CHAPTER 1

THE ACCOUNTANCY PROFESSION

Definition of Accounting according to:

Accounting Standard Council (ASC)

Accounting is service activity. Its function is to provide quantitative information, primarily financial in
nature, about economic entities, that is intended to be useful in making economic decision.

American Institute of Certified Public Accountant (AICPA)

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

American Accounting Association (AAA)

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

Important Points:

1. Accounting is about quantitative information.

2. The information is likely to be financial in nature.
3. Information should be useful in decision making.

The definition that stood the test of time is the definition given by American Accounting Association.

This definition states that the very purpose of accounting is to provide quantitative information to be
useful in making an economic decision.

The definition also states that accounting has a number of components namely:

A. Identifying as the analytical component.

B. Measuring a the technical component.
C. Communicating as the formal component.

Identifying

This accounting process is the recognition or nonrecognition of business activities as “accountable”

event. An event is accountable o quantifiable when it has an effect on asset, liability and equity.

Measuring

This accounting process is the assigning of peso amount to the accountable economic transactions and

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events. The Philippine Peso is the unit of measuring accountable economic transaction.

Communicating

This is the process of preparing and distributing accounting reports to potential users of accounting
information. Actually, the communicating process is the reason why accounting has been called the
“universal language of business”.

Accounting as an information system

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

Overall objective of accounting

“Provide quantitative financial information about a business that is useful to statement users particularly
owners and creditors, in making economic decision”.

The Accountancy Profession

Republic Act No. 9298 is the law regulating the practice of accountancy in the Philippines. This law is
known as the “Philippine Accountancy Act of 2004”.

In the Philippines, in order to qualify to practice the accountancy profession, a person must finish a
degree in Bachelor of Science in Accountancy and pass a very difficult government examination given by
the Board of Accountancy.

The Board of Accountancy is the body authorized by law to promulgate rules and regulations affecting
the practice of the accountancy profession in the Philippines.

Limitation of the practice of public accountancy

Single practitioners and partnerships foe the practice of public accountancy shall be registered certified
public accountants in the Philippines. The securities and Exchange Commission shall not register any
corporation organized for the practice of public accountancy.

Accreditation to practice public accountancy

The Professional Regulation Commission upon favorable recommendation of the Board of Accountancy
shall issue the Certificate of Registration” to practice public accountancy which shall be valid for 3 years
and renewable every 3 years upon payment of required fees.

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Public Accounting

Public accountants usually offer three kinds of services, namely auditing, taxation and management
advisory services.

Auditing has traditionally been the primary services offered by most public accounting practitioners.
Auditing or specifically external auditing is the “examination of financial statements by independent
certified public accountant for the purpose of expressing an opinion as to the fairness with which the
financial statements are prepared”. Actually external auditing is the “attest function” on independent
CPA's.

Taxation service includes the preparation of annual income tax returns and determination of tax
consequences of certain proposed business.

Management advisory services have become increasingly important i recent years, although audit and
tax services are undoubtedly the mainstay of public accountants

Private Accounting

The highest accounting officer in an entity is known as the controller. The major objective of the private
accountant is to assist management in planning and controlling the entity’s operations. The private
accountant has also the responsibility for the determination of the various taxes the entity is obliged to
pay.

Government Accounting

Government accounting “encompasses the process of analyzing, classifying, summarizing and

communicating all transactions involving the receipt and disposition of government funds and property
and interpreting the result thereof”. The focus of government accounting is the custody and
administration of public funds.

Continuing Professional Development (CPD)

Under Resolution 59 of the Board of Accountancy, the term Continuing Professional Development is used
in lieu of Continuing Professional Education.

CPD credit units

The CPD credit units refer to the CPD credit hours required for the renewal of CPA licenses and
accreditation of a CPA to practice the accountancy profession every 3 years. The total CPD credit units
shall be 60 credit units for 3 years. Under the new BOA Resolution, the required 60 credit units may be
earned in any of the 3 years preceding the year of application for accreditation.

The Continuing Professional Development is required for the renewal of CPA license and accreditation of
CPA to practice the accountancy profession.

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Exemptions from CPD

A CPA shall be permanently exempted from CPD requirement upon reaching the age of 65 years.

A CPA shall be temporarily exempted from compliance with the CPD requirements under the following
circumstances:

A. The CPA is working or practicing the profession or furthering studies abroad.

B. The exemption is for the duration f stay abroad.
C. The CPA has been out of the country for at least 2 years immediately prior to the date of renewal of
license and accreditation.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

As a new types of transactions occur in trade and commerce, accountants develop rules and procedures
for recording them.

These accounting rules procedures and practices came to be known as generally accepted accounting
principle or simply GAAP.

Generally accepted accounting principles represent the “rules, procedures, practice and presentation of
financial statements”. Generally accepted accounting principles are like laws that must be followed in
financial reporting.

FINANCIAL REPORTIG STANDARD COUNCIL

The development of generally accepted accounting principle is formalized initially through the creation
of the Accounting Standards Council or ASC.

The Financial Reporting Standard Council or FRSC now replaces the Accounting Standard Council. This is
the accounting standard setting body created by the Professional Regulation Commission upon
recommendation of the Board of Accountancy to assist the Board of Accountancy in carrying out it
powers and functions provided under R.A. No. 9298.

The main function is to establish and improve accounting standards that will be generally accepted in the
Philippines.

The accounting standard promulgated by the Financial Reporting Standards Council constitute the
“highest hierarchy” of generally accepted accounting principles in the Philippines. The approved
statements of the FRSC re known as Philippines Accounting Standards or PAS and Philippine Financial
Reporting Standards or PFRS.

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Composition of FRSC

The FRSC is composed of 15 members with a chairman who had been or is presently a senior accounting
practitioner and 14 representative from the following:

Board of Accountancy

1
Securities and Exchange Commission

1
Bangko Sentral ng Pilipinas

1
Bureau of Internal Revenue

1
Commission on Audit

1
Major organization of preparers and users of
financial statements-Financial Executives Institute
of the Philippines or FINEX

1
Accredited national professional organization of CPA’s:
Public Practice

2
Commerce and Industry

2
Academe or Education
2
Government

2
Total

14

Philippine Interpretations Committee

The Philippine Interpretations Committee or PIC was formed by the FRSC in August 2006 and has
replaced the Interpretations Committee or IC formed by the Accounting Standard Council in May 2000.

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The role of the PIC is to prepare interpretations of PFRS for approval by the FRSC and in the context of
Conceptual Framework, to provide timely guidance on financial reporting issues not specifically
addressed in current PFRS.

INTERNATIONAL ACCOUNTING STANDARDS COMMITTEE

The International Accounting Standards Committee or IASC s an independent private sector body, with
the objective of achieving uniformity in the accounting principles which are used by business and other
organizations for financial reporting around he world.

Objective of IASC

A. To formulate and publish in the public interest accounting standards to be observed in the
presentation of financial statements and to promote their worldwide acceptance and observance.

B. To work generally for the improvement and harmonization of regulations, accounting standards and
procedures relating to the presentation of financial statement.

INTERNATIONAL ACCOUNTING STANDARDS BOARD

The International Accounting Standard Board or IASB now replaces the International Accounting
Standards Committee.The IASB publishes standards in a series of pronouncements called “International
Financial Reporting Standards” or IFRS.

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CHAPTER 2
CONCEPTUAL FRAMEWORK

Assumptions and financial reporting

UNDERLYING ASSUMPTION

Accounting assumptions are the basic notions or fundamental premises on which the accounting process
is based. Accounting assumptions are also known as postulates.

The Conceptual Framework for Financial Reporting mentions only one assumption, namely going
concern. However, implicit in accounting are the basic assumptions of accounting entity, time period
and monetary unit.

Going Concern

The going concern assumption means that in the absence of evidence to the contrary, the accounting
entity is viewed as continuing in operation indefinitely.

Thus, assets are normally recorded at costs. As a rule market values are ignored.

Accounting Entity

In financial accounting, the accounting entity is the specific business organization, which maybe a
proprietorship, partnership or corporation.

Under this assumption, the entity is separate from the owners, managers, and employees who constitute
the entity. The reason for the entity assumption is to have a fair presentation of financial statements.

Each business is an independent accounting entity.

Time Period

The time period assumption requires that “the indefinite life of an entity is subdivided into time period
or accounting periods which are usually of equal length for the purpose of preparing financial reports on

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financial position, performance and cash flow”.

By convention, the accounting period or fiscal period is one year or a period of twelve months. The
“one-year period” is traditionally the accounting period because usually it is after one year that
government reports are required.

Monetary Unit

The monetary unit assumption has two aspects, namely quantifiability aspects and stability aspects.The
quantifiability aspects means that the assets,liabilities, equity, income and expenses should e stated in
terms of a unit of measure which is the peso in the Philippines.

The stability of the peso assumption means that the purchasing power of the peso is stable or constant
and that its instability is insignificant and therefore may be ignored.
CONCEPTUAL FRAMEWORK

The Conceptual Framework for Financial Reporting is a complete, comprehensive and single document
promulgated by the International Accounting Standard Board.

The Conceptual Framework is a summary of the terms and concepts that underlie the preparation and
presentation of financial statement for external users. This an attempt to provide an overall theoretical
foundation for accounting which will guide standard-setters, preparers and users of financial information
in the preparation and presentation of statements. It is the underlying theory for the development of
accounting standards and revision of previously issued accounting standards.

Users of Financial Information

Under the Conceptual Framework for Financial Reporting, the users of financial information may be
classified into two, namely:

A. Primary users
B. Other users

Primary users

The primary users of financial information are the parties to whom general purpose financial reports are
primarily directed. It include the existing and potential investors, lenders and other creditors.

Existing and potential investors

Existing inventors are concerned with the risk inherent in and return provided by their investment. The
investors need information to help them determine whether they should buy, hold or sell.

Lenders and other creditors

Existing and potential lenders and other creditors are interested in information which enables the to
determine whether their loans, interest thereon and other amounts owing to them will be pain when
due.

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Other users

By residual definition “other users” are users of financial information other than the existing and
potential investors, lenders and other creditors.

Financial Reporting

Financial Reporting is the provision of financial information about an entity to external users that is
useful to them in making economic decisions and for assessing the effectiveness of the entity’s
management.
Objective of Financial Reporting

The objective of financial reporting forms the foundation of the Conceptual Framework.

The overall objective of financial reporting is to provide financial information about the reporting entity
that is useful to existing and potential investors, lenders and other creditors in making decisions about
providing resources to the entity.

Economic resources and claims

General purpose of financial reports provides information about the financial position of a reporting
entity.

Financial position is information about the entity’s economic resources and the claims against the
reporting entity.

In other words, financial position comprises the assets, liabilities and equity of an entity at a particular
moment in time.

Information about financial position can help users to assess the entity’s liquidity, solvency and the need
for additional financing.

Liquidity is the availability of cash in the near future to cover currently maturing obligations.

Solvency is the availability of cash over a long term o meet financial commitments when they fall due.

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CHAPTER 3
CONCEPTUAL FRAMEWORK

Qualitative Characteristics

Qualitative characteristics are the qualities or attributes that make financial accounting information
useful to the users.

Fundamental qualitative characteristics are:

a. Relevance
b. Faithful representation

*Information must be both relevance and faithfully represented if it is to be useful.

Relevance

In the simplest terms, relevance is the capacity of the information to influence a decision. To be relevant,
the financial information must be capable of making differences in the decisions made by the users.

Ingredients of relevance

Financial information is capable of making a difference in a decision if it has predictive value and
confirmatory value. Financial information has predictive value if it can be used as an output to process
employed by the users to predict future outcome. It has confirmatory value if it provides feedback about
previous evaluations.

Materiality

Materiality is a practical rule in accounting which dictates that strict adherence to GAAP is not required
when the items are not significant enough to affect the evaluation, decision and fairness of the financial
statements. The materiality concept is also known as the doctrine of convenience.

Materialism of an item depends on relative size rather than absolute size.“An item is material if
knowledge of it would affect or influence the decision of the informed users of the financial statements.”

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Factors of Materiality

In the exercise of judgment in determining materiality, the relative size and nature of an item are
considered.

The size of the item in relation to the total of the group to which the item belongs is taken into account.

The nature of the item maybe inherently material because by its very nature it affects economic decision.

Faithful Representation

Faithful representation means that financial reports represent economic phenomena or transactions in
words and numbers.

Simply worded, faithful representation means that the actual effects of the transactions shall be properly
accounted for and reported in the financial statements.

Ingredients of faithful representation

a. Completeness
b. Neutrality
c. Free from error

Completeness

Completeness requires that relevant information should be presented in a way that facilitates
understanding and avoids erroneous implication.Completeness is the result of the adequate disclosure
standard or the principle of full disclosure.

Neutrality

A neutral depiction is “without bias” in the preparation or presentation of financial information. In other
words, to be neutral, the information contained in the financial statements must be fee from bias.
Neutrality is synonymous with the all-encompassing “principle of fairness”.

To be neutral is to be fair.

Free from error

Free from error means there are no errors or omissions in the description of the phenomenon or
transaction, and the process used to produce the reported information has been selected and applied
with no errors in the process.

What about conservatism?

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The Conceptual Framework did not include conservatism or prudence as an aspect of faithful
representation because to do so would be inconsistent with neutrality. However, discussion of the
qualities of financial information would not be complete without discussion of conservatism or
prudence.

Conservatism

Under conservatism, when alternative exist, the alternative which has the least effect on equity should
be chosen. In the simplest words, conservatism means “in case of doubt, record any loss an do not
record any gain”. Contingent loss is recognized as a “provision” if the loss is probable and the amount can
be reliably measured. Continent gain is not recognized but disclose only.

Conservatism is synonymous with prudence.

Prudence is the desire to exercise care and caution when dealing with the uncertainties in the
measurement process such that asset or income are not overstated and liabilities or expense are not
understated.

Expression of conservatism and prudence

“Anticipate no profit and provide for probable and measurable loss”.

“In the matter of income recognition, the accountant takes the position that no matter how sure the
businessman might be in capturing the bird in the bush, he, the accountant, must see it in the hand”.

“Don’t count your chicks until the eggs hatch”>

Enhancing qualitative characteristics are:

A. Comparability
B. Understand ability
C. Verifiability
D. Timeliness

Comparability

Comparability means the ability to brig together for the purpose of noting points of likeness and
difference. Comparability my be made within an entity or between and across entities.

Consistency

The principle of consistency requires that “the accounting methods and practices should be applied on a
uniform basis from period to period.

Consistency is not the same as comparability.

Understandability

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Understandability requires that financial information must be comprehensible or intelligible if it is to be
most useful. Accordingly, the information should be presented in a form and expressed in terminology
that a user understands.

Verifiability

Verifiability means that different knowledgeable and independent observers cold reach consensus,
although not necessarily complete agreement, that a particular depiction is a faithful representation.

In other words, verifiability implies consensus.

Verification can be direct or indirect. Direct verification means verifying an amount or other
representation through direct observation. Indirect verification means verifying an amount or other
representation through direct observation.

Timeliness

Timeliness means that financial information must be available or communicated early enough when a
decision is t be made.

Timeliness enhances the truism that “without knowledge of the past, the basis for prediction will usually
be lacking and without interest int the future, knowledge of the past is sterile”.

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CHAPTER 4
CONCEPTUAL FRAMWORK

Elements of financial statements

The elements of financial statements refer to the quantitative information reported in the statement of
financial position and income statement.

The elements directly related to the measurement of financial position in the statement of financial
position are:

A. Asset
B. Liability
C. Equity

The elements directly related to the measurement of financial performance in the income statement are:

A. Income
B. Expenses

Equity is the “residual interest in the asset of the entity after deducting all of the liabilities”.

RECOGNITION OF ELEMENTS

Recognition is a term which means the reporting of an asset, liabilities, income or expense on the face of
the financial statements of an entity.

There are four main recognition principles, namely:

A. Asset recognition principle

B. Liability recognition principle
C. Income recognition principle
D. Expense recognition principle

Asset recognition principle

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An asset is defined as “a resource controlled by the entity as a result of past events and from which
future economic benefits are expected to flow to the entity”.

An asset is recognized when it is probable that future economic benefits will flow to the entity and the
asset has a cost or value that can be measured reliably.

The future economic benefit embodied in an asset is the potential to contribute directly or indirectly to
the flow of cash an cash equivalents to the entity.

Inherent in asset recognition is the cost principle.

The cost principle requires that assets should be recorded initially at original acquisition cost.

Liability recognition principle

A liability is defined as “a present obligation arising from past events the settlement of which is expected
to result in an outflow from the entity of resources embodying economic benefits”.

A liability is recognize when it is probable that an outflow of resources embodying economic benefits will
be required for the settlement of present obligation and the amount of the obligation can be measured
reliably.

An essential characteristic of a liability is that the entity has a present obligation which maybe legal or
constructive. Obligation may be legally enforceable as a consequence of a binding contract or statutory
requirement.

Income recognition principle

Income is “increase in economic benefit during the accounting period in the form of inflow or increase in
asset or decrease in liability that results in increase in equity participants”. The definition of income
encompasses both revenue and gains.

The basic principle is that “income shall be recognized when earned”

The Conceptual Framework provides that “income is recognized when it is probable that an increase in
future economic benefits related to an increase in an asset or a decrease in a liability has arisen and that
the increase in economic benefits can be measured reliably”.

Expense recognition principle

Expense is “decrease in economic benefit during the accounting period in the form of outflow or
decrease in asset or increase in liability that results in decrease in equity other than distribution to
equity participants”. Expenses encompasses losses as well as those expenses that arise in the course of
the ordinary regular activities.

The basic expense recognition principle means that “expenses are recognized when earned”.

The Conceptual Framework provides that “expenses are recognized when it is probable that a decrease

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in future economic benefits related to a decrease in an asset or an increase in liability has occurred and
that the decrease in economic benefits can be measured reliably”.

Matching principle

Actually, the expense recognition principle is the application of the matching principle.

The generation of revenue is not without any cost. There ha got to be some cost in earning a revenue.

CHAPTER 7
CASH AND CASH EQUIVALENTS

Definition of cash

From the point of view of a layman, “cash” simply means money. Money is the standard medium of
exchange in business transactions. However, in the accounting parlance, the term “cash” has a special
and broader meaning. As contemplated in accounting, cash includes “money and any other negotiable
instrument that is payable with money and acceptable by the bank for deposit and immediate credit.

Unrestricted Cash

There is no specific standard dealing with “cash”. The only guidance is found in PAS 1, paragraph 66,
which provides that “an entity shall classify an asset as current when the asset is cash or equivalent
unless it is restricted from being exchanged or used to settle a liability for at least twelve months after
the end of the reporting period.”

Accordingly, to be reported as “cash” , an item must be unrestricted in use.

Cash Equivalents

PAS 7, paragraph 6, defines “cash equivalents” as short- term and highly liquid investments that are
readily convertible into cash and so near their maturity that they present insignificant risk of changes in
value because of changes in interest rates.

