VHINSON Intermediate Accounting 1 Part 1 2023 2024 Edition

2023 - 2024
EDITION
The Book R̶e̶a̶d̶e̶r̶s̶ Raiders | Nevule

INTERMEDIATE
ACCOUNTING 1 PART 1
BASED ON PFRSs, PASs AND
PHILIPPINE GAAP
Well Organized
Comprehensive
Illustrative
Simplified
Philippine Financial Reporting Standards (PFRSs) Updated
Self-taught
Designed for OBE
An Integrated Principle-based Approach
A Guide to Understanding and Mastering Financial Accounting

Principles and Applications
For
Accountancy students
CPA Board Exam candidates
Finance & Business students
Practitioners
and
Instructors
By
VHINSON JAY S. GARCIA, CPA
The
The Book R̶e̶a̶d̶e̶r̶s̶ Raiders
Book Readexs- Raiders || Nevule
Nevule 6689 CamScanner
Philippine Copyright, 2023
by
No part of this book may be reproduced in any form or any means without the
written permission from the author.
Any copy of this book not bearing the full signature of the author in colored
pen shall be considered proceeding from an illegal source. Violators shall be
dealt with by law.
ALL RIGHTS RESERVED
ISBN: 978-971-95940-6-2
Published and distributed by:
(REAL
Y
},
\l
Nl EXCELLENCE Vy
REAL EXCELLENCE PUBLISHING

1985 C.M. Recto Avenue corner S.H. Loyola St. (4th Floor),
Manila, Philippines
Cell Nos. 09669063062 / 09603130705
The
Nevule cs CamScanner
CamScanner
ABOUT THE AUTHOR
CPA Board Exam Top 1
National CPA Reviewer in Financial Accounting and Reporting (FAR)

National CPA Reviewer in Auditing Theory (AT)
Member of Technical Team and

Academics Officer
Real Excellence Online CPA Review
Lecturer
Wesleyan University-Philippines, Cabanatuan City
Mary the Queen College, Pampanga
Holy Angel University, Pampanga
National University - Baliwag, Bulacan
Former Auditor
Sycip, Gorres, Velayo (SGV) & Company
Makati City
Credit Derivatives Reviewer
[a multinational bank]
Bonifacio Global City, Taguig
Summa Cum Laude, BS Accountancy

Wesleyan University-Philippines, Cabanatuan City
Valedictorian, High School

San Antonio Montessori School, San Antonio, Nueva Ecija
Salutatorian, Elementary
San Francisco Elementary School, San Antonio, Nueva Ecija
The
DEDICATION
To the Supreme Being up above, who gave me the strength and knowledge in
finishing this craft,
To my parents, Papa, Vic Garcia and Mama, Lorna Garcia, who always give their
unwavering support, guidance and inspiration from the beginning until now,
To my grandparents, Itay, Cipriano Samson and Inay, Conchita Samson, who

guided me at a very young age and raised me froma very humble beginning,
To my uncles, Tito Rod, Tito Cris and Tito Dennis, who showed me at a very young
age that I can achieve many things through hardwork and perseverance,
To my former professors in Wesleyan University - Philippines, as spearheaded by

then Dean, Dra. Maria Victoria Mones-Cruz, who nurtured and equipped me with
the knowledge that greatly contributed to what I have achieved so far,
To every student and professor in quest of real excellence,
This book is dedicated to you.
A special thanks to my former students who gave feedback and suggestions for the
improvement of this book, to my friends and colleagues in REO CPA Review, and
to Sir Nifio Jerald Cruz, Seanne Veniene Esguerra, and Robert Carl Arrojo, who
shared their expertise in reviewing this craft.
A dearest thanks to Sir Rex Banggawan, who inspired me to create this book and
share my knowledge to a wider audience, and to Wency Giron and Khim
Afionuevo for their utmost support.
The
CamScanner
INSTRUCTION TO READERS
Dear readers,
Financial Accounting and Reporting is a complex and interesting topic, yet it is

one of the most integral fields of knowledge inherent to finance and accounting
professionals. Thus, an adequate understanding of Financial Accounting and Reporting
is a hallmark of a true accountant. Although the topic at hand may seem daunting, the
author shall do his best to make the subject easily understandable.
Financial Accounting and Reporting is complex because it establishes the

foundation of accounting rules, pronouncements, and standards. Here, students will
learn about the different classes of assets, liabilities, and equity. Each classification of
assets and liabilities will have their own corresponding standards, principles, and
disclosure requirements. This book shall follow a standard-based discussion to ensure
a practical understanding of the topics at hand. Furthermore, the author devised a
principle-based structural presentation of Financial Accounting and Reporting to aid
in the understanding of the concepts through concept maps, diagrams, and simple
discussions. The aim is to inculcate a thorough understanding for long-term concept
retention and decisive application.
In studying the text, focus on the principles before the application. These
principles are derived directly from the Financial Reporting Standards. Afterwards,
mastery of the topic is achieved through the application of the principles through
computational problem discussions further supported by self-test exercises on the
concepts and problems.
The author has carefully arranged the topics in this book from chapter to
chapter and volume to volume. I strongly recommend that you read the book from the
first chapter to the end. References between chapters are being made in order to
strengthen the interconnectedness of the topics. One must not forget the past topics as
they delve deeper into the book. Your understanding of previous concepts will always
be needed in later chapters.
After understanding the chapters, practice is the stepping stone to mastery.

Thus, always answer the end-of-chapter self-test exercise to gauge your
understanding of the topic. The discussion questions serve as summaries of the
concepts. The theory questions are for strengthening your understanding based on the
accounting standards. The numerical problems are for practice of the application of
the theories. However, we advised our beloved readers that the solution manual of
the book is restricted only to financial accounting professors of adopting
schools. This is to ensure that students attempt and successfully master the concepts,
theories, and problems.
It is in my sincerest hope that this humble piece of work will be able to guide,
shape, and teach our future CPAs. I hope this book will be able to deliver its objective
and assist you in your goals. Welcome to the world of financial accounting! May this
book serve as your partner and your guide. God Bless!
The
For commentaries, inquiries, or suggestions:
We highly value your feedback. Please share your thought with us. Please feel
free to e-mail us at realexcellence.publishing@yahoo.com. You may also contact Real
Excellence Publishing at 09669063062 / 09603130705. Thank you!
Interested readers may secure copies of our books from Real Excellence
Publishing.
Vhinson Jay S. Garcia, CPA
REAL EXCELLENCE PUBLISHING - Intellectual Property Rights Advisory

When you read books, you benefit from the learning. More often, you learn from books
more than the direct inputs of your school. Should you reward the authors who
wholeheartedly devoted tremendous time and effort to produce excellent books for you
or the self-centered people who merely steal the reward from them?
For many decades, piracy disheartened numerous competent authors. Most authors
stopped revising their books because they are deprived of the fruits of their labor.
Piracy is counterproductive to the educational advancement of the country. It’s now
time for a change. Let that change start in you!
We are truly committed in making high quality books. That’s why we are very serious in
protecting our intellectual property rights. High quality books deserve respect. We
will prosecute any violation of our copyrights to the fullest extent.
If you were tricked to buy a pirated copy, we are willing to replace it with a genuine
copy in exchange for the seller's information such as identity and location. We will keep
your identity confidential.
The
The Book
Book R̶Readexs-Raiders
e̶a̶d̶e̶r̶s̶ Raiders || Nevule
INTERMEDIATE ACCOUNTING VOLUME 1 PART 1
2023 EDITION
Vv iW_OF
CHAPTER Cash and Cash Equivalents 1-29

Bank Reconciliation 30-54
oLaxtiulatusawnn
CHAPTER
CHAPTER Proof of Cash 55-79
CHAPTER Accounts Receivable 80-97
CHAPTER Accounting for Bad Debts 98-121
CHAPTER Notes Receivable - Interest-Bearing 122-140
CHAPTER Notes Receivable - Subject to Present Value 141-164
CHAPTER Receivable Financing - Pledge and Assignment 165-179
CHAPTER Receivable Financing - Factoring and Discounting 180-198
CHAPTER Inventories - Preliminary Considerations 199-223
CHAPTER Inventories - Inclusions and Exclusions 224-248
CHAPTER Inventory Cost Flow Assumptions 249-268
CHAPTER Subsequent Measurement of Inventory 269-294
CHAPTER Gross Profit Method 295-317
CHAPTER 9A Retail Inventory Method 318-339
CHAPTER 10 Introduction to Investments 340-355
CHAPTER 11 Investments in Equity Securities 356-380
CHAPTER 11A Dividends, Share Splits and Share Rights 381-402
CHAPTER 12 Investments in Debt Securities - Introduction 403-421
CHAPTER 12A Investments in Debt Securities - FVTPL 422-440
CHAPTER 12B Investments in Debt Securities - Amortized Cost 441-470
CHAPTER 12C Investments in Debt Securities - FVTOCI 471-495
CHAPTER 13 Reclassification of Financial Assets 496-512
CHAPTER 14 Loans Receivable 513-530
CHAPTER 15 Impairment of Financial Assets 531-555
CHAPTER 16 Financial Assets - Other Matters 556-575
CHAPTER 17 Other Investments 576-596
The
TABLE OF CONTENTS
CHAPTER 1 Cashand Cash Equivalents
Identifying items of cash
Measurement of cash
Checks
Special cases on checks (stale, unreleased, post-dated)
Bank overdrafts
Cash funds
Compensating balances
Cash equivalents
Items not considered cash and cash equivalents
Keeping up with technological trends
Petty cash fund
Petty cash short or over
Chapter summary
Exercise Drills
CHAPTER 2 Bank Reconciliation 30-54

Transactions affecting cash in bank
Identifying reconciling items
Bank reconciling items
Book reconciling items
Consideration of errors in bank reconciliation
Different forms of bank reconciliation
Recording of reconciling items
Determining the amounts of reconciling items
Chapter summary
Exercise Drills 44-54
CHAPTER 3 Proof of Cash 55-79
Introduction to proof of cash 55
Preliminary considerations on proof of cash 55
Steps in preparing proof of cash 57
Incorporating correction of errors in proof of cash 61
Different forms of proof of cash 63
Computation of deposit in transit 64
Computation of outstanding checks 66
Errors committed and discovered during the same period 67
Special case of redeposited NSF check 69
Chapter summary 70
CHAPTER 4 Accounts Receivable 80-97

Classifications of receivables 80
Trade receivables 80
Nontrade receivables 81
82
Financial reporting of receivables
84
Initial measurement of accounts receivable
The
Nevule cS CamScanner
Transactions affecting accounts receivable 84
Gross method and net method of recording receivables 85
Subsequent measurement of accounts receivables 87
Expected sales returns 88
Expected sales discounts 88
Expected freight out 89
Credit balances in customers’ accounts 90
Chapter summary 91
CHAPTER 4A Accounting for Bad Debts 98-121

Methods of accounting for bad debts 98
Comparison of direct write-off and allowance methods 99
Allowance for bad debts account 100
Estimating bad debts expense and allowance for bad debts 100
Percentage-of-sales method 101
Accounts receivable method 102
Aging method 104
Debit balance in the allowance for bad debts account 105
Changes in the estimate of bad debts 107
Estimating the percentage of bad debts 109
Using the t-account approach to determine missing elements 110
Chapter summary 111
CHAPTER 5 Notes Receivable - Interest-Bearing 122-140

Parties in a promissory note 122
Different types of promissory notes 123
Initial recognition of notes receivable 123
Subsequent accounting for promissory notes 124
Accounting for interest-bearing (stated rate = market rate) 124
Computation of accrued interest receivable 127
Reporting of interest-bearing note receivable 129
Determining the term (in days) of a promissory note 131
Special case of compounding interest rate 132
Chapter summary 133
CHAPTER 5A Notes Receivable - Subject to Present Value Calculations 141-164

Concept of time value of money 141
Computing the present value of cash flows 141
Computing present value factor of single payment 142
Computing present value factor of ordinary annuity 143
Computing present value factor of annuity due 144
Initial measurement of noninterest-bearing notes 145
Subsequent measurement of noninterest-bearing notes 146
Reporting of notes subjected to present value calculations 152
Initial measurement of interest-bearing notes
(stated rate # market rate) 153
The
Nevule 8) CamScanner
Subsequent measurement of interest-bearing notes
(stated rate # market rate) 154
Concept of day 1 loss 155 |
Chapter summary 157
CHAPTER 6 Receivable Financing - Pledge and Assignment 165-179
Concept of receivable financing 165
Pledge of receivables 165
Assignment of receivables 166
Notification vs. non-notification bases 168
Credit card transactions 173
Chapter summary 174
CHAPTER 6A Receivable Financing - Factoring and Discounting 180-198

Factoring transactions 180
Computing the net proceeds from factoring 180
Accounting for factoring transactions 181
Discounting of notes receivable 183
Computing the net proceeds from discounting 184
Accounting for the discounting of notes receivable 186
Different forms of discounting of notes 186
Discounting with recourse —- the maker failed to pay 189
Discounting of an entity’s own promissory note 190
Chapter summary 191
CHAPTER 7 Inventories - Preliminary Considerations 199-223

Inventories according to accounting standards 199
Initial measurement of inventory 200
Costs of purchase - 200
Basket purchase of inventories 201
Costs of conversion 202
Other inventory costs 202
Costs excluded from the cost of inventories 202
Inventory of a trader of a merchandiser 203
Inventories of a manufacturer 203
Recording of inventory purchases and sales 207
Perpetual vs periodic inventory methods 207
Trade discount vs purchase discount 208
Gross method vs net method of recording 210
Allocation of factory overhead 211
Joint and by-products 212
Chapter summary 213
The
Nevule oJ CamScanner
CamScanner
a5id Nie
CHAPTER 7A Inventories - Inclusions and Exclusions 224-248
Items to be included in the inventory balance 224
Inventory in transit 224
Freight terms 226
Special sales arrangements 229
Consigned inventory 230
Bill-and-hold arrangements 231
Lay away sales 232
Installment sales 233
Sales on approval 234
Sale or purchase with a right of return 235
Inventory financing 235
Repurchase agreements 236
Chapter summary 237
CHAPTER 8 Inventory Cost Flow Assumptions 249-268

What happens to the initially capitalized inventory cost? 249
Determining the applicable cost flow assumption 250
Specific identification method 251
FIFO cost flow assumption 252
Average method 253
Average — periodic vs average - perpetual 253
Comparison of different cost flow assumptions 258
Change from FIFO method to average method and vice versa 258
Chapter summary 259
CHAPTER 8A Subsequent Measurement of Inventory 269-294

Lower of cost and net realizable value (LCNRV) 269
Determining the net realizable value 269
Application of LCNRV assessment 270
Recording of write-down of inventory 272
Allowance method vs direct method of recording 272
Recording additional loss on inventory write-down 273
Gain on reversal of loss on inventory write-down 275
Writing-down raw materials 276
Level of application of LENRV assessment 277
Consideration of selling prices after reporting date 279
Exceptions to the LCNRV assessment 279
Purchase commitments 280
Loss on purchase commitments 281
Gain on reversal of loss on purchase commitment 284
Chapter summary 285
The
The Book
CHAPTER 9 Gross Profit Method 295-317
Reasons for estimating the ending inventory 295
Gross profit method - general model 296
Computation of total goods available for sale 296
Computation of net sales to for gross profit method purposes 297
Variations in gross profit rate 298
Converting gross profit rate from one variation to another 298
Computation of COGS using net sales and gross profit rate 299
Computing the estimated ending inventory balance 299
Effects of improperly deducting sales discounts and allowances 301
Distortions in gross profit rate 301
Estimating inventory loss from catastrophe 303
Estimating inventory shortage or overage 306
Estimating the gross profit rate to be used 306
Chapter summary 308
CHAPTER 9A Retail Inventory Method 318-339

Retail inventory method - general model 318
Determining the amounts of total goods available for sale
at cost and at retail 319
Net markups and net markdowns 320
Determining net sales for retail inventory method purposes 321
Variations in cost ratio (conventional, average and FIFO) 325
Special consideration on FIFO method 326
Estimating inventory losses from catastrophes 328
Estimating inventory shortage or overage 329
Chapter summary 330
CHAPTER 10 Introduction to Investments 340-355

Investments of an entity 340
What investment to choose? 340
Financial instruments, financial assets and financial liabilities 341
Items not considered as financial instruments 342
Broad classifications of financial assets 344
Classifications of financial assets under PFRS 9 345
Basis for the classification of financial assets under PFRS 9 346
When to recognize financial assets 346
Initial measurement of financial assets 346
Methods of computing the amount of fair value 348
Accounting when the transaction price # fair value 348
Basket purchase of financial assets 349
Chapter summary 351
The
CamScanner
CHAPTER in Equity Securities
11 Investments ; 356-380
Investments in equity securities vs debt securities 356
Classification of investments in equity securities under PFRS9 357
FVTPL accounting vs FVTOCI accounting 358
FVTOCI - cumulative balance of unrealized gainorloss-OCI 361
Profit or loss vs other comprehensive income 364
Amounts to be reported in profit or loss, OCI or equity 368
Cost as substitute for fair value of investments 368
Transaction costs arising from selling equity securities 369
Chapter summary 370
Exercise Drills , 371-380
CHAPTER 11A Dividends, Share Splits and Share Rights 381-402

Types of dividends 381
Relevant dates regarding dividends 381
Accounting for cash dividends 382
Effects of dividends in selling or purchasing investments 383
Accounting for property dividends 385
Accounting or liquidating dividends 385
Accounting for share dividends of the same class 386
Accounting for share dividends of the different class 388
Accounting for share splits 389
Accounting for share rights aol
Special assessments 393
Chapter summary 394
CHAPTER 12 Investments in Debt Securities - Introduction 403-421

Overview of investments in debt securities 403
Classification of investments in debt securities under PFRS9 403
Basis for classifying investments in debt securities 403
Business model assessment 404
Relating business model to classification of debt securities 405
Contractual cash flow characteristics assessment 406
Combining business model and contractual cash flow assess. 407
Fair value option for investments in debt securities 407
Computing fair value using quoted price approach 409
Computing fair value using present value approach 409
Computing fair value using different interest frequencies 411
Computing fair value of serial debt securities 413
Chapter summary 414
CHAPTER 12A Investments in Debt Securities - FVTPL 422-440

Accounting for investments in debt securities at FVTPL 422
Fair value computations not on interest payment date 425
Acquisition of investment not on interest payment date 427
Sale of investment on interest payment date 429
Sale of investment not on interest payment date 431
The
Nevule © camscanner
CamScanner
Chapter summary 432
CHAPTER 12B Investments in Debt Securities - Amortized Cost 441-470

Held-to-maturity (or hold-to-collect) business model 441
Accounting for amortized cost classification 442
Methods of amortizing premium or discount 443
Relationship of interest income and interest received 443
Straight-line method of amortization . 444
Bond outstanding method of amortization 445
Effective interest rate method of amortization 448
Amortization for different interest payment frequencies 450
Effects of transaction costs in subsequent measurement 452
Interest payment date other than reporting date 453
Sale of debt securities on interest payment date 454
Sale of debt securities not on interest payment date 456
Serial debt securities — effective interest method 458
Chapter summary 460
CHAPTER 12C Investments in Debt Securities - FVTOCI 471-495

Held-to-maturity and held-for-selling business model 471
Accounting for FVTOCI classification 471
FVTOCI vs amortized cost 473
Debt securities at FVTOCI vs equity securities at FVTOCI 473
Unrealized gains/losses from debt securities at FVTOCI 473
Selling of debt securities on interest payment date 480
Selling of debt securities not on interest payment date 483
FVTPL vs amortized cost vs FVTOCI classification 485
Chapter summary 487
CHAPTER 13 Reclassification of Financial Assets 496-512

Concept of reclassification 496
Reclassification of equity securities 496
Reclassification of debt securities 496
Recording of reclassification 497
Reclassification scenarios of investments in debt securities 498
Reclassification from FVTPL to amortized cost category 498
Reclassification from FVTPL to FVTOCI category 498
Reclassification from FVTOCI to FVTPL category 501
Reclassification from FVTOCI to amortized cost category 501
Reclassification from amortized cost to FVTPL category 504
Reclassification from amortized cost to FVTOCI category 504
Generalizations on reclassification of debt securities 506
Chapter summary 507
The
The Book
vad
CHAPTER 14 Loans Receivable 513-530
Loans receivable vs investments in bonds 513
Accounting classifications for loans receivables 513
Amortized cost of loans receivables . . 514
Accounting for origination costs and origination fees 515
Installment payments of loan principal 520
Loans with equal periodic payments 522
Chapter summary 523
CHAPTER 15 Impairment of Financial Assets . 531-555

Impairment model under PFRS 9 531
Financial assets covered by impairment provisions in PFRS9 532
Computation of expected credit loss amount 532
General approach in determining the expected credit loss 533
Three-bucket or stages of credit risk 533
Probability of default x loss given default approach 534
Computation of loss given default 537
Financial asset is credit-impaired (stage 3 of general approach) 538
Reversal of impairment loss in credit-impaired asset 541
Stage 1 to stage 3 impairment 542
Impairment of debt security at FVTOCI 545
Simplified approach 546
Chapter summary 547
CHAPTER 16 Financial Assets - Other Matters 556-575

Regular way purchase or sale 556
Trade date vs settlement date 556
Trade date accounting vs settlement date accounting - general 557
Trade date accounting vs settlement date accounting - buying 557
Trade date accounting vs settlement date accounting - selling 560
Modification of terms of financial assets at amortized cost 561
Derecognition of financial assets 563
Incorporating risks and rewards in the derecognition of assets 564
Transfers involving only a portion of financial assets 565
Chapter summary 568
CHAPTER 17 Other Investments 576-596

Establishment of bond sinking fund 576
Accounting for bond sinking fund transactions 576
Determining the projected balance in bond sinking fund 578
Future value vs present value 578
Different future value factors and their applicability 579
Determining future value of single payment 579
Determining future value of ordinary annuity 580
Determining future value of annuity due 581
Determining the amounts to be invested in the sinking fund 582
The
CamScanner
i
Reporting of bond sinking fund 583

Cash surrender value 584
Accounting for insurance-related transactions 585 |
Determining the amount of net insurance expense 585
Determining the amount of net gain on insurance settlement 585 |
Chapter summary 589
The
Chapter 1 — Cash and Cash Equivalents
CHAPTER 1
CASH AND CASH EQUIVALENTS
Chapter Overview and Objectives
After this chapter, readers are expected to comprehend:

The items that can be considered as part of cash and cash equivalents.
Oa FWN PrP
The measurement of cash and cash equivalents items.

The accounting for postdated, unreleased, and stale checks.
The accounting for bank overdrafts.
The accounting for petty cash fund.
CASH AND CASH EQUIVALENTS - INTRODUCTION

Cash, in layman’s term, contains bills and coins. In business and economic sense, it
also includes checks, cash in banks, and money orders. This also serves as the
medium of exchange, and it is considered to be the most liquid asset as it can be
used in the greatest number of transactions.
Cash is what an entity is after and is the final result of an entity's operations. Entities
spend money for machineries and equipment to turn raw materials to inventory,
sell the inventory as receivables, and finally collect the receivables as cash. It can
also be said that “cash is king”.
The prospect of receiving more cash is also a driving force for investors to invest
their money in a profit motivated entity in the form of investments in stocks or
loans. This additional cash comes from dividends, interests, other distributions, and
the proceeds from the ultimate disposal of these investments.
IDENTIFYING ITEMS OF CASH

Determining which items can be classified as cash can be a bit tricky since there are
no explicit guidelines in the accounting standards. Usually, those items which have
the following characteristics are considered as part of cash:
a. Can be spent for a wide range of objectives; and
b. Substantially unrestricted as to the usage.
For accounting purposes, “cash” can be classified into the following three
categories, including some examples under each category:
The
~~ Cash on hand -Cashinbank | . Cashfunds

Coins, currency, paper Demand and savings Shall be used in
bills, checks received, deposit. operations such as
money orders, etc. payroll fund, tax funds
Time deposits are and dividend funds
Checks include manager’s | classified as cash
check, traveler’s check, equivalents, which will
customer’s check, be discussed later in the
employee's check chapter.
Details of each category are to be discussed shortly.
MEASUREMENT OF CASH
Cash items are measured at their face amount. For example, a 1,000-peso bill shall
be recorded as P1,000 and not any other amount. A check received with a written
amount of “P36,550” shall be recorded at P36,550 in the accounting books.
Ifa cash item is denominated in foreign currency (i.e., US Dollars, Euro), it shall be
translated using the exchange rate as of the reporting date (i.e., spot rate).
CHECKS
Aside from the coins, currency and paper bills, checks also form part the bulk of the
amount of cash on hand. The following are the parties in a check document:
a. Maker (drawer) - the person who made the check in favor of the payee. This is
usually a debtor.
b. Drawee - the person (usually a bank) which the maker directed to pay the
payee. The drawee has custody over the maker’s cash (i.e., cash in bank).
c. Payee - the person for whom the check is made and given to (i.e., beneficiary).
This is usually a creditor or supplier.
Graphically, these relationships can be shown as follows:
provides goods/services
gives check as payment J
The
Illustration 1. Cleaners Corporation provided cleaning and maintenance services

to ABC Company. As payment for the services received, ABC Company wrote a check
and immediately gave it to Cleaners Corporation. The bank indicated on the check
is PB Corporation.
In this scenario, ABC Company is considered the maker while Cleaners Corporation is
considered as the payee. PB Corporation is considered as the drawee.
Depending on the role of the entity, a check shall be accounted for as follows (the
perspective of the drawee is not that relevant moving forward):
The Entity is the PAYEE The Entity is the MAKER

Given to suppliers or creditors
Received from customers for
Description : for payment of goods or services
the payment of their accounts that the entity availed
Deducted to arrive at cash in
bank balance and deducted from
Initial Added to the cash on hand | the accounts payable balance.
accounting balance and deducted from Assumption: Whenever there is
procedures accounts receivable balance a_ check prepared, its amount is
already deducted from the cash in
bank balance.
“check was received from | “check written”; “prepared
Key words or | customers”; “check received as | check”; “check as payment of
phrases payment of accounts | accounts payable”; “supplier
receivable” check”
Inquiry: Why is the amount of the check already considered in the computation of
the balance of cash items?
Answer: The reason is that there is already an economic transfer whenever a maker
gives a check to the payee. The payee has already obtained “control” over the
amount represented by the check as it can be deposited in the drawee bank
anytime to obtain the actual amount of cash.
SPECIAL CASES ON CHECKS
Despite the general rules mentioned regarding checks in the previous section,
adjustments shall be made for the following checks:
Post-dated check | Unreleased check Stale check
Check that is not encashed within a
Check not yet reasonable time. Based on banking
Check dated after given to the practices, reasonable time is within
the reporting date payee as of the 180 days or 6 months from the date
reporting date
of the check
The
“4
||
|
In making adjustments, the role of an entity is crucial in executing the specific
adjustment procedures:
Adjustments to be Made if Adjustments to be Made if 7)
the Entity is the PAYEE the Entity is the MAKER _ eS
These shall be all excluded | Based on _ the previously
Post-dated | fom the cash balance. mentioned assumption, the
Check amount of check shall be added
ae Lea i ieee ee. cod back to both the cash in bank and
Stale Check balance, the following adjusting BOCAS Pay avleIalaheee:
entry shall be made: Cash XxX
See Accounts receivable — xx Hecounis payanie =
Check C
ash XX
Adjustments are made since the control over the amount of cash represented by the
check is not yet transferred from the maker to the payee:
a. For postdated check, the control will be transferred from the maker to the
payee only upon the date indicated on the check (i.e., during the next period).
b. For unreleased check, the control will be transferred only when the maker has
given the physical possession of the check to the payee.
c. For stale check, the control is lost since the right of the payee over the check
has already expired. Consequently, the control has been transferred back to
the maker.
Illustration 2. FLUFFY Company reported unadjusted cash in bank. balance of

P4,500,000 as of December 31, 2023. As the Company's bookkeeper, you found out
that the following checks from customers were already included in the reported cash
balance:
a. Check amounting to P500,000 dated December 26, 2023.
b. Check amounting to P300,000 dated January 4, 2024.
c. Check amounting to P180,000 dated April 1, 2023.
First of all, the entity is the payee for all of these checks. Based on this, the adjusted
cash balance as of December 31, 2023 is computed as follows:
Particulars Amounts Remarks
Unadjusted balance P4,500,000
Check A - Properly included (not postdated, stale nor
unreleased)
Check B (300,000) Postdated (dated after December 31, 2023)
Check C (180,000) Stale (not encashed for more than 6 months)
Adjusted balance P4,020,000 saan
Compound journal entry to record the adjustments to the cash in bank balance:
4
The
CamScanner
Accounts receivable 480,000

Cash in bank (P300K + P180K) 480,000
Illustration 3. On December 31, 2023, ZORO Company reported cash in bank

balance amounting to P3,200,000. Upon inspection of journal entries, the following
supplier checks were already deducted to arrive at the ending cash in bank balance:
a. Check amounting to P250,000 and dated January 10, 2024 was already given to
the payee last December 23, 2023.
b. Check amounting to P360,000 and dated December 20, 2023 was given to the
payee only on January 12, 2024.
c. Check amounting to P150,000 and dated December 28, 2023 was given to the
payee last December 15, 2023. This is yet to be encashed by the payee.
d. Check amounting to P450,000 and dated May 1, 2023 was given to the payee last
May 15, 2023. This is yet to be encashed by the payee.
First of all, the entity is the maker for all of these checks. Based on this, the adjusted
cash balance as of December 31, 2023 is computed as follows:
Particulars Amounts Remarks

Check A 250,000 Postdated (dated after December 31, 2023)
Check B 360,000 Unreleased check as of December 31, 2023
Check C - Properly included (not postdated, stale nor
unreleased)
Check D 450,000 Stale (not encashed for more than 6 months)
Adjusted balance P4,260,000
Compound journal entry to record the adjustments to the cash in bank balance:
Cash in bank (P250K + P360K + P450K) 1,060,000
Accounts payable 1,060,000
CASH IN BANK - ACCOUNTING FOR BANK OVERDRAFTS

Entities usually maintain more than one bank account, either with the same bank
or with another bank. Each bank account serves a purpose such as the following:
a. account to which the check amounts were deposited
b. account from which the checks prepared by the entity for the suppliers are
deducted
c. account from which the salaries of employees are deducted
Bank overdrafts happen when a particular bank account results in a negative

balance. In other words, there is an overdraft if the total amount of checks encashed
by payees is higher than the amount of cash that the entity maintains for that bank
account.
The
an
Bank overdrafts are accounted for as follows:
Is there any other bank account Present the whole

with a positive balance overdraft as part of
maintained in the same bank? current liabilities
—
—.,
Present the overdraft as

deduction from cash
Is the positive balance enough and cash equivalents to
to cover the overdraft amount? the extent of the
No
positive balance
Present the excess

overdraft as part of
Present whole overdraft as a
current liabilities
deduction from cash and cash
equivalents (i.e., full offsetting)
By default, these rules shall be followed in the absence of additional information.

However, despite these rules, an entity may deduct any overdraft amount from
cash and cash equivalents, provided the overdraft is an integral part of an entity’s
cash management.
Illustration 4. NOEMI Company maintains bank accounts with three different
banks. As of December 31, 2023, the following information is relevant:
a. Account 000123 has P900,000 balance while Account 000124 has P350,000
overdraft balance, both maintained with ARLAN Bank.
b. Account 800456 has P700,000 balance while Account 800457 has P800,000
overdraft balance, both maintained with EDWARD Bank.
c. Account 987654, which is maintained with FOXY Bank, has P50,000 overdraft
balance. There were no other bank accounts maintained with FOXY Bank.
By default, the amounts to be reported as part of cash and cash equivalents and
current liabilities are as follows:
The
The Book
Chapter 1 - Cash and Cash Equivalents
Cash and cash Current

equivalents liabilities Remarks
ARLAN Bank:
Account 000123 P900,000
Account 000124 (350,000) Positive balance is enough
EDWARD Bank:
Account 800456 700,000 Positive balance is not enough
Account 800457 (700,000) 100,000 Excess over the positive balance
FOXY Bank:
Account 987654 50,000 _ No positive balance
Totals P550,000 —P150,000
Assuming that the overdraft amounts are an integral part of the Company's cash
management, the amounts to be reported as part of cash and cash equivalents and
current liabilities are as follows:
Cash and cash Current
equivalents liabilities Remarks
ARLAN Bank:
Account 000123 P900,000
Account 000124 (350,000)
EDWARD Bank:
Account 800456 700,000
Account 800457 (800,000) Deducted to full extent
FOXY Bank:
Account 987654 (50,000) Deducted to full extent
Totals P400,000 p-
ACCOUNTING FOR CASH FUNDS"

Entities usually maintain cash funds for a wide range of purposes:
a. For use in the operations, such as funds earmarked for payroll, petty cash, tax,
dividends, payment to suppliers, change, and for any other current purpose.
b. For use in the capital expenditures, such as funds earmarked for the
acquisition of land, building, equipment, long-term investments and for any
other noncurrent purpose.
c. For the payment of long-term debts, such as bond sinking fund. These funds
can either be voluntarily or mandatorily (as part of a loan agreement)
established. Mandatorily established sinking funds are usually in the custody of
another entity (i.e., trustee) and its use is highly restricted.
Cash funds are accounted and reported as follows:
The
The Book
Funds 8 Presentation in the balance sheet

Operating funds Part of cash and cash equivalents a
: di fund Part of noncurrent assets as long-term investments
Capital expenditure funds (excluded from cash and cash equivalents)
If the related liability is noncurrent, presented as
Bond sinking fund - long-term investment as part of noncurrent assets.
voluntary establishment | [f the related liability is current, presented as part of
cash and cash equivalents within currentassets.|
If the related liability is noncurrent, presented as
Bond sinking fund - long-term investment as part of noncurrent assets.
mandatory establishment | | the related liability is current, presented as part of
short-term investments within current assets.
For petty cash funds, the amount to be included in the cash and cash equivalent
balance is equal to the coins and currency on hand, and accommodation check
(i.e., check of petty cash custodian).
Illustration 5. At the end of 2023, USOPP Company reported the following cash funds:
Tax fund P400,000

Payroll fund 3,200,000
Warehouse fund 5,500,000
Machinery fund 4,000,000
Bond sinking fund - voluntarily established; related
bonds will mature on December 31, 2026 1,500,000
bonds will mature on July 31, 2024 2,000,000
Bond sinking fund - mandatorily established; related
bonds will mature on March 31, 2024 4,400,000
Bond sinking fund - mandatorily established; related
bonds will mature on December 31, 2027 5,000,000
Pension fund 1,200,000
Based on the given information, the amount of cash and cash equivalents is
computed as follows:
Amounts Remarks
Tax fund P400,000
Warehouse fund Noncurrent asset
Machinery fund Noncurrent asset
Bond sinking fund - voluntarily established;
related bonds will mature on 12/31/26 Noncurrent asset
Bond sinking fund - voluntarily established;
related bonds will mature on 07/31/24 2,000,000
8
The
CamScanner
Chapter 1 —- Cash and Cash Equivalents
Bond sinking fund - mandatorily established; Current asset but as

related bonds will mature on 03/31/24 - short-term inv.
Bond sinking fund - mandatorily established;
related bonds will mature on 12/31/27 - Noncurrent asset
Pension fund - Noncurrent asset
Included in cash and cash equivalents P5,600,000
COMPENSATING BALANCES
When an entity borrows funds, the lender may require the entity to maintain a
minimum amount in its bank account. This minimum balance is normally reported
as part of cash and cash equivalents despite the restriction.
However, if the cash balance is legally restricted, the cash balance shall be excluded
from the cash and cash equivalents balance.
CASH EQUIVALENTS
Cash equivalents are short-term, highly liquid investments that are readily
convertible to known amounts of cash and which are subject to an insignificant risk
of changes in value. [PAS 7.6].
In other words, cash equivalents are not really cash per se, but due to their high
liquidity, they are considered as equivalent to cash. For an investment to qualify as
a cash equivalent it must be both:
a. readily convertible to a known amount of cash; and
b. be subject to an insignificant risk of changes in value.
Usually, a cash equivalent has a short maturity of not more than three months.
This three-month period is computed using the following dates:
<s 3 months = cash equivalent Z

Date of p>, Maturity
Purchase > 3 months = not cash equivalent Date
Based on the above diagram, the original issue date nor the original term of an
investment is not relevant in applying the three-month rule. In addition, an
investment is not automatically classified as cash equivalent even if there is less
than three months from the reporting date up to the maturity date. Again, only
the date of purchase and maturity date are the relevant dates.
Depending on the period from the date of purchase up to maturity date, the
following can be classified as cash equivalents:
a. Commercial papers (usually with less than 3 months maturity)
b. Money market placements (usually with less than 3 months maturity)
The
c. Time deposit, provided with 3 months or less maturity

d. Government debt issuances, for example:
1. Treasury bills - with term of one year or less
2. Treasury bonds - with term of more than one year
e. Corporate bonds
f. Redeemable preference shares
Equity securities, in general, cannot be classified as cash equivalents since they do
not have specific maturity dates. The exception is the redeemable preference shares
since the issuing corporation is required to redeem these shares on a pre-
determined date.
Illustration 6. During 2023, QRS Company invested its excess cash in the following
investments:
Term Date Acquired Maturity Date

a. Commercial paper 3months November 23,2023 February 3, 2024
b. Treasury bill 9 months April 16, 2023 January 16, 2024
c. Time-deposit 2 months December 5,2023 February 5, 2024
d. Redeemable pref. shares 5 years October 26, 2023 January 7, 2024
e. Treasury bond 10 years June 26, 2023 June 26, 2025
f. Treasury bill 11 months December 27, 2023 March 3, 2024
*Most of these investments can be purchased from other investors so the duration between
the Date of Purchase and Maturity Date is not necessarily the length of the Term.
The following list contains should be treatment for each investment as of December
31, 2023 and the related analyses:
a. Commercial paper - cash equivalent. The original term is three months and
based on the nature of the short-term investment, it is not subject to significant
risk of changes in value.
Treasury bill - not cash equivalent. Even though there were only 16 days from
December 31, 2023 to January 16, 2024 (its maturity), the investment shall not
be reclassified from short-term investments category to cash equivalent
category. The period of nine months between the date of acquisition to maturity
date already exposed the investment to significant risk of changes in value.
Time deposit - cash equivalent. Same analysis as in (a).
Redeemable preference shares - cash equivalent. Even though the original
term is five years, the investment was acquired within three months before its
maturity.
Treasury bond - not cash equivalent. The investment was acquired two years
before its maturity which already exposed the investment to significant risk of
changes in value.
Treasury bill - cash equivalent. Even though the original term is 11 months, the
investment was acquired three months before its maturity.
10
The
CamScanner
ACCOUNTING FOR ITEMS NOT CONSIDERED AS CASH AND CASH EQUIVALENTS

The following are the accounting treatment for items that are usually associated
with cash and cash equivalents but are not classified as such:
Non-Cash Items | Accounting Treatment and Remarks
Unused postage | Prepaid expense - noncash item due to limited use related
stamps to sending of mails only.
Gift certificates | Prepaid expense - noncash item due to the fact that it can
on hand only be used on the merchant who issued the certificate
lOUs trom Advances from employees - literally means “I Owe You”
employees
pavers fe Trade and other receivables
suppliers
KEEPING UP WITH TECHNOLOGICAL TRENDS

During the past few years, technological advances have introduced new
circumstances resulting to new accounting issues. As for cash and cash equivalents,
the relevant technological advances relate to electronic and digital payments as
follows:
_ Trends Suggested Accounting Treatment

This can be considered as cash item since it is considered
Electronic wallet
good as cash. In addition, almost everyone accepts this as a
such as GCash
form of payment (i.e., wide acceptability).
This shall be considered as prepaid expenses (i.e., not cash
Prepaid cards such item) since only limited number of entities accept this as a
as Happy Plus
form of payment (i.e., limited use). By analogy, this is very
Cards
similar to gift certificates.
This cannot be considered as cash item since only a limited
number of entities accept this as a form of payment (i.e.,
Cryptocurrency limited use). Instead, it is accounted for under PAS 38,
: Intangible Assets, unless it qualifies as an inventory, which
will then be accounted for under PAS 2, Inventories.
ACCOUNTING FOR PETTY CASH

Cash in the form of money and bills are highly susceptible to theft. As a result,
entities usually implement an internal control system wherein all cash receipts are
immediately deposited in a bank and expenditures are made through checks.
However, not all expenditures can be practically paid by check, such as small items
of expenses like transportation, snacks for visitors, some office supplies, etc, Due to
this limitation, entities maintain a small amount of cash on hand called the petty
cash fund to pay for small items of expenditures.
Accounting for petty cash fund will depend on what method an entity follows:
11
The
The Book
Imprest Fund System | Fluctuating Balance

Maintaining the balance in | Updating the balance in the
the petty cash fund | petty cash fund account as
General goal account at all times equal the amounts are used
to the initially established and/or replenished
balance in the fund
Recording the Petty cash fund xx Petty cash fund xx
establishment of the fund Cashin bank _ xx Cashinbank xx
Recording the payments Memo entry on the fund Expenses Me
of expenses from the fund register only Petty cash fund xx
Recording the Expenses Xxx Petty cash fund xx
replenishment of the fund Cashin bank xx Cashin bank xx
Recording of the increase Petty cash fund xx Petty cash fund xx
in fund amount Cashinbank xx Cashinbank xx
Recording of the decrease | Cash in bank XX Cash in bank xx
in fund amount Petty cash fund xx Petty cash fund xx
Adjusting the petty cash E No corresponding entry
’ xpenses XX .
fund for unreplenished
: Petty cash fund xx since the petty cash fund
:
expenditures amount is always updated
Optional reversing entry Petty cash fund xx No corresponding entry
at the start of next period Expenses XX since no adjusting entry
was made
It should be noted that only those expenditures using petty cash that cannot be
recovered shall be replenished. Security deposits paid from petty cash shall be
excluded from the replenishment amount since these can be received in cash later on.
This scenario is similar to a time when you bought a bottled softdrinks and that the
store demanded a deposit of a certain amount (e.g., P5 per bottle). This amount will
be returned to you when you return the empty softdrink bottle.
Lastly, the amount of petty cash fund to be included in the cash and cash equivalents
balance is computed as follows (whether imprest or fluctuating balance):
Coins and currencies in the fund Pxx
Check of the petty cash custodian (i.e., accommodation check) XX
Petty cash fund to be included in cash balance Pxx
Petty cash vouchers are not included in the cash balance since they are just a form
of documentation on how the fund was utilized.
Illustration 7.0n December 1, 2023, ROBIN Company established a petty cash fund
for P12,000. During the rest of the month, the following transactions transpired:
Date Particulars
12/09/23 P2,400 was paid from the fund for the transportation expenditures
12/12/23 _ PS,000 was paid from the fund for the lunch treat of a prospective client
12
The
CamScanner
12/15/23 The fund was replenished

12/18/23 8,500 was paid from the fund for the purchase of some office supplies
12/20/23 The fund was replenished and increased to P15,000.
12/28/23 _P3,200 was paid from the fund for the transportation expenditures
Record these transactions using (a) imprest fund system and (b) fluctuating balance
system.
Date Imprest Fund System Fluctuating Balance

12/01/23 Petty cash fund 12,000 Petty cash fund 12,000
/ Cash in bank 12,000 Cash in bank 12,000
‘ Transportation expense 2,400
12/09/23 | Memo entry on the fund register Petty cash fund 2,400
; Representation expense 5,000
Transportation expense 2,400
12/15/23 | Representation expense 5,000 ra une k as 0
Cash in bank 7,400 :
; Office supplies expense 8,500
Office supplies expense 8,500
12/20/23 | Petty cash fund 3000 |” a i onl 0
Cash in bank 11,500 ,
: Transportation expense 3,200
12/28/23 | Memo entry on the fund register Petty cash fund 3.200
Adjusting entry: No corresponding entry since the

12/31/23 | Transportation expense 3,200 petty cash fund amount has already
Petty cash fund 3,200 | been updated.
Note: Despite these differences in entries, the petty cash balance under each method is P11,800.
PETTY CASH SHORT AND OVER

Periodically, in irregular intervals, the amount of items accounted in a petty cash
fund is compared with the initial established balance (i.e., accountability). In simple
terms, the petty cash accounted items and petty cash accountability are compared
as follows:
Petty Cash Accounted Items Petty Cash Accountability

Comprise of the following:
a. Coins and currencies Equal to the imprest balance of
b. Accommodation check the petty cash fund.
c. Petty cash vouchers
The accommodation is normally the petty cash custodian’s check representing
his/her salary. To be included in the petty cash balance, the check shall not be post-
dated.
The
CamScanner
The amount of petty cash short or over shall be determined based on the
relationship between the amounts of accounted items and accountability:
Scenario Accounting consequence
Accounted items = accountability | No petty cash short or over
Accounted items > accountability Petty cash overage
Accounted items < accountability Petty cash shortage
Illustration 8. During 2023, SANDY Company established petty cash fund for
P20,000, to be accounted for using the imprest balance method. At the end of the
year, the following items were found in the petty cash fund:
Coins P800
Currency 3,000
Accommodation check (petty cash custodian’s paycheck) 8,000
Petty cash vouchers 7,800
Total accounted items P19,600
Since the P20,000 accountability is higher than the total of the accounted items of
P19,600, there is a cash shortage of P400. The year-end adjustment can now be
recorded as follows:
Expenses 7,800
Cash shortage 400
Petty cash fund 8,200
After this entry, the petty cash fund balance to be included in the amount of cash
and cash equivalents will now have a balance of P11,800 (P20,000 - P8200),
composed of the following:
Coins and currencies in the fund (P800 + P3,000) P3,800
Check of the petty cash custodian (i.e., accommodation check) 8,000
Petty cash fund to be included in cash balance P11,800
Illustration 9. Going back to SANDY Company, except that the petty cash fund is
originally established for P19,000. Based on this revised information, there will
now be a cash overage of P600 since the total accounted items of P19,600 is now
higher than the revised P19,000 accountability. The year-end adjustment can now
be recorded as follows:
Expenses 7,800
Cash overage 600
After this entry, the petty cash fund balance to be included in the amount of cash
and cash equivalents will now have a balance of P11,800 (P19,000 - P7,200). This
also equal to the amount in the previous scenario.
14
The
CamScanner
COMPREHENSIVE PROBLEM
As of December 31, 2023, HENRY Company reported the following unadjusted
general ledger balances:
Cash on hand P1,500,000
Cash in bank 6,000,000
Cash funds 5,000,000
Cash equivalents 7,000,000
Total cash and cash equivalents P19,560,000
Other data regarding these balances are the following:

a. Included in the cash on hand are the following checks:
i. Customer check amounting to P200,000, dated January 31, 2024.
ii. Customer check amounting to P100,000, dated February 14, 2023.
b. Based on the inspection of the petty cash fund, coins and currency amounted to
P20,000, while the remaining P40,000 are in the form of petty cash vouchers.
c. Cash in bank included the following items:
Checking Account No. 1, ETA Bank P4,000,000
Checking Account No. 2, ETA Bank (1,000,000)
Checking Account No. 1, GAMMA Bank (3,000,000)
Checking Account No. 2, GAMMA Bank 2,500,000
Time deposit, 12/1/23 - 2/1/24 3,500,000
Total cash in bank P6,000,000
d. Cash funds included the following amounts:

Business travel fund P300,000
Fund for machinery acquisition 1,000,000
Bonding sinking fund (related bonds will mature on 2027) 2,000,000
Other operating fund 650,000
Total cash funds ~P5,000,000°
e. Cash equivalents included the following investments:
Original Date Maturity
Investment Amount Issue Date Purchased Date
Money market placements P2,750,000 12/10/23 12/10/23 1/10/24
Commercial papers 3,000,000 6/15/23 6/15/23 1/15/24
Treasury bills 1,250,000 5/1/23 11/30/23 1/30/24
P7,000,000
The adjusted carrying amount of cash and cash equivalents shall be determined as
follows:
15
The
Cash on hand:
Less: Post-dated customer check (200,000)
Stale customer check (100,000)
Cash on hand, adjusted P1,200,000
Petty cash fund, adjusted (coins and currencies) 20,000
Cash in bank*
Checking Account No. 1, ETA Bank P4,000,000
Less: Checking Account No. 2, ETA Bank (overdraft) __ (1,000,000)
Cash in bank, adjusted 3,000,000
Cash funds
Business travel fund P300,000
Payroll fund ’ 1,050,000
Other operating fund 650,000
Cash funds, adjusted 2,000,000
Cash equivalents**
Time deposits*** P3,500,000 :
Money market placements . 2,750,000
Treasury bills 1,250,000
Cash equivalents, adjusted 7,500,000
Cash and cash equivalents, adjusted P13,720,000
*Accounts in the GAMMA Bank are not included since the amount of P3M overdraft is higher
than the P2.5M positive balance. Instead, the P500K shall be presented in current liabilities.
**Original issue dates shall be totally ignored.
***Since the time deposit was acquired 2 months before its maturity date, it was reclassified
from cash in bank to cash and cash equivalents
16
The
The Book
CHAPTER SUMMARY
1: General groupings of items that can be included in the cash and cash equivalents
balance are the following: cash on hand, cash in bank (excluding those deposits
maintained in a closed bank), cash funds and cash equivalents.
Cash on hand includes checks received from customers, provided they are not post-
dated nor stale.
Cash in bank includes both demand deposits and savings deposits since time
deposits are classified as cash equivalents.
Checks prepared that are post-dated, unreleased and/or stale shall be added back to
the cash in bank balance.
Cash funds included in cash and cash equivalents are those arising from operating
funds (PPE fund and bond sinking fund are generally excluded).
Petty cash vouchers are excluded from the cash and cash equivalents balance.
Petty cash short or over are recognized based on the difference between accounted
amount and the amount of accountability.
Investments are included as cash equivalents only if they are acquired three months
before their maturity.
Investments in the shares of other entities are never considered as cash equivalents
due to the lack of specific maturity dates. The exception will be the investment in
redeemable preference shares, where it can be classified as cash equivalent if it was
acquired three months before maturity date.
‘17
The
CamScanner
CHAPTER 1: SELF-TEST EXERCISES
True or False
1. Cash is the most liquid asset in the statement of financial position.
2. Customer’s checks are generally excluded in the cash balance since these do not
represent actual cash.
3. The cash balance includes coins and currencies but not demand deposits nor
savings deposits.
Postdated checks are dated after the reporting date.
Cash denominated in foreign currency is translated at the exchange rate as of the
1
date the cash was received.

Postdated customer's checks shall not be included in the cash balance.
OND
Postdated supplier’s checks shall be included in the cash in bank balance.

The amount of unreleased supplier's checks shall still be included in the accounts
payable balance.
Postdated customer's checks shall not be included in the accounts receivable
balance.
10. Cash in bank shall not be included in the cash balance since the actual amount of
cash is not in the possession of the entity.
is Unlike demand and savings deposits, time deposits are reported as part of cash
equivalents if certain conditions were met.
12. Cash funds, regardless of their purpose, are always included in the cash balance
since they represent actual amounts of cash.
13. Cash set aside for the acquisition of a land shall be excluded from the cash balance.
14. Investments in the ordinary shares of another entity may be classified as cash
equivalent, provided these were acquired three months before the expected date of
sale.
15. Investments in the redeemable preference shares of another entity may be
classified as cash equivalent, provided these were acquired three months before the
maturity date.
16. Generally, the original term ofan investment is not relevant in determining whether
it can be classified as cash equivalent or not.
Ef; By their very nature, cash equivalents are not cash per se, but owing to their high
level of liquidity, they are considered as “equivalents to cash”.
18. To be classified as cash equivalents, the original term of the investment shall not
exceed six months.
19. Cryptocurrencies can be considered as cash since some people or entities accept
them as a mode of payment.
20. Amounts maintained in online payment platforms (e.g., online banking apps) are
not considered as cash,
21. Generally, bank overdrafts are reported as current liabilities.
22; On December 10, 2023, an entity received a customer check dated December 28,
2023. This check shall be excluded in the cash balance as of December 31, 2023
since it was post-dated when originally received,
18
The
23. On December 10, 2023, an entity received a customer check dated January 5, 2024.
This check shall be excluded in the cash balance as of December 31, 2023 since it
was post-dated as of that date.
24. If a customer’s check in the possession of the entity becomes stale, it shall be
excluded from the cash balance and included in the accounts receivable balance.
25. An entity invested its excess funds to a treasury bill with an original term of one
year but with 2 months left before its maturity. This investment cannot be
considered as cash equivalent.
Multiple Choice: Theories

1. Given the following items, which of them is/are included in the total cash balance?
I. Post-dated customer check
Il. Post-dated supplier check
a. lonly c. Both I and II
b. ILonly d. Neither I nor II
2. The following may be included in the cash balance, except

a. Foreign currency
b. Coins
c. Deposit maintained ina closed bank
d. Check from’customer
3. Upon the receipt of a post-dated check from a customer, an entity shall do which of
the following?
a. Reduce the accounts receivable from the customer,
b. Increase the cash on hand balance.
c. Record revenue equal to the amount of the check.
d. Donotrecord the check.
4. The following checks received shall be included in the cash balance, except
a. Checkmate
b. Customer's check
c. Traveler’s check
d. Manager’s check
5. TULIP Company gave a check to LILY Company for the services performed by the
latter. The check indicated that LILY Company shall encash the check in BDI Bank.
Based on this information, which of the following is incorrect?
a. TULIP Company is the maker of the check.
b, LILY Company is the payee.
c. BDI Bank is the drawee.
d. None of the above.
6. Few days before the reporting date, an entity made and recorded a check dated in
the succeeding period to one of its suppliers. In this case, the entity shall
a. Add back the amount of the check to the accounts receivable balance.
19
The
The Book
b: . Deduct the amount of the check from the accounts payable balance.
c. Add back the amount of the check to the cash in bank balance.
d. Donothing.
7, An entity made and recorded a check that is dated before the reporting date. In this
case, the entity shall
a. Add back the amount of the check to the accounts receivable balance.
b. Deduct the amount of the check from the accounts payable balance.
c. Add back the amount of the check to the cash in bank balance.
d. Donothing.
Gift certificates shall be reported as

a. Part of cash and cash equivalents since these can be used to purchase limited
selection of goods or services.
b. Part of prepayments.
c. Eithera or b depending on the entity's accounting policy.
d. Half cash and cash equivalent, half prepayments.
At the end of 2023, an entity had US dollars in its cash on hand. In this case, the
amount in US dollars shall be |
a. Translated using the exchange rate on the date of entity's receipt.
b. Translated using the exchange rate on the reporting date.
c. Translated using the either the exchange rate on the date of entity’s receipt or
on the reporting date, whichever is higher.
d. Translated using the either the exchange rate on the date of entity’s receipt or
on the reporting date, whichever is lower.
10. As of December 31, 2023, an entity reported P800,000 positive balance in its
checking account no. 1 in Buko Bank and P500,000 overdraft in its checking account
no. 2 in the same bank. Which of the following correctly states the required
reporting of these amounts?
a. The P800,000 positive balance shall be presented as part of cash and cash
equivalents while the P500,000 overdraft shall be presented as current
liability.
b. The P500,000 overdraft shall be presented as part of cash and cash equivalents
while the P800,000 positive balance shall be presented as current liability.
c. NetamountofP300,000 shall be presented as part of cash and cash equivalents.
d. Netamount of P300,000 shall be presented as current liability.
AL As of December 31, 2023, an entity reported P700,000 positive balance in its

no. 1 in Atis Bank. Which of the following correctly states the required reporting of
these amounts?
a while the P450,000 overdraft shall be presented as current
iability.
20
The
CamScanner
c. NetamountofP250,000 shall be presented as part of cash and cash equivalents.
d. Netamount of P250,000 shall be presented as current liability.
12. As of December 31, 2023, an entity reported P700,000 positive balance in its
no. 1 in Atis Bank. Any overdraft amount is part of the entity’s cash management.
Which of the following correctly. states the required reporting of these amounts?
equivalents while the P450,000 overdraft shall be presented as current
liability.
c. Netamount of P250,000 shall be presented as part of cash and cash equivalents.
d. Net amount of P250,000 shall be presented as current liability.
13. An entity reported the following deposits with a bank:

I. Savings deposit that was set aside for the future purchase of building.
Il. Demand deposit from which the payroll of its employees is deducted.
Which of these is/are includible in the cash balance?
a. lonly c. Both | and II
b. Ilonly d. Neither I nor II
14. Generally, which of the following is not a ‘characteristic of cash and cash
equivalents?
a. Generally unrestricted as to use.
b. Measured at their fair values.
c. May include items in addition to coins and currencies on hand.
d. Most liquid among all the assets of an entity.
15. The following items are generally considered as part of cash, except
a. Gift certificates purchased with no expiry date.
b. Foreign currency on hand
c. Customer's check
d. Money order
16. All of these items should not form part of an entity’s cash, except
a. AnJI.0.U. from an entity’s finance officer
b. Advances to employees
c. Traveler’s check .
d. Petty cash vouchers
17. Adeposit in a closed bank should be classified as
a. Part of cash and cash equivalents at its net realizable value.
21
The
The Book
b. Part of other assets at its net realizable value.

c. Either part of cash and cash equivalents or other assets at its net realizable
value, depending on the policy of an entity
d. Neither part of cash and cash equivalents nor other assets.
18. Post-dated checks received from customers should
a. be excluded from the cash balance
b. be included in other assets balance
c. be deducted from accounts receivable balance
d. be deducted from accounts payable balance
19. The three-month rule for cash equivalents shall be counted from
until its maturity date.
a. The original date of issuance of the related security.
b. The relevant reporting date.
c. The date of purchase of the related security.
d. The latest of the above dates.
20. The following should form part of an entity’s cash, except for
a. Customer check not yet encashed in the bank for the last 18 months
b. Check issued dated January 25 of the next year
c. Coins and currencies in petty cash fund
d. Cashin bank
21. Generally, the following funds are part of cash, except for
a. Fund earmarked for the purchase of warehouse.
b. Dividend fund
c. Salary fund
d. Tax fund
22. Which of the following items is considered as cash equivalent?

a. Checking account in a bank
b. Time deposit with remaining maturity of one year
c. 10-year treasury bonds purchased two months before its maturity date
d. 5-year treasury bonds purchased five months before its maturity date
23. All of the following are considered as cash equivalents, except

a. Treasury bills with original term of one year but acquired three months before
maturity date.
b. Redeemable preference shares with original term of four-years but acquired
two months before maturity.
c. Investment in ordinary shares of another entity that is expected to be sold
within the next two weeks.
d. All of the above are considered as cash equivalents,
24. The amount to be included in the cash balance on account of the petty cash fund
shall include the following, except
22
The
The Book
ao op Coins
Currencies
Accommodation check that is dated on or before the reporting date
All of the above are included in the cash balance on account of the petty cash
fund.
25. Petty cash fund may be used for any of the following, except
a. Payment of outstanding purchases from suppliers.
b. Payment of transportation of the entity’s messengers.
c. Payment for snacks served to a client.
d. Payment for small items of office supplies.
Straight Problems
1. JAYSON Company reported an unadjusted cash in bank balance of P3,500,000 as of
December 31, 2023. In addition, it provided the following details:
e Customer check of P480,000 dated January 2, 2024 was already included in the
cash balance.
e Customer check of P350,000 dated December 8, 2023 was included in the cash
balance even though it is not yet encashed as of December 31, 2023.
e Supplier check of P400,000 dated November 30, 2023 was already deducted
even though the supplier actually encashed it on January 20, 2024.
e Supplier check of P250,000 dated December 28, 2023 was already deducted even
though it was given to the supplier only on January 5, 2024.
Required: From this information, determine the following:

a. Adjusting journal entries to correct the recording of each check, if relevant.
b. Adjusted amount of cash balance as of December 31, 2023.
2. As of December 31, 2023, PARALUMAN Company reported cash balance of

P4,600,000. In addition, the following checks were already recorded:
e Acheck written for P190,000 dated February 28, 2023 is yet to be encashed by
the payee.
e A check written for P110,000 dated September 28, 2023 is also yet to be
encashed by the payee.
e A check written for P280,000 dated January 10, 2024 was already in the
possession of the payee as of December 31, 2023.
e Acheck received amounting to P360,000 dated January 15, 2024.
e Acheck received amounting to P500,000 dated October 1, 2023.

a. Adjusting journal entries to correct the recording of each check, if relevant.
b. Adjusted amount of cash balance as of December 31, 2023.
3. EDITH Company reported the following information as of December 31, 2023:

e Investment in common shares of another entity amounting to P400,000 is
expected to be sold next month.
23
The
The Book
e Three-year treasury bonds amounting to P2,000,000 were acquired on the

original date of issue.
e Five-year treasury bonds amounting to P3,000,000 were acquired on November
15, 2023. Maturity date is on February 1, 2024.
e Redeemable preference shares amounting to P1,800,000 were acquired last
December 1, 2023. The shares will mature on January 15, 2024.
e Excess funds of P3,500,000 were parked to time deposit on July 1, 2023. The
certificate indicated a January 12, 2024 maturity date.
Required: From the above information, determine the amount of cash equivalents,
4. As of December 31, 2023, MANDAUE Company reported the following information:

Checking account 1 - UBP 4,500,000
Checking account 2 - UBP (1,200,000)
Checking account - BPI (700,000)
Savings account - PNB 2,000,000
Savings account - BDO 5,500,000
Commercial papers 1,800,000
Money market placements 1,000,000
Time deposit, 3 months 800,000
Time deposit, 6 months 1,500,000
Additional details are the following:

a. Included in the cash on hand balance is a P200,000 customer check dated
February 14, 2024.
b. Deducted from the checking account 1 - UBP is a P300,000 supplier check dated
December 20, 2023 that was only given to the payee on January 3, 2024.
c. Deducted from the checking account 1 - UBP is a P450,000 supplier check dated
December 22, 2023 and was given to the payee on the same date, but was
encashed only on January 18, 2024.
d. Half of the savings account maintained in BDO is for the purchase of inventories
for the next three months while the other half is for the marketing employees’
travel fund.
e. The savings account set aside in PNB is for the acquisition of fleet of
transportation vehicles for use of its marketing employees.
Required: Determine the amount of cash and cash equivalents.

5. SORSOGON Company reported the following items as of December 31, 2023:

Post-dated customer check included in cash on hand 550,000
Post-dated supplier check reflected in cash in bank 320,000
24
The
CamScanner
2023-dated unencashed supplier check reflected in cash in bank 260,000

2023-dated unreleased supplier check reflected in cash in bank 460,000
Petty cash, including P70,000 vouchers and P20,000 employee
check representing her salary for December 2023 200,000
Advances to employees 1,400,000
Gift certificates 80,000
Travel fund already disbursed to marketing employees 600,000
Payroll fund not yet included in cash in bank balance 1,000,000
Bond sinking fund, related liability will mature in 2028 3,000,000
Investment in 5-year government bonds acquired two months
before the maturity date. 2,000,000
Required: From this information, determine the amount of cash and cash
equivalents.
6. KIMBERLY Company reported the following petty cash transactions for the last two
months of 2023 and on January 2024:
Date ‘Particulars
Nov.1 Established P30,000 petty cash fund.
5S Paid P8,000 transportation of messengers.
12 Paid P10,000 for office supplies purchased.
28 Paid P5,000 for miscellaneous expenses. |
30 Replenished the petty cash fund and increased it to P40,000
Dec.8 Paid P12,000 to repairmen who fixed the office aircon.
20 Paid P15,000 for the treats and snacks given to VIP customer
Jan.10 Paid P11,000 for the transportation of messengers.
25 _ The petty cash has been replenished.
Required: Determine the journal entries using (a) imprest fund system; and (b)
fluctuating fund system.
Multiple Choice - Problems

1. As of December 31, 2023, ALABEL Company reported the following details:
e Customer check of P450,000 was already included in the cash on hand balance
even though it is dated January 22, 2024.
e Supplier check of P600,000 dated December 10, 2023 was already deducted from
the cash in bank balance, even it was only given to the payee on January 4, 2024.
Cash on hand and cash in bank as of December 31, 2023 amounted to P2,200,000
and P3,100,000, respectively. From this information, determine the adjusted cash
balance as of December 31, 2023.
a. P5,900,000 c. P5,450,000
b. P5,300,000 d, P4,850,000
25
The
CamScanner
2. MAGALLANES Company is in the process of determining its cash balance to be

presented in its December 31, 2023 statement of financial position. The following
information was gathered related to some of the components of the P3,800,009
unadjusted cash balance:
Postage stamps P100,000

Office supplies 400,000
Customer check dated December 10, 2023 60,000
Customer check dated January 8, 2024 240,000
Gift certificates 350,000
In addition, the following supplier's checks were already deducted from the
unadjusted cash balance:
e P90,000 check dated December 1, 2023 and given to payee on December 20,
2023.
e P75,000 check dated January 3, 2024 and given to payee on December 29, 2023.
Based on this information, the adjusted cash balance should be

a. P2,875,000 c. P2,975,000
b. P2,785,000 d. P2,725,000
3. ROOSEVELT Company reported the following information as of December 31, 2023;

Checking account no. 1 - BDO 2,100,000
Checking account no. 2 - BDO (2,400,000)
Checking account no. 1 - PNB 1,400,000
Checking account no. 2 - PNB (300,000)
Checking account - BPI (640,000)
Checking account - UBP (payroll fund) 1,800,000
Savings account - UCPB (maintained as dividend fund) 2,200,000
Savings account - Banco Filipino, a closed bank 1,750,000
Time deposit - UCPB, one year 3,000,000
IOU from employees 730,000
Traveler's check received not yet included in cash on hand 140,000
Manager's check received not yet included in cash on hand 220,000
Bond sinking fund, to be disbursed in 2030 2,000,000
The correct cash and cash equivalent balance from this information shall be
a. P8,700,000 c. P7,060,000
b. P6,700,000 d. P4,020,000
26
The
The Book
4. As of December 31, 2023, KATIPUNAN Company reported the following

information:
Cash on hand P600,000

Cash in bank - PNB 3,000,000
Cash in bank - UBP 4,200,000
Petty cash fund in branch A 50,000
Petty cash fund in branch B 50,000
As of the same date, the Company also has existing borrowings from PNB and UBP,
where it is required to have compensating balances amounting to P400,000 and
P550,000, respectively. Compensating balance in UBP is legally restricted.
On the other hand, all of the P38,000 vouchers in petty cash fund in branch A have
been fully replenished. However, petty cash fund in branch B was not replenished
but is composed of the following: P10,000 coins and currencies, P15,000 check of
petty cash custodian representer here December 2023 salary and P23,000 vouchers.
Based on these data, the correct cash balance shall be

a. P7,875,000 c. P7,325,000
b. P6,925,000 d. P7,837,000
5. FRANKLIN Company generated the following unadjusted general ledger account

balances as of December 31, 2023:
Cash in bank P1,700,000

Accounts receivable 4,000,000
The following supplier’s checks were already deducted from the cash in bank
balance:
e Acheck for P140,000 dated December 23, 2023 was given to payee on January 2,
2024.
e Acheck for P200,000 dated December 1, 2023 was given to payee on November
10, 2023. The check is yet to be encashed at the end of 2023.
Upon inspection of the petty cash fund, it consisted of the following components:
e P5,000 coins and currencies
e 14,000 check of the petty cash custodian representing her salary.
e P11,000 petty cash vouchers.
The cash equivalents balance is composed of the following:

e P500,000 six-month time deposit
e P2,000,000 two-month commercial papers
e P800,000 five-year treasury bonds acquired two months before maturity.
e P200,000 one-year treasury bills acquired on original issue date.
27
The
The Book
Accounts receivable included the following amounts

e AP600,000 account with related customer check dated December 29, 2023. The
check is not included in any of the cash accounts since it was not actually
encashed.
e AP450,000 account with related customer check dated January 10, 2024. Similar
with the reasons in the check above, it was not included in any of the cash
accounts.
From the above information, determine the adjusted cash and cash equivalents
a. P5,745,000 c. P4,659,000
b. P5,245,000 d. P5,259,000
6. As of December 31, 2023, KRAKATOA Company invested its excess cash funds to the
following securities:
e Commercial paper of P4,000,000 with six-month term and maturity date of
February 15, 2024. This was acquired on December 15, 2023.
e Money market placements of P3,000,000 with nine-month term and maturity
date of January 31, 2024. These were acquired on September 1, 2023.
e Treasury bills of P1,200,000 with six-month term and maturity date of May 1,
2024. These were acquired on December 1, 2023.
e Treasury bonds of P2,000,000 with ten-year term and maturity date of March 31,
2024. These were acquired on December 31, 2023.
Based on the above information, cash equivalents shall have a balance of

a. P4,200,000 c. PO
b. P6,000,000 d. P10,200,000
7. TAMBORA Company reported the following information as of December 31, 2023:
Cash on hand . P1,500,000

Cash in bank - UCPB (250,000)
Cash in bank - PNB , 320,000
Cash in bank - BDO 750,000
Savings account - UBP (for the purchase ofinventories) 1,100,000
Savings account - Maybank (for the purchase of land) 2,300,000
Bond sinking fund - required by contract; related
liability will mature on June 30, 2024 2,000,000
liability will mature on September 30, 2024 3,000,000
Savings dollar account - BDO $10,000
Average exchange rate during the year is USD1: PHP50 while exchange rate at the
end of the year is USD1: PHP52. In addition, the following checks were deducted
from the indicated bank accounts:
¢ From UCPB account, an unreleased check of P800,000 dated December 28, 2023.
¢ From PNB account, a P300,000 check dated January 12, 2024.
28
The
The Book
Based on the above information, the cash balance to be reported shall be

a. P8,040,000 c. P10,040,000
b. P8,020,000 d. P10,020,000
g. As of December 31, 2023, ALEXIS Company reported unadjusted cash balance of
P4,500,000. Additional data were provided as follows:
e Customer check of P240,000 dated January 10, 2024 was already included in the
cash balance.
e Customer check of P300,000 dated December 31, 2023 was not included in the
cash balance.
e Cash receipts from January 1-15, 2024 of P800,000 and cash disbursements of
P350,000 during the same period were recorded as if they occurred during 2023.
e Supplier check of P160,000 dated December 31, 2023 was not deducted from this
balance since this was given to the payee only on January 15, 2024.
Determine the adjusted cash balance as of December 31, 2023
a. P4,270,000 c. P3,660,000
b. P3,820,000 d. P4,110,000
9. PATRICIA Company had the following information as of December 31, 2023:

Change fund (i.e., smaller bills and coins) 80,000
Pension fund 2,400,000
Dividend fund 1,000,000
From this information, the amount to be included in the cash and cash equivalents
should be
a. P680,000 c. P4,080,000
b. P1,680,000 d. P600,000
10.As of December 31, 2023, ANTOINETTE Company had the following information
related to its cash balance:
Treasury bills, acquired 6 months before maturity 200,000
Cash in bank - savings account for general purpose 1,500,000
Cash in bank - demand deposit account 900,000
Cash in bank - savings account for payroll purposes 1,000,000
Bond sinking fund, related liability will mature in 2025 2,000,000
Held for trading investments 1,200,000
Based on this information, the amount of cash and cash equivalents shall be
a. P3,400,000 c. P5,300,000
b. P4,100,000 d, P6,100,000
29
The
The Book
Chapter 2 — Bank Reconciliation
CHAPTER 2
BANK RECONCILIATION

How different transactions affect the records of an entity and the bank.
The different book-reconciling and bank-reconciling items, including errors
bi
The different methods of preparing bank reconciliation.

The recording of reconciling items.
Pie
The computation of missing items using bank reconciliation.

BANK RECONCILIATION - INTRODUCTION
As part of the internal control mentioned in the previous chapter, entities maintain
their cash balances in bank accounts. Entities keep records of the transactions
involving its cash in bank using a “cash in bank” account and then compute for the
ending cash in bank balance after reflecting these transactions.
On the other hand, banks also keep records of the transactions involving their
depositors. These transactions are recorded through a deposit liability account,
which is maintained for each depositor. At the end of each period, usually monthly,
the bank sends a bank statement to each depositor showing the transactions the
bank has recorded and the resulting ending balance of each bank account.
The focus of this chapter is to reconcile the cash in bank balance computed by the
entity (i.e., the book balance) and the bank account balance appearing on the bank
statement (i.e., the bank balance) to arrive at the adjusted cash in bank balance.
This adjusted cash in bank balance is the amount to be included
in the cash and cash
TRANSACTIONS AFFECTING CASH IN BANK

It is crucial to be oriented first on how the depositor entity (through the cash in
bank account) and the bank (through deposit liability account) process each
transaction as this will affect the bank reconciliation:
Transaction __| Recording by the Entity | Recording by the Bank |
Deposit of cash _| Cash in bank XX Cash XX
Cash on hand XX Depositliability xx_|
Payment of check to Accounts payable _ xx Depositliability xx
entity's creditors Cash in bank XX Cash XX
Bank service charge from | Service charge exp. xx Depositliability xx
the bank Cash in bank XX Service income 7
Expenses of the entity | Expenses XX Depositliability xx
directly paid by the bank Cash in bank xx.| Cash Xx_]
(to be continued in the next page)
30
The
CamScanner
Transaction Recording by the Entity| Recording by the

Customer’s defective
Accounts receivable xx Depositliability xx
check returned by the Cash in bank XX Cash XX
bank
Payment of entity’s loan
from the bank that was__| Loans payable xX Depositliability xx
directly deducted from Cash in bank XX Loans receivable xx
the entity’s bank account
Proceeds of aJpan Cash in bank XX Loan receivable XX
granted by the bankt Loan payable XX Deposit liability xx
the entity Bey P
Proceeds from the bank’s ‘
collection of the entity’s ana boa aan Cash ado cusig hae
; Accounts receivable xx Deposit liability xx
receivables
The readers should take note of the following:

a. Cash in bank and deposit liability accounts are complements for each
transaction. The bank recognizes liability since it has the obligation to safe keep
the amounts deposited by the entity.
b. For the transactions that reduce (i.e., credit) the amount of cash in bank balance,
there is a corresponding decrease (i.e., debit) in the deposit liability balance.
c. Forthe transactions that increase (i.e., debit) the amount of cash in bank balance,
there is a corresponding increase (i.e., credit) in the deposit liability balance.
d. Deposit liability per depositor is equal to the bank account balance appearing on
the bank statement given to each depositor.
IDENTIFYING RECONCILING ITEMS
In a perfect world, the entity and the bank will record each transaction at the same
time, resulting to equal amounts of cash in bank balance and deposit liability at all
times. However, since this world is imperfect, the entity’s recording of some
transactions is not in synch with the bank’s recording and vice versa, resulting to
different unadjusted balances in the entity’s and bank’s records.
For every transaction, it is crucial to identify which party first records the
transaction (i.e., the initiator of that particular transaction). This particular
transaction is a reconciling item of the other party.
For example, deposits and payment of checks were both initiated by the depositor
entity; hence these may result to bank-reconciling items. On the other hand,
transactions are initiated by the bank may result to book-reconciling items.
BANK-RECONCILING ITEMS
The bank reconciliation using the bank statement balance as the starting point is
as follows:
a1
The
CamScanner
Bank statement balance (bank balance) Pxx

Add: Deposits in transit XX
Errors committed by the bank (if there are any) XX
Less: Outstanding checks, excluding certified checks XX
Errors committed by the bank (if there are any) XX
Adjusted cash in bank balance Pxx
Deposits in transit are the deposit amounts made by the depositor entity that are
not yet reflected in the bank statement balance due to the deposit being made after
a certain cut-off time. This amount is added since the bank is yet to record these.
Outstanding checks are checks made by the depositor entity which were already
given to the payees but not yet encashed with the bank. This is completely normal
since the bank reduces bank account balance only when the payee actually presents
the
check
for payment. Nonetheless, these shall be deducted from the cash balance
since the payee already has control over the amount represented by the check.
However, certified checks shall be excluded from the amount of outstanding checks.
Certified checks are checks already guaranteed by the bank for payment and have
already been deducted from the bank statement balance.
Errors are discussed in a separate subsection.
Illustration 1. On May 31, 2023, CHAMPION Company received a bank statement
from its bank showing a balance of P4,350,000 as of that date. The Company would
like to seek your help in determining the adjusted cash in bank balance and
provided to you the following information:
Bank service charge P16,000
Deposit in transit 250,000
Proceeds from the bank loan granted to the Company 1,200,000
Outstanding checks, including P50,000 certified checks 400,000
Based on this information, the adjusted cash in bank balance is computed as:
Bank statement balance (bank balance) P4,350,000
Add: Deposits in transit 250,000
Less: Outstanding checks (P400,000 - P50,000) (350,000)
Adjusted cash in bank balance P4,250,000
a. The amount of certified checks is excluded from the outstanding checks.
b. The bank service charge and the proceeds from bank loan are excluded since
they have already been recorded by the bank (i.e., the bank initiated these
transactions). These items are considered as book-reconciling items, which will
be discussed in the succeeding subsection.
32
The
CamScanner
BOOK-RECONCILING ITEMS
The bank reconciliation using the balance per entity’s general ledger as the
starting point is as follows:
Balance per general ledger (book balance) Pxx
Add: Credit memos XX
Errors committed by the book (if there are any) XX
Less: Debit memos XX
Errors committed by the book (if there are any) xX
Adjusted cash in bank balance PXX
Credit memos are those already added to the bank balance but the depositor
entity is yet to record. The “credit” means increase in deposit liability. Examples of
credit memos are the following:
a. Receivable of the depositor entity collected by the bank on its behalf.
b. Proceeds of the loan granted by the bank to the depositor entity.
Debit memos, are those already deducted from the bank balance but the depositor
entity is yet to record. The “debit” means decrease in deposit liability. Examples of
debit memos are the following:
a. Bank service charge
b. Defective customer’s checks such as no-sufficient fund (NSF) checks. These are
checks drawn against bank accounts with no or insufficient balance to cover the
check amount. However, if an NSF check was properly redeposited and cleared
within the same period, it shall not form part of debit memos.
c. Utilities incurred by the depositor entity but directly paid by the bank as
previously agreed upon (usually through auto-debit arrangements).
d. Maturing bank loans directly deducted by the bank from the depositor entity’s
bank account.
Errors are discussed in a separate subsection.
Illustration 2. FRANCIS Company’s general ledger reported cash in bank balance
of P6,000,000 as of September 30, 2023. In preparing the bank reconciliation for
that month, the following information was granted:
Deposit in transit P560,000
Bank service charge 30,000
Proceeds from the bank loan granted to the Company 2,000,000
NSF check not yet redeposited at the end of the month 70,000
NSF check redeposited and cleared during the month 100,000
Utilities bill of the Company paid directly by the bank 200,000
Accounts receivable of the Company directly collected
by the bank, less collection charge of P6,000 800,000
Based on this information, the adjusted cash in bank balance is computed as;
33
The
Balance per general ledger (book balance) P6,000,000

Add: Credit memos:
Proceeds from bank loan 2,000,000
Accounts receivable collected directly by
the bank (P800,000 - P6,000) 794,000
Less: Debit memos:
Bank service charge (30,000)
NSF check not yet redeposited (70,000)
Utilities bill paid directly by the bank (200,000)
Adjusted cash in bank balance P8.494,000
a. Deposits in transit and outstanding checks were excluded since they are bank-
reconciling items, not book-reconciling items.
b. NSF check that was redeposited and cleared during September has already been
cured and not considered as NSF as of September 30, 2023.
CONSIDERATION OF ERRORS IN BANK RECONCILIATION
As previously mentioned, errors committed by the bank are considered as bank-
reconciling items. These include, but are not limited to, the following:
a. Overstatement or understatement of deposits
b. Overstatement or understatement of checks
c. Crediting of deposits or charging of checks belonging to another depositor to the
depositor entity’s bank account.
d. Crediting of deposits or charging of checks belonging to the depositor entity to
another depositor’s bank account.
On the other hand, errors committed by the book are considered as book-
reconciling items. These include, but are not limited to, the following:
a. Overstatement, understatement, or non-recording of deposits
b. Overstatement, understatement, or non-recording of checks
In correcting errors for bank reconciliation, the readers may use the following steps
(applicable whether the error is a bank error or book error):
1. Remove the initial effect of the error:
a. Ifthe error involves a deposit, deduct the initially recorded amount, if there
is any. There is no initial effect if the error involves nonrecording of deposit.
b. If the error involves a check, add back the initially recorded amount, if there
is any. There is no initial effect if the error involves nonrecording of check.
2. After removing the initial effect of the error, the correct amount shall be reflected:
a. Ifthe error involves a deposit, add the correct amount, if there is any.
b. Ifthe error involves a check, deduct the correct amount, if there is any.
It should be noted that there is no correct amount to be reflected if there are
recorded checks and/or deposits that should not be recorded in the first place.
34
The
Nevule CamScanner
Usually, errors are committed in the book records, however, in limited

circumstances, bank errors may also be committed.
Illustration 3. BROOK Company received its bank statement showing a balance of
P3,600,000. In addition, it discovered the following information when comparing it
with the general ledger:
a. Deposits not yet reflected in the bank statement amounted to P350,000, while
checks yet to be encashed by payees totaled P280,000.
b. A deposit amounting to P45,000 was erroneously recorded as P54,000 by the
bank.
c. A check was erroneously recorded by the bank as P10,000, when the correct
amount is P100,000.
d. Acheck of another entity amounting to P50,000 was erroneously deducted from
the entity’s bank account.
e. A deposit amounting to P300,000 was recorded in the books as P30,000.
f. Adeposit amounting to P150,000 was erroneously credited by the bank to other
depositor’s account.
Since the given unadjusted balance is based on bank statement, the focus is on the
identification of bank-reconciling items. Relevant bank reconciliation is as follows:
Particular Amounts Remarks
Balance per bank statement P3,600,000
Less: Outstanding checks (280,000)
Errors:
Error item b (a deposit)
Removal of initial effect (54,000)
Recording of correct amount 45,000
Error item c (a check)
Removal of initial effect 10,000
Recording of correct amount (100,000)
Error item d (a check)
Recording of correct amount - Nocorrect amount since the check
was made by another depositor
Error item f (a deposit)
Removal of initial effect - Norecorded amount since the
account of another depositor was
initially affected
Adjusted cash in bank balance P3.771.000
It should be noted that the deposit error in item e is excluded since this was
committed by the depositor entity (i.e., considered as book-reconciling item).
35
The
CamScanner
DIFFERENT FORMS OF BANK RECONCILIATION

There are three forms of bank reconciliation which are described as follows:
‘Adjusted Balance Book-to-Bank | ' Bank-to-Book: ——)]

Method Method Method |
Both the book and bank | The starting point is the | The starting point is the
balances are used as the | book balance, while the end | bank balance, while the
starting points in | pointis the bank balance. end point is the book
computing for the balance.
adjusted cash in bank The treatment for book-
falance. reconciling items is the | The treatment for bank-
same with adjusted | reconciling items is the
In other words, there | balance method. same with adjusted
will be two sets of balance method.
However, the treatment for
computations that
bank-reconciling items is However, the treatment for
shall arrive at the same
reversed of whatis normally book-reconciling items is
amount of adjusted
done (e.g., deposits in transit reversed of what is
cash in bank balance
are deducted, while normally done (e.g., credit
outstanding checks are memos are deducted, while
added) debit memos are added)
These forms are best illustrated with.a comprehensive example.

Illustration 4. ANJO Company prepares its bank reconciliation on a monthly basis.
For the month of April 2023, the following information was provided:
General ledger balance P6,617,000

Bank statement balance 8,854,000
NSF check 95,000
Notes receivable of the Company collected by the bank:
Face amount 700,000
Interest 70,000
Collection charge 5,000
Company’s telephone bills directly paid by the bank 75,000
Company’s customers who paid directly to the bank 420,000
Deposits in transit 920,000
Bank Joan proceeds directly credited to Company’s account 2,500,000
Maturing portion of the bank loan directly deducted from the
Company’s bank account 250,000
Correct amount of check recorded by the Company as P120,000 12,000
Correct amount of deposit recorded by the Company as P78,000 87,000
Amount of check not recorded by the Company 150,000
Check of ANJA Company deducted by the bank from the
36
The
CamScanner
Deposit of the Company added by the bank to ANJA Company’s

bank account 360,000
The bank reconciliation using the adjusted balance method is as follows:

Errors:
Company’s bank account
Recording of correct amount =
Deposit of the Company added by the bank to ANJA
Removal of initial effect
General ledger balance (book balance) P6,617,000
Add: Credit Memos:
Notes receivable collected by the bank
(P700,000 +P70,000 — P5,000) 765,000
Payments from Company’s customers 420,000
Proceeds of bank loan 2,500,000
Less: Debit Memos:
Bank service charge ; (25,000)
NSF check (95,000)
Company’s telephone bill directly paid by the bank (75,000)
Maturing portion of bank loan (250,000)
Errors
Overstatement in the Company’s recording of a check
Understatement in the Company’s recording of a deposit
Company’s nonrecording of a check
Removal of initial effect , -
It should be noted that the errors shall be attributed to the party who committed
them. The readers are advised that, if possible, use both the book balance and
bank balance in computing for the adjusted cash in bank balance.
37
The
The Book
The bank reconciliation using the book-to-bank method is as follows:

Add: Credit Memos:
(P700,000 +P70,000 - P5,000) 765,000
Payments from Company’s customers 420,000
Outstanding checks (reverse) 570,000
Less: Debit Memos:
Bank service charge (25,000)
NSF check (95,000)
Company’s telephone bill directly paid by the bank (75,000)
Maturing portion of bank loan (250,000)
Deposits in transit (reverse) (920,000)
Errors ,
Understatement in the Company’s recording of a deposit
Removal of initial effect -
Removal of initial effect (reverse) (260,000)
Recording of correct amount -
Company’s bank account .
Removal of initial effect
Recording of correct amount (reverse) (360,000)

a. The treatment of book-reconciling items is the same as the treatment under
the adjusted balance method.
b. The treatment of bank-reconciling items is the reverse of the operations
used in the adjusted balance method. For example, outstanding checks are
instead added while the deposits in transit are instead deducted.
The bank reconciliation using the bank-to-book method is as follows:
38
The
The Book

Debit memos (reverse):
NSF check 95,000
Company’s telephone bill directly paid by the bank 75,000
Maturing portion of bank loan 250,000
Credit memos (reverse):
(P700,000 +P70,000 - P5,000) (765,000)
Payments from Company’s customers (420,000)
Proceeds of bank loan (2,500,000)
Errors:
Recording of correct amount me
Removal of initial effect ~
Removal of initial effect (reverse) (120,000)
Recording of correct amount (reverse) 12,000
Understatement in the Company's recording of a deposit
Removal of initial effect (reverse) 78,000
Recording of correct amount (reverse) (87,000)
Removal of initial effect (reverse) -
Recording of correct amount (reverse) 150,000

a. The treatment of bank-reconciling items is the same as the treatment under
the adjusted balance method.
b. The treatment of book-reconciling items is the reverse of the operations
used in the adjusted balance method. For example, debit memos are instead
added while the credit memos are instead deducted.
RECORDING OF RECONCILING ITEMS

After preparing the bank reconciliation and noting the differences, it is now time to
record the adjustments. As far as the depositor entity is concerned, only those
book-reconciling items are recorded as adjustments.
39
The
CamScanner
However, in practice, no adjustments are recorded as of the end of each month since
the reconciling items only result from timing differences and they will be effectively
recorded in the succeeding month. The purpose of the bank reconciliation is to
merely identify the reasons for the differences in the cash in bank balance per book
and per bank, and take action if necessary, especially in cases of book errors.
Nonetheless, as of the reporting date (e.g., December 31), book-reconciling items
shall be recorded to properly capture the adjusted cash in bank balance as of that
date.
Illustration 5. In relation to ANJO Company, the following journal entries shall be

made in the books (only the book-reconciling items were recorded):
Reconciling Items Corresponding Journal Entries Effect in Cash
Cash in bank 765,000
Notes receivable Bank service charge 5,000 P765.000
collected by the bank Notes receivable 700,000 :
Interest income 70,000
Payments from Cash in bank 420,000 420.000
Company’s customers Accounts receivable 420,000 ‘
Proceeds of bank loan Loanpayable 2,500,000 2,500,000
: Bank service charge 25,000
Bank service charge Cash in bank 25,000 (25,000)
NS check Cash in bank 95,000 (95,000)
Bank’s direct payment | Telephone expense 75,000 (75,000)
of telephone bill Cash in bank 75,000 ,
Maturing portion of | Loan payable 250,000
bank loan Cash in bank 250,000 (258,600)
Correcting overstated | Cashin bank 108,000 108,000
check (P120K — P12K) Accounts payable 108,000 ’
Correcting of .
understated deposit cohin pane nis receivable ae 000 9,000
(P87,000 - P78,000) cou
Recording of the Accounts payable 150,000 00
unrecorded check Cash in bank 150,000 (150,000)
Net increase in cash in bank balance from reconciliation P3,207,000
Unadjusted cash in bank balance 6,617,000
DETERMINING THE RECONCILING ITEMS

In the previous illustrations, the amounts of reconciling items were already
provided for simplicity. However, in real life, the person reconciling the book
balance and bank balance shall determine the reconciling items by comparing the
40
The
transactions in the general ledger with the transactions in the bank statement.
Any differences are considered as reconciling items.
Illustration 6, On June 1, 2023, PETER Company established a bank account with
ABC Bank. During that same month, the related general ledger account for this bank
account showed the following transactions:
Cash in Bank - ABC Bank

Date Amount Date Amount
6/1 P620,000 6/5 P280,000
6/5 420,000 6/8 200,000
6/7 500,000 6/10 370,000
6/15 380,000 6/20 340,000
6/22 260,000 6/23 220,000
6/27 200,000 6/29 80,000
6/30 560,000 6/30 — 440,000
P2,940,000 P1,930,000
The bank statement provided by ABC Bank showed the following information:
PETER Company
Date Receipts DisbursementsRunning Balance
6/1 P620,000 P620,000
6/6 420,000 1,040,000
6/8 500,000 1,540,000
6/9 P200,000 1,340,000
6/11 280,000 1,060,000
6/16 380,000 1,440,000
6/19 370,000 1,070,000
6/23 260,000 1,330,000
6/28 200,000 220,000 1,310,000
6/30 80,000 1,230,000
6/30 *210,000 1,020,000
6/30 **15,000 1,005,000
6/30 ***1,000,000 2,005,000
*NSF check **Bank service charge ***Proceeds
of bank loan
The readers should not be confused that the t-account in the book records include
the name of the bank, while the name of the depositor entity is indicated on the
bank statement.
In this case, the first step is to determine the amounts of:deposits in transit,
outstanding checks, debit memos and credit memos:
a. The deposits on transit are determined by comparing the book receipts (the
debits in the Cash in Bank account) with the bank receipts (the amounts in the
“Receipts” column of the bank statement):
The
CamScanner
Chapter 2 - Bank Reconciliation
Book Receipts Reflected in Bank Receipts? Deposit in Transit

P620,000 - Yes on 6/1 p-
420,000 Yes on 6/6 -
500,000 Yes on 6/8 -
380,000 Yes on 6/16 -
260,000 Yes on 6/23 -
200,000 Yes on 6/28 -
560,000 No 560,000
Total, deposit in transit P560,000
The readers should take note that the P1,000,000 proceeds of a bank Ioan in the
receipts column of the bank statement is not considered in the above
comparison. Instead, it is considered as a credit memo.
b. The outstanding checks are determined by comparing the book
disbursements (the credits in the Cash in Bank account) with the bank
receipts (the amounts in the “Disbursements” column of the bank statement):
Book Disbur. Reflected in Bank Disbur. Outstanding Checks

P280,000 Yes on 6/11 P-
200,000 Yes on 6/9 7
370,000 Yes on 6/19 fe
340,000 No 340,000
220,000 Yes on 6/28 +
80,000 Yes on 6/30 +
440,000 No 440,000
Total, outstanding checks P780,000
The readers should take note that the P210,000 NSF check and P15,000 bank
service charge in the disbursements column of the bank statement are not
considered in the above comparison. Instead, these are considered as debit
memos.
c. Next, the usual bank reconciliation can now be made as follows (using the
adjusted balance method):
Bank statement balance P2,005,000
Adjusted cash in bank balance P1,785.000
General ledger balance (P2,940,000 - P1,930,000) P1,010,000
Add: Credit memo (Proceeds of a bank loan) 1,000,000
Less: Debit memos (P210,000 + P15,000) (225,000)
Adjusted cash in bank balance P1.785.000
42
The
The Book
Chapter 2 —- Bank Reconciliation
CHAPTER SUMMARY
Using the adjusted balance method, the following are the relevant bank reconciliation
procedures:
Bank statement balance (bank balance) Pxx

Add: Deposits in transit XX
Less: Outstanding checks (excluding certified checks) (xx)
Errors:
Errors in the recording of deposit (including nonrecording of deposit)
Less: Initially recorded amount of deposit, if any (xx)
Add: Correct amount of deposit of deposit, ifany - XX
Errors in the recording of check (including nonrecording of check)
Add: Initially recorded amount of check, if any XX
Less: Correct amount of deposit of check, if any (xx)
Adjusted cash in bank balance PXxx
General ledger balance (book balance) Pxx

Add: Credit memos (e.g., receivables collected by the bank, proceeds of
bank loan) XX
Less: Debit memos (e.g., bank service charge, NSF check, direct deduction
for maturing bank loan, utilities of the entity paid by the bank) (xx)
Errors:
Errors in the recording of deposit (including nonrecording of deposit)
Less: Initially recorded amount of deposit, if any (xx)
Add: Correct amount of deposit of deposit, if any XX
Errors in the recording of check (including nonrecording of check)
Add: Initially recorded amount of check, if any XX
Less: Correct amount of deposit of check, if any (xx)
Adjusted cash in bank balance PXxx
Only those book-reconciling items are recorded in the books as of the reporting date.
If the reconciling items are not explicitly given, the following procedures are relevant
(assuming there were no errors were committed):
a. Deposits in transit - book debits are traced to bank receipts. Generally, any book
debits not in the bank receipts are considered as deposits in transit.
b. Outstanding checks - book credits are traced to bank disbursements. Generally, any
book credits not in the bank disbursements are considered as outstanding checks.
c. Credit memos - bank receipts are traced to book debits, Generally, any bank receipts
that are not in the book debits are considered as credit memos.
d. Debit memos - bank disbursements are traced to book credits. Generally, any bank
disbursements that are not in the book credits are considered as debit memos.
43
The
The Book

True or False
1. A deposit made by an entity will increase the bank’s deposit liability.
2. At the time a check was made by an entity, there is already a corresponding
decrease in the bank’s deposit liability.
3 Utilities incurred by the entity that was directly paid by the bank is considered as a
debit memo.
Granting of a loan by a bank to a depositor entity will increase the bank’s deposit
liability to the entity.
The bank’s direct deduction of its maturing loan receivable from the depositor’s
w
bank account is considered as a credit memo.

Bank service charge is considered as a bank-reconciling item.
ao
A depositor entity’s note receivable that was collected by the bank is considered as
a credit memo.
Defective customer checks are considered as book-reconciling item.
so &
Outstanding checks are those already in the possession of the payees but are yet to
be encashed in the drawee bank.
10. When determining the adjusted cash in bank balance, certified checks are deducted
from the bank statement balance.
11. Deposits in transit are added to the bank statement balance.
12. Bank service charges are added to the book balance in determining the adjusted
cash in bank balance.
13. In determining the adjusted cash in bank balance, customer's direct payments to
the entity’s bank account are added to the bank statement balance.
14. The correction of overstatement in the entity’s recording of a check will have a net
increasing effect to the book balance in determining the adjusted cash in bank.
15. The correction of understatement in the entity’s recording of its deposit will have a
net decreasing effect to the book balance in determining the adjusted cash in bank.
Multiple Choice - Theories

1. When determining the outstanding checks,
a. the list of checks prepared by the entity shall be compared to the bank
statement. The checks that cannot be traced to the bank statement are
considered outstanding checks,
b. the list of checks prepared by the entity shall be compared to the bank
statement. The checks that can be traced to the bank statement are considered
outstanding checks.
c. the list of checks already paid by the bank shall be compared to the list of checks
prepared by the entity. The paid checks that can be traced to the list of checks
prepared by the entity are considered outstanding checks.
d. the list of checks already paid by the bank shall be compared to the list of checks
prepared by the entity. The paid checks that cannot be traced to the list of checks
prepared by the entity are considered outstanding checks.
44
The
CamScanner
2. When determining the deposits in transit,

a. the list of deposits prepared by the entity shall be compared to the bank
statement. The deposits that cannot be traced to the bank statement are
considered deposits in transit.
b. the list of deposits prepared by the entity shall be compared to the bank
statement. The deposits that can be traced to the bank statement are
considered deposits in transit.
c. the list of deposits already recorded by the bank shall be compared to the list
of deposits made by the entity. The deposits that can be traced to the list of
deposits made by the entity are considered deposits in transit.
d. the list of deposits already recorded by the bank shall be compared to the list
of deposits made by the entity. The deposits that cannot be traced to the list of
deposits made by the entity are considered deposits in transit.
3. The following are considered bank-reconciling items, except

a. Deposits in transit
b. Outstanding checks
c. Bank service charge
d. Errors committed by the bank
4. The following are considered bank-reconciling items, except

a. Certified checks
b. Deposit of one depositor recorded to another depositor’s bank account
c. Check of one depositor recorded against another depositor’s bank account.
d. Deposit of a depositor that was recorded half of the correct amount.
5. Bank-reconciling items that have a net increasing effect to the bank statement
balance to arrive at the adjusted cash in bank include the following, except
a. Deposit in transit.
b. Deposit of the entity but was recorded as the deposit of another entity.
c. Check of P100,000 but was recorded by the bank as P1,000,000.
d. Deposit of P50,000 but was recorded by the bank as P500,000.
6. Bank-reconciling items that have a net decreasing effect to the bank statement
balance to arrive at the adjusted cash in bank include the following, except
_a. Check of P20,000 but was recorded by the bank as P200,000.
b. Deposit of P40,000 but was recorded by the bank as P400,000.
c. Check of the entity but was deducted from the account of another entity.
d. Deposit of another entity but was recorded by the bank in the entity’s account.
7. Given the following statements below, determine which of them is/are true:
I. Debit memos have already reduced the bank statement balance but not the
book balance.
Il. Credit memos have already increased the book balance but not the bank
statement balance.
a. lIonly c. Both | and II
45
The
The Book
8. Given the following statements below, determine which of them is/are considered
as debit memo:
I. Proceeds from the bank loan.
Il. Direct deduction of maturing bank loan.
a. _lonly c. Both
I and II
b. Tlonly ’ d, Neither
I nor Il
9. The following are considered as credit memos, except

Collections from account customers received directly by the entity.
Collections from account customers who paid the entity’s partner bank.
aoe
Proceeds from the bank loan.

Net proceeds from a long outstanding customer note that was collected by the
bank on behalf of the entity.
10. An inexperienced accountant proposed the following bank reconciliation
procedures in determining the adjusted cash in bank balance:
I. Debit memos are added to the book balance.
Il. Credit memos are deducted from the book balance.
a. Onlylis correct c. Both I and II are correct
b. Only Il is correct d. Neither I nor II is correct
11. In the absence of errors, which of the following is/are true in the absence of errors?
a. If the total amount of debit memos is higher than the total amount of credit
memos, then book balance is higher than the adjusted cash in bank balance.
b. If the total amount of debit memos is lower than the total amount of credit
memos, then book balance is higher than the adjusted cash in bank balance.
c. Ejitheraorb.
d. Neither anor b.
12. Determine which of the items below is an example of a debit memo

a. Net proceeds collected by the bank from its depositor’s accounts receivable.
b. Proceeds of a bank loan which directly increased the depositor’s bank account.
c. Amounts paid by the bank on account of the depositor’s utilities as part of their
agreement regarding the bank automatically paying the depositor’s expenses.
d. Cash deposit of another depositor incorrectly added by the bank to another
depositor’s account.
13. The following are all debit memos, except
a. NSF check
b. Bank service charge for the processing of the entity's checks
c. Service charge for the collection of the entity's note receivable
d. Amounts received from customers who paid directly to the bank
14. The following bank reconciliation procedures applying the adjusted balance method
are correct, except
a. Unadjusted book balance is generally obtained from the entity's ledger.
46
The
The Book
b. Unadjusted bank balance is generally the ending balance in the bank statement.
C. Deposits in transit are added to the unadjusted book balance.
d. Credit memos are added to the unadjusted book balance.
15. When using the book to bank method of bank reconciliation, which of the following
procedures is not correct?
a. Credit memos are deducted from the unadjusted book balance.
b. Deposits in transit are deducted from the unadjusted book balance.
c. Outstanding checks are added to the unadjusted book balance.
d. Debit memos are deducted from the unadjusted book balance.
Straight Problems
1. For each of the following transactions below, determine the journal entries to be
made by JUAN Company (a depositor) and the depository bank.
a. The Company deposited P800,000 to the bank.
b. The Company writes a check amounting to P900,000.
Cc. The bank charged the Company’s account due to a service charge amounting to
P6,000.
d. As previously agreed with the Company, the bank paid the utilities expense of the
Company amounting to P50,000.
As previously authorized by the Company, the bank collected a P1,000,000 notes
receivable of the Company less collection service charge of P3,000.
The bank lent P2,000,000 to the Company.
g. The bank reduced the account of the Company by P200,000 as partial payment
to the bank’s loan to the Company.
The bank returned a P100,000 customer check initially deposited by the
Company. The reason for the return is the insufficiency in the bank account of the
Company’s customer.
2. In preparing its bank reconciliation for the month of June 2023, PARIS Company
provided the following information:

General ledger balance 2,460,000
NSF check - redeposited during the same month 120,000
NSF check - redeposited in the succeeding month 180,000
Deposits not appearing in the bank statement 240,000
Checks not yet encashed by the payee, including
P270,000 certified checks 650,000
Proceeds from a bank loan 2,000,000
Payment of maturing portion of the bank loan 500,000
Electricity bills directly deducted from the
Notes receivable collected by the bank 700,000
47
The
CamScanner
Required: From the above information, determine the following:

a. Adjusted cash in bank balance by preparing a bank reconciliation using adjusted
balance method.
b. Journal entries to record the reconciling items at the end of June 2023.
3. For the month of May 2023, BONNIE Company opened a bank account with EPSILON
Bank. At the end of that month, the Company wants to determine the amounts of
deposit in transit and outstanding checks. Relevant data are as follows:
a. Entries in the Company’s T-account for its deposits and issued checks in
EPSILON Bank are the following:
Epsilon Bank
5/1 P300,000 5/5 P130,000
5/5 200,000 5/8 90,000
5/7 240,000 5/10 175,000
5/15 180,000 5/20 160,000
5/22 120,000 5/23 100,000
5/27 90,000 5/29 30,000
5/31 270,000 5/31 210,000
P1,400,000 P895,000
b. The bank statement provided by the bank showed the following information:
BONNIE Company
Date Receipts Disbursements Running Balance
5/1 P300,000 P 300,000
5/6 200,000 500,000
5/8 240,000 740,000
5/9 P90,000 650,000
5/11 130,000 520,000
5/16 180,000 700,000
5/19 175,000 525,000
5/23 120,000 645,000
5/28 90,000 100,000 635,000
5/30 30,000 605,000
5/31 *5,000 600,000
*Bank service charge

balance method.
b. Journal entries to record the reconciling items at the end of May 2023.
48
The
4, On March 1, 2023, AURORA Company established a new bank account with XYZ
Bank. A few days after that month, it received a bank statement containing the
following information:
AURORA Company
Date Receipts Disbursements Running Balance
3/1 P1,000,000 P1,000,000
3/5 270,000 1,270,000
3/7 165,000 1,435,000
3/8 250,000 1,185,000
3/10 145,000 1,040,000
3/15 185,000 1,225,000
3/18 330,000 895,000
3/22 43,000 938,000
3/27 380,000 558,000
3/29 *800,000 **100,000 1,258,000
3/31 ***6,000 1,252,000
*Proceeds ofbankloan **NSF check ***Bank service charge
In addition, the relevant cash in bank general ledger account showed the following
information:
XYZ Bank - Cash in Bank

3/1 P1,000,000 3/5 P250,000
3/4 270,000 3/7 33,000
3/6 165,000 3/9 145,000
3/14 185,000 3/19 86,000
3/21 430,000 3/22 380,000
3/30 95,000 3/28 75,000
3/31 ___263,000| 3/31 60,000
P2,408,000 P1,029,000
The correct amount of P430,000 receipts recorded in the books is P43,000, while the
correct amount of P33,000 check recorded in the books is P330,000.

balance method.
b. Journal entries to record the reconciling items at the end of March 2023.
5. LUCAS Company reported the following information in relation to its bank

reconciliation for the month of December 2023:
49
The

Balance per general ledger 22?
Outstanding checks 680,000
NSF check that was not redeposited 70,000
NSF check that was redeposited 55,000
Utilities of the Company directly paid by the bank 220,000
Proceeds ofa bank loan 1,000,000
Maturing portion of the bank loan that was directly deducted
from the bank account 200,000
Notes of the Company collected by the bank 500,000
Payments from the customers who directly paid their accounts
to the Company’s bank account 300,000
Correct amount of a check recorded by the Company as P80,000 8,000
Correct amount of a check recorded by the Company as P4,000 40,000
Deposit that was not recorded by the Company 110,000
Check of LUCIO Company that was recorded by the bank as
belonging to LUCAS ~ 230,000
Deposit of LUCAS Company that was recorded by the bank as
belonging to LUCIO Company 170,000
Check of LUCAS Company that was recorded by the bank as
belonging to LUCIO Company 90,000

a. Unadjusted cash in bank balance per book
b. Adjusted cash in bank balance
c. Journal entries to record the relevant reconciling items
1. As of January 31, 2023, JAYSON Company reported the following information in
relation to its bank reconciliation:

NSF check 250,000
Proceeds from bank loan 1,500,000
Outstanding check, including P70,000 certified checks 820,000
Adjusted cash in bank balance shall be

a. P3,550,000 c. P2,000,000
b. P3,250,000 d. P3,180,000
Unadjusted cash in bank balance per general ledger shall be

a. P3,550,000 c, P2,000,000
b. P3,250,000 d, P4,800,000
50
The
The Book
2. JORDAN Company reported the following information as of December 31, 2023:
Balance per general ledger P2,800,000

Utilities of the Company directly paid by the bank 150,000
Notes receivable of the Company collected by the bank - 300,000
In addition, a check for P120,000 was recorded by the Company as P12,000.
Adjusted cash in bank balance shall be determined as

a. P2,918,000 c. P3,058,000
b. °P2,702,000 d. P2,842,000
Unadjusted cash in bank per bank statement shall be determined as follows:

a. P2,918,000 c. P3,058,000
b. P2,702,000 d. P2,842,000
3. For the month of September 2023, SYLVIA Company received its bank statement
showing a balance of P1;800,000.-Based on its general ledger, cash in bank has a
balance of P1,251,000. Upon comparing the receipts and disbursements in the bank
statement and its general ledger, it noted the following differences:
Deposit that was not recorded by the Company _—_P130,000
Correct amount of a check that was recorded by
the Company as P27,000 270,000
-Correct amount of the deposit that was
recorded by the Company as P18,000 180,000
NSF customer check 120,000
Check of another entity charged by the bank
against the Company’s bank account 330,000
Deposit of the Company added by the bank to
another entity’s bank account 150,000
In addition, deposits in transit and outstanding checks amounted to P400,000 and

ned as
P520,000, respectively. The adjusted cash in bank balance shall be determi
a. P1,960,000 c. P2,160,000
b. P2,760,000 d. P2,360,000
4. ELENA Company gathered the following information in relation to its bank

reconciliation for the month of December 2023:
Receipts from January 1-15, 2024 recorded during
December 2023 900,000
51
The
Chapter 2 —- Bank Reconciliation
Disbursements from January 1-15, 2024 recorded

during December 2023 500,000
NSF check 120,000
Reduction of bank account due to maturing loan 600,000
Face amount of the note collected by the bank 400,000
Accrued interest related to the note 40,000
Collection fee related to the note 3,000
Deposit recorded as P450,000 in the books 540,000
Check recorded as P240,000 in the books 420,000
ELENITA’s deposit included in ELENA Company’s
bank account by the bank in error 100,000
From this information, the adjusted cash in bank balance shall be determined as
a. P3,672,000 c. P3,472,000
b. P3,602,000 d. P3,802,000
From this information, the unadjusted cash in bank balance shall be determined as
a. P3,672,000 c. P3,472,000
b. P3,602,000 d. P3,802,000
5. When preparing for its bank reconciliation as of December 31, 2023, the bank
statement of ADAMITE Company reported a balance of P7,470,000. The following
additional information was gathered:
e Netproceeds from the accounts receivables collected by the bank on behalf of the
Company amounted to P150,000.
e Outstanding checks as of December 31, 2021 amounted to P604,000.
e ADAMITE Company’s account was credited with the deposit of ADELITE
Company amounting to P42,000.
e Unacknowledged deposits by the bank amounted to P206,000.
e@ NSF customer checks totaled P30,000
Determine the unadjusted balance per books as of December 31, 2021.

a P6,910,000 c. P7,030,000
b. P7,114,000 d. P6,994,000
6. WENDY Company reported cash in bank in its general ledger amounting to P800,000
while its bank statement indicated P730,000. Deposits in transit and outstanding
checks amounted to P156,000 and P230,000, respectively. In addition, bank service
charge amounted to P10,000, and there is an unknown amount of NSF check.
Assuming that there are no other reconciling items, the adjusted amount of cash in
bank balance shall be
a. P744,000 c, P790,000
b. P846,000 ~ d. P656,000
52
The
The Book
The amount of NSF check shall be determined as

a. P134,000 c. PO
b. P143,000 d. P214,000
7, AsofDecember 31, 2023, MICHAEL Company’s bank account showed P1,260,000 in

the bank statement. In addition, the following items were also noted:
Bank service charge P8,000

Outstanding check ‘ 380,000
NSF check 180,000
Proceeds from the bank’s collection of the Company’s note 22?
Check recorded by the Company as P140,000 14,000
Deposit recorded by the Company as P790,000 970,000
Cash in bank balance per general ledger amounted to P984,000.
Assuming that there are no other reconciling items, the adjusted amount of cash in
bank balance shall be
a. P1,330,000 c. P1,953,000
b. P1,456,000 d. P2,070,000
The amount of proceeds from the bank’s collection of the Company’s note shall be
a. P228,000 c. P236,000
b. P348,000 _ d. P252,000
8. Incomparing its bank statement with a balance of P1,670,000 to its own records and
vice versa, JOHN Company noted the following differences:
e AP15,000 charge in the bank statement involving the bank service charge.
© P640,000 receipts were recorded in the bank statement involving the collection
of one of the Company’s notes.
e A total of P560,000 deposits did not appear in the bank statement.
e A total of P460,000 checks did not appear in the bank statement.
e AP50,000 check belonging to other entity was recorded in the bank statement.
Based on this information, the adjusted cash in bank balance shall be determined as
a. P1,255,000 c. P1,720,000
b. P1,820,000 d. P1,195,000
9. GEORGE Company reported unadjusted cash in bank balance of P2,740,000 in its

general ledger. Upon comparing its records to the bank statement, it found the
following differences:
e P560,000 check was recorded in the books as P650,000.
e P750,000 deposit was recorded in the books as P570,000.
e P780,000 checks were not reflected in the bank statement.
53
The
The Book
There were no other reconciling items noted aside from these. In this case, the
adjusted cash in bank shall be determined as
a. P3,790,000 c. P2,650,000
b. P3,010,000 : d. P2,830,000
10. At the beginning of November 2023, MARY Company had the following outstanding
checks:
Check 20056 P56,000 Check 20101 P112,000

Check 20078 90,000 Check 20105 75,000
In addition, during that month, it prepared the following checks:
Check 20108 =P78,000

Check 20109 145,000
Check 20110 200,000
Check 20111 69,000
Check 20112 330,000
Check 20113 160,000
Check 20114 280,000
On the other hand, the bank statement showed the following checks that cleared
during the month:
Check 20110 200,000

Check 20109 145,000
Check 20056 56,000
Check 20113 160,000
Check 20112 330,000
Check 20108 78,000
Check 20078 90,000
Based on these data, the amount of outstanding checks shall be

a. P536,000
b. P349,000
c. P654,000
d. P385,000
54
The
The Book
Chapter 3 — Proof of Cash
CHAPTER 3
PROOF OF CASH

1.. Objective and purpose of proof of cash.
2. How do book-reconciling and bank-reconciling items, including errors, affect the
proof of cash
3. The different methods of preparing proof of cash
4. The computation of deposits in transit and outstanding checks
5. The computation of other missing items using proof of cash
PROOF OF CASH - INTRODUCTION

In the previous chapter, the bank reconciliation showed the effects of reconciling
items to the cash in bank balance as of a single date. However, in this chapter, bank
reconciliation concepts are applied on a more comprehensive fashion; hence, the
understanding of these concepts is crucial to understanding proof of cash.
Proof of cash is a two-date bank reconciliation showing the amounts of receipts
and disbursements during the period for which the proof of cash is made. These two
dates are as of the beginning and ending of the period. The receipts and
disbursements bridge the beginning-of-the-period balance to the ending-of-the-
period balance.
The primary purpose of proof of cash is to show the effects of reconciling items as
of the start and end of the period to the receipts and disbursements during the same
period. The primary end products of the proof of cash are the adjusted amounts of
beginning balance, ending balance, receipts, and disbursements.
One of the secondary purposes of proof of cash is the independent computation of
some amounts included in the bank reconciliation, such as deposits in transit and
outstanding checks.
PRELIMINARY CONSIDERATIONS
Before making an actual proof of cash, the readers shall be first oriented regarding
the columns and terminologies to be used in the preparation. For proof of cash
utilizing balances per books, the following columns shall be initially used:
Unadjusted Unadjusted Unadjusted Unadjusted

Beginning Book Receipts/ Book Disbursements/ | Ending Bank
Book Balance Book DEBITS Book CREDITS Balance
For proof of cash utilizing balances per bank, the following columns shall be
initially used:
55
The
Unadjusted Unadjusted Unadjusted Unadjusted

Beginning Bank Receipts/ Bank Disbursements/ | Ending Bank
Bank Balance Bank CREDITS Bank DEBITS Balance
1. Beginning balances of the current period are equal to the ending balances
at the end of the prior period.
2. The other term for book receipts is book debits since receipts increase the
“cash in bank” balance in the entity’s records, with the increase recorded as a
debit to that account.
3. The other term for book disbursements is book credits since disbursements
decrease the “cash in bank” balance in the entity’s records, with the decrease
recorded as a credit to that account.
4. The other term for bank receipts is bank credits since receipts increase the
“deposit liability” balance in the bank’s records, with the increase recorded
as a credit to that account.
5. The other term for bank disbursements is bank debits since disbursements
decrease the “deposit liability” balance in the bank’s records, with the
decrease recorded as a debit to that account.
The arithmetic relationships among these four columns are expressed as follows:
Using Book Amounts:

Beginning-of-the-period book balance Pxx
Add: Book receipts/book debits XX
Less: Book disbursements/book credits (xx)
Ending-of-the-period book balance Pxx
Using Bank Amounts:
Beginning-of-the-period bank balance Pxx
Add: Bank receipts/bank credits XX
Less: Bank disbursements/bank debits (xx)
Ending-of-the-period bank balance Pxx
Illustration 1. For each of the following independent scenarios, determine the

missing amounts:
Scenario 1; Scenario 2:
Beginning balance P2,500,000 Beginning balance P3,800,000
Book debits 6,500,000 Bank debits 22?
Book credits 5,400,000 Bank credits 7,300,000
Ending balance 22? Ending balance P2,900,000
The missing amounts are determined as follows:
56
The
The Book
Scenario 1:
Beginning balance P2,500,000
Add: Book debits 6,500,000
Less: Book credits (5,400,000)
Ending balance (squeeze) P3,600,000
Scenario 2:
Beginning balance P3,800,000
Add: Bank credits 7,300,000
Less: Bank debits (squeeze) (8,200,000)
Ending balance P2,900,000
STEPS IN PREPARING PROOF OF CASH

The readers may follow these steps when preparing proof of cash:
1. Arrange the amounts of beginning balance, receipts, disbursements and ending
balances in a four-column format. Compute for missing amounts, if necessary.
2. In the beginning balance and ending balance columns, apply the usual bank
reconciliation procedures as discussed in the previous chapter. This will be a
useful guide in applying the next step.
3. In adjusting the receipts and disbursement columns, the readers may use the
following assumptions:
a. Reconciling items (including errors) from previous period are assumed to be

recorded (or corrected) during the current period.
b. Reconciling items (including errors) for the current period are assumed to be
NOT yet recorded during the current period.
As a result of these general assumptions, the following specific assumptions can

now be made:
a. In the book’s records, credit memos of the previous period have been
included in the current period’s receipts, while debit memos of the previous
period have been included in the current period’s disbursements.
b. In the bank’s records, deposits in transit of the previous period have been
included in the current period's receipts, while outstanding checks of the
previous period have been included in the current period's disbursements.
The goal in adjusting the receipts and disbursement columns is to remove the
effects of the previous period’s reconciling items and the errors committed
during the current period. These columns should only include the correct
amounts of transactions that occurred during the current period.
57
The
The Book
Illustration 2. ROSARIO Company reported the following information to be used in

the preparation of its proof of cash:
May 31,2023 June 30,2023
Balances per bank statement P3,555,000 P???
Bank debits 8,155,000
Bank credits 7,500,000
Balances per general ledger 3,500,000 22?
Book debits 7,200,000
Book credits 8,300,000
NSF check 240,000 200,000
Bank service charge 25,000 30,000
Notes receivable collected by the bank 800,000 950,000
Utilities 150,000 120,000
Deposits in transit 750,000 600,000
Outstanding checks 420,000 500,000
1. Arrange the amounts of beginning balance, receipts, disbursements and ending

balances in a four-column format. Compute for missing amounts, if there are any.
Unadjusted Unadjusted
Beginning Bank Bank Bank Ending Bank
Balance CREDITS DEBITS Balance
P3,555,000 P7,500,000 P8,155,000 P2,900,000 (squeeze)
Beginning Book Book Book Ending Book
Balance DEBITS CREDITS Balance
P3,500,000 P7,200,000 P8,300,000 P2,400,000 (squeeze)
2. In the beginning balance and ending balance columns, apply the usual bank
reconciliation procedures. This will be a useful guide in applying the next step.
Beg. Bank Bank Bank End. Bank
Particulars Balance CREDITS DEBITS Balance
Unadjusted balances P3,555,000 P7,500,000 \P8,155,000 P2,900,000
Deposits in transit
May 31 750,000
June 30 600,000
Outstanding checks
May 31 (420,000)
June 30 (500,000)_
Adjusted balances P3,885,000 P3,000,000 |
58
The
CamScanner
Beg. Book Book Book End. Book
Particulars Balance DEBITS CREDITS Balance
Unadjusted balances P3,500,000 P7,200,000 P8,300,000 P2,400,000
NSF check
May 31 (240,000)
June 30 (200,000)
Bank service charge
May 31 (25,000)
June 30 (30,000)
Notes rec. collected
May 31 800,000
June 30 950,000
Utilities
May 31 (150,000)
June 30 (120,000)
Adjusted balances P3,885,000 P3,000,000
3. Next, include the corresponding effects of the reconciling items to the amounts
of receipts and disbursements:
Particulars Balance CREDITS DEBITS Balance
Deposits in transit
May 31 750,000 (750,000)
June 30 600,000 600,000
Outstanding checks
May 31 (420,000) (420,000)
June 30 500,000 (500,000)|
Adjusted balances P3,885,000 P7,350,000 P8,235,000 P3,000,000
The procedures made on the bank credits and bank debits, based on the
previously discussed assumptions, are described as follows:
a. Deposits in transit as of May 31 were already included in the bank credits for
the month of June. However, these amounts shall be deducted from June
credits since the receipt actually happened during May.
b. Deposits in transit as of June 30 are not yet included in the bank credits.
However, these amounts shall be added to the June credits since the receipt
actually happened during June.
c. Outstanding checks as of May 31 were already included in the bank debits for
the month of June. However, these amounts shall be deducted from June
debits since the disbursement actually happened during May.
59
The
d. Outstanding checks as of June 30 are not yet included in the bank debits.
However, these amounts shall be added to June debits since the
disbursement actually happened during June.
Particulars Balance DEBITS CREDITS Balance
Unadjusted balances _—P3,500,000 P7,200,000 P8,300,000 P2,400,000
NSF check
May 31 (240,000) (240,000)
June 30 200,000 (200,000)
Bank service charge
May 31 (25,000) (25,000)
June 30 30,000 (30,000)
Notes rec. collected
May 31 800,000 (800,000)
June 30 950,000 950,000
Utilities :
May 31 (150,000) (150,000)
June 30 120,000 (120,000)
The procedures made on the book credits and book debits, based on the
previously discussed assumptions, are described as follows:
a. Credit memos (notes receivable collected) as of May 31 were already
included in the book debits for the month of June. However, these amounts
shall be deducted from June debits since the receipt actually happened
during May.
b. Credit memos as of June 30 are not yet included in the book debits. However,
these amounts shall be added to June debits since the receipt actually
happened during June.
c. Debit memos (e.g., NSF checks, bank service charge, utilities paid) as of May
31 were already included in the book credits for the month of June. However,
these amounts shall be deducted from June credits since the disbursement
actually happened during May.
d. Debit memos as of June 30 are not yet included in the book credits. However,
these amounts shall be added to June credits since the disbursement actually
happened during June.
4. Similar to the bank reconciliation, the proof of cash shall arrive at the same
amounts of adjusted beginning balance, ending balance, receipts and
disbursements, whether using the book amounts or the bank amounts as the
starting point.
60
The
The Book
INCORPORATING CORRECTION OF ERRORS IN PROOF OF CASH

In incorporating the correction of errors, the previously mentioned procedures and
assumptions in preparing proof of cash are still applicable as follows:
1. For previous period errors (applicable to both bank and book):
_ What the concerned ©
Effect of correcting the |__ party initiallydidto | Adjustments to be made
error (whether from | correct the error during in the receipts and
check or deposit) _ the current period? disbursement columns
Increase in cashin bank | Added to receipts during | Deducted from receipts
balance the current period column
Decrease in cashin bank | Added to disbursements Deducted from
balance during the current period | disbursements column
2. For current period errors (applicable to both bank and book):

Error committed (assumed not Adjustment to be made in the
corrected during the current period) ‘receipts and disbursement columns
Understated (recorded < correct) check, Amount of understatement to be added
including nonrecordingof check to disbursements column
Amount of overstatement to be
Overstated (recorded > correct) check
deducted from disbursements column
Understated (recorded < correct)
Amount of understatement to be added
deposit, including nonrecording of
to receipts column
deposit
Amount of overstatement to be
Overstated (recorded > correct) deposit
deducted from receipts column
Similar to the previous chapter, an error committed by book is considered as book-

reconciling item while an error committed by bank is considered as bank-
reconciling item.
Illustration 3. SILANG Company provided the following condensed information to
be used in preparing proof of cash:
March 31,2023 April30,2023
Balances per bank statement P5,679,000 P4,962,000
Bank receipts 7,094,000
Bank disbursements 7,811,000
Balances per general ledger 5,459,000 6,127,000
Book receipts 7,654,000
Book receipts 6,986,000
Credit memos 1,200,000 400,000
Debit memos 550,000 880,000
Deposits in transit 1,000,000 900,000
61
The
CamScanner
In addition, the following errors were committed:

a. Check of P200,000 was recorded in the books as P20,000 during March 2023.
b. Deposit of P140,000 for April 2023 was not recorded in the books.
c. Deposit of SILONG Company amounting to P300,000 was recorded by the bank
in SILANG’s bank account during March 2023.
d. Check of P25,000 was recorded by the bank as P250,000 during April 2023.
The related proof of cash can now be prepared as follows:
Particulars Balance Receipts Disburse. Balance
Deposits in transit
March 31 1,000,000 (1,000,000)
April 30 900,000 900,000
Outstanding checks
March 31 (450,000) (450,000)
April 30 300,000 (300,000)
Deposit of other entity
March 31 (300,000) (300,000)
Overstated check
April 30
(P250K - P25K) (225,000) 225,000
Particulars Balance Receipts Disburse. Balance
Debit memos
March 31 (550,000) (550,000)
April 30 880,000 (880,000)
Credit memos
March 31 1,200,000 (1,200,000)
April 30 400,000 400,000
Understated check
March 31
(P200K - P20K) (180,000) (180,000)
Unrecorded deposit
April 30 140,000 140,000
SS
62
The
CamScanner
DIFFERENT FORMS OF PROOF OF CASH

Similar to bank reconciliation in the previous chapter, a proof of cash can be
prepared in the following different manners:
Adjusted Balance Book-to-Bank _ Bank-to-Book
Method Method Method
Both the book and The starting point are the The starting point are the
bank balances are book balances, while the bank balances, while the
used as the starting end point are the bank end point are the book
points in computing balances. balances.
for the adjusted
The treatment for book- The treatment for bank-
balances.
reconciling items is the reconciling items is the
In other words, there same with adjusted same with adjusted
will be two sets of balance method. balance method.
computations _ that
However, the treatment for However, the treatment for
should arrive at the
bank-reconciling items is book-reconciling items is
same amount of
the reverse of what is done the reverse of what is done
adjusted balances
in the adjusted balance in the adjusted balance
method. method
Illustration 4. For this example, the same information as with SILANG Company
will be used. For the adjusted balance method, this has already been shown in the
previous page.
The proof of cash using the book-to-bank method is as follows:

—
Beg. Disburse- End.
Particulars Balance Receipts ments Balance
Unadj. book balances P5,459,000 P7,654,000 P6,986,000 P6,127,000
Debit memos
March 31 (550,000) (550,000)
April 30 880,000 (880,000)
Credit memos
March 31 1,200,000 (1,200,000)
April 30 400,000 400,000
Understated check
March 31
(P200K - P20K) (180,000) (180,000)
Unrecorded deposit
April 30 140,000 140,000
Deposits in transit
March 31 (reverse) (1,000,000) — 1,000,000
|__ April 30 (reverse) (900,000) (900,000)
63
The
Outstanding checks
March 31 (reverse) 450,000 450,000
April 30 (reverse) (300,000) 300,000
March 31 (reverse) 300,000 300,000
Overstated check
April 30 (reverse)
(P250K- P25K) 225,000 (225,000)
Unadj. bank balances P5,679,000 P7,094,000 P7,811,000 P4,962,000
The proof of cash using the bank-to-book method is as follows:
Beg. Disburse- End.

