Chapter 1

CASH AND CASH EQUIVALENTS

Cash

 Includes money and any other negotiable instrument that is payable in money and acceptable by the bank for
deposit and immediate credit.
 Includes checks, bank drafts, and money orders
 Postdated checks received cannot be considered as cash yet. But Postdated checks drawn are still part of cash.

Unrestricted cash

 Cash must be UNRESTRICTED IN USE

 This means that cash must be readily available in the payment of current obligations and not be subject to any
restrictions, contractual or otherwise.

Cash items included in cash

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

Cash Equivalents

 Short-term and highly liquid investments that are readily convertible into cash and so near their maturity that
they present insignificant risk of changes in value because of changes in interest rates.
 Only highly liquid investments that are acquired three months before maturity CAN QUALIFY as cash
equivalents.
 Examples:
a) Three-month BSP treasury bill
b) Three-year BSP treasury bill purchased three months before date of maturity
c) Three-month time deposit
d) Three-month money market instrument or commercial paper
 Equity securities CANNOT QUALIFY as cash equivalents because shares do not have a maturity date.
 Preference share with specified redemption date and acquired three months before redemption date CAN
QUALIFY as cash equivalents.
 Note: what is important is the date of purchase which should be three months or less before maturity.

Classification of investment of excess cash

Excess cash may be invested in time deposits, money market instruments and treasury bills for the purpose of earning
interest income.

a) If three months of less – cash equivalent, included in “cash and cash equivalents”
b) If more than three months but within one year – short-term financial assets or temporary investments
presented separately in current assets.
c) More than one year- noncurrent or long-term investments; if becomes due within one year from the end of
reposting period, it is being reclassified as current or temporary investment.

Measurement of Cash

 Measured in face value.

  Cash in foreign currency is measured at the current exchange rate.
 If an entity is in bankruptcy, cash should be written down to estimated realizable value if the amount
recoverable is estimated to be lower than the face value.

Foreign Currency

 Cash in foreign currency should be translated to Philippine pesos using the current exchange rate.
 Deposits in foreign countries which are not subject to any foreign exchange restriction are included in “cash”.
 If subject to foreign exchange restriction, it should be classified separately among noncurrent assets and the
restriction clearly indicated.

Cash fund for a certain purpose

 If cash fund is set aside for use in current operations or for payment of current obligation, it is current
asset.
 Cash fund is included as part of cash and cash equivalents.
 Examples: petty cash fund, payroll fund, travel fund, interest fund, dividend fund, and tax fund.
 If set aside for noncurrent purpose or payment of noncurrent obligation, it is shown as long-term
investment.
 Examples: sinking fund, preference share redemption fund, contingent fund, insurance fund, and fund for
acquisition or construction of property, plant and equipment.

Classification of Cash Fund

 Classification of a cash fund as current or noncurrent should parallel the classification of the related liability.

Bank Overdraft

 When the cash in bank account has a credit balance resulting from issuance of checks in excess of the deposits.
 Classified as current liability and should not be offset against other bank accounts with debit balances.
 Overdrafts are not permitted in the Philippines.

Exception to the rule on overdraft

 When an entity maintains two or more accounts in one bank and one account results in an overdraft, such
overdraft can be offset against the other bank account with debit balance to show cash, net of bank overdraft
or bank overdraft, net of other bank account.
 Overdraft can also be offset against other bank account if the amount is immaterial.
 Only if part of an integral part of cash management

Compensating Balance

 Minimum checking or demand deposit account balance that must be maintained in connection with a
borrowing arrangement with a bank.

Classification of Compensating Balance

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

Types of Checks
 1. Undelivered or unreleased check – drawn and recorded but not given to the payee before the end of reporting
period.
2. Postdated check delivered – check drawn, recorded and already given to the payee but it bears a date
subsequent to the end of reposting period.
 No payment until check can be presented to the bank for encashment or deposit.
3. Stale check or check long outstanding – check not encashed by the payee within a relatively long period of time.
 In banking practice, a check becomes stale if not encashed within six months from the time of issuance.
Accounting for Cash Shortage

 Cash counts shows cash which is less than the balance per book
 Cash short or over account is only a temporary or suspense account

Accounting for Cash Overage

 Cash counts shows cash which is more than the balance per book
 If no claim, it is treated as miscellaneous income.

Imprest system

 A system of control of cash which requires that all cash receipts should be deposited intact and all cash
disbursements should be made by means of check.

Petty Cash Fund

 is money set aside to pay small expenses which cannot be paid conveniently by means of check.
 Two methods handling the petty cash
a) Imprest Fund System – usually followed in handling petty cash transaction

Accounting Procedures:

a. A check is draw to establish the fund.

Petty cash fund xx
Cash in bank xx
b. Payment of expense out of the fund. No formal journal entries are made.
c. Replenishment of petty cash payments. It is usually equal to the petty cash disbursement. It is the time petty
cash disbursements are recorded.
Expenses xx
Cash in bank xx
d. At the end of accounting period, it is necessary to adjust the unreplenished expenses in order to state the
correct petty cash balance.
Expenses xx
Petty cash fund xx
e. An increase in the fund is recorded as:
Petty cash fund xx
Cash in bank xx
f. A decrease in fund is recorded as:
Cash in bank xx
Petty cash fund xx

b) Fluctuating Fund System – checks drawn to replenish the fund do not necessarily equal the petty cash
disbursement.

Accounting Procedures:
a. Establishment of the fund.
Petty cash fund xx
Cash in bank xx
b. Payment of expenses out of the petty cash fund.
Expenses xx
Petty cash fund xx
c. Replenishment or increase of the fund
Petty cash fund xx
Cash in bank xx
d. At the end of the reposting period, no adjustment is necessary because the petty cash expenses are recorded
outright.
e. Decrease of the fund is reverted to the general cash.

Cash in bank xx

Petty cash fund xx

Chapter 2

BANK RECONCILIATION

Bank deposits

 There are three kinds: demand deposit, saving deposit, and time deposit.

Demand deposit

 Current account or checking account or commercial deposit where deposits are covered by deposit slips and
where funds are withdrawable on demand by drawing checks against the bank.
 Noninterest bearing

Saving deposit

 The depositor is given a passbook upon the initial deposit. Passbook is required when making deposits and
withdrawals.
 Withdrawals are made anytime but the bank sometimes may require notice of withdrawal.
 Interest bearing.

Time deposit

 Interest bearing
 A time deposit is evidenced, however, by a formal agreement embodied in an instrument called certificate of
deposit.
 Time deposit may be preterminated or withdrawn on demand or after a certain period of time agreed upon.

Bank Reconcilliation

 Statement which brings into agreement the cash balance per book and cash balance per bank.
 Prepared monthly because the bank provides the depositor with the bank statement at the end of the month
 It shows the following:
1. Cash balance per bank at the beginning
2. Deposits made by the depositor and acknowledged by the bank
3. Checks drawn by the depositor and paid by the bank
4. Daily cash balance per bank during the month
 attached thereto are the cancelled checks – issued by depositor and paid by the bank

Reconciling items

1. Book reconciling items

a. Credit memos – items credited by the bank but not yet added in the debtor’s book
b. Debit memos – items debited by the bank but not yet deducted in the debtor’s book
c. Book errors – errors committed by the entity
2. Bank reconciling items
a. Deposits in transit – collections recorded by the debtor but not yet reflected on the bank statement
b. Outstanding checks – checks recorded as disbursement but not yet reflected on the bank statement
c. Bank errors – errors committed by the bank

Forms of bank reconciliation

a. Adjusted balance method – book and bank balance are brought to a correct cash balance that must appear on
the balance sheet
b. Book to bank method – book balance adjusted to equal the bank balance
c. Bank to book method – bank balance adjusted to equal the book balance
 Book Balance Bank Balance
Book balance Bank balance
Add: Credit memos Add: Deposit in transit
Total Total
Less: Debit memos Less: Outstanding check
Adjusted book balance Adjusted bank balance

Chapter 3
 PROOF OF CASH

Two-date bank reconciliation

 the bank reconciliation is so-called “two-date” because it literally involves two dates

Computation of book balance

Balance per book – beginning of month

Add: book debits during the month
Total
Less: book credits during the month
Balance per book – end of month

Book debits – cash receipts or all items debited to the cash in bank account

Book credits – cash disbursement or all items credited to the cash in bank account

Computation of bank balance

Balance per bank – beginning of month

Add: bank credits during the month
Total
Less: bank debits during the month
Balance per bank – end of month
Bank credits – all items credited to the depositors account

Bank debits – all items debited to the depositors account

Computation of deposits in transit

Deposits in transit – beginning of month

Add: cash receipts deposited during the month
Total
Less: deposits acknowledge by bank during the
month
Deposits in transit – end of month

Computation of outstanding checks

Outstanding checks – beginning of month

Add: checks drawn by depositor during the month
Total
Less: checks paid by bank during the month
Outstanding checks – end of month

Proof of cash

 expanded reconciliation in that it includes proof of receipts and disbursements

 may be useful in discovering possible discrepancies in handling cash particularly when cash receipts have been
recorded but have not been deposited.

Chapter 4
 ACCOUNTS RECEIVABLE

Receivable

 financial assets that represent a contractual right to receive cash or another financial asset from another entity.
 For retailers or manufacturers, receivables are classified into trade receivables and nontrade receivables.

Trade receivables

 Claims arising from sale of merchandise or services in the ordinary course of business
 Include accounts receivable and notes receivable
 Accounts receivable – open accounts arising from the sale of goods and services in the ordinary course of
business and not supported by promissory notes; also called customers’ accounts, trade debtors, and trade
accounts receivable
 Notes receivable – those supported by formal promises to pay in the form of notes.

Nontrade receivable

 Claims arising from sources other than the sale of merchandise or services in the ordinary course of business
 Should be collectible within one year from the balance sheet date or operating cycle whichever is longer.

Loans receivable

 For banks and other financial institutions, receivables result primarily from loans to customers.
 Loans are made to heterogeneous customers and the repayment periods are frequently longer or over several
years.

Classification

 Trade receivables - are expected to be realized in cash within the normal operating cycle or one year,
whichever is longer, are classified as current assets.
 Nontrade receivables - are expected to be realized in cash within one year, the length of operating cycle
notwithstanding are classified as current asset; if collectible beyond one year, nontrade receivables are
classified as current assets.

Customers’ credit balances

 Are credit balances in accounts receivable resulting from overpayments, returns and allowances, and advance
payments from customers.
 Classified as current liabilities and are not offset against the debit balances in other customers’ accounts, except
when the same is not material in which case only the net accounts receivable may be presented.

Initial measurement of accounts receivable

 Recognized initially at fair value plus transaction costs that are directly attributable to the acquisition.
 Fair value is usually the transaction price
 For short-term receivables, face value is equal to the face amount or original invoice amount.

Subsequent measurement

 Accounts receivable shall be measured at amortized cost / net realizable value of accounts receivable
 It is the amount of cash expected to be collected or the estimated recoverable amount.

Net realizable value

 The amount recognized for accounts receivable shall be reduced by adjustments which in the ordinary course of
business will reduce the amount recoverable from the customer.
  Based from principle that assets shall not be carried at above their recoverable amount.
 The following deductions are made:
a. Allowance for freight charge
b. Allowance for sales return
c. Allowance for sales discount
d. Allowance for doubtful accounts

Terms related to freight charge

 FOB destination – the ownership of the goods purchased is vested in the buyer upon receipt thereof; the seller
shall be responsible for the freight charge up to the point of destination.
 FOB shipping point – the ownership of the goods purchased is vested in the buyer upon shipment thereof;
buyer to pay for the transportation from the point of shipment to the point of destination.
 Freight collect – freight change on the goods shipped is not yet paid. Courier shall collect from the buyer. Thus,
freight charge is actually paid by buyer.
 Freight prepaid – freight charge on the goods shipped is already paid by the seller.

Allowance for sales return

 The entity should recognize the probability that some customers will return goods.

Sales discount

 Cash discounts offered by the entity if payment was done within discount period.

Methods of recording credit sales

a. Gross method – the accounts receivable and sales are recorded at gross amount of the invoice. This is the
common and widely used method because it is simple to apply.
b. Net method – the accounts receivable and sales are recorded at net amount of the invoice, meaning the invoice
price minus the cash discount.

Allowance for sales discount

 Account is opened when customers are granted cash discounts for prompt payment.

Accounting for bad debts

 When an account becomes uncollectible, the entity has sustained a bad debt loss. This loss is simple one of the
costs of doing business on credit.
 Two methods for bad debt loss:
a. Allowance method
b. Direct writeoff method

Allowance method

 Requires recognition of a bad debt loss if the allowance are doubtful of collection.
 This method is used because it conforms with the matching principle.

Direct writeoff method

 Requires recognition of a bad debt loss when the accounts proved to be worthless or uncollectible
 BIR recognizes only this method for income tax purposes.
 Violated the matching principle
 Not permitted under IFRS
Doubtful accounts in the income statement

1. Distribution cost – considered if the granting of credit and collection of accounts are under the charge of the
sales manager.
2. Administrative expense – considered if the granting of credit and collection of accounts are under the charge of
an officer other than the sales manager.

In the absence of any contrary statement, doubtful account shall be classified as administrative expense.

