CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS (AE 14)

LEARNING MATERIAL

UNIT NUMBER/ HEADING: MODULE 1/INTRODUCTION TO ACCOUNTING

LEARNING OUTCOMES:
At the end of the unit, the students will be able to:
a. Define accounting and understand better and deeply the
accountancy profession;
b. Understand the generally accepted accounting principles;
c. Trace the history of the International Accounting Standards
Board;
d. Illustrate the IASB structure and identify each structure’s
function;
e. Understand and explain the need for accounting standards.

INTRODUCTION:
Accounting has evolved, as in the case of medicine and law, in response
to the social and economic needs of society. As business and society become
more complex, accounting develops new concepts and techniques to meet the
ever-increasing needs for financial information. Without such information,
many complex economic developments and social programs may never have
been undertaken.
Accounting is relevant in all walks of life and it is absolutely essential
in the world of business. Accounting is the system that measures business
activities, processes that information into reports and communicates the
results to decision-makers. Accounting quantifies business communication.
For this reason, accounting is called the language of business. The task of
learning accounting is very similar to the task of learning a new language;
thus, the need for this module to fully understand the accounting profession
and the standard-setting bodies that regulate the practice of the accountancy
profession.

Topic 1: THE ACCOUNTANCY PROFESSION

Learning Objectives:
At the end of the topic, the students will be able to:
a. Define accounting according to ASC, AICPA and AAA;
b. Determine the overall objective of accounting;
c. Describe the practice of accountancy profession in the
Philippines and understand the Continuing Professional
Development in the field of accounting;

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 d. Know the meaning of generally accepted accounting principles
(GAAP);
e. Identify and describe Board of Accountancy, International
Accounting Standards Board and IFRS.

Activating Prior Learning

In order to understand our topic, we have to see first your prior learning
about accounting. Your task is to write everything that comes into your mind
when you hear the word ACCOUNTING. Write them in the circles below.

ACCOUNTING

Presentation of Content

Definition
You have your own idea about accounting and what it means.
But for common and correct understanding of what accounting really
is, let us look at the definition given by 3 accounting bodies. I hope you’ll be able to
memorize these three definitions not only with your head but with your heart. If there is one
term you must know the definition by heart and can define even if asked during sleep is, the
word ACCOUNTING because in the first place you are accounting students. Magmumukha
ka pang matalino kapag tinanong ka ‘What is Accounting’, tapos isasagot mo, ‘Kaninong
definition ang gusto mo, according to ASC, AICPA, or AAA?’ Oh di ba? Bongga ka neng!
Hahahahahaha
(Note: If we’ll be able to see each other in class face to face, this is the
first thing I will ask you. ☺ So make sure to memorize these three.)

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Accounting is defined as:
a. Accounting Standards Council (ASC)
Accounting is a service activity. Its function is to provide quantitative
information, primarily financial in nature, about economic entities,
that is intended to be useful in making economic decision.

b. American Institute of Certified Public Accountants (AICPA)

Accounting is the art of recording, classifying and summarizing in a
significant manner and in terms of money, transactions and events,
which are in part at least of a financial character and interpreting the
results thereof.

c. American Accounting Association (AAA)

Accounting is the process of identifying, measuring, and
communicating economic information to permit informed judgment
and decision by users of the information.

STOP. STOP. STOP.

Do not proceed with the next part of this learning material without you,
memorizing the three definitions of accounting above. Make sure to
memorize it first so that it will be easier for you understand the next topics
that we will discuss. ☺ Go, fighting!

Are you done now? Are you sure, you already memorized the definition with
your mind and with your heart? Congratulations if you did! Well then, let us
proceed with our discussion.

In the given definitions, there are three (3) points that should be noted:
(1) Accounting is about quantitative information, meaning, that the
information needed are at least given is numerical;
(2) The information is likely to be financial in nature, which means, it
has something to do with finances or in simple term, money; and
(3) The information should be useful in decision-making.

So, in looking for information that will be considered as accounting

information, make sure that these 3 features are present.

The definition that has stood the test of time is the definition given by the AAA
or the American Accounting Association. (Before you proceed, can you recite again
the definition of accounting by AAA without looking at your notes?)

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This definition states that the very purpose of accounting is to provide
quantitative information to be useful in making economic decision. The
definition also states that accounting has a number of components, namely:

a. Identifying as the analytical component;

b. Measuring as the technical component;
c. Communicating as the formal component.

Let us now discuss in detail these three components.

I. IDENTIFYING
➢ It is the recognition and nonrecognition of business activities
as “accountable” events, meaning it has effect on assets,
liabilities and equity. In other words, the subject matter of
accounting is economic activity or the measurement of economic
resources and economic obligations. Only economic activities are
emphasized and recognized in accounting.
Transactions – economic activities of an entity
- can be external (exchange transactions or those
involving one entity and another entity) or internal
(involving the entity only)

External Transactions Internal Transactions

Purchase of goods from a supplier Production of goods

Borrowing money from a bank Casualty loss

Sale of goods to a customer Sale of goods to branch office

Payment of salaries of employees

Payment of taxes to the government

Payment of debt to creditors

II. MEASURING
➢ It is the assigning of peso amounts to the accountable
economic transactions and events.
➢ If accounting information is to be useful, it must be expressed in
terms of a common financial denominator. As in our case, the
Philippine peso is the unit of measuring accountable economic
transactions

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 ➢ Financial statements without monetary amounts would be
largely unintelligible or incomprehensible
Historical cost – original acquisition cost and the most common
measure of financial transactions
Current value – this includes fair value, value in use, fulfilment value,
and current cost

III. COMMUNICATING
➢ It is the process of preparing and distributing accounting
reports to potential users of accounting information.
➢ The first two components are useless if it is not communicated
to users for decision making
➢ This is the reason why accounting is called the “language of
business”
➢ Implicit in this process are:
✓ Recording or journalizing is the process of
systematically maintaining a record of all economic
business transactions after they have been identified
and measured
✓ Classifying is the sorting or grouping of similar and
interrelated economic transactions into their
respective classes. This is accomplished by posting to
the ledger (a group of accounts which are
systematically categorized into asset accounts,
liability accounts, equity accounts, revenue accounts
and expense accounts)
✓ Summarizing is the preparation of financial
statements (by-product of accounting process)
which includes
o Statement of Financial Position
o Statement of Financial Performance or
Income Statement
o Statement of Comprehensive Income
o Statement of Changes in Equity
o Statement of Cash Flows

❖ Accounting is also an information system that measures business

activities, processes information into reports and communicates the
reports to decision makers
❖ A key product of this information system is a set of financial statements
– the documents that report financial information about an entity to
decision makers

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 ❖ Financial reports tell us how well an entity is performing in terms of
profit and loss and where it stands in financial terms.
❖ The overall objective of accounting is to provide quantitative financial
information about a business that is useful to statement users
particularly owners and creditors in making economic decisions
❖ The essence of accounting is decision-usefulness
❖ An accountant’s primary task is to supply financial information so that
the statement users could make informed judgment and better decision.
Remember, accounting is not about MATH. It is more than
that. If you are thinking that accounting is Math, then, you are in
the wrong course. Better turn back now before it’s too late. Haha!
It is not also for intelligent people only because Accounting is for
those who brave and strong who do not give up. If you are that
person, then, keep it up. Accounting is not that easy, but if you are
persistent and determined, you’ll learn to love the course, and can
pass through all challenges along your way as Accounting
students. Let us learn together! Have fun!

This time, let us look closely and understand the accountancy

profession and how accountants apply their knowledge and skills
in accounting.

THE ACCOUNTANCY PROFESSION

➢ Republic Act No.9298, Philippine Accountancy Act of 2004, is the law
regulating the practice of accountancy in the Philippines
➢ Accountancy has developed as a profession attaining a status
equivalent to that of law and medicine
➢ To qualify to practice the accountancy profession, a person must:
✓ A graduate of Bachelor of Science in Accountancy; and
✓ Pass the CPA Board Examination given by BOA which is
scheduled twice a year (May and October)
➢ The Board of Accountancy (BOA), the body authorized by law to
promulgate rules and regulations affecting the practice of the
accountancy profession in the Philippines. It is responsible for
preparing and grading the Philippine CPA examination.
➢ Single practitioners and partnerships for the practice of public
accountancy shall be registered certified public accountants in the
Philippines. The Securities and Exchange Commission shall not
register any corporation organized for the practice of public
accountancy
➢ A minimum of three years of meaningful experience in any of the areas
of public practice including taxation is required before BOA will issue a
certificate of accreditation to CPAs in public practice

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 ➢ CPAs, firms and partnerships of CPAs, including partners and staff
members thereof, are required to register with the Board of
Accountancy and Professional Regulation Commission (PRC) for the
practice of public accountancy.
➢ The PRC will issue the Certificate of Registration to practice public
accountancy which shall be valid for 3 years and renewable every 3
years upon payment of required fees.

SCOPE OF THE ACCOUNTANCY PROFESSION

Certified Public Accountants generally practice their profession in
three main areas, namely:
1. Public Accounting
- this is composed of individual practitioners, small accounting
firms and large multinational organizations that render
independent and expert financial services to the public
- it usually offers three kinds of services:
✓ Auditing or external auditing, the primary service offered
by most public accountants, is the examination of financial
statements by independent CPA for the purpose of
expressing an opinion as to the fairness with which the
financial statements are prepared. It is the attest function
of independent CPAs (attest function means a CPAs review
of company’s financial statement and expressing an
opinion).
✓ Taxation service includes the preparation of annual
income tax returns and determination of tax consequences
of certain proposed business endeavors. The CPA must be
thoroughly familiar with tax laws and regulations and
updated with changes in taxation law and court cases
concerned with interpreting taxation laws.
✓ Management Advisory Services refer to services to clients
on matters of accounting, finance, business policies,
organization procedures, product costs, distribution and
many other phases of business conduct and operations. It
includes:
o Advice on installation of computer system
o Quality control
o Installation and modification of accounting
system
o Budgeting
o Forward planning and forecasting
o Design and modification of retirement plans

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 o Advice on mergers and consolidations

2. Private Accounting
- includes CPAs who are employed in business entities in various
capacity as accounting staff, chief accountant, internal auditor and
controller (highest accounting officer in an entity)
- includes maintaining the records, producing the financial reports,
preparing the budgets and controlling and allocating the resources
of the entity
3. Government Accounting
- it encompasses the process of analyzing, classifying, summarizing
and communicating all transactions involving the receipt and
disposition of government funds and property and interpreting the
results thereof
- its focus is the custody and administration of public funds
- many CPAs are employed in many branches of the government
such as:
o Commission on Audit (COA)
o Bureau of Internal Revenue (BIR)
o Department of Budget and Management (DBM)
o Securities and Exchange Commission (SEC)
o Bangko Sentral ng Pilipinas (BSP)

CONTINUING PROFESSIONAL DEVELOPMENT (CPD)

➢ This refers to the inculcation and acquisition of advanced
knowledge, skill, proficiency, and ethical and moral values after
the initial registration of the CPA
➢ CPD raise and enhances the technical skill and competence of
the CPA
➢ Under the new BOA Resolution, all CPAs regardless of area or
sector of practice shall be required to comply with 15 CPD credit
units for renewal of CPA license and 120 CPD credit units to
practice the accountancy profession
➢ A CPA shall be permanently exempted from CPD requirements
in renewal of CPA license upon reaching the age of 65 years but
not for the purpose of accreditation to practice the accountancy
profession.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)

➢ GAAP represents the rules, procedures, practice and standards
followed in the preparation and presentation of financial
statements

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 ➢ It developed on the basis of experience, reason, custom, usage,
and practical necessity
➢ The overall purpose of accounting standards is to identify proper
accounting practice for the preparation and presentation of
financial statements
➢ Accounting standards create a common understanding between
preparers and users of financial statements
Application
These activities are assessment if you understand that discussions we had.
Though this will not be recorded, it will still form part of your class standing so
make sure to accomplish the tasks given to you. ☺

Your tasks:
a. Make a video of yourself defining ACCOUNTING according to the
three accounting bodies – ASC, AICPA, and AAA – and send your
video to my email account ( [email protected]) or to our
messenger group chat. Say your name at the beginning of the video
before reciting the definitions.
b. In your own words, describe and explain what you have understand
about accounting and its overall objective. Write your answer in the
box provided below.

Feedback
The items below will be checked and recorded as your seatwork and
quiz. Do well and enjoy!

Choose the best answer among the choices.

1. What is the law regulating the practice of accountancy in the

Philippines?
a. RA No.9298 c. RA No. 9928

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 b. RA No. 9198 d. RA No. 9892
2. What is the body authorized by law to promulgate rules and regulations
affecting the practice of the accountancy profession in the Philippines?
a. Board of Accountancy
b. Philippine Institute of Certified Public Accountants
c. Securities and Exchange Commission
d. Financial Reporting Standards Council
3. What are the three main areas in the practice of the accountancy
profession?
a. Public accounting, private accounting, and managerial accounting
b. Auditing, taxation and managerial accounting
c. Financial accounting, managerial accounting and corporate
accounting
d. Public accounting, private accounting and government accounting
4. Which statement is incorrect in relation to the practice of public
accountancy?
a. Single practitioners for the practice of public accountancy shall be
registered CPAs in the Philippines
b. Partners of partnerships formed for the practice of public
accountancy shall be registered CPAs in the Philippines
c. The Securities and Exchange Commission can register any
corporation organized for the practice of public accountancy
d. All of these statements are incorrect
5. CPAs are licensed by
a. The PICPA c. The city government
b. The SEC d. State government
6. All of the following describe accounting, except
a. A service activity
b. An information system
c. A universal language of business
d. An exact science rather than an art
7. The important points made in the definition of accounting include all of
the following except
a. Accounting information is quantitative
b. Accounting information is both quantitative and qualitative
c. Accounting information is financial in nature
d. Accounting information is useful in decision making
8. The accounting process is the recognition or nonrecognition of business
activities as accountable events
a. Identifying c. Communicating
b. Measuring d. Reporting
9. What are the events that affect the entity and in which other entities
participate

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 a. Internal events c. Current events
b. External events d. Obligating events
10. GAAP is an abbreviation for
a. Generally authorized accounting procedures
b. Generally applied accounting procedures
c. Generally accepted auditing practices
d. Generally accepted accounting principles
11. What is the primary service of CPAs in public practice
a. Auditing c. Taxation
b. Managerial Accounting d. Controllership
12. Accountants employed in entities in various capacities as
accounting staff, chief accountant or controller are said to be engaged
in
a. Public accounting c. Government accounting
b. Private accounting d. Financial Accounting
13. It is the area of the accountancy profession that encompasses the
process of analyzing, classifying, summarizing and communicating all
transactions involving receipt and disposition of government funds and
property and interpreting the results thereof.
a. Internal auditing c. Private accounting
b. External auditing d. Government accounting
14. How many CPD units are required for accreditation to practice
the accountancy profession?
a. 120 units b. 100 units c. 60 units d. 15 units
15. How many CPD units are required for renewal of CPA license?
a. 120 units b. 100 units c. 60 units d. 15 units

16. A CPA shall be permanently exempted from renewal of CPA

license
a. At the age of 65 years c. When practicing abroad
b. When working abroad d. When studying abroad
17. This refers to the inculcation and acquisition of advanced
knowledge, skill, proficiency, and ethical and moral values after the
initial registration of the CPA
a. Continuing Professional Development
b. Continuing Practical Development
c. Continuing Personal Development
d. Continuing Professional Discipline
18. What is the measuring component in the definition of
accounting?
a. The recognition or nonrecognition of business activities as
accountable events
b. The assigning of peso amounts to the accountable events

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 c. The preparation and distribution of accounting reports to users of
accounting information
d. The preparation of audit report by CPAs

19. The communicating process of accounting includes all of the

following except
a. Recording
b. Classifying
c. Summarizing
d. Interpreting

20. What is the overall objective of accounting?

a. To provide the information that the managers of an economic entity
need to control the operations
b. To provide information that the creditors can use in deciding
whether to grant loans to an entity
c. To measure the periodic income of the economic entity
d. To provide quantitative financial information about an entity that is
useful in making economic decision

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Topic 2: THE INTERNATIONAL ACCOUNTING STANDARDS
BOARD (IASB)

Learning Objectives:
At the end of the topic, the students will be able to:
a. Demonstrate the history and formation of IASB;
b. List and differentiate the structures of IASB;
c. Compare and contrast the IASB structures’ function;
d. Illustrate and discuss the IASB standard-setting process;
e. Explain the importance of having International Accounting
Standards;
f. Discuss the developments in Philippine Accounting
Standards.

Presentation of Content

This time, we will be discussing about one of the accounting standard-setting

bodies to which most of our Philippine Accounting Standards are based. Good
luck and enjoy!

INTERNATIONAL ACCOUNTING STANDARDS BOARD

❖ The International Accounting Standards Board or IASB now replaces

the International Accounting Standards Committee or IASC.
❖ The IASC is an independent private sector body, with the objective of
achieving uniformity in the accounting principles which are used by
business and other organizations for financial reporting around the
world
❖ The IASB publishes standards in a series of pronouncements called
International Financial Reporting Standards (IFRS)
❖ However, the IASB has adopted the body of standards issued by the
IASC called International Accounting Standards (IAS)
❖ The IASB standard-setting process includes in the correct order
research, discussion paper, exposure draft and accounting standard.

HISTORY

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 International International IASC Foundation (known
Accounting Standards Accounting Standards as IFRS Foundation)
Committee (IASC) Board (IASB) was finalized the second
Foundation was for established on April phase of the 2008-2010
Constitution Review in
med on March 2001 2001
January 2010

THE INTERNATIONAL ACCOUNTING STANDARDS BOARD STRUCTURE

MONITORING BOARD
Approve and oversee trustees

IFRS FOUNDATION
22 Trustees appoint, oversee, raise funds

BOARD 16 (max. 3 part-time)

Set technical agenda, approve standards, exposure
drafts and interpretations

IFRS INTERPRETATIONS
IFRS ADVISORY COUNCIL
COMMITTEE
Approx. 40 members
14 members

WORKING GROUPS
For major agenda projects KEY:
Appoints
Reports to
Advises

Key terms and notes to remember:

➢ International Accounting Standards Committee (IASC)
Foundation was formed as a not-for-profit corporation incorporated
in the State of Delaware, USA. It is an independent accounting
standard setter based in London, UK
➢ International Accounting Standards Board (IASB) is an
independent private sector body. Its objective is to achieve convergence
in the accounting principles that are used by businesses and other
organizations for financial reporting around the world
➢ Monitoring Board’s primary purpose is to serve as a mechanism for
formal interaction between capital market authorities and the IFRS
Foundation

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 ➢ IFRS Advisory Council has 40 members and provides a forum for
organizations
➢ IFRS Interpretations Committee (formerly called the IFRIC) is the
interpretative body of the IASB. It comprises 14 voting members
appointed by the Trustees

IASB STANDARD-SETTING PROCESS

Staff are asked to identify and review the issues associated with a potential agenda
topic and to consider the application of the Framework to the issues

National accounting requirements and practices are studied and views about the
issues are exchanged with national standard-setters

The IFRS Foundation Trustees and the IFRS Advisory Council are consulted about
the topics and priorities in the IASB’s agenda

The IASB is required to carry out a public consultation on its agenda every three
years, the first of which was required to begin no later than June 30, 2011

An advisory group is formed (generally called a ‘working group’) to advise the IASB
and its staff on the project

A discussion document is published for public comment

An exposure draft approved by at least 9 votes of the IASB is published for public
comment

A basis for conclusions is published within the exposure draft

All comments received within the comment period on discussion documents and
exposure drafts are considered and discussed in open meetings

The desirability of holding a public hearing and of conducting field-tests is considered

A Standard is approved by at least 9 votes of the IASB and any dissenting opinions
are included in the published standard

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 A basis for conclusions is included within the final Standard explaining, among other
things, the steps in the IASB’s due process and how the IASB has dealt with public
comments received on the exposure draft.

❖ The Financial Reporting Standards Council (FRSC) now replaces the

Accounting Standards Council (ASC). It is the accounting standard
setting body created by the PRC upon recommendation of BOA to assist
the latter in carrying out its powers and functions provided under RA
No. 9298.
❖ The FRSC’s main function is to establish and improve accounting
standards that will be generally accepted in the Philippines. These
accounting standards constitute the “highest hierarchy” of generally
accepted accounting principles in the Philippines.
❖ The approved statements of the FRSC are known as Philippine
Accounting Standards (PAS) and Philippine Financial Reporting
Standards (PFRS)
❖ The Philippine Interpretations Committee (PIC) was formed by the
FRSC in August 2006 and has replaced the Interpretations Committee
formed by the ASC in May 2000 and its role is to prepare interpretations
of PFRS for approval by the FRSC and to provide timely guidance on
financial reporting issues not specifically addressed in current PFRS
❖ The FRSC is composed of the following
✓ Chairman who had been or is presently a senior accounting
practitioner
✓
1 Representative each from:
• Board of Accountancy
• Securities and Exchange Commission
• Bangko Sentral ng Pilipinas
• Bureau of Internal Revenue
• Commission on Audit
• Major organization of preparers and users of financial
statements – Financial Executives Institute of the Philippines
(FINEX)
✓ 2 Representatives each from accredited national professional
organization of CPAs:
• Public practice
• Commerce and industry
• Academe or Education
• Government
❖ The PFRS collectively include all of the following:
✓ PFRS which correspond to IFRS;
✓ PAS which correspond to IAS;
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 ✓ Philippine Interpretations which correspond to interpretations of
IFRIC and Standing Interpretations Committee and Interpretations
developed by the PIC.
Application
I. Arrange the following steps of IASB standard-setting process
according to its proper order. Write 1-12 to the spaces provided.
____ The IASB is required to carry out a public consultation on its agenda every three years,
the first of which was required to begin no later than June 30, 2011

___ A Standard is approved by at least 9 votes of the IASB and any dissenting opinions are
included in the published standard

___ All comments received within the comment period on discussion documents and
exposure drafts are considered and discussed in open meetings

____ An advisory group is formed (generally called a ‘working group’) to advise the IASB and
its staff on the project

___ Staff are asked to identify and review the issues associated with a potential agenda topic
and to consider the application of the Framework to the issues

___ The IFRS Foundation Trustees and the IFRS Advisory Council are consulted about the
topics and priorities in the IASB’s agenda

___ A basis for conclusions is published within the exposure draft

__National accounting requirements and practices are studied and views about the issues
are exchanged with national standard-setters

_____ A discussion document is published for public comment

A basis for conclusions is included within the final Standard explaining, among other things,
the steps in the IASB’s due process and how the IASB has dealt with public comments

An exposure draft approved by at least 9 votes of the IASB is published for public
comment

II. TheDraw
____ the IASB
desirability Organizational
of holding Structure
a public hearing and of conducting field-tests is considered

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 Feedback

I. Multiple Choice: Answer the following questions by encircling the

correct answer.
1. The International Accounting Standards Board was formed
a. To enforce IFRS in foreign countries
b. To develop a single set of high quality IFRS
c. To establish accounting standards for multinational entities
d. To develop accounting standards for countries that do not have their
own standard-setting bodies
2. The International Accounting Standards Board
a. Was the predecessor to the IASC
b. Can overrule the USA GAAP when their policies disagree
c. Promotes the use of high-quality and understandable global
accounting standards
d. Has its headquarters in Geneva
3. The IASB declared that the merits of proposed standards are assessed
a. From a position of neutrality
b. From a position of materiality
c. Based on possible impact on
behavior
d. Based on arguments of lobbyist

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4. The standard-setting process includes in the correct order
a. Exposure draft, research, discussion paper and accounting
standard
b. Research, exposure draft, discussion paper and accounting
standard
c. Research, discussion paper, exposure drafts and accounting
standard
d. Discussion paper, research, exposure draft and accounting standard
5. The IASB employs a due process system which
a. Is an efficient system for collecting dues from members
b. Enables interested parties to express their views on issues under
consideration
c. Identifies the accounting issues that are the most important
d. Requires that all CPAs must receive a copy of IFRS
6. What is due process in standard-setting by IASB?
a. IASB operates in full view of the public
b. Public hearings are held on proposed standards
c. Interested parties can make their views known
d. All of these are part of due process in standard-setting.
7. The standards published by IASB are called
a. International Accounting Standards
b. Financial Reporting Standards
c. International Financial Reporting Standards
d. Statement of Financial Accounting Standards
8. What is a possible danger if politics plays too big a role in developing
IFRS?
a. Financial reporting standards are not truly generally accepted
b. Individuals may influence the standards
c. User groups become active
d. The IASB delegates its authority to elected officials
9. Accounting standard-setting
a. Can be described as a political process which reflects political
actions of various interested user groups as well as a product of
research and logic
b. Is based solely on research and empirical findings
c. Is a legalistic process
d. Is democratic in the sense that a majority of accountants must agree
with a standard before it becomes enforceable
10. IFRIC Interpretations issued by IASB
a. Are considered authoritative and must be followed
b. Cover newly identified financial reporting issues not specifically
addressed

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 c. Cover issues where unsatisfactory or conflicting interpretations have
developed
d. All of these are true about IFRIC interpretations

II. Identification. Identify the term described in each item. Write your
answer in the space provided before each item.

1. These are standards published by IASB in a series of pronouncements.

2. It is the accounting standard setting body created by the Professional
Regulation Commission to assist the Board of Accountancy.
3. It is an independent private sector body whose objective is to achieve
convergence in the accounting principles that are used by businesses and
other organizations for financial reporting around the world.
4. This committee is the interpretative body of the IASB.
5. These are the terms used for the approved statement of the FRSC.
________6. These accounting standards constitute the ____________ of
generally accepted accounting principles in the Philippines.
7. What do you call the predecessor accounting body of IASB?
8. What do you call the predecessor accounting body of FRSC?
9. The FRSC is composed of how many members?
10. A function in the IASB structure whose primary purpose is to serve as
mechanism for formal interaction between capital market authorities and the
IFRS Foundation.

