Subsequent expenditure
➢ As a rule, a subsequent expenditure on an intangible
asset shall be recognized as expense.
➔ The reason is that most subsequent
expenditures are likely to maintain only the
expected future economic benefits embodied
in the intangible asset.
➢ Subsequent expenditure may be capitalized or added
to the cost of the intangible asset if the following
recognition criteria for an intangible asset are met:
● It is probable that future economic benefits
that are attributable specifically to the
subsequent expenditure will flow to the entity.
● The subsequent expenditure can be measured
reliably.
Identifiable intangible assets (PAS 38)
➢ If the intangible asset is acquired through purchase,
there is a transfer of legal right that would make the
asset identifiable.
➢ Moreover, if the asset could be sold, transferred,
licensed, rented or sold separately, the intangible asset
is identifiable.
Examples of identifiable intangible assets are:
❖ Patent
❖ Copyright.
❖ Franchise
❖ Trademark or brandname
❖ Customer list
❖ Computer software
❖ Broadcasting license, airline right and fishing
right
Unidentifiable intangible asset
➢ An intangible asset is unidentifiable if it cannot be
sold, transferred, licensed, rented or exchanged
separately.
➢ The intangible asset is inherent in a continuing
business and can only be identified with the entity as
a whole.
➢ This unidentifiable intangible asset squarely
describes a goodwill.
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.
- The revalued amount is the fair value at the
date of revaluation and is determined by
reference to an active market.
- Thus, an intangible asset can only be carried at
revalued amount if there is an active market for
the asset.
AMORTIZATION OF INTANGIBLE ASSETS
PAS 38 provides the following on the amortization of
Intangible assets:
● Paragraph 97 states that intangible assets with
limited or finite life are amortized over their
useful life.
● Paragraphs 107 and 108 state that intangible
assets with indefinite life are not amortized but
are tested for impairment at least annually and
whenever there is an indication that the
intangible asset may be impaired.
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.
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.
➢ The amortization is recorded by debiting
amortization expense and crediting the intangible
account.
➔ Normally, the intangible asset account is
credited directly for the periodic amortization
but an accumulated amortization account may
be maintained.
Amortization period
 The amortizable amount of an intangible asset shall
be amortized on a systematic basis over the useful
life.
 Amortization shall begin when the asset is available
for use, meaning, when the asset is in the location
and condition for the intended use.
 Amortization shall cease when the intangible asset is
derecognized.
Useful life
The useful life of an intangible asset must be assessed as
either indefinite or finite.
58 | M i k e e P .
 ● FINITE - the useful life may be expressed in
terms of years or the number of units to be
produced.
● INDEFINITE - when there is no foreseeable
limit to the period over which the asset is
expected to generate net cash flows.
- the useful life is indefinite when there
are no legal, contractual, competitive and
other factors that would limit the useful
life of the intangible asset.
~ The major problem for an intangible asset is
determining useful life. the
Factors affecting useful life
● Technical, technological, commercial or other type of
obsolescence
● Expected action by competitors or potential
competitors
● Expected usage of the asset by the entity
● Typical product life cycle for the asset
● Stability of the industry in which the asset operates
● Level of maintenance expenditure required to obtain
the expected future economic benefits from the asset
● The useful life of the asset may be dependent on the
useful life of other assets of the entity
● 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
➢ However, if such pattern cannot be determined
reliably, the straight line method of amortization
shall be used.
RESIDUAL VALUE
The residual value of an intangible asset shall be
presumed to be zero, except:
I. When a third party is committed to buy the
intangible asset at the end of the useful life.
II. When there is an active market for the
intangible asset so that the expected residual
value can be measured and it is probable that
there will be a market for the asset at the end of
the useful life.
❖ The residual value is reviewed at each financial
year-end.
❖ A change in the residual value is accounted for as a
change in accounting estimate.
Derecognition of an intangible asset
a. On disposal of the asset.
b. When no future economic benefits are expected
from its use and disposal.
