Chapter 1

Definition of Accountancy
 Accounting process is the recognition or non-
ACCORDING TO ACCOUNTING STANDARDS COUNCIL: recognition of business activities as
“ACCOUNTABLE” event
 The accounting function is to provide  Not all business activities are accountable
quantitative information primarily financial in (hiring of employees, death of the entity
nature, about economic entities, that is president, and entering into a contract)
intended to be useful in making economic  An event is accountable or quantifiable
decision when it has an effect on assets, liabilities and
equity
ACCORDING TO COMMITTEE ON ACCOUNTING TERMINOLOGY  The subject matter of accounting is
OF THE AMERICAN INSTITUTE OF CERTIFIED PUBLIC economic activity or the measurement of
ACCOUNTANT: economic resources and economic liabilities
(only economic activities are emphasized and
 Accounting is an art of recording, classifying recognized in accounting)
and summarizing in a significant manner and  Sociological and psychological matters are
in terms of money, transactions and events beyond the province of accounting
which are in part at least of a financial
character and interpreting the results thereof

ACCORDING TO THE AMERICAN ACCOUNTING ASSOCIATION IN EXTERNAL ACTIVITIES

ITS STATEMENT OF BASIC ACCOUNTING THEORY
 Exchange transactions
 Accounting is the process of identifying,  Economic events involving one entity and
measuring, and communicating economic another entity
information to permit informed judgment and  Purchase of goods from a supplier
decision by users of the information  Borrowing money from a bank
 Sale of goods to a customer
 Payment of salaries to employees
 Payment of taxes to the government
1. Accounting is about
information INTERNAL ACTIVITIES
2. The information is likely to be  Economic events involving the entity only
 Economic activities that take place entirely
3. The information should be within the entity
>>>EXAMPLE OF INTERNAL ACTIVITIES<<<
a. PRODUCTION – process by which resources
The definition that has stood the test of time is the are transformed into products
definition given by the American Accounting b. CASUALTY LOSS - any sudden and
Association unanticipated loss from fire, flood,
earthquake and other event ordinarily as
 The very purpose of accounting is to an act of God.
provide quantitative information to be
useful in making an economic decision
 Accounting has a number of components  Assigning of peso amounts to the
 Identifying as the ANALYTICAL accountable economic transactions and
component event
 Measuring as the TECHNICAL  If accounting information is to be useful, it
component must be expressed in terms of a common
 Communicating as the FORMAL financial denominator or one unit of measure.
component  A Financial Statement without monetary
amounts would be largely unintelligible or
incomprehensible

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 THE PHILIPPINE PESO – unit of measuring  FINANCIAL STATEMENTS
accountable economic transactions  Key product of information system
 Documents that report financial
information about an entity to decision
a. – original makers
acquisition cost and the most common  Financial reports tell us how well an entity is
measure of financial statement performing in terms of profit and loss and
where it stands in financial terms
b. – includes fair value,
value in sue, fulfilment value and current OVERALL OBJECTIVE OF ACCOUNTING
cost
 To provide quantitative financial information
about a business that is useful to statement
users particularly owners and creditors in
 Process of preparing and distributing making economic decisions
accounting reports to potential users of  Accountant’s primary task is to supply
accounting information financial information so that the statement
 Identifying and measuring are pointless if the users could make informed judgment and
information contained in the accounting better decisions
records cannot be communicated in some  The essence of accounting is decision-
form to potential users usefulness
 Reason why accounting has been
called the “universal language of The accountancy profession
business”
 Implicit in communicating process:  REPUBLIC ACT NO. 9298
 ( )  The la[w regulating the practice of
 is the process of systematically accountancy in the Philippines.
maintaining a record of all economic  the law is known as the Philippine
business transactions after they have Accountancy Act of 2004
been identified and measured In the Philippines, in order to qualify to practice
 the accountancy profession, a person:
 sorting or grouping of similar and
interrelated economic transactions into  Must finish a degree in Bachelor of Science
their perspective classes (accomplished by in Accountancy
posting to the ledger)  Pass a very difficult government
 THE LEDGER – group of accounts which examination given by the Board of
Accountancy
are systematically categorized into
asset, liability, equity, revenue and 
expense account  body authorized by law to promulgate
rules and regulations affecting the practice

of the accountancy professions in the
 preparation of financial statements
Philippines
 Statement of financial position
 responsible for preparing and grading the
(Balance Sheet)
Philippine CPA examination
 Income statement
 The computer-based examination is
 Statement of comprehensive income
 Statement of changes in equity offered twice a year (May and October), in
 Statement of cash flows authorized testing centers around the
o Notes to Financial Statement country.
(supplementary)
LIMITATION OF THE PRACTICE OF PUBLIC
ACCOUNTING AS INFORMATION SYSTEM ACCOUNTANCY
 Measures business activities, processes  single practitioners and partnerships for the
information into reports and communicates practice of the public of accountancy shall
the reports to decision makers be registered certified public accounts in the
Philippines
 A certificate of accreditation shall be issued to
certified public accountants in public

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practice upon showing in accordance with changes in taxation law and court cases
rules and regulations promulgated by the BOA concerned with interpreting taxation law
and approved by the PRC that such registrant
has acquired a minimum of 3 years of c.
meaningful experience in any areas of public
practice (including taxation)  Has no precise coverage but is used
 Security and Exchange Commission shall not register generally to refer to services to clients on
any corporation organized for the practice of matters of accounting, finance, business
public accountancy policies, organization procedures,
product costs, distribution and many
ACCREDITATION TO PRACTICE OF PUBLIC other phases of business conduct and
ACCOUNTANCY operations.
 Specifically it includes:
 CPAs, firms and partnership of certified public
 Advice on installation of computer
accountants (partners & staff members) are required
system
to register with BOA and PRC for the practice
of public accountancy  Quality control
 The PRC upon favorable recommendation of  Installation and modification of
the BOA shall issue the Certified of Registration accounting system
to practice accountancy which shall be valid  Budgeting
for 3 years and renewable every 3 years upon  Forward planning and forecasting
payment of required fees
 Design and modification of retirement
plans
 Advice on mergers and consolidations

 Composed of individual practitioners, small  Accounting staff, chief accountant, internal

accounting firms and large multinational auditor, and controller
organizations that render independent and  – the highest
expert financial services to the public accounting officer in an entity
 Public accountants usually offer three kinds of  MAJOR OBJECTIVE OF PRIVATE ACCOUNTANT:
services:  To assist management in planning and
controlling the entity’s operation
a.
 Has traditionally been the primary service  Private accounting includes:
offered by most public accounting 
maintaining the records
practitioners 
producing the financial reports
 Or external auditing is the examination of 
preparing the budgets
financial statements by independent 
controlling and allocating the
CPA for the purpose of expressing an resources of an entity
opinion as to the fairness with which the  the private accountant has also the
financial statements are prepared responsibility for the determination of the
 External auditing is the at least function of various taxes the entity is obliged to pay
independent CPAs
 The BIR requires audited financial
statements to accompany the filing of  Encompasses the process of analysing,
annual income tax return classifying, summarizing and
communicating all transactions involving
b. the receipt and disposition of government
 Includes the preparation of annual funds and property and interpreting the
income tax returns and determination of results thereof.
tax consequences of certain proposed  Focus of government accounting:
business endeavors. a) Custody
 To offer this service effectively and b) Administration of public funds
efficiently, the public accountant must  CPAs that are employed in many branches
be thoroughly familiar with the tax laws of the government more particularly:
and regulations and updated with  Bureau of Internal revenue
 Commission on Audit

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 Department of Budget and Exemption from CPD
Management
 Securities and Exchange Commissions  CPA shall be permanently exempted from CPD
 Bangko Sentral ng Pilipinas requirements upon reaching the age of 65
years.
CONTINUING PROFESSIONAL DEVELOPMENT (CPD)  Applied only to the renewal of CPA license and
NOT for the purpose of accreditation to
 REPUBLIC ACT NO 10912 is the law mandating and practice the accountancy profession.
strengthening the continuing professional
development program for all regulated
profession including accountancy profession
 All certified public accountants shall abide by (broad sense) (broad sense) Auditing
the requirements, rules and regulations on Accounting is one of the areas of
embraces Auditing accounting
continuing professional development to be
specialization.
promulgated by the BOA, subject to the
(Limited Sense) (Limited Sense)
approval of the PRC, in coordination with the -Accounting is -Auditing is analytical.
credited national professional organization of essentially -The work of an auditor
CPAs or any duty accredited educational constructive in begins when the work
institutions nature. of the accountant
 refers to the inculcation and acquisition of -It ceases when ends. (After the FS are
financial statements prepared)
advanced knowledge, skill, proficiency, and
are already
ethical and moral values of the initial prepared.
registration of the CPA for assimilation intro The Auditor examines
professional practice and lifelong learning the FS to ascertain
 raises and enhances the technical skill and whether they are in
competence of the CPA conformity with
generally accepted
CPD CREDIT UNITS accounting principles.

