MANAGING CREDIT RISK
3.3 percent, in one day
Cost of debt = interest exp (1 - Tax Rate)
A company named Viz Pvt. Ltd took a loan
of $200,000 from a Bank at the rate of
interest of 8% to issue a company bond of
$200,000. Based on the loan amount and
rate of interest, interest expense will be
$16,000 and the tax rate is 30%.
Cost of Debt = $16,000(1-30%)
Cost of Debt = $16000(0.7)
Cost of Debt = $11,200
Cost of debt of the company is $11,200.
Risk Free Rate of Return = RF - inflation
rate
Mr. A wants to borrow funds from B. The
risk free rate is 6% and current inflation is
2%. It is expected that inflation is expected
to grow at 3%. B finds a relevant margin of
4% on the loan.
Risk free rate is 6% - 2% = 4%
New nominal risk free rate is 4% + 3% = 7%
Interest rate for the loan will be 7% + 4% =
11%
It’s up for Mr. A to evaluate whether to
borrow or source another financing
institution that offers lower interest rate
Basis Points (BPS) are a unit of
measurement equal to 1/100th of 1
percent.
Examples:
> The difference between bond interest
rates of 9.85 percent and 9.35 percent is 0.5
percent,equivalent to 50 basis points.
> The Federal Reserve boosts the
interest rates at 100 BPS, signaling an
increase from 10percent to 11 percent.
> Due to the growth of iPhone sales,
Apple Inc. reported high earnings, more
than what was
estimated; the stock increased 330 BPS, or
Ratios that are used to measure
Solvency and Liquidity:
Current Ratio
The current ratio expresses the capability of
current assets to cover its current liabilities
without resorting to selling long-term assets
to cover its current obligations.
Current Assets/Current Liabilities
Quick Ratio
Higher liquidity ratio using quick assets
should reveal a very liquid company in
terms of financial health. It should show that
a business has more funds to be used for
other purposes.
Current Assets -Inventories & Prepayments
Current Liabilities
Debt Ratio
This ratio measures the business total
liabilities as a percentage of its total assets.
It is the business ability to pay its liabilities
with its existing assets; which means that
when a business sells all its assets, this
ratio will determine whether all liabilities can
be paid off or not. The higher the ratio, the
riskier the business is for the lenders.
Total Liabilities /Total Assets
Debt to Equity Ratio
Total liabilities / Total Equity
MODULE 4. FINANCIAL INSTRUMENTS
CASH TO ACCRUAL ACCOUNTING AND
VALUATION ON MONEY MARKET SINGLE ENTRY SYSTEM
SECURITIES
Cash to Accrual Basis
Present Value = PV = CF/(1+r)n Cash basis,
Where: - income i recognized when received
CF= cash flow regardless of when earned,
in future period - Expenses are recognized when paid
r= the periodic rate of return or interest (also regardless of when incurred.
called the discount rate or the - Less costly & more reliable since
required rate of return) estimates and judgment is not
n = number of periods required.
- Does not recognize AP, AR,
IAS 34: INTERIM REPORTING AC,DI,AE,PE

- Reports covering a SHORTER Accrual basis

period than a full financial yr. - Recognize income when earned
Objectives: regardless when cash is received.
● Prescribe the minimum content of - Recognize expenses when incurred
FR. regardless of when paid.
● Prescribes the principle of - Basis for recording or presentation.
recognition & measurement in - Recognize AR,AP,AE,PE, AI,DI
complete OR condensed FS.
● Time and reliable IFR improves the
ability of investors, creditors, and
others to understand an entity’s
capacity to generate earnings and
cash flows and its financial condition
and liquidity.

Scope:
Entry for AR’s: Illustrative Case 1: Accrual Basis
Credit Sales Collection
AR xx Cash xxx MM Company reported revenue of
Credit Sales xx AR xxx P5,000,000 in its accrual basis income
statement for the year ended December 31,
Sales Discount Sales Return 2020. Additional information were as
SD xxx SR xxx follows:
AR xxx AR xxx AR, 12/31/2019 P 900,000
AR, 12/31/2020 P2,500,000
Write off Account
Allow for Doubtful Acc xxx Under cash basis, how much should MM
AR xxx report as revenue for 2020?

