OVERVIEW OF ACCOUNTING

DEFINITION OF ACCOUNTING

 Accounting
o Is “the process of identifying, measuring, and communicating economic
information to permit informed judgments and decisions by users of the
information.”

THREE IMPORTANT ACTIVITIES INCLUDED IN THE DEFINITION OF ACCOUTNING

1. Identifying
2. Measuring
3. Communicating

IDENTIYING

 Is the process of analyzing events and transactions to determine whether or not they
will be recognized.
 Recognition
o Refers to the process of including the effects of an accountable event in he
statement of financial position or the statement of comprehensive income
through a journal entry.
 Accountable events
o Is one that affects the assets, liabilities, equity, income or expenses of an
entity.
o It is also known as economic activity, which is the subject matter of
accounting.
o Only accountable events are recognized (i.e., journalized).
o Only economic activities are emphasized and recognized in accounting.
o Sociological and psychological matters are not recognized.
 Non-accountable events
 o Are not recognized but disclosed only in the notes, if they have accounting
relevance.
o Disclosure only in the notes is not an application of the recognition process.
o A non-accountable event that has an accounting relevance may be recorded
through a memorandum entry.

TYPES OF EVENTS OR TRANSACTIONS

1. External events
 Are events that involve an entity and another external party.
Types of External events
 Exchange (reciprocal transfer)
o An event wherein there is a reciprocal giving and receiving of
economic resources or discharging of economic obligations between
an entity and an external party. Examples:
 Sale
 Purchase
 Payment of liabilities
 Receipt of notes receivable in exchange for accounts receivable,
and the like.
 Non-reciprocal transfer
o Is a “one way” transaction in that party giving something does not
receive anything in return while the party receiving does not give
anything in exchange. Examples:
 Donations
 Gifts or charitable contributions
 Payment of taxes
 Imposition of fines
 Theft
 Provision of capital by owners
 Distribution to owners, and the like.
  External event other than transfer
o An event that involves changes in the economic resources or
obligations of an entity caused by an external party or external source
but does not involve transfers of resources or obligations. Examples:
 Changes in fir values and price levels
 Obsolescence
 Technological changes
 Vandalism, and the like.
2. Internal events
 Are events that do not involve an external party.
Types of internal events
 Production
o The process by which resources are transformed into finished goods.
Examples:
 Conversion of raw materials into finished products
 Production of farm products, and the like.
 Casualty
o An unanticipated loss from disasters or other similar events.
Examples:
 Loss from fire
 Flood
 And other catastrophes

MEASURING

 Involves assigning numbers, normally in monetary terms, to the economic

transactions and events.
 Several measurement bases are used in accounting which include, but not limited to:
o Historical cost
o Fair value
o Present value
 o Realizable value
o Current cost
o Inflation-adjusted costs.
 The most commonly used is historical cost.
 This is usually combined with the other measurement bases.
 Accordingly, financial statements are said to be prepared using a mixture of costs
and values.
 Costs include historical cost and current cost while values include the other
measurement bases.

VALUATION BY FACT OR OPINION

 The use of estimates is essential in providing relevant information.

 Thus, financial statements are said to be a mixture of fact and opinion.
 When measurement is affected by estimates, the items measured are said to be
valued by opinion. Examples:
o Estimates of uncollectible amounts of receivables.
o Depreciation and amortization expenses, which are affected by estimates of
useful life and residual value.
o Estimated liabilities, such as provisions.
o Retained earnings, which is affected by various estimates of income and
expenses.
 When measurement is unaffected by estimates, the items measured are said to be
valued by fact. Examples:
o Ordinary share capital values at par value
o Land stated at acquisition cost
o Cash measured at face amount

COMMUNICATING
  Is the process of transforming economic data into useful accounting information,
such as financial statements and other accounting reports, for dissemination to
users.
 It also involves interpreting the significance of the processed information.
 The communicating process of accounting involves three aspects:
1. Recording
 Refers to the process of systematically committing into writing the
identified and measured accountable events in the journal through
journal entries.
2. Classifying
 Involves the grouping of similar and interrelated items into their
respective classes through postings in the ledger.
3. Summarizing
 Putting together or expressing in condensed form the recorded and
classified transactions and events.
 This includes the preparation of financial statements and other
accounting reports.
 Interpreting
o The processed information involves the computation of financial statement
ratios.
o Some regulatory bodies, such as the Bangko Sentral ng Pilipinas (BSP),
require certain financial ratios to be disclosed in the notes to financial
statements.

BASIC PURPOSE OF ACCOUNTING

 The basic purpose of accounting is to provide information that is useful in making

economic decisions.
 Various sources of information are used when making economic decisions and the
financial statements are only one of those sources. Other sources may include:
o Current events
 o Industry publications
o Internet resources
o Professional advices
o Expert systems, et..
 Economic entities
o Use accounting to record economic activities, process data, and disseminate
information intended to be useful in making economic decisions.
 Economic entity
o Is a separately identifiable combination of persons and property that uses or
controls economic resources to achieve certain goals or objectives. An
economic entity may either be a:
 Not-for-profit
 One that carries out some socially desirable needs of the
community or its members and whose activities are not
directed towards making profit; or
 Business entity
 One that operates primarily for profit.
 Economic activities
o Are activities that affect the economic resources (assets) and obligations
(liabilities), and consequently, the equity of an economic entity. Economic
activities include:
1. Production
 The process of converting economic resources into outputs of
goods and services that are intended to have utility than the
required inputs.
2. Exchange
 The process of trading resources or obligations for other
resources or obligations.
3. Consumption
 The process of using the final output of the production process.
 4. Income distribution
 The process of allocating rights to the use of output among
individuals and groups in society.
5. Savings
 The process of setting aside rights to present consumption.
6. Investment
 The process of using current inputs to increase the stock of
resources available for output as opposed to immediately
consumable output.

TYPES OF INFORMATON PROVIDED BY ACCOUNTING

1. Quantitative information
 Information expressed in numbers, quantities, or units.
2. Qualitative information
 Information expressed in words or descriptive form.
 Is found in the notes to financial statements as well as on the face of the
other financial statements.
3. Financial information
 Information expressed in money.
 Is also quantitative information because monetary amounts are normally
expressed in numbers.

TYPES OF ACCOUNTING INFORMATION CLASSIFIED AS TO USERS’ NEEDS

1. General purpose accounting information

 Designed to meet the common needs of statement users.
 This information is provided under financial accounting.
 Is governed by generally accepted accounting principles (GAAP) represented
by the Philippine Financial Reporting Standards (PFRSs).
2. Special purpose accounting information
 Designed to meet the specific needs of particular statement users.
  This information is provided by other types of accounting other than
financial accounting, e.g., managerial accounting, tax basis accounting.

SOURCES OF INFORMATION IN FINANCIAL STATEMENTS

 Information in the financial statements is not obtained exclusively from the entity’s
accounting records.
 Some are obtained from external sources. For example:
o Fair value measurements
o Resolutions of uncertainties
o Future lease payments
o Contractual commitments are only a few of the information presented in the
financial statements that are derived from external sources.

ACCOUNTING AS SCIENCE AND ART

1. As a social science
 Accounting is a body of knowledge which has been systematically gathered,
classified and organized.
2. As a practical art
 Accounting requires the use of creative skills and judgment.

ACCOUNTING AS AN INFORMATION SYSTEM

 Accounting identifies and measures economic activities, processes information into

financial reports, and communicates these reports to decision makers.

ACCOUNTING AS A LANGUAGE OF BUSINESS

 Accounting is often referred to as a “language of business” because it is

fundamental to the communication of financial information.

CREATIVE AND CRITICAL THINKING IN ACCOUNTING

 The practice of accountancy requires the exercise of creative and critical thinking.
 Creative thinking
 o Involves the use of imagination and insight to solve problems by finding new
relationships (ideas) among items of information.
o It is important in identifying alternative solutions.
 Critical thinking
o Involves the logical analysis of issues, using inductive or deductive reasoning
to test new relationships to determine their effectiveness.
o It is most important in evaluating alternative solutions.
 Creative skills and judgment are exercised in problem solving. The following are the
steps in the problem solving:
1. Recognizing a problem
2. Identifying alternative solutions
3. Evaluating the alternatives
4. Selecting a solution from among the alternatives
5. Implementing the solution

ACCOUNTING CONCEPTS

 Refers to the principles upon which the process of accounting is based.

 The term “accounting concepts” is used interchangeable with the following terms:
 Accounting assumptions (Accounting postulates)
1. Are the fundamental concepts or principles and basic notions that provide
the foundation of the accounting process.
 Accounting theory
1. Is logical reasoning in the form of a set of broad principles that:
 Provide a general frame of reference by which accounting proactive
can be evaluated and
 Guide the development of new practices and procedures.
2. It is the organized set of concepts and related principles that explain and
guide the accountant’s action in identifying, measuring, communicating
accounting information.
 3. Comprises the Conceptual Framework and the Philippine Financial
Reporting Standards (PFRSs).
 Most accounting concepts are derived from the Conceptual Framework and the
Philippine Financial Reporting Standards (PFRSs).
 However, some accounting concepts are implicit, meaning they are not expressly
stated in the Framework of PFRSs but are generally accepted because of their long-
time use in the profession.
 Examples of accounting concepts:
1. Double-entry system
 Each accountable event is recorded in two parts- debit and credit.
2. Going concern assumption
 The entity is assumed to carry on its operations for an indefinite
period of time.
 Meaning, the entity does not expect to end its operations in the
foreseeable future.
 The measurement basis involving mixture of costs and values is
appropriate only when the entity is a going concern.
 If the entity is a liquidating concern, the appropriate measurement
basis is realizable value, i.e., estimated selling price less estimated
costs to sell for assets and expected settlement amount for liabilities.
3. Separate entity (Accounting entity/Business entity concept/Entity
concept
 The entity is viewed separately from its owners.
 Accordingly, the personal transactions of the owners among
themselves or with other entities are not recorded in the entity’s
accounting records.
 This concept defines the area of interest of the accountant.
4. Stable monetary unit (Monetary unit assumption)
 Assets, liabilities, equity, income and expenses are stated in terms of a
common unity* of measure, which is the peso in the Philippines; and
  The purchasing power of the peso is regarded as stable or constant
and that its instability is insignificant and therefore ignored.
 *To be useful, accounting information should be stated in a common
denominator. For example, amounts in foreign currencies should be
translated into pesos.
5. Time period (Periodicity/ Accounting period)
 The life of the entity is divided into series of reporting periods.
 An accounting period is usually 12 months and may either be a
calendar year or fiscal year period.
 Calendar year period
o Starts on January 1 and ends on December 31 of that same
year.
 Fiscal year period
o Also covers 12 months but starts on a date other than January
1.
6. Materiality concept
 Information is material if its omission or misstatement could influence
economic decisions.
 Materiality is a matter of professional judgment and is based on the
size and nature of the item being judged.
7. Cost benefit (Cost constraint/ Reasonable assurance)
 The cost of processing and communicating information should not
exceed the benefits to be derived from it.
8. Accrual Basis of accounting
 The effects of transactions and other events are recognized when they
occur (and not as cash is received or paid) and they are recorded in
the accounting records and reported in the financial statements of the
periods to which they relate.
 Under accrual basis, income is recognized when earned rather than
when cash is collected and expenses are recognized when incurred
rather than when cash is paid.
9. Historical cost concept (Cost principle)
 The value of an asset is determined on the basis of acquisition cost.
 This concept is not always maintained.
 Some PFRSs require the departure from this concept, such as when
inventories are measured at net realizable value (NRV) rather than
at cost when applying the “lower of cost and NRV” measurement.
10.Concept of Articulation
 All of the components of a complete set of financial statements are
interralated.
 The preparation of a worksheet (and the eventual completion of the
financial statements) recognizes that the financial statements are
fundamentally interralated and interact with each other.
 Accordingly, when users use the financial statements in making
decisions, they need to use each financial statement in conjunction
with the other financial statements.
 For example, when evaluating an entity’s ability to generate future
cash flows, all the financial statements should be used and not only
the statement of cash flows.
o Receivables and payables in the statement of financial
position provide information on expected cash receipts and
cash disbursements in future periods.
o Income and expenses in the statement of profit or loss and
other comprehensive income provide information on the
entity’s ability to generate cash flows from its operations.
o Information on issued and unissued shares in the statement of
changes in equity provides information on the availability of
equity financing.
o Information on historical changes in cash and cash equivalents
in the statement of cash flows help users assess future
sources and uses of funds.
 o The notes to financial statements provides information on the
quality of earnings, e.g. whether income or expenses are
realized or unrealized or whether they are recurring or non-
recurring.
11.Full disclosure principle
 The principle recognizes that the nature and amount of information
included in the financial statements reflect a series of judgmental
trade-offs. The trade-offs strive for:
o Sufficient detail to disclose matters that make a difference to
users, yet
o Sufficient condensation to make the information
understandable, keeping in mind the costs of preparing and
using it.
12.Consistency concept
 The financial statements are prepared on the basis of accounting
principles that are applied consistently from one period to the next.
 Changes in accounting policies are made only when required or
permitted by the PFRSs or when the change results to more relevant
and reliable information.
 Changes in accounting policies are disclosed in the notes.
13.Matching (Association of cause and effect)
 Costs are recognized as expenses when the related revenue is
recognized.
14.Entity theory
 The accounting objective is geared towards proper income
determination.
 Proper matching of costs against revenues is the ultimate end.
 This theory emphasizes the income statement and is exemplified by
the equation “Assets=Liabilities + Capital.”
15.Proprietary theory
  The accounting objective is geared towards the proper valuation of
assets.
 This theory emphasizes the importance of the balance sheet and is
exemplified by the equation “Assets-Liabilities= Capital.”
16.Residual equity theory
 This theory is applicable when there are two classes of shares issued,
i.e., ordinary and preferred.
 The equation is “Assets-Liabilities-Preferred Shareholders’
Equity= Ordinary Shareholders’ Equity.”
 This theory is applied in the computation of book value per share and
return on equity.
17.Fund theory
 The accounting objective is neither proper income determination nor
proper valuation of assets but the custody and administration of
funds,
 The objective is directed towards cash flows, exemplified by the
formula “cash inflows minus cash outflows equals fund.”
 This concept is used in government accounting and fiduciary
accounting.
18.Realization
 The process of converting non-cash assets into cash or claims for cash.
 It is also the concept that deals with revenue recognition.
 For example, realization occurs when goods are sold for cash or in
exchange for accounts receivable or notes receivable. The goods are
non-cash assets and they are converted into cash or, in the case of the
receivables, claims for cash.
19.Prudence (Conservatism)
 Is the use of caution when making estimates under conditions of
uncertainty, such that assets or income are not overstated and
liabilities or expenses are not understated.
  In other words, when exercising prudence, the one which has the
least effect on equity is chosen.
 However, the exercise of prudence does not allow the deliberate
understatement of assets or overstatement of liabilities in order to
create hidden reserves because the financial statements would not be
faithfully represented.
 An example of a hidden reserve is the “cookie jar reserve.” It is a
form of fraudulent reporting wherein during periods of high profits,
liabilities are overstated through excessive provisions of expenses or
non-recognition of income.
 In subsequent periods, when the entity’s financial performance is
poor, the “cookie jar reserve” is reversed to income in order to report
high profits.
 Management engages in such fraud because of various reasons, which
may include smoothing earnings in order to secure bonuses over time,
defer profits to the periods when they are evaluated for promotion or
for election are members of the board of directors, or to show profits
when other entities belonging to the same industry show declining
financial performance.
Expense recognition principles
20.Matching concept (Direct association of costs and revenues)
 Costs that are directly related to the earning of revenue are recognized
as expenses in the same period the related revenue is recognized.
 For example, the cost of inventory is initially recognized as asset and
recognized as expense (i.e., cost of sales) when the inventory is sold.
 Other examples include:
 Freight-out, and
 Sales commissions
These are expensed in the period the related sales are
recognized.
21.Systematic and rational allocation
  Costs that are not directly related to the earning of revenue are
initially recognized as assets and recognized as expenses over the
periods their economic benefits are consumed, using some method of
allocation,
 For example, the cost of equipment is initially recognized as asset and
subsequently recognized as depreciation expense over the periods
the equipment is used,
 Other examples include:
o Amortization
o Expensing of prepayments
o Effective interest method of allocation
22.Immediate recognition
 Costs that do not meet the definition of an asset, or ceases to meet the
definition of an asset, are expensed immediately. Examples include:
o Casualty losses
o Impairment losses

COMMON BRANCHES OF ACOCUTNING

1. Financial accounting
 Is the branch of accounting that focuses in general purpose financial
statements.
 General purpose financial statements
o Are those statements that cater to the common needs of external
users, primarily the potential and existing investors, and lenders and
other creditors.
o External users
 Are those who are not involved in managing the entity.
 Is governed by the Philippine Financial Reporting standards (PFRSs).

Financial accounting vs. Financial reporting

  The term “financial accounting” is often used interchangeably with the term
“financial reporting.”
 Although, both financial accounting and financial reporting focus on general
purpose financial statements, the latter endeavors to promote principles
that are also useful in “other financial reporting.”
 “Other financial reporting” comprises information provided outside the
financial statements that assists in the interpretation of a complete set of
financial statements or improves users’ ability to make efficient economic
decisions.

Financial statements vs. Financial report

 Financial statements
o Are the structured representation of an entity’s financial position and
results of its operations.
o They are the end product of the accounting process and the means by
which information gathered and processed are periodically
communicated to users.
 Financial report
o Includes the financial statements plus other information provided
outside the financial statements that assists in the interpretation of a
complete set of financial statements or improves users’ ability to make
efficient economic decisions.

Financial statements Financial report

1. Statement of financial position
2. Statement of profit or loss and other
comprehensive income
3. Statement of changes in equity
4. Statement of cash flows
5. Notes
6. Additional statement of financial
1. Statement of financial position
2. Statement of profit or loss and other
comprehensive income
3. Statement of changes in equity
4. Statement of cash flows
5. Notes
6. Additional statement of financial
 position position
7. Other information
 Financial reporting
o Is the provision of financial information about an entity that is useful
to external users, primarily the investors, lenders, and other creditors,
in making investment and credit decisions.
 Primary objective of financial reporting
o To provide information about an entity’s economic resources, claims
to those resources, and changes in those resources.
 Secondary objective of financial reporting
o To provide information useful in assessing the entity’s management
stewardship (i.e., how efficiently and effectively the entity’s
management has discharged its responsibilities to use the entity’s
economic resources).
2. Management accounting
 Refers to the accumulation and communication of information for use by
internal users or management.
 An offshoot of management accounting is management advisory services
which includes:
o Services to clients on matters of accounting
o Finance
o Business policies
o Organization procedures
o Product costs
o Distribution, and
o Many other phases of business conduct and operations.
3. Cost accounting
 Is the systematic recording and analysis of the costs of materials, labor, and
overhead incident to production.
4. Auditing
  Is the process of evaluating the correspondence of certain assertions with
established criteria and expressing an opinion thereon.
5. Tax accounting
 The preparation of tax returns and rendering of tax advice, such as the
determination of the tax consequences of certain proposed business
endeavors.
6. Government accounting
 Refers to the accounting for the government and its instrumentalities, placing
emphasis on the custody of public funds, the purposes for which those funds
are committed, and the responsibility and accountability of the individuals
entrusted with those funds.
7. Fiduciary accounting
 Refers to the handling of accounts managed by a person entrusted with the
custody and management of property for the benefit of another.
8. Estate accounting
 Refers to the handling of accounts for fiduciaries who wind up the affairs of a
deceased person.
9. Social accounting (social and environmental accounting or social
responsibility reporting)
 The process of communicating the social and environmental effects of an
entity’s economic actions to the society.
10.Institutional accounting
 The accounting for non-profit entities other than the government.
11.Accounting systems
 The installation of accounting procedures for the accumulation of financial
data and designing of accounting forms to be sued in data gathering.
12.Accounting research
 Pertains to the careful analysis of economic events and other variables to
understand their impact on decisions.
  Includes a broad range of topics, which may be related to one or more of the
other branches of accounting, the economy as a whole, or the market
environment.

BOOKKEEPING ANDD ACCOUNTING

 Bookkeeping
o Refers to the process of recording the accounts or transactions of an entity.
o Normally ends with the preparation of the trial balance.
o Does not require the interpretation of the significance of the processed
information.

ACCOUNTANCY

 Accountancy
o Refers to the profession or practice of accounting.
o The practice of accounting can be broadly classified into two:
 Public practice
 Does not involve an employer-employee relationship.
 Private practice
 Involves an employer-employee relationship, meaning the
accountant is an employee.

FOUR SECTORS IN THE PRACTICE OF ACCOUNTANCY

 Under R.A. 9298 also known as the “Philippine Accountancy Act of 2004,” the
practice of accounting is sub-classified into the following:
1. Practice of Public Accountancy
 Involves the rendering of audit or accounting related services to more
than one client on a fee basis.
2. Practice in Commerce and Industry
 Refers to employment in the private sector in a position which
involves decision making requiring professional knowledge in the
 science of accounting and such position requires that the holder
thereof must be a certified public accountant.
3. Practice in Education/Academe
 Employment in an educational institution which involves teaching of
accounting, auditing, management advisory services, finance, business
law, taxation, and other technically related subjects.
4. Practice in the Government
 Employment or appointment to a position in an accounting
professional group in the government or in a government-owned
and/or controlled corporation, including those performing
proprietary functions, where decision making requires professional
knowledge in the science of accounting, or where civil service
eligibility as a certified public accountant is a prerequisite.
 Accountants practicing under numbers 2 to 4 above are considered in private
practice.

ACCOUNTING STANDARDS

 Philippine Financial Reporting Standards (PFRSs)

1. Represent the generally accepted accounting principles (GAAP) in the
Philippines.
2. Are Standards and Interpretations adopted by the Financial Reposting
Standards Council (FRSC). They comprise:
 Philippine Financial Reporting Standards (PFRSs)
 Philippine Accounting Standards (PASs)
 Interpretations
3. Are accompanied by guidance to assist entities in applying their
requirements.
4. A guidance that is an integral part of the PFRSs is mandatory.

THE NEED FOR REPROTING STANDARDS

  For financial statements to be useful, they should be prepared using reporting
standards that are generally acceptable.
 Otherwise, each entity would have to develop its own standards.
 If that is the case, every entity may just present any asset or income it wants and
omit any liability or expense it does not want.
 Financial statements would mot be comparable, the risk of fraudulent reporting is
heightened, and economic decisions based on these financial statements would be
grossly incorrect.
 For this reason, entities should follow a uniform set of reporting standards when
preparing and presenting financial statements.
 The term “generally acceptable” means that either:
1. The standard has been established by an authoritative accounting rule-
making body, e.g., the PFRSs adopted by the FRSC; r
2. The principle has gained general acceptance due to practice over tine and has
been proven to be most useful, e.g., double-entry recording and other implicit
concepts.
 The process of establishing financial accounting standards is a democratic process in
that a majority of practicing accountants must agree with a standard before it
becomes implemented.

HIERARCHY OF REPORTING STANDARDS

 When selecting its accounting policies, an entity considers the following in

descending order:
1. Philippine Financial Reporting Standards (PFRSs)
2. In the absence of a PFRS that specifically applies to a transaction or event,
management shall use its judgment in developing and applying an
accounting policy that results in information that is relevant and reliable.
 In making the judgment,
1. Management shall refer to, and consider the applicability of, the following
sources in descending order:
a. The requirement in PFRSs dealing with similar and related issues
 b. The Conceptual Framework
2. Management may also consider the following:
a. Pronouncements of other standard-setting bodies
b. Accounting literature and accepted industry practices
 The term “shall” as sued in the PFRSs means “must” or it is required, while the term
“may” means it is optional or “may or may not”.
 Although the selection of appropriate accounting policies is the responsibility of the
entity’s management, the proper application of accounting principles is most
dependent upon the professional judgment of the accountant.

ACCOUNTING STANDARD SETTING BODIES AND OTHER RELEVANT ORGANIZATIONS

1. Financial Reporting Standards Council (FRSC)

 Is the official accounting standard setting body in the Philippines created
under the Philippine Accountancy Act of 2001 (R.A. No. 9298).
 Composed of fifteen (15) individuals)- A chairperson who had been or
presently a senior accounting practitioner in any of the scope of accounting
practice and fourteen (14) representing members:
Chairperson 1
Fourteen representative members form:
Board of Accountancy (BIR) 1
Commission on Audit (COA) 1
Securities and Exchange Commission (SEC) 1
Bangko Sentral ng Pilipinas (BSP) 1
Bureau of Internal Revenue (BIR) 1
A major organization composed of preparers
And users of financial statements 1
Accredited National Professional Organization
Of CPAs (i.e., PICPA):
Public Practice 2
Commerce and Industry 2
Academe/Education 2
 Government 2 8 14

Total 15

2. Philippine Interpretations Committee (PIC)

 Is a committee formed by the Accounting Standards Council (ASC), the
predecessor of FRSC, with the role of reviewing the interpretations of the
International Financial Reporting Interpretations Committee (IFRIC) for
approval and adoption by the FRSC.
3. Board of Accountancy (BOA)
 Is the professional regulatory board created under R.A. No. 9298 to supervise
the registration, licensure and practice of accountancy in the Philippines.
 Consists of a chairperson and six (6) members appointed by the President
of the Philippines.
 The Board shall elect a vice-chairperson from among its members for a term
of one (1) year.
4. Securities and Exchange Commission (SEC)
 Is the government agency tasked in regulating corporations and
partnerships, capital and investment markets, and the investing public.
 Some SEC rulings affect the accounting requirements of entities and the
adoption and application of accounting policies.
5. Bureau of Internal Revenue (BIR)
 Administers the provisions of the National Internal Revenue Code.
 These provisions do not always reflect the goals of financial reporting,
 However, they do at times influence the choice of accounting methods and
procedures.
6. Bangko Sentral ng Pilipinas (BSP)
 Influences the selection and application of accounting policies by banks and
other entities performing banking functions.
7. Cooperative Development Authority (CDA)
  Influences the selection and application of accounting policies by
cooperatives.
 Accounting policies prescribed by a regulatory body (e.g., BSP, CDA) are sometimes
referred to as regulatory accounting principles.

INTERNATIONAL ACCOUTNIGN STANDARDS (IASB)

 Is the standard-setting body of the IFRS Foundation with the main objectives of
developing and promoting global accounting standards.
 Was established in April 1, 2001 as part of the International Accounting
Standards Committee (IASC) Foundation.
 IASC Foundation
o Is a non-profit organization based in Delaware, USA and is the parent of the
IASB, which is based in London.
o On July 1, 2010, the IASC Foundation was renamed to International Financial
Reporting Standards foundation or IFRS Foundation.
o The standards issued by the IASB are the International Financial Reporting
Standards (IFRS), composed of the following:
 International Financial Reporting Standards (IFRSs)
 Are standards issued by the IASB after it replaces its
predecessor, the International Accounting Standards
Committee (IASC), in April 1, 2001.
 International Accounting Standards (IASs)
 Are standards issued by the IASC which were adopted by the
IASB. The PFRSs and PASs are based in these standards.
 Interpretations
o The IASC was founded in June 1973.
 It was established as a result of an agreement by accountancy bodies
in ten national jurisdictions which constituted the original board,
namely:
 Australia
  Canada
 France
 Germany
 Japan
 Mexico
 Netherlands
 UK
 Ireland
 US

DUE PROCESS

 The IFRSs are developed through an international due process that involves
accountants and other various interested individuals and organizations from around
the world.
 Due process normally involves the following steps:
1. The staff identifies and reviews issues associated with a topic and considers
the application of the Conceptual Framework to the issues.
2. Study of national accounting requirements and practice, including
consultation with national standard-setters.
3. Consulting the Trustees and the Advisory Council about the advisability of
adding the topic to the IASB’s agenda.
4. Formation of an advisory group to give advice to the IASB on the project.
5. Publishing a discussion document for public comment.
6. Publishing an exposure draft(a) for public comment.
7. Publishing with an exposure draft a basis for conclusions and the alternative
views of any IASB member who opposes publication.
8. Consideration of all comments received.
9. Holding a public hearing and conducting field tests, if necessary, and
10.Publishing a standard(a), including:
 i. A basis for conclusions, explaining, among other things, the step dint
he IASB’s due process and how the IASB dealt with public comments
on the exposure draft, and
ii. The dissenting opinion of any IASB member.
(a)
Approved by at least 8 votes of the IASB of there are fewer than 14
members, or by 9 if there are 14 members.

OTHER RELEVANT INTERNATIONAL ORGANIZATIONS

1. International Financial Reporting Interpretations Committee (IFRIC)

 Is a committee that prepares interpretations of how specific issues should be
accounted for under the application of IFRS where:
o The standards do not include specific authoritative guidance; and
o There is a risk of divergent and unacceptable accounting practices.
 Is composed mostly of technical partners in audit firms but also includes
preparers and users.
 In 2002, IFRIC replaced the former Standing Interpretations Committee
(SIC) which had been created by the IASC.
 All of the SIC Interpretations have been adopted by the IASB.
2. IRFS Advisory Council (previously known as the Standards Advisory Council
“SAC”)
 Is a group of organizations and individuals with an interest in international
financial reporting.
 The Advisory Council’s role includes advising on priorities within the IASB’s
work program.
 The IASB is required to consult with the Advisory council in advance of any
board decisions on major projects that it wishes to add to its agenda.
 Members of the Advisory Council
o Are appointed by the IFRS Foundation which also appoints members
to the IASB.
 o These members are drawn from different geographic locations and
have a wide variety of backgrounds, including users, preparers,
academics, auditors, analysts, regulators and professional accounting
bodies.
3. International Federation of Accountants (IFAC)
 Is a non-profit, non-governmental, non-political organization of accountancy
bodies that represents the worldwide accountancy profession.
 Its mission is to develop and enhance the profession to provide services of
consistently high quality in the public interest.
 Membership to the IFAC is open to all accountancy bodies recognized by law
or consensus within their countries.
4. International Organization of Securities Commissions (IOSCO)
 Is an international body o security commissions.
 The Philippine SEC is a member of IOSCO.

MOVE TO IFRSs

 Prior to the full adoption of the IFRSs in 2005, the accounting standards used in the
Philippines were previously based on US GAAP, i.e., the Statements of Financial
Standards issued by the Federal Accounting Standards Board (FASB), the U.S.
national standard setting body.
 The move to IFRSs was primarily brought about by the increasing acceptance of
IFRSs world-wide and increasing internationalization of businesses thereby
increasing the need for a common financial reporting standards that minimize, if not
eliminate, inconsistencies of financial reporting among nations.

THE FUTURE OF IFRSs

 Norwalk Agreement
o A significant milestone towards achieving the goal of having one set of global
standards was reached in October 2002 when the FASB and the IASB entered
into a memorandum of understanding.
 o In this Agreement, the FASB and the IASB formalized their commitment to
the convergence of U.S. GAAP and IFRSs by agreeing to use their best efforts
to:
 Make their existing financial reporting standards fully compatible as
soon as practicable, i.e., minimize differences, and
 Coordinate their future work programs to ensure that once
achieved, compatibility is maintained.
o Since the publication of the Norwalk Agreement, the IASB and FASB have
been working together with the common goal of producing a single set of
global accounting standards.
o “In a public statement issued in January 2017,t he outgoing (US) SEC Chair
expressed support for the development of high-quality, globally accepted
accounting standards, and suggested that the (US) SEC support further
efforts by the FASB and IASB to converge their accounting standards to
enhance the quality and comparability of financial reporting.”

CHANGES IN REPORTING STANDARDS

 Once established, financial reporting standards are continually reviewed, revised or

superseded.
 Changes to reporting standards are primarily made in response to users’ needs.
 Users’ needs for financial information change and so must financial reporting
standards.
 Regulatory bodies, lobbyists, laws and regulations, and changes in economic
environments affect the choice of accounting treatment provided under the
reporting standards.

CONCEPTUAL FRAMEWROK FOR FINANCIAL REPORTING

PURPOSE OF THE CONCEPTUAL FRAMEWORK

 Conceptual Framework
 o Prescribes the concepts for general purpose financial reporting. Its
purpose is to:
 Assist the International Accounting Standards Board (IASB) in
developing Standards* that are based on consistent concepts
 Assist preparers in developing consistent accounting policies when no
Standard applies to a particular transaction or when a Standard
allows a choice of accounting policy; and
 Assist all parties in understanding and interpreting the Standards.
* In our succeeding discussions, we will use the term Standard(s) to
refer to both the International Financial Reporting Standards
(IFRS) and the Philippine Financial Reporting Standards (PFRS).
o The Conceptual Framework provides the foundation for the development of
Standards that:
a. Promote transparency by enhancing the international comparability
and quality of financial information.
b. Strengthen accountability by reducing the information gap between
providers of capital and the entity’s management.
c. Contribute to economic efficiency by helping investors to identify
opportunities and risks around the world, thus improving capital
allocation. The use of a single, trusted accounting language lowers the
cost of capital and reduces international reporting costs.

STATUS OF THE CONCEPTUAL FRAMEWORK

 The Conceptual Framework is not a Standard.

 If there is a conflict between a Standard and the Conceptual Framework, the
requirement of the Standard will prevail.
 The authoritative status of the Conceptual Framework is depicted in the hierarchy
of guidance shown below:

Hierarchy of reporting standards

 1. PFRSs
2. Judgment
When making the judgment:
 Management shall consider the following:
a. Requirements in other PFRSs dealing with similar
transactions
b. Conceptual Framework
 Management may consider the following:
a. Pronouncement issued by other standard-setting bodies
b. Other accounting literature and industry practices

 The hierarchy guidance above means that in the absence of a PFRS that
specifically applies to a transaction, management shall consider the
applicability of the Conceptual Framework in developing and applying an
accounting policy that results in useful information.
 To meet the objectives of general purpose financial reporting, a Standard
sometimes contains requirements that depart from the Conceptual
Framework.
o In such cases, the departure is explained in the “Basis for Conclusions”
on that Standard.
 The Conceptual Framework may be revised from time to time based on the
IASB’s experience of working with it.
 However, revisions do not automatically result to changes in the Standards—
not until after the IASB goes through its due process of amending a Standard.

SCOPE OF THE CONCEPTUAL FRAMEWORK

 The Conceptual Framework is concerned with general purpose financial

reporting.
 General purpose financial reporting involves the preparation of general purpose
financial statements.
  The Conceptual Framework provides the concepts that underline general purpose
financial reporting with regard to the following:
1. The objective of financial reporting
2. Qualitative characteristics of useful financial information
3. Financial statements and the reporting entity
4. The elements of financial statements
5. Recognition and derecognition
6. Measurement
7. Presentation and disclosure
8. Concepts of capital and capital maintenance

THE OBJECTIVE OF FINANCIAL REPORTING

 The objective of general purpose financial reporting is to provide financial

information about the reporting entity that is useful to existing and potential
investors, lenders and other creditors in making decisions about providing
resources to the entity.
 This objective is the foundation of the Conceptual Framework.
 All the other aspects of the Conceptual Framework revolve around this objective.

PRIMARY USERS

 The objective of financial reporting refers to the following, so called the primary
users:
1. Existing and potential investors; and
2. Lenders and other creditors
 These users cannot demand information directly from reporting entities and must
rely on general purpose financial reports for much of their financial information
needs.
 Accordingly, they are the primary users to whom general purpose financial reports
are directed to.
 Lenders refer to those who extend loans (e.g., banks), while other creditors refer to
those who extend other forms of credit (e.g., supplier).
  The Conceptual Framework is concerned with general purpose financial reporting.
 General purpose financial reporting (or simply “financial reporting) deals with
providing information that caters to the common needs of the primary users,
 Therefore, general purpose financial reports do not and cannot provide all the
information needs of primary users.
 These users will need to consider other sources for their other information needs
(for example, general economic conditions and expectations, political events and
political climate, and industry and company outlooks).
 The information needs of individual primary users may differ and possibly conflict.
 Accordingly, financial reporting aims to provide information that meets the needs of
the maximum number of primary users,
 Focusing on common needs, however, does not prohibit the provision of additional
information that is most useful to a particular subset of primary users.
 Other users, such as the entity’s management, regulators, and the public, may find
general purpose financial reports useful. However, such reports are not primarily
directed to these users.
 General purpose financial reports do not directly show the value of a reporting
entity. However, they provide information that helps users in estimating the value of
an entity.
 Providing useful information requires making estimates and judgments.
 The Conceptual Framework establishes the concepts that underlie those estimates
and judgments.

DECISIONS ABOUT PROVIDING RESOURCES TO THE ENTITY

 The primary users’ decisions about providing resources to the entity involve
decisions on:
o Buying, selling or holding investments
o Providing or settling loans and other forms of credit; or
o Exercising voting or similar rights that could influence management’s action
relating to the use of the entity’s economic resources.
  These decisions depend of the investor/lender/other creditor’s expected returns
(e.g., investment income or repayment of loan).
 Expectations about returns, in turn, depend on assessments of the entity’s:
i. Prospects for future net cash inflows
ii. Management stewardship
 To make these assessments, investors, lenders and other creditors need information
on:
o The economic resources of the entity, claims against the entity and changes in
those resources and claims; and
o How efficiently and effectively by the entity’s management has utilized the
entity’s economic resources.

INFORMATION ON ECONOMIC RESOURCES, CLAIMS, AND CHANGES

 General purpose financial reports provide information on a reporting entity’s:

o Financial position
 Information on economic resources (assets) and claims against the
reporting entity (liabilities and equity); and
o Changes in economic resources and claims
 Information on financial performance (income and expenses) and
other transactions and events that lead to changes in financial
position.
 Collectively, these are referred to under the Conceptual Framework as the
economic phenomena.

ECONOMIC RESOURCES AND CLAIMS

 Information about the nature and amounts of an entity’s economic resources

(assets) and claims (liabilities and equity) can help users to identify the entity’s
financial strengths and weaknesses. That information can help users in assessing the
entity’s:
o Liquidity and solvency
 o Needs for additional financing and how successful it is likely to be in
obtaining that financing; and
o Management’s stewardship on the use of economic resources.
 Liquidity
o Refers to an entity’s ability to pay short-term obligations
 Solvency
o Refers to an entity’s ability to meet its long-term obligation
 All of these contribute to the assessment of the entity’s ability to generate future
cash flows. For example:
o Information on currently maturing receivables and obligation can help users
assess the timing of future cash flows.
o Information about the nature of economic resources can help users assess
whether a resource can produce future cash flows independently or only in
combination with other resources.
o Information on liquidity and solvency can help users assess the entity’s
ability to obtain additional financing. Overleverage (use of too much debt)
may cause difficulty in obtaining additional financing.
o Information about priorities and payment requirements of claims can help
users predict how future cash flows will likely to be distributed among the
claims.

CHANGES IN ECONOMIC RESOURCES AND CLAIMS

 Changes in economic resources and claims result from:

o Financial performance (income and expenses); and
o Other events and transactions.
 Information on financial performance help users assess the entity’s ability to
produce return from its economic resources.
 Return provides an indication on how well management has efficiently and
effectively used the entity’s resources.
  Information on the variability off the return helps users in assessing the uncertainty
of future cash flows.
o For example, significant fluctuations in reported profits may indicate
financial instability and uncertainty on the entity’s ability to generate cash
flows from its operations.
 Information based on accrual provides a better basis for assessing an entity’s
financial performance than information based solely on cash receipts and payments
during the period.
 Information on past cash flows helps users assess the entity’s ability to generate
future cash flows by providing users a basis in understanding the entity’s operating.
Investing and financing activities, assessing its liquidity or solvency, and interpreting
other information about its financial performance.
 Information resources and claims may also change for reasons aside from financial
performance, such as issuing debt or equity instruments.
o Information on these types of changes is necessary for a complete
understanding of the entity’s changes in economic resources and claims and
the possible impact of those changes on the entity’s future financial
performance.

INFORMATION ABOUT USE OF THE ENTITY’S ECONOMIC RESOURCES

 Information on how efficiently and effectively the entity’s management has

discharged its responsibilities to use the entity’s economic resources helps users
assess the entity’s management stewardship.
 This information also helps in predicting how efficiently and effectively the entity’s
resources will be used in future periods; thus, helping in the assessment of the
entity’s prospects for future net cash inflows.
 Examples of management’s responsibilities to use the entity’s economic resources
include safeguarding those resources and ensuring the entity’s compliance with
laws, regulations and contractual provisions.

Summary
  The decisions of primary users are based on assessments of an entity’s prospects
for future net cash inflows and management stewardship.
 To make these assessments, users need information on the entity’s financial
position, financial performance and other changes in financial position, and
utilization of economic resources.

QUALITATIVE CHARACTERISITICS

 The qualitative characteristics of useful financial information identify the types of

information that are likely to be most useful to the primary users in making
decisions using an entity’s financial report.
 Qualitative characteristics apply to information in the financial statements as well
as to financial information provided in other ways.
 The Conceptual Framework classifies the qualitative characteristics into the
following:
1. Fundamental qualitative characteristics
 These are the characteristics that make information useful to users.
They consist of the following:
o Relevance
o Faithful representation
2. Enhancing qualitative characteristics
 These are the characteristics that enhance the usefulness of
information. They consist of the following:
o Comparability
o Verifiability
o Timeliness
o Understandability

FUNDAMENTAL QUALITATIVE CHARACTERISTICS

 Relevance
 o Information is relevant if it can make a difference in the decisions of users.
Relevant information has the following:
 Predictive value
 The information can help users in making predictions about
future outcomes.
 Confirmatory value (feedback value)
 The information can help users in confirming their previous
predictions.
o Predictive value and confirmatory value are interrelated.
o Information that has predictive value is likely to also have confirmatory
value.
 For example, revenue in the current period can be used to predict
revenue in a future period and at the same time can also be used in
confirming a past prediction.

MATERIALITY

 Information is material if omitting, misstating or obscuring it could reasonably be

expected to influence decisions that the primary users of a specific reporting entity’s
general purpose financial statements make on the basis of those financial
statements.
 The Conceptual Framework states that materiality is an “entity-specific” aspect of
relevance, meaning materiality depends on the facts and circumstances surrounding
a specific entity.
 Accordingly, the Conceptual Framework and the Standards do not specify a
uniform quantitative threshold for materiality.
 Materiality is a matter of judgment.
 IFRS Practice Statement 2 Making Materiality Judgments
o Provides a non-mandatory guidance that entities may follow in making
materiality judgments.
 o The guidance consists of a four-step process called the “materiality
process.”

Step 1- Identify information that has the potential to be material.

 The starting point in making the identification is the requirements of the

Standards.
 This is because, when developing Standards, the IASB identifies the information
needs of a wide range of primary users and considers the balance between the
benefits to be derived from the information and the cost of producing it.
 However, cost is not a factor when making materiality judgments.
 The entity also considers the common information needs of its primary users, in
addition to those specified in the PFRSs.

Step 2- Assess whether the information identified in Step 1 is, in fact material.

 In making this assessment, the entity considers the following:

o Whether the information could influence the users’ decisions, on the basis of
the financial statements as a whole.
o The item’s nature or size, or both.
o Quantitative and qualitative factors.
 Quantitative factors
 Include the size of the impact of the item.
 The size of an item can be assessed in relation to a percentage
of another amount (e.g., percentage of total assets or total
revenues) or a threshold amount (e.g., a capitalization
threshold).
 Qualitative factors
 Are characteristics of the item or its context. These are:
i. Entity-specific qualitative factors, e.g., involvement of a
related part or rarity of the item.
 ii. External qualitative factors, e.g., the entity’s industry
sector or the state of the economy.
 Although there is no hierarchy among materiality factors, an entity normally first
assesses an item on the basis of quantitative factors,
 If an item is quantitatively material the entity need not reassess it on the basis of
qualitative factors.
 However, if an item is quantitatively not material , the entity needs to reassess it on
the basis of qualitative factors.
 For example, an item that has a zero amount (i.e., not quantitatively material) may
nevertheless be considered material in light of qualitative factors.

Step 3-Organize the information within the draft financial statements in a way that
communicates the information clearly and concisely to primary users.

 The entity exercises judgment on how to present information in a manner that

maximizes understandability to the primary users.

Step 4- Review the draft financial statements to determine whether all material
information has been identified and materiality considered from a wide perspective
and in aggregate, on the basis of the complete set of financial statements.

 The review allows the entity to “step-back” and get a wider perspective of the
information provided.
 This is necessary because an item might not be material on its own, but it might be
material if used in conjunction with the other information in the complete setoff
financial statements.

The four step Materiality process

Step 1 Identity Knowledge about primary users’

Requirements of IFRS Standards
common information needs

Quantitative Qualitative
Step 2 Assess

Organize the information within the

draft financial statements.

Step 3 Organize

Step 4 Review Review the draft

financial statements

FAITHFUL REPRESENTATION

 Means the information provides a true, correct and complete depiction of the
economic phenomena that it purports to represent.
 When an economic phenomenon’s substance differs from its legal form, faithful
representation requires the depiction of the substance (i.e., substance over form).
 Depicting only the legal form would not faithfully represent the economic
phenomenon.
 Faithfully represented information has the following characteristics:
1. Completeness
 All information (in words and numbers) necessary for users to
understand the phenomenon being depicted is provided.
 These include description of the nature of the item, numerical
depiction (e.g., monetary amount), description of the numerical
 depiction (e.g., historical cost or fair value) and explanations of
significant facts surrounding the item.
2. Neutrality
 Information is selected or represented without bias.
 Information is not manipulated to increase the probability that users
will receive it favorably or unfavorably.
 Is supported by prudence, which is the use of caution when making
judgments under conditions of uncertainty, such that assets or income
are not understated.
 Equally, the exercise of prudence does not allow the understatement
of assets or overstatement of liabilities because the financial
statements would not be faithfully represented.
3. Free from error
 This does not mean that the information is perfectly accurate in all
respects.
 Means there are no errors in the description and in the process by
which the information is selected and applied.
 If the information is an estimate, the fact should be described clearly,
including an explanation of the process used in making that estimate.

ENHANCING QUALITATIVE CHARACTERISTICS

COMPARABILITY

 Information is comparable if it helps users identify similarities and differences

between different sets of information that are provided by:
o Intra-comparability
 A single entity but in different periods
o Inter-comparability
 Different entities in a single period
 Unlike the other qualitative characteristics, comparability does not relate to only one
item because a comparison requires at least two items.
  Comparison is not uniformly, meaning like things must look alike and different
things must look differently.
o It would be inappropriate to make different things look alike, or vice versa.
 Although related, consistency and comparability are not the same.
 Consistency
o Refers to the use of the same methods for the same items.
o Comparability is the goal while consistency is the means of achieving that
goal.

VERIFIABILITY

 Information is verifiable if different users could reach a general agreement as to

what the information purports to represent.
 Verification can be direct or indirect.
 Indirect verification
o Involves checking the inputs to a model or formula and recalculating the
outputs using the same methodology (e.g., checking the debits and credits in
the cash ledger and recalculating the ending balance).

TIMELINESS

 Information is timely if it is available to users in time to be able to influence their

decisions.

UNDERSTANDABILITY

 Information is understandable if it is presented in a clear and concise manner.

 Does not mean that complex matters should be excluded to make information
understandable to users because this would make information incomplete and
potentially misleading.
 According, financial reports are intended for users:
 o Who have reasonable knowledge of business activities; and
o Who are willing to analyze the information diligently.

Summary: Qualitative Characteristics

1. Fundamental qualitative characteristics

 Relevance
o Predictive value
o Confirmatory value

Materiality (entity-specific aspect of relevance)

 Faithful representation
o Completeness
o Neutrality
o Free from error
2. Enhancing qualitative characteristics
 Comparability
 Verifiability
 Timeliness
 Understandability

APPLYING THE QUALITATIVE CHARACTERISTICS

 Fundamental qualitative characteristics

o Are essential to the usefulness of information; meaning, information must be
both relevant and faithfully represented for it to be useful.
o For example, neither a relevant information that is erroneous nor a correct
information that is irrelevant helps users make good decisions.
 Enhancing qualitative characteristics only enhance the usefulness of information
that is both relevant and faithfully represented but cannot make information that is
irrelevant or erroneous to useful,
  Accordingly, the enhancing qualitative characteristics should be maximized to the
extent possible.
 There is no prescribed order in applying the enhancing qualitative characteristics.
 Sometimes one enhancing qualitative characteristic may have to be sacrificed to
maximize another.

THE COST CONSTRAINT

 Cost
o Is a pervasive constraint on the entity’s ability to provide useful financial
information.
o Providing information entails cost and this can only be justified by the
benefits expected to be derived from using the information.
o Accordingly, an optimum balance between costs and benefits is desirable
such that costs do not outweigh the benefits.

FINANCIAL STATEMENTS AND THE REPORTING ENTITY

OBJECTIVE AND SCOPE OF FINANCIAL STATEMENTS

 The objective of general purpose financial statements is to provide financial

information about the reporting entity’s assets, liabilities, equity, income and
expenses that is useful in assessing:
o The entity’s prospects for future net cash inflows; and
o Management’s stewardship over economic resources.
 The information is provided in the:
o Statement of financial position (for recognized assets, liabilities, and equity.
o Statement(s) of financial performance (for income and expenses)
o Other statements and notes (for additional information on recognized assets
and liabilities, information on unrecognized assets and liabilities, information
on cash flows, information on contributions from/distributions to owners,
and other relevant information).
REPORTING PERIOD

 Financial statements are prepared for a specified period of time and provide
information on assets, liabilities and equity that existed at the end of the reporting
period, or during the reporting period, and income and expenses for the reporting
period.
 Comparative information
o To help users of financial statements in evaluating changes and trends,
financial statement also provide comparative information for at least one
preceding reporting period.
o For example, an entity’s 2019 current-year financial statements include the
2018 preceding year-financial statements as comparative information.
 This allows users to assess the information’s intra-comparability.
 Forward-looking information
o Financial statements are designed to provide information about past events
(i.e., historical data).
o Information about possible future transactions and other events is included
in the financial statements only if it relates to the past information presented
in the financial statements and is deemed useful t users of financial
statements.
o Financial statements
 However, do not typically provide forward-looking information about
management’s expectations and strategies for the reporting entity.
 Include information about events after the end of the reporting period
if it is necessary to meet the objective of financial statements.
 Perspective adopted in financial statements
o Information in financial statements is prepared from the perspective of the
reporting entity, not from the perspective of any particular group of financial
statement user.

GOING CONCERN ASSUMPTION

  Financial statements are normally prepared on the assumption that the reporting
entity is a going concern, meaning the entity has neither the intention nor the need
to end its operations in the foreseeable future.
 If this is not the case, the entity’s financial statements are prepared on another basis
(e.g., measurement at realizable values rather than mixture of costs and values).
 Going concern is referred to as the “underlying assumption” in the previous
version of the Conceptual Framework.

THE REPORTING ENTITY

 Is the one that is required, or chooses, to prepare financial statements, and is not
necessarily a legal entity.
 It can be a single entity or a group or combination of two or more entities.
 Sometimes an entity controls another entity.
 Controlling entity
o Is called the parent.
 Controlled entity
o Is called the subsidiary.
 Consolidated financial statements
o If a reporting entity comprises both the parent and its subsidiaries.
o Provide information on a parent and its subsidiaries viewed as a single
reporting entity.
o Are not designed to provide information on any particular subsidiary; that
information is provided in the subsidiary’s own financial statements.
o Enables users to better assess the parent’s prospects for future cash flows
because the parent’s cash flows are affected by the cash flows of its
subsidiaries.
 Unconsolidated financial statements
o If a reporting entity is the parent alone.
 o Accordingly, when consolidation is required, unconsolidated financial
statements cannot be used as substitute for consolidated financial
statements.
o However, a parent may nonetheless be required or choose to prepare
unconsolidated financial statements in addition to consolidated financial
statements.
 Combined financial statements
o If a reporting entity comprises two or more entities that are not all linked by
a parent-subsidiary relationship.

THE ELEMENTS OF FINANCIAL STATEMENTS

 The elements of financial statements are:

o Financial position
1. Assets
2. Liabilities
3. Equity
o Financial performance
4. Income
5. Expenses

ASSET

 Is “a present economic resource controlled by the entity as a result of past events.

 An economic resource is a right that has the potential to produce economic benefits.”
 The definition of asset has the following three aspects:
o Right
o Potential to produce economic benefits
o Control

RIGHT
 Asset is an economic resource and an economic resource is a right that has the
potential to produce economic benefits.
 Rights that have the potential to produce economic benefits include:
a. Rights that correspond to an obligation of another party:
i. Right to receive cash, goods or services.
ii. Right to exchange economic resources with another party on
favorable terms.
iii. Right to benefit from an obligation of another party to transfer an
economic resource if a specified uncertain future event occurs.
b. Right that do not correspond to an obligation of another party:
i. Right over physical objects (e.g., right to use a property or right to sell
an inventory).
ii. Right to use intellectual property.
 Rights normally arise from law, contract or similar means.
o For example, the right to use a property may arise from owning it or leasing
it.
 However, rights could also arise from other means.
o For example, by creating a know-how (e.g., trade secret) that is not in the
public domain or through a constructive obligation created by another party.
 For goods or services that are received and immediately consumed (e.g. supplies and
employee services), the entity’s right to obtain the related economic benefits exists
momentarily until the entity consumes the goods or services.
 Not all rights are assets.
 To be an asset, the right must have the potential to produce for the entity economic
benefits that are beyond the benefits available to all other parties and those
economic benefits must be controlled by the entity.
o For example, a public road which anybody can access without significant cost
and a know-how that is in the public domain are not assets of the entity.
 An entity cannot have a right to obtain economic benefits from itself. Thus, treasury
shares are not an entity’s assets.
 o Similarly, debt and equity instruments issued by a parent and held by its
subsidiary (or vice versa) are not assets (or liabilities) in the consolidated
financial statements.
 Theoretically, each right is a separate asset. However, for accounting purposes,
related rights are often treated as a single asset.
o For example, ownership of a physical object typically gives rise to several
rights, such as the right to use the object, the right to sell it, the right to
pledge it, and other similar rights.
 The asset is the set of rights and not the physical object.
o For example, a lessee (someone who rents a property) may recognize an
asset for its right to use the property (i.e., ‘right-of-use asset’ or, in layman’s
terms, leasehold rights) but not for the property itself (because the lessee
does not legally own the leased property- the lessor does).
o Nonetheless, describing the set of rights as the physical object will often
provide a faithful representation of those rights.
 There can be instances where the existence of a right is uncertain.
o For example, when the entity’s right is disputed by another party.
o Until that uncertainty is resolved (for example, by a court ruling) it is
uncertain whether an asset exists.

POTENTIAL TO PRODUCE ECONOMIC BENEFITS

 The asset is the present right that has the potential to produce economic benefits
and not the future economic benefits that the right may produce.
 Thus, the right’s potential to produce economic benefits need not be certain, or even
likely- what is important is that the right already exists and that, in at least one
circumstance, it would produce economic benefits for the entity.
 Consequently, an asset can exist even if the probability that it will produce benefits
is low, although that low probability affects decisions on whether the asset is to be
 recognized, how it is measured, what information is to be provided about the asset,
and how that information is provided.
 An economic resource can produce economic benefits for an entity in many ways.
For example, the asset may be:
o Sold, leased, transferred or exchanged for other assets;
o Used singly or in combination with other assets to produce goods or provide
services;
o Used to enhance the value of other assets;
o Used to promote efficiency and cost savings; or
o Used to settle a liability.
 The presence or absence of expenditure is not necessary in determining the
existence of an asset.
o For example, expenditure on penalty for violation of law does not result to n
asset.
o On the other hand, an asset can be obtained for free from donation.
o Moreover, acquiring an asset and incurring expenditure do not necessarily
need to coincide.
 For example, inventory purchased on account is recognized as asset
before purchase price is paid.

CONTROL

 Means the entity has the exclusive right over the benefits of an asset and the ability
to prevent others from accessing those benefits.
 Accordingly, if one party controls an asset, no other party controls that asset.
 Control does not mean that the entity can ensure that the resource will produce
economic benefits in all circumstances.
 It only means that if the resource produces benefits, it is the entity who will obtain
those benefits and not another party.
 Control links an economic resource to an entity and indicates the extent to which an
en entity should account for that economic resource.
 o For example, an economic resource that an entity does not control is not an
asset of the entity.
o If an entity controls only a portion of an economic resource, the entity
accounts only that portion and not the entire resource.
 Control normally stems from legally enforceable rights (e.g., ownership or legal
title.)
o However, ownership is not always necessary for control to exist because
control can arise from other rights.
o For example, Entity a acquires a car through bank financing. Although the
bank retains legal title over the car until full payment, the car is nonetheless
an asset of Entity A because Entity A has the exclusive right to use the car and
therefore controls the benefits from it.
 Physical possession is also not always necessary for control to exist.
o For example, goods transferred by a principal to an agent on consignment
remain as assets of the principal until the goods are sold to third parties. This
is because the principal retains control over the goods despite the fact that
physical possession is transferred to the agent. Similarly, the agent does not
recognize the goods as his assets because he does not control the economic
benefits from the goods- the principal does.

LIABILITY

 Is “a present obligation of the entity to transfer an economic resource as a result of

past events.”
 The definition of liability has the following three aspects:
o Obligation
o Transfer of an economic resource
o Present obligation as a result of past events

OBLIGATION

 Is “a duty or responsibility that an entity has no practical ability to avoid.”

  An obligation is either:
o Legal obligation
 An obligation that results from a contract, legislation, or other
operation of law; or
o Constructive obligation
 An obligation that results from an entity’s actions (e.g., past practice
or published policies) that create a valid expectation on others that
the entity will accept and discharge certain responsibilities.
 An obligation is always owed to another party. However, it is not necessary that the
identity of that party is known.
o For example, an obligation for environment damages may be owed to the
society at large.
 One party’s obligation normally corresponds to another party’s right.
o For example, a buyer’s obligation to pay an accounts payable of 100 normally
corresponds to the seller’s right to collect an accounts receivable of 100.
o However, this accounting symmetry is not maintained at all times because
the Standards sometimes contain different recognition and measurement
requirements for the liability of one party and the corresponding asset of the
other party.
 For example, direct origination costs result to different
measurements of the lender’s loan receivable and the borrower’s loan
payable. Similarly, a seller may be required to recognize a warranty
obligation but the buyer would not recognize a corresponding asset
for that warranty.
 There can be instances where the existence of an obligation is uncertain. Until that
uncertainty is resolved (for example, by a court ruling), it is uncertain whether a
liability exists.

TRANSFER OF AN ECONOMIC RESOURCE

  The liability is the obligation that has the potential to require the transfer of an
economic resource to another party and not the future economic benefits that the
obligation may cause to be transferred.
 Thus, the obligation’s potential to cause a transfer of economic benefits need not be
certain, or even likely.
o For example, the transfer may be required only if a specified uncertain future
event occurs.
o What is important that the obligation already exists and that, in at least one
circumstance, it would require the entity to transfer an economic resource.
 Consequently, a liability can exist even if the probability of a transfer of an economic
resource is low, although that low probability affects decisions on whether the
liability is to be recognized, how it is measured, what information is to be provided
about the liability, and how that information is provided.
 An obligation to transfer an economic resource may be an obligation to:
o Pay cash, deliver goods, or render services;
o Exchange assets with another party on unfavorable terms;
o Transfer assets if a specified uncertain future event occurs; or
o Issue a financial instrument that obliges the entity to transfer an economic
resource.

PRESENT OBLIGATIONAS A RESULT OF PAST EVENTS

 The obligation must be a present obligation that exists as a result of past events. A
present obligation exists as a result of past events if:
o The entity has already obtained economic benefits or taken an action; and
o As a consequence, the entity will or may have to transfer an economic
resource that it would not otherwise have had to transfer
 Examples:
o Entity A intends to acquire goods in the future.
 Entity A has no present obligation. A present obligation arises only
when Entity A:
  Has already purchased and received the goods; and
 As a consequence, Entity A will have to pay the purchase price.
o Entity B operates a nuclear power plant. In the current year, a new law was
enacted penalizing the improper disposal of toxic waste. No similar law
existed in prior years.
 The enactment of legislation is not in itself sufficient to result in an
entity’s present obligation, except when the entity:
 Has already taken an action contrary to the provisions of that
law; and
 As a consequence, the entity will have to pay a penalty.
 Accordingly:
o Entity B has no present obligation if its existing method of waste disposal
does not violate the new law. Similarly, Entity B has no present obligation if it
can avoid penalty by changing its future method of waste disposal.
o On the other hand, Entity B has a present obligation if its previous waste
disposal has already caused damages, and as a consequence, Entity B has
to pay for those damages.
 Examples:
o Entity C enters into an irrevocable commitment with another party to acquire
goods in the future on credit.
 A non-cancellable future commitment gives rise to a present
obligation only when it becomes onerous (i.e., burdensome), for
example, if the goods become obsolete without paying a substantial
penalty.
 Unless it becomes burdensome, no present obligation normally arises
from a future commitment.
o Although not stated in the sales contract, Entity d has a publicly-known
policy of providing free repair services for the goods it sells. Entity D has
consistently honored this implied policy in the past.
  Entity D has a present constructive obligation to provide free repair
services for the goods it has already sold because:
 Entity D has already taken an action by creating valid
expectations on the customers that it will provide free repair
services; and
 As a consequence, Entity D will have to provide those free
services.
o Entity E obtained a load from a bank. repayment of the loan is due in 10-
years’ time.
 Entity E has a present obligation because it has already received
the loan proceeds, and as a consequence, has to make the
repayment even though the bank cannot enforce the repayment until
a future date.
o Entity F employed Mr. Juan.
 Entity F has no present obligation until after Mr. Juan has rendered
services. Before then, the contract is executor-Entity F has a combined
right and obligation to exchange future salary for Mr. Juan’s future
services.

EXECUTORY CONTRACTS

 Is “a contract that is equally unperformed- neither party has fulfilled any of its
obligations, or both parties have partially fulfilled their obligations ot an equal
extent.”
 Establishes a combined right and obligation to exchange economic resources, which
are interdependent and inseparable.
o Thus, the two constitute a single asset or liability.
o The entity has an asset if the terms of the contract are favorable, a liability
if the terms are unvafovorable.
o However, whether such an asset or liability is included in the financial
statements depends on the recognition criteria and the selected
 measurement basis, including any assessment of whether the contract is
onerous.
 The contract ceases to be executor when one party performs its obligation,
o If the entity performs first, the entity’s combined right and obligation
changes to an asset.
o If the other party performs first, the entity’s combined right and obligation
changes to a liability.
 Continuing the previous example:
o Entity F neither recognizes an asset nor a liability upon entering the
employment contract with Mr. Juan because, at that point, the contract is
executor.
o If Mr. Juan renders services, the contract ceases to be executor, and Entity F’s
combined right and obligation changes to a liability- an obligation to pay Mr.
Juan’s salary (e.g., salaries payable).
o If Entity f pays Mr. Juan’s salary in advance, Entity F’s combined right and
obligation changes to an asset- a right to receive the services or a right to be
reimbursed if the services are not received (e.g, advances to employees).

EQUITY

 Is the residual interest in the assets of the entity after deducting all its liabilities.
 The definition of equity applies to all entitles regardless of form (i.e., sole
proprietorship, partnership, cooperative, corporation, non-profit entity, or
government entity).
 Although, equity is defined as a residual, it may be sub-classified in the statement of
financial position.
o For example, the equity of a corporation may be sub-classified into share
capital, retained earnings, reserves and other components of equity.
o Reserves may refer to amounts set aside for the protection of the entity’s
creditors or stakeholders from losses.
 o For some entities (e.g., cooperatives), the creation of reserves is required by
law.
o Transfers to such reserves are appropriations of retained earnings rather
than expenses.

INCOME

 Is increase in assets, or decreases in liabilities, that result in increases in equity,

other than those relating to contributions from holders of equity claims.

EXPENSES

 Are decreases in assets, or increases in liabilities, that result in decreases in equity,

other than those relating to distributions to holders of equity claims.
 The definitions of income and expenses are opposites.

Income
 Increases in assets or
Decreases in liabilities
 Results in increase in equity
 Excludes contributions from the
entity’s owners
Expenses
 Decreases in assets or
Increases in liabilities
 Results in decrease in equity
 Excludes distributions to the
entity’s owners

 Contributions from, and distributions to, the entity’s owners are not income, and
expenses, but rather direct adjustments to equity.
 Although income and expenses are defined in terms of changes in assets and
liabilities, information on income and expenses is just as important as information
on assets and liabilities because financial statement users need information on both
the financial position and financial performance of an entity.

RECOGNITION AND DERECOGNITION

THE RECOGNITION PROCESS

  Is the process of including in the statement of financial position or the statement(s)
of financial performance an item that meets the definition of one of the financial
statement elements (i.e., asset, liability, equity, income or expense).
 This involves recording the item in words and in monetary amount and including
the amount in the totals of either of those statements.
 The amount at which an asset, a liability or equity is recognized in the statement of
financial position is referred to as its carrying amount.
 Recognition links the elements, the statement of financial position and the
statement(s) of financial performance as follows:

Statement of financial position at beginning of reporting period

Assets-Liabilities=Equity

Statement(s) of financial performance

Income-Expenses
Changes
in equity

Contributions from holders of equity claims minus

Distributions to holders of equity claims

Statement of financial position at end of reporting period

Assets-Liabilities=Equity

 The statements are linked because the recognition of one element (or a change in its
carrying amount) requires the recognition or derecognition of another element(s).
 Examples:

 Recognition of income resulting  Recording a sale increases both

in an increase in asset. ‘cash’/’receivable’ (asset) and
‘sales’ (income).
 Recognition of income resulting  Earning an unearned income
 in a decrease in liability.
 Recognition of expense resulting
in an expense in liability.
 Recognition of expense resulting
in a decrease in assets.
decreases ‘unearned income’
(liability) and increases income.
 Accruing unpaid salaries
increases both ‘salaries expense’
and ‘salaries payable’ (liability).
 Payment for supplies expense
increases ‘supplies expense’ and
decreases ‘cash’.

 Sometimes the recognition of income results in the simultaneous recognition of a

related expense.
 Matching of costs and income (matching concept)
o The simultaneous recognition of income and expense.
o For example, the sale of goods results in the simultaneous recognition of
‘sales’ (income) and ‘cost of sales’ (expense).

RECOGNITION CRITERIA

 An item is recognized if:

o It meets the definition of an asset, liability, equity, income or expense; and
o Recognizing it would provide useful information, i.e., relevant and faithfully
represented information.
 Both the criteria above must be met before an item is recognized.
 Accordingly, items that meet the definition of a financial statement element but do
not provide useful information are not recognized, and vice versa.
 Providing information, as well as using that information, entails cost.
o For example, the reporting entity may incur costs in appraising its property
for measurement purposes; users spend time and effort in analyzing and
interpreting the information.
o Thus, an entity should consider the cost constraint (cost-benefit principle)
when making recognition decisions such that the usefulness of the
information justifies its costs.
 o It is not possible, however, to establish a uniform threshold for determining
an optimum balance between costs and benefits.
o This would depend on the item and the facts and circumstances.
o Accordingly, judgment is required when deciding whether to recognize an
item, and thus the recognition requirements in the Standards may need to
vary.
 Even if an item that meets the definition of an asset or liability is not recognized,
information about that item may still need to be disclosed in the notes.
o In such cases, the item is referred to as unrecognized asset or unrecognized
liability.

RELEVANCE

 The recognition of an item may not provide relevant information if, for example:
o It is uncertain whether an asset or liability exists; or
o An asset or liability exists, but the probability of an inflow or outflow of
economic benefits is low.

EXISTENCE UNCERTAINTY & LOW PROBABILITY OF INFLOWS/OUTFLOWS

 Existence uncertainty or low probability of an inflow or outflow of economic

benefits may result in, but does not automatically lead to, the non-recognition of an
asset or liability.
 Other factors should be considered.
 If one or both of the foregoing factors result to non-recognition, information about
the unrecognized asset or liability may still need to be provided or the possible
inflows or outflows).
 Despite the presence of one or both of the foregoing factors, an asset or liability may
nonetheless be recognized if this provides relevant information.
o For example, the cost of an asset (liability) arising from an exchange
transaction on market terms generally reflects the probability of an inflow
(outflow) of economic benefits.
 o Thus, the asset liability ( may be recognized because not recognizing it would
result to the recognition of income (expense), which may not faithfully
represent the transaction.

FAITHFUL REPRESENTATION

 The recognition of an item is appropriate if it provides both relevant and faithfully

represented information, The level of measurement uncertainty and other factors
(i.e., presentation and disclosure) affect an item’s faithful representation.

MEASUREMENT UNCERTAINTY

 An asset or liability must be measured for it to be recognized.

 Often, measurement requires estimation and thus subject to measurement
uncertainty.
 The use of reasonable estimates is an essential part of financial reporting and does
not necessarily undermine the usefulness of information.
 Even a high level of measurement uncertainty does not necessarily preclude an
estimate from providing useful information if the estimate is clearly and accurate
described and explained.
 However, an exceptionally high measurement uncertainty can affect the faithful
representation of an item, such as when the asset or liability can only be measured
using cash-flow based measurement techniques and, in addition, one or more of the
following circumstances exists:
o There is an exceptionally wide range of possible outcomes and each outcome
is exceptionally difficult to estimate.
o The measure is high sensitive to small changes in estimates of the probability
of different outcomes.
o The measurement requires exceptionally difficult or exceptionally subjective
allocations of cash flows that do not relate solely to the asset or liability
measured.
RECOGNITION

 Is the opposite of recognition.

 It is the removal of a previously recognized asset or liability from the entity’s
statement of financial position.
 Occurs when the item no longer meet the definition of an asset or liability, such as
when the entity loses control of all or part of the asset, or no longer has a present
obligation for all or part of the liability.
 On derecognition, the entity
o Derecognizes the assets or liabilities that have expired or have been
consumed, collected, fulfilled or transferred (i.e., ‘transferred component’),
and recognizes any resulting income and expenses.
o Continues to recognize any assets or liabilities retained after the
derecognition (i.e., ‘retained component). No income or expense is normally
recognized on the retained component unless there is a change component
becomes a unit of account separate from the transferred component.

UNIT OF ACCOUNT

 Is the right or the group of rights, the obligation or the group of obligations, or the
group of rights and obligations, to which recognition criteria and measurement
concepts are applied.
 Can be account title:
o Cash
o Accounts receivable
 Can be a group of similar assets:
o Property, plant and equipment
 Can be a group of assets and liabilities:
o Cash-generating unit
 Unit of account is selected for an asset or liability when determining how that asset
or liability, and the related income or expense, will be recognized and measured.
 o For example, Cash is recognized when it is either on hand or deposited in the
bank and is measured at face amount, while Accounts receivable is
recognized when a sale occurred and is measured at the transaction price,
adjusted for any uncollectible amount.
 If an entity transfers part of an asset or part of a liability, the unit of account may
change at that time, so that the transferred component and the retained component
become separate units of account.
 Transfers
o Derecogition is not appropriate if the entity retains substantial control of a
transferred asset. In such case, the entity continues to recognize the
transferred asset and recognizes any proceeds received from the transfer as a
liability.
o If there is only a partial transfer, the entity derecognizes only that transferred
component and continues to recognize the retained component.

COMMENTARY ON THE CHANGES IN THE CONCEPTUAL FRAMEWORK

ASSET

Previous version New version

Definition Definition
 Asset is a resource controlled by the  Asset is a present economic resource
entity as a result of past events and controlled by the entity as a result of
from which future economic benefits past events.
are expected to flow to the entity.  An economic resource is a right that
has the potential to produce
economic benefits.
Essential elements Essential elements
a. Control a. Right
b. Past events b. Potential to produce economic
c. Future economic benefits benefits
c. Control
  Commentary:
o The new Conceptual Framework deleted the notion of an “expected” flow
of future economic benefits and clarifies that the asset is the ‘right’ and not
the ultimate inflow of economic benefits from the right.
o Moreover, it stresses that the right is what the entity controls and not the
future economic benefits.
o Accordingly, an asset can exist even if tis potential to produce economic
benefits is not certain or even likely (although this could affect the asset’s
recognition and measurement).

Previous version New version

Recognition criteria
a. The item meets the definition of a
financial statement element;
b. It is probable that any future
economic benefit associated with the
item will flow to or from the entity;
and
c. The item has a cost or value that can
be measured with reliability.
Recognition criteria
a. The item meets the definition of a
financial statement element; and
b. Recognizing it would provide useful
information, i.e., relevant and
faithfully represented information.

 Commentary:
o The new Conceptual Framework deleted the notion of a ‘probability’
threshold and states that an asset can exist even if its probability to produce
economic benefits is low (although this can affect recognition decisions on
the asset’s ability to provide useful information). It further states that what is
important is that in at least one circumstance the economic resource will
produce economic benefits.
o The new Conceptual Framework also deleted the ‘reliable measurement’
criterion and states that even a high level of measurement uncertainty does
 not necessarily preclude an asset from being recognized if the estimate is
clearly and accurately described and explained.
o The main effect of the changes is a shift of focus to the principle of providing
useful information, rather than on rules. Accordingly, the non-recognition of
an asset does not necessarily preclude an entity from providing information
about that unrecognized asset in the notes.

Previous version New version

Derecognition (asset) Derecognition (asset)
 Not specifically addressed  An asset is derecognized when it has
expired or has been consumed,
collected, or transferred.

LIABILITY

Previous version New version

Definition
 Liability is a present obligation off
the entity arising from past events,
the settlement of which is expected
to result in an outflow from the entity
of resources embodying economic
benefits.
Essential elements
a. Present obligation arising from past
events
b. Outflow of economic benefits
Definition
 Liability is a present obligation of
the entity to transfer an economic as
a result of past events.
Essential elements
a. Obligation
b. Transfer of an economic resource
c. Present obligation as a result of past
events

 Commentary:
 o The notion of an “expected” flow of future economic benefits is deleted,
similar to the change in the definition of an asset.
o The new Conceptual Framework emphasizes that the liability is the
”obligation” and not the ultimate outflow of economic benefits from that
obligation.
o The new Conceptual Framework also introduced the concept of “no
practical ability to avoid” to the definition of an obligation.

RECOGNITION AND DERECOGNITION

 The changes in the recognition and derecognition of a liability parallel those for an
asset.

EQUITY, INCOME & EXPENSES

 Commentary:
o The new Conceptual Framework retained the definitions of equity, income
and expenses. However, the emphases that income includes both revenues
and losses, were deleted. The IASB, however, do not expect that these
deletions would cause any changes in practice.
o Also , the new Conceptual Framework states that income and expenses are
classified as recognized either in profit or loss or other comprehensive
income.
o The new Conceptual Framework also removed the explicit references to the
expense recognition principles of “systematic and rational allocation” and
“immediate recognition,” but not “matching”. This, however, does not
mean that the former two are no longer relevant as they are still implied in
the new Conceptual Framework.
o Other relevant changes: The new Conceptual Framework also introduced
the concepts of ‘unit of account’ and ‘executory contracts’.

SUMMARY:
  The changes align the Conceptual Framework to the IASB’s current thinking in
formulating Standards. For example:
o Focusing the definition of an asset to a right, rather than a physical object,
parallels the requirement of PFRS 16 Leases on the recognition of a “right-
of-use asset” by a lessee.
o Focusing on providing useful information when making recognition
decisions, rather than on probability threshold and reliable measurement,
parallels the requirements of :
 PFRS 3 Business Combination for goodwill.
 PFRS 9 Financial Instruments for certain derivative instruments
 PFRS 13 Fair Value Measurement on the ‘hierarchy of fair value
and measurement’.
o Including the concept that income and expenses are recognized either in
profit or loss or other comprehensive income parallels the requirements of
PAS 1 Presentation of Financial Statements and other relevant standards.
o Introducing the concepts of ‘unit of account’ and ‘executory contracts’
aligns the Conceptual Framework to the provisions of PFRS 9 on the
accounting for investment portfolios and PFRS 15 Revenue from Contracts
with Customers on the recognition of ‘contract asset’, ‘contract liability’ or
‘receivable’.
 The Conceptual Framework is not a Standard, hence it does not provide
requirements for specific transactions or other events- these are addressed by the
Standards. The Conceptual Framework’s main purpose is to provide the
foundation for the development of globally acceptable Standards.

MEASUREMENT

 Recognition requires quantifying an item in monetary terms, thus necessitating the

selection of an appropriate measurement basis.
 The application of the qualitative characteristics, including the cost constraint, is
likely to result in the selection of different measurement bases for different assets,
 liabilities, income and expenses. Accordingly, the Standards prescribe specific
measurement bases for different types of assets, liabilities, income and expenses.

MEASUREMENT BASES

 The Conceptual Framework describes the following measurement:

1. Historical cost
2. Current value
a. Fair value
b. Value in use and fulfillment value
c. Current cost

HISTORICAL COST

 The historical cost of an asset is the consideration paid to acquire the asset plus
transaction costs.
 The historical cost of a liability is the consideration received to incur the liability
minus transaction costs.
 In cases where it is not possible to identify the cost, such as in transactions that are
not on market terms, the resulting asset or liability is initially recognized at current
value. That value becomes the asset’s (liability’s) deemed cost for subsequent
measurement at historical cost.
 Unlike current value, historical cost does not reflect changes in value, but is updated
overtime to depict the following:

Historical cost of an asset Historical cost of a liability

a. Impairment, depreciation or
amortization
b. Collections that extinguish part of
all of the asset
c. Discount or premium
amortization when the asset is
a. Increase in the obligation
resulting from the liability
becoming onerous
b. Payments or fulfillments made
that extinguish part or all of the
liability
c. Discount or premium
amortization when the liability is
 measured at amortized cost measured at amortized cost
CURRENT VALUE

 Measures reflect changes in value at the measurement date. Unlike historical cost,
current value is not derived from the price of the transaction of other event that
gave rise to the asset or liability.
 Current value measurement bases include the following:
o Fair value
o Value in use for assets and Fulfilment value for liabilities
o Current cost

FAIR VALUE

 Is the price that would be received to sell an asset, or paid to transfer a liability, in an
orderly transaction between market participants at the measurement date.
 Fair value reflects the perspective of market participants (i.e., participants in a
market to which the entity has access).
o Accordingly, it is not an entity-specific measurement.
 Fair value can be measured directly by observing prices in an active market or
indirectly using measurement techniques, e.g., cash-flow-based measurement
techniques.
o Fair value is not adjusted for transaction costs.

VALUE IN USE AND FULFILMENT VALUE

 Value in use
o Is the present value of the cash flows, or other economic benefits, that an
entity expects to derive from the use of an asset and from its ultimate
disposal.
 Fulfilment value
o Is the present value of the cash, or other economic resources, that an entity
expects to be obliged to transfer as it fulfills a liability.
 Value in use and fulfillment value
 o Reflect entity-specific assumptions rather than assumptions by market
participants.
o Are measured indirectly using cash-flow-based measurement techniques,
similar to those used in measuring fair value but from an entity-specific
perspective rather than from a market-participant perspective.
o Do not include transaction costs in acquiring an asset or incurring a liability
but include transaction costs expected to be incurred on the ultimate disposal
of the asset or fuflfilment of the liability.

CURRENT COST

 Current cost of an asset

o Is the cost of an equivalent asset at the measurement date, comprising the
consideration that would be paid at the measurement date plus the
transaction costs that would be incurred at that date.
 Current cost of a liability
o Is the consideration that would be received for an equivalent liability at the
measurement date minus the transaction costs that would be incurred at that
date.
 Entry values
o They reflect prices in acquiring an asset or incurring liability
 Current cost
 Reflects conditions at the measurement date.
 Can only be measured indirectly.
 For example, by adjusting the current price of a new
asset to reflect the current age and condition of the
asset held by the entity.
 Historical cost
 Exit values
o They reflect prices in selling or using an asset or transferring or fulfilling a
liability.
  Fair value
 Value in use
 Fulfilment value

CONSIDERATION WHEN SELECTING A MEASUREMENT BASIS

 When selecting a measurement basis, it is important to consider the following:

o The nature of information provided by a particular measurement basis; and
o The qualitative characteristics, the cost constraint, and other factors.

INFORMATION PROVIDED BY PARTICULAR MEASUREMENT BASES

 Different measurement bases result in different information to be provided in the

financial statements. For example:
o Measuring an asset at historical cost may result in the subsequent
recognition of depreciation or impairment whereas measuring that asset at
fair value would result in the subsequent recognition of gain or loss from
changes ni fair value; measuring an asset at current cost may result to the
recognition of holding gains and losses from price changes.
o Measuring an asset (liability) at historical cost or current cost does not result
to gain or loss on initial recognition, unless the asset is impaired (or the
liability is onerous), whereas measuring an asset at fair value or value in
use may result to gain or loss on initial recognition if the market in which the
asset is required is different from the market that is the source of the prices
used in measuring the asset’s fair value; the initial gain or loss is the
difference between the consideration paid and the fair value of the asset
acquired.
o Historical cost and current cost measurements include transaction costs in
acquiring an asset whereas fair value measurement excludes transaction
costs; value in use measurement considers only the transaction costs on the
asset’s disposal.
 o The computation of gain or loss on the derecognition of an asset depends on
its measurement basis.
 For example, the gain or loss on the derecognition of an asset
measured at historical cost is computed as the difference between the
net disposal proceeds, if any, and the asset’s historical cost adjusted
for depreciation and impairment, whereas, if the asset is measured at
fair value, the gain or loss is the difference between the net disposal
proceeds, if any, and the asset’s fair value.

THE QUALITATIVE CHARACTERISTICS AND THE COST CONSTRAINT

 An entity also considers whether the information provided by a particular

measurement basis is useful.
 Information is useful if it is relevant and faithfully represented and, as far as
possible, comparable, verifiable, timely and understandable.
 Relevance
o The relevance information is affected by:
 The characteristics of the asset or liability; and
 How that asset or liability contributes to future cash flows.
 Characteristics of the asset or liability
o Affects the relevance of the information provided by a measurement
basis.
 For example, an asset or liability whose value is sensitive to market
factors is more approximately measured at fair value rather than
at historical cost.
 Fair value measurement
 Results in reporting the changes in market factors as they
occur, rather than only when the asset or liability is
derecognized.
 On the other hand, an asset that can be sold independently (e.g.,
investment in stocks) is likely to be measured at fair value.
FAITHFUL REPRESENTATION

 The level of measurement uncertainty may affect the faithful representation of

information,
 Measurement uncertainty
o Arises when a measure cannot be determined directly by observing prices in
an active market and must instead be estimated.
 A high level of measurement uncertainty does not necessarily prevent the use of a
measurement basis that provides relevant information.
 Thus, in cases where the measurement uncertainty associated with a particular
measurement basis is so high that it cannot provide sufficiently faithfully
represented information, it is appropriate to consider selecting a different
measurement basis that would also result in relevant information.
 Measurement uncertainty is different from both outcome uncertainty and existence
uncertainty:
o Outcome uncertainty
 Arises when there is uncertainty about the amount or timing of any
inflow or outflow of economic benefits that will result from an asset or
liability.
o Existence uncertainty
 Arises when it is uncertain whether an asset or a liability exists.
 May affect decisions on whether an asset or a liability is to be
recognized.
 Outcome uncertainty or existence uncertainty may sometimes contribute, but does
not necessarily lead, to measurement uncertainty.
o For example, there is no measurement uncertainty if an asset’s fair value can
be determined directly by observing prices in an active market, even if it is
uncertain how much cash that asset will ultimately produce and hence there
is outcome uncertainty.

ENHANCING QUALITATIVE CHARACTERISTICS AND THE COST CONSTRAINT

COMPARABILITY

 Consistently using same measurement bases for same items, either from period to
period within a single entity (intra-comparability) or within a single period across
different entities (inter-comparability), makes the financial statements more
comparable.
 This does not mean, however, that a selected measurement basis should never be
changed.
 A change is appropriate if it results in more relevant information. Because a change
in measurement basis can make financial statements less understandable,
explanatory information should be disclosed to enable users of financial statements
to understand the effect of the change.

UNDERSTANDABILITY

 Generally, the more different measurement bases are used, the more complex the
resulting information become, and hence less understandable.
 Using more different measurement bases is appropriate only if it is necessary to
provide useful information.

VERIFIABLITY

 Using measurement bases that result in measures that can be independently

corroborated either directly (e.g., by observing prices) or indirectly (e.g., by checking
inputs to a model) enhances verifiability.
 If a measure cannot be verified, explanatory information should be disclosed to
enable users of financial statements to understand how the measure was
determined.
 In some cases, it may be more appropriate to indicate the use of a different
measurement basis.
 Depending on the facts and circumstances, the use of either historical cost or
current value has its own merits in relation to verifiability. For example:
 o In many situations, using historical cost is simpler and generally well
understood, and hence verifiable. However, measuring depreciation,
impairment or onerous liabilities can be subjective, and hence lessens
verifiability,
o Fair value is determined from the perspective of market participants, not
from the entity’s perspective, and is independent of when the asset was
acquired or the liability was incurred. Thus, in principle, different entities
that have access to the same markets would come up with essentially the
same amount of fair value for a particular asset or a liability, and hence
verifiable. This could also enhance comparability because, unlike historical
cost, fair value measurement results in the same amount of measure for
identical assets (liabilities) with different acquisition (incurrence) dates.
o Value in use and fulfilment value are costly to implement and requires
subjective assumptions. Accordingly, these may result in different measures
for identical assets or liabilities by different entities. This reduces verifiability
and comparability. Nonetheless, value in use may provide useful
information, for example, when determining the recoverable amount of a
group of assets, i.e., cash-generating unit.
o Current cost results in the same amount of measure for identical assets
(liabilities) acquired (incurred) at different dates. This enhances
comparability. However, determining current cost can be costly, complex,
and subjective, thus reducing verifiability and understandability.
Nonetheless, current cost may provide useful information, for example, when
revaluing a property whose fair value cannot be determined directly by
observing prices in an active market.
 Selecting an appropriate measurement basis requires the consideration of all factors
in combination, including the cost constraint and other factors, rather than only a
single facto in isolation.
FACTORS SPECIFIC TO INTIAL MEASUREMENT

 In transaction on market terms, an asset’s (liability’s) cost is normally similar to its

fair value on initial recognition.
 Even so, it is still necessary to describe the measurement basis used at initial
recognition because this determines whether any income or expenses arises on that
date.
o For example, measuring an asset or liability at cost does not result to any
income or expenses on initial recognition, except when the asset is impaired
or the liability is onerous, or when income or expense arises from the
derecognition of a transferred asset or liability.
 Moreover, the initial and subsequent measurement bases usually parallel each other.
o For example,, if historical cost is to be used subsequently, that measurement
basis is also normally appropriate at initial recognition,
 In transactions not on market terms, measurement at historical cost may not
provide faithfully represented information, examples of transactions not on market
terms include:
o Transactions in which the transaction price is affected by related party
relationships or by financial distress of one of the parties
o Receipt of donation from another party or a grant from the government
o Incurrence of a liability that is imposed by law or a penalty for an act of
wrongdoing
 In such cases, it may be appropriate to measure the resulting asset or liability at a
‘deemed cost’ (e.g., fair value).

MORE THAN ONE MEASUREMENT BASIS

 Sometimes it may be necessary to sue more than one measurement basis on

order to provide useful information,
 In most cases, the use of different measurement basis is applied in such a way
that:
 o A single measurement basis is used in the statement of financial position
and statement (s) of financial performance; and
o Additional information is disclosed in the notes for a different
measurement basis.
 For example, an investment property may be measured using the cost model.
However, the investment property’s fair value is disclosed in the notes.
 In some cases, however, it may be more appropriate to:
o Use a current value measurement basis for the asset or liability in the
statement of financial position; and
o A different measurement basis for the related income and expenses in the
statement of profit or loss.
 In such cases, the related total income or expense may need to be allocated to
both profit or loss and other comprehensive income.
 For example, a debt instrument may be measured at fair value in the statement
of financial position. However, the interest income is measured in relation to the
instrument’s amortized cost, while the fair value changes are recognized in other
comprehensive income.

MEASUREMENT OF EQUITY

 Total equity is not measured directly.

 It is simply equal to the difference between the carrying amounts of recognized
assets and recognized liabilities.
 Financial statements are not designed to show an entity’s value. Thus, total equity
cannot be expected to be equal to the entity’s market value nor the amount that can
be raised from either selling liquidating the entity.
 Although total equity is not measured directly, some its components can be
measured directly (e.g., share capital). However, because equity is a residual amount,
at least one of its components cannot be measured directly (e.g., retained earnings).
 Equity is generally positive although some of its components may be negative (e.g.,
retained earnings can be negative if the entity has accumulated losses). In some
 cases, even total equity can be negative such as when total liabilities exceed total
assets.

CASH-FLOW-BASED MEASUREMENT TECHNIQUES

 A measure that cannot be observed directly needs to be estimated.

 One way to make the estimate is by using cash-flow-based measurement techniques.
 Such techniques are not measurement bases, but rather used in applying a
measurement basis,
 Accordingly, when using a technique, it is necessary to identify which measurement
basis is used and the extent to which measurement basis is used and the extent to
which the technique reflects the factors applicable to that measurement basis.
 When making an estimate from a range of possible outcomes, the single amount that
provides the most relevant information is usually one from within the central part of
the range (a central estimate). However, different central estimates provide different
information. For example:
o Statistical mean (Expected value or Probability-weighted average)
 Reflects the average amount within the entire range, giving more
weight to the outcomes that are more likely.
 Expected value is not intended to predict the ultimate cash inflow
(outflow) from an asset (liability).
o Statistical median (Maximum amount that is more likely than not to
occur)
 Is the middle amount within the range and reflects the probability of
an inflow or outflow to be no more than that amount.
o Statistical mode (Most likely outcome)
 Reflects the single most likely ultimate inflow (outflow) from the asset
(liability), which is the amount that occurs the highest number of
times within the range.
 Example:
A range of possible outcomes consists of the following:
 13, 18, 13, 14, 13, 16, 14, 21, and 13.
o Statistical mean
 Is the average, so we simply add the values then divide the sum by the
number of the values in the range.
 (13 + 18 + 13 + 14 + 13 + 16 + 14 + 21 + 13)/9+ 15
o Statistical median
 Is the middle value, so we simply rearrange the values in numerical
order then get the middle value.
 13, 13, 13, 13, 14, 14, 16, 18, 21. The median is 14.
 In case the number of values is an even number, say 10 instead of 9 as
in the illustration above, the two middle values are added and divided
by two (e.g., if the number of values is 10, the 5th and 6th values are
added and then divided by two to get the median).
o Statistical mode
 Is the most frequent value.
 The mode 13 (because it occurs four times).