The standard further states that “only the highly liquid investments that are acquired three months
before maturity can qualify as cash equivalents”.

Measurements of cash

Cash is measured at face value. Cash in foreign currency is measured at the current exchange rate.

Financial statement presentation

The caption “cash and cash equivalents” should be shown as the first item among the current assets.
However, the details comprising the “cash and cash equivalents” should be disclosed in the notes to
financial statements.

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Cash fund for a certain purpose

If the cash fund is set aside for the use in current operations or for the payment of current obligation, it is
a current asset. It is included as part of cash and cash equivalents. One of the other hand , if the cash
fund is set aside for noncurrent purpose or payment of noncurrent obligation, it is known as long-term
investment.

Classifications of class fund

The classification of class fund as current or non current should parallel the classification of the related
liability.

Bank overdraft

When the cash in the bank has a credit balance , it is said to be an overdraft. The credit balance in the
cash in bank account results from the issuance of checks in excess of the deposits. A bank overdraft is
classified as a current liability and should not be offset against other bank accounts with debit balances.

Compensating balance

A compensating balance generally takes the from of minimum checking or demand deposit account
balance that must be maintained in connection with a borrowing arrangement with a bank. In effect, this
arrangement results in the reduction of the amount borrowed because the compensating balance
provides a source of fund to the bank as partial compensation for the loan extended.

Classification of compensating balance

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

Undelivered or unreleased check

An undelivered or unreleased check is one that merely drawn and recorded but not given to the payee
before the end of the reporting period. Adjusting entry:

Cash xx
Accounts payable or appropriate account xx

Postdated check delivered

A postdated check delivered is a check drawn, recorded and already given but it bears date subsequent
to the end of reporting period. Reversing entry:

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Cash xx
Accounts payable or appropriate account xx

Stale check or check long outstanding

A stale check is a check not en cashed by the payee within a relatively long period of time. If amount os
stale check is immaterial, it is simply accounted for as miscellaneous income as follows:

Cash xx
Miscellaneous income xx

If the amount is material and liability is expected to continue the journal entry:
Cash xx
Accounts payable or appropriate account xx
Window dressing

Window dressing is a practice of opening books of accounts beyond the close of the reporting period for
the purpose of showing a better financial position and performance. The entries made to window dress
must be reversed to correct the statements. In a very broad sense, window dressing is any deliberate
misstatement of the assets, liabilities, income and expenses.

Lapping

Lapping is a practice used for concealing a cash shortage. Lapping consists of misappropriating a
collection from one customer and concealing this defalcation by applying a subsequent collection made
from another costumer.Lapping involves a series of postponements of the entries for the collection of
receivables.

Kiting

Kiting is another device used to conceal a cash shortage. Kiting is possible when an entity maintains
current accounts in different banks. Kiting is usually employed at the end of the month. Kiting occurs
when a check is drawn against the same check in a second bank to cover the shortage in the latter bank.

Accounting for cash shortage

Where the cash count shows cash which is less than the balance per book, there is a cash shortage to be
recorded as:
Cash short or over xx
Cash xx
If the cashier or custodian is held responsible for cash shortage,the adjustment:

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 Due from cashier xx
Cash short or over xx
However if reasonable efforts fail to disclose the cause of shortage,adjustments:
Loss from cash shortage xx
Cash short or over xx

Accounting for cash overage

When cash count is more than the balance per book, there s cash overage to be recognize as follows:
Cash xx
Cash short or over xx
The cash overage is treated as miscellaneous income if there is no claim on the same,entry:
Cash short or over xx
Miscellaneous income xx
If cash overage is found to be money of cashier,entry:
Cash short or over xx
Payable to cashier xx

Imprest system

The imprest system is a system of control of cash which requires that all cash receipts should be
deposited intact and all cash disbursements should be made by means of check.

While internal control ideally requires that all payments should be made by means of check , this is
sometimes impossible.

Petty cash fund

The petty cash fund is a money set aside to pay small expenses which cannot be paid conveniently by
means of check.

There are two methods of handling the petty cash, namely :

A. Imprest fund system - the imprest fund system is the one usually followed in handling petty cash
transactions.

B. Fluctuating fund system - it is called the “fluctuating fund system” because the checks drawn to
replenish the fund do not necessarily equal the petty cash disbursements.

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CHAPTER 8
BANK RECONCILIATION

Bank deposits

Demand deposit- this is the current account where deposits are covered by deposit slips and where
finds are withrawable on demand by drawing checks against the bank.

A demand deposit is non-interest bearing.

Saving deposit - the depositor is given a passbook is required when making deposits and withdrawals.

A saving deposit is interest bearing.

Time deposit - this is similar to saving deposit in the sense that it is interest bearing. A time deposit is
evidenced, however, by a formal agreement embodied in an instrument called certificate of deposit.

Bank reconciliation

A bank reconciliation is a statement which brings into agreement that cash balance per book and cash
balance per bank. The reconciliation is usually prepared monthly because the bank provides the
depositor with the bank statement at the end of every month.

A bank statement is a monthly report of the bank to the depositor showing :

A. The cash balance per bank at the beginning.

B. The deposits made by the depositor and acknowledged by the bank.
C. The checks drawn by the depositor and paid by the bank.
D. The daily cash balance per bank during the month.

Actually the bank statement is an exact copy of the depositor’s ledger in the records of the bank. When
the bank statement is received, attached thereto are the depositor’s cancelled checks and any debit or
credit memoranda that have affected the depositor’s account. The cancelled checks are the checks
issued by the depositor and paid by the bank during month. These are called cancelled checks because
they are literally cancelled by stamping or punching to show that they have been paid.

Reconciling items

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1. Books reconciling items :
- credit memos
- debit memos
-errors

2. . Bank reconciling items:

-deposits in transit
-outstanding checks
-errors
Credit memos

Credit memos refer to items not representing deposit credited by the banks to the account of the
depositor but not yet recorded by the depositor as cash receipts. The credit memos have the effect of
increasing balance.

Debit memos

Debit memos refers to the items not representing checks paid by bank which are more charged or
debited by the bank to the account of the depositor but not yet recorded by the depositor as cash
disbursement. The debit have the effect of decreasing the bank balance.

Deposit in transit

Deposit in transit are collections already recorded by the depositor as cash receipts but not yet reflected
on the bank statement.

Outstanding checks

Outstanding checks are checks already recorded by the depositor as cash disbursement but not yet
reflected on the bank statement.

Forms of bank reconciliation

The following formats may be used in reconciling the book balance and the bank balance:

A. Adjusted balance method - under this method, the book balance and the bank balance are brought to
a correct cash balance that must appear n the balance sheet.

B. Book to bank method - under this method, the book balance is reconciled with the bank balance or
the book balance is adjusted t equal the bank balance.

C. Bank to book method - under this method. The bank balance is reconciled with the book balance or
the bank balance adjusted to equal the book balance.

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Proforma reconciliation

Adjusted balance method

Book balance
Add : credit memos
Total
Less : debit memos
Adjusted book balance
Bank balance
Add: deposit in transit
Total
Less: outstanding checks
Adjusted bank balance
Book to bank method

Book balance
Add: credit memos
Outstanding checks
Total
Less: debit memos
Deposit in transit
Bank balance

Bank to book method

Bank balance
Add: deposit in transit
Debit memos
Total
Less: outstanding checks
credit memos
Book balance

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CHAPTER 9
PROOF OF CASH

Two date bank reconciliation

The bank reconciliation is so called “two date” because it literally involves two dates. The procedure
followed or a one-date reconciliation are the same for a two date reconciliation.

Among others, the omitted information may be any one or a combination of the following:

A. Book balance - beginning and ending

B. Bank balance - beginngin and ending
C. Deposit in transit - beginning and ending
D. Outstanding in transit - beginning and ending

If the ending balances are not given, the following formulas may help, if the beginning balances are
omitted, the formula should simply be reversed or just work back.

Computation of book balance

Balance per book - beginning of month

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

Computations of bank balance

Balance per bank - beginning of month

Add: bank credits during the month
Total
Less: bank debits during the month
Balance per bank - end of the month

Proof of cash

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.

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There are three forms of proof of cash, namely:

A. Adjusted balance method

B. Book to bank method
C. Bank to book method

CHAPTER 10
ACCOUNTS RECEIVABLE

Definition

Receivable are financial assets that represent a contractual right to receive cash or other financial assets
from another entity.

For retailers or manufacturers, receivables are classified into trade receivables and non-trade
receivables.

Trade receivables refer to claims arising from the sale of merchandise or services in the ordinary course
of business. Trade receivables include accounts receivable and notes receivable.

Accounts receivable are open accounts arising from the sale of goods and services in the ordinary course
of business and not supported by promissory notes.

Notes receivable are those supported by formal promises to pay in the form of notes.

Non trade receivables represent claims arising from sources other than the sale of merchandise or
service.

Classification

Trade receivables which are expected to be realized in cash within the normal operating cycle or one
year. Whichever is longer, are classified as current assets.

Non trade receivables which are expected to be realized in cash within one year, the length of the
operating cycle notwithstanding, are classified as current assets.

If collectible beyond one year, nontrade receivables are classified as noncurrent assets.

Costumers’ credit balance

Costumers’ credit balances are credit balances in accounts receivable resulting from over payments,
returns and allowances, and advance payments from costumers.

These credit balances are classified as current liabilities and are not offset against the debit balances in
other costumers’ accounts, except when the same is not material in which case only the net accounts

~ 24 ~
receivable may be presented.

Initial measurement of receivable

PFRS 9, paragraph 5.1.1 provides that financial assets shall be recognized initially at fair value plus
transaction costs that are directly attributable to the acquisition. For short-term receivables, the fair
value is equal to the face value or original invoice amount. For long term receivables that are interest-
bearing, the fair value is equal to the face value. However, for long term receivables that are noninterest-
bearing, the fair value is equal to the present value of all future cash flows discounted using the
prevailing market rate of interest for similar receivables.

Accounts receivable

Accounts receivable shall be measured at net realizable value, meaning the amount of the cash expected
to be collected or the estimate recoverable amount. However subsequently the accounts receivable shall
be measured at net realizable value, meaning the amount of cash expected to be collected or the
estimated recoverable amount.

Net realizable value

In estimating the net realizable value of trade accounts receivable, the following deductions are made:

A. Allowance for freight charge

B. Allowance for sales return
C. Allowance for sales discount
D. Allowance for doubtful accounts

Terms related to freight charge

The term “FOB destination” means that ownership of the goods purchased is vested in the buyer upon
receipt thereof. Accordingly, the seller shall be responsible for the freight charge up to the point of
destination. The term “FOB shipping” point means that ownership of the foods purchased is vested in
the buyer upon shipment thereof. Thus, it is incumbent upon the buyer to pay for the transportation
charge from the point of shipment to the point of destination.

The term “freight collect” means that freight charge on the shipped goods is t yet paid. Under this, the
freight charge is paid by the buyer. The term “freight prepaid” means that freight charge on the goods
shipped is already paid by the seller.

Allowance for sales returns

The measurement of accounts receivable shall also recognize the probability that some costumers will
return foods that are unsatisfactory or will make other claims requiring reduction in the amount die as in
the case of shipment shortages and defects.

Sales discount

Entities usually offer cash discounts to credit costumers. A cash discount is reduction from an invoice

~ 25 ~
price by reason of prompt payment. A cash discount us known as sales discount in the part of the seller
and a purchase discount on the part of the buyer.

Methods of recording credit sales

1. Gross method - the accounts receivable and sale are recorded at gross amount of the invoice. This is
the common and widely used method because it is simple to apply.

2. Net method - the accounts receivable and sales are recorded at net amount if the invoice, meaning
the invoice price minus the cash discount.

Accounting for bad debts

Business entities sell on credit rather that only for cash to increase total sales and thereby increase
income. When an account becomes noncollectable, the entity has sustained a bad debt loss. This loss is
simply one of the costs of doing business on credit.

Two methods are followed in accounting for this bad debt loss namely:

1. Allowance method
2. Direct write-off method

Allowance method

The allowance method requires recognition of bad debt loss if the accounts are doubtful of collection.

Recoveries of accounts written off

If a collection is made upon on account previously written off as uncollectible , the customary procedure
is first to recharge the costumers’ account with the amount collected and possibly with the entire
amount previously charged off if it is now expected that collection will be received in full. The collection
s then recorded normally by debiting cash and crediting accounts receivable.

Direct write off method

The direct write off methods requires recognition of bad debt loss only when the accounts proved to be
worthless or uncollectible.

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CHAPTER 11
ESTIMATION OF DOUBTFUL ACCOUNTS

Methods of estimating doubtful accounts

There are three methods f estimating doubtful accounts namely:

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

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

Aging of accounts receivable

The aging of accounts receivable involves an analysis where the accounts are classified into not due or
past due

The major argument for the used this method is more accurate and scientific computation of the
allowance for the doubtful accounts, and consequently, the accounts receivable are fairly presented in
the statement of financial position at the net realizable value.

The objection to the aging method is that it violates the matching process, more over this method could
become prohitively time consuming if a large number of accounts are involved.

The amount computed by aging of accounts receivable represent the required allowance for doubtful
accounts at the end of the period.

When is an account past due?

The credit terms will determine whether an account is past due. For example, if the credit terms were
2/10, n/30, and the account is 45 days old,, it is considered to be 15 days past due.

Therefore the phrase “past due” refers to the period beyond the maximum credit term, in example, the
credit term or credit period is 30 days.

Percent of accounts receivable

A certain rate is multiplied by the open accounts at the end of the period in order to get the required
allowance balance.

This procedure has the advantage of presenting the accounts receivable at estimated net realizable

~ 27 ~
value.the approach is also simply to apply. However, the application of this approach violates the
principle of matching bad debt loss against the sales revenue.

Percent of sales

The amount of sales for the year is multiplied by a certain rate to get the doubtful accounts expense. The
rate may be applied on credit sales or total sales.

Theoretically, the rate to be used is computed by dividing the bad debt losses in prior years by the charge
sales of prior years.

Practically, however, there is no substantial difference if in the computation of the rate, the basis is total
sales of the prior periods.

In such a case, the rate thus obtained is multiplied by the current year’s total sales. To get the doubtful
accounts expense.

Argument for percent of sales method

When the percent of sales method is used in computing doubtful accounts, proper matching of cost
against revenue is achieved, thus this method is an income statement approach because it favors the
income statement.

Argument against percent of sales method

The main argument against this method is that the accounts receivable may not be shown at estimated
realizable value because the allowance for doubtful accounts may prove excessive or inadequate.

Correction in allowance for doubtful accounts

As pointed out earlier, the percent of sales method of estimating doubtful accounts has the disadvantage
of the allowance for doubtful accounts being inadequate or excessive. Aging the accounts is then
necessary to test the reasonableness of the allowance.

The correction is to be reported i the income statement either as an addition to or subtraction from
doubtful accounts expenses.

Accordingly, an inadequate allowance is adjusted as follows:

Doubtful accounts xx
Allowance for doubtful accounts xx

An excessive allowance is recorded as follows:

Allowance for doubtful accounts xx
Doubtful accounts xx

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Debit balance in allowance account

The allowance for doubtful accounts normally has s credit balance. However a certain instances, it may
have a debit balance because it may be the policy of thee entity to adjust the allowance at the end of the
period and recorded accounts written off during the year.

Impairment of accounts receivable

Accounts receivable considered uncollectible are deemed to be “impaired”. PFRS 9, paragraph 5.5.1,
provides that an entity shall recognize a loss allowance for expected credit losses on financial asset
measured at amortized cost.

Paragraph 5.5.3 provides that an entity shall measure the loss allowance for a financial instrument at an
amount equal to the lifetime expected credit losses if the credit risk on the financial instrument has
increased significantly since initial recognition. Credit losses are the present value of all cash shortfalls.

Impairment assessment

The following guideline may be of help in assessing whether accounts receivable should be considered
impaired:

A.Individually significant accounts receivable should be considered for impairment separately and if
impaired, the impairment loss is recognized.

B. Accounts receivable not individually significant should be collectively assessed for impairment.

C. Accounts receivable not considered impaired should be included with other accounts receivable with
similar credit- risk characteristics and collectively assessed for impairment.

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CHAPTER 12
NOTES RECEIVABLE

Definition

Notes receivable are claims supported by formal promises to pa usually in the form of notes. Simply
stated, a promissory note is a written contract which one person, known as the maker, promises to pay
another person, known as the payee, a definite sum of money.

Standing alone, the term “notes receivable” represents only claims arising from sale of merchandise or
service in the ordinary course of business.

Dishonored notes

When a promissory note matures and is not paid, it is said to be dishonored. Theoretically, dishonored
notes shall be removed from the notes receivable account and transferred to accounts receivable at an
amount to include, if any , interest and other charges.

Initial instrument of notes receivable

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.

The initial measurement of long-term notes will depend on whether the notes are interest-bearing or
noninterest-bearing.

Interest bearing long-term notes are measured at face value which is actually the present value upon
issuance.

Noninterest-bearing long-term notes are measured at present value which is the discounted value of the
future cash flows using the effective interest rate.

Subsequent measurement

Subsequent to initial recognition, long-term notes receivable shall be measured at amortized cost using
the effective interest method. For long-term noninterest-bearing notes receivable, the amortized cost is
the preset value plus amortization of the discount, or the face vale minus the unamortized unearned
interest income.

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CHAPTER 13
LOAN RECEIVABLE

Definition

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

Initial measurement of loan receivable

At initial recognition, an entity shall measure a loan receivable at fair value plus transaction costs that
are directly attributed to the acquisition of the financial asset.

Transaction costs that are directly attributable to the loan receivable include direct origination costs.

Direct origination costs should be included in the initial measurement of the loan receivable. However,
indirect origination costs should be treated as outright expense.

Subsequent measurement of loan receivable

PFRS 9, paragraph 4.1.2, provides that if the business model in managing financial asset is to collect
contractual ash flows on specified dates and the contractual cash flows are solely payments of principal
and interest, the financial asset shall be measured at amortized costs.

Accordingly, a loan receivable is measured at amortized cost using the effective interest method. In
other words, if the initial amount recognized is lower than the principal amount, the amortization of the
difference is added to the carrying amount. If the initial amount recognized is higher than the principal
amount, the amortization of the difference is deducted from the carrying amount.

Origination fees

Lending activities usually precede the actual disbursement of funds and generally include efforts to
identify and attract potential borrowers and to originate a loan. The fees charged by the bank against
the borrower for the creation of the loan are known as “origination fees”.

Accounting for origination fees

The origination fees received from borrower are recognized as unearned interest income and amortized
over the term of the loan. If the origination fees are not chargeable against the borrower, the fees are
known as “direct origination cost”.