Chapter 5
 ESTIMATION OF DOUBTFUL ACCOUNTS

Methods of estimating doubtful accounts

1. Aging the accounts receivable or “statement of financial position approach”

2. Percent of accounts receivable or “statement of financial position approach”
3. Percent of sales or “income statement approach”

Aging the accounts receivable

 Involves analysis where the accounts are classified into not due or past due
 Determined by multiplying the total of each classification by the rate or percent of loss experienced by the entity
for each category.
 More accurate and scientific computation of the allowance for doubtful accounts.
 Validates the matching process
 What you get is the required balance for the AFDA at the end of the period.
 Past due – period beyond the maximum credit term.

Percent of accounts receivable

 A certain rate is multiplied by the open accounts at the end of the period in order to get the required allowance
balance.
 Violates the principle of matching bad debt loss against sales revenue.
 Loss experience rate may be difficult to obtain and may not be reliable.

Percent of sales

 The amount of sales for the year is multiplied by a certain rate to get the doubtful account expense.
 Rate may be applied on credit sales or total sales.
 This has the advantage of eliminating the extra work of making record of cash sales and credit sales.
 May prove unsatisfactory when there is a considerable fluctuation in the proportion of cash and credit sales
periodically.

Allowance for doubtful accounts

Writeoff Beginning balance
Recovery
Current year provision
Ending balance

Chapter 6
 NOTES RECEIVABLE

Notes receivable

 Claims supported by formal promises to pay usually in the form of notes.

 Claims arising from sale of merchandise or service in the ordinary course of business
 A negotiable promissory note is a written contract in which one person, known as the maker, promises to pay
another person, known as the payee, a definite sum of money.
 Note may be payable on demand or at a definite future date.

Dishonored notes

 when a promissory note matures and is not paid.

 Should be removed from notes receivable account and transferred to accounts receivable
 Should include the face account, interest, and other charges.

Initial measurement of notes receivable

 Shall be measured initially at present value.

 The present value is the sum of all future cash flows discounted using the prevailing market rate of interest for
similar notes.
 Prevailing market rate of interest = effective interest rate
 Short-term notes receivable shall be measured at face value.

Interest-bearing notes receivable

 Measured at face value which is actually the present value upon issuance.

Noninterest-bearing notes receivable

 Measured at present value which is discounted value of the future cash flows using the effective interest rate.
 The term “noninterest-bearing” is a misnomer because all notes implicitly contain interest.
 Interest being included in the face amount rather than being stated separately.

Subsequent measurement

 long-term notes receivable shall be measured at amortized cost using the effective interest method.

Amortized cost

 amount at which the note receivable is measured initially:

a. Minus principal repayment
b. Plus or minus cumulative amortization of any difference between the initial carrying amount and the
principal maturity amount.
c. Minus reduction for impairment or uncollectibility.
 For long-term noninterest-bearing notes receivable, the amortized cost is the present value plus amortization of
the discount, or the face value minus the unamortized unearned interest income.

Lumpsum payment – used of present value of 1

Installment payment – used of present value of an ordinary annuity of 1

Chapter 7
 LOAN RECEIVABLE

Loan receivable

 Is a financial asset arising from a loan granted by a bank or other financial institution to a borrower or client.
 It may be short-term, but in most cases, the repayment periods cover several years.

Initial measurement of loan receivable

 shall be measured at fair value plus transaction costs that are directly attributable to the acquisition of the
financial asset.
 Fair value of the loan receivable at initial recognition is normally the transaction price, meaning, the amount of
the loan granted.
 Direct origination costs – transaction costs that are attributable to the loan receivable; should be included in the
initial measurement of the loan receivable.
 Indirect origination costs – should be treated as outright expense.

Subsequent measurement of loan receivable

 Loan receivable is measured at amortized cost using the effective interest method.

Meaning of amortized cost

 Amount at which the loan receivable is measured initially:

a. Minus principal repayment
b. Plus or minus cumulative amortization of any difference between the initial carrying amount and the
principal maturity amount.
c. Minus reduction for impairment or uncollectibility.
 If the initial amount recognized is lower than the principal amount, the amortization of the difference is added
to the carrying amount.
 If the initial amount is higher than the principal amount, the amortization of the difference is deducted from the
carrying amount.

Origination fees

 Fees charged by the bank against the borrower for the creation of loan.
 It includes compensation for the following activities:
a. Evaluating the borrower’s financial condition
b. Evaluating guarantees, collateral and other security
c. Negotiating the terms of the loan
d. Preparing and processing the documents related to the loan
e. Closing and approving the loan transaction

Accounting for origination fees

 Origination fees received from borrower are recognized as unearned interest income and amortized over the
term of the loan
 If not chargeable against the borrower, the fees are known as direct origination costs.
 Direct origination costs are deferred and also amortized over the term of the loan.
 Preferably, direct origination costs are offset directly against any unearned origination fees received.
 Origination fees received > direct origination costs, the difference is unearned interest income
 Origination fees received < direct origination costs, the difference is charged to direct origination costs.
 Both are included in the measurement of the loan receivable.

Effective interest method

  Interest received = principal times nominal rate
 Interest income = carrying amount times effective rate.

Impairment of loan

 PFRS 9, paragraph 5.5.1, provides that an entity shall recognize a loss allowance for expected credit losses on
financial asset measured at amortized cost.
 Paragraph 5.5.3, provides that an entity shall measure the loss allowance for a financial instrument at an
amount equal to the lifetime expected credit losses if the credit risk on that financial instrument has increased
significantly since initial recognition.
 Credit losses are the present value of all cash shortfalls.
 Expected credit losses are an estimate of credit losses over the life of the financial instrument.

Measurement of impairment

 When measuring unexpected credit losses, an entity should consider:

a. The probability-weighted outcome
b. The time value of money
c. Reasonable and supportable information that is available without undue cost or effort.
 an entity may use various sources of data both internal or entity-specific and external measuring expected credit
losses.
 The amount of impairment loss can be measured as the difference between the carrying amount and the
present value of estimated future cash flows discounted at the original effective rate.
 The carrying amount of the loan receivable shall be reduced either directly or through the use of an allowance
account.

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.
 The risk contemplated is the risk that the issuer will fail to perform a particular obligation.
 The risk does not necessarily relate to the credit worthiness of the issuer.
 Credit risk will be different when an entity issued a collateralized and noncollateralized liability.

Computation of Impairment loss

 The impairment loss is the difference between the carrying amount of the loan and the present value of the cash
flows.

Carrying amount of loss Php 3,300,000

Present value of cash flows 2,407,900

Impairment loss Php 892,100

Three-stage impairment approach

Stage 1 – This stage covers debt instruments that have not declined significantly in credit quality since initial
recognition or that have low credit risk. – 12-month expected credit loss is recognized.

Stage 2 – This stage covers debt instruments that have declined significantly in credit quality since initial
recognition but do not have objective evidence of impairment. – a lifetime expected credit loss is recognized and there is
a rebuttable presumption that there is a significant increase in credit risk if the contractual payments are more than 30
days past due.
 Stage 3 – This stage covers debt instruments that have objective evidence of impairment at the reposting date. –
a lifetime expected credit loss is recognized.

12-month expected credit loss

 Defined as the portion of the lifetime expected credit loss from default events that are possible within 12
months after reporting period.

Lifetime expected credit loss

 Defined as the expected credit loss that results from all default events over the expected life of the instrument.
 Shall always be recognized for trade receivables through aging, percentage of accounts receivable and
percentage of sales.

Interest Income

a. Stage 1 and 2 – interest income is computed based on the gross carrying amount of face amount.
b. Stage 3 – interest income is computed based on the net carrying amount which is equal to the face amount
minus allowance for loan impairment.

Chapter 8

RECEIVABLE FINANCING – PLEDGE, ASSIGNMENT AND FACTORING

Concept of receivable financing

 Receivable financing is the financial flexibility or capability of an entity to raise money out of its receivables.

Forms of receivable financing

a. Pledge of accounts receivable

b. Assignment of accounts receivable
c. Factoring of accounts receivable
d. Discounting of notes receivable

Pledge of accounts receivable

 When loans are obtained from the bank or any lending institution, the accounts receivable may be pledged as
collateral security for the payment of the loan.
 Normally, the borrowing entity makes the collections of the pledged accounts but may be required to turn over
the collections to the bank in satisfaction of the loan.
 Loan is recorded by debiting cash and discount on note payable if loan is discounted, and crediting note payable.
 Record subsequent payments by debiting loan payable and crediting cash.
 No entry is necessary for the pledge accounts – only disclosure on note.

Assignment of accounts receivable

 Here, a borrower called the assignor transfers rights in some accounts receivable to a lender called the assignee
in consideration for a loan.
 Formal type of pledging of accounts receivable.
 Assignment is secured borrowing evidenced by a financial agreement and a promissory note both of which the
assignor signs.
 Assignment is specific because specific accounts receivable serve as collateral security for the loan.
 It can be done on notification or nonnotification basis.
 Notification basis – customers are notified to make their payments directly to the assignee.
 Nonnotification basis – customers are not informed that their accounts have been assigned.
 The assignee usually lends only a certain percentage of the face value of the accounts assigned.
 The assignee also usually charges interest for the loan and requires a service or financial charge or commission
for the assignment agreement.

Factoring

 It is a sale of accounts receivable on a without recourse, notification basis.

 In factoring arrangement, an entity sells accounts receivable to a bank or finance entity called a factor.
 A gain or loss is recognized for the difference between the proceeds received and the net carrying amount of the
receivables factored.
 Factoring differs from assignment in that an entity actually transfers ownership of the accounts receivable to the
factor.
 Factor assumes responsibility for uncollectible factored accounts.
 The customers whose accounts are factored are notified and required to pay directly to the factor.
 The factor has then the responsibility of keeping the receivable records and collecting the accounts.
 Factoring may take the form of the following:
a. Casual factoring
b. Factoring as a continuing agreement

Casual factoring
  Entity may factor some or all of its accounts receivable at a substantial discount to a bank or a finance entity to
obtain the much needed cash.

Factoring as a continuing agreement

 factoring may involve a continuing arrangement where a finance entity purchases all of the accounts receivable
of a certain entity.
 In this setup, before a merchandise is shipped to a customer, the selling entity requests the factor’s credit
approval. If approved, the account is sold immediately to the factor after the shipment of the goods.
 The factor assumes the credit function as well as the collection function.
 Factor may also withhold a predetermined amount as a protection against customer returns and allowances and
other special adjustments.
 This is called factor’s holdback which is actually a receivable from factor and classified as current asset.

Credit Card

 A plastic card which enables the holder to obtain credit up to a predetermined limit from the issuer of the card
for the purchase of goods and services.
 It has enabled retailers and other businesses to continue to sell goods and services where the customers obtain
possession of the goods and services immediately but do not have to pay for the goods for about one month.

Chapter 9

RECEIVING FINANCING – DISCOUNTING OF NOTE RECEIVABLE

Concept of discounting

 Discounting specifically pertains to note receivable

 In a promissory note, the original parties are the maker and payee.
 The maker – liable and the payee – one entitled to payment on the date of maturity.
 When a note is negotiable, the payee may obtain cash before maturity date by discounting the note at the bank
or other financing company.
 To discount the note, the payee must endorse it.
 Payee becomes an endorser and bank becomes an endorsee

Endorsement

 It is the transfer of right to a negotiable instrument by simply signing at the back of the instrument.
 It may be with recourse which means that the endorser shall pay the endorsee if the maker dishonors the note.
 In the legal parlance, this is the secondary liability of the endorser.
 In the accounting parlance, this is the contingent liability of the endorser.
 It may also be without remorse which means that the endorser avoids future liability even if the maker refuses
to pay endorsee on the date of maturity.
 In absence of any evidence to the contrary, endorsement is assumed to be with recourse.

Terms related to discounting of note

1. Net proceeds – refers to the discounted value of the note received by the endorser from the endorsee. (Net
proceeds = Maturity value - Discount)
2. Maturity value – is the amount due on the note at the date of maturity. (Principal + Interest = Maturity value)
3. Maturity date – is the date on which the note should be paid.
4. Principal – is the amount appearing on the face of the note. It is also referred to as face value.
5. Interest – is the amount of the interest for the full term of the note. (Interest = Principal x Rate x time)
6. Interest rate – is the rate appearing on the face of the note.
7. Time – is the period within which interest shall accrue. For discounting purposes, it is the period from the date
of note to maturity date.
8. Discount – is the amount of interest deducted by the bank in advance. (Discount = Maturity value x Discount
rate x Discount period)
9. Discount rate – is the rate used by the bank in computing the discount. Discount rate and interest rates are
different. IF no discount rate is given, interest rate is used.
10. Discount period – is the period of time from date of discounting to maturity date. This is the unexpired term of
the note. (Discount period = Term of the note – Expired portion up to the date of discounting.

Illustration – discounting without recourse

A P1,500,000, 180-day, 12% note dated July 1 was received from a customer and discounted without recourse
on August 30 at 15% discount rate.

Computation:

Maturity value

Principal P1,500,000
Interest (1,500,000 x 12% x 180/360) 90,000
Maturity value P1,590,000

Discount
Discount (1,590,000 x 15% x 120/360) P 75,500

Net proceeds from discounting

Maturity value P1,590,000

Discount ( 75,700 )

Net Proceeds P1,510,500

Carrying amount of the note receivable

Principal P1,500,000

Accrued interest receivable

(1,500,000 x 12% x 60/360) 30,000

Carrying amount of note receivable P1,530,000

Gain or loss on note discounting

Net proceeds P1,510,500

Carrying amount of note receivable 1,530,000

Loss on note discount (P 19,500 )

Illustration – discounting with recourse

A P2,400,000, 6-month, 12% note dated February 1 is received from a customer by an entity and discounted by
First Bank on March 1 at 15%.