PRESENTATION AND DISCLOSURE

PRESENTATION AND DISCLOSURE AS COMMUNICATION TOOLS

 Information about assets, liabilities, equity, income and expenses is communicated

through presentation and disclosure in the financial statements.
 Effective communication makes information more useful.
 Effective communication requires:
o Focusing on presentation and disclosure objectives and principles rather
than on rules.
o Classifying information by grouping similar items and separating dissimilar
items.
o Aggregating information in a manner that it is not obscured either by
excessive detail or by excessive summarization.
  The cost constraint (cost-benefit principle) is a pervasive constraint-meaning it
affects all aspects of financial reporting. Hence, it affects decisions about
presentation and disclosure.

PRESENTATION AND DISCLOSURE OBJECTIVES AND PRINCIPLES

 Presentation and disclosure objectives are specified in the Standards.

 Those requirements strive for a balance between:
o Giving entities the flexibility to provide relevant and faithfully represented
information; and
o Requiring information that has both intra-comparability (comparability
from period to period within a single entity) and inter-comparability
(comparability within a single period across different entities).
 Effective communication also requires the consideration of the following principles:
o Entity-specific information is more useful than standardized descriptions,
also known as ‘boilerplate’; and
o Duplication of information is usually unnecessary as it can make financial
statements less understandable.

CLASSIFICATION

 Refers to the sorting of assets, liabilities, equity, income or expenses with similar
nature, function, and measurement basis for presentation and disclosure purposes.
 Combining dissimilar items can reduce the usefulness of information.

CLASSIFICATION OF ASSETS AND LIABILITIES

 Classification is applied to an asset’s or liability’s selected unit of account.

 However, it is sometimes necessary to apply classification to a higher level of
aggregation and then sub-classify the components separately.
  For example, assets or liabilities are classified as current and noncurrent and then
each component of those classifications are sub-classified separately.

OFFSETTING

 Occurs when an asset and a liability with separate units of account are combined
and only the net amount is presented in the statement of financial position.
 Is generally not appropriate because it combines dissimilar items.
 Treating a set of rights and obligations as a single unit of account is not offsetting.

CLASSIFICATION OF EQUITY

 Equity claims with different characteristics may be classified separately.

o For example, a corporation’s equity may be classified into share capital,
retained earnings, and other components.
 Similarly, equity components that are subject to legal or similar requirements may
be classified separately.
o For example, statutory reserves, appropriated retained earnings, and
unrestricted retained earnings.

CLASSIFICATION OF INCOME AND EXPENSES

 Income and expenses are classified as recognized either in:

o Profit or loss; or
o Other comprehensive income
 Profit or loss
o Is customarily used as the main indictor of an entity’s return or earnings,
and hence the entity’s financial performance.
o However, a complete understanding of an entity’s financial performance
requires information on all recognized income and expenses, including those
that are recognized in other comprehensive income, as well as other
information included in the financial statements.
 Standards
 o Specify whether an income or expense is to be recognized in profit or loss or
in other comprehensive income.
o Generally, income and expenses associated with assets and liabilities that are
measured at historical cost are recognized in profit or loss.
o Also specify whether an income or expense that was previously recognized in
other comprehensive income is subsequently reclassified to profit or loss or
transferred directly within equity.

AGGREGATION

 Is the adding together of assets, liabilities, equity, income or expenses that have
shared characteristics and are included in the same c classification,
 Example:

Classifying vs. Aggregation

 All receivables arising from sales
on account are classified as
“Accounts receivable.”
 Accounts receivable is a unit of
account for recognition and
measurement purposes.
 All receivables (i.e., Accounts
receivable, Notes receivable,
advances, etc.) are aggregated and
presented in the statement of
financial position under a single
line item called “Trade and other
receivables.”

 Aggregation summarizes a large volume of detail, thus making information more

useful. However, balance should be strived for because excessive aggregation can
conceal important detail.
 Typically, summarized information is presented in the statement of financial
position and the statement(s) of financial performance while detailed information is
provided in the notes.

CONCEPTS OF CAPITAL AND CAPITAL MAINTENANCE

 The Conceptual Framework mentions two concepts of capital, namely:
o Financial concept of capital
 Capital is regarded as the invested money or invested purchasing
power.
 Capital is synonymous with equity, net assets, or net worth.
o Physical concept of capital
 Capital is regarded as the entity’s productive capacity, e.g., units of
output per day.
 The choice of an appropriate concept is based on users’ needs.
 Thus, if users are primarily concerned with the maintenance of nominal invested
capital or purchasing power of invested capital, the financial concept should be
used; whereas, if their primary concern is the entity’s operating capability, the
physical concept should be used.
 Most entities adopt the financial concept of capital in preparing their financial
statements,
 The concept choses affects the determination of profit. In this regard, the concepts of
capital give rise to the following concepts of capital maintenance:
o Financial capital maintenance
 Under this concept, profit is earned if the net assets at the end of the
period exceeds the net assets at the beginning of the period, after
excluding any distributions to, and contributions from, owners during
the period.
 Can be measured in either nominal monetary units or units of
constant purchasing power.
 Does not require any particular measurement basis. This would
depend on the type of financial capital that the entity seeks to
maintain.
o Physical capital maintenance
 Under this concept, profit is earned only if the entity’s productive
capacity at the end of the period exceeds the productive capacity at
 the beginning of the period, after excluding any distributions to, and
contributions from, owners during the period.
 Requires the use of current cost.
 The concept of capital maintenance is essential in distinguishing between a return
on capital and a return of capital.
o Only inflows of assets in excess of the amount needed to maintain capital is
regarded as return on capital or profit.
 The main difference between the two concepts of capital maintenance is the
treatment of the effects of changes in the prices of assets and liabilities. This is
summarized below:

Financial capital Physical capital

Nominal cost Constant purchasing
power
 Profit represents the  Profit represents the  All price changes are
increase in nominal increase in invested treated as capital
money capital over purchasing power maintenance
the period. over the period. adjustments that are
 Increases in the  Only the portion of part of equity and not
prices of assets held the increase in prices as profit.
over the period, also in excess of the
called holding gains, increase in the
are, conceptually, general level of
profits but are prices is regarded as
recognized as such profit. The remainder
only when the assets is treated as capital
are disposed of. maintenance
adjustment (i.e., part
of equity).

 The Conceptual Framework has been designed to apply to a range of accounting

models and concepts of capital and capital maintenance.
 o Accordingly, the Conceptual Framework does not prescribe a particular
model, except for financial reporting under hyperinflationary economy.

CAPITAL MAINTENANCE ADJUSTMENTS

 The revaluation or restatement of assets and liabilities results in increases or

decreases in equity.
 Although these increases or decreases meet the definition of income or expenses,
they are not recognized in profit or loss under certain concepts of capital
maintenance.
o Accordingly, these items are included in equity as capital maintenance
adjustments or revaluation reserves.

EXAMPLE:

Manong Magbabalut sells balut. One morning, MAnong has 100, MAnong used that amount
to buy balut, cook the balut, and sell them. At the end of the day, Manong has 240.

Question 1:

If Manong uses the financial capital maintenance concept (measured in nominal

monetary unit) how much profit did Manong earn? Assume Manong did not eat any of his
baluts.

 240 net assts. end- 100 net assets, beg. = 140

Question 2:

What if Manong ate one balut costing 10, how much is the profit?

 240 net assets. end + 20 distribution to owner – 100 net assets, beg. = 150
PAS 1 PRESENTATION OF FINANCIAL STATEMENTS

Philippine Accounting Standard (PAS) 1 Presentation of Financial Statements

 Prescribes the basis for the presentation of general purpose financial statements,
the guidelines for their structure, and the minimum requirements for their content
to ensure comparability.

TYPES OF COMPARABILITY

 Intra-comparability
o Horizontal or inter-period
o Refers to the comparability of financial statements of the same entity but
one period to another.
 Inter-comparability
o Dimensional
o Refers to the comparability of financial statements between different
entities

Comparability requires consistency in the adoption and application of accounting

policies and in the presentation of financial statements, e.g., the use of line-item
descriptions and accounts titles, either within a single entity form one period to another or
across different entities.

PAS 1 applies to the preparation and presentation of general purpose financial

statements. The recognition, measurement and disclosure requirements for specific
transactions and other events are set out in other PFRSs.

The terminology used in PAS 1 is suitable for profit-oriented entities. If non-profit

organizations apply PAS 1, they may need to amend the line-item and financial statement
descriptions.

FINANCIAL STATEMENTS

 Are the “structured representation of an entity’s financial position and results of its
operations”.
 Are the end product of the financial reporting process and the means by which the
information gathered and processed is periodically communicated to users.
 The financial statements of the entity pertain only to that entity and not to the
industry where the entity belongs or the economy as a whole.

GENERAL PURPOSE FINANCIAL STATEMENTS (financial statements)

 Are “those intended to meet the needs of users who are not in a position to require
an entity to prepare reports tailored to their particular information needs”.
 Cater to most of the common needs of a wide range of external users.
 Are the subject matter of the conceptual framework and the PFRSs.

PURPOSE OF FINANCIAL STATEMENTS

1. Primary objective
 To provide information about the financial position, financial
performance, and cash flows of an entity that is useful to a wide range of
users in making economic decisions.
2. Secondary objective
 To show the results of management’s stewardship over the entity’s resources.
To meet the objective, financial statements provide information about an entity’s:

a) Assets (economic resources)

b) Liabilities (economic obligations)
c) Equity
d) Income
e) Expenses
f) Contributions by, and distributions to, owners
g) Cash flows

This information, along with the other information in the notes, helps users assess
the entity’s prospects for future net cash inflows.

COMPLETE SET OF FINANCIAL STATEMENTS

1. Statement of financial position

2. Statement of profit or loss and other comprehensive income
3. Statement of changes in equity
4. Statement of cash flows
5. Notes
a. (5a) Comparative information
6. Additional statement of financial position (required only when certain instances
occur).

An entity may use other titles for the statements.

 For example, an entity may use the title “balance sheet” in lieu of “statement of
financial position” or “statement of comprehensive income” instead of
“statement of profit or loss and other comprehensive income.”

However, and “income statement” is different from a “statement of comprehensive

income.”

Outside the scope of PFRSs

  Reports that are presented outside of the financial statements, such as:
o Financial reviews by management
o Environmental reports
o Value added statements

GENERAL FEATURES OF FINANCIAL STATEMENTS

1. Fair presentation and Compliance with PFRSs

2. Going Concern
3. Accrual Basis of Accounting
4. Materiality and Aggregation
5. Offsetting
6. Frequency of reporting period
7. Comparative Information
8. Consistency of presentation
1. Fair Presentation and Compliance with PFRSs
 Fair presentation
o Is faithfully representing, the in the financial statements, the effects of
transactions and other events in accordance with the definitions and
recognition criteria for assets, liability, income and expenses set out
in the Conceptual Framework.
o Also requires the proper selection and application of accounting
policies, proper presentation of information, and provision of
additional disclosures whenever relevant to the understanding of the
financial statements.
 Compliance with the PFRSs
o Is presumed to result in fairly presented financial statements.
 Inappropriate accounting policies cannot be rectified by mere disclosure.
 PAS 1 requires an entity whose financial statements comply with PFRSs to
make an explicit and unreserved statement of such compliance in the
notes.
 o However, an entity shall not make such statement unless it complies
all the requirements of PFRSs.

STAMENT OF COMPLIANCE WITH PHILIPPINE FINANCIAAL REPORTING STANDARDS

o The financial statements of the Bank have been prepared in accordance with
Philippine Financial Reporting Standards (PFRSs), which are adopted by the
Financial Reporting Standards Council (FRSC) from the pronouncements issued
by the International Accounting Standards Board (IASB).

There may be cases wherein an entity’s management concludes that compliance with a
PFRS requirement is misleading.

In such cases, PAS 1 permits a departure from a PFRS requirement if the relevant
regulatory framework requires or allows such a departure.

Relevant regulatory framework

o Refers to the accounting principles and other financial reporting requirements

prescribed by a government regulatory body. For example:
o Banks in the Philippines are regulated by the Bangko Sentral ng Pilipinas
(BSP).
 Therefore, in addition to the PFRSs, banks must also comply with the
requirements of the BSP.

Regulatory Accounting Principles (RAP)

o Accounting principles prescribed by a regulatory body.

o In practice, banks commonly refer to the financial reporting required by the BSP as
“FRP” or Financial Reporting Package.

When and entity departs from a PFRS requirement, it shall disclose the management’s
conclusions to the:

 fair presentation of the financial statements

 that all other requirements of the PFRSs are complied with
  the title of the PFRS from which the entity has departed, and
 the financial effect of the departure.

Statement of Compliance

 The financial statements of the Bank have been prepared in compliance with the:
o Philippine Financial Reporting Standards (PFRS),
o Except for the deferral of losses on sale on nonperforming assets (NPAs)
to special purpose vehicles (SPVs)
o Non-recognition of allowance for credit losses on subordinated notes issued
by the SPV, and
o Non-consolidation of the SPV that acquires the NPAs sold in 20x5, and 20x4.
 PFRS 9 Financial Instruments and the Conceptual Framework
o Require that the losses be charged to current operations and that the
accounts of SPVs be consolidated into the Bank’s accounts.

Accounting Guidelines on the Sale on NPAs to Special Purpose Vehicles

 The allowance for credit losses previously provided for the NPAs sold to SPVs was
released to cover additional allowance for credit losses required for other existing
NPAs and other risk assets of the Bank.

All other requirements of the PFRSs have been complied with except those described
above.

Management concludes that the financial statements present fairly the Bank’s financial
position, financial performance and cash flows.

2. Going Concern
 Financial statements are normally prepared on a going concern basis unless
the entity has a intention to liquidate or has no other alternative but to do
so.
 When preparing financial statements, management shall assess the entity’s
ability to continue as a going concern, taking into account all available
 information about the future, which is at least, but not limited to 12 months
from the reporting date.
 If the entity has a history of profitable operations and ready access to the
financial resources, management may conclude that the entity is a going
concern without detailed analysis.
 If there are material uncertainties on the entity’s ability to continue as a
going concern, those uncertainties shall be disclosed.
 If the entity is not a going concern, its financial statements shall be
prepared using another basis. This fact shall be disclosed, including the
basis used, and the why the entity is not regarded as a going concern.
3. Accrual Basis of Accounting
 All financial statements shall be prepared using the accrual basis of
accounting except for the statement of cash flows, which is prepared using
cash basis.
4. Materiality and Aggregation
 Each material class of similar items is presented separately
 Line item
o A class of similar items
 Dissimilar items are presented separately unless they are immaterial.
 Individual immaterial items are aggregated with other items.
5. Offsetting
 Assets and liabilities or income and expenses are presented separately and
are not offset, unless offsetting is required or permitted by a PFRS.
 Offsetting is permitted when it reflects the substance of the transaction.
Examples of offsetting:
o Presenting gains or losses from sales of assets net of the related
selling expenses.
o Presenting at net amount the unrealized gains and losses arising from
trading securities and from translation of foreign currency
denominated assets and liabilities, except if they are material.
 o Presenting a loss from a provision net of a reimbursement from a
third party.
 Measuring assets net of valuation allowances is not offsetting.
o For example, deducting allowance for doubtful accounts from
accounts receivables or deducting accumulated depreciation from a
building account is not offsetting.
6. Frequency of reporting
 Financial statements are prepared at least annually.
 If an entity changes its reporting period to a period longer or shorter than
one year, it shall disclose the following:
o The period covered by the financial statements
o The reason for using a longer or shorter period
o The fact that amounts presented in the financial statements are not
entirely comparable.

7. Comparative Information
 PAS 1 requires an entity to present comparative information in respect of the
preceding period of all amounts reported in the current period’s financial
statements, unless another PFRS requires otherwise.
 As a minimum, an entity presents two of each of the statements and related
notes.
 PAS 1 permits entities to provide comparative information in addition to the
minimum requirement.
o For an example, an entity may provide a third statement of
comprehensive income.
o In this case, however, the entity need not provide a third statement
for the other financial statements, but must to provide the related
notes for that additional statement of comprehensive income.

Additional Statement of financial position

 As mentioned earlier, a complete set of financial statements includes an additional
statement of financial position when certain instances occur. Those instances are
as follows:
a. The entity applies an accounting policy retrospectively, makes a
retrospective restatement of items in its financial statements, or
reclassifies items in its financial statements.
b. The instance in (a) has a material effect on the information in the statement
of financial position at the beginning of the preceding period.

For example, if any other instances above occur (a and b), the entity shall present
three statements of financial position as follows:

Statement of financial position Date

1. Current year  As at December 31, 20x2
2. Preceding year (comparative  As at December 31, 20x1
information)
3. Additional  As at January 1, 20x1
o The opening statement of
financial position is dated
as at the beginning of the
preceding period even if
the entity presents
comparative information
for earlier periods.
o The entity need not
present the related notes to
the opening statement of
financial position.
 8. Consistency of presentation
 The presentation and classification of items in the financial statements is
retained from one period to the next unless a change in presentation:
o Is required by a PFRS, or
o Results in information that is reliable and more relevant.
 A change in presentation requires the reclassification of items in the
comparative information.
 If the effect of a reclassification is material, the entity shall provide the
“additional statement of financial position.”

STRUCTURE AND CONTENT OF FINANCIAL STATEMENTS

 Each of the financial statements shall be presented with equal prominence and
shall be clearly identified and distinguished from other information in the same
published document. For example:
o Financial statements are usually included in an annual report, which also
contains other information.
o The PFRSs apply only to the financial statements and not necessarily to the
other information.
 The following information shall be displayed prominently and repeatedly
whenever relevant to the understanding of the information presented:
o The name of the reporting entity
o Whether the statements are for the individual entity or for a group of entities
o The date of the end of the reporting period or the period covered by the
financial statements
o The presentation currency
o The level of rounding used (e.g., thousands, million, etc.)
  The statement of financial position is dated as at the end of the reporting period
while the other financial statements are dated for the period that they cover.
 PAS 1 requires particular disclosures to be presented either in the notes or on
the face of the other financial statements (e.g., footnote disclosures).
 Other disclosures are addressed by other PFRSs.

MANAGEMENT’S RESPONSIBILITY OVER FINANCIAL STATEMENTS

 The management is responsible for an entity’s financial statements. The

responsibility encompasses:
o The preparation and fair presentation of financial statements in accordance
with PFRSs
o Internal control over financial reporting
o Going concern assessment
o Oversight over the financial reporting process; and
o Review and approval of financial statements
 The responsibilities are expressly stated in a document called “Statement of
Management’s Responsibility for Financial Statements,” which is attached to the
financial statements as a cover letter. This document is signed by the entity’s:
o Chairman of the Board (or equivalent)
o Chief Executive Officer (or equivalent), and
o Chief Financial Officer (or equivalent)
STATEMENT OF FINANCIAL POSITION

 The statement of financial position shows the entity’s financial condition (i.e.,
status of assets, liabilities and equity) as at a certain date. It includes line items that
present the following amounts:
a. Property, plant and equipment
b. Investment property
c. Intangible assets
d. Financial assets excluding:
 Investments accounted for using the equity method
 Trade and other receivables
 Cash and cash equivalents
e. Investments accounted for using the equity method
f. Biological assets
g. Inventories
h. Trade and other receivables
i. Cash and cash equivalents
j. Assets held for sale, including disposal groups
k. Trade and other payables
l. Provisions
m. Financial activities excluding:
 Trade and other payables
 Provisions
n. Current tax liabilities and deferred tax assets
o. Liabilities included in disposal groups
p. Non-controlling interests; and
q. Issued capital and reserves attributable to owners of the parent.
 PAS 1 does not prescribe the order or format of presenting items in the statements
of financial position.
 The foregoing is simply a list of items that are sufficiently different in nature or
function to warrant separate presentation.
  Accordingly, and entity may modify the descriptions used the sequence of their
presentation to suit the nature of the entity and its transactions.
 Moreover, additional line items may be presented whenever relevant to the
understanding of the entity’s financial position.

PRESENTATION OF STATEMENT OF FINANCIAL POSITION

 A statement of financial position may be presented in a “classified” or an

“unclassified” manner.
o A classified presentation
 Shows distinctions between current and noncurrent assets and
current and noncurrent liabilities.
 Shall be used except when an unclassified presentation provides
information that is reliable and more relevant.
 When that exception applies, assets and liabilities are
presented in order of liquidity (this is normally the case for
banks and other financial institutions).
 Highlights an entity’s working capital and facilitates the computation
of liquidity and solvency ratios.
 Working capital= Current Assets- Current Liabilities
o An unclassified presentation
 Also called “based on liquidity”
 Shows no distinction between current and noncurrent items.
o A mixed presentation
 Presenting some assets and liabilities using a current/non-current
classification and others in order of liquidity.
 This may be appropriate when the entity has diverse operations.

Whichever method is used, PAS 1 requires the disclosure of items that are expected
to be recovered or settled:

 Within 12 months
 Beyond 12 months, after the reporting period.
CURRENT ASSETS AND CURRENT LIABILITIES

Current Assets Current Liabilities

-are assets that are:
 Expected to be realized, sold, or
consumed in the entity’s normal
operating cycle.
 Held primarily for trading.
 Expected to be realized within 12
months after the reporting period;
or
 Cash or cash equivalents, unless
restricted from being exchanged or
used to settle a liability for at least
twelve months after the reporting
period.
- are liabilities that are:
 Expected to be settled in the entity’s
normal operating cycle.
 Held primarily for trading.
 Due to be settled within 12 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 other assets and liabilities are classified as noncurrent.

 The operating cycle of an entity is the time between the acquisition of assets for
processing and their realization in cash or cash equivalents. When the entity’s
normal operating cycle is not clearly identifiable, it is assumed to be 12 months.
 Deferred tax assets and liabilities are always presented as noncurrent items in a
classified statement of financial position, regardless of their expected dates of
reversal.

Examples:

Current assets Current liabilities

 Cash and cash equivalents  Accounts payable
 Accounts receivable  Salaries payable
 Non-trade receivable collectible  Dividends payable
within 12 months  Income (Current) tax payable
 Held for trading securities  Unearned revenue
  Inventory  Portion of notes/loans/bonds
 Prepaid assets payable due within 12 months

Noncurrent assets Noncurrent liabilities

 Property, plant and equipment  Portion of notes/loans/bonds
 Non-trade receivable collectible payable due beyond 12 months
beyond 12 months  Deferred tax liability
 Investment in associate
 Investment property
 Intangible assets
 Deferred tax asset

REFINANCING AGGREEMENT

 Refinancing
o Refers to the replacement of an existing debt with a new one but with
different terms, e.g., and extended maturity date or a revised payment
schedule.
o Refinancing normally entails a fee or penalty.
o A refinancing where the debtor is under financial distress is called “troubled
debt restructuring.’
 Loan facility refers to a credit line.
 Current
o Classified as a long-term obligation that is maturing within 12 months after
the reporting period, even if a refinancing agreement to reschedule payments
on a long-term basis is completed after the reporting period but before the
financial statements are authorized for issue.
 Noncurrent
o An obligation classified if the entity expects, and has the discretion, to
refinance it on a long-term basis under an existing loan facility.
  If the refinancing is not at the discretion of the entity (for example, there is no
arrangement for refinancing), the financial liability is current.

LIABILITIES PAYABLE ON DEMAND

 Liabilities that are payable upon demand of the lender are classified as current.
 A long-term obligation may become payable on demand as a result of a breach of a
loan provision.
 Such an obligation is classified as current even if the lender agreed, after the
reporting period and before the authorization of the financial statements for issue,
not to demand payment.
o This is because the entity does not have an unconditional right to defer
settlement of the liability for at least twelve months after the reporting
period.
 However the liability is noncurrent if the lender provides the entity by the end of
the reporting period.

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

 Income and expenses for the period may be presented in either:

o A single statement of profit or loss and other comprehensive income
(statement of comprehensive income); or
o Two statements
1. A statement of profit or loss (income statement)
2. A statement presenting comprehensive income
  PAS 1 requires an entity to present information on the following:
a. Profit or loss
b. Other comprehensive income; and
c. Comprehensive income
 Presenting a separate income statement is allowed as long as a separate statement
showing comprehensive income is also presented (i.e., Two-statement
presentation).
 Presenting only an income statement is prohibited.

PROFIT OR LOSS

 Is income less expenses, excluding the components of other comprehensive income.

 Profit
o The excess of income over expenses
 Loss
o The excess of expenses over income
 Transaction approach
o The method of computing for profit or loss
 Income and expenses are usually recognized in profit or loss unless:
o They are items of other comprehensive income;, or
o They are required by other PFRSs to be recognized outside of profit or loss.
 The following are not included in determining the profit or loss for the period:

Transaction
1. Correction or prior period error
2. Change in accounting policy
3. Other comprehensive income
4. Transactions with owners (e.g.,
issuance of share capital, declaration
of dividends, and the like)
Accounting
 Direct adjustment to the beginning
balance of retained earnings.
 The adjustment is presented in the
statement of changes in equity.
 Similar treatment to correction of
prior period error.
 Changes during the period are
presented in the “other
comprehensive income” section of
the statement of comprehensive
income.
 Cumulative balances are presented
in the equity section of the
statement of financial position.
 Recognized directly in equity.
 Transactions during the period are
presented in the statement of
changes in equity.

 The profit or loss section line items that present the following amounts for the
period:
o Revenue, presenting separately interest revenue
o Finance costs
o Gains and losses arising from the derecognition of financial assets measured
at amortized cost
o Impairment losses and impairment gains on financial assets
o Gains and losses on reclassifications of financial assets from amortized cost
or fair value through other comprehensive income too fair value through
profit or loss/
 o Share in the profit or loss of associates and joint ventures
o Tax expense; and
o Result of discontinued operations

Additional line items shall be presented whenever relevant to the understanding of

the entity’s financial performance. The nature and amount of material items of income or
expense shall be disclosed separately.

Circumstances that would give rise to the separate disclosure of items of income and
expense include:

 Write-downs of inventories to net realizable value or of property, plant and

equipment to recoverable amount, as well as reversals of such write-downs
 Restructurings of the activities of an entity and reversals of any provisions for
restructuring costs
 Disposals of items of property, plant and equipment
 Disposals of investments
 Discontinued operations
 Litigation settlements; and
 Other reversals of provisions

PAS 1 prohibits the presentation of extraordinary items in the statement off profit
or loss and other comprehensive income or in the notes.

PRESENTATION OF EXPENSES

 Expenses may be presented using either of the following methods:

a. Nature of expense method
 Under this method, expenses are aggregated according to their
nature:
 Depreciation
 purchases of materials
 Transport costs
 employee benefits and advertising costs
 o and are not reallocated according to their functions
within the entity.
 The nature of expense method is simpler to apply because it
eliminates considerable judgment needed in reallocating expenses
according to their function.
b. Function of expense method (Cost of sales methods)
 Under this method, an entity classifies expenses according to their
function:
 Cost of sales
o At a minimum, cost of sales shall be presented
separately from other expenses.
 Distribution costs
 Administrative expenses
 And other functional classifications
 If the function of expense method is used, additional disclosures
on the nature of expenses shall be provided, including depreciation
and amortization expense and employee benefits expense.
 This information is useful in predicting future cash flows.
OTHER COMPREHENSIVE INCOME (OCI)

 Comprises items of income and expense (including reclassification adjustments)

that are not recognized in profit or loss as required or permitted by other PFRSs.
 The components of other comprehensive income include the following:
o Changes in revaluation surplus
o Remeasurements of the net defined benefit liability (asset)
o Gains and losses on investments designated or measured at fair value
through other comprehensive income (FVCOI)
o Gains and losses arising from translating the financial statements of a foreign
operation
o Effective portion of gains and losses in hedging instruments in a cash flow
hedge
o Changes in fair value of a financial liability designated at fair value through
profit or loss (FVPL) that are attributable to changes in credit risk:
o Changes in the time of value of option when the option’s intrinsic value and
time value are separated and only the changes in the intrinsic value is
designated as the hedging instrument; and
o Changes in the value of the forward elements of forward contracts when
separating the forward element and spot element of a forward contract and
designating as the hedging instrument only the changes in the spot element,
and changes in the value of the foreign currency basis spread of a financial
instrument when excluding it from the designation of that financial
instrument as the hedging instrument.

RECLASSIFICATION ADJUSTMENTS

Items of OCI include reclassifications adjustments.

 Reclassification adjustments
 o Are amounts classified to profit or loss in the current period that were
recognized in other comprehensive income in the current or previous
periods.
o On derecognition, the cumulative gains and losses that were accumulated in
equity on these items are reclassified from OCI to profit or loss. The amount
reclassified is called the reclassification adjustment.
o A reclassification adjustment for a gain is a deduction in OCI and an
addition profit or loss.
 This is to avoid double inclusion in total comprehensive income.
o Reclassification adjustments for a loss is an addition to OCI and a
deduction from profit or loss.
o Reclassification adjustments do not arise on changes in revaluation
surplus, derecognition of equity instruments designated at FVCOI, and
remeasurements of the net defined benefit liability (asset).
o On derecognition, the cumulative gains and losses that were accumulated in
equity on these items are transferred directly to retained earnings, rather
than to profit or loss as a reclassification adjustment.

PRESENTATION OF OCI

 The other comprehensive income section shall group items of OCI into the
following:
o Those for which reclassification adjustment is allowed; and
o Those for which reclassification adjustment is not allowed.
 The entity’s share in the OCI of an associate or joint venture accounted for under
the equity method shall also be presented separately and also grouped according to
the classifications above.

Type of Other Comprehensive Income Reclassification adjustment?

a. Changes in revaluation surplus No
b. Remeasurements of the net defined benefit No
liability (asset)
c. Fair value changes in FVCOI
  Equity instruments(election) No
 Debt instrument (mandatory) Yes
d. Translation differences on foreign Yes
operations
e. Effective portion of cash flow hedges Yes
Items of OCI, including reclassification adjustments, may be presented at either net
of tax or gross of tax.

TOTAL COMPREHENSIVE INCOME

 Is the change in equity during a period resulting from transactions and other events,
other than those changes resulting from transactions with owners in their capacity
as owners.
 Is the sum of profit or loss and other comprehensive income, and not just profit or
loss, help users better assess the overall financial performance of the entity.

STATEMENT OF CHANGES IN EQUITY

The statement of charges in equity shows the following information:

a. Effects of change in accounting policy (retrospective application) or correction of

prior period error (retrospective statement)
b. Total comprehensive income for the period; and
c. For each component of equity, a reconciliation between the carrying amount at the
beginning and the end of the period, showing separately changes resulting from:
i. Profit or loss
ii. Other comprehensive income; and
iii. Transactions with owners, e.g., contributions by and distributions to owners
 Retrospective adjustments and retrospective statements are presented in the
statement of changes inequity as adjustments to the opening balance of retained
earnings rather than as changes in equity during the period.
 Components of equity include, for example, each class of contributed equity, the
accumulated balance of each class of other comprehensive income and retained
earnings.
  PAS 1 allows the disclosure of dividends, and the related amount per share, either
in the statement of changes in equity or in the notes.

Note:

 “Non-owner” changes in equity are presented in the statement of comprehensive

income while “owner” changes (e.g., contributions by and distributions to owners)
are presented in the statement of changes in equity.
 This is to provide better information by aggregating items with shared
characteristics and separating items with different characteristics.

NOTES

 Provides information in addition to those presented in the other financial

statements.
 It is an integral part of a complete set of financial statements.
 All the other financial statements are intended to be read in conjunction with the
notes.
 Accordingly, information in the other financial statements shall be cross-
referenced to the notes.
 PAS 1 requires an entity to present the notes in a systematic manner. Notes are
normally structured as follows:
1. General information on the reporting entity.
 This includes the domicile and legal form of the entity, its country
of incorporation and the address of its registered office and a
description of the nature of the entity’s operations and its principal
activities.
2. Statement of compliance with the PFRSs and Basis of preparation of
financial statements.
3. Summary of significant accounting policies.
 This includes narrative descriptions of the line items in the other
financial statements, their recognition criteria measurement bases,
derecognition, transitional provisions, and other relevant information.
 4. Disaggregation (breakdowns) of the line items in the other financial
statements and other supporting information.
5. Other disclosures required by PFRSs, such as (the list is not exhaustive):
 Contingent liabilities and unrecognized contractual commitments.
 Non-financial disclosures, e.g., the entity’s financial risk management
objectives and policies.
 Events after the reporting date, if material.
 Changes in accounting policies and accounting estimates and
corrections of prior period errors.
 Related party disclosure.
 Judgments and estimations.
 Capital management
 Dividends declared after the reporting period but before the financial
statements were authorized for issue, and the related amount per
share.
 The amount of any cumulative preference dividends not recognized.
6. Other disclosures not required by PFRSs but the management deems relevant
to the understanding of the financial statements.
 Notes are prepared in a necessarily detailed manner. They are voluminous and
occupy a bulk portion of the financial statements.
PAS 2 INVENTORIES

Introduction

PAS 2

 Prescribes the accounting treatment for inventories

 Recognizes that a primary issue in the accounting for inventories is determination of
cost to be recognized as asset and carried forward until it is expensed.
 Provides guidance in the determination cost of inventories, including the:
o use of cost formulas
o subsequent measurement
o recognition as expense

PAS 2 applies to all inventories except for the following:

 Assets accounted for under other standards

o Financial instruments
o Biological assets and agricultural produce at the point of harvest
 Assets not measured under the lower of cost or net realizable value (NRV) under PAS
2
o Inventories of producers of agricultural, forest, and mineral products
measured at net realizable value in accordance with well-established practices
in those industries.
o inventories of commodity broker-traders measured at fair value less costs to
sell.
Inventories

Inventories are as assets:

o Held for sale in the ordinary course of business (Finished Goods).

o In the process of production for such sale (Work In Process)
o In the form of materials or supplies to be consumed in the production
process or in the rendering of services (Raw materials and manufacturing
supplies)

Examples of inventories:

 Merchandise purchased by a trading entity and held for resale.

 Land and other property held for sale in the ordinary course of business.
 Finished goods, goods undergoing production, and raw materials and suppliers
awaiting use in the production process by a manufacturing entity.

Ordinary course of business refers to the necessary, normal or usual

business activities of an entity.

Financial statement presentation

 All items that meet the definition of inventory are presented on the statement of
financial position as one line item under the caption “Inventories.” The breakdown
of this line item (as finished goods, WIP and Raw materials) is disclosed in the notes.
 Inventories are normally presented in a classified statement of financial position as
current assets.

Measurement

 Inventories are measured at the lower of cost and net realizable value.
 The cost of inventories comprise all:
o costs of purchase
o costs of conversion and
 o other costs incurred in bringing the inventories to their present location and
condition.
 Net realizable value (NRV)
o is the estimated selling price in the ordinary course of business less the
estimated costs of completion and the estimated costs necessary to make the
sale

Cost

The cost of inventories comprises the following:

 Purchase cost- this includes the purchase price (net of trade discounts and other
rebates), import duties, non-refundable or non-recoverable purchase taxes, and
transport, handling and other costs directly attributable to the acquisition of the
inventory.
 Conversion cost- this refers to the costs necessary inweight converting raw
materials into finished goods. Conversion costs include:
o Costs of direct labor and
o Production overhead
 Other costs- necessary in bringing the inventories to their present location and
condition.

The following are excluded from the cost of inventories and are expensed in the period in
which they are incurred:

 Abnormal amounts of wasted materials, labor or other production costs.

 Selling costs, for example, advertising and promotion costs and delivery expense or
freight out.
 Administrative overheads that do not contribute to bringing inventories to their
present location and condition.
 Storage costs, unless those costs are necessary in the production process before a
further production stage, (e.g., the storage costs of partly finished goods may be
 capitalized as cost of inventory, but the storage costs of completed finished goods are
expensed).

When a purchase transaction effectively contains a financing element, such as when

payment of the purchase price us deferred, the difference of the purchase fro normal credit
terms and the amount paid is recognized as interest expense over the period of the
financing.

The advertising costs are selling costs. These are expensed in the period in which
they are incurred.

Cost Formulas

 Deals with the computation of cost inventories that are charged as expense when
the related revenue is recognized (‘cost of sales’ or ‘cost of goods sold’) as well as the
cost of unsold inventories at the end of the period that are recognized as asset
(‘ending inventory’).
PAS 2 provides the following cost formulas:

1. Specific identification
o shall be used for inventories that are not ordinarily interchangeable (i.e., used
for inventories that are unique) and those are segregated for specific projects.
o Specific costs are attributed to identified items of inventory.
o Cost of sales is the cost of the specific inventory that was sold while ending
inventory represents the actual costs of the specific items on hand.
o Records should be maintained that enables the entity to identify the cost
and movement of each specific inventory.
o Specific identification is not appropriate when inventories consist of large
number of items that are ordinarily interchangeable. In such cases, the entity
shall choose between the other formulas.

2. First-In, First-Out (FIFO)

o It is assumed that inventories that were purchased or produced first are sold
first, and therefore unsold inventories at the end of the period are those most
recently purchased or produced.
o Cost of sales represents costs from earlier purchases while the cost of
ending inventory represents costs from the most recent purchases.
3. Weighted Average Cost
o Cost of sales and ending inventory are determined based on the loanloan
average cost of beginning inventory and all inventories purchased or
produced during the period.
o The average may be calculated on a periodic bases, or as each additional
purchase is made, depending upon the circumstances of the entity.
o Refer to cost of flow assumptions meaning they pertain to the flow of costs
(from inventory to cost of sales) and not necessarily to the actual physical
flow of inventories.
o The FIFO or Weighted Average can be used regardless of which item of
inventory is physically sold first.
o Same cost formula shall be used for all inventories with similar nature and
use.
o Different cost formulas may be used for inventories with different nature
and use.
o However, a difference in geographical location of inventories, by itself, is not
sufficient to justify the use of different cost formulas.
o PAS 2 does not permit the use of a last-in, first out (LIFO) cost formula.
 Cost of sales is based on the average cost of all inventories purchased during
the period. Ø Wtd. Ave. Cost = (TGAS in pesos ÷ TGAS in units)
Net Realizable Value (NRV)

 is the estimated selling price in the ordinary course of business less the
estimated costs of completion and the estimated costs of necessary to make
the sale.
 NRV is different from fair value.
 NRV refers to net amount that an entity expects to realize from the sale of
inventory in the ordinary course of business.
 Fair Value reflects the price at which an orderly transaction to sell the same
inventory would take place between market participants at the measurement
date.
 The former is an entity-specific value; the latter is not.
 NRV for inventories may not equal fair value less costs to sell.
 Measuring inventories at the lower cost and NRV is in line with basic
accounting concept that an asset shall not be carried at an amount that
exceeds its recoverable amount.
 The cost of an inventory may exceed its recoverable amount if the inventory
is damaged.
 The amount of write-down is recognized as an expense.
 If the NRV subsequently increases, the previous write-down is reversed.
However, the amount of reversal shall not exceed the original write-down.
This is so that the new carrying amount is the lower of the cost and the
revised NRV.
 Write-downs of inventories are usually carried out on an item by item basis,
although in some circumstances, it may be appropriate to group similar
items.
 It is not appropriate to write down inventories on the basis of their
classification (finished goods or all inventories of an operating segment).
 Raw materials inventory is not written down below cost if the finished goods
in which they will be incorporated are expected to be sold at or above cost.
  If however, this is not the case, the raw materials are written down to their
NRV. The best evidence of NRV for raw materials is replacement cost.

ANALYSIS:
 Product A need not be written-down because its cost is lower than its NRV.
 Product B shall be written-down by 10,000 because its cost exceeds its NRV
(200,000 cost less 190,000 NRV).
 The total inventory to be shown in the statement of financial position is
290,000 (100,000 for Product A + 190,000 for Product B).
 The 10,000 write down is recognized as expense in profit or loss.
 ANALYSIS:
 The increase is 20,000 (100,000-80,000). However, the amount of reversal
that Entity A can recognize is limited to 10,000, i.e., the amount of the
original write-down.
 The amount of inventory to be shown in the statement of financial position is
90,000 (80,000 + 10,000 reversal).

ANSWER:

 160,000 total cost (60,000 + 100,000). The raw materials need not be written-
down to replacement cost because the NRV of the finished goods exceed the cost.

RECOGNITION AS AN EXPENSE
  The carrying amount of an inventory that is sold is charged as expense (i.e., cost of
sales) in the period in which the related revenue is recognized.
 Likewise, the write-down of inventories to NRV and all losses of inventories are
recognized as expense in the period the write-down or loss occurs.
 The amount of any reversal of any write-down of inventories, arising from an
increase in net realizable value, shall be recognized as reduction in the amount of
inventories recognized as an expense in the period in which the reversal occurs.
 Inventories that are used in the construction of another asset is not expensed but
rather capitalized as cost of the constructed asset.
o For example, some inventories may be used in constructing a building. The
cost of those inventories is capitalized as cost of the building and will be
included in the depreciation of that building.

DISCLOSURES

a) Accounting policies adopted in measuring inventories, including the cost formula

used.
b) Total carrying amount of inventories and the carrying amount in classifications
appropriate to the entity.
c) Carrying amount of inventories carried at fair value less costs to sell.
d) Amount of inventories recognized as an expense during the period.
e) Amount of write-down of inventories recognized as an expense during the period.
f) Amount of any reversal of write-down that is recognized as a reduction in the
amount of inventories recognized as expense in the period.
g) Circumstances or events that led to the reversal of a write down of inventories
and
h) Carrying amount of inventories pledged as security for liabilities.

SUMMARY:

 Inventories include goods that are held for sale in the ordinary course of business,
in the process of production for such sale, and in the form of materials and supplies
to be consumed in the production.
  Inventories are measured at the lower of cost and net realizable value (NRV).
 The cost of inventories comprises all costs of purchase, costs of conversion and
other costs incurred in bringing the inventories to their present location and
condition.
 Trade discounts, rebates and other similar items are deducted in the
determining the costs of purchase.
 The following are excluded from the cost of inventory:
o Abnormal costs
o Storage costs (unless necessary)
o Administrative costs
o Selling costs
 The cost formulas permitted under PAS 2 are:
o Specific Identifications
o FIFO
o Weighted Average
 Specific identification shall be used for inventories which are not ordinarily
interchangeable.
 Net realizable value is the estimated selling price in the ordinary course of
business less the estimated costs of completion and the estimated costs necessary to
make the sale.
 Inventories are usually written down to NRV on an item by item basis.
 Raw materials inventory is not written down below cost if the finished goods in
which they will be incorporated are expected to be sold at or above cost.
 Reversals of in inventory write-downs shall not exceed the amount of the original
write-down.

PAS 7 STATEMENT OF CASH FLOWS

PAS 7 prescribes the requirements in the presentation of statement of cash flows.

  Statement of cash flows provides information about the sources and utilization
(i.e., historical charges ) of cash and cash equivalents during the period.

DEFINITION OF TERMS

 Cash comprises cash on hand and cash in bank.

 Cash equivalents are “short-term, highly liquid investments that are readily
convertible to known amounts of cash and which are subject to an insignificant risk
of changes in value.”
o Only debt instruments acquired within 3 months or less before their
maturity date can qualify as cash equivalents. Examples of cash equivalents:
 1-year treasury bill acquired 3 months before maturity date
 90-day money market instrument or commercial paper
 3-month time deposit
 Cash flows include inflows (sources) and outflows(uses) of cash and cash
equivalents.

When used in conjunction with the rest of the financial statements, the statements,
the statement of cash flows helps users assess:

o The ability of the entity to generate cash and cash equivalents

o The timing and certainty of the generation of cash flows, and
o The needs of the entity to utilize those cash flows

The statement of cash flows may also provide information on the quality or
earnings of an entity. An entity may report profit under the accrual basis but suffers
negative cash flows from its operating activities. This may provide indicators of, among
other things, difficulty in collecting accounts receivable.

As the statements of cash flows can only be prepared on a cash basis, it enhances
inter-comparability among different entities because it eliminates the effects of using
different accounting treatments for the same transactions.

CLASSIFICATION OF CASH FLOWS

 The statement of cash flows presents cash flows according to the following
classifications:

1. Operating activities
2. Investing activities
3. Financing activities

OPERATING ACTIVITIES

 Cash flows from operating activities are primarily derived from the principal
revenue-producing activities of the entity.
 Operating activities usually include cash inflows and outflows on items of income
and expenses, or those that enter into the determination of profit or loss (i.e.,
included in the income statement)

Examples of cash flows from operating activities:

a) Cash receipts from the sale of goods, rendering services, or other forms of income
b) Cash payments for purchases of goods and services
c) Cash payments for operating expenses, such as employee benefits, insurance, and
the like, and payments or refunds or income taxes
d) Cash receipts and payments from contracts held for dealing or trading purposes

SPECIAL ITEMS INCLUDED IN OPERATING ACTIVITIES

 Cash flows from buying and selling held for trading securities (whether financial
assets or financial liabilities) are classified as operating activities. Held for trading
securities are similar to inventories in the sense that they are acquired specifically
for resale.
 Some entities, in the ordinary course of their activities, routinely manufacture or
acquire items of property, plant and equipment to be held for rental to others and
subsequently transfer these assets to inventories when they cease to be rented and
become held for sale. For these entities, cash flows from the acquisition, rentals and
 subsequent sale off such assets are considered operating activities. The proceeds
from the sale of such assets are recognized as revenue.
 Loan transactions of financial institutions (e.g., banks) are operating activities
because they relate to the main revenue-producing activity of financial institution.

INVESTING ACTIVITIES

 Involve the acquisition and disposal of noncurrent assets and other investments.
Examples include:
a) Cash receipts and cash payments in the acquisition and disposal of property,
plant and equipment, investment property, intangible assets and other
noncurrent assets.
b) Cash receipts and cash payments in the acquisition and sale of equity or debt
instruments of other entities (other than those that are classified as cash
equivalents or held fro trading)
c) Cash receipts and cash payments on derivative assets and liabilities (other
than those that are held for trading or classified as financing activities)
d) Loans to other parties and collections thereof (other than loans made by a
financial institution)

FINANCING ACTIVITIES

 Are those that affect the entity’s equity capital and borrowing structure. Examples
include:
a) Cash receipts from issuing shares or other equity instruments and cash
payments to redeem them
b) Cash receipts from issuing notes, loans, bonds and mortgage payable and
other short-term or long-term borrowings, and their repayments
c) Cash payments by a lease for the reduction of the outstanding liability
relating to a lease
 Cash flows on trade payables, accrued expense and other operating liabilities are
classified as operating activities and not financing activities. Only cash flows
on non-operating or non-trade liabilities are included as financing activities.

Remember the following:

1. Operating activities - affect profit or loss

2. Investing activities - affect non-current assets and other investments
3. Financing activities - affect borrowings and equity

CASH FLOWS EXCLUDED FROM THE ACTIVITIES SECTIONS

 Cash flows on movements between “cash” and “cash equivalents” are not
presented separately because these are part of the entity’s cash management rather
than its operating, investing and financing activities.
 Bank overdrafts that cannot be offset to cash are presented as financing activities.
Those that can be offset to cash (or are part of the entity’s cash management) forms
part of the balance of cash and cash equivalents and therefore not presented
separately in the activities sections.
 Cash flows denominated in a foreign currency are translated using the spot
exchange rate at the date of the cash flow. Exchange differences are not cash flows.
“However, the effect of exchange rate changes on cash and cash equivalents held or
due in a foreign currency is reported in the statement of cash flows in order to
reconcile cash and cash equivalents at the beginning is reported separately from
the operating, investing and financing activities.

GENERAL CONCEPT IN THE PREPARATION OF STATEMENT OF CASH FLOWS

 The statement of cash flows is prepared using cash basis. Under the cash basis of
accounting, income is recognized only when collected and expenses are recognized
only when paid, rather than when these items are earned or incurred.
 Accordingly, only transaction that affected cash and cash equivalents are
reported in the statement of cash flows. Non-cash transactions are excluded and
disclosed only.
 o When preparing statement of cash flows:
 Include only transactions that have affected cash and cash
equivalents (e.g., purchase of assets by paying cash).
 Exclude transactions that have not affected cash and cash equivalents
( e.g., purchase of assets by issuing note payable or shares of stock and
conversion of debt to equity).

INTERESTS AND DIVIDENDS

 Entities (except financial institutions or non-financial institution) may classify

cash flows on interests and dividends as follows:

Cash flows Option 1 Option 2

1. Interest income received Operating activity Investing activity
2. interest expense paid Operating activity Financing activity
3. Dividend income received Operating activity Investing activity
4. Dividend paid to owners Financing activity Operating activity

Option 1
 Interest income, interest
expense and dividend income
are classified as operating
activities because they enter
into the determination of profit
or loss (i.e., income and
expenses)
 Dividend paid is classified as
financing activity because it is a
transaction with the owners
and alters the equity structure.
Option 2
 Interest income and dividend
income are classified as
investing activities because they
result from investments.
 Interest expense is classified as
financing activity because it
results from borrowing.
 Dividend paid is classified as
operating activity in order to
assist users in assessing the
entity’s ability to pay dividends
 out of operating cash flows.
 Only interests and dividends received or paid in cash are included in the
statement of cash flows.
o For example, dividends declared in Year 1 but paid in Year 2 are excluded
from the statement of cash flows in Year 1 and reported only in Year 2.
 Only option 1 is available to financial institutions.
 When answering CPA board questions wherein the problem is silent, it is presumed
that the entity uses option 1.

PRESENTATION

Cash flows from operating activities may be presented using either:

a) Direct method- shows each major class of gross cash receipts and gross cash
payments; or
b) Indirect method- profit or loss is adjusted for the effects of non-cash items and
changes in operating assets and liabilities.

 PAS 7 does not require any particular method; both methods are acceptable.
 However, PAS 7 encourages the direct method because it provides information
that may be useful in estimating future cash flows which is not available under
the indirect method.
 In practice, however, the indirect method is more commonly used because it is
easier to apply.
 Moreover, the choice between direct and indirect method of presenation is
applicable only for operating activities.
 For investing and financing activities, gross cash receipts and gross cash
payments for the related transactions are presented separetely, unless they
qualify for net presentation.
CHANGES I OWNERSHIP INTERESTS IN SUBSIDIARIES

 Cash flows arising from acquisitions and disposals of subsidiaries or other business
units resulting to loss or obtaining of control are classified as investing activities.
 Thos that do not result to loss or obtaining of control are classified as financing
activities.

DISCLOSURE

PAS 7 requires the following disclosures:

a) Components of cash and cash equivalents and a reconciliation of amounts in the

statement of cash flows with the equivalent items in the statement of financial
position.
 b) Significant cash and cash equivalents held by the entity that are not available for use
by the group, together with a management commentary.

SUMMARY

 The statement if cash flows shows the historical changes (i.e., sources and
utilization) in cash and cash equivalents during the period. It is an integral part of
a complete set of financial statements and is used in conjunction with the other
fianncial statements in assessing the ability of an entity to generate cash and cash
equivalents, the timing and certainty of their generation, and the needs of the entity
to utilize those cash flows.
 Cash flows are classified into
o Operating activities
 Include transactions that enter into the determination of profit or
loss
 Income
 expenses
o Investing activities
 Include transactions that affect:
 Non-current assets
 And other non-operating assets
o Financing activities
 Include transactions that affect:
 Equity
 Non-operating liabilities
 Only transactions that have affected cash and cash equivalents are included in the
statement of cash flows.
 Non-cash transactions are excluded and disclosed only.
 Entites other than fianncial institutions have options in presenting cash flows
relating to interests and dividends.
 Cash flows from operating activities may be reported using either:
 o Direct method
 Shows each major class or gross cash receipts and gross cash
payments.
o Indirect method
 Profit or loss is adjusted for the effects of non-cash items and
changes in operating assets and liabilities.
 Cash flows relating to investing and financing activities are presented separately
at gross amounts, unless they qualify for net presentation.

PAS 8 ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS

 Prescribes the criteria for selecting, applying, and changing accounting policies and
the accounting and disclosure of:
o Changes in accounting policies
o Changes in accounting estimates
o Correction of prior period errors

These are intended to enhance the relevance, reliability and comparability of

the entity’s financial statements.

ACCOUNTING POLICIES

 Are the “the specific principles, bases, conventions, rules and practices applied by an
entity in preparing and presenting financial statements”.
  When selecting and applying accounting policies, and entity shall refer to the
hierarchy guidance summarized below.

HIERARCHY OF REPORTING STANDARDS

1. PFRSs
2. Judgment
 When making the judgment:
o Management shall consider the following:
a. Requirements in other PFRSs dealing with similar transactions
b. Conceptual Framework
o Management may consider the following:
a. Pronouncements issued by other standard-setting bodies
b. Other accounting literature and industry practices
 The foregoing means that, to account for a transaction, an entity refers to the PFRSs
first (which consist of the PFRSs, PASs and Interpretations); in the absence of a
PFRS that specifically deals with that transaction, management uses its judgment in
developing and applying an accounting policy that results in information that is
relevant and reliable.
 In making the judgments, management considers the applicability of the references
listed above.
 PFRS are accompanied by guidance to assist entities in applying their requirements.
 A guidance states whether it is an integral part of the PFRSs.
 A guidance that is an integral part of the PFRSs is mandatory.

CHANGES IN ACCOUNTING POLICIES

PAS 8

 Requires the consistent selection and application of accounting policies.

 Permits a change in accounting policy only if the change:
o Is required by a PFRS; or
o Results in reliable and more relevant information
A change in accounting policy usually results from a change in measurement basis.
Examples of changes in accounting policies:

a. Change from FIFO to the Weighted Average cost formula for inventories.
b. Change from the cost model to the fair value model of measuring investment
property.
c. Change from the cost model to the revaluation model of measuring property, plant,
and equipment and intangible assets.
d. Change in business model for classifying financial assets.
e. Change in the method of recognizing from long-term construction contracts.
f. Change to a new policy resulting from the requirement of a new PFRS.
g. Change in financial reporting framework, such as from PFRS for SMEs to full PFRSs.

The following are not changes in accounting policies:

a. The application of an accounting policy for transactions, other events or conditions

that differ in substance from those previously occurring.
b. The application of a new accounting policy for transactions, other events or
conditions that did not occur previously or were immaterial.

ACCOUNTING FOR CHANGES IN ACCOUNTING POLICIES

 Changes in accounting policies are accounted for using the following order of
priority:
1. Transitional provision in a PFRS, if any.
2. Retrospective application, in the absence of a transitional provision.
3. Prospective application, if retrospective application is impracticable.
 For example, if an entity changes an accounting policy, it shall refer first to any
specific transitional provision of the PFRS that specifically deals with that
accounting policy.
 If there is no transitional provision, the entity shall account for the change using
retrospective application.
  If however, retrospective application is impracticable, the entity is allowed to
account for the change using prospective application.

RETROSPECTIVE APPLICATION

 Means adjusting the opening balance “of each affected component of equity (e.g.,
retained earnings) for the earliest prior period presented and the other comparative
amount disclosed for each prior period presented as if the new accounting policy
had always been applied.”
 For example, if an entity changes its accounting policy from the Average to the FIFO
cost formula, all previous financial statements presented in comparative with the
current-year financial statements are restated to apply FIFO.
 It is as if FIFO has always been applied.
 If retrospective application is impracticable for all periods presented, the entity
shall apply the new accounting policy as at the beginning of the earliest period for
which retrospective is practicable, which may be the current period.
 If retrospective application is still impracticable as at the beginning of the current
period, the entity is allowed to apply the new accounting policy prospectively from
the earliest date practicable.
 Impracticable
o Means it cannot be done after making every reasonable effort to do so.
 A retrospective application is impracticable if the prior period effects cannot be
determined of if it requires significant estimates and assumptions to have been
made when the prior period financial statements were prepared and these are
impossible to determine in te current period.
 A voluntary change in accounting policy is accounted for by retrospective
application.
 An early application of a PFRS is not a voluntary change in accounting policy.

CHANGES IN ACCOUNTING ESTIMATES

 Many items un the financial statements cannot be measured with precision but
only through estimation because of uncertainties inherent in business activities.
  The use of reasonable estimates therefore is necessary in order to provide relevant
information.
 Estimates are an essential part of financial reporting and do not undermine the
reliability of financial reports. For example, the following necessarily requires
estimation:
o Net realizable value of inventories
o Depreciation
o Bad debts
o Fair value of financial assets or financial liabilities; and
o Provisions
 Estimates involve judgments based on latest available information. Consequently,
estimates need to be revised when there is a change in circumstances such that new
information or more experience is obtained.
 A change in accounting estimate
o Is “an adjustment of the carrying amount of an asset or a liability, or the
amount of the periodic consumption of an asset, that results from the
assessment of the present status of, and expected future benefits and
obligations associated with, assets and liabilities,
o Changes in accounting estimates result from new formation or new
developments and, accordingly, are not corrections of errors.

Change in Accounting Policy Change in Accounting Estimate

 Normally results from a change in o Normally results from
measurement basis. E.g., : changes on how the expected
o FIFO to Weighted Average inflows or outflows of
o Cost to Fair Value economic benefits are
realized from assets or
incurred on liabilities.

If a change is difficult to distinguish between these two, the change is treated as a change
in an accounting estimate. Examples of changes in accounting estimates:
  Change in depreciation method
 Change in estimated useful life or residual value of a depreciable asset
 Change in the required balance of allowance for uncollectible accounts or
impairment losses
 Change in estimated warranty obligations and other provisions

ACCOUNTING FOR CHAANGES IN ACCOUNTING ESTIMATES

Changes in accounting estimates are accounted for by prospective application.

Prospective application

 Means recognizing the effects of the change in profit or loss, either in:
o The period of change; or
o The period of change and future periods, if both are affected.
 Under prospective application, the beginning balance of retained earnings and the
previous financial statements are not restated.

ERRORS

 Include misapplication of accounting policies, mathematical mistakes, oversights or

misinterpretations of facts, and fraud.
 “Financial statements do not comply with PFRSs if they contain either material
errors or immaterial errors made intentionally to achieve a particular
performance or cash flows.”
 Material errors
o Are those that cause the financial statements to be misstated.
 Intentional errors
o Are fraud.
o In the case of fraud, it does not matter whether the error is material or
immaterial.
o Fraudulent financial reporting does not comply with PFRSs.
 Errors can be errors of commission or errors of omission.
  An error of commission is doing something wrong.
 An error of omission is not doing something that should have been done.
 The types of errors according to the period of occurrence are as follows:

Current period errors Prior period errors

 Are errors in the current period that
were discovered either during the
current period or after the current
period but before the financial
statements were authorized for issue.
 These are corrected simply by
correcting entries.
 Are errors in one or more prior
periods that were only discovered
either during the current period or
after the current period but before
the financial statements were
authorized for issue.
 These are corrected by retrospective
restatement.

RETROSPECTIVE RESTATEMENT

 Restating the comparative amounts for the prior period(s) presented in which the
error occurred; or
 If the error occurred before the earliest prior period presented, restating the
opening balances of assets, liabilities and equity for the earliest prior period
presented.

Retrospective restatement Retrospective application

 Correcting a prior period error as if  Applying a new accounting policy as
the error had never occurred. if the policy had always been
applied.
 Just like retrospective application, retrospective restatement shall be made as far
back as practicable.
 If it is impracticable to determine the cumulative effect of a prior period error at
the beginning of the current period, the entity is allowed to correct the error
prospectively from the earliest date practicable.

SUMMARY:
  The two types of accounting changes are
o Change in accounting policy
o Change in accounting estimate
 Accounting policies
o Are those adopted by an entity in preparing and presenting its financial
statements.
 PAS 8 requires the consistent selection and application of accounting policies.
 An accounting policy shall be changed only when:
o It is required by a PFRS; or
o Results in relevant and more reliable information

Scope of PAS 8 Description Accounting Effect of adjustment

treatment
1. Change in  Change in a. Transitional  On the beginning
accounting measurement provision balance of retained
policy basis. b. Retrospective earnings, if
application accounted for
c. If (b) is retrospectively.
impracticable,
prospective
application.
2. Change in  Changes in the  Prospective  In profit or loss of
accounting realization (or application current period or
estimate incurrence) of current and future
expected inflow periods, of the
(or outflow) of change affects both.
economic
benefits from
assets (or
liabilities)
3. Correction of  Misapplication of a. Retrospective  On the beginning
prior period principles, restatement balance of retained
 error oversight or b. If (a) is earnings, if
misinterpretation impracticable,. accounted for
of facts, and Prospective retrospectively.
mathematical application.
mistakes.
 When it is difficult to distinguish a change in accounting policy from a change in
accounting estimate, the change is treated as a change in an accounting estimate.
 A voluntary change in accounting policy is accounted for by retrospective
application.
 Early application of a PFRS is not a voluntary change in accounting policy.

PAS 10 EVENTS AFTER THE REPORTING PERIOD

 Prescribes the accounting for, and disclosures of, events after the reporting period,
including disclosures regarding the date when the financial statements were
authorized for issue.

EVENTS AFTER THE REPORTING PERIOD

 Are “those events, favorable and unfavorable, that occur between the end of the
reporting period and the date when the financial statements are authorized for
issue.”
 For an example:
o Entity A’s reporting period ends on December 31, 20x1 and its financial
statements are authorized for issue on March 31, 20x2. Events after the
reporting period are those events that occur within January 1, 20x2 to
March 31, 20x2.
 Date of authorization of the financial statements
 o Is the date when management authorizes the financial statements for issue
regardless of whether such authorization is final or subject to further
approval.

TWO TYPES OF EVENTS AFTER THE REPORTING PERIOD

1. Adjusting events after the reporting period

 Are events that provide evidence of condition that existed at the end of the
reporting period.
2. Non-adjusting events after the reporting period
 Are events that are indicative of conditions that arose after the reporting
period.

ADJUSTING EVENTS AFTER THE REPORTING PERIOD

 Adjusting events, as the name suggests, require adjustments of amounts in the

financial statements. Examples of adjusting events:
a. The settlement after the reporting period of a court case that confirms that
the entity has a present obligation at the end of the period.
b. The receipt of information after the reporting period indicating that an asset
was impaired at the end of reporting period. For example:
 The bankruptcy of a customer that occurs after the reporting period
may indicate that the carrying amount of a trade receivable at the end
of the reporting period is impaired.
 The sale of inventories after the reporting period may give evidence to
their net realizable value at the end of reporting period.
c. The determination after the reporting period of the cost of asset purchased,
or the proceeds from asset sold, before the end of reporting period.
d. The determination after the reporting period of the amount of profit-sharing
or bonus payments, if the entity had a present legal or constructive obligation
at the end of reporting period to make such payments.
e. The discovery of fraud or errors that indicate that the financial statements
are incorrect.
NON-ADJUSTING EVENTS AFTER THE REPORTING PERIOD

 Non-adjusting events do not require adjustments of amounts in the financial

statements.
 However, they are disclosed if they are material. Examples of non-adjusting events
after the reporting period:
a. Changes in fair values, foreign exchange rates, interest rates or market prices.
b. Casualty losses (e.g., fire, storm or earthquake) occurring after the
reporting period but before the financial statements were authorized for
issue.
c. Litigation arising solely from events.
d. Significant commitments or contingent liabilities e.g., significant guarantees.
e. Major ordinary share transactions and potential ordinary share transactions.
f. Major business combination.
g. Announcing, or commencing the implementation of, a major restructuring.
h. Announcing a plan to discontinue an operation.
i. Change in tax rate
j. Declaration of dividends

DIVIDENDS

 Declared after the reporting period are not recognized as liability at the end of
reporting period because no present obligation exists at the end of reporting period.

GOING CONCERN

 PAS 10 prohibits the preparation of financial statements on a going concern basis

if management determines after the reporting period either that it intends to
liquidate the entity or to cease trading, or that it has no realistic alternative but to do
so.
PAS 12 INCOME TAXES

 Prescribes the accounting for income taxes.

 For purposes of PAS 12, income taxes refers to taxes that are based on taxable
profits.
 The income tax expense reported in the statement of comprehensive income may
be different from the amount of income tax required to be paid to the Bureau of
Internal Revenue (BIR).
o This is because the income tax expense in the statement of comprehensive
income is computed using PFRSs while the current tax expense in the
income tax return (ITR) is computed using Philippine tax laws, and the
PFRSs and tax laws have different accounting treatments for some economic
activities.
 Some items are appropriately recognized as income(expense) under financial
reporting but are either:
o Non-taxable (non-deductible)
o Taxable (deductible) only at some other periods under Philippine tax
laws.
  Amount of income tax expense presented in the statement of comprehensive
income.
 Amount of current tax expense to be paid to the BIR.
 Difference to be reconciled in the notes.

ACCOUNTING PROFIT AND TAXABLE PROFIT

 Accounting profit
o Is “profit or loss for a period before deducting tax expense.”
 Taxable profit (tax loss)
o Is “profit (loss) for a period, determined in accordance with the rules
established by the taxation authorities, upon which income taxes are payable
(recoverable).”

Accounting profit or loss Taxable profit (Tax loss)

 Computed using PFRSs  Computed using tax laws
 Total income less total expenses,  Taxable income less tax-deductible
excluding tax expense expenses
 Other terms:  Other terms:
o Pretax income o Taxable income
o Financial income
o Accounting income

INCOME TAX EXPENSE AND CURRENT TAX EXPENSE

 Tax expense or income tax expense (tax income)

o Is the total amount included in the determination of profit or loss for the
period.
o It “comprises current tax expense (current tax income) and deferred tax
expense (deferred tax income).
 Current tax or current tax expense
o Is “the amount of income taxes payable (recoverable) in respect of the
taxable profit (tax loss) for a period.
 Deferred tax expense (income or benefit)
o Is the sum of the net changes in deferred tax assets and deferred tax
liabilities during the period.
 If the increase in deferred tax liability exceeds the increase in
deferred tax assets, the difference is deferred tax expense.
 If the increase in deferred tax asset exceeds the increase in
deferred tax liability, the difference is deferred tax income of
benefit.

 Income tax expense= Current tax expense + Deferred tax expense /

- Deferred tax benefit
 Income tax expense = 300 computed using tax laws – 30 determined using PFRSs =
270 amount presented in the statement of comprehensive income
Or

 In accounting to “squeeze” means:

o To come up with an unknown amount in a given formula by performing
basic arithmetic functions like adding, subtracting, multiplying or
dividing.
 o When squeezing “upwards”, the arithmetic function is simply reversed.
Thus, the amount is 30 which is added when solving downwards is
deducted when “squeezing” upwards.
 The varying treatments of economic activities between the PFRSs and the tax laws
result to following differences:
o Permanent differences
o Temporary differences

PERMANENT DIFFERENCES

 Arise when income and expenses enter in the computation of either accounting
profit or taxable profit but not both.
 If an item is included in the computation of one, it will never enter in the
computation of the other.
 Permanent differences usually arise from non-taxable and non-deductible
expenses and those that have already been subjected to final taxes.
o In other words, these are items excluded from the income tax return.
 Since permanent differences are non-taxable, non-deductible or have already been
taxed under final taxation, they do not have future tax consequences, and hence do
not give rise to deferred tax assets and liabilities.
 Examples of permanent differences:
o Interest income on government bonds and treasury bills
o Interest income on bank deposits
o Dividend income
o Fines, surcharges, and penalties arising from violation of law
o Life insurance premium on employees where the entity is the irrevocable
beneficiary

TEMPORARY DIFFERENCES

 Are “differences between the carrying amount of an asset or liability in the

statement of financial position and its tax base.”
  Temporary differences may be either:
o Taxable temporary differences
 Those that result to future taxable amounts when carrying amount
of the asset or liability is recovered or settled
 Give rise to deferred tax liabilities
o Deductible temporary differences
 Those that result to future deductible amounts when the carrying
amount of the asset or liability is recovered or settled.
 Give rise to deferred tax assets
 Temporary differences have future tax consequences; hence they give rise to either
deferred tax assets or deferred tax liabilities.
 Temporary differences include timing differences.
 Timing differences
o Arise when income and expenses recognized for financial reporting purposes
in one period but are recognized for taxation purposes in another period (or
vice versa).
o They are called “timing differences” because only the timing or period of
their recognition differs between financial reporting and taxation.
o They are temporary differences because their effect reverses in one or more
subsequent periods.

TAXABLE TEMPORARY DIFFERENCES

 Taxable temporary differences arise when:

o Financial income (accounting profit) is greater than the taxable income
(taxable profit);
o The carrying amount of an asset is greater than its tax base; or
o The carrying amount of a liability is less than its tax base.
 Examples of Taxable temporary differences:
o Revenue is recognized in full under financial reporting but is taxable only
when collected.
 o A prepayment is capitalized and amortized to expense under financial
reporting but is tax deductible in full upon payment.
o An asset is revalued upward and no equivalent adjustment is made for tax
purposes.
o Depreciation recognized under financial reporting is lower than the
depreciation recognized for taxation purposes.
 Taxable temporary difference multiplied by the tax rate results to deferred tax
liability.
 Deferred tax liabilities
o Are “the amounts of income taxes payable in future periods in respect of
taxable temporary differences.

DEDUCTIBLE TEMPORARY DIFFERENCES

 Deductible temporary differences arise when:

o Financial income (accounting period) is less than the Taxable income
(taxable profit);
o The carrying amount of an asset is less than its tax base; or
o The carrying amount of a liability is greater than its tax base.
 Examples of Deductible temporary differences:
o Rent received in advance is treated as unearned income (liability) under
financial reporting but is taxable in full upon receipt of cash
o Bad debts expense is recognized for financial reporting when the
collectability of accounts receivable becomes doubtful while it is tax
deductible only when the accounts receivable is a deemed worthless.
o Warranty obligation is recognized as expense when a product is sold under
financial reporting but is tax deductible only when actually paid.
o Depreciation recognized under financial reporting is higher than the
depreciation recognized for taxation purposes.
o Losses and tax credits that can be carried forward and deducted from
future taxable profits.
  Deductible temporary difference multiplied by the tax rate results to deferred tax
asset.
 Deferred tax asset
o Are “the amounts of income taxes recoverable in future periods in respect of:
 deductible temporary differences
 the carryforward of unused tax losses
 the carryforward of unused tax credits
 The recognition of deferred tax assets and liabilities does not alter the amount of
tax to be paid to the BIR in the current period. However, when they reverse in a
future period:
o Deferred tax liability results to a higher amount of tax to be paid to the
BIR.
o Deferred tax asset results to a lower amount of tax to be paid to the BIR

SUMMARY OF CONCEPTS:

Taxable temporary difference Deductible temporary difference

 Financial income greater than taxable
income.
 Carrying amount of asset greater than
tax base.
 If multiplied by the tax rate, it results to
deferred tax liability.
 When it reverses in a future period, it
results to higher tax payment.
 Financial income less than taxable
income.
 Carrying amount of asset less than tax
base.
 If multiplied by the tax rate, it results to
deferred tax asset.
 When it reverse in a future period, it
results to lower tax payment.

ACCOUNTING FOR DEFERRED TAXES

 PAS 12 requires the use of the asset-liability method (also called balance sheet
liability method) in accounting for deferred taxes.
o This method is a comprehensive approach in accounting for deferred taxes in
that it accounts both:
  Timing differences
 Differences between the carrying amounts and tax base of assets
and liabilities
 Timing differences
o Are differences between accounting profit and taxable profit that originate
in one period and reverse in one or more subsequent periods.
 Temporary differences
o Are differences between the carrying amount of an asset or liability in the
statement of financial position and its tax base.
o It includes all timing differences: however, not all temporary differences are
timing differences.
 “The tax base of an asset or liability is the amount attributed to that asset or liability
for tax purposes.”
 Tax base of an asset
o Is “the amount that will be deductible for tax purposes against any taxable
economic benefits that will flow to n entity when it recovers will not be
taxable, the tax base of the asset is equal to its carrying amount.
 Tax base of a liability
o Is “its carrying amount, less any amount that will be deductible for tax
purposes in respect of that liability in future periods.
o In the case of revenue which is received in advance, the tax base of the
resulting liability is its carrying amount, less any amount of the revenue that
will not be taxable in future periods.

Examples:

1. An asset has a carrying amount of 1,000 and tax base of 400.

Analysis:
  The difference of 600 (1,000-400) is a taxable temporary difference, i.e.,
carrying amount of an asset greater than its tax base. If the tax rate is 30%,
the deferred tax liability is 180 (600 x 30%).
2. Entity A has dividends receivable with carrying amount of 1,000. The dividends are
not taxable.

Analysis:

 Since the dividends are not taxable, the tax base is equal to the carrying
amount of 1,000.
 No temporary difference or deferred tax arises from the dividends, i.e., 1,000
carrying amount- 1,000 tax base= 0 difference
3. Entity A has accounts receivable with carrying amount of 1,000. The receivable is
taxable only when collected.

Analysis:

 Since the carrying amount is taxable in full when collected, the tax base is
zero.
 The difference of 1,000 (1,000 carrying amount- 0 tax base) is a taxable
temporary difference.
 If the tax rate is 30%, the deferred tax liability is 300 (1,000 x 30%).

RECOGNITION

 The fundamental principle under PAS 12 is that “ an entity shall, with certain
limited exceptions, recognized a deferred tax liability (asset) whenever recovery or
settlement of the carrying amount of an asset or liability would make future
tax payments larger (smaller) than they would be if such recovery or settlement
were to have no tax consequences.”
 Deferred tax liability
o is recognized for all taxable temporary differences, except those that arise
from the following:
 Initial recognition of goodwill
  Initial recognition of an asset or liability in a transaction which is not a
business combination and, at the time of the transaction, affects
neither accounting profit nor taxable profit (tax loss).
 Investments in subsidiaries, branches, and associates, and interests
in joint arrangements to the extent that the entity is able to control the
timing of the reversal of the differences and it is probable that the
reversal will not occur in the foreseeable future.
 Deferred tax asset
o Is recognized for all deductible temporary differences, including unused
tax losses and unused tax credits, to the extent that it is probable that taxable
profit will be available against which the deductible temporary difference can
be utilized, unless the deferred tax asset arises from the initial recognition of
an asset or liability in a transaction that is not a business combination and, at
the time of the transaction, affects neither accounting profit nor taxable profit
(tax loss).

Limitation on the recognition of deferred tax asset

 A deferred tax asset reduces the tax payment when it reverses in a future period.
 However, an entity can benefit from this reduction only if it earns sufficient taxable
profit against which the reduction can be applied.
 Accordingly, PAS 12 permits an entity to recognized deferred tax assets only when it
is probable that taxable profits will be available against which the deductible
temporary differences can be utilized or there is sufficient taxable temporary
differences that are expected to reverse in the same period that the deductible
temporary differences are expected to reverse.
 When it is not probable that a deferred tax asset will be realized, it is either:
o Not recognized; or
o Reduced to its realizable value, which is appropriate.
 The reduction in deferred tax asset increases income tax expense but does not
affect current tax expense.
MEASUREMENT

 Deferred tax assets and liabilities

o Are measured at the tax rates that are expected to apply to the period of their
reversal, based on tax rates that have been substantively enacted by the end
of the reporting period.
 PAS 12 prohibits the discounting of deferred tax assets and liabilities.
 Illustration:
o Entity A has a taxable temporary difference of 2,000 in Year 1. The difference
is expected to reverse as follows: 1,000 in Year 2 and 1,000 in Year 3. The tax
rate in Year 1 is 30%. However, by the end of Year 1, a tax law is enacted
which requires tax rates of 32% in Year 2 and 35% in Year 3 and in
succeeding years.
 Entity A recognized a deferred tax liability of 670 at the end of Year 1,
computed as follows: [(1,000 x 32%) + (1,000 x 35%]

PRESENTATION IN THE STATEMENT OF FINANCIAL POSITION

 Deferred tax assets and deferred tax liabilities are presented separately as
noncurrent assets and noncurrent liabilities, respectively, in a classified
statement of financial position.
 Pas 12 permits offsetting of deferred tax assets and deferred tax liabilities only
if:
o The entity has a legally enforceable right to offset current tax assets against
current tax liabilities; and
o The deferred tax assets and the deferred tax liabilities relate to income taxes
levied by the same taxation authority.

ACCOUNTING FOR CURRENT TAXES

 An entity uses relevant tax laws in computing for its current taxes.
 Unpaid current taxes are recognized as current tax liability, e.g., income tax
payable.
  Excess tax payments over the current tax due are recognized as current tax asset,
e.g., prepaid income tax.
 Pas 12 permits offsetting of current tax assets and current tax liabilities only if
the entity has:
o A legally enforceable right to offset the recognized amounts; and
o An intention to settle/ realize the recognized amounts on a net basis or
simultaneously.

PRESENTATION IN STATEMENT OF COMPREHENSIVE INCOME

 Tax consequences
o Are accounted for in the same way as the related transactions or events.
o Thus, if a transaction is recognized in profit or loss, its tax effect is also
recognized in profit or loss.
o If a transaction is recognized outside profit or loss, the tax effect is also
recognized outside profit or loss (e.g., in other comprehensive income or
directly in equity).
 Current and deferred taxes are usually recognized in profit or loss. The following
are examples taxes that are recognized outside of profit or loss:
o Taxes recognized in other comprehensive income:
 Revaluation of property, plant and equipment.
 Exchange differences arising on the translation of the financial
statements of a foreign operation.
o Taxes recognized directly in equity:
 Adjustment to the opening balance of retained earnings resulting from
a change in accounting policy or correction of a prior-period
error.
 Amounts arising on initial recognition of the equity component of a
compound financial instrument.
 A tax effect that is recognized directly in equity is accounted for as a direct
adjustment to the related component of equity, e.g., retained earnings or share
 premium, rather than presented in the profit or loss or other comprehensive income
sections of the statement of comprehensive income.

SUMMARY:

 The varying treatments of economic activities between the PFRSs and tax laws result
to permanent and temporary differences.
 Permanent differences
o Are those that do not have future tax consequences.
 Temporary differences are either:
o Taxable temporary differences
 Arise when financial income is greater than taxable income or the
carrying amount of an asset is greater than its tax base.
 Result to deferred tax liabilities
o Deductible temporary differences
 Arise in case of the opposites of the foregoing.
 Result to deferred tax assets.
 If the increase in deferred tax liability exceeds the increase in deferred tax asset,
the difference is deferred tax income or benefit.
 Income tax expense (benefit)
o Is computed using PFRSs.
o It comprises current tax expense and deferred tax expense(income or
benefit).
 Current tax expense
o Is computed using tax laws.
 Deferred tax asset
o Is recognized only to the extent that it is realizable.
 Deferred taxes
o Are measured using enacted or substantially enacted tax rates that are
applicable to the periods of their expected reversals.
 Deferred tax assets and liabilities are not discounted.
  In the statement of financial position, current tax assets and liabilities are
presented separately as current items while deferred tax assets and liabilities
are presented separately as noncurrent items.
 Tax consequences
o Are recognized either in profit or loss, other comprehensive income, or
directly in equity depending on the accounting treatment of the related
transaction or event.

PAS 16 PROPERTY, PLANT AND EQUIPMENT

 Prescribes the accounting treatment for property, plant and equipment (PPE).
 It addresses the principal issues of recognition as assets, measurement of carrying
amount and recognition of depreciation charger.
 PAS 16 applied to all items of PPE except to the following for which other standards
apply:
a. Assets classified as held for sale (PFRS 5 Non-current Assets Held for Sale
and discontinued Operations)
b. Biological assets other than bearer plants but it does not apply to the
produce on bearer plants
c. The recognition and measurement of exploration and evaluation assets
(PFRS 6 Exploration for and Evaluation of Mineral Resources)
d. Mineral rights and mineral reserves such as oil, natural gas and similar non-
regenerative resources
 However, PAS 16 applies to PPE used to develop or maintain the assets described in
(B) – (D).

PROPERTY, PLANT AND EQUIPEMNT (PPE)

Property, plant and equipment are:

 Tangible assets
o Have physical substance
  Used in business
o Used in the production or supply of goods or services, for rental or for
administrative purposes); and
 Long-term in nature
o Expected to be used for more than one period

Examples of PPE:

 Land used in business

 Land held for future plant site
 Building used in business
 Equipment used in the production of goods
 Equipment held for environmental and safety reasons
 Equipment held for rentals
 Major spare parts and long-lived stand-by-equipment
 Furniture and fixture
 Bearer plants

The following are not PPE:

 Land held for speculation

 Land held for an undetermined future use
 Land and/ or building classified as investment property under PAS 40 Investment
Property
 Property held for sale in the ordinary course of business
 Assets classified as held for sale under PFRS 5
 Biological assets relate to agricultural activity, other than bearer plants
 Intangible assets
 Minor spare parts and short-lived stand-by equipment

RECOGNITION

 An item of PPE is recognized if:

 o It is probable that future economic benefits associated with the item will flow to
the entity; and
o The cost of the item can be measured reliably
 Spare parts, stand-by equipment and servicing equipment are recognized as
PPE if they meet the definition of PPE (i.e., they are expected to be used for more
than one period); otherwise, they are classified as inventory.
 Safety and environmental equipment are usually recognized as PPE because,
although they do not directly increase the future economic benefits of other existing
assets, they are necessary in obtaining the future economic benefits from other
assets.
o For example, a factory may be required to install safety and environmental
equipment by the government, non-compliance may result to the factory
being shut down.

INITIAL MEASUREMENT

An item of PPE is initially measured at cost. Cost comprises the following:

 Purchase price, including import duties, nonrefundable purchase taxes, less trade
discounts and rebates.
 Direct costs of bringing the asset to the location and condition necessary for it to be
used in the manner intended by management.
 Initial estimate of dismantlement, removal and site restoration costs for which the
entity incurs an obligation by acquiring oor using the asset other than to produce
inventories,

Examples of directly attributable costs:

 Costs of employee benefits arising directly from the construction or acquisition of

PPE
 Costs of site preparation
 Initial delivery and handing costs (e.g., freight costs)
 Installation and assembly costs
  Testing costs, net of disposal proceeds of samples generated during testing; and
 Professional fees

Examples of costs that are expensed outright:

 Costs of opening a new facility.

 Costs of introducing a new product or service (including costs of advertising and
promotional activities).
 Costs of conducting business in a new location or with a new class of customers
(including costs of staff training).
 Administration and other general overhead costs.

Illustration:

 Entity A acquires equipment on January 1, 20x1. Information on costs is as follows:

Purchase price, gross of trade discount 1,000,000

Trade discount available 10,000

Freight costs 20,000

Testing costs 30,000

Net disposal proceeds of samples generated

during testing 5,000

Presented value of estimated costs of dismantling

the equipment at the end of its useful life 6,209

 The initial cost of the equipment is computed as follows:

Purchase price, gross of trade discount 1,000,000

Freight costs 20,000

Testing costs 30,000

Net disposal proceeds of samples generated

during testing (5,000)

Presented value of estimated costs of dismantling

the equipment at the end of its useful life 6,209

Initial measurement 1,041,209

INCIDENTAL OPERATIONS

 Incidental operations before or during the construction of a PPE are not necessary
in bringing the PPE to the location and condition necessary for it to be capable of
operating in the manner intended by managements.
 Accordingly, income and related expenses of incidental operations are recognized in
profit or loss, and hence do not affect the measurement of cost of a PPE.
o For example, a vacant lot may be temporarily used as parking space before or
during the construction of a building. The income and the related expenses
from the parking space are recognized in profit or loss.

SELF-CONSTRUCTED ASSETS

 “The cost of a self-constructed asset is determined using the same principles as for
an acquired asset.”
 Accordingly, the cost of a self-constructed asset excludes internal profits (e.g.,
savings on self-construction) and the cost of abnormal amounts of wasted
material, labor, or other resources incurred in self-constructing the asset.

BEARER PLANTS

 A bearer plant is a living plant that:

o Is used in the production or supply of agricultural produce;
o Is expected to bear produce for more than one period; and
 o Has a remote likelihood of being sold as agricultural produce, except for
incidental scrap sales.
 Bearer plants
o Are accounted for similar to self-constructed assets
o PAS 16 uses the term ‘construction’ to include activities that are necessary
to cultivate the bearer plants before they are in the location and condition
necessary to be capable of operating in the manner intended by management.

MEASUREMENT OF COST

 Cost is measured at the cash price equivalent at the acquisition date.

 If payment is deferred beyond normal credit terms, the difference between the cash
price equivalent and the total payment is recognized as interest over the credit
period.
 The cost of PPE acquired through an exchange of monetary assets is measured
using the following order of priority”
o Fair value of the asset given up
o Fair value of the asset received
o Carrying amount of the asset given up
 If the exchange lacks commercial substance, the PPE acquired is measured at the
carrying amount of the asset given up.

SUBSEQUENT EXPENDITURES ON RECOGNIZED PPE

 Capitalization of costs ceases when the PPE is in the location and condition
necessary for it to be capable of operating in the manner intended by management.
 Therefore, costs incurred in using or redeploying a PPE are not capitalized.
 The following subsequent expenditures on PPE are recognized as expenses:
o Costs of day-to-day servicing of a PPE (i.e., repairs and maintenance
expense).
 o Costs incurred while an item capable of operating in the manner intended by
management has yet to be brought into use or is operated at less than full
capacity.
o Initial operating losses.
o Costs of relocating or reorganizing part or all of the entity’s operations.
 An entity uses the recognition criteria when determining whether subsequent
expenditures can be capitalized.
 PAS 16 specifically addresses the capitalization of the following subsequent
expenditures:
o Replacement cost
 Some PPE have parts that need to be replaced, e.g., the seats in an
aircraft.
 The cost of replacing a part of an item of PPE is capitalized if the
recognition criteria are met.
 The carrying amount of the replaced part (old part) is derecognized
and charged as loss, regardless of whether it had been depreciated
separately or not.
 If the carrying amount of the replaced part cannot be determined,
the cost of the replacement part (new part) is used as an indication of
what the cost of the replaced part was at the time it was acquired or
constructed.
o Major inspections
 Some PPE require regular major inspections as condition for their
continued operation.
 For example, a cruise ship may not be permitted to continue
sailing without inspection.
 Major inspections are accounted for similar replacement costs, i.e.,
the cost of a major inspection is capitalized while the carrying
amount of the previous inspection is derecognized.

SUBSEQUENT MEASUREMENT
  After initial recognition, an entity chooses either the cost model or the revaluation
model as its accounting policy and applies that policy to an entire class of PPE.

COST MODEL

 Under the cost model, a PPE is carried at its cost less any accumulated
depreciation and any accumulated impairment losses.
 Cost
o Is “the amount of cash or cash equivalents paid or the fair value of the other
consideration given to acquire an asset at the time of its acquisition or
construction or, where applicable, the amount attributed to that asset when
initially recognized in accordance with the specific requirements of other
PFRSs.”

DEPRECIATION

 Depreciation
o Is “the systematic allocation of the depreciable amount of an asset over its
useful life.”
 Depreciable amount
o Is “the cost of an asset, or other amount substituted for cost, less its residual
value.”
 Residual value
o Is “the estimated amount that an entity would currently obtain from disposal
of the asset, after deducting the estimated costs of disposal, if the asset were
already of the age and in the condition expected at the end of its useful life.”
 Useful life is:
o The period over which an asset is expected to be available for use by an
entity; or
o The number of production or similar units expected to be obtained from the
asset by an entity.
 Each significant part of an item of PPE is depreciated separately.
 o For example, the engines and airframe of an aircraft are depreciated
separately.
 Depreciation is recognized as expense (in profit or loss) unless it is included in the
cost of producing another asset.
o For example, the depreciation of a factory building is included in the cost if
inventories.
 Depreciation starts when the asset is available for use, in the manner intended by
management.
 Depreciation stops when the asset is:
o Derecognized (i.e., sold or disposed of)
o Classified as held for sale under PFRS 5; or
o Fully depreciated. An asset is fully depreciated when its carrying amount is
zero or equal to its residual value. However, if the residual value decreases
below the carrying amount, the decrease is recognized as an additional
depreciation.
 Carrying amount
o Is “the amount at which an asset is recognized after deducting any
accumulated depreciation and accumulated impairment losses.”
 Depreciation does not cease when the asset becomes idle or is retired from active
use.
 Land and buildings are accounted for separately even when they are acquired
together.
 Land is not depreciated because it has an unlimited useful life (with certain
exceptions, such as quarries and landfill sites).
 Buildings are depreciated because they have limited useful life.

DEPRECIATION METHOD

 There are a variety of depreciation methods. PAS 16 mentions three examples,

namely:
o Straight-line method
 o Diminishing balance
o Units of production method
 However, PAS 16 does not prescribe any specific method. The choice of depreciation
method depends on management’s judgment.
 When making the judgment, PAS 16 requires management to choose the method
that best reflects the expected pattern of consumption of the future economic
benefits embodied in the asset and to apply that method consistently from period
to period unless there is a change in the expected pattern of consumption of those
future economic benefits.
 PAS 16, however, prohibits the use of depreciation method that is based on
revenue.
 Revenue generally reflects factors other than the consumption of the economic
benefits of the asset.
o For example, revenue is affected by selling activities, changes in sales
volumes and prices, inflation, and other inputs and process.
 All of which have no bearing on the way the future economic benefits of an asset are
consumed.
 PAS 16 requires an annual review of the depreciation method and the estimates of
useful life and residual value at each year-end. Any change is accounted for as a
change in accounting estimate.
 The most commonly used depreciation method is the straight-line method.

Illustration: Straight-line method of depreciation

On January 1, 20x1, Entity A acquires equipment for a total cost of 1,000,000. The
equipment is estimated to have a useful life of 5 years and a residual value of 50,000.

 The annual depreciation is computed as follows:

Cost 1,000,000

Less: Residual value (50,000)

Depreciable amount 950,000

Divided by: Useful life 5

Annual depreciation 190,000

 The carrying amount of the equipment at the end of 20x1 is computed as follows:

Cost 1,000,000

Accumulated depreciation (190,000 x 1 yr.) (190,000)

Carrying amount 810,000

Entity A recognized depreciation of 190,000 per year during the 5-year life of the
equipment. The carrying amount of the asset at December 31,20x5, when the asset is fully
depreciated, would be 50,000, equal to the residual value or [1M cost-(190K x 5 yrs.)].