Summary of the Unit

Accounting is defined by three accounting bodies – ASC, AICPA and
AAA. Among these, the definition of AAA states the very purpose of
accounting which is to provide quantitative information to be useful in
making an economic decision.
Accounting, according to American Accounting Association, is the
process of identifying, measuring and communicating economic
information to permit informed judgment and decision by users of the
information.
Identifying is the recognition or nonrecognition of accountable events.
Measuring is the assigning of peso amounts to the accountable
economic transactions and events
Communicating is the process of preparing and distributing accounting
reports to potential users of accounting information.
Republic Act No. 9298, known as Philippine Accountancy Act of 2004,
is the law regulating the practice of accountancy in the Philippines and
authorized Board of Accountancy to promulgate rules and regulations.
CPAs practice their profession either in public accounting, private
accounting or government accounting.

20
 GAAP or generally accepted accounting principles are accounting rules,
procedures, practice and standards followed in the preparation and
presentation of financial statements
The International Accounting Standards Board or IASB is the standard-
setting body for the world. In the Philippines, its counterpart is the
Financial Reporting Standards Council (FRSC).

Student’s Reflection on Learning

This part of the module will be a time for you to look back, and reflect on what
you have learned from this unit. Though, this will not be checked and recorded,
I would appreciate if you will do this wholeheartedly and with all seriousness.

Answer the following questions and put your answers in the space provided.

1. Did you learn what you expected to learn? If yes, what made you
successful with this unit of instruction?

2. What did you learn that was unexpected and how did it change your
perspective about the course?

References:

• Valix, C. T., Peralta, J.F & Valix C. A. M. (2020). Conceptual Framework

and Accounting Standards. Manila, Philippines: GIC Enterprises & Co..
Inc.
• Ballada, W., & Ballada S. (2020). Conceptual Framework and
Accounting Standards. Manila, Philippines: DomDane Publishers

21
 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS (AE 14)
LEARNING MATERIAL

UNIT NUMBER/ HEADING: MODULE 2/INTRODUCTION TO

CONCEPTUAL FRAMEWORK
LEARNING OUTCOMES:
At the end of the unit, the students will be able to:
f. Define conceptual framework and identify its purpose and
scope;
g. Identify the objective and limitations of financial reporting;
h. Differentiate and discuss the qualitative characteristics of
accounting information;
i. Enumerate and define the elements of financial statements;
j. Understand the different underlying assumptions of financial
statements and reporting entity; and
k. Differentiate recognition and measurement of accounts

INTRODUCTION:
This module will focus on the discussion of the conceptual framework
for financial reporting. It will discuss the purpose of the conceptual framework
and how it will be used for the preparation and presentation of financial
statements especially when no IFRS standards applied to a specific
transaction.
I hope that at the end of this learning material, your understanding of
the course and its conceptual framework will be widened and enhanced. Enjoy
learning!

Activating Prior Learning

Before we proceed with the discussion proper about conceptual

framework, I want you to watch the video of the interview of Hans Hoogervorst,
Chairman of the International Accounting Standards Board, on the debriefing
of the Revised Conceptual Framework for Financial Reporting. You can click
on the link below to redirect you to the video.

https://www.youtube.com/watch?v=KkFcpdPwK-I

Or, you can read the article published by the IFRS News and Events regarding
the completion of the revisions of IASB conceptual framework on this link:

https://www.ifrs.org/news-and-events/2018/03/iasb-completes-revisions-to-its-conceptual-
framework/

22
 Presentation of Content

The content of these modules will be presented through the copy of the
powerpoint presentation of the Instructor taken from the website of IFRSbox.
Important ideas and principles are already in the slides below. If you want a
detailed discussion on the topics, you can visit the links below:

https://www.ifrsbox.com/ifrs-conceptual-framework-2018/

https://www.youtube.com/watch?v=v56_VJkjAX4

23
24
25
26
27
28
29
 Application

Your task:

I. Enumerate the 8 chapters discussed in the Conceptual Framework

for Financial Reporting and give a brief discussion on each topic.
II. Using a Venn Diagram, compare recognition from measurement.

RECOGNITION MEASUREMENT

30
 Feedback

I. Choose the best answer from the following choices.

1. What is the authoritative status of the Conceptual Framework?
a. The Conceptual Framework has the highest authority.
b. In the absence of a standards or an interpretation that specifically
applies to a transaction, the Conceptual Framework shall be
followed
c. In the absence of a standard or an interpretation that specifically
applies to a transaction, management shall consider the
applicability of the Conceptual Framework in developing and
applying an accounting policy that results in information that is
relevant and faithfully represented
d. The Conceptual Framework applies only when the IASB develops
new standards
2. The Conceptual Framework is intended to establish
a. GAAP in financial reporting
b. The meaning of “present fairly in accordance with GAAP”
c. The objective and concepts for use in developing standards of
financial accounting and reporting
d. The hierarchy of sources of GAAP
3. A Conceptual Framework should
a. Lead to uniformity of financial statements
b. Eliminate alternative accounting principles
c. Guide multinational entities in developing generally accepted
auditing standards
d. Define the basic objectives, terms and concepts of accounting
4. Which is not a purpose of the Conceptual Framework?
a. To provide definitions of key terms and fundamental concepts
b. To provide specific guidelines for resolving situations not covered by
existing accounting standards
c. To assist accountant in selecting among alternative accounting and
reporting methods
d. To assist the International Accounting Standards Board in the
standard-setting process
5. In the Conceptual Framework for Financial Reporting, what provides
the “why” of accounting?
a. Measurement and recognition concept
b. Qualitative characteristic of accounting information
c. Element of financial statement
d. Objective of financial reporting
6. The underlying theme of Conceptual Framework is
a. Decision usefulness

31
 b. Understandability
c. Timeliness
d. Comparability
7. The objectives of financial reporting
a. Is the foundation for the Conceptual Framework
b. Includes the qualitative characteristics of useful information
c. Is not found in the Conceptual Framework
d. All of these are correct choices regarding the objective of financial
reporting
8. Which of the following is not a benefit associated with the Conceptual
Framework?
a. A Conceptual Framework should increase users’ understanding and
confidence in financial reporting
b. Practical problems should be more quickly solvable
c. A coherent set of accounting standards should result
d. Business entities will need far less assistance from accountants
9. Which statement is not true concerning the Conceptual Framework?
a. The Conceptual Framework should be a basis for standard-setting
b. The Conceptual Framework should allow practical problems to be
solved more quickly
c. The Conceptual Framework should be based on fundamental truth
derived from the law of nature
d. The Conceptual Framework should increase users’ understanding
and confidence in financial reporting
10. The overall objective of financial reporting is to provide
information
a. That is useful for decision making
b. About assets, liabilities and equity of an entity
c. About financial performance during a period
d. That allows owners to assess management performance
Summary of the Unit

Conceptual Framework is a summary of the terms and concepts that

underlie the preparation and presentation of financial statements for
external users
The Conceptual Framework’s scope include the following: (a) Objective
of financial reporting; (b) Qualitative characteristics of useful financial
information; (c) Financial statements and reporting entity; (d) Elements
of financial statements; (e) Recognition and derecognition; (f)
Measurement; (g) Presentation and disclosure; (h) Concepts of capital
and capital maintenance

32
 The objective of general purpose financial reporting is to provide
financial information useful to investors, lenders and other creditors for
decision-making.
The qualitative characteristics of useful financial information includes
fundamental characteristics of Relevance and Faithful Representation
and enhancing characteristics of Verifiability, Comparability,
Understandability and Timeliness. (VCUT)
The financial statements that will be reported by a reporting entity
includes Statement of Financial Position, Statement of Financial
Performance, Statement of Cash Flows, and Statement of Changes in
Equity.
The elements of financial statements include Assets, Liabilities, Equity,
Income and Expenses
Recognition is the inclusion of an element of financial statements;
derecognition is the removal of asset/liability from the statement of
financial position while measurement basis is the selection of the
methodology for measuring an element of FS

Student’s Reflection on Learning

This part of the module will be a time for you to look back, and reflect on what
you have learned from this unit. Though, this will not be checked and recorded,
I would appreciate if you will do this wholeheartedly and with all seriousness.

Answer the following questions and put your answers in the space provided.

1. Did you learn what you expect to learn?

2. How might you use what you learned in the future in your life or
profession?
References:
• Valix, C. T., Peralta, J.F & Valix C. A. M. (2020). Conceptual Framework
and Accounting Standards. Manila, Philippines: GIC Enterprises & Co..
Inc.
• Ballada, W., & Ballada S. (2020). Conceptual Framework and
Accounting Standards. Manila, Philippines: DomDane Publishers.
• https://www.ifrsbox.com/ifrs-conceptual-framework-2018/
• https://www.youtube.com/watch?v=v56_VJkjAX4
• https://www.ifrs.org/news-and-events/2018/03/iasb-completes-revisions-to-its-conceptual-
framework/
• https://www.youtube.com/watch?v=KkFcpdPwK-I

33
 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS (AE 14)
LEARNING MATERIAL

UNIT NUMBER / HEADING: UNIT 1 - MODULE 2 / PREPARATION OF

FINANCIAL STATEMENTS
Introduction

In this unit you will learn the Presentation of Financial Statements that sets out the
overall requirements for financial statements, including how they should be
structured, the minimum requirements for their content and overriding concepts such as going
concern, the accrual basis of accounting and the current/non-current distinction. It also includes
the discussion of Statement of financial position, income statement, statement of
comprehensive income, statement of changes in equity and notes to financial statements.

Topic 1: Statement of financial position

Learning Objectives:

● To identify the components of financial statements.

● To understand the objective of financial statements
● To know the preparation of a statement of financial position
● To identify the minimum line items to be presented in a statement of financial position
as required by IFRS.
● To understand the current and noncurrent classification of assets and liabilities.
● To know the forms of presenting the statement of financial position.

FINANCIAL STATEMENTS

Financial statements are the means by which the information accumulated and processed in
financial accounting is periodically communicated to the users.

The financial statements are the end product or main output of the financial accounting process.

Components of financial statements

A complete set of financial statements comprises the following components:

1. Statement of financial position (balance sheet) as at the end of the period

2. Statement of financial performance (income statement) for the period.
3. Statement of comprehensive income
4. Statement of changes in equity
5. Statement of cash flows
6. Notes, comprising a summary of significant accounting policies and other explanatory
notes

Objective of financial statements

34
The objective of financial statements is to provide information about the financial position, financial
performance and cash flows of an entity that is useful to a wide range of users in making
economic decisions.

To meet objectives, financial statements must provide information on

⮚ Assets and Liabilities
⮚ Equity
⮚ Incomes & Expenses (including gains and losses)
⮚ Contributions by and distribution to owners
⮚ Cash flows

Frequency of reporting

Financial statements shall be presented at least annually.

When an entity’s end of reporting period changes and financial statements are presented for period
longer or shorter than one year, an entity shall disclose:

a. The period covered by the financial statements.

b. The reason for using a longer or shorter period.
c. The fact that amounts presented in the financial statements are not entirely comparable.

Overall Considerations

Fair Presentation and Compliance with IFRSs

● The financial statements must present fairly the financial position, financial
performance and cash flows of an entity. Fair presentation requires the faithful
representation of the effects of transactions, other events, and conditions in accordance
with the definitions and recognition of criteria for assets, liabilities, income and
expenses set out in the Framework.
● IAS 1 requires that an entity whose financial statements comply with IFRSs make an
explicit and unreserved statement of such compliance in the notes. Financial statements
shall not be described as complying with IFRSs unless they comply with all the
requirements of IFRSs.
● Inappropriate accounting policies are not rectified either by disclosure of the accounting
policies used or by notes or explanatory material.
● IAS 1 acknowledges that, in extremely rare circumstances, management may conclude
that compliance with an IFRS requirement would be so misleading that it would conflict
with the objective of financial statements set out in the Framework. In such a case, the
entity is required to depart from the IFRS requirement, with detailed disclosure of the
nature, reasons and impact of the departure.
Going Concern
● An entity preparing IFRS financial statements is presumed to be a going concern. If
management has significant concerns about the entity’s ability to continue as a going
concern, the uncertainties must be disclosed. If management concludes that the entity
is not a going concern, the financial statements should not be prepared on a going
concern basis, in which case IAS 1 requires a series of disclosures.

35
Accrual Basis of Accounting/Presentation
● Accrual Basis
IAS 1 requires that an entity prepare its financial statements, except for cash flow information,
using the accrual basis of accounting.

● Consistency of Presentation
The presentation and classification of items in the financial statements shall be retained from
one period to the next unless a change is justified either by a change in circumstances
or a requirement of a new IFRS.

Materiality and Aggregation

● Materiality and Aggregation

An entity shall present separately each material class of similar items. Material items that are
dissimilar in nature or function should be separately disclosed.

● Offsetting
An entity shall not offset assets and liabilities, income and expenses unless required or
permitted by an IFRS.

Statement of financial position

A statement of financial position is a formal statement showing the three elements comprising
financial position, namely assets, liabilities and equity.

Definition of asset
An asset is an economic resource controlled by an entity as a result of past event.

Classification of Assets
Assets are classified into current assets and noncurrent assets.

Current assets
PAS 1, paragraph 66, provides that an entity shall classify an asset as current when:

a. The asset is cash or cash equivalent unless the asset is restricted to settle a liability for
more than twelve months after the reporting period.
b. The entity holds the asset primarily for the purpose of trading.
c. The entity expects to realize the asset within twelve months after the reporting period.
d. The entity expects to realize the asset or intends to sell or consume it within the entity’s
normal operating cycle.

PRESENTATION OF CURRENT ASSETS

Current assets are usually listed in the order of liquidity. PAS 1, paragraph 54, provides that
as a minimum, the line items under current assets are:

a. Cash and cash equivalents.

b. Financial assets at fair value such as trading securities and other investments in
quoted equity instruments

36
 c. Trade and other receivables
d. Inventories
e. Prepaid expenses

NONCURRENT ASSETS
The caption ‘’the noncurrent assets’’ is a residual definition.

PAS 1, paragraph 66, simply states that ‘’ an entity shall classify all other assets not classified
as current as noncurrent’’.

In other words, what is not included in the definition of current asset is deemed excluded. All
others are classified as noncurrent assets. Accordingly, noncurrent assets include the
following:

a. Property, plant and equipment

b. Long-term investment
c. Intangible assets
d. Deferred tax assets
e. Other noncurrent asset

PROPERTY, PLANT AND EQUIPMENT

PAS 16, paragraph 6, defines property, plant and equipment as ‘’tangible assets which are
held by an entity for use in production or supply of goods and services, for rental to others, or
for administrative purposes, and are expected to be used during more than one period

Examples of property, plants and equipment include land, building, machinery, equipment,
furniture and fixtures, patterns, molds, dies and tools.

Most property, plant and equipment, except land, are presented at cost less accumulated
depreciation.

LONG-TERM INVESTMENTS
The international accounting standards committee defines investment as ‘’an asset held by an
entity for accretion of wealth through capital 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’’.

INTANGIBLE ASSETS
An intangible asset is simply defined as an identifiable nonmonetary asset without physical
substance.

The common examples of identifiable intangible assets include patent, franchise, copyright,
lease right, trademark and computer software.

An example of an unidentifiable intangible asset is goodwill.

OTHER NONCURRENT ASSETS

Other noncurrent assets are those assets that do not fit into the definition of the previously
mentioned noncurrent.

37
Examples of other noncurrent assets include long-term advances to officers, directors,
shareholders and employees or abandoned property and long-term refundable deposit.

DEFINITION OF LIABILITY
A liability is a present obligation of an entity to transfer an economic resource as a result of
past event.

Current Liabilities
PAS 1, paragraph 69, provides that an entity shall classify a liability as current when:

a. The entity expects to settle the liability within the entity’s normal operating cycle.
b. The entity holds the liability primarily for the purpose of trading.
c. The liability is due to be settled within twelve months after the reporting period.
d. The entity does not have unconditional right to defer settlement of the liability for at least
twelve months after reporting period.

Presentation of current liabilities

PAS 1, paragraph 54, provides that as a minimum, the face of the statement of financial position
shall include the following line items for current liabilities:
a. Trade and other payable
b. Current provisions
c. Short-term borrowing
d. Current portion of long-term debt
e. Current tax liability

38
The term “trade and other payables” is a line items for accounts payable, dividends payable
and accrued expenses.
No objection can be raised if the trade accounts and notes payable are separately presented.

NONCURRENT LIABILITIES
The term “noncurrent liabilities” is also a residual definition.
PAS 1, paragraph 69, provide all liabilities not classified as current are classified as noncurrent.

a. Noncurrent portion of long-term debt

b. Finance lease liability
c. Deferred tax liability
d. Long-term obligations to company officers
e. Long-term deferred revenue

CURRENTLY MATURING LONG-TERM DEBT

A liability which is due to be settled within twelve months after the reporting period is classified
as current, even if:

a. The original term was for a period longer than twelve months.
b. An agreement to refinance or to reschedule payment on a long-term basis is completed
after the reporting period and before the financial statements are authorized issue.

However, if the refinancing on a long-term basis is completed on or before the end of the
reporting period and financial statements are authorized issue, the refinancing is an adjusting
even and therefore the obligation is classified as noncurrent.

DISCRETION TO REFINANCE
If the entity has the discretion to refinance or roll over an obligation for at least twelve
months after the reporting period under an existing loan facility, the obligation is classified as
noncurrent even if it would otherwise be due within shorter period.

The reason for this treatment is that such obligation is considered to form part of the entity’s
long-term refinancing because the entity has unconditional right under the existing loan
agreement to defer payment to defer payment for at least twelve months after the end of the
reporting period.

Note that the refinancing or rolling over must be at the discretion of the entity.

Otherwise, if the refinancing or rolling over is not at the discretion of the entity, the
obligation is classified as current liability.

Covenants
Covenants are often attached to borrowing agreements which represent undertakings by the
borrower.

Covenants are actually restrictions on the borrower as to undertaking further borrowings,

paying dividends, maintaining specified level of working capital and so forth.

39
Under these covenants, if certain conditions relating to the borrower’s financial situation are
breached, the liability becomes payable on demand.

Effect of breach of covenants

PAS 1, paragraph 74, provides that the liability is classified as current even if the lender has
agreed after the reporting period and before the statements are authorized for issue, not to
demand payment as a consequence of the breach.

This liability is classified as current because at reporting date the borrower does not have an
unconditional right to defer payment for at least twelve months after reporting period.

However, paragraph 75 provides that liability is classified as noncurrent if the lender has
agreed on or before the end of reporting period to provide a grace period ending at least
twelve months after the of reporting period.

Definition of equity
The term equity is the residual interest in the assets of the entity after deducting all of its
liabilities.
Simply stated, equity means “net assets” or total assets minus liabilities
The terns used in reporting the equity of an entity depending on the form of the business
organization are:
a. owner’s equity in a proprietorship
b. partners’ equity in a partnership
c. stockholders’ equity or shareholders’ equity in corporation.
However, the term equity may simply be used for all business entities.

Under PAS 1, paragraph 7, the holders of instruments classified as equity are simply known
as owners.

Shareholders’ equity
Shareholders ‘equity is the residual interest of owners in net assets of a corporation measured
by the excess of assets over liabilities.

Generally, the elements constituting shareholders’

Equity with their equivalent IAS term are:

Philippine term IAS term

Capital stock share capital

Subscribed capital stock subscribed share capital
Preferred stock preference share capital
Common stock ordinary share capital
Additional paid in capital share premium
Retained earnings (deficit) accumulated profit (losses)
Retained earnings appropriated appropriation reserve
Revaluation surplus revolution reserve
Treasury stock treasury share

Notes to financial statements

40
Notes to financial statements provide narrative description or dis aggregation of items
presented in the financial statements and information about items that do not qualify for
recognition

Notes contain information in addition to that presented in the statement of financial position,
income statement, statement of comprehensive of cash flows.

In other words, notes to financial statements are used to report information that does not fit
into the body of the financial statements in order to enhance the understandability of the
financial statement.