Unadj. bank balances P5,679,000 P7,094,000 P7,811,000 P4,962,000
Deposits in transit
March 31 1,000,000 (1,000,000)
April 30 900,000 900,000
Outstanding checks
March 31 (450,000) (450,000)
April 30 300,000 (300,000)
March 31 (300,000) (300,000)
Overstated check
April 30
(P250K - P25K) (225,000) 225,000
Debit memos
March 31 (reverse) 550,000 550,000
April 30 (reverse) (880,000) 880,000
Credit memos
March 31 (reverse) (1,200,000) 1,200,000
April 30 (reverse) (400,000) (400,000)
Understated check
March 31 (reverse)
(P200K - P20K) 180,000 180,000
Unrecorded deposit
April 30 (reverse) (140,000) (140,000)
COMPUTATION OF DEPOSIT IN TRANSIT

By applying the concepts involving proof of cash, an entity can compute for the
amount of its deposit in transit at the end of the period using the following formula:
64
The
CamScanner
Prx
Beginning deposit in transit
Add: Deposits made to the bank (book debits less contaminants, such as
credit memos from previous period, and some book errors from current
and previous periods) XX
Total deposits to be received by the bank Pxx
Less: Deposits acknowledged by the bank (bank credits less
contaminants, such as credit memos for the current period, and some
bank errors from current and previous periods) xX
Ending deposit in transit Pxx
L___—
It should be noted that the amount of book debits (or receipts) is not necessarily equal
to the amounts of deposits made to the bank. The purpose of the adjustments is to
remove any amounts that are not considered as deposits. The same is also true for
bank credits.
Illustration 5. CARMONA Company would like to compute for the ending balance
of its deposit in transit. It provided the following partial information:
June 30,2023 July 31,2023
Deposit in transit P780,000 P???
Bank loan proceeds 1,000,000
Company notes collected by the bank 200,000 330,000
Customers directly paying to the bank 150,000 120,000
NSF check 75,000 50,000
The ending deposit in transit can now be computed as:

Beginning deposit in transit, June 30,2023. P780,000
Add: Deposits made to the bank (book debits less contaminants:
P5,500,000 - P1,000,000 - P200,000 - P150,000) 4,150,000
Total deposits to be received by the bank P4,930,000
Less: Deposits acknowledged by the bank (bank credits less
contaminants, P4,800,000 - P330,000 - P120,000) (4,350,000)
Ending deposit in transit, July 31, 2023 P580,000
Only credit memos were used in the calculation. Debit memos (bank service charge
and NSF check) are ignored since they are irrelevant in computing deposits in
transit.
65
The
The Book
COMPUTATION OF OUTSTANDING CHECKS |

Similar to the computation of ending deposits in transit, proof of cash concepts are
applied in the following formula:
Beginning outstanding checks Pxx |

Add: Checks written (book credits less contaminants, such as debit
memos from previous period, and some book errors from current and
previous periods) XX
Total checks to be paid by the bank Pxx
Less: Checks paid by the bank (bank debits less contaminants, such as
debit memos for the current period, and some bank errors from current
and previous periods) Xx
Ending outstanding checks Pxx
It should be noted that the amount of book credits (or disbursements) is not
necessarily equal to the amounts of checks written. The purpose of the adjustments
is to remove any amounts that are not considered as checks. The same is also true
for bank debits.
Illustration 6. TANZA Company would like to compute for the ending balance of its
deposit in transit. It provided the following partial information:
June 30,2023 July 31,2023
Outstanding checks P400,000 P???
Bank loan proceeds 2,000,000
Partial payment of bank loan directly
debited from bank account 200,000 250,000
Company notes collected by the bank 650,000 300,000
NSF check 500,000 100,000
The ending outstanding checks can now be computed as:

Beginning outstanding checks, June 30, 2023 P400,000
Add: Checks written (book credits less contaminants,
P7,050,000 - P200,000 - P40,000 - P500,000) 6,310,000
Total checks to be paid by the bank P6,710,000
Less: Checks paid by the bank (bank debits less contaminants,
P6,800,000 - P250,000 - P38,000 - P100,000) (6,412,000)
Ending outstanding checks, July 31, 2023 P298,000
66
The
CamScanner
ERRORS COMMITTED DURING THE CURRENT PERIOD BUT DISCOVERED AND

CORRECTED DURING THE CURRENT PERIOD
In the previous problems, the errors committed were dorfectad only during the
succeeding period. However, in limited circumstances, there are some errors that
may be detected even before the preparation of bank reconciliation and corrections
were made during the same period these errors were committed.
Generally, when recording the correction of errors, no negative amounts are entered
in the receipts and disbursements column whether in the records of the entity or in
the bank statement. Instead, the following are usually made during the same period
the errors were committed:
a. If the correction of the error involves an increasing adjustment to the cash
balance, the amount of correction is added to the receipts column.
In connection with the error correction above, if the error originally involved an
overstated recording of a check, both the receipts and disbursements columns
are overstated.
b. If the correction of the error involves a decreasing adjustment to the cash
balance, the amount of correction is added to the disbursements column.
In connection with the error correction above, if the error originally involved an
overstated recording of a receipt, both the receipts and disbursements columns
are overstated.
Consequently, under both of these scenarios, the amount of the error correction
shall be deducted from both the receipts and disbursements columns. The
beginning and ending balances columns are not affected.
Illustration 7 - Overstatement in the Recording of a Check. Near to the close of
July 2023, OXANA Company reported beginning balance of P5,700,000, receipts of
P8,000,000, disbursements of P7,600,000 and running balance of P6,100,000.
At the last few hours of the business day, it recorded a check for P400,000, even
though its correct amount is P300,000. The error was corrected immediately after
few minutes. The initial recording of the check, including the error correction is as
follows:
Initial Recording: Beg. Disburse- End.
Preliminary balances P5,700,000 P8,000,000 P7,600,000 P6,100,000
Initial recording 400,000 (400,000)
Upward error correction 100,000 100,000
67
The
Chapter 3 - Proof of Cash
However, the readers should take note that assuming the error was not committed
in the first place, the balances shall be as follows:
Should be Amounts: Beg. Disburse- End,
Correct check amount 300,000 (300,000)
Adjusted
book balances 5,700,000 P8,000,000 =P7,900,000 + P5,800,000—
As the readers may have noted, ending balance of P5,800,000 has not been changed,
however, the amounts of receipts and disbursements are different from the reported
amounts. Consequently, when preparing proof of cash, the following adjustment
shall be made on account of the error correction:
Beg. Disburse- End.

Proof of cash adjustment (100,000) (100,000)
Adjusted book balances P5,700,000 P8,000,000 P7,900,000 P5,800,000
Illustration 8 - Overstatement in the Recording of a Deposit. Using the same

information as in OXANA Company, except that instead of a check, it recorded a
deposit for P500,000, even though its correct amount is P350,000. The error was
corrected immediately after few minutes. The initial recording of the check,
including the error correction is as follows:
Initial Recording: Beg. Disburse- End.
Initial recording 500,000 500,000
Downward error
correction 150,000 (150,000)
Unadj. book balances P5,700,000 P8,500,000 —~P7,750,000 P6,450,000
The readers should take note that assuming the error was not committed in the first
place, the balances shall be as follows:
Should be Amounts: Beg. Disburse- End.

Correct check amount 350,000 350,000_
Adjusted book balances P5,700,000 P8,350,000 —-P7,600,000 P6,450,000
Consequently, when preparing proof of cash, the following adjustment shall be

made on the account of the error correction:
68
The
Beg. Disburse- End.

Proof of cash adjustment (150,000) (150,000)
Adjusted book balances P5,700,000 P8,350,000 P7,600,000 P5,800,000
SPECIAL CASE OF REDEPOSITED NSF CHECK

As mentioned in the previous chapter, NSF customer checks that were redeposited
during the same period are not included in the bank reconciliation. However, for
proof of cash purposes, the amounts of bank receipts and bank disbursements
are both overstated. This is with the assumption that the entity did not record in
the books the initial NSF status of the check and the its eventual redepositing.
Consequently, the amount of the redeposited check shall be deducted from both the
bank receipts and bank disbursements columns. An illustration will clarify this
point:
Illustration 9. During the current month, SAMUEL Company had an NSF customer
check amounting to P600,000. The check was redeposited the very next day. The
Company did not make entries in its books related to this NSF check.
However, in the bank’s perspective, it made the following entries in the receipts and
disbursements columns:
Disburse-
Particulars - Bank’s Perspective Receipts ments
Recording of the check when it was initially
deposited by the Company P600,000
Recording of the return of the check as NSF P600,000
Recording of when the NSF check was redeposited 600,000
Unadjusted bank balances P1,200,000 P600,000
Based on the above recording of the bank, its receipts and disbursements are clearly
overstated. Consequently, the proof of cash adjustment as far as this redeposited
NSF check is concerned, is as follows:
Disburse-
Particulars - Bank’s Perspective Receipts ments
Unadjusted bank balances related to the NSF check
that was later on redeposited P1,200,000 P600,000
Adjustment: Amount of NSF check redeposited (600,000) (600,000)
Adjusted bank balances P600,000 P-
69
The
The Book
CHAPTER SUMMARY
Using the adjusted balance method, the following are the effects of the reconciling items
in the proof of cash:
Balance Receipts Disburse. Balance
Unadjusted bank balances Pxx Pxx Pxx Pxx
Deposits in transit
Previous period XX (xx)
Current period XX xx
Outstanding checks
Previous period (xx) (xx)
Current period XX (xx)
Overstated check
Current period (xx) XX
Understated check
Current period xX (xx)
Overstated deposit
Current period (xx) (xx)
Understated deposit
Current period XX xx
NSF check redeposited
Current period (xx) (xx)
Adjusted balances Pxx Pxx Pxx Pxx
Note: The errors committed above are assumed to be corrected only during the succeeding
period.
Balance Receipts Disburse. Balance
Unadjusted book balances Pxx Pxx Pxx Pxx
Credit memos
Current period XX XX
Debit memos
Current period XX (xx) |
Adjusted balances Pxx Pxx Pxx PXX_]
*The accounting for overstatement or understatement of checks and deposits is the same
as in the proof of cash using the bank balances.
70
The
True or False
di The proof of cash is composed of four money columns.
2. The amount of book receipts is equivalent to book debits.
3: The amount of bank receipts is equivalent to bank debits.
4 Prior period reconciling items do not affect the ending balance of the current
period.
Debit memos from the prior period were already included in the amount of the
current period’s bank disbursements.
In the adjusted balance method of proof of cash, credit memos from the prior period
are deducted from the book receipts.
In the adjusted balance method of proof of cash, debit memos for the current period
are added to the book disbursements.
In the adjusted balance method of proof of cash, outstanding checks = the current
period are added to the book disbursements.
In the adjusted balance method of proof of cash, deposits in transit for the current
period are added to the bank receipts.
10. In the adjusted balance method of proof of cash, deposits in transit from the
previous period are deducted from the bank receipts.
11. The amount of bank receipts should be equal to the amount of deposits made by the
depositor entity.
iz, The amount of book disbursements already include the amount of debit memos
arising from the current period.
13. The amount of book receipts already include the amount of credit memos arising
from the previous period.
14. Book credits should equal the amount of checks written by the entity.
15. Book debits should equal the amount of deposits made by the entity.

i: In determining the amount of deposits in transit at the end of the period, the
following are true, except
a. The amount of deposits acknowledged by the bank is equal to the bank receipts.
b. Deposits in transit at the beginning of the period are added to the amount of
deposits made by the entity during the current period.
c. Deposits made by the entity is not necessarily equal to book receipts.
d. Deposits made by the entity can be determined by removing the non-deposit
components in the book receipts.
Given the following statements, determine which of these is/are true:

I, Anincrease in the receipts column generally have an increasing effect to the
ending balance column of the proof of cash.
Il. Anincrease in the disbursements column generally have an increasing effect to
the ending balance column of the proof of cash,
71
The
CamScanner
a. lonly c. Il only
b. Iand II d. Neither I nor II
3. The following are removed from the amount of bank receipts in determining the
amount of deposits acknowledged by the bank, except
a. Proceeds froma bank loan granted to the entity during the current period.
b. Proceeds from a collection of the entity’s note receivable during the current
period.
c. Errors involving the overstatement of deposits committed but uncorrected
during the current period.
d. Errors involving the overstatement of checks committed but uncorrected during
the current period.
4. The following are removed from the amount of book receipts in determining the
amount of deposits made by the entity, except
a. Proceeds from a bank loan granted to the entity during the previous period.
b. Proceeds from a collection of the entity’s note receivable during the previous
period.
c. Errors involving overstatement of checks committed during the previous period
but corrected during the current period.
d. Errors involving overstatement of deposits committed during the previous
period but corrected during the current period.
5. In determining the amount of checks cleared through the bank, the effects of the
following are removed from the bank disbursements, except
a. Bankservice charge during the current period
b. NSF check during the current period
c. Errors involving overstatement of deposits during the previous period.
d. Errors involving overstatement of checks during the previous period.
6. When comparing the bank statement and the general ledger for the current month,
an entity found out that deposits during the last day of the current month were not
reflected in the bank statement. Using the adjusted balance method, this difference
should be reflected in the current month’s proof of cash as
Deduction from the book receipts,
ano p
Addition to the book receipts.

Deduction from the bank receipts.
Addition to the bank receipts.
7. When comparing the bank statement and the general ledger for the previous month,
an entity found out that deposits during the last day of the previous month were not
reflected in the bank statement. Using the adjusted balance method, this difference
should be reflected in the current month's proof of cash as
a. Deduction from the book receipts,
b. Addition to the book receipts.
72
The
The Book
c. Deduction from the bank receipts.

d. Addition to the bank receipts.
g. Outstanding checks at the end of the current month should be reflected in the
current month’s proof of cash as
a. Deduction from the bank disbursements.
b. Addition to the bank disbursements.
c. Deduction from the book disbursements.
d. Addition to the book disbursements.
9. Outstanding checks at the beginning of the current month should be reflected in the
current month’s proof of cash as
a. Deduction from the book disbursements.
b. Addition to the book disbursements.
c. Deduction from the bank disbursements.
d. Addition to the bank disbursements.
10.In computing for the ending deposit in transit, the following procedures are
generally correct, except
a. Beginning deposit in transit is added to the amounts of deposits made to the
bank during the current period.
b. The total amount of deposits made to the bank is equal to the amount of book
receipts.
c. The amount of total deposits acknowledged by the bank is deducted from the
sum of the beginning deposit in transit and deposits made to the bank during
the current period.
d. The total amount of deposits acknowledged by the bank is not necessarily equal
to the amount of bank receipts.
Straight Problems
1. ISAIAH Company reported the following information relevant in preparing its proof
of cash for the month of July 2023:
June 2023 = July 2023
Balance per bank P4,600,000 P???
Balance per books 4,085,000 22?
NSF check 149,000 96,000
Proceeds from bank loan 1,000,000 -
Collection of accounts receivable - 250,000
73
The
The Book
Required: Based on this information, prepare the proof of cash for the month of July
2023 using the following methods:
a. Adjusted balance method
b. Bank to book method
c. Bookto bank method
2. MAHARLIKA Company (the “Company”) provided the following information:

e The bank statement reported balance of P3,750,000 and P4,350,000 as of
November 30, 2023 and December 31, 2023, respectively. Bank credits
amounted to P6,050,000 while bank debits amounted to P5,450,000.
e Deposits in transit amounted to P950,000 and P750,000 as of November 30,
2023 and December 31, 2023, respectively.
e Outstanding checks amounted to P1,185,000 and P975,000 as of November 30,
2023 and December 31, 2023, respectively.
e Note collected by the bank on behalf of MAHARLIKA Company amounted to
P345,000 and P232,000 as of November 30, 2023 and December 31, 2023,
respectively.
e Service charges and NSF check as of November 30, 2023 amounted to P4,000 and
P217,000, respectively. As of December 31, 2023, the relevant amounts were
P5,000 and P93,000, respectively.
e The bank frequently makes mistakes related to the accounts of the Company and
MAHALKITA Company. During November 2023, the bank charged the Company’s
account with a check belonging to MAHALKITA Company amounting to P90,000.
The same thing also happened during December 2023, but the amount of check
was P110,000. In addition, a check of the Company amounting to P200,000 was
incorrectly charged to MAHALKITA Company during December 2023. All errors
were corrected by the bank on the succeeding month.
e During December 2023, the Company recorded a check amounting to P90,000 as
P9,000.
Required: From this information, prepare a proof of cash using the following
methods:
a. Bank to book method.
b. Adjusted balance method.
3. For the month of May 2023, VIVALDI Company had the following bank
reconciliation:

Add: Proceeds of bank loan 800,000
Less: Bank service charge (25,000)
Unrecorded check (110,000)
74
The
The Book

Deposit of VIVALDI Company added to VIVIAN’s account 420,000
For the month of June 2023, it reported the following information:

e Bank debits and bank credits amounted to P7,250,000 and P8,300,000,
respectively.
e Book debits and book credits amounted to P7,980,000 and P6,970,000,
respectively.
NSF checks as of June 30, 2023 amounted to P250,000.
Bank service charge for the month of June 2023 amounted to P30,000.
Notes collected by the bank on behalf of the Company amounted to P400,000.
P75,000 check of VIVIAN Company was charged by the bank against the
Company’s bank account.
P180,000 deposit was not recorded by the Company.
e Deposits in transit and outstanding checks amounted to P460,000 and P670,000,
respectively.
Required: From this information, prepare a proof of cash using the adjusted balance
method.
4. DAINTY Company reported the following information regarding its cash in bank
balance:
Jan. 31, Feb. 28,
2023 2023
Balance per bank statement P4,400,000 P4,150,000
Balance per books 1,503,000 3,715,000
NSF check deposited only the next month 90,000 130,000
NSF checks redeposited the same month 216,000 199,000
Proceeds of a bank loan 2,000,000
Loan repayments directly debited by the bank 100,000
Utilities paid by the bank on behalf of the Company 50,000 75,000
Note receivable collected by the bank 200,000 300,000
Deposits of DEITY Company credited by the bank to
DAINTY’s bank account 445,000 241,000
Checks of DEITY Company debited by the bank to
DAINTY’s bank account 345,000 401,000
75
The
The Book
Correct amount of check that was recorded by

DAINTY as P92,000 _ 29,000
Correct amount of deposit that was recorded by
DAINTY as P12,000 120,000
Required: Based on the above information, determine the following amounts:

a. Adjusted cash in bank balance as of January 31, 2023
b. Adjusted cash in bank balance as of February 28, 2023
c. Adjusted receipts for the month of February 2023
d. Adjusted disbursements for the month of February 2023
5. Uponinspection of the general ledger entries and the bank statement related to MAP
Company’s cash in bank for the month of September 2023, the following information
are summarized:
Book credits for September, including August service charge of

P3,500 and NSF check of P37,000 P1,143,000
Book debits for September, including August credit memo for the
loan proceeds of P105,000 1,360,000
Bank debits for September, including September service charge of
P4,600 and August outstanding checks of P200,700. 840,000
Bank credits for September, including credit memo for September
for note collected with proceeds of P248,000 and August
deposit in transit of P169,000 990,000
Required: Based on the above information, determine the following amounts:

a. Amount of deposit in transit as of September 30, 2023.
b. Amount of outstanding checks as of September 30, 2023.

1. The total amount of checks that MELVIN Company has prepared for March 2023
amounted to P4,150,000. During February 2023, bank service charge and NSF check
amounted to P20,000 and P80,000, respectively. During the same period, a P200,000
note of the Company was directly collected by the bank.
On the other hand, during March 2023, bank service charge amounted to P23,000
and utilities directly paid by the bank amounted to P95,000, Based on these data, the
amount of unadjusted book disbursements shall be
a. P4,450,000 c. P4,250,000
b. P4,368,000 d, P4,132,000
2. For the moth of November 2023, the bank statement of REESE Company reported
unadjusted bank receipts of P3,600,000 and unadjusted bank disbursements of
P4,140,000. During the previous month, the following are the reconciling items:
e Deposits in transit of P740,000 and outstanding checks of P468,000
76
The
The Book
e Debit memos and credit memos amounted to P120,000 and P400,000,

respectively.
During the current month, the following are the reconciling items:
e Deposits in transit of P650,000 and outstanding checks of P808,000.
e Debit memos and credit memos amounted to P90,000 and P210,000,
respectively.
Based on this information, the amount of adjusted receipts shall be determined as
a. P3,510,000 c. P3,410,000
b. P3,690,000 d. P3,570,000
Based on this information, the amount of adjusted disbursements shall be
determined as
a. P4,050,000 c: P3,800,000
b. P4,480,000 d. P4,230,000
3. Inits bank reconciliation for the month of January 2023, KISSES Company reported
the following reconciling items:
e Bank service charge and NSF check amounted to P56,000 and P145,000,
respectively.
e Proceeds from bank loan amounted to P1,000,000.
respectively.
e Check of P340,000 was recorded as P430,000.
On the other hand, reconciling items for the month of February are the following:
e Bank service charge and payment of the maturing portion of the bank loan
amounted to P45,000 and P200,000, respectively.
e Company’s notes collected by the bank amounted to P550,000.
respectively.
e Deposit of P210,000 was recorded as P120,000.
Unadjusted book debits and unadjusted book credits amounted to P5,600,000 and
P4,500,000, respectively.
The adjusted book debits for the month of February 2023 shall amount to
a. P5,240,000 c. P5,060,000
b. P5,150,000 d. P5,330,000
The adjusted book credits for the month of February 2023 shall amount to
a. P4,544,000 c. P4,364,000
b. P4,454,000 d. P4,634,000
av
The
The Book
4. PAULA Company reported the following information related to its bank

reconciliation for the months of July 2023 and August 2023:
7/31/2023 8/31/2023
Bank credits P3,915,000
Deposit in transit P400,000 a
Outstanding checks 363,000 “227
NSF check 90,000 75,000
Note receivable collected 132,000 197,000
Deposit of PAOLA Company added by the
bank to PAULA’s bank account 39,000
Unrecorded deposit in the books 45,000
The amount of deposits in transit at the end of August 2023 shall be

a. P500,000 c. P605,000
b. P445,000 d. P486,000
The amount of outstanding checks at the end of August 2023 shall be

a. P390,000 c. P440,000
b. P432,000 d. P512,000
For the month of April 2023, CIARA Company reported unadjusted book receipts of
P6,650,000 and unadjusted bank disbursements of P4,460,000. The following
reconciling items were noted for the months of March 2023 and April 2023:
March 2023 = April 2023

Bank service charge P35,000 P38,000
NSF check 180,000 80,000
Notes collected by the bank 400,000 480,000
Deposit in transit 680,000 590,000
In addition, the following errors were noted;

e P80,000 check belonging to CLARA Company was charged against CIARA’s bank
account during March 2023.
e P136,000 deposit belonging to CLARA Company was added to CIARA’S bank
account during March 2023.
* P98,000 check was recorded in the books as P89,000 during April 2023.
¢ P120,000 deposit was recorded in the books as P21,000 during April 2023.
The adjusted book receipts shall be
a. P6,959,000 c. P6,829,000
b. P7,068,000 d. P7,108,000
78
The
CamScanner
The adjusted bank disbursements shall be

a. P4,384,000 c. P4,832,000
b. P4,563,000 d. P5,043,000
The unadjusted book disbursements shall be

a. P4,092,000 c. P4,562,000
b. P4,472,000 d. P4,942,000
The unadjusted bank receipts shall be

a. P6,579,000 c. P6,999,000
b. P6,799,000 d. P6,669,000
79
The
Chapter 4 — Accounts Receivable
CHAPTER 4
ACCOUNTS RECEIVABLE

1. The characteristics of receivables.
2. The different forms and classifications of receivables
3. The transactions affecting the accounts receivable balance
4. The gross method and net method of recording accounts receivable
5. The factors affecting the net realizable value of accounts receivable
RECEIVABLES - INTRODUCTION
In a general sense, a receivable is the right of an entity to obtain cash from another
entity. When an entity has a receivable, it is said to be a creditor of its counterparty,
Receivables can arise from different types of transactions such as providing
services on account, selling goods on account, lending funds to other entities,
accrual of other income, and other claims against other entities, suppliers, and
shareholders.
CLASSIFICATIONS OF RECEIVABLES
Receivables can be broadly classified into trade and nontrade receivables:
RECEIVABLES
Trade Receivables Nontrade Receivables

These are the receivables arising from These are receivables arising from
the primary revenue-generating activities other than the primary
activities of an entity. Classifying revenue-generating activities of an
receivables as “trade” depends to the entity.
industry in which the entity belongs.
Nontrade receivables cover a much
It is expected that only a handful of broader scope compared to trade
receivables can be classified as trade. receivables.
TRADE RECEIVABLES
Depending on the primary activities of an entity, the following can be considered as
trade receivables:
a. Accounts receivable
b. Notes receivable
c. Loans receivable (depending on the primary business of the entity)
The
CamScanner
Chapter 4 - Accounts Receivable
Accounts receivable arises from the rendering of service on credit (if the entity is
a provider of service) or from selling of inventories (if the entity is a merchandiser
or manufacturer) to customers. “On credit”, in this context, means that the
customer’s payment is to be received at a later date.
Installment receivable, a variation of accounts receivable, arises from the selling

of high-value inventories such as vehicles, and house and lot. This type of receivable
is still considered as trade receivable, even if they are collectible beyond one year
after the reporting date, provided that the installment basis granted is the usual
credit terms of the entity.
Notes receivable arises from the same transactions as accounts receivable. The
difference is that this is supported by a formal document called a promissory note.
However, if a note receivable arises from a transaction other than rendering of
service or selling of goods (e.g., selling of fixed assets, lending of funds of a non-
financial entity, etc.), it cannot be classified as part of trade receivables.
Loans receivable (and related accrued interest receivable) arises from lending of
funds to borrowers. These can be classified as trade receivables in the perspective
of an entity wherein its primary activities include the lending of funds to earn
interest. Financial institutions, such as banks and lending companies, can classify
loans receivable as part of their trade receivables.
However, if the entity is not a financial institution (e.g., manufacturing entity), its
loans receivable cannot be classified as part of its trade receivables.
NONTRADE RECEIVABLES
In general sense, the following are non-exhaustive examples of nontrade
receivables:
1. Advances to employees and officers —- these are loans granted to employees and
officers that are periodically deducted from their salaries.
2. Advances to suppliers - these are usually the down payments required by
suppliers before shipping out the entity’s order of inventory. This can also arise
from debit balances in suppliers’ account due to overpayments.
Loans or advances to affiliates and other related parties.
Pi ee
Subscription receivable from subscriber of an entity's own shares.

Notes receivable arising from selling land, building, equipment, machinery and
other assets not considered as inventories.
6. Accrued other income such as arising from interest income, dividends income,
commission income, rental income etc.
7. Claims of damages against other entities, such as against the courier in case the
purchased goods were lost in transit.
81
The
CamScanner
FINANCIAL REPORTING OF RECEIVABLES

The reporting of receivables, whether as part of current or noncurrent assets, will
depend on their classification as trade or nontrade:
FINANCIAL REPORTING OF RECEIVABLES
see nla a
oy _. Trade Receivables. Nontrade Receivables
Classified as part of current assets The portion that is collectible within
since these are generally collectible one year from reporting date is
within the longer of the following: classified as part of current assets.
a. One year; or
b. Operating cycle of the entity The portion that is collectible beyond
one year from reporting date is
classified as part of noncurrent assets.
Based on the above diagram, trade receivables are always classified as current
while nontrade receivables can be classified as current only if they are collectible
within one year after the reporting date. Examples of nontrade receivables that are
usually classified as current are the following:
a. Advances to employees, officers and suppliers
b. Subscription receivable, if collectible within one year after the reporting date,
otherwise reported as a reduction from equity.
c. Notes receivable, if collectible within one year after the reporting date
d. Accrued other income
e. Claims of damages
It should be noted that advances to affiliates and other related parties are usually
reported as part of noncurrent assets since these amounts, in substance, are not
expected to be paid by the affiliates in the foreseeable future.
Trade receivables, plus the current portion of nontrade receivables, are
presented on the current assets section of the statement of financial position in a
single line item called “Trade and Other Receivables’.
Illustration 1. LOBO Company, a manufacturer of wide range of inventory items,
reported the following amounts as of December 31, 2023:
Subscription receivable due in 60 days P600,000

Accounts receivable - customers 5,000,000
Accounts receivable - affiliates 1,000,000
Advances to employees 400,000
Advances to executives 800,000
Accounts receivables from employees 300,000
Accounts receivables from executives 200,000
82
The
CamScanner
Accounts receivables which postdated checks were received 150,000

Advances to subsidiary 2,000,000
Notes receivable arising from selling inventory 550,000
Notes receivable arising from lending funds (due in 2026) 1,200,000
Notes receivable arising from lending funds (due in 2024) 2,400,000
Interest receivable 90,000
Advances to suppliers 420,000
Debit balances in suppliers’ accounts 50,000
Accounts receivable - installment basis 900,000
Required: From this information, determine the following amounts:

a. Total trade receivables
b. Total nontrade receivables
c. Total receivables to be classified as current and noncurrent
These amounts can be computed as follows:
Trade or Nontrade Current or Noncurrent

Trade Nontrade Current Noncurrent
Subscription receivable P600,000 P600,000
Accounts receivable - customers 5,000,000 5,000,000
Accounts receivable - affiliates 1,000,000 1,000,000
Advances to employees 400,000 400,000
Advances to executives 800,000 800,000
Accounts receivables from employees 300,000 300,000
Accounts receivables from executives 200,000 200,000
Accounts receivables which postdated '
checks were received 150,000 150,000
Advances to subsidiary (an affiliate) 2,000,000 2,000,000
Notes receivable arising from selling
inventory 550,000 550,000
Notes receivable arising from lending
funds (due in 2026) 1,200,000 1,200,000
Notes receivable arising from lending
funds (due in 2024) 2,400,000 2,400,000
Interest receivable 90,000 90,000
Advances to suppliers 420,000 420,000
Debit balances in suppliers’ accounts 50,000 50,000
Accounts receivable - installment 900,000 900,000
Totals P8,100,000 P7,960,000 P12,860,000 P3,200,000
The readers should take note the following:

a. The P12,860,000 balance of current receivables is also equal to the amount to
be presented as “Trade and other receivables”.
b. All accounts receivables, whether from customers, employees, executives, and
affiliates, are considered as trade receivables since these arise from the primary
activities of an entity.
83
The
CamScanner
c. Only those notes receivables arising from selling of inventory are considered as
trade receivables. .
d. All nontrade receivables are subject to the “one-year rule”.
e. Notes receivable due in 2024 (a nontrade receivable) is considered as current
since it is collectible within one year from December 31, 2023. On the other hand,
notes receivable due in 2026 is considered as noncurrent since it is collectible
beyond one year from December 31, 2023.
f. Advances to affiliates are usually considered as noncurrent since these are not
expected to paid by affiliates soon.
Moving forward, the focus of the discussions will now be upon accounts receivable.
INITIAL MEASUREMENT OF ACCOUNTS RECEIVABLES

As financial assets (to be thoroughly discussed in Chapter 10 onwards), receivables
are initially measured at their fair value on initial recognition. [PFRS 9.5.1.1].
However, for trade receivables with no significant financing component, the
initial measurement can be equal to the transaction price. The transaction
price is the total amount that the entity is entitled to receive, which is usually equal
to the selling price of the related goods or services.
TRANSACTIONS AFFECTING ACCOUNTS RECEIVABLES

In the context of an entity normally selling items of its inventory, the following
transactions have the following effects in the accounts receivable (A/R) balance and
the corresponding journal entries:
Transactions Effectin A/R Pro-Forma Journal Entries

Credit sales made Increase Accounts recetvable a
Sales XX
Collection from Decrease equal to Cash
customers without the amount of cash i oe ax
sales discount received ECOUIES TeCelvaDle "XX is
Collection from Decrease equal ts Cash xx
customers less sales the amounts of cash Sales discount : XX
‘ received plus sales
discount discount Accounts receivable xx
Sales returns or
allowance from unpaid Decrease Sales returns or allow. XX
credit sales (issuance Accounts receivable — xx
of credit memo) anal
Receipt of promisso ‘
Li for ee Decrease Notes receivable ; wt
accblints eeceivabls Accounts receivable xx |
_ Write-off
Gis of D Allowance for bad debts — xx
ecrease :
uncollectible accounts Accounts receivable _xx__)
84
The

qa. Cash sales do not affect the balance of accounts receivable.
b. Cash refunds paid to customers for sales returns or allowances shall not also
affect the accounts receivable balance.
These transactions can be summarized as follows:
Accounts
Receivable
Beginning balance XX XX Cash received from credit sales
Credit sales XX XX Sales discount
Recoveries (be discussed XX XX Sales return or allowances from
in the next chapter) unpaid credit sales
xx | Receipt of promissory note for
overdue accounts receivable
XX Recoveries
XX Write-off of accounts receivable
XX Ending balance (squeeze)
Totals (should be equal) XX XX
Illustration 2. At the beginning of 2023, SAN JUAN Company reported accounts

receivable balance of P2,500,000. The following transactions have occurred during the
year 2023:
a. Cash sales amounted to P800,000 while credit sales amounted to P6,500,000. The
Company has an established credit term of 2/10, n/30 for all credit sales.
b. Cash received from credit customers totaled P6,400,000, of which P3,920,000 were
received from customers paying within the discount period (i-e., net of discount).
c. Credit memos issued for sales return totaled P200,000, while cash refund made to
customers amounted to P100,000.
d. Apromissory note was received for overdue account amounting to P120,000.
e. Receivable of P60,000 was written-off since the customer is nowhere to be found.
The ending balance of accounts receivable as of December 31, 2023 is computed as:
Accounts Receivable
Beginning balance | P2,500,000 | 6,400,000 | Cash received from credit sales
Creditsales | 6,500,000 80,000 | Sales discount
[P3,920,000/(1 - 2%)] x 2%
200,000 | Sales return or allowances from
unpaid credit sales
120,000 | Receipt of promissory note for
overdue accounts receivable
60,000 | Write-off of accounts receivable
2,140,000 | Ending balance (squeeze)
Totals (should be equal) | P9,000,000 | P9,000,000
Note: 2% is from the 2/10, n/30 credit terms.
85
The
GROSS METHOD VS NET METHOD

As the readers may have noted, the amount to be received from customers within the
discount period is lower compared to the amount to be received beyond the discount
period. This difference is called the “sales discount” and is substantially a financing
mechanism that, theoretically, shall be recognized as a financing income, separate
from sales revenue.
The net method of accounting accommodates this theoretical separate recognition
of financing income. The comparison between the gross method (the usual
approach) and the net method is as follows:
—.
__. Gross Method Net Method |

Accounts receivable xx | Accounts receivable XX
Sales XX Sales XX
Initial recording Sales and A/R_ recorded | SalesandA/Rrecorded amounts
ofcreditsale | amounts are gross of sales | are netof sales discount, hence
discount, hence the name of | the name of the method
the method
Cash XX
Receipt of Cash x Accounts receivable XX
payment within | Sales discount XX Cash received is equal to the
discount period Accounts receivable xX | amount of recorded A/R, which
is already net of discount
Cash XX
Accounts receivable XX
Receipt of ae = Sales discount lost XX
eee ras Accounts receivable xx | Sales discount lost account is
SSCOUHE DENS usually reported as other
income (excluded from gross
profit amount)
Even though the net method is theoretically the more correct choice, it is usually
difficult to implement in practice due to the level of monitoring needed.
Nonetheless, the total amount of sales discount is usually immaterial, which yields
an insignificant difference in the amounts reported under the gross and net
methods. Gross method is usually followed in practice since it is much easier to
implement.
The differences in the amounts to be reported under both methods are summarized
as follows:
86
The
CamScanner
Payment received WITHIN Paymentreceived —

Amounts discount period BEYOND discount period
Net sales amount | Gross method = net method | Gross method > net method
|Gross profit Gross method = net method | Gross method > net method
|Other income N/A Gross method < net method
| Net income Gross method = net method | Gross method = net method
Illustration 3. On June 1, 2023, TALISAY Company sold inventory on account for

P50,000, with terms of 1/15, n/30. Related cost of the goods amounted to P20,000. The
sale transaction and the corresponding receipt of customer payments are recorded as
follows:
Gross Method Net Method

Initial Accounts receivable 49,500
recording of | Accounts receivable 50,000 Sales 49,500
credit sale on Sales 50,000 2
June 1, 2023 *P49,500 = P50,000x (100% - 1%)
Receipt of
payment on or a : 43,800 Cash 49,500
Sales discount 500 .
before June ‘ Accounts receivable 49,500
16, 2023
Receipt of Cash 50,000
payment after ae irervivah cae 00 Accounts receivable 49,500
June 16, 2023 ’, Sales discount lost 500
The differences in the amounts to be reported under both methods are summarized as:
Payment received Payment received BEYOND

WITHIN discount period discount period
Amounts Gross Net Gross Net
Gross sales P50,000 P49,500 P50,000 P49,500
Less: Sales discount (500) = - ~
Net sales P49,500 P49,500 P50,000 P49,500
Less: Cost of sales (20,000) (20,000) (20,000) (20,000)
Gross profit P29,500 P29,500 P30,000 P29,500
Add: Other income* - = - 500
Net income P29,500 P29,500 P30,000 P30,000
*sales discount lost
SUBSEQUENT MEASUREMENT OF ACCOUNTS RECEIVABLES

At the end of each reporting period, accounts receivable shall be measured at its net
realizable value. It is based on the general notion that assets shall not be carried at
amounts more than the amount of cash that can be obtained from them. The net
realizable value of accounts receivable can be computed as follows:
87
The
CamScanner
Gross accounts receivable Pxx

Less: Expected sales returns XX
Expected sales discounts xX
Expected freight out xX
Expected bad debts (discussed in detail in the next chapter) XX
Net carrying amount of accounts receivable Pxx
These expected amounts are maintained in allowance accounts, which are contra-
asset accounts (i.e., with normal credit balances) against accounts receivables.
Expected Sales Returns

Some of the sales returns in the succeeding period may come from the accounts
receivable balance as of the reporting date. In this case, the amount of expected
sales returns shall be estimated using the entity's best and reasonable inputs
primarily from past experience, but adjusted with expectations in the future. Pro-
forma journal entry to record the recognition of expected sales returns is as follows:
Sales returns XX
Allowance for sales returns _ XX
The above sales return amount is included in the reductions from gross sales to
arrive at the amount of net sales for the current period.
Expected Sales Discounts

Similar to sales returns, some of the sales discounts early in the succeeding period
may arise from the credit sales made near the end of the current reporting period.
The amount of expected sales discounts shall take into account only the accounts
receivable balance that are entitled to the sales discount. Pro-forma journal entry to
record the recognition of expected sales discounts is as follows:
Sales discounts XX
Allowance for sales discounts XX
The above sales discount amount is included in the reductions from gross sales to
arrive at the amount of net sales for the current period.
Illustration 4. MABINI Company had a balance of P6,000,000 in its accounts receivable

as of December 31, 2023, aged as follows:
Age Balance
More than 90 days P200,000
61 - 90 days 300,000
21 - 60 days 500,000
11-20 days 1,000,000
10 days and below 4,000,000
P6,000,000
88
The
The Company reasonably expects that only 60% of the receivables still entitled to
sales discount will pay within the discount period. Required: Under each of the
independent scenarios, determine the amount of expected sales discount:
1. The Company’s grants 2/10, n/30 credit terms to all of its customers.
2. The Company's grants 1/20, n/30 credit terms to all of its customers.
Scenario 1
Since the discount period is 10 days, only those receivables with age of 10 days and
below (i.e., P4,000,000) shall be the basis of the expected amount of sales discount.
Pro-forma journal entry is as follows:
Sales discounts (P4M x 2% x 60%) 48,000
Allowance for sales discounts 48,000
Scenario 2
Since the discount period is 20 days, only those receivables with age of 20 days and
below (ie. P5,000,000 or P4,000,000 plus P1,000,000) shall be the basis of the
expected amount of sales discount. Pro-forma journal entry is as follows:
Sales discounts (P5M x 1% x 60%) 30,000
Allowance for sales discounts 30,000
Expected Freight Out

To understand how anallowance for freight out arises, it is crucial to know first the
shipping terms and freight terms:
Shipping Terms | Owner ofIn-TransitGoods | Liable to Pay Freight

FOB shipping point Buyer Buyer
FOB destination Seller Seller
Freight Terms Description

Freight prepaid The seller pays the freight amount upon shipment
Freight collect The buyer pays the freight amount upon receipt
Combining shipping terms and freight terms will result to the following analysis:
Liable to Who Actually
Scenario | Shipping/Freight Terms Pay Freight | Paid the Freight
1 FOB shipping point, freight prepaid Buyer Seller
2 FOB shipping point, freight collect Buyer Buyer
3 FOB destination, freight prepaid Seller Seller
4 FOB destination, freight collect Seller Buyer
The readers should take note that no further accounting issues will arise in
Scenarios 2 and 3 since the liable party actually paid for the freight.
89
The
Chapter 4 —- Accounts Receivable
It is in the Scenario 4, when the shipping and freight terms is FOB destination,
freight collect, that will give rise to the expected amount of freight out. There
is a reduction in the amounts to be received since the buyer will charge its
shouldered freight against its payment to the entity.
Illustration 5. On December 27, 2023, CUENCA Company sold goods with selling
price of P400,000 under shipping and freight terms of FOB destination, freight
collect and credit terms of 1/15, n/30. It is expected that the buyer will receive the
goods on January 5, 2024. Amount of freight that the buyer will pay on that date is
estimated to be P10,000.
The entry to record the sale on December 27, 2023 is as follows:

Sales 400,000
The entry to record the estimate of freight out on December 31, 2023 is as follows:
Freight out 10,000
Allowance for freight out 10,000
As December 31, 2023, the accounts receivable will have a net carrying amount of
P390,000 (P400,000 - P10,000). Assuming that the buyer paid on January 10, 2024
(i.e., within the discount period), the journal entry shall be:
Cash 386,000
Sales discount (P400,000 x 1%) 4,000
Allowance for freight out 10,000
It should be noted that even though the buyer can reduce the amount it will pay to
the entity due to the freight it initially shouldered, the basis of the sales discount
is still the original invoice price (i.e., not reduced by the amount of shouldered
freight).
CREDIT BALANCES IN CUSTOMERS’ ACCOUNTS

In accounting, the general ledger for accounts receivable is supported by subsidiary
ledger, which shows the breakdown of accounts receivable balance on a per
customer basis.
No issues will arise when each of the customer accounts has a debit or positive
balance. However, adjustments shall be made when some of the customer accounts
result to a credit or negative balance. This credit or negative balance shall not be
deducted from other customer accounts but shall be presented separately as
part of current liabilities.
90
The
CamScanner
Illustration 6. MALVAR Company reported P4,200,000 balance in its accounts

receivable general ledger. Based on the subsidiary ledger, this can be broken down
as follows:
Customer 001045 P2,000,000
Customer 001052 1,500,000
Customer 001067, (300,000)
Customer 001058 1,000,000
Accounts receivable balance P4,200,000
In this case, the accounts receivable balance shall be revised to the following
amount:
Customer.001045 P2,000,000
Customer 001052 1,500,000
Customer 001058 1,000,000
Accounts receivable balance, adjusted P4,500,000
The negative balance of Customer 001067 shall be reclassified to current liabilities
through the following journal entry:
Accounts receivable . 300,000

Advances from customers 300,000
CHAPTER SUMMARY
Trade receivables include those receivables directly arising from the selling of goods or
providing of services.
1. Trade and other receivables include trade receivables and other receivables that can
be considered as current.
2. Generally, receivables are initially measured at the fair values, except for trade
receivables which can be measured at their face amounts.
3. Credit sales are the primary transactions that increase the accounts receivable
balance. Cash sales do not affect accounts receivable balance.
4, Transactions that will decrease the accounts receivable balance include cash
receipts from credit customers, sales discounts, sales returns and allowances from
unpaid credit sales, and write-off of uncollectible accounts.
5. Cash refund given to customers does not affect the accounts receivable balance.
6. Recovery of accounts receivable does not affect the accounts receivable balance.
7. Netmethod is, conceptually, the more correct way of recording accounts receivables.
However, the gross method is more practical.
8. Both the net method and gross method will arrive at the same amount of netincome.
9. Freight terms determine the party obliged to pay the related freight charges.
10.Receivables shall be reported at their net realizable values (i.e, net of expected
amounts that cannot be collected).
11.Credit balances in customer’s accounts shall be separately presented as part of
current liabilities.
91
The
CamScanner
True or False
1. Generally, receivables are considered as financial assets.
be The classification “nontrade receivables” covers more types of receivables
compared to the “trade receivables” classification.
3: Generally, trade receivables are classified as part of noncurrent assets.
4. Nontrade receivables are almost always classified as current assets.
5 Nontrade receivables can be considered as current if they can be collected within
12 months after the reporting date.
Trade and other receivables include trade receivables and the current portion of
nontrade receivables.
A subscription receivable that will be received within one year from the reporting
date is presented as a deduction from the shareholders’ equity.
Advances to affiliates are normally reported outside of the trade and other
receivables classification.
Cash refunds given to the customers will usually decrease the balance of the
accounts receivable.
10. Assuming that a credit customer has paid within the discount period, the decrease
in the accounts receivable balance is equal to the cash received.
11. The net method is easier to apply in the accounting records compared to the gross
method.
12. The gross method will result to a higher net sales relative to the net method if a
customer paid within the discount period.
13; The gross method will result to a higher gross sales relative to the net method
whether the customer paid within the discount period or not.
14. No further accounting issues will arise if the freight term is FOB destination, freight
collect.
15. Freight prepaid means that the buyer has already paid the freight to the courier,
even if the goods are yet to be shipped.
i Given the following statements:
I. The net realizable value of accounts receivable is equal to its gross amount less
actual amounts of sales discounts, sales returns, sales allowances, and written-
off accounts.
Il. Generally, accounts receivable give the entity the right to receive cash from
customers or from another entity.
Which of the above statements is/are true?

a. Tonly c. Both I and II
b. Ilonly d Neither I nor II
in Accounts receivable is the result of
a. credit sales only c. Both credit sales and cash sales
b. cash sales only d. Neither credit sales and cash sales
92
The
3. Given the following statements:

I; Accounts receivable is a formal type of receivable.
II. Notes receivable is not evidenced by any written document, except for the sales
invoice or billing statement given to the customer.
Which of the above statements is/are true?
b. Ilonly d. Neither [I nor II
4. Generally, receivables are measured initially attheir_____——+——/s and subsequently

at their ;
a. Fair values; net realizable values
b. Face amounts; face amounts
c. Netrealizable values; fair values
d. Face amounts; net realizable values
5. Allofthe following receivables shall be initially measured at their fair values, except
a. Notes receivable
b. Loans receivable
c. Accounts receivable
d. Long-term advances to employees
6. The following terminologies are relevant in accounting for receivables, except
a. Recognition
b. Depreciation
c. Disposal
d. Write-down
7. Which of the following incorrectly states the effects of the transactions to the
accounts receivable balance?
a. Cash sales do not affect the balance of accounts receivable.
b. Credit sales increase the balance of accounts receivable.
c. Sales returns, including those issued with credit memos and cash refunds,
decrease the balance of accounts receivable.
d. Cash received plus sales discount, if any, decrease the accounts receivable
balance.
8. The net method will report a lower amount of net sales compared to the gross
method in which of the following scenarios?
When some of the customers pay beyond the discount period.
ano p
When there are sales returns,

When all of the customers pay within the discount period.
There is no case that the net method will report lower net sales compared to the
gross method.
93
The
The Book
9. If the shipping and freight terms are FOB destination, freight collect
I. The seller is required to pay the freight since it is still the owner of the goods
while in transit.
I]. The buyer will actually pay for the freight, but it can claim reimbursement from
the seller.
a. only c. Both I and II
10. If the shipping and freight terms are FOB shipping point, freight collect
I]. The buyer is required to pay for the freight since it became the owner of the
goods while in transit.
Il. The buyer will also actually pay for the freight, but it can claim reimbursement
from the seller.
a. lIonly c. Both I and II

Straight Problems
1. As of December 31, 2023, BARCELONA Company reported the following items as
comprising its P9,498,700 net receivables balance:
Unassigned trade accounts receivables from customers P3,340,000

Subscription receivable due in 40 days 569,000
Assigned trade accounts receivables from customers 1,312,000
Trade accounts receivables in installment basis for 20 months 697,800
Trade receivables from executive employees 128,000
Advances to employees 119,000
Trade receivables which the Company received postdated checks 290,200
Trade receivables which the Company received stale checks 265,700
Interest receivable on bond investment 330,000
Credit balances arising from customer accounts (68,000)
Loans and advances to affiliates 2,100,000
Debit balances on suppliers’ accounts 220,000
Advance payments to suppliers 155,000
Receivables known to be worthless 40,000
Total P9,498,700
Required: From these data, determine the amounts to be presented as:

a. Trade receivables
b. Trade and other receivables
c. Noncurrent receivables.
94
The
2. VALENCIA Company reported the following amounts for the year 2023:
Accounts receivable, 1/1 P450,000
Cash sales 1,800,000
Credit sales 4,060,000
Cash received from credit customers 4,230,000
Sales returns from cash/paid sales 80,000
Sales returns from credit sales 55,000
Accounts ascertained to be worthless 18,000
Required: From this information, determine the balance of accounts receivable as of

December 31, 2023.
3. For the year 2023, ZARAGOZA Company reported the following information:
a. Accounts receivable at the start of the year, P825,000.
b. Cash sales amounted to P790,000 while sales on account amounted to
P2,640,000. The credit term is 3/10, n/30.
Cash received from customers paying within the discount period amounted to
P727,500. On the other hand, cash received from customers paying beyond the
discount period amounted to P1,475,000.
Credit memos sent to customers amounted to P25,000.
Accounts written-off amounted to P8,000. An account that was written-off in the
previous year was collected during the year, P5,000 (not yet included in cash
received from customers in item c above).
Required: From these data, determine the ending balance of accounts receivable.
4, GRANADA Company reported the following transactions for the year just ended:
Credit sales, 2/10, 1/20, n/60 P5,000,000
Cash sales 800,000
Accounts proved to be worthless 50,000
Promissory notes received as payment of accounts 300,000
Sales allowance allowed on credit sales . 60,000
Refunds made to cash/paid customers 100,000
Cash received from customers paying within 10 days 2,450,000
Cash received from customers paying beyond 10 days
but within 15 days 1,485,000
Cash received from customers paying beyond 15 days 495,000
Recoveries from accounts written-off (not yet included
from the cash receipts above) 19,000
Accounts receivable, beg. 650,000
Required: Determine the ending balance of accounts receivable.
95
The
5. On June 10, 2023, TOLEDO Company sold, on credit, goods with list price of
P800,000. The credit terms were 2/10, n/45.
Required: Under each of the following independent scenarios, determine the journal
entries under the net method and gross method:
a. The customer paid on June 5, 2023
b. The customer paid on June 23, 2023

1. PAMPLONA Company reported the following amounts:
Sales discounts 35,000
Sales returns from cash/paid sales 45,000
Allowance for sales discount 5,000
Allowance for bad debts 24,000
Allowance for freight 18,000
The net carrying amount of the accounts receivable to be presented in the balance
sheet as of the end of the year shall be
a. P673,000 c. P604,000
b. P634,000 d. P557,000
2. As of December 31, 2023, SANTANDER Company showed the following aging of its
accounts receivable:
Age Amount
0-5 days P2,600,000
6-10 days 1,700,000
11-15 days 1,500,000
15-30 days 700,000
31-60 days 500,000
61-90 days 200,000
More than 90 days 100,000
Total P7,300,000
The Company has credit terms of 3/15, n/60. Based on the Company's experience
from prior years, 75% of eligible outstanding accounts as of year-end pay within the
discount period. How much should be the allowance for sales discount?
a. P33,750 c. P130,500
b. P96,750 d. P164,250
96
The
CamScanner
3, SEVILLE Company reported an ending balance of P1,526,000 for its accounts

receivable. Total cash received from customers, including cash sales, is P4,500,000.
Total credit sales amounted to P4,000,000 which represented 80% of the total gross
sales. The beginning balance of accounts receivable shall be
a. P1,526,000 c. P1,026,000
b. P2,026,000 d. P1,426,000
4, LAS PALMAS Company reported the following information:
Accounts receivable, ending P646,000

Cash sales 700,000
Sales on account 2,490,000
Notes received as payment of accounts 110,000
Refunds made to cash/paid customers 16,000
Recoveries from accounts written-off 9,000
How much is the beginning balance of accounts receivable?

a. P476,000 c. P452,000
b. P468,000 d. P460,000
5. BILBAO Company had a P375,000 beginning balance of accounts receivable. Total

sales amounted to P2,600,000 of which 20% is made on cash. Accounts of
P1,950,000 were collected, 40% of which was subjected to a cash discount of 3%.
How much should be the ending balance of accounts receivable?
a. P1,025,000 c. P485,000
b. P505,000 d. P425,000
6. CATALONIA Company reported following subsidiary ledger of its accounts

receivable:
Customer Balance
MIGUEL Company P500,000
LUCIA Company (25,000)
MATIAS Company (50,000)
LILIANA Company 200,000
ISABEL Company 450,000
Net total balance P1,075,000
The accounts receivable shall be presented at

a. P1,225,000 c. P1,150,000
b. P1,175,000 d, P1,075,000
97
The
The Book
Chapter 4A — Accounting for Bad Debts
CHAPTER 4A
ACCOUNTING FOR BAD DEBTS

1. The source of an entity’s bad debts
2. The direct write-off and allowance methods of accounting for bad debts
3. The different types of estimating allowance for bad debts and bad debts
expense.
BAD DEBTS - INTRODUCTION

To increase revenues, entities usually render services or sell goods ona credit basis,
wherein the customers may pay at a later date after the date of purchase. When
granting credit to customers, entities evaluate their credit-worthiness by
considering the customer's _ capacity, capital, collateral, conditions and character
(i.e., the “SCs” of credit).
However, as rigorous as the credit evaluation process may be, not all processes are
perfect. Some of the customers will still be unable to pay their accounts due to
unforeseen circumstances. The corresponding receivables from these nonpaying
customersare called “bad debts” or “uncollectible accounts”. The accounting and
measurement of these bad debt amounts are the main focus of this chapter.
METHODS OF ACCOUNTING FOR BAD DEBTS

Bad debts can be accounted for using either the direct write-off method or the
allowance method:
Direct Write-off Method Allowance Method

Bad debts are recorded only Bad debts are estimated and
General principle when accounts receivables recorded even if there are no
cannot be actually collected actual collectability issues
Timing of bad
debts expense Late recognition Timely recognition
recognition eee
Theoretically more correct since

Easier to apply since no this is based on the
Basis of use estimates for bad debts are requirements of PFRS 9 in
needed to be made applying the “expected loss
model” —w
98
The
CamScanner
a Direct Write-off Method . Allowance Method

ae Bad debts expense XX
Allow. for bad debts XX
Recording of Not applicable (ie, no
estimated bad estimation of bad debts There is a decrease in the net
debts amounts) carrying amount of accounts
receivable and amount of net
income
Bad debts expense xx Allow. for bad debts XX
Accounts receivable xx Accounts receivable XX
Recording of There is a decrease in the net No
effect in the net carrying
actual write-off carrying amount of accounts amount of the accounts
receivable and amount of net receivable and amount of net
income income
Accounts receivable XX Accounts receivable XX
Bad debts expense XX Allow. for bad debts XX
Cash XX Cash XX
Recording of Accounts receivable XX Accounts receivable XX
collection of
previously There is no effect in the gross There is no effect in the gross
written-off and net carrying amount of carrying amount of accounts
accounts accounts receivable receivable and amount of net
(recoveries) income.
There is an increase in the
amount of net income, due to There is a decrease in the net
a credit to bad debts expense carrying amount of accounts
receivable
Illustration 1. As of December 31, 2022, MALVAR Company reported a P3,000,000

balance in its accounts receivable. It is estimated that P40,000 of these will become
uncollectible in the future.
On January 30, 2023, it was confirmed that P30,000 of accounts receivables cannot
be collected and was written-off since the customers filed for bankruptcy and has
no assets remaining. However, on March 31, 2023, one of these customers
miraculously recovered and paid the previously written-off account of P20,000.
Based on this information and using the direct write-off method and allowance
method, the following entries shall be made:
99
The
CamScanner
—,
meas ~<|=- Direct Write-off Method Allowance Method
Recording of ea
. Bad debts expense 40,000
estimated'bad
debts
easing Allow.forbaddebts 40,000
ces te Bad debts expense 30,000 Allow. for bad debts 30,000
on 01/30/23 Accounts receivable 30,000 Accounts receivable 30,000
Accounts receivable 20,000 Accounts receivable 20,000|
Recording of Bad debts expense 20,000 | Allow. for bad debts 20,000
recoveries on
03/31/23 Cash 20,000 Cash 20,000
Accounts receivable 20,000 Accounts receivable 20,000
Since the allowance method is the more correct method, it will be the focus for
the rest of the chapter.
ALLOWANCE FOR BAD DEBTS ACCOUNT

As previously illustrated under the allowance method, this account represents the
estimated portion of receivables that are NOT expected to be collectible
from customers. It has a normal credit balance as itis acontra-asset
account against accounts receivable.
The transactions that affect this account are shown in the following t-account
(credits increase the balance while debits decrease the balance):
Allowance for
Bad Debts
Write-off xX XX Beginning balance
Ending balance (squeeze) XX xX Estimated bad debts expense
XX Recoveries
Totals (should be equal) XX xX
It should be noted that the primary driver of the balance of this account is the
amount of estimated bad debts expense, which will be discussed next.
ESTIMATING BAD DEBTS EXPENSE AND ALLOWANCE FOR BAD DEBTS

There are three methods of estimating the amounts of bad debts expense and the
allowance for bad debts:
100
The
CamScanner
Percentage-of- Accounts Receivable | ==

Sales Method Method Aging Method
Usually, the amount | Ending balance of | Ending balance of
Basi of net credit sales | accounts receivable | accounts receivable
asis ;
(ie
: : :
an income | (ie. a balance sheet | (i.e, a balance sheet
ae statement account) | account) account)
Amount of Basisx estimated | Squeezed bad debts | Squeezed bad debts
bad debts uncollectible expense amount using | expense amount using
expense accounts (in %) the t-account the t-account
euciny Squeezed ending Basis x estimated x (Ag ae pao *
balance of : applicable estimated
balance amount | uncollectible accounts }
allowance for usinethe taceount (in %) uncollectible accounts
bad debts : : (in %))
Asnimenk Directly matches | More focus on the | More focus on the
poe ee bad debts expense | measurement of the | measurement of the
a with the amounts of | net realizable of the | net realizable of the
revenue accounts receivable | accounts receivable
The key in solving problems involving bad debts expense is the proper
understanding of the method to be applied in each scenario. In addition, the
accounts receivable method and the aging method are very similar with each other.
Details of each method are discussed in the succeeding sections.
PERCENTAGE-OF-SALES METHOD
In applying this method, the readers may apply the following two-step procedures:
1. First, compute the amount of estimated bad debts expense using the following
formula:
Bad Debts Expense = Net Credit Sales x Expected Uncollectible Accounts (in %)
Generally, net credit sales is the basis instead of the total sales since there are no
collectability issues that will arise from cash sales.
2. Next, use the computed bad debts expense amount in step 1 to compute for the
ending balance of the allowance for bad debts using the pro-forma t-account
that was previously shown.
Illustration 2. During the year 2023, LAUREL Company reported net sales of
P10,000,000, of which 20% were cash sales. At the beginning of the year, allowance
for bad debts amounted to P150,000. Write-off and recoveries during the same
period amounted to P120,000 and P12,000, respectively. It is expected that 2% of
the net credit sales amount will become uncollectible. As of December 31, 2023,
accounts receivable account balance amounted to P3,500,000. Required: From this
information, determine the amounts of bad debts expense and ending allowance for
bad debts.
101
The
Applying the two-step procedure:

1. Net credit sales is computed as P8,000,000 (P10,000,000x 80%). The amount of
estimated bad debts expense is then computed as:
Bad Debts Expense = P8,000,000 x 2% = P160,000
2.. The ending balance of the allowance for bad debts can now be determined as
follows:
Allowance for
Bad Debts
Write-off | P120,000 | P150,000 | Beginning balance
Ending balance (squeeze) | 202,000 | 160,000 | Estimated bad debts expense
12,000 | Recoveries
Totals (should be equal) | P322,000 | P322,000
This can also be computed as follows:

Beginning allowance for bad debts P150,000
Add: Bad debts expense 160,000
Recoveries 12,000
Less: Write-off (120,000)
Ending allowance for bad debts P202,000
The carrying amount of the accounts receivable as of December 31, 2023 is
Accounts receivable P3,500,000
Less: Allowance for bad debts (202,000)
Accounts receivable, carrying amount P3,298,000
ACCOUNTS RECEIVABLE METHOD

In applying this method, the readers may apply the following two-step procedures:
1. First, compute the ending balance of allowance for bad debts as follows:
Ending Balance of Allowance = Accounts Receivable x Expected Uncollectible
Accounts (in %)
It should be noted that unlike in the percentage-of-sales method, the ending
balance of the allowance for bad debts is the first amount that will be computed
under the accounts receivable method.
In addition, the accounts receivable balance shall be properly adjusted (e.g., credit
balances in customers’ accounts shall not be netted against the debit balances)
before applying the expected percentage.
2. Next, compute the bad debts expense as the “squeeze amount” or the missing
amount in the allowance for bad debts _t-account.
102
The
In other words, the amount of bad debts expense is the amount that, when
considered with the beginning balance of allowance for bad debts, write-offs and
recoveries, will result to the computed ending balance of allowance for bad debts.
period amounted to P120,000 and P12,000, respectively. It is expected that 5% of
the accounts receivable balance will become uncollectible. As of December 31, 2023,
accounts receivable account balance amounted to P3,500,000. Required: From this
information, determine the amounts of bad debts expense and ending allowance for
bad debts.
Applying the two-step procedure:
1. The ending balance of allowance for bad debts shall be computed as:
Ending Balance of Allowance = P3,500,000 x 5% = P1 75,000
2. The bad debts expense is computed as:

Allowance for
Bad Debts
Ending balance | 175,000 | 133,000 | Bad debts expense (squeeze)
12,000 | Recoveries
This can also be determined as follows:

End. allow. for bad debts (adjusted) P175,000
Less: End. allow. for bad debts (unadjusted):
Beg. allow. for bad debts P150,000
Add: Recoveries 12,000
End. allow. for bad debts (unadjusted) (42,000)
Bad debts expense P133,000

103
The
The Book
AGING METHOD
As previously mentioned, this method is very much similar to the accounts
receivable method. The previously mentioned two-step procedures on the accounts
receivable method are still applicable in the aging method.
Their main difference arises from the number of percentages used in calculating the
ending allowance for bad debts. Accounts receivable method uses only one
percentage to apply to the total accounts receivable balance, while aging method
uses more than one percentage.
Under the aging method, the balance of accounts receivable is split based on their
age bracket. Age in this case is how long each receivable has been outstanding. Each
age bracket has a corresponding percentage of expected uncollectible accounts.
period amounted to P120,000 and P12,000, respectively. As of December 31, 2023,
accounts receivable account balance amounted to P3,500,000, which can be aged as
follows:
Age Bracket Amount %Collectible %Uncollectible
Less than 31 days P2,800,000 96% 4%
31 - 60 days 500,000 90% 10%
More than 60 days 200,000 86% 14%
P3,500,000
Required: From this information, determine the amounts of bad debts expense and
ending allowance for bad debts.
Applying the two-step procedures:
1. The ending balance of allowance for bad debts is computed as:
[A] [B] % [A] x [B] Allow.
Age Bracket Amount Uncollectible for Bad Debts
Less than 31days P2,800,000 4% P112,000
31-60 days 500,000 10% 50,000
More than 60 days 200,000 14% 28,000
Totals P3,500,000 P190,000

a. The % collectible and % uncollectible are complements. In other words, the
% uncollectible = 100% less % collectible
b. The older the receivable, the higher the chance that it will not be collected,
as confirmed by increasing % chance of being uncollectible.
104
The
CamScanner
2. The computed ending balance of allowance for bad debts in Step 1 will be used
similarly as in the accounts receivable method to compute for the amount of bad
debts expense:
Allowance for
Bad Debts
12,000 | Recoveries
This can also be determined as follows:

Less: End. allow. for bad debts (unadjusted):
End. allow. for bad debts (unadjusted) (42,000)

DEBIT BALANCE IN THE ALLOWANCE FOR BAD DEBTS

It was mentioned that the allowance for bad debts has a normal credit balance.
However, if there are huge amounts of write-offs, it could have a debit balance. This
debit balance will usually be overturned by the amount of bad debts expense when
arriving at the adjusted amount allowance for bad debts.
If the entity uses either the accounts receivable method or the aging method,
and that there is a debit balance in the unadjusted allowance for bad debts, the
amount of bad debts expense is higher than the required ending balance of
allowance for bad debts.
If the entity uses the percentage-of-sales method, it is possible that the allowance
could still have a debit balance despite recording bad debts expense. In this
case, the entity shall revisit the process of estimating its bad debts and adjust it to
reflect the updated circumstances.
105
The
The Book
Illustration 5. On January 1, 2023, PASCUAL Company reported a beginning

balance of P400,000 in its allowance for bad debts. During the year, accounts of
P450,000 were written-off and P35,000 were recovered. Net credit sales amounted
to P10,000,000, while accounts receivable had P4,200,000 balance as of December
31, 2023. Required: Under each of the following independent scenarios, determine
the amounts of (a) bad debts expense and (b) ending allowance for bad debts:
1, Estimated bad debts is 4% of net credit sales
2. Estimated bad debts is 6% of accounts receivable balance
3. Estimated bad debts is based on the aging of the accounts receivable as follows:
Age Amount %Uncollectible
0 - 30 days P2,500,000 3%
31 - 60 days 1,100,000 8%
61 - 120 days 400,000 20%
More than 120 days 200,000 50%
P4,200,000
Scenario 1 - Percentage-of-Sales Method
The amount of bad debts expense is computed as P400,000 (P10,000,000 x 4%).
Ending balance of allowance for bad debts can be computed as follows:
Allowance for
Bad Debts
Ending balance (squeeze) | 385,000 | 400,000 | Estimated bad debts expense
35,000 | Recoveries —
This ending balance of allowance for bad debts can also be computed as:
Beginning allowance for bad debts P400,000
Ending allowance for bad debts (unadjusted debit bal.) (P15,000)
Add: Bad debts expense 400,000
Ending allowance for bad debts (adjusted) P385,000
Scenario 2 - Accounts Receivable Method
The ending balance for allowance for bad debts is computed as P252,000
(P4,200,000 x 6%). The bad debts expense is computed as:
Allowance for
Bad Debts
Write-off | P450,000 | P400,000.| Beginning balance
35,000 | Recoveries
106
The
The Book
The bad debt expense can also be computed as follows:

Add: End. allow. for bad debts (unadj. debit bal.):
Beg. allow. for bad debts , P400,000
End. allow. for bad debts (unadj. debit bal.) 15,000
It should be noted that the unadjusted balance is added to the adjusted balance
since the allowance account had a debit balance before making the adjustment.
Scenario 3 - Aging Method
The ending balance for allowance for bad debts is computed as follows:
[A] [B] % [A] x [B] Allow.
Age Bracket Amount Uncollectible for Bad Debts
0 - 30 days P2,500,000 3% P75,000
31-60 days 1,100,000 8% 88,000
61-120 days 400,000 20% 80,000
More than 120 days 200,000 50% 100,000
P4,200,000 P343,000
The bad debts expense is computed as follows:

Allowance for
Bad Debts
35,000 | Recoveries
The bad debt expense can also be computed as follows:

Add: End. allow. for bad debts (unadjusted):
End. allow. for bad debts (unadjusted debit bal.) 15,000
CHANGES IN THE ESTIMATE OF BAD DEBTS

Changes in the estimate of the bad debts amount shall be accounted for
prospectively (only the current and future periods are to be affected). Previously
recognized amounts in the prior periods shall not be adjusted for the change in
107
The
The Book
estimate. Instead, the amount of adjustment shall be reflected in the current

period’s bad debt expense amount.
Illustration 6. LOOC Company reported the following amounts for the years 2022
and 2023:
2022 2023
Allowance for bad debts, beginning P60,000 P???
Write-off 40,000 55,000
Recoveries 15,000 18,000
Bad debts expense 22? 22?
Allowance for bad debts, ending 22? 22?
Accounts receivable ending 2,000,000 3,000,000
Over the past few years, the Company estimates that 4% of its accounts receivable
will become uncollectible. However, for the year 2023, the Company relaxed its
credit standards by granting more credit to their customers. As a result, the amount
of expected bad debt expense increased to 6% of its accounts receivable balance.
Year 2022
The ending balance for allowance for bad debts as of December 31, 2022 is computed
as P80,000 (P2,000,000x 4%). The bad debts expense for 2022 is computed as:
Allowance for
Bad Debts
Write-off | P40,000 | P60,000 | Beginning balance, 1/1/22
Ending balance, 12/31/22 80,000 45,000 | Bad debts expense (squeeze)
15,000 | Recoveries
Year 2023
The ending balance for allowance for bad debts as of December 31, 2023 is computed
as P180,000 (P3,000,000 x 6%). The bad debts expense for 2023 is computed as:
Allowance for
Bad Debts
Write-off | P55,000 | P80,000 | Beginning balance, 1/1/23
Ending balance, 12/31/23 | 180,000 | 137,000 | Bad debts expense (squeeze
18,000 | Recoveries
It should be noted that the sudden increase in the bad debt expense for 2023 came
from the overall increase in the estimated bad debts. Previously reported amounts it
2022 shall not be affected.
108
The
ESTIMATING THE PERCENTAGE OF BAD DEBTS

In addition to the general methods of estimating bad debts, entities usually set
specific accounting policies in estimating its bad debts. As a starting point, entities
will usually use the previous amounts reported for accounts written off and recoveries
during prior periods. This historical information is adjusted to reflect the expected
future changes in the circumstances.
Illustration 7. LUBANG Company, an entity that estimates its bad debts by using
the percentage-of-sales method, reported’ the following information related to
past four years:
Year Credit sales Write-offs Recoveries
2019 P8,000,000 - P200,000 P40,000
2020 10,000,000 300,000 60,000
2021 16,000,000 500,000 -
2022 14,000,000 400,000 140,000
Every year, the Company estimates the percentage based on credit sales by relating
the cumulative net write-offs to the cumulative credit sales during the previous
three years. The effects of future expected changes are deemed to be immaterial.
During 2023, the Company has written off accounts amounting to P360,000 and
recoveries amounting to P70,000. Credit sales amounted to P15,000,000.
Allowance for bad debts at the beginning of the year amounted to P930,000.
In this case, the percentage to be multiplied to the credit sales for the year 2023
shall be determined as follows:
Percentage- _ _(P300K+P500K + P400K) - (P60K + P140K)— y
(P10M + P16M + P14M) 2.50%0
of-sales rate ~
The readers should take note that information related to the year 2019 shall not be
considered since it is beyond the three prior-year period (2020, 2021 and 2022)
prior to the year 2023.
Based on this, the amount of bad debts expense for 2023 shall be estimated as
P375,000 (P15,000,000 x 2.50%). The allowance for bad debts balance as of
December 31, 2023 shall be determined as follows:
Allowance for
Bad Debts
Write-off 360,000 930,000 | Beginning balance
Ending balance (squeeze) | 1,015,000 | 375,000 | Estimated bad debts expense
70,000 | Recoveries
Totals (should be equal) | 1,375,000 | 1,375,000
109
The
USING T-ACCOUNT TO DETERMINE MISSING ELEMENTS

Inherent to the mastery of using the t-account of allowance for bad debts is the
ability to use it as a tool in determining one of the inputs (e.g., accounts written-off,
recoveries, etc.) to the balance of allowance for bad debts. The missing input is
actually the “squeeze” amount in the said t-account.
Illustration 8. At the beginning of 2023, CURTAIN Company reported allowance
for bad debts amounting to P600,000. During the year, bad debts expense and
recoveries amounted to P750,000 and P80,000, respectively. On December 31,
2023, the allowance had an adjusted balance of P820,000. Required: From this
information, determine the total amount of accounts written-off during 2023.
The total amount of accounts written-off is determined by using the allowance for
bad debts t-account as follows:
Allowance for
Bad Debts
Write-off (squeeze)
(P1.43M —- P820K) | P610,000 | P600,000 | Beginning balance
Ending balance 820,000 750,000 | Bad debts expense
80,000 | Recoveries
Totals (should be equal) | P1,430,000 | P1,430,000
Illustration 9. At the start and end of 2023, STAGE Company reported the following
information:
January 1,2023 December 31,2023
Accounts receivable, gross P4,500,000 P5,700,000
Accounts receivable, net 3,700,000 5,000,000
During 2023, the Company recognized bad debts expense of P550,000 and accounts
written-off amounted to P740,000. Required: From this information, determine the
total amount of recoveries during 2023.
The total amount of recoveries is determined by using the allowance for bad debts
t-account as follows:
Allowance for
Bad Debts
Beginning balance
Write-off | P740,000 | P800,000
(P4.5M - P3.7M)
Ending balance
(P5.7M - P5M) 700,000 550,000 | Bad debts expense
Recoveries (squeeze)
90,000 | (p1.44M - P800K ~ P5SOK)
Totals (should be equal) | P1,440,000 | :P1,440,000
110
The
CHAPTER SUMMARY
1; When using the direct write-off method of accounting for bad debts, no allowance
is maintained and bad debts expense is recognized only during the actual write-off of
receivables, .
Direct write-off method results to late recognition of bad debts and not in line with
generally accepted accounting principles.
When using the allowance method of accounting for bad debts, estimated
uncollectible accounts are maintained in an allowance account and at the same, bad
debts expense is recognized, even if there are no actual write-offs.
Allowance method results to timely recognition of bad debts and in line with the
impairment provisions under PFRS 9.
The following transactions affect the allowance for bad debts account:
Allowance for
Bad Debts
Write-off XX XX Beginning balance
Ending balance XX XX Estimated bad debts expense
Xx Recoveries
Transactions on the credit side increase the allowance while transactions on the
debit side decrease the allowance.
Depending on the method, either the ending balance or the estimated bad debts
expense is the “squeeze” amount.
There are three ways of estimating the bad debts expense and the allowance for bad
debts, namely the percentage-of-sales method, accounts receivable method and
aging method.
Under percentage-of-sales method, bad debts expense is usually equal to Credit
Sales x Relevant %. The ending balance of allowance is determined as the squeeze
amount using the t-account.
Under the accounts receivable method, the allowance for bad debts is equal to
Balance of Accounts Receivable x Relevant %. The bad debts expense is determined
as the squeeze amount using the t-account.
Under the aging method, the allowance for bad debts is equal to }}\(Balance of
Accounts Receivable per Age Bracket x Relevant %), The bad debts expense is
determined as the squeeze amount using the t-account.
10. Any debit balance to the unadjusted allowance for bad debts will make the bad debts
expense higher under accounts receivable and aging methods.
11.Changes in the estimate of the allowance for bad debts shall be accounted for
prospectively and the amounts previously reported in the prior periods shall not be
revised.
12. The t-account of the allowance for bad debts can be used to determine the missing
amounts of transactions related to bad debts.
111
The
CamScanner
CHAPTER 4A: SELF-TEST EXERCISES —
True or False
1. Direct write-off method of accounting for bad debts recognizes bad debts expense
only when there is an actual write-off of _ receivables.
2. Under direct write-off method, the net realizable value of the accounts receivable
will decrease after the actual write-off.
3. Under allowance method, the net realizable value of the accounts receivable will
decrease after recognizing a write-off.
4. Under allowance method, the estimation of the bad debts expense will decrease the
net realizable value of accounts receivable.
5. Allowance for bad debts is debited when writing off the receivable under direct
write-off method.
6. The allowance for bad debts has a normal debit balance.
7. In determining the net realizable value of accounts receivable, the bad debts
expense shall be deducted from the gross accounts receivable.
8. When using the allowance method, the entries to recognize the recovery of
accounts receivable will have no effect in the gross accounts receivable balance.
9. The required ending allowance under percentage-of-sales method is determined as
credit sales multiplied by the relevant percentage.
10. The bad debts expense under accounts receivable method is determined as the
ending balance of accounts receivable multiplied by relevant percentage. .
11. The recovery of accounts previously written off will increase the balance of
allowance for bad debts.
12. When an account is written-off, the balance in the allowance for bad debts will
decrease.
13. Under the aging method, the bad debts expense is equal to the difference between
the required allowance for bad debts and the unadjusted balance in the allowance
account.
14. Changes in the estimate of bad debts shall be accounted retrospectively.
15. As the age of an accounts receivable increases, the probability that it can be
collected also increases.
1. The amount of unadjusted allowance for bad debts is not used in determining the
amount of bad debts expense in which of the following methods?
a. Percentage-of-sales method
b. Accounts receivable method
c. Aging method
d. None of the above
2. When using the direct write-off method of recording bad debts
a. Bad debts expense amounts are recognized every year.
b. Accounts receivable balance is decreased when there is an actual write-off.
c. Estimate of bad debts is made at the end of each year.
d. Allowance for bad debts account is debited when there is an actual write-off.
112
The
CamScanner
3. An entity that is using allowance method has written off one of its overdue
receivables. In this case, the debit on the entry shall be to
Bad debts expense
ao op
Allowance for bad debts

Accounts receivable
Cash
4, Ifapreviously written off account has been recovered, the following are true, except
a. Under the allowance method, the profit or loss during the period the recovery
has occurred shall not be affected.
b. Under the direct write-off method, the profit or loss during the period the
recovery has occurred shall decrease.
c. Under the allowance method, the allowance for bad debts shall increase.
d. Under the direct write-off method, the net realizable value of the accounts
receivable shall not be affected.
5. When using the percentage-of-sales method

a. The matching of expenses withrevenuesis emphasized
b. The net realizable value of the accounts receivable is emphasized
c. The relationship between statement of financial position accounts is
emphasized.
d. Expense is recognized when the account is actually written off.
6. Anentity uses accounts receivable method in estimating its bad debts. In this case,
a. The matching of expenses with revenuesis emphasized
b. The net realizable value of the accounts receivable is emphasized
c. Therelationship between income statement accounts is emphasized.
d. Expense is recognized when the account is actually written off.
7. Under the aging method of estimating bad debts, all of the following are applicable,
except
a. The amount of bad debts expense is determined as the difference between the
unadjusted balance in the allowance and required allowance for bad debts.
b. The required allowance for bad debts is determined using multiple percentages.
c. Bothaandb.
d. Neitheranorb.
8. Which of the following methods best matches the expenses with the related
revenues?
a. Percentage-of-sales method
b. Accounts receivable method
c. Aging method
d. All of the above equally
113
The
9. Given the following statements, which of the following is/are correct?

I. Under the aging method, the probability that an amount will not be collected
will increase as the age of the receivables increases.
Il. |The estimation of bad debt expense under the aging method is similar to the
procedures under the accounts receivable method.
a. lonly c. Both
I and Il
b. Ilonly d Neither
I nor II
10. If there is a debit balance in the unadjusted balance of allowance for bad debts,
I. |The amount of bad debts expense is higher than the required allowatice for bad
debts under aging method.
Il. It is not considered in determining the bad debts expense under the
percentage-of-sales method.

Straight Problems
1. At the beginning of the current year, ROSE Company reported accounts receivable
amounting to P5,000,000. No allowance for bad debts is maintained since the
Company is using the direct write-off method of recording bad debts. During the
year, the Company has written off P60,000 accounts and recovered P20,000
accounts that were previously written off.
Required: Determine the journal entries to record these transactions.
2. On January 1, 2023, DAHLIA Company reported a beginning allowance for bad debts
amounting to P760,000. On July 31, 2023, P240,000 accounts were written off while
on October 1, 2023, P80,000 previously written off accounts were recovered. Based
on the December 31, 2023 adjustment, bad debts expense for the year shall be
P360,000.
Based on these data:

a. Determine the journal entries for 2023.
b. Determine the ending balance in the allowance for bad debts
3. During 2023, GERBERA Company had the following transactions involving its
accounts receivable and allowance for bad debts;
a. Accounts amounting to P420,000 were written-off.
b. P140,000 recoveries of accounts previously written-off.
c. Credit sales amounted to P10,000,000,
Allowance for bad debts at the beginning of the year amounted to P540,000. On the
other hand, ending balance of accounts receivable amounted to P6,000,000,
114
The
The Book
Required: Under each of the following independent methods, determine the

amounts of (a) ending allowance for bad debts; (b) bad debts expense; (c) and net
realizable value of accounts receivable:
1. Percentage-of-sales method using 2% of credit sales,
2. Accounts receivable method using 5% of accounts receivable balance.
3. Aging method using the following breakdown of accounts receivable balance:
Age Bracket Amounts % Uncollectible
less than 1 month P4,000,000 2%
1 month to 3 months 1,400,000 4%
more than 3 months 600,000 30%
P6,000,000
4. At the end of the current year and before making entry on the bad debts expense,
TULIPS Company reported a P20,000 debit balance in its allowance for bad debts.
For the current year, the Company reported net credit sales of P5,000,000, while
ending receivables amounted to P2,500,000, which can be aged as follows:
Age Balance
Less than one month P1,750,000
More than one month but less than a year 500,000
More than a year 250,000
P2,500,000
Required: Under each of the following scenarios, compute for the (a) bad debts
expense; and (b) the allowance for bad debts after the adjustment:
1. Bad debts expense is estimated at 3.50% of credit sales
2. Allowance for bad debts is 5% of accounts receivable balance.
3. Allowance for bad debts is based on the estimated percentage per age bracket
as follows:
Probability of
Age Collection
Less than one month 98%
More than one month but less than a year - 90%
More than a year 80%
5. LILY Company reported the following data for the last four years related to the net
realizable value of its accounts receivable:
Accounts Allowancefor Bad Debts

Year Receivable Bad Debts Expense Write-Off Recoveries
2019 4,000,000 P200,000
2020 3,500,000 (a) (b) P87,500 P2,500
2021 3,750,000 (c) 112,500 100,000 (d)
2022 3,000,000 (e) 68,750 (f) 18,750
2023 ~— 2,500,000 (g) 45,000 (h) 0
115
The
The Book
The Company consistently estimates allowance for bad debts as 5% of accounts

receivable balance.
Required: Determine the missing amounts as represented by each letter.
6. For the years 2018 to 2022, ORCHID Company reported the following information;
Year Creditsales Write-offs Recoveries

2018 P9,000,000 P330,000 P140,000
2019 9,500,000 450,000 200,000
2020 8,500,000 602,500 -
2021 12,000,000 400,000 100,000
2022 11,500,000 300,000 ~
The Company estimates the bad debts expense using the percentage-of-sales
method. The percentage to be applied to the amount of credit sales is determined by
using the cumulative amounts of credit sales, accounts written off, and recoveries
for the previous three years plus the current year (i.e., total of four-year data). Effects
of the changes in the expected circumstances in the future are deemed to be
immaterial.
At the beginning of 2022, the Company reported allowance for bad debts amounting
to P800,000. In addition, during 2023, accounts written offand recoveries amounted
to P657,500 and P80,000, respectively during 2023. During the same period, credit
sales amounted to P12,500,000.
From this information, determine the following items:

a. Percentage to be applied to credit sales in 2022 to arrive at the amount of bad
debts expense for that year.
b. Estimated bad debts expense for 2022.
c. Allowance for bad debts expense as of December 31, 2022.
d. Percentage to be applied to credit sales in 2023 to arrive at the amount of bad
debts expense for that year.
e. Estimated bad debts expense for 2023.
f. Allowance for bad debts expense as of December 31, 2023.

1. For the year 2023, CARNATION Company reported total sales of P8,000,000, 30% of
which are cash sales. Beginning allowance for bad debts amounted to P80,000 while
ending receivables balance amounted to P430,000. On the other hand, P45,000
account was written-off while recoveries amounted to P16,000. The Company
estimates that 1.5% of credit sales may become worthless,
Based on these data, the bad debts expense for the year 2023 shall be
a. P36,000 c. P84,000
b. P45,000 d, P120,000
116
The
The Book
The balance of allowance for bad debts at the end of 2023 shall be
a. P87,000 c. P135,000
b. P96,000 d, P201,000
2. Atthe beginning of 2023, IRIS Company reported accounts receivable and allowance
for bad debts amounting to P2,700,000 and P148,000. __—respectively. During the
year, cash sales amounted to P2,400,000, which represented 25% of total sales.
Accounts written-off and recoveries from accounts previously written-off amounted
to P126,000 and P18,000 __ respectively. Credit memos and cash refunds given to
customers amounted to P200,000 and P80,000 _ respectively. Ending receivables
amounted to P2,000,000. The Company estimates that 1.5% of net credit sales will
become worthless.
Based on these data, the bad debts expense for the year 2023 shall be
a. P103,800 c. P108,000
b. P105,000 d. P139,800
The balance of allowance for bad debts at the end of 2023 shall be
a. P143,800 c. P148,000
b. P145,000 d. P179,800
3. DAISY Company reported the following amounts for the year 2023:

Allowance for bad debts, 1/1 13,000
Sales returns from cash/paid credit sales _ 35,000
Sales returns from unpaid credit sales 60,000
Recoveries of accounts written-off 10,000
The Company estimates that 5% of its accounts receivable balance will become
worthless. The gross amount of accounts receivable at the end of 2023 shall be
a. P245,000 c. P280,000
b. P250,000 d. P340,000
The required allowance for bad debts at the end of 2023 shall be
a. P12,250 c. P14,000
b, P12,500 d. P17,000
i
Estimated bad debts expense for the year 2023 shall be

a. P29,250 c. P31,000
b. P29,500 d. P34,000
117
The
The Book
4. For the current year, LAVENDER Company reported the following amounts:

Allowance for bad debts, 1/1 41,600
Accounts receivable, 12/31 475,000
The Company estimates the bad debts using the same percentage of allowance
relative to accounts receivable balance at the beginning of the year.
Determine the required allowance for bad debts as of year end
a. P22,100 c. P42,000
b. P34,000 d. P38,000
The bad debts expense for the year shall be

a. P24,700 c. P19,900
b. P11,900 d. P15,900
5. During the current year, PRIMROSE Company reported the following balances:
Allowance for bad debts, 1/1 P210,000

Aging of the ending balance of accounts receivable is as follows:
Collectability
Aging Balance Rate
0-15 days - P1,400,000 98%
16-30 days 550,000 90%
31-45 days 350,000 85%
46-60 days 300,000 80%
61-75 days 100,000 55%
More than 75 days 75,000 40%
P2,775,000
Using the aging method, determine the required allowance for bad debts as of year
end
a. P285,500 c. P330,500
b. P312,500 d. P347,500
Using the aging method, the bad debts expense for the year shall be
a. P150,500 c. P195,500
b. P177,500 d, P212,500
118
The
6. At the beginning of 2023, SPRUCE Company reported allowance for bad debts
amounting to P715,000. During the year, credit sales amounted to P32,000,000,
accounts written-off amounted to P495,000, and recoveries from accounts
previously written-off amounted to P82,500. Aging of ending accounts receivable of
P12,650,000 is as follows:
Estimated
Period Sold Balance Bad Debts
less than 3 months P5,940,000 2%
3 months to 6 months 3,575,000 10%
more than 12 months 825,000 80%
P12,650,000
Based on December 31, 2023 assessment of receivables under “more than 12
months” classification, additional receivables of P415,000 are to be written-off as of
that date.
Using the aging method, determine the required allowance for bad debts as of year
end
a. P1,436,800 c. P1,512,800.
b. P1,768,800 d. P1,638,800
Using the aging method, the bad debts expense for the year shall be
a. P909,300 c. P1,324,300
b. P1,134,300 d. P1,549,300
MONTANA Company uses a combination of estimation methods in computing for its

bad debts expense. For quarterly reporting purposes, the Company recognizes bad
debts expense equal to 2.50% of credit sales in the relevant quarter. Amounts of
credit sales, write-offs, and recoveries per quarter are the following:
1stQuarter 2"4¢Quarter 3'¢Quarter 4‘ Quarter
Net credit sales P2,100,000 2,620,000 P1,750,000 P3,325,000
Accounts receivable 4,500,000 4,300,000 3,800,000 5,600,000
Write-offs 70,000 44,000 63,000 80,000
Recoveries 8,000 - 18,000 -
Beginning balance of allowance of bad debts amounted to P175,000. The Company's

final estimate of the allowance for bad debts is equal to 4.50% of the accounts
receivable balance.
The preliminary amount of bad debts expense for first three quarters of the year
shall amount to
a. P156,750 c. P161,750
b. P166,000 d. P210,750
119
The
The unadjusted allowance for bad debts as of the end of third quarter shall be
a. P234,750 c. P180,750
‘-b. P190,000 d. P185,750
The net amount of bad debts expense for the fourth quarter shall amount to
a. P146,250 c. P142,000
b. P97,250 d. P151,250
The required ending balance in the allowance for bad debts as of December 31, 2023
shall be
a. P252,000 c. P332,000
b. P209,775 d. P120,750
8. NALDO Company reported accounts receivable balances amounting to P2,500,000

and P3,200,000 as of January 1, 2023 and December 31, 2023 respectively,
Consistently, the Company estimates its allowance for bad debts as 6% of its
accounts receivable balance. During the year, accounts of P210,000 were written off
while P25,000 previously written off accounts were recovered.
Based on this information, the required ending balance of allowance for bad debts
shall be
a. P212,000 c. P182,000
b. P192,000 d. P232,000
Based on this information, the bad debts expense for the year shall be
a. P247,000 c. P157,000
b. P227,000 d. P187,000
9. The following accounts were extracted from COLORADO Company’s unadjusted trial
balance at December 31, 2023:
Debit Credit
Net credit sales P18,500,000
The Company estimates that 3.50% of the gross accounts receivable will become
uncollectible. Bad debts expense for 2023 shall be
a. P245,750 c. P141,750
b. P647,550 d. P225,750
120
The
The Book
10. WILHELM Company reported the following information for the years 2022 to 2023:
2022 2023
Credit sales P12,500,000 P14,000,000
Cash sales 1,500,000 1,800,000
Receipts from credit sales excluding recoveries 12,200,000 14,300,000
Accounts written-off 160,000 450,000
Recoveries 40,000 10,000
Allowance for bad debts and accounts receivable at the beginning of 2022 amounted
to P460,000 and P7,600,000 __ respectively. Consistently, the Company estimates
its bad debts expense by applying 2% to the amount of credit sales.
However, starting 2023, the Company estimated its allowance for bad debts equal to
5% of ending accounts receivable balance.
Bad debts expense for 2022 shall amount to

a. P87,000 c. P250,000
b. P47,000 d. P350,000
Allowance for bad debts expense as of December 31, 2022 shall amount to
a. P590,000 c. P387,000
b. P385,000 d. P580,000
Bad debts expense for 2023 shall amount to

a. P280,000 c. P199,500
b. P202,500 d. P296,000
Allowance for bad debts expense as of December 31, 2023 shall amount to
a. P349,500 c. P412,500
b. P430,000 d. P360,000
121
The
The Book
Chapter 5 — Notes Receivable — Interest-Bearing
CHAPTER 5
NOTES RECEIVABLE - INTEREST-BEARING

1. The structure of and parties in the promissory note.
2. The different types of promissory notes for accounting purposes (e.g., interest-
bearing, noninterest-bearing). :
The different types of interest-bearing promissory notes
ee 8
The initial and subsequent accounting for interest-bearing promissory notes.

BST
The computation of interest income and accrued interest receivable.

The reporting of interest-bearing promissory notes receivable and accrued
interest receivable as current or noncurrent
PROMISSORY NOTES - INTRODUCTION

In the previous chapter, accounts receivables represent a claim from customers for
goods or services provided to them based on the mutual understanding of the
general credit terms granted by the entity (e.g., 2/10, n/30). However, there are
circumstances wherein formal understanding about specific terms and conditions
is needed. This is when the promissory note will enter the scene.
Promissory notes can be used in the following non-exhaustive list of circumstances:
1. For accounts receivable still not paid by the customer even after the end of the
credit period (i.e., overdue).
2. Selling of the entity’s other assets on credit. These other assets include, but not
limited to, entity’s land, building, equipment, machinery, etc.
3. Lending of funds to other entities or persons.
PARTIES IN A PROMISSORY NOTE
The following are the parties in a promissory note:
a. Maker - the one who makes and signs the promissory note. This is the party
who obligates itself to pay cash to the payee on maturity date.
b. Payee - the beneficiary of the promissory note. This is the party who will receive
the cash from the maker on maturity date. As a result, the payee recognizes a
notes receivable. For the rest of the chapter, the concepts are to be discussed in
the point-of-view of the payee.
Initially, the relationship between maker and payee can be represented as:
provides cash/goods/services
i
Maker > Payee
gives promissory note
122
The
CamScanner
On maturity date, the relationship between the maker and payee will change as
follows:
releases maker from the obligation

¢
Maker >| Payee
pays cash
The students may have encountered promissory notes when paying their tuition
fees beyond the initially set deadline of their respective schools. In this case, a
student is considered as the maker while the school is considered the payee.
DIFFERENT TYPES OF PROMISSORY NOTES

For accounting purposes, promissory notes can be classified as follows:
Notes receivable
v v
Interest-bearing Noninterest-bearing
ptr
Stated rate is Stated rate is not
substantially equal substantially equal
to market rate to market rate
INITIAL RECOGNITION OF NOTES RECEIVABLE

Initially, notes receivable shall be measured at their fair values. The amount of fair
value will depend on the cash flows that can be received from the promissory note:
Is the note interest-bearing?
Yes
Stated Rate = Market Rate? :;
Yes v
Fair value = present value of cash
Fair value is equal to note’s face flows using market rate as of
amount initial recognition
123
The
Stated rate means the amount of interest that the maker shall pay in addition to
the face amount of the promissory note. Market rate is the general prevailing rate
of return that the investors expect from the investments with similar characteristics
as the promissory note, regardless of whether the note is interest-bearing or not.
Nevertheless, if the term of the note receivable is less than twelve (12) months, it
can be initially measured equal to its face amount, whether it is interest-bearing
or not. The reason is that the effect of present value computations is usually
immaterial. These provisions are in line with PFRS 9, Financial Instruments.
If an entity sells land, building and other assets and receives notes receivable in
return. The amount of gain or loss on sale can be determined as follows:
Comparison Gain or Loss? _.
IM of NR plus cash received, if any > carrying amount Gain on sale
IM of NR plus cash received, if any < carrying amount Loss on sale
IM of NR plus cash received, if any = carrying amount No gain or loss on sale
Note: IM is initial measurement, while NR is notes receivable.
SUBSEQUENT ACCOUNTING FOR PROMISSORY NOTES

Since the initial recognition is different depending on whether the notes receivable
is interest-bearing or mnoninterest-bearing, subsequent accounting will,
consequently, be different depending on the note receivable:
Interest-Bearing | Interest-Bearing See
Stated Rate = Stated Rate + Noninterest-
Market Rate MarketRate | Bearing
Based on stated Based on market rate on initial
Interest income rate applied to recognition applied to beginning-of-
face amount the-period carrying amount
Carrying amount Based on face The present value amounts appearing
each reporting date amount in the amortization able
Recognition of :
seemed interest Based on stated rate Novapplicable
osasluable (no stated rate)
Details on the initial recognition and subsequent ‘accounting procedures for

interest-bearing notes receivable (stated rate = market rate) will be discussed in
the succeeding sections. Notes receivables with present value calculations will be
discussed in the next chapter.
ACCOUNTING FOR INTEREST-BEARING NOTES (STATED RATE = MARKET RATE)

As previously discussed, interest-bearing notes receivable which bears stated rate
that is substantially equal to the market rate shall be initially measured equal to their
face amount. In the absence of additional information about market rates, the
stated rate is presumed to be equal to market rates.
124
The
CamScanner
When subsequently accounting for this kind of note receivable, it is crucial to

distinguish it to term notes and serial (installment) notes:
ss Term Notes: |. Serial (Installment) Notes
The whole face amount (or | Portions of the face amount (or
Description principal) is payable only on | principal) are payable
maturity date periodically
Carrying amount Equal to remaining unpaid face
as of each Equal to original face amount | amount (i.e., decreasing every
reporting date reporting date)
Stated rate applied to beginning-of-the-period face amount.
In addition, interest income is pro-rated depending on the
length of period the note is outstanding during the period:
: Interest Income = Face Amount x Stated Rate x Time
Interest income
(earned through Time is stated as a portion of one year that the note is
passage of time) outstanding, based on either of the following:
a. Time divided by 12 months if the term of the note is stated
in number of months or years; or
b. Time divided by 360 days if the note’s term is stated in
number of days.
Illustration 1.- Term Notes. On January 1, 2023, SAN FRANCISCO Company
received a promissory note with face amount of P1,000,000 from one of its
customers who is unable to pay its P1,000,000 account within the credit period. The
note bears 10% interest and matures on December 31, 2024 (i.e., two-year term).
Interest is payable every December 31 of each year. Required: Determine the
journal entries to be made in 2023 and 2024 related to this promissory note.
The entry to record the receipt of promissory note on January 1, 2023 is as follows:
Notes receivable 1,000,000
To record the receipt of interest on December 31, 2023:

Cash (P1,000,000 x 10% x 12/12) 100,000
To record the receipt of interest and principal on December 31, 2024:

Cash (P1,000,000 x 110%) 1,100,000
The readers should take note that for term note, its carrying amount is the same all
throughout its term (P1,000,000 for this particular illustration).
125
The
The Book
Illustration 2 - Serial (Installment) Notes, At the beginning of 2023, SAy

ANDRES Company sold its land with carrying amount of P3,600,000 by receivinga
-note receivable with face amount of P4,500,000. This note is payable in installments
of P1,500,000 every December 31, starting in 2023. Interest of 12% is also payable
at the same time as the principal installment amounts. Required: Determine the
journal entries to be made in 2023 and 2024 related to this promissory note.
The entry to record the sale of land and receipt of promissory note on January 1,
2023 is as follows:
Land 3,600,000
Gain on sale of land 900,000
Interest income per year is computed as follows:
Beg. Face End. Face Interest Inc.

Year Amount Amount’ fortheYear Remarks
2023 P4,500,000 P3,000,000 P540,000 (P4,500,000x 12% x 12/12)
2024 3,000,000 1,500,000 360,000 (P3,000,000x 12% x 12/12)
2025 1,500,000 - 180,000 (P1,500,000x 12% x12/12)

a. The basis ofinterest income is the face amount (or principal) at the beginning
of each period and not as of the end of each period.
The reason for this is that during the whole duration of each period, the
outstanding face amount is equal to its beginning balance and was just reduced
by the principal installment payment at the end of each period.
b. Due to the annual decrease in the face amount of the note receivable, the related
interest income per year is also decreasing.
c. The carrying amount of the note receivable at the end of each year is equal to the
ending face amounts in the above table (i.e., decreasing carrying amount).
Cash (P1,500,000 + P540,000) 2,040,000

Cash (P1,500,000 + P360,000) 1,860,000
126
The
The Book
Cash (P1,500,000 + P180,000) 1,680,000

COMPUTING ACCRUED INTEREST ON INTEREST-BEARING NOTES RECEIVABLE

Inthe previous illustrations, the amount of interest for each year has been fully paid
every December 31 of each year. As a result, no accrued interest receivable is
recorded. However, most of the time, interest payments are not made every
December 31 and computation of accrued interest receivable is necessary.
In computing the accrued interest receivable, the following formula is relevant:

Face amount x stated rate x (period from immediately
Accrued ae _ __ preceding interest payment date up to reporting date)
Receivable 12 months or 360 days
It should be noted that the “immediately preceding interest payment date (IPD)”
can also mean the issue date of notes receivable in the first year of its issuance. In
addition, the above formula applies to all interest-bearing notes, whether the
stated rate is substantially equal to market rate or not. There is no accrued interest
receivable arising from noninterest-beari receivable.
Illustration 3 - Term Notes. On April 1, 2023, MAUBAN Company received a five-
year promissory note with face amount of P2,000,000 for the amounts lent to
another entity. The note bears interest of 11%. Required: Under each of the
following independent scenarios, determine the amount of accrued interest
receivable as of December 31, 2024:
1. Interest is payable every March 31, starting in 2024.
2. Interest is payable every March 31 and September 30, starting on September 30,
2023.
Scenario 1
As of December 31, 2024, the immediately preceding IPD is March 31, 2024. From
March 31, 2024 to December 31, 2024, there are nine months to be used in the
computation of accrued interest receivable as follows:
Accrued interest = P2,000,000 x 11% x 9 months - P165,000

receivable 12 months
Actually, the Company will report accrued interest receivable of P165,000 every
December 31 of each year covered by the note receivable. The entry to record the
accrual of interest on December 31, 2024 is as follows:
On March 31, 2025, the entry to record the receipt of interest is as follows:
127
The
Cash (P2,000,000x 11%) 220,000

Interest income (P2M x 11% x 3/12) 55,000
‘The three (3) months used in the computation of interest income is from January 1,
2025 to March 31, 2025.
Scenario 2
As of December 31, 2024, the immediately preceding IPD is September 30, 2024.
From September 30, 2024 to December 31, 2024, there are three months to be
used in the computation of accrued interest receivable as follows:
Accruedinterest _ _ P2,000,000 x 11% x 3 months
receivable 12 months P55,000
Similar to Scenario 1, every December 31 of each year covered by the note

receivable, the Company will report accrued interest receivable of P55,000. The
entry to record the accrual of interest on December 31, 2024 is as follows:
On March 31, 2025, the entry to record the receipt of interest is as follows:
Cash (P2,000,000x 11% x 6/12) 110,000
Similar to Scenario 1, the three (3) months used in the computation of interest
income is from January 1, 2025 to March 31, 2025. However, the amount of interest
received is good for six (6) months only since the interest covers the period from
September 30, 2024 (i.e, the immediately preceding IPD) to March 31, 2025.
Illustration 4 - Serial (Installment) Notes. On June 1, 2023, CANDELARIA

Company received a P4,000,000 note from one of its customers as a payment for an
overdue accounts receivable. The face amount (or principal) is payable in four
installments of P1,000,000 per year starting on May 31, 2024. Interest indicated in
the note was 12%. Required: Determine the amount of accrued interest receivable
every December 31 of each year.
The computations are the following:
Face No.of Months Accrued Int.
Amount (May 31 - Receivable
Year (May 31) Dec. 31) (Dec31) Remarks
2023 P4,000,000 7 P280,000 (P4,000,000 x 12% x 7/12)
2024 3,000,000 7 210,000 (P3,000,000 x 12% x 7/12)
2025 2,000,000 7 140,000 (P2,000,000x 12% x 7/12)
2026 ~— 1,000,000 i 70,000 (P1,000,000x 12% x 7/12)
128
The
The Book
\t should be noted that every December 31 of each year, the immediately preceding
interest payment is every May 31 of that year. So, May 31 to December 31 of each
year has a span of seven (7) months,
The amount of interest income per year is computed as follows:
Calendar Years
Interest income 2023 2024 2025 2026 2027
6/1/23 - 5/31/24: P480K (P4Mx 12%)
6/1/23 - 12/31/23 (P480Kx 7/12) P280,000
1/1/24- 5/31/24 (P480Kx 5/12) P200,000
6/1/24 - 5/31/25: P360K (P3Mx 12%)
6/1/24- 12/31/24 (P360Kx 7/12) 210,000
1/1/25 - 5/31/25 (P360Kx 5/12) P150,000
6/1/25 - 5/31/26: P240K (P2Mx 12%)
6/1/25 - 12/31/25 (P240Kx 7/12) 140,000
1/1/26 - 5/31/26 (P240Kx 5/12) P100,000
6/1/26 - 5/31/27: P120K (P1M x 12%)
6/1/26- 12/31/26 (P120Kx 7/12) 70,000
1/1/27- 5/31/27 (P120Kx 5/12) P50,000
Total interest income per year P280,000 410,000 P290,000 P170,000 P50,000
REPORTING OF INTEREST-BEARING NOTE RECEIVABLE

The carrying amount of a note receivable as of each reporting period shall be
presented as either current or noncurrent, or partly current and partly noncurrent.
For notes receivable arising from the usual sale of goods or provision of services, they
are normally considered as current.
For all other notes receivable, an entity shall know the timing of the cash receipts
relative to the reporting date. By knowing this information, the following rules are
relevant:
a. Current portion - for amounts (including accrued interest, if there is any) that
will be received within twelve (12) months from the reporting date.
b. Noncurrent portion - for amounts that will be received beyond twelve (12)
months from the reporting date.
These general rules can be applied specifically to different types of notes receivable
as of each reporting date:
! Term Notes — | Serial (Installment) Notes
Usually the accrued interest | Usually the accrued interest
receivable, plus the whole face | receivable, plus the portion of
Current
amount of the note if reporting | face amount that will be received
Portion
date to maturity date is 12 months | within 12 months from
or less reporting date
The whole face amount of the note | The portion of the face amount
Noncurrent
Portion
if reporting date to maturity date is | that will be received beyond 12
more than 12 months months after the reporting date
129
The
Illustration 5 - Term Notes. On October 1, 2023, DOLORES Company received 4

notes receivable with face amount of P5,000,000. The note bears 8% interest anq
matures on September 30, 2027. The amounts that will appear as current and
noncurrent assets in the Company’s balance sheet are the following:
Amounts Reported As
Notes Interest
Date Receivable Receivable* Current Noncurrent
12/31/23 P5,000,000 P100,000 P100,000 P5,000,000
12/31/24 5,000,000 100,000 100,000 5,000,000
12/31/25 5,000,000 100,000 100,000 5,000,000
12/31/26 5,000,000 100,000 5,100,000 ~
*P100,000 = P5,000,000 x 8% x 3/12
Before the December 31, 2026 reporting date, the notes receivable itself is classified
as noncurrent since it will be received more than twelve (12) months after each
reporting date. By December 31, 2026, it will be classified as current since there is
only nine (9) months until its September 30, 2027 maturity date.
Illustration 6 - Serial (Installment) Notes. On January 1, 2023, TAYABAS

Company received a P6,000,000 notes receivable by selling its old building. Partial
principal payments of P1,200,000 are due every December 31, starting in 2023.
Interest of 12% is payable at the same time as the principal payments.
The amounts that will appear as current and noncurrent assets in the Company’s
balance sheet are the following:
Amounts Reported As
[A] Notes Interest [B] [A] - [B]
Date Receivable Receivable Current Noncurrent
12/31/23 4,800,000 P- P1,200,000 P3,600,000
12/31/24 3,600,000 - 1,200,000 2,400,000
12/31/25 2,400,000 -. 1,200,000 1,200,000
12/31/26 1,200,000 - 1,200,000 -

a. There is no accrued interest receivable since interest income for each year are
fully paid every December 31 reporting date.
b. The succeeding year’s principal installment payment represents the current
portion of the note receivable every December 31 reporting date.
130
The
The Book
DETERMINING THE TERM (IN DAYS) OF THE PROMISSORY NOTE

So far, the discussions have focused on the term of a promissory note stated in
number of months. However, there are some circumstances where the number of
days between the issue date and maturity date is relevant. This is the case where
the.maturity date does not correspond to the “monthsary” of issue date.
For example, the number of days is relevant if the issue date is on March 1, 2023
and its maturity date is on June 10, 2023. The maturity date does not correspond to
the supposed monthsary for the month of June 2023 (i.e., June 1, 2023).
In this case, it is generally accepted that the counting of days shall exclude the first
day (i.e., issue date) but include the last day (i.e., maturity date). Consequently, it is
important for the readers to determine the number of days per month:
Month No. of Days Month No. of Days

January 31 July — 31
February 28 or 29* August 31
March 31 September 30
April 30 October 31
May 31 November 30
June 30 December 31
*28 if normal year, 29 if leap year
Illustration 7. On April 5, 2023, an entity received a promissory note with face

amount of P1,200,000 from its customers as a payment for its overdue account. The
note bears 12% annual interest and will mature on July 20, 2023. In this case, the
term of the note can be determined as follows:
Month Days Remarks

April 25 30 days in April less “5” for April 5
May 31 The note is outstanding all throughout the month
June 30 The note is outstanding all throughout the month
July 20 20 days stand for July “20”
106
Since the term is stated in days, the computation of the interest income over the
note’s term shall utilize “360” as the denominator in the “time” component of the
formula:
P1,200,000 x 12% x 106 days
Interestincome = P42,40
360 days ,
131
The
The Book
SPECIAL CASE OF COMPOUNDING INTEREST

So far, the discussions used the concept of simple interest. However, in limited
circumstances, the interest may be compounding, wherein accrued interest earns
additional interest. Simple and compound interest are differentiated as follows:
——,
Simple Interest Compound Interest

Basis Face amount only | Face amount plus total accrued interest |
Payment of interest Periodically Normally only on maturity date
Generally, equal . ; )
i
Interest income a
every period Generally,y increasing 1g every
every year
ye
The readers should take note that in the absence of the word “compounding” or its
equivalent, the interest is deemed to be simple interest only.
Illustration 8. On January 1, 2023, BRIGHTNESS Company received a three-year,

12% interest-bearing promissory note with P4,000,000 face amount. The interest
is compounded annually and is payable on maturity date. Required: Determine the
following:
a. Interest income per year
b. Accrued interest receivable at the end of each year
The amounts of interest income per year shall be determined as follows:
Face amount, 1/1/23 P4,000,000
Add: Interest, 2023 (P4,000,000 x 12%) 480,000
Face amount + accrued interest, 12/31/23 P4,480,000
Add: Interest, 2024 (P4,480,000 x 12%) 537,600
Add: Interest, 2025 (P5,017,600 x 12%) 602,112
On the other hand, the amounts of accrued interest receivable each year shall be
determined as follows
[A] Principal [B] [A] - [B] Accrued

Date + Interest Principal interest receivable
12/31/23 P4,480,000 P4,000,000 P480,000
12/31/24 5,017,600 4,000,000 1,017,600
12/31/25 5,619,712 4,000,000 1,619,712
The readers should take note that on December 31, 2025 maturity date, the
Company will receive a total amount of P5,516,712, to be recorded as follows:
Cash 5,619,712
Interest receivable 1,619,712
132
The
CHAPTER SUMMARY
1. Notes receivable are supported by formal document known as the promissory note.
2. The following are the parties in a promissory note:
a. Maker - the one who makes and signs the promissory note. This is the party
who obligates itself to pay cash to the payee on maturity date.
b. Payee - the beneficiary of the promissory note. This is the party who will
receive the cash from the maker on maturity date, hence it recognizes notes
receivable.
3. Initial and subsequent accounting procedures will depend on the characteristics of
notes receivable:
Interest-Bearing | Interest-Bearing | —
Stated Rate= Stated Rate+ | Noninterest-
_ Market Rate _ Market Rate | © Bearing
At present value of cash flows
Initial measurement At face amount discounted using market rates on
initial recognition
Based on stated Based on market rate on initial
Interest income rate applied to face | recognition applied to beginning-of-
amount the-period carrying amount
Carrying amount Based on remaining The present value amounts
each reporting date face amount appearing in the amortization able
Recognition of Not applicable
accrued interest Based on stated rate (no stated
receivable rate)
4. Interest-bearing promissory notes can be classified as either term or serial:
a. Term -the whole face amount is payable on maturity date.
b. Serial - the face amount is periodically payable before maturity date.
5. Interest income for interest-bearing promissory notes can be determined as:
Beginning-of-the-period carrying amount x Interest Rate x Time.
6. Interest income is the same every year for term notes but decreasing for serial notes.
7. Accrued interest receivable can be determined as: Beginning-of-the-period
carrying amount x Interest Rate x Time. Time is counted from the immediately
preceding interest payment date up to reporting date.
8. The frequency (e.g., annually, quarterly, etc.) of interest payments greatly affects the
amount of accrued interest receivable.
9. The face amount of a non-trade notes receivable that will be received within 12
months after the reporting date is classified as current.
10,Jn compounding interest, accrued interest receivable earns interest income.
133
The
CamScanner
True or False
1. Notes receivable is more formal compared to accounts receivable.
2. The payee in the promissory recognizes notes receivable.
3. The maker of promissory note recognizes interest income from the promissory
note.
The payee has an obligation in a promissory note.
The initial measurement of a note receivable will depend on whether it is interest-
nn
bearing or not.
6. Generally, interest-bearing notes receivable are initially measured at the present
value of principal and interest, except when stated rate = market rate.
7. The stated rate is the general level of rate of return demanded by investors.
8. Marketrate is the basis of interest income for interest-bearing notes receivable.
9. Interest income shall be determined based on the beginning-of-the-period face
amount of the note receivable.
10. The more frequent the interest paymentis, then _ the lower the amount of accrued
interest receivable is at the end of each year.
11. The whole face amount of a term note receivable is payable on maturity date.
12. Annual interest income from serial notes receivable is decreasing every year.
13. Holding other inputs constant, the amount of accrued interest receivable is higher
if the interest payment is paid quarterly compared to when it is annually.
14. The amount of interest income is determined by using the period from the
immediately preceding interest payment date until the reporting date.
15. The carrying amount of serial note receivable is decreasing.

1. Given the following statements, determine which of them is/are true
I. Notes receivable are considered as financial assets.
Il. Notes receivable are considered as nonmonetary assets.

b. Il only d. Neither I nor II
2. This party is the beneficiary of a note receivable
a. Maker
b. Payee
c. Drawee
d. Customer
3. Given the following statements related to a promissory note issued in connection
with borrowing of funds, determine which of them is/are true
I. On maturity date, the payee pays the face amount of the note to the maker.
Il. Onissuance date, the maker pays the face amount of the note to the payee.
134
The
The Book
4, Setting other inputs constant, which among these interest payment frequencies will
~ result to the highest amount of accrued interest receivable?
a. Annually
b. Semi-annually
c. Quarterly
d. Monthly
5. Given the following statements, determine which of them is/are false

-|. Serial notes receivable will result to decreasing amount of interest income
every year.
Il.. Term notes receivable will result to steady amount of interest income every
year.
a. lonly c. Both J and II

6. On April 1, 2023, an entity received a two-year promissory note from one of its
"customers as a payment for its overdue account. The principal is payable at the end
of two-year period while the interest is payable annually every March 31, starting in
2024. As of December 31, 2023 reporting date, the accrued interest receivable shall
comprise of
a. 12 months
b. 9 months
c. 6months-
d. 3months
7. On April 1, 2023, an entity received a two-year, interest-bearing promissory note

from one of its customers as a payment for its overdue account. The principal is
payable at the end of two-year period while the interest is payable semi-annually
every September 30 and March 31 of each year, starting in 2023. As of December 31,
2023 reporting date, the accrued interest receivable shall comprise of
a. 12months
b. 9 months
c. 6months
d. 3months
8. OnMay 1,2023,an entity received a five-year, interest-bearing promissory note. The

whole face amount is payable on maturity date while the interest is payable every
April 30 and October 31 of each year, starting in 2023. Based on this information,
determine which of the following statements is/are correct:
J. Interest income for the year 2023 is composed of 8-month worth of interest.
Il. Accrued interest receivable as of December 31, 2023 is composed of 6-month
worth of interest.
b. Ilonly d. Neither I nor Il
135
The
The Book
9. On July 1, 2023, an entity received a four-year, interest-bearing promissory note,

The whole face amount is payable on maturity date while the interest is payable
every June 30 of each year, starting in 2024. Based on this information, determine
which of the following statements is/are correct:
I. Interest income for the year 2024 is composed of 6-month worth of interest.
Il. Accrued interest receivable as of December 31, 2023 is composed of 6-month
worth of interest.
a. lonly c. Both I and Il
b. Ilonly d. Neither I nor Il
10. On October 1, 2023, an entity received a P5,000,000, five-year, interest-bearing

promissory note. The P1,000,000 face amount is payable every September 30 of
each year, starting in 2024. The interest is also payable at the same time as the
partial principal payments. Based on this information, which of the following
statements is not correct?
a. Interest income for 2023 is based on the P5,000,000 face amount prorated for
three months.
b. Accrued interest receivable as of December 31, 2023 has the same amount as
the interest income for 2023
c. Accrued interest receivable as of December 31, 2024 is based on the P3,000,000
face amount prorated for three months.
d. Interest income for 2024 is the sum of interest based on the P5,000,000 face
amount prorated for nine months and interest based on the P4,000,000 face
amount prorated for three months.
Straight Problems
1. On January 1, 2023, SHEEP Company received a 6% interest-bearing promissory
note with face amount of P6,000,000 and maturity date of December 31, 2026 from
selling its land with carrying amount of P4,500,000. Interest is payable every
December 31 of each year, starting in 2023.
Required: Determine the journal entries for the years 2023 to 2024.
2. On July 1, 2023, LAMB Company received a three-year, P3,000,000 face amount

promissory note from its customer to settle its overdue account for the same
amount Annual interest of 8% is payable every June 30 of each year, starting in
2024.
Required: Determine the journal entries for the years 2023 to 2024.
3. On April 1, 2023, MUTTON Company sold its building with original cost of
P10,000,000 and accumulated depreciation of P4,500,000 by receiving P1,000,000
cash and P5,000,000 four-year promissory note, The interest of 12% is payable
every September 30 and March 31 of each year, starting on September 30, 2023.
Required: Determine the journal entries for the years 2023 to 2024,
136
The
The Book
4. On January 1, 2023, BEEF Company agreed to sell its old equipment with cost of
P7,000,000 and accumulated depreciation of P4,200,000 by receiving P2,500,000
10% interest-bearing promissory note. The face amount of the note is payable in
P500,000 installments every December 31 of each year, starting in 2023. Interest is
payable in the same frequency as the installment payments of face amount.
a. Journal entries for the years 2023, 2024 and 2025.
b. Current and noncurrent assets as of December 31, 2023, 2024 and 2025.
5. BRISKET Company lent P6,000,000 to one of its customers. In return, it received a

9% interest-bearing promissory note with face amount of P6,000,000 on April 1,
2023. The face amount is payable in six equal annual installments starting on March
31, 2024. The interest is also payable on the same dates as the face amount
installment payments.
a. Journal entries for the years 2023, 2024 and 2025.
b. Current and noncurrent assets as of December 31, 2023, 2024 and 2025.
6. CHUCK Company lent P5,000,000 to one of its customers on January 1, 2023. The
loan matures on December 31, 2026 and bears 10% compounded interest that is
payable on maturity date.
Required: From the given information determine the following:
a. Journal entries for the years 2023 and 2024
b. Journal entry to record the receipt of the note’s maturity value on December 31,
2026.

1. On March 1, 2023, MEDIUM Company sold its land with carrying amount of
P2,750,000 by receiving P500,000 cash and P3,000,000 face amount promissory
note that will mature on February 28, 2027. The note bears annual interest of 10%
and payable every February 28 of each year, starting in 2024.
The gain or loss on sale shall be
a. P750,000 loss c. P250,000 loss
b. P750,000 gain d. P250,000 gain
Interest income for the year 2023 shall be
a. P250,000 c. P291,667
b. P300,000 d. P350,000
Accrued interest receivable as of December 31, 2023 shall be
a. P250,000 c. P291,667
b. P300,000 d. P350,000
a. P250,000 c, P291,667
b. P300,000 d. P350,000
137
The
The Book
2. On September 1, 2023, RARE Company sold its building with carrying amount of
P4,600,000 by receiving P1,000,000 cash and P3,500,000 face amount promissory
note that.will mature on August 31, 2028. The note bears 12% annual interest and
is payable every February 28 and August 31 of each year, starting on February 28,
2024.
Gain or loss on sale shall be
a. P100,000 loss c. P1,100,000 loss
b. P100,000 gain d. P1,100,000 gain
a. P140,000 c. P420,000
b. P280,000 d. P540,000
a. P140,000 c. P420,000
b. P280,000 d. P540,000
a. P140,000 c, P420,000
b. P280,000 d, P540,000
3. On May 1, 2023, COLD Company received a notes receivable with face amount of
P6,000,000 from selling its land with carrying amount of P6,300,000. The face
amount is payable in five equal annual installments every April 30 of each’ year,
starting in 2024. The note bears 6% annual interest and payable on the same dates
as the installment payments of the face amount. -

a. P312,000 c. P288,000
b. P240,000 d. P336,000

a. P240,000 c. P192,000
b. P360,000 d. P288,000

a. P312,000 c. P240,000
b. P336,000 d. P288,000
Total amounts to be included in the current and noncurrent assets, respectively, as

of December 31, 2023 with respect to the note receivable shall be
a. P1,200,000 and P4,800,000 c. P1,200,000 and P3,600,000
b. P1,440,000 and P4,800,000 c. P1,440,000 and P3,600,000
a. P1,392,000 and P3,600,000 c. P1,392,000 and P2,400,000
b. P1,440,000 and P3,600,000 c, P1,440,000 and P2,400,000
138
The
The Book
4, As of December 31, 2023, an entity reported a notes receivable with carrying

amount of P4,500,000 dated September 1, 2022. Upon inspection of the terms of the
note, it bears 12% interest per annum that is payable every August 31 of each year,
starting in 2023, In addition, the face amount is payable in P500,000 annual
installments on the same dates as the payment of annual interest.
Interest income for 2023 shall be
a. P640,000 c. P600,000
b. P580,000 d. P540,000
Interest income for 2024 shall be
a. P500,000 c. P520,000
b. P480,000 d. P600,000
a. P500,000 and P4,000,000 c. P500,000 and P4,500,000
b. P680,000 and P4,000,000 c. P680,000 and P4,500,000
a. P660,000 and P3,500,000 c. P500,000 and P4,000,000
b. P500,000 and P3,500,000 c. P660,000 and P4,000,000
5. During the year 2023, FREEZE Company received the following promissory notes:
e On March 1, five-year note with P3,000,000 face amount and annual interest of
10%. The whole face amount is payable on maturity date while the interest is
payable every February 28 of each year, starting in 2024.
e On April 1, six-year note with P5,000,000 face amount and annual interest of
12%. The whole face amount is payable on maturity date while the interest is
payable every March 31 and September 30 of each year, starting on September
30, 2023.
e On July 1, four-year note with P6,000,000 face amount and annual interest of 9%.
The face amount is payable in four annual installments every June 30 of each
year, starting on June 30, 2024. Interest is payable on the same dates as the face
amount installments.
Total interest income for 2023 shall be

a. P1,440,000 c. P930,000
b. P970,000 d. P860,000
Total accrued interest receivable as of December 31, 2023 shall be

a. P970,000 c. P670,000
b. P860,000 d. P590,000
of December 31, 2023 with respect to all of the notes receivable shall be
a. P670,000 and P14,000,000 c. P1,870,000 and P12,800,000
b. P970,000 and P14,00,000 d. P2,170,000 and P12,800,000
139
The
The Book
Total interest income for 2024 shall be

a. P1,440,000 c. P1,050,000
b. P1,386,000 d. P1,156,000
Total accrued interest receivable as of December 31, 2024 pene be!
a. P616,000 c. P676,000
b. P716,000 d. P786,000

of December 31, 2024 with respect to all of the notes receivable shall be
a. P1,816,000 and P11,600,000 c. P616,000 and P12,800,000
b. P1,986,000 and P11,600,000 d. P786,000 and P12,800,000
6. At the beginning of the year 2023, AMBER Company received afive-year P6,000,000
promissory note from its customer as a settlement of an overdue account. The note
bears 8%, compounded annually.

a. P480,000 c. P518,400
b. P559,872 d. P604,662
Total accrued interest receivable as of December 31, 2025 shall be
a. P1,440,000 c. P1,639,749
b. P2,162,934 d. P1,558,272
140
The
The Book
Chapter 5A — Notes Receivable — Subject to Present Value
CHAPTER 5A
NOTES RECEIVABLE - SUBJECT TO PRESENT VALUE

1. The concept of time value of money.
2. The computation of different present value factors.
3, The application of different present value factors depending on the cash flows of
noninterest-bearing promissory note.
4. The application of different present value factors depending on the cash flows of
interest-bearing promissory note (stated rate + mare rate).
5. The concept of day 1 loss.
TIME VALUE OF MONEY

To have an initial grasp on the concepts of present value, a practical example shall
be presented:
If someone offered you P1,000 and you have the choice whether to receive it
immediately or after one year, what would you choose?
Most likely, you will choose to receive it immediately, primarily because of the
following reasons:
a. Due to inflation, the purchasing power of P1,000 to be received after one year is
lower than the purchasing power of P1,000 to be received immediately.
b. The immediately received P1,000 can be used for investment purposes which
will allow you to earn investment income.
Based on your choice, it can be said that as the period before an amount is received
gets longer, its value will be lower. The present value concepts can facilitate the
relevant calculations.
The goal of the present value calculations is to determine the current value of the
specified amounts to be received in the future. In relation to the previous example,
the present value of the P1,000 that will be received after one year shall be lower
than P1,000.
COMPUTING THE PRESENT VALUE OF CASH FLOWS

When computing for the present value (PV) of cash flows, the following formula
shall be used:
PV of Cash Flows = Relevant Amount of Cash Flows x Present Value Factor
141
The
Chapter 5A — Notes Receivable - Subject to Present Value
The present value (PV) factors can be classified as PV factor of single payment, Py
factor of ordinary annuity, and PV factor of annuity due. These PV factors are used in
the circumstances described as follows:
PV factor of PV factor of Ordinary PV factor of Annuity|
Single Payment Annuity Due
Generally, when there is only Only when equal Only when equal
one payment to be made on amounts are paid in amounts are paid in
maturity date. However, a equal intervals and ‘equal intervals and
series of PV factors of single that cash flows are paid that cash flows are paid
payment if the PV factor of at the END of each at the BEGINNING of
ordinary annuity or annuity period. each period.
due cannot be used.
The readers are advised to master the present value concepts as they are applicable
to a lot of topics in addition to notes receivable. In terms of calculation, these
different types of PV factors are interconnected with each other.
COMPUTING PV FACTOR OF SINGLE PAYMENT

The following formula is relevant in computing the PV factor of single payment:
PV factor = (1+i)™
where:
i= periodic interest, usually equal to market rates
n= number of periods covered, usually equal to note’s term
For scientific calculators, this formula can be easily encoded. However, since the
board exams require the use of non-scientific calculators, procedures on computing
the PV factors using simple calculators is the highlight of this chapter.
For non-scientific calculators, the PV factor can be computed by following these steps,
using 12% and 5 years as an example:
1. Input 1 +/in the calculator (In our example, 1 + 12%, the screen should show 1.12).
2. Double press the divide sign (+).
3. Press the equal sign (=) at the number of times equal to the number of periods (In
our example, press the equal sign five (5) times, corresponding to the 5-year term.
This will result to 0.567427 as the PV factor of single payment).
Note: In some calculators, the first press on the equal sign will show “1” on the screen. In
these cases, that first press shall not be counted in the total number of presses required to
be made in the equal sign.
The readers should take note that the PV factor of single payment shall always be
less than 1. Another illustration using 10% and 4 periods can reinforce the readers’
understanding:
142
The
Chapter 5A - Notes Receivable - Subject to Present Value
1. Input 1.10 (or1 + 10%) in the calculator.