REVALUATION MODEL

 Under the revaluation model, a PPE is carried at its fair value at the date of the
revaluation less any subsequent accumulated depreciation and subsequent
accumulated impairment losses.
 Fair value
o Is “the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date.”
 The frequency of revaluation depends on the significance of changes in fair values.
 Assets whose fair values fluctuate significantly may need to be revalued annually.
 Assets whose fair values do not fluctuate significantly may be revalued every three
or five years.
 Revaluations are applied to an entire class of PPE. A class of PPE is a grouping of
assets with similar nature. The following are examples of separate classes:
o Land
o Land and building
 o Machinery ships
o Aircraft
o Motor vehicles
o Furniture and fixtures
o Office equipment; and
o Bearer plants
 For example, if an entity revalues a bearer plant, it must revalue all of its bearer
plants.
 Moreover, all the bearer plants are revalued simultaneously to avoid selective
revaluation.
 If simultaneous revaluation is not possible, the revaluation may be carried out on a
rolling basis (i.e., one asset after another) provided the revaluation of all the
assets within a class is competed within a short period.

ACCOUNTING FOR REVALUATIONS

 An increase or decrease in the carrying amount of a PPE resulting from revaluation

is recognized in other comprehensive income and accumulated in equity under
the “Revaluation surplus” account, except for the following:
o An increase that represents a reversal of a previous impairment loss is
recognized in profit or loss as impairment gain.
o A decrease in excess of the credit balance in the “Revaluation surplus” of
the asset is recognized in profit or loss as impairment loss.
 The revaluation increase or decrease is computed using the following formula:
o Fair value * xx
Less: Carrying amount (xx)
Revaluation surplus xx
 The fair value is determined using an appropriate valuation technique in
accordance with PFRS 13 Fair Value Measurement.

Illustration:
On December 31, 20x1, Entity A determines that its building with historical cost of
20,000,000 and accumulated depreciation of 5,000,000 has a fair value of 17,000,000.

 The revaluation surplus is computed as follows:

o Fair value 17,000,000
Less: Carrying amount (20,000,000-5,000,000) (15,000,000)
Revaluation surplus 2,000,000

DEPRECIATION

 After revaluation, a revalued asset is depreciated based on its fair value

Illustration:

Continuing the illustration above, assume that the building has a remaining useful life of 10
years with no residual value. The annual depreciation in subsequent periods using the
straight-line method is computed as follows:

 Fair value 17,000,000

Divide by: Remaining useful life 10
Annual depreciation 1,700,000

SUBSEQUENT ACCOUNTING FOR REVAULATION SURPLUS

 Revaluation surplus is subsequently accounted for as follows:

o If the revalued asset is non-depreciable, e.g., land, the whole of the
revaluation surplus is transferred directly to retained earnings when the
asset is derecognized.
o If the revalued asset is depreciable, a portion of the revaluation surplus may
be transferred directly to retained earnings as the asset is used. The portion
transferred each year is equal to the difference between the depreciation
based on the revalued carrying amount and the depreciation based on the
original cost.
 Transfers from revaluation surplus to retained earnings are not made through
profit or loss.
Illustration:

Continuing again the illustration above, the amount of revaluations surplus to be

transferred directly to retained earning each year as the asset is used is computed as
follows:

 Depreciation based on revalued carrying amount

(17M fair value/10) 1,700,000
Depreciation based on original cost
(15M carrying amount/10) (1,500,000)
Amount of revaluation surplus transferred
to retained earnings each year 200,000
 Alternative solution:
o (2,000,0000 revaluation surplus/10 years)= 200,000

As mentioned earlier, revaluation increases and decreases are recognized on other

comprehensive income and accumulated in equity unless they represent impairment gain
or impairment loss. These concepts are illustrated below.

Illustration:

On December 31, 20x1, Entity A acquires a piece of land for 1,000,000. Entity A revalues the
land to fair value o the following dates:

12/31/x2 12/31/x3 12/31/x4

Fair value 800,000 1,300,000 900,000

 The revaluation decrease on December 31, 20x2 represents impairment loss

because the carrying mount of the asset is decreased below its original cost.

Fair value-12/31/20x2 800,000

Less: Carrying amount (original cost) (1,000,000)

Impairment loss 200,000

 The impairment loss is recognized in profit or loss rather than in other

comprehensive income.
 The revaluation increase on December 31, 20x3 is partly impairment gain and partly
revaluation surplus.

Fair value-12/31/20x3 1,300,000

Less: Carrying amount (fair value on 12/31/20x2) (800,000)

Total increase 500,000

Impairment gain (reversal of the 20x2 impairment loss) (200,000)

Revaluation surplus 300,000

 The impairment gain of 200,000 is recognized in profit or loss while the 300,000
revaluation surplus is recognized in other comprehensive income and
accumulated in equity.
 The revaluation decrease in December 31, 20x4 is partly a decrease in revaluation

surplus and an impairment loss.

 The decrease in revaluation surplus is recognized in other comprehensive income
while the impairment loss is recognized in profit or loss.
Fair value-12/31/20x4 900,000

Less: Carrying amount (fair value on 12/31/20x3) (1,300,000)

Total decrease (400,000)

Decrease in revaluation surplus 300,000

Impairment loss (100,000)

DERECOGNITION

 Is the opposite of recognition.

 Refers to the removal of a previously recognized asset or liability from the entity’s
statement of financial position.
 The carrying amount of a PPE is derecognized when:
o It is disposed (e.g., sold); or
o No future economic benefits are expected from the asset’s use or disposal
 On derecognition, the difference between the carrying amount of the derecognized
PPE and the net disposal proceeds, if any, is recognized as gain or loss in profit or
loss.
 If the asset derecognized is revalued, any balance in the related revaluation surplus
is transferred directly to retained earnings and will not affect the amount of gain or
loss recognized in profit or loss.
Special case:

Some entities, in the ordinary course of their activities, routinely manufacture or acquire
items of PPE to be held for rental to others and subsequently transfer these assets to
inventories when they cease to be rented and become held for sale. For these entities, the
proceeds from the sale of such assets are recognized as revenue.

Illustration:

Entity A sells a machine with carrying amount of 860,000 for 1,000,000. Entity A paid
broker’s commission of 100,000.

 The gain(loss) on the sale is computed as follows:

Net disposal proceeds (1M-100K broker’s commission) 900,000

Carrying amount (860,000)

Gain on sale 40,000

 There is gain because the net selling price exceeds the carrying amount.

DISCLOSURE

General disclosures for each class of PPE:

 The measurement bases used

 The depreciation methods used
 The useful lives or depreciation rates used
 The gross carrying amount and the accumulated depreciation (aggregated with
accumulated impairment losses) at the beginning and end of the period
 A reconciliation of the carrying amount at the beginning and end of the period
showing: addition, disposals, and other changes.

Additional disclosures:

 Restrictions on title and PPE pledged as security for liabilities

  Expenditures to construct PPE during the period
 Contractual commitments for the acquisition of PPE
 Compensation for impairment losses
 Changes in estimates relating to PPE

Disclosures for revalued PPE:

 Date of the revaluation

 Whether an independent value was involved
 The carrying amount of each revalued class of PPE if they had been measured under
the cost model
 Revaluation surplus, including changes during the period and any restrictions on its
distribution to sshareholders.

Encouraged disclosures:

 Carrying amount of temporarily idle PPE

 Gross carrying amount of any fully depreciated PPE that is still is use
 Carrying amount of PPE retired from active use and not classified as held for sale in
accordance with PFRS 5
 When the cost model is used, the fair value of PPE when this is materially different
from the carrying amount

SUMMARY:

 PPE are initially measured at cost. Cost comprised the:

o Purchase price plus non-refundable taxes minus trade and cash discounts
o Direct costs
o Initial estimate of dismantlement, removal and restoration costs
 PPE acquired in an exchange with commercial substance is measured at the:
o Fair value of the asset/ Given up
o Fair value of the asset/ Received
o Carrying amount of the asset/Given up
  If the exchange lacks commercial substance, the PPE acquired is
measured at the carrying amount of the asset given up.
 Recognition of costs in the carrying amount of an item of PPE ceases when the item
is in the location and condition necessary for it to be capable of operating in the
manner intended by management.
 Subsequent to initial recognition, an entity shall choose either the cost model or
the revaluation model as its accounting policy to an entire class of PPE.
 Depreciation is the systematic allocation of the depreciable amount of an asset
over its estimated useful life.
 Changes in depreciation method, useful life or residual value are treated as changes
in accounting estimate.
 Depreciation begins when the asset is available for use and ceases when the asset
is derecognized, classified as held for sale under PFRS 5, or fully depreciated.
 An asset is fully depreciated when its carrying amount is zero or equal to its
residual value.
 Depreciation does not cease when the asset becomes idle or is retired from active
use.
Depreciation (Cost or Fair value-Residual value)
(straight-line method) Useful life
 Revaluation surplus= Fair value less carrying amount
 Gain or loss on disposal= Net disposal proceeds-carrying amount
PAS 19 EMPLOYEE BENEFITS

 PAS 19 prescribes the accounting for employee benefits by employers, except

employee benefits within the scope of PFRS 2 Share-based Payment and resorting
by employee benefit plans to which PAS 26 Accounting and Reporting by
Retirement Benefit Plans applies.
 Employee benefits
o Are “all forms of consideration given by an entity in exchange for service
rendered by employees or for the termination of employment.”
o Can be in any form i.e., cash, goods or services, and may be provided to either
the employees or their dependents.
 Employees include all employees whether regular, part-time or casual, and
regardless of position in the entity. i.e., rank-and-file, director or other management
personnel.

RECOGNITION

 Employee benefits
o Are recognized as expense when employees have rendered service, except
to the extent that the employee benefits from part of the cost of another asset
(e.g., salaries of factory workers are included in the cost of inventories).
o Already earned by employees but not yet paid are recognized as liabilities.
o May arise from:
 contractual agreements (e.g., employment contracts)
 legislations (e.g., Social Security System ‘SSS’ contributions)
 or informal practices that create constructive obligations.
  The following are the four categories of employee benefits under PAS 19:
o Short-term employee benefits
o Post-employment benefits
o Other long-term employee benefits
o Termination benefits

SHORT-TERM EMPLOYEE BENEFITS

 Are those that are due to be settled within 12 months after the end of the period in
which the employees have rendered the related services. Examples include:
o Salaries, wages, and SSS, PhilHealth and Pag-IBIG contributions
o Paid vacation leaves and sick leaves
o Profit-sharing and bonuses
o Non-monetary benefits (e.g., goods or services)

GENERAL ACCOUNTING REQUIREMENTS

 The accounting for short-term employee benefits is generally simple, in the sense
that actuarial valuations are not necessary to measure the obligation or the cost.
 Moreover, short-term employee benefits are not discounted.
 Employee benefits are recognized as expense (or as part of the cost o another asset)
and as an accrued liability, to the extent that they are unpaid, after the employee
has rendered service and become entitled to payment.
 If payments exceed the benefits earned by employees, the excess is recognized as
prepaid asset.
 Short-term employee benefits are recognized periodically. For example,
o Salaries usually paid every 15th and 30th of the month.

SHORT-TERM PAID ABSENCES

 Include:
o Variation
o Holiday (e.g., regular and nonworking holiday)
 o Maternity
o Paternity
o Sick leaves
 Entitlement to paid absences may be either:
o Accumulating
 Those that can be carried forward and used in future periods if not
used in the current period. Accumulating paid absences may be either:
 Vesting
o Unused entitlement are paid in cash when the employee
leaves the entity (i.e., monetized)
 Non-vesting
o Unused entitlements are not monetized.
o Non-accumulating
 Those that expire of nor used in the current period and are not paid in
cash when the employee leaves the entity.
 Compensated absences are recognized as follows:
o Accumulating and vesting
 All unused entitlements are accrued and measured at the expected
amount to be paid when those entitlements are used or monetized in
a future period.
o Accumulating and non-vesting
 Only the unused entitlements that are expected to be utilized accrued,
taking into account the possibility that employees may leave before
they utilized those entitlements.
o Non-accumulating
 Unused entitlements are not accrued but recognized only when the
absences occur.

PROFIT-SHARING AND BONUS PLANS

  Are additional incentives given to eligible employees for a variety of reasons-the
most obvious is to motivate the employees to be more productive.
 Profit sharing and bonuses are recognized when:
o The entity has a present obligation to pay for them; and
o The cost can be measured reliably

POST-EMPLOYMENT BENEFITS

 Are “employee benefits (other than termination benefits and short term benefits)
that are payable after the completion of employment.”
 Examples of post-employment benefits:
o Retirements benefits
 Lump sum payment
 Pensions
o Other post-employment benefits
 Post-employment life insurance; or
 Medical care.
 Are provided to employees through post-employment benefits plans, which are
referred to in various names including “retirement plans” and “pension schemes.”
 Can be a formal arrangement:
o explicitly stated in employment contracts and in the entity’s employee
manual or handbook
 Or it can also be informal arrangement:
o Not documented by employees are entitled to post-employment benefits
based on the employer’s past practice or the minimum requirements of law.
 Post-employment benefit plans can be:
o Contributory or Non-contributory; and
o Funded or Unfunded
 Contributory Non-contributory
 Both the employee and employer  Only the employer contributes to the
contribute to the retirement benefits retirement benefits fund of the
fund of the employee. employee.
Funded Unfunded
 The retirement fund is isolated from  The employer manages any established
the employer’s control and is fund and pays directly the retiring
transferred to a trustee (e.g., employees.
Investment Company) who
undertakes to manage the fund and
pay directly the retiring employees.
 Post-employment benefit plans are either:
o Defined contribution plans; or
o Defined benefit plans

DEFINED CONTRIBUTION PLANS

 Under a defined contribution plan, the employer commits to make fixed

contributions to a fund that will be used to pay for the retirement benefits of the
employees.
 The amount of post-employment benefits to be received by employees depends on
the amount of contributions to the fund together with the investment income
therefrom.
 If the fund balance is less than expected, the employer has no obligation to make
good the deficiency.
  Therefore, the risk that retirement benefits may be insufficient rests with the
employee.

ACCOUNTING FOR DEFINED CONTRIBUTION PLAN

 The accounting for defined contribution plans is straightforward.

 Since the employer’s obligation is limited to the amount that it has agreed to
contribute, it simply recognizes the contribution as expense (unless it forms part of
the cost of another asset) and a liability (if unpaid) when employees have
rendered service during a period.
 The amount of contribution is measured at an undiscounted amount if it is due
within 12 months; if due beyond 12 months, it is discounted.
 Actuarial valuations are not necessary; therefore there are no actuarial gains or
losses.

Illustration:

Under Entity A’s defined contribution plant, it agrees to make fixed annual contributions of
200,000 to a retirement fund for the benefit of its employees.

 Accounting:
o At each year-end, Entity A recognized a fixed retirement benefit cost of
200,000, regardless of whether that amount has actually been contributed
and regardless of whether an employee has actually retired during the
period.
o If the contribution is not yet made, Entity A recognized the retirement
benefit cost as a liability (e.g., accrued payable) measured at an
undiscounted amount (i.e., 200,000) if it is due within 12 months from
year-end.
o If the actual contribution during the period exceeds the fixed amount (for
example, Entity A contributed 230,000) the excess (of 30,000) is accounted
for as a prepaid asset.
 o The fact that an employee has actually retired and was paid his/her
retirement benefits during the period does not affect the accounting above.
o For example, assume that an employee has retired during the period and was
paid 1,000,000 for her retirement benefits.
o The amount of retirement benefits cost that Entity A recognized for the
period is still 200,000, i.e., the agreed amount of contribution.
o If the plan is funded, the trustee is the one who will pay the retiring
employee and not Entity A.

DEFINED BENEFIT PLANS

 Under a defined benefit plan, the employer commits to pay a definite amount of
retirement benefits, which can be determined using a plan formula.
 The amount of promised benefits is independent of any fund balance.
 Accordingly, if the fund proves to be insufficient to pay for the promised benefits, the
employer is obligated to make good the deficiency.
 Therefore, the risk of fund insufficiency rests with the employer.

Defined contribution plan Defined benefit plan

 The employer commits to make fixed
contributions to a fund. The amount of
benefits that an employee will receive us
dependent on the fund balance.
 The risk that the fund may be insufficient 
to meet the expected benefits rests with
the employee.
 The employer commits to pay a definite
amount of retirement benefits. Such
amount is independent of any fund
balance.
The risk that the fund may be insufficient
to pay for the promised benefits rests
with the employer.

Illustration:

Case 1: Entity A agrees to provide post-employment benefits to its employees by making

monthly contribution equal to 10% of employee’s monthly salary to a retirement fund.
Upon retirement, the employee is entitled to any accumulated contributions to the fund
plus any investment income thereon. The employee bears any investment losses.
  Analysis:
o This is a defined contribution plan because the benefits to be received by
the employee are dependent on the contributions to the retirement fund. The
employee bears the risk that benefits will be less than expected.

Case 2: Entity A agrees to provide post-employment benefits to its employees in the form
of a lump sum payment of 2,000,000 upon retirement plus monthly pension, equal to half of
the final monthly salary level, for two years after the retirement date. After the first two
years, monthly benefits will decrease by 105 every year and will cease upon death of the
retired employee.

 Analysis:
o This is a defined benefit plan because the benefits to be received by the
employee are definite amounts and not dependent of contributions to a
retirement fund. The employer bears the risk that the fund set aside will be
deficient of the promised benefits.

Case 3: Upon retirement, the employees of Entity A re entitled to a lump sum payment
equal to half of the final monthly salary level multiplied by the number of years of service.
The minimum service period is 10 years.

 Analysis:
o This is a defined benefit plan because the benefits to be received by the
employee are definite amounts and not dependent of contributions to a
retirement fund. The employer bears the risk that the fund set aside will be
deficient of the promised benefits.

ACCOUTNING FOR DEFINED BENEFITS PLAN

 The employer’s obligation under a defined benefit plan is to provide the agreed
benefits.
 Therefore, the employer bears the risk that the promised benefits will cost more
than expected if actuarial or investment experience is worse than expected.
 In such case, the related obligation may need to be increased.
  Consequently, the accounting for defined benefits plans is complex because
actuarial assumptions are necessary to measure the obligation on a discounted
bases. This results to actuarial gains or losses.
 Also, the retirement benefit cost is not necessarily equal to contribution due for the
period.

The accounting for defined benefit plans involves the following steps:

 Step #1: Determine the deficit or surplus

The deficit or surplus is the difference between the following:
a. Present value of the defined benefit obligation (PV of DBO)
b. Fair value of plan assets (FVPA), if any
o PV of DBO represents the entity’s obligation for the accumulated retirement
benefits earned by employees to date. This is determined using an actuarial
valuation method called the projected unit credit method.
o FVPA represents the balance of any fund set aside for the payment of the
retirement benefits.
o If FVPA is less than PV of DBO, the difference is a deficit.
o If FVPA is greater than PV of DBO, the difference is a surplus.
 Step #2: Determine the Net defined benefit liability (asset)
o The net defined benefit liability or asset is the amount that is presented in
the statement of financial position.
o If there is a deficit, the deficit is a net defined benefit liability.
o If there is a surplus, the net defined benefit asset is the lower of the:
 Surplus, and
 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.”
 Step #3: Determine the Defined Benefit Cost
The defined benefit cost is determined using the formula below:
Recognized in profit or loss
o Service cost: (recognized in P/L)
a. Current service cost xx
b. Past service cost xx
c. Any (gain) or loss on settlement xx xx
o Net interest on the net defined benefit liability (asset): (recognized in
P/L):
a. Interest cost on the defined benefit obligation xx
b. Interest income on plan assets xx
c. Interest on the effect of the asset ceiling xx xx

Recognized in other comprehensive income

o Remeasurements of the net defined liability (asset): (recognized in OCI)

a. Actuarial (gains) and losses) xx
b. Difference between interest income on
plan assets and return on plan assets xx
c. Difference between the interest on the effect
of the asset ceiling and change in the
effect of the asset ceiling xx xx

Total Defined Benefit Cost xx

Service cost:
o Current service cost
 Is the increase in the PV of DBO resulting from employee service in the
current period.
o Past service cost
 Is the change in the PV of DBO for employee service in prior periods
resulting from a plan amendment or curtailment.
o Gain or loss on settlement
  Arises when the employer’s obligation to provide benefits is
eliminated other than form payment of benefits according to the
terms of the plan.

Net interest in the net defined benefit liability (asset)

 Is the change in the net defined benefit liability (asset) during the period that arises
from the passage of time.
 It comprises the three items listed in the formula above.

Remeasurements of the net defined benefit liability (asset):

 Actuarial gains and losses

o Are changes in the PV of DBO resulting from changes in actuarial
assumptions.
o Actuarial assumptions
 Are estimates of variables used in determining the ultimate cost of
providing post-employment benefits. These include:
 Demographic assumptions (e.g., employee turnover rate,
morality or lifespan and health condition)
 Financial assumptions (i.e., discount rate and future salary
levels)
o Discount rate
 Used in measuring defined benefit obligations and costs is based on
high quality corporate bonds.
o PAS 19 encourages, but does not require, involving a qualified actuary in
measuring defined benefit obligations.
 Return on plan assets
o Represents the investment income earned by the plan assets during the year
after deducting the costs of managing the fund and taxes.

Illustration:
Information on Entity A’s defined benefit plan is as follows:

PV of DBO-Jan. 1, 20x1 1,500,000

FVPA-Jan. 1, 20x1 1,200,000

PV of DBO-Dec.31, 20x1 1,800,000

FVPA, end.-Dec. 31, 20x1 1,310,000

Current service cost 325,000

Actuarial gain 100,000

Return on plan assets 110,000

Discount rate 5%

Requirement: Compute for the amounts that will be presented in Entity A’s December 31,
20x1 statement of financial position and statement of comprehensive income.

Solutions:

 Step #1: Determine the deficit or surplus

FVPA, end. Dec. 31, 20x1 1,310,000
PV of DBO- Dec. 31, 20x1 1,800,000
Deficit (490,000)
 Step #2: Determine the Net defined benefit liability (asset)
o The net defined benefit liability is 490,000- the deficit determined in Step
#1. This is presented in the noncurrent liabilities section of Entity A’s
December 31, 20x1 statement of financial position.
o The net defined benefit liability in the preceding year is 300,000 (1.2M FVPA,
beg. – 1.5M PV of DBO, beg.).
 Step #3: Determine the Defined Benefit Cost

Service cost:
 a. Current service cost 325,000
b. Past service cost -
c. Any (gain) or loss on settlement -
325,000

Net interest on the net defined benefit liability (asset):

a. Interest cost on the DBO (1.5M, beg. X 5%) 75,000

b. Interest income on plan assets *1.2M, beg. X 5%) (60,000)
c. Interest on the effect of the asset ceiling -
15,000

Remeasurements of the net defined benefit liability (asset):

1. Actuarial (gains) and losses (100,000)

2. Difference between interest income on plan
assets and return on plan assets
(60,000-110,000) (50,000)
3. Difference between the interest on the effect
of the asset ceiling and change in the effect
of the asset ceiling -
(150,000)

Total Defined Benefit Cost 190,000

 The amount shown in the profit or loss section of the statement of comprehensive
income is 340,000 expense (325,000 service cost + 15,000 net interest on the net
defined benefit liability).
 The amount shown in the other comprehensive income section of the statement of
comprehensive income of 150,000 income, i.e., the total remeasurements of the net
defined benefit liability.
  The net effect on total comprehensive income is 190,000 (340,000 expense -
150,000 income).

MULTI-EMPLOYER PLANS

 Under a multiemployer plan, various unrelated employers contribute to a common

fund that is managed by a trustee to provide post-employment benefits to the
employees of the participating employers.
 Contribution and benefit levels are determined without regard to the identities of
the employers.
 A multiemployer plan is classified as either a defined contribution plan or a
defined benefit plan.

STATE PLANS

 A state plan is one that is established by law and operated by the government.
 It is mandatory for all entities within its scope and is not subject to control or
influence by the entity. Examples include:
o Government Service Insurance System (GSIS), which covers government
employees
o Social Security System (SSS), which covers those in the private sector.
o A state plan is accounted for in the same way as a multiemployer plan, i.e.,
classified as either a defined contribution plan or a defined benefit plan.

Illustration 1: Social Security System (SSS)

Entity A pays monthly SSS contributions as part of its employee retirement benefits. The
retirement benefit plan under the SSS law is described below:

Qualification for retirement benefit:

 The member is 60 years old, separated from employment or ceased to be self-

employed, and has paid at least 120 monthly contributions prior retirement.
 The member is 65 years old whether employed or not and has paid at least 120
monthly contributions prior to retirement.
Types of retirement benefits:

1. Lifetime monthly pension

o For a retiree who has paid at least 120 monthly contributions prior to
retirement.
2. Lump sum amount
o For a retiree who has not paid the required 120 monthly contributions.

Monthly pension:

The monthly pension is based on the contributions paid, credited years of service and the
number of dependent minor children not to exceed five. The amount of monthly pension is
the highest of the following:

1. The sum of 300 plus 20% of the average monthly salary credit plus 2% of the
average monthly salary credit for each credited year of service in excess of ten years;
or
2. 40% of the average monthly salary credit: or
3. 1,200, provided that the credited years of service (CYS) is at least 10 or more but
less than 20 or 2,000, if the CYS is 20 or more. The monthly pension is paid for not
less than 60 months.

A retiree has the option to receive in advance, upon date of eligibility, the first 18 monthly
pension in lump sum discounted at a preferential rate of interest to be determined by the
SSS. The member will receive the monthly pension on the 19th month and every month
thereafter.

If the member retires after age of 60, the monthly pension shall be the higher of the
following:

1. The monthly pension computed at the earliest time the member could have retired,
had been separated from self-employment or ceased to be self-employed plus all
adjustments thereto: or
2. The monthly pension computed at the time when the member actually retires.
  Lump sum
o The lump sum benefit is equal to the total contributions paid by the
member and by the employer including interest.
 Death of retiree:
o Upon the death of the retiree, the primary beneficiaries are entitled to 100%
of the monthly pension, and the dependents to the ‘dependents’ pension.’
o If the retiree dies within 60 months from the commencement of the monthly
pension and has no primary beneficiaries, the secondary beneficiaries are
entitled to a lump sum benefit equivalent to the total monthly pensions
corresponding to the 5-year guaranteed period excluding the ‘dependents’
pension.’

Requirement: Identify whether the retirement benefit plan described above is a defined
contribution plan or defined benefit plan.

 Analysis
o The retirement plan is a state plan- it is established by law and operated by
the government.
o It is a defined contribution plan- Entity a is liable to the employees only for
its share in the monthly SSS contributions.

Illustration 2: R.A. 7641 Retirement Pay Law

Entity A does not have a post-employment benefit plan for its employees. Accordingly,
entity A is subject to the minimum requirements of the law. Republic Act No. 7641
provides the following:

 In the absence of a retirement plan (or its similar) that provides for the employee’s
retirement benefits in the establishment, an employee shall be entitled to an
employee retirement benefit upon reaching the compulsory retirement age.
 The age of sixty (60) years or more, but not beyond sixty-five (65) years is the
considered compulsory retirement age.
  If the employee has served the least of five (5) years in the said establishment,
he/she may retire and enjoy the retirement benefits equivalent of at least one-half
(1/2) month salary for his/her every year of service.
 A fraction of at least six (6) months is considered as one whole year.
 Unless acknowledged by both parties otherwise, one-half (1/2) month salary shall
represent the fifteen (15) working days in addition to the one-twelfth (1/12) for
the mandated 13th month pay.
 This also includes the cash equivalent of not more than five (5) days of paid leaves.

Requirement: Identify whether the retirement benefit plan described above is a defined
contribution plan or defined benefit plan.

 Analysis:
o The retirement plan is not a state plan- although it is promulgated by law, it
is not operated by the government.
o It is a defined benefit plan- Entity A is liable to pay retiring employees the
minimum amount computed in accordance with the provisions of the law.

INSURED BENEFITS

 An employer may pay insurance premiums to fund a post-employment benefit plan.

Such plan is classified as either defined contribution plan or defined benefit
plan.
 It is a defined benefit plan if the employer retains the obligation to either pay
directly the benefits to the employee or make good any deficiency of the insurer fails
to pay in full the benefits.

OTHER LONG-TERM EMPLOYEE BENEFITS

 Are employee benefits (other than post-employment benefits and termination

benefits) that are due to be settled beyond 12 months after the end of the period
in which the employees have rendered the related service. Examples include:
o Long-term compensated absences, e.g., sabbatical leave
o Jubilee or other long-service benefits
 o Long-term disability benefits
o Profit-sharing and bonuses payable beyond 12 months after the end of the
period in which the employees have rendered the related service
o Deferred compensation payable beyond 12 months after the end of the
period in which it is earned.
 Other long-term employee benefits are accounted for similar to defined benefit
plans (see ‘3-step accounting’ above) except that all the components of the defined
benefit cost is recognized in profit or loss, including the remeasurements of the net
defined benefit liability (asset).

TERMINATION BENEFITS

 Termination benefits are those provided as a result of either:

o The entity’s decision to terminate the employee before normal retirement
date; or
o The employee’s decision to accept the employer’s offer of benefits in
exchange for termination.
 Unlike the other types of employee benefits, the obligation to pay termination
benefits arises from the employer’s act of terminating an employee rather than
from employee service.
 Accordingly, benefits resulting from termination at the employee’s request without
the employer’s offers are not termination benefits but rather post-employment
benefits.

RECOGNITION

 Termination benefits are recognized as a liability and expense at the earlier of the
following dates:
o When the entity can no longer withdraw he offer of those benefits; and
o When the entity recognizes restructuring costs under PAS 7 that involve
payment of termination benefits.

MEASUREMENT
  Termination benefits are accounted for in accordance with the nature of the
employee benefit. If the termination benefits are:
o Payable within 12 months, they are accounted for similar to short-term
employee benefits.
o Payable beyond 12 months, they are accounted for similar to other long-
term benefits.
o In substance, enhancement to post-employment benefits, they are accounted
for as post-employment benefits.

SUMMARY:

 Types of employee benefits under PAS 19:

1. Short-term
2. Post-employment
3. Other long-term
4. Termination
 Entitlement to compensated absences is either:
o Accumulating
 Can be carried to future periods if not used.
 Vesting- monetized
 Non-vesting – not monetized
o Non-accumulating
 Forfeited if not used
 Accumulating and vesting
o All unused absences are accrued
 Accumulating and non-vesting
o Only the unused absences expected to be used are accrued
 Non-accumulating
o Not accrued; absences are recognized as expense when they occur.
 Post-employment benefit plans are either:
o Defined contribution plan
 o Defined benefit plan
 The accounting for defined contribution plans is straightforward
o The employer recognizes the agreed foxed amount of contribution as
retirement benefit cost after the end of each period that the employees have
rendered service.
 The accounting for defined benefit plans is complex
o It requires actuarial valuations using the projected unit credit method.
 Steps in the accounting for defined benefit plans:
1. Determine the deficit or surplus
 If FVPA is less than PV of DBO, difference is deficit
 If FVPA is greater than PV of DBO, difference is surplus
2. Determine the net defined benefit liability (asset)
 Net defined benefit liability=deficit
 Net defined benefit asset= lower of surplus and asset ceiling
3. Determine the components of the defined benefit cost to be recognized
in P/L and OCI.
 Other long-term employee benefits
o Are accounted for like defined benefit plans except that all the components of
the defined benefit cost are recognized in profit or loss.
 The obligation to pay termination benefits arises from the employer’s act of
terminating an employee rather than from employee service.

1. Which of the following is an example of a non-adjusting event?

a. Bankruptcy of a major customer with a balance owing at the period end
b. Amounts received in respect of an insurance claim being negotiated at the period
end
c. Destruction of a machine by fire after the reporting period
d. Sale of inventory for less than its carrying value shortly after the reporting
period
2. PAS 8 permits a change in accounting policy only if the change
a. is required by a PFRS.
 b. results in reliable and more relevant information
c. a or b.
d. PAS 8 does not permit a change in accounting policY
3. Which of the following is not one of the essential characteristics of a PPE?
a. used in business
b. primarily held for sale
c. long-term in nature
d. tangible asset
4. During the period, deferred tax assets increase by ₱400 while deferred tax liabilities
increase by ₱500. The net change of ₱100 is a
a. deferred tax expense
b. deferred tax income
c. deferred tax asset
d. deferred tax liability
5. Which of the following is most likely to be a non-adjusting event?
a. The determination after the reporting period of the cost of asset purchased,
or the proceeds from asset sold, before the end of reporting period.
b. A major customer liquidates its business after the end of the reporting
period.
c. The entity announces a major restructuring after the end of the
reporting period.
d. The settlement after the reporting period of a court case that confirms that
the entity has a present obligation at the end of reporting period.
6. If plotted on a graph (X-axis: time; Y-axis: ₱), the depreciation charges under the
straight-line method would show
a. an upward line sloping to the right.
b. a downward line sloping to the left.
c. a straight-line
d. a curvilinear line sloping here and there.
7. How should the following changes be treated, according to PAS 8?
 I. A change is to be made in the method of calculating the provision for
uncollectible receivables.
II. Investment properties are now measured at fair value, having previously
been measured at cost.
a. Change 1 Change 2
Change of accounting policy Change of accounting policy

b. Change 1 Change 2
Change of accounting estimate Change of accounting policy

c. Change 1 Change 2
Change of accounting policy Change of accounting estimate

d. Change 1 Change 2
Change of accounting estimate Change of accounting estimate

8. These are differences that have future tax consequences.

a. Deductible differences
b. Taxable differences
c. Permanent differences
d. Temporary differences
9. Deferred tax assets and deferred tax liabilities do not alter the tax to be paid in the
current period. However, they cause tax payments to either increase or decrease
when they reverse in a future period. The reversal of which of the following will
cause an increase in tax payment?
a. Deferred tax liability
b. Deferred tax expense
c. Deferred tax benefit
d. Deferred tax asset
10. A change in the pattern of consumption of economic benefits from an asset is most
likely a
a. change in accounting policy
b. change in accounting estimate
 c. error
d. any of these
11. This type of difference will give rise to deferred tax liability.
a. Permanent difference
b. Deductible temporary difference
c. Deferred difference
d. Taxable temporary difference
12. According to PAS 16, the selection of an appropriate depreciation method rests upon
the entity’s
a. management
b. accountant
c. regulator
d. all of these
13. These arise from misapplication of accounting policies, mathematical mistakes,
oversights or misinterpretations of facts, or fraud.
a. Change in accounting policy
b. Change in accounting estimate
c. Error
d. Impracticable application

14. PAS 16 requires an entity to review the depreciation method and the estimates of
useful life and residual value at the end of each year-end. A change in any of these is
accounted for using
a. a specific transitional provision of a PFRS.
b. retrospective application.
c. prospective application.
d. any of these.
15. According to PAS 8, these are the specific principles, bases, conventions, rules and
practices applied by an entity in preparing and presenting financial statements.
a. Accounting assumptions
 b. Accounting standards
c. Accounting estimates
d. Accounting policies
16. The Sarin Company's financial statements for the year ended 30 April 20X8 were
approved by its finance director on 7 July 20X8 and a public announcement of its
profit for the year was made on 10 July 20X8. The board of directors authorised the
financial statements for issue on 15 July 20X8 and they were approved by the
shareholders on 20 July 20X8. Under PAS 10, after what date should consideration
no longer be given as to whether the financial statements to 30 April 20X8 need to
reflect adjusting and non-adjusting events?
a. 7 July 20x8
b. 15 July 20x8
c. 10 July 20x8
d. 20 July 20x8
17. At the end of the period, Entity A has taxable temporary difference of ₱100,000.
Entity A’s income tax rate is 30%. Entity A’s statement of financial position would
report which of the following?
a. 30,000 deferred tax liability
b. 30,000 deferred tax asset
c. 30,000 deferred tax expense
d. 30,000 income tax expense
18. According to PAS 10, these are those events, favorable and unfavorable, that occur
between the end of the reporting period and the date when the financial statements
are authorized for issue.
a. Events after the reporting period
b. Non-adjusting events
c. Adjusting events
d. all of these
19. Entity A acquires equipment on January 1, 20x1. Information on costs is as follows:
Purchase price, gross of trade discount 1,000,000
Trade discount available 10,000

Freight costs 20,000

Testing costs 30,000

Net disposal proceeds of samples generated during testing 5,000

Present value of estimated costs of dismantling the

equipment at the end of its useful life 6,209

a. How much is the initial cost of the equipment?

SOLUTIONS:

Purchas price, net of trade discount (1,000,000-10,000) 990,000

Freight costs 20,000

Testing costs 30,000

Net disposal proceeds of samples generated during testing (5,000)

Present value of estimated costs of dismantling the

equipment at the end of its useful life 6,209

INITIAL COST/MEASUREMENT 1,041,209

b. The equipment has an estimated useful life of 10 years and a residual value of
₱200,000. Entity A uses the straight line method of depreciation. How much is the
carrying amount of the equipment on December 31, 20x3?
SOLUTIONS:

Initial cost/ measurement 1,041,209

Less: Residual value (200,000)

Depreciation amount 841,209

Divided by: Useful life 10

DEPRECIATION EXPENSE 84,120.90 or 84,121

Initial cost/ measurement 1,041,209

Less: Accumulated depreciation (84,121 x 3) ( 252,363)

CARRYING AMOUNT 788,846

c. On December 31, 20x3, Entity A revalues the equipment at a fair value of ₱820,000.
There is no change in the residual value and the remaining useful life of the asset.
How much is the revaluation surplus on December 31, 20x3?
SOLUTIONS:

Fair value 820,000

Less: Carrying amount (788,846)

REVALUATION SURPLUS 31,154

d. How much is the depreciation expense in 20x4?

SOLUTIONS:

Fair value 820,000

Less: Residual value (200,000)

Depreciate amount 620,000

Divide: Remaining useful life (10-3) 7

REVALUATION SURPLUS 88,571

e. Entity A sells the equipment for ₱870,000 on January 1, 20x5. Entity A incurs selling
costs of ₱20,000 on the sale. How much is the gain (loss) on the sale?
SOLUTIONS:
Net disposal proceeds (870,000-20,000) 830,000

Less: Carrying amount(FV on preceding year)(820,000-88,571)(731,429)

GAIN ON SALE 118,571

20. Which of the following instances does not preclude an entity from recognizing
depreciation during a certain period?
a. The asset is classified as held for sale under PFRS 5.
b. The asset is fully depreciated.
c. The asset becomes idle or is taken out of active use.
d. The asset is being depreciated using the units of production method and
there is no production during the period.
21. One of Entity A’s delivery trucks had an accident on February 14, 20x2. The truck is
totally wrecked and is uninsured. Entity A’s December 31, 20x1 current-period
financial statements were authorized for issue on March 31, 20x2. Entity A asked
you if it can write-off the carrying amount of the destroyed truck from its December
31, 20x1 statement of financial position. What will you tell Entity A?
a. Yes, go ahead. Write-off the truck because the event is an adjusting event.
b. No. Don’t write-off the truck because the event is a non-adjusting event.
You should, however, disclose the event if you deem it to be material.
c. No. Don’t write-off the truck because the event is a non-adjusting event.
d. Yes, go ahead. I will support you.
PAS 20 ACCOUNTING FOR GOVERNMENT GRANTS AND DISCLOSUE OF GOVERNMENT
ASSISTANCE

INTRODUCTION

 Prescribes the accounting and disclosure of government grants and the disclosure of
other forms of government assistance.

PAS 20 does not apply to:

a. Accounting for government grants under hyperinflationary economies

b. Tax benefits such as income tax holidays, investment tax credits, accelerated
depreciation allowances and reduced income tax rates
c. Government participation in the ownership of the entity
d. Government grants covered by PAS 41 Agriculture

GOVERNMENT GRANTS

 Sometimes called subsidies, subventions, or premiums are assistance received

from the government in the form of transfers of resources in exchange for
compliance with certain conditions. Examples of government grants:
o Receipt of cash, land, or other non-cash assets from the government subject
to compliance with certain conditions
o Receipt of financial aid in case of loss from a calamity
o Forgiveness of an existing loan from the government
o Benefit of a government loan with below-market rate of interest
 Only government assistance that meet the asset recognition criteria are recognized
as government grants.
  Accordingly, government grants exclude government assistance whose value
cannot be reasonably measured or cannot be distinguished from the entity’s
normal trading transactions.
 The following are forms of government assistance but are not government grants:
o Tax benefits
o Free technical or marketing advice
o Provision of guarantees
o Government procurement policy that is responsible for a portion of the
entity’s sales
 If significant, these are disclosed but not recognized as government grants.
 The following are not government assistance and therefore are neither disclosed
nor recognized:
o Public improvements that benefit the entire community
o Imposition of trading constraints on competitors
 PAS 20 provides the following reasons why the receipt of government assistance
may be significant in the preparation of the financial statements:
o If the resources are received, an appropriate accounting method is necessary
to account for the receipt; and
o The indication of the extent to which the entity has benefited from the
assistance during the period improves the comparability of its financial
statements.

RECOGNITION

 Government grants are recognized if there is reasonable assurance that:

o The attached conditions will be complied with; an
o The grants will be received
 The mere receipt of a grant is not conclusive evidence that the attached condition
has been or will be satisfied.

TYPES OF GOVERNEMNT GRANTS ACCORDING TO ATTACHED CONDITION

 1. Grants related to assets
 Grants whose primary condition is that the recipient entity should acquire
or construct long-term assets. Examples:
o Cash is received from the government with the condition that the
amount should be used to acquire equipment
o Land is received from the government with the condition that
abuilding should be constructed on it
 Grants related to income
o Grants other than those related to assets.

MEASUREMENT

Monetary grants Non-monetary grants

(e.g., land and other resources)
a. Amount of cash received a. Fair value of the non-monetary asset
b. Fair value of amount receivable received
b. Alternatively, at nominal amount

 Fair value
o Is the “the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date.
 Government grants may also be in the form of loan, such as:
o Forgivable loan
 A loan that the lender (government) waives repayment subject to
certain conditions
 Is measured at the carrying amount of the loan forgiven.
o Loan at below-market rate of interest or zero-interest
 The benefit of a loan at below-market rate of interest or zero-
interest is measured as the difference between the initial carrying
 amount of the loan determined in accordance with PFRS 9 Financial
Instruments and the proceeds received.

APPROACHES TO THE ACCOUNTING FOR GOVERNEMNT GRANTS

Capital approach Income approach

 Grants is recognized outside profit or  Grant is recognized in profit or loss
loss in equity over one or more periods

 PAS 20 uses the income approach. The capital approach is used only when
donations are received from shareholders.

ACCOUNTING FOR GOVERNMENT GRANTS

 Government grants
o Are “recognized in profit or loss on a systematic basis over the periods in
which the entity recognizes as expenses the related costs for which the grants
are intended to compensate.”
 Simply stated, the accounting for government grants uses a ‘matching’ concept
such that, if the related expense is not yet recognized, income from government
grants is also not yet recognized. Accordingly:
o Grants related to depreciable assets
 Are “recognized in profit or loss over the periods and in the
proportions in which depreciation expense on those assets is
recognized.”
o Grants related to non-depreciable assets
 Are recognized in profit or loss when the costs of fulfilling the
attached condition are incurred.
 For example, a grant of land conditioned on the construction of a
building on it is recognized over the periods that the constructed
building is depreciated.
 o Grants received as financial aid for expenses or losses already incurred are
recognized immediately in profit or loss when the grant becomes
receivable (because the related costs have already been expensed).
 Recognizing government grants in profit or loss on a receipts basis (e.g., cash basis)
is prohibited as it violates the accrual basis of accounting.
 A receipt basis would only be acceptable if there is no allocation basis other than
the one in which the grant was received.

Illustration 1: Grant related to depreciable asset

On January 1, 20x1, Entity A receives 1,000,000 cash as government grant conditioned on

the acquisition of equipment. Entity A acquires the equipment on January 1, 20x2 for
3,000,000.

Accounting:

Entity A recognizes income from the government grant as it depreciates the equipment.
Assume the equipment is depreciated using the straight-line method over a useful life of 5
years with no residual value. Income from the government grant is determined as follows:

Depreciation expense Income from gov’t. grant

1/1/20x1 -
1/1/20x2 -
12/31/20x3 600,000 (a) 200,000 (b)
12/31/20x3 600,000 200,000
…… and so on
(a)
Depreciation expense= Cost of equipment/ years

=3,000,000/5

= 600,000

(b)
Income from government grant = Cash grant/ years

=1,000,000/5

= 200,000
  Notice that even on January 1, 20x2 when the equipment is actually acquired, no
income from the government grants is yet recognized.
 This is because the cost of the equipment is not expensed but rather capitalized as
PPE.
 Grants related to depreciable assets are recognized in profit or loss in the
proportions in which depreciation expense on those assets is recognized.
 Thus, in the illustration above, since depreciation expense is computed using the
straight-line method, income from government grant is also computed using the
straight-line method.
 If in case depreciation expense is computed using some other method, income from
government grants will also be computed using that other method.

Illustration 2: Grant related to non-depreciable asset

On January 1,20x1, Entity a received land from the government with the condition that a
building should be constructed in it. The fair value of the land was 500,000. The
construction of the building was completed on January 1, 20x3 for a total cost of 1,000,000.
The building has a useful life of 10 years and a zero residual value. Entity A uses the
straight-line method.

Accounting:

Since the grant relates to a non-depreciable asset (i.e., land) income from the government
grant will recognized as the related building is depreciated.

Depreciation expense Income from gov’t. grant

1/1/20x1 - -
1/1/20x2 - -
-
12/31/20x3 -
12/31/20x3 100,000 (a) 50,000 (b)
…… and so on
(a)
Depreciation expense= Cost of building/ years

=1,000,000/5

= 100,000
(b)
Income from government grant = Fair value of land/ years

=500,000/10

= 50,000

Illustration 3: Grant received as compensation for losses incurred

A recent typhoon caused 40,000,000 in damages to Entity A’s properties. Accordingly, the
government gave Entity A a financial aid of 10,000,000.

Accounting:

The 10,000,000 grant is recognized immediately in profit or loss because losses for which
grant is intended to compensate were already incurred.

PRESENTATION

Grants related to assets

 Grants related to assets may be presented either by gross presentation or net

presentation bas follows:

Statement of financial position

Gross presentation Net presentation
 The grants is presented as a deferred  The grant is deducted from the
income (liability) carrying amount of the related asset.
Statement of comprehensive income (profit or loss section)
Gross presentation Net presentation
 The income from the grant is reported  The income form the grant is deducted
separately or included in ‘Other from the depreciation change.
income.’

 However, in the statement of cash flows, the cash flows from the receipt of the
grant and the purchase of the related asset are presented separately, even if the
entity uses the net presentation above.

Grants related to income

  Grants related to income may also be presented either by gross presentation or net
presentation as follows:

Statement of comprehensive income (profit or loss section)

Gross presentation Net presentation
 The income from the grant is reported  The income from the grant is deducted
separately or included in ‘Other from the related expense.
income.’

Illustration 4: Presentation of Grant related to assets

Continuing “Illustration 1: Grant related to depreciable asset’ above, the 1,000,000 grant
will be presented in Entity A’s December 31, 20x2 financial statements as follows:

Statement of financial position

Gross presentation Net presentation
ASSETS ASSETS
Equipment 3,000,000 Equipment (3,000,000-1,000,000) 2,000,000
Less: Accumulated depreciation (600,000) Less: Accumulated depreciation(a) (400,000)
Carrying amount 2,400,000 Carrying amount 1,600,000

LIABILITIES LIABILITIES
Deferred income
(1,000,000-200,000) 800,000

EQUITY (2,400,000-800,000) 1,600,000 EQUITY (1,600,000-0) 1,600,000

Statement of comprehensive income (profit or loss section)
Gross presentation Net presentation
Other income 200,000
Less: Depreciation expense (600,000) Less: Depreciation expense (400,000)
PROFIT/(LOSS) (400,000) PROFIT/(LOSS) (400,000)
(a)
Depreciation expense= Cost of equipment- grant/years

= 3,000,000-1,000,000/5
 = 400,000

 Notice that regardless of the presentation method used, the net effect of the grant on
equity and profit or loss is the same.

Illustration 5: Presentation of Grant related to income

Continuing “Illustration 3: Grant received as compensation for losses incurred’ above, the
10,000,000 grant will be presented in Entity A’s current year financial statements as
follows:

Statement of comprehensive income (profit or loss section)

Gross presentation Net presentation
Other income 10,000,000
Less: Depreciation expense (40,000,000) Loss from typhoon
PROFIT/(LOSS) (30,000,000) (40,000,000 -10,000,000) (30,000,000)
PROFIT/(LOSS) (30,000,000)

REPAYMENT OF GRANTS

 A government grant that becomes repayable, for example, due to failure to satisfy
the attached condition, is treated as a change in accounting estimate and
accounted for prospectively.
 The repayment of a grant related to income is deducted from the related deferred
income balance, if any. Any excess is recognized immediately as in profit or loss.
 The repayment of a grant related asset is treated as a reduction in the deferred
income balance or an increase in the carrying amount of the asset.
 The cumulative additional depreciation that would have been recognized in the
absence of the grant is recognized immediately in profit or loss.
 Following the repayment, the entity may need to consider the possibility of
impairment of the new carrying amount of the asset.

DISCLOSURE

 Accounting policy and method of presentation

  Nature and extent of government grants and other forms of government assistance
from which the entity has directly benefited.
 Unfulfilled conditions and contingencies attached to the government grants

PAS 21 THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES

INTRODUCTION

 Prescribes the accounting for foreign activities and the translation of financial
statements into a presentation currency.
TWO WAYS OF CONDUCTING FOREIGN ACTIVITIES

1. Foreign currency transactions

 E.g., import or export transactions that are to be settled in a foreign currency.
These transactions need to be translated to Philippine pesos before they can
be recorded in the books of accounts.
2. Foreign operations
 E.g., a branch in another country.
 The overseas branch will normally maintain its accounting records and
prepare its financial statements in a foreign currency.
 Those financial statements need to be translated to Philippine persons before
they can be combined with the home office’s financial statements.

TWO MAIN ACCOUNTING ISSUES

 Exchange rates are constantly changing. Therefore , the principal issues in the
accounting for foreign activities are determining:
o Which exchange rate(s) to use
o How to report the effects of changes in exchange rates in the financial
statements.

FUNCTIONAL CURRENCY

 Pas 21 requires an entity to determine and disclose its functional currency, which
is “the currency of the primary economic environment in which the entity operates.”
 Functional currency is the currency in which the entity’s cash inflows and outflows
are normally denominated into and is not necessarily the currency of the country
where the entity is based.
 An entity considers the following factors (in descending order) when determining
its functional currency:
o The currency that mainly influences the entity’s sale prices and costs of
goods or services
 o The currency in which cash flows from financing activities and operating
activities are usually generated and retained.
 Additional factors are considered in determining the functional currency of a
foreign operation, such as whether the foreign operation is essentially an extension
of the entity (and therefore the foreign operation’s functional currency is the same
as that of the entity), the proportion of the foreign operation’s transactions with the
entity, and the nature of the foreign operation’s cash flows in relation to the entity.
 Once determined, the functional currency is not changed unless there is a change in
underlying transactions, events and conditions.
 In such cases, a change in functional currency is accounted fro by translating the
financial statements into the new functional currency prospectively from the date
of change.
 All currencies other than the entity’s functional currency are considered foreign
currencies.

FOREIGN CURRENCY TRANSACTIONS

 Is “a transaction that is denominated or requires settlement in a foreign currency.”

Examples:
o Purchase or sale of goods
o Services or other assets at a price that is denominated in a foreign currency
o Borrowing, lending or settling receivables or payables at amounts that are
denominated in a foreign currency

INITIAL RECOGNITION

 A foreign currency transaction is initially recognized by translating the foreign

currency amount into the functional currency using the spot exchange rate at the
date of the transaction.
o Spot exchange rate
 Is “the exchange rate for immediate delivery.”
 Or simply, the currency exchange rate on a given date.
 o Date of a transaction
 Is “the date on which the transaction first qualifies for recognition in
accordance with PFRSs.”
 For example: goods, acquired for $100 are initially recognized by translating the
$100 into pesos using the spot exchange rate on the date of acquisition.
 For practical reasons, an average rate (e.g., for a week or a month) may be used for
all transactions occurring during that period. However, if exchange rates fluctuate
significantly, the use of the average rate for a period is inappropriate.

SUBSEQUENT MEASUREMENT

At each reporting date, the following items are translated as follows:

Items Translated using

a. Monetary items  Closing rate
b. Nonmonetary items measured at  Exchange rate at the date of transaction
historical cost
c. Nonmonetary items measured at fair  Exchange rate at the date when the fair
value value was determined.

 Closing rate
o The spot exchange rate at the reporting date.

MONETARY ITEMS VS. NON-MONETARY IETMS

 Monetary items
o Are currencies held and assets and liabilities to be received or paid in a foxed
or determinable amount of money.
 Non-monetary items
o Are those which do not give rise to the receipt or payment of a fixed or
determinable amount of money.
 Examples:

Monetary assets Non-monetary items

a. Cash and cash equivalents a. Inventories
 b. Accounts/Notes/Loans receivable and b. Prepaid assets
their related allowances and other c. Property, plant and equipment
financial assets measured at amortized d. Investment property
cost e. Intangible assets
c. Finance lease receivables f. Goodwill
d. Cash surrender value g. Provisions that are to be settled by the
delivery of a non-monetary asset
h. Share capital and share premium
Monetary liabilities
a. Accounts/Notes/Loans/Bonds payable
and other financial liabilities measured
at amortized cost
b. Employee benefits to be paid in cash
c. provisions and accrued payables to be
settled in cash
d. cash dividends payable

EXCHANGE DIFFERENCES

 Is “the difference resulting from translating a given number of units of one currency
into another currency at different exchange rates.”
 Exchange differences arising from settling or translating:
o Monetary items
 Are recognized in profit or loss in the period in which they arise.
o Non-monetary items
 If the gain or loss is recognized in other comprehensive income
(OCI), the exchange component of the gain or loss is also recognized
in OCI.
 Conversely, if the gain or loss us recognized in profit or loss, the
exchange component is also recognized in profit or loss.

Illustration: Foreign currency transaction-Purchase

On December 1, 20x1, Entity A purchases inventories for 10,000, to be settled on January 3,
20x2. The following are the exchange rates:

December 1, 20x1 58

December 31, 20x1 60

January 3, 20x2 61

 Initial recognition:

Entity A records the inventories and the related accounts payable at 580,000
(10,000 x 58 spot exchange rate at acquisition date).

TRANSLATION OF FINANCIAL STATEMENTS

 An entity is required to present its financial statements using s functional currency

(i.e., Philippine pesos).
 However, whenever needed, the entity may translate its financial statements into
any presentation currency (e.g., Japanese yen, US dollars, etc,) as follows:

Items Translated using

a. Assets and liabilities (including  Closing rate at the date of the statement
comparatives) of financial position
b. Income and expenses (including  Exchange rates at the dates of the
comparatives) transactions
PAS 23 BORROWING COSTS

CORE PRINCIPLE UNDER PAS 23

 Borrowing costs (interest or finance costs)

o That are directly attributable to the acquisition, construction or production of
a qualifying asset are capitalized as cost of that asset. Other borrowing
costs are expensed when incurred.
o Are costs incurred in relation to the borrowing of funds. Examples:
 Interest expense on financial liabilities or lease liabilities computed
using the effective interest method
 Exchange differences on foreign borrowings that are regarded as an
adjustment to interest costs.
 Borrowing costs do not include actual or imputed cost of equity or
capital.
 Qualifying asset
o Is “an asset that necessarily takes a substantial period of time to get ready for
its intended use or sale.”
o Examples of qualifying assets:
 Inventories that take a long period of time to produce
 Items of PPE (e.g., building) that take a long period of time to
construct or to get ready for their intended use
 Intangible assets that take a long period of time to develop
o The following are not qualifying assets:
 Financial assets
 Inventories that are routinely produced over a short period of time or
are mass-produced on a repetitive basis
 Assets that are ready for their intended use or sale when acquired
 Assets measured at fair value

CAPITALIZATION OF BORROWING COSTS

  Borrowing costs are capitalized if they are avoidable, meaning they would not have
been incurred if the expenditure in the qualifying asset has not been made.
 Capitalization of borrowing costs starts when all of the following conditions are
met:
o Expenditures for the asset are being incurred
o Borrowing costs are being incurred
o Activities necessary to prepare the asset for its intended use or sales are
being undertaken.
 Capitalization is suspended during extended periods in which active development
is interrupted. Borrowing costs during these periods are expensed.
 Capitalization, however, is not suspended if substantial technical and administrative
work is being performed or a temporary delay is a necessary part of the
development process. For example:
o Capitalization of borrowing costs is not suspended when construction is
temporarily stopped dude to a typhoon.
 Capitalization of borrowing costs ceases when the qualifying asset is substantially
complete.
 If the construction of a qualifying asset is completed in parts, capitalization ceases
for each part that is completed and ready for its intended use.
 Capitalization continues or the uncompleted parts.

SPECIFIC BORROWING

 Refers to funds borrowed specifically for the purpose of obtaining a qualifying

asset.
 The capitalizable borrowing costs on specific borrowings are computed as follows:
o Capitalizable= Actual borrowing costs- Investment income

Illustration:
On January 1, 20x1, Entity A obtained a 10%, 1,000,000 loan, specifically to finance the
construction of a building. The proceeds of the loan were temporarily invested and earned
interest income of 20,000. The construction was completed on December 31, 20x1.

 Caitalizable BC= 1,000,000 x 10% -20,000

= 80,000

GENERAL BORROWING

 Are those obtained for more than one purpose, e.g., the acquisition or construction
of a qualifying asset and some other purposes..
 The capitalizable borrowing costs on general borrowings are computed as follows:
o Capitalizable= Ave. Expenditure x Capitalization Rate
 The borrowing cost to be capitalized is the lower of the amount computed using the
formula above and the actual borrowing costs.

Illustration:

On January 1, 20x1, Entity A had the following general borrowings. A part of the proceeds
was used to finance the construction of a qualifying asset.

Principal

12% short –term note 10,000,000

14% bank loan (3-year) 18,000,000

16% note payable (5-year) 22,000,000

Expenditures made on the qualifying asset were as follows:

January 1 4,800,000

March 31 2,200,000

July 31 3,500,000
 October 1 5,400,000

December 31 300,000

The capitalization rate is computed as follows:

 Capitalizabe BC= Ave. Expenditure x Capitalization rate

The average expenditure is computed as follows:

Date Expenditures Month outstanding Average

(a) over 12 months expenditure
(b) (c)=(a) x(b)
January 1 4,800,000 12/12 4,800,000
March 31 2,200,000 9/12 1,650,000
July 31 3,500,000 5/12 1458,000
October 1 5,400,000 3/12 1350,000
December 31 300,000 0/12
9,258,333

The capitalization rate is computed as follows:

 Capitalization rate= Total interest expense on general borrowings

Total general borrowings

DISCLOSURE

 The amount of borrowing costs capitalized during the period.

 The capitalization rate used to determine the capitalizable borrowing costs.
PAS 24 RELATED PARTY DISCLOSURES

INTRODUCTION

 PAS 24 prescribes the guidelines in identifying related party relationships,

transactions, outstanding balances and commitments, and the necessary disclosures
for these items.
 Related party relationships
o Are a common features of business. For example, the companies operating
under the trade names:
 Chowking
 Greenwich
 Red ribbon
 Mang Inasal
Are all subsidiaries of Jollibee Foods Corporation, the parent
company. All these companies are related parties. Collectively,
they are referred to as the “Jollibee Group.”
o Sometimes the mere existence of a related party relationship is sufficient to
affect an entity’s financial position and performance even in the absence of
related party transactions. For example:
 A parent might dictate a subsidiary’s choice of supplier.
o For these reasons, users of financial statements need information on related
party relationships, transactions, outstanding balances and commitments to
help them better assess the risks and opportunities surrounding the entity.
 Related party disclosures
o Are necessary to indicate the possibility that an entity’s financial position and
performance might have been affected by the existence of such relationship.
o This is because related parties often enter into transactions that unrelated
parties would not. For example:
 A subsidiary might sell goods to its parent at preferential rates that
are unavailable to unrelated parties,
RELATED PARTIES

 Parties are related if one party has the ability to affect the financial and operating
decisions of other party through control, significant influence or joint control.
 Control, significant influence and joint control refer to the degree of one party’
ability to affect the relevant decisions of another.
 These are defined and discussed in the other sections of this book.
 Examples of related parties:
1. Parent and its subsidiary
2. Fellow subsidiaries with a common parent
3. Investor and its associate; and the associate’s subsidiary
4. Venturer and the joint venture; and the joint venture’s subsidiary
5. A joint venture and an associate of a common investor.
6. Key management personnel of the reporting entity or of the reporting
entity’s parent.
7. A person who has control, significant influence or joint control over
the reporting entity.
8. Close family member off the person referred to in (6) and (7)
9. Post-employment benefit plan of the employees of either the
reporting entity or an entity related to the reporting entity.
 Key management personnel
o Are “those persons having authority and responsibility for planning, directing
and controlling the activities of the entity, directly or indirectly, including any
director (whether executive or otherwise) of that entity.”
 Close family member
 Is one who may be expected to influence, or be influenced by, the
person in his/her dealings with the reporting entity. It includes the
person’s spouse, their children and their dependents.
 The following are not related parties:
o Two entities simply because they have one director or key management
personnel in common.
 o Two join ventures simply because they are co-venturers in a joint venture.
o Financers, trade unions, public utilities, and government agencies that do not
control, jointly control or significantly influence the reporting entity, simply
by virtue of their normal dealings with the entity, even though they may place
some restrictions on the entity or participate it its decision-makings.
o A customer, supplier, or other business that the entity does significant
transactions with, simply because of economic dependence.

Illustration:

Mr. X is a director in A Co. and also in B Co.

Analysis: The related parties are A Co. and Mr. X and B. Co and Mr. X because Mr. X is a key
management personnel of these companies. A Co. and B Co. are not related parties simply
because they have an interlocking director.

DISCLOSURES

 Relationships between parents and subsidiaries

o A parent-subsidiary relationship is disclosed even if there have been no
transactions between them during the period.
o A subsidiary discloses the name of its parent, and if different, the name of the
ultimate parent.
o If neither of these two prepares consolidated financial statements for public
use, the subsidiary discloses the name of the next most senior parent that
does so.
 Key management personnel compensation
o An entity discloses the total key management personnel compensation
broken down as follows:
 Short-term employee benefits
 Post-employment benefits
 Other long-term benefits
 Termination benefits
  Share-based payment
 Related party transactions
o Is “a transfer of resources, services or obligations between a reporting entity
and a related party, regardless of whether a price is charged.”
o Examples of transactions that are disclosed if they are with a related party:
 Purchases or sales of goods, services or other assets
 Leases
 Transfers of research and development
 Transfers under license agreements
 Loans and other financing arrangements, including equity
contributions
 Provision of guarantee or collateral
 Commitments
 Settlement of liabilities by or on behalf of either party
 Participation by a parent or subsidiary in a defined benefit plan
wherein risks are shared.
o The following are disclosed when there are related party transactions during
the periods covered by the financial statements:
 Nature of the related party relationship
 Nature, terms and amount of the transaction and outstanding
balances
 Doubtful debts recognized on the outstanding balances.
o Related party transactions and their outstanding balances are disclosed in an
entity’s separate or individual financial statements. These, however, are
eliminated in the groups consolidated financial statements.
o Disclosures that related party transactions were on arm’s length basis are not
made unless this can be substantiated.
 Government-related entities
o Is “an entity that is controlled, jointly controlled or significantly influenced by
a government.”
o A government-related entity discloses the following if there have been
related party transactions with the government:
 Name of the government and the nature of the relationship
 Nature and amount of each individually significant transaction
 Other transactions that are collectively significant but are individually
insignificant
PAS 26 ACCOUTING AND REPORTING BY RETIREMENT BENEFIT PLANS

INTRODUCTION

PAS 26

 Applies to the preparation of financial statements of retirement benefit plans (also

called “pension schemes” “superannuation schemes” or “retirement benefit
schemes”).
 Views a retirement benefit plan as a reporting entity separate from the employers of
the participants in the plan. Accordingly, the retirement benefit plan may have its
own financial statements.
 Deals with the accounting and reporting by the plan to all participants as a group,
rather than individually regarding their retirement benefit rights.

PAS 19
Applied by an employer in (among others)
determining the cost of providing
retirement benefits.
PAS 26
Applied by, for example, a trustee, when
preparing the financial statements of a
retirement benefit plan. PAS 26
complements PAS 19.

 PAS 26 applies to all retirement benefit plans whether:

o Formal or informal
o Contributory or non-contributory
o Funded (managed by a trustee), or
o Unfunded (managed by the employer), and
o Defined contribution plan, or
o Defined benefit plan
 Some plans may have characteristics of both a defined contribution plan and a
defined benefit plan.
 Such hybrid plans are considered defined benefit plans under PAS 26.
  However, Pas 26 does not apply to government social security type arrangements
and employee benefits other than retirement benefits.
 Funding
o Is “the transfer of assets to an entity (the fund) separate from the employer’s
entity to meet future obligations for the payment of retirement benefits.”

DEFINED CONTRIBUTION PLANS

 Under a defined contribution plan, the employer’s obligation is usually discharged

by making the agreed contributions.
 The benefits to be received by employees are dependent on the contributions and
investment income of the fund.
 The participant therefore are interested in information about actual contributions
and the plan’s investment performance.
 To address the foregoing needs the financial statements of a defined contribution
plan shall contain the following:
o A statement of net sales available for benefits
o A statement of changes in net assets available for benefits
o Accompanying notes to the financial statements
 Net assets available for benefits
o Are “the assets of a plan less liabilities other than the actuarial present value
of promised retirement benefits.”

Illustrative financial statements:

Entity A-Defined Contribution Plan

Statement of Net Assets Available for Benefits
As of December 31, 20x1
ASSETS: 20x1 20x0
Investments at fair value 1,120,000 484,000
Investments at contract value 1,020,000 1,020,000
Contributions receivable from employer 60,000
Total assets 2,200,000 1,504,000
LIABILITIES:
Accrued management fees payable 4,000

NET ASSETS AVAILABLE FOR BENEFITS 2,200,000 1,500,000

Entity A-Defined Contribution Plan

Statement of Changes Net Assets Available for Benefits
For the period ended December 31, 20x1
ADDITIONS: 20x1 20x0
Net fair value changes 940,000 240,000
Interest income 42,000 30,000
Dividends 106,000 50,000
1,088,000 320,000
Contributions 140,000 200,000
Total additions 1,228,000 520,000

DEDUCTIONS:
Benefits paid to participants 500,000 -
Administrative expenses 28,000 20,000

Total deductions 528,000 20,000

Net increase for the period 700,000 500,000

Net assets available for benefits 1,500,000 1,000,000
NET ASSETS AVAILABLE FOR BENEFITS 2,200,000 1,500,000

DEFINED BENEFIT PLANS

 Under a defined benefit plan, the benefits to be received by employees are definite
amounts which can be determined by reference to the plan formula.
 The employer’s obligation is not discharged simply by making contributions to a
funds, but rather by actually paying the promised benefits when they become due.
  The payment of benefits therefore is dependent on the availability of earmarked
funds and the employer’s ability to make good any deficiency in those funds.
 Accordingly, the plan participants are not only interested in information on the
earmarked funds (net assets available for benefits) but also on the obligation
(actuarial present value of promised retirement benefits) for which those funds
were set aside.
 Thus, the financial statements of a defined benefit plan requires the reporting of the
actuarial present value of promised retirement benefits either within those
financial statements (see #1 below) or by reference to an accompanying separate
actuarial report (see # 2 below).
 The financial statements of a defined benefit plan contain either:
1. A statement that shows:
a. The net assets available for benefits
b. The actuarial present value of promised retirement benefits,
distinguishing between vested benefits and non-vested benefits
c. The resulting excess or deficit
or
2. A statement of net assets available for benefits including either:
a. A note disclosing the actuarial present value of promised retirement
benefits, distinguishing between vested benefits and non-vested
benefits
b. A reference to this information an accompanying actuarial report.
A statement of changes in net assets for benefits and
accompanying notes are provided in both (1) and (2) above.
 Vested benefits
o Are “benefits, the rights to which, under the conditions of a retirement
benefit plan, are not conditional on continued employment.”

ACTUARIAL PRESENT VALUE OF PROMISED RETIREMENT BENEFITS

 Is “the present value of the expected payments by a retirement benefit plan to

existing and past employees, attributable to the service already rendered.”
  The present value of the retirement benefits may be calculated using either current
salary levels or projected salary levels at the retirement dates.
 Actuarial valuations are frequently prepared every three years.
 If an actuarial valuation has not been made prepared at the date of the financial
statements, the latest actuarial valuation is used as the basis. The valuation date is
disclosed.

VALUATION OF PLAN ASSETS

 Plan assets are measured at fair value or market value.

 Securities with fixed redemption values that have been acquired to match the
obligations of the plan may be measured at their final redemption values.
 If an estimate of fair value is not possible, the reason for this is disclosed.

DISCLOSURE

 Aside from a statement of net assets available for benefits and a statement of
changes in net assets available for benefits, the financial statements of ether a
defined contributions plan or a defined benefit plan shall also provide information
on the following:
o Summary of significant accounting policies
o Description of the plan and the effect of any changes in the plan during the
period
o Details of any single investment exceeding 5% of net assets or 5% of any
category of investment
o Details of any investment in the employer
o Contribution of employer and employee, if applicable
o Analysis of benefits paid or payable according to, for example, retirement,
death and disability benefits, and lump sum payments
o Funding policies and, for defined contribution plans, investment policies
o Investment income on the plan assets
o Administrative, tax, and other expense
 o Transfers from or to other plans
o For defined benefit plans, the actuarial present value of promised retirement
benefits, including information on significant actuarial assumptions, the
methods used the number of plan participants, a description of the promised
benefits, and the names of the employers and the employee groups covered.
These may be presented either within financial statements or in a separate
report.

PAS 27 SEPARATE FINANCIAL STATEMENTS

INTRODUCTION

PAS 27
  Prescribes the accounting and disclosure requirements for investment in
subsidiaries, associates and joint ventures when an entity prepares separate
financial statements.
 Does not mandate which entities should produce separate financial statements.
 Is applied when an entity chooses, or is required by aw, to present separate
financial statements that comply with PFRSs.

SEPARATE FINANCIAL STATEMENTS

 Are those presented in addition to:

o Consolidated financial statements
o The financial statements of an entity with an investment in associate or joint
venture that is accounted or using equity method in accordance with PAS 28
Investments in Associates and Joint Ventures.
 The financial statements of an entity that does not have an investment in subsidiary,
associate or joint venture are not separate financial statements.
 Entities exempted from preparing consolidated financial statements present
separate financial statements as their only financial statements.
 Consolidated financial statements
o Are “the financial statements of a group in which the assets, liabilities, equity,
income, expenses and cash flows of the parent and its subsidiaries are
presented as those of a single economic entity.”

PREPARATION OF SEPARATE FINANCIAL STATEMENTS

 Separate financial statements

o Are prepared in accordance with all applicable PFRS, except that investments
in subsidiaries, associates or joint ventures are accounted for either:
 At cost
 In accordance with PFRS 9 Financial Instruments
 Using the equity method under PAS 28 Investments in Associates and
Joint Ventures
 o The entity applies the same accounting for each investment category (i.e.,
subsidiaries, associates, and joint venture).
o If the investments are measured at fair value through profit or loss in non-
separate financial statements, that same measurement is also used in the
separate financial statements.
o Investments classified for as held for sale are accounted for in accordance
with PFRS 5 Non-current Assets Held for Sale and Discontinued Operations.

DIVIDENDS

 Dividend from a subsidiary, associate or joint venture are recognized in profit or

loss when the entity’s right to receive the dividends is established, except when the
investment is accounted for using the equity method, in which case the dividends
are recognized as deduction to the carrying amount of the investment.

PAS 28 INVESTMENTS IN ASOCIATES AND JOINT VENTURES

INTRODUCTION

PAS 28
  Prescribes the accounting for investments in associates and the application of the
equity method to investments in associates and joint ventures.
 Investors apply PAS 28 when they have significant influence or joint control over an
investee.

INVESTMENT IN ASSOCIATE

 An associate is “an entity over which the investor has significant influence.”
 The existence of significant influence distinguishes an investment in associate
from all other types of investments.

Type of investment Nature of Applicable

relationship with reporting
investee standard
 Investment measured at fair value Regular investor PFRS 9
 Investment in associate Significant influence PAS 28
 Investment in subsidiary Control PFRS 3 and PFRS
10
 Investment in joint venture Joint control PFRS 11 and Pas
28

 Significant influence
o Is “the power to participate in the financial and operating policy decisions of
the investee but is not control or joint control of those policies.”
o Is presumed to exit if the investor holds, directly or indirectly (e.g. through
subsidiaries), 20% or more of the voting power of the investee.
o Conversely, significant influence is presumed not to exist if the voting power
is less than 20%.
o However, these are only presumptions, meaning they are generally held to be
true in the absence of evidence to the contrary.
o Thus, an investor may have significant influence even is it has less than 20%
voting power, and conversely, may not have significant influence even if it has
more than 20% voting power, if these can be dearly demonstrated.
 o When determining the existence of significant influence, an entity considers
the effect of potential voting rights that are currently exercisable.
o Any off the following may provide evidence of the existence of significant
influence:
 Representation on the board of directors or equivalent governing
body of the investee
 Participation in policy-making processes, including participation in
decisions about dividends or other distributions
 Material transactions between the entity and its investee
 Interchange of managerial personnel
 Provision of essential technical information

Percentage of ownership interest Type of investment

Less than 20% Financial assets at fair value
20% to 50% Investment in associate
51% to 100% Investment in subsidiary
Contractually agreed sharing of control Investment in joint venture

ACCOUNTING FOR INVESTMENTS IN ASSOCIATES

 Investments in associates are accounted for using the equity method.

 Under the equity method, the investment is initially recognized at cost and
subsequently adjusted for the investor’s share in the investee’s changes in equity
(e.g., profit or loss, dividends and other comprehensive income).

Share in associate’s Effect on investment in Effect on investment

associate income
a. Profit or loss  Increase for share in  Increase for share in
profit/decrease for profit; decrease for
share in loss share in loss
b. Dividends  Decrease  No effect
c. Other comprehensive  Increase for share in  No effect; the share in
income gain/ decrease for OCI is included in the
share in loss investor’s OCI
Illustration:

On January 1, 20x1, Entity A acquires 20% interest in Entity B for 400,000. Entity B reports
profit or 100,000 and declares dividends of 50,000 in 20x1.

 The carrying amount of the investment in associate on December 31, 20x1 is

computed as follows:

Investment in associate
1/1/x1 400,000
Sh. in profit (100K x 20%) 20,000 10,000 Dividends (50K x 20%)
410,000 12/31/x1

Notes:

 The investment is initially measured at cost (i.e., 400,000) and subsequently

adjusted for the inventor’s share in the associate’s profit and dividends.
 Investment in associate is an asset; it has a normal debit balance. Thus, the
beginning balance is placed on the debit side of the T-account. The ending balance is
placed on the opposite side to facilitate analysis of the equality of debits and credits.
 The share in profit is placed on the debit side because it increases in the carrying
amount of the investment.
 Dividends from investments accounted for using the equity method are not income
but rather reductions, from the carrying amount of the investment.
 The investment income in 20x1 is 20,000-the share in profit.
 Investments in associates are presented as noncurrent assets.

APPLICATION OF THE EQUITY METHOD

 An investor starts using the equity method as from the date when it obtains
significant influence or joint control over an investee.
  On acquisition, the difference between the cost of the investment and the entity’s
share in the net fair value of the investee’s identifiable assets and liabilities is
accounted for as follows:
o If cost is greater than the fair value of the interest acquired, the excess is
goodwill.
o If cost is less than the fair value of the interest acquired, the deficiency is
included as income in determining the entity’s share in the investee’s profit
or loss in the period of acquisition.
 Any resulting goodwill is included in the carrying mount of the investment and is
not accounted for separately. Meaning, the goodwill is neither amortized nor
tested for impairment separately.
 Adjustments are subsequently made on the entity’s share in the investee’s profit or
loss to account for the depreciation or amortization of any undervaluation or
overvaluation in the investee’s identifiable assets and liabilities.

INVESTEE’S FINANCIAL STATEMENT AND ACCOUTNING POLICIES

 When applying the equity method, the investor uses the investee’s most recent
financial statements.
 When the reporting periods of the investee and investor do not conclude, the
investee shall prepare financial statements that coincide with the investor’s
reporting period for purposes of applying the equity method.
 If this is impracticable, adjustments shall be made for significant transactions and
events that occur between the end of the investee’s reporting period and that of the
investor’s.
 The difference between the investor’s and investee’s end of reporting periods shall
not exceed three months.
 Uniform accounting policies shall be used. If the investee uses different accounting
policies, its financial statements need to be adjusted before the investor uses them
for purposes of applying the equity method.

CUMULATIVE PREFERENCE SHARES

  If the investee has outstanding cumulative preference shares that are held by parties
other than the investor and classified as equity, the investor computes its share of
profits or losses after deducting one-year dividends on those shares, whether
declared or not.

SHARE IN LOSSES

 The investor shares in the investee’s losses only up to the amount of its interest in
the associate or joint venture.
 Interest in the associate or joint venture includes the following:
o Carrying amount of the investment in associate/joint venture
o Investment in preference shares of the associate/joint venture
o Unsecured, long-term receivables or loans
 Interest in the associate or joint venture does not include trade receivables and
payables and secured long-term receivables or loans.
 Share in losses
o Are applied first to the carrying amount of the investment in associate/joint
venture.
o After this is zeroed-out, shares in losses are applied to the other components
of the interest in the associate or joint venture in the reverse order of
their seniority (i.e., reverse order of priority in liquidation).
 After the total balance of the interest in the associate or joint venture I zeroed-
out, the investor stops sharing in further losses, except to the extent that the
investor:
o Has incurred legal or constructive obligations or]
o Made payments on behalf of the associate
 If the investee subsequently reports profits, the investor resumes recognizing its
share in those profits only after its share in the profits equals the share in losses not
recognized.

EXEMPTIONS FROM APPLYING THE EQUITY METHOD

  An investor is exempt from applying the equity method if it is exempted from
preparing consolidated financial statements, e.g., the investor is a parent but is a
subsidiary of another parent and its securities are not being traded.
 Investments in associates and joint ventures held by an entity that is a venture
capita organization, mutual fund, unit trust, investment-linked insurance fund and
similar entities may be measured at fair value through profit or loss in accordance
with PFRS 9 Financial Instruments.

CLASSIFICATIONS AS HELD FOR SALE

 Investments in associates or joint ventures that are classified as held for sale in
accordance with PFRS 5 Non-current Assets Held for Sale and Discontinued
Operations are accounted for using that standard.
 If only a portion of the investment is classified as held for sale, the remaining portion
class is accounted for using the equity method until the portion classified as held
for sale is actually sold.
 After the sale, the retained portion is accounted for under PFRS 9, unless significant
influence or joint control remains, in which case the equity method continues to be
applied.
 If the investment previously as held for sale cease to be so classified as held for sale
ceases to be so classified, it is accounted for using the equity method
retrospectively from the date of its classification as held for sale. The prior year
financial statements are restated accordingly.

DISCONTINUANCE OF EQUITY METHOD

 An entity stops using the equity method as from the date when it loses significant
influence or joint control over the investee.
o If the investment becomes a subsidiary, it I accounted for using PFRS
Business Combinations and PFRS 10 Consolidated Financial Statements.
o If the investment becomes a regular investment, it is accounted for using
PFRS 9. The fair value of the retained interest is regarded as its fair value on
 initial recognition under PFRS 9. The difference between the following is
recognized in profit or loss:
 The fair value of the retained interest and any proceeds from
disposing part of investment; and
 The carrying amount of the investment at the date the equity method
was discontinued.
o If an investment n associate becomes an investment in joint venture or vice
versa, the entity continues to apply the equity method and does not
remeasure the retained interest.
o When the equity method is discontinued, all amounts previously recognized
on other comprehensive income in relation to the investment are either
reclassified to profit or loss as a reclassification adjustment or transferred
directly to retained earnings using the provisions of other PFRSs. For
example, revaluation surplus is transferred directly to retained earning while
exchange differences from translating foreign operations are reclassified to
profit or loss.
o If ownership interest is reduced but significant influence or joint control is
not lost, only a proportionate amount of the OCI relating to the reduction of
interest is reclassified to profit or loss or transferred directly to retained
earnings, as appropriate.
o Gains and losses resulting from transactions between an entity’s financial
statements only to the extent of unrelated investors’ interests in the associate
or joint venture.

INVESTMENT IN JOINT VENTURE

 The investor uses PFRS 11 Joint Arrangements to determine whether its interest in a
joint arrangement is an investment in joint venture. If this is so, the investor
accounts for the investment in joint venture in accordance with APS 28 i.e., using the
equity method similar to an investment in associate.
PAS 29 FINANCIAL REPROTING IN HYPERINFALTIONARY ECONOMIES

INTRODUCTION

PAS 9

 Prescribes the restatement procedures for the financial statement of an entity

whose functional currency is the currency of a The Effects of Changes In Foreign
Exchange Rates economy.
 Inflation is normally ignored in accounting due to the stable monetary unit
assumption.
 However, when inflation is very high (hyper), it can no longer be ignored. This is
because financial statements are stated in terms of money and when money loses its
purchasing power at a very high rate, the financial statements become misleading.
 The financial statements therefore must be restated otherwise they are useless.
 Inflation
o Refers to a general increase in prices and decrease in the purchasing power
of money.
  PAS 29 does not prescribe an absolute rate at which hyperinflation is deemed to
arise. This is a matter of judgment.
 Instead, Pas 29 provides the following indicators which an entity considers when
determining the existence of hyperinflation:
o The general population prefers to keep its wealth in non-monetary assets or
in a relatively stable foreign currency. Amounts of local currency held are
immediately invested to maintain purchasing power.
o The general population regards monetary amounts not in terms of the local
currency but in terms of a relatively stable foreign currency. Prices may be
quoted in that currency
o Sales and purchases on credit take place at prices that compensate for the
expected loss of purchasing power during the credit period, even if the period
is short.
o Interest rates, wages and prices are linked to a price index; and
o The cumulative inflation rate over three years is approaching, or exceeds,
100%.

CORE PRINCIPLE

 The financial statements of an entity that reports in the currency of a

hyperinflationary economy, whether they are based on historical cost or current
cost, shall be stated in terms of the measuring unit current at the end of the
reporting period.
 Comparative figures for prior period(s) shall also be restated into the same current
measuring unit.
 Pas 29 prohibits the presentation of the required information as supplement to
unrestated financial statements.
 PAS 29 discourages the separate presentation of the financial statements before
restatements.

RESTATEMENT OF FINANCIAL STATEMENTS

 a. Financial statements are restated by applying a general price index as follows:

Statement of financial position

a. Monetary items*
b. Non-monetary items* measured at
cost
c. Non-monetary items measured at
fair value or NRV at the end of the
reporting period.
Statement of comprehensive income & Statement of cash flows
d. All items are restated
 Not restated
 Restated
 Not restated. However, if the fair
value or NRV was determined at a
date other than the end of the
reporting period, that fair value or
NRV is nonetheless restated, from the
date ot was determined.

 The corresponding figures for prior period(s), whether monetary or nonmonetary,

are all restated.
 The gain or loss on the net monetary position resulting from the restatements is
recognized in profit or loss.
 Formula for restatements:

Historical x Current price index (index as of end of reporting period

Cost history price index* (index as of acquisition date)

 When it is impracticable to determine the historical price indices such as for

transactions recurring very frequently, an entity may use the average price index
for the period.

CONSOLIDATED FINANCIAL STATEMENTS

 If any of the entities belonging to a group entity reports in a hyperinflationary

economy, the financial statements of that entity needs to be restated first before they
are consolidated in the groups financial statements.
  If a foreign operation reports in a hyperinflationary economy, its financial
statements are also restated first under PAS 29 before they are translated in
accordance with PAS 21.

DISCLOSURES

 The fact that the financial statements, including corresponding figures, have been
restated for changes in the general purchasing power of the reporting currency
 Whether the financial statements are based on historical cost or current cost
 The identity and level of the price index at the end of the reporting period and the
movement s during the current previous reporting periods.

PAS 32 FINANCIAL INSTRUMENTS: PRESENTATION

INTRODUCTION

PAS 32

 Prescribed the principles for presenting financial instruments as liabilities or equity

and for offsetting financial assets and financial liabilities.
 Complements PFRS 9 Financial Instruments:
o Which prescribes the recognition and measurement of financial assets and
financial liabilities
 and PRFS 7 Financial Instruments; Disclosures:
o Which prescribes the disclosures for financial instruments.
 Applies to all types of financial instruments except the following for which other
standards apply:
o Investments in subsidiaries, associates and joint ventures
o Employer’s rights and obligations under employee benefit plans and share-
based payments
o Insurance contracts
  Applies to instruments designated to be measured at fair value through profit or loss
and contracts for the future purchase or delivery of a commodity or other
nonfinancial items that can be settled net.

FINANCIAL INSTRUMENTS

 Is “any contract that gives rise to a financial asset of one entity and a financial
liability or equity instrument of another entity.”
 Financial asset is any asset that is:
o Cash
o An equity instrument of another entity
o A contractual right to receive cash or another financial asset from another
entity
o A contractual right to exchange financial instruments with another entity
under conditions that are potentially favorable
o A contract that will or may be settled in the entity’s own equity instruments
and is not classified as the entity’s own equity instrument,
 Financial liability is any liability that is:
o A contractual obligation to deliver cash or another financial asset to another
entity
o A contractual obligation to exchange financial assets or financial liabilities
with another entity under conditions that are potentially unfavorable to the
entity
o A contract that will or may be settled in the entity’s own equity instruments
and is not classified as the entity’s own equity instrument.
 Equity instrument
o Is “any contract that evidences a residual interest in the assets of an entity
after deducting all of its liabilities.”
o This definition reflects the basic accounting equation “Assets-
Liabilities=Equity.”
 Example:
 o Bank deposit is a financial instrument. It is a contract that gives rise to both a
financial asset (cash in bank) on the part of the depositor and a financial
liability (Deposit liability) on the part of the bank. The depositor has a
contractual right to withdraw his cash while the bank has a contractual
obligation to deliver cash when the depositor withdraws.
 Cash
o Is the most basic financial instrument because it is the medium of exchange
and the basis of measurement of all financial statement elements.
 The term “financial instrument” encompasses both financial asset and financial
liability but not the entity’s “own” equity instrument. Examples of an entity’s “own”
equity instrument include:
o Ordinary shares
o Non-redeemable preference shares
o Stock options and warrants.

EXAMPLES OF FINANCIAL ASSETS

 Cash and cash equivalents

o Cash on hand
o In banks
o Short-term money placements
o Cash funds
 Receivables
o Accounts
o Notes
o Loans
o Financial lease receivables
 Investments in equity or debt instruments of other entities
o Held for trading securities
o Investments in subsidiaries
o Associates
 o Join ventures
o Investments in bonds
o Derivative assets
 Sinking fund and other long-term funds composed of cash and other financial
assets.

The following are not financial assets:

 Physical assets
o Inventories
o Biological assets
o PPE
o Investment property
 Intangible assets
 Prepaid expenses and advances to suppliers
 The entity’s own equity instrument
o Treasury shares

EXAMPLES OF FINANCIAL LIABILITIES

 Payables
o Accounts
o Notes
o Loans
o Bonds payable
 Lease liabilities
 Held for trading liabilities and derivative liabilities
 Redeemable preference shares issued
 Security deposits and other returnable deposits

The following are not financial liabilities:

  Unearned revenues and warranty obligations that are to be settled by future
delivery of goods or provision of services
 Taxes, SSS, Philhealth, and PAG-IBIG payables
o Are not financial liabilities because these obligations do not arise from
contracts.
 Constructive obligations
o Are not financial liabilities because these obligations do not arise from
contracts.

PRESENTATION

 The issuer classifiers a financial instrument, or its component parts, as a financial

asset, a financial liability or an equity instrument in accordance with the
substance of the contract (rather than its legal from) and the definitions of a
financial asset, a financial liability and an equity instrument.
 When determining whether a financial instrument is a financial liability or an equity
instrument, the overriding consideration is whether the instrument meets the
definition of a financial liability.

Financial liability Equity instrument

 The entity has a contractual
obligation to pay cash or another
financial asset or to exchange
financial instruments under
potentially unfavorable condition.
 The entity has no obligation to pay
cash or another financial asset or to
exchange financial instruments
under potentially unfavorable
condition.

 A contract is not an equity instrument merely because it is to be settled in the

entity’s own equity instruments.
 The following guidance applies when a contract requires settlement in the entity’s
own equity instruments:

Financial liability Equity instrument

 The contact requires the delivery of:  The contract requires the delivery
 a. Variable number of the entity’s (receipt) of a fixed number of the
own equity instruments in entity’s own equity instruments in
exchange for a fixed amount of cash exchange for a fixed amount of cash
or another financial asset or or another financial asset.
b. Fixed number of the entity’s own  Example: a share option that gives the
equity instruments in exchange for holder a right to buy a fixed number
a variable amount of cash or of the issuer’s shares for a fixed price.
another financial asset.
 Examples:
a. Variable number for a fixed
amount:
o A contract to deliver as
many shares as are equal to
the value of a fixed amount
of cash, say 100,000; or a
fixed number of units of a
commodity, say 50 grams of
gold.
b. Fixed number for a variable
amount:
o A contract to deliver 1,000
own equity instruments in
exchange for an amount of
cash equal to the value of 10
grams of gold.

 A contract to receive (rather than to deliver) is a financial asset.

Notes:
 Financial asset/ Financial liability Equity instrument
 Variable number for a fixed amount.  Fixed number for a fixed amount.
 Fixed number for a variable
amount.

 An essential feature of an equity instrument is the absence of a contractual

obligation to pay cash or another financial asset.
o This is true even of the holder of the instrument is entitled to pro rate share
in dividends or of the net assets of the entity in case of liquidation.
 Legal form is also irrelevant when determining if a financial instrument is a financial
liability or an equity instrument.
 Some instruments are in the form of shares of stocks but the issuer classifies them
as financial liabilities if they meet the definition of a financial liability.