Principal P2,400,000

Interest 144,000

Maturity value P2,544,000

Discount (2,544,000 x 12% x 6/12) ( 159,000)

Net proceeds P2,385,000

Carrying amount of the notes receivable

Principal P2,400,000

Accrued interest receivable

(2,400,000 x 12% x 1/12) 24,000

Carrying amount of note receivable P2,424,000

Gain or loss on note discounting

Net proceeds P2,385,000

Carrying amount of note receivable 2,424,000

Loss on note receivable discounting (P 39,000)

If with recourse, transaction is accounted for as either of the following:

a. Conditional sale of note receivable recognizing a contingent liability

b. Secured borrowing

Conditional sale

Cash P2,385,000

Loss on note receivable discounting 39,000

Note receivable P2,400,000

Interest income 24,000

Note is paid by maker on maturity

On August 1, date of maturity, the note is paid by the maker to the First Bank. The contingent liability is
extinguished as follows:

Note receivable discounted 2,400,000

Note receivable 2,400,000

Note is dishonored by maker

The note is dishonored by the maker on August 1, and the entity pays the First Bank the maturity value of the
note, P2,544,000, plus protest fee and other bank charges of P6,000.

1. To record the payment to First Bank

Accounts receivable 3,550,000

Cash 3,550,000

2. To cancel the contingent liability

Note receivable discounted 2,400,000

Note receivable 2,400,000

Secured borrowing

The note receivable is not derecognized but instead an accounting liability is recorded at an amount equal to the
face amount of the note receivable discounted.

Cash 2,385,000

Interest expense 39,000

Liability for note receivable discounted 2,400,000

Interest income 24,000

Note is paid by maker on maturity

If the note is paid by the maker to the First Bank, the liability for note receivable discounted and note receivable
are derecognized.
Liability for note receivable discounted 2,400,000

Note receivable 2,400,000

Note is dishonored by maker

The note is dishonored by the maker on August 1, and the entity pays the First Bank the maturity value of the
note, P2,544,000 plus protest and other bank charges of P6,000.

1. To record the payment to First Bank

Accounts receivable 3,550,000

Cash 3,550,000

1. To cancel the contingent liability

Liability for note receivable discounted 2,400,000

Note receivable 2,400,000

Conditional sale or secured borrowing

PFRS 9, paragraph 3.2.3, provides that an entity shall derecognize a financial asset when either one of the
following criteria is met:

a. The contractual rights to the cash flows of the financial asset have expired.
b. The financial asset has been transferred and the transfer qualifies for derecognition based on the extent of
transfer of risks and rewards of ownership.

Application of the first criterion is easy because contractual rights to the cash flows may expire such as when a note
receivable from a customer is fully collected while the second is often complex. Second criterion relies on the
assessment of the extent of the transfer of risks and rewards of ownership.

PFRS 9, paragraph 3.2.6, provides the following guidelines for deregonition based on transfer of risks and
rewards.

1. If the entity has transferred substantially all risks and rewards, the financial asset shall be derecognized.
2. If the entity has retained substantially all risks and rewards, the financial asset shall not be derecognized.
3. If the entity has neither transferred nor retained substantially all risks and rewards, derecognition depends on
whether the entity has retained control of the asset.
a. If the entity has lost control of the asset, the financial asset is derecognized in its entirely,
b. If the entity has retained control over the asset, the financial asset is not derecognized.

Chapter 10

INVENTORIES
Inventories

 Are assets held for sale in the ordinary course of business, in the process of production for such sale or in the
form of materials or supplies to be consumed in production process or in the rendering of services.
 Encompass goods purchased and held for resale, for example:
a. Merchandise purchased by a retailer and held for resale
b. Land and other property held for resale by a subdivision entity and real estate developer.
 Encompass finished goods produced, goods in process and materials and supplies awaiting use in the production
process.

Classes of inventories

 Inventories of a trading concern – is one that buys and sells goods in the same form purchased. – merchandise
inventory is generally applied to goods held by a trading concern.
 Inventories of manufacturing concern – is one that buys goods which are altered or converted into another form
before they are made available for sale.

The inventories of a manufacturing concern are:

a. Finished goods – are completed products which are ready for sale; have been assigned their full share of
manufacturing costs.
b. Goods in process – also called work in process are partially completed products which require further process or
work before they can be sold.
c. Raw materials – are goods that are to be used in the production process; covers all materials used in the
manufacturing operations.
d. Factory or manufacturing supplies – similar to raw materials but their relationship to the end product is indirect;
it may be referred as indirect materials – not physically incorporated in the product being manufactured.

Goods includible in the inventory

 All goods to which the entity has title shall be included in the inventory, regardless of location.
 The phrase “passing of title” is a legal language which means “the point of time at which ownership changes”.

Legal test

 Is the entity the owner of the goods to be inventoried?

a. If the answer is affirmative, the goods shall be included in the inventory.
b. If the answer is in the negative, the goods shall be excluded from the inventory.
 Applying the legal test, the following items are includible in inventory:
a. Goods owned and on hand
b. Goods in transit and sold FOB destination
c. Goods in transit and purchased FOB shipping point
d. Goods out on consignment
e. Goods in the hands of salesmen or agents
f. Goods held by customers on approval or trial.

Exception to the legal test

 Goods sold on installment are included in the inventory of the buyer and excluded from that of the seller.

Who is the owner of goods in transit?

  FOB destination – ownership of goods purchased is transferred only upon receipt of the goods by the buyer at
the point of destination. Thus, the goods in transit are still the property of the seller. The seller shall legally be
responsible for freight charges and other expenses up to the point of destination.
 FOB shipping point – ownership is transferred upon the shipment of the goods and therefore, the goods in
transit are the property of the buyer. The buyer shall be legally responsible for freight charges and other
expenses from the point of shipment to the point of destination.
 Purchases are recorded when received and sales when shipped

Freight terms

 Freight collect – freight charges on the goods shipped is not yet paid. The common carrier shall collect the same
from the buyer. This is actually paid by the buyer.
 Freight period – freight charges on the goods shipped is already paid by the seller.
 FOB destination and FOB shipping point determined ownership of the goods in transit and the party who is
supposed to pay the freight charge and other expenses.
 Freight collect and freight prepaid determine the party who actually paid the freight charge but not the party
who is supposed to legally pay the freight charge.

Maritime shipping terms

 FAS or free alongside – a seller who ships FAS must bear all expenses and risk involved in delivering the goods to
the dock next to or alongside the vessel on which the goods are to be shipped.
 The buyer bears the cost of loading and shipping and thus, title passes to the buyer when the carrier takes
possession of the goods.
 CIF or cost, insurance and freight – the buyer agrees to pay in a lump sum the cost of the goods, insurance cost
and freight charge. This may be modified as CF.
 Ex-ship – a seller who delivers the goods ex-ship bears all expenses and risk of loss until the goods are unloaded
at which time title and risk of loss shall pass to the buyer.

Consigned goods

 Consignment – is a method of marketing goods in which the owner called the consignor transfers physical
possession of certain goods to an agent called the consignee who sells them on the owner’s behalf.
 Consigned goods shall be included in the consignor’s inventory and excluded from the consignee’s inventory.
 Freight and other charges on goods out on consignment are part of the cost of goods consigned.
 For example, a consignee sells consigned goods for P100,000. This amount is remitted to the consignor less
commission of P15,000 and advertising of P2,000.

Cash P83,000

Commission 15,000

Advertising 2,000

Sale P100,000

Accounting for inventories

  Periodic and perpetual system
 Periodic system – calls for the physical counting if goods on hand at the end of the accounting period to
determine qualities; used when individual inventory items have small peso investment, such as groceries,
hardware, and auto parts.
 Perpetual system – requires the maintenance of records called stock cards that usually offer a running summary
of the inventory inflow and outflow; used where the inventory items treated individually represent a relatively
large peso investment such as jewelry and cars.

Illustration – periodic system

1. Purchase of merchandise on account, P300,000

Purchases P300,000

Accounts payable P300,000

2. Payment of freight on the purchase, P20,000

Freight in 20,000

Cash 20,000

3. Return on merchandise purchased to supplier, P30,000

Accounts payable 30,000

Purchase return 30,000

4. Sale of merchandise in account, P400,000, at 40% gross profit.

Accounts receivable 400,000

Sales 400,000

5. Return of merchandise sold from customer, P25,000

Sales return 25,000

Accounts receivable 25,000

6. Adjustment of ending inventory, P65,000

Merchandise inventory – end 65,000

Income summary 65,000

Illustration – pepetual system

1. Purchase of merchandise on account, P300,000

Purchases P300,000

Accounts payable P300,000

2. Payment of freight on the purchase, P20,000

Merchandise inventory 20,000

Cash 20,000

3. Return on merchandise purchased to supplier, P30,000

 Accounts payable 30,000

Merchandise inventory 30,000

4. Sale of merchandise in account, P400,000, at 40% gross profit. The cost of merchandise sold is 60% or P240,000

Accounts receivable 400,000

Sales 400,000

Cost of goods sold 240,000

Merchandise inventory 240,000

5. Return of merchandise sold from customer, P25,000. The cost of merchandise returned is 60% or P15,000.

Sales return 25,000

Accounts receivable 25,000

Merchandise inventory 15,000

Cost of goods sold 15,000

6. Adjustment of ending inventory.

As a rule, the ending merchandise inventory is not adjusted. The balance of the merchandise inventory account
represents the ending inventory.

Inventory shortage or overage

 If at the end of the accounting period, a physical count indicates a different amount, an adjustment is necessary
to recognize any inventory shortage or overage.
 Inventory shortage is usually closed to cost of goods sold because this is often the result of shrinkage and
breakage in inventory.
 However, abnormal and material shortage shall be separately classified and presented as other expense.

Trade discounts and cash discounts

 Trade discounts – deductions from the list or catalog price in order to arrive at the invoice price which is the
amount actually charged to the buyer. Thus, trade discounts are not recorded. The purpose is to encourage
trading or increase sale. This also suggest to the buyer the price at which the goods may be resold.
 Cash discounts – deductions from the invoice price when payment is made within the discount period. The
purpose is to encourage prompt payment. This is recorded as purchase discount by the buyer and sales discount
by the seller.

Methods of recording purchases

1. Gross method – purchases and accounts payable are recorded at gross.

2. Net method – purchases and accounts payable are recorded at net.

Illustration – Gross method

1. Purchases on account, P200,000, 2/10, n/30.

Purchases 200,000
Accounts payable 200,000
2. Assume payment is made within the discount period.
Accounts payable 200,000
Cash 196,000
 Purchase discount 4,000
3. Assume payment is made beyond the discount period.

Accounts payable 200,000

Cash 200,000

Illustration – Net method

1. Purchases on account, P200,000, 2/10, n/30.

Purchases 196,000
Accounts payable 196,000
2. Assume payment is made within the discount period.
Accounts payable 196,000
Cash 196,000
3. Assume payment is made beyond the discount period.
Accounts payable 196,000
Purchase discount lost 4,000
Cash 200,000
4. Assume it is the end of accounting period, no payment is made and the discount period has expired.
Purchase discount lost 4,000
Accounts payable 4,000

Gross method vs. net method

 The cost measured under the net method represents the cash equivalent price on the date of payment and
therefore the theoretically correct historical cost.
 However, in practice, most entities record purchases at gross invoice amount.
 The gross method violates the matching principle because discounts are recorded only when taken or when cash
is paid rather than when purchases that give rise to the discounts are made.

Cost of inventories

a. Cost of purchase
b. Cost of conversion
c. Other cost incurred in bringing the inventories to their present location and condition

Cost of purchase

 Comprises the purchase price, import duties and irrecoverable taxes, freight, handling and other costs directly
attributable to the acquisition of finished goods, materials, and services.
 Trade discounts, rebates and other similar items are deducted in determining the cost of purchase.
 The cost of purchase shall not include foreign exchange differences which arise directly from the recent
acquisition of inventories involving a foreign currency.

Cost of conversion

 Includes cost directly related to the units of production such as direct labor.
 It also includes a systematic allocation of fixed and variable production overhead that is incurred in converting
materials into finished goods.
 Fixed production overhead – indirect cost of production that remains relatively constant regardless of the
volume of production; depreciation and maintenance of factory building and equipment, and the cost of factory
management and administration
  Variable production overhead – indirect cost of production that varies directly with the volume of production;
indirect labor and indirect materials

Allocation of fixed production overhead

 Based on the normal capacity of the production facilities.

 Normal capacity – production expected to be achieved on average over a number of periods or seasons
under normal circumstances taking into account the loss of capacity resulting from planned maintenance.
 Unallocated fixed overhead – recognized as expense in the period in which it is incurred.

Allocation of variable production overhead

 Variable production overhead – allocated to each unit of production on the basis of the actual use of the
production facilities.
 Production process may result in more than one product being produced simultaneously.
 By – products are measured at net realizable value and this value is deducted from the cost of the main product.

Other cost

 Included in the cost of inventories only to the extent that it is incurred in bringing the inventories to their
present location and condition.
 The following costs are excluded from the cost of inventories and recognized as expenses in the period when
incurred:
a. Abnormal amounts of wasted materials, labor and other production cost
b. storage costs, unless these costs are necessary in the production process prior to a further production stage.
Thus, storage costs in goods in process are capitalized but storage costs on finished goods are expensed.
c. Administrative overheads that do not contribute to bringing inventories to their present location and
condition.
d. Distribution or selling costs.

