CHAPTER 3: NOTES TO FINANCIAL STATEMENTS

Notes to Financial Statements

Notes to financial statements provide narrative description or disaggregation of items presented in the

financial statements and information about items that do not qualify for recognition.

Order of Presenting the Notes

Under PAS 1, paragraph 114:

a. Statement of compliance with PFRS

b. Summary of significant accounting policies used

c. Supporting information or computation for line items presented in the financial statements

d. Other disclosures, such contingent liabilities, unrecognized contractual commitments and

nonfinancial disclosures.

Compliance with PFRS

PAS 1, paragraph 16, provides that an entity whose financial statements comply with Philippine Financial

Reporting Standards shall make an explicit and unreserved statement of such compliance in the notes.

Accounting Policies

Accounting policies are defined as the specific principles, methods, practices, rules, bases and

conventions adopted by an entity in preparing and presenting financial statements.

Significant Accounting Policies

The summary of significant accounting policies shall disclose the following:

a. The measurement basis used

b. The accounting policies used

Disclosure of Measurement Basis

It is important for an entity to inform users of the measurement basis used in the financial statements

because the basis on which the entity prepare the financial statements significantly affects the users’

analysis.

Under the Revised Conceptual Framework, the measurement bases are historical cost and current value.

Current value includes fair value, value in use, fulfillment value and current cost.

Disclosure of Accounting Policies

In deciding whether a particular accounting policy should be disclosed, management shall consider
whether the disclosure would assist users in understanding how transactions, other events and

conditions are reflected in the financial statements.

Disclosure of particular accounting policies is especially useful to users when those policies are selected

from alternatives allowed in Philippine Financial Reporting Standards.

Disclosure of Judgement

PAS 1, paragraph 122, provides that an entity shall disclose in the summary of significant accounting

policies the judgements that management has made in the process of applying accounting policies and

that have a significant effect on the amounts recognized in the financial statements.

For example, management makes judgment in determining the following:

a. Whether financial assets are to be measured at fair value or at amortized cost.

b. Whether in substance particular sales of goods are product financing arrangement and
therefore

do not give rise to revenue.

Disclosure of Estimation Uncertainty

PAS 1, paragraph 125, provides that an entity shall disclose information about the assumptions it makes

about the future, and other major sources of uncertainty at the end of reporting period that have a

significant risk of resulting in a material adjustment to the carrying amount of assets and liabilities within
the next financial year.

With respect to those assets and liabilities, the notes shall include the nature and carrying amount of the
assets and liabilities at the end of reporting period.

Other Disclosures

PAS 1, paragraph 138, provides that an entity shall disclose the following:

a. The domicile and legal form of the entity, its country of incorporation and the address of the

registered office or principal place of business.

b. A description of the nature of the entity’s operations and its principal activities.

c. The name of the parent and the ultimate parent of the group.

Paragraph 137 provides that an entity shall disclose the following:

a. The amount of dividends proposed or declared before the financial statements were
authorized

for issue but not recognized as distribution during the period and the related amount per share.
 b. The amount of any cumulative preference dividends not recognized

CHAPTER 3: NOTES TO FINANCIAL STATEMENTS

PROBLEMS

Problem 1

The audit of Anne Company for the year ended December 31, 2018 was completed on March 1, 2019.

The financial statements were signed by the managing director on March 15, 2019 and approved by the

shareholders on March 31, 2019.

On January 15, 2019, a customer owing P900,000 to Anne Company filed for bankruptcy.

The financial statements included an allowance for doubtful accounts pertaining to this

customer of P100,000.

Anne Company’s issued share capital comprised 100,000 ordinary shares with P100 par value.

The entity issued additional 25,000 shares on March 1, 2019 at par value.

Equipment with carrying amount of P525,000 was destroyed by fire on December 15, 2018.

Anne Company has booked a receivable of P400,000 from the insurance entity on December 31,

2018.

After the insurance entity completed an investigation on February 1, 2019, it was discovered that

the fire took place due to negligence of the machine operator. As a result, the insurer’s liability

was zero on this claim.

What total amount should be reported as “adjusting events” on December 31, 2018?

a. 1,300,000 b. 1,200,000 c. 3,800,000 d. 3,700,000

Solution: Answer B

Doubtful accounts (900,000 minus allowance 100,000) 800,000

Loss on claim receivable 400,000

Total adjusting entries 1,200,000

Problem 2

The end of reporting period of Norway Company is December 31, 2018 and the financial statements for
2018 are authorized for issue on March 15, 2019.

On December 31, 2018, Norway Company had a receivable of P400,000 from a customer that is

due 60 days after the end of reporting period. On January 15, 2019, a receiver was appointed for

the said customer. The receiver informed Norway that the P400,000 would be paid in full by June

30, 2019.

Norway Company had equity investments held for trading. On December 31, 2018, these

investments were recorded at the fair value of P5,000,000. During the period up to February 15,

2019, there was a steady decline in the fair value of all the shares in the portfolio, and on

February 15, 2019, the fair value had fallen to P2,000,000.

