LIABILITIES

Liabilities are present obligations of an entity arising from past transactions or events, the
settlement of which is expected to result in an outflow from the entity of resources embodying
economic benefits.

Essential characteristics of an accounting liability:

a) The liability is the present obligation of a particular entity.
b) The liability arises from past transaction or event.
c) The settlement of the liability requires an outflow of resources embodying economic
benefits.

CURRENT LIABILITIES
Measurement:
 Conceptually, all liabilities are initially measured at present value and subsequently
measured at amortized cost.
 In practice, current liabilities or short-term obligations are not discounted anymore but
measured and reported at face amount.

Classification:
PAS 1, paragraph 69, provides that an entity shall classify a liability as current when:
a) The entity expects to settle the liability within the entity's operating cycle.
b) The entity holds the liability primarily for the purpose of trading.
c) The liability is due to be settled within twelve months after the reporting period.
d) The entity does not have an unconditional right to defer settlement of the liability for at
least twelve months after the reporting period.
 Trade payables and accruals for employee and other operating costs are classified as
current liabilities even if settled more than twelve months after the reporting period.
Presentation:
Under Paragraph 54 of PAS 1, as a minimum, the face of the statement of financial position shall
include the following line items for current liabilities:
 a. Trade and other payables
b. Current provisions
c. Short-term borrowing
d. Current portion of long-term debt
e. Current tax liability
NONCURRENT LIABILITIES
The term "noncurrent liabilities" is a residual definition. All liabilities not classified current are
classified as liabilities include:
a. Noncurrent portion of long-term debt
b. Finance lease liability
c. Deferred tax liability
d. Long-term obligation to officers
e. Long-term deferred revenue

Measurement:
 Noncurrent liabilities, for example, bond payable and noninterest-bearing note payable,
payable are initially measured at present value and subsequently measured at
amortized cost.
 If the long-term note payable is interest-bearing, it is initially and subsequently
measured at face amount. In this case, the face amount is equal to the present value of
the note payable.

Long-term debt falling due within one year

A liability which is due to be settled within twelve months after the reporting period is classified
as current, even if:
a. The original term was for a period longer months.
b. An agreement to refinance or to reschedule payment on a long-term basis is
completed after the reporting period and before the financial statements are
authorized for issue.

 If the refinancing on a long-term basis is completed on or before the end of the

reporting period, the refinancing is an adjusting event and therefore the obligation is
classified as noncurrent.
 If the entity has the discretion to refinance or roll over an obligation for at least twelve
months after the reporting period under an existing loan facility, the obligation is
classified as noncurrent.
  If the entity has an unconditional right under the existing loan facility to defer
settlement of the liability for at least twelve months after the reporting period, the
obligation is considered part of the entity's long-term refinancing.

Breach of covenants - the liability becomes payable on demand.

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

ESTIMATED LIABILITIES
Are obligations which exist at the end of reporting period although their amount is not definite.
 In many cases, the date when the obligation is due, is not also definite and in some
instances, the exact payee cannot be identified or determined.
 Estimated liabilities are either current or noncurrent in nature.
 Examples include estimated liability for premium award points, warranties, gift
certificates and bonus.

PREMIUM LIABILITY
Premiums
Premiums are articles of value such as toys, dishes, silverware and other goods and in some cases
cash payments, given to customers as a result of past sales or sales promotion activities.
 Purpose: stimulate the sale of their products
 When the merchandise in sold, an accounting liability for the future distribution of
the premium arises and should be given accounting recognition.

Cash rebate program

 Purpose: to stimulate sales.
 Estimated amount of the cash rebate should be recognized both as an expense and an
estimated liability in the period of sale.

Cash discount coupon

  Like a premium offer and cash rebate program, an expense and an estimated liability for
the expected cash discount should be recognized in the period of sale.

Customer loyalty program - IFRS 15

 If a customer buys goods or services, the entity grants the customer award credits often
described as "points".

Measurement:
 An entity shall account for the award credits as a “separately component of the
initial sale transaction". In other words, the granting of award credits is effectively
accounted for as a "future delivery of goods or services"
 IFRS 15, paragraph 74, provides that an entity shall allocate the transaction price
to each performance obligation identified in a contract on a relative stand-alone
selling price basis.
 The fair value of the consideration received with respect to the initial sale shall be
allocated between the award credits and the sale based on relative stand-alone selling
price.

Recognition:
 The consideration allocated to the award credits is initially recognized as
deferred revenue and subsequently recognized as revenue when the award
credits are redeemed.
 The amount of revenue recognized shall be based on the number of award credits
that have been redeemed relative to the total number expected to be redeemed.
 The estimated redemption rate is assessed each period.
 Changes in the total number expected to be redeemed do not affect the total
consideration for the award credits.
 The calculation of the revenue to be recognized in any one period is made on a
"cumulative basis" in order to reflect the changes in estimate.

WARRANTY LIABILITY
At the point of sale, a constructive obligation arises and a liability is incurred.
Recognition of warranty provision
PAS 37, paragraph 14, provides that a provision shall be recognized as a liability in the financial
statements under the following conditions:
a) The entity has a present obligation, legal or constructive, as a result of a past event.
 b) It is probable that an outflow of resources embodying economic benefits would be
required to settle the obligation.
c) The amount of the obligation can be measured reliably.

Accounting for warranty

a. Accrual approach
 The accrual approach has the soundest theoretical support because it properly matches
cost with revenue.
 Any difference between estimate and actual cost is a change in estimate and therefore
treated currently or prospectively, if necessary.
b. Expense as incurred approach
 The "expense as incurred approach" is the approach of expensing warranty cost only
when actually incurred.
 Justified on the basis of expediency when the warranty cost is not very substantial or
when the warranty period is relatively short.

Sale of warranty
 The amount received from the sale of the extended warranty is recognized initially as
deferred revenue and subsequently amortized using straight line over the life of the
warrant contract.

 If costs are expected to be incurred in performing services under the extended warranty
contract, revenue is recognized in proportion to the costs to be incurred annually.

DEFERRED REVENUE
Deferred revenue or unearned revenue is income already received but not yet earned.
 If the deferred revenue is realizable within one year, it is classified as current liability.
 If the deferred revenue is realizable in more than one year, it is classified as noncurrent
liability.
 Typical examples of current deferred revenue are unearned interest income, unearned
rental income and unearned subscription revenue.
  Typical examples of noncurrent deferred revenue are unearned revenue from long term
service contracts and long-term leasehold advances.

Payroll Taxes
Under our law, the entity as an employer is required to withhold from the salaries of each
employee the following:
a. Income tax payable by the employee
b. Employee contribution to the Social Security System or SSS
c. Employee contribution for Philhealth
d. Employee contribution to the Pag-ibig Fund
 Such amounts withheld from the salaries of the employees shall be recognized as
current liability until remitted by the entity to the appropriate government authority.

Value Added taxes or VAT

Under the National Internal Revenue Code, an entity is required to collect value added taxes
from customers on sales of tangible personal property and certain services.
 Shall be remitted monthly to BIR.

Gift certificates payable

The Philippine DTI ruled that gift certificates no longer have an expiration period.

Refundable Deposits
Consists of cash or property received from customers but which are refundable after compliance
with certain conditions (example: bottles, drums, tanks, barrels).

Bonus Computation
 Before bonus and before tax
B = Income before bonus and before tax * % Bonus

 After bonus but before tax

B = %Bonus (Income before bonus and before tax – B)
  After bonus and after tax
B = %Bonus (Income before bonus and before tax – B - T)
T = Income Tax Rate (Income before bonus and before tax – B)

 After tax but before bonus

B = %Bonus (Income before bonus and before tax - T)
T = Income Tax Rate (Income before bonus and before tax – B)
PROVISION
 an existing liability of uncertain timing or uncertain amount.
 may be the equivalent of an estimated liability or a loss contingency that is accrued
because it is both probable and measurable.

Recognition of provision
PAS 37, paragraph 14, states that a provision shall be recognized as liability under the following
conditions:
 The entity has a present obligation as a result of a past event.
 It is probable that an outflow of economic benefits shall be required to settle the
obligation.
 The amount of the obligation can be measured reliably.

Measurement of a provision
 The amount recognized as a provision should be the best estimate of the expenditure
required to settle the present obligation at the end of reporting period.
 The best estimate is the amount that an entity would rationally pay to settle the
obligation at the reporting date or to transfer it to a third party at that time.
 Where a single obligation is being measured, the individual most likely outcome may be
the best estimate.
 Where there is a continuous range of possible outcomes and each point in that range
is as likely as any other, the midpoint of the range is used.
 Where the provision being measured involves a large population of items, the
obligation is estimated by "weighting" all possible outcomes by their associated
possibilities.
 The amount of the provision shall be discounted if the effect of the time value of money
is material.
Certain considerations in the measurement of provision
a) The risks and uncertainties that inevitably surround many events and circumstances
shall be taken into account in reaching the best estimate of a provision.
b) Where the effect of the time value of money is material, the amount of provision shall
be the present value of the expenditures required to settle the obligation.
c) Future events that affect the amount required to settle an obligation shall be reflected
in the amount of a provision when there is a sufficient evidence that they will
occur.
d) Gains from expected disposal of assets shall not be taken into account in measuring a
provision.
e) Where the expenditure required to settle a provision is expected to be reimbursed by
another party, the reimbursement shall be recognized when it is virtually certain that
reimbursement will be received.
 The reimbursement shall be treated as a separate asset and not "netted" against the
estimated liability for the provision. The amount shall not exceed the amount of the
provision.
 In the income statement, the expense relating to the provision may be presented net of
reimbursement
f) Provisions shall be reviewed at each reporting date and adjusted to reflect the current
best estimate. The provision shall be reversed if it is no longer probable that an outflow
of economic benefits would be required to settle the obligation.
g) A provision shall be used only for expenditures for which the provision was
originally recognized.
h) Provision shall not be recognized for future operating losses.
i) If an entity has an onerous contract, the present obligation under the onerous contract
shall be recognized and measured as a provision.
PAS 37, paragraph 68, mandates that the unavoidable costs under a contract represent
the “least net cost of exiting from the contract”.
Restructuring
PAS 37, paragraph 10, defines restructuring as a "program that is planned and
controlled by management and materially changes either the scope of a business of an entity or
the manner in which that business is conducted".
Examples:
a) Sale or termination of a line of business.
b) Closure of business location in a region or relocation of business activities from one
location to another.
c) Change in management structure, such as elimination of a layer of management.
 d) Fundamental reorganization of an entity that has a material and significant impact on the
operations.

Provision for restructuring

A constructive obligation for restructuring arises when two conditions are present:
1. The entity has a detailed formal plan for the restructuring which includes the following:
a. The business is being restructured.
b. The principal location affected.
c. The location, function and approximate number of employees who will be
compensated for terminating their employment.
d. Date when the plan will be implemented.
e. The expenditures that will be undertaken.

2. The entity has raised valid expectation in the minds of those affected that the entity will
carry out the restructuring by starting to implement the plan and announcing the main
features to those affected by it.

Amount of restructuring provision

 A restructuring provision shall include only direct expenditures arising from the
restructuring.
 The expenditures are necessarily entailed by the restructuring and not associated with the
ongoing activities of the entity.

PAS 37, paragraph 81, specifically excludes the following expenditures from the restructuring
provision:
a. Cost of retraining or relocating continuing staff.
b. Marketing or advertising program to promote the new entity image.
c. Investment in new system and distribution network.

CONTINGENT LIABILITY
PAS 37, paragraph 10, defines a contingent liability in two ways:
a) A contingent liability is a possible obligation that arises from past event and whose
existence will be confirmed only by occurrence or nonoccurrence of one or more
uncertain future events not wholly within the control of the entity.
 b) A contingent liability is a present obligation that arises from past event but is not
recognized because it is not probable that an outflow of resources embodying economic
benefits will be required to settle the obligation or the amount of the obligation cannot
be measured reliably.

Contingent liability and provision

 The present obligation is either probable or measurable but not both to be considered
a contingent liability.
 If the present obligation is probable and the amount can be measured reliably, the
obligation is not a contingent liability but shall be recognized as a provision.

Treatment of contingent liability

A contingent liability shall not be recognized in the financial statements but shall be
disclosed only. The required disclosures are:
a. Brief description of the nature of the contingent liability.
b. An estimate of its financial effects.
c. An indication of the uncertainties that exist.
d. Possibility of any reimbursement.
 If a contingent liability is remote, no disclosure is necessary.

Contingent asset
PAS 37, paragraph 10, defines contingent asset as a "possible asset that arises from past
event and whose existence will be confirmed only by the occurrence or nonoccurrence of one or
more uncertain future events not wholly within the control of the entity".
 A contingent asset shall not be recognized because this may result to recognition of
income that may never be realized.
 A contingent asset is only disclosed when it is probable.
 The disclosure includes a brief description of the contingent asset and an estimate of its
financial effects.
 If a contingent asset is only possible or remote, no disclosure is required.

Decommissioning liability
An obligation to dismantle, remove and restore an item of property, plant and equipment as
required by law or contract.
Change in decommissioning liability
Under IFRIC 1, changes in the measurement of an existing decommissioning liability shall be
accounted for as follows:
1. A decrease in the liability is deducted from the cost of the asset. If the decrease in
liability exceeds the carrying amount, the excess is recognized in profit or loss.
2. An increase in liability is added to the cost at the asset. However, the entity shall
consider whether this is an indication that the carrying amount of the asset may not be
fully recoverable.
 If there is such an indication, the asset should be tested for impairment.

BONDS PAYABLE
A bond is a contract of debt whereby one party called the issuer borrows funds from
another party called the investor.
Measurement:
 PFRS 9, paragraph 5.1.1, provides that bonds payable not designated at fair value
through profit or loss shall be measured initially at fair value minus transaction
costs that are directly attributable to the issue of the bonds payable.
 The fair value of the bonds payable is equal to the present value of the future cash
payments to settle the bond liability.
 Bond issue costs shall be deducted from the fair value or issue price of the bonds
payable in measuring initially the bonds payable.
 If the bonds are designated and accounted for "at fair value through profit or loss", the
bond issue costs are treated as expense immediately.

PFRS 9, paragraph 5.3.1, provides that after initial recognition, bonds payable shall be measured
either:
a) At amortized cost using the effective interest
b) At fair value through profit or loss method

Accounting for issuance of bonds

a) Memorandum Approach
b) Journal Entry Approach

Issuance of bonds at a premium – Sales price is more than face amount of the bonds. The
bond premium is in effect a gain on the part of the issuing entity.
Issuance of bonds at a discount - Sales price is less than face amount of the bonds. The bond
discount is in effect a loss on the part of the issuing entity.
Presentation of Discount and Premium
The discount on bond payable is a deduction from the bond payable and the premium
on bond payable is an addition to the bond payable.
Bond issue costs
Under PFRS 9, bond issue costs shall be deducted from the fair value or issue price of
bonds payable in measuring initially the bonds payable.
Bond retirement on maturity date
The periodic cash deposits plus the interest earned on sinking fund securities should
cause the fund to approximately equal the amount of bond issue on maturity date.
Bond retirement prior to maturity date
1. The bond premium or bond discount should be amortized up to the date of retirement.
2. The balance of the bond premium or bond discount should be determined.
3. The accrued interest to date of retirement should be determined.
4. The total cash payment should be computed. (Retirement price plus accrued interest)
5. The carrying amount of the bonds retired is determined.
6. The gain or loss on the retirement is computed.
Retirement Price is more than the Carrying Amount of the bonds = Loss
Retirement Price is less than the Carrying Amount of the bonds = Gain
7. The retirement of the bonds is then recorded by canceling the bond liability together with
the unamortized premium or discount.

Bond Refunding/ Bond Refinancing

 Premature retirement of the old bonds by means of issuing new bonds.
 When made prior to maturity date of the old bonds, consideration must be given to the
refunding charges pertaining to the old bonds.
 Shall be accounted for as an extinguishment of a financial liability.

Amortization of bond discount or premium

a) Straight line
b) Bond outstanding method
c) Effective interest method
"Fair value option" of measuring bonds payable
 PFRS 9, paragraph 4.2.2, provides that at initial recognition, bonds payable may be
irrevocably designated as at fair value through profit or loss.
 Under the fair value option, the bonds payable shall be measured initially at fair value
and remeasured at every year-end at fair value and any changes in fair value are
recognized in profit or loss.
 Any change in fair value attributable to the credit risk of the bond payable designated at
fair value through profit or loss is recognized in other comprehensive income.
 Interest expense is recognized using the nominal or stated interest rate and not the
effective interest rate.
Change in fair value recognized in OCI
PFRS 9, paragraph 5.7.7, provides that the gain or loss on financial liability designated at fair
value through profit or loss shall be accounted for as follows:
a) Change in Fair value attributable to the credit risk of the liability is recognized in OCI.
b) The remaining amount of the change in fair value is recognized in profit or loss.

Paragraph 5.7.8 provides that if presenting the change in fair value attributable to credit risk
would create or enlarge an accounting mismatch, all gains and losses including the effects of
changes in credit risk are recognized in profit or loss.

Application Guidance B5.7.9. provides that amounts recognized in other comprehensive

income resulting from changes in fair value of credit risk of a financial liability designated at fair
value through profit or loss shall not be subsequently transferred to profit or loss.

EFFECTIVE INTEREST METHOD

PFRS 9 requires that discount on bonds payable, premium on bonds payable and bond issue cost
shall be amortized using the effective interest method.
 Nominal Rate is the rate appearing on the face of the bonds while the effective rate is the
actual interest incurred on the bond issue.
 The nominal rate is also known as coupon or stated rate.
 Effective rate is the rate that exactly discounts estimated cash future payments through
the expected life of the bonds payable or when appropriate, a shorter period to the net
carrying amount of the bonds payable.
 The effective rate is also known as yield or market rate.
 If the bonds are sold at face amount, the nominal rate and effective rate are the same.
If the bonds are sold at a discount, the effective rate is higher than nominal rate.
If the bonds are sold at a premium, the effective rate is lower than nominal rate.
Effective interest method of amortizing discount and premium on bonds payable
 The annual amortization of premium or discount is the difference between the
effective interest expense and nominal interest expense.
 The effective interest expense is computed by multiplying the carrying amount of the
bonds payable at the beginning of the year by the effective rate.
 The nominal interest expense is computed by multiplying the face amount of the bonds
payable by the nominal rate.
 The effective interest method provides for an increasing amount of discount amortization
and increasing amount of interest expense.
 The effective interest method provides for an increasing amount of premium
amortization but a decreasing amount of interest expense.