Increase in Accounts/ Notes Receivable Solution:

- trade (A,N/R, ending > A,N/R, Revenue (Accrual Basis) 5,000,000
beginning), means there were more Increase in A/R
sales on account than collection (2,500,000 – 900,000) (1,600,000)
(Thus, add the increase to cash Revenue (Cash Basis) 3,400,000
basis to get accrual basis sales or
deduct increase from the accrual Illustrative Case 2: Cash Basis
basis to get the cash basis sale)
Accrual basis sales xxx WW Company reported revenue of
Increase in A/N R (xxx) P7,000,000 under the cash basis for the
Cash Basis Sales xxx year ended 2020. Additional information
or were as follows:
Cash basis sales xxx
Increase in A/N R xxx AR, 12/31/2019 P1,500,000
Accrual Basis Sales xxx AR, 12/31/2020 P1,000,000
Decrease in Accounts/ Notes Receivable
- trade (A,N/R, ending < A,N/R, Under accrual basis, how much should WW
beginning), means that there was report as revenue for 2020?
more collection than sales on
account (this, Add the decrease to Solution:
the accrual basis to get the cash Revenue (Cash Basis) 7,000,000
basis sales or deduct the decrease Decrease in A/R
from the cash basis to get the (1,000,000 – 1,500,000) (500,000)
accrual basis sales) Revenue (Accrual Basis) 6,500,000
Accrual basis sales xxx
Decrease in A/N R xxx
Cash Basis Sales xxx
or
Cash basis sales xxx
Decrease in A/N R (xxx)
Accrual Basis Sales xxx
Entry for AP’s: or
Purchases Payment Cash basis Purchases xxx
Purchase xx AP xxx Decrease in A/N P (xxx)
AP xx Cash xxx Accrual Basis Purchases xxx

Purchase Discount Purchase R&A Illustrative Case 3:

AP xxx AP xxx
Pur Dis xxx Puchase R&A xx
Increase in the Accounts/ Notes Payable
- trade (A,N/P, ending > A,N/P,
beginning), means that there were
more purchases on account than
payments to suppliers (thus, add the
increase to the cash basis
purchases (payments made) to get
the accrual basis purchases or
Deduct the increase from the accrual
basis purchases to get the cash
basis purchases)
Accrual basis purchases xxx
Increase in A/N P (xxx)
Cash Basis Purchases xxx
or
Cash basis Purchases xxx
Increase in A/N P xxx
Accrual Basis Purchases xxx
Decrease on Accounts/ Notes Payable
- trade (A,N/P, ending < A,N/P,
beginning), means that there were
more payments to supplies (cash
basis purchases) than accrual basis
purchases (thus, add the decrease
to the accrual basis purchases to get
the cash basis purchases or the total
payments made or Deduct the
decrease from the cash basis
purchases to get the accrual basis
NN Company reported total purchases of
P3,500,000 in its cash basis financial
statement on December 31, 2020.
Additional information revealed the
following:
Accounts Payable, 12/31/2019 P 800,000
Accounts Payable, 12/31/2020 P1,200,000
Under the accrual basis of measuring
revenues and expenses, how much is the
total purchases for the year ended
December 31, 2020?
Solution:
Purchases (Cash Basis) 3,500,000
Increase in A/P
(1,200,000 – 800,000) 400,000
Purchases (Accrual Basis) 3,900,000
Computation for converting cash basis data
to accrual would include the ff: REVENUE
Cash receipts representing revenue xxx
Accrual revenue, beg. (xxx)
Accrual revenue, end. xxx
Unearned revenue, beg. xxx
Unearned revenue, end. (xxx)
Revenue under accrual basis xxx
*** Any increase in accrued revenue is
added (cash - accrual)
*** Any increase in unearned revenue is
deducted (cash - accrual)