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If the origination fees received exceed the direct origination cost, the difference is unearned interest
income and the amortization will increase interest income. If the direct origination costs exceed the
origination fees received, the difference is charged to “direct origination costs” and the amortization will
decrease interest income. Accordingly, the origination fees received and the direct origination costs are
included in the measurement of the loan receivable.
Impairment of loan

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

Measurement of impairment

When measuring expected credit losses, an entity should consider:

A. The probability-weighted outcome

The estimate should reflect the possibility that a credit loss occurs and the possibility that no credit loss
occurs.

B. The time value of money

The expected credit losses should be discounted.

C. Reasonable and supportable information that is available without undue cost or effort.

PFRS 9 does not prescribe particular method of measuring expected credit loss.

The amount of impairment loss may be measured as the difference between the carrying amount and
the present value of estimated future cash flows discounted at the original effective rate.

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CHAPTER 14
RECEIVABLE FINANCING
Pledge, assignment and factoring
Concept of receivable financing

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

The common forms of receivable financing are:

A. Pledge of accounts receivable

B. Assignment of accounts receivable
C. Factoring of accounts receivable
D. Discounting of notes receivable

Pledge of accounts receivable (Hypothecation)

When loans are obtained from the bank or any lending institution, the accounts receivable may be
pledge as collateral security for the payment of the loan. Normally, the borrowing entity makes the
collections of the pledge accounts but may be required to turn over the collections to the bank in
satisfaction for the loan. No complex problems are involved in this from of financing except the
accounting for the loan.

Assignment of accounts receivable

In substance, assignment of accounts receivable means that a borrower called the assignor transfers its
rights in some of its accounts receivable to a lender called the assignee in consideration for a loan.
Actually,, assignment is a more formal type of pledging of accounts receivable.

Assignments are secured borrowing evidence by a financing agreement on a promissory note both which
the assignor signs. However, pledging is general because all accounts receivable serve as collateral
security for the loan. On the other hand, assignment is specific because specific accounts receivable
serve as collateral security for the loan.

Assignment may be done either on a non-notification or notification basis.

When accounts are assigned on a non-notification basis, as is usually the case, costumers are not
informed that their accounts have been assigned. As a result, the costumer continues to make payments
directly to the assignee.

~ 33 ~
 When accounts are assigned on a notification basis, costumers are notified to make their payments
directly to the assignee.

Factoring

Factoring is a sale of accounts receivable on without recourse notification basis. In factoring

arrangement, an entity sells accounts receivable to a bank or finance entity called a factor. Factoring
differs from an assignment in that an entity actually transfers ownership of the accounts receivable to he
factor.
Factoring may take form of the following:

A. Casual factoring
B. Factoring as a continuing agreement

Casual factoring

If an entity finds itself in a critical cash position, it may be forced to factor some of all of its accounts
receivable at a substantial discount to a bank or a finance entity to obtain the much needed cash.

Financing as continuing agreement

Factoring may involve a continuing arrangement where a finance entity purchases all of the accounts
receivable of a certain entity. In this set up, before the merchandise is shipped to a costumer, the selling
entity requests the factor’s credit approval. If it is approved, the account is sold immediately to he factor
after shipment of the goods. The factor then assumes the credit function as well as the collection
function.

Moreover, the factor may withhold a predetermined amount as a protection against costumer returns
and allowances and other special adjustments. This amount withheld is known as the “ factor’s
holdback”. The factor’s holdback is actually a receivable from the factor and classified as current asset.

~ 34 ~
CHAPTER 15
RECEIVABLE FINANCING
Discounting of note receivable
Concept of discounting

As a form of receivable financing, discounting specifically pertains to note receivable. In a promissory

note , the original parties are the maker and payee. The maker is the one liable and the payee is the one
entitled to payment on the date of maturity.

When a note is negotiable, the payee may obtain cash before maturity date by discounting the note at a
bank or other financing company. To discount the note, the payee must endorse it. Thus, legally the
payee becomes an endorser and the bank becomes an endorse.

Endorsement may be with recourse which means that the endorser shall pay the endorsee if the maker
dishonors the note. This is the contingent or secondary liability of the endorser. Endorsement may be
without recourse means that the endorser avoids future liability even if the maker refuses to pay the
endorsee on the date of maturity. In the absence of any evidence to the contrary, endorsement is
assumed to be with course.

Terms related to discounting of note

1. Net proceeds refer to the discounted value of the note received by the endorser from the endorsee.
2. Maturity value is the amount due on the note at the date of maturity. Principal plus interest equals
the maturity value.
3. Maturity date is the date on which the note should be paid.
4. Principal is the amount appearing on the face of the note. It is also referred to as face value.
5. Interest is the amount of interest for the full term of the note, interest is computed as principal x rate
x time.
6. Interest rate is the rate appearing on the face of the note.
7. Time is the period within which interest shall accrue. For discounting purposes, it is the period from
date of note to maturity date. In other words, the term “time” is the entire period or “full term” of the
note.
8. Discount is the amount of interest deducted by the bank in advance. Discount is equal to maturity
value times discount rate times discount period.
9. Discount rate is the rate used by the bank in computing the discount. The discount rate should not be
confused with the interest rate. The discount rate and interest rate are different from each other.
10. Discount period is the period of time from date of discounting to maturity date.

Accounting for note receivable discounting

The accounting for the note receivable discounting depends in whether the discounting is with or

~ 35 ~
without resource. The discounting without recourse, the sale of the note receive is absolute and
therefore there is no contingent liability.

Secured borrowing

If the discounting s treated as a secured borrowing, the note receivable is not derecognized but instead
an accounting liability is recorded at an amount equal to the face amount of the note receivable
discounted.

Conditional sale or secured borrowing

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

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

Discounting own note

In the previous discussion, the maker of note discounted is a costumer. In other words, the party
discounting is the payee and is endorser and therefore only a person secondarily liable. There is then a
contingent liability on the note discounted. Where the note discounted is made by the partly
discounting, a primary liability, not a contingent liability exists. In effect, the party discounting is entering
into a contract of loan with the endorsee.

~ 36 ~
CHAPTER 16
INVENTORIES
DEFINITION OF INVENTORIES:
 Assets held for sale in the ordinary course of business (Finished goods)
 Assets in the process of production for such sale (Goods in process)
 Materials or supplies to be consumed in the production process or in the rendering of services
 Goods purchased for resale
 Reported as one line item under "current assets"

CLASSES OF INVENTORIES:
1. INVENTORIES OF TRADING CONCERN
-buys and sells goods in the same form as purchased
-"Merchandise Inventory" is generally applied to these kind of goods
2. INVENTORIES OF A MANUFACTURING CONCERN
-buys goods which are converted into another form
-"Finished Goods", "Goods in Process", "Raw Materials", "Factory or Manufacturing Supplies"
refer to inventories of a manufacturing concern

DEFINITION OF TERMS:
 Finished Goods
-completed products which are ready for sale
-have been assigned their full share of manufacturing costs
 Goods in Process/ Work in Process
-partially completed
-require further process before they can be sold
 Raw Materials
-goods to be used in the production
-no work/process has been done to these
*Raw Materials are frequently restricted to materials that will be physically incorporated in the
production of other goods and which can be traced directly to the end product.
 Factory/Manufacturing Supplies
-similar to Raw Materials but their relationship in the end product is indirect
-referred to as "Indirect Materials" because they are not physically incorporated in the products
being manufactured (e.g. paint, nails)
-find their way into the product cost as part of the "Manufacturing Overhead"

GOODS INCLUDIBLE IN THE INVENTORY:

All goods to which the entity has title regardless of location. Where the title passes from the seller to the
buyer, the goods are included in the inventories of the buyer.

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*LEGAL TEST
Applying the legal test the following are all includible in inventory:
 Goods owned in hand
 Goods in transit and sold FOB Destination
 Goods in transit and purchased FOB Shipping Point,
 Goods out on consignment
 Goods in the hand of a salesman or agents
 Goods held by customers on approval or on trial

*EXCEPTION TO THE LEGAL TEST

Following the legal test, goods sold in INSTALLMENT BASIS are still the property of the seller.
However, in such a case, it is an accepted accounting procedure to record the installment sale as a
regular sale involving deferred income on the part of the seller and as a regular purchase on the part of
the buyer.
Thus, the goods sold on installment are included in the inventory of the buyer and excluded from that of
the seller. the legal test to the contrary notwithstanding.
This is a clear example of economic substance prevailing over form.
*GOODS IN TRANSIT
1. LAND SHIPPING TERMS
-determines who really owns the goods in transit and who is liable to pay for the freight
1a.) FOB Destination
-ownership of goods purchased is transferred only upon receipt of goods
-SELLER is the one liable to pay for the freight and other charges up to the point
of destination
1b.)FOB Shipping Point
-ownership of goods purchased is transferred upon shipment of goods
-BUYER is the one liable to pay for the freight and other charges from point of
shipment up to the point of destination

2. FREIGHT ERMS
-determines who actually paid for the freight
2a.) Freight Collect
-means that freight charge on goods shipped is not yet paid
-freight is actually paid by the BUYER
2b.) Freight Prepaid
-means that freight charge is already paid by the SELLER

3. MARITIME SHIPPING TERMS

3a.)Free Alongside/FAS
-ownership passes to the buyer when the carrier takes possession of the goods
-SELLER must bear all expenses and risks up to the dock next to or alongside
the vessel
-BUYER bears the cost of loading and shipment

~ 38 ~
 3b.) Cost, Insurance, and Freight/CIF
-title and risk of loss shall pass to the buyer upon delivery of goods to the
carrier
-BUYER pays the cost of goods, insurance cost and freight charge on a LUMP
SUM BASIS
-SELLER must pay for the cost of loading
3c.)Ex-ship
-title and risk of loss shall pass to the buyer when the goods are unloaded
- SELLER bears all expenses and risk of loss until the goods are unloaded from
the dock

*CONSIGNED GOODS
-included in the owner's/consignor's inventory
-FREIGHT and other HANDLING CHARGES on goods out on consignment are part of the cost of goods
consigned.
CONSIGNMENT
-This is a method of marketing goods in which he owner called the "consignor" transfers physical
possession of goods to an agent called the "consignee" who sells them in the owner's behalf.
-When consigned goods are sold, a report together with a cash remittance is made to the consignor less
commission and other expenses chargeable to the consignor.
*Incidentally, consigned goods are recorded by the consignor by means of a memorandum entry. Thus, it
may be necessary for the consignor to maintain subsidiary ledger for various consignees.
ACCOUNTING FOR INVENTORIES
TRANSACTION PERIODIC SYSTEM PERPETUAL SYSTEM
Purchase of merchandise on Purchases xx Merchandise Inventory xx
account Accounts Payable xx Accounts Payable xx

Payment of freight on purchase Freight In xx Merchandise Inventory xx

Cash xx Cash xx
Return of purchased Accounts Payable xx Accounts Payable xx
merchandise to supplier Purchase Return xx Merchandise Inventory xx
Sale of merchandise on account Accounts Receivable xx Accounts Receivable xx
Sales xx Sales xx
Cost of goods sold xx
Merchandise Inventory xx
Return of merchandise sold from Sales return xx Sales return xx
customer Accounts receivable xx Accounts receivable xx
Merchandise inventory xx
Cost of goods sold xx
Adjustment of ending inventory Merchandise inventory- end xx NO ADJUSTMENT because the
Income Summary xx balance of the inventory account is
the ending inventory
INVENTORY SHORTAGE or OVERAGE
-This occurs when a physical count of the inventories states a different amount from the ending balance
of inventories
-Inventory shortage= closed to Cost of goods sold

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 =result of normal shrinkage and breakage (however, abnormal and material
shortage shall be treated as expense
TRADE DISCOUNTS
-deductions to list/catalogue price
-not recorded
-purpose of this is to encourage trading and increase sales
CASH DISCOUNTS
- deductions from the invoice price
-recorded as "Purchase discount" in the part of the buyer and "Sales discount" in the part of the seller
purpose of this is to encourage prompt payment
TRANSACTION GROSS METHOD- recorded at NET METHOD- recorded at net
gross amount amount
Purchase on account Purchases xx Purchases xx
Accounts payable xx Accounts payable xx
Payment within the discount Accounts payable xx Accounts payable xx
period Cash xx Cash xx
Purchase discount xx
Payment beyond the discount Accounts payable xx Accounts payable xx
period Cash xx Purchase discount lost xx
Cash xx

End of accounting period, NO ENTRY Purchase discount lost xx

discount period has expired and Accounts payable xx
no payment was made

COST OF PURCHASE
-includes purchase price
-import duties
-irrevocable taxes
-freight
-handling costs
-other costs directly attributable to the acquisition

COST OF CONVERSION
-includes direct labour
-fixed production overhead(based on normal capacity)
-variable overhead (based on actual use)
OTHER COST
-costs incurred in bringing the inventories to their present location and condition
*COST of INVENTORIES OF A SERVICE PROVIDER
-cost of labour and other cost of personnel directly engaged in providing the service

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CHAPTER 17
INVENTORY COST FLOW
COST FORMULAS
-includes the cost of purchase, cost of conversion and other costs incurred in bringing the inventories to
its location and condition
PAS 2, Paragraph 25 expressly provides that the cost of inventories shall be determined by using either:
1. FIRST IN, FIRST OUT
-"first come, first sold"
-favours the Statement of Financial Position
PERIODIC:
* Inventory- beginning
Purchases
Total goods available for sale
Less:
Inventory- ending
Cost of goods sold
PERPETUAL:
* Sale 1
Sale 2
Cost of goods sold
2. WEIGHTED AVERAGE
*Weighted Average Unit Cost= Total cost of goods available for sale / Total units of goods available for
sale
*Ending Inventory= Units on hand at year end * Weighted Average Unit Cost
PERIODIC:
* Inventory- beginning
Purchases
Total goods available for sale
Less:
Inventory- ending
Cost of goods sold
PERPETUAL:
-also known as the "Moving Average Method"
- a new weighted average unit cost is computed every after purchase and purchase return

* Sale 1
Sale 2
Cost of goods sold
LAST IN, FIRST OUT

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-favours the Income Statement
*IFRS prohibits LIFO because there is reduction in tax burden under inflationary economies
*US GAAP permits LIFO because it provides more realistic performance

SPECIFIC IDENTIFICATION

-this means that specific cost is attributed to identified items in the inventory
- maybe used in periodic or perpetual method
*Cost of inventory= Units on hand * actual costs

STANDARD COSTS

- these are predetermined product costs established on the basis of normal levels of materials, labour,
efficiency, and capital utilization
- if these costs are determined, it is applied to all inventory movements- inventories, goods available for
sale, purchases, and goods sold or placed in production

RELATIVE SALES PRICE METHOD

-used when there is an acquisition of different commodities at a lump sum

*In allocating the price of each commodity, multiply the basket price by the derived fraction of
commodities. Fractions are formed by having the cost of each commodity as the numerator and having
the total cost of all the commodities as the denominator.

~ 42 ~
CHAPTER 18
LOWER OF COST AND NET REALIZABLE VALUE
PAS 2, Paragraph 9 provides that inventories shall be measured at lower of cost and net realizable value.

NET REALIZABLE VALUE (NRV)

-inventories are written down to NRV on an individual basis
NRV =Estimated selling price less the estimated cost of completion and the estimated cost of disposal

ACCOUNTING FOR INVENTORY WRITEDOWN

NRV is higher than COST
-no accounting problem
-inventory is stated at cost and increase in value is not recognized
NRV is lower than COST
-inventory is measured at NRV
METHODS:
1. Direct Method
- "Cost of goods sold method"
- any loss on inventory write down is not accounted for separately but it is buried in the
cost of goods sold
- inventory is measured at LOWER OF COST or NET REALIZABLE VALUE
2. ALLOWANCE METHOD
-"Loss method"
- any loss is accounted for separately in the "loss on inventory write down" account
ENTRY: Loss on inventory write down xx
Allowance for inventory write down xx
*If the allowance increases, additional loss is recognized
*If the allowance decreases, a "gain on reversal of inventory write down" is recorded but it is only
limited to the extent of the allowance balance.
ENTRY: Allowance for inventory write down xx
Gain on reversal of inventory write down xx

PURCHASE COMMITMENTS
- are obligations of the entity to acquire certain goods at some future time at a fixed price and fixed
quantity

TRANSACTION JOURNAL ENTRY

Market decline of purchase price Loss on purchase commitment
Estimated liability for purchase commitment
Actual purchase is made in subsequent period and Purchases
purchase price further decreases Loss on purchase commitment
Estimated liability for purchase commitment

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 Accounts payable
Assuming above did not occur, if the purchase Purchases
price (or replacement cost) increases Estimated liability for purchase commitment
Accounts payable
Gain on purchase commitment
CHAPTER 19
BIOLOGICAL ASSETS
PAS 41 is applied to agricultural produce at the point of harvest
PAS 2 is applied on inventories which are actually the products produced after harvest

BIOLOGICAL ASSETS
-living animals and plants

AGRICULTURAL PRODUCE
- unprocessed harvested product of the biological assets of an entity

HARVEST
- detachment of produce from a biological asset
EXAMPLES:
BIOLOGICAL ASSET AGRICULTURAL PRODUCE (PAS PRODUCT AFTER HARVEST (PAS
41) 2)
Sheep Wool Yarn, carpet
Trees in plantation forest Felled Trees Logs, lumber
Plant Harvested Cane Sugar
Dairy Cattle Milk Cheese
Pigs Carcass Sausage, cured ham

AGRICULTURAL ACTIVITY
- this is the management of the biological transformation and harvest of biological assets for sale or
for conversion
-e.g. Raising livestock, Annual or Perennial Cropping, Cultivating orchards and plantations, Floriculture,
Aquaculture including fish farming

FEATURES OF AGRICULTURAL ACTIVITY

1. Capability to change
- living animals and plants are capable of biological transformation
2. Management of change
- enhancing or stabilizing conditions necessary for the process to take place
- Enhancement of nutrient levels, moisture, temperature, fertility, and light
3. Measurement of change
- change in quality or quantity is measured and monitored

BIOLOGICAL TRANSFORMATION
- processes of growth, degeneration, production, and procreation that cause qualitative or quantitative
changes
- results from:

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 1. Asset changes through:
a.) Growth- increase in quantity/ improvement of quality
b.) Degeneration- decrease in quantity or deterioration in quality
c.) Procreation- creation of additional living animal or plant
2. Production of agricultural produce
MEASUREMENT
Biological asset= Fair value less cost of disposal
Agricultural produce= Fair value less cost of disposal at the point of harvest
*GAIN AND LOSS is included in profit or loss

AGRICULTURAL LAND
-not considered as a biological asset but as Property, Plant, or Equipment (PPE)

BIOLOGICAL ASSETS ATTACHED TO LAND

Amount of biological asset= Combined price of the assets less Fair value of the land

BEARER PLANTS
- Property, Plant, or Equipment

ANIMAL-RELATED RECREATIONAL ACTIVITIES

- not a managed activity therefore it is a PPE

GOVERNMENT GRANT
Unconditional= recognized as income when the grant becomes receivable
Conditional= recognized as income when the conditions are met

~ 45 ~
CHAPTER 20
GROSS PROFIT METHOD
USES OF ESTIMATE IN INVENTORY:
1. For insurance purposes in case of fire and other catastrophe
2. To prove the correctness or reasonableness of physical count
3. For the preparation of interim financial statements

BASIC FORMULA:
* Total goods available for sale
Less: Cost of goods sold
Ending inventory
COST OF GOODS SOLD
a) Gross profit rate is based on sales
= Net Sales * Cost Ratio
b) Gross profit is based on cost
= Net Sales / Sales Ratio

SALES ALLOWANCE AND DISCOUNT

- these are ignored and therefore not deducted from sales
- decrease the amount of the sales but does not affect the physical volume of goods
*In the case of SALES RETURN, it is not ignored because there is an actual addition of goods on hand. In
some cases, an entity may have an account of " Sales return and allowance" for both returns and
allowances. This, however, is included in the computation for the inventory.