 Refer to the CPD credit hours required for the

renewal of CPA license and accreditation of a Conceptual Procedural element of
CPA to practice the accountancy profession accounting
every 3 years Concerned with the Largely concerned
 Under the BOA Resolution, all CPAs regardless why, reason or with development and
of area or sector of practice shall be required justification for any maintenance of
action adopted. accounting records
to comply with 120 CPD credit units
“ ” “ ” of the
 CPD is required for the renewal of CPA license
accounting
and accreditation of CPA to practice the
accountancy profession
 Only 15 CPD credit units are required for the
Broadly speaking, the two terms are
renewal of CPA license
synonymous because they both refer to the
 120 CPD credit units are required for entire field of accounting theory and practice.
accreditation of a CPA to practice the Technically speaking
accountancy profession Accounting is used Accountancy refers to
 Excess credit units earned shall not be carried in reference only to a the profession of
over to the next 3-year period, except credit particular field of accounting practice.
units earned for masteral and doctoral accountancy such as
public, private, and
degrees.
government
 MANDATORY for CPAs.
accounting.

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 The FRSC is the accounting setting body
created by Professional Regulation
Commission (PRC) upon recommendation of
the BOA to assist the BOA in carrying out its
Primarily concerned It is the accumulation powers and functions provided under R.A Act.
with the recording of and preparation of No 9298.
business transactions financial reports for  The main function is to establish and improve
and the eventual INTERNAL USERS only. accounting standards that will be generally
preparation of accepted in the Philippines.
financial statements  The accounting standards promulgated by the
Focuses on general It is the area of FRSC council constitute the “highest hierarchy”
purpose reports known accounting that of GAAP in the Philippines.
as financial statements emphasizes  The approved statements of the FRSC are known as
intended for INTERNAL developinh Philippine Accounting Standards (PAS) and
and EXTERNAL USERS. accounting Philippine Financial Reporting Standards (PRFS)
information for use
within an entity.
Composition of FRSC
GENERALLY ACCEPTED ACCOUNTING  FRSC is composed of 15 members
PRINCIPLES  with a chairman who had been or is presently
 Accounting rules, procedures, and practices a senior accounting practitioner and
known as GAAP  14 representatives.
 The principles have developed o the basis of  The chairman and members of the FRSC shall
experience, reason, custom, usage and have a term of 3 years renewable for another
practical necessity. term.
 GAAP represent the rules, procedures,  Any member of the ASC shall not be
practice, and standards followed in the disqualified from being appointed to the FRSC.
preparation and presentation of financial
reporting.
 GAAP are like laws that must be followed in
financial reporting.  The PIC was formed by the FRSC in August 2006
 The process of establishing GAAP is a political and has replaced the Interpretation
process which incorporates political actions of Committee or IC formed by the Accounting
a various interested user groups as well as Standards Council in May 2000.
professional judgement, logic, and research.  ROLE of PIC:
 prepare interpretations of PFRS for
Purpose of Accounting Standards approval by the FRSC
 The overall purpose of accounting standards is  provide timely guidance on financial
to identify proper accounting practices for the reporting issues not specifically addressed
preparation and presentation of financial in current PFRS
statements.  Interpretations are intended to give
 Accounting standards create a common authoritative guidance on issues that are likely
understanding between preparers and users of to receive divergent or unacceptable
FS particularly the measurement of assets and treatment because the standards do not
liabilities. provide specific and clearcut rules and
 A Set of high-quality accounting standards is a guidelines.
necessity to ensure comparability and
uniformity in financial statements based on the
same financial information.
 The IASC is an interdependent private sector
body,
 Objective is to achieve uniformity in the
accounting principles which are used by
 In the Philippines, the development of GAAP business and other organizations for financial
is formalized initially through the creation of reporting around the world.
the Accounting Standards Council or ASC.  IT was formed in June 1973 through an
 The FRSC now replaces the ASC agreement.

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Factors considered in deciding to move totally to
 To formulate and publish in the public international accounting standards.
interest accounting standards to be
observed in the presentation of financial a) Support of international accounting
statements and to promote their standards by Philippine organizations, such as
worldwide acceptance and observance/ the Philippine SEC, BOA and PICPA
 To work generally for the improvement b) Increasing internalization of business which
and harmonization of regulations, has heightened interest in a common
accounting standards and procedures language for financial reporting
relating to the presentation of financial c) Improvement of international accounting
statements. standards or removal of free choices of
accounting treatments.
d) Increasing Recognition of international
Accounting standards by the World Bank,
 The IASB now replaces the international Asian Development Bank and World Trade
Accounting Standards Committee. Organization.
 The IASB publishes standards in a series of
pronouncements called International
Financial Reporting Standards or IFRS.
 However, the IASB has adopted the body of
The Financial Reporting Standard Council issues
standards issued by the IASC
standards in a series of pronouncements called
 The pronouncements of the IASC continue to
PFRS.
be designated “International Accounting
Standards” or IAS
The PFRS collectively include all of the following:
 The IASB standard-setting process includes in
the correct order research discussion paper, a) PFRS which correspond to IFRS
exposure draft and accounting standard.  The PFRS are numbered the same as
their counterpart in IFRS
Move toward IFRS b) PAS which correspond to IAS
 In developing accounting standards that will  The PFRS are numbered the same as
be generally accepted in the Philippines, their counterpart in IAS
standards issued by other standard-setting c) Philippine Interpretations which correspond
bodies such as the USA Financial Accounting to interpretation of the IFRIC and the Standing
Standards Board (FASB) and the IASB are Interpretations Committee, and
considered. Interpretations developed by the Philippine
 In the past years, most of the Philippine interpretations Committee.
standards issued are based on American
Accounting Standards.
 The move toward IFRS is essential to achieve
the goal of one uniform and globally
accepted financial reporting standards.
 The Philippines is fully compliant with IFRS
effective January 2005, a process which was
started back in 1997 in moving from USA
GAAP to IFRS

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Chapter 2
Objective of Financial Reporting
The Conceptual Framework for Financial  It is to be stated that the conceptual
framework is not an IFRS. Nothing in the
Reporting Conceptual Framework overrides any
 is a complete, comprehensive and single specific IFRS.
document promulgated by the IASB.  If there is conflict between CF and IRFS, IFRS
 It is also the summary of terms and concepts shall prevail.
that underlie the preparation and
presentation of financial statement for USERS OF FINANCIAL INFORMATION
external users.
 Describes the concepts for general purpose
financial reporting. 1. PRIMARY USERS
 To provide an overall theoretical foundation  Are the parties whom general purpose
for accounting financial reports are primarily directed. They
 To guide standard setter, preparers and user can’t require the reporting entity to provide
of financial information in the financial all of the information they want.
statements.
 This will be used for the future accounting
standards without changing the current IFRS  They are concerned with the risk inherent
in and rerun provided by their
investments.
THE CONCEPTUAL FRAMEWORK PROVIDES THE FOUNDATION  Shareholders are also interested in
FOR STANDARDS THAT: information which enables them to assess
the ability and
.  the entity to pay dividends
 By enhancing international comparability
and quality of financial information
.  They are interested in information which
 By reducing information gap between enables them to determine whether their
the providers of capital and the people loans, interest thereon and other amounts
to whom they have entrusted their owning to them will be paid when due.
money 2. OTHER USERS
.
 Are users of financial information other than
the existing and potential users.
 By helping investors to identify
 They are parties that may find the general
opportunities and risks across the world.
purpose of financial report such as she
reports are not directed primarily.

 are interested in information about the

 To assist IASB to develop IFRS standards stability and profitability of the entity.
based on consistent concepts.  They are interested in the information in
 To assist prepares of financial statements order to assess the ability of the entity to
to develop consistent accounting policy provide remuneration, retirement
when no Standard applies to a particular benefits and employment opportunities.
transaction.
 To assist preparers of financial statements  They are interested in the information
to develop accounting policy especially when they have a long-term
 To assist all parties to understand and involvement with or are dependent on
interpret the IFRS standards. the entity.