Cost of inventories of a service provider

 Consists primarily of the labor and other costs of personnel directly engaged in providing the service, including
supervisory personnel and attributable overhead.
 Labor and other costs relating to sales and general administrative personnel are not included but are recognized
as expenses in the period in which they incurred.

Chapter 11

INVENTORY COST FLOW

Cost formulas

 PAS 2, paragraph 25, expressly provides that the cost of inventories shall be determined by using either:
a. First in, first out
b. Weighted average
 The standard does not permit anymore the use of the last in, first out as an alternative formula in measuring
cost of inventories.

First in, first out

 FIFO method assumes that “the goods first purchased are first sold” and consequently the goods remaining in
the inventory at the end of the period are those most recently purchased or produced.
 The goods are sold in the order they are purchased.
 “first come, first sold”
 The inventory is thus expressed in terms of recent or new prices while the cost of goods sold is representative of
earlier or old prices.
 This method favors the statement of financial position in that inventory is stated at current replacement cost.
 The objection is that there is improper matching of cost against revenue because the goods sold are stated at
earlier or older prices resulting in the understatement of cost of sales.
 In a period of inflation or rising prices, the FIFO method would result to the highest net income.
 In a period of deflation or declining prices, the FIFO method would result to the lowest net income.

Illustration – FIFO

The following date pertain to an inventory item:

Units Unit Total Sales

cost cost (in
units)
Jan 1 Beg.bal 800 200 160k
.
8 Sale 500
18 Pur 700 210 147k
22 Sale 800
31 Pur 500 220 110k
The ending inventory is 700 units.

FIFO – Periodic

Units Unit cost Total cost

From Jan. 18
200 210 42,000
Purchase
From Jan. 31
500 220 110,000
Purchase
700 152,000

Cost of goods sold

Inventory – Jan. 1 P160,000

Purchases (147,000 + 110,000) 257,000

Goods available for sale 417,000

Inventory – Jan. 31 (152,000)

Cost of goods sold 265,000

FIFO – Perpetual

This requires the preparation of stock card.

Purchases Sales Balance

Unit Total Unit Total Unit Total
Date Units Units Units
cost cost cost cost cost cost
Jan. 1 800 200 160,000
8 100,00
500 200 300 200 60,000
0
18 147,00
700 210 300 200 60,000
0
700 210 147,000
22 300 200 60,000
105,00
500 210 200 210 42,000
0
31 110,00
500 220 200 210 42,000
0
500 220 110,000

NOTA BENE

 Note well that under FIFO – periodic and FIFO – perpetual, the inventory costs are the same.

Weighted average – Periodic

 the cost of the beginning inventory plus the total cost of purchases during the period is divided by the total units
purchased plus those in the beginning inventory to get a weighted average unit cost.
 Such weighted average unit cost is then multiplied by the units on hand to derive the inventory value.
 The average unit cost is computed by dividing the total cost of goods available for sale by the total number of
units available for sale.

Units Unit cost Total cost

Jan. 1 Beginning balance 800 200 160,000
18 Purchase 700 210 157,000
31 Purchase 500 220 110,000
Total goods available for sale 2,000 417,000
Weighted average unit cost (417,000/2,000) 208.50

Inventory cost (700 x 208.50) 145,000

Cost of goods sold

Inventory – January 1 160,000

Purchases 257,000

Goods available for sale 417,000

Inventor – January 31 (145,950)

Cost of goods sold 271,050

Weighted average – Perpetual

 When used in conjunction with the perpetual system, the weighted average method is popularly known as the
moving average method.
 PAS 2, paragraph 27, provides that the weighted average may be calculated on a periodic basis or as each
additional shipment is received depending upon the circumstances of the entity.
 New weighted average unit cost must be computed after every purchase and purchase return

Units Unit cost Total cost

Jan. 1 Balance 800 200 160,000
8 Sale (500) 200 100,000
Balance 300 200 60,000
18 Purchase 700 210 147,000
Total 1,000 207 207,000
22 Sale (800) 207 (165,600)
Balance 200 207 41,400
31 Purchase 500 220 110,000
Total 700 216 151,400

Cost of goods sold from the stock card

January 8 Sale 100,000

22 Sale 165,600

Cost of goods sold 265,600

Last in, First Out (LIFO)

 Assumes that the gods last purchased are first sold and consequently the goods remaining in the inventory at
the end of the period are those first purchased or produced.
 The inventory is thus expressed in terms of earlier or old prices and the cost of goods sold is representative or
recent or new prices.
 Favors income statement because current cost and current revenue match
 Objection: there is a significant lag between inventory valuation and current replacement cost
 Permits manipulation of income
 Rising prices - lowest net income.
 Declining prices – highest net income

LIFO – Periodic

Units Unit cost Total cost

From January 1 balance 700 200 140,000
Cost of goods sold under LIFO – Periodic

Inventory – January 1 160,000

Purchases 257,000

Goods available for sale 417,000

Inventor – January 31 (140,000)

Cost of goods sold 277,000

LIFO – Perpetual

Purchases Sales Balance

Unit Total Unit Total Unit Total
Date Units Units Units
cost cost cost cost cost cost
Jan. 1 800 200 160,000
8 100,00
500 200 300 200 60,000
0
18 147,00
700 210 300 200 60,000
0
700 210 147,000
22 147,00
700 210
0
100 200 20,000 200 200 40,000
31 110,00
500 220 200 200 40,000
0
500 220 110,000

Specific identification

 Means that specific costs are attributed to identified items of inventory

 Cost of the inventory is determined by simply multiplying the units on hand by their actual unit cost.
 PAS 2, paragraph 23, provides that this method is appropriate for inventories that are segregated for a specific
project and inventories that are not ordinarily interchangeable.
 May be used in either periodic or perpetual inventory system.

Standard costs

 Are predetermined product costs established on the basis of normal levels of materials and supplies, labor,
efficiency and capacity utilization.
 PAS 2, paragraph 21, states that the standard cost method may be used for convenience if the results
approximate cost.

Relative sales price method

 When different commodities are purchased at a lump sum, the single cost is apportioned among the
commodities based on their respective sales price.
 For example, product A, B, and C are purchased at basket price of P3,000,000. Assume that the said products
have the following sales price: A P500,000, B P1,000,000, and C P3,000,000.

Computation of cost of each product

Product A 500,000 5/50 x 3,000,000 300,000

Product B 1,500,000 15/50 x 3,000,000 900,000

Product C 3,000,000 30/50 x 3,000,000 1,800,000

5,000,000 3,000,000
Chapter 12

LOWER OF COST AND NET REALIZABLE VALUE

Measurement of inventory

 PAS 2, paragraph 9, provides that inventories shall be measured at the lower of cost and the net realizable value.
 The measurement of inventory at the lower of cost and net realizable value is now known as LCNRV.

Net realizable value

 Is the estimated selling price in the ordinary course of business less than the estimated cost of completion and
the estimated cost of disposal.
 Cost of inventories may not be recoverable under the following circumstances.
a. The inventories are damaged.
b. The inventories have become wholly or partially obsolete.
c. The selling prices have declined.
d. The estimated cost of completion or the estimated cost of disposal has increased.

Accounting for inventory writedown

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

Methods of accounting for the inventory writedown

a. Direct method or cost of goods sold method

b. Allowance method or loss method

Direct method

 Inventory is recorded at the lower of cost or net realizable value.

 Also know as cost of goods sold method because any loss on inventory writedown or gain on reversal of
inventory writedown is not accounted for separately but buried in the cost of goods sold.

Allowance method

 The inventory is recorded at cost and any loss on inventory writedown is accounted for separately.
 Also know as loss method because a loss account “loss on inventory writedown” is debited and a valuation
account “allowance for inventory writedown” is credited.

PAS 2, paragraph 34, provides that the amount of any reversal of any writedown arising from an increase in net
realizable value shall be recognized a a reduction in the amount of inventory recognized as an expense in the period in
which the reversal occurs.

Purchase commitments

 Are obligations of the entity to acquire certain goods sometime in the future at a fixed price and fixed quantity.
 Purchase contract has already been made for future delivery of goods fixed in price and in quantity.
 Disclosure is required in the notes when purchase commitments are significant or unusual.
 Any losses which are expected to arise from firm and noncancelable commitments shall be recognized.
  If there is a decline in purchase price after purchase commitment has been made, a loss is recorded in the period
of the price decline.

LCNRV Adaptation

 Recognition of loss on purchase commitment is an adaptation of the measurement at the lower of cost or net
realizable value.
 Accordingly, if market price rises by the time the entity makes the purchase, a gain on purchase commitment
would be recorded.
 However, the amount of gain to be recognized is limited to the loss on purchase commitment previously
recorded.

Disclosures

With respect to inventories, the financial statements shall disclose the following:

a. The accounting policies adopted in measuring inventories, including the cost formula used.
b. The total carrying amount of inventories and the carrying amount in classifications appropriate to the entity –
merchandise, production supplies, goods in process, and finished goods.
c. The carrying amount of inventories carries at fair value less cost of disposal.
d. The amount of inventories recognized as an expense during the period.
e. The amount of any writedown of inventories recognized as an expense during the period.
f. The amount of reversal of writedown that is recognized as income.
g. The circumstances or events that led to reversal of a writedown of inventories.
h. The carrying amount of inventories pledged as security for liabilities.

Agricultural, forest and mineral products

 PAS 2, paragraph 4, provides that inventories of agricultural, forest and mineral products are measured at net
realizable value at certain stages of production.
 Agricultural crops that have been harvested or mineral products that have been extracted are measured at net
realizable value:
a. When a sale is assured under a forward contract or government guarantee.
b. When a homogeneous market exists and there is a negligible risk of failure to sell.

Commodities of broker-traders

 PAS 2, paragraph 3, provides that commodities of broker-traders are measured at fair value less cost of disposal.
 PFRS 13, paragraph 9, defines fair value of an asset as the price that would be received to sell the asset in an
orderly transaction between market participants.
 Broker-traders are those who buy and sell commodities for others or on their own account.
 Inventories of broker-traders are principally acquired with the purpose of selling them in the near future and
generating a profit from fluctuations in price or broker-traders’ margin.
Chapter 13

GROSS PROFIT METHOD

Use of estimate in inventory valuation

 Two widely accepted procedures for approximating the value of inventory: gross profit method and the retail
inventory method
 Common reasons for making an estimate of the cost of the goods on hand are:
a. The inventory is destroyed by fire and other catastrophe or theft of the merchandise has occurred and the
amount of inventory is required for insurance purposes.
b. A physical count of the goods on hand is made and it is necessary to prove the correctness or
reasonableness of such count by making an estimate. – gross profit test
c. Interim financial statements are prepared and a physical count of the goods on hand is not necessary
because it may take time to do the same.

Gross profit method

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

Basic formula under gross profit method

GOODS AVAILABLE FOR SALE xx

Less: COST OF GOODS SOLD xx

ENDING INVENTORY xx

Goods available for sale

The usual items affecting the goods available for sale are:

Beginning inventory xx

Purchases xx

Add: Freight in xx

Total xx

Less: Purchase return, allowance, and discount xx xx

Goods available for sale xx

Cost of goods sold

 The gross profit method is so called because the cost of goods sold is computed through the use of gross profit
rate.
 The cost of goods sold is computed as follows:
a. Net sales multiplied by cost ratio – this formula is used when the gross profit rate is based on sales.
b. Net sales divided by sales ratio – this formula is used when the gross profit rate is based on cost.

Illustration
Beginning inventory 100,000

Net purchase 500,000

Net sales 700,000

Gross profit rate based on sales 40%

The ending inventory is computed as follows:

Beginning inventory 100,000

Net Purchases 500,000

Goods available for sale 600,000

Less: Cost of goods sold:

Net sales 700,000

Multiply by cost ratio 60% 420,000

Ending inventory 180,000

Illustration

Beginning inventory 200,000

Net purchase 1,000,000

Net sales 1,260,000

Gross profit rate based on cost 40%

The ending inventory is computed as follows:

Beginning inventory 200,000

Net Purchases 1,000,000

Goods available for sale 1,200,000

Less: Cost of goods sold:

Net sales 1,260,000

Divide by sales ratio 140% 900,000

Ending inventory 300,000

Computation of gross profit rate

 Gross profit rate on sales is computed by dividing the amount of gross profit and by the net sales.
 Gross profit rate on sales is a common way of quoting gross margin because goods are stated on a sale price
basis, rather than on a cost basis.
 This is naturally lower than that based on cost and this lower rate creates a favorable impression on the part of
the customers.
 Gross profit rate on cost is computed by dividing the gross profit by the cost of goods sold.

Gross profit rate on cost to gross profit on sales

  If the gross profit rate on cost is 25%, the gross profit rate on sales is computed as follows:

Net sales 125%

Cost of goods sold 100%

Gross profit on cost 25%

Gross profit on sales (25/125) 20%

 Note that cost of sales is 100% because it is the basis of the gross profit.

Gross profit rate on sales to gross profit on cost

 If the gross profit on sales is 20%, the gross profit on cost is computed as follows:

Net sales 100%

Cost of goods sold 80%

Gross profit on sales 20%

Gross profit on cost (20/80) 25%

 Note that net sales is 100% because it is the basis of the gross profit.