3. Press the equal sign (=) four times (corresponding to 4 periods).
4, The PV factor of single payment that will appear on the screen shall be 0.683013.
A partial list of PV factors of single payment is presented so that the readers can
practice more of their newfound skill of computing such PV factors:
Discount Rates
Period (s) 5% 6% 71% 8% 9%
1 0.952381 0.943396 0.934579 0.925926 0.917431
2 0.907029 0.889996 0.873439 0.857339 0.841680
3 0.863838 0.839619 0.816298 0.793832 0.772183
4 0.822702 0.792094 0.762895 0.735030 0.708425
5 0.783526 0.747258 0.712986 0.680583 0.649931
Based on the above table, the readers should take note of the following related to
the PV factors of single payment:
a. The longer the period, the lower the PV factor
b. The higher the market rate (or discount rate), the lower the PV factor.
COMPUTING PV FACTOR OF ORDINARY ANNUITY

The following formula is relevant in computing the PV factor of ordinary annuity:
PV Factor = A-G+p"
i
where:
Similar to PV factor of single payment, no issues can be encountered for scientific

calculators.
For non-scientific calculators, the PV factor of ordinary annuity can be computed by
following these steps, using 7% and 6 years as an example:
1. Input 1 +/in the calculator (In our example, 1 + 7%, the screen should show 1.07).
3. Press the equal sign at the number of times equal to the number of periods (In our
example, press the equal sign six (6) times, corresponding to the 6-year term. This
will result to 0.666342),
4. Input the computed number in step 3 in the PV factor of ordinary annuity formula:
1 - 0.666342...
PV Factor =
7% ’
The simplification of the above expression will result to the PV factor of ordinary
annuity. (In our example the PV factor to be computed is 4.766540)
143
The

a. The first three steps are the same as the computation as the PV factor of single
payment. To compute for the PV factor of ordinary annuity, itis necessary to first
compute for the PV factor of single payment. In other words, PV factor of
ordinary annuity can be derived from the PV factor of single payment as follows:
PVFactorof _ 1-PV Factor of Single Payment
Ordinary Annuity ~ i
The PV factor of ordinary annuity is always less than the number of periods used
in the calculations. In our example, 4.766540 is less than 6 (i.e., 6 periods).
Another example of computing PV factor of ordinary annuity using 6% and 5 years:

i. Input 1.06 in the calculator.
Zs Double press the divide sign (+).
a Press the equal sign five times (corresponding to 5-year period), resulting to
0.747258.
4, Input the computed number in step 3 in the PV factor of ordinary annuity
formula:
PV Factor
_ _1-0.747258...
6%
The simplification of the above expression will result to the PV factor of ordinary
annuity of 4.212364. This PV factor is less than 5 (i.e., 5 periods).
A partial list of PV factors of ordinary annuity is presented so that the readers can
practice more of their newfound skill of computing such PV factors:
Discount Rates
Period (s) 5% 6% 7% 8% 9%
1 0.952381 0.943396 0.934579 0.925926 0.917431
2 1.859410 1.833393 1.808018 1.783265 1.759111
3 2.723248 2.673012 2.624316 2.577097 2.531295
4 3.545951 3.465106 3.387211 3.312127 3.239720
z 4.329477 4.212364 4.100197 3.992710 3.889651
Based on the above table and similar to the PV of single payment, the readers should
take note of the following related to the PV factors of ordinary annuity:
a. The longer the period, the higher the PV factor.
b. The higher the market rate (or discount rate), the lower the PV factor.
COMPUTING PV FACTOR OF ANNUITY DUE

The following formula is relevant in computing the PV factor of annuity due:
144
The
ae n
PV Factor = Jo. x (1+/
I
where:
The readers should take note that the first portion of the formula is simply the
computation of PV factor of ordinary annuity. In other words, PV factor of annuity
due can be derived from PV factor of ordinary annuity as follows:
PV Factor of Annuity Due = PV Factor of Ordinary Annuity x (1 + i)
Using the 7% and 6 periods example in the PV factor of ordinary annuity, the PV
factor of annuity due is computed as:
PV Factor of Annuity Due = 4.766540... x 1.07 = 5.100197
Using the 6% and 5 periods example in the PV factor of ordinary annuity, the PV
factor of annuity due is computed as:
PV Factor of Annuity Due = 4.212364... x 1.06 = 4.465106

a. Similar to ordinary annuity, the PV factor of annuity due is always less than the
number of periods used in the calculations.
b. Using the same discount rate and number of periods, the PVfactor of annuity due
is always higher than the PV factor of ordinary annuity.
PV FACTORS APPLIED IN THE INITIAL MEASUREMENT OF NONINTEREST-

BEARING NOTES RECEIVABLE
In the previous chapter, it was discussed that notes receivables shall be initially
measured at their fair values. The fair value of the noninterest-bearing note is equal
to the present value of the cash flows discounted using the market rates on the
initial recognition. The amount present value is computed as follows:
Present Value Amount = Cash flow amount x relevant PV factor
Caution shall be applied on deciding what PV factor should be used in the

calculations. The amounts and the frequency of cash flows shall be used as the bases
in determining the relevant PV factors in computing for the fair value of noninterest-
bearing note receivable:
145
The
PV factor of Single PV factor of Ordinary PV factor of

Payment Annuity | Annuity Due
Generally, for term notes Generally, for _ serial Generally, for serial|
receivable. Can be used (installment) notes installment notes
for some serial notes receivable with principal to receivable to be received
where the installment be received in equal in equal installment
payments are unequal installment amounts in amounts’ in equal
and/or intervals are equal intervals at the end interval at the beginning
unequal. of each period. of each period.
Cash flow amountis equal Cash flow amount is equal Cash flow amount is equal
to face amount to periodic installment to periodic installment
amount amount
SUBSEQUENT MEASUREMENT OF NONINTEREST-BEARING NOTE RECEIVABLE

In subsequently measuring noninterest-bearing notes receivable (and any other
assets or liabilities with present value calculations), an amortization table shall be
used. This amortization table will have the following columns:
Payments Interest Amorti- Present Value/

Date Received Income zation Carrying Amount
These columns have the following descriptions and purposes as follows:

a. Date - usually the date when the cash flows were to be received (for serial notes)
or the end of each period covered by the note (for term notes) ,
b. Payments received - the amounts of cash flows to be received (principal, plus
interest if relevant) corresponding to each date in the date column. Payments
received decrease the carrying amount of the note receivable.
c. Interest income (also called accretion of interest) - computed as the
beginning-of-the-period present value or carrying amount times the
discount rate as of the initial recognition. Market rates at the end of each year
are not used in computing the interest income amount. Interest income increases
the carrying amount of the note receivable. Yes, jinterest income shall still be
nt haari
d. Amortization - the amount of addition to or deduction from the beginning-of-

the-period carrying amount of the note receivable. This can be computed as
interest income less amounts received:
Interest income > amount received Addition

Interest income < amount received Deduction
e Present Value/Carrying Amount - the carrying amount of note receivable that

shall be reported as of each corresponding date. This can be computed as:
146
The
CamScanner
Beginning-of-the-period present value/carrying amount Pxx

Add: Amortization (if interest income > payments received) XX
Less: Amortization (if interest income < payments received) __ (xx)
End-of-the-period present value/carrying amount Pxx
The use of amortization table can also be called the effective interest method, with
the market rate on the initial recognition as the effective interest. The readers are
advised to master the use of amortization table since there are a lot more
accounting concepts which use the concepts of amortization table. Market rates as
r in re not used in the amortizati ble.
Illustration 1 - Term Note. On January 1, 2023, LUCBAN Company received a four-

year note from the buyer of its land with carrying amount of P4,000,000. The note
has a face amount of P7,500,000 and is payable on maturity date. There is no stated
rate but the market rate on January 1, 2023 averaged 9%.
Since the face amount will be received at full amount on maturity date (i.e., term
notes), the PV factor of single payment shall be used (using i = 9%, n = 4 and cash
flow amount of P7,500,000):
Initial Fair
PV Factor of PV Factor Cash Flow Value
Single payment for 4 periods at9% 0.708425 P7,500,000 P5,313,188
Less: Face amount of promissory note 7,500,000
Unearned financeincome P2,186,812
The entry to record the transaction on January 1, 2023:

Land 4,000,000
Gain on sale of land (squeeze) 1,313,188
Unearned finance income 2,186,812
Based on the above entry, the readers should take note of the following:
a. Notes receivable account is always debited at the note’s face amount, not at its
fair value.
b. Unearned finance income represents the total interest income to be recognized
over the note’s term. Yes, interest income will be recognized even though there is
no stated rate.
c. Unearned finance income is a contra-asset account against notes receivable.
In subsequently accounting for the note receivable, the following procedures are
relevant in preparing the related amortization table:
1. Populate the date and payments received columns, plus the initial amount in the
present value/carrying amount (P.V./C.A.) column:
147
The
[9%]
Pmts, Interest Amorti-
Date Received Income zation P.V./ CA.
1/1/23 5,313,188
12/31/23 -
12/31/24 -
12/31/25
12/31/26 7.5M
Since the P7,500,000 face amount will be received on maturity date, that full
amount is placed corresponding to December 31, 2026. In addition, there are no
payments to be received from 2023 to 2025 since the note is noninterest-
bearing.
2. Next, compute for the P478,187 interest income for 2023 as P5,313,188x 9%:
[9%]
Pmts. Interest Amorti-
Date Received Income zation P.V./ C.A.
1/1/22 5,313,188
12/31/22 ~ 478,187 478,187 5,791,375
12/31/23 ~
12/31/24 -
12/31/25. 7.5M
The amount of amortization is equal to interest income since there were no
payments received for 2023. In addition, add the P478,187 amortization to the
P5,313,188 beginning-of-the-period P.V./C.A. to arrive at P5,791,375 end-of-
the-period P.V./C.A as of December 31, 2023.
3. Continue repeating the procedures in step 2 in computing for interest income,
amortization and P.V./C.A. Finished amortization table, including the related
account balances for notes receivable and unearned finance income, is as
follows:
Account Balances
[9%] P.V./ Unearned
Pmts. Interest Amorti- Carrying Notes Finance
Date Received Income zation Amount’ Receivable Income
1/1/23 5,313,188 7,500,000 2,186,812
12/31/23 - 478,187 478,187 5,791,375 7,500,000 1,708,625
12/31/24 - 521,224 521,224 6,312,599 7,500,000 1,187,401
12/31/25 - 568,134 568,134 6,880,733 7,500,000 619,267
12/31/26 7.5M 619,267 619,267 o 7 7
For 2024, interest income of P521,224 is computed as P5,791,375 x 9%. PV/CA
as of December 31, 2024 is computed as P5,791,375 beginning balance plus
P521,224 amortization.
148
The
The Book

a. The amount of interest income reduces the balance in the unearned finance
income account. For 2023, P1,708,625 =,P2,186,812 - P478,187.
b. The PV/CA of the note receivable = balance in the notes receivable account
less balance in unearned finance income account (e.g., for 2024, =
P6,312,599 = P7,500,000 - P1,187,401).
Journal entries subsequent to initial recognition will be based on the amounts
appearing in the amortization table. Journal entry to record the recognition of
interest income and amortization as of December 31, 2023:
Unearned finance income 478,187
Journal entry to record the recognition of interest income and amortization as of

December 31, 2024:

December 31, 2025:
Journal entry to record the recognition of interest income and amortization, plus
the receipt of the note’s face amount as of December 31, 2026:
Cash 7,500,000
On the December 31, 2026 maturity date, the unearned finance income will have a
zero balance.
Illustration 2 - Serial Note. At the beginning of 2023, TAYABAS Company received
a five-year, noninterest-bearing promissory note with face amount of P5,000,000
from the selling of its equipment with cost of P6,000,000 and accumulated
depreciation of P1,500,000, The note’s face amount is payable in equal annual
installments of P1,000,000 every December 31, starting in 2023, Market rates at the
start of 2023 averaged 10%.
Since the face amount will be received in equal periodic installments of P 1,000,000
and in equal intervals of one year, at the end of each year, the PV factor of ordinary
annuity will be used (using i = 10%, n = 5 and cash flow amount of P1,000,000):
149
The
Initial Fair
PV Factor of PV Factor Cash Flow: Value
Ordinary annuity for 5 periods at10% 3.790787 P1,000,000 P3,790,787
Less: initial face amount of promissory note 5,000,000
Unearned financeincome P1,209,213
The readers should take note that the cash flow amount to be used with the PV
factor of ordinary annuity is the periodic cash flow (P1,000,000 in the
illustration) rather than the note’s total face amount (P5,000,000 in the
illustration).
The entry to record the transaction on January 1, 2023:

Accumulated depreciation 1,500,000
Loss on sale of equipt. (squeeze) 709,213
Equipment 6,000,000
In subsequently accounting for the note receivable, the following procedures are
relevant in preparing the related amortization table: |
1. Populate the date and payments received columns, plus the initial amount in the
present value/carrying amount (P.V./C.A.) column.
[10%]
1/1/23 3,790,787
12/31/23. 1M
12/31/24 1M
12/31/25 1M
12/31/26 1M
12/31/27 1M
Since the P5,000,000 face amount will be received on annual amounts of
P1,000,000 for the next five years, each date was assigned with P1,000,000
payments received.
2. Next, compute for the P379,079 interest income for 2023 as P3,790,787 x 10%:
[10%]
1/1/23 3,790,787
12/31/23 1M 379,079 (620,921) 3,169,866
12/31/24 1M
12/31/25 1M
12/31/26 1M
12/31/27 1M
150
The
The Book
The amount of amortization for 2023 is computed as interest income less

payments received (-P620,921 = P379,079 - P1,000,000). Deduct P620,921
amortization from the P3,790,787 beginning-of-the-period P.V./C.A. to arrive at
P3,169,866 end-of-the-period P.V./C.A as of December 31, 2023.
3, Continue repeating the procedures in step 2 in computing for interest income,
amortization and P.V./C.A. Finished amortization table, including the related
account balances for notes receivable and unearned finance income, is as
follows:
Account Balances
[10%] P.V./ Unearned
Pmts. Interest Amorti-. Carrying Notes Finance
Date Received Income zation Amount’ Receivable Income
1/1/23 3,790,787 5,000,000 1,209,213
12/31/23 1M 379,079 (620,921) 3,169,866 4,000,000 830,134
12/31/24 1M 316,987 (683,013) 2,486,853 3,000,000 513,147
12/31/25 1M 248,685 (751,315) 1,735,538 2,000,000 264,462
12/31/26 1M 173,554 (826,446) 909,092 1,000,000 90,908
12/31/27, 1M 90,908 (909,092) = ui -
For 2024, interest income of P316,987 is computed as P3,169,866 x 10%. PV/CA
as of December 31, 2024 is computed as P3,169,866 beginning balance less
P683,013 amortization.

a. The amount of interest income reduces the balance in the unearned finance
income account.
b. The difference between the balances in the notes receivable account and
unearned finance income account is equal to the PV/CA of the note receivable
(e.g., for 2024, P3,000,000 - P513,147 = P2,486,853).
Similar to term notes, journal entries subsequent to initial recognition will be based
on the amounts appearing in the amortization table. Journal entry to record the
recognition of interest income and amortization, plus the receipt of installment
payment as of December 31, 2023:

Cash 1,000,000
Journal entry to record the recognition of interest income and amortization plus the
receipt of installment payment as of December 31, 2024:
151
The
Cash 1,000,000
Journal entries for the years 2025 to 2027 are similar to the entries made for 2023
and 2024, except for the amounts of interest income and unearned finance income,
REPORTING OF RECEIVABLES SUBJECTED TO PRESENT VALUE CALCULATIONS

Similar to interest-bearing notes discussed in the previous chapter, notes
receivables subjected to present value calculations are reported as either current,
noncurrent or partly current and partly noncurrent. The 12-month rule previously
discussed is also applicable in this case.
Illustration 3 - Term Notes. Using the same information as in LUCBAN Company,

the carrying amounts in the amortization table previously discussed are reported
as follows:
Current/Noncurrent
P.V./ Carrying Reporting
Date Amount Current Noncurrent
1/1/23 5,313,188 4
12/31/23 5,791,375 - 5,791,375
12/31/24 6,312,599 - 6,312,599
12/31/25 6,880,733 6,880,733 -
12/31/26 - ~ -
The readers should take note that because of the accretion of interest, the carrying
amount of the term notes receivable increases by mere passage of time.
Illustration 4 - Serial Notes. Using the same information as in TAYABAS Company,
the carrying amounts in the amortization table previously discussed are reported
as follows:
Current/Noncurrent
Amorti- _P.V./ Carrying Reporting
Date zation Amount Current Noncurrent
1/1/23 3,790,787
12/31/23 (620,921) __3,169,866------- 683,013.----2,486,853
12/31/24 (683,013)4°"~"2,486,853 4::--751,315-----1,735,538
etme SE rs 6 eh a ee
12/31/25 (751,315)4----1,735,538 4°--""826,446 909,092

12/31/26 (826,446) 909,092 909,092 é
12/31/27 (909,092) 7" a" -
a. The amounts of installment payments are not used when determining the amount
of current and noncurrent portions of a noninterest-bearing note receivable.
b. Current portion as of each reporting date is equal to the amount of amortization
in the succeeding period.
c. Noncurrent portion as of each reporting date is equal to the carrying amount as
of the end of the succeeding period.
152
The
The Book
APPLICATION OF PV FACTORS IN THE INITIAL MEASUREMENT OF INTEREST-

BEARING NOTES RECEIVABLE BUT WITH STATED RATE # MARKET RATE
In this case, the computation of fair value on initial recognition will use both of the
following PV factors:
a. PV factor of single payment for the face amount (principal) amount; and
b. PV factor of ordinary annuity for the periodic interest payments
Illustration 5. SAMPALOC Company sold one of its land, with carrying amount of
P5,500,000, on January 1, 2023 for a total price of P9,000,000. The Company
received P2,000,000 down payment and a 6% interest-bearing promissory note for
the remainder of the total price. The note’s face amount is payable on December 31,
2025 and its interest is payable every December 31 of each year. Market rates on
initial recognition averaged 11%.
In computing the initial fair value, the following cash flows and the related PV factor
to be used shall be identified as follows:
a. Face amount of P7,000,000 (P9,000,000 - P2,000,000) will be received after
three years (i.e., January 1, 2023 to December 31, 2025). Since this cash flow will
be received one-time on maturity date, the PV factor of single payment shall
be used for the principal.
b. Interest of P420,000 (P7,000,000 x 6%) will be received at the end of each year.
Since there are equal amounts and equal interval of the cash flows, the PV factor
of the ordinary annuity shall be used for the periodic interest.
The actual computation of initial fair value is as follows:
Initial Fair
Single payment for 3 periods at 11% 0.731191 P7,000,000 P5,118,337
Ordinary annuity for 3 periodsat11% 2.443715 420,000 1,026,360
P6,144,697
Unearned finance income P855,303
The description and the amounts to be recorded for the notes receivable and
unearned finance income accounts are similar to those discussed in the
noninterest-bearing notes. Journal entry to record the transaction on January 1,
2023 is as follows:
Cash 2,000,000
Land 5,500,000
Gain on sale of land (squeeze) 2,644,697
153
The
SUBSEQUENT MEASUREMENT OF INTEREST-BEARING NOTES RECEIVABLE BUT

WITH STATED RATE+ MARKET RATE
Similar to the noninterest-bearing notes, the subsequent accounting for this type of
note involves the use of an amortization table. Previously discussed concepts on the
creation of an amortization still apply in this case.
Illustration 6. Using the same information as in SAMPALOC Company, the relevant
amortization table is as follows:
Account Balances
[11%] PV./ Unearned
Pmts, Interest Amorti- Carrying Notes Finance
Date Received Income zation Amount Receivable Income
1/1/23 6,144,697 7,000,000 855,303
12/31/23 420,000 675,917 255,917 6,400,614 7,000,000 599,386
12/31/24 420,000 704,068 284,068 6,684,682 7,000,000 315,318
12/31/25 420,000 735,318 315,318 7,000,000 7,000,000 =
12/31/25 7,000,000 2 (7,000,000) : - -
Based on the amortization table presented, the readers should take note of the
following:
a. The amount of unearned finance income will now be reduced by the amounts of
amortization (rather than the interest income as discussed in noninterest-
bearing notes).
b. Interest income shall still be based on the market rate on initial recognition even
though interest amounts to be received are based on stated rate.
c. In addition to principal amounts, the amounts of interest to be received shall
also be included in the payments received column.
December 31, 2023:
Cash 420,000

December 31, 2024:
Cash 420,000
the receipt of the full payment of the note, as of December 31, 2025:
Cash 420,000
154
The
Chapter 5A — Notes Receivable —- Subject to Present Value
Cash 7,000,000 :
CONCEPT OF DAY 1 LOSS

In the previous scenarios, any difference between the initial fair value of notes
receivable and the carrying amount of the sold asset is recognized as either gain or
loss on sale.
However, for lending of money transactions, the initial fair value of the notes
receivable may be lower than the amount of cash lent. This difference is called the
day 1 loss and shall be recognized immediately in profit or loss. Nonetheless, this
day 1 loss amount will be recouped as interest income when subsequently accounting
for the note receivable. Previously discussed concepts on amortization table are still
relevant in this case.
Illustration 7. MAUBAN Company lent P8,000,000 to one of its affiliates on January

1, 2023. The affiliate issued a noninterest-bearing note that will mature after four
years on December 31, 2026. Market rates on initial recognition averaged 8%.
On January 1, 2023, the fair value of the note of P5,880,240 is computed as follows:
Initial Fair
Single payment for 4 periods at8% —_(0.735030 P8,000,000 P5,880,240
Unearned finance income P2,119,760
PV factor of single payment was used since the amount will be received fully on
maturity date. Journal entry to record the lending transaction on January 1, 2023 is
as follows:
Day 1 loss 2,119,760
Cash 8,000,000
Relevant amortization table is as follows:

Account Balances
[8%] P.V./ Unearned
Pmts. Interest Amorti- Carrying Notes Finance
Date Received Income zation Amount Receivable Income
1/1/23 5,880,240 8,000,000 2,119,760
12/31/23 - 470,419 470,419 6,350,659 8,000,000 1,649,341
12/31/24 - 508,053 508,053 6,858,712 8,000,000 1,141,288
12/31/25 - 548,697 548,697 7,407,409 8,000,000 592,591
12/31/26 592,591 592,591 8,000,000 8,000,000 -
12/31/26 8, 000, 000 - (8,000,000) " * -
155
The
CamScanner
As the readers may have noted, the total of interest income over the term of the note
is equal to the amount of day 1 loss. Journal entry to record the recognition of
interest income and amortization as of December 31, 2023:

December 31, 2024:

December 31, 2025: .
the receipt of the note’s face amount as of December 31, 2026:
Cash 8,000,000
156
The
CHAPTER SUMMARY
1. Noninterest-bearing promissory notes are initially measured at their fair values,
which is equal to the present value of cash flows discounted using market rate on
initial recognition.
The present value is determined as Amount of cash flow x PV factor.
The PV factor to be used will depend on the amounts and frequency of cash flows:
. - PV factor of Single PV factor of Ordinary PV factor of
-. Payment Annuity Annuity Due
Generally, for term | Generally, for serial | Generally, for serial
notes receivable. Can be | installment notes | installment notes
used for some _ serial | receivable to be receivedin | receivable to be received in
notes where _ the | equal installment | equal installment
installment payments | amounts in equal | amounts in equal
are unequal and/or | interval atthe end ofeach | interval at the beginning
intervals are unequal. | period. of each period.
Cash flow amount is | Cash flow amount is equal | Cash flow amount is equal
equal to face amount to periodic installment | to periodic installment
amount amount
When using PV factor of single payment, the present value can be computed as Face
amount of the note x PV factor of single payment.
When using PV factor of ordinary annuity or annuity due, the present value can
be computed as the periodic cash flowsx PV factor of ordinary annuity or annuity
due.
The subsequent measurement shall use the effective interest method by using an
amortization table.
Interest income is equal to effective interest rate x beginning-of-the-period carrying
amount of the note receivable.
Carrying amounts as of each reporting date are usually equal to the amortized cost
in the amortization table.
The carrying amount of a term noninterest-bearing notes receivable can either be
current or noncurrent but not both.
10.The carrying amount of a serial noninterest-bearing notes receivable can be split
into current and noncurrent portions. Current portion is equal to the amount of
amortization in the succeeding year.
11.Interest-bearing note receivable with stated rate # market rate is also subject to
present value calculations.
12. The amount of day 1 loss will be recouped as amounts of interest income during the
term of the note.
157
The
CamScanner
CHAPTER SA: SELF-TEST EXERCISES
True or False
A. Noninterest-bearing notes receivable are initially measured equal to their fair
values.
2. Interest income from noninterest-bearing notes receivable shall be recognized
even if there is no stated rate.
Interest income from noninterest-bearing notes receivable is based on the
beginning-of-the-period carrying amount multiplied by the market rate as of
reporting date.
PV of single payment shall be used if the whole face amount of the noninterest-
bearing promissory note is payable on maturity date.
PV of ordinary annuity shall be used if the face amount of the noninterest-bearing
promissory note is payable in installments, regardless of the frequency as long as
the installment amounts are equal.
PV of annuity due shall be used if the face amount of the noninterest-bearing
promissory note is payable in equal amounts of installments at the end of each year.
The carrying amount of a term noninterest-bearing promissory note is increasing.
The carrying amount of a serial noninterest-bearing promissory note is increasing.
ON
There is no accrued interest receivable for noninterest-bearing promissory notes.

For serial noninterest-bearing promissory note, the amount of interest income is
increasing every year. .
. For term noninterest-bearing promissory note, the amount of interest income is
decreasing every year.
12. The day 1 loss is initially recorded as a direct deduction from an entity’s equity.
13. If relevant, accrued interest receivable is recognized for interest-bearing
promissory note even though its stated rate is different from market rate.
14. Accrued interest receivable for interest-bearing promissory note shall be based on
its stated rate, regardless of the market rate.
15. The portion of the serial noninterest-bearing note receivable that will be received
after 12 months after the reporting period is reported as part of current assets.
1. Interest-bearing notes receivable are initially measured at their
a. Face amount, regardless of the relationship between stated rate and market
rate.
b. Face amount, only if the stated rate and market rate are substantially equal.
c. Present value, regardless of the relationship between stated rate and market
rate,
d. Present value, only if the stated rate is higher than the market rate.
In determining the interest income for a term noninterest-bearing promissory note,
which of the following is true?
a. Nointerest income shall be recognized since it has no stated rate.
b. Interest income shall be based on the market rate at the end of reporting period.
c. Interest income shall be based on the market rate on initial recognition.
158
The
CamScanner
Chapter 5A - Notes Receivable - Subject to Present Value
d. Interest income shall be based on the market rate at the beginning of reporting
period.
3, In relation to a serial noninterest-bearing promissory note, which of the following

statements is/are true?
a. The amount of interest income increases every year.
b. The annual net decrease in its carrying amount is equal to the installment
payment of the principal.
c. Bothaandb.
d. Neither anor b.
4. The difference between the initial measurement of a noninterest-bearing

promissory note shall’be recognized as
a. aliability
b. deduction from equity
c. immediate amount of loss
d. acontra-asset account
5. The difference between the initial measurement of a noninterest-bearing

promissory note and its face amount shall be subsequently recognized as
a. Direct addition to equity.
b. Direct addition to interest income.
c. Direct deduction from equity.
d. Direct deduction from the carrying amount of notes receivable
6. If the stated rate of a promissory note is substantially different from the average
market rate, which of the following is relevant?
The promissory note shall be initially measured at its face amount.
Accrued interest receivable shall be recognized using the market rate.
Interest income shall be based on the market rate on initial recognition.
on
The promissory note shall be subsequently measured equal to its remaining face
amount
7. Most of the time, effective interest rate is equal to

a. Market rate on initial recognition
b. Market rate as of the reporting date
c. Market rate as of the beginning of the reporting period
d. Average market rate all throughout the period.
8. The following correctly indicates the PV factor to be used for noninterest-bearing
promissory notes, except
a. PV factor of single payment ifthe whole face amountis payable on maturity date.
b. PV factor of ordinary annuity if the face amount is payable in equal periodic
installments in equal intervals and the payments are made at the end of each
period.
159
The
The Book
c. PV factor of annuity due if the face amount is payable in equal periodic

installments in equal intervals and the payments are made at the beginning of
each period.
d. All of the above are correct.
9. Which of the correctly indicates the correct computation of the initial present value
of term interest-bearing promissory note with stated rate not substantially equal to
market?
a. PV factor of single payment shall be used for the face amount while the PV factor
of ordinary annuity shall be used for the annual interest based on stated rate.
b. PV factor of ordinary annuity shall be used for the face amount while the Py
factor of single payment shall be used for the annual interest based on stated
rate.
c. PV factor of ordinary annuity shall be used for both the face amount and annual
interest based on stated rate.
d. PV factor of single payment shall be used for both the face amount and annual
interest based on stated rate.
10.Which of the following statements is/are true in relation to a serial noninterest-

bearing note receivable?
a. Its carrying amount at the end of each year is increasing.
b. Annual interest income is decreasing.
c. Bothaandb.
d. Neither anor b.
Straight Problems
1, At the beginning of 2023, MISTLETOE Company sold its land with carrying amount
of P5,000,000 for a total amount of P7,000,000. Cash of P1,000,000 was received as
a down payment while a five-year noninterest-bearing note was received for the
remaining portion of the selling price. Market rates averaged 8% on that date.
Required: Determine the related journal entries from 2023 to 2024.
2. On April 1, 2023, MANGER Company received a four-year noninterest-bearing note

by selling goods to a customer. The note has a face amount of P4,500,000 and is
payable at the end ofits term on March 31, 2027. Market rates averaged 9% on April
1, 2023.
Required: Determine the related journal entries from 2023 to 2024,
3. On January 1, 2023, NATIVITY Company sold its building with original cost of
P8,000,000 and carrying amount of P4,200,000 by receiving a P4,800,000
noninterest-bearing promissory note that will mature on December 31, 2028. The
face amount is payable in P800,000 annual installments to be made at the end of
each year. Market rates averaged 7% on January 1, 2023.
160
The
The Book
From this information, determine the following:

a. Journal entries for the years 2023 to 2024.
b. Current and noncurrent portion of the carrying amount of notes receivable as
of December 31, 2023 and December 31, 2024.
4. On October 1, 2023, CANE Company sold its vacant land with carrying amount of
P5,000,000 for a total selling price of P8,000,000. The buyer made a P500,000 initial
payment and signed a five-year noninterest-bearing promissory note that is payable
in five equal annual installments of P1,500,000 every September 30 of each year,
starting in 2024. Market rates on the date of issue averaged 10%.
5. CANDY Company lent P3,500,000 to one of its customers on January 1, 2023. The
customer signed a noninterest-bearing promissory note for the same amount that
will mature on December 31, 2026. Relevant market rate is 8%.

6. SLEIGH Company lent P3,500,000 to one of its customers on January 1, 2023. The
customer signed a noninterest-bearing promissory note for the same amount that
will mature on December 31, 2026. The face amount is payable in four equal annual
installments at the end of each year, starting on December 31, 2023. Relevant market
rate is 8%.

7. On January 1, 2023, SNOWMAN Company sold its vacant lot to a buyer for a total
price of P8,000,000, which is equal to its carrying amount. The buyer paid
P2,000,000 down payment and signed a 4% interest-bearing promissory note for
the balance. The note will mature on December 31, 2026, while the interest is
payable at the end of each year. Relevant market rate is 9%,

1. At the beginning of 2023, FOLK Company sold goods costing P 1,000,000 to a buyer
who signed a noninterest-bearing promissory note with a face amount of
P2,500,000. The note will mature on December 31, 2026. Relevant market rate on
the date of issuance is 6%.
The amount of sales revenue to be recognized during 2023 shall be

a. P2,500,000 c. P1,854,396
b. P1,980,235 d. P1,924,587
The amount of interest income for the year 2023 shall be
a. PO c. P118,814
b. P125,943 d, P133,500
161
The
The Book
The carrying amount of the notes receivable as of December 31, 2023 shall be
a. P2,500,000 c, P2,099,049
b. P2,224,992 d. P2,128,962

a. PO c. P118,814
b. P125,943 d. P133,500
a. P2,500,000 c. P2,099,049
b. P2,224,992 d. P2,128,962
2. On July 1, 2023, MARGARET Company sold its land for a total price of P7,000,000.
Related carrying amount of the land is P6,000,000. The buyer paid P1,500,000 down
payment and for the balance, signed a noninterest-bearing promissory note that will
mature on June 30, 2026. Relevant market rate is 9%.
The amount of gain or loss on sale of land to be recognized during 2023 shall be
a. P1,000,000 gain c. P252,993 gain
b. P1,000,000 loss d. P252,993 loss
a.. P191,116 c. P382,231
b. P495,000 d. P416,631
a. P4,629,238 ~ c. P4,438,123
b. P4,247,007 d. P4,837,554

a P416,631 c. P454,131
b. P382,231 d. P399,431
a. P4,629,238 c. P4,438,123
b. P4,247,007 d. P4,837,554
3. At the beginning of 2023, ELIZABETH Company sold its building with cost of
P9,000,000 and accumulated depreciation of P5,500,000. Total selling price is
P4,200,000, which is equal to the face amount of the noninterest-bearing note issued
by the buyer. The note is payable in six annual installment payments of P700,000 to
be made every December 31 of each year, starting in 2023, Average market rate on
the date of issue is 10%.
The amount of gain or loss on sale of building to be recognized during 2023 shall be
a. P451,317 gain c. P700,000 gain
b. P451,317 loss d. P700,000 loss
162
The
The Book

a. P356,295 c. P265,355
b. P304,868 d, P253,628
a. P2,198,529 , c. P2,218,906
b. P2,712,386 d. P2,653,551

a. P356,295 c. P265,355
b. P304,868 d. P253,628
a. P2,198,529 c. P2,218,906
b. P2,712,386 d. P2,653,551
4. On January 1, 2023, GEORGE Company lent P7,000,000 to one of its customers. In

return, it received a four-year noninterest-bearing note that will mature after five
years, on December 31, 2027. Relevant market rate is 7%.
The amount of day 1 loss to be recognized for 2023 shall be
a; PO c. P3,129,098
b. P2,009,098 d. P2,679,098

a. PO c. P373,819
b. P349,363 d. P399,986
a. P5,340,265 c. P5,410,475
b. P5,289,345 d. P5,714,084

a. PO c. P373,819
b. P349,363 d. P399,986
a. P5,340,265 c. P5,410,475
b. P5,289,345 d. P5,714,084
5. At the beginning of 2023, MARY Company lent P5,000,000 to its chief executive
officer (CEO). In exchange, the CEO signed a four-year 5% interest-bearing
promissory note equal to the proceeds, even if the prevailing market rates is 9%.
The amount of day 1 loss to be recognized for 2023 shall be

a. P683,855 c. P647,944
b. P715,598 d. P732,952
163
The
The Book
Chapter 5A — Notes Receivable'- Subject to Present Value

a. P250,000 c. P398,549
b. P391,685 d. P402,526
a. P4,750,605 c. P4,743,741
b. P4,500,605 d. P4,493,741

a. P404,437 c. P405,054
b. P427,554 d. P426,937
a. P5,170,678 c. P4,648,178
b. P5,178,159 d. P4,655,659
164
The
The Book
Chapter 6 - Receivable Financing - Pledge and Assignment
CHAPTER 6
RECEIVABLE FINANCING - PLEDGE AND ASSIGNMENT

1. The essence of receivable financing
2. The different ways of obtaining financing by using receivables
3, The accounting for pledge of receivables
4, The accounting for the assignment of receivables using the non-notification and
notification bases.
RECEIVABLE FINANCING
Receivables, on their own, cannot be used directly as a payment for purchases of
goods and other assets, nor can they be used as payment for liabilities. As a result,
entities shall wait until the customer or borrower pays what they owe to the entity.
However, there are some circumstances when entities do not have enough cash on
hand to pay their maturing obligations and that their customers or borrowers are
slow-paying. In these cases, entities are compelled to fast-track the realization ofits
receivables into cash by entering into any of the following receivable financing
methods:
- Receivables as Security ~ Selling of Receivables
Receivables serve asmere ~ ‘
asi sir Receivables are sold or
Description collateral for the entity's eat
: transferred to other entities
borrowing of funds
memes Pledge of receivables; Factoring of receivables;
P Assignment of receivables Discounting of note receivable
PLEDGE OF RECEIVABLES
Pledging of receivables involve the borrowing of funds from a financial institution,
with the general balance of receivables serving as the collateral. The following are
the accounting procedures when there is a pledge of receivables:
a. The pledged receivables shall not be derecognized because of the pledge.
Derecognition means the elimination of the previously recognized asset or
liability from an entity’s records. Despite this non-derecognition, the existence of
pledged receivables shall be disclosed in the notes to financial statements.
b. The borrowed funds shall be recognized as a separate liability.
No gain or loss is recognized.
2
Interest income (if there is any) from receivables is separately recognized from
interest expense (if there is any) from the borrowed funds.
165
The
The Book
Chapter 6 — Receivable Financing — Pledge and Assignment
Illustration 1. On January 1, 2023, CARRANGLAN Company borrowed P2,000,009

from the bank. The loan matures on December 31, 2023 and bears 12% interest. T,
persuade the bank to lend the Company in the first place, the Company pledged aj)
of its accounts receivable with carrying amount of P4,500,000.
On January 1, 2023, the Company shall make the following entry to record the
borrowing transaction:
Cash 2,000,000
Loan payable 2,000,000
On December 31, 2023, to record the payment of the loan and the related interest:
Interest expense (P2,000,000x 12%) 240,000
Cash 2,240,000
The readers should take note that in pledge, there are no entries made pertaining
to the related receivables. However, if the customers pay the pledged receivables,
then the Company shall record such payments normally.
ASSIGNMENT OF RECEIVABLES
Assignment of receivables has the following characteristics and related accounting
procedures including the comparison with the pledge of receivables:
Pledge | Assignment
Specific - assigned receivable
Nature of ee pee a a amounts are specifically
collateralization pas oe vane identified. Unassigned
aan’ receivables are unaffected.
Not derecognized asa Not derecognized as a result
Aaeoaintia f result of pledge. Pledged | of assignment. However, the
eohaes eee receivables are not assigned receivables are
Wales | recorded in a separate segregated in a separate
account receivable account
Who receives the Non-notification basis - still
customers’/debtors’ | Still the pledging entity the assigning entity
payments? Notification basis - the lender_
Application of Not required to be Recelpts from assigned
; j accounts are required to be
receipts from applied to the amount of aniilied in the amount of
customers/debtors borrowing PP mone
borrowing eee
Accounting for eoicate ;
borrowing Separate liability Separate liability essa
Recognition of gain
or loss None None
166
The
Chapter 6 — Receivable Financing - Pledge and Assignment
In an assignment transaction, the entity assigning its receivables is called the

assignor while the bank or other financial institution who lends to the entity is
‘called the assignee.
The amount to be received from the assignment is computed as follows:
Total amount of assigned receivable = Pxx
Multiply: Percentage to be lent %
Gross proceeds from the assignment Pxx
Less: Service charge, if there is any xXx
Advance interest, if there is any XX
Net proceeds from the assignment Pxx
The percentage of the assigned receivables to be lent out to the assignor-entity is

usually less than 100% (e.g., 90%, 80%) to account for possible uncollectible
accounts, sales returns, sales discounts, and sales allowances. The higher the quality
of the assigned receivables, the higher the percentage to be lent out to the assignor.
Illustration 2. LUPAO Company assigned P3,000,000 of its accounts receivable on

June 1, 2023. The bank lent 80% of the accounts receivable and charged P10,000
service fee. The loan will mature after one year together with 12% interest.
Net proceeds from the assignment shall be determined as follows:
Total amount of assigned receivable P3,000,000

Multiply: Percentage to be lent 80%
Gross proceeds from the assignment P2,400,000
Less: Service charge, if there is any 10,000
Net proceeds from the assignment P2,390,000
The journal entry to record the receipt of net proceeds from the assignment:
Cash 2,390,000
Service charge 10,000
The journal entry to record the segregation of the assigned receivables:

Accounts receivable - assigned 3,000,000
SUBSEQUENT ACCOUNTING FOR ASSIGNMENT OF RECEIVABLES

Recording of assignment of receivables will depend whether the assignment is
made on non-notification or notification basis:
167
The
Non-Notification Basis Notification Basis

Customers/debtors do not Customers/debtors have been|
Koowledge of the know that their accounts have informed that their accounts
assianment been assigned and they still have been assigned and that
remit their payments to the they shall remit their
assignor-entity payments to the assignee.
Recipient of the Assigning entity (i.e., the Bank or other lenders (i.e., the
payments from assienor) Noe]
customers/debtors ssigng pnee)
Cash XX Cash |
Service charge (ifany) xx Service charge (ifany) xx
Recording of the Other expense (ifany) Xx Other expense (ifany) xx
assignment Loan payable XX Loan payable xx
A.R. - assigned XX A.R. - assigned XX
Accounts receivable XX Accounts receivable Xx
Receipt of Cash XX
payments from | Sales discount (ifany) xx No real-time recording
customers/debtors A.R. - assigned XX
Recording of ;
write-off of plow (or bad GebiS 5 ae No real-time recording
: A.R. - assigned XX
assigned accounts
Recording of sales | Sales ret./allow. (ifany) xx ; :
returns /allow. A.R. - assigned XX No realtime tecording
Loan payable XX
Sales discount (ifany) xx
Sales ret./allow. (if any) xx
Loan payable XX Allow. for bad debts XX
Periodic Cash © XX A.R. - assigned XX
application of | Interest expense XX Interest expense XX

collections as Cash xX Cash XX
payment of
borrowing (usually
at the end of each
The amount of interest
expense is based on the
eS euld Betoreg thar the
above entry is just a summary
month) beginning-of-the-period of transactions that happened
loan pay:
payable balance during the period.
The computation of interest
expense is similar to that of
non-notification basis. _|
Upon full payment
of borrowing Accounts receivable — xx Accounts receivable XX
(remaining bal. of A.R. - assigned XX A.R. - assigned XX
assigned A.R.) ea
*A.R. = Accounts receivable
168
The
CamScanner

q. For notification basis, there are no debits made to cash since the cash was
directly received by the bank and applied against the borrowing.
b. Despite the differences between non-notification and notification bases, the
ending balances of assigned receivables and loan payable are the same.
[Illustration 3. Continuing with LUPAO Company (from Illustration 2), the
following are the transactions for the month of June 2023:
a. June 10, 2023 - P1,000,000 assigned accounts were received less P20,000 sales
discount. In addition, P800,000 unassigned accounts were received.
b. June 15, 2023 - P30,000 assigned accounts were written-off.
c. June 22, 2023 - P50,000 assigned accounts were issued with credit memo due
to returns.
Application of collections from assigned receivables against the loan payable is

made at the end of each month.
The recording of transactions under the non-notification and notification bases are
as follows:
Date Non-Notification Basis Notification Basis

June | Cash 980,000
10, | Sales discount 20,000 No real-time recording
2023 A.R. - assigned 1,000,000
June
15, sy ee a 000 No real-time recording
2023 4
June
Sales returns 50,000 e ;
22) AR —assigned 50,000 No real-time recording
2023
The transactions during the month
Only the cash collection of P980,000 | are summarized as follows:
is applied as payment for the loan: Loan payable 980,000
Loan payable 980,000 Sales discount 20,000
June Cash 980,000 Allow. for bad debts 30,000
30 Sales returns 50,000
2023 Payment of interest for the month: A.R. - assigned 1,080,000
Interest expense 24,000* Remittance to the bank for the
Cash 24,000 | payment of interest expense:
*(P24,000 = P2.4M x 12% x 1/12) Interest expense 24,000
oe Cash 24,000
169
The
CamScanner
Chapter 6 — Receivable Financing - Pledge and Assignment

a. Receipts from unassigned accounts shall not be applied as payments to the loan
payable.
b. In computing for the amount of interest expense, the basis is the beginning-of-
the-month loan balance of P2,400,000, not on the ending balance of P1,420,000
(P2,400,000 - P980,000).
c. The differences in journal entries in each basis arise from timing differences in
the recording of transactions and shall still result to same ending balances in the
accounts receivable - assigned and loan payable accounts.
Illustration 4 - Comprehensive. SAN JOSE Company assigned P5,000,000 of its

accounts receivable to a bank on March 1, 2023. The bank advanced 70% of the
accounts receivable, less P30,000 service charge. The loan bears 9% interest. Over
the next three months, the following transactions involving the assigned accounts
were noted:
1. March 21, 2023- P2,000,000 assigned accounts were collected.
2. March 27, 2023- P500,000 assigned accounts were collected.
3. April 10, 2023 - P800,000 assigned accounts were collected.
4. May 15, 2023 - P750,000 assigned accounts were collected.
The amount of net proceeds on March 1, 2023 shall be determined as follows:
Total amount of assigned receivable P5,000,000
Multiply: Percentage to be lent 70%
Gross proceeds from the assignment _P3,500,000
Less: Service charge, if there is any 30,000 |
Net proceeds from the assignment P3,470,000
These transactions are recorded as follows: |
Date Non-Notification Basis Notification Basis

Cash 3,470,000 Cash 3,470,000
iach Service charge 30,000 Service charge 30,000
: Loan payable 3,500,000 Loan payable 3,500,000 | |
2023 | 4p - assigned 5,000,000 AR. ~ assigned 5,000,000

Accounts receivable —_ 5,000,000 Accounts receivable 5,000,000
a Cast ZNO No real-time recordi |

2023 A.R. - assigned 2,000,000 meOveIng
March a4
27 Cash 500,000 N Iti di
2023 | 4R- assigned 500,000 ESE AME TRO Sing |
ee
170
The
Date - Non-Notification Basis tee _Notification Basis

f Total cash collection of P2,500,000 is | The transactions during the month
applied as payment for the loan: are summarized as follows:
Loan payable 2,500,000 Loan payable 2,500,000
March Cash 2,500,000 A.R. - assigned 2,500,000
ae Payment of interest for the month: Remittance to the bank for the
Interestexpense 26,250" payment of interest expense:
Cash 26,250 | Interest expense 26,250
*(P26,250 = P3.5M x 9% x 1/12) Cash 26,250
April C
ash 800,000 : y
an AR. - assigned 800,000 No ale sme recording
The cash collection of P800,000 is
applied as payment for the loan:
The transactions during the month
Loan payable 800,000 : ;
Cush 800,000 | 3° summarized as follows:
: ; Loan payable 800,000
April | Payment of interest for the month: AR. ~ assigned 800,000
30, #
2023 : ies EXPENSE ne 500 Remittance to the bank for the
a if payment of interest expense:
*(P7,500 = PIMx 9% x 1/12). The loan
payable has a beginning-of-the month Interest expense 7,500
balance of P1M (P3.5M~ P2.5M), while Cash 7,500
its ending balance amounted to
P200,000 (P1M - P800,000)
May
Cash 750,000 3 :
sk Ap issigned 750,000 No real-time recording
Only the P200,000 portion of The transactions during the month

receipts is applied as payment for are summarized as follows:
the remaining balance of the loan: Loan pavabte 200,000
Loan payable 200,000 Receivable from bank 548,500
Ma Cash 200,000 | Interest expense 1,500
3 y ; A.R. - assigned 750,000
1, | Payment of interest for the month:
2023 The readers should take note that no
Interest expense 1,500 remittance is needed for interest
Cash 1,500 expense since the interest due will be
*(P1,500 = P200,000 x 9% x 1/12). The just offset against the amount of
loan payable has a beginning-of-the entity's receivable from the bank:
month balance of P200,000.
171
The
CamScanner
Cash 548,500 5
Lastly, the entry to record the Receivable from bank 548,500
transfer of uncollected assigned A.R.
to unassigned A.R: The above entry is exclusive to
notification basis. Lastly, the entry
Accounts receivable 950,000* to record the transfer of uncollected
A.R. - assigned 950,000 | assigned A.R. to unassigned A.R.:
*P5,000,000 - P2,000,000 - P500,000- | Accounts receivable 950,000

P800,000 - P750,000 A.R. - assigned 950,000
—]
Under the notification basis, the amount of receivable from bank shall be
determined as follows:
Cash received during May P750,000
Less: Balance of loan payable (200,000)
Interest during May (1,500)
Net receivable from bank P548,500
Summarizing the preceding transactions, the following amounts are reported as of

the following dates:
3/1/23 3/31/23 4/30/23 5/31/23
AR. - assigned P5,000,000 P2,500,000 P1,700,000 P950,000
Less: Loan payable 3,500,000 1,000,000 200,000 =
Equity in assigned A.R. 1,500,000 1,500,000 1,500,000 =
The readers should take note that in the absence of sales discounts, sales returns,
sales allowance and written-off accounts related to the assigned accounts receivable,
the equity in the assigned accounts receivable is the same all throughout.
172
The
The Book
CREDIT CARD TRANSACTIONS

The following are the parties in a transaction involving the purchase of goods or
services using credit cards:
presents credit card as payment

Seller ¢ Customer (Credit
(Merchant) >| Cardholder)
provides goods or services
Bank or other
financial
institutions
A credit card is a plastic card with either a magnetic strip or a chip which contains
information about the credit cardholder (e.g., available credit, PIN, etc.). The
readers should take note that the focus of this section is on the perspective of the
seller (merchant).
Illustration 5. On June 15, 2023, MUZON Company sold P900,000 worth of goods
to a customer. That customer presented a credit card issued by BPI. On June 20,
2023, the Company obtained payment from BPI, less 0.5% service charge.
On June 15, 2023, the entry to record the sale is as follows:
Accounts receivable — BPI : 900,000

Sales 900,000
The readers should take note that the receivable is against the bank, not against the
customer. On June 20, 2023, the entry to record the Company’s receipt from bank,
less service charge, is as follows:
Cash 895,500
Service charge (P900,000x 0.50%) 4,500
Accounts receivable - BPI 900,000
173
The
Assignment
r 6 - Re ce iv ab le Fi nancing — Pledge and
Chapte
‘
CHAPTER SUMMARY ity 0 cash from the entity,
hods accelerate the availabil
1. Receivable financing met
collateral f, r
receivables.
ng, the gen era l bal anc e 0 f accounts receivable serves as the
2. In pledgi no gain or loss shal be
ts receivab le is not derecognized anda
the related loan. Accoun
dged receivables.
recognized from the ple ogn ized as a separate liability
. Related interes,
the pr oc ee ds are rec
3. In pledging,
cognized separately.
expense shall also be re receivable serve as the col
lateral for the relate
me nt , spe cif ic ac co un ts the assigneg
4. In assi gn
loa ned to the ent ity is usually less than 100% of and write.
loan. The amount
anc e to acc oun t for pos sible returns, discounts,
accounts receivable bal
= (Assigneq
offs.
ds fro m assignment is determined as Proceeds
5. The amount of procee vice Charge.
Rec eiv abl e x % Loa n ed) - Finance or Ser to separate
Accounts
rec eiv a ble are not der ecognized but transferred
6. Assigned accounts ounts Receivable - Assigned)
.
rec eiv abl e acc oun t (i.e . Acc
accounts tification basis.
e through notific ation or non-no
Assignment can either be mad pay the bank
men t is mad e thr oug h not ification basis, the debtors shall
ON
If the ass ign

bank shall be returned to
directly instead of the entity. Any excess collection of the
the entity. rs shall continue
ough non-notifica tion basis, the debto
9. Ifthe assignment is made thr to the
ts are require d to be periodically remitted
to pay the entity, but the paymen
bank. es less
al to the balance of assigned receivabl
10. Equity from assigned receivables is equ
the balance of the related borrowing.
s redit card, the receipt of cash is accelerated
11.Ifa sale is made through the customer' c customer
uer (i.e., a bank) pays the entity sooner than the
since the credit card iss
normally could.
174
The
Nevule amScanner
Le] CamScanner
CamS
True or False
i Receivable financing is concerned with accelerating an entity's ability to turn its
unsold inventory into receivable from customers.
Zz Pledging of receivables is one of the ways to sell an entity's receivables.
3. Factoring of receivables is one of the ways to sell an entity’s receivables.
4 In assignment, the risk and rewards from the assigned receivables are retained by
the assignor.
Cash receipts from pledged receivables are not required to be applied to the related
loan payable.
Cash receipts from unassigned receivables are not required to be applied to the
entity’s borrowings.
In assignment, a journal entry is made to derecognize the assigned receivables since
the cash receipts from these receivables are required to be applied to the related
borrowing.
Gain or loss on assignment shall be determined as the difference between the net
proceeds received and the carrying amount of the assigned receivables.
In an assignment made in a notification basis, the bank is entitled to the amount of
cash receipts in excess of amount loaned to the entity.
10. After fully paying the related borrowing, any remaining balance in the accounts
receivable-assigned account shall be reverted back to the general accounts
receivable account.

1. The following are modes of receivable financing, except
a. Pledging
b. Assignment
c. Factoring
d. Allofthe above are modes of receivable financing
2. Which of the following is not correct regarding assignment of receivables?

a. Ifthe assignment is made on a notification basis, the assigned receivables shall
be derecognized since it is the bank that will now collect the receivables.
b. Ifthe assignment is made on a non-notification basis, the assigned receivables
shall not be derecognized since it is still the entity that will collect the
receivables.
c. No gain or loss shall be derecognized whether the assignment is made on
notification or non-notification bases.
d. Interest expense from the related borrowing shall be based on the beginning-of-
the-month balance of the borrowing.
175
The
CamScanner
3. Which of the following modes of receivable financing involve the “selling” of

receivables?
a. Discounting and assignment
b. Pledging and assignment
c. Discounting and factoring
d. Factoring and pledging
4. Which of the following modes of receivable financing involve the “collateralization”
of receivables?
a. Pledging and assignment
b. Discounting and pledging
c. Factoring and assignment
d. Factoring and pledging
5. In accounting for pledge of receivables, which of the following is/are true?
a. The difference between the carrying amount of pledged receivables and the net
proceeds is not recognized as gain or loss on pledging.
b. The pledged receivables shall not be separately recorded nor disclosed in the
financial statements.
c. Bothaandb
d. Neitheranorb
Straight Problems
1. On January 1, 2023, BRITAIN Company, who is currently experiencing collection
issues with its receivables, pledged its accounts receivable amounting to P5,000,000
to a bank. In return, the bank lent P4,000,000 2-year, 7% interest-bearing loan.
Interest is payable every December 31 of each year, starting in 2023.
Required: Determine the journal entries for the year 2023 and the disclosure to be
presented in the notes in relation to the pledge.
2. ABRAHAM Company assigned, on March 1, 2023, P3,000,000 of its accounts

receivable because of cash flow problems. The assignee bank loaned the Company
80% of face amount of the receivables and will charge 12% interest per annum. After
one month, accounts of P1,350,000, less P45,000 sales discount, were collected from
the assigned account. Accounts of P15,000 were written-off.
Required: Determine the journal entries for the months of March and April 2023
assuming the assignment is made under (a) non-notification basis and (b)
notification basis.
3. On July 1, 2023, IRELAND Company assigned P4,000,000 of its accounts receivable

to a bank. Due to high quality of the accounts, the bank lent 90% of the assigned
receivable and charged P12,000 service charge. The loan bears 12% annual interest
that is payable at the end of each month.
176
The
The Book
During the month of July 2023, P1,800,000 accounts were collected less P50,000
sales discount. On the other hand, during the month of August 2023, the remaining
accounts were collected, less P60,000 sales discount.
Required: Determine the journal entries for the months of July and August 2023
assuming the assignment is made under (a) non-notification basis and (b)
notification basis.
4. At the start of 2023, ANDREW Company had a total balance of accounts receivable
at P4,000,000 and allowance for bad debts of P150,000. Because of cash flow
problems, the Company was forced to assign P2,500,000 of these. receivables
(related allowance for bad debts amounted to P100,000) to a bank. The bank loaned
the Company 80% of the gross amount of the receivables, less 1% service charge
based on assigned accounts and will charge 9% interest on the loan balance.
Collections are applied to the loan balance at the end of each month. The following
monthly collections were recorded:
Assigned Unassigned
January P900,000 — P500,000
February 750,000 400,000
March 350,000 250,000
April 300,000 200,000
May 150,000 125,000
Accounts amounting to P50,000 and P25,000, related to assigned and unassigned
receivables, respectively, were written off during the month of May. Receivable
collections are to be fully applied to the principal (i.e., additional amounts are paid
or remitted for the interest).
Required: Determine the journal entries January 2023 to May 2023 assuming the
assignment is made under (a) non-notification basis and (b) notification basis.

1. BOOTH Company assigned P2,000,000 of its receivables to a financing company,
with related allowance for bad debts amounting to P12,000. The financing company
lent the Company 75% of the face amount of receivables, less 3% service charge
based on the face amount of receivables.
The amount of net proceeds received by the Company at the date of assignment
a. P1,428,000 c. P1,440,000
b. P1,488,000 d, P1,455,000
The initial amount of equity in assigned receivables shall be

a. P500,000 c. P460,000
b. P488,000 d. P448,000
177
The
The Book
2. LINCOLN Company assigned P2,000,000 of its accounts receivable on September 1,

2023. The assignee bank loaned the Company 70% of face amount of the receivables
and charged 12% interest per annum and P30,000 service fee. After one month,
assigned accounts of P1,000,000 were collected less P50,000 sales discount.
The amount of net proceeds received by the Company on the date of assignment
a. P1,370,000 c. P1,400,000
b. P1,970,000 d. P1,160,000
The equity in assigned receivables at the end of the first month shall be
a. P570,000 c. P600,000
b. P520,000 c. P550,000
The interest expense during the second month shall be
a. P4,500 c. P14,000
b. P5,000 c. P13,700
3. On July 1, 2023, ULYSSES Company assigned P3,000,000 of its accounts receivables

to a bank. The bank loaned 85% of the face amount of these receivables due to their
high credit quality less P40,000 service charge. Related interest rate is 9%. The
customers were informed of the assignment and were required to pay directly to the
bank. For the months of July, August and September, the bank collected 40%, 35%
and 25% of the assigned accounts receivable, with no deductions (i.e., no sales
discounts, returns, allowances or bad debts). For simplicity, the collections are
applied to the amount of the loan at end of each month.
The amount of net proceeds received by the Company on the date of assignment
a. P2,550,000 c. P3,000,000
b. P2,510,000 d. P2,960,000
The total amount of interest expense from July to September 2023 shall be
a. P28,600 c. P31,500
b. P29,525 d. P34,550
Assuming that the interest due for September 2023 is deducted from the bank's
excess collections of assigned receivables, the net amount of excess collections that
shall be returned to the Company at the conclusion of assignment shall be
a. P750,000 c. P747,750
b. P517,750 d. P447,750
4. At the beginning of 2023, HOPKINS Company reported a total accounts receivable

balance of P10,000,000 and related allowance for bad debts of P250,000. The
Company expects that it will need a huge amount of cash early in the year to pay its
maturing obligations.
178
The
The Book
Consequently, P4,000,000 of the balance is pledged to a one-year bank loan

amounting to P2,500,000. The bank deducted in advance the annual interest of 8%.
Another P3,000,000 accounts were assigned to another bank while receiving a 7%
interest-bearing loan representing 80% of the assigned receivables, Related service
charge amounted to P25,000,
From this information, the total amount of net proceeds received from all of the
receivable financing transactions shall be
a. 4,675,000 c. P4,900,000
b. P4,875,000 d. P4,775,000
179
The
Chapter 6A — Receivable Financing — Factoring and Discounting
CHAPTER 6A
RECEIVABLE FINANCING - FACTORING AND
DISCOUNTING

1. The structure of factoring transactions.
2. The accounting for factoring transactions (i.e., with recourse or without recourse)
3. Thestructure of discounting of notes receivable.
4. The accounting for the different types of discounting of notes receivable (ie,
without recourse, conditional sale, and secured borrowing).
FACTORING TRANSACTION
In a factoring transaction, the entity sells its receivables to another entity called a
“factor”. The factor is usually a bank, lending company, or other financial institution
who will then collect the receivables directly from the customers. —
As to the frequency, the following are the different types of factoring transactions:
Casual Factoring Regular Factoring Agreement
One-time or irregular factoring of | All of the entity's accounts receivables
receivables only when the need for extra | are regularly factored, instead of waiting
cash arises for the customers to pay their accounts
As to the entity’s liability for the factored receivables, the following are the
different types of factoring transactions:
Without Recourse With Recourse
The entity is not liable in cases wherein | The entity is still liable in cases wherein
the customers were unable to pay the the customers were unable to pay the
factor factor
The net proceeds from factoring are computed as:

Balance of factored accounts receivable PXxx
Less: Factor’s holdback (% x balance of factored accounts receivable), if any XX
Factoring charge or commission, if any XX
Financing charge (interest expense), if any XX_
Net proceeds from factored accounts receivable PXX
Factor’s holdback represents the portion of the factored accounts receivable

withheld by the factor (i.e., the portion that is not immediately given to the entity):
The purpose of withholding is to account for the possible sales discounts, returns:
allowances, and uncollectible accounts arising from factored receivables.
180
The
This amount is considered as a receivable since after collecting all of the factored
receivables, the factor shall pay this amount to the entity less actual sales discounts,
returns, allowances and uncollectible accounts, if any, related to factored accounts.
ACCOUNTING FOR FACTORING TRANSACTIONS
In general, the following are the accounting procedures that shall be made as a
result of a factoring transaction:
a. The factored receivables shall be derecognized.
b. Factor’s holdback is recognized as a receivable from factor.
c. Factoring charge, commissions, and financing charge are all recognized as
expenses. The total of these amounts can also be considered as the total “loss on
factoring”.
d. For factoring with recourse, a recourse liability and a corresponding loss shall be
recognized in addition to procedures a, b, and c above.
Illustration 1 - Casual Factoring Without Recourse. As of January 15, 2023, an

entity had a very small amount of cash, but it needs to pay a large short-term
obligation maturing on January 20, 2023. Due to this financial:constraint, as of the
same date, the entity sold P500,000 of its accounts receivable for P420,000, with all
the risks and rewards assumed by the factor. Related allowance for bad debts for
the factored accounts amounted to P45,000.
The entry to record the factoring on January 15, 2023 is as follows:
Cash 420,000
Loss on factoring (squeeze) 35,000
Illustration 2 - Regular Factoring Without Recourse. On September 1, 2023,

PANTABANGAN Company factored P3,000,000 of its accounts receivable without
recourse. The factor withheld 15% of the accounts receivable and charged 5%
service charge. In addition, advance annual interest of 12% are deducted based on
the 45-day expected average period before the customers fully pay the factor.
The net proceeds received from factor on September 1, 2023 is computed as

follows:
Balance of factored accounts receivable P3,000,000
Less: Factor’s holdback (P3,000,000 x 15%) (450,000)
Factoring charge (P3,000,000 x 5%) (150,000)
Financing charge (P3,000,000 x 12% x 45/360) (45,000)
Net proceeds from factored accounts receivable P2,355,000
Journal entry to record the factoring on September 1, 2023 shall be as follows:
181
The
CamScanner
Cash 2,355,000
Receivable from factor 450,000
Factoring fee 150,000
Interest expense 45,000
Based on the above entry, total “loss on factoring” will amount to P195,000
(P150,000 + P45,000).
Assuming that on September 30, 2023, the factor reported that P40,000 of the
factored accounts cannot be collected and was deemed uncollectible. Additionally,
P50,000 of the factored accounts were covered by a credit memo due to returns,
The Company will record these amounts as follows:
Salesreturns 50,000
Receivable from factor : 90,000
After recording this entry, the receivable from factor will be reduced to P360,000
(P450,000 - P90,000). Assuming that on the same date, the factor settled the
remaining balance of factor’s holdback, the Company will record the settlement of
factor’s holdback as follows:
Cash 360,000
Illustration 3 - Regular Factoring With Recourse. Using the same information as

in PANTABANGAN Company, except that the factoring is without recourse.
Recourse liability had fair value of P400,000 on the same date. On | BEBE t,
2023, the factoring shall be recorded as follows:
Cash 2,355,000
Factoring fee 150,000
Interest expense 45,000
Loss from recourse liability 400,000
Recourse liability 400,000
Based on the above entry, total “loss on factoring” will amount to P595,000
(P150,000 + P45,000 + P400,000).
Assuming that on September 30, 2023, the factor reported that P40,000 of the
factored accounts cannot be collected and was deemed uncollectible. Additionally,
P50,000 of the factored accounts were covered by a credit memo due to returns.
The Company will record these amounts as follows:
182
The
The Book
Chapter 6A — Receivable Financing - Factoring and Discounting

Sales returns 50,000
After recording this entry, the receivable from factor will be reduced to P360,000
(P450,000 - P90,000). Assuming that on the same date, the factor settled the
remaining balance of factor’s holdback, the Company will record the settlement as
follows:
Cash 360,000
Lastly, the amount of recourse liability shall be reversed as follows:

Recourse liability 400,000
Loss from recourse liability 400,000
After recording the above reversal, net loss on factoring shall be P195,000
(P595,000 - P400,000), which is equal to factoring fee and interest expense.
DISCOUNTING OF NOTES RECEIVABLE

Every note receivable has a stated maturity date. The entity needs to wait until
maturity date to receive the note’s maturity value. However, tight cash positions
may compel an entity to look for ways to turn notes receivable into cash even before
the maturity date. This is when the discounting of notes receivable comes in to help
the entity manage its cash outflows. Discounting has the following general structure:
Entity Initial debtor-creditor relationship

(Payee) t > Maker
Bank or other
financial
institutions
For this chapter, discounting is told in the perspective of the payee-entity.
183
The
Since the payee-entity has already transferred the note receivable, the bank is now
entitled to receive the maturity value of the promissory note from the maker. Maturity
value will be discussed shortly.
NET PROCEEDS FROM DISCOUNTING
To understand more about discounting, it is crucial to understand initially how
much will be the net proceeds that an entity can receive when discounting its note
receivable:
Maturity value of notes receivable (Principal + Interest) Pxx
Less: Amount of discount XX
Net proceeds from discounting of notes receivable Pxx
The detailed step-by-step procedures in determining the net proceeds from discounting
are as follows:
1. First, compute for the total interest using the period from the note’s issue date up
to its maturity date as the “Time” in the following formula:
Total Interest = Principal x Stated Rate x Time
2. Next, compute for the maturity value using the following formula:
Maturity Value = Principal + Total Interest
It should be noted that noninterest-bearing note’s maturity value is equal to its

principal amount (i.e., no interest is added to arrive at maturity value).
3. Determine the Discount amount by using the period from the date of discounting
up to the note’s maturity date as the “Time” in the following formula:
Discount = Maturity Value x Discount Rate x Time
The discount rate, which is usually higher, is different from the stated rate. Discount
rate is the amount of advance interest charged by the bank or other financial
institutions. On the other hand, the stated rate is the interest rate appearing on the
face of the promissory note.
4. Finally, compute for the net proceeds using the Discount computed in Step 3:
Net Proceeds = Maturity Value - Discount ——
Illustration 4. On January 1, 2023, TALUGTUG Company received a 9% interest-

bearing promissory note, with P4,000,000 face amount, from one of its customers.
The note will mature on September 30, 2023. Required: Under each of the following
independent scenarios, determine the net proceeds from the discounting:
1. The note was discounted on April 1, 2023 at a 12% discount rate.
2. The note was discounted on July 1, 2023 at a 12% discount rate.
3. The note was discounted on July 1, 2023 ata 14% discount rate.
184
The
Chapter 6A - Receivable Financing - Factoring and Discounting
Scenario 1 - Discounted on April 1, 2023 at 12% Discount Rate

The following are the step-by-step procedures in computing for the net proceeds:
1. Compute for the total interest over the note’s term of nine months (January 1,
2023 to September 30, 2023) using the 9% stated rate as follows:
Interest = P4,000,000 x 9% x 9/12 = P270,000
2. Determine maturity value of the note:
Maturity Value = P4,000,000 + P270,000 = P4,270,000
3. Compute for the discount amount using 12% discount rate and six-month period
(April 1, 2023 discount date until September 30, 2023 maturity date):
Discount = P4,270,000 x 12% x 6/12 = P256,200
4. Finally, determine the net proceeds from discounting:
Net Proceeds = P4,270,000 - P256,200 = P4,013,800
Scenario 2 - Discounted on July 1, 2023 at 12% Discount Rate

Using the maturity value previously computed in Scenario 1, the net proceeds from
discounting in this Scenario 2 can now be easily computed as follows:
Maturity value of notes receivable P4,270,000
Less: Discount (P4,270,000 x 12% x 3*/12) (128,100)
Net proceeds from discounting of notes receivable P4,141,900
*three-month period from July 1, 2023 date of discounting to September 30, 2023 maturity.
Scenario 3 - Discounted on July 1, 2023 at 14% Discount Rate

Using the maturity value previously computed in Scenario 1, the net proceeds from
discounting in this Scenario 3 can now be easily computed as follows:
Maturity value of notes receivable P4,270,000
Less: Discount (P4,270,000 x 14% x 3*/12) (149,450)
*three-month period from July 1, 2023 date of discounting to September 30, 2023 maturity.
Generalization - Scenarios 1 to 3
The results of the computations are summarized as follows:
Discounted on Discountedon Discounted on
4/1/23 at12% 7/1/23at12% 7/1/23 at 14%
Maturity value P4,270,000 P4,270,000 P4,270,000
Less: Discount amount 256,200 128,100 149,450
Net proceeds 4,013,800 4,141,900 4,120,550
Based on this summary, the following can be generalized:
185
The
The Book
a. The closer the date of discounting to maturity date, the higher the amount of net
proceeds due to the lower amount of discount.
b. The higher the discount rate, the lower the amount of net proceeds due to the
higher amount of discount.
Illustration 5. On May 1, 2023, GUIMBA Company received a 180-day, noninterest.

bearing note with face amount of P2,000,000. Market rates on the same date
averaged 8%, On June 15, 2023, the note was discounted at 9% with a bank. (Use
360 days in interest and/or discount computations).
Net proceeds from discounting shall be computed as follows:
Maturity value of notes receivable (equal to faceamount) P2,000,000

Less: Discount (P2,000,000 x 9% x 135/360) (67,500)
The 135 days used in the computation of the discount amount is from June 15, 2023
date of discounting until October 28, 2023 date of maturity and shall be determined
as follows:
Month Days
June (30-15) 15
July 31 Note: Maturity date is on October 28, 2023 or 180
August 31 days after May 1, 2023.
September 30
October 28
135
ACCOUNTING FOR THE DISCOUNTING OF NOTES RECEIVABLE

The accounting for the discounting transaction will depend on the entity’s liability
(whether with or without recourse) after its notes receivable has been discounted:
Discounted Without Recourse — Discounted With Recourse -
Entity is not liable in case the maker did | Entity is still liable in case the maker did
not pay the bank or other party who | not pay the bank or other party who
discounted the note. discounted the note. This is classified
into either of the following:
1. Conditional sale - the sale will be
fully effective upon the full payment
of the maker.
2. Secured borrowing - the note
receivable merely serves as a security
(collateral) in the same manner as the
pledged receivables in the previous
chapter
186
The
CamScanner
Pro-forma journal entries to record the discounting are the following:

— “Piscounted Without Recourse Discounted With Recourse |
Cash XX If conditional sale:
Loss on discounting, ifany XX
XX Cash XX
Notes receivable
XX Loss on discounting, if any XX
Interest income
XX Notes receivable - discounted xx
Gain on discounting, ifany
Interest income XX
Notes receivable account is credited Gain on discounting, ifany Xxx
since the entity is not liable anymore in
Almost similar to discounting without
case the maker did not pay.
recourse except for the account credited.
Interest income is computed from the Notes receivable - discounted is a
note’s issue date up to the date of contingent liability account § and
discounting. This computation is also presented as a deduction from notes
applicable to discounting with recourse receivable account.
scenarios. If secured borrowing:
The amount of gain or loss is a squeeze Cash XX
amount. Most of the time, there is a loss Interest expense, if any XX
on discounting since the discount rate is Loan payable XX
almost always higher than stated rate. Interest income XX
Since the note receivable is just a

collateral, it is not derecognized. Instead,
a separate liability will be recognized.
The supposed loss on discounting is

reported as interest expense, while the
supposed gain is added to the interest
income.
To differentiate the periods used in computing amounts related to note discounting,

the following graphic is presented:
Used in computing maturity value

\
\
Used in computing interest income Used in computing discount
~-=--- fon nnn anand faa

Y { y
Date of Date of Date of
note’s issue discounting maturity
187
The
Illustration 6. On September 1, 2023, CUYAPO Company received an 11% interest.

bearing promissory note with face amount of P3,000,000 and maturity date of
August 31, 2024. Required: Assuming that on October 31, 2023, the Company
discounted it with a bank at a 14% discount rate, record the journal entry under
each of the following independent scenarios:
1. Discounting is without recourse
2. Discounting is with recourse and considered as conditional sale
3. Discounting is with recourse and considered as a secured borrowing
Scenario 1 - Discounting Without Recourse
The net proceeds from the discounting shall be determined as follows:
Principal amount P3,000,000
Add: Interest until maturity (P3,000,000 x 11% x 12/12) 330,000
Maturity value P3,330,000
Less: Discount amount (P3,330,000 x 14% x 10*/12) (388,500)
Net proceeds from discounting P2,941,500
*10 months from October 31, 2023 date of discounting to August 31, 2024 maturity.
The journal entry to record the discounting on October 31, 2023:

Cash 2,941,500
Loss on discounting (squeeze) 113,500
Interest income is computed over two months, from September 1, 2023 (note’s
issue date) to October 31, 2023 (date of discounting).
Scenario 2 - Discounting With Recourse - Conditional Sale
Computations are similar to the computations made in Scenario 1. The journal entry
to record the discounting on October 31, 2023:
Cash 2,941,500
Loss on discounting (squeeze) 113,500
Notes receivable - discounted 3,000,000
Assuming that on August 31, 2024, the maker paid the bank, CUYAPO Company
shall derecognize the contingent liability and the related notes receivable:
Notes receivable - discounted . 3,000,000
No journal entry was made for cash receipts since it is the bank that have received
the note’s maturity value.
188
The
The Book
Scenario 3 - Discounting With Recourse - Secured Borrowing

Computations are similarto the computations made in Scenario 1. The journal entry
to record the discounting on October 31, 2023:
Cash 2,941,500
Interest expense (squeeze) 113,500
Loans payable 3,000,000
Assuming that on August 31, 2024, the maker paid the bank, CUYAPO Company
shall derecognize the loan payable and the related notes receivable:
DISCOUNTING WITH RECOURSE - THE MAKER FAILED TO PAY

A note is considered as dishonored if the maker failed to pay the bank or other
financial institutions. No further accounting issues will arise if the discounting was
initially made as without recourse.
However, additional accounting procedures shall be made if the discounting is with

recourse to account for the entity’s liability to the bank or other financial
institutions. Despite the entity’s liability, it can still go after the maker and recoup
the payment it previously made to the bank on account of dishonoring the note.
The following are the accounting procedures if the maker dishonored the note and that
the discounting is made with recourse:
a. Derecognize the dishonored notes receivable and the related notes receivable -
discounted (for conditional sale) or loan payable (for secured borrowing).
b. Recognize, as a receivable from the maker, the total amount paid to the bank. These
amounts include the note’s face amount, interest, protest fees, and other charges that
bank may require from the entity.
c. Generally, no further gain or loss will be recognized since the amounts paid to the bank
are recoverable from the maker.
d. The receivable from the maker shall be derecognized upon full payment of the maker
which may or may not include additional interest.
Illustration 7. Continuing with Scenarios 2 and 3 of CUYAPO Company (Illustration

6), assume that on August 31, 2024, the maker did not pay the bank, and that the
Company became liable to pay the maturity value and P400,000 protest fee to the
bank. The following are the journal entries to record the entity's liability:
Scenario 2 - Conditional Sale Scenario 3 - Secured Borrowing
To record the derecognition of | To record the derecognition of
contingent liability and the related note | previously recorded liability and the
receivable: related note receivable:
189
The
CamScanner
N.R. - discounted 3,000,000 Loan payable 3,000,000

Notes receivable 3,000,000 Notes receivable 3,000,000
To record the total amount paid to the To record the total amount paid to the
bank which is comprised of P3,000,000 bank which is comprised of P3,000,000
face amount, P330,000 total interest and face amount, P330,000 total interest and
P400,000 protest fee: P400,000 protest fee:
Receivable from maker —_ 3,730,000 Receivable from maker = 3,730,000

Cash 3,730,000 Cash 3,730,000
Assume further that on December 1, 2024, the maker paid its obligation to the
Company, plus 11% interest. The journal entry to record this payment, whether
under Scenario 2 or 3, is as follows:
Cash 3,832,575
Receivable from maker 3,730,000
Interest income (P3.73M x 11% x 3/12) 102,575
The three months used in the computation of interest income is from August 31,
2024 to December 1, 2024.
DISCOUNTING OF AN ENTITY’S OWN PROMISSORY NOTE

In the previous examples, the discounted notes receivable is issued by the entity’s
customers or borrowers. However, an entity may also issue its own promissory
note when borrowing funds from a bank or other financial institutions. In this case,
the discounting of the entity's own promissory note will involve the advance
deduction of interest to arrive at the net proceeds from discounting.
Illustration 8. On January 1, 2023, PAPAYA Company discounted its own 6-month,

P2,000,000 face amount promissory note with a bank at a discount rate of 10%.
In this case, the proceeds from the discounting can be determined as follows:
Maturity value (equal to face amount) P2,000,000

Less: Discount amount (P2,000,000 x 10% x *6/12) (100,000)
Net proceeds from discounting P1,900,000
*term of the note
Journal entry to record the discounting on January 1, 2023 shall be:

Cash 1,900,000
Discount on notes payable 100,000
Notes payable 2,000,000
For simplicity’s sake, this discount amount is recognized as interest expense using
straight-line method. In this case, monthly interest expense of P16,667 (P100,000/6
months) will be recognized.
190
The
The Book
CHAPTER SUMMARY
1. Factoring is a form of receivable financing involving the “selling” of receivables.
zs As to frequency, factoring can either be casual factoring (i.e., one-time factoring) or
regular factoring (i.e., continuous factoring).
3. As to the liability of the entity related to the factored accounts, factoring can either
be without recourse (i.e., the entity is not liable) or with recourse (i.e., the entity is
still liable).
The proceeds from factoring can be determined as follows:
Balance of factored accounts receivable Pxx
Less: Factor’s holdback (% x factored accounts receivable),ifany xx
Factoring charge or commission, if any XX
Financing charge (interest expense), if any XX
Net proceeds from factored accounts receivable Pxx
In factoring, the factored receivables are derecognized and the difference between
the proceeds and the carrying amount of factored receivables is recognized in profit
or loss.
In factoring with recourse, a recourse obligation shall be recognized at its fair value.
This has the effect of increasing the loss to be recognized from factoring.
Discounting is a form of notes receivable financing involving the “selling” of
receivables.
The proceeds from discounting of notes receivable can determined as follows:
Principal amount Pxx

Add: Interest until maturity, if any XX
Maturity value PXX: -
Less: Discount amount (xx)
Net proceeds from discounting Pxx
The discount amount is determined as Maturity Value x Discount Rate x Time from
Date of Discounting Until Maturity Date.
The gain or loss on discounting shall be determined as the difference between the
following:
Carrying amount of the note, including accrued interest, if any Pxx
Less: Net proceeds from discounting (xx)
Loss (gain) on discounting Pxx
10. There are three forms of discounting of notes receivable: without recourse,
conditional sale, and secured borrowing. Their primary difference arises from the
entity's liability in case the maker of the note did not pay the bank.
1; Conditional sale and secured borrowing will make the entity still liable to the bank.
ae The account to be credited for discounting without recourse is the notes receivable
account; for conditional sale, it is the notes receivable discounted account; and for
secured borrowing, it is the loan payable account.
191
The
CamScanner
CHAPTER 6A: SELF-TEST EXERCISES

<==
True or False
1. In casual factoring, the amounts supposedly to be recognized in profit or loss are
lumped in a single amount of gain or loss on factoring.
2. The amount withheld by the factor shall be recognized as part of gain or loss on
factoring.
3. Inregular factoring, the supposed amount of gain or loss on factoring is categorized
into different accounts such as factoring fee, financing fee, loss on recourse
obligation, etc.
4, In factoring without recourse, the factored receivables are derecognized while in
factoring with recourse, the factored receivables are not derecognized.
5. Any sales discount, sales returns, sales allowances, and uncollectible accounts
arising from factored receivables shall be recognized by the entity and will reduce
the amount of factor’s holdback.
6. For accounting purposes, there are three types of discounting, namely the
discounting without recourse, conditional sale, and secured borrowing.
7. Under the conditional sale type of discounting, the entity is not liable in case the
maker did not pay the bank.
8. The amount of discount is generally based on the note’s face amount and computed
from the date of discounting until the note’s maturity date.
9. The noninterest-bearing promissory note’s maturity value is equal to its face
amount.
10. Under secured borrowing, the discounted notes receivable is derecognized.

1. In the perspective of the entity, the factor’s holdback is recognized as
a. addition to profit or loss
b. reduction of liability
c. anasset
d. deduction from profit or loss
2. The primary difference between the casual factoring and regular factoring is the
a. frequency of factoring transactions.
b. amount of factoring transactions.
c. entity's liability over the factoring transactions.
d. identity of the factor.
3. In determining the total gain or loss on factoring, all of the following are considered,
except
a. factoring fee, if any
b. interest charge, if any
c. factor’s holdback, if any
d. all of the above are considered in the amount of gain or loss on factoring.
192
The
The Book
Carre
4. The following are correct accounting procedures for factoring of receivables, except
a. Aliability is recognized whether the factoring is with or without recourse.
b. Whether casual or regular factoring, the factored receivables shall be
derecognized in the books of the entity.
c. The final settlement amount of factor’s holdback is reduced by the amounts of
sales discount, allowances, returns and uncollectible accounts.
d. Allofthe above are correct accounting procedures for factoring transactions.
5. In determining the net proceeds from factoring, all of the following are considered,
except:
a. Factor’s holdback
b. Service charge
c. Financing charge
d. Allowance for bad debts
6. The net proceeds from discounting can be determined as the difference between the
a. Face amount of the note and the discount amount.
b. Maturity value of the note and the discount amount.
c. Face amount of the note and the maturity value.
d. Total interest and the discount amount.
7. Generally, in determining the discount amount, all of the following are the relevant
inputs, except
a. Face amount of the note.
b. Discount rate.
c. Period of time.
d. All ofthe above are relevant inputs in computing the discount amount.
8. The discount amount shall be determined by applying the discount rate and using a
period of time
a. from the note’s issue date until its maturity date.
b. from the notes issue date until the date of discounting.
c. from the date of discounting until its maturity date.
d. any ofthe above, whichever is the shortest.
9. The net amount of gain or loss on discounting
is the difference between which of the
following amounts:
a. Face amountand the proceeds from discounting.
b. Face amount and the maturity value,
c. Discountamount and accrued interest.
d. Face amount plus accrued interest and proceeds from discounting.
10. All of the following accounting procedures in relation to note discounting are
correct, except
a. The notes receivable - discounted account shall be credited if the discounting is
considered as a conditional sale.
b. The supposed loss on discounting shall be considered as interest expense if the
discounting is considered as a secured borrowing.
193
The
The Book
c.. The notes receivable account shall be credited if the discounting is considereq
as a secured borrowing.
d. The difference between the face amount plus accrued interest and proceeds
from discounting is recognized as gain or loss on discounting if the transaction
is considered as a conditional sale.
Straight Problems
1. On January 1, 2023, MERMAID Company casually factored on a without recourse
basis P2,500,000 of its accounts receivable. The factor withheld 15% of the amount
of the factored receivables and charged 4% commission based on the same amount.
Required: Determine the journal entry to record the January 1, 2023 factoring.
2. On June 1, 2023, PRIMATE Company is in a very tight cash position and decided to
casually factor on a without recourse basis P1,800,000 of its accounts receivable
balance. The factor withheld 20% of the factored receivables and charged 6%
commission on the factored accounts. The Company estimates its allowance for bad
debts at 3% of its accounts receivable balance.
By the end of June 2023, the factor collected all of the receivables, except for the sales
discount of P25,000 and uncollectible accounts of P55,000. Consequently, the
remaining factor’s holdback was settled with the entity.
Required: Determine the journal entries related to the factoring.
3. To accelerate the collection of its receivables, CLAW Company entered into a

continuing and with recourse factoring arrangement with a factor. During the month
of September 2023, the Company factored P3,000,000 of its receivable wherein the
factor withheld 25% of the factored receivables balance. In addition, commission of
5% and advanced interest of 12% based on the estimated weighted average period
of time of 30 days before the receivables are collected from the customers were
charged. Recourse liability had a fair value of P150,000 on the date of factoring.
By the end of September 2023, all of the factored receivables were collected in cash,
except for P100,000 sales returns and P60,000 uncollectible accounts.
Required: Determine the journal entries related to the factoring.

4. An entity entered into the following note discounting transactions:
Face | Issuance | Maturity Date of | Stated | Discount

Note Amount Date Date | Discounting |__Rate Rate
1_ | P3,000,000 1/1/23 | 6/1/23 3/1/23 6% 7%
2 4,000,000 | 2/28/23 | 9/30/23 7/1/23 5% 7%
3 4,500,000 3/1/23 3/1/24 12/1/23 7% 9% |
4 2,000,000 | _5/1/23 | 2/1/24 8/1/23 9% 10%
5 | 5,000,000 | 6/1/23 | 1/1/24 9/1/24 | 8% 10%|
194
The
Required: Determine the following for each of the discounted note:

a. Proceeds from each of the discounted notes.
b. Journal entry to record each of the discounting, assuming it is done without
recourse.
c. Journal entry to record each of the discounting, assuming it is considered
conditional sale.
d. Journal entry to record each of the discounting, assuming it is considered as
secured borrowing.
5. On March 1, 2023, LEGION Company received a 180-day 7% interest-bearing note

with face amount of P2,500,000. On April 30, 2023, the Company decided to discount
the note with a bank at a discount rate of 9%.
Required: Determine the journal entry to record the discounting under each of the
following independent assumptions:
a. the note is discounted without recourse
b. the discounting is considered as conditional sale
c. the discounting is considered as a secured borrowing
6. At the beginning of 2023, TESLA Company received a one-year noninterest-bearing
note with face amount of P3,500,000. Market rates on that date averaged 8%. On July
1, 2023, the note was discounted with a bank at a discount rate of 10%.
Required: Determine the journal entry to record the discounting under each of the
a. the note is discounted without recourse
b. the discounting is considered as conditional sale; and
c. the discounting is considered as a secured borrowing.
7. On April 1, 2023, RHINO Company discounted its 10-month, 6% interest-bearing

note receivable dated January 1, 2023 and with face amount of P6,000,000. The bank
charged a discount rate of 8%. On November 1, 2023, the date of maturity, the maker
of the note failed to pay the bank. The Company paid the bank the maturity value of
the note plus protest fee of P300,000.
Later, on January 31, 2024, the maker paid the Company all the amount due from it
plus interest of 6% on the amount due.
Required: Determine the journal entry to record the discounting, the dishonoring of
the note and the subsequent payment of the maker under each of the following
independent assumptions:
a. the discounting is considered as conditional sale; and
b. the discounting is considered as a secured borrowing.
195
The
The Book
8. HARRISON Company had the following notes receivable transactions for the year
2023:
Received a nine-month, 7%, P600,000 note from ALPHA Company
01/01/2023 for goods sold.
Received an eight-month, noninterest-bearing P1,000,000 note
02/28/2023 from BETA Company as payment for goods sold by the Company.
Effective interest rate as of this date was 8%.
Discounted the note from ALPHA Company at a discount rate of
04/01/2023 8%. The discounting is with recourse and considered as
conditional borrowing.
Received a one-year, 9%, P900,000 note from GAMMA Company
05/01/2023 as a settlement of a long outstanding accounts receivable.
Discounted the note from BETA Company ata discount rate of 6%.
06/30/2023 The discounting is with recourse and considered as secured
borrowing.
Lent P2,000,000 to OMEGA Company, receiving a four-month,
07/31/2023 10% promissory note.
ALPHA Company did not pay the bank. As a result, the Company
10/01/2023 paid the bank the maturity value of the note plus P18,500 other
charges.
Received a notice from the bank that BETA Company has already
10/28/2023 paid the maturity value of the note.
11/30/2023 OMEGA Company paid its note.
12/31/2023 ALPHA Company paid the total amount due, plus 7% interest.
Required: Record the journal entries related to the preceding transactions

(including adjusting entries, if there are any).

1. RUTHERFORD Company reported total receivables of P2,000,000. To obtain
additional cash, the Company factored, without recourse, P700,000 of accounts
receivable with a financing company. The finance charge is 5% of the amount
factored while service charge is 1%. In addition, the finance company withheld 15%
of the accounts receivable to cover future sales discounts, returns, or write-offs.
Allowance for bad debts related to the factored receivables amounted to P40,000.
The amount of proceeds from factoring shall be

a. P1,580,000 c. P521,400
b. P553,000 d. P658,000
The total net gain or loss from factoring shall be

a. P42,000 gain c. P2,000 gain
b. P42,000 loss d. P2,000 loss
196
The
Chapter 6A ~ Receivable Financing — Factoring and Discounting
2. On January 1, 2023, HAYES Company factored P500,000 of its accounts receivable

on a with recourse basis. The factor withheld 20% for possible write-offs, sales
discounts, or sales returns. In addition, finance charge of 4% and service charge of
2% were deducted from the proceeds. The fair value of the recourse obligation
amounted P30,000 as of that date.
By January 31, 2023, the factor reported P300,000 cash collections while write-offs
and sales discount amounted to P25,000 and P10,000, respectively. By February 28,
2023, the finance company collected all of the remaining receivables less P20,000
account written-off. The finance company immediately returned the excess amount
collected to the Company.
The amount of proceeds from factoring shall be

a. P470,000 c. P370,000
b. P440,000 d. P340,000
Net amount to be returned by the finance company on February 28, 2023 shall be
a. P75,000 . c. P65,000
b. P55,000 d. P45,000
3. On July 1, 2023, YAM Company discounted without recourse its 9-month notes
receivable with face amount of P3,000,000 and stated rate of 10%. The note is dated
March 1, 2023 and discounted using 12% discount rate from the bank.
The amount of proceeds from discounting shall be

a. P3,096,000 c. P2,838,750
b. P3,063,750 d. P2,871,000
The gain or loss on discounting shall be

a. P36,250 gain c. P261,250 gain
b. P36,250 loss d. P261,250 loss
4. On March 5, 2023, POTATO Company received a 240-day note receivable from one
of its customers. The face amount is P4,500,000 while interest rate is stated at 9%.
On June 3, 2023, the note was discounted without recourse and with the bank
charging 12% discount rate.
a. P4,542,500 c. P4,626,900
b. P4,625,800 d. P4,531,500
The gain or loss on discounting shall be °

a. P69,750 gain c. P25,650 gain
b. P69,750 loss d. P25,650 loss
197
The
The Book
5. On May 1, 2023, TUBER Company received a 9-month, 8% interest-bearing

promissory note from its customer. The note has a face amount of P3,000,000.
On November 1, 2023, the note was discounted with recourse to a bank at a discount
rate of 10%. On maturity date, the maker failed to pay the note, requiring the
Company to pay the maturity value of the note plus protest fee of P120,000 to the
bank.
On April 30, 2024, the maker paid the Company the total amount due plus interest
of 8%.
a. P3,090,500 c. P3,100,500
b. P3,016,000 d. P3,021,000
The gain or loss on discounting shall be

a. P19,500 gain c. P99,000 gain
b. P19,500 loss d. P99,000 loss
The total amount paid to the bank on maturity date shall be
a. P3,300,000 c. P3,120,000
b. P3,180,000 d. P3,000,000
The total amount paid by the maker to the Company on April 30, 2024 shall be
a. P3,366,000 c. P3,182,400
b. P3,243,600 d. P3,060,000
198
The
The Book
Chapter 7 — Inventories — Preliminary Considerations
CHAPTER 7
INVENTORIES - PRELIMINARY CONSIDERATIONS

1. The definition of inventories and the items that can qualify as such.
2. Theinitial measurement of inventories and the capitalizable amounts that will form
part of that initial measurement.
3. The different types of inventories depending on the entity’s operations.
4. The different ways of recording inventory purchases (periodic vs. perpetual and
gross method vs. net method)
INVENTORIES - INTRODUCTION
Imagine yourself in the aisle of the largest supermarket in your area. The canned
goods, raw meat, vegetables, packed noodles, drinks, cosmetics, detergents and
other things you will see are all “inventories” of that supermarket. The same goes
with the clothes in department stores and medicines in the pharmacies. In short, in
layman’s term, inventories are those being sold by an entity in their normal
operations.
So, why do entities sell inventories? They sell inventories to earn “gross profit”
which is the difference between the selling price and the cost to produce or
purchase the inventory sold. From this amount, other operating expenses will be
charged and the remaining amount will serve as the “net profit”. Based on this, for
entities who are involved in selling tangible products, inventories are their lifeline
and serve as the reason for them to continue their operations.
INVENTORIES ACCORDING TO ACCOUNTING STANDARDS

According to PAS 2 Inventories, inventories are assets:
a. held for sale in the ordinary course of business;
b. in the process of production for such sale; or
c. inthe form of materials or supplies to be consumed in the production process or
in the rendering of services. [PAS 2.6].
It should be noted that for a product to qualify as inventory, any one of these
criteria should be met. Students should master this definition as it is very crucial
in solving problems involving items of inventory.
Item (a) in the definition mentions ordinary course of business which means the
activities that are normally undertaken by an entity in its operations. In other
words, the classification of an asset as inventory depends on who currently controls
the asset in question.
199
The
CamScanner
For example, the chairs and tables of a restaurant are not inventories of that
restaurant because the ordinary course of its business involves selling food and
service, not selling chairs and tables. However, these are considered as inventories
of the manufacturer of chairs and tables since its normal operations involve the
manufacturing and selling these items.
Other examples of assets that will qualify as inventories of specified entities:
a. House and lot for sale by a real property developer.
b. Animals for sale by a pet shop.
c. Machinery for sale by a hardware store or manufacturer of hardware products.
INITIAL MEASUREMENT OF INVENTORY
The cost of inventories shall comprise all costs of purchase, costs of conversion,
and other costs incurred in bringing the inventories to their present location
and condition. /PAS 2.10]. Details on each category will be discussed shortly.
COSTS OF PURCHASE
The costs of purchase of inventories comprise the following:
purchase price;
import duties;
non-recoverable taxes (recoverable taxes are excluded);
transport costs (excluding transport costs to customers or freight out);
moan
handling costs; and

other costs directly attributable to the acquisition of finished goods, materials
and services. [PAS 2.11].
Trade discounts, rebates, and other similar items are deducted in determining the
costs of purchase. [PAS 2.11].
Illustration 1. ANNA Company purchased inventories from abroad for resale
incurring the following costs:
List price of inventory P1,000,000
Trade discount 10%
Import duties 200,000
Import tax - not recoverable 75,000
Import tax - recoverable 25,000
Freight from abroad to Philippine port 30,000
Freight from Philippine port to warehouse 10,000
Freight from warehouse to customer 15,000
The total cost to be included in the balance of inventory is computed as follows:
200
The
CamScanner
List price of inventory P1,000,000

Trade discount (P1,000,000 x 10%) (100,000)
Import duties 200,000
Import tax - not recoverable 75,000
Freight from abroad to Philippine port 30,000
Freight from Philippine port to warehouse 10,000
Cost to be included in inventories P1,215,000

a. Thelist price shall be reduced by the trade discount to arrive at the invoice price.
Assuming that the P1,000,000 is already stated as the invoice price, no deduction
of trade discount will be made.
_ b. Import tax - recoverable amounting to P25,000 can be recovered through other
means so this will be reported as an asset apart from the inventory.
c. Freight from warehouse to customer of P15,000 will be reported as selling
expense as freight out.
Basket Purchase of Inventories
An entity may purchase different inventories in a single transaction. In that case,
the “basket” price (including common costs) shall be allocated using the relative
sales value method. This method uses the proportion of the selling price of each
inventory to the total selling price of all the inventories purchased.
Illustration 2. In a single transaction, a supermarket purchased boxes of soap,

shampoo, and detergent for its inventory. The total purchase price is P1,600,000
while the selling prices of soap, shampoo and detergent were P800,000, P700,000
and P500,000, respectively. Using the relative sales value method, the total
purchase price is allocated to each of the three products as follows:
Selling Allocation Allocated
Prices Ratio Cost
Soap P800,000 40% (800/2,000) P640,000 (1,600,000 x 40%)
Shampoo 700,000 35% (700/2,000) 560,000 (1,600,000 x 35%)
Detergent 500,000 25% (500/2,000) 400,000 (1,600,000x 25%)
P2,000,000 100% __P1,600,000
Based on the previous computations, the allocated costs are P640,000, P560,000
and P400,000 for soap, shampoo, and detergent, respectively.
Costs of Inventory Purchased under Deferred Settlement Basis
When the arrangement effectively contains a financing element, such as when there
is a difference between the purchase price for normal credit terms and the amount
paid, the entity recognizes the difference as interest expense over the period of the
financing. [PAS 2.18]. The cost of purchase in this case shall be equal to the cash price
of the acquired inventory. This will be discussed later under the net method of
recording.
201
The
COSTS OF CONVERSION
The costs of conversion of inventories include the costs directly related to the units
of production such as direct labor. They also include a systematic allocation of
fixed and variable production overheads that are incurred in converting
materials into finished goods. [PAS 2.12]. These costs are to be discussed in the
inventories of a manufacturer.
OTHER COSTS
Other costs are included in the cost of inventories only to the extent that they are
incurred in bringing the inventories to their present location and condition.
For example, it may be appropriate to include non-production overheads or the costs
of designing products for specific customers in the cost of inventories. [PAS 2.15].
COSTS EXCLUDED FROM THE COST OF INVENTORIES

Examples of costs excluded from the cost of inventories and recognized as expenses
in the period in which they are incurred are the following:
a. abnormal amounts of wasted materials, labor or other production costs;
b. storage costs unless those costs are necessary in the production process before
a further production stage;
c. administrative overheads that do not contribute to bringing inventories to their
present location and condition; and
d. selling costs. [PAS 2.16].
In relation to storage cost, it shall be capitalized as cost of inventories if it relates
to the storage of raw materials and work-in-process. On the other hand, storage
cost shall not be capitalized (i.e., expensed) if it relates to storage of finished
goods as there will be no further production stage.
Illustration 3. BEATRICE Company accepted a special manufacturing order from
RIZZA Company. The Company incurred P250,000 for materials and P170,000 for
conversion costs. Since this is a special order, the Company also incurred P100,000
for designing the product and P50,000 for modifying the current production
process. In addition, excessive wastage of materials amounting to P80,000 was
incurred because of the highly-specialized nature of the order. Lastly, the Company
also incurred storage cost of P70,000 when the inventory was in work-in-process
stage and P40,000 when it was already a finished product.
The amount to be capitalized as part of the cost of inventory is determined as
follows:
Materials P250,000
Conversion costs 170,000
Cost of designing 100,000
Cost of modification 50,000
Storage cost in work-in-process stage 70,000
Cost to be included as part of inventory’ P640,000
202
The
CamScanner
All of the costs included were all necessary for the production of the inventory. The
following costs were excluded due to the reasons provided:
a. Wasted materials of P80,000 are excluded as this is part of inefficiencies on the
part of the management.
b. Storage costs of P40,000 were incurred when the order has already been
finished. Hence, no further production process will be applied, and the order is
now ready for sale to RIZZA Company.
INVENTORY OF A TRADER OR A MERCHANDISER
A trader or a merchandiser is an entity that buys finished goods from another
trader or directly from a manufacturer for resale. It has only one type of inventory
which can be called as “merchandise inventory”, “inventory for resale”, “inventory”
or any other term which can properly describe it. Merchandiser tries to sell the
inventory at a higher price above its cost of purchase to earn gross profit. Good
examples of a merchandiser are convenience stores, bookstores, pharmacies and
supermarkets.
Income Statement Balance Sheet

Beginning inventory P xx
Add: Purchases XX
Total goods available
for sale (TGAS) Pxx
Less: Ending inventory Xx | > Inventory
Cost of goods sold Pxx C=>Cost of Goods Sold ;
INVENTORIES OFA MANUFACTURER

Unlike a trader or merchandiser, a manufacturer maintains more types of
inventories as described below:
Inventories. | Description
Raw materials represent the physical aspect of an inventory item.
These can be classified as either direct or indirect materials.
Direct materials are those which can be easily traced to the finished
Ra product. For example, the paper used in a : book, the : metal frame ofa
w : :
Materials bicycle, the flour in a cake, the corn used in corn chips, etc.
Indirect materials are those which cannot be economically
attributed to the finished product. For example, the glue used in a
book, the screws used in a bicycle, the food coloring used in a cake,
and seasonings or flavorings used in corn chips.
Work-in- Work-in-process represents cost of unfinished products (i.e.,
Process partially transformed) as of a reporting date
Finished Finished goods represent cost of fully transformed products ready
Goods for sale
203
The
In addition, the manufacturer also incurs the following manufacturing costs in

creating its finished goods:
“~ Costs © Description
Direct Includes the cost of direct materials used during the period.
Materials Excludes the cost of indirect materials used during the period.
Represents costs which are paid to personnel who are directly
involved in the production process, such assembly line workers. This
Direct Labor
excludes amounts paid to personnel which are not directly involved
in the production such as production supervisors.
This represents costs which are not directly traceable to the finished
product but still necessary costs of production. Includes capitalizable
costs that are not classified as direct materials (e.g., indirect
materials) or direct labor (e.g., salary of production supervisors).
Manufacturing
Fixed factory overheads are those indirect costs of production that
Overhead
remain relatively constant regardless of the volume of production.
Variable factory overheads are those indirect costs of production
that vary directly with the volume of production such as indirect
materials and indirect labor.
These costs, combined with the different types of inventories discussed earlier, will
result to the following statement of cost of goods sold:
Statement of Cost of Goods Sold Income Statement || Balance Sheet

Beginning direct materials P xx
Add: Direct materials purchases XX
Total direct materials available XX
Less: Ending direct materials XX Raw materials
Cost of direct materials used Pxx (plus indirect
Add: Direct labor XX materials)
Manufacturing overhead XX
Total manufacturing costs Pxx
Add: Beginning work-in-process XX
Total cost of goods putinto process Pxx
Less: Ending work-in-process Xx [ ‘.Work-in-process
Cost of goods manufactured Pxx
Add: Beginning finished goods XX
Total goods available for sale Pxx
Less: Ending finished goods XX > Finished goods
Cost of goods sold Pxx cb Cost of goods sold
Note: Beginning inventory balances are added, while ending inventory balances are deducted.
204
The
CamScanner
Illustration 4. A manufacturing company reported the following asset balances as

of beginning and ending of the year:
January 1, December
2023 31,2023
Direct materials P2,000,000 P1,200,000
Work-in-process 500,000 800,000
Finished goods 1,500,000 1,900,000
Factory supplies 500,000 400,000
Office admin. supplies 50,000 40,000
In addition, the company also incurred the following costs:

Purchases of direct materials P1,000,000
Purchases of factory supplies 200,000
Purchases of office supplies 20,000
Depreciation of factory building 600,000
Depreciation of office building 450,000
Utilities in factory 120,000
Utilities in office building 100,000
Salaries of production line workers 900,000
Salaries of admin office workers 850,000
Salaries of factory supervisors 700,000
Required: Determine the cost of goods sold, prime costs, and conversion costs for
2023 and total amount inventory to be reported as of December 31, 2023.
1. First, determine the amounts of materials and supplies that were used during
2023:
Direct Factory Office
Materials Supplies Supplies
Beginning balances P2,000,000 P500,000 P50,000
Add: Purchases 1,000,000 200,000 20,000
Total available for use 3,000,000 700,000 70,000
Less: Ending balances (1,200,000) (400,000) _(40,000)
Cost of materials/supplies used = P1,800,000 P300,000 P30,000
The readers should take note that the P30,000 of office supplies used shall not
be part of manufacturing costs and shall be reported as supplies expense as
these relate to office use as opposed to production use.
2. Next, identify the cost items which will qualify as direct labor and factory
overhead (all other costs are expensed outright as part of operating expenses):
205
The
Chapter 7 - Inventories — Preliminary Considerations
Direct Factory Operating

Labor Overhead Expenses
Depreciation of factory building P600,000
Depreciation of office building P450,000
Utilities in factory 120,000
Utilities in office building 100,000
Salaries of production line workers §P900,000
Salaries of admin office workers 850,000
Salaries of factory supervisors 700,000
Factory supplies used (from step 1) 300,000
Office supplies used (from step 1) 30,000
Total P900,000 P1,720,000 P1,430,000
All expenses pertaining to office functions cannot be considered as part of

factory overhead as these costs do not relate to production but more on the
administration of the entity as a whole.
3. Next, plug-in the computed amounts of used raw materials, direct labor, factory
overhead and inventory balances (except for office supplies) in the statement of
cost of goods sold as follows:
Beginning direct materials P2,000,000
Add: Direct materials purchases 1,000,000
Total direct materials available for use P3,000,000
Less: Ending direct materials (1,200,000)
Cost of direct materials used P1,800,000
Add: Direct labor 900,000
Factory overhead 1,720,000
Total manufacturing costs P4,420,000
Add: Beginning work-in-process 500,000
Total cost of goods put into process P4,920,000
Less: Ending work-in-process (800,000)
Cost of goods manufactured P4,120,000
Add: Beginning finished goods 1,500,000
Total Goods available for sale P5,620,000
Less: Ending finished goods (1,900,000)
Cost of goods sold P3,720,000
4, The amounts of prime costs and conversion costs are determined as follows:
Prime Conversion
Costs Costs
Cost of direct materials used P1,800,000
Direct labor 900,000 P900,000
Factory overhead 1,720,000
Total P2,700,000 P2,620,000
206
The
CamScanner
Prime Costs = Direct Materials + Direct Labor, while Conversion Costs =

Direct Labor + Factory Overhead. \t should also be noted that direct labor
counts as part of both prime costs and conversion costs.
5. The total amount of “Inventory” to be reported as of December 31, 2023 shall be

Raw materials P1,200,000

Work-in-process 800,000
Finished goods 1,900,000
Factory supplies 400,000
Total inventory P4,300,000
Factory supplies are included because these satisfy one of the criteria for it to be
classified as inventory (“...in the form of materials or supplies to be consumed
in the production process or in the rendering of services.”).
Office supplies, on the other hand, do not qualify as inventory as these are not
involved in the production and will only be consumed in the administration of an
entity as a whole. It shall be reported as a separate asset apart from inventory
(i.e., prepaid expenses).
RECORDING OF INVENTORY PURCHASES AND SALES
There are two methods of recording additions and reductions in inventory, namely
periodic and perpetual inventory methods. Their use depends on the nature of the
underlying inventory.
Perpetual Inventory Method Periodic Inventory Method
This method is used when the inventory This method is used when the inventory
is of high-value and the turnover is is of low-value and the turnover is fast
slow such as Cars, jewelry, house and lot, such as grocery items, small tools, most
etc. medicines, etc.
An “Inventory” account will be updated Different accounts will be used for every
whenever there are purchases, freight in, purchase, freight in, sales, purchase
sales, purchase returns and allowances, returns and allowances, purchase
purchase discounts, and the cost portion of discounts, sales returns and allowances,
sales returns. and sales discounts
The Inventory account shall not be
affected by sales allowances and sales
discounts as these transactions do not
affect the cost of inventories,
Physical count is used to adjust the Physical count is used to determine the
recorded amount of inventory. amount of inventory
Inventory records are updated both in Inventory records are updated either in
units and in cost. units or in cost but not both
207
The
CamScanner
When inventory is of high-value and the turnover is slow, it will now be more cost-
efficient for an entity to monitor the cost and number of units of every purchase and
sale. Imagine applying the same in grocery items. This is very cost-inefficient since
there are many items to monitor, and each is of low-value.
The following are the pro-forma journal entries under both perpetual inventory
method and periodic inventory method:
Perpetual Inventory Method | \PeriodicInventory Method _|
Purchase of | /nventory XX Purchases XX
inventory Accts. payable/Cash XX Accts. payable/Cash xx __|
Payment for | Accts. payable Xxx Accts. payable xX
the credit Inventory (if any) XX Purchase disc. (if any) XX
purchase __Cash XX Cash XxX |
Accts. receivable/Cash XX Accts. receivable/Cash = xx
Sales XX Sales = ae
Sale of
inventory Cost of sales XX No corresponding entry for cost
Inventory xx | of sales and inventory.
Purchase Accts. payable/Cash XX Accts. payable/Cash XX
returns Inventory XX Purchase returns XX
Sales return Xx Sales return XX
Accts. receivable/Cash Xx Accts. receivable/Cash xx
Sales return
Inventory xy No corresponding entry for cost
Cost of sales xx | of sales and inventory.
gs Inventory, end. XX
ae etaice Cost of sales (squeeze) xx
oe d Purchase returns XX
ae No corresponding entry. Purchase allowance XX
recognizing ;
: Purchase discount XX
ending Purch
fruenton urchases XX
Inventory, beg. XX
If recorded > physical count:
Adjustment | Cost of sales XX
to reflect the Inventory ae 8 di 5
; o corresponding entry.
physical If recorded < physical count: P oo
count
Inventory XX
Cost of sales XX
Note: Despite of these differences in journal entries, the amounts of cost of sales (or cost of
goods sold) and ending inventory are the same under each method.
TRADE DISCOUNT VS PURCHASE DISCOUNT
These two types of discounts in transactions arising from the purchasing of goods
are differentiated as follows:
208
The
The Book
Trade Discount ’ Purchase Discount _

Because of perceived difficulties ‘
Rationale for in updating each and every list pi Pe ldcene
granting price given by the supplier to its PET eat.
purchase.
customers
Application Applied to list price Applied to invoice price
Not recorded since the amount Usually included in the
Recording to be initially recorded is already | purchases amount (see Gross
net of trade discount vs Net Methods section)
For example, 2/10, n/30
: Stand-alone percentage or which means 2% purchase
Quotation ; ; Aa
series of percentage discount when paid within 10
days from invoice date.
Illustration 5. MABEL Company purchased inventory from its supplier with list
price of P1,000,000. Required: Under each of the following independent scenarios,
compute for the invoice price:
1. trade discount is 30%
2. trade discount is series of 10% and 20%.
Scenario 1 - Trade Discount is 30%
Invoice price is computed as List Pricex (1 - trade discount rate). In this case, invoice
price is P700,000 /P1,000,000 x (1 - 30%)].
Scenario 2 - Trade Discount is series of 10% and 20%
In this case, invoice price shall be computed as List Price x (1 - trade discount rate
1) x (1 - trade discount rate 2). In this case, invoice price is P720,000 [P1,000,000 x
(1 - 10%) x (1-20%)].
The purchase discount, if there is any, shall be applied on the computed invoice
amounts under the two scenarios.
Illustration 6. On March 1, 2023, MABEL Company purchased inventory from its
supplier with list price of P800,000. The trade discount is 20% and the credit terms
is 3/15,n/40. Compute for the amount to be paid by MABEL Company if it pays the
invoice on March 11, 2023.
The amount to be paid by MABEL Company is P620,800, computed as follows:
List price P800,000
Less: Trade discount (20%) (160,000)
Invoice price 640,000
Less: Purchase discount (3%) (19,200)
Amount to be paid P620,800
Since the invoice was paid within 15 days (i.e., 10 days) after the invoice date,
purchase discount of 3% will be granted.
209
The
CamScanner
GROSS METHOD VS NET METHOD

The same principles in the usage of either the gross method or the net method in
Chapter 4 are still applicable in this context. However, the point-of-view has been
changed to a purchaser. Pro-forma journal entries are the following:
Gross Method — _ Net Method:

Purchases XX Purchases XX
Accounts payable XX Accounts payable XX
Initial recording | Recorded amounts for the | Recorded amounts for the
of credit purchases and _ accounts | purchases and accounts payable
purchase payable are gross of purchase | are net of purchase discount.
discount. Hence, the name of | Hence, the name of the method.
the method.
Accounts payable XX
Payment within | “Ms Payame = =

discount period : urchase discount = -XX_| Cash paid is equal to the amount
ash XX | of recorded accounts payable
which is already net of discount
Accounts payable XX
Purchase discount lost xx
Cash XX
Payment beyond | Accounts payable XX
discount period Cash xx | Purchase discountlost account
is usually reported as other
expense (excluded from cost of
goods sold amount)
as follows:
. |. Payment made WITHIN Payment made BEYOND -

Amounts _ - discount period discount period ©. -
Cost of sales Gross method = net method | Gross method > net method
Gross profit Gross method = net method | Gross method < net method
Other expenses Gross method = net method | Gross method < net method
Net income Gross method = net method | Gross method = net method
Illustration 7.On May 21, 2023, TALAVERA Company purchased an inventory with
an invoice price of P70,000 under the terms 2/15, n/30. These goods were
subsequently sold for P90,000. The purchase transaction and the corresponding
Payment to supplier are recorded as follows:
210
The
CamScanner
Gross Method Net Method |

Initial recording Purchases 68,600
of credit Purchases 70,000 Accounts payable 68,600
ae Accounts payable 70,000 | , 68,600 = P70,000 x (100% - 2%)
Paymentonor | Accounts payable 70,000

before June 5, Purchase discount 1,400 a payable ee 00
2023 Cash 68,600 ‘
Receipt of Accounts payable 68,600
payment after ae payanle ee 00 Purchase discount lost 1,400
June 5, 2023 : Cash 70,000
as follows:
Payment received Payment received BEYOND

WITHIN discount period discount period
Amounts i Gross Net Gross Net
Gross sales P90,000 P90,000 - P90,000 P90,000
Less: Cost of sales *(68,600) **(68,600). (70,000) **(68,600)
Gross profit P21,400 P21,400 P20,000 P21,400
Less: Other expense*** + = - (1,400)
Net income P21,400 P21,400 P20,000 P20,000
*P70,000 initially recorded purchases less purchase discount of P1,400.
**equal to initially recorded purchases, which is already net of purchase discount
*** purchase discount lost
ALLOCATION OF FACTORY OVERHEAD

Variable factory overhead is allocated to each unit of production on the basis of
the actual use of the production facilities. [PAS 2.13]. This is the correct treatment
since the variable factory overhead directly varies with the changes in number of
units.
Fixed factory overhead is allocated based on the normal capacity of the

production facilities. Normal capacity is the production expected to be achieved on
average over a number of periods or seasons under normal circumstances which
takes into account the loss of capacity resulting from planned maintenance. The
actual level of production may be used if it approximates normal capacity. [PAS 2.13].
The amount of fixed overhead allocated to each unit of production is not increased
as a consequence of low production or idle plant, Unallocated overheads are
recognized as an expense in the period in which they are incurred. [PAS 2.13).
These unallocated overheads are expensed since these represent inefficiencies on
the part of management by not fully utilizing the available capacity.
211
The
CamScanner
In periods of abnormally high production, the amount of fixed overhead

allocated to each unit of production is decreased so that inventories are not
measured above cost. [PAS 2.13].
Illustration 8. For the year 2023, a manufacturer incurred P1,500,000 of fixed

factory overhead. The normal capacity is 120,000 units. Required: Determine the
unit cost on account of the fixed factory overhead to be allocated to each unit
assuming the actual production is 90,000 units, 120,000 units and 150,000 units.
90,000 120,000 150,000
units units units
Fixed factory overhead P1,500,000 P1,500,000 P1,500,000
Divided by: Denominator units 120,000 120,000 150,000
Fixed factory overhead per unit P12.50 P12.50 P10.00
The following should be noted from the previous calculations:

a. For 90,000 units, the amount allocated per unit is not P16.67 (P1,500,000/90,000)
as the allocation should be based on 120,000 units normal capacity. The amount to
be capitalized to inventory is P1,125,000 (P12.50x 90,000 units) while the amount
to be expensed outright is P375,000 (P12.50 x 30,000 units).
b. For 150,000 units, the unit cost allocated to each unit is P10 and the whole fixed
factory overhead of P1,500,000 is capitalizable. If the fixed factory overhead per
unit under the normal capacity is used, the fixed factory overhead that would have
been capitalized is P1,875,000 (P12.50 x 150,000), which is way higher than the
actual cost of P1,500,000. That is the reason why it is just limited to P10 per unit.
From the previous calculations, the following can be summarized with regards to
fixed overhead:
Scenarios | Number of units to be used in allocation

Normal capacity > Actual no. of units Normal capacity units
Normal capacity < Actual no. of units Actual no. of units
JOINT AND BY-PRODUCTS

A production process may result in more than one product being produced
simultaneously. Joint products and by-products are differentiated as follows:
Joint products By-products =

Joint products have values that are not | By-products have values that are
drastically different from each other. minimal relative to the value of the
main product.
For example, gasoline and diesel are joint
products from crude oil. For example, rice bran (“darak”) is
considered as a by-product from the
milling of rice since its value is much
lower compared to the milled rice itself._|
212
The
CamScanner
Generally, the costs are attributed to each joint or by-product. However, if the costs
are not separately identifiable, these shall be allocated among the products on a
rational and consistent basis. [PAS 2.14).
For example, the allocation method may be any of the following:
a. Inthe case of joint products, based on the relative sales value of each product.
b. Inthe case of by-products, their net realizable values are deducted from the cost
of the main product.
Details on the allocation to joint and by-products are discussed in a Cost Accounting
subject.
CHAPTER SUMMARY
1. Inventories are assets:
a. held for sale in the ordinary course of business;
b. in the process of production for such sale; or
c. inthe form of materials or supplies to be consumed in the production process or
in the rendering of services. [PAS 2.6].
2. The classification of an asset as an inventory will depend on the entity’s ordinary
course of business. An asset might be an inventory of one entity but not an inventory
of another entity.
3. A merchandising entity only maintains one type of inventory: the merchandise
inventory.
4. A manufacturing entity maintains more than one type of inventory: the direct
materials, work-in-process, finished goods. and factory supplies.
5. Initially, inventory shall be measured at cost. The cost is composed of costs of
purchase, costs of conversion, and other costs incurred in bringing the inventories
to their present location and condition.
6. Incase several types of inventory items were acquired at a basket price, their cost is
determined using the relative sales value method.
7. Capitalizable manufacturing costs include materials used, direct labor, and factory
overhead.
8. Factory overhead can be classified as either variable or fixed.
9. Storage costs are capitalized only if these relate to unfinished inventory items.
10.Costs that are not normally capitalized include abnormal wastage, administrative
overheads, and selling costs,
11. Methods of recording of inventory can either be perpetual inventory method (used
for inventory with high value and slow turnover) or periodic inventory method
(used for inventory with low value and high turnover).
12.Trade discount is applied to list price to arrive at the invoice price while purchase
discount is applied to invoice price to arrive at the amount payable to supplier.
13. Purchase discount can be accounted using either the gross or net method,
14. Variable factory overheads are allocated based on actual use of production facilities
while fixed factory overheads are generally allocated based on normal capacity.
15.The common cost of joint and/or by-products shall be allocated to each product.
213
The
CamScanner
True or False
1. Inventories are assets that are normally sold by an entity in its ordinary course of
business.
es A land can never become inventory of another entity since it is not movable.
3: The utensils in a restaurant are not considered as its inventory, however these
utensils can be considered as inventory of an entity that is supplier of kitchen items,
Office supplies are included in the inventory of an entity.
we
Work-in-process goods cannot be considered as inventory since they are not yet
available for sale in the entity's ordinary course of business.
All of the criteria set in the definition of inventory under PAS 2 shall be met in order
for an asset to be classified as inventory.
Inventory is initially measured at its cost.
Nonrecoverable taxes are capitalized as cost of inventory.
ON
Transport costs are not capitalized since they do not modify the physical
characteristics of related inventory items.
10. For manufacturing entities, the costs of conversion (direct labor and overhead)
shall be capitalized.
Tes All storage costs may be capitalized as part of inventory cost.
12. Perpetual inventory system uses more general ledger accounts compared to the
periodic inventory system.
13. Purchase discounts are recorded while trade discounts are not.
14. An entity will report the same amount of net income under both gross method and
net method of accounting for purchase discounts whether or not the payments
were made within the discount period.
15. By-products have a much lower value compared to the related main product.
1 Which of the following correctly describes the major characteristic of direct
materials and factory supplies?
a. Factory supplies can be physically traced to the finished product while direct
materials cannot.
b. Direct materials can be physically traced to the finished product while factory
supplies cannot be.
c. Both the direct materials and factory supplies are physically traceable to the
finished product.
d. Neither the direct materials nor factory supplies are physically traceable to the
finished product.
In a manufacturing entity, the following are components of total manufacturing
costs, except
a. Direct materials purchased
b. Direct materials used
c. Direct labor
d. Factory overhead
214
The
CamScanner
— Inventories — Preliminary Considerations
chapter /
3, A
nentity incurred the following costs in ac quiring its merchandise
inventory:
I Import duties
taxes
II. Recoverable
which of these costs are capitalizable as inventory?
a, lonly c. Both I and II
p. llonly d. Neither I nor IJ
A manufacturing entity incurred storage costs related to its inventory item.
Which
of the following correctly describe the relevant accounting procedures for these
costs?
a, Storage costs related to finished goods are capitalized while storage costs
related to work-in-process inventory are expensed outright.
b. Storage costs related to finished goods are expensed outright while storage
costs related to work-in-process inventory are capitalized.
c, Storage costs related both to finished goods and work-in-process inventory are
capitalized.
d. Storage costs related both to finished goods and work-in-process inventory are
expensed outright.
When incurring conversion costs in manufacturing inventories, which of the

following shall not be capitalized?
a. Depreciation of factory building
b. Depreciation of delivery truck
c. Salaries of factory administration employees
d. Salaries of production line workers
If the number of produced units is lower than the normal capacity, an entity shall
allocate the fixed production overhead in what manner?
a. Increase the amount allocated per unit of produced units.
b. Maintain the amountallocated per unit while still basing it on the level of normal
Capacity.
€. Decrease the amount allocated per unit of produced units.
d. Anentity shall not capitalize amounts of fixed production overhead.
- In acquiring its merchandise inventory, an entity incurred transportation costs.
When selling these items, the entity also incurred transportation costs related to the
delivery to customers, Which of the following correctly describes the accounting
Procedures for these costs? 2
4. Transportation costs related to the acquisition of goods shall be capitalized
while the transportation costs related to the delivery of goods to customers shall
b be expensed outright.
expensed
- Transportation costs related to the acquisition of goods shall be
goods to
outright while the transportation costs related to the delivery of
Customers shall be capitalized.
and delivery of
Both the transportation costs related to acqu isition of goods
800ds to customers shall be capitalized.
215
The
CamScanner
d. Both the transportation costs related to acquisition of goods and delivery of

goods to customers shall be expensed outright.
8. The following assets are correctly classified as inventory of the relevant entity,
except for
a. Condominium units being sold by a real estate developer.
b. Equipment sold by a hardware store.
c. Land sold by a fastfood restaurant.
d. Vegetables sold by a market vendor.
9. Statement I: Raw materials inventories are the goods that a manufacturer has
completed and are ready to be sold to customers.
Statement II: Work-in-process inventories are the goods that a manufacturer has
started processing but not yet finished as of the reporting date.
a. Onlylis correct
b. Only Ilis correct
c. Neither I nor Il is correct
d. BothIand Il are correct
10.Statement I: An asset classified as inventory by one entity is not necessarily
considered as an inventory by another entity.
Statement II: Land can be classified as an inventory even though it is immovable.
a. Only lis correct
c. Neither! nor II is correct
d. BothIand Il are correct
11.Entity A manufactures kitchen equipment, including blenders. Entity B, who
operates a milk tea shop, acquired one of these blenders. Which of the following
correctly indicates the classification of the blender in the entities’ balance sheet?
a. Entity A- inventory; Entity B - inventory
b. Entity A - inventory; Entity B - property, plant and equipment
c. Entity A - property, plant and equipment; Entity B - property, plant and
equipment
d. EntityA - property, plant and equipment; Entity B - inventory
12.An entity received a special order from a customer. Because of the special order's
specifications, a modification in the entity's production line is warranted. The cost
of this modification shall be accounted for in which of following manners?
a. The modification costs shall be expensed outright since the entity may opt not
to accept the special order in the first place.
b. The modification costs shall be capitalized as part of inventory cost as it
incurred to bring the special order to their intended condition.
c. The modifications costs shall be capitalized as part ofinventory cost only if these
are reimbursable against the customer.
d. The modification costs shall be expensed outright as these can only be used in
this special order.
216
The
13.If an entity uses gross method in recording its purchases, and there were purchases
that were not paid within the discount period, which of the following is true?
Statement I: The entity’s gross profit is higher under gross method compared to
when it had applied the net method.
Statement II: The entity’s net income is the same compared to when it had applied
the net method
a. Only /is correct
c. Neither I nor Il is correct
d. Both1land Il are correct
14. When an entity uses gross method in recording its purchases, which of the following
is false?
a. An entity initially records the related accounts payable without deducting the
prompt payment discount.
b. Ifthere is a failure to pay the accounts payable within the discount period, other
loss shall be recorded.
c. Ifthe accounts payable has been paid within the discount period, there will be
an overall decrease in the amount of cost of goods sold.
d. An account named “purchase discount lost” is not used whether or not the
accounts payable have been paid within the discount period or not.
15. Which of the following is true ifan entity uses net method in recording its purchases?
a. The amount of cost of goods sold will not change, whether or not the payments
were made within the discount period.
b. Accounts payable are initially measured equal to the amount appearing in the
invoice.
c. Ifthere is a failure to pay within the discount period, the amount of purchases
will be increased.
d. Compared to gross method, the net method will normally report a higher
balance in accounts payable.
Straight Problems
1. KONGCompany, a manufacturer of laptops and related electronic products, reported
the following information as of December 31, 2023:
Direct materials purchased —_ P1,200,000
Direct materials used 900,000
Selling costs 80,000
Direct labor 400,000
Factory overhead 600,000
Administrative costs 300,000
Required: Determine the total amount of manufacturing costs.
e217
The
The Book
2. As of the beginning and ending of the year 2023, GOOSE Company reported th,
following balances:
January1 December 31
Direct materials P2,500,000 P1,800,000
Indirect materials 750,000 820,000
In-process inventory 1,100,000 960,000
Finished inventory 3,600,000 3,900,000
Office supplies 500,000 640,000
In addition, the Company also incurred the following costs and expenditures:
Salaries of production workers P2,400,000
Salaries of factory supervisors and managers 1,300,000
Salaries of marketing and salesforce employees 1,000,000
Salaries of administration employees 2,200,000
Utilities bill in the office building 250,000
Utilities bill in the retail store HAND 320,000
Utilities bill in the factory 900,000
Depreciation of production equipment 800,000
Depreciation of delivery equipment 450,000
Depreciation of office equipment 550,000
Depreciation of factory building 1,600,000
Depreciation of retail store improvements 700,000
Depreciation of office building 1,250,000
Depreciation of retail store furniture and fixtures 200,000
Depreciation of office furniture and fixtures 400,000
Purchases of direct materials 3,000,000
Purchases of indirect materials 1,000,000
Purchases of office supplies 850,000
Transport costs of direct materials 380,000
Transport costs of finished goods to customers 270,000
Required: Based on the given information, determine the following amounts:
a. Cost of goods sold
b. Total amount to be presented as “inventory” as of December 31, 2023
c. Total amount to be expensed outright
3. During 2023, GUARDIAN Company received a special order from one of its
customers. In relation to this special order, the Company incurred the following
costs:
Materials used in the order P2,300,000

Storage costs incurred before the order is completed 100,000
Storage costs incurred after the order is completed 80,000
Delivery costs to the customer 200,000
Salaries of factory workers involved in the order 1,000,000
218
The
CamScanner
Overhead allocable to the order 800,000

Costs of designing the order based on customer's
specifications 300,000
Costs of wasted materials and labor, 75% of which is
considered normal 600,000
Administrative costs allocable to the order 400,000
Costs of modification to the manufacturing process
to accommodate the order 500,000
Required: Determine the capitalizable amount of the special order.
4. OnJanuary 1, 2023, UMAMI Company started its operations. During the same month,
it reported the following transactions involving its inventory:
Date Transaction
Jan.4,2023 Acquired goods for sale costing P2,000,000.
Jan. 8,2023 Goods costing P1,200,000 were sold for P1,900,000.
Jan. 10,2023 Defective goods costing P200,000 were returned to supplier.
Jan. 14,2023 Goods costing P300,000 and selling price of P475,000 were
returned by the customer.
Assume that the physical inventory at the end of January 2023 is equal to P900,000.
entries that the Company shall make:
a. The Company uses periodic inventory system.
b. The Company uses perpetual inventory system.
5. GLUTAMATE Company started its merchandising operations on November 15, 2023.