 They are interested because of the

allocation of resources and activities of
 When there are no specific standard or an the entity.
interpretation that applies to a transaction,  They also need financial information in
the management shall consider the order to provide taxation policies and as
applicability of the conceptual framework basis of national income and similar
statistics.
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TARGET USERS
 They are interested in financial  financial reporting information is directed
information because entities make primarily to the existing and potential Investors,
substantial contribution to the local lenders and other creditors (primary users)
economy in many ways including the  reason: they are the most critical and
rate of employment and their patronage immediate need for the information.
to certain local suppliers and in order for  The primary users of financial information are
them to know the trend and range of its the parties that provide resources to the entity.
activities.  Information that meets the needs of the
specifies primary users is likely to meet the
needs of the other users such as employees,
customers, governments and their agencies
a. Objective of Financial Reporting  MANAGEMENT is also interested in the
b. Qualitative characteristics of useful financial financial information but they only need it in
information order to obtain or access additional
c. Financial Statements and reporting entity information financial information internally.
d. Elements of Financial Statements
e. Recognition and derecognition SPECIFIC OBJECTIVE OF FINANCIAL
f. Measurement REPORTING
g. Presentation and Disclosure The Conceptual Framework places more
h. Concepts of Capital and Capital emphasis on the importance of providing
Maintenance. information needed to assess the management
stewardship of the entity’s economic resources
OBJECTIVE FINANCIAL REPORTING
a. To provide information useful in making
 The objective financial reporting forms the decisions about providing resources to the
foundation of Conceptual Framework entity
 Overall objective of financial reporting: b. To provide information useful in assessing
 To provide financial information about the cash flow prospects of the entity
the reporting entity that is useful to (investing/financing/operating)
existing and potential investors, lenders c. To provide information about entity
and other creditors in making decisions resources, claims and changes in
about providing resources to the entity. resources and claims (financial statement)
 It is the “ ” of the Accounting

 FINANCIAL REPORTING
 is the provision of Financial information  Existing and potential investors need general
about an entity to external users that is purpose financial reports in order to enable
useful to them in making economic them in making decisions whether to buy, sell
decisions and for assessing the or hold equity investments
effectiveness of the entity’s management.  While other existing and potential lenders and
 Encompasses not only financial statements other creditors need general purpose
but also other information such as financial financial reports In order to enable them in
highlights, summary of important financial making decisions whether to provide or settle
figures, analysis of financial statements and loans and other forms of credit
significant ratios.

 ANNUAL FINANCIAL STATEMENTS  Decisions of the primary users depend on the

 principal way of providing financial RETURNS that they expect from the
information to external users. investment or called as DIVIDENDS.
 It is also depend on the PRINCIPAL and
 FINANCIAL REPORT INTEREST PAYMENTS on the side of the creditor
 also include nonfinancial information  Financial Reporting should provide
such as description of major products information useful in assessing the amount,
and a listing of officers and directors timing and uncertainty of prospects for the
future net cash inflows of the entity

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Economic Resources & Claims ACCRUAL ACCOUNTING
 General purpose financial reports provide  Depicts the effect of transactions and other
information about the financial position of a events and circumstances on an entity’s
reporting entity economics resources and claims even if the
 FINANCIAL POSITION cash receipts occur in different period of time
 is information about the entity’s economic  ACCRUAL BASIS: The effects of transactions and
resources (ASSETS) and the claims (LIABILITY other events are recognized when they occur
AND EQUITY) against the reporting entity and not as cash is received or paid
 comprises the assets, liabilities and equity of  INCOME recognized when earned regardless
an entity at a particular moment in time. of when it is received and EXPENSES are
 Information about Financial Position can recognized when they have incurred
help users to assess the strength and regardless of when it is paid
weakness of the entity. Also, the liquidity,  provides a better basis for assessing past and
solvency and the need for additional future performance rather than information
financing. that is solely about cash basis during a period.
 – is the availability of cash in
LIMITATIONS OF FINANCIAL REPORTING
the near future to cover currently
maturing obligations (short-term) a. General Purpose Financial Reports DO NOT
 – is the availability of cash and CANNOT provide all of the information
that existing and potential investors and other
over a long term to meet financial creditors need
commitments when they fall due  These users need to consider pertinent
information from other sources (general
Changes in Economic Resources and economic conditions, political events
Claims and industry outlook)
 Financial reports provide information about the b. General Purpose Financial reports are not
effects of transactions and other events that designed to show the value of the entity but
changes the economic resources and claims they provide information for the users to assess
 Changes in economic resources and claims and estimate the value of the entity.
result from financial performance and from c. General Purpose Financial Reports are
other events or transactions such as issuing debt intended to provide common information to
or equity instruments users and cannot accommodate every
 Financial performance comprises revenue, request for information.
expenses and net income or loss for a period of d. To a large extent, reports are based on
time. In other words, it is the level of income estimate and judgment rather than exact
earned by the entity through the efficient and depiction
effective use of its resources.
MANAGEMENT STEWARDSHIP
 The FINANCIAL PERFORMANCE is also known as
 Information about how efficiently and
and is portrayed in the Income Statement and effectively management has used its
Statement of the Comprehensive Income. responsibilities to use the entity’s economic
resources helps the users to assess the
USEFULNESS OF FINANCIAL PERFORMANCE management stewardship.
 Information about the past financial  Such information is also useful for predicting
performance is usually helpful in predicting the how management will use the economic
future returns on the entity’s economic resources in the future
resources  Can be useful in assessing the entity’s
 Information about the return the entity has prospects for the future net cash flows.
produced provide an indication of how well  For example, management can decide
management has discharged its not to dispose or sell investments when
responsibilities to make efficient and effective prices are declining in order to avoid
use of the entity’s economic resources realizing losses.
 Information about financial performance
during a period is useful to assess the entity’s
ability to generate future cash inflows from the
normal operation.
9|Mikee P.
Chapter 3
Qualitative characteristics

For example:
 The statement of financial position is relevant
 Qualitative characteristics are the qualities or in determining financial position and the
attributes that make financial accounting income statement is relevant in determining
information useful to the users. performance
 In deciding which information to include in  The earnings per share information is more
financial statements, the objective is to relevant than book value per share in
ensure that the information is useful to the determining the attractiveness of an
users in making economic decisions. investment.
 Under the Conceptual Framework for
Financial Reporting, qualitative
characteristics are classified into fundamental
INGREDIENTS OF RELEVANCE
qualitative characteristics and enhancing Financial information is capable of making
qualitative characteristics
difference in a decision if it has predictive value and
confirmatory value

 The fundamental qualitative characteristics

relate to the content or substance of  Financial information has predictive value if
financial information. it can be used as an input to processes
 The fundamental qualitative characteristics employed by users to predict future
are RELEVANCE and FAITHFUL PRESENTATION and outcome.
 If it can help users increase the likelihood of
information must be both relevant and
correctly or accurately predicting or
faithfully represented if it is to be useful
forecasting outcomes of events
APPLICATION OF QUALITATIVE For Example:
CHARACTERISTICS  Information about financial position
and past performance is frequently
The most efficient and effective process of used in predicting dividend and wage
applying the fundamental qualitative payments and the ability of the entity
characteristics would usually be: to meet maturing commitments
1) Identify an economic phenomenon that has
the potential to be useful  Financial information has confirmatory value
2) Identify the type of the information about if it provides feedback about previous
the phenomenon that would be most evaluations.
relevant and can be faithfully represented  When it enables users confirm or correct
3) Determine whether the information is earlier expectations
available

RELEVANCE  Practical rule in accounting which dictates

 capacity of information to influence a that strict adherence to GAAP is not required
when the items are not significant enough to
decision.
 To be relevant, the financial information must affect the evaluation, decision and fairness of
the financial statements
be capable of making a difference in the
decisions made by users.  The materiality concept is also known as the
 It requires that the financial information doctrine of convenience.
should be related or pertinent to the  Really a quantitative “threshold” linked very
economic decision closely to the quantitative characteristics of
relevance
 Information that does not bear on an
economic decision is useless.  The relevance of information is affected by its
nature and materiality.
 Materiality is a subquality of relevance based
on the nature or magnitude or both of the
items to which the information relates.

10 | M i k e e P .
Examples:
 The language is vague or unclear
 Materiality of an item depends on relative  The information is scattered throughout the
size rather than absolute size. financial statements
 Dissimilar items are aggregated
inappropriately
 Similar items are disaggregated
 Dependent on good judgement, professional
inappropriately
expertise and common sense
PRIMARY USERS
 Information is material if omitting, misstating or  Narrows the definition to primary users who
obscuring it could reasonably be expected to are primarily affected by general purpose
influence the economic decisions that financial statements
primary users of general purpose financial  Includes existing and potential investors,
statements make on the basis of those lenders and other creditors.
statements which provide financial  New definition specifies that only primary
information about a specific reporting entity. users of financial statements are considered
 An information is material if the omission, because these groups are the users to whom
misstatement and obscuring of the general purpose financial statements are
information could reasonably affect the primarily directed
economic decision of primary users

Important aspects:
 Materiality depends on the magnitude and
a. Could reasonably be expected to nature of the financial information
influence  Relative size and nature of an item are
b. Obscuring information considered
c. Primary users  The size of the item in relation to the total of
the group to which the item belongs is taken
COULD RESONABLY BE EXPECTED TO into account
INFLUENCE  The nature of the item may be inherently
material because by its very nature it affects
 Threshold adds an element of reasonability economic decision
of financial information on which economic
decision is based.
 Material information shall be limited to the
FAITHFUL REPRESENTATION
economic decision of primary users rather
 Financial representation means the financial
than to all users which is too broad in scope
reports represent the economic phenomena
 Insures that information capable to
or transactions in words and numbers.
influence economic decision of the primary
 Faithful representation means that the actual
users shall be included in the financial
effects of the transactions shall be properly
statements.
accounted for and reported in the financial
statements.