Redeemable preference shares Callable preference shares

 Are preferred stocks which the
holder has the right to redeem at a
set date.
 Are classified as financial liability
because when the holder exercises its
right to redeem, the issuer is
mandatory obligated to pay for the
redemption price.
 Are preferred stocks which the
issuer has the right to call at a set
date.
 Are classified as equity instrument
because the right to call is at the
discretion of the issuer and therefore
has no obligation to pay unless it
chooses to call on the shares.

 IFRIC 2 Members’ Shares in Co-operative Entities and Similar Instruments

o Addresses the classification of members’ shares in cooperatives.
o Used the same principles as those of PAS 32.
 Members’ shares in cooperative entities and similar instruments are equity if:
o The entity has an unconditional right to refuse redemption of the members’
shares
o Redemption is unconditionally prohibited by law or relevant regulation.
PUTTABLE INSTRUMENT

 Is one that gives the holder the right to return (put back) the instrument to the
issuer in exchange for cash or another financial asset or is automatically put back to
the issuer upon the occurrence of a specified future event, e.g., death of the holder.
 Includes a contractual obligation for the issuer to redeem or repurchase the
instrument.
 Accordingly, it is classified as a financial liability except when the instrument also
represents a residual interest in the net assets of the issuing entity, in which case the
instrument is classified as an equity instrument.
 As an exception to the definition of a financial liability, a puttable instrument is
classified as an equity instrument if it has the features of an equity instrument,
such as entitlement to pro rata share in case of liquidation, non-priority over other
instruments, no other contractual obligations similar to those of a financial liability,
and total cash flows based substantially on profit or loss and changes in net assets.
 In addition to these features, the issuer must have no other instrument that has total
cash flows based substantially on profit or loss and changes in net assets and the
effect of substantially restricting or fixing the residual return to the puttable
instrument holders.

COMPOUND FINANCIAL INSTRUEMENTS

 Is a financial instrument that, from the issuer’s perspective, contains both a liability
and an equity component.
 These components are classified and accounted for separately.
 An example of a compound instrument is convertible bonds.
 Convertible bonds
o Are bonds that can be converted into shares of stocks of the issuer.
o When an entity issues convertible bonds, in effect, it is issuing two
instruments:
1. A debt instrument for the bonds payable
2. An equity instrument for the equity conversion feature.
 o These two components are presented separately in the statement of financial
position.
 Equity
o Is defined as a residual amount.
o Therefore, to separate the debt and equity components of a compound
instrument, the entity simply deducts from the fair value of the whole
instrument the fair value of the debt component without the equity feature;
the remaining amount represents the equity component. This procedure
follows the basic accounting equation “Assets-Liabilities=Equity.”

Assets - Liabilities = Equity

Cash proceeds from Fair value of debt
issuance of component without the
compound Less equity feature Equals Equity component
instrument

 The sum of the carrying amounts allocated to the liability and equity components is
always equal to the fair value of the whole instrument.
 No gain or loss is recognized on the initial recognition of the components.
 The separate classifications of the components are not revised for subsequent
changes in the likelihood that the conversion option will be exercised.

Illustration:

Entity A issues convertible bonds with face amount of 1,000,000 for 1,050,000. Each 1,000
bond is convertible into 8 shares with par value of 100 per share. On issuance date, the
bonds are selling at 98 without the conversion option.

 The issue price is allocated to the liability and equity components as follows:

Issue price 1,050,000

Fair value of debt instrument without equity feature (1M x 98%) (980,000)
Equity component 70,000

 “Selling at 98” mean the fair value is 98% of the face amount. Thus, the fair value of
the bonds without the equity feature is computed as (1M face amount x 98%) or
980,000.

TREASURY SHARES (TREASURY STOCKS)

 Are an entity’s own shares that were previously issued but were subsequently
reacquired but not retired.
 Are presented separately either in the statement of financial position or in the noted
as deduction from equity.
 No gain or loss arises from the purchase, sale, issue or cancellation of the entity’s
own equity instruments. The consideration paid or received from such transactions
is recognized directly in equity.

INTEREST, DIVIDENDS, LOSSES AND GAINS

 The classification of a financial instrument as a financial liability or an equity

instrument determines the accounting for the related interest, dividends, losses and
gains.

Interest, dividends, losses and gains that relate to:

Financial liability Equity instrument
 Are recognize as income or  Are recognized directly in equity.
expenses in profit or loss.

 For example, dividends on redeemable preference shares (financial liability) are

recognized as expense (e.g., interest expense) in profit or loss while dividends on
callable preference shares and other equity instruments are recognized
directly in equity as a deduction from retained earnings.
  Premium or discount on financial liabilities is included in the carrying amount of the
financial liability an d subsequently amortized to profit or loss while premium or
discount on equity instruments are recognized directly in equity.
 Gains and losses on redemptions or refinancings of financial liabilities are
recognized in profit or loss while redemptions or refinancings of equity
instruments are recognized as changes in equity.
 Changes in the fair value of a financial liability are generally not recognized unless
the financial liability is measured at fair value through profit or loss.
 Changes in the fair value of an equity instrument are not recognized.

TRANSACTION COSTS

 Transaction costs on issuing equity instruments (e.g., stock issuance costs, such as
legal fees, registration costs and stock certificate printing costs), to the extent that
they are avoidable costs, are accounted for as a deduction from equity while
transaction costs on issuing financial liabilities (except liabilities measured at fair
value through profit or loss) are included in the carrying amount of the financial
liability and subsequently amortized to profit or loss.
 Because of the varying treatments, transaction costs on issuing compound financial
instruments are allocated to the debt and equity components based on their
assigned valued.
 Likewise, transaction costs that relate jointly to more than one transaction are
allocated to those transactions using a rational basis of allocation.
 The costs of an abandoned equity transaction are recognized as expense.

OFFSETTING A FINANCIAL ASSET AND A FINANCIAL LIABILITY

 A financial asset and a financial liability are offset and only the net amount is
presented in the statement of financial position when the entity has both:
o A legal right of setoff and
o An intention to settle the amounts on a net basis or simultaneously
 Both of the conditions above must be met before offsetting is permitted.
  PAS 32 requires presenting financial assets and financial liabilities on a net basis
when doing so reflects an entity’s expected future cash flows from settling two or
more separate financial instruments.
 When the entity has the both the legal right to net settlement and the intention to
do so, it has, in effect, only a single financial asset or financial liability.
 Neither a legal right alone nor an intention alone warrants offsetting.
o A mere intention to settle net without the right to do so is not sufficient to
justify offsetting because the rights and obligations associated with the
individual financial asset and financial liability remain unaltered.
o Conversely, a legal right to settle net without the intention to do so is also not
sufficient to justify offsetting because this does not reflect the entity’s
expected future cash flows from settling two or more separate financial
instruments.
 Offsetting is inappropriate for:
o Financial or other assets that are pledged as collateral for non-recourse
financial liabilities and
o Sinking fund and the related financial liability for which the fund was
established.

SUMMARY

 Financial instrument
o Is any contract that gives rise to a financial asset of one entity and a financial
liability or equity instrument of another entity.
 Financial asset
o Is cash, equity instrument of another entity, contractual right to receive cash
or to exchange financial instrument under favorable condition.
 Financial liability
o Is contractual obligation to pay cash or exchange financial instrument under
unfavorable condition.
  An instrument is classified as a financial liability if the entity has a contractual
obligation to pay cash or another financial asset or to exchange financial
instruments under potentially unfavorable condition. The instrument is classified as
equity instrument if the entity does not have such a contractual obligation.
 Offsetting of a financial asset and a financial liability is permitted if the entity has
both the legal right or setoff and the intention to settle the amounts on a net basis.

PAS 33 EARNINGS PER SHARE

INTRODUCTION

PAS 33

 Prescribes the principles in computing and presenting earnings per share (EPS) to
promote inter- and intra-comparability of performance of entities.
 Because of differing accounting policies, PAS 33 recognizes that EPS data may have
limitations- particularly on “earnings” which is the numerator in the EPS
calculation.
o Therefore, the focus of PAS 33 is on the consistent determination of the
denominator of the EPS calculation.
 Requires publicly listed entities, including those in the process of enlisting, to
present EPS information.
 Publicly listed entity
o Is one whose ordinary shares or potential ordinary shares are traded in a
public market. Example:
 Philippine Stock Exchange “PSE”
 No-publicly listed entities
o Are not required to present EPS information.
o However, if they choose to do so, they will need to apply PAS 33.
 If both consolidated and separate financial statements are prepared, EPS is
required only for the consolidated financial statements.
EARNINGS PER SHARE

 Is a computation made for ordinary shares.

 It is a form of profitability ration which provides a measure of how much profit
(loss) each ordinary share has earned (incurred) during the period.
 Normally, no EPS is computed for preference shares because they have a fixed
return, as represented by their dividend rates.
 In some cases, however, EPS may be computed for preference shares when they are
also entitled to a variable return in addition to their fixed return (e.g., participating
preference shares).
 Such preference shares are considered special ordinary shares for purposes of EPS
computation.
 Ordinary shares
o Is “an equity instrument that is subordinate to all other classes of equity
instruments.”
o Participate in profit for the period after all other classes of shares (e.g.,
preference shares) have participated.
 An entity may have more than one type of ordinary shares, often referred to as
“alphabet shares.” For example:
o An entity may have “Class A” and “Class B: ordinary shares. One class, called
the “super voting shares,” has more voting rights than the other. One purpose
of issuing “super voting” shares is to give key company insiders (e.g.,
founders and executives) greater control over the company’s voting rights.
This enables them to control corporate policies and management decisions.
 Preference share
o Is one that has preference over other classes of shares, such as preference
over dividends or preference over net assets in cases of liquidation, but
typically does not have voting rights.

TYPES OF EARNINGS PER SHARE

 PAS 33 requires the following two presentations of EPS:

 1. Basic earnings per share
2. Diluted earnings per share
 If the entity does not have dilutive potential ordinary shares, it presents basic
earnings per share only.

BASIC EARNINGS PER SHARE

 Basic EPS is computed as follows:

 Basic EPS= Profit (Loss) less Preferred dividends
Weighted average number of outstanding ordinary shares

EARNINGS

 Profit (loss)
o Is net of income tax expense.
o It includes any exceptional, unusual or infrequent gains or losses.
 Preferred dividends are deducted as follows:

o If the preference shares are cumulative, one-year dividend is deducted,
whether declared or not.
o If the preference shares are non-cumulative, only the dividend declared
during the period is deducted.
 Dividends in arrears (i.e., those pertaining to prior periods) are ignored in the
computation of EPS.
 The numerator (or the difference between the profit and preferred dividends)
represents the profit or loss attributable to ordinary shareholders.
 This amount is also adjusted for the following, which are treated like preferred
dividends:
o Amortization of discount or premium on increasing rate preference
shares. Discount amortization is deducted from, while premium
amortization is added to, profit or loss.
 o Any gain or loss (that is recognized directly in retained earnings) arising from
settling or repurchasing preference shares. Loss is deducted from, while gain
is added to, profit or loss.
o In an induced or early conversion of convertible preference shares, the excess
of fair value of ordinary shares or other additional consideration paid the fair
value of the ordinary shares issuable under the original conversion terms
(‘loss’) is deducted from profit or loss. Conversely, a ‘gain’ is added to profit or
loss.

SHARES

 The denominator is the weighted average number of shares outstanding,

 This is computed by applying a time-weighing factor to the number of ordinary
shares at the beginning of the period and to all issuances and reacquisitions during
the period.
 The time-weighing factor is the number of days that the shares are outstanding over
the total number of days in the period.
 However, a reasonable approximation of the weighted average 9e.g., months
outstanding) is allowed.
 Outstanding shares
o Are those that are entitled to participate in dividends. Outstanding shares are
issued shares plus subscribed shares minus treasury shares.
 Other events:
o Shares issued in a business combination are averaged from the acquisition
date.
o Shares issuable upon the conversion of a mandatorily convertible instrument
are averaged from the date the contract is entered into.
o Contingently issuable shares are averaged when the conditions have been
satisfied.
 Contingently issuable ordinary shares
 o Are “ordinary shares issuable for little or no cash or other consideration
upon the satisfaction of specified conditions in a contingent share
agreement.”
 Partly paid shares are treated as fractional shares to the extent of their participation
in dividends.
 Partly paid shares that are not entitled to dividends are treated as equivalent of
warrants or options in the calculation of diluted earnings per share.
o Under the Philippine Corporation Code, subscribed shares are entitled to
participate in dividends in full. Accordingly, subscribed shares are treated as
fully outstanding in EPS computation.
o In some countries, where partly paid shares are entitled to partial dividends
only, the subscribed shares are treated as partly outstanding. For example, a
50% paid subscribed shares that are entitled to only 50% dividends are
treated as 50% outstanding.

Illustration:

Entity A had 50,000, Php 10 par, 6% cumulative preference shares outstanding all
throughout 20x1.

Entity A reported profit after tax of 1,200,000 for the year ended December 31, 20x1. The
movements in the number of ordinary shares are as follows:

1/1/20x1 Ordinary shares outstanding 180,000

4/1/20x1 Shares issued for cash 30,000

6/30/20x1 Subscribed shares 10,000

10/1/20x1 Reacquisition of treasury shares (20,000

Outstanding shares at the end of period 200,000

 The weighted average number of ordinary shares outstanding is computed as

follows:
 Date No. of sh. Months outstanding Weighted average
(a) (b) (c)=(a)x(b)
1/1/20x1 180,000 12/12* 180,000
4/1/20x1 30,000 9/12** 22,500
6/30/20x1 10,000 6/12 5,000
10/1/20x1 (20,000) 3/12 (5,000)
202,500

*12 months from Jan. 1 to Dec. 31 divided by 12 months in a year.

**9 months from April 1 to Dec. 31 divided by 12 months in a year.
 The basic earnings per share is computed as follows:
Basic EPS= Profit (Loss) less Preferred dividends
Weighted average number of outstanding ordinary shares
Basic EPS= 1,200,000-(50,000 x 10x 6%)
202,500
Basic EPS= (1,200,000-30,000)/ 202,500
= Php 5.78

One-year dividend (whether declared or not) is deducted from profit

or loss because the preference shares are cumulative.

RETROSPECTIVE ADJUSTMENTS

 When ordinary shares are issued without a corresponding change in resources

(assets), the basic and diluted EPS and the weighted average number of ordinary
shares outstanding during the period and for all periods presented are adjusted
retrospectively.
 Examples of issuance of ordinary shares without a corresponding change in
resources include:
o Share or stock dividend (capitalization or bonus issue)
o A bonus element in any other issue (e.g., preemptive stock rights)
 o Share split or stock split-up (i.e., increase in number of shares with
corresponding decrease in par value); and
o Reverse share split or stock split-down (consolidation of shares or decrease
in number of shares with corresponding increase in par value).
 The aforementioned do not affect the entity’s assets because they are issued for free.

Illustration:

Entity A had 100,000 ordinary shares outstanding all through out 20x1. Entity a reported
profit of 7,200,000 in 20x1 and, accordingly, the basic earnings per share was
72(7,200,000/100,000).

In 20x2, three distributions of additional ordinary shares occurred:

 On April 1, a 10% bonus issue (share dividend) was declared.

 On July 1, 10,000 treasury shares were sold.
 On September 1, a 2-for-1 share split was issued.

Profit in 20x2 was 9,250,000.

 The weighted average number of ordinary shares outstanding are adjusted

retrospectively as follows:

20x1 20x2

1/1 (100,000 x 110% x 2) 220,000 (100,000 x 110% x2 x12/12) 220,000

4/1 -
7/1 (10,000 x 2 x 6/12) 10,000
9/1 -
Weighted average 220,000 220,000
 Bonus issues are retrospectively adjusted as of the earliest date that the related
shares are outstanding. Thus:
o The 10% share dividends are adjusted to all outstanding shares prior to April
1, 20x2. Accordingly, the share dividends do not affect the treasury shares
that were sold on July 1, 20x2.
 o The 2-for-1 share split is adjusted to all outstanding shares prior to
September 1, 20x2.
 The restated basic earnings per share are computed as follows:

20x2 20x1
Profit after tax 9,250,000 7,200,000
Adjusted weighted ave. no. of outstanding sh, 230,000 220,000
Basic EPS 40.22 32.73
 Notice that the share dividends and share split in 20x2 resulted to a restatement of
the 20x1 EPS from 72 (see given in the problem) to 32.73.

RIGHTS ISSUE

 When stock rights are issued to shareholders in conformance with their preemptive
right, the exercise price is normally less than the fair value of the shares.
 This type of rights issue includes a bonus element.
 Thus, for basic and diluted EPS computation, the number of shares outstanding for
all periods before the rights is multiplied by the following factor:
Adjustment factor= Fair value of stocks immediately before the

exercise of rights

Theoretical ex-rights fair value per share

 Theoretical ex-rights fair value per share

o Is “calculated by adding the aggregate market value of the shares
immediately before the exercise of the rights to the proceeds from the
exercise of the rights, and dividing by the number of shares outstanding after
the exercise of the rights.”
o Alternatively, the theoretical ex-rights fair value per share may also be
computed as follows:

Fair value of shares selling right-on xx

Less: Value of 1 right (xx)
Theoretical ex-rights fair value per share xx
  Where:

Value of 1 right= Fair value of share right-on – Subscription price

No. of rights needed to purchase one share + 1
Illustration:

Entity A has 100,000 ordinary shares outstanding on January 1, 20x1. Entity a offers rights
issue to its existing shareholders that enable them to acquire 1 ordinary share at a
subscription price of 80 for every 4 rights held. The rights are exercised on April 1, 20x1.
The market price of one ordinary share immediately before exercise is 120. Entity A
reported profit after tax of 900,000 in 20x1.

 The adjustment factor is computed as follows:

 Using the definition above:

Aggregate mkt. value of shares before exercise of rts.

(100,000 sh. x 120) 12,000,000
Add: Proceeds from exercise of rts. [(100,000 rts./4)x 80] 2,000,000
Total 14,000,000
Divide by: Outstanding shares after exercise of rts.
[100,000 sh. before exercise + (100,000 rts/4 rts per sh.)] 125,000
Theoretical ex-rights fair value per share 112
Fair value of stocks immediately before the

Adjustment factor= exercise of rights

Theoretical ex-rights fair value per share

 The adjustment factor is 120/112.

 Alternative solution:
Fair value of shares selling right-on (given) 120
Less: Value of 1 right (see below) (8)
Theoretical ex-rights fair value per share 112
 Where:
 Value of 1 right= Fair value of share right-on – Subscription price
No. of rights needed to purchase one share + 1
Value of 1 right = 120-80
4+1
Value of 1 right= (40/5)
= 8

Fair value of stocks immediately before the

Adjustment factor= exercise of rights

Theoretical ex-rights fair value per share

 The adjustment factor is 120/112.

The adjustment factor can also be stated as “FV of share right-on/FV of share ex-right.”

 The weighted average number of ordinary shares outstanding is compute as

follows:

Jan. 1: (100,000 x 120/112 x 3/12) 26,786

Apr. 1: (125,000 x 9/12) 93,750

Weighted average no. of outstanding ordinary shares 120,536

Notes:

 The adjustment factor is applied only to the outstanding shares before the
exercise date (i.e., April 1, 20x1).
 The number of outstanding shares on April 1,20x1, immediately after the exercise
of the rights, is computed as follows:

Ordinary shares before the exercise of rights 100,000

Shares issued on the exercise of rights
(100,000 rights/4 rights needed to purchase one share) 25,000
Outstanding shares after the exercise of rights 125,000
  The basic earnings per share is computed as follows:
Profit for the year 900,000
Divide by: Weighted average no. of outstanding sh.(see above) 120,536
Basic earnings per share 7.47
DILUTED EARNINGS PER SHARE
 An entity with dilutive potential ordinary shares (i.e., complex capital structure)
presents diluted EPS in addition to basic EPS.
 An entity with no dilutive potential ordinary shares (i.e., simple capital structure)
presents basic EPS only.
 Potential ordinary share
o Is “a financial instrument or other contract that may entitle its holder to
ordinary shares.”
 Examples of potential ordinary share:
o Convertible preference shares
 Are preference shares that are convertible into the issuer’s ordinary
shares.
o Convertible bonds
o Options, warrants and their equivalents
 Are “financial instruments that give the holder the right to purchase
ordinary shares.”
 Potential ordinary shares
o Are considered when computing for diluted EPS only when they are
dilutive.
o Potential ordinary shares are dilutive if, when exercised, they decreased
basic earnings per share or increase basic loss per share.
 Antidilutive potential ordinary shares
o Are ignored.
o Potential ordinary shares are antidilutive if, when exercised, they
increase basic earnings per share or decrease basic loss per share.
  Convertible bonds and convertible preference shares
o Are dilutive if their conversion decreases basic EPS or increases in basic
loss per share.
 Options, warrants and their equivalents
o Are dilutive if their exercise price is less than the market value of the
ordinary shares, making the exercise favorable on the part of the holder.
 The computation of diluted earnings per share is based on the assumption that the
dilutive potential ordinary shares were converted or exercised. It is:
1. “As if” the convertible preference shares or convertible bonds have been
converted; or;
2. “As if” the options or warrants have been exercised.
 The conversion or exercise is assumed to have taken place on the date the
potential ordinary shares first became outstanding, regardless of the date of
actual conversion or exercise.
 For example, convertible bonds outstanding as of January 1 are assumed to have
been converted on January 1. Options issued on April 1 are assumed to have been
exercised on April 1,
 Diluted EPS is computed as follows:
Profit(Loss) plus After tax interest expense on
convertible bonds

Diluted EPS= Weighted average number of outstanding ordinary share plus

Incremental shares arising from the assumed conversion of
exercise of dilutive potential
ordinary shares
CONVERTIBLE PREFERENCE SHARES
 When computing for diluted EPS, convertible preference shares are assumed to have
already been converted into additional ordinary shares.
 Thus, there is no adjustment to profit or loss for any dividends on the convertible
preference shares.
  The incremental shares arising from the assumed conversion of the convertible
preference shares are added in the denominator of the diluted EPS formula.
Illustration: Diluted EPS- Convertible preference shares
Entity A had the following capital structure during 20x1:
Convertible preference shares, 10 par, 6% cumulative,
50,000 shares issued and outstanding 500,000
Ordinary shares, 10 par, 200,000 shares issued and
outstanding 2,000,000
Each preference share is convertible into two ordinary shares. Profit after tax in 20x1 is
1,200,000.
 Entity a presents two EPS, basic and diluted, in its 20x1 statement of profit or loss.
Basic EPS
 Basic EPS= Profit (Loss) less Preferred dividends
Weighted average number of outstanding ordinary shares

Basic EPS= 1,200,000 – (500,00 x 6%)

200,000
Basic EPS= (1,200,000-30,000)/200,000=5.85
Diluted EPS
Profit(Loss) plus After tax interest expense on
convertible bonds

Diluted EPS= Weighted average number of outstanding ordinary share plus

Incremental shares arising from the assumed conversion of
exercise of dilutive potential
ordinary shares
Diluted EPS= 1,200,000 + 0
200,000 + (50,000 x2)
Diluted EPS= 1,200,000/300,000= 4.00
Notes:
 Profit is not reduced by the preferred dividends because the convertible preference
shares are assumed to have been converted into ordinary shares.
  No after tax interest expense is added because the potential ordinary shares are
convertible preference shares and not convertible bonds.
 The incremental shares are computed as (50,000 x2) because each of the 50,000
outstanding preference shares is convertible into two ordinary shares.
CONVERTIBLE BONDS
 When computing for diluted EPS, convertible bonds are assumed to have been
converted into additional ordinary shares.
 Thus, the after tax interest expense incurred on the bonds is added back to profit
or loss. It is net of tax because interest expense has a tax consequence.
 The incremental shares arising from the assumed conversion of the convertible
bonds are added in the denominator of the diluted EPS formula.
Illustration: Diluted EPS- Convertible bonds
Entity A had the following instruments outstanding all throughout 20x1:
10% convertible bonds payable issued at face amount, each
1,000 bond is convertible into 30 ordinary shares 4,000,000
Ordinary shares, 10 par, 200,000 share issued and
outstanding 2,000,000
 Profit for the year is 1,200,000. Entity A’s income tax rate is 30%.
Basic EPS
 Basic EPS= Profit (Loss) less Preferred dividends
Weighted average number of outstanding ordinary shares

Basic EPS= 1,200,000 – 0

200,000
Basic EPS= 6.00
Diluted EPS
Profit(Loss) plus After tax interest expense on
convertible bonds

Diluted EPS= Weighted average number of outstanding ordinary share plus

Incremental shares arising from the assumed conversion of
exercise of dilutive potential
 ordinary shares
Diluted EPS= 1,200,000 + (4,000,000 x10% x 70%
200,000 + [(4,000,000/1,000)x 30]
Diluted EPS= (1,200,000+280,000a)/(200,000+ 120,000)
Diluted EPS= (1,480,000/320,000b)=4.63
Alternative solutions:
Interest expense (4,000,000 x 10%) 400,000
Income tax benefit of the interest expense (400,000 x 30%) (120,000
a
After tax interest expense 280,000

Weighted average number of outstanding ordinary shares 200,000

Incremental shares (4,000,000 bonds/1,000 bonds)x 30 ord. shares 120,000
b
Denominator for diluted EPS computation 320,000
OPTIONS, WARRANTS AND THEIR EQUIVALENTS
 Options, warrants and their equivalents are considered in computing for diluted EPS
only when they are dilutive, such as when their exercise price is less than the
average market price of the ordinary shares (i.e., ‘in the money’).
 If the exercise price is less than the average market price of the ordinary shares, the
holder would probably exercise the option or warrant because the exercise is
favorable on his part. This would result to a dilution to a dilution in the number of
outstanding shares.
 On the other hand, if the exercise price is more than the average market price of the
price of the ordinary shares, the holder would probably not exercise the option or
warrant because the exercise is unfavorable on his part. Therefore, there would be
no dilution.
 When computing for diluted EPS, the “treasury share method” is used in
computing for the incremental shares. This method assumes that;
o The options or warrants are exercised; and
o The proceeds received from the exercise are used to purchase treasury
shares at the average market price.
 o The difference between the treasury shares assumed to have been
purchased and the option shares represents the incremental shares.
Illustration:
Entity A has the following information for the entire year:

Profit after tax 1,000,000

Outstanding ordinary shares, 1 par 100,000

Employee stock options outstanding during the entire year:

Option shares 10,000
Exercise price 140
Fair value of each share option 10
Average market price 200
Ending market price at year-end 300
Basic EPS
 Basic EPS= Profit (Loss) less Preferred dividends
Weighted average number of outstanding ordinary shares

Basic EPS= 1,000,000 – 0

100,000
Basic EPS= 10.00
Diluted EPS
The treasury shares assumed to have been purchased under “treasury share method” is
computed as follows:

Option shares 10,000

Multiply by: Total exercise price (see notes below) 150
Proceeds from assumed exercise of options 1,500,000
Divide by: Average market price 200
Treasury shares assumed to have been purchased 7,500
Notes:
  The total exercise includes the fair value of the share option. This is computed as
follows: (140 exercise price + 10 fair value of each share option)= 150 total
exercise price.
 The average market price is used in the computation while the ending price is
ignored.
 The incremental shares from the assumed exercise off the options are computed as
follows:
Option shares 10,000

Less: Treasury shares assumed to have been purchased (7,500)

Incremental shares 2,500

 The incremental shares are used in the computation of diluted EPS below:

Profit(Loss) plus After tax interest expense on

convertible bonds

Diluted EPS= Weighted average number of outstanding ordinary share plus

Incremental shares arising from the assumed conversion of
exercise of dilutive potential
ordinary shares
Diluted EPS= 1,000,000 + 0
100,000 + 2,500
Diluted EPS= 1,000,000/ 102,500= 9.76
MULTIPLE POTENTIAL ORDINARY SHARES
 When there are two or more potential ordinary shares, they need to be “ranked”
according to their dilutive effect on basic EPS.
 The most dilutive potential ordinary share is ranked first; the least dilutive is
ranked last.
 The most dilutive potential ordinary share is the one with the least incremental
EPS.
  When testing potential ordinary shares for dilution, the profit figure used as the
“control number” (i.e., the numerator in the EPS formula) is profit from
continuing operations.
 When computing for the diluted EPS, the potential ordinary shares are considered
step-by-step according to their “rankings.”
 If any time the diluted EPS exceeds the basic EPS, the entity discontinues
considering further any potential ordinary share and the lowest amount computed
is the amount presented as diluted EPS.
PRESENTATION
 The two EPS (basic and diluted) are presented with equal prominence on the face of
the statement of profit or loss and other comprehensive income.
 In the entity used a ‘two-statement’ presentation as described in PAS 1, it presents
the EPS only in the separate statement of profit or loss.
 EPS is presented every time a statement of profit or loss and other comprehensive
income is presented, including comparatives.
 If diluted EPS is presented for at least one period, it will be presented for all periods,
even if it equals basic EPS.
 Basic and diluted EPS are presented even if the amounts are negative (i.e., loss per
share).
 If an entity reports discontinued operations, it presents basic and diluted EPS for
each of the following
o Profit or loss from continuing operations
o Results of discontinued operations
o Profit or loss for the year.
 An entity is not required to present EPS on other comprehensive income and total
comprehensive income.
SUMMARY
 Basic EPS= Profit (Loss) less Preferred dividends
Weighted average number of outstanding ordinary shares
 If preference shares are cumulative, only one-year dividend is deducted, whether
or not.
 If non-cumulative, only the dividends declared are deducted.
 When computing for the weighted average number of outstanding ordinary
shares:
o Ordinary shares issued for cash are averaged from the date cash becomes
receivable.
o Treasury shares are averaged as a negative value from the acquisition date;
or as a positive value from the reissuance date.
o Share dividends and share splits are averaged retrospectively from the
original issuance date of the related shares on which the share dividends or
share splits are based.
 When stock rights are issued, the weighted average shares before the issued is
multiplied by the following adjustment factor: (FV of stocks right-on/ FV of stocks
ex-right).
 FV of stocks ex-right= FV stocks right-on less Value of 1-right
Profit(Loss) plus After tax interest expense on
convertible bonds

Diluted EPS= Weighted average number of outstanding ordinary share plus

Incremental shares arising from the assumed conversion of
exercise of dilutive potential
ordinary shares
 Diluted EPS
o Is computed when an entity has potential ordinary shares that are dilutive.
 Potential ordinary shares are dilutive if, when exercised, they decrease basic EPS or
increase basic loss per share.
 Diluted EPS is not presented if the effect of the potential ordinary share is
antidilutive.
PAS 34 INTERIM FINANCIAL REPORTING

INTRODUCTION

 PAS 34 Prescribed the minimum content of an interim financial report and the
recognition and measurement principles in complete or condensed financial
statements for an interim period.
 PAS 34 does not mandate which entities should produce interim financial reports.
 Is applied when an entity chooses, or is required by the government or other
institution, to publish interim financial report that complies with PFRS.
 PAS 34, however, encourages publicly listed entities to provide at least a semi-
annual financial report for the first half of the year to be issued not later than 60
days after the end of the interim period.
 Under the reportorial requirements of the Revised Securities Act in the Philippines,
the Securities and Exchange Commission (SEC) and the Philippine Stock Exchange
(PSE) require certain entities to provide quarterly financial reports within 45 days
after the end of the first three quarters.
o Similarly, the SEC requires entities covered under the Rules of Commercial
Papers and Financing Act to file quarterly financial reports within 45 days
after each quarter-end.
 Financial reports, whether annual or interim, are evaluated for conformity to the
PFRSs on their own.
 Non- preparation of interim reports or non-compliance with PAS 34 does not
necessarily prevent the entity’s annual financial statements from conforming to the
PFRSs.

INTERIM FINANCIAL REPORT

 Is a financial report prepared for an interim period and contains either:

o A complete set of financial statements as described in PAS 1; or
 o A set of condensed financial statements as described in PAS 4
 Interim period
o Is “a financial reporting period shorter than a full financial year.”
 An entity presenting an interim financial report has the option of applying either
PAS 31 or PAS 34.
o The entity applies PAS 1 if it opts to provide a complete set of financial
statements in its interim financial report.
o The entity applies PAS 34 it is opts to provide a condensed set of financial
statements in its interim financial report.

PAS 1 Complete set of FS PAS 34 Condensed set of FS

1. Statement of financial position 1. Condensed statement of financial
2. Statement of profit or loss and other position
comprehensive income 2. Condensed statement of profit or
3. Statement of changes in equity loss and other comprehensive
4. Statement of cash flows income
5. Notes 3. Condensed statement of changes in
5.a Comparative information equity
6. Additional statement of financial 4. Condensed statement of cash flows
position (required only when certain 5. Selected explanatory notes
instances occur)
 An entity is not prohibited or discouraged from preparing a complete set of financial
statements (in accordance with PAS1) for its interim financial reporting.
 However, in view of timeliness and cost considerations and to avoid repetition of
information previously reported, an entity may be required or elect to provide less
information at interim dates as compared with its annual financial statements.
o In such case, the entity applies PAS 34 to provide a set of condensed
financial statements.
o Condensed
 Means the entity need only provide the minimum information
required under PAS 34.
  At a minimum, condensed interim financial statements include each of the headings
and subtotals that were included in the entity’s most recent annual financial
statements and the selected explanatory notes required by PAS 34.
o Additional line items or notes are provided if their omission makes the
condensed financial statements misleading.

SIGNIFICANT S\EVENTS AND TRANSACTIONS

 Interim reports
o Are intended to provide an update on the latest complete set of annual
financial statements.
o Hence, they focus on providing information on significant events and
transactions that have occurred since the latest annual period, rather
than duplicating previously reported information or providing relatively
insignificant updates on them.
o Consequently, users of interim financial report are assumed to also have
access to the entity’s latest annual financial report.
o Examples of events and transactions fro which disclosures would be required
if they are significant:
 Write-down of inventories and reversal thereof
 Impairment losses and reversal thereof
 Reversal of provision for restructuring costs
 Acquisitions and disposals of PPE, including purchase commitments
 Litigation settlements
 Corrections or prior period errors
 Business or economic circumstances affecting the fair value of
financial assets and financial liabilities
 Unremedied loan default or breach of loan agreement
 Related party transactions
 Transfers between levels of the fair value hierarchy used in measuring
the fair value of financial instruments
  Changes in the classification of financial assets
 Change sin contingent liabilities or contingent assets

OTHER DISCLOSURES

 In addition to significant events and transactions, the following are also disclosed in
the interim financial report:
o A statement that the same accounting policies were used in the interim
financial statements. If there have been charges, those changes are disclosed.
o Explanation of seasonality or cyclicality of interim operations
o Unusual items affecting the financial statement elements
o Changes in accounting estimates
o Issuances and settlements of debt and equity securities
o Dividends paid
o Segments information (if the entity is covered by PFRS 8)
o Events after the reporting period
o Changes in the composition of the entity, e.g., business combinations,
obtaining or losing control of subsidiaries, restructurings, and discontinued
operations
o Disclosures on the fair value of financial instruments
o Disclosures required by PFRS 12 when the entity becomes or ceases to be an
investment entity
o Disaggregation of revenue from contracts with customers as required by
PFRS 15
 The entity presents basic and diluted earnings per share if the entity is within the
scope of PAS 33.
 The entity discloses its compliance with PFRSs if it has complied with PAS 34 and
all the requirements of other PFRSs.

PERIODS FOR WHICH INTERIM FINANCIAL STATEMENTS ARE PRESENTED

  The following illustrates the periods covered by interim financial statements,
including comparative information:

SEMI-ANNUAL INTERIM FINANCIAL REPORTING

 For an entity that uses the calendar year as its accounting period, the following
interim financial statements will appear in its semi-annual interim financial report
on June 30, 20x1:

Current time Comparative

Statement of financial position
As of June 30, 20x1 December 31,20x0
Statement of profit o loss and other comprehensive income
For the 6 months ending June 30, 20x1 June 30, 20x0
Statement of changes in equity
For the 6 months ending June 30,20x1 June 30,20x0
Statement of cash of flows
For the 6 months ending June 30, 20x1 June 30, 20x0

QUARTERLY INTERIM FINANCIAL REPORTING

 For an entity that used the calendar year, the following statements will appear in the
its third quarter interim financial report on September 30, 20x1.

Current time Comparative

Statement of financial position
As of September 30, 20x1 December 31,20x0
Statement of profit o loss and other comprehensive income
For the 9 months ending June 30, 20x1 June 30, 20x0
For the 3 months ending September 30,20x1 September 30, 20x0
Statement of changes in equity
For the 9 months ending September 30,20x1 September 30,20x0
Statement of cash of flows
For the 6 months ending September 30, 20x1 September 30, 20x0
Notes:

 The comparative statement of financial position is the most recent annual

financial statement.
 For the other financial statements, the comparatives are presented on a comparable
year-to-date period.
 The interim financial statements are presented on a cumulative basis (year-to-
date). However, an additional statement of profit or loss and other
comprehensive income is presented that covers the current quarter only.
 If an entity’s business is highly seasonal, PAS 34 encourages disclosures of financial
information for the latest 12 months and comparative information for the prior
12-month period in addition to the interim period financial statements above.
 If an entity changes an accounting estimate in the final interim period (e.g., 4 th
quarter) but interim financial statements are not prepared for that period, the
change in accounting estimate is disclosed in the annual financial statements.

MATERIALITY

 Materiality judgments on recognition, classification and disclosure of items in the

interim financial report are assessed in relation to the interim period financial data,
and not forecasted annual data.
 Pas 34 recognizes that interim measurements may rely on estimates to a greater
extent than measurements of annual financial data.

RECOGNITION AND MEASUREMENT

SAME ACCOUTNIGN POLICIES AS ANNUAL

 The same accounting policies are used in interim reports as those used in annual
reports, except for accounting policy changes made after the date of the most recent
annual financial statements that are to be reflected in the next annual financial
statements.
TWO VIEWS ON INTERIM REPORTING

1. Integral view
 The interim period is considered as an integral part of the annual accounting
period.
 Thus, annual operating expenses are estimated and then allocated to the
benefitted interim periods based on forecasted annual activity levels.
 Subsequent interim period financial statements are adjusted to reflected the
effect of changes in estimates in earlier interim periods of the same financial
year.
2. Discrete view
 The interim period is considered as a discrete (‘stand-alone’) accounting
period.
 The same expense recognition principles applied in annual reporting are
used in the interim period.
 No special interim accruals or deferrals are made.
 Annual operating expense are recognized in the interim period in which they
are incurred regardless of whether subsequent interim periods are
benefitted.
 Proponents of the integral view
a. Argue that the estimation and allocation procedures for interim expenses are
necessary to avoid fluctuations in period-to-period results that might be
misleading to financial statement users.
b. The use of integral view arguably increases the predictive value of interim
reports by showing interim performance that is indicative of what the annual
performance would be.
 Proponents of the discrete view
a. Argue that smoothing interim results for purposes of forecasting annual
performance may have undesirable effects.
b. A significant change in performance trend could be obscured if smoothing
techniques implied by the integral view approach were to be employed.
 PAS 34 adopts a combination of the two views.
 PAS 34.29 recognizes that while the requirement that same accounting policies shall
be used in the interim period as those used in the annual period suggests that the
interim period is a stand-alone period (discrete view).
 PAS 34.28 states that the frequency of the reporting (annual, half-yearly, or
quarterly) shall not affect the measurement of the annual results, which is on a year-
to date basis; and therefore, the interim period is part of a larger financial year
(integral view).
 PAS 34 provides the following accounting principles:
a. Losses from inventory, write-downs, restructurings, or impairments in an
interim period are accounting for in the same way as in annual financial
statements (i.e., losses are recognized immediately in the interim period in
which they arise).
 If there are subsequent changes in estimates, the original estimate is
adjusted by accruing an additional loss or by reversing a previously
recognized loss.
 Financial statements in previous interim periods are not restated.
b. A cost that does not qualify as an asset in an interim period is not deferred
either to wait if it qualifies in the next period or to smooth earnings over the
interim periods within a financial year.
 Likewise, a liability at the end of an interim period must meet all the
recognition criteria at that date, just as it must at the end of an annual
reporting period.
c. Income tax expenses in interim periods are based on the best estimate of
the weighted average annual income tax rate expected for the full financial
year.
 Losses and cost favor the discrete view.
 Income tax expenses favor the integral view.
 The recognition principles of assets, liabilities, income and expenses under the
Conceptual Framework are applied in the interim period in the same way as in the
annual period.
  Thus, items that do not qualify as assets, liabilities, income or expenses in the annual
period do not also qualify as such in the interim period.

MEASUREMENT

 Measurements in the interim period are made on a year-to-date basis, so that the
frequency of reporting (annual, semi-annual, or quarterly) does not affect the
measurement of annual results.

REVENUSES RECEIVED SEASONALLY, CYCLICALLY, OR OCCASIONALLY

 Revenues that are received seasonally, cyclically, or occasionally are not anticipated
or deferred in the interim period if anticipation or deferral is also not appropriate at
the end of the annual period. Examples include:
o Dividend revenue
o Royalties
o Government grants
 Such revenues are recognized when they occur.

COSTS INCURRED UNEVENLY DURING THE FINANCIAL YEAR

 Costs that are incurred unevenly during a financial year are anticipated or deferred
in the interim period only if it is also appropriate to anticipate or defer them at the
end of the financial year.

PAS 36 IMPAIRMENT OF ASSETS

INTRDUCTION
PAS 36

 Prescribes the procedures necessary to ensure that assets are not carries in excess
of their recoverable amount.
 Applies in accounting for the impairment of the following assets:
o Property, plant, and equipment
o Investment property measured under the cost model
o Investments in associates, joint ventures and subsidiaries
o Intangible assets
o Goodwill
 The assets within the scope of PAS 36 are noncurrent assets.

CORE PRINCIPLE

 The carrying amount of an asset shall not exceed its recoverable amount.
 If the carrying amount of an asset exceeds its recoverable amount, the assets is
impaired.
 The excess shall be written-off as impairment loss.
 If carrying amount is greater than recoverable amount, the asset is impaired.
The excess is impairment loss.
 If carrying amount is equal to or less than recoverable amount, the asset is not
impaired. No accounting problem.
 Carrying amount

o Is “the amount at which an asset is recognized after deducting any

accumulated depreciation amortization) and accumulated impairment losses
thereon.”
 Recoverable amount
o Is the amount expected to be recovered from the sale or use of an asset. It is
higher of an asset’s:
 Fair value less costs of disposal, and
 Value in use
  Fair value
o Is “the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date.”
 Costs of disposal
o Are” incremental costs directly attributable to the disposal of an asset or
cash-generating unit, excluding financial costs and income tax expense.”
 Value in use
o Is “the present value of the future cash flows expected to be derived from an
asset or cash-generating unit.”

Illustration:

On December 31, 20x1, Entity a determines that its building is impaired. The following
information is gathered:

Building 1,000,000

Accumulated depreciation 300,000

Fair value less costs of disposal (FVLCD) 600,000

Value in use (VIU) 580,000

 The impairment loss is computed as follows:

Recoverable amount (higher of FVLCD and VIN) 600,000

Less: Carrying amount (1,000,000-300,000) (700,000)

Impairment loss (100,000)

IDENTIFYING AN ASSET THAT MAY BE IMPAIRED

 The entity assesses at the end of each reporting period whether there is an
indication that an asset may be impaired.
 If such an indication exists, the entity estimates the recoverable amount of the asset.
  If no such indication exists, the entity need not estimate the recoverable amount of
the asset.

INDICATIONS OF IMPAIRMENT

 An entity shall consider the following indications of impairment:

I. External sources of information:
a. Significant decline in the asset’s (market) value.
b. Significant changes in technological, market, economic, or legal
environment that adversely affect the recoverable amount of an asset.
c. Increase in market interest rates that adversely affect the discount
rate used in calculating an assets value in use, and consequently, its
recoverable amount.
d. The carrying amount of an entity’s net assets exceeds it market
capitalization.
II. Internal sources of information
e. Obsolescence or physical damage of an asset.
f. Significant changes in the expected use of an asset that adversely
affect its recoverable amount (e.g., the asset becomes idle, plan to
discontinue or restructure the operation to which an asset belongs,
plan to dispose of the asset earlier than expected, and reassessment of
an asset’s useful life from indefinite to finite).
g. Indications that the economic performance of an asset is, or will be,
worse than expected (e.g., the maintenance costs of the asset are
significantly higher than expected; or the cash inflows from the asset
are significantly lower than expected).
 An indication that an asset may be impaired may be impaired may signify that the
remaining useful life, the depreciation or amortization method, or the residual value
of the asset needs to be reviewed and adjusted even if no impairment loss is
recognized for the asset.

REQUIRED TESTING FOR IMPAIRMENT

  The following assets are required to be tested for impairment at least annually
even if there are no indications for impairment:
a. Intangible asset with indefinite useful life
b. Intangible asset not yet available for use
c. Goodwill acquired in a business combination
 These assets may be tested for impairment at any time during the annual period
provided it is performed at the same time every year.
 Concurrent testing is not required for dissimilar assets.
 Such an asset recognized during the year must be tested for impairment in relation
to the cash-generating unit which it has beel allocated.

MEASURING RECOVERABLE AMOUNT

 Recoverable amount is the higher of an asset’s FVLCD and VIU.

 Pas 36 provides the following guidance when measuring an asset’s recoverable
amount:
o It is not always necessary to determine both the FVLCD and VIU. If one of
them exceeds the asset’s carrying amount, the asset is not impaired, and the
other amount need not be computed.
o If it is not possible to determine the FVLCD, the VIU is used as the recoverable
amount.
o If there is no reason to believe that the VIU exceeds the FVLCD, the FVLCD is
used as the recoverable amount. This is normally the case if the asset is held
for disposal.

FAIR VALUE LESS COSTS OF DISPOSALS (FVLCD)

 An entity uses (PFRS 13 Fair Value Measurement when measuring an asset’s fair
value.
 Costs of disposal, except those that have been recognized as liabilities, are deducted
in measuring fair value less costs of disposal. Examples of such costs are:
 o Legal costs, stamp duty and similar transaction taxes
o Costs of removing the asset
o Direct incremental costs to bring an asset into condition for its sale
 Termination benefits and costs associated with reducing or reorganizing a business
following the disposal of an asset are not regarded as costs of disposal.

VALUE IN USE (VIU)

 Value in use
o Is the present value of the future net cash flows expected to be derived from
the continuing use off an asset and from its disposal at the end of its useful
life. VIU is computed using the following steps:
1. Estimate the future cash inflows and outflows expected to be derived
from continuing use of the asset and from its final disposal.
2. Apply an appropriate discount rate to those future cash flows.

ESTIMATES OF FUTURE CASH FLOWS

 Cash flow projections are based on management’s best estimates. When making the
estimates, management gives greater weight to external evidence.
 Cash flow projections are based on the most recent financial budgets/forecasts
approved by management.
 Cash flow projections are based on the asset’s current condition and exclude and
include the following:

Exclude cash flows arising from:
1. Future restructurings not yet
committed
2. Improving or enhancing the asset’s
performance
3. Income taxes
4. Financing activities
Include cash flows arising from:
1. Revenues to be derived from the
continuing use of the asset
2. Day-to-day costs of using the asset
3. Any residual value of the asset and
disposal costs
  Cash flow projections cover a maximum period of 5 years, unless a longer period
can be justified.
o Projections beyond the 5-year period are extrapolated using a steady or
declining growth rate (e.g., zero or negative), unless an increasing rate can be
justified.
 “To avoid double-counting, estimates of future cash flows do not include:
o Cash inflows from assets that generate cash inflows that are largely
independent of the cash inflows from the asset under review (for example,
financial assets such as receivables); and
o Cash outflows that relate to obligations that have been recognized as
liabilities (for example, payables, pensions or provisions).”
 Cash flow projections based on a foreign currency are translated using the spot
exchange rate at the date the VIU is calculated.

DISCOUNT RATE

 The discount rate is a pre-tax rate that reflects current assessments of the time
value of money and risks for which the future cash flow estimates have not been
adjusted.
 VIU computation takes into account the effect of inflation.
 However, to avoid double-counting, either the estimates of future cash flows or the
discount rate is adjusted for inflation, but not both.

RECIGNIZING AND MEASURING AN IMPAIRMENT LOSS

 If the carrying amount of an asset exceeds its recoverable amount. The reduction is
impairment loss.
 Impairment loss
 o Is recognized immediately in profit or loss, unless the asset is carried at
revalued amount, in which case, revaluation surplus is decreased first and
any excess is recognized in profit or loss.
 The decrease in the revaluation surplus is recognized in other
comprehensive income.
o If the impairment loss exceeds the carrying amount of the asset, a liability is
recognized if this is required by another PFRS. For example, this would be the
case for a leased asset for which the lessee guarantees a residual value.
o After impairment, the subsequent depreciation (amortization) for the asset
is based on the asset’s recoverable mount.

Illustration:

On December 13, 20x0, ABC Co. identifies that its building with a carrying amount of
600,000 is impaired. Is estimating the recoverable amount, Entity A determines the
following information:

 Fair value less costs of disposal, 400,000

 Projected cash flows:

Year Future cash inflows Future cash outflows

20x1 300,000 100,000
20x2 280,000 100,000
20x3 260,000 80,000
 The discount rate is 10%. The following are the relevant present value factors:
PV of 1 @10%, n=1 0.909091
PV of 1 @10%, n=2 0.826446
PV of 1 @10%, n=1 0.751315
 The value in use is computed as follows:

Year Cash inflows Cash outflows Net cash flows PV factors Present value
(a) (b) (c)=(a) – (b) (d) (e)=(c) x (d)
20x1 300,000 100,000 200,000 0.909091 181,818
20x2 280,000 100,000 180,000 0.826446 148,760
 20x3 260,000 80,000 180,000 0.751315 135,237
Value in use 465,815

 The impairment loss is computed as follows:

Recoverable amount (VIU-higher) 465,815

Less: Carrying amount (600,000)

Impairment loss (134,185)

 If the building has a remaining useful life of 10 years and a zero residual value, the
depreciation in subsequent periods using the straight-line method is computed as
follows:

Recoverable amount 465,815

Less: Carrying amount (10)
Revised depreciation 46,582

CASH-GENERATING UNITS AND GOODWILL

 Recoverable amount is normally determined for an individual asset, except when

the asset belongs to a cash-generating unit (CGU), in which case, recoverable
amount is determined for the CGU to which the asset belongs.
 Cash-generating unit (CGU
o Is “the smallest identifiable group of assets that generates cash inflows that
are largely independent of the cash inflows from other assets or groups of
assets.”
 For example, a CGU may be a:
o Retail store of a fast food chain
o A bookstore of a school
o A convenient store of a gasoline station
o A supermarket of a mall
o A product line, etc.
  These examples generate cash flows that are independent from the
cash flows of the entity as a whole. If these segments are the smallest
identifiable group of assets, then they are considered as CGUs.
 Assets are generally tested for impairment individually.
 Accordingly, their recoverable amounts are determined individually.
 However, when it is not possible to determine an individual asset’s recoverable
amount, the recoverable amount of the CGU to which that individual asset belongs is
determined.
 This would be the case if the asset’s VIU cannot be estimated to be close to its FVLCD
and the asset does not independently generate its own cash inflows.
 In such cases, the asset is tested for impairment, not on its own, but together with
the other assets in the CGU as a whole.
 As an exception, an asset for which management is committed to dispose is
tested for impairment separately even if it belongs to a CGU.

RECOVERABLE AMOUNT AND CARRYING AMOUNT OF A CGU

 The recoverable amount of a CGU is the higher of the CGU’s FVLCD and VIU.
 The CGU’s carrying amount is determined in a manner that is consistent with how
the CGU’s recoverable amount is determined,
 Accordingly, the carrying amount of a CGU includes only those assets and liabilities
that are directly attributable to the CGU or are allocated to the CGU on a reasonable
basis and will generate the future cash flows used in determining the CGU’s value in
use.
 The carrying amount of a CGU does not include financial assets, such as receivables,
and recognized liabilities, such as payables, pensions or provisions, just as these
items are excluded in determining the CGU’s recoverable amount.
 However, for practical reasons, the recoverable amount of a CGU is sometimes
determined by considering financial assets, such as receivables, and recognized
liabilities, such as payables, pensions or provisions. In such case, these items are also
included in the CGU’s carrying amount.
GOODWILL

 For purposes of impairment testing, goodwill recognized in a business

combination is allocated to each of the acquirer’s CGUs in the year of business
combination.
 If the allocation cannot be completed before the end of that year, it must be
completed before the end of the immediately following year.
 Goodwill
o Does not generate its own cash flows but it often contributes to the cash
flows of multiple CGUs
o Is an unidentifiable asset; thus, it can only be tested for impairment if it is
allocated to the CGUs that are expected to benefit from the synergies of the
combination.
 The CGUs to which goodwill is allocated represent the lowest levels within the entity
at which the goodwill is monitored for internal management purposes and are not
larger than an operating segment.
 If a CGU to which goodwill is allocated is partially disposed, the allocated goodwill is
reallocated to the portions sold and unsold based on their relative values for
purposes of determining the gain or loss on the disposal.
 Similarly, if an entity reorganizes its reporting structure in a manner that changes
the composition of CGUs to which goodwill has been allocated, the goodwill is
reallocated to the CGUs affected based ont heir relative vlues.

IMPAIRMENT OF A CGU

 A CGU to which goodwill has been allocated or contains an intangible asset which
indefinite useful life or an intangible asset not yet available for use is tested for
impairment at least annually whether or not there are indications of impairment.
 A CGU is tested for impairment by comparing the CGU’s carrying amount, including
any allocated goodwill, with CGI’s recoverable amount.
  The CGU is impaired if its carrying amount, including the allocated goodwill, exceeds
its recoverable amount. In such case, the impairment loss on the CGU is allocated as
follows:
a. First, to any goodwill included in the CGU;
b. Then, to the other assets of the CGU pro rate based on their carrying
amounts.
 When allocating the impairment loss, the carrying amount of an asset belonging to
the CGU shall not be reduced below the highest of:
a. Its fair value less costs of disposal (if determinable)
b. Its value in use (if determinable); and
c. Zero
 Any amount that cannot be allocated to an asset because of the limitation above is
allocated to the other assets of the CGU pro rate based on their carrying amounts.
 If the recoverable amount of an individual asset cannot be determined, no
impairment loss is recognized for that asset if the CGU to which it belongs is not
impaired. This applies even if the individual asset’s fair value less costs of disposal
is less than its carrying amount.

Illustration:

Entity A determines that one of its cash-generating units is impaired. The following
information was gathered:

 Carrying amount of CGU

Assets Carrying amount

Inventory 200,000
Investment property (at cost model) 400,000
Building 600,000
Goodwill 300,000
1,500,000

o Fair value less costs of disposal of CGU: 900,000

 o Value in use of CGU: 1,000,000
 The impairment loss is computed as follows:

Recoverable amount (value in use-higher) 1,000,000

Carrying amount (1,500,000)
Impairment loss (500,000)

 The impairment loss is allocated as follows:

First, to goodwill:
Impairment loss (500,000)
Allocation to goodwill 300,000
Excess impairment loss (200,000)
Then, to the other noncurrent assets in the CGU:

Assets Carrying amounts Fractions Allocation of excess Impairment loss

Inventory N/A N/A N/A -

Investment property 400,000 400/1,000 (-200K x 400/1,000) (80,000)
Building 600,000 600/1,000 (-200K x 600/1,000) (120,000)
1,000,000 1,000/1,000 (200,000)

Notes:

 No impairment loss is allocated to the inventory because inventories are outside the
scope of Pas 36.
 The impairment loss on a CGU is allocated only to the assets that are within the
scope of PAS 36.
 The fractions above are derived from the carrying amounts of the noncurrent assets.
 The carrying amount of the CGU after impairment is analyzed below:

Assets Carrying amounts Allocations of Carrying amounts

BEFORE impairment loss AFTER
Impairment Impairment
Inventory 200,000 - 200,000
Investment property 400,000 (80,000) 320,000
Building 600,000 (120,000) 480,000
Goodwill 300,000 (300,000) -
1,500,000 (500,000) 1,000,000

 The procedure illustrated above is called the “bottom-up test.”

 This is performed when goodwill can be allocated to individual CGUs on a
reasonable and consistent basis.
 However, if goodwill cannot be allocated t individual CGUs but only to groups of
CGUs, the entity performs both a “bottom-up test” and a “top-down test,” as
follows:
a. Compare the carrying amounts of the CGUs comprising the smallest unit (i.e.,
the group of CGUs) to which goodwill can be allocated, excluding the
goodwill, with their respective recoverable amounts. Recognize any
impairment loss.
b. Compare the carrying amount of the unit as a whole after recognizing any
impairment loss from procedure (a) above with the unit’s recoverable
amount (top-down test”). Recognize any additional impairment loss.

CORPORATE ASSETS

 Are assets that contribute to the future cash flows of several departments of
divisions within an entity. Examples include Electronic Data Processing (EDP)
equipment, such as:
o A mainframe computer used by several divisions within an entity,
o The entity’s headquarters building or a research center.
  Do not independently generate their own cash inflows. Thus, to test a corporate
asset for impairment, it needs to be allocated to the various CGUs using that asset.
 The accounting procedures applied to the impairment testing of a corporate asset
are similar to those applied to goodwill.

REVERSAL OF IMPAIRMENT LOSS

 The entity assesses at the end of each reporting period whether there is an
indication that an impairment loss recognized in prior periods for an asset may no
longer exist or may have decreased.
 If such indication exists, the entity estimates the recoverable amount of that asset.
 In making the assessment, the entity considers the exact opposites of the
indications of impairment provided earlier (e.g., significant increase in the asset’s
market value – rather than decline, significant changes in technological…… that
favorably affect the recoverable amount of an asset – rather than adversely, etc.)
 If the recoverable amount of the previously impaired asset exceeds its carrying
amount,
 The increase is the reversal of impairment loss. However, this is subject to the
following limitations:
o The reversal of impairment shall not result to a carrying amount in excess of
the asset’s would-be carrying amount had no impairment loss been
recognized in prior periods; and
o Impairment loss on goodwill is never reversed.
 The reversal of impairment loss is recognized in profit or loss, unless the asset is
carried at revalued amount, in which case, revaluation surplus is increased for the
portion representing a revaluation increase.
 The revaluation increase is recognized in other comprehensive income.
 The portion that represents a reversal of an amount that was previously recognized
in profit or loss is also recognized in profit or loss.
 After reversal impairment, the subsequent depreciation (amortization) for the
asset is based on the asset’s revised carrying amount.
  An indication that a previously recognized impairment loss may no longer exist or
may have decreased may signify that the remaining useful life, the depreciation or
amortization method, or the residual value of the asset needs to be reviewed and
adjusted even if no reversal of impairment loss is recognized.
 For a CGU, the reversal of impairment loss is allocated as increases in the carrying
amounts of the assets in the CGU, except goodwill, pro rata based ont heir carrying
amounts.
 In making this allocation, the carrying amount of an asset shall not be increased
above the lower of:
o Its recoverable amount (if determinable); and
o Its would-be carrying amount had no impairment loss bee recognized in
prior periods.

Illustration:

On January 1, 20x1, Entity A acquires a building for a total cost of 1,200,000. The building
is estimated to have a 30-year useful life and a 5% residual value. Entity A uses the straight-
line method of depreciation.

 The annual depreciation is 38,000 [1,200,000 x 95%)/30].

On December 31, 20x5, Entity a determines that the building is impaired and makes the
following estimates:

Fair value less costs to sell………………….. 650,000

Value in use…………………………………………750,000

 The impairment loss is computed as follows:

Recoverable amount (VIU-higher) 750,000
Carrying amount 1,010,000
Impairment loss (260,000)
 Following the impairment, Entity A revises the building’s residual value to 5% of the
recoverable amount.
 The revised annual depreciation in subsequent periods is 28,500 [750,000 x
95%)/25 years remaining].
 On December 31, 20x8, Entity A determines an indication that the impairment loss
recognized in the prior period may no longer exist. Entity A makes the following
estimates and computations:
Fair value less costs to sell………………800,000
Value in use……………………………………900.000
 The new recoverable amount is 900,000 (higher).
 The actual carrying amount on December 31, 20x8 is computed as follows:
Carrying amount (C.A)- 12/31/x5 750,000
Accumulated depreciation (28,500 x 3 years) (85,500)
Carrying amount (C.A.)- 12/31/x8 664,500
 The would-be carrying amount had no impairment loss been recognized in the
prior period is computed as follows:
Historical cost 1,200,000
Accumulated (original) depreciation (38,000 x 8 years) (304,000)

Carrying amount had not impairment loss been

Recognized in prior period – 12/31/x8 896,000

 The reversal of impairment loss is computed as follows:

 From the graph above, the components of the reversal are analyzed as
follows:
C.A had no impairment loss been recognized in prior pd. 896,000
C.A at date of reversal 664,500

Gain on reversal of impairment loss (profit or loss) 231,500

New recoverable amount 900,000

C.A had no impairment loss been recognized in prior pd. 896,000

Revaluation increase (other comprehensive income) 4,000

Total increase in carrying amount 235,500

SUMMARY:

 An asset is impaired if its carrying amount exceeds its recoverable amount. The
excess represents the impairment loss.
 Recoverable amount is the higher of an asset’s (a) fair value less costs of
disposal and its (b) value in use.
 An asset is tested for impairment only when an indication of impairment exists,
except for certain intangible assets that are required to be tested for impairment at
least annually.
 It is not always necessary to compute both the FVLCD and the VIU. If any one of
them exceeds the carrying amount, the asset is not impaired and the other one need
not be computed. If the FVLCD cannot be determined, the VIU is sued as the
recoverable amount is the FVLCD.
 Value in use is the present value of estimated future cash flow expected to arise
from the continuing use of an asset (or CGU) and from its disposal at the end of its
useful life.
 Impairment loss is recognized in profit or loss, unless it represents a revaluation
decrease.
 After impairment, the subsequent depreciation (amortization) for the asset is based
on the asset’s recoverable amount.
 If an asset’s recoverable amount can be determined reliably, it is tested for
impairment on its own. If its recoverable amount cannot be determined reliably, the
CGU to which that asset belongs is the one tested for impairment.
 For purposes of impairment, goodwill and corporate assets are allocated to CGUs.
 The impairment loss on a CGU is allocated first to any goodwill in the CGU. The
excess is allocated to the other assets of the CGU pro rata based on their carrying
amounts.
 The reversal of impairment loss shall not result to a carrying amount in excess of
the asset’s would-be carrying amount had no impairment loss been recognized in
prior periods.
 Impairment loss on goodwill is never reversed.
PAS 37 PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS

INTRODUCTION

PAS 37

 Prescribes the accounting and disclosure requirements for provisions, contingent

liabilities and contingent assets to help users understand their nature, timing and
amount,
 Applies to the accounting for provisions, contingent liabilities and contingent assets,
except those arising from executor contracts, unless they are onerous, and those
that are covered by other PFRSs.
 Executor contracts
o Are contracts that are not yet fully executed, meaning, the parties thereto still
have obligations to perform.
 Onerous
o Means burdensome.
o A contract becomes onerous when the cost of fulfiling it exceeds the
economic benefits expected to be derived from it.
 For example, Entity A commits to purchase 1,000 units of inventory for 100 per unit
under a non-cancellable purchase commitment for future deliver.
 Generally, no liability is recognized on the contract until the inventories are
delivered.
 However, if the inventories become obsolete before the delivery, such that the price
declines to 20 per unit, Entity A recognizes a loss of 80 per unit (100 committed
price-20 actual price).
o In this case, PAS 37 applies because the contract became onerous.

PROVISIONS

 Is a liability of uncertain timing or amount.

  Provisions differ from other liabilities because of the uncertainty in the timing of
their settlement of the amount needed to settle them.
 Unlike other liabilities, provisions must necessarily be estimated.
 Although some other liabilities are also estimated, their uncertainty is generally
much less compared to provisions.
 Examples of provisions:
a. Warranty obligations
b. Estimated liabilities on pending lawsuits
c. Provisions for environmental damages
d. Provisions of decommissioning costs of an item of PPE
e. Obligations caused by an entity’s policy to make refunds to customers
f. Obligations arising from guarantees
g. Provisions on onerous contracts (e.g., purchase commitment)
h. Provisions for restructuring costs
 Provisions are presented in the statement of financial position separately from
other types of liabilities.

RECOGNITION

 A provision is recognized when all of the following conditions are met:

a. The entire has a present obligation (legal or constructive) resulting from a
past event;
b. It is probable that an outflow of resources embodying economic benefits will
be required to settle the obligation; and
c. The amount of the obligation can be reliably estimated.
 If any of the conditions is not met, no provision is recognized.

PRESENT OBLIGATION

 In rare cases where it is not clear whether there is a present obligation, an entity
deems a past event to give rise to a present obligation if available evidence shows
that it is more likely than not that a present obligation exists at the end of the
reporting period.
PAST EVENT

 Obligating event
o A past event that creates a present obligation.
o Is one whereby the entity does not have any other recourse but to settle an
obligation. This is the case where:
a. The obligation is legally enforceable (legal obligation); or
b. The entity’s actions (e.g., past practice or published policies) have
created valid expectations on others that the entity will discharge the
obligation (constructive obligation).
 Financial statements deal with past or historical information.
o Therefore, no provision is recognized for future operating costs.
o The only liabilities recognized in an entity’s statement of financial position
are those that exist at the end of the reporting period.
 Only those obligations arising from past events existing independently of an entity’s
future actions are recognized as provisions.
o Thus, possible outflows of resources embodying economic benefits that the
entity can avoid by changing its future actions are not recognized as
provision.
 Although an obligation always involve another party to whom the obligation is owed
(i.e., oblige), it is not necessary that the identity of the oblige is known- indeed the
oblige may be the public at large.
 For a constructive obligation to create a valid expectation on others, it is necessary
that the commitment must have been communicated to the parties concerned before
the end of the reporting period.

PROBABLE OUTFLOW OF RESOURCES EMBODYING ECONOMIC BENEFITS

 Probable
o Means “more likely than not.”
o Meaning there is a greater chance that the present obligation will cause
settlement than not.
RELIABLE ESTIMATE OF THE OBLIGATION

 Provisions necessarily need to be estimated.

 If a reliable estimate cannot be made, no provision is recognized.

CONTINGENT LIABILITIES

 In a general sense, all provisions are contingent because they are of uncertain timing
or amount.
 However, PAS 37 uses the term “contingent” to refer to those liabilities and assets
that are not recognized because they do not meet all of the recognition criteria.
 A provision and a contingent liability are differentiated below:

Provision Contingent liability

 A liability of an uncertain timing
or amount that meets all of the
following conditions:
a. Present obligation
b. Probable outflow; and
c. Reliably estimated
 A possible obligation whose
existence will be conformed only
by the occurrence or non-
occurrence of one or more
uncertain future events nit
wholly within the control of the
entity; or
 A present obligation but:
i. It is not probable that it
will cause an outflow in
its settlement; or
ii. Its amount cannot be
reliably estimated.

 Contingent liabilities are disclosed only, except when the possibility of an outflow
of resources embodying economic benefits is remote.

CONTINGENT ASSETS
  Are those that are not recognized because they do not meet all of the asset
recognition criteria (i.e., ‘resource controlled arising from past events’, ‘probable
inflow’, and ‘reliable estimation’).
 Include possible inflows of economic benefits from unplanned or unexpected events,
such as claims that an entity is seeking through legal processes where the outcome
is uncertain (e.g., claims under tax disputes and disputed insurance claims).
 Are disclosed only, if the inflow of economic benefits is probable.
 They are not recognized because recognizing them may result to the recognition of
income that may never be realized.
 However, when the realization of income is virtually certain (100% chance of
occurrence), the asset is not a contingent asset and therefore it is appropriate to
recognize it.

Summary:
Provision Contingent liability

Contingent Probable Possible Remote

 Liability Recognized and Disclose only Ignore
Disclose
 Asset Disclose only Ignore Ignore

Contingent asset
MEASUREMENT

 Provisions are measured at the best estimate of the amount needed to settle them
at the end of the reporting period.
 Making the estimate requires management’s judgment, supplemented by experience
from similar transactions, and in some cases, report from independent experts.
 The estimate also considers events after the reporting period.
 If the provision being measured involves a large population of items, the
obligation is measured at its “expected value.”
 Expected value
 o Is computed by weighting all possible outcomes by their associated
probabilities.
 If 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.

Nature of the outflow Measurement basis

1. General rule (e.g., one-off event)  Best estimate
2. Involves a large population of  Expected value (Probability
items Weighted Average)
3. Each possible outcome in a range  Mid-point
is as likely as any other

 Estimates take into account risks and uncertainties.

o Thus, estimates may be increased by a risk adjustment factor to provide an
allowance for imprecision inherent in estimates.
o This, however, does not mean that the entity can make excessive provisions
or can deliberately overstate liabilities.
 If the effect of time value of money is material, the estimate of a provision is
discounted to its present value using a pre tax discount rate.
o This is usually the case for provisions for restoration and decommissioning
costs where cash outflows occur only after a relatively long period of time
from the date of initial recognition.
 Future events may affect the amount needed to settle an obligation.
o However, future events are considered in estimating a provision only if there
is objective evidence that supports their anticipation.
o For example, the penalty for an environmental damage may be affected by
legislation. If a new law that will increase the amount of penalty is expected
to be enacted, that new law is anticipated only when it is virtually certain
that it will be enacted. Otherwise, it would not be appropriate to anticipate it.
 Gains from the expected disposal of assets are not taken into account when
measuring a provision.
o Gains are recognized when the disposals occur.
  If another party is expected to reimburse the settlement amount of a provision, a
reimbursement asset is recognized if it is virtually certain that the reimbursement
will be received.
o The reimbursement asset is present in the statement of financial position
separately from the provision.
o However, in the statement of comprehensive income, the expense related to
the provision may be presented net of the reimbursement.
o The amount recognized for the reimbursement should not exceed the
amount of the provision.
 An example of an instance where a reimbursement asset may be recognized is when
the obligating event that caused the recognition of a provision is insured.
o The reimbursement asset would be the amount that the entity can claim from
the insurance company.

RECORDING THE PROVISION

 Provisions are normally recognized as a debit to expense (or loss) and a credit to an
estimated liability account.
 However, sometimes a provision forms part of the cost of an asset.
 For example, provisions for restoration and decommissioning costs are capitalized
as part of the cost of a PPE.

CHANGES IN PROVISIONS

 Provisions are reviewed at the end of each reporting period and adjusted to reflect
the current best estimate.
 Changes in provisions are accounted for prospectively by accruing an additional
amount or by reversing a previously recognized amount.
 When the provision is discounted, the unwinding (amortization) of the related
discount which increases the carrying amount of the provision is recognized as
interest expense.

USE OF PROVISIONS
  A provision is used only for the expenditure it was originally intended for.
 Changing expenditure against a provision that is intended for another purpose is
inappropriate as it would conceal the impact of two different events.

APPLICATION OF THE RECOGNITION AND MEASUREMENT RULES

FUTURE OPERATING LOSSES

 No provision is recognized for future operating losses because they do not meet the
definition of a liability (i.e., ‘arising from past events’).
 The expectation of future operating losses may indicate that certain assets may be
impaired.
 Those assets are tested for impairment under PAS 36.

ONEROUS CONTRACTS

 The provision recognized from an onerous contract reflects the least net cost of
exiting from the contract, which is the lower of the cost of fulfling it and any
compensation or penalties arising from failure to fulfill it.

RESTRUCTING

 Is a program that is planned and controlled by management, and materially changes

either:
a. The scope of a business undertaken by an entity; or
b. The manner in which that business is conducted.
 Examples:
a. Sale or termination of a line of business;
b. Closure of business locations in a country or region or the relocation of
business activities from one country or region to another;
c. Changes in management structure, for example, eliminating a layer of
management; and
d. Fundamental reorganizations that have a material effect on the nature and
focus of the entity’s operations.
  An entity applies the general recognition criteria provided earlier when recognizing
provisions for restructuring costs.
 In addition, the entity considers the following:

SALE OF OPERATION

 A legal obligation exists (and therefore a provision is recognized) only if, at the end
of the reporting period, a binding sale agreement is obtained.
 This is because, until a binding sale agreement is obtained, the entity can still change
its mind and may withdraw its plan to sell if it cannot find a purchaser under
acceptable terms.
 If the binding sale agreement is obtained only after the end of the reporting period,
no provision is recognized because no present obligation exists at the end of the
reporting period.
 This, however, may be disclosed as a non-adjusting event after the reporting period.

CLOSURE OR REORGANIZATION

 A constructive obligation exists (and therefore a provision is recognized) only if at

the reporting date, the entity has created valid expectations from others that it will
discharge certain responsibilities.
 This would be the case if, at the end of the reporting period, both the following
conditions are met:
a. Detailed formal plan for the restructuring is adopted; and
b. The plan is announced to those affected by it.
 A mere board decision to restructure is not enough.
 No provision is recognized if the detailed plan is adopted or announced after the
end of the reporting period,
 This may also be disclosed as a non-adjusting event after reporting period.

MEASUREMENT OF RESTRUCTURING PROVISION

  Restructuring provision
o Includes only the direct costs that are necessarily entailed with the
restructuring.
o It does not include costs that relate to the ongoing activities of the entity or
the future conduct of its business.
o Excludes the following costs:
a. Retraining or relocating continuing staff
b. Marketing
c. Investment in new systems and distribution networks

DISCLOSURE

a. Reconciliation for each class of provision showing:

i. Beginning balance
ii. Additions (additional provisions recognized, unwinding of the discount, and
effect of a change in the discount rate)
iii. Deductions (amounts charged against the provision or reversed)
iv. Ending balance
b. Comparative information is not required.
c. For each class of provision, a brief description of the:
i. Nature
ii. Timing
iii. Uncertainties
iv. Assumptions
v. Reimbursement

PAS 38 INTANGIBLE ASSETS

PAS 38

 Applies to all intangible assets except those that are specifically dealt with under
other Standards.
  Does not apply to goodwill acquired in a business combination (PFRS 3), intangible
assets held as inventory (PAS 2), and intangible assets classified as held for sale
(PFRS 5).

INTANGIBLE ASSET

 Is an identifiable non-monetary asset without physical substance.

 Normally refer to intangible resources such as scientific or technical knowledge,
design and implementation of new processes or systems, licenses, intellectual
property, market knowledge and trademarks (including brand names and publishing
titles.
 Common examples include:
o Computer software
o Patents
o Copyrights
o Motion picture films
o Customer lists
o Mortgage servicing rights
o Fishing licenses
o Import quotas
o Franchises customer or supplier relationships
o Customer loyalty
o Market share
o Marketing rights
 These items, however, are recognized as intangible assets only if they have essential
elements of an intangible asset and meet the recognition criteria.

ESSENTIAL ELEMENTS OF AN INTANGIBLE ASSET

1. Identifiability
 An asset is identifiable if it either:
 a. Is separable, i.e., capable of being separated and divided from the
entity and sold, transferred, licensed, rented, or exchanged, either
individually or together with a related contract, identifiable asset or
liability, regardless of whether the entity intends to do so; or
b. Arises from contractual or other legal rights, regardless of whether
those rights are transferable or separable from the entity or from
other rights and obligations.
 An intangible asset must be identifiable to distinguish it from goodwill.
 Goodwill
o Does not have physical substance (i.e., neither seen nor touched) but
is outside the scope of PAS 38 because it is unidentifiable (i.e.,
goodwill cannot be sold separately).
o Is accounted for under:
 PFRS 3 Business Combinations
 PFRS 10 Consolidated Financial Statements
 PAS 36
 Some financial assets, such as deposits in banks, receivables, and other debt
instruments, do not have physical substance but are also outside the scope of
PAS 38 because they are monetary assets.
 The definition of an intangible asset encompasses an asset that is
identifiable, non-monetary and has no physical substance.
2. Control
 Means the entity has the ability to benefit from the intangible asset or
prevent others from benefitting from it,
 Control of an intangible assets normally arises from legal rights that are
enforceable in a court of law.
 However, legal enforceability of a right may be able to control an asset’s
future economic benefits in some other way.
 Market and technical knowledge
 o Meet the control criterion if the knowledge is protected by legal rights,
such as copyrights, restraint of trade agreement or legal duty on
employees to maintain confidentiality.
 Employees’ skills
o Developed from training provided by the entity are not recognized as
intangible assets because the entity does not control the future
actions of its employees.
o This is true even if the entity expects that the employees will continue
to make their skills available to the entity.
o Training costs are expensed when incurred.

 Specific managerial or technical talent

o Is not recognized as intangible asset, unless it is protected by legal
rights and it also meets the other elements of the definition.
 Customer relationships and loyalty
o Are usually not recognized as intangible asset unless they are
protected by legal rights or other ways of control and they also meet
the other elements of the definition.
3. Future economic benefits
 The future economic benefits from an intangible asset may include revenue
from the sale of products or services, cost savings (e.g., reduction in
production costs rather than increase in revenues), or other benefits
resulting from the entity’s use of the asset.

ASSETS WITH BOTH INTANGIBLE AND TANGIBLE ELEMENTS

 Some assets may have both intangible and tangible elements.

 In determining whether such as an asset is to be accounted for as a PPE or an
intangible asset, the entity uses judgment to assess which element is more
significant.
  If the intangible component is an integral part of the asset as whole, the intangible
element is treated as PPE.
o Otherwise, it is treated as a separate intangible asset.
 For example, the computer software of a computer-controlled machine that cannot
operate without the software is an integral part of the related hardware and,
therefore, the software is treated as PPE.
o The same applies to the operating system (e.g., Microsoft Windows 10) of a
computer.
o A computer cannot operate without an operating software.
o Thus, the operating software forms part of the cost off the computer, which is
classified as PP.
 If the software is not an integral part of the related hardware (e.g., application
software, such as an accounting system), it is treated as a separate intangible asset.

FINANCIAL STATEMENT PRESENTATION

 Intangible assets
o Accounted for under PAS 38 are presented separately from goodwill.
o Such intangible assets are aggregated and presented as one line item under
the heading “Intangible assets” or “Other intangible assets” in the
statement of financial position.
o The breakdown of the line item is disclosed in the notes.
o Goodwill is presented separately under a line item described as “Goodwill.”

RECOGNITION

 An intangible asset is recognized when it meets the definition of an intangible asset

as well as the asset recognition criteria of “probable future economic benefits”
and “reliable measurement of cost.”

INITIAL MEASUREMENT

 Intangible assets are initially measured at cost.

  The measurement of cost depends on how the intangible asset is acquired.
 Intangible assets may be acquired through:
a. Separate acquisition
b. Acquisition as part of a business combination
c. Acquisition by way of a government grant
d. Exchanges of assets; or
e. Internal generation

SEPARATE ACQUISITION

 The cost of a separately acquired intangible asset comprises:

a. Its purchase price, including import duties and non-refundable purchase
taxes, after deducting trade discounts and rebates; and
b. And directly attributable cost of preparing the asset for its intended use.
 Examples of directly attributable costs:
a. Cost of employee benefits arising directly from bringing the asset to its
working condition
b. Professional fees arising directly from bringing the asset to its working
condition
c. Costs of testing whether the asset is functioning properly
 The following costs are not part of the cost of an intangible asset:
a. Costs of introducing a new product or service (including costs of advertising and
promotional activities)
b. Costs of conducting business in a new location or with a new class of customer
(including costs of staff training)
c. Administration and other general overhead costs
 If the payment is deferred, the cost is the cash price equivalent.
 The difference between this amount and the total payments is recognized as interest
expense over the credit period, unless it qualifies for capitalization under PAS 23.

ACQUISITION AS PART OF A BUSINESS COMBINATION

  The cost of an intangible asset acquired in a business combination is its fair value at
the acquisition date.
 The acquired recognizes an intangible asset at the acquisition date, separate from
goodwill, whether or not the intangible asset had been recognized by the acquirer
before the business combination.
 The acquirer can recognize the acquiree’s research and development project as an
intangible asset if the project meets the definition of an intangible asset and is
identifiable.

ACQUISITION BY WAY OF A GOVERNMENT GRANT

 Intangible assets acquired by way of government grant (e.g., airport landing, rights,
licenses to operate radio or television stations, import licenses or quotas or rights to
access other restricted resources) may be initially measured either:
a. At fair value; or
b. Alternatively, at nominal amount plus direct costs incurred in preparing the
asset for its intended use

EXCHANGES OF ASSETS

 An intangible asset may be acquired in exchange for another non-monetary asset.

 The measurement of the intangible asset acquired depends on whether the
exchange transaction has commercial substance or not.
a. With Commercial Substance
o An exchange has a commercial substance if the entity’s subsequent
cash flows are expected to change as a result of the exchange.
o The intangible asset received is measured using the following order
of priority:
1. Fair value of the asset Given up
2. Fair value of the asset Received; or
3. Carrying amount of the asset Given up.
b. Lacks Commercial Substance
 o The intangible asset received is measured at the Carrying amount of
the asset Given up.
 No gain or loss arises if the asset received is measured at the carrying amount of the
asset given up.

INTERNALLY GENERATED INTANGIBLE ASSETS

 To determine whether an internally generated intangible asset meets the

recognition criteria, its generation is classified into:
o Research phase; and
o Development phase

RESEARCH PHASE

 Research
o Is original and planned investigation undertaken with the prospect of gaining
new scientific or technical knowledge and understanding.
 Costs incurred during the research phase are expensed because, during this phase,
an entity cannot demonstrate the existence of an intangible asset that will generate
future economic benefits.

EXAMPLES OF RESEARCH ACTIVITIES

a. Activities aimed at obtaining new knowledge

b. The search for, evaluation and final selection of, applications of research findings or
other knowledge
c. The search for alternatives for materials, devices, products, processes, systems or
services; and
d. The formulation, design, evaluation and final selection of possible alternatives for
new or improved materials, devices, products, processes, systems or services.

DEVELOPMENT PHASE

 Development
 o Is the application of research findings or other knowledge to a plan or design
for the production of new or substantially improved materials, devices,
products, processes, systems or services before the start of commercial
production or use.
 Costs incurred during the development phase are capitalized if the entity can
demonstrate all of the following:
a. Technical feasibility of completing the intangible asset
b. Intention to complete the intangible asset
c. Ability to use or sell the intangible asset
d. Probable future economic benefits
e. Availability of adequate resources needed to complete the development; and
f. Reliable measurement of the cost of the intangible asset.
 Examples of development activities:
a. The design. Construction and testing of pre-production or pre-use
prototypes and models
b. The design of tools, jigs, molds and dies involving new technology
c. The design, construction and operation of a pilot plant that is not of a scale
economically feasible for commercial production; and
d. The design, construction and testing of a chose alternative for new or
improved materials, devices, products, processes, systems or services.
 If it is not clear whether an expenditure is a research or a development cost, it is
treated as a research cost.
 Internally generated brands, mastheads, publishing titles, customer lists and
similar items similar are not recognized as intangible assets. similarly, an internally
generated goodwill is not recognized as an asset. The costs to develop these items,
including subsequent expenditures on them are expensed.
 Research costs and development costs that do not qualify for capitalization are
expensed and disclosed as “research and development expense” (R&D expense)

COST OF AN INTERNALLY GENERATED INTANGIBLE ASSET

  The cost of an internally generated intangible asset includes all directly
attributable costs necessary to create, produce, and prepare the asset for its
intended purpose, as from the date the recognition criteria and the conditions for
capitalization of development costs have been met.
 Examples of directly attributable costs:
a. Costs of materials consumed and services used in generating the intangible
asset
b. Costs of employee benefits arising from the generation of the intangible asset
c. Registration fees for a legal right
d. Amortization of patents and licenses that are used to generate the intangible
asset
e. Capitalizable borrowing costs for qualifying intangible assets.
 The following costs are expensed when incurred:
a. Selling, administrative and other general overhead expenditure unless
this expenditure can be directly attributed to preparing the asset for use
b. Identified inefficiencies and initial operating losses incurred before the
asset achieves planned performance; and
c. Expenditure on training staff to operate the asset.
 PAS 38 prohibits the reinstatement of costs, meaning, if a cost had been expensed, it
cannot anymore be capitalized as an intangible asset at a later date.

ORGANIZATIONALC OSTS (start-up costs)

 Are costs incurred in establishing a new business.

 These are expensed when incurred.
 Examples:
a. Legal and secretarial costs incurred in establishing a legal entity (e.g., legal
costs to create bylaws and articles of incorporation and filing fees with
regulatory bodies)
b. Pre-opening costs (e.g., blessing of the new business)
c. Pre-operating costs (e.g., costs of launching new products or processes)
SUBSEQUENT EXPENDITURES

 Capitalization of costs ceases when the intangible asset is in the condition necessary
for it to be capable of operating in the manner intended by management.
 By nature, intangible assets have no parts that need to be replaced and, usually, no
additions can be made on them.
 Subsequent expenditures on intangible assets, therefore, are most likely just to
maintain their future economic benefits rather than qualify for recognition as
intangible assets.
 Accordingly, subsequent expenditures on intangible assets are expensed, unless it is
very clear that the subsequent expenditures meet the definition of an intangible
asset and the recognition criteria.
 The following subsequent expenditures are expensed when incurred:
a. Costs of suing or redeploying an intangible asset
b. Costs incurred while an asset capable of operating in the manner intended by
management has yet to be brought into use.
c. Initial operating loses
d. Costs of relocating or reorganizing part or all of an entity
e. Advertising and promotional costs
f. Litigation costs of defending an intangible asset, whether the defense is
successful or not. If the defense is unsuccessful, the intangible asset may be
impaired and needs to be written-off as loss.

Summary:

Mode of acquisition Initial measurement

1. Separate acquisition  Purchase cost plus direct costs
2. Business combination  Fair value at the acquisition date
3. Government grant  Fair value or nominal amount
4. Exchange Order of priority:
a. Fair value of asset Given up
b. Fair value of asset Received
c. Carrying amount of asset Given up
 If the exchange lacks commercial substance,
the intangible asset received is measured
using (c) above.
5. Internal generation  Research
o Expensed (except R&D
acquired in a business
combination).
 Development
o Expensed; capitalize only if all
the conditions are met.

SUBSEQUENT MEASUREMENT

 After initial recognition, an entity chooses either the cost model or the revaluation
model as its accounting policy and applies that policy to an entire class of intangible
assets.

Cost model Revaluation model

 The intangible asset is carried at its
cost less any accumulated
amortization and any accumulated
impairment losses.
 The intangible asset is carried at its
fair value at the date of the
revaluation less any subsequent
accumulated depreciation and
subsequent accumulated
depreciation and subsequent
accumulated impairment losses.

 When revaluing an intangible asset, an entity determines the fair value by reference
to an active market.
 Accordingly, the revaluation model is used only if there is an active market for the
intangible asset, which is rarely the case but it can happen.
o For example, an active market may exist for freely transferable taxi licenses,
fishing licenses or production quotas.
 o However, no active market exists for intangible assets that are individually
unique, such as brands, newspaper mastheads, music and film publishing
rights, patents or trademarks.
 Intangible assets with no active market are measured under the cost model.

USEFUL LIFE

 An entity shall assets whether the intangible asset has:

a. Finite useful life; or
b. Indefinite useful life
 This is because only intangible assets with finite useful life are amortized.
 Intangible assets with indefinite useful life are not amortized but tested for
impairment at least annually using PAS 36.
 An intangible asset has finite useful life if the entity can determine reliable the
length of, or number of production or similar units constituting, the intangible
asset’s useful life,
 An intangible asset has an indefinite useful life if there is no foreseeable limit to
the period over which the asset is expected to provide future economic benefits.
 The term “indefinite” does not mean “infinite.”
 “Infinite”
o Means the asset’s useful life has no end.
 “Indefinite”
o Means the asset’s useful life has an end except that it cannot be forecasted.
 An intangible asset’s useful life is indefinite if there are no legal, contractual,
competitive and other restrictions that would limit the period over which the asset
is used.
 An intangible asset that has a legal life that can be renewed for an indefinite number
of renewals without restriction and only for an insignificant cost is also considered
an intangible asset with indefinite useful life.
 Factors considered in determining an intangible asset’s useful life:
 a. Expected usage of the asset, and whether it can be managed efficiently by
another management team
b. Product life cycles and public information on estimates of useful lives of
similar assets with similar use
c. Technical, technological, commercial or other types of obsolescence
d. Industry stability and demand for the asset’s output
e. Expected actions by competitors or potential competitors
f. Maintenance costs of the asset
g. Legal and similar restrictions on the use of the asset; and
h. Dependence of the asset’s useful life with the useful life of other assets of the
entity.

AMORTIZATION

 Is the systematic allocation of the depreciable amount of an intangible asset over its
useful life.
 Is similar to the depreciation of PPE.
 The term “amortization” is sued simply to refer to intangible assets.
 The depreciable amount of an intangible asset with a finite useful life is amortized
over the shorter of its useful life and legal life, if any.
 Some intangible assets have legal life while some do not.
o For example, patents have a legal life of 20 years.
o Therefore, a patent is amortized over the shorter of its useful life and 20
years.
 Intangible assets with no legal life, e.g., computer software, are amortized over their
useful life.
 Amortization starts when the asset is available for use, in the manner intended by
management.
 Amortization stops when the asset is derecognized (i.e., sold or disposed of),
classified as held for sale under PFRS 5, or becomes fully depreciated.
 Amortization does not cease when the asset is no longer used, unless one of the
conditions above are met.
  Amortization is recognized as expense (in profit or loss) unless it is included in the
cost of producing another asset.

AMORTIZATION METHOD

 There are a variety of amortization methods.

 PAS 38 mentions three examples, namely:
o Straight-line method
o Diminishing balance method
o Units of production method
 However, PAS 38 does not prescribe any specific method.
 The choice of depreciation method depends on management’s judgment.
 When making the judgment, PAS 38 requires management to choose the method
that best reflects the expected pattern of consumption of the future economic
benefits embodied in the asset.
 If that pattern cannot be determined reliably, the entity shall use the straight-line
method.
 PAS 38 prohibits the use of an amortization method that is based on revenue.
 An intangible asset’s residual value is assumed to be zero unless the entity can
demonstrate its ability to sell the intangible asset before the end of its economic life,
as evidenced by the existence of:
a. A third party commitment to purchase the asset at the end of its useful life; or
b. An active market where the asset can be sold at the end of its useful life.
 PAS 38 requires an annual review of the amortization method and the assessments
and estimates of useful life and residual value at each-year end.
 Any change is accounted for as a change in accounting estimate.