Treatment of bond issue cost under the effective interest method

 The calculation of effective interest rate shall include all transaction costs, premiums and
discounts.
 Under the effective interest method, bond issue cost must be "Lumped" with the discount
on bonds payable and “netted" against the premium on bonds payable.
 Accordingly, bond issue costs will increase discount on bonds payable and will
decrease premium on bonds payable.

Market price or issue price of bond payable

Equal to the present value of the principal bond liability plus the present value of
future interest payments using the effective or market rate of interest.

COMPOUND FINANCIAL INSTRUMENT

Financial Instrument
PAS 32, paragraph 11, defines a financial instrument as any contract that gives rise to both a
financial asset of one entity and a financial liability or equity instrument of another entity.
 There must be a contract
 There are at least two parties to the contract
  The contract shall give rise to a financial asset of one party and financial liability or
equity instrument of another party

Compound Financial Instrument

PAS 32, paragraph 28, defines a compound financial instrument as a financial instrument
that contains both a liability and an equity element from the perspective of the issuer.

Accounting for a compound financial instrument

 If the financial instrument contains both a liability and an equity component, PAS 32,
paragraph 29, mandates that such components shall be accounted for separately in
accordance with the substance of the contractual arrangement and the definition of a
financial liability and an equity.
 Split Accounting
 Consideration received from the issuance of the compound financial instrument shall
be allocated between the liability and equity components.
 The fair value of the liability component is first determined.
 The fair value of the liability component is then deducted from the total consideration
received from issuing the compound financial instrument
 The residual amount is allocated to the equity component.

Accounting for bonds payable issued with share warrants

 Bonds issued with share warrants are considered as compound financial instrument.
 Proceeds from the issuance of the bonds payable with share warrants shall be accounted
for as partly liability and partly equity.
 The proceeds shall be allocated between the bonds payable and the share warrants.
 PAS 32 does not differentiate whether the equity component is detachable or
nondetachable. Whether detachable or nondetachable, share warrants have a value and
therefore shall be accounted for separately.
 PAS 32, paragraph 31, provides that equity instruments are instruments that evidence a
residual interest in the assets of an entity after deducting all of its liabilities.
 The bonds are assigned an amount equal to the "market value of the bonds ex-
warrant", regardless of the market value of the warrants.
 The residual amount or remainder of the issue price shall then be allocated to the share
warrants.
  If the bonds have no known market value ex-warrant, the amount allocated to the
bonds is equal to the present value of the bonds payable.

Accounting for convertible bonds at the time of original issuance

 Convertible bonds are conceived as compound financial instrument.

 Issuance of convertible bonds shall be accounted for as partly liability and partly
equity.
 The issue price of the convertible bonds shall be allocated between the bonds payable
and the conversion privilege.

 Bonds are assigned an amount equal to the market value of the bonds without the
conversion privilege.
 The residual amount or remainder of the issue price shall then be allocated to the
conversion privilege or equity component.

Accounting for the conversion of convertible bonds into share capital

Application Guidance 32 of PAS 32 provides that on conversion of a convertible instrument at
maturity, the entity derecognizes the liability component and recognizes it as equity.
 There is no gain or loss on conversion at maturity.
 The carrying amount of the bonds payable is the measure of the share capital issued
because the carrying amount is the "effective price" for the shares issued as a result of
the conversion.
 Any cost incurred in connection with the bond conversion shall be deducted from share
premium, if any. Otherwise, the cost incurred is treated as expense.

NOTE PAYABLE
Initial measurement:
 PFRS 9, paragraph 5.1.1, provides that a note payable not designated at fair value through
profit or loss shall be measured initially at fair value minus transaction costs that are
directly attributable to the issue of the note payable.
 Transaction costs are included in the measurement of note payable.
 If the note payable is irrevocably designated at fair value through profit or loss, the
transaction costs are expensed immediately.

Subsequent measurement:
  PFRS 9, paragraph 5.3.1, provides that after initial recognition, a note payable shall be
measured either:
a) At amortized cost using the effective interest method.
b) At fair value through profit or loss.

 PFRS 9, paragraph 4.2.2, provides that at initial recognition, a note payable may be
irrevocably designated as at fair value through profit or loss.
 Under the fair value option, the note payable shall be measured initially at fair value and
remeasured at every year-end at fair value and any changes in fair value are recognized in
profit or loss.
 Interest expense is recognized using the interest rate and not the effective nominal or
stated interest rate.

Fair value of note payable

 The fair value of the note payable is equal to the present value of the future cash payment
to settle the note payable.
 The term "present value" is the discounted amount of the future cash outflow in settling
the note payable using the market rate of interest.

a. When a note is issued solely for cash, the present value is equal to the cash proceeds.
b. When a property or noncash asset is acquired by issuing a note payable which is interest
bearing, the property or asset is recorded at the purchase price.
 The purchase price is reasonably assumed to be the present value of the note payable.
 When a noninterest bearing note is issued for property the property is recorded at the
cash price of the property.
 The cash price is assumed to be the present value of the note issued.
 The difference between the cash price and the face amount of the note payable represents
the imputed interest.

Fair value option of measuring note payable

 PFRS 9, paragraph 4.2.2, provides that at initial recognition, a note payable may
be irrevocably designated as at fair value through profit or loss.
 PFRS 9, paragraph 5.7.7, provides that the gain or loss on financial liability
designated at fair value through profit or loss shall be accounted for as follows:
a) The change in fair value attributable to the credit risk is recognized in
other comprehensive income.
b) The remaining amount of the change in fair value is recognized in profit or
loss.
  Application Guidance B5.7.9, provides that the amount recognized in other
comprehensive income resulting from change in fair value attributable to credit
risk shall not be subsequently transferred to profit or loss.

DEBT RESTRUCTURE
 Debt restructuring is a situation where the creditor, for economic or legal reasons related
to the debtor's financial difficulties grants to the debtor concession that would not
otherwise be granted in a normal business relationship.
 The objective of the creditor in a debt restructuring is to make the best of a bad situation
or maximize recovery of investment.
 The creditor usually sustains an accounting loss on debt restructuring and the debtor
realizes an accounting gain.

The common forms of debt restructuring are:

a) Asset swap
b) Equity swap
c) Modification of terms

Asset Swap

 Asset swap is the transfer of any asset such as real estate, inventory or investment by the
debtor to the creditor in full settlement of an obligation.
 Under PFRS 9, paragraphs 3.3.1 and 3.3.3, asset swap is treated as a derecognition of a
financial liability or extinguishment of an obligation.
 The difference between the carrying amount of the financial liability and the
consideration given shall be recognized in profit or loss.

USA GAAP
Asset Swap is recorded as if two transactions have taken place, namely, the sale of the
asset and the extinguishment of the liability. Two gains or losses are recognized. PFRS 9
should be followed.
Dacion en pago accounting
 Arises when a mortgaged property is offered by the debtor in full settlement of
the debt.
 The transaction shall be accounted for an “asset swap” form of debt restructuring.
Equity Swap
An equity swap is a transaction whereby a debtor and creditor may renegotiate the terms
of a financial liability with the result that the liability is fully or partially extinguished by the
debtor issuing equity instruments to the creditor.
 The accounting issue of "extinguishment of a financial liability by issuing equity
instruments" is now well-settled under IFRIC 19.
 IFRIC 19 provides that when equity instruments issued to extinguish all or part of a
financial liability are recognized initially, an entity shall measure the equity instruments
at the fair value of the equity instruments issued, unless that fair value cannot be reliably
measured.
 The equity instruments issued to extinguish a financial liability shall be measured at the
following amounts in the order of priority:
a. Fair value of equity instruments issued
b. Fair value of liability extinguished
c. Carrying amount of liability extinguished
 The difference between the carrying amount of the financial liability extinguished and
the "initial measurement” of the equity instruments issued shall be recognized in profit
or loss.
 Such gain or loss on extinguishment shall be disclosed as a separate line item in the
income statement.

Accounting for substantial modification of terms

 PFRS 9, paragraph 3.3.2, provides that a substantial modification of terms of an existing
financial liability shall be accounted for as an extinguishment of the old financial
liability and the recognition of a new financial liability.
 Under Application Guidance B3.3.6 of PFRS 9, there is substantial modification of terms
if the gain or loss on extinguishment is at least 10% or 10% or more of the carrying
amount of the old financial liability.
 The difference between the carrying amount of the old liability and the present value of
new or restructured liability shall be accounted for as gain or loss on extinguishment.
 The present value of the new liability shall be determined using the original effective
interest rate.
 Any costs or fees incurred as a result of the substantial modification of terms shall be
recognized as part of gain or loss on extinguishment.

No substantial modification
  If the gain or loss on extinguishment of the old liability is less than 10% of the carrying
amount of the old liability, there is no substantial modification of terms.
 The gain or loss is not recognized because the modification is not an extinguishment of
the old liability.
 Any costs incurred in modifying the terms are adjusted to the carrying amount of the
old liability and amortized over the remaining term of the modified liability.
 A new effective interest rate must be computed to equate the carrying amount of the old
liability with the present value of the cash outflows of the modified liability.

LESSEE ACCOUNTING
Lease
Under Appendix A of IFRS 16, a lease is defined as a contract or part of a contract that
conveys the right to use the underlying asset for a period of time in exchange for consideration.
Appendix B9 provides that to be a lease, a contract must convey the right to control the
use of an identified asset.
Appendix B13 states that an asset is typically identified by being explicitly specified in a
contract or implicitly specified when made available to customer.

Right to control the use of an asset

 Obtain substantially all of the economic benefits from the use of the identified asset.
 Direct use of the identified asset.

Accounting for lease on the part of the lessee under the new lease standard
 IFRS 16, paragraph 22, provides that at the commencement date, a lessee shall recognize
a right of use asset and a lease liability.
 All leases shall be accounted for by the lessee as a finance lease under the new lease
standard.
 IFRS 16, paragraph 5, provides that a lessee is permitted to make an accounting policy
election to apply the operating lease accounting and not recognize an asset and lease
liability in two optional exemptions.
a. Short-term lease
 b. Low value lease
 A lessee may or may not apply the operating lease accounting if the lease is short-
term or if the underlying asset is of low value.
 A lease that contains a purchase option is not a short-term lease.
 Under the operating lease model, the periodic rental is simply recognized as rent expense
on the part of the lessee.

How much is low value of the underlying asset?

The new lease standard does not provide for a quantitative threshold for low value
asset. Low value asset is a matter of professional judgment.
 Appendix B3 states that a lessee shall assess the value of an underlying asset based on
the value of the asset when it is new regardless of the age of the asset being leased.
 A lease of an underlying asset does not qualify as a low value lease if the nature of the
asset is such that the asset is typically not of low value when new.
 IIFRS 16, paragraph 8, provides that the election for low value lease is made on a lease
by lease basis.

Initial measurement of right of use asset

A right of use asset is defined as an asset that represents the right of a lessee to use an
underlying asset over the lease term in a finance lease.

 IFRS 16, paragraph 24, provides that the lessee shall measure the right of use asset at
cost at commencement date which comprises:

a. The amount of initial measurement of the lease liability or the present value of lease
payments
b. Lease payments made to lessor at or before commencement date, such as lease
bonus, less any lease incentives received
c. Initial direct costs incurred by the lessee
d. Estimate of cost of dismantling, removing and restoring the underlying asset for
which the lessee has a present obligation

 Lease incentives should be deducted from the cost of the right of use asset.
Subsequent measurement of right of use asset
 IFRS 16, paragraph 29, provides that a lessee shall measure the right of use asset at cost
less any accumulated depreciation and impairment loss.
 The carrying amount of the right of use asset is adjusted for any remeasurement of the
lease liability.

Presentation of the right of use asset

 Paragraph 47 provides that the lessee shall present the right of use asset as a separate
line item in the statement of financial position.
 As an alternative, the lessee may include the right of use asset in the appropriate line item
within which the corresponding underlying asset would be presented if owned.
 Disclosure is necessary.

Depreciation of right of use asset

 IFRS 16, paragraph 32, provides that the lessee shall depreciate the right of use asset
over the useful life of the underlying asset under the following conditions:
o The lease transfers ownership of the underlying asset to the lessee at the end of
lease term.
o The lessee is reasonably certain to exercise a purchase option.
 If there is no transfer of ownership to the lessee or if the purchase option is not
reasonably certain to be exercised, the lessee shall depreciate the right of use asset over
the shorter between the useful life of the asset and the lease term.

Measurement of lease liability

 IFRS 16, paragraph 26, provides that at the commencement date, the lessee shall measure
the lease liability at present value of lease payments.
 The lease payments shall be discounted using the interest rate implicit in the lease.
 If the implicit interest rate cannot be readily determined the incremental borrowing rate
of the lessee is used.
 The interest rate implicit in the lease is the interest rate that causes the present value of
the lease payments and the unguaranteed residual value to equal the fair value of the
underlying asset and initial direct costs of the lessor.
 The lessee's incremental borrowing rate is the rate of interest that the lessee would have
to pay to borrow funds necessary to obtain a similar asset over a similar term and similar
security.
The lease payments comprise the following payments for the right to use the underlying asset
during the lease term:
a. Fixed lease payments
- Payments made by the lessee to the lessor for the right to use an underlying asset during
the lease term.
b. Variable lease payments
- Payments made by the lessee for the right to use the underlying asset during the lease
term that vary because of changes in facts or circumstances occurring after the
commencement date other than passage of time.
c. Exercise price of purchase option if the lessee is reasonably certain to exercise the option
d. Amount expected to be payable by the lessee under a residual value guarantee
e. Termination penalties if the lease term reflects the exercise of a termination option
 Executory costs, such as real estate taxes, repair and maintenance and insurance are not
included in lease liability but expensed immediately.

Lease term
Appendix A defines lease term as noncancelable period for which the lessee has the right to use
the underlying asset together with both of the following:
a) Period covered by an option to extend the lease if the lessee is reasonably certain to
exercise the extension option.
b) Period covered by an option to terminate the lessee if the lessee is reasonably certain not
to exercise the termination option.

Disclosures- Lessee
1. Depreciation charge for right of use assets by class of underlying asset
2. Interest Expense on lease liability
3. The expense relating to short term leases excluding the expense relating to leases with a
term of one month or less
4. The expense relating to low value leases excluding the expense relating to low value
leases with term of one month or less
5. The expense relating to variable lease payments not included in the measurement of lease
liability.
6. Income from subleasing right of use assets
7. Total cash outflow for leases
 8. Addition to right of use assets
9. The carrying amount of right of use assets at the end of the reporting period by class of
underlying asset.
10. Short term leases or low value leases accounted for as operating lease.

Lease modification accounted for separately

IFRS 16, paragraph 44, provides that the lessee shall account for the lease modification as a
separate lease under the following conditions:
a. The modification increases the scope of the lease by adding the right to use an
additional underlying asset.
b. The rental for the lease modification increases by an amount commensurate with
the increase in scope and equivalent to the current market rental.

Decrease in scope
IFRS 16, paragraph 46, states that a gain or loss should be recognized as a result of the partial
termination of the lease.
 Decrease in CA of Lease liability > Decrease in CA of right of use asset = Termination
gain
 Decrease in CA of Lease liability < Decrease in CA of right of use asset = Termination
loss

LESSOR ACCOUNTING
Accounting for lease on the part of the lessor under the new lease standard
 Lessor accounting under the new lease standard is business as usual.
 IFRS 16, paragraph 61, provides that a lessor shall classify leases as either an operating
lease or a finance lease.
 Whether a lease is a finance lease or an operating lease depends on the substance of the
transaction rather than the form of the contract.

Under IFRS 16, paragraph 63, any of the following situations would normally lead to a lease
being classified as a finance lease:
a. The lease transfers ownership of the underlying asset to the lessee at the end of the
lease term.
 b. The lessee has an option to purchase the asset at a price which is expected to be
sufficiently lower than the fair value at the date the option becomes exercisable. At the
inception of the lease, it is reasonably certain that the option will be exercised.
c. The lease term is for the major part of the economic life of the underlying asset even
if title is not transferred. Under USA GAAP “major part" means at least 75% of the
economic life of the underlying asset.
d. The present value of the lease payments amounts to substantially all of the fair value
of the underlying asset at the inception lease. Under USA GAAP, “substantially all" means
at least 90% of the fair value of the underlying asset.
Other criteria
 The underlying asset is of such specialized nature that only the lessee can use it without
major modification.
 If the lessee can cancel the lease, the lessor’s losses associated with the cancelation are
borne by the lessee.
 Gains or losses from the fluctuation in the fair value of the residual accrue to the lessee.
 The lessee has the ability to continue the lease for a secondary period at a rent that is
substantially lower than the market rent.

Land and building Lease

Application Guidance B55 provides that in classifying a lease on land and building, a
lessor normally considers the land and building separately.
Application Guidance B56 provides that the lease payments are allocated between the
land and building elements in proportion to the relative fair value of the leasehold interests in
the land and building elements at the inception of the lease.
Operating lease on the part of lessor
IFRS 16, paragraph 81, provides that lease income from operating lease on the part of the lessor
shall be recognized on a straight line basis over the lease term, unless another systematic basis
is more representative of the time pattern in which benefit from the use of the underlying asset
is diminished.
a. The periodic rental in an operating lease is simply recognized by the lessor as rent
income.
b. A lessor shall present an asset subject to operating lease in the statement of financial
position according to the nature of the asset.
 c. The underlying asset remains as an asset of the lessor and consequently, the lessor
bears all ownership or executory costs such as depreciation of leased property, real
property taxes, insurance and maintenance.
d. The depreciation policy for depreciable underlying asset shall be consistent with the
lessor's normal depreciation for similar asset.
e. Any security deposit refundable upon the lease expiration shall be accounted for as
liability by the lessor.
f. Any lease bonus received by the lessor from the lessee is recognized as unearned
rent income to be amortized over the lease term.
g. Initial direct costs incurred by lessor in an operating shall be added to the carrying
amount of the underlying asset and recognized as an expense over the lease term on the
same basis as the lease income.