For the rest of the year 2023, it reported the following transactions:
Date Transactions
11/15/23 Goods costing P3,500,000 were acquired on account.
11/17/23 Goods costing P2,500,000 were acquired on account.
11/20/23 Goods costing P4,000,000 were sold on account for P6,000,000.
11/22/23 Defective goods costing P600,000 and arising from November 15
purchase were returned to supplier.
11/23/23 Payment was made for the November 15 purchase.
11/24/23 The customer returned goods billed for P450,000 but has a cost
of P300,000.
11/28/23 Payment was made for the November 17 purchase.
11/30/23 Customer payment from November 20 sale was received.
12/1/23 Goods costing P1,500,000 were sold on account for P2,250,000.
12/7/23 Purchase of goods on account with total cost of P2,400,000.,
12/12/23 Goods costing P500,000 with wrong specifications and arising
from December 7 purchase were returned to supplier.
12/14/23 Goods costing P1,200,000 were sold on account for P1,800,000
219
The
The Book
12/16/23 Payment was made for the December 7 purchase.

12/20/23 Customer payment from December 1 sale was received.
As of December 31, 2023, goods costing P820,000 were on hand based on the
physical count made on that date. All purchasing and selling transactions were made
using credit terms 2/10, n/30. Required: Under each of the following independent
scenarios, determine the journal entries that the Company shall make (use the gross
method of accounting for cash discounts):
a. The Company uses periodic inventory system.
b. The Company uses perpetual inventory system.
6. On January 1, 2023, SPREAD Company acquired the following inventory items, both
on account:
a. Goods costing P500,000 under 1/15, n/60 credit terms.
b. Goods costing P700,000 under 2/10, n/30 credit terms.
The goods costing P500,000 were paid for on January 17, 2023 while the goods
costing P700,000 were paid for on January 10, 2023.
Required: From this information, determine the journal entries for the month of
January 2023 under each of the following independent scenarios:
a. The Company uses gross method of accounting for cash discounts.
b. The Company uses net method of accounting for cash discounts.

1. During the year 2023, DREADED Company acquired, for a single price of P7,500,000,
the following items of inventory:
Supplier’s Company’s
Items Cost Selling Prices
Lawn mowers P2,400,000 P2,800,000
Grass cutters 1,600,000 2,000,000
Small gardening tools 2,500,000 3,200,000
P6,500,000 P8,000,000
In addition, freight cost of P400,000 was incurred to bring the inventory items to the
Company’s premises.
The total cost allocated to lawn mowers shall be
a. P3,318,000 c. P2,765,000
b. P3,150,000 d. P2,625,000
The total cost allocated to grass cutters shall be

a. P1,875,000 c, P1,800,000
b. P1,975,000 d. P1,896,000
220
The
The Book
2. During 2023, FELIPE Company, a real estate developer, acquired an idle tract of land
to be developed into a subdivision. Total purchase price amounted to P10,000,000.
Aside from the purchase price, the Company also incurred levelling and clearing
costs of P2,000,000.
After partitioning the land, the following are the resulting number of salable lots,
classified based on available house models:
House Model No.of Selling Price Directly Attributable

Name Lots per House Cost per House
Erica 100 P200,000 P100,000
Sab 80 150,000 90,000
Brenda 50 160,000 80,000
The total inventoriable costs for each Erica-type house shall be

a. P110,000 c. P100,000
b. P150,000 d. P160,000
The total inventoriable costs for each Sab-type house shall be
a. P90,000 c. P127,500
b. P135,000 d. P97,500
The total inventoriable costs for each Brenda-type house shall be
a. P120,000 c. P128,000
b. P132,000 d. P80,000
3. During the year, an entity incurred total fixed overhead amounting to P1,200,000.
Normal capacity is set at 200,000 units. In addition, variable overhead amounted to
P6/unit.
Assuming the actual production reached 250,000 units, capitalizable overhead costs
shall be
a. P2,700,000 c. P2,400,000
b. P3,000,000 d. P3,300,000
Assuming the actual production only reached 120,000 units, capitalizable overhead
costs shall be
a. P2,700,000 c. P1,212,000
b. P1,440,000 d, P1,188,000
4. On July 1, 2023, LUIS Company acquired goods with list price of P1,200,000. The
supplier granted 25% trade discount to the Company and allowed credit terms of
2/15, n/60.
If the Company paid its supplier on July 15, 2023, the amount of payment shall be
a. P1,200,000 c. P900,000
b. P1,176,000 d. P882,000
221
The
The Book
If the Company paid its supplier on July 25, 2023, the amount of payment shall be
a. P1,200,000 c. P900,000
b. P1,176,000 d. P882,000
5. On March 10, 2023, PRESLEY Company acquired inventory items for invoice price
of P1,000,000. Trade discount of 20% was already applied to arrive at that invoice
amount. In addition, the supplier granted the Company 2/10, n/30 credit terms.
If the Company paid its supplier on March 27, 2023, the amount of payment shall be
a. P1,000,000 _ ¢ P800,000
b. P980,000 d, P784,000
If the Company paid its supplier on March 15, 2023, the amount of payment shall be
a. P1,000,000 c. P800,000
b. P980,000 d. P784,000
6. KIMBERLY Company acquired goods with list price of P500,000 on October 5, 2023.
The supplier gave the Company series of trade discounts of 25% and 10% and credit
terms of 3/20, n/60.
If the Company paid on October 20, 2023, the amount of payment shall be
a. P325,000 c, P337,500
b. P315,250 d. P327,375
If the Company paid on October 31, 2023, the amount of payment shall be
a. P325,000 c. P337,500
b. P315,250 d. P327,375
7. As of December 31, 2023, ACTION Hardware Company reported the following

partial list of assets and the related carrying amounts in one of its retail stores:
Light bulbs to be sold to customers P560,000

Point-of-sale machine and cash register 240,000
Light bulbs illuminating the store 20,000
Tables for sale to customers 1,200,000
Tables holding small items of equipment for sale 300,000
Small items of equipment for sale 2,500,000
Cabinets and drawers containing small tools for sale 430,000
Small tools for sale to customers 1,800,000
From this partial information, the amount to be included in the Company's inventory
shall be
a. P4,860,000 c. P6,060,000
b. P5,290,000 d. P6,080,000
222
The
The Book
g. ANEACompany, an entity engaged in trading imported goods, acquired a huge batch

of goods for sale at a total purchase price of P3,000,000 (already in PHP equivalent).
In addition, it also incurred the following costs:
Import duties P240,000
Other amounts charged by the customs for the release
of goods 180,000
Transportation costs from foreign country to the local
port, including insurance of P45,000 450,000
Transportation costs from local port to Company’s
warehouse, including insurance of P20,000 120,000
Transportation costs from Company’s warehouse to
entity's premises, including insurance of P15,000 85,000
Irrecoverable taxes 220,000
Recoverable taxes 145,000
From the above information, the total capitalizable cost of inventory shall be
a. P4,210,000 c. P4,440,000
b. P4,355,000 d. P4,375,000
223
The
Chapter 7A — Inclusions and Exclusions from Inventory
CHAPTER 7A
INCLUSIONS AND EXCLUSIONS FROM INVENTORY

1. The inventory items to be included in the inventory balance.
2. The different freight terms and their effects in the determination of ending
inventory balance.
3. The different types of special sales arrangements such as, but not limited to, bill and
hold arrangements, lay-away sales, installment sales, consigned inventory, etc..
4. The effects of special sales arrangements in the determination of ending inventory
balance.
ITEMS TO BE INCLUDED IN THE INVENTORY BALANCE

In general, goods that meet the definition of inventory and are being controlled by
the entity shall be included in the inventory balance wherever they are located.
Therefore, goods in the main warehouse, receiving department, retail store
warehouse, displayed in retail store, and even in transit are all included in the
inventory balance.
Per Conceptual Framework, an entity controls an economic resource if it has the
present ability to direct the use of the economic resource and obtain the economic
benefits that may flow from it. Control of an entity over an asset will be relevant
in assessing whether or not it will recognize the goods as its inventory.
If one party controls an economic resource, no other party can control that
resource. Because of this provision, either the seller or the buyer, but not both, can
recognize the goods as its inventory,
PFRS 15, Revenue from Contracts with Customers requires an entity to consider
indicators of the transfer of control, which include but are not limited to, the
following:
a. the entity has a present right to payment for the asset
b. the customer has legal title to the asset (generally, but not all the time)
the entity has transferred physical possession of the asset
eo a9
the customer has the significant risks and rewards of ownership of the asset
the customer has accepted the asset
INVENTORY IN TRANSIT
Goods purchased or sold in transit are included in inventory when an entity
acquired control (for purchase transactions) or when an entity retained control (for
selling transactions) over the goods. Shipping terms serve as the major
consideration on deciding whether or not the entity controls the inventory in
transit.
224
The
CamScanner
Chapter 7A— Inclusions and Exclusions from Inventory
The shipping terms determine which of the parties (seller or buyer) has the legal
title over the inventory in transit. Most common shipping terms are the following:
Trigger for the transfer Owner of goods
Shipping terms of title over the goods while in transit
FOB shipping point | Seller's shipment of goods Buyer
FOB destination Buyer's receipt of goods Seller
Cost of insurance Upon seller's delivery to fiver
and freight (CIF) the carrier mar
Free alongside Upon seller’s delivery
alongside the previously Buyer
(FAS) :
nominated vessel
*FOB = free on board
[Illustration 1. HAPPY Company, a merchandising company, reported the following

items as of December 31, 2023 based on physical count:
Goods counted in the warehouse P1,500,000
Goods in the bodega of retail store 800,000
Goods displayed in the retail store 100,000
Goods in the receiving department 150,000
Advertising supplies 30,000
In addition, the following goods were all in transit as of December 31, 2023:
a. P180,000 goods purchased from ELATED Company shipped under FOB
shipping point.
b. P210,000 goods sold to ECSTATIC Company shipped under FOB destination.
c. P50,000 goods sold to JUBILANT Company shipped under FOB shipping point.
d. P175,000 goods purchased from ELATED Company shipped under FOB
destination.
e. P300,000 goods were sold to JOLLY Company under CIF shipping term.
f. P240,000 goods were purchased from MERRY Company under FAS shipping
terms.
Required: Determine the amount of inventory to be reported by HAPPY Company

as of December 31, 2023.
a. The inventory on hand as of December 31, 2023 shall be determined as follows:
Goods counted in the warehouse P1,500,000
Goods in the bodega of retail store 800,000
Goods displayed in the retail store 100,000
Goods in the receiving department 150,000
Inventory on hand, Dec. 31, 2023 P2,550,000
225
The
Chapter 7A - Inclusions and Exclusions from Inventory
It should be noted that advertising and office supplies are excluded sinc,
these supplies are not involved in the manufacturing process. Instead, these wij
be used in marketing and administration purposes respectively,
b. For the goods in transit, the following analysis will be made:
In- Ownerof Roleof Amounts tobe
transit in-transit HAPPY included in
items Shipping terms items Company HAPPY’s invty.
a. FOB shipping point Buyer Buyer P180,000
b. FOB destination Seller Seller 210,000
C. FOB shipping point Buyer Seller ~
d. FOB destination Seller Buyer =
e. CIF Buyer Seller -
f. Free alongside Buyer Buyer 240,000
P630,000
c. The total inventory (on hand + in-transit) shall be determined as follows:
Inventory on hand P2,550,000
Inventory in-transit controlled by HAPPY 630,000
Total Inventory, Dec. 31, 2023 P3,180,000
Inventory items in-transit, over which HAPPY Company has control, are added
to the inventory on hand. The reason is that, in the absence of contrary
information, these in transit inventories are not yet included in the physical count.
FREIGHT TERMS
Shipping terms indicate who is the owner of the goods while they are in transit. On
the other hand, freight terms identify who should actually pay the freight cost. As
previously mentioned in Chapter 4, there are two types of freight terms, to wit:
Freight Terms -— Description FLEES

Freight prepaid The seller pays the freight amount upon shipment
Freight collect The buyer pays the freight amount upon receipt
Combining the FOB shipping terms and these freight terms will result to the
following analysis:
ay ~ Liable to | Who Actually
Scenario | Shipping/Freight Terms ae Pay Freight | Paid the Freight?
1 FOB shipping point, freight prepaid Buyer Seller
2 FOB shipping point, freight collect Buyer Buyer
3 FOB destination, freight prepaid Seller Seller
4 FOB destination, freight collect Seller Buyer
Note: Under FOB shipping point, the buyer is required to pay the freight since it already owns the
inventory while in transit. On the other hand, under FOB destination, the seller is required to pay
the freight since it is still the owner of the goods in transit.
226
The
Chapter 7A— Inclusions and Exclusions from Inventory
Based on the above, no complex accounting procedures will arise from FOB shipping
-_ point, freight collect and FOB destination, freight prepaid since the party liable to pay
the freight actually paid the freight.
However, for the following scenarios, additional considerations shall be made:
a. FOB shipping point, freight prepaid - the buyer shall pay additional amount to
the seller in the form of freight reimbursement.
b. FOB destination, freight collect - the buyer can claim reimbursement from the
seller by reducing the amount that it will pay later on for its purchase.
If relevant, the cash discount shall still apply to the amount of invoice price of the
goods without considering the amount of the freight. In addition, regardless of the
freight term, the recognition of freight in (buyer's perspective) or freight out (seller’s
perspective) shall depend solely on shipping terms as follows:
Amounts to be recorded for the freight
Shipping terms _ Buyer _ Seller
FOB shipping point Freight in None
FOB destination None Freight out
Illustration 2. On May 1, 2023, FLOR Company acquired low-value goods with

P400,000 invoice price from LUNA Company under 2/10, n/30. Related freight
amounted to P30,000. FLOR Company paid the goods on May 9, 2023. Required:
Under each of the following independent scenarios of shipping/freight terms,
determine the journal entries in the books of FLOR Company and LUNA Company:
1. FOB shipping point, freight collect
2. FOB destination, freight prepaid
3. FOB shipping point, freight prepaid
4. FOB destination, freight collect
Scenario 1 - FOB shipping point, freight collect
: FLOR Company (buyer) LUNA Company (seller)

On May 1, 2023, the purchase shall be | On May 1, 2023, the sale shall be
recorded as follows: recorded as follows:
Purchases 400,000 Accounts receivable 400,000

Accounts payable 400,000 Sales 400,000
Freight in 30,000 No recording of freight out since the
Cash 30,000 | buyer is required to pay the freight.
On May 9, 2023, the payment shall be | On May 9, 2023, the receipt shall be
Accounts payable 400,000 Cash [P400Kx(1-2%)] 392,000

Purchase discount (squeeze) 8,000 | Sales discount (squeeze) 8,000
Cash [P400K x (1-2%)] 392,000 Accounts receivable 400,000
227
The
Scenario 2 - FOB destination, freight prepaid

FLOR Company (buyer) LUNA Company (seller) : oe
No recording of freight in since the seller | Freight out 30,000

is required to pay the freight. Cash 30,000 |
Accounts payable 400,000 Cash [P400K x (1 - 2%)] 392,000
Scenario 3 - FOB shipping point, freight prepaid

FLOR Company (buyer) LUNA Company (seller)

Freight in 30,000 Accounts receivable 30,000
Accounts payable 30,000 Cash 30,000
No recording of freight out since the
The buyer recorded the freight in since it
is required to pay or reimburse the buyer is required to pay the freight. The
freight to the seller. seller can claim from the buyer the
peta (ont :
amount of freight it initially paid.
Accounts payable 400,000 Cash [P400K x (1 - 2%)] 392,000
Purchase discount (squeeze) _—_ 8,000 | Sales discount (squeeze) 8,000
Accounts payable 30,000 Cash 30,000
Cash 30,000 Accounts receivable 30,000
The readers should take note that the sales/purchase discount of P8,000 (P400,000
x 2%) is still based on the P400,000 original invoice amount (not considering the
P30,000 freight). Total cash paid by FLOR to LUNA amounted to P422,000
(P392,000 + P30,000).
228
The
The Book
Chapter 7A-—Inclusions and Exclusions from Inventory
Scenario 4 - FOB destination, freight collect

ae FLOR Company (buyer) LUNA Company (seller)

Accounts payable 30,000 Freight out 30,000

Cash 30,000 Allow. for freight 30,000
No recording of freight in since the seller | Since the seller is required to pay the
is required to pay the freight. The buyer | freight based on freight terms, it shall
can claim from the seller the amount of | record the freight out.
freight it initially paid by reducing its
payment for the goods.
Accounts payable* 370,000 Cash (P392K - P30K) 362,000
Cash (P392K - P30K) 362,000 | Allow. for freight 30,000
*P370,000 = P400,000 invoice price less P30,000 freight.
Generalizations - Scenarios 1 to 4
a. Under FOB shipping point, the buyer shall recognize freight in and the seller
shall not recognize freight out regardless of who actually paid the freight.
b. Under FOB destination, the seller shall recognize freight out and the buyer shall
not recognize freight in regardless of who actually paid the freight.
c. The sales/purchase discount is not affected by the amount of freight.
SPECIAL SALES ARRANGEMENTS

In this section, the following special considerations related to inventories are
discussed:
Consigned inventory
Bill-and-hold arrangements
m~moaoop
Lay-away sales
Installment sales
Sale with a right of return
Sale on trial
Repurchase agreements
The concept of control is relevant in determining whether or not the products
covered by these special considerations are to be included in or excluded from the
229
The
CamScanner
inventory balance. These special considerations also contain exceptions to the

general rule of control.
In addition, this is also the perfect time to mention that the carrying amount of
inventories shall be recognized as expense during the period in which the
related revenue is recognized. /PAS 2.34]. As a result of this requirement, the
provisions of the revenue standard, PFRS 15, will be mentioned every now and
then.
CONSIGNED INVENTORY
Consignment involves delivery of goods from the consignor to the consignee for
the latter (the consignee) to sell and dispose of on account of the former (the
consignor). This relationship can be graphically represented as follows:
Consignor - retained Consignee - has the

the ownership, risks, transfers goods possession but not
and rewards over the ownership over the
transferred goods. transferred goods.
Indicators that an arrangement is a consignment arrangement include, but are not

limited to, the following:
a. the product is controlled by the entity (consignor) until a specified event occurs,
such as the sale of the product to a customer of the dealer (consignee) or until a
specified period expires;
b. the dealer (consignee) is able to require the return of the product or transfer the
product to a third party [such as another dealer (consignee)]; and
c. the dealer (consignee) does not have an unconditional obligation to pay for the
product (although it might be required to pay a deposit). [PFRS 15.B78].
Consignor and consignee shall apply the following accounting procedures:
Consignor Consignee —
Transferred goods are not| Received goods are not
Transfer of derecognized since the | recognized as part of its
consigned goods | consignor retained the control | inventory since the control is
over the goods, not transferred.
Sales revenue is recognized | No sales revenue to be
Recognition of when the consignee has sold recognized. However,
awienlie the goods (not when the commission income will be
goods are transferred to the | recognized for the consigned
consignee), goods that were sold.
Unsold Included in the _ ending | Excluded from the ending
consigned goods | inventory balance inventory balance
230
The
CamScanner
In addition, the consignor shall also capitalize the freight costs incurred in
transferring the goods to the consignee. These freight costs are included in the cost
_of goods sold when the related consigned goods were sold.
Illustration 3. ZARAGOZA Company reported an inventory balance of P2,400,000

based on physical count as of December 31, 2023. In addition, the following
information might be relevant:
a. Excluded from physical count are unsold goods on consignment in the hands of
a consignee, which have total cost of P300,000.
b. Included in the physical count are the goods with cost of P120,000, which were
held on consignment from consignors.
Based on this information, ZARAGOZA Company shall adjust its reported inventory
balance as follows:
Unadjusted inventory balance, 12/31/23 P2,400,000
Add: Unsold goods on consignment (ZARAGOZA as the consignor) 300,000
Less: Unsold goods on consignment (ZARAGOZA as the consignee) (120,000)
Adjusted inventory balance, 12/31/23 P2,580,000
BILL-AND-HOLD ARRANGEMENTS
A bill-and-hold arrangement is a contract under which an entity (i.e., the seller)
bills a customer for a product, but the entity retains physical possession of the product
until it is transferred to the customer at a point in time in the future. For example, a
customer may request an entity to enter into such a contract because of the
customer's lack of available space for the product or because of delays in the
customer's production schedules. [PFRS 15.B79]. This relationship can be
graphically represented as follows:
Seller - retains Buyer/Customer -

the possession of bills the buyer/ customer requests for the delayed
the sold goods. delivery of purchased
goods to a future date
In addition to applying the general requirements and for a customer to have

obtained control of a product in a bill-and-hold arrangement, all of the following
criteria must be met:
a. the reason for the bill-and-hold arrangement must be substantive (for example,
the customer has requested the arrangement);
b. the product must be identified separately as belonging to the customer;
c. the product currently must be ready for physical transfer to the customer; and
d. the entity cannot have the ability to use the product or to direct it to another
customer. [PFRS 15.B81].
231
The
CamScanner
As can be seen from the above provisions of the PFRS 15, the seller of the
inventory recognizes revenue from the bill-and-hold arrangement as the control
over the goods sold were already transferred to the buyer (customer). This is also |
|
supported by the fact that the buyer can direct the seller on what it wants to do with
the inventory covered by the arrangement. Consequently, the inventory will be
expensed as part of cost of goods sold and effectively be excluded from the seller's
inventory balance, even if it has the possession of the goods.
Illustration 4. On December 28, 2023, LICAB Company sold goods costing
P4,000,000 to one ofits customers for P6,000000. The customer requested that the
delivery of the goods be delayed until January 5, 2024 since a lot of its warehouse
employees are on holiday leave. The Company agreed and properly segregated the
goods to make it ready for delivery and to prevent it from being sold to other
customers. ,
Analysis: The transaction can be considered as a bill-and-hold arrangement since
all of the conditions set in PFRS 15 were met. As a result, even though the Company
has the possession, it shall exclude the P4,000,000 goods from its ending inventory.
In addition, sales revenue of P6,000,000 shall also be recognized in 2023 (not in 2024).
Illustration 5. On December 25, 2023, to meet the sales quota for the year 2023,
one of the QUEZON Company’s account managers agreed with one of its customers
to sell goods with total selling price of P5,000,000 and cost of P3,000,000. These
goods are to be delivered any time during January 2024 and that the customer has
been billed on December 25, 2023. The Company properly segregated the goods to
prevent it from being sold to another customer.
Analysis: The transaction cannot be considered as bill-and-hold arrangement
since the reason is not substantive (i.e., improperly inflating sales to meet sales quota).
As a result, the Company shall still include the P3,000,000 goods in its ending
inventory and shall not recognize the related sales revenue in 2023.
LAYAWAY SALES
Lay away sale involves the buyer periodically paying a portion of the price for the
purchase of goods. The seller maintains custody of the goods until the buyer has fully
paid the balance of the transaction price. This is usually done to stimulate the sales
of products, especially to lower-income buyers who could not pay the full
transaction price in one payment. This relationship can be graphically presented as
follows:
periodically pays the purchase price

Seller |* Buyer
—>
transfers goods only upon buyer's full payment
232
The
CamScanner
As a way of comparison, the request from the buyer is the reason for the seller
maintaining custody of goods in bill-and-hold arrangement while for the lay way
sale it is for the protection of the seller’s financial interests.
Since the control is retained by the seller (i.e., the buyer cannot direct the seller with
regards to the goods covered by the lay away sale), the goods shall still be
included in the seller's inventory balance. The amounts received by the seller
shall be recorded as liability (i.e., unearned income), and shall be recognized as
revenue upon the delivery of goods to the buyer.
INSTALLMENT SALES
Installment sale involves the seller’s delivery of goods to the buyer, with the buyer
agreeing to pay the balance of the transaction price in installment basis. This
relationship can be graphically presented as follows:
periodically pays the purchase price

Seller /* Buyer
>
transfers goods even if the buyer is not fully paid
The main difference between installment sales and lay away sales is that in
installment sales, there is already a transfer of possession of the inventory items to
the buyer even if the buyer is not yet fully paid. Whether or not the legal
ownership is transferred, the buyer obtains control of the goods as it has the
possession and the ability to use it in any manner it prefers.
The seller, in granting financing, first assesses the creditworthiness (ability and
willingness to pay) of the buyer. This assessment is relevant in determining the
accounting procedures that the seller shall apply to each of its installment sales:
Is it probable that the seller will

collect the installment payments
from the buver? [/PFRS 15.9/e)]
qigsallar ciall vecaenize The seller shall not recognize

6 revenue and shall still include
revenue and exclude the goods : :
‘ ; the goods in its ending
in its ending inventory
inventory
The readers should take note that if there is no revenue recognized, then no cost of
goods sold shall be recorded, and the inventory shall still be recognized by the entity.
233
The
CamScanner
Illustration 6. JAEN Company reported unadjusted inventory balance of

P5,200,000 based on physical count as of December 31, 2023. During the year, the
Company entered into three installment sales contracts with some of its customers:
a. An automobile with cost of P800,000 was sold for P1,400,000 through the
customer's credit card.
b. Atruck with cost of P1,200,000 was sold for P1,800,000 with the entity financing
the purchase price. It is probable that the customer will pay the remaining
installment payments as they became due.
c. An automobile with cost of P700,000 was sold for P1,500,000 with the entity
financing the purchase price. It is not probable that the customer will pay the
remaining installment payments as they became due.
Based on the data given, only the P700,000 cost in the item c shall be added to
the Company’s ending inventory balance since there shall be no revenue
recognized as it is not probable that the Company will receive the installment
payments. In addition, items sold through the customer's credit card are lik
collectible since it is the bank that will pay the Company, not the customer.
SALE ON APPROVAL
If an entity (the seller) delivers products to a customer for trial or evaluation
purposes and the customer (the buyer) is not committed to pay any consideration
until the trial period lapses, control of the product is not transferred to the customer
until either the customer accepts the product or the trial period lapses. [PFRS
15.B86]. The accounting procedures can be simplified as follows:
Does the customer on trial _

accepted the product or the trial
period has elapsed?
The seller shall not recognize

; The wens shall mines ; eovienudand shall sll Includ
evenue and exclude the goods the goods in its ending
in its ending inventory inventory
Acceptance of the customer does not need to be explicit, such as when the customer
used the product in a manner that will preclude its ability to return the same. For
example, the product has been damaged due to the customer's negligence.
Illustration 7. As of December 31, 2023, TALAVERA Company reported an

unadjusted balance in its inventory of P4,800,000 based on physical count, In
234
The
Chapter 7A- Inclusions and Exclusions from Inventory
addition, the following goods, which were sold on approval covering 30 days, were
excluded in the physical count since these are in the possession of the customers:
a. P150,000 goods were sent to customer last November 15, 2023. The customer
is yet to signify its acceptance of the sale.
b. P240,000 goods were sent to customer last December 18, 2023. The customer is
yet to signify its acceptance of the sale.
c. P100,000 goods were sent to customer last December 20, 2023. The customer is
yet to signify its acceptance but the goods were damaged due to its negligence.
d. P300,000 goods were sent to customer last December 10, 2023. The customer
signified its acceptance of the sale on December 25, 2023.
The adjusted inventory balance as of December 31, 2023 is computed as follows:
Items Status as of 12/31/23 Amounts

a. Trial period elapsed (11/15/23 to 12/31/24 is 46 days) p-
b. Not yet accepted and trial period has not yet elapsed 240,000
c. Considered as formally sold due to damage =
d Customer accepted the sale before 12/31/23 =
Net adjustment increase in inventory P240,000
Unadjusted inventory balance 4,800,000
Adjusted inventory balance, 12/31/23 P5,040,000
SALE OR PURCHASE WITH A RIGHT OF RETURN

Usually, when consumers buy products, the seller allows them to return the items
after a certain number of days if they found any defects, the products did not
conform to the buyer’s specification or purpose, or for any other reasons, subject to
consumer laws (e.g., Consumer Protection Act). The buyer could get a partial or full
refund, credit in future purchases, or another product in exchange.
Because the buyer already controls the goods, the seller should exclude these
from its inventory. The full accounting for sales with a right of return is tackled in
the Volume 2 of this Intermediate Accounting Series.
INVENTORY FINANCING
Similar to receivables, inventories can be used to generate cash, other than the
normal sales to customers. This can be achieved through either of the following:
a. Secured inventory financing; or
b. Repurchase agreements
Secured Inventory Financing

An entity may obtain a bank loan with its inventory items serving as the security or
collateral. This may range from a simple pledge to the more complicated chattel
mortgage. In either case, the borrowing entity shall still include pledged or
mortgaged inventory items in its ending inventory balance even if the lender
takes possession of these inventory items.
235
The
CamScanner
Repurchase Agreements
An entity (the seller) may sell an inventory to another entity (the buyer) promising
to repurchase it again in the future at a fixed amount. This amount, called the
repurchase price, is usually higher than the inventory’s initial selling price.
On the date of sale, the transaction can be graphically represented as follows:
pays selling price

Seller |¢— Buyer
“sells” goods
——_]
On the repurchase date, the repurchase can be graphically represented as follows:
returns the previously “sold” goods

Seller |} Buyer
pays repurchase price (original selling price
+ interest on financing)
In substance, it can be viewed that the seller borrowed an amount equal to the selling
price. The inventory delivered to the buyer served as the loan security with the
subsequent payment of the repurchase price considered as the settlement for the
borrowing. The excess of repurchase amount over the original selling price is
viewed as interest on financing.
Because of this, the seller shall still include in its ending inventory the goods it
previously sold that are subject to repurchase. This is still true even ifthe buyer
takes physical possession of the goods. In addition, the amount of selling price
initially received from buyer shall be presented as a liability (i. not
recognized as revenue).
Illustration 8. GABALDON Company’s physical count of its inventory as of
December 31, 2023 resulted to unadjusted inventory balance of P4,500,000.
However, the following items were excluded from this amount since the accountant
is unsure of the accounting treatment:
a. Goods costing P2,000,000 were pledged for a P1,200,000 bank loan. The lender
took possession of these goods for security purposes.
b. Goods costing P1,600,000 were sold on December 20, 2023 for P2,500,000, but
the Company shall repurchase this at P3,000,000 in 2024.
The adjusted inventory balance as of December 31, 2023 is computed as follows:
236
The
CamScanner
Unadjusted inventory balance, 12/31/23 4,500,000

Add: Pledged goods 2,000,000
Goods subject to repurchase 1,600,000
Adjusted inventory balance, 12/31/23 8,100,000
The readers should take note that the amounts of related bank loans and P2,500,000
“selling price” shall be recognized as separate liabilities and shall not affect the
adjusted amount of inventory balance as of December 31, 2023.
CHAPTER SUMMARY
1. Control is the determining factor whether to include an item in an entity’s inventory.
Control does not require an entity to have legal title over its inventory items.
2. As long as the entity controls an inventory item, it shall include this item in its
inventory balance regardless of where it is located.
3. Freight prepaid means the seller actually paid for the freight while freight collect
means the buyer actually paid for the freight.
4. As to shipping terms, the following are the triggers for the transfer of title and the
corresponding party owns the inventory in transit:
Trigger for the transfer | Owner of goods

Shipping terms of title over the goods while in transit
FOB shipping point | Seller’s shipment of goods Buyer
FOB destination’ Buyer's receipt of goods Seller
Cost of insurance Upon seller's delivery to paver
and freight (CIF) the carrier y
Predaloneside Upon seller s delivery
alongside the previously Buyer
(FAS) nominated vessel
5. For each special sales arrangement, the following parties shall recognize the related
inventory:
Arrangements Who Recognizes the Inventory Items?
Consignment sales Consignor
Bill-and-hold arrangements Buyer
Lay-away sales Seller
Installment sales - reasonably Buyer
collectible
Installment sales - not ller
reasonably collectible hina
Sale with a right of return Buyer
Sale on trial Seller (before buyer's acceptance)
Pledging of inventory Borrower-pledgor
Inventory repurchase agreements Seller
237
The
True or False
1. Only those inventories located in an entity's warehouse are included in the entity’s
inventory balance.
Zz. The inclusion or exclusion of inventory in transit shall depend on the party who
actually paid for the freight.
Goods purchased through FOB shipping point shall be included in the buyer’s
inventory.
Goods sold through FOB shipping point shall be excluded from the seller’ inventory.
Under FOB shipping point, freight prepaid, no additional accounting issues will
ha
arise since the entity required to pay the freight actually paid the freight.
Under FOB shipping point, freight collect, no additional accounting issues will arise
since the entity required to pay the freight actually paid the freight. :
Under FOB destination, freight collect, the seller shall not recognize freight out
since it is the buyer who actually paid the freight.
For goods sold under FOB destination, freight-collect, the sales discount shall be
based on the amount to be received from the buyer, gross of freight costs.
A consignor shall not recognize revenue upon delivery of inventory items to a
consignee. |
10. The consignee shall include in its inventory balance the goods held under
consignment since it already has physical possession over the goods.
11. An entity shall include in its inventory balance the goods out of consignment, even
if it does not have the physical possession.
12. To be considered as a bill-and-hold arrangement, the request for such arrangement
shall come from the buyer.
13. To be considered as consummated sale, the acceptance on a sale on trial shall be
explicit.
14. Goods sold through installment sales shall be generally excluded from the seller’s
inventory.
1S, Goods sold, but required to be reacquired at a fixed amount in the future, shall be
excluded from the seller's inventory since it does not have the physical possession
anymore.

1. Under PFRS 15, the following shall be considered in determining whether or not
there is a transfer of control over inventory items, except
a. The customer’s actual payment for the inventory items.
b. The customer’s legal title to the inventory item.
c. The customer’s physical possession of the inventory item.
d The customer's assumption of significant risks and rewards of ownership of the
asset.
For inventories in transit, the primary basis for the control over the goods shall be
a. Payment for the goods
238
The
CamScanner
b. Payment for the related freight costs

c. Physical possession over the goods
d. Legal title over the goods
3. Statement I: Freight terms determine which of the parties is required to pay for the
freight.
Statement II: Shipping terms determine which of the parties shall actually pay for
the freight.
a. Only lis true c. Both I and Il are true
b. Only Ilis true d. Neither I nor Il is true
4. As to inventories in transit, which of the following shall still be included in seller’s

inventory?
a. Goods sold FOB destination. c. Both a and b.
b. Goods sold FOB shipping point. d.Neitheranorb.
5. As to inventories in transit, all of the following shall be included in the entity’s

inventory, except
a. Goods sold FOB destination
b. Goods purchased FOB shipping point
c. Goods purchased FAS where the seller is yet to deliver the goods to the
nominated vessel
d. Goods purchased CIF currently in the possession of the carrier
6. All ofthe following inventory items shall be included in the inventory balance, except
a. Goods out of consignment to other entities.
b. Goods still in the receiving department.
c. Goods received on consignment from other entities.
d. Goods in the shipping department to be sold FOB destination.
7. Under the terms FOB shipping point, freight prepaid, all of the following are true,
except
a. The buyer shall pay additional amount to the seller when paying the invoice.
b. The buyer shall recognize freight in, even if the seller paid for the freight.
c. The entity required to pay the freight actually paid the freight.
d. The seller shall recognize additional receivable equal to the amount of the
freight.
8. Under the terms FOB destination, freight collect, all of the following are true, except
a. The cash discount shall be based on the invoice less the amount of freight.
b. The seller shall recognize freight out, even if the buyer actually paid the freight.
c. The buyer can claim reimbursement from the seller.
d. The buyer shall not recognize freight in, even if it actually paid the freight.
9. Regarding consignment sales, the following are correct accounting procedures,
except
239
The
The Book
Ses Ay,
a. The consignor shall recognize revenue only when the consignee actually solq
the goods to third parties.
b. The consignee’s revenue is limited to commission income.
c. Goods out on consignment shall be included in consignor’s inventory at their
selling prices.
d. Goods held on consignment from other entities shall not be included in the
inventory even if the entity has the physical possession.
10. The following conditions shall be met for a transaction to be accounted for as bill-
and-hold arrangement, except
a. The goods shall be ready for physical transfer to the customer.
b. The goods are available to be sold to other customers.
c. The goods are properly segregated and identified as belonging to the bill-and-
hold customer.
d. The arrangement shall be requested by the customer.
11.Which of the following is correct in relation to installment sales and lay-away sales?
a. Under installment sales, the price is not fully paid but the buyer has already the
possession over the goods.
b. Under lay-away sales, the price is fully paid but the possession is still with the
seller.
c. Goods sold under lay-away sales shall be excluded from seller's inventory.
d. Goods sold under installment sales shall still be included in the seller’s inventory
since it will normally retain the ownership over the goods.
12.An entity has introduced a new type of smart refrigerator in the market. Due to the
unknown functionality of the product, the entity decided to sell these on trial for 45
days. Any unreturned items after the trial period shall be considered as sold. Some
of the refrigerator sold on trial are as follows:
I. Unit sold on November 10, 2023 was yet to be returned by the customer as of
year-end.
II. Unit sold on December 5, 2023 was yet to be returned by the customer as of
year-end.
II]. Unit sold on December 10, 2023 was yet to be returned by the customer as of
year-end. As reported, the customer damaged the compressor after attempting
to explore the components of a “smart refrigerator”.
Which of these goods shall be excluded from the seller’s inventory as of December
31, 2023?
a. lonly c. | and III only
b. Jand II only d, III only
13.A real estate developer is in the business of selling condominium units. Today, it sold
the following units through installment sales:
I. A unit in the 10" floor. It is probable that the total consideration can be
collected.
240
The
The Book
II. A unit in the 8" floor. It is not probable that the total consideration can be
collected.
Which of these units shall be excluded from the real estate developer's inventory?
14.ABC Company sold goods to XYZ Company after ABC Company promised to purchase
them back after three months for a fixed amount. In relation to this transaction, the
following accounting procedures are correct, except
a. ABC Company shall recognize the proceeds received as liability.
b. XYZ Company shall recognize the amount paid as receivable.
c. ABC Company shall exclude the goods from its inventory balance.
d. XYZ Company shall recognize as financing income the excess of the repurchase
price received over the original purchase price it paid to ABC Company.
15.Statement I: Goods sold that can be returned shall still be included in the seller’s
inventory balance due to the possibility that these can be returned by the customers.
Statement II: Inventory items, which served as collateral for a bank loan payable,
shall be excluded from the inventory balance if the bank took possession of them for
safekeeping purposes.
a. Onlylis true c. Both I and II are true
b. Only Ilis true d. Neither I nor Il is true
Straight Problems
1. On December 31, 2023, BROWNIES Company, a merchandiser, compiled the
Goods in the main warehouse at cost P5,000,000
Goods in the retail store warehouse at selling prices 2,000,000
Goods on display in the retail store at selling prices 600,000
Cost of unsold goods in the possession of sales representatives 900,000
Goods in the receiving department, including P200,000 goods
returned by customers 750,000
Goods in the shipping department, including P300,000 goods
to be returned to the supplier, who agreed to the return 800,000
Storage costs of goods in the main warehouse 150,000
Cost of unsalable and damaged goods 100,000
Fire insurance costs for goods in the main warehouse 80,000
Invoice price of goods in transit sold FOB destination 400,000
Invoice price of goods in transit purchased FOB shipping point 240,000
The Company maintains 30% gross profit based on selling prices in all of its
inventory sale transactions,
Required: From the above information, determine the amount to be included in the
inventory balance.
241
The
2. MARINA Company, a manufacturer of ready-to-wear apparels, reported the

following information as of the end of 2023:
Unused direct materials in the warehouse P1,600,000
Cost of unfinished goods in the warehouse 2,600,000
Cost of finished goods in the warehouse 4,000,000
Storage costs of direct materials and unfinished goods 200,000
Storage costs of finished goods 300,000
Advances received from customers 800,000
Advances to suppliers for undelivered materials 450,000
Small tools and lubricants for production equipment 180,000
Lubricants for delivery vehicles 80,000
Selling price of finished goods in the retail store 900,000
Property insurance for the retail store 90,000
Advertising and selling supplies 120,000
Goods held out of consignment, at selling price 1,000,000
The Company consistently applies 40% gross profit rate based on sales.
Required: From the above information, determine the amount to be included in the
inventory balance.
3. WONDER Company reported an unadjusted inventory balance of P4,800,000, which

is based on the physical count made at the close of business on December 31, 2023.
In addition, the Company also provided the following information in relation to
goods in transit:
a. Goods with invoice price of P200,000 were purchased from FULL Company
through FOB destination terms. Freight amounted to P40,000.
b. Goods with invoice price of P320,000 were purchased from EMPTY Company
through FOB shipping point terms. Freight amounted to P30,000.
c. Goods with invoice price of P640,000 were sold to WONDER Company through
FOB shipping point terms. Freight amounted to P20,000.
d. Goods with invoice price of P400,000 were sold to MISAMIS Company through
FOB destination terms. Freight amounted to P25,000.
e. Goods with invoice price of P550,000 were sold to ORIENTAL Company through
FOB shipping point terms, Related freight amounted to P32,000.
The Company has consistently maintained 20% gross profit rate on all of its sales.
Required: From this information, determine the adjusted amount of inventory as of
December 31, 2023.
4, ETERNITY Company conducted physical inventory count in its warehouse as of

December 31, 2023. At the conclusion of the inventory count, the Company
determined the inventory in the warehouse had cost of P4,200,000, In addition, the
following information were also provided:
242
The
The Book
of
Goods with total selling price of P1,200,000 were counted in the retail store.
Goods with invoice price of P80,000 were purchased from a supplier through
FOB shipping point terms. The goods were shipped on December 30, 2023 and
were received by the Company on January 4, 2024. Freight costs amounted to
P10,000.
c. Goods with invoice price of P100,000 were purchased from a supplier through
FOB shipping point terms. The goods were shipped on January 2,2024 and were
received by the Company on January 7, 2024. Freight costs amounted to P8,000.
d. Goods with invoice price of P70,000 were purchased from a supplier through
FOB destination terms. The goods were shipped on December 30, 2023 and
were received by the Company on January 4, 2024. Freight costs amounted to
P5,000.
e. Goods billed for P150,000 were sold to a customer through FOB destination
terms. The goods were shipped on December 27, 2023 and were received by the
customer on January 5, 2024. Freight costs amounted to P6,000.
f. Goods billed for P180,000 were sold to a customer through FOB destination
customer on December 30, 2023. Freight costs amounted to P12,000.
g. Goods billed for P200,000 were sold to a customer through FOB shipping point
customer on January 2, 2024. Freight costs amounted to P15,000.
The Company has maintained 30% gross profit rate on all of its sales. From this
information, determine the adjusted amount of inventory
5. On September 5, 2023, ORANGE Company acquired goods on account with list price
of P1,600,000 from PINEAPPLE Company. PINEAPPLE granted 20% trade discount
to ORANGE and credit terms of 3/15, n/90. ORANGE paid the goods on September
18, 2023.
Required: Under each of the following independent scenarios of shipping and freight
terms, determine the journal entries in the books of ORANGE Company and
PINEAPPLE Company:
1. FOB shipping point, freight collect
2. FOB destination, freight prepaid
3. FOB shipping point, freight prepaid
4. FOB destination, freight collect
6. YELLOW Company reported an unadjusted inventory balance of P5,500,000 as of

December 31, 2023. None of the following amounts were included in this balance
since the Company's inexperienced accountant is unsure how these shall be
accounted for:
a. Goods received on consignment from BLUE Company with selling price of
P800,000.
b. Goods out on consignment to GREEN Company with selling price of P900,000
and cost of P600,000.
243
The
The Book
Goods costing P400,000 were billed to a customer for P620,000, However, the
customer requested that the delivery of the goods be deferred to January 10,
2024.
Total payments received from lay-away sales amounted to P700,000.
A high-value item with cost of P2,000,000 were sold to a customer for
P3,200,000, payable on installment basis. So far, the customer has paid
P400,000. It is probable that the customer will pay the remaining amount.
Goods costing P300,000 and with selling price of P470,000 were out on
approval to customers. The trial period for half of these goods has already
elapsed without the customers returning the items.
Goods costing P3,000,000 and with probable selling price of P5,000,000 were in
the possession of the bank since these are the collateral for a P4,000,000 bank
loan payable.
Goods costing P1,600,000 were sold to another entity for P2,400,000. However,
the Company is obligated to repurchase these on March 31, 2024 at a fix amount
of P2,700,000.
Required: Based on this information, determine the adjusted inventory balance as of
December 31, 2023.
7. Based on its physical count, DANDELION Company reported unadjusted inventory

balance of P6,600,000. Upon inspection of its detailed records, the following data
were gathered.
a. Includedinthe countare the goods with selling price of P650,000 that were held
on consignment from THISTLE Company.
. b. Excluded in the count are the goods with selling price of P700,000 out on
consignment to CAMIA Company. The Company applies 40% gross profit sale
on goods to be sold on consignment.
c. Included in the count are goods with billed price of P400,000 that were covered
by a bill-and-hold arrangement. The Company maintains 30% gross profit rate
to all other sales transaction aside from consignment sales.
d. Excluded from the physical count are the goods sold for P1,400,000 under
installment basis. It is probable that all of the buyers will pay the whole
installment price.
e. Included in the physical count are goods with total selling price of P1,000,000
covered by lay-away sales. So far, the customers have already paid P450,000 of
the total selling price.
f. Excluded from the physical count are goods costing P600,000 that were sold to
customers on trial.
g. Excluded from the physical count are the goods sold to PEACH Company for
P1,500,000. The Company is required to repurchase these on January 31, 2024
for P1,600,000.
Required: Based on this information, determine the adjusted inventory balance as of

December 31, 2023.
244
The
CamScanner

1. As of December 31, 2023, RED Company reported inventory of P1,600,000 based on
physical count In addition, the following goods were in transit:
e Goods purchased for P140,000 were shipped by the supplier under FOB
destination terms. Related freight amounted to P2,400. These were actually
received on January 10, 2024.
e Goods purchased for P300,000 were shipped by the supplier under FOB shipping
point terms. Related freight amounted to P3,700. These were actually received
on January 4, 2024.
The Company maintains 25% gross profit on all ofits sale transactions. Based on this
information, the correct amount of inventory as of December 31, 2023 shall be
a. 2,046,100 c. P1,903,700
b. P2,040,000 d. P1,900,000
2. PURPLE Company reported inventory of P2,400,000 based on the physical count as

of December 31, 2023. The Company reported sales of P7,900,000 during the year.
Lastly, the following goods were in transit and were already recorded as part of
sales:
e Goods sold for P200,000 were shipped to the customer under FOB destination
terms. Related freight amounted to P4,300. The buyer actually received these on
January 3, 2024.
e Goods sold for P400,000 were shipped to the customer under FOB shipping point
terms. Related freight amounted to P6,500.
The Company maintains 30% gross profit on all of its sale transactions. Based on this
information, the correct amount of inventory as of December 31, 2023 shall be
a. P2,600,000 c. P2,604,300
b. P2,540,000 d. P2,544,300
Based on this information, the adjusted amount of sales for the year 2023 shall be
a. P7,900,000 c. P7,700,000
b. P7,500,000 d. P7,300,000
3. MAROON Company initially reported an unadjusted inventory balance of

P3,600,000 as of December 31, 2023. This amount is based on the physical count on
the same date. In addition, it also provided the following information:
e Goods sold FOB destination on January 2, 2024 for P500,000 (costing P330,000)
were received by the customer on January 5, 2024, Related cost of freight
amounted to P5,000.
¢ Goods purchased FOB shipping point for P300,000 were shipped by the supplier
on January 3, 2024. These goods were actually received on January 6, 2024,
Related cost of freight amounted to P4,000.
245
ter
The
The Book
e Goods purchased FOB shipping point for P360,000 were shipped by the supplier
on December 29, 2023. These were already received on January 4, 2024. Freight
costs amounted to P3,000.
e Goods purchased FOB shipping point for P280,000 were shipped by the suppler
on December 24, 2023. These were actually received on December 29, 2023.
Freight costs amounted to P2,000.
Based on this information, the correct amount of inventory as of December 31, 2023
shall be
a. P3,963,000 c. P4,234,000
b. P3,960,000 d. P4,516,000
4. On April 4, 2023, VIOLET Company purchased goods with a list price of P2,000,000.
The supplier granted the Company 10% trade discount and credit terms of 2/10,
1/15, n/60. The goods were shipped FOB shipping point, freight prepaid. Freight
amounted to P30,000.
Assuming that the Company paid on April 10, 2023, its total payment to the supplier
shall be
a. P1,832,000 c. P1,830,000
b. P1,812,300 d. P1,812,000
shall be
a. P1i,832,000 c. P1,830,000
b. P1,812,300 d. P1,812,000
shall be
c. P1,832,000 c. P1,830,000
d. P1,812,300 d. P1,812,000
5. On January 3, 2023, GOMEZ Company sold inventory items with invoice price of
P800,000, after applying 20% trade discount. The Company shipped the goods FOB
destination, freight collect and granted the customer 1/15, n/45 credit terms. Freight
costs amounted to P40,000.
Assuming that the customer paid on January 12, 2023, its total payment to the
Company shall be
a. P792,000 c, P633,600
b. P752,000 d, P593,600
Assuming that the customer paid on January 25, 2023, its total payment to the
Company shall be
a. P640,000 c, P800,000
b. P600,000 d. P760,000
246
The
The Book
6. In its draft financial statements, GREEN Company reported unadjusted inventory

balance of P3,600,000. Upon inspection of the composition of this balance and other
relevant details, the following additional data were gathered:
® Goods under consignment from JELLY Company were included in the balance at
their P650,000 selling prices.
e Goods costing P420,000, which are out on consignment to ACE Company, were
excluded in the balance since the Company does not have physical possession of
the goods.
e Goods costing P300,000, which were properly segregated as instructed by the
customer, were still included in the inventory balance even though it is covered
by a bill-and-hold arrangement.
e Goods with equivalent cost of P500,000 are covered by a sales commitment
entered into with the customer in order for the Company to meet it sales quota
for 2023. Since none of the covered goods were shipped by year-end, no amounts
were deducted to arrive at the unadjusted inventory balance.
e Goods with equivalent cost of P800,000 are covered by lay-away sales that are
yet to be fully paid. None of this amount was deducted to arrive at the unadjusted
inventory balance. Total amounts received from customers amounted to
P260,000.
shall be
a. P3,720,000 c. P2,650,000
b. P3,070,000 d. P2,570,000
7. TEAL Company's accounting supervisor determined a preliminary inventory

balance of P5,270,000 as of December 31, 2023. Upon reviewing the supervisor's
work, the accounting manager generated the following additional information:
e The following goods, which were sold on 30-day trial to customers, are yet to be
returned by the customers (none of these goods were included in the inventory
balance):
> Goods costing P550,000 were sold to customers on November 25, 2023.
> Goods costing P380,000 were sold to customers on December 8, 2023.
> Goods costing P270,000 were sold to customers on December 12, 2023. These
goods were damaged due to the customer's negligence.
¢ A P420,000 invoice was received from a supplier. Upon inspection, the related
goods were shipped on December 29, 2023 under FOB shipping point terms.
Since the supplier’s invoice was already on hand, the amount was already
included in the unadjusted inventory balance, even if the goods were actually
received only on January 3, 2024.
e A P600,000 invoice was received from a supplier. Upon inspection, the related
goods were shipped on December 27, 2023 under FOB destination terms. The
amount of the invoice was already included in the unadjusted inventory balance,
even if the related goods were actually received only on January 5, 2024.
247
The
The Book
e Goods costing P1,400,000 were sold to another entity for P2,000,000. The
Company is required to purchase these goods on April 1, 2024 ata fixed price of
P2,200,000. Since the goods were not in the Company’s possession, these were
excluded in determining the unadjusted inventory balance.
shall be
a. P7,270,000 c. P6,450,000
b. P7,000,000 d. P5,050,000
8. Based on its physical count in its main warehouse, CRIMSON Company determined
its unadjusted balance of P3,480,000. However, based on the cut-off procedures
made by the accounting manager as part of his review, the following additional data
were gathered:
e Aninvoice for P750,000 was received from a supplier. The goods were shipped
on December 30, 2023 through FOB shipping point and were actually received
on January 6, 2024.
on January 2, 2024 through FOB shipping point and were actually received on
January 8, 2024.
e An invoice for P440,000 was received from a supplier. The goods were shipped
on December 20, 2023 through FOB shipping point and were actually received
on December 29, 2023.
e An invoice for P360,000 was received from a supplier. The goods were shipped
on December 27, 2023 through FOB destination and were actually received on
January 7, 2024.
on December 22, 2023 through FOB destination and were actually received on
December 30, 2023.
e On December 23, 2023 goods costing P360,000 were sold for P420,000 through
FOB destination terms. The buyer actually received these on January 5, 2024.
e On January 3, 2024 goods costing P240,000 were sold for P370,000 through FOB
destination terms. The buyer actually received these on January 8, 2024.
FOB destination terms. The buyer actually received these on December 30, 2023.
FOB shipping point terms. The buyer actually received these on January 6, 2024.
shall be
a. P5,860,000 c. P4,840,000
b. P4,590,000 d, P4,320,000
248
The
The Book
Chapter 8 - Inventory Cost Flow Assumptions
CHAPTER 8
INVENTORY COST FLOW ASSUMPTIONS

1. The reporting of inventory after initial recognition.
2. The different cost flow assumptions and how they should be applied.
3. The computational exercises to be made in applying the different cost flow
assumptions.
4. The comparison of resulting amounts for every cost flow assumption.
WHAT HAPPENS TO THE INITIALLY CAPITALIZED INVENTORY COST?

The readers may have previously encountered the following “formula” in
computing for the amount of cost of goods sold:
Beginning inventory P xx
Add: Net purchases XX
Total goods available for sale (TGAS) ~ Pxx
Less: Ending inventory XX
Cost of goods sold Pxx
Graphically, these amounts can be presented as follows:
Beginning Net Purchases

Inventory (including freight in)
Total Goods Available

for Sale (TGAS)
Ending Cost of Goods

Inventory Sold
(cost of unsold (cost of sold
inventory items) inventory items)
Based on the graph above, it can be said that beginning inventory and net purchases
amounts are considered as inputs. Combined, they will arrive at the amount of total
goods available for sale (i.e., the process), which at the end of the period, will be
split into the amounts of ending inventory and cost of goods sold (i.e, the outputs).
249
The
CamScanner
Chapter 8 — Inventory Cost Flow Assumptions
But how shall we determine the amounts to be assigned in the ending inventory and
cost of goods sold? The answer is by using cost flow assumptions, which will be the
main topic for the rest of the chapter.
DETERMINING THE APPLICABLE COST FLOW ASSUMPTION

In determining the cost of ending inventory and the cost of goods sold, an entity
may apply any of the following cost formulas:
a. Specific identification method;
b. First-in, first-out (FIFO) method; or
c. Average method
It should be noted, that unlike in US GAAP, PAS 2 does not allow the use of last-in,
first-out (LIFO) method.
Given the three cost formulas allowed in PAS 2, can an entity choose at its own
discretion the cost formula that it will use to subsequently account for its inventory?
The answer is partly no and partly yes. Cost formula to be used shall depend on the
characteristics of inventory items:
Are the inventory items not

ordinarily interchangeable or
are they produced and
segregated for specific projects?
The entity is required to apply The entity is required to apply

the specific identification either the FIFO method or the
method Average method
As far as the application of either the FIFO or average methods is concerned, an

entity shall use the same cost formula for all inventories having similar nature
and use to the entity. For inventories with different nature or use, different cost
formulas may be justified. [PAS 2.25]. However, a difference in geographical location
of inventories (or in the respective tax rules), by itself, is not sufficient to justify the
use of different cost formulas. [PAS 2.26].
Regardless of the cost formula used, it is important to be reminded that the goal of
inventory cost flow assumption is to facilitate the allocation of the TGAS to the
cost of goods sold and the ending inventory.
250
The
SPECIFIC IDENTIFICATION METHOD

As previously discussed, the specific identification shall be applied to the following
types of inventories:
a. Inventory items that are not ordinarily interchangeable
b. Goods and services that are produced and segregated for specific projects
The following are the examples of inventory items that are not ordinarily
interchangeable and those that are ordinarily interchangeable:
Not Ordinarily Interchangeable — Ordinarily Interchangeable
High-value jewelry items, goods in antique Grocery items, automobiles,
shop, art galleries, and goods especially department stores, and medicines.
manufactured based on a customer’s Basically, all other inventory items
specifications. In other words, there shall be aside from those that are not
no two items that are identical. ordinarily interchangeable.
Specific identification of cost means that specific costs are attributed to

identified items of inventory. [PAS 2.24).
The readers might be wondering why PAS 2 requires that the inventory items to be
not ordinarily interchangeable before an entity can apply the specific identification.
The answer is that PAS 2 acknowledges that when items of inventory are ordinarily
interchangeable, specific identification can be used in selecting those items that
remain in inventories to obtain predetermined effects on profit or loss. [PAS 2.24]. In
other words, entities may manipulate their reported earnings.
The primary advantage of specific identification is that the cost flow coincides with
the physical flow of inventory. The amount of cost of goods sold is equal to the
actual cost of the underlying inventory items that were sold, and the amount of
ending inventory is equal to the actual cost of the inventory that were not sold.
On the other hand, the primary disadvantage of specific identification is the need for
the entity to track the cost of each inventory items that were either sold or were
unsold during the reporting period.
Illustration 1. ORIENTAL JEWELS purchased the following during 2023:
Purchase
Date Sold Item Cost
Date
Jan. 8 Apr.9 Diamond ring P50,000
Mar. 27 Mar. 31 24K gold necklace 75,000
Jul. 15 White gold ring 60,000
Aug. 5 Nov. 3 Diamond necklace 110,000
Sept. 9 18k gold necklace 40,000
Oct. 11 Pearl earrings 30,000
Dec. 20 Dec. 21 Topaz earrings 45,000
Total purchases P410,000
251
The
There were no beginning inventories, and the unsold items form part of the ending
inventories.
Required: Determine the amounts of cost of goods sold and ending inventory using
the specific identification method.
Since there were no beginning inventories, TGAS is equal to total cost of purchases
amounting to P410,000. The amounts of COGS and ending inventory are computed
as follows:
Purchase Cost of Ending

date Date sold Item goodssold inventory
Jan. 8 Apr. 9 Diamond ring P50,000
Mar. 27 Mar.31 24Kgold necklace 75,000
Jul. 15 White gold ring . 60,000
Aug. 5 Nov. 3 Diamond necklace 110,000
Sept. 9 18k gold necklace 40,000
Oct. 11 Pearl earrings 30,000
Dec. 20 Dec. 21 Topaz earrings 45,000
Total amounts P280,000 P130,000
From the previous computations, the following should be noted:

a. The sum of cost of goods sold and ending inventory is equal to TGAS of P410,000.
Thus, the readers can use this equality in checking their answers.
b. The amount assigned to cost of goods sold specifically pertain to the total actual
cost of the jewelries sold. The same goes for ending inventory wherein the
amount assigned is the total actual cost of unsold jewelries.
FIFO COST FLOW

The FIFO formula assumes the items of inventory that were purchased or produced
first are sold first. Consequently, the items remaining in inventory at the end of the
period are those most recently purchased or produced. [PAS 2.27]. The principle is
“first purchased (or produced), first to be sold’.
The readers should take note that only the cost of inventories that were purchased
or produced first are assumed to be sold first, not necessarily the physical inventory
itself. However, as part of an entity's inventory management procedures, it may
adhere to FIFO policy wherein the items of inventory that were purchased or
produced first are the first to be physically sold.
Unlike with specific identification, using FIFO will generally result to mismatch
between the cost flow and the physical flow of the inventory. On the upside, using
FIFO also means that there is lesser monitoring and tracing of costs whenever there
is inventory sold as compared to specific identification.
252
The
AVERAGE METHOD
Under the average formula, the cost of each item is determined from the weighted
average of the cost of similar items at the beginning of a period and the cost of
similar items purchased or produced during the period.
Compared with specific identification and FIFO methods, the average method has
the greatest cost mismatch with the physical flow of inventory.
APPLICATION OF INVENTORY SYSTEM IN COST FLOW ASSUMPTION

The frequency of computations depends on the system (periodic or perpetual)
adapted by an entity to record its transactions involving inventories:
Periodic Inventory System _ _ Perpetual Inventory System
The amounts of cost of goods sold and | The amount of TGAS right before each
ending inventory can only be computed | sale transaction is immediately
at the end of each reporting period |,allocated to cost of goods sold and
(i.e., delayed financial information). remaining inventory (i.e. updated
financial information).
These inventory systems, coupled with the FIFO and average cost flow formulas,
will result to the following subclassifications of cost flow assumptions:
a. FIFO - periodic
b. FIFO —- perpetual
c. Average - periodic (also known as weighted average method)
d. Average — perpetual (also known as moving average method)
As will be seen in the succeeding example, FIFO - periodic and FIFO - perpetual will
result to same amounts of cost of goods sold and ending inventory. However,
variations of average method will give different amounts because of the following:
Average - Periodic a Average - Perpetual

Anew average unit cost (i.e., moving
average unit cost) is computed every
time an entity receives items of
AmBAnEGE At the end each period: inventory (whether from purchases
or sales returns) or makes purchase
aur ABE Weighted average unit cost = | yeturns:
unit cost TGAS at cost + TGAS in units
Moving average unit cost =
Remaining total cost + Remaining
total units
Number of Multiple moving average unit cost
average Single weighted average unit | for each period depending on the
unit costto | cost for each period frequency of transactions which
|_ be used change the average cost
253
The
CamScanner
ie
_ Average - Periodic Average - Perpetual me

Computed every sale transaction:
Computed only at the end of
COGS in every sale = no, of units
Amount of | ¢ach period: SOLD x moving average unit cost
cost of Total COGS = total no. of units
goods sold | sorp x weighted average unit | The computed amounts of COGS in
cost every sale transaction are aggregated
to arrive at total COGS for the period
Computed only at the end of Computed only at the end ofeach|
Amount of | €ach period: period:
; ending Ending inventory = total no. of Ending inventory = total no. of
inventory units NOT SOLD x weighted units NOT sold x latest moving
average unit cost average unit cost a
Illustration 2. At the start of August 2023, OLIVIA Company had no beginning

inventories. In addition, the following inventory transactions happened during the
month of August 2023:
Purchases Sales
Unit Total Sales
Date Units Cost Cost Date Units Revenue
8/1 1,000 P50 P50,000 8/8 1,500 P120,000
8/5 3,000 55 165,000 8/17 2,500 200,000
8/7 2,000 58 116,000 8/31 2,200 176,000
8/12 900 58 52,200 Total 6,200 P496,000
8/21 800 60 48,000
Total —_7,700 TGAS — P431,200
Required: Determine the amount of COGS and ending inventory for each of the
following cost flow scenarios:
a. FIFO - periodic
b. FIFO - perpetual
c. Weighted average - periodic
d. Weighted average -perpetual
FIFO - Periodic Scenario

a. First, compute the total number of units sold and the number of units in ending
inventory:
Total units available for sale 7,700
Less: Number of units sold (6,200)
Number of units in ending inventory 1,500
254
The
The Book
b. Using the principle of “first purchased, first to be sold”, the amount of cost of
goods sold is computed from the cost of the first 6,200 units purchased. On the
other hand, the amount of ending inventory is computed as the cost of the latest
1,500 units purchased. Since we are using periodic inventory method, the cost of
goods sold will only be recorded at the end of the period.
COGS Ending Inventory
Purchase Unit Sold Total Unsold Total
Date Units Cost Units Cost Units Cost
8/1 1,000 P50 = 1,000 P50,000
8/5 3,000 55 3,000 165,000
8/7 2,000 58 2,000 116,000
8/12 900 58 200 11,600 700 P40,600
8/21 800 60 800 48,000
Totals 6,200 P342,600 1,500 P88,600
Since the purchases were already arranged chronologically, we can already pick
the first 6,200 units and multiply them with their corresponding unit cost. The
readers should note that 8/12 batch is split into sold and unsold portions as the
cut-off for the first 6,200 units ends within this batch.
c. Asaconclusion, the amount of cost of goods sold is P342,600, while the amount
of ending inventory is P88,600. The sum of these two amounts total P431,200,
which is equal to the TGAS. Readers are therefore advised to always check
this equality.
FIFO - Perpetual Scenario

a. First, arrange the sale and purchase transactions in chronological order as
shown below:
Unit Total
Date Transaction Units Cost Cost
8/1 Purchase 1,000 P50 P50,000
8/5 Purchase 3,000 55 165,000
8/7 Purchase 2,000 58 116,000
8/8 Sale (1,500)
8/12 Purchase 900 58 52,200
8/17 Sale (2,500)
8/21 Purchase 800 60 48,000
8/31 Sale (2,200)
Remaining unsold units = 1,500 TGAS P431,200
b. Next, compute the cost of goods sold and ending inventory as follows:
255
The
The Book
Unit Remaining
Date Transaction Units Cost Cost COGS
8/1 Purchase 1,000 P50 P50,000
8/5 Purchase 3,000 55 165,000
8/7 Purchase 2,000 58 116,000
TGAS 6,000 P331,000
8/8 Sale (1,000) 50 (50,000) P50,000
(500) 55 (27,500) 27,500
TGAS 4,500 P253,500
8/12 Purchase 900 58 52,200
TGAS 5,400 P305,700
8/17 Sale (2,500) 55 (137,500) 137,500
TGAS 2,900 P168,200
8/21 Purchase 800 60 48,000
TGAS 3,700 P216,200
8/31 Sale (2,000) 58 (116,000) 116,000
(200) 58 (11,600) 11,600
Ending Inv. 1,500 P88,600 P342,600
When using perpetual inventory method and whenever there is a sale

transaction, the amount of TGAS is immediately allocated between the cost of
goods sold and the cost of inventory remaining right after each sale transaction.
c. Asaconclusion, the amounts of cost of goods sold and ending inventory are
the same when using FIFO - periodic or FIFO - perpetual.
Weighted Average - Periodic Scenario

a. The first step is to compute the average unit cost of all purchases during the
period. This is done by dividing the amount of TGAS by the total number of
units available for sale during the period.
Date TotalCost Units UnitCost
8/1 P50,000 1,000 P50
8/5 165,000 3,000 55
8/7 116,000 2,000 58
8/12 52,200 900 58
8/21 48,000 800 60
TGAS P431,200 7,700
The single weighted average unit cost is computed as follows:

Weighted average _ _P431,200 _
unit cost = "7.700 P56
Assuming there is a beginning inventory, its cost will be included in the TGAS at
cost while the number of units will be included in the TGAS in units.
256
The
The Book
b. Next, compute for the amounts of cost of goods sold and ending inventory using
the single weighted average unit cost:
Total goods available

for sale - P431,200
peels wet eae

Cost of goods sold - P347,200 Ending inventory - P84,000
(6,200 sold units x P56 weighted (1,500 unsold unitsx P56
average unit cost) weighted average unit cost)
Weighted Average - Perpetual Scenario

a. First, arrange the purchase and sale transactions in chronological order similar
to the FIFO - Perpetual scenario.
b. Next, compute a new moving average unit cost whenever there is a purchase.
This changing moving average unit cost shall be used in allocating the TGAS to
the cost of goods sold and remaining inventory for every sale transaction moving
forward. Rounding errors in the unit costs are inevitable in this case.
Unit Remaining
Date Transaction Units Cost Cost COGS
8/1 Purchase 1,000 x P50.00 = P50,000
8/5 Purchase 3,000 x 55.00 = 165,000
TGAS 4,000 x 53.75 = 215,000
8/7 Purchase 2,000 x 5800 = 116,000
TGAS 6,000 x 55.17 = P331,000
8/8 Sale (1,500) x 55.17. = (82,755) P82,755
TGAS 4,500 x 55.17 = P248,245
8/12 Purchase 900 x 58.00 = 52,200
TGAS 5400 x 55.64 = P300,445
8/17 Sale (2,500) x 55.64 = (139,100) | 139,100
TGAS 2,900 x 55.64 = P161,345
8/21 Purchase 800 x 60.00 = 48,000
TGAS 3,700 x 56.58 = P209,345
8/31 Sale (2,200) x 56.58 = (124,476) 124,476
Totals 500: x 56.58 = P84,869 P346,331
Unit cost used for the allocation of TGAS is computed as Remaining Cost = No. of
Units right before each sale transaction. The readers should also note that the
average unit cost “moves” to different amounts. Hence, the average cost -
perpetual method is called as the “moving average” method.
257
The
The Book
c. As aconclusion, the amount of cost of goods sold is P346,331, while the amount
of ending inventory is P84,869,
Comparison of Methods
After applying the different methods, the following amounts can be compared:
Cost of Ending Unit Cost in
Goods Sold Inventory Ending Inventory
FIFO - periodic P342,600 P88,600 P59.07
FIFO - perpetual 342,600 88,600 59.07
Average — periodic 347,200 84,000 56.00
Average - perpetual 346,331 84,869 56.58
From the above comparison, the following should be noted:

a. Whenusing FIFO, whether perpetual or periodic, the amounts of cost of goods
sold will be the equal. The same is also true for ending inventory. The readers
are then advised to not to go through the tedious process of FIFO - perpetual
and just use the amounts computed using the relatively simple process of FIFO
— periodic.
b. The unit carrying amount of ending inventory using FIFO (P59.07) is closer to
the current replacement cost of the inventory (P60) than the unit carrying
amount of ending inventory using average method (P56 or P56.58). Because of
this, the FIFO method is said to favor the balance sheet.
c. The trend in unit cost, whether rising or declining, has profound effects to the
amounts of cost of goods sold and ending inventory determined using either
FIFO method or average method. This can be summarized as follows:
Amount of cost of Amount of ending
goods sold inventory
Increasing unit cost FIFO < Average FIFO > Average
Decreasing unit cost FIFO > Average FIFO < Average
This can be proven in the information with OLIVIA Company where the unit cost
is increasing.
CHANGE FROM FIFO METHOD TO AVERAGE METHOD AND VICE VERSA

Since the entity is allowed to choose either of the FIFO method or the average
method as its accounting policy, it may change its choice of method later on if the
change will result to a better information provided in the financial statements.
The change from FIFO method to average method and vice versa, is considered as
change in accounting policy and shall be accounted retrospectively. In other
words, previously reported financial information shall be restated to reflect the
change in the cost flow assumption applied.
258
The
The Book
CHAPTER SUMMARY
1. The beginning inventory and net purchases are the inputs in determining the
amount of total goods available for sale (TGAS),.
2. During a particular period, the amount of TGAS shall be allocated to cost of goods
sold (for sold units) and ending inventory (for unsold units).
3. The allocation shall be made using one of the following cost flow assumptions:
Cost Flow | Accounting Procedures
Can be applied only if the inventory items are not ordinarily
Specific
interchangeable. Under this cost formula, the costs are identified
identification
directly with the flow of goods.
Under this cost formula, the items of inventory that were
purchased or produced first are sold first. Consequently, the items
remaining in inventory at the end of the period are those most
FIFO method | recently purchased or produced.
The amounts of cost of goods sold and ending inventory are equal
whether the entity uses the perpetual or periodic method
Under this cost formula, the cost of each item is determined from
the weighted average of the cost of the items at the beginning of
a period and the cost of items purchased or produced during the
period.
The computation of average cost will depend on whether the

entity is using periodic or perpetual system:
1. Average - periodic (weighted average method) - only one
average unit cost is used for each period:
Average unit cost = TGAS at cost + TGAS in units

Average
method Cost of goods sold = no. of units sold x average unit cost, while
Ending inventory = no. of unsold units x average unit cost.
2. Average - perpetual (moving average method) - multiple

average unit cost is determined each period. A new average
unit cost is determined generally after each purchase.
Cost of goods sold is determined after each sale as no. of units

sold x current average unit cost, while ending inventory is
determined as no, of unsold units x latest moving average
unit cost as of reporting date.
4. Change from FIFO method to average method and vice versa is considered as change
in accounting policy and shall be accounted retrospectively.
259
The
The Book
True or False
3F Gross purchases plus beginning inventory are equal to total goods available for sale.
Z Ending inventory is generally equal to the cost of unsold inventory items.
a An entity shall only use judgement in allocating the amount of total goods available
for sale to ending inventory and cost of goods sold.
4. An entity may choose to its liking any of the following: specific identification, FIFO,
and average methods as its cost formula, regardless of the inventory characteris tics.
LIFO method is not allowed as a cost formula under PAS2.
wn
Specific identification shall only be used if the inventory items are ordinarily
interchangeable.
Under FIFO method, the cost of ending inventory represents the cost of latest
inventory purchase.
Under specific identification cost flow, the cost of goods sold is equal to the actual
exact cost of sold units.
An entity using FIFO method will arrive at different amounts of ending inventory
under periodic or perpetual inventory methods.
10. An entity using average method will arrive at the same amounts of ending inventory
when using periodic or perpetual inventory method.
11. Under moving average method, multiple averages may be used during a particular
period.
12. Under weighted average method, the average unit cost may be determined only at
the end of a particular period.
i. Which of the following are the inputs to the computation of total goods available for
sale?
a. Beginning inventory and ending inventory
b. Ending inventory and cost of goods sold
c. Netpurchases and beginning inventory
d. Net purchases and cost of goods sold
Which of the following are the outputs from the computation of total goods available
for sale?
a. Beginning inventory and ending inventory
b. Ending inventory and cost of goods sold
c. Netpurchases and beginning inventory
d. Net purchases and cost of goods sold
Which of the following is not a common cost flow assumption used in costing
inventory?
a. First-in, first-out
b. Average-in, average-out
c. Specific identification
d. Average cost
260
The
CamScanner
4. Which of the following statements is true regarding inventory cost flow

assumptions?
Acompany may use more than one costing method concurrently.
A company must comply with the method specified by industry standards.
aoop
A company must use the same method for domestic and foreign operations.
A company may never change its inventory costing method once it has chosen a
method.
5. Which of the following statements is correct with respect to inventories?
a. The FIFO method assumes that the costs of the earliest goods acquired are the
last to be sold.
b. Itis generally good business practice to sell the most recently acquired goods
first.
c. Under FIFO method, the ending inventory is based on the cost of the latest units
purchased.
d. Average method always coincides with the actual physical flow of inventory.
6. In periods of rising prices, the inventory method which results in the carrying
amount on the balance sheet that is nearest to prevailing costs is the
FIFO method.
aA op
Specific identification method.

Average-cost method.
All of the cost flow assumptions will produce the same amount of inventory
value.
7. Two companies reported the same total goods available for sale but each adapted
different cost formula. If the price of goods has increased during the period, then the
company using
a. Average method will have the higher ending inventory.
b. FIFO method will have the higher cost of goods sold.
c. FIFO method will have the higher ending inventory.
d. Average method will have the lower cost of goods sold.
8. If two companies have identical inventoriable costs but use different inventory flow
assumptions when the unit cost is increasing, then the
a. Cost of goods sold of the companies will be identical.
b. Cost of goods available for sale of the companies will be identical.
c. Ending inventory of the companies will be identical.
d. Netincome of the companies will be identical.
9, Generally, when using average method, a new moving average shall be determined
after each of the following transactions, except
a. Purchase of goods
b. Return of goods to suppliers
c. Return of goods from customers
d. Sale of goods to customers
261
The
The Book
10.When valuing ending inventory under a perpetual inventory system, the

a. Valuation using the average method is the same as the valuation using the
average method under the periodic inventory system.
b. Moving average requires that a new average be computed after every sale.
c. Valuation using the FIFO assumption is the same as under the periodic
inventory system.
d. Units purchased earlier during the period are allocated to the ending inventory
under FIFO assumption.
Straight Problems
1. BELLE Company started its antique shop operations on January 1, 2023. During that
month, it acquired the following antique items at their corresponding costs:
Item A P250,000 Item E P80,000
Item B 90,000 Item F 200,000
Item C 150,000 Item G 350,000
Item D 180,000 Item H 95,000
Each item is unique from each other and they are not ordinarily interchangeable. At
the end of the month, the Items B, D and F were not yet sold.
a. Total goods available for sale for January 2023
b. Ending inventory as of January 31, 2023
c. Cost of goods sold during the month of January 2023
2. LUCAS Company inventory records contained the following information regarding
its latest snowboard model:
Unit Cost/
Units Unit Sales
Beginning balance, July 1 30,000 P80.00
Purchases:
July 10 50,000 95.20
July 19 40,000 100.00
Sales:
July 4 20,000 120.00
July 25 40,000 130.00
July 29 20,000 135.00
Required: Determine the amounts of (a) cost of goods sold; (b) gross profit; and (c)
ending inventory for each of the following cost flow scenarios;
a. FIFO - periodic
b. FIFO - perpetual
262
The
3. At the beginning of June 2023, LOMBARDY Company had inventory composing of

3,200 units costing P28 per unit. During the month, it had the following transactions:
Purchases Sales
Unit Unit
Date Units Cost Date Units Sales
6/3 1,000 P27.20 6/9 2,400 P42.00
6/8 2,300 26.80 6/17 3,100 41.20
6/15 800 26.20 6/19 2,500 40.90
6/16 3,000 25.90 6/21 2,900 40.20
6/20. 1,600 25.50 6/28 2,700 38.80
6/22 900 = 25.00
6/26 3,200 24.50
Required: Determine the amounts of (a) cost of goods sold; (b) gross profit; and (c)
ending inventory for each of the following cost flow scenarios:
a. FIFO - periodic
b. FIFO - perpetual
4. TUSCANY Company had inventory balance of 1,300 units at P145 unit as of October
1, 2023. In addition, during the month of October, it had the following transactions:
Date Units Unit Cost Unit Sales

10/3 3,400 P148.00
10/6 1,800 P210
10/10 1,900 204
10/14 2,000 141.99
10/16 1,300 144.00
10/20 2,200 206
Required: Determine the amount of cost of goods sold, gross profit, and ending
inventory for each of the following cost flow scenarios:
a. FIFO - periodic
b. FIFO - perpetual
5. Acomputer virus contaminated some of the January 2023 files of CALIPH Company.
Fortunately, some information was salvaged from the hardcopy printouts it
maintains:
263
The
CamScanner
Gross profit P248,500

Cost of goods sold 1,011,500
Total goods available for sale 1,247,300
Unit cost of beginning inventory P82 per unit
Unsold units at the end of the month 2,800 units
In addition, the following were the purchases made during the month:
Date Units Unit Cost
1/9 3,000 84
1/12 5,000 86
1/17 2,600 83
1/20 1,700 85
Lastly, the Company is using FIFO method as the cost formula for its inventories.
Required: From the limited information provided, determine the following items:
Number of units in beginning inventory
Cost of beginning inventory
ena
Number of units sold during the month

Selling price per unit
Cost of ending inventory on January 31, 2023
6. During November 2023, a flood devastated EMIRATE Company’s accounting

records. Luckily, some of its accounting information were uploaded in its cloud
drive. Upon downloading the data from the drive, the following information were
extracted:
e Total sales for the month amounted to P 1,274,000 at P70 unit selling price.
e Ending inventory had a value of P83,016.
e Gross profit amounted to P434,616.
e The following are the purchases during the month:
Date Units Unit Cost
11/4 1,800 45
11/18 4,000 47
11/23 6,000 46
11/26 5,500 48
Required: Assuming that the Company uses the weighted average method,
determine the following:
Number of units sold
Number of units in the ending inventory
mmonooe
Average unit cost

Cost of goods sold
Total goods available for sale
Number of units in the beginning inventory
Cost of beginning inventory.
264
The
The Book
7. Onits May 1, 2023, TIGRIS Company reported inventory of 20,000 units with unit
cost of P28. During the months of May 2023 and June 2023, the Company entered
into the following transactions:
Date Transaction Units Unit Cost Unit Sales

5/2 Sale 15,000 P50.00
5/8 Purchase 30,000 P27.00
5/10 Sale 28,000 52.00
5/11 Purchase 40,000 29.03
5/12 Purchase 25,000 30.00
5/18 Sale 60,000 51.00
5/22 Purchase 45,000 26.00
5/27 Sale 32,000 50.50
6/1 Purchase 50,000 25.02
6/3 Purchase 48,000 25.50
6/9 Sale 76,000 51.00
6/14 Purchase 53,000 25.50
6/17 Sale 70,000 52.00
6/25 Purchase 24,000 26.50
6/26 Sale 33,500 53.00
of goods sold; (b) gross profit; and (c)

Required: Determine the amounts of (a) cost
ending inventory, separately for the months of May 2023 and June 2023 under each
of the following cost flow scenarios:
a. FIFO - periodic
b. FIFO — perpetual
c. Weighted average — periodic (the Company computes weighted average unit
cost every month)

1. Atthe beginning of the current month, GERARD Company had a beginning inventory
balance of P250,000, which comprised of P150,000 for Product A and P100,000 for
Product B. During the year, the Company acquired P135,000 of Product C, P90,000
of Product D, and P175,000 of Product E. For the current month, the Company sold
Products A, C, and D. The products are unique relative to each other (i.e., not
ordinarily exchangeable). Using the specific identification method, answer the
following questions:
The amount of cost of goods sold for the month shall be
a. P425,000 c. P385,000
b. P405,000 d, P375,000
The amount of ending inventory for the month shall be
a. P275,000 c. P245,000
b. P225,000 d. P265,000
265
The
2. RAY Company sellsa single product and accounts for the related costs using the FIFQ —
method. The following are the Company’s transactions for the month of June 2023.
June 1 Beginningbalance 5,400 units at P10 each
5 Sale 4,800 units at P17 each
10 Purchase 9,000 units at P12 each
22 Purchase 9,600 units at P14 each

a. P163,200 c. P170,400
b. P168,800 d. P173,600
a. P133,200 c. P122,800
b. P127,600 d. P126,000
The amount of gross profit for the month shall be
a. P100,800 c. P000,000
b. P000,000 d. P000,000
Assume instead that the Company uses average method - periodic, the amount of
cost of goods sold for the month shall be
a. P188,750 c. P184,650
b. P185,250 d. P183,350
ending inventory for the month shall be
a. P111,150 c. P111,750
b. P107,650 d. P113,050
gross profit for the month shall be
a. P86,550 c. P85,950
b. P87,850 d, P82,450
3. MATT Company uses FIFO method in accounting for its Product A. At the beginning
of February 2023, the Company reported beginning inventory of 9,000 units costing
P10 each. Selling price is fixed at P17.50 per unit. Purchases and sales transaction’
during the month are summarized as:
Date Purchases Date Sales
Feb.6 20,000 units at P10,20 each Feb. 7 19,000 units
10 15,000 units at P10.60 each 14 11,000 units
28 10,000 units at P11.54 each
266
The
The Book

a. P908,500 c. P918,500
b. P915,100 d. P910,300

a. P160,500 c. P158,700
b. P150,500 d. P153,900

a. P598,650 c, P595,250
b. P605,250 d. P603,450
cost of goods sold for the month shall be
a. P918,658 c. P924,685
b. P914,568 d. P938,865
ending inventory for the month shall be
a. P154,432 c. P130,135
b. P150,342 d. P144,315
gross profit for the month shall be
a. P574,885 _c. P599,182
b. P589,065 d. P595,092
4. On September 1, 2023, FRANK Company started its operations. During the month of
September 2023, it purchased the following products:
Products Units TotalCost Unit Sales

ProductA 10,000 P125,000 P24.00
ProductB 20,000 640,000 45.00
ProductC 15,000 600,000 65.00
ProductD 12,000 840,000 100.00
ProductE 40,000 2,400,000 92.00
These products are unique from each other. Consequently, the Company applies the
weighted average method on a per product level basis. As of September 30, 2023,
the following number of units were not yet sold:
Products Units
Product A 2,000
Product B 3,500
Product C 1,600
Product D 4,000
ProductE 14,000
267
The
The Book

a. P3,126,000 c. P3,306,000
b. P3,284,000 c. P3,428,000
a. P1,479,000 c. P1,321,000
b. P1,299,000 c. P1,177,000
a. P1,569,500 c. P1,871,500
b. P1,691,500 c. P1,713,500
5. At the beginning of March 2023, MERCH Company had 8,000 units of Product Z in
its inventory costing P30 each. During the month, it had the following transactions:
Date Transactions Units Unit Cost

3/2 Purchase 10,000 P28
3/5 Purchase return 500 28
3/9 Sale 12,000:
3/10 Sales return* 400
3/15 Purchase 20,000 32
3/16 Sales return* 600
3/20 Sales 16,000
*Related to 3/9 sale.
Selling price is fixed at P120 per unit. In addition, the Company is using the moving
average method as its cost flow formula (Round-off all average unit cost amounts in
four decimal places).
From this information, the net amount of cost of goods sold to be recorded for the
month of March 2023 shall be
a. P817,947 c. P843,843
b. P835,296 d. P852,297
From this information, the ending inventory as of March 31, 2023 shall be
a. P293,703 c, P328,053
b. P302,157 d. P310,704
268
The
The Book
Chapter 8A — Subsequent Measurement of Inventory
CHAPTER 8A
SUBSEQUENT MEASUREMENT OF INVENTORY

1. The subsequent measurement of inventory.
2. The concept of lower of cost and net realizable value (LCNRV).
3. The computation of net realizable value (NRV) depending on the type of inventory
that is measured.
4. The application of LCNRV to a group of inventory items.
5. The accounting for purchase commitments.
SUBSEQUENT MEASUREMENT OF INVENTORY

At the end of each reporting period, inventory’s carrying amount shall be the lower
of cost and net realizable value (LCNRV). The cost of the inventory is determined
using the different cost flow assumptions discussed in the previous chapter.
DETERMINING THE NET REALIZABLE VALUE

Net realizable value (NRV) refers to the net amount that an entity expects to realize
from the sale of inventory in the ordinary course of business. [PAS 2.7]. NRV is
computed as the estimated selling price less costs to sell and costs to complete.
Estimated selling price is normally the list price adjusted for any expected price
concessions to be made when the inventory items are to be sold. This is not
necessarily equal to the normal selling price of inventory items.
Costs to sell include sales commission, distribution costs, freight out, and other
costs which are directly related to the selling of the inventory. Costs to complete
comprise the direct materials and conversion costs needed to complete the work-
in-process inventory.
The readers may use the following guide in determining the amount NRV:
Type of Inventories | Amount of Net Realizable Value

Finished goods Estimated selling price less costs to sell
Estimated selling price (which is lower than the normal
Damaged goods selling price due to the goods’ lower quality) less costs
to sell and costs to rectify, if not yet rectified.
Estimated selling price less costs to sell and costs to
Work-in-process
complete
Replacement cost since the materials are not really sold
Materials, including | but used in the production instead. Replacement cost is
factory supplies the amount that shall be paid if the materials are to be
purchased on reporting date,
269
The
Chapter 8A - Subsequent Measurement of Inventory
Estimates of NRV also take into consideration the purpose for which the inventory
is held. For example, the NRV of the quantity of inventory held to satisfy firm sales or
service contracts is based on the contract price less directly related contract costs,
[PAS 2.31]. Because of these characteristics, NRV is an entity-specific value as the
amounts used in the computations are specific to an entity.
Illustration 1 - NRV of Finished Goods. BUBOY Company’s finished goods in good

condition have total normal selling price of P3,000,000, but has an estimated selling
price of just P2,700,000 due to decrease in demand. Costs to sell these goods are
estimated at P250,000.
NRVin this case is P2,4.50,000 (P2,700,000 - P250,000). The readers should take note
that the normal selling price is not used since it is not the amount that will be received
from selling the finished goods.
Illustration 2 - NRV of Damaged Finished Goods. BUKNOY Company’s quality
control team has identified damaged finished goods with normal selling price of
P500,000. The Company plans to rectify these for a total cost of P90,000 and then
sell these for P380,000 as “seconds”. Commissions to be paid are estimated at
P30,000.
NRV in this case is P260,000 (P380,000 - P30,000 - P90,000). The readers should
take note that the commission to be paid is considered as cost to sell. Again, the normal
selling price of P500,000 is not relevant in this case since it is based on the premise
that the goods are not damaged.
Illustration 3 - NRV of Work-in-Process Goods. At the end of the current period,

BELEKOY Company had some goods that were unfinished. To be able to sell these
unfinished goods at an estimated selling price of P900,000, the Company shall incur
additional P180,000 to turn them into finished goods. Costs to sell these are
expected to be P40,000
The NRV of these work-in-process goods is P680,000 (P900,000 - P180,000 -

P40,000). The additional P180,000 costs are considered as costs to complete.
The readers should take note that costs already incurred (i.e., PAST costs) are
included in the inventory’s COST but costs to be incurred in the FUTURE are
deducted from estimated selling price to arrive at NRV.
LOWER OF COST AND NET REALIZABLE VALUE
At end of each reporting period, the computed cost of ending inventory is compared
with its NRV. In the absence of contrary information, the amount of recorded
inventory right before the comparison is equal to its cost. Since inventory shall be
measured at LCNRV, the following rules shall apply:
270
The
Scenario —| Accounting procedures

Cost=NRV_ | Generally, no further accounting procedures.
Cost <NRV _ | Generally, no further accounting procedures.
The inventory shall be written-down to its NRV, with the
Cost>NRV | difference reported as loss on inventory write-down. This loss
amount is usually added to the amount of cost of goods sold.
The loss amount is usually reported within the amount of cost of goods sold. The
practice of writing the cost of inventories down below to NRV is consistent with the
view that assets should not be carried in excess of amounts expected to be realized
from their sale or use. [PAS 2.28].
What could be the reasons for any decline in NRV? To answer that question, it is
important to go back to the formula in computing for NRV: estimated selling price
less costs to sell and/or costs to complete. Based on this, any one or combinations of
the following may result to a decline in NRV:
a. decrease in estimated selling price, for example, because of obsolescence; and
b. increase in costs to sell and/or costs to complete.
Illustration 4. As of December 31, 2023, CRISTINA Company’s merchandise
inventory had cost of P3,000,000 applying the FIFO cost formula. Required: Under
each of the following independent scenarios, determine the amount of loss on
inventory write-down, if any, that the Company shall record:
1. Estimated selling price of P3,300,000 and P300,000 estimated costs to sell.
Amounts of loss on inventory write-down, if any, to be recognized for each scenario
are the following:
Loss on Invty.
Scenario Cost NRV Lower Write-down
1 3,000,000 P3,000,0004 Cost=NRV p-
2 3,000,000 P3,150,0008 Cost -
3 3,000,000 __ P2,920,000° NRV 80,000?
A = P3,300,000 - P300,000
B = P3,400,000 - P250,000
C = P3,120,000 - P200,000
D = P3,000,000 - P2,920,000
Illustration 5 - LCNRV of Work-in-Process. JENNIFER Company's work-in-

process had total accumulated cost of P1,500,000. These can be sold for P1,800,000
after incurring completion costs of P400,000 and selling costs of P140,000.
271
The
The NRV in this case is P1,260,000 (P1,800,000 - P400,000 - P140,000). Since this
amount is lower than the P1,500,000 cost, loss on inventory write-down of
P240,000 (P1,260,000 - P1,500,000) shall be recorded.
RECORDING OF WRITE-DOWN OF INVENTORY

As previously mentioned, when the inventory’s cost is higher than the related NRV,
the entity shall write-down the carrying amount of its inventory to equal its NRV
using either of the following methods:
Allowance Method Direct Method

The inventory account will not be The ending inventory account will be
directly reduced but a_ separate directly recorded equal to the amount
allowance on inventory write-down of NRV.
account will be used instead. This is a
As a result, the amount of loss on
contra-asset account charged against
the inventory balance.
inventory write-down _ will be
automatically included in the amount
The balance of this allowance account of cost of goods sold (applying the
represents the cumulative amounts of concepts of closing entries).
inventory write-down recorded.
Despite these seemingly different procedures, the carrying amount of ending

inventory shall be equal under these methods. The same is also true for the amount
of cost of goods sold.
Between these two methods, the author humbly suggests that the allowance method
is the better choice because it tracks the cumulative amount of losses which is very
useful in accounting for the reversal of the previously recognized loss on write-
down. Reversal will be discussed shortly.
Illustration 6. At the beginning of 2023, WILMA Company reported P4,000,000 as

the carrying amount of inventory. Net purchases during the year amounted to
P8,000,000. Ending inventory had cost of P3,100,000 with the related NRV is
estimated at P2,650,000.
In this illustration, there is a loss on inventory write-down of P450,000 (P3,100,000

- P2,650,000), which is accounted for as follows under the different methods:

To record the amount of inventory write- No separate entry to record the amount
down using an allowance account: of loss on inventory write-down.
Loss on invty. write-down 450,000
Allow. on invty. write-down 450,000
272
The
CamScanner
es Allowance Method Direct Method

To close the balances of beginning | To close the balances of beginning
inventory and net purchases and | inventory and net purchases and
recognize the balances of ending | recognize the balances of ending
inventory and the amount of cost of | inventory and the amount of cost of
goods sold: goods sold:
Inventory, end. 3,100,000 Inventory, end, 2,650,000
Cost of goods sold 8,900,000 Cost of goods sold 9,350,000
Inventory, beg. 4,000,000 Inventory, beg. 4,000,000
Net purchases 8,000,000 Net purchases 8,000,000
The readers should take note that the The readers should take note that the
ending inventory is still debited equal ending inventory is debited equal to
to its COST (i.e., not at NRV). its lower NRV (i.e., not at cost).
The final amount of cost of goods sold is The final amount of cost of goods sold is
computed as: equal to the initially recorded cost of
goods sold of P9,350,000, which
Cost of goods sold P8,900,000 automatically included the P450,000 loss
Add: Loss on invty. W.D. 450,000 on inventory write-down.
Total cost of goods sold 9,350,000
The ending inventory’s carrying amount The ending inventory’s carrying amount
as of 12/31/23 is computed as: as of 12/31/23 is equal to the initially
recorded Inventory, end. of P2,650,000.
Inventory, end. P3,100,000
Less: Allow. on invty. W.D. (450,000)
Ending inventory, net P2,650,000
Note W.D. = write-down
For the allowance method, the required amount of allowance on inventory write-
down may change from one period to another. These changes are accounted for
during the subsequent period as follows:
Scenario What to be recognized?
Increase in required allowance Additional loss on inventory write-down
Decrease in required allowance Gain on reversal of inventory write-down
ADDITIONAL LOSS ON INVENTORY WRITE-DOWN

Additional losses on inventory write-down during the subsequent periods are
determined and accounted for as follows:

The amount of loss on inventory write- The additional loss on inventory write-
down is computed as the difference down is automatically included in the
between the following amounts: amount of cost of goods sold.
273
The
|Required ending allowance Pxx The amounts of beginning and ending

Less: Beginning allowance (xx) | inventory to be used in computing cost of
Loss on invty. write-down Pxx | goods sold is always the lower of the
corresponding cost and NRV.
Required ending allowance is
Ending inventory at cost Pxx
Less: Ending inventory at NRV (xx)
Required ending allowance Pxx
Illustration 7. Continuing with WILMA Company (Illustration 6), for the year 2024,
it reported net purchases of P7,500,000. As of December 31, 2024, ending inventory
had cost of P2,600,000 and NRV of P2,000,000. This additional information is
processed and accounted for as follows:
Allowance Method. Direct Method
Required ending allowance is computed No equivalent procedure.
as follows:
Ending invty. - cost P2,600,000
Less: Ending invty.- NRV _ (2,000,000)
Required ending allowance P600,000
The amount of loss on inventory write- No corresponding separate entry to

down is computed as follows: record the amount of loss on inventory
write-down.
Required ending allowance P600,000
Less: Beginningallowance (450,000)
Loss on invty. write-down P150,000
This loss shall be recorded as:
Loss on invty. write-down 150,000

Allow. on invty. write-down 150,000
ee
To close the balances of beginning To close the balances of beginning

inventory and net purchases and inventory and net purchases and
recognize the balances of ending recognize the balances of ending
inventory and the amount of cost of inventory and the amount of cost of
goods sold: goods sold:
Inventory, end. 2,600,000 Inventory, end. 2,000,000
Cost of goods sold 8,000,000 Cost of goods sold 8,150,000
Inventory, beg. 3,100,000 Inventory, beg. 2,650,000
Net purchases 7,500,000 | Net purchases 7,500,000
274
The
The readers should take note that the The readers should take note that the
ending inventory is still debited equal ending inventory is debited equal to
to its cost (i.e., not at NRV). its lower NRV (i.e., not at cost).
The final amount of cost of goods sold is The final amount of cost of goods sold is
computed as: equal to the initially recorded cost of
goods sold of P8,150,000, which
Gast uigoodsee'd BE,0O0/000 automatically included the P150,000 loss
Add Loss Inviye Wi: 150,000 on inventory write-down for the year
Total cost of goods sold 8,150,000 2024.
The ending inventory’s carrying amount The ending inventory’s carrying amount
as of 12/31/24 is computed as: as of 12/31/24 is equal to the initially
recorded Inventory, end. of P2,000,000.
Inventory, end. P2,600,000
Less: Allow. on invty. W.D. (600,000)
Ending inventory, net P2,000,000
GAIN ON REVERSAL OF PREVIOUS LOSS ON INVENTORY WRITE-DOWN

If, during the succeeding period, the NRV increases, the previously recorded amount
of loss on inventory write-down shall be reversed as a gain. However, the amount
of gain on reversal shall not exceed the amount of loss on inventory write-
down that were recognized in previous periods. The gain on reversal is usually
reported as a deduction from cost of goods sold. [PAS 2.34].
Readers are hereby advised to utilize the allowance method in determining the
amount of gain on reversal that shall be recognized.
The gain to be recognized is equal to the decrease in the required balance of
allowance. Consequently, the maximum amount of gain on reversal that can be
recognized is equal to the beginning-of-the-period balance in the allowance
(regardless of the excess of NRV over cost). Pro-forma journal entry is as follows:
Allowance for inventory write-down XX

Gain on reversal of inventory write-down XX
Illustration 8. At the end of 2022, ANNE Company's inventory had cost of

P5,000,000 and NRV of P4,700,000. The P300,000 loss on inventory write-down is
properly recorded during that year using the allowance method. Fast forward to
2023, ending inventory had P3,400,000 cost as of December 31, 2023. Required:
Under each of the following independent scenarios, determine the amount of gain
on reversal to be recognized, if any for the year 2023:
1. NRV as of December 31, 2023 amounted to P3,200,000.
275
The
Solution:
Scenario1 Scenario 2 Scenario 3
Ending inventory - cost P3,400,000 P3,400,000 P3,400,000
Less: Ending inventory - NRV (3,200,000) (3,650,000) (3,350,000)
Required allowance, 12/31/23 P200,000 P- P50,000
Allowance balance, 1/1/23 P300,000 P300,000 P300,000

Less: Required allowance,12/31/23 (200,000) - (50,000)
Gain on reversal to be recorded P100,000 P300,000 P250,000
The readers should take note that there is no required allowance in Scenario 2 since
the P3,650,000 NRV is now higher than the P3,400,000 cost.
WRITING-DOWN RAW MATERIALS

As previously mentioned, NRV of raw materials (including factory supplies) is not
computed since these are not usually sold by the manufacturing entity who will use
them. Special circumstances call for special accounting procedures wherein the
related finished goods in which these raw materials and factory supplies will
be incorporated are also considered as follows:
Can the related finished goods be

sold at or above their total cost?
Is the replacement cost of raw

materials lower than its carrying
amount?
Write-down the carrying amount of the raw Do not record any

materials to its replacement cost witha write-down of raw
corresponding loss on inventory write-down materials
Illustration 9. MELCHOR Company would like to subject its raw materials

inventory to LCNRV measurement. This raw. materials inventory had cost of
P1,000,000. Under each of the following independent scenarios, determine the
amount of loss on inventory write-down to be recorded for the raw materials:
276
The
Related Finished Goods Raw Materials

Scenario Cost NRV Replacement Cost
1 P1,700,000 P1,900,000 P850,000
2 1,700,000 1,450,000 1,100,000
3 1,700,000 1,450,000 900,000
Scenario 1 - No amount of loss on inventory write-down shall be recognized

since the related finished goods can be sold at above its cost (i.e, NRV> cost).
Scenario 2 ~ Even though the related finished goods cannot be sold at or above its
cost (i.e, NRV < cost), no amount of loss on inventory write-down shall be
recognized for the raw materials since the raw materials’ replacement cost of
P1,100,000 is still higher than the related P1,000,000 cost.
Scenario 3 - Since the related finished goods’ NRV is lower than its cost and the
raw materials’ replacement cost is lower than its recorded cost, a loss on
inventory write-down of P100,000 (P1,000,000 - P900,000) shall be recognized
for the raw materials. In addition, the raw materials inventory shall now be carried
at P900,000 (i.e., equal to its replacement cost).
LEVEL OF APPLICATION OF LOWER OF COST AND NET REALIZABLE VALUE
The LCNRV measurement shall be applied on an item-by-item basis. In other
words, items of inventory shall not be grouped with other items, aside from
exceptional circumstances. As a result, comparison of cost and NRV shall not be
facilitated in geographical basis nor on the basis of the classification of inventory.
This rule is made to preclude an entity to group its inventory on an arbitrary basis so
that no loss on decline in NRV will be made as inventories with higher NRVs will tend
to offset those with lower NRVs.
Illustration 10. A merchandiser, which sells different kinds of products in two of
its retail stores, reported the following as of December 31, 2023:
Number Unit Total Unit Total
ofUnits Cost Cost NRV NRV
Retail Store 1
Product A 10,000 P42 P420,000 P41 P410,000
Product B 2,000 12 24,000 15 30,000
Product C 3,000 20 60,000 25 75,000
Subtotal P504,000 P515,000
Retail Store 2
Product D 1,000 P63 P63,000 P65 ~=P65,000
Product E 4,000 90 360,000 85 340,000
Product F 1,500 30 45,000 40 60,000
Subtotal P468,000 P465,000
Grand Total P972,000 P980,000
277
The
Required: Determine amount to be recorded as loss on decline of NRV and the total
carrying amount of inventory to be reported as of December 31, 2023.
The following discussions will be relevant in solving the problem:
a. There will be no loss to be recorded if the “Grand Total” amounts are to be used
since the amount of total NRV (i.e, P980,000) is higher than the amount of total
cost (i.e., P972,000).
Meanwhile, at the “Subtotal” or Retail Store level, total loss to be recognized is
Subtotal Cost SubtotalNRV Loss, if any
Retail Store 1 P504,000 P515,000 P-
Retail Store 2 468,000 465,000 3,000
Total loss on inventory write-down P3,000
These “Grand Total” and “Subtotal” levels are to be completely ignored and
the assessment shall be made on an item-by-item basis as shown in (b) below.
b. The item-by-item assessment shall be made as follows:
Total Total Lower Loss due
Cost NRV Amount toLCNRV
Product A P420,000 P410,000 P410,000 P10,000
Product B 24,000 30,000 24,000
Product C 60,000 75,000 60,000
Product D 63,000 65,000 63,000
Product E 360,000 340,000 340,000 20,000
Product F 45,000 60,000 45,000
Total P972,000 P942,000 P30,000
As can be seen from the preceding table, whenever the NRV is the lower amount,
a corresponding loss equal to the difference between the cost and the
corresponding NRV will be recognized.
The readers should also take note that the recorded amount of the inventory
before any write-down is P972,000 (i.e. equal to total cost), but its carrying
amount should be P942,000 after the LCNRV comparison. To write-down the
carrying amount of the inventory to P942,000 using the allowance method, the
following entry shall be made:
Loss on inventory write-down 30,000
Allowance on inventory write-down 30,000
Going back to assessment in (a), there are a lot more products (Products B, C, D
and F) with higher NRVs which offset the low NRV of Products A and E, which
resulted to zero amount of loss in “Grand Total” level. This only shows that the
278
The
The Book
Chapter 8A —- Subsequent Measurement of Inventory
item-by-item basis is more effective in exposing the inventory items that

need to be written-down.
c. Asaconclusion, the carrying amount of the inventory as of December 31, 2023
shall be P942,000 and that the loss on inventory write-down shall amount to
P30,000.
CONSIDERATION OF SELLING PRICES AFTER REPORTING DATE

Generally, transactions occurring after the reporting date are not considered in
measuring the carrying amounts of assets as of the reporting date. However, for
inventories, selling prices during the first few days of the subsequent period may be
indicative of its estimated selling price as of the current reporting date.
Illustration 11. As of December 31, 2023, JERICHO Company had 10,000 units in
its finished goods inventory costing P40/unit. On January 3, 2024, 2,000 units were
sold for P38 per unit.
In this case, in the absence of costs to sell, the P38 unit selling price may be considered
as the NRV of the finished goods as of December 31, 2023. Consequently, there is a loss
on inventory write-down of P20,000 [(P38 - P40) x 10,000 units] to be recognized
during 2023 since the P38 NRV is less than the P40 unit cost. This is still true even if
the sale transaction occurred during 2024.
EXCEPTIONS TO THE LOWER OF COST AND NET REALIZABLE VALUE
Currently, PAS 2 recognizes two measurement exemptions under LCNRV, meaning
the relevant inventories are not measured at the lower of cost and NRV, instead the
following rules shall apply:
Measurement of | Amounts to be Recognized
Inventory Exceptions Inventories in Profit or Loss
Inventories of producers of Always at NRV, if
agriculturaland forest that is the well- ; Changes in NRV at the end of
Paster harv minertals | €Stbl

andes i
ished practice
duce ;
in their industry.
each period
:
and mineral products
‘ : Always at fair Changes in fair value less
Inventories of commodity
bpsleetrail bee value less cost to costs to sell at the end of
sell (FVLCTS) each period
Broker-traders are those who buy or sell commodities for others or on their own
account. The amount of unrealized gain or loss will depend on the changes in NRV
and FVLCTS as follows:
Scenario Accounting Consequence
Increase in NRV/FVLCTS Unrealized gain
Decrease in NRV/FVLCTS Unrealized loss
279
The
Illustration 12 - Changes in NRV. On December 1, 2023, ZINC Company extracted

minerals with total NRV of P800,000. These minerals are to be held for an extended
period time, waiting for the best possible selling price. As of December 31, 2023 and
2024, the following information is relevant:
2023 2024
Estimated selling price P900,000 1,200,000
Estimated costs to sell 120,000 160,000
On December 31, 2023, the inventory’s NRV is P780,000 (P900,000 - P120,000).
Consequently, the Company shall recognize unrealized loss of P20,000 (P780,000 -
P800,000) as follows (using direct method):
Unrealized loss 20,000
Inventory - minerals 20,000
Fast forward to December 31, 2024, the inventory’s NRV is P1,040,000 (P1,200,000
- P160,000). In this case, the full increase in NRV amounting to P260,000
(P1,040,000 - P780,000) shall be recognized in full as gain:
Inventory - minerals 260,000
Unrealized gain 260,000
a. The LCNRV accounting is not applicable in this case. Instead, changes in NRV are
recognized in full whether or not it will make the carrying amount of the inventory
higher than its original cost.
b. The inventories are carried equal to their NRVs as of each reporting date. In the
illustration, inventory has carrying amounts of P780,000 and P1,040,000 as of
December 31, 2023 and 2024, respectively.
c. As to inventories measured at FVLCTS, the accounting entries are substantially
the same as in the accounting entries for inventories measured at NRV.
PURCHASE COMMITMENTS
An entity may enter in to a contract with its supplier for purchase of raw materials
and/or finished goods in the future. This contract may state specific quantities to
be purchased, the timing of the purchase, and the fixed price (or the commitment
price) to be paid for the inventory items.
Since the price to be paid in the future is already fixed, there may be circumstances
wherein the amount of NRV of inventory underlying the purchase commitment
becomes different from commitment price. These differences are accounted for as
follows:
280
The
CamScanner
Scenario Accounting Procedures

Commitment price = NRV No further. accounting procedures needed.
Commitment price < NRV No further accounting procedures needed.
The difference is considered as loss, provided the
Commitment price > NRV | purchase commitment is noncancelable. No loss shall
be recognized if the purchase commitment is cancelable.
LOSS ON PURCHASE COMMITMENT

Loss on purchase commitment indicates that the contract has become onerous since
the entity will be paying more than the true value (i.e. NRV) of the inventory. By
analogy, the previously discussed rules on comparing the NRV with the cost of
inventory can be applied in this case (i.e., lower of purchase price and NRV).
In computing and accounting for the amount of loss on purchase commitment, an
entity may follow the following guidelines:
1. Loss on purchase commitment shall be computed using the following formula:

Loss on purchase commitment = Number of units x Loss per unit
Details on these inputs are described in the following table:

Inputs Description
Usually, the total number of units covered in the noncancelable
purchase commitment that will be received in the future.
In cases when a purchase commitment has both cancelable and
noncancelable portions, the loss is computed based on the
Number noncancelable portion only.
ofunits | For example, a noncancelable purchase commitment requires the
entity to purchase at least 1,000 units, but the entity may opt to
purchase additional 5,000 units. In this case, the loss is computed
000 mini umber its not on 5,000 units nor
6,000 units.
On initial recognition of loss on purchase commitment, loss per unit

is computed as: NRV per unit less unit commitment price.
Loss per
unit In the subsequent periods, a further loss per unit, if any, is computed
as: NRV beginning less NRV ending.
2. The recognition of the loss is made at end of each reporting period or when the
entity actually purchases the inventories whichever is earlier. Pro-forma journal
entry to record the loss on purchase commitment is as follows:
Loss on purchase commitment XX
Liability from purchase commitment XX
281
The
The Book
The credit is made on the liability account in accordance with the provisions of
PAS 37, Provisions, Contingent Liabilities and Contingent Assets with regards to
onerous contracts. This will be thoroughly discussed in the Volume 2 of this
Intermediate Accounting series.
3. Any further decrease in NRV is recognized as an additional loss (and liability)

on purchase commitment, while any subsequent increase in NRV is
recognized as gain on reversal of purchase commitment. Gain on reversal of
loss on purchase commitment will be discussed shortly.
4. In cases the inventory covered by the purchase commitment has been actually
received, the purchasing entity shall make the following pro-forma journal
entry:

Purchases/Inventory (equal to the lower of
commitment price and NRV on receipt date) XX
Loss on purchase commitment (if any) XX
Cash (equal to commitment price) XX
Gain on reversal of loss (if any) XX
There is an additional loss on purchase commitment if the NRV further

decreased from reporting date to the purchase date. On the other hand, there is
a gain on reversal of loss if the NRV increased from reporting date to the
purchase date.
Illustration 13 - Basic. On December 1, 2023, CORAZON Company entered into a
purchase commitment covering 30,000 units of its merchandise inventory at fixed price
of P20/unit. These units are to be delivered on January 31, 2024. Required: Under each
of the following independent scenarios, determine the amount of loss on purchase
commitment to be recognized, if any, on December 31, 2023:
1. Purchase commitment is cancelable and NRV per unit amounted to P25/unit.
2. Purchase commitment is noncancelable and NRV per unit amounted to P25/unit.
3. Purchase commitment is cancelable and NRV per unit amounted to P18/unit.
4. Purchase commitment is noncancelable and NRV per unit amounted to P18/unit.
Scenarios 1 and 2 - No loss on purchase commitment since the NRV of P25/unit is
higher than the commitment price.
Scenario 3 - Even though the NRV of P18/unit is lower than the commitment price of
P20/unit, no amount of loss on purchase commitment is recognized since the
purchase commitment is cancelable.
Scenario 4 - Since the NRV of P18/unit is lower than the P20/unit commitment price
and that the purchase commitment is noncancelable, loss on purchase commitment
of P60,000 [30,000 unitsx (P20 - P18)] shall be recognized.
282
The
Illustration 14 - With Actual Purchase. CARLA Company entered into a

noncancelable purchase commitment covering 40,000 units of its merchandise
inventory on November 15, 2023, to be delivered on January 15, 2024. Commitment
price is set at P40/unit while NRV as of December 31, 2023 and January 15, 2024
amounted to P37/unit and P35/unit, respectively.
On December 31, 2023, the loss on purchase commitment of P120,000 [40,000 units
x (P40 - P37)] shall be recognized as follows:
Loss on purchase commitment 120,000
Liability from purchase commitment 120,000
On January 15, 2024, the actual purchase of the 40,000 units shall be recorded as:
Purchases (P35 x 40,000) 1,400,000
Cash (P40 x 40,000) 1,600,000
The additional P80,000 loss is determined as 40,000 units x (P37 - P35).
Illustration 15 - Cancelable and Noncancelable Portions. CHELSIE Company

manufactures luxury products and uses a raw material with widely fluctuating price
in the market. On November 30, 2023, the Company entered into a noncancelable
purchase commitment covering a minimum of 15,000 units per year, for the next
three years, starting in 2024. The Company has the option to purchase additional
35,000 units per year during the same three-year period. Commitment price is set
at P30/unit. NRV as of December 31, 2023, 2024 and 2025 were P29/unit,
P27 /unit, and P25.50/unit, respectively.
Amounts of loss on purchase commitment to be recognized from 2023 to 2025,
related to goods not yet received, are determined as follows:
[A] x [B]
[A] [B] Loss on Purchase
Date Noncancelable portion Loss per unit Commitment
12/31/23 45,000 units (15,000x3 yrs.) P1.00 (P30 - P29) P45,000
12/31/24 30,000 units (15,000x2 yrs.) P2.00 (P29 - P27) 60,000
12/31/25 15,000 units (15,000x1yr.) P 1.50 (P27 - P25.50) 22,500
Based on these computations, the readers should take note of the following:
a. Only the noncancelable portion of 15,000 units per year is used as the number
of units (i.e., excluding the cancelable portion of 35,000 units per year).
b. As each year passes by, the remaining noncancelable number of units is
decreasing since some of these have already been received during the current
and prior years.
c. Loss per unit shows the gradual decrease in the NRV from the beginning of the
period to the end of the period.
283
The
d. These amounts exclude the further amounts of gain or loss on purchase

commitment arising from the actual delivery of the units.
GAIN ON REVERSAL OF LOSS ON PURCHASE COMMITMENT

After recording loss on purchase commitment, the NRV of the inventory items may
subsequently increase in the succeeding periods. In these cases, there could be a
partial or full reversal of previously recorded losses on purchase commitment.
However, the maximum amount of gain on reversal of loss on purchase
commitment is limited to the amounts of loss on purchase commitment
during the prior periods (which is also equal to the carrying amount of liability
from purchase commitment). In other words, any increase in the NRV in excess of
the commitment price shall not be recognized.
Pro-forma journal entry to record the reversal is as follows:

Gain on purchase commitment Xx
Illustration 16. On December 20, 2022, CALOY Company entered into a

noncancelable purchase commitment involving 5,000 barrels of oil at a fixed price
of P1,000/barrel, to be delivered on January 15, 2024. On December 31, 2022, the
NRV of each barrel declined to P950. Consequently, loss on purchase commitment
of P250,000 [5,000 unitsx (P1,000 - P950)] was properly recorded on that date:
On December 31, 2023, economic conditions improved and the NRV per barrel has
increased as of this date. Required: Under each of the following independent
scenarios, determine the amount of gain on reversal of loss on purchase
commitment that shall be recorded:
1. NRV as of December 31, 2023 amounted to P985/barrel.
2. NRVas of December 31, 2023 amounted to P1,018/barrel.
Scenario 1 ~ Gain on reversal of loss on purchase commitment to be recognized is

P175,000 [5,000 unitsx (P985 - P950)]. This partial reversal is recorded as follows:

Gain on purchase commitment 175,000
Scenario 2 - Gain on reversal of loss on purchase commitment to be recognized is

P250,000 [5,000 unitsx (P1,000 - P950)]. This full reversal is recorded as follows:
Gain on purchase commitment 250,000
284
The
The readers should take note that the increase in NRV from P1,000/barrel to
P1,018/barrel shall not be recognized. Recognizing this will result to a debit
balance in the liability from purchase commitment account and overstated amount of
gain on purchase commitment.
CHAPTER SUMMARY
1. After measuring the cost of inventory items, these shall be subsequently measured
at the lower of cost and net realizable value (LCNRV).
2. In general sense, net realizable value (NRV) is the estimated net amount that an
entity can receive from selling its inventory items.
3. The estimated amount of NRV will depend on the type of inventory being measured:
Type Amount of Net Realizable Value

Finished goods _| Estimated selling price less costs to sell
Estimated selling price less costs to sell and costs to rectify, if
Damaged goods
not yet rectified.
Work-in-process | Estimated selling price less costs to sell and costs to complete
Replacement cost since the materials are not really sold but
ial
seeaheahe els ry used in the production instead. Replacement cost is the
supplies amount that shall be paid if the materials are to be purchased
on reporting date.
The inventory shall be written down to its NRV if its NRV is lower than its cost.
NED Ue
The LCNRV assessment shall be made on an item-by-item basis.

Loss on inventory write-down is usually reported as part of cost of goods sold.
Write-downs can be recorded using either the allowance method or the direct
method.
Under the allowance method, the loss on inventory write-down is separately tracked
~
in a separate and contra-asset allowance account.

9. Under the direct method, the loss on inventory write-down is automatically included
in the amount of cost of goods sold and the inventory account is directly reduced by
the amount of write-down.
10.Gain on reversal of loss on inventory write-down shall. be recognized if the NRV
subsequently increases. The gain is a deduction from the amount of cost of goods sold
and is limited by the previously recognized amount of loss on write-down.
11.Loss shall be determined from noncancellable purchase commitment if the goods’
NRV becomes lower than the commitment price. A corresponding liability shall also
be recognized.
12.The loss shall be based only on the noncancellable portion of the total quantity
covered by a purchase commitment.
13.Gain on reversal of previously recognized loss on purchase commitment shall be
determined if NRV subsequently increases,
14. The increase in NRV over the commitment price shall not be recognized.
15.Some inventories may be measured at NRV or FVLCTS, Increases in these amounts
recognized as unrealized gains while decreases are recognized as unrealized losses.
285
The
The Book
True or False
1. NRVis the net amount of cash that shall be paid in acquiring inventory items.
2. At the end of each reporting period, inventories shall be measured at the lower of
cost and NRV.
3. NRV is determined as the estimated selling price less costs to sell and costs to
complete.
4, Estimated selling price is necessarily equal to the normal selling price.
5. The computation of NRV will depend on the inventory item being measured.
6. For LCNRV purposes, conversion costs to be incurred in the future shall be added
to the inventory’s cost.
7. Costs to complete include the conversion costs that were incurred during the
current and previous periods.
8. Aloss oninventory write-down shall be recognized if the inventory’s NRV becomes
lower than its cost.
9. Costs to sell include transport costs that will be shouldered by the entity but shall
exclude the transport costs that will be shouldered by the customers.
10. The NRV of an inventory item determined by one entity shall also equal to the NRV
of that same inventory item as determined by another entity.
11. Inventory write-down can be recorded by directly reducing the balance in
inventory account or through an allowance account.
12. Loss on inventory write-down is deducted from cost of goods sold while gain on
reversal of loss on inventory write-down is added to the cost of goods sold.
13. LCNRV assessment shall be based on inventory groupings, such as a grouping based
on geographical locations.
14. Inanoncancelable purchase commitment, loss shall be recognized if the inventory’s
NRV becomes lower than the purchase commitment price.
15. A corresponding liability on a noncancelable purchase commitment shall be
recognized since the purchase commitment price becomes onerous relative to the
inventory’s value (i.e., NRV).
1, Which of the following is the basis of writing-down inventories to their NRV?
a. Inventories shall not be carried at amounts higher than the net amount that can
be realized from them.
b. Inventories shall be carried at amounts higher than the net amount that can be
realized from them,
c. Inventories are always sold at amounts higher than their costs,
d. Inventories can never be sold at amounts lower than their costs.
Ds LCNRV assessment shall be made on a/an
Item-by-item basis
>
b. Geographical basis
c. Retail store basis
d. Price segment basis
286
The
The Book
3. All of the following can be considered as costs to sell for NRV calculation purposes,
except
a. Depreciation of delivery equipment
b. Transport costs if the goods are to be shipped FOB shipping point
c. Transport costs if the goods are to be shipped FOB destination
d. Commissions to be paid to sales personnel
4, Statement 1: Estimated selling price may be based on fixed prices agreed in sales
contracts.
Statement 2: Normal selling price is not necessarily the same with the estimated
selling price.
Which of these statements is/are correct?