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CHAPTER 21
RETAIL INVENTORY METHOD
INFORMATIONS REQUIRED
a. Beginning inventory at cost and retail
b. Purchases during the period at cost and retail
c. Adjustments to original price- mark ups and mark downs
d. Other adjustments- departmental transfer in, breakage, shrinkage, theft, damaged goods, and
employee discounts

BASIC FORMULA
* Goods available for sale at retail price
Less: Net sales
Ending inventory
Multiply by cost ratio
Ending inventory at cost
* Cost ratio= Goods available for sale at COST / Goods available for sale at SELLING PRICE
TREATMENT OF ITEMS
1. Purchase discount- deducted from purchases at cost
2. Purchase allowance- deducted from purchases at cost
3. Purchase return- deducted from purchases at cost and retail
4. Freight in- addition to purchases at cost
5. Departmental transfer in or debit- added to purchases at cost and retail
6. Departmental transfer out or credit- deducted from purchases at cost and retail
7. Sales discount and sale allowances- disregarded/ not deducted from sales
8. Sales return- deducted from sales
9. Employee discounts- added to sales
10. Normal shortage, shrinkage, spoilage, breakage- deducted from total goods available for sale at
retail
11. Abnormal shortage, shrinkage, spoilage, breakage- deducted from total goods available for sale
at cost and retail
* Any abnormal amount is recorded as loss

ITEMS RELATED TO RETAIL METHOD

1. Original retail= original sales price
2. Initial mark-up= original mark-up on goods
3. Additional mark-up= increase in sales price above the original sales price

~ 47 ~
 4. Mark-up cancellation= decrease in sales price that does not decrease the sales price below
original sales price
5. Net additional mark-up/ Net mark-up= mark-up less mark-up cancellation
6. Markdown= decrease in sales price below the original sales price
7. Markdown cancellation= increase in sales price but still below the original sales price
8. Net markdown= markdown less markdown cancellation
9. Maintained mark-up/ "markon"= difference between cost and sales price after adjustments

APPROACHES IN RETAIL METHOD

1. Conservative/ Conventional/ Lower of cost and Net realizable value Approach
-exclude markdowns and markdown cancellation
2. Average cost Approach
- includes markdowns and markdown cancellation
3. FIFO Approach
-a current cost is determined every year considering the NET PURCHASES and excluding the
BEGINNING INVENTORY
* Beginning inventory
Net purchases
Additional mark-up
(Mark-up cancellation)
GAS- conservative
(Markdown)
Markdown cancellation
GAS- average
(Net sales)
Ending inventory at retail

* Ending inventory at retail

Multiply by cost ratio
Conservative cost and/or Average cost

~ 48 ~
CHAPTER 22
FINANCIAL ASSET AT FAIR VALUE
INVESTMENTS
- are held for accretion of wealth, for capital appreciation or for other benefits to the investing entity
-assets that occupy only an auxiliary relationship

FINANCIAL INSTRUMENT
-must be a contract that gives rise to a financial asset of one entity and a financial liability or an equity
instrument of another

FINANCIAL ASSET
- pertains to cash or a contractual right to receive cash or any other financial asset from another entity
- contractual right to exchange financial instrument with another entity under potentially favorable
conditions
-an equity instrument or a financial liability of another entity

CLASSIFICATIONS OF FINANCIAL ASSET

1. Financial asset at fair value through profit or loss
- include equity and debt securities
2. Financial asset at fair value through other comprehensive income
- include equity and debt securities
3. Financial at amortized cost
- include debt securities

*Equity Security
-instrument representing ownership shares and right, warrants or options to acquire or dispose
ownership
- includes ordinary share, preference share and other share capital
- excludes redeemable preference share, treasury shares, and convertible debt
*Debt security
-represents a creditor relationship with another entity
- includes corporate bonds, treasury bills, commercial papers, redeemable preference shares

MODELS FOR MANAGING FINANCIAL ASSETS

1. To hold investment in order to realize fair value changes
2. To hold investment in order to collect contractual cash flows

~ 49 ~
INITIAL MEASUREMENT
 Fair Value through profit or loss (FVPL)
- fair value
-transaction costs are expensed outright
 Fair value through other comprehensive income (FVOCI)
-fair value plus transaction costs

*Transaction Costs
-fees and commissions paid to agents, advisers, brokers and dealers, levies by regulatory agencies and
transfer taxes and duties

SUBSEQUENT MEASUREMENT
 Fair value through profit or loss
 Fair value through other comprehensive income
 Amortized cost

MEASUREMENT OF TERMS
 Equity Investments
1. Held for trading -FVPL
2. Not held for trading- as a rule, FVPL
3. Not held for trading- if irrevocably designated, FVOCI
4. Investments in quoted equity instruments- FVPL
5. Investments in unquoted equity instruments- Cost
 Debt Investments
1. Held for trading- FVPL
2. Held for collection of contractual cash flows- amortized cost
3. Held for collection of contractual flows -if irrevocably designated, FVPL
4. Held for collection of contractual flows and for sale of financial asset- FVOCI
5. Held for collection of contractual flows and for sale of financial asset- if irrevocably
designated, FVPL

RECLASSIFICATION
- The entity shall not restate any previously recognized gains or losses and interest
-There must be a disclosure of the change in business model
1. Reclassification from FVPL to amortized cost
-New carrying amount= fair value at reclassification date
-Difference between the carrying amount and the face value= amortized in profit or loss using
the effective interest method
2. Reclassification from amortized cost to FVPL
-fair value is measured at reclassification date
- difference between the previous carrying amount and fair value= recognized in profit or loss
3. Reclassification from amortized cost to FVOCI
- fair value is measured at reclassification date

~ 50 ~
 -difference between the amortized cost carrying amount and fair value= recognized in other
comprehensive income
4. Reclassification from FVOCI to amortized cost
-New amortized carrying amount= fair value at reclassification date
- Cumulative gain or loss previously recognized in other comprehensive income is removed from
equity and adjusted against the fair value at reclassification date
5. Reclassification from FVPL to FVOCI
- continuously measured at fair value
- New carrying amount= fair value at reclassification date
6. Reclassification from FVOCI to FVPL
- continuously measured at fair value
- New carrying amount= fair value at reclassification date
- Cumulative gain or loss previously recognized in other comprehensive income is reclassified at
profit or loss at reclassification date

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CHAPTER 23
INVESTMENT IN EQUITY SECURITIES
INVESTMENT IN EQUITY SECURITIES
- acquisition of equity securities to accrue income or to increase market value or to control another
entity
- owners of these securities are called shareholders
ACQUISITION OF EQUITY SECURITIES by EXCHANGE
- acquisition cost is determined by reference to the following the order of priority
a. Fair value of asset given
b. Fair value of asset received
c. Carrying amount of asset given

LUMP SUM ACQUISITION

- single cost is allocated to the securities acquire on the basis of their fair value
* If only one security has a known market value, an amount is allocated to the security with a known
market value equal to its market value. The remainder of the single cost is then allocated tot he other
security with no known market value
CASH DIVIDENDS
- dividends earned are considered as income
- they do not affect the investment account
TRANSACTION JOURNAL ENTRY
Cash dividends earned but not received Dividends receivable xx
Dividend income xx
Cash dividends are subsequently received Cash xx
Dividends receivable xx

DIVIDENDS
Date of declaration
- date on which the payment of dividends is approved by the Board of Directors
-recognition of dividend income by the shareholder
Date of record
- date on which the stock and transfer of book of the corporation is closed for registration
- only shareholders registered as of this date are entitled to receive dividends
Date of payment
-date on which the dividends declared shall be paid

*Between the date of declaration and date of record, the share is selling DIVIDEND- ON

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ENRTY: Cash xx
Investment in equity securities xx
Dividend Income xx
Gain on sale of investment xx
*Between the date of record and date of payment , the share is selling EX- DIVIDEND

PROPERTY DIVIDENDS
- dividends in kind
- also considered as income and is recorded at fair value
ENTRY: Noncash asset xx
Dividend Income xx
LIQUIDATING DIVIDENDS
-represent returns of invested capital and therefore not considered as income
ENTRY: Cash xx
Investment in equity securities xx
*LIQUIDATING DIVIDENDS on a WASTING ASSET CORPORATION
-designated as partly income and partly return of capital
ENTRY: Cash xx
Dividend income xx
Investment in equity securities xx
STOCK DIVIDENDS
- IAS term for this is " bonus issue"
- in the form of issuing entity's on shares
KINDS OF STOCK DIVIDENDS
 Stock dividends of the same class
- recorded by means of a memorandum entry
- do not affect the total cost of the investment but reduce the cost of the investment per share
 Stock dividends different from those held
ENTRY: Receipt of preference shares as dividends
Investment in preference shares xx
Investment in ordinary shares xx

CASH RECEIVED IN LIEU OF CASH DIVIDENDS

-income is equal to the fair value of the shares received
- in the absence of fair value of shares received, income is equal to the cash dividends that would have
been received
ENTRY: Investment in equity securities xx
Dividend income xx
CASH RECEIVED IN LIEU OF STOCK DIVIDENDS
-use the " As if Approach"
ENTRY: Cash xx
Investment in equity securities xx
Gain on investment xx
SHARE SPLIT
-restructuring of capital by effecting a number of shares without capitalizing retained earnings

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 1. Split Up
-outstanding shares are called in and replaced by a larger number accompanied by a reduction
par or stated value of each share
2. Split Down
- outstanding shares are called in and replaced by a smaller number accompanied by an increase
in the par or stated value
- does not affect the total cost of investment but there is a decrease or increase in the cost per
share
-a memorandum entry is made to record the receipt of new shares

SPECIAL ASSESSMENT
-additional capital contributions
- on the part of the shareholders, it is an additional cost of the investment and on the part of the entity,
it is recorded as share premium
ENTRY: Investment in equity securities xx
Cash xx
REDEMPTON OF SHARES
- preference shares may be called in for redemption and cancellation by the entity issuing them
ENTRY: Cash xx
Investment in preference shares xx
Gain on investment xx
STOCK RIGHT
- pre-emptive right granted to shareholders to subscribe for new shares
- IAS term for this is "right issue"
ACCOUNTING FOR STOCK RIGHTS
 Stock rights are accounted for separately
- a portion of the carrying amount of the original investment in equity securities is allocated to
the stock rights at an amount equal to the fair value of the stock rights at the time of acquisition
 Stock rights are not accounted for separately
-stock rights are recognized as embedded derivatives and not a stand-alone derivatives

*Between the date of declaration and date of record, the shares are considered to be selling RIGHT ON
*Between the date of record and expiration date, the shares are considered to be selling EX- RIGHT
TRANSACTION JOURNAL ENTRY
Receipts of stock rights (measured at fair value) Stock rights xx
Investment in equity securities xx
Exercise of stock rights Investment in equity securities xx
Cash xx
Stock rights xx
Sale of stock rights Cash xx
Stock rights xx
Gain on sale of stock rights xx
Expiration of stock rights Loss on stock rights xx
Stock rights xx
THEORETICAL OR PARITY VALUE OF STOCK RIGHT
-this is assumed to be the fair value of the right that is derived from the market value of the share

~ 54 ~
FORMULAS:
 When the share is selling RIGHT ON
Market value of share right on minus subscription price
Value of one right=
Number of rights to purchase one share plus 1
 When the share is selling EX- RIGHT
Market value of share right on minus subscription price
Value of one right=
Number of rights to purchase one share

CHAPTER 24
INVESTMENT IN ASSOCIATE
INTERCORPORATE SHARE INVESTMENT
-purchase of the equity securities/ acquisition of share capital

DEFINITIONS
Significance Influence
- power to participate in the decision of investee but not to control or joint over those policies
-if the investor holds directly or indirectly through subsidiaries 20% or more of the voting power of the
investee
Control
- is the power over the investee/ the power to govern the financial and operating policies of an investee
so as to obtain benefits
Associate
-an entity over which the investor has significant influence
Subsidiary
- an entity that is controlled by another entity

POTENTIAL VOTING RIGHTS

-share warrants, debt or equity instruments that are convertible into ordinary shares
- if these are exercised or converted, it gives the entity additional voting power over the financial and
operating policies of the entity
- it should be currently exercisable

EQUITY METHOD
-initially recognized at cost
- carrying amount is increased/ decreased by investor's share of the profit or loss respectively
-dividends received reduce carrying amount
TRANSACTION JOURNAL ENTRY
Purchase of shares Investment in associate xx
Cash xx
Share in net income Investment in associate xx
Investment income xx
Receipt of stock dividend Memo entry

~ 55 ~
Share in net loss Loss on investment xx
Investment in associate xx
Receipt of cash dividend Cash xx
Investment in associate xx

EXCESS OF COST OVER ARRYING AMOUNT

-may be attributable to undervaluation of investee's assets (building, lad, or inventory) and goodwill
*If the assets of the investee are fairly valued, the excess of cost over carrying amount is attributable to
GOODWILL and it is not amortized
*If the excess is attributable to a depreciable asset, it is amortize over the remaining useful life of the
asset
*If the excess is attributable to undervaluation of land, it is not amortized
*If the excess is attributable to inventory, the amount is expensed once the inventory is sold

EXCESS OF NET FAIR VALUE OVER COST

PAS 28, Paragraph 32
"Any excess of the investor's share of the net fair value of the associate's identifiable assets and liabilities
over the cost of the investment is included as income in the determination of the investor's share of the
associate's profit or loss in the period in which the investment is acquired."

INVESTEE WITH HEAVY LOSSES

PAS 28, Paragraph 38
" If an investor's share of losses of an associate equals or exceeds the carrying amount of an investment,
the investor discontinues recognizing its share of further losses"

IMPAIRMENT LOSS
-when recoverable amount is measured as higher between fair value less cost of disposal and value in
use
- allocated firstly to any remaining goodwill

INVESTEE WITH CUMULATIVE PREFERENCE SHARES

-If an associate has outstanding cumulative preference shares, the investor shall compute its share of
earnings or losses after deducting the preference dividends, whether or not such dividends are declared.

INVESTEE WITH NON-CUMULATIVE PREFFERENCE SHARES

-When an associate has outstanding non-cumulative preference shares, the investor shall compute its
share after deducting the preference dividends only when declared

OTHER CHANGES IN EQUITY

-adjustments to the carrying amount of the investment in associate may e necessary for changes in the
investor's proportionate interest in the investee arising from changes in the investee's equity that have
not been recognized in the investee's profit or loss
-such changes include those arising from revaluation of property, plant and equipment and from foreign
exchange differences
ENTRY: Share in Revaluation Surplus
Investment in Associate xx
Revaluation Surplus- investee xx

~ 56 ~
UPSTREAM TRANSACTIONS
-are sale of assets from an associate to the investor
- income is recognized only when the investor sells the asset to a third party
- the unrealized profit from these transactions must be eliminated in determining the investor's share in
the profit or loss

DOWNSTREAM TRANSACTIONS
-are sale of asset from the investor to an associate
- the unrealized profit from these transactions must be eliminated in determining the investor's share in
the profit or loss

SALE OF DEPRECIABLE ASSET

- the profit on the sale of the equipment is realized as the asset is used or over the remaining useful life
of the asset

DISCONTINUANCE OF EQUITY METHOD- CHANGE FROM EQUITY

PAS 28, Paragraph 22
" An investor shall discontinue the use of the equity method from the date that it ceases to have a
significant influence over an associate"
Consequently, the investor shall account for the investment as follows:
1. FVPL
2. FVOCI
3. Non marketable investment at cost or Investment in unquoted equity instrument

MEASUREMENT OF LOSS OF SIGNIFICANT INFLUENCE

Pas 28, Paragraph 22
"On the date the significant influence is lost, the investor shall measure any retained investment in
associate at fair value."
*The difference between the carrying amount of the retained investment at the date the significant
influence is lost and the fair value of the retained investment shall be included in profit or loss

ASSOCIATE HELD FOR SALE

- shall be measured at the lower of carrying amount and air value less cost of disposal

INVESTMENT LESS THAN 20%

-when this occurs, the investor has clearly no significant influence over the entity unless such influence
can be clearly demonstrated

ACCOUNTING FOR INVESTMENT OF LESS THAN 20%

1. Fair Value Method
- applicable to financial asset measured at FVPL and FVOCI
- the investor does not share in the profit or loss
- the dividends received are accounted for as dividend income

~ 57 ~
 2. Cost Method
- usually applied with respect to investment in unquoted equity instrument or non marketable
equity investment
- the investor does not share in the profit or loss
- the dividends received are accounted for as dividend income

TRANSACTION JOURNAL ENTRY

Purchase of shares Investment in equity securities xx
Cash xx
Share in net income No entry
Stock Dividend Memo entry
Net loss No entry
Cash dividend Cash xx
Dividend Income xx
Sale of shares by investor Cash xx
Investment in equity securities xx
Gain on sale of investment xx

INVESTMENT IN ASSOCIATE ACHHIEVED IN STAGES

-known as "investment achieved in stages"
-fair value approach should be followed

FAIR VALUE APPROACH

 The existing interest in the associate is remeasured at fair value with any change in fair value
included in profit or loss
 f the existing interest is accounted for through other comprehensive income, any unrealized
gain or loss at the date the investee becomes an associate is reclassified to retained earnings
 Fair value of the existing interest plus the cost of the additional interest acquired constitutes the
total cost of investment for the initial application of the equity method
 Total cost of the investment for the initial application of the equity method minus the carrying
amount of the net assets acquired at the date the significant influence is obtained equals excess
of cost over carrying amount or net fair value

~ 58 ~
CHAPTER 25
FINANCIAL ASSET AT MORTIZED COST

Definition of bonds

A bond is a formal unconditional promise made under seal to pay a specified sum of money at a
determinable future date and to make periodic interest payments at a stated rate until the principal sum
is paid. In simple language, a bond is a contract of debt whereby one party called the issuer borrows fund
from another party called the investor. A bond is evidenced by a certificate and the contractual
agreement between the issuer and investor is contained in anther document known as “bond
indenture”.