Unequal rental payments

IFRS 16, paragraph 81, provides that lease payments under an operating lease shall be
recognized as income on a straight line basis or another systematic basis.
DIRECT FINANCING LEASE-LESSOR
On the part of the lessor, a finance lease is either:
a) Direct Financing Lease – recognizes only interest income
b) Sales Type Lease – recognizes interest income and gross profit on sale

Direct Financing Lease

 Arrangement between a financing entity and a lessee
 Income of lessor is only in the form of interest income
 No dealer profit is recognized because the fair value and the cost of asset are equal

1. Gross investment in the lease

The gross investment in the lease is equal to the gross rentals for the entire lease term
plus the absolute amount of the residual value, whether guaranteed or unguaranteed. This is
the amount debited to lease receivable.
2. Net investment in the lease
 The net investment in the lease is equal to the cost of the asset plus any initial direct cost
incurred by the lessor.
3. Unearned interest income
The unearned interest income is the total financial revenue of the lessor which is the
difference between the gross investment and net investment in the lease.
4. Initial direct cost
 In a direct financing lease, the initial direct cost incurred by the lessor is added to the
cost of the asset to get the net investment in the lease.
 This would effectively spread the initial direct cost over the lease term and reduce the
amount of interest income.
 The interest rate implicit in the lease is recomputed so as to include the initial direct cost
in the measurement of the lease receivable.

SALES TYPE LEASE-LESSOR

 Lessor is actually a manufacturer or dealer.
 Involves recognition of a manufacturer or dealer profit on the transfer of the asset to the
lessee in addition to the recognition of interest income

1. Gross investment - This is equal to the gross rentals for the entire lease term plus the
absolute amount of the residual value, whether guaranteed or unguaranteed.
2. Net investment in the lease - This is equal to the present value of the gross rentals plus the
present value of the residual value, whether guaranteed or unguaranteed.
3. Unearned interest income - This is the total financial revenue of the lessor which is the
difference between the gross investment and net investment in the lease.
4. Sales - The amount is equal to the net investment in the lease or fair value of the asset,
whichever is lower.
5. Cost of goods sold - This is equal to the cost of the asset sold plus the initial direct cost
incurred by the lessor.
6. Gross profit - This is the usual formula of sales minus cost of goods sold.
7. Initial direct cost - This amount is expensed immediately in a sales type lease as component
of cost of goods sold.
Actual sale of underlying asset
The difference between the sale price and the carrying amount of the lease receivable is
recognized in profit or loss.
Disclosures – Lessor
1. For finance lease:
a) Selling profit or loss
b) Finance Income on the net investment in the lease
c) Income relating to variable lease payments not included in the
measurement of the net investment in the lease
2. For operating lease, lease income, separately disclosing income relating to
variable lease payments that do not depend on an in index or rate.

SALES AND LEASEBACK

 An arrangement whereby one party sells an asset to another party and then
immediately leases the asset back from the new owner.
 The seller-lessee would like to avoid the burden of paying the executory costs
attendant to the asset, such as repairs, insurance and taxes.

Transfer of the asset is sale

IFRS 16, paragraph 100, provides that the transfer of an asset must satisfy the
requirements for the recognition of sale in order to be accounted for as a sale and leaseback.
 There is a sale
 There is a lease agreement for the same asset in which the seller is the lessee and
the buyer is the lessor.
 There is no physical transfer of asset.

Measurement of right of use of asset

IFRS 16, paragraph 100, provides that the seller-lessee shall measure the right of use
asset arising from the leaseback at the proportion of the previous carrying amount of the
asset that relates to the right of use retained by the seller-lessee.
 Paragraph 100 provides that the gain or loss that pertains to the right retained by the
seller-lessee is not recognized.
  The gain or loss that pertains to the right transferred to the buyer-lessor is recognized.
 Paragraph 100 provides that the buyer-lessor shall account for the purchase of the asset
applying lessor accounting standard.
o IFRS 16, paragraph 101, provides that if the sale price does not equal the fair
value of the asset, the seller-lessee shall make adjustment to measure the sale
price at fair value.

Transfer of the asset is not sale

IFRS 16, paragraph 103, provides that if the transfer of an asset by the seller-lessee does
not satisfy the requirements for the recognition of a sale:
a) The seller-lessee shall continue to recognize the transferred asset and shall recognize a
financial liability equal to the transfer proceeds.
b) The buyer-lessor shall not recognize the transferred asset but shall recognize a financial
asset equal to the transfer proceeds.

ACCOUNTING FOR INCOME TAX

Deferred tax accounting is applicable to all entities, whether public or nonpublic
entities.
 Accounting Income or financial income is the net income for the period before
deducting income tax expense. Under IFRS, this is known "accounting profit"
income statement.
 Taxable income is the income appearing on the income tax return and computed
in accordance with the income tax law.
 Permanent differences are items of revenue and expenses which are included in
either accounting income or taxable income but will never be included in the
other. It pertains to nontaxable revenue and nondeductible expenses. It does
not give rise to deferred tax asset and liability.
 Temporary differences are differences between the carrying amount of an asset
or liability and its tax base. Temporary differences include timing differences.
 Taxable temporary difference is the temporary difference that will result in
future taxable amount in determining taxable income of future periods when the
carrying amount of the asset or liability is recovered or settled.
 Deductible temporary difference is the temporary difference that will result in
future deductible amount in determining taxable income of future periods when
the carrying amount of the asset or liability is recovered or settled.

Deferred Tax Liability

  Deferred tax liability is the amount of income tax payable in future periods with respect
to a taxable temporary difference.
 A deferred tax liability is the deferred tax consequence attributable to a future taxable
amount or taxable temporary difference.

A deferred tax liability arises from the following:

a) When the accounting income is higher than taxable income because of timing
differences.
Revenues and gains are included in accounting income of the current period but are
taxable in future periods.
Expenses and losses are deductible for tax purposes in the current period but deductible
for accounting purposes in future periods.
b) When the carrying amount of an asset is higher than the tax base.
c) When the carrying amount of a liability is lower than the tax base.

Tax Base

 The tax base of an asset or a liability is the amount attributable to the asset or liability for
tax purposes.
 Amount of the asset or liability that is recognized for tax purposes.
 The tax base of an asset is the amount that will be deductible for tax purposes against
future profit.
 The tax base of a liability is normally the carrying amount less the amount that will be
deductible for tax purposes in the future.

Recognition of a deferred tax liability

PAS 12, paragraph 15, provides that a deferred tax liability shall be recognized for all
taxable temporary differences.
Not recognized when taxable temporary differences arise from:
a) Goodwill resulting from a business combination and which is nondeductible for tax
purposes.
b) Initial recognition of an asset or liability in a transaction that is not a business
combination and affects neither accounting income nor taxable income.
c) Undistributed profit of subsidiary, associate or joint venture when the parent, investor
or venturer is able to control the timing of the reversal of the temporary difference.
Deferred Tax Asset
 A deferred tax asset is the amount of income tax recoverable in future periods with
respect to deductible temporary difference and operating loss carry forward.
 A deferred tax asset is the deferred tax consequence attributable to a future deductible
amount or deductible temporary difference and operating loss carry forward.

A deferred tax asset arises from the following:

 When the taxable income is higher than accounting income because of timing
differences.
Revenues and gains are included in taxable income of the current period but are
included in accounting income of future periods.
Expenses and losses are deducted from accounting income of the current period but are
deductible for tax purposes in future periods.
 When the tax base of asset is higher than carrying amount.
 When the tax base of a liability is lower than carrying amount.
Recognition of deferred tax asset

 PAS 12, paragraph 24, provides that a deferred tax asset shall be recognized for all
deductible temporary differences and operating loss carryforward when it is
probable that taxable income will be available against which the deferred tax asset can
be used.
 Operating loss carryforward is an excess of tax deductions over gross income in a year
that may be carried forward to reduce taxable income in a future year.

Method of Accounting
a) Income Statement Approach – focuses on timing differences only in the computation of
deferred tax asset or deferred tax liability.
b) Statement of Financial Position approach – considers all temporary differences including
timing differences.

Measurement of current tax liability and current tax asset

- using the tax rate that has been enacted and effective at the end of the reporting period.
Measurement of deferred tax liability or deferred tax asset.
- using the tax rate that has been enacted by the end of the reporting period and expected
to apply to the period when the asset is realized or the liability is settled.
Offset of deferred tax asset and deferred tax liability
PAS 12, paragraph 70, provides that a deferred tax asset shall be classified as noncurrent
asset and a deferred tax liability shall be classified as noncurrent liability regardless of reversal
period. Moreover, a deferred tax asset or deferred tax liability shall not be discounted.
PAS 12, paragraph 74, provides that an entity shall offset deferred tax asset and deferred
tax liability when:
a) The deferred tax asset and deferred tax liability relate to income taxes levied by the
same taxing authority.
b) The entity has a legal enforceable right to set off a current tax asset against a current
tax liability.

Deferred tax consequence of revaluation of asset.

 Generally, revaluation of an asset is not a taxable event. The future recovery of the
asset either through continuing use or through disposal would lead to a taxable amount.
 The amount of depreciation based on cost deductible for tax purposes would differ
from the amount of depreciation based on revalued amount that is recognized for
accounting purposes.
 The difference between the carrying amount and tax base of a revalued asset is a
temporary difference.
 An upward revaluation shall give rise to a taxable temporary difference resulting to a
deferred tax liability.

Intraperiod tax allocation and interperiod tax allocation

 Intraperiod tax allocation is the allocation of income tax expense to the various
revenues that brought about the tax. It associates the tax expense with the items in the
income statement. The total income tax expense is allocated to income from continuing
operations, income from discontinued operations and prior period errors or items directly
charged or credited to retained earnings.
 Interperiod tax allocation is the recognition of a deferred tax asset or deferred tax
liability.

Recognition of a deferred tax asset for unrealized loss

 PAS 12 has been amended to clarify how to recognize a deferred tax asset for
unrealized loss on debt investment measured at fair value through other
comprehensive income.
  Paragraph 61A of PAS12 states that deferred taxes arising from other
comprehensive income shall be recognized in other comprehensive income.

Disclosures
1. Components of the total income tax expense.
2. An explanation of the relationship between total income tax expense and
accounting profit.
3. The applicable tax rate, the basis on which the tax rate has been applied, and the
explanation for any change in the applicable tax rate.
4. The aggregate amount of current and deferred tax relating to items recognized
directly in equity.
5. The aggregate amount of temporary differences associated with investments in
subsidiary, associate and joint venture for which no deferred tax liability has been
recognized.
6. Analysis of the beginning and ending balance of deferred tax asset and deferred
tax liability.

EMPLOYEE BENEFITS
 Employee benefits are all forms of consideration given by an entity in exchange for
services rendered by employees or for the termination of employment.
 For the purpose of PAS 19R, employees include directors and other management
personnel.

 Under PAS 19R, employee benefits include:

a) Short-term employee benefits
b) Postemployment benefits
c) Long-term employee benefits, other than postemployment benefits
d) Termination benefits

POSTEMPLOYMENT BENEFITS
Postemployment benefits are employee benefits, other than termination benefits and short-
term employee benefits, which are payable after completion of employment.
a. Retirement benefits, such as pensions and lump sum payments on retirement
b. Postemployment life insurance
c. Postemployment medical care
Defined Contribution Plan
 A defined contribution plan is a postemployment benefit plan under which an entity
pays fixed contributions into a separate entity known as the fund.
 The entity shall have no legal or constructive obligation to pay further contributions if
the fund does not hold sufficient assets to pay all employee benefits relating to employee
service in the current and prior periods.
 The entity makes a specific or definite amount of contribution to a separate fund without
specifying the retirement benefit to be received by the employee.
 The contribution is definite but the benefit is indefinite.
 If the plan provides exceptional investment performance, the employee will share in the
gain in the form of larger retirement benefit.
 If the plan does poorly, the employee will share in the loss by receiving smaller
retirement benefit.
 The employee bears the investment risk in a defined contribution plan.

Defined benefit plan

 An entity's obligation is to provide the agreed benefits to employees.
 An employee is guaranteed specific or definite amount of benefit which is usually related
to the salary and years of service.
 The benefit is definite but the contribution is indefinite.
 The entity assumes the investment risk in a defined benefit plan.

Multiemployer Plan
A defined contribution plan or defined benefit pan that pools the assets contributed by
various entities that are not under common control and uses those assets to provide benefits to
employees of more than one entity.

Postemployment benefits under the Philippine law

a. Social Security System - defined contribution plan
b. R. A. 7641 – defined benefit plan

Accounting procedure for a defined contribution

  Accounting for a defined contribution plan is straightforward because the
obligation of the entity is determined by the amount contributed for each period.
 There are no actuarial assumptions to measure the contribution and there is no
possibility of any actuarial gain or loss.

1. The contribution shall be recognized as expense in the period it is payable. The

entity shall disclose the amount recognized as expense for a defined contribution
plan.
2. Any unpaid contribution at the end of the period shall be recognized as accrued
expense.
3. Any excess contribution shall be recognized as prepaid expense but only to
the extent that the repayment will lead to a reduction in future payments or a cash
refund.

Accounting for a defined benefit plan

 Accounting for a defined benefit plan is complex because actuarial assumptions are
required to measure the obligation and the expense and there is a possibility of actuarial
gains and losses.
 The obligations are measured on a discounted basis because the benefits may be
settled many years after the employees render the related service
 The expense recognized is not necessarily the amount of contribution for the period.

Components of defined benefit cost

PAS 19R, paragraph 120, provides that an entity shall recognize the following components of
defined benefit cost:
1. Service cost which comprises:
a) Current service cost
b) Past service cost
c) Any gain or loss on plan settlement

2. Net interest which comprises:

a) Interest expense on defined benefit liability
b) Interest income on plan assets
 3. Remeasurements which comprise:
a) Actuarial gain and loss
b) Actual return on plan assets less interest income on plan assets
c) Any change in the effect of asset ceiling minus interest expense on the beginning
effect of asset ceiling

 The service cost and net interest are included in profit or loss as component of employee
benefit expense.
 All of the remeasurements are fully recognized through other comprehensive
income and may be reclassified subsequently through retained earnings.
 The defined benefit cost is partly profit or loss representing service cost and net
interest, and partly other comprehensive income representing the remeasurements.
 PAS 19R encourages but does not require an entity to involve a qualified actuary in the
measurement of a defined benefit obligation.

Actuarial Valuation Method

 Projected unit credit method/accrued benefit method
 Sees each period of service as giving rise to an additional unit of benefit
entitlement and measures each unit separately to build up the final obligation.

Current Service Cost, Net Interest and Past Service Cost

 Current service Cost is the increase in the present value of the defined benefit
obligation resulting from employee service in the current period.
 The net interest expense or net interest income is the difference between the
interest expense on the defined benefit obligation and interest income on the
plan assets.
a) Interest expense is computed by multiplying the defined benefit
obligation at the beginning of the reporting period by the "discount rate".
b) Interest income is computed by multiplying the fair value of plan assets at
the beginning of the reporting period by the "same discount rate".
 Past service cost is the change in the present value of defined benefit obligation
for employee service in prior periods resulting from a plan amendment or
curtailment.
 PAS 19R, paragraph 103, provides that all past service costs, whether vested or
unvested, shall be recognized as expense immediately.

Recognition of Past Service Cost

PAS 19R, paragraph 102, provides that an entity shall recognize past service cost as an expense
at the earlier of the following dates:
a) When the plan amendment or curtailment occurs.
b) When the entity recognizes related restructuring costs or termination benefits.

Plan Assets
Plan assets include assets held by a long-term benefit fund and qualifying insurance policy.
 The conditions for assets held by a long-term benefit fund are:
a. The assets are held by an entity, the fund itself, that is legally separate from the
reporting entity.
b. The assets are available to pay only employee benefits.
c. The assets are not available to the reporting entity's own creditors even in
bankruptcy.
d. The assets cannot be returned to the reporting entity or can be returned only to the
reporting entity if the remaining assets of the fund are sufficient to meet all employee
benefit obligations or the assets are returned to the reporting entity to reimburse it for
employee benefits already paid.
 A qualifying insurance policy is an insurance policy issued by an insurer that is not a
related party of the reporting entity and the proceeds of the policy can be used only to
pay employee benefits and are not available to the reporting entity's own creditors even
in bankruptcy.

Return on plan assets

The components of return on plan assets include the following:
a) Interest, dividend and other income derived from the plan assets.
b) Realized and unrealized gains and losses on the plan assets.

Measurement of Plan Assets

- At Fair value
Recognition of return on plan assets
- Fully recognized as “remeasurement” and accounted for as component of other
comprehensive income
Projected benefit obligation
  Projected benefit obligation is the actuarial present value of all benefits attributed by the
pension benefit formula to employee service rendered before a specified date based on
future compensation level.
 The amount of the benefit obligation includes future salary increases that the entity
projects it will pay to employees during the remainder of their employment.

Actuarial gains and losses

 Actuarial gains and losses are changes in the present value of the defined benefit
obligation resulting from experience adjustments and the effects of changes in actuarial
assumptions.
 Experience adjustments are adjustments from the difference between the previous
actuarial assumptions and what has actually occurred
 Actuarial assumptions comprise of demographic assumptions and financial assumptions.
 Demographic assumptions deal with mortality, rate of employee turnover, disability,
early retirement, proportion of plan members eligible for benefits, and claim rates under
medical plans.
 Financial assumptions deal with discount rate, future salary and benefit levels, future
medical costs and taxes payable by the plan.
 The discount rate shall be determined by reference to market yields at the end of
reporting period on high quality bonds.
 If there are no such bonds, the market yields on government bonds shall be used as
discount rate.