5. The following correctly states the computation of NRV for each corresponding type
of inventory, except
a. Raw materials - estimated selling price of related finished goods less costs to
complete and costs to sell.
b. Finished goods - estimated selling price less costs to sell.
c. Work-in-process - estimated selling price less costs to sell and costs to
complete.
d. Damaged but salable goods - estimated selling price less costs to sell and costs
to rectify, if any.
6. In which of the following circumstances a loss on inventory write-down shall be

recognized?
a. When NRVis lower than cost
b. When cost is lower than NRV
c. Bothaandb
d. Neitheranorb
7. In accounting for inventory write-down using allowance method, all of these are
correct, except
a. The initially computed amount of cost of goods sold does not yet include the loss
on inventory write-down.
b. The inventory account is not directly reduced by the amount of write-down.
c. The corresponding credit shall be to an allowance account, which is a contra-
account against the cost of goods sold.
8. The NRV of previously written-down inventory has increased. In recognizing gain

on reversal of inventory write-down, which of the following is true?
a. The amount of gain may exceed the previously recognized loss on inventory
write-down.
287
The
The Book
Rape
b. The amount of cost of goods sold will be reduced by the amount of gain.
c. Bothaandb
d. Neitheranorb
9. In recognizing loss on purchase commitment, an entity shall consider all of the
following, except
a. Whether the purchase commitment is cancelable or not.
b. The relationship between the commitment price and the NRV.
c. The portion thatis cancelable and the portion that is noncancelable.
d. The quantity of goods already received from the supplier.
10.Statement 1: Further decreases in the amount of NRV will require additional
recognition of loss on purchase commitment.
Statement 2: Increases in the amount of NRV may warrant the recognition of gain on
reversal of loss on purchase commitment.
Which of these statements is/are correct?

b. Ilonly d. NeitherI nor II
Straight Problems
1. GALOP Company presented the following information related to its work-in-process
and finished goods as of December 31, 2023:
Work-in- Finished
Process Goods
Cost P4,000,000 6,000,000
Estimated selling price 5,500,000 6,600,000
Normal selling price 6,200,000 7,500,000
Estimated costs to complete 900,000 =
Estimated delivery costs 200,000 350,000
Commission and other estimated costs to sell are estimated to be 4% of the relevant
selling price.
a. NRVofwork-in-process inventory and finished goods inventory.
b. Journal entry to record inventory write-down, if any, under allowance method.
2. CLARA Company undertakes quality control (QC) of its manufactured inventories

twice each month, every 15" day and the last day, During December 2023, the
following QC inspections revealed the following;
e December 15 QC - Finished goods costing P500,000 were found to be below the
minimum standards. Consequently, these were rectified for P100,000. Total
selling price of these goods considering their lower quality is P400,000 less 1%
estimated sales commission.
288
The
CamScanner
e December 31 QC - Finished goods costing P600,000 were found to be below the

minimum standards. Estimated cost of rectification during the first week of
January 2024 amounted to P150,000. Estimated selling price of these goods after
rectification and considering their lower quality is P700,000, less 1% estimated
sales commission.
None of the damaged goods were sold by December 31, 2023.

a. Carrying amount of each batch of damaged goods before inventory write-down.
b. NRV of each batch of damaged goods.
c. Journal entry to record inventory write-down, if any, under allowance method.
3. As of December 31, 2023, GRANDPUP Company had 100,000 units in its finished
goods inventory of school uniforms costing P25 each. Of these, 20,000 units are
covered by a government procurement contract at P30 per unit selling price less 5%
for estimated contract costs. The remaining 80,000 units can be sold equal to the
Company’s normal unit selling price of P35 less 10% for estimated costs to sell.
None of the damaged goods were sold by December 31, 2023.
a. Total NRV of finished goods.
b. Journal entry to record inventory write-down, if any, under allowance method.
4. RAY Company sells a single product and account for the related costs using the FIFO
method. The following are the Company’s transactions for the month of December
2023:
December1 Beginningbalance 54,000 units at P10.00 each

4 Sale 48,000 units at P11.00 each
9 Purchase 90,000 units at P12.00 each
21 Purchase 96,000 units at P14.00 each
Estimated selling price at the end of the year is the same as the latest unit selling
price of P15. Estimated costs to sell is 10% of the selling price.
a. Cost of ending inventory
b. NRV of ending inventory
c. Loss oninventory write-down, if any, under allowance method.
5. Going back to RAY Company, except that it uses weighted average method as its cost
formula. Under this revised information, determine the following:
a. Cost of ending inventory
b. NRV of ending inventory
c. Loss oninventory write-down, if any, under allowance method.
289
The
The Book
6. BEHEMOTH Company reported the following information as of each indicated dates;

1/1/23 12/31/23 12/31/24 12/31/25
Cost P2,300,000 2,400,000 2,600,000 P2,580,000
NRV 2,550,000 2,240,000 2,690,000 2,420,000
In addition, net purchases for the years 2023, 2024, and 2025 amounted to
P8,000,000, P9,800,000 and P9,000,000, respectively.
Requireds: From this information, determine the following:

a. Journal entries to recognized loss on inventory write-down or gain on reversal
of previous loss on inventory write-down, whichever is applicable, under both
direct method and allowance method.
b. The amount of cost of goods sold for each year.
7. OBELISK Company is selling different products as part of its operations. On

December 31, 2023, it provided the following information:
Estimated Normal Estimated Unit
No. of Unit Unit Selling UnitSelling UnitSelling Replace-
Products Units Cost Price Price Costs ment Cost
A 30,000 P7.00 P9.50 P10.00 P1.25 P6.50
B 40,000 9.00 12.50 13.00 2.70 8.70
C 25,000 6.00 6.80 8.00 1.40 9.20
D 10,000 15.00 16.00 16.00 0.60 14.50
E 60,000 10.00 11.20 14.00 2.50 11.60
Required: From this information, determine the amount of loss on inventory write-
down, if any.
8. CROCUS Company, a broker-trader, reported the following information related to

one of its commodities it is selling:
12/31/23 12/31/24 12/31/25
Fair value P3,400,000 3,600,000 4,180,000
Costs to sell 240,000 265,000 — 310,000
This commodity was acquired for P3,150,000 during 2023.
Required: Determine the journal entries from the year 2023 to 2025.
9. OnNovember 15, 2023, CHEMICAL Company entered into a noncancelable purchase

commitment to acquire a 10,000 barrels of jet fuel in January 2025 atacommitment
price of P500 per barrel. On the commitment date, the NRV of the jet fuel is PSO05 per
barrel.
However, on December 31, 2023, there is an unexpected downturn in economic

activity which decreased the jet fuel’s NRV to P440 per barrel. A P600,000 loss on
purchase commitment was properly recorded on the same date.
290
The
The Book
Required: Under each of the following independent scenarios, determine the

relevant journal entry on December 31, 2024:
NRV as of that date is P475 per barrel.
Noe

PoP
10.JADE Company manufactures laptops and smartphones. As of December 31, 2023, it

provided the following information:
Laptops Smartphones
Raw materials:
Cost P900,000 P800,000
Replacement cost 760,000 680,000
Work-in-process:
Cost P2,000,000 P3,500,000
Estimated costs to complete 500,000 450,000
Finished goods:
Cost P5,500,000 P7,600,000
Required: From this information, determine the total amount of loss on inventory
write-down that the Company shall record. as of December 31, 2023.

1. As of December 31, 2023, NUTCRACKER Company reported the following
information related to its work-in-process and finished goods inventories for its
Product AAA:
Work-in-Process Finished Goods

Direct materials consumed to date P500,000 P1,200,000
Conversion costs incurred to date 800,000 2,000,000
Direct materials to be consumed 300,000 -
Conversion costs to be incurred 400,000 ~
Estimated delivery costs 50,000 300,000
Commission 5% of selling price 5% of selling price
291
The
CamScanner
The carrying amounts of work-in-process and finished goods inventories,

respectively, as of December 31, 2023 shall be
a. P2,000,000; P3,500,000 c, P1,300,000; P3,200,000
b. P1,300,000; P3,500,000 d. P2,000,000; P3,200,000
The NRV of work-in-process and finished goods inventories, respectively, as of
December 31, 2023 shall be
a. P1,150,000; P3,500,000 c. P1,340,000; P3,880,000
b. P1,150,000; P3,880,000 d. P1,340,000; P3,500,000
Total amount of loss on inventory write-down to be recognized for the year shall be
a. PO c. P300,000
b. P150,000 d. P450,000
2. As of December 31, 2023, CHIVE Company had damaged goods that can be sold for
P900,000 after incurring rectification costs of P150,000 and P50,000 sales
commission. These goods had manufacturing cost of P1,000,000. Based on this
information, the amount of loss on inventory write-down shall be
a. P100,000 c. P300,000
b. P250,000 d. P350,000
3. On October 1, 2023, ONION Company discovered that goods with original total
manufacturing costs of P1,500,000 were damaged. During the remainder of 2023,
these goods were rectified for a total cost of P400,000. As of December 31, 2023,
these rectified goods are yet to be sold at an estimated selling price of P2,000,000
less estimated costs to sell of P250,000. From this information, the goods’ NRV and
related loss on inventory write-down, respectively, shall be
a. P1,750,000; P150,000 c. P1,350,000; P150,000
b. P1,750,000; P550,000 d. P1,350,000; P550,000
4. JACOB Company had work-in-process inventory with total cost of P520,000. Total
normal selling price if all of these goods are to be sold will be P500,000, with a
normal profit margin of P100,000. Since the demand for the inventory has increased
recently, the Company expects to sell the inventory for P600,000 less 5%
commission expense. Costs to complete the inventory will amount to P40,000. From
this information, the goods’ NRV and related loss on inventory write-down,
respectively, shall be
a. P475,000; P45,000 c. P570,000; PO
b. P435,000; P85,000 d. P530,000; PO
5. SWEET Company reported the following information related to one of its inventory
items as of December 31, 2023:
Cost using FIFO method P1,500,000
Normal selling price ‘2,000,000
Estimated selling price 1,600,000
Commission expense 3% of selling price
Transportation costs to be incurred 55,000
Other selling costs 25,000
292
The
From this information, the goods’ NRV and related loss on inventory write-down,
respectively, shall be
a. P1,940,000; PO c. P1,552,000; P52,000
b. P1,860,000; PO d. P1,472,000; P28,000
6. WHITNEY Company is involved in the retailing of different appliances. As of

December 31, 2023, the Company reported the following information related to four
of the appliances that it is currently selling:
Cooking Refri-
Televisions Aircons Appliances gerators
Cost P7,000,000 P3,000,000 P4,500,000 P5,000,000
Normal selling price 7,900,000 3,800,000 5,500,000 5,800,000
Estimated selling price 7,800,000 3,600,000 4,900,000 5,700,000
Estimated costs to sell 970,000 360,000 540,000 270,000
The total amount to be recognized as loss on inventory write-down shall be

a. PO c. P310,000
b. P210,000 d. P440,000
7. On October 31, 2023, HALE Company entered into a noncancelable purchase

commitment for a minimum purchase of 30,000 units of special parts at a
commitment price of P30 per unit in February 2025. In addition, the Company may
increase the number of units up to 75,000 units. On February 15, 2025, the Company
actually acquired 30,000 units of the special parts.
On December 31, 2023, 2024, and February 15, 2025, the parts had NRV of P25/unit,
P29/unit and P32/unit, respectively.
The gain or loss on purchase commitment to be recognized for 2024 shall be

a. P120,000 gain c. P300,000 gain
b. P120,000 loss d. P300,000 loss
The amount gain or loss on purchase commitment and the amount of purchases,
respectively, to be recognized on February 15, 2025 shall be
a. P30,000 gain; P960,000 c. P75,000 gain; P900,000
b. P30,000 loss; P900,000 d. P75,000 loss; P960,000
8. On January 1, 2023, SUMMA Company entered into a four-year noncancelable

purchase commitment covering up to maximum of 70,000 ounces of titanium
annually at a commitment price of P80 per ounce. The minimum quantity that the
Company shall acquire each year shall be 40,000 ounces.
At the end of each year from 2023-2025, the Company had the following
information:
293
The
The Book
12/31/23 12/31/24 12/31/25

Ounces on hand 50,000 20,000 25,000
NRVperounce P78/ounce P75/ounce P79/ounce
The Company is using the allowance method in recording the write-downs.
The amount loss on purchase commitment and the loss on inventory write-down,
respectively, to be recognized on December 31, 2023 shall be
a. P320,000 loss; P100,000 loss c. P240,000 loss; P100,000 loss
b. P560,000 loss; P140,000 loss d. P420,000 loss; P140,000 loss
Liability on purchase commitment to be recognized on December 31, 2024 shall be

a. P400,000 c. P700,000
b. P800,000 d. P1,400,000
Liability on purchase commitment to be recognized on December 31, 2024 shall be
a. P30,000 c. P120,000
b. P70,000 d. P280,000
294
The
The Book
Chapter 9 — Gross Profit Method
CHAPTER 9
GROSS PROFIT METHOD

1. The bases for estimating inventory balances.
2. The methods of estimating inventory balances.
3. The computation of gross profit rate.
4. The relationships among net sales, cost of goods sold, total goods available for sale
(TGAS), and ending inventory.
5. The application of gross profit method in estimating ending inventory, losses from
catastrophe, and inventory shortage/overage.
REASONS FOR ESTIMATING THE ENDING INVENTORY

As previously discussed in Chapter 7, an entity conducts physical inventory count
to determine the accuracy of inventory records (perpetual inventory system) or
establish the balance of inventory (periodic inventory system). Even though there
are two different purposes for physical count, the main goal is to determine the
balance of existing inventory for financial reporting purposes.
On the flipside, circumstances that may need the estimated amount (i.e., not actual
amount) of ending inventory include, but are not limited to, the following:
a. Interim financial reporting
b. Monthly reports to management for its decision-making functions
c. Determination of the existence of inventory shortage
d. Determination of the amount of inventory loss in case of fire, floods and other
catastrophe.
Physical count is usually required for purposes of annual financial reporting

to determine the inventory to be included in the financial statements. Physical
count is costly, time-consuming, and inconvenient on the part of entity conducting
it. In cases of catastrophe, no inventory can be counted. As a result, for purposes
other than annual financial reporting, an inventory estimate is sufficient.
Estimate of inventory balance can also be compared to the physical count to

determine the reasonableness and correctness of such count. This could also reveal
shortages due to pilferage, theft, defalcation, or any other reasons.
There are two methods in estimating the inventory balance: the gross profit method
and the retail inventory method. Gross profit method is the focus of this chapter
while the retail inventory method will be discussed in the succeeding chapter.
295
The
CamScanner
GROSS PROFIT METHOD - GENERAL MODEL

In Chapter 8, the following relationships between the TGAS, cost of goods sold, and
ending inventory were discussed as follows:
Total Goods Available

for Sale (TGAS)
jae mse ens,
Ending Cost of Goods

Inventory Sold (COGS)
Mathematically, this can be expressed through the following formula:
TGAS = COGS cp | Ending Inventory
Based on the formula above, TGAS is the total amount to be accounted for and it
will flow either to COGS or to the ending inventory. In other words, if the cost
ofinventory becomes part of COGS, it will be excluded in ending inventory (i.e.,
COGS and ending inventory are complements). This formula can be modified to
directly compute the ending inventory as follows:
Ending Inventory = TGAS = coGs
Inputs to this formula are discussed separately in the succeeding sections.
COMPUTATION OF TOTAL GOODS AVAILABLE FOR SALE (TGAS)

The amount of TGAS is computed as follows:
Beginning inventory Pxx

Add: Purchases xX
Freight in XX
Less: Purchase discounts, returns and allowances __ (xx)
TGAS Pxx
COMPUTATION OF COST OF GOODS SOLD (COGS)

Under the gross profit method, the computation of COGS involves multiple steps
and utilizes the following relationship:
Net sales Pxx

Less: COGS (xx)
Gross profit — Pxx
296
The
The Book
Since the amount of Net Sales is comprised of COGS component and gross profit
component, it is necessary to eliminate the gross profit component to arrive at
the amount COGS. When using gross profit method, it is presumed that there is
a stable relationship between the amount of Net Sales and the COGS. This
relationship is established by the gross profit rate, to be discussed later in the
Chapter.
COMPUTATION OF NET SALES AMOUNT FOR GROSS PROFIT METHOD PURPOSES

The Net Sales amount to be used to get the amount of COGS shall represent the
actual physical flow of goods. For the purposes of gross profit method this is
Gross sales Pxx
Less: Sales returns __(xx)
Net sales for gross profit method purposes Pxx
The accounting procedures on the contra-revenue accounts for the gross profit
method purposes are discussed as follows:
Contra-
Revenue Accts Accounting Procedures Under Gross Profit Method
This account represents the selling price of the goods which
were physically returned by customers to the entity. The
Sales returns corresponding cost should not form part of COGS. Thus, the
amount of sales returns shall be deducted from the amount of
gross sales.
This account represents the reduction in the entity’s receivable
from its customer or a partial refund for amounts already paid
without any corresponding physical return of goods.
Since there is no physical flow of goods back to the entity, the

Sales related cost of goods is. properly includible in full in the amount
allowance COGS. Consequently, for purposes of gross profit method, this
should not be deducted from gross sales, or should be added
back to the reported net sales.
If the account is “sales returns and allowances”, apply the rules on
sales returns.
Same with sales allowance. This account represents reduction in
sales amount without any corresponding physical flow of
goods back to the entity.
Sales discounts
For gross profit method purposes, this should not be deducted
from gross sales, or it should be added back to the reported
net sales.
297
The
he A .
aos:
VARIATIONS IN GROSS PROFIT RATE

Gross profit rate can be stated as either gross profit rate based on sales or gross profit
rate based on cost. The gross profit percentages are computed as follows:
_ _Gross profit amount
Gross profit rate based on sales
Net sales
G Gross profit amount

ross prof
ms
it rate based on cost =
COGS amount
It should be noted that the gross profit rate based on sales is always lower than the
gross profit based on cost.
Illustration 1. An entity reported the following amounts for the current year:
Net sales P4,000,000
Less: COGS (2,500,000)
Gross profit P1,500,000
Gross profit rates based on different bases are computed as follows:

P1,500,000
Gross profitrate based onsales =
SS P4,000,000 = 37.50%0
P1,500,000_ _
Gross profit rate based on cost = P2,500,000. ~ 60.00%
CONVERTING GROSS PROFIT RATE BASED ON SALES TO GROSS PROFIT RATE

BASED ON COST AND VICE VERSA
A given gross profit rate based on sales can be converted to gross profit rate based
on cost and vice versa.
Illustration Z. An entity reported gross profit rate based on sales of 20%. This can
be converted to gross profit rate based on cost as follows:
Net sales 100% é

Less:COGS — 80% Gross profitraly <0. 80%
gaa
Gross profit 20% based on cost ~
Illustration 3. An entity reported gross profit rate based on cost of 35%. This can
be converted to gross profit rate based on sales as follows:
Net sales 135%

; Gross profitrate __ 35% =| tk
Less:COGS _ 100% based onsales ~ 135%. = 25.93%
Gross profit 35%
The readers should take note that the conversion utilizes the relationship between
the relevant percentages.
298
The
The Book
Chapter 9 - Gross Profit Method
COMPUTING COGS USING NET SALES AND GROSS PROFIT RATE

Depending on the basis of the gross profit rate, the amount of COGS to be deducted
from the TGAS to arrive at the estimated ending inventory is computed as follows:
Scenario cob hee ‘Amount of COGS
Gross profit rate is based on sales | COGS = Net Salesx (1 - Gross Profit Rate)
: Net sales
fit rate is based =
eee oe ou (1 + Gross Profit Rate)
Illustration 4. MARIZ Company reported the following information for the year:
Gross sales P3,400,000
Sales discount 36,000
Sales allowance 80,000
Under each of the following independent scenarios, determine the amount of COGS:
1. Gross profit rate based on sales of 25%
2. Gross profit rate based on cost of 25%
Scenario 1 - Gross Profit Rate is 25% Based on Sales

Net Sales for gross profit method purposes shall be computed as P3,200,000
(P3,400,000 - P200,000). Again, sales discount and sales allowance are not deducted
from the gross sales for gross profit method purposes.
Since the gross profit rate of 25% is based on sales, the amount of cost of goods sold
for gross profit method purposes is computed as:
COGS = P3,200,000 x (1 - 25%) = P2,400,000
Scenario 2 - Gross Profit Rate is 25% Based on Cost
The same amount of Net Sales of P3,200,000 computed in Scenario 1 will also be
used in this scenario.
Since the gross profit rate of 25% is based on cost, the amount of cost of goods sold
for gross profit method purposes is computed as:
P3,200,000
Costratio —1+25%)
= = P2,560,000
The readers are advised to always look at the basis of the given gross profit rate
as the amount of COGS will differ depending on the basis.
COMPUTING THE ESTIMATED ENDING INVENTORY BALANCE

After understanding the inputs to the gross profit method in isolation, this is now
the best time to use them together in determining the amount of estimated ending
inventory by using the following “formula guide”:
299
The
The Book
Ending Inventory eS TGAS = COGS
Illustration 5. For the year 2023, APPLE Company had purchases of P1,200,000,
purchase discounts of P15,000, purchase returns and allowances of P90,000 and
freight in of P300,000. At the beginning of the year, the Company also had P400,000
of inventory. During 2023, the Company generated gross sales of P2,135,000, sales
returns of P135,000, sales allowances of P70,000 and sales discounts of P30,000.
The Company usually applies a gross profit rate of 30% based on sales. Required:
Using the gross profit method, determine the estimated amount of inventory as of
December 31, 2023.
The following procedures are relevant in determining the estimated ending

inventory:
1. First, determine the amount of TGAS as follows:
Beginning inventory P400,000
Add: Purchases 1,200,000
Freight in 300,000
Less: Purchase discounts (15,000)
Purchase returns and allowances (90,000)
TGAS P1,795,000
For the computation of TGAS, purchase discounts and purchase allowances

are deducted from gross purchases.
2. Next, compute for the amount of Net Sales from which the amount of COGS is
derived. Net Sales for gross profit method purposes is computed as follows:
Less: Sales returns (135,000)
Net sales for gross profit method P2,000,000
Again, only the sales return is deducted from the amount of gross sales.
3. Next, derive the amount of COGS from the Net Sales amount computed in step 2
above by applying the gross profit rate of 30% based on sales:
COGS = P2,000,000x (1 - 30%) = P1,400,000
4. Lastly, plug-in the computed COGS of P1,400,000 and TGAS of P1,795,000 in the
equation to compute for the amount of ending inventory:
Ending Inventory i TGAS COGS

P395,000 =| p1,795,000 | P1,400,000
300
The
The Book
The estimated amount of ending inventory is computed as P395,000

(P1,795,000 - P1,400,000).
ILLUSTRATING THE EFFECTS OF IMPROPERLY DEDUCTING SALES DISCOUNTS

AND/OR SALES ALLOWANCES FROM THE GROSS SALES
1. Going back to APPLE Company and assuming instead that the amounts of sales
discounts and sales allowances were improperly deducted from gross sales, the
amount of net sales will be computed as follows:
Sales allowances (70,000)
Sales discounts (30,000)
2. The amount of COGS will now be P1,330,000 (P1,900,000 x 70%) as the

computation presumed that the sales allowances and sales discounts resulted to
P70,000 (P1,400,000 - P1,330,000) cost of returned inventory to the entity,
which is not really the case. Because of this, the amount of computed COGS is
understated by P70,000.
3. Plugging-in this understated COGS in the equation with the correct amount of
TGAS will result to the following:
Ending Inventory oo TGAS COGS

P465,000 [| P1,795,000 P1,330,000
The estimated amount of ending inventory will now be overstated as the

deduction of the sales discounts and sales allowances from the gross sales resulted
to the presumption that there is a physical return of underlying goods. This is not
the case as there are really no goods returned to the entity as a result of sales
allowances and sales discounts.
As a conclusion, sales allowances and sales discounts shall not be deducted
from the gross sales as it will result to understated COGS and overstated
estimate of ending inventory.
DISTORTIONS IN GROSS PROFIT RATE

As can be seen from the previous illustration, the same gross profit rate (i.e., at 30%)
is presumed to apply to all the products sold.
In real life scenario, it could be that an entity sells different products, each with
different gross profit rate, If each gross profit rate is materially different from
each other, separate computations of COGS for each group of products with
substantially same gross profit rates should be performed.
301
The
The Book
To facilitate these separate computations, the amount of net sales will be also be
grouped in the same manner. These groupings are done to prevent the distortions
brought by the averaging of the gross profit rate due to changes in the sales mix.
In addition, there could also be circumstances wherein there is a substantial
amount of sales with special gross profit rates. It could be lower than the normal
gross profit rate because of special arrangements with a VIP customer. It could also
be higher to exploit the selling opportunity in other markets. In all cases, the
related net sales and COGS amounts under special terms are computed
separately.
Illustration 6. BANANA Company has two types of inventories Product A and
Product B with gross profit rates based on sales of 20% and 50%, respectively. Total
goods available for sale (TGAS) is P1,000,000 for Product A and P2,500,000 for
Product B. Net sales totaled P3,950,000, divided into P950,000 for Product A and
P3,000,000 for Product B. Required: Compute for the total estimated amount of
ending inventory using the gross profit method.
1. First, compute for the COGS separately by using the Net Sales and gross
profit rates attributable to each product. The computation is as follows:
Net Sales Conversion Total COGS

ProductA P950,000x(1-20%)= 760,000
ProductB 3,000,000x(1-50%)= 1,500,000
P2,260,000
2. Next, the amount computed as COGS of P2,260,000 and total amount of TGAS of
P3,500,000 (P1,000,000 + P2,500,000) will be plugged in the equation to
compute the total amount of ending inventory
Ending Inventory a TGAS coGS

P1,240,000 [| P3,500,000 | P2,260,000
The estimated balance of total ending inventory is P1,240,000.
Illustration 7. At the beginning of 2023, CITRUS Company had an inventory

balance of P1,600,000. For the year 2023, the Company reported the following
information:
Purchases P1,900,000 Gross sales P4,100,000

Purchase discounts 30,000 Sales returns 100,000
Purchase returns 50,000 Sales discounts 20,000
Freight in 100,000 Sales allowances 80,000
The Company normally charges 30% gross profit on its regular sales. However,
sales amounting to P1,000,000 were made through a one-time wholesale
302
The
CamScanner
transaction. Gross profit rate on sales charged in this transaction was 20% and that
no sales returns were received from this. Required: Determine the estimated
ending inventory using gross profit method.
1. First, determine the amount of TGAS, which is computed as follows:
Beginning inventory P1,600,000
Add: Purchases 1,900,000
Freight in 100,000
Purchase returns _ (50,000)
TGAS P3,520,000
2. Next, compute for the amount of Net sales from which the amount of COGS is
computed. The amount of net sales for gross profit method purposes is as
follows:
Net sales for gross profit method P4,000,000
3. Next, remove the gross profit portion of the previously computed net sales
amount to reveal the amount of COGS. In this case, the sales amount shall be split
based on their gross profit rate:
Net Sales Conversion Total COGS
Regular sales *P3,000,000 x (1 - 30%) = 2,100,000
Special wholesale 1,000,000 x (1 - 20%) = 800,000
P2,900,000
*P4 000,000 net sales less P1,000,000 special wholesale price.
4. Lastly, plug in the amounts computed as COGS and TGAS in the equation to
compute for the amount of ending inventory:
Ending Inventory co TGAS cOoGS

co cc
P620,000 P3,520,000 P2,900,000
The estimated amount of ending inventory is P620,000.
ESTIMATING INVENTORY LOSSES FROM CATASTROPHE

Generally, the amount of inventory loss after a catastrophe is computed as follows:
Estimated ending inventory using gross profit method Pxx
Less: NRV of salable damaged goods (if any) (xx)
Cost of undamaged goods (if any) (xx)
Cost of in-transit inventory (if any) (xx)
Cost of goods located in another location (if any) (xx)
Loss on inventory due to catastrophe Pxx
303
The
The Book
It was discussed in the previous chapters that the balance of inventory includes
those that are in transit, provided control is obtained by the entity (for purchases)
or retained by the entity (for sales). In this regard, the following are the relevant
gross profit method procedures for in-transit goods:
Relevant In-Transit Goods Gross Profit Method Procedures
Purchased, FOB shipping point Shall be included in TGAS
Sold, FOB destination Shall be excluded from the amount of net sales
Since the goods in transit, these are not yet “stored” or situated ina warehouse or
any relevant facilities. Consequently, they should be excluded from the
inventory loss amount. The equivalent cost of in-transit inventories to be
deducted in determining the inventory loss amount are the following:
Relevant In-Transit Goods Equivalent Cost to be Deducted
Purchased, FOB shipping point Equal to invoice price from supplier
Sold, FOB destination Equivalent cost is equal to sales invoice price
less the amount of gross profit
Illustration 8. At the beginning of 2023, DURIAN Company had an inventory
balance of P3,200,000. On the night of September 9, 2023, a fire broke out on
DURIAN Company's warehouse and destroyed all the inventories in that
warehouse. Damaged goods with cost of P50,000 and NRV of P20,000 were
recovered. The Company wishes to estimate the extent of inventory loss from the
compiled information as follows:
Purchases P3,800,000 Gross sales P8,200,000
Purchase discounts 60,000 Sales returns 200,000
Purchase returns 100,000 Sales discounts 40,000
Freight in 200,000 Sales allowances 160,000
Information about inventory in transit are as follows:
a. P80,000 of goods purchased and shipped under FOB shipping point terms.
b. P63,000 cost of goods sold to a buyer shipped under FOB destination terms.
Selling price is P90,000.
c. P49,000 cost of goods sold to a buyer shipped under FOB shipping point terms.
Selling price is P70,000.
d. P75,000 of goods purchased and shipped under FOB destination terms,
None of the amounts above were recorded in purchases nor included in sales,
whichever may be applicable. The Company charges 30% gross profit on sale on all
of its sale transactions. Required: Determine the estimated inventory loss due to
fire.
1. First, update the purchases and gross sales amount for the inventories in transit
depending on the freight terms and the Company's role (i.e., buyer or seller) as
304
The
CamScanner
Chapter 9 —- Gross Profit Method
discussed in Chapter 7A. In addition, it is important to note the following

statement: “None of the amounts above were recorded in purchases nor included
in sales, whichever is applicable”.
Selling Gross Gross
Costs Prices Purchases Sales
P3,800,000 P8,200,000
a. Purchased, FOBS.P. — P80,000 N/A 80,000
b. Sold, FOB Dest. 63,000 90,000
c. Sold, FOB S. P. 49,000 70,000 70,000
d. Purchased, FOB Dest. 75,000 N/A
Adjusted amounts P3,880,000 P8,270,000
2. Next, compute for the amount of TGAS:

Add: Adjusted purchases 3,880,000
Freight in 200,000
Purchase returns (100,000)
TGAS P7,120,000
3. Next, compute for the amount net sales from which the amount of COGS will be
derived:
Adjusted gross sales P8,270,000
Consequently, the COGS is computed as P5,649,000 [P8,070,000 x (1 - 30%)].

4. Next, plug in the amounts of COGS and TGAS in the equation:
Ending Inventory = TGAS cs COGS

P1,471,000 P7,120,000 P5,649,000
5. Lastly, compute for the inventory loss as follows:

Estimated ending inventory P1,471,000
Less: NRV of salable damaged goods (not based on cost) (20,000)
*Cost of includible in-transit inventories (P80,000 + P63,000) (143,000)
Loss on inventory due to fire P1,308,000
*P80,000 is purchased FOB shipping point; P63,000 is sold FOB destination.
The readers should take note that with the exception of damaged goods, the
amounts to be deducted from estimated inventory balance in computing
305
The
The Book
inventory loss shall be equal to the corresponding cost of those inventory items
(i.e., not at their selling prices).
ESTIMATING INVENTORY SHORTAGE OR OVERAGE

As previously mentioned, the gross profit method can also be used in estimating
inventory shortage or overage whether due to theft or errors in recording inventory
transactions, among others. In estimating these amounts, an entity shall compare
the ending inventory balance based on physical count and ending inventory
estimated using the gross profit method:
oes Scenario Inventory Shortage or Overage

Physical count < estimated inventory balance Inventory shortage
Physical count > estimated inventory balance Inventory overage
Illustration 9. On January 1, 2023, DANDELION Company reported inventory

balance of P780,000. During 2023, the Company reported net sales of P4,200,000
and net purchases of P3,250,000. Relevant gross profit rate is 40% based on cost.
amount of inventory shortage or overage:
1. Inventory has cost of P925,000 based on physical count.
2. Inventory has cost of P1,085,000 based on physical count.
Scenario 1
The amount of COGS can easily be computed as P3,000,000 /P4,200,000/(1 + 40%)].
TGAS, on the other hand, is computed as P4,030,000 (P780,000 + P3,250,000).
Estimated ending inventory balance using these amounts is computed as follows:
Ending Inventory — TGAS _ COGS

co
P1,030,000 P4,030,000 P3,000,000
Since the physical count balance of P925,000 is lower than the P1,030,000 estimated
ending inventory using the gross profit, there is an estimated inventory shortage of
P105,000 (P1,030,000 - P925,000).
Scenario 2
In this scenario, the estimated ending inventory of P1,030,000 is still relevant. Since
the physical count balance of P1,085,000 is higher than the P1,030,000 estimated
ending inventory using the gross profit, there is an estimated inventory overage of
P55,000 (P1,085,000 - P1,030,000).
SPECIAL CASE- ESTIMATING THE GROSS PROFIT RATE TO BE USED

There are some circumstances wherein an entity cannot decide the gross profit rate
to be applied to its products. Most likely, this is the case if the industry itis operating
306
The
CamScanner
in is characterized by pure competition, wherein the entities are price-takers with

the forces of demand and supply dictating the prices it can charged to customers.
In these cases, in estimating its gross profit rate, an entity may use its prior years’
experience, adjusted by expected changes in circumstances.
Illustration 10. During 2022 and 2023, CORDIAL Company reported the following
information related to its inventory:
2022 2023
Beginning inventory P1,600,000 P1,850,000
Net purchases 5,150,000 6,080,000
Net sales 7,000,000 8,600,000
The Company would like to estimate its ending inventory as of December 31, 2023
to check the accuracy of its inventory records. Required: Under each of the
following independent scenarios, determine the estimated ending inventory:
1. The same gross profit rate on sales during 2022 is maintained in 2023.
2. The 2023 gross profit rate is equal to 2022 gross profit rate plus additional 5%.
Scenario 1
COGS for 2022 shall be determined as P4,900,000 (P1,600,000 + P5,150,000 -
P1,850,000). Consequently, gross profit for the year amounted to P2,100,000
(P7,000,000 - P4,900,000). From these inputs, the gross profit rate for 2022 shall be
_ —P2,100,000. _
Gross profit rate based on sales 30.00%
P7,000,000 —
Fast forward to 2023, the estimated inventory as of December 31, 2023 shall be
TGAS, 2023 (P1,850,000 + P6,080,000) P7,930,000
Less: COGS [P8,600,000 x (1 - 30%*)] (6,020,000)
Estimated inventory, 12/31/23 P1,910,000
*Using the same gross profit rate based on sales as in 2022.
Scenario 2
Estimated inventory as of December 31, 2023 shall be determined as follows:
TGAS, 2023 (P1,850,000 + P6,080,000) P7,930,000

Less: COGS [P8,600,000x (1 - 35%*)] (5,590,000)
Estimated inventory, 12/31/23 P2,340,000
*30% gross profit rate on sales in 2022 plus 5%.
307
The
The Book
CHAPTER SUMMARY
1, Inventory estimation can be used in a wide variety of purposes, including but not
limited to the following: inventory balance for interim reporting, estimating loss on
inventory due to catastrophe and estimating inventory shortage or overage.
Inventory can be estimated using either the gross profit method or retail inventory
method.
Under the gross profit method, the ending. inventory is estimated using the
relationship between the net sales and COGS.
Under the gross profit method, the general formula is as follows:
Ending Inventory = TGAS = coGs
TGAS is equal to beginning inventory plus net purchases.

no
The amount of Net Sales to be used in computing the COGS is equal to gross sales less
sales returns. Sales discounts and sales allowances are not deducted since they do
not represent physical flow of goods.
From the amount of Net Sales, the COGS can be determined using the following
formulas, depending on the given gross profit rate (GPR):
Scenario ot Amount of COGS Bt

GPR is based on sales | COGS = Net Sales x (1 - Gross Profit Rate)
GPR is based on cost COGS = Net sales
(1 + Gross Profit Rate)
Inventory loss from catastrophe can be estimated as follows:

Estimated ending inventory using gross profit method Pxx
Loss on inventory due to catastrophe Pxx
In relation to the cost of in-transit inventories above, invoice price of “sold” goods is
shall be restated back to its cost. On the other hand, invoice cost of “purchased”
goods is already the cost of the inventory (i.e., no restatement back to cost is
necessary).
Inventory shortage or overage can be determined as follows:

Scenario =~ |. Consequence __
Physical count < estimated inventory balance | Inventory shortage
Physical count > estimated inventory balance | Inventory overage
10. An entity may estimate its current year’s gross profit rate based on prior years’ gross
profit rate, adjusted for expected changes in circumstances.
308
The
CamScanner
True or False
Z. An entity cannot estimate its ending inventory if these are damaged by fire or other
catastrophe.
2 Gross profit method is based on the relationship between the amount of net sales
and COGS.
3. Gross profit is equal to the amount of TGAS less the amount of Net Sales.
4. The estimated ending inventory can be determined by obtaining the difference
between the TGAS and the estimated amount of COGS.
Gross profit rate based on sales can never be higher than the gross profit rate based
on cost.
The amount of COGS can be determined by applying the gross profit rate to the
amount of TGAS.
If the gross profit rate given is based on cost, then the amount of COGS is equal to
Net Sales divided by 1 plus the gross profit rate.
Given the same gross profit rate, except that one is based on cost and the other one
is based on sales, the gross profit rate based on cost will result to a lower amount
of COGS.
Given the same gross profit rate, except that one is based on cost and the other one
is based on sales, the gross profit rate based on sales will result to a higher amount
of gross profit.
10. In determining the final amount of inventory loss, the normal selling price of any
undamaged goods shall be deducted from the initial estimate of ending inventory.
a Gross profit method is based on the relationship between which of the following
pairs of amounts?
a. COGS and TGAS
b. Netsales and COGS
c. TGAS and net sales
d. Beginning inventory and net sales
In determining the amount of Net Sales from which the amount of COGS is derived,
which of the following is/are deducted from the amount of gross sales?
a. Sales returns
b. Sales discounts
c. Sales allowances
d. All ofthe above
Gross profit method may be used in all of the following scenarios, except
a. The amount of net purchases during the current period increased dramatically
compared to the prior period.
b. There is a suspected theft being committed by warehouse employees.
c. The ending inventory is consumed by fire.
d. The relationship between the Net Sales and COGS is unstable.
309
The
4. Which of the following correctly indicates the derivation of the amount of COGS from
the amount of Net Sales?
a. Ifthe gross profit rate is based on sales, the COGS is equal to Net Sales times 1
less the gross profit rate.
b. If the gross profit rate is based on cost, the COGS is equal to Net Sales divided by
1 plus the gross profit rate.
c. Bothaandb
d. Neitheranorb
During the year, an entity had a one-time transaction involving a bulk order for a
customer. The gross profit rate charged in this transaction is substantially lower
than the normal gross profit rate. In applying the gross profit method, the entity shall
do which of the following? j
a. Indetermining the amount of COGS, the amount of net sales from this one-time
transaction shall be segregated from the normal sales and applied with the
relevant substantially lower gross profit rate.
b. In determining the amount of COGS, the amount of net sales from this one-time
transaction shall be segregated from the normal sales and applied with the
relevant normal gross profit rate.
c. Indetermining the amount of COGS, the normal gross profit rate shall be applied
to the total Net Sales including those arising from the one-time transaction.
d. Indetermining the amount of COGS, the relevant substantially lower gross profit
rate shall be applied to the total Net Sales including those arising from the one-
time transaction.
On September 10, 2023, a fire burned substantially all of an entity’s inventory

situated in its main warehouse. In determining the final amount of inventory loss, all
of the following shall be deducted from the initial estimate of ending inventory,
except
a. Netrealizable value of undamaged goods.
b. Cost of relevant inventories in transit.
c. Cost of inventories situated in other locations.
On June 26, 2023, a fire burned substantially all of an entity’s inventory situated in
its main warehouse. In determining the final amount of inventory loss, which of the
following shall be deducted from the initial estimate of ending inventory?
a. Invoice price of in-transit inventories sold FOB destination.
b. Invoice price of in-transit inventories purchased FOB shipping point.
c. Cost of damaged goods.
d. Invoice price of in-transit inventories sold FOB shipping point.
An entity suspects that its accounting system generates inaccurate perpetual
inventory records. As a result, it decided to apply the gross profit method to
determine the reasonableness of its accounting records. Which of the following
310
The
CamScanner
sn
incorrectly describes the judgment that the entity may make regarding this
reasonableness test?
a. There is a possible understatement of recorded inventory if the ending
inventory based on perpetual inventory records is higher than the ending
inventory estimated using gross profit method.
b. There is a possible overstatement of recorded inventory if the ending inventory
based on perpetual inventory records is lower than the ending inventory
estimated using gross profit method.
c. Bothaandb
d. Neitheranorb
9. During the current year, an entity reported net sales of P5,000,000 and COGS of
P4,000,000. Based on this limited information, which of the following is incorrect?
a. Gross profit amount is P1,000,000.
b. Gross profit rate based on sales is 20%.
c. Gross profit rate based on cost is 25%.
10.In the entity’s application of the gross profit method in its inventory estimation, all
of the following are correct, except | :
a. Sales returns shall not be added back to the reported amount of net sales.
b. Sales discounts shall be added back to the reported amount of net sales.
c. Sales allowances shall be added back to the reported amount of net sales.
Straight Problems
1. At the beginning of 2023, COSINE Company reported inventory of P1,900,000.
During the year, net purchases and net sales. amounted to P5,800,000 and
P7,900,000, respectively. The Company consistently applies 35% gross profit rate
based on sales.
Required: Based on. the given information, determine the estimated ending
inventory as of December 31, 2023.
2. For the year 2023, SINE Company reported the following information that may be
relevant in estimating its ending inventory:

Sales allowances 100,000
Beginning inventory 2,120,000
Gross purchases 6,160,000
Purchase discounts 40,000
Purchase returns 180,000
Purchase allowances 80,000
Freight in 250,000
311
The
Freight out 330,000

Advertising expense 500,000
Salaries expense - office employees 2,500,000
The Company has consistently applied a gross profit rate of 25% based on cost to all
of its sale transactions during year.
Required: From this information and using the gross profit method, determine the
estimated ending inventory as of December 31, 2023.
3. TANGENT Company, a retailer of bags who caters to a wide range of customers,

offers a variety of products from low-cost shoulder bags to highly-valued designer
bags. During the year, Company was able to consistently applied the following gross
profit rates (all based on sales) on each of the following product segments: 15% for
low-cost bags, 25% for mid-range bags, and 35% for designer bags. In addition, the
Company also provided the following financial information:
Net sales - low-cost bags P2,500,000
Net sales - mid-range bags 4,600,000
Net sales - designer bags 5,800,000
Beginning inventory 3,350,000
Gross purchases - all bags 10,120,000
Freight in 350,000
Freight out 600,000
Required: From this information and using the gross profit method, determine the
estimated ending inventory as of December 31, 2023.
4. In preparing its interim financial reports for the quarter ending March 31, 2023,
TRIGO Company decided to use the gross profit method in estimating its ending
inventory. Information that may be relevant for this purpose is provided as follows:
January 1 to
Year 2022 March 31,2023
Gross purchases 7,530,000 1,800,000
Gross sales 10,350,000 2,500,000
Purchase returns 260,000 60,000
Sales returns 350,000 100,000
Freight in 400,000 90,000
estimated inventory as of March 31, 2023:
1. The Company maintained during the first quarter of 2023 the 2022 gross profit
rate based on sales.
312
The
CamScanner
2. The Company maintained during the first quarter of 2023 the 2022 gross profit
rate based on sales plus additional 3%.
S. For the years 2021, 2022, and 2023, DEGREE Company reported the following
information:
2021 2022 2023
Beginninginventory 3,630,000 P3,480,000 P3,790,000
Net purchases 6,075,000 6,004,000 5,566,000
Net sales 8,300,000 7,800,000 8,600,000
The Company would like to estimate its ending inventory using gross profit method
to be compared to the accounted inventory of P3,520,000 based on physical count.
This comparison is made to determine the merit of the allegation that some
warehouse employees are stealing inventory items.
Required: Determine the estimated amount of inventory shortage as of December
31, 2023 assuming that the trend of gross profit rates based on sales from 2021 to
2022 will continue to 2023.
6. On the evening of July 15, 2023, RADIUS Company’s warehouse became submerged
underwater due to flashfloods. The Company would like to estimate the inventory
loss for purposes of filing claims from the property insurer. In connection with this
purpose, the Company had collated the following information from January 1, 2023
up to July 15, 2023:
Freight in 180,000
As to estimate of gross profit rate, the Company decided to use the overall gross profit
rate from 2020 to 2022:
2020 2021 2022
Beginninginventory 1,760,000 P1,850,000 P1,960,000
Net purchases 3,900,000 4,450,000 4,670,000
Net sales 5,000,000 8,500,000 7,500,000
Inventory as of January 1, 2023 is P2,180,000. After the flood has subsided, the
Company inspected the warehouse for salvageable materials and recovered
damaged goods with original cost of P100,000 but can be sold for P30,000. In
313
The
The Book
addition, inventories intended to be sold for P400,000 were in the possession of a

consignee.
Required: Determine the estimated inventory loss that can be claimed from the
property insurer.

1. BUSH Company prepares monthly financial statements and uses the gross profit
method to estimate its ending inventories. Historically, the company had a 40%
gross profit rate. During September, net sales and net purchases amounted to
P500,000 and P230,000, respectively. The beginning inventory on September 1 was
P150,000. The estimated cost of the Company's inventory on September 30 is
a. P75,000 c. P110,000
b. P80,000 d. P130,000
. SENPIE Company’s inventory as of October 31, 2023 has been destroyed by flood.
For the ten-month period ended October 31, 2023, the Company reported the
following amounts:
Beginning inventory 530,000

Net purchases 1,380,000
Net sales 2,200,000
The Company maintains a gross profit rate on cost of 25%. Determine the estimated
cost of the destroyed inventory
a. P120,000 c. P150,000
b. P140,000 d. P260,000
. For the year 2023, MELANIE Company reported the following amounts:

Purchases 6,400,000
Net sales 9,000,000
The Company maintains gross profit on sales of 40%, Determine the estimated
ending balance of inventory.
a. P2,240,000 c, P2,420,000
b. P2,540,000 d, P2,180,000
. OSCAR Company would like to estimate its ending inventory balance using gross
profit method because there was an anonymous tip received indicating that some of
| its warehouse employees are involved in inventory misappropriation schemes. For
the current period, the Company reported the following amounts:
314
The
CamScanner

Purchases 6,384,000
Sales 7,392,000
Sales allowances ) 112,000
The Company always applies a 25% gross profit rate on cost. Physical count showed
inventory of P1,064,000. Determine the estimated amount of stolen inventory, if any.
a. P313,600 c. P341,600
b. P302,400 d. P330,400
5. On the night of June 30, 2023, DENNIS Company's warehouse, together with its
records have been engulfed by fire. Luckily, the following information has been
obtained from previous reports uploaded in the Company’s cloud storage:
June 30, 2023 2022
Beginning inventory P??? + P730,000
Ending inventory P???.- 1,095,000
Net purchases 2,482,000 4,015,000
Net sales 3,504,000 5,840,000
After the fire has been put out, undamaged inventories with normal selling price of
P292,000 and damaged inventories with selling price of P146,000 were discovered.
The damaged inventories are saleable for scrap at P14,600. Assuming that the entity
has not yet changed its gross profit policy, the amount of loss shall be
a. P1,109,600 c. P1,080,400
b. P1,102,300 d. P1,189,900
6. On September 30, 2023, GIORGIO Company’s warehouse was flooded due to

successive typhoons that ravaged its location. Based on the remaining records
salvaged from the flooded warehouse, the following amounts were identified:
9 months ending
September 30, 2023 2022
Beginninginventory — P2,480,000 P1,860,000
Net purchases 7,750,000 11,470,000
Net sales 12,400,000 15,500,000
Starting January 1, 2023, the Company adjusted its selling prices to increase its gross
profit rate on sales by 5% compared to gross profit rate on sales in 2022. In addition,
purchased inventory in transit through FOB shipping point terms with invoice cost
of P232,500 was properly included in the net purchases amount. Determine the
amount of inventory loss
315
The
The Book
a. P1,937,500 c. P1,550,000
b. P1,860,000 d. P1,317,500
7. For the past three years, WILLIAMS Company reported the following amounts:
2020 2021 2022
Beginning inventory P996,000 P1,152,000 P1,056,000
Net purchases 3,960,000 3,780,000 4,550,400
Net sales 4,755,000 5,100,000 6,120,000
On the evening of August 31, 2023, the Company's inventory has been consumed by
fire. The following information was collated up to August 31, 2023 in estimating the
amount of inventory loss:
Beginninginventory —P1,200,000
Net purchases 4,320,000
Net sales 6,480,000
In addition, the following inventories were in transit as of August 31, 2023:
a. Purchased inventories under FOB shipping point with an invoice price of
P108,000.
b. Purchased inventories under FOB destination with invoice price of P144,000.
c. Sold inventories under FOB destination with selling price of P180,000.
There were no errors noted in recording or non-recording of these in-transit
inventories. The Company’s gross profit rate on sales for the year 2023 followed the
same trend from the preceding three-year period. Determine the amount of
inventory fire loss to be recognized.
a. P624,000 c. P883,200
b. P1,113,600 d. P854,400
8. Acatastrophic flood damaged MENDIOLA’S inventory as of December 31, 2023:
Invoice price of purchased goods in transit,
FOB shipping point 91,800
Invoice price of purchased goods in transit,
FOB destination 129,600
Invoice price of sold goods in transit, FOB
shipping point 237,600
Invoice price of sold goods in transit, FOB
destination 270,000
All purchased goods in transit were included in the amount of gross purchases while
all sold goods in transit were included in the amount of gross sales. Beginning
316
The
CamScanner
inventory for 2023 amounted to P1,296,000, Determine the amount of inventory

loss assuming that the entity maintains gross profit rate on sales of 30% for all of its
sold inventories
a. P1,182,600 c. P1,387,800
b. P1,463,400 d. P1,485,000
317
The
The Book
Chapter 9A — Retail Inventory Method
CHAPTER 9A
RETAIL INVENTORY METHOD

1. The inputs used in applying the retail inventory method.
2. The determination of the amounts of inputs.
3. The different variations in applying the retail inventory method such as the LCENRV
method, average method, and FIFO method.
4. The computation of cost ratio under each variation of retail inventory method.
5. The determination of estimated ending inventory using retail inventory method.
RETAIL INVENTORY METHOD

From the name itself, retail inventory method is normally applicable to retail
companies. The nature of the inventories of these companies are the same with the
inventories which are accounted for using the periodic inventory system (i.e., items
that are low-value but with high turnover). These companies include, but not
limited to department stores, grocery shops and pharmacies.
With the advent of technology, entities can now maintain the following information,
which are prerequisites in applying the retail inventory method:
a. Total goods available for sale (TGAS) stated at cost.
b. TGAS stated at their selling prices.
c. Sales amount.
The initial goal in retail inventory method is to compute for the amount of the ending
inventory at retail. The equation previously used in the gross profit method is still
relevant, but the only thing that will be different is that the amounts were all now
stated at retail value as follows:
Ending Inventory
(at retail)
se eG)
(at retail)
ee Net Sales
TGAS at retail means the total selling prices of all the goods available for sale. Net
Sales is the equivalent of “COGS at retail”. Ending inventory at retail represents
the total selling prices of inventory items that were not sold during the period.
Since inventories are not reported at their selling prices, the computed ending
inventory at retail shall be deflated back to its cost by multiplying it with the
relevant cost ratio. This deflated ending inventory at cost is the estimate of ending
inventory using retail inventory method.
318
The
The cost ratio is generally computed as TGAS at cost +TGAS at retail. Due to this,
both the TGAS at cost and TGAS at retail shall be separately computed.
TGAS at cost is simply the usual TGAS in the context of gross profit method,
adjusted by some additional amounts. In addition, there are also variations in
computing the cost ratio which will all be discussed later in the Chapter.
To geta high-level understanding of retail inventory method, let us trya very simple
example.
Illustration 1. ELDERBERRY Company uses retail inventory method in estimating

its ending inventory. For the year ended December 31, 2023, it reported the
following amounts:
At cost At retail
Beginning inventory P900,000 ~—_P1,100,000
Net purchases 1,900,000 2,900,000
TGAS P2,800,000 = P4,000,000
Net Sales 3,400,000
Required: Compute for the estimated ending inventory using the retail inventory
method.
1. Since the amounts of TGAS (at cost and at retail) were already given, the next
step is to compute for the ending inventory at retail as follows:
Ending mee ae Tee a Net Sales

(at retail) = | (atretail) P3,400,000
P600,000 P4,000,000
2. Next, compute for the cost ratio, which in this illustration computed as 70%
(P2,800,000/P4,000,000).
3. Lastly, compute for the ending inventory at cost as follows:
Ending Inventory at Cost = P600,000 x 70% = P420,000
Details in determining the amounts of TGAS (at cost and at retail) and Net Sales are
to be discussed in the succeeding sections.
DETERMINING THE AMOUNTS OF TGAS AT COST AND AT RETAIL

TGAS at cost and at retail value can be simultaneously computed as follows:
319
The
Atcost Atretail
Beginning inventory Pxx Pxx
Gross purchases XX XX
Freight in XX
Purchase returns (xx) (xx)
Purchase allowances (xx)
Purchase discounts (xx)
Transfer-in XX XX
Transfer-out (xx) (xx)
Net markups XX
Net markdowns (xx)
TGAS Pxx Pxx
It is important to note that every TGAS item has both a corresponding cost amount
and retail amount, save for some exceptions. The main reason for having both the
cost amount and retail amount is that these items represent an actual physical
flow of goods, hence affecting both the cost amount and retail amount of the TGAS.
Gross purchases bring in actual goods while purchase returns reduce the actual
goods (i-e., physical flow). Transfer-in brings in additional goods for sale from
different locations within the entity (e.g., from warehouse, other retail stores, etc.)
to the department in which we are estimating the ending inventory. The opposite is
true with transfer-out which results to reduction in goods for sale due to
transferring of goods to different locations within the entity.
Freight in, purchase allowances, and purchase discounts do not have

corresponding retail amounts because these amounts do not represent a
corresponding physical flow of goods. Nevertheless, these items are used to
determine the net cost of purchases for TGAS at cost.
Retail Adjustments - Net Markups and Net Markdowns

The amounts at the retail columns are the regular or the original prices of the
goods and from time to time will be adjusted through net markups and net
markdowns:
Retail Adj. | Description and Examples

Net Markups | Markups less markup cancellations
Net
Markdowns less markdown cancellations
Markdowns
These are increases in the regular or original prices of the goods.
These are usually done to increase the price of goods in response to
Markups | anincrease in demand.
For example, few days leading to Valentine’s Day flower shops
normally increase their prices to cope up with the demand. For|
320
The
CamScanner
example, from a normal selling price of P500 per bouquet of flowers,

the price may increase up to P800. The P300 increase is the amount
of markup.
These are reductions in the markups previously made. The amount
of markup cancellation is limited to the amount of the initial markup
and should not make the current selling price of the goods go below
their regular or the original price.
Marku
ene In our Valentine’s Day example, after February 14, the flower shops
will bring down the prices back to their original price, from P800
down to P500. The P300 decrease is the amount of markup
cancellation. It should be noted that in our example, the amount of
markup cancellations may range from PO to P300.
These are decreases in the regular or original prices of the goods.
These are usually done to boost the sales of certain productions as in
“promotional sales”.
Markdowns | A good example of this is a three-day sale in a department store

wherein the prices of the products were temporarily reduced below
their regular or original prices. For example, a pair of pants originally
sells for P1,500 may be written down to P900. The decrease of P600
is the amount of markdown.
Similar with markups, markdown cancellations reduce the
amount of initially made markdowns. Continuing with the three-
Markdown | day sale example, after the promotional sales, the selling prices of the
cancellations | goods will be increased back to their regular or original selling prices.
The price of the pair of pants will be restored back to P1,500 from
P900. The increase of P600 is the amount of markdown cancellations.
DETERMINING NET SALES FOR RETAIL INVENTORY METHOD PURPOSES

The same principles on the gross profit method regarding gross sales, sales returns,
sales allowances, and sales discounts are also applicable in the retail inventory
method. By analogy, sales allowances and sales discounts shall not be deducted
from the amount of gross sales in computing for the Net Sales (i.e., to be deducted
from TGAS at retail to arrive at ending inventory at retail). Again, the rationale is
that there is no corresponding physical flow of goods.
In addition to sales returns, the following items shall adjust the amount of Net Sales:
a. Employee discounts - these are the discounts given to the entity's employees
when they purchase goods from the entity. The sales amount recorded related to
goods that were sold to employees were
already
net of the discount. As a result,
this amount shall be added to the amount of gross sales.
321
The
The Book
To further support this treatment, let us assume a good that is normally selling
for P1,000 and was sold to an employee at a discounted amount of P600
(employee discount amounted to P400). This good is already stated at P1,000 in
the TGAS at retail column while the recorded amount of sales would be P600. If
the P400 employee discount is not be added back to the amount of sales, our
equation will result to the following:
Ending Inventory TGAS N
et Sal
(at retail) 3 (atretail) | = P60 i
P400 P1,000
As we can see, there is an amount left in the ending inventory at retail, basically
translating to the assumption of remaining physical good. This is not the case as
the good has already been sold and no physical inventory has remained in the
ending inventory. As a conclusion, if the employee discounts are not added
to the gross sales, the amount of Net Sales (and COGS) is understated while
the ending inventory will be overstated.
If the employee discount is added back to the amount of sales, our equation
would look like this:
Ending Inventory = Teas Net Sales

(at retail) cS | (atretail) | = P600 + P400
PO P1,000
Based on this equation, there is no amount left in the ending inventory at retail,
which translates to the assumption of no remaining physical good in the ending
inventory, which is really the actual case.
b. Normal loss, breakage, and shrinkage - these amounts represent expected

losses, shrinkages, and wastages in the normal course of business and within the
normal levels. The relevant retail amounts shall be added to the amount of
gross sales (effectively as a deduction from TGAS - retail) to be subsequently
absorbed in the amount of COGS. The related cost will be completely ignored.
Consequently, these amounts have no effect in the determination of the cost ratio.
The computation of the cost ratio will be discussed later in the chapter.
c. Abnormal loss, breakage, and shrinkage -these represent the losses that
exceed the normal level of losses, shrinkages, and wastages. To prevent the
possible distortion of the cost ratio, these losses are to be deducted from both
TGAS at cost and TGAS at retail before computing the cost ratio. Consequently,
these amounts affect the determination of cost ratio.
322
The
The Book
Chapter 9A - Retail Inventory Method
To summarize, the total amount to be deducted as “Net Sales” in the retail inventory
method equation is computed as follows:
Gross sales Pxx
Add: Employee discounts xX
Normal losses xx
Less: Sales returns (xx)
Total amount to be deducted as “Net Sales” Pxx
To incorporate the abnormal loss, breakage, and shrinkage in the TGAS amounts
discussed so far:
Atcost Atretail
Beginning inventory Pxx Pxx
Freight in XX
Purchase discounts _ (xx)
Transfer-in xX XX
Net markups XX
Net markdowns (xx)
Abnormal losses (xx) (xx)
TGAS Pxx Pxx
Illustration 2. FRUITS Company wants to estimate its ending inventory balance by

applying the retail inventory method. For the year ended and as of December 31,
2023, the following amounts were reported:
Beg. Inv., at cost P1,300,000 Transfer-in, retail P1,000,000

Beg. Inv., at retail 2,000,000 Transfer-out, retail 650,000
Gross purchases, cost 5,916,000 Normal loss, cost 70,000
Gross purchases, retail 8,870,000 Normal loss, retail 100,000
Purchase returns, cost 500,000 Abnormal loss, cost 616,000
Purchase returns, retail 720,000 Abnormal loss, retail 800,000
Purchase allow., cost 120,000 Gross sales 8,500,000
Purchase discounts, cost 90,000 Sales returns 550,000
Transfer-in, cost 700,000 Sales discounts 130,000
Transfer-out, cost 490,000 Sales allowances 400,000
Employee discounts 250,000 Freight in 900,000
Markups 1,700,000 Markdowns 1,450,000
Markup cancellations 200,000 Markdown cancellations 250,000
Net markups 1,500,000 Net markdowns 1,200,000
323
The
Based on the given information, determine the estimated ending inventory at retail.
The following steps are to be followed in solving the problem:

1. First, compute for the amounts of TGAS at cost and TGAS at retail:
At cost At retail
Freight in 900,000
Purchase returns (500,000) (720,000)
Purchase allowances (120,000)
Purchase discounts (90,000)
Transfer-in 700,000 1,000,000
Transfer-out (490,000) (650,000)
Net markups 1,500,000
Net markdowns (1,200,000)
Abnormal losses (616,000) (800,000)_
TGAS P7,000,000 10,000,000
It should be noted that both the cost of normal loss and its retail amount were
excluded from the computations above.
2. Next, determine the total amount of Net Sales to be deducted from the TGAS at
retail. This is computed as follows:
Add: Employee discounts 250,000
Normal losses 100,000
Total amount to be deducted as “Net Sales” P8,300,000
The readers should take note that the sales discounts and sales allowances were
not considered in the computation for the same reason as mentioned in the gross
profit method (i.e., no physical flow of inventory back to the entity).
3. Next, compute for the amount of ending inventory at retail using TGAS at retail
computed in (1) and the amount computed in (2) as “Net Sales”.
Ending Inventory TGAS

(at retail) = | atretail) | = aan
P1,700,000 P10,000,000 1800,
This computed amount of ending inventory at retail will be used in computing
the amount of ending inventory at cost by applying a cost ratio. Calculation of
ending inventory at cost will be continued after the discussion on the variations
in cost ratio in the succeeding section.
324
The
The Book
VARIATIONS IN COST RATIO

The general formula in computing the cost ratio is TGAS at cost divided by TGAS at
retail. Currently, there are three methods of computing for the cost ratio:
a. Average cost method
b. Conventional or the LCNRV method
c. FIFO method
These three methods will start to differ only as to the cost ratio percentage,
which will lead to different amounts of ending inventory at cost and COGS.
Needless to say, all of these methods will use the same
amounts of TGAS at cost,
TGAS at retail, net sales, and ending inventory at retail. Details about these
methods and their differences are the following:
Variations/
Method Description
TGAS at cost
Cost ratio °= Teas at retail
Average This is the preferred method and the method to be used if the
Method problem is silent as this is in line with paragraph 22 of PAS 2, to wit:
“The percentage used takes into consideration inventory that has been
marked down below its original selling price.”
TGAS at cost
Cost ratio = ~(rGAs at retail + net markdowns)
Conventional
Compared to the average method, this method will usually result to
a lower cost ratio. Consequently, it will result to a lower ending
or LCNRV
Method
inventory at cost and higher COGS.
The rationale for this variation is that the existence of net
markdowns indicates a decrease in NRV, which shall be reflected in
a higher COGS and lower ending inventory.
(TGAS at cost - beg. inventory at cost)
Costratio =~ 7rGAsat retail
- beg. inventory at retail)
FIFO Method Under this method, the beginning inventory is assumed to be sold
first and shall not affect the cost ratio for the current period. Aside
from this, this method is very much similar with the average method
(i.e., net markdowns are considered),
Illustration 3. This illustration is the continuation of FRUITS Company (Illustration

2), where the computed ending inventory at retail is at P1,700,000. Cost ratios
under each method/variation are computed as follows:
325
The
CamScanner
_ Method. . _...... Computation of Cost Ratio ae.

Average on} = P7,000,000 ss 0
Method Cost ratio = 579 000,000 7000

Conventional 4
: P7,000,000
or LCNRV Cost ratio P10,000,000 + P1,200,000 62.50%
Method
ase P7,000,000 - P1,300,000 i
FIFO Method Cost ratio P10,000,000 ~ P2,000,000 71.25%
These cost ratios will be used in computing for the ending inventory at cost under
each method as follows:
Average Conventional FIFO
Ending inventory, retail P1,700,000 P1,700,000 P1,700,000
Multiply by: Cost ratio 70.00% 62.50% 71.25%
Ending inventory, cost P1,190,000 1,062,500 P1,211,250
Since the ending inventory at cost is already known under each method, the COGS
can now be determined under each method as follows:
Average Conventional FIFO
TGAS, cost P7,000,000 P7,000,000 P7,000,000
Less: Ending inventory, cost (1,190,000) _(1,062,500) _(1,211,250)
coGs P5,810,000 5,937,500 P5,788,750
SPECIAL CONSIDERATION ON FIFO METHOD

If an entity uses FIFO method, the amount of Net Sales and beginning inventory at
retail shall be compared as follows:
Scenario ' Accounting Considerations
Net Sales > Beg. Inventory at Retail No further considerations
Net Sales < Beg, Inventory at Retail | Additional considerations shall be made
Ifthe amount of Net Sales isi lower than the amount of besinuins inventory at retail,
ere p e entory.In this
case, two cost ratios will be used in deflating the ending inventory at retail back to its
cost. In addition to the cost ratio of purchases made during the year, cost ratio of the
beginning inventory shall also be used for the portion of the ending inventory coming
from the beginning inventory.
Illustration 4, GUAVA Company applies FIFO method in estimating its ending
inventory using the retail inventory method. At the beginning of 2023, it reported
beginning inventory at cost and at retail amounting to P3,000,000 and P4,000,000,
respectively. For the year ended December 31, 2023, it reported net purchases at
326
The
cost and at retail amounting to P2,000,000 and P2,200,000, respectively. Also, net
markups amounted to P500,000 while net markdowns amounted to P200,000.
Lastly, sales for the year amounted to P3,500,000. Required: Determine the ending
inventory using the retail inventory method.
1. First, compute for the TGAS at cost and at retail as follows:
At cost At retail
Net purchases 2,000,000 2,200,000
Net markups 500,000
Net markdowns (200,000)
TGAS P5,000,000 P6,500,000
2. Since the sales amount is already determined, the next step is to compute for the
ending inventory at retail:
Ending Inventory = TGAS ar Net Sales

(at retail) (at retail) — -P3.500.000
P3,000,000 P6,500,000 mato sae
3. Next, compute for the cost ratio as follows:
At cost | At retail
Net purchases P2,000,000 P2,200,000
Net markups 500,000
Net markdowns (200,000)
Net purchases - FIFO P2,000,000 P2,500,000
Cost ratio for net purchases is 80% (P2,000,000/P2,500,000). In addition, the

cost ratio of beginning inventory is 75% (P3,000,000/P4,000,000).
4. Since the amount of net sales of P3,500,000 is lower than the beginning
inventory balance at retail of P4,000,000, the ending inventory at retail of
P3,000,000 is composed of the following portions:
From beginning inventory (P4,000,000 - P3,500,000) P500,000
From current year’s purchases (P3,000,000 - P500,000) __ 2,500,000
Ending inventory at retail P3,000,000
Cost ratio of 75% is applied to the balance remaining from beginning inventory
while cost ratio of 80% is applied to the balance coming from net purchases.
[B] Cost [A] x [B]
[A] At Retail Ratios At Cost
From beg. inventory P500,000 75% P375,000
From purchases 2,500,000 80% 2,000,000
P3,000,000 P2,375,000
Ending inventory
327
The
APPLICATIONS OF RETAIL INVENTORY METHOD

Similar to gross profit method, aside from estimating the inventory balance for
interim reporting purposes, the retail inventory method may also be used in
estimating the amount of inventory loss or the inventory shortage or overage.
ESTIMATING INVENTORY LOSSES FROM CATASTROPHES

The amount of loss on inventory can be determined as follows:
Estimated ending inventory Pxx
Loss on inventory due to catastrophe PXxx
Similar to gross profit method, the following are the relevant inventories in transit:
Relevant In-Transit Goods Retail Inventory Method Procedures
Purchased, FOB shipping point Shall be included in TGAS at cost and at retail
Sold, FOB destination Shall be excluded from the amount of net sales
The equivalent cost of both of these in-transit goods shall be deducted from the
estimated ending inventory at cost to arrive at the amount of inventory loss. The
determination of the equivalent costs is as follows:
Relevant In-Transit Goods Equivalent Cost

Purchased, FOB shipping
Invoice price from the supplier is already the cost
point
Invoice price is stated at the entity’s selling prices;
Sold, FOB destination required to be restated back to relevant cost by
applying the computed cost ratio.
Illustration 5. On the night of June 1, 2023, a fire consumed a significant portion of

RASPBERRY Company’s inventory in one of its warehouses. From January 1, 2023
to June 1, 2023, the Company reported the following information:
At cost At retail
Net purchases 2,584,000 3,800,000
TGAS P3,900,000 P6,000,000
Net Sales 4,500,000
The Company uses the average method, Additional information was provided as
follows:
a. Damaged goods originally marked to sell at P300,000 is saleable to a recycling
plant for P50,000.
b. Undamaged goods originally marked to sell at P200,000 were recovered.
328
The
The Book
c, In-transit goods purchased FOB shipping point at an invoice amount of P120,000

were already included in the net purchases at cost and at retail columns.
d. There were in-transit goods sold FOB destination at an invoice price of P80,000.
These were not included in the reported net sales
Required: Determine the amount of estimated inventory fire loss.
1. Since the TGAS at retail and Net Sales amounts were already provided and no
errors were committed in recording in-transit inventories, the ending inventory
at retail can now be determined as follows:
Ending Inventory 1 TGAS: Net Sales

(at retail) SS | (atretail), |) = P4,500,000
P1,500,000 P6,000,000 ae
2. Next, determine the cost ratio using average method. The relevant cost ratio is
65% (P3,900,000/P6,000,000).
3. Next, using the cost ratio determined in step 2, deflate the P1,500,000 ending
inventory at retail to its equivalent cost of P975,000 (P1,500,000 x 65%).
4. Finally, deduct the relevant amounts (that were not consumed by the fire) from
the ending inventory at cost of P975,000 to determine the estimated inventory
fire loss:
Estimated ending inventory at cost P975,000
Less: NRV of salable damaged goods (not based on cost) (50,000)
Cost of undamaged goods (P200,000 x 65% cost ratio) (130,000)
Cost of purchased goods in transit (equal to invoice price) (120,000)
Cost of sold goods in transit (P80,000x 65% cost ratio) (52,000)
Estimated inventory fire loss P623,000
The readers should take note that both the P200,000 and P80,000 amounts were
all stated at the entity’s selling prices, hence, they were deflated to the
corresponding cost amounts using 65% cost ratio.
ESTIMATING INVENTORY SHORTAGE OR OVERAGE

In estimating the amount of inventory shortage or overage, an entity shall compare
the ending inventory balance based on physical count and ending inventory
estimated using the retail inventory method:
Scenario == = —~-~——S_|_ Inventory Shortage or Overage

Physical count < estimated inventory balance Inventory shortage
|Physical count > estimated inventory balance Inventory overage
329
The
The Book
CHAPTER SUMMARY
1. General formula under retail inventory method is as follows:
Ending inventory at retail = TGAS at retail - Net sales
2. The amounts of TGAS at retail and TGAS at cost are determined as follows:
Atcost Atretail
Beginning inventory Pxx PXx
Freight in XX
Purchase discounts (xx)
Transfer-in XX XX
Net markups XX
Net markdowns (xx)
Abnormal losses (xx) (xx)
TGAS Pxx Pxx
3. The amount of Net Sales is determined as follows:
Gross sales Pxx

Add: Employee discounts XX
Normal losses XX
Less: Sales returns (xx)
Total amount to be deducted as “Net Sales” Pxx
4. After determining the ending inventory at retail, this shall be restated to its cost
using the following formula:
Ending inventory at cost = Ending inventory at retail x cost ratio
5. There three variations of computing cost ratio as follows:
Variations/
Method Description
TGAS at cost
A verage Method Cost ratioio = TGAS at retail
Conventional or TGAS at cost

tratio =
LCNRV Method Gost rene (TGAS at retail + net markdowns)
FIFO Method Coktvatlo = (TGAS at cost - beg. inventory at cost)
(TGAS at retail - beg. inventory at retail)
Despite these differences, the variations will use the same amount of ending
inventory at retail.
330
The
The Book
True or False
1. Retail inventory system is mainly used by retail companies.
2. When using the retail inventory method, only the amount of TGAS at retail is
relevant.
TGAS at retail is equivalent to the amount of sales that can be generated assuming
all goods available for sale were sold.
Freight in is added to both the TGAS at cost and TGAS at retail columns.
Markups are added to both the TGAS at cost and TGAS at retail columns.
The amount of ending inventory at retail shall be restated to its equivalent cost by
applying a relevant cost ratio.
Both abnormal losses and normal losses affect the cost ratio for retail inventory
method purposes.
Similar to the gross profit method, sales discounts shall not be deducted from gross
sales to determine the amount of Net Sales for retail inventory method purposes.
When using the FIFO method in determining the cost ratio, the cost and retail
amounts of beginning inventory shall not be considered.
10. Employee discounts shall be deducted from the gross sales to determine the
amount of Net Sales.
11. Average method, LCNRV method, and FIFO method will use different amounts of
ending inventory at retail to be multiplied with the relevant cost ratio in order to
arrive at the ending inventory at cost.
12. Under LCNRV method, the amount of net markdowns is not considered in
determining both the cost ratio and ending inventory at retail.
13. The relevant amounts of departmental transfer-in shall be considered in both the
TGAS at cost and TGAS at retail columns. .
14. Under the average method variation, the cost ratio can be determined by simply
dividing the amount of TGAS at cost by the amount of TGAS at retail.
15. In determining the amount of inventory loss, the invoice price of in-transit
inventory sold FOB destination shall be deducted from the initially estimated
ending inventory at cost.
1 Under the retail inventory method, which of these amounts have both cost and retail
amounts?
a.- Purchase returns
b. Purchase discounts
c. Freightin
d. Purchase allowance
Ending inventory at retail is the difference between which of the following amounts
a. TGAS at cost less COGS
b. TGAS at cost less Net Sales
c. TGAS at retail less Net Sales
d. TGAS at retail less COGS
331
The
CamScanner
3. The following amounts shall be added to the TGAS at cost column, except
a. Beginning inventory
b. Freight out
c. Departmental transfer in
d. Gross purchases
The variations when determining the cost ratio under retail inventory method will
use the same amounts with respect to the following except.
a. TGAS at cost.
b. TGAS at retail.
c. Ending inventory at retail.
d. Allofthe above.
The following are variations in determining the cost ratio when using the retail
inventory method, except
a. FIFO method.
b. Specific identification method.
c. Average method.
d. LCNRV method.
The following statements are true about markups and markdowns, except
a. Markups increase the total goods available for sale at retail.
b. Markdown cancellations decrease the total goods available for sale at retail.
c. Markdowns decrease the total goods available for sale at retail.
d. Markup cancellations decrease the total goods available for sale at retail.
Which of the following correctly states the relationship of cost ratio under average
method and cost ratio under lower of cost or net realizable value (LCNRV) method
if there are net markdowns?
a. Thecost ratio under average method is normally less than the cost ratio under
the LCNRV method.
b. The cost ratio under LCNRV method is normally less than the cost ratio under
the average method.
c. The cost ratio under average method is generally equal to the cost ratio under
the LCNRV method.
d. There is no such relationship that can be established between these two cost
ratios.
In computing the amount of total goods available at retail and for computing the cost
ratio, the following are used under both the average method and lower of cost or net
realizable value method, except
a. Netmarkups
b. Net markdowns
c. Beginning inventory
d. Both net markups and net markdowns
332
The
-9, In applying the retail inventory method, which of the following is the correct
treatment for the amount of normal loss?
a. Deducted from total goods available for sale at retail
b. Deducted from both total goods available for sale at cost and at retail
c. Added to the amount of gross sales when determining the amount of net sales
d. Deducted from the amount of gross sales when determining the amount of net
sales
10.In applying retail inventory method, which of the following is the correct treatment
for the amount of abnormal loss? |
a. Deducted from total goods available for sale at retail
b. Deducted from both total goods available for sale at cost and at retail
c. Added to the amount of gross sales when determining the amount of net sales
d. Deducted from the amount of gross sales when determining the amount of net
sales
Straight Problems
1. LENTEN Company reported the following information for the six-month ending June
30, 2023:
At cost At retail
Beginning inventory P3,000,000 4,000,000
Net purchases 6,800,000 10,000,000
TGAS P9,800,000 P14,000,000
Net sales 11,200,000
Required: Determine the (a) estimated ending inventory as of June 30, 2023; and (b)
cost of goods sold under each of the following independent scenarios:
1. Costratio is determined using the average method.
2. Cost ratio is determined using the FIFO method.
2. RECOLLECTION Company would like to estimate its ending inventory to be reported

for its September 30, 2023 interim reports. In relation to this, it reported the
At cost At retail
Freight in 331,000
Net markups 320,000
Net markdowns 300,000
Gross sales 8,900,000
Employee discounts 120,000
333
The
The Book
Required: Determine the (a) estimated ending inventory as of June 30, 2023; and (b)
cost of goods sold under each of the following independent scenarios:
1. Cost ratio is determined using the average method.
2. Costratio is determined using the LCNRV method.
. For the first calendar quarter just ended, STEVEN Company would like to estimate
its ending inventory for interim reporting purposes. It reported the following
information during the quarter:
Cost Retail
Inventory, January1 656,000 P41,010,240
Freight in 64,000
Net markups 360,000
Sales 3,280,000
Normal losses 28,800 40,000
Abnormal losses 192,000 312,000
Required: Determine the (a) estimated cost of inventory as of March 31, 2023; and
(b) cost of goods sold for the quarter ending March 31, 2023 under each of the
following independent retail inventory methods (round off cost ratio to two decimal
percentage, e.g., 12.3456...% shall be rounded to 12.35%):
1. Average method
2. Lower of cost or market (conservative) method
3. FIFO method.
. EARLIE Company’s inventory in its warehouse as of June 30, 2023 were all
destroyed by a fire. Relevant information regarding the estimation of inventory loss
is as follows:
Cost Retail
Beginning inventory P972,000 P1,495,800
Net purchases 4,050,000 6,064,200
Freight in 264,060
During the earlier parts of the year, some of the inventory’s selling prices were
increased by P810,000 while other inventory’s selling prices were decreased by
P237,600. Gross sales before the fire amounted to P6,696,000 while sales returns
and sales discounts amounted to P216,000 and P64,800, respectively.
In addition, inventory in transit that is purchased FOB shipping point and has an
invoice price of P86,400 was properly included in the amount of net purchases.
334
The
CamScanner
Required: Assuming that the Company uses the average method in determining the
cost ratio, determine the estimated amount of inventory loss.
5. KRISHA Company, a listed company, is currently preparing its semi-annual report
for the six-month period ended June 30, 2023 for filing to Securities and Exchange
Commission. Since the physical count will be costly and disruptive of its operations,
the Company decided to engage your services as an accountant to estimate the
amount of its ending inventory in one of. its departments by using the retail
inventory method. The following primary information was provided to you:
Cost Retail
Gross purchases 8,740,000 12,190,000
Purchase returns 1,035,000 1,380,000
Freight in 335,800
Additional data were also provided as follows:

a. Markups amounted to P1,242,000, while markup cancellations amounted to
P207,000.
b. Markdowns amounted to P1,035,000 while markdown cancellations amounted
to P138,000.
c. Goods costing P2,070,000 and with a total retail price of P2,760,000 were
transferred to other branches while goods with total retail price of P3,680,000
and total cost of P2,875,000 were transferred from other branches.
d. Inventory with total cost of P86,250 were lost due to usual and ordinary
circumstances. Related lost revenue from these lost goods totaled P115,000.
e. Due to unusual circumstances, goods with total selling price of P1,495,000 were
lost. Related records showed that.these had total cost of P1,150,000.
f. Data about revenues are the following:
Determine the estimated cost of inventory as of June 30, 2023 and cost of goods sold
for the six-month ending June 30, 2023 under each of the following independent
retail inventory methods (round off cost ratio to whole percentage number, e.g.,
12.3456...% shall be rounded to 12.35%);
a, Average method
b. Lower of cost or market (conservative) method
c. FIFO method.
335
The
The Book

1. During the year 2023, DARLING Company reported the following amounts:
e Beginning inventory, cost of P332,800 but marked to sell at P468,000.
e Gross purchases, cost of P5,616,000 but will generate P8,008,000 revenue when
all of these were sold.
e Goods returned to suppliers that were marked to sell at P74,880 but with cost of
P54,600.
e Freight in, purchase allowance, purchase discount amounted to P520,000,
P31,200 and P83,200, respectively.
e Netsales amounted to P7,592,000.
From this information, determine the estimated ending inventory using the average
method.
a. P619,320 c. P809,120
b. P813,800 d. P606,840 «
2. For the year 2023, DOROT Company reported the following information:
Cost Retail
Beginning inventory P701,000 P968,000
Net purchases 3,973,600 5,509,660
Net markups ~ 200,340
Sales amounted to P5,275,620 while net markdowns amounted to P445,200.
Assuming the use of average method, the estimated ending inventory shall be
a. P717,885 c. P893,368
b. P1,042,942 d. P1,205,008
Assuming the use of average method, the estimated cost of goods sold shall be
a. P3,469,592 c. P3,631,658
b. P4,004,574 d. P3,956,715
Assuming the use of LCNRV method, the estimated ending inventory shall be
a. P957,180 c. P670,026
b. P1,042,942 d. P1,205,008
Assuming the use of average method, the estimated cost of goods sold shall be
a. P3,469,592 c, P3,631,658
b. P4,004,574 d. P3,717,420
3. PEONY Company wants to estimate its ending inventory in one of its retail stores as
of March 31, 2023 for interim reporting purposes. The following are the relevant
information:
336
The
The Book
Cost Retail
During the same period, there were items of inventory with cost of P1,062,560
received from Company’s other retail store. These are marked to be sold for
P1,624,000. Net increases made from original selling prices amounted to P266,800
while net decreases from original selling prices amounted to P208,800.
Based on the Company’s sales records, its gross sales amounted to P9,164,000 while
sales returns amounted to P406,000. In addition, there was a note indicating that
P232,000 employee discounts were granted. Based on the given information,
determine the estimated amount of inventory as of March 31, 2023 under
conventional retailinventory method .,
a. P1,412,880 c. P1,621,680
b. P1,343,280 d. P1,389,680
4. For the purposes of monthly reporting, GEORGINA Company uses the LCNRV retail
inventory method in estimating its inventory. For the month of June 2023, it
reported the following information for one of its branches:
e Net purchases for the year amounted to P6,702,360 which will produce revenue
of P9,660,000 when sold.
e Beginning inventory had cost of P1,785,000 and marked to be sold for a total
price of P2,415,000.
e Some inventory items with total selling price of P1,837,500 were transferred to
another branch. Inspection of cost records showed related total cost of
P1,260,000.
e Inventory items costing P630,000 were damaged due to causes not normal to the
Company’s business. These items would have contributed P903,000 to revenue
when actually sold.
e Inventory items costing P52,500 were lost due to thieves. This amount of loss is
considered normal but would have resulted to P78,750 revenue when actually
sold.
e The following information regarding the sales revenue and selling prices is
relevant:
Employee discount 105,000
Net markups 367,500
From the given data, estimate the ending balance of inventory as of June 30, 2023
for this branch
337
The
The Book
a. P1,463,910 c. P1,424,430
b. P1,447,530 d. P1,477,980
5. HELENA Company uses FIFO retail inventory method in estimating its inventory for
interim financial reporting purposes. As an accountant, the Company seeks your
help in the estimation process and presented you the following information related
to one of the Company's branches for the quarter ending September 30, 2022:
Cost Retail
Beginning inventory P2,030,000 . P2,900,000
Gross purchases 8,444,220 12,841,200
Purchase returns 812,000 1,241,200
Additional data were given to you as follows:
a. Purchase allowances and discounts amounted to 'P232,000 and P139,200,
respectively, while the total freight to deliver the purchased goods to the
Company amounted to P522,000.
b. There were goods with total selling price of P1,740,000 transferred from other
branches. Based onthe related records, these have a total cost of P1,160,000.
c. Inventory losses above the normal levels amounted'to P928,000. These would
have contributed P1,392,000 in revenues when sold.
d. Net markups and net markdowns amounted to P777,200 and P394,400,
respectively.
e. Data about the revenue are the following:

Based on the given information, estimate the ending inventory balance as of

September 30, 2023 for this branch.
a. P2,344,940 c. P2,333,340
b. P2,357,700 d. P2,341,460
6. On the evening of February 28, 2023, AIDA Company's warehouse has been burned
to the ground, including substantially all of the inventory contained therein. The
Company seeks your help in estimating the amount of inventory loss using the retail
inventory method for claims from the insurance company. The following data were
given to you for the two-month ended February 28, 2023:
a. Beginning inventory had total cost of P1,530,000 and total retail price of
P2,040,000.
b. Net purchases amounted to P2,856,000 with corresponding total retail price of
P4,080,000.
338
The
The Book
c. Dueto downturn in economic activities, the Company generated P1,428,000 of

sales only.
d. After recovering the debris, inventory marked to sell P306,000 was
miraculously undamaged. This inventory came from purchases during the two-
month period.
The Company is applying the FIFO cost flow assumption. Based on this information,
determine estimated amount of inventory loss.
a. P3,070,200 c. P2,978,400
b. P3,100,800 d. P3,009,000
339
The
The Book
Chapter 10 - Introduction to Investments
CHAPTER 10
INTRODUCTION TO INNES EMEN IS 5p
- Chapter Overview and Objectives
The different investment outlets that an entity can.use to increase its wealth.
Glob ONE
How to identify financial assets and financial liabilities.

The different broad classifications of financial assets.
The different classifications of financial assets under PFRS 9.
The initial recognition and initial measurement requirements for financial assets.
The determination of fair value.
MD
The accounting procedures if transaction price is different from fair value.
INVESTMENTS OF AN ENTITY
As previously discussed in the first chapter, cash in itself is not capable of earning
more money unless it is invested in short-term investments which qualify as cash
equivalents. The goal of almost every business entity is to earn profit, and they can
supplement this by investing its excess cash to earn additional income. Short-term
investments that an entity can make include but are not limited to time deposits,
money market placements, commercial papers, etc.
An entity may also invest for long-term purposes such as investments in facilities
that can increase the business capacity of an entity, which in turn, will generate
more cash inflows to the entity. This form of investment is an active one as the entity
is highly engaged in this investment.
Long-term investments include but are not limited to investments in the stock
market, investments in debt securities (bonds and loans), and investments in idle
lands. These investments are passive in nature as the entity will only wait for the
investment to give it earnings in the form of dividends, interest, and/or capital
appreciation.
WHAT INVESTMENT TO CHOOSE?

The choice of what investment outlet an entity should choose mainly depends on
the following:
a. Core activities - if the core activities of an entity are not related to investing
funds in stocks and debt securities, such as a manufacturing entity, it will most
likely invest its cash on the facilities related to its operations.
b. Availability of excess funds - if the excess funds are available for only a short
period of time before its eventual use, an entity may only choose to put them in
short-term investments. On the other hand, if the excess funds are available for
long-term use or commitments, an entity may now invest in longer-term
investments.
340
The
Chapter 10 — Introduction to Investments
c. Risk appetite - every investment entail risk. Risk is represented by the

possibility that these investments may or may not provide returns to an entity
or worse, diminish the amount invested due to losses. The higher the level of
risk, the higher the return that an investment should provide (i.e., the higher the
risk, the higher the return). An entity is called risk-averse if it is willing to accept
a lower level of risk while it is called risk-seeking if it is willing to accept a
higher level of risk.
Generally, short-term investments have a lower level of risk but a lower level of
return. As a result, if an entity is very risk-averse, it may decide to invest in this
outlet. On the other hand, investments in stocks have a higher level of risk but a
higher level of return, so if an entity is risk-seeking it may decide to invest in this
type of investment.
ACCOUNTING FOR INVESTMENTS

Investments that are classified as financial instruments are accounted under PFRS
9, Financial Instruments. All other investments are accounted under either PAS 16,
Property, Plant and Equipment, PAS 40, Investment Properties, PAS 38, Intangible
Assets, and all other applicable accounting standards.
FINANCIAL INSTRUMENTS, FINANCIAL ASSETS, AND FINANCIAL LIABILITIES
A financial instrument is any contract that gives rise to a financial asset of one
entity and a financial liability or equity instrument of another entity. [PAS 32.11].
A financial asset is any asset that is:
a. cash;
b. an equity instrument of another entity;
c. a contractual right:
i. to receive cash or another financial asset from another entity; or
ii. to exchange financial assets or financial liabilities with another entity under
conditions that are potentially favorable to the entity; or
d. acontract that will or may be settled in the entity's own equity instruments and
is:
i. anon-derivative for which the entity is or may be obliged to receive a variable
number of the entity's own equity instruments; or
ii. a derivative that will or may be settled other than by the exchange of a fixed
amount of cash or another financial asset for a fixed number of the entity's
own equity instruments. [PAS 32.11].
A financial liability is any liability that is:

a. a contractual obligation: |
i, to deliver cash or another financial asset to another entity; or
|’ conditions that are potentially unfavorable to the entity; or
341
The
The Book
b. a contract that will or may be settled in the entity’s own equity instruments and
is:
i. anon-derivative for which the entity is or may be obliged to deliver a variable
number of the entity's own equity instruments; or
ii. a derivative that will or may be settled other than by the exchange of a fixed
amount of cash or another financial asset for a fixed number of the entity's
own equity instruments. [PAS 32.11].
For financial assets, the focus is on the (a), (b) and (c) portions of its definition while
for financial liabilities the focus is on the (a) portion of its definition.
Currency (cash) is a financial asset because it represents the medium of exchange.

It is the basis on which all transactions are measured and recognized in the financial
statements. [PAS 32.AG3].
Common examples of financial assets representing a contractual right to receive
cash in the future and corresponding financial liabilities representing a contractual
obligation to deliver cash in the future are the following:
a. trade accounts receivable and payable;
b. notes receivable and payable;
c. loans receivable and payable; and
d. bonds receivable (investment in bonds) and payable.
In each case, one party’s contractual right to receive (or obligation to pay) cash is
matched by the other party’s corresponding obligation to pay (or right to receive).
[PAS 32.AG4].
As can be previously be seen from the examples laid down by PAS 32, most financial
assets and their corresponding financial liabilities have all of the following
characteristics:
a. The financial assets and financial liabilities arise from contractual rights and
obligations, meaning the counterparties agreed to the terms and conditions of
the instrument. These contracts need not be in writing but should conform to
the legal requirements for their enforceability. As a result, a financial asset of
one party is the financial liability of the other party and vice versa.
b. For financial assets, there would be a present right to receive cash or other
financial assets, and for financial liabilities, there would be a present obligation
to pay cash or other financial assets.
The following items are not financial instruments due to the following reasons:
a. Inventories - these assets give an entity a chance to receive cash or other
financial asset (e.g., accounts receivable) upon their selling. Nevertheless, what
the standard requires is the present right to receive cash or other financial
assets. Since the inventories are not yet sold, no such present right exists.
342
The
b. Prepaid expenses - these include prepaid rentals, prepaid insurance, prepaid

inventory purchases, and other operating expenses that were paid in advance.
By default, these assets, do not give an entity the right to receive cash or other
financial assets. Instead, an entity will receive goods or services. However, if these
are refundable in cash, then these can be considered as financial assets.
c. Physical assets (property, plant and equipment, investment properties
and intangible assets) - an entity can generate cash flows by using these assets
(e.g., cash flows from selling the products made by equipment or rentals from
investment properties) or from their ultimate disposal. The downside is the
same with inventories as these assets do not give an entity the present right to
receive cash or other financial assets.
d. Unearned income, warranty liability, and other provisions - these are not
financial instrument as the obligation of an entity, by default, would be to
provide services or products in the future, not to pay cash nor other financial
assets. However, if these are refundable in cash, these can be considered as
financial liabilities.
e. Tax items - these include income taxes, business taxes, and deferred taxes.
These items do not arise from contractual obligations since taxes are “enforced
contributions” from an entity to the government (i.e., statutory requirement).
f. Constructive obligations - these obligations do not arise from contracts.
Hence, these are not qualified as financial instruments.
Differentiating assets and liabilities into financial or non-financial classification is
important because assets that are not financial assets nor financial liabilities are not
covered by PAS 32, PFRS 9, and PFRS 7. Since nonfinancial assets and nonfinancial
liabilities are not covered by the aforementioned standards, these will be excluded in
our discussions in the immediately succeeding chapters.
Illustration 1. DONNA Company reported the following information:
Cash P600,000 Investment in equity securities P1,000,000
Accounts receivable 2,000,000 _ Biological assets 800,000
Notes receivable 500,000 Land 1,800,000
Inventory 5,000,000 Building 3,000,000
Loans receivable 6,000,000 _ Intangible assets 1,200,000
Investmentsinbonds 10,000,000 § Goodwill 870,000
Prepaid expenses 400,000 Accounts payable 1,850,000
Equipment 4,500,000 Notes payable 615,000
Deferred tax asset 600,000 Bonds payable 8,000,000
Prepaid taxes 150,000 =‘ Income tax liability 700,000
Advances to suppliers 325,000 Loans payable 1,100,000
Investment properties 2,700,000 | Adyance,payments from customers 100,000
Derivative assets 350,000 _ Derivative liabilities 750,000
343
The
The Book
The total amount of financial assets, nonfinancial assets, financial liabilities, and
nonfinancial liabilities are computed as follows:
Financial Nonfinancial Financial Nonfinancial

Assets Assets _ Liabilities Liabilities
Cash P600,000
Notes receivable 500,000
Inventory P5,000,000
Loans receivable 6,000,000
Investments in bonds 10,000,000
Prepaid expenses 400,000
Equipment 4,500,000
Deferred tax asset 600,000
Prepaid taxes 150,000
Advances to suppliers *325,000
Investment properties 2,700,000
Derivative assets 350,000
Investment in equity
securities 1,000,000
Biological assets 800,000
Land 1,800,000
Building 3,000,000
Intangible assets 1,200,000
Goodwill 870,000
Accounts payable P1,850,000
Notes payable 615,000
Bonds payable 8,000,000
Income tax liability P700,000
Advance payments from
customers *100,000
Derivative liabilities 750,000
Totals P20,450,000 21,345,000 P12,315,000 P800,000
*Assuming these are nonrefundable,
BROAD CLASSIFICATIONS OF FINANCIAL ASSETS

The broad classifications of financial assets are:
a. Investments in debt securities - these include but are not limited to loans
receivables, notes receivables, investments in bonds, and investments in
redeemable preference shares. These are basically the financial liabilities of
another entity in the form of loans payable, notes payable, and bonds payable.
Normally, these investments are interest-bearing.
344
The
The Book
b. Investments in equity securities - these include but are not limited to

investments in common shares or preference shares. These are considered as
investments in the point-of-view of the shareholder owning shares of stock ina
corporation; thus, it is the equity of another entity in the form of common share
capital or preference share capital.
c. Derivatives -in the simplest way, derivatives “derive” their value from changes
in the specified underlying. Common examples of derivatives include forwards,
futures and options. Examples of underlying include but are not limited to
interest rate, commodity price, foreign exchange rate, or other variables.
Derivatives are usually classified into those held for speculation and those that
are used in hedging. Derivatives used in speculation will be thoroughly
discussed in the Volume 2 of this Intermediate Accounting Series. Hedging is
discussed in a higher accounting subject.
The readers should take note that these classifications are not mentioned in PFRS
9, but these broad classifications are very helpful in easily classifying financial
assets for accounting purposes.
CLASSIFICATIONS OF FINANCIAL ASSETS UNDER PFRS 9

According to Chapter 4 of PFRS 9, the following are the classifications of financial
assets:
1. Fair value through profit or loss (FVTPL)
a. by default (for both debt and equity securities); or
b. by irrevocable designation on initial recognition (for both debt and equity
securities)
2. Fair value through other comprehensive income (FVTOCI)
a. by meeting certain conditions (for debt securities only); or
b. by irrevocable designation on initial recognition (for equity securities only)
3. Amortized cost
a. by meeting certain conditions (for debt securities only)
Based on the above possible classifications, the readers should take note of the
following:
a. Investments in equity securities cannot be classified at amortized cost.
b. Unlike investments in equity securities, investments in debt securities cannot be
irrevocably designated at FVTOCI, but need to meet certain conditions to be
classified at FVTOCI.
Combining these classifications with previously discussed broad classifications of

financial assets, the classification tree for financial assets is as follows:
345
The
Financial Assets
|
v v v
Investments in Investments in Derivatives (used
Equity Securities Debt Securities for speculation)
a ey ¥
FVTPL FVTOCI FVTPL FVTOCI FVTPL
(irrevocable (by meeting certain (by default)
designation conditions only)
only) v
Amortized Cost
BASIS FOR THE CLASSIFICATION OF FINANCIAL ASSETS

Generally, the financial assets are classified on the basis of both of the following:
a. the entity’s business model for managing the financial assets; and
b. the contractual cash flow characteristics of the financial asset
Specific requirements and criteria for classifying financial are discussed in Chapter
11 for investments in equity securities and in Chapter 12 for investments in debt
securities.
WHEN TO RECOGNIZE FINANCIAL ASSETS?

An entity shall recognize a financial asset or financial liability in its statement of
financial position when, and only when, the entity becomes party to the
contractual provisions of the instrument. [PFRS 9.3.1.1].
For example, if an entity acquires bonds in the securities market, it becomes party
to the terms and conditions of that instrument. The same goes when an entity lends
funds to other entity with the terms and conditions of the loan stated in the relevant
documents.
Planned future transactions, no matter how likely, are not assets and liabilities
because the entity has not yet become a party to,a contract, [PFRS 9,B3.1.21]. For
example, if an entity has plans of purchasing common shares of another entity, it
should not recognize those as its assets as long as there is no actual acquisition of
share even if the future transaction has already been approved by the entity’s Board
of Directors.
INITIAL MEASUREMENT OF FINANCIAL ASSETS
Initial measurement of financial assets depends on the related classification:
346
The
FVTPL Financial Assets _ All others (FVTOCI and Amortized Cost)

At fair value (i.e., transaction costs At fair value plus transaction costs (i.e.,
are expensed outright) transaction costs are capitalized)
PERS 13, Fair Value Measurement, defines fair value as the price that would be
received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.
The amount of fair value is usually equal to the amount of the transaction price paid
in obtaining the financial asset. In this regard, fair value is not necessarily equal to
the par value of equity securities or the face amount of debt securities.
Concepts on fair value measurement are to be discussed in the Volume 1 Part 2 of
this Intermediate Accounting series.
Transaction costs are incremental costs that are directly attributable to the
acquisition, issue, or disposal of a financial asset or financial liability. An
incremental cost is one that would not have been incurred if the entity had not
acquired, issued, or disposed of the financial instrument. /PFRS9.A].
Transaction costs include fees and commission paid to agents, advisers, brokers
and dealers, levies by regulatory agencies and security exchanges, and transfer
taxes and duties. Transaction costs do not include debt premiums or discounts,
financing costs or internal administrative or holding costs. [PFRS9.B5.4.8].
Illustration 2. An entity acquired a financial asset for P700,000 which is equal to
its fair value on that date. In addition, the entity also incurred P12,000 transaction
costs of the acquisition. Required: Under each of the following independent
scenarios, determine the journal entry to record the acquisition of the financial
asset:
1. The financial asset is accounted as FVTPL.
2. The financial asset is accounted as FVTOCI.
Scenario 1
Since the financial asset is measured at FVTPL, the transaction costs are expensed
outright:
Financial asset at FVTPL 700,000
Transaction costs (expense) 12,000
Cash 712,000
Scenario 2
Since the financial asset is measured at FVTOCI, the transaction costs are included
in the initial measurement (i,e., capitalized):

Cash 712,000
347
The
CamScanner
METHODS OF COMPUTING THE AMOUNT OF FAIR VALUE

Depending on the financial asset, the following are the applicable methods of
computing the fair value:
Approaches | Description
This approach is applicable to both investments in equity securities
and debt securities wherein the fair value is determined using the
quoted price of the financial asset.
Quoted price
For investments in equity securities, it is usually stated as the
approach
quoted price per share,
For investments in debt securities, it is usually stated as a

percentage of face amount.
This approach is primarily applicable to investments in debt
Present value | securities. Fair value is determined by obtaining the present value
approach of contractual cash flows (principal + interest) discounted
using the market yield rate as of the measurement date.
Details on computing these amounts are discussed in Chapter 11 for investments in

equity securities and on Chapter 12 for investments in debt securities. For the
present value approach, similar concepts on computing the present value of cash
flows of a noninterest-bearing promissory note are applicable in this case.
WHEN THE TRANSACTION PRICE IS NOT EQUAL TO FAIR VALUE
There are circumstances wherein transaction price is different from the amount of
fair value. For example, transaction price might be lower than the fair value if the
seller is forced to accept the transaction price due to financial difficulty (e.g., rush
sale).
Regardless of the difference between transaction price fair value, a financial asset
shall always be initially measured equal to its fair value, with the difference
accounted for as follows:
_ Scenario Accounting for the difference

Transaction price < Fair value Unrealized gain
Transaction price > Fair value Unrealized loss
As the readers may have remembered, this is the basis of the recognition and
accounting for the day 1 loss on Chapter 5A.
Illustration 3. An entity acquired a financial asset to be measured at FVTPL for
P1,000,000. Required: Under each of the following independent scenarios,
determine the journal entry to record the acquisition:
1. Financial asset’s fair value amounted to P1,100,000.
2. Financial asset’s fair value amounted to P985,000.
348
The
Scenario 1
The acquisition is recorded as follows:
Financial asset at FVTPL (fair value) 1,100,000
Cash 1,000,000
Unrealized gain - profitorloss(P/L) 100,000
Scenario 2
The acquisition is recorded as follows:
Financial asset at FVTPL (fair value) 985,000
Unrealized loss - P/L 15,000
Cash 1,000,000
Under both scenarios, the financial asset shall always be measured at its fair value.
BASKET PURCHASE OF FINANCIAL ASSETS
Similar to inventories in Chapter 7, several financial assets may also be acquired at
a single transaction price. The accounting for this transaction can be either of the
following:
Traditional Approach Contemporary Approach

The transaction price is allocated | The transaction price is not allocated but the
between or among the covered | financial assets are:measured at their fair
financial assets based on _ their | values.
relative fair values.
Any difference between the transaction price
There is no gain or loss to be | paid and the total fair value shall be
recognized on initial recognition. recognized as unrealized gain or loss in
profit or loss. This is similar to the
This approach is a relic from the past | recognition of day 1 gain or loss
generally accepted accounting pean Ven
principles. This approach is more correct since it is in
line with the requirement of PFRS 9 of
initially measuring financial assets at their
fair values.
Illustration 4. On January 1, 2023, KNOWLEDGE Company acquired from another

investor ordinary shares of AAA Company and ordinary shares of BBB Company at
a single price of P9,500,000, both to be accounted for at FVTPL. As of the same date,
the acquired shares of AAA Company had fair value of P4,000,000 while the
acquired shares of BBB Company had fair value of P6,000,000. Record the
transaction using the (a) traditional approach and (b) contemporary approach.
Traditional Approach
Under this approach, the P9,500,000 transaction price shall be allocated based on
the financial assets’ relative fair values:
349
The
The Book
[A] Alloc. Cost

Securities Fair Value Proportion (P9.5Mx[A])
AAA P4,000,000 4/10 P3,800,000
BBB 6,000,000 6/10 5,700,000
P10,000,000 10/10 P9,500,000
Relevant journal entry on January 1, 2023 is as follows:

Financial asset at FVTPL - AAA 3,800,000
Financial asset at FVTPL - BBB 5,700,000
Cash 9,500,000
No gain or loss is recognized under this approach.

Contemporary Approach
Under this approach, journal entry on January 1, 2023 is as follows:
Financial asset at FVTPL - AAA 4,000,000
Financial asset at FVTPL - BBB 6,000,000
Cash 9,500,000
Unrealized gain - P/L 500,000
The difference between the total fair value of acquired financial assets and the
amount of consideration paid is recognized in profit or loss.
350
The
CamScanner
CHAPTER SUMMARY
1. An entity chooses the type of investment by considering its core activities, risk-
appetite, and availability of excess funds.
2. A financial instrument is any contract that gives rise to a financial asset of one
entity and a corresponding financial liability or equity instrument of another entity.
3. A financial asset is any asset that is:
a. cash;
b. an equity instrument of another entity;
c. acontractual right:
i. to receive cash or another financial asset from another entity; or
conditions that are potentially favorable to the entity.
4. A financial liability is any liability that is a contractual obligation:
a. to deliver cash or another financial asset to another entity; or
b. to exchange financial assets or financial liabilities with another entity under
conditions that are potentially unfavorable to the entity; or
5. Examples of financial asset include but are not limited to cash and cash equivalents,
accounts receivable, notes receivable, loans receivable, investments in securities
and derivatives. ~
6. Examples of financial liabilities include but are not limited to accounts payable,
notes payable, loans payable and bonds payable
7. The following are the non-exhaustive examples of nonfinancial items: inventories,
prepaid expenses, fixed assets, unearned income, tax items, and constructive
obligations.
8. In general sense, financial assets can be classified into the following categories:
investments in equity securities, investments in debt securities, and derivatives.
9. According to PFRS 9, financial assets can be classified into FVTPL, FVTOCI or
Amortized Cost categories.
10. The following are the bases of classifying financial assets under PFRS 9:
a. the entity’s business model for managing the financial assets; and
11. Investment in equity securities can be classified as either FVTPL or FVTOCI, while
investment in debt securities can be classified as either FVTPL, FVTOCI or amortized
cost.
12. Financial assets are recognized when, and only when, the entity becomes party to
the contractual provisions of the instrument,
13. In general, financial assets are initially measured at their fair values plus transaction
costs. The exception would be for FVTPL financial assets, which shall be initially
measured at fair value (i.e., transaction costs are expensed outright).
14, Fair values can be determined using either the quoted price approach or the present
value approach.
15.In general, the difference between the acquired financial asset's fair value and the
consideration paid shall be recognized as unrealized gain or loss in profit or loss (i.e.,
day 1 gain or loss).
351
The
True or False
di The entity's variety of investments are accounted for differently from each other,
depending on the underlying asset.
Z Generally, shorter-term investments are riskier relative to longer-term
investments.
Financial instruments arise from contractual rights and/or obligations.
Investment in equity instruments of another entity is recognized as financial asset.
Ue
Inventories can be considered as financial assets due to its ability to generate cash
inflows upon their actual selling.
Accounts receivable arise from the contractual right to collect cash from customers.
ey
Land can be considered as a financial asset since its value is increasing over time,
and it can be sold to generate cash inflow.
Refundable advances to suppliers cannot be considered as financial asset at all
since the entity will primarily receive goods or services from suppliers.
Income tax payable cannot be considered as a financial liability since it arises from
statutory requirement.
10. Investments in equity securities can be classified as either at FVTPL or at FVTOCI
but not at Amortized Cost.
11. Investments in debt securities can be classified as either at FVTPL or at Amortized
Cost but not at FVTOCI.
12. Financial assets at FVTPL shall be initially measured at its. purchase price plus
relevant transaction costs.

rE; The following statements are descriptive of financial assets, except
a. Financial assets include cash
b. Financial assets include equity instruments issued by the entity
c. Financial assets arise from contractual rights to receive cash and other financial
assets
d. All ofthe above describes financial assets
Z: All of the following are considered as financial assets, except

a. Cash
b. Accounts receivable
c. Land
d. Notes receivable
3B: Nonfinancial assets include the following, except

a. Building
b. Inventory
c. Prepaid insurance
d. Investment in common shares of another entity
352
The
CamScanner
4. Inrelation to financial and nonfinancial assets, all of the following are true, except
a. Inventories are not classified as financial assets since these do not give an entity
a present right to receive cash or other financial assets.
b. In recognizing accounts receivable, it is important to take note that the
counterparty entity recognizes accounts payable.
c. Furniture and fixtures are not classified as nonfinancial assets since these do not
give the entity a present right to receive cash or other financial assets.
d. Cash is considered as a financial asset since it acts as the medium of exchange
for business transactions.
5. Tax liabilities are considered as nonfinancial liabilities since

a. These are enforced contributions to the government and do not arise from
contractual obligations.
b. Their amounts are subject to manipulation of the tax-paying entity.
c. Their amounts are subject to the jurisdiction of the taxation authority of the
country.
d. Allofthe above.
6. In a general sense, financial assets can be classified into the following major
categories, except
a. Investments in equity securities
b. Investments in debt securities
c. Derivatives
d. All of the above are the general classifications of financial assets
7. Under PFRS 9, the following are classifications of financial assets, except

a. At fair value through profit or loss
b. At fair value through other comprehensive income
c. At fair value through retained earnings
d. Atamortized cost
8. Investments in equity securities can be classified into the following categories,
except
c. Atamortized cost
d. Any of the above can be a classification of investments in equity securities
9. Investments in debt securities can be classified into the following categories, except
c. Atamortized cost
d. Any of the above can be a classification of investments in debt securities
10. In relation to initial measurement of financial assets, all of the following are correct,
except
353
The
_ a. In general, financial assets are initially measured at their fair values plus
transaction costs.
b. Financial assets at FVTPL shall be initially measured at their fair values with the
transaction costs expensed outright.
c. Incase the transaction price is different from the financial asset's fair value, the
initial measurement shall be equal to the transaction price plus transaction
costs, if relevant.
Straight Problems
1. CONTACT Company reported the following partial list of its asset accounts as of
December 31, 2023:
Deferred tax assets P700,000

Cash 300,000
Inventories 4,000,000
Building 6,000,000
Required: From the information given, determine the total amount of financial
assets.
2. LAGUNDI Company reported the following account balances as of December 31,

2023:
Land P5,000,000
Building 7,000,000
Investment in equity securities 1,000,000
Investment in the Company’s own shares 800,000
Investment in government bonds 2,000,000
Investment in commercial bonds 3,000,000
Cash and cash equivalents 900,000
Derivative assets 400,000
Deferred tax assets 1,200,000
Office equipment 2,300,000
Factory building 3,500,000
Common share capital 1,600,000
Preference share capital 2,700,000
Required: From the information given, determine the total amount of financial
assets.
354
The
The Book
3. As of December 31, 2023, ENIGMA Company reported the following account

balances:
Accounts payable P800,000
Advances from.customers (nonrefundable) 300,000
Advances to suppliers (nonrefundable) 200,000
Furniture and fixtures 500,000
Deferred tax liabilities 450,000
Prepaid insurance 150,000
Building 4,000,000
Land 3,000,000
Loan receivable 2,000,000
Investment in equity securities 1,800,000
Investment in debt securities 1,200,000.
Equipment 1,600,000
Deferred tax assets 900,000
Derivative liabilities 240,000
Notes payable 600,000
Bonds payable 2,500,000
Estimated warranty liability 350,000
Supplies 120,000
Investment properties 2,400,000
Intangible assets 2,100,000
Required: From the information given, determine the total amount of (a) financial
assets; (b) nonfinancial assets; (c) financial liabilities, and (d) nonfinancial liabilities.
4. On March 1, 2023, REVERSE Company acquired financial assets to be accounted for

at FVTPL for P5,000,000 plus P50,000 transaction costs. Related fair value is
P5,500,000. Additional financial assets were also acquired for P4,000,000 plus
P30,000 transaction costs on August 1, 2023, which are to be accounted for at
FVTOCI. Related fair values amounted to P3,800,000.
Required: Determine the journal entries to record the transactions.
5. During 2023, LEAF Company acquired two financial assets to be accounted for at
FVTPL ata single transaction price of P6,000,000. The financial assets are composed
of preference shares of ZZZ Company with fair value of P3,740,000 and ordinary
shares of YYY Company with fair value of P3,060,000, Transaction costs amounted
to P100,000.
Required: Determine the journal entries to record the transaction under (a)
traditional approach; and (b) contemporary approach.
355
The
The Book
Chapter 11 — Investments in Equity Securities — Basic Considerations
CHAPTER 11
INVESTMENTS IN EQUITY SECURITIES

The differences between equity securities and debt securities.
The different classifications of investments in equity securities under PFRS 9.
Gy. OT BObe
The accounting for investments in equity securities classified at FVTPL.

