Intermediate Accounting I

Intermediate Accounting I
Marylin L. Asumbra, CPA

Table of Contents
Module 1: CASH AND CASH EQUIVALENTS

Introduction 1
Learning Objectives 1
Lesson 1. Definition of Cash 2
Lesson 2. Definition of Cash Equivalents 3
Lesson 3. Financial Statement Presentation 4
Lesson 4. Measurement of Cash 6
Lesson 5. Internal Controls Over Cash 6
Lesson 6. Cash Shortages and Overages 8
Lesson 7. Petty Cash Fund 10
Lesson 8. Bank Reconciliation 11
Lesson 9. Proof of Cash 14
Assessment Task 17
Summary 27
References 29
Module 2: RECEIVABLES
Introduction 30
Lesson 1. Definition of Receivables 31
Lesson 3. Initial Measurement of Accounts Receivable 32
Lesson 4. Subsequent Measurement of Accounts Receivable 32
Lesson 5. Notes Receivable 37
Lesson 6. Initial Measurement of Notes Receivable 37
Lesson 7. Subsequent Measurement of Notes Receivable 39
Lesson 8. Definition of Loans Receivable 40
Lesson 9. Initial and Subsequent Measurement of Loans Receivable 40
Lesson 10. Receivable Financing 42
Assessment Task 45
Summary 55
References 57
Module 3: INVENTORIES
Introduction 58
Lesson 1. Definition of Inventories 59
Lesson 2. Recognition of Inventories 59
Lesson 4. Accounting for Inventories 63
Lesson 5. Measurement of Inventories 64
Lesson 6. Cost Formulas 65
Lesson 7. Net Realizable Value 67
Lesson 8. Inventory Estimation 68
Assessment Task 72
Summary 83
References 84
Course Code: ACCTG 3
Course Description: Intermediate Accounting 1 involves a thorough study of

accounting theory and the conceptual framework project. This course
provides an in-depth review of financial statement preparation with an
emphasis on disclosure. Topics include time value of money; cash;
receivables; inventory valuation; acquisition, disposition, and depreciation
methodologies of property, plant, equipment, and intangible assets; and
revenue recognition.
Course Intended Learning Outcomes (CILO):
At the end of the course, students should be able to:

1. Recall and define the nature of cash and cash equivalents,
receivables and inventories;
2. Determine how and at what amounts cash and cash
equivalents, receivables, and inventories accounts has to be
measured initially and subsequently;
3. Formulate entries for transactions affecting these accounts;
4. Apply the fundamental conceptual framework in the
preparation of financial statements; and
5. Disclose related financial information of these accounts in
the financial statements.
Course Requirements:
 Assessment Tasks - 60%

 Major Exams - 40%
Periodic Grade 100%
PRELIM GRADE : Total CS% + (40% of Prelim Exam)

MIDTERM GRADE : 30% of Prelim Grade + 70% (Total CS% + 40% of
Midterm exam)
FINAL GRADE : 30% Midterm Grade) + 70 % (Total CS% + 40% of
Final exam
MODULE 1
CASH AND CASH EQUIVALENTS
Introduction
Financial statements users focus on a variety of information in making credit and

investment decisions. Investors, long-term creditors, and short-term creditors are interested in
the company’s financial flexibility, the ability to use its financial resources to adapt to change. One
part of a company’s financial flexibility that external users are concerned with is liquidity. Liquidity
is the ability of a company’s liquid assets, that is, cash or other assets that may be easily
converted to cash, to pay its bills (Bazley, Nikolai, & Jones, 2010).
In this module, we begin our study of assets by looking at cash and cash equivalents. Key
issues pertinent to cash and cash equivalents are the proper classification in the statement of
financial position, measurement and valuation procedures , internal control procedures and cash
management, and the preparation of bank reconciliation and proof of cash.
Learning Outcomes
At the end of this module, students should be able to:

1. Define cash and cash equivalents;
2. Explain the possible restrictions on cash and cash equivalents and their implications for
classification and valuation in the statement of financial position;
3. Prepare a bank reconciliation , proof of cash ; and
4. Apply the accounting procedures for petty cash fund.
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Lesson 1. Definition of Cash
Cash classified as current asset include coins, currency and other unrestricted funds on
deposit with a bank (either checking or saving accounts), negotiable checks and bank drafts. The
amount that a company reports as cash in the current asset section on its statement of financial
position must be available to pay current obligation (Bazley et al., 2010).
Cash items included in cash account are the following (Valix, Peralta, & Valix, 2020):
a. Cash on hand – this includes undeposited cash collections and other cash items
awaiting deposit such as customers’ checks, cashier’s or manager’s checks,
traveler’s checks, bank drafts and money orders.
b. Cash in bank - this includes demand deposits or checking account and saving
deposits which are unrestricted as to withdrawal.
c. Cash fund – refers to fund set aside for current purposes.
Furthermore, Millan (2019) enumerated the following as qualifying for inclusion of the
account cash:
a. Coins and currencies

b. Demand deposits
c. Bank drafts
d. Money orders
e. Checks
f. Petty cash fund
g. Revolving fund
h. Payroll fund
i. Change fund
j. Dividend fund
k. Tax fund
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l. Travel fund
m. Interest fund
n. Other types of imprest bank accounts used in current operations
Some items may be confused with cash but normally are listed under other balance sheet
captions. Examples of items not included as cash (Millan, 2019):
a. Postdated checks
b. IOUs or Advances to employees
c. Cash funds not available for use in current operations, such as Sinking fund, Plant
expansion fund, Contingency fund, Insurance fund, and Preference share
redemption fund.
d. Postage stamps - treated as prepaid supplies.
Postdated checks from customers are checks dated in the future so they become payable
on a date later than the issue date. In practice, all check collections are recorded as cash receipts
and adjustments for postdated checks are made only when financial statements are prepared.
No separate accounting is needed for checks that were initially received as postdated but became
due and encashed prior to the preparation of financial statements (Millan, 2019).
Travel advances are funds or checks given to company employees to cover out-of-pocket
expenses while traveling on company business. Postage stamps, on the other hand, are classified
as prepaid items because they will be used rather than exchanged for cash (Bazley et al., 2010).
Lesson 2. Definition of Cash Equivalents
PAS 7, paragraph 6, defines cash equivalents as short-term and highly liquid investments
that readily convertible into cash and so near their maturity that they present insignificant risk of
changes in value because of changes in interest rates. The standard further states that only
highly liquid investments that are acquired three months before maturity can qualify as cash
equivalents (Valix et al., 2020).
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Millan (2019) reiterated that only debt instruments acquired within three months or less
before their maturity date can qualify as cash equivalents. Examples of cash equivalents are the
following:
a. Treasury bills, notes, or bonds acquired three months before maturity date
b. Money market instrument or commercial paper acquired three months before
maturity date
c. Three-month time deposit
Checks and bank drafts cannot qualify as cash equivalents because they are not short-
term investments. When checks and bank drafts are available for unrestricted and immediate use,
they are included as cash but not as cash equivalents. Equity securities (investments in stocks)
cannot qualify as cash equivalents because shares of stocks do not have a maturity date.
However, redeemable preference shares (preference shares with mandatory redemption) that are
acquired three months or less before their specified redemption date may qualify as cash
equivalents. This is because redeemable preference shares are debt instruments rather than
equity instruments (Millan, 2019).
Lesson 3. Financial Statement Presentation
The caption cash and cash equivalents should be shown as the first line item under current
assets. This caption includes all cash items, such as cash on hand, cash in bank, petty cash fund
and cash equivalents which are unrestricted in use for current operations. However, the details
comprising the cash and cash equivalents should be disclosed in the notes to financial statements
(Valix et al., 2020).
Bank overdraft is a negative balance in the cash in bank account resulting from
overpayment of checks in excess of the amount in deposit. Overdrafts occur only in checking
accounts; not in saving accounts or time deposits. They are presented as current liabilities, except
in cases where offsetting is permitted. When two or more bank accounts are maintained in the
same bank, and one account results to an overdraft, the overdraft may be offset or deducted from
the other bank account with a positive balance, provided the other bank account is also
unrestricted (Millan, 2019).
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Compensating balance takes the form of minimum checking or demand deposit account
balance that must be maintained in connection with a borrowing arrangement with a bank. If the
deposit is not legally restricted as to withdrawal by the borrower because of an informal
compensating balance agreement, the compensating balance is part of cash. If the deposit is
legally restricted because of a formal compensating balance agreement, the compensating
balance is separately classified as “cash held as compensating balance” under current assets if
the related loan is short-term. If the related loan is long-term, the compensating balance is
classified as noncurrent investment (Valix et al., 2020).
Restricted deposits in foreign banks that are not available for immediate withdrawal are
excluded from cash and presented as receivable subject to appropriate allowances for
uncollectability and impairment. The classification of the restricted deposit as current or
noncurrent depends on the nature of the restriction. The nature of restriction is disclosed in the
notes (Millan, 2019).
The following items are reverted back to cash balance at the end of the reporting period
by means of an adjusting entry:
a. Unreleased or undelivered check to the payee – a check drawn, recorded but not
yet given to the payee, so there is no payment made yet.
b. Delivered but postdated check to the payee – although the check was already
given to the payee, it has a date after the end of the reporting period, thus, no
payment can be made until presented to the bank for encashment.
c. Stale checks – these are checks delivered to the payee but not yet presented to the
bank for encashment within a relatively long period of time, which is a matter of
company policy.
Investments in time deposit, money market instruments and treasury bills, should be
classified as follows (Valix et al., 2020):
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a. If the term is three months or less, such instruments are classified as cash
equivalents, and therefore included in the caption “cash and cash equivalents”.
b. If the term is more than three months but within one year, such investments are
classified as short-term financial assets or temporary investments and presented
separately as noncurrent assets.
c. If the term is more than one year, such investments are classified as noncurrent or
long-term investments.
Lesson 4. Measurement of Cash
The measurement and reporting of cash and cash equivalents are largely straightforward
because cash generally present no measurement problems. It is the standard medium of
exchange and the basis for measuring assets and liabilities (Spiceland, Sepe, & Nelson, 2011).
Cash is measured at face value. Cash denominated in foreign currency is translated at

the current exchange rate at the reporting date. Cash maintained in a bank undergoing
bankruptcy is excluded from cash and presented as receivable measured at realizable value.
Realizable value is the amount expected to be recovered from the deposit and is determined
usually by reference to the insured amount of the deposit. If the realization is deferred, the amount
is discounted to its present value (Millan, 2019).
Lesson 5. Internal Controls Over Cash
Efficient cash management is very important to every company. Each company must
ensure that it has enough cash to pay its current obligations. However, it must recognize the fact
that idle cash is a nonproductive resource. Although a company may wish to protect itself against
business failure by amassing a large amount of cash to keep itself liquid, it can improve its
performance by investing these funds and earning interest. Proper cash management requires
that a company invest its idle cash and estimate the timing of its cash inflows and outflows to
insure that it has enough cash to meet its needs. Information on cash management is important
in financial accounting because one objective in financial reporting is to communicate how well
the managers of the company have fulfilled their stewardship responsibility to the shareholders.
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In this regard, cash management includes planning and control aspects. Cash planning systems
are those methods and procedures that a company uses to ensure that it has adequate cash to
meet maturing obligations. Cash control systems are the methods and procedures a company
uses to safeguard its funds. Cash control systems require adequate internal control measures.
Internal control is the process (policies and procedures) a company uses so that its financial
reports are reliable, its operations (including safeguarding its assets) are effective and efficient,
and that it complies with laws and regulations (Bazley et al., 2010).
Examples of internal controls over cash (Millan, 2019):
a. Segregation of incompatible duties -The duties of authorization, execution,

recording and custody over cash should be segregated. The custody of cash
should be given only to the treasurer. Neither the purchasing department,
manager, nor the accountant should have access to cash.
b. Imprest system - the imprest system requires that all cash receipts should be
deposited intact and all cash disbursements should be made through checks.
Disbursements for small amounts are made through the petty cash fund.
c. Bank reconciliation - Bank reconciliation should be prepared immediately upon the

receipt of the monthly bank statement, to reconcile on a timely basis the
differences between the cash balance per books and the cash balance per bank
statement.
d. Cash counts – periodic cash counts should be performed to provide reasonable

assurance that actual cash tallies with the balance per records. Surprise cash
counts should also be performed at irregular intervals as part of the internal audit.
e. Minimum cash balance – Minimum cash balance should be maintained, especially

for cash funds, sufficient only to defray specific business requirements.
Maintaining excessive cash balances may increase the risk of embezzlement.
f. Lockbox accounts – Entities often utilize lockbox accounts to expedite cash
collections and to ensure that cash collections are deposited intact. A lockbox is
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rented for a fee and customers are advised to remit payments directly to the
lockbox account. The bank empties the box at least once a day and immediately
credits the entity’s account for collections.
g. Non-encashment of personal checks from the petty cash fund – This is to

discourage the concealment of a possible cash shortages.
h. Voucher system – The voucher system is an internal control measure over all cash
disbursements. Under this system, a voucher is prepared for every cash
disbursement in order to ensure that each disbursement is properly authorized,
made for a valid expenditure and properly recorded.
Lesson 6. Cash Shortages and Overages
Accounting for cash shortages and overages (Millan, 2019)
When the cash count results to an amount less than the balance per records, there is a
cash shortage. Cash shortage is initially recorded to a suspense account called “Cash shortage
or overage” pending proper investigation of the cause of shortage.
When the financial statements are prepared, the “Cash shortage or overage” account is
closed to either a nominal account or real account. Suspense accounts should not appear in the
financial statements. Depending on the result of the investigation, the shortage may be:
a. closed to a “ receivable” account if the shortage was due to the fault of an
employee
b. charged to a “loss” if the investigation was without merit.
When the cash count results to an amount more than the balance per records, there is a
cash overage. Cash overage is initially credited to the “Cash shortage or overage” account
pending proper investigation of the cause of overage. Depending on the result of the investigation
, the ”overage” may be closed to a “payable” account if the overage was due to cash belonging
to an employee that was commingled with the entity’s cash or “gain” if the investigation was
without merit.
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Concealment of cash shortages (Millan, 2019)
Cash shortages are fraudulently concealed in various ways. Examples include, but not
limited to, the following:
1. Lapping - occurs when collection of receivable from one customer is misappropriated
and then concealed by applying a subsequent collection from another customer.
Lapping is made possible when the incompatible duties of recording and cash
custody are combined. Lapping may be discovered through various audit
procedures which may include analytical procedures and confirmation using proper
sampling techniques.
2. Kiting - occurs when cash shortages is concealed by overstating the balance of

cash. Kiting is made possible by exploiting the “float” period. Kiting normally occurs
at month-end when a check is written to transfer funds from one bank account to
another bank account where the misappropriation was made. The “fraudster” would
include the check as a deposit to the account where he misappropriated the money.
Because of the float period, the check drawn on the other bank account will not be
reported in the month-end bank statement.
3. Window dressing - In a broad sense, window dressing is a form of fraudulent

financial reporting, and not primarily a form of concealing cash shortage. Window
dressing occurs when books are not closed at year-end and transactions in the
subsequent period are deliberately recorded in the current period in order to improve
the entity’s financial performance or financial ratios. Window dressing can also be
used to conceal cash shortages as of the reporting date by including collections in
the subsequent period to the current period or by deferring the recording of current
year’s disbursements to the subsequent period.
Lesson 7. Petty Cash Fund
A petty cash fund is a type of imprest fund providing ready currency for routine
disbursements. A large organization may have several petty cash funds in a variety of offices
and production facilities. Although the amount in any one location may be relatively minor, the
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total of all petty cash may be significant. The balance of the petty cash account, which is part of
the total cash balance, changes only when the fund is established, changed in amount, or
discontinued (Morton & Conrod, 1992).
The imprest fund system is the one usually followed in handling petty cash transactions.
The following accounting procedures illustrate the typical petty cash fund operation (Valix et al.,
2020):
1. A check is drawn to establish the fund.
Petty cash fund xx