Recognition of Actuarial gain and loss

 PAS 19R, paragraph 120 provides that all remeasurements, including actuarial gains and
losses, shall be recognized immediately in other comprehensive income.
 Paragraph 122 provides that an entity may transfer remeasurements recognized in other
comprehensive income within equity or reclassified to retained earnings.
 Actuarial gains and losses are permanently excluded from profit or loss.

DEFINED BENEFIT PLAN

Relationship between the FVPA and PBO in the accounting for a defined benefit plan
 The fair value of the plan assets is the source of fund set aside in meeting future
benefit payments.
 The projected benefit obligation is the present value of the defined benefit liability.
o If the FVPA is less than the PBO, the plan is underfunded, and therefore, there is
an accrued benefit cost, a noncurrent liability.
 o If the FVPA is more than the PBO, the plan is overfunded and therefore, there is
a prepaid benefit cost or surplus, a noncurrent asset.
 PAS 19R, paragraph 64, provides that the surplus in defined benefit plan must not
exceed the asset ceiling.
 The asset ceiling is the present value of any economic benefits available in the form of
refunds from the plan or reductions in future contributions to the plan.
 PAS 19R, paragraph 8, provides that any change in the effect of the asset ceiling,
excluding interest on the effect of the asset ceiling is a remeasurement to be recognized
through other comprehensive income.
 Paragraph 126 provides that the "interest on the effect of the asset ceiling" is part of the
total change in the effect of the asset ceiling determined by multiplying the effect of the
asset ceiling at the beginning of the period by the discount rate.
 The portion attributable to the interest on the effect of asset ceiling is included as
component of employee benefit expense.
 The remainder of the change in the effect of asset ceiling is a remeasurement
recognized as component of other comprehensive income.

Settlement of plan
 A settlement is a transaction that eliminates all further legal or constructive obligations
for part or all of the benefits provided under a defined benefit plan.
 PAS 19R clarified that a lump sum payment to plan participants made under the terms of
the existing defined benefit plan is not a settlement. This is referred to as "routine
settlement" and considered an actuarial assumption that should be included in the
measurement of the defined benefit obligation.

Gain or loss on settlement

 PAS 19R, paragraph 110, provides that an entity shall recognize gain or loss on the
settlement of a defined benefit plan when the settlement occurs.
 The gain or loss on settlement is the difference between the settlement price and the
present value of the defined benefit obligation on the date of settlement.
 Any gain or loss on settlement is fully recognized and included in service cost in the
computation of employee benefit expense.

Transitional provision
 PAS 19R, paragraph 173, provides that an entity shall apply this standard
restrospectively.
  An entity need not adjust the carrying amount of assets for changes in employee benefit
costs that were included in the initial carrying amount of the assets.

Disclosures - Defined benefit plan

a) Characteristics of the defined benefit plan and risks associated with the plan
b) Reconciliations for the fair value of plan assets and the present value of the defined
benefit obligation
c) Separate showing of current service cost, past service cost, interest expense or income
and remeasurements
d) Disaggregation of the fair value of plan assets into classes that distinguish the nature and
risks of assets
e) A sensitivity analysis for each significant actuarial assumption showing the effect on
the defined benefit obligation for any change
f) Description of any funding arrangement and policy
g) Expected contribution to the plan for the next period
h) Maturity profile of the defined benefit obligation

PAS 26
 This standard deals with "accounting and reporting by retirement benefit plans"
 For purposes of this standard, such a hybrid plan is deemed to be a defined benefit plan.

Report of defined contribution plan

 The report of a defined contribution plan shall contain a statement of net assets
available for benefits and a description of the funding policy.
 In preparing the "statement of net assets available for benefits", the plan investments
shall be carried at fair value.

Report of defined benefit plan

1. A statement that shows the net assets available for benefits, the actuarial present value of
promised benefits, distinguishing between vested and nonvested benefits, and the
resulting excess or deficit.
2. A statement of net assets available for benefits, including either a note disclosing the
actuarial present value of promised vested and nonvested benefits or a reference to this
information in accompanying actuarial report.
Frequency of actuarial valuation
 In many countries, actuarial valuations are not obtained more frequently than every
three years.
 PAS 26 does not make it incumbent upon the plan to use annual actuarial valuation
 If an actuarial valuation has not been prepared on the date of the report, the most recent
valuation is used and the date of actuarial valuation is disclosed.

Disclosures
The report of a retirement plan, defined contribution and defined benefit, shall disclose the
following information:
a) Statement of changes in net assets available for benefits.
b) Summary of significant accounting policies.
c) Description of the plan and the effect of any changes in the plan during the period.

OTHER EMPLOYEE BENEFITS

Short-term employee benefits
Short-term employee benefits are employee benefits other than termination benefits
which are expected to be settled wholly within twelve months after the end of annual
reporting period in which the employees render the related service.

Short-term employee benefits include the following:

 Salaries, wages and social security contributions
 Short-term compensated or paid absences such as paid annual leave and paid sick leave
 Profit sharing and bonuses payable within twelve months
 Nonmonetary benefits, such as medical care, housing, car and free or subsidized goods.

Recognition and measurement

There is no possibility of actuarial gain or loss because short-term employee benefits
are measured on an undiscounted basis.
Accounting procedures
The rules for short-term employee benefits are essentially an application of basic accounting
principles and practices.
a. Unpaid short-term employee benefits at the end of the accounting period shall be
recognized as accrued expense.
b. Any short-term benefits paid in advance shall be recognized as a prepayment, to
the extent, that it will lead to a reduction in future payments or a cash refund.
c. The cost of short-term benefits shall be recognized as expense in the period when
the economic benefit is given, except when such cost may be included within the
cost of an asset, for example, property, plant and equipment in accordance with another
standard.
Short-term compensated or paid absences
 Accumulating paid absences are those that are carried forward and can be used in future
periods if the current period's entitlement is not used in full.
 Vesting – employees are entitled to a cash payment for unused entitlement on leaving the
entity.
 Nonvesting - employees are not entitled to a cash payment for unused entitlement on
leaving the entity.
 Nonaccumulating paid absences are those that are not carried forward. Such benefits
lapse if the current period's entitlement is not used and do not entitle the employees to a
cash payment for unused entitlement on leaving the entity.

Profit-sharing and bonus plans

 Under some profit-sharing plans, employees shall receive a share of the profit only if
they remain with the entity for a specified period.
 Such plans create a constructive obligation as employees render service that increases
the amount to be paid if they remain in service until the end of the specified period.
 The measurement of such constructive obligation reflects possibility that some
employees may leave without receiving profit-sharing payments.

Recognition and measurement

PAS 19R, paragraph 19, provides that an entity shall recognize the expected cost of profit
sharing and bonus payment when all of the following conditions are present:
a) The entity has a present legal or constructive obligation to make such payment as a result
of past event.
 b) A reliable estimate of the obligation can be made.

Other long-term employee benefits

 The term "other long-term employee benefits" is a residual definition.
 Other long-term employee benefits are all employee benefits other than short-term
employee benefits, postemployment benefits and termination benefits.
 In other words, other long-term employee benefits are employee benefits which are not
expected to be settled wholly within twelve months after the end of annual
reporting period in which the employees render the related service.

Recognition and measurement

 The recognition and measurement of liability for other long-term employee benefits are
the same as the recognition and measurement of defined benefit obligation.
 In other words, the liability recognized for other long-term employee benefits is equal to
the excess of the present value of the liability over the fair value of the plan assets at
the end of reporting period.
 The only difference is the recognition of the components of the defined benefit cost.

For other long-term employee benefits, all of the following components of defined benefit cost
are recognized in profit or loss and included in the computation of employee benefit expense:
a) Current service cost
b) Past service cost
c) Any gain or loss on settlement
d) Net interest expense or net interest income
e) Remeasurements, such as actuarial gains and losses, the difference between actual return
on plan assets and interest income, and the change in the effect of asset ceiling.

Termination benefits
Termination benefits are employee benefits provided in exchange for the termination of an
employee’s employment as a result of either:
a. An entity's decision to terminate an emplovee’s employment before the normal retirement
date.
b. An employee's decision to accept an offer of benefits in exchange for the termination of
employment.
  A benefit that is in any way dependent on providing service in the future is not a
termination benefit.
 The difference between the benefit provided for the termination of employment at the
request of the employee and a higher benefit provided at the request of the entity is a
termination benefit.

Fundamental principles
The fundamental principles in relation to termination benefit are:
a. Not conditional on future service being provided
b. Short period between offer of termination and actual termination

Recognition of termination benefits

PAS 19R, paragraph 165, provides that an entity shall recognize an expense and a liability for
termination benefits at the earlier of the following dates:
a. When the entity can the no longer withdraw the offer of termination benefits, for
example, when the plan of termination is already communicated or announced to affected
employees.

b. When the entity recognizes the cost of restructuring that involves the payment of
termination benefits.

 Implicit in the recognition criteria is that there needs to be an offer of termination that
binds the entity in some way.

Measurement of termination benefits

PAS 19R, paragraph 169, provides that:
a. If the termination benefits are expected to be settled wholly within twelve months after
the end of reporting the period in which the termination benefit is recognized, the requirements
for short-term employee benefits shall be applied.

 the termination benefits are measured at the undiscounted amount.

 b. If the termination benefits are expected not to be settled wholly within twelve months
after the end of reporting period, the requirements for other long-term employee benefits shall be
applied.

 The termination benefits are measured at discounted amount using the applicable
discount rate.

References:
Valix, C. et al., (2019). Financial Accounting Volume Two (2019 ed.,). Manila: GIC Enterprises
& Co., Inc.
Valix, C. et al., (2018). Theory Financial Accounting (2018 ed.,). Manila: GIC Enterprises &
Co., Inc.

PROBLEMS:

CURRENT LIABILITIES
1. ELO Company reported the following liabilities on December 31, 2018:

Accounts payable and accrued interest 1,000,000

12% note payable issued November 1, 2017
maturing July 1, 2019 2,000,000
10% note payable issued October 1, 2017
maturing October 1, 2019 1,400,000
10% debentures payable, next annual principal
installment of P500,000 due February 1, 2019 7,000,000

On December 31, 2018. the entity consummated a noncancelable agreement with the lender to
refinance the 12% note payable on a long-term basis.

The entity has the discretion to refinance the 10% note payable for at least twelve months after
the end of reporting period.

What total amount should be reported as current liabilities on December 31, 2018?
a) 2,900,000
b) 3,000,000
c) 1,500,000
d) 2,500,000

ANSWER: C
SOLUTION:
Accounts payable and accrued interest 1,000,000
Debentures payable – current portion 500,000
Total current liabilities P 1,500,000

Source: Valix, C. et al., (2018). Practical Financial Accounting Volume Two (2018 ed.,).
Manila: GIC Enterprises & Co., Inc.

EXPLANATION:

The total amount that should be reported as current liabilities on December 31, 2018 is
P1,500,000. An obligation that matures within one year shall be classified as current liability
regardless of refinancing that was consummated after the end of reporting period and before
issuance of financial statements. However, if the refinancing occurs on or before the end of
reporting period, the obligation is classified as noncurrent liability. PAS 1, paragraph 72,
provides that an obligation that matures within one year from the end of reporting period is
classified as current even if it is refinanced on a long-term basis after the reporting period and
before issuance of the financial statements. PAS 1, paragraph 73, states that if an entity has the
discretion to refinance or roll over an obligation for at least twelve months after the reporting
period under an existing loan facility, the obligation shall be classified as noncurrent, even if it
would otherwise be due within a shorter period. The 12% note payable shall be classified as
noncurrent because the refinancing is made on December 31, 2018. If an entity has the discretion
to refinance an obligation for at least twelve months after the end of reporting period, it shall
classify the obligation as noncurrent. Thus, the 10% note payable is also classified as noncurrent.
Therefore, only the accounts payable and accrued interest, and the current portion of debentures
payable are classified as current liabilities.

2. On December 31 2014, the bookkeeper of GERALD Company provided the following

information:

Accounts payable, including deposits and advances

from customers of P500,000 P 2,500,000
Notes payable, including note payable to bank
due on December 31, 2016 for P1,000,000 3,000,000
Share dividends payable 800,000
Credit balance in customers’ accounts 400,000
Serial bonds, payable in semiannual installments of P1,000,000 10,000,000
Accrued interest on bonds payable 300,000
Contested BIR tax assessment 600,000
Unearned rent income 100,000

In the December 31, 2014 statement of financial position, how much current liabilities
should be reported?
a) P6,800,000
b) P7,300,000
c) P7,900,000
d) P8,700,000

ANSWER: B

SOLUTION:
Accounts payable P2,000,000
Deposits and advances from customers 500,000
Notes payable 2,000,000
Credit balance in customers' accounts 400,000
Current portion of serial bonds 2,000,000
Accrued interest on bonds payable 300,000
Unearned rent income 100,000
Total current liabilities P7,300,000

Source: Uberita, C. (2015). Practical Accounting 1 (2015 ed.,). Manila: DomDane Publishers

EXPLANATION:

The current liabilities to be reported is P7,300,000. In accordance with the revised PAS 1
par. 69, an entity shall classify a liability as current when it expects to settle the liability in its
normal operating cycle, it holds the liability primarily for the purpose of trading, the liability is
due to be settled within twelve months after the reporting period or the entity does not have an
unconditional right to defer settlement of the liability for at least twelve months after the
reporting period. The notes payable to bank due on December 31, 2016 should be reported as a
non-current liability. Share dividends payable is reported as a component of shareholders' equity
and the Contested BIR tax assessment should only be disclosed in the notes to Financial
Statements (F/S). In the absence of any information, the unearned rent income should be
classified as current liability.

3. The balance in COLE Company's accounts payable account at December 31, 2014 was
P1,170,000 before any year-end adjustments relating to the following:

 Goods were in transit from a vendor to Cole on December 31, 2014. The invoice cost
was P65,000 and the goods were shipped FOB shipping point on December 29, 2014.
The goods were received on January 2, 2015.
 Goods shipped FOB shipping point on December 20, 2014 from a vendor to Cole, were
lost in transit. The invoice cost was P32,500. On January 5, 2015, Cole filed a
P32,500 claim against the common carrier.
 Goods shipped FOB destination on December 21, 2014, from a vendor to Cole, were
received on January 6, 2015. The invoice cost was P19,500.
What amount should Cole report as accounts payable on its December 31, 2014 statement
of financial position?
a) P1,202,500 c) P1,235,000
b) P1,222,000 d) P1,267,500

ANSWER: D

SOLUTION:
Accounts Payable –unadjusted P1,170,000
Goods in transit 65,000
Goods lost in transit – shipped FOB shipping point 32,500
Accounts Payable – December 31, 2014, adjusted P1,267,500

Source: Uberita, C. (2015). Practical Accounting 1(2015 ed.,). Manila: DomDane Publishers

EXPLANATION:

In accordance with the revised PAS 1 par. 69, an entity shall classify a liability as current
when it expects to settle the liability in its normal operating cycle, it holds the liability primarily
for the purpose of trading, the liability is due to be settled within twelve months after the
reporting period or the entity does not have an unconditional right to defer settlement of the
liability for at least twelve months after the reporting period. For goods shipped FOB shipping
point, the title to the goods passes from seller to the buyer at the point of shipment or point of
delivery while goods shipped FOB destination, the title to the goods passes to the buyer upon
receipt of the goods. The goods shipped FOB shipping point on December 20, 2014 but lost in
transit does not negate the liability of Cole Company to the seller. The goods in transit should be
added because the goods were shipped on December 29, 2014, as well as the goods lost in transit
because it was shipped on December 20, 2014. Therefore, P 65,000 and P32,500 should be added
to the unadjusted accounts payable to get the adjusted accounts payable on December 31,2014.
The Goods shipped FOB destination should not be added because the goods were received on
January 6, 2015.
4. DAY CARE Company offers 3 payment plans on its 12 months’ contracts. Information on the
3 plans and the number of children enrolled in each plan for the September 1, 2014 through
August 31, 2015 contract year follows:

Plan Initial Payment Per Monthly Fees per Number of Children

Child Child
1 P5,000 15
2 2,000 P300 12
3 - 500 9

DAY CARE received P99,000 of initial payments on during the period September 1, 2014 and
P32,400 monthly fees during the period September 1 through December 31, 2014.

In its December 31, 2014 statement of financial position, what amount should Day Care
report as deferred revenues?
a) P33,000
b) P43,800
c) P66,000
d) P99,000

ANSWER: C
SOLUTION:
Initial Payment
Plan 1 (P5,000 x 15) P75,000
Plan 2 (P2,000 x 12) 24,000
Total Initial Payment P99,000
x Ratio of unexpired term 8/12
Unearned Fees P66,000

Term Plan 12 months

 Less: Expired Term (Sept. to Dec 31) 4 months
Unexpired Term 8 months

Source: Uberita, C. (2015). Practical Accounting 1(2015 ed.,). Manila: DomDane Publishers

EXPLANATION:

Based on the revised PAS 1 par. 69, an entity shall classify a liability as current when it
expects to settle the liability in its normal operating cycle, it holds the liability primarily for the
purpose of trading, the liability is due to be settled within twelve months after the reporting
period or the entity does not have an unconditional right to defer settlement of the liability for at
least twelve months after the reporting period. All liabilities not classified as current are
classified as noncurrent liabilities. Deferred revenue or unearned revenue is income already
received but not yet earned. If the deferred revenue is realizable within one year, it is classified
as current liability. If the deferred revenue is realizable in more than one year, it is classified as
noncurrent liability. Answer C is correct because under the accrual basis, revenue is earned as
time goes by and care is provided. Regardless of the timing of cash receipts, revenue should be
recognized when the equivalent amount of care is provided, it is to be assumed, therefore, that
the amount of care is provided on a uniform basis throughout the term of the plan, straight-line
method should be applied to amortize the initial fee, while the monthly fees can be recognized on
a monthly basis.