 Norway Company had

reported a contingent liability on
December 31, 2018 related to a
court
case un which Norway Company
was the defendant. The case was
not heard until the first week
of February 2019. On February 11,
2019, the judge handed down a
decision against Norway
Company. The judge determined
that Norway Company was liable
to pay damages and costs
totaling P3,000,000.
 On December 31, 2019,
Norway Company had a receivable
from a large customer in the
amount
of P3,500,000. On January 31,
2019, Norway Company was
advised in writing by the liquidator
of
the said customer that the customer
was insolvent and that only 10% of
the receivable will be
paid on April 30, 2019.
What total amount should be
reported as “adjusting events” on
December 31, 2018?
a. 6,150,000 b. 9,150,000 c.
9,550,000 d. 6,500,000
Solution: Answer A
Litigation loss 3,000,000
Bad debt expense (3,500,000 x
90%) 3,150,000
Total amount of adjusting events
6,150,000
The financial assets held for
trading are measured at fair value
which must be determined at the
end of
each reporting period.
Problem 3
Ginger Company is completing the
preparation of the financial
statements for the year ended
December
31, 2018. The financial statements
are authorized for issue on March
31, 2019.
 On March 15, 2019, a
dividend of P1,750,000 was
declared and a contractual profit
share
payment of P350,000 was made,
both based on the profit for the
year ended December 31,
2018.
 On February 1, 2019, a
customer went into liquidation
having owed the entity P340,000
for the
past 5 months.
No allowance had been made
against this debt in the financial
statements.
 On March 20, 2019, a
manufacturing plant was destroyed
by fire resulting in a financial loss
of
P2,600,000.
What total amount should be
recognized in profit or loss for the
year ended December 31, 2018 to
reflect adjusting events after the
end of reporting period?
a. 1,750,000 b. 3,290,000 c.
2,600,000 d. 690,000
Solution: Answer D
Contractual profit share payment
350,000
Bad debt loss 340,000
Total adjusting events 690,000
Norway Company had reported a contingent liability on December 31, 2018 related to a court

case un which Norway Company was the defendant. The case was not heard until the first week

of February 2019. On February 11, 2019, the judge handed down a decision against Norway

Company. The judge determined that Norway Company was liable to pay damages and costs

totaling P3,000,000.

On December 31, 2019, Norway Company had a receivable from a large customer in the amount

of P3,500,000. On January 31, 2019, Norway Company was advised in writing by the liquidator of

the said customer that the customer was insolvent and that only 10% of the receivable will be

paid on April 30, 2019.

What total amount should be reported as “adjusting events” on December 31, 2018?

a. 6,150,000 b. 9,150,000 c. 9,550,000 d. 6,500,000

Solution: Answer A

Litigation loss 3,000,000

Bad debt expense (3,500,000 x 90%) 3,150,000

Total amount of adjusting events 6,150,000

The financial assets held for trading are measured at fair value which must be determined at the end of

each reporting period.

Problem 3

Ginger Company is completing the preparation of the financial statements for the year ended December

31, 2018. The financial statements are authorized for issue on March 31, 2019.

On March 15, 2019, a dividend of P1,750,000 was declared and a contractual profit share

payment of P350,000 was made, both based on the profit for the year ended December 31,

2018.

On February 1, 2019, a customer went into liquidation having owed the entity P340,000 for the

past 5 months.

No allowance had been made against this debt in the financial statements.

On March 20, 2019, a manufacturing plant was destroyed by fire resulting in a financial loss of

P2,600,000.

What total amount should be recognized in profit or loss for the year ended December 31, 2018
to

reflect adjusting events after the end of reporting period?

a. 1,750,000 b. 3,290,000 c. 2,600,000 d. 690,000

Solution: Answer D

Contractual profit share payment 350,000

Bad debt loss 340,000

Total adjusting events 690,000

The dividend declaration is not recognized in profit and loss but a deduction from retained earnings on

March 15, 2019.

The manufacturing plant destroyed by fire on March 20, 2019 is a Nonadjusting event requiring

disclosure only.
Problem 4

During 2018, Marian Company was sued by a competitor for P5,000,000 for infringement of patent.

Based on the advice of the legal counsel, the entity accrued the sum of P3,000,000 as a provision on

December 31, 2018.

Subsequently, on March 15, 2019, the Supreme Court decided in favor of the party alleging infringement

of the patent and ordered the defendant to pay the aggrieved party a sum of P3,500,000.

The financial statements were prepared by management on February 15, 2019 and approved by the

board of directors on March 31, 2019.

1. What amount should be recognized as accrued liability on December 31, 2018?

a. 5,000,000 b. 3,500,000 c. 3,000,000 d. 1,500,000

2. What amount should be adjusted on December 31, 2018 in relation to this event?

a. 1,500,000 b. 3,000,000 c. 500,000 d. -0-

Solution:

Question 1: Answer B

Accrued liability – December 31, 2018 3,500,000

The actual amount of P3,500,000 should be accrued as liability because the suit was decided on March

15, 2019 which is prior the issuance of the financial statements on March 31, 2019.

Question 2: Answer C

Accrued liability – December 31, 2018 3,500,000

Provision already recognized 3,000,000

Increase in provision 500,000

Problem 5

Caroline Company provided the following events that occurred after December 31, 2018:

Jan. 15, 2019 P3,000,000 of accounts receivable was written off due to the bankruptcy of a major

customer

Feb. 15, 2019 A shipping vessel of the entity with carrying amount of P5,000,000 was completely lost

at sea because of a hurricane.

Mar. 10, 2019 A court case involving the entity as the defendant was settled and the entity was
obligated to pay the plaintiff P1,500,000. The entity previously has not recognized a

liability for the suit because management deemed it possible that the entity would lose

the case.

Mar. 15, 2019 A factory with a carrying amount of P4,000,000 was completely razed by forest fire that

erupted in the vicinity.

The management completed the draft of the financial statement for 2018 on February 10, 2019. On

March 31, 2019, the board of directors authorized the financial statements for issue.

The entity announced the profit and other selected information on March 22, 2019.

The financial statements were approved by shareholders on April 2, 2019 and filed with the regulatory

agency the very next day.

What total amount should be reported as adjusting events on December 31, 2018?

a. 9,500,000 b. 8,500,000 c. 9,000,000 d. 4,500,000

Solution: Answer D

Accounts written off 3,000,000

Provision for lawsuit 1,500,000

Total adjusting events 4,500,000