Cash in bank xx
2. Payment of expenses out of the fund.
No formal journal entries are made. The petty cashier requires a signed petty cash
voucher for such payment and simply prepares memorandum entries in the petty cash journal.
3. Replenishment of petty cash payments.
Expenses xx
Cash in bank xx
Whenever the petty cash fund runs low, a check is drawn to replenish the fund. The
replenishment check is usually equal to the petty cash disbursements.
4. Adjusting entry for unreplenished expenses
Expenses xx
Petty cash fund xx
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The adjustment is to be reversed at the beginning of the next accounting period. The reversal
is made in order that the normal replenishment procedures may be followed by simply debiting
expenses and crediting the cash in bank account without distinguishing whether the expenses
pertain to the current period or prior period.
5. An increase in the fund is recorded as:
Petty cash fund xx 10

Cash in bank xx
6. A decrease in the fund is recorded as:
Cash in bank xx
Petty cash fund xx
Lesson 8. Bank Reconciliation
A bank reconciliation is a schedule that a company prepares to analyze the difference

between the ending cash balance in its accounting records and the ending cash balance reported
by its bank in a bank statement to determine the correct ending balance.
Banks send a monthly statement to each depositor summarizing the activities that have
taken place in the depositor’s account. These activities include deposits, checks cleared,
miscellaneous items, and the ending balance in the checking account. The bank statement and
the company’s accounting records usually will not be in agreement. When the company receives
the bank statement each month, it prepares a bank reconciliation to compare the bank statement
balance and its cash balance to reconcile these records (Bazley et al., 2010).
The causes of difference between the cash balance listed on a company’s bank statement
and the balance shown in the company’s cash account include the following items:
1. Outstanding checks – Millan (2019) defined outstanding checks as checks drawn and
released to the payees but are not yet encashed with the bank. However, certified checks
and stale checks are excluded from outstanding checks.
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2. Deposits in transit - these are collections already recorded by the depositor as cash
receipts but not yet reflected on the bank statement. It may take the form of collections
already forwarded to the bank for deposit but too late to appear in the bank statement or
undeposited collections or those still in the hands of the depositor (Valix et al., 2020).
3. Debit memos – are deductions (bank debits) made by bank to the depositor’s account but
not yet recorded by the depositor. Examples of debit memos include the following (Millan,
2019):
a. Bank service charges – bank charges for fees, interest, penalties and
surcharges
b. NSF/DAIF checks - checks deposited and already recorded by the bank but
subsequently returned to the depositor because the
drawer’s fund is insufficient to pay for the check
c. Automatic debits- such as when the depositor and the bank agree that the
bank will make automatic payments of bills on behalf of the
depositor
d. Payment of loans – which the entity (depositor) agreed to be made out
directly from its bank account
4. Credit memos - refer to items not representing deposits credited by the bank to the
account of the depositor but not yet recorded by the depositor as cash receipts. The
credit memos have the effect of increasing the bank balance. Typical examples of credit
memos are notes receivable collected by the bank in favor of the depositor, proceeds of
bank loan credited to the account of the depositor, and matured time deposits transferred
by the bank to the current account of the depositor (Valix et al., 2020).
5. Errors – Despite the internal control procedures established by the bank and the
company, the company may discover errors in either the bank’s records or its records
when it prepares the bank reconciliation. For example, the bank may include a deposit or
a check from another customer’s account or make an error in recording an amount. A
company may similarly make an error in recoding an amount. For example, a common
error is to transpose two numbers (Bazley et al., 2010).
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General procedures in preparing the reconciliation (Valix et al., 2020)
1. Determine the balance per book and the balance per bank.
2. Trace the cash receipts to the bank statement to ascertain whether there are deposits not
yet acknowledged by the bank.
3. Trace the checks issued to the bank statement to ascertain whether there are checks not
yet presented for payment.
4. The bank statement should be examined to determine whether there are bank credits
and bank debits not yet recorded by the depositor.
5. Watch out for errors. Errors are reconciling items of the party which committed them.
Proforma reconciliation (Valix et al., 2020)
Under the adjusted balance method, the book balance and the bank balance are brought
to a correct cash balance that must appear on the balance sheet. It must be observed that under
this method, the credit memos are always added to the book balance and the debit memos are
always deducted from the book balance. Deposits in transit are always added to the bank balance
and outstanding checks are always deducted from the bank balance. Errors will have to be
analyzed for proper treatment.
The illustration below does not show the details to simplify the presentation.
Book balance xx Bank balance xx

Add: Credit memos xx Add: Deposits in transit xx
Total xx Total xx
Less: Debit memos xx Less: Outstanding checks xx
Adjusted book balance xx Adjusted bank balance xx
Preparation of adjusting entries
Adjusting or reconciling entries are made only for book reconciling items, that is, credit
memos, debit memos and errors (Millan, 2019).
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In the preparation of adjustments, an item added to the book balance is debited to cash
and an item deducted from the book balance is credited to cash (Valix et al., 2020).
Lesson 9. Proof of Cash (Valix et al., 2020)
A proof of cash is an expanded reconciliation in that it includes proof of receipts and

disbursements. This approach may be useful in discovering possible discrepancies in handling
cash particularly when cash receipts have been recorded but have not been deposited. Actually,
the proof of cash is a reconciliation of the receipts and disbursements for the current period.
The proof of cash following the adjusted balance method means that the book receipts
and disbursements, and the bank receipts and disbursements for the current month are adjusted
to equal the correct receipts and disbursement for the current month.
Comments on the book items
a. Credit memos of the previous month do not affect the book receipts for the current month
but increased the book receipts for the current month because the credit memos of the
previous month are recorded only by the depositor during the current month.
Consequently, the book receipts for the current month is overstated in relation to the
correct receipts for the current month. Hence, credit memos of the previous month are
deducted from the book receipts of the current month.
b. Credit memos of the current month already increased the bank receipts for the current
month but have no effect on the book receipts for the current month because the credit
memos of the current month are not yet recorded by the depositor during the current
month.
Consequently, the book receipts for the current month are understated in relation to the
correct receipts for the current month. Hence, credit memos of the current month are
added to the book receipts for the current month.
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c. Debit memos of the previous month do not affect the bank disbursements for the current
month but increased the book disbursements for the current month because the debit
memos of the previous month are recorded only by the depositor during the current
month.
Consequently, the book disbursements for the current month are overstated in relation to
the correct disbursements for the current month. Hence, debit memos of the previous
month are deducted from the book disbursements for the current month.
d. Debit memos of the current month already increased bank disbursements for the current
month but have no effect on the book disbursements for the current month because the
debit memos of the current month are not yet recorded by the depositor.
Consequently, the book disbursements for the current month are understated in relation
to the correct disbursements for the current month. Hence, debit memos of the current
month are added to the book disbursements for the current month.
Comments on the bank items
a. Deposits in transit of the previous month do not affect book receipts for the current month
but increased bank receipts for the current month because the deposits are recorded only
by the bank during the current month.
Consequently, bank receipts for the current month are overstated in relation to the correct
receipts for the current month. Hence, deposits in transit of the previous month are
deducted from the bank receipts for the current month.
b. Deposits in transit of the current month already increased book receipts but have no effect
on the bank receipts for the current month because the deposits are not yet recorded by
the bank during the current month.
Consequently, the bank receipts for the current month are understated in relation to the
correct receipts for the current month. Hence, deposits in transit of the current month are
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added to the bank receipts of the current month.
c. Outstanding checks of the previous month do not affect the book disbursements but
increased the bank disbursements for the current month because the outstanding checks
of the previous month are paid only by the bank during the current month.
Consequently, the bank disbursements for the current month are overstated in relation to
the correct disbursements for the current month. Hence, outstanding checks of the
previous month are deducted from the bank disbursements of the current month.
d. Outstanding checks of the current month increased the book disbursements for the current
month but have no effect on the bank disbursements for the current month because the
checks are not yet paid by the bank during the current month.
Consequently, the bank disbursements for the current month are understated in relation to
the correct disbursements for the current month. Hence, outstanding checks of the current
month are added to the bank disbursements for the current month.
For proof of cash problems, the following format is followed using the adjusted balance method.
Beginning Receipts Disbursements Ending
Unadjusted balance per bank xx xx xx xx

Deposits in transit, beginning xx (xx)
Deposits in transit, end xx xx
Outstanding checks, beginning (xx) (xx)
Outstanding checks, end xx (xx)
Adjusted balances xx xx xx xx
Beginning Receipts Disbursements Ending

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Unadjusted balance per book xx xx xx xx

Unrecorded credit, beginning xx (xx)
Unrecorded credit, end xx xx
Unrecorded debit, beginning (xx) (xx)
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Unrecorded debit, end xx (xx)
NSF check, beginning (xx) (xx)
NSF check, end xx (xx)
Adjusted balances xx xx xx xx
Assessment Tasks (Valix et al., 2020)
Assessment Task 1 -1
1. Tranvia Company revealed the following information on December 31, 2020:
Cash in checking account 350,000
Cash in money market account 750,000
Treasury bill, purchased November 1, 2020
maturing January 31, 2021 3,500,000
Time deposit purchased December 1, 2020
maturing March 31, 2021 4,000,000
What amount should be reported as cash and cash equivalents on December 31, 2020?
2. Affable Company provided the following information at year-end comprising the cash
account:
Cash in bank – demand deposit 5,000,000
Cash on hand 400,000
Postage stamps unused 5,000
Certificate of time deposit 1,500,000
Money order 50,000
Manager check 100,000
Traveler check 1,000,000
Postdated customer check 500,000
What total amount should be reported as cash at year end?
3. Thor Company provided the following data on December 31, 2020:
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Checkbook balance 4,000,000
Bank statement balance 5,000,000
Check drawn on Thor’s account, payable to supplier,
dated and recorded on December 31, 2020 but not
mailed until January 31, 2021 500,000
Cash in sinking fund 2,000,000
On December 31, 2020, what amount should be reported as cash under current
assets?
4. On December 31, 2020 Lamentable Company had the following cash balances:
Cash in bank – current account 6,000,000

Petty cash fund – all funds were reimbursed at year end 50,000
Time deposit – three months, due January 15, 2021 2,500,000
Saving deposit 1,000,000
Cash in bank included P400,000 of compensating balance against short term

borrowing arrangement.
The compensating balance is legally restricted as to withdrawal
What total amount should be reported as cash and cash equivalents?

5. Baloney Company had the following account balances on December 31, 2020:
Cash in bank 2,250,000

Cash on hand 125,000
Cash restricted for addition to plant in 2021 1,600,000
Cash in bank included P600,000 of compensating balance against short-term

borrowing arrangement.
The compensating balance is not legally restricted as to withdrawal.
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What total amount should be reported as cash on December 31, 2020?
6. In preparing the bank reconciliation for the month of August, Apex Company
provided the following information:
Balance per bank statement 1,805,000

Deposit in transit 325,000
Return of customer check for insufficient fund 60,000
Outstanding checks 275,000
Bank service charge for August 10,000
What is the adjusted cash in bank?
7. In preparing the bank reconciliation for the month of December, Case Company
provided the following data:

Amount erroneously credited by bank to Case’s account 40,000
Bank service charge for December 5,000
NSF check 50,000
Outstanding checks 675,000
What is the unadjusted cash in bank balance per book?