The purpose of the notes to financial statements is “to provide the necessary disclosures
required by Philippine financial reporting standards”

Forms of statement of financial position

In practice, there are two customary forms in presenting the statement of the financial
position, namely:

a. report form

This form sets forth the three major sections in a downward sequence of assets,
liabilities and equity
b. account form

As the title suggests, the presentation follows that of an account, meaning, the assets
are shown on the left side and liabilities and equity on the right side of the statement
of financial position.

The following is an illustration of the two forms of statement of financial position.

Report Form
JEWEL COMPANY
Statement of Financial Position
December 31, 2020

ASSETS

41
Current assets: Note
Cash and cash equivalents (1) 500,000
Financial assets at fair value 200,000
Trade and other receivables (2) 700,000
Inventories (3) 900,000
Prepaid Expenses (4) 50,000

Total current assets 2,350,000

Noncurrent Assets:
Property, plant and equipment (5) 5,000,000
Investment in associate, at equity 1,000,000
Long-term investments (6) 5,100,000
Intangible assets (7) 2,000,000
Other noncurrent assets (8) 100,000

Total noncurrent assets 13,200,000

Total assets 15,550,000

LIABILITIES AND SHAREHOLDERS’EQUITY

Current liabilities:
Trade and other payables (9) 750,000
Note payable-short-term debt 400,000
Current portion of bonds payable 200,000
Warranty liability 50,000

Total current liabilities 1,400,000

Noncurrent liabilities:
Bonds payable-remaining portion 1,800,000
Note payable-due July 1, 2022 600,000
Deferred tax liability 100,000

Total noncurrent liabilities 2,500,000

Shareholders ‘equity
Share capital, 100 par 5,000,000
Reserves (10) 3,000,000
Retained Earnings 3,650,000

Total shareholders’ equity 11,650,000

Total liabilities and shareholders’ equity 15,550,000

Note 1-Cash and cash equivalents

Cash on hand 40,000

42
Cash in bank 300,000
Petty cash fund 10,000
BSP Treasury bill, purchased on December 1,2020
And due March 1, 2021 150,000

Total cash and cash equivalents 500,000

Note 2-Trade and other receivables

Accounts receivable 580,000

Allowance for doubtful accounts (20,000)
Notes receivable 100,000
Accrued interest on note receivable 10,000
Advances to employees, collectible currently 30,000

Total trade and other receivables 700,000

Note 3-Inventories

Finished goods 300,000

Goods in process 400,000
Raw materials 150,000
Manufacturing supplies 50,000

Total inventories 900,000

Note 4-Prepaid Expenses

Office supplies unused 30,000

Prepaid insurance 20,000

Total prepaid expenses 50,000

Note 5-Property, Plant and Equipment

Land 1,500,000
Building 4,500,000
Machinery and Equipment 1,000,000
Furniture and Fixtures 300,000
Patterns, Molds, dies and tools 100,000

Total 7,400,000
Accumulated depreciation (2,400,000)

Carrying Amount 5,000,000

Accumulated Depreciation:

Building 1,900,000

43
 Machinery and Equipment 350,000
Furniture and fixtures 150,000

Total accumulated depreciation 2,400,000

Note 6-Long term investments

Plant expansion fund 2,000,000

Investment in bonds 3,000,000
Cash surrender value 100,000

Total long term investments 5,100,000

Note 7-Intangible assets

Patent 500,000
Franchise 1,500,000
Total intangible assets 2,000,000

Note 8-Other noncurrent assets

Long-term refundable deposit 20,000

Long-term advances to officers 80,000

Total other noncurrent assets 100,000

Note 9-Trade and other payables

Accounts payable 350,000

Notes payable 150,000
Accrued interest on notes payable 15,000
Income tax payable 50,000
Dividends payable 100,000
Accrued expenses 85,000

Total trade and other payables 750,000

Note 10-Reserves

Share premium 2,000,000

Retained earnings appropriated for contingencies 1,000,000

Total reserves 3,000,000

44
Account Form

JEWEL COMPANY
Statement of Financial Position
December 31, 2020

ASSETS LIABILITIES AND EQUITY

Current Assets Current Liabilities

Cash and Cash equivalents 500,000 Trade and other payables 750,000
Financial assets at fair value 200,000 Note payable-short term debt 400,000
Trade and other receivables 700,000 Current portion of bonds payable 200,000
Inventories 900,000 Warranty liability 50,000
Prepaid expenses 50,000 ________
Total current assets 2,350,000 Total current liabilities 1,400,000

Noncurrent assets Noncurrent liabilities

Property, Plant Bond payable - remaining

And Equipment 5,000,000 portion 1,800,000

Investment in associates 1,000,000 Note payable-due

July 1,2022 600,000
Long term investment 5,100,000 Deferred tax liability 100,000
Intangible assets 2,000,000
Other noncurrent assets 100,000

Total noncurrent assets 13,200,000 Total noncurrent liabilities 2,500,000

Equity:

Share capital, 100 par 5,000,000

Reserves 3,000,000
Retained earnings 3,650,000

Total equity 11,650,000

Total assets 15,550,000 Total liabilities and equity 15,550,000

45
SUMMARY:

⮚ Financial statements are the end product or main output of the financial accounting
process.
⮚ The components of financial statements are:Statement of financial position,Statement
of financial performance,Statement,Statement of comprehensive income,Statement of
changes in equity,Statement of Cash flows and Notes to Financial Statement.
⮚ The objective of financial statements is to provide information about the financial
position,financial performance and cash flows of an entity that is useful to a wide range
of users in making economic decisions.
⮚ Financial statements shall be presented at least annually.
⮚ Statement of financial position is a formal statement showing the three
elements:assets,liabilities and equity.
⮚ Assets and Liabilities are classified into current and noncurrent.
⮚ Equity is the residual interest in the assets of the entity after deducting all of its
liabilities.
⮚ Shareholders’equity is the residual interest of owners in the net assets of a corporation
measured by the excess of assets over liabilities.
⮚ Notes to financial statements provide narrative description or disaggregation of items
presented in the financial statements and information about items that do not qualify
for recognition.

Activity 1

Queen Company provided the following account balances on December 31, 2020:

Notes Receivable 250,000

Computer Software 3,250,000
Prepaid expenses 70,000
Trading Securities 280,000
Unearned rent income 40,000
Retained earnings (deficit) (1,800,000)
Share premium-preference 600,000
Premium on bonds payable 1,000,000
Preference share capital 2,000,000
Share premium-ordinary 200,000
Notes payable 300,000
SSS payable 10,000
Accounts payable 400,000
Accrued salaries 100,000
Accumulated depreciation-building 2,000,000
Accumulated depreciation-equipment 200,000
Allowance for doubtful accounts 20,000
Bonds payable 5,000,000
Dividends payable 120,000
Ordinary share capital 5,000,000
Withholding tax payable 30,000
Preference share redemption fund 350,000
Accounts receivable 400,000

46
Advances to officers-not currently collectible 100,000
Sinking fund 400,000
Building 5,000,000
Long-term refundable deposit 50,000
Cash and cash equivalents 500,000
Cash surrender value 60,000
Equipment 1,000,000
Patent 100,000
Accrued interest on notes receivable 10,000
Inventories 1,300,000
Land 1,500,000
Land held for speculation 500,000
Goodwill 100,000
Subscription Receivable – Current 150,000
Subscribed Ordinary Shares 250,000
Subscription Receivable – Noncurrent 100,000

Required:

Prepare a properly classified statement of financial position on December 31,2020.

Activity 2
Primo Company provided the following information for the purpose of presenting the statement
of financial position on December 31, 2020.
Cash 400,000
Accounts Receivable 800,000
Allowance for doubtful accounts 50,000
Inventories 1,000,000
Land 500,000
Building 5,000,000
Accumulated Depreciation-building 2,000,000
Machinery 3,000,000
Accumulated Depreciation-machinery 1,200,000
Investment in associate 1,300,000
Trading Securities 150,000
Prepaid Expense 100,000
Abandoned Building 150,000
Notes Payable 750,000
Accounts Payable 350,000
Income tax payable 50,000
Accrued Expenses 60,000
Mortgage note payable in quarterly installments 2,000,000
Of 100,000
Estimated Liability for damages 140,000
Retained earnings appropriated for plant expansion 1,000,000
Retained earnings appropriated for contingencies 100,000
Share capital 3,000,000
Share premium 300,000
Retained earnings unappropriated 1,250,000

47
Trademark 150,000
Secret processes and formulas 200,000
Bank loan payable-due to June 30, 2022 500,000

Required:

Prepare in good form a properly classified statement of financial position on December 31,2020
with supporting notes and computations.

Activity 3 multiple choice

1. The major financial statements include all, except
a.Statement of financial position
b.Statement of changes in financial position
c.Statement of comprehensive income
d.Statement of changes in equity

2. The major financial statements include all,except

a.Statement of financial position
b.Income statement
c.Statement of comprehensive income
d.Statement of retained earnings

3. What is the objective of financial statements?

a.To provide information about the financial position,financial performance,and
changes in financial position of an entity that is useful to a wide range of users in making
economic decisions.
b.To present a statement of financial position and statement of comprehensive income.
c.To present relevant,reliable,comparable and understandable information to investors.
d.To present financial statements in accordance with all applicable standards.

4. Financial statements must be prepared at least

a.Annually
b.Quarterly
c.Semi annually
d.Every two years

5. When entity changed the end of reporting period longer or shorter than one year,the entity
a.Period covered by the financial statements
b.The reason for using a longer or shorter period
c.The fact that amounts presented are not entirely comparable
d.The fact that similar entities have done so.

6. An entity shall classify an asset as current under all of the following conditions,except
a.The entity expects to realize the asset or intends to sell or consume it within the
entity’s normal operating cycle.
b.The entity holds the asset for the purpose of trading.
c.The entity expects to realize the asset within twelve months after the reporting period.
d.The asset is cash or a cash equivalent that is restricted to settle a liability for more
than twelve months after the reporting period.
7. An entity shall classify a liability as current when under all of the following conditons,except

48
 a.The entity expects to settle the liability within the entity’s normal operating cycle.
b.The entity holds the liability primarily for the purpose of trading.
c.The liability is due to be settled within twelve months after the reporting period.
d.The entity has an unconditional right to defer settlement of the liability for at least
twelve months after the reporting period.
8. Assets to be sold,consumed or realized as part of the normal operating cycle are
a.Current assets
b.Non current assets
c.Classified as current or non current in accordance with other criteria
d.Noncurrent investments
9. Liabilities that an entity expects to settle within the normal operating cycle are classified as
a.Non current liabilities
b.Current or noncurrent liabilities in accordance with other criteria
c.Current liabilities
d.Equity
10. The statement of financial position is useful for analyzing all of the following,except.

a.Liquidity
b.Solvency
c.Profitability
d.Financial flexibility

Topic 2: Statement of Comprehensive Income

Learning Objectives:

a. To understand the objective and usefulness of an income statement

b. To understand the concept of comprehensive income, profit or loss and other
comprehensive income
c. To identify the components of other comprehensive income
d. To know the minimum line items in the statement of comprehensive income
e. To know the natural and functional presentation of the income statement.

INCOME STATEMENT
An income statement is a formal statement showing the financial performance of an entity for
a given period of time.

The financial performance is also known as the results of operations of the entity.

The income statement for a period presents the income, expenses, gains, losses and net income
or loss recognized during the period.

COMPREHENSIVE INCOME
Comprehensive Income is the change in equity during a period resulting from transactions and
other events, other than changes resulting from transactions with owners in their capacity as
owners.

49
 Comprehensive income includes:

a. Components of profit and loss

b. Components of other comprehensive income

Other Comprehensive Income

Other comprehensive income comprises items of income and expenses including
reclassification adjustments that are not recognized in profit or loss as required or permitted by
Philippine Financial Reporting Standards.

Components of Other Comprehensive Income

1. Unrealized gain or loss on equity investment measured at fair value through other
comprehensive income
2. Unrealized gain or loss on debt investment measured at fair value through other
comprehensive income
3. Gain or loss from translation of the financial statements of a foreign operation.
4. Revaluation surplus during the year.
5. Unrealized gain or loss from derivative contracts designated as cash flow hedge
6. Remeasurement of defined benefit plan including actuarial gain or loss
7. Change in fair value attributable to credit risk of a financial liability designated at fair
value through profit or loss.

Presentation of other Comprehensive income

PAS 1, paragraph 82A, provides that the statement of comprehensive income shall present line
items for amounts of other comprehensive income during the period classified by nature.

The line items for amounts of OCI shall be grouped as follows:

a. OCI that will be reclassified subsequently to profit or loss when specific conditions are
met.
b. OCI that will not be reclassified subsequently to profit or loss but to retained earnings.

OCI that will be reclassified to profit or loss

a. Unrealized gain or loss on debt investment measured at fair value through other
comprehensive income.
b. Gain or loss from translating financial statements of a foreign operation.
c. Unrealized gain or loss on derivative contracts designated as cash flow hedge.

OCI that will be reclassified to retained earnings

a. Unrealized gain or loss on equity investment measured at fair value through other
comprehensive income.
b. Revaluation surplus during the year
c. Remeasurement of defined benefit plan, including actuarial gain or loss.
d. Change in fair value attributable to credit risk of a financial liability designated at fair
value through profit or loss.

Presentation of comprehensive income

An entity has two options of presenting comprehensive income, namely:

50
 1. Two statements
a. An income showing the components of profit or loss.
b. A statement of comprehensive income beginning with profit or loss as shown in the
income statement plus or minus the components of other comprehensive income.

2. Single statement of comprehensive income

This is the combined statement showing the components of profit or loss and components of other
comprehensive income in a single statement.

Sources of income
a. Sales of merchandise to customers
The income from sales shall include all sales to customers during the period.
Sale returns, allowances and discounts shall be deducted from gross sales to arrive at
net sales.

b. Rendering of services
Income from rendering of services, among others, includes professional fees, media
advertising commissions, insurance agency commissions, admission fees for artistic
performance and tuition fees.

c. Use of entity resources

This income category includes interest, rent, royalty and dividend income.

d. Disposal of resources other than products

Samples include gain on sale of investments, gain on sale on sale of property, plants
and equipment and gain on sale of intangible assets.

Components of Expenses
a. Cost of goods sold or cost of sales
b. Distribution costs or selling expenses
c. Administrative expenses
d. Other expenses
e. Income tax expenses

Classification of expenses
Distribution costs constitute costs which are directly related to selling, advertising and delivery of
goods to customers.

It includes the following:

a. Salesmen’s salaries
b. Salesmen’s commissions
c. Travelling and marketing expenses
d. Advertising and publicity
e. Freight out
f. Depreciation of delivery equipment and store equipment

Administrative expenses constitute cost of administering the business.

Administrative expenses ordinarily include all operating expenses not related to selling and cost of
goods sold.

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Examples include:
a. Doubtful accounts
b. Office salaries
c. Expenses of general executives
d. Expenses of general accounting and credit departments
e. Office supplies used
f. Certain taxes
g. Contribution
h. Professional fees
i. Depreciation of office building and office equipment
j. Amortization of intangible assets

Other expenses are those expenses which are not directly related to the selling and administrative
function.

Examples include
a. Loss on sale of trading investments
b. Loss on disposal of property, plant and equipment
c. Loss on sale of non-current investment
d. Casualty loss – flood, earthquake, fire

Line items
PAS 1, paragraph 82, provides that as a minimum, the income statement and statement of
comprehensive income shall include the following line items:
a. Revenue
b. Gain and loss from the derecognition of financial asset measured at amortized cost as required
by PFRS 9.
c. Finance cost
d. Share in income or loss of associate and joint venture accounted for using the equity method.
e. Gain or loss on the reclassification of financial asset from amortized cost to fair value profit or
loss.
f. Gain or loss on the reclassification of financial asset from fair value other comprehensive income
to fair value profit or loss.
g. Income tax expenses
h. A single amount comprising discontinued operations.
i. Profit or loss for the period.
j. Total other comprehensive income
k. Comprehensive income for the period being the total of profit or loss and other comprehensive
income.

The following items shall be disclosed on the face of the income statement and statement of
comprehensive income.
a. Profit or loss for the period attributable to non-controlling interest and owners of the parent.
b. Total comprehensive income for the period attributable to non-controlling interest and owners of
the parent.

Forms of income statement

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PAS 1,paragraph 99,provides that an entity shall present an analysis of expenses recognized in
profit or loss using a classification based on either the function of expenses or their nature
within the entity ,whichever provides information that is reliable and more relevant.
The income statement may be presented in two ways, the functional and natural.

Functional presentation
This form classifies expenses according to their function as part of cost of goods sold, distribution
costs, administrative expenses and other expenses.

Natural presentation
The natural presentation is referred to as the nature of expense method.

Under this form, expenses are aggregated according to their nature and not allocated among the
various functions within the entity.

“Functional” income statement

EXAMPLAR COMPANY
Income Statement
Year Ended December 31,2020

Note
Net sales (1) 9,000,000
Cost of goods sold (2) (5,400,000)
Gross income 3,600,000
Other income (3) 900,000
Investment income (4) 500,000
Total income 5,000,000

Expenses:
Distribution costs (5)1,350,000
Administrative expenses (6) 1,000,000
Other Expenses (7) 320,000
Finance cost (8) 200,000 2,870,000

Income before tax 2,130,000

Income tax expense 580,000
Net Income 1,550,000

Note 1-Net sales

Gross sales 9,300,000

Sales return and allowance ( 100,000)
Sales discount ( 200,000)
Net sales 9,000,000

Note 2-Cost of goods sold

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 Inventory, January 1 1,500,000
Purchases 6,000,000
Freight in 300,000
Total 6,300,000
Purchase return and allowance ( 150,000)
Purchase discount ( 250,000) 5,900,000
Goods available for sale 7,400,000
Inventory, December 31 ( 2,000,000)
Cost of Sales 5,400,000

Note 3-Other Income

Interest revenue 180,000

Dividend revenue 120,000
Rent revenue 100,000
Gain from expropriation 500,000
Total 900,000

Note 4-Investment income

Share in net income of associate (25%) 500,000

Note 5-Distribution costs

Sales salaries 600,000

SSS and Philhealth-sales 20,000
Sales commission 180,000
Advertising 100,000
Store supplies expenses 50,000
Delivery expense 250,000
Depreciation-store equipment 150,000
Total distribution costs 1,350,000

Note 6-Administrative expenses

Office salaries 650,000

SSS and Philhealth-office 30,000
Bonuses 100,000
Office Supplies expenses 70,000
Taxes and licenses 20,000
Doubtful accounts 40,000
Depreciation-office equipment 90,000
Total administrative expenses 1,000,000

Note 7-Other expenses

Loss on sale of investment 30,000

Loss on sale of property 120,000
Casualty loss from earthquake 170,000
Total 320,000

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Note 8-Finance cost

Interest expense on bank loan 50,000

Interest expense on bonds payable 150,000
Total finance cost 200,000

“Natural” income statement

EXAMPLAR COMPANY
Income Statement
Year Ended December 31,2020

Note
Net sales (1) 9,000,000
Other income (2) 900,000
Investment income (3) 500,000
Total income 10,400,000

Expenses:

Increase in inventory (4) (500,000)

Net purchases (5)5,900,000
Employee benefit costs (6)1,400,000
Sales commission 180,000
Advertising 100,000
Supplies expense (7) 120,000
Delivery expenses 250,000
Depreciation (8) 240,000
Taxes and licenses 20,000
Doubtful accounts 40,000
Other expenses (9) 320,000
Finance cost (10) 200,000 8,270,000

Income before tax 2,130,000

Income tax expense 580,000
Net income 1,550,000

Note 1-Net sales

Gross sales 9,300,000

Sales return and allowance ( 100,000)
Sales discount ( 200,000)
Net sales 9,000,000

Note 2-Other income

Interest revenue 180,000

Dividend revenue 120,000

55
Rent revenue 100,000
Gain from expropriation 500,000
Total 900,000

Note 3-Investment income

Share in net income of associate(25%) 500,000

Note 4-Increase in inventory

Inventory-December 31 2,000,000
Inventory-January 1 1,500,000
Increase in inventory 500,000

Note 5-Net purchases

Purchases 6,000,000
Freight in 300,000
Purchase return and allowance (150,000)
Purchase discount (250,000)
Net purchases 5,900,000

Note 6-Employee benefit costs

Sales salaries 600,000

SSS and Philhealth-sales 20,000
Office salaries 650,000
SSS and Philhealth-office 30,000
Bonuses 100,000
Total employee costs 1,400,000

Note 7-Supplies expense

Store supplies 50,000

Office supplies 70,000
Total supplies expense 120,000

Note 8-Depreciation

Depreciation-store 150,000
Depreciation-office 90,000
Total depreciation 240,000

Note 9-Other expenses

Loss on sale of investment 30,000

Loss on disposal of property 120,000
Casualty loss from earthquake 170,000

56
Total 320,000

Note 10-Finance cost

Interest expense on bank loan 50,000

Interest expense on bonds payable 150,000
Total finance cost 200,000

Statement of comprehensive income

The statement of comprehensive income starts with the profit or loss as shown in the income
statement plus or minus the components of other comprehensive.

The purpose of this statement is to provide more comprehensive information on financial

performance measured more broadly than the income as traditionally computed.

EXEMPLAR COMPANY
Statement of Comprehensive Income
Year Ended December 31, 2020

Net income 1,550,000

Other comprehensive income to be reclassified to profit or loss:
Foreign currency translation gain 150,000
Unrealized loss on derivative contract
Designated as cash flow hedge (100,000) 50,000
Comprehensive income 1,600,000

Statement of retained earnings

The statement of retained earnings shows the changes affecting directly the retained earnings
of an entity and relates the income statement to the statement of financial position.

The important data affecting the retained earnings that should be clearly disclosed in the
statement of retained earnings are:

a.Profit or loss for the period

b.prior period errors
c.Dividends declared and paid to shareholders
d.Effect of change in accounting policy
e.Appropriation of retained earnings

Illustration-all amounts are assumed

EXEMPLAR COMPANY
Statement of Retained Earnings
Year Ended December 31,2020

Retained earnings,January 1 1,000,000

Correction of error resulting from prior
Year underdepreciation (100,000)
Change in accounting policy from weighted
Average to FIFO inventory valuation resulting

57
 In an increase 300,000
Corrected beginning balance 1,200,000
Net income for the period 1,550,000
Dividends declared during the year (400,000)
Appropriated for contingencies (200,000)
Retained earnings,December 31 2,150,000

Statement of Changes in Equity

The statement of changes in equity is a basic statement that shows the movements in the
elements or the components of the shareholder’s equity.

The statement of retained earnings is no longer a required basic statement but it is a part of the
statement of changes in equity.

An entity shall present a statement of changes in equity showing the following:

1. Comprehensive income for the period.

2. For each component of equity,the effects of changes in accounting policies and
corrections of errors.
3. For each component of equity,a reconciliation between the carrying amount at the
beginning and end of the period,separately disclosing changes from:
a. Profit or loss
b. Each item of other comprehensive income
c. Transactions with owners in their capacity as owners showing separately
contributions by and distributions to owners.