 Is a new concept added to the new INGREDIENTS OF FAITHFUL

definition of materiality REPRESENTATION
 Information is obscured if presenting or  Completeness
communicating it would have similar effect  Neutrality
as omitting or misstating the information  Free from error
 Means the presentation of financial
information not readily understood or not
clearly expressed  Completeness requires that relevant
 May be characterized by deliberate information should be presented in a way
vagueness, ambiguity and abstruseness that facilitates understanding and avoids
erroneous application.
 Completeness is the result of the adequate
disclosure standard or the principle of full
disclosure.
11 | M i k e e P .
 A complete depiction includes all CONSERVATISM
information necessary for a user to
understand the phenomenon being  synonymous with prudence
depicted  means that when alternatives exist, the
alternative which has the least effect on
STANDARD OF ADEQUATE DISCLOSURE equity should be chosen
 means “in case of doubt, record any loss
 Means that all significant and relevant and do not record any gain”
information leading to the preparation of
 Contingent loss is recognized as a
financial statements shall be clearly “provision” if the loss is probable and the
reported
amount can be reliably measured
 Does not mean disclosure of just any data  Contingent gain is not recognized but
disclosed only
NOTES TO FINANCIAL STATEMENTS
 The financial statements shall be
accompanied by “notes to financial
statements”  Free from error means there are no errors or
 To provide necessary disclosures required omissions in the description of the
by Philippine Financial Reporting phenomenon or transaction.
Standards  Free from error does not mean perfectly
 It provides narrative description or accurate in all respects.
disaggregation of the items presented in
the financial statements and information MEASUREMENT UNCERTAINTY
about items that do not qualify for
recognition  Arises when monetary amounts in financial
reports cannot be observed directly and
must be estimated
 Can affect faithful representation if the
 A neutral depiction is without bias in the level of uncertainty in providing an
preparation or presentation of financial estimate is high
information.  The use of reasonable estimate is an
 Neutral depiction is not slanted, weighted, essential part of providing financial
emphasized, de-emphasized or otherwise information and does not undermine the
manipulated to increase the probability that usefulness of the financial information
financial information will be received
favorably or unfavorably by users SUBSTANCE OVER FORM
 To be neutral, the information contained in
the financial statements must be free from  It is necessary that the transaction and
bias. events are accounted in accordance with
 Financial information should not favor one their substances and reality and not merely
party to the detriment of another party their legal form
 The information is directed to the common  Usually emphasized when economic
needs of many users and not be particular substance differs from legal form
needs of specific users  is not considered a separate component
 Neutrality is synonymous with the all- of faithful representation because it would
encompassing principle of fairness be redundant
 To be neutral is to be fair  faithful representation inherently
represents the substance of an economic
PRUDENCE phenomenon or transaction rather than
 The exercise of care and caution when merely representing the legal form
dealing with the uncertainties in the
measurement process such that assets or Enhancing Qualitative
income are not overstated and liabilities or
expenses are not understated Characteristics
 neutrality is supported by the exercise of
 The enhancing qualitative characteristics
prudence
relate to the presentation or form of the
financial information.
 The enhancing qualitative characteristics are
intended to increase the usefulness of the
12 | M i k e e P .
financial information that is relevant and  Financial reports are prepared for users who
faithfully represented have reasonable knowledge of business
 The enhancing qualitative characteristics are and economic activities and who review
COMPARABILITY, UNDERSTANDABILITY, VERIFIABILITY and analyze the information diligently
 Understandability is very essential because a
and TIMELINESS.
relevant and faithfully represented may
 Relevant and faithfully represented financial prov useless if it is not understood by users
information is useful but the information would
be most useful if it is comparable,
understandable, verifiable, and timely 3. VERIFIABILITY
 Verifiability means that different
knowledgeable and independent observers
1. COMPARABILITY
could reach consensus, although not
 Comparability means the ability to bring necessarily complete agreement, that a
together for the purpose of noting points of particular depiction is a faithful
likeness and difference. representation
 Enables users to identify and understand  Implies consensus
similarities and dissimilarities among items  Verifiable financial information provides
 May be made within an entity or between results that would be substantially
and across entities duplicated y measurers using the same
 Comparability within an entity is also measurement method
known as horizontal comparability or  It helps assure users that information
intracomparability represents the economic phenomenon or
 Comparability across entities is also known transaction it purports to present
as intercomparability or dimensional
comparability.
 Comparability between and across
a. DIRECT VERIFICATION – means verifying an
entities is the quality of information that
allow comparisons between two or more amount or other representation through
entities engaged in the same industry direct observation, for example, by
(uniform application) counting cash.
b. INDIRECT VERIFICATION – means checking
the inputs to a model, formula or other
 Refers to the use of the same method for the
technique and recalculating the inputs
same item, either from period to period within
using the same methodology
an entity or in a single period across entities
 Comparability is the goal and consistency
help to achieve that goal 4. TIMELINESS
 Consistency is the uniform application of  Timeliness means that financial information
accounting method from period to period must be available or communicated early
within an entity enough when a decision is to be made.
2. UNDERSTANDABILITY  The older the information, the less useful
 Timeliness enhances the truism that without
 Understandability requires that financial
knowledge of the past, the basic for
information must be comprehensible or
prediction will usually be lacking and
intelligible if it is to be most useful.
without interest in the future, knowledge of
 The information should be presented in a
the past is sterile
form and expressed in terminology that a
 What happened in the past would become
user understands.
the basis of what would happen in the future
 Classifying, characterizing and presenting
information “clearly and concisely” makes it Cost constraint on useful information
understandable  Cost is a pervasive constraint on the
 Financial statements should be readily information that can be provided by financial
understandable by users reporting
 The users shall have an understanding of the  The benefit derived from the information
complex economic activities, the financial should exceed the cost incurred in obtaining
accounting process and the terminology in the information
the financial statements  The evaluation of the cost constraint is
 Financial statements cannot realistically be substantially a judgmental process
understandable to everyone

13 | M i k e e P .
Chapter 4
Financial Statements and Reporting Entity Underlying Assumptions

equity, income and expenses of a particular

GENERAL OBJECTIVE OF FINANCIAL subsidiary
STATEMENTS  A subsidiary’s own FS are designed to
provide such information.

 provide information about economic 2) UNCONSOLIDATED FINANCIAL

resources of the reporting entity, claims STATEMENTS
against the entity and changes in the  These are the financial statements prepared
economic resources and claims when the reporting entity is the parent
 provide financial information about an alone.
entity’s assets, liabilities, equity, income and  Are designed to provide information about
expenses useful to users of financial the parent’s assets, liabilities, income and
statements in: expenses and not about those of
a. Assessing future cash flows to the subsidiaries.
reporting entity.  It is useful for existing and potential investors,
b. Assessing management stewardship of lenders and other creditors because a claim
the entity’s economic resources. against the parent typically does not give
the holder of that claim against subsidiaries
The financial information is provided in the following:  Information provided is typically not
1. Statement of financial position, by sufficient to meet the requirement needs of
recognizing assets, liabilities and equity primary users
2. Statement of financial performance, by  Note: when consolidated financial
recognizing income and expenses statements are required, unconsolidated
3. Other statements and notes by presenting financial statements cannot serve as
and disclosing information about: substitute for consolidated financial
(a) Recognized assets, liabilities, equity, statements
income and expenses
(b) Unrecognized assets and liabilities 3) COMBINED FINANCIAL
(c) Cash flows STATEMENTS
(d) Contribution from equity holders and
 These are the financial statements when the
distribution to equity holders
reporting entity comprises two or more
(e) Method, assumption and judgment in
entities that are not linked by a parent and
estimating amount presented
subsidiary relationship
Types of financial statements  Combined financial statements provide
financial information about the assets,
liabilities, equity, income and expenses of
1) CONSOLIDATED FINANCIAL two or more entities not linked with parent
STATEMENTS and subsidiary relationship.
 These are the financial statements prepared
when the reporting entity comprises both
the parents and its subsidiaries.  A reporting entity is an entity that is required
 Provide information about the assets, or chooses to prepare financial statements.
liabilities, equity, income and expenses of  The reporting entity can be a single entity or
both the parent and its subsidiaries as a a portion of an entity, or can comprise more
single reporting entity. than one entity.
 The is the entity that exercises  A reporting entity is not necessarily a legal
control over the subsidiaries entity.
 It is useful for existing and potential investors,
lenders and other creditors of the parent in The following can be considered a reporting entity:
their assessment of future net cash inflows to a. Individual corporation, partnership or
the parent proprietorship
 Are not designed to provide separate b. The parent alone
information about the assets, liabilities, c. The parent and its subsidiaries as single
entity