Gain and loss arising from the derecognition of an
intangible asset shall be determined as the difference
between the net disposal proceeds and the carrying
amount of the asset
Research and development
● PAS 38, paragraph 52,
➔ provides that to assess whether an internally
generated intangible asset meets the criteria for
recognition, an entity classifies the generation of
the asset inte 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.
RESEARCH
➢ Research is an original and planned investigation
undertaken with the prospect of gaining scientific or
technical knowledge and understanding.
➢ Otherwise stated, a research activity is undertaken to
discover new knowledge that will be useful in
developing new product.
EXAMPLES OF RESEARCH ACTIVITIES
● Laboratory research aimed at obtaining or
discovering new knowledge.
● Searching for application of research finding
and other knowledge.
● Conceptual formulation and design of possible
product or process alternative.
● Testing in search for product or process
alternative.
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.
➢ Simply stated, a development activity involves the
application of research findings to develop a new
product.
EXAMPLES OF DEVELOPMENT
ACTIVITIES
● Design, construction, and testing of preproduction
prototype and model.
● Design of tools, jigs, molds and dies involving new
technology.
● Design, construction and operation of a pilot plant
that Is not of a scale economically feasible to the
entity for commercial production.
● Design, construction and testing of a chosen
alternative for new or improved product or process.
ACTIVITIES NOT CONSIDERED
RESEARCH AND DEVELOPMENT (R&D)
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 ➢ Research and development activities typically occur
prior to the beginning of commercial production and
distribution of a product or process.
➢ Accordingly, activities that relate to commercial
production do not result to research and
development cost.
ACTIVITIES NOT CONSIDERED R&D
● Engineering follow through in an early phase of
commercial production.
● Quality control during commercial production
including routine testing.
● Trouble shooting breakdown during production.
● Routine on-going effort to refine, enrich or improve
quality of an existing product.
● Adaptation of an existing capability to a particular
requirement or customer need.
● Periodic design changes to existing products.
● Routine design of tools, jigs, molds and dies.
● Activity, including design and construction
engineering related to construction, relocation,
rearrangement or start-up of facilities and
equipment.
Accounting for Research Cost
➢ PAS 38, paragraph 54, provides that expenditure
on research or on the research phase of an internal
project shall be recognized as expense when
incurred.
➔ The reason is that at the research phase of a
project, an entity cannot be certain that
future economic benefits would probably
flow to the entity.
➢ At the research stage, there is too much
uncertainty about the likely success of the project.
➢ In the research phase, an entity cannot
demonstrate that an intangible asset exists that will
generate probable future economic benefits.
Accounting for Development Cost
➢ In contrast with research cost, development cost is
incurred at a later stage in a project and the
probability of success may be more apparent.
➢ Development cost may or may not be recognized
as an intangible asset depending on very strict
criteria.
Criteria for recognition
Development cost may qualify as intangible asset if and
only if the entity can demonstrate all of the following:
● The technical feasibility of completing the
intangible asset so that it will be available for use or
sale.
➔ This is achieved when a prototype or model
is produced.
➔ The entity has completed the testing of the
model and it is now convinced that it has a
product to sell or use that is significantly
better than any other product available on
the market.
➔ The entity plans to file a patent application
for the product.
● The intention to complete the intangible asset and
use or sell it.
● The ability to use or sell the intangible asset.
● How the intangible asset will generate probable
future economic benefits.
➔ Among other things, the entity shall
demonstrate the existence of a market for
the output of the intangible asset or the
intangible asset itself.
● Availability of resources or funding to complete
development and to use or sell the asset.
● The ability to measure reliably the expenditure
attributable to the intangible asset during its
development.
Capitalizable expenditures
➢ Expenditures for research and development which
have alternative future use, either in additional
research project or for productive purposes, can be
capitalized.
➢ This means that costs incurred for materials,
equipment and intangible asset related to research
and development activities which have an
alternative future use can be capitalized.
➢ Subsequently, the following should be charged to
research and development expense:
● Cost of materials used
● Depreciation of equipment used in research
and development
● Amortization of intangible asset used in
research and developmen
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