EXEMPLAR COMPANY
Statement of Changes in Equity
Year Ended December 31, 2020

Share Capital Reserves Retained earnings

Balances-January 1 5,000,000 2,000,000 1,000,000
Correction of error resulting
from prior year underdepreaciation (100,000)
Change in accounting policy from weighted
Average to FIFO-credit 300,000
Issuance of 10,000 ordinary shares
With 100 par at 150 per share 1,000,000 500,000
Issuance of 5,000 preference shares
With 50 par at 100 per share 250,000 250,000
Comprehensive income:
Net income 1,550,000
Other comprehensive income 50,000
Dividends paid during the year (400,000)
Current appropriation for contingencies 200,000 (200,000)
_______________________________________
Balances-December 31 6,250,000 3,000,000 2,150,0000

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 Summary:

⮚ The statement of financial performance or income statement is a formal statement

showing the financial performance of an entity for a given period of time.
⮚ The financial performance is also known as the results of operations of the entity.
⮚ Comprehensive income is the change inequity during a period resulting from
transactions and other events, other than changes in resulting from transactions with
owners in their capacity as owners.
⮚ The statement of comprehensive income starts with the profit or loss as shown in the
income statement plus or minus the components of other comprehensive.
⮚ The statement of retained earnings shows the changes affecting directly the retained
earnings of an entity and relates the income statement to the statement of financial
position.
⮚ Statement of changes in equity is a basic statement that shows the movements in the
elements or components of the shareholders’equity.

Activity 4

Marquez provided the following information for the current year:

Purchases 5,250,000
Purchase returns and allowances 150,000
Rental income 250,000
Selling expenses:
Freight out 175,000
Salesmen’s commission 650,000
Depreciation-store equipment 125,000
Merchandise inventory-January 1 1,000,000
Merchandise inventory-December 31 1,500,000
Sales 7,850,000
Sales returns and allowances 140,000
Sales discounts 10,000
Administrative expenses:
Officers’ salaries 500,000
Depreciation-office equipment 300,000
Freight in 500,000
Income tax 250,000
Loss on sale of equipment 50,000
Purchase discounts 100,000
Dividend revenue 150,000
Loss on sale of investment 50,000

Required:

a. Prepare an income statement for the year using the “functional” method with supporting
notes.

Activity 5(Multiple choice)

59
1. Gabriel Company reported operating expenses in two categories, namely distribution and
administrative. The adjusted trial balance at year-end included the following expense and loss
accounts for current year. One-half of the rented premises is occupied by the sales department.

Accounting and legal fees 1,200,000

Advertising 1,500,000
Freight out 800,000
Interest 700,000
Loss on sale of long-term investment 300,000
Officers’salaries 2,250,000
Rent for office space 2,200,000
Sales salaries and commissions 1,400,000

What amount should be reported as distribution costs?

a.4,800,000
b.4,000,000
c.3,700,000
d.3,600,000

2.Levis Company reported the following data for the current year:

Legal and audit fees 1,700,000

Rent for office equally shared by sales
And accounting 2,400,000
Loss on abandoned data processing equipment 350,000
Interest on inventory loan 2,100,000
Freight in 1,750,000
Freight out 1,600,000
Officers’ salaries 1,500,000
Insurance 850,000
Sales representative salaries 2,150,000
Research and development expenses 1,000,000

What amount should be classified as administrative expenses?

a.5,250,000
b.6,450,000
c.5,600,000
d.6,250,000

3.Villanueva company reported net income of P7,410,000 for the current year which included
the following amounts:

Unrealized loss on foreign currency translation (540,000)

Gain on early retirement of bonds payable 2,200,000
Adjustment of profit of profit of prior
Year for error in depreciation, net of tax effect (750,000)
Loss from fire (1,400,000)

What amount should be reported as adjusted net income?

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a.6,500,000
b.6,610,000
c.8,160,000
d.8,700,000

4.Quirino Company provided the following information for the current year:

Increase in raw materials inventory 150,000

Decrease in goods in process inventory 200,000
Decrease in finished goods inventory 350,000
Raw materials purchased 4,300,000
Direct labor payroll 2,000,000
Factory overhead 3,000,000
Freight out 450,000
Freight in 250,000

What is the cost of goods sold for the current year?

a.9,950,000
b.9,550,000
c.9,250,000
d.9,150,000

5.S company reported the following information for the current year.

Ending goods in process 1,000,000

Depreciation on factory building 320,000
Beginning raw materials 400,000
Direct labor 1,980,000
Factory supervisor’s salary 560,000
Depreciation on headquarters building 210,000
Beginning goods in process 760,000
Ending raw materials 340,000
Indirect labor 360,000
Purchases of raw materials 2,300,000

What is the cost of goods manufactured for the current year?

a.5,340,000
b.5,580,000
c.5,550,000
d.5,820,000

References:
● Valix, C. T., Peralta, J.F & Valix C. A. M. (2020). Conceptual Framework
and Accounting Standards. Manila, Philippines: GIC Enterprises & Co..
Inc.
● Ballada, W., & Ballada S. (2020). Conceptual Framework and
Accounting Standards. Manila, Philippines: DomDane Publishers.

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 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS (AE 14)
LEARNING MATERIAL

UNIT NUMBER/ HEADING: MODULE 3/ PAS 8: ACCOUNTING POLICIES

ESTIMATES AND ERRORS
LEARNING OUTCOMES:
At the end of the unit, the students will be able to:
l. Recognize and describe the effect of change in accounting policy and
accounting estimate
m. Apply the concept in change of accounting policy and accounting
estimate
n. Recognize and describe the effect of accounting errors
o. Apply the concept in prior period accounting errors

INTRODUCTION:
Accounting policies are essential for proper understanding of the information
contained in the financial statements. Accounting estimates on the other hand are
the circumstances on which the estimate was based or as a result of new information,
more experience or subsequent or subsequent development. Prior period errors are
omissions and misstatement in the financial statements for one or more period
arising from a failure to use or misuse of reliable information.

In this unit, you will learn the reason why we need to change accounting
policies and accounting estimates. You will also gain knowledge and comprehension
oh how accounting policies, estimates and prior period errors are recognized, and
reported, including their effects on financial statements.

Topic 1: CHANGE IN ACCOUNTING POLICY, ACCOUNTING

ESTIMATE AND PRIOR PERIOD ERRORS

Learning Objectives:
At the end of the topic, the students will be able to:
a. Recognize and describe the effect of change in accounting policy and
accounting estimate
b. Apply the concept in change of accounting policy and accounting
estimate
c. Recognize and describe the effect of accounting errors
d. Apply the concept in prior period accounting errors

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Activating Prior Learning

Give 3 transactions or events that describe each of the following:

Change in Change in Accounting Prior Period error

Accounting Policy Estimate

1. 1. 1.
2. 2. 2.
3. 3. 3.

Presentation of Content

CHANGE IN ACCOUNTING POLICIES

Accounting policies are the specific, principles, bases, conventions, rules and
practices. The entity shall select and apply the same accounting policies each period
in order to achieve comparability of financial statements or to identify trends in the
financial statements

It is very important to note that an accounting policy has been selected; it

must be applied consistently for similar transactions and events. However a change
in accounting policy shall be allowed for change when the following justifications
arise:
a. Required by an accounting standard
b. The change will result in more relevant and faithfully represented information
about the financial statements

Examples of changes in accounting policy are:

a. Change in the method of inventory pricing (e.g. FIFO to Weighted average
method)
b. Change in the accounting recognition for long term construction contract
(e.g. cost recovery method to percentage of completion method)
c. Change from cost model to fair value model in measuring investment
property
d. The initial adoption of policy to carry over assets at revalued amount is
change in accounting policy to be dealt with as revaluation
e. Change to new reporting policy resulting from the requirement of a new
PFRS

How to report a change in accounting policy?

A change in accounting policy required by a standard or an interpretation shall be
applied in accordance with the transitional provision.

63
If the standard or interpretation contains no transitional provisions or an
accounting policy is changed voluntarily, the change shall be applied
retrospectively or retroactively

Retrospective application
The comparative financial statements of all prior years presented shall be restated
as if the new policy had always been applied. The cumulative effect of change in
accounting policy, net of applicable income tax, shall be treated as an adjustment
to the beginning balance of retained earnings in the earliest prior period presented.

Limitation of Retrospective application

Retrospective application of the change in accounting policy need not be made, if it
is IMPRACTICABLE to do so. A procedure is considered impracticable if:
1. The effects of the retrospective application are not determinable;
2. The retrospective application requires assumptions about what management’s
intentions would have been at the time;
3. The retrospective application requires significant estimates of amounts, and
it is impossible to distinguish objectively, from other information, information
about those estimates that provides evidence of circumstances that existed at
that time and would have been available at that time
When it is impracticable to make retrospective application, the entity applies the
change to the earliest period to which it is possible to apply the change, which
normally is the beginning of the current period

If comparative information is presented, the financial statements of the prior period

presented shall be restated to conform with the new accounting policy

Illustration:
An entity has used weighted average method in valuation of its inventory since 2019.
The entity decided to change the weighted average method to FIFO method for
determining inventory cost at the beginning of 2020
Weighted FIFO
Average
December 31, 2019 1,000,000 750,000
December 31, 2020 1,500,000 1,200,000

Inventory January 1, 2020

Weighted average inventory 1,000,000
FIFO 750,000
Increase/Decrease 250,000

Adjustment of the decrease in beginning inventory

Retained earnings 250,000
Inventory 250,000

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The computation of the cost of goods sold for 2020 would then show beginning
inventory at P750,000 and ending inventory at P1,200,000 to confirm with the FIFO
method.

The statement of changes in in equity for the year ended December 31, 2020 would
show the effect of the change of P250,000 net of tax as a deduction from beginning
balance of retained earnings.

Absence of accounting Standard

PAS 8, paragraph 10, provides that in the absence of an accounting standard
that specifically applies to a transaction or event, management shall use judgment
in selecting and applying accounting policy that results in information that is
relevant to the economic decision making needs of users and faithfully represented.

In the absence of accounting standards, the following hierarchy of guidance

may use by management when selecting accounting policies.
1. Requirements of current standards dealing with similar matters
2. Definition, recognition criteria and measurement concepts for assets,
liabilities, income and expenses in the conceptual framework for financial
reporting
3. Most recent pronouncement of other standard-setting bodies that use a
similar Conceptual Framework, other accounting literature and accepted
industry practices

CHANGE IN ACCOUNTING ESTIMATE

A change in accounting estimate is a normal recurring correction or

adjustment of an asset or liability which is the natural result of the use of an
estimate.

An estimate may need revision if changes occur regarding the circumstances

on which the estimate was based or as a result of new information, more experience
or subsequent or subsequent development. The revision of the estimate does not
relate to prior period error and is not a correction of an error

If it is difficult to distinguish a change in accounting estimate and accounting

policy, the change is treated as a change in accounting estimate and is supported by
appropriate disclosure.

Examples of accounting estimates

As a result of the uncertainties in business activities, many items in financial

statements cannot be measured with precision but can only be estimated. Estimates
also involved judgment based on the latest available and reliable information.
Estimates may be required for the following:
1. Doubtful accounts
2. Inventory obsolescence

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 3. Useful life, residual value and expected pattern of depreciation of
depreciable asset
4. Provisions liability
5. Fair value of assets and liability

How to report change in accounting estimate?

The effect of a change in accounting estimate shall be recognized currently and
prospectively by including it in profit or loss of:
a. The period of change if the change affects that period only
b. The period of change and future periods if the change affects both

A change in accounting estimate shall not be accounted for restating amounts

reported in financial statements of prior period. Changes in accounting estimates are
treated currently and prospectively, if necessary. Prospective recognition of the effect
of change in accounting estimates means that the change is applies to transactions
or other events and condition from the date of change in estimate.

To illustrate, let us take this as an example:

A depreciable asset costing P800,000 is estimated to have a life of 5 years. At the
beginning of the third year, the original life is changed to 8 years. Thus the asset has
a remaining life of 6 years. In this case, the procedure is not to correct past
transaction but to allocate the remaining carrying amount of the asset to its
remaining useful life.
Carrying amount (P800,000 -320,000) 480,000
Divide: New remaining useful life 6________
Subsequent annual depreciation 80,000

The entry to record the annual depreciation, starting in the third year is:
Depreciation 50,000
Accumulated Depreciation 50,000

CORRECTING PRIOR ERRORS

Prior period errors are omissions and misstatement in the financial

statements for one or more period arising from a failure to use or misuse of reliable
information. Errors make arise as a result of mathematical mistakes, mistakes in
applying accounting policies, misinterpretation of facts, fraud or oversight

How to treat prior period error?

An entity shall correct material prior period errors respectively in the first set
of financial statements authorised for issue after their discovery by:
(a) Restating the comparative amounts for prior period(s) in which error
occurred, or
(b) If the error occurred before that date – restating the opening balance of
assets, liabilities and equity for earliest prior period presented.

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 If comparative statements are presented, the financial statements of the prior
period error shall be restated, so as to reflect the retroactive application of the prior
period error as a retroactive restatement

Application
These activities are assessment if you understand that discussions we had.
Though this will not be recorded, it will still form part of your class standing so
make sure to accomplish the tasks given to you. ☺

Your tasks:

1. When is change in accounting policy allowed?

2. Differentiate Change in accounting policy and change in accounting
estimates. How these changes recognized and reported?
Change in Accounting Policy Change in Accounting Estimate

Feedback

Multiple Choice
1. A change in measurement basis is most likely a
A) Change in accounting policy
B) Change in accounting estimate
C) Error
D) Any of these
2. A correction of prior error is accounted for by
A) Retrospective application
B) Retrospective restatement
C) Prospective application
D) Impracticable application
3. Which of the following is a change in accounting estimate?
A) Change from the cost model to the fair value model of measuring
investment property
B) Change in business model for classifying financial assets resulting to the
reclassification of financial assets from being measured at amortized cost
to fair value
C) Change in the method of recognizing revenue from long-term
construction contract
D) Change in the depreciation method, useful life or residual value of an
item of property, plant and equipment
4. These result from new information or new development
A) Change in accounting estimates
B) Change in accounting policies
C) Correction of errors
D) All of these

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 5. The effect of which of the following is presented in the profit or loss in the
current period ( or current or future periods if both are affected) rather than
as an adjustment to the opening balance of retained earnings
A) Correction of prior period error
B) Change in accounting policy
C) Change in accounting estimate
D) All of these
6. According to PAS 8, in the absence of PFRS that specifically deals with a
transaction, management shall
A) Refer to the concepts under the conceptual framework
B) Adopt the provisions of the GAAP
C) Use judgment in developing and applying an accounting policy that
results in information that is relevant and reliable
D) Consider the applicability of relevant accounting information
7. According to PAS 8, a change in accounting policy is accounted for
A) Using a transitional provision if any
B) Retrospectively
C) Prospectively, if retrospective application is impracticable
D) A,B or C whichever is most appropriate
8. This refers to applying a new accounting policy to transactions, other events
and conditions as if that policy had always been applied
A) Retrospective application
B) Prospective application
C) Retrospective restatement
D) Impracticable application
9. According to PAS 8. A change in accounting estimate is accounted for
A) Using transitional provision
B) Retrospectively
C) Prospectively
D) A,B, or C whichever is most appropriate
10. Entity A changes its inventory cost formula from FIFO to weighted average.
How should entity A account for this change?
A) By retrospective restatement, as a change in accounting policy
B) By prospective application, as change in accounting estimate
C) By retrospective application, as change in accounting policy
D) As a correction of prior period error

Summary of the Unit

The two types of accounting changes are the; change in accounting policy and
change in accounting estimate
Accounting policies are the specific, principles, bases, conventions, rules and
practices. The entity shall select and apply the same accounting policies each
period in order to achieve comparability of financial statements or to identify
trends in the financial statements

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 A change in accounting policy required by a standard or an interpretation
shall be applied in accordance with the transitional provision
The change in accounting policy is treated retrospectively or retroactively

An estimate may need revision if changes occur regarding the circumstances

on which the estimate was based or as a result of new information, more
experience or subsequent or subsequent development. The revision of the
estimate does not relate to prior period error and is not a correction of an error
A change in accounting estimate is a normal recurring correction or
adjustment of an asset or liability which is the natural result of the use of an
estimate.
Change in accounting policy normally results from a change in measurement
basis. Change in accounting estimate results from changes on how the
expected inflows or outflows of economic benefits are realized from assets or
incurred on liabilities
Change in accounting estimate shall be recognized currently and prospectively
by including it in profit or loss of:
If it is difficult to distinguish a change in accounting estimate and accounting
policy, the change is treated as a change in accounting estimate and is
supported by appropriate disclosure.
Prior period errors are omissions and misstatement in the financial
statements for one or more period arising from a failure to use or misuse of
reliable information. Errors make arise as a result of mathematical mistakes,
mistakes in applying accounting policies, misinterpretation of facts, fraud or
oversight

Student’s Reflection on Learning

This part of the module will be a time for you to look back, and reflect on what
you have learned from this unit. Though, this will not be checked and recorded,
I would appreciate if you will do this wholeheartedly and with all seriousness.

Answer only one the following questions

1. Think of personal policies you are using in your financial
undertakings? Think of the instance when you depart from that
policy and explain why you need to deviate from / or change that
policy? What is the effect of your departure from your policy to your
undertaking?
2. Think of personal financial goals that you had undergone (e.g.
budgeting, savings, business undertakings, etc.) and relate to the
estimates or projections that you applied. Does your
estimates/projections still reliable at present? Explain the effect of
your estimates to the result of your undertakings.

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 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS (AE 14)
LEARNING MATERIAL

UNIT NUMBER/ HEADING: STATEMENT OF CASH FLOWS

LEARNING OUTCOMES:
At the end of the unit, the students will be able to:
p. Understand the nature and purpose of a Statement of Cash
Flows;
q. Explain the concept and components of cash and cash
equivalents;
r. Classify items as operating, investing and financing;
s. Differentiate the direct method and indirect method

INTRODUCTION:
Cash is always a crucial but very useful factor in carrying out the
operations of an entity and eventually achieving the goals and objectives of
the organization. That is why it is very important for financial managers and
accountants to have a wide knowledge on the nature, sources and
management of the entity’s cash.
In this module, you will learn and understand deeper the accounting
principles for Statement of Cash Flows. You will also learn the different
business transactions that includes cash.

Activating Prior Learning

It has been argued that ‘profit’ does not always give a useful or
meaningful picture of a company’s operations. Readers of a company’s
financial statements might even be misled by a reported profit figure.

a. Shareholders might believe that if a company makes a profit after tax,

say, P100,000 then this is the amount which it could afford to pay as a
dividend. Unless the company has sufficient cash available to say in
business and also to pay a dividend, the shareholders’ expectations
would be wrong.
b. Employees might believe that if a company makes profits, it can afford
to pay higher wages next year. This opinion may not be correct. The
ability to pay wages depends on the availability of cash.
c. Survival of a business entity depends not so much on profits as on its
ability to pay its debts when they fall due. Such payments might include
‘revenue’ items such as material purchases, wages, interest and
taxation etc., but also capital payments for new non-current assets and
the repayment of loan capital when this falls due (for example on the
redemption of debentures)

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For these examples, it may be apparent that a company’s performance and
prospects depend not so much on the profits’ earned in a period, but more
realistically on liquidity or cash flows.

Presentation of Content

CONCEPTS OF STATEMENT OF CASH FLOWS

❖ Statement of cash flows is a component of financial statements

summarizing the operating, investing and financing activities of an
entity
❖ It provides the information about the cash receipts and cash payments
of entity during the period. It explains the nature of change in an
entity’s cash and cash equivalents.
❖ Frequently given as an additional statement; supplementing the
statement of financial position, statement of profit or loss and other
comprehensive income and related notes.
❖ Should be presented as an integral part of an entity’s financial
statements

IAS 7 Statement of Cash Flows which aims:

o to provide information to users of financial statements about the
entity’s ability to generate cash and cash equivalents.
o Requires an entity to present a statement of cash flows as an
integral part of its primary financial statements.
The standard gives the following definitions:
▪ Cash comprises cash on hand and demand deposits
▪ Cash equivalents are short-term, highly liquid investments that are
readily convertible to known amounts of cash and which are subject
to an insignificant risk of changes in value
▪ Cash flows are inflows and outflows of cash and cash equivalents.

THE 3 CLASSIFICATION OF CASH FLOWS

1. Operating activities are the principal revenue-producing activities of
the entity and other activities that are not investng or financing
activities.
- most of the components of cash flows from operating activities will be
those items which determine the net profit or loss of the entity.
Examples are:
✓ Cash receipts from the sale of goods and the rendering of
services
✓ Cash receipts from royalties, fees, commissions and other
revenue

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 ✓ Cash payments to suppliers for goods and services
✓ Cash payments to and on behalf of employees
✓ Cash payments for taxes
✓ Cash payments for interest expense
✓ Cash payments for other operating expenses

An entity reports cash flows from operating activities using either:

o Direct method, whereby major classes of gross cash receipts and gross
cash payments are disclosed; or
o Indirect method, whereby profit or loss is adjusted for the effects of
transactions of a non-cash nature, any deferrals or accruals of past or
future operating cash receipts or payments and items of income or
expense associated with investing or financing cash flows.
- this is undoubtedly easier from the point of view of the preparer
of the statement of cash flows. The net profit or loss for the period
is adjusted for:
a. Changes during the period in inventories, operating
receivables and payables;
b. Non cash items, e.g. depreciation, provisions,
profits/losses on the sales of the assets
c. Other items, the cash flows from which should be
classified under the investing or financing activities
- proforma of such calculation is as follows:

Cash flows from operating activities

Profit before taxation xx
Adjustments for:
Depreciation xx
Foreign exchange loss xx
Investment income (xx)
Interest expense xx
xx
Increase in trade and other receivables (xx)
Decrease in inventories xx
Decrease in trade payables (xx)
Cash generated from operations xx
Interest paid (xx)
Income taxes paid (xx)
Net cash from operating activities xx

72
 It is important to understand why certain items are added and others
subtracted. Note the following:
a. Depreciation is not a cash expense but is deducted in arriving at profit.
It makes sense, therefore, to eliminate it by adding it back.
b. By the same logic, a loss on a disposal of a non-current asset (arising
through under provision of depreciation) needs to be added back and a
profit deducted.
c. An increase in inventories means less cash – you have spent cash on
buying inventory.
d. An increase in receivables means the company’s debtors have not paid
as much, and therefore there is less cash
e. If we pay off payables, causing the figure to decrease, again we have
less cash.
2. Investing Activities are the acquisition and disposal of long-term assets
and other investments not included in cash equivalents. Examples are:
✓ Cash payments to acquire property, plant and equipment, intangibles
and other non-current assets, including those relating to capitalized
development costs and self-constructed property, plant and
equipment
✓ Cash receipts from collections of notes receivable
✓ Cash receipts from sales of property, plant and equipment,
intangibles and other non-current assets
✓ Cash payments to acquire shares or debentures of other entities
✓ Cash receipts from sales of shares or debentures of other entities
✓ Cash advances and loans made to other parties
✓ Cash receipts from the repayment of advances and loans made to
other parties
3. Financing activities are activities that result in changes in the size and
composition of the contributed equity and borrowings of the equity.
Examples are:
✓ Cash proceeds from issuing shares
✓ Cash payments to owners to acquire or redeem the entity’s sharea
✓ Cash proceeds from issuing debentures, loans, notes, bonds,
mortgages and other short or long-term borrowings
✓ Principal repayments of amounts borrowed under leases.
(amounts as financing acitivities are repayment of the principal
while payment of interest will be shown under operating
activities)

Other matters
 Trading securities
o Cash flows arising from the purchase and sale of dealing or trading
securities are classified as operating activities. Similarly, with cash

73
 advances and borrowings made by financial institutions since they
relate to the main revenue producing activity.
 Interests
o Interest paid and interest received shall be classified as operating cash
flows. Alternatively, interest paid may be classified as financing cash
flow as it is a cost of borrowing funds, while interest received may be
classified as investing as a return on investment.
 Dividends
o Dividend received shall be classified as operating cash flow,
alternatively, may be classified as investing cash flow because it is a
return on investment.
o Dividend paid shall be classified as financing cash flow because it is a
cost of obtaining financial resources, alternatively, may be classified
as operating cash flow.
 Income taxes
o Separately disclosed as cash flows from operating activities unless
they can be specifically identified with investing and financing
activities.