14 | M i k e e P .
d. Two or more entities without parent and continue in operations for the foreseeable
subsidiary relationship as a single entity future
e. A reportable business segment of an entity  The going concern postulate is the very
foundation of the COST PRINCIPLE
 The going concern assumption is
ABANDONED  If the there is an evidence
 The reporting period is the period when
financial statements are prepared for the that the entity would experience large and
persistent losses or entity’s operations are to
purpose of general purpose financial
be terminated.
reporting
 Financial statements may be prepared on an
interim basis (3/6/9 months)
ACCOUNTING ENTITY
 INTERIM FINANCIAL STATEMENTS ARE NOT
 In financial accounting, the accounting entity
REQUIRED BUT OPTIONAL
is the specific business organization, which may
 Financial statements must be prepared on an
be a proprietorship, partnership or corporation.
annual basis or a period of twelve months.
 Under this assumption, the entity is separate
 Financial statements are prepared for a
from the owners, managers, and employees
specified period of time and provide
who constitute the entity.
information about:
 The transaction of the entity shall not be
a. Assets, liabilities, equity and the end of
merged with the transactions of the owners
the reporting period
 The reason of the entity assumption is to have
b. Income and expenses during the
a fair presentation of financial statements
reporting period
 Each business is an independent accounting
 Financial statements also provide
entity
comparative information for at least one
 The shareholder is not the corporation and the
preceeding reporting period
corporation is not the shareholder
 FS may include information about
 However, when parent and subsidiary
transactions and other events that occurred
relationship exists, consolidated statements for
after the end of reporting period
the affiliates are usually made because for
practical and economic purposes, the parent
Underlying Assumptions and the subsidiary are a “single economic
entity”
 Accounting assumptions are the basic notions
or fundamental premise on which the
accounting process is based.
TIME PERIOD
 Accounting assumptions are also known as  The time period assumption requires that
. indefinite life of an entity is subdivided into
 Accounting assumptions serve as the accounting periods which are usually of equal
foundation of bedrock of accounting in order length for the purpose of preparing financial
to avoid misunderstanding but rather enhance reports on financial position, performance and
the understanding and usefulness of the cash flows.
financial statements  A completely accurate report on the financial
 The Conceptual Framework for Financial position and performance of an entity cannot
Reporting mentions only one assumption, be obtained until the entity is finally dissolved
and liquidated
namely .
 Users of financial information need timely
 However, IMPLICIT in accounting are the
information for making an economic decision.
basic assumptions of ACCOUNTING ENTITY, TIME It becomes necessary therefore to prepare
PERIOD and MONETARY UNIT. periodic reports on financial position,
performance and cash flows of an entity
GOING CONCERN  By convention, the accounting period or fiscal
period is one year or a period of twelve months
 The going concern or continuity assumption  The “one-year period” is traditionally the
means that in the absence of evidence to accounting period because usually it is
the contrary, the accounting entity is after one year that government reports
viewed as continuing in operation and required
indefinitely.
 Financial Statements are normally prepared
on the assumptions that the entity will

15 | M i k e e P .
 – 12-month period
that ends on December 31
 – 12-
month period that ends on any month when
the business is at the lowest or experiencing
slack season

MONETARY UNIT
 The monetary unit assumption has two aspects,
namely and stability of
the peso.
 The QUANTIFIABILITY aspect
means that assets, liabilities, equity,
income and expenses should be stated
in terms of a unit of measure which is the
peso in the Philippines.
 The STABILITY OF THE PESO
ASSUMPTION means that the purchasing
power of the peso is stable or constant and
that its instability is insignificant and therefor
may be ignored.
 The STABLE PESO POSTULATE is
actually an amplification of the going
concern assumption so that
adjustments are unnecessary to reflect
any changes in purchasing power
 The accounting function is to account for
NOMINAL PESOS ONLY and not for constant
pesos or changes in purchasing power

16 | M i k e e P .
Chapter 5
Elements of Financial Statements

Rights that have the potential to produce

 Financial statements portray the financial economic benefits may take the following forms:
effects of the transactions and other events by
1. RIGHTS THAT CORRESPOND TO AN
grouping them into broad classes according to
their economic characteristics OBLIGATION OF ANOTHER ENITY
 The elements of FS refer to quantitative a. Right to receive cash
information reported in SFP and Income b. Right to receive goods or services
Statement. c. Right to exchange economic resources
 Are the “building blocks” from which financial with another party on favorable terms
statements are constructed d. Right to benefit from an obligation of
 The preparation of these involves process of another party if a specified uncertain
classification and subclassification future event occurs
 The Conceptual Framework identifies no 2. RIGHTS THAT DO NOT CORRESPOND
elements that are unique to the statement of TO AN OBLIGATION OF ANOTHER
changes in equity because such statement ENTITY
comprises items that appear in the statement a. Right over physical objects, such as
of financial position and the income statement property, plant and equipment or
o EQUITY inventories
– residual interest in the assets of the entity b. Right to intellectual property
after deducting all of the liabilities
3. RIGHTS TO ESTABLISHED BY
ELEMENTS DIRECTLY RELATED TO THE CONTRACT OR LEGISLATION SUCH
AS OWNING A DEBT INSTRUMENT OR
MEASUREMENT OF FINANCIAL POSITION: AN EQUITY INSTRUMENT OR OWNINF
 Asset A REGISTERED PATENT
 Liability
 Equity
POTENTIAL TO PRODUCE ECONOMIC
ELEMENTS DIRECTLY RELATED TO THE BENEFITS
MEASUREMENT OF FINANCIAL PERFORMANCE:
 Income  An economic resource is a right that has the
 Expense potential to produce economic benefits
 It does not need to be certain or even likely
that the right will produce economic benefits
 It is only necessary that the right already exists
 Under the Revised Conceptual Framework,
 The economic resource is the present right
an asset is defined as a present economic
that contains the potential and not the future
resource controlled by the entity as a result of
economic benefits may produce
past events.
 An ECONOMIC RESOURCE is a right that has An economic resource could produce economic
the potential to produce economic benefits.
 The new definition clarifies that an asset is an benefits if an entity is entitled:
economic resource and that the potential
 To receive contractual cash flows
economic benefits no longer need to be
 To exchange economic resources with
expected to flow to the entity
another party on favorable terms
 To produce cash inflows or avoid cash
outflows
 To receive cash by selling the economic
a. The asset is a present economic resource resource
b. The economic resource is a right that has the  To extinguish a liability by transferring an
potential to produce economic benefits. economic resource
c. The economic resource is controlled by the
entity as a result of past events

17 | M i k e e P .
Control of an economic
resource a. Obligation to pay cash
b. Obligation to deliver goods or noncash
resources
 An entity controls an asset if it has the c. Obligation to provide sevices at some future
present ability to direct the use of the time
asset and obtain the economic benefits d. Obligation to exchange economic resources
that flow from it with another party on unfavorable terms
 Control also includes the ability to prevent e. Obligations to transfer an economic resource if
others from using such as asset and specified uncertain future event occurs
therefore preventing others from
obtaining the economic benefits from the Past event
assets
An obligation exists as a result of past event if both
 Control may arise if an entity enforces
of the following conditions are satisfied:
legal rights
a. An entity has already obtained economic
benefits
b. An entity must transfer an economic resource

 Under the Revised Conceptual Framework, a

liability is defined as present obligation of an
entity to transfer an economic resource as a  Income is defined as increases in assets or
result of past events. decreases in liabilities the result in increases in
 The outflow of economic benefits no longer equity, other than those relating to
needs to be expected similar to the definition contributions from equity holders
of an asset.  The definition of income encompasses both
 A liability is the obligation to transfer an revenue and gains:
economic resource and not the ultimate  REVENUE – arises in the course of the
outflow of economic benefits
ordinary regular activities and is referred
to by variety of different names including
ESSENTIAL CHARACTERISTICS OF sales, fees, interest, dividends, royalties
and rent
LIABILITY
 the essence of revenue is regularity
a. The entity has an obligation  GAINS – represent other items that
 The entity liable must be identified. It is meet the definition of income and do not
not necessary that the payee or the arise in the course of the ordinary regular
entity to whom the obligation is owed activities
be identified  Include gain from disposal of
b. The obligation is to transfer an economic noncurret asset, unrealized gain on
resource trading investment and gain from
c. The obligation is a present obligation that expropriation
exists as a result of past event
 This means that a liability is not Statement of financial performance
recognized until it is incurred  The Revised Conceptual Framework
introduces the term statement of financial
Obligation performance
 This statement refers to the statement of profit
 An obligation is a duty or responsibility that
or loss and a statement presenting other
an entity has no practical ability to avoid.
comprehensive income
 Obligation can be either be legal or
 Statement of profit or loss is the primary source
constructive
of information about an entity’s financial
 Obligations may be LEGALLY ENFORCEABLE
performance.
as a consequence of a binding contract or
 GENERAL RULE: all income and expense are
statutory equipment
included in profit or loss
 CONSTRUCTIVE OBLIGATIONS arise from
 Recycling is permitted as long as it would result
normal business practice, custom and a
to relevant and faithfully represented
desire to maintain good business relations or
information about financial performance.
act in an equitable manner.
18 | M i k e e P .
 Expense is defined as decreases in assets or
increases in liabilities that result in decreases
in equity, other than those relating to
distributions to equity holders.
 Expenses encompass losses as well as those
expenses that arise in the course of the
ordinary regular activities:
 EXPENSES that arise in the course
of ordinary regular activities include
cost of goods sold, wages and
depreciation
 LOSSES do not arise in the course of
the ordinary regular activities and
include losses resulting from disasters
 Examples include losses from
fire, flood, storm surge, tsunami
and hurricane, as well as those
arising from disposal of
noncurrent assets.