Classification of bond investments

Bond investments are classified and accounted for as follows:

A. Financial asset at held for trading

B. Financial asset at amortized cost
C. Financial asset at fair value through other comprehensive income
D. Financial asset at fair value to profit or loss by irrevocable designation or by fair value option.

Initial measurement

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

Subsequent measurement

Subsequent to initial recognition, bond investments are measured and accounted for as follows:

~ 59 ~
A. At fair value through profit or loss
B. At amortized cost
C. At fair value through other comprehensive income

Acquisition of bond investment

Bods are acquired on interest date or between interest dates. When acquired on interest date there is
no accounting problem because purchase price is initially recognized as the acquisition cost. When
acquired between interest dates, the purchase price normally includes the accrued interest.

In effect, in this case, two assets are acquired, namely the bonds and the accrued interest. On the date
of acquisition, the accrued interest is charged either to accrued interest receivable or interest income.

Amortized cost

Amortized cost is the initial recognition amount of the investment minus repayments, plus amortization
of discount, minus amortization of premium, and minus reduction for impairment or uncollectibility.

Investment in bonds at amortized cost

PFRS 9,provides that a financial asset shall be measured at amortized cost if both of the following
conditions are met:

A. The business model is to hold the financial asset in order to collect contractual cash flows on specified
dates.

B The contractual cash flows are solely payments of principal and interest on the principal amount
outstanding.

Amortization of premium or discount

Any premium or discount on the acquisition of long-term investment in bonds must be amortized. Bond
premium or discount is amortized over the life of the bonds.

Amortization is done through the interest income account:

A. Amortization of bond discount:

Investment in bonds xx
Interest income xx

B. Amortization of bond premium:

Interest income xx
Investment in bonds xx

Philosophy on amortization

~ 60 ~
The reason for amortization of bond premium or discount is to bring the carrying amount of the
investment to face value on the date of maturity. The bondholder is a creditor and will collect on the
date of maturity an amount equal only to face value of the bonds no more and no less.

Conceptually, bond premium is a loss on the part of the bondholder. On the other hand, bond discount is
a gain on the part of the bondholder. Such process of allocating the bond premium as deduction from
the interest income and the bond discount as addition o interest income is what is traditionally called
amortization.

Sale of bonds prior to maturity

When bonds are sale prior to maturity date, it is necessary to determine the carrying amount of the
bonds investment to be used as the basis for gain or loss on sale. In such a case, amortization of the
premium or discount should be recognized up to the date f sale.
If sale is between interest dates, the sale price normally includes the accrued interest. Accordingly, that
portion of the sale price pertaining to the accrued interest should be credited to interest income. The
difference between sale price after deducting accrued interest and carrying amount represent gain or
loss.

Callable bonds

Callable bonds are those which may be called in or redeemed by the issuing entity prior to their date of
maturity. Usually, the call price or redemption price is at a premium or more than the face amount of the
bonds.

Convertible bonds

Convertible bonds are those which give the bondholders the right to exchange their bonds for share
capital of the issuing entity at any time prior to maturity. Accordingly, investment in convertible bonds
can be classified as financial assets measured at fair value.

Serial bonds

Serial bonds are those which have a series of maturity dates or those bonds which are payable in
instalment.

Term bonds

Term bonds are those bonds that mature on a single date. Callable and convertible bonds are classified
as term bonds despite their special features.
Methods of amortization

a. Straight line method- this method provides for an equal amount of premium or discount amortization

~ 61 ~
 each accounting period.

b. Bonds outstanding method- this method is applicable to serial bonds and provides for a decreasing
amount of amortization.

c. Effective interest method or simply “interest method” or scientific method- this method provides for
an increasing amount of amortization.

In accordance with PFRS 9, bond investment shall be classified as a financial assets measured at
amortized cost using effective interest method.

Straight line method

Following straight line method, the annual amortization of discount or premium is simply computed by
dividing the total discount or premium by the life of the bounds.

Bond outstanding method

Following the bond outstanding method, the bond outstanding is determine every bond year and is
decrease by the annual instalments. Fractions are developed from the bond outstanding column. And
the annual discount or premium amortization is computed by multiplying the fractions by the amount of
the discount.

~ 62 ~
CHAPTER 26
EFFECTIVE INTEREST METHOD

PFRS 9, requires that bond discount and bond premium shall be amortized using the effective interest
method. This method distinguishes two kinds of interest rates, namely nominal rate and effective rate.

The nominal rate is the coupon rate or stated rate which is the actual or true rate of interest which the
bondholder earns on the bond investment.

The effective rate is the rate that exactly discounts estimated future cash payments through the
expected life of the bonds or when appropriate, a shorter period to the net carrying amount of the bond.

Effective rate versus nominal rate

The effective rate and the nominal rate are the same if the cost of the bond is investment is equal to the
face value. When bonds are acquired at a premium, the effective interest rate is lower than the
nominal rate. On the other hand, when bonds are acquired at a discount, the effective rate is higher
than the nominal rate.

Effective interest method

The effective interest method simply requires the comparison between the interest earned or interest
income and the interest receive.

Interest earned or interest income is computed by multiplying the effective rate by the carrying amount
of the bond investment.

Interest received is computed by multiplying the nominal rate by the face amount of the bond.

Bond investment-FVOCI

PFRS 9, provides that a financial asset shall be measured at fair value to other comprehensive income if
both of the following conditions are met:

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A. The business model is achieved both by collecting contractual ash flows and by selling the financial
asset.
B. The contractual cash flows are solely payments of principal and interest on the principal outstanding.

* note that the business model includes selling the financial asset in addition to collecting contractual
cash flows. Another is that unlike trading bod investment, transaction cost is included in the cost of
financial asset measured at far vale through OCI.

Fair value option

PFRS 9, provides that an entity at initial recognition may irrevocably designate a financial assets as
measured at fair value through profit or loss even if the financial asset satisfies the amortized cost
measurement. In other words, investments in bonds can be designated without revocation as measured
at fair value through profit or loss even if the bonds are held for collection as a business model.
CHAPTER 27
INVESTMENT PROPERTY

PAS 40, prescribes the accounting treatment for investment property and related disclosure
requirements.

Investment property is defined as property (land or building or part of a building or both) held by an
owner or by the lessee under a finance lease to earn rentals or for capital appreciation or both. In other
words, only land and building can qualify as investment property.

An equipment or any movable property cannot qualify as investment property. The property held by an
owner or by the lessee under a finance lease for use in the production or supply of goods or services, or
for administrative purposes is known as owner-occupied property.

Investment property versus owner-occupied

Investment property is held to earn rentals or for capital appreciation or both. Therefore, an investment
property generates cash flows that are largely independent of the other assets of the entity. This is the
characteristic that distinguishes investment property from owner-occupied property.

Property interest held by lessee

A property interest held by the lessee under an operating lease may be classified and accounted for as
investment property provided:

A. The property meets the definition of investment property.

B. The operating lease is accounted for as if it were a finance lease.
C. The lessee uses the fair value model in measuring the property interest.

This classification alternative is available on a property by property basis

Partly investment and partly owner-occupied

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Certain properties may include a portion that is held to earn rentals for appreciation and another portion
is held for manufacturing or administrative purposes.

If these portions could be sold or leased out separately, an entity shall account the proportions
separately as investment property and owner-occupied. If the portions could not be sold separately, the
property is investment property if only an insignificant portion is held for manufacturing or
administrative purposes.

However, if the services provide are a more significant component of the arrangement, the property is
treated as owner-occupied property.

Property leased to an affiliate

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

Initial measurement of investment property

An investment property shall be measured initially at its cost. Transaction cost shall be included i the
initial measurement.

The cost of a purchased investment property comprises the purchase price and any directly attributable
expenditure. The cost of self-constructed investment property is the cost at the date when the
construction or development is complete.

If payment for an investment property is deferred, the cost is the cash price equivalent. The difference
between this amount and the total payments is recognized as interest expense over the credit period.

Subsequent measurement

An entity shall choose either of the following to be applied to all of the investment property:

A. Fair value model- investment property is carried at

B. Cost model- investment property is carried at cost less any accumulated depreciation and any
impairment losses.

However, when a property interest held by a lessee under an operating lease is classified as an
investment property, the fair value model shall be applied.

Fair value of investment property

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly

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transaction between market participants at the measurement ate. The fair value of investment property
excludes prepaid or accrued operating lease income.

Active market and principal markets

An active market is a market in which transactions for the asset or liability take place with sufficient
regularity and volume to provide pricing information on an ongoing basis.

A principal market is the market with the greatest volume and level of activity for the asset or liability.

The market participants are the buyers and sellers in the principal market who are:
A. Independent or unsaturated parties.
B. Knowledgeable or having a reasonable understanding of the transaction.
C. Willing or motivated but not forced and compelled
Cost model

If the entity decides to measure the investment property under the cost model, the asset shall be carried
at cost less accumulated depreciation and any accumulated impairment losses.

Fluctuations in the fair value of the investment property from year to year are not recognized. Instead,
the annual depreciation of the investment property is the change against profit or loss for the year,
unless there is impairment of the asset.

Fair value model

If entity decided to measure the investment property under the fair value model, the changes in the fair
value from year to year are recognized in profit or loss. No depreciation is recorded for the investment
property.

Transfer of investment property

Transfer to and from investment property shall be made when and only when there is a change of use
evidence by:

A. Commencement of owner occupation- transfer from investment property to owner-occupied

property.
B. Commencement of development with a view to sale- transfer from investment property to inventory.
C. End of owner occupation- transfer from owner-occupied property to investment property.
D. Commencement of an operating lease to another entity- transfer from owner-occupied property to
investment property.

Measurement of transfer

1. When cost model is used, transfers between investment property,owner-occupied property and
inventory shall be made at carrying amount.
2. A transfer from investment property carried at fair value to owner-occupied property or inventory
shall be accounted for at fair value which becomes the deemed cost for subsequent accounting.
3. If owner-occupied property is transferred to investment property that is to be carried at fair value,

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the difference between the fair value and the carrying amount of the property shall be accounted for as
revaluation of property, plant and equipment.
4. If an inventory is transferred to investment property that is to be carried at fair value, the re
measurement to fair value shall be included in profit or loss.
5. When an investment property under construction is completed and to be carried at fair value, the
difference between fair value and carrying amount shall be included in profit or loss.

Disposal of investment property

Gain or loss from disposal of investment property shall be determined as the difference between the net
disposal proceeds and the carrying amount of the assets and shall be recognize on profit or loss.

CHAPTER 28
FUND AND INVESTMENT
The term fund is defined as cash and other assets set aside for a specific purpose either by reason of the
action of management or by virtue of contract or legal requirement. The specific purpose my be current
or noncurrent.

Measurement of fund

Long term fund shall be carried at the amount of cash plus the cost of securities adjusted for discount or
premium amortization, and other assets in the fund.

Sinking fund

Sinking fund or redemption fund is a fund set aside for the liquidation of long term debt, more
particularly long term bonds payable. The accounting for sinking fund depends on whether the fund is
under the administration of the entity or under the charge of a trustee.

Fund under the administration of the entity

When funds are under the administration of the entity, the entity records the fund transactions currently
and thus makes a distinction whether the fund is in the form of cash, securities and other assets.

Fund under the administration of a trustee

If the funds are under the administration of a trustee, fund transactions are not currently recorded by
the entity. The account “sinking fund-trustee” is used.

Sinking fund contribution

The amount of periodic contribution to the sinking fund may be voluntary or mandatory.

It is voluntary if the sinking fund contribution is the result of a discretionary action of management.

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It is mandatory if the sinking fund contribution is required by contract, usually with bondholders

Annual contribution at the end of each year

The annual contribution is simply computed by dividing the fund to be accumulated by the future value
of an ordinary annuity of 1.

Classification of sinking fund

As a rule, sinking fund is classified as noncurrent asset. However, if the bond for where the sinking fund
was set aside becomes due within 12 months after the end of reporting period, the sinking fund is
reclassified as current asset. The classification of fund shall parallel the classification of the related
liability.
Fund for acquisition of property

The future acquisition of property, plant and equipment may involve the setting aside of a certain
amount of cash. Such fund may be called “replacement fund” or “plant expansion funds”.

A replacement fund, as the title suggests is cash set aside in anticipation of future acquisition of
additional property because of expanded or increased volume of operations.

Contingency fund

A contingency fund is cash set aside for the purpose of meeting obligations that may arise from
contingencies like pending lawsuits or taxes in dispute.

Insurance fund

An insurance fund is cash set aside for the purpose of meeting obligations that may arise from certain
risks not insured against, such as fire, typhoon, explosion and other similar casualties. The establishment
of an insurance fund is the result of a policy of self-insurance which is actually a policy of “no insurance”

Cash surrender value

Cash surrender value is the amount which is the amount which the insurance firm will pay upon the
surrender and cancellation of the life insurance policy.

The entity may insure the life of its officers and name itself as beneficiary. If the beneficiary is the officer
insured or any person other than the entity like the wife of the officer, no accounting problem is
encountered because the payment of the premium is simply charged to insurance expense. An
accounting problem will arise when the beneficiary is the entity itself. It is on this assumption that the
following discussion is geared.
CHAPTER 29
DERIVATIVES
INTERST RATE SWAP

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Purpose of derivative

Entities use derivative financial instruments to manage financial risk. Financial risk originates from
sources, such a change in commodity price, change in cash flows and foreign currency exposure.
Actually, derivative financial instruments create rights and obligations that have the effect of transferring
between the parties to the instrument the financial risks inherent in an underlying primary financial
instrument.

Types of financial risk

A Price risk is the uncertainty about the future price of an asset.

A credit risk is the uncertainty over whether a counter party or the party on the other side of the
contract will honor the terms of the contract.

Interest rate risk is the uncertainty about future interest rates and their impact on cash flows and the
fair value of the financial instruments

Foreign currency risk is the uncertainty about future Philippine peso cash flows stemming from assets
and liabilities denominated in foreign currency.

What is derivative?

A derivative is simply a financial instrument that derives its value from the movement in commodity
price, foreign exchange rate and interest rate of an underlying asset or financial instrument. Actually, a
derivative is an executory contract, meaning, it is not a transaction but n exchange of promise about
future action.

On inception, derivative financial instrument give one party a contractual right to exchange financial
asset, or financial liability with another party under conditions that are potentially favorable. On the
other hand, the other party has a contractual obligation to exchange under potentially unfavorable
conditions.

Hedging

Hedging means designating one or more hedging instruments so that the change in fair value or cash
flows is an offset, in whole or in part, to exchange in fair value or cash flow of an hedge item. Simply
stated, hedging is means of protecting a financial loss or the structuring of a transaction to reduce risk.

There are three types of hedging relationship, namely fair value hedge, cash flow hedge, hedge of a net
investment in a foreign operation.
Hedging instrument

A hedging instrument is the derivative whose fair value or cash flow would be expected to offset changes
in the fair value or cash flow of the hedged item.

Hedge item

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A hedged item is an asset, liability, firm commitment, highly probable forecast transaction or net
investment in a foreign operation. To be designated as hedge item, the hedge item should expose the
entity to risk of changes in fair value or future cash flows.

Measurements of derivatives

An entity shall recognized and measure all derivatives as either assets or liabilities at fair value. An
unrealized gain or loss is recognized when there is change in the fair value.

No hedging designation

Changes in fair value of a derivative that is not designated as a hedging instrument shall be recognized in
profit or loss.

Cash flow hedge

A cash flow hedge is a derivative that offsets in whole or in part the variability in cash flows from the
probable forecast transaction.

Fair value hedge

A fair value hedge s a derivative that offsets in whole or in part the change in the fair value of an asset or
a liability.

Examples of derivatives

A. Interest rate swap

B. Forward contract
C. Futures contract
D. Option
E. Foreign currency forward contract

Note that these derivatives are financial instruments separate from the primary financial instruments,
meaning, “”stand-alone” derivatives.

Interest rate swap

Interest rate swap is contract whereby two parties agree to exchange cash flows for future interest
payments based on a contract of loan. The contract of loan is the primary financial instrument and the
interest rate swap agreement is the derivative financial instrument.

CHAPTER 30
DERIVATIVES
FORWARD CONTRACT
-is an agreement between two parties to exchange a specified amount of commodity, security, or foreign

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currency on a specified date at a specified price or exchange rate
TRANSACTION JOURNAL ENTRY
Forward Contract Forward contract receivable xx
Unrealized gain- forward contract xx
Actual purchase Purchases xx
Cash xx
Cash payment from bank/ another entity Cash xx
Forward contract receivable xx
Unrealized gain- forward contract xx
Purchases xx

FUTURES CONTRACT
-contract to purchase or to sell at some future date at a specified price
- standard contract traded in a futures exchange market and one party will never know who is on the
other side of the contract and it is traded in a futures exchange market
TRANSACTION JOURNAL ENTRY
Futures Contract Future contract receivable xx
Unrealized gain- futures contract xx
Actual purchase Purchases xx
Cash xx
Cash payment from bank/ another entity Cash xx
Future contract receivable xx
Unrealized gain- futures contract xx
Purchases xx

OPTION

- is a contract that gives the holder the right to purchase or sell an asset at a specified price during a
definite period at some future time
- it is a right not an obligation
- requires a initial small payment for the protection against unfavourable movement in price which is
called as "option premium"
 Call Option
- give the holder the right to purchase
-if this is not exercised, a loss is to be recognized amounting to the amount of initial small
payment
*Market Price < Exercise Price -out of the money
*Market Price > Exercise Price -in of the money
*Market Price = Exercise Price- at the money
 Put Option
- give the holder the right to sell
 Time Value Option
-an amount over and above the intrinsic value
*Intrinsic value - excess of the market price over the strike price
-any loss is recognized in profit or loss

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 TRANSACTION JOURNAL ENTRY
Purchase of option Call option xx
Cash xx
Actual purchase of asset Purchases xx
Cash xx
Increase in fair value of option Call option xx
Unrealized gain- call option xx
Exercise of option (amount equal to the Unrealized gain- call option xx
difference between market price and exercise Gain on call option xx
price)
If the option is not exercised Loss on call option xx
Unrealized gain- call option xx
Call option xx

FOREIGN CURRENCY FORWARD CONTRACT

- protection for foreign currency risks which arises by reason of the volatility of the exchange rate of peso
in relation to foreign currency

EMBEDDED DERIVATIVE
-is a component of a hybrid or combined contract with the effect that some of the cash flows of the
combined contract vary in a way similar to stand- alone derivative
-this means that a basic contract known as "host contract" has an embedded derivative
EXAMPLES OF EMBEDDED DERIVATIVE
 Equity Conversion Option
 Redemption Option
 Investment in bond whose interest and principal is linked to a price of gold or silver

EMBEDDED DERIVATIVE- Accounted for separately

*Bifurcation0 is the process of separating the embedded derivative from the host contract
PFRS 9, Paragraph 4.3.3,
"An embedded derivative shall be separated from the host contract and accounted for as if it were a
stand-alone derivative if the following conditions are met:
1. A separate instrument with the same terms as the embedded feature would meet the definition
of a derivative
2. The combined contract is not measured at profit or loss
3. The economic characteristics and risks of the embedded derivative and host contract are not
closely related
4. The host contract is outside the scope of PFFRS 9

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HOST CONTRACT WITHIN THE SCOPE OF PFRS 9
*If the host contract is a financial asset, the embedded derivative is not separated.
* Accordingly, the host contract in its entirety is measured either at amortized cost, fair value through
profit or loss, and fair value through other comprehensive income, depending on the business model of
the entity in managing financial assets.