5. In November and December 2014, ABAD Company received P792,000 for P1,000, 3-year
subscriptions at P264 per issue per year, starting with the January 2015 issue. Abad elected to
include the entire P792,000 in its 2014 income statement for tax purposes.

What amount should Abad report in its 2014 statement of financial position as unearned
subscription revenue?
a) None c) P264,000
b) P44,000 d) P792,000

ANSWER: D

SOLUTION:
 Unearned Subscription Revenue P792,000

Source: Uberita, C. (2015). Practical Accounting 1(2015 ed.,). Manila: DomDane Publishers

EXPLANATION:

Deferred revenue or unearned revenue is income already received but not yet earned. If
the deferred revenue is realizable within one year, it is classified as current liability. If the
deferred revenue is realizable in more than one year, it is classified as noncurrent liability.
Typical examples of current deferred revenue are unearned interest income, unearned rental
income and unearned subscription revenue. Answer D is correct. The full amount of P792,000
will be recognized as unrealized revenue during 2014 accounting period since subscription will
only start in January 2015. PAS 1 par. 69 states that an entity shall classify a liability as current
when it expects to settle the liability in its normal operating cycle, it holds the liability primarily
for the purpose of trading, the liability is due to be settled within twelve months after the
reporting period or the entity does not have an unconditional right to defer settlement of the
liability for at least twelve months after the reporting period. All liabilities not classified as
current are classified as noncurrent liabilities.

6. AESPA Department Store sells gift certificates, redeemable for store merchandise that expires
one year after their issuance. Aespa has the following information pertaining to its gift
certificates sales and redemptions:

Unearned at December 31, 2014 600,000

2015 sales 2,000,000
2015 redemptions of prior-year’s sales 200,000
2015 redemptions of current-year sales 1,400,000

Aespa’s experience indicates that 10% of gift certificates sold will not be redeemed.
In its December 31, 2015 statement of financial position, what amount should Aespa report
as unearned revenue?
a) P400,000 c) P800,000
 b) P600,000 d) P1,000,000

ANSWER: A

SOLUTION:
Expected gift certificates to be redeemed (90% x 2,000,000) P 1,800,000
Less: Gift certificates redeemed – 2015 sales 1,400,000
Unearned revenue on gift certificates P 400,000

Source: Uberita, C. (2015). Practical Accounting 1(2015 ed.,). Manila: DomDane Publishers

EXPLANATION:

According to the revised PAS 1 par. 69, an entity shall classify a liability as current when
it expects to settle the liability in its normal operating cycle, it holds the liability primarily for the
purpose of trading, the liability is due to be settled within twelve months after the reporting
period or the entity does not have an unconditional right to defer settlement of the liability for at
least twelve months after the reporting period. Deferred revenue or unearned revenue is income
already received but not yet earned. If the deferred revenue is realizable within one year, it is
classified as current liability. If the deferred revenue is realizable in more than one year, it is
classified as noncurrent liability. Aespa should report in its December 31, 2015 statement of
financial position an unearned revenue amounting to P400,000. Sales on 2015 is multiplied to
90% because the 10% of gift certificates sold will not be redeemed. To get the unearned revenue
on gift certificates, the expected gift certificates to be redeemed is reduced by the gift certificates
redeemed on 2015 sales. Any unearned gift certificate from prior year sale, which has yet to be
presented as of December 31, 2015, should be reversed due to expiration. However, the
Philippine Department of Trade and Industry ruled that gift certificates no longer have an
expiration period.

7. On December 30, 2014, Sara Company leased equipment under a finance lease. Annual lease
payments of P200,000 are due December 31 for 10 years. The equipment's economic life is 10
years and the interest rate implicit in the lease is 10%. The finance lease obligation was recorded
on December 30, 2014 is 1,350,000, and the first lease payment was made on that date.
What amount should Sara include in current liabilities for this finance lease in its
December 31, 2014 statement of financial position?
a) P65,000
b) P85,000
c) P115,000
d) P200,000

ANSWER: B

SOLUTION:
Annual rental P200,000
Less: Interest Expense – 2015
Total Liabilities P1,350,000
Less: Down Payment 200,000
Total Liabilities as of December 31, 2014 P 1,150,000
x effective interest rate 10% 115,000
Current Portion of lease liabilities P 85,000

Source: Uberita, C. (2015). Practical Accounting 1(2015 ed.,). Manila: DomDane Publishers

EXPLANATION:

Sara should include P85,000 in current liabilities for the finance lease in its December 31,
2014 statement of financial position. Thus, Answer B is the correct answer. PAS 17, par. 23
states that it is not appropriate for liabilities for leased assets to be presented in the financial
statements as a deduction from leased assets. If for the presentation of liabilities on the face of
the balance sheet a distinction is made between current and non-current liabilities, the same
distinction is made for lease liabilities.

8. MIKA Company sells its products in reusable, expensive containers. The customer charged a
deposit for each container delivered and receives a refund for each container returned within two
years after the year of delivery. Mika accounts for the containers not returned within the time
limit as being retired by sale at deposit amount. Information for 2015 is as follows:

Deposits for containers at December 31, 2014 from deliveries in:

 2013 P150,000
2014 430,000 P580,000
Deposits for containers delivered in 2015 780,000
Deposits for containers returned in 2015 from deliveries in:
2013 90,000
2014 250,000
2015 286,000 626,000

What amount should Mika Company report as a liability for deposits on returnable
containers at December 31, 2015?
a) P494,000 c) P674,000
b) P644,000 d) P734,000

ANSWER: C

SOLUTION:

Deposits – Returned = Balance

2013 P150,000 P90,000 P60,000
2014 430,000 250,000 180,000
2015 780,000 286,000 494,000 = P 674,000

Source: Uberita, C. (2015). Practical Accounting 1(2015 ed.,). Manila: DomDane Publishers

EXPLANATION:

Answer C is correct. The amount of liability for deposits on returnable containers is

P674,000 (2014 and 2015 balances), because the company’s policy is to refund deposits only if
containers are returned within the two-year prior from the year of delivery, as a result, the
P60,000 balance from 2013 delivery not returned at the end of 2015 is no longer an accounting
liability for the reason that the 2-year expiration period had elapsed. The Conceptual Framework
for Financial Reporting provided that Liabilities are present obligations of an entity arising from
past transactions or events, the settlement of which is expected to result in an outflow from the
entity of resources embodying economic benefits. PAS 1 par. 69 states that an entity shall
classify a liability as current when it expects to settle the liability in its normal operating cycle, it
holds the liability primarily for the purpose of trading, the liability is due to be settled within
twelve months after the reporting period or the entity does not have an unconditional right to
defer settlement of the liability for at least twelve months after the reporting period.

9. All of GOLD Company's employees are entitled to two weeks of paid vacation for each full
year in Gold's employ. Unused vacation time can be accumulated and carried forward to
succeeding years and will be compensated at the salary in effect when the vacation is taken.
Silver started her employment with Gold on January 1, 2008. As of December 31, 2014, when
Silver's salary was P5,000 per week, Silver had used 10 weeks of her accumulated vacation time.
In December 2014, Silver notified Gold of Silver's intention to use her accumulated vacation
weeks in June 2015. Gold regularly scheduled salary adjustments in July of each year. Gold
properly did not deduct compensation for unused vacations in Silver's 2014 income tax return.

How much should Gold report as a liability at December 31, 2014 for Silver's accumulated
vacation time?
a) None
b) P5,000
c) P10,000
d) P20,000

ANSWER: D

SOLUTION:
Years employed (January 1, 2008 to December 31, 2014) 7 years
xVacation leave per year 2 weeks
Total accumulated vacation leaves 14 weeks
Less: used vacation leave 10 weeks
Unused vacation leaves 4 weeks
 xSalary per week P 5,000
Liability for accumulated vacation time P20,000
Source: Uberita, C. (2015). Practical Accounting 1(2015 ed.,). Manila: DomDane Publishers

EXPLANATION:

Gold should report a liability amounting to P20,000 at December 31, 2014 for Silver's
accumulated vacation time. In accordance with PAS 18, paragraph 10, when an employee has
rendered service to an entity during an accounting period, the entity shall recognize the
undiscounted amount of short-term employee benefits expected to be paid in exchange for that
service. As a liability (accrued expense), after deducting any amount already paid. If the amount
already paid exceeds the undiscounted amount of the benefits, an entity shall recognize that
excess as an asset (prepaid expense) to the extent that the prepayment will lead to, for example,
a reduction in future payments or a cash refund; and as an expense, unless another standard
requires or permits the inclusion of the benefits in the cost of an asset (example, PAS 2
inventories and PAS 16 property, plant and equipment). Based on PAS 19, paragraph 11, an
entity shall recognize the expected cost of short-term employee benefits in the form of
compensated absences, where in the case of accumulating compensated absences, when the
employees render service that increases their entitlement to future compensated absences, and in
the case of non-accumulating compensated absences, when the absences occur. Accumulating
compensated absences are those that are carried forward and can be used in future periods if the
current period's entitlement is not used in full. Accumulating compensated absences may be
vesting (in other words, employees are entitled to a cash payment for unused entitlement on
leaving the entity) or non-vesting (when employees are not entitled to a cash settlement for
unused entitlement on leaving). An obligation arises, as employees render service that increases
their entitlement to future compensated absences. The obligation exists, and is to recognized,
even if the compensated absences are non-vesting, although the possibility that employees may
leave before they use an accumulated entitlement affects the measurement of that obligation.
Accordingly, the obligation shall be recognized even if the compensated absences are non-
vesting.

10. During 2010, ALAMAT Company guaranteed a supplier’s P500,000 loan from a bank. On
October 1, 2010, Alamat was notified that the supplier had defaulted on the loan and filed for
bankruptcy protection. Counsel believes Alamat will probably have to pay between P250,000
and P450,000 under its guarantee. As a result of the supplier’s bankcruptcy, Alamat entered into
a contract in December 2010 to retool its machines so that Alamat could accept parts from others
suppliers. Retooling costs are estimated to be P300,000.
What amount should Alamat report as a liability in its December 31, 2010, statement of
financial position?
 a) P250,000
b) P450,000
c) P350,000
d) P650,000

ANSWER: C
SOLUTION:
Provision for guarantee, 12/31/10
[(P250,000+450,000)/2] P350,000

Source: Ocampo, R. (2010). Auditing Problems (2010 ed.,).

EXPLANATION:

Alamat should report a liability amounting to P350,000 in its December 31, 2010,
statement of financial position. Based on PAS 37, par. 36, a provision is a liability of uncertain
timing or amount. The amount recognized as a provision shall be the best estimate of the
expenditure required to settle the present obligation at the end of the reporting period.
Additionally, PAS 37, par. 39 states that where there is a continuous range of possible outcomes,
and each point in that range is as likely as any other, the mid-point of the range is used. The
retooling cost is not recognized as a liability because the contract is executory (i.e. neither party
has performed any of its obligations).

NONCURRENT LIABILITIES

1. MARKUS COMPANY has the following three loans payable scheduled to be repaid in
February of next year. The company's accounting year ends on December 31.
a) The company intends to repay Loan 1 for P100,000 when it comes due in February. In
the following October, the company intends to get a new loan for P80,000 from the
same bank.
b) The company intends to refinance Loan 2 for P150,000 when it comes due in February.
The refinancing agreement, for P180,000, will be signed in April, after the financial
statements for this year have been authorized for issue.
c) The company intends to refinance Loan 3 for P200,000 before it comes due in February.
The actual refinancing, for P175,000, took place in January, before the financial
statements for this been authorized for year have issue.

As of December 31 of this year, the total noncurrent liabilities to be reported in the

company's statement of should be financial position
 a) P25,000 c) P175,000
b) 0 d) P350,000

ANSWER: B
SOLUTION:
Loan 1 P100,000
Loan 2 150,000
Loan 3 200,000
Total Current liabilities P450,000

Noncurrent Liabilities P0

Source: Roque, G. (2018). Auditing Problems (2018-2019 ed.,). Manila: GIC Enterprises & Co.,
Inc.

EXPLANATION:

Answer B is correct because under PAS 1: Presentation of Financial Statements, an entity

classifies its financial liabilities as current when they are due to be settled within 12 months
after the end of the reporting period, even if the original term was for a period longer than 12
months; and an agreement to refinance, or to reschedule payments, on a long-term basis is
completed after the end of the reporting period and before the financial statements are
authorized for issue. PAS 1 further provides that if the refinancing on a long-term basis occurs
between the end of the reporting period and the date the financial statements are authorized for
issue; such event qualifies for disclosure as a non-adjusting event in accordance with PAS 10.
Therefore, the amount of noncurrent liability is zero as loan 1 (P100,000), loan 2 (P150,000) and
loan 3 (P200,000) are classified as current liabilities.

2. MAIDA Company reported the following liability balances on December 31,2018:

10% note payable issued on October 1, 2017 maturing October 1,2019 2,000,000
12% note payable issued on March 1, 2017, maturing on March 1, 2019 4,000,000

The 2018 financial statements were issued on Mach 31, 2019.

Under the loan agreement for the 10% note payable, the entity has the discretion to refinance the
obligation for at least twelve months after December 31,2018.

On March 1, 2019, the entire P4,000,000 balance of the 12% note payable was refinanced
through issuance of a long-term obligation payable lump sum.

What amount of the notes payable should be classified as noncurrent on December 31,
2018?
a) 6,000,000
b) 4,000,000
c) 2,000,000
d) 0

ANSWER: C
SOLUTION:
Notes payable - Current P4,000,000
Notes payable - Noncurrent P2,000,000

Source: Valix, C. et al., (2018). Practical Financial Accounting Volume One (2018 ed.,).
Manila: GIC Enterprises & Co., Inc.

EXPLANATION:

The 10% note payable is classified as noncurrent because according to PAS 1,

paragraph 73, if an entity has the discretion to refinance or roll over an obligation for at least
twelve months after the reporting period under an existing loan facility, the obligation shall be
classified as noncurrent, even if it would otherwise be due within a shorter period. Therefore,
since under the loan agreement for the 10% note payable, the entity has the discretion to
refinance the obligation for at least twelve months after December 31,2018, it is classified as
noncurrent. On the other hand, the 12% note payable is classified as current because PAS 1,
paragraph 72, provides that an obligation that matures within one year from the end of reporting
period is classified as current even if it is refinanced on a long-term basis after the reporting
period and before issuance of the financial statements. Thus, since the 12% note payable is
refinanced on March 1, 2019 after the end of the reporting period on December 31, 2018, it is
classified as current.
3. At December 31, 2018, JISU Company’s liabilities include the following:

1. P10 million of 10% notes are due on March 31, 2023. The financing agreement contains
a covenant that requires Jisu to maintain current assets at least equal to 200% of its
current liabilities. As of December 31, 2018, Jisu has breached this loan covenant. On
February 10,2019, before Jisu’s financial statements are authorized for issue, Jisu
obtained a period of grace from ABC Bank until January 31,2020, having convinced the
bank that the company’s normal 3 to 1 ratio of current assets to current liabilities will be
reestablished during 2019.

2. P15 million of noncancelable 12% bonds were issued at face value on September
30,1997. The bonds mature on August 31, 2019. Jisu expects to have sufficient cash
available to redeem the bonds at maturity.

3. P20 million of 10% bonds were issued at face value on June 30, 1999. The bonds mature
on June 30, 2028, but bondholders have the option to call (demand payment on) the
bonds on June 30, 2019. However, the call option is not expected to be exercised, given
prevailing market conditions.

What portion of Jisu Company’s debt should be reported as a noncurrent liability?

a) P10 million c) P20 million
b) P30 million d) P 0

ANSWER: D
SOLUTION:

Noncurrent liability P 0

All of the above liabilities should be reported as current liabilities.

Source: Roque, G. (2018). Auditing Problems (2018-2019 ed.,). Manila: GIC Enterprises & Co.,
Inc.

EXPLANATION:

Answer D is correct because all of the above liabilities should be reported as current
liabilities in Jisu’s statement of financial position as of December 31, 2018. PAS 1, paragraph
74, provides that such a liability is classified as current even if the lender has agreed, after the
reporting period and before the statements are authorized for issue, not to demand payment as a
consequence of the breach. This liability is classified as current because at the end of the
reporting period, entity does not have an unconditional right to defer settlement for at least
twelve months after that date. However, the liability is classified as noncurrent if the lender has
agreed on or before the end of the reporting period to provide a grace period ending at least
twelve months after that date. On the P10 million notes, the period of grace was given by the
bank only after Jisu’s reporting date. As of December 31, 2018, Jisu does not have an
unconditional right to defer settlement of its liability for at least 12 months from the end of the
reporting period. Additionally, the P15 million bonds are payable in the succeeding year. As of
the end of the reporting period, no long-term refinancing has been made by Jisu. Lastly, the P20
million callable bonds are callable by the creditor in the succeeding year, thus, Jisu does not have
an unconditional right to defer its settlement beyond 12 months from the end of the reporting
period, even if the debt is not expected to be called. Therefore, the amount of noncurrent liability
is zero.

4. You were able to obtain the following from the accountant for AGUIRANGAN Corp. related
to the company's liabilities as of December 31, 2010.