19 | M i k e e P .
CHAPTER 6
Recognition and Measurement

RECOGNITION
 The BASIC EXPENSE RECOGNITION means that
 The Revised Conceptual Framework defines expenses are recognized when incurred
recognition as the process of capturing for  The expense recognition principle the
inclusion in the financial statements an item application of the matching principle
that meets the definition of an asset, liability,  “There is no gain of there is no pain.”
equity, income or expense  The MATCHING PRINCIPLE requires that those
 The amount at which an asset, a liability or costs and expenses incurred in earning a
equity is recognized in the statement of revenue shall be reported in the same period.
financial position is reported as carrying
amount The matching principle has
 Recognition links the elements to the namely:
statement of financial position and statement 1)
of financial performance 2)
 The recognition of an item is one
statement requires the recognition of 3)
the same item in another statement
 The recognition of the expense happened Cause and effect association
simultaneously with the recognition of a
decrease in asset or decrease in liability  Under this principle, the expense is recognized
when the revenue is already recognized.
Recognition criteria  The reason is the presumed direct association
of the expense with specific items of income.
 Only items that meet the definition of an asset,
a liability or equity are recognized in the This is actually the “STRICT MATCHING CONCEPT”
statement of financial position.  This process, commonly referred to as the
 Similarly, only items that meet the definition of matching of cost with revenue, involves
income or expense are recognized in the simultaneous or combined recognition of
statement of financial performance. revenue and expenses that result directly and
 Items are recognized only when their jointly from the same transactions or events.
recognition provides users of financial
statements with information that is both Example:

relevant and faithful represented

 Recognition does not focus anymore on how 
probable economic benefits will flow to or from 
the entity and that the cost can be measured
reliably Systematic and rational allocation
 An asset or liability and any corresponding
 Under this principle, some costs are expensed
income or expense can exist even if the
probability of inflow or outflow of the benefits is by simply allocating them over periods
low benefitted
 The cost incurred will benefit future
periods and that there is an absence of
a direct or clear association of the
 The BASIC PRINCIPLE OF INCOME recognition expense with specific revenue
is that income shall be recognized when  When economic benefits are expected to
earned. arise over several accounting periods and the
 Legal title to the goods passes to the buyer at
association with income can only be broadly
the point of scale
 However, under certain conditions, income or indirectly determined, expenses are
may be recognized at the point of recognized on the basis of systematic and
production, during production and at the allocation procedures.
point of collection.
20 | M i k e e P .
Examples:  The historical cost of a liability is them
consideration received to incur the liability
 , minus transaction cost.
 Historical cost is the entry price or entry value
 to acquire an asset or to incur a liability
 ,
 An application of this is to measure financial
asset and financial liability at amortized cost
 The amortized cost reflects the
Immediate recognition estimate of future cash flows
discounted at a rate determine at
initial recognition
 Under this principle, the cost incurred is
expensed outright because of uncertainty of
future economic benefits or difficulty of reliably
associating certain costs with future revenue.
1. HISTORICAL COST OF AN ASSET IS UPDATED
BECAUSE OF:
An expense is recognized immediately: a. Depreciation and amortization
b. Payment received as a result of
a. When an expenditure produces no future
disposing part or all of the asset
economic benefit.
c. Impairment
b. When cost incurred does not qualify or
d. Accrual of interest to reflect any
ceases to qualify for recognition as an asset.
financing component of the asset
e. Amortized cost measurement of
DERECOGNITION financial asset
 Removal of all or part of a recognized asset 2. HISTORICAL COST OF A LIABILITY IS UPDATED
or liability from the statement of financial
BECAUSE OF:
position.
a. Payment made or satisfying an
 Normally occurs when an item no longer obligation to deliver goods
meets the definition of an asset or a liability b. Increase in value of the obligation to
 DERECOGNITION OF AN ASSET occurs when transfer economic resources such that
the entity losses control of all or part of the the liability becomes onerous
c. Accrual of interest to reflect any
asset
financing component of the liability
 DERECOGNITION OF A LIABILITY occurs d. Amortized cost measurement of
when the entity no longer has a present financial liability
obligation for all or part of the liability
2) CURRENT VALUE
MEASUREMENT Current value includes:

 Measurement is defined as quantifying in a. Fair value

monetary terms the elements in the financial b. Value in use for asset
statements. c. Fulfillment value for liability
The revised Conceptual Framework mentions
d. Current cost
.

1. Historical cost
(a) FAIR VALUE
2. Current value  Fair value of an asset is the price that would
be received to sell an asset in an orderly
transaction between market participants
1) HISTORICAL COST at measurement date.
 The historical cost or original acquisition cost of  FAIR VALUE OF A LIABILITY is the price that
an asset is the cost incurred in acquiring or would be paid to transfer a liability in an
creating the asset comprising the consideration orderly transaction between market
paid plus transaction cost. participants at measurement date
 Fair value is an exit price or exit value

21 | M i k e e P .
 Can be observed directly using market
price of the asset or liability in an active
market
 In cases where fair value cannot be
directly measured, an entity can use
present value of cash flows.
 Fair value is not adjusted for transaction
cost.
 Cost is a characteristic of the
transaction and not of the asset
or liability

(b) VALUE IN USE

 Value in use is the present value of the cash
flows that an entity expects to derive from
the use of an asset and from the ultimate
disposal
 Does not include transaction cost on
acquiring the asset but includes
transaction cost on the disposal of the
asset
 Is an exit price or exit value

(c) FULFILLMENT VALUE

 Fulfillment value is the present value of
cash that an entity expects to transfer in
paying or settling a liability.
 Does not include transaction cost on
incurring a liability but includes transaction
cost on fulfillment of a liability
 Is an exit price of exit value
(d) CURRENT COST
 Current cost of an asset is the cost of an
equivalent asset at the measurement date
comprising the consideration paid and
transaction cost.
 CURRENT COST OF A LIABILITY is the
consideration that would be received less
any transaction cost at measurement
date.
 Current cost is also based on the entry
price or entry value but reflects market
conditions on measurement date

 It is necessary to consider the nature of the

information that the measurement basis will
produce
 No single factor will determine which
measurement basis should be selected
 The information must be both relevant and
faithfully represented
 HISTORICAL COST is the measurement basis most
commonly adopted in preparing financial
statements
 generally well understood and verifiable

22 | M i k e e P .
CHAPTER 7
Presentation and Disclosure Concepts of Capital
Aggregation
Presentation & Disclosure  Aggregation is the adding together assets,
 Can be an effective communication tool liabilities, equity, income and expense that
about the information in financial statements. have similar or shared characteristics and are
 A reporting entity communicates information included in the same classification
about its assets, liabilities, equity, income and  Makes information more useful by summarizing
expense by presenting and disclosing a large volume of detail (however,
information in the FS. aggregation may conceal some of the detail.)
 Effective communication in FS is supports by  Balance should be made so that relevant
not duplicating information in different parts information is not obscured either by a large
of the FS. amount of insignificant detail or by excessive
 DUPLICATION is usually unnecessary and can aggregation.
make FS less understandable.  Typically, the statement of financial position
and the statement of financial performance
provide summarized or condensed
CLASSIFICATION information.
 Classification is the sorting of assets, liabilities,  More detailed information is provided in the
equity, income, and expense on the basis of notes to financial statement.
shared or similar characteristics.
 Classifying dissimilar assets, liabilities, equity,
income and expense can:
Capital maintenance
The financial performance of an entity us
 Obscure relevant information,
determined using two approaches namely:
 Reduce understandability and
1) TRANSACTION APPROACH
comparability;
 The traditional preparation of an income
 may not provide a faithful
statement
representation of financial information
2) CAPITAL MAINTENANCE APPROACH
 It may be necessary to classify components
 Net income occurs only after the capital
of equity separately if such components are
used from the beginning of the period is
subjects to legal, regulatory and other
maintained.
requirements.
 Should be disclosed separately:
 Ordinary share capital,  NET INCOME is the amount of the entity can
 Preference share capital, distribute to its owners and be as “well-off” at
 Share premium the end of the year as at the beginning
 Retained earnings  The distinction between return of capital and
return on capital
Classification of o RETURN ON CAPITAL or an amount in
excess of their original investment
income and expense o RETURN OF CAPITAL – is an erosion of the
 Income and expense are classified as capital invested in the entity
components of profit, loss and components of  The Conceptual Framework considered two
other comprehensive income concepts of capital maintenance namely:
 The Revised Conceptual Framework has 1) Financial capital
introduced the term statement of financial 2) Physical capital
performance to refer to the statement of profit FINANCIAL CAPITAL
or loss together with the statement presenting
 Under financial capital concept, such as
other comprehensive income
 The statement of profit or loss is the primary invested money or invested purchasing
power, capital is synonymous with net assets
source of information about an entity’s
or equity
financial performance for the reporting period.
 of the entity
 All income and expense should be
 Financial capital is the monetary amount of
appropriately classified and included in the
statement of profit or loss the net assets contributed by shareholders
and the amount of the increase in net assets
 Certain items of income and expense that are
presented outside of profit or loss but included resulting from earnings retained by the entity
 Traditional concept based on historical cost
or retained earnings.
and adopted by most entities

