Sec. 1. Scope.

This Chapter provides principles for:

(a) presenting financial instruments as liabilities or net assets/equity and for offsetting financial assets and
financial liabilities;
(b) recognizing and measuring financial assets, financial liabilities and some contracts to buy or sell non-
financial items; and
(c) disclosure in the entity’s financial statements that enable users to evaluate the significance of financial
instruments for the entity’s financial position and performance and the nature and extent of risks arising from
financial instruments to which the entity is exposed during the period and at the end of the reporting period, and
how the entity manages those risk.

Sec. 2. Definition of Terms. For the purpose of this Manual, the terms stated below shall be construed to mean
as follows:
a. Equity instrument
b. Derivative
c. Financial instrument
d. Financial asset;
1. Cash;
2. An equity instrument of another entity;
3. A contractual right to receive cash or another financial asset from another entity;
4. A contractual right to exchange financial instruments with another entity under conditions that are potentially
favorable; or
5. A contract that will or may be settled in the entity’s own equity instruments.
e. Financial liability
1. A contractual obligation:
2. A contract that will or may be settled in the entity’s own equity instruments

Sec. 3. Financial Instruments. The following are the characteristics of a financial instrument:
a. There must be a contract;
b. There are at least two parties to the contract; and
c. The contract shall give rise to both a financial asset of one party and a financial liability or equity instrument
of another party.

Sec. 4. Cash and other Financial Assets. Cash is the most basic financial instrument because it is the medium of
exchange and is the basis on which all transactions are measured and recognized in the financial statements.
Cash deposited with a bank or similar financial institution is a financial asset because it represents the
contractual right of the depositor to withdraw money from the bank or to draw a check or similar instrument
against the balance in favor of a creditor in payment of a financial liability. The bank, on the other hand, views
this deposit as a financial liability because of its obligation to deliver the money upon demand from the
depositor.

Sec. 5. Initial Recognition of Financial Asset. An entity shall recognize a financial asset in its statement of
financial position when it becomes a party to the contractual provisions of the instrument. (Par. 16, PPSAS 29)

Sec. 6. Initial Measurement of Financial Assets. When a financial asset at fair value through surplus or deficit is
recognized initially, an entity shall measure it at its fair value. In the case of a financial asset not at fair value
through surplus or deficit, the financial asset is recognized at fair value plus transaction costs that are directly
attributable to the acquisition, issue or disposal of the financial asset.

Sec. 7. Categories of Financial Assets. For the purpose of measuring a financial asset after initial recognition,
the financial assets are classified into four categories, namely: (Par. 47, PPSAS 29)
a. Financial asset at fair value through surplus or deficit.
1. A held-for-trading asset, or
2. An asset designated as at fair value through surplus or deficit on initial
recognition. Any financial asset can be classified in this category if its fair value
can be reliably estimated.
b. Held-to-maturity investments.
c. Loans and receivables.
d. Available-for-sale financial assets.

Sec. 8. Subsequent Measurement of Financial Assets. After initial recognition, an entity shall measure financial
assets, including derivatives that are assets, at their fair values, without any deduction for transaction costs it
may incur on sale or other disposal, except for:
a. Loans and receivables and Held-to-maturity investments, which shall be measured at amortized cost using the
effective interest method; and
b. Investments in equity instruments that do not have a quoted market price in an active market and whose fair
value cannot be reliably measured and derivatives that are linked to and must be settled by delivery of such
unquoted equity instruments, which shall be measured at cost. (Par. 48, PPSAS 29)

Sec. 9. Measurement at Amortized Cost. Investments of NGAs in BTr issued bonds, loans and receivable
accounts are measured at amortized cost.

Sec. 10. Impairment of Financial Assets. An entity shall assess at the end of each reporting period whether there
is any objective evidence that a financial asset or group of financial assets is impaired. If any such evidence
exists, the entity shall measure the amount of loss as the difference between the carrying amount of the asset
and the present value of estimated future cash flows discounted at the financial asset’s original effective interest
rate. The carrying qamount of the asset shall be reduced either directly or through use of an allowance account.
The amount of the loss shall be recognized in surplus or deficit.

Sec. 11. Derecognition of Financial Assets. Derecognition is the process of removing a previously recognized
financial asset, liability or equity from the statement of financial position. An entity shall derecognize a
financial asset when, and only when:
a. The contractual rights to the cash flows from the financial asset expire or are waived; or
b. The entity transfers the financial assets provided the following conditions exist:
The derecognition of financial assets is subject to the provisions of P.D. No. 1445 on the writing off of
receivables and other policies issued by the COA.

Sec. 12. Transfer of Financial Assets. An entity transfers a financial asset if, and only if, it either:
a. Transfers the contractual rights to receive the cash flows of the financial asset; or
b. Retains the contractual rights to receive the cash flows of the financial asset, but assumes a contractual
obligation to pay the cash flows to one or more recipients in an arrangement that meets the following
conditions:

When an entity transfers a financial asset, it shall evaluate the extent to which it retains the risks and rewards of
ownership of the financial asset. In this case:
a. If the entity transfers substantially all the risks and rewards of ownership of the financial asset, the entity shall
derecognize the financial asset and recognize separately as assets or liabilities any rights and obligations created
or retained in the transfer.
b. If the entity retains substantially all the risks and rewards of ownership of the financial asset, the entity shall
continue to recognize the financial asset.
c. If the entity neither transfers nor retains substantially all the risks and rewards of ownership of the financial
asset, the entity shall determine whether it has retained control of the financial asset.