PROBLEM ILLUSTRATION
Illustration 1
Riverdale Company provided the following data for the current year:
a. Purchased a building for 1,200,000
Paid 400,000 and signed a mortgage with the seller for the remaining
balance.
b. Executed a debt-equity swap and replaced a 600,000 loan by giving
the lender ordinary shares worth 600,000 on the date swap was
executed.
c. Purchased land for 1,000,000. Paid 350,000 and issued ordinary
shares worth 650,000.
d. Borrowed 550,000 under a long-term loan agreement
Used the cash from the loan proceeds to purchase additional
inventory of 150,000, to pay cash dividend 300,000 and increase cash
balance of 100,000

Compute for the cash inflow and outflow from Operating, Investing and
Financing activities.
Step 1: Identify if transactions are cash or noncash transactions
a. Cash 400,000 Noncash 800,000
b. Noncash
c. Cash 350,000 Noncash 650,000
d. Cash 550,000
Step 2: Identify the cash transactions as inflow or outflow
a. Outflow 400,000
b. NA
c. Outflow 350,000
d. Inflow 550,000 Outflow 450,000

74
Step 3: Identify what kind of activity is the cash transaction
a. Investing
b. NA
c. Investing
d. Financing and Operating
Step 4: Combine the same group of activities and compute for the net
cash provided or (used).
Operating:
Purchase of inventory (150,000)

Net cash used in Operating activity (150,000)

Investing:
Purchase of building (a) (400,000)
Purchase of land (c) (350,000)
Net cash used in Investing activities (750,000)
Financing:
Proceeds of long-term loan (d) 550,000
Payment of dividends (d) (300,000)
Net cash provided by financing activities 250,000

Observe the following:

1. A transaction may result to one or more kind of activity, refer to
transaction (d), affecting both financing and operating.
2. A transaction may be classified as both cash and noncash transaction,
refer to transaction (a) and (c), and again only cash transactions are
taken into consideration.
3. Purchase and payments are negative or deductions while proceeds or
receipts are positive or additions.

Example of a Statement of Cash Flows

Direct Method

ABC Company
Statement of Cash Flows
For the month ended July 31, 2020

Cash flows from Operating Activities:

Cash received from clients P30,330
Cash paid to suppliers and employees (27,600)
Cash generated from operations 2,730
Interest paid ( 270)
Income taxes paid ( 900)
Net cash from operating activities 1,560

Cash flows from Investing Activities:

Purchase of property, plant and equipment (P 900)
75
 Proceeds from sale of equipment 20
Interest received 200
Dividends received 200
Net cash used in investing activities ( 480)

Cash flows from financing activities

Proceeds from issue of share capital 250
Proceeds from long-term borrowings 250
Dividends paid* (1,290)
Net cash used in financing activities ( 790)
Net increase in cash and cash equivalents 290
Cash and cash equivalents at the beginning of period 120
Cash and cash equivalents at end of period 410

*This could also be shown as an operating cash flow

Indirect Method

ABC Company
Statement of Cash Flows
For the month ended July 31, 2020
(amounts in millions)

Cash flows from operating activities

Profit before taxation P 3,570
Adjustments for:
Depreciation 450
Investment income ( 500)
Interest expense 400
3,920
Increase in trade and other receivables ( 500)
Decrease in inventories 1,050
Decrease in trade payables ( 1,740)
Cash generated from operations 2,730
Interest paid ( 270)
Income taxes paid ( 900)
Net cash from operating activities 1,560

Cash flows from investing activities

Purchase of PPE ( 900)
Proceeds from sale of equipment 20
Interest received 200
Dividends received 200

76
Net cash used in investing activities ( 480)

Cash flows from financing activities

Proceeds from issue of share capital 250
Procees from long-term borrowings 250
Dividends paid* ( 1,290)
Net cash used in financing activities ( 790)
Net increase in cash and cash equivalents 290
Cash and cash equivalents at beginning period 120
Cash and cash equivalents at end of period 410

*This could also be shown as an operating cash flow

Advantages of Cash Flow Accounting

The advantages of cash flow accounting are:

a. Survival in business depends on the ability to generate cash. Cash flow
accounting directs attention towards this critical issue.
b. Cash flow is more comprehensive than profit which is dependent on
accounting conventions and concepts
c. Creditors (lon adn short-term) are more interested in an entity’s ability
to repay them than in its profitability. Whereas profits might indicate
that cash is likely to be available, cash flow accounting is more direct
with its message.
d. Cash flows reporting provides better means of comparing the results of
different companies than traditional profit reporting.
e. Cash flow reporting satisifies the needs of all user
f. Cash flow forecasts are easier to prepare, as well as more useful, tha
profit forecasts
g. They can in some respects be audited more easily than accounts based
on the accruals concept

Application

TRY THIS:
III. Activity 1:
1. Refer to Illustration 1, assuming cash balance beginning is 780,000.
Compute for the ending cash balance.
2. Refer to Illustration 1, assume that shares issued are sold in quoted
market, and proceeds were used in purchase of land. What could have
been the effect on operating, investing and financing activity?
3. Refer to Illustration 1, assume that the proceeds from long-term loan
(d) were use in payment of 100,000 interest expense, 300,000 cash
dividends, and 150,000 operating expenses. All transactions remain
77
 unchanged, compute for cash provided or used in operating, investing
and financing.
IV. Activity 2: Identify the transactions whether it is a cash or noncash
transaction and the kind of activity. Place an X for identified noncash
transactions, and inflow or outflow for cash transactions. Number 1
has been answered for your reference.
Transactions Noncash Cash Activity

1. Collecting cash from customers Inflow Operating

2. Proceeds from borrowing a long-

Inflow
term debt
3. Borrowing cash as working capital Inflow
4. Collection from issuance of ordinary
shares
5. Receipt of property dividends

6. Disposal of computer equipment

7. Purchase of merchandise
inventories on account
8. Payment of wages and salaries of
employees
9. Loaned money to an associate

10. Payment of cash dividends

11. Accrual of interest on short-term

loans
12. Payment of utility bills

13. Selling of stocks and bonds held for

long-term investment
14. Credit of interest income on bank
savings deposit
15. Disbursements for annual payment
on long-term loans
Feedback

Problem 1:

Moira Company provided the following information during the current year;
Dividend received P 500,000
Dividend paid P1,000,000
Cash received from customers P9,000,000
Proceeds from issuing share capital P1,500,000
Interest received P 200,000
Proceeds from sale of long term investments P2,000,000

78
Cash paid to suppliers and employees P6,000,000
Interest paid on long term debt P 400,000
Income taxes paid P 300,000
Cash balance, January 1 P1,800,000
1. What is the net cash provided by operating activities?
a. P3,000,000
b. P3,300,000
c. P2,700,000
d. P2,000,000
2. What is the net cash provided by investing activities?
a. P2,500,000
b. P2,000,000
c. P2,200,000
d. 0
3. What is the net cash provided by financing activities?
a. P1,500,000
b. P1,000,000
c. P 500,000
d. 0
4. What is the cash balance on December 31?
a. P6,300,000
b. P5,500,000
c. P4,800,000
d. P7,300,000

Problem 2:
On December 31, 2020, Pina A. Asa Company had the following balances:
Cash balance, beginning of year P1,300,000
Cash flow from financing activities P1,000,000
Cash flow from operating activities P 400,000
Cash flow from investing activities (P1,500,000)
Total shareholders’ equity, beginning of the year P2,000,000

What is the cash balance at the end of the current year?

a. P1,200,000
b. P1,600,000
c. P1,400,000
d. P1,700,000

Problem 3:
Dina M. Hall Company provided the following data for the current year:
Purchase of real estate for cash P5,500,000
Cash was borrowed from bank to purchase real estate P5,500,000

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Sale of investment for cash P5,000,000
Dividend paid P6,000,000
Issuance of ordinary shares for cash P2,500,000
Purchase of patent for cash P1,250,000
Payment of bank loan P1,500,000
Issuance of bonds payable for cash P3,000,000

Summary of the Unit

Statement of cash flows provides the information about the cash
receipts and cash payments of entity during the period. It explains the
nature of change in an entity’s cash and cash equivalents.
International Accounting Standards (IAS) 7 is the standard that governs
the presentation of statement of cash flows
The three classifications of cash flows are operating, investing and
financing activities
Operating activities are the principal revenue-producing activities of the
entity and other activities that are not investng or financing activities.
The two methods to present operating activities are direct method and
indirect method
Investing activities are the acquisition and disposal of long-term assets
and other investments not included in cash equivalents
Financing activities are activities that result in changes in the size and
composition of the contributed equity and borrowings of the equity
Student’s Reflection on Learning

This part of the module will be a time for you to look back, and reflect on what
you have learned from this unit. Though, this will not be checked and recorded,
I would appreciate if you will do this wholeheartedly and with all seriousness.

Answer the following questions and put your answers in the space provided.
3. Did you learn what you expect to learn?
4. How might you use what you learned in the future in your life or
profession?

References:

• Valix, C. T., Peralta, J.F & Valix C. A. M. (2020). Conceptual Framework

and Accounting Standards. Manila, Philippines: GIC Enterprises & Co..
Inc.
• Ballada, W., & Ballada S. (2020). Conceptual Framework and
Accounting Standards. Manila, Philippines: DomDane Publishers.
• https://www.iasplus.com/en/standards/ias/ias7
• https://www.youtube.com/watch?v=NMubNKCQV0A

80
 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS (AE 14)
LEARNING MATERIAL

UNIT NUMBER / HEADING: UNIT 1 - MODULE 5.1 / IFRS 15 – REVENUE

FROM CONTRACT WITH CUSTOMERS

INTRODUCTION

IFRS 15 is the new global framework for revenue recognition.

Entities sell products and services in a bundle or multiple deliverables or

those engaged in major projects could see significant change in timing of
revenue recognition.

Entities likely to be affected by this new revenue standard include those

engaged in telecom, software, engineering, construction and real estate.

Revenue is income in the ordinary course of business activities.

Income is increase in economic benefit during the accounting period in the

form of an inflow or enhancement of asset or decrease in liability that
results in an increase in equity, other than contribution from equity
participants.

PFRS 15 applies to all contracts with customers, except:

a. Leases under IFRS 16

b. Insurance contracts under IFRS 17
c. Financial instruments under IFRS 9

LEARNING OUTCOMES

At the end of the unit, students will be able to

• Discuss the core principle of revenue recognition

• Enumerate the five-step model for revenue recognition
• Define a contract, performance obligation and transaction price
• Describe the revenue recognition at a point in time or over time

ACTIVATING PRIOR LEARNING

1. Explain the Revenue Recognition Principle.

81
 2. Enumerate the common account titles used in recording income.
3. Describe how Accrual Basis of Accounting relates to the Revenue
Recognition Principle.

PRESENTATION OF CONTENTS

RECOGNITION AND MEASUREMENT

Generally, revenue is recognized when the entity has transferred promised

goods or services to the customer. IFRS 15 sets out five steps for the
recognition process:

The Five-Step Model:

82
IFRS 15 provides a guidance about contract combinations and contract
modifications, too.

Contract combination happens when you need to account for two or more
contract as for 1 contract and not separately. IFRS 15 sets the criteria for
combined accounting.

Contract modification is the change in the contract’s scope, price or both.

In other words, when you add certain goods or services, or you provide some
additional discount, you are effectively dealing with the contract
modification.

IFRS 15 sets different accounting methods for individual contract

modification, depending on certain conditions.

83
84
Revenue recognition over time

Revenue is recognized over time when any of the following is satisfied:

a. The customer simultaneously receives and consumes the benefits

provided by the entity’s performance as the entity performs.

For example, routine or recurring payroll processing services.

85
 b. The entity’s performance creates or enhances an asset that the
customer controls as the asset is created or enhanced.
For example, constructing an asset on a customer site.

c. The entity’s performance does not create an asset with an alternative

use of the entity and the entity has an enforceable right to receive
payment for performance completed to date.

For example, constructing a specialized asset that only the customer

can use or constructing an asset in accordance with customer order.

Revenue recognition at a point in time

The following factors would indicate revenue recognition at a point in time:

a. The entity has the right to receive payment for the asset and for which
the customer is obliged to pay.
b. The customer has legal title to the asset.
c. The entity has transferred physical possession of the asset to the
customer.
d. The customer has the significant risks and rewards of ownership of
the asset.
e. The customer has accepted the asset.

Contract costs

IFRS 15 provides a guidance about two types of costs related to the contract:
1. Costs to obtain a contract
Those are the incremental costs to obtain a contract. In other words,
these costs would not have been incurred without an effort to obtain a
contract – for example, legal fees, sales commissions and similar.
These costs are not expensed in profit or loss, but instead, they
are recognized as an asset if they are expected to be recovered (the
exception is the contract costs related to the contracts for less than 12
months).
2. Costs to fulfill a contract. If these costs are within the scope of IAS
2, IAS 16, IAS 38, then you should treat them in line with the
appropriate standard. If not, then you should capitalize them only if
certain criteria are met.

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COMMON TYPES OF TRANSACTIONS

Warranties
If a customer has the option to purchase a warranty separately from a
product to which it relates, it constitutes a distinct service and is accounted
for as a separate performance obligation. This would apply to a warranty
which provides the customer with a service in addition to the assurance that
the product complies with agreed-upon specifications.

Principal Vs. Agent

Am entity must establish in any transaction whether it is acting as principal
or agent.

It is principal if it controls the promised goods or services before it is

transferred to the customer. When the performance obligation is satisfied,
the entity recognizes revenue in the gross amount of the consideration to
which it expects to be entitled for those goods or services.

It is acting as an agent if its performance obligation is to arrange for the

provision of goods or services by another party. Satisfaction of this
performance obligation will give rise to the recognition of revenue in the
amount of any fee or commission to which it expects to be entitled in
exchange for arranging for the other party to provide its goods or services.

Repurchase Agreements
Under a repurchase agreement, an entity sells an asset and promises, or
has the option, to repurchase it. Repurchase agreements generally come in
three forms:

a. An entity has an obligation to repurchase the asset (a forward

contract).
b. An entity has the right to repurchase the asset (a call option).
c. An entity must repurchase the asset if requested to do so by the
customer (a put option).
In the case of a forward contract or a call option the customer does not
obtain control of the asset, even if it has physical possession. The entity will
account for the contract as:

a. A lease in accordance with IFRS 16, if the repurchase price is below

the original selling price; or
b. A financing arrangement if the repurchase price is equal to or greater
than the original selling price. In this case the entity will recognize
both asset and corresponding liability.

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Consignment Arrangement
Consignment is a method of marketing goods in which the entity called the
consignor transfers physical possession of certain goods to a dealer or
distributor called consignee that sells the goods on behalf of the consignor.

When consigned goods are sold by the consignee, a report called account
sales is given to the consignor together with a cash remittance for the
amount of sales minus commission and other expenses chargeable to the
consignor.

Bill and Hold Arrangement

Bill and hold arrangement is a contract under which an entity bills a
customer for a product but the entity retains possession of the product.

For example, a customer may request an entity to enter into such contract
because of lack of space for the product or because of delays in the
customer’s production schedule.

Depending on the terms of the contract, revenue shall be recognized when

the customer obtains control or takes title of the product even though the
product remains in an entity’s physical possession.

PRESENTATION

Contracts with customers will be presented in an entity’s statement of

financial position as a contract liability, a contract asset or receivable,
depending on the relationship between the entity’s performance and
customer’s payment.

A contract liability is recognized and presented in the statement of financial

position where a customer has paid an amount of consideration prior to the
entity performing by transferring control of the related good or service to the
customer.

When the entity has performed but the customer has not yet paid the
related consideration, this will give rise either a contract asset or a
receivable. A contract asset is recognized when the entity’s right to
consideration is conditional on something other than the passage of time,
for instance future performance. A receivable is recognized when the entity’s
right to consideration is unconditional except for the passage of time.

When revenue has been invoiced, a receivable is recognized. Where revenue

has been earned but not invoiced, it is recognized as a contract asset.

88
DISCLOSURE

The objective is for an entity to disclose sufficient information to enable

users of financial statements to understand the nature, amount, timing, and
uncertainty of revenue and cash flows arising from contracts with
customers. The following amounts should be disclosed unless they have
been presented separately in the financial statements in accordance with
other standards:

a. Revenue recognized from contracts with customers, disclosed

separately from other sources of revenue.
b. Any impairment losses recognized on any receivables or contract
assets arising from an entity’s contracts with customers, disclosed
separately from other impairment losses.
c. The opening and closing balances of receivables, contract assets and
contract liabilities from contract with customers.
d. Revenue recognized in the reporting period that was included in the
contract liability balance at the beginning of the period.
e. Revenue recognized in the reporting period from performance
obligations satisfied in previous periods (such as changes in
transaction price).

APPLICATION

1. Briefly discuss the 5-step model for revenue recognition.

2. Differentiate revenue recognition at a point in time vs. revenue
recognition over time.
3. Enumerate the common types of transactions where IFRS 15 is
applicable.

FEEDBACK

Choose the best answer for each question:

1. Which is within the scope of IFRS 15?

a. Lease
b. Insurance contract
c. Financial instrument
d. All of these are beyond the scope of IFRS 15
2. What is the core principle of PFRS 15?
a. Revenue is recognized when earned
b. Revenue is recognized at a point in time or over time
c. Revenue is recognized when collected

89
 d. Revenue is recognized in a manner that depicts the transfer of good
or service to a customer and the revenue reflects the consideration
to which an entity expects to be entitled.
3. The revenue recognition in accordance with the core principle is
applied following
a. Four-step model
b. Five-step model
c. Three-step model
d. Any model
4. Which statement is true about a contract?
a. A contract is an arrangement between two or more parties that
creates enforceable rights and obligations
b. Enforceability of the rights and obligations in a contract is a matter
of law
c. A contract can be in writing, oral or implied by customary business
practice
d. All of these are true
5. A contract with a customer must meet all of the following criteria,
except
a. The contract is approved by all parties
b. The rights and obligations of the parties and payment terms are
identified
c. The contract has a commercial substance
d. It is not probable that the consideration will be collected
6. A performance obligation is
a. A promise to deliver a distinct good in a contract with a customer
b. A promise to deliver an indistinct good in a contract with a
customer
c. The consideration to which an entity is expected to be entitled
d. An executed contract
7. The transaction price
a. Is the amount of consideration in a contract
b. May include variable or a non cash consideration
c. May be affected by the time value of money if the contract contains
a significant arrangement
d. All of these describe a transaction price
8. The transaction price is allocated to the performance obligations
based on relative
a. Stand-alone selling price
b. Fair value
c. Adjusted market price
d. Residual value
9. When shall an entity recognize revenue from contract with a customer
a. When it is probable that the future economic benefits will flow to
the entity

90
 b. When or as the entity satisfies the performance obligation by
transferring control of a good or service to a customer
c. When the entity collected the consideration from the customer
d. When the entity and the customer signed the contract
10. Revenue shall be recognized at a point in time under all of the
following, except
a. The customer has legal title to the asset
b. The customer has physical possession of the asset
c. The entity has not transferred the significant risk and reward of
ownership
d. The entity has the right to receive payment for the asset

References:

• Valix, C. T., Peralta, J.F & Valix C. A. M. (2020). Conceptual Framework

and Accounting Standards. Manila, Philippines: GIC Enterprises & Co..
Inc.
• Ballada, W., & Ballada S. (2020). Conceptual Framework and
Accounting Standards. Manila, Philippines: DomDane Publishers.
• https://www.ifrsbox.com/ifrs/ifrs-15/
• https://www.ifrsbox.com/ifrs-15-revenue-contracts-customers/

91
 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS (AE 14)
LEARNING MATERIAL

UNIT NUMBER / HEADING: UNIT 1 - MODULE 5.2 / IAS 20 - Accounting

for Government Grants and Disclosure of Government Assistance

INTRODUCTION

IAS 20, par. 3, defines government grant as assistance by

government in the form of transfer of resources to an entity in return for
part or future compliance with certain conditions relating to the operating
activities of the entity.

LEARNING OUTCOMES

At the end of the unit, students will be able to

• Define a government grant

• Explain how government grants are recognized
• Identify the classifications of a government grant
• Properly account for government grant transactions
• Differentiate government grant from government assistance

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 ACTIVATING PRIOR LEARNING

4. Explain the core principle of IFRS 15 that can be applied to in

accounting for government grants.
5. Give an example of a transaction that can be accounted for under
revenue recognition over time.
6. Give an example of a transaction that can be accounted for under
revenue recognition at a point in time.

PRESENTATION OF CONTENTS
RECOGNITION AND MEASUREMENT

Government grant shall be recognized when there is a reasonable assurance

that:

a. The entity will comply with the conditions attaching to the grant.
b. The grant will be received.
Government grant shall not be recognized on a cash basis as this is not
consistent with generally accepted accounting practice.

Classification of government grant

Grant related to asset – grant whose primary condition is that an entity

qualifying for the grant shall purchase, construct or otherwise acquire long
term asset

Grant related expenditure/income - grant other than grant related to

asset

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Accounting for government grant

Government grant is taken to income over one or more periods in which the
related cost is incurred.

Special rules on accounting for government grant:

➢ Grant in recognition of specific expenses shall be recognized as income

over the period of the relate expense.

➢ Grant related to depreciable assets shall be recognized as income over

the periods and in proportion to the depreciation of the related asset.

➢ Grant related to nondepreciable asset requiring fulfillment of certain

conditions shall be recognized as income over the periods which bear
the cost of meeting the conditions.