8. Sapphire Company provided the following information for the month of December:
Balance per bank statement December 31 2,800,000

Bank service charge for December 12,000
Interest paid by bank to Sapphire Company for December 10,000
Deposits made but not yet recorded by the bank 350,000
Checks written but not yet recorded by the bank 650,000
The entity discovered that it had drawn and erroneously recorded a check for
P46,000 that should have been recorded for P64,000
19
What is the cash balance per ledger on December 31?
9. Core Company provided the following data for the purpose of reconciling the cash
balance per book with the cash balance per bank statement on December 31:
Balance per book 850,000
Outstanding checks, including certified check of P100,000 500,000
December NSF checks, of which P50,000 had
been redeposited and cleared on December 27 150,000
Erroneous credit to Core’s account, representing
proceeds of loan granted to another company 300,000
Proceeds of note collected by bank for Core,
net of service charge of P20,000 750,000
What amount should be reported as cash in bank at year-end?
10. Laconic Company received the bank statement for the month of April which
included the following information:
Bank service charge for April 15,000

Check deposited by Laconic during April was not collectible
and has been marked “NSF” by the bank and returned 40,000
Deposits made but not yet recorded by bank 130,000
Checks written and mailed but not yet recorded by bank 100,000
The entity found a customer check for P35,000 payable to the entity that had not
yet been deposited and had not been recorded.
The general ledger showed a bank account balance of P920,000
20
What amount should be reported as adjusted cash in bank on April 30?
Items 11 to 13 are based on the following information:
Pearl Company maintains a checking account at the City Bank. The bank provides a bank
statement along with canceled checks on the last day of each month. The July bank
statement included the following information:
Balance, July 1 550,000

Deposits 1,800,000
Cheeks processed 1,400,000
Service charge 30,000
NSF check 120,000
Monthly loan payment deducted by bank from account 100,000
Deposits outstanding totaled P100,000 and all checks written by the depositor were
processed by the bank except for check of P150,000.
A P200,000 July deposit from a credit customer was recorded as P20,000 debit cash and
credit accounts receivable.
A check correctly recorded by the entity as P 30,000 disbursement was incorrectly

processed by the bank as P300,000 disbursement.
11. What is the balance per bank on July 31?

12. What amount should be reported as cash in bank on July 31?
13. What is the cash in bank balance per ledger on July 31?
Humanizer Company provided the following information:
21
Balance per bank statement — May 31 2,600,000
Deposits outstanding 300,000
Checks outstanding ( 100,000)
Correct bank balance — May 31 2,800,000
Balance per book — May 31 2,810,000

Bank service charge ( 10,000)
Correct book balance — May 31 2,800,000
June data are as follows: Bank Book
Checks recorded 2,200,000 2,500,000

Deposits recorded 1,600,000 1,800,000
Service charges recorded 50,000
Note collected by bank, P500,000 plus interest 550,000
NSF check returned with June 30 statement 100,000
Balances 2,400,000 2,100,000
14. What is the amount of outstanding checks on June 30?
15. What is the amount of deposits in transit on June 30?
16. What is the adjusted cash in bank on June 30?
Cool Company prepared the following bank reconciliation for the month of November:
Balance per bank statement, November 30 3,600,000

Add: Deposit in transit 800,000
4,400,000
Less: Outstanding checks 1,200,000
Bank credit recorded in error 200,000 1,400,000
22
Balance per book, November 30 3,000,000
Data per bank statement for the month of December:
December deposits, including note receivable

collected of P 1,000,000 for Cool Company 5,500,000
December disbursements, including NSF check
P350,000 and service charge P50,000 4,400,000
All items that were outstanding on November 30 cleared through the bank in December,
including the bank credit.
In addition, checks of P500,000 were outstanding and deposits of P700,000 were in transit on
December 31.
17. What is the adjusted cash in bank on December 31?

18. What is the balance of cash per ledger on December 31?
19. What is the amount of cash receipts per book in December?
20. What is the amount of cash disbursements per book in December?
Assessment Task 1 - 2
1.Which of the following should not be considered cash?
a. Petty cash fund
b. Money order
c. Coin and currency
d. IOU
2. Which of the following is usually considered cash?
a. Certificate of deposit
b. Checking account
c. Money market certificate
d. Postdated check
3. Which of the following should not be included in cash?
a. Travel cash advance
b. Certified check
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c. Personal check
d. Manager check
4. All of the following may be included in cash, except
a. Currency
b. Money market instrument
c. Checking account balance
d. Saving account balance
5. Technically, cash may not include
a. Foreign currency
b. Money order
c. Restricted cash
d. Undeposited customer check
6. All of the following can be classified as cash and cash equivalents, except
a. Redeemable preference shares due in 60 days
b. Commercial papers due for repayment in 90 days
c. Equity investments
d. A bank overdraft
7. Cash equivalents do not include
a. Money market funds
b. High grade marketable equity investments
c. BSP treasury bills
d. Commercial papers
8. The internal control feature specific to petty cash is
a. Separation of duties c. Proper authorization
b. Assignment of responsibility d. Imprest system
9. A cash over and short account
a. Is not generally accepted.
b. Is debited when the petty cash fund proves out over.
c. Is debited when the petty cash fund proves out short.
d. Is a contra account to cash
10. Petty cash fund is
a. Separately classified as current asset
b. Money kept on hand for making minor disbursements of coin and currency rather
24
than by writing checks
c. Set aside for the payment of payroll
d. Restricted cash
11. A bank reconciliation is

a. A financial statement that lists all of the bank account balances of an entity.
b. A merger of two banks that previously were competitors.
c. A statement sent by the bank to depositor on a monthly basis.
d. A schedule that accounts for the differences between cash balance shown on
the bank statement and the cash balance shown on the general ledger.
12. Which of the following items must be added to the cash balance per ledger in preparing
a bank reconciliation which ends with adjusted cash balance?
a. Note receivable collected by bank in favor of the depositor and credited to the
account of the depositor
b. NSF customer check
c. Service charge
d. Erroneous bank debit
13. Which of the following would be added to the balance per bank statement to arrive
at the correct cash balance?
a. Outstanding check
b. Bank service charge
c. Deposit in transit
d. A customer mote collected by the bank on behalf of the depositor
14. Which of the following must be deducted from the bank statement balance in
preparing a bank reconciliation which ends with adjusted cash balance?
a. Deposit in transit
b. Outstanding check
c. Reduction of loan charged to the account of the depositor
d. Certified check
15. If the balance shown in the bank statement is less than the correct cash balance
and neither the entity nor the bank has made any errors, there must be
a. Deposits credited by the bank but not yet recorded by the depositor
25
b. Outstanding checks
c. Deposits in transit
d. Bank charges not yet recorded by the depositor
16. If the cash balance shown in the accounting record is less than the correct cash
balance and neither the entity nor the bank has made any errors, there must be
a. Deposits credited by the bank but not yet recorded by the depositor
b. Deposits in transit
c. Outstanding checks
d. Bank charges not yet recorded by the depositor
17. Bank reconciliations are normally prepared on a monthly basis to identify
adjustments needed in the depositor's records and to identify bank errors.
Adjustments on the part of the depositor should be recorded for
a. Bank errors, outstanding checks and deposits in transit.
b. All items except bank errors, outstanding checks and deposits in transit.
c. Book errors, bank errors, deposits in transit and outstanding checks.
d. Outstanding checks and deposits in transit.
18. Bank statements provide information about all of the following, except
a. Checks cleared during the period
b. NSF checks
c. Bank charges for the period
d. Errors made-by the depositor
19. Which statement in relation to a certified check is not true?
a. A certified check is a liability of the bank certifying it.
b. A certified check will be accepted by many persons who would not otherwise
accept a personal check.
c. A certified check is one drawn by a bank upon itself.
d. A certified check should not be included in the outstanding checks.
20. Which statement in relation to bank reconciliation is true?
a. Bank service charge will cause the cash balance per ledger to be higher than
that reported by the bank, all other things being equal.
b. Credit memos will cause the cash balance per ledger to be higher than that
reported by the bank, all other things being equal.
26
c. Outstanding checks will cause the cash balance per ledger to be greater than
the balance reported by the bank, all other things being equal.
d. The cash amount reported in the statement of financial position must be the
balance reported in the bank statement.
Summary (Millan, 2019)
 Postdated checks received from customers are excluded from cash and reverted
back to accounts receivable.
 Undelivered checks drawn and postdated checks drawn are included in cash and
reverted back to accounts payable.
 Only highly liquid investments that are acquired 3 months or less before maturity
can qualify as cash equivalents.
 Shares of stocks generally cannot qualify as cash equivalents, except for
redeemable preference shares acquired 3 months or less before redemption
date.
 Bank overdrafts are reported as current liabilities except in cases where
offsetting is permitted.
 Compensating balances that are legally restricted are excluded from cash. Those
that are not legally restricted are included in cash. Whether restricted or not,
compensating balances are disclosed in the notes
 The voucher system is an internal control over cash disbursements which require
that every disbursement should be supported by a written authorization
embodied in a document called the voucher.
 Cash shortages are initially debited, while cash overages are initially credited, to
the “Cash shortage or overages” account pending due investigation.
 A bank reconciliation statement is a report that is prepared for the purpose of
bringing the balances of cash (a) per records and (b) per bank statement into
agreement.
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 Pro forma bank reconciliation:
Bal. per books, end xx Bal. per bank, end. xx

Add: CM xx Add: DIT xx
Less: DM (xx) Less: OC (xx)
+/-: Book errors: xx +/-: Bank errors xx
Adjusted balance xx Adjusted balance xx
 Credit memos (CM) – are additions (bank credits) made by the bank to the
depositor’s bank account but not yet recorded by the depositor, e.g., collections
made by the bank on behalf of the depositor.
 Debit Memos (DM) – are deductions (bank debits) made by the bank to the
depositor’s bank accounts but not yet recorded by the depositor, e.g., NSF
checks, bank service charges
 Deposit in transit (DIT) – are deposits made but not yet credited by the bank to
the depositor’s bank account.
 Outstanding checks (OC) – are checks drawn and released to payees but are not
yet encashed with the banks.
References
Bazley, J.D., Nikolai, L.A., & Jones,J.P., (2010). Intermediate Accounting (11 th Ed.).
Canada:Rob Dewey
Millan, Z.V.B., (2019). Intermediate Accounting 2: Baguio City, Philippines: Bandolin Enterprise
Morton, N., & Conrod, J.D., (1995). Intermediate Accounting (7th Ed.). Canada: Roderick T
Banister
Spiceland, D.J., Sepe, J.F., & Nelson, M.W., (2011) Intermediate Accounting (6th Ed.). New
York: McGraw Hill/Irwin
Valix, C.T., Peralta, J.F., & Valix, C. A. M., (2020). Theory Financial Accounting (2020
Ed.).Manila, Philippines: GIC Enterprises & Co.,Inc.
28
MODULE 2
RECEIVABLES
Introduction
An objective of financial reporting is to help users assess the amounts, timing, and
uncertainty of future cash flows. Those assessments are affected by how a firm reports its liquidity
position. The ability of firms to convert accounts receivable into cash on a timely basis is an
important element of their cash management strategy. Banks and other financial institutions
aggressively compete for the opportunity to provide loans secured by accounts receivable. Firms
also issue securities based on their receivables (Morton et al., 1992).
This module tackles the key issues affecting the receivables accounts, particularly on the
valuation and related income statement effects of transactions. Furthermore, this module also
zeroes-in on the many variations in financing arrangements, specifically where receivables are
involved.
Learning Outcomes

1. Define the nature of receivables;
2. State the initial and subsequent measurement of trade receivables, notes receivable
and loans receivable;
3. Illustrate the adjustments necessary in determining the net realizable value of accounts
receivable;
4. Account for interest-bearing and non-interest bearing note receivable;
5. Account for the impairment of loan receivable; and
6. Apply the accounting principles and procedures in receivables financing.
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Lesson 1. Definition of Receivables
Receivables are amounts owed to the company by customer and other parties arising
from the company’s operations. Most receivables are canceled through the receipt of cash,
although others may be canceled through the receipt of other assets or services (Bazley et al.,
2010).
Receivables are financial assets that represent a contractual right to receive cash or
another financial asset from another entity. For retailers or manufacturers, receivables are
classified into trade receivables and nontrade receivables (Valix et al., 2020).
Trade receivables are receivables arising from the sale of goods or services in the ordinary
course of business. They include trade accounts receivable and trade notes receivable. Trade
receivables are classified as current assets when they are expected to be realized in cash within
the normal operating cycle or one year, whichever is longer. Nontrade receivables are receivables
arising from other sources. They are classified as current assets only when they are expected to
be realized in cash within one year (Millan, 2019).
Examples of nontrade receivables (Valix et al., 2020)
a. Advances to or receivable from shareholders, directors, officers, or employees

b. Advances to affiliates
c. Advances to supplier for the acquisition of merchandise
d. Subscriptions receivable
e. Creditor’s accounts with debit balances
f. Special deposits on contract bids
g. Accrued income
h. Claims receivable
Financial institutions need not classify their receivables as trade or nontrade because
their statement of financial position is presented based on liquidity, that is, no current and
noncurrent distinction (Millan, 2019).
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Trade receivables and nontrade receivables which are currently collectible shall be
presented on the face of the statement of financial position as one line item called trade and other
receivables. However, the details of the total trade and other receivables shall be disclosed in
the notes to financial statements (Valix et al., 2020).
The classification of receivables as to being current or noncurrent are in accordance with