Accounts payable P 650,000

Notes payable - trade 190,000
Notes payable – bank 800,000
Wages and salaries payable 15,000
Interest payable ?
Mortgage notes payable 10% 600,000
Mortgage notes payable 12% 1,500,000
Bonds payable 2,000,000
The following additional information pertains to these liabilities.
a) All trade notes payable are due within six months from the end of the reporting period.
b) Bank notes-payable include two separate notes payable to Allied Bank.
1) A P300,000, 8% note issued March 1, 2008, payable on demand. Interest is
payable every six months.
2) A 1-year, P500,000, 11 ½% note issued January 2, 2010. On December 30, 2010,
Aguirangan negotiated a written agreement with Allied Bank to replace the note
with a 2-year, P500,000, 10% note to be issued January 2, 2011. The interest
was paid on December 31, 2010.
c) The 10% mortgage note was issued October 1, 2007, with a term of 10 years. Terms of
the note give the holder the right to demand immediate payment if the company fails to
make a monthly interest payment within 10 days of the date the payment is due. As of
December 31, 2010, Aguirangan is three months behind in paying its required interest
payment.
d) The 12% mortgage note was issued May 1, 2004, with a term of 20 years. The current
principal amount due is P1,500,000. Principal and interest payable annually on April 30.
A payment of P220,000 is due April 30, 2011. The payment includes interest of
P180,000.
e) The bonds payable is 10-year, 8% bonds, issued June 30,2001. Interest is payable semi-
annually every June 30 and December 31.

Based on the above and the result of your audit, what is the total noncurrent liabilities as of
December 31, 2010?
a) P1,760,000 c) P2,560,000
b) P3,960,000 d) P1,960,000

ANSWER: D
SOLUTION:
P300, 000 note payable to bank (P300,000 x 8% x 4/12) P 8,000
Mortgage note payable – 10% (P600,000 x 10% x 3/12) 15,000
Mortgage note payable – 12 % (P1,500,000 x 12% x 8/12) 120,000
Total interest payable, 12/31/10 P143,000
 Accounts Payable P650,000
Notes payable – trade 190,000
Notes payable – bank (payable on demand) 300,000
Wages and salaries payable 15,000
Interest payable 143,000
Mortgage note payable – 10% (with breach of loan covenant)600,000
Mortgage note payable – 12% (P220,000 – P180,000) 40,000
Bonds payable, due 7/1/11 2,000,000
Total current liabilities, 12/31/10 P3,938,000

Notes payable – bank P500,000

Mortgage Notes Payable – 12%
(P1,500,000 – P40,000) 1,460,000
Total noncurrent liabilities, 12/31/10 P1,960,000

Source: Ocampo, R. (2010). Auditing Problems (2010 ed.,).

EXPLANATION:

The P500,000 note payable to bank will be classified as noncurrent because it was
refinanced on a long-term basis as of December 31, 2010. On the 12% mortgage note payable,
P40,000 was deducted because that is classified as current liability. In accordance with the
revised PAS 1 par. 69, an entity shall classify a liability as current when it expects to settle the
liability in its normal operating cycle, it holds the liability primarily for the purpose of trading,
the liability is due to be settled within twelve months after the reporting period or the entity does
not have an unconditional right to defer settlement of the liability for at least twelve months after
the reporting period. Based also on PAS 1, par. 74, when an entity breaches an undertaking under
a long-term loan agreement on or before the end of the reporting period with the effect that the
liability becomes payable on demand, the liability is classified as current, even if the lender has
agreed, after the reporting period and before the authorization of the financial statements for
issue, not to demand payment as a consequence of the breach. The liability is current, because
at the end of the reporting period, the entity does not have an unconditional right to defer its
settlement for at least twelve months after that date. However, according to PAS 1 par. 75, the
liability is classified as non-current if the lender agreed by the end of the reporting period to
provide a period of grace ending at least 12 months after the reporting period, within which the
entity can rectify the breach and during which the lender cannot demand immediate repayment.
Therefore, the total noncurrent liabilities as of December 31, 2010 is P1,960,000.

5. CHARM Company sells televisions at an average price of P7,500 and also offers to each
customer a separate 3-year warranty contract for P750 that requires the company to perform
periodic services and to replace defective parts. During 2014, the company sold 300 televisions
and 270 warranty contracts for cash. It estimates the 3-year warranty costs as P200 for parts and
P400 for labor and accounts for warranties separately. Assume sales occurred on December 31,
2014, income is recognized on the warranties, and straight line recognition of warranty revenues
occurs.

What amount of non-current liability relative to warranty revenue would appear on the
December 31, 2014 statement of financial position?

a) P202,500
b) P135,000
c) P67,500
d) P0

ANSWER: B

SOLUTION:
Unearned Warranty Revenue (270 x P750) P202,500
÷ Coverage of Warranty Contract 3 years
Warranty Contract per year P67,500

Noncurrent liability = (P202,500 x 2) / 3

= P135,000

Source: Uberita, C. (2015). Practical Accounting 1(2015 ed.,). Manila: DomDane Publishers

EXPLANATION:
 According to the revised PAS 1 par. 69, an entity shall classify a liability as current when
it expects to settle the liability in its normal operating cycle, it holds the liability primarily for the
purpose of trading, the liability is due to be settled within twelve months after the reporting
period or the entity does not have an unconditional right to defer settlement of the liability for at
least twelve months after the reporting period. All liabilities not classified as current are
classified as noncurrent liabilities. The current liability for warranty contract is the equivalent
amount of P67,500 that is to be realized the following year, since it is to be assumed that
warranty costs will be incurred equally for the next 3 years. On the other hand, the noncurrent
liability is P135,000 which is the result of multiplying the unearned warranty revenue to 2 years
and dividing the result to the coverage of the warranty contract.

6. JONA Company provided the following information on December 31, 2018:

Accounts payable, net of creditors' debit 2,000,000

balances P200,000
Accrued expenses 800,000
Bonds payable due December 31, 2020 4,500,000
Premium on bonds payable 500,000
Deferred tax liability 500,000
Income tax payable 1,100,000
Cash dividend payable 600,000
Share dividend payable 400,000
Note payable - 6%, due March 1, 2019 1,500,000
Note payable - 8%, due October 1, 2019 1,000,000

The financial statements for 2018 were issued on March 31, 2019.
On December 31, 2018, the 6% note payable was refinanced on a long-term basis.
Under the loan agreement for the 8% note payable, the entity has the discretion to refinance the
obligation for at least twelve months after December 31, 2018.

What amount should be reported as total noncurrent liabilities?

a) 8,400,000
b) 5,500,000
c) 8,000,000
d) 7,500,000

ANSWER: C

SOLUTION:
Bonds payable 4,500,000
Premium on bonds payable 500,000
Deferred tax liability 500,000
Note payable – 6% 1,500,000
Note payable – 8% 1,000,000
Total noncurrent liabilities P8,000,000

Source: Valix, C. et al., (2018). Practical Financial Accounting Volume One (2018 ed.,).
Manila: GIC Enterprises & Co., Inc.

EXPLANATION:
 Accounts payable, accrued expenses, income tax payable and cash dividend payable are
classified as current liabilities. The creditor’s debit balances are not netted against accounts
payable but should be reported as current asset. The share dividend payable is part of
shareholders’ equity as an addition to share capital. The 6% note payable is classified as
noncurrent because it is refinanced at the end of reporting period on December 31, 2018. The 8%
note payable is also classified as noncurrent because the entity has discretion to refinance. PAS
1, paragraph 72, provides that an obligation that matures within one year from the end of
reporting period is classified as current even if it is refinanced on a long-term basis after the
reporting period and before issuance of the financial statements. However, if the refinancing on a
long-term basis is completed on or before the end of the reporting period, the refinancing is an
adjusting event and therefore the obligation is classified as noncurrent. PAS 1, paragraph 73, if
an entity has the discretion to refinance or roll over an obligation for at least twelve months after
the reporting period under an existing loan facility, the obligation shall be classified as
noncurrent, even if it would otherwise be due within a shorter period.

7. CELESTINE Company provided the following account balances at year-end which had been
adjusted except for income tax expense:

Cash 600,000
Accounts Receivable 3,500,000
Cost in excess of billings on long-term contracts 1,600,000
Billings in excess of cost on long-term contracts 700,000
Prepaid Taxes 450,000
Property, plant, and equipment, at carrying amount 1,510,000
Note-payable – noncurrent 1,620,000
Share capital 750,000
Share premium 2,030,000
Retained earnings unappropriated 900,000
Retained earnings restricted for note payable 160,000
Earnings from long-term contracts 6,680,000
Costs and expenses 5,180,000

All receivables on long-term contracts are considered to be collectible within 12 months. During
the year, estimated tax payments of P450,000 were charged to prepaid taxes. The entity has not
recorded income tax expense. The tax rate is 30%.

At year-end, what amount should be reported as total noncurrent liabilities?

a) 1,620,000
b) 1,780,000
c) 2,320,000
d) 2,480,000

ANSWER: A

SOLUTION:

Note payable – noncurrent 1,620,000

Source: Valix, C. et al., (2018). Practical Financial Accounting Volume One (2018 ed.,).
Manila: GIC Enterprises & Co., Inc.

EXPLANATION:

Based on the revised PAS 1 par. 69, an entity shall classify a liability as current when it
expects to settle the liability in its normal operating cycle, it holds the liability primarily for the
purpose of trading, the liability is due to be settled within twelve months after the reporting
period or the entity does not have an unconditional right to defer settlement of the liability for at
least twelve months after the reporting period. All liabilities not classified as current are
classified as noncurrent liabilities. Only the note payable – noncurrent will be classified as non-
current liability. The billings in excess of cost on long-term contracts is a current liability. Cash,
accounts receivable and the cost in excess of billings on long term contracts are current assets.
The prepaid tax expense represents the tax expense for the current year. Earnings from long-term
contracts, costs and expenses, Income tax, retained earnings unappropriated and retained
earnings restricted are used to compute the total retained earnings. The share capital, share
premium and the computed retained earnings are components of the shareholders’ equity.

8. On January 1, 2018, PEARL Company leased a building to BABA Company for a ten-year
term at an annual rental of P500,000.

At inception of the lease, Pearl received P2,000,000 covering the first two years’ rent of
P1,000,000 and a security deposit of P1,000,000.

This deposit will not be returned to Baba upon expiration of the lease but will be applied to
payment of rent for the last two years of the lease.

What portion of the P2,000,000 should be reported as noncurrent liability on December 31,
2018?
a) 2,000,000
b) 1,000,000
c) 1,500,000
d) 0

ANSWER: B
SOLUTION:

Current liability P 500,000

 Noncurrent liability P 1,000,000

Source: Valix, C. et al., (2018). Practical Financial Accounting Volume Two (2018 ed.,).
Manila: GIC Enterprises & Co., Inc.

EXPLANATION:

In accordance with the revised PAS 1 par. 69, an entity shall classify a liability as current
when it expects to settle the liability in its normal operating cycle, it holds the liability primarily
for the purpose of trading, the liability is due to be settled within twelve months after the
reporting period or the entity does not have an unconditional right to defer settlement of the
liability for at least twelve months after the reporting period. All liabilities not classified as
current are classified as noncurrent liabilities. The deposit of P1,000,000 is unearned rent deposit
classified as noncurrent liability because it is applied to payment of rent for the last two years of
the lease. While the portion of 2,000,000 that should be reported as current liability on December
31, 2018 is the second year’s rent of P500,000, received in 2018, which is an unearned rent
income.

9. On December 31, 2018, TRINA Company reported the following tax effects of temporary
differences:
Deferred Tax asset (liability) Related Asset classification
Accelerated tax depreciation (75,000) Noncurrent
Additional cost in inventory for tax 25,000 Current

The entity anticipated that P10,000 of the deferred tax liability will reverse in 2020.

On December 31, 2018, what amount should be reported as noncurrent deferred tax
liability?
a) 40,000
b) 50,000
c) 65,000
d) 75,000
ANSWER: D
SOLUTION:

Noncurrent deferred tax asset 25,000

Noncurrent deferred tax liability 75,000

Source: Valix, C. et al., (2018). Practical Financial Accounting Volume Two (2018 ed.,).
Manila: GIC Enterprises & Co., Inc.

EXPLANATION:

The amount that should be reported as noncurrent deferred tax liability on December 31,
2018 is 75,000. PAS 12, paragraph 70, provides that a deferred tax asset shall be classified as
noncurrent asset and a deferred tax liability shall be classified as noncurrent liability regardless
of reversal period. Moreover, a deferred tax asset or deferred tax liability shall not be discounted.

10. GIO Company reported the following liability account balances on December 31, 2018:

Accounts Payable 1,900,000

Bonds Payable, due December 31, 2019 3,400,000
Discount on bonds payable 200,000
Deferred tax liability 400,000
Dividends payable 500,000
Income tax payable 900,000
Note payable, due January 31, 2020 600,000

On December 31, 2018, what total amount should be reported as noncurrent liabilities?
a) 600,000
b) 400,000
c) 1,000,000
d) 500,000
ANSWER: C
SOLUTION:
Deferred tax liability 400,000
Notes payable, due January 31, 2020 600,000
Noncurrent liabilities P1,000,000

Source: Valix, C. et al., (2018). Practical Financial Accounting Volume One (2018 ed.,).
Manila: GIC Enterprises & Co., Inc.

EXPLANATION:

Accounts payable, dividends payable, income tax payable, bonds payable due on
December 31, 2019, and the discounts on bonds payable, will be used to get the total current
liabilities. The bonds payable minus the discount on bonds payable should be classified as
current because the bonds are due within one year. The dividends payable and income tax
payable are normally classified as current. PAS 12, paragraph 70, provides that a deferred tax
liability shall be classified as noncurrent liability regardless of reversal period. The note payable
is classified as noncurrent because it matures in more than one year from the end of reporting
period.

SHAREHOLDERS’ EQUITY

Shareholders’ equity - residual interest of owners in the net assets of a corporation measured by
the excess of assets over liabilities.
Single Proprietorship – owner’s claim against the assets is called capital or owners’ equity.
Partnership – partners’ claim against the assets is called partners’ capital or partners’ equity.
Corporation - owner’s claim against the assets is called shareholders’ equity or stockholders’
equity.
 In a single proprietorship and partnership, the investment of the owner or owners and the
changes therein resulting from net income or loss from operations are recorded in the
capital accounts.
 In corporation, distinction is made between invested capital and earnings or losses
accumulated in the business.
Definition of Terms
 The term "capital stock" or "share capital" is the portion of the paid in capital
representing the total par or stated value of the shares issued.
 Subscribed Share Capital is the portion of the authorized share capital that has been
subscribed but not yet fully paid and therefore still unissued. It is reported minus
subscription receivable not collectible currently.
 Additional paid in capital or share premium is the portion of the paid in capital
representing excess over the par or stated value.

Broadly, the common sources of share premium are:

a) Excess over par value or stated value
b) Resale of treasury shares at more than cost
c) Donated capital
d) Issuance of share warrants
e) Distribution of share dividends
f) Quasi-reorganization and recapitalization

 Retained Earnings represent the cumulative balance of periodic earnings, dividend

distributions, prior period error and other capital adjustments
 Revaluation surplus is the excess of revalued amount over the carrying amount of the
revalued asset
 Treasury shares are the corporation’s own shares that have been issued and then
reacquired but not canceled.
 Deposits on subscriptions to a proposed increase in share capital may be reported as part
of the shareholder’s equity as a separate item of the equity section.

Capital Stock
 Is the amount fixed in the articles of incorporation to be subscribed and paid in or
secured to be paid in by the shareholders of the corporation.
 Actually, the amount fixed in the articles of incorporation is
called the authorized share capital.

Four basic rights of a Shareholder

a) To share in the earnings of the corporation
b) To vote in the election of directors and in the determination of certain corporate policies
c) To subscribe for additional share issues- This is the right of preemption or stock right
 d) To share in the net assets of the corporation upon liquidation

 Share certificate is issued only when the subscription is paid.

 A par value share is one with specific value fixed in the articles of incorporation and
appearing on the share certificate. The purpose of the par value is to fix the minimum
issue price of the share.
 A no-par value share is one without any value appearing on the face of the share
certificate. But a no-par share has always an "issued value" or "stated value" based on
the consideration for which is issued.

Ordinary Share capital

 if there is only one class of share capital
 ordinary shareholders have the same rights and privileges
 have no fixed or specific return on investment

Preference Share Capital

 preferences are granted to shareholders (claim on dividends and net assets in the
event of liquidation)
 have limited or fixed return on investment

Legal Capital
 portion of the paid in capital arising from issuance of share capital which cannot
be returned to the shareholders in any form during the lifetime of the
corporation.

a. Par value share – aggregate par value of the shares issued and subscribed
b. No-par value share – total consideration received from shareholders including the
excess over stated value.
Trust fund doctrine
 share capital of a corporation is considered as a trust fund for the protection of the
creditors.
 can pay dividends but limited only to the retained earnings balance

Accounting for Share Capital

a) Memorandum Method – no entry is made to record the authorized share capital.
 When share capital is issued, it is credited to the share capital account.
b) Journal entry Method – the authorization to issue share capital is recorded by debiting
unissued share capital and crediting authorized share capital.
When share capital is issued, it is credited to the unissued share capital account.

Accounting for The Issuance of Share Capital

 When shares with par value are sold, the proceeds shall be credited to the share
capital account to the extent of the par value, with any excess being reflected as share
premium.
 When shares without par value are sold, the proceeds shall be credited to the share
capital account to the extent of the stated value, and any excess being reflected as share
premium.

Shares issued at discount

 Shares are sold at a price which is below par or stated value
 Corporation code prohibits this.
 Shareholder is liable
 “Discount on share capital” is a deduction from the total shareholder’s equity
 The prohibition refers to the original issue not to subsequent transfer of such
share.

Measurement of share capital

If share capital is issued for noncash consideration such as property, plant and
equipment, and intangible asset, the share capital is measured at an amount equal to the
following
in the order of priority:

a) Fair value of the noncash consideration received

b) Fair value of the shares issued
c) Par value or stated value of the shares issued

If share capital is issued for services already rendered, the share capital is measured at an
amount equal to the following in the order of priority:
a) Fair value of services rendered
b) Fair value of shares issued
 c) Par value or stated value of shares issued

IFRIC 19 provides that the equity instruments issued to extinguish a financial liability shall be
measured initially at the following in the order of priority:
a) Fair value of equity instruments issued
b) Fair value of liability extinguished
c) Carrying amount of liability extinguished

Share Issuance Costs

 Share issuance costs are direct costs to sell share capital which normally include legal
fees, CPA fees, underwriting fees, commissions, cost of printing certificates,
documentary stamps, filing fees with SEC and cost of advertising and promotion or
newspaper publication fee.
 PAS 32, paragraph 37, provides that share issuance costs shall be deducted from share
premium arising from the share issuance.
 If the share premium is insufficient to absorb such expenses, the Philippine
Interpretations Committee or PIC concluded that the excess shall be debited to "share
issuance costs".
 The share issuance costs shall be reported as a contra equity account as a deduction from
share premium from original issuance and retained earnings, respectively.