CHAPTER 31
PROPERTY, PLANT AND EQUIPMENT

Definition
Property, plant and equipment are tangible assets that ar held for use in the production or supply of
goods or services, for rental to others, or for administrative purposes, and are expected to be used
during more than one period. Property, plant and equipment are classified as noncurrent assets. The old
term for Property, plant and equipment is “fixed assets”.
Recognition
An item of property, plant and equipment shall be recognized as an asset when:
a. It is probable that future economic benefits associated with the asset will flow to the entity.

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

Spare Parts and Servicing Equipment

Major spare parts and stand-by equipment qualify as property, plant and equipment when the entity
expects to use them during more than one period.
The spare parts and servicing equipment are depreciated over their useful life or the useful life of the
related asset, whichever is shorter.

Measurement at recognition
An item of property, plant and equipment that qualifies for recognition as an asset shall be measured at
cost. Cost is the amount of cash or cash equivalent paid and the fair value of the other consideration
given to acquire an asset at the time of acquisition or construction.

Elements of cost
a. Purchase price, including import duties and non-refundable purchase taxes, after deducting trade
discounts and rebates.
b. Cost directly attributable
c. Initial estimate of the cost of dismantling and removing the item and restoring the site on which it is
located, the obligation for which an entity incurs.

Directly attributable costs

a. Cost of employee benefits arising directly from the construction or acquisition of the item of property,
plant and equipment
b. Cost of site preparation
c. Initial delivery and handling cost
d. Installation and assembly cost
e. Professional fees
f. Cost of testing
Costs not qualifying for recognition
a. Costs of opening a new facility
b. Costs of introducing a new product or service
c. Costs of conducting business in a new location or with a new class of customer, including costs of staff
training
d. Administration and other general overhead costs
e. Costs incurred while an item capable of operating in the manner intended by management has yet to
be brought into use or is operated at less than full capacity
f. Initial operating losses
g. Costs of relocating or reorganizing part or all of an entity’s operations

Measurement after recognition

An entity shall choose either the cost method or the revaluation method as the accounting policy for
property, plant and equipment.
The entity shall apply such accounting policy to an entire class of property, plant and equipment.
The cost model means that property, plant and equipment are carried at cost less any accumulated
depreciation and any accumulated impairment loss.
The revaluation model means that property, plant and equipment are carried at the fair value at the
date of revaluation less any subsequent accumulated depreciation and subsequent accumulated
impairment loss.

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Acquisition of property

Acquisition on a cash basis

The cost of an item of property, plant and equipment is the cash price equivalent at the recognition ate.
The cost of the asset acquired on a cash basis simply includes the cash paid plus directly attributable
costs.
Moreover, when several assets are acquired at a “basket price” or “lmp sum price”, it is necessary to
apportion the single price to the assets acquired on the basis of relative fair value.

Acquisition on account
An asset is subject to a cash discount, the cost of the asset is equal to the invoice price minus the
discount, regardless of whether the discount is taken or not.
If the discount is taken, the same is charged to purchase discount lost account which is shown as other
expense.
Cash discounts are generally considered as reduction of cost and not as income.

GROSS METHOD
1. To record the acquisition
Equipment xxxx
Accounts payable xxxx

2. To record the payment within the discount period

Accounts payable xxxx
Cash xxxx
Equipment xxxx

3. To record the payment within the discount period

Accounts payable xxxx
Purchase discount lost xxxx
Cash xxxx
Equipment xxxx

NET METHOD
1. To record the acquisition
Equipment xxxx
Accounts payable xxxx

2. To record the payment within the discount period

Accounts payable xxxx
Cash xxxx

3. To record the payment beyond the discount period

Accounts payable xxxx
Purchase discount lost xxxx
Cash xxxx

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Acquisition on instalment basis
If an asset is offered at a cash price and at an instalment price and is purchased at the instalment price,
the asset shall be recorded at the cash price.
No available cash price
The asset is recorded at an amount equal to present value of all payments using an implied interest rate.

Issuance of share capital

The property shall be measured at an amount equal to the following in order of priority:
a. Fair value of the asset received
b. Fair value of the share capital
c. Par or sated value of the share capital

Issuance of bonds payable

The asset acquired by issuing bonds payable is measured in the following order:
a. Fair value of the bonds payable
b. Fair value of the asset received
c. Face amount of the bonds payable

Exchange
The cost of an item of property, plant and equipment is measured at fair value.
However, the exchange is recognized at carrying amount under the following circumstances:
a. The exchange transaction lacks commercial substance
b. The fair value of the asset given or received is not reliably measurable

Exchange-no cash involved, with commercial substance

The cost is measured at the following in order of priority:
a. Fair value of the property given
b. Fair value of property received
c. carrying amount of property given

Exchange-cash is involved
The cost of the property is equal to the following:
a. Fair value of the asset plus cash payment- on the part of the payor
b. Fair value of the asset minus cash payment- on the part of the recipient

Trade in
Trade in is a form of exchange.
This means that a property is acquired by exchanging another property as part payment and the balance
payable in cash or any other form of payment in accordance with agreed terms.
The new asset is recorded at the following in the order of priority:
a. Fair value of the asset given plus cash payment
b. Trade in value of the asset given plus cash payment

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CHAPTER 32
GOVERNMENT GRANT
Definition

Government grant is assistance by the government in the form of transfer of resources to an etity in
return for part or future compliance with certain conditions relating to the operating activities of the
entity.

Recognition and measurement

Government grant shall be recognized when there is reasonable assurance that:
a. The entity will comply with the conditions attaching to the grant

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b. The grant will be received

Accounting for government grant

PAS 20 provides that “grant” in recognition of specific expenses shall be recognized as income over the
period of the related expense.

PAS 20 provides that “grant related to depreciable asset shall be recognized as income over the periods
and in proportion to the depreciation of the related asset”.

PAS 20 provides that ‘grant related to nondepreciable asset requiring fulfilment of certain conditions
shall be recognized as income over the periods which bear the cost of meeting the condition”.

PAS 20 provides that “a government grant that becomes receivable as compensation for expenses or
losses already incurred or for the purpose of giving immediate financial support to the entity with no
further related costs shall be recognized as income of the period in which it becomes receivable”.

Presentation of government grant

1. Government grant related to asset, including nonmonetary grant at fair value, shall be presented in
the statement of financial position in either of two ways:

a. By setting the grant as deferred income

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

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

a. The grant is presented in the income statement, either separately or under the general heading “other
income”
b. Alternatively, the grant is deducted from the related expense

Repayment for government grant

A government grant that becomes repayable because of noncompliance with conditions shall be
accounted for as a change in accounting estimate.
Repayment of a grant related to income shall be applied first against any unamortized deferred income
and any excess shall be recognized immediately as an expense.
The cumulative additional depreciation that would have been recognized to date in the absence of the
grant shall be recognized immediately as an expense.

Grant of interest-free loan

A forgivable loan from government is treated as a government grant when there is reasonable assurance
that the entity will meet the terms for forgiveness of the loan.
The benefit of a government loan with a NIL or below market rate of interest is treated as a government
grant.
The benefit is measured as the difference between the face amount and the present value of the loan.

Government assistance
Government assistance is action by government designed to provide an economic benefit specific to an
entity or range of entities qualifying under certain criteria.

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Examples of government assistance are:

a. Free technical or marketing advice

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

Government assistance does not include the following indirect benefits:

a. Infrastructure in development areas such as improvement to the general transport and

communication network
b. Imposition of trading constraints on competitors
c. Improved facilities such as irrigation for the benefit of an entire local community

CHAPTER 33
BORROWING COSTS
Definition

Under PAS 23, paragraph 5, borrowing costs are defined as “interest and other costs that an entity incurs
in connection with borrowing of funds”.
This definition encompasses interest on all types of borrowing, including finance leases and ancillary
costs incurred in connection with the arrangement of borrowing.

Paragraph 6 provides that borrowing costs specifically include:

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a. Interest expense calculated using the effective interest method.
b. Finance charge with respect to a finance lease.
c. Exchange difference arising from foreign currency borrowing to the extent that it is regarded as an
adjustment to interest cost.

Qualifying asset
A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for the
intended use or sale.

Accounting for borrowing cost

1. If the borrowing is directly attributable to the acquisition, construction or production of a qualifying

asset, the borrowing cost is required to be capitalized as cost of the asset.
2. All other borrowing costs shall be expensed as incurred.

Asset financed by “specific borrowing”

PAS 23, paragraph 12, provides that if the funds are borrowed specifically for the purpose of acquiring a
qualifying asset, the amount of capitalizable borrowing cost is the actual borrowing cost incurred during
the period less any investment income from the temporary investment of those borrowings.

Asset financed by “general borrowing”

PAS 23, paragraph 14, provides that if the funds are borrowed generally and used for acquiring a
qualifying asset, the amount of capitalizable borrowing cost is equal to the average carrying amount of
the asset during the period multiplied by a capitalization rate or average interest rate.

However, the capitalizable borrowing cost shall not exceed the actual interest incurred.
The capitalization rate or average interest rate is equal to the total annual borrowing cost divided by the
total general borrowings outstanding during the period.
No specific guidance is provided for general borrowing with respect to investment income.
Accordingly, any investment income from general borrowing is not deducted from capitalizable
borrowing cost.

Commencement of capitalization

The capitalization of borrowing costs as part of the cost of a qualifying asset shall commence when the
following three conditions are present:

a. When the entity incurs expenditures for the asset.

b. When the entity incurs borrowing costs.
c. When the entity undertakes activities that are necessary to prepare the asset for the intended use or
sale.

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CHAPTER 34
LAND and BUILDING
LAND ACCOUNT

Statement classification
The classification of land in the statement of financial position depends on the nature and purpose of
the land.
Land used as a plant site shall be treated as property, plant and equipment.
Land held for a currently undetermined use is treated as an investment property.
However, if the land is held definitely as a future plant site, it is classified as owner-occupied property
and not an investment property and therefore shall be included in property, plant and equipment.

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This accounting treatment is in accordance with paragraph 9 of PAS 40.

Costs chargeable to land

a. Purchase price
b. Legal fees and other expenditures for establishing clean title
c. Broker or agent commission
d. Escrow fees
e. Fees for registration and transfer of title
f. Cost of relocation or reconstruction of property belonging to others in order to acquire possession
g. Mortgages, encumbrances and interest on such mortgages assumed by buyer
h. Unpaid taxes up to date of acquisition assumed by buyer
i. Cost of survey
j. Payments to tenants to induce them to vacate the land in order to prepare the land for the intended
use but not to make room for the construction of new building
k. Cost of permanent improvements such as cost of clearing, cost of grading, levelling and landfill
l. Cost of option to buy the acquired land.
If the land is not acquired, the cost of option is expensed outright.

Land improvements

If land improvements are additions to cost not subject to depreciation, these are charged to the land
account.
Examples of these expenditures are cost of surveying, cost of clearing, cost of grading, levelling and
landfill, cost of subdividing and other cost of permanent improvement.
On the other hand, if land improvements are depreciable, these are charged to a special account “land
improvements”.
Examples of these improvements are fences, water systems, drainage systems, sidewalks, pavements
and cost of trees, shrubs, and other landscaping.
Land improvements of this type should be depreciated over their useful life.

Special assessments
Special assessments are taxes paid by the landowner as a contribution to the cost of public
improvements. Special assessments are treated as part of the cost of the land.

Real property taxes

As a rule, real property taxes are treated as outright expense.
However, if unpaid real property taxes are assumed by the buyer in acquiring land, the taxes are
capitalized but only up to the date of acquisition.

BUILDING ACCOUNT

Costs of building when purchased

a. Purchase price
b. Legal fees and other expenses incurred in connection with the purchase
c. Unpaid taxes up to date of acquisition
d. Interest, mortgages, liens and other encumbrances on the building assumed by the buyer
e. Payments to tenants to induce them to vacate the building

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f. Any renovating or remodeling costs incurred to put a building purchased in a condition suitable for the
intended use such as lighting installations, partitions and repairs.

Costs of building when constructed

a. Material used, labor employed and overhead incurred during the construction
b. Building permit or license
c. Architect fee
d. Superintendent fee
e. Cost of excavation
f. Cost of temporary buildings used as construction offices and tools or materials shed
g. Expenditures incurred during the construction period such as interest o construction loans and
insurance.
h. Expenditures for service equipment and fixtures made a permanent part of the structure.
i. Cost of temporary safety fence around construction site and cost of subsequent removal thereof.
However, the construction of a permanent fence after the completion of the building is recognized as
land improvement.
j. Safety inspection fee

Claims for damages

Where insurance is taken during the construction of a building, the cost of insurance is charged to the
building because it is a necessary and a reasonable cost o bringing the building into existence.
However, where insurance is not taken, an accounting problem arises when the entity is required to pay
claims for damages for injuries sustained during the construction.

Building fixtures
Expenditures for shelves, cabinets and partitions may be charged to the building or furniture and fixtures
depending upon the nature of the expenditures.
If such expenditures are in movable in the sense that these are attached to the building in such that the
removal thereof may destroy the building, these are charged to the building account.
On the other hand, if such expenditures are movable, these are charged to furniture and fixtures and
depreciated over their useful life.

PIC Interpretation on land and building

1. Land and an old building are purchased at a single cost.

a. If the old building is usable, the single cost is allocated to land and building based on relative fair
value.
b. If the old building is unusable, the single cost is allocated to land only.

2. The old building is demolished immediately to make room for construction of a new building:

a. Any allocated carrying amount of the usable old building is recognized as a loss if the new building is
accounted for as property, plant and equipment or investment property
b. Any allocated carrying amount if the usable old building is capitalized as cost of the new building if

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the new building is accounted for as inventory.
c. The demolition cost minus salvage value is capitalized as cost of the new building whether the new
building is accounted for as property, plant and equipment, investment property or inventory.
d. Needless to say, the net demolition cost is capitalized as cost of the land if the old building is
demolished to prepare the land for the intended use but not to make room for the construction of new
building.

3. A building is acquired and used in a prior period but demolished in the current period to make room
for construction of a new building:

a. The carrying amount of the old building is recognized as a loss, whether the new building is property,
plant and equipment, investment property or inventory.
b. The net demolition cost is capitalized as cost of the new building whether the new building is
accounted for as property, plant and equipment, investment property or inventory.
c. If the old building is subject to a contract of lease, any payments to tenants to induce them to vacate
the old building shall be charged to the cost of the new building.

CHAPTER 35
MACHINERY
Capital and revenue expenditure

Cost of machinery

When machinery is purchased, the cost normally includes the following:

a. Purchase price
b. Freight, handling, storage and other cost related to the acquisition
c. Insurance while in transit
d. Installation cost, including site preparation and assembling

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e. Cost of testing and trial run, and other cost necessary in preparing the machinery for its intended use.
f. Initial estimate of cost of dismantling and removing the machinery and restoring the site on which it is
located, and for which the entity has a present obligation.
g. Fee paid to consultants for advice on the acquisition of the machinery.
h. Cost of safety rail and platform surrounding machine.
i. Cost of water device to keep machine cool.
The value added tax or VAT on the purchase of machinery is not capitalizable but charged to input tax to
be offset against output tax.
However, any irrecoverable or non-refundable purchase tax is capitalized as cost of the machinery.

Tools
Tools are classified as machine tools and hand tools. Machine tools include drills and punches. Hand
tools include hammer and saws. Tools should be segregated from the machinery account.

Equipment
The term “equipment” includes delivery equipment, store equipment, office equipment and furniture
and fixtures.
The cost of such equipment includes the purchase price, freight and other handling charges, insurance
while in transit, installation costs and other costs necessary in preparing them for the intended use.

Returnable containers
Returnable containers include bottles, boxes, tanks, drums and barrels which are returned to the seller
by the buyer when the contents are consumed or used.
Containers in big units or of great bulk as in the case of tanks, drums and barrels are classified as
property, plant and equipment.
On the other hand, containers that are small and individually involve small amount as in the case of
bottles and boxes are classified as other noncurrent assets.

Recognition of subsequent cost

The recognition of subsequent cost is subject to the same recognition criteria for the initial cost of
property, plant and equipment.
Accordingly, the subsequent cost incurred for property, plant and equipment shall be recognized as an
asset when:
a. It is probable that future economic benefits associated with the subsequent cost will flow to the
entity.
b. The subsequent cost can be measured reliably.
In other words, if the subsequent cost will increase the future service potential of the asset, the cost
should be capitalized.
If the subsequent cost merely maintains the existing level of performance, the cost should be expensed
when incurred.

Subsequent cost
Generally, the following expenditures are incurred during ownership of existing property, plant and
equipment.
a. Additions
b. Improvements or betterments
c. Replacements
d. Repairs

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e. Rearrangement cost

Addition
Additions are modifications or alterations which increase the physical size or capacity of the asset. Such
expenditures are of two types, namely:
a. An entire new will
b. An expansion, enlargement or extension of the old asset

Improvements or betterments
Improvements or betterments are modifications or alternations which increase the service life or the
capacity of the asset.
Improvements may represent replacement of an asset or part thereof with one of the better or superior
quality. Such expenditures are normally capitalized.

Replacements
Replacements also involve substitution but the new asset is not better than the old asset when acquired.
The basic difference between an improvement and replacement is that an improvement is a substitution
of a better or superior quality whereas a replacement is a substitution of an equal or lesser quality.

Repairs
Repairs are those expenditures used to restore assets to good operating condition upon their breakdown
or replacement of broken parts.
Repairs may be classified as extraordinary repairs and ordinary repairs.
Extraordinary repairs are material replacement of parts, involving large sums and normally extend the
useful life of the asset.
Extraordinary repairs are usually capitalized.
Ordinary repairs are minor replacement of parts, involving small sums and are frequently encountered.
Ordinary repairs are normally charged to expense when incurred.

Repair and maintenance

Repair is different from maintenance in that repair restores the asset in good operating condition while
maintenance keeps the asset in good condition.
Thus, repair is restorative or curative while maintenance is preventive.

Rearrangement cost
Rearrangement cost is the relocation or reinstallation of an asset which proves to be less efficient in the
original location.

The rearrangement normally increases the future service potential of the asset and therefore the
rearrangement cost should be capitalized.

However, if the rearrangement merely maintains the existing level of performance of the asset, the
rearrangement cost should be expensed immediately.

Accounting for major replacement

An important consideration in determining the appropriate accounting treatment for a replacement is
whether the original part of an existing asset is separately identifiable.

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If separate identification is practicable, the major replacement is debited to the asset account.