PAS 1, Presentation of Financial Statements, paragraph 66, which states:
“An entity shall classify an asset as current when the entity expects to realize the asset or
intends to sell or consume it in the entity’s normal operating cycle, or when the entity expects to
realize the asset within twelve months after the reporting period. (Valix et al., 2020)”
Lesson 3. Initial Measurement of Accounts Receivable
Receivables are initially recognized at fair value plus transaction costs which are directly
attributable to the acquisition. However, trade receivables that do not have a significant financing
component are measured at their transaction price in accordance with PFRS 15 (Revenue from
Contracts with Customers). Transaction price is the amount of consideration to which an entity
expects to be entitled in exchange for transferring promised goods or services to a customer,
excluding amounts collected on behalf of third parties. Moreover, as a practical expedient, PFRS
15 allows the non-discounting of the amount of consideration if it is due within one year from the
date of transfer of goods or services (Millan, 2019).
Lesson 4. Subsequent Measurement of Accounts Receivable
Accounts receivable are subsequently measured at recoverable historical cost or net

realizable value. Recoverable historical cost or net realizable value represents the amount of
cash expected to be recovered from the contractual cash flows of the receivable. Net realizable
value is normally computed as the transaction price minus subsequent payments of principal and
minus any reduction directly or through the use of an allowance account for uncollectability or
impairment. In estimating the recoverable historical cost (net realizable value) of trade accounts
receivable, an entity considers sales discounts and doubtful accounts (Millan, 2019).
3231
Allowance for sales discounts (Valix et al., 2020)
If customers are granted cash discounts for prompt payment, then, conceptually estimates
of cash discounts on open accounts at the end of the period based on past experience shall be
made.
The adjustment to record the expected sales discount is:
Sales discount xx
Allowance for sales discount xx
The adjustment may be reversed at the beginning of the next period in order that
discounts can be charged normally to sales discount amount.
Accounting for bad debts
Companies that extend credit to customers know that it is unlikely that all customers will
fully pay their accounts. Bad debt expense is an inherent cost of granting credit. It is an operating
expense incurred to make sales. As a result, even when specific customer accounts haven’t been
proven uncollectible by the end of the reporting period, the expense should be matched with sales
revenue in the income statement for that period. Likewise, as it is not expected that all accounts
receivable will be collected, the balance sheet should report only the expected net realizable value
of the asset, that is, the amount of cash the company expects to actually collect from the
customers (Spiceland et al., 2011).
There are two methods of accounting for bad debts, namely, the allowance method and
the direct write-off method. As the name implies, an allowance is recognized for bad debts
expenses when the collectability of accounts becomes doubtful or questionable. This method
conforms to the concepts of accrual basis of accounting, matching, and conservatism in that, bad
debts expenses are recognized when they become probable so as not to overstate receivables.
When it becomes certain that accounts are uncollectible, or worthless as opposed to being merely
doubtful of collection, the accounts are written off. When accounts previously written-off are
32
subsequently recovered, the previous entry to record the write-off is reversed or reestablished
and the collection is recorded in the customary way (Millan, 2019).
The direct write-off method requires recognition of a bad debt loss only when the accounts
proved to be worthless or uncollectible. Worthless accounts are recorded by debiting bad debts
and crediting accounts receivable. If the accounts are only doubtful of collection, no adjustment
is necessary. Small businesses often use this approach because of its simplicity. The Bureau of
Internal Revenue recognizes only this method for income tax purposes. However, the direct write-
off method violates the matching principle because the bad debt loss is often recognized in later
accounting period than the period in which the sales was recognized. The direct write-off method
is not permitted under IFRS (Valix et al., 2020).
Allowance method vs. Direct write-off method
Comparative entries under the two methods of accounting for bad debts are illustrated
below.
Allowance Method Direct write off method
a. Collectability become doubtful

Bad debt expense xx No entry
Allowance for bad debts xx
b. Write-off
Allowance for bad debts xx Bad debt expense xx
Accounts receivable xx Accounts receivable xx
c. Recovery
Accounts receivable xx No entry
Allowance for bad debts xx
Cash xx Cash xx
Accounts receivable xx Gain on recovery xx
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Estimating doubtful accounts
Bad debt expense is recognized when loss becomes probable and can be measured
reliably. There are three methods of estimating doubtful accounts – percentage of net credit sales;
percentage of receivables, and aging of accounts receivable.
Percentage of net credit sales
Under this method, bad debt expense is computed by applying a percentage on

net credit sales during the period. The bad debt expense is computed without regard to
the beginning balance of the allowance for doubtful accounts and write-off and
recoveries recorded during the year. The percentage applied is determined based on
the entity’s past experience and careful analysis of the historical relationship between
credit sales and bad debts. This method favors the income statement in that a strict
adherence to the matching principle is attained. The ending balance of the allowance for
doubtful accounts is equal to the bad debt expense recognized for the period plus the
beginning balance in the allowance account minus write-offs plus recoveries (Millan,
2019).
The main argument against this method is that the accounts receivable may not
be shown at estimated realizable value because the allowance for doubtful account may prove
excessive or inadequate. Thus, it becomes necessary that from time to time
the accounts should be “aged” to ascertain the probable loss (Valix et al., 2020).
Percentage of receivable
Under this method, the required balance of allowance is computed by applying

a percentage on the ending balance of the receivables. The difference between the
required balance and the unadjusted carrying amount of the allowance for doubtful
accounts before recognizing the bad debt expense, represents the bad debt expense for
the period. This method favors the statement of financial position in that it provides a
reasonable estimate of the receivables’ net realizable value. However, it does not strictly
adhere to the concept of matching because bad debts are recognized based on the
34
ending balance of receivables and not directly on the sales revenue recognized in the
period. Meanwhile, recoveries may not be presented on the accounts receivable, since
the entries to record recovery involve a debiting and crediting accounts receivable.
Hence, the recovery of an accounts receivable previously written off does not actually
affect the balance of gross accounts receivable (Millan, 2019).
Aging of receivables
The aging of accounts receivable involves an analysis where the accounts are classified
into not due or past due. The allowance is determined by multiplying the total of each classification
by the rate or percent of loss experienced by the entity for each category. The major argument
for the use of this method is the more accurate and scientific computation of the allowance for
doubtful accounts. This method has the advantage of presenting fairly the accounts receivable
in the statement of financial position at net realizable value. The objection to the aging method is
that it violates the matching process. Moreover, this method could become prohibitively time
consuming if a large number of accounts are involved. The credit terms will determine whether
an account is past due. The phrase “past due” refers to the period beyond the maximum credit
term (Valix et al., 2020).
The aging of receivables method is a variation of the percentage of receivables method.

However, under the aging of receivables method, the required balance of the allowance for
doubtful accounts is computed by applying the various estimated percentages to the breakdown
of the receivables according to age. Bad debt expense is computed similar to percentage of
receivables method (Millan, 2019).
Debit balance in allowance for doubtful accounts
There may be instances when the allowance for doubtful accounts result to a debit
balance, such as when the amount needed to be written off exceeds the existing balance of the
allowance. When this occurs, the allowance for doubtful accounts is said to have an abnormal
balance. An adjusting entry is needed to eliminate the abnormal balance by debiting “bad debt
expense” and crediting “allowance for bad debts”. The debit balance is eliminated by increasing
the bad debts expense for the year (Millan, 2019).
35
Lesson 5. Notes Receivable
Notes receivable are claims supported by formal promises to pay usually in the form of
notes. A negotiable promissory note is an unconditional promise in writing made by one person
to another, signed by the maker, engaging to pay on demand or at a fixed determinable future
time a sum certain in money to order or to bearer. The note may be payable on demand or at a
definite future date. Standing alone, the term notes receivable represents only claims arising from
sale of merchandise or service in the ordinary course of business (Valix et al., 2020).
Although all notes contain an interest element because of the time value of money, entities
classify notes either as interest-bearing or non-interest bearing. Interest bearing notes have a
stated interest rate, that is, the contracted interest rate stated in the promissory note. Other terms
for stated interest rate include nominal rate, coupon rate, or face rate. Non-interest bearing notes
do not have a stated interest rate because they include the interest element as part of the face
amount. Present value computation is needed to separate the interest element from the principal
element (Millan, 2019).
Lesson 6. Initial Measurement of Notes Receivable

(Valix et al., 2019)
Conceptually, notes receivable shall be measured initially at present value. The present
value is the sum of all future cash flows discounted using the prevailing market rate of interest for
similar notes. The prevailing market rate of interest is actually the effective interest rate. However,
short-term notes receivable shall be measured at face value. Cash flows relating to short-term
notes receivable are not discounted because the effect of discounting is usually not material.
Interest-bearing notes receivable
The initial measurement of long-term notes will depend on whether the notes are
interest bearing or non-interest bearing.
Interest –bearing long-term notes receivable are measured at face value which is
actually the present value upon issuance.
Non-interest bearing notes receivable
36
Non-interest bearing long-term notes are measured at present value which is the
discounted value of the future cash flows using the effective interest rate.
Summary of Initial measurement of receivables (Millan, 2019)
Type of Receivable Initial measurement
1. Short-term receivables (trade receivables and Fair value plus transaction costs
and nontrade receivables collectible Fair value equal to:
within one year) a. face amount
b. present value
c. transaction price (with
allowed practical
expedient) for trade
receivables
2. Long-term receivables bearing reasonable interest Fair value plus transaction costs
rate Fair value is equal to face
amount
3. Long-term noninterest bearing receivables Fair value plus transaction costs

Fair value is equal to the
present value of future cash
flows from the receivable
4. Long-term receivables bearing unreasonable Fair value plus transaction costs

Interest rate (below market interest rate) Fair value equal to the
present value of future cash
flows from the receivable
37
Lesson 7. Subsequent Measurement of Notes Receivable
Subsequent to initial recognition, long-term notes receivable shall be measured at

amortized cost using the effective interest method. The amortized cost is the amount at which
the note receivable is measured initially:
a. Minus the principal payment;

b. Plus or minus cumulative amortization of any difference between the initial carrying
amount and the principal maturity amount; and
c. Minus reduction for impairment or uncollectability.
For long-term noninterest bearing notes receivable, the amortized cost is the present value
plus the amortization of the discount, or the face value minus the unamortized unearned interest
income (Valix et al., 2020).
The amortized cost of a receivable is determined using the effective interest method.
Effective interest method is a method of calculating the amortized cost of a financial asset or a
financial liability and of allocating the interest income or interest expense over the relevant
period.
Summary of subsequent measurement of receivables (Millan, 2019)
Type of receivable Subsequent measurement
1. Short-term receivables (trade receivables and If the initial measurement is:

nontrade receivables) a. face amount –the subsequent
measurement is recoverable
historical cost
b. present value – at amortized cost
c. transaction price- updated using
the principles of PFRS 15
2. Long-term receivables bearing reasonable Recoverable historical cost

Interest rate
38
3. Long-term noninterest bearing receivables At amortized cost
4. Long-term receivables bearing unreasonable At amortized cost

Interest rate
Lesson 8. Definition of Loans Receivable
A loan receivable is a financial asset arising from a loan granted by a bank or other
financial institution to a borrower or client (Valix et al., 2020).
Loan receivable is similar to a note receivable in that it is also a claim supported by a

formal promise to pay a certain sum of money at specific future date(s) usually in the form of a
promissory note. However, the term “loans receivable” is more appropriately used by entities
whose main operations involve lending of money, such as banks, financing companies, lending
companies, insurance companies, pawnshops, non-bank intermediaries like savings and loan
associations , credit cooperatives and the like (Millan, 2019).
Lesson 9. Initial and Subsequent Measurement of Loans

Receivable
Initial measurement (Millan, 2019)
Initial measurement of loans receivable shall be at fair market value, which shall be the
net investment or the net cash given-up on the loan transaction. More specifically, the net initial
investment shall be:
Principal amount of the loan xx

Add: Origination costs xx
Less: Origination fees (xx)
FMV of the loan/Net initial investment xx
Origination costs are costs that are directly attributed to the loan transaction such as
broker’s fees and commissions, professional fees like payment to lawyers for drafting debt
agreements or to accountants for assessment of any asset collateral on the loan.
39
Direct origination costs are initially added to the carrying amount of the loan and
subsequently amortized using the effective interest method. The subsequent amortization
decreases both the carrying amount of the loan and interest income.
Origination fees are origination costs chargeable to the debtor as per the debt agreement.
It can be an amount higher or lower than the actual origination cost incurred.
Origination fees are initially deducted from the carrying amount of the loan and
subsequently amortized using the effective interest method. The subsequent amortization
increases both the carrying amount of the loan and the interest income.
Subsequent measurement
Loans receivable shall be measured at the balance sheet date at amortized cost, which
shall be:
Initial amount recognized/FMV at initial recognition xx

Less: Principal collections (xx)
Less: Amortization of premium on loan or xx
Add: Amortization of discount on loan (xx)
Less: Impairment loss, if any xx
Amortized cost xx
Impairment loss on loans receivable shall be:

Carrying value of the Loans and Receivable (including accrued
Interest as a general rule) xx
Less: Present value of expected cash to be recovered using the
original effective interest rate (xx)
Impairment loss/Bad debt expense xx
40
Lesson 10. Receivable Financing
Receivable financing is the financial flexibility or capability of an entity to raise money out
of its receivables. During a business decline, an entity may find itself in a tight cash position
because sales decrease and customers are not paying their accounts on time. But the entity’s
current accounts and notes payable must continue to be paid if its credit standing is not to suffer.
The entity then would be in a financial distress as collections of receivable are delayed but cash
payments for obligations must be maintained. Under these circumstances, if the situation
becomes very critical, the entity may be forced to look for cash by financing its receivables. The
common forms of receivable financing are (a) pledge of accounts receivable, (b) assignment of
account receivable, (c) factoring of accounts receivable, and (d) discounting of notes receivable
Pledge of receivable (Hypothecation)
Under pledge transactions, receivables are used as collateral security for loans. Pledge
does not qualify as transfer of financial assets for derecognition because the pledger/borrower
retains control over the pledged receivables. Therefore, pledged receivables are neither
derecognized nor specifically identified from other receivables. Pledged is treated as secured
borrowing. Only the loan transaction is recorded. No entry is made for the pledged receivables.
Only a note disclosure is made for a pledge transaction (Millan, 2019).
The loan is recorded by debiting cash and discount on note payable if loan is discounted
and crediting note payable. The subsequent payment of the loan is recorded by debiting note
payable and crediting cash (Valix et al., 2020).
Assignment of Accounts receivable
Assignment is a formal form of pledge wherein the receivables assigned or used as

collateral security for borrowing are specifically identified and stated in the loan contract.
Assignment is a transfer of financial asset that does not normally qualify for derecognition
because the assignor usually retains control over the receivables transferred. However, an entry
is needed to specifically identify the assigned receivables from other receivables through the use
of the “Receivables- assigned” account. Assigned receivables are presented in the statement of
41
financial position as regular receivables, that is, included in “trade and other receivables”.
However, the “equity in the assigned receivables” is disclosed in the notes. Equity in the assigned
receivables is the carrying amount of receivable minus carrying amount of the related loan
payable. This is only a note disclosure. The assigned receivable and the related loan payable
are presented separately in the statement of financial position, and are not offset (Millan, 2019).
Assignment may be done either on a nonnotification basis or notification basis. When