23 | M i k e e P .
ILLUSTRATION: Assume in the previously given illustration, the net
assets of P500,000 on January 1 had a current cost
Jan 1 Dec 31 of P800,000 by reason of inflationary condition
Total assets 1,500,000 2,500,000
Total liabilities 1,000,000 1,200,000 Net assets – Dec 31 1,300,000
Additional investments during the yr 400,000 Add: Dividends paid 300,000
Dividends paid during the year 300,000 Total 1,600,000
Less: Net assets – Jan 1 800,000
Computation of Net Income Additional Investments 400,000 1,200,000
Net income 400,000
Net assets – Dec 31 1,300,000
Add: Dividends paid 300,000
Total 1,600,000
Less: Net assets – Jan 1 500,000
Additional Investments 400,000 900,000
Net income 700,000

NET ASSETS APPROACH: Note that the amount of

net assets is “the excess of total assets over
the total liabilities”

physical capital

 Is the quantitative measure of the physical

productive capacity to produce goods and
services
 The physical productive capacity may be
based on units of output per day or physical
capacity of productive assets to produce
goods and services
 Productive assets be measure at CURRENT
COST, rather than historical cost
 Productive assets:
 Inventories
 PPE
 The current cost of this these must be
maintained in order that physical capital is
also maintained
 Physical capital is equal to the net assets of the
entity expressed in terms of current cost
 This concept should be adopted if the main
concern of users is the operating capability of
the entity – the resource or fund needed to
achieve that operating capability or capacity
 Net income occurs “when the physical
productive capital at the beginning of the
period, also after excluding distributions to and
contributions from owners during the period”

ILLUSTRATION:

24 | M i k e e P .
Chapter 8
Presentation of Financial Statements
(Statement of Financial Position) - PAS 1
FINANCIAL STATEMENTS
 Financial statements shall be presented at least
 Are the means by which the information annually
accumulated and processed in financial  When an entity’s end of reporting period
accounting is periodically communicated to changes and financial statements are
the users presented for a period longer or shorter than
 Are the end product of main output of the one year, an entity shall disclose:
financial accounting process a. The period covered by the financial
 A structured financial representation of the statements
financial position and financial performance of b. The reason for using a longer or shorter
an entity period
c. The fact that amounts presented in the
GENERAL PURPOSE FINANCIAL STATEMENTS financial statements are not entirely
comparable
 An entity shall prepare and present general
purpose financial statements in accordance
with the International Financial Reporting Statements of Financial
Standards
 Simply referred to financial statements – Position
intented to meet the needs of users who are  Is a formal statement showing the three
not in a position to require an entity to prepare elements comprising financial position:
reports tailored to their particular information  Assets, liabilities, and equity
needs  Investors, creditors and other statement users
 Are directed to all common users and not to analyze the statement of financial position to
specific users evaluate such factors as:
 Liquidity, solvency, and the need of the
COMPONENTS OF FINANCIAL entity for additional financing

STATEMENTS
1. Statement of Financial Position (SFP)
 an asset is an economic resource controlled by
2. Income Statement (IS)
an entity as a result of past event
3. Statement of Comprehensive Income (SCI)
 an economic resource is a right that has the
4. Statement of Changes in Equity (SCE)
potential to produce economic benefits
5. Statement of Cash Flow (SCF)
6. Notes to Financial Statement
 Comprising a summary of significant CLASSIFICATION OF ASSETS
accounting policies and other
explanatory notes  classified into two – current and noncurrent
assets
 when an entity supplies goods or services within
a clearly identifiable operating cycle, the
 To provide information about the financial separate classification of current and
position, financial performance and cash flows noncurrent assets is a useful information by
of an entity that is useful to a wide range of distinguishing between net assets that are
users in making economic decisions continuously circulating as working capital
 Also show the results of the management’s from the net assets used in long-term operation
stewardship of the resources entrusted to it  the operating cycle of an entity is the time
Financial statements provide information about: between the acquisition of assets for
processing and their realization in cash or cash
a. Assets
equivalent
b. Liabilities
c. Equity  when the entity’s normal operating cycle is not
clearly identifiable, the duration is assumed to
d. Income and expenses, including gains and
losses be 12 months
e. Contributions by and distributions to owners
in their capacity as owners
f. Cash flows
25 | M i k e e P .
 Most PPE, except land, are presented at
 CURRENT ASSETS cost less accumulated depreciation.
 Examples of PPE
PAS 1, paragraph 66 provides that an entity shall
classify an asset as current when:  Land
 Building
a. the asset is cash or cash equivalent unless the  Machinery
asset is restricted to settle a liability for more  Equipment
than 12 months after the reporting period  Furniture
b. the entity holds the asset primarily for the  Fixtures
purpose of trading  Patterns
c. the entity expects to realize the asset within  Molds
12 months after the reporting period  Dies
d. the entity expects to realized the assets of  Tools
intends to sell or consume it within the entity’s
normal operating cycle (b) LONG-TERM INVESTMENTS
 The IASC defines investment as” an asset
PRESENTATION OF CURRENT ASSETS held by an entity for the accretion of
wealth through capital distribution, such as
Current assets are usually listed in the order interest, royalties, dividends, and rentals,
of liquidity. PAS 1, paragraph 54, provides the for capital appreciation or for other
MINIMUM LINE ITEMS UNDER CURRENT ASSETS: benefits to the investing entity such as
those obtained through trading
. relationships”
b.
such as trading securities and
other investments in quoted equity
(c) INTANGIBLE ASSETS
instruments  An identifiable nonmonetary asset without
. physical substance
.  Patent
.  Franchise
 Copyright
 NONCURRENT ASSETS  Lease right
 Trademark
 Is a Residual definition  Computer software
 PAS1, paragraph 65, states that “an entity
shall classify all other assets not classified as
current as noncurrent”
(d) OTHER NONCURRENT
 What is not included in the definition of ASSETS
current assets is deemed excluded. All  Those assets that do not fit into the
others are classified as noncurrent assets definition of the previously mentioned
noncurrent assets.
NONCURRENT ASSETS INCLUDE THE  Long term advances to officers
FOLLOWING:  Directors
 Shareholders and employees
. ,
 Abandoned property
. -  Long-term refundable deposit
.
.
.  Is a present obligation of an entity to
transfer an economic resource as a result
(a) PROPERTIES, PLANT AND of past event.
 An obligation is a duty or responsibility that
EQUIPMENT an entity has no practical ability to avoid.
 Pas 16, paragraph 6, defines PPE as  Obligation can either be legal or
“tangible assets which are held by an constructive
entity for use in production or supply of  Liability is classified as current and
goods and services, for rental to other, or noncurrent liability
for administrative purposes, and are
expected to be used during more than one
period”
26 | M i k e e P .
 CURRENT LIABILITIES
PAS 1, paragraph 69, provides that an entity shall A liability which is due to be settled within 12
classify a liability as current when:
months after the reporting period is classified as
a. The entity expects to settle the liability current, even if:
within the entity’s normal operating cycle
b. The entity holds the liability primarily for a. The original term was for a period longer
the purpose of trading than 12 months.
c. The liability is due to be settled within 12 b. An agreement to refinance or to
months AFTER the reporting periods reschedule a payment on a long-term
d. The entity does not have an basis is completed after the reporting
unconditional right to defer settlement of
period and before the financial statements
the liability for at least 12 months after the
reporting period. are authorized for issue.
However, if the refinancing on a long term
basis is completed on or before the end of the
reporting period, the refinancing is an
PAS 1, paragraph 54, provides that as a minimum,
the face of the statement of financial position adjusting event and therefore the obligation is
shall include the following MINIMUM line items classified as noncurrent.
for current liabilities:
.  If the entity has the discretion to refinance or
 accounts payable, roll over an obligation for at least 12 months
 notes payable, after the reporting period under an existing
 accrued interest on note payable, loan facility, the obligation is classified as
 dividends payable, NONCURRENT even it would otherwise be due
 accrued expense within a shorter period
.  The reason for this treatment is that such
. - obligation is considered to form part of
. - the entity’s long-term refinancing
because the entity has an
.
unconditional right under the existing
 No objection can be raised if the trade accounts loan agreement to defer payment for at
and notes payable are separately represented least 12 months after the end of the
reporting period.
 NONCURRENT LIABILITEIS  Note that the refinancing or rolling over is must
The term “noncurrent liabilities” is also a residual be at the discretion of entity.
definition  Otherwise, if the refinancing or rolling
PAS 1, paragraph 69, provides that all liabilities not over is not at the discretion of the entity,
classified as current are classified as noncurrent. the obligation is classified as a current
liability.
. -