The accounting for investments in equity securities classified at FVTOCI.
The difference between profit or loss and other comprehensive income.
The use of cost of the investment as substitute to fair value.
INVESTMENTS IN EQUITY SECURITIES VS INVESTMENTS IN DEBT SECURITIES

To understand more about equity securities, it is much better to compare it with
debt securities. In addition, it is important to note that the discussions made here
are in the point-of-view of the investors, rather than the issuer.
i Equity Securities Debt Securities

Reporting of the issuer _| Part of the issuer's equity | Part of the issuer’s liability
Investor's relationship h The investor isa The investor is a creditor
with the issuer : ee zy OWE ot of the issuer
the issuer
lavelorack Higher level; perfect for Lower level; perfect for
risk-seeking investors risk-averse investors
Higher level due to higher | Lower level due to lower
Level of return level of risk level of risk
= rf Usually, interest income
Dividends and gains from : ”
Components of return flicuiations ie - fir-value and some minor gains from
changes in fair value _|
Variability of returns Highly variable Relatively stable
No maturity date; amount
: of initial investment may With specified maturity
Maninity date be returned only upon date
liquidation xt Lal
Investments in common Investment in bonds, loans
Examples and preference shares, receivables, redeemable
share rights and warrants preferenceshares _|
The readers should take note, that in classifying investments as equity securities or
as debt securities, the substance of the transaction shall be considered over the legal
form of the financial asset. This is the reason why redeemable preference shares are
classified as debt securities even though their legal form is those of “shares of
stock”.
356
The
Chapter 11 - Investments in Equity Securities - Basic Considerations
CLASSIFICATION OF INVESTMENTS IN EQUITY SECURITIES UNDER PFRS 9

As previously mentioned, investments in equity securities are classified as either
FVTPL or FVTOCI. Requirements and conditions in the classification are
summarized as follows:
Is the investment in equity

securities held for trading?
Did the entity make an

irrevocable election on
initial recognition to present
the changes in FV in other
comprehensive income (OCI)?
Account for the Account for the

investment at FVTPL investment at FVTOCI
This flowchart can be interpreted as follows:

1. If the investment is held for trading, it shall be automatically accounted for at
FVTPL (not allowed to be at FVTOCI). Held for trading is a financial asset that:
a. is acquired for the purpose of selling or repurchasing it in the near term;
b. on initial recognition is part of a portfolio of identified financial instruments
where there is evidence of recent actual pattern of short-term profit-making;
or
c. derivative (except those designated and effective hedging instrument)
2. Ifthe investment is not held for trading, the election to account the financial asset
at FVTOCI is irrevocable. In other words, it cannot be changed to FVTPL later on.
In addition, the irrevocable election shall be made on the date of acquisition of
the investment. Consequently, currently recognized investment in equity
securities at FVTPL cannot be reclassified to FVTOCI later on.
3. The default classification of investment in equity securities is at FVTPL,
4. Anentity can have some ofits investment in equity securities accounted forat FVTPL
and some accounted for at FVTOCI, depending on the circumstances,
357
The
The Book
FVTPL ACCOUNTING VS FVTOCI ACCOUNTING

Accounting procedures under each classification are distinguished as follows:
FVTPL — FVTOCI
Initial Faleunlvemadaitinlfeeauntiion Fair value on initial recognition
measurement 6 plus transaction costs
Accounting for
incurred Expensed outright Capitalized
transaction costs
Measurement Fair value on the reporting date. The fair value shall not be
every reporting reduced by the amount of estimated transaction costs that are
date expected to be incurred assuming the financial asset is to be sold.
Changes in fair value is reported | Changes in fair value is reported
in profit or loss in OCI
Accounting for
changes in fair Increase in fair value is Increase in fair value is
value reported as unrealized gain. reported as unrealized gain.
Decrease in fair value is Decrease in fair value is
reported as unrealized loss. reported as unrealized loss.
Separate account for cumulative
Amounts None - unrealized gains and net unrealized gains or losses
separately losses are closed to retained recognized up to date:
reported in earnings (“unrealized” since the | Net credit balance = cumulative
equity section of gains and losses are yet to be net unrealized gains
the balance sheet actually received) Net debit balance = cumulative
net unrealized losses
A aod Realized gain or loss is
eae sald er Reported.as realized ealivor recognized and reported in OCI.
loss on sale loss in profit or loss In addition, the portion of net
(“realized” since There is a realized gain if unrealized gain or = account
there is an actual proceeds > carrying amount. ree a ee ay
securities and the realized gain
receipt of the hare lized loss if
investment’s y af ma PRA or loss recognized in OCI shall be
value) Progen ds < Carry Ne amount, transferred directly to retained
earnings. om
. Cash and property dividends are reported in profit or loss
subnets (whether the financial asset is FVTPL or FVTOCI). Accounting for
other types of dividends is discussed in the succeeding chapter.J
Illustration 1 - Unrealized Gains. On January 1, 2023, AMELIA Company acquired
100,000 ordinary shares of another entity for P6 per share, which is equal to the
share’s fair value at that time (total fair value of P600,000 or 100,000 x P6), \n
connection with the transaction, transaction costs of P12,000 were incurred. Fair
value information for each reporting date is as follows:
358
The
Fair value Transaction costs

Date per share expected to be incurred
December 31, 2023 P7.00 P12,500
December 31, 2024 P8.50 P14,000
On May 15, 2025, all of the ordinary shares were sold for P9.25 per share.
Journal entries if the investment is Journal entries if the investment is
classified as FVTPL classified as FVTOCI
Fin. asset at FVTPL 600,000
Jan. 1, Fin. asset at FVTOCI 612,000
Transaction costs 12,000
2023 Cash 612,000
Cash 612,000
Fin. asset at FVTPL 100,000 Fin. asset at FVTOCI 88,000
Unrealized gain - P/L* 100,000 Unrealized gain - OCI* 88,000
*[(100,000x P7) - P600,000] *((100,000 x P7) - P612,000]
Dec. The carrying amount of the financial The carrying amount of the financial
31, asset as of this date is P700,000 asset as of this date is P700,000
2023 (100,000 x P7). (100,000 x P7).
Expected transaction costs of Cumulative unrealized gain - OCI in
P12,500 is ignored in measuring the equity has a credit balance of
fair value of the financial asset. P88,000 as of 12/31/23.
Fin. asset at FVTPL 150,000 Fin. asset at FVTOCI 150,000

Unrealized gain - P/L* 150,000 Unrealized gain - OCI* 150,000
*[(100,000
x P8.50) - P700,000] *[(100,000 x P8.50) - P700,000}
Dec. The carrying amount of the financial The carrying amount of the financial
31, asset as of this date is P850,000 asset as of this date is P850,000
2024 (100,000x P8.50). (100,000 x P8.50).
Cumulative unrealized gain - OCI in
Expected transaction’ costs of
equity has a credit balance of
P14,000 is ignored in measuring the
P238,000 (P88,000 + P150,000) as of
fair value of the financial asset.
12/31/24
Cash (100,000 x P9.25) 925,000
Fin. asset at FVTOCI 850,000
Gain on sale - OCI* 75,000
Cash (100,000 x P9.25) 925,000 *P925,000 - P850,000
May
Fin, asset at FVTPL 850,000
15, To record the direct transfer to
Gain on sale - P/L* 75,000
2025 retained earnings:
*P925,000 - P850,000
Unrealized gain - OCI 238,000
Gain on sale - OCI 75,000
Retained earnings 313,000
359
The
CamScanner
Illustration 2 - Unrealized Losses, On July 1, 2023, BRONZE Company acquired

50,000 shares for P10 per share and incurring P8,000 transaction costs. Fair value
of each share amounted to P9.10 per share and P8.35 per share as of December 31,
2023 and 2024, respectively.
On October 12, 2024, 30,000 of these shares were sold for P8.65 per share while
20,000 of these shares were sold for P8.95 per share on March 1, 2025.
Journal entries if the investmentis | Journal entries if the investment is

jul. 1, ne eee x ig aos Fin.assetat FVTOCI 508,000
2023 -| ‘fansaction
Cash cos 00
508,000
Cash 508,000
z
Unrealized loss - OCI* 53,000
Unrealized loss - P/L* 45,000 Fin.
in. asset at FVTOCI 53,000
Fin. asset at FVTPL 45,000 | *[(50,000 x P9.10) - P508,000]
Dec. *[(50,000 x P9.10) - P500,000] The carrying amount of the financial

31, . asset as of this date is P455,000
2023 | The carrying amount of the financial (50,000 x P9.10).
asset as of this date is P455,000
(50,000 x P9.10). Cumulative unrealized loss - OCI has
a debit balance of P53,000 as of
12/31/23.
Loss on sale - OCI 13,500
Cash (30,000 x P8.65) 259,500
Fin. asset at FVTOCI* 273,000
*30,000 x P9.10 carrying amount as of

12/31/23
be *
Loss eneiie 70 13500 Right after the sale, the financial asset
Cash (30,000x P8.65) 259,500 h : f 2.000
Fin. : assetatFVTPL** 273,000
d
| (P455,000
-#8_C@rtying- P273,000).
amount of P182,
*squeeze amount ‘ ‘
Oct. 12, | +39 090 x P9.10 carrying amount per To record the direct proportional
2024 | share as of 12/31/23 transfer to retained earnings:
Soe a nanco| Uelaedos oct 21,80

. ; Retained earnings 45,300
(P455,000 - P273,000). : Loss on sale - OCI 500

13,50
*1P53,000 x (30,000/50,000)]
Cumulative unrealized loss - OCI in
equity has now a debit balance of
P21,200 (P53,000 - P31,800) right
after the sale.
360
The
CamScanner
Chapter 11- Investments in Equity Securities - Basic Considerations
Journal entries if the investment is Journal entries if the investment is

Fin, asset at FVTOCI 15,000
Unrealized loss - P/L* 15,000
Fin. asset at FVTPL 15,000 *1(20,000 x P8.35) - P182,000]
Dec. | *[(20,000 x P835) - P182,000 carrying | The

*! carrying amount of the financial
31, | amount right after the 10/12/24 sale] asset as of this date is P167,000
2024 (20,000 x P8.35).
The carrying amount of the financial
asset as of this date is P167,000 | Cumulative unrealized loss - OCI in
(20,000x P8.35). equity has now a debit balance of
P36,200 (P21,200 + P15,000) as of
12/31/24.
Cash (20,000 x P8.95) 179,000
Fin. assetat FVTOCI* 167,000
Gain on sale - OCI** 12,000
Cash (20,000 x P8.95) 179,000 *20,000 x P8.35 per share carrying amount
Fin. asset at FVTPL* 167,000 | as of 12/31/24
Gain on sale - P/L** 12,000 | **squeeze amount
Mar. 1,
2025 | *20,000x P8.35 per share carrying amount | To record the direct full transfer to
as of 12/31/24 retained earnings:
**squeeze amount
*debit balance as of 12/31/24
CUMULATIVE BALANCE OF NET UNREALIZED GAIN OR LOSS - OCI

Accounting for investments in equity securities accounted for at FVTOCI requires
the monitoring of cumulative balance of net unrealized gain or loss - OCI account,
to be reported in equity section of entity's balance sheet. To get away with the
tedious process of this monitoring, the readers may apply the following “shortcut”
in determining the cumulative balance of net unrealized gain or loss - OCI:
Scenario: 832734 |}: Corresponding Unrealized Amount

FV as of reporting date > Remaining The difference is cumulative
original capitalized cost unrealized gain - OCI (credit balance)
FV as of reporting date < Remaining The difference is cumulative
original capitalized cost unrealized loss - OCI (debit balance)
Using a t-account, the net unrealized gain or loss account can be analyzed as follows:
361
The
CamScanner
Chapter 11 —- Investments in Equity Securities - Basic Considerations
Unrealized gain or
loss - OCI ,
Beginning net unrealized loss XX XX Beginning net unrealized gain
balance (if net cum. losses) balance (if net cum. gains)
Net unrealized loss - OCI for XX XX Net unrealized gain - OCI for
the current year the current year
Unrealized gain transferred XX XX Unrealized loss transferred
directly to retained earnings directly to retained earnings
Ending net unrealized losses XX XX Ending net unrealized gain
balance (if net cum. losses) balance (if net cum. gains)
(squeeze) (squeeze)
From the above t-account, the following can be deduced:

Scenarios: 3.8 Corresponding T-Account Balance -
Cumulative unrealized gains > Net credit balance (cumulative net
cumulated unrealized losses unrealized gains)
Cumulative unrealized gains < Net debit balance (cumulative net
cumulated unrealized losses unrealized losses)
Illustration 3. Using the same information in AMELIA Company (from Illustration

1), the cumulative balance in net unrealized gain or loss - OCI amounts for each
reporting date can also be determined as:
[A] FVasof [B] Remaining Cum. Unrealized
Reporting Reporting Original OCI Amount
Date Date capitalized cost [A] - [B]*
12/31/23 P700,000 P612,000 P88,000 gain
12/31/24 850,000 612,000 238,000 gain
*these have credit balances
Illustration 4. Using the same information in BRONZE Company (from Illustration

2), the cumulative balance in net unrealized gain or loss - OCI amounts for each
reporting date can also be determined as:
[A] FVasof [B] Remaining Cum. Unrealized
Date Date capitalized cost [A] - [B]
12/31/23 P455,000 P508,000 P53,000 loss
12/31/24 167,000 *203,200 36,200 loss
*P203,200 = P508,000 x (20,000/50,000)
For both illustrations (AMELIA Company and BRONZE Company), the computed
cumulative net unrealized gain or loss - OCI using the shortcut are the same as those
previously computed using the original approach.
362
The
The Book
Illustration 5. On October 1, 2023, LANSANGAN Company acquired equity

securities for P3,000,000, to be accounted for at FVTOCI. As of December 31, 2023,
2024, and 2025, the securities had fair values of P3,250,000, P2,900,000, and
P3,140,000, respectively.
On December 31, 2023, the increase in fair value shall be recorded as follows:
Financial asset at FVTOCI 250,000

Unrealized gain - OCI
[(P3,250,000) = P3,000,000] 250,000
On December 31, 2024, the decrease in fair value shall be recorded as follows:
Unrealized loss - OCI
[(P2,900,000) - P3,250,000] 350,000
To offset the P250,000 balance in unrealized gain - OCI account against the
P350,000 balance in unrealized loss - OCI account on December 31, 2024:
Unrealized loss - OCI 250,000
After this entry, as of December 31, 2024, the net unrealized loss - OCI account will
have a net debit balance of P100,000 in shareholders’ equity.
On December 31, 2025, the increase in fair value shall be recorded as follows:
[(P3,140,000) - P2,900,000] 240,000
To offset the P100,000 balance in the net unrealized loss - OCI account against the
P240,000 balance in unrealized gain - OCI account on December 31, 2025:
Unrealized gain - OCI . 100,000
After this entry, as of December 31, 2025, the net unrealized gain - OCI account will
have a net credit balance of P140,000 in shareholders’ equity.
The cumulative balance in net unrealized gain or loss - OCI amounts for each
reporting date can also be determined as follows:
[A] FVasof [B] Remaining Cum, Unrealized
Date Date capitalized cost [A] - [B]
12/31/23 3,250,000 P3,000,000 P250,000 gain
12/31/24 2,900,000 3,000,000 100,000 loss
12/31/25 3,140,000 3,000,000 140,000 gain
363
The
Chapter 11— Investments in Equity Securities - Basic Considerations
The evolution of the cumulative net unrealized gain or loss amount at the end of
each year is summarized as follows:
Net cumulative unrealized gain - OCI, 1/1/23 P-
Add: Unrealized gain - OCI, 2023 P250,000
Net cumulative unrealized gain - OCI, 12/31/23 P250,000
Less: Unrealized loss - OCI, 2024 (350,000)
Net cumulative unrealized loss - OCI, 12/31/24 (P100,000)
Add: Unrealized gain - OCI, 2025 240,000
Net cumulative unrealized gain - OCI, 12/31/25 P140,000
PROFIT OR LOSS VS OTHER COMPREHENSIVE INCOME
As previously discussed, the changes in the fair value of the investment in equity
security is reported in profit or loss or in OCI depending on the investment’s
classification. The primary difference between these two is summarized as follows:
‘ProfitorLoss =———* «|| ~~ OtherComprehensive Income —_-

Also called “net income”, computed as | Represents other gain or loss that are
total income less expenses, excluding | explicitly excluded by relevant
components of OCI. It is the primary | accounting standards in measurement
financial performance metric | of profit or loss. More OCI items are to be
assessed by the users of financial | discussed as the readers progress in
statements. This amount is reported in | Intermediate Accounting. These amounts,
“income statement” together with profit or loss, are reported in
“statement of comprehensive income”.
Despite of these differences, these two amounts are the components of “total
comprehensive income”:
Total Other
Comprehensive = Profit or Loss cn Comprehensive
Income Income
Illustration 6 - FVTPL and FVTOCI. On May 1, 2023, CORNELIA Company

acquired 30,000 shares of ABC Corporation for P21 per share to be held for trading.
Transaction costs of P6,000 were incurred. On October 26, 2023, 40,000 shares of
XYZ Corporation were acquired for P35 per share, Transaction costs of P10,000
were incurred. The Company irrevocably designated the investment at FVTOCI.
Fair value data as of December 31, 2023 and 2024 are the following:
Date ABCCorp.Shares XYZ Corp. Shares
December 31, 2023 P28 P37
December 31, 2024 P25 P40
On May 1, 2023, journal entry to record the purchase of ABC Corporation’s shares:
364
The
The Book
Chapter 11 - Investments in Equity Securities — Basic Considerations
Financial asset at FVTPL (30K x P21) 630,000

Transaction costs 6,000
Cash 636,000
On October 26, 2023, journal entry to record the purchase of XYZ Corporation’s
shares:
Financial asset at FVTOCI 1,410,000
Cash [(40Kx P35)+ P10,000] 1,410,000
On December 31, 2023, journal entries to record the changes in the investments’
fair values:
Financial assetat FVTPL ies 210,000
Unrealized gain - P/L
[(30,000
x P28) - P630,000] 210,000
[(40,000 x P37) - P1,410,000] 70,000
As of December 31, 2023, financial asset at FVTPL shall have carrying amount of
P840,000 (30,000 x P28), while financial asset at FVTOCI shall have carrying
amount of P1,480,000 (40,000x P37).
As of December 31, 2024, journal entries to record the changes in the investments’
fair values:
Unrealized loss - P/L
[(30,000x P25) - P840,000] 90,000

[(40,000
x P40) - P1,480,000] 120,000
As of December 31, 2024, financial asset at FVTPL shall have carrying amount of
P750,000 (30,000 x P25), while financial asset at FVTOCI shall have carrying
amount of P1,600,000 (40,000 x P40).
The amounts that can be found in the Company's balance sheet are the following:
Assets Equity
Reporting Financialasset Financial asset Cumulative
Date at FVTPL at FVTOCI unrealized gain - OCI*
12/31/23 P840,000_ . P1,480,000 P70,000
12/31/24 750,000 1,600,000 **190,000
*the supposed cumulative amounts for financial assets at FVTPL are not separately
presented in equity but already included within the balance of retained earnings.
**P70,000 unrealized gain in 2023 plus P120,000 unrealized gain in 2024.
365
The
The Book
The amounts that can be found in the Company’s statement of comprehensive

income are the following:
2022 2023
Profit (loss) (reported in income statement)* ***P204,000 (P90,000)
Other comprehensive income** 70,000 120,000
Total comprehensive income P274,000 P30,000
*from FVTPL securities **from FVTOCI securities ***P210,000 - P6,000
Illustration 7. MELFORD Company reported the following information related to

its investments in equity securities, all acquired in 2023:
Fair Value, FairValue, Fair Value,
Original December December December
Securities Cost 31, 2023 31, 2024 31,2025
FVTPL Category
A P1,200,000 P1,500,000 1,100,000 P1,250,000
B 1,600,000 1,800,000 1,420,000 1,350,000
P2,800,000 P3,300,000 P2,520,000 P2,600,000
FVTOCI Category
C P2,400,000 P2,700,000 P2,500,000 P2,200,000
D 5,000,000 5,400,000 5,100,000 5,050,000
P7,400,000 8,100,000 P7,600,000 P7,250,000

a. Amounts to be reported for the investments in equity securities in the asset
section of the Company’s balance sheet as of December 31, 2023, 2024, and
2025.
b. Amounts to be reported in the income statement, other comprehensive income
and statement of comprehensive income for the years 2023, 2024, and 2025.
c. Amounts to be reported in the shareholders’ equity section of the Company’s
balance sheet as of December 31, 2023, 2024, and 2025.
Solution:
a. The amounts that can be found in the assets section of the Company’s balance
sheet are the following:
Reporting Financialasset Financial asset
Date at FVTPL at FVTOCI
12/31/23 P3,300,000 P8,100,000
12/31/24 2,520,000 7,600,000
12/31/25 2,600,000 7,250,000
“these amounts are all equal to the financial assets’
fair values as each reporting date.
b. The amounts that are reported in the Company's income statement for each
year (items of profit or loss from FVTPL securities) are the following:
366
The
Unrealized Gain
Year (Loss) - P/L
2023 P500,000 (P3.3M - P2.8M)
2024 (780,000) (P2.52M - P3.3M)
2025 80,000 (P2.6M - P2.52M)
The amounts that are reported in the Company's other comprehensive income
(OCI) for each year (items of OCI from FVTOCI securities) are the following:
Unrealized Gain
Year (Loss) - OCI
2023 P700,000 (P8.1M - P7.4M)
2024 (500,000) (P7.6M - P8.1M)
2025 (350,000) (P7.25M - P7.6M)
Combining the amounts reported in income statement and in other
comprehensive income will result to the following amounts of total
comprehensive income as can be found in the statement of comprehensive
income:
0.C.Income Total Compre.
Profit (Loss) (Loss) Income (Loss)
Year Amounts[A] Amounts [B] [A + B}
2023 P500,000 P700,000 P1,200,000
2024 (780,000) (500,000) (1,280,000)
2025 80,000 (350,000) (270,000)
c. The cumulative amounts to be reported in the shareholders’ equity section of
the Company’s balance sheet (as composed of cumulative unrealized gains and
losses from FVTOCI securities) are as follows:
Cumulative Unrealized
Reporting Date Gain (Loss) - Equity
12/31/23 P700,000 (P700K)
12/31/24 200,000 (P700K - P500K)
12/31/25 (150,000) (P200K- P350K)
These cumulative amounts can also be determined by comparing the FVTOCI
securities’ fair value as of corresponding year-end with its original cost of
P7,400,000:
Cumulative Unrealized Fair Value vs Original Cost
Reporting Date Gain (Loss) - Equity
12/31/23 P700,000 (P8.1M - P7.4M)
12/31/24 200,000 (P7.6M - P7.4M)
12/31/25 (150,000) (P7.25M- P7.4M)
367
The
The Book
To summarize, it is important for the readers to pinpoint what is being asked by the
accounting problems to be able to correctly supply the relevant amounts:
* Amounts Asked Corresponding Amounts
e Realized and unrealized gain or loss from
Total amount to be reported in profit FVTPL securities for the current year.
or loss or in the income statement e Expensed transaction costs.
e Dividends from FVTPL and FVTOCI.
Total amount to be reported in other Realized and unrealized gain or loss from
comprehensive income FVTOCI securities for the current year.
e Realized and unrealized gain or loss from
Total amount to be reported in both the FVTPL and FVTOCI securities for
statement of comprehensive the current year.
aU ME 3) Se a Ge a neoel e Expensed transaction costs
comprehensive income :
P e Dividends from FVTPL and FVTOCI.
Total “amount to’ “be: reported Net cumulative unrealized gain or loss from
: , | FVTOCI securities or the difference between
separately in the shareholders ; ca
equity the fair value and original cost of FVTOCI
securities.
COST AS SUBSTITUTE FOR FAIR VALUE OF INVESTMENTS IN EQUITY SECURITIES

In general, all investments in equity securities shall be measured at their fair
values. However, in limited circumstances when the fair value cannot be
determined outright, cost can be used if it is representative of the best estimate of the
fair value.
In cases where the cost is not representative of the fair value of the equity securities,
the relevant fair value shall be estimated using valuation techniques. Indicators that
the cost is not representative of fair value included, but limited to, the following:
a. a significant change in the performance of the investee compared with budgets,
plans or milestones.
b. changes in expectation that the investee’s technical product milestones will be
achieved.
c. a significant change in the market for the investee’s equity or its products or
potential products.
d. a significant change in the global economy or the economic environment in
which the investee operates.
e. a significant change in the performance of comparable entities, or in the
valuations implied by the overall market.
f. internal matters of the investee such as fraud, commercial disputes, litigation,
changes in management or strategy.
g. evidence from external transactions in the investee’s equity, either by the
investee (such as a fresh issue of equity), or by transfers of equity instruments
between third parties.
368
The
Needless to say, cost is never the best estimate of fair value for investments in quoted
equity instruments (e.g., shares listed in the stock exchange).
TRANSACTION COSTS ARISING FROM SELLING EQUITY SECURITIES
Transaction costs actually incurred in the process of selling equity securities,
whether classified as FVTPL or FVTOCI shall be reported in profit or loss. This
accounting treatment is also applicable to transaction costs incurred in selling debt
securities regardless of their classification (FVTPL, FVTOCI, or Amortized Cost).
Illustration 8. On January 1, 2023, MARIVIC Company acquired investment in
equity securities for P700,000 plus P5,000 transaction costs. On March 31, 2023,
the investment was immediately sold for P780,000 with the Company incurring
P6,500 transaction costs. In this case, the following are the relevant journal entries
for this investment assuming it is classified as at FVTPL and at FVTOCI, respectively:
Journal entries if the investmentis | Journal entries if the investment is
Fe
2023
geTransaction
eae costs
TE (P/L)
owe5,000
orae'.: | Fin Cash
OsseCQeRVTOCI ©. 705000
705.000
Cash 705,000 ‘
Cash 780,000
Fin. asset at FVTOCI 705,000
Cash 780,000 Gain on sale - OCI (squeeze) 75,000
Fin. asset at FVTPL 700,000 | The transaction costs incurred in

Gain on sale - P/L (squeeze) 80,000 | relation to the sale shall be
oo The transaction costs incurred in recognized as:
2 023 relation to the sale shall be Transaction costs (P/L) 6,500
recognized as: Cash 6,500
Transaction costs (P/L) 6,500 To record the direct transfer to
Cash 6,500 | retained earnings:

To summarize, the following are the accounting treatments for transaction costs:
FVTPL FVTOCI
Actual transaction costs Expensed outright in Capitalized as part of cost
related to purchasing profit or loss of the investment
Actual transaction costs Expensed outright in Expensed outright in
related to selling profit or loss profit or loss
Estimated transaction Not considered in measuring the investment as of
costs to be incurred reporting date (i.e., not deducted from fair value)
369
The
CamScanner
Chapter 11- Investments in Equity Securities - Basic Considerations
For FVTPL securities, the transaction costs related to selling may be netted against
realized gain on sale or added to realized loss on sale since these are also recognized
in profit or loss.
CHAPTER SUMMARY
1, Investments in equity securities are reported as part of the shareholders’ equity of
the issuer.
Z; In generally, investments in equity securities are riskier relative to investments in
debt securities. Consequently, investments in equity securities have higher returns
relative to investments in debt securities.
Investments in equity securities can be classified as either at FVTPL (i.e., default
classification) or at FVTOCI.
Held-for-trading investments in equity securities are automatically accounted for at
FVTPL and cannot be accounted for at FVTOCI.
To be classified as at FVTOCI, investment in equity securities shall be irrevocably
designated as such on initial recognition.
Transaction costs are expensed outright and capitalized if these are related to
investments at FVTPL and at FVTOCI respectively.
At each reporting date, investments in equity securities, regardless of classification,
shall be measured at their fair values (withing deducting future transaction costs).
Changes in fair value from investments at FVTPL are recognized in profit or loss
while changes from investments at FVTOCI are recognized in OCI.
Cumulative unrealized gain or loss - OCI arising from investments at FVTOCI are
accumulated in equity section of the balance sheet. This cumulative amount can also
be determined by comparing the fair value of the investment and its original cost:
Scenario — Corresponding Unrealized Amount

FV as of reporting date > The difference is cumulative
Remaining original capitalized cost unrealized gain - OCI
FV as of reporting date < The difference is cumulative
Remaining original capitalized cost unrealized loss - OCI
10.If an investment at FVTPL is sold, the difference between the proceeds and the
related carrying amount shall be recognized as realized gain or loss on sale in profit
or loss.
11.If an investment at FVTOCI is sold, the difference between the proceeds and the
related carrying amount shall be recognized as realized gain or loss on sale in OCI.
This gain or loss - OCI plus cumulative unrealized gain or loss - OCI related to the
sold investment shall be directly transferred to retained earnings.
12. All transaction costs related to the selling of investment in equity securities shall be
recognized in profit or loss, whether the investment is classified as FVTPL or
FVTOCI.
370
The
CamScanner
True or False
ds Generally, investments classified as equity securities do not have specific maturity
dates.
a Return on investment from equity securities has a higher variability compared to
investments from debt securities.
Investment in redeemable preference shares is considered as investment in equity
securities since it covers shares issued by another entity.
An investment in equity securities that is held for trading is classifiable at FVTOCI,
provided it is irrevocably designated as such on initial recognition.
By default, in the absence of irrevocable designation, investments in equity
securities are classified at FVTPL.
An existing investment in equity securities at FVTPL, which was acquired a few
years ago, may be irrevocably designated at FVTOCI later on,
Irrevocable designation means that an investment in equity securities designated
at FVTOCI cannot be re-designated later on at FVTPL.
Transaction costs related to investment in equity securities at FVTOCI may be
capitalized or expensed outright, depending on an entity’s policy.
Regardless of the accounting for investment in equity securities at FVTOCI or at
FVTPL, its measurement shall be equal to its fair value as of each reporting date.
10. Transaction costs related to the purchase of investment in equity securities at
FVTPL shall be expensed outright.
11. Changes in the investment’s fair value shall be recognized in profit or loss whether
the investment in equity securities is accounted for at FVTPL or FVTOCI.
#2. The total amount to be reported in the income statement shall exclude the changes
in the fair value of investment in equity securities accounted for at FVTOCI.
13. Net cumulative changes in the fair value of investment in equity securities
accounted for at FVTPL are accumulated in a separate shareholders’ equity account.
14. Increases in the fair value of FVTPL equity securities are recognized as unrealized
gain in profit or loss while decreases are recognized as unrealized loss in profit or
loss.
15. Transaction costs related to the actual selling of FVTPL equity securities shall be
recognized in profit or loss while those related to the actual selling of FVTOCI
securities shall be recognized in OCI.

%. In relation to the differences between equity securities and debt securities, all of the
following are generally correct, except
a. Returns from equity securities include dividends and fluctuations from fair
value while returns from debt securities primarily include interest income.
b. Equity securities do not have specific maturity date.
c. Equity securities are more applicable to risk-averse investors.
d. In equity securities, the investor is a shareholder of the issuer while in debt
securities, the investor is a creditor of the issuer.
371
The
CamScanner
Chapter 11 — Investments in Equity Securities - Basic Considerations
zs: The default classification of investments in equity securities is

a. AtFVTPL
b. AtFVTOCI
c. Either at FVTPL or FVTOCI whichever will give the entity a higher total
comprehensive income.
d. There is no default classification.
Which of the following statements is incorrect regarding the classification of
investments in equity securities?
a. Held-for-trading equity securities shall be classified at FVTPL.
b. Equity securities not held-for-trading may be classified as either FVTPL or
FVTOCI.
c. Equity securities that are related to the short-term profit-taking activities of an
entity shall be accounted for at FVTPL.
d. Equity securities that are held for strategic or statutory purposes are required
to be accounted for at FVTPL.
An entity had the following investments in equity securities:
e Investment 1 - A held-for-trading equity investment that was acquired today.
e Investment 2 - An equity investment not held-for-trading but was acquired two
years ago.
Which of these investments can be irrevocably designated at FVTOCI?

a. Investment 1 only c. Both Investment 1 and 2
b. Investment 2 only d. Neither Investment 1 nor 2
An entity had the following investments in equity securities:
*® Investment 1 - A held-for-trading equity investment that was acquired three
months ago.
e Investment 2 - An equity investment not held-for-trading but acquired today.
Which of these investments can be irrevocably designated at FVTOCI?
a. Investment 1 only c. Both Investment 1 and 2
b. Investment 2 only d. Neither Investment 1 nor 2
Which of the following is true in relation to the initial measurement of investments
in equity securities?
a. FVTPL equity securities are initially measured at the purchase price, regardless
of the amount of fair value plus transaction costs, if any.
b. FVTPL equity securities are initially measured at their fair values plus
transaction costs, if any.
c. FVTOCI equity securities are initially measured at the purchase price, regardless
of the amount of fair value plus transaction costs, if any.
d. FVTOCI equity securities are initially measured at their fair values plus
transaction costs, if any,
372
The
7. Inrelation to the subsequent measurement of investments in equity securities as of

each reporting date, which of the following is correct?
a. FVTPL equity securities are measured at their fair values while FVTOCI equity
securities are measured at their fair values less estimated transaction costs to
be incurred in selling these securities.
FVTOCI equity securities are measured at their fair values while FVTPL equity
securities are measured at their fair values less estimated transaction costs to
be incurred in selling these securities.
Both the equity securities at FVTPL and FVTOCI shall be measured at their fair
values without deducting the estimated transaction costs to be incurred in
selling these securities. —
Both the equity securities at FVTPL and FVTOCI shall be measured at their fair
values less the estimated transaction costs to be incurred in selling these
securities. |
8. All of the following are correct in connection with the accounting for the changes in
the fair value of investments in equity securities, except
a. Increase in fair value shall be recognized as unrealized gain.
b. Decrease in fair value shall be recognized as unrealized loss.
Cc, Realized gain or loss on sale of FVTPL equity securities shall be recognized in
profit or loss.
d. Realized gain or loss on sale of FVTOCI equity securities shall be recognized in
profit or loss.
9. Inrelation to the amounts that shall appear in an entity’s financial statements, which
of the following is not correct?
a. Amounts to be reported in profit or loss include the unrealized and realized gain
or loss for the current year arising from FVTPL securities only.
b. Amounts to be reported in statement of comprehensive income include the
unrealized and realized gains or losses for the current and previous years
arising from both FVTPL and FVTOCI securities.
Amounts to be reported in the shareholders’ equity section ofan entity's balance
sheet include the net unrealized gains or losses for the current and previous
years arising from FVTOCI securities only. :
Amounts to be reported in the other comprehensive income include the
unrealized and realized gains or losses for the current year arising from FVTOCI
securities only.
10. All of the following are true in relation to accounting for transaction costs, except
a. Transaction costs related to the acquisition of FVTOCI equity securities shall be
capitalized.
b. Transaction costs that are expected to be incurred in selling equity securities
shall not be deducted from the fair value for purposes of measuring the
securities as of each reporting date.
Transaction costs related to the selling of FVTOCI equity securities shall be
capitalized, similar to transaction costs incurred in acquiring these securities.
373
The
CamScanner
d. Transaction costs related to the selling of FVTPL equity securities shall be

recognized in profit or loss.
Straight Problems
1. At the beginning of 2023, IVAN Company acquired 200,000 ordinary shares of
another entity at PS/share (equal to its fair value). Transaction costs amounted to
P9,000. At the end of 2023 and 2024, the shares have the following fair values and
corresponding estimated transaction costs that will be incurred assuming the shares
are to be sold on each reporting dates:
Date Fair Value perShare — Transaction Costs

December 31, 2023 P5.75 P10,000
December 31, 2024 6.35 11,500
The investment was actually sold on January 10, 2025 for P6.55/share with the
Company incurring P12,000 transaction costs.
Required: Determine the journal entries from 2023 to 2025 under each of the
1. The investment is accounted for at FVTPL
2. The investment is accounted for at FVTOCI
2. On July 1, 2023, WHITE Company acquired 50,000 preference shares of NAUGHTY

Company for a total price of P2,500,000 and incurred P20,000 transaction costs for
the transaction. Relevant fair values for the years 2023 and 2024 are the following:
Date Total Fair Value
December 31, 2023 P2,420,000
December 31, 2024 2,360,000
The investment was actually sold on February 14, 2025 for P2,330,000 less
transaction costs of P15,000.
3. At the beginning of 2023, ZOFIA Company reported investment in equity securities
with carrying amount of P4,700,000 and original cost of P4,500,000. Relevant fair
values for the years 2023 and 2024 are the following:
December 31, 2023 P4,850,000
December 31, 2024 4,460,000
On April 10, 2025, the Company decided to cut the loss it Is experiencing and sold
the investment for P4,375,000.
374
The
The Book
. On May 1, 2023, ELENA Company acquired equity securities for a total price of
P1,950,000 (equal to its fair value) plus P50,000 transaction costs. The Company
irrevocably designated changes in the fair value of this investment to be recognized
in OCI. Relevant fair values for the years 2023 to 2025 are the following:
December 31, 2023 P2,100,000
December 31, 2024 1,940,000
December 31, 2025 2,250,000
On February 5, 2026, the Company sold half of the securities for P1,180,000. The
remaining shares had fair value of P1,080,000 as of December 31, 2026.
Required: From the information given, determine the following:

a. Journal entries from 2023 to 2026.
b. The cumulative balance of net unrealized gains or loss - OCI account to be
reported in the shareholders’ equity at the end of each year.
. POLICE Company reported the following information in relation to its investments
in equity securities that were acquired in 2021:
Fair Value, FairValue, FairValue, Fair Value,

December December December December
Securities 31,2022 31, 2023 31, 2024 31,2025
FVTPL Category
AAA P2,600,000 2,650,000 P2,720,000 P2,790,000
BBB 1,300,000 1,150,000 1,400,000 1,560,000
P3,900,000 P3,800,000 P4,120,000 P4,350,000
FVTOCI Category
CCC P1,900,000 1,700,000 P1,480,000 P1,850,000
In addition, as of December 31, 2022, the Company reported net cumulative

unrealized gain - OCI of P350,000 in its shareholders’ equity.
a. Amounts to be reported for the investments in equity securities in the asset
section of the Company’s balance sheet as of December 31, 2023, 2024, and
2025.
b. Amounts to be reported in the income statement, other comprehensive
income, and statement of comprehensive income for the years 2023, 2024,
and 2025.
375
The
CamScanner
c. Amounts to be reported in the shareholders’ equity section of the Company’s

6. RAINBOW Company had the following investments in equity securities

transactions from the years 2023 to 2025:
Date Transactions
01/01/23 | Acquired 400,000 ordinary shares of DDD Company for P8/share
and incurred transaction costs of P30,000. The shares are to be
accounted for at FVTPL.
06/15/23 | Acquired 200,000 preference shares of EEE Company at P12/share,
which are to be accounted for at FVTOCI. Transaction costs incurred
03/12/24 | Acquired 100,000 ordinary shares of FFF Company at P7/share, to
be accounted for at FVTOCI.
09/10/24 | Acquired 300,000 preferences shares of GGG Company at P9/share,
to be accounted for at FVTPL.
04/05/25 | Sold 150,000 ordinary shares of DDD Company for P9.75/share.
Transaction costs incurred amounted to P12,000.
05/08/25 | Sold 120,000 preference shares of GGG Company for P8.40/share.
07/08/25 | Sold 75,000 ordinary shares of FFF Company for P8/share.
The Company also compiled the following fair value information as of the end of
each year, from 2023 to 2025:
Equity Securities FV,12/31/23 FV,12/31/24 FV,12/31/25

DDD Company P8.75/share P9.50/share P10.20/share
EEE Company 11.50/share 10.90/share 9,80/share
FFF Company 6.50/share 7.75/share 8.45/share
GGG Company 9,25/share 8.65/share 8.15/share

a. Journal entries from 2023 to 2025,
b. Amounts to be reported for the investments in equity securities in the asset
section of the Company's balance sheet as of December 31, 2023, 2024, and
2025.
c. Amounts to be reported in the income statement, other comprehensive
income, and statement of comprehensive income for the years 2023, 2024,
and 2025,
d. Amounts to be reported in the shareholders’ equity section of the Company's
376
The
The Book

1. On March 1, 2023, DONALD Company acquired a number of ordinary shares of
RACHELLE Company at a total purchase price of P2,000,000 plus transaction costs
of P50,000. On October 1, 2023, the Company sold half of these shares for
P1,100,000 and incurred P10,000 transaction costs. As of December 31, 2023, the
remaining shares had a total fair value of P1,260,000 and estimated transaction
costs of P11,000 are to be incurred in selling the shares.
From this information, the net gain or loss amount to be reported in profit or loss,
assuming the equity securities are accounted for at FVTPL, shall be
a. P300,000 net loss c. P289,000 net loss
b. P300,000 net gain d. P289,000 net gain
From this information, the net gain or loss amount to be reported in OCI, assuming
the equity securities are accounted for at FVTOCI, shall be
2. On January 1, 2023, ALBINO Company reported carrying amount of P6,500,000 for

its investments in equity securities accounted for at FVTOCI. In addition, net
cumulative unrealized gains - OCI amounted to P200,000. During 2023, equity
securities with original cost and carrying amount of P2,450,000 and P2,300,000,
respectively, were sold for P2,380,000. The remaining equity securities had total fair
value of P4,060,000 as of December 31, 2023.
The net amount to be reported in the Company’s 2023 OCI shall be

a. P60,000 net gain c. P140,000 net gain
b. P60,000 net loss d. P140,000 net loss
The direct net effect of the sale transaction in the Company’s retained earnings shall
be
a. P80,000 net increase c. P70,000 net decrease
b. P80,000 net decrease d. P70,000 net increase
The net cumulative unrealized gain or loss - OCI to be reported as of December 31,
2023 in the Company’s equity shall be
a. P210,000 net gain c, P60,000 net gain
b. P210,000 net loss d, P60,000 net loss
3. At the beginning of 2023, ZOLO Company reported the following carrying amounts
of its investments in equity securities:
Carrying Amounts
FVTPL equity securities P5,000,000
FVTOCI equity securities 6,000,000
377
The
The Book
Chapter 11 - Investments in Equity Securities - Basic Considerations |
In addition, as of that date, the Company also reported net unrealized loss ~ OCI of
P500,000. Fast forward to December 31, 2023, these investments in equity
securities had the following fair values:
Fair Values
FVTPL equity securities P4,600,000
FVTOCI equity securities 6,230,000
Based on this limited information, the amounts to be recognized in income

statement and OCI, respectively, shall be
a. P400,000 net loss; P230,000 net gain c. P400,000 net gain; P230,000 net loss
b. P230,000 net loss; P400,000 net gain d.P230,000 net gain; P400,000 net loss
The net amount that shall be reported in the Company’s equity shall be
4. On January 1, 2023, BEETLE Company acquired the following equity securities, both
to be accounted for at FVTOCI:
e 200,000 preference shares of AAA Company at a total purchase price of
P2,800,000 plus P30,000 transaction costs.
e 300,000 preference shares of BBB Company at a total purchase price of
P3,300,000 plus P40,000 transaction costs.
For the years 2023 and 2024, there were no changes in these investments. However,
during 2025, the following equity securities were sold:
e 100,000 preference shares of AAA Company at total proceeds of P1,800,000 with
the Company incurring P20,000 transaction costs.
e 180,000 preference shares of BBB Company at total proceeds of P2,160,000 with
the Company incurring P18,000 transaction costs.
Fair value data for these equity securities are the following:
Securities FV,12/31/23 -FV,12/31/24 = FV,12/31/25

AAA Company P15,00/share P16.50/share = P19.20/share
BBB Company 10.50/share 12.80/share 11.20/share
The net amount to be recognized in OCI for the year 2023 shall be
b. P20,000 net loss d, P50,000 net loss
378
The
The Book
The cumulative net unrealized gain or loss - OCI to be reported in the Company’s
equity as of December 31, 2025 shall be
5. At the beginning of 2023, GOLD Company reported the following FVTOCI equity
securities:
Securities No.ofShares OriginalCost Fair Value
AAA 100,000 P5.00/share P6.00/share
BBB 300,000 9.00/share 8.00/share
ccc 200,000 20.00/share 21.50/share
On March 31, 2023, 250,000 shares of DDD Company were acquired for
P30/share. During 2024, all of AAA Company’s shares were sold for P7.50/share
less P5,000 transaction costs while 150,000 shares of BBB Company were sold
for P7/share less P6,000 transaction costs.
Fair value data at the end of 2023 and 2024 are the following:
Securities FV,12/31/23 FV,12/31/24

AAA P6.70/share P7.80/share
BBB 6.90/share 7.10/share
CCC 20.80/share 22.00/share
DDD 32.00/share 31.20/share
The net amount to be reported in the OCI for the year 2023 shall be
2023 in the Company’s equity shall be
The net amount to be reported in the OCI for the year 2024 shall be
b. P165,000 net gain d, P215,000 net gain
2024 in the Company's equity shall be
6. JOANA Company reported the following information to its investments in equity

securities, all of which were acquired during 2023:
379
The
The Book
Fair Value, Fair Value, Fair Value,

Original December December December
Securities Cost 31, 2023 31, 2024 31,2025
FVTPL Category
XXX P1,200,000 1,100,000 P1,400,000 P1,250,000
YY¥Y 3,200,000 3,560,000 3,440,000 3,470,000
P4,400,000 P4,660,000 P4,840,000 P4,720,000
FVTOCI Category '
ZZZ P3,600,000 P3,400,000 P3,500,000 P3,550,000
AAA 4,300,000 4,100,000 4,280,000 4,500,000
P7,900,000 7,500,000 P7,780,000 P8,050,000
The net amount to be reported in the statement of comprehensive income for the
year 2023 shall be
The net amount to be reported in the statement of comprehensive income for the
year 2024 shall be
The net amount to be reported in the income statement for the year 2025 shall be
The cumulative net unrealized gain or loss - OCI to be reported in the Company’s
equity as of December 31, 2025 shall be
b. P470,000 net loss . d. P150,000 net loss
380
The
The Book
Chapter 11A — Dividends, Share Splits and Share Rights
CHAPTER 11A
DIVIDENDS, SHARE SPLITS AND SHARE RIGHTS

1. The different types of dividends.
2. The accounting for each type of dividends.
3. The accounting for share splits.
4, The accounting for share rights and share warrants.
DIVIDENDS - IN GENERAL
Generally, dividend is the portion of the earnings of an entity (i.e., the investee) that
was distributed to the shareholders (i.e., the investors). This is one of the returns
on investment that the investors are interested (the other one being the changes in
the shares’ fair value). The following are the major types of dividends that the
investors can receive from the investee:
Type Description - es
Cash is received from the investee. Most common
Cash dividends
and most attractive type of dividends.
Noncash asset is received from the investee. Most
Property dividends
uncommon and least attractive type of dividends.
Normally received during liquidation or from time
Liquidating dividends
to time if the investee is a wasting asset entity.
Own shares of the investee entity are received.
Share dividends (also
Shares of other entities received as dividends from
known as “bonus issue”)
the investee are considered as property dividends.
Dividends are voluntary and investors do not have unconditional right to receive
them. The power to declare dividends rests on the investee entity’s Board of
Directors. The following dates are relevant in accounting for dividends:
Date Description
This is when the dividend declaration’ is made and that the
Date of Board of Directors binds the investee entity to pay dividends
declaration | Thisis also the time when the investors’ right to receive
dividends are established.
This is the date when the names of investors that are entitled
ee, to receive the dividends are determined, Only a memorandum
entry is prepared on this date.
peu Date when the dividends are actually received.
|. payment :
381
The
Chapter 11A - Dividends, Share Splits and Share Rights
CASH DIVIDENDS
On the date of declaration, dividend income shall be recognized equal to the amourt
of cash dividends that will be received. This dividend income is always recognized
in profit or loss regardless whether the related investment in equity securitiesis
accounted for at FVTPL or at FVTOCI.
Depending on the type of underlying shares of stock, the amount cash dividends
that can be received is determined as follows:
Underlying Shares of Stock Amount of Cash Dividends
Number of shares held x cash
Ordinary or common shares
dividends per share
Total par value of shares held x
Preference shares
preference shares dividend rate
Illustration 1. On January 1, 2023, DANILO Company acquired 80,000 ordinary
shares of DEF Corporation for a total price of P1,000,000. On November 30, 2023,
DEF declared cash dividends of P3.25 per share for shareholders on record on
December 15, 2023. These cash dividends are to be paid on January 10, 2024.
DANILO Company shall make the following entry on November 30, 2023 (i.e., date
of declaration) to recognize the amount of dividend income:
Dividend receivable 260,000
Dividend income (80,000
x P3.25) 260,000
On December 15, 2023, the date of record, only a memorandum entry is recorded.
On January 10, 2024, the receipt of dividends shall be recorded as follows:
Cash 260,000
The readers should take note that no dividend income is recognized on the date of
receipt of the dividends.
Illustration 2. On June 26, 2023, ELSA Company acquired 60,000 preference shares
of ABC Corp. for P90 per share. These shares have P50 par value and preference
dividend rate of 8%. On October 20, 2023, ABC Corp. declared the annual dividend
for the its preference shares with payment date of December 20, 2023, for
shareholders on record as of December 1, 2023.
ELSA Company shall recognize dividend income on October 20, 2022 through the
following journal entry:
Dividend income (60,000x P50x 8%) 240,000
The readers should take note that P50 par value is the basis of the preference share
dividend, not the amount of purchase price of P90 per share.
382
The
On December 11, 2023, the date of record, only a memorandum entry is recorded.
On December 20, 2023, the receipt of dividends shall be recorded as follows:
Cash 240,000
EFFECTS OF DIVIDENDS IN SELLING OR PURCHASING INVESTMENTS

It is not uncommon for entities to sell or purchase investments in equity securities
during the period from the date of declaration up to the date of payment. To
understand the effects of dividends in this case, the concept of ex-dividend date will
be introduced.
Ex-dividend date is the date when the declared dividend is not anymore attached
to the related shares. This is usually set one business day before the date of record.
This can be summarized in the following graphical representation:
Dividend-on Ex-dividend
\ J
[ Wo |
| | | >
'
Date of
| eeeDate of
Ex-dividend
{
Date of
Declaration Date Record Payment
Corresponding differences in accounting procedures are summarized as follows:

Dividend-on _ _ Ex-dividend
Period covered fron Gotan date up to | After ex-dividend date
ex-dividend date
Value of equity securities Includes the dividends Excludes the dividends
Right to receive dividends
if the shares were sold Transferred to the buyer Retained by the seller
during the period
ee Derecognized Not derecognized
Excluded from the initial No effect in investment
Buyer's accounting for measurement of investment and no dividend
dividends and recognized separately as receivable shall be
dividend receivable recognized
These analyses are not limited to cash dividends but are also applicable to other
types of dividends,
Illustration 3, At the beginning of 2023, FELIX Company maintains 120,000 shares
of another entity with carrying amount of P2,500,000 and accounted for at FVTPL.
383
The
The Book
On June 1, 2023, dividends of P2.50 per share were declared for these shares to be
paid on July 31, 2023. Ex-dividend date and date of record were set on June 30, 2023
and July 1, 2023, respectively. Required: Under each of the following independent
scenarios, determine the relevant journal entries:
1. The investment was sold for P3,000,000 on J une 18, 2023.
2. The investment was sold for P3,000,000 on J uly 10, 2023.
Scenario 1 - The shares were sold DIVIDEND-ON
Date Books of FELIX Company (seller) | Books of the buyer
Jun.1, | Dividend receivable 300,000 N/A - only the entities holding the
2023 Dividend income* 300,000 | shares as of the declaration date
*120,000 x P2.50 shall recognize the dividend income
Jun. 18, | Cash 3,000,000
2023 Fin. asset at FVTPL 2,500,000 | Fin.assetatFVTPL 2,700,000
Dividend receivable 300,000 | Dividend receivable 300,000
Gain on sale — P/L (squeeze) 200,000 Cash 3,000,000
Portion of the selling price is The amount of dividends is

allocated to the dividends since the recognized as a receivable since the
right to receive has been transferred right to receive has been transferred
to the buyer; thus, affecting the to the buyer.
amount of gain on sale.
Jul. 31, Cash 300,000
2023 N/A - the right to receive the Dividend receivable 300,000
dividends has been transferred to the
Even though the buyer actually
buyer received the dividends, it shall not
recognize dividend income.
Scenario 2 - The shares were sold EX-DIVIDEN D

Date Books of FELIX Company (seller) © Books of the buyer
Jun.1, | Dividend receivable 300,000 N/A - only the entities holding the
a0ce Dividend income* 300,000 | shares as of the declaration date
*120,000 x P2.50 shall recognize the dividend income
Jul.10, | Cash 3,000,000 ;
2023 Fin. asset at FVTPL 2,500,000 Fin. asset at FVTPL 3,000,000
Cash 3,000,000
Gain on sale - P/L (squeeze) 500,000
No amount of dividends receivable
Since the right to receive the dividends is recognized since it is the seller
has been retained by the Company, the who will receive the dividends on the
dividend receivable shall not be
date of payment.
derecognized.
Jul.31, | Cash 300,000 N/A - the right to receive the
2023 Dividend receivable 300,000 dividends has been retained by the
seller, :
384
The
CamScanner
PROPERTY DIVIDENDS
Noncash asset to be received as property dividend shall be measured at its fair
value with a corresponding credit to dividend income.
Similar to cash dividends, dividend income arising from property dividends is
always recognized in profit or loss whether the related investment in equity
securities is accounted for at FVTPL or at FVTOCI.
Illustration 4. GLENDA Company received some equipment items as property
dividends from one of its investments in equity securities accounted for at FVTPL.
Total fair value of the equipment items amounted to P3,200,000 while the related
cost in the investee’s books amounted to P4,000,000.
The receipt of property dividends is recorded as follows:
Equipment (at fair value, notat cost) 3,200,000
Dividend income 3,200,000
LIQUIDATING DIVIDENDS
This kind of dividend represents “return of investment” as contrast to cash and
property dividends that are considered as “return on investment”. Due to this
peculiar nature of liquidating dividends, the following accounting procedures are
relevant:
1. First, recognize the amounts of liquidating dividends received as reduction
from the investment in equity securities account. Any unrecovered carrying
amount is recognized as loss.
2. Any excess of the total liquidating dividends received over the carrying
amount of the investment is recognized as dividend income, which is always
Illustration 5. At the beginning of 2023, HAROLD Company’s investment in equity
securities at FVTPL had carrying amount of P1,400,000. On April 30, 2023,
liquidating dividends of P600,000 were received and another P900,000 were
received on September 30, 2023.
Journal entry to record the receipt of P600,000 liquidating dividends on April 30,
2023:
Cash 600,000
After this entry, the investment will now have carrying amount of P800,000
(P1,400,000 - P600,000). Journal entry to record the receipt of P900,000 liquidating
dividends on September 30, 2023 is as follows:
Cash 900,000
Dividend income (squeeze) 100,000
385
The
CamScanner
SHARE DIVIDENDS
Accounting for the receipt of share dividends depends on whether the shares issued
by the investee entity is similar to the class of shares held by the investor.
For example, if the investee declared share dividends on its ordinary shares, it is
understood that it will issue additional ordinary shares (i.e., share dividends of the
same class). However, the investee is not precluded to issue preference shares as
share dividends to its ordinary shares and vice versa (i.e., share dividends not of the’
same class).
SHARE DIVIDENDS OF THE SAME CLASS
This is the more common type of share dividends. There are two ways of accounting
for these share dividends, depending on the frequency of recording the changes in
the investment’s fair value:
Traditional Contemporary
When an entity records changes | When an entity regularly
in investment’s fair value only at | records changes in
year end. This approach is investment’ fair values with the
Applicability
primarily used in the academe. advent of technology. Primarily
used by financial institutions and
other investment entities
Only a memorandum entry is Unrealized gain or loss. is
prepared. However, the recognized based on the difference
beginning-of-the-period carrying between the carrying amount of
amount or the cost is now the investment and its fair value
allocated to the increased number after the share dividends.
Recognition as
of share oe eee If total fair value after share
dividends | As a result of this, carrying | dividends > carrying amount,
amount per share will decrease there is an unrealized gain.
and will impact the subsequent
amount of gain or loss on sale, if If total fair value after share
there is any.
dividends < carrying amount,
there is an unrealized loss.
Information Late recognition of changes in Timely recognition of changes
provided the fair value in the fair value
Despite of these differences, net amount to be reported in profit or loss or in OCI is

the same under each method. Needless to say, as of the end of each reporting date,
the traditional approach will catch up with the contemporary approach due to the
updating of fair values. Consequently, after one reporting date, both methods will
now have the same carrying amount per share moving forward.
Illustration 6. On November 2, 2023, IRENE Company acquired 100,000 ordinary

shares of another entity for P12 per share or for a total of P1,200,000 to be
386
The
CamScanner
accounted for at FVTPL. Subsequently, on November 30, the investee entity issued
20% ordinary share dividends when the shares’ fair value is P14 per share. Forty
thousand (40,000) of these shares were sold on December 15, 2023 for P15 per
share. Fair value of these shares as of December 31, 2023 amounted to P15.50 per
share. Required: Under each of the following independent scenarios, determine the
relevant journal entries for 2023 assuming:
1. The Company uses traditional approach.
2. The Company uses contemporary approach and records changes in fair value
every month.
Fin.assetatFVTPL 1,200,000 Fin.assetatFVTPL 1,200,000
11/02/23 Cash 1,200,000 Cash 1,200,000
Memo entry - Received 20,000 Fin. asset at FVTPL 480,000
ordinary share dividends (100,000x Unrealized gain-P/L 480,000
20%). The revised carrying amount
The amount of unrealized gain is
per share is computed as:
computed as: (120,000 x P14) -
11/30/23 | Carrying amount P1,200,000 | P1,200,000 = P480,000.
eee ee et=o In this case, total carrying amount

will now be P1,680,000 (P1.2M +
“revised P480K) and carrying amount per
share is updated to P14/share.
Cash (40,000 x P15) 600,000 Cash (40,000x P15) 600,000
Fin. asset at FVTPL* 400,000 Fin. asset at FVTPL* 560,000
Gain on sale - P/L** 200,000 Gain on sale - P/L** 40,000
*40,000 x P10 carrying amount per share | *40,000x P14 carrying amount per share
12/15/23 | ** squeeze amount ** squeeze amount
Carrying amount will now be Carrying amount will now be

reduced to P800,000 (P1.2M - reduced to P1,120,000 (P1.68M -
P400K). Remaining no. of shares is P560K). Remaining no. of shares is
now 80,000 (120,000 - 40,000). now 80,000 (120,000 - 40,000).
Fin. asset at FVTPL 440,000 Fin, asset at FVTPL 120,000
12/31/23 Unrealized gain-P/L* 440,000 Unrealized gain- P/L* 120,000
*(80,000 x P15.50) - P800,000 *(80,000 x P15.50) - P1,120,000

Carrying amount as of 12/31/23 un der both methods will now be equal
12/31/23 at P1,240,000 (80,000 x P15.50).
Net P640,000 net gain = P200,000 gain P640,000 net gain = P480,000
amountin on sale + P440,000 unrealized gain unrealized gain + P40,000 gain on
rofit/loss on 12/31/23 sale + P120,000 unrealized gain
Note: If the investment is accounted for at FVTOCI, gains and losses are recognized in OCI.
387
The
CamScanner
It is in the author’s humble opinion that the contemporary approach should be

followed since it provides timely information that can be used in decision-making.
SHARE DIVIDENDS OF DIFFERENT CLASS
There will be also two approaches that can be applied in this scenario, the
traditional and contemporary approaches:
Traditional = - Contemporary
. ys), | The approach primarily used in | The approach in accordance with
Applicability the academe. the requirements of PFRS 9.
The carrying amount of the The share dividends received
original investment is allocated shall be measured at their fair
based on relative fair values of the values with corresponding
Recognition now two different classes of shares. unrealized gain.
of share
dividends As a result, no gain or loss is This in line with the requirements
recognized on the date of receipt of PFRS 9 that the financial assets
of share dividends. be initially measured at their fair
values.
Illustration 7. On January 1, 2023, JACK Company acquired 200,000 ordinary

shares of another entity fora total of P2,400,000 (or P12 per share), to be accounted
for at FVTPL. On July 1, 2023, 40,000 preference shares were received from the
investee as share dividends. As of this date, ordinary shares and preference shares
had fair values of P15/share and P25/share, respectively.
As of December 31, 2023, ordinary shares and preference shares had fair values of
P17.50/share and P26/share. Journal entries to be made for 2023 are the following:
‘Traditional Contemporary
FA atFVTPL-ord. 2,400,000 FA.atFVTPL-ord. 2,400,000
01/01/23 |. cash 2,400,000 | _ Cash 2,400,000
F.A.atFVTPL-pref* 600,000 FA. at FVTPL -pref* 1,000,000
F.A. at FVTPL - ord. 600,000 Unrealizedgain-P/L 1,000,000
Total fair value of both classes is | *40,000x P25 pref. shares fair value
Note: By ‘default, the investment in
Ordinary (200Kx P15) —_ P3,000,000 | preference shares shall be accounted for at
07/01/23 Preference (40KxP25) 1,000,000 | FvTPL (in the absence of irrevocable
Total fair value P4,000,000 | designation to present gains and losses in
Oct).
The P2,400,000 carrying amount can
now be allocated as follows:
Ordinary (P2.4M x %) P1,800,000
*Preference (P2.4Mx%4) __600,000
Total P2,400,000 aa
388
The
CamScanner
Chapter 11A— Dividends, Share Splits and Share Rights
‘Traditional Contemporary
F.A. at FVTPL - ord.* 1,700,000 FA. atFVTPL-ord.* 1,100,000
Unrealized gain - P/L 1,700,000 Unrealized gain-P/L — 1,100,000
*(200,000 x P17.50) - P1,800,000 *(200,000 x P17.50) - P2,400,000
12/31/23
F.A. at FVTPL - pref** 440,000 F.A. at FVTPL - pref.** 40,000
Unrealized gain - P/L 440,000 Unrealized gain - P/L 40,000
*#(40,000 x P26) - P600,000 *#(40,000x P26) - P1,000,000
Carrying amounts as of 12/31/23 under both methods for both the ordinary
and preference shares will now amount to:
12/31/23 Ordinary (200,000 x P17.50) 3,500,000
Preference (40,000 x P26) 1,040,000
Net P2,140,000 net gain = P1,700,000 P2,140,000 net gain = P1,000,000

amountin unrealized gain + P440,000 unrealized gain + P1,100,000 unrealized gain
profit/loss unrealized gain +P40,000 unrealized gain
*Note: If the investment is accounted for at FVTOCI, gains and losses are recognized in OCI.
Despite these differences, net amount to be reported in profit or loss or in OCI is the
same under each method. Needless to say, as of the end of each reporting date, the
traditional approach will catch up with the contemporary approach due to the
updating of fair values. Consequently, after one reporting date, both methods will
now have the same carrying amount per share moving forward.
SHARE SPLITS
Share splits involve the change in the number of shares held with corresponding
proportional changes in the par value of the shares held. These changes do not affect
the total capital of the investee entity. Share splits can be categorized as either split-
up or split-down:
R a te Split-Up Split-Down
Effect in the No. of Shares Increase Decrease
Effect in the Par Value Decrease Increase
If there is a share split, the old shares are effectively “retired” and new shares with
revised par value and quantity are simultaneously issued to the investors.
A 2-for-1 share split-up for 100,000 shares with P10 par value will result to 200,000
shares (100,000 x 2) with P5 par value (P10/2). On the other hand, a 2-for-1 share
split-down will result to 50,000 shares (100,000/2) with P20 par value (P10 x 2).
The accounting for share splits is the same as the approaches used in accounting for
the share dividends of the same class (i.e. the traditional and contemporary
approaches),
389
The
Illustration.8 - Share Split-Up. On January 1, 2023, KATRINA Company has

maintained an investment in equity securities accounted at FVTPL with carrying
amount of P3,000,000 as represented by 150,000 ordinary shares (i.e., P20/share
carrying amount).
On July 1, 2023, a 2-for-1 share split-up was initiated by the investee entity after
which the shares had fair value of P11/share. Subsequently, the Company sold
50,000 of these shares on October 1, 2023 for P12.50/share. As of December 31,
2023, these shares had fair value of P14/share.
Memo entry - The shares held were Fin. asset at FVTPL 300,000
subjected to a 2-for-1 share-split up Unrealized gain-P/L 300,000
where the 150,000 shares originally
The amount of unrealized gain is
held became 300,000 shares:
computed as: (300,000 x P11) -
07/01/23 | Carrying amount P3,000,000 | P3,000 P300,000.
= ,000
Divideby: Shares held 300,000
ving ait per as Pio | = this case, total carrying amount
sovesadt will now be P3,300,000 (P3M +
revise
P300K) and carrying amount per
share is updated to P11/share.
Cash (50,000 x P12.50) 625,000 Cash (50,000x P12.50) 625,000
Fin. asset at FVTPL* 500,000 Fin. asset at FVTPL* 550,000
Gain on sale - P/L** 125,000 Gain on sale - P/L** 75,000
*50,000x P10 carrying amount per share *50,000x P11 carrying amount per share
12/15/23 ** squeeze amount ** squeeze amount
Carrying amount will now be Carrying amount will now be

reduced to P2,500,000 (P3M - reduced to P2,750,000 (P3.3M -
P500K). Remaining no. of shares is P550K). Remaining no. of shares is
now 250,000 (300,000 - 50,000). now 250,000 (300,000 - 50,000).
Fin.assetatFVTPL — 1,000,000 - Fin, asset at FVTPL 750,000
12/31/23 Unrealized gain-P/L* 1,000,000 Unrealized gain- P/L* 750,000
*(250,000 x P14) - P2,500,000 *(250,000 x P14) - P2,750,000
12/31/23 Carrying amount as of 12/31/23 under both methods will now be equal
at P3,500,000 (250,000 x P14). tI
Net P1,125,000 net gain = P125,000 | P1,125,000 net gain = P300,00
amountin | gain on sale + P1,000,000 | unrealized gain + P75,000 gain on
profit/loss | unrealized gain sale + P750,000 unrealized gain _J
*Note: If the investment is accounted for at FVTOCI, gains and losses are recognized in OCI.
Illustration 9 - Share Split-Down. On January 1, 2023, IGUANA Company has
maintained an investment in equity securities accounted at FVTPL with carrying
amount of P4,500,000 as represented by 200,000 ordinary shares (i.e.
P22.50/share carrying amount).
390
The
The Book
On October 1, 2023, a 2-for-1 share split-down was initiated by the investee entity,
after which the shares had fair value of P42.50/share. Subsequently, the Company
sold 30,000 of these shares on December 1, 2023 for P44.50/share. As of December
31, 2023, these shares had fair value of P47.50/share.
Traditional — Contemporary
Memo entry - The shares held were Unrealized loss- P/L 250,000
subjected to a 2-for-1 share-split Fin, asset at FVTPL 250,000
down where the 200,000 shares
originally held became 100,000 The amount of unrealized loss is
shares: computed as: (100,000 x P42.50) -
10/01/23 P4,500,000 = P250,000.
Carrying amount P4,500,000
Divide by: Shares held In this case, total carrying amount
100,000
Carrying amt. per share* P45 will now be P4,250,000 (P4.5M -
P250K) and carrying amount per
*revised
share is updated to P42.50/share.
Cash (30,000x P44.50) 1,335,000 Cash (30,000 x P44.50) 1,335,000
Loss on sale - P/L** Fin.assetatFVTPL* 1,275,000
15,000
Fin. asset at FVTPL* Gain on sale - P/L** 60,000
1,350,000
*30,000 x P45 carrying amount per share *30,000 x P42.50 carrying amount per
share
12/01/23 ** squeeze amount
** squeeze amount
Carrying amount will now be
Carrying amount will now be
reduced to P3,150,000 (P45M -
reduced to P2,975,000 (P4.25M -
P1.35M). Remaining no. of shares is
P1.275M). Remaining no. of shares
now 70,000 (100,000 - 30,000).
is now 70,000 (100,000 - 30,000).
Fin. asset at FVTPL 175,000 Fin. asset at FVTPL 350,000
12/31/23 Unrealized gain-P/L* 175,000 Unrealized gain- P/L* 350,000
*(70,000 x P47.50) - P3,150,000 *(70,000 x P47.50) - P2,975,000
Carrying amount as of 12/31/23 under both methods will now be equal
12/31/23
at P3,325,000 (70,000 x P47.50).
Net P160,000 net gain = -P250,000
P160,000 net gain = -P15,000 loss
amountin unrealized loss + P60,000 gain on
on sale + P175,000 unrealized gain
rofit/loss sale + P350,000 unrealized gain
“Note: If the investment is accounted for at FVTOCI, gains and losses are recognized in OCI.
SHARE RIGHTS
Share rights represent a special privilege given by the investee to its existing
shareholder investors. This privilege involves the right of the investors to acquire
additional shares that the investee entity will issue at an exercise price that could
be lower than the additional shares’ fair value,
391
The
CamScanner
In addition, share rights give chance to the existing shareholders to prevent the
dilution of their ownership interest in the investee entity due to issuance of new
shares to other shareholders. (i.e., pre-emptive right)
In accounting, it is important to understand that share rights can be viewed as
“embedded derivative”. Why?
First, share rights cannot be transferred by the shareholders since this right is
personal to them and given to them as part-time owners of the investee.
Second, since its value depends on the relationship of the exercise price to fair value
of the covered shares, the larger the gap between the higher fair value and the lower
exercise price, the higher the value of the share rights. Collectively, the investment in
equity securities (i.e., the host contract) and the related share rights (i.e, embedded
derivative) is called the “hybrid contract”.
As aresult of this, the following are the relevant accounting procedures for share rights:
a. Since the host (i.e., the investment in equity securities) is within the scope of PFRS
9, the whole hybrid contract is accounted for together under PFRS 9 (i.e., the share
rights shall not be accounted for separately or there is no bifurcation).
b. Changes in the value of the entire hybrid contract is usually reported in profit or loss.
c. If the share rights were received subsequently, the change in the fair value of the
related hybrid contract will already include the value of these share rights.
d. In subsequently exercising of the share rights, the acquired shares shall be initially
measured at their fair values (i.e., not at their exercise price), with the difference
accounted for as unrealized gain or loss as discussed in Chapter 11.
e. The exercise or expiration of share rights will be automatically incorporated
in the changes in the fair value of the hybrid contract.
f. Ifthe share rights were sold separately, the proceeds can be simply deducted from
the carrying amount of the hybrid contract.
Illustration 10. At the beginning of 2023, LUIS Company reported investment in

equity securities at FVTPL with carrying amount of P4,000,000 representing 50,000
ordinary shares of the investee. On May 1, 2023, share rights to acquire additional
50,000 ordinary shares were received, with exercise price set at P80/share. Due to
the share rights, the fair value of investment in equity securities increased to
P4,450,000. All of these share rights were exercised on September 1, 2023 when
the shares’ fair value is P95/share.
On May 1, 2023, the increase in fair value of the investment due to the receipt of
share rights is recorded as follows:
392
The
Take note that no new account is established. On September 1, 2023, the exercise
of the share rights is recorded as follows:
Financial asset at FVTPL (50K x P95) 4,750,000
Cash (50,000x P80) i 4,000,000
Unrealized gain - P/L (squeeze) 750,000
Take note that the newly acquired shares are initially recognized equal to their fair
values (i.e., P95/share) not on the P80/share exercise price.
Assume that instead of exercising the share rights, the Company sold these for
P480,000. The journal entry to record the selling is as follows:
Cash 480,000
In cases that the share rights lapsed before they can be exercised, the decline in the
fair value of investment in equity securities will already reflect the lapsing of the
share rights.
SPECIAL ASSESSMENTS
Special assessments are additional amounts given to the investee for a specific
purpose, for example, additional capital infusion in case the investee is in a deficit
position.
Special assessments paid may be initially capitalized by the investor. However, at
the end of each reporting period, the updating of the investment’s carrying amount
as of reporting date (i.e., to equate to its fair value) will diminish the effect of
capitalizing the special assessment.
Illustration 11. At the beginning of 2023, STAIRS Company reported investment in

equity securities at FVTOCI with carrying amount of P2,490,000. During the year,
the investee entity requested for additional contributions from existing
shareholders with the Company paying P200,000. At the end of 2023, the fair value
of the equity securities amounted to P2,900,000. —
In this case, the special assessment of P200,000 made during the year shall be
capitalized as follows:
Cash 200,000
After this entry, the carrying amount of the investment will now be P2,690,000
(P2,490,000 + P200,000). On December 31, 2023, to update the investments
carrying amount to equate it to its P2,900,000 fair value as of that date:
Unrealized gain - OCI (P2.9M-P2.69M) 210,000
393
The
CHAPTER SUMMARY
1. Dividends is a form of distribution from an investee entity. It can be in the form of
cash dividends, property dividends, liquidating dividends, and share dividends.
2. Cash dividends to be received are recognized in profit or loss whether the
investment is accounted for at FVTPL or at FVTOCI on the date of declaration.
3. Property dividend income is recognized in profit or loss equal to the fair value of the
noncash property to be distributed. The value of which is determined as of the date
of declaration.
4. Liquidating dividends are recognized as reduction from the investment’s carrying
amount with the excess recognized as dividend income. In cases the investment’s
carrying amount is not fully recovered, any remaining carrying amount shall be
recognized as loss.
5. Share dividends of the same class can be accounted for using either of the following:
a. Traditional - the receipt of the share dividends is recorded through memo entry
only, but the carrying amount per share will decrease (i.e., no unrealized gains
or losses).
b. Contemporary - the receipt of the share dividends shall trigger the updating of
fair values of the existing shares plus the share dividend received (i.e.,
unrealized gains or losses in profit or loss, or in OCI, whichever is applicable,
shall be recognized).
6. Share dividends belonging to the different class shall be accounted for using either
of the following:
a. Traditional - the carrying amount of the related investment shall be allocated to
the original investment and to share dividends received based on their relative
fair values (i.e., no unrealized gain or loss).
b. Contemporary - the received share dividends shall be measured at their fair
values with corresponding unrealized gain to be recognized in profit or loss by
default.
7. Share splits are accounted for in similar manner as the receipt of share dividends
belonging to the same class.
8. Share rights are considered as embedded derivatives. Since the host contract (i.e.,
investment in equity securities) they relate to is within the scope of PFRS 9, they
shall not be accounted for separately.
9. Share rights are automatically incorporated in the changes in the fair value of the
entire hybrid contract (i.e., investment in equity securities plus the attached share
rights).
10. Shares acquired by exercising the share rights shall be initially measured at their fair
values, rather than at the exercise price.
394
The
The Book
True or False
1. Cash dividends received from investment accounted for at FVTOCI shall be
recognized as dividend income in OCI.
2. The exactidentities of the shareholders who will actually receive the cash dividends
are determined on the date of declaration.
3. Cash dividends to be received from preference shares shall be based on preference
dividend rate applied on the shares’ aggregate par value, and not on the shares’
carrying amount.
4. Dividend income to be recognized from: property dividends shall be based on the
fair value of the noncash asset as determined on the date of declaration.
5. Generally, liquidating dividends are recognized as dividend income since the bulk
of these amounts represents a return on capital in contrast to a return of capital.
6. Under the traditional approach, share dividends of the same class decrease the
investment’s carrying amount per share.
7. Under the contemporary approach, share dividends belonging to a different class
of shares are separately recognized as unrealized gain equal to their fair values.
8. Share split-up increases the par value per share.
9. Share split-down decreases the par value per share.
10. By default, share rights are not separately accounted for since the investments in
equity securities are covered
1. Which of the following correctly indicates the recognition of cash dividends in an
entity’s financial performance?
a. Dividends from FVTPL equity securities are paiuaaed in profit or loss while
dividends from FVTOCI equity securities are recognized in OCI.
b. Dividends from FVTPL equity securities are recognized in OCI while dividends
from FVTOCI equity securities are recognized in profit or loss.
c. Both the dividends from FVTPL and FVTOCI equity securities are recognized in
profit or loss,
d. Both the dividends from FVTPL and FVTOCI equity securities are recognized in
OCI.
2. Generally, during which of the following dates does an entity recognize dividend
income?
a. Date of declaration
b. Date of record
c. Date of payment
d. Date of receipt
3. Property dividends are recognized as dividend income equal to their fair values and
are determined on which of the following dates?
a. Date of declaration
b. Date of record
395
The
The Book
c. Date of payment
d. Date of receipt
4. The following are correct accounting procedures for liquidating dividends, except
a. In general, liquidating dividends shall be recognized as a reduction from the
related investment’s carrying amount.
b. By default, liquidating dividends are considered as a recovery of investment
rather than a return on investment.
c. Any excess liquidating dividends shall be recognized as dividend income.
d. Any remaining carrying amount of the investment after the receipt of all
liquidating dividends shall be recognized as a receivable from the investee.
5. At the beginning of 2023, FIDEL Company has maintained a number of ordinary
shares of HARI Company. The shares are accounted for at FVTPL. On March 1, 2023,
HARI Company declared cash dividends for shareholders on record as of March 31,
2023, which are to be paid on April 30, 2023. If FIDEL Company has sold the ordinary
shares on March 20, 2023 to MAESTRO Company, which of the following is correct?
a. FIDEL shall not recognize dividend income since the shares were sold before
receiving the dividends from HARI.
b. FIDELshall retain the previously recorded dividend receivable even after selling
the related shares.
c. MAESTRO shall recognize dividend income since it will actually receive the
dividends on the date of payment.
d. MAESTRO shall allocate a portion of the transaction price for the amount of
dividend receivable.
6. On January 1, 2023, MONICA Company invested in the equity securities of SAMSON

Company. SAMSON declared cash dividends on June 1, 2023 for shareholders on
record on June 15, 2023. Date of payment was set on June 30, 2023. Assuming that
MONICA sold the equity securities to DAVID Company on June 25, 2023, which of the
following is not correct?
A. MONICA shall still recognize dividend income even if the shares were sold since
it holds the shares on the date of dividend declaration.
B. MONICA shall derecognize the dividend receivable account since DAVID is now
the owner of the related shares as of the date of payment.
C. DAVID shall initially measure the acquired shares of SAMSON Company without
regard to the amount of cash dividends recently declared.
D. DAVID is not the recipient of the cash dividends on the date of payment since it
acquired the shares only after the date of record.
7. Share dividends received that belongs to the same class as the original shares held
shall be accounted for as follows, except
a. Under traditional method, carrying amount per share shall decrease after the
receipt of the share dividends.
b. Under traditional method, no gain or loss shall be recognized on the receipt of
share dividends.
396
The
The Book
c. Under contemporary approach, the difference between the carrying amount of

the investment and its fair value (including share dividends) shall be recognized
as unrealized gain or loss.
Under the contemporary approach, there is a higher amount of profit or loss or
OCI to be reported during the period of receipt of share dividends.
g. Which of the following is correct in accounting for share dividends received

belonging to a different class?
a. Under the contemporary approach, the share dividends received shall be
separately recognized, with a reese credit to unrealized gain that is
equal to their par values.
Under the contemporary approach, in general, the carrying amount of the
original shares held shall not be affected by the share dividends.
Under the traditional approach, the carrying amount of the original investment
shall be allocated to the original shares and share dividends received based on
their relative par values. J
Under the traditional approach, an entity will report a higher amount of profit
or loss or OCI during the period of receipt of share dividends.
9. Share splits have the following consequences, except
a. Share split-up increases the number of shares.
b. Share split-down decreases the number of shares.
K Share split-up increases the par value per share.
10. An investee entity may grant share rights to its existing shareholders, which shall be
accounted for as follows, except
a. Theshare rights, as embedded derivatives, shall not be accounted for separately
since the host contract is within the scope of PFRS 9.
b. The additional shares acquired through share rights shall be measured at the
exercise price paid plus the value of the share rights.
c. The value of share rights is already embedded in the value of the related shares.
Straight Problems
1, Atthe beginning of 2023, RONALD Company had the following investments in equity
securities both accounted for at FVTPL:
a. 200,000 ordinary shares of AAA Company with P10 par value and total carrying
amount of P3,600,000.
b, 120,000 preference shares of BBB Company with P50 par value and total
carrying amount of P9,000,000, Relevant preference dividend rate is 9%,
On May 1, 2023, AAA Company declared cash dividend of P2.00/share for

shareholders on record on June 1, 2023. The dividends were eventually received on
July 1, 2023.
397
The
CamScanner
On September 1, 2023, BBB Company declared the preference dividend for

shareholders on record on September 15, 2023. The dividends were eventually
received on September 30, 2023.
As of December 31, 2023, AAA Company’s ordinary shares had P19.50/share fair
value, while BBB Company's ordinary shares had P78/share fair value.
Required: From the given information, determine the following:
a. Journal entries to be made for the year 2023.
b. Total amount to be recognized in profit or loss for the year 2023.
2. Using the same information as in RONALD Company, except that all of the equity
securities are accounted for at FVTOCI. Determine the following:
a. Journal entries to be made for the year 2023.
b. Total amount to be recognized in profit or loss for the year 2023.
3. At the beginning of 2023, CESAR Company reported investment in equity at

securities at FVTPL at their fair value of P2,400,000 as represented by 100,000
ordinary shares. On April 1, 2023, the investee entity declared cash dividends of
P2.75/share to its ordinary shares for shareholders on record as of April 20, 2023.
Date of payment is set on May 15, 2023.
entries to be made by CESAR Company and the buyer:
1. The shares were sold on April 15, 2023 for P2,600,000.
2. The shares were sold on April 30, 2023 for P2,520,000.
4. On April 1, 2023, GALAXY Company received a notice that one of its investees
declared some of its inventory items composed of office supplies as property
dividends. The supplies that the Company will receive on May 1, 2023 had fair value
of P500,000 and P400,000 carrying amount in the investee’s books.
Required: Determine the journal entries in the books of GALAXY Company.

5. At the beginning of 2023, PIZZA Company had investment in equity securities of
PEPPERONI Company, an entity involved in mining operations. The investment had
carrying amount of P3,000,000. During the year, the Company received the following
liquidating dividends:
Date Liquidating Dividends

March 12, 2023 P1,600,000
July 20, 2023 900,000
October 5, 2023 725,000
Required: Determine the journal entries to be made in the books of PIZZA Company.
6. On January 1, 2023, RESILIENT Company reported investment in equity securities
representing 400,000 shares of STRONG Company at its fair value of P12/share.
398
The
The Book
On June 1, 2023, 20% share dividends were declared making the fair value of the
shares at P9/share. On August 1, 2023, 100,000 shares were sold for P9.50/share.
On October 31, 2023, 150,000 shares were sold for P10.75/share. As of December
31, 2023, the shares had fair value of P11/share.
’ Required: Determine the journal entries for the year 2023 for this investment under
the (a) traditional approach; and (c) contemporary approach.
7. Atthe beginning of 2023, PLASMA Company invested in the 500,000 ordinary shares
of MATTER Company for P12/share. On July 1, 2023, MATTER Company distributed
10% share dividends. However, instead of ordinary shares, MATTER Company
distributed preference shares with fair value of P60/share. On the same date, the
ordinary shares had fair value of P14/share.
On September 1, 2023, 24,000 preference shares were sold for P50/share. As of
December 31, 2023, the ordinary shares and preference shares had fair values of
P15.50/share and P56/share, respectively.
Required: Determine the journal entries for the year 2023 under the (a) traditional
approach; and (c) contemporary approach.
8. On January 1, 2023, CHICKEN Company’s investment in 250,000 ordinary shares of
another had total fair value of P7,500,000. On February 1, 2023, the investee entity
executed a 3-for-1 share split-up, resulting to the fair value of the shares decreasing
to P12.50/share.
On May 1, 2023, 400,000 of these shares were sold for P11.50/share. As of December
31, 2023, the remaining shares had fair value of P11/share.
Required: Determine the journal entries for the year 2023 for this investment under
9. On March 1, 2023, TURKEY Company acquired 900,000 ordinary shares of another

entity at P4.50/share. On July 15, 2023, the investee entity instituted a 4-for-1 share
split-down, increasing the fair value of the ordinary shares to P16/share.
On July 1, 2023, 140,000 of these shares were sold for P17/share. As of December
31, 2023, the remaining shares had fair value of P19,50/share.
Required; Determine the journal entries for the year 2023 for this investment under
10,At the beginning of 2023, MIGHTY Company had the following investments with
corresponding original costs and carrying amounts (i.e., at fair value):
399
The
The Book
Securities No.ofShares CostperShare FV per Share

FVTPL Category
AAA 200,000 P9,00 P8.00
BBB 300,000 12.00 13.50
FVTOCI Category
ccc 100,000 20.00 18.00
DDD 400,000 5.00 7.50
During the year, the following transactions involving these shares have taken place:
e On February 1, 2023, AAA Company declared P2.50/share cash dividends to its
ordinary shareholders on record as of March 1, 2023, which will be paid on
March 31, 2023. MIGHTY sold 50,000 of its AAA shares on February 25 for
P10/share.
e On March 15, 2023, DDD Company declared P1.40/share cash dividends to its
ordinary shareholders on record as of April 15, which will be paid on May 15,
2023. MIGHTY sold 100,000 of its DDD shares on April 27, 2023 for P9.20/share.
e On April 20, 2023, BBB Company instituted a 2-for-1 share split-up, decreasing
the shares’ fair value to P7/share. MIGHTY uses the traditional method in
recording share splits. MIGHTY sold 250,000 of BBB shares on May 31, 2023 for
P7.50/share.
e As of December 31, 2023, the shares had the following fair values:
AAA BBB ccc DDD
P11.50/share P7.80/share P16.60/share P8.80/share
Required: Determine the journal entries to be made for the year 2023.

1. At the beginning of 2023, CIPRIANO Company had 200,000 ordinary shares of ZZZ
Company carried at P15/share accounted for at FVTPL. On May 1, 2023, additional
50,000 ordinary shares of ZZZ Company were acquired for P16/share. On June 1,
2023, ZZZ Company declared P3.25/share cash dividends for shareholders on
record as of June 30, 2023 and to be paid on July 15, 2023. On June 26, 2023,
CIPRIANO sold 100,000 shares from its beginning-of-the-period holdings for
P18/share. On December 31, 2023, ZZZ shares had fair value of P16.50/share.
Based on this information, the net amount to be reported in CIPRIANO’s 2023 profit
or loss shall be
a. P987,500 net income c. P962,500 netincome
2. On February 15, 2023, CONCHITA Company acquired 200,000, P40 par value
preference shares of YYY Company for P55/share. Preference dividend rate is 5%.
On July 1, 2023, YYY Company declared the preference share dividend for the year
2023 for shareholders on record as of July 15, 2023 and to be paid on July 31, 2023.
Fast forward to December 31, 2023, YYY shares had P54.50/share fair value.
400
The
The Book
Based on this information, the net amount to be reported in CONCHITA’s 2023

statement of comprehensive income shall be
a. P400,000 net income c. P450,000 net income
3, On January 1, 2023, LORNA Company had the following investments:
Securities No.ofShares CostperShare FV per Share
FFF 300,000 P6.00 P7.50
GGG 250,000 10.00 9.50
FFF is accounted for at FVTPL while GGG is accounted for at FVTOCI. During the year
2023, the following events occurred:
e On April 5, 2023, the Company acquired additional 100,000 FFF shares for
P8/share.
e OnJune 10, 2023, FFF declared cash dividends of P2.50/share to its shareholders
on record as of June 20, 2023, which will be paid on June 30, 2023.
e On September 6, 2023, GGG declared cash dividends of P1.80/share for
shareholders on record as of September 30, 2023, which will be paid on October
15, 2023. On September 25, 2023, the Company acquired additional 120,000 GGG
shares for P10.80/share.
e As of December 31, 2023, the equity securities had the following fair values:
FFF GGG
P11.50/share P7.80/share
Based on this information, the net amount to be reported in LORNA’s 2023 profit or
loss shall be
a. P3,000,000 net income c. P2,550,000 net income
b. P3000,000 net loss d. P2,550,000 net loss
Based on this information, the net amount to be reported in LORNA’s 2023 other
comprehensive income shall be
a. P119,000 net income c. P569,000 net income
4. On January 31, 2023, DENNIS Company acquired 100,000 ordinary shares of CCC
Company for P60/share to be accounted for at FVTPL. On March 31, 2023, CCC
Company declared 20% share dividends to be distributed on April 15, 2023. On June
15, 2023, additional 60,000 CCC shares were acquired for P58/share. CCC Company
dividends declared P2.60/share cash dividends on July 31, 2023 to be paid on
August 31, 2023 for shareholders on record as of August 20, 2023. Lastly, on
December 31, 2023, the CCC shares had fair value of P59,50/share.
From this information, determine the total amount to be reported in DENNIS

Company's 2023 profit or loss.
a. P1,230,000 net income c, P1,698,000 net income
b. P1,230,000 net loss d, P1,698,000 net loss
401
The
The Book
5. At the beginning of 2023, CRISANTO Company reported investments in ordinary

shares at FVTPL amounting to P1,040,000 as represented by 200,000 ordinary
shares. These shares were issued by RC Company. On February 15, 2023, RC
declared share dividends of 30% to be issued on February 28, 2022. In addition, on
July 15, 2023 RC also executed a 2-for-1 share split up. Further, on November 15,
2023, 300,000 of these shares were sold for P3.20 per share. Lastly, as of December
31, 2023, the remaining shares have fair value of P3.40 per share. The Company uses
the traditional approach. :
The amount of gain or loss to be recognized on November 15, 2023 sale shall be
a. P360,000 gain c. P540,000 gain
b. P360,000 loss d. P540,000 loss
The amount of unrealized gain or loss to be recognized on December 31, 2023 due
to the changes in fair value shall be
a. P396,000 gain c. P308,000 gain
b. P396,000 loss d. P308,000 loss
The total carrying amount of the investment as of December 31, 2023 shall be
a. P1,144,000 c. P630,000
b. P748,000 d. P340,000
402
The
Chapter 12 - Investments in Debt Securities - Introduction
CHAPTER 12
INVESTMENTS IN DEBT SECURITIES - INTRODUCTION

The characteristics and examples of debt securities.
The different classifications of investment in debt securities under PFRS 9.
SA ef G0 fo
The basis for such different classifications.

The assessment of business model and the contractual cash flows.
The fair value computation of investment in debt securities on initial recognition.
INVESTMENTS IN DEBT SECURITIES - IN GENERAL

In a general sense, investments in debt securities are classified as liabilities of the
issuer. The investor entity, in this case, is considered as the creditor of the investee
entity. Notable examples of debt securities include notes receivable, loans
receivable, investment in bonds, and redeemable preference shares. The readers
are advised to refer back to the comparison of equity securities and debt securities
in Chapter 11 to understand more about the characteristics of debt securities.
Notes receivable and loans receivable are both privately agreed-upon contracts
while investment in bonds is a contract usually available to the general public.
CLASSIFICATIONS OF INVESTMENT IN DEBT SECURITIES UNDER PFRS 9

Under PFRS 9, an investment in debt securities can be classified as follows:
Investments in Debt
Securities
Fair Value Through Fair Value Through

Profit or Loss Other Comprehensive At Amortized Cost
(FVTPL) Income (FVTOCI)
Accounting procedures for each of these classifications will be discussed in the

succeeding chapters.
BASIS FOR CLASSIFYING INVESTMENTS IN DEBT SECURITIES

Can an entity choose any of the three classifications, at its discretion, to account for
each of its debt securities? The answer is NO. In classifying investments in debt
securities, an entity shall consider BOTH of the following:
a. the business model of managing the financial asset; and
b. the contractual cash flow characteristics of the financial asset.
403
The
The Book
Chapter 12 —- Investments in Debt Securities — Introduction
BUSINESS MODEL ASSESSMENT

Simply stated, an entity’s business model refers to how it manages its investments in
debt securities to generate cash flows. According to PFRS 9, the following are the
different types of business models that are relevant in classifying investments in
debt securities:
Business Models
Held-to-maturity -
holding debt Bai Bele \o: Held-for-selling -
eau vee and bee: selling debt securities
maturity in order-to ar ering lie, to receive cash inflows
collect the contractual middle ground)
cash flows
The following are the general guidelines and relevant characteristics in assessing
the type of business model:
Both Held-maturity
Held-to-maturity and Held-for-selling Held-for-selling
Usually based on the | Usually based on| Usually based on
Performance | amounts of interest | overall return (i.e. | realized and
evaluation | income and credit | credit quality plus the | unrealized gains and
andreporting | quality of the | fair valuation of the | losses and fair value
securities securities) of the securities
Primarily credit risk Primarily market
Risks since the amount of risk since market
affecting the cash to be collected | Both credit risk and | factors determine the
will depend on the | marketrisk amount that can be
penormance ability of the issuer to received from selling
pay them the debt security
Compensation Usually based on the
: Usually based on | overall return which | Usually based on
ofbusiness |. ‘ : ; ‘
eae interest income and|is composed of realized and realized
principal collections | contractual cash flows | gains and losses
managers :
and gains and losses
The readers should take note that the business model of “both held-to-maturity and
held-for-selling” possess the characteristics of both of the other business models.
According to PFRS 7, credit risk and market risk are defined as follows;
404
The
CamScanner
Risk | Description
Credit | The risk that one party to a financial instrument will cause a financial loss
Risk | for the other party by failing to discharge an obligation
Market | The risk that the fair value or future cash flows of a financial instrument
Risk | will fluctuate because of changes in market prices. Market risk can be
further subdivided to the following:
1. Interest rate risk - The risk that the fair value or future cash flows of
a financial instrument will fluctuate because of changes in market
interest rates.
2. Currency risk - The risk that the fair value or future cash flows of a
financial instrument will fluctuate because of changes in foreign
exchange rates.
3. Other price risk - market risk not classified into either interest rate
risk or currency risk (i.e., residual risks).
The following are the general principles regarding an entity’s business model:
1. The business model assessment shall be based on fact and not merely on
assertion or the intention of the management.
For example, the management may state that the intention of the business model
is to collect contractual cash flows, but the actual activities involve the selling of
financial assets. In this case, the business model shall be assessed to be “held-
for-selling” since this what is actually happening.
2. The business model assessment is made on a portfolio basis rather than on
an investment-by-investment basis. Portfolio is simply defined as a collection
of different financial assets for the purpose of managing investments.
3. A single entity may have more than one business model. Consequently,
depending on the entity's operations, it can have all of the previously mentioned
three different types of business models. In other words, an entity can also
utilize all of the different classifications (i.e, FVTPL, FVTPL, and Amortized
Cost) at the same time to account for its debt securities, depending on the business
models of its portfolios and cash flow characteristics of debt securities.
4. The assessment shall not incorporate worst case scenarios. Usually, the
worst-case scenario includes the selling of financial assets, which when
considered, will result to assessing all portfolios as held-for-selling.
RELATING BUSINESS MODEL TO CLASSIFICATIONS OF DEBT SECURITIES

Considering solely the business model, the classification of debt securities can be
attributed as follows:
Business model Accounting classification

Held-for-selling FVTPL
Both held-to-maturity and held-for-selling FVTOCI
2 Held-to-maturity Amortized cost
405
The
The Book
Chapter 12 - Investments in Debt Securities — Introduction
The readers should take note that this designation based on the business model
may be overridden by the assessment of the contractual cash flow
characteristics, which will be discussed in the succeeding section.
CONTRACTUAL CASH FLOW CHARACTERISTICS
In assessing the contractual cash flow characteristics, the question below shall be
answered:
Are the contractual cash flows solely payment of principal and interest?
In practice, this question is called the solely payment of principal and interest
test or SPPI test. If the answer in the above questions is “Yes”, SPPI test is said to
have been “Passed.” Otherwise, the SPPI test is said to have been “Failed”. These
will have the following accounting consequences:
Are the contractual cash flows solely payment of principal and interest?
YES (i.e., Passed the SPPI test) NO (i.e., Failed the SPPI test)
Depending on the related The debt security shall be

business model, the debt automatically accounted for at
security can be accounted for FVTPL by default regardless of
either at FVTPL, at FVTOCI or the business model
at Amortized Cost
To pass the SPPI test, the contractual cash flows shall be consistent with a basic
lending arrangement, which contains the following elements:
1. Principal, which is the fair value of the financial asset at initial recognition; and
2. Interest, which shall have the following elements and considerations:
a. time value of money
b. credit risk
c. other basic lending risk (e.g., liquidity risk) and cost (e.g. administrative
costs)
d. profit margin if still consistent with basic lending arrangement.
Circumstances that will fail the SPPI test, provided they have material or genuine
effects, include but not limited to, the following:
1. Leverage, which increases the variability of the contractual cash flows with the
result that they do not have the economic characteristics of interest (e.g.,
derivatives, debt securities based on an index, etc.). Generally, complex criteria
in determining the amount of interest are considered as containing leverage.
Excessive prepayment penalties.
=
3. Convertibility option on bonds.
406
The
CamScanner
The contractual cash flows assessment is the culprit why investments in equity
securities are accounted for differently (i.e., cannot be accounted for at amortized
cost) since equity securities do not have principal and interest.
COMBINING BUSINESS MODEL AND CONTRACTUAL CASH FLOW ASSESSMENTS
Finally, the classification of debt securities, incorporating both the business model
and contractual cash flow assessments, can now be summarized as follows:
Accounting classification
Business model Passed SSPI Test | Failed SPPI Test
Held-for-selling FVTPL FVTPL
Both held-to-maturity and held-for-selling FVTOCI FVTPL
Held-to-maturity Amortized cost FVTPL
Note: If a debt security failed the SPPI test, it will be automatically classified at FVTPL.
Illustration 1. An entity acquired a bond investment to be held at a portfolio with

the objective of collecting the contractual cash flows until maturity. The bond’s
features are consistent with a basic lending arrangement.
In this case, the investment shall be accounted for at Amortized Cost because of the
held-to-maturity business model and the contractual cash flows are for solely
payment of principal and interest.
Illustration 2. An entity invested its excess fund to a government bond which will
be included in the portfolio with the objective of collecting the contractual cash
flows. When the opportunity arises, the entity will sell the financial assets to obtain
a higher profit. The bond’s features are consistent with a basic lending
arrangement.
In this case, the investment shall be accounted for at FVTOCI since the business model
is both held-to maturity and held-for-selling, and the contractual cash flows are solely
payment of principal and interest.
Illustration 3. At the beginning of the year, an entity acquired a commercial bond
and put it in a portfolio with the objective of collecting contractual cash flows until
maturity. The commercial bond is convertible to issuer's ordinary shares.
In this case, even though the commercial bond is held-to-maturity, the contractual
cash flows are not solely payments of principal and interest due to the convertibility
option. As a result, the commercial bond shall be accounted for at FVTPL by default.
FAIR VALUE OPTION FOR INVESTMENTS IN DEBT SECURITIES
Despite the rules on the business model assessment and contractual cash flows
characteristics, an entity may apply the fair value
option
designate a debt security at FVTPL if doing so will eliminate or irrevocably
or significantly
reduce the accounting mismatch, Accounting
“recognition inconsistency.” mismatch simple means
407
The
For example, there is an accounting mismatch if interest expense from bonds

payable used to finance the investment is recognized in profit or loss while the
changes in the fair value of the investment is recognized in OCI. However, the
accounting mismatch will be eliminated or significantly reduced if the changes in
the fair value of the investment is allowed to be recognized in profit or loss.
The irrevocable designation shall be made on the date of initial recognition (i.e.,
the date of acquisition). In other words, previously recognized debt securities cannot
be irrevocably designated at FVTPL.
In addition, the irrevocable designation at FVTPL will disqualify a debt security to be
subsequently reclassified to either FVTOCI or at amortized cost later on.
The following flowchart summarizes the previously discussed rules and conditions
in classifying investments in debt securities:
Did the entity apply the fair

value option?
Are the contractual cash flows

solely payment of principal
and interest?
Is the business model either

(a) held-to-maturity; or (b)
both held-to-maturity and
No - held-
held-for-selling?
for-selling
Yes - Yes -
Held-to- Both held-to-maturity
maturity and held-for-selling
Account for the Account for the Account for the

investment at investment at investment at
Amortized Cost FVTOCI FVTPL
408
The
COMPUTING THE FAIR VALUE OF INVESTMENTS IN DEBT SECURITIES

As indicated in Chapter 10, the fair value of debt securities can be computed using
either the quoted price approach and the present value approach:
Approach Description
Quoted price Face amount of the debt security x quoted price in %
approach
Present value Present value of contractual cash flows discounted
approach using the market rate on measurement date
COMPUTING FAIR VALUE USING QUOTED PRICE APPROACH

This approach is easier to execute since only one operation (i.e., multiplication) is
involved. For example, a quoted price of “101” means that the fair value of the debt
security is 101% of its face amount, while a quoted price of “98.50” means that the
fair value of the debt security is 98.50% of its face amount.
Based on this, the following relationships can be summarized:
Scenario Consequence
Quoted price > 100% Fair value > face amount
Quoted price < 100% Fair value < face amount
Illustration 4. On January 1, 2023, MELANIA Company acquired government

bonds with face amount of P2,000,000 for 100.50, equal to its quoted price.
In this case, the fair value of the government bonds is computed as P2,010,000
(P2,000,000 x 100.50%).
Illustration 5. At the beginning of 2023, NEIL Company acquired government
bonds with face amount of P3,500,000 for 99.25.
In this case, the fair value of the government bonds is computed as P3,473,750
(P3,500,000 x 99.25%).
COMPUTING FAIR VALUE USING PRESENT VALUE APPROACH

Discount rate to be used in the present value calculations shall be equal to the
market rate on the measurement date (i.e, market yield rates). This rate is
usually different from the stated rate, which determines the amount of interest
that can be actually received from the debt security.
The present value concepts discussed on noninterest-bearing notes receivable in

Chapter 5A are relevant for these computations. As a general guide, the following
present value factors are relevant:
409
The
CamScanner
Chapter 12 — Investments in Debt Securities — Introduction
Type of Debt Security Relevant Present Value Factors

a. PV factor of single payment for the
Term debt security (one-time face amount (principal) amount; and
principal payment on maturity date) | b. PV factor of ordinary annuity for the
periodic interest payments
Serial debt security (periodic
principal payments) Series of PV factors of f single payment
In addition, relationship between the discount rate and stated rate (or nominal
rate) has predetermined effects on the amounts of fair value relative to the face
amount:
Scenarios Effects
Discount rate = Stated rate Fair value = face amount
Discount rate > Stated rate Fair value < face amount or “Discount”
Discount rate < Stated rate Fair value > face amount or “Premium”
Illustration 6. On January 1, 2023, an entity acquired commercial bonds with face

amount of P4,000,000 and stated rate of 10%, to be paid every December 31 of each
year. The bonds were originally dated January 1, 2021 and will mature on
December 31, 2027. Required: Under each of the following independent scenarios,
determine the bonds’ fair value on initial recognition:
1. Market yields on January 1, 2023 averaged 10%
Scenario 1 - Market yields averaged 10% (Discount Rate = Stated Rate)
The following cash flows and the related PV factor to be used shall be identified as
follows:
a. Face amount of P4,000,000 will be received after five years (i.e., January 1, 2023
to December 31, 2027, with the original bond issue date of January 1, 2021
completely ignored). Since this cash flow will be received one-time on maturity
date, the PV factor of single payment shall be used.
b. Interest of P400,000 (P4,000,000x 10%) will be received at the end of each year.
Since there are equal amounts and equal interval of the cash flows, the PV factor
of the ordinary annuity shall be used.
The actual computation of fair value on initial recognition is as follows:
Initial Fair
Ordinary annuity for5 periodsat10% 3.790787 400,000 1,516,316
P4,000,000 = P4,000,000
410
The
Chapter 12 - Investments in Debt Securities ~ Introduction
Scenario 2 - Market yields averaged 12% (Discount Rate > Stated Rate)
Similar cash flows and number of periods as in Scenario 1 will be used in this case.
However, a discount rate of 12% will be used in the computation of fair value on
initial recognition as follows:
Initial Fair
Ordinary annuity for5 periods at12% 3.604776 400,000 1,441,910
P4,000,000 > P3,711,618
Scenario 3 - Market yields averaged 9% (Discount Rate < Stated Rate)

Similar cash flows and number of periods as in Scenario 1 will be used in this case.
However, a discount rate of 9% will be used in the computation of fair value on
initial recognition as follows:
Initial Fair
P4,000,000 < P4,155,584
COMPUTING FAIR VALUE USING DIFFERENT INTEREST PAYMENT FREQUENCIES

The previous calculations using the present value approach involve interest
payments that are received annually. What if the frequency of interest payments
becomes semi-annually or quarterly? The same principles apply but modifications
to the discount rate and the number of periods will be necessary as follows:
Modifications Depending on Interest Frequency
Semi-annual Quarterly
Discount rate Market yield divided by 2 | Market yield divided by 4
Number of periods Remaining years times 2_| Remaining years times 4
Periodic interest to be | Annual amount based on | Annual amount based on
received stated rate divided by 2 stated rate divided by 4
Illustration 7. Consider a P100,000 face amount debt security bearing an interest

of 8% per annum with maturity of five (5) years was purchased last January 1, 2023.
Required: Under each of the following independent scenarios, determine the initial
fair value of the investment in debt security:
1, Interest is payable semi-annually and market rates averaged 10%
2. Interest is payable semi-annually and market rates averaged 6%
3. Interest is payable quarterly and market rates averaged 10%
4. Interest is payable quarterly and market rates averaged 6%
411
The
Scenario 1 - Interest is payable semi-annually; Market rates averaged 10%

The inputs in the present value calculations are determined as follows:
Discount rate 5% (10%/2)
Number of periods 10 semi-annual periods (5 years x 2)
Semi-annualinterest P4,000 /(P100,000 x 8%)/2]
Based on these inputs, initial fair value can now be computed as follows:
Initial Fair
PV Factor of PVFactor Cash Flow Value
Single payment for 10 periods at 5% 0.613913 P100,000 P61,391
Ordinary annuity for 10 periodsat5% 7.721735 4,000 30,887
P92,278
Scenario 2 - Interest is payable semi-annually; Market rates averaged 6%

Semi-annualinterest __P4,000 /(P100,000 x 8%)/2]
Initial Fair
P108,530
Scenario 3 - Interest is payable quarterly; Market rates averaged 10%

Discount rate 2.50% (10%/4)
Number of periods 20 quarterly periods (5 yearsx 4)
Quarterly interest P2,000 /(P100,000 x 8%)/4]
Initial Fair
Single payment for 20 periods at 2.50% 0.610271 P100,000 P61,027
Ordinary annuity for 20 periods at 2.50% 15.589162 2,000 31,178
P92,205
Scenario 4 - Interest is payable quarterly; Market rates averaged 6%

_ The inputs in the present value calculations are determined as follows:
412
The
Discount rate 1.50% (6%/4)

Number of periods 20 quarterly periods (5 yearsx 4)
Quarterly interest P2,000 /(P100,000 x 8%)/4]
Initial Fair
Single payment for 20 periods at 1.50% 0.742470 P100,000 P74,247
Ordinary annuity for 20 periods at 1.50% 17.168639 2,000 34,337
P108,584
COMPUTING FAIR VALUE OF SERIAL DEBT SECURITIES

In computing for the initial fair value of serial debt securities or those which have
periodic principal payments, the readers may use the following guide:
1. First, compute for the amount of cash flows (principal and interest) that will be
received over the term of the debt security. It is important to note that the
amount of interest that will be received is decreasing since the principal is also
decreasing.
2. Next, determine the timing of these cash flows.
3. Next, compute for the related PV factor of single payment, related to each cash
flow based on the timing of each receipt and using the market rate of interest on
measurement date.
4. Lastly, multiply each PV factor with each cash flow to arrive to their
corresponding PV amount. Aggregate these PV amounts to ultimately determine
the initial fair value of serial debt securities.
Illustration 8. On January 1, 2023, OSCAR Company acquired a P4,000,000 face

amount debt security with term of four years, with the P1,000,000 portion of
principal to be received every December 31 of each year, starting in 2023. This debt
security bears 10% and to be received at the same time with principal payments.
Assuming that the market rates averaged 11% on January 1, 2023, determine the
initial fair value of the debt security.
1. Determine the amounts and timing of cash flows:
[A] Beg. [B]Interest TotalCash Date tobe No. of
Face Amounts Inflows Received Periods
Year Amount [A]x10% [B]+P1M_ (Timing) from1/1/23
2023 P4,000,000 P400,000 P1,400,000 12/31/23 1 period
2024 3,000,000 300,000 1,300,000 12/31/24 2 periods
2025 2,000,000 200,000 1,200,000 12/31/25 3 periods
2026 — 1,000,000 100,000 1,100,000 12/31/26 4 periods
413
The
2. Determine the PV factors of single payment using the number of periods

determined above and 11% discount rate. After this, PV amounts can now be
Initial Fair
PV Factor of PVFactor Cash Flow Value
Single payment for 1 period at 11% 0.900901 P1,400,000 P1,261,261
Single payment for 2 periods at 11% 0.811622 1,300,000 1,055,109
Single payment for 3 periods at 11% 0.731191 1,200,000 877,429
Single payment for 4 periods at 11% 0.658731 1,100,000 724,604
P3,918,403
CHAPTER SUMMARY
1. Investments in debt securities are accounted for based on BOTH of the following:
a. the business model of managing the financial asset; and
2.. Incorporating both the business model and contractual cash flow characteristics
(“SPPI test”), the debt securities can be accounted for as follows:
Accounting classification
Business model 7 Passed SSPI Test | Failed SPPI Test
Held-for-selling FVTPL FVTPL
Both held-to-maturity and held- FVTOCI FVTPL
for-selling
Held-to-maturity Amortized cost FVTPL
“Passed” means the contractual cash flows contain principal and interest only (i.e.,
not other form of cash flows).
3. Depending on the entity’s circumstances, it can have more than one business model.
Consequently, it can account some ofits debt securities at FVTPL, some at amortized
cost and some at FVTOCI.
4. Despite of the business model and contractual cash flow characteristics, an entity,
on initial recognition, may irrevocably designate investments in debt securities at
FVTPL.
5. The following formula is relevant in determining the fair value of debt securities
when using quoted prices: Fair value = Quoted prices x Face amount.
6. The following are the inputs when using the present value approach in determining
the fair value of debt securities:
a. Amounts and timing of cash flows.
b. Discount rate, which is equal to market rates on measurement date.
7. The PV factors to be used will depend on the amounts and timing of cash flows of the
debt securities:
414
The
The Book
Type of Debt Security Relevant Present Value Factors

a. PV factor of single payment for the
Term debt security (one-time
face amount (principal) amount; and
principal payment on maturity
b. PV factor of ordinary annuity for the
date)
periodic interest payments
Serial debt security (periodic
Series of PV factors of single payment
principal payments)
8. The relationship between the discount rate and stated rate have the following
predetermined effects to the fair value and face amount of the debt securities:
Scenarios Effects
Discount rate = Stated rate Fair value = face amount
Discount rate > Stated rate Fair value < face amount or “Discount”
Discount rate < Stated rate Fair value > face amount or “Premium”
9. If the frequency of interest payments is quarterly or semi-annually, the following

modifications shall be made to the inputs of PV factor calculation:
Modifications Depending on Interest Frequency
Semi-annual Quarterly
Discount rate Market yield divided by 2_| Market yield divided by 4
Number of periods Remaining years times 2_| Remaining years times 4
Periodic interest to be | Annual amount based on | Annual amount based on
received stated rate divided by 2 stated rate divided by 4
415
bei:
The
True or False
1. Investments in debt securities are less risky compared to investments in equity
securities.
2. Anentity can voluntarily choose the accounting classification of its investments in
debt securities based solely on its discretion.
3. Considering only the business model, an investment in debt security that is held to
collect the amounts of interest and principal until maturity shall be accounted for
at FVTOCI.
4. If the contractual cash flow characteristics of an investment in debt security is
composed of additional amounts aside from principal and interest, it shall be
automatically accounted for at FVTPL, regardless of the related business model.
5. On initial recognition, an entity may irrevocably designate its investment in debt
securities at FVTOCI.
6. Indetermining the fair value of a debt security, its face amount shall be divided by
the quoted price as expressed in percentage.
7. If a quoted price expressed as a percentage is less than 100%, then the debt
security’s fair value is also less than its face amount.
8. Ifthe market rate is lower than the stated rate, then the debt security’s fair value is
higher than its face amount.
9. Indetermining the fair value of a debt security with quarterly interest payment and
using the present value approach, the number of years shall be multiplied by 4 in
determining the number of periods to be used in calculating the PV factor.
10. The amount of annual interest cash flows from serial debt securities is increasing
every year.

1. All of the following are characteristics of debt securities, except
a. Return on investment includes dividends
b. More steady returns
c. Less risky compared to equity
d. Liabilities of the issuing entity
2. In classifying debt securities for accounting purposes, which of the following shall
be considered?
a. Business model of managing cash flows.
b. Characteristics of contractual cash flows.
c. Bothaandb,
d. Either aand b.
3. In assessing an entity's business model, the following are correct, except
a. Business model shall be based on what is actually happening rather than the
management's intention.
b. The assessment shall be on an investment-by-investment basis.
c. The assessment shall not incorporate the worst-case scenarios.
416
The
The Book
Chapter 12 - Investments.in Debt Securities - Introduction
4. Inone ofanentity’s portfolios, debt securities are acquired and sold immediately to
realize short-term profits, These debt securities shall be accounted for as
a. FVTPL
b. FVTOCI
c. Amortized cost
d. Any of the above based on entity's discretion
5. Anentity had the following investments in debt securities acquired during the year:
Business Model SPPI Test
Investment 1 Held-to-maturity Failed
Investment 2 Held-to-maturity Passed
Which of the following correctly describes the accounting treatment for these
investments?
a. Investment 1: Amortized Cost; Investment 2: Amortized Cost
b. Investment 1: FVTPL; Investment 2: Amortized Cost
c. Investment 1: FVTOCI; Investment 2: Amortized Cost
d. Investment 1: Amortized Cost; Investment 2: FVTPL
6. An entity had the following investments in debt securities acquired during the year:
Investment 1 Held-for-selling Failed
Investment 2 Held-for-selling Passed
investments?
a. Investment 1: Amortized Cost; Investment 2: Amortized Cost
b. Investment 1: FVTPL; Investment 2: Amortized Cost
c. Investment 1: FVTOCI; Investment 2: FVTOCI
d. Investment 1: FVPTL; Investment 2: FVTPL
7. An entity had the following investments in debt securities acquired during the year:
Investment 1 Both held-to-maturity and Passed
held-for-selling
Investment 2 Both held-to-maturity and Failed
held-for-selling
investments?
a. Investment 1: Amortized Cost; Investment 2; FVTOCI
b. Investment 1: FVTPL; Investment 2: FVTOCI
c. Investment 1; FVTOCI; Investment 2; FVTOCI
d. Investment 1; FVTOCI; Investment 2; FVTPL
417
The
The Book
8. Anentity had the following investments in debt securities acquired during the year:
Business Model Remarks
Investment 1 Held-to-maturity Convertible into
issuer’s shares
Investment 2 Both held-to-maturity and Very plain debt
held-for-selling security
investments?
a. Investment 1: Amortized Cost; Investment 2: FVTOCI
b. Investment 1: Amortized Cost; Investment 2: FVTPL
c. Investment 1: FVTPL; Investment 2: FVTOCI
d. Investment 1: FVTPL; Investment 2: FVTPL
. When using the quoted price approach in determining the fair value of debt
securities, the following are correct, except
a. Ifthe quoted price is higher than 100%, the face amount is lower than the fair
value.
b. If the quoted price is lower than 100%, the fair value is lower than the face
amount.
c. The quoted price shall be multiplied to the face amount to determine the debt
security’s fair value.
10. In using the present value approach in determining the fair value of debt securities,
the following are correct, except
a. For term debt securities, PV factor of single payment is applied to the face
amount in determining the debt security’s fair value.
b. For serial debt securities, a series of PV factors of single payments is applied to
the unequal amounts of cash flows.
c. Forterm debt securities, the amount of interest cash flow to which the PV factor
of ordinary annuity is applied shall be based on the market rate on
measurement date.
d. For serial debt securities, the amount of annual interest cash flows decreases
every year.
11.In assessing the business model of managing financial assets, the following are
correct, except
a. A single entity may have more than one business model for managing its
financial instruments,
b. The entity's business model does not depend on management's intentions for
an individual instrument.
c. An entity's business model refers to how an entity manages its financial assets
in order to generate cash flows.
d. The business model assessment considers worst case or stress case scenarios.
418
in !
The
12.The following are the correct bases in assessing the business model of an entity,
except
a. Anentity’s business model for managing financial assets is a matter of fact and
not merely an assertion.
b. Howthe performance of business model and the financial assets held within that
business model are evaluated and reported.
c. The risks affecting the performance of business model and the management of
such risks.
d. The amount of the total investment for the assets in the business model relative
to the total assets of the entity.
13.Which of the following provisions is inconsistent with hold to collect business
model?
a. Sales have occurred to take profits from sudden increases in the financial assets’
fair value.
b. The funding needs of the entity are predictable, and the maturity of its financial
assets is matched to the entity’s estimated funding needs.
c. Sales have typically occurred when the financial assets’ credit risk has increased.
d. Infrequent sales have occurred as a result of unanticipated funding needs.
e. Reports to key management personnel focus on the credit quality of the financial
assets and the contractual return.
14. Contractual cash flows that are solely payments of principal and interest on the
principal amount outstanding are consistent with a basic lending arrangement.
Which of the following are not consistent with basic lending agreement?
a. Time value of money
b. Liquidity risk
c. Creditrisk
d. Leverage
15. Which of the following is/are consistent with basic lending agreement?
1. Administrative costs
I]. Profit margins
a. lonly
b. Il only
c. BothlandII
d. Neither J nor II
Straight Problems
1. As of December 31, 2023, ROD Company had the following investments in equity
securities with the following information:
Security MaturityDate FaceAmount Interest Rate Quoted Price
1 12/31/28 P8,000,000 9% 97.55%
2 12/31/26 5,000,000 10% 102,35%
2 12/31/29 4,000,000 12% 99.25%
4 12/31/30 7,000,000 8% 104.75%
419
The
CamScanner
_ Required: Using the quoted price approach, determine each of the debt securities’
fair value
2. At the beginning of 2023, STEVE Company acquired a five-year government bond
with face amount of P6,000,000 and maturity date of December 31, 2026. The bonds
bear interest of 10% even though the market rates average 12% on the acquisition
date. Under each of the following independent scenarios, determine the fair value of
the government bonds on January 1, 2023:
1. The interest is payable every December 31 of each year.
2. The interest is payable every June30 and December 31 of each year.
3. The interest is payable every March 31, June 30, September 30 and December
31 each year.
3. On January 1, 2023, JOBS Company acquired seven-year corporate bonds with face
amount of P5,000,000 and dated January 1, 2021. The bonds bear 9% interest even
though the market rates averaged 7% on the date of acquisition. Under each of the
following independent scenarios, determine the fair value of the government bonds
on January 1, 2023:
31 each year.
4. Atthe beginning of 2023, CONSTANTINE Company acquired a ten-year government

bond with face amount of P7,000,000 and maturity date of December 31, 2025. The
bonds bear interest of 8% even though the market rates average 10% on the
acquisition date. Under each of the following independent scenarios, determine the
fair value of the government bonds on January 1, 2023:
31 each year.
5. On January 1, 2023, AUGUSTUS Company acquired eight-year corporate bonds with

face amount of P4,000,000 and dated January 1, 2020. The bonds bear 11% interest
even though the market rates averaged 9% on the date of acquisition. Under each of
the following independent scenarios, determine the fair value of the government
bonds on January 1, 2023:
31 each year,
6. At the beginning of 2023, JULIUS Company acquired the newly issued five-year
government bonds with face amount of P5,000,000 and nominal rate of 9%, The face
amount is payable in annual installments of P1,000,000 every December 31 of each
420
The
The Book
year. Annual interest is also payable at the same dates as the principal amounts.
Under each of the following independent scenarios, determine the fair value of the
bonds on January 1, 2023:
1. Market rates averaged 12% on January 1, 2023
2. Market rates averaged 7% on January 1, 2023.
7. On January 1, 2023, CEASAR Company acquired a six-year corporate bonds

originally dated January 1, 2021. The bonds have remaining face amount of
P8,000,000 and is payable in equal annual installments every December 31 of each
year. As of the date of acquisition, the issuer of the bonds has already paid two years’
worth of principal repayments. Interest of 8% is also payable at the same dates as
the principal amounts. Under each of the following independent scenarios,
determine the fair value of the bonds on January 1, 2023:
1. Market rates averaged 10% on January 1, 2023
2. Market rates averaged 6% on January 1, 2023.
421
The
Chapter 12A — Investments in Debt Securities - FVTPL
CHAPTER 12A
INVESTMENTS IN DEBT SECURITIES - FVTPL

i; The initial measurement of investment in debt securities at FVTPL.
2. The subsequent measurement of investment in debt securities at FVTPL.
3. The amount of interest income from investment in debt securities at FVTPL.
4 The fair value computation of investment in debt securities on initial recognition
depending on different circumstances.
5. The accounting for the sale of debt securities accounted for at FVTPL.
INVESTMENTS IN DEBT SECURITIES ACCOUNTED FOR AT FVTPL

Under this classification the following accounting procedures are relevant:
a. At end of each reporting period, the investments shall be carried at their fair values
as of those dates.
b. Changes in fair value from one reporting date to another shall be reported as
unrealized gain or loss in profit or loss. Increase in fair value is recognized as
unrealized gain while decrease in fair value is recognized as unrealized loss.
Realized gain or loss on actual disposal shall be reported in profit or loss.
Interest income is computed using the stated or nominal interest rate multiplied
by the face amount.
There shall be no amortization of the premiums or discount amounts as there
will be no tracking of the difference between the initial fair value and the face
amount of the debt security.
These rules and procedures shall be applied regardless of whether the FVTPL is a default
classification or as irrevocable designation on initial recognition.
Illustration 1 - Quoted Price Approach. On January 1, 2023, MAHARLIKA

Company purchased 6% interest-bearing debt security with a face amount of
P1,000,000 for 110. Transaction costs amounted to P11,500. Interest is to be paid
every December 31 of each year while maturity date is set at December 31, 2027.
The debt security is to be accounted for as at FVTPL. Quoted prices as of December
31, 2023 and 2024 were 115 and 105, respectively. Required: Determine the
journal entries for 2023 to 2024.
Year 2023
On January 1, 2023, the purchase is recorded as follows:
Financial asset at FVTPL (P1Mx110%) 1,100,000
Transaction costs (expense) 11,500
Cash 1,111,500
422
The
CamScanner
Chapter 12A - Investments in Debt Securities - FVTPL
The readers should recall that the transactions costs are not included in the initial
measurement of FVTPL category, but shall be expensed outright.
On December 31, 2023 to record the interest income of P60,000:
Cash 60,000
Interest income (P1M x 6%) 60,000
Also, on December 31, 2023, to recognize the investment at its fair value of
P1,150,000 (P1,000,000 x 115%) and recognize increase in fair value of P50,000
(P1,150,000 - P1,100,000):
For 2023, the net amount to be reported in profit or loss, as far as the investment is
concerned, is P98,500 net income (P60,000 + P50,000 - P11,500).
Year 2024
Fast forward to December 31, 2024 to record the interest income of P60,000:
Cash 60,000
Also, on December 31, 2024, to recognize the investment at its fair value of
P1,050,000 (P1,000,000 x 105%) and recognize decrease in fair value of P100,000
(P1,050,000 - P1,150,000):
concerned, is P40,000 net loss (P60,000 - P100,000).
Illustration 2 - Present Value Approach. On January 1, 2023, DUGONG-BUGHAW
Company purchased a 7% interest-bearing debt security with face amount of
P1,000,000 when market yield rates averaged 8%. Interest is to be paid every
December 31 of each year while maturity date is set at December 31, 2027. The debt
security is to be accounted for as at FVTPL. Market yields as of December 31, 2023
and 2024 averaged 9% and 8.50%, respectively. Required: Determine the journal
entries for 2023 to 2024.
Year 2023
The amount of transaction price, which is equal to the debt security's initial fair
value, shall be determined by applying present value approach as follows:
423
The
PV Factor of PV Factor CashFlow Fair Value

Single payment for 5 periods at 8% 0.680583 P1,000,000 P680,583
Ordinary annuity for 5 periods at8% 3.992710 70,000 279,490
Initial fair value, 1/1/23 P960,073
Note: 1/1/23 to 12/31/27 is 5 years; hence, 5 periods.
On January 1, 2023, the purchase is recorded as follows:

Cash 960,073
On December 31, 2023, to record the interest income of P70,000:

Cash 70,000
Also, on December 31, 2023, the debt security shall be measured at its fair value as
of that date, which is computed as follows:
Fair value, 12/31/23 P935,205
Less: Fair value, 1/1/23 960,073
Decrease in fair value (unrealized loss) P24,868
Note: 12/31/23 to 12/31/27 is 4 years; hence, 4 periods. In addition, 9% is the market yield as
of 12/31/23.
This amount of unrealized loss shall be recorded as follows:
concerned, is P45,132 net income (P70,000 - P24,868).
- Year 2024
Fast forward to December 31, 2024, to record the interest income of P70,000:
Cash 70,000
Also similar to 2023, on December 31, 2024, the debt security shall be measured at
its fair value as of that date, which is computed as follows:
424
The
The Book
Chapter 12A — Investments in Debt Securities —- FVTPL
PV Factor of PV Factor Cash Flow Fair Value

Single payment for 3 periods at 8.50% 0.782908 —P1,000,000 P782,908
Ordinary annuity for 3 periods at 8.50% 2.554022 70,000 178,782 |
Fair value, 12/31/24 P961,690
Less: Fair value, 12/31/23 935,205
Increase in fair value (unrealized gain) P26,485
Note: 12/31/24 to 12/31/27 is 3 years; hence, 3 periods. In addition, 8.50% is the market yield as
of 12/31/24.
This amount of unrealized loss shall be recorded as follows:

concerned, is P96,485 net income (P70,000 + P26,485).
FAIR VALUE COMPUTATIONS NOT ON INTEREST PAYMENT DATE

So far, the computations of PV in the previous illustrations are either computed as
of the issue date of the debt security or as of interest payment date every December
31. In the actual world, debt securities can be issued by an entity on any trading
date.
For example, a debt security can be issued on July 1, 2023 with annual interest
payable every June 30 of each year. How should its fair value be computed as of
December 31 of each year?
When using the quoted price approach, no additional and complicated computations
will arise. However, when using the present value approach, additional procedures
will be made.
The principles that were previously discussed involving the computation of fair
value using the PV approach are all still relevant, but with the following
modifications:
1. The PV computations are made as of the immediately preceding interest
payment date, or if earlier, issue date.
For example, if the annual interest payments are made every September 30 and
its fair value as of December 31, 2023 needs to be computed, the present value
of cash flows shall be computed as of September 30, 2023 (i.e., the immediately
preceding interest payment date).
Despite of this, the readers should take note that we will be using the market
rate as of the reporting date since we are actually computing the debt
Security's fair value as of that date.
425
The
CamScanner
Chapter 12A - Investments in Debt Securities —- FVTPL
2. After computing the initial PV as of the immediately preceding interest payment

date, the initial PV shall be partially amortized until the reporting date. This
partial amortization will not be recorded as it is made for the purposes of
computing the fair value only.
Continuing with the example, the initial PV computed as of September 30, 2023
shall be adjusted by partially “amortizing” it up to December 31, 2023. The
adjusted amount is now the fair value of the debt security as of December 31,
2023 reporting date.
Illustration 3. On October 1, 2023, DAKILA Company purchased a debt security

with a face value of P2,000,000, when the prevailing market rate is 10%. The debt
security bears interest of 8% payable every September 30 of each year. Maturity
date is on September 30, 2027. Determine the fair value as of December 31, 2023
and 2024 assuming the relevant market rates were 9% and 9.50%, respectively.
Fair Value as of December 31, 2023
As of this reporting date, the immediately preceding interest payment date was
September 30, 2023. Consequently, the initial PV as of September 30, 2023 is
PV Factor of j PV Factor CashFlow Fair Value
Ordinary annuity for4 periods at9% 3.239720 160,000 518,355
Initial PV amount P1,935,205
Note: 9/30/23 to 9/30/27 is 4 years; hence, 4 periods. In addition, 9% market yield as of
12/31/23 (the relevant reporting date) shall be used as the discount rate (not the 10%).
P160,000 = P2,000,000 x 8% stated rate.
This initial PV amount shall be “partially amortized” from September 30, 2023 to
December 31, 2023 (i.e., 3 months):
Initial PV, 9/30/23 P1,935,205
Add: Discount rate amount (P1,935,205 x 9% x 3/12) 43,542
Less: Stated rate amount (P2,000,000 x 8% x 3/12) (40,000)
Final fair value, 12/31/23 P1,938,747
Fair Value as of December 31, 2024

As of this reporting date, the immediately preceding interest payment date was
September 30, 2024. Consequently, the initial PV as of September 30, 2024 is
PV Factor of PVFactor CashFlow Fair Value

Single payment for 3 periods at 9.50% 0.761654 2,000,000 P1,523,308
Ordinary annuity for 3 periods at9.50% — 2.508907 160,000 401,425
Initial PVamount — P1,924,733
426
The
CamScanner
Note: 9/30/24 to 9/30/27 is 3 years; hence, 3 periods. In addition, 9.50% market yield as of
12/31/24 (the relevant reporting date) shall be used as the discount rate.
This initial PV amount shall be “partially amortized” from September 30, 2024 to
December 31, 2024 (i.e., 3 months);
Initial PV, 9/30/24 P1,924,733
Add: Discount rate amount (P1,924,733 x 9.50% x 3/12) 45,712
Final fair value, 12/31/24 P1,930,445
ACQUISITION OF INVESTMENT NOT ON INTEREST PAYMENT DATE

The previous examples showed the debt securities were all purchased at the issue
date or at the interest payment date. More likely than not, debt securities that are
traded in the bond market are usually purchased (traded) subsequent to the issue
date and not on each interest payment dates.
In this case, accrued interest from the immediately preceding interest payment
date until the acquisition date shall be paid to the counterparty in addition to
the fair of the debt security itself. Consequently, the following terms will be
introduced:
a. Clean price - fair value of the debt security
b. Dirty price - fair value of the debt security plus the accrued interest
The reason for the additional accrued interest is that the seller gave up its right to
receive the full amount of interest in the immediately succeeding interest payment
date, which the purchaser will receive fully.
Illustration 4 - Quoted Price Approach. On September 1, 2023, LAKANDULA
Company acquired a commercial bond with face amount of P3,000,000 and stated
rate of 12% at a clean price of 99. Required: Under each of the following
independent scenarios, determine the journal entry to record the acquisition and
the receipt of interest on December 31, 2023:
1. The interest is payable annually every December 31 of each year.
2. The interest is payable semi-annually every June 30 and December 31 of each
year.
Scenario 1 - Annual Interest Payments
In this scenario, the immediately preceding interest payment date as of September
1, 2023 is December 31, 2022. Consequently, the accrued interest that shall be paid
to the seller is for eight (8) months (December 31, 2022 to September 1, 2023).
Journal entry to record the acquisition on September 1, 2023 is as follows:
Financial asset at FVTPL (P3Mx 99%) 2,970,000
Interest receivable (P3M x 12% x 8/12) 240,000
Cash 3,210,000
427
The
Based on the above entry, P2,970,000 is considered as the “clean price”, while
P3,210,000 is considered as the “dirty price”.
The receipt of one-year interest on December 31, 2023 is recorded as follows:
Cash (P3M x 12%) 360,000
Based on this, it can be viewed that the previously paid accrued interest to the
seller has been “reimbursed” by the receipt of the full amount of interest. In
addition, the Company shall recognize interest income only during the period it
held the commercial bond. In this illustration, this is four (4) months, from
September 1, 2023 to December 31, 2023.
Scenario 2 - Semi-Annual Interest Payments
In this scenario, the immediately preceding interest payment date as of September
1, 2023 is June 30, 2023. Consequently, the accrued interest that shall be paid to the
seller is for two (2) months (June 30, 2023 to September 1, 2023). Journal entry to
record the acquisition on September 1, 2023 is as follows:
Financial asset at FVTPL (P3Mx 99%) 2,970,000
Cash 3,030,000
Based on the above entry, P2,970,000 is considered as the “clean price”, while
P3,030,000 is considered as the “dirty price”.
The receipt of six-month interest on December 31, 2023 is recorded as follows:
Cash (P3Mx 12%x 6/12) 180,000
The four (4) months used in interest income computation above is from September
1, 2023 to December 31, 2023 (i.e., same holding period as with Scenario 1). In
addition, there is only six-month worth of interest received on December 31, 2023
since the other six-month interest was already received on June 30, 2023.
Illustration 5 - Present Value Approach. On April 1, 2023, DAKILA Company
purchased a debt security with a face amount of P2,000,000 and maturity of June
30, 2026. The debt security was originally issued last July 1, 2021 and had 9%
interest to be paid annually every June 30 of each year. The debt security was
purchased when the prevailing market rate of interest was 10%, plus the accrued
interest. Determine the journal entries for the April 1, 2023 acquisition and June 30,
2023 receipt of interest.
428
The
April 1, 2023 - Date of Purchase

As of this date, the immediately preceding interest payment date was June 30, 2022.
Consequently, the initial PV as of June 30, 2022 is computed as follows:
Ordinary annuity for 4 periods at 10% 3.169865 180,000 570,576
Initial PVamount _P1,936,602
Note: 6/30/22 to 6/30/26 is 4 years; hence, 4 periods. In addition, 10% market yield as of
4/1/23 (the purchase date) will be used as the discount rate. P180,000 = P2,000,000x 9% stated
rate.
This initial PV amount shall be “partially amortized” from June 30, 2022 to April
1, 2023 (i.e. 9 months):
Initial PV, 6/30/22 P1,936,602

Add: Discount rate amount (P1,936,602 x 10% x 9/12) 145,245
Final fair value, 4/1/23 (clean price) P1,946,847
The purchase can now be recorded as follows:
Financial asset at FVTPL (clean price) 1,946,847
Cash (dirty price) 2,081,847
Again the 9-month period used in the computation of interest receivable and
interest income is from June 30, 2022 to April 30, 2023.
June 30, 2023 - Receipt of Interest

The receipt of one-year interest is recorded as follows:
Cash (P2Mx 9% x 12/12) 180,000
Interest income (P2M
x 9% x 3/12) 45,000
The three (3) months used in interest income computation above is from April 1,
2023 to June 30, 2023, the period during which the Company held the bonds.
SALE OF INVESTMENT ON INTEREST PAYMENT DATE

When the investments are sold, any difference between the proceeds received and
the carrying amount will be reported as realized gain or loss in profit or loss:
Scenario Gain or Loss?