Sales allowance and sales discount

 This account is ignored. Thus, not deducted from sales.

 The reason is that while these items decrease the amount of sales, they do not affect the physical volume of
goods sold.
 They do not increase the physical inventory of goods, unlike in sales return where there is an actual addition to
goods on hand.
 To deduct this account from sales would result to overstatement of inventory with a consequent
understatement of cost of goods sold and overstatement of gross income.
 Chapter 14

RETAIL INVENTORY METHOD

Retail inventory method introduction

 Retail inventory method is the other method of estimating the value of inventory.
 PAS 2, paragraph 22, provides that this method is often used in the retail industry for measuring inventory of
large number of rapidly changing items with similar margin for which it is impracticable to use other costing
method.
 Employed by department stores, supermarkets and other retail concerns where there is a wide variety of goods.

Information required

 The use of retail inventory method requires hat records be kept which must show the following data:
a. Beginning inventory at cost and at retail price
b. Purchases during the period at cost and at retail price
c. Adjustments to the original retail price such as additional markup, markup cancelation, markdown, and
markdown cancelation
d. Other adjustments such as department transfer, breakage shrinkage, theft, damaged goods and employee
discount

Basic formula

 Very similar with gross profit method

 The difference is that under gross profit method, the ending inventory is stated at cost while under the retail
inventory method, the ending inventory is expressed in terms of selling price.

Goods available for sale at retail price xx

Less: Net sales (gross sales - sales return only) xx

Ending inventory at selling price xx

Multiply by cost ratio xx

Ending inventory at cost xx

Goods available for sale at cost

Cost ratio =
goods available for sale at selling price
Illustration

Cost Retail

Beginning inventory 150,000 230,000

Purchases 400,000 650,000

Freight in 10,000

Purchase return (55,000) (80,000)

Purchase allowance ( 5,000)

Purchase discount (20,000)

Goods available for sale 480,000 800,000

Cost ratio (480,000/800,000) 60%

Less: Sales 630,000

Sales return (30,000) 600,000

Ending inventory at retail 200,000

Ending inventory at cost (200,000 x60%) 120,000

Treatment of items

a. Purchase discount – deducted from purchases at cost only.

b. Purchase return – deducted from purchases at costa and at retail.
c. Purchase allowance – deducted from purchases at cost only.
d. Freight in 0 addition to purchases at cost only
e. Departmental transfer in or debit – addition to purchases at cost and at retail.
f. Departmental transfer out or credit – deduction from purchase cost and at retail.
g. Sales discount and sales allowance – disregarded, meaning not deducted from sales.
h. Sales return – deducted from sales. If the account is sales return and allowance, the same should be deducted
from sales.
i. Employee discount – added to sales.
j. Normal shortage, shrinkage, spoilage or breakage – this is deducted from goods available for sale at retail. Any
normal shortage is usually absorbed or included in cost of goods sold.
k. Abnormal shortage, shrinkage, spoilage or breakage – deducted from goods available for sale at both cost and
retail so as not to distort the cost ratio. Any abnormal amount is reported separately as loss.

Items related to retail method

 The original sales price is frequently raised or lowered particularly at the end of the selling season where
replacement costs are changing.
a. Initial markup – original markup on the cost of goods.
b. Original retail – the sales price at which the gods are first offered for sale.
c. Additional markup 0 increase in sales price above the original sales price.
d. Markup cancelation – decrease in sales price that does not decrease the sales price below the original sales
price.
e. Net additional markup or net markup – markup minus markup cancelation.
f. Markdown – decrease in sales price below the original sales price.
g. Markdown cancelation – increase in sales price that does not increase the sales price above the original sales
price.
h. Net markdown – markdown minus markdown cancelation.
i. Maintained markup – difference between cost and sales price after adjustment for all of the above items.
Sometimes referred to as markon.

Illustration

Cost 200

a. Initial markup 40
 b. Original retail or sales price 240
c. Additional markup 60

New sales price 300

d. Markup cancelation 40

New sales price (not below the original sales price) 260

e. Net markup (60-40) at this point, the item is marked down to 210 20
Markup cancelation 20
f. Markdown ( decrease in sales price below the original sales price) 30 50
New sales price 210
g. Markdown cancelation (increase in sales price that does not increase the
New sales price above the original sales price of 240) 20
New sales price 230
h. Net markdown (30-20) 10
i. Maintained markup (230-200) 30

Approach in the use of retail method

 To obtain the appropriate inventory value under the retail inventory method, three approaches are followed,
namely:
a. Conservative or conventional or lower of cost and net realizable value approach
b. Average cost approach
c. FIFO approach

Illustration

Cost Retail

Beginning inventory 180,000 250,000

Net purchase 1,020,000 1,575,000

Additional markup 200,000

Markup cancelation 25,000

Markdown 140,000

Markdown cancelation 15,000

Sales 1,450,000

Sales return 50,000

Sales allowance 10,000

Sales discount 20,000

Employee discount 40,000

Spoilage and breakage 35,000

Conservative and average cost

Cost Retail
Beginning inventory 180,000 250,000

Net purchases 1,020,000 1,575,000

Additional markup 200,000

Markup cancelation (25,000)

GAS – conservative 1,200,000 2,000,000

Cost ratio (1,200,000 / 2,000,000) 60%

Markdown (140,000)

Markdown cancelation 15,000

GAS – Average 1,200,000 1,876,000

Cost ration (1,200,000 / 1,875,000) 64%

Less: Sales 1,450,000

Sales return (50,000)

Employee discount 40,000

Spoilage and breakage 35,000 1,475,000

Ending inventor at retail 400,000

Conservative cost (400,000 x 60%) 240,000

Average cost (400,000 x 64%) 256,000

Computation of cost of goods sold

Conservative Average

Goods available for sale 1,200,000 1,200,000

Ending inventory (240,000) (256,000)

Cost of goods sold 960,000 944,000

 The conservative approach includes markup and excludes net markdown in determining the cost ratio in order
to arrive a conservative cost.
 Conservative cost is lower than the average cost. Thus, this approach is also known as the lower of average cost
or marker.
 The average cost approach includes both net markup and net markdown in determining cost ratio.
 The reason for such an approach is to arrive at an inventory that will approximate or equal historical cost.
 PAS 2, paragraph 22, provides that the percentage used under the retail method shall take into consideration
inventory that has been marked down to below the original selling price.
 Average cost approach shall be applied in conjunction with the retail inventory method.

FIFO retail approach

 Similar to the average cost approach in that it considers both net markup and net markdown in computing the
cost ratio.
 However, a current cost ratio is determined every year considering the net purchases during the year and
excluding the beginning inventory.
  FIFO approach is based on the assumption that markup and markdown apply to goods purchased during the
year and not to beginning inventory.

Illustration – FIFO retail

Cost Retail

Beginning inventory 495,000 900,000

Purchase 1,800,000 3,300,000

Net markup 300,000

Net markdown 600,000

Net sales 2,700,000

The ending inventory using FIFO retail approach is computed as follows:

Cost Retail

Beginning inventory 495,000 900,000

Purchases 1,800,000 3,300,000

Net markup 300,000

Net markdown (600,000)

Net purchases 1,800,000 3,000,000

Current year cost ratio (1,800,000 / 3,000,000) 60%

Goods available for sale 2,295,000 3,900,000

Less: Net sales 2,700,000

Ending inventory at retail 1,200,000

FIFO cost (1,200,000 x 60%) 720,000

The cost of goods sold is ordinarily computed.

Goods available for sale 2,295,000

Ending inventory at FIFO cost (720,000)

Cost of goods sold 1,575,000

Chapter 15

FINANCIAL ASSET AT FAIR VALUE

Investments

 The international Accounting Standards Board defines investment as follows

Investments are assets held by an entity for the accretion of wealth through distribution such as interest,
royalties, dividends and rentals, for capital appreciation or for other benefits to the investing entity such as
those obtained through trading relationships.
 Investments are assets not directly identified with the operating activities of an entity.

Purposes of investments

 Investments are held for diverse reasons such as:

a. For accretion of wealth or regular income through interest, dividends, royalties and rentals.
b. For capital appreciation as in the case of investments in land and real estate held for appreciation and direct
investments in gold, diamond and other precious commodities.
c. For ownership control as in the case of investments in subsidiaries and associates.
d. For meeting business requirements as in the case of sinking fund, preference share redemption fund, plant
expansion fund and other noncurrent fund.
e. For protection as in the case of interest in life insurance contract in the form of cash surrender.

Examples of investments

1. Trading securities or financial asset at fair value through profit or loss

2. Financial asset at fair value through other comprehensive income
3. Investment in nontrading equity securities
4. Investment in bonds or financial asset at amortized cost
5. Investment in associate
6. Investment in subsidiary
7. Investment property
8. Investment in fund
9. Investment in joint venture

Statement classification

 Investments are classified either as current or noncurrent assets.

 Current investments are investments that are by their very nature readily realizable and are intended to be held
for not more than one year.
 Trading securities are normally classified as current asset because they are expected t be realized within twelve
months after the end of reporting period.
 Noncurrent investments are intended to be held for more than one year or are not expected to be realized
within twelve months after the end of the reporting period.

Financial asset

 A financial asset is any asset that is:

a. Cash
 b. A contractual right to receive cash or another financial asset from another entity.
c. A contractual right to exchange financial instrument with another entity under conditions that are
potentially favorable.
d. An equity instrument of another equity.

Examples of financial assets

 Cash or currency – it represents a medium of exchange and therefore the basis on which all transactions are
measured and recognized in financial statements.
 Deposit of cash – it represents a contractual right of depositor to obtain cash from the bank or to draw a check
against the balance in favor of a creditor om payment of a financial liability.
Note: Gold bullion deposited in bank is not a financial asset because although it is very precious gold the gold is
a commodity.
 Financial assets representing a contractual right to receive cash in the future include trade accounts receivable,
notes receivable and loans receivable.
 In exchange of financial instruments with another entity, conditions are potentially favorable when such
exchanges will result to gain. Example: an option held by the holder to purchase shares of another entity at less
than market price.

Not considered financial assets

 Intangible assets
 Physical assets such as inventory and property, plant, and equipment
 Prepaid expenses
 Leased assets

Classification of financial assets

Under PFRS 9, paragraph 4.1.1, financial assets are classified into three, namely:

1. Financial assets at fair value through profit or loss – include both equity securities and debt securities.
2. Financial assets at fair value through other comprehensive income – include both equity securities and debt
securities.
3. Financial assets at amortized cost – include only debt securities.

The classification depends on the business model for managing financial assets which may be:

a. To hold investments in order to realize fair value changes

b. To hold investments in order to collect contractual cash flows
c. To hold investments in order to collect contractual cash flows and sell the investment.

Equity security

 Encompasses any instrument representing ownership shares and right, warrants or options to acquire or dispose
of ownership shares at a fixed or determinable price.
 Represents an ownership interest in an entity.
 Ownership shares include ordinary shares, preference shares and right or option to acquire ownership shares.
 Owners are known as shareholders.
 A share is the ownership interest or right of a shareholder in an entity. It is evidenced by share certificate.
 This right pertains to the share in earnings, election of directors, subscription for additional shares and share in
net assets upon liquidation.
 Equity securities do not include redeemable preference shares, treasury shares and convertible debt.

Debt security
  Any security that represents a creditor relationship with an entity.
 It has a maturity date and a maturity value.
 Examples:
a. Corporate bonds
b. BSP treasury bills
c. Government securities
d. Commercial papers
e. Preference shares with mandatory redemption date or are redeemable at the option of the holder.

Initial measurement of financial asset

 PFRS 9, paragraph 5.1.1, provides that at initial recognition, an entity shall measure a financial asset at fair value
plus, in the case of financial asset not at fair value through profit or loss, transaction costs that are directly
attributable to the acquisition of the financial asset.
 The fair value of a financial asset at initial recognition is normally the transaction price.
 Financial asset is recognized initially at fair value.
 Transaction costs that are directly attributable to the acquisition of the financial asset shall be capitalized as cost
of the financial asset.
 However, if the financial asset is held for trading, or measured at fair value through profit or loss, transaction
costs are expensed outright.
 Transaction costs – include fees and commissions paid to agents, advisers, brokers and dealers, levies by
regulatory agencies and securities exchanges and transfer taxes and duties. – do not include debt premiums or
discounts, financing costs and internal administrative or holding costs.

Subsequent measurement

 PFRS 9, paragraph 5.2.1, provides that after initial recognition, an entity shall measure a financial asset at:
a. Fair value through profit or loss
b. Fair value through other comprehensive income
c. Amortized cost

Financial assets at fair value through profit or loss

1. Financial assets held for trading or popularly known as trading securities.

2. All other investments in quoted equity instruments.
3. Financial assets that are irrevocably designated on initial recognition as at fair value through profit or loss
4. All debt investments that do not satisfy the requirements for measurement at amortized cost and at fair value
through other comprehensive income.

Financial asset held for trading

 Appendix A of PFRS 9 provides that a financial asset is held for trading if:
a. It is acquired principally for the purpose of selling or repurchasing it in the near term.
b. On initial recognition, it is part of a portfolio identified financial assets that are managed together and for which
there is evidence of a recent actual pattern of short-term profit taking.
c. It is derivative, except for a derivative that is a financial guarantee contract or a designated and an effective
hedging instrument
 Trading securities are debt and equity securities that are purchased with the intent of selling them in the near
term.