ILLUSTRATION:

On January 1, 20x1, Entity A purchases a patent from Entity B for 300,000. Entity B, the
original owner, has held the patent for 5 years. Entity A estimates that the patent has a
remaining useful life of 16 years.
  The annual amortization expense is computed as follows:

Cost 300,000

Residual amount -

Depreciable amount 300,000

Divide by: (shorter of useful life and remaining legal life(a) 15

Annual amortization expense 20,000

(a)
20 year. Legal life

- 5 years held by Entity B

15, shorter than the 16-yr. useful life

 The carrying amount of the intangible asset on December 31, 20x2 (after two years)
is determined as follows:

Cost 300,000

Accumulated amortization (20,000 x 2 yrs.) (40,000)

Carrying amount- 12/31/20x2 260,000

Alternative solution:

(300,000 x 13 remaining life after two years/ 15)= 260,000

IMPAIRMENT

 Intangible assets are tested for impairment using PAS 36.

DERECOGNITION

 An intangible asset is derecognized when it is disposed of or when no future

economic benefits are expected from it.
  On derecognition, the difference between the carrying amount and the net disposal
proceeds, if any, is recognized as gain or loss in profit or loss (unless PFRS 16 Leases
requires otherwise on a sale and leaseback.).

DISCLOSURE

 The following are disclosed for each class of intangible assets, distinguishing
between internally generated intangible assets and other intangible assets:
a. Whether the useful lives are indefinite or finite and, if finite, the useful lives
or the amortization rates used:
b. Amortization methods used
c. Gross carrying amount and any accumulated amortization (aggregated with
accumulated impairment losses) at the beginning and end of the period.
d. The line item(s) of the statement of comprehensive income in which any
amortization of intangible assets is included
e. A reconciliation of the carrying amount at the beginning and end of the
period showing increases and decreases to intangible assets and related
accumulated amortization and accumulated impairment loss.
f. Changes in accounting estimates in accordance with PAS 8.
g. Intangible assets assessed as having indefinite useful lives and reasons
supporting the assessments.
h. Intangible assets acquired by way of a government grant and initially
recognized at fair value.
i. Any restriction on title to intangible assets (e.g., pledges of intangible assets).
j. Contractual commitments to acquire intangible assets.
k. Revaluation surplus recognized on revalued intangible assets and the
methods and assumptions used in estimating fair values of intangible assets.
l. Aggregate amount of research and development expenditure recognized as
an expense during the period.
m. The following are encouraged, but not required, disclosures:
i. Description of any fully amortized intangible asset that is still in use;
and
 ii. Brief description of significant intangible assets controlled by the
entity but not recognized as assets because they did not meet the
recognition criteria.

SEPARATE CLASSES OF INTANGIBLE ASSETS

 Class of intangible assets

o Is a grouping of assets of a similar nature and use in an entity’s operations.
Examples of separate classes of intangible assets:
 Brand names
 Mastheads and publishing titles
 Computer software
 Licenses and franchises
 Copyrights, patents and other industrial property rights, service and
operating rights
 Recipes, formulae, models, designs and prototypes; and
 Intangible assets under development

PAS 40 INVESTMENT PROPERTY

INTRODUCTION

 PAS 40 prescribes the accounting and disclosure requirements for investment

property.

INVESTMENT PROPERTY

 Investment property
 o Is land and/or building held to earn rentals or for capital appreciation or
both,
o Includes only land and building.
o It does not include any other type of asset.
o Is held to earn rentals or for capital appreciation or both.
o Meaning, it generates its own cash flows independently from the other assets
of an entity and is not:
a. Owner-occupied property
 Held for use in the production or supply of goods or services or
for administrative purposes
 Is classified as PPE
b. Held for sale in the ordinary course of business
 This is classified as inventory
c. Classified as “held for sale” under PFRS 5 Non-current assets Held
for Sale and Discontinued Operations.
 Examples of investment property:
o Land held for long-term capital appreciation rather than for short-term sale
in the ordinary course of business.
o Land held for a currently undetermined future use.
o A building owned by the entity (or a right-of use asset relating to a building
held by the entity) and leased out under one or more operating leases.
o A building that is vacant but is held to be leased out under one or more
operating leases.
o Property that is being constructed or developed for future use as investment
property.
 The following are not investment property:
o Property acquired exclusively for sale in the near future or for development
and resale.
o Owner-occupied property, including:
i. Property held for future use as owner-occupied property
 ii. Property held for future development and subsequent use as owner-
occupied property
iii. Property occupied by employees (whether or not the employees pay
rent at market rates); and
iv. Owner-occupied property awaiting disposal.
o Property that is leased out to another entity under a finance lease.

ILLUSTRATION

The following information pertains to Entity A:

Land held for long-term capital appreciation 1,000,000

Land held for a currently undetermined future use 700,000

Land held for future plant site 600,000

Land held for sale in the ordinary course of business 500,000

Building leased out under finance lease 1,900,000

Building leased out under operating lease 800,000

Right-of-use asset relating to a building held by the entity

and leased out under an operating lease 1,200,000

equipment leased out under an operating lease 100,000

 The total investment property is determined as follows:

Land held for long-term capital appreciation 1,000,000

Land held for a currently undetermined future use 700,000

Building leased out under operating lease 800,000

Right-of-use asset relating to a building held by the entity

 and leased out under an operating lease 1,200,000

total investment property 3,700,000

NOTES:

 The land held for future plant site and the equipment are classified as PPE.
 The land held for sale in the ordinary course of business is classified as
inventory.
 The building leased out under finance lease is not an asset of Entity A-it is the
asset of the lessee.

PARTLY INVESTMENT PROPERTY AND PARTLY OWNER-OCCUPIED

 A property may be partly held to ear rentals or for capital appreciation and partly
owner-occupied.
 A common example is a building and that is partly being rented out and partly being
used as office space.
 Such properties are accounted for as follows:
o If the portions could be sold separately (or leased out separately under a
finance lease), they are accounted for separately. The portion being rented
out under operating lease is classified as investment property while the
owner-occupied portion is classified as PPE.
o If the portions could not be sold separately, the entire property is classified
as investment property if the owner-occupied portion is insignificant. If
the owner-occupied portion is significant, the entire property is classified as
PPE.

ANCILLARY SERVCIES TO OCCUPANTS

 When ancillary services are provided to the occupants of a property held, the
property is classified as investment property if the services are insignificant to
the arrangement as a whole.
  An example is when the owner of an office building provides security and
maintenance services to the building tenants.
 If the services provided are significant, the entire property is classified as PPE.
o An example is services provided to hotel guests in an owner-managed hotel.
An owner-managed hotel is classified as PPE rather than investment
property.

INVESTMENT PROPERTY IN CONSOLIDATED FINANCIAL STATEMENTS

 A property that is leased by a member of a group to another member (parent or

subsidiary) does not qualify as investment property in the consolidated financial
statements because, from the group’s perspective, the property is owner-occupied.
 However, the property is classified as investment property in the lessor/owner’s
individual financial statements.

RECOGNITION

 An investment property is recognized when it meets the definition of an investment

property as well as the asset recognition criteria of “probable future economic
benefits” and “reliable measurement of cost.”

INITIAL MEASUREMENT

 An investment property is initially measured at cost.

 The measurement of cost depends on the mode of acquisition,

ACQUISITION BY PURCHASE

 The cost of a purchased investment property comprises the purchase price and any
directly attributable costs incurred in bringing the asset to its intended condition,
e.g., professional fees for legal services, property transfer taxes and other
transaction costs.
 If the payment is deferred, the cost is the cash price equivalent.
 The difference between this amount and the total payments is recognized as interest
expense over the credit period, unless it qualifies, for capitalization under PAS 23.
  The cost of an investment property excludes the following:
o Start-up costs, unless they are necessary to bring the property to the
condition necessary for it to be capable of operating in the manner intended
by management
o Operating losses incurred before the investment property achieves the
planned level of occupancy; or
o Abnormal amounts of wasted materials, labor or other resources incurred in
constructing or developing the property.

EXCHANGES OF ASSETS

 The measurement of an investment property acquired in exchange for another non-

monetary asset depends on whether the exchange transaction has commercial
substance or not.
o With Commercial Substance
 An exchange has a commercial substance if the entity’s subsequent
cash flows are expected to change as a result of the exchange.
 The asset received is measured using the following order or priority:
1. Fair value of the asset Given up
2. Fair value of the asset Received; or
3. Carrying amount of the asset Given up.

o Lacks Commercial Substance

 The asset received is measured at the Carrying amount of the asset
Given up
 No gain or loss arises if the asset received is measured at the carrying amount of the
asset given up.

SUBSEQUENT MEASUREMENT
  After the initial recognition, an entity chooses either the cost model or the fair
value model as its accounting policy and applies that policy to all of its investment
property.
 Only one model shall be used.
 Using both models selectively for items of investment property is prohibited, except
in the following cases:
1. When the fair value model is used but the fair value of one investment
property cannot be reliably determined on initial recognition, that
investment property will be measured under the cost model; the rest are
measured under the fair value model. For purposes of depreciation, the
residual value of the said property is assumed to be zero.
2. Separate choices of accounting policy may be made for:
a. Investment property that backs liabilities that pay return linked
directly to the fair value of, or returns from, specified assets including
that investment property; and
b. All other investment property.
 PAS 40 requires an entity to determine the fair value of its investment property,
regardless of the accounting policy used.
 Under the fair value model, fair value is used for measurement purposes while
under the cost model, fair value is used for disclosure purposes.
 PAS 40 encourages, but does not require, the use of an independent valuer in
determining the fair value of an investment property.
 An entity may subsequently change its accounting policy from the cost model to
the fair value model, subject to the provisions of PAS 8.
 However, PAS 40 states that it is highly unlikely that a change from the fair value
model to the cost model will result in a more relevant presentation.
 Accordingly, if the fair value model is chosen, it shall be applied until the investment
property is derecognized or reclassified to another asset classification, even if fair
value becomes less readily determinable.

COST MODEL
  An entity that chooses the cost model shall measure the investment property using
the cost model under PAS 16 (PPE).
 The entity uses PFRS 5 Non-current Assets Held for Sale and Discontinued
Operations if it classifies an investment property as “held for sale” or PFRS 16
Leases if the investment property is a right-of-use asset resulting from a lease.

FAIR VALUE MODEL

 Under the fair value model, an investment property is subsequently measured at its
fair value at the end of each reporting period.
 Fair value
o Is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date.
 Gains or losses arising from changes in fair value are recognized in profit or loss.
 Assets measured under the fair value model are not depreciated
 If the investment property is a right-of-use asset, fair value is measured for the right-
of-use asset and not the underlying property.
 An entity uses the principles in PFRS 13 Fair Value Measurement when determining
the fair value of an investment property.
 To avoid double-counting, assets and liabilities that are integral parts of the
investment property are not recognized separately.
o For example, elevator and air-conditioning are an integral part of a building
and are necessarily included in the building’s fair value.
o Therefore, these items are included on the measurement of the investment
property (i.e., the building as a whole) rather than as separate items of PPE.

ILLUSTRATION
Entity A acquires a building at a purchase price of 10,000,000 and spends an additional
3,000,000 in getting the building to the condition for its intended use. The building is
intended to be leased out under various operating leases. Accordingly, it is classified as
investment property. The building becomes available for lease on January 1,20x1, at which
date, Entity A estimates its useful life to be 20 years, with no residual value. On December
31, 20x1, the investment property’s fair value is 12,000,000.

 Initial measurement
o The building is initially measured at its cost of 13,000,000 (10,0000
purchase price + 3,000,000 direct costs.) this is irrespective of the accounting
policy chosen for the subsequent measurement,
 Subsequent measurement-Dec.31, 20x1 (Cost model)
o Under the cost model, the investment property is carried at its cost less
accumulated depreciation and accumulated impairment losses.

Statement of financial position:

Cost 13,000,000

Accumulated depreciation [(13,000,000/20) x 1 yr.} (650,000)

Carrying amount -12/31/x1 12, 350,000

Statement of profit or loss:

Depreciation expense (13,000,000/20) 650,000

 Subsequent measurement – Dec. 31, 20x1 (Fair value model)

o Under the fair model, the investment property is carried at its fair value at
the end of each reporting period.
o Changes in fair value are recognized in profit or loss. The investment
property is not depreciated
Statement of financial position:
Carrying amount-12/31/x1 (fair value) 12,000,000
Statement of profit or loss:
 Unrealized loss (a) 1,000,000
(a)
The unrealized loss from the fair value change is analyzed below:
Carrying amount 13,000,000
Fair value -12/31/x1 12,000,000
Decrease in value –unrealized loss 1,000,000

SUMMARY:

Cost model Fair value model

Statement of financial position:
 Initial measurement: 13,000,000
 Subsequent measurement:
Carrying amount: 12,350,000
Statement of profit or loss:
 Depreciation expense: 650,000
Statement of financial position:
 Initial measurement: 13,000,000
 Subsequent measurement:
Carrying amount: 12,000,000
Statement of profit or loss:
 Unrealized loss: 1,000,000

TRANSFERS

 Transfers to or form investment property are made only when there is a change in
use, as evidenced by the following:
a. Commencement of owner-occupation, for a transfer from investment
property to PPE;
b. End of owner-occupation, for a transfer from PPE to investment property;
c. Commencement of an operating lease to another party, for a transfer from
inventories to investment property; or
d. Commencement of development with a view to sale, for a transfer from
investment property to inventories.
 In the absence of a change in use, no transfer is made to or from investment
property.
o For example, in (d) above, a building that is classified as investment property
which the entity decides to dispose of without development (e.g., no
 renovation) remains as investment property until it is derecognized, and not
transferred to inventories, because there is no change in use.
 Similarly, an investment property that is redeveloped for continued use as
investment property remains as investment property.
 If the entity uses the cost model transfers between investment property, PPE and
inventories are accounted for at the carrying amount of the asset transferred.
 No gain or loss arises because the asset’s measurement remains the same before
and after the transfer.
 If the entity uses the fair value model, transfers between investment property, PPE,
and inventories are accounted for at the asset’s fair value at the date of change in
use, and:
a. For a transfer from investment property to PPE or inventories, the entity
applies PA 40 until the date of transfer. Accordingly, the entity recognizes the
change in fair value on that date as unrealized gain or loss in profit or loss,
just as it would if the investment property is remeasured to fair value at the
end of the period. The asset’s fair value at the date of transfer becomes its
deemed cost for subsequent accounting using PAS 16, PFRS 16 or PAS 2.
b. For a transfer from PPE to investment property, the entity applies PAS 16
until the date of transfer. Accordingly, the entity recognizes any depreciation
on the asset until that date. Any difference between the fair value and
carrying amount is recognized in other comprehensive income as an
adjustment to the asset’s revaluation surplus, except if the difference
represents an impairment loss or reversal thereof.
c. For a transfer from inventories to investment property, the difference
between the fair value on the date of transfer and the previous carrying
amount is recognized in profit or loss.

DERECOGNITION

 An investment property is derecognized when it is disposed of or when no future

economic benefits are expected from it.
  On derecognition, the difference between the carrying amount and the net disposal
proceeds, if any, is recognized as gain or loss in profit or loss (unless PFRS 16 Leases
requires otherwise on a sale and leaseback)..

SELF-CONSTRUCTED INVESTMENT PROPERTY

 Is accounted for in much the same way as a purchased investment property.

 The initial cost of a self-constructed investment property includes all directly
attributable costs of constructing and preparing the property for its intended use,
such as materials, labor and construction overhead.
 The cost excludes abnormal amounts of wasted material, labor or other resources
incurred in constructing or developing the property.
 A self-constructed investment property is subsequently measured using either the
cost model or the fair value model.
 The fair value model may be applied even during the construction period. If,
however, fair value cannot be determined until construction is finished, the
investment property is temporarily measured under the cost model. Upon
completion, the difference between the investment property’s cost and fair value is
recognized in profit or loss.

SUBSEQUENT EXPENDITURES

 Subsequent expenditures on recognized investment property are generally

expensed, unless they clearly meet the recognition criteria.
 For example, costs of day-to-day servicing of an investment property are expensed
in the period in which they are incurred (i.e., as repairs and maintenance expense).
 PAS 40 states an instance where a subsequent expenditure is capitalized, which is
the replacement of parts of an investment property. Replacements are accounted
for as follows:
o Under the cost model, the cost of the replacement part (new part) is
capitalized to the investment property, if it meets the recognition criteria. The
carrying amount of the replaced part (old part) is derecognized and charged
as loss, regardless of whether is had been depreciated separately. If the
 carrying amount of the replaced part cannot be determined, the cost of the
replacement part is used as an indication of what the cost of the replaced
part was at the time it was acquired or constructed.
o Under the fair value model, the cost of the replacement part (new part) is
capitalized to the investment property. The investment property’s fair value
is then reassessed and any difference between the fair value and the carrying
amount is recognized in profit or loss.

IMPAIRMENT

 An investment property that is subsequently measured under cost model is tested

for impairment using PAS 36.
 There is no separate accounting for impairment losses for investment property
measured under the fair value because any increase or decrease in fair value is
simply recognized as gain or loss in profit or loss.
 Any compensation from a third party for an investment property that is impaired,
lost or given up is recognized in profit or loss when the compensation becomes
receivable.
 The impairment or loss, the compensation from the third party, and any subsequent
acquisition of a replacement asset are separate economic events and are accounted
for separately.

DISCLOSURE

 General disclosures:
a. Whether the entity uses the fair value model or the cost model.
b. When classification is difficult, the criteria used to distinguish investment
property from PPE and inventory.
c. The extent to which the fair value if investment property is based on a
valuation is not obtained, that fact is disclosed
d. The amounts recognized in profit or loss for rental income and related
expenses.
e. The existence and amounts of restrictions on investment property.
 f. Contractual obligations to purchase, construct or develop investment
property or for repairs, maintenance or enhancements.
 Additional disclosures under the Fair value model
a. Reconciliation showing increases and decreases in investment property.
b. When a valuation obtained for investment property is adjusted to avoid
double-counting of assets or liabilities that are recognized as separate assets
and liabilities, the entity discloses a reconciliation between the valuation
obtained and the adjusted valuation.
c. Disclosure of any investment property whose fair value on initial recognition
cannot be reliably measured and hence measured under the cost model using
the exception allowed under PAS 40.

 Additional disclosures under the Cost model

a. The depreciation methods used, the useful lives, and the depreciation rates
used.
b. Reconciliation showing increases and deceases in investment property and
related accumulated depreciation and accumulated impairment loss.
PAS 41 AGRICULTURE

INTRODUCTION

 Agriculture means farming or the process of producing crops and raising livestock.
 PAS 41 prescribes the accounting and disclosures for agricultural and related
activity.
 PAS 41 applies to the following when they relate to agricultural activity:
a. Biological assets, except bearer plants
b. Agricultural produce at the point of harvest; and
c. Unconditional government grants related to a biological asset measured at
its fair value less costs to sell
 PAS 41 does not apply to the following:
a. Land related to agricultural activity (PAS 16 and PAS 40).
b. Bearer plants (PAS 16). However, PAS 41 applies to the produce on those
bearer plants.
c. Government grants related to bearer plants (PAS 20).
 d. Intangible assets related to agricultural activity (PAS 38).
 PAS 41 applies to agricultural produce only at the point of harvest. After harvest,
PAS 2 Inventories or other applicable standard is applied.

BIOLOGICAL ASSET

 Is a living animal or plant.

 “Bio” means life. Therefore, dead animals, dead plants and other non-living things
cannot qualify as biological assets.
 Biological assets can be either:
a. Consumable biological assets
o Those that are to be harvested as agricultural produce or sold as
biological assets.
o Examples;
i. Livestock intended for the production of meat
ii. Livestock held for sale
iii. Fish in farms
iv. Crops such as maize and wheat
v. Produce on a bearer plant
vi. Trees being grown for lumber
b. Bearer biological assets
o Those that are held to bear produce. Only produce is harvested while
the bearer biological asset remains.
o Examples:
i. Livestock from which milk is produced
ii. Fruit trees from which fruit is harvested
 Living animals, whether consumable or bearer, are classified as biological assets if
they relate to agricultural activity.
 However, living plants are classified as biological assets only if they are consumable.
 Bearer plants are classified as PPE.
 Bearer plant is a living plant that:
 a. Is used in the production or supply of agricultural produce;
b. Is expected to bear produce for more than one period; and
c. Has a remote likelihood of being sold as agricultural produce, except for
incidental scrap sales.
 Plants that are to be harvested as agricultural produce are not bearer plants.
o For example, a tree that is intended to be cut down and used as lumber is a
consumable plant, and therefore classified as biological asset.
o A tree that is intended to bear fruits and only the fruits are harvested while
the tree remains is a bearer plant, and therefore classified as property,
plant and equipment.
 Bearer plants that may be sold as scrap when no longer used are not necessarily
precluded from being classified as bearer plants.
 Annual cops and similar plants that die once their produce has been harvested are
considered consumable pants, and therefore classified as biological asset.
Example:
o Peanut
o Rice
o Beans
o Sugarcane
o Tobacco
o Banana
o Garlic
o Onion
o Lettuce
o Cabbage
o Carrots
o And the like.
 Only plants that bear produce relatedly over a long period of time are considered
bearer plants (PPE).
Remember the following:

Items Applicable standard

 Bearer and Consumable animals PAS 41
 Consumable plants PAS 41
 Bearer plants PAS 16
 Produce growing on bearer plants PAS 41

AGRICULTURAL PRODUCE

 Is the harvested produce of the entity

 S biological assets.
 Harvest
o Is the detachment of produce from a biological asset or the cessation of a
biological asset’s life processes.
 Refers to those that are in their natural state and are not yet processed.
 Those that are already subjected to processing are treated as inventories.
 Apple fruits growing on the tree.
o Biological asset (PAS 41)
 Apple tree
o Bearer plant (held to bear produce), accounted for under PAS 16 PPE.
 Harvested apple
o Agricultural produce, accounted for under PAS 41 at the point of harvest.
 Apple pie
o Subjected to processing, accounted for under PAS 2 Inventories.
 PAS 41.5C
o States that produce growing on bearer plants is a biological asset.
o However, in many cases, it is impractical to account for fruits growing on
trees before they are harvested.
 Many companies, therefore, start to apply PAS 41 on the fruits only at the point of
harvest.
 o This is also true for produce of animals, e.g., milk is accounted for only after it
is squeezed from the cow’s breast.

Remember the following:

Nature of asset Type of asset

 Living animal or plant Biological asset (PA 41)
However, bearer plants are classified as
PPE (PAS 16)
 Unprocessed harvested Agricultural produce (PAS 41)
 Processed product Inventory (PAS 2)
 The table below shows examples of items that are include and excluded from the
scope of PAS 41:

Products that are the

result of processing
Agricultural produce after harvest
at point of harvest (PAS 2 Inventories)
Biological asset Bearer plants (PAS 41)
(PAS 41) (PAS 16 PPE)

Sheep Wool Yarn, carpet

Trees in a timber Felled trees Logs, lumber
Dairy cattle Milk Cheese
Pigs Carcass Sausages, cured hams
Cotton plants Harvested cotton Thread clothing
Sugarcane Harvested cane Sugar
Tobacco plants Picked leaves Cured tobacco
Tea bushes Picked leaves Tea
Grape vines Picked grapes Wine
Fruit trees Picked fruit Processed fruit
 Oil palms Picked fruit Palm oil
Rubber trees Harvested latex Rubber

AGRICULTURAL ACTIVITY

 Biological assets and agricultural produce are accounted for under PAS 41 only
when they relate to agricultural activity,
 Those that do not relate to agricultural activity are accounted for under other
applicable Standards.
o For example, plants used un landscaping are not biological assets but rather
land improvements (i.e., PPE).
 Is the management by an entity of the biological transformation and harvest of
biological assets for sale or for conversion into agricultural produce or into
additional biological assets.
 Examples of agricultural activities include:
o Raising livestock
o Forestry
o Annual or perennial cropping
o Cultivating and plantations
o Floriculture
o Aquaculture (including fish farming).
 The following are the common features of agricultural activities:
a. Capability to change
o Living animals and plants are capable of biological transformation.
b. Management of change
o Management facilitates biological transformation by enhancing, or at
least stabilizing, conditions necessary for the process to take place.
o Such management distinguishes agricultural activity from other
activities.
 o For example, harvesting from unmanaged sources (such as ocean
fishing and deforestation) is not agricultural activity; and

c. Measurement of change
o The change in quality or quantity brought about by biological
transformation or harvest is measured and monitored as a routine
management function.
 Biological Transformation
o Comprises the following processes that cause qualitative or quantitative
changes in a biological asset:
I. Asset changes through:
a. Growth
 Is an increase in quantity or improvement in quality of an animal or
plant.
b. Procreation
 Is the creation of additional living animals or plants.
c. Degeneration
 Is a decrease in the quantity or deterioration in quality of an animal or
plant.
II. Production of agricultural produce.

RECOGNITION

 A biological asset or agricultural produce is recognized when it meets the asset

recognition criteria, including the reliable measurement of its fair value or cost.

MEASUREMENT

 Biological assets
o Are initially and subsequently measured at fair value less costs to sell.
o The gain or loss from initial measurement and subsequent changes in fair
value less costs to sell are recognized in profit or loss.
 A gain may arise on the initial recognition of a biological asset, for example, when a
calf is born.
o A loss may arise on the initial recognition of a biological asset because costs
to sell are deducted from fair value.
 Biological assets whose fair value cannot be reliably determined on initial
recognition are initially measured at cost and subsequently measured at cost less
accumulated depreciation and accumulated impairment losses.
 Once the fair value becomes reliably measurable, the biological asset is measured at
its fair value less costs to sell.
 Agricultural produce
o Is, in all cases, initially measured at fair value less costs to sell at the point
of harvest.
o This will be deemed cost for subsequent accounting using PAS 2 or another
applicable Standard.
o The gain or loss arising from the initial measurement is recognized in profit
or loss.
 Fair value
o Is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date.
 Cost to sell
o Are the incremental costs directly attributable to the disposal of an asset,
excluding finance costs and income taxes.
 An entity uses PFRS 13 Fair Value Measurement when measuring the fair value of
biological assets and agricultural produce.
 Fair value measurement may be facilitated by grouping biological assets or
agricultural produce according the significant attributes, such as age and quality.
 Contract prices are not necessarily relevant when measuring fair value.
o Accordingly, fair value is not adjusted by the existence of a contract.
  Cash flows on finance costs, taxes, and costs of reestablishing biological assets after
harvest (e.g., the cost of replanting after harvest) are not considered when
measuring fair value.
 Cost may sometimes approximate fair value, particularly when:
i. Little biological transformation has taken place since initial cost incurrent
(e.g., seedlings planted immediately prior to the end of a reporting period or
newly acquired livestock); or
ii. The impact of the biological transformation on price is not expected to be
material (e.g., the initial growth in a 30-year pine tree plantation production
cycle).
 Biological assets attached to land (e.g., trees in a plantation forest) may not have a
separate market but an active market may exists for the combined assets (i.e.,
biological assets, raw land, and land improvements) as a package.
 In such case, the fair value of the raw land and land improvements may be deducted
from the fair value of the combined assets to arrive at the fair value of the biological
assets.
 A biological assets that is previously measured at fair value less costs to sell is
continued to be measured at fair value less costs to sell until it is disposed of.

GOVERNMENT GRANTS

 Only government grants that are related to biological assets measured at fair value
less costs to sell are accounted for under PAS 41.
 Those that are related to biological assets measured at cost less accumulated
depreciation and accumulated impairment losses are accounted for under PAS 20.
 Under PA 41, if the government grant is:
a. Unconditional
o The grant is recognized in profit or loss when it becomes receivable.
b. Conditional
o The grant is recognized in profit or loss when the attached
conditions are met.
 c. Conditional but the terms of the grant allow part of it to be retained
according to the time that has elapsed
o A portion of the grant is recognized in profit or loss as time passes
(e.g., on a straight-line basis).

DISCLOSURE

 General disclosures:
a. The aggregate gain or loss arising on initial recognition of biological assets
and agricultural produce and from the change in fair value less costs to sell of
biological assets.
b. Description of each group of biological assets.
c. Description of the nature of activities involving each group of biological
assets and physical quantities of assets on hand at the end of the period and
output of agricultural produce during the period.
d. Restrictions on titles to biological assets.
e. Commitments for the development acquisition of biological assets.
f. Financial risk management strategies related to agricultural activity.
g. Reconciliation of changes in the carrying amount of biological assets,
showing separately changes in fair value less costs to sell, purchases, sales,
harvesting, business combinations, and foreign exchange differences.
 Encouraged disclosures:
a. Consumable and bearer biological assets.
b. Mature and immature biological assets.
 Mature biological assets
 Are those that have attained harvestable specifications (for
consumable biological assets) or are able to sustain regular
harvests (for bearer biological assets).
c. Change in fair value less costs to sell during the period:
1. Due to price change; and
2. Due to physical change.
 This information is useful if the production cycle extends beyond one year.
 It is less useful if the production cycles is less than a year (e.g., raising chickens or
growing annual crops).
 Disclosures for biological assets measured at cost:
a. Description of the assets
b. An explanation of why fair value cannot be reliably measured
c. If possible, a range within which fair value is highly likely to lie
d. Depreciation method, useful lives or depreciation rates
e. Reconciliation of gross carrying amount and accumulated depreciation at the
beginning and end of the reporting period, showing information on
depreciation, impairment loss and reversal of impairment loss.
 Disclosures for government grants:
a. Nature and extent of recognized government grants
b. Unfulfilled conditions
c. Significant decreases expected in the level of government grants.
PFRS 1 FIRST-TIME ADOPTION OF PHILIPPINE FINANCIAL REPORTING STANDARDS

INTRODUCTION

 Prior to the full adoption of the IFRS in 2005, the reporting standards used in the
Philippines were primarily based on US GAAP (then called ‘SFASs’- Statements of
Financial Accounting Standards).
 In 2005, these SFASs were superseded by PFRSs (based on IFRS).
 Reporting entities in the Philippines were mandated to transition from their
previous GAAP to PFRSs.
 On their transition to PFRSs in 2005, reporting entities were required to apply
PFRS1.
 The application of PFRS 1, however, is not confined only to the year 2005.
 Entities that were previously exempted from applying the “full” PFRSs, such as Small
and Medium-sized Entities (SMEs) who have adopted Other Acceptable Basis of
Accounting (OCBOA), are required to apply PFRS 1 when they transition to the “full”
PFRSs (a).
(a)
o “Full” PFRSs refer to the Standards that we are discussing in this book.
 Also, entities that are issuing general purpose financial statements for the first time
may need to apply PFRS 1.

OBJECTIVE

 The objective of PFRS 1 is to ensure that an entity’s First PFRS financial statements,
including interim financial reports covered thereon, contain high quality
information that is transparent to users, comparable, makes way for accounting in
accordance with PFRSs, and can be prepared with cost efficiency.

FISRT PFRS FINANCIAL STATEMENTS

 Are the first annual financial statements in which an entity adopts PFRSs, by an
explicit and unreserved statement of compliance with PFRSs.
 Financial statements prepared in accordance with PFRSs, are considered the entity’s
“First PFRS financial statements” if the previous financial statements:
 a. Were prepared in accordance with other reporting standards not consistent
with the PFRSs; or
b. Did not contain an explicit and unreserved statement of compliance with
PFRSs; or
c. Contained an explicit and unreserved statement of compliance with some,
but not all, PFRS; or
d. Were prepared using some, but not all, applicable PFRS; or
e. Prepared in accordance with PFRSs but were used for internal reporting
purposes only; or
f. Did not contain a complete set of financial statements as required under PAS
1 Presentation of Financial Statements.
g. The entity did not present financial statements in previous periods.
 PFRS 1
o Is applied only once, that is, when the entity first adopts PFRSs.
o Does not apply when previous financial statements contained an explicit and
unreserved statement of compliance with PFRSs, even if the auditors’ report
has been qualified.
o Does not apply when an entity that has been applying the PFRSs
subsequently changes its accounting policy in accordance with PAS 8 or
specific transitional provisions of other standards.
 First-time adopter
o An entity presenting its first PFRS financial statements.

ILLUSTRATION: EXPLICIT AND UNRESERVED STATEMENT OF COMPLIANCE WITH

PFRSs

An excerpt from a published financial statement of a first-time adopter is shown below:

 Note 2. Basis of preparation

a. Statement of compliance
o The financial statements have been prepared in accordance with
Philippine Financial Reporting Standards (PFRSs).
 o These are the Company’s first financial statements prepared in
accordance with PFRS and PFRS 1 First-time Adoption of Philippine
Financial Reporting Standards has been applied.
o An explanation of how the transition to PFRSs has affected the
reported financial position, financial performance and cash flows of
the Company is provided in Note 25.

RECOGNITION AND MEASUREMENT

 PFRS 1 requires an entity to prepare and present an opening PFRS statement of

financial position at the date of transition to PFRSs.
 Date to transition to PFRSs
o Is the beginning of the earliest period for which an entity presents full
comparative information under PFRSs in its first PFRS financial statements.
o The application of the PFRSs starts on this date.

ACCOUNTING POLICIES

 The entity selects its accounting policies based on the latest versions of PFRSs as at
the current reporting date.
 The selected policies are then applied to all financial statements presented together
with the first PFRS financial statements (i.e., opening statement of financial position,
comparative financial statements, and current-year first PFRS financial statements).
 PFRS 1 prohibits the application of non-uniform accounting policies or earlier
versions of PFRSs to the comparative periods as these undermine comparability.
 The latest standards provide the most up-to-date requirements and therefore
provide the most suitable starting point for the application of the PFRSs.
 Early, application of PFRSs that have not yet become effective as of the current
reporting period is permitted, but not required.

ILLUSTRATION
ABC Co. uses a calendar year accounting period. In 20x3, ABC Co. decides to adopt the
PFRSs for the first time. ABC Co. reports one-year comparative information.

Requirements:

a. What is the date of transition to PFRSs?

a. The date of transition is January 1, 20x2, the beginning of the earliest period
for which ABC Co. presents full comparative information under PFRSs in its
first PFRS financial statements.
b. What is the date of the opening PFRS statement of financial position?
a. The date of the opening PFRS statement of financial position is January 1,
20x2.
c. What financial statements shall be prepared on December 31, 20x3?
 ABC Co. shall prepare the following financial statements:
1. Statement of financial position as of January 1, 20x2 (opening)
2. Complete set of financial statements dated December 31, 20x1
(comparative)
3. Complete set of financial statements dated December 31, 20x3
(current-year ‘first PFRS financial statements’)
 ABC Co. shall apply uniform accounting policies based on the latest version of
PFRS on December 31, 20x3 to all of the financial statements listed above.
d. What is ABC co. reports two-year comparative information, what is the date of
transition to PFRSs?
a. The date of transition is January 1, 20x2, the beginning of the earliest period
for which ABC Co. presents full comparative information under PFRSs in its
first PFRS financial statements.

RETROSPECTIVE APPLICATION
  In general (but subject to some exceptions which will be discussed momentarily),
PFRS 1 requires retrospective application of the accounting policies selected by the
first-time adopter.
 Retrospective application means as if PFRSs have been used all along.
o This application requires restating assets and liabilities in the opening
statement of financial position in order to conform to PFRSs.
o The resulting adjustments are recognized directly in retained earnings (or
other category of equity, if appropriate).
 PFRS 1 requires an entity to do the following in its opening PFRS statement of
financial position:
a. Recognize all assets and liabilities whose recognition is required by PFRSs:
b. Not recognize items as assets or liabilities if PFRSs do not permit such
recognition;
c. Reclassify items recognized under previous GAAP that have different
classifications under PFRSs; and
d. Apply PFRSs in measuring all recognized assets and liabilities.
 PFRS 1 clarifies that the transitional provisions in other PFRSs apply only to entities
that already use PFRSs.
 First-time adopters should not apply these, except in certain cases specified under
PFRS 1.
 In general, first-time adopters shall apply the transitional provisions of PFRS 1.

ILLUSTRATION 1: RESTATEMENT OF OPENING SFP

ABC Co. is adopting the PFRSs for the first time. ABC’s financial statements prepared under
previous GAAP included the items listed below. You are to state the accounting treatments
for these items in ABS’s opening statement of financial position.

a. Significant losses from robbery have been deferred pending recovery of losses from
the insurance company.

ACCOUNTING:
 PFRS principle
Impairment of assets and related
compensation from third party are separate
economic events. Hence, they are accounted
for separately under PFRSs.
Application
 Derecognize the deferred losses that
were recognized as assets and charge
them to retained earnings.
 Recognize the compensation from
the insurance company in profit or
loss when it becomes receivable.

b. ABC received deposits for future subscription of its own shares from investors. ABC
classified the deposits as equity. The deposits are refundable in case of failure or
delay by ABC Co. to obtain authorization for increased capitalization from the SEC.
ABC Co. has not yet filed amended articles of incorporation to reflect the planned
increase in capitalization.

ACCOUNTING:

PFRS principle Application

If the deposits are repayable in cash at any  Reclassify the deposits from equity to
time prior to the approval of the entity’s liability.
application for increase in capitalization, the
deposits are classified as liability. In the
absence of such provision, the deposits are
classified as equity, i.e., as contributed
capital.

c. ABC declared dividends and classified them as liability. However, the dividends are
subject to final approval by a regulatory agency. ABC received the approval two
months after the date of transition.

ACCOUNTING:

PFRS principle Application

Liability for dividends is recognized when  Derecognize the dividends payable
the dividends are appropriately authorized
and is no longer at the discretion of the
entity.
Dividends declared after the reporting
period are non-adjusting events.
from the opening statement of
financial position and revert it to
retained earnings.

d. Organization costs have been capitalized and are being amortized over a period of 5
years.

ACCOUNTING:

PFRS principle Application

PAS 38 prohibits the recognition of  Derecognize the organization costs
organization costs as assets. and charge them to retained
earnings.

e. Redeemable preference shares issued are classified as equity under the previous
GAAP.

ACCOUNTING:

PFRS principle Application

Preference shares with mandatory  Reclassify the redeemable preference
redemption are classified as debt shares to liability.
instruments (i.e., liability).

f. Deferred taxes have been discounted to their presented values under the previous
GAAP.

ACCOUNTING:

PFRS principle Application

PAS 12 prohibits the discounting of deferred  Restate the deferred taxes to their
taxes. undiscounted amounts.
ILLUSTRATION 2: RESTAATEMENT OF OPENING SFP

ABC Co. is adopting the PFRSs for the first time. The following information has been
gathered:

a. Derivative assets and liabilities were not recognized because they are not accounted
for under the previous GAAP.

ACCOUNTING:

PFRS principle Application

PFRS requires the recognition of derivative  Recognize the derivative assets and
assets and liabilities. liabilities, measured at their fair
values on the date of transition.

b. ABC Co. has obtained a right to charge users of public infrastructure under a service
concession arrangement with the government. This transaction is not accounted for
under ABC’s previous GAAP.

ACCOUNTING:

PFRS principle Application

The ‘operator’ in a service concession  Recognize an intangible asset for the
arrangement recognizes an intangible asset license obtained from the
if the ‘operator’ has a contractual right to government, unless impracticable
charge users of the public services. (see discussion on exceptions below).

c. Research and development costs incurred in developing an intangible asset have

been capitalized under the previous GAAP and being amortized over a period of 5
years.

ACCOUNTING:

PFRS principle Application

R&D costs are generally expensed when
incurred. However, development costs may
be capitalized in limited cases where all of
the capitalization criteria under PAS 38
Intangible Assets are met.
 Derecognize the carrying amount of
the R&D costs and charge it to
retained earnings.

d. Land which was sold a few days after the date of transition to PFRSs was classified
as current asset. This treatment is permitted under the previous GAAP.

ACCOUNTING:

PFRS principle Application

Noncurrent assets are classified as current  Reclassify the land back to
only when all of the criteria under PFRS 5 noncurrent assets.
Non-current Assets Held for Sale and
Discontinued Operations are met as of the
end of the reporting period. If the criteria
are met after the end of the reporting
period, it is treated as a non-adjusting event.

e. ABC Co. operates in a geographical area frequently struck by typhoons. Losses on

typhoons are recurring every year. ABC believes that such losses are probable and
can be measured reliably. Accordingly, ABC recognized a provision for losses on
future typhoons.

ACCOUNTING:

PFRS principle Application

A liability is recognized if it is a “present  Derecognize the provision because it
obligation arising from past events” and does not meet the definition of a
meets the recognition criteria of “probable” liability.
and “measured reliably.”
 f. Warranty obligation has not been recognized because the previous GAAP requires
recognition of warranty only if there is legal obligation. Although, ABC Co. is not
contractually obliged to provide warranty, it has a past practice of honoring
warranty claims of customers. Warranty costs are charged as expenses when the
warranty services are rendered.

ACCOUNTING:

PFRS principle Application

Liabilities arise from obligating events,  Recognize a liability based on the
which are either: concept of “constructive obligation.”
1. Legal obligation (i.e., law, contracts,
or other operation of law); or
2. Constructive obligation (i.e., past
practice that creates valid
expectations from others that the
entity will settle an obligation).

EXCEPTIONS TO THE REQUIREMENTS OF PFRS 1

 PFRS 1 grants certain exemptions from compliance with the “retrospective

application” requirement when the cost of compliance exceeds the expected
benefits.
 Also, PFRS 1 prohibits retrospective application in cases where retrospective
application requires management judgments about past conditions after the
outcome of a particular transaction is already known.
 For example, estimates as at the date of transition made under the previous GAAP
are not changes unless here are differences in accounting policies or the previous
estimates were erroneous.
o Information received after the date of transition about the previous estimates
is treated as non-adjusting event.
 o Any resulting change in estimate is accounted for prospectively in profit or
loss.

ILLUSTRATION: ESTIMATES AS AT THE DATE OF TRANSITION

FACT PATTERN:

ABC Co. uses a calendar year accounting period. In 20x3, ABC Co. decides to adopt the
PFRSs for the first time. ABC Co. reports one-year comparative information.

Case #1: Consistent estimate

ABC’s statement of financial position as of January 1, 20x2 (prepared under previous GAAP)
included an allowance for bad debts computed using the aging of accounts receivable”
method.

 Question:
o Does ABC Co. need to revise its previous estimate of bad debts as of January
1, 20x2 (date of transition) on December 31, 20x3 (end of first PFRS
reporting period)?
 Answer:
o No. The “aging of accounts receivable” method is also acceptable under
PFRSs. ABC Co. need not revise its previous estimate.

Case #2: Difference in accounting policies

ABC’s statement of financial position as of January 1, 20x2 (prepared under previous GAAP)
did not include an allowance for bad debts. The “direct write-off” method had been used
because it was allowed under the previous GAAP.

 Question:
o Is ABC Co. required to provide an allowance for debts as of January 1, 20x2
(date of transition) on December 31, 20x3 (end of first PFRS reporting
period)?
 Answer:
 o Yes. PFRSs require the use of the accrual basis of accounting and the “direct
write-off” is not consistent with this concept. ABC shall estimate the
uncollectible accounts as of January 1, 20x2 and establish an allowance
account. Bad debts recognized in years 20x2 and 20x3 under the previous
GAAP shall be adjusted prospectively in profit or loss.
o The same accounting treatment shall also be made if the previous estimate is
clearly erroneous.

Case #3: Change in accounting estimate

ABC’s statement of financial position as of January 1, 20x2 (prepared under previous GAAP)
included an allowance for bad debts computed using the “percentage of accounts
receivable” method based on a 5% allowance rate. A review of the events that occurred in
20x2 revealed that significant amounts of accounts receivable have been written-off. The
rate that should have been used is 10% rather than 5%. ABC Co. could not have foreseen
this event when it made its previous estimate.

 Question:
o Does ABC Co. need to revise its previous estimate of bad debts as of January
1, 20x2 (date of transition) on December 31, 20x3 (end of first PFRS
reporting period)?
 Answer:
o No. The change in accounting estimate shall be accounted for prospectively.
The effects of the increase in the rate shall be reflected in profit or loss in
20x2 and 20x3.

OTHER EXCEPTIONS

 PFRS 1 provides numerous other exemptions from retrospective application. Some

of those exemptions are briefly summarized below:
1. Derecognition of financial instruments
 o A first-time adopter may not recognize financial instruments that it
has already derecognized under its previous GAAP prior to the date of
transition.
2. Hedge accounting
o A first-time adopter is required to do the following at the date of
transition to PFRS”
i. Measure all derivations at fair value: and
ii. Eliminate all deferred losses and gains on derivatives that were
reported under its previous GAAP.
3. Business combinations
o A first-time adopter is exempted from applying PFRS 3 Business
Combinations retrospectively to business combinations that occurred
prior to the date of transition to PFRSs. However, if it elects to restate
any business combination to comply with PFRS 3, it shall also restate
all subsequent business combinations.
o For example, a first-time adopter may apply PFRS 3 prospectively
from January 1, 20x2 (date of transition). If, however, the first-time
adopter elects to restate a business combination that occurred on
April 1, 20x1, it shall also restate all business combinations that
occurred between April 1, 20x1 and January 1, 20x2.
4. Fair value or Revaluation amount as deemed cost
o An entity adopting cost model for its:
a.Property, plant and equipment
b. Investment property
c. Intangible assets
-Is permitted to measure those assets at the date of
transition to PFRSs at fair value and use that fair value as their
deemed cost at that date.
 o Alternatively, the entity may elect to use a revaluation amount
determined under its previous GAAP as the deemed cost at the date of
revaluation, if the revaluation is comparable to:
a.Fair value
b. Cost or depreciated cost in accordance with PFRSs,
adjusted to reflect, for example, changes in a general or specific
price index.
5. Cumulative translation differences
o A first-time adopter is permitted to zero-out any cumulative
translation differences recognized in equity under the previous GAAP.
6. Compound financial instruments
o A first-time adopter need not separate the two components of a
compound financial instrument (i.e., liability and equity components)
if the liability component is no longer outstanding at the date of
transition to PFRSs.

PRESENTATION AND DISCLOSURE

 The first PFRS financial statements shall include at least one-year comparative
information.
 If the entity presents non-PFRS comparative information and historical summaries
for periods before the date of transition (e.g., summary of income and expenses
earned in the previous three years); it need not restate those summaries to PFRS.
However, it shall label them as being prepared in accordance with the previous
GAAP and shall disclose the nature of the main adjustments that would make those
summaries comply with PFRSs.
 The entity shall explain how the transition from previous GAAP to PFRSs affected its
financial position, financial performance and cash flows. This includes:
a. Reconciliations of equity reported under previous GAAP to equity under
PFRSs both:
a) At the date of transition to PFRSs and
 b) The end of the last annual period reported under the
previous GAAP.
o For example, for an entity adopting the PFRSs for the first time in its
December 31, 20x3 financial statements, the reconciliations would be
as of January 1, 20x2 (date of transition) and December 31, 20x2 (end
of last annual period reported under the previous GAAP).
b. Reconciliation of total comprehensive income for the last annual reported
under the previous GAAP to total comprehensive income under PFRSs for the
same period.
o Using the example above, this reconciliation would be for the period
ended December 31, 20x2.
c. Disclosure of impairment losses and reversals of impairment losses
recognized when the opening statement of financial position was prepared.
d. Disclosures of errors discovered in the course of transition to PFRSs.
e. Material adjustments made to restate the financial statements to PFRSs.
f. Appropriate explanations if the entity has elected to apply any of the
exemptions permitted under PFRS 1.
PFRS 2 SHARE-BASED PAYMENT

INTRODUCTION

 A corporation may issue its own shares in exchange for noncash consideration, such
as noncash assets or services.
 However, the Corporation Code of the Philippines prohibits the issuance of shares in
exchange for promissory notes or future services.
 Meaning, the consideration must be received first, if in the form of services, the
services must have been rendered first, before shares are issued.
 Furthermore, the value of the consideration received must not be less than the par
value or issued value of the shares,
 Transactions involving the issuance of shares in exchange for noncash consideration
are accounted for under PFRS 2.

SHARED-BASED PAYMENT TRANSACTIONS

 Is a transaction in which the entity acquires goods or services and pays for them by
issuing its own equity instruments or cash based on the value of its own equity
instruments. A share-based payment transaction can be:
1. Equity-settled share-based payment transaction
o One in which the entity receives goods or services and pays for them
by issuing its shares of stocks or share options; or
2. Cash-settled share-based payment transaction
o One in which the entity receives goods or services and incurs an
obligation to pay cash at an amount that is based on the fair value of
its own equity instruments; or
3. Choice between equity-settled and cash-settled
o One in which the entity receives goods or services and either the
entity or the counterparty is given a choice of settlement in the form
of equity instruments or cash based on the fair value of equity
instruments.
 Equity instrument
 o Is a contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities.
 PFRS 2 applies to all entities, including subsidiaries using their parent’s or fellow
subsidiary’s equity instruments as consideration for goods or services, and to all
share-based payment arrangements except the following:
a. Transactions with owners (including employees who are also shareholders)
acting in their capacity as owners, e.g., issuance of dividends, granting of
stock rights in relation to an owner’s preemptive right, and treasury share
transactions.
b. Business combinations (PFRS 3 Business Combinations)
c. Issuance of shares as a settlement of forward contracts, futures, and other
derivative instruments (PAS 32 and PFRS 9 Financial Instruments.)

RECOGNITION

 Goods or services acquired in share-based payment transactions are recognized

when the goods are received or as the services are received.
 Goods or services received that do not qualify as assets are recognized as expenses.
 The entity recognizes:
a. A corresponding increase in equity if the goods or services are received in an
equity-settled share-based payment transaction, or
b. A liability if the goods or services are acquired in a cash-settled share-based
payment transaction.

EQUITY-SETTLED SHARE-BASED PAYMENT TRANSACTIONS

 Goods or services received from equity-settled share-based payment transactions

with non-employees are measured at the fair value of the goods or services received,
or this is not determinable, at the fair value of the equity instruments granted.
 For transactions with employees and others providing similar services, the fair value
of the services received is often not possible to estimate reliably.
  Accordingly, PFRS 2 requires those services to be measured at the fair value of the
equity instruments granted, or if this is not determinable, at the intrinsic value of the
entity’s shares of stocks.

Equity-settled share-based payment transaction with:

Non-employees
Order of priority in measurement:
1. Fair value of goods or services
received
2. Fair value of equity instruments
granted
Employees and Others providing similar
services
Order of priority in measurement:
1. Fair value of equity instruments
granted
2. Intrinsic value

 Employees and others providing similar services

o Refer to individuals who render personal services to the entity and either:
a. The individuals are regarded as employees for legal or tax purposes,
b. The individuals work for the entity under its direction in the same
way as individuals who are regarded as employees for legal or tax
purposes, or
c. The services rendered are similar to those rendered by employees.
 Equity instrument granted
o Is the right (conditional or unconditional) to an equity instrument of the
entity conferred by the entity in another party under a share-based payment
arrangement.
 Fair value is measured at the measurement date.
a. For transactions with non-employees, the measurement date is the date
when entity receives the goods or services.
b. For transactions with employees and others providing similar services, the
measurement date is the grant date.
 Grant date
 o Is the date at which the entity and the counterparty agree to, and have shared
understanding of the terms and conditions of, a share-based payment
arrangement. If the agreement is subject to further approval (e.g., by
shareholders), grant date is the date when that approval is obtained.
 Intrinsic value
o Is the difference between the fair value of the shares which the counterparty
has the right to subscribe or receive and the subscription price (if any) that
the counterparty is required to pay. For example, a share option with fair
value off 50 and an exercise price of 30 has an intrinsic value of 20. (i.e., 50-
30).

ILLUSTRATION:

Entity A agrees to issue 1,000 of its shares of stocks as consideration for services that it has
received.

Case 1: Transaction with Non-employee

The counterparty is a non-employee. The fair value of the services received is 50,000 while
the fair value of the shares is 40 per share.

 Accounting
o The services are measured at 50,000, the fair value of the services received. If
this amount cannot be determined reliably, the services, the services will be
measured by reference to the fair value of the shares or 40,000 (40 x 1,000
sh.).

Case 2: Transaction with Employee

The counterparty is an employee. The fair value of the shares is 40 per share.

 Accounting
o The services are measured at 40,000, the fair value of the equity instruments
granted. If this amount cannot be determined reliably, the services will be
 measured at the intrinsic value. Assuming the subscription price is 30 per
share, the intrinsic value is 10,000 [(40 -30) x 1,000 shares].

SHARE-BASED COMPENSATION PLANS

 Is an arrangement whereby, in exchange for services, an employee is compensated in

the form of (or based on) the entity’s instrument. Examples of share-based
compensation:
a. Employee share options (equity-settled)
b. Employee share appreciation rights (cash-settled)
c. Compensation plans with a choice of settlement between (a) and (b) above.
 Share-based compensations are given to key employees as bonuses or additional
compensation.
 The benefits of a share-based compensation to the employer may include a possible
reduction in employee turnover because employees will have to remain in the
entity’s employ during the service period in order to exercise the equity instrument
granted.
 Employees will also be more motivated in contributing to the achievement of the
entity’s goals because they are given an opportunity to become owners of the entity.

EMPLOYEE SHARE OPTION PLANS

 Share option
o Is a contract that gives the holder the right, but not the obligation, to
subscribe to the entity’s shares at a fixed or determinable price for a specified
period of time.
o Some share options given to employees do not require any subscription price,
meaning the shares will be issued solely in exchange for employee services.

MEASUREMENT OF COMPENSATION

 Employee share option plans are equity-settled share-based payment transactions

with employees.
  Accordingly, the services received are measured using the following order of
priority:
1. Fair value of equity instruments granted at grant date
2. Intrinsic value
 The compensation expense (salaries expense) on the employee share option plan is
recognized as follows:
a. If the share options granted vest immediately, meaning the employee is
entitled to the shares without the need to satisfy any condition, salaries
expense is recognized in full, with a corresponding increase in equity, at grant
date.
b. If the share options granted do not vest until the employee completes a
specified period of service, the entity recognizes salaries expense as the
employee renders service over the vesting period.
 In the absence of evidence to the contrary, it is presumed that share options vest
immediately.

ILLUSTRATION:

On January 1, 20x1, Entity A grants 10,000 share options to its key employees. The share
options entitle the employees to purchase Entity A’s shares at a subscription price of 110
per share. Entity A’s shares have a par value 100 per share and a fair value on grant date of
120 per share. The share options have fair value of 15 per share option.

Case 1: Share options vest immediately

If the share options vest immediately, Entity A will recognize salaries expense of 150,000
(10,000 share options x 15 fair value per share option) on January 1, 20x1.

Case 2: Share options do not vest immediately

If the share options vest in 3 years, Entity A recognizes salaries expense over the 3-year
vesting period as follows:
Dec. Total share options expected to vest 10,000
31, Multiply by: Fair value per share option at grant date 15
20x1 Fair value of share options at grant date 150,000
Multiply by: Vesting pd. passed over Total vesting period 1 yr./3 yrs.
Cumulative salaries expense to date 50,000
Less: Salaries expense recognized in previous periods -
Salaries expense-20x1 50,000

Dec. Total share options expected to vest 10,000

31, Multiply by: Fair value per share option at grant date 15
20x2 Fair value of share options at grant date 150,000
Multiply by: Vesting pd. passed over Total vesting period 2 yr./3 yrs.
Cumulative salaries expense to date 100,000
Less: Salaries expense recognized in previous periods (50,000)
Salaries expense-20x2 50,000

Dec. Total share options expected to vest 10,000

31, Multiply by: Fair value per share option at grant date 15
20x3 Fair value of share options at grant date 150,000
Multiply by: Vesting pd. passed over Total vesting period 3 yr./3 yrs.
Cumulative salaries expense to date 150,000
Less: Salaries expense recognized in previous periods (100,000)
Salaries expense-20x1 50,000

 Notice that no salaries expense is recognized on January 1, 20x1 (grant date)

because the employees have not yet rendered service.
 Expenses are recognized at the end of each year over the vesting period (i.e., every
December 31) after the employees have rendered services for the year.

SUMMARY OF SOLUTION:

Date Salaries expense

 Jan. 1 20x1 -
Dec. 31, 20x1 (10,000 x 15 x 1/3) 50,000
Dec. 31, 20x2 (10,000 x 15 x 2/3)-50,000 50,000
Dec. 31, 20x3 (10,000 x 15 x 3/3)-50,000 – 50,000 50,000

CHANGES IN SERVICE CONDITION

 Service condition
o Means, to be entitled to receive or subscribe to the shares embodied in the
share options, the employee needs to remain in the entity’s employ for a
specified period of time.
 Adjustments for employees leaving the entity’s employ before the share options vest
are accounted for prospectively.
 Salaries expense recognized in previous periods are not restated.

ILLUSTRATION:

On January 1, 20x1, Entity A grants 100 share options to each of its 100 key employees
conditional upon each employee remaining in Entity A’s employee over the next 3 years.
The fair value of each share option is 15.

 On the basis of a weighted average probability, Entity A estimates on January 1, 20x1

that about 20 employees (i.e., 20% or 20 out of the 100 employees) will leave during
the three-year period and therefore forfeit their rights to the share options,
 During 20x1, 7 employees left. Entity A revises its estimate to a total of 25%
employee departure over the vesting period.
 During 20x2, 9 employees left. Entity A revises its estimate to a total of 28%
employee departure over the vesting period.
 During 20x3, 8 employees left. Therefore, the actual employee departure over the
past three years is 24$% [(7 + 9 + 8) + 100].

Entity A recognizes salaries expense over the vesting period as follows:

 Date Salaries expense
Jan. 1 20x1 -
Dec. 31, 20x1 (10,000(a) x 75%(b)) x 15 x 1/3 37,500
Dec. 31, 20x2 [(10,000 x 72%) x 15 x 2/3] – 37,500 34,500
Dec. 31, 20x3 [(10,000 x 76%) x 15 x 3/3] – 37,500-34,500 50,000

(a)
100 employees x 100 share options = 10,000 total share options granted

(b)
100%25% estimate of total employee departure = 75%

NOTES:

 The initial estimate of 10% on January 1, 20x1 is ignored because salaries expense
are recognized at year-end.
 On the vesting date (Dec. 31, 20x3), the actual employee departures are used in
computing for salaries expense.
 The total salaries expense recognized over the vesting period equals the grant date
fair value of the share options that have actually vested. This amount is only
allocated over the vesting period. Analyze the reconciliation below:
o 10,000 x 76% = 7,600 share options that have actually vested x 15 = 114,000
total salaries expense;
o 37,500 + 34,500 + 42,000 = 114,000 total salaries expense

CASH-SETTLED SHARE-BASED PAYMENT TRANSACTIONS

 Is one whereby an entity acquires goods or services and incurs an obligation to pay
cash at an amount that is based on the fair value of equity instruments.
 The goods or services received, and the related liability, are measured at the fair
value of the liability.
 At the end of each reporting period and even on settlement date, the liability is
remeasured to fair value. Changes in fair value are recognized in profit or loss.
 The most common form of a cash-settled share-based payment transaction is share
appreciation rights (SARs) granted to an employee.
EMPLOYEE SHARE APPRECIATION RIGHTS (SARs)

 Share appreciation rights

o Is a form of compensation given to an employee whereby the employee is
entitled to future cash payment (rather than equity instrument), based on the
increase in the entity’s share price from a specified level over a specified
period of time.
 Another form of a share appreciation rights is when an employee is granted a right
to receive future cash payments by a grant to a right shares that are redeemable,
either mandatorily (e.g., upon cessation of employment) or at the employee’s option.

MEASUREMENT OF COMPENSATION

 The liability for the future cash payment on share appreciation rights is measured,
initially and at the end of each reporting period until settled, at the fair value of the
share appreciation rights. Changes in fair value are recognized in profit or loss.
 The fair value of the share appreciation rights is derived by applying an option
pricing model, taking into account the terms and conditions on which the share
appreciation rights were granted, and the extent to which the employees have
rendered service to date.
 The compensation expense (salaries expense) on the SARs is recognized similar to
employee share options, that is, if the SARs vest immediately, salaries expense is
recognized in full, with a corresponding increase in liability, at grant date; if the SARs
do not vest immediately, salaries expense is recognized over the vesting period as
the employee renders service.

ILLUSTRATION: SHARE APPRECIATION RIGHTS

On January 1, 20x1, Entity A grants 1,000 share appreciation rights (SARs) t employees
with the condition that the employees remain in service within the next years. Information
on the SARs is shown below:

Date No. of SARs expected to vest Fair value of each SAR

Jan. 1 20x1 1,000 10
 Dec. 31, 20x1 900 12
Dec. 31, 20x2 800 15
Dec. 31, 20x3 750 16

 Entity A recognizes salaries expense over the vesting period as follows:

Date Salaries expense

Jan. 1 20x1 -
Dec. 31, 20x1 (900 x 12 x 1/3) 3,600
Dec. 31, 20x2 (800 x 15 x 2/3) – 3,600 4,400
Dec. 31, 20x3 (750 x 16 x 3/3) – 3,600 – 4,400 4,000

REMEMBER THE FOLLOWING:

Employee share option plans Employee share appreciation rights (SARs)

 Share options are not remeasured.
Expenses recognized over the vesting
period are based on the fair value of
the share options at grant date.
 Settled through the issuance of
equity instruments.
 SARs are remeasured at each year-
end and on settlement date. Changes
in fair value are recognized in profit
or loss.
 Settled through payment in cash.

CHOICE BETWEEN EQUITY-SETTLED AND CASH SETTLED

 A share-based payment transaction that can be settled either through equity

instrument or cash is accounted for depending on which party is given the right of
choice of settlement:
a. The counterparty has the right of choice of settlement; or
b. The entity has the right of choice of settlement

COUNTERPARTY HAS THE RIGHT OF CHOICE

  If the counterparty has the right to choose settlement between cash (or other
assets) or equity instruments, the entity has granted a compound instrument.
 Compound instrument is one which includes both a:
o Debt component
 The counterparty’s right to demand payment in cash
o Equity instrument
 The counterparty’s right to demand settlement in equity instruments
rather than in cash.
 As discussed earlier, the accounting for a share-based payment transaction depends
on whether the counterparty is a non-employee or an employee or others providing
similar services.

TRANSACTIONS WITH NON-EMPLOYEES

 For transactions with non-employees, the equity component is computed as the

difference between:
a. The fair value of goods or services received; and
b. The fair value of the debt component at the date the goods or services are
received.
 For example, if the goods or services acquired from a non-employee have a fair value
of 100 (asset) while the cash alternative has a fair value of 80 (liability), the equity
component is 20.

TRANSACTIONS WITH EMPLOYEES

 The transaction with employees and others providing similar services, the entity
measures the fair value of the compound instrument and its components as follows:
a. If the fair value of one settlement alternative is the same as the other, the fair
value of the equity component is zero, and hence the fair value of the
compound financial instrument is the same as the fair value of the debt
component.
 b. If the fair values of the settlement alternatives differ, the fair value of the
equity component will be greater than zero, in which case, the fair value of
the compound financial instrument will be greater than the fair value of the
debt component.
 Each component of the compound instrument is accounted for separately, similar to
a purely equity-settled or a purely cash-settled share-based payment transaction.
Meaning,
a. The value assigned to the equity alternative on grant date (if any) is
recognized as salaries expense and an increase in equity over the vesting
period; and
b. The value assigned to the cash alternative is recognized as salaries expense,
and a liability, that is remeasured at each year-end and on settlement, as the
services are received. Changes in fair values are recognized in profit or loss.

SETTLEMENT

 On settlement date, the liability component is remeasured to fair value. If the entity
settles the transaction in the form of:
a. Equity instruments
o The liability is transferred directly to equity as consideration for the
issuance of the shares.
b. Cash
o The cash payment is applied as settlement of the liability.
 The previously recognized equity component remains within equity, regardless of
the settlement option chosen.
o However, a transfer within equity may be made.
o For example, by transferring any balance in the ‘Share premium – share
options outstanding” accounting to the “Share premium” general account.

ENTITY HAS THE RIGHT OF CHOICE

  If the entity has the right to choose settlement between cash (or other assets) or
equity instruments, the entity has not granted a compound instrument.
 Accordingly, the entity accounts for the transaction as either equity-settled or cash
settled share-based payment transaction, depending on whether the entity has a
present obligation to pay cash.
a. If the entity has a present obligation to pay cash, the transaction is accounted
for as cash-settled. Consequently, the equity alternative is simply ignored.
b. If the entity has no present obligation to pay cash, the transaction is
accounted for as equity-settled. Consequently, the cash alternative is simply
ignored.

SETTLEMENT

 Upon settlement:
a. If the entity elects to settle in cash, the cash payment is accounted for as a
repurchase of an equity interest, i.e., as deduction from equity, except as
noted in © below.
b. If the entity elects to settle by issuing instruments, no further accounting is
required other than a transfer from one component of equity to another, if
necessary, except as noted in (c) below.
c. If the entity elects the settlement alternative with the higher fair value as at
the date of settlement, the entity recognizes an additional expense for the:
i. Excess of cash paid over the fair value of equity instruments that
would otherwise have been issued, or
ii. Excess of fair value of the equity instruments issued and the amount
of cash that would otherwise have been paid, whichever is applicable.
PFRS 3 BUSINESS COMBINATION

INTRODUCTION

 Business combination
o occurs when one company acquires another or when two or more companies
merge into one.
o After combination, one company gains control over the other.
 Parent or Acquirer
 o Company obtains control over the other .
 Subsidiary or Acquiree
o Other company that is controlled
 PFRS 3 applies to business combinations.
 Its objective is to enhance the relevance, reliability and comparability of the
acquirer’s financial reporting by establishing the recognition and measurement
principles and disclosure requirements for a business combination
 PFRS does not apply to the following:
a. Formation of a joint venture
b. The acquisition of an asset or a group of assets and related liabilities that
does not constitute a business.
o In this case, the acquirer allocates the lump sum purchase price to the
acquired items based on their relative fair values on the purchase
date.
o this transaction does not give rise to goodwill
c. A combination of entities under common control.

BUSINESS COMBINATION

 Is a transaction or other event in which the acquirer obtains control of one or more
businesses.
 Transaction referred to as true mergers or mergers of equals are also business
combination under PFRS 3.
 Essential elements in the definition of a business combination
1. Control
2. Business

CONTROL

 An investor controls an investee when the investor has the power to direct the
investee’s relevant activities (i.e., operating and financing policies), thereby affecting
the variability of the investor’s investment returns from the investee.
  Control exist when the. acquirer holds more than 50% (or 51 or more) interest in
the acquiree’s voting rights.
 However, this only a presumption because the control can be obtained in some other
ways, such as when:
a. The acquirer has the power to appoint or remove the majority of the board of
directors of the acquirer
b. The acquirer has the power to cast the majority of votes at board meetings or
equivalent bodies within the acquire
c. The acquirer has power over more than half of the voting rights because of an
agreement with other investors
d. The acquirer controls the acquiree’s operating and financial policies because
of a law or an arrangement
 An acquirer may obtain control of an acquiree in a variety of ways, for example:
a. By transferring cash or other assets (including net assets that constitute a
business)
b. By incurring liabilities
c. By issuing interests
d. By providing more than one type of consideration
e. Without transferring consideration, including by contract alone.

BUSINESS

 An integrated set of activities and assets that is capable of being conducted and
manages for the purpose of providing goods or services to customers, generating
investment income (such as dividends or interest) or generating other income from
ordinary activities.
 A business has the following three elements:
1. Input- any economic resource that results to an output when one or more
processes are applied to it,
  non-current assets
 intellectual property
 the ability to obtain access to necessary materials or rights and
employees
2. Process- any system, standard, protocol, convention, or rule that when
applied to an input, creates an output.
 strategic management processes
 operational processes, and
 resource management
3. Output- the result of 1 and 2 above that provides goods or services to
customers, investment income or other income from ordinary activities.

IDENTIFYING A BUSINESS COMBINATION

 An entity determines whether a transaction is a business combination in relation to

the definition provided under PFRS 3.
 If the assets acquired (and related liabilities assumed) do not constitute a business,
the entity accounts for the transaction as a regular asset acquisition and not a
business combination.
 Accordingly, the entity applies other applicable Standards (PAS 2 for inventories
acquired, PAS 16 for PPE acquired)

ACCOUNTING FOR BUSINESS COMBINATION

 Business combinations are accounted for using acquisition method.

 The method requires the following:
a. Identifying the acquirer
b. Determining the acquisition date
c. Recognizing and measuring goodwill. This requires recognizing and
measuring the following:
i. Consideration transferred
 ii. Non-controlling interest in the acquire
iii. Previously held equity interest in the acquire
iv. Identifiable assets acquired and liabilities assumed on the business
combination

IDENTIFYING THE ACQUIRER

 For each business combination, one of the combining entities is identified as the
acquirer.
 The acquirer is the entity that obtains control of the acquire.
 The acquiree is the business that the acquirer obtains control of in a business
combination.

DETERMINING THE ACQUISITION DATE

 Acquisition date
o Is the date in which the acquirer obtains control of the acquiree.
o This is normally the closing date (i.e., the date on which the acquirer legally
transfers the consideration, acquires the assets and assumes the liabilities of
the acquiree).
o However, the acquirer might obtain control on a date that is either earlier or
later than the closing date, for example, when there is a written agreement to
the effect.

RECOGNITION AND MEASURING GOODWILL

 On acquisition date, the acquirer computes and recognizes goodwill (or gain on a
bargain purchase) using the following formula:
Consideration transferred xx
Non-controlling interest (NCI) in the acquire xx
Previously held equity interest in the acquire xx xx
Total xx
 Less: Fair value of net identifiable assets acquired xx
Goodwill / (Gain on a bargain purchase) xx
 A negative amount resulting from the formula is called gain on bargain purchase
(also referred as negative goodwill)
 A bargain purchase may occur for example, in a business combination that is a
forced sale in which the acquiree is acting under compulsion.
o However, a bargain purchase may also occur in other instances such as when
the application of the recognition and measurement exceptions for particular
items provided under PFRS 3 results in a gain on bargain purchase.
 On acquisition date, the acquirer recognizes a resulting:
a. Goodwill as an asset
b. Gain on a bargain purchase as gain in profit or loss
 However, before recognizing a gain on a bargain purchase, the acquirer shall
reassess whether it has correctly identified all of the assets acquired and all of the
liabilities assumed and shall recognize any additional assets or liabilities that are
identified in that review.
o This is an application of the concept of conservatism

CONSIDERATION TRANSFERRED

 The consideration transferred in a business combination is measured at fair value,

which is the sum of the acquisition-date fair values of the assets transferred by the
acquirer, the liabilities incurred by the acquirer to form owners of the acquiree and
the equity interests issued by the acquirer.
 Examples of potential forms of consideration include:
a. Cash
b. Non-cash assets
c. Equity instruments (shares, options, warrants)
d. A business or a subsidiary of the acquirer
e. Contingent consideration

ACQUISITION-RELATED COSTS
  Acquisition-related costs are costs that acquirer incurs to effect a business
combination. Examples:
a. Finder’s fees
b. Professional fees, such as advisory, legal, accounting, valuation and consulting
fees
c. General administrative cost, including the costs of maintaining an internal
acquisitions department
d. Costs of registering and issuing debt and equity securities
 Acquisition-related costs are recognized as expenses when they are incurred, except
for the following:
a. Cost to issue debt securities measured at amortized cost are included in the
initial measurement of the securities, e.g., bond issue costs are included (as
deduction) in the carrying amount of bonds payable.
b. Cost to issue equity securities are deducted from share premium. If share
premium is insufficient, the issue costs are deducted from retained earnings.

NON-CONTROLLING INTEREST

 Non-controlling interest (NCI) is the equity in a subsidiary not attributable,

directly or indirectly, to a parent.
 Non-controlling interest is also called “minority interest.”
 For example, ABC Co. acquires 80% interest in XYZ, Inc. The controlling interest is
80% while the non-controlling interest in XYZ, Inc., the non-controlling interest is
zero.
 For each business combination, the acquirer measures any non-controlling interest
in the acquiree either at:
a. Fair value; or
b. The NCI’s proportionate share of the acquiree’s identifiable net assets.

PREVIOUSLY HELD EQUITY INTEREST IN THE ACQUIREE

 Previously held equity interest in the acquiree pertains to any interest held by the
acquirer before the business combination.
  This affects the combination of goodwill only in the business combinations achieved
in stages.

NET IDENTIFIABLE ASSETS ACQUIRED

Recognition principle

 On the acquisition date, the acquirer recognized the identifiable assets acquired, the
liabilities assumed and any NCI in the acquiree separately from goodwill.
 Unidentifiable assets are not recognized. Example of unidentifiable assets:
a. Goodwill recorded by the acquiree prior to the business combination.
b. Assembled workforce
c. Potential contracts that the acquire is negotiating with prospective new
customers at the acquisition date

Recognition conditions

a. To qualify for recognition, identifiable assets acquired and liabilities assumed must
meet the definitions of assets and liabilities provided under the Conceptual
Framework at the acquisition date.
 For example, costs that the acquirer expects but is not obliged to incur in the
future to effect its plan to exit the acquiree’s activity or to terminate or
relocate the acquiree’s employees are not liabilities at the acquisition date.
Hence, these are not recognized when applying the acquisition method but
rather treated as post-combination costs in accordance with other applicable
Standards.
b. The identifiable assets acquired and liabilities assumed must be part of what the
acquirer and the acquiree (or its former owners) exchanged in the business
combination transaction rather than the result of separate transactions.
c. Applying the recognition principle may result to the acquirer recognizing assets and
liabilities that the acquiree had not previously recognized in its financial statements.
 For example, the acquirer may recognize an acquired intangible asset, such as
a brand name, a patent or a customer relationship, that the acquire did not
 recognize as an asset in its financial statements because it has developed the
intangible asset internally and charged the related cost as expense.

Classifying identifiable assets acquired and liabilities assumed

 Identifiable assets acquired and liabilities assumed are classified at the acquisition
date in accordance with other PFRSs that are to be applied subsequently.
o For example, PPE acquired in the business combination are classified at the
acquisition date in accordance with PAS 16 if the assets are to be used as PPE
subsequent to the acquisition date.

Measurement principle

 Identifiable assets acquired and liabilities assumed are measured at their

acquisition-date fair values.
 Separate valuation allowances are not recognized at the acquisition date because the
effects of uncertainty about future cash flows are included in the fair value
measurement.
o For example, the acquirer does not recognize an “allowance for doubtful
accounts” on accounts receivable acquired on a business combination.
Instead, the acquired accounts receivable are recognized at their acquisition-
date fair values.
 All acquired assets are recognized regardless of whether an acquirer intends to use
them.
o For example, the acquirer recognizes the acquiree’s research and
development costs as intangible asset even if it does not intend to use them
or intends to use them in some other way.
o The acquisition-date fair value of such assets is determined in accordance
with their use by other market participants.

Illustration:
On January 1, 20x1, ABC Co. acquired 80% interest in XYZ, Inc. for P 1,000,000 cash ABC Co.
incurred transaction cost of P 100,000 for legal, accounting and consultancy fees in
negotiating the business combination.

ABC Co. elected to measure NCI at the NCI’s proportionate share in XYZ Inc.’s identifiable
net assets. The carrying amounts and fair values of XYZ’s assets and liabilities at the
acquisition date were as follows:

Assets Carrying amount Fair values

Cash 10,000 10,000
Receivables 200,000 120,000
Allowance for bad debts (30,000)
Inventory 520,000 350,000
Building-net 1,000,000 1,100,000
Goodwill 100,000 i 20,000 i
Total assets 1,800,000 i 1,600,000 i
Liabilities
Payables 400,000 i 400,000 i

 The acquisition-date fair value of identifiable net assets acquired is computed as

follows:

Fair value of identifiable assets required excluding

Goodwill (1,600,000 total assets-20,000 goodwill) 1,580,000

Less: Fair value of liabilities assumed (400,000

Fair value of identifiable net assets acquired 1,180,000

 The acquiree’s goodwill is excluded because it is unidentifiable. Only identifiable

assets acquired are recognized.
  The NCI’s proportionate share in the acquiree’s identifiable net assets is computed
as follows:
Fair value of identifiable net assets acquired 1,180,000
Multiply by: Non-controlling interest (100%-80%) 20%

NCI’s proportionate share in identifiable net assets 236,000

 Goodwill (Negative goodwill) is computed as follows:

Consideration transferred 1,000,000
NCI in the acquire 236,000
Previously held equity interest in the acquire -

Total 1,236,000
Less: Fair value of identifiable net assets acquired (1,180,000)
Goodwill 56,000

The P100,000 transaction cost are expensed. Acquisition-related cost do not affect the
measurement of goodwill.
PFRS 5 NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

INTRODUCTION

 Assets classified as noncurrent in accordance with PAS 1 are classified as current

assets only if they meet the criteria to be classified as held for sale under PFRS 5.
 PFRS 5 prescribes the accounting for assets held for sale including disposal groups,
and the presentation and disclosure of discontinued operations.
 Noncurrent asset – is an asset that does not meet the definition of a current asset.
 Noncurrent assets within the scope of PFRS 5:
a. Property, plant, and equipment
b. Investment property measured under the cost model
c. Investment in associate, subsidiary, or joint venture
d. Intangible assets
 Noncurrent assets outside the scope of PFRS 5:
a. Deferred tax assets
b. Assets arising from employee benefits
c. Financial assets within the scope of PFRS 9 Financial Instruments
d. Investment property measured under the fair value model
e. Biological assets
f. Contractual rights under insurance contracts

 Disposal group is a group of assets to be disposed of, by sale or otherwise, together

as a group in a single transaction, and liabilities directly associated with those assets
that will be transferred in the transaction.

CLASSIFICATION AS HELD FOR SALE

 A noncurrent asset (or disposal group) is classified as held for sale or held for
distribution to owners if its carrying amount will be recovered principally
through a sale transaction rather than through continuing use.
 This means that more economic benefits will be derived from the asset if it is to be
sold rather than continually used.
CONDITIONS FOR CLASSIFICATION AS HELD FOR SALE

 A noncurrent asset or a disposal group is classified as held for sale (and

consequently, presented as current asset in the statement of financial position) if the
both of the following conditions are met:
a. The noncurrent asset or disposal group is available for immediate sale in its
present condition subject only to terms that are usual and customary; and
b. The sale is highly probable, as evidenced by the existence of all of the
following:
i. The entity's management is committed on selling the asset;
ii. The entity is actively locating a buyer;
iii. The sale price is reasonable in relation to the asset's (or disposal
group's) current fair value;
iv. The sale is expected to be completed within one year from the date of
classification; and
v. It is unlikely that the plan to sell will be withdrawn.

*The terms "highly probable" and "probable" are used differently in the Standards. "Highly
probable" connotes a higher chance of occurrence than Probokt Highly probable means
"significantly more likely than not" while probable means "more likely than not."

 Sale includes exchanges (of noncurrent assets for other noncurrent assets) that have
commercial substance.

Illustration 1: Available for immediate sale in present condition

ABC Co. is committed to a plan to sell its office building and has initiated actions to locate a
buyer.

Case #1: ABC Co. will transfer the ownership of the building to the buyer after ABC Co.
vacates the building.
  Analysis: The building will be classified as held for sale. The criteria would be met
at the plan commitment date because the time to vacate is necessary, usual, and
customary for sales.

Case #2: ABC Co. will continue to use the building until the construction of a new building
is completed.

 Analysis: The building will not be classified as held for sale. The criteria would not
be met because the delay in the transfer of ownership imposed by the entity (seller)
indicates that the building is not available for immediate sale, even if a purchase
commitment for the future transfer of the building is obtained earlier. The building
continues to be classified as PPE.

Illustration 2: Highly probable sale

ABC Co. is a commercial leasing and finance company. As of year-end, ABC holds equipment
that is available either for sale or lease. ABC is not yet decided whether to sell or to lease
the equipment.

 Analysis: The equipment is not classified as held for sale because the criterion for
highly probable sale is not met as the ultimate form of the future transaction (sale or
lease) has not yet been determined.

EXCEPTION TO THE ONE-YEAR REQUIREMENT

 An asset (or disposal group) that is not sold within 1 year from the date of its
classification as held for sale is reclassified back to its previous classification (e.g.,
from 'held for sale' back to 'PPE').
 However, the asset (or disposal group) is continued to be classified as held for sale if
the following conditions are met:
a. the delay is caused by events beyond the entity's control; and
b. there is sufficient evidence that the entity remains committed on selling
the asset (or disposal group).
Illustration:

On December 31, 20x1, Entity A commits to a plan to sell its building. The building has a
fair value of P1M and is being actively marketed at a sale price of P990K. On December 31,
20x2, the building is not yet sold.

 General rule: Entity A shall reclassify the building from "held for sale" back to PPE
on December 31, 20x2.

 Exception: The delay in the sale is beyond the control of Entity A. Entity A reduces
the sale price from 990K to P890K.

o Entity A shall continue to classify the building as "held for sale" in its
December 31, 20x2 financial statements because the conditions for the
exception to the one-year requirement are met. The fact that Entity A
reduced the sale price evidences that Entity A remains committed to its plan
to sell the asset.

EXCLUSIVE VIEW OF SUBSEQUENT DISPOSAL

 A noncurrent asset (or disposal group) that is acquired exclusively with a view to
its subsequent disposal is classified as held for sale at the acquisition date if the "sale
within one-year" requirement is met and it is highly probable that the other
requirements will be met within a short period of time after the acquisition (usually
within the three months).

EVENT AFTER THE REPORTING PERIOD

 A noncurrent asset or disposal group that meets the criteria classification as held
for sale only after the reporting period is not classified as held for sale in the
current period's financial statements.
 Meaning, the event is treated as a non-adjusting event after the reporting period.

PROPERTY DIVIDENDS

 Noncurrent assets (or disposal groups) declared as property dividends are

classified as held for distribution to owners when they are available for
 immediate distribution in their present condition and the distribution is highly
probable.
 The probability that a further approval (if any) of the dividend declaration will be
obtained is considered as part of the assessment of whether the distribution is
highly probable.

NON-CURRENT ASSETS THAT ARE TO BE ABANDONED

 A noncurrent asset or disposal group that is to be abandoned is not classified as

held for sale because its carrying amount will be recovered through continuing use
rather than principally through sale.
 Noncurrent assets to be abandoned include those that are to be used to the end of
their economic life or are to be closed rather than sold.
 Noncurrent assets that are temporarily taken out of use are not treated as if they
have been abandoned.

MEASUREMENT

 Held for sale assets are initially and subsequently measured at the lower of
carrying amount and fair value less costs to sell.
 Fair value - is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement
date.
 Costs to sell - are the incremental costs directly attributable the disposal of an asset
or disposal group, excluding finance costs and income tax expense.
o Costs to sell are discounted to their present value if the sale is expected to
occur beyond one year.
 Assets classified as held for distribution to owners are measured at the lower of
carrying amount and fair value less costs to distribute.
 Held for sale assets that are acquired as part of a business combination are
measured at fair value less costs to sell, not at fair value as required by PFRS 3.
CHANGES IN FAIR VALUE LESS COSTS TO SELL

 Subsequent changes in fair value less costs to sell are recognized in profit or loss as
impairment losses or gains on reversal of impairment.
 However, a gain on reversal of impairment is recognized only to the extent of
cumulative impairment losses that have previously been recognized.

DEPRECIATION AND AMORTIZATION

 Held for sale assets are not depreciated or amortized while they are classified as
held for sale.
 However, interest and other related expenses attributable to financial instruments
included in a disposal group are continued to be recognized.

CHANGES TO A PLAN OF SALE

 An asset that ceases to be classified as held for sale is measured that the lower of the
asset's
a. Carrying amount before it was classified as held for sale, adjusted for any
depreciation, amortization or revaluation that would have been recognized
had the asset not been classified as held for sale; and
b. Recoverable amount at the date of subsequent decision not to sell.
 Recoverable amount is the higher of an asset's:
a. fair value less costs of disposal, and
b. Its value in use
 Value in use is the present value of estimated future cash flows expected to arise
from the continuing use of an asset and from its disposal at the end of its useful life.

DISCONTINUED OPERATIONS

 A discontinued operation is a component of an entity that either has been

disposed of or is classified as held for sale, and
a. Represents a major line of business or geographical area of operations;
 b. is part of a single coordinated plan to dispose of a separate major line of
business or geographical area of operations; or
c. is a subsidiary acquired exclusively with a view to resale." (PFRS 5.32)

 A component of an entity comprises operations and cash flows that can be clearly
distinguished, operationally and for financial reporting purposes, from the rest of
the entity.

 Operations and cash flows can be clearly distinguished operationally and for
financial reporting purposes if the assets, liabilities, income, and expenses that are
directly attributable to the component will be eliminated if the component is to
be sold.
 A component of an entity can be a cash-generating unit (CGU) or group of CGUS, an
operating segment, a reporting unit, a geographical area or operations, a subsidiary,
or an asset group.
 A CGU is the smallest identifiable group of assets that generates cash inflows that
are largely independent of the cash inflows from other assets of group of assets.
 A discontinued operation occurs when two things happen:
a. A company eliminates (or will eliminate) the results of operations and cash
flows of a component of an entity from its ongoing operations; and
b. There is no significant continuing involvement in that component after its
disposal.
 Discontinued operations occur at the earlier of the date the component is actually
disposed of and the date the criteria for classification as held for sale are met.

PRESENTATION OF DISCONTINUED OPERATIONS

 The results of discontinued operations are presented in the statement of profit or

loss and other comprehensive income as a single amount comprising the total of
the following:
a. post-tax profit or loss of discontinued operations; and
b. post-tax gain or loss recognized on the measurement to fair value less costs
to sell or on the disposal of the assets constituting the discontinued operation
  The results of discontinued operations are presented after profit or loss from
continuing operations.

GAINS OR LOSSES ON DISPOSAL OF DISCONTINUED OPERATIONS

 If the actual disposal of a discontinued operation occurs in the same period that the
component is classified as "held for sale," the gain or loss on disposal of
discontinued operations is the actual gain or loss on the disposal.
 If the actual disposal of a discontinued operation occurs in a subsequent period
after the component is classified as "held for sale," the entity recognizes an
estimated loss on disposal in the period that the component is classified as
discontinued operation.
o However, any gain on sale is not recognized until the component is actually
disposed of.
 Gains or losses on disposal of discontinued operations, including estimated losses,
are presented as part of the single amount representing the post-tax results of
discontinued operations.
 Gains or losses on held for sale assets that do not meet the criteria for presentation
as discontinued operations are presented as part of continuing operations.

Illustration:

On March 1, 20x1, Entity A classifies a component of an entity as held for sale. The event
qualifies for presentation as discontinued operations. Entity A makes the following
estimates:

 Estimated gain on sale of some assets of the component, P100,000.

 Estimated impairment losses and losses on sale of the remaining assets of the
component, P200,000.
 Estimated operating losses prior to the expected date of sale, P300,000.

The component's actual operating profit and loss in 20x1 are as follows:

 January 1 to February 28, 20x1 - P50,000 profit

  March 1 to December 31, 20x1 - P1,000,000 loss

Entity A's tax rate is 30%. The actual sale of the component occurred in 20x2.

 The single amount representing the post-tax results of discontinued operations is

computed as follows:
Estimated impairment losses and losses on sale (200,000)
Jan. 1 to Feb. 28 profit from operations 50,000
Mar. 1 to Dec. 31 loss from operations (1,000,000)

Total (1,500,000)
Multiply by: 100% less 30% tax rate 70%

Loss from discontinued operations (805,000)

 Notice that both the estimated gain on disposal and estimated operating losses and
are disregarded.

PRESENTATION IN THE STATEMENT OF FINANCIAL POSITION

 Held for sale assets are presented in the statement of financial position as current
assets.
 The assets and liabilities of a disposal group are presented separately.
 Offsetting is prohibited.

Summary:

 Noncurrent assets are presented as current assets in the statement of financial

position only when they qualify as held for sale assets.
 Held for sale classification is permitted when the noncurrent asset or disposal group
is (a) available for immediate sale in its present condition and (b) the sale is highly
probable.
 If the criteria for classification as held for sale are met after the reporting period but
before the financial statement are authorized for issue, that event is treated as a
non-adjusting event after reporting period.
 Held for sale assets are measured at the lower of carrying amount and fair value less
costs to sell.
 Held for sale assets are not depreciated.
 Gains and losses on remeasurement of held for sale assets are recognized in profit or
loss.
 Gain on impairment reversal is recognized only to the extent of cumulative
impairment losses previously recognized.
 A disposal group may qualify as discontinued operation if it is a component of an
entity and meets the other requirements under PFRS 5.
 The results of discontinued operations are presented separately in the statement of
comprehensive income as a post-tax single amount.
 The assets and liabilities of a disposal group are presented separately on the face of
the statement of financial position. Offsetting is prohibited.
PFRS 6 EXPLORATION FOR AND EVALUATION OF MINERAL RESOURCES

INTRODUCTION

 PFRS 6 addresses the accounting for expenditures on exploration for and

evaluation of mineral resources.
 Exploration for and evaluation of mineral resources
o Is the search for mineral resources, including minerals, oil, natural gas and
similar non-regenerative resources after the entity has obtained legal
rights to explore in a specific area, as well as the determination of the
technical feasibility and commercial viability of extracting the mineral
resource.
 Exploration and evaluation expenditures
o Are expenditures incurred by an entity in connection with the exploration for
and evaluation of mineral resources before the technical feasibility and
commercial viability of extracting a mineral resource are demonstrable.
 PFRS 6 applies to expenditures incurred after the entity has obtained legal rights
to explore in a specific area (it is illegal to explore for mineral resources without
obtaining firs an authorization from the government) but before the existence of
mineral reserves is in fact established and the technical feasibility and commercial
viability of extracting mineral resources are demonstrable.
 Expenditures incurred after technical feasibility and commercial viability are
demonstrate are called development costs.
 Development costs are accounted for under other applicable Standards.
 PFRS 6 is not applicable:
o Before legal rights to explore are obtained.
o After technical feasibility and commercial viability are demonstrate.
 PFRS 6 is applicable:
o After legal rights are obtained but before technical feasibility and
commercial viability are demonstrate.
EXEMPTION FROM HIERARCHY OF REPORTING STANDARDS UNDER PAS 8

HIERARCHY OF REPORTING STANDARDS (PAS 8)

1. PFRS
2. Judgment
When making the judgment:
 Management shall consider the following:
a. Requirements in other PFRS dealing with similar transactions
b. Conceptual Framework
 Management may consider the following:
a. Pronouncements issued by other standard-setting bodies
b. Other accounting literature and industry practices
 PFRS 6 temporarily exempts an entity from applying the hierarchy above.
 PFRS permits entities to develop their own accounting policy for exploration and
evaluation assets that results in relevant and reliable information based entirely on
management’s judgment and without the need to consider the hierarchy of
standards in PAS 8.
 Accordingly, an entity may recognize exploration and evaluation expenditures as
expenses or assets depending on its chosen accounting policy (which is developed
based entirely on management’s judgment).
 In making the judgment, an entity considers the degree to which the expenditure
can be associated with finding specific mineral resources.