Proceeds > Carrying Amount | Realized gain on sale
Proceeds < Carrying Amount | Realized loss on sale
429
The
The Book
The carrying amount indicated above is equal to the investment’s fair value in the
immediately preceding reporting date, or if the investment was acquired only
during the current period, fair value as of the initial measurement date.
When the investment is partially sold, the realized gain or loss is computed as the
difference between the proceeds received and the aliquot portion of the carrying
amount pertaining to the sold portion. From the date of partial sale of investment
and moving forward, the amount of interest and changes in fair value will be
based on the remaining unsold portion of the investment.
Illustration 6. On July 1, 2023, BLUEBLOOD Company purchased P1,000,000 of
bonds to be carried at FVTPL at its fair value of 97. The bonds will mature on July 1,
2028 and had interest of 9% payable every July 1 of each year. On July 1, 2024,
P300,000 of the bonds were sold for 110. On July 1, 2026, the remaining bonds were
sold for 115.25. The fair value of the bonds as of December 31, 2023, 2024, and
2025 were 99, 105 and 120, respectively. Required: Prepare the journal entries to
record the July 1, 2024 and July 1, 2026 sales.
July 1, 2024 Sale at 110

As of this date, the carrying amount of the investment in bonds amounted to
P990,000 (P1,000,000x 99% quoted price as of 12/31/23, the immediately preceding
reporting date). Consequently, the carrying amount of the portion sold is computed
as P297,000 (P990,000 x P300K/P1M). Journal entry to record this partial sale is as
follows:
Cash (P300,000x 110%) 330,000
After this sale, the remaining face amount of the bonds will now be P700,000
(P1,000,000 - P300,000). In addition, annual interest income of P63,000 (P700,000
x 9%) shall now be based on this reduced face amount. Lastly, moving forward, the
unrealized gains and losses shall now be determined based on the P700,000 face
amount.
July 1, 2026 Sale at 115.25
As of this date, the carrying amount of the investment in bonds amounted to
P840,000 (P700,000 x 120% quoted price as of 12/31/25, the immediately preceding
reporting date). Journal entry to record the sale of the remaining portion is as
follows:
Cash (P700,000x 115.25%) 806,750
Loss on sale - P/L (squeeze) 33,250
430
The
SALE OF INVESTMENT NOT ON INTEREST PAYMENT DATE

The same principles when the investment is sold on interest payment date also
applies in this case. However, additional amounts related to the accrued
interest will be received from the buyer. This accrued interest runs from the
immediately preceding interest payment date up to the date of sale.
This concept is similar to the additional interest paid when buying an investment
not on interest payment date, albeit the perspective is now with the seller. The
entity, as the seller, gave upthe right to receive the full amount of interest in the
immediately succeeding interest payment date.
To reiterate, the total amount (inclusive of accrued interest) to be received from the
buyer is called the “dirty price” while the amounts to be received on account of the
investment itself is called the “clean price’.
Illustration 7. On October 1, 2023, NOBLE Company purchased P800,000 of bonds
to be carried at FVTPL at its fair value of 101. The bonds will mature on September
30, 2028 and had interest of 8% payable every September 30 of each year. Fair
value of the bonds amounted to 100.50 as of December 31, 2023. Required: Under
each of the following independent scenarios, determine the journal entry to record
the sale of the bonds:
1. The bonds were sold on March 31, 2024 at 107, including accrued interest.
2. The bonds were sold on June 30, 2024 at 99, plus accrued interest.
Scenario 1 - March 31, 2024 Sale
Before focusing on the sale transaction, it is crucial to know the journal entry to be
made as of December 31, 2023 related to the accrual of interest from October 1,
2023 to December 31, 2023 as follows:
Interest income (P800,000
x 8% x 3/12) 16,000
Fast forward to March 31, 2024, the carrying amount as of this date amounted to
P804,000 (P800,000x 100.50%) based on the immediately preceding reporting date
of December 31, 2023. Journal entry to record the sale is as follows:
Cash (P800,000x 107%) 856,000
Interest receivable (as of 12/31/23) 16,000
Interest income (P800,000x 8% x 3/12) 16,000
Total cash received is equal to P856,000 since the selling price of 107 already
included the accrued interest (ie, already the dirty price), In addition, interest
income of P16,000 is for the period January 1, 2024 to March 31, 2024,
Gain on sale can also be computed as follows:
431
The
Total proceeds or dirty price (P800,000x 107%) P856,000

Less: Accrued interest portion from Oct 1, 2023 to
Mar 31, 2024 (P800,000 x 8% x 6/12) 32,000
Portion pertaining to investment (clean price) P824,000
Less: Carrying amount of the investment 804,000
Gain on sale P20,000
Scenario 2 - June 30, 2024 Sale

The same analysis as in Scenario 1 is still relevant in this scenario regarding the
amounts of accrued interest receivable (i.e, P16,000) and carrying amount of the
investment (i.e, P804,000), both as of December 31, 2023.
Specific to this scenario, since the amount of accrued interest is not yet included
in the selling price (i.e, 99%), the total amount of cash received from the sale
(i.e., the dirty price) shall be computed as follows:
Clean price (P800,000x 99%) P792,000
Accrued interest from 10/1/23 to 6/30/24 (P800,000
x 8% x 9/12) 48,000
Total cash received from selling the investment (dirty price) P840,000
Journal entry to record the sale under this scenario is as follows:
Cash (dirty price) 840,000
Interest receivable (as of 12/31/23) 16,000
Interest income (P800,000 x 8% x 6/12) 32,000
Interest income of P32,000 is for the period January 1, 2024 to June 30, 2024. Loss
on sale can also be computed as follows:
Clean price (P800,000x 99%) P792,000
Less: Carrying amount of the investment 804,000
Loss on sale P12,000
CHAPTER SUMMARY
1. Investments in debt securities measured at FVTPL shall be measured at their fair
value. Transaction costs shall be expensed outright,
2. Investments in debt securities at FVTPL shall be measured at their fair values as of
each reporting date. Changes in fair value are recorded in profit or loss.
3. Interest income from investment in debt securities at FVTPL is measured as face
amountx stated or nominal rate x period of time the investment is held.
4. In acquiring and selling investment in debt securities not on interest payment date,
accrued interest shall be considered in determining the investment's initial
measurement and realized gain or loss on sale, respectively.
5. Realized gain or loss on sale of FVTPL debt securities shall be recognized in profit or
loss.
432
The
CamScanner
m
True or False
i, FVTPL debt securities are initially measured at fair value plus transaction costs.
Z: Interest income for FVTPL debt securities shall be based on its beginning-of the-
period carrying amount times the stated or nominal rate.
ss Changes in the fair value of FVTPL debt securities shall be recognized in profit or
loss.
Realized gains and losses from selling FVTPL debt securities shall be recognized in
profit or loss.
The amount of realized gain or loss on sale of FVTPL debt securities shall be the
difference between the proceeds received, including the accrued interest and the
carrying amount of the debt securities sold.
If a debt security is acquired not on an interest payment date, a portion of the
purchase price shall be allocated to the accrued interest receivable.
Interest income is automatically equal to the amount of interest received.
Dirty price is equal to the fair value of debt security less the amount of accrued
interest.
If a debt security is sold not on an interest payment date, the investor shall not
recognize interest income during the period from the immediately preceding
interest payment date until the date of sale.
10. The investor holding a debt security on an interest payment date shall receive the
whole amount of periodic interest, even if it originally acquired the debt security
not on an interest payment date.
Multiple Choice - Multiple Choice
i. On initial recognition, FVTPL debt securities shall be measured at their
a. Fair value.
b. Fair value plus transaction costs incurred in acquiring the security.
c. Far value less transaction costs that are expected to be incurred assuming the
security is to be sold.
d. Fair value less transaction costs incurred in acquiring the security.
At the end of each year, FVTPL debt securities shall be measured at their
a. Fair value.
d. Fair value less transaction costs incurred in acquiring the security.
. Which of the following formula correctly describes the manner of determining the
amount of interest income from FVTPL debt securities?
a. Interest income = Face amount x Market rate of interest on initial recognition
b. Interest income = Face amount x Stated rate or nominal rate
c. Interest income = Fair value x Market rate of interest on initial recognition
d. Interest income = Fair value x Stated rate or nominal rate
433
The
CamScanner
4. On January 1, 2023, an entity acquired a 10% interest-bearing debt security when

market rates averaged 9%, Fast forward to December 31, 2023, the market rates
averaged 8%. The rate to be used in determining interest income for 2023 and
carrying amount of the debt security as of December 31, 2023 shall be
a. 10% and 9%, respectively.
b. 9% and 8%, respectively.
c. 10% and 8%, respectively.
d. 9% and 10%, respectively.
In determining the amount of realized gain or loss from selling FVTPL debt securities
on an interest payment date, which of the following pairs shall be compared?
a. Proceeds from the sale and original cost of the debt securities sold.
b. Proceeds from the sale and carrying amount of the debt securities sold.
c. Fair value on the date of sale and original cost of the debt securities sold.
d. Fair value on the date of sale and carrying amount of the debt securities sold.
In determining the amount of realized gain or loss from selling FVTPL debt securities
NOT on an interest payment date, which of the following pairs shall be compared?
a. Dirty price received and original cost of the debt securities sold.
b. Dirty price received and carrying amount of the debt securities sold.
c. Clean price received and original cost of the debt securities sold.
d. Clean price received and carrying amount of the debt securities sold.
In cases where an entity acquired FVTPL debt security not on the related interest
payment date, the following are correct, except
a. The periodic amount of interest that will be received on the immediately
succeeding interest payment date is not affected by the fact that the debt
security was acquired not on an interest payment date.
b. Interest income shall be recognized only from the date of acquisition until the
immediately succeeding interest payment date.
c. Additional amount shall be paid to the seller on account of accrued interest as
computed from the date of acquisition until the immediately succeeding interest
payment date.
As of December 31, 2023, an entity is currently maintaining a debt security

accounted for at FVTPL. This debt security has stated rate of 8%, In relation to this,
the following statements are correct, except
a. Ifthe market rates as of that date averaged 9%, then its fair value is lower than
its face amount.
b. Ifthe market rates as of that date averaged 6%, then its fair value is higher than
its face amount.
c. Ifthe market rates as of that date averaged 9%, then its fair value is equal to its
face amount.
434
The
CamScanner
9. On January 1, 2023, an entity acquired an FVTPL debt security when prevailing

market rates averaged 12%. Stated or nominal rate of the debt security is 12%. In
determining whether there is an unrealized gain or loss on December 31, 2023, the
following statements are correct, except
a. If the market rates averaged 11% as of December 31, 2023, there will be
unrealized loss.
b. If the market rates averaged 14% as of December 31, 2023, there will be
unrealized loss.
c. If the market rates averaged 10% as of December 31, 2023, there will be
unrealized gain.
d. Ifthe market rates averaged 12% as of December 31, 2023, there will be no
unrealized gain or loss.
10. During 2023, an entity acquired an FVTPL debt security for 98.75. Stated or nominal
rate of the debt security is 8%. In determining whether is an unrealized gain or loss
on December 31, 2023, the following statements are correct, except
a. If the quoted price as of December 31, 2023 becomes 99.70, there is an
unrealized gain.
b. Ifthe quoted price as of December 31, 2023 becomes 100, there is no unrealized
gain or loss.
c. If the quoted price as of December 31, 2023 becomes 95.50, there is an
unrealized loss.
d. If the quoted price as of December 31, 2023 becomes 102.50, there is an
unrealized gain.
Straight Problems
1. On January 1, 2023, JACK Company acquired a 7% interest-bearing FVTPL debt
security for 101.60. Related face amount is P3,000,000 while maturity date is on
December 31, 2025. Interest is payable every December 31 of each year. As of
December 31, 2023 and 2024, quoted prices were 100.20 and 102.80, respectively.
Required: Determine the journal entries to be made for the years 2023 and 2024.
2. On October 1, 2023, HALL Company acquired a 9% interest-bearing FVTPL debt

security for 98.75. Related face amount is P4,000,000 while maturity date is set on
September 30, 2026. Interest is payable every September 30 of each year. As of
December 31, 2023 and 2024, quoted prices were 99.80 and 97.65, respectively.
3. On July 1, 2023, LUCY Company acquired a 10% interest-bearing FVTPL debt

security for 104.40. Related face amount is P5,000,000 while maturity date is set on
July 1, 2027. Interest is payable every July 1 of each year, On July 1, 2024, P1,000,000
face amount of the security was sold for 102.70, On July 1, 2025, P2,500,000 face
amount of the security was sold for 103,50, As of December 31, 2023, 2024, and
2025, quoted clean prices were 103.80, 102,40, and 101.70, respectively.
435
The
The Book
Required: Determine the journal entries to be made for the years 2023, 2024 and
2025.
4, On January 1, 2023, SAM Company acquired a six-year, 6% interest-bearing
government bonds with face amount of P6,000,000 to be accounted for at FVTPL.
Acquisition price is 96.80. Interest is payable every December 31 of each year.
Quoted prices as of December 31, 2023, 2024, and 2025 were 97.35, 98, and 98.90,
respectively.
entry to record the sale:
1. All of the bonds were sold for 99.80 on March 31, 2023, including accrued
interest.
2. Half of the bonds were sold for 97.10 on September 30, 2023 plus accrued
interest.
3. All ofthe bonds were sold for 97.20 on July 1, 2024 plus accrued interest.
4. P2,000,000 of the bonds were sold for 99.50 on September 30, 2024 including
accrued interest.
5. P4,000,000 of the bonds were sold on March 31, 2025 for 101.20, including
accrued interest.
5. On September 1, 2023, JD Company acquired 12% interest-bearing corporate bonds
dated January 1, 2023 and with face amount of P7,000,000, to be accounted for at
FVTPL. As of December 31, 2023, the bonds had fair value of 102.40. Required:
Under each of the following independent scenarios, determine the journal entries to
be made for the year 2023 in relation to the corporate bonds:
1. Acquisition price is 101.70 plus accrued interest. Interest is payable every
December 31 of each year.
2. Acquisition price is 110.90 including accrued interest. Interest is payable every
3. Acquisition price is 103.25 plus accrued interest. Interest is payable every June
30 and December 31 of each year.
4, Acquisition price is 103.20 including accrued interest. Interest is payable every
6. At the beginning of 2023, FRANK Company acquired ten-year, P4,000,000 face
amount government bonds that were originally dated January 1, 2021. Market yields
averaged 10% even if the bond has a stated rate of only 8%. Interest from the bonds
is payable every December 31 of each year. As of December 31, 2023 and 2024,
market yields averaged 8.50% and 10.5%, respectively.
7. On January 1, 2023, OGIE Company acquired corporate bonds with face amount of
P10,000,000 when the market yields averaged 9%. The bonds have maturity date of
December 31, 2027 and bear interest of 12%, payable every December 31 of each
436
The
CamScanner
year. On December 31, 2023, the Company sold the P4,000,000 face amount portion
of the bonds for 103.60. Market yields as of December 31, 2023 and 2024 averaged
10% and 11%, respectively.
Required: Determine the journal entries to be made for the years 2023 and 2024,
8. OnMarch 31, 2023, REGINE Company acquired 7% interest-bearing P5,000,000 face
amount government bonds that will mature on March 31, 2028. On the date of
purchase, market yields averaged 9%. Interest is payable every March 31 of each
year. As of December 31, 2023 and 2024, market yields averaged 8.50% and 7.75%,
respectively.
9. On January 1, 2023, JAYSON Company acquired corporate bonds with face amount
of P4,000,000 and maturity date of December 31, 2027. Market yields averaged 10%
even though the bonds have stated or nominal rate of just 9%. Market yields
averaged 12% and 11% as of December 31, 2023 and 2024, respectively.
entry to record the sale of the debt security:
1. Allofthe bonds were sold on July 1, 2023 for 97.50 plus accrued interest.
2. Half of the bonds were sold on September 30, 2023 for 102.50, including
accrued interest.
3. Allofthe bonds were sold on October 1, 2024 for 96, including accrued interest.
4, P3,000,000 of the bonds were sold on March 31, 2024 for 92.30 plus accrued
interest.
10.On April 1, 2023, JULIA Company acquired government bonds with face amount of
P3,000,000 and maturity date of December 31, 2026, to be accounted for at FVTPL.
Market yields averaged 8% even though stated rate is 10%. As of December 31, 2023
and 2024, market yields were 9% and 9.50%, respectively.
11.As of January 1, 2023, GERALDINA Company had the following investments in debt
securities, all to be accounted for at FVTPL:
Face Original Quoted Stated Interest

Issuer Amount Cost Price* Rate Pmt. Date
BBBCompany P3,000,000 99.80 97.50 9% 12/31
CCC Company 6,000,000 97.60 98.90 9% 12/31
DDD Company 5,000,000 102.40 101.90 10% 6/30
EEE Company 2,000,000 104.80 105.60 12% 9/30
*All clean prices.
During 2023, the following transactions occurred:
437
The
The Book
e 3,000,000 of CCC Company’s bonds were sold last June 30, 2023 for 102.70 ,
including accrued interest.
e P2,000,000 of DDD Company’s bonds were sold for 103.10 last September 30,
2023 plus accrued interest
e 4,000,000 additional BBB Company's bonds were acquired last October 31,
2023 for 99.70, including accrued interest.
As of December 31, 2023, the debt securities had the following quoted prices:
Issuer Quoted Price

BBB Company 100.20
CCC Company 98.20
DDD Company 104.50
EEE Company 105.20
Required: Determine the journal entries to be made for the year 2023.
1. On January 1, 2023, SCORPION Company acquired 8% interest-bearing corporate
bonds with face amount of P5,000,000 for 103.40 to be accounted for at FVTPL.
Interest is payable every December 31 of each year. As of December 31, 2023 and
2024, the bonds had quoted prices of 101.90 and P102.80, respectively.
Based on this information, determine the net amount to be recognized in profit or
loss for the year 2023
a. P75,000 c. P325,000
b. P400,000 d. P475,000
a. P400,000 c. P45,000
b. P445,000 d. P355,000
2. At the beginning of 2023, VIRGIN Company had outstanding 8% interest-bearing
government bonds with face amount of P6,000,000 and quoted price of 98. The
bonds are being accounted for at FVTPL. On September 30, 2023, P2,000,000 face
amount of the bonds was sold at its dirty price of 105.10. On July 1, 2024, P3,000,000
face amount of the bonds was sold at its clean price of 99.80. As of December 31,
2023 and 2024, the bond’s quoted prices were 99,60 and 98.20, respectively.
a. P526,000 c. P480,000
b. P406,000 d. P440,000
a. P216,000 c. P192,000
b. P242,000 d. P186,000
438
The
The Book
3. On October 1, 2023, CASTOR Company acquired a 6% interest-bearing government

bond with face amount of P4,000,000 and maturity date of December 31, 2028 at its
dirty price of 105. Transaction costs incurred amounted to P15,000. The bonds were
originally dated January 1, 2020 with the interest payable every December 31 of
each year. As of December 31, 2023, the bonds had quoted price of P101.50. These
bonds are accounted for at FVTPL.
The total amount paid to acquire the bonds on October 1, 2023 amounted to
a. P4,380,000 c. P4,200,000
b. P4,235,000 d. P4,110,000
The initial measurement of the investment as of October 1, 2023 shall be

a. P4,2035,000 c. P4,035,000
b. P4,020,000 d. P4,060,000
The net amount of income to be reported in 2023 profit or loss shall be
a. P100,000 c. P85,000
b. P115,000 d. P95,000
4. On July 31, 2023, POLLUX Company acquired corporate bonds with face amount of
P8,000,000 and maturity date of November 30, 2027. The bonds were acquired at
its clean price of 97.50 with the Company incurring P50,000 transaction costs. The
seller reportedly incurred P30,000 transaction costs. Interest of 12% is payable
every May 31 and November 30 of each year. As of December 31, 2023, the quoted
clean price of the bonds was 98.20. The bonds are accounted at FVTPL.
The total amount paid to acquire the bonds on July 31, 2023 amounted to
a. P7,800,000 c. P7,960,000
b. P7,850,000 d. P8,010,000
The initial measurement of the investment as of July 31, 2023 shall be
a. P7,800,000 c. P7,960,000
b. P7,850,000 d. P8,010,000
The net amount to be reported in 2023 profit or loss shall be
a. P350,000 c. P400,000
b. P406,000 d. P456,000
5. At the beginning of 2023, AQUARIUS Company had P10,000,000 face amount
government bonds that had a quoted price of 102.50, These bonds were acquired
during 2022 for its 103 clean price. The bonds pay interest of 9% every December
31 of each year. During 2023, the Company has sold the following portions of these
bonds:
e OnMarch 31, 2023, P3,000,000 face amount was sold for its dirty price of 105.10.
439
The
The Book
e On September 1, 2023, P4,000,000 face amount was sold for its clean price of
101.80. Transaction costs incurred amounted to P30,000.
As of December 31, 2023, the bonds had quoted price of 102.15,
The net amount received from March 31, 2023 shall be

a. P3,200,500 c. P3,133,000
b. P3,220,500 d. P3,153,000
The net amount received from September 1, 2023 shall be

a. P4,042,000 c. P4,072,000
b. P4,282,000 d. P4,042,000
The total interest income for the year 2023 shall be

a. P900,000 c. P592,500
b. P820,000 d. P577,500
The net income to be recognized in the profit or loss for the year 2023 shall be
a. P695,500 c. P549,500 ©
b. P654,500 d. P499,500
6. On January 1, 2023, BULL Company acquired a six-year, 8% interest-bearing,

P5,000,000 face amount corporate bonds when market yields averaged 10%. The
bonds were originally dated on January 1, 2022. Interest is payable every December
31 of each year. As of December 31, 2023 and 2024, market yields averaged 9.5%
and 8.50%, respectively.
The net amount to be recognized in profit or loss for the year 2023 shall be
a. P400,000 c. P538,743
b. P462,092 d. P261,257
The net amount to be recognized in profit or loss for the year 2024 shall be
a. P576,486 c. P452,168
b. P223,514 d. P400,000
440
The
The Book
Chapter 12B - Investments in Debt Securities - Amortized Cost
CHAPTER 12B
INVESTMENTS IN DEBT SECURITIES -
AMORTIZED COST

1. The initial measurement of investment in debt securities at amortized cost.
2. The subsequent measurement of investment in debt securities at amortized cost.
3. The amount of interest income from investment in debt securities at amortized
cost.
4. The application of amortization table to debt securities and different interest
payment frequencies.
5. The accounting for debt security with interest payment date not on reporting date.
6. The effect and subsequent accounting of capitalized transaction costs.
7. The accounting for the sale of investment in debt securities at amortized cost.
INVESTMENTS IN DEBT SECURITIES ACCOUNTED FOR AT AMORTIZED COST

As previously discussed in Chapter 12, debt securities that meet BOTH of the
following shall be measured at amortized cost:
a. the financial asset is held within a business model whose objective is to hold
financial assets in order to collect contractual cash flows (held-to-maturity);
b. the contractual terms of the financial asset give rise on specified dates to cash
flows that are solely payments of principal and interest on the principal
amount outstanding. /PFRS 9.4.1.2]
HELD-TO-MATURITY (OR HOLD-TO-COLLECT) BUSINESS MODEL

Generally, under this model, the objective of an entity is to collect all of the
contractual cash flows until each debt security's maturity date.
Due to this, is an entity prohibited to sell any of the debt securities under this model
before the related maturity date? The answer is NO since PFRS 9 provides some
exceptions which allow the entity to sell some debt securities under the held-
to-maturity business model without affecting the classification of the remaining
debt securities in that business model.
Some of these exceptions include the following:
1, Selling of debt securities due to increase in the counterparty’s credit risk, This
selling is still consistent with held-to-maturity business model since the credit
quality of a debt security is relevant to the entity's ability to collect cash flows
from the counterparty.
441
The
CamScanner
Chapter 12B — Investments in Debt Securities - Amortized Cost
2. Sales made close to the maturity date of debt security. The difference between the
‘total contractual cash flows to be collected on the maturity date and the sales
proceeds are generally immaterial.
3. All other sales that are infrequent, even if the amounts are significant in value or
sales that are frequent but the amounts are insignificant in value.
Nonetheless, if the sales are both frequent and significant in value, it will not
automatically make the remaining debt securities as held-for-selling (i.e., at
FVTPL). An entity is still given a chance to assess if these sales are still consistent
with the held-to-maturity business model.
Illustration 1. ZANDRA Company maintains a portfolio of debt securities with the
objective of collecting the contractual cash flows until maturity. These debt
securities were properly accounted for at amortized cost. Later during the year,
some of these debt securities were sold due to the increase in credit risk of the
counterparties while some were sold at a very close proximity to their related
maturity dates.
Under both of the selling cases, the remaining debt securities in the portfolio shall
continue to be accounted for at amortized cost.
ACCOUNTING FOR AMORTIZED COST CLASSIFICATION
The following are the accounting procedures for investments in debt securities
accounted for at amortized cost (with corresponding comparison with FVTPL):
~ Amortized Cost FVTPL

Tuitial measurement Fair value plus transaction | Fair value (with transaction
costs costs expensed outright)
At amortized cost amounts
Subsequent based on amortization table. Fair value as of each
measurement Fair value as of each reporting date
reporting date is ignored
Changes in fair Recognized as unrealized
value Ignored gain or loss in profit or loss_|
Beginning-of-the-period
hiepaatiicioe amortized cost x effective Face amount x stated or
interest rate determined on nominal rate
initial recognition —
Interest received Face amount x stated or nominal rate x period ii
Subsequent Amortized using either
accounting for straight-line, bond- :
premium or outstanding and effective Not considered
- discount interest method ——'
Gain or loss on sale Reported in profit or loss ad
442
The
The amortized cost represents the present value of the remaining cash flows
discounted using the effective interest rate determined on initial recognition. In the
absence of transaction costs, effective interest rate= market yield on initial
recognition. Consequently, market yields at the end of each reporting period shall
be
ignored. Amortization table concepts discussed in Chapter 5A are also relevant
in this case.
Since the business model of the entity is to collect contractual cash flows (as opposed
to selling the investment), reporting the investment at amortized cost (i.e., at the
present value of such contractual cash flows) is more relevant in the circumstances.
It is more relevant because it better reflects the amounts of cash flows to be
collected in the future periods (as opposed to cash flows from selling the
investment).
METHODS OF AMORTIZING PREMIUM OR DISCOUNT

There are three methods in amortizing the initial amount of premium or discount:
Methods | Description
Simplest among the methods Equal amounts of discount or premium
ou amortization per period. Generally, used when the initial fair value is
computed using quoted price approach.
Based on the remaining face amount of debt security. Used for serial
ane bonds when the initial fair value is computed using quoted pri
outstanding P 64 PEt
approach.
Uses effective interest rate that exactly discounts estimated future
cash payments or receipts through the expected life of the financial
Effective | asset to the carrying amount ofa financial asset. The only method that
interest | isin accordance with the requirements of PFRS 9. This is used when the
initial fair value is computed using the present value approach. Lastly,
this is the method applied in Chapter 5A for notes receivable.
In addition, the amortization of premium or discount has predetermined effects to
the amounts of interest received, interest income, and amortized cost:
Scenario | Interest Income vs Interest Received | Amount of Amortized cost
Discount Interest Income > Interest Received Increasing amortized cost
Premium Interest Income < Interest Received Decreasing amortized cost
The relationship between the interest income and interest received can also be
observed in the following pro-forma entries related to the recognition of interest
income and amortization of discount or premium:
Cash (or Interest receivable) XX
Financial asset at amortized cost XX
Interest income XX
to recognize interest income and amortization of discount
443
The
CamScanner
Cash (or Interest receivable) XX

Financial asset at amortized cost xX
Interest income XX
to recognize interest income and amortization of premium
Illustration 2 - Straight-line Method. At the beginning of 2023, XININA Company

acquired a commercial bond with face amount of P6,000,000. These bonds were
originally dated January 1, 2021 and will mature on December 31, 2025. The stated
rate on these bonds was 10%. Required: Under each of the following independent
scenarios, prepare the related amortization table:
1. The bonds were acquired for 97.
Scenario 1
The investment had an initial carrying amount of P5,820,000 (P6,000,000 x 97%)
resulting to discount of P180,000 (P6,000,000 - P5,820,000). The discount shall be
amortized from January 1, 2023 to December 31, 2025 or for three years. Original
date of the bonds (e.g., January 1, 2021) shall be ignored for amortization purposes.
Annual amount of discount amortization shall be P60,000 (P180,000/3 years).
Consequently, the relevant amortization table is as follows:
[10%] Interest Interest P.V./ Carrying

Date Received Income Amortization Amount
1/1/23 5,820,000
12/31/23 600,000 660,000 60,000 5,880,000
12/31/24 600,000 660,000 60,000 5,940,000
12/31/25 600,000 660,000 60,000 6,000,000
Based on this amortization table, the readers should take note that the P60,000
discount amortization is added to the amount of interest received in order to
arrive at the amount of interest income, which in turn will also be added to the
carrying amount of the investment.
The reason for this treatment is that the initial amount of discount can be viewed
as a “gain” since an entity acquired an investment at a price lower than its face
amount, but will receive that face amount on maturity date. This “gain” is not
immediately recognized, but periodically added to the amount of interest income.
As an example, the compound journal entry related to the receipt of interest and
amortization of discount on December 31, 2023 is as follows:
Cash (P6,000,000x 1 0%) 600,000

Financial asset at amortized cost 60,000
444
The
To reiterate, the amounts in the P.V./Carrying Amount column are those reported in
the balance sheet as of the corresponding date in the Date column. For example, as of
December 31, 2023, the investment shall be reported at P5,880,000.
Scenario 2
resulting to a premium of P120,000 (P6,000,000 - P6,120,000). Similar to a discount
amount, this premium amount shall be amortized from January 1, 2023 to
~ December 31, 2025 or for three years.
Annual amount of premium amortization is computed as P40,000 (P120,000/3

years). Consequently, the relevant amortization table is as follows:
[10%] Interest Interest P.V./ Carrying
1/1/23 6,120,000
12/31/23 600,000 560,000 (40,000) 6,080,000
12/31/24 600,000 560,000 (40,000) 6,040,000
12/31/25 600,000 560,000 (40,000) 6,000,000
Based on this amortization table, the readers should take note that the P40,000
premium amortization is deducted from the amount of interest received in
order to arrive at the amount of interest income, which in turn will also be
deducted from the carrying amount of the investment.
The reason for this treatment is that the initial amount of premium can be viewed
as a “loss” since an entity acquired an investment at a‘ price higher than its face
amount but will only receive the face amount on maturity date. This “loss” is not
immediately recognized but is periodically deducted from the amount of interest
income.
As an example, the compound journal entry related to the receipt of interest and
amortization of premium on December 31, 2023 is as follows:
Cash (P6,000,000x 10%) 600,000

BOND OUTSTANDING METHOD

This method addresses the dilemma of using the straight-line method which is
recording equal amounts of amortization for each year without any regard to the
bonds’ outstanding face amount. This method is mainly applicable to serial bonds.
Under the bond outstanding method, there is a higher amount of amortization
during the initial years when the bonds’ outstanding face amount is higher.
When applying this method, the readers may follow these procedures:
445
The
CamScanner
Chapter 12B — Investments in Debt Securities — Amortized Cost
1. Understand the payment schedule of the debt security such as the periodic
amounts of principal installment payments and the related frequency.
2. Determine the balances of the debt security’s face amount at the beginning of
each year, and compute the sum of these balances (to be used as the
determinator in step 3).
3. The amount of amortization in a particular year is equal to the following:
Initial Discount or Beginning-of-the-year face amount
Premium Amount Total of beginning-of-the-year face amounts
Despite these seemingly different procedures, the discount amortization shall still
be added to both interest income and carrying amount, while the premium
amortization shall still be deducted from interest income and carrying amount.
Illustration 3. On January 1, 2023, YULE Company acquired a serial bond with face
amount of P4,000,000 and stated rate of 12% to be received every December 31 of
each year. The face amount is payable in P1,000,000 annual installments every
December 31, starting in 2023. Required: Under each of the following independent
scenarios, determine the related amortization table:
Scenario 1
resulting to a premium of P160,000 (P4,000,000 - P4,160,000). Premium
amortization is determined per year as follows:
Premium
Year Beg. Bal. Ratio Amortization
2023 4,000,000 4M/10M P64,000 (P160,000 x 4M/10M)
2024 3,000,000 3M/10M 48,000 (P160,000 x 3M/10M)
2025 2,000,000 2M/10M 32,000 (P160,000 x 2M/10M)
2026 1,000,000 1M/10M 16,000 (P160,000x 1M/10M)
P10,000,000 P160,000
The amount of interest received and interest income for each year are determined
as follows:
[A] Interest [B] Premium [A] - [B]

Year Beg. Bal. Received Amortization Interest Income
2023 P4,000,000 x 12% = P480,000 P64,000 P416,000
2024 3,000,000 x 12% = 360,000 48,000 312,000
2025 2,000,000 x 12% = 240,000 32,000 208,000
2026 1,000,000 x 12% = 120,000 16,000 104,000
Amortization table can now be made as follows:
446
The
CamScanner
[A] Principal/ [B]

Interest Interest [B] - [A] P.V./ Carrying
1/1/23 4,160,000
12/31/23 1,480,000 416,000 (1,064,000) 3,096,000
12/31/24 1,360,000 312,000 (1,048,000) 2,048,000
12/31/25 1,240,000 208,000 (1,032,000) 1,016,000
12/31/26 1,120,000 104,000 __(1,016,000) -
There are principal amounts received in the amortization table due to installment
principal payments.
Scenario 2
In this case, the investment had an initial carrying amount of P3,920,000
(P4,000,000 x 98%) resulting to a discount of P80,000 (P4,000,000 - P3,920,000).
Discount amortization is determined per year as follows:
Discount
Year Beg. Bal. Ratio Amortization
2023 4,000,000 4M/10M P32,000 (P80,000x4M/10M)
2024 3,000,000 3M/10M 24,000 (P80, 000
x 3M/10M)
2025 2,000,000 2M/10M 16,000 (P80, 000
x 2M/10M)
2026 1,000,000 1M/10M 8,000 000
x 1M/10M)
(P80,
P10,000,000 P80,000
The amount of interest received and interest income for each year are determined
as follows:
[A] Interest [B] Discount [A] + [B]
Year Beg. Bal. Received Amortization Interest Income
2023 ~=P4,000,000 x 12% = P480,000 P32,000 P512,000
2024 3,000,000 x 12% = 360,000 24,000 384,000
2025 2,000,000 x 12% = 240,000 16,000 256,000
2026 1,000,000 x 12% = 120,000 8,000 128,000
Amortization table can now be made as follows:

[A] Principal/ [B]
Interest Interest [B] - [A] P.V./ Carrying
1/1/23 3,920,000
12/31/23 1,480,000 512,000 (968,000) 2,952,000
12/31/24 1,360,000 384,000 (976,000) 1,976,000
12/31/25 1,240,000 256,000 (984,000) 992,000
12/31/26 1,120,000 128,000 (992,000) -
447
The
EFFECTIVE INTEREST RATE METHOD

Generally, the effective interest rate (EIR) is the market rate (yield) on the date
of bond issuance, regardless whether it is higher, lower, or equal to the stated rate.
The exception is when there are bond issue costs, which will be discussed later in the
chapter. Consequently, market yields at the end of each reporting period will be
ignored. Again, the amortization concepts discussed in Chapter 5A are relevant in
this case.
Moving forward, the discussions will focus on this method of amortization.
Illustration 4. On January 1, 2023, AMAYA Company bought an investment in debt

security having a face amount of P900,000. The investment bears an interest of 7%
payable annually every December 31 starting 2023. The investment will mature on
December 31, 2027. The market rates of interest as of December 31, 2023, 2024,
2025, 2026, and 2027 were 8.50%, 9.00%, 8.00%, 7.50%, and 7.25%, respectively.
related amortization table:
1. The debt security was acquired when the prevailing market yields averaged 8%.
2. The debt security was acquired when the prevailing market yields averaged 5%
Scenario 1 - Discount
On initial recognition, January 1, 2023, the initial measurement is computed as
follows:

Fair value, 1/1/23 P864,066
Note: 1/1/23 to 12/31/27 is 5 years; hence, 5 periods. P63,000 = P900,000 x 7%.
There is a discount since 8% market yield > 7% stated rate. From this initial fair
value, the amortization table can now be constructed as follows:
[A] [B] [B] - [A] P.V./

[7%] Interest [8%]Interest Amorti- Carrying
Date Received Income zation Amount
1/1/23 864,066
12/31/23 63,000 69,125 6,125 870,191
12/31/24 63,000 69,615 6,615 876,806
12/31/25 63,000 70,144 7,144 883,950
12/31/26 63,000 70,716 7,716 891,666
12/31/27 63,000 71,334 8,334 900,000
12/31/27 900,000 900,000 -
To reiterate, the amount of interest income is computed as the beginning-of-the-
period carrying amount times the effective interest rate. For example, interest
448
The
CamScanner
income of P69,125 for 2023 is computed as P864,066 x 8% while interest income of

P69,615 for 2023 is computed as P870,191 x 8%. Again, effective interest rate is
usually the market yield on the initial recognition.
Based on the above amortization table, the compound journal entry to be made on
December 31, 2023 shall be as follows:
Cash 63,000
The compound journal entry to be made on December 31, 2024 shall be as follows:
Cash 63,000
There are debits to the investment account since the discount amortization
increases the amortized cost of the investment.
Scenario 2 - Premium
On initial recognition, January 1, 2023, the initial measurement is computed as
follows:

Ordinary annuity for5 periods at5% 4.329477 63,000 © 272,757
Fair value, 1/1/23 _ P977,930
Note: 1/1/23 to 12/31/27 is 5 years; hence, 5 periods. P63,000 = P900,000 x 7%.
There is a premium since 5% market yield < 7% stated rate. From this initial fair
value, the amortization table can now be constructed as follows:
[A] [B] [B]-[A] —P.V./
1/1/23 977,930
12/31/23 63,000 48,897 (14,103) 963,827
12/31/24 63,000 48,191 (14,809) 949,018
12/31/25 63,000 47,451 (15,549) 933,469
12/31/26 63,000 46,673 (16,327) 917,142
12/31/27 63,000 45,858 (17,142) 900,000
12/31/27 900,000 900,000 -
Interest income of P48,897 for 2023 is computed as P977,930 x 5%, while interest
income of P48,191 for 2024 is computed as P963,827 x 5%.
449
hie
The
The Book
Chapter 12B — Investments in Debt Securities —- Amortized Cost
Based on the above amortization table, the compound journal entry to be made on
December 31, 2023 shall be as follows:
Cash 63,000
The compound journal entry to be made on December 31, 2024 shall be as follows:
Cash 63,000
There are credits to the investment account since the premium amortization
decreases the amortized cost of the investment.
AMORTIZATION FOR DIFFERENT INTEREST PAYMENT FREQUENCIES

The computation of initial fair values in this case was already discussed in Chapter
12. As for the amortization table, similar rules apply, except for the increase in the
number of periods involved and decrease in the amounts of interest income and
interest received per row in the amortization table.
Illustration 5. BERNADETH Company acquired on January 1, 2023 a bond

investment with face amount of P2,000,000 to be accounted for at amortized cost.
The bond has a maturity date of December 31, 2024 (two-year remaining term) and
nominal rate of 10%. Market yields on acquisition date averaged 12%. Required:
Under each of the following independent scenarios, determine the related
amortization table:
1. Interest is payable semi-annually every June 30 and December 31.
2. Interest is payable quarterly every March 31, June 30, September 30, and
December 31.
Scenario 1 - Semi-annual interest payments
Semi-annualinterest P100,000 /(P2,000,000 x 10%)/2]
Fair value, 1/1/23 P1,930,699

450
The
The Book
[A] [B] [B] - [A] P.V./

[5%] Interest [6%] Interest Amorti- Carrying
1/1/23 1,930,699
6/30/23 100,000 115,842 15,842 1,946,541
12/31/23 100,000 116,792 16,792 1,963,333
6/30/24 100,000 117,800 17,800 1,981,133
12/31/24 100,000 118,867 18,867 2,000,000
12/31/24 2,000,000 (2,000,000) -
If the interest is payable semi-annually, the amount of interest income per year is
composed of two rows of interest income amount. For example, total interest
income for 2023 is computed as P232,634 (P115,842 + P116,792).
In addition, the amounts of interest income per row are computed based on six-
month periods. For example, P115,842 is computed as P1,930,699 x 12% x 6/12.
Scenario 2 - Quarterly interest payments

Number of periods 8 quarterly periods (2 years x 4)
Quarterly interest P50,000 /(P2,000,000 x 10%)/4]
Fair value, 1/1/23 _P 1,929,803
Relevant amortization table is as follows
[A] [B] [B] - [A] P.V./

[2.50%] Interest [3%] Interest Amorti- Carrying
1/1/23 1,929,803
3/31/23 50,000 57,894 7,894 1,937,697
6/30/23 50,000 58,131 8,131 1,945,828
9/30/23 50,000 58,375 8,375 1,954,203
12/31/23 50,000 58,626 8,626 1,962,829
3/31/24 50,000 58,885 8,885 1,971,714
6/30/24 50,000 59,151 9,151 1,980,865
9/30/24 50,000 59,426 9,426 1,990,291
12/31/24 50,000 59,709 9,709 2,000,000
|12/31/24 2,000,000 (2,000,000) ~
451
The
If the interest is payable quarterly, the amount of interest income per year is
composed of four rows of interest income amount. For example, total interest
income for 2023 is computed as P233,026 (P57,894 + P58,131 + P58,375 + P58,626).
In addition, the amounts of interest income per row are computed based on three-
month periods. For example, P57,894 is computed as P1,929,803 x 12% x 3/12.
EFFECTS OF TRANSACTION COSTS IN SUBSEQUENT MEASUREMENT
Regardless of the amortization method used, transaction costs incurred in
acquiring debt securities are added to the initial carrying amount of the debt security
accounted at amortized cost. This has the following effects in the discount or
premium amounts:
a. Decrease in the amount of discount; or
b. Increase in the amount of premium.
Under both cases, transaction costs will make EIR < market yield on initial
recognition. Consequently, in computing for the interest income in the amortization
table, the effective interest rate to be used is lower than the market yield.
Illustration 6. On January 1, 2023, CALLISTO Company acquired a four-year
government bond with face amount of P3,000,000 when prevailing market yields
averaged 10%, to be accounted at amortized cost. Nominal rate for the bonds is 8%,
which is payable every December 31 of each year. The Company also incurred
transaction costs amounting to P93,001, making 9% as the effective interest rate.
On January 1, 2023, the initial measurement is computed as follows:

Fair value, 1/1/23 P2,809,807
Add: Transaction costs 93,001
Initial carrying amount, 1/1/23 P2,902,808
Note: P240,000 = P3,000,000 x 8%,
From this initial carrying amount, the amortization table can now be constructed as
follows:
[A] [B] [B] - [A] P.V./
1/1/23 2,902,808
12/31/23 240,000 261,253 21,253 2,924,061
12/31/24 240,000 263,165 23,165 2,947,226
12/31/25 240,000 265,250 25,250 2,972,476
12/31/26 240,000 267,524 27,524 3,000,000
12/31/26 3,000,000 (3,000,000) e
452
The
CamScanner
Chapter 12B - Investments in Debt Securities —- Amortized Cost
Interest income is computed using the 9% effective interest rate (i.e., not the market
yield of 10%). For example, P261,253 interest income is computed as P2,902,808 x
9%.
INVESTMENTS WITH INTEREST PAYMENT DATE OTHER THAN REPORTING DATE
So far, the scenarios illustrated have interest payment dates every December 31,
which is normally the reporting date for most of the entities. More likely than not,
in an actual setting, interest payment dates are not every December 31 of each year.
The previously discussed concepts on the use of amortization table are all still
relevant, except for the adjustment at the end of each period. For example, if the
interest payment date is every October 31 of each year, the carrying
amount/present value computed in the amortization table were all as of October 31
of each year. As a result, these amounts need to be partially amortized for additional
two months (November 1 to December 31 of the same year) to reflect the carrying
amount as of December 31 of each year.
In addition, the computation of interest income to be recorded for each year will be
slightly different. Lastly, accrual of interest from the latest interest payment
date to the reporting date will also be recorded.
Illustration 7. On October 1, 2023, MARIAN Company purchased P700,000 face
value of debt securities at the market rate of 6%. The debt securities mature on
September 30, 2027 and pay interest of 8% every September 30 of each year
starting in 2024. The Company’s reporting date is every December 31 of each year.
On October 1, 2023, the initial measurement is computed as follows:

Ordinary annuity for 4 periods at6% 3.465106 56,000 194,046 |
Fair value, 1/1/23 P748,512
Note: 10/1/23 to 9/30/27 is 4 years; hence, 4 periods. P56,000 = P700,000x 8%.
From this initial fair value, the amortization table can now be constructed as
follows:
[A] [B] [B] - [A] P.V./

10/1/23 748,512
9/30/24 56,000 44,911 (11,089) 737,423
9/30/25 56,000 44,245 (11,755) 725,668
9/30/26 56,000 43,540 (12,460) 713,208
56,000 42,792 (13,208) 700,000
9/30/27 -
9/30/27 700,000 (700,000)
453
The
CamScanner
To determine the carrying amount of the investment as of December 31, 2023, the
P748,512 initial measurement as of October 1, 2023 shall be partially amortized for
three months (10/1/23 to 12/31/23) as follows:
Carrying amount, 10/1/23 P748,512
Add: Interest income (P748,512 x 6% x 3/12) _ 11,228
Less: Accrued interest receivable (P700,000 x 8% x 3/12) (14,000)
This partial amortization is recorded on December 31, 2023 as follows:

Financial asset at A.C. 2,172
The partial amortization of P2,772 can also be computed as P11,089 x 3/12.
On September 30, 2024, the receipt of interest, including the partial premium
amortization, shall be recorded as follows: .
Cash (P700,000 x 8%) 56,000

Interest income (P44,911 x 9/12) 33,683
Financial asset at A.C. (P11,089 x 9/12) 8,317
The nine-month period used in the computations above is from January 1, 2024 to
September 30, 2024. Similar to 2023, the December 31, 2024 carrying amount can
also be determined by partially amortizing the P737,423 September 30, 2024
carrying amount for three months (10/1/24 to 12/31/24):
Add: Interest income (P737,423 x 6% x 3/12) 11,061
Less: Accrued interest receivable (P700,000 x 8% x 3/12) (14,000)
This partial amortization is recorded on December 31, 2024 as follows:

Financial asset at A.C. 2,939
Based on these journal entries, total interest income for 2024 is P44,744 [(P33,683 +
P11,061) or (P44,911 x 9/12) + (P44,245 x 3/12)].
SALE OF AMORTIZED COST DEBT SECURITIES ON INTEREST PAYMENT DATE
Similar to debt securities accounted for at FVTPL, any difference between the
carrying amount and the sales proceeds are recognized as realized gain or loss in
profit or loss:
454
The
The Book
Chapter 12B - Investments in Debt Securities — Amortized Cost
Scenario » Gain or Loss?

Proceeds < Carrying Amount Realized loss on sale
For the amortized cost classification, the carrying amount is equal to the
corresponding amortized cost in the amortization table.
In case there is a partial sale, the following discussions are relevant:
a. The aliquot portion of the carrying amount as of the date of sale shall be
compared with the proceeds received to get the amount of gain or loss on sale.
b. From the date of sale and moving forward, the amounts in the amortization
table will also be proportionately reduced. In other words, the interest
received, interest income, and principal amortization will all be based on the
remaining unsold portion.
c. Despite the changes above, the effective interest rate shall not change.
Illustration 8. On January 1, 2023, AVILA Company bought an investment in debt
security having a face amount of P1,000,000 when the market rate of interest is 7%.
The investment bears interest of 6% payable annually every December 31 starting
2023. The investment will mature on December 31, 2027. Required: Under each of
the following independent scenarios, determine the journal entry to record the sale
of the investment:
1. All of the investment were sold on December 31, 2026 for 99.50.
2. All of the investment were sold on December 31, 2025 for 95.75.
3. P400,000 face amount was sold on December 31, 2024 for 96.50.
Before recording the sale in each scenario, the initial fair value of the investment on
January 1, 2023 shall be computed first as follows:
PV Factor of PV Factor CashFlow _ Fair Value
Fair value, 1/1/23 P958,998
Note: 1/1/23 to 12/31/27 is 5 years; hence, 5 periods. P60,000 = P1,000,000 x 6%.
The related amortization table can now be made as follows:
[A] [B] [B] - [A] P.V./

1/1/23 958,998
12/31/23 60,000 67,130 7,130 966,128
12/31/24 60,000 67,629 7,629 973,757
12/31/25 60,000 68,163 8,163 981,920
12/31/26 60,000 68,734 8,734 990,654
12/31/27 60,000 69,346 9,346 1,000,000
455
The
CamScanner
Chapter 12B — Investments in Debt Securities —- Amortized Cost
Scenario 1
Based on the amortization table, the related carrying amount as of December 31,
2026 is P990,654. The journal entry to record the sale in this scenario is as follows:
Cash (P1,000,000 x 99.50%) 995,000
Scenario 2
Based on the amortization table, the related carrying amount as of December 31,
2025 is P981,920. The journal entry to record the sale in this scenario is as follows:
Cash (P1,000,000 x 95.75%) 957,500
Loss on sale - P/L (Squeeze) 24,420
Financial asset at amortized cost - 981,920
Scenario 3
Based on the amortization table, the related carrying amount is P973,757 as of
December 31, 2024. The carrying amount of the portion sold is computed as
P389,503 (P973,757 x P400K/P1,000K). The journal entry to record the sale in this
scenario is as follows:
Cash (P400,000 x 96.50%) 386,000
Moving forward, the amortization table will look like this (based on the P600,000
remaining face amount):
[A] [B] [B] - [A] P.V./

12/31/24 584,254
12/31/25 36,000 40,898 4,898 589,152
12/31/26 36,000 41,241 5,241 594,393
12/31/27 36,000 41,607 5,607 600,000
12/31/27 600,000 (600,000) =
SALE OF AMORTIZED COST DEBT SECURITIES NOT ON INTEREST PAYMENT DATE

In addition to the considerations when the sale was made on interest payment
dates, the following accounting procedures are necessary when accounting for the
sale not on interest payment date:
a. The amortized cost shall be updated, The amortized cost as of the immediately
preceding interest payment date shall be partially amortized up to the date of sale.
b. Similar to FVTPL classification, accrued interest will be received from the buyer
from the immediately preceding interest payment date up to the date of sale.
456
The
The Book
Illustration 9, RAVENA Company, on January 1, 2023, acquired a commercial bond

with face amount of P5,000,000 and maturity date of December 31, 2025 when
market yields averaged 12%. Nominal rate was set at 11% and receivable every
December 31 of each year. Required: Under each of the following independent
scenarios, determine the journal entry to record the sale:
1. All of the bonds were sold on March 31, 2024 at 100.25 plus accrued interest.
2. All of the bonds were sold on September 30, 2025 at 102, including accrued
interest
Before recording the sale in each scenario, the initial fair value of the investment on
January 1, 2023 shall be computed as follows:
PV Factor of PV Factor CashFlow _ Fair Value

Ordinary annuity for 3 periodsat12% 2.401831 550,000 1,321,007
Fair value, 1/1/23 P4,879,907
Note: 1/1/23 to 12/31/25 is 3 years; hence, 3 periods. P550,000 = P5,000,000 x 11%.
The related amortization table can now be made as follows:
[A] [B] [B] - [A] P.V./

1/1/23 4,879,907
12/31/23 550,000 585,589 35,589 4,915,496
12/31/24 550,000 589,860 39,860 4,955,355
12/31/25 550,000 594,645 44,645 5,000,000
12/31/26 5,000,000 (5,000,000) =
Scenario 1 - Sale on March 31, 2024

As of March 31, 2024 date of sale, the immediately preceding interest payment date
was on December 31, 2023, which the investment had amortized cost of
P4,915,496. This carrying amount shall be partially amortized from January 1, 2023
to March 31, 2024 (i.e, 3 months):
Amortized cost, 12/31/23 P4,915,496

Add: Interest income (P4,915,496 x 12% x 3/12) 147,465
Less: Accrued interest receivable (P5M x 11% x 3/12) (137,500)
Updated amortized cost, 3/31/24 P4 461
The journal entry to record the updating of the carrying amount right before the
sale is:
457
ri
The
The total amount of cash received amounted to P5,150,000 /(P5,000,000x 100.25%)

+ P137,500]. Journal entry to record the actual sale on March 31, 2024:
Cash 5,150,000
Financial asset at amortized cost 4,925,461
Scenario 2 - Sale on September 30, 2025

As of this date of sale, the immediately preceding interest payment date was on
December 31, 2024, which the investment had amortized cost of P4,955,355. This
carrying amount shall be partially amortized from January 1, 2025 to September
30, 2025 (i.e, 9 months):
Amortized cost, 12/31/24 P4,955,355
Add: Interest income (P4,955,355 x 12% x 9/12) 445,982
Less: Accrued interest receivable (P5M x 11% x 9/12) (412,500)
Updated amortized cost, 9/30/25 P4,988,837
Journal entry to record the updating of carrying amount right before the sale:
The total amount of cash received amounted to P5,100,000 (P5,000,000 x 102%.),

which already included the amount of accrued interest. Journal entry to record the
actual sale on September 30, 2025:
Cash 5,100,000
Loss on sale can also be computed as follows:

Total proceeds (dirty price) (P5,000,000 x 102%) P5,100,000
Less: Interest portion from Jan 1, 2025 to
Sept. 30, 2025 (P5,000,000x 11%x 9/12) 412,500
Portion pertaining to investment (clean price) P4,687,500
Less: Carrying amount of the investment 4,988,837
Loss on sale P301,337
SERIAL DEBT SECURITIES - EFFECTIVE INTEREST METHOD
As previously mentioned, the effective interest method is preferable among the
amortization method. The same can also true for serial debt securities when using
the present value approach in determining its initial fair value as discussed in
Chapter 12.
458
The
The Book
Illustration 10. On January 1, 2023, BUENOS Company acquired an P8,000,000

face amount debt security with term of four years, to be accounted for at amortized
cost. Principal is payable in equal annual installments of P2,000,000 each. This debt
security bears 10% interest and is to be received at the same time with the principal
payments. Market rates averaged 11% on January 1, 2023. Required: Determine the
subsequent accounting for the investment.
1. First, determine the amounts and timing of cash flows:
[A] Beg. [B]Interest TotalCash Date tobe No. of
Face Amounts Inflows Received Periods
Year Amount [A]x10% [B]+P2M (Timing) from1/1/23
2023 P8,000,000 P800,000 P2,800,000 12/31/23 1 period
2024 6,000,000 600,000 2,600,000 12/31/24 2 periods
2025 4,000,000 400,000 2,400,000 12/31/25 3 periods
2026 2,000,000 200,000 2,200,000 12/31/26 4 periods
2. Next, determine the PV factors of single payment using the number of periods
determined above and 11% discount rate. After this, PV amounts can now be
PV Factor of PV Factor Cash Flow Initial FV
Single payment for 1 period at 11% 0.900901 P2,800,000 P2,522,523
P7,836,806
3. The relevant amortization table is as follows:
[A]
Interest/ [B] [B] - [A] P.V./
Principal [11%] Interest Amorti- Carrying
1/1/23 7,836,806
12/31/23 2,800,000 862,049 (1,937,951) 5,898,855
12/31/24 2,600,000 648,874 (1,951,126) 3,947,729
12/31/25 2,400,000 434,250 (1,965,750) 1,981,979
12/31/26 2,200,000 218,021 (1,981,979)
Journal entries to made on December 31, 2023 shall be as follows:
Cash 800,000
Cash 2,000,000
459
The
The readers should take note that the amortization amount for 2023 is also equal
to the P2,000,000 principal installment less P62,049 discount amortization.
CHAPTER SUMMARY
1. For a business model with a goal of holding debt securities until their maturity to
collect contractual cash flows (i.e., held-to-maturity), the covered debt securities
shall be accounted for at amortized cost, provided the securities pass the SPPI test.
On initial recognition, debt securities at amortized cost shall be measured at its fair
value plus transaction costs incurred in the acquisition.
There is a discount if fair value < face amount, while there is a premium if fair value
> face amount. Discount and premium are amortized for debt securities at amortized
cost.
There are three methods in amortizing discount or premium:
a. Straight-line method - equal amounts of discount or premium amortization are
made each period.
b. Bond-outstanding method - applicable to serial bonds where the amount of
discount or premium amortization is higher during initial years and lower
during the later years.
c. Effective interest method - uses a single rate that exactly discounts the cash
flows equal to the debt security’s initial measurement. This method is in line
with the requirements of PFRS 9.
The existence of discount and premium has the following consequences:

Scenario | Interest Income vs Interest Received | Amount of Amortized cost
Discount Interest Income > Interest Received Increasing amortized cost
Premium Interest Income < Interest Received Decreasing amortized cost
Under the effective interest method, there is a discount if stated rate < market rates
while there is a premium if stated rate > market rates.
Under the effective interest method, interest income is computed as beginning-of-
the-period carrying amount x effective interest rate.
Under the effective interest method, the absolute amount of amortization per year
is increasing, regardless of whether there is a discount or premium.
If interest payment date does not coincide with a reporting date (e.g., December 31),
partial amortization shall be made from the latest interest payment date up to the
reporting date.
10.If debt securities at amortized cost were sold on an interest payment date, the
difference between the proceeds and amortized cost in the amortization table shall
be recognized as realized gain or loss in profit or loss,
11. There is a realized gain if proceeds > amortized cost while there is a realized loss if
proceeds < amortized cost.
12. If debt securities at amortized cost were sold NOT on an interest payment date, the
amortized cost shall be updated up to the date of sale by way of partial amortization.
This updated carrying amount shall then be compared to the proceeds (excluding
accrued interest) to determine the amount of realized gain or loss.
460
The
CamScanner
CHAPTER 12B: SELF-TEST EXERCISES
True or False
1. Transaction costs incurred in acquiring debt securities at amortized cost shall be
expensed outright.
2: Any debt security at amortized cost sold before its maturity date will automatically
require the remaining debt securities in the portfolio to be accounted for at FVTPL.
Any initial discount or premium from debt securities at amortized cost shall be
amortized over the remaining term of the debt security.
If the bond outstanding method is applied to term bonds, equal amounts of
premium or discount amortization are recognized each year.
The amount of discount amortization shall be deducted from the amount of interest
received to arrive at the amount of interest income.
Under the effective interest method, if the stated rate is lower than the market rate,
the initial measurement of the debt security is lower than its face amount.
Under the effective interest method, the amount of interest income is increasing
every year if there is a premium on initial recognition.
Under the straight-line method, the annual amounts of interest income are the same
each period.
Under the bond outstanding method, the annual amounts of interest income is
decreasing every year regardless whether there is an initial amount of premium or
discount.
10. Changes in the fair values of debt securities at amortized cost are recognized as
addition to interest income (if unrealized gain) or deduction from interest income
(if unrealized loss)
a. On initial recognition, debt securities at amortized cost shall be measured at their
a. Fair value.
d. Amortized cost.
Z: At the end of each year, debt securities at amortized cost shall be measured at their
a. Fair value
d. Amortized cost.
3. Changes in the fair value of debt securities at amortized cost
a. shall be recognized in profit or loss.
b. shall be recognized in other comprehensive income.
c. shall be recognized directly to retained earnings
d. shall not be recognized at all
461
é
'
Beaa
The
CamScanner
4. The following are true when using the straight-line method of amortizing discount
or premium, except
a. The amounts of interest income are equal during each period, whether there is
a discount or premium being amortized.
b. The amount discount amortization steadily increases the carrying amount
of the
debt investment while the amount of premium amortization decreases the
carrying amount of the debt investment.
The premium amortization makes the amount of interest income lower than the
amount of interest received while the discount amortization makes the amount
of interest income higher than the amount interest received.
The initial amount of discount or premium shall be amortized from the debt
security’s original issuance date up until its maturity date.
5. Which of the following is true when using the bond outstanding method?
a. The carrying amount of the debt security at the end of each year is increasing
due to the amortization of discount.
b. The carrying amount of the debt security at the end of each year is increasing
due to the amortization of premium.
Cc. The method is primarily applicable to bonds with principal that is payable in
installments.
6. Generally, the effective interest rate is equal to

a. Stated rate
b. Nominal rate
Cc. Market rate on initial recognition
d. Market rate as of each reporting date.
7. Under the effective interest method, the amount of interest income from debt
securities at amortized cost shall be determined as
a. Beginning-of-the-period carrying amount times average market rate on initial
recognition of the related debt security.
b. Beginning-of-the-period carrying amount times average market rate as of the
reporting date.
Face amount times average market rate on initial recognition of the related debt
security.
d. Face amount times average market rate as of the reporting date,
8. If the acquisition of a debt security resulted to a discount and the investor is using
the effective interest method, which of the following is not correct?
The amount of amortization is increasing each year.
Interest income is higher than interest received.
p
Carrying amount of the debt security is increasing every year.

ao
None of the above.
462
The
a
9. Which of the following amounts coming from investment in debt securities at

amortized cost is/are reported in profit or loss?
Amount 1: Unrealized gain or loss on changes in fair value.
Amount 2: Realized gain or loss on sale.
a. Amount 1 only,
b. Amount 2 only.
c. BothAmounts 1 and 2.
d. Neither Amount 1 nor 2.
10.A bond was acquired at a premium. Which of the following statements is/are true?
Statement 1: Interest income is decreasing every year.
Statement 2: Premium amortization is decreasing every year.
a. lonly
b. Ilonly
c. Bothland Il
d. Neither! nor Il
11.When an entity’s business model is to collect contractual cash flows, the following
are correct, except
a. Generally, the financial assets are held until their maturity date to collect
interest and principal payments.
b. If any of the financial assets held under this business model is sold, the hold to
collect model should be changed to another business model.
c. The business model may still be holding assets to collect contractual cash flows
even if the entity sells financial assets when there is an increase in the assets’
credit risk. .
d. Reassessment of business model is still not required even if there are infrequent
sales of financial assets, even if their amounts are significant.
12.An entity acquired a bond to be accounted for at amortized cost. The effective rate is
higher than the stated rate in the bond. One year after the acquisition date, which of
the following amounts is/are higher than the bond’s present carrying amount?
I. Bond’s face amount
II. Bond's initial carrying amount
a. lonly
b. Ilonly
c. BothJand II
d. Neither J nor II
Straight Problems
1. On January 1, 2023, KABUL Company acquired seven-year government bonds with
face amount of P5,000,000 equal to its quoted price of 106, to be accounted for at
amortized cost. The bonds bear 8% interest and payable every December 31 of each
year. Maturity date is on December 31, 2027. Quoted prices of the bonds as of
463
The
CamScanner
December 31, 2023 and 2024 were 104.50 and 103.80, respectively. (Use straight-
line method in amortizing the discount or premium)
Required: Determine the amortization table over the bonds’ remaining term and the
journal entries for the years 2023 and 2024
2. At the beginning of 2023, TIRANA Company acquired eight-year, 10% interest-
bearing corporate bonds with face amount of P6,000,000 equal to its quoted price of
106, to be accounted for at amortized cost. Transaction costs of P60,000 were
incurred. The bonds were originally dated January 1, 2021. Interest is payable semi-
annually every June 30 and December 31 of each year. Quoted prices of the bonds as
of December 31, 2023 and 2024 were 97.50 and 98.20, ener (Use straight-
line method in amortizing the discount or premium)
3. On June 30, 2023, ALGIERS Company invested in six-year corporate bonds with face
amount of P3,000,000 and interest of 9%.to be accounted for at amortized cost.
Acquisition price is equal to 97.75 plus accrued interest. The nominal interest is
payable every December 31 of each year. Originally, the bonds were dated January
1, 2022. Quoted prices of the bonds as of December 31, 2023 and 2024 were 98.10
and 98.70, respectively. (Use straight-line method in amortizing the discount or
premium)
4, At the beginning of 2023, VILLA Company acquired five-year, P10,000,000 face

amount, newly issued corporate bonds for 95.50. The bonds are accounted for at
amortized cost. The face amount is payable in five equal annual installments every
December 31 of each year. Interest of 12% is payable at the same dates as the
principal installment payments. (Use bond-outstanding method in amortizing the
discount or premium)
5. On January 1, 2023, LUANDA Company decided to invest its excess funds for long-
term purposes. In connection with this, the Company invested in government bonds
with face amount of P7,500,000 for 103.50, incurring P112,500 transaction costs.
The face amount is payable in four equal annual installments every December 31 of
each year. Interest of 10% is payable at the same dates as the principal installment
payments. (Use bond-outstanding method in amortizing the discount or premium)
464
The
The Book
6. At the beginning of 2023, JOHN Company acquired a newly issued, six-year

corporate bonds with face amount of P5,000,000 for 93.30. The face amount is
payable in the following schedule, which is expressed as a percentage of face
amount:
12/31/28) 0) = 12/31/26 25%

12/31/24. 12/31/27 25%
12/31/25 30% 12/31/28 20%
Interest of 8% is payable every December 31 of each year. (Use bond-outstanding
method in amortizing the discount or premium)
7. YEREVAN Company acquired a 7% interest-bearing, P3,000,000 face amount debt

security on January 1, 2023 to be accounted for at amortized cost. The debt security
is originally dated January 1, 2020 and has an original term of six years. Market
yields on the date of acquisition averaged 9%. As of December 31, 2023 and 2024,
market yields averaged 8.50% and 8%, respectively.
amortization table over the bonds’ remaining term and the journal entries for the
years 2023 and 2024:
1. Interest is payable every December 31 of each year.
2. Interest is payable every June 30 and December 31 of each year.
8. On January 1, 2023, CANBERRA Company acquired a 9% interest-bearing,
P6,000,000 face amount corporate bonds when market yields averaged 8%. The
bonds will mature on December 31, 2024 and to be accounted for at amortized cost.
1. Interest is payable every December 31 of each year.
2. Interest is payable every June 30 and December 31 of each year.
3. Interest is payable every March 31, June 30, September 30 and December 31 of
each year.
9. On April 1, 2023, VIENNA Company acquired government bonds with face amount
of P7,500,000, to be accounted for at amortized cost. On the date of acquisition,
market yields averaged 12% even though stated rate is just 10%. Maturity date is
set on March 31, 2026.
1. Interest is payable every March 31 of each year.
2. Interest is payable every March 31 and October 31 of each year.
465
The
The Book
Chapter 12B — Investments in Debt Securities — Amortized Cost
10.At the beginning of 2023, BAKU Company acquired an 8% interest-bearing,

P3,000,000 face amount corporate bonds to be accounted for at amortized cost.
Market yields on the date of acquisition averaged 6%. Principal amounts are payable
in six equal annual installments every December 31 of each year, starting in 2023,
Interest is also payable at the same dates as the principal installments.
11.0n January 1, 2023, NASSAU Company invested in 5,000 newly issued, five-year,
government bonds, each with P1,000 face amount when market yields averaged 9%.
The bonds are to be accounted for at amortized cost. Interest of 10% is payable every
entries to record the sale of the debt security:
1. All ofthe bonds were sold on December 31, 2024 at its clean price of 102.40.
2. All ofthe bonds were sold on December 31, 2025 at its clean price of 101.60
3. . All of the bonds were sold on July 1, 2025 at its dirty price of 107.20.
4. P3,000,000 of the bonds were sold on December 31, 2025 at clean price of
101.70.
5. P4,000,000 of the bonds were sold on September 30, 2024 at its dirty price of
110.50.
6. P2,000,000 of the bonds were sold on December 31, 2026 at its clean price of
100.80.
12. At the beginning of 2023, MANAMA Company acquired the following debt securities
in separate transactions:
e Bond 1 - Convertible bonds with face amount of P4,000,000 and maturity date of
December 31, 2026. Acquired when market yields averaged 10%, even if the
stated rate is only 9%. Transaction costs incurred amounted to P80,000. Interest
is payable every December 31 of each year.
e Bond 2 - Plain vanilla bonds with face amount of P7,000,000 and maturity date
of December 31, 2027. Acquired when market yields averaged 7%, even if the
stated rate is 8%. Interest is payable every December 31 of each year.
All of these securities are held in a portfolio wherein the cash flows are collected
until the maturity date,
As of December 31, 2023 and 2024, these debt securities had the following quoted
prices:
December 31,2023 December 31,2024
Bond 1 98.70 103.60
Bond 2 97.60 104.40
466
The
The Book

a. Journal entries for the years 2023 and 2024
b. Total net amount to be recognized in profit or loss during 2023 and 2024.
c. Total carrying amount of the bonds as of December 31, 2023 and 2024.
1. On January 1, 2023, BRIDGETOWN Company acquired four-year corporate bonds
with face amount of P3,000,000 at its quoted price of 94.50 plus P90,000 transaction
costs. Interest of 9% is payable every December 31 of each year. The bonds are to be
accounted for at amortized cost. Use the straight-line method in amortizing the
discount or premium.

a. P270,000 c. P251,250
b. P288,750 d. P311,250
Carrying amount of the bonds as of December 31, 2024 shall be
a. P2,917,500 c. P2,962,500
b. P2,876,250 d. P2,943,750
Assume that the bonds were sold on July1, 2025 for P2,985,000 plus accrued
interest, the gain or loss on sale shall be
a. P13,125 gain c. P22,500 gain
b. P13,125 loss d. P22,500 loss
2. On March 31, 2023, MINSK Company invested in a P5,000,000 government bonds to

be accounted for at amortized cost. Acquisition cost is equal to clean price of 105.98.
Maturity date is set on December 31, 2028. Interest of 12% is payable very
December 31 of each year. Use straight-line method in amortizing the discount or
premium.
Total cash paid on March 31, 2023 to acquire the debt security shall be
a. P5,299,000 c. P5,749,000
b. P5,449,000 d. P5,669,000
c. P600,000 c. P450,000
d. P548,000 ~ d,P411,000
a. P5,260,000 c. P5,208,000
b. P5,247,000 d, P5,195,000
a. P5,235,000 c, P5,124,000
b. P5,156,000 d, P5,106,000
467
The
The Book
Chapter 12B —Investments in Debt Securities — Amortized Cost
3. BRUSSELS Company acquired serial government bonds with face amount of

P6,000,000 on January 1, 2023, to be accounted for at amortized cost. Transaction
price amounted to 92.50. The principal is payable in four equal annual installments
every December 31 of each year. Interest of 6% is also payable at the same dates as
the installment principal payments. Use bond-outstanding method in amortizing the
discount or premium.
a. P360,000 c. P540,000
b. P180,000 d. P620,000

c. P405,000 c. P270,000
d. P135,000 d. P330,000
Carrying amount of the investment as of December 31, 2024 shall be

a. P2,785,000 c. P2,865,000
b. P2,875,000 d. P2,685,000
4. Atthe beginning of 2023, BELMOPAN Company reported a P4,000,000 face amount

investment in government bonds that was acquired‘on January 1, 2022 when the
market rates averaged 8%. The bonds are being held to collect the contractual cash
flows until its maturity date on December 31, 2028. Quoted prices at the beginning
of 2023 averaged 9%. Interest of 6% is payable every December 31 of each year. On
July 1, 2023, P2,000,000 face amount of the bonds was sold atts dirty price of 92.75.
Carrying amount of the investment on January 1, 2023 shall be
a. P3,583,489 c. P3,593,452
b. P3,630,168 d. P3,654,329
Total interest income for the year 2023 shall be
a. P320,000 c. P217,809
b. P360,000 d. P290,413
Gain or loss from July 1, 2023 sale shall be
a. P32,688 gain c. P27,312 gain
b. P32,688 loss d, P27,312 loss
a. P1,834,732 c. P1,815,084
b. P1,827,688 d. P1,840,291
5. On January 1, 2023, NOVO Company had an investment in ten-year corporate bonds

with face amount of P8,000,000. These bonds are accounted for at amortized cost.
The bonds were acquired on its original issue date of January 1, 2020 when market
rates averaged 8%. Market rates as of January 1, 2023 averaged 7%. Interest of 9%
is payable every December 31 of each year. On October 1, 2023, P5,000,000 face
amount of the bonds was sold at its clean price of 105 less P15,000 transaction costs.
468
The
CamScanner

a. P523,429 c. P457,328
b. P620,360 d. P587,452
Net cash received from October 1, 2023 sale shall be
a. P5,250,000 c. P5,587,500
b. P5,235,000 d. P5,572,500
a. P3,285,991 c. P3,246,011
b. P3,323,356 d. P3,342,943
6. On January 1, 2023, THIMPHU Company acquired four-year, P7,000,000 face

amount government bonds when prevailing market rates averaged 12%. The
investment is accounted for at amortized cost. Interest of 10% is payable every June
30 and December 31 of each year. On November 1, 2024, P3,000,000 face amount of
the bonds was sold for its dirty price of 99.35.
a. P790,473 c. P788,972
b. P801,655 d. P799,649
a. P804,752 c. P801,655
b. P749,538 d. P744,182
a. P6,609,231 c. P6,705,132
b. P6,655,785 d. P6,757,440
a. P3,776,703 c. P3,831,504
b. P3,803,306 d. P3,861,394
The gain or loss from the November 1, 2024 sale shall be
a. P8,073 gain c. P91,927 gain
b. P8,073 loss d. P91,927 loss
7. At the beginning of 2023, BRASILIA Company acquired the following plain vanilla
debt securities:
Face Stated Interest Maturity
Amount’ Rate Pmt. Date/s Date
Bond1 2,000,000 10% Every12/31 12/31/26
Bond2 6,000,000 8% Every12/31 12/31/28
Bond3 5,000,000 11% Every12/31 12/31/28
Bond4 3,000,000 7% Every12/31 12/31/27
469
The
The Book
Bonds 1 and 3 are held in a portfolio with the objective of realizing cash flows
through selling of financial assets while Bonds 2 and 4 are held in a portfolio with
the objective of collecting the contractual cash flows until maturity date.
As of December 31, 2023 and 2024, these securities had the following quoted prices:
1/1/23.) 12/31/23 12/31/24

Bond 1 95.60 97.20 98.00
Bond 2 97.50 98.50 97.80
Bond 3 106.00 104.30 103.20
Bond 4 103.00 104.90 105.20
For simplicity, the Company uses the straight-line method of amortizing any
premium or discount arising from relevant securities.
a. P1,440,000 c. P1,560,000
b. P1,447,000 , d. P1,578,000
Net unrealized gain or loss to be recognized in 2023 profit or loss shall be
a. P1,440,000 c. P1,560,000
b. P1,447,000 d. P1,578,000
Net unrealized gain or loss to be recognized in 2024 profit or loss shall be
Total carrying amount of the investments in debt securities as of December 31, 2023
shall be
a. P16,092,000 c. P16,106,000
b. P16,122,000 d, P16,216,000
Total carrying amount of the investments in debt securities as of December 31, 2024
shall be
a. P16,074,000 c. P16,146,000
b. P16,046,000 d. P16,144,000
470
The
The Book
Chapter 12C — Investments in Debt Securities - FVTOCI
CHAPTER 12C
INVESTMENTS IN DEBT SECURITIES - FVTOCI

1. The initial measurement of investment in debt securities at FVTOCI.
2. The subsequent measurement of investment in debt securities at FVTOCI.
3. The accounting for the unrealized gain or loss - OCI.
4, The accounting for the selling’of investment in debt securities at FVTOCI
INVESTMENTS IN DEBT SECURITIES ACCOUNTED FOR AT FVTOCI

As previously discussed in Chapter 12, debt securities that meet BOTH of the
following shall be measured at amortized cost:
a. the financial asset is held within a business model whose objective is achieved
by BOTH collecting contractual cash flows (i.e., held-to-maturity) and selling
financial assets (i.e., held-for-selling); and
b. the contractual terms of the financial asset give rise on specified dates to cash
flows that are solely payments of principal and interest on the principal
amount outstanding. /PFRS 9.4.1.2A].
The readers should take note, that unlike in equity securities, the debt securities
shall meet the above requirements to be accounted for at FVTOCI. In other words,
irrevocable designation at FVTOCI is not available for debt securities.
“HELD-TO-MATURITY AND HELD-FOR-SELLING” BUSINESS MODEL

Specific objectives under this model might be any of the following:
a. Managing everyday liquidity needs.
b. Maintaining a particular interest yield profile.
c. Matching the duration of the financial assets to the duration of the liabilities
those assets are funding.
Generally, under this model, the selling of debt securities is more frequent and the
value of sales is higher compared to the solely held-to-maturity business model. Lastly,
this business model combines the characteristics of both the held-to-maturity and
held-for-selling business models (i.e., middle ground), which will have interesting
accounting consequences,
ACCOUNTING FOR INVESTMENT IN DEBT SECURITIES AT FVTOCI

Accounting procedures for investments in debt securities at FVTOCI, compared to
amortized cost and FVTPL classifications are summarized as follows:
471
The
The Book
FVTOCI Amortized Cost FVTPL

“8, ir ir value plus ;
Initial measurement Sa vale pins es ye Fair value
transaction cost transaction cost
Transaction costs Capitalized Capitalized Expensed outright
Subsequent defaiedalie At amortized cost ‘Ataievdtiie
measurement based on table
Beginning-of-the Beginning-of-the Race ariountsx
: period amortized | period amortized ,
Interest income ; ! stated or nominal
cost x effective cost x effective fate
interest rate interest rate
Use of amortization
ible Yes Yes No
Chan in fair :
ee Reported in OCI Not recognized Profit or loss
Amounts Separately Giateed cane None None

reported i i
P ay or losses - OCI
Profit or loss,
including the
Recognition of gain reclassification of Profitur loss Prone orlaks
or loss on sale cumulative
unrealized gains
or losses - OCI
Based, on the above comparison of accounting procedures, it can be said that the
FVTOCI classification combines the accounting procedures from FVTPL classification
and amortized cost classification.
The reason for this is that the business model underlying the FVTOCI classification
also combines the characteristics of business models underlying the FVTPL and
amortized cost classifications:
Held-to-Maturity Held-for-Selling
Account for the debt security Account for the debt security at
at amortized cost by using FVTPL by measuring it at fair
an amortization table value as of each reporting date
y
Held-to-Maturity + Held-for-Selling
Account for the debt security at FVTOCI by using an
amortization table but measuring the debt security at
its fair value as of each reporting date.
Needless to say, accounting procedures for FVTOCI are more closely related to
the accounting procedures for amortized cost classification.
472
The
CamScanner
Chapter 12C - Investments in Debt Securities - FVTOCI
FVTOCI AND AMORTIZED COST CLASSIFICATIONS

As shown in the comparison table, the bulk of the accounting procedures to be
applied to debt securities at FVTOCI, specifically the use of the amortization table,
were already discussed in the previous chapter, Chapter 12B. In particular, the
total amount to be recognized in profit or loss for each period (from interest
income and realized gain or loss on sale) under FVTOCI classification is the
same as if its accounted for at amortized cost.
Again, their primary difference arises from the fact that debt security at FVTOCI is
being measured at fair value at the end of each reporting period with resulting
amounts recognized in OCI. The amounts to be recognized in OCI will be discussed
in the succeeding sections.
DEBT SECURITIES AT FVTOCI VS EQUITY SECURITIES AT FVTOCI

There is a common mistake of presuming that the accounting procedures are
similar in both equity securities at FVTOCI and debt securities at FVTOCI. The truth
is, accounting procedures are very much different as compared below:
DEBT Security - FVTOCI EQUITY Security - FVTOCI
Required to meet the specified
business model and contractual.
Irrevocable designation on
Basis of cash flow characteristics. If lnidal’ Peabation”° Ge
classification these are not met, the debt saa ae
: é voluntary designation)
security cannot be classified as
at FVTOCI
: il . iscussed later,
Computation of = es oe Hise ; be .
:
unrealized gains comparison will be made | Direct changes in the fair
; ae
and losses between the amortized cost | value of the equity securities
and fair value
Recognized in OCI with
Recognized in profit or loss
previously accumulated OCI
Realized gain or
with previously accumulated
amounts directly
loss on sale
OCI amounts recognized in
transferred to retained
profit or loss as
earnings (ie, not a
reclassification adjustment.
reclassification adjustment)
UNREALIZED GAINS AND LOSSES FROM DEBT SECURITIES AT FVTOCI

Amounts of unrealized gains and losses in OCI are determined by applying the
following procedures:
1. First, compare the computed amortized cost in the amortization table with the
corresponding fair value on each reporting date. The following rules are the used
to evaluate the comparison:
Fair value > Amortized cost | Cumulative net unrealized gains in OCI
Fair value < Amortized cost | Cumulative net unrealized losses in OCI
473
The
CamScanner
Chapter 12C — Investments in Debt Securities —- FVTOCI
As cumulative amounts, these are the ending balances that shall be reported
in the equity section of the balance sheet. Cumulative net unrealized gains -
OCI are presented as addition to the equity while cumulative net unrealized
losses - OCI are presented as deduction from equity. This concept is similar to
the cumulative net unrealized gains and losses from equity securities at FVTOCI.
2. Changes in the cumulative net unrealized gains or loss in OCI from the
previous year to the current year are reported as unrealized gains or losses in
the current year’s OCI:
Changes Amounts in current year’s OCI
Increase in cumulative unrealized gain - OCI Unrealized gain - OCI
Decrease in cumulative unrealized gain —- OCI Unrealized loss - OCI
Increase in cumulative unrealized loss - OCI Unrealized loss - OCI
Decrease in cumulative unrealized loss - OCI Unrealized gain - OCI
Change from cumulative unrealized gain -
Unrealized loss - OCI
OCI to cumulative unrealized loss - OCI
Change from cumulative unrealized loss -
Unrealized gain — OCI
OCI to cumulative unrealized gain - OCI
Pro-forma journal entries to record these unrealized gains and losses in the
current year’s OCI are the following:
Financial asset at FVTOCI XX

Unrealized gain - OCI (if gain) XX
Unrealized loss - OCI (if loss) XX

Financial asset at FVTOCI XX
The following t-account as used in the net cumulative unrealized gain or loss of
equity securities at FVTOCI in Chapter 11 is also relevant in this case:
Unrealized gain or
loss - OCI ss
Beginning net unrealized loss XX XX Beginning net unrealized gain
balance (if net cum. losses) balance (ifnetcum. gains) _|
Net unrealized loss - OCI for XX XX Net unrealized gain - OCI for
the current year (squeeze) the current year (squeeze)
Unrealized gain reclassified to XX XX Unrealized loss reclassified to
profit or loss profit or loss zl
Ending net unrealized losses XX XX Ending net unrealized gain
balance (if net cum. losses)* balance (if net cum. gains) *
*Note: Equal to the difference between amortized cost and fair value at the end of each period.
474
The
The Book
The readers should take note that in this case, the squeeze amounts are the net
unrealized gain or loss to be recognized in current period’s OCI.
As to the investment account, its t-account can be summarized as follows:
Financial Asset at
FVTOCI
Beginning balance XX XX Premium amortization for
the year, if any
Discount amortization for the XX XX Unrealized loss - OCI for the
year, if any current year, if any (squeeze)
Unrealized gain - OCI for the XX XX Ending balance (equal to fair
current year, if any (squeeze) value as of reporting date)
Illustration 1 - Cumulative Gains. On January 1, 2023, an entity acquired a five-

year, 8% interest-bearing debt security with face amount P6,000,000 when the
prevailing market rates averaged 10%. This debt security is to be accounted for at
FVTOCI. In addition, the related fair values as of December 31, 2023, 2024, 2025,
2026 and 2027 were 99, 101, 103, 100.50 and 100, respectively. Interest is payable
every December 31 of each year.

Ordinary annuity for 5 periods at10% 3.790787 480,000 1,819,578
Fair value, 1/1/23 P5,545,104
Note: P480,000 = P6,000,000 x 8%.
[A] [B] [B] - [A] P.V./

1/1/23 5,545,104
12/31/23 480,000 554,510 74,510 5,619,614
12/31/24 480,000 561,961 81,961 5,701,575
12/31/25 480,000 570,158 90,158 5,791,733
12/31/26 480,000 579,173 99,173 5,890,906
12/31/27 480,000 589,094 109,094 6,000,000
12/31/27 6,000,000 (6,000,000) =
The amortized cost amounts above are compared with the corresponding fair
values to determine the cumulative unrealized gain or loss - OCI as of each
reporting date:
475
The
CamScanner
Chapter 12C — Investments in Debt Securities — FVTOCI
Amortized | Fair Value Cum. Unrealized

Date Cost [A] [B] Gains [B] - [A]
12/31/23 | 5,619,614 | 5,940,000 (P6Mx99%) 320,386
12/31/24 | 5,701,575 | 6,060,000 (P6Mx 101%) 358,425
12/31/25 | 5,791,733 | 6,180,000 (P6Mx 103%) 388,267
12/31/26 | 5,890,906 | 6,030,000 (P6Mx100.50%) 139,094
12/31/27 | 6,000,000 | 6,000,000 (P6Mx 100%) -
There were cumulative unrealized gains since all of the fair value amounts are
higher than the related amortized cost amounts. These cumulative unrealized
gains — OCI are reported in the equity section of the balance sheet.
In addition, the related debt security is reported in the assets section of the
balance sheet equal to its fair value (i.e., not at its amortized cost).
Next, determine the unrealized gains or losses to be reported in OCI for each
period, together with the total amount to be reported in total comprehensive
income:
[A] Cum. [B] Cum. Unrealized gain _Interest Total

Unrealized Unrealized (loss) - OCI Income- Compre. Inc.
Year Gains-Beg. Gains-End. [C]=[B]-[A] P/L[D] —_[D] +[C]
2023 - 320,386 320,386 554,510 874,896
2024 320,386 358,425 38,039 561,961 600,000
2025 358,425 388,267 29,842 570,158 600,000
2026 388,267 139,094 (249,173) 579,173 330,000
2027 139,094 - (139,094) 589,094 450,000
Based on this table, the readers should take note of the following:
a. For 2023 to 2025, there were increases in cumulative unrealized gains
resulting to unrealized gains - OCI to be recognized for those years.
b. For 2026 to 2027, there were decreases in cumulative unrealized gains
resulting to unrealized losses - OCI to be recognized for those years.
c. Interest income amounts are reported in profit or loss.
d. Total comprehensive income can also be computed as: Interest Received +
Change in Investment’s Fair Value. For example, total comprehensive income
of P600,000 for 2024 is computed as: P480,000 + (P6,060,000 - P5,940,000).
Journal entry to be made on January 1, 2023 to record the acquisition is as follows:
Cash 5,545,104
Fast forward to December 31, 2023, the following are the journal entries
recognizing the interest income and unrealized gain - OCI for the year 2023;
476
The
Cash 480,000

After recording these entries, the investment’s carrying amount as of December 31,
2023 can now be determined as follows:
Financial Asset at
FVTOCI
Beg. balance, 1/1/23 | 5,545,104 | 5,940,000 | Ending balance- also equal
Discount amortization for 74,510 to its fair value as of
the year 12/31/23
Unrealized gain-OCI forthe | 320,386
current year
Fast forward yet again, to December 31, 2024, the following are the journal entries
recognizing the interest income and unrealized gain - OCI for the year 2024:
Cash 480,000

Financial Asset at
FVTOCI
Beg. balance, 1/1/24 | 5,940,000 | 6,060,000 | Ending balance (squeeze) -
Discount amortization for 81,961 equal to its fair value as of
the year 12/31/24
Unrealized gain - OCI for the 38,039
current year
Illustration 2 - Cumulative Gains and Losses. At the beginning of 2023, SOFIA

Company acquired a commercial bond with face amount of P2,000,000 and
maturity date of December 31, 2028. The bond was acquired when the market
yields averaged 9% even if it bears 10% nominal rate and accounted for at FVTOCI.
In addition, the related fair values as of December 31, 2023, 2024, 2025, 2026, 2027
and 2028 were 98, 101.25, 104, 100.50, 99.75 and 100, respectively.
477
The
The Book

Fair value, 1/1/23 P2,089,718
Note: 1/1/23 to 12/31/28 is 6 years, hence 6 periods; P200,000 = P2,000,000 x 10%.
[A] [B] [B] - [A] P.V./

1/1/23 2,089,718
12/31/23 200,000 188,075 (11,925) 2,077,793
12/31/24 200,000 187,001 (12,999) 2,064,794
12/31/25 200,000 185,831 (14,169) 2,050,625
12/31/26 200,000 184,556 (15,444) 2,035,181
12/31/27 200,000 183,166 (16,834) 2,018,347
12/31/28 200,000 181,653 (18,347) 2,000,000
12/31/28 2,000,000 (2,000,000) -
reporting date:
Amortized Fair Value Cum. Unrealized Gains

Date Cost [A] [B] (Losses) [B] - [A]
12/31/23 2,077,793 1,960,000 (P2Mx 98%) (117,793)
12/31/24 2,064,794 2,025,000 (P2Mx101.25%) (39,794)
12/31/25 2,050,625 2,080,000 (P2Mx 104%) 29,375
12/31/26 2,035,181 2,010,000 (P2Mx 100.50%) (25,181)
12/31/27 2,018,347 1,995,000 (P2Mx 99.75%) (23,347)
12/31/28 2,000,000 2,000,000 (P2Mx 100%) =
Next, determine the unrealized gains or losses to be reported in OCI for each
period, together with the total amount to be reported in total comprehensive
income:
478
The
CamScanner
[A] Cum. [B] Cum. Unrealized Interest Total

Unrealized Unrealized gain (loss)- Income Compre.
Gains (Losses) Gains (Losses) - OCI -P/L Inc.
Year =Beginning Ending [C]=[B]-[A] [D] [D] +{c]
2023 - (117,793) (117,793) 188,075 70,282
2024 (117,793) (39,794) 77,999 187,001 265,000
2025 (39,794) 29,375 69,169 185,831 255,000
2026 29,375 (25,181) (54,556) 184,556 130,000
2027 (25,181) (23,347) 1,834 183,166 185,000
2028 (23,347) - 23,347 181,653 205,000
Based on the previous table, the readers should take note of the following:
a. For the year 2024, there was a decrease in cumulative unrealized loss
resulting to unrealized gain - OCI to be recognized for that year.
b. For 2025, cumulative unrealized loss became cumulative unrealized gain,
which resulted to unrealized gain - OCI to be recognized for that year.
Journal entry to be made on January 1, 2023 to record the acquisition is as follows:
Cash 2,089,718
Fast forward to December 31, 2023, the following are the journal entries
recognizing the interest income and unrealized loss - OCI for the year 2023:
Cash 200,000

Financial Asset at
FVTOCI
Beginning balance, 1/1/23 | 2,089,718 11,925 | Premium amortization for
the year
117,793 | Unrealized loss - OCI for the
current year
1,960,000 | Ending balance (squeeze) -
equal to its fair value as of
12/31/23
Fast forward yet again, to December 31, 2024, the following are the journal entries
recognizing the interest income and unrealized gain - OCI for the year 2024:
479
The
The Book
Cash 200,000

Financial Asset at
FVTOCI
Beginning balance, 1/1/24 | 1,960,000 12,999 | Premium amortization for
the year
Unrealized gain - OCI for the 77,999 | 2,025,000 | Ending balance (squeeze) —-
current year equal to its fair value as of
12/31/24
SELLING OF DEBT SECURITIES AT FVTOCI ON INTEREST PAYMENT DATE

Any difference between the carrying amount and proceeds is reported immediately
as realized gain or loss in profit or loss:
Scenario ___ Gain or Loss?

Proceeds < Carrying Amount | _ Realized loss on sale
In addition to the amount of immediately recognized realized gain or loss on sale,

the related balance in the cumulative unrealized gain or loss - OCI shall be
recognized in profit or loss (i.e., reclassification adjustment), in the following
manner:
Cumulative OCI Balance Accounting procedures
The amount is debited and
Cumulative unrealized gain - OCI added to the gain on sale or
deducted from the loss on sale
The amount is credited and
Cumulative unrealized loss- OCI | Deducted from the gain on sale or
added to the loss on sale
If there is a partial sale, only a portion of the cumulative unrealized gain or loss -
OCI amount shall be reclassified to profit or loss.
Illustration 3. RAMBO Company presented the following information related to

one of its investments in debt securities at FVTOCI:
480
The
The Book
Chapter 12C - Investments in Debt Securities — FVTOCI
j Amortized Cum. Unrealized

Date Cost Fair Value Gain (Loss) - OCI
12/31/23 3,855,308 3,950,000 94,692
12/31/24 3,796,072 3,900,000 103,928
12/31/25 3,733,876 3,650,000 (83,876)
12/31/26 3,668,568 —_ 3,500,000 (168,568)
12/31/27 3,600,000 3,600,000 -

journal entries to record the sale (assume that right before the sale, the carrying
amounts and cumulative unrealized gains (losses) - OCI have already been
updated):
1. All of the debt securities were sold for P3,960,000 on December 31, 2024.
4. All ofthe debt securities were sold for P3,600,000 on December 31, 2025.
5. 70% of the debt securities were sold for P2,380,000'on December 31, 2026.
Scenario 1 .
The immediately realized gain from December 31, 2024 sale is recorded as follows:
Cash 3,960,000
The readers should take note that, if the sale occurred during a reporting date, the
carrying amount of the investment is equal to its fair value as of the date of
sale. On the other hand, the reclassification of cumulative unrealized gain of
P103,928 as of this date shall be recorded as follows:
Gain on sale - P/L 103,928
The total amount of gain on sale is P163,928 (P60,000 + P103,928). The readers
should take note that the total amount of realized gain or loss on sale can also
be computed by comparing the proceeds and the amortized cost as of the date
of sale:
Scenario pein TOTAL Gain or Loss?
Proceeds > Updated Amortized Cost There is a total gain on sale
Proceeds < Updated Amortized Cost. |_ There is a total loss on sale
For this scenario, this can be computed as P163,928 gain = P3,960,000 - P3,796,072.
Scenario 2 ;
The immediately realized loss from December 31, 2024 sale is recorded as follows:
481
The
The Book
Cash 3,700,000
Reclassification of cumulative unrealized gain of P103,928 shall be recorded as
follows:
Loss on sale - P/L 103,928
Net amount of loss in this case is P96,072 (P200,000 - P103,928). This can also
be computed as P96,072 loss = P3,700,000 — P3,796,072.
Scenario 3
The immediately realized gain from December 31, 2025 sale is recorded as follows:
Cash 3,750,000
Reclassification of cumulative unrealized loss of P83,876 shall be recorded as
follows:

Net amount of gain in this case is P16,124 (P100,000 - P83,876). This can also be
computed as P16,124 gain = P3,750,000 — P3,733,876.
Scenario 4
Cash 3,600,000
Reclassification of cumulative unrealized loss of P83,876 shall be recorded as

follows:

Total amount of loss in this case is P133,876 (P50,000 + P83,876). This can also
be computed as P133,876 loss = P3,600,000 - P3,733,876.
Scenario 5
482
Bsr
The
The Book
Cash 2,380,000
Financial asset at FVTOCI (P3.5Mx 70%) 2,450,000
Partial reclassification of cumulative unrealized loss of P117,998 (P168,568x 70%)

shall be recorded as follows:
The readers should take note that there is only a partial reclassification since not
all of the bonds were sold. Total amount of loss on sale is now computed as
P187,998 (P70,000 + P117,998). This can also be computed as P187,998 loss =
P2,380,000 - (P3,668,568 x 70%).
SELLING OF DEBT SECURITIES AT FVTOCI NOT ON INTEREST PAYMENT DATE

The different scenarios of selling FVTOCI debt securities in the previous illustration
were all made as of interest payment date. However, FVTOCI debt securities can
also be sold not on an interest payment date.
In this case, since the accounting for FVTOCI debt securities involves the use of
amortization table, partial amortization of discount or premium shall be made from
the immediately preceding interest payment date until the date of sale. In addition,
additional amounts shall be received for accrued interest from immediately preceding
interest payment date until the date of sale.
Illustration 4. On January 1, 2023, CARACAS Company acquired a four-year debt
security with face amount of P4,000,000 and stated rate of 8%. Market yields on the
date of acquisition averaged 10%. Interest is payable every December 31 of each
year. The debt security is to be accounted for at FVTOCI.
As of December 31, 2023,
2024 and 2025, quoted prices were 95.60, 95.40 and 98.70, respectively. Required:
Under each of the following independent scenarios, determine the journal entries
to record the sale of the debt security:
1. All of the debt security were sold on March 31, 2024 for 98.25 dirty price.
2. All of the debt security were sold on July 1, 2025 for 99.30 dirty price.

Ordinary annuity for 4 periods at10% 3.169865 1,014,357|
320,000 ___
Fair value, 1/1/23 _P3,746,409
Note: P320,000 = P4,000,000 x 8%.
483
The
[A] [B] [B]-[A] —P.V./

1/1/23 3,746,409
12/31/23 320,000 374,641 54,641 3,801,050
12/31/24 320,000 380,105 60,105 3,861,155
12/31/25 320,000 386,115 66,115 3,927,270
12/31/26 320,000 392,730 72,730 4,000,000
12/31/26 4,000,000 (4,000,000) -
reporting date:
Amortized Fair Value Cum. Unrealized Gains
Date Cost [A] [B] (Losses) [B] - [A]
12/31/23 3,801,050 3,824,000 (P4Mx 95.60%) 22,950
12/31/24 3,861,155 3,816,000 (P4Mx 95.40%) (45,155)
12/31/25 3,927,270 3,948,000 (P4Mx 98.70%) 20,730
Scenario 1 — All were sold on March 31, 2024 for 98.25 dirty price
Right before the date of sale, the journal entry to record the accrual of interest
receivable, recognition of interest income and partial amortization of discount:
Interest receivable (P320K x 3/12) 80,000
Financial asset at FVTOCI (P60,105 x 3/12) 15,026
The “3” in the above journal entry stands for the period from January 1, 2024 to
March 31, 2024. In addition, the amounts pro-rated were all based on 12/31/24
row in the amortization table.
After this journal entry, the carrying amount of the debt security at FVTOCI on
March 31, 2024 and right before sale is P3,839,026 [P3,824,000 1/1/24 balance
(also equal to its fair value) plus P15,026 partial discount amortization]. The journal
entry to record the actual sale is as follows:
Cash (P4M x 98.25%) (already the dirty price) 3,930,000
To reclassify the cumulative unrealized gain - OCI as of December 31, 2023 to profit
or loss:

484
The
The Book
Total gain on sale to be recognized in profit or loss is P33,924 (P10,974 + P22,950).

Scenario 2 - All were sold on July 1, 2025 for 99.30 dirty price
On the date of sale, the journal entry to record the accrual of interest receivable,
recognition of interest income and partial amortization of discount:
Interest receivable (P320K x 6/12) 160,000
Financial asset at FVTOCI (P66,115 x 6/12) 33,058
The “6” in the above journal entry stands for the period from January 1, 2025 to July
1, 2025. In addition, the amounts pro-rated were all based on 12/31/25 row in the
amortization table.
After this journal entry, the carrying amount of the debt security at FVTOCI on July
1, 2025 and right before sale is P3,849,058 [P3,816,000 1/1/25 balance (also equal
to its fair value) plus P33,058 partial discount amortization]. The journal entry to
record the actual sale is as follows:
Cash (P4M x 99.30%) (already the dirty price) 3,972,000
To reclassify the cumulative unrealized loss - OCI as of December 31, 2024 to profit
or loss:
Total loss on sale to be recognized in profit or loss is P82,213 (P37,058 + P45,155).

COMPARISON OF AMOUNTS TO BE REPORTED UNDER FVTPL, AMORTIZED COST
AND FVTOCI CLASSIFICATIONS
As a culmination, an illustration will be provided so as the readers can compare,
side-by-side, the amounts that will be reported in the entity's statement of
comprehensive income and statement of financial position depending on the debt
security's accounting classification:
Illustration 5. On January 1, 2023, FORENSIC Company acquired a three-year
investment in debt security with total face amount of P4,000,000 when market
rates averaged 10%, even though the stated rate is only 8%, Interest is payable
every December 31. Quoted prices were 98, 97 and 100 as of December 31, 2023,
2024 and 2025, respectively.
Required: Determine the total amount to be reported in profit or loss each year and
investment’s carrying amount at the end of each year, assuming the investment is
accounted as at FVTPL, at Amortized Cost or at FVTOCI,
485
The
CamScanner
The amounts to be reported in profit or loss for each year, under each independent
classification of the investment are the following:
2023 2024 2025
FVTPL
Interest income P320,000 P320,000 P320,000
Unrealized gain (loss) 118,947 (40,000) 120,000
P438,947 P280,000 P440,000
Amortized cost
FVTOCI
Based on the above, the readers should take note of the following:
a. Interest income from FVTPL classification is equal to P4,000,000 face amount
multiplied with 8% stated rate.
b. Unrealized gains (losses) in the FVTPL classification are determined as follows:
Date Fair values Unrealized gain (loss)
1/1/23 P3,801,053 (see below)
12/31/23 3,920,000 (P4M x 98%) | P118,947 (P3.92M - P3,801,053)
12/31/24 | 3,880,000 (P4Mx 97%) (40,000) (P3.88M - P3.92M)
12/31/25 4,000,000 (P4Mx 100%) 120,000 (P4M- P3.88M)
The initial fair value on January 1, 2023 is determined as follows:

PV Factor of PV Factor Cash Flow ‘Fair Value
Fair value, 1/1/23 P3,801,053
c. Interest income for Amortized cost and FVTOCI classifications is based on the
following amortization table:
[A] [B] [B] - [A] P.V./

1/1/23 3,801,053
12/31/23 320,000 380,105 60,105 3,861,158
12/31/24 320,000 386,116 66,116 3,927,274
12/31/25 320,000 392,726 72,726 _ 4,000,000
The carrying amounts of the investment at the end of each year are the following:
Dec. 31, 2023 Dec. 31,2024 Dec.31,2025
FVTPL (at fair value) P3,920,000 P3,880,000 P4,000,000
Amortized cost (based on table) 3,861,158 3,927,274 4,000,000
FVTOCI (at fair value) 3,920,000 3,880,000 4,000,000
486
The
The Book
CHAPTER SUMMARY
1. For business model with a goal of both holding debt securities until their maturity
(i.e., held-to-maturity) and selling financial assets to collect contractual cash
flows, the covered debt securities shall be accounted for at FVTOCI provided the
securities pass the SPPI test.
. On initial recognition, debt securities at amortized cost shall be measured at its fair
nN
value plus transaction costs incurred in the acquisition.

3. Accounting procedures for debt securities at FVTOCI are the combination of the
accounting procedures for debt securities at FVTPL and debt securities at amortized
cost.
4. Ateach reporting date, debt securities at FVTOCI are measured at their fair values.
5. Interest income from debt securities at FVTOCI are determined using an
amortization table similar to when it is accounted for at amortized cost.
6. Any difference between the debt security’s fair value as of each reporting date and
corresponding amortized cost shall be considered as the cumulative unrealized gain
or loss - OCI to be reported in the entity's equity.
7. Amounts to be recognized in current year’s OCI will depend on the changes in the
amounts of cumulative gain or loss - OCI, as summarized below:
Changes _-.«.... | Amounts in current year’s OCI

Increase in cumulative unrealized gain - OCI Unrealized gain - OCI
Decrease in cumulative unrealized gain - OCI Unrealized loss - OCI
Increase in cumulative unrealized loss - OCI Unrealized loss - OCI
Decrease in cumulative unrealized loss - OCI Unrealized gain - OCI
Change from cumulative unrealized gain -
Unrealized loss — OCI
OCI to cumulative unrealized loss - OCI
Change from cumulative unrealized loss -
OCI to cumulative unrealized gain - OCI
8. Ifa debt security at FVTOCI is sold, the related cumulative unrealized gain or loss -
OCI shall be reclassified to profit or loss through the following manner:
Cumulative OCI Balance Accounting procedures
The amount is debited and
Cumulative unrealized gain - OCI added to the gain on sale or
deducted from the loss on sale
The amount is credited and
Cumulative unrealized loss - OCI | Deducted from the gain on sale or
added to the loss on sale
9. The total gain or loss on sale to be recognized in profit or loss (including

reclassification of cumulative OCI amounts) can also be determined as follows:
Scenario TOTAL Gain or Loss?

Proceeds > Updated Amortized Cost_|_ There is a total gain on sale
Proceeds < Updated Amortized Cost _| There isa total loss on sale
487
The
The Book
CHAPTER 12C: SELF-TEST EXERCISES
True or False
1 Since debt securities at FVTOCI are measured at fair value, transaction costs related
to its acquisition shall be expensed outright.
2: Interest income from debt securities at FVTOCI is based on the relevant
amortization table.
3, When accounting for debt securities at FVTOCI, amortized cost amounts in the
amortization table are not relevant.
Debt securities at FVTOCI shall always have carrying amounts that are equal to their
fair values as of each reporting date.
The amounts to be recognized in OCI are equal to the changes in the fair value of
the debt securities at FVTOCI.
The difference between the debt securities at FVTOCI’s fair value and amortized
cost shall be recognized as the cumulative amount of unrealized gain or loss - OCI
at the end of each year.
Decrease in the amount of cumulative unrealized loss - OCI shall be recognized in
the current year’s OCI as unrealized gain.
Increase in the amount of cumulative unrealized gain - OCI shall be recognized in
the current year’s OCI as unrealized loss.
The total gain or loss to be recognized in net income from selling debt securities at
FVTOCI is equal to the difference between the proceeds and the security's carrying
amount.
10. In selling debt securities at FVTOCI, cumulative unrealized gains or loss - OCI shall
be reclassified to profit or loss.

1. On initial recognition, debt securities at amortized cost shall be measured at their
a. Fair value.
d. Amortized cost.
At the end of each year, debt securities at amortized shall be measured at their
a. Fair value.
d. Amortized cost.
Interest income from debt securities at FVTOCI shall be determined as
a. Beginning-of-the-period carrying amount times average market rate on initial
recognition of the related debt security.
488
The
CamScanner
b. Beginning-of-the-period carrying amount times average market rate as of the

reporting date.
c. Face amount times average market rate on initial recognition of the related debt
security.
d. Face amount times average market rate as of the reporting date.
4. Discount and premium arising from the acquisition of debt securities at FVTOCI
a. Shall be amortized over the remaining term of the debt security using the
effective interest method.
b. Shall not be amortized since these amounts will already be incorporated into
the amounts of unrealized gain or loss - OCI.
c. Shall not be amortized but shall be reclassified to profit or loss upon selling of
the related debt security at FVTOCI.
5. The following are characteristics of a business model involving the collection of

contractual cash flows and sale of financial assets, except
a. An entity will hold financial assets to collect the contractual cash flows, and
when an opportunity arises, it will sell financial assets to re-invest the cash in
other financial assets with a higher return.
b. Anentity invests in short-term financial assets before the expected timing of the
entity’s major expenditure. When the financial assets mature, the proceeds at
maturity are re-invested in new short-term financial assets. The entity
maintains this strategy until the funds are needed.
c. The managers responsible for the business model are compensated based on
the overall return generated by the financial assets within that business model.
d. An entity seeks to maximize its earnings and therefore actively manages the
return on the portfolio by realizing short-term gains.
6. The following accounting procedures for debt securities at FVTOCI are correct,
except
a. Interest income is computed using the discount rate determined during the
initial recognition.
b. Interest income is recognized in profit or loss.
c. The difference between the investment’s amortized cost and fair value at the
end of each year is the amount of unrealized gains and losses to be reported in
OCI.
d. Changes in the cumulative unrealized gain or loss - OCI from one reporting date
to another are recognized in the current period’s OCI.
7. Statement 1: Ifan FVTOCI debt securities’ fair value is higher than its amortized cost,
the difference is considered as cumulative unrealized gains to be reported in the
shareholders’ equity.
Statement 2: If the fair value of FVTOCI debt securities is lower than its amortized
cost, the difference is considered as cumulative unrealized loss to be reported in
shareholders’ equity.
489
The
a. True, True
b. True, False
c. False, True
d. False, False
8. Statement 1: If, during the current year, an FVTOCI debt securities’ cumulative
unrealized gains - OCI increased from last year, the amount of increase is reported
as unrealized loss in OCI for the current year,
Statement 2: If, during the current year, an FVTOCI debt securities’ cumulative
unrealized gains - OCI decreased from last year, the amount of decrease is reported
as unrealized loss in OCI for the current year.
a. True, True
b. True, False
c. False, True
d. False, False
9. Statement 1: If, during the current year, an FVTOCI debt securities’ cumulative
unrealized loss - OCI increased from last year, the amount of increase is reported as
unrealized gain in OCI for the current year.
Statement 2: If, during the current year, an FVTOCI debt securities’ cumulative
unrealized loss decreased from last year, the amount of decrease is reported as
unrealized gain in OCI for the current year.
a. True, True
b. True, False
c. False, True
d. False, False
10.If FVTOCI investments in debt securities are sold, which of the following is the
correct accounting treatment for the gain or loss?
a. The difference between the investment's carrying amount and proceeds from
sale is immediately reported in profit or loss. Unrealized gains or loss amounts
previously accumulated in the shareholders’ equity are directly transferred to
retained earnings.
b. The difference between the investment’s carrying amount and proceeds from
sale is recognized directly to retained earnings. Unrealized gains or loss
amounts previously accumulated in the shareholders’ equity are reclassified to
profit or loss.
c. The total amount of gain or loss on the sale can also be computed as the
difference between the investment’s amortized cost on the date of sale and the
proceeds from sale.
d. The total amount of gain or loss on the sale can also be computed as the
difference between the investment’s carrying amount on the date of sale and the
proceeds from sale.
11.In reporting interest income from a debt security, which of the following is not
correct, assuming all other information are constant?
490
The
The Book
a. FVTPL treatment will report different interest income compared to amortized

cost treatment.
b. Amortized cost treatment will report the same interest income as FVTOCI
treatment.
c. FVTOCI treatment will report different interest income compared to FVTPL
treatment.
d. FVTPL treatment will report the same interest income as FVTOCI treatment.
12.During the current year, an entity acquired an investment in debt security at a
discount. The entity would like to know the effect of the investment in its profit or
loss. Determine which combination of accounting treatments will report the same
amounts to the entity’s profit or loss every year
I. FVTPL
II. FVTOCI
Ill. Amortized Cost
a. landil
b. Iland Ill
c. landlIil
d. The above accounting treatments will report different amounts in profit or loss.
Straight Problems
1. On January 1, 2023, HARARE Company acquired newly issued five-year corporate
bonds with face amount of P6,000,000, which are to be accounted for at FVTOCI. On
that date, market yields averaged 8%, even though stated rate is 10%. Interest is
payable every December 31 of each year. As of December 31, 2023, 2024, 2025, and
2026, quoted prices were 107.25, 106.10, 105.30, and 103.80, respectively.
b. Cumulative unrealized gain or loss - OCI to be recognized in equity as of
December 31, 2023, 2024, 2025, and 2026.
c. Unrealized gain or loss to be recognized in the OCI each year from 2023 to 2026.
2. At the beginning of 2023, LUSAKA Company invested in a seven-year government
bonds with face amount of P5,000,000 to be accounted for at FVTOCI. Market yields
averaged 12%, The bonds were originally dated January 1, 2022. Interest of 11% is
2026, quoted prices were 96,15, 96.00, 97.10, and 97.60, respectively.

a. Journal entries from 2023 to 2024,
December 31, 2023, 2024, 2025, and 2026.
491
The
The Book
3. On January 1, 2023, CARDIFF Company acquired a ten-year, 8% interest-bearing,

P3,000,000 face amount corporate bonds to be accounted for at FVTOCI. Market
rates averaged 6% while interest is payable every December 31 of each year.
Maturity date is on December 31, 2029. As of December 31, 2023, 2024, 2025, and
2026, quoted prices were 110.70, 108.10, 107.35, and 105, respectively.

December 31, 2023, 2024, 2025, and 2026.
4, HANOI Company acquired an eight-year, newly issued government bonds with face
amount of P4,000,000 on January 1, 2023 to be accounted for at FVTOCI. Market
rages averaged 9%, Interest of 7% is payable every December 31 of each year. As of
December 31, 2023, 2024, 2025, and 2026, quoted prices were 89.25, 92.30, 91.80,
and 93.80, respectively.

relevant journal entries in recording the sale transaction:
On December 31, 2023, all of the bonds were sold for 90,30.
PP
On December 31, 2023, all of the bonds were sold for 88.75.
On December 31, 2023, P2,500,000 of the bonds were sold for 90.10
Sew
On December 31, 2024, P1,500,000 of the bonds were sold for 92.80
5. On January 1, 2023, CARACAS Company invested in corporate bonds with total face
amount of P6,000,000 and maturity date of December 31, 2027, which are to be
accounted for at FVTOCI. Market rates averaged 10% while interest of 12% is
2026, quoted prices were 89.25, 92.30, 91.80, and 93.80, respectively.

relevant journal entries in recording the sale transaction:
1. On March 31, 2024, all of the bonds were sold for its 107.10 clean price.
2. On September 30, 2025, all of the bonds were sold its 111.90 dirty price.
3. On June 30,2026, all of the bonds were sold for its 101.90 clean price.
6. VILA Company acquired a 7% interest-bearing, P8,000,000 face amount debt

security on January 1, 2023. The debt security is originally dated January 1, 2020
and has an original term of ten years. Market yields on the date of acquisition
averaged 9%. As of December 31, 2023 and 2024, quoted prices were 97.45 and
98.25, respectively.
492
The
The Book
entries to be made from 2023 to 2024, and the carrying amount of the investment
as of December 31, 2023 and 2024:
1. The debt security is accounted for at FVTPL.
2. The debt security is accounted for at amortized cost.
3. The debt security is accounted for at FVTOCI.
7. At the beginning of 2023, TASHKENT Company had the following investments in

debt securities:
e Bond 1 - Has face amount of P6,000,000 and interest of 9% payable every
December 31 of each year. Acquired last January 1, 2020 when market yields
averaged 10%, Has maturity date of December 31, 2026.
averaged 9%. Has maturity date of December 31, 2027.
averaged 7%. Has maturity date of December 31, 2026.
Bonds 1, 2, and 3 are accounted for at amortized cost, FVTOCI, and FVTPL,
respectively. As of December 31, 2023 and 2024, these debt securities had the
following quoted prices:
December 31, 2023 December 31, 2024

Bond 1 95.80 96.70
Bond 2 107.30 108.20
Bond 3 98.40 97.70
Required: Based on the above information, determine the following:

a. Total carrying amount of the investments in debt securities as of December 31,
2023 and 2024.
b. Total interest income from 2023 to 2024.
c. Unrealized gains and losses to be recognized in 2023 and 2024 profit or loss.
d. Unrealized gains and losses to be recognized in 2023 and 2024 OCI.
1. On January 1, 2023, MONTEVIDEO Company acquired newly issued six-year
corporate bonds with face amount of P7,500,000, which are to be accounted for at
FVTOCI. On that date, market yields averaged 7%, even though stated rate is 9%.
Interest is payable every December 31 of each year. As of December 31, 2023, 2024,
2025, and 2026, quoted prices were 108.80, 107.20, 104.90, and 104,10,
respectively.
Unrealized gain or loss to be recognized in 2023 OCI shall be
a. P44,971 gain c, P54,980 gain
b. P44,971 loss d. P54,980 loss
493
The
The Book
Net comprehensive income from the debt security during 2023 shall be
a. P719,971 gain c, P620,020 gain
b. P719,971 loss d. P620,020 loss
a. P31,919 gain c. P13,052 gain
b. P31,919 loss d. P13,052 loss
Net comprehensive income from the debt security during 2024 shall be
a. P555,000 gain c. P599,971 gain
b. P555,000 loss d. P599,971 gain
Net cumulated unrealized gain or loss - OCI to be recognized in December 31, 2024
equity shall be
a. P31,919 gain c. P44,971 gain
b. P31,919 loss d. P44,971 loss
The investment’s carrying amount as of December 31, 2025 shall be

a. P7,893,647 c. P8,040,000
b. P7,867,500 d. P8,008,081
2. At the beginning of 2023, WASHINGTON Company invested in 8,000 newly issued,

five-year, government bonds, each with P1,000 face amount when market yields
averaged 8%. The bonds are to be accounted for at FVTOCI. Interest of 7% is payable
every December 31 of each year. On December 31, 2023 and 2024 the bonds’ fair
values were 97.90 and 96.80, respectively.

a. P151,418 gain c. P96,971 gain
b. P151,418 loss d. P96,971 loss

a. P7,744,000 c. P7,735,029
b. P7,832,000 d. P7,793,831

a. P49,831 gain c. P146,802 gain
b. P49,831 loss d, P146,802 loss
a. P614,447 c. P618,802
b. P560,000 d. P472,000
a. P7,744,000 c. P7,735,029
b. P7,832,000 d, P7,793,831
Cumulative unrealized gain or loss to be recognized in 2024 equity shall be

494
The
CamScanner
a. P49,831 gain c. P96,971 gain

b. P49,831 loss d. P96,971 loss
3. On January 1, 2023, LONDON Company decided to invest its excess funds on debt
securities to be accounted at FVTOCI. In connection with this, the Company invested
in government bonds with face amount of P6,600,000 when market rates averaged
9%. Maturity date of the bonds is on December 31, 2026. Interest of 10% is payable
every December 31 of each year, Quoted prices as of December 31, 2023 and 2024
were 101.50 and 99.80, respectively. Half of the bonds were sold on December 31,
2024 for 101.
Total comprehensive income to be recognized in 2023 shall be
a. P545,180 income c. P613,244 income
b. P545,180 loss d. P613,244 loss
The carrying amount of the investment as of December 31, 2023 shall be

a. P6,767,064 c. P6,699,000
b. P6,716,100 d. P6,586,800
a. P660,000 c. P613,244
b. P609,036 d. P604,449
Total gain or loss on sale on December 31, 2024 shall be
a. P39,600 gain c. P25,050 gain
b. P39,600 loss d. P25,050 loss
4. On January 1, 2023, KOALA Company invested in an eight-year government bonds

with face amount of P7,000,000 to be accounted for at FVTOCI. Market yields
averaged 12%. The bonds were originally dated January 1, 2022. Interest of 10% is
payable every December 31 of each year. As of December 31, 2023 and 2024, the
bonds were quoted 92.60 and 94.20, respectively.
Assuming that all of the bonds were sold on December 31, 2023 for 92.10, the total
or net amount of gain or loss on sale shall be
a. P22,598 gain c, P92,898 gain
b. P22,598 loss d, P92,898 loss
Assuming that all of the bonds were sold on December 31, 2024 for 95.20, the total
a. P28,670 gain c. P168,670 gain
b. P28,670 loss d, P168,670 loss
Assuming that 40% of the bonds were sold on December 31, 2024 for 93.80, the total
a. P28,268 loss c. P70,670 loss
b. P28,268 gain d. P70,670 gain
495
The
The Book
Chapter 13 — Reclassification of Financial Assets
CHAPTER 13
RECLASSIFICATION OF FINANCIAL ASSETS

1. The concept of reclassification.
2. The financial assets that can be reclassified and the basis for such reclassification
3. The timing of recording of reclassification.
4. The accounting for different reclassification scenarios.
5. The comparison among the different scenarios of reclassification.
CONCEPT OF RECLASSIFICATION
Reclassification means the transfer of a financial asset from one classification to
another. For example, a transfer from FVTPL classification to FVTOCI classification
and vice versa are considered as reclassification.
RECLASSIFICATION OF EQUITY SECURITIES

As for equity securities, the following concepts were discussed in Chapter 11:
a. Equity securities at FVTPL cannot be reclassified to FVTOCI since the
designation to FVTOCI shall be made on the initial recognition.
b. Equity securities at FVTOCI cannot be reclassified to FVTPL since the FVTOCI
designation is “irrevocable”.
In other words, equity securities cannot be reclassified between FVTPL and

FVTOCI classifications.
RECLASSIFICATION OF DEBT SECURITIES

As for debt securities, the classification to either FVTPL, FVTOCI, or amortized cost
is based on the business model and contractual cash flow characteristics, as
discussed in Chapter 12. Any changes in these bases might warrant the
reclassification of debt securities.
In particular, it is the change in the business model that will trigger the
an entity's business
reclassification for debt securities. Accordingly, a change in
an acttivity
model will occur only when an entity either begins or ceases to perform
that is significant to its operations; for example, when the entity has acquire,
disposed of or terminated a business line. [PFRS9.B4.4.1].
— ances
However, the following are not changes in business model:
assets (even in circums a
a. achange in intention related to particular financial
of significant changes in market conditions). ;
for financia l ase tall
b. the temporary disappearancofe a particular market
with different
c. a transfer of financial assets between parts of the entity
models. [PFRS9.B4.4.3].
496
The
Chapter 13 - Reclassification of Financial Assets
As an exception, the following debt securities cannot be reclassified and will

continue to be accounted for at FVTPL regardless of changes in business model:
a. debt securities “irrevocably” designated at FVTPL on initial recognition; and
b. debt securities that were classified at FVTPL by default because the
contractual cash flows are not solely payment of principal and interest (i-e.,
failed the SPPI test).
In conclusion, generally, debt securities can be reclassified.
RECORDING OF RECLASSIFICATION
Reclassification of financial assets shall be recorded prospectively from the
reclassification date. Consequently, the entity shall not restate previously
recognized gains, losses, or interest amounts before the reclassification.
Reclassification date is the first day of the first reporting period following the
change in business model that results in an entity reclassifying financial assets.
[PFRS9.A]. A change in the objective of the entity's business model must be effected
before the reclassification date. [PFRS9.B4.4.2].
Illustration 1. An entity's business model has changed on November 23, 2023 and
its reporting date is every December 31 of each year.
In this case, the reclassification date would be January 1, 2024, the first day of the
first reporting period following November 23, 2023 (which is part of December 31,
2023 reporting period).
Illustration 2. Two years ago, an entity acquired a debt security to be included ina
held-to-maturity business model. Contractual cash flows have passed the SPPI test,
with the investment properly accounted for at amortized cost. On October 15, 2023,
the entity’s business model has changed to held-for-selling.
Reclassification date in this case is on January 1, 2024, the day after the period
ending December 31, 2023. Consequently, even there is a change in business model on
October 15, 2023, the debt security shall still be accounted for at amortized cost
until December 31, 2023. It is only starting January 1, 2024 that the debt security
shall be accounted for at FVTPL.
Illustration 3, At the beginning of 2023, an entity acquired a debt security and

irrevocably designated it at FVTPL, even if it belongs to a held-to-maturity business
model. On December 1, 2023, the business model changed to held-to-maturity and
held-for-trading business model.
In this case, the particular debt security cannot be reclassified to FVTOCI since its
initial FVTPL designation is irrevocable,
497
The
CamScanner
RECLASSIFICATION SCENARIOS
Reclassification can be either one of the following:
a. At FVTPL to either at FVTOCI or at amortized cost.
b. At FVTOCI to either at FVTPL or at amortized cost.
c. Atamortized cost to either at FVTPL or at FVTOCI.
RECLASSIFICATION FROM FVTPL CATEGORY

The following accounting procedures are relevant for each reclassification scenario:
FVTPL to Amortized Cost
Fair value as of the reclassification date. This fair value
Measurement of the is usually the same as of the immediately preceding
investment as of the reporting date.
reclassification date
This fair value is also the starting amount in the
amortization table moving forward.
Since the debt security will now be measured using an
Computation of interest
amortization table, the effective interest rate shall be
income moving forward
based on the market rates as of reclassification date.
No amount of gain or loss is recognized on reclassification
Other matters
date
FVTPL to FVTOCI
Measurement of is usually the same as of the immediately preceding
reclassification date This fair value is also the starting amount in the
amortization table moving forward.
Since the debt security will now be measured using an
amortization table, the effective interest rate shall be
based on the market rates as of reclassification date.
No amount of gain or loss is recognized on reclassification
date.
Other matters
Despite of the reclassification, the debt security shall
continue to be measured at fair value, albeit the changes in
fair value are now unrealized gain or loss in OCI.
Illustration 4. On January 1, 2023, BRAZIL Company acquired P700,000 of bonds

when the market rate is 7%. The bonds mature on December 31, 2025 and bears
interest of 10% payable every December 31 of each year. The market rates as of
December 31, 2023 and 2024 were 8% and 9%, respectively. Based on the entity's
business model at the time of acquisition, the bonds will be carried at FVTPL. On
December 1, 2023, the entity's business model has changed and reclassification to
another category is warranted.
498
The
CamScanner
Required: Prepare the journal entries for 2023 and 2024 under each of the
following scenarios:
1. The asset is reclassified to at Amortized Cost category.
2. The asset is reclassified to FVTOCI category.
To solve for the problem, the first step is to compute for the fair values as of January
1, 2023, December 31, 2023 and December 31, 2024 as follows:
PV Factor of PVFactor CashFlow Total PV/FV
FV, 01/01/23 P755,111

FV, 12/31/23 __P724,966__

Single payment for 1 period at 9% 0.917431 P700,000 P642,202
Ordinary annuity for 1 period at9% 0.917431 70,000 64,220
FV, 12/31/24 P706,422
These amounts will be used later on. In addition to these computed amounts, the
reclassification date for both of the scenarios is on January 1, 2024.
Scenario 1: Reclassification to Amortized Cost Category

On January 1, 2023, the acquisition of investment is recorded as follows:
Cash 755,111
For December 1, 2023 change in business model, no entry shall be made since the
reclassification will be recorded only on January 1, 2024.
On December 31, 2023, to record the change in fair value (P724,966 - P755,111) and
interest received:
Cash 70,000
The readers should note that the financial asset is still accounted for as FVTPL
as of December 31, 2023. It is only starting January 1, 2024 that the investment
will be accounted for as a different category.
499
=
femur epee
The
CamScanner
As of January 1, 2024 (equivalent to December 31, 2023), the investment has a

carrying amount of P724,966 (equal to its fair value). This amount shall be the
initial carrying amount when the reclassification is recorded as follows:
This initial carrying amount will also be the starting point in the amortization
table to be used moving forward. Since this amount is based on 8% market rate
at the reclassification date, this rate will be used in the amortization table
below (not the original 7% market rate):
[A] [B] [B]-[A] _ P.V./

[10%] Interest, [8%] Interest Amorti- Carrying
1/1/24 724,966
12/31/24 70,000 57,997 (12,003) 712,963
12/31/25 70,000 57,037 (12,963) 700,000
12/31/25 700,000 (700,000) Fi
For the year 2024 and moving forward, interest income shall now be based on the
amortization table above. In addition, the carrying amounts shall now also be based
on the amortized cost amounts indicated in the amortization table above (i.e., not at
fair values).
Scenario 2: Reclassification to FVTOCI category

Journal entries for January 1, 2023, December 1, 2023, and December 31, 2023 are
the same with Scenario 1.
As of January 1, 2024 (equivalent to December 31, 2023), the investment has a

carrying amount of P724,966 (equal to its fair value). This amount would be the
initial carrying amount when the reclassification is recorded as follows:
Similar with Scenario 1, this initial carrying amount will also be the starting point
in the amortization table to be used moving forward. Interest income shall now be
based on the same amortization table. However, since the debt security is
reclassified as FVTOCI, it shall still be measured at its fair value as of each reporting
date.
The same amortization table as in Scenario 1 is also relevant moving forward.
RECLASSIFICATION FROM FVTOCI CATEGORY

500
The
CamScanner
FVTOCI to FVTPL ae
Measurement of the ‘ ; ;
j is usually the same as of the immediately preceding
investment as of the ; ML
Bad reporting date. No amortization table shall be used moving
forward.
Computation ofinterest | Since there is no amortization table to be used, interest
income moving forward _| income is now computed as face amount x stated rate.
Cumulative unrealized Any balance shall be reclassified as gain or loss on
gains or losses - OCI reclassification in the entity's profit or loss.
Despite of the reclassification, the debt security shall
Other matters continue to be measured at fair value, albeit the changes are
now reported as unrealized gain or loss in profit or loss.
FVTOCI to Amortized Cost

Amortized cost as of reclassification date. This can be
Measurement of the easily determined since there is already a maintained
investment as of the amortization table under FVTOCI accounting.
reclassification date In addition, the same amortization table shall continue to be
used despite of the reclassification.
Conitatonafineres:_ | smetie sme martaton oble sal snd oe ee

income moving forward 5 Seles
interest rate used when it is accounted at FVTOCI.
Any balance shall be reversed against the carrying
amount of the debt security to make it equal to its
amortized cost as of the reclassification date:
Cumulative unrealized e Unrealized gain - deducted from carrying amount
gains or losses - OCI e Unrealized loss - added to carrying amount
This reversal shall also affect the OCI on reclassification

date.
The debt security shall now be measured at its amortized
cost (based on amortization schedule) as of each reporting
Other matters date (i.e., fair values are ignored).
In addition, no amount of gain or loss on reclassification is

Illustration 5. On January 1, 2023, ARGENTINA Company acquired P800,000 of

bonds when the market rate is 10%. The bonds mature on December 31, 2026 and
bears interest of 7% payable every December 31 of each year, The market rates as
of December 31, 2023 an d 2024 were 9% and 8%, respectively. Based on the
entity's business model at the time of acquisition, the bonds will be carried at
FVTOCI. On November 5, 2023, the entity's business model has changed and
reclassification to another category is warranted.
501
The
Required: Prepare the journal entries for 2022 and 2023 under each of the
following scenarios:
1. The asset is reclassified to at Amortized Cost category.
2. The asset is reclassified to FVTPL category.
To solve for the problem, the first step is to compute for the fair values as of January
1, 2023, December 31, 2023 and December 31, 2024, as follows:
FV, 01/01/23 P723,922
FV, 12/31/23 P759,499

FV, 12/31/24 P785,734
Since the debt security is initially accounted for at FVTOCI, amortization table will
be used with effective interest rate of 10% and starting point of P723,922, its initial
fair value:
[A] [B] [B]-[A] PV.