Equity investment at fair value through OCI

  At initial recognition, PFRS 9, paragraph 5.7.5 provides that an entity may make an irrevocable election to
present in other comprehensive income subsequent changes un fair value of an investment in equity instrument
that is not held for trading.
 Irrevocable approach is designed to impose discipline in accounting for nontrading equity investment.
 The amount recognized in OCI is not reclassified to profit or loss under any circumstances.
 On derecognition, the amount may be transferred to equity or retained earnings.
 Investment in equity instrument is held for trading, the election to present gain and loss in OCI is not allowed.
 Investment in equity instrument is held for trading, subsequent changes in fair value are always included in
profit or loss.

Debt investment at amortized cost

 PFRS 9, paragraph 4.1.2, provides that a financial asset shall be measured at amortized cost if both of the
following conditions are met:
a. The business model is to hold the financial asset in order to collect contractual cash flows on specified date.
b. The contractual cash flows are solely payments of principal amount outstanding.

Debt investment at fair value through OCI

 PFRS 9, paragraph 4.1.2A, provides that a financial asset shall be measured at fair value through OCI if both of
the following conditions are met:
a. The business model is achieved both by collecting contractual cash flows and by selling the financial asset.
b. The contractual cash flows are solely payments of principal and interest on the principal outstanding.

Fair value

 Fair value of an asset is the price that would be received to sell an asset in an orderly transaction between
market participants at the measurement date.
 The best evidence of fair value in descending hierarchy is the quoted price of identical asset in an active market,
the quote price of similar asset in as active market and the quoted price of identical and similar asset in an
inactive market.
 Active market – transactions take place with sufficient regularity and volume to provide pricing information on
an ongoing basis.
 Fair value – price agreed by seller and buyer in an arm’s length or orderly transaction.

Quoted price

 If the quoted price pertains to a share or equity security, it means pesos per share.
 If the quoted price pertains to a bond or debt security, it means percent of the face amount of the bond.

Gain and loss – financial asset at fair value

 Under PFRS 9, paragraph 5.7.1, gain and loss on financial asset measured at fair value shall be presented in
profit or loss except:
a. When the financial asset is an investment in nontrading equity instrument and the entity has irrevocable elected
to present unrealized gain and loss in OCI.
b. When the financial asset is a debt investment that is measured at fair value through OCI.

Gain and loss – financial asset at amortized cost

 Unrealized gain and loss on financial asset at amortized cost are not recognized simply because such
investments are not reported at fair value.
  PFRS 9, paragraph 5.7.2, provides that gain and loss on financial asset measured at amortized cost shall be
recognized at profit or loss when the financial asset is derecognized, sold, impaired or reclassified and through
the amortization process.

Sale of trading securities

 PFRS 9, paragraph 3.2.12, privodes that trading investment, the difference between the cash received and the
carrying amount is recognized as gain or loss on disposal to be reported in the income statement.

Equity investment at fair value through OCI

 As stated earlier, at initial recognition, an entity may make an irrevocable election to present in other
comprehensive income subsequent changes in value of an investment in nontrading equity instrument.

Sale of equity investment – FVOCI

 Gain or loss on disposal of equity investment measured at fair value through other comprehensive income is
recognized in retained earnings in accordance with PFRS 9 Application guidance paragraph 5.7.1

Impairment – equity investments at fair value

 For financial assets measured at fair value, all gains and losses are either presented in profit or loss or in OCI
depending whether the election to present gains and losses on equity investments in OCI is taken or not.
 It is not necessary to assess financial assets measured at fair value through profit or loss and equity investments
measured at fair value through OCI for impairment.

Impairment – debt investments

 PFRS 9, paragraph 5.5.1, provides that an entity shall recognized expected credit loss on:
a. Debt investment measured at amortized cost
b. Debt investment measured at fair value through other comprehensive income
 Paragraph 5.5.3 provides that an entity shall measure the loss allowance for a financial instrument at an
amount equal to the lifetime expected credit loss if the credit risk on that financial instrument has increased
significantly since initial recognition.
 Credit loss is the present value of all cash shortfalls.
 Expected credit loss is an estimate of credit loss over the life of the financial instrument.
Chapter 16

EQUITY INVESTMENTS – DIVIDENDS, SHARE SPLIT AND SHARE RIGHT

Acquisition by exchange

 If equity securities are acquired in an exchange, the acquisition cost is determined by reference to the following
in the order of priority:
a. Fair value of asset given
b. Fair value of asset received
c. Carrying amount of asset given

Lump sum acquisition

 If two or more equity securities are acquired at a single cost or lump sum, the single cost is allocated to the
securities acquired on the basis of their fair value.
 If only one security has a known market value, an amount is allocated to the security with a known market
value equal to its market value.
 The remainder of the single cost is then allocated to the other security with no known market value.

Investment categories

 Investments in equity securities are accounted for as one of the following categories:
a. Trading securities or financial assets at fair value through OCI
b. Financial assets at fair value through OCI
c. Investment in associate
d. Investment in subsidiary
e. Investment in unquoted equity instruments
f. Investment in equity instrument

Investment in unquoted equity instruments

 Under the Application of Guidance B5.4.14 of PFRS 9, all investments in equity instruments shall be measured at
fair value.
 However, investments in unquoted equity instruments are measured at cost if the fair value cannot be
measured reliably.

Sale of equity shares

 PFRS 9, paragraph 3.2.12, provides that on derecognition of a financial asset measured at fair value through
profit or loss, the difference between the consideration received and the carrying amount of the financial
asset shall be recognized in profit or loss.
 When equity shares are of the same class acquired on different dates at different costs, a problem will arise
as to the determination of cost of shares sold when only a portion is subsequently sold.
 In this case, the entity shall determine the cost of the shares sold using either the FIFO or average cost
approach.
Cash dividends

 If measured at fair value through profit or loss or at fair value through OCI or cost, dividends are considered as
income.
a. When the cash dividends are earned but not received.
Dividends receivable xx
Dividend income xx
b. When the cash dividends are subsequently received:
Cash xx
Dividends receivable xx
 The cash dividends do not affect the investment account.

When are dividends considered earned?

a. Date of declaration – this is the date on which the payment of dividends is approved by the Board of Directors.
b. Date of record – this is the date on which the stock and transfer book of the corporation is closed for
registration.
c. Date of payment – this is the date on which the dividends declared shall be paid.
 Between the date of declaration and the record date, the shares are selling dividend-on. This means that when
shares are sold after the date of declaration but prior to record date, they carry with them the right to receive
dividends.
 Between the date of record and the date of payment, the shares are selling ex-dividend which means that the
shares can be sold, and still the original shareholder has the right to receive the dividends on payment date.

When to recognize dividends as income

 Dividends shall be recognized as revenue when the shareholder’s right to receive payment is established.
 Dividends shall be recognized as revenue on the date of declaration.
 The remainder of the sale price should be used as basis for determining gain or loss on the sale of the
investment.

Illustration

 A shareholder owns 1,000 shares costing P100,000. Subsequently, the shareholder receives notice of dividend
declaration of P5 per share or P5,000.
 If prior to record date, the shareholder sells the investment for P150,000 which includes the dividend of P5,000,
the journal entry to record the sale is:

Cash 150,000

Investment in shares 100,000

Dividend income 5,000

Gain on sale of investment 45,000

Property dividends

 Dividends in the form of property or noncash assets.

 Also considered as income and recorded at fair value.

Noncash assets xx

Dividend income xx

Liquidating dividends
  Represent return of invested capital and therefore, are not income. The payment may be in the form of cash or
noncash assets.
 It is recognized as follows:

Cash or other appropriate amount xx

Investment in shares xx

 Normally it is paid when corporation is dissolved and liquidated.

 However, in wasting asset corporation or mining entity, liquidating dividends maybe paid even before
dissolution and liquidation.
 When it exceeded the cost of investment, the difference is credited as gain on investment.

Share dividends or stock dividends

 Are in the form of the issuing entity’s own shares. The IAS term for share dividend is bonus issue.
 Shares of another entity declared as dividends are not share dividends but property dividends.

Kinds of share dividends

 Share dividends may be the same as those held or different from those held.
 Share dividends whether of the same class or different are not income. The reason is that there is no distribution
of the assets of the entity.

Share dividends of the same class

 Recorded only by means of a memorandum entry on the part of the shareholder. An example of memorandum
entry on the part of the shareholder.
 Share dividends do not affect the total cost of investment but reduce the cost of the investment per share.

Share dividends different from those held

 These are not income.

 However, the original cost of the investment is apportioned between the original shares and the share dividends
on the basis of market value of each at the date of receipt.

Shares received in lieu of cash dividends

 it is generally accepted that shares received in lieu of cash dividends are income at fair value of the shares
received.
 In the absence of fair value of the shares received, income is equal to the cash dividends that would have been
received.

Cash received in lieu of share dividends

 The as if approach is followed. This means that the share dividends are assumed to be received and
subsequently sold at the cash received. Therefore, a gain or loss may be recognized.

As If approach

 The original cost of P1,100,000 applies to 11,000 shares which is the sum of the original 10,000 shares and the
1,000 shares assumed to be received as share dividends. The cost per share would then be P100.
 The 1,000 shares representing share dividends are assumed to be sold for the cash received.

Cash 150,000

Investment in shares 100,000

 Gain on investment 50,000

BIR approach

 Under the ruling of BIR, all cash received whether originally designated as cash dividend or share dividend, is
recognized as income.
 Under this approach, the cash received of P150,000 is simply debited to cash and credited to dividend income.
 However, the as if approach is theoretically sound and should be followed for financial accounting purpose.

Share split

 A corporation may restructure its capital by effecting a change in the number of shares without capitalizing
retained earnings or changing the amount of its legal capital.
 Share split may be split up or split down.
 Split up is a transaction whereby the outstanding shares are called in and replaced by a larger number,
accompanied by a reduction in the par or stated value of each share.
 For example, if a shareholder owns 10,000 shares and the share is split up 5-for-1, the shareholder receives
50,000 new shares in exchange for the original 10,000 shares.
 Split down is a transaction whereby the outstanding are called in and are replaced by smaller number,
accompanied by an increase in the par or stated value.
 For example, if a shareholder owns 10,000 shares and the share is split down 5-for-1, the shareholder receives
2,000 new shares in exchange for the original 10,000 old shares.
 Share split does not affect the total cost of investment but there is a decrease or an increase in the cost per
share.

Special assessment

 Are additional capital contribution of the shareholders.

 On the part of the shareholders, special assessments are recorded as additional cost of investments

Redemption of shares

 Redemption of shares is recorded in the same manner as sale of share. The redemption price is treated as the
sale price.

Share right or stock right

 Share right or preemptive right is a legal right granted to shareholders to subscribe for new shares issued by a
corporation at a specified price during a definite period.
 The IAS term for share right is right issue.
 A share right is inherent in every share. A shareholder receives one right for every share owned.
 Share right is valuable to a shareholder because the price at which the new shares are sold is generally below
the prevailing market price.
 The purpose is to preserve their equity interest in the corporation.
 The ownership of share rights is evidenced by instruments or certificates called share warrants.

Accounting for share rights

 PFRS 9 does not address this accounting issue categorically. But unquestionably, a share right is a form of a
financial asset.
 There are two schools of thought on the matter, namely:
1. Share rights are accounted for separately
2. Share rights are not accounted separately

Accounted for separately

  When share rights are issued, the investor is now the owner of two financial assets, namely the original shares
from which they are derived.
 Share rights are normally classified as current assets if the rights are accounted for separately.

Not accounted for separately

 Share rights are recognized as embedded derivative but not a stand-alone derivative.
 Accordingly, the share right as an embedded derivative is not accounted for separately because the host
contract investment in equity instrument is a financial asset.

Between the date of declaration and date of record

 During this period the shares are considered to be selling right-on, this means that the share and the right are
inseparable and are treated as one.
 Shares cannot besold without selling the right or vice versa.

Between the date of record and expiration date

 On the date of record, the warrants evidencing the share rights are issued to the shareholders. On or after this
date, the shares are said to be the selling ex-right.
 This means that the share can now be sold separate from the right and vice versa.

Exercise of share right

 When share rights are exercised, the cost of the new investments includes the subscription price and the cost of
the share rights exercised.

Sale of share rights

 The share rights are financial assets separate from the original shares. Accordingly, the share rights can be sold
independently of the original investment.

Expiration of share rights

 Share rights can be exercised inly up to a certain date after which the rights become worthless.
 Thus, if the rights are not exercised but expired, loss on share rights is debited while share rights are credited.

Where the share is selling right on

market value of share ¿−on−subscription price ¿ purchase one share+1 ¿ = Value of one right
number of rights ¿
Where the share is selling ex-right

market value of share ex−¿−subscription price

purchase one share ¿ = Value of one right
number of rights ¿
Chapter 17

INVESTMENT IN ASSOCIATE

Intercorporate share investment

 The purchase of the equity shares of one entity by another entity.

 It is a case of one entity investing in another entity through the acquisition of share capital.
 An entity may purchase enough shares of another entity in order to exert significant influence over the financial
and operating policies of the investee entity.