Accrual basis purchases xxx

*** Any decrease in unearned revenue is
Decrease in A/N P xxx deducted (cash - accrual)
Cash Basis Purchases xxx
 The following information was obtained from
the incomplete records of AA related to its
Illustrative Case 4: operating expenses:
12/31/19 12/31/20
Under the cash basis, rental income of DD Total payment made P800,000
Company for the calendar year 2020 is Total operating expenses P700,000
P700,000. Additional information regarding Prepaid OE P210,000 ?
rental income are presented below: Accrued OE P250,000 P200,000
Unearned rental income, 1/1/20 P60,000
Unearned rental income, 12/31/20 P85,000 What is the balance of the Prepaid
Accrued rental income, 1/1/20 P40,000 Operating Expenses account on Dec. 31,
Accrued rental income, 12/31/20 P50,000 2020

Under the accrual basis, how much rental Solution:

income should be reported by DD Company Total Payment made 800,000
in year 2020? Increase in Prepaid OE
(260,000 – 210,000) (50,000)
Solution: Decrease in Accrued OE
Revenue (Cash basis) 700,000 (200,000 – 250,000) (50,000)
Increase in Unearned income Total operating expenses 700,000
(85,000 – 60,000) (25,000)
Increase in Accrued income Other Computation Guides:
(50,000 – 40,000) 10,000
Revenue (Accrual basis) 685,000

Computation for converting cash basis data

to accrual would include the following:
EXPENSES

Cash payments representing exp XX

Accrual expenses, beg (XX)
Accrual expenses, end XX
Prepaid Expenses, beg XX
Prepaid Expenses, end (XX)
Expense under accrual basis XX

** Any increase in accrued expense is

added(cash - accrual)
**Any increase in Prepaid expense is
deducted(cash - accrual)

BOOKKEEPING SYSTEM
llustrative Case 5:
 - is the systematic and chronological
recording of transactions and events
in the books of accounts. It is also
known as the recording phase of
accounting.
Bookkeeping VS Accounting
The computation procedure followed in
determining net income or loss is simply to
compare the capital or retained earnings at
the beginning of the year and capital or
retained earnings at the end of the same
year after taking into consideration
withdrawals or dividends and other
investment.

Any difference is either net income or net

loss. Any increase in capital or retained
earnings is net income and any decrease in
Systems of Bookkeeping
capital or retained earnings is net loss.
- Single-entry bookkeeping - a system
of bookkeeping whereby, as a rule,
The single entry method of determining net
only cash and personal accounts are
income or loss is also known as “net
recognized. The system may range
assets approach” or “capital
from mere narrative transactions to
maintenance approach”.
one that approximates but does not
completely adopt a double entry
Capital is the excess of total assets over
system. The use of the single-entry
total liabilities.
system is simple and economical.
Increases in assets and decreases in
However, the accounting record will
liabilities increase net assets while
be incomplete and the double entry
increases in liabilities and decreases in
automatic check (debit is equal to
assets decrease net assets.
credit) is missing.
Below are some other characteristics of
Formula for Proprietorship or
single-entry system:
Partnership
● Accounting equation is disregarded
Capital, end of the year XXX
● Usually one effect of each
Add: Withdrawals XXX
transaction is recognized
Total XXX
● Typically, only cash is recording, and
Less: Capital, beg. XXX
personal accounts are maintained
Addi Investment XXX XXX
● Trial balance cannot be prepared
Net income/Net loss XXX
● Data needed for preparation of
financial statement is incomplete
● Net income is determined by
reconstructing revenue and
expenses or comparing beginning
and ending capital.

Formula for Corporation

Single entry method
Retained earnings, end XXX
Add: Dividends declared or paid
Other items that decreases
retained earnings but not P/L XXX
Total XXX
Less: Retained earnings, beg XXX
Other items that increases
retained earnings but not P/L XXX
Net income/Net loss XXX

SINGLE ENTRY ACCOUNTING SYSTEM

Illustrative Case 6:

AA Company reported capital at P2,500,000

on January 1, 2020 and P3,800,000 on
December 31, 2020. During the current
year, the owner withdrew merchandise with
carrying amount of P400,000. The company
also paid P1,350,000 for the investment
made during the year. What is the net
income or loss of the company for the year?

Solution:
Capital, end 3,800,000
Add: Withdrawals 400,000
Total 4,200,000
Less: Capital, beg 2,500,000
Add Investment 1,350,000 3,850,000
Net income
350,000