INITIAL MEASUREMENT

 Exploration and evaluation are initially measured at cost.

 Exploration and evaluation assets
o Are exploration and evaluation expenditures recognized as assets in
accordance with the entity’s accounting policy.
 Examples of expenditures that might be included in the initial measurement of
exploration and evaluation assets:
a. Acquisition of rights to explore
 b. Topographical, geological, geochemical and geophysical studies
c. Exploratory drilling
d. Trenching
e. Sampling
f. Activities in relation to evaluating the technical feasibility and commercial
viability of extracting a mineral resource.
 The initial measurement also includes the present value of any decommissioning
and restoration costs for which the entity has incurred an obligation as a
consequence of having undertaken the exploration and evaluation activities.
 Expenditures related to the development of mineral resources are not recognized
as exploration and evaluation assets.

SUBSEQUENT MEASUREMENT

 Exploration and evaluation assets are subsequently measured using either the
cost model or the revaluation model.

CHANGES IN ACCOUNTING POLICIES

 An entity may change its accounting policy for exploration and evaluation
expenditures if the changes results in more relevant and no less reliable, or more
reliable and no less relevant, information.
 The entity judges relevance and reliability using the criteria in PAS 8.

CLASSIFICATION OF EXPLORATION AND EVALUATION ASSETS

 Exploration and evaluation assets are treated as a separate class of assets and
classified as tangible (e.g. vehicles and drilling rigs) or intangible (e.g. drilling
rights) depending on the nature of the assets.

RECLASSIFICATION OF EXPLORATION AND EVALUATION ASSETS

  When the technical feasibility and commercial viability of extracting a mineral
resource are demonstrable, the exploration and evaluation assets are reclassified in
accordance with other relevant Standards,
 The exploration and evaluation assets are assessed first for impairment before the
reclassification.

IMPAIRMENT LOSS

 Exploration and evaluation assets are assessed for impairment when indication
exists that their carrying amount exceeds their recoverable amount.
 The entity applies PAS 36 when making the assessment, except for the allocation of
impairment loss on assets within cash-generating units wherein the entity is
allowed to determine its own accounting policy for the allocation,
 Examples of indications that exploration and evaluation assets need to be assessed
for impairment:
a. The right to explore has expired or will expire in the near future and is not
expected to be renewed.
b. Expenditures for further exploration and evaluation activities are
significantly higher than expected.
c. The exploration and evaluation activities in a specific area have to be
discontinued because no mineral resources have been discovered.
d. Indication exists that, although a specific area will be developed, the carrying
amount of the exploration and evaluation assets is unlikely to be fully
recovered.

PFRS 7 FINANCIAL INSTRUMENTS: DISCLOSURES

INTRODUCTION

 PFRS 7 prescribes the disclosure requirements for financial instruments.

 The disclosures are broadly classified into the following two main categories:
a. Significance of financial instruments to the entity’s financial position and
performance; and
b. The nature and extent of risks arising from financial instruments to which the
entity is exposed, and how the entity manages those risks.
 PFRS 7 complements the presentation principles in PAS 32 Financial Instruments:
Presentation and the recognition and measurement principles in PFRS 9 Financial
Instruments.
 PFRS 7 applies to financial instruments that are within the scope of PFRS 9.
 PFRS 7 does not apply to financial instruments that are dealt with under other
Standards, such as interests in subsidiaries (PFRS 10 Consolidated Financial
Statements), associates and joint ventures (PAS 28), those arising from employee
benefit plans (PAS 19) and share-based payment transactions (PFRS 2), and those
that are required to be classified as equity instruments.

SIGNIFICANCE OF FINANCIAL INSTRUMENTS

 Statement of financial position

Carrying amounts of financial assets and financial liabilities
An entity is required to disclose the carrying amounts of each off the following
categories of financial instruments under PFRS 9:
a. Financial assets measured at fair value through profit or loss (FVPL),
showing separately:
i. Those that are designated and
ii. Those that are mandatorily measured at FVPL.
b. Financial assets measured at amortized cost.
c. Financial assets measured at fair value through other comprehensive
income (FVOCI), showing separately:
i. Those that are mandatorily classified as such and
 ii. Those that are elected to be classified as such.
d. Financial liabilities at amortized cost.
e. Financial liabilities at fair value through profit or loss (FVPL), showing
separately:
i. Those that are designated and
ii. Those that meet the definition of held for trading.
Financial assets and financial liabilities measured at FVPL
o If an entity designates a financial asset to be measured at FVPL it shall
disclose the financial asset’s exposure to credit risk and the change in fair
value attributable to changes in credit risk.
o If an entity designates a financial liability to be measured at FVPL, it shall
disclose the change in fair value that is attributable to changes in credit risk,
the difference between the carrying amount and maturity value, and, if the
entity is required to present the effects of changes in the liability’s credit risk
in OCI, any cumulative gain or loss that were transferred within equity or
were realized.
Financial assets measured at FVOCI
o If an entity elected to measure investments in equity securities at FVOCI, it
shall disclose those investments, the reason for the election, any dividends
recognized during the period, and may transfers of cumulative gain or loss
within equity,
o If any of those were disposed of, the entity shall disclose the reason for the
disposal, the fair value on derecognition date, and the cumulative gain or loss
on disposal.

Reclassification
 o If an entity has reclassified financial assets, it shall disclose the date of
reclassification, an explanation of the change in business model, and the
amount reclassified between categories.’
o If the entity reclassifies financial assets from FVOCI or FVPL to amortized
cost or from FVPL to FVOCI or amortized cost, it shall disclose the fair value
gain or loss that would have been recognized in profit or loss or OCI if the
financial had not been reclassified.
Offsetting financial assets and financial liabilities
o If an entity has offset financial assets and financial liabilities, it shall disclose
the gross amounts of those assets and liabilities, the amounts that were set-
off, the net amounts presented in the statement of financial position and a
description of the related legal right of set-off.
Collateral
o An entity shall disclose the carrying amounts of financial assets pledged as
collateral for liabilities, including the terms and conditions of the pledge.
o If the entity holds collateral that it is permitted to sell or repledge, the entity
shall disclose the fair value of such collateral and, if it has been sold or
repledged, whether the entity has an obligation to return it, and the terms
and conditions associated with the entity’s use of the collateral.
Allowance account for credit losses
o The carrying amount of a financial asset that is mandatorily measured at
FVOCI is not reduced by a loss allowance.
o However, the loss allowance is disclosed in the notes.
Defaults and breaches
o The entity shall disclose any defaults and breaches relating to loans payable,
the principal, interest, sinking funds, or redemption terms, and whether the
default was remedied, or the terms of the loans payable were renegotiated,
before the financial statements were authorized for issue.

 Statement of comprehensive income

 Items of income, expense, gains or losses
An entity shall disclose the following:
a. Net gains or net losses on”
i. Financial assets and financial liabilities measured at FVPL. Showing
separately those relating to designated and mandatorily measured
at FVPL
ii. Financial assets measured at amortized cost
iii. Financial liabilities measured at amortized cost
iv. Financial assets measured at FVOCI, showing separately those relating
to elected and mandatorily measured at FVOCI.
b. Total interest revenue and total interest expense, computed using the
effective interest method, for financial instruments measured at amortized
cost or mandatory FVOCI (showing these amounts separately).
c. Fee income and expense.
 Other disclosures
Fair value
o The entity shall disclose the fair value of each class of financial assets and
financial liabilities in a way that the fair value can be compared with the
carrying amount.
o However, fair value disclosure is not required when the carrying amount
approximates fair value, such as for short-term trade receivables and
payables, and for lease liabilities.

NATURE AND EXTENT OF RISKS ARISING FROM FINANCIAL INSTRUMENTS

 The second category of disclosures required by PFRS 7 is the disclosure of the

nature and extent of risks arising from financial instruments to which the entity is
exposed, and how the entity manages those risks.
 PFRS 7 requires the disclosure of the following risks:
1. Credit risk- is the risk that one party to a financial instrument will cause a
financial loss for the other party by failing to discharge an obligation.
 2. Liquidity risk- is the risk that an entity will encounter difficulty in meeting
obligations associated with financial liabilities that are settled by delivering
cash or another financial asset.
o Credit risk and liquidity risk are opposites. For example, credit risk
includes the possibility that an entity cannot collect on its
receivables, while liquidity risk includes the possibility that an entity
cannot play its payables.
o As a guide, recall the liquidity is defined in the Conceptual
Framework as the ability of the entity to pay its short-term liabilities.
3. Market risk- is the risk that the fair value or future cash flows a financial
instrument will fluctuate because of changes in market prices. Market risk
comprises the following three types of risk:
a. Currency risk- is the risk that the fair value of future cash flows of a
financial instrument will fluctuate because of changes in foreign
exchange rates.
b. Interest rate risk- is the risk that the fair value or future cash flows of
a financial instrument will fluctuate because of changes in market
interest rates
c. Other price risk- the risk that the fair value or future cash flows of a
financial instrument will fluctuate because of changes in market
prices (other than those arising from interest rate risk or currency
risk), whether those changes are caused by factors specific to the
individual financial instrument or its issuer, or factors affecting all
similar financial instruments traded in the market.

The entity shall provide both qualitative and quantitative disclosures for
each type of the foregoing risks.

Examples of qualitative disclosures:

a. Risk exposures and how they arise.

 b. The entity’s risk management objectives, policies and processes, including
methods used to measure risk.
c. Any changes in (a) or (b) from the precious period.

Examples of quantitative disclosures:

a. Summary of quantitative data about the entity’s risk exposure at the end of
the reporting period.
b. Concentrations of risk.
c. Other relevant disclosures not provided in (a) and (b).

Disclosure of concentration of credit risk is required of most financial instruments.

Disclosure of market risk (or price risk) is normally required of financial

instruments measured at fair value.

Disclosure of interest rate risk is normally required of debt instruments with

variable interest rates.

Disclosure of currency risk is required of financial instruments measured in foreign

currency.

PFRS 8 OPERATING SEGMENTS

INTRODUCTION

 The business environment is constantly changing-the needs of consumers

change, business regulations change, the demand for products and services,
and consequently the supply thereof, may decline or end.
 Entities need to adapt to these changes in order to stay in business.
 One response to the constantly changing business environment is
diversification of operations.
 Increasingly, many entities engage in diversified business activities and
operate in different market environments.
 For example, business scandals in insurance and banking industries create
loss of trust on consumers.
 Consumers become reluctant in doing business with entities belonging to this
industry.
 To minimize loss of revenue, these entities may need to diversify their
operations to address this type of industry-specific risk.
 Another example is market saturation.
o Entities may find that the oversupply of or lack of demand for
products or services in certain geographical areas would pose threat
to profitability.
o As a response to this risk, entities expand their business operations to
new territories.
 Diversification of operations, either by engaging in different business
activities or doing business in different geographical areas, creates operating
segments within an entity.
 The more diverse an entity’s operations become, the more information is
needed by users in making economic decisions about the entity,
 The full disclosure principle calls for financial reporting of any financial facts
significant enough to influence the judgment of an informed user.
 To address user’s needs, PFRS 8 prescribes the required disclosures for
operating segments.
CORE PRINCIPLE

 PFRS 8 requires an en entity to disclose information needed in evaluating the nature

and financial effects of the business activities in which it engages and the economic
environments in which it operates.
 The required disclosures under PFRS 8 aim to help users of financial statements:
a. Better understand the entity’s performance.
b. Better assess the entity’s prospects for future net cash flows.
c. Make more informed judgments about the entity as a whole.

SCOPE

 PFRS 8 applies to the separate or individual financial statements of an entity, and

to the consolidated financial statements of a group with a parent, that is publicly
listed or in the process of enlisting.
 If a financial report contains both consolidated and separate financial statements,
segment information is required only in the consolidated financial statements.
 Non-publicly listed entities are not required to disclose segment information.
o However, if they choose to do so, they will need to apply PFRS 8.

OPERATING SEGMENTS

 An operating segment is a component of an entity:

a. That engages in business activities from which it may earn revenues and
incur expenses (including revenues and expenses relating to transactions
with other components of the same entity),
b. Whose operating results are regularly reviewed by the entity’s chief
operating decision maker to make decisions about resources to be
allocated to the segment and asses its performance, and,
c. For which discrete financial information is available.
 A component of an entity comprises operations and cash flows that can be clearly
distinguished, operationally and for financial reporting purposes, from the rest of
the entity.
  Not every part of an entity is necessarily an operating segment.
 To qualify as an operating segment, one must be a profit center (i.e., it earns its own
revenues and incurs its own expenses), used internally by management for decision
making, and on which separate financial information is available.
 A start-up operation can be operating segment even it it has to earn revenues.
 However, departments that do not earn revenues or earn revenues that are only
incidental to the activities of the entity are not operating segments (e.g., corporate
headquarters).
 Also, an entity’s post-employment benefit plan is not an operating segment.
 The term “chief operating decision maker” refers to a function rather than a
manager with a specific title.
 That function includes allocating resources and assessing the performance of
operating segments.
 A chief operating decision maker may be the entity’s chief executive officer, chief
operating officer, a group of executive directors, or others.

REPORTABLE SEGMENTS

 An operating segment is reportable (i.e., disclosed separately) if it:

a. Is used by management in internal reporting or results from aggregating
two or more segments; and
b. Qualifies under the quantitative thresholds

MANAGEMENT APPROACH

 PFRS 8 adopts a management approach to identifying reportable segments.

 Under this approach, operating segments are identified on the basis of internal
reports that are regularly reviewed by the entity’s chief operating decision maker
in order to allocate resources to the segment and asses its performance.
 Basically, the decision on whether an operating segment is reportable or not is
based on management’s judgment.
 Operating segments used by management for internal reporting are also operating
segments used for external reporting.
AGGREGATION CRITERIA

 Two or more operating segments may be aggregated into a single operating segment
if aggregation is consistent with the core principle of PFRS 8, the segments have
similar economic characteristics, and the segments are similar in each of the
following respects:
a. Nature of the products and services;
b. Nature of the production processes;
c. Type or class of customer for their products and services;
d. The methods used to distribute their products or provide their services; and
e. Nature of the regulatory environment, if applicable, e.g., banking, insurance
or public utilities.

QUANTITATIVE THRESHOLDS

 An operating segment is reportable if it meets any off the following:

a. Its revenue, including both external and intersegment sales, is 10% or more
of the total revenue, external and internal, of all operating segments.
b. Its profit or loss is 10% or more of the greater, in absolute amount, of the:
i. Total profit of all operating segments that reported a profit; and
ii. Total loss of all operating segments that reported a loss.
c. Its assets are 10% or more of the total assets of all operating segments.

ILLUSTRATION: QUANTITATIVE THRESHOLDS

Entity A is preparing its year-end financial statements and has identified the following
operating segments:
 Segments Revenues Profit(loss) Assets
A 1,000,000 200,000 14,000,000
B 1,200,000 140,000 18,000,000
C 270,000 (70,000) 12,000,000
D 240,000 (700,000) 1,000,000
E 290,000 50,000 1,400,000
Totals 3,000,000 (380,000) 46,400,000

Requirement: Identify the reportable segments.

Solution:

Revenue test

 The threshold under the revenue test is 300,000 (3,000,000 total revenues x 10%).
 Segments A and B qualify under this test because their respective revenues are at
least 300,000.

Segments Revenues 10% test

A 1,000,000 /
B 1,200,000 /
C 270,000 X
D 240,000 X
E 290,000 X
Totals 3,000,000

Profit or loss test

 Step 1: Total separately the profits and losses of the operating segments.

Segments Revenues Loss

A 200,000
B 140,000
C (70,000)
D (700,000)
E 50,000
Totals 390,000 (770,000)
  Step 2: Determine the higher between the totaled amounts, in absolute terms (i.e.,
ignore the negative value of losses). The higher amount is used for the 10% test.
Based on the table above, the aggregate losses of 770,000 is higher than the
aggregate profits. Therefore, the 10% threshold for profit or loss is 77,000 (770,000
x 10%).
Segments A, B, and D qualify under this test because each of their profit or loss is at
least 77,000.

Segments Profit Loss 10% test

A 200,000 /
B 140,000 /
C (70,000) X
D (700,000) /
E 50,000 X
Totals 390,000 (770,000)

Assets test

 The threshold under the asset test is 4,640,000 (46,400,000 total assets x 10%).
 Segments A, B, and C are responsible because each of their total assets is at least
4,640,000.
 Note: Total assets may include inter-segment assets, such as intersegment
receivables.

Segments Assets 10% test

A 14,000,000 /
B 18,000,000 /
 C 12,000,000 /
D 1,000,000 X
E 1,400,000 X
Totals 46,400,000

Conclusion

 Based on all the tests performed, the reportable segments are A, B, C, and D. each
of these segments will be disclosed separately in notes.

Segments Revenue test Profit or loss test Assets test

A /
B /
C X
D X
E X
/ /
/ /
X /
/ X
x x

 To be reportable, operating segments need only to qualify in any of the quantitative

thresholds.
 So even if segment C did not qualify under the revenue and profit or loss tests, it is
still reportable because it qualified under the assets test.
 The same applies to Segment D.
 Segment E is not reportable because it did not qualify in any of the quantitative
tests.

REPORTING OF NON-REPOTABLE SEGMENTS

 Operating segments that are not reportable are combined and disclosed in an “all
other segments” category.

LIMIT ON EXTERNAL REVENUE

 If the total external revenues of the identified reportable segments are less than
75% of the entity’s total external revenue. Additional operating segments are
 included as reportable, even if they do not meet the quantitative threshold, until at
least 75% of the entity’s external revenue is included reportable segments.
 Additional reportable segments are identified based on management’s judgment.

REPORTING OF INTEREST REVENUE AND INTEREST EXPENSE

 Interest revenue and interest expense are reported separately for each reportable
segment unless the segment’s revenue is primarily from interest (e.g., the segment is
a financial institution) and internal decision-making is based on net interest
revenue.
 In such case, the entity may report the segment’s interest revenue net of interest
expense and disclose the fact.

INFORMATION ABOUT MAJOR CUSTOMERS

 An entity discloses the extent of its reliance on its major customers.

 A major customer is a single external customer who has provided 10% or more of
the entity’s revenues.
 If an entity has major customers, it discloses the fact, along with the total amount of
revenues from each major customer, and the identity of the segment or segments
reporting the revenues.
 The entity need not disclose the identity of a major customer or the amount of
revenues that each segment reports from that customer.
 For the purpose of this disclosure, a group of customers under common control,
such as subsidiaries of a common parent, or various government agencies are
considered as a single customer.
PFRS 9 FINANCIAL INSTRUMENTS

INTRODUCTION

 PFRS 9 establishes the financial reporting principles for financial assets and
financial liabilities, particularly their classification and measurement.
 PFRS 9 applies to all financial instruments except those that are dealt with under
other Standards, such as interests in subsidiaries (PFRS 10 Consolidated Financial
Statements), associates and joint ventures (PAS 28), those arising from employee
benefit plans (PAS 19), leaves (PFRS 16 Leases) and share-based payment
transactions (PFRS 2), those that are required to be classified as equity instruments
 (PAS 32), and those arising from contracts with customers that are specifically
accounted for under PFRS 15 Revenue from Contracts with Customers.

INITIAL RECOGNITION

 Financial assets and financial liabilities are recognized only when the entity
becomes a party to the contractual provisions of the instrument.

CLASSIFICATION OF FINANCIAL ASSETS

 Financial assets are classified as subsequently measured at:

a. Amortized cost
b. Fair value through other comprehensive income (FVOCI); or
c. Fair value through profit or loss (FVPL)

BASIS OF CLASSIFICATION

 Financial assets, except those that are designated, are classified on the basis of
both:
a. The entity’s business model for managing the financial assets; and
b. The contractual cash flow characteristics of the financial asset.

CLASSIFICATION AT AMORTIZED COST

 A financial asset is measured at amortized cost if both of the following conditions

are met:
a. The asset is held within a business model whose objective is to hold
financial assets in order to collect contractual cash flows (‘Hold to collect’
business model); and
b. The contractual terms of the financial asset give rise on specified dates to
cash flows that are solely payments of principal and interest on the
principal amount outstanding. (SPPI)
CLASSIFICATION AT FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME

 A financial asset is measured at fair value through other comprehensive income

(FVOCI) if both of the following conditions are met:
a. The financial asset is held within a business model whose objective is
achieved by both collecting contractual cash flows and selling financial
assets (“Hold to collect and sell” business model); and
b. The contractual terms of the financial asset give rise on specified date to cash
flows that are solely payments of principal and interest on the principal
amount outstanding (SIPPI).

CLASSIFICATION AT FAIR VALUE THROUGH PROFIT OR LOSS

 A financial asset that does not meet the conditions for measurement at amortized
cost or FVOCI is measured at fair value through profit or loss (FVPL).
 This is normally the case for “held for trading” securities.

EXCEPTIONS:

1. Investments in equity instruments at FVOCI

 An entity may make an irrevocable(a) election at initial recognition to
classify an investment in equity instruments that is neither held for
trading nor contingent consideration in a business combination as FVOCI
even if it would otherwise be measured at FVPL.
2. Option to Designate a financial asset at FVPL
 An entity may irrevocably(a) designate a financial asset, at initial
recognition, as measured at fair value through profit or loss (FVPL) if
doing so eliminates or significantly reduces a measurement inconsistency
(accounting mismatch) that arises when assets and liabilities or gains and
losses are measured on different bases.
(a)
The irrevocable choices above are available only on initial recognition (i.e., the
first time that the financial asset is recorded in the books of accounts).
 Once the election is made, the classification is permanent until the financial asset is
derecognized.
Derecognition is the removal of a recognized asset or liability from an entity’s
statement of financial position.

REMEMBER THE FOLLOWING:

Basis of Classification Classification

 Business model: ‘Hold to collect  Amortized cost
Cash flow characteristics: ‘SPPI’ (e.g.,
debit instrument)
 Business model: ‘Hold to collect and sell’  FVOCI (mandatory)
Cash flow characteristics: ‘SPPI’ (e.g.,
debt instrument)
 Business model: Not defined  FVPL
Cash flow characteristics: Not defined
(e.g., held for trading securities and equity
instrument)
 Exceptions:
1. Investment in equity securities  FVOCI (election)
2. Eliminates or significantly reduces  FVPL (designated)
‘accounting mismatch’
Equity instrument Debt instrument
 Evidence a residual interest in the net  Represents a debtor-creditor
assets of an entity, e.g., shares of stocks. relationship (i.e., lending
transaction), e.g., bonds.

BUSINESS MODEL

 Refers to how an entity manages its financial assets in order to generate cash flows.
 That is, whether to:
a. Hold financial assets in order to collect the contractual cash flows over the
life of the instrument (Hold to collect); or
 b. Hold financial assets to collect the contractual cash flows but also sell them
to realize fair value gains whenever an opportunity arises (Hold to collect
and sell).
 A business model is a matter of fact that is observable through the entity’s activities
rather than merely an assertion.
 A business model is determined by the entity’s key management personnel and does
not depend in management’s intentions for an individual instrument.
 It is therefore not an instrument-by-instrument approach to classification but rather
results from a higher level of aggregation.
 However, classification need not be determined at the reporting entity level because
the entity may have more than one business model.
 In such case, a portfolio of financial assets are separated into sub-portfolios in order
to reflect the level at which the entity manages those financial assets.
 The assessment of a business model is forward-looking, so cash flows from financial
assets may be realized in a manner that is different from expectations at the time the
original assessment was made.
 For example, the entity might make unanticipated sales of financial assets held
under the “hold to collect” business model before their maturity dates.
 This does not result in a prior period error or a reclassification of the remaining
financial assets held within the business model if the original assessment
considered all the relevant information that was available at the time.
 However, an increase in the level (or frequency) of sales, and the reason thereof, may
be relevant in assessing the business model for new financial assets.
 In practice, an entity’s business model for managing financial assets is normally
codified in the entity’s “risk management manual” which includes, among others,
the entity’s approach to managing risks related to financial assets. The Bangko
Sentral ng Pilipinas (BSP) requires banks to have a formal codification of their risk
management policies.

“HOLD TO COLLECT’ BUSINESS MODEL

 Under this model, financial assets are managed to realize cash flows by collecting
payments over the life of the instrument.
 An entity considers the following factors when determining whether cash flows will
be generated through collections:
a. The frequency, value and timing of sales in prior periods;
b. The reasons for those sales; and
c. Expectations about future sales activity.
 However, sales in themselves are not necessarily relevant in determining a business
model and should not be considered in isolation.
 It is, therefore, not necessary for an entity to hold all financial assets until maturity.
 Past sales and expectations about future sales are considered because they provide
evidence related to how the entity’s objective of managing financial assets is
achieved and how cash flows are realized.
 A “hold to collect” business model is appropriate even when some sales occur or
are expected to occur in the future.
o For example, this business model remains appropriate under the following
circumstances:
a. Sales of financial assets because of increase in credit risk;
b. Sales of financial assets with insignificant value, even when such sales
are frequent;
c. Sales of financial assets that re infrequent, even when the sales have
significant value; or
d. Sales made close to the maturity when the sale proceeds approximate
the collection of the remaining contractual cash flows.
 A significant increase in the frequency or value of sales is not in itself necessarily
inconsistent with a hold to collect business model if the entity can explain the
reasons for those sales and demonstrate why those sales do not reflect a change in
the entity’s business model.
 However, the entity may need to assess whether and how those sales are consistent
with the objective of a hold to collect business model.
“HOLD TO COLLECT AND SELL” BUSINESS MODEL

 This model is applicable when both collecting contractual cash flows and selling
financial assets are integral to achieving the entity’s objective of holding financial
assets.
 Compared to the “hold to collect” business model, this business model will typically
involve greater frequency and value of sales.
o This is because selling financial assets is integral to achieving the business
model’s objective rather than only incidental to it.
o There is no threshold for the frequency or value of sales that can or must
occur in this business model.
 This model may be appropriate when the entity’s objective is:
a. A debt instrument that is neither held under a “hold to collect” nor a “hold
to collect and sell” business model.
b. An equity instrument that the entity does not elect to classify as FVOCI.
c. An equity or debt instrument that meets the definition of a held for trading
security.
 A held for trading security is a financial asset that is:
a. Acquired principally for the propose of selling it in the near term;
b. Part of a portfolio of financial instruments that are managed together and for
which there is evidence f a recent actual pattern of short-term profit-
taking; or
c. A derivative (except for a derivative that is a financial guarantee contract or
a designated and effective hedging instrument).
 A financial guarantee contract is a contract that requires the issuer to make
specified payments to reimburse the holder for a loss it incurs because a specified
debtor fails to make payment when due in accordance with the original or modified
terms of a debt instrument.

Notes:
  Only debt instruments can be classified under the amortized cost or FVOCI
(mandatory) measurement categories.
 Equity instruments are measured at FVPL, unless the entity makes an irrevocable
election on initial recognition to measure them at FVOCI (election).
 Debt instruments that are not measured at amortized cost or at FVOCI are measured
at FVPL.

CONTRACTUAL CASH FLOW CHARACTERISTICS

 Financial assets are classified as either amortized cost of FVOCI (depending on the
business model) if their contractual terms give rise on specified dates to cash flows
that are solely payments of principal and interest on the principal amount
outstanding (SPPI).
 Financial assets that for not qualify under this “SPPI test” are classified as FVPL.
 PFRS 9 provides the following definitions for purposes of applying the SPPI test.
 Principal is the fair value of the financial asset at initial recognition and that it may
change over the life of the financial asset (e.g., if there are repayments of principal).
o For example, Entity A acquires bonds with a face amount of 1,000,000 for
900,000. From the point of view of Entity A, the principal is 900,000. Notice
that the principal is not necessarily the contractual face amount of the
financial asset.
 Interest is the consideration for the time value of money, for the credit risk
associated with the principal amount outstanding during a particular period of time
and for other basic lending risks and costs, as well as a profit margin.

Notes:

 The “business model” and “SPPI” tests are relevant inly to debt instruments.
 Equity instruments do not qualify under the “SPPI” test because they do not have
contractual cash flows that are solely payments of principal and interest.
 Equity instruments therefore are classified as FVPL, unless they are irrevocably
elected to be classified as FVOCI.
SUMMARY OF CLASSIFICATION OF FINANCIAL ASSETS

Are cash flows solely payments for FVPL*

principal and interest (SPPI)? (e.g., Trading portfolios,
No investments in equity securities.
Assets managed in a fair value
Yes basis

Is the business model ‘hold to Amortized Cost

collect’? (e.g., Receivables, Debt securities)
Yes

FVOCI (mandatory)
Is the business model ‘hold to (e.g., Liquidity portfolio, Assets
collect and sell’? held to back liabilities)
Yes

No
*Exceptions:
1. Election to measure
investments in equity
FVPL * securities at FVOCI.
2. Option to designate
financial assets as FVPL
MEASUREMENT OF FINANCIAL ASSETS

Initial measurement

 Financial assets are initially measured at fair value plus transaction costs, except
FVPL.
 Financial assets classified as FVPL are initially measured at fair value; transaction
costs are expensed immediately.
o The fair value of a financial asset on initial recognition is normally the
transaction price (i.e., the fair value of the consideration given).
o Transaction costs are incremental costs that are directly attributable to
the acquisition, issue or disposal of a financial asset or financial liability. An
incremental cost is one that would not have been incurred if the entity had
not acquired, issued or disposed of the financial instrument.
 o Transaction costs include fees and commissions paid to agents (including
employees acting as selling agents), advisers, brokers and dealers, levies by
regulatory agencies and securities exchanges, and transfer taxes and duties.
o Transaction costs do not include debt premiums or discounts, financing costs
or internal administrative or holding costs.

Subsequent measurement

 After initial recognition, financial assets are measured at:

a. Amortized cost;
b. Fair value through other comprehensive income (FVOCI); or
c. Fair value through profit or loss (FVPL).

Gains or losses

FVPL

 Gains and losses on financial assets measured at FVPL are recognized in profit or
loss.

FVOCI-mandatory

 Gains and losses on financial assets that are mandatorily measured at FVOCI are
recognized in other comprehensive income (except for impairment gains or losses
and foreign exchange gains or losses) until the financial asset is derecognized or
reclassified.
 When the financial asset is derecognized, the cumulative gain or loss previously
recognized in other comprehensive income is reclassified from equity to profit or
loss as a reclassification adjustment (i.e., ‘with recycling’).
 Interest calculated using the effective interest method is recognized in profit or loss.

FVOCI –ELECTION

 Gains and losses on investments in equity securities that are irrevocably elected to
be measured at FVOCI are also recognized in other comprehensive income.
  However, when the financial asset is derecognized, the cumulative gain or loss
previously recognized in other comprehensive income is not subsequently
transferred to profit or loss, but the entity may transfer the cumulative gain or loss
within equity, e.g., as a direct transfer to retained earnings (i.e., ‘without recycling).
 Dividends received are recognized in profit or loss.

AMORTIZED COST

 Gains or losses on financial assets measured at amortized cost, such as those arising
from arising from derecognition, reclassification, amortization, or impairment, are
recognized in profit or loss.
 Fair value changes are not recognized.
o Amortized cost is the amount at which the financial asset or financial
liability is measured at initial recognition minus principal repayments, plus
or minus the cumulative amortization using the effective interest method of
any difference between the initial amount and the maturity amount and, for
financial assets adjusted for any loss allowance.

Financial instruments

Statement Statement of
Classification of Composition of financial Initial Subsequent comprehensive income
financial asset position measurement measuremen
t
1. FVPL Debt or equity Current asset Fair value Fair value  Changes in fair value
securities are recognized in P/L
2. FVOCI Equity Current or Fair value plus Fair value  Changes in fair value
(election) securities noncurrent transaction are recognized in OCI
asset costs (‘without recycling’)
3. FVOCI Debt Current or Fair value plus Fair value  Changes in fair value
(mandatory securities noncurrent transaction are recognized in OCI
) asset costs (’with recycling’)
 Interest income
computed using the
 effective interest
method is recognized
in P/L.
 Impairment
gains/losses are
recognized in P/L
(with offset to OCI.
4. Amortized Debt Current or Fair value plus Amortized  Interest income
cost securities noncurrent transaction cost less computed using the
asset costs impairment effective interest
allowance method is recognized
in P/L.
 Impairment
gains/losses are
recognized in P/L.

RECLASSIFICATION

 After initial recognition, financial assets are reclassified only when the entity
changes its business model for managing financial assets.
 Reclassifications of financial assets are applied prospectively from the
reclassification date.
 Gains, losses or interests that were recognized in the previous periods are not
restated.
 Reclassification date is the first day of the first reporting period following the
change in business model that results in an entity reclassifying financial assets.
 Only debt instruments can be reclassified.
 Equity instruments (e.g., investments in shares of stocks) cannot be reclassified.
 Financial assets that are reclassified are remeasured to their fair value on
reclassification date.
  For reclassifications from FVOCI (mandatory) to amortized cost, the cumulative gain
or loss previously recognized in other comprehensive income is removed from
equity and adjusted against the fair value of the financial asset at the reclassification
date.
 The difference between the carrying amount and the reclassification date fair value
is recognized in profit or loss (for reclassifications to or from FVPL and amortized
cost) and in other comprehensive income (for reclassifications to or from FVOCI).

IMPAIRMENT

 PFRS 9 uses expected credit loss model for recognizing impairment losses on
debt-type financial assets that are measured at amortized cost or FVOCI
(mandatory).
 There is no special accounting for impairment of financial assets measured at FVPL
because changes in fair values are simply recognized as unrealized gains or losses in
profit or loss.
 The ECL model requires three approaches depending on the type of asset or credit
exposure. These are summarized below:

Type of asset/ exposure Approach

1. Trade receivables, contract assets
and lease receivables
2. Originated or purchased credit-
impaired financial assets
3. Other assets/exposures
 Simplified approach
 Changes in lifetime expected
credit losses approach
 General approach (i.e., ‘three-
stage’ or ‘three-bucket’ approach)

GENERAL APPROACH

 The general approach is based on three stages which are intended to reflect the
credit deterioration and improvement of a financial instrument.
 An overview of this ‘three-stage’ or ‘three-bucket’ approach is shown below:

Stage 1 Stage 2 Stage 3

  Credit risk has not  Credit risk has  Credit risk has
increased increased increased
significantly since significantly since significantly since
initial recognition. initial recognition, initial recognition
 ‘low credit risk’ plus there is
expediency objective evidence
of impairment.
 Recognize 12-  Recognize  Recognize
month expected Lifetime expected Lifetime expected
credit losses credit losses credit losses
 Interest revenue is  Interest revenue is  Interest revenue is
computed on the computed on the computed on the
gross carrying gross carrying net carrying
amount of the asset amount of the asset amount (i.e., gross
carrying amount
less loss
allowance)
Change in credit risk since initial recognition
IMPROVEMENT DETERIORATION

 An entity recognizes a loss allowance for expected credit losses.

 Loss allowance- is the allowance for expected credit losses on financial assets that
are within the scope of the impairment requirements of PFRS 9.
 Expected credit losses- is the weighted average of credit losses with the respective
risks of a default occurring as the weights.
 Credit loss- is the difference between all contractual cash flows are due to an entity
in accordance with the contract and all the cash flows that the entity expects to
receive (i.e., all cash shortfalls), discounted at the original effective interest rate (or
credit-adjusted effective interest rate for purchased or originated credit-impaired
financial assets).
 The amount of the loss allowance shall reflect the credit quality of the instrument.
As shown on the table above:
1. If credit risk has not increased significantly since initial recognition or if the entity opts
to apply the ‘low credit risk’ expediency, the entity shall recognize a loss allowance
equal to 12-month expected credit losses.
1. 12-month expected credit losses- the portion of lifetime expected credit
losses that represent the expected credit losses that result from default events
on a financial instrument that are possible within the 12 months after the
reporting date.
2. Credit risk- the risks that one party to a financial instrument will cause a
financial loss for the other party by failing to discharge an obligation.
3. ‘Low credit risk’ expediency: An entity may assume that the credit risk has not
increased significantly since initial recognition if the financial instrument is
determined to have low credit risk at the reporting date.
o This optional simplification is designed to relieve entities from tracking
changes in the credit risk of high quality assets.
o This option can be applied on an instrument by instrument basis.
2. If credit risk has increased significantly since initial recognition but there is no
objective evidence of impairment, the entity shall recognize a loss allowance equal to
lifetime expected credit losses.
 Lifetime expected credit losses- the expected credit losses that result from all
possible default events over the expected life of a financial instrument.
3. If credit risk has increased significantly since initial recognition and there is an
objective evidence of impairment, the entity shall also recognize a loss allowance equal
to lifetime expected credit losses.

Notice that the measurement of loss allowance is the same in Stages 2 and 3.

 However, the measurement of interest revenue varies.

 Under Stage 2, interest revenue is measured on the gross carrying amount of the
instrument while under Stage 3, interest revenue is measured on the net carrying
amount of the instrument (i.e., gross carrying amount less loss allowance).
  If the credit quality of an instrument improves, an entity may revert to measuring
the loss allowance from the lifetime expected credit losses to the 12 month
expected credit losses.
 A decrease in the loss allowance is recognized as a gain.

DERECOGNITION

 Financial assets are derecognized when:

a. The contractual rights to the cash flows from the financial asset expire; or
b. The financial assets are transferred and the transfer qualities for
derecognition.

EXPIRATION OF CONTRACTUAL RIGHTS TO CASH FLOWS

 Contractual rights to cash flows from a financial asset expire when the cash flows
are collected, cancelled, or, when they become uncollectible because of loss events.

TRANSFER

 A financial asset is measured if the entity either:

a. Transfers the contractual rights to receive the cash flows of the financial
asset; or
b. Retains the contractual rights to receive the cash flows of the financial asset,
but assumes an obligation to remit the collections to a recipient in an
arrangement that meets all of the conditions listed below:
i. The entity is not obligated to pay the recipient unless it collects an
equivalent amount from the original asset.
ii. The entity is prohibited from selling of pledging the original asset
except as security in favor of the recipient.
iii. The entity is obligated to remit collections to the eventual recipients
without material delay. In addition, the entity is prohibited from
reinvesting the collections, except in cash or cash equivalents during
 the short period from the collection date to the required remittance
date, and any interest earned on the investment is also remitted to
the recipient.

EVALUATION OF TRANSFERS

 If the entity transfers substantially all the risks and rewards of ownership of the
financial asset, the entity derecognizes the financial asset and recognizes
separately as assets or liabilities any rights and obligations created or retained in
the transfer.
 If the entity retains substantially all the risks and rewards of ownership of the
financial asset, the entity continues to recognize the financial asset.
 If the entity neither transfers nor retains substantially all the risks and rewards (e.g.,
when there is partial transfer and partial retention), the entity determines whether
it has retained control of the financial asset:
a. If the entity has not obtained control, it derecognizes the financial asset
and recognizes separately as assets or liabilities any rights and obligations
created or retained in the transfer.
b. If the entity has retained control, it continues to recognize the financial
asset to the extent of its continuing involvement in the financial asset.

CLASSIFICATION OF FINANCIAL LIABILITIES

 All financial liabilities are classified as subsequently measured at amortized cost,

except for the following:
a. Financial liabilities at fair value through profit or loss (FVPL) and derivative
liabilities-subsequently measured at fair value (e.g., designated or held for
trading).
b. Financial liabilities that arise when a transfer of a financial asset does not
qualify for derecognition-subsequently measured on a basis that reflects the
rights and obligations that the entity has retained.
c. Financial guarantee contracts and Commitments to provide a loan at a below-
market interest rate-subsequently measured at the higher of:
 i. The amount of the loss allowance (12-month expected credit loss) and
ii. The amount initially recognized less, when appropriate, the
cumulative amount of income recognized in accordance with the
principles of PFRS 15.
d. Contingent consideration recognized by an acquirer in a business
combination- subsequently measured at fair value through profit or loss.
 Reclassification of financial liabilities after initial recognition is prohibited.

MEASUREMENT OF FINANCIAL LIABILITIES

 Initial measurement
o Financial liabilities are initially measured at fair value minus transaction
costs, except financial liabilities at FVPL whose transaction costs are
expected immediately.
 Subsequent measurement
o Financial liabilities classified as amortized cost are subsequently measured
at amortized cost.
o Financial liabilities classified as held for trading are subsequently measured
at fair value with changes in fair values recognized in profit loss.
o Financial liabilities designated at FVPL are subsequently measured at fair
value with changes in fair values recognized as follows:
a. The amount of change in the fair value of the financial liability that is
attributable to changes in the credit risk of that liability is presented
in other comprehensive income, and
b. The remaining amount of change in the fair value of the liability is
presented in profit or loss.
PFRS 10 CONSOLIDATED FINANCIAL STATEMENTS

INTRODUCTION

 PFRS 10 prescribes the principles for the preparation and presentation of

consolidated financial statements.
 Consolidated financial statements
o The financial statements of a group in which the assets, liabilities, equity,
income, expenses and cash flows of the parent and its subsidiaries are
presented as those of a single economic entity.
 Group
o A parent and its subsidiaries.
 Parent
o An entity that controls one or more entities.
 Subsidiary
o An entity that is controlled by another entity.
  PFRS 3 deals with the accounting for a business combination at the acquisition date
while PFRS 10 deals with the preparation of consolidated financial statements after
the business combination.
 All parent entities are required to prepare consolidated financial statements, except
as follows:
1. A parent is exempt from presenting consolidated financial statements if:
a. It is a subsidiary of another entity (whether wholly-owned or partially-
owned) and all its other owners do not object to its non-presentation of
consolidated financial statements;
b. Its debt or equity instruments are not traded in a public market (or
being processed for such purpose); and
c. Its ultimate or any intermediate parent produces consolidated financial
statements that are available for public use and comply with PFRSs.
2. Post-employment benefit plans or other long-term employee benefit plans to
which PAS 19 applies.

CONTROL

 Control is the basis for consolidation.

 PFRS 10 requires an investor to determine whether it is a parent by assessing
whether it controls the investee.
 Control of an investee
o An investor controls an investee when the investor is exposed, or has rights,
to variable returns from its involvement with the investee and has the ability
to affect those returns through its power over the investee.
 Control exists if the investor has all of the following:
a. Power over the investee;
b. Exposure, or rights, to variable returns from the investee; and
c. Ability to the affect returns through use of power.
 Only one entity is identified to have control over an investee.
  If two or more investors collectively control an investee, such as when they must
act together to direct the investee’s relevant activities, then none of the investors
individually controls the investee.
 Accordingly, each investor accounts for its interest in the investee in accordance
with:
o PFRS 11 Joint Arrangements
o PAS 28 Investments in Associates and Joint Ventures. Or
o PFRS 9 Financial Instruments, as appropriate.

POWER

 An investor has power over an investee when the investor has existing rights that
give it the current ability to direct the investee’s relevant activities.
 Relevant activities
o Activities of the investee that significantly affect the investee’s returns.
 The investor’s current ability to direct the investee’s relevant activities is often
evidenced by the investor’s ability to establish and direct the investee’s operating
and financing policies.
 Examples of decision about relevant activities:
a. Establishing operating and capital decisions of the investee, including
budgets; and
b. Appointing and remunerating an investee’s key management personnel or
service providers and terminating’ their services or employment.
 Power arises from rights and it may be obtained directly from the voting rights
conferred by shareholdings.
 However, power may also arise from other sources, such as contractual
arrangements.
 Examples of rights that, either individually or in combination, can give an investor
power include:
a. Rights in the form of voting rights (or potential voting rights) of an investee;
 b. Rights to appoint, reassign or remove members of an investee’s key
management personnel who have the ability to direct the relevant activities;
c. Rights to appoint or remove another entity that directs the relevant activities;
d. Rights to direct the investee to enter into, or veto any changes to, transactions
for the benefit of the investor; and
e. Other rights (such as decision-making rights specified in a management
contract) that give the holder the ability to direct the relevant activities.

ADMINISTRATIVE RIGHTS

 When voting rights cannot have a significant effect on an investee’s returns, such as
when voting rights relate to administrative tasks only and contractual
arrangements determine the direction of the relevant activities, the investor needs
to asses those contractual arrangements in order to determine whether it has rights
sufficient to give it power over the investee.

UNILATERAL RIGHTS

 If two or more investor individually (unilaterally) have the ability to direct different
relevant activities, the investor that has the current ability to direct the activities
that most significantly affect the returns of the investee has power over the
investee.

PROTECTIVE RIGHTS

 An investor can have power over an investee even if other entities have existing
rights that give them the current ability to participate in the direction of the relevant
activities, for example when another entity has significant influence.
 However, an investor that holds only protective rights does not have power over an
investee, and consequently does not control the investee.
 Protective rights
 o Are rights designed to protect the interest of the party holding those rights
without giving that party power over the entity to which those rights relate.
o Examples of protective rights:
a. A lender’s right to restrict a borrower from undertaking activities that
could significantly change the credit risk of the borrower to the
detriment of the lender.
b. The right of a party holding a non-controlling interest in an investee to
approve capital expenditure greater than that required in the ordinary
course of business, or to approve the issue of equity or debt
instruments.
c. The right of a lender to seize the assets of a borrower if the borrower
fails to meet specified loan repayment conditions.

SUBSTANTIVE RIGHTS

 In assessing whether it has a power, an investor considers only substantive rights,

i.e., rights where the holder has the ability to exercise.

VOTING RIGHTS

 The investor’s ability to direct the relevant activities of an investee is normally

obtained through voting or similar rights.
 Power with a majority of the voting rights
o An investor that holds more than half (51% or more) of the voting rights of
an investee is presumed to have power over the investee, except when this is
clearly not the case.
o Holding more than half of the voting rights results to power when:
a. The relevant activities are directed through majority vote; or
b. A majority of the members of the governing body that directs the
relevant activities are appointed through majority vote.
 Majority of the voting rights but no power
 o An investor does not have power over an investee, even if he holds more
than half of the voting rights, if:
a. The right to direct the investee’s relevant activities is conferred to a
third party who is not an agent of the investor.
 For example, the investee’s relevant activities are subject to
direction by a government, court, administrator, receiver,
liquidator or regulator.
b. The investor’s voting rights are not substantive.
 Power without a majority of the voting rights
o An investor can have power even if he holds less than a majority of the
voting rights of an investee. For example, through:
a. A contractual arrangement between the investor and other vote
holders;
b. Rights arising from other contractual arrangements;
c. The investor’s voting rights;
d. Potential voting right; or
e. A combination of (a)-(d)
 Contractual arrangement with other vote holders
o A contractual arrangement between an investor and other vote holders can
give the investor power if the contractual arrangement gives the investor:
a. The right to exercise the voting rights of other vote holders sufficient
to give the investor power; or
b. The right to direct how other vote holders vote to enable the investor
to make decisions about the relevant activities.
 Under the Corporation Code of the Philippines, an example of a contractual
arrangement described above is referred to as “proxy.”

POTENTIAL VOTING RIGHTS

 An investor with the current ability to direct the relevant activities has power even
if its rights to direct have yet to be exercised. This is true in the case of potential
voting rights.
  Accordingly, when assessing whether it controls an investee, a parent shall consider
potential voting rights that are currently exercisable, irrespective of
management’s intention or financial ability to exercise them.
 Potential voting rights include share warrants, share call options, debt or equity
instruments that are convertible into ordinary shares, or other similar instruments
that, if exercised, have the potential to give the entity voting power or reduce
another party’s voting power over an investee.
 Potential voting rights are not currently exercisable if they cannot be exercised until
a future date or until the occurrence of a future event.
 However, during consolidation, non-controlling interests are determined on the
basis of present ownership interests and do not reflect the effect of potential
voting rights.
 Potential voting rights are considered only for purposes of determining the
existence of control, which in turn determines whether an investee should be
consolidated.

SUBSTANTIVE REMOVAL AND OTHER RIGHTS HELD BY OTHER PARTIES

 Substantive removal and other rights held by other parties may affect the decision
maker’s ability to direct the relevant activities of an investee.
 Removal rights
o Are rights to deprive the decision maker of its decision-making authority.
 Such rights are considered when evaluating whether the decision maker is a
principal or an agent for other parties.
 An investor acting as an agent does not control an investee.
o For example, a decision maker that is required to obtain approval from a
small number of other parties for its actions is generally an agent.

EXPOSURE OF RIGHTS TO VARIABLE RETURNS

  An investor is exposed, or has a right, to variable returns if its returns from its
involvement with the investee vary depending on the investee’s performance.

ABILITY TO USE POWER TO AFFECT INVESTOR’S RETURNS

 The investor’s ability to use its power to affect its returns from its involvement with
the investee provides the link between power and variable returns.
 Only if this ability is present along with power and exposure, or right, to variable
returns does the investor obtain control over the investee.

Elements of Control

Power Ability to affect returns Variable returns

Control

ACCOUNTING REQUIREMENTS

 Reporting dates and Uniform accounting policies

o The financial statements of the parent and its subsidiaries used in preparing
consolidated financial statements shall have the same reporting dates.
o If a parent and a subsidiary’s reporting periods do not coincide, the
subsidiary shall prepare financial statements that coincide with the parent’s
reporting period before consolidation.
o If this is impracticable, the subsidiary’s financial statements shall be adjusted
for significant transactions and events that occur between the end of the
subsidiary’s reporting period and that of the parent’s.
o The difference between the parent’s and subsidiary’s end of reporting
periods shall not exceed three months.
o Uniform accounting policies shall be used.
 o If the subsidiary uses different accounting policies, its financial statements
need to be adjusted to conform to the parent’s accounting policies before
they are consolidated.
 Consolidated period
o Consolidation begins from the date the investor obtains control of the
investee and ceases when the investor loses control of the investee.
o For example, if an investor obtains control of an investee on July 1, 20x1, the
group’s consolidated financial statements for the year ended December 31,
20x1 shall include only the investee’s results of operations from July 1 to
December 31, 20x1.
o On the other hand, if a parent loses control over its subsidiary on September
30, 20x2, the group’s consolidated financial statements for the year ended
December 31, 20x2 shall include only the investee’s results of operations
from January 1 to September 30, 20x2.

MEASUREMENT

 Income and expenses

o Income and expenses of the subsidiary are based on the amounts of the
assets and liabilities recognized in the consolidated financial statements at
the acquisition date.
o For example, depreciation expense in the consolidated financial statements is
based on the related asset’s fair value on the acquisition date (i.e., business
combination date), rather than its carrying amount in the subsidiary’s
accounting records.
 Investment in subsidiary
o Investments in subsidiaries are accounted for in the parent’s separate
financial statements either:
a. At cost;
b. In accordance with PFRS 9; or
c. Using the equity method.
  Measurement at cost
o The investment in subsidiary is initially measured equal to the value
assigned to the consideration transferred at the acquisition date and
subsequently measured at that amount, unless the investment becomes
impaired.
 Measurement in accordance with PFRS 9
o The investment in subsidiary is initially measured equal to the value
assigned to the consideration transferred at the acquisition date and
subsequently measured at fair value.
 Measurement using the equity method
o The investment in subsidiary is initially measured equal to the value
assigned to the consideration transferred at the acquisition date and
subsequently increased or decreased for the investor’s share in the changes
in the investee’s equity.

NON-CONTROLLING INTERESTS (NCI)

 Is equity in a subsidiary not attributable, directly or indirectly, to a parent.

 NCI in the net assets of the subsidiary
o NCI in net assets is presented in the consolidated statement of financial
position within equity, separately from the equity of the owners of the
parent.
o NCI in the net assets of the subsidiary consists of:
a. The amount determined at the acquisition date using PFRS 3; and
b. The MCI’s share of changes in equity since the acquisition date.
 NCI in profit or loss and comprehensive income
o The profit or loss and each component of other comprehensive income on the
consolidated statement of profit or loss and other comprehensive income are
attributed to the following:
1. Owners of the parent
2. Non-controlling interests
  Total comprehensive income is attributed to the owners of the parent and to the NCI
even if this results in the non-controlling interests having a deficit balance.

PREPARING THE CONSOLIDATED FINANCIAL STATEMENTS

o Consolidated financial statements are prepared by combining the financial

statements of the parent and its subsidiaries line by line by adding
together similar items of assets, liabilities, equity, income and expenses.

CONSOLIDATION AT DATE OF ACQUISITION

 The consolidation procedures at the acquisition date are simple-in the sense that
only the statements of financial position of the combining constituents are
consolidated.
 These involve the following steps:
1. Eliminate the “Investment in subsidiary” account. This requires:
a. Measuring the identifiable assets required and liabilities assumed in
the business combination at their acquisition-date fair values.
b. Recognizing the goodwill from the business combination.
c. Eliminating the subsidiary’s pre-combination equity accounts and
replacing them with the non-controlling interest.
2. Add, line by line, similar items of assets and liabilities of the combining
constituents. The subsidiary’s assets and liabilities are included in the
consolidated financial statements at 100% of their amounts irrespective of
the interest acquired by the parent.

CONSOLIDATION SUBSEQUENT TO DATE OF ACQUISITION

 The consolidation procedures subsequent to the acquisition date involve the same
procedures as above, but changes in the subsidiary’s net assets since the acquisition
date are considered.

ILLUSTRATION: CONSOLIDATION AT ACQUISITION DATE

The financial statements of a parent and its subsidiary at the acquisition date (i.e., business
combination date) are shown below:

Parent Subsidiary
Cash 10,000 5,000
Accounts receivable 30,000 12,000
Inventory 40,000 23,000
Investment in subsidiary 75,000 -
Equipment, net 180,000 40,000
Total assets 335,000 80,000

Accounts payable 50,000 6,000

Share capital 170,000 50,000
Share premium 65,000 -
Retained earnings 50,000 24,000
Total liabilities and equity 335,000 80,000

Additional information:

 The subsidiary’s assets and liabilities are stated at their acquisition-date fair values,
except for the following:
o Inventory, 31,000
o Equipment, net, 48,000
 The goodwill determined under PFRS 3 is 3,000.
 The NCI in the net assets of the subsidiary, also determined under PFRS 3, is 18,000

Requirement: Prepare the consolidated statement of financial position.

Solution:

Step 1: Eliminate the “Investment in subsidiary” account and:

a. Measure the subsidiary’s assets and liabilities at their acquisition-date fair

values;
b. Recognize the goodwill; and
 c. Replace the subsidiary’s pre-combination equity accounts with the NCI in
net assets.

Step 2: Add, line by line, similar items of assets and liabilities of the combining
constituents.

Parent Subsidiary Consolidated

Cash 10,000 5,000 15,000
Accounts receivable 30,000 12,000 42,000
Inventory 40,000 31,000 71,000
Investment in subsidiary
Equipment, net 180,000 48,000 228,000
Goodwill 3,000 3,000
Total assets 359,000

Accounts payable 50,000 6,000 56,000

Share capital 170,000 170,000
Share premium 65,000 65,000
Retained earnings 50,000 50,000
NCI in net assets 18,000 18,000
Total liabilities and equity 359,000
PFRS 11 JOINT ARRANGEMENTS

INTRODUCTION

 PFRS 11 prescribes the principles for financial reporting by parties to a joint

arrangement.
 All parties to a joint arrangement shall apply PFRS 11.

JOINT ARRANGEMENT

 Is an arrangement of which two or more parties have joint control.

 Essential element in the definition of joint arrangement:
a. Contractual arrangement
b. Joint control

CONTRACTUAL ARRANGEMENT

 The existence of contractual agreement for sharing of joint control over an investee
distinguishes interests in joint arrangements from other investments, such as
investments in equity securities measured at fair value (PFRS 9), investment in
associate (PAS 28), and investment in subsidiary (PFRS 3 and PFRS 10).
 PFRS 11 is not applicable in the absence of such an agreement.

EVIDENCE OF CONTRACTUAL ARRANGEMENT

 The contractual arrangement may be evidenced in a number of ways.

o For example, by a contract between the parties or minutes of discussions
between the parties.
o In some cases, the arrangement is incorporated in the articles or other by-
laws of the joint arrangement.
o Whatever its form, the contractual arrangement is usually in writing and
deals with such matters as:
a. The activity, duration and reporting obligations of the joint
arrangement;
 b. The appointment of the board of directors or equivalent governing
body of the joint arrangement and the voting rights of the parties;
c. Capital contributions by the parties; and
d. The sharing by the parties of the output, income, expenses or results
of the joint arrangement.
 The contractual arrangement establishes joint control over the joint arrangement.
 Such a requirement ensures that no single party is in a position to control the
activity unilaterally.

JOINT CONTROL

 Is the contractually agreed sharing of control of an arrangement, which exists

only when decisions about the relevant activities require the unanimous consent of
the parties sharing control.
 In contrast with significant influence and control, an investor obtains joint control
over an investee through a contractual agreement with fellow investors.
 Financial and operating decisions relating to the joint arrangement’s activities
require the consent of each of the parties sharing joint control.
 No single party obtains leverage over another in respect of voting rights over
financial and operating decisions.
 Contrast joint control with the following:
o Significant influence is the power to participate in the financial and
operating policy decisions of an investee but is not control or joint control
over those policies.
o Control is the power to govern the financial and operating policies of an
investee so as to obtain benefits from it.
 Joint control exists when all the parties sharing joint control over the arrangement
act collectively (or together) in directing the activities that significantly affect the
returns of the arrangement.
 An arrangement is considered a joint arrangement even if not all of the parties to
the arrangement have joint control.
o It is sufficient that at least two of those parties share control.
  PFRS 11 distinguishes between:
a. Parties that have joint control of a joint arrangement (referred to joint
operators or joint ventures), and
b. Parties that participate in, but do not have joint control of, a joint
arrangement.
 Party to a joint arrangement
o Is an entity that participates in a joint arrangement, regardless of whether
that entity has joint control of the arrangement,

TYPES OF JOINT ARRANGEMENT

 An entity is required to determine the type of joint arrangement in which it is

involved.
 The types of joint arrangement are:
a. Joint operation
o Is a joint arrangement whereby the parties that have joint control of
the arrangement have rights to the assets and obligations for the
liabilities, relating to the arrangement.
o Those parties are called joint operators.
b. Joint venture
o Is a joint arrangement whereby the parties that have joint control of
the arrangement have rights to the net assets of the arrangement.
o Those parties are called joint venturers.
 An entity applies judgment when determining the type of joint arrangement in
which it is involved by:
a. Considering its rights and obligations arising from the arrangement.
b. Assessing its rights and obligations in relation to the:
i. Structure and legal form of the arrangement,
ii. Terms of the contractual agreement, and
iii. Other facts and circumstances.

RIGHTS AND OBLIGATIONS ARISING FROM THE ARRANGEMENT

  The classification of joint arrangements requires the parties to assess their rights
and obligations arising from the arrangement.
a. If the contractual arrangement confers to the parties that have joint control
rights to the assets and obligations for the liabilities of the joint
arrangement, the joint arrangement is a joint operation.
o The parties that have joint control are referred to as joint operators.
b. If the contractual arrangement confers to the parties that have joint control
rights to the net assets of the joint arrangement, the joint arrangement is a
joint venture.
o The joint control are referred to as joint venturers.

ASSESSMENT OF RIGHTS AND OBLIGATIONS

 Structure and legal form of the arrangement

a. A joint arrangement that is not structured through a separate vehicle is joint
operation.
b. A joint arrangement in which the assets and liabilities relating to the
arrangement are held in a separate vehicle can be either a join venture or
a joint operation.
 Separate vehicle
o A separately identifiable financial structure, including separate legal entities
or entities recognized by statue, regardless of whether those entities have a
legal personality.
 Remember the following:
o Joint operation: Rights to & obligations for: ASSETS and LIABILITIES
o Joint venture: Rights to: EQUITY

JOINT OPERATIONS

 A joint operator recognizes its own assets, liabilities, income and expenses plus its
share in the joint operation’s assets, liabilities, income and expenses.
 o These items are accounted for under other PFRSs applicable to the particular
assets, liabilities, income and expenses.

ILLUSTRATION 1:

Entity A and Entity B agreed to combine their operations, resources and expertise to
manufacture, market and distribute jointly a particular product. The joint arrangement
qualifies as a joint operation. Different parts of the manufacturing process are carried out
by each of the joint operators. Each joint operator bears its own costs and shares equally
on the revenue from the sale of the product.

The joint operation was completed, and thus terminated, during the year. The following
were the transactions:

 Entity A incurred total costs of 100, assumed obligations amounting to 20, and made
sales amounting to 200.
 Entity B incurred total costs of 80 and made sales amounting to 150.

Financial reporting

 The individual statements of comprehensive income of the entities will show the
following:

Entity A Entity B
Sales [(200 + 150) x 50%] 175 Sales [(200 + 150) x 50%] 175
Expenses (100) Expenses (80)
Profit 75 Profit 95

ILLUSTRATION 2:

Entity A and B agreed to contribute resources to construct an oil pipeline that each will use
to transport its own oil. In return, the joint operators agreed to share equally the
acquisition cost and operation costs of the pipeline. The acquisition cost of the pipeline
was 100,000,000 while operating expenses totaled 30,000,000. Entity A had total sales of
120,000,000 while Entity B had total sales of 150,000,000.
Financial reporting:

 The individual financial statement of the entities will show the following:

Entity A Entity B
Statement of financial position Statement of financial position
PPE (oil pipeline), 100M x 50% 50M PPE (oil pipeline), 100M x 50% 50M

Statement of profit or loss Statement of profit or loss

Sales 120M Sales 150M
Expenses (30M x 50%) (150M) Expenses (30M x 50%) (15M)
Profit 105M Profit 135M

INTEREST IN JOINT OPERATIONS WHOSE ACTIVITY CONSTITUTES A BUSINESS

 When an entity acquires an interest in a joint operation whose activity constitutes a

business, it shall account for its share as a business combination.
 A business is an integrated set of activities and assets that is capable of being
conducted and managed for the purpose of providing a return in the form of
dividends, lower costs or other economic benefits directly to investors or other
owners, members or participants.
 Accordingly, the entity shall apply the following principles of business
combination:
a. Measured identifiable assets and liabilities at fair value (other than items for
which exceptions are given in PFRS 3 and other PFRSs);
b. Recognize acquisition-related costs as expenses when they are incurred,
(except costs to issue debt or equity securities which are recognized in
accordance with PAS 32 and PFRS 9, respectively.)
c. Recognize deferred tax assets and deferred tax liabilities that arise from the
initial recognition of assets or liabilities, (except for deferred tax liabilities
that arise from the initial recognition of goodwill);
 d. Recognize goodwill as the excess of the consideration transferred over the
net of the acquisition-date amounts of the identifiable assets acquired and
the liabilities assumed; and
e. Test for impairment a cash-generating unit to which goodwill has been
allocated at least annually, and whenever there is an indication that the unit
may be impaired.
 The foregoing applies to the following:
o Acquisition of both the initial interest and additional interests in a joint
operation whose activity constitutes a business. If the acquisition of
additional interest:
 Does not result to control (i.e., the party merely retains joint control),
the previously held interest in the joint operation is not
remeasured.
 Results to control, the transaction is accounted for as a business
combination achieved in stages. Accordingly, the previously held
interest in the joint operation is remeasured in accordance with the
principles of PFRS 2.
o Formation of a joint operation if an existing business is contributed to the
joint operation on its formation by one of the parties that participate in the
joint operation.
 However, the foregoing does not apply to the following:
o Formation of a joint operation if all of the parties that participate in the joint
operation only contribute assets or groups of assets that do not constitute
businesses.
o The acquisition of an interest in a joint operation when the parties sharing
joint control, including the entity acquiring the interest in the joint operation,
are under the common control of the same ultimate controlling party or
parties both before and after the acquisition, and that control is not
transitory.
JOINT VENTURES

 An entity first applies PFRS 11 to determine the type of arrangement in which it is

involved.
 If the entity determines that it has an interest in a joint venture, the entity
recognizes that interest as an investment and account for it using the equity
method under PAS 28 Investment in Associates and Joint Ventures, unless the
entity is exempted from applying the equity method as specified in that standard.
 Under the equity method, the investment is initially recognized at cost and
subsequently adjusted for the investor’s share in the changes in the equity of the
investee.
 Such share includes the investor’s share in the investee’s:
1. Profit or loss,
2. Dividends declared,
3. Results of discontinued operations, and
4. Other comprehensive income.

PRESENTATION IN STATEMENT OF FINANCIAL POSITION

 Investments accounted for under the equity method (i.e., investment in associate or
joint venture)a represented as non-current assets in the statement of financial
position, except when they are classified as held for sale in accordance with PFRS 5.

PARTICIPANT TO A JOINT ARRANGEMENT WITH NO JOINT CONTROL

 Participant to a Joint operation

o A party that participates in, but does not have joint control of, a joint
operation shall account for its interest in the arrangement:
a. Similarly with the procedures applicable to a joint operator if that
party has rights to the assets, and obligations for the liabilities,
relating to the joint operation.
 b. In accordance with the PFRS applicable to that interest if that
party has no rights to the assets, and obligations for the liabilities,
relating to the joint operation.
 Participant to a Joint venture
o A party that participates in, but does not have joint control of, a joint venture
shall account for its interest in the arrangement in accordance with PFRS 9,
unless it has significant influence over the joint venture, in which case it shall
apply PAS 28.

SUMMARY:

Nature of Interest in voting

relationship with Type of rights of investee Standard Accounting
investee investment

 Regular investor FVPL or FVOCI Less than 20% PFRS 9 Fair value

 Significant Investment in 20% to 50% PAS 28 Equity method*

influence associate

 Control Investment in 51% to 100% PFRS 3 & PFRS 10 Consolidation*

subsidiary
PFRs 11 and other Recognize own
relevant PFRSs assets, liabilities,
income and
expenses plus
 Joint control a. Joint share in the assets,
operation Contractually liabilities, income
agreed and expenses of
the joint
operation.
b. Joint PFRS 11 and PAS Equity method*
venture 28
 *In the separate financial statements, investments in associates, subsidiaries, and
joint ventures are accounted for either:
a. At cost,
b. At fair value in accordance with PFRS 9,
c. Using the equity method.
 A joint arrangement is either:

Type of joint arrangement Characteristics

1. Joint operation  The parties that have joint control have
rights to the assets and obligations
for the liabilities relating to the joint
arrangement.
 Normally, not structured through a
separate vehicle.
2. Joint venture  The parties that have joint control have
rights to the net assets of the joint
arrangement.
 Normally, structured through a
separate vehicle.

PFRS 12 DISCLOSURE OF INTERESTS IN OTHER ENTITIES

INTRODUCTION
  The objective of PFRS 12 is to prescribe the minimum disclosure requirements for
an entity’s interests in other entities, particularly:
a. The nature of, and risks associated with, those interests and
b. The effects of those interests on the entity’s financial statements.
 An entity considers the level of detail and emphasis placed on the disclosure
requirements necessary to meet the objective of PFRS 12 and provides additional
information whenever the minimum disclosures are insufficient to meet the
objective.
 Interest in another entity
o Refers to involvement that exposes an entity to variability of returns form the
performance of another entity.
o It is evidenced by the holding of equity or debt instruments or other form of
involvement, such as the:
 Provision of funding,
 Liquidity support,
 Credit enhancement, and
 Guarantees.
o It includes the means by which an entity obtains control, joint control, or
significant influence over another entity.
o An entity does not necessarily have an interest in another entity solely
because of a typical customer-supplier relationship.
 PFRS 12 applies to entities that have an interest in a (an):
a. Subsidiary;
b. Joint arrangement (i.e., Joint operation or Joint venture);
c. Associate; or
d. Unconsolidated structured entity.
 PFRS 12 does not apply to an interest in another entity that is accounted for in
accordance with PFRS 9 Financial Instruments.

SUMMARY OF MINIMUM DISCLOSURES UNDER PFRS 12

 Significant judgments and assumptions
o PFRS 12 requires disclosure of information about significant judgments and
assumptions (including change thereto) that an entity has made in
determining the following:
a. Existence of control, joint control or significant influence over an
investee.
b. The type of joint arrangement (i.e., joint operation or joint venture)
when the arrangement has been structured though a separate vehicle.
 Investment entity status
o Investment entity- is an entity that:
a. Obtains funds from one or more investors for the purpose of providing
those investor(s) with investment management services;
b. Commits to its investor(s) that its business purpose is to invest funds
solely for returns from capital appreciation, investment income, or
both; and
c. Measures and evaluates the performance of substantially all of its
investments on a fair value basis.
 PFRS 12 requires the following disclosure for an investment entity:
a. Significant judgments and assumptions that the entity has made in
determining whether the entity is an investment entity.
b. Changes in the entity’s status as an investment entity (i.e., becoming or
ceasing as an investment entity).
c. An entity that becomes an investment entity discloses the following:
i. The total fair value, as of the date of change of status, of the
subsidiaries that cease to be consolidated;
ii. The total gain or loss and the line item in which that gain or loss is
recognized, if not presented separately.
 Interests in Subsidiaries
o PFRS 12 requires the following disclosures for an entity’s interest in a
subsidiary:
 a. The composition of the group.
i. Name of subsidiary, its principal place of business, and country
of incorporation.
ii. Interests or voting rights held by non-controlling interest
(NCI).
iii. Profit or loss allocated to NCI during the period.
iv. NCI in net assets as of the end of the period.
v. Dividends paid to NCI.
vi. Summary of the subsidiary’s assets, liabilities, profit or loss
and cash flows.
b. The nature and extent of significant restrictions on the entity’s ability
to access assets and settle liabilities of the group.
c. The effects of changes in ownership interest that:
i. Do not result in a loss of control; and
ii. Result in a loss of control.
d. If a subsidiary uses a different reporting period, the entity discloses
that fact and the reason thereof.
 Interests in Joint Arrangements and Associates
o PFRS 12 requires the following disclosures for an entity’s interest in a joint
arrangement or associate that is material:
a. Name of the joint arrangement or associate, its principal place of
business, and country of incorporation.
b. Nature of the entity’s relationship with the joint arrangement or
associate.
c. Ownership interest, participating share, or voting rights held by the
entity.
d. Measurement of the investment (i.e., equity method or fair value).
e. If the equity method is used, the entity shall disclose the fair value of
the investment, if there is a quoted market price for the investment.
f. Dividends received from the joint venture or associate.
g. Summarized financial information about the joint venture or associate
which includes the following:
i. Current and noncurrent assets
ii. Current and noncurrent liabilities
iii. Revenue
iv. Profit or loss from continuing operations
v. Post-tax profit or loss from discontinued operations
vi. Other comprehensive income
vii. Total comprehensive income
h. For a material joint venture, the entity discloses the amounts of the
following:
i. Cash and cash equivalents
ii. Current and noncurrent financial liabilities (excluding trade
and other payables and provisions)
iii. Depreciation and amortization
iv. Interest income and interest expense
v. Income tax expense or benefit
i. The entity discloses the following in aggregate and separately for all
investments in joint ventures and associates that are not individually
material:
i. The carrying amount of all individually immaterial investments
in joint ventures or associates that are accounted for using the
equity method
ii. Profit or loss from continuing operations
iii. Post-tax profit or loss from discontinued operations
iv. Other comprehensive income
v. Total comprehensive income
j. The nature and extent of any significant restrictions on the ability of
joint ventures or associates to transfer funds to the entity in the form
of cash dividends, or to repay loans or advances made by the entity.
 k. If a joint venture or associate uses a different reporting period, the
entity discloses that fact and the reason thereof.
l. Unrecognized share of losses of a joint venture or associate.
m. Commitments relating to joint ventures.
n. Contingent liabilities relating to joint ventures and associates, unless
the probability of loss is remote.
 Interests in unconsolidated structured entities
a. A structured entity is an entity that has been designed so that voting or
similar rights are not the dominant factor in deciding who controls the entity,
such as when any voting rights relate to administrative tasks only and the
relevant activities are directed by means of contractual arrangements.
b. Examples of structured entities:
a. Securitization vehicles
b. Asset-backed financings
c. Some investment funds
c. PFRS 12 requires the following disclosures for an entity’s interest in an
unconsolidated structured entity:
a. Qualitative and quantitative information about the interest in an
unconsolidated structured entity, including the nature, purpose, size
and activities of the structured entity and how the structured entity is
financed.
b. Summary of the following in a tabular format, unless another format is
more appropriate:
i. Carrying amounts of the assets and liabilities recognized in the
entity’s financial statements relating to its interests in
unconsolidated structured entities.
ii. The line items in the statement of financial position in which
those assets and liabilities are recognized.
iii. The best estimate of the entity’ maximum exposure to loss
from its interests in unconsolidated structured entities,
including how the estimate is determined. If the maximum
 exposure to loss cannot be quantified, that fact is disclosed
including the reasons therefor,
iv. Comparison of the carrying amounts of the assets and
liabilities of the entity that relate to its interests in
unconsolidated structured entities and the entity’s maximum
exposure to loss from those entities.
c. If during the reporting period the entity has, without having a
contractual obligation to do so, provided financial or other support to
an unconsolidated structured entity, the entity discloses:
i. The type and amount of support provided, including situations
in which the entity assisted the structured entity, the entity
discloses:
ii. The reasons for providing the support.
d. Any current intentions to provide financial or other support to an
unconsolidated structured entity, including intentions to assist the
structured entity in obtaining financial support.

PFRS 13 FAIR VALUE MEASUREMENT

INTRODUCTION
  PFRS 13 applies to the fair value measurement, and related disclosures, of an asset,
liability or equity when other PFRSs require measurement at fair value or fair value
less costs to sell.
 PFRS 13 does not apply to the following:
a. Share-based payment transactions (PFRS 2);
b. Leases (PFRS 16 Leases); and
c. Measurements that have some similarities to fair value but are not fair value,
such as net realizable value in PAS 2 or value in use in PAS 36.
 The disclosure requirements of PFRS 13 do not apply to plan assets measured at fair
value in accordance with PAS 19 and PAS 26, and assets for which recoverable
amount is fair value less costs of disposal in accordance with PAS 36.
 PFRS 13 applies to both initial and subsequent measurements at fair value.

FAIR VALUE

 Is the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date.
 The following underlies the definition of fair value:
o Fair value is a market-based measurement, not an entity-specific
measurement (i.e., fair value measurement does not depend on facts and
circumstances surrounding a specific entity).
o Fair value measurement requires the use of assumptions that market
participants would undertake when pricing the asset or liability under
current market condition, including assumptions about risk.
o Fair value measurement presumes that the entity is a going concern
without any intention or need to liquidate, to curtail materially, the scale of
its operations or to undertake a transaction on adverse terms. Fair value is
the price in an orderly transaction and is no, therefore, the amount that an
entity would receive or pay in a forced transaction, involuntary liquidation or
distress sale. However, fair value reflects the credit quality of the instrument.
As a result, an entity’s intention to hold an asset or to settle or otherwise
fulfill a liability is not relevant when measuring fair value.
  Measurement at fair value is also called “market-to-market “ accounting.

REQUIREMENTS ON FAIR VALUE MEASUREMENT

 PFRS 13 requires an entity to determine the following when measuring fair value:
a. The particular asset or liability being measured.
b. The market in which an orderly transaction would take place for the asset or
liability.
c. The appropriate valuation technique(s) to be used in measuring fair value.
d. For a non-financial asset, the highest and best use of the asset and whether
the asset is used in combination with other assets of on a stand-alone basis.

THE ASSET OR LIABILITY

 Fair value measurement pertains to a particular asset or liability,

 Accordingly, the characteristics of the asset or liability affect its fair value
measurement. Examples of such characteristics include:
a. The condition and location of the asset; and
b. Restrictions, if any, on the sale or use of the asset.
 Depending on the unit of account of an asset or liability, fair value measurement
may be applied to:
a. A stand-alone asset or liability; or
b. A group of assets or liabilities, or group of assets and liabilities (e.g., cash-
generating unit)
 Unit of account
o Is the level at which an asset or a liability is aggregated or disaggregated in a
PFRS for recognition purposes.

THE MARKET

 Fair value measurement requires assumptions based on current market

conditions.
  It assumes that the transaction to sell the asset of transfer the liability takes place
either:
a. In the principal market for the asset or liability; or
b. In the absence of a principal market, in the most advantageous market for
the asset or liability.
 Principal market
o Is the market with the greatest volume and level of activity for the asset or
liability.
o If the principal market is identifiable, the price in that market is used In
measuring the fair value of an asset or liability, even if the price in another
market is potentially more advantageous.
o In the absence of a principal market, the price in the most advantageous
market is used in measuring the fair value of an asset or liability.
 Most advantageous market
o Is the market that maximizes the amount that would be received to sell the
asset or minimizes the amount that would be paid to transfer the liability,
after taking into account transaction costs and transport costs.
 An entity is not required to make an exhaustive search of all possible markets to
identify the principal market or, in the absence thereof, the most advantageous
market.
o However, it should consider all information that is reasonably available.
o In the absence of evidence to the contrary, it is presumed that the market
where the entity would normally sell the asset or to transfer the liability
is the principal market or, in the absence thereof, the most advantageous
market.
 An entity must have access to the principal (or most advantageous) market, but not
necessarily the ability to sell the asset or transfer the liability, on the measurement
date to be able to measure fair value on the basis of the price in the market.

THE PRICE
  The market price (either in the principal or most advantageous market) used in
measuring fair value is not adjusted for any transaction costs, but is adjusted for
any transport costs.
 Fair value is computed as follows:
Market price (in ‘principal’ or ‘most advantageous’ market xx
Less: Transport costs (xx)
Fair value xx
 Transaction costs
1. Are costs to sell an asset or transfer a liability in the principal (or most
advantageous) market for the asset or liability that are directly attributable
to the disposal of the asset or the transfer of the liability and meet both of the
following criteria:
o They result directly from and are essential to that transaction.
o They would not have been incurred by the entity had the decision to
sell the asset or transfer the liability not been made.
2. Are not a characteristic of an asset or a liability; rather they are specific to a
transaction and will differ depending on how an entity enters into a
transaction for the asset or liability.
3. Are similar to “costs to sell,” and are accounted for in accordance with the
other PFRSs.
4. Do not include transport costs.
 If location is a characteristic of the asset (e.g., for a commodity) the
price in the principal (or most advantageous) market is reduced by
the transport costs when measuring fair value.
o Are costs that would be incurred to transport an asset from its current
location to its principal (or most advantageous) market.

ILLUSTRATION: PRINCIPAL MARKET VS. MOST ADVANTAGEOUS MARKET

Entity A has an asset that is required under a PFRS to be measured at fair value. The asset is
sold in two different active markets. Entity A has access to both of these markets.
Information on these markets is shown below:
 Active market #1 Active market #2
Market price 130 125
Transaction costs 15 5
Transport costs 10 10

Case #1: Principal market

 If “Active market #1” is the principal market for the asset, how much is the fair value
of the asset?
1. Solution:
Price in Active market #1 130
Less: Transport costs (10)
Fair value 120

Case #2: Most advantageous market

 If neither market is the principal market for the asset, how much is the fair value of
the asset?
1. Solution:
In the absence of a principal market, the price in the most advantageous
market for the asset or liability is used. The most advantageous market is
the market that maximizes the amount that would be received to sell the
asset or minimizes the amount that would be paid to transfer the liability,
after taking into account transaction costs and transport costs.

The most advantageous market is determined as follows:

Active market #1 Active market #2

Market price 130 125
Transaction costs (15) (5)
Transport costs (10) (10)
Amount received from sale 105 110
 o Active market #2 is the most advantageous market because the sale
proceeds is higher. The price in Active market #2 is sued in the fair value
measurement as follows:
Price in Active market #2 125
Less: transport costs (10)
Fair value 115
o Notice that when determining the most advantageous market, both
transaction costs and transport costs are considered. However, when
measuring fair value, only transport costs are considered; transaction costs
are simply ignored.

TRANSACTION PRICE VS. FAIR VALUE AT INITIAL RECOGNITION

 Transaction price
1. Is the price to acquire an asset or price received to assume a liability.
2. Is also called the entry price.
3. In many cases, the transaction price is equal to fair value. However, in case
where the transaction price differs from the fair value at initial
recognition, the difference is recognized as gain or loss in profit or loss,
unless another PFRS specifies otherwise.

VALUATION TECHNIQUES

 When measuring fair value, PFRS 13 requires the use of a valuation technique that is
appropriate in the circumstances and for which sufficient data are available to
measure fair value.
 Such a valuation technique maximizes unobservable inputs.
 Fair value measurement involves estimating the price at which an asset can be sold
or a liability can be transferred in an orderly transaction between market
participants at the measurement date and under current market conditions.
  Accordingly, the inputs used in measuring fair value shall be consistent with the
inputs that a market participant would use when pricing the asset or liability.
 The three widely used valuation techniques are:
1. Market approach
o Uses prices and other relevant information generated by market
transactions involving similar assets, liabilities, or a group of assets
and liabilities.
2. Cost approach
o Reflects the amount that is currently needed to replace the service
capacity of an asset (i.e., current replacement cost).
3. Income approach
o Converts future amounts (cash flows or income and expenses) to a
single current (discounted) amount, reflecting current market
expectations about those future amounts.
 In some cases, a single valuation technique would suffice, whereas in others,
multiple valuation techniques would be more appropriate.

INPUTS BASED ON BID AND ASK PRICES

 If an asset or a liability measured at fair value has a bid price and an ask price, the
price within the bid-ask spread that is most representative of fair value in the
circumstances is used to measure fair value.
o Bid price represents the maximum price at which market participants are
willing to buy an asset.
o Ask price represents the minimum price at which market participants are
willing to sell an asset.
 The use of bid prices for asset positions and ask prices for liability positions is
permitted, but is not required. For example:
o The bid price may be used as fair value for an asset held or liability to be
issued.
 o The ask price may be used as fair value for an asset to be acquired or
liability held.
 Entities are not prohibited from using mid-market pricing or other pricing
conventions that are used by market participants as a practical expedient for fair
value measurements within a bid-ask spread.
 When current bid and asking prices are unavailable, the price of the most recent
transaction provides evidence of fair value for as long as there has not been a
significant change in economic circumstances since the time of the transaction.

FAIR VALUE HIERARCHY

 PFRS 13 provides the following fair value hierarchy (order of priority) that
categorizes the inputs to valuation techniques used in measuring fair value into
three levels:

Fair Value Hierarchy

Level 1 inputs Quoted prices for identical assets
or liabilities in active markets. Most reliable
Level 2 inputs Inputs other than quoted prices
included in Level 1 that are
observable for the asset or liability
either directly or through
corroboration with observable
data.
Level 3 inputs Unobservable inputs (for example,
an entity’s own data or
Least reliable
assumptions).

 Level 1 inputs are quoted prices in active markets for identical assets or liabilities
that the entity can access at the measurement date.
o Active market is a market in which transactions for the asset or liability take
place with sufficient frequency and volume to provide pricing information on
an ongoing basis.
 o A quoted market price in an active market provides the most reliable
evidence of fair value and is used without adjustment to measure fair value
whenever available (with limited exceptions).
o If a market price at the exact measurement date is not readily available, or is
available but not representative of fair value because the market is not active
or because events occurring after the last available quoted price is to be
adjusted to more accurately reflect fair value.
 Level 2 inputs are inputs other than quoted prices included within Level 1 that are
observable for the asset or liability, either directly or indirectly.
o Level 2 inputs are used only when Level 1 inputs are not available. Examples
of Level 2 inputs:
1. Quoted prices for similar assets or liabilities in active markets
2. Quoted prices for similar assets or liabilities in markets that are not
active. A market may not be considered active if:
a. There is insufficient volume or frequency of transactions for
the asset or liability
b. Prices are not current
c. Quotations vary substantially over time and among market
makers
d. Insufficient information is released publicly
3. Interest rates and yield curves observable at commonly quoted
intervals; volatiles; prepayment speeds; loss severities; credit risks;
and default rates
4. Inputs that are derived principally from or corroborated by
observable market data that, through correlation or other means, are
determined to be relevant to the asset or liability being measured
(‘market-corroborated inputs’)
 Level 3 inputs are unobservable inputs.
 o These inputs reflect management’s own assumptions regarding an exit price
that a market participant holding the asset or owing the liability would make,
including assumptions about risk.
o These measurements may be developed using expected cash flow and
present value techniques.
o Level 3 inputs are used only when Level 1 and Level 2 inputs are not
available.

FAIR VALUE MEASUREMENT OF NON-FINANCIAL ASSETS

 When determining the fair value of a non-financial asset, an entity considers the
asset’s highest and best use, in addition to the other requirements of PFRS 13 (i.e.,
valuation techniques and fair value hierarchy).
 Highest and best use
o Is the use of a non-financial asset by market participants that would
maximize the value of the asset or the group of assets and liabilities (e.g., a
business) within which the asset would be used.
 The highest and best use of a non-financial asset takes into account the following:
a. Physical characteristics of the non-financial asset (e.g., location or size of the
property);
b. Legal restrictions on the use of the non-financial asset (e.g., zoning
regulations applicable to the property); and
c. Financial feasibility- whether the use of the asset generates adequate
income or cash flows.

Level 1 inputs Quoted prices in active market

Level 2 inputs Prices derived from observable data
Level 3 inputs Unobservable inputs
PFRS 14 REGULATORY DEFERRAL ACCOUNTS

INTRODUCTION

 PFRS 14 prescribes the financial reporting requirements for regulatory deferral

account balances arising from the sale of goods or services that are subject to rate
regulation.
 Regulatory deferral account balance
o The balance of any expense (or income) account that would not recognized
as an asset or a liability in accordance with other Standards, but that qualifies
 for deferral because it is included, or is expected to be included, by the rate
regulator in establishing the rate(s) that can be charged to customers.
 Rate regulation
o A framework for establishing the prices that can be charged to customers for
goods or services and that framework is subject to oversight and/or approval
by a rate regulator.
 Rate regulator
o An authorized body that is empowered by statute or regulation to establish
the rate or a range of rates that bind an entity.
o The rate regulator may be a third-party body or a related party of the entity,
including the entity’s own governing board, if that body is required by statute
or regulation to set rates both in the interest of the customers and to ensure
the overall financial viability of the entity.

SCOPE

 PRFS 14 is an optional standard that is available only to first-time adopters.

Existing PFRS users are prohibited from using PFRS 14.
 PFRS 14 is intended to provide first-time adopters temporary relief from
derecognizing rate-regulated assets and liabilities that the first-time adopter has
recognized under its previous GAAP pending IASB’s final decision on rate-regulated
activities.
 A first-time adopter is allowed, but is not required, to apply PFRS 14 in its-first
PFRS financial statements if the first-time adopter conducts rate-regulated
activities and has recognized regulatory deferral accounts under with its previous
GAAP.
 An entity is allowed to apply PFRS 14 in subsequent periods only if it has applied
PFRS 14 in its first PFRS financial statements.

SUMMARY OF PRINCIPLES UNDER PFRS 14

 Continuation of existing accounting policy

 o A first-time adopter continues to apply its previous GAAP to the
recognition, measurement, impairment and derecognition of regulatory
deferral account balances, except for changes in accounting policies and the
presentation of regulatory deferral accounts.
 Changes in accounting policy
o An entity may change its accounting policy if the change results in more
relevant and no less reliable, or more reliable and no less relevant,
information.
o An entity shall use the criteria in PAS 8 when judging relevance and
reliability.,
o However, an entity is prohibited from changing its accounting policy in order
to start recognizing regulatory deferral account balances.
 Interaction with other Standards
o PFRS 14 prescribes specific exception, exemption or additional requirements
related to the interaction of PFRS 14 with other PFRSs.
o These are briefly summarized below:
a. PAS 10 Events After the Reporting Period is applied when
determining whether estimates and assumptions relating to
regulatory deferral account balances need to be adjusted for events
after the reporting period.
b. PAS 12 Income Taxes is applied when recognizing deferred tax assets
and liabilities and income tax expense relating to rate-regulated
activities. However, the deferred tax assets and liabilities and income
tax expenses resulting from these activities are presented separately
either:
i. Within the regulatory deferral account balances (for deferred
tax assets and liabilities) and movements in regulatory deferral
account balances (for income tax expense); or
ii. As separate line items alongside the regulatory deferral
account balances (for deferred tax assets and liabilities) and
 movements in regulatory deferral account balances 9for
income tax expense).
c. PAS 33 Earnings per Share is applied when presenting EPS
information. However, an entity applying PFRS 14 is required to
present an additional basic and diluted EPS that excludes the effects
of the net movement in regulatory deferral account balances.
d. PAS 36 Impairment of Assets is applied to the impairment testing of
regulatory account balances that are included in CGUs.
e. PFRS 3 Business Combination is applied to business combinations. If
an entity that sues PFRS 14 acquires another business, it shall apply
its accounting policy for regulatory deferral account balances, which
could result to the recognition of the acquiree’s regulatory deferral
account balances even if the acquire had not recognized those
balances.
f. The measurement and presentation requirements of PFRS 5 Non-
current Assets Held for Sale and Discontinued Operations do not
apply when regulatory deferral account balances are included in a
disposal group or discontinued operations. Accordingly, the regulatory
deferral account balances and movements in the account balances are:
i. Measured in accordance with the entity’s previous GAAP; and
ii. Presented separately from the other assets and liabilities of
the disposal group and from the single amount representing
the results of discontinued operation required by PFRS 5.
g. PFRS 10 Consolidated Financial Statements and PAS 28
Investments in Associates and Joint Ventures require the use of
uniform accounting policies when consolidating subsidiaries and
when applying the equity method, respectively. Accordingly, when an
entity consolidates a subsidiary or applies the equity method for its
investment in associates or joint venture, it shall recognize regulatory
deferral account balances even if the subsidiary, associate or joint
venture had not recognized those balances.
 h. If the entity had recognized regulatory deferral account balances in
respect of its subsidiary, associate or joint venture, it shall make
separate disclosures for those balances in relation to the disclosure
requirements of PFRS 12.
o In all other cases, subject to the exceptions listed above, other PFRS shall be
applied whenever they are relevant to the accounting for regulatory deferral
account balances.
 For example, PAS 21 The Effects of Changes in Foreign Exchange
Rates is applied when translating regulatory deferral account
balances that are denominated in a foreign currency.
 Presentation
Statement of financial position
o Separate line items are presented for the totals of:
a. Regulatory deferral account debit balances; and
b. Regulatory deferral account credit balances.
o The regulatory deferral account balances are not presented as current or
noncurrent. Instead, they are presented separately from the sub-totals of
assets and liabilities that are presented in accordance with other Standards,

ILLUSTRATION: ASSETS SECTION OF A STATEMENT OF FINANCIAL POSITION

20x2 20x1
Cash and cash equivalents 1,000 5,000
Trade and other receivables 3,000 1,000
Inventories 4,000 3,000
Total current assets 8,000 9,000
Property, plant and equipment 6,000 7,000
Total noncurrent assets 6,000 7,000
Total assets 14,000 16,000
Regulatory deferral account debit balances and related
deferred tax asset 2,000 1,000
Total assets and regulatory deferral account debit
balances 16,000 17,000

o A similar presentation is made for regulatory deferral account credit balances

in the liabilities section of the statement of financial position.
 Statement of profit or loss and other comprehensive income
Separate line items are presented:
a. In other comprehensive income for the net movement of regulatory
deferral account balances that relate to items recognized in OCI, showing
distinctions between those that will be and will not be reclassified to profit or
loss; and
b. In profit or loss for the remaining net movement of regulatory deferral
account balances, excluding movements that are not reflected in profit or
loss.