accounts are assigned on a nonnotification basis, customers are not informed that their accounts
have been assigned. As a result, the customers continue to make payments to the assignor, who
in turn remits the collection to the assignee. On the other hand, when accounts are assigned on
a notification basis, customers are notified to make their payments directly to the assignee. The
assignee usually lends only a certain percentage of the face value of the accounts assigned
because the assigned accounts may not be fully realized by reason of such factors as sales
discounts, sales return and allowances and uncollectible accounts. The assignee usually charges
interest for the loan that it makes and requires a service or financing charge or commission on
the assignment agreement (Valix et al., 2019).
Factoring (Millan, 2019)
Instead of borrowing money and pledging or assigning the receivables as collateral

security, entities sometimes sell the receivables to a financial institution known as “factor “. This
is referred to as factoring. Factoring is usually done on a notification basis and either on a without
recourse or with recourse basis.
Factoring without recourse, the factor assumes the risk of uncollectability and absorbs any
credit losses. The transferor is not held liable in case the debtor fails to pay. Factoring on a
without recourse basis is an outright sale or ordinary sale of receivable, both in form and
substance. This type of factoring is a transfer of financial asset that qualifies derecognition. It is
treated as a sale and not a secured borrowing.
When receivables are factored on a with recourse basis, the transferor guarantees
payment to the factor in the event the debtor fails to pay. The transferor is held liable up to the
guaranteed amount in case the debtor fails to pay. This type of transaction is recorded using a
42
financial component approach because of the transferor’s continuing involvement with the
receivable.
Factor’s holdback
The factor usually retains a certain percentage of the transferred receivables to serve as
cushion for sales returns, discounts and allowances. The transferor records this amount under
Factor’s holdback” account or “Receivable from factor” account. The factor returns the “holdback”
to the transferor when the receivables are fully collected or when there are no further sales returns
and discounts expected (Millan, 2019).
Discounting of notes receivable (Millan, 2019)
Another form of receivable financing is discounting of notes receivable. In here, the holder
endorses the note to a bank in exchange for a maturity value of the note less a discount. At
maturity, the bank collects the maturity value of the note from the maker. If the note is discounted
on a without recourse basis, the holder is not liable in case the maker fails to pay. The note
discounted has essentially been sold outright, and therefore, derecognized. If the note is
discounted on a with recourse basis, the holder is held liable in case the maker fails to pay. The
note is discounted is not derecognized. The accounting is accounted for as either:
a. Conditional sale of note receivable – a contingent liability equal to the face amount of
the note discounted is disclosed only in the notes to financial statements
b. Secured borrowing – a liability equal to the face amount of the note discounted is
recognized on the discounting
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Assessment Task 2-1

1. Rapture Company had the following information for the current year relating to accounts
receivable:
Accounts receivable, January 1 1,300,000
Credit sales 5,400,000
Collections from customers, excluding recovery 4,750,000
Accounts written off 125,000
Collection of accounts written off in prior year,
customer credit was not reestablished 25,000
Estimated uncollectible receivables per aging
at December 31 165,000
What is the balance of accounts receivable before allowance for doubtful accounts on
December 31?
2. Jinx Company provided the following information for the current year in relation to
accounts receivable:
Accounts receivable, January 1 1,300,000

Sales return 150,000
Accounts written off 100,000
Collections from customers 5,000,000
Estimated future sales return on December 31 50,000
Estimated uncollectible accounts per aging at year-end 250,000
What amount should be reported as net realizable value of accounts receivable on

December 31?
3. At year-end, Harem Company reported accounts receivable of P8,200,000 with the following
analysis:
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Accounts known to be worthless 100,000
Advance payments on purchase orders 400,000
Advances to subsidiary 1,000,000
Customers' accounts reporting credit balances arising
from sales returns (600,000)
Trade accounts receivable 3,500,000
Subscription receivable due in 30 days 2,000,000
Trade installments receivable due 1 — 18 months,
including unearned finance charge of P50,000 850,000
Trade accounts receivable from officers, due currently 150,000
Trade accounts on which postdated checks are held and
no entries were made on receipt of checks 200,000
What is the correct balance of trade accounts receivable?
4. Gruesome Company provided the following information for the current year:
Allowance for doubtful accounts on January 1 200,000

Accounts receivable deemed worthless and written off 300,000
As a result of a review and aging of accounts receivable, it has been determined that an
allowance for doubtful accounts of P400,000 is needed on December 31.
What amount should be recorded as doubtful accounts expense for the current- year?
5. Namesake Company reported the following unadjusted balances at year-end:
Debit Credit
Accounts receivable 3,000,000
Allowance for doubtful accounts 10,000
Net credit sales 8,000,000
The entity estimated that 3% of the gross accounts receivable would become uncollectible.
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What amount should be, reported as doubtful accounts expense for the current year?
6. Bestial Company reported the following accounts at year-end before adjustments:
Debit Credit
Allowance for doubtful accounts 5,000
Sales 7,200,000
Sales return 200,000
The entity estimated uncollectible accounts receivable at 2% of net sales.
What amount of doubtful accounts expense should be reported for the current year?
7. Castaway Company provided the following information for the current year:
Allowance for doubtful accounts — January 1 200,000

Sales — all on credit 9,500,000
Sales discount 1,000,000
Sales returns and allowances 500,000
Accounts written off as uncollectible 100,000
Recovery of accounts written off 50,000
The entity recorded doubtful accounts expense at the rate of 5% of net credit sales.
What amount should be reported as allowance for doubtful accounts "on December 31?
8. On January 1, 2020, Savage Company sold goods to another entity. The buyer signed a
noninterest-bearing note requiring payment of P600, 000 annually for seven years. The
first payment was made on January 1, 2020.
The prevailing rate of interest for this type of note at date of issuance was 10%.
Periods Present value of 1 at 10% Present value of ordinary annuity of 1 at 10%

6 .56 4.36
7 .51 4.87
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What amount should be reported as sales revenue?
9. On December 31, 2020, Humility Company sold a machine to another entity in exchange
for a noninterest-bearing note requiring ten annual payments of P500,000. The buyer
made the first payment on December 31, 2020.
The market interest rate for similar notes at date of issuance was 8%.
Period Present value of 1 at 8% Present value of ordinary annuity of 1 at 8%

9 0.50 6.25
10 0.46 6.71
On December 31, 2020, what is the carrying amount of note receivable?
Solid Bank loaned P5,000,000 to a borrower on January 1, 2018. The terms of the loan require
principal payments of P 1,000,000 each year for 5 years plus interest at 8%.
The first principal and interest payment is due on January 1, 2019. The borrower made the
required payments during 2019 and 2020.
However, during 2020 the borrower began to experience financial difficulties, requiring the bank
to reassess the collectibility of the loan.
On December 31, 2020, the bank has determined that the remaining principal payment will be
collected as originally scheduled but the collection of the interest is unlikely.
The bank did not accrue the interest on December 31, 2020.
Present value of 1 at 8%
For one period 0.926
For two periods 0.857
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For three periods 0.794
10. What is the impairment loss for 2020?

11. What is the interest income for 2021?
12. What is the carrying amount of the loan receivable on December 31, 2021?
On December 1, 2020, Solvent Company assigned specific accounts receivable totaling

P5,000,000 as collateral on a P4,000,000 12% note from a certain bank. The entity will continue
to collect the assigned accounts receivable.
In addition to the interest on the note, the bank also charged a 5% finance fee deducted in
advance on the assigned accounts.
The December collections of assigned accounts receivable amounted to P 2,000,000 less cash
discount of P200,000.
On December 31, 2020, the entity remitted the collections to the bank in payment for the
interest accrued on December 31, 2020 and the note payable.
The entity accepted sales returns of P 100,000 on the assigned accounts and wrote off
assigned accounts 'of P300,000.
13. What amount of cash was received from the assignment of accounts receivable on
December 1, 2020?
14. What is the carrying amount of note payable on December 31, 2020?
15. What amount should be disclosed as the equity of Solvent Company in assigned
accounts on December 31, 2020?
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Foremost Company received from a customer a one-year, P500,000 note bearing annual
interest of 8%.
Alter holding the note for six months, the entity discounted the note at the bank at an effective
interest rate of 10%.
16. What amount of cash was received from the bank?

17. What is the loss on note receivable discounting?
18. On July 1, 2020, Jolly Company sold goods in exchange for P2,000,000, 8-rnonth,
noninterest- bearing note receivable.
At the time of the sale, the note's market rate of interest, was 12%. The note was
discounted at 10% on September 1, 2020.
What amount was received from the note receivable discounting?
Assessment Task 2– 2
1.Credit balances in accounts receivable are classified as
a. Current liabilities
b. Part of accounts payable
c. Long term liabilities
d. Deduction from accounts receivable
2. Which of the following does not change the balance in accounts receivable?
a. Return on credit sales
b. Collection from customers
c. Bad debt expense adjusting entry
d. Write off
3. In recording cash discounts related to accounts receivable, which is more
theoretically correct?
a. Net method c. Allowance method
b. Gross method d. All three methods are theoretically correct
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4. Which accounting principle primarily supports the use of allowance for doubtful
accounts?
a. Continuity principle
b. Full disclosure principle
c. Matching principle
d. Conservatism
5. Which method of recording bad debt loss is consistent with accrual accounting?
a. Allowance method
b. Direct write off method
c. Percent of sales method
d. Percent of accounts receivable method
6. Collection of accounts receivable previously written off results in an increase in cash
and an increase in
a. Accounts receivable
b. Allowance for doubtful accounts
c. Bad debt expense
d. Retained earnings
7. A method of estimating bad debts that focuses on the income statement rather than the
statement of financial position is the allowance method based on
a. Direct write off
b. Aging the trade accounts receivable
c. Credit sales
d. Trade accounts receivable
8. A method of estimating uncollectible accounts that emphasizes asset valuation rather

than income measurement is the allowance method based on
a. Aging of accounts receivable
b. Direct writeoff
c. Gross sales
d. Credit sales less returns and allowances
9. The advantage of relating the bad debt experience to accounts receivable is that this
approach
a. Gives a reasonably accurate measurement of accounts receivable in the statement
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of financial position.
b. Relates bad debt expense to the period of
c. Is the only generally accepted method for measuring accounts receivable.
d. Makes estimates of uncollectible accounts unnecessary.
10. When an accounts receivable aging schedule is prepared, a series of computations is
made to determine the estimated uncollectible accounts. The resulting amount from this
aging schedule
a. When added to the total accounts written off during the year is the desired credit
balance of the allowance for doubtful accounts at year-end
b. Is the amount of doubtful accounts expense for the year
c. Is the amount that should be added to the beginning allowance for doubtful
accounts to get the doubtful accounts expense for the year
d. Is the amount of desired credit balance of the allowance for doubtful accounts to be
reported at year-end
11. The estimate of uncollectible accounts receivable based on a percentage of sales
a. Emphasizes measurement of the net realizable value of accounts receivable.
b. Emphasizes measurement of bad debt expense.
c. Emphasizes measurement of total assets.
d. Is only acceptable for tax purposes.
12. On October 1 of the current year, an entity received a one-year note receivable bearing
interest at the market rate. The face amount of the note receivable and the entire amount
of the interest are due on September 30 of next year. The interest receivable on
December 31 of the current year would consist of an amount representing
a. Three months of accrued interest income
b. Nine months of accrued interest income
c. Twelve months of accrued interest income
d. The excess on October 1 of the present value of the note receivable over the face
amount
13. On July 1 of the current year, an entity obtained a two-year 8% note receivable for
services rendered. At that time, the market rate of interest was 10%. The face amount of
the note and the entire amount of interest are due on the date of maturity. Interest
receivable on December 31 of the current year is
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a. 5% of the face amount of the note
b. 4% of the face amount of the note
c. 5% of the present value of the note
d. 4% of the present value of the note
14. What is imputed interest?
a. interest based on the stated interest rate
b. Interest based on the implicit interest rate
c. Interest based on the average interest rate
d. Interest based on the bank prime interest rate
15. Accounting for the interest in a noninterest bearing note receivable is an example of what
aspect of accounting theory?
a. Relevance
b. Verifiability
c. Substance over form
d. Form over substance
16. On July 1 of the current year, an entity received a one-year note receivable bearing
interest at the market rate. The face amount of the note receivable and the entire
amount of the interest are due in one year. When the note receivable was recorded on
July 1, which of the following was debited?
a. Interest receivable
b. Unearned discount on note receivable
c. Interest receivable and unearned discount on note receivable
d. Neither interest receivable nor unearned discount on note receivable
17. On August 15, an entity sold goods for which it received a note bearing the market rate of
interest on that date. The four-month note was dated July 15. Note principal, together
with all interest, is due November 15. When the note was recorded on August 15, which
of the following accounts increased?
a. Unearned discount c. Prepaid interest
b. Interest receivable d. Interest revenue
18. Why would an entity factor accounts receivable?
a. To improve the quality of credit granting process
b. To limit its legal liability
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c. To accelerate access to amount collected
d. To comply with customer agreements
19. Which of the following is a method to generate cash from accounts receivable?
a. Assignment
b. Factoring
c. Assignment and factoring
d. Assignment, factoring and discounting
20. The practice of realizing cash from accounts receivable prior to maturity date is
widespread. Which term is not associated with this practice?
a. Hypothecation
b. Factoring
c. Defalcation
d. Pledging
21. When the accounts receivable are sold outright, the accounts receivable have been
a. Pledged c. Factored
b. Assigned d. Collateralized
22. Which of the following is used to account for probable sales discounts, sales returns and
sales allowances in a factoring arrangement?
a. Factor holdback
b. Recourse liability
c. Both factor holdback and recourse liability
d. Neither factor holdback nor recourse liability
23. If a note receivable is discounted with recourse
a. A contingent liability does not exist.
b. Note receivable discounted is credited.
c. Liability for note receivable discounted is credited.
d. Note receivable must be credited.
24. The note receivable discounted account' is reported as
a. Contra asset account for the proceeds from discounting
b. Contra asset account for the face amount of the note
c. Liability account for the proceeds from the discounting
d. Liability account for the face amount of the note
25. If a note receivable is discounted without recourse
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a. The contingent liability may be disclosed
b. Liability for note receivable discounted is credited
c. Note receivable is credited
d. The transaction is a secured borrowing
 Trade receivables are receivables arising from the sale of goods or services in the
ordinary course of business. Receivables arising from other sources are non-trade
receivables
 Trade receivables are classified as current assets when they are expected to be realized
in cash within the normal operating cycle or one year, whichever is longer. Non-trade
receivables are classified as current assets only when they are expected to be realized
in cash within one year.
 The adjusting entry to eliminate a credit balance in a receivable or a debit balance in a
payable increases total receivables.
 Trade receivables that do not have a significant financing component, are • measured at
their transaction price in accordance with PFRS 15. As a practical expedient, a trade
receivable may not be discounted if it is due within 1 year.
 Under FOB shipping point, ownership is transferred to the buyer upon shipment.
Therefore, sales and accounts receivable are recognized on shipment date.
 Under. FOB destination, ownership is transferred only upon receipt of the goods by the
buyer. Therefore, sales and accounts receivable are recognized only when the buyer
receives delivery of the goods.
 The allowance method of recognizing bad debts on accounts receivable is used for
financial reporting purposes.
 Doubtful accounts may be estimated using: (a) percentage of credit sales, (b)
percentage of receivables, or (c) aging of receivables.
 The amount computed under the percentage of credit sales method is the bad debts
expense for the period.
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 The amount computed under the percentage of receivables and aging methods is the
required balance of the allowance account.
 Receivables are initially recognized at fair value plus transaction costs. However, trade
receivables that do not have a significant financing component are measured at the
transaction price.
 Short-term receivables are initially measured at whichever of the following is most
appropriate: face amount, present value, or transaction price.
 Long-term receivables with reasonable interest rate are initially recognized at face
amount and subsequently measured at recoverable historical cost.
 Long-term noninterest-bearing receivables and Long-term receivables with
unreasonable interest rate are initially measured at present value and subsequently
measured at amortized cost.
 Stated interest rate (nominal rate, coupon rate, or face rate) is the rate appearing on the
face of an interest-bearing note.
 Effective interest rate (imputed rate of interest, current market rate or yield rate) is the
rate used in present value computations.
 A noninterest-bearing note has an unspecified principal and an unspecified interest.
These elements are separated through present value computations.
 Direct origination costs are added to, while origination fees are deducted from, the initial
carrying amount of a receivable.
 Impairment of financial assets is accounted for under the expected credit loss" model.
 Financial assets are derecognized when: (a) the contractual rights to the cash flows from
the financial asset expire; or (b) the financial assets are transferred and the transfer
qualifies for derecognition.
 Pledge transactions are disclosed only.
 Assignments are recorded by debiting "Accounts receivable assigned" and crediting
accounts receivable.
 Factoring on a without recourse basis is an outright sale.
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References
Bazley, J.D., Nikolai, L.A., & Jones,J.P., (2010). Intermediate Accounting (11th Ed.).
Canada:Rob Dewey
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MODULE 3
INVENTORIES
Introduction
Effective management and control of inventory is critical to the profitability and overall
performance of many companies. Management of inventory involves widespread tasks such as
making sure that a company has sufficient quantities of the right items , controlling shrinkage (the
reduction of inventory because of theft or loss), and evaluating the impact of interest costs related
to the debt financing of inventory. Company executives realize that effective inventory
management maybe the difference between success and failure (Bazley et al., 2010).
Proper accounting for inventories is essential for manufacturing, wholesale, and retail
companies (enterprises that earn revenue by selling goods). Inventory is usually one of the most
valuable assets listed in the balance sheet of these firms. Cost of goods sold –the expense
recorded when inventory is sold- typically is the largest expense in the income statement
(Spiceland et al., 2011).
In this module, we discuss the measurement and reporting issues of inventory,
specifically, describing the characteristics of inventories and its components, the application of
periodic and perpetual inventory system, valuing inventory using various alternative cost flow
assumptions and the use of estimation methods.
Learning Outcomes