Treatment of "Costs of Public Offering of Shares"

 The Philippine Interpretations Committee concluded that "costs that relate to stock
market listing, or otherwise are not incremental costs directly attributable to the issuance
of new shares, shall be recorded as expense in the income statement.
 The costs of listing shares are not considered costs of an equity transaction since no
equity instrument has been issued.
 Therefore, such costs of listing shares are recognized immediately as an expense when
incurred.
 Costs of listing shares include road show presentation and public relations consultant
fees.

Joint Costs
 PAS 32, paragraph 38, requires that joint costs or transaction costs that relate jointly to
the concurrent listing and issuance of new shares, and listing of old existing shares shall
 be allocated between the newly issued and listed shares, and the newly listed old
existing shares.
 PAS 32 provides no further guidance as to what basis of allocation should be followed.
 PIC concluded that the joint costs shall be allocated prorata on the basis of outstanding
newly issued and listed shares and outstanding newly listed old existing shares.
 Examples of joint costs are tax opinion, opinion of counsel, audit and other professional
advice.

Watered Share
 is share capital issued for inadequate or insufficient consideration.
 consideration received is less than par or stated value, but the share capital is
issued as fully paid.
 Asset is overstated and capital is overstated

Secret Reserve
 reverse of watered share
 arises when the asset is understated or liability is overstated with a consequent
understatement of capital.

Delinquent Subscription
 if the shareholder does not pay on the date fixed, the shareholder is declared
delinquent and the delinquent share will be sold at public auction.

Highest bidder
 person who is willing to pay the offer price of the delinquent shares for the
smallest number of shares.

Callable preference share

 the one which can be called in for redemption at a specified price at the option of
the corporation.
 has no definite redemption date as this is dependent on the call of the issuer
 equity instrument rather than a financial liability

 When preference shares are called in at more than the original issue price of the
preference shares, the excess is debited to retained earnings
  The excess of the call price over the par value of the preference shares is charged to the
following:
a. Share premium from original issuance of the preference share
b. Retained Earnings

 When preference shares are called in at less than the original issue price of the
preference shares, the difference is credited to share premium related to ordinary shares.

Redeemable preference share

 PAS 32, paragraph 18, defines a redeemable preference share as   follows:
  a. A preference share that provides for mandatory redemption by the issuer for a fixed
or determinable amount at a future date.
  b. A preference shares that   gives the holder the right to require the issuer to redeem
the instrument for a fixed or determinable amount at a future date.

 Simply stated, a redeemable preference share is one which has a mandatory redemption
date or one which must be redeemed at the option of holder.
 PAS 32 further provides that a redeemable preference share has the legal form of an
equity instrument but meets the definition of a financial liability.
 A redeemable preference share shall be classified as current or noncurrent liability
depending on the redemption date.
 Accordingly, dividend paid to holders of redeemable preference share shall be accounted
for as interest expense as a component of finance cost.
 PAS 32, paragraph 36, provides that gain and loss associated with redemption or
refinancing of a financial liability shall be recognized in profit or loss.  
 Thus, the difference between the redemption price and the financial liability is accounted
for as gain or loss on redemption.

Convertible preference share

 A convertible preference share is one which gives the holder the right to exchange the
holdings for other securities of the issuing corporation.
 A preference shareholder may convert the preference share into ordinary share because
operations are successful and earnings on the ordinary share are unlimited.
 A preference shareholder may convert the preference share into bonds which is actually
a change of equity from   that of an owner to that of a creditor. Normally, preference
share is convertible into ordinary share.
TREASURY SHARES
Treasury shares, are an entity's own shares that have been issued and then reacquired but  
not canceled.

 Three requisites to qualify as treasury shares:

 The shares must be the entity's own shares. The acquisition of shares of another entity
is not treasury but an investment.
 The shares must have been issued originally. This requisite distinguishes treasury
shares from unissued shares. Treasury shares can be legally reissued at a discount without
any discount liability while unissued shares must be issued at least at par or stated value.
In other respects, treasury shares and unissued shares are the same. Both are equity items
rather than assets.
 The shares are reacquired but not canceled.

 Legal limitation on treasury shares

 The Corporation Code provides that "no corporation shall redeem, repurchase, or
reacquire its own shares, of whatever class, unless it has adequate amount of
unrestricted retained earnings to support the cost of said shares.”
 Thus, the corporation can acquire treasury shares only to the extent of retained
earnings balance.
 What is prohibited to be done directly cannot be done by indirection.
 In order to preserve the legal capital, the retained earnings must be appropriated
to the extent of the cost of treasury shares, and the same must not be declared
as dividend until the treasury shares are subsequently reissued.

Accounting for treasury shares

 The cost method is used in accounting for treasury shares.
 Treasury shares shall be recorded at cost, regardless of whether the shares are acquired
below or above the par or stated value.
  If the treasury shares are acquired for cash, the cost is equal to the cash payment.
 If treasury shares are acquired for noncash consideration, PAS 32 does not provide
explicit guidance.
 PAS 32, paragraph 33, provides that no gain or loss shall be recognized on the purchase,
sale, issue or cancelation of an entity's equity instrument.
  If the treasury shares are acquired for noncash consideration, the cost is usually
measured by the carrying amount of the noncash asset surrendered.

Reissuance at more than cost

 No gain or loss shall be recognized on the purchase, sale, issue or cancelation of an
entity's equity instrument.
 Thus, gain from sale of treasury shares shall not be credited to income but recognized  
directly in equity as share premium.

 Reissuance at below cost

 The excess of the cost over the reissue price is charged to the following in the order of
priority:
a. Share premium from treasury shares of the same class
b. Retained earnings
 In other words, the "loss" on the sale of treasury shares debited to share premium
 from treasury shares   of the same class, if any, and when this balance is exhausted, it is
charged to retained earnings.

Par value or stated value method

 The par   value or stated value method is the other method of accounting for treasury
shares. It is also known as retirement method.
 As the title suggests, the treasury shares account is debited at par value or stated value.
 The cost method is the acceptable method in accounting treasury shares.  
 The par value or stated value method is not an acceptable approach because of the legal
requirement that retained earning must be appropriated to the extent of the cost of
treasury shares.

Retirement of treasury shares

 If treasury shares are subsequently retired, the share capital account is debited at par
value or stated value and the treasury shares account is credit at cost.  
 If the retirement results in a gain, meaning the par value exceeds the cost of treasury
shares, such gain is credited to share premium from treasury shares.
 If the retirement results in a loss, meaning, the cost of the treasury shares
  exceeds the par value, such loss is debited to the following in the order of priority:
a) Share premium from original issuance
b) Share premium from treasury shares
 c) Retained earnings
 Share premium from original issuance is canceled on a prorata basis in the absence of
specific amount identified with the treasury shares.

Disclosure of treasury shares

The   disclosure relating to treasury shares shall include the following:
 a. The number of shares held in the treasury
 b. The restriction on the availability of retained earnings for distribution   of dividends
equal to the cost of treasury shares.

 PAS 32, paragraph 33, provides that if an entity reacquires its own equity

instruments, the treasury shares shall be deducted from equity.
 Simply   stated, the cost of treasury shares   shall be deducted from total shareholders'
equity.
 Under Application Guidance 36 of PAS 32, an entity's own equity instruments are not
recognized as financial asset regardless of the reason   for which the equity shares
are reacquired.

 Donated shares
 Donated shares refer to shares received by the entity from the shareholders by way of
donation.
 Donated shares are actually treasury shares and may therefore be reissued at any price
without any discount liability.
 Donated shares are secured without cost and consequently, the entity's assets, liabilities
and shareholders' equity are not affected but the number of outstanding shares is reduced.
 The reissue or resale of donated shares increases assets and donated
capital or share premium.
 
Treasury share   subterfuge

 Treasury share subterfuge occurs when excessive shares are issued for a property
 with the understanding that the shareholders   shall subsequently donate a portion
of the shares.

 The   donated shares may then be reissued at a discount without any liability on

  the part of the shareholder.
  In this case, the resale or reissue of the treasury donated shares is not credited entirely to
donated capital.
 The sale price shall   be used in correcting the overvalued asset and   share capital.
 
 Donation of capital

 Contributions, including shares of an entity, received from shareholders shall be

recorded at fair value with the credit going to donated capital.
 Capital gifts or grants shall be recorded at fair value when received or receivable.
 Such capital gifts or grants from nonshareholders are generally subsidies and credited to
income.
 
Assessments on shareholders

 Assessment may be levied on shareholders when shares are originally issued at discount

or when the corporation is in dire need of financial assistance.
 When the corporation is in dire need of financial assistance, the shareholders can vote to
assess themselves a certain amount per share owned.

 Recapitalization
Recapitalization occurs when there is a change in the capital structure of the entity. The
old shares are canceled and new shares are issued.

 Typical recapitalizations
 1. Change from par to no-par
The old no-par value share is called in and replaced by new no-par share.

2. Change from no-par to par

The old no-par share is canceled and replaced by new par value share.

3. Reduction of par value

The old share is canceled and share but with a reduced replaced by a new par value. The
reduction in the par value is credited to share premium.
4. Reduction of stated value
The old share is canceled and replaced by a new no-par share but with a reduced stated
value. The reduction in the stated value is credited to share premium.

5. Share split
No formal entry is necessary to record share split.
Split up or share split is a transaction whereby the original shares are called in for cancelation
and replaced by a larger number accompanied by a reduction in the par or stated value.
Split down or reverse share split is a transaction whereby the original shares are canceled and
replaced by a smaller number accompanied by an increase in the par or stated value.

RIGHTS ISSUE
 granted to existing shareholders to enable them to acquire new shares at a
specified price during the specified period.
 Philippine term is stock right
 Whenever the share capital of a corporation is increased and new shares are
issued, the new issue must be offered first to the existing shareholders in
proportion to their shareholdings before subscriptions are received from the
general public.
 This is the legal right of shareholders which is called the right of preemption.
 In the accounting parlance, the preemptive right is called stock right or right issue.
 Share warrant represents the certificate or instrument evidencing ownership over
the right issue.

Accounting for rights issue

 No entry is required when the share warrants are issued to existing shareholders
because these warrants are issued usually without consideration.
 The entity only needs to make a memorandum to indicate the number of rights
issued to shareholders and the number of shares that can be purchased through the
exercise of the rights.
 The subsequent issuance of new shares through the exercise stock rights is recorded
normally by debiting cash and crediting share capital and share premium, if any.
 Only memorandum entry is required for the expiration of rights.
Preference shares issued with share warrants
 When share warrants are issued together with preference share, there is actually a
sale of two securities – the preference share and the share warrants.
 The consideration received shall be allocated between the preference share and
the warrants on the basis of their market value.

RETAINED EARNINGS
Retained earnings represent the cumulative balance of periodic net income or loss,
dividend distributions, prior period errors, effects of change in accounting policy and other
capital adjustments.
 Under IAS, the term for retained earnings is accumulated profits.
 When the retained earnings account has a debit balance, it is called a "deficit.
 A deficit is not an asset but a deduction from shareholders' equity.
 The IAS term for deficit is "accumulated losses".

Retained earnings can be classified into two, namely:

a. Unappropriated retained earnings represent that portion which is free and can be declared
as dividends to stockholders.
b. Appropriated retained earnings represent that portion which is restricted and therefore not
available for any dividend declaration.

DIVIDENDS
 Dividends are distributions of earnings or capital to shareholders in proportion to their
shareholdings.
 Dividends out of earnings can be declared only from retained earnings.
 If the entity has a deficit, it is illegal to pay dividends.
 The common forms of dividends out of earnings are cash dividend, property dividend and
share dividend.
 Dividends out of capital are distributions of capital to shareholders in proportion to their
shareholdings (Liquidating Dividends).

Recognition of Dividends
  Under IFRIC 17 "Distribution of noncash assets to owners" paragraph 10, the liability to
pay dividend shall be recognized when the dividend is appropriately authorized and is no
longer at the discretion of the entity, which is the date:
a) When the dividend is declared by management or the board of directors if the local
jurisdiction does not require further approval.
b) When the declaration of dividend by management or the board of directors is approved
by relevant authority, for example, the shareholders, if the local jurisdiction requires
such approval.
 The liability for dividend must be recognized on the date of declaration.

Dividends out of earnings

a. Cash dividends
b. Property dividends
c. Liability dividends in the form of bond and scrip
d. Share dividends or bonus issue

Cash dividends
 Most common type of dividend.
 When cash dividends are declared, a current liability is recognized on the date of
declaration by debiting retained earnings or dividends and crediting dividends payable.

Property dividends
 Property dividends or dividends in kind are distribution of earnings to the shareholders
in the form of noncash assets.
 IFRIC 17, paragraph 11, provides that an entity shall measure a liability to distribute
noncash asset as a dividend to owners at the fair value of the asset to be distributed.
 Paragraph 13 provides that the dividend payable is initially recognized at fair value of the
noncash asset on date of declaration and is increased or decreased as a result of the
change in fair value of the asset at every year-end and date of settlement.
 Paragraph 14 provides that when an entity settles the dividend payable, the difference
between the carrying amount of the dividend payable and the carrying amount of the
noncash asset distributed shall be recognized in profit or loss.
 PFRS 5, Paragraph 15A, provides that an entity shall measure a noncurrent asset
classified for distribution to owners at the lower of carrying amount and fair value less
cost to distribute.
 If the fair value less cost to distribute is lower than the carrying amount of the asset
at the end of the reporting period, the difference is accounted for as impairment loss.
  IFRIC 17, paragraph 12, provides that if an entity gives its owners a choice of either a
noncash asset or a cash alternative, the entity shall estimate the dividend payable by
considering both the fair value of each alternative and the associated probabilities of
owners selecting each alternative.

Share dividend
 IAS term for share dividend is "bonus issue".
 Share dividend is distribution of the earnings of the entity in the form of the entity's
own shares.
 When share dividend is declared, the retained earnings of the entity are in effect
capitalized or transferred to share capital.
 Share dividend payable is not a liability but an addition to the share capital in the
shareholders' equity.
 The IFRS does not address share dividends.

Guidance is based on Philippine GAAP in accounting for share dividends.

a) If the share dividend is 20% or more, the par or stated value is capitalized or debited to
retained earnings.
 If the share dividend is 20% or more, the par or stated value is capitalized
because this is conceived to materially affect a reduction in the share
market value.
 "Share dividend of 20% or more" is considered as large share dividend.
b) If the share dividend is less than 20% the fair value of the share on the date of
declaration is capitalized.
 If the fair value is lower than the par or stated value, the par or stated value is
capitalized.
 If the fair value is higher than par or stated value, the difference is credited to
share premium from share dividend.
 Share dividend of less than 20% is considered a small share dividend.

Fractional share dividends

a. The entity may issue warrants for the fractional shares and give the holders thereof
enough time to accumulate sufficient warrants for full share.
b. They entity may pay cash in lieu of fractional share.

Special cases in accounting for share dividend

  Under Philippine GAAP, treasury shares may be reissued as dividends in which case the
cost of the shares shall be charged to retained earnings.

 When shareholders may elect to receive cash in lieu of share dividend, the amount to be
charged to retained earnings shall be equivalent to the optional cash dividend.
 In closely held entities, if share dividends are declared, retained earnings shall be
capitalized only to the extent of par value or stated value of the shares.
 In certain cases, share dividends are declared on the basis of a proposed increase in
authorized share capital, the application for which has been filed but not yet approved by
SEC at the end of reporting period.

The proposed increase and such dividend declaration generally shall not be reflected in
the statement of financial position prior to SEC approval.
If the proposed increase in authorized share capital is approved by SEC, after the end of
reporting period and the share dividends are subsequently effected before the issuance of
statements, the new authorized share capital may be presented.
The share dividend may be shown as part of issued share capital.

Dividends as Expense
 PAS 32, paragraph 35, provides that distributions to holders of an equity
instrument shall be debited by the entity directly to equity.
 Paragraph 36 provides that distribution to holders of an equity instrument
classified as financial liability are recognized in the same way as interest expense
on a bond.
 Paragraph 40 further provides that dividends classified as an expense may be
presented in the income statement either with interest on other liabilities or as a
separate line item.

APPROPRIATION AND QUASI-REORGANIZATION

Three kinds of appropriation of retained earnings

1. Legal appropriation
 required by law as in the case of treasury shares. Retained earnings must be appropriated
to the extent of the cost of treasury shares.
  Arises from the fact that the legal capital cannot be returned to the shareholders until the
entity is dissolved and liquidated.
2. Contractual appropriation
 required by contract, usually with bondholders and preference shareholders who may
impose restriction on payment of dividend.
 The appropriation may be described as retained earnings appropriated for bond or
preference share redemption.
3. Voluntary appropriation is a matter of discretion on the part of management.
The appropriation may be described as follows:
a. Retained Earnings appropriated for plant expansion
b. Retained Earnings appropriated for increase in working capital
c. Retained Earnings appropriated for contingencies

Accounting procedure for the appropriation of retained earnings

 The establishment of the appropriation is recorded by debiting retained earnings
unappropriated and crediting retained earnings appropriated.
 The retained earnings appropriated balance is still part of total retained earnings and a
shareholders' equity item.
 When no longer needed or required, the appropriation balance is canceled by debiting
retained earnings appropriated and crediting retained earnings unappropriated.