➢ A government grant that becomes receivable as compensation for

expenses or losses already incurred or for the purpose of giving
immediate financial support to the entity with no further related costs
shall be recognized as income of the period in which it becomes
receivable.
Presentation of government grant

1. Government grant relate to asset shall be presented in the statement

of financial position in either of two ways:

a. By setting the grant as deferred income

b. By deducting the grant in arriving at the carrying amount of the

asset.

2. Government grant related to income is presented as follows:

a. The grant is presented in the income statement, either separately

or under the general heading “other income.”

b. Alternatively, the grant is deducted from the related expense

Government assistance

Government assistance is the action by government designed to provide an

economic benefits specific to an entity or range of entities qualifying under
certain criteria.

94
The essence of government assistance is that no value can reasonably be
placed upon it. Examples include:

a. Free technical or marketing advice

b. Provision of guarantee
c. Government procurement policy that is responsible for a portion of the
entity’s sales.
Disclosures about government grant:

a. The accounting policy adopted for the government grant, including the
method of presentation adopted in the financial statements.

b. The nature and extent of government grant recognized in the financial

statements and an indication of other forms of government assistance
from which the entity has directly benefited.

c. Unfulfilled conditions and other contingencies attaching to

government assistance that has been recognized.

APPLICATION

1. Briefly explain the recognition and measurement of government grant.

2. Explain the accounting treatment of grant related to asset and grant
related to income.
3. Differentiate government grant from government assistance.

FEEDBACK

Answer the following questions:

1. In the case of grant related to an asset, which of the following

accounting treatment is prescribed?
a. Record the grant at a nominal value in the first year and write off
in the subsequent year.
b. Either set up the grant as deferred income or deduct it in arriving
at the carrying amount of the asset.
c. Record the grant at the fair value in the first year and record it as
income in the subsequent year.
d. As an extraordinary gain.

2. In the case of grant related to income, which of the following

accounting treatment is prescribed?
a. Credit the grant equity

95
 b. Present the grant as other income or as a separate line item, or
deduct it from the related expense
c. Credit the grant to retained earnings
d. Credit the grant to sales revenue

3. The deferred grant income is classified as

a. Separate component of shareholders’ equity
b. Noncurrent liability
c. Current liability
d. Partly current liability and partly noncurrent liability

4. If the cost of the asset is recorded net of grant

a. Equity is overstated
b. Liability is overstated
c. Asset is understated
d. Net income is understated

5. Which is included in government assistance?

a. The provision of infrastructure in developing areas
b. The imposition of trading constraints on competitors
c. Improvement to the general transport and communication network
d. None of these can be included

References:
• Valix, C. T., Peralta, J.F & Valix C. A. M. (2020). Conceptual Framework
and Accounting Standards. Manila, Philippines: GIC Enterprises & Co..
Inc.
• Ballada, W., & Ballada S. (2020). Conceptual Framework and
Accounting Standards. Manila, Philippines: DomDane Publishers.

96
 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS (AE14)

UNIT 2 Module 6 – IAS 2 Inventories

Introduction

In this unit you will learn the meaning of inventories, cost of inventories,
the cost formulas, the measurement of inventory as well as accounting for
agricultural activity – the management of the biological transformation of
biological assets (living plants and animals) into agricultural produce
(harvested product of the entity's biological assets).
Learning Objectives

1. To understand the meaning of inventories.

2. To identify the items included in inventory cost.
3. To identify the cost formulas required by IFRS.
4. To know the measurement of inventory in the statement of financial
position.
5. To apply the lower of cost and net realizable value basis of
measurement.
6. To know the accounting treatment and disclosure related to agricultural
activity.

Discussion

Definition of Inventories
IFRS defines inventories as assets that are:

• held for sale in the ordinary course of business,

• in the process of production for such sale, and
• in the form of materials or supplies to be consumed in the production
process or in the rendering of services (International Accounting
Standards, n.d., 2.6).

The key feature of inventory is that it is held for sale in the normal course of
business, which differentiates it from other tangible assets, such as property,
plant, and equipment that are only sold only when their productive capacity
is exhausted or no longer required by the business. The definition also
recognizes that for manufacturing businesses, inventory can take various
forms throughout the production process. Raw materials, work in process,
and finished goods are all considered inventory. For many businesses,
inventory can represent a significant asset.

Initial Recognition and Measurement

An obvious question that arises when considering inventory is, what costs
should be included? In answering this question, IFRS has provided some

97
general guidance: the cost of inventories shall include all costs of purchase,
costs of conversion, and "other costs incurred in bringing the inventories to
their present location and condition" (International Accounting Standards,
n.d., 2.10).

Costs of Purchase

Purchase costs include not only the direct purchase price of the goods but
also the costs to transport the goods to the company's premises and any
nonrecoverable taxes or import duties paid on the purchase. As well, any
discounts or rebates earned on the purchase should be deducted from the
cost of the inventory.

One issue that often needs to be considered when determining inventory costs
at the end of an accounting period is the matter of goods in transit. Goods
may be shipped by a seller before the end of an accounting period but are not
received until after the end of the purchaser's accounting period. The question
of who owns the goods while they are in transit obviously needs to be
addressed. More specifically, three issues arise from this question:

1. Who pays for the shipping costs?

2. Who is responsible for the loss if goods are damaged in transit?
3. When should the transfer of ownership be recorded in the accounting
records?

To answer these questions, the legal term free on board (FOB) needs to be
understood. When goods are shipped by a seller, the invoice will usually
indicate that the goods are shipped either FOB shipping or FOB destination. If
the goods are FOB shipping, the purchaser is assuming legal title as soon as
the goods leave the seller's warehouse. This means the purchaser is
responsible for shipping costs as well as for any damage that occurs in transit.
As well, the purchaser should record these goods in his or her inventory
accounts as soon as they are shipped, even if they don't arrive until after the
end of the accounting period. If the goods are FOB destination, the purchaser
is not assuming ownership of the goods until they are received. This means
that the seller would be responsible for shipping costs and any damage that
occurs in transit. As well, the purchaser should not include these goods in
his or her inventory until they are actually received. Likewise, the seller would
still include the goods in his or her inventory until they are actually delivered
to the purchaser. Accountants and auditors pay close attention to the FOB
terms of purchases and sales near the fiscal period end, as these terms can
affect the accurate recording of the inventory amount on the balance sheet.

Costs of Conversion

Another more complex issue arises in the determination of the cost of

manufactured inventories. As noted above, IAS 2-10 requires the inclusion of
costs to convert inventories into their current form. For a manufacturing
company, this means that inventories will include raw materials, work in

98
progress, and finished goods. For raw materials, the cost is fairly easy to
determine. However, for work in progress and finished goods, the
determination of which costs to include becomes more complicated. Although
labour and variable overhead costs, such as utilities consumed by operating
factory machines, are fairly easy to associate directly with the production of a
product, the treatment of other fixed overhead costs is not as clear. It can be
argued that costs such as factory rent should not be included in the inventory
cost because this cost will not vary with the level of production. However, it
can also be argued that without the payment of rent, the production process
could not occur. For management accounting purposes, a variety of methods
are used to account for overhead costs. For financial accounting purposes,
however, it is clear that all conversion costs need to be included in inventory.
Thus, the financial accountant will need to determine the best way to allocate
fixed overhead costs. In normal circumstances, the fixed overhead costs are
simply allocated to each unit of inventory produced in an accounting period.
However, if production levels are significantly higher or lower than normal
levels, then the accountant needs to apply some judgment to the situation. If
fixed overhead costs are applied to very low levels of production, the result
would be inventory that is carried at a value that may be higher than its
realizable value. For this reason, fixed overhead costs should be allocated to
low production volumes using the rate calculated on normal production
levels, with unallocated overhead being expensed in the period. This is done
to avoid reporting misleadingly high inventory levels. On the other hand, if
abnormally high production occurs, the fixed overhead costs are allocated
using the actual production level. This would result in lower per-unit costs
for the inventory produced. This situation could result in higher profits, as
presumably some of the excess production would be held in inventory at the
end of the year. A manager may be tempted to increase production strictly for
the purpose of increasing current earnings. Although this does not violate any
accounting standard, the accountant should be careful in this situation, as
there may be a risk of obsolete inventory as a result of the overproduction, or
there may be other forms of income-maximizing earnings management
occurring.

Other Costs
IAS 2–15 indicates that other costs can be included in inventory only to the
extent "they are incurred in bringing the inventories to their present location
and condition." The standard provides examples such as certain non-
production overhead costs or product-design costs for specific customers.
Clearly, the accountant would need to exercise judgment in allocating these
kinds of costs to inventory. The standard also clearly defines some costs that
should not be included in inventories but rather expensed in the current
period. These costs include the following:

• Abnormal amounts of wasted materials, labour, or other production

costs
• Storage costs, unless those costs are necessary in the production
process before a further production stage

99
 • Administrative overheads that do not contribute to bringing inventories
to their present location and condition
• Selling costs

COST FORMULAS
PAS 2 paragraph 25-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(LIFO)
as an alternative formula in measuring cost of inventories.

First in, First out (FIFO)

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

The rule is “first come, first sold”.

Is this method there is improper matching of cost against revenue because

the goods sold are stated at earlier or older prices resulting in understatement
of cost of goods sold.

Illustration-FIFO

The following data pertain to an inventory item:

Date Particulars Units Unit cost Total cost Sales(in

unit)
Sept 1 Beginning 900 210 189,000
balance
Sept 8 Sale 600
Sept 22 Purchase 600 220 *132,000
Sept 25 Sale 800
Sept 30 Purchase 600 230 *138,000

The ending inventory is 700 units.

Date Particulars Units Unit cost Total cost

From Sept 22 Purchase 100 220 22,000
From Sept 30 Purchase 600 230 138,000
Total 700 160,000

Cost of goods sold

100
 Inventory-Sept 1 189,000
*Purchases 270,000
Goods available for sale 459,000
Inventory-Sept 30 (160,000)
Cost of goods sold 299,000

When making an inventory cost flow assumption, what factors do managers

need to consider? Generally, the cost flow assumption should attempt to
reflect the actual physical flow of goods as much as possible. For example, a
grocery retailer selling perishable merchandise may want to use FIFO, as it is
common practice to place the oldest items at the front of the rack to encourage
their sale first. Alternatively, consider a hardware store that sells bulk nails
that are scooped from a bin. There is no way to identify the individual items
specifically, and it is likely that over time, customers scooping out nails would
mix together items stocked at different times. Weighted average costing would
make the most sense in this case, as this would likely represent the real
movement of the product. For a company selling heavy equipment, specific
identification would likely make the most sense, as each item would be unique
with its own serial number, and these items can be easily tracked.

A further consideration would be the effects on the income statement and

balance sheet. FIFO results in the inventory reported on the balance being
reported at more current costs. As there is an increasing emphasis in
standard setting on valuation concepts, this approach would result in the
most useful information for determining the value of the company. If
profitability is more important to a financial-statement reader, then weighted
average cost would be more useful, as more current costs would be averaged
into income.

Income taxes may also be a consideration when choosing a cost flow formula.
This motivation must be considered carefully, however, as income will be
affected in opposite ways, depending on whether input prices are rising or
falling. As well, although taxes could be reduced in any given year through
the cost flow assumption made, this is only a temporary effect, as all inventory
will eventually be expensed through cost of goods sold.

Whatever method is chosen, it should be applied on a consistent basis. It

would be inappropriate for a company to change cost flow assumptions year
to year, simply to achieve a certain result in net income. Once the cost flow
assumption is determined, it should be applied the same way each year,
unless there has been a significant change in circumstances that warrants a
change. A company may use different cost flow assumptions for different
major inventory classes, but these choices should still be applied consistently.

WEIGHTED AVERAGE
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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.

In other words, the average unit cost is computed by dividing the total cost of
goods available for sale by the total number of units available for sale.

The preceding illustrative data are used.

Date Particulars Units Unit cost Total cost
Sept 1 Beginning 900 210 189,000
balance
Sept 22 Purchase 600 220 132,000
Sept 30 Purchase 600 230 138,000
Total goods available 2,100 459,000
for sale

Weighted average unit cost (459,000/2,100) 218.57

Inventory cost (700 x 218.57) 152,999

Cost of goods sold

Inventory-Sept 1 189,000
*Purchases 270,000
Goods available for sale 459,000
Inventory-Sept 30 (152,999)
Cost of goods sold 306,000

Last in, First out(LIFO)

The LIFO method assumes that the goods last purchased are first sold and
consequently the goods remaining in the inventory at the end of the period
are those first purchased or produced.

The inventory is thus expressed in terms of earlier or old prices and the cost
of goods sold is representative of recent or new prices.

Illustration-LIFO

In the preceding illustration, the cost of 700 units under the LIFO is computed
as follows:

102
 Units Unit cost Total cost
From Sept 1 700 210 147,000
balance
Inventory-Sept 1 189,000
Purchases 270,000
Goods available 459,000
for sale
Inventory-Sept (147,000)
30
Cost of goods sold 312,000

Specific identification

Specific identification means that specific costs are attributed to identify items
of inventory.

The cost of the inventory is determined by simply multiplying the units on

hand by the 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.

Measurement of inventory

PAS 2, paragraph 9, provides that inventories shall be measured at the lower

of cost and net realizable value.

The cost of inventory is determined using either FIFO cost or average cost.

The measurement of inventory at the lower of cost and net realizable value is
known as LCNRV.

What Is Net Realizable Value?

Net realizable value or NRV is the estimated selling price in the ordinary
course of business less the estimated cost of completion and the estimated
cost of disposal.

The cost of inventories may not be recoverable under the following

circumstances:

a. The inventories are damaged

b. The inventories have become wholly or partially obsolete.
c. The selling prices have declined
d. The estimated cost of completion or the estimated cost of disposal has
increased.

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Inventories are usually written down to net realizable value on an item by item
or individual basis.

How Is the Lower of Cost and Net Realizable Test Applied?

In general, the lower of cost and net realizable test should be applied to the
most detailed level possible. This would normally be considered to be
individual inventory items. However, in some situations, it may be appropriate
to group inventory items together and apply the test at the group level. This
would be appropriate only when items relate to the same product line, have
similar end uses, are produced and marketed in the same geographic area,
and cannot be segregated from other items in the product line in a reasonable
or cost-effective way. If grouping is appropriate, the amount of inventory write-
downs will be less than if the test is applied on an individual-item basis. This
occurs because grouping allows for some offsetting of over- and undervalued
items.

Accounting for inventory writedown

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

If the net realizable value is lower than cost, the inventory is measured at net
realizable value.

The writedown of inventory to net realizable value is accounted for using the
allowance method.

Illustration-Inventory data on December 31, 2020

Inventory item Total cost NRV LCNRV

A 2,000,000 1,900,000 1,900,000
B 1,500,000 1,550,000 1,500,000
C 2,500,000 2,100,000 2,100,000
D 3,000,000 3,200,000 3,000,000
Total 9,000,000 8,750,000 8,500,000

The measurement of the inventory at LCNRV is applied on an item by item or

individual basis or 8,500,000.

Total cost 9,000,000

LCNRV 8,500,000
Inventory writedown 500,000

The loss on inventory writedown is accounted for separately.

104
The loss on inventory writedown is included in the computation of cost of
goods sold.

The allowance for inventory writedown is presented as a deduction from the

inventory

Inventory-December 31,2020,at cost 9,000,000

Allowance for inventory writedown (500,000)
Net realizable value 8,500,000

Presentation and Disclosure

Inventories are required to be disclosed as a separate item on the company's

balance sheet. As well, significant categories of inventories should be
disclosed, such as raw materials, work in process, and finished goods. As with
any significant balance sheet item, the company's accounting policies for
measuring and reporting inventories, including its chosen cost formula,
should be disclosed. The company should also disclose the amount of
inventories recognized as an expense during the period. This would normally
be disclosed as cost of goods sold, but there may be other material amounts
that could be disclosed separately, such as write-downs due to obsolescence
and subsequent reversals of those write-downs. As well, under IFRS,
additional details of the write-downs need to be disclosed, such as qualitative
reasons for the write-downs or subsequent reversal. If the inventory has been
pledged as collateral for any outstanding debt, this fact needs to be disclosed,
along with the amount pledged.
If thefair

IAS 41-Agriculture
Key definitions
• Biological asset-A living animal or plant
• Agricultural produce-The harvested product from biological assets
• Costs to sell The incremental costs directly attributable to the disposal
of an asset, excluding finance costs and income taxes

Initial recognition
• An entity recognizes a biological asset or agriculture produce only when
the entity controls the asset as a result of past events, it is probable that
future economic benefits will flow to the entity, and the fair value or cost
of the asset can be measured reliably. [IAS 41.10]

Measurement
• Biological assets within the scope of IAS 41 are measured on initial
recognition and at subsequent reporting dates at fair value less estimated
costs to sell, unless fair value cannot be reliably measured. [IAS 41.12]

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• Agricultural produce is measured at fair value less estimated costs to sell
at the point of harvest. [IAS 41.13] Because harvested produce is a
marketable commodity, there is no 'measurement reliability' exception for
produce.
• The gain on initial recognition of biological assets at fair value less costs
to sell, and changes in fair value less costs to sell of biological assets
during a period, are included in profit or loss. [IAS 41.26]
• A gain on initial recognition (e.g. as a result of harvesting) of agricultural
produce at fair value less costs to sell are included in profit or loss for the
period in which it arises. [IAS 41.28]
• All costs related to biological assets that are measured at fair value are
recognized as expenses when incurred, other than costs to purchase
biological assets.
• IAS 41 presumes that fair value can be reliably measured for most
biological assets. However, that presumption can be rebutted for a
biological asset that, at the time it is initially recognized, does not have a
quoted market price in an active market and for which alternative fair
value measurements are determined to be clearly unreliable. In such a
case, the asset is measured at cost less accumulated depreciation and
impairment losses. But the entity must still measure all of its other
biological assets at fair value less costs to sell. If circumstances change
and fair value becomes reliably measurable, a switch to fair value less
costs to sell is required. [IAS 41.30]
• Guidance on the determination of fair value is available in IFRS 13 Fair
Value Measurement. IFRS 13 also requires disclosures about fair value
measurements.
• Other issues
• The change in fair value of biological assets is part physical change
(growth, etc) and part unit price change. Separate disclosure of the two
components is encouraged, not required. [IAS 41.51]
• Agricultural produce is measured at fair value less costs to sell at harvest,
and this measurement is considered the cost of the produce at that time
(for the purposes of IAS 2 Inventories or any other applicable standard).
[IAS 41.13]
• Agricultural land is accounted for under IAS 16 Property, Plant and
Equipment. However, biological assets (other than bearer plants) that are
physically attached to land are measured as biological assets separate
from the land. In some cases, the determination of the fair value less
costs to sell of the biological asset can be based on the fair value of the
combined asset (land, improvements and biological assets). [IAS 41.25]
• Intangible assets relating to agricultural activity (for example, milk
quotas) are accounted for under IAS 38 Intangible Assets.

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 Government grants
• Unconditional government grants received in respect of biological assets
measured at fair value less costs to sell are recognized in profit or loss
when the grant becomes receivable. [IAS 41.34]
• If such a grant is conditional (including where the grant requires an entity
not to engage in certain agricultural activity), the entity recognizes the
grant in profit or loss only when the conditions have been met. [IAS 41.35]

Disclosure

Disclosure requirements in IAS 41 include:

• aggregate gain or loss from the initial recognition of biological assets and
agricultural produce and the change in fair value less costs to sell during
the period* [IAS 41.40]
• description of an entity's biological assets, by broad group [IAS 41.41]
• description of the nature of an entity's activities with each group of
biological assets and non-financial measures or estimates of physical
quantities of output during the period and assets on hand at the end of
the period [IAS 41.46]
• information about biological assets whose title is restricted or that are
pledged as security [IAS 41.49]
• commitments for development or acquisition of biological assets [IAS
41.49]
• financial risk management strategies [IAS 41.49]

• reconciliation of changes in the carrying amount of biological assets,

showing separately changes in value, purchases, sales, harvesting,
business combinations, and foreign exchange differences* [IAS 41.50]
• * Separate and/or additional disclosures are required where biological
assets are measured at cost less accumulated depreciation [IAS 41.55]
• Disclosure of a quantified description of each group of biological assets,
distinguishing between consumable and bearer assets or between mature
and immature assets, is encouraged but not required. [IAS 41.43]

If fair value cannot be measured reliably, additional required

disclosures include: [IAS 41.54]
• description of the assets
• an explanation of why fair value cannot be reliably measured
• if possible, a range within which fair value is highly likely to lie
• depreciation method
• useful lives or depreciation rates

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• gross carrying amount and the accumulated depreciation, beginning and
ending.
If the fair value of biological assets previously measured at cost
subsequently becomes available, certain additional disclosures are
required. [IAS 41.56]

Disclosures relating to government grants include the nature and

extent of grants, unfulfilled conditions, and significant decreases
expected in the level of grants. [IAS 41.57]

Chapter Summary

Inventories can be a significant asset for many businesses. The key feature of
inventory is that it is held for sale in the normal course of business, which
distinguishes it from financial instruments and long-lived assets, such as
property, plant, and equipment.

Recognition of the initial cost of purchase should include transportation,

discounts, and other nonrecoverable taxes and fees that need to be paid to
transport the goods to the place of business. FOB terms of purchase need to
be considered when applying cut-off procedures at the end of the accounting
period. This is important for determining when the responsibility for the
inventory passes from the seller to the buyer. For manufacturers, conversion
costs must also be included in inventory. For direct materials and labour, this
allocation is fairly straightforward. However certain issues with overhead
allocations can occur with low or high production levels. With abnormally low
production levels, overheads should be allocated at the rate used for normal
production levels. With abnormally high production levels, overheads should
be allocated using the actual level of production. Other costs required to bring
the inventory to the place of business and get into a saleable condition may
also be included. The accountant will need to exercise judgment when
considering other costs to include.

The cost flow formula determines how to allocate inventory costs between the
income statement and the balance sheet. Although specific identification of
individual inventory items is the most precise way to allocate these costs, this
method would only be appropriate with inventory items whose characteristics
uniquely differentiate them from other inventory units. For homogeneous
inventory products, weighted average or first in, first out (FIFO) are
appropriate choices. Weighted average (or moving average, when used with a
perpetual inventory system) recalculates the average cost of the inventory
every time a new purchase is made. This revised cost is used to determine the
cost of goods sold. With FIFO, the oldest inventory items are assumed to be
sold first. Each method has certain advantages and disadvantages, and each
has a different effect on the balance sheet and income statement. The choice
of method will depend on the actual physical movement of goods, financial
reporting objectives, tax considerations, and other factors. Whatever method
is chosen, it should be applied consistently.

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When economic circumstances change, such as a shift in consumer
preferences, a company may find itself holding inventory that cannot be sold
for its carrying value. In this case, the inventory should be written-down to
its net realizable value (selling price less estimated costs required to complete
and sell the goods) in order to ensure the balance sheet is not reporting a
current asset at a value greater than the amount of cash that can be realized
from its sale. Generally, this technique should be applied on an individual-
item basis, but in certain cases where a group of products all belong to one
product line, are produced and marketed in one geographic area, have similar
end uses, or are difficult to segregate, it may be appropriate to apply the test
on a grouped basis. Judgment is required in applying this technique, as net
realizable values are estimates that may not be easy to verify.