PFRS 15 REVENUE FROM CONTRACTS WITH CUSTOMERS

INTRODUCTION

 PFRS 15 provides the principles in reporting the nature, amount, timing and
uncertainty of revenue and cash flows arising from an entity’s contracts with
customers.
 Income
o Is increases in economic benefits during the accounting period in the form of
inflows or enhancements of assets or decreases of liabilities that result in
increases in equity, other than those relating to contributions from equity
participants.
 o Income encompasses both revenue and gains.
 Revenue
o Is income arising in the course of an entity’s ordinary activities.
 PFRS 15 applies to contracts wherein the counterparty is a customer.
 Contract
o An agreement between two or more parties that creates enforceable rights
and obligations.
o A contract can be written, oral, or implied by an entity’s customary
business practice.
 Customer
o Is a party that has contracted with an entity to obtain goods or services that
are an output of the entity’s ordinary activities in exchange for consideration.
 A counterparty to a contract is not a customer if he agrees to participate in the
entity’s activities wherein he shares the related risks and benefits (e.g., co-
developing an asset) rather than to obtain the output of the entity’s ordinary
activities.
 PFRS 15 applies to individual contracts with customers. However, as a practical
expedient, PFRS 15 may also be applied to a group of similar contracts; provided,
the effects on the financial statements would not differ materially when PFRS 15 is
applied separately to each of the contracts within that group.
 PFRS 15 does not apply to the following:
a. Lease contracts (PFRS 16 Leases);
b. Insurance contracts (PFRS 17 Insurance Contracts);
c. Financial instruments; and
d. Non-monetary exchanges between entities in the same line of business to
facilitate sales to customers.
o For example, PFRS 15 is not applicable to a contract between two oil
companies that agree to exchange oil to fulfill customer demands in
different locations on a timely basis.

CORE PRINCIPLE
  An entity recognizes revenue to depict the transfer of promised goods or services to
customers in an amount that reflects the consideration to which the entity expects
to be entitled in exchange for those goods or services.

REVENUE RECOGNITION

 An entity applies the following steps when recognized revenue:

Step 1: identify the contract with the customer
Step 2: Identify the performance obligations in the contract
Step 3: Determine the transaction price
Step 4: Allocate the transaction price to the performance obligations in the
contract.
Step 5: Recognize revenue when (or as) the entity satisfies a performance
obligation

STEP 1: IDENTIFY THE CONTRACT WITH THE CUSTOMER

 A contract with a customer is accounted for only when all of the following criteria
are met:
a. The contracting parties have approved the contract 9in writing, orally or
impliedly from customary business practices) and are committed to perform
their respective obligations;
b. The entity can identify each party’s rights regarding the goods or services to
be transferred;
c. The entity can identify the payment terms for the goods or services to be
transferred;
d. The contract has commercial substance (i.e., the risk, timing or amount of
the entity’s future cash flows is expected to change as a result of the
contract); and
e. The consideration in the contract is probable of collection. When assessing
collectability, the entity considers only the customer’s ability and intention
to pay the consideration on due date.
 No revenue is recognized on a contract that does not meet the criteria above.
  Any consideration received from such contract is recognized as a liability and
recognized as revenue only when either of the following has occurred;
a. The entity has no remaining obligation to transfer goods or services to the
customer and all, or substantially all, of the consideration has been received
is non-refundable; or
b. The contract has been terminated and the consideration received is non-
refundable.
 The entity need not reassess the criteria above if they have been met on contract
inception unless there is an indication of a significant change in facts and
circumstances, for example, when the customer’s ability to pay subsequently
deteriorates significantly.
 If the criteria are not met on contract inception, the entity shall continue to assess
the contract to determine if the criteria are subsequently met.
 PFRS 15 is applied over the duration of the contract (i.e., the contractual period) in
which the contracting parties have present enforceable rights and obligations.
 A contract does not exist if each contracting party has the unilateral enforceable
right to terminate a wholly unperformed contract without compensating the other
party.
 A contract is wholly unperformed if the entity has not yet transferred any promised
good or service to the customer and has not yet received or not yet entitled to
receive any consideration.

COMBINATION OF CONTRACTS

 Two or more contracts entered into at or near the same time with the same
customer (or related parties of the customer) are combined and accounted for as a
single contract if:
a. The contracts are negotiated as a package with a single commercial
objective;
b. The amount of consideration to be paid in one contract depends on the price
or performance of the other contract; or
 c. Some or all of the goods or services promised in the contracts are a single
performance obligation.

ILLUSTRATION: IDENTIFYING THE CONTRACT WITH THE CUSTOMER

ABC. CO sells industrial printing equipment to a customer for 5,000,000. The customer pays
a 1,000,000 nonrefundable deposit and issues a long-term note for the balance. The
customer obtains control of the equipment at contract inception.

Additional information:

 The customer intends to open a publishing business. The equipment acquired from
ABC Co. will be the main asset of the business. The business is located in an area
where the market for publishing businesses is overly congested. The customer will
need to compete with large and long-time established companies to get a market
share and the customer has little experience in the publishing industry.
 The customer intends to repay the loan primarily from income derived from the
publishing businesses. The customer has no other significant source of income that
can be used to repay the loan.
 The financial arrangement is on a non-recourse basis.

Analysis:

 The customer’s ability and intention to pay the balance of the consideration is in
doubt because of the following reasons:
a. The customer intends to pay the balance of the consideration (which is
significant) primarily from income derived from the publishing business,
which faces a high risk of failure because of high levels of competition and the
customer lacks experience.
b. The customer lacks other sources of income that can be used to pay the
balance.
c. The financing arrangement is on a non-resource basis, meaning, if the
customer defaults, ABC Co. can repossess the equipment but cannot seek
 further compensation even if the collateral does not fully cover the unpaid
balance.

Conclusion:

 ABC Co. shall not recognize any revenue from the contract. ABC Co. shall treat the
1,000,000 nonrefundable deposit, and any subsequent collections, as deposit
liability. Revenue shall be recognized only when the collectability of the
consideration becomes probable or when either of the following occurs:
a. ABC Co. has no remaining obligation to transfer the equipment to the
customer and all, or substantially all, of the consideration has been received
and is non-refundable; or
b. The contract has been terminated and the consideration received is non-
refundable.

STEP 2: IDENTIFY THE PERFORMANCE OBLIGATIONS IN THE CONTRACT

 A contract includes promises to transfer goods or services to the customer.

 Each promise to transfer the following is a performance obligation to be accounted
for separately:
a. A distinct good or service (or a distinct bundle of goods or services); or
b. A series of distinct goods or services that are substantially the same and
have the same pattern of transfer to the customer
 A promised good or service is distinct if:
a. The customer can benefit from the good or service either on its own or
together with other resources that are readily available to the customer; and
b. The promise to transfer the good or service is separately identifiable from
the other promises in the contract.
 Customer can benefit:
o A customer can benefit from a good or service if the good or service could be
used, consumed, sold for an amount that is greater than scrap value or
otherwise held in a way that generates economic benefits. The fact that the
entity regularly sells a good or service separately indicates that a customer
 can benefit from the good or service on its own or with the readily available
resources.
 Separately identifiable:
o A promise to transfer a good or service is separately identifiable if the good
or service:
a. Is not an input to a combined output specified by the customer.
b. Does not significantly modify another good or service promised in the
contract.
c. Is not highly interrelated with other goods or services promised in the
contract. For example, the customer’s decision of not purchasing a
good or service does not affect the other promised goods or services
in the contract.
 A promised good or service that is not distinct is combined with other promised
goods or services until a bundle of goods or services that is distinct is identified.
o In some cases, this may result to treating all the promised goods or services
in a contract as a single performance obligation.
 A promise that is implied by the entity’s customary business practices, published
policies or specific statements is also treated as a performance obligation if, at
contract inception, the promise creates a valid expectation of the customer that the
entity will satisfy the implied promise.
 Performance obligations include only activities that involve the transfer of a good or
service to a customer.
o Performance obligations do not include administrative tasks to set up a
contract.
 Examples of promised goods or services:
a. Sale of goods produced by a manufacturing entity;
b. Resale of goods purchased by a trading entity 9e.g., retailer);
c. Resale of rights to goods or services purchased by an entity;
d. Performing a contractually agreed-upon task(s) by a service-oriented
entity;
 e. Constructing, manufacturing or developing an asset on behalf of a
customer;
f. Providing a service of standing ready to provide goods or services (e.g.,
unspecified updates to software that are provided on a when-and-if-available
basis) or of making goods or services available for a customer to use as and
when the customer decides;
g. Providing a service of arranging for another party to transfer goods or
services to a customer (e.g., acting as an agent of another party);
h. Granting rights to goods or services to be provided in the future that a
customer can resell or provide to its customer (e.g., an entity selling a
product to a retailer promises to transfer an additional good or service to an
individual who purchase the product from the retailer);
i. Granting licenses; and
j. Granting options to purchase additional goods or services (when those
options provide a customer with a material right).

ILLUSTRATION: DETERMINING WHETHER GOODS OR SERVICES ARE DISTINCT

ABC Co., a software developer, enters into a contract with a customer to transfer a software
license, perform an installation service and provide unspecified software updates and
technical support for a two-year period.

Additional information:

 ABC Co. regularly sells the license, installation service and technical support
separately.
 The installation service is routinely performed by other entities and does not
significantly modify the software. The software remains functional without the
updates and the technical support.

Analysis:

 Each of the promised goods and services are distinct because of the following
reasons:
 a. The customer can benefit from each promised good or service either on its
own or together with the other promised goods or services.
o Each of the promised goods or services can be sold separately.
o The software remains functional even without the updates and
technical support.
b. Each promised good or service is separately identifiable.
o The installation service does not significantly modify the software.
o As such, the software and the installation service are separate outputs
rather than inputs used to produce a combined output.

Conclusion:

 There are four performance obligations in the contract:

1. The software license;
2. An installation service;
3. Software updates; and
4. Technical support

Variation:

 If the installation service significantly modify or customize the software to add

significant new functionality to enable the software to interface with the other
customized software applications used by the customer, then there will be three
performance obligations in the contract as follows:
1. Customized installation service (including the software license);
2. Software updates; and
3. Technical support

STEP 3: DETERMINE THE TRANSACTION PRICE

 The entity determines the transaction price because this is the amount at which
revenue will be measured.
 Transaction price
 o Is the amount of consideration to which an entity expects to be entitled in
exchange for transferring promised goods or services to a customer,
excluding amounts collected on behalf of third parties 9e.g., some sales
taxes).
o The consideration may include fixed amounts, variable amounts, or both.

STEP 4: ALLOCATE THE TRANSACTION PRICE TO THE PERFORMANCE OBLIGATIONS

 The transaction price is allocated to each performance obligation identified in a

contract based on the relative stand-alone prices of the distinct goods or services
promised to be transferred.
 Stand-alone selling price
a. Is the price at which a promised good or service can be sold separately to a
customer.
 A list price or a contract price may be (but is not presumed to be) the stand-alone
selling price of a good or service.
 If the stand-alone selling price is not directly determinable, it shall be estimated-
maximizing the use of observable inputs and applying estimation methods
consistently in similar circumstances.
 The following methods may be used to estimate the stand-alone selling price:
a. Adjusted market assessment approach
o The entity evaluates the market where the goods or services are sold
and estimates the price that a customer would be willing to pay for
those goods or services.
o This may also include referring to competitor’s prices for similar
goods or services and adjusting those prices as necessary to reflect
the entity’s costs and margins.
b. Expected cost plus a margin approach
o The entity forecasts the expected cost of satisfying a performance
obligation and then adds an appropriate margin.
c. Residual approach
 o The stand-alone selling price of a good or service is the residual
amount after deducting all the stand-alone selling prices of the other
promised goods and services in the contract from the total transction
price.
 A combination of methods may be used if two or more goods or services have highly
variable or uncertain stand-alone selling prices.

STEP 5: RECOGNIZE REVENUE WHEN (OR AS) THE ENTITY SATISFIES A

PERFORMANCE OBLIGATION

 Recognition
o Revenue is recognized when (or as) the entity satisfies a performance
obligation.
 Measurement
o Revenue is measured at the amount of the transaction price allocated to
the satisfied performance obligation.

SATISFACTION OF PERFORMANCE OBLIGATIONS

 A performance obligation is satisfied when the control over a promised good or

service is transferred to the customer.
 Control is the ability to direct the use of, and obtain substantially all of the economic
benefits from, an asset.
o It includes the ability to prevent others from obtaining these benefits.
o Control exists even if only momentarily when goods or services are received
and used.
 Benefits include the potential cash inflows or savings in cash outflows that can be
obtained directly or indirectly in many ways, such as by:
a. Using the asset to produce goods or provide services;
b. Using the asset to enhance the value of other assets;
c. Using the asset to settle liabilities or reduce expenses;
d. Selling or exchanging the asset;
 e. Pledging the asset to secure a loan; and
f. Holding the asset.
 The entity determines at the contract inception whether a performance obligation
will be satisfied either:
a. Over time; or
b. At a point in time

PERFORMANCE OBLIAGTIONS SATISFIED OVER TIME

 Revenue from a performance obligation that is satisfied over time is recognized

over time AS the entity progresses towards the complete satisfaction of the
obligation.
 A performance obligation is satisfied over time if one of the following criteria is met:
a. The customer simultaneously receives and consumes the benefits
provided by the entity’s performance as the entity performs.
Examples:
i. Routing or recurring services in which the receipt and simultaneous
consumption by the customer of the benefits of the entity’s
performance can be readily identified.
ii. If the contract with the customer is discontinued and the customer
enters into a contract with another entity to fulfill the remaining
performance obligation, the other entity would not need to
substantially re-perform the work that the entity has completed to
date.
b. The entity’s performance creates or enhances an asset (e.g., work in
progress) that the customer controls as the asset is created or enhanced.
c. The entity’s performance does not create an asset with an alternative use
to the entity and the entity has an enforceable right to payment for
performance completed to date.
Alternative use:
 i. An asset does not have an alternative use to the entity if the entity is
restricted contractually from directing the asset for another use
during or after the asset’s completion.
 In the absence of a contractual restriction, the entity is still
restricted from directing the asset for another use if the entity
would incur significant losses to direct the asset for another
use because it needs to rework the asset at a significant cost or
the asset at a significant cost or the asset can only be sold at a
significant loss (e.g., the asset has design specifications that are
unique to the customer or is located in a remote area).

Enforceable right to payment for performance completed to date:

ii. An entity has an enforceable right to payment for performance

completed to date if the entity is entitled to an amount that
compensates the entity for any performance completed in the event
that the customer or another party terminates the contract for
reasons other than the entity’s failure to perform as promised.
iii. The amount referred to in (ii) above shall be sufficient for the entity to
recover the costs incurred in satisfying the performance obligation
plus a reasonable profit margin. The compensation for a reasonable
profit margin need not equal the profit margin expected if the contract
was fulfilled as promised.
 Examples of performance obligations satisfied over time:
a. Rendering of cleaning, security, maintenance, and other similar services that
are provided over a specified period of time and that the customer
simultaneously receives and consumes the related benefits as the entity
performs
b. Construction of an asset, such as a building, that the customer controls as
the asset is constructed
MEASURING PROGRESS TOWARDS COMPLETE SATISFACTION OF A PERFORMANCE
OBLIGATION

 An entity recognizes revenue for each performance obligation satisfied over time by
measuring the progress towards the complete satisfaction of that performance
obligation.
 The entity uses a single method of measuring progress for each performance
obligation satisfied over time and applies that method to remeasure its progress at
the end of each reporting period. Appropriate methods of measuring progress
include:
a. Output methods
b. Input methods

OUTPUT METHODS

 Under output methods, progress is measured based on direct measurements of the

value of the goods or services transferred to date relative to the remaining goods or
services promised under the contract. Examples:
a. Surveys of performance completed to date
b. Appraisals of results achieved, milestones reached, time elapsed and units
produced or units delivered.
 As a practical expedient, billings to the customer may be recognized as revenue if the
entity has the right to that amount and that amount corresponds directly with the
value of performance completed (e.g., a service contract in which an entity bills a
fixed amount for each hour of service provided).
 The disadvantages of output methods are that the outputs used to measured
progress may not be directly observable and the information required to apply them
may be costly.

INPUT METHODS
  Under input methods, progress is measured based on efforts or inputs expended
relative to the total expected inputs needed to fully satisfy a performance obligation.
Examples:
a. Costs incurred
b. Resources consumed
c. Labor hours expended
d. Machine hours used
e. Time elapsed
 If efforts or inputs are extended evenly throughout the performance period, revenue
may be recognized on a straight-line basis.
 A weakness of input methods is that there may not be a direct relationship between
an entity’s inputs and the transfer of control of an asset to a customer.
 In such cases, the entity may need to adjust the inputs used in the measurement.
 Changes in the measure of progress
o The measure of progress is updated as circumstances change over time to
reflect any changes in the outcome of the performance obligation.
o Such changes are accounted for as a change in accounting estimate in
accordance with PAS 8.
 Reasonable measure of progress
o Revenue for a performance obligation satisfied over time is recognized only
if the progress towards the complete satisfaction of the performance
obligation can be reasonably measured.
o If the outcome of a performance obligation cannot be reasonably measured
but the entity expects to recover the costs incurred in satisfying the
performance obligation, revenue is recognized only to the extent of the
costs incurred until such time that the outcome of the performance
obligation can be reasonably measured.

PERFORMANCE OBLIGATION SATISFIED AT A POINT IN TIME

 A performance obligation that is not satisfied over time is presumed to be satisfied
at a point in time.
 Revenue from a performance obligation that is satisfied at a point in time is
recognized WHEN the performance obligation is satisfied.
 The entity considers the following indicators of transfers of control when
determining the point in time at which the promised good or service is transferred
to the customer:
a. The entity has a present right to payment for the asset.
b. The customer has legal title to the asset.
 However, the entity is not precluded from transferring control of an
asset to the customer if the entity retains the legal title solely to
protect the collectability of the transportation price. In this case,
revenue may nevertheless be recognized.
c. The entity has transferred physical possession of the asset.
 However, physical possession may not coincide with control of an
asset if the sale is subject to a repurchase agreement or the sale is in
fact a consignment agreement.
 Conversely, in a bill-and-hold arrangement, control may be
transferred to the customer even though the entity retains physical
possession of the asset.
d. The customer has the significant risks and rewards of ownership of the asset.
e. The customer has accepted the asset.
 Examples of performance obligations satisfied at a point in time:
a. Rendering of installation, one-time repair, and similar services that the
customer obtains the related benefits only after the service has been
completely rendered
b. Sale of assets for which the customer obtains control of only after the asset
is transferred.
 Remember the following:

Revenue recognition
 Step 1: Identify the contract with the
customer.
Step 2: Identify the performance
obligations in the contract
Step 3: Determine the transaction price
Step 4: Allocate the transaction price to
the performance obligations
Step 5: Recognize revenue when (or as)
a performance obligation is satisfied
ILLUSTRATION:
the contract is with a customer and
(among others) the collectability of the
consideration is probable.
Each promise to deliver a distinct good
or service in the contract is treated as a
separate performance obligation.
The transaction price is the amount that
the entity expects to be entitled to in
exchange for satisfying a performance
obligation.
The transaction price is allocated to the
performance obligations based on the
relative stand-alone prices of the
distinct goods or services.
 For performance obligations satisfied
over time, revenue is recognized as
the entity progresses towards the
complete satisfaction of the
performance obligation.
 For performance obligations satisfied
at appoint in time, revenue is
recognized when the entity
completely satisfies the
performance obligation.
Revenue is measured at the amount of
transaction price allocated to the
performance obligation satisfied.
On January 1, 20x1, Entity A enters into a contract with a customer for the sale of a machine
and related one-year maintenance services for a total contract price of 1,000,000. Entity A
regularly sells these items separately. If they were to be purchased separately, they stand-
alone selling prices are as follows:

 900,000 for the machine; and

 300,000 for the one-year maintenance services

Entity A transfers the machine, and collects the total contract price, on February 1, 20x1.
The maintenance services start on that date.

Revenue recognition:

 Step 1: Identify the contract with the customer

o The contract qualifies for accounting in accordance with PFRS 15 because all
the requirements are met.
 Step 2: Identify the performance obligations in the contract
o There are two performance obligations in the contract
1. Transfer to machine; and
2. Rendering of maintenance services.
o Each of these is a distinct good or service because:
a. The customer can benefit from the machine and the maintenance
services on their own. This is evidenced by the fact that they are sold
separately.
b. The promises to transfer the machine and provide the maintenance
services are separately identifiable.
 Step 3: Determine the transaction price
o The transaction price is 1,000,000.
 Step 4: Allocate the transaction price to the performance obligations
o The transaction price is allocated to the performance obligations based on
their relative stand-alone selling prices as follows:

Stand-alone selling prices Allocations As allocated

 Machine 900,000 (1M x 9000/1,200) 750,000
Maintenance services 300,000 (1M x 300/1,200) 250,000
1,200,000 1,000,000
 Step 5: Recognize revenue when (or as) a performance obligation is satisfied
o The promise to transfer the machine is a performance obligation satisfied at
a point in time because it does not meet any of the conditions for a
performance obligation satisfied over time.
 The promise to provide the maintenance services is a performance obligation
satisfied over time because the customer simultaneously receives and consumes
the benefits from the maintenance services as they are rendered. Accordingly:
o Entity a recognizes revenue of 750,000 on February 1, 20x1 when the
machine is transferred to the customer.
o Entity a recognizes revenue from the maintenance services over the one-year
contract period as the services are rendered. If the costs of providing the
maintenance services are expended evenly throughout the performance
period. Entity a may recognize revenue on a straight-line basis, i.e.,
20,833.33 per month (250,000/12 months).

CONTRACT COSTS

 Contract costs include:

a. Incremental costs of obtaining a contract
b. Costs to fulfill a contract
 Incremental costs of obtaining a contract
o Incremental costs of obtaining a contract are costs incurred in obtaining a
contract with a customer that the entity would not have incurred had the
contract not been obtained (e.g., sales commission).
o These costs are recognized as asset if they are expected to be recovered.
However, as a practical expedient, they are expensed when incurred if the
expected amortization period of the asset is one year or less.
o Costs that would have been incurred regardless of whether the contract is
obtained are expensed, unless they are explicitly chargeable to the customer.
 Costs to fulfill a contract
o Costs incurred in fulfilling a contract that are within the scope of other
standards (e.g., PAS 2 Inventories, PAS 16 PPE, or PAS 38 Intangible Assets)
are accounted for in accordance with those standards.
o Costs incurred in fulfilling a contract that are outside the scope of other
standards are recognized as asset if all of the following criteria are met:
 The costs are directly related to a contract or specifically identifiable
anticipated contract.
 The costs generate or enhance resources that will be used in
satisfying performance obligations in the future; and
 The costs are expected to be recovered.
o Costs that are relate directly to a contract (or a specific anticipated contract)
include any of the following:
 Direct labor
 Ex: Salaries and wages of employees who provide the promised
services directly to the customer
 Direct materials
 Ex: Supplies used in providing the promised services to a
customer
 Allocations of costs that relate directly to the contract or to
contract activities
 Ex: Costs of contract management and supervision, insurance
and depreciation of tools and equipment used in fulfilling the
contract
 Costs that are explicitly chargeable to the customer under the
contract; and
 Other costs that are incurred only because an entity entered into
the contract
 Ex: payments to subcontractors
o The following costs are expensed when incurred:
  General and administrative costs (unless those costs are explicitly
chargeable to the customer under the contract);
 Costs of wasted materials, labor or other resources to fulfill the
contract that were not reflected in the price of the contract;
 Costs that related to satisfied or partially satisfied performance
obligations in the contract (i.e., costs that relate to past performance);
and
 Costs for which an entity cannot distinguish whether the costs relate
to unsatisfied performance obligations or to satisfied or partially
satisfied performance obligations.
 Amortization and impairment
o Contract costs that are recognized as asset are amortized on a systematic
basis that is consistent with the transfer of the related goods or services to
the customer.
o The amortization is updated for any significant change in the expected timing
of transfer of the related goods or services to the customer.
 Such a change is accounted for as a change in accounting estimate in
accordance with PAS 8.
o Impairment loss is recognized in profit or loss as follows:
1. First, recognize impairment loss in accordance with another Standard
(e.g., PAS 2, PAS 16 and PAS 38);
2. Next, recognize impairment loss in accordance with PFRS 15, which is
the excess of the asset’s carrying amount over:
a. The remaining amount of consideration that the entity expects
to receive in exchange for the goods or services to which the
asset relates; less
b. The costs that relate directly to providing those goods or
services and that have not been recognized as expenses.
 3. Lastly, the resulting carrying amount after applying ‘Step 2’ is
included in the cash-generating unit (CGU) to which the asset belongs
for the purpose of applying PAS 36 Impairment of Assets to that CGU.
 A subsequent reversal of impairment is recognized in profit or loss. however, the
reversal should not result to an increase in the asset’s carrying amount in excess of
the amount that would have been determined (net of amortization) if no
impairment loss had been recognized previously.

PRESENTATION

 A contract is presented in the statement of financial position as a contract liability

or a contract asset when one of the contracting parties has performed.
 An unconditional right to consideration is presented separately as a receivable.
 Contact liability
o Is an entity’s obligation to transfer goods or services to a customer for which
the entity has received consideration (or the amount is due) from the
customer.
o A contract liability is recognized at the earlier of the date:
a. The entity receives consideration before the good or service is
transferred to the customer (i.e., advance payment).
b. The entity has an unconditional right to the consideration before
the good or service is transferred to the customer (e.g., a non-
cancellable contract requires payment in advance).
 Contract asset
o Is an entity’s right to consideration in exchange for goods or services that the
entity has transferred to a customer when the right is conditioned on
something other than the passage of time (for example, the entity’s future
performance).
o A contract asset (excluding amounts recognized as a receivable) is
recognized when the good or service is transferred to the customer before
the consideration is received or becomes due.
 o A contract asset is measured, assessed for impairment, presented and
disclosed in accordance with PFRS 9.
 Receivable
o Is an entity’s right to consideration that is unconditional.
o A right to consideration is unconditional if only the passage of time is
required before payment of that consideration is due, even if the amount is
subject to refund in the future.
o Receivables are accounted for under PFRS 9.
o On initial recognition, any difference between the measurement of the
receivable in accordance with PFRS 9 and the corresponding amount of
revenue recognized is recognized as expense (e.g., impairment loss).
 PFRS 15 does not prohibit the use of alternative terms for “contract asset” and
“contract liability” so long as sufficient information is provided to enable users of
the financial statements to distinguish between “receivables “ and “contract
assets.”
 Remember the following:

Scenario Accounting
 Consideration is received or  Recognize a contract liability.
becomes due before goods or
services are transferred to the
customer.
 Goods or services are transferred
to the customer before
consideration is received:
a. Right to consideration is  Recognize a contract asset.
conditional.
b. Right to consideration is  Recognize a receivable.
unconditional.

DISCLOSURE
 PFRS 15 requires an entity to disclose qualitative and quantitative information
about the following:
a. Its contract with customers;
b. The significant judgments, and changes in the judgments, made in applying
PFRS 15 to those contracts; and
c. Any assets recognized from the costs to obtain or fulfill a contract with a
customer.
 PFRS 15 requires an entity to consider the level of detail necessary to satisfy the
disclosure objective and how much emphasis to place on each of the requirements.
 An entity shall aggregate or disaggregate disclosures so that useful information is
not obscured.
PFRS 16 LEASES

INTRODUCTION

 PFRS 16 prescribes the accounting and disclosure requirements for leases.

 The objective is to provide information that is faithfully represented, necessary for
financial statement users to access the effect of leases on the financial statement
users to assess the effect of leases on the financial position, financial performance
and cash flows of an entity.
 PFRS 16 applies to all leases, including subleases, except for:
a. Leases to explore for or use minerals and similar resources;
b. Leases of biological assets;
c. Service concession arrangements;
d. Licenses of intellectual property; and
e. Lessee’s rights under licensing agreements relating to motion picture films,
video recordings, plays, manuscripts, patents and copyrights. A lessee may
apply PFRS 16 to leases of intangible assets other than these items.

LEASES

 Is a contract, or part of a contract, that conveys the right to use an asset (the under
asset) for a period of time in exchange for consideration.
 The following are the parties to a lease contract:
a. Lessee- the entity that obtains the right to use an underlying asset for a
period of time in exchange for consideration.
b. Lessor- the entity that provided the right to use an underlying asset for a
period of time in exchange for consideration.

IDENTIFYING A LEASE

 A contract is, or obtains, a lease if the contract conveys the right to control the use
of an identified asset for a period of time in exchange for consideration.
 An entity has the right to control the use of n identified asset if it has both of the
following throughout the period of use:
 a. The right to obtain substantially all of the economic benefits from the use
of the identified asset; and
b. The right to direct the use of the identified asset.

IDENTIFIED ASSET

 Is essential in the definition of a lease.

 An asset can be identified by being explicitly stated in the contract or by being
implicitly specified at the same time the asset is made available for use by the
customer.

Illustration:

Customer X enters into a five-year contract with Supplier Y for the use of a towing car. The
specification of the car is stated in the contract (brand, engine, capacity, dimension, etc.)

Case 1: The towing car is readily available at the inception of the contract.

 Analysis: The towing car is an identified asset. It is identified by being explicitly

specified in the contract.

Case 2: The towing car is not yet built at the inception of the contract.

 Analysis: The towing car is an identified asset. Although the towing car cannot be
identified at the inception of the contract, it is expected to be identifiable at the
commencement of the lease, i.e., it is implicitly specified at the time that the asset is
made available for use by the customer.

PORTIONS OF ASSETS

 Is an identified asset if it is physically distinct (e.g., floor of a building).

 If not physically distinct, the portion is not an identified asset, unless it represents
substantially all of the capacity of the asset thereby providing the customer the right
to obtain substantially all of the economic benefits from the asset.

Illustration:
Customer X enters into a 10-eyar contract with Supplier Y for the right to use three fibres
within a larger cable (consisting of 15 fibres) connecting Country and Country B.

Case 1: Physically distinct

The contract specifically identifies the 3 fibres within the 15 fibres comprising the cable.
The 3 fibres shall be used exclusively to transmit Customer X’s data during the duration of
the contract.

 Analysis: The three fibres are identified assets because they are physically distinct
and explicitly specified in the contract.

Case 2: Not physically distinct

The contract does not specifically identify the 3 fibres within the 15 fibres comprising the
cable. Instead, the contract requires Supplier Y to make available for Customer X the
equivalent capacity of 3 fibres all throughout the duration of the contract, which could be
ny 3 of the 15 fibres. Supplier Y makes the decision as to which of the 15 fibres will be sued
in transmitting Customer X’s data.

 Analysis: The three fibres are not identified assets because they are not physically
distinct. Moreover, the equivalent capacity of the 3 fibres does not represent
substantially all of the capacity fo the larger cable consisting of 15 fibres.

SUBSTANTIVE SUBSTITUTION RIGHTS

 An asset is not an identified asset if the supplier has the substantive right to
substitute it throughout the period of use.
 A supplier’s right to substitute an asset is substantive if both of the following
conditions exist:
a. The supplier has the practical ability to substitute alternative assets
throughout the period of use (for example, the customer cannot prevent the
supplier form substituting the asset and alternative assets are readily
available to the supplier or could be sourced by the supplier within a
reasonable period of time); and
 b. The supplier would benefit economically from the exercise of its right to
substitute the asset (i.e., the economic benefits associated with substituting
the asset are expected to exceed the costs associated with substituting the
asset).
 A supplier’s right to substitute an asset is not substantive if it cannot be exercised
throughout the period of use, such as when substitution is made:
a. Only on a particular date or upon the occurrence of a specified event; or
b. Only during repairs, maintenance or upgrading.
 A supplier’s substitution right is resumed not substantive if it is not readily
determinable as substantive.

RIGHT TO OBTAIN ECONOMIC BENEFITS FROM USE

 A customer controls the use of an identified asset if it has the right to obtain
substantially all of the economic benefits from the asset throughout the period of
use (for example, by having exclusive use of the asset throughout that period).
 Economic benefits include potential inflows from the asset’s output, which can be
obtained directly or indirectly from using, holding or sub-leasing the asset.
 When assessing the right to obtain substantially all of the economic benefits within
the defined scope of tis rights to use the asset.
o For example, if contract limits the use of a motor vehicle within a specific
territory or up to a specified mileage, the entity considers only the economic
benefits from use of the asset within that territory, or up to that specified
mileage, and not beyond.
 A stipulation in a contract requiring the customer to pay additional consideration
based on a portion of the cash flows derived from use of an asset (e.g., percentage of
sales derived from a retail space) does not prevent the customer from having the
right to obtain substantially all of the economic benefits from the use of the asset.

RIGHT TO DIRECT THE USE

  A customer has the right to direct the use of an identified asset throughout the
period to use if:
a. The customer has the right to direct how and for what purpose the asset is
used throughout the period of use; or
b. The asset’s use is predetermined and the supplier is precluded from
changing that predetermined use.
 The following decision-making rights may signify the existence of the right to change
how and for what purpose the asset is used:
a. Rights to change the type of output that is produced by the asset (for
example, to decide whether to use a shipping container to transport goods or
for storage, or to decide upon the mix of products sold in a retail space);
b. Rights to change when the output is produced (for example, to decide when
an item of machinery or a power plant will be used);
c. Rights to change where the output is produced (for example, to decide upon
the destination of a truck or a ship, or to decide where an item of equipment
is used); and
d. Rights to change whether the output is produced, and the quantity of that
output (for example, to decide whether to produce energy from a power
plant and how much energy to produce from that power plant).
 Although essential for the efficient use of an asset, rights to operate or maintain the
asset do not necessarily grant the right to direct how and for what purpose the asset
is used.
o However, rights to operate an asset may grant the customer the right to direct
the use of the asset if the relevant decisions about how and for what purpose
the asset is used are predetermined.

PROTECTIVE RIGHTS

 Protective rights include contractual restrictions designed to protect the supplier’s

interest in the asset or its personnel, or to ensure compliance with laws or
regulations.
 For example, a contract may:
 i. Specify the maximum amount of use of n asset or limit where or when the
customer can use the asset,
ii. Require a customer to follow particular operating procedures, or
iii. Require a customer to inform the supplier of changes on how an asset will be
used.
 Protective rights typically define the scope of the customer’s right of use but do
not, in isolation, prevent the customer from having the right to direct the use of an
asset.

FLOWCHART: IDENTIFYING A LEASE

Is there an identified asset?

Yes No

Does the customer have the right to

obtain substantially all of the
economic benefits from the use of Contract is not (does not
the identified asset throughout the
No contain) a lease.
period of use?
Yes

Does the customer have the right to

direct the use of the identified asset No
throughout the period of use?
Yes

Contract is (contains) a lease.

Illustration 1: Identifying a lease

Customer X, engaged in quarrying construction aggregates, enter into a ten-year contract

with Supplier Z for the use of 20 dump trucks of a particular type.
 The contract specifies the following:
o Supplier Z remains the owner of the specified trucks and shall provide
drivers for their operation and technicians for repairs and maintenance.
o The trucks are to be used for hauling excess materials from Customer X’s
mining site to any dumping site that Customer X will specify. Customer X can
also use the trucks to deliver construction aggregates to customers. However,
Customer X is prohibited from using the trucks to transport toxic wastes.
o Customer X operates 24.7 and 365 days a year. Thus, Supplier Z is required to
make all the specified trucks available at all times during the duration of the
contract.
o The trucks are to be kept in Customer X’s premises. If not in use, a truck
becomes idle. Supplier Z cannot receive any of the trucks other than for
reasons of default.
o If a truck needs to be serviced or repaired, Supplier Z is required to provide a
substitute truck of the same type.
 Analysis: The contract contains a lease because Customer X has the right to control
the use of an identified asset for a period of time. This is evidenced by the following:
a. The trucks are identified assets (explicitly specified in the contract) and
Customer X has the right to obtain substantially all of the economic
benefits from their use throughout the period of use (Customer X has
exclusive use of the trucks).
 Substitution rights: Supplier Z’s substitution rights are not
substantive because substitution is made only during repairs and
maintenance, rather than throughout the period of use.
b. Customer X has the right to direct the use of the trucks because Customer X
makes the relevant decisions on how and for what purpose the trucks are to
be used. Although Supplier Z controls the drivers and the technicians, this is
necessary only for the efficient use of the trucks and does not give Supplier Z
the right to direct how and for what purpose the trucks are used.
  Protective rights: The contractual restriction on the cargo that can be
transported by the trucks is a protective right of Supplier Z and does
not prevent Customer X from having the right to direct the use of the
trucks.

Illustration 2: Identifying a lease

Customer X, a seller of “siomai,” enters into a contract with Supplier Y to use a space in
Supplier Y’s mall to sell its goods. The contract states the amount of space and that the
space may be located at any one of several areas within the mall. Supplier Y has the right to
change the location of the space allocated to Customer X at any time during the period of
use. Changing the space entails minimal cost to Supplier Y because Customer X uses a booth
that it owns and can be moved easily. There are many areas in the mall that are available
and would meet the specifications for the space in the contract.

 Analysis: The contract does not contain a lease because there is no identified asset.
Customer X controls its booth but the contract is for space in the mall, and this space
can change at the discretion of Supplier Y. supplier Y’s substitution right is
substantive because:
a. Supplier Y has the practical ability to substitute alternative spaces
throughout the period of use (i.e., Customer X cannot prevent Supplier Y
from substituting another space and an alternative space is readily available
and meets the specifications in the contract); and
b. Supplier Y would benefit economically from the exercise of its right to
substitute the space (i.e., substitution allows Supplier Y to make the most
effective use of mall space to meet changing circumstances and it entails
minimal cost as Customer X’s booth can be moved easily).

LEASE TERM

 Lease term is the non-cancellable period of a lease, together with both:

a. Periods covered by an option to extend the lease if the lessee is reasonably
certain to exercise that option; and
 b. Periods covered by an option to terminate the lease if the lessee is
reasonably certain not to exercise that option.
 Non-cancellable period is the period in which the contract is enforceable. A lease is
no longer enforceable when each of the lessor and the lessee can terminate the lease
without permission from the other and subject only to an insignificant penalty.
 If only the lessee has the right to terminate the lease, the lessee considers this
right when determining the lease term (i.e., whether exercise is reasonably
certain or not).
 If only the lessor has the right to terminate a lease, the non-cancellable
period of the lease includes the period covered by the option to terminate the
lease.
 In assessing whether a lessee is reasonably certain to exercise an option to extend a
lease, or not to exercise an option to terminate a lease, an entity considers all
relevant facts and circumstances that create an economic incentive for the lessee
to exercise the option to extend the lease, or not to exercise the option to terminate
the lease.
 For example:
o The lessee may be reasonably certain to exercise an option to extend the
lease if:
 Lease payments on the extended period are expected to be below
market rate.
 The lessee made significant leasehold improvements with useful llife
longer than the original lease term.
o The lessee may be reasonably certain not to exercise an option to terminate
the lease if:
 The costs of terminating the lease (e.g., relocation costs) are
significant.
 The lease asset is important to the lessee’s operations (e.g., because it
is specialized in nature or because of its location and it would be
difficult to find a replacement asset if the lease is terminated).
  The shorter the non-cancellable period is, the more likely that a lessee will
exercise its right to extend (or not to exercise its right to terminate) the lease
because the shorter the non-cancellable period of, the more likely that the costs
associated with obtaining replacement asset would be higher.
 The lease term begins at the commencement date and includes any rent-free periods
provided by the lessor to the lessee.

ACCOUNTING FOR LEASES BY LESSEE

Recognition

 A lessee recognizes a lease liability and a right-of-use at the commencement date.

Initial measurement of Lease liability

 The lease liability is initially measured at the present value of the lease payments
that are not yet paid as at the commencement date.
 Lease payments include the following:
a. Fixed payments, including in-substance fixed payments, less any lease
incentives receivable;
b. Variable lease payments that depend on an index or rate, initially measured
using the index or rate as the commencement date;
c. Amounts expected to be payable by the lessee under residual value
guarantees;
d. The exercise price of a purchase option if the lessee is reasonably certain to
exercise that option; and
e. Payments of penalties for terminating the lease, if the lease term reflects the
lessee exercising an option to terminate the lease.
 Lease payments do not include:
i. Payments for non-lease elements (except when the entity elects to apply the
practical expedient).
ii. Payments in optional extension periods, unless the extension is reasonably
certain.
 iii. Future changes in variable payments that depend on an index or rate
iv. Variable payments linked to the lessee’s future sales or usage of the
underlying asset (also called contingent rent).

Discount rate

 The lease payments are discounted using the interest rate implicit in the lease.
o If that rate is not readily determinable, the lessee’s incremental borrowing
rate is used.
 The lessee’s incremental borrowing rate is the rate of interest that a lessee would
have to pay to borrow over a similar term, and with a similar security, the funds
necessary to obtain an asset of a similar value to the right-of-use asset in a similar
economic development.

Initial measurement of Right of use asset

 The right-of-use asset is initially measured at cost.

 The cost comprises the following:
a. The amount of the initial measurement of the lease liability;
b. Any lease payments made at or before the commencement date, less any
lease incentives received;
c. Any initial direct costs incurred by the lessee; and
d. The present value of decommissioning and restoration costs for which the
entity has incurred an obligation, unless those costs are incurred to produce
inventories.

Subsequent measurement of Lease liability

 The lease liability is subsequently measured similar to an amortized cost financial

liability (but remeasured to reflect any reassessments or lease modifications).
Accordingly:
o Interest on the lease liability is computed using the effective interest method
and recognized in profit or loss, unless it forms part of the carrying amount
of another asset.
  Interest in each period reflects a constant periodic rate of interest on
the remaining balance of the lease liability.
o Lease payments are apportioned between the interest and a reduction to the
lease liability.

Subsequent measurement of the Right-of-use asset

 The right-of-use asset is subsequently measured similar to a purchased asset.

 Accordingly, the asset is subsequently measured under the cost model, except
when:
a. It relates to a class of PPE that is measured under the revaluation model in
which case the asset may be measured under the revaluation model.
b. It meets the definition of an investment property and the entity uses the fair
value model, in which case, the asset is measured under the fair value
model.

Cost model

 Under the cost model, the right-of-use asset is measured at cost:

a. Less any accumulated depreciation and any accumulated impairment losses;
and
b. Adjusted for any remeasurement of the lease liability.

Depreciation

 The lessee depreciates the underlying asset over its useful life if:
a. The contract provides for the transfer of ownership to the lessee by the end
of the lease term; or
b. There is a reasonable certainty that the lease will exercise a purchase
option.
 In any other case, the lessee depreciates the underlying asset over the shorter of the
asset’s useful life and the lease term.
 Depreciation starts from the commencement date off the lease
Illustration: General recognition

On January 1, 20x1, Entity X enters into a 3-year lease of equipment for an annual rent of
100,000 payable at the end of each year, the equipment has a remaining useful life of 10
years. The interest rate implicit in the lease is 10%, while the lessee’s incremental
borrowing rate is 12%. Entity X uses the straight-line method of depreciation. The relevant
present value factors are as follows:

PV of an ordinary annuity of 1@10%, n=3…………….2.48684

PV of an ordinary annuity of 1@10%, n=3…………….2.40183

Initial measurements of Lease liability and Right-of-use asset

Fixed payments 100,000

Multiple by: PV of an ordinary annuity of 1@10%, n=3 2.48685

Lease liability 248,685

Subsequent measurement

 The lease liability is subsequently measured at amortized cost.

 Amortized cost is computed using an amortization table.
 The right-of-use asset is subsequently measured under the cost model.
o Since the lease contract neither provides for the transfer of ownership to the
lessee nor a ‘reasonably certain’ purchase option, the asset will be
depreciated over the shorter of its useful life (10 years) and the lease term (3
years).
 The annual depreciation, using the straight-line method is computed as follows:

Cost 248,685
Divide by: Lease tern (shorter) 3
Annual depreciation 82,895

RECOGNITION
  A lessee may elect not to apply the recognition requirements described earlier (i.e.,
recognition of lease liability and right-of-use asset) for:
a. Short-term leases; and
b. Leases for which the underlying asset is of low value.

Short-term lease

 Is a lease that, at the commencement date, has a lease term of 12 months or less.
 A lease that contains a purchase option is not a short-term lease.
 The election for short-term leases is made based on the class (i.e., grouping of assets
with similar nature and use) of underlying asset to which the right of use relates.

Low valued asset

 The assessment of value is based on the value of the asset when it is new, regardless
fo the age of the asset being leased.
o For example, an old car cannot qualify as a low valued asset because a car,
when new, is not considered of low value.
 The assessment is performed on an absolute basis, meaning, it is not affected by
materiality or the lessee’s size, regardless of whether he lessee is a small or a big
company.
 Examples of assets of low value include tablet and personal computers, small items
of office furniture and telephones.
 If the leased asset is subleased, the head lease does not qualify as a lease of low-
value asset.
 The election for leases of low valued assets can be made on a lease-by-lease basis.

The Basis for Conclusions accompanying IFRS 16 states that, at the time of reaching its
decisions about the exemption, the IASB had in mind leases of underlying assets with a
value, when new, of US$5,000 or less. This threshold is not in the main body of the Standard
and, hence, is not a requirement. Factors such as inflation and changes in foreign exchange
rates may reduce the relevance of this guideline over time.

Accounting
  The lessee may elect to recognize the lease payments associated with a:
a. Short-term lease, or
b. Lease of a low valued asset as an expense on a straight line basis over the
lease term, unless another systematic basis is more representative of the
pattern of the lessee’s benefit.

Illustration: Recognition exemptions

Assuming the recognition exemptions are applied to the illustration above, Entity X does
not recognize any lease liability or right-of-use asset at the lease commencement. Instead,
Entity X recognizes the 100,000 annual lease payments as expenses in the periods in which
they are incurred.

Separating the components of a contract

 An entity accounts for each lease component of a contract separately from the non-
lease components of that contract.
 A lessee allocates the consideration in the contract to each lease component on the
basis of the relative stand-alone price of the lease component and the aggregate
stand-alone price of the non-lease components.
 Relative stand-alone price is the price that the lessor or similar supplier would
charge for a component (or similar component) separately.
o If a separate price is not readily available, the lessee shall estimates it,
maximizing the use of observable information.

LEASE OF MULTIPLE ASSETS

 For a contract that contains rights to use multiple assets (e.g., a lease of two or more
pieces of equipment), the right to use each asset is considered a separate lease
component if both of the following criteria are met:
a. The lessee can benefit from the use of the asset either on its own or together
with other resources that are readily available to the lessee; and
 b. The underlying asset is neither highly dependent on, nor highly interrelated
with, the other underlying assets in the contract.
o For example, the lessee’s decision of not leasing an asset does not
affect its right to use the other assets in the contract.
 If the criteria are not met, the right to use multiple assets is considered a single lease
component.

NON-LEASE ELEMENTS

 A non-lease elements is considered a separate element if it transfers goods or

services to the lessee.
 Examples of non-lease elements:
1. Maintenance
o Cleaning of common areas in a building
o Garbage collection
o Repairs, etc
2. Security services
3. Supply of utilities
o Water
o Heat
o Electricity
o Internet
o Air conditioning, etc
4. Supply of goods
o Consumables for a manufacturing equipment
5. Supply of operational services
o A driver for a leased vehicle
o A machine operator for a leased equipment, etc.
 Non-lease components are accounted for under other applicable Standards.
 Payments for activities or costs that do not transfer goods or services to the lessee
are not a separate components of the contract.
  Examples:
1. Administrative tasks.
2. Real property taxes for which the lessor is liable regardless of whether it has
leased the property.
3. Insurance costs that protect the lessor’s investment in the asset and, in
which, the lessor is the beneficiary.
 The payments for these items are included in the total consideration that is allocated
to the separately identified components of the contract.

Illustration: Separating the components of a contract

ABC Co. enters into a 3-eyar contract for three machines- a printer, a binder, and electric
power converter equipment, The binding machine can be used on its own. However, the
converter is necessary to run the printer. ABC Co. would not lease a printer without a
converter, and vice versa.

The contract requires fixed annual payments of 240,000, itemized as follows: 225,000 rent
for the three machines, 11,000 for maintenance, and 4,000 for administrative tasks.

 Analysis:
o The contract includes two lease components and three non-lease
components:
 Lease components:
1. Lease of binder, and
2. Lease of printer and converter
o Non-lease components:
1. Three maintenance services for the three machines
o The rights to use the printer and the converter are treated as one component
because:
a. The lessee cannot benefit from the use of either asset on its own or
together with other resources that are readily available to the lessee
(i.e., the converter is needed to run the printer); and
 b. The printer and the converter are highly depended on each other (i.e.,
the lessee would not lease either asset without the other).
o The payment for administrative tasks is not a separate component because it
does not transfer goods or services to the lessee. This is included in the total
consideration that is allocated to the separately identified components.

ABC Co. identifies the following stand-alone prices:

Binder 52,000
Printer 180,000
Converter 15,000
Maintenance of binder 4,000
Maintenance of printer 8,000
Maintenance of converter 1,000

The total consideration of 240,000 is allocated to the separately identified component as

follows:

Stand-alone prices Allocation

Binder 52,000 (240k x 52/260) 48,000
Printer & converter *180k+15k) 195,000 (240k x 195/260) 180,000
Maintenance (4k +8k + 1k) 13,000 (240k x 13/260) 12,000

Totals 260,000 240,000

Accounting

 The lessee shall:

a. Recognize a lease liability and a right-of-use asset for the binder equal to the
present value of 48,000;
b. Recognized a lease liability and a right-of-use for the printer and converter
equal to the present value of 180,000; and
 c. Recognize the 12,000 allocated to the non-lease components as maintenance
expense at the end of each year over the lease term.

PRACTICAL EXPEDIENT

 PFRS 16 allows an entity to elect, by class of underlying asset, not to separate the
lease and non-lease components of a contract and instead account for them as a
single lease component.
 Applying the practical expedient simplifies accounting but it would increase the
amounts recognized for the lease liability and right-of-use asset and this could have
implications for impairment.

GENERAL RECOGNITION

LEASE LIABILITY

INITIAL MEASUREMENT
Fixed future payments (including in-substance
fixed), less any lease incentives receivable, plus
payments in optional extension periods if
extension is reasonably certain. Discounted at interest rate
implicit in the lease (or lease’s
incremental borrowing rate)
 +

Variable payments linked to an index/rate based

on level of index/rate at commencement.

+
Amounts expected to be payable under residual
value guarantees.
+
Exercise price of a purchase option if exercise is
reasonably certain.

Termination penalties if termination is

reasonably certain.

SUBSEQUENT MEASUREMENT

 Similar to an amortized cost financial liability. Interest is computed suing the

effective interest method. Payments are apportioned to both interest and a
reduction to lease liability.

RIGHT OF USE ASSET

INITIAL MEASUREMENT

Initial amount of lease liability

+
Lease payments made to lessor at or before
commence ment.
 +

Lease incentives received.

Initial direct costs.

Estimated cost of removing and/or restoring

leased asset.

SUBSEQUENT MEASUREMENT

 Similar to a purchased asset, i.e., measured under cost model, revaluation model
or fair value model, as appropriate.

RECOGNITION EXEMPTION-PRACTICAL EXPEDIENT

 A lessee may elect to recognize the lease payments as expense on a straight line
basis (or another more appropriate basis) if lease is:
a. Short-term, or
b. Low value

PRESENTATION

Statement of financial position

 Right-of-use assets are presented either:

a. Separately from other assets; or
b. Together with other assets as if they were owned, with disclosure of the line
items that include the right-of-use assets.
  Right-of-use assets that meet the definition of investment property are presented as
investment property.
 Lease liabilities are presented either:
a. Separately from other liabilities; or
b. Together with other liabilities, with disclosure of the line items that include
the lease liabilities

Statement of profit or loss and other comprehensive income

 Depreciation and interest expense are presented separately (i.e., offsetting is

prohibited).
 Interest expense on the lease liability is a component of finance costs.

DISCLOSURE

 Depreciation charge on right-of-use asset

 Interest expense on the lease liability
 Expense relating to low-value and short-term leases (other than leases of 1 month of
less)
 Expense relating to variable lease payments not included in lease liabilities.
 Income from subleasing
 Total cash outflow for leases
 Additions to right-of-use assets
 Carrying amount of right-of-use assets by class of underlying asset
 Additional information on right-of-use assets that are investment property or are
revalued under PAS 16
 Maturity analysis of lease liabilities using the following time bands under PFRS 7
Financial Instruments: Disclosures
a. Not later than one month;
b. Later than one month and not later than three months;
c. Later than three months and not later than one year; and
d. Later than one year and not later than five years.
ACCOUNTING FOR LEASES BY LESSOR

 A lessor classified each of its leases as either a finance lease or an operating lease.

CLASSIFICATION OF LEASE BY A LESSOR

1. Finance lease (capital lease) is a lease that transfers substantially all the risks
and rewards incidental to ownership of an underlying asset.
2. Operating lease is a lease that does not transfer substantially all the risks and
rewards incidental to ownership of an underlying asset.
 Risks include the possibilities of losses from idle capacity or technological
obsolescence and of variations in return because of changing economic conditions.
 Rewards may be represented by the expectation of profitable operation over the
asset’s economic life and of gain from appreciation in value in value or realization of
a residual value.
 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.

INITIAL OF A FINANCE LEASE

 The following are situations that individually or in combination would normally lead
to a finance lease classification:
a. The lease transfers ownership of the asset to the lessee by the end of the
lease term.
b. The lessee has the option to purchase the underlying asset at a price that is
expected to be sufficiently lower than the fair value at the date the option
becomes exercisable for it to be reasonably certain, at the inception date, that
the option will be exercised (i.e., bargain purchase option)
c. The lease term is for the major part of the economic life of the asset even if
title is not transferred.
o PFRS 16 does not provide specific guidance in determining what
constitutes a “major part” of the economic life of a leased asset.
However, under Financial Accounting Series (FAS), Statement of
 Financial Accounting Standards (SFAS) No. 13 of US GAAP, if the lease
term is at least 75% of the economic life of the leased asset, it is
generally held that the lease term constitutes a major part of the
economic life of the asset.
o Economic life is either:
i. The period over which an asset is expected to be economically
usable by one or more users; or
ii. The number of production or similar units expected to be obtained
from the asset by one or more users.
d. The present value of the lease payments amounts to at least substantially
all of the fair value of the leased asset at the inception date.
o Again, PFRS 16 does not provide specific guidance in determining
what constitutes ‘substantially all’ of the fair value of the asset at
inception date. Under SFAS 13 of US GAAP, if the present value of the
lease payments amounts to at least 90% of the fair value of the leased
asset at inception date, it is generally held that the present value of the
lease payments amounts to at least substantially all of the fair value of
the leased asset at the inception of the lease
e. The leased asset is of such a specialized nature that only the lessee can use
it without major modifications.

Remember the following:

 Any of the following will lead to a finance lease classification.

1. Transfer of ownership
2. Bargain purchase option (BPO)
3. Lease term is at least 75% of the useful life of the leased asset
4. Present value of lease payments is at least 90% of the fair value of the leased
asset at the inception date.
5. Leased asset is of specialized nature
OTHER INDICATIORS OF FINANCE LEASE

 Any of the following could also lead to a lease being classified as a finance lease:
a. If the lessee can cancel the lease, the lessor’s losses associated with the
cancellation are borne by the lessee (transfer of risk);
b. Gains or losses from the fluctuation in the fair value of the residual accrue to
the lessee (transfer of risks and rewards); and
c. The lessee has the ability to continue the lease for a secondary period at a
rent that is substantially lower than market rent (transfer of reward).
 The above indicators are not always conclusive. If it is clear that the lease does not
transfer substantially all the risks and rewards incidental to ownership, the lease is
classified as an operating lease.
o For example, this may be the case if the purchase option is not bargain, i.e.,
the exercise price is equal to the fair value of the asset.

INCEPTION AND COMMENCEMENT OF LEASE

 Lease classification is made at the inception date and is reassessed only if there is
a lease modification.
 Changes in estimates (e.g., changes in economic life or residual value), or changes in
circumstances (e.g., default by the lessee), do not give rise to a new classification of a
lease for accounting purposes.
1. Inception date is the earlier of:
o The date of the lease agreement, band
o Date of commitment by the parties to the principal provisions of the
lease. As at this date:
a) A lease is classified as either an operating or a finance
lease; and
b) In the case of a finance lease, the amounts to be
recognized at the commencement date are determined.
 2. Commencement date is the date on which a lessor makes an underlying
asset available for use by a lessee. It is on this date that the lessee is entitled
to exercise its right to use the leased asset.
o The commencement date is the date of initial recognition for the
lease, i.e., it is on this date that journal entries are recorded.
o However, the amounts in the journal entries are determined at the
inception date.

For example, you need a place to stay while you finish your studies. On Day 1, you went out
to look for a suitable boarding house. You found one. However, the landlady told you that
she will rent you a rom if you shave first your mustache as she is accepting ladies only. You
agreed and the landlady promised to reserve the room for you. On Day 2, you shaved your
mustache and went back to the landlady. You both agreed that you can move in after three
days.

 Analysis: The inception date is Day 1, the earlier of the date of lease agreement and
date if commitment (i.e., shaving). The commencement date is Day 5(i.e., three
days after Day 2), the date from which you are entitled to move in to your new
boarding house.

FINANCE LEASE

Initial measurement

 A lessor recognizes an asset from a finance lease as receivable measured at an

amount equal to the net investment in the lease.
 Under a finance lease, the lessor transfers substantially all the risks and rewards
incidental to ownership over the leased asset to the lessee,
o Thus, the lessor derecognizes the leased asset and recognizes a finance
lease receivable.
o The receivable is treated as repayment of principal and finance income to
reimburse and reward the lessor for its investment and services.
 Gross investment in the lease (gross lease receivable)- the sum of:
 a. The lease payments receivable by the lessor under a finance lease, and
b. Any unguaranteed residual value accruing to the lessor.
 Net investment in the lease (net lease receivable)
o The gross investment in the lease discounted at the interest rate implicit in
the lease.
 Unearned finance income (unearned interest income)- the difference between:
a. The gross investment in the lease, and
b. The net investment in the lease

Lease payments

 Lease payments include the following:

a. Fixed payments, including in-substance fixed payments, less any lease
incentives payable;
b. Variable lease payments that depend on an index or a rate, initially measured
using the index or rate as at the commencement date;
c. Guaranteed residual value;
d. The exercise price of a purchase option if the lessee is reasonably certain to
exercise that option; and
e. Payments of penalties for terminating the lease, if the lease term reflects the
lessee exercising an option to terminate the lease.

Discount rate

 The net investment is measured using the interest rate implicit in the lease.
 In the case of a sublease, if the interest rate implicit in the sublease cannot be readily
determined, an intermediate lessor may use the discount rate used for the head
lease (adjusted for any initial direct costs associated with the sublease) to measure
the net investment in the sublease.

Subsequent measurement

 The net investment in the lease (net lease receivable) is subsequently measured
similar to an amortized cost financial asset. Accordingly:
 o Finance income (interest income) is computed using the effective interest
method and recognized in profit or loss. interest in each period reflects a
constant periodic rate of return on the lessor’s net investment in the lease.
o Lease payments are applied against the gross investment in the lease to
reduce both the principal and the unearned finance income.

Illustration: Finance lease

On January 1, 20x1, Entity Y leases out an equipment to Entity X. information on the lease is
as follows:

Lease term 3 years

Annual rent payable at the end of each year 100,000
Interest rate implicit in the lease 10%

The lease provides for the transfer of ownership of the equipment to the lessee at the end
of the lease term. The relevant present value factor is as follows:

PV of an ordinary annuity 1@10%, n=3……………………….2.48685

 Analysis: The lease is a finance lease because it transfers ownership of the asset
to the lessee by the end of the lease term.

Initial measurement:

Gross investment= Lease payments + Unguaranteed residual value

Fixed lease payments 100,000

Multiply by: Lease term 3
Total lease payments 300,000
Add: Unguaranteed residual value -
Gross investment in the lease 300,000

Net investment= Present value of Gross investment or (PV of lease payments +PV of
Unguaranteed residual value)
 Fixed lease payments 100,000
Multiply by: PV of ordinary annuity of 1@10%, n=3 2.48685
Net investment in the lease 248,685

Unearned interest income= Gross investment-Net investment

Gross investment 300,000

Less: Net investment (248,685)
Unearned interest income 51,315

Unearned interest income is a valuation account (deduction) to the finance lease

receivable. The carrying amount of the finance lease receivable on January 1, 20x1 is
determined as follows:

Finance lease receivable-gross (gross investment) 300,000

Unearned interest income (51,315)
Finance lease receivable-net (net investment) 248,685

Subsequent measurement:

 The net investment in the lease (net finance lease receivable) is subsequently
measured at amortized cost.
 Amortized cost is computed using an amortization table.
 The lessor (Entity Y) does not recognize depreciation because the leased asset is
already derecognized. The lessee Entity X) will be the one to depreciate the asset.

OPERATING LEASE

 Is a lease that does not transfer substantially all the risks and rewards incidental to
ownership of an underlying asset.
 The accounting for operating leases is a straight-forward.
 The lessor recognizes the lease payments as income on a straight line basis over
the lease term, unless another systematic basis is more representative of the pattern
in which benefit from the use of underlying asset is diminished.
  The accounting for operating leases by a lessor is the same as the recognition
exemption available to a lessee for “short-term” and “low value” leases.
 The leased asset remains the asset of the lessor. Therefore, the lessor continues to
depreciate it.
 Under an operation lease, the lessor does not recognize any finance lease receivable.

Illustration: Operating lease

Assuming the lease in the illustration above is an operating lease, Entity Y does not
recognize any finance lease receivable. Instead, Entity Y recognizes the 100,000 annual
lease payments as income (i.e., rent income or lease income) in the periods in which they
are earned.

Below is an overview of the accounting of both the lessee and lessor for the previous
illustrations.

Facts:

Lease term 3 years

Annual rent payable at the end of each year 100,000
Interest rate implicit in the lease 10%
PV of an ordinary annuity 1@10%, n=3 2.48685

Lessee (entity X) Lessee (Entity Y)

GENERAL RECOGNITION FINANCE LEASE
Initial measurement Initial measurement
 Right-of-use asset, 248,685  Net measurement in the lease,
 Lease liability, 248,685 248,685

Subsequent measurement Subsequent measurement

 Right-of-sue asset (cost model),  Net investment in the lease
annual depreciation, 82,895 (amortized cost)
 Lease liability (amortized cost)  Depreciation, none
RECOGNITION EXEMPTIONS OPERATING LEASE
Initial measurement Initial measurement
 None  None

Subsequent measurement Subsequent measurement

 Annual lease expense, 100,000  Annual lease income, 100,000

LEASE OF LAND AND BUILDING

 When a lease includes both land and buildings elements, a lessor asses the
classification of each element as a finance lease or an operating lease separately.
 In determining whether the land element is an operating or a finance lease, an
important consideration is that land normally has an indefinite economic life, and
therefore the “useful life or 75%” criterion does not apply.
 However, even if the lease does not transfer title over the land, a lessor may
nonetheless classify the land element as a finance lease if the lease extends to a
relatively very long period of time.
 In reaching this conclusion the IASB had considered the example of a 999-year lease
of land and buildings. It had noted that, for such a lease, significant risks and
rewards associated with the land during the lease term would have been transferred
by the lessor despite there being no transfer of title.
 To account for the land and building components of a lease separately , a lessor
allocates the lease payments to the elements based on their relative fair values at
the inception date.
 If no reliable allocation basis exists, the entire lease is classified as a finance lease,
unless it is clear that both elements are operating leases, in which case the entire
lease is classified as an operating lease.
 If the land payment is immaterial to the lease, both components may be treated as a
single unit for purposes of lease classification. In such case, a lessor regards the
economic life of the building as the economic life of the entire underlying asset.

SUBLEASES
  Is a transaction for which an underlying asset is released by a lessee (intermediate
lessor) to a third party, and the lease (head lease) between the head lessor and
lessee remains in effect.
 An intermediate lessor classifies a sublease as a finance lease or an operating lease
as follows:
a. If the head lease is a short-term lease that the entity, as a lessee, has
accounted for applying the recognition exemption, the sublease is classified
as an operating lease.
b. Otherwise, the sublease is classified by reference to the right-of-use asset
arising from the head lease, rather than by reference to the underlying asset
(for example, the item of property, plant or equipment that is the subject of
the lease).
 If the leased asset is subleased, the head lease does not qualify as a lease of a low-
value asset.

PRESENTATION

 Underlying assets subject to operating leases are presented in the statement of

financial position according to their nature.

DISCLOSURE

Finance leases

 Selling profit or loss

 Finance income on the net investment in the lease
 Income relating to variable lease payments not included in the measurement of the
net investment in the lease
 Qualitative and quantitative explanation of significant changes in net investment in
the lease
 Maturity analysis of lease receivable

Operating leases
  Lease income, separately disclosing income for variable lease payments that do not
depend on an index or rate.
 As applicable for underlying asset, relevant disclosures in:
o PAS 16 for leases of PPE, disaggregated by cash
o PAS 36 Impairment of Assets
o PAS 38 Intangible Assets
o PAS 40 Investment Property
o PAS 41 Agriculture
 Maturity analysis of lease payments

SALE AND LEASEBACK TRANSACTIONS

 A sale and leaseback, transaction occurs when a party sells an asset and
immediately leases it back from the buyer.
o The seller becomes the lessee while the buyer becomes the lessor.
 To account for a sale and leaseback transaction, both the seller/lessee and the
buyer/lessor determine whether the transfer qualifies as a sale based on the
requirements for satisfying a performance obligation in PFRS 15.

TRANSFER OF ASSET IS A SALE

 If the transfer qualifies as a sale under PFRS 15:

a. The seller/lessee shall:
i. Measure the right-of-use arising from the leaseback at the proportion
of the precious carrying amount of the asset that relates to the right of
use retained by the seller-lessee; and
ii. Recognize only the amount of any gain or loss that relates to the rights
transferred to the buyer-lessor
 b. The buyer-lessor shall account for the purchase of the asset applying
applicable Standards (e.g., PAS 16 if the asset is an item of PPE), and for the
lease applying the lessor accounting under PFRS 16.

Adjustments

If (a) the sale price is not equal to the fair value of the asset, or if (b) the lease payments are
not at market rates, the following adjustments shall be made to measure the sale proceeds
at fair value:

a. Any below-market terms shall be accounted for as a prepayment of lease

payments; and
b. Any above-market terms shall be accounted for as additional financing provided by
the buyer-lessor to the seller-lessee.

The adjustment is measured based on the more readily determinable of:

a. The difference between the fair value of the consideration for the sale and the fair
value of the asset; and
b. The difference between the present value of the contractual payments for the lease
and the present value of payments for the lease at market rates.

TRANSFER OF THE ASSET IS NOT A SALE

 If the transfer does not qualify as a sale, the parties shall account for it as a financing
transaction. Accordingly,
a. The seller/lessee continues to recognize the asset and accounts for the
amounts received as a financial liability under PFRS 9.
b. The buyer/lessor does not recognize the transferred asset and accounts for
the amounts paid as a financial asset under PFRS 9.

Summary:

Identifying a lease
Essential elements Guidance
 Identified asset  Identified explicitly or implicitly.

 Right to obtain substantially all of
the economic benefits
 Right to direct the use
 Not identified if the supplier has
substantive substitution rights.
 A portion of an asset that is
a. Physically distinct can be an
identified asset;
b. Not physically distinct is not an
identified asset.
 Consider direct and indirect benefits.
 Consider only the economic benefits
within the defined scope of a customer’s
rights to use an asset, and not beyond.
 Customer has the right to decide how and
for what purpose the asset is used

LEASE ACCOUNTING

 General recognition: A lessee recognizes both a right-of-use asset and a lease

liability.
 The lease liability is initially measured at the present value of the lease payments
that re not yet paid as at the commencement date and subsequently measured at
amortized cost.
 The discount rate used is the interest rate implicit in the lease. If this is not
determinable, the lessee’s incremental borrowing rate is used.
 The right-of-use asset is initially measured at cost and subsequently measured similar
to a purchased asset (i.e., cost model, revaluation model or fair value model, as
appropriate).
 Recognition exemption: For “short-term” and “low value” leases, the lessee may elect
to recognize lease payments as expense over the lease term using the straight-line
basis, or another more appropriate basis.

LESSOR ACCOUNTING
  A lessor classifies a lease as either a finance lease or an operating lease. A finance
lease transfers substantially all the risks and rewards incidental to ownership of an
underlying asset; an operating lease does not.
 Indicators of a finance lease:
1. Transfer of ownership
2. Bargain purchase option ‘BPO’
3. Major part of useful life ‘75%;
4. PV of LP is substantially all of fair value ‘90%’
5. Specialized in nature.
 Finance lease: Initial accounting: Lessor derecognizes leased asset (and hence,
discontinues depreciating it) and recognizes net investment in the lease.
Subsequent accounting: net investment in the lease is subsequently measured at
amortized cost.
 Net investment=PV of lease payments+ PV of Unguaranteed residual value
 Operating lease: Lessor recognizes lease payments as lease income over the lease
term using the straight line basis, or another more appropriate basis. Lessor continues
to depreciate the leased asset.

PFRS 17 INSURANCE CONTRACTS

INTRODUCTION

 The accounting practices for insurance contracts have been diverse and often
differed from practices in other sectors.
 Prior to the completion of PFRS 17, an interim standard-PFRFS 4 Insurance
Contracts- was issued to make limited improvements to the accounting for, and
disclosure of, insurance contracts.
 PFRS 4 basically allowed insurance companies to retain their accounting policies
under their previous GAAP.
  PFRS 17 supersedes PFRS 4.
 PFRS 17 prescribes the principles for the recognition, measurement, presentation
and disclosure of insurance contracts by an insurer.
 PFRS 17 applies to:
a. Insurance and reinsurance contracts issued by an insurer;
b. Reinsurance contracts held by an insurer; and
c. Investment contracts with discretionally participation features issued by an
insurer.
 Insurer
o Issuer of insurance contract
o Is the party that has an obligation under an insurance contract to compensate
a policyholder if an insured event occurs (e.g., insurance company).
 PFRS 17 does not apply to contracts that are not insurance contracts, including
financial guarantee contracts (unless the issuer explicitly regards them as insurance
contracts) and insurance contracts whereby the entity is the policyholder rather
than the issuer.
 Contracts that meet the definition of an insurance contract bit have as their primary
purpose the provision of services for a fixed fee are accounted for under PFRS 15
instead of PFRS 17 if the following conditions are met:
a. The price in the contract is not affected by an assessment of the risk
associated with the individual customer;
b. The customer is compensated through services rather than cash payment;
and
c. The insurance risk primarily arises from the customer’s use of services
rather than from uncertainty over the cost of those services.

INSURANCE CONTRACT

 Is a contract under which one party (the issuer) accepts significant insurance risk
from another party (the policyholder) by agreeing to compensate the policyholder if
a specified uncertain future event (the insured event) adversely affects the
policyholder.
 o Policyholder- a party that has a right to compensation under an insurance
contract if an insured event occurs.
o Insured event- an uncertain future event that is covered by an insurance
contract and creates insurance risk.
 The definition of an insurance contract determines which contracts are within the
scope of PFRS 17 rather than other PFRSs.

ESSENTIAL ELEMENTS IN THE DEFINITION OF AN INSURANCE CONTRACT

1. Transfer of significant insurance risk- there is a transfer of significant insurance

risk from the insured (policyholder) to the insurer (insurance provided).
2. Payment from the insured (premium)- generally, the insured pays to a common
fund from which losses are paid. However, not all insurance contracts have explicit
premiums (e.g., insurance cover bundled with some credit card contracts).
3. Indemnification against loss- the insurer agrees to indemnify the insured or other
beneficiaries against loss or liability from specified events and circumstances (i.e.,
insured event) that may occur or be discovered during a specified period.

SIGNIFICANT INSURANCE RISK (UNCERTAIN FUTURE EVENT)

 Risk (uncertainty) is an essential element of an insurance contract.

 Risk is the possibility of loss or injury when an uncertain future event occurs.
 Risk can be speculative risk (i.e., results to0 either gain or loss) or pure risk (i.e.,
results only to loss).
 At least one of the following is uncertain at the inception of an insurance contract:
a. The occurrence of an insured event;
b. The timing of the event; or
c. The amount of payment when the insured event occurs.
 Insurance risk
o Is risk, other than financial risk, transferred from the holder of a contract to
the issuer.
 The risk must be pre-existing at the same time the insurance contract was
executed.
 o A new risk created by the contract is not an insurance risk.
 Insurance risk is significant if an insured event could cause an insurer to pay
significant additional benefits (i.e., those that would exceed the amount payable if no
insured event occurred).
o The significance of insurance risk is assessed on a contract by contract basis.
o A contract that transfers only an insignificant insurance risk is not an
insurance contract.
 A contract that exposes the issuer to financial risk is not an insurance contract,
unless it also exposes the issuer to significant insurance risk.
 Financial risk
o Is the risk of a possible future change in one or more of a specified interest
rate, financial instrument price, commodity price, foreign exchange rate,
index or prices or rates, credit rating or credit index or other variable,
provided in the case of a non-financial variable that the variable is not
specific to a party to the contract.
 From the definitions above, insurance risk includes only “pure risk.”
 In addition to financial risk, the following risks are also not insurance risk:
a. Lapse or persistency risk
o The risk that the policyholder will cancel the contract earlier or later
than the issuer had expected in pricing the contract because the
payment is not contingent on an uncertain future event that adversely
affects the policyholder.
b. Expense risk
o The risk of unexpected increases in the administrative costs
associated with the servicing of a contract, rather than in costs
associated with insured events because the increase in expenses does
not adversely affect the policyholder.
 A contract that exposes the issuer to lapse or persistency risk or expense risk is not
an insurance contract, unless it also exposes the issuer to significant insurance risk.

INDEMNIFICATION AGAINST LOSS

  Generally, indemnification on insurance contracts is in the form of cash.
 However, some insurance contracts require or permit payments to be made in kind
(i.e., non-case). For example, the insurer may indemnify the insured
a. By replacing the insured property; or
b. By providing services, such as medical, repair or other services.

EXAMPLES OF INSURANCE CONTRACTS

 The following are examples of contracts that are insurance contracts if the transfer
of insurance risk is significant:
a. Insurance against theft or damage
b. Insurance against product liability, professional liability, civil liability or legal
expenses
c. Life insurance and prepaid funeral plans
d. Life-contingent annuities and pensions
o Contracts that provide compensation for the uncertain future vent
o The survival of the annuitant or pensioner
o To assist the annuitant or pensioner in maintaining a given standard
of living, which would be otherwise be adversely affected by his or her
survival.
e. Disability and medical cover
f. Safety bonds, fidelity bonds, performance bonds and bid bonds
o Contracts that compensate the holder if another party fails to perform
a contractual obligation; for example, an obligation to construct a
building.
g. Product warranties issued by another party for goods sold by a
manufacturer, dealer or retailer. Product warranties issued directly by a
manufacturer, dealer or retailer are outside the scope of PFRS 17. These are
accounted for under PFRS 15 or PAS 37.
h. Title insurance
 o Insurance against the discovery of defects in the title to land or
buildings that were not apparent when the insurance contract was
issued.
i. Travel insurance
o Compensation to policyholders for losses suffered while they are
travelling
j. Catastrophe bonds that provide for reduced payments of principal, interest
or both, if a specified event adversely affects the issuer of the bond (except
when the insured event is not specific to a party to the contract, e.g., changes
in interest rates or foreign exchange rates, or climatic, geological or other
physical variable).
k. Insurance swaps and other contracts that require a payment depending on
changes in climatic, geological or other physical variables that are specific to
party to the contract.
 The following are examples of items that are not insurance contracts:
a. Investment contracts that have the legal form of an insurance contract but do
not transfer significant insurance risk to the issuer.
b. Self-insurance
o There is no insurance contract because there is no agreement with
another party.
c. Gambling contracts
d. Derivatives that expose a party to financial risk but not insurance risk,
including weather derivatives.
e. Credit-related guarantees
o Letter of credit
o Credit derivative default contract or credit insurance contract that
require payments even if the holder has not incurred a loss on the
failure of the debtor to make payments when due.

TYPES OF INSURANCE CONTRACTS

  For purposes of applying PFRS 17, insurance contracts may be classified as:
1. Direct insurance contract- an insurance contract where the insurer directly
accepts risk from the insured and assumes the sole obligation to compensate
the insured in case of a loss event.
2. Reinsurance contract- an insurance contract issued by one insurer (the
reinsurer) to compensate another insurer (the cedant) for losses on or
more contracts issued by the cedant.
o Reinsurer- the party that has an obligation under a reinsurance
contract to compensate a cedant if an insured event occurs.
o Cedant- the policyholder under a reinsurance contract.

Examples:

Case 1: Direct insurance contract

Mr. Juan obtains fire insurance for his house from ABC Insurance Co. In case of fire, ABC
Insurance Co. is liable for compensating Mr. Juan for the losses he has incurred.

 This is an example of a direct insurance contract (or simply insurance contract).

ABC Insurance CO. is the issuer while Mr. Juan is the policyholder.

Case 2: Reinsurance contract

ABC Insurance Co. is concerned about possible losses on the insurance contract with Mr.
Juan. Thus, ABC Insurance Co. obtains insurance from XYZ Insurance Co. for protection
against possible losses on the insurance contract with Mr. Juan. In case of fire, ABC
Insurance Co. compensates Mr. Juan, but this time, ABC Insurance Co. can claim
compensation from XYZ Insurance Co.

 This is an example of a reinsurance contract (simply described as ‘insurance of an

insurance’). ABC Co, is referred to as the cedant (or ceding company or primary
insurer) while XYZ Insurance Co. is referred to as the reinsurer.
 By entering into the reinsurance contract, ABC Insurance Co. is managing the risk
loss from the direct insurance contract with Mr. Juan.
  Assuming that only 40% of the risk accepted from Mr. Juan is ceded to XYZ
Insurance Co., the other 60% risk retained by ABC Insurance Co. is referred to as the
retention limit (or net retention). The 40% risk ceded to XYZ Insurance Co. is
referred to as the cession.

Case 3: Retrocession

Assume that XYZ Insurance Co. also obtains insurance from another reinsurer, 123
Insurance Co., for protection against possible losses from the reinsurance contract with
ABC Insurance Co.

 This is an example of retrocession (simply described as ‘reinsurance of a

reinsurance). 123 Insurance Co. is referred to as the retrocessionaire and the risk
transferred is referred to as the retrocession.

SEPARATING COMPONENTS FROM AN INSURANCE CONTRACT

 An insurance contract may contain one or more non-insurance components (e.g.,

investment component and. Or service component) that need to be separated and
accounted for under other Standards.
o For this purpose, an entity applied PFRS 9 to separate an embedded
derivative or a distinct investment component from a host insurance contract
and applies PFRS 15 to allocate the cash flows to be separated components.

LEVEL OF AGGREGATION OF INSURANCE CONTRACTS

 Insurance contracts are combined into portfolios.

 A portfolio consists of insurance contracts with similar risks and managed together
(e.g., contracts within a product line).
 Each portfolio is then further subdivided into the following groups:
a. A group of contracts that are onerous at initial recognition, if any;
b. A group of contracts that at initial recognition have no significant possibility
of becoming onerous subsequently, if any; and
c. A group of the remaining contracts in the portfolio, if any.
  PFRS 17 prohibits the inclusion of contracts issued more than one year apart in the
same group.

RECOGNITION

 A group of insurance contracts is recognized from the earliest of the following:

a. The beginning of the coverage period of the group of contracts;
b. The date when the first payment from a policyholder in the group becomes
due; and
c. For a group of onerous contracts, when the group becomes onerous.

INITIAL MEASUREMENT

 A group of insurance contracts is initially measured at the total of:

a. The fulfillment cash flows, and
b. The contractual service margin

FULFILLMENT CASH FLOWS

 The fulfillment cash flows are an explicit, unbiased and probability-weighted

estimate 9i.e., expected value) of the present value of the future cash outflows minus
the present value of the future cash inflows that will arise as the entity fulfills
insurance contracts, including a risk adjustment for non-financial risk.
 Fulfillment cash flows comprise the following:
a. Estimates of future cash flows, which include all future cash flows within
the boundary of each contract in the group. Estimates may be determined at
a higher level of aggregation and then allocated to individual groups of
contracts.
b. Adjustment for time value of money and financial risks (if financial risks
are not included in the estimates of future cash flows).
c. Risk adjustment for non-financial risk.
CONTRACTUAL SERVICE MARGIN

 The contractual service margin is the unearned profit in a group of insurance

contracts that the entity recognizes as it provides services in the future.
 This is initially measured at an amount that, unless the group of contracts is
onerous, results in no income or expenses arising from:
a. The initial recognition of the fulfillment cash flows;
b. The derecognition at the date of initial recognition of any asset or liability
recognized for insurance acquisition cash flows; and
c. Any cash flows arising from the contracts in the group at that date.
 Insurance acquisition cash flows- are cash flows arising from the costs of selling,
underwriting and starting a group of insurance contracts that are directly
attributable to the portfolio of insurance contracts to which the group belongs. Such
cash flows include cash flows that are not directly attributable to individual
contracts or groups of insurance contracts within the portfolio.
o Are recognized as asset or liability (unless the entity elects to recognize them
as expenses or income) when the entity pays or receives the cash flows
before the group is recognized. When the group is recognized, the asset or
liability is derecognized.

SUBSEQUENT MEASUREMENT

 The carrying amount of a group of insurance contracts at the end of each reporting
period is the sum of:
a. The liability for remaining coverage comprising:
i. The fulfillment cash flows related to future service allocated to the
group at that date;
ii. The contractual service margin of the group at that date; and
b. The liability for incurred claims, comprising the fulfillment cash flows related
to past service allocated to the group at that date.
 The contractual service margin at the end of the reporting period represents the
balance of unearned profit relating to future service.
 o For contracts without direct participation features, this is computed as the
beginning carrying amount adjusted for:
a. New contracts added to the group;
b. Changes in fulfillment cash flows relating to future service;
c. Effect of any currency exchange differences;
d. The amount recognized as insurance revenue during the period; and
e. Interest on the contractual service margin.
o For contracts without direct participation features, this is computed as the
beginning carrying amount adjusted for (a) to (d) above and the entity’s
share of the change in the fair value of the underlying items.
 Income and expenses are recognized as follows:
o From changes in the carrying amount of the liability for remaining
coverage:
a. Insurance revenue- for the reduction in the liability for remaining
coverage because of services provided in the period;
b. Insurance service expenses- for losses on groups of onerous
contracts, and reversals of such losses; and
c. Insurance finance income or expenses- for the effect of the time
value of money and the effect of financial risk.
o From the changes in the carrying amount of the liability for incurred
claims;
a. Insurance service expenses- for the increase in the liability because
of claims and expenses incurred in the period, excluding any
investment components;
b. Insurance service expenses- for any subsequent changes in
fulfillment cash flows relating to incurred claims and incurred
expenses; and
c. Insurance finance income or expenses- for the effect of the time
value of money and the effect of financial risk.

ONEROUS CONTRACTS
  An insurance contract is onerous if the total of its fulfillment cash flows, any
previously recognized acquisition cash flows and any cash flows arising from the
contract at initial recognition date is a net outflow.
o The net outflow is recognized as a loss in profit or loss.
o This results to a carrying amount of the liability for the group equal to the
fulfilment cash flows and a zero contractual service margin.
 On subsequent measurement, any excess net outflow for a group of insurance
contracts that becomes onerous or more onerous is recognized in profit or loss.

PREMIUM ALLOCATION APPROACH

 PFRS 17 allows a simplified measurement of a group of insurance contracts (called

‘premium allocation approach’) if at the group’s inception:
a. The entity reasonably expects that the simplification would result to an
approximation of the general model; or
b. The coverage period of each contract in the group is one year or less.
 The premium allocation approach is not applicable if at the group’s inception, the
entity expects significant variability in the fulfillment cash flows during the period
before a claim is incurred.

Initial measurement

 Under the premium allocation approach, the liability is initially measured at:
a. The premiums received at initial recognition, if any;
b. Minus any insurance acquisition cash flows at that date, unless the entity
chooses to recognize the payments as an expense; and
c. Plus or minus any amount arising from the derecognition at that date of the
asset or liability recognized for insurance acquisition cash flows.

Subsequent measurement

 At the end of each subsequent reporting period, the carrying amount of the liability
is the carrying amount at the start of the reporting period:
a. Plus the premiums received in the period;
 b. Minus insurance acquisition cash flows, unless the entity chooses to
recognized the payments as an expense;
c. Plus any amounts relating to the amortization of insurance acquisition cash
flows recognized as an expense in the reporting period, unless the entity
chooses to recognize insurance acquisition cash flows as an expense;
d. Plus any adjustment to a financing component;
e. Minus the amount recognized as insurance revenue for coverage provided in
that period; and
f. Minus any investment component paid or transferred to the liability for
incurred claims.

Other practical expedients under the Premium Allocation Approach

 Insurance acquisition cash flows may be expensed when incurred, provided that the
coverage period of each contract in the group at initial recognition is one year or
less.
 The liability may not be adjusted for the time value of money and financial risks if, at
initial recognition, the time between providing each part of the coverage and the due
date of the related premium is expected to be one year or less.

REINSURANCE CONTRACTS HELD

 To understand what a ‘reinsurance contract held’ is, let us recall the example
provided earlier:

Fact: Mr. Juan obtains insurance from ABC Insurance Co. ABC Insurance Co. then cedes the
insurance contract to XYZ Insurance Co.

Analyses:

 As to ABC Insurance Co., the reinsurance contract with XYZ Insurance Co. is a
reinsurance contract held (i.e., reinsurance ceded).
 As to XYZ Insurance CO., the reinsurance contract with XYZ Insurance Co. is a
reinsurance contract issued (i.e., reinsurance assumed).
  ABC Insurance Co. accounts for the reinsurance contract held using the principles
discussed below. XYZ Insurance Co. accounts for the reinsurance contract issued
similar to a direct insurance issued 9i.e., using the general model discussed above).

General model is modified for reinsurance contracts held as follows:

 When subdividing portfolios of reinsurance contracts held, references to onerous

contracts are replaced with a reference to contracts on which there is a net gain on
initial recognition.
 Recognition: A group of reinsurance contracts held are recognized as follows:
a. If the reinsurance contracts held provide proportionate coverage- at the
beginning of the coverage period of the group or at the initial recognition of
any underlying contract, whichever is the later; and
b. In all other cases- from the beginning of the coverage period of the group.
 Initial measurement:
a. Estimates of future cash flows include the risk of the reinsurer’s non-
performance.
b. The risk adjustment for non-financial risk is determined in such a way that it
depicts the transfer of risk from the holder of the reinsurance contract to the
reinsurer.
c. The contractual service margin is regarded as a net gain or loss on
purchasing the reinsurance, rather than an unearned profit.
 Subsequent measurement:
a. Changes in the fulfillment cash flows resulting from changes in the
reinsurer’s risk of non-performance do not adjust the contractual service
margin but rather recognized in profit or loss.
 Onerous contracts:
o Reinsurance contracts held cannot be onerous.
o Hence, the requirements of the general model for onerous contracts do not
apply.
 Premium Allocation Approach:
 o The premium allocation approach may be applied to reinsurance contracts
held, but modified to reflect the features of reinsurance contracts held that
differ from insurance contracts issued, e.g., the generation of expenses or
reduction in expenses rather than revenue.