Significant influence

 The power to participate in the financial and operating policy decisions of the investee but not control or joint
control over those policies.
 20% or more of the voting power of the investee, it is presumed that the investor has significant influence,
unless it can be clearly demonstrated that this is not the case.
 Less than 20% of the voting power of the investee, it is presumed that the investor does not have significant
influence, unless such influence can be clearly demonstrated.
 Beyond the mere 20% threshold of ownership, PAS 28, paragraph 6, provides that the existence of significant
influence is usually evidenced by the following factors:
a. Representation in the board of directors
b. Participation in policy making process
c. Material transactions between the investor and the investee
d. Interchange of managerial personnel
e. Provision of essential technical information

Potential voting rights

 PAS 28, paragraph 7, provides that the existence of such voting rights is considered in assessing whether an
entity has significant influence.
 The possible voting rights should be currently exercisable or convertible.

Loss on significant influence

 An entity loses significant influence over an investee when it loses the power to participate in the financial and
operating policy decisions of the investee.
 The loss of significant influence can occur with or without change in the absolute or relative ownership interest.
 It can also occur as a result of a contractual agreement.

Equity method

 Based on the economic relationship between the investor and the investee.
 Viewed as a single economic unit.
 Applicable when the investor has a significant influence over the investee.

Accounting procedure
 a. The investment is initially recognized at cost.
b. The carrying amount is increase by the investor’s share of profit of the investee and decreased by the investor’s
share of the loss of the investee. Profit or loss of the investee is recognized as investment income.
c. Distributions or dividends received from an equity investee reduce the carrying amount of the investment.
d. Note that the investment must be in ordinary shares.
e. Technically, if the investor has significant influence over the investee, the investee is said to be an associate.
f. The investment in associate accounted for using the equity method shall be classified as noncurrent asset.

Excess of cost over carrying amount

 If the investor pays more than the carrying amount of the net assets acquired, the difference is commonly
known as excess of cost over carrying amount and may be attributed to the following:
a. Undervaluation of the investee’s assets such as buildings, land, and inventory
b. Goodwill
 If the assets of the investee are fairly valued, accountants frequently attribute the excess of cost over carrying
amount of underlying net assets to goodwill.
 If the excess is attributable to undervaluation of depreciable asset, it is amortized over the remaining life of the
depreciable asset.
 If the excess is attributable to undervaluation of land, it is not amortized because the land is nondepreciable.
 The amount is expensed when the land is sold.
 If the excess is attributable to inventory, the amount is expensed when the inventory is sold.
 If the excess is attributable to goodwill, it is included in the carrying amount of the investment and not
amortized.

Excess of net fair value over cost

 PAS 28, paragraph 32, provides that any excess of the investor’s share of the net fair value of the associate’s
identifiable assets and liabilities over the cost of the investment is included as income in the determination of
the investor’s share of the associate’s profit or loss in the period in which the investment is acquired.

Investee with heavy losses

 PAS 28, paragraph 38, provides that if an investor’s share of losses of an associate equals or exceed the carrying
amount of an investment, the investor discontinues recognizing its share of further losses.
 The investment is reported at nil or zero value.
 The carrying amount of the investment in associate is not just the balance of account investment in associate.
 It also includes other long-term interests in an associate such as long-term receivables, loans and advances and
investment in preference shares.
 Excluded: trade receivables and any long-term receivables such as secured loans.

Impairment loss

 If there is an indication that an investment in associate may be impaired, PAS 28, paragraph 40, requires that an
impairment loss shall be recognized whenever the carrying amount of the investment in associate exceeds
recoverable amount.
 The recoverable amount is measured as the higher between fair value less cost of disposal and value in use.
 Fair value is the price that would be received to sell an asset in an orderly transaction between the market
participants at the measurement date.
 Value in use of an investment in associate is the investor’s share in either of the following:
a. Present value of estimated future cash flows expected to be generated by the investee, including cash
flows from the operations of the investee and the proceeds on the ultimate disposal of the investment.
 b. Present value of estimated future cash flows expected to arise from dividends to be received from the
investment and from its ultimate disposal.
 PAS 28, paragraph 42, states that since goodwill is not separately recognized from the investment amount, the
impairment loss recognition is applied to the investment as a whole.
 The recoverable amount of an investment in associate is assessed for each individual associate.
 An exception is when an individual associate does not generate cash inflows from continuing use that are largely
independent of those from other assets of the reporting entity.

Investee with preference shares

 When an associate has outstanding cumulative preference shares, the investor shall compute its share of
earning or losses after deducting the preference dividends, whether or not such dividends are declared.
 When an associate has outstanding noncumulative preference shares, the investor shall compute its share of
earning after deducting the preference dividends only when declared.
Chapter 18

INVESTMENT IN ASSOCIATE – OTHER ACCOUNTING ISSUES

Adjustment of investee’s operations

a. The most recent available financial statements of the associate are used by the investor in applying the equity
method. When the reposting dates of the investors and the investee are different, the associate shall prepare
for the use of the investor financial statements as of the same date as the financial statement of the investor
unless it is impracticable to do so. In any case, the difference between the reporting date of the associate and
that of the investor shall be no more than three months.
b. If an associate uses accounting policies other than those of the investor, adjustments shall be made to conform
the associate’s accounting policies to those of the investor.
c. Profits and losses resulting from upstream, and downstream transactions between an investor and an associate
are recognized in the investor’s financial statements only to the extent of the unrelated investors’ interests in
the associate. The investor’s share in the associate’s profits and losses resulting from these transactions is
eliminated.

Upstream transactions

 Sales of assets from an associate to the investor.

 Unrealized profit from these transactions must be eliminate in determining the investor’s share in the profit or
loss of the associate.

Downstream transactions

 Sales of assets from the investor to associate.

 Unquestionably, the unrealized profit from these transactions must also be eliminated as prescribed by
Paragraph 28 or PAS 28.

Discontinuing of equity method – change from equity

 PAS 28, paragraph 22, provides that an investor shall discontinue the use of the equity method from the date
that is ceases to have significant influence over an associate.
 Consequently, the investor shall account for the investment as follows:
a. Financial asset at fair value through profit or loss
b. Financial asset at fair value through other comprehensive income
c. Nonmarketable investment at cost or investment in unquoted equity instrument
 Significant influence must be lost before the equity method ceases to be applicable.

Measurement after loss of significant influence

 PAS 28, paragraph 22, provides that on the date the significant influence is lost, the investor shall measure any
retained investment in associate at fair value.
 The difference between the carrying amount of the retained investment at the date the significant influence is
lost and the fair value of the retained investment shall be included in profit or loss.
  Paragraph 22 further provides that the fair value of the investments at the date it ceases to be an associate shall
be regarded as the fair value in initial recognition as a financial asset.

Equity method not applicable

 PAS 28, paragraph 17, provides that an investment in associate shall not be accounted for using the equity
method if the investor is a parent that is exempt from preparing consolidated financial statements or if all of the
following apply:
a. The investor is wholly-owned subsidiary, or a partially owned subsidiary of another entity and the other
owners do not object to the investor not applying the equity method.
b. The investor’s debt and equity instruments are not traded in a public market or over the market.
c. The investor did not file or it is not in the process of filing financial statements with the SEC for the purpose
of issuing any class of instruments in a public market.
d. The ultimate or any intermediate parent of the investor produces consolidated financial statements
available for public use that comply with the PFRS.

Associate held for sale

 PAS 28, paragraph 20, provides that if the investment in associate is classified as held for sale, it is accounted for
in accordance with PFRS 5.
 The investment in associate classified as held for sale shall be measured at the lower of carrying amount and fair
value less cost of disposal.

Investment of less than 20%

 If the investor holds, directly or indirectly, through subsidiaries less than 20% of the voting power of the
investee, it is presumed that the investor does not have significant influence, unless such influence can be
clearly demonstrated.

Accounting for investment of less than 20%

a. Fair value method – applicable to financial asset measured at fair value through profit or loss and financial asset
measured at fair value through OCI.
b. Cost method – usually applied with respect to investment in unquoted equity instrument or nonmarketable
equity investments.
 under these methods, the investor does not share in the profit or loss of the investee because of the legal
relationship between the investor and the investee.

Dividend from preacquisition retained earnings

 there is no longer a distinction between preacquisition dividends and postacquisition dividends.

 In applying the fair value and cost method, dividends received from an investee are recognized as dividend
income, regardless of whether the dividends originated from preacquisition retained earnings or postacquisition
retained earnings.

Investment in associate achieved stages

 Not covered by PAS 28. However, this is parallel to a business combination achieved in stages.
 PFRS 3, paragraph 42, provides that in a business combination achieved in stages, the acquirer shall remeasure
the previously held equity interest at fair value and recognize the resulting gain or loss in profit or loss.

Fair value approach

a. The existing interest in the associate is remeasured at fair value with any change in fair value included in profit
or loss.
 b. If the existing interest is accounted for at fair value through OCI, any unrealized gain or loss at the date the
investee becomes an associate is reclassified to retained earnings.
c. The fair value of the existing interest plus the cost of the additional interest acquired constitutes the total cost of
the investment for the initial application of the equity method.
d. The total cost of the investment for the initial application of the equity method minus the carrying amount of
the net assets acquired at the date of significant influence is obtained equals excess of cost over carrying
amount or excess net fair value.

Chapter 19

FINANCIAL ASSET AT AMORTIZED COST – BOND INVESTMENT

Definition of bond

 Bond is a formal unconditional promise made under seal to pay a specified sum of money at a determinable
future date, and to make periodic interest payments at a stated rate until the principal sum is paid.
 Bond is a contract of debt whereby one party called the issuer borrows fund from another party called the
investor.

Interest payment date

 the interest on the bond either as temporary or permanent investment is usually paid semiannually or every siz
months as follows:
a. January 1 and July 1
b. February 1 and August 1
c. March 1 and September 1
d. April 1 and October 1
e. May 1 and November 1
f. June 1 and December 1
 Of course, there are certain bonds that pay interest annually.

Classification of bond investments

 Bonds may be acquired as current or noncurrent investment depending on the business model of managing
financial assets.
 Accordingly, bond investments are classified and accounted for as follows:
a. Financial assets held for trading
b. Financial asset at amortized cost
c. Financial asset at fair value through OCI
d. Financial asset at fair value through profit or loss by irrevocable designation or by fair value option

Initial measurement

 In accordance with PFRS 9, paragraph 5.1.1, bond investments are recognized initially at fair value plus
transaction costs that are directly attributable to the acquisition.
 Transaction costs attributable to the acquisition of bond investments held for trading or at fair value through
profit or loss are expensed immediately.

Subsequent measurement

a. At fair value through profit or loss

b. At amortized cost
c. At fair value through other comprehensive income.

Acquisition of bond investment

  Bonds may be acquired on interest date or between interest dates.
 When bonds are acquired between interest dates, meaning the date of acquisition os not any one of the interest
dates, the purchase price normally includes the accrued interest.
 That portion of accrued interest should not be reported.
 In effect, two assets are acquired, bond and accrued interest.

Investment in bonds at amortized cost

 PFRS 9, paragraph 4.1.2, provides that a financial asset shall be measured at amortized cost if both of the
following conditions are met:
a. The business model is to hold the financial asset in order to collect contractual cash flows on specified dates.
b. The contractual cash flows are solely payments of principal and interest on the principal amount
outstanding.
 Amortized cost is the initial recognition amount of the investment minus repayments, plus amortization of
discount, minus amortization of premium, and minus reduction for impairment or uncollectibility.

Amortization of premium or discount

 Amortized over the life of the bonds. On the part of the bondholder, the life of the bonds is from the date of
acquisition to the date of maturity.
 Amortization is done through interest income account.
a. Amortization of bond discount:
Investments un bonds xx
Interest income xx
b. Amortization of bond premium:
Interest income xx
Investments in bonds xx

Sales of bonds prior to maturity

 It is necessary to determine the carrying amount of the bond investment to be used as basis in computing gain
or loss on the sale.
 Amortization of the premium or discount should be recognized up to the date of sale.
 The difference between the sale price, after deducting accrued interest, and the carrying amount of the bond
investment, and the carrying amount of the bond investment represents the gain or loss on the sale of the
investment.

Callable bonds

 Those which may be called in or redeemed by the issuing entity prior to their date of maturity.
 The call price or redemption price is at a premium or more than the face amount of the bonds.
 The difference between the redemption price and the carrying amount of the bond investment on the date of
redemption in profit or loss.

Convertible bonds

 Those which give the bondholders the right to exchange their bonds for share capital of the issuing entity at any
prior to maturity.
 Can be classified as financial assets measured at fair value.

Serial bonds

 Those which have a series of maturity dates or those bonds which are payable in installments.
Term bonds

 Those bonds that mature on a single date.

 Callable and convertible bonds can be classified as term bonds despite their special features.

Methods of amortization

a. Straight line method – provides an equal amount of premium or discount amortization each accounting period.
b. Bond outstanding method – applicable to serial bonds and provides for decreasing amount of amortization.
c. Effective interest method – provides for an increasing amount of amortization
 In accordance with PFRS 9, bond investments shall be classified as financial assets measured at amortized cost
using the effective interest method.
Chapter 20

EFFECTIVE INTEREST METHOD – AMORTIZED COST, FVOCI AND FVPL

Introduction

 This method distinguished two kinds of interest rate, namely, nominal and effective rate.
 The nominal rate is the coupon rate or stated rate appearing on the face of the bond.
 The effective rate is the yield rate or market rate which is the actual or true rate of interest which the
bondholder earns on the bond investment. This is the rate that exactly discounts estimated future cash
payments through the expected life of the bond or when appropriate, a shorter period to the net carrying
amount of the bond.