1. Define inventories and identify the timing of its recognition;
2. Compare the entries under the periodic inventory system and perpetual inventory system;
3. Account for the measurement of inventories applying the cost formulas;
4. Account for inventory write-down ; and
5. Apply the methods of inventory estimation.
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Lesson 1. Definition of Inventories
Inventories are assets held for sale in the ordinary course of business, in the process of
production for such sale or in the form of materials or supplies to be consumed in the production
process or in the rendering of services (Valix et al., 2020).
Inventories include (a) merchandise purchased by a trading entity and held for resale, (b)
land and other property held for sale in the ordinary course of business, and (c) finished goods
undergoing production, and raw materials and supplies awaiting in the production process by a
manufacturing entity (Millan, 2019).
A company may use several different accounts to classify inventory, depending on its
business. A merchandising company, whether wholesale or retail, purchases goods for resale
and does not alter the physical form. Consequently, it needs only type of inventory account
usually called merchandise inventory. A manufacturing company does change the physical form
of the goods and typically uses three inventory accounts, usually called raw materials inventory,
work in process inventory, and finished goods inventory. A service company generally does not
have a physical inventory. However, it often has an “inventory” of services that it has provided
but not yet billed (Bazley et al., 2010).
Lesson 2. Recognition of Inventories
Inventories are recognized when they meet the definition of inventory and they qualify for
recognition of assets, such as when legal title is obtained by the buyer from the seller. Legal title
normally passes when possession over the goods is transferred. However, there may be cases
where the transfer of control (ownership) does not coincide with the transfer of physical
possession. Control may be transferred even before or after the transfer of physical possession.
Regardless of location, and entity shall report in its financial statements all inventories over which
it holds legal title to or obtained control of the related economic benefits. In this regard, proper
consideration should be given to (Millan, 2019):
a. Goods in transit
b. Consigned goods
c. Inventory financing agreements
d. Sale with unusual right of return
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e. Sale on trial or sale on approval
f. Installment sale
g. Bill and hold sale
h. Lay away sale
Goods in transit
Goods are often shipped under one of two alternatives: FOB (free on board) shipping point
or FOB destination. When goods are in transit at the end of the accounting period, the terms of
shipment determine whether the seller or the buyer includes them in its inventory. If the goods
are shipped FOB shipping point, control of and legal title to the goods is transferred at the shipping
point when the seller delivers them to the buyer, or to a transportation company that is acting as
an agent to the buyer. The buyer has an economic control and includes those goods in its
inventory, and the seller excludes them. If goods are shipped FOB destination, control of and
legal title to the goods is not transferred until the goods are delivered to the buyer’s destination.
The seller has economic control and includes those goods in its inventory, and the buyer excludes
them (Bazley et al., 2010).
Consigned goods
Sometimes, a company arranges for another company to sell its product under
consignment. The goods are physically transferred to the other company (the consignee), but
the transferor (the consignor) retains legal title. Because risk is retained by the consignor, the sale
is not complete (revenue is not recognized) until an eventual sale to a third party occurs. As a
result, goods held on consignment generally are not included in the consignee’s inventory. While
in stock, they belong to the consignor and should be included in inventory of the consignor even
though not in the company’s physical possession (Spiceland et al., 2011).
Inventory financing agreements
In product financing agreement, the company “sells” the inventory to another company.
Then, in a related transaction, it agrees to repurchase the inventory back from the other company
at specified prices over specified periods. Typically, the inventory is not delivered to the “buyer”
59
and is repurchased at a higher price, the difference being an interest charge. When the “sale”
under the product financing arrangement occurs, the transaction is similar to borrowing cash with
the inventory being used as collateral, sometimes referred to a “parking” transaction. As a result
of not recording a sale, the inventory also remains in the accounts at cost (Bazley et al., 2010).
In pledge of inventory, a borrower uses its inventory as collateral security for a loan. This
arrangement does not result to the transfer or control over the asset, whereas, in loan of inventory,
an entity borrows inventory from another entity to be replaced with the same kind of inventory,
This arrangement results to transfer of control over the asset. Accordingly, the borrower includes
the loaned goods in its inventory (Millan, 2019).
Sale with unusual right of return
The buyer normally recognizes goods purchased under a sale with right of return at the
time of sale, unless the goods purchased does not qualify for recognition as asset. The buyer
does not recognize any inventory when the buyer assesses that no economic benefits will be
derived from the goods, such as when they are defective or unsalable and the buyer intends to
return the goods to the seller within the time limit allowed under the sale agreement (Millan, 2019).
Sale on trial
Under a sale on trial, a seller allows a prospective customer to use a good for a given
period of time. At the end of that time, if the prospective customer is satisfied with the good, he
purchases it, if not, he returns it to the seller. Under this type of arrangement, the legal title over
the good does not pass to the prospective customer until he approves it and purchase s it.
Accordingly, the prospective customer does not include the good in his inventory until he
purchases it (Millan, 2019).
Installment sale
Installment sales involve a financing agreement whereby the customer signs a contract,
makes a small down payment, and agrees to make periodic payments over an extended period,
often several years. The customer accepts possession of the item when the contract is signed
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(thereby enjoying its use during the payment period), while the seller retains legal title until the
payments are complete (Bazley et al., 2010).
Title of the goods is retained by the seller for reason of assuring the collectability of the
account, but nevertheless, such goods are included in the customer’s inventory and excluded
from the seller’s account.
Bill and hold arrangement
Economic control may also transfer before or after physical possession transfer. For
example, suppose the buyer requests that the seller holds the goods to be delivered later, and
the goods are segregated from the seller’s other inventory so that the risk of ownership has
transferred to the buyer. In this case, control has passed, and the seller should exclude the goods
from the inventory and the buyer should include them (Bazley et al, 2010).
Lay away sale
Lay away sale is a type of sale in which goods are delivered only when the buyer makes
the final payment in a series of installments. This is different from a regular installment sale
wherein goods are delivered at the time of sale. The goods sold under a lay away sale are
included in the seller’s inventory until the goods are delivered to the buyer. Delivery is made after
the final installment payment is paid. However, when significant payments have already been
made, the goods may be included in the buyer’s inventory, provided delivery is probable (Millan,
2019).
Inventories are generally classified as current assets. The inventories shall be presented
as one line item in the statement of financial position but the details of the inventories shall be
disclosed in the notes to financial statements (Valix et al., 2020).
A company reports the cost of inventory that it sold during the period as cost of goods sold
on its income statement, and deducts the amount from net sales to determine its gross profit. A
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company reports the cash it paid to purchase or produce its inventory during the period in its
operating activities section in the statement of cash flow. The inventory cost that a company
reports on its statement of financial position at the end of the period is the final amount that results
from a series of steps (Bazley et al., 2010).
Lesson 4. Accounting for Inventories
A company may account for inventory quantities using either the perpetual system or the
periodic system.
A company using a perpetual keeps a continuous record of the physical quantities in its
inventory. It records the purchase, or the production, and use of each item of inventory in detailed
subsidiary records, although it often only records units without including costs. A perpetual system
allows management to plan and control the inventory and avoid stock-outs. When a company
uses the perpetual system, it should take a physical count at least once a year to confirm the
balance in the inventory account. Any difference between the physical count and the inventory
count balance results from errors in recording, shrinkage, waste, breakage, theft, and other
causes. The company adjusts its inventory account and also increases cost of goods sold (or
recognizes a loss) for the cost of difference in the two quantities so that the perpetual records are
in agreement with the physical count (Bazley et al., 2010).
The system is aptly termed perpetual because the account “inventory” is continually
adjusted for each change in inventory, whether it is caused by a purchase, a sale, or a return of
merchandise by the company to its supplier ( a purchase return for the buyer, a sales return for
the seller). The cost of goods sold account, along with the inventory account is adjusted each
time goods are sold or are returned by a customer (Spiceland et al., 2011).
A company using a periodic system does not maintain a continuous record of the physical
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quantities (or costs) of inventory on hand. It takes physical count periodically, which should be at
least once a year and generally at the end of the year. The company determines the cost of the
ending inventory by assigning costs to the physical quantities on hand based on the cost flow
assumptions it is using. Then it calculates the cost of goods sold by subtracting the ending
inventory from the cost of goods available for sale. The cost of goods available for sale is the
sum of the beginning inventory and either the net purchases for a merchandising company or the
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costs of units produced for the period for a manufacturing company. This system is adequate for
a relatively low-cost inventory items, particularly when the costs of perpetual inventory system are
likely to be greater than its benefits. In a periodic inventory system, a company typically does not
record (debit) the costs of the purchases of inventory in an inventory account, rather, it records
(debits) costs of purchases of inventory in a temporary account, Purchases , while the beginning
inventory cost remains in the inventory account (Bazley et al., 2010).
Lesson 5. Measurement of Inventories
The cost of inventory is the price paid or consideration given to acquire it. Thus, inventory
costs includes costs directly or indirectly incurred in bringing an item to its existing condition and
location. For each item of inventory purchased or manufactured, a company must make a
decision as to whether or not each cost meets this definition. The cost of purchased inventory
should include the purchase price ( net of purchases discounts) plus payments directly related to
the inventory, such as freight, receiving, unpacking, inspecting, storage, insurance, and other
applicable taxes (Bazley et al., 2010).
Purchase cost does not include refundable or recoverable taxes. For example, Value-
added taxes (VAT) paid by VAT taxpayers are not included as cost of inventory but rather
recognized as “Input Vat” and treated as a reduction to VAT payments to the BIR (Millan, 2019).
When a company manufactures inventory, it adds the product cost that are directly or
indirectly incurred in the production activity to the cost of inventory. The costs that it includes are
acquisition and production costs including manufacturing overhead (Bazley et al., 2010).
The following are excluded from the cost of inventories and are expenses in the period in
which they are incurred (Millan, 2019):
a. Abnormal amounts of wasted materials, labor or other production costs;
b. Selling costs – refers to advertising and promotion costs and delivery expense or
freight-out;
c. Administrative overhead s that do not contribute to bringing inventories to their
present location and condition; and
d. Storage costs, unless these costs are necessary in the production process before a
further production stage.
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Lesson 6. Cost Formulas
A company typically starts an accounting period with some units in the beginning inventory
and then purchases or produces additional units during the period. Together, these are the goods
available for sale, which the company then either sells or retains in its ending inventory. For
financial statement purposes, the company must attach costs to these units. Cost flow
assumptions are important for two reasons. First, a company has inventories at each year-end. If
there were none, all the cost of goods available for sale would be transferred to cost of goods
sold. Second, the cost of purchases and production change during the year. If these costs did
not change, all units would have the same cost. Therefore, alternative cost flow assumptions
would not affect the cost of goods sold or the ending inventory (Bazley et al., 2010).
PAS 2, paragraph 25, expressly provides that the cost of inventories shall be by using
either First-in, First-out (FIFO) or the weighted average method (Valix et al., 2020).
First-In, First-Out
Under the FIFO cost flow assumption, a company included the earliest costs incurred in
the cost of goods sold, and includes the most recent costs in the ending inventory. In other words,
the first costs incurred are the first transferred to cost of goods sold. Consequently, the ending
inventory consists of the most recent costs incurred. Therefore, in the period of rising costs, FIFO
produces a lower cost of goods sold amount based on the older and lower costs. However, the
ending inventory is based on the most recent and higher costs. Note that the ending inventory
and the cost of goods sold under both the periodic and perpetual systems are identical; this is
always true for the FIFO cost flow assumption because the most recent costs incurred always are
included in the ending inventory (Bazley et al., 2010).
Average cost (Bazley et al., 2010)
Under the average cost flow assumption, a company considers all the costs and units to
be combined so the no individual units or costs are identified. When a company uses the periodic
inventory system, the average cost method is known as the weighted average. The company
calculates the cost of the units for the period based on the cost of the beginning inventory and the
average cost of the units purchased or manufactured, weighted according to the number of units
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at each cost. In other words, under the weighted average method, the average cost per unit for
the period is the cost of goods available for sale divided by the number of units available for sale.
The company uses this average cost for both its ending inventory and the cost of goods sold.
When a company uses the average cost method under a perpetual inventory system (for
costs as well as physical quantities), the same principles are applied. But it is known as moving
average method because a new weighted average
item stocked be specifically marked so that its unit cost can be identified at any time. When
the cost must be calculated after each purchase. The new weighted average is computed in the
same way as in the weighted average method. That is, under the moving average method, the
average cost per unit is the cost of units available for sale after the purchase divided by the
number of units available for sale at that time. This average cost is used to determine the cost of
each sale made until the next purchase, when a new average cost is calculated.
Specific Identification
The specific identification method requires that each items involved are large or
expensive, or only small quantities are handled, it may be feasible to tag or number each item
when purchased or manufactured. This method makes it possible to identify at date of sale the
specific unit cost of each item sold and each item remaining in inventory. Thus, the specific
identification method relates the cost flow directly with the specific flow of physical goods (Morton
et al., 1992).
The specific identification method, however, is not feasible for many type of products either
because items are not uniquely identifiable or because it is too costly to match a specific purchase
price with each item sold or each item remaining in the inventory(Spiceland et al., 2011).
LIFO (Last-in, First-out)
PAS 2 prohibits the use of LIFO. This illustration only aims to show how LIFO is applied
for the purpose of comparing it with the FIFO formula. Under LIFO, items of inventory that were
purchased or produced first are sold last. Consequently, the cost of ending inventory is based on
the cost of the beginning inventory and earliest purchases (Millan, 2019).
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The LIFO favors the income statement because there is matching of current cost against
current revenue, the cost of goods sold being expressed in terms of current or recent cost. The
objection of the LIFO is that the inventory is stated at earlier or older prices and therefore there
may be a significant lag between inventory valuation and current replacement cost. Moreover,
the use of LIFO permits income manipulation, such as by making year-end purchases designed
to preserve existing inventory layers. At times, these purchases may not even be in the best
economic interest of the entity (Valix et al., 2020).
Lesson 7. Net Realizable Value
PAS 2, paragraph 9, provides that inventories shall be measured at the lower of cost and
net realizable value. The measurement of inventory at the lower of cost and net realizable value
is now known as LCNRV. Net realizable value is the estimated selling price in the ordinary course
of business less the estimated cost of completion and the estimated cost of disposal. The practice
of writing inventories down below cost to net realizable value is consistent with the view that
assets shall not be carried in excess of amounts expected to be realized from their sale or use
Write-downs of inventories are usually carried out on an item by item basis, although in
some circumstances, it may be appropriate to group similar items. It is not appropriate to write
down inventories on the basis of their classification, that is, finished goods or all inventories of an
operating segment. If the cost of an inventory exceeds its NRV , the inventory is written down to
NRV, the lower amount. The excess of cost over NRV represents the amount of write-down. If
the cost of an inventory is lower than its NRV, no write-down is necessary. Write-downs of
inventories are normally charged to cost of good sold. However, material write-downs and those
that arise from abnormal losses, such as theft, obsolescence, and casualties are charged to loss
(Millan, 2019).
Lesson 8. Inventory Estimation
Two commonly used methods of estimating inventory costs are (1) gross profit method
and (2) the retail inventory method.
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Gross Profit Method
A company uses the gross profit method to estimate the cost of the inventory by applying
the gross profit rate from previous period(s) to the net sales of the current period. It may be used
in the following situations:
1. To determine the cost of inventory at the end of an interim period without taking
physical count;
2. For the internal or external auditor to check the reasonableness of an inventory cost
developed from a physical inventory or perpetual inventory system;
3. To estimate the cost of inventory that is destroyed by a casualty, such as fire;
4. To estimate the cost of inventory from incomplete records; and
5. To develop a budget of cost of goods sold and ending inventory from a sales budget
(Bazley et al., 2010)
Sales allowance and sales discount
Sales allowance and sales discount are ignored, that is, not deducted from sales. The
reason is that while these items decrease the amount of sales, they do not affect the physical
volume of goods sold. Sales allowance and sales discount do not increase the physical inventory
of goods, unlike in sales returns where there is an actual addition to goods on hand (Valix et al.,
2020).
Application of the gross profit method
Estimating the ending inventory by the gross profit method requires the following basic
steps (Morton et al., 1992):
1. Estimate the gross profit rate on the basis of prior year’s sales: (sales – cost of goods
sold) divided by sales;
2. Compute total cost of goods available for sale in the usual manner (beginning
inventory plus purchases), based on the actual data provided by the accounts;
3. Compute the estimated gross profit by multiplying sales by the estimated gross profit
rate;
4. Compute cost of goods sold by subtracting the computed gross profit from sales; and
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5. Compute ending inventory by subtracting the computed cost of goods sold from the
cost of goods available for sale.
The gross profit ratio is by definition, a percentage of sales. Sometimes, though, the gross
profit is stated as a percentage of cost instead. In that case, it is referred to as the markup on
2
cost. For instance, a 66 % markup on cost is equivalent to a gross profit ratio of 40%. Here’s why:
3
A gross profit ratio of 40% can be formulated as:

Sales = Cost + Gross Profit
100% = 60% + 40%
Now expressing gross profit as a percentage of cost we get:

Gross profit% ÷ Cost % = Gross profit as a % of cost
2
40% ÷ 60% = 66 %
3
Conversely, gross profit as a percentage of cost can be converted to gross profit as a

percentage of sales (the gross profit ratio) as follows:
Gross profit as a % of cost

Gross profit as a % of sales =
1+Gross profit as a % of cost
2
663 %
2 = 40%
1+663%
Be careful to note which way the percentage is being stated. If stated as a markup on cost, it can
be converted to the gross profit ratio, and the gross profit method can be applied the usual way
(Spiceland et al., 2011).
Retail inventory method (Millan, 2019)
The retail inventory method is used widely to estimate the cost of inventory when there is
a consistent pattern between the cost of a company’s purchases and selling prices. This pattern
may exist either for the whole company or for identifiable departments within the company. This
method is best used by retail stores where prices often are set based on a consistent markup
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above cost and the accounting systems are based on retail values rather than costs. The retail
inventory method requires a company to use the following information:
a. beginning inventory at cost and retail
b. goods purchased at cost and retail
c. changes in selling price resulting from additional markups and markdowns
d. sales
The typical retail store makes many changes in selling prices after setting the original
price. The following terms describe these changes:
a. Markup – original markup from cost to the first selling price
b. Additional markup – an increase above the original sales price
c. Markup cancellation – a reduction in the selling price after there has been an
additional markup. The markup cancellation cannot be greater than the additional
markup.
d. Net markup – total additional markups less total markup cancellations
e. Markdown – a decrease below the original sales price
f. Markdown cancellation – an increase in the selling price after there has been a
markdown. The markdown cancellation cannot be greater than the markdown.
g. Net markdown – total markdowns less total markdown cancellation
To illustrate the meaning of these terms, suppose that a company purchased an item for
P6 and initially priced the item to sell for P10. The markup is P4. If the company subsequently
increases the selling price to P12, there is an additional markup of P2. If it then lowers the
selling price to P7, there is a markup cancellation of P2 and a markdown of P3. If the company
raises the selling price to P8, there is a markdown cancellation of P1. The net markup is zero
(P2-P2), and the net markdown is P2 (P3-P1) (Bazley et al., 2010).
Application of the Retail Method
The retail method is applied using either the average cost method and FIFO cost
method. Under the average cost method, the total goods available for sale at cost (beginning
inventory plus net purchases) is determined and divided by the total goods available for sale at
sales price to come up with the cost ratio. The cost ratio is then multiplied with net sales to
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compute for the cost of goods sold or multiplied with the ending inventory at sales price or at
retail to compute for the ending inventory at cost.
Cost of goods sold = Net sales x Cost ratio
Ending inventory at cost = Ending inventory at retail x Cost ratio
When determining total goods available for sale at sales price, net markups are added
while net markdowns are deducted. PAS 2 requires that the cost ratio to be used in estimating
inventory under the retail method should be marked down below its original price.
The application of the FIFO cost method is very similar to the application of the average
cost method. The only difference lies on the computation of the cost ratio. Under the FIFO cost
method, the beginning inventories at cost and at retail are simply excluded from TGAS when
computing for the cost ratio.
TGAS at cost less beginning inventory at cost

Cost ratio =
TGAS at retail less beginning inventory at retail
Assessment Task 3-1

1. Empty Company reported inventory on December 31, 2020 at P2,500,000 based on physical
count priced at cost and before any necessary adjustment for the following:
 Merchandise costing P100,000, shipped FOB shipping point from a vendor on

December 30, 2020 was received and recorded on January 5, 2021.
 Goods in the shipping area were excluded from inventory although shipment was not
made until January 5, 2021.
The goods billed to the customer FOB shipping point on December 30, 2020 had a cost
of P400,000.
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What amount should be reported as inventory on December 31, 2020?
2. Dignity Company had the following consignment transactions during the current year:
Inventory shipped on consignment to a consignee 600,000
Freight paid by Dignity Company 50,000
Inventory received on consignment from a consignor 800,000
Freight paid by consignor 50,000
No sales of consigned goods were made during the current year.
What amount should be reported as consigned inventory at year-end?
3. Kindness Company regularly buys sweaters and is allowed a trade discount of 20% and 10%.
The entity made a purchase on March 20 and received an invoice with a list price of
P900,000, a freight charge of P50,000, and payment terms of net 30 days.
What is the cost of the purchase?
4. On June 1, Compassion Company sold merchandise with a list price of P 1,000,000 to a

customer.
The entity allowed trade discounts of 20% and 10%. Credit terms were 5 / 10; n/30 and the
sale was made FOB shipping point.
The entity prepaid P50,000 of delivery cost for the customer as an accommodation. The
customer paid in full on June 11.
What amount is received from the customer as full remittance?
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5. Massive Company provided the following information for the current year:
Units Unit cost Total cost

January 1 Inventory on hand 200 1,500 300,000
April 3 Purchase 300 1,750 525,000
October 1 Purchase 500 2,000 1,000,000
The entity sold 400 units on June 25 and 400 on December 10. What is the weighted average
cost of the inventory at year-end?
6. Jailbird Company provided the following data about the inventory for the month of January:
Units Unit cost Total cost
Jan. 1 Beginning 16,000 140 2,240,000
5 Purchase 4,000 150 600,000
10 Sale 15,000
15 Purchase 20,000 160 3,200,000
16 Purchase return 1,000 160 160,000
25 Sale 8,000
26 Sale return 4,000
31, Purchase 30,000 150 4,500,000
What is the moving average cost of the inventory on January 31?
7. At the beginning of the current year, Diamond Company purchased a tract of land for
P 12,000,000.
The entity incurred additional cost of P3,000,000 during the remainder of the year in
subdividing the land for sale.
Of the tract acreage, 70% was subdivided into residential lots and 30% was conveyed to the
city for roads and a park.
Lot class Number of lots Sale price per lot
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A 100 240,000
B 100 160,000
C 200 100,000
Using the relative sales value method, what amount of cost should be allocated to Class A
lots?
8. Elixir Company bought a 10-hectare land in Novaliches to be improved, subdivided into lots
and eventually sold. The purchase price of the land was P5,800,000.
Taxes and documentation expenses on the transfer of the property amounted to
Lot class Number of lots Selling price per lot Total clearing cost
A 10 100,000 None
B 20 80,000 100,000
C 40 70,000 300,000
D 50 60,000 800,000
What amount should be allocated as total cost of Class B lots under the relative sales price
method?
9. Based on a physical inventory at year-end, Cherry Company determined the chocolate

inventory on a FIFO basis at P2,600,000 with a replacement cost of P2,500,000.
Cherry Company estimated that, after further processing costs of P 1,200,000, the chocolate
could be sold as finished candy bars for P4,000,000. The normal profit margin is 10% of
sales.
What amount should be reported as chocolate inventory at year-end?
Items 10 to 11 are based on the following information
Gatekeeper Company has two products with cost and selling price as follows:
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Product X Product Y
Selling price 2,000,000 3,000,000
Estimated selling cost 600,000 700,000
Materials and conversion cost 1,500,000 1,800,000
General administration cost 300,000 800,000
At year-end, the manufacture of inventory has been completed but no selling cost has yet been
incurred.
10. Under LCNRV by individual item, the inventory shall be measured at what amount?
11. Under LCNRV by total, the inventory shall be measured at what amount?
12. Gem Company measured inventory at the lower of cost and net realizable value. Data
regarding the items in the inventory are:
Markers Pens Highlighters
Historical cost 240,000 188,000 300,000
Selling price 360,000 250,000 360,000
Estimated cost to complete 48,000 50,000 68,000
Replacement cost 208,000 168,000 318,000
Normal profit margin as a
percentage selling price 25% 25% 10%
What is the measurement of the inventory?
13. Fearless Company began operations at the beginning of current year. The following
information is available for the current year:
Total merchandise purchases 7,000,000