Inventory should be described separately on the balance sheet, with separate

disclosure of major categories such as raw materials, work in process, and
finished goods. Accounting policies used should also be disclosed, as well as
the amount of any inventory that has been pledged as collateral for any
liability. The amount of inventory expensed during the period should be
disclosed as cost of goods sold on the income statement, but other categories,
if material, could be disclosed separately, such as significant write-downs or
reversals of write-downs.

References

• International Accounting Standards. (n.d.). In IAS Plus. Retrieved from

http://www.iasplus.com/en/standards/ias
• Valix, C. T., Peralta, J.F & Valix C. A. M. (2020). Conceptual Framework
and Accounting Standards. Manila, Philippines: GIC Enterprises & Co..
Inc.
• Exe https://www.iasplus.com/en/standards/ias/ias41rcise

Exercise 1

1. IFRS prohibits which of the following cost flow assumption?

a.LIFO
b.Specific Identification
c.Weighted average
d.Any of these cost flow assumptions is allowed.
2. Which inventory method measures most closely the current cost of
inventory?
a.FIFO
b.Specific Identification
c.Weighted average
d.LIFO
3. In a period of declining prices,the inventory which tends to give the
highest amount of cost of goods sold is.
a. Specific Identification

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 b. Average cost
c. FIFO
d. LIFO
4. In a period of falling prices, which inventory method provides the lowest
amount of inventory?
a. Weighted average
b. FIFO
c. Moving average
d. Specific Identification
5. In a period of rising prices which inventory method provides the highest
amount of net income?
a. Weighted average
b. Moving average
c. FIFO
d. Specific Identification
6. Which of the following should not be reported in inventory?
a. Raw materials
b. Equipment
c. Finished goods
d. Factory supplies
7. Why is inventory included in the computation of net income?
a. To determine cost of goods sold
b. To determine sales revenue
c. To determine merchandise returns
d. Inventory is not included in the computation of net income.
8. Which of the following would not be separately accounted for in the
computation of cost of goods sold?
a. Trade discounts applicable to purchase
b. Cash discounts taken during the period
c. Purchase returns and allowances during the period
d. Cost of transportation for merchandise purchased.
9. Biological assets shall be measured
a. Fair Value
b. Cost
c. fair value less estimated less cost to sell
d. fair value less estimated less cost to sell at the point of harvest
10. Agricultural produce shall be measured
a.Fair Value
b.Cost
c.fair value less estimated less cost to sell
d.fair value less estimated less cost to sell at the point of harvest

110
111
 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS (AE 14)
LEARNING MATERIAL

UNIT NUMBER/ HEADING: MODULE 7/ PAS 16: TANGIBLE NON-CURRENT

ASSETS AND DEPRECIATION
LEARNING OUTCOMES:
At the end of the unit, the students will be able to:
t. Describe tangible non-current assets
u. Recognize and derecognize tangible non-current assets
v. Apply proper accounting treatment of borrowing costs.

INTRODUCTION:
In this unit we will discuss PAS 16, the accounting treatment for
property plant and equipment (PPE), PAS 23 Borrowing Costs and Investment
property. We will study the recognition as assets, measurement of carrying
amount as well as derecognition of tangible non-current assets.

Topic 1: Property Plant and Equipment

Learning Objectives:
At the end of the topic, the students will be able to:
✓ Describe property, plant and equipment.
✓ Recognize, measure and record of property, plant and equipment.
✓ Apply the different methods of depreciation property, plant and equipment.

Activating Prior Learning

Write in the boxes the property plant and equipment acquisition modes that
you know
Mode of acquisition
1.

2.

Property, plant and equipment

3.

4.

5.

Presentation of Content
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 Property, plant and equipment are tangible assets that are held for use in
production or supply of goods or services, for rental to others, or for administrative
purposes, and are expected to be used during more than one period.

Accordingly, the major characteristics in the definition of property, plant and

equipment are:
a) The property, plant and equipment are tangible assets,
meaning with physical substance.
b) The property, plant and equipment are used in business,
meaning used in production or supply of goods or services, for
rental purposes and for administrative purposes.
c) The property, plant and equipment are expected to be used
over a period of more than one year.

Examples of property, plant and equipment

a) Land
b) Land and improvement
c) Building
d) Machinery
e) Ship
f) Aircraft
g) Motor Vehicle
h) Furniture and fixture
i) Office equipment
j) Patterns, mold and dies
k) Tools
l) Bearer plants

Recognition of property, plant and equipment

An item of property, plant and equipment shall be recognized as an asset when:
a) It is probable that future economic benefits associated with the asset will flow
to the entity.
b) The cost of the asset can be measured reliably.

Measurement at recognition
An item of property, plant and equipment that qualifies for recognition as an
asset shall be measured at cost.

Cost is the amount of cash or cash equivalent paid and the fair value of the other
consideration given to acquire an asset at the time of acquisition or construction.

Elements of cost
The cost of an item of property, plant and equipment comprises:
a) Purchase price, including import duties and non-refundable purchase taxes,
after deducting trade discounts and rebates.
b) Cost directly attributable to bringing the asset to the location and condition
necessarily for it to be capable of operating in the manner intended by
management.
c) Initial estimate of the cost of dismantling and removing the item and
restoring the site on which it is located for which an entity has a present
obligation.

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Directly attributable costs
Examples of directly attributable costs that qualify for recognition include:
a) Cost of employee benefit arising directly from the construction or acquisition
of the item of property, plant and equipment.
b) Cost of site preparation
c) Initial delivery and handing cost
d) Installation and assembly cost
e) Professional fee
f) Cost of testing whether the asset is functioning properly.

Costs not qualifying for recognition

Examples of costs that are expensed rather than recognized as element of cost
of property, plant and equipment are:
a) Cost of opening a new facility
b) Cost of introducing a new product or service, including cost of advertising
and promotion
c) Cost of conducting business in a new location od with a new class of
customer, including cost of staff training
d) Administration and other general overhead cost
e) Cost incurred while an item capable of operating in the manner intended by
management has yet to be brought into use or is operated at less than full
capacity
f) Initial operating loss
g) Cost of relocating or reorganizing part or all of an entity’s operations

Measurement after recognition

After initial recognition, an entity shall choose either the cost model or the
revaluation mode as the accounting policy for property, plant and equipment.

The entity shall apply such accounting policy to an entire class of property, plant
and equipment.

The cost model means that property, plant and equipment are carried at cost less
any accumulated depreciation and any accumulated impairment loss.

The revaluation model means that property, plant and equipment are carried at
revalued carrying amount.

The revalued carrying amount is the fair value at the date of revaluation less any
subsequent accumulated depreciation and subsequent accumulated impairment
loss.

Acquisition in a cash basis

The cost of an item of property, plant and equipment is the cash price
equivalent at the recognition date.

The cost of asset acquired on a cash basis simply includes the cash paid plus
directly attributable costs such as freight, installation cost and other cost
necessary in bringing the asset to the location and condition for the intended use.

Acquisition on account
When an asset is acquired on account subject to a cash discount, the cost of
the asset is equal to the invoice price minus the discount, regardless of whether the
discount is taken or not.

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Cash discounts are generally considered as reduction of cost and not as income.

Acquisition on installment basis

When payment for item of property, plant and equipment is deferred beyond
normal credit terms, the cost is the cash price equivalent.

In other words, if an asset is offered at a cash price and at an installment price and
is purchased at the installment price, the asset shall be recorded at the cash price.

The excess of the installation price over the cash price is treated as an
interest to be amortized over the credit period.

Issuance of share capital

Philippine GAAP provides that if shares are issued for consideration other
than actual cash, the proceeds shall be measured by the fair value of the
consideration received.

Accordingly, where a property is acquired through the issuance of share capital,

the property shall be measured at an amount equal to the following in the order of
priority:

a) Fair value of the property received

b) Fair value of the share capital
c) Par value or stated value of the share capital

Issuance of bonds payable

PFRS 9, paragraph 5.1.1, provides the asset acquired by issuing bonds payable is
measured in the following order:

a) Fair value of bonds payable

b) Fair value of assets received
c) Face amount of bonds payable

Exchange
PAS 16, paragraph 24, provides that the cost of an item of property, plant
and equipment acquired in exchange for a nonmonetary asset is measured at fair
value plus any cash payment.

However, the exchange is recognized at carrying amount if the exchange

transaction lacks commercial substance.

Definition of commercial substance

Commercial substance is a new notion and is defined as the event of
transaction causing the cash flows of the entity to change significantly by reason of
the exchange.

An exchange transaction has commercial substance when the cash flows of

the asset received differ significantly from the cash flows of the asset transferred.

Construction
The cost of self-constructed asset is determined using the same principles as
for an acquired asset.

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The cost of self-constructed property, plant and equipment includes:

a) Direct cost of materials

b) Direct cost of labor
c) Indirect cost and incremental overhead specifically identifiable or traceable
to the construction.

Provides that the cost of abnormal amount of wasted material, labor or

overhead incurred in the production of self-constructed asset is not included in the
cost of the asset.

Derecognition
Derecognition means that the cost of the property, plant and equipment
together with the related accumulated depreciation shall be removed from the
statement of financial position.

It provides that the carrying amount of an item of property, plant and

equipment shall be derecognized on disposal or when no future economic benefits
are expected from the use of disposal.

The gain or loss from the derecognition of an item of property, plant and
equipment shall be included in profit or loss.

Gains shall not be included in revenue but treated as other income.

The gain or loss arising from the derecognition of an item of property, plant
and equipment shall be determined as the difference between the net disposal
proceeds and the carrying amount of the item.

Fully depreciated property

A property is said to be fully depreciated when the carrying amount is equal
to zero, or the carrying amount is equal to the residual value.

In such a case, the asset account and the related accumulated depreciation
account are closed and he residual value is set up in a separate account.

However, it is not uncommon for an entity to continue to use an asset after

it has been fully depreciated.

The cost of fully depreciated asset remaining in service and the related
accumulated depreciation ordinarily shall not be removed from the accounts.

However, entities are encouraged but not required to disclose fully

depreciated property.

Concept of depreciation
Depreciation is defined as the systematic allocation of the depreciable
amount of an asset over the useful life.

Depreciation is not so much a matter of valuation.

Depreciation is a matter of cost allocation in recognition of the exhaustion of

the useful life of an item of property, plant and equipment.

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The objective of depreciation is to have each period benefiting from the use of the
asset bear an equitable share of the asset cost.

Depreciation in the financial statements

Depreciation is an expense.

Depreciation may be a part of the cost of goods manufactured or an operating

expense.

The depreciation charge for each period shall be recognized as expense unless it is
included in the carrying amount of another asset.

Depreciation period
The depreciable amount of an asset shall be allocated on a systematic basis over
the useful life.

Depreciation of an asset begins when it is available for use, meaning, when the
asset is in the location and condition necessary for the intended use by
management.

Depreciation ceases when the asset is derecognized.

Therefore, depreciation does not cease when the asset becomes idle temporarily.

Temporary idle activity does not preclude depreciating the asset as future economic
benefits are consumed not only through usage but also through wear and tear and
obsolescence.

Factors of depreciation
In order to properly compute the amount of depreciation, three factors are
necessary, namely depreciable amount, residual value and useful life.

Depreciable amount
Depreciable amount is the cost of an asset or other amount substituted for cost,
less the residual value.

Each part of an item of property, plant and equipment with a cost that is
significant in relation to the total cost off the item shall be depreciated separately.

For example, it may be appropriate to depreciate separately the airframe, engines,

fittings (seats and floor coverings) and tires of and aircraft.

The entity also depreciates separately the remainder of the item and the remainder
consists of the parts of the item that are individually not significant.

Residual Value
Residual value is the estimated net amount currently obtainable if the asset
is sat the end of the useful life.

The residual value of an asset shall be reviewed at least at each financial

year-end and if expectation differs from previous estimate, the change shall be
accounted for as a change in an accounting estimate.

117
 The residual value of an asset may increase to an amount equal to or greater
than the carrying amount.

If it does, the depreciation charge is zero unless and until the residual value
subsequently decreases to an amount below the carrying amount.

Depreciation is recognized even if the fair value of the asset exceeds the
carrying amount as long as the residual value does not exceed the carrying
amount.

Useful life
Useful life is either the period over which an asset is expected to be available
for use by the entity, or the number of production or similar units expected to be
obtained from the asset by the entity.

Factors in determining the useful life

a) Expected usage of the asset – Usage is assessed by reference to the asset’s
expected capacity or physical output.
b) Expected physical wear and tear – This depends on the operational factors
such as the number of shifts the asset is used, the repair and maintenance
program, and the care and maintenance of the asset while idle.
c) Technical or commercial obsolescence – This arises from change or
improvements in production, or change in the market demand for the
product output of the asset.
d) Legal limits for the use of asset, such as the expiry date of the related lease.

Depreciation method
The depreciation method shall reflect the pattern in which the future
economic benefits from the asset are expected to be consumed by the entity.

The depreciation method shall be reviewed at least at every year-end.

If there has been a significant change in the expected pattern of economic

benefits, the method shall be changed to reflect the changed pattern.

Such change shall be accounted for as a change in accounting estimate.

A variety of depreciation methods can be used.

Depreciation methods include straight line, production method, and diminishing

balance method.
Straight line method
Under the straight line method, the annual depreciation charge is calculated
by allocating the depreciable amount equally over the number of years of useful
life.

In other words, straight line depreciation is a constant charge over the

useful life of the asset.

The straight line method is adopted when the principal cause of depreciation
is passage of time.

The straight line approach considers depreciation as a function of time

rather than as a function of usage.

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Production method
The production method or output method assume that depreciation is more
a function of use rather than passage of time.

The useful life of the asset is considered in terms of the output it produces
or the number of hours it works.

Thus, depreciation is related to the estimated production capability of the

asset and is expressed in rate per unit of output or per hour of use.

The production method is adopted if the principal cause of depreciation is

usage.

Diminishing balance or accelerated methods

The diminishing balance or accelerated methods provide higher depreciation
in the earlier years and lower depreciation in the later years of the useful life of the
asset.

Thus, these methods result in a decreasing depreciation charge over the

useful life.

The accelerated depreciation is on the philosophy that new assets are

generally capable of producing more revenue in the earlier years than in the later
years.

The accelerated methods include sum of years’ digits method and double
declining balance method.

Application

These activities are assessment if you understand that discussions we had.

Though this will not be recorded, it will still form part of your class standing so
make sure to accomplish the tasks given to you. ☺

Your tasks:

1. Explain the measurement of property plant and equipment at

recognition and after recognition
2. Discuss the accounting procedure when asset is through the issuance
of share capital
3. Discuss the derecognition of property plant and equipment

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Summary:
• Property, plant and equipment are tangible assets that are held for use in
production or supply of goods or services, for rental to others, or for
administrative purposes, and are expected to be used during more than one
period.
• The cost of an item of property, plant and equipment comprises:

o Purchase price, including import duties and non-refundable purchase

taxes, after deducting trade discounts and rebates.
o Cost directly attributable to bringing the asset to the location and
condition necessarily for it to be capable of operating in the manner
intended by management.
o Initial estimate of the cost of dismantling and removing the item and
restoring the site on which it is located for which an entity has a
present obligation.
• After initial recognition, an entity shall choose either the cost model or the
revaluation mode as the accounting policy for property, plant and
equipment.
• PPE can be acquired through:
o Acquisition in a cash basis
o Acquisition on account
o Acquisition on installment basis
o Issuance of share capital
o Issuance of bonds payable
o Exchange
o Construction
• Derecognition means that the cost of the property, plant and equipment
together with the related accumulated depreciation shall be removed from
the statement of financial position.
• Depreciation is defined as the systematic allocation of the depreciable
amount of an asset over the useful life
• The depreciation method shall reflect the pattern in which the future
economic benefits from the asset are expected to be consumed by the entity

References:

• Valix, C. T., Peralta, J.F & Valix C. A. M. (2020). Conceptual Framework

and Accounting Standards. Manila, Philippines: GIC Enterprises & Co.
Inc.
• Millan, Zeus Vernon B. (2019). Conceptual Framework and Accounting
Standards. Baguio City, Philippines: Bandolin Enterprise Publishing
and Printing

120
 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS (AE 14)
LEARNING MATERIAL

UNIT NUMBER / HEADING: UNIT 2 - MODULE 8 / IAS 38 INTANGIBLE

ASSETS

INTRODUCTION

An intangible asset is simple defined as an identifiable nonmonetary

asset without physical substance. In this chapter you will learn all the
pertinent accounting provisions to account for this kind of asset.

LEARNING OUTCOMES

At the end of the unit, students will be able to

• Identify the criteria for when an intangible asset may be recognized

• Specify how intangible assets should be measured
• Enumerate the disclosure requirements of assets

ACTIVATING PRIOR LEARNING

7. What are the two criteria that needs to be considered in recognizing

items of asset in the statement of financial position?
8. What are the features that are distinct only to tangible asset?

PRESENTATION OF CONTENTS

Recognition of intangible asset

There are 3 essential criteria in the definition of an intangible asset, namely:

a. Identifiability
b. Control
c. Future economic benefits
Identifiability
An asset is identifiable when:
• It is separable. This means that the asset can be separated from an
entity thru sale, exchange and other form of transfer.
• It arises from contractual or other legal rights.

121
Control
Control is the power of the entity to obtain the future economic benefits
flowing from intangible asset and restrict the access of others to those
benefits.

Future economic benefits

This includes revenue from sale of products and services, cost savings or
other benefits resulting from the use of the asset of the entity.

Recognition and measurement

An intangible asset shall be recognized if the following conditions are
present:

a. It is probable that future economic benefits attributable to the asset

will flow to the entity.

b. The cost of the intangible asset can be measured reliably.

Intangible assets that are acquired separately are initially measured a cost.
Cost within this context comprises:

• Purchase price
• Import duties and nonrefundable purchase tax
• Directly attributable costs of preparing the asset for the intended use
➢ Cost of employee benefit arising directly from bringing the asset
to its working condition.
➢ Professional fee arising directly from bringing the asset to its
working condition.
➢ Cost of testing whether the asset is functioning properly.
Internally generated intangible asset comprises of all directly attributable
costs necessary to create, produce and bring the asset into the desired
condition by management.

These costs include:

a. Cost of materials and services used of consumed in generating the

intangible asset.
b. Cost of employee benefit arising from the generation of the intangible
asset.
c. Fee to register a legal right.
d. Amortization of patent used to generate the intangible asset.
Recognition as an expense

An expenditure on an intangible item that does not meet the recognition

criteria for an intangible asset shall be expensed when incurred. Examples
of expenditures include:

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 - Start-up costs
- Training costs
- Advertising and promotional cost
- Business relocation or reorganization costs
Subsequent expenditure

The general rule for subsequent expenditure on an intangible asset is for it

to be recognized as outright expenses. The logic behind this is that most
expenditures merely maintain the condition of the intangible asset thus
contributing no additional future economic benefits.

However, subsequent expenditures may be capitalized if they meet the

following criteria:

a. It is probable that future economic benefits that are attributable

specifically to the subsequent expenditure will flow to the entity.
b. The subsequent expenditure can be measured reliably.
Identifiable intangible assets
a. Patent
b. Copyright
c. Franchise
d. Trademark or brandname
e. Customer list
f. Computer software
g. Broadcasting license, airline right and fishing right
Unidentifiable intangible asset
An intangible asset is said to be unidentifiable if it cannot be sold,
transferred, licensed, rented or exchanged separately.

The intangible asset is inherent in a continuing business (meaning it will

cease to exist if the business will close) and can only be identified with the
entity as a whole (meaning the only way for it to be sold or transferred is by
selling the whole entity).

This unidentifiable intangible asset squarely describes a goodwill.

Measurement of intangible asset after initial recognition

An entity shall choose either the cost model or revaluation model as an

accounting policy.

1. Cost model – an intangible asset shall be carried at cost, less any

accumulated amortization and any accumulated impairment loss.

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 2. Revaluation model – an intangible asset shall be carried at a
revaluation amount, less any subsequent amortization and any
subsequent accumulated impairment loss.

The revalued amount is the fair value at the date of revaluation and is
determined by reference to an active market.

Thus, an intangible asset can only be carried at revalued amount if

there is an active market for the asset.

Amortization of intangible assets

IAS 38 provides the following on the amortization of intangible assets:

1. Par. 97 states that intangible assets with limited or finite life are
amortized over their useful life.
2. Par. 107 and 108 state that intangible assets with indefinite life are
not amortized but are tested for impairment at least annually and
whenever there is an indication that the intangible asset may be
impaired.

Impairment of intangible assets

Intangible assets with finite useful life are tested for impairment whenever
there is an indication of impairment at the end of reporting period.

Intangible assets with indefinite useful life are tested for impairment at least
annually and whenever there is an indication of impairment.

An impairment loss on an intangible asset is recognized if the recoverable

amount is less than the carrying amount.

Research and development

IAS 38, paragraph 52, provides that to assess whether an internally
generated intangible asset meets the criteria for recognition, an entity
classifies the generation of the asset into research phase and development
phase.

Par. 53 provides that if an entity cannot distinguish the research from

development phase. The entity treats the expenditure as if it were incurred
in the research phase only.

Research is an activity undertaken to discover new knowledge that will be

useful in developing new product while development is the application of
research findings.

Accounting for research and development cost

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All expenditure that are incurred for research purposes or has been incurred
during the research phase are all charged to expense. Development cost on
the other hand may or may not be capitalized depending on very strict
criteria. These includes:

a. Technical feasibility of completing the intangible asset

b. Intention to complete the asset
c. Ability to use the asset
d. Generate future economic benefits
e. Availability of resources to complete the project
f. Ability to measure reliably the expenditure related to the asset
Capitalization of expenditures

Expenditures for research and development which have alternative future

use, either in additional research project or for productive purposes, can be
capitalized. Otherwise, they are charged as outright expense.