Statement of Retained Earnings

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

Items affecting directly Retained earnings

 Net income/loss for the period
 Prior period errors – if the net income of the prior period is understated, the amount of
error is added to retained earnings while if the net income of the prior period is
overstated, the amount of the error is deducted from retained earnings
 Dividends to shareholders
 Effect of change in accounting policy
 Appropriation of retained earnings
  Components of other comprehensive income reclassified subsequently to retained
earnings

Reserves
Under international accounting standard, the use of equity reserves is based on whether a
reserve is part of distributable equity (unappropriated retained earnings) or nondistributable
equity (share premium reserve, appropriation reserve, asset revaluation reserve, other
comprehensive income reserve).

Statement of changes in equity

A formal statement that shows the movements in the elements or components of the
shareholder’s equity.

Components of Comprehensive Income

1. Net Income or loss
2. Other comprehensive income
a. Unrealized gain or loss on equity instrument designated at fair value through other
comprehensive income
b. Unrealized gain or loss on debt instrument designated at fair value through other
comprehensive income
c. Gain or loss from translating the financial statements of a foreign operation
d. Change in revaluation surplus
e. Unrealized gain or loss from derivative contracts designated as cash flow hedge
f. Remeasurements of defined benefit plan, such as actuarial gain or loss recognized
in the current year
g. Change in the fair value attributable to the credit risk of a financial liability
irrevocably designated at fair value through profit or loss.

Quasi-Reorganization
 A quasi-reorganization is the procedure of restating assets, liabilities and capital in
conformity with fair value for the purpose of eliminating a deficit.
 If done through recapitalization, the deficit is eliminated against the share premium
from recapitalization.
 If done through revaluation, the deficit is eliminated against the revaluation surplus.
Circumstances that may justify quasi-reorganization
a) When large deficit exists.
b) When approved by the shareholders and creditors.
c) When the cost basis of the accounting for property, plant and equipment becomes
unrealistic.
d) When a "fresh start" appears to be desirable or advantageous to all parties concerned.
 An entity in financial difficulty may be permitted by the SEC to undergo a quasi-
reorganization and in the process may be allowed to revalue property, plant and
equipment if current value is substantially more than cost.
 Retained earnings subsequent to quasi-reorganization shall be restricted to the
extent of the deficit wiped out during the reorganization and cannot be declared as
dividend.
 Losses subsequent to quasi-reorganization cannot be charged to the remaining
revaluation surplus.
 The quasi-reorganization shall be disclosed for at least 3 years.

References:
Valix, C. et al., (2019). Financial Accounting Volume Two (2019 ed.,). Manila: GIC Enterprises
& Co., Inc.
Valix, C. et al., (2018). Theory Financial Accounting (2018 ed.,). Manila: GIC Enterprises &
Co., Inc.

PROBLEMS:

SHAREHOLDERS EQUITY
1. GLAM Company issued 6,000 shares of its P100 ordinary share to Mazy as compensation for
1,000 hours of legal services performed. Mazy usually bills P500 per hour for legal services. On
this date of issuance, the share was selling at a public trading at P150 per share.
By what amount should the share premium account of Glam Company increase as a result
of the issuance of those shares?
a) P300,000 c) P900,000
b) P600,000 d) P3,000,000

ANSWER: A
SOLUTION:
Value of the service (6,000 shares x P150) P900,000
Less: par value of the share (6,000 x P100) 600,000
Share premium P300,000

Source: Uberita, C. (2015). Practical Accounting 1(2015 ed.,). Manila: DomDane Publishers

EXPLANATION:

The increase in share premium account of Glam Company is P300,000. PFRS 2,

paragraph 10 states that for equity-settled share based payment transactions, the entity shall
measure the goods or services received and the corresponding increase in equity, directly, at the
fair value of the goods or services received, unless that fair value cannot be estimated reliably. If
the company cannot estimate reliably the fair value of the goods or services received, the entity
shall measure their value and the corresponding increase in equity, indirectly, by reference to the
fair value of the equity instruments granted.

2. GRAMMY Corporation purchased 10,000 shares of its P10 par value ordinary share as
treasury share for P120,000 on March 2, 2014. On December 19, 2014, Grammy issued all
10,000 treasury shares for P190,000.
Under the cost method of accounting for treasury shares, the reissuance would result in a
credit to:

a) Share Capital of P100,000

b) Accumulated Profits and Losses of P70,000
c) Gain on sale of investment of P70,000
d) Share Premium of P70,000

ANSWER: D
SOLUTION:
Cash P190,000
Treasury Shares P120,000
Share premium – Treasury Shares 70,000

Source: Uberita, C. (2015). Practical Accounting 1(2015 ed.,). Manila: DomDane Publishers

EXPLANATION:

Under the cost method of accounting for treasury shares, the reissuance would result in a
credit to Share premium of P70,000. Treasury shares are company’s shares that have been issued
and fully paid for, but subsequently reacquired by the issuing corporation by purchase,
redemption, and donation or through other lawful means, with the intention of reissuing them
again. PAS 32, paragraph 33 states that if an entity reacquires its own instruments, those
instruments (treasury shares) shall be deducted from equity. No gain or loss shall be recognized
in profit or loss on the purchase, sale, issue or cancellation of an entity’s own instruments. Such
treasury shares may be reacquired and held by the entity or by other members of the consolidated
group. Consideration paid or received shall be recognized directly in equity.

3. GLENN Company provided the following information at year-end:

Preference share capital, P100 par 3,000,000

Share premium – preference share 500,000
Ordinary share capital, P10 par 6,000,000
Share premium – ordinary share 2,000,000
Subscribed ordinary share capital 4,000,000
Retained Earnings 2,500,000
Subscription receivable – ordinary share 1,000,000

What is the amount of legal capital?

a) 15,500,000
b) 13,000,000
c) 15,000,000
d) 12,000,000

ANSWER: B
SOLUTION:

Preference share capital 3,000,000

Ordinary share capital 6,000,000
Subscribed ordinary share capital 4,000,000
Total Legal capital P13,000,000

Source: Valix, C. et al., (2018). Practical Financial Accounting Volume Two (2018 ed.,).
Manila: GIC Enterprises & Co., Inc.

EXPLANATION:

The total amount of legal capital is P13,000,000. In accordance with the provision of
Corporation Code of the Republic of the Philippines, in case of par value share capital, legal
capital is the aggregate par value of all shares issued and subscribed. In the case of no-par value
share capital, legal capital is the aggregate stated value of shares issued and subscribed plus any
excess over stated value. Thus, to get the legal capital, the preference share capital, ordinary
share capital and subscribed ordinary share capital, were added.
4. LAUREN Company reported the following shareholders’ equity on January 1, 2018:

Share Capital 1,500,000

Share Premium 3,000,000
Retained Earnings 2,000,000

The entity had 400,000 authorized shares of P5 par value, of which 300,000 shares were issued
and outstanding.

On March 1, 2018, the entity acquired 50,000 shares for P10 per share to be held as treasury. The
shares were originally issued at P8 per share. The entity used the cost method to account for
treasury shares.

On December 31, 2018, the entity declared and distributed a property dividend of inventory.

The inventory had a P750,000 carrying amount and a P1,000,000 fair value. The net income for
2018 was P2,500,000.

What amount should be reported as unappropriated retained earnings on December 31,

2018?
a) 3,500,000
b) 3,250,000
c) 3,350,000
d) 3,000,000

ANSWER: D
SOLUTION:
Retained Earnings – January 1, 2018 2,000,000
Net Income 2,500,000
Property dividend of inventory at fair value (1000,000)
Appropriated for treasury shares (50,000xP10) (500,000)
Unappropriated Retained Earnings – December 31,2018 P 3,000,000

Source: Valix, C. et al., (2018). Practical Financial Accounting Volume Two (2018 ed.,).
Manila: GIC Enterprises & Co., Inc.

EXPLANATION:

The amount that should be reported as unappropriated retained earnings on December 31,
2018 is P3,000,000. Unappropriated retained earnings represent that portion which is free and
can be declared as dividends to shareholders. Under International Financial Reporting
Interpretations Committee (IFRIC) 17, paragraph 11, an entity shall measure a liability to
distribute noncash asset as dividend to the owners at the fair value of the asset to be distributed.
In other words, a property dividend is recognized as liability at the fair value of the property.

5. At the beginning of the current year, KATH Company declared a 10% share dividend. The
market price of the entity’s 300,000 outstanding shares of P50 par value was P90 per share on
that date.
The share dividend was distributed on July 1 when the market price was P100 per share.
What amount should be credited to share premium for the share dividend?
a) 1,200,000
b) 2,700,000
c) 1,500,000
d) 0

ANSWER: A

SOLUTION:
Market value on date of declaration
(10% x 300,000 = 30,000 shares x 90) 2,700,000
Par value of shares issued as share dividend
(30,000 x 50) 1,500,000
Share Premium P1,200,000

To record the declaration of the share dividend January 1:

Retained Earnings 2,700,000
Share dividend payable 1,500,000
Share premium 1,200,000

To record the issuance of the stock dividend on July 1:

Share dividend payable 1,500,000
Share capital 1,500,000

Source: Valix, C. et al., (2018). Practical Financial Accounting Volume Two (2018 ed.,).
Manila: GIC Enterprises & Co., Inc.

EXPLANATION:

The amount that should be credited to share premium for the share dividend is
P1,200,000. The IFRS does not address share dividends. However, Guidance is based on
Philippine GAAP in accounting for share dividends. If the share dividend is less than 20%, the
market value of the share on date of declaration is debited to retained earnings. But, if market
value is lower than par or stated value, the par or stated value is charged to retained earnings.

6. KARA Company provided the following information on January 1, 2018:

Share capital, 250,000 shares authorized;

100,000 shares issued and outstanding 3,000,000
Share premium 4,000,000
Retained earnings 8,000,000

The entity declared a 10% share dividend on April 1, 2018 when the market value of the share
was P70.

The share dividend was issued on July 1, 2018 when the market value of the share was P100.
The share has a par value of P30.

The entity sustained a net loss of P1,200,000 for 2018.

What amount should be reported as retained earnings on December 31, 2018?

a) 6,100,000
b) 6,500,000
c) 6,800,000
d) 5,050,000

ANSWER: A

SOLUTION:

Retained earnings – January 1, 2018 8,000,000

Share dividend declared on April 1, 2018
(10% x 100,000 shares x P70) (700,000)
Net loss (1,200,000)
Retained earnings – December 31, 2018 P 6,100,000

Source: Valix, C. et al., (2018). Practical Financial Accounting Volume Two (2018 ed.,).
Manila: GIC Enterprises & Co., Inc.

EXPLANATION:

The amount that should be reported as retained earnings on December 31, 2018 is
P6,100,000. The 10% share dividend should be charged to retained earnings at the fair value on
the date of declaration. This is regardless of the fair value of the shares on the date of issue.
However, the fair value on the date of declaration should not be lower than par or stated value.
Otherwise, the par or stated value is charged to retained earnings. The IFRS does not address
share dividends. However, Guidance is based on Philippine GAAP in accounting for share
dividends. If the share dividend is less than 20%, the market value of the share on date of
declaration is debited to retained earnings.

7. CLARA Company provided the following information at year-end:

Share Capital 15,000,000

Share Premium 5,000,000
Treasury shares, at cost 2,000,000
Actuarial loss on defined benefit plan 1,000,000
Retained earnings unappropriated 6,000,000
Retained earnings appropriated 3,000,000
Revaluation Surplus 4,000,000
Cumulative translation adjustment-credit 1,500,000

What amount should be reported as total shareholders’ equity?

 a) 31,500,000
b) 32,500,000
c) 28,500,000
d) 25,500,000

ANSWER: A

SOLUTION:

Share Capital 15,000,000

Share Premium 5,000,000
Retained earnings unappropriated 6,000,000
Retained earnings appropriated 3,000,000
Revaluation Surplus 4,000,000
Cumulative translation adjustment-credit 1,500,000
Actuarial loss on defined benefit plan (1,000,000)
Treasury shares, at cost (2,000,000)
Total shareholders’ equity P31,500,000

Source: Valix, C. et al., (2018). Practical Financial Accounting Volume One (2018 ed.,).
Manila: GIC Enterprises & Co., Inc.

EXPLANATION:

The amount that should be reported as total shareholders’ equity is P31,500,000. The
actuarial loss on defined benefit plan is reported as component of other comprehensive income.
The credit in the cumulative translation adjustment account is a translation gain reported as
component of other comprehensive income. If the cumulative translation adjustment account has
a debit balance, it is a translation loss. PAS 32, paragraph 33, provides that if an entity
reacquires its own equity instruments, the treasury shares shall be deducted from equity. Simply  
stated, the cost of treasury shares shall be deducted from total shareholders' equity.
8. NIANA Company was incorporated on January 1, 2018 with the following authorized
capitalization:

Ordinary share capital; 200,000 shares, no par, P100 stated value 20,000,000
Preference share capital, 200,000 shares, 10% fixed rate, P50 par value 10,000,000

During 2018, the entity issued 150,000 ordinary shares for a total of P18,000,000 and 50,000
preference shares at P60 per share.

In addition, on December 15, 2018, subscriptions for 20,000 preference shares were taken at a
purchase price of P100. These subscribed shares were paid for on January 15, 2019.

Net income for 2018 was P5,000,000.

What amount should be reported a total contributed capital on December 31, 2018?
a) 28,000,000
b) 21,000,000
c) 23,000,000
d) 26,000,000

ANSWER: C

SOLUTION:

Ordinary share capital – 150,000 shares 18,000,000

Preference share capital – 50,000 shares x 60 3,000,000
Subscribed preference share capital – 20,000 x 100 2,000,000
Total contributed capital P23,000,000

Source: Valix, C. et al., (2018). Practical Financial Accounting Volume Two (2018 ed.,).
Manila: GIC Enterprises & Co., Inc.

EXPLANATION:

The subscribed share capital is already included in contributed capital because the
subscription receivable is collected within one year. Otherwise, the subscription receivable is
deducted from subscribed share capital. Contributed Capital includes the aggregate par value and
any share premium but does not include retained earnings. The cost of treasury shares is not
deducted in computing contributed capital or paid in capital. Therefore, to get the total
contributed capital, the ordinary share capital (150 000 shares), the preference share capital
(50,000 shares x 60) and the subscribed preference share capital (20,000 x 100), were added.

9. On December 31, 2018, TANGI Company declared a cash dividend of P800,000 to

shareholders of record on January 15, 2019 and payable on February 15, 2019.

The entity reported the following information on December 31, 2018:

Accumulated Depletion 200,000

Share Capital 1,000,000
Share premium 300,000
Retained earnings 600,000

What amount should be recognized as liquidating dividend?

a) 600,000
 b) 300,000
c) 200,000
d) 50,000

ANSWER: C

SOLUTION:

Dividends declared 800,000

Retained earnings balance 600,000
Liquidating dividend P200,000

Source: Valix, C. et al., (2018). Practical Financial Accounting Volume Two (2018 ed.,).
Manila: GIC Enterprises & Co., Inc.

EXPLANATION:

Any amount paid in excess of the retained earnings balance is a liquidating dividend or
return of capital. This liquidating dividend is legal under the wasting asset doctrine embodied in
the Philippine Corporation Code. Wasting asset corporations may declare dividends which are in
part distribution of earnings and in part distribution of capital. This rule is in conformity with
wasting asset doctrine which holds that a wasting asset entity can declare dividends not only to
the extent of the retained earnings balance but also to the extent of the accumulated depletion
balance.

10.   During its first year of operations, LEN-LEN COMPANY entered into the following
transactions relating to shareholders' equity. Len-len's articles of incorporation authorized the
issue of 2,400,000 ordinary shares, P10 par per share, and 300,000 preference shares, P50 par per
share.
Mar. 14   Sold 500,000 ordinary shares for P100 per share.
15   Issued 20,000 ordinary shares to attorneys in exchange for legal services.
  15 Sold 35,000 of its ordinary shares and 10,000 preference shares for P6,000,000.
Nov.20 Issued 1,900 of its ordinary shares in exchange for equipment for which the cash price
was known to be P185,000.

Based on the preceding information, what is the correct balance of Ordinary share capital?
a) P5,569,000
b) P5,219,000
c) P5,550,000
d) P6,069,000

ANSWER: A
SOLUTION:
March. 14 Cash (P100 x 500,000) 50,000,000
Ordinary Share Capital
(P10 x 500,000) 5,000,000
Share premium – ordinary shares
(difference) 45,000,000

March 15 Legal Expenses (P100 x 20,000) 2,000,000

Ordinary Share Capital (P10 x 20,000) 200,000
Share premium – ordinary shares
(difference) 1,800,000

March 15 Cash 6,000,000

Preference Share Capital
(P50 x 10,000) 500,000
 Ordinary share capital
(P10 x 35,000) 350,000
Share premium – preference shares
(P2,500,000-P500,000) 2,000,000
Share premium – ordinary shares
(P3,500,000-P350,000) 3,150,000

Proceeds P6,000,000
Fair value of ordinary shares (P100 x 35,000) (3,500,000)
Fair value of preference shares P2,500,000

Nov. 20 Equipment 185,000

Ordinary share capital (P10 x 1900) 19,000
Share premium – ordinary shares 166,000

Date Ordinary Share Capital

March. 14 P 5,000,000
15 200,000
15 350,000
Nov. 20 19,000
Total P5,569,000

Source: Roque, G. (2018). Auditing Problems (2018-2019 ed.,). Manila: GIC Enterprises & Co.,
Inc.

EXPLANATION:
 The correct balance of ordinary share capital is P5,569,000. PFRS 2 states that for equity-
settled share-based payment transactions, the goods and services received as well as the
corresponding increase in equity, shall be measured directly at the fair value of the goods and
services received. However, if that fair value cannot be estimated reliably, the transaction is
measured by reference to the fair value of the equity instruments granted. Because 500,000
ordinary shares were sold the previous day for P100 per share, it is reasonable to assume P100
fair value per share. Since the fair value of the ordinary shares is known, the fair value of the
preference shares is assumed from total proceeds.