Effective rate versus nominal rate

 They are the same if the cost of the bond investment is equal to the face value.
 When the bonds are acquired at a premium, the effective rate Is lower than the nominal rate. The premium is a
loss on the part of bondholder.
 When bonds are acquired at a discount, the effective rate is higher than the nominal rate. The discount is a gain
on the part of the bondholder.

Effective interest method

 Simply requires the comparison between the interest earned or interest income and the interest received.
 The difference between the two represents the premium or discount amortization.
 Interest income is computed by multiplying the effective rate by the carrying amount of the bond investment.
 Interest received is computed by multiplying the nominal rate by the face amount of the bond. .
 The carrying amount of the bond investment is the initial cost gradually increased by periodic amortization
discount or gradually reduced by periodic amortization of premium.

Bond investment – FVOCI

 PFRS 9, paragraph 4.1.2A, provides that a financial asset shall be measured at fair value through OCI if both of
the following conditions are met:
a. The business model is achieved both by collecting contractual cash flows and by selling the financial asset.
b. The contractual cash flows solely payments of principal and interest on the principal outstanding.

Fair value option

 PFRS 9, paragraph 4.1.5, provides that an entity at initial recognition may irrevocably designate a financial asset
as measured at fair value through profit or loss even if the financial assets satisfies the amortization cost or
FVOCI measurement.
 Under this, all changes in fair value are recognized in profit or loss.
 Interest income is based on the nominal interest rate rather than the effective interest rate.

Market price of bonds

 Equal to the present value of the principal plus the present value of future interest payments using the effective
rate.
Chapter 21

RECLASSIFICATION OF FINANCIAL ASSET

Requirement for reclassification

 PFRS 9, paragraph 4.4.1, provides that an entity shall reclassify financial assets only when it changes the business
model for managing the financial assets.
 Where reclassification occurs, paragraph 5.6.1 provides that an entity shall apply the reclassification
prospectively from the reclassification date.
 The entity shall not restate any previously recognized gains, losses and interest.
 As defined in Appendix A of PFRS 9, he reclassification date is the first day of the reporting period following the
change in the business model that results in an entity reclassifying financial asset.
 This means that if the change in business model is in 2020, the reclassification date is January 1,2021, the first
day of the next reporting period.
 However, the entity must disclose the change in business model in the 2020 financial statements because the
change in the entity’s business model is a significant and demonstrable event.

Exemptions from reclassification

a. Equity investment held for trading or measured at FVPL cannot be reclassified by reason of the consequential
requirement of PFRS 9. Actually, all equity investments cannot be classified.
b. Equity investment measured at FVOCI by irrevocable election cannot be reclassified simply because the election
is irrevocable.
c. Only debt investment can be reclassified because the change in business model applies appropriately to debt
investment. However, debt investment measured at FVPL by irrevocable election cannot be reclassified simply
because the election is irrevocable.

Reclassification from FVPL to amortized cost

 PFRS 9, paragraph 5.6.3, provides the following if a financial asset is reclassified from FVPL to amortized cost:
a. The fair value at the reclassification date becomes the new carrying amount of the financial asset at
amortized cost.
b. The difference between the new carrying amount of the financial asset at amortized cost and the face
amount of the financial asset at amortized cost and the face amount of the financial asset shall be amortized
through profit or loss over the remaining life of the financial asset using the effective interest method.
c. A new effective interest rate must be determined based on the new carrying amount or fair value at
reclassification date.

Reclassification from amortized cost to FVPL

 PFRS 9, paragraph 5.6.2, provides that when an entity reclassifies a financial asset from amortized cost to fair
value is determined at reclassification date.
 The difference between the previous carrying amount and fair value is recognized in profit or loss.

Reclassification from amortized cost to FVOCI

 PFRS 9, paragraph 5.6.2, provides the following if a financial asset is reclassified from amortized cost to FVOCI
a. The financial asset is measured at fair value at reclassification date.
 b. The difference between the amortized cost carrying amount and the fair value at reclassification date is
recognized in other comprehensive income.
c. The original effective interest rate is not adjusted.

Reclassification from FVOCI to amortized cost

 PFRS 9, paragraph 5.6.5, provides the following if a financial asset is reclassified from FVOCI to amortized cost:
a. The fair value at reclassification date becomes the new amortized cost carrying amount.
b. The cumulative gain or loss previously recognized in other comprehensive income is eliminated and adjusted
against fair value at reclassification date. As a result, the investment is reverted back to amortized cost
measurement.
c. The original effective rate is not adjusted.

Reclassification from FVPL to FVOCI

 PFRS 9, paragraph 5.6.6, provides the following if a financial asset is reclassified from FVPL to FVOCI:
a. The financial asset continues to be measured at fair value.
b. The fair value at reclassification date becomes the new carrying amount.
c. A new effective interest rate must be determined based on the new carrying amount or fair value at
reclassification date.

Reclassification from FVOCI to FVPL

 PFRS 9, paragraph 5.6.7, provides the following if a financial asset is reclassified from FVOCI to FVPL:
a. The financial asset continues to be measured at fair value.
b. The fair value at reclassification date becomes the new carrying amount.
c. The cumulative gain or loss previously recognized in other comprehensive income is reclassified to profit or loss
reclassification date.
Chapter 22

INVESTMENT PROPERTY – CASH SURRENDER VALUE

Investment property

 Property (land or building or part of a building or both) held by owner or by the lessee under a finance lease to
earn rentals or for capital appreciation or both.
 Only land and building can qualify as investment property.
 An investment property is not held:
a. For use in the production or supply of goods or services or for administrative purposes.
b. For sale in the ordinary course of business.
 The property held by an owner for use in the production or supply of goods or services or for administrative
purposes is known as owner-occupied property.

Examples of investment property

a. Land held for long-term capital appreciation

b. Land held for a currently undetermined use
c. Building owned by the reporting entity leased out under an operating lease
d. Building that is vacant but is held to be leased out under an operating lease
e. Property that is being constructed or developed for future use as investment property

Items not considered investment property

a. Owner-occupied property or property held for use in the production or supply of goods or services or for
administrative purposes.
b. Property held for future use as owner-occupied property.
c. Property occupied held for future development and subsequent use as owner-occupied property.
d. Property occupied by employees, whether or not the employees pay rent at market rate.
e. Owner-occupied property awaiting disposal.
f. Property held for sale in the ordinary course of business or in the process of construction or development for
such sale.
g. Property being constructed or developed on behalf of third parties.
h. Property that is leased to another entity under a finance lease.

Investment property held by lessee

 IFRS 16, the new standard on leases, requires a lessee to recognize a right of use asset and a lease liability
 The right of use asset is initially recognized at cost which includes the following:
a. The present value of the lease payment
b. Lease payment made to the lessor at or before commencement date less any lease incentive
c. Initial direct cost incurred by the lease
d. Estimate of cost of dismantling and restoring the underlying asset for which the lessee has a present
obligation.

Subsequent measurement
  IFRS 16, paragraph 34, provides that if a lessee applies the fair value model in measuring investment property,
the lessee shall also apply the fair value model to the right of use asset that meets the definition of investment
property.

Partly investment and partly owner-occupied

 Certain property may include a portion that is held to earn rentals or for appreciation and another portion that is
held for manufacturing or administrative purposes.
 If these portions could be sold or leased out separately, an entity shall account the portions separately as
investment property and owner-occupied property.

Property leased to an affiliate

 From the perspective of the individual entity that owns it, the property leased to another subsidiary or its parent
is considered an investment property.
 However, from the perspective of the group as a whole and for purposes of consolidated financial statements,
the property is treated as owner-occupied property.

Recognition of investment property

 Investment property shall be recognized as an asset when and only when:

a. It is probable that the future economic benefits that are associated with the investment property will flow to
the entity.
b. The cost of the investment property can be measured reliably.

Initial measurement of investment property

 An investment property shall be measured initially at its cost. Transaction costs shall be included in the initial
measurement.
 The cost of a purchased investment property comprises the purchase price and any directly attributable
expenditure.
 Directly attributable expenditure includes professional fees for legal services, property transfer taxes and other
transaction costs.

Cost excluded from cost of investment property

a. Start up costs, unless necessary to bring the property to the condition necessary for its intended use.
b. Operating losses incurred before the investment property achieves the planned level of occupancy.
c. Abnormal amounts of wasted material, labor or other resources incurred in constructing or developing the
property.

Subsequent measurement of investment property

 An entity shall choose either of the following models as the accounting policy and shall apply that policy to all of
the investment property:
a. Fair value model – the investment property is carried at fair value.
b. Cost model – the investment property is carried at cost less any accumulated depreciation and any
accumulated impairment loss.

Fair value of investment property

  Fair value of an asset is the price that would be received to sell an asset in an orderly transaction between
market participants at the measurement date.
 The price in the principal market used to measure fair value shall not be adjusted for transaction cost.
 Fair value of investment property excludes prepaid or accrued operating lease income.

Inability to determine fair value reliably

 Under this case, PAS 40, paragraph 53, mandates that the entity shall measure such investment property using
the cost method until the disposal of the investment property.
 It is only in this case that the residual value of the investment property shall be assumed to be zero.
 PAS 40, paragraph 54, states that an entity that uses the fair value model shall continue to measure other
investment property at fair value, notwithstanding the fact that one investment property is carried using the
cost model due to exceptional case.

Cost model

 If the entity decided=s to measure the investment property under the cost model, the asset shall be carried at
cost less accumulated depreciation and any accumulated impairment loss.
 Fluctuations in the fair value of the investment property from year to year are not recognized.
 Instead, the annual depreciation of the investment property is the charge against profit or loss for the year.

Fair value model

 If the entity decides to measure the investment property under the fair value model, the changes in fair value
from year to year are recognized in profit or loss.
 No depreciation is recorded for the investment property.
 The net gains and losses from fair value adjustments shall be disclosed.

Transfer of investment property

 Transfers to and from investment property shall made when and only when there is a change of use evidenced
by:
a. Commencement of owner occupation or development with view to owner-occupation – transfer from
investment property to owner-occupied property.
b. Commencement of development with a view to sale – transfer from investment property to inventory.
c. End of owner occupation – transfer from owner-occupied property to investment property.
d. Inception of an operating lease to another equity – transfer from owner-occupied property to investment
property.

Measurement of transfer

1. When the entity uses the cost model, transfer between investment property, owner-occupied property and
inventory shall be made at carrying amount.
2. A transfer from investment property carried at fair value to owner-occupied property or inventory shall be
accounted for at fair value which becomes the deemed cost for subsequent accounting.
3. If owner-occupied property is transferred to investment property that is to be carried at fair value, the
difference between the fair value and the carrying amount of the property shall be accounted for as revaluation
or property, plant and equipment.
4. If an inventory is transferred to investment property that is to be carried at fair value, the remeasurement to fair
value shall be included in profit or loss.
Derecognition of investment property

 An investment property shall be derecognized:

a. On disposal.
b. When the investment property is permanently withdrawn from use.
c. When no future economic benefits are expected from the investment property.

Disclosure related to investment property

 The general disclosures are:

a. Whether the entity uses the cost model or fair value model
b. The amount of rental income with the related expense
c. Restrictions on the investment property
d. Contractual obligations to purchase or construct investment property
 When the fair value model is used, the disclosures are:
a. Detailed reconciliation between carrying amount of investment property at the beginning and end of the
period
b. the method of determining the fair value of investment property and whether the valuation is carried out by
an independent qualified valuer.
c. Net gains or losses from fair value adjustments.
d. Whether significant fixtures, such as lift and office furniture, within an investment property, have been
separately recognized
 When the cost model is used, the disclosures are:
a. The depreciation method or rate and useful life
b. Detailed reconciliation of the gross cost of investment property and the related accumulated depreciation
c. Fair value of the investment, such fact shall be explained.

Cash surrender value

 Amount which the insurance firm will pay upon the surrender and cancelation of the life insurance policy.
 Cash surrender value arises if the following requisites are present:
a. The policy is a life policy. There is no cash surrender value in fire, accident, and other nonlife policies.
b. Premiums for three full years must have been paid.
c. The policy is surrendered at the end of the third year or anytime thereafter.
 Thus, a cash surrender value legally commences to accrue at the end of the thirst year.
 Cash surrender value is classified as noncurrent investment
 A loan value is the amount which the insured can borrow from the insurance firm with the cash surrender value
as collateral security.
 The loan shall not be deducted from the cash surrender value but accounted for as an ordinary obligation.

Accounting procedures

 The accounting procedures concerning the cash surrender value are as follows:
a. Payment of the insurance
Life insurance expense xx
Cash xx
b. Adjustment of the unexpired premium at the end of the period:
Prepaid life insurance xx
Life insurance expense xx
c. Dividends received on the life policy are not income but a reduction of the life insurance expense.
Cash xx
 Life insurance expense xx
d. Initial recognition of the cash surrender value at the end of the third year:
Cash surrender value xx
Life insurance expense xx
Retained earnings xx

e. Recognition of cash surrender value subsequent to the third year:

Cash surrender value xx
Life insurance expense xx
f. Receipt if the proceeds of the life policy
Cash xx
Cash surrender value xx
Life insurance expense xx
Gain on life insurance settlement xx
 The amount to be credited to the cash surrender value should be adjusted balance at the time of the death of
the insured.
 The life insurance expense account is credited for the unexpired premium at the time of death. The gain on life
insurance settlement is determined as follows:
Face policy xx
Less: cash surrender value xx
Unexpired premium xx xx
Gain on life insurance settlement xx