Ending inventory 1,400,000
Collections from customers 4,000,000
All merchandise is marked to sell at 40% above cost. All sales are credit sales and all
accounts are collectible.
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What is the balance of accounts receivable at year-end?
14. On September 30, 2020, a fire destroyed most of the merchandise inventory of Paragon
Company.
All goods were completely destroyed except for partially damaged goods that normally sell
for P 100,000 and that had an estimated net realizable value of P25,000 and undamaged
goods that normally sell for P60,000.
Inventory - January 1, 2020 660,000

Net purchases, January 1 through September 30, 2020 4,240,000
Net sales, January 1 through September 30, 2020 5,600,000
2019 2018 2017

Net sales 5,000,000 3,000,000 1,000,000
Cost of goods sold 3,840,000 2,200,000 710,000
What is the amount of fire loss to be recognized on September 30, 2020?
15. Fairy Company provided the following information:
2019 2020
Sales 7,500,000 4,500,000
Beginning inventory 1,260,000
Purchases 6,450,000 3,180,000
Freight in 350,000 220,000
Purchase discounts 90,000 45,000
Purchase returns 120,000 40,000
Purchase allowances 20,000 15,000
Ending inventory 2,355,000
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What is the inventory on December 31, 2020?
16. Wholesome Company sold merchandise on a consignment basis to dealers. The gross
profit was 25% above cost.
The dealer is paid a 10% commission of the sales price for all sales made. All dealer sales
are made on a cash basis.
The following consignment activities occurred during the current year:
Manufacturing cost of goods shipped on consignment 8,800,000

Sales price of merchandise sold by dealers 9,600,000
Payments remitted by dealers after deducting commission 6,300,000
What was the gross profit on consignment sales?
17. Sublime Company showed the following information at year-end:
Cost Retail
Beginning inventory 280,000 700,000
Sales 5,000,000
Purchases 2,480,000 5,160,000
Freight in 75,000
Markup 500,000
Markup cancelation 60,000
Markdown 250,000
Markdown cancelation 50,000
Estimated normal shrinkage is 2% of sales.
The entity used the conservative retail inventory method in estimating the value of
inventory.
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What is the estimated cost of ending inventory?
18. Abscond Company used the retail inventory method to estimate inventory for interim
statement purposes.
The entity provided the following information for the current par:
Cost Retail
Beginning inventory 700,000 1,000,000
Purchases 4,100,000 6,300,000
Markup 700,000
Markdown 500,000
Sales 5,900,000
Normal shoplifting losses 100,000
Under the average cost approach, what is the estimated cost of ending inventory?
19. Bouquet Company used the conventional retail inventory method to account for inventory.
Cost Retail
Beginning inventory and purchases 6,000,000 9,200,000
Net markup 400,000
Net markdown 600,000
Sales 7,800,000
What amount should be reported as cost of goods sold?
20. Airborne Company used the average cost retail inventory method.
Cost Retail
Beginning inventory 1,650,000 2,200,000
Net purchases 3,725,000 4,950,000
Department transfer – credit 200,000 300,000
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Net markup 150,000
Inventory shortage – sales price 100,000
Sales, including gales of P400,000 of items which 4,000,000
were marked down from P500,000
What is the estimated cost of ending inventory?
Assessment Task 3-2

1. Which of the following should not be taken into account when determining the cost of
inventory?
a. Storage costs of part-finished goods
b. Trade discounts
c. Recoverable purchase taxes
d. Import duties on shipping of inventory inward
2. Which of the following costs of conversion cannot be included in cost of inventory?
a. Cost of direct labor
b. Factory rent and utilities
c. Salaries of sales staff
d. Factory overhead based on normal capacity
3. Which of the following should be taken into account when determining the cost of inventory?
a. Storage cost of part-finished goods
b. Abnormal freight in
c. Recoverable purchase tax
d. Interest on inventory loan
4. A property developer must classify properties that it holds for sale in the ordinary course of
business as
a. Inventory
b. Property, plant and equipment
c. Financial asset
d. Investment property
5. Factory supplies to be consumed in the production process are reported as
a. Inventory
b. Property, plant and equipment
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c. Investment property
d. Prepaid expenses
6. 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
7. Which of the following should not be reported as inventory?
a. Land acquired for resale by a real estate firm
b. Shares and bonds held for resale by a brokerage firm
c. Partially completed goods held by a manufacturing entity
d. Machinery acquired by a manufacturing entity
8. When determining the cost of an inventory, which of the following should not be included?
a. Interest on loan obtained to purchase the inventory
b. Commission paid when inventory is purchased
c. Labor cost of the inventory when manufactured
d. Depreciation of plant equipment used in manufacturing
9. IFRS prohibits which cost flow assumption?
a. LIFO
b. Specific identification
c. Weighted average
d. Any of these cost flow assumptions is allowed
10. What is the inventory pricing procedure in which the oldest costs rarely have an effect on the
ending inventory?
a. FIFO
b. LIFO
c. Specific identification
d. Weighted average
11. In a period of falling prices which inventory method generally provides the lowest amount of
ending inventory?
a. Weighted average
b. FIFO
c. Moving average
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d. Specific identification
12. Which inventory cost flow assumption would consistently result in the highest income in a
period of inflation?
a. FIFO
b. LIFO
c. Weighted average
13. The costing of inventory must be deferred until the end of reporting period under which of
the following method of inventory valuation?
a. Moving average
b. Weighted average
c. LIFO perpetual
d. FIFO perpetual
14. Cost of goods sold is the same under periodic system and perpetual system using
a. FIFO
b. LIFO
c. Weighted average
15. Net realizable value is
a. Current replacement cost
b. Estimated selling price
c. Expected selling price less expected cost to complete and cost of disposal
d. Estimated selling price less estimated cost to complete and cost of disposal
16. Inventories are usually written down to net realizable value
a. Item by item
b. By classification
c. By total
d. By segment
17. LCNRV is best described as the
a. Reporting of a loss when there is a decrease in the future utility below the original cost.
b. Method of determining cost of goods sold.
c. Assumption to determine inventory flow.
d. Change in inventory value to net realizable value.
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18. LCNRV of inventory
a. Is always either the net realizable value or cost.
b. Must be equal to net realizable value.
c. May sometimes be less than net realizable value.
d. Must be equal to estimated selling price less cost to complete and cost of disposal.
19. Which statement is true regarding inventory writedown and reversal of writedown?
a. Reversal of inventory writedown is prohibited.
b. Separate reporting of reversal of inventory writedown is required.
c. An entity is required to record an inventory writedown in a separate loss account.
d. All of the choices are correct.
20. The gross profit method assumes that
a. The amount of gross profit is the same as in prior years.
b. Sales and cost of goods sold did not change.
c. Inventory values have not increased.
d. The relationship between selling price and cost of goods sold is similar in prior years.
21. The gross profit method is not valid when
a. There is substantial increase in the quantity of inventory.
b. There is substantial increase in the cost of inventory.
c. The gross margin percentage changes significantly.
d. All ending inventory is destroyed by fire
22. Which statement is not valid about the gross profit method?
a. It may be used by auditors.
b. It is an acceptable accounting procedure.
c. It may be used for interim statements.
d. It may be used for annual statements.
23. Which is not a basic assumption of the gross profit method?
a. The beginning inventory plus net purchases equals total goods to be accounted for.
b. Goods not sold must be on hand.
c. The sales reduced to cost basis when deducted from the sum of beginning inventory and
net purchases would result to inventory on hand.
d. The amount of purchases and the amount of sales remain relatively unchanged from the
previous period.
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24. How is the gross profit method used in relation to inventory?
a. To verify the accuracy of the perpetual inventory record
b. To verify the accuracy of the physical inventory
c. To estimate the cost of goods sold
d. To provide a FIFO inventory value
25. An advantage of the retail inventory method is that it
a. Permits entities to avoid taking an annual physical inventory.
b. Yields a more accurate measurement of inventory
c. Hides costs from customers and employees.
d. Provides a method for inventory control and facilitates determination of the periodic
inventory.
26. To produce an inventory valuation which approximates the lower of cost and NRV using the
retail method, the computation of the ratio of cost to retail should
a. Include markup but not markdown
b. Include markup and markdown
c. Ignore both markup and markdown
d. Include markdown but not m
27. When the conventional retail inventory method is used, markdowns are commonly ignored
in the computation of cost to retail ratio because
a. There may be no markdowns during the year.
b. This tends to give a better approximation of the lower of average cost and net realizable
value.
c. Markups are also ignored.
d. This tends to result in the showing of a normal profit margin in a period when no
markdown goods have been sold.
28. The retail inventory method would include which of the following in the calculation of the
goods available for sale at both cost and retail?
a. Freight in
b. Purchase return
c. Markup
d. Markdown
82
29. With regard to the retail inventory method, which is the most accurate statement?
a. Generally, accountants ignore net markups and net markdowns in computing the cost
ratio.
b. Generally, accountants exclude net markups and include net markdowns in computing
cost ratio.
c. The retail method results in a lower ending inventory if net markups are included but net
markdowns are excluded in computing the cost ratio,
d. It is not adaptable to FIFO costing.
30. The conventional retail method produces an ending inventory that approximates
a. Lower of average cost and net realizable value
b. Lower of FIFO cost and net realizable value
c. Lower of LIFO cost and net realizable value
d. Lower of cost and net realizable value
 Inventories sold under installment sale whereby the seller retains title solely to
protect the collectability of the amount due are included in the buyer's inventory
(and are excluded from the seller's inventory) at the time of sale.
 The objectives of inventory accounting are: (a) proper determination of income and
(b) proper representation of costs in the statement of financial position.
 The two systems of accounting for inventories are (a) perpetual and (b) periodic.
 Inventories are measured at the lower of cost and net realizable value (NRV).
 The cost of inventories comprises all costs of purchase, costs of conversion and
other costs incurred in bringing the inventories to their present location and
condition.
 The cost formulas permitted under PAS 2 are (a) specific identification, (b) FIFO,
and (c) weighted average.
 Net realizable value (NRV) is estimated selling price less estimated costs of
completion and estimated costs to sell.
 Inventories are usually written down to NRV on an item by item basis.
83
 Inventory may be estimated using the (a) gross profit method or the (b) retail
method.
 Cost ratio under average cost method = TGAS at cost ÷ TGAS at retail.
 Cost ratio under FIFO cost method = (TGAS at cost less BI at cost) ÷ (TGAS at
retail less BI at retail). BI is beginning inventory.
References
Bazley, J.D., Nikolai, L.A., & Jones,J.P., (2010). Intermediate Accounting (11 th Ed.).
Canada:Rob Dewey
Morton, N., & Conrod, J.D., (1995). Intermediate Accounting (7 th Ed.). Canada: Roderick T
Banister
84

Intermediate Accounting I

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Intermediate Accounting I

Marylin L. Asumbra, CPA

Module 1: CASH AND CASH EQUIVALENTS

Course Description: Intermediate Accounting 1 involves a thorough study of

Course Intended Learning Outcomes (CILO):

At the end of the course, students should be able to:

 Assessment Tasks - 60%

PRELIM GRADE : Total CS% + (40% of Prelim Exam)

Financial statements users focus on a variety of information in making credit and

At the end of this module, students should be able to:

c. Cash fund – refers to fund set aside for current purposes.

a. Coins and currencies

Lesson 2. Definition of Cash Equivalents

Lesson 3. Financial Statement Presentation

Lesson 4. Measurement of Cash

Cash is measured at face value. Cash denominated in foreign currency is translated at

Lesson 5. Internal Controls Over Cash

Examples of internal controls over cash (Millan, 2019):

a. Segregation of incompatible duties -The duties of authorization, execution,

c. Bank reconciliation - Bank reconciliation should be prepared immediately upon the

d. Cash counts – periodic cash counts should be performed to provide reasonable

e. Minimum cash balance – Minimum cash balance should be maintained, especially

g. Non-encashment of personal checks from the petty cash fund – This is to

Lesson 6. Cash Shortages and Overages

Accounting for cash shortages and overages (Millan, 2019)

2. Kiting - occurs when cash shortages is concealed by overstating the balance of

3. Window dressing - In a broad sense, window dressing is a form of fraudulent

Lesson 7. Petty Cash Fund

1. A check is drawn to establish the fund.

Petty cash fund xx

2. Payment of expenses out of the fund.

3. Replenishment of petty cash payments.

4. Adjusting entry for unreplenished expenses

Petty cash fund xx 10

6. A decrease in the fund is recorded as:

Lesson 8. Bank Reconciliation

A bank reconciliation is a schedule that a company prepares to analyze the difference

Proforma reconciliation (Valix et al., 2020)

Book balance xx Bank balance xx

Lesson 9. Proof of Cash (Valix et al., 2020)

A proof of cash is an expanded reconciliation in that it includes proof of receipts and

Comments on the book items

Comments on the bank items

Beginning Receipts Disbursements Ending

Unadjusted balance per bank xx xx xx xx

Beginning Receipts Disbursements Ending

Unadjusted balance per book xx xx xx xx

Assessment Tasks (Valix et al., 2020)

What total amount should be reported as cash at year end?

3. Thor Company provided the following data on December 31, 2020:

Cash in bank – current account 6,000,000

Cash in bank included P400,000 of compensating balance against short term

The compensating balance is legally restricted as to withdrawal

What total amount should be reported as cash and cash equivalents?

Cash in bank 2,250,000

Cash in bank included P600,000 of compensating balance against short-term

The compensating balance is not legally restricted as to withdrawal.

Balance per bank statement 1,805,000

What is the adjusted cash in bank?

Balance per bank statement 3,800,000

What is the unadjusted cash in bank balance per book?

Balance per bank statement December 31 2,800,000