Sec. 13. Financial Liability. Examples of financial liabilities which are transacted by many national government
agencies are Accounts Payable, Bail Bonds Payable, Notes Payable, Interest Payable, Bonds Payable-Domestic,
Bonds Payable-Foreign, and Loans Payable-Domestic and Loans Payable-Foreign representing domestic and
foreign debt accounted at the BTr.

Sec. 14. Recognition of a Financial Liability. An entity shall recognize a financial liability in its statement of
financial position when it becomes a party to the contractual provisions of the instrument. (Par. 16, PPSAS 29)
A financial instrument that does not explicitly establish a contractual obligation to deliver cash or another
financial asset may establish an obligation indirectly through its terms and conditions.
a. A financial instrument may contain a non-financial obligation
b. A financial instrument is a financial liability if it provides that on settlement the entity will deliver either:
1. Cash or another financial asset; or
2. Its own shares whose value is determined to exceed substantially the value of the cash or other financial
asset.

Sec. 15. Initial Measurement of Financial Liabilities. When a financial liability is recognized initially, an entity
shall measure it at its fair value plus, in the case of a financial liability not at fair value through surplus or
deficit, transaction costs that are directly attributable to the issue of the financial liability. (Par. 45, PPSAS 29)
For financial liability designated initially as at fair value through surplus and deficit, the related transactions
costs are expensed immediately. For financial liability measured at amortized cost, transaction costs are
included in the initial measurement.
Transaction costs are incremental costs that are directly attributable
An incremental cost is one that would not have been incurred if
the entity had not issued or disposed the financial liability.
Transaction costs include:
(a) fees and commissions paid to agents, advisers, brokers and dealers;
(b) levies by regulatory agencies and securities exchanges; and
(c) transfer taxes and duties.

Sec. 16. Subsequent Measurement of Financial Liabilities. After initial recognition, an entity shall measure a
financial liability at amortized cost using the effective interest method. The “amortized cost” of a financial
liability is the amount at which the financial liability is measured at initial recognition minus the principal
repayments, plus or minus the cumulative amortization using the effective interest method of any difference
between the initial amount and the maturity amount, and minus any reduction (directly or through the use of an
allowance account) for impairment or collectability.

Sec. 17. Derecognition of Financial Liability. An entity shall remove a financial liability (or a part of a financial
liability) from its statement of financial position when, and only when, it is extinguished, that is, when the
obligation specified in the contract is discharged, 1waived, or cancelled, or expires.

Sec. 18. Equity Instrument. The term “equity instrument” may be used to denote the
following:
a. A form of unitized capital such as ordinary or preference shares;
b. Transfers of resources (either designated or agreed as such between the parties to the transaction) that
evidence a residual interest in the net assets of another entity; and/or
c. Financial liabilities in the legal form of debt that, in substance, represent an interest in an entity’s net assets.
(AG27, PPSAS 28)

Sec. 19. Derivatives. Derivative is 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.
PPSAS 29 provides the following characteristics of a derivative financial instrument:
a. Its value changes in response to the change in a specified interest rate, financial
instrument price, commodity price, foreign exchange rate, index of prices or rates,
credit rating or credit index, or other variable, provided in the case of a non-financial
variable that the variable is not specific to a party to the contract (sometimes called
the “underlying”);
b. It requires no initial net investment or an initial net investment that is smaller than
would be required for other types of contracts that would be expected to have a
similar response to changes in market factors; and
c. It is settled at a future date.
The very purpose of derivatives is risk management. Risk management is the process of
identifying the desired level of risk, identifying the actual level of risk and altering the latter to
equal the former.

Sec. 20. Hedging. Hedging is a method of offsetting a potential financial loss or the structuring of a transaction
to reduce risk involving financial instruments. Hedge accounting recognizes the offsetting effects on surplus or
deficit of changes in the fair values of the hedging instrument and the hedged item.
Par. 96 of PPSAS 29 provides the 3 types of hedging relationships:
a. Fair value hedge: a hedge of the exposure to changes in fair value of a recognized asset or liability or an
unrecognized firm commitment, or an identified portion of such an asset, liability or firm commitment, that is
attributable to a particular risk and could affect surplus or deficit.
b. Cash flow hedge: a hedge of the exposure to variability in cash flows that (i) is attributable to a particular risk
associated with a recognized asset or liability (such as all or some future interest payments on variable rate debt)
or a highly probable forecast transaction and (ii) could affect surplus or deficit.
c. Hedge of a net investment in a foreign corporation.

Sec. 21. Hedging Instrument. A designated derivative or a designated non-derivative financial asset or non-
derivative financial liability whose fair value or cash flows are expected to offset changes in the fair value or
cash flows of designated hedged item.

Sec. 22. Hedged Item. Hedged item is an asset, liability, firm commitment, highly probable forecast transaction
or net investment in a foreign operation that (a) exposes that entity to risk of changes in fair value or future cash
flows and (b) is designated as being hedged.

Sec. 23. Presentation of Financial Instruments. The issuer of a financial instrument shall classify the instrument,
or its component parts, on initial recognition as a financial asset, a financial liability or an equity instrument in
accordance with the substance of the contractual arrangement and the definitions of a financial asset, a financial
liability and an equity instrument.