1/1/23 723,922
12/31/23 56,000 72,392 16,392 740,314
12/31/24 56,000 74,031 18,031 758,345
12/31/25 56,000 75,835 19,835 778,180
12/31/26 56,000 77,820 21,820 800,000
12/31/26 800,000 (800,000) -
Cumulative unrealized gains - OCI as of each reporting date are as follows,

assuming no changes in the principal amount:
Reporting date 1/1/23 12/31/23
Fair value P723,922 P759,499
Less: Amortized cost 723,922 740,314
Unrealized gain - OCI P- P19,185
In addition to these computed amounts, the reclassification date for both of the
scenarios is on January 1, 2024.
502
The
CamScanner
meg
son
Scenario 1: Reclassification to Amortized Cost Category

To record the acquisition of investment on January 1, 2023:
Cash 723,922
For November 5, 2023 change in business model, no entry shall be made since the
reclassification will be recorded only on January 1, 2024.
To record the interest income and discount amortization based on the amortization
table on December 31, 2023:
Cash 56,000
The amount of unrealized gain - OCI as of December 31, 2023 is computed as:
The readers should take note that the financial asset is still accounted for as at
FVTOCI as of December 31, 2023. It is only starting January 1, 2024 that the
investment will be accounted for as a different category.
As of January 1, 2024 (equivalent to December 31, 2023) the carrying amount of
the investment is P759,499 (equal to its fair value). This amount will be reclassified
to at amortized category as follows:
The financial asset at amortized cost is measured at the amortized cost as of

December 31, 2023 (equivalent to January 1, 2024) as indicated in the amortization
table that the entity is currently using. The amount of unrealized gain - OCI served
as the balancing figure in the reclassification entry.
Moving forward, the debt security will now be carried at amortized cost and interest
income is recognized, both based on the amounts indicated in the same amortization
. Lastly, fair
value changes shall be ignored moving forward.
Scenario 2: Reclassification to FVTPL Category
Journal entries for January 1, 2023, November 5, 2023 and December 31, 2023 are
the same with Scenario 1.
503
bus
The
CamScanner
Chapter 13 — Reclassification of Financial Assets.
As of January 1, 2023 (equivalent to December 31, 2023) the carrying amount of the
investment is P759,499 (equal to its fair value), This amount will be reclassified to
FVTPL category as follows:
To reverse the balance of cumulative unrealized gain - OCI of P19,185 to profit or

loss as gain on reclassification:

Gain on reclassification - P/L 19,185
Assuming that there is an unrealized Joss - OCI, this is reversed as a Joss on

reclassification instead.
Moving forward, the Company shall recognize interest income of P56,000

(P800,000 x 7%) for each succeeding year. Nonetheless, the debt security shall
continue to be measured at fair value at the end of each succeeding periods.
RECLASSIFICATION FROM AMORTIZED COST CATEGORY
Amortized Cost to FVTPL

Measurement of the s A :
invastantak oF thé is usually the same as of the immediately preceding
: : reporting date. No amortization table shall be used moving
forward.
Computation of interest Since there is no amortization table to be used, interest
income moving forward | income is now computed as face amountx stated rate.
The difference between the amortized cost and fair value as
Other matters of reclassification date is recognized as gain or loss on
reclassification in profit or loss.
Amortized Cost to FVTOCI

Measurement of the is usually the same as of the immediately preceding
reclassification date In addition, this same amortization table shall continue to
be used despite of the reclassification. sal
Since the same amortization table shall continue to be used,
interest income is still based on the same effective
interest rate used in that amortization table, =|
The difference between the amortized cost and fair value as
Other matters of reclassification date is recognized as unrealized gain or
loss in OCI. ——
504
The
CamScanner
Under both of these cases, the debt security shall now be carried at its fair value at
the end of each reporting period subsequent to the reclassification.
Illustration 6, On January 1, 2022, COLOMBIA Company acquired P1,000,000 of
bonds when the market rate is 10%. The bonds mature on December 31, 2026 and
bears interest of 7% payable every December 31 of each year. The market values of
the bondsas of December 31, 2022, 2023, 2024 and'2025 were 98.30, 95, 98.20 and
99.40, respectively. Based on the entity's business model at the time of acquisition,
the bonds will be carried at Amortized Cost. On October 23, 2023, the entity's
business model has changed and reclassification to another category is warranted.
Required: Prepare the journal entry recording the reclassification under each of the
following independent scenarios: ;
1. The asset is reclassified to FVTPL category.
2. The asset is reclassified to FVTOCI category
The computation of the transaction price at 10% market rate:
PV Factor of PV Factor CashFlow Fair value
Single payment for 5 periods at 10% 0.620921. P1,000,000 P620,921
Fair value, 1/1/22 886,276
From this initial fair value, the amortization table can now be prepared as follows:
[A] [B] [B] - [A] P.V./

1/1/22 886,276
12/31/22 70,000 88,628 ' 18,628 904,904
12/31/23 70,000 90,490 20,490 925,394
12/31/24 70,000 92,539 22,539 947,933
12/31/25 70,000 94,793 24,793 972,726
12/31/26 70,000 97,274 27,274 1,000,000
12/31/26 1,000,000 2
The carrying amount of the debt security at the end of each year is equal to the
amortized cost amounts indicated in the above amortization table. In addition to
these computed amounts, the reclassification date for both of the scenarios is on
January 1, 2024.
Scenario 1: Reclassification to FVTPL category

No entry shall be made on October 23, 2023 since the reclassification will be
recorded only on January 1, 2024. On January 1, 2024 (equivalent to December 31,
2023) the investment had carrying amount of P925,394. This carrying amount is
reclassified to FVTPL category as follows:
505
The
CamScanner
Financial asset at FVTPL (P1M x 95%) 950,000

Gain on reclassification - P/L (squeeze) 24,606
The financial asset at FVTPL account is debited equal to the 95 quoted price of the
debt security as of December 31, 2023, which is equivalent to January 1, 2024 for
financial reporting purposes.
Scenario 2: Reclassification to FVTOCI category
Similar analysis as with Scenario 1, except for the recognition of unrealized gain —
OCI, instead of gain on reclassification - P/L:
Financial asset at FVTOCI (P1M x 95%) 950,000

Financial asset at Amortized Cost 925,394
Unrealized gain - OCI (squeeze) 24,606
GENERALIZATIONS
Based on the previous discussions, the following generalizations can be deduced:
a. Any transfer from FVTOCI category to at Amortized Cost or vice versa will
not change the effective interest rate and the original amortization table
will be of continuing use. Consequently, amortization of discount or premium
will continue.
b. Any transfer from FVTOCI category to FVTPL category or vice versa will not
change the measurement of the financial asset (i.e., still at fair value).
c. Except for FVTOCI to Amortized Cost reclassification, the fair value of the
investment as of the reclassification date will always be the initial carrying
amount of the investment under the new accounting category.
d. The following amounts are to be reported as either part of profit or loss or other
comprehensive income on the reclassification date:
-. Change > Profit or Loss OCI
FVTPL to amortized cost None. None.
FVTPL to FVTOCI None. None.
FVTOCI to Amortized Reversal of cumulative OCcl
None. amount against the
Cost ; :
investment carrying amount.
Cumulative unrealized
gains and losses to be Reclassification of cumulative
VEO OFVTEL reclassified as gainorloss | OCI amount to profit or loss.
on reclassification a
A Difference between the
Amortized Cost to FVTPL carrying amount and RV. None.
Amortized Cost to Nona Difference between the
FVTOCI ; carrying amount and FV.
506
The
CamScanner
CHAPTER SUMMARY
1. Equity securities cannot be reclassified from FVTPL to FVTOCI and vice versa.
2. Debt securities can be reclassified from one category to another, except for those
irrevocably designated at FVTPL and those who failed the SPPI test. These will be
retained at FVTPL.
3. The trigger for the reclassification is the change in business model (i.e., not change
in management’s intention).
4. The change in business model shall be accounted for prospectively on
reclassification date.
5. Reclassification date is the first day of the succeeding period after the period of
change in business model.
6. The table below summarizes the accounting procedures that shall be made on
reclassification date:
Reclassified TO: _
FVTPL “Amortized Cost _| FVTOCI
Initially measured at the FV as of
reclassification date. No gain or loss on
FVTPL
N/A reclassification. A new effective interest rate

(EIR) shall be determined as of the
Initially measured at Initially measured at
the FV as of the FV as of
_ | reclassification reclassification date.

S | date. :
oO Gain or loss on
3 |Gain or loss on reclassification — shall
s s reclassification shall N/A be recognized in OCI.
S z ihe ae eee ™ No change in EIR and
= <|P ‘ amortization table.
& EIR is irrelevant
3 moving forward.
= Initially measured at | Initially measured at
eZ the FV as_ of | the amortized cost as
reclassification of _ reclassification
date. date.
> | Unrealized gain or | Unrealized

gain or loss
E loss ~ OCI shall be | - OCI shall be offset N/A
reclassified to | against the asset's
profit or loss, carrying amount and
will affect the OCI on
EIR is irrelevant | reclassification date.
moving forward.
No change in EIR and
amortization table.
507
The
The Book
True or False
Ae Debt securities may be classified into different accounting classifications based on
the changes in the intentions of the entity.
Zw FVTPL equity securities can be reclassified at FVTOCI, but the FVTOCI equity
securities cannot be reclassified to at FVTPL.
3: The basis of reclassification of financial assets shall be the change in the business
model.
The reclassification shall be accounted for prospectively on reclassification date.
Reclassification date is the last day of the period during which the change in
business model has occurred.
If an FVTPL debt security is reclassified to Amortized Cost classification, the
effective interest rate to be used in the amortization table will generally be based
on market rates on reclassification date.
If an FVTOCI debt security is reclassified to FVTPL classification, the cumulative
unrealized gain or loss - OCI shall be transferred directly to retained earnings.
If an Amortized Cost debt security is reclassified to FVTOCI classification, the same
amortization table shall continue to be used after reclassification date.
If an FVTOCI debt security is reclassified to Amortized Cost classification, the debt
security shall be measured at its amortized cost as of reclassification date.
10. If an Amortized Cost debt security is reclassified to FVTPL classification, any
difference between the debt security’s amortized cost and fair value on
reclassification date shall be recognized in retained earnings.

1. The reclassification of financial assets is initiated by the
a. Change in management’s intention.
b. Sudden changes in the fair value of financial assets
c. Change in business model.
d. Any of the above
The reclassification shall be recorded on the
a. Last day of the period during which there is a change in business model.
b. Last day of the succeeding period after the period during which there is a change
in business model.
c. First day of the period during which there is a change in business model.
d. First day of the succeeding period after the period during which there is a
change in business model.
The following financial assets cannot be reclassified to other accounting categories,

except:
a. Debt securities irrevocably designated at FVTPL on initial recognition,
b. Debt securities with contractual cash flows in addition to principal and interest.
c. Equity securities in general,
d. All of the above.
508
The
CamScanner
4. On October 1, 2023, an entity's business model changed from held-for-selling to

held-to-maturity. This change shall be recorded on
a. October 1,2023
b. January 1, 2024
c. December 31, 2023
d. December 31, 2024
5. Which of the following accounting procedures involving the reclassification from

FVTPL category to Amortized Cost category are correct?
a. The initial measurement for the transfer to Amortized Cost category shall be
equal to the financial asset’s fair value. .
b. Effective interest rate to be used moving forward shall be based on market rates
on reclassification date.
c. Bothaand b correct.
d. Neither anor bis correct.
6. Inaccounting for the transfer from FVTPL category to FVTOCI category, which of the
following is correct?
a. Effective interest rate shall be based on the market rates on the date of initial
recognition of financial assets.
b. Any previously recognized unrealized gains and losses in profit or loss shall be
transferred to a separate unrealized gain or loss - OCI in equity.
c. Amortization table shall be used moving forward.
d. Interest income shall now be based on the face amount of the financial asset
multiplied by the stated rate.
7. A financial asset previously accounted for at FVTOCI has been reclassified to FVTPL
category. In accounting for the transfer, all of the following are correct, except
a. The transferred financial asset shall be initially measured at its fair value on the
b. Any accumulated unrealized gain or loss - OCI amounts shall be directly
transferred to retained earnings.
c. Effective interest rate shall be based on the market rates prevailing on the
8. In relation to the reclassified from FVTOCI category to Amortized Cost category,

which of the following is correct?
a. The effective interest rate for subsequent accounting at Amortized Cost
category shall be based on the market rate on the reclassification date.
b. Any accumulated unrealized gain or loss - OCI amounts shall be reclassified to
profit or loss.
c. Thesameamortization table during the time that the financial asset is accounted
for at FVTOCI shall continue to be used when the financial asset is accounted for
at Amortized Cost.
509
The
The Book
9. Inrelation to the reclassified from Amortized category to FVTOCI category, which of

the following is not correct?
a. Anew amortization table shall be used.
b. The transferred financial asset shall be initially measured at its fair value as of
c. The effective interest rate used in the amortization table will not change and
shall still be based on the originally determined effective interest rate.
d. None of the above. t
10. Which of the following accounting procedures is correct related the reclassification
of financial asset from Amortized Cost category to FVTPL category?
a. The interest income shall continue to be based on the amortization table
previously used when the financial asset is being accounted for at Amortized
Cost.
b. The transferred financial asset shall be measured at its fair value as of
c. The difference between the financial asset’s fair value and amortized cost, both
as of reclassification date, shall be recognized directly in retained earnings.
Straight Problems
1. KAMPALA Company acquired a 7% interest-bearing, P5,000,000 face amount debt
security on January 1, 2023 to be accounted for at FVTPL since it is held-for-trading.
The debt security is originally dated January 1, 2022 and has an original term of six
years. Market yields on the date of acquisition averaged 9%. On October 15, 2023,
the business model has changed. As of December 31, 2023, 2024, and 2025 market
yields averaged 8.50%, 8%, and 7.50%, respectively.
entry to record the reclassification:
1. The business model has changed to held-to-maturity model.
2. The business model has changed to held-to-maturity and held-for-sale model.
2. On January 1, 2023, FUNAFUTI Company acquired a ten-year corporate bond with
face amount of P6,000,000 to be held in a held-to-maturity model. The bonds were
originally date January 1, 2020. On the date of acquisition, market yields averaged
10%, even if stated rate is 12%. Interest is payable every December 31 of each year.
On November 10, 2024, there was a change in business model. As of December 31,
2023, 2024, and 2025, quoted prices were 106.80, 107.10, and 106.70, respectively.
1. The business model has changed to held-for-sale model.
2. The business model has changed to held-to-maturity and held-for-sale model.
510
The
The Book
3. At the beginning of 2023, ASHGABAT Company acquired a newly issued, six-year

government bonds with face amount of P4,000,000 to be held in the held-to-
maturity and held-for-sale business model. On the date of purchase, market yields
averaged 8%, even though the stated rate is only 6%. On December 1, 2023, the
Compaeny’s business model has changed to a different one. As of December 31, 2023
and 2024, quoted prices were 92.40 and 93.00, respectively.
1. The business model has changed to held-for-sale model.
2. The business model has changed to held-to-maturity model.
1. As of January 1, 2023, ANKARA Company had an investment in a corporate bond
with face amount of P3,000,000 being accounted for at amortized cost. These were
acquired last January 1, 2020 when market yields averaged 8%. On the other hand,
market yields averaged 9% as of January 1, 2023. Interest of 7% is payable every
December 31 of each year. The bonds have maturity date of December 31, 2026. On
September 30, 2023, the Company's business model changed to held-for-selling.
Quoted prices of the bonds as of December 31, 2023 and December 31, 2024 were
96.90 and 97.20, respectively
a. 2,880,218 c. P2,922,686
b. P2,946,501 d. P2,900,635
The amount of gain or loss on reclassification, if any, shall be
a. P15,686 gain c. P25,632 gain
b. P15,686 loss d. no gain or loss
The corporate bond shall be initially measured on reclassification date at

a. P2,916,000 c. P2,956,000
b. P3,000,000 d. P2,907,000
a. P2,916,000 c. P2,900,635
b. P2,946,501 d. P2,972,221
2. Way back on January 1, 2022, TUNIS Company acquired a newly-issued, eight-year
government bonds with face amount P7,000,000 to be included in the held-to-
maturity and held-for-sale business model. As of January 1, 2022 market yields
averaged 7%, Interest of 9% is payable every December 31 of each year. During
2024, the Company's business model has changed to solely held-for-sale model. As
of December 31, 2022, 2023, 2024, and 2025, the bonds were quoted 109.90, 109.70,
108, and 107.30, respectively.
511
The
The Book
a. ‘P7,574,027 c. P7,560,000
b. | P7,667,315 d. P7,679,000

a. PO c. P14,027 gain
b. P11,685 gain d. P14,027 loss

a. P7,574,027 c. P7,560,000
b. P7,667,315 d. P7,679,000
a. P7,511,000 c. P7,679,000
b. P7,474,209 d. P7,367,404
3. Previously, on January 1, 2019, SPAIN Company acquired a newly-issued, ten-year

government bonds with face amount P5,000,000 to be included in the held-to-
maturity and held-for-sale business model. As of that date, market yields averaged
12%. Interest of 11% is payable every December 31 of each year. During 2023, the
Company’s business model has changed to solely held-to-maturity model. As of
December 31, 2022, 2023, and 2024, the bonds were quoted 96.50, 96.10, and 96.70,
respectively.
a. P4,805,000 c. P4,825,000
b. P4,819,759 d. P4,794,428

a. P14,759 gain c. P30,572 gain
b. P14,759 loss d. PO
a. P4,805,000 c. P4,825,000
b. P4,819,759 d. P4,794,428
a. P4,835,000 c. P4,825,000
b. P4,879,906 d, P4,848,130
512
The
The Book
Chapter 14 - Loans Receivable
CHAPTER 14
LOANS RECEIVABLE

1. The nature of loans receivable.
2. The differences between loans receivable and investments in bonds.
3. The accounting for origination costs and origination fees.
4. The subsequent accounting for loans receivable.
LOANS RECEIVABLE - IN GENERAL

Loan receivable represents the amounts lent to the borrowers, either as part of
ordinary course of business (i.e., banks and other financial institutions) or casually
(e.g., lending of excess cash by a manufacturing entity). Regardless of the frequency
of lending transactions, it is indispensable that loan receivables are considered as a
debt security since this is a liability in the perspective of the borrower.
LOANS RECEIVABLE VS INVESTMENTS IN BONDS
Loans receivable and investments in bonds are both considered as debt securities.
However, they are more different than the readers may think. The following is the
comparison between bonds and loans:
Bonds Loans
Traded in an exchange | yo. _ in bond markets No
market?
Contract disclosure Public contract Private contract
: A lender or group
i
Counterparty/ies G eneral p public AF lenders
Determination of Based on prevailing Privately agreed-
interest rate market rates upon
Stable and well- Ae senatGt
Issuers (borrowers) known entities. Also, a
entities
the government.
ACCOUNTING CLASSIFICATIONS FOR LOANS RECEIVABLES

Since loans receivable are considered as debt securities, they are also subject to
business model assessment and the contractual cash flow test (SPPI test), Because
of this, loans receivables can also be accounted for at FVTPL, at amortized cost, or
at FVTOCI.
In the Philippine setting, most banks and other financial institutions maintain a
business model of collecting the interest and principal up to the loan’s maturity date
513
bk
The
CamScanner
Chapter 14 — Loans Receivable
and these cash flows normally pass the SPPI test. Consequently, virtually all of the
loans receivable of the Philippine banks and other financial institutions are accounted
for at amortized cost.
In the international setting, loans, especially those held by investment banks, can
be accounted for across all the categories mentioned in PFRS 9 (i.e., FVTPL, FVTOCI,
and amortized cost). These investment banks include but are not limited to
JPMorgan Chase, Goldman Sachs, Citigroup, and Deutsche Bank, among others.
These international banks, in addition to loans that are accounted at amortized cost,
may also include in their portfolios loans that are to be sold to investors (accounted
for at FVTPL). They may also include loans whose cash flows are to be realized by
collecting the cash flows up to maturity or selling the loan itself (accounted for at
FVTOCI). Previously discussed concepts on FVTPL and FVTOCI accounting will
continue to be relevant in these cases.
AMORTIZED COST OF LOANS RECEIVABLES
The amortized cost of loans is usually its face amount or principal amount, except
for the effect of two items, origination costs incurred and origination fees received
from the borrower:
_ Origination costs =~ _.- Origination fees -
Amounts actually incurred by an entity in Amounts charged by a lender entity to the
relation to checking of creditworthiness borrower to compensate the former for
of a prospective borrower. the origination activities that it had
undertaken prior to the granting of the
These may include legal costs, loan. These fees are normally stated as a
documentation
: costs, background percentage of the loan amount.
checking costs and other agency costs.
In accounting, origination costs are

classified as either direct origination
costs and indirect origination costs.
On their own, origination costs appear to be as expenses at the time they are
incurred while the origination fees are considered as income on the period they
were earned.
Contrary to this general notion, PFRS 9 identifies that the origination costs and
origination fees are integral parts of the determination of the effective
interest rate of a financial instrument. [PFRS9.B5,4,1]. These are integral because
they will not be incurred (for origination costs) or received (for origination fees)
unless there is a loan receivable.
Because of this, the amounts of direct origination costs and origination fees affect
the initial carrying amount of loans receivable as follows:
514
The
Face amount of loans ( Pxx

Add: Direct origination costs XX
Less: Origination fees (xx)
Initial carrying amount ofloan receivable Pxx
Indirect origination costs shall be expensed outright (i.e., not included in the
initial carrying amount of the loan receivable).
The relationship between the amounts of direct origination costs and origination
fees will have the following effects:
Consequences
Initial Carrying Amount | Premium or Discount on
Scenarios vs Face Amount | Initial Recognition
Direct origination costs | Initial carrying amount > ‘
ewe Premium
> origination fees face amount
Direct origination costs | Initial carrying amount < :
pee as Discount
< origination fees face amount
The premium and discount on loans receivable have the following details:
Premium on Loans. |... Discount on Loans
Normal balance Debit Credit
aoe to loan Added (i.e., adjunct account) | Deducted (contra-asset account)
receivable account
Effective interest Effective interest rate < Effective interest rate > stated
rate vs stated rated stated rated rated
Interest income vs Interest income < interest Interest income > interest
interest received received received
Other names Direct origination fees Unearned interest income
Illustration 1 - Premium. On January 1, 2023, LIVERPOOL Bank lent P2,500,000

Joan with a maturity date of December 31, 2028. The loan has interest of 10% per
year and payable every December 31 of each’ year. The Bank incurred direct
origination costs of P295,760 while it charged the borrower a 5% origination fee.
Indirect origination costs amounted to P56,980. After considering the relevant
integral costs and fees, the effective interest rate is 8.50%. Required: Determine the
journal entries for 2023 to 2024.
Solution:
First, compute for the initial carrying amount of the loan on January 1, 2023:
Principal P2,500,000
Add: Direct origination costs 295,760
Less: Origination fee (P2.50M x 5%) (125,000)
Initial carrying amount P2,670,760
515
The
Chapter 14 —- Loans Receivable
The following computations will confirm that the present value of the principal of
P2.500,000 and annual interest of P250,000 discounted using 8.50% will equal the
initial carrying amount of P2,670,760:
PV Total
PV Factor of Factor Cash Flow PV/FV
Single payment for 6 periods at 8.50% 0.612945 2,500,000 P1,532,363
Ordinary annuity for 6 periods at8.50% 4.553587 250,000 1,138,397
Based on the initial carrying amount computed, there is a premium of P170,760.

This is also apparent with the fact that the effective interest rate of 8.50% is lower
than the stated interest rate of 10%.
Needless to say, indirect origination costs of P56,980 shall be expensed in 2023.
Since the loan is to be accounted for at Amortized Cost, the relevant amortization
table is as follows:
Carrying
Interest/ Amount/ Premium
Principal Interest Amorti- Present onLoans
Date Received Income zation Value _——- Receivable
1/1/23 2,670,760 170,760
12/31/23 250,000 227,015 (22,985) 2,647,775 147,775
12/31/24 250,000 225,061 (24,939) 2,622,836 122,836
12/31/25 250,000 222,941 (27,059) 2,595,777 95,777
12/31/26 250,000 220,641 (29,359) 2,566,418 66,418
12/31/27 250,000 218,146 (31,854) 2,534,564 34,564
12/31/28 250,000 215,436 (34,564) 2,500,000 =
12/31/28 2,500,000 (2,500,000) - -
Based on this amortization table, the carrying amount or amortized cost of the loan
can be determined as: Face amount of loan receivable plus Premium on loans
receivable. In addition, similar to the concepts of amortization in the previous
chapters, interest income is based on effective interest rate multiplied to the
beginning amortized cost.
To reiterate, the amount of premium is actually a “loss” on the part of the Bankas it
had an initial net investment in the loan amounting to P2,670,760 but will receive
only P2,500,000 at the maturity date. The premium is, little-by-little, recognized
as a “loss” in a form of reduced amount of interest income per year.
On January 1, 2023, the loan grant date, the following entry shall be made:
Cash 2,500,000
516
The
The Book
Since it has already been determined that the amount of direct origination cost in the
problem is higher, Premium on loans receivable shall be used in recording the direct
origination costs and origination fees, respectively:
Premium on loans receivable 295,760
Cash (direct origination costs) 295,760
Cash (origination fees) 125,000

Indirect origination costs shall be recorded as follows:

Indirect origination expense 56,980
Cash 56,980
Based on these entries, the initial carrying amount of the loan can be determined as
follows:
Loans receivable P2,500,000
Add: Premium on loans receivable (P295,760 - P125,000) 170,760
Initial carrying amount, 1/1/23 P2,670,760
Fast forward to December 31, 2023, the recognition of interest income, receipt of
interest and amortization of premium on loans receivable are all recorded in one
entry:
Cash 250,000
Fast forward yet again to December 31, 2024, the recognition of interest income,
receipt of interest and amortization of premium on loans receivable are all recorded
in one entry:
Cash 250,000
On December 31, 2028, the date of maturity, when the premium on loans receivable
has been fully amortized, the receipt of the loan is recorded as follows (no entry for
the premium since it has been fully amortized at this point);
Cash 2,500,000
Loans receivable ' 2,500,000
Illustration 2 - Discount. On January 1, 2023, MANCHESTER Bank lent P3,000,000

loan with a maturity date of December 31, 2026, The loan has interest of 9% per
year and will be payable every December 31 of each year. The Bank incurred direct
517
The
The Book
origination costs of P500,000 while it charged the borrower origination fee of

P686,147. Indirect origination costs amounted to P117,065. After considering the
relevant integral costs and fees, the effective interest rate is 11%. Required:
Determine the journal entries for 2023 to 2024.
Solution:
Less: Origination fee (686,147)
The following computations will confirm that the present value of the principal of
P3,000,000 and annual interest of P270,000 discounted using 11% will equal the
initial carrying amount of P2,813,853:
PV Total
PV Factor of Factor Cash Flow PV/FV
Single payment for 4 periods at 11% 0.658731 3,000,000 P1,976,193
Based on the initial carrying amount computed, there is a discount of P186,147

(P3,000,000 - P2,813,853). This is also apparent with the fact that the effective
interest rate of 11% is higher than the stated interest rate of 9%.
Indirect origination costs of P117,065 will be expensed in 2023.
Interest/ Carrying Discount
Principal Interest Amorti- Amount/ on Loans
Date Received Income zation Present Value Receivable
1/1/23 2,813,853 186,147
12/31/23 270,000 309,524 39,524 2,853,377 146,623
12/31/24 270,000 313,871 43,871 2,897,248 102,752
12/31/25 270,000 318,697 48,697 2,945,945 54,055
12/31/26 270,000 324,055 54,055 3,000,000 -
12/31/26 3,000,000 (3,000,000) - =
Based on this amortization table, the carrying amount or amortized cost of the loan
can be computed as: Face amount of loan receivable less Discount on loans
receivable, In addition, similar to the concepts of amortization in the previous
chapters, interest income is based on effective interest rate multiplied to the
beginning amortized cost.
518
The
CamScanner
To reiterate, the amount of discount is actually a “gain” on the part of the Bank as it
had an initial net investment in the loan amounting to P2,813,853 but will receive
a higher amount of P3,000,000 at the maturity date. The discount is, little-by-little,
recognized as a “gain” in a form of higher amount of interest income per year.
Cash 3,000,000
Since it has already been determined that the amount of origination fees in the
problem is higher, Discount on loans receivable shall be used in recording the direct
Discount on loans receivable 500,000


Indirect origination costs shall be recorded as follows:
Indirect origination expense 117,065

Cash 117,065
Based on these entries, the carrying amount of the loan can be determined as
follows:

Less: Discount on loans receivable (P686,147 - P500,000) (186,147)
interest and amortization of discount on loans receivable are all recorded in one
entry:
Cash 270,000
receipt of interest,and amortization of discount on loans receivable are all recorded
in one entry:
Cash 270,000
519
The
On December 31, 2026, the date of maturity, when the discount on loans receivable
has been fully amortized, the receipt of the loan is recorded as follows:
Cash 3,000,000
INSTALLMENT PAYMENTS OF LOAN PRINCIPAL

So far, the principal amounts in the examples that have been discussed were all paid
at the maturity date. Sometimes, portion of the principal is also payable periodically
(e.g., annually) before the maturity date. In this case, computation of a loan’s effective
interest rate, interest income, and carrying amount will all be affected.
In confirming the effective interest rate, PV factor of ordinary annuity will not be
used. Instead, a series of PV factors of single payments are to be used since the
total amount of cash flows per year will be different. The main reason is the
decreasing amount of principal per year, which is the basis of decreasing interest
payments for each year.
Illustration 3. On January 1, 2023, CHELSEA Bank lent P4,000,000 loan with a
maturity date of December 31, 2026. The loan has interest of 11% per year and
payable every December 31 of each year. In addition, annual payments of principal
amounting to P1,000,000 will be paid every December 31 of each year, starting with
December 31, 2023. The Bank incurred direct origination costs of P319,779 while
it charged the borrower origination fee of 10% of the principal amount. After
considering the relevant integral costs and fees, the effective interest rate is 12%.
Required: Determine the journal entries for 2023 to 2024.
Solution:
Less: Origination fee (400,000)
Since the amount of interest to be received per year changes, additional step of
computing these interest amounts is necessary:
Date of
Receipt of [A] [B] [C]=[A]x11% [D]=[B]+I[C]
Total Cash Beg, Principal Interest Cash Total Cash
Flows Principal Cash Flows Flows Inflows
12/31/23 4,000,000 1,000,000 440,000 1,440,000
12/31/24 3,000,000 1,000,000 330,000 1,330,000
12/31/25 2,000,000 1,000,000 220,000 1,220,000
12/31/26 1,000,000 _—_1,000,000 110,000 1,110,000
520
The
Nevule CamScanner
These total cash flows will be discounted using 12% to confirm whether this is the
effective interest rate that will make the cash flows equal to the P3,919,779 initial
carrying amount of the loan:
PV factor ofsingle DateofCash Total Cash PV

payment for Flow Flows Factors Total PV
1 period at 12% Dec. 31,2023 P1,440,000 0.892857 P1,285,714
2 periods at 12% Dec. 31, 2024 1,330,000 0.797194 1,060,268
3 periods at 12% Dec. 31, 2025 1,220,000 0.711780 868,372
4 periods at 12% Dec. 31, 2026 1,110,000 0.635518 705,425
Initial carrying amount, January 1,2023 P3,919,779
Based on the initial carrying amount computed, there is a discount of P80,221

(P4,000,000 - P3,919,779). This is also apparent with the fact that the effective
interest rate of 12% is higher than the stated interest rate of 11%.
Interest Carrying
and Interest Amorti- Amount/ Discount
Principal Income zationof Principal Present on Loans
Date Received Portion Discount Portion Value Receivable
1/1/23 3,919,779 80,221
12/31/23 1,440,000 470,373 30,373 (969,627) 2,950,152 49,848
12/31/24 1,330,000 354,018 24,018 (975,982) 1,974,170 25,830
12/31/25 1,220,000 236,900 16,900 (983,100) 991,070 8,930
12/31/26 1,110,000 118,930 8,930 (991,070) - -
The readers should take note that the Amortization of Discount amounts =
Interest income less the interest received. For example, on December 31, 2023,
P30,373 is computed as P470,373 less P440,000 and so on.
Cash 4,000,000
Since it has already been determined that the amount of origination fees in the
problem is higher, discount on loans receivable shall be used in recording the direct

521
re
The
Based on these entries, the carrying amount of the loan can also be determined as
follows:
Less: Discount on loans receivable (P400,000 - P319,779) 80,221
interest and principal, and amortization of discount on loans receivable are all
recorded in one entry:
Cash 1,440,000
receipt of interest and amortization of discount on loans receivable are all recorded
in one entry:
Cash 1,330,000
LOANS WITH EQUAL PERIODIC PAYMENTS

As previously seen in the loans with installment payments of principal, the total
amount (principal + interest) being paid by the borrower each year is decreasing.
However, some loans are structured so that the borrowers will pay equal amounts
each period. Each periodic payment is already composed of the interest and principal
components. This setup is prevalent in consumer loans or personal loans.
Generally, the periodic payments are assumed to be made at the end of each period.
In connection with this, the following formula is relevant:
Equal Periodic Payment = Principal Amount + PV of Ordinary Annuity

The stated or nominal rate is used in computing the PV factor of ordinary annuity.
Illustration 4. At the beginning of 2023, ZAGREB Company granted a four-year, 8%
interest-bearing loan receivable with face amount of P6,000,000. Based on the loan
agreement, the borrower shall pay the loan in equal amounts, which already include
the payment for the principal and the payment for interest. These loan payments
are made at the end of each year.
In this case, using the PV factor of ordinary annuity for four periods at 8%, the
amount of periodic payment every December 31 is computed as follows:
522
The
CamScanner
Periodic Payment
. P6,000,000
= P1,811,525
di
=
3.312127
In this case, every December 31, the borrower shall pay the Company P1,811,525,
no more, no less. This amount already included the relevant interest. The related
amortization table shall be:
Interest Amorti-
Total Income zation of Carrying
Date Receipts [8%] Principal Amount
1/1/23 6,000,000
12/31/23 1,811,525 480,000 (1,331,525) 4,668,475
12/31/24 1,811,525 373,478 (1,438,047) 3,230,428
12/31/25 1,811,525 258,434 (1,553,091) 1,677,337
12/31/26 1,811,525 134,188 (1,677,337) =
The readers should take note that there is no discount nor premium account to be
used in this case. Consequently, the balance of the loan receivable account as of each
reporting date is equal to the corresponding amounts in the Carrying Amount
column.
CHAPTER SUMMARY
1. Generally, loans are private contracts while bonds are public contracts. As such,
bonds are usually sold in a bond exchange (i.e., easy transfer among investors) while
loans cannot be easily transferred from one investor to another.
2. Inthe Philippine setting, loans are usually accounted for at amortized cost. However,
depending on the circumstances, loans may be accounted for at FVTPL or FVTOCI.
3. The initial measurement of loan receivable is as follows: Face amount + direct
origination costs incurred - origination fees received. Indirect origination costs
are expensed outright. Face amount is also the principal amount.
4. The relationship between direct origination costs and origination fees received has
the following accounting consequences:
Consequences
4) Initial Carrying Amount ‘| Premium or Discount
Scenarios __ vsFace Amount _|_on Initial Recognition
Direct origination costs > | Initial carrying amount > Bremiira
origination fees face amount
Direct origination costs < | Initial carrying amount < Discount
origination fees face amount
5. In exceptional circumstances, loans may require equal periodic payments (inclusive

of principal and interest portions). In these cases, the periodic payment can be
Equal Periodic Payment = Principal Amount/PV of Ordinary Annuity
523
The
True or False
i. Loans are private contracts.
Z. Bonds are usually issued by well-known companies with a good track record in the
eyes of the general public.
3. A loan’s fair value is easier to determine relative to bonds since loans are private
contracts.
Loans shall be accounted for using the amortized cost classification only.
Ga he
Direct origination costs incurred shall be included in the initial measurement of a

loan receivable, but the origination fees received shall be recognized as outright
income.
If origination fees are higher than direct origination costs, the loan’s initial
measurement is lower than its face amount.
If origination fees are lower than direct origination costs, the amount of interest
income is lower than the amount of interest received.
Indirect origination costs are deferred as prepaid assets and shall be amortized
using the straight-line method over the related loan’s remaining term.
9. If direct origination costs are lower than origination fees, the amount of interest
received is higher than the interest income.
10. For serial loans, interest income per year is decreasing, regardless of the
relationship between the direct origination costs and origination fees.

1. All of the following are characteristics of loans, except
a. Usually, the fair value of the loans cannot be easily determined.
b. The counterparty is a lender or group of lenders.
c. The loan contract is available to the general public.
d. Usually issued by not so known entities
The following are the characteristics of bonds, except
a. Traded ina bond exchange.
b. Usually issued by stable and well-known entities.
c. The counterparty is the general public.
d. Usually, the fair value of the loans cannot be easily determined.
Which of the following is/are the possible accounting classification/s of loans

receivable?
a. FVTPLonly
b. FVTOCI only
c. Amortized cost only
d. Any of the above
During the current year, an entity lent a certain amount to be repaid after five years.
In addition, the entity has also the option convert the loan receivable into the
524
The
borrower's ordinary shares any time before maturity date. Based on this
information, the loan shall be accounted for in which of the following categories?
a. FVTPL.
b. FVTOCI.
c. Amortized cost.
d. Any of the above, based on the entity’s model.
5. An entity lent P10,000,000 to another entity. The loan will mature after three years.
Interest rate will be based on the probability that the borrower will fail to pay the
loan (i.e., credit risk). In other words, the higher the credit risk of the borrower, the
higher the interest rate. The entity has the business model of collecting all of the
contractual cash flows until their maturity date. Most likely, the loan is classified as
a. FVTPL
b. FVTOCI
c. Amortized cost
d. Any of the above
6. As of the end of the current year, an entity had a loan receivable that will mature
after six years. The interest rate'is based on the changes in the Philippine Stock
Exchange index (PSEi). That is, the higher the index number, the higher the interest
rate. The loan is held in a both held-to-maturity and held-for-sale business model.
Most likely, the loan is classified as
a. FVTPL
b. FVTOCI
c. Amortized cost
d. Any of the above
7. On initial recognition, loans receivable accounted for at amortized cost shall be

measured at:
a. Face amount + direct origination costs + indirect origination costs - origination
fees received.
b. Face amount + direct origination costs — origination fees received.
c. Face amount - direct origination costs + origination fees received.
d. Face amount - direct origination costs - indirect origination costs + origination
fees received.
8. Which of the following is the correct treatment for indirect origination costs?
a. Amortized over the loan’s term using straight-line method.
b. Offset with the amount of origination fees if origination fees received is higher
than direct origination costs.
c.Offset with the amount of direct origination costs if direct origination costs is
higher than origination fees received.
d. Expensed outright.
9. Which of the following is not correct if the amount of direct origination costs is
higher than the amount of origination fees received?
525
The
The Book
The amount of interest received is higher than the amount of interest income,
aap The initial measurement of the loan is higher than its face amount.
The loan’s carrying amount is increasing at the end of each year.
None of the above.
10. If the amount of direct origination costs is lower than the amount of origination fees
received, then
The loan’s carrying amount is decreasing at the end of each year.
op
The effective interest rate is higher than the stated rate.

The initial measurement of the loan is higher than its face amount.
pep
None of the above.
Straight - Problems
1. At the beginning of 2023, BANCO Bank granted a 7% interest-bearing, P3,000,000
face amount loan to a borrower. The loan has a maturity of December 31, 2026. The
interest is payable every December 31 of each year. In connection with the loan, the
Bank incurred total origination costs of P150,637, including P50,000 indirect
origination costs. In addition, the Bank also charged the borrower origination fee of
P200,000. After considering the relevant amounts, the loan has an effective interest
rate of 8%.
Required: Determine the journal entries that shall be made for the years 2023 and
2024.
2. On January 1, 2023, OBRAS Company lent P5,000,000 to another entity. The loan is
payable after five years. Interest of 10% is payable every December 31 of each year.
In connection with the loan, the Company received origination fees of P100,000 from
the borrower. While making a background investigation and assessing the
creditworthiness of the borrower, the Company incurred direct and indirect
origination costs amounting to P294,481 and P84,600, respectively. After
considering the relevant amounts, the loan has an effective interest rate of 9%.
2024.
3. On April 1, 2023, PIAS Company lent P6,000,000 to a borrower. The loan shall be
repaid in full on March 31, 2029. Interest of 9% is payable every March 31 of each
year, starting in 2024, The Company incurred P92,337 direct origination costs and
received P600,000 origination fees from the borrower. After considering the
relevant amounts, the loan has an effective interest rate of 11%.
2024.
4. CREDIT Company lent P7,000,000 to another entity on January 1, 2023. The loan has
a maturity date of December 31, 2025. Interest of 12% is payable every June 30 and
526
The
The Book
December 31 of each year. Direct origination costs amounted to P505,296 while

origination fees amounted to P150,000. After considering the relevant amounts, the
loan has an effective interest rate of 10%.
2024.
5. On January 1, 2023, DEBIT Company lent P10,000,000 to another entity. The loan is
payable in five equal annual installments of P2,000,000 every December 31 of each
year, starting in 2023. Interest of 9% is payable at the same dates as the principal
installment amounts. Origination fees received amounted to P220,000 while direct
origination costs amounted to P734,172. After considering the relevant amounts, the
loan has an effective interest rate of 7%.
2024. |

1. At the beginning of 2023, LEVERAGE Company granted a six-year, 7% interest-
bearing loan with principal amount of P4,000,000 to a borrower. In connection with
loan, the Company incurred direct and indirect origination costs amounting to
P165,086 and P68,903, respectively. In addition, the borrower also paid the
Company origination fees of P350,000. Interest is payable every December 31 of
each year. After considering the relevant amounts, the loan has an effective interest
rate of 8%.
The loan’s initial carrying amount shall be

a. P4,184,914 c. P3,815,086
b. P4,116,011 d. P3,883,989
The net income from the loan for the year 2023 shall be
a. P305,207 c. P280,000
b. P267,056 d. P309,508
The interest income for 2024 shall be
a. P280,000 c. P307,223
b. P296,539 d, P312,629
Carrying amount as of December 31, 2024 shall be
a. P3,867,516 c. P3,840,293
b. P3,896,918 d. P3,899,693
2. On January 1, 2023, CUSHION Company granted a four-year loan with principal

amount of P5,000,000 to a borrower. Interest of 10% is payable every June 30 and
December 31 of each year. In connection with the loan, the Company incurred direct
and indirect origination costs amounting to P141,265 and P78,594, respectively, In
addition, the borrower also paid the Company origination fees of P445,000. After
527
The
CamScanner

a. P4,696,265 c. P5,303,735
b. P4,774,859 d. P5,225,141
a. P563,552 c. P500,000
b. P484,958 d. P421,406

a. P579,719 c. P563,552
b. P589,286 d. P571,178
a. P4,759,817 c. P4,830,995
b. P4,784,632 d. P4,910,714
3. On October 1, 2023, GYMNASIUM Company lent a five-year, P6,000,000 face amount

loan to a borrower. Interest of 11% is payable every September 30 of each year. The
Company received P380,000 origination fees and incurred direct origination costs
and indirect origination costs amounting P846,756 to P103,285, respectively. After

a. P5,533,244 c. P6,466,756
b. P5,249,959 d. P6,570,041
a. P42,217 c. P582,008
b. P145,502 d. P478,723

a. P582,853 c. P589,389
b. P580,253 d. P582,749
a. P6,211,091 c. P6,388,764
b. P6,303,753 d, P6,367,511
4, On January 1, 2023, LAPTOP Company granted a seven-year loan, with principal

amount of P8,400,000 to a borrower. Interest of 14% is payable every December 31
of each year. In connection with the loan, the Company incurred direct and indirect
origination costs amounting to P1,036,030 and P102,962, respectively. In addition,
the borrower also paid the Company origination fees of P470,000. After considering
the relevant amounts, the loan has an effective interest rate of 12.50%.

a. P9,618,992 c. P7,833,970
b. P8,966,030 d. P8,486,932
528
The
The Book
a. P1,120,754 c. P1,176,000
b. P1,017,792 d. P1,073,038

a. P1,243,141 c. P1,113,848
b. 1,251,534 d. P1,120,754

a. P8,910,784 c. P8,778,711
b. P8,700,050 d. P8,848,632
5. At the beginning of 2023, CALYPSO Company granted a six-year, 7% interest-

bearing, P6,000,000 loan to a borrower. The principal is payable in four equal annual
installments starting on December 31, 2025. Interest is payable every December 31
of each year. Origination fees received from the borrower amounted to P480,000,
while direct origination costs amounted. to P55,600. After considering the relevant
amounts, the loan has an effective interest rate of 9%.

a. P5,575,600 c. P5,754,400
b. P6,424,400 d. P6,632,400
a. P517,191 c. P501,804
b. P509,166 d. P420,000

a. P517,191 c. P501,804
b. P509,166 d. P420,000

a. P5,746,570 c. P5,838,953
b. P4,157,404 d. P4,568,932
6. On January 1, 2023, BISHOP Company granted a four-year, 11% interest-bearing,

P7,000,000 loan to a borrower. The principal is payable in accordance with the
following schedule:
Date Amount
December 31, 2023 P1,000,000
December 31, 2024 1,500,000
December 31, 2025 2,000,000
December 31, 2026 2,500,000
Interest is payable every December 31 of each year. Origination fees received from
the borrower amounted to P520,000 while direct origination costs amounted to
P684,106. After considering the relevant amounts, the loan has an effective interest
rate of 10%,
529
The
The Book

a. P7,164,106 c. P7,056,843
b. P6,835,894 d. P6,956,942
a. P456,157 c. P716,411
b. P578,983 d. P611,052
a. P456,157 c. P716,411
b. P578,983 d. P611,052
a. P4,894,832 c. P4,430,421
b. P4,561,569 d. P4,743,298
7. Atthe beginning of 2023, MERTON Company granted a six-year, 9% interest-bearing

loan with principal amount of P10,000,000 to a borrower. Based on their agreement,
the borrower shall pay equal periodic amounts composed of principal and interest
portions, every December 31 of each year starting in 2023.
a. P800,000 c. P750,000
b. P1,000,000 d. P900,000
Carrying amount of the loan receivable as of December 31, 2023 shall be
a. P8,670,802 c. P8,789,763
b. P8,723,865 d. P8,856,765
a. P780,372 c. P798,654
b. P769,876 d. P804,652
Carrying amount of the loan receivable as of December 31, 2024 shall be
a. P7,367,854 c. P7,221,977
b. P7,598,503 d. P7,432,643
530
The
The Book
Chapter 15 - Impairment of Financial Assets
CHAPTER 15
IMPAIRMENT OF FINANCIAL ASSETS

The concept and source of credit losses.
The financial assets covered by impairment provisions under PFRS 9.
CON
The recognition and measurement of expected credit losses.

The general approach on measuring expected credit losses.
PY Oe
The accounting and measurement of credit losses from credit-impaired assets.

The special accounting and measurement of credit losses from financial assets at
FVTOCI.
IMPAIRMENT OF FINANCIAL ASSETS

When extending credit to trade customers (for selling of goods or providing of
services) or lending to borrowers (for financial institutions), entities perform credit
evaluation on their counterparties to ascertain their creditworthiness. This is to
ensure that only those counterparties that can pay in the future will be allowed to
have credit transactions with the entity.
Despite the rigorous credit evaluation, some of the counterparties will still fail to
pay the amounts due from them. This possibility is called credit risk. Formally,
credit risk is the risk that one party to a financial instrument will cause a financial
loss for the other party by failing to discharge an obligation. [PFRS 7.A]. The failure
of the counterparties to pay the lending entity will result to credit loss to the lending
entity.
This probability of credit loss and the actual failure of the counterparty to pay the
entity will be the focus of the discussions in this chapter.
IMPAIRMENT MODEL UNDER PFRS 9
Under the requirements of PFRS 9, entities are required to recognize expected credit
losses.
Expected credit loss is the weighted average of credit losses with the respective
risks of a default occurring as the weights, [PFRS 9.A]. Credit loss is the present
value of the difference (i.e., cash shortfalls) between the cash flows below
discounted using the original effective interest rate:
a. All contractual cash flows that are due to an entity in accordance with the
contract; and
b. All the cash flows that the entity expects to receive (including the cash flows
from the collateral, if there is any). [PFRS 9.A].
Alternatively, the amount of credit loss can also be computed as follows:
531
The
Chapter 15 — Impairment of Financial Assets
Carrying amount of the financial asset Pxx

Less: Present value of revised cash flows discounted
using the original effective interest rate XX
Amount of credit loss Pxx
In other words, credit losses are recognized even if there are no actual defaults
or inability of the counterparties in paying their owed amounts to the entity.
Actually, the recording of allowance for bad debts in Chapter 4A is a simple example
of the application of this requirement.
The goal of the expected credit loss. model is to recognize the credit losses to
coincide with the events indicative of the counterparty’s possible failure to pay
its obligation to the entity (i.e., changes in credit risk) .instead of recognizing the
credit losses only when there is an actual failure. This will result to a more timely
financial information about the financial asset's credit risk.
FINANCIAL ASSETS COVERED BY IMPAIRMENT PROVISIONS UNDER PFRS 9
The following are the analysis of financial assets that may or may not be covered by
the impairment provisions discussed in this chapter:
At FVTPL - NOT covered, since any impairment will already be
reflected in the unrealized gains or losses recognized in profit or loss
Equity arising from the changes in fair value.
Securities | at FVTOCI - NOT covered, since no amount will ever be recorded in

profit or loss arising from the changes in fair value or realized
gains/losses from sale.
At FVTPL - NOT covered, since any impairment will already be
reflected in the unrealized gains or losses recognized in profit or loss
arising from the changes in fair value.
Debt
Securities | Atamortized cost - COVERED, since its measurement does not reflect
(including | any changes in the fair value of the debt security.
loans
) At FVTOCI - COVERED, even though its measurement reflects the
changes in the fair value, this security still has elements of amortized
cost which shall be subjected to impairment losses.
In conclusion, only the following financial assets are covered by the impairment
provisions of PFRS 9:
a. Debt securities at amortized cost; and
b. Debt securities at FVTOCI.
COMPUTATION OF EXPECTED CREDIT LOSS (ECL) AMOUNT

Under PFRS 9, there are three approaches in computing for the expected credit loss
(ECL), namely the (a) general approach; (b) simplified approach; and (c)
purchased or originated credit-impaired approach. For this chapter, the focus
532
The
will be on the general approach. The simplified approach has already been
discussed in Chapter 4A when estimating the amounts of allowance for bad debts,
GENERAL APPROACH
When using this approach, the following “three-stage approach” may be applied for
an easier understanding:
Stage 1 > Stage2. . StageZ
Credit Risk No significant Significant Credit-impaired
increase increase (actually impaired)
ECL Amount 12-month ECL Lifetime ECL Lifetime ECL
EIR applied to EIR applied to | EIR applied to gross
Interest Income gross carrying gross carrying | carrying amount less
amount. amount allowance for ECL.
Stage 1 and 2 - No Actual Impairment

Based on the above table, the financial asset is not actually impaired under Stages
1 and 2. Nonetheless, an entity is required to recognize ECL based on the following:
Is there a significant increase in

credit risk since the initial
recognition?
Measure the ECL equal to

Measure the ECL equal to 12-month ECL
Life-time ECL
12-month ECL is the portion of lifetime expected credit losses that represent the
expected credit losses that result from default events on a financial instrument that
are possible within the 12 months after the reporting date. [PFRS9.A].
Lifetime ECL is the expected credit losses that result from all possible default
events over the expected life of a financial instrument. [PFRS9.A].
Based on these definitions, the amount of lifetime ECL is always higher than the
amount of 12-month ECL. This is because the longer the period to the maturity date,
the higher the credit risk of a financial asset. For example, a loan to be received in
five years carries more risk than a loan to be received in one year, The main reason
is that there are a lot more uncertain things that can happen during a five-year
window compared to a one-year window.
533
The
This is in line with the goal of this approach which is to recognize increasing
amounts of ECL when there is a significant increase in credit risk since the
initial recognition. This increase in credit risk indicates an increased likelihood
that the entity’s counterparty will fail to pay its obligations. That is, the higher the
credit risk, the higher the amount of ECL.
The following is a portion of the non-exhaustive list that PFRS 9 mentioned that are
relevant in assessing whether there is a significant increase in credit risk from the
initial recognition:
a. existing or forecast adverse changes in business, financial or economic
conditions
b. anactual or expected significant change in the operating results of the borrower that
results in a significant change in the borrower's ability to meet its debt
obligations.
c. significant increases in credit risk on other financial instruments of the same
borrower.
d. an actual or expected significant adverse change in the regulatory, economic, or
technological environment of the borrower.
e. significant changes, such as reductions in financial support from a parent entity or
other affiliate. [PFRS9.B5.5.17].
In computing for the amount of ECL, an entity may apply either of the following:
a. PD x LGD approach - a complicated one; or
b. Loss rate approach - a simpler one. By analogy, this has already been applied
in Chapter 4A under the aging method of estimating allowance for bad debts.
PD x LGD Approach
Under this approach, ECL amounts are computed in the following fashion:
ECL = PD x LGD x EAD
PD - probability of default, indicates how likely that a counterparty will default. This
is stated as a percentage.
LGD -loss given default, the credit loss that an entity will incur assuming a
counterparty defaults. This is stated as a percentage and complement to the
recovery rate (RR), where LGD = 1 - RR. For example, if the RR is 30%, then the
LGD will be 70%.
EAD - exposure at default, the amount recognized in the records of an entity during the
expected timing of default. This is not necessarily equal to the present carrying
amount, but for purposes of the discussion, it will be assumed that EAD is equal
to the financial asset’s amortized cost. _
The computed ECL amountis the required ending balance of the “allowance for
ECL” account and will be a deduction from the financial asset's gross carrying
amount to get its net carrying amount. By analogy, this is similar to the ending
534
The
CamScanner
balance of allowance for bad debts computed using the accounts receivable method
or the aging method in Chapter 4A.
Any changes in the required balance of the allowance for ECL from one reporting
date to another are recognized in the profit or loss as follows:
a. Any increase in the allowance is recognized as impairment loss
b. Any decrease in the allowance is recognized as gain on reversal of impairment.
For bonds and other debt securities issued by governments and private
corporations, PD and LGD percentages are normally available publicly as part of
credit rating agencies’ (e.g., Moody’s, Standard & Poor's, etc.) publications.
Illustration 1. As of December 31, 2023, ACCLAIMED Company has an investment
in 10% interest-bearing government bonds with a carrying amount of P10,000,000
as of date. The investment is accounted for at amortized cost. Based on a credit
agency’s publications, the relevant PD within 12 months is 2%, lifetime PD is 30%
and recovery rate (RR) is 80%. The balance of allowance for ECL as of December
31, 2022 is P21,000.
Required: Determine the amounts of allowance for ECL, impairment loss, net
carrying amount of the bonds, and interest income under each of the following
independent scenarios:
1. No significant increase in credit risk
2. Significant increase in credit risk.
Scenario 1 - No significant increase in credit risk
The amount allowance for ECL as of December 31, 2023 is computed as follows:
Allowance for ECL = 2% x 20% x P10,000,000 = P40,000

v v v
PD LGD EAD
From the above computations, the reader should take note of the following:
a. The PD used is the PD within 12 months since there is no significant increase
in credit risk.
b. The LGD of 20% is computed as the complement of the 80% recovery rate (1 -
80%).
c. EAD used is equal to the carrying amount of the government bonds.
For the year 2023, there is an impairment loss of P19,000 (P40,000 - P21,000)
since the required allowance increased from P21,000 on December 31, 2022 to
P40,000 on December 31, 2023. This can be recorded as follows:
Impairment loss 19,000
Allowance for impairment - ECL 19,000
To compute for the net carrying amount of the investment as of December 31, 2023:
535
The
CamScanner
Gross carrying amount P10,000,000

Less: Allowance for impairment = ECL (40,000)
Net carrying amount, 12/31/23 P9,960,000
Despite of this net carrying amount, the computation of P1,000,000 interest

income for 2023 shall still continue to be based on the gross carrying amount of
P10,000,000 times 10% interest rate (i.e., allowance for ECL shall be ignored).
Scenario 2 - With significant increase in credit risk

The amount allowance for ECL as of December 31, 2023 is computed as follows:
Allowance for ECL = 30% x 20% x P10,000,000 = P600,000

v v Vv
PD LGD EAD
The readers should take note that the PD used is the PD beyond 12 months since
there is a significant increase in credit risk.
For the year 2023, there is an impairment loss of P579,000 (P600,000 - P21,000)
since the required allowance increased from P21,000 on December 31, 2022 to
P600,000 on December 31, 2023. This can be recorded as follows:
Allowance for impairment - ECL 579,000
To compute for the net carrying amount of the investment as of December 31, 2023:
Gross carrying amount P10,000,000
Less: Allowance for impairment - ECL (600,000)
Net carrying amount, 12/31/23 P9,400,000
Similar to Scenario 1, the computation of P1,000,000 interest income

(P10,000,000x 10%) ignores the amount of allowance for ECL.
Generalization - Scenarios 1 and 2

The difference in the computation of allowance for ECL arises from the different
PDs used, The amount of ECL is higher in Scenario 2 to coincide with the
significant increase in credit risk. As a result, recognition of impairment losses
will now be more timely.
Illustration 2. Continuing with Scenario 2, as of December 31, 2024, assume that

the significant increase in credit risk last December 31, 2023 has been reverted
back to credit risk levels as of December 31, 2022 (i.e., no significant increase in
credit risk since the initial recognition), The relevant PD within 12 months is 1.5%,
lifetime PD is 35%, and LGD is 25%, Required: Compute for the ending balance of
allowance for impairment and impairment loss for 2024,
536
The
The Book
Allowance for ECL amount as of December 31, 2024 is computed as follows:
Allowance for ECL = 1.50% x 25% x P10,000,000 = P37,500
Since there is no significant increase in credit risk from the initial recognition as of
December 31, 2024, the allowance for ECL shall now be equal to 12-month ECL,
which is computed using the PD within 12 months of 1.50%.
For the year 2024, there is a gain on reversal of impairment of P562,500 (P37,500
— P600,000) since the required allowance decreased from P600,000 on December
31, 2023 to P37,500 on December 31, 2024. The entry to record the updated
amount of ECLis as follows:
Allowance for impairment 562,500
Gain on reversal of impairment 562,500
For loans receivables, the banks internally estimate PD and LGD percentages based
on its past data, which is then adjusted by forward-looking information. These
estimations use statistical analyses like regression and correlation, which are
beyond the scope of this book.
COMPUTATION OF LGD
For the readers’ appreciation, a very simple example of LGD computation is
illustrated below. This simple approach involves the following steps:
1. First, discount using the original effective interest rate the expected total cash
flows to be recovered from the financial asset assuming the counterparty will
default. The period to be used in computing for the PV factor is not necessarily
the remaining period until maturity date but should reflect the expected timing of
the cash flows.
Nevertheless, when there is no expected timing of cash flow indicated, the period
to maturity can be used instead.
2. The amount computed in Step 1 is considered as the present value of expected
recoveries from which we can compute for the recovery rate as follows:
Recovery Rate (RR) = Present value of expected recovery/Carrying amount

From the above formula, the LGD can be computed as 1 - Recovery Rate.
Illustration 3 - Computation of LGD, On January 1, 2023, GENUINE Company

entered in to a Joan agreement with a borrower by lending P5,000,000. The loan
bears interest of 9% that is payable every December 31. Maturity date is December
31, 2028. If the borrower defaults, the Company expects to receive P4,000,000 of
the principal on the maturity date. No amounts of interest are expected to be
537
The
received if the borrower defaults. Required: Compute for the estimated rate of LGD
Solution:
1. First, compute for the present value of recoveries as of December 31, 2023:
PV Factor of PV Factor CashFlow Present Value

Single payment for 5 periods at9% —_(0.649931 4,000,000 P2,599,724
Note: 12/31/23 to 12/31/28 is 5 years; hence, 5 periods.
2. Next, compute for the recovery rate:

Recovery rate = P2,599,724/P5,000,000 = 51.99%
3. Lastly, compute for the LGD as follows:

LGD = 1 - 51.99% = 48.01%
FINANCIAL ASSET IS CREDIT-IMPAIRED (STAGE 3 OF GENERAL APPROACH)

So far, the discussions only include the financial assets before they become credit-
impaired. When a financial asset is credit-impaired, there is either an actual failure
to pay (default), or it is virtually certain that the counterparty will fail to pay.
Evidence that a financial asset is credit-impaired include observable data about the
following events:
a. significant financial difficulty of the issuer or the borrower;
b. a breach of contract, such as a default or past due event;
c. the lender(s) of the borrower, for economic or contractual reasons relating to the
borrower's financial difficulty, having granted to the borrower a concession(s) that
the lender(s) would not otherwise consider;
d. it is becoming probable that the borrower will enter bankruptcy or other financial
reorganization;
e. the disappearance of an active market for that financial asset because of financial
difficulties; or
f. the purchase or origination of a financial asset at a deep discount that reflects the
incurred credit losses. [PFRS 9.A].
In these cases, an entity shall measure the financial asset at the present value of
the modified cash flows discounted at original EIR. Using this present value
amount, impairment loss to be recognized in profit or loss can be determined as:
Gross carrying amount of financial asset Pxx

Add: Accrued interest receivable (if any) XX
Less: Allowance for ECL (if any) (xx)
Net carrying amount of financial asset Pxx
Less: PV of modified cash flows discounted
using original effective interest rate (xx)
Impairment loss Pxx
538
The
The Book
Interest income shall now be based on the net carrying amount of the financial
asset (after deducting the amount of allowance for impairment). This is similar
to the computation of interest income from an amortization table.
Illustration 4. On January 1, 2023, HARMONIOUS Bank lent P8,000,000 to a
borrower. The loan has interest of 10% payable every December 31 of each year
and maturity date of December 31, 2025. Starting 2024, the borrower experienced
financial difficulties which forced it to enter into agreement with the Bank for the
modification of the loan as of December 31, 2024:
a. Interest will continue to be paid but to a reduced rate of 5% starting December
31, 2025. Accrued interest for 2024 is to be waived.
b. Principal amount will be reducedto P7,000,000 (i.e., P1,000,000 will be waived)
and will be paid on December 31, 2027.
Allowance for impairment as of December 31, 2023, computed using PD x LGD
approach, amounted to P12,000. Determine the amount of impairment loss to be
recognized in 2024 and the subsequent accounting for the loan starting 2025.
Solution:
First, as of December 31, 2024, the Bank shall compute for the present value of the
revised cash flows discounted using the original effective interest rate of 10%:
PV Factors of PVFactor CashFlow Present Value

Ordinary annuity for 3 periods at 10% 2.486852. 350,000 870,398
Present value of modified future cash flows P6,129,603
Note: 12/31/24 to 12/31/27 revised maturity is 3 years; hence, 3 periods. P350,000 = P7,000,000 x 5%.
Next, this computed present value amount shall be compared with the net carrying
amount of the loan right before the impairment to determine the impairment loss:
Less: Allowance for impairment (12,000)
Net carrying amount before impairment P8,788,000
Less: Present value of modified future cashflows __ (6,129,603)
Impairment loss in 2024 P2,658,397
Journal entry to record this impairment loss on December 31, 2024 is as follows:
Impairment loss 2,658,397
Allowance for impairment 2,658,397
To record the write-off of interest receivable and P1,000,000 portion of the principal
since it is very certain that these amounts cannot be collected anymore:
539
The
The Book

Summarizing these entries will give us the balances of the following accounts:
Loans Interest Allowance for
Receivable Receivable Impairment
Balances before impairment P8,000,000 P800,000 P12,000
Recording of impairment loss 2,658,397
Recording of write-off (1,000,000) (800,000) (1,800,000)
Balances after impairment P7,000,000 p- P870,397
From these balances, the net carrying amount of the loans receivable after
impairment as of December 31, 2024 can now be computed as follows:
Loans receivables P7,000,000

Less: Allowance for impairment (870,397)
Net carrying amount after impairment P6,129,603
In conclusion, the carrying amount of the loan receivable right after impairment
is equal to the present value of revised future cash flows.
This carrying amount shall be subsequently accounted for using the following
amortization table:
Carrying
Interest/ [10%] Amount/ Allowance
Principal _ Interest Amorti- Present for
Date Received Income zation Value Impairment
12/31/24 6,129,603 870,397
12/31/25 350,000 612,960 262,960 6,392,563 607,437
12/31/26 350,000 639,256 289,256 6,681,819 318,181
12/31/27 350,000 668,181 318,181 7,000,000 -
12/31/27 7,000,000 (7,000,000) - -

a. Interest income shall now be based on the net carrying amount of the loan
receivable (i.e., after deducting the allowance). /Beginning-of-the-period
carrying amountx original effective interest rate].
b. The balance of allowance for impairment is effectively amortized as an addition
to both the amount of interest income each year and to the carrying amount of the
loan at the end of each period. By analogy, this is similar to the concept of
amortizing the discount on loans receivable account in the previous chapter.
Fast forward to December 31, 2025, to record the receipt of interest and the
amortization of allowance for impairment:
540
The
Cash 350,000
REVERSAL OF IMPAIRMENT LOSS IN CREDIT-IMPAIRED ASSET

Events which gave rise to credit-impairment of a financial asset may cease to
happen completely or partially. In these cases, gain on reversal of impairment
shall be recognized in profit or loss equal to the difference of the following:
Net carrying amount of financial asset before the reversal Pxx
Less: PV of modified cash flows discounted using original
effective interest rate (xx)
Gain on reversal of previous impairment Pxx
Illustration 5. Continuing with HARMONIOUS Bank in Illustration 4, except that as

of December 31, 2025, the borrower has partially recovered and agreed to pay 8%
interest for 2026 and 2027 (i.e., P560,000 annual interest or P7,000,000x 8%). What
is the amount of Gain on Reversal of Impairment in 2025?
Solution:
As of December 31, 2025, the present value of the revised cash flows discounted at
the original EIR of 10% is determined as follows:
PV Factor of PVFactor CashFlow Present Value

Present value of modified future cash flows P6,757,023
Note: 12/31/25 to 12/31/27 revised maturity is 2 years; hence, 2 periods.
This present value amount can now be compared with the carrying amount of the
loan right before the reversal (based on the amortization table) in order to
determine the amount of the gain on reversal of impairment:
Loans receivable, 12/31/25 P7,000,000
Less: Allowance for impairment, 12/31/25 (607,437)
Net carrying amount before reversal P6,392,563
Less: PV of revised cash flows 6,757,023
Gain on reversal of impairment, 12/31/24 P364,460
This gain will be recorded on December 31, 2025 as follows:

Gain on reversal of impairment 364,460
After recording this reversal, the accounts will have the following balances:
541
The
Loans Allowance for

Receivable Impairment
Balances before reversal P7,000,000 (P607,437)
Recording of reversal of impairment 364,460
Balances after reversal P7,000,000 (P242,977)
Based on the above balances, the loan will now have a net carrying amount of
P6,757,023 (P7,000,000 - P242,977), which is equal to the present value of the
revised cash flows. This net carrying amount shall be amortized for the rest of the
remaining term of the loan as follows:
Carrying —
Interest/ [10%] Amount/ Allowance
Principal Interest Amorti- Present for
Date Received Income zation: Value Impairment
12/31/25 6,757,023 242,977
12/31/26 | 560,000 675,702 115,702 6,872,725 127,275
12/31/27 560,000 687,275 127,275 7,000,000 -
12/31/27 7,000,000 (7,000,000) - =
STAGE 1 TO STAGE 3 IMPAIRMENT

Illustration 6 - Comprehensive. On January 1, 2023, DAZZLING Bank lent
P9,000,000 to a borrower. The loan has interest of 10%, payable every December
31 of each year and has maturity date of December 31, 2028.
As of December 31, 2023, no major events have happened and as a result, there is
no significant increase in credit risk. On December 31, 2024, events happened
which led to the deterioration of the borrower’s financial performance, hence
causing a significant increase in credit risk. Nevertheless, interest amounts for 2023
and 2024 were received.
The following are the PD and recovery information that are relevant in computing
the ECL as of December 31, 2023 and 2024:
Within 12
PD Months Lifetime
December 31, 2023 2% 40%
December 31, 2024 3% 45%
Amounts to be Estimated Years

Received if there Before it Can Be
_| Recovery Amounts is a Default* Received
December 31, 2023 8,000,000 2 years
December 31, 2024 7,000,000 3 years
*no amount of interest is expected to be received in case of default.
542
The
The Book
The events of 2024 became worse in 2025 and as a result, the loan is considered as
credit-impaired. The Bank estimates that it will receive P2,000,000 on December
31, 2026, P2,500,000 on December 31, 2027, and P2,500,000 on December 31,
2028. Interest for 2025 has been paid, but no amounts of interest are to be received
moving forward.
Required: Determine the journal entries related to impairment over the term of the
loan.
Solution:
1. First, compute the amounts of ECL using PD x LGD approach as of December 31,
2023 and December 31, 2024 (both with no actual credit-impairment). Since the
LGD is not explicitly mentioned, it will be computed separately:
December
PV Factor of PV Factor Cash Flow 31, 2023
PV of expected recovery in case of default P6,611,568
Note: 2 periods correspond to the 2 years before P8,000,000 will be recovered.
December
PV Factor of PV Factor Cash Flow 31, 2024
Note: 3 periods correspond to the 3 years before P7,000,000 will be recovered.
The readers should note that the number of periods used is not necessarily the
number of years up to the loan’s maturity date. Instead, these are the expected
number of periods before the cash flows are to be recovered in case of
borrower's hypothetical default. However, in the absence of additional
information, the remaining term until maturity date shall be used instead.
To compute for the LGD, the previously computed present value amounts shall
be divided by the carrying amount of P9,000,000:
Dec. 31,2023 Dec. 31,2024
PV of expected recovery P6,611,568 P5,259,205
Divide by: Carrying amount 9,000,000 9,000,000
Recovery rate (RR) 73.46% 58.44%
LGD (1 - RR) 26.54% 41.56%
To compute for the ECL and impairment loss by applying the PD x LGD x EAD
approach:
543
Bh
The
The Book
Dec. 31, 2023 Dec. 31, 2024

PD 2% 45%
Multiply by: LGD 26.54% 41.56%
Multiply by: EAD P9,000,000 P9,000,000
ECL (PD x LGD x EAD) P47,772 P1,683,180
Less: Beginning ECL - 47,772
Impairment loss P47,772 P1,635,408
Since there is no significant increase in credit risk as of December 31, 2023, ECL
shall be equal to 12-month ECL. The PD to be used for ECL computation is PD
within 12 months (i.e., 2%). On the other hand, since there is a significant
increase in credit risk as of December 31, 2024, ECL is equal to lifetime ECL. The
PD to be used is for lifetime (i.e., 45%).
2. To record the ECL amounts as of December 31, 2023 and 2024:
December 31, 2023:

December 31, 2024:

After recording these entries, the loan’s net carrying amounts are as follows:
Dec. 31,2023 Dec.31,2024

Loans receivable P9,000,000 P9,000,000
Less: Allowance for impairment (47,772) (1,683,180)
Net carrying amounts P8,952,228 P7,316,820
Annual interest income for 2023 and 2024 shall be P1,000,000 (P10M x 10%).
3. As of December 31, 2025, the loan becomes credit-impaired. The present value
‘of expected future cash flows discounted using the original EIR (i.e., 10%) is
December
PV Factor of Single payment for PV Factor Cash Flow 31, 2025
1 period at 10% (12/31/26) 0.909091 2,000,000 P1,818,182
2 periods at 10% (12/31/27) 0.826446 2,500,000 2,066,115
3 periods at 10% (12/31/28) 0.751315 2,500,000 _ 1,878,288
This present value amount shall be compared with the loan’s carrying amount
right before impairment (or as of December 31, 2024). The amount of
impairment loss for 2025 is computed as follows:
ul
The

Less: Allowance for impairment (1,683,180)
Net carrying amount before right credit-impairment P7,316,820
Less: PV of revised cash flows (5,762,585)
Impairment loss, 2025 P1,554,235
To record the impairment loss on December 31, 2025:
Since only P7,000,000 (P2M+P2.5M+P2.5M) of the principal amount of

P9,000,000 are to be received, the P2,000,000 portion shall be written-off:
The carrying amount of the loan after impairment and write-off are as follows:
Loans Allowance for Carrying
December 31, 2025 Receivable Impairment Amount
Balances before impairment —P9,000,000 P1,683,180 P7,316,820
Impairment loss for 2025 1,554,235 (1,554,235)
Write-off (2,000,000) (2,000,000)
Balances after impairment P7,000,000 P1,237,415 P5,762,585
Again, the carrying amount after recording impairment is equal to the present
value of estimated recoveries. The following amortization table will be used
assuming that the estimated of amounts of recovery will actually be received:
Carrying
Amount/ Allowance
Principal Interest Amorti- Present for
Date Received Income zation Value Impairment
12/31/25 5,762,585 1,237,415
12/31/26 2,000,000 576,259 (1,423,741) 4,338,844 661,156
12/31/27 2,500,000 433,884 (2,066,116) 2,272,728 227,272
12/31/28 2,500,000 227,272 (2,272,728) - -
IMPAIRMENT OF DEBT SECURITY AT FVTOCI

So far, the concepts that were discussed apply to debt security at amortized cost.
For debt securities at FVTOCI, virtually the same concepts on impairment of
financial assets at amortized cost also apply. For example, impairment losses are
also charged to profit or loss and the manner of computation ofinterest income
depends on the stage bucket (i.e., Stage 1 to 3) of the financial asset.
545
bs
The
The main. difference would be the credit in the journal entry when recognizing
impairment loss. Pro-forma entry is as follows:
Impairment loss (P/L) XX
Other comprehensive income XX
The main reason for this treatment is that the even though there is an impairment,
financial assets at FVTOCI shall always be reported at their fair values. These
fair values already reflect the impairment (i.e., the higher the credit risk, the
lower fair value).
If an allowance account is deducted from the gross carrying amount, this will result
into double deduction of the amount of impairment (i.e., already reduced fair value
and additional deduction through allowance).
Illustration 7. During the current year, an entity acquired a debt security at a price
equal to its face amount of P4,000,000. This debt security is to be accounted for at
FVTOCI. At the end of the year, this investment had a fair value of P4,100,000 and
amortized cost of P4,000,000. Expected credit loss using the PD x LGD approach
The entry to record the change in fair value at the end of the year is as follows:

The entry to recognize ECL amount is as follows:

Impairment loss (P/L) 15,000
Other comprehensive income 15,000
The readers should take note that the carrying amount of the debt security at
FVTOCI is still equal to its fair value of P4,100,000 since no allowance was recorded
on account of the ECL. In addition, the impairment loss of P15,000 shall still be
SIMPLIFIED APPROACH
This approach is primarily applicable to trade receivables (e.g., accounts
receivables). Under this approach, the amount of ECL is always based on the lifetime
ECL due to the short-term nature of the related receivables (i.e., maturity of less
than one year), This is very similar to the estimation of allowance for bad debts in
Chapter 4A.
546
The
CamScanner
CHAPTER SUMMARY
A. Under PFRS 9, an entity shall recognize expected credit losses (ECLs) from relevant
financial assets, even if there are no counterparties who failed to pay the amounts
due to the entity.
ALL equity securities and FVTPL debt securities are not covered by the impairment
provisions of PFRS 9.
Only the debt securities accounted for at FVTOCI and amortized cost are subject to
the impairment provisions of PFRS 9.
The following are the accounting procedures relevant for the general approach
under PFRS 9:
Stagei | Stage 2 Ee Stage 3

Credit Risk No significant Significant Credit-impaired
increase increase (actually impaired)
ECL Amount 12-month ECL Lifetime ECL Lifetime ECL
EIR applied to EIR applied to EIR applied to gross
Interest
gross carrying gross carrying | carrying amount less
Income
amount. amount allowance for ECL.
12-month ECL is the portion of lifetime expected credit losses that represent the
expected credit losses that result from default events on a financial instrument that
are possible within the 12 months after the reporting date. /PFRS9.A]. Lifetime ECL
is the expected credit losses that result from all possible default events over the
expected life of a financial instrument. [PFRS9.A].
The higher the credit risk, the higher the amount of ECL.
nu
The amount of ECL may be determined by using the PD x LGD approach as follows:
ECL = PD x LGD x EAD, where
PD - probability of default, indicates how likely that a counterparty will default.

LGD -loss given default, the credit loss that an entity will incur assuming a
counterparty defaults.
EAD - exposure at default, the amount recognized in the records of an entity during
the expected timing of default.
Increase in ECL is recorded as impairment loss while decrease in ECL is recorded as
gain on reversal of impairment loss. Generally, these gains and losses are recognized
in profit or loss. |
If there is an actual impairment, an entity shall estimate the expected amounts that
it can receive from the financial asset. The present value of these expected
recoveries, discounted using original EIR, shall be compared to the financial asset's
net carrying amount to determine the amount of impairment loss.
Impairment of FVTOCI debt securities is the same as impairment of amortized cost
debt securities, except that the credit is in OCI rather than to an allowance account.
547
The
True or False
dk Credit risk is the probability that the counterparties will be able to pay the amounts
they owed to an entity.
i PFRS 9 requires an entity to recognize impairment loss only when there is an actual
failure of the counterparty to pay the entity.
3 The higher the credit risk, the higher the amount of ECL.
Both the equity securities at FVTOCI and debt securities at FVTOCI are subject to
the impairment provisions of PFRS 9.
If there is a significant increase in credit risk, the amount of ECL shall be based on
the 12-month ECL.
Lifetime ECL cover the expected credit losses that result from possible default
events over five years.
The higher the LGD, the higher the computed amount of ECL.
so ON
Increase in the amount of ECL shall be recognized as impairment loss.

If there is an actual impairment, the net carrying amount of a financial asset after
recording the impairment loss is equal to the present value of expected cash flows
discounted using the market rate of interest on the date of estimation.
10. Interest income from the credit-impaired financial asset is based on the financial
asset's net carrying amount after deducting the allowance for impairment.

G Which of the following models are required by the accounting standards in
measuring impairment losses?
a. Expected credit loss model
b. Incurred credit loss model
c. Expected credit loss model or incurred credit loss model, whichever will result
to higher impairment loss.
d. Expected credit loss model or incurred credit loss model, whichever will result
to lower impairment loss.
All of the following financial assets are subject to impairment, except

a. Accounts receivable
b. Investments in equity securities
c. Amortized cost debt securities
d. All ofthe above are subject to impairment
The following are the approaches that can be used in determining the amount of
expected credit losses, except
General approach
oP
Simplified approach
Purchased or originated credit-impaired approach
ao
All of the above are the approaches that can be used in determining the amount
of expected credit losses,
548
The
CamScanner
4. Which of the following is correct under the Stage 1 of the general approach of
determining expected credit losses?
a. The expected credit loss amount shall be based on the 12-month ECL.
b. Interest income shall be computed as the effective interest rate applied to the
carrying amount of the financial asset net of allowance for ECL.
c. Bothaandb
d. Neitheranorb
Which of the following is correct under the Stage 3 of the general approach of
determining expected credit losses?
a. The expected credit loss amount shall be based on the lifetime ECL.
b. Interest income shall be computed as the effective interest rate applied to the
carrying amount of the financial asset net of allowance for ECL.
c. Bothaandb
d. Neitheranorb
The following are true about 12-month ECL and lifetime ECL, except
a. Lifetime ECL covers a longer period of time compared to the 12-month ECL.
b. Incomputing the interest income, both of these are deducted from the carrying
amount of the related financial asset.
c. Generally, the amount of lifetime ECL is higher than the amount of 12-month
ECL.
d. Ifthere is no significant increase in credit risk since the initial recognition, the
expected credit loss is equal to the 12-month ECL. Otherwise, it is equal to the
lifetime ECL.
Circumstances that may indicate a financial asset is credit-impaired include the

following, except
a. Decline in the fair value of the issuer’s equity securities due to investors’
negative outlook in the economy.
b. The borrower or the issuer has breached a provision of the contract such as
missed payments.
c. The borrower or the issuer has entered into a financial reorganization to give it
a fresh start.
d. Significant financial difficulty of the issuer or the borrower.
When there is an actual credit-impairment, the amount of expected recoveries shall

be discounted using which of the following rates?
a. Stated rate
b. Original effective rate
c. Current market rate
d. Whichever is the highest among the stated rate, original effective rate and
current market rate.
One of the approaches of determining the expected credit loss amount is the PD x
LGD approach, Which of the following incorrectly describe the effects of the inputs
in the computation?
549
The
CamScanner
a. Any increase in PD will have an increasing effect in the amount of expected

credit loss amount.
b. Any decrease in EAD will have an increasing effect in the amount of expected
credit loss amount.
c. Any decrease in recovery rate will have an increasing effect in the amount of
expected credit loss amount.
d. Any decrease in LGD will have a decreasing effect in the amount of expected
credit loss amount.
10.In accounting for credit losses, whether expected or incurred, the following are
generally correct, except
a. Increase in credit risk will result to an increase in expected credit losses.
b. Impairment loss from credit-impairment in a financial asset is determined by
comparing the present value of expected recoveries with the carrying amount
of the financial asset.
c. Fordebt securities at FVTOCI, the impairment loss shall be charged to OCI.
d. All ofthe above are correct.
Straight Problems
1. CANON Company had beginning-of-the-period ECL amount of P14,000 as of January
1, 2023. This is related to a loan with principal amount of P6,000,000. Related
interest of 9% is payable every December 31 of each year. In estimating the ECL
amount as of December 31, 2023, the following information may be relevant:
PD withini2 months PD within expected life LGD

2% 30% 40%
Required: Under each of the following independent scenarios, determine the amount
of impairment loss for the year 2023 and allowance for ECLas of December 31, 2023:
1. There is no significant increase in credit risk since the initial recognition.
2. There is a significant increase in credit risk since the initial recognition.
2. In 2023, BALL Company had beginning-of-the-period ECL amount of P15,000. This
is related to a loan with principal amount of P7,000,000. Related interest of 8% is
payable every December 31 of each year. In estimating the ECL amount as of
December 31, 2023, the following information may be relevant:
PD within12 months PD within expected life

2.50% 35%
In case the borrower defaults, only 80% of the principal amount can be recovered
on December 31, 2026, which is its maturity date (no interest will be recoverable).
Market rates as of December 31, 2023 averaged 10%.
Required: Under each of the following independent scenarios, determine the amount
of impairment loss for the year 2023 and allowance for ECLas of December 31, 2023:
1. There is no significant increase in credit risk since the initial recognition.
2. There is a significant increase in credit risk since the initial recognition.
550
The
CamScanner
3. OnJanuary 1, 2023, OBLIVION Company granted a P10,000,000 loan with a maturity

date of December 31, 2030. Interest of 10% is payable every December 31 of each
year, As of December 31, 2023 and 2024, the following information may be relevant
in the computation of ECL:
PD within 12 months 1.50% 2.00%
PD within expected life 40.00% 45.00%
LGD 30.00% 35.00%
As of December 31, 2023, there is no significant increase in credit risk since the
initial recognition. However, as of December 31, 2024, there is a significant increase
in credit risk.

a. Allowance for ECL as of December 31, 2023 and December 31, 2024.
b. Impairment loss for the years 2023 and 2024.
4. At the beginning of 2023, LIMBO Company granted a P8,000,000 loan with maturity
date of December 31, 2027. Interest of 12% is payable every December 31 of each
year. As of December 31, 2023 and 2024, the following information may be relevant
in the computation of ECL:

Market rates 11.00% 10.00%
As of December 31, 2023, there is a significant increase in credit risk since the initial
recognition. However, as of December 31, 2024, the significant increase in credit risk
during 2023 has now subsided.
In addition, if the borrower is to default as of December 31, 2023, only 70% of the
principal amount can be received on maturity date. On the other hand, as of
December 31, 2024, if the borrower is to default, only 65% of the principal amounts
can be received on maturity date. No interest can be received in case the borrower
has defaulted.

a. LGD as of December 31, 2023 and December 31, 2024.
b. Allowance for ECLas of December 31, 2023 and December 31, 2024,
c. Impairment loss for the years 2023 and 2024.
5. As of December 31, 2023, one of RAMBO Company's loans receivable, with

P6,000,000 principal amount and related allowance for ECL of P20,000, was deemed
to be impaired. As of the same date, accrued interest receivable for 2023 amounted
to P600,000. The Company and borrower agreed to the following modifications:
551
The
The Book
a. Reducing of principal amount to P5,000,000.

b. Extending the maturity date from December 31, 2024 to December 31, 2027,
c. Reducing annual interest to 6%.
d. Waiving of accrued interest as of December 31, 2023.

a. Amount of impairment loss for the year 2023.
b. Journal entries related to the impairment.
c. Interest income for the year 2024
6. Way back last January 1, 2021, MANNY Company granted an eight-year, 10%
interest-bearing loan with face amount of P7,000,000. After considering the relevant
direct origination costs and origination fees, the effective interest rate is 12%.
As of December 31, 2023, the loan became credit-impaired. There is an accrued
interest of P700,000 and allowance for ECL amounting to P420,000.
Based on the Company’s estimates, the borrower will be able to pay the whole
amount of principal in accordance with the following schedule: P3,500,000 on
December 31, 2028 and another P3,500,000 on December 31, 2029. No interest can
be collected from the loan, including the accrued interest as of December 31, 2023.

a. Amount of impairment loss for the year 2023.
b. Interest income for the year 2024
to another
7. On January 1, 2023, ELLIE Company lent a five-year, P10,000,000 loan
year. The direct
entity. Interest of 8% is payable every December 31 of each
not included
origination costs and origination fees are very immaterial, so these are
in the initial measurement of the loan receivable.
Relevant data as of December 31, 2023 and 2024 are the following:
12-month PD 3% 4%
Lifetime PD 40% 35%
Assuming that the borrower defaults as of December 31, 2023, only 80% of the
assuming
principal amount will be recovered on maturity date. On the other hand,
that the borrower defaults as of December 31, 2024, only 75% of the princip?
amount will be recovered on maturity date. In both assumptions, no amounts
interest can be recovered. Market rates as of December 31, 2023 and 2024 average
10% and 9%, respectively.
552
The
There is no significant increase in credit risk as of December 31, 2023. However,

there is a significant increase in credit risk as of December 31, 2024. Interest for the
years 2023 and 2024 were paid. The circumstances in 2024 became worse during
2025, and the loan is considered as credit-impaired.
In connection with this, the Company estimates that it can receive the following
amounts on each of the following indicated dates:
Dates Amounts
December 31,2026 P1,000,000
December 31, 2027 1,500,000
December 31, 2028 2,000,000
December 31, 2029 2,500,000
Accrued interest as of December 31, 2025 and the subsequent interest cannot be
collected anymore. Market rates as of this date averaged 10%.

a. LGD as of December 31, 2023 and December 31, 2024.
b. Journal entries for the years 2023, 2024 and 2025.
c. Impairment loss for the years 2023, 2024 and 2025.
8. On December 31, 2023, one of SCRAT Company’s investments in corporate bonds

with face amount of P4,000,000 became credit impaired. The bonds were acquired
last January 1, 2020 when the market rates averaged,8% to be accounted for at
FVTOCI. Interest of 7% is payable every December 31 of each year while maturity
date is originally set on December 31, 2026. The bonds were quoted 92.50 and 70.90
as of January 1, 2023 and December 31, 2023, respectively.
As of December 31, 2023, the Company estimated that it can receive the following
cash flows from the borrower:
Dates Amounts
December 31,2026 1,000,000
December 31, 2027 1,500,000
December 31, 2028 1,000,000
Required: Determine the journal entries to be made for the year 2023 in relation to
the investment in debt securities.

1, As of December 31, 2023, BUCK Company had a loan with principal amount of
P7,000,000. Related unadjusted allowance for ECL amounted to P15,000. Interest of
10% is payable every December 31 of each year. In estimating the ECL amount as of
the end of 2023, the following information may be relevant:
553
The
The Book
PD withini12 months PD within expected life LGD

3% 45% 25%
Assuming that there is no significant increase in credit risk, the impairment loss for
the year shall be
a. P52,500 c. P787,500
b. P37,500 d, P772,500
Assuming that there is a significant increase in credit risk, the impairment loss for
the yearshallbe
a. P52,500 c. P787,500
b. P37,500 d. P772,500
2. At the end of 2023, ROGER Company had a noncredit-impaired loan receivable with
face amount of P4,000,000. As of that date, the unadjusted allowance for ECL
amounted to P10,500. The following information may be relevant in determining the
amounts of expected credit losses for the years 2023 and 2024:

LGD 40.00% 50.00%
As of December 31, 2023, there is a significant increase in credit risk since the initial
recognition. However, as of December 31, 2024, the level of the loan’s credit risk
reverted back to its original level on initial recognition.
The amount of impairment loss for the year 2023 shall be

a. P48,000 c. P960,000
b. P37,500 d. P949,500
The amount of impairment loss or gain for the year 2024 shall be
a. P880,000 loss c. P32,000 loss
b. P880,000 gain d. P32,000 gain
3. On January 1, 2023, WOLVES Company lent a four-year, P8,000,000 loan to another

entity. Interest of 9% is payable every December 31 of each year. There were no
direct origination costs nor origination fees involved in the loan transaction.
Relevant data as of December 31, 2023 and 2024 are the following:
December 31,2023 December 31, 2024

12-month PD 4% 6%
Lifetime PD 50% 60%
Assuming that the borrower defaults as of December 31, 2023, only 70% of the
principal amount will be recovered on maturity date, On the other hand, assuming
that the borrower defaults as of December 31, 2024, only 65% of the principal
554
The
The Book
amount will be recovered on maturity date. In both assumptions, no amounts of

interest can be recovered. Market rates as of December 31, 2023 and 2024 averaged
8% and 10%, respectively. Round off LGD rates into two decimal percentages.
There is no significant increase in credit risk as of December 31, 2023. However,

there is a significant increase in credit risk as of December 31, 2024. Interest for the
years 2023 and 2024 were paid. The circumstances in 2024 became worse during
2025, and the loan is now considered as credit-impaired.
In connection with this, the Company estimates that it can receive the following
amounts on each of the following indicated dates:
Dates Amounts
December 31,2026 P2,000,000
December 31, 2027 1,500,000
December 31, 2028 2,000,000
Interest for 2025 has been paid, but the subsequent interest amounts cannot be
collected anymore. Market rates as of this date averaged 11%.
Impairment loss for the year 2023 shall be
a. P147,040 c. P107,440
b. P1,838,000 d. P1,745,540

a. P217,392 c. P2,173,920
b. P70,352 d. P2,026,880

a. P3,358,252 c. P858,252
b. P1,184,332 d. P2,342,836

a. P438,942 c. P417,757
b. P442,838 d. P426,629
4. As of December 31, 2023, one of GRASS Company’s loans receivable, with

P9,000,000 principal amount and related allowance for ECL of P850,000, was
deemed to be impaired. As of the same date, accrued interest receivable for 2023
amounted to P810,000. The parties agreed to the following modifications:
e Reducing of principal amount to P7,000,000.
e Extending the maturity date from December 31, 2025 to December 31, 2028.
e Reducing annual interest to 5% to be paid starting December 31, 2026.
e Waiving of accrued interest as of December 31, 2023.
The impairment loss for the year 2023 shall be
a. P3,089,106 c, P3,704,794
b. P3,899,106 d, P4,514,794
555
The
The Book
Chapter 16 - Financial Assets — Other Matters
CHAPTER 16
FINANCIAL ASSETS - OTHER MATTERS

1. The concept of trade date and settlement date in a regular way purchase or sale
transaction.
2. The application of trade date accounting and settlement date accounting to each
financial asset category (i.e., FVTPL, FVTOCI, and amortized cost).
3. The accounting for modification of financial assets at amortized cost.
4. The special considerations in derecognizing financial assets.
REGULAR WAY PURCHASE OR SALE

This transaction is a purchase or sale of a financial asset under a contract whose
terms require delivery of the asset within the time frame established generally by
regulation or convention in the marketplace concerned. [PFRS 9.A].
The time frame mentioned in the definition above is the number of days between the
trade date and settlement date as defined below:
Settlement date
Trade date
. : is; the date that an asset isi
is the date that an entity delivered to or delivered
commits itselfto §=|-—-------------------- - by an entity which
purchase or sell an asset includes the payment or
(i.e., commitment date) receipt of cash (i.e.,
execution or delivery
date)
Regular way purchases or sales can usually be found in a stock market or ina bond
market. In practice, the time frame between the trade date and settlement date is
usually stated as T + [No. of days], with “T” stands for trade date.
For example, T+1 means that the settlement is one trading day after the trade date
while T+3 means that the settlement date is three days after the trade date.
A question may arise: should a buying entity recognize its purchase of assets on the
trade date or on the settlement date? On the other hand, should a selling entity
recognize its sale of assets on trade date or on settlement date?
The answers to these questions will depend on the accounting policy chosen by an
entity on whether to use trade date accounting or settlement date accounting. These
policies are the subject of the succeeding section.
556
The
CamScanner
Chapter 16 - Financial Assets - Other Matters
TRADE DATE ACCOUNTING AND SETTLEMENT DATE ACCOUNTING

Trade date accounting and settlement date accounting can be compared as follows:
Trade Date Accounting | Settlement Date Accountin
Buyer's perspective:
Timing of recognition | On the trade date, with
of purchased asset corresponding liability Oe His See emma ate
i Profit or loss for FVTPL; Profit or loss for FVTPL;
aca see OCI for FVTOCI; and OCI for FVTOCI; and
None for amortized cost | None for amortized cost
Seller’s perspective:
Timing of On the trade date,
errs together with On the settlement date,
derecognition of sold 3 : : ;
corresponding receivable | with amount of gain/loss
asset 2
and amounts of gain/loss
Changes in fair value : ?
Der trade date Not recognized Not recognized
Regardless of accounting policy, the payment or receipt of cash shall always be

recorded on settlement date.
An entity shall apply the same method consistently for all purchases and sales of
financial assets that are classified in the same way in accordance with PFRS 9. These
classifications are the following:
a. Financial assets mandatorily measured at FVTPL
b. Financial assets irrevocably designated at FVTPL
c. Investments in equity securities irrevocably designated at FVTOCI
d. Investments in debt securities measured at FVTOCI
e. Investments at amortized cost
If both the trade and settlement dates belong to the same reporting period, the
trade date accounting and settlement date accounting will report the same amounts.
However, if the settlement date spilled over to the succeeding period, differences
in the reported amounts will arise between trade date accounting and settlement date
accounting. The latter scenario is the focus of the succeeding illustrations.
For debt securities, regardless of accounting policy, interest shall accrue starting
on the settlement date only.
Illustration 1. On December 29, 2023 trade date, an entity acquired a debt security
for P2,000,000 through a bond market. Settlement date was set on January 3, 2024
based on the bond market rules and conventions, The debt security had fair values
of P2,080,000 and P2,120,000 on December 31, 2023 and January 3, 2024,
respectively. Required: Under each of the following independent scenarios,
determine the journal entries to be made using (a) trade date accounting and (b)
settlement date accounting:
557
The
CamScanner
Chapter 16 — Financial Assets — Other Matters
1. The debt security is accounted for at FVTPL.

2. The debt security is accounted for at FVTOCI.
3. The debt security is accounted for at amortized cost.
Scenario 1 - Debt security is accounted for at FVTPL
—,
Date Trade date accounting Settlement date accounting

F.A. at FVTPL 2,000,000
12/29/23 Accounts payable — 2,000,000 po entty
F.A. at FVTPL* 80,000 F.A. at FVTPL* 80,000
Unrealized gain- P/L 80,000 Unrealized gain-P/L 80,000
12/31/23 | *P2,080,000 - P2,000,000 *P2,080,000 - P2,000,000
On this date, the investment has | On this date, the investment has
carrying amount of P2,080,000. | carrying amount of P80,000.
Accounts payable 2,000,000 F.A. at FVTPL 2,000,000
Cash 2,000,000 Cash 2,000,000
1/3/24 Unrealized gain-P/L 40,000 Unrealized gain-P/L 40,000
*P2,120,000 - P2,080,000 *P2,120,000 - P2,080,000
carrying amount of P2,120,000. | carrying amount of P2,120,000.
Scenario 2 — Debt security is accounted for at FVTOCI

FA.atFVTOCI — 2,000,000
12/29/23 Accounts payable 2,000,000 NOeOuY
F.A. at FVTOCI* 80,000 F.A. at FVTOCI* 80,000
Unrealized gain- OCI 80,000 Unrealized gain- OCI 80,000
12/31/23 | *P2,080,000 - P2,000,000 *P2,080,000 - P2,000,000
carrying amount of P2,080,000. | carryingamountofP80,000. _|
Accounts payable 2,000,000 FA.atFVTOCI — 2,000,000
Cash 2,000,000 Cash 2,000,000
F.A. at FVTOCI* 40,000 FA, at FVTOCI* 40,000
1/3/24 Unrealized gain- OCI 40,000 Unrealized gain- OCI 40,000
*P2,120,000 - P2,080,000 *P2,120,000 - P2,080,000
carrying amount of P2,120,000. | carrying amount of P2,120,000.
558
The
CamScanner
Scenario 3 - Debt security is accounted for at amortized cost (A.C.)

FA. at A.C. 2,000,000
12/29/23 Accounts payable — 2,000,000 a oansy
12/31/23 No entry No entry
1/3/24 Accounts payable 2,000,000 FA. at A.C. 2,000,000
/ Cash 2,000,000 | Cash 2,000,000
Note: The effective interest rate to be used in the amortization table shall always be
determined as of the trade date whether the entity is using trade date accounting or
settlement date accounting. Effectively, the amortized cost investment is initially
measured at its fair value on trade date regardless of the accounting policy chosen.
Generalizations - Scenarios 1 to 3
The readers should take note of the following in the buyer’s perspective:
a. Total assets and liabilities are higher under trade date accounting.
b. Under both trade date and settlement date accounting, changes in fair value from
trade date to reporting date to settlement date are recognized in profit or loss if
the debt security is accounted for at FVTPL or in OCI if the debt security is
account for at FVTOCI.
c. Changes in fair value after the trade date are not recognized if the debt
security is accounted for at amortized cost.
Illustration 2 - With Decrease in Fair Value. On December 27, 2023 trade date,
an entity acquired an equity security for P1,500,000 through a stock exchange.
Settlement date was set on January 2, 2024 based on the stock exchange rules and
conventions. The equity security had fair value of P1,590,000 and P1,560,000 on
December 31, 2023 and January 2, 2024, respectively. Required: Under each of the
following independent scenarios, determine the journal entries to be made using
(a) trade date accounting and (b) settlement date accounting:
1. The equity security is accounted for at FVTPL.
2. The equity security is accounted for at FVTOCI.
Scenario 1 - Equity security is accounted for at FVTPL
Date Trade date accounting — Settlement date accounting

F.A. at FVTPL 1,500,000 N
Wai o entr
easel lee Accounts payable 1,500,000 y
Unrealized gain- P/L 90,000 Unrealized gain - P/L 90,000
12/31/23 | *P1,590,000 - P1,500,000 *P1,590,000 ~ P1,500,000

has
On this date, the investment has | On this date, the investment
carrying amount of P1,590,000. carrying amount of P90,000,
559
The
CamScanner
Chapter 16 — Financial Assets - Other Matters
Date ~ Trade date accounting Settlement date accounting

Accounts payable 1,500,000 F.A. at FVTPL 1,500,000
Cash 1,500,000 Cash 1,500,000
Unrealized loss - P/L 30,000 Unrealized loss - P/L 30,000
1/2/24 F.A. at FVTPL* 30,000 F.A. at FVTPL* 30,000
/ *P1,560,000 — P1,590,000 *P1,560,000 - P1,590,000
carrying amount of P1,560,000. | carrying amount of P1,560,000._|
Scenario 2 - Equity security is accounted for at FVTOCI

F.A. at FVTOCI 1,500,000
12/27/23 Accounts payable 1,500,000 No entry
F.A. at FVTOCI* 90,000 F.A. at FVTOCI* 90,000
Unrealized gain- OCI 90,000 Unrealized gain- OCI 90,000
12 /3 1 / 23 *P1,590,000 - P1,500,000 *P1,590,000 - P1,500,000
carrying amount of P1,590,000. | carrying amount of P90,000.
Accounts payable 1,500,000 F.A. at FVTOCI 1,500,000
Cash 1,500,000 Cash 1,500,000
Unrealized loss - OCI 30,000 Unrealized loss - OCI 30,000

1/2/24 F.A. at FVTOCI* 30,000 F.A. at FVTOCI* 30,000
*P1,560,000 - P1,590,000 *P1,560,000 - P1,590,000
carrying amount of P1,560,000._| carrying amount of P1,560,000.
Illustration 3 - Selling. On December 28, 2023, an entity sold its equity securities,
with carrying amount of P3,100,000 and purchased last December 1, 2023, through
a stock market for P3,200,000. The stock market rules require the entity to deliver
the securities and the buyer to pay for the securities on January 4, 2024. These
equity securities had fair values of P3,300,000 and P3,330,000 as of December 31,
2023 and January 4, 2024, respectively. Required: Under each of the following
independent scenarios, determine the journal entries to be made using (a) trade
date accounting and (b) settlement date accounting:
1. The equity security is accounted for at FVTPL.
2, The equity security is accounted for at FVTOCI.
560
The
CamScanner
Scenario 1 - Equity security is accounted for at FVTPL
Date Trade date accounting: | Settlement date accounting

Accts. receivable 3,200,000
12/28/23 F.A. at FVTPL 3,100,000 No entry
Cash 3,200,000
Cash 3,200,000 aE
1/4/24 ; eae F.A. at FVTPL 3,100,000
Accts. receivable 3,200,000 Gain‘on sale B/E 100,000
Scenario 2 - Equity security is accounted for at FVTOCI

12/28/23 Gain on sale - OCI 100,000 No entry
Cash 3,200,000
1/4/24 Cash : 3,200,000 Gain on sale - OCI 100,000
Gainonsale- OCI 100,000
Retained earnings —_ 100,000
Generalizations - Scenarios 1 and 2

The readers should take note of the following in the seller’s perspective:
a. Any changes in the fair value after the trade date are not recognized even if
the asset sold is accounted for at FVTPL, FVTOCI or amortized cost.
b. Gain or loss on sale is recognized immediately under trade date accounting.
c. Gain or loss on sale is recognized at a later date on settlement date under
settlement date accounting.
MODIFICATION OF TERMS OF FINANCIAL ASSETS AT AMORTIZED COST

If the terms of a financial asset at amortized cost have been modified, but did not
result to its derecognition, its modified carrying amount shall be recomputed
equal to: PV of modified cash flows discounted using original effective interest
rate, Any difference shall be accounted for as modification gain or loss to be
recognized in profit or loss:
561
The
CamScanner
Chapter 16 — Financial Assets —- Other Matters
Scenario... Accounting consequence

Modified carrying amount > carrying | Gain on modification in
amount before modification profit or loss
Modified carrying amount < carrying | Loss on modification in
amount before modification profit or loss
Any costs or fees incurred are added to the modified carrying amount while
any fees received from the counterparty are deducted from the modified
carrying amount. These costs incurred or fees received will change the effective
interest rate.
Needless to say, for FVTPL and FVTOCI classification, any modification will already
be reflected in the changes in the fair value.
Illustration 4. At the end of 2023, an entity reported a loan receivable with carrying
amount of P4,000,000 (equal to face amount). Originally, this loan matures on
December 31, 2026 and bears 10% interest payable every December 31. On
December 31, 2023, the stated rate is increased to 12%, when market rates
averaged 13%. No other loan terms were modified. Costs incurred related to
modification amounted to P40,000.
The modified carrying amount before modification costs is computed as follows:
PV Factor of PV Factor Cash Flow PV

P4,198,949
Note: 12/31/23 to 12/31/26 is 3 years; hence, 3 periods. P480,000 = P4M x 12%
Discount rate to be used shall be equal to the original effective interest of 10% (i.e.,
market rate on the date of modification shall be ignored).
Modification gain is computed as follows:
Modified carrying amount P4,198,949
Less: Carrying amount before modification (4,000,000)
Modification gain P198,949
To record the modification and the incurrence of the related modification cost:
Modification gain - P/L 198,949
Cash (modification costs) “40,000
After effecting these entries, modified carrying amount of the loan is P4,238,949
(P4,198,949 + P40,000).
562
The
CamScanner
Chapter 16 - Financial Assets —- Other Matters
DERECOGNITION OF FINANCIAL ASSETS

Derecognition is the removal of the carrying amount of an asset or liability from the
accounting records of an entity. A selling transaction is just one of the ways to
derecognize financial assets. An entity may use the following flowchart from PFRS
9 in assessing whether or not to derecognize a financial asset:
Have the rights to the cash flows Derecognize the

from the asset expired? transferred asset
Has the entity transferred its

rights to receive the cash flows
from the asset?
Hasprety
the entity assumed
: an Continue to
obligation to remit the cash recognize the
flows received from the asset No tranerarran ascak
to the transferee?
Has the entity transferred ;

substantially all the risks and eae ares a
ansierred asse
rewards?
Has the entity transferred

control over the asset?
Continue to recognize the

transferred asset
_
Based on the above diagram, it can be inferred that not all sales or transfers of
financial assets will result to their derecognition. More importantly, the risks
563
The
and rewards are the primary consideration on deciding whether to derecognize

the transferred asset or not.
The following are the examples when the entity transferred substantially all the
risks and rewards of ownership:
a. an unconditional sale of a financial asset;
b. a sale of a financial asset together with an option to repurchase the financial
asset at its fair value at the time of repurchase; and
c. asale of a financial asset together with a put or call option that is deeply out of
the money.
The following are the examples when the entity has retained substantially all the
risks and rewards of ownership:
a. asale and repurchase transaction where the repurchase price is a fixed price or
the sale price plus a lender’s return;
b. asecurities lending agreement;
c. a sale of a financial asset together with a total return swap that transfers the
market risk exposure back to the entity;
d. asale of a financial asset together with a deep in-the-money put or call option;
and
e. a sale of short-term receivables in which the entity guarantees to compensate
the transferee for any credit losses that are likely to occur.
The following are the accounting procedures that shall be observed depending on
whether the risks and rewards were transferred or retained substantially:
Risks and Rewards
; Transferred substantially Retained substantially
Ss on Derecognized Continue to be recognized

‘ Measured at fair value and
Proceeds Measured at fair value and separately recognized as
received compared with the carrying aa ‘
includi tofd eed anoweto liability. This shall not be
Cneneng OU OR Sear Oscar offset with the transferred
noncash) arrive at the amount of gain or loss cap
eecoanition Gain or loss is to be recognized in
et profit or loss as follows: No amount of gain or loss to
of gain or ey j
lose Gain if Proceeds > Carrying Amt. be recognized.
Loss if Proceeds < Carrying Amt, _
Subsequent Separate recognition of
income/ Not applicable income from the
expense transferred asset and
expense from the liability. _J
564
The
Nevule CamScanner
Chapter 16 — Financial Assets - Other Matters
Illustration 5. An entity transferred one of its investments in debt securities held

at amortized cost, with carrying amount of P3,250,000, by receiving P3,500,000.
journal entry to record the transfer:
1. The entity transferred substantially all the risks and rewards of ownership.
2. The entity retained substantially all the risks and rewards of ownership.
Scenario 1 - Risks and rewards were transferred substantially
In this scenario, the journal entry to record the transfer is as follows:
Cash 3,500,000
Gain on transfer - P/L (squeeze) 250,000
Scenario 2 - Risks and rewards were retained substantially

In this scenario, the journal a to record the transfer is as follows:
Cash 3,500,000
Liability from transferred asset 3,250,000
Again, no gain or loss shall be recognized and proceeds shall be recognized as

liability if the risks and rewards were retained substantially.
Illustration 6. During the year, an entity exchanged its investment in debt security
at FVTPL, with carrying amount of P2,400,000, for an investment in equity security
to be accounted for at FVTOCI, with fair value of P2,000,000. To account for the
difference in fair value, the counterparty paid P600,000 cash to the entity. In
addition, the entity shall recognize service liability with fair value of P50,000. The
transaction transferred substantially the risks and rewards over the investment in
debt security.
The journal entry to recognize the exchange is as follows:
Cash 600,000
Financial asset at FVTOCI (at FV) 2,000,000
Financial asset at FVTPL 2,400,000
Service liability (at FV) 50,000
Gain on exchange - P/L (squeeze) 150,000
The readers should take note that the inclusion of noncash asset and the incurrence
of liability in the net proceeds affect the amount of gain or loss on transfer.
TRANSFERS INVOLVING ONLY A PORTION OF FINANCIAL ASSETS

Entities may also sell only a portion of cash flows from financial assets while
retaining the other cash flows. For example, an entity may transfer only the interest
payments from a debt security while retaining the right to receive the principal
payments.
565
The
The Book
In these cases, a question may arise on how much of a financial asset’s carrying
amount is to be derecognized. The answer is that the financial asset’s carrying
amount shall be allocated to the sold and retained portions based on their relative
fair values (FV) on the date of sale:
Carrying Total (CA) of :

Amount (CA) of = financialasseton x —. a oe a
Sold Portion the date of sale ota of financial asset
The carrying amount allocated to the sold portion shall now be compared with the
net proceeds to determine the amount of gain or loss.
Illustration 7. On January 1, 2023, when market yields averaged 10%, NEIL
Company acquired an 8% interest-bearing, P4,000,000 face amount government
bonds with maturity date of December 31, 2027. The investment is accounted for
at amortized cost. On December 31, 2024, when market rates averaged 9%, the
Company sold the right for the remaining annual interest for P798,000, while
retaining the right to receive the principal amount on maturity date.
The initial measurement of the investment can be determined as follows:
PV Factor of : PV Factor CashFlow Fair Value

Ordinary annuity for 5 periods at 10% 3.790787 320,000 1,213,052
Initial measurement, 1/1/23 P3,696,736
Note: 1/1/23 to 12/31/27 is 5 years, hence 5 periods.
The following is the relevant amortization table until the December 31, 2024, the
date when the right to receive the future interest has been transferred:
[A] [B] [B]-[A]P.V./

1/1/23 3,696,736
12/31/23 320,000 369,674 49,674 3,746,410
12/31/24 320,000 374,641 54,641 3,801,051
To facilitate the allocation of the P3,801,051 carrying amount to the sold (i.e.
interest) and retained (i.e., principal) portions, the following computations of fair
values are necessary, using the market rate of 9%:
Total fair value, 12/31/24 P3,898,746
Note: 12/31/24 to 12/31/27 is 3 years, hence 3 periods. Based on the above, fair value of the
principal is P3,088,732 while the fair value of the remaining interest payments is P810,014.
566
The
CamScanner
Chapter 16 - Financial Assets - Other Matters
From these fair values, the carrying amount allocated to the sold portion is
Allocation to P810,014_
P3,801,051 P3,898,746 P789,717
Sold Portion
Finally, the journal entry to record the partial selling is as follows:

Cash 798,000
567
The
CHAPTER SUMMARY
1. Financial assets acquired or sold under regular way purchase or sale can be
accounted for using either the trade date accounting and settlement date accounting.
2. Trade date is the date that an entity commits itself to purchase or sell an asset (i.e.,
commitment date). On the other hand, settlement date is the date that an asset is
delivered to or delivered by an entity which includes the payment or receipt of cash
(i.e., execution or delivery date)
3. Trade date accounting and settlement date accounting can be compared as follows:
Trade Date Accounting | Settlement Date Accounting
Buyer's perspective:
Timing of recognition | On the trade date, with Gia tin cetlement date
of purchased asset corresponding liability
Recognition of Profit or loss for FVTPL; Profit or loss for FVTPL;
changes in FV after OCI for FVTOCI; and OCI for FVTOCI; and
trade date None for amortized cost None for amortized cost
Seller's perspective:
Timing of On the trade date,
Si together with On the settlement date,
derecognition of : : ; E
aldnesok corresponding receivable with amounts of gain/loss
and amounts of gain/loss
ae cnet ea Not recognized Not recognized
4. The application of trade date accounting or settlement date accounting is based on

how the financial asset was classified.
5. Risks and rewards are the basis on whether to derecognize a financial asset or not.
Derecognition is the removal of the carrying amount of an asset or liability from the
accounting records of an entity
Risks and Rewards
Transferred substantially Retained substantially
Transferred Derecognized Continue to be recognized

asset
i e
Proceeds Measured at fair value and compared eS
received with the carrying amount of iabili ee hall othe
(including derecognized asset to arrive at the ability, Tis shanna
offset with the transferred
noncash) amount of gain: or loss
asset. air il
Gain or loss is to be recognized in
Recognition of profit or loss as follows: No amount of gain or
gain or loss Gain if Proceeds > Carrying Amt. loss to be recognized.
Loss if Proceeds < Carrying Amt. —
568
The
True or False
1. Trade date is the date wherein the entity will actually receive the acquired financial
asset or the date wherein it will actually deliver the financial asset sold.
2. When using the settlement date accounting, an entity recognizes the acquired
financial asset on the date of actual delivery to the entity.
3. For purchased financial assets at FVTPL, the changes in fair value from the trade
date until the reporting date is recognized only when the entity uses trade date
accounting.
If an entity uses trade date accounting, it shall recognize a financial asset and a
corresponding liability on the trade date.
Changes in the fair value of amortized cost debt securities shall be recognized if the
entity uses trade date accounting. Otherwise, it shall not be recognized.
Settlement date accounting for purchase of financial assets will result to lower
assets and liabilities as of the reporting date if the settlement date will occur in the
subsequent period.
For debt securities, the accrual of interest Shall start on the trade date if the entity
uses the trade accounting.
There is a substantial transfer of risks and rewards in a securities lending
arrangement.
If there is no substantial transfer of risks and rewards when transferring a financial
asset, the proceeds received are recognized as liability.
10. If there is a substantial transfer of risks and rewards and the total amount of
proceeds is higher than the financial asset's carrying amount, a gain on sale shall be
recognized.

1. The terminology T+2 means that
a. The trade date will happen in the coming 2 days.
b. The settlement date will happen 2 days before the trade date.
c. The settlement date will happen 2 days after the trade date.
d. The trade date will happen 2 days before the reporting date.
The following are correct regarding the application of trade date accounting and
settlement date accounting as an accounting policy, except
a. All financial assets measured at FVTPL, whether by default or by irrevocable
designation, shall use the same accounting policies.
b. An entity may apply a different accounting policy to FVTOCI equity securities
other than the policy applied to FVTOCI debt securities.
c. The application of accounting policy shall be based on a grouping of financial
assets and not on an investment-by-investment basis.
Which of the following is not true when applying the trade date accounting in
purchasing financial assets?
569
The
CamScanner
SEESResIeT Ts
a. The financial asset shall be recognized on the date the commitment to purchase
the asset has been entered into.
b. A liability for the payment of financial asset shall be recognized on the trade
date.
c. Changes in the fair value of the financial asset from trade date until the reporting
date shall be recognized whether the financial asset is accounted for at FVTPL,
FVTOCI, or amortized cost.
4. An entity has recently acquired a financial asset to be accounted at FVTOCI. When
applying the settlement date accounting, which of the following is correct?
a. Changes in the fair value from trade date to reporting date shall be recognized
in profit or loss.
b. Changes in the fair value from reporting date to settlement date shall be
recognized in OCI.
c. AQ liability for the payment of financial asset shall be recognized on the
commitment daie.
5. An entity recently acquired, through regular way purchase transaction, a debt

security to be accounted for at amortized cost. The settlement date will occur in the
succeeding period. In connection with this, which of the following is correct?
a. If the entity uses trade date accounting, any change from trade date to
settlement date shall be recognized in profit or loss.
b. If the entity uses trade date accounting, effective interest rate shall be
determined as of the trade date. Otherwise, it is determined as of the settlement
date.
c. The interest shall start to accrue on trade date if the entity uses trade date
accounting, otherwise, it shall start to accrue only on settlement date.
6. When recording the sale of a financial asset using the settlement date accounting,
which of the following is correct?
a. Ifthe asset sold is accounted for at FVTPL, any change in its fair value from trade
date to settlement date shall be recognized in profit or loss.
b. If the asset sold is accounted for at FVTOCI, any change in its fair value from
trade date to settlement date shall be recognized in OCI.
c. The gain or loss on sale shall be recognized only on settlement date.
d. Allofthe above.
7. When recording the sale of a financial asset using the trade date accounting, which
of the following is not correct?
The gain or loss shall be recognized on the trade date.
A receivable shall be recognized on the trade date,
aoop
The sold financial asset shall be derecognized on the trade date.

None of the above.
570
The
The Book
8. The following transactions will usually result to the substantial transfer of risks and
rewards except
a. Anunconditional sale ofa financial asset.
b. A sale of a financial asset together with an option to repurchase the financial
asset at its fair value at the time of repurchase.
c. Asale ofa financial asset together with a put or call option that is deeply out of
the money.
9. The following transactions will usually not result to the substantial transfer of risks
and rewards, except
a. Asale and repurchase transaction where the repurchase price is already fixed.
b. Asecurities lending agreement.
c. Asale of a financial asset together with a total return swap that transfers the
market risk exposure back to the selling entity.
d. A sale of short-term receivables in which the entity does not guarantee to
compensate the transferee for credit losses that are likely to occur.
10. An entity recently transferred one of its financial assets. In connection with this, the
following are correct, except
a. If there is a substantial transfer of risks and rewards, the financial asset shall be
derecognized.
b. If there is no substantial transfer of risks and rewards, the proceeds received
shall be recognized as liability.
c. If there is a substantial transfer of risks and rewards, a gain or loss shall be
recognized as the difference between financial asset’s carrying amount and
proceeds received.
d. If there is no substantial transfer of risks and rewards, the recognized liability
shall be offset with the carrying amount of the related financial asset.
Straight Problems
1. On December 29, 2023, EUROPA Company acquired debt securities with face
amount of P5,000,000, to be delivered on January 5, 2024 in accordance with the
bond market regulations. As of December 29, 2023, December 31, 2023, and January
5, 2024, the debt securities were quoted at 104,00, 104.50, and 103.70, respectively.
entries to be made assuming the use of (a) trade date accounting; and (b) settlement
date accounting:
1, The debt security is accounted for at FVTPL
2. The debt security is accounted for at FVTOCI
3. The debt security is accounted for at amortized cost
571
The
The Book
2. On December 27, 2023, CALLISTO Company acquired corporate bonds with face
amount of P6,000,000 to be delivered on January 5, 2024 in accordance with the
bond market regulations. As of December 29, 2023, December 31, 2023, and January
5, 2024, the debt securities were quoted at 98.60, 99.10, and 99.80, respectively.
date accounting:
1. The debt security is accounted for at FVTPL
2. The debt security is accounted for at FVTOCI
3. The debt security is accounted for at amortized cost
3. On December 30, 2023, GANYMEDE Company purchased 100,000 ordinary shares

of another entity to be received on January 4, 2024. As of December 30, 2023,
December 31, 2023, and January 5, 2024, quoted prices were P45.00, P44.80, and
P45.10, respectively.
date accounting:
4. On December 26, 2023, AYO Company sold all of its investment in equity securities
with carrying amount of P7,400,000 for P7,250,000, to be delivered on January 5,
2024. The investment had an original cost of P7,500,000. As of December 31, 2023
and January 5, 2024, the investment had fair values of P7,350,000 and P7,300,000,
respectively.
date accounting:
1. Theinvestment is accounted for at FVTPL
5. As of December 31, 2023, GURU Company had a loan receivable with principal
amount of P7,000,000 and allowance for ECL amounting to P40,000. Interest of 7%
is payable every December 31 of each year, As of the same date, the Company agreed
with the borrower to the following modification of loan receivable:
a. Maturity date is extended from December 31, 2025 to December 31, 2028.
b. Principal amount is reduced by P500,000,
c. Interest is increased to 10% per annum until the revised maturity date.
Modification costs incurred amounted to P100,000,
Required: Determine the amount of modification gain or loss for

2023,
572
Bes:
The
The Book
6. During the year, CORONA Company sold its investment in debt security at FVTPL
with carrying amount of P5,500,000 for P4,000,000 cash and land with fair value
and cost of P2,000,000 and P1,500,000, respectively.
entry to record the transfer of the debt security:
1. There is a substantial transfer of risks and rewards.
2. There is no substantial transfer of risks and rewards.
7. On December 31, 2023, MARINA Company transferred its investment in government
bonds at amortized cost with face amount of P4,000,000. These bonds were acquired
last January 1, 2021 when the market rates averaged 10%. Interest of 9% is payable
every December 31 of each year. Originally, the bonds have maturity date of
December 31, 2028.
The Company received P2,500,000 cash and P1,000,000 par value ordinary shares
of another entity with fair value of P1,600,000. Additionally, the entity also received
a service asset with P150,000 fair value. The transaction substantially transferred
the risks and rewards to the counterparty.
Required: Determine the journal entry to record the transfer transaction.
8. At the end of 2023, PANGOLIN Company sold for P3,800,000 its right to receive the
principal amount from its P6,000,000 face amount investment in corporate bonds
accounted for at amortized cost. However, the Company retained the right to receive
the interest amounts over the remaining term of the bonds.
The bonds were acquired last January 1, 2022 when market rates averaged 10%.
Interest of 12% is payable every December 31 of each year. The bonds have maturity
date of December 31, 2027. Market rates as of December 31, 2023 averaged 11%.
Required: Determine the journal entry to record the transfer transaction.

1. On December 24, 2023, LOUSIANA Company acquired an investment in debt
security with face amount of P4,000,000 to be accounted for at FVTPL. The debt
security is to be actually received on January 5, 2024. Interest of 12% is payable
every December 31 of each year, Quoted prices of the bonds were 106.50, 106.90,
106.75, and P107,00 as of December 24, 2023, December 31, 2023, January 5, 2024,
and December 31, 2024, respectively, (Use the actual number of days over 365 days
in computing interest income and ignore leap years, if relevant).
Assuming that the entity uses the trade date accounting, the net amount to be
recognized in 2023 profit or loss shall be
a. P16,000 net income c, P16,000 net loss
b. P25,205 net income d, P25,205 net loss
573
The
The Book
About the Author
Vhinson is a proud son of Nueva Ecija anda true-
blooded Novo Ecijano. He was born into a family with a
mother who is a teacher and a father who is a farmer.
During his formative years as a toddler, he was rdised
by his grandparents.
Growing up, he was inspired by his parents and

grandparents. It is through their hardwork and
perseverance that young Vhinson discovered the key to
success. He vowed to strive for excellence in all things
that he do. These principles served as his motivation in
pursuing excellence in academics as a means of giving
back for the help and sacrifices of people around him.
He was able to graduate as the class salutatorian in San Francisco Elementary
School and in high school, he was the class valedictorian in San Antonio
Montessori School. He obtained his Bachelor of Science in Accountancy degree
from Wesleyan University — Philippines where he graduated as Summa Cum
Laude and the batch valedictorian. A feat that he dedicates to his humble
beginnings and hardworking parents and grandparents.
After placing Ist in the October 2016 Licensure Examinations for Certified
Public Accountants (garnering a 94.33% rating), he joined the audit practice of
Sycip, Gorres, Velayo (SGV) & Company. After his stint in public practice as a
Senior Audit Associate, he joined a multinational bank as a reviewer of
derivative documentations primarily on credit derivatives.
During the height of the recent COVID-19 pandemic, he realized that his passion
is sharing his accumulated knowledge from the academe and his experience
in practice to the younger generation. Currently, he is a Financial Accounting
and Reporting (FAR) and Auditing Theory (AT) reviewer in REO CPA Review.
To the person reading this, the author offers the following wisdom:
“Work hard now and reap the benefits of tomorrow. All of our efforts will be
reciprocated in due time. Trust the process and put our heart and soul in
everything that we do.”
_
For comments, suggestions, or inquiries, please feel

ii
free to reach us at:

.
REAL EXCELLENCE PUBLISHING

‘A € @realexcelpublishing
4 © sales@realexcellencepublishing ph
@ 1985 C.M. Recto Avenue corner S.H. Loyola St.
(4th Floor), Manila, Philippines
REALEXCELLENCE (@) 09669063062 | 09603130705
PUBLISHING
( (02)-788-8731
| (02) -886-6875
The
The Book
Book R̶ e̶a̶d̶e̶r̶s̶ Raiders
Readexs- Raiders || Nevule
Nevule

VHINSON Intermediate Accounting 1 Part 1 2023 2024 Edition

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

VHINSON Intermediate Accounting 1 Part 1 2023 2024 Edition

Uploaded by

Copyright:

Available Formats

2023 - 2024

The Book R̶e̶a̶d̶e̶r̶s̶ Raiders | Nevule

An Integrated Principle-based Approach

A Guide to Understanding and Mastering Financial Accounting

CPA Board Exam candidates

Finance & Business students

VHINSON JAY S. GARCIA, CPA

VHINSON JAY S. GARCIA, CPA

ALL RIGHTS RESERVED

Published and distributed by:

REAL EXCELLENCE PUBLISHING

VHINSON JAY S. GARCIA, CPA

CPA Board Exam Top 1

National CPA Reviewer in Financial Accounting and Reporting (FAR)

Member of Technical Team and

Summa Cum Laude, BS Accountancy

Valedictorian, High School

To my grandparents, Itay, Cipriano Samson and Inay, Conchita Samson, who

To my former professors in Wesleyan University - Philippines, as spearheaded by

To every student and professor in quest of real excellence,

This book is dedicated to you.

Financial Accounting and Reporting is a complex and interesting topic, yet it is

Financial Accounting and Reporting is complex because it establishes the

After understanding the chapters, practice is the stepping stone to mastery.

Vhinson Jay S. Garcia, CPA

REAL EXCELLENCE PUBLISHING - Intellectual Property Rights Advisory

CHAPTER Cash and Cash Equivalents 1-29

CHAPTER 2 Bank Reconciliation 30-54

CHAPTER 4 Accounts Receivable 80-97

CHAPTER 4A Accounting for Bad Debts 98-121

CHAPTER 5 Notes Receivable - Interest-Bearing 122-140

CHAPTER 5A Notes Receivable - Subject to Present Value Calculations 141-164

CHAPTER 6A Receivable Financing - Factoring and Discounting 180-198

CHAPTER 7 Inventories - Preliminary Considerations 199-223

CHAPTER 8 Inventory Cost Flow Assumptions 249-268

CHAPTER 8A Subsequent Measurement of Inventory 269-294

CHAPTER 9A Retail Inventory Method 318-339

CHAPTER 10 Introduction to Investments 340-355

CHAPTER 11A Dividends, Share Splits and Share Rights 381-402

CHAPTER 12 Investments in Debt Securities - Introduction 403-421

CHAPTER 12A Investments in Debt Securities - FVTPL 422-440

CHAPTER 12B Investments in Debt Securities - Amortized Cost 441-470

CHAPTER 12C Investments in Debt Securities - FVTOCI 471-495

CHAPTER 13 Reclassification of Financial Assets 496-512

CHAPTER 15 Impairment of Financial Assets . 531-555

CHAPTER 16 Financial Assets - Other Matters 556-575

CHAPTER 17 Other Investments 576-596

Reporting of bond sinking fund 583

After this chapter, readers are expected to comprehend:

The measurement of cash and cash equivalents items.

CASH AND CASH EQUIVALENTS - INTRODUCTION

IDENTIFYING ITEMS OF CASH

~~ Cash on hand -Cashinbank | . Cashfunds

Details of each category are to be discussed shortly.

Graphically, these relationships can be shown as follows:

gives check as payment J

Illustration 1. Cleaners Corporation provided cleaning and maintenance services

The Entity is the PAYEE The Entity is the MAKER

Illustration 2. FLUFFY Company reported unadjusted cash in bank. balance of

Accounts receivable 480,000

Illustration 3. On December 31, 2023, ZORO Company reported cash in bank

Particulars Amounts Remarks

CASH IN BANK - ACCOUNTING FOR BANK OVERDRAFTS

Bank overdrafts happen when a particular bank account results in a negative