INVESTMENT CONTRACTS WITH DISCRETIONARY PARTICIPATION FEATURES

 An investment contract with discretionary participation features is a financial

instrument that gives an investor a contractual right to receive additional payments;
a. That are a significant portion of the total contractual benefits;
b. The timing or amount of which is contractually at the issuer’s discretion; and
c. Are contractually based:
i. On the returns of a specified pool of contracts or a specified type of
contract
ii. Realized and/or unrealized investment returns on a specified pool of
assets held by the issuer; or
iii. The profit or loss of the entity or fund that issues the contract.
 Investment contracts with discretional participation features do not transfer
significant insurance risk.
 Accordingly, the general model is also modified for these contracts as follows:
o Recognition- on the date the entity becomes party to the contract.
o Estimates of cash flows- the contract boundary is modified so that cash
flows are within the contract boundary if they result from a substantive
obligation of the entity to deliver cash at a present or future date. The entity
has no substantive obligation to deliver cash if it has the practical ability to
set a price for the promise to deliver the cash that fully reflects the amount of
cash promised and related risks.
o Contractual service margin- the allocation of the contractual service
margin is modified so that it is recognized over the duration of the group of
contracts in a systematic way that reflects the transfer of investment services
under the contract.
MODIFICATION OF AN INSURANCE CONTRACT

 If the terms of an insurance contract are modified, the original contract is

derecognized and the modified contract is recognized as a new contract if the
modification meets any of the following conditions:
a. If the modified terms had been included at the contract inception, this would
have resulted to:
i. Exclusion of the contract from the scope of PFRS 17;
ii. Separation of different components from the host insurance contract
resulting to a different insurance contract to which PFRS 17 would
have applied;
iii. Substantially different contract boundary; or
iv. Inclusion of the contract to a different group of contracts.
b. The original contract qualified as an insurance contract with direct
participation features, but the modified contract no longer qualifies as such,
or vice versa; or
c. The original contract was measured using the premium allocation approach,
but the modified contract is no longer eligible for such measurement.
 Changes in cash flows caused by a modification that does not meet any of the
conditions above are treated as changes in the estimates of fulfilment cash flows.

DERECOGNITION

 An insurance contract is derecognized when:

a. It is extinguished, i.e., when the obligation in the insurance contract expires
or is discharged or cancelled; or
b. The contract is modified and the modification meets any of the conditions for
derecognition.

PRESENTATION

Statement of financial position

  The carrying amounts of the following groups are presented separately in the
statement of financial position:
a. Insurance contracts issued that are assets;
b. Insurance contracts issued that are liabilities;
c. Reinsurance contracts held that are assets; and
d. Reinsurance contracts held that are liabilities.
 The carrying amount of a group includes any asset or liability recognized for
insurance acquisition cash flows.

Statement(s) of financial performance

 The amounts recognized in the statement(s) of profit or loss and other

comprehensive income are disaggregated into to the following:
a. Insurance service result, comprising insurance revenue and insurance
service expenses; and
b. Insurance finance income or expenses.
 Income or expenses from reinsurance contracts held are presented separately from
income or expenses from insurance contracts issued.

INSURANCE SERVICE RESULT

 Insurance revenue and insurance service expenses, comprising incurred claims and
other incurred contracts issued are presented in profit or loss.
 Insurance revenue and insurance service expenses exclude any investment
components.
 Premium information is not presented in profit or loss if that information is
inconsistent with the revenue presented.

INSURANCE FINANCE INCOME OR EXPENSES

 Insurance finance income or expenses are changes in the carrying amount of a group
of insurance contracts resulting from the consideration of the time value of money
and financial risk, but excluding those relating to insurance contracts with direct
 participating insurance contracts that are adjustments to the contractual service
margin and are presented as insurance service expenses.
 An entity has an accounting policy choice for insurance finance or expenses
between:
a. Recognizing them in profit or loss; or
b. Disaggregating them into an amount recognized in profit or loss and an
amount recognized in other comprehensive income (OCI).
 If an entity chose to disaggregate insurance finance income or expenses, the amount
previously recognized in OCI is reclassified to profit or loss when the related
contract is derecognized. However, in the case of insurance contracts with direct
participation features, for which the entity holds the underlying items, the amount
previously recognized in OCI is not reclassified to profit or loss.

SUMMARY:

 PFRS 17 applies to the accounting for insurance and reinsurance contracts,

including investment contracts with discretionary participation features, by an
insurer.
 Insurance contract is a contract under which one party (the insurer) accepts
significant insurance risk from another party (the policyholder) by agreeing to
compensate the policyholder if a specified uncertain future event (the insured
event) adversely affects the policyholder.
 Insurance risk is risk, other than financial risk, transferred from the holder of a
contract to the issuer.
 A contract that transfers only an insignificant insurance risk is not an insurance
contract.
 PFRS 17 provides a general measurement model and a simplified model called
premium allocation approach.
o The general model is modified for onerous contracts, reinsurance
contracts held and investment contracts with discretionary
participation features.
 The following are presented separately in the statement of financial position:
 a. Insurance contracts issued that are assets
b. Insurance contracts issued that are liabilities
c. Reinsurance contracts held that are assets; and
d. Reinsurance contracts held that are liabilities.
 The amounts recognized in the statement(s) of profit or loss and other
comprehensive income are disaggregated into following:
a. Insurance service result, comprising insurance revenue and insurance
service expenses; and
b. Insurance finance income or expenses.
 Insurance service result is recognized in profit or loss.
 Insurance finance income and expenses are:
a. Recognized in full in profit or loss or
b. Disaggregated into amounts that are recognized in profit or loss and OCI, as
an accounting policy choice.

Types of tests: Matching 20 items and Multiple choice 39 items (9 computational items)

Identifying/Matching:

1. A contractual right to receive cash or to exchange financial instruments under

favorable conditions. FINANCIAL ASSET
2. It represents the excess of the carrying amount of the asset over its recoverable
amount. IMPAIRMENT LOSS
3. An amount higher of an asset’s fair value less the cost of disposal and value in use.
RECOVERABLE AMOUNT
4. The present value of a future cash flows expected to be derived from an asset or cash
generating unit. VALUE IN USE
5. It is an incremental cost directly attributable to the disposal of an asset or cash
generating unit, excluding finance costs and income tax expense. COST OF
DISPOSAL
6. A pre-tax rate that reflects current assessments of the time value of money and risks
for which the future cash flows estimates have not been adjusted. DISCOUNT RATE
7. Any contract that gives rise to a financial asset of one entity and the financial liability
or equity instrument of another entity. FINANCIAL INSTRUMENT
8. A contractual obligation to pay cash or exchange financial instrument under
unfavorable conditions. FINANCIAL LIABILITY
9. A contract that evidence a residual interest in the entity’s assets after deducting all
of its liabilities. EQUITY INSTRUMENT
10. A form of profitability ratio which provides a measure of how much profit or loss
each ordinary share has earned during the period. EARNINGS PER SHARE
11. An equity instrument that is subordinate to all other classes of equity instruments.
ORDINARY SHARE
12. It has preference over other classes of shares like preference over other classes of
shares. PREFERENCE SHARE
13. The sum of subscribed and issued shares less treasury shares. OUTSTANDING
SHARE
14. A financial instrument or other contract that may entitle its holder to ordinary
shares. POTENTIAL ORDINARY SHARE
15. When converted or exercised, they decrease the basic earnings per share or increase
basic loss per share. DILUTIVE POTENTIAL ORDINARY SHARE
16. Financial instruments that give rise the holder the right to purchase ordinary shares.
OPTIONS AND WARRANTS
17. It is computed when an entity has potential ordinary shares that are dilutive.
DILUTED EARNINGS PER SHARE
18. Financial statements that provide only the minimum information required by PAS
34. CONDENSED FINANCIAL STATEMENTS
19. The smallest identifiable group of assets generates cash inflows that are largely
independent of the cash in flows. CASH GENERATING UNIT
20. Financial statements prepared for a period of less than one year. INTERIM
FINANCIAL STATEMENTS
Computations to take note: (similar to the ones in the quiz)

1. Computation for the basic earnings per share

2. Computation for the earnings per share with adjustments on the outstanding shares
(adjustment factor)

3. Problem on the determination of the annual expenses to be recognized in the interim

report (refer to PAS 34 Problem 2)

4. Problem on determination of the equity component of convertible bonds

- Equity Component of Convertible Bonds = Issue Price – Fair Value of Debt Instrument
without Equity Feature

5. Computation for diluted earnings per share

6. Computation of Impairment Loss

7. Computation for Gain on Reversal of Impairment Loss

1. Study the Computation for Revaluation Increase as well

8. Computation for basic earnings per share with adjustment factor (again)

9. Problem on the impairment loss for a CGU

Total Score: 76/76

 CFAS
CHAPTER EXAM NO. 1

Measuring is the accounting process of analyzing business activities as to whether or

not they will be recognized in the books.

Answer: False

Which of the following statements about materiality is not correct?

a. An item must make a difference; otherwise, it need not be reported.

b. Materiality is affected by an item’s relative size and/or importance.

c. An item is material if its inclusion or omission would influence or change the

judgment of a reasonable person.

d. All of these are correct statements about materiality.

Accountable events are those that have an effect in an entity's assets, liabilities,
equity, income or expenses.

Answer: True

The elements of faithful representation do not include

Select one:

a. neutrality

b. free from error

c. completeness

d. comparability

“I say red; you say green.” The information lacks which of the following qualitative
characteristics?

Select one:
 a. timeliness

b. relevance

c. verifiability

d. colorfulness

All of the following statements incorrectly refer to the concepts in the Conceptual
Framework except

Select one:

a. The financial statements prepared by a reporting entity comprising a parent and

its subsidiaries are referred to as ‘combined financial statements’.

b. Financial statements are prepared and presented at least annually and are
directed toward both the common and specific information needs of a wide range of
users.

c. The Conceptual Framework is concerned with all-purpose financial statements.

d. The objective of general purpose financial statements is similar to the

objective of general purpose financial reporting.

All events and transactions of an entity are recognized in the books of accounts.

Answer: False

Which of the following events is considered as an internal event?

a. sale of inventory on account

b. conversion of raw materials into finished goods

c. borrowing of money

d. payment of liabilities

e. provision of capital by owners

Valuing assets at their liquidation values rather than their cost is inconsistent with
the __________.

Select one:

a. historical cost principle

b. matching principle

c. materiality constraint

d. periodicity assumption

The primary objective of financial reporting is to provide

Select one:

a. information about economic resources, claims to these resources, and changes in

them.

b. information useful for investment and credit decisions.

c. information useful in predicting future cash flows.

d. all of these

What is the authoritative status of the Conceptual Framework?

Select one:

a. The Conceptual Framework applies only to the IASB when developing or

amending Standards. A reporting entity should never use the Conceptual
Framework.

b. It has the highest level of authority. In case of a conflict between the Conceptual
Framework and a Standard, the Conceptual Framework overrides that Standard.
 c. If there is a Standard that specifically applies to a transaction, that Standard
overrides the Conceptual Framework. In the absence of such a Standard, the
requirement of the Conceptual Framework should be followed.

d. If there is a Standard that applies to a transaction, that Standard overrides

the Conceptual Framework. In the absence of such a Standard, the entity’s
management should consider the applicability of the Conceptual Framework
in developing and applying an accounting policy that will result in useful
information.

External users are those

a. who do have the authority to demand financial reports tailored to their specific
needs.

b. who do not have the authority to demand financial reports tailored to their
specific needs.

c. who belong to countries other than the domicile country of the reporting entity

d. who do not have the authority to demand financial reports tailored to their
common needs.

The proper application of accounting principles is most dependent upon the

Answer: Accountant

Free from bias toward a predetermined result is

Answer: neutrality

The assumption that a business enterprise will not be sold or liquidated in the near
future is known as the

a. conservatism assumption

b. economic entity assumption

 c. monetary unit assumption

d. going concern

An item is derecognized if it ceases to meet the definition of an asset or a liability.

Select one: True

Entity A is making a materiality judgment. Entity A considers an item to be material,

and therefore included in the financial statements, if it pertains to a related party
transaction. What type of materiality assessment is Entity A using?

a. Faithful representation

b. Relevance

c. Qualitative

d. Quantitative

Under the stable monetary unit assumption, the owners of the business and the
business are viewed as a single reporting entity. Therefore, the personal transactions
of the owners are recorded in the books of accounts.

Select one: False

The foundation of the Conceptual Framework is formed from

a. the objective of general purpose financial reporting.

b. the concept of reporting entity.

c. the principles and objectives of presentation and disclosure of financial

information.

d. the qualitative characteristics that makes information useful to users.

Which of the following are considered aspects of the qualitative characteristic of
relevance under the Conceptual Framework? I. Predictive value II. Confirmatory
value III. Timeliness IV. Materiality

a. I and II

b. I, II and III

c. I, II and IV

d. I, II, III and IV

During the lifetime of an entity, accountants produce financial statements at

arbitrary points in time in accordance with which basic accounting concept?

a. Conservatism constraint

b. Cost/benefit constraint

c. Periodicity assumption

d. Matching principle

The element that is related to the measurement of an entity’s financial performance

is

a. income

b. expenses

c. a and b

d. neither a nor b

The practice of accountancy in the Philippines is regulated under R.A. 9892.

Answer: False

Which of the following financial statements would not be dated as covering a certain
reporting period?
 Select one:

a. Statement of changes in equity

b. Statement of profit or loss and other comprehensive income

c. Statement of financial position

d. Statement of cash flows

The bottom part of each of Entity A’s financial statements states the following “This
statement should be read in conjunction with the accompanying notes.” This is most
likely an application of which of the following accounting concepts?

Select one:

a. accrual basis

b. articulation

c. consistency

d. time period

General purpose financial statements are

Select one:

a. those statements that cater to the common and specific needs of a wide range of
external users.

b. those statements that cater to the common needs of a wide range of external users
and internal users.

c. those statements that cater to the common needs of a wide range of external
users.

d. those statements that cater to the common needs of a limited range of external
users.
This refers to the use of caution in the exercise of judgments needed in making
estimates required under conditions of uncertainty, such that assets or income are
not overstated and liabilities or expenses are not understated.

Answer: Prudence

Financial reporting standards continuously change primarily in response to

Select one:

a. political influence.

b. changes in social environments.

c. users' needs.

d. government regulations.

Refers to the one that is required, or chooses, to prepare financial statements.

Answer: Reporting entity

The cost of inventory is recognized as expense

a. immediately.

b. using the matching concept.

c. by systematic allocation.

d. any of these as a matter of accounting policy choice.

Financial statements are said to be a mixture of fact and opinion. Which of the
following items is factual?

a. retained earnings

b. discount on capital stock

c. patent amortization expense

 d. cost of goods sold

The term “recognition” as used in accounting refers to the process of incorporating

the effects of an accountable event in the statement of financial position or the
statement of profit or loss and other comprehensive income through a memo entry.

Answer: False

All quantitative information is also financial in nature.

Answer: False

Which of the following statements is incorrect regarding the basic accounting

concepts?

a. The time period concept means that financial statements are prepared only
at the end of the life of a business.

b. Under the consistency concept, the financial statements should be prepared on

the basis of accounting principles which are followed consistently.

c. One of ABC Co.’s delivery trucks was involved in an accident. Although no lawsuits
have yet been filed against ABC, ABC recognized a liability for the probable loss on
the event. This is an application of the prudence or conservatism concept.

d. Under the entity theory, the business is viewed as a separate entity. Therefore, the
personal transactions of the business owners are not recorded in the business’
accounting records.

Entity A computes for its profit or loss periodically instead of waiting until the end of
the life of the business before doing so. This is an application of which of the
following accounting concepts?

Select one:

a. historical cost
 b. accrual basis

c. stable monetary unit

d. time period or reporting period

The Conceptual Framework broadly classifies the qualitative characteristics into

a. cold and hot qualitative characteristics

b. major and minor qualitative characteristics

c. primary and secondary qualitative characteristics

d. fundamental and enhancing qualitative characteristics

According to the Conceptual Framework, the pervasive constraint on the information

that can be provided by financial reporting is

Select one:

a. materiality

b. going concern

c. cost-benefit

d. historical

Which of the following may result to an expense?

a. increase in liability

b. decrease in liability

c. distribution to holders of equity claims

d. increase in asset

Physical concept of capital means that capital is the invested money or invested
purchasing power.
 Answer: False

The measurement bases described under the Conceptual Framework are least
applicable to the measurement of

a. equity.

b. assets.

c. liabilities.

d. income.

Which of the following statements is true?

I. Loss from theft is classified as a nonreciprocal transfer.

II. Internal events are changes in economic resources by actions of other entities
that do not involve transfers of resources and obligations.

III. Nonreciprocal transfers involve the transfer of resources in only one

direction, either from an entity to other entities or from other entities to the entity.

IV. Internal events are sudden, substantial, unanticipated reductions in resources

not caused by other entities.

V. Fire, earthquake and flood are examples of accountable events classified as

internal events.

a. I, II, III and V

b. I, III and V

c. II, III, IV and V

d. I, III, IV and V

Which of the following is considered a pervasive constraint by the Conceptual

Framework?
 a. conservatism

b. cost constraint

c. verifiability

d. cost constraint

The ability through consensus among measurers to ensure that information

represents what it purports to represent is an example of the concept of

Answer: Verifiability

The PFRSs consist of all of the following except

a. Interpretations.

b. PASs.

c. PFRSs.

d. Conceptual Framework.

Which of the following events is considered as an external event?

Select one:

a. production

b. payment of taxes

c. gifts and charitable contributions

d. provision of capital by owners

e. b, c and d

The accounting process of assigning numbers, commonly in monetary terms, to the

economic transactions and events is referred to as classifying.

Answer: False
The accounting concept that justifies the use of accruals and deferrals is the going
concern concept.

Answer: True

These are users of financial information who are not in a position to require a
reporting entity to prepare reports tailored to their particular information needs.

Answer: primary users

Asset measurements in conventional financial statements

a. do not reflect output values.

b. are confined to historical cost.

c. reflect several financial attributes.

d. are confined to historical cost and current cost.

Which of the following statements about the Norwalk Agreement is correct?

a. The Norwalk Agreement requires all domestic companies in the U.S. to prepare
financial statements in accordance with the IFRSs.

b. The Norwalk Agreement is a short-term convergence between the FASB and the
IASB which has long-time been abolished.

c. The Norwalk Agreement is a convergence between the FASB and the IASB to
make their existing financial reporting standards compatible and coordinate
their future work programs to ensure that once achieved, compatibility is
maintained.

d. The Norwalk Agreement does not affect the financial reporting standards in the
Philippines.

According to the revised Conceptual Framework, an item is recognized if

 a. it meets the definition of an asset, liability, equity, income or expense.

b. recognizing it would provide useful information.

c. it is probable that the item will result to an inflow or outflow of economic benefits
and its cost can be measured reliably.

d. a and b

An accountable event is an event that has an effect on the assets, liabilities or equity
of an entity and its effect can be measured reliably.

Answer: True

Accounting has been given various definitions, which of the following is not one of
those definitions?

a. Accounting is a service activity. Its function is to provide quantitative information,

primarily financial in nature, about economic entities that is intended to be useful in
making economic decisions.

b. Accounting is a systematic process of objectively obtaining and evaluating

evidence regarding assertions about economic actions and events to ascertain
the degree of correspondence between these assertions and established
criteria and communicating the results to interested users.

c. Accounting is the art of recording, classifying, and summarizing in a significant

manner and in terms of money, transactions and events which are, in part of at least,
of a financial character and interpreting the results thereof.

d. Accounting is the process of identifying, measuring, and communicating economic

information to permit informed judgment and decisions by users of information.

The Conceptual Framework uses the term “economic resources” to refer to

Answer: Assets
Which of the following is not one of the decisions that primary users make?

a. deciding on whether to hold or sell investment in stocks

b. deciding on how to run the day-to-day operations of the entity

c. deciding on whether to buy investment in stocks

d. deciding on whether to extend loan to the reporting entity

General purpose financial statements are those statements that cater to the common
and specific needs of a wide range of external users.

Answer: False

It is the official accounting standard setting body in the Philippines. It is composed of

a chairperson and 14 members.

a. Accounting Standards Council (ASC)

b. Accounting Standards Committee (ASC)

c. Financial Reporting Standards Council (FRSC)

d. Financial Reporting Standards Committee (FRSC)

Refers to the professional regulatory board created to supervise the registration,

licensure and practice of accountancy in the Philippines (full word).

Answer: Board of Accountancy

It is the accounting process of assigning numbers, commonly in monetary terms, to

the economic transactions and events.

Answer: Measuring

Information that is capable of making a difference in the decisions made by users has
this qualitative characteristic.

Answer: Relevance
What is the objective of general purpose financial statements according to the
Conceptual Framework?

a. To prepare and present comparable, relevant, reliable, and understandable

information for investors and creditors.

b. To prepare financial statements in accordance with all applicable Standards and

Interpretations.

c. To provide information about the financial position, financial performance,

and changes in financial position of an entity that is useful to primary users in
making economic decisions.

d. To prepare and present a balance sheet, an income statement, a cash flow

statement, and a statement of changes in equity.

The basic purpose of accounting is to provide information about economic activities

intended to be useful in making economic decisions.

Answer: True

A CPA employed as an accountant in a government agency is considered to be in

a. private practice

b. public practice

c. academe

d. service

It is the branch of accounting that focuses on the preparation of general purpose financial
statements. financial accounting

These are events that do not involve an external party. internal events
This concept defines the area of interest of the accountant. It determines which
transactions are recognized in the books of accounts and which are not. separate entity
concept

The quality of information that gives assurance that it is reasonably free of error and bias
and provides a true, correct and complete depiction of what it purports to represent is
__________. faithful representation

The Filipino adage “Aanhin mo pa ang damo pag patay na ang kabayo” relates to which of
the following qualitative characteristics? timeliness

Decision makers vary widely in the types of decisions they make, the methods of decision
making they employ, the information they already possess or can obtain from other
sources, and their ability to process information. Consequently, for information to be useful
there must be a linkage between these users and the decisions they make. This link is
___________. understandability

The process of identifying, measuring, analyzing, and communicating financial information

needed by management to plan, evaluate, and control an organization’s operations is called
__________. managerial accounting

It refers to the process of incorporating the effects of an accountable event in the statement
of financial position or the statement of profit or loss and other comprehensive income
through a journal entry. recognition

These are events involving an entity and another external party. external events

When information about two different entities has been prepared and presented in a
similar manner, the information exhibits the characteristic of ________. comparability

Entity A appropriates ₱1M to fund employee benefits for the last quarter of the
following year. Entity A deposits the ₱1M fund in a payroll account. This economic
activity is most appropriately referred to as

a. Production
 b. Investment

c. Exchange

d. Savings

The Board of Accountancy consists of a chairperson and six members.

Answer: True

You are the accountant of ABC Co. During the period, your company purchased
staplers worth ₱1,500. Although the staplers have an estimated useful life of 10
years, you have charged their cost as expense. Which of the following is most likely to
be true?

a. You are applying the concept of matching.

b. You are applying the concepts of materiality and cost-benefit consideration.

c. You are applying the concept of verifiability.

d. You are just lazy to compute for the periodic depreciation.

The accounting standards used in the Philippines are adapted from the standards
issued by the

a. Philippine Institute of Certified Public Accountants (PICPA).

b. Federal Accounting Standards Board (FASB).

c. International Accounting Standards Board (IASB).

d. Democratic People's Republic of Korea Accounting Standards Committee

(DPKRASC).

The revised Conceptual Framework defines an asset as

a. a resource controlled by the entity as a result of past events and from which future
economic benefits are expected to flow to the entity.
 b. a present economic resource controlled by the entity as a result of past
events. An economic resource is a right that has the potential to produce
economic benefits.

c. a physical object that can produce economic benefits for the entity.

d. all of these.

Which of the following statements is incorrect concerning materiality?

a. Materiality can be assessed quantitatively or qualitatively

b. Materiality is a quantitative matter. It should never be assessed qualitatively.

c. Materiality is a matter of judgment

d. There are no specific materiality thresholds provided under the PFRSs

Accounting is often called the "language of business" because

a. accountants in many companies share financial information.

b. it is easy to understand.

c. it is fundamental to the communication of financial information.

d. all business owners have a good understanding of accounting principles.

 CHAPTER 2

PAS 1 prescribes an order or format of presenting items in the financial statements.

Answer: False

Which of the following is added to the cost of inventories?

a. Refundable purchase taxes

b. Trade discounts

c. Storage costs of part-finished goods

d. Administrative costs

An entity’s financial position or condition refers to which of the following?

a. The status of the entity’s assets, liabilities and equity.

b. The amount of return that the entity has generated from its economic resources
during the period.

c. The level of change in the entity’s economic resources and claims to those
resources, also referred to as the economic phenomena.
 d. All of these.

This type of presentation of statement of financial position does not show

distinctions between current and noncurrent items.

a. Non-discriminating presentation

b. Unclassified presentation

c. Classified presentation

d. Awesome presentation

Who is responsible for the preparation and the fair presentation of an entity’s
financial statements in accordance with the PFRSs?

a. Any accountant

b. Management

c. Certified Public Accountant

d. Auditor

These are the costs necessary in converting raw materials into finished goods, which
include direct labor costs and production overhead.

Answer: Conversion costs

According to PAS 2, inventories are measured at net realizable value.

Answer: False

Non-financial institutions have the option of classifying interest income received as

either investing or financing activities.

Answer: False

Which of the following financial statements would be dated as at a certain date?

 a. Statement of financial position

b. Statement of profit or loss and other comprehensive income

c. Statement of cash flows

d. All of these

An additional statement of financial position is provided if the effect of

reclassification of items in the comparative information is material as a result of a
change in presentation.

Answer: True

Entity JFK, a trading entity, buys and sells Product Z. Movements in the inventory of
Product Z during the period are as follows:

Date Transaction Units Unit cost Total cost

Feb. 1 Beginning inventory 100 ₱15 ₱1,500

7 Purchase 300 18 5,400

12 Sale 320

21 Purchase 200 21 4,200

How much is the ending inventory and cost of sales under the FIFO cost formula?

Answer: Ending inventory - 5,640 Cost of sales - 5,460

Bank overdraft that can be offset with cash. → NOT PRESENTED

Purchase of equipment through cash. → INVESTING

Issuance of shares of stocks through cash. → FINANCING

Cash invested in a 90-day time deposit. → NOT PRESENTED

Purchase of a treasury bill three months before its maturity. → NOT PRESENTED

Redemption of equity instruments through cash. → FINANCING

Collection of accounts receivables. → OPERATING

Exchange differences in translating a foreign currency denominated cash flows. → NOT

PRESENTED

Acquisition of loans from a bank. → FINANCING

Cash payments by a lessee for the reduction of the outstanding liability relating to a lease.
→ FINANCING

Cash payments on derivative assets other than those held for trading. → INVESTING

Dividends paid this year although declared in a prior year. → FINANCING

Cash dividends received by a financial institution from its investments in marketable

securities during the year. → OPERATING

Purchase of office supplies on account. → NOT PRESENTED

Acquisition of equipment through issuance of note payable. → NOT PRESENTED

Bank overdrafts that cannot be offset with cash. → FINANCING

Cash purchase of inventories. → OPERATING

A bank entity releases loan to its borrowers. → OPERATING

Payment for acquisition of intangible assets. → INVESTING

Cash receipts from contracts held for trading purposes. → OPERATING

Write-downs of inventories to their net realizable value are recognized

a. in profit or loss

b. in other comprehensive income

c. directly in equity

d. any of these
PAS 1 requires an entity to provide an additional balance sheet dated as of the beginning of
the preceding period if certain instances occur. Which is not one of those instances?
(Assume all of the following has a material effect).

a. Change in the frequency of reporting.

b. Retrospective application of an accounting policy.

c. Retrospective restatement.

d. Reclassification of items in the financial statements.

Factory management cost is not included in the cost of inventory.

Answer: False

Comprehensive income (or total comprehensive income) includes

a. profit or loss

b. other comprehensive income

c. transactions with owners

d. a and b

e. all of these.

Entity A acquires equipment by issuing shares of stocks. How should Entity A report
the transaction in the statement of cash flows?

a. Operating activities

b. Investing activities

c. Financing activities

d. Not reported

Which of the following costs of conversion cannot be included in cost of inventory?

 a. Factory overheads based on normal capacity.

b. Factory rent and utilities

c. Salaries of sales staff (sales department shares the building with factory
supervisor).

d. Cost of direct labor

Inventories are measured at

a. Lower of cost and fair value.

b. Lower of cost and net realizable value.

c. Lower of cost and nominal value.

d. Lower of cost and net selling price.

e. Choices b and d.

Information on the utilization of economic resources is most useful when assessing

an entity’s

a. management stewardship.

b. financial strengths and weaknesses, including the entity’s needs for additional
financing.

c. liquidity and solvency.

d. financial position and financial performance.

How should trade discounts be dealt with when valuing inventories at the lower of
cost and net realizable value (NRV) according to PAS 2?

a. Ignored

b. Deducted from cost

 c. Deducted in arriving at NRV

d. Added to cost

These are short-term, highly liquid investments that are readily convertible to known
amounts of cash and which are subject to an insignificant risk of changes in value.

Answer: Cash equivalents

A classified presentation of statement of financial position shall be used except when

an unclassified presentation provides information that is reliable and more relevant.

Answer: True

The amounts reclassified to profit or loss in the current period that were recognized
in other comprehensive income in the current or previous periods.

Answer: Reclassification adjustments

A statement of financial position presentation showing distinctions between current

and noncurrent assets and current and noncurrent liabilities.

Answer: Classified presentation

A balance sheet presentation that is based on liquidity.

Answer: Unclassified presentation

Refers to the comparability of financial statements between different entities.

Answer: Inter-comparability

It is the time between the acquisition of assets for processing and their realization in
cash or cash equivalents.

Answer: Operating cycle

Which of the following statements is incorrect regarding the use of cost formulas?
 a. Different cost formulas may be used for each class of inventory with dissimilar
nature and use.

b. Entities may choose between the FIFO and the Weighted Average cost formulas for
inventories that are ordinarily interchangeable.

c. Only one formula shall be used for all inventories regardless of differences
in their nature and use.

d. PAS 2 requires the use of specific identification of costs for inventories that are not
ordinarily interchangeable.

All financial statements shall be prepared using accrual basis of accounting.

Answer: False

Which of the following statements best describes a statement of cash flows?

a. The statement of cash flows is also called the statement of activities.

b. The statement of cash flows shows information on an entity’s assets, liabilities

and equity.

c. The statement of cash flows shows information on an entity’s income and

expenses during the period.

d. The statement of cash flows shows historical changes of cash and cash
equivalents during the period.

The cost of inventory is recognized as expense

a. immediately.

b. using the matching concept.

c. by systematic allocation.

d. any of these as a matter of accounting policy choice

Entity ABC, a trading entity, buys and sells Product Y. Movements in the inventory of
Product Y during the period are as follows:

Date Transaction Units Unit cost Total cost

Mar. 1 Beginning inventory 100 ₱15 ₱1,500

7 Purchase 300 18 5,400

12 Sale 320

21 Purchase 200 21 4,200

How much is the ending inventory and cost of sales under the Weighted Average cost
formula? (The average is calculated as each additional purchase is made, i.e., ‘moving
average’.)

Answer: Ending inventory - 5,580 Cost of sales - 5,520

Entity A buys and sells artifacts. Each artifact is unique and not ordinarily
interchangeable. According to PAS 2, the cost formula that Entity A should use is

a. Specific identification

b. Weighted average

c. FIFO

d. Any of these.

Which of the following is not correct regarding the determination of the cost of an
inventory?

a. Insurance costs while the inventory is in transit are included.

b. Purchase price, net of trade discounts, is included.

c. Import duties and non-refundable taxes are included.

d. Purchase price, gross of trade discounts, is included.

This comprises all “non-owner changes in equity.” It excludes owner changes in
equity, such as subscription, issuance, and reacquisition of share capital and
declaration of dividends.

a. Profit or loss

b. Other comprehensive income

c. Total comprehensive income

d. Changes in equity

This refers to the comparability of financial statements of the same entity but in
different periods.

Answer: Intra-comparability

The Coronet Company has a cost card in relation to an item of goods manufactured as
follows: Materials 80 Storage costs of finished goods 18 Delivery to customers
(Freight out) 4 Non-recoverable purchase taxes 6 According to PAS 2, at what figure
should the item be valued in inventory?

a. 98

b. 86

c. 108

d. 104

The cost of inventory should not include

I. Purchase price.

II. Import duties and other taxes.

III. Abnormal amounts of wasted materials.

IV. Administrative overhead.

V. Fixed and variable production overhead.

VI. Selling costs.

Select one:

a. II, III, IV, V

b. III, IV, VI

c. I, II

d. II, III, IV, V, VI

Entity EDF, a trading entity, buys and sells Product X. Movements in the inventory of
Product X during the period are as follows:

Date Transaction Units Unit cost Total cost

Apr. 1 Beginning inventory 100 ₱15 ₱1,500

7 Purchase 300 18 5,400

12 Sale 320

21 Purchase 200 21 4,200

How much is the ending inventory and cost of sales under the Weighted Average cost
formula? (The average is calculated on a periodic basis.)

Answer: Ending inventory - 5,180 Cost of sales - 5,920

Reversals of inventory write downs should exceed the amount of the original write-
down previously recognized.

Answer False:

Entity A acquires inventories and incurs the following costs:

Purchase price, gross of trade discount 100,000
Trade discount 20,000
Non-refundable purchase tax, not included
 in the purchase price above 5,000
Freight-in (Transportation costs) 15,000
Commission to broker 2,000
Advertisement costs 10,000

How much is the cost of the inventories purchased?

Answer: 102,000

It shows the historical changes (i.e. sources and utilization) in cash and cash
equivalents during the period.

Answer: Statement of cash flows

In making an economic decision, an investor needs information on the amounts of an

entity’s economic resources and claims to those resources. That investor would most
likely refer to which of the following financial statements?

Select one:

a. Statement of financial position

b. Statement of cash flows

c. Statement of comprehensive income

d. Statement of changes in equity

Cash flows relating to investing and financing activities are presented separately at
gross amounts, unless they qualify for net presentation.

Answer: True

Entity A had the following balances at December 31, 20x1:

Cash in checking account 35,000
Cash in 90-day money market account 75,000
Treasury bill, purchased 12/1/x0, maturing 5/31/x2 150,000
Treasury bill, purchased 12/1/x1, maturing 2/28/x2 200,000

How much cash and cash equivalents is reported in Entity A’s December 31, 20x1 statement
of financial position?

Answer: 310,000

Which of the following costs are included in the cost of inventories?

a. Administrative and general overhead

b. Storage costs relating to finished goods

c. Transport costs for raw materials

d. Abnormal material usage

In which of the following instances is a write-down of inventories to net realizable

value may not be required?

a. The estimated costs to complete or costs to sell have increased.

b. The inventories have become wholly or partially obsolete.

c. Selling prices are rising because demand has increased.

d. The inventories are damaged.

Inventories are usually written down to net realizable value

a. Every year

b. On the basis of their classification, for example, as all finished goods, all work in
process and all raw materials and supplies

c. On the basis of their relative stand-alone selling prices

d. On an item by item basis

Inappropriate accounting policies can be rectified by mere disclosures.

 Answer: False

The statement of financial position of which of the following entities does not show
current and noncurrent distinctions among assets and liabilities?

a. Mining companies

b. Manufacturing firms

c. Banks and other financial institutions

d. Trading enterprises

Which of the following statements is correct regarding the classification of financial

liabilities as current or noncurrent in accordance with PAS 1?

a. Currently maturing obligations are presented as current liabilities even if

their original term is longer than one year and even if a refinancing agreement
is completed after the end of the reporting period but before the financial
statements are authorized for issue.

b. Currently maturing obligations are presented as noncurrent liabilities only if a

refinancing agreement is completed after the end of the reporting period but before
the financial statements are authorized for issue.

c. Currently maturing obligations are presented as noncurrent liabilities only if their

original term is longer than one year.

d. Currently maturing obligations are presented as noncurrent liabilities if a

refinancing agreement is completed after the financial statements are authorized for
issue.

Which of the following is not a disclosure requirement of PAS 1?

a. Any material uncertainties on the entity’s ability to continue as a going concern.

 b. The reason for using a longer or shorter period when an entity changes the
frequency of its reporting.

c. The recognition, measurement and disclosure of specific transactions and

other events.

d. The financial effect of a departure when an entity departs from a PFRS

requirement.

Which of the following is not one of the general features of financial statements
under PAS 1?

a. Cash basis

b. Materiality and aggregation

c. Fair presentation and compliance with PFRSs

d. Going concern

The end product of the financial reporting process and the means by which
information gathered and processed is periodically communicated to users.

Answer: Financial statements

The information provided by financial reporting pertains to

a. individual reporting entities, rather than to industries, the economy as a

whole or members of society as consumers.

b. individual business entities and industries, rather than to the economy as a whole
or to members of society as consumers.

c. individual business entities, industries and the economy as a whole, rather than to
members of society as consumers.

d. individual business entities and the economy as a whole, rather than to industries
or to members of society as consumers.
Which of the following statements is correct when an entity departs from a provision
of a PFRS?

a. The entity’s financial statements would be grossly incorrect; therefore, PAS 1 does
not allow such a departure.

b. PAS 1 permits such a departure if the relevant regulatory framework requires, or

otherwise does not prohibit, such a departure.

c. PAS 1 requires certain disclosures when an entity departs from a provision of a

PFRS.

d. b and c

Comprehensive income excludes which of the following

a. Gains and losses from investments measured at fair value through profit or loss

b. Distributions to owners

c. Revaluation surplus

d. Income tax expense

What is the purpose of reporting comprehensive income?

a. To report changes in equity due to transactions with owners.

b. To combine income from continuing operations with income from discontinued

operations and extraordinary items.

c. To replace profit with a better measure.

d. To report a measure of the overall financial performance of an entity.

These deal with the computation of cost of sales and cost of ending inventory.

a. Costing

b. Perpetual inventory system

 c. Cost formulas

d. Net realizable value

In the statement of cash flows of a non-financial institution, interest income received

is presented under

a. operating activities

b. financing activities

c. investing activities

d. a or c

CHAPTER 3
On December 31, 20x1, Entity A revalues the machinery costing ₱850,000 at a fair
value of ₱870,000. The residual value of the machinery is ₱50,000and the remaining
useful life is 5 years.

How much is the revaluation surplus on December 31, 20x1 and how much is the
depreciation expense in 20x2?

Answer: Revaluation surplus P20,000, Depreciation expense P164,000

Deferred tax assets and liabilities are not discounted.

Answer: True

Taxable temporary differences arise when the carrying amount of an asset is greater
than its tax base.

Answer: True

The estimated amount that an entity would currently obtain from disposal of the
asset, after deducting the estimated costs of disposal, if the asset were already of the
age and in the condition expected at the end of its useful life.

Answer: Residual value

Imagine you are an employer. When should you recognize short-term employee
benefits?

a. Every 1st day of the month

b. Every 15th and 30th of the month

c. When the employees have rendered service in exchange for the employee benefits

d. Never!

Taxable temporary differences arise when financial income is smaller than the
taxable income.
Answer: False

PAS 8 permits a change in accounting policy only if the change

a. is required by a PFRS

b. results in reliable and more relevant information

c. a or b

d. PAS 8 does not permit a change in accounting policy

Which of the following is not one of the essential characteristics of a PPE?

a. tangible asset

b. primarily held for sale

c. used in business

d. long-term in nature

The systematic allocation of the depreciable amount of an asset over its useful life.

Answer: Depreciation

Benefits provided as a result of the entity’s decision to terminate the employee

before normal retirement date.

Answer: Termination benefits

Information on Entity A’s defined benefit plan is as follows:

PV of DBO – Jan. 1, 20x1 1,800,000

FVPA – Jan.1, 20x1 1,440,000

PV of DBO – Dec. 31, 20x1 2,160,000

FVPA, end. – Dec. 31, 20x1 1,572,000

Current service cost 390,000

Actuarial gain 120,000

Return on plan assets 132,000

Discount rate 5%

How much is the total defined benefit cost for 20x1?

Answer: 228,000

At the end of the period, Entity A has taxable temporary difference of ₱100,000.
Entity A’s income tax rate is 30%. Entity A’s statement of financial position would
report which of the following?

Select one: 30,000 deferred tax liability

Under a profit-sharing plan, Entity A agrees to pay its employees 5% of its annual
profit. The bonus shall be divided among the employees currently employed as at
year-end. Relevant information follows:

Profit for the year ₱8,000,000

Employees at the beginning of the year 8

Average employees during the year 7

Employees at the end of the year 6

If the employee benefits remain unpaid, how much liability shall Entity A accrue at
the end of the year?

Answer: a. 400,000

Information on Entity A’s defined benefit plan is as follows:

PV of DBO – Jan. 1, 20x1 1,800,000

FVPA – Jan.1, 20x1 1,440,000

PV of DBO – Dec. 31, 20x1 2,160,000

FVPA, end. – Dec. 31, 20x1 1,572,000

How much is the net defined benefit liability (asset) in Entity A’s December 31, 20x1
statement of financial position?

Answer: 588,000 liability

These are differences that have future tax consequences.

a. Temporary differences

b. Deductible differences

c. Taxable differences

d. Permanent differences

Benefits other than termination benefits and short-term benefits that are payable
after the completion of employment.

Answer: Post-employment benefits

Which of the following is an example of a non-adjusting event?

a. Amounts received in respect of an insurance claim being negotiated at the period end

b. Bankruptcy of a major customer with a balance owing at the period end

c. Destruction of a machine by fire after the reporting period

d. Sale of inventory for less than its carrying value shortly after the reporting period

Termination benefits are accounted for in accordance with the short-term employee
benefits if payable beyond 12 months.

Answer: False

Benefits that are due to be settled within 12 months after the end of the period in
which the employees have rendered the related services
Answer: short-term employee benefits

One of Entity A’s delivery trucks had an accident on February 14, 20x2. The truck is
totally wrecked and is uninsured. Entity A’s December 31, 20x1 current-period
financial statements were authorized for issue on March 31, 20x2. Entity A asked you
if it can write-off the carrying amount of the destroyed truck from its December 31,
20x1 statement of financial position. What will you tell Entity A?

a. No. Don't write-off the truck because the event is a non-adjusting event.

b. Yes, go ahead. I will support you.

c. No. Don't write-off the truck because the event is a non-adjusting event. You
should, however, disclose the event if you deem it to be material.

d. Yes, go ahead. Write-off the truck because the event is an adjusting event.

Which of the following instances does not preclude an entity from recognizing
depreciation during a certain period?

a. The asset is fully depreciated

b. The asset is being depreciated using the units of production method and there is no
production during the period

c. The asset becomes idle or is taken out of active use.

d. The asset is classified as held for sale under PFRS 5.

Arise when income and expenses enter in the computation of either accounting
profit or taxable profit but not both.

Answer: Permanent differences

Is profit for a period, determined in accordance with the rules established by the
taxation authorities.

Answer: Taxable profit

Compensated absences that can be carried forward and used in future periods if not
fully used in the current period of entitlement are referred to as accumulating.

Answer: True

Income tax expense is computed using PFRSs.

Answer: True

Deferred tax assets and deferred tax liabilities do not alter the tax to be paid in the
current period. However, they cause tax payments to either increase or decrease
when they reverse in a future period. The reversal of which of the following will
cause an increase in tax payment?

a. Deferred tax asset

b. Deferred tax expense

c. Deferred tax benefit

d. Deferred tax liability

According to PAS 10, these are those events, favorable and unfavorable, that occur
between the end of the reporting period and the date when the financial statements
are authorized for issue.

a. events after the reporting period

b. non-adjusting events

c. adjusting events

d. all of these

The Sarin Company's financial statements for the year ended 30 April 20X8 were
approved by its finance director on 7 July 20X8 and a public announcement of its
profit for the year was made on 10 July 20X8. The board of directors authorised the
financial statements for issue on 15 July 20X8 and they were approved by the
shareholders on 20 July 20X8. Under PAS 10, after what date should consideration no
longer be given as to whether the financial statements to 30 April 20X8 need to
reflect adjusting and non-adjusting events?

a. 20 July 20x8

b. 10 July 20x8

c. 15 July 20x8

d. 7 July 20x8

Current tax expense is computed using tax laws.

Answer: True

Entity A acquires equipment on January 1, 2001. Information costs are as follows:

Purchase price, gross of trade discount 900,000

Trade discount available 5,000

Freight costs 10,000

Testing costs 20,000

Net disposal proceeds of samples generated during testing 5,000

PV of estimated costs of dismantling the equipment at the end of its useful life 4,000

Estimated life is 10 years, residual value of P100,000

How much is the initial cost of the equipment and how much is its carrying amount
on December 31, 20x2?

Answer: Initial cost of equipment P924,000, Carrying amount on Dec. 31, 2002
P759,200
Classify the following as to adjusting or non-adjusting event.

Change in fair value, foreign exchange rate, interest rate or market price after the reporting
period → Non-adjusting event

Change in tax rate enacted before the end of the reporting period → Adjusting event

Change in tax rate enacted after the reporting period → Non-adjusting event

Litigation arising solely from events occurring after the reporting period → Non-adjusting
event

Dividends declared after the reporting period → Non-adjusting event

The bankruptcy of a customer that occurs after the reporting period. → Adjusting event

Major business combination after the reporting period → Non-adjusting event

The discovery of fraud or errors that indicate that the financial statements are incorrect →
Adjusting event

The settlement after the reporting period of a court case confirming a liability. → Adjusting
event

The sale of inventories after the reporting period. → Adjusting event

This type of difference will give rise to deferred tax liability.

a. Deductible temporary difference

b. Deferred difference

c. Permanent difference

d. Taxable temporary difference

When unused sick leave is converted to cash when an employee resigns or retires, the
sick leave benefits are considered non-vesting.

Answer: False
These arise from misapplication of accounting policies, mathematical mistakes,
oversights or misinterpretations of facts, or fraud.

a. error

b. change in accounting policy

c. impracticable application

d. change in accounting estimate

PAS 16 requires an entity to review the depreciation method and the estimates of
useful life and residual value at the end of each year-end. A change in any of these is
accounted for using

a. a specific transitional provision of a PFRS

b. retrospective application

c. prospective application

d. any of these

A change in the pattern of consumption of economic benefits from an asset is most

likely a

a. change in accounting policy

b. change in accounting estimate

c. error

d. any of these

Under this model, a PPE is carried at its fair value at the date of revaluation less any
subsequent accumulated depreciation and subsequent impairment losses.

Answer: Revaluation model

Change from cost model to the fair value model of measuring investment property →
Change in Accounting Policy

Change in the financial reporting framework, such as from PFRS for SMEs to full PFRS. →
Change in Accounting Policy

Change in depreciation method → Change in Accounting Estimates

Change in the required balance of allowance for uncollectible accounts or impairment

losses → Change in Accounting Estimates

Change from FIFO to the Weighted Average cost formula for inventories → Change in
Accounting Policy

Change in estimated useful life or residual value of a depreciable asset → Change in

Accounting Estimates

Change in estimated warranty obligations → Change in Accounting Estimates

Change from cost model to the revaluation model of measuring property, plant and
equipment and intangible assets. → Change in Accounting Policy

Change in the method of recognizing revenue from long-term construction contracts. →

Change in Accounting Policy

Change in other provisions → Change in Accounting Estimates

Under this model, a PPE is carried at its cost less any accumulated depreciation and
any accumulated impairment losses.

Answer: Cost model

Information on Entity A’s defined benefit plan is as follows:

PV of DBO – Jan. 1, 20x1 1,800,000

FVPA – Jan.1, 20x1 1,440,000

PV of DBO – Dec. 31, 20x1 2,160,000

FVPA, end. – Dec. 31, 20x1 1,572,000

How much is the net defined benefit liability (asset) in Entity A’s December 31, 20x0
statement of financial position?

Answer: 360,000 liability

Other long-term employee benefits are accounted for similar to defined benefit plans
except that all the components of the defined benefit cost is recognized in other
comprehensive income.

Answer: False

According to PAS 8, these are the specific principles, bases, conventions, rules and
practices applied by an entity in preparing and presenting financial statements.

a. Accounting assumptions

b. Accounting policies

c. Accounting standards

d. Accounting estimates

Deferred tax asset are the amounts of income taxes recoverable in future periods in
respect of

a. Deductible temporary differences

b. The carryforward of unused tax losses

c. The carryforward of unused tax credits

d. all of the above

If plotted on a graph (X-axis: time; Y-axis: ₱), the depreciation charges under the
straight-line method would show

a. a downward line sloping to the left

b. a straight-line

c. an upward line sloping to the right

d. a curvilinear line sloping here and there

Taxable temporary differences arise when the carrying amount of a liability is

greater than its tax base.

Answer: False

During the period, deferred tax assets increase by ₱400 while deferred tax liabilities
increase by ₱500. The net change of ₱100 is a

a. deferred tax expense

b. deferred tax income

c. deferred tax liability

d. none of the above

Is profit for a period before deducting tax expense.

Answer: Accounting profit

Which of the following is most likely to be a non-adjusting event?

a. The entity announces a major restructuring after the end of the reporting period.

b. A major customer liquidates its business after the end of the reporting period.

c. The determination after the reporting period of the cost of asset purchased, or the
proceeds from asset sold, before the end of reporting period.
d. The settlement after the reporting period of a court case that confirms that the entity has
a present obligation at the end of reporting period.

CHAPTER 4

When computing the amount of interest cost to be capitalized, the concept of

"avoidable interest" means

a. a cost of capital charge for equity.

b. that portion of total interest cost which would not have been incurred if
expenditures for asset construction had not been made.

c. that portion of average accumulated expenditures on which no interest cost was incurred.

d. the total interest cost actually incurred.

Coney Co. owns 25% of the voting rights in Dong Corp. However, Coney Co. has no
representation on the board of directors of Dong Corp. Which of the following
statements is correct?

a. Representation on an investee’s board of directors is never considered when determining

the existence of significant influence

b. Coney Co. cannot be presumed to have significant influence over Dong Corp. because
Coney Co. does not have board representation

c. Coney Co. is presumed to have signification influence over Dong Corp. because it holds
25% or more of the voting rights in Dong Corp.
d. Coney Co. is presumed to have signification influence over Dong Corp. because it
holds 20% or more of the voting rights in Dong Corp.

ABC Philippines Co. (ABC-P) is a branch of ABC U.S. Co. ABC-P is engaged in the
apparel business and operates in a Philippine Economic Zone Authority (PEZA)
Special Economic Zone. All raw materials are imported from the main office in the
U.S. and all finished products are exported directly to U.S. customers. The U.S.
customers remit payments to the U.S. main office. The U.S. main office will then
provide the Philippine branch its working capital needs. None of ABC-P’s finished
products are sold in the Philippines. The raw materials imported and finished goods
exported are denominated in $. What is ABC-P’s functional currency?

a. Philippine peso

b. US dollar

c. A or B

d. none of these

If a business entity entered into certain related party transactions, it would be

required to disclose all of the following information except the

a. Peso amount of the transactions for each of the periods for which an income statement is
presented

b. amounts due from or to related parties as of the date of each statement of financial
position presented

c. nature of the relationship between the parties to the transactions

d. nature of any future transactions planned between the parties and the terms
involved

In a defined-contribution plan, a formula is used that

a. requires an employer to contribute a certain sum each period based on the
formula

b. defines the benefits that the employee will receive at the time of retirement

c. ensures that pension expense and the cash funding amount will be different

d. ensures that employers are at risk to make sure funds are available at retirement

In a related party relationship, one party has the ability, through control, significant
influence or joint control, to affect the:

a. Financial decisions of the other party

b. Financial, operating and investing decisions of the other party

c. Operating decisions of the other party

d. Financial and operating decisions of the other party

ABC Philippines Co. (ABC-P) is a branch of ABC U.S. Co. ABC-P is engaged in the
apparel business and operates in a Philippine Economic Zone Authority (PEZA)
Special Economic Zone. All raw materials are imported from the main office in the
U.S. and all finished products are exported directly to U.S. customers. The U.S.
customers remit payments to the U.S. main office. The U.S. main office will then
provide the Philippine branch its working capital needs. None of ABC-P’s finished
products are sold in the Philippines. The raw materials imported and finished goods
exported are denominated in $. ABC-P is required to file audited financial statements
with the Philippine Securities and Exchange Commission (SEC) and the Bureau of
Internal Revenue (BIR). What is the presentation currency for the financial
statements to be filed with the said government agencies?

a. Philippine peso

b. US dollar

c. A or B
d. none of these

Which of the following is considered a government grant?

a. Free technical advice

b. Award of major government contracts

c. Public improvements

d. Cancellation of an existing loan from the government

The period of time during which interest must be capitalized ends when

a. the activities that are necessary to get the asset ready for its intended use have begun

b. the asset is abandoned, sold, or fully depreciated

c. no further interest cost is being incurred

d. the asset is substantially complete and ready for its intended use

On December 1, 2019, B Company imported a machine from a foreign supplier for

$100,000, due for settlement on January 6, 2020. B’s functional currency is the
Philippine peso. When preparing the December 31, 2019 statement of financial
position, which item will be translated to the closing rate?

a. machine

b. accounts payable

c. A and B

d. none of these

Which of the following is not a condition that must be satisfied before interest
capitalization can begin on a qualifying asset?

a. The interest rate is equal to or greater than the company's cost of capital
b. Activities that are necessary to get the asset ready for its intended use are in progress

c. Interest cost is being incurred.

d. Expenditures for the assets have been made.

Under constant peso accounting, items are restated using this formula:

a. Historical cost x (Current price index ÷ Average price index)

b. Revalued amount x (Current price index ÷ Historical price index)

c. Historical cost x (Current price index ÷ Historical price index*) *However, if the
historical price index is impracticable to determine, the average price index may be
used.

d. Historical cost x (Current price index ÷ Historical price index)

Which of the following statements is true regarding capitalization of interest?

a. When excess borrowed funds not immediately needed for construction are temporarily
invested, any interest earned should be recorded as interest revenue.

b. The amount of interest cost capitalized during the period should not exceed the
actual interest cost incurred.

c. The minimum amount of interest to be capitalized is determined by multiplying a

weighted average interest rate by the amount of average accumulated expenditures on
qualifying assets during the period.

d. Interest cost capitalized in connection with the purchase of land to be used as a building
site should be debited to the land account and not to the building account

The amount of benefits to be received by employees enrolled in a defined benefit

plan is

a. dependent on the level of contributions to a fund

b. dependent on the level of investment performance of a fund

c. A and B

d. neither A nor B

Which of the following assets do not qualify for capitalization of interest costs
incurred during construction of the assets?

a. Assets not currently undergoing the activities necessary to prepare them for their
intended use.

b. Assets intended for sale or lease that are produced as discrete projects.

c. Assets under construction for a company's own use.

d. Assets financed through the issuance of long-term debt.

Match the following with the items found on the right side of your screen.

Method used for recording the Investments in Associates → Equity method

Asset that necessarily takes a substantial period of time to get ready for its intended use or
sale → Qualifying assets

Borrowing Costs → PAS 23

Parties involved wherein one party has the ability to affect the financial and operating
decisions of the other party through control, significant influence or joint control. →
Related parties Exchange rate for immediate delivery or on a given date → Spot exchange
rate

Costs that are directly attributable to the acquisition, construction or production of a

qualifying asset and are capitalized as cost of that asset → Borrowing costs

General increase in prices and decrease in purchasing power of money → Inflation

Accounting and Reporting by Retirement Benefit Plans → PAS 26

Present value of the expected payments by a retirement benefit plan to existing and past
employees, attributable to the service already rendered → Actuarial present value of
promised retirement benefits

The Effects of Changes In Foreign Exchange Rates → PAS 21

Entity over which the investor has significant influence → Associate

Separate Financial Statements → PAS 27

Transactions related to import or export activities that are to be settled in a foreign

currency. → Foreign currency transactions

Accounting for Government Grants and Disclosure of Government Assistance → PAS 20

Assistance received from the government in the form of transfers of resources in exchange
for compliance with certain conditions → Government grants

Related Part Disclosures → PAS 24

Investments in Associates and Joint Ventures → PAS 28

Currency of the primary economic environment in which the entity operates, or in which
the entity’s cash inflows and outflows are normally denominated. → Functional currency

Financial statements of a group in which the assets, liabilities, equity, income, expenses and
cash flows of the parent and its subsidiaries are presented as those of a single economic
entity → Consolidated Financial Statements

Financial Reporting In Hyperinflationary Economies → PAS 29

Under the equity method of accounting for investments, an investor recognizes its
share of the earnings in the period in which the

a. investor sells the investment

b. earnings are reported by the investee in its financial statements

c. investee pays a dividend

d. investee declares a dividend

Which of the following items are restated in a hyperinflationary economy:

a. Non-monetary items measured at cost

b. Share capital and share premium

c. Nonmonetary items measured at fair value or NRV at the end of the reporting period

d. Monetary items in the statement of financial position

Which of the following disclosures of pension plan information would not normally
be required?

a. The contributions of the employer or employee, if applicable

b. The description of the plan and the effect of any changes in the plan during the period

c. The amount of past service cost changed or credited in previous years

d. The summary of significant accounting policies

On January 1, 2019, A Corporation obtained a 10%, ₱5,000,000 loan, specifically to

finance the construction of a building. The proceeds of the loan were temporarily
invested and earned interest income of ₱180,000. The construction was completed
on December 31, 2019 for total construction costs of ₱7,000,000. How much are the
borrowing costs capitalized to cost of the building?

a. 500,000

b. 320,000

c. 680,000

d. 300,000

G Group acquired an investment in associate for ₱1M many years ago. At the end of
the current reporting period, the investment has a fair value of ₱2.9M. If the equity
method is used, the investment would have a current carrying amount of ₱2.6M. In G
Group’s separate financial statements, the investment should be valued at

a. 1,000,000

b. 2,600,000

c. 2,900,000

d. any of these, as a matter of an accounting policy choice

Which of the following is required by the PAS 20?

a. Resources acquired through government grants must be accounted for using the
income approach.

b. Resources acquired through government grants must be accounted for using the capital
approach.

c. Resources acquired through government grants must be recorded at cost.

d. Resources acquired through government grants must be recorded at fair value.

In 2019, A Corp. proposes an environmental clean-up project for a river. The

government supports this project and gives A Corp. a ₱1M monetary grant on the
condition that the money will only be spent on the proposed project. The proposed
project is expected to be completed in about 2 years. A Corp. starts the clean-up
project in 2020. How should A Corp recognize income from the government grant?

a. over the period of the project as expenses are incurred

b. the grant is not recognized as income

c. over 2 years starting in 2019

d. in full when A Corp A receives the grant

When funds are borrowed to pay for construction of assets that qualify for
capitalization of interest, the excess funds not needed to pay for construction may be
temporarily invested in interest-bearing securities. Interest earned on these
temporary investments should be

a. interest rate to determine the amount of interest to be capitalized

b. used to increase the cost of assets being constructed

c. multiplied by an appropriate

d. offset against interest cost incurred during construction

e. recognized as revenue of the period

These are financial statements presented in addition to consolidated financial

statements or the financial statements of an entity with an investment in associate or
joint venture that is accounted for using equity method in accordance with PAS 28.

a. Separate financial statements

b. Consolidated financial statements

c. Individual financial statements

d. Equity financial statements

PAS 29 is generally not applied by entities unless their functional currency is that of a
hyperinflationary economy. This is because of which of the following basic
accounting concepts?

a. Price level concept

b. Stable monetary assumption

c. Materiality

d. Going concern
An asset is being constructed for an enterprise's own use. The asset has been
financed with a specific new borrowing. The interest cost incurred during the
construction period as a result of expenditures for the asset is

a. interest expense in the construction period

b. a part of the historical cost of acquiring the asset to be written off over the term of the
borrowing used to finance the construction of the asset

c. a part of the historical cost of acquiring the asset to be written off over the
estimated useful life of the asset

d. recorded as a deferred charge and amortized over the term of the borrowing

Items that do not give rise to a right to receive or an obligation to deliver a fixed or
determinable amount of money.

a. Monetary items

b. Non-monetary items

c. Financial items

d. Non-financial items

Kehn Corporation accounts for its investment in the ordinary shares of Selas
Company under the equity method. Kehn Corporation should ordinarily record a
cash dividend received from Selas as

a. dividend income

b. a reduction of the carrying value of the investment

c. an addition to the carrying value of the investment

d. share premium
Which of the following best describes the term ‘significant influence’ as used under
PAS 28?

a. The contractually agreed sharing of profits and losses in an investee

b. The power to participate in the financial and operating policy decisions of an

entity

c. The ability to control an investee’s relevant activities through holding of significant

portion of the investee’s voting rights

d. The holding of 20% interest in an investee

Vested benefits

a. does not require a certain minimum number of years of service

b. are those that the employee is entitled to receive even if fired

c. are contingent upon additional service under the plan

d. are defined by all of these

On January 1, 2019, C Inc. acquires 25% interest in D Corp. for ₱800,000. D Corp
reports profit of ₱1,000,000 and declares dividends of ₱100,000 in 2019. How much
is the carrying amount of the investment in associate on December 31, 2019?

a. 800,000

b. 1,000,000

c. 1,025,000

d. 1,250,000

The following are the disclosures required for an entity operating in a

hyperinflationary economy, except for:

a. Whether the financial statements are based on historical cost or current cost
b. Whether the financial statements are consolidated or not

c. The identity and level of the price index at the end of the reporting period and the
movements during the current and previous reporting periods

d. The fact that financial statements, including corresponding figures, have been restated
for changes in the general purchasing power of the reporting currency

Trustee Jhon undertakes to manage the retirement benefit fund of Adam Company
for the benefit of its employees. When reporting to Adam Company regarding the
status and performance of the fund, Trustee Jhon would most likely apply which of
the following standards?

a. PAS 24

b. PFRS 6

c. PAS 19

d. PAS 26

PAS 24 requires the disclosure of key management personnel compensation. Which

of the following is not included in this disclosure?

a. termination benefits

b. short-term employee benefits

c. reimbursements of officers’ out-of-pocket expenses

d. share-based payment

HI Corp operates in a hyperinflationary economy. HI Corp has the following assets

before restatement on December 31, 2019:

Investment in bonds (amortized cost) ₱700,000

Land 1,000,000

The land was acquired on May 21, 2017. The general price indices are as follows:

May 21, 2017 100 Average – 2019 180

December 31, 2018 160 December 31, 2019 220

What are the restated amounts of the assets?

Answer: Investment in bonds Land

700,000 2,200,000

Winsor Corp. received a grant from the government of P160,000 to acquire P800,000
of delivery equipment on January 2, 2019. The delivery equipment has a useful life of
4 years. Winsor Corp. uses the straight-line method of depreciation. The delivery
equipment has a zero-residual value. Instructions: For December 31, 2019, what is
the carrying amount of the delivery equipment on the Balance Sheet and amount of
grant revenue on the income statement? For 2020, what is the amount of
depreciation expense related to the delivery equipment?

a. 2019 2020 P600,000, P80,000 P 150,000

b. 2019 2020 P800,000, P40,000 P 200,000

c. 2019 2020 P600,000, P40,000 P 200,000

d. 2019 2020 P800,000, P160,000 P 150,000

In a defined-benefit plan, a formula is used that

a. defines the contribution the employer is to make; no promise is made concerning the
ultimate benefits to be paid out to the employees

b. defines the benefits that the employee will receive at the time of retirement
c. requires that the benefit of gain or the risk of loss from the assets contributed to the
pension plan be borne by the employee

d. requires that pension expense and the cash funding amount be the same

Which of the following are not related parties under PAS 24?

a. An investor and its associate

b. Family member of a Chief Executive Officer and the entity

c. A parent and its subsidiaries

d. A shareholder who holds 2% interest in the voting rights of the entity

Which of the following is not true with regard to the accounting for government
grants?

a. Assets may be recorded at fair value or nominal cost.

b. Companies may use either the capital or income approach to account for the asset
and the grant.

c. Companies may apply the income approach either by recording the grant as deferred
revenue or as an adjustment to the asset.

d. None of these answer choices are correct.

The main concept used in recognizing income from government grants is

a. capital approach

b. materiality

c. historical cost

d. matching

The Es Company acquired a 30% equity interest in Isla Company for P400,000 on
January 1, 2019. For the year 2019, Isla earned profits of P80,000 and paid no
dividend. For the year 2020, Isla incurred losses of P32,000 and paid total dividends
of P10,000 to all shareholders. In Es' consolidated statement of financial position at
31 December 2020, what should be the carrying amount of its interest in Isla?

a. 411,400

b. 400,000

c. 438,000

d. 414,400

A government grant that becomes repayable is accounted for

a. retrospectively

b. prospectively

c. A or B

d. not accounted for

Which of the following is not required to be disclosed under PAS 24?

a. Loans to officers

b. A parent-subsidiary relationship when there were transactions between them during the
period.

c. A parent-subsidiary relationship when there were no transactions between them during

the period.

d. The name of the parent of the entity’s associate

When a company holds between 20% and 50% of the outstanding ordinary shares of
an investee, which of the following statements applies?

a. The investor must use the fair value method unless it can clearly demonstrate the ability
to exercise "significant influence" over the investee.
b. The investor should always use the equity method to account for its investment.

c. The investor should use the equity method to account for its investment unless
circumstances indicate that it is unable to exercise "significant influence" over the
investee.

d. The investor should always use the fair value method to account for its investment.

Capitalization of borrowing costs

a. Shall be suspended during temporary periods of delay.

b. Shall be suspended only during extended periods of delays in which active

development is delayed.

c. May be suspended only during extended periods of delays in which active development is
delayed.

d. Should never be suspended once capitalization commences.

According to PAS 27, investments in subsidiaries, associates or joint ventures are

accounted for in the separate financial statements

a. at cost

b. at fair value in accordance with PFRS 9.

c. using the equity method under PAS 28

d. any of these, as a matter of accounting policy choice

On January 1, 2019, A Corporation obtained a 10%, ₱5,000,000 loan, specifically to

finance the construction of a building. The proceeds of the loan were temporarily
invested and earned interest income of ₱180,000. The construction was completed
on December 31, 2019 for total construction costs of ₱7,000,000. How much is the
cost of the building on initial recognition?

a. 7,500,000
b. 7,320,000

c. 7,000,000

d. 6,680,000

On December 1, 2019, B Company imported a machine from a foreign supplier for

$100,000, due for settlement on January 6, 2020. B’s functional currency is the
Philippine peso.

The relevant exchange rates are as follows:

Dec. 1, 2019 Dec. 31, 2019 Jan. 6, 2020

₱50: $1 ₱52: $1 ₱47: $1

How much foreign exchange gain (loss) will be recognized on December 31, 2019?

Answer: (200,000)

Quiz 1: CFAS Overview

Which of the following statements correctly refer to the accounting process?

1. Disclosure of events in the notes to financial statement without including their

effect in the totals of the statement of financial position or statement of profit
or loss and other comprehensive income is not an application of the
recognition principle.
2. An accountable event is an event that has an effect on the assets, liabilities or
equity of an entity and its effect can be measured reliably

When products or other assets are exchanged for cash or claims for cash, they are said to be
realized.
It is the accounting process of assigning numbers, commonly in monetary terms, to the
economic transactions and events. Measuring

All of the following are events considered as exchange or reciprocal transfer, except
subscription of the entity's own equity instrument (i.e., contributions by owners).

During the lifetime of an entity, accountants produce financial statements at arbitrary

points in time in accordance with which basic accounting concept? Time Period

The assumption that a business enterprise will not be sold or liquidated in the near future
is known as the going concern.

A type of information provided by accounting. Quantitative

Which of the following statements is true?

1. Loss from theft is classified as a nonreciprocal transfer.

2. Nonreciprocal transfers involve the transfer of resources in only one direction,
either from an entity to other entities or from other entities to the entity.
3. Fire, earthquake and flood are examples of accountable events classified as
internal events.

These are events involving an entity and another external party. External Event

All of the following are events considered nonreciprocal transfers, except payment of
accounts payable.
What is the basic purpose of accounting?

To provide quantitative financial information about economic activities intended to

be useful in making economic decisions.

Which of the following statements is true?

External users are those who do not have the authority to demand financial reports
tailored to their specific needs.

Valuing assets at their liquidation values rather than their cost is inconsistent with the
historical cost principle.

It refers to the process of incorporating the effects of an accountable event in the statement
of financial position or the statement of profit or loss and other comprehensive income
through a journal entry. Recognition

These are events involving an entity and another external party. External Events

PAS 1:

The maintenance costs of a machine used in the manufacturing process are not included in
the cost of inventories.

Select one:
True

False

This comprises all “non-owner changes Total comprehensive income

in equity.” It excludes owner changes in
equity, such as subscription, issuance,
and reacquisition of share capital and
declaration of dividends.

This is the most commonly used method Classified presentation

of presenting a statement of financial
position. It facilitates the computation
of liquidity and solvency ratios.

Entities that do not show current and Banks and other financial institutions
noncurrent distinctions among assets
and liabilities in the statement of
financial position.

PAS 1 requires an assessment of the Management

entity’s ability to continue as a going
concern each time financial statements
are prepared. Who is responsible in
making this assessment?
Under this method, expenses are Nature of expense method
aggregated according to their nature.

These are the end product of the Financial Statements

financial reporting process and the
means by which information gathered
and processed is periodically
communicated to users.

A horizontal or inter-period comparison Intra-comparability

of financial statements of the same
entity

A financial statement that would be Statement of financial position

dated as at a certain date.

This type of presentation of statement of Unclassified presentation

financial position does not show
distinctions between current and
noncurrent items.

The amounts reclassified to profit or Reclassification adjustments

loss in the current period that were
 recognized in other comprehensive
income in the previous periods.

PAS 1 prescribes an order or format of presenting items in the financial statements.

Select one:

True

False

According to PAS 1, the line items "Cash and cash equivalents" should always be presented
first in the statement of financial position.

Select one:

True

False

Cash basis is one of the general features of financial statements under PAS 1.

Select one:

True

False

PAS 1 encourages, but does not require, the presentation of the preceding year's financial
statements as comparative information to the current year's financial statements.

Select one:
True

False

PAS 2:

Determine to what activity the following transactions are presented in the cash flow
statement.

The correct answer is: Exchange differences in translating a foreign currency denominated
cash flows. → not presented

Cash payments on derivative assets other than those held for trading. → investing

Purchase of marketable securities. → investing

Issuance of note for payment of accounts payable. → not presented

Bank overdrafts that can be offset to cash. → not presented

Cash payment to suppliers. → operating

Cash receipts from contracts held for trading purposes. → operating

Issuance of common stock for cash. → financing

Sale of treasury stocks. → financing

Payments for acquisition of intangible assets. → investing

Payment of long term loan with cash. → financing

Bank overdrafts that cannot be offset to cash. → financing

Purchase of inventory on account. → not presented

Redemption of equity instruments through cash. → financing

Purchase of land through the issuance of shares of stocks. → not presented

Cash invested in a 90-day time deposit. → not presented

Proceeds from sales of marketable securities. → investing

Loans released by a bank to its borrower. → operating

Proceeds from disposal of a fixed asset. → investing

Collection of accounts receivables. → operating

PAS 7:

Match the questions with the choices found on the right side of your screen. Drag and drop
your choice on the box provided for each question.

A cost formula wherein the cost of sales Specific identification

is the cost of the specific inventory sold.

It provides information about the Statement of cash flows

sources and utilization of cash and cash
equivalents for the period.

Inventories are measured at Lower of cost and net realizable value

The best evidence of Net Realizable Replacement cost

Value (NRV) for raw materials is

It is added to the cost of inventories Transport costs for raw materials

The costs necessary in converting raw Conversion costs

materials into finished goods, which
include direct labor and production
overhead.
In what activity of its statement of cash Operating activity
flows will Entity A (a financial
institution) present its cash dividends
received from its investments in
marketable securities?

A loan acquired from a bank institution Financing activity

is presented in what activity in the
statement of cash flows?

It is computed by dividing the total Weighted average cost

goods available for sale in pesos by the
total goods available for sale in units.

A cost formula wherein the cost of FIFO

ending inventory is based on the cost of
the latest purchases.

The estimated selling price in the Net realizable value

ordinary course of business less
estimated costs of completion and the
estimated costs necessary to make the
sale.

These are short-term, highly liquid Cash equivalents

investments that are readily convertible
to cash
 A presentation of operating activity Indirect method
section of cash flow statement where
profit or loss is adjusted for the effects
of non-cash items and changes in
operating assets and liabilities.

A conversion cost that is not included in Salaries of sales staff

the cost of inventory.

An operating activity presentation that Direct method

shows each major class of gross cash
receipts and gross cash payments.

Entity A, a trading entity, buys and sells Product Z. Movements in the inventory of Product Z
during the period are as follows:

Date Transaction Units Unit cost Total cost

Feb. 1 Beginning 100 ₱15 ₱1,500

inventory

7 Purchase 300 18 5,400

12 Sale 320

21 Purchase 200 21 4,200

How much is the ending inventory under the Weighted Average cost formula? (The average
is calculated as each additional purchase is made, i.e., ‘moving average’.)

The correct answer is: 5,580

Entity A, a trading entity, buys and sells Product Z. Movements in the inventory of Product Z
during the period are as follows:

Date Transaction Units Unit cost Total cost

Feb. 1 Beginning 100 ₱15 ₱1,500

inventory

7 Purchase 300 18 5,400

12 Sale 320

21 Purchase 200 21 4,200

How much is the ending inventory under the FIFO cost formula?

The correct answer is: 5,640

Entity A had the following balances at December 31, 20x1:

Cash in checking account 35,000

Cash in 90-day money market account 75,000

Treasury bill, purchased 12/1/x0, maturing 5/31/x2 150,000

Treasury bill, purchased 12/1/x1, maturing 2/28/x2 200,000

How much cash and cash equivalents is reported in Entity A’s December 31, 20x1 statement
of financial position?

The correct answer is: 310,000

Entity A, a trading entity, buys and sells Product Z. Movements in the inventory of Product Z
during the period are as follows:
 Date Transaction Units Unit cost Total cost

Feb. 1 Beginning 100 ₱15 ₱1,500

inventory

7 Purchase 300 18 5,400

12 Sale 320

21 Purchase 200 21 4,200

How much is the ending inventory under the Weighted Average cost formula? (The average
is calculated on a periodic basis.)

The correct answer is: 5,180

PAS 19:

Deferred tax assets and deferred tax liabilities do not alter the tax to be paid in the current
period. However, they cause tax payments to either increase or decrease when they reverse
in a future period. The reversal of which of the following will cause an increase in tax
payment? Deferred tax liability

The Sarin Company's financial statements for the year ended 30 April 20X8 were approved
by its finance director on 7 July 20X8 and a public announcement of its profit for the year
was made on 10 July 20X8. The board of directors authorised the financial statements for
issue on 15 July 20X8 and they were approved by the shareholders on 20 July 20X8. Under
PAS 10, after what date should consideration no longer be given as to whether the financial
statements to 30 April 20X8 need to reflect adjusting and non-adjusting events? 15 July
20x8

According to PAS 10, these are those events, favorable and unfavorable, that occur between
the end of the reporting period and the date when the financial statements are authorized
for issue. Events after the reporting period

This type of difference will give rise to deferred tax liability. Taxable temporary
difference

One of Entity A’s delivery trucks had an accident on February 14, 20x2. The truck is totally
wrecked and is uninsured. Entity A’s December 31, 20x1 current-period financial
statements were authorized for issue on March 31, 20x2. Entity A asked you if it can write-
off the carrying amount of the destroyed truck from its December 31, 20x1 statement of
financial position. What will you tell Entity A? No. Don’t write-off the truck because the
event is a non-adjusting event. You should, however, disclose the event if you deem it
to be material.

According to PAS 8, these are the specific principles, bases, conventions, rules and practices
applied by an entity in preparing and presenting financial statements. Accounting policies

At the end of the period, Entity A has taxable temporary difference of ₱100,000. Entity A’s
income tax rate is 30%. Entity A’s statement of financial position would report which of the
following? 30,000 deferred tax liability
How should the following changes be treated, according to PAS 8?

1. A change is to be made in the method of calculating the provision for uncollectible

receivables.
2. Investment properties are now measured at fair value, having previously been
measured at cost.

Change 1 Change 2

Change of accounting estimate Change of accounting policy

Which of the following is most likely to be a non-adjusting event? The entity announces a
major restructuring after the end of the reporting period.

During the period, deferred tax assets increase by ₱400 while deferred tax liabilities
increase by ₱500. The net change of ₱100 is a deferred tax expense.

Which of the following instances does not preclude an entity from recognizing depreciation
during a certain period? The asset becomes idle or is taken out of active use.

Which of the following is an example of a non-adjusting event? Destruction of a machine

by fire after the reporting period

PAS 8 permits a change in accounting policy only if the change

a. is required by a PFRS.

b. results in reliable and more relevant information

Entity A acquires equipment on January 1, 20x1. Information on costs is as follows:

Purchase price, gross of trade discount 1,000,000

Trade discount available 10,000

Freight costs 20,000

Testing costs 30,000

Net disposal proceeds of samples generated during testing 5,000

Present value of estimated costs of dismantling the equipment at the

end of its useful life 6,209

a. How much is the initial cost of the equipment?

b. The equipment has an estimated useful life of 10 years and a residual value of ₱200,000.
Entity A uses the straight line method of depreciation. How much is the carrying amount of
the equipment on December 31, 20x3?

c. On December 31, 20x3, Entity A revalues the equipment at a fair value of ₱820,000.
There is no change in the residual value and the remaining useful life of the asset. How
much is the revaluation surplus on December 31, 20x3?

d. How much is the depreciation expense in 20x4?

e. Entity A sells the equipment for ₱870,000 on January 1, 20x5. Entity A incurs selling
costs of ₱20,000 on the sale. How much is the gain (loss) on the sale?

a. P1,041,209.00

b. P957,008.10
c. P137,008.00

d. P82,000.00

e. P20,000.00

A change in the pattern of consumption of economic benefits from an asset is most likely a
change in accounting estimate

If plotted on a graph (X-axis: time; Y-axis: ₱), the depreciation charges under the straight-
line method would show a straight-line

PAS 16 requires an entity to review the depreciation method and the estimates of useful life
and residual value at the end of each year-end. A change in any of these is accounted for
using prospective application.

These arise from misapplication of accounting policies, mathematical mistakes, oversights

or misinterpretations of facts, or fraud. Error

These are differences that have future tax consequences. Temporary differences

Which of the following is not one of the essential characteristics of a PPE? primarily held
for sale

PAS 20,21,23:

You are an auditor. ABC Philippines Co., your client, is not sure on what to disclose in its
financial statements as its functional currency. Relevant information follows:

ABC Philippines Co. is a branch of ABC U.S. Co. ABC Philippines operates in a Philippine
Economic Zone Authority (PEZA) Special Economic Zone. ABC Philippines is engaged in the
apparel business. All of its raw materials are imported from the main office in the U.S. and
all of its finished products are exported directly to U.S. customers. The U.S. customers remit
payments to the U.S. main office. The U.S. main office will then provide the Philippine
branch its working capital needs. None of ABC Philippines Co.s’ finished products are sold
in the Philippines. The raw materials imported and finished goods exported are
denominated in U.S. dollars.

What is ABC Philippines Co.’s functional currency? U.S. dollar

Which of the following costs may not be eligible for capitalization as borrowing costs under
PAS 23? Imputed cost of equity.

On January 1, 20x1, Entity A obtained a 10%, ₱5,000,000 loan, specifically to finance the
construction of a building. The proceeds of the loan were temporarily invested and earned
interest income of ₱180,000. The construction was completed on December 31, 20x1 for
total construction costs of ₱7,000,000. How much is the cost of the building on initial
recognition? 7,320,000

On December 1, 20x1, you imported a machine from a foreign supplier for $100,000, due
for settlement on January 6, 20x2. Your functional currency is the Philippine peso. The
relevant exchange rates are as follows:

Dec. 1, 20x1 Dec. 31, 20x1 Jan. 6, 20x2

₱50:$1 ₱52:$1 ₱47:$1

How much foreign exchange gain (loss) will you recognize on January 6, 20x2? 500,000

On December 1, 20x1, you imported a machine from a foreign supplier for $100,000, due
for settlement on January 6, 20x2. Your functional currency is the Philippine peso. The
relevant exchange rates are as follows:

Dec. 1, 20x1 Dec. 31, 20x1 Jan. 6, 20x2

₱50:$1 ₱52:$1 ₱47:$1

How much foreign exchange gain (loss) will you recognize on December 31, 20x1?
(200,000)

You are an auditor. ABC Philippines Co., your client, is not sure on what to disclose in its
financial statements as its functional currency. Relevant information follows:

ABC Philippines Co. is a branch of ABC U.S. Co. ABC Philippines operates in a Philippine
Economic Zone Authority (PEZA) Special Economic Zone. ABC Philippines is engaged in the
apparel business. All of its raw materials are imported from the main office in the U.S. and
all of its finished products are exported directly to U.S. customers. The U.S. customers remit
payments to the U.S. main office. The U.S. main office will then provide the Philippine
branch its working capital needs. None of ABC Philippines Co.s’ finished products are sold
in the Philippines. The raw materials imported and finished goods exported are
denominated in U.S. dollars.

ABC Philippines Co. is required to file audited financial statements with the Philippine
Securities and Exchange Commission (SEC) and the Bureau of Internal Revenue (BIR). What
is the presentation currency for the financial statements to be filed with the said
government agencies? Philippine peso

These are those which do not give rise to a right to receive (or an obligation to deliver) a
fixed or determinable amount of money. Non-monetary items

On January 1, 20x1, Entity A started the construction of a qualifying asset. The qualifying
asset is financed through general borrowings. The average expenditures during the year
amounted to ₱9,500,000. The capitalization rate is 11%. The actual borrowing costs
incurred during the period were ₱1,990,000. How much are the borrowing costs eligible
for capitalization? 1,045,000

According to PAS 20, a government grant that becomes repayable is accounted for

Which of the following may not be considered a “qualifying asset” under PAS 23? An
expensive private jet that can be purchased from a local vendor
On December 1, 20x1, you imported a machine from a foreign supplier for $100,000, due
for settlement on January 6, 20x2. Your functional currency is the Philippine peso. When
preparing the December 31, 20x1 statement of financial position, which of the following
will you translate to the closing rate? accounts payable

In 20x1, Entity A proposes an environmental clean-up project for a river. The government
supports this project and gives Entity A a ₱1M monetary grant conditioned that the money
will only be spent on the proposed project. The proposed project is expected to take about
2 years to complete. Entity A starts the clean-up project in 20x2. How should Entity A
recognize income from the government grant? over the period of the project as expenses
are incurred

An asset is being constructed for an enterprise's own use. The asset has been financed with
a specific new borrowing. The interest cost incurred during the construction period as a
result of expenditures for the asset is a part of the historical cost of acquiring the asset
to be written off over the estimated useful life of the asset.

Capitalization of borrowing costs Shall be suspended only during extended periods of

delays in which active development is delayed.

The main concept used in recognizing income from government grants is matching.

Which of the following is not considered a government grant under PAS 20? Tax breaks

On January 1, 20x1, Entity A obtained a 10%, ₱5,000,000 loan, specifically to finance the
construction of a building. The proceeds of the loan were temporarily invested and earned
interest income of ₱180,000. The construction was completed on December 31, 20x1 for a
total construction costs of ₱7,000,000. How much are the borrowing costs capitalized to
cost of the building? 320,000

Which of the following is considered a government grant under PAS 20? Cancellation of an
existing loan from the government

PAS 32 and 33:

These are bonds that can be exchanged for shares of stocks of the issuer. Convertible
bonds

Entity A has 200,000 ordinary shares outstanding on January 1, 20x1. Entity A offers rights
issue to its existing shareholders that enable them to acquire 1 ordinary share at a
subscription price of ₱120 for every 5 rights held. The rights are exercised on May 1, 20x1.
The market price of one ordinary share immediately before exercise is ₱180. Entity A
reported profit after tax of ₱2,700,000 in 20x1. What is the basic earnings per share in
20x1? 11.71

Entity A had 100,000, ₱10 par, 10% cumulative preference shares outstanding all
throughout 20x1. Entity A reported profit after tax of ₱1,200,000 for the year ended
December 31, 20x1. The movements in the number of ordinary shares are as follows:

1/1/20x1 Ordinary shares outstanding 120,000

3/1/20x1 Shares issued for cash 42,000

9/30/20x1 Subscribed shares 20,000

11/1/20x1 Reacquisition of treasury shares (12,000)

170,000
Outstanding shares at the end of period

What is the basic earnings per share?

6.96

Which of the following is not a financial instrument?

a. Accounts receivable

b. Investment in share of stocks

c. Accounts payable
 Which of the following is within the scope of PAS 32? Financial instruments that are
within the scope of PFRS 9

Entity A had 200,000 ordinary shares outstanding all throughout 20x1. In 20x2, share
issuances occurred:

● On April 1, 20,000 shares were issued for cash.

● On September 30, a 10% bonus issue (share dividend) was declared.
● On November 1, a 2-for-1 share split was issued.

Entity A had the following profits: ₱1,200,000 in 20x2 and ₱900,000 in 20x1. What are the
earnings per share to be disclosed in Entity A’s 20x2 comparative financial statements?
20x2 - 2.54 ; 20x1 - 2.05

Entity A had the following instruments outstanding all throughout 20x1:

12% convertible bonds payable issued at face amount, each ₱1,000

bond is convertible into 30 ordinary shares ₱2,000,000

Ordinary shares, ₱10 par, 100,000 shares issued and outstanding 1,000,000

Profit for the year is ₱1,200,000. Entity A’s income tax rate is 30%.

What is the diluted earnings per share in 20x1? 8.55

Which of the following is not a financial asset? Inventory

Entity A is computing for its basic earnings per share and has gathered the following
information:

Loss for the year (800,000)

Preferred dividends 50,000

Outstanding ordinary shares 100,000

There have been no changes in the number of outstanding ordinary shares during the
period. What is the basic earnings (loss) per share? -8.50

PAS 37 and 38:

Which of the following statements is correct? A contingent asset that is possible is

usually ignored

Intangible asset arising from business combination is measured at fair value or nominal
amount. False

A provision is a liability of an uncertain timing or amount that meets all of the following
conditions, except: future obligation

According to PAS 37, a provision arises from future operating losses. False

According to PAS 37, provisions are (choose the incorrect statement) disclosed only,
unless their expected occurrence is remote

If it is not clear whether an expenditure is a research or a development cost, it is treated as

a regular expense. False

The essential elements of an intangible asset do not include probable outflow of

resources embodying economic benefits

According to PAS 37, a present obligation that is possible and can be measured reliably is
disclosed only

A probable contingent asset is disclosed only

Intangible asset from separate acquisition is measured initially at its fair value. False

According to PAS 38, research and development costs incurred in self-generating intangible
asset are recognized as expense. False
On January 1, 20x0, Entity A registers a patent for a total registration and legal costs of
P600,000. Entity A estimates that the patent has a remaining useful life of 15 years. How
much is the carrying amount of the patent on December 31, 20x0? 560,000

On January 1, 20x1, Entity A registers a patent for a total registration and legal costs of
₱600,000. Entity A estimates that the patent has a remaining useful life of 25 years. How
much is the amortization expense for 20x1? 30,000

Intangible assets are measured as follows: Initial measurement at cost; Subsequent

measurement at cost model or revaluation model

Provisions are measured at its expected value. False

If a contingent liability is possible, it is disclosed only

Provision differs from other liabilities because of its uncertainty. True

According to PAS 38, which of the following may be recognized as cost of intangible asset?
Purchase cost of an externally acquired publishing title

2 types of exams

TF- 30pts

MC theory- 45pts

MC computations- 30pts (15 items)

Total: 105pts

Computations:

 PAS 2: Weighted average cost formula under periodic basis; inventory write-down
 PAS 26: Computation of salaries and recognition
  PAS 21: Foreign currency translations; gain or loss importation delivered at a
different time *3 dollar gain* (mentioned answer during review) *other
comprehensive income*
 PAS 23: Borrowing cost (amount to be capitalized as part of the cost in the project)
*100,000* (computation for the borrowing cost formula)
 PAS 28: Items that will increase or decrease investment in associates’ account
 PAS 32: Convertible bonds
 PAS 33: Basic earnings per share computation; diluted earnings per share
 PAS 29: Hyper-inflationary economy (the restatement)
 PAS 12: Deferred tax assets and liabilities
 PAS 7: Computation for cash and cash equivalents

TF:

1. Cash flows relating to income and expenses are normally classified as investing activities
in the statement of cash flows. F

2. Dividends declared after the reporting period are recognized as liabilities at the end of
the reporting period. F

3. The basic purpose of accounting is to provide information about economic activities

intended to be useful in making economic decisions. T

4. Under a defined benefit plan, the employer commits to make fixed contributions to a fund
that will be used to pay for the retirement benefits of the employees. F

5. According to PAS 28, significant influence is presumed to exist when the investor holds
51% or more of the voting power of the investee. F

6. PAS 12 permits off-setting of current tax assets and current tax liabilities only if the
entity has a legally unforeseeable right to offset the recognized amount or an intention to
settle or realize the recognized amount on a net basis or simultaneously. F

7. Adjusting events are events that provide evidence of conditions that existed at the end of
the reporting period. T
8. A correction of a prior period error is accounted for by prospective application. F

9. According to PAS 29, monetary items are restated in case an entity’s functional currency
is that of a hyper-inflationary economy. F

10. A significant decline in the fair value of investments in stocks after the reporting period
is treated as an adjusting event under PAS 10. F

11.Cash benefits received by an entity is a form of government grant. F

12. PAS 1 encourages but does not require the presentation of the preceding years’ financial
statements as comparative information to the current year’s financial statements. F

13. At each reporting period, nonmonetary items in foreign currency transactions are
translated at closing rate. F

14.Functional currency means the currency of the primary economic environment in which
the entity operates, the entity’s cash inflows and outflows are normally denominated into
and should necessary be the currency of the country the entity is based. F

15.According to PAS 2, net realizable value and fair value less cost to sell are the same. F

16.General purpose financial statements are those statements that cater to the common
and specific needs of a wide range of external users. F

17. According to the conceptual framework, revenue are items of income that arise from the
entity’s ordinary activities while gains are those that do not arise from the entity’s ordinary
activities. F

18.According to PAS 36, an asset is impaired if its carrying amount exceeds its recoverable
amount. T

MC:

1. PFRS are adopted from the standards issuesd by who. IASB

2. Accoding to PAS 2, inventories are measured at lower of cost and NRV.

3. It is the qualitative characteristics that enhance the usefulness of financial information.
Verifiability, Comparability, Timeliness

4. According to PAS 36, if an asset’s fair value less disposal costs cannot be determined, its
recoverable amount would be its value in use.

5. The manner in which the accounting records are organized and implied within a
business. Accounting system

6. The process of converting noncash resources and rights into cash or equivalent claims to
cash is called realization.

7. A concept that states that all the components of a complete set of financial statements are
interrelated. Articulation

8. What type of users’ needs is catered by general purpose financial statements. Common
needs

9. The issuance of financial reporting standards in the Philippines is the responsibility of

the FRSC.

10. Grants are normally recognized as at its fair value.