The cost of the part eliminated and the related accumulated depreciation are removed from the
accounts and the remaining carrying amount of the old part is treated as a loss.

If it is not practicable for an entity to determine the carrying amount of the replaced part, it may use the
cost of the replacement as an indication of the “likely original cost” of the replaced part at the time it
was acquired or constructed.

However, the current replacement cost shall be discounted.

CHAPTER 36
DEPRECIATION
Concept of depreciation

Property, plant and equipment, except land, normally are usable for a number of years after which the
assets have relatively little value either for service or for sale.
The difference between the original cost of a property and any remaining value when it is retired or
worn out is in expense that should be distributed to the periods during which the asset is used.
Depreciation is defined as “the systematic allocation of the depreciable amount of an asset over the
useful life.”

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Depreciation is not so much a matter of valuation as it is a matter of cost allocation in recognition of the
exhaustion of the useful life of an item of property, plant and equipment.
The objective of depreciation is to have each period benefiting from the use of the asset bear an
equitable share of the asset cost.

Depreciation in the financial statements

Depreciation is an expense. It may be a part of the cost of goods manufactured or an operating expense.
The depreciation charge for each period shall be recognized as expense unless it is included in the
carrying amount of another asset.

Depreciation period
Depreciation of an asset begins when it is available for use, meaning, when the asset is in the location
and condition necessary for it to be capable of operating in the manner intended by management.
Depreciation ceases when the asset is derecognized.

Kinds of depreciation
There are two kinds of depreciation, namely physical depreciation and functional or economic
depreciation.
Physical depreciation is related to the depreciable assets and tear and deterioration over a period.
Physical depreciation may be caused by:
a. Wear and tear due to frequent use
b. Passage of time due to nonuse
c. Action of the elements such as wind, sunshine, rain or dust
d. Accidents such as fire, flood, earthquake and other natural disaster
e. Disease- This physical cause is applicable to animals and wooden buildings.

Accordingly, physical depreciation results to the ultimate retirement of the property or termination of
the service of the asset.

Functional or economic depreciation arises from inadequacy, supersession and obsolescence.

Inadequacy arises when the asset is no longer useful to the entity because of an increase in the volume
of operations.

For example, adequate buildings acquired at the inception of business may become inadequate or
limited in their future service potential when unexpected business growth or expansion requires larger
facilities for efficient operation.

Supersession arises when a new asset becomes available and the new asset can perform the same
function more efficiently and economically or for substantially less cost.

Obsolescence is the catchall for economic or functional depreciation.

For example, obsolescence arises when there is no future demand for the product which the asset
produces.

Obsolescence encompasses inadequacy and supersession.

In other words, an asset becomes obsolete if it is inadequate or superseded.

Depreciable amount

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

Residual value
Residual value is the estimated amount that an entity would currently obtain from disposal of an asset,
after deducting the estimated cost of disposal, if the asset were already of the age and condition
expected at the end of the useful life.

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

Methods of depreciation

Straight line method

Under the line method, the annual depreciation charge is calculated by allocating the depreciable
amount equally over the number of years of estimated useful life.
Cost−Residual Value
Annual Depreciation=
Useful life

Composite and group method

Under the composite method, assets that are dissimilar in nature or assets that have different physical
characteristics and vary widely in useful life, are grouped and treated as a single unit.
Under the group method all assets that are similar in nature and in estimated useful life are grouped and
treated as a single unit.
The accounting procedure and the method of computation for the composite and group method are
essentially the same.
In other words, the average useful life and the composite or group rate are computed, and the assets in
the group are depreciated on that basis.

Accounting procedures

a. Depreciation is reported in a single accumulated depreciation account. Thus, the accumulated

depreciation account is not related to any specific asset account.
b. The composite or group rate is multiplied by the total cost of the assets in the group to get the
periodic depreciation.
c. When an asset in the group is retired, no gain or loss is reported. The asset account is credited for the
cost of the asset retired and the accumulated depreciation account is debited for the cost minus salvage
proceeds.
d. When the asset retired is replaced by a similar asset, the replacement is recorded by debiting the
asset account and crediting cash or other appropriate account.
Subsequently the composite or group rate is multiplied by the balance of the asset account to get the
periodic depreciation.

Group method

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Variable charge or activity methods

The variable or activity methods assume that depreciation is more a function is use rather than passage
of time.

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

There are two variables namely:

a. Working hours method
b. Output or production method

These methods are adopted if the principal cause of depreciation is usage.

The use of these methods is based on the following:

a. Assets depreciate more rapidly if they are used full time or overtime
b. There is a direct relationship between utilization of assets and realization of revenue.

If assets are used more intensively in production, greater revenue is expected.

Output or production method

The output or production method results in a charge based on the expected use or output.

Decreasing charge or accelerated method

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

Thus, these methods result in a decreasing depreciation charge over the useful life.
This is on the philosophy that new assets are generally capable of producing more revenue in the earlier
years than in the later years.

Sum of years’ digits

The sum of years’ digits method provides for depreciation that is computed by multiplying the
depreciable amount by a series of fractions whose numerator is the digit in the useful life of the asset
and whose denominator is the sum of the digits in the useful life of the asset.
Life+1
SYD = Life( )
2

Declining balance method

Under the declining balance method, a fixed or uniform rate is multiplied by the declining carrying

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amount of the asset in order to arrive at the annual depreciation.
Because of the use of the fixed rate, this method is also known as fixed rate on diminishing carrying
amount method.
The problem in this method is the determination of the fixed rate to be applies against the carrying
amount.

Formula of fixed rate

res idual value
Rate=1
√
−n

cost
The “n” in the formula is the useful life of the asset.

Double declining balance method

The common application of the declining balance method is the “double declining balance.”
The procedure for the double declining balance method is the same as the declining balance method in
that a fixed rate is multiplied by the declining carrying amount of the asset tp arrive at the annual
depreciation.
But under the double declining balance method, the straight line rate is simply doubled to get the fixed
rate.

Inventory method

The inventory method consists of merely estimating the value of the asset at the end of the period.

The difference between the balance of the asset account and the value at the end of the year is then
recognized as depreciation for the year.

In recording depreciation, no accumulated depreciation account is maintained. The depreciation is

credited directly to the asset account.

Retirement and replacement method

Under the retirement method of depreciation, no depreciation is recorded until the asset is retired.

The amount of depreciation is equal to the original cost of the asset retired minus salvage proceeds.

Under the replacement method, no depreciation is recorded until the asset is retired and replaced.

The amount of depreciation is equal to the replacement cost of the asset retired, minus salvage
proceeds.

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If the asset retired is not replaced, the original cost of the asset retired but not replaced is recognized as
depreciation.

The retirement and replacement method may be used in much the same situations as the inventory
method.

CHAPTER 37
DEPLETION
Definition

The term “exploration and evaluation of mineral resources” is defined as the search for mineral
resources after the entity has obtained legal right to explore in an specific area as well as the
determination of the technical feasibility and commercial viability of extracting the mineral resources.
The expenditures incurred by an entity in connection with the exploration and evaluation of mineral
resources before the technical feasibility and commercial viability of extracting a mineral resource are

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known as exploration and evaluation expenditures.

Accordingly, exploration and evaluation expenditures do not include expenditures incurred:

a. Before an entity has obtained the legal right to explore a specific area.
b. After the technical feasibility and commercial viability of extracting a mineral resource are
demonstrable.

This pertains to development expenditure.

Exploration and evaluation expenditures

a. Acquisition of rights to explore

b. Topographical, geological, geochemical, and geophysical studies.
c. Exploratory drilling
d. Trenching
e. Sampling
f. Activities in relation to evaluating the technical feasibility and commercial viability of extracting a
mineral resource.
g. General and administrative costs directly attributable to exploration and evaluation activities.

Expenditures related to development of mineral resources, for example, preparation for commercial
production, such as building roads and tunnels, cannot be recognized as exploration and evaluation
expenditures.

Exploration and evaluation asset

The exploration and evaluation expenditures may qualify as exploration and evaluation asset.

However, the standard does not provide a clearcut guidance for the recognition of exploration and
evaluation asset.

As a matter of fact, PFRS 6 permits an entity to continue to apply its previous accounting policy provided
that the resulting information is relevant and reliable.

Measurement and classification

Exploration and evaluation asset shall be measured initially at cost.

After initial recognition, an entity shall apply either the cost model or the revaluation model.

Exploration and evaluation asset is classified either as tangible asset or an intangible asset.

For example, vehicles and drilling rings would be classified as tangible assets and drilling rings would be
classified as intangible assets.

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Impairment

Facts and circumstances that may indicate impairment include:

a. The period for which the entity has the right to explore in a specific area has expired and is not
expected to be renewed.
b. Substantive expenditure for exploration and evaluation is neither budgeted nor planned.
c. The exploration and evaluation activities have not led to the discovery of commercially viable quantity
of mineral resource and the entity has decided to discontinue such activities.
d. Sufficient data indicate that the carrying amount of the exploration and evaluation asset is unlikely to
be recovered in full from successful development or by sale.

Wasting assets

Wasting assets are material objects of economic value and utility to man produced by nature. Actually,
wasting assets are natural resources.

Natural resources usually include coal, oil, ore, precious metals, like gold, silver, and timber.
Wasting assets are so called because these are physically consumed and once consumed, the assets
cannot be replaced anymore.

If ever, the wasting assets can be replaced only by the process of nature. Natural resources cannot be
produced by man.

Thus, wasting assets are characterized by two main features:

a. The wasting assets are physically consumed.

b. The wasting assets are irreplaceable.
Cost of wasting asset

Entities follow a wide variety of practices in accounting for an extractive industry.

At present, IFRS does not address wasting assets.

There is no comprehensive standard that is applicable to the extractive or mining industry.

In general, the cost of wasting asset can be divided into four categories, namely:

a. Acquisition cost
b. Exploration cost
c. Development cost
d. Estimated restoration cost

Acquisition cost

Acquisition cost is the price paid to obtain the property containing the natural resource.

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Unquestionably, this is the initial cost of the wasting asset. Generally, the acquisition cost is charged to
any descriptive natural resource account.

If there is a residual land value after the extraction of the natural resource, the portion of the acquisition
cost applicable to the land may be included in the natural resource account.

Actually, the land value is the residual value of a wasting asset for purposes and computing depletion.

Thus, this should be deducted from the total acquisition cost to get the depletable amount.

Exploration cost

As started earlier, exploration cost is the expenditure incurred before the technical feasibility and
commercial viability of extracting a mineral resource are demonstrated.

Simply stated, the exploration cost is the cost incurred in an attempt to locate the natural resource that
can economically be extracted or exploited. The exploration may result in either success or failure.

Two methods of accounting for exploration cost

1. Successful effort method- The exploration cost directly related to the discovery of commercially
producible natural resource is capitalized as cost of the resource property.
The exploration cost related to “dry holes” or unsuccessful discovery is expensed in the period incurred.
2. Full cost method- All exploration costs, whether successful or unsuccessful is capitalized as cost of the
successful resource discovery.

This in on the theory that any exploration cost is a “wild goose chase” any therefore necessary before
any commercially producible and profitable resource can be found.

Development cost

Development cost is the cost incurred to exploit or extract the natural resource that has been located
through successful exploration.
Development cost may be in the form of tangible equipment and intangible equipment cost.
Tangible equipment includes transportation equipment, heavy machinery, tunnels, bunker and mine
shaft.

The cost of tangible equipment is not capitalized as cost of natural resource but set up in a separate
account and depreciated in accordance with normal depreciation policies.
Intangible development cost is capitalized as a cost of the natural resource. Such cost includes drilling,
sinking mine shaft and construction of wells.

Restoration cost

Estimated restoration cost is the cost to be incurred in order to bring the property to its original
condition.

Such restoration cost may be added to the cost of resource property or “netted” against the expected

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residual value of the resource property.

PAS 16, paragraph 16, provides that the estimated cost of restoring the property to its original condition
is capitalized only when the entity incurs the obligation when the asset is acquired.
In other words, the estimated restoration cost must be an existing present obligation required by law or
contract. The estimated restoration cost must be “discounted”.

Depletion

The removal, extraction or exhaustion of a natural resource is called depletion.

Depletion is the systematic allocation of the depletable amount of a wasting asset over the period the
natural resource is extracted or produced.

Depletion method

Normally, depletion is computed using the output or production method.

The depletable amount of the wasting asset is divided by the units estimated to be extracted to obtain a
depletion rate per unit. The depletion rate per unit is then multiplied by the units extracted during the
year to arrive at the depletion for the period.

Revision of depletion rate

The revision of the original estimate of recoverable resource deposit gives rise to the same problem
faced in accounting for change in estimate concerning the useful life of property, plant and equipment.
Changes in estimate are to be handled currently and prospectively, if necessary.
Accordingly, the procedure is to revise the depletion rate on a prospective basis, that is, by dividing the
remaining depletable cost of the wasting asset by the revised estimate of the productive output.

Depreciation of mining property

Tangible equipment such as transportation equipment, heavy machinery, mine shaft and other
equipment used in mining operations shall be reported in separate accounts and depreciated following
normal depreciation policies.

Generally, the depreciation of equipment used in the mining operations is based on the useful life of the
equipment or the useful life of the wasting asset, whichever is shorter.

If the useful life of the equipment is shorter, the straight line method of depreciation is normally used.

But if the useful life of the wasting asset is shorter, the output method of depreciation is frequently used.

However, if the mining equipment is movable and can be used in future extractive project, the
equipment is depreciated over its useful life using the straight line method.

Shutdown

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When the output method is used in depreciating mining property, in the event of shutdown, such
method cannot be used.

In this case, the depreciation in the year of shutdown is based on the remaining life of the equipment
following the straight line method.

The remaining carrying amount of the equipment is divided by the remaining life of the equipment to
arrive at the depreciation in the year of shutdown.

Trust fund doctrine

Under this doctrine, the share capital of a corporation is conceived as a trust fund for the protection of
creditors.

Consequently, such capital cannot be returned to shareholders during the lifetime of the corporation.

However, the corporation can pay the dividends to shareholders but limited only to the balanced of
retained earnings.

Accordingly, the corporation cannot pay dividends if it has a deficit because this would be a tantamount
to a return of capital to shareholders.

Wasting asset doctrine

Under this doctrine, a wasting asset corporation or an entity engaged in the extraction of a natural
resource, can legally return capital to shareholders during the lifetime of the corporation.

Accordingly, a wasting asset corporation can pay dividend not only to the extent of retained earnings but
also to the extent of accumulated depletion.

The amount paid in excess of retained earnings is accounted for as a liquidating dividend or return of
capital.

Complete formula

The complete formula in determining the maximum dividend that can be declared and paid by a wasting
asset corporation is as follows
Retained earnings xx
Add: Accumulated depletion xx
Total xx
Less: capital liquidated in prior years xx
Unrealized depletion in ending inventory xx xx
Maximum dividend xx

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CHAPTER 38
REVALUATION
Measurement of Property, Plant and Equipment

Initially, an item of property, plant and equipment that qualifies for recognition shall be measured at
cost.

After recognition, an entity shall choose either the cost model or revaluation model as an accounting
policy and shall apply that policy to an entire class of property, plant and equipment.

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Revaluation Model

After recognition as an asset, an item of property, plant and equipment whose fair value can be
measured reliably can be carried at a revalued amount.
The revalued amount is the fair value at the date of the revaluation less any subsequent accumulated
depreciation and subsequent accumulated impairment loss.
Revaluations shall be made with sufficient regularity such that the carrying amount does not differ
materially from the fair value at the end of the reporting period.

Basis of revaluation

The revalued amount of property, plant and equipment is based on the following:

1. Fair value- The fair value is determined by appraisal normally undertaken by professional qualified
valuers.
2. Depreciated replacement cost- Where market value is not available, depreciated replacement cost
shall be used.

Definition of Terms

Revalued amount is the fair value or depreciated replacement cost of the item of property, plant and
equipment.

Fair value is the price that would be received to sell an asset or paid to transfer a liability on an orderly
transaction between market participants at the measurement date.

Depreciated replacement cost is the replacement cost of the property, plant and equipment minus the
corresponding accumulated depreciation. This amount is actually the sound value of the asset.

Replacement cost is the current “purchase price” of the property, plant and equipment.

Carrying amount is equal to historical cost minus the corresponding accumulated depreciation.

Revaluation surplus is equal to the fair value or depreciated replacement cost minus the carrying amount
of the property, plant and equipment. This amount is also known as revaluation increment.

Appreciation or revaluation increase is the excess of the revalued amount over the historical cost.
Appreciation minus the corresponding accumulated depreciation equals the net appreciation or
revaluation surplus.

Two approaches in recording the revaluation

1. The accumulated depreciation at the date of revaluation is restated proportionately with the change in
the gross carrying amount of the asset so that the carrying amount of the asset after revaluation equals
the revalued amount. Simply described, this is the “proportional approach”.
2. The accumulated depreciation is eliminated against the gross carrying amount of the asset and the net
amount restated to the revalued amount of the asset. This procedure may be called the “elimination

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approach”.

Reversal of a revaluation increase

When an asset’s carrying amount is decreased as a result of revaluation, the decrease shall be
recognized as an expense.

However, a revaluation decrease shall be charged directly against any revaluation surplus to the extent
that the decrease is a reversal of a previous revaluation and the balance is charged to expense.

Reversal of a revaluation decrease

When an assets carrying amount is increased as a result of revaluation, the increase shall be credited to
revaluation surplus.

However, a revaluation increase shall be recognized as income to the extent that it reverses a revaluation
decrease of the same asset previously recognized as an expense.

Disclosures related to revaluation

When property, plant and equipment are measured at revalued amount, the following shall be disclosed:

a. The effective date of revaluation

b. Whether an independent valuer was involved
c. Method and significant assumptions applied in estimating fair value
d. The extent to which the fair value was determined directly by reference to observable prices in an
active market or recent market transactions on an arm’s length terms or was estimated using other
revaluation technique.
e. Historical cost and carrying amount of each class of revalued property, plant and equipment
f. Revaluation surplus, indicating the movement for the period and any restrictions on the distribution of
the balance to shareholders.

CHAPTER 39
IMPAIRMENT OF ASSETS
Definition

Impairment is a fall in the market value of an asset so that the “recoverable amount” is now less than
the carrying amount in the statement of financial position.
The carrying amount is the amount at which an asset is recognized in the statement of financial position
after deducting accumulated depreciation and accumulated impairment loss.

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Accounting for impairment

In this regard, there are three main accounting issues to consider, namely:

a. Indication of possible impairment

b. Measurement of the recoverable amount
c. Recognition of impairment loss

Indication of impairment

The events and changes in circumstances that lead to an impairment of assets may be classified as
external and internal sources of information.