APPLICATION

4. Discuss the amortization process for intangible asset.

5. How do we account for development cost?

FEEDBACK

Choose the best answer for each question:

1. Which does not qualify as an intangible asset?
a. Compute software
b. Register patent
c. Copyright
d. Notebook computer
2. The recognition criteria for an intangible asset include which of the
following conditions?
a. The intangible asset must be measured at cost
b. The cost can be measured reliably
c. It is probable that future economic benefit will arise from use
d. It is probable that future economic benefit will arise from use and
the cost can be measured reliably.
3. Which is not a consideration in determining the useful life of an
intangible asset?
a. Legal, regulatory or contractual
b. Provision for renewal or extension
c. Initial cost
d. Obsolescence

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4. Amortization of an intangible asset with a finite useful life shall
commence when
a. It is recognized as an asset
b. It is probable that it will generate economic benefit
c. It is available for the intended use
d. The cost can be identified with reasonable certainty
5. Intangible assets are classified as
a. Amortizable and unamortizable
b. Limited life and indefinite life
c. Specifically identifiable and goodwill type
d. Legally restricted and goodwill type
6. How should research and development costs be accounted for?
a. Capitalized when incurred and amortized over the useful life
b. Expensed in the period incurred
c. Either capitalized or expensed when incurred depending upon
materiality
d. Expensed in the period incurred unless it can be clearly
demonstrated that the expenditure will have alternative future use
or unless contractually reimbursable
7. Which of the following costs should not be capitalized?
a. Acquisition cost of equipment to be used on current and future
project
b. Engineering cost incurred to advance the product to the full
production stage
c. Cost incurred to file for patent
d. Cost of testing prototype before economic feasibility has been
demonstrated
8. Which of the following costs should be excluded from research and
development expense?
a. Modification of the design of a product
b. Acquisition of research and development equipment for use on a
current project only
c. Cost of marketing research for a new product
d. Engineering activity required to advance the design of a new
product to the manufacturing stage
9. Intangible assets with indefinite useful life are tested for impairment
a. Quarterly
b. Annually
c. Biannually
d. There is no definite guideline for impairment
10. Intangible assets are reported
a. With an accumulated amortization account
b. Under property, plant and equipment
c. As a separate line item
d. All of these are allowed

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 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS (AE 14)
LEARNING MATERIAL

UNIT NUMBER/ HEADING: IMPAIRMENT OF ASSETS

LEARNING OUTCOMES:
At the end of the unit, the students will be able to:
w. Know the basic principle for the recognition of impairment;
x. Explain the concept of fair value less cost of disposal and value
in use;
y. Compute recoverable amount;
z. Recognize an impairment loss and reversal of an impairment
loss; and
aa.Elaborate the concept of cash generating unit

INTRODUCTION:
In this module, you will be introduced to the discussion of impairment
of assets. You will learn how assets are impaired and how to compute for an
asset’s recoverable amount.

Presentation of Content

Definition
❖ Impairment is a fall in the market value of an asset so that the
recoverable amount is now less than the carrying amount in the
statement of financial position
❖ The basic principle relating to impairment of asset states that an asset
shall not be carried at above the recoverable amount. This means, that
an entity shall write down the carrying amount of an asset to the
recoverable amount if the carrying amount is not recoverable in full.
CA > recoverable amount = asset has impairment loss

❖ The three main accounting issues to consider in impairment loss:

a. Indication of impairment
- An entity shall assess at each reporting date whether there is any
indication that an asset may be impaired, then, the entity shall
estimate the recoverable amount of the asset
- An entity shall test an intangible asset with anindefinite useful
life or an intangible asset not yet available for use for impairment
annually by comparing the carrying amount with the recoverable
amount whether there is any indication of impairment
- Events and changes that lead to an impairment of assets:
a. External sources

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 ✓ Significant decrease or decline in the market value of the
asset as result of passage of time or normal use ofr a
new competitor entering the market
✓ Significant change in the technological, market, legal or
economic environment of the business in which the
asset is employed or the change in customer taste.
✓ An increase in the interest rate or market rate or return
on investment which will likely affect the discount rate
used in calculating the value in use
✓ the carrying amount exceeds the fair value of the net
assets or market capitalization
b. Internal sources
✓ Evidence of obsolescence or physical damage of an asset
✓ Significant change in the manner or extent in which the
asset is used with an adverse effect on the entity
✓ Evidence that the economic performance of an asset will
be worse than expected

❖ After establishing evidence that an asset has been impaired, the

recoverable amount (fair value less cost of disposal or value in use,
whichever is higher), must be determined.
➢ Fair value of an asset is the price that would be received
to sell the asset in an orderly transaction between market
participants at the measurement date. Hierarchy of fair
value is as follows:
1. Level 1 inputs – quoted prices in an active market
for identical assets
2. Level 2 inputs – inputs that are observable either
directly or indirectly which includes quoted prices
for similar assets in an active market and quoted
prices for identical or similar assets in an
inactive market
3. Level 3 inputs – unobservable inputs for the asset
which are usually developed by the entity using
the best available information from the entity’s
own data.
➢ Cost of disposal is an incremental cost directly
attributable to the disposal of an asset or cash generating
unit, excluding finance cost and income tax expense.
➢ Fair value less cost of disposal is equal to exit price or
selling price of an asset minus cost of disposal

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 ➢ Active market is a market in which transactions for the
asset take place with sufficient regularity and volume to
provide pricing information on an ongoing basis
➢ Principal market is the market with the greatest volume
and level of activity for the asset
➢ Market participants are the buyers and the sellers in the
principal market who are:
✓ Independent or unrelated parties
✓ Knowledgeable or having a reasonable
understanding of the transaction
✓ Willing or motivated but not forced and compelled
➢ Value in use is measured as the present value or
discounted value of future net cash flows (inflows minus
outflows) expected to be derived from an assets. The cash
flows are pretax cash flows and pretax discount rate is
applied in determining the present value. It is calculated by
considering the following:
✓ Cash flow projections shall be based on reasonable
and supportable assumptions
✓ Cash flow projections shall be based on the most
recent budgets on financial forecasts, usually 5
years.
✓ Cash flow projections beyond the 5-year period shall
be estimated by extrapolating the 5-year projections
using a steady or declining growth rate each
subsequent year, unless an increasing rate can be
justified.
The following are the composition of estimates of future
cash flows:
✓ Projections of cash inflows from the continuing use
of the asset
✓ Projections of cash outflows necessarily incurred to
generate the cash inflows from the continuing use
of the asset
✓ Net cash flows received on the disposal of the asset
at the end of the useful life in an arm’s length
transaction

Illustration:
At year-end, an entity has a machinery with the following cost and
accumulated depreciation:

Machinery P5,000,000

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 Accumulated Depreciation
(5 year life, 2 years expired) P2,000,000
Carrying amount P3,000,000

Due to obsolescence and physical damage, the machinery is found to be

impaired. The entity has determined the following information with respect to
the machinery at year-end:

Fair value less cost of disposal P2,400,000

Value in use P2,200,000

**Because the fair value less cost of disposal is higher than the value in use,
P2,400,000 will be considered as recoverable amount to compute the
impairment loss:

Carrying amount P3,000,000

Fair value less cost of disposal (P2,400,000)
Impairment loss P 600,000

**The impairment loss will now be adjusted through the accumulated

depreciation account

Impairment loss P600,000

Accumulated Depreciation P600,000

**The adjusted carrying amount of P2,400,000 is allocated over the 3 years

remaining useful life to get the annual depreciation of P800,000.

Another Illustration;
On December 31, 2020, an entity has a machinery with the following cost
and accumulated depreciation:

Machinery P60,000,000
Accumulated Depreciation P20,000,000
Carrying Amount P40,000,000

The fair value less cost of disposal of the machinery is determined to be

P31,000,000. The future cash flows from the continued use of the machinery
over the remaining useful life of 4 years are:
Revenue Costs, exc. Net
Depreciation Cash flows
2021 P24,000,000 P10,000,000 P14,000,000
2022 P26,000,000 P14,000,000 P12,000,000

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2023 P25,000,000 P16,000,000 P 9,000,000
2024 P15,000,000 P11,000,000 P 4,000,000
P90,000,000 P51,000,000 P39,000,000

The value in use is calculated by discounting the net cash flows at an

appropriate discount rate of 10%.
Net cash flows PV of 1 Present Value
2021 P14,000,000 0.909 P12,726,000
2022 P12,000,000 0.826 P 9,912,000
2023 P 9,000,000 0.751 P 6,759,000
2024 P 4,000,000 0.683 P 2,732,000
P39,000,000 P32,129,000

**The value in use of P32,129,000 is the recoverable amount of the

machinery because this is higher than the fair value less cost of disposable
of P31,000,000.

Carrying amount P40,000,000

Recoverable amount P32,129,000
Impairment loss P 7,871,000

❖ An impairment loss recognized for an asset in prior years shall be

reversed if there has been a change in the estimate of the recoverable
amount. That means, if the recoverable amount of an asset that has
previously been impaired turns out to be higher than the current carrying
amount, the carrying amount of the asset shall be increased to new
recoverable amount.
❖ The increased carrying amount of an asset due to a reversal of an
impairment loss shall not exceed the carrying amount that would have
been determined, had no impairment loss been recognized for the asset
in prior years.
❖ The reversal of the impairment loss shall be recognized immediately
as income.

Concepts of Cash Generating Unit (CGU)

❖ A cash generating unit is the smallest identifiable group of assets that
generate cash inflows from continuing use that are largely independent
of the cash inflows from other assets or group of assets.
❖ As a basic rule, the recoverable amount of an asset shall be determined
for the asset individually. However, if it is not possible, an entity shall
determine the recoverable amount of the cash generating unit to which
the asset belongs.

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 ❖ The CGU must be the smallest aggregation of assets. An aggregation
that is “too high” is prohibited.
❖ When an impairment loss is recognized for a cash generating unit, this
loss shall be allocated to the assets of the unit in the following order:
a. First, to the goodwill, if any.
b. Then, to all other noncash assets of the unit prorate based
on their carrying amount.

Illustration:
An entity has determined that one of its cash generating units is
impaired. The assets of the cash generating unit at carrying amount are:

Building P2,400,000
Land P1,800,000
Equipment P1,500,000
Inventory P 300,000
Carrying amount of CGU P6,000,000

Most often the recoverable amount of a cash generating unit is equal to the
value in use because the unit is not to be disposed of.

The entity calculated the value in use of the cash generating unit to be
P4,500,000.

Carrying amount of CGU P6,000,000

Value in use P4,500,000
Impairment loss P1,500,000

Application

Your task:

a. In your own words, explain fair value less cost of disposal, value in
use and cash generating unit.

Fair value less cost Cash generating unit

Value in use
of disposal

b. What are the internal sources of information that would indicate

possible impairment?

Feedback

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Problem 1:

At year-end, Zee Company has an equipment with the following cost and
accumulated depreciation:
Equipment P9,000,000
Accumulated Depreciation P3,000,000

Due to obsolescence and physical damage, the equipment is found to be

impaired. At year-end, the entity has determined the following information
related to the equipment:

Fair value less cost of disposal P4,500,000

Value in use or discounted net cash inflows P4,000,000

What amount should be reported as impairment loss for the year?

a. P1,500,000 b. P2,000,000 c. P500,000 d. 0

Problem 2:
Cynosure Company has an equipment with carrying amount of P1,600,000
at year-end after recording depreciation for the year. The following information
is available at year-end relative to the equipment:
Fair value less cost of disposal P1,400,000
Discounted future cash flows P1,300,000
Undiscounted future cash flows P1,350,000

At what amount should the equipment be reported at year-end?

a. P1,600,000 b. P1,400,000 c. P1,300,000 d. P1,350,000

Problem 3:
Ivana Company determined that there had been a significant decrease in
market value of an equipment used in the manufacturing process. At year-
end, the entity computed the following information:
Original cost of equipment P5,000,000
Accumulated depreciation P3,000,000
Expected undiscounted net future cash inflows
related to the continued use and eventual
disposal of the equipment P1,750,000
Fair value of equipment P1,250,000

What amount of impairment loss should be reported in the income statement

for the year?
a. P3,250,000 b. P3,750,000 c. P750,000 d. P250,000

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Problem 4:
On January 1, 2017, New Normal Company purchased a machine for
P800,000 and established an annual depreciation charge of P100,000 over an
8-year life. During 2020, after issuing the 2019 financial statements, the
entity concluded that the machine suffered permanent impairment of the
operational value.
The reasonable estimate of the amount expected to be recovered through
the use of the machine for the period January 1, 2020 through December 31,
2024 is P200,000. What should be reported as carrying amount of the
machine on December 31, 2020?

Problem 5:
Tiktok Company acquired a machine for P3,200,000 on August 31, 2017.
The machine has a 5-year useful life, a P500,000 residual value, and was
depreciated using the straight line method.
On May 31, 2020, a test for recoverability revealed that the expected net
future undiscounted cash inflows related to the continued use and eventual
disposal of the machine amount to P1,500,000.
The fair value less cost of disposal of the machine on May 31, 2020 is
P1,350,000 with no residual value. What is the depreciation of the machine
for June 2020?
Problem 5:
On January 1, 2020, Haze Company owned a machine having a carrying
amount of P2,400,000. The machine was purchased four years earlier for
P4,000,000 and depreciated using straight line.
During December 2020, the entity determined that the machine suffered
impairment of the operational value and will not be economically useful in the
production process after December 31, 2020.
The entity sold the machine for P650,000 on January 5, 2021. What
amount should be recognized as impairment loss for 2020?
Summary of the Unit

The main aspects of IAS 36 to consider are:

• Indicators of impairment of assets
• Measuring recoverable amount, as fair value less costs of disposal
or value in use
• Measuring value in use
• Cash generating units
• Accounting treatment of an impairment loss, for individual assets
and cash-generating units

134
 For additional reading reference, you can go the IFRSbox website with
the following link: https://www.ifrsbox.com/ifrs/ias-36/ and
https://www.iasplus.com/en/standards/ias/ias36 or you can watch the discussion
video on youtube: https://www.youtube.com/watch?v=vJD9Pmdag8E

References:

• Valix, C. T., Peralta, J.F & Valix C. A. M. (2020). Conceptual Framework

and Accounting Standards. Manila, Philippines: GIC Enterprises & Co..
Inc.
• Ballada, W., & Ballada S. (2020). Conceptual Framework and
Accounting Standards. Manila, Philippines: DomDane Publishers.
• https://www.ifrsbox.com/ifrs/ias-36/
• https://www.youtube.com/watch?v=vJD9Pmdag8E

135
 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS (AE 14)
LEARNING MATERIAL

UNIT NUMBER/ HEADING: FINANCIAL INSTRUMENTS

LEARNING OUTCOMES:
At the end of the unit, the students will be able to:
bb. Define financial instrument;
cc. Define financial asset, financial liability and equity
instrument;
dd. Know the guideline when an instrument is a financial
liability or an equity instrument; and
ee. Know the recognition of a compound financial instrument.

INTRODUCTION:
In this module, you will be introduced to the discussion of impairment
of assets. You will learn how assets are impaired and how to compute for an
asset’s recoverable amount.

Presentation of Content

Definition
❖ A financial instrument is any contract that gives rise to both a
financial asset of one entity and a financial liability o equity
instrument of another entity.

❖ Examples of financial instruments include:

Financial Instrument Financial asset of: Financial Liability of:

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FINANCIAL ASSETS
1. Cash or Currency is a financial asset because it represents the medium
of exchange and is therefore the basis on which all transactions are
measured and recognized in financial statements
2. Deposit of Cash with a bank or similar institutions – it represents the
contractual right of the depositor to obtain cash from the bank or to
draw a check against the balance
** A gold bullion, though deposited in the bank, is not a financial asset
because it is a commodity.
3. Financial assets representing contractual right to receive cash in the
future are: (a) Trade accounts receivable, (b) Notes Receivable, (c) Loans
Receivable, (d) Bonds Receivable.

**In cases that financial instruments are exchanged with another entity,
conditions are favorable if such exchanges will result to gain or additional
cash inflow to the entity such as an option held by the holder to purchase
shares of another entity at less than market price. But if it will result to loss,
conditions are unfavorable.
4. Investments in shares or other equity instruments issued by other
entities, for example, trading securities.

FINANCIAL LIABILITY
➢ Any liability that is contractual obligation:
a. To deliver cash or other financial asset to another entity.
b. To exchange financial instruments with another entity under conditions
that are potentially unfavorable.

➢ Example includes (a) trade accounts payable, (b) Notes Payable, (c)
Loans Payable, and (d) Bonds Payable.

Nonfinancial Assets Nonfinancial Liabilities

1. Physical assets, such as 1.Deferred Revenue and warranty

inventory and PPE. obligations

2. Intangible assets, such as patent 2.Income tax Payable because it is

and trademark imposed by law and noncontractual

3. Prepaid expenses for which the 3.Constructive obligation because the

future economic benefit is the obligation does not arise from
receipt of goods or services, contracts.
rather than the right to receive
cash or another financial asset.

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 4. Right of use of asset or leased
asset is not a financial asset
because control of the underlying
asset does not give rise to a
present right to receive cash or
another financial asset.

EQUITY INSTRUMENT
➢ Is any contract that evidences a residual interest in the assets of an
entity after deducting all of the liabilities
➢ Includes ordinary share capital, preference share capital and warrants
or option.
➢ To determine whether a financial instrument is an equity instrument
rather than a financial liability: A financial instrument is an equity
instrument if the instrument includes no contractual obligation to deliver
cash or another financial asset.
➢ Redeemable preference share are classified as financial liability of
the issuer if:
✓ The preference share provides for mandatory redemption by
the issuer
✓ A preference share that gives the holder the right to require
the issuer to redeem the instrument at a particular date for a
fixed or determinable amount
✓ The mandatorily redeemable preference share shall be classified
as current or noncurrent liability depending on the date of
redemption
✓ Dividends paid to holders of mandatorily redeemable preference
share shall be accounted for as interest expense

INITIAL MEASUREMENT
o Financial instruments are initially measured at fair value of the
consideration given + (or minus for financial liability) direct
transaction costs
o If the financial instrument is designated at FVPL, transaction costs are
not added to fair value at initial recognition
SUBSEQUENT MEASUREMENT
o After initial recognition, financial assets are measured at:
a. Amortized cost
b. Fair value through other comprehensive income; or
c. Fair value through profit or loss

Financial liabilities:
a. At fair value through profit or loss

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 b. At amortized cost

COMPOUND FINANCIAL INSTRUMENT

➢ A financial that contains both a liability and an equity element from the
perspective of the issuer
➢ Common example are:
✓ bonds payable issued with share warrants
- bondholders are given the right to acquire shares of the issuer
at a specified price at some future time
- share warrants attached may be detachable (can be traded
separately from the bond) or nondetachable (cannot be traded
separately)
- the bonds are assigned an amount equal to “market value of the
bonds ex-warrants” regardless of the market value of the
warrants. The remainder or residual amount of the issue price
shall then be allocated to the warrants.
✓ convertible bonds payable
- give the holders the right to convert their bondholdings into
share capital of the issuing entity within a specified period of
time.
- the bonds are assigned an amount equal to the market value of
the bonds without the conversion privilege
➢ PAS 32 mandates that if the financial instrument contains both a
liability and equity component, such component shall be accounted
for separately using “split accounting”.
➢ In split accounting, fair value of the liability component is first
determined. Then it is deducted from the total consideration received.
The residual amount is allocated to the equity component.

RECOGNITION OF FINANCIAL INSTRUMENT

a. Scope
- IFRS 9 applies to all entities and to all types of financial instruments
excepts those specifically excluded, for example investments in
subsidiaries, associated, joint ventures and other joint arrangements.
b. Initial Recognition
- a financial asset or financial liability should be recognized in the
statement of financial position when the reporting entity becomes a
party to the contractual provisions of the instrument.
c. Derecognition
- it is the removal of a previously recognized financial instrument from
an entity’s statement of financial position.
- an entity should derecognize a financial asset when:

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 ✓ The contractual rights to the cash flows from the financial assets
expire; or
✓ It transfers substantially all the risks and rewards of ownership
of the financial asset to another party.
- an entity should derecognize a financial liability when it is
extinguished

DISCLOSURE OF FINANCIAL INSTRUMENTS

➢ According IFRS 7, mandates that as well as specific monetary
disclosures, narrative commentary by issuers is encouraged by the
Standards. This will enable users to understand management’s attitude
to risk, whatever the current transactions involving financial
instruments are at the period end.

Application

Your task:

1. Compare financial asset, financial liability and equity instrument

Financial Asset Financial Liability Equity Instrument

Feedback

Problem 1:

At the beginning of current year, Case Company issued P5,000,000 of 12%

nonconvertible 5-year bonds at 103. In addition, each P1,000 bonds was
issued with 30 detachable share warrants, each of which entitled the
bondholder to purchase, for P50, one ordinary share of Case Company, par
value P25. The quoted market value of each warrant was P4. The market value
of the bonds ex-warrants at the time of issuance is 95.

1. What is the carrying amount of the bonds payable?

a. P5,000,000 b. P4,750,000 c. P5,150,000 d. P4,550,000
2. What amount of the proceeds from the bond issue should be recognized
as an increase in shareholder’s equity?
a. P600,000 b. P300,000 c. P200,000 d. P400,000

Problem 2:

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Marion Company issued P5,000,000 face amount 12% convertible bonds at
110 at the beginning of current year. The bonds pay interest semiannually on
January 1 and July 1. It is estimated that the bonds would sell only at 102
without the conversion feature. Each P1,000 bond is convertible into 10
ordinary shares with P100 par value. What is the increase in shareholder’s
equity arising from the original issuance of the convertible bonds payable?
a. P400,000 b. P500,000 c. P100,000 d. 0

Multiple Choice:
1. A financial instrument is any contract that gives rise to
a. A financial asset
b. A financial liability
c. A financial asset of one entity and a financial liability of another
entity
d. A financial asset of one entity and a financial liability or equity
instrument of another entity
2. Which is not classified as a financial instrument?
a. Convertible bond
b. Foreign currency contract
c. Warranty provision
d. Loan receivable
3. Which cannot be considered a financial asset?
a. Cash
b. A contractual right to receive cash or another financial asset from
another entity
c. A contractual right to exchange financial instruments with another
entity under conditions that are potentially unfavourable
d. An equity instrument of another entity
4. Which should be classified as financial asset?
a. Patent
b. Trade accounts receivable
c. Inventory
d. Land
5. A financial liability
a. Must be classified as noncurrent liability
b. Is a contractual obligation to deliver cash or another financial asset
to another entity
c. Is a contractual obligation to exchange financial instrument with
another entity under conditions that are potentially favourable to the
entity
d. Is a contractual obligation to deliver cash or any asset to another
entity.
6. Financial liabilities include all of the following, except

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 a. Trade accounts payable
b. Notes payable
c. Bonds payable
d. Income tax payable
7. It is any contract that evidences residual interest in the assets of an
entity after deducting all of the liabilities
a. Equity instrument
b. Debt instrument
c. Loan receivable
d. Financial asset with indeterminable fair value
8. How should preference shares that are redeemable mandatorily be
presented in the statement of financial position?
a. Noncurrent liability
b. Current liability
c. Equity
d. Either current or noncurrent liability depending on redemption date
9. What is the presentation of preference dividend on mandatorily
redeemable preference share?
a. Deducted from retained earnings
b. Deducted from share premium
c. Interest expense
d. Deducted from share capital
10. Which is not an equity instrument?
a. Ordinary share capital
b. Bond payable
c. Preference share capital
d. Share option or warrant

Summary of the Unit

Issuers of financial instruments must classify them as liabilities or
equity
The substance of the financial instrument is more important than its
legal form
The critical feature of a financial liability is the contractual obligation
to deliver cash or another financial asset
Compound instruments are split into equity and liability parts and
presented accordingly
Interest, dividends, losses and gains are treated according to whether
they relate to a financial liability or an equity instrument.

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