External sources

a. Significant decrease or decline in the market value of the asset as a result of passage of time or normal
use or a new competitor entering the market.
b. Significant change in the technological, market, legal or economic environment of the business in
which the asset is employed. This could be as simple as a change in customer taste.
c. An increase in the interest rate or market rate of return on investment which will likely affect the
discount rate used in calculating the value in use
d. The carrying amount of net assets of the entity is more than the ‘market capitalization”. In other
words, the carrying amount exceeds the fair value of the net assets.

Internal sources

a. Evidence of obsolescence or physical damage of an asset

b. Significant change in the manner or extent in which the asset is used with an adverse effect on the
entity. For example, the asset is part of restructuring or held for sale or the asset is idle.
c. Evidence that the economic performance of an asset will be worse than expected.

Measurement of recoverable amount

After establishing evidence that an asset has been impaired, the next step is to determine the
recoverable amount preparatory to the recognition of an impairment loss.
The recoverable amount of an asset is the fair value less cost of disposal or value in use, whichever is
higher.
Fair value less cost of disposal

Fair value less cost of disposal is equal to the exit price or selling price of an asset minus cost of disposal.

Value in use

Value in use is measured at the present value or discounted value of future net cash flows expected to be
derived from an asset.
The cash flows are pretax cash flows and pretax discount rate is applied in determining the present
value.

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Calculation of value in use

Calculating a value in use calls for estimates of future cash flows and there is the possibility that an entity
might come up with “overoptimistic” estimates of cash flows.

The following should be considered in determining value in use:

a. Cash flow projections shall be based on Reasonable amount and supportable assumptions.
b. Cash flow projections shall be based on the most recent budgets on financial forecasts, usually up to a
maximum period of 5 years unless a longer period can be justified.
c. Cash flow projections beyond the 5-year period shall be estimated by extrapolating the 5-year
projections using a steady or declining growth rate each subsequent year, unless an increasing rate can
be justified.

Discount rate

The discount rate used in estimating future cash flows is the current pretax rate that reflects the current
assessment of the time value of money and the risks specific to the asset.
The discount rate should not reflect risks for which future cash flow estimates have already been
adjusted.

Recognition of impairment loss

If the recoverable amount of an asset is less than the carrying amount, an impairment loss has occurred.
The impairment loss shall be recognized immediately by reducing the asset’s carrying amount to its
recoverable amount.
The impairment loss is recognized in profit or loss presented separately in the income statement.

Cash generating unit (CGU)

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

Cash generating units with Goodwill

Goodwill does not generate cash flows independently from other assets or group of assets, and
therefore, the recoverable amount of goodwill as an individual assert cannot be determined.
As a consequence, if there is an indication that goodwill may be impaired, recoverable amount is
determined for the cash generating unit to which goodwill belongs.

Determination of impairment

PAS 36, paragraph 90,provides that a cash generating unit to which goodwill has been allocated shall be
tested for impairment at least annually by comparing the carrying amount of the unit, including the

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goodwill, with the recoverable amount.

a. If the recoverable amount exceeds the carrying amount of the unit, the unit and the goodwill allocated
to that unit shall be regarded as not impaired.
b. If the carrying amount exceeds the recoverable amount of the unit, the entity must recognize an
impairment loss.

Reversal of an impairment loss

PAS 36, paragraph 114, provides that an impairment loss recognized for an asset in prior years shall be
reversed if there has been a change in the estimate of the recoverable amount.

However, PAS 36, paragraph 117, provides that “the increased carrying amount of an asset due to a
reversal of an impairment loss shall not exceed the carrying amount that would have been determined,
had no impairment loss been recognized for the asset in prior years”.

The reversal of the impairment loss shall be recognized immediately as income in the income statement.

But any reversal of an impairment loss on a revalued asset shall be credited to income to the extent that
it reverses a previous revaluation decrease and any excess credited directly to revaluation surplus.

CHAPTER 40
INTANGIBLE ASSETS
Definition

PAS 38, paragraph 8, simply defines an intangible asset as follows:

“An intangible asset is an identifiable nonmonetary asset without physical substance”.

Paragraph 8 further states that “the intangible asset must be controlled by the entity as a result of past
event and from which future economic benefits are expected to flow to the entity”.

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Identifiability

The clear definition of an intangible asset requires that an intangible asset must be identifiable in order
to distinguish it clearly from goodwill.

a. It is separable.
b. It arises from contractual or other legal rights.

Control

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

In other words, the entity must be able to enjoy the future economic benefits from the asset nad
prevent others from enjoying the same benefits.

Future economic benefits

Future economic benefits may include revenue from the sale of products or services, cost savings or
other benefits resulting from the use of the asset by the entity.

Recognition of intangible asset

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

a. It is probable that future economic benefits attributable to the asset will flow to the entity.
b. The cost of the intangible asset can be measured reliably.

Initial measurement of intangible asset

PAS 38, paragraph 24, provides that an intangible asset shall be measured initially at cost. The cost of an
intangible asset depends on the following:

Separation acquisition

1. If an intangible asset is acquired separately, the cost of the intangible asset can be measured reliably,
particularly so if the purchase consideration is in the form of cash or other monetary assets.
2. If the payment for an intangible asset is deferred beyond normal credit terms, its cost is the cash price
equivalent.

Acquisition as part of business combination

a. If an intangible asset is acquired in a business combination, the cost of the intangible asset is based on
the fair value on the date of acquisition.

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b. If there is an active market, the quoted price of an identical asset provides the most reliable evidence
of fair value.
c. If there is no active market, the fair value of an intangible asset is equal to any available quoted price
for identical or similar asset.
d. The fair value can also be based on unobservable input usually developed by the entity using the best
available information from the entity’s own data.

Acquisition by government grant

This may occur when a government transfers or allocates to an entity intangible assets such as:
a. Airport land rights
b. Licenses to operate radio or television stations
c. Import licenses or quotas or rights to access restricted resources

The intangible asset acquired by way of government grant may be initially recorded at either:
a. Fair value
b. Nominal amount or zero, plus any expenditure that is directly attributable to preparing the asset for
its intended use.

Acquisition by exchange

The cost of such intangible asset is measured at fair value unless the exchange transaction lacks
commercial substance or the fair value of neither the asset given up nor the asset received is reliably
measurable.

If the exchange transaction lacks commercial substance, the acquired intangible asset is not measured at
fair value but its cost is the carrying amount of the asset given up.

An exchange transaction lacks commercial substance when the cash flows of the asset received do not
differ significantly from the cash flows of the asset transferred.

Internally generated intangible asset

The cost of an internally generated intangible asset comprises all directly attributable costs necessary to
create, produce, and prepare the asset to be capable of operating it in the manner intended by
management.
a. Cost of materials or services used
b. Cost of employee benefits
c. Fees to register the legal right
d. Amortization of patents and licenses

However, the following expenditures are not components of the cost of an internally generated
intangible asset:
a. Selling, administrative and other general overhead
b. Clearly identified inefficiencies and initial operating losses
c. Expenditure on training staff to operate the asset

Recognition as an expense

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1. An expenditure on an intangible asset that does not meet the recognition criteria for an intangible
asset shall be expensed when incurred.

2. However, if this item is acquired in a business combination, this expenditure shall form part of the
amount attributed to goodwill at the date of acquisition

3. Examples of expenditures that are expensed when incurred include:

a. Start up costs
b. Training costs
c. Advertising and promotional costs
d. Business relocation or reorganization costs

4. An expenditure on an intangible item that was initially recognized as an expense shall not be included
as part of the cost of intangible asset at a later date.

5. A prepayment can be recognized as an asset when payment for goods has been made in advance of
the entity obtaining a right to access those goods or when payment for services has been made in
advance of the entity receiving those services.

Subsequent expenditure

As a rule, a subsequent expenditure on an intangible asset shall ne recognized as expense.

However, the subsequent expenditure may be capitalized or added to the cost of the intangible asset if
the following recognition criteria for an intangible asset are met:

a. It is probable that future economic benefits that are attributable specifically to the subsequent
expenditure will flow to the entity.
b. The subsequent expenditure can be measured reliably.

Identifiable intangible assets

PAS 38 specifically pertains to identifiable intangible assets.

If the intangible asset is acquired through purchase, there is transfer of legal right that would make the
asset identifiable.

Examples of identifiable assets are:

a. Patent
b. Copyright
c. Franchise
d. Trademark or brand name
e. Leasehold or lease right
f. Computer software
g. Broadcasting license, airline right, and fishing right

Unidentifiable intangible asset

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An intangible asset is unidentifiable if it cannot be sold, transferred, licensed, rented or exchanged
separately.

The intangible asset is inherent in a continuing business and can only be identified with the entity as a
whole.

This unidentifiable intangible asset squarely describes goodwill.

Measurement after recognition

1. Cost model- An intangible asset shall be carried at cost, less any accumulated amortization and any
accumulated impairment loss
2. Revaluation model- An intangible asset shall be carried at a revalued amount, less any subsequent
amortization and any subsequent accumulated impairment loss.

Amortization of intangible assets

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

1. Paragraph 97 states that intangible assets with limited or finite life are amortized over their useful life.
2. Paragraph 107 and 108 state that intangible assets with indefinite life are not amortized but tested for
impairment at least annually.

Impairment of intangible assets

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

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

An impairment loss on an intangible asset is recognized if the recoverable amount is less than the
carrying amount.

Amortization method

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

However, if such pattern cannot be determined reliably, the straight line method of amortization shall be
used.

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CHAPTER 41
SPECIFIC INTANGIBLE ASSETS
Patent, trademark and goodwill
Patent

A patent is an exclusive right granted by the government to an inventor enabling the grantee to control
the manufacture, sale or other use of the invention for a specified period of time.
The legal life of patent is 20 years from the date of filing the application.

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A patent cannot be renewed but its life can be extended beyond the legal life by a new patent for
improvements and changes.

Cost of patent

If the patent is acquired by purchase, the cost comprises:

a. Purchase price
b. Import duties
c. Nonrefundable purchase taxes
d. Any directly attributable cost of preparing the asset for the intended use

Amortization of patent

With regard to amortization of the patent, the following rules shall be observed:

a. The original cost shall be amortized over the legal life or useful life, whichever is shorter.
b. If a competitive patent is acquired to protect an original patent, the cost of the competitive patent
shall be amortized over the remaining life of the old patent.
c. If a related patent is acquired in order to extend the life of the old patent, the cost of any related
patent and any unamortized cost of the old patent shall be amortized over the extended life.

Acquired patent

If the patent was acquired by the entity from an original patentee, the cost shall be amortized over the
remaining legal life or useful life, whichever is shorter.

Impairment of patent

Since a patent is an intangible asset with finite useful life, the cost is amortized.
However, the patent should be tested for impairment whenever there is an indication of impairment at
the end of reporting period.

Trademark

A trademark is a symbol, sign, slogan or name used to mark a product to distinguish it from other
products.

Under US GAAP, a trademark is a market-related intangible asset.

When a trademark is purchased, the cost includes the purchase price plus costs directly attributable to
the acquisition.

When a trademark is internally developed, the cost includes expenditures required to establish it,

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including filing fees, registry fees and other expenses incurred in securing the trademark such as design
cost of the trademark.

Amortization of trademark

The legal life of trademark is 10 years and may be renewed for 10 years each.
Considering the almost automatic renewal of a trademark an entity may properly classify a trademark as
an intangible asset with an indefinite life.

Accordingly, the cost of the trademark is not amortized but subject to test for impairment at least
annually and whenever there is an indication that it may be impaired.

Impairment of trademark

A trademark with finite useful life is amortized at the end of each reporting period.

However, a trademark with finite useful life is also tested for impairment whenever there is an indication
of impairment at the end of the reporting period.

A trademark with indefinite useful life is not amortized.

However, the trademark with indefinite useful life is tested for impairment at least annually and
whenever there is an indication of impairment.

Goodwill

Goodwill is an intangible asset that is not specifically identifiable, has an indeterminate life, is inherent in
a continuing business and relates to the entity as a whole.

Goodwill arises when earnings exceed normal earnings by reason of good name, capable staff and
personnel, high credit standing, reputation for fair dealings, reputation for superior products, favourable
location and a list of regular customers.

Measurement of goodwill

The value of goodwill is a matter for purchaser and seller to agree upon in fixing the purchase price of
the business.

Two approaches may be followed in measuring goodwill, namely residual approach and direct approach.

Residual approach

Goodwill is measured by comparing the purchase price for the entity with the net tangible and
identifiable assets, meaning total assets excluding goodwill minus liabilities assumed.

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Direct approach

Goodwill is measured on the basis of the future earnings of the entity. An attempt is made to value the
anticipated excess earnings which are the essential component of goodwill.

A sophisticated application of this approach requires the following information:

a. A normal rate of return for representative entities in the industry.

b. Fair value of tangible assets and any identifiable intangible assets.
c. The estimated normal future earnings of the entity.
d. The probable duration of any “excess earnings” attributable to goodwill.

Goodwill in a business combination

Consideration transferred xx
Amount of noncontrolling interest in the acquire xx
Fair value of previously interest held in the acquire xx
Total xx
Net amount of identifiable assets and liabilities assumed at fair value (xx)
Goodwill xx

Negative goodwill

If the purchase price or consideration transferred for the entity is less than the net fair value of the
identifiable assets acquired and liabilities assumed, the difference is negative goodwill.
PFRS 3, paragraph 34, provides that such negative goodwill is recognized in profit or loss as “gain on
bargain purchase”.

CHAPTER 42
SPECIFIC INTANGIBLE ASSETS
Copyright, franchise, leasehold, license, customer list
Copyright

A copyright is an exclusive right granted by the government to the author, composer or artist enabling
the grantee to publish, sell or otherwise benefit from the literary, musical or artistic work.

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The cost assigned to copyright consists of all expenses incurred in the production of the work including
those required to establish or obtain the right.

Amortization of copyright

The cost of the copyright shall be amortized over the useful life. The useful life is that period in which
benefits, sales, and royalties are expected.

It is usually advisable to write off the cost of the copyright against the revenue of the first printing.

Acquired copyright

The cost includes the cash paid plus directly attributable cost necessary for the intended use.
As in internally generated copyright, the cost of an acquired copyright should be amortized over the
useful life.

The copyright should also be reviewed for impairment by assessing at the end of each reporting period
whether there is an indication it may be impaired.

Franchise

Under US GAAP, a franchise is a contact-based intangible asset. The franchise agreement may be:
a. Between the government and a private entity or individual
b. Between private entities or individuals

Franchise cost

The cost of the franchise includes the lump sum payment for the acquisition of the franchise plus directly
attributable cost costs necessary for the intended use, such as legal fees and expenses incurred in
connection with the acquisition of the right.

Amortization of franchise

If the franchise is granted for a definite period, the cost of franchise shall be amortized over the useful
life or definite period whichever is shorter.

If the franchise is granted indefinitely or perpetually, the cost of the franchise shall not be amortized but
tested for impairment.

Leasehold or lease right

Leasehold is the right acquired by the lessee by virtue of a contact of lease to use the specific property

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owned by the lessor for a definite period of time on consideration for a certain sum of money in the
form of rent.

The leasehold account may be recorded on the books under the following circumstances:

a. Where the lessee is required to pay a certain lump sum at the first negotiation of the lease as a lease
bonus in consideration for favorable lease terms, the payment is charged to leasehold account.
b. When an amount is paid in obtaining an assignment of lease from the original lessee, the payment is
charged to the leasehold account.

Amortization of leasehold

The cost of the leasehold shall be amortized over the life of the lease. If the cost of the leasehold is not
very substantial, it is charged outright as an expense.

Leasehold improvements

Leasehold improvements are alterations or modifications on the leased property made by the lessee.

Legally, leasehold improvements revert to the lessor upon termination of the lease contract.

Leasehold improvements are classified as property, plant and equipment of the lessee.

Depreciation of leasehold improvements

The cost of leasehold improvements shall be depreciated over the lease term or useful life of the
improvements, whichever is shorter.

The residual value of the leasehold improvements shall be ignored in computing depreciation because
legally the improvements become the property of the lessor upon termination of the lease.

Renewal option

If the lease contract contains provision for n option to renew, and the likelihood of renewal is too
uncertain, the leasehold improvement are depreciated over the original lease term or the useful life of
the improvements, whichever is shorter.

Customer list

A customer list is a customer database containing the name, contract information, order history and
other vital and social statistics, such as death, birth and sickness.

An acquired customer list may be recognized as an intangible asset and amortized over the useful life.
The customer list shall also be reviewed for impairment.

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CHAPTER 43
RESEARCH AND DEVELOPMENT COST
Definition

Research is original and planned investigation undertaken with the prospect of gaining specific or
technical knowledge and understanding.

A research activity is undertaken to discover new knowledge that will be useful in developing new
product or that will result in significant improvement of existing product.

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Development is the application of research findings or other knowledge to a plan or design for the
production of new or substantially improved material, device, product, process, system or service, prior
to the commencement of commercial production.

Examples of research activities

a. Laboratory research aimed at obtaining or discovering new knowledge.

b. Searching for application of research finding and other knowledge
c. Conceptual formulation and design of possible product or process alternative
d. Testing in search for product or process alternative

Examples of development activities

a. Design, construction and testing of preproduction prototype and model

b. Design of tools, jigs, molds and dies involving new technology
c. Design, construction and operation of a pilot plant
d. Design, construction and testing of a chosen alternative for new or improved product or process.

Accounting for research cost

PAS 38, paragraph 54, provides that expenditures on research or on the research phase of an internal
project shall be recognized as an expense when incurred.

Accounting for development cost

Development cost is incurred at a later stage in a project and the probability of success may be more
apparent.

Criteria for recognition

a. Technical feasibility of completing the intangible asset
b. The intention to complete the intangible asset and use or sell it.
c. The ability to use or sell the intangible asset
d. How the intangible asset will generate probable future economic benefits
e. Availability of resources of funding to complete development and to use or sell the asset
f. The availability to measure reliably the expenditure attributable to the intangible asset during its
development
Internally developed computer software

Costs incurred in creating a computer software product shall be charged to expense when incurred until
a technical feasibility has been established for a product.

This is the research stage where there is so much uncertainty about the future economic benefits.

Accordingly, all the research costs shall be expensed outright.

The costs incurred to actually produce the software from masters and package the software for sale shall
be charged as inventory.

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Amortization of computer software

The amortization method for computer software shall reflect the pattern in which the future economic
benefits are expected to be consumed by the entity.

If such pattern cannot be determined reliably, the straight line method is used.

Impairment of computer software

The cost is amortized at the end of reporting period over the useful life.

However, the computer software is tested for impairment whenever there is an indication of impairment
at the end of reporting period.

Classification of computer software

a. As a rule, computer software is classified as an intangible asset.

b. Computer software purchased for resale shall be treated as inventory.
c. A computer software purchased as an integral part of a computer controlled machine tool that cannot
operate without the specific software shall be treated as property, plant and equipment.

Web site development costs

Under SIC 32, a web site that has been developed for the purpose of promoting and advertising an
entity’s products and services does not meet the requirement of PAS 38 to be recognized as an
intangible asset.

Therefore, web site development costs shall be expensed as incurred.

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