.
.  Covenants are often attached to borrowing
. - agreements which represents undertaking by
the borrower.
. -  Covenants are actually restrictions on the
borrower as to:
 Undertaking further borrowings,
 Paying dividends,
 Maintaining specified level of working
capital
 and so forth
 Under these covenants, if certain conditions
relating to the borrower’s financial situation
are breached = the liability becomes
payable on demand.
27 | M i k e e P .
 PAS 1, paragraph 74, provides that the liability
is classified as current even if the lender has  Is the residual interest of owners in the net
agreed, after the reporting period and before assets of a corporation measured by the
the statements are authorized for issue, not to excess of assets over liabilities
demand payment as a consequence of the  The elements constituting shareholders’ equity
breach. with their equivalent IAS Term are:
 This liability is classified as current because
Philippine term IAS Term
at reporting date the borrower does not
 Capital stock  Share capital
have an unconditional right to defer
 Subscribed capital  Subscribed share
payment for at least 12 months after the stock capital
reporting period.  Preferred stock  Preference share
 Paragraph 75, provides that the liability is  Common stock capital
classified as noncurrent if the lender has  Additional paid  Ordinary share capital
agreed on or before the end of the reporting capital  Share premium
period to provide a grace period ending at  Retained earnings  Accumulated profit
least 12 months after the end of the reporting (Deficit) (losses)
period.  Retained earnings  Revaluation reserve
appropriated  Treasury share
 Revaluation surplus
 Treasury stock
 The term EQUITY is the residual interest in the
assets of the entity after deducting all of its
liabilities Notes to
 Equity means “net assets” or total assets minus
liabilities Financial Statements
 The terms used in reporting the equity of an  Provide narrative description or disaggregation
entity depending on the form of the business of items presented in the financial statements
organization are: and information about items that do not
a. Owner’s equity in a proprietorship qualify for recognition
b. Partners’ equity in a partnership  Are used to report information that does not fit
c. Stockholders’ equity or shareholders’ into the body of the financial statements in
equity in a corporation order to enhance the understandability of the
 The term “equity” may simply be used for all financial statements
business entities  It contains information in addition to that
 Under PAS 1, paragraph 7, the holders of the presented in the statement of financial
instruments classified as equity are simply position, income statement, statement of
known as owners comprehensive income, statement of
changes in equity and statement of cash flows
 : to provide the necessary
disclosures required by the Philippine Financial
Reporting Standards (PFRS)

There are two customary forms in presenting the

statement of financial position namely:
(a) REPORT FORM
 This form sets forth the three major sections
in a downward sequence of assets,
liabilities and equity
(b) ACCOUNT FORM
 The presentation follows that an account –
the assets are shown on the left side and
the liabilities and equity on the right side of
the statement of financial position
28 | M i k e e P .
Chapter 9
Presentation of Financial Statements
(statement of comprehensive income) – pas 1

INCOME STATEMENT 5) Unrealized gain or loss from derivative

contracts designated as cash flows hedge
 Is a formal statement showing the financial
6) “ ” of defined benefit
performance of an entity for a given period of
plan, including actual gain or loss
time
7) Change in fair value attributable to credit
 The financial performance of an entity is
risk of a financial liability designated at fair
primarily measured in terms of the level of
value through profit or loss
income earned by the entity through the
effective and efficient utilization of its resources
 Financial performance is also known as results
of operations of the entity
 The transaction approach is the traditional
preparation of the income statement in PAS 1, paragraph 82A, provides that the
conformity with accounting standards statement of comprehensive income shall
 The income statement for a period presents present line items for amounts of other
the income, expenses, gains, losses and net comprehensive income during the period
classified by nature
income or loss recognized during the period
 Information about financial performance is
useful in predicting future performance and The line items for amounts of OIC shall be grouped as follows:
ability to generate future cash flows A. OCI that will be RECLASSIFIED
SUBSEQUENTLY TO PROFIT OR LOSS when
specific conditions are met
COMPREHENSIVE INCOME
Is the change in equity during a period resulting (a) Unrealized gain or loss on debt
from transactions and other events, other than investment measured at fair value
changes resulting from transactions with owners in through other comprehensive income
their capacity as owners It includes: (b) Gain or loss from translating financial
statements of a foreign operation
A. COMPONENTS OF PROFIT OR LOSS (c) Unrealized gain or loss on derivative
contracts designated as cash flow
 The term profit or loss is the total of income
hedge
less expenses (excluding the components
of OIC) B. OCI that will not be RECLASSIFIED
 The bottom line in the traditional income subsequently to profit or loss but RETAINED
statement
EARNINGS
 Entity may use “net income” or “net loss”
to describe profit or loss  Unrealized gain or loss on equity
investment measured at fair value through
B. COMPONENTS OF OTHER other comprehensive income
COMPREHENSIVE INCOME  The Application Guidance of PFRS,
paragraph B5.7.1, provides that such
 Comprises items of income and expenses
unrealized gain or loss is reclassified to
including reclassification adjustments that
retained earnings upon disposal of the
are not recognized in profit or loss as
investments
required or permitted by PFRS
 Revaluation surplus during the year
The components of OCI include the following:  The realization of the revaluation
1) Unrealized gain or loss on equity investment surplus is through retained earnings
measured at fair value through other  “Remeasurements” of defined benefit plan,
comprehensive income including actual gain or loss
2) Unrealized gain or loss on debt investment  The remeasurements are not classified
measured at fair value through other subsequently but are permanently
comprehensive income excluded from profit or loss
3) Gain or loss from translation of the financial  The measurements, may be
statements if a foreign operation transferred within equity or retained
4) Revaluation surplus during the year earnings

29 | M i k e e P .
 Change in fair value attributable to credit Components of expense
risk of a financial liability designated at fair
value through profit or loss  Cost of goods sold or cost of sales
 Such gain or loss from change in fair  Distribution costs or selling expenses
value attributable to credit risk of a  Administrative expenses
financial liability may be transferred
within equity or retained earnings  Other expenses
 Income tax expense

Cost of goods sold of merchandising

concern
1) TWO STATEMENTS Beg. Inventory 500,000
(a) An income statement showing the Net Purchases 2,000,000
comprehensive components of profit Goods available for sale 2,500,000
or loss Ending inventory (300,000)
(b) A statement of comprehensive COGS 2,220,000
income beginning with profit or loss Gross profit 1,900,000
shown in the income statement plus or Freight in 50,000
minus the components if other Total 2,050,000
comprehensive income. Purchase returns allowances & discounts (50,000)
Net purchases 2,000,000
2) SINGLE STATEMENT OF
COMPREHENSIVE INCOME
 Combined statement showing the
components of profit or loss and Cost of goods sold of manufacturing
components of other comprehensive concerns
income in a single statement. Beg. Raw materials 500,000
 The revised con. Framework calls this Net purchases 2,000,000
as statement of financial performance Raw materials available for use 2,500,000
Ending raw materials (300,000)
Raw materials used 3,200,000
Direct labor 3,000,000
a) SALES OF MERCHANDISE TO CUSTOMERS Factory overhead 1,300,000
 Income from sales shall include all sales to Total manufacturing cost 6,500,000
customers during the period Beg. Goods in process 900,000
 Sales return, allowances and sicounts Total cost of goods in process 7,400,000
shall be deducted from gross sales to Ending goods in process (1,000,000)
arrive at net sales Cost of goods manufactured 6,400,000
b) RENDERING OF SERVICES Beg. Finished goods 1,600,000
 Income from rendering of services, Goods available for sale 8,000,000
among others, includes Ending finished goods (1,500,000)
 professional fees, COGS 6,500,000
 media advertising commissions,
 insurance agency commissions,
 admission fees for artistic dividend
income DISTRIBUTION COSTS constitute costs
c) USE OF ENTITY RESOURCES which are directly related to selling, advertising
and delivery of goods to customers
 Income category includes interest, rent,
royalty and dividend income
Distribution costs ordinary include:
d) DISPOSAL OF RESOURCES OTHER THAN PRODUCTS
 gain on sale of investments, a. Salesmen’s salaries
 gain on sale of property, plant and b. Salesmen’s commissions
equipment c. Traveling and marketing expenses
 gain on sale of intangible assets. d. Advertising and publicity
e. Freight out
f. Depreciation of delivery equipment and
store equipment
30 | M i k e e P .
ADMINISTRATIVE EXPENSES comprehensive income to fair value profit or
loss
 Administrative expenses constitute costs of g. Income tax expense
administering the business h. A single amount comprising discontinued
 Ordinarily include all operating expenses not operations
related to selling and cost of goods sold i. Profit or loss for the period
j. Total other comprehensive income
a. Doubtful accounts k. Comprehensive income for the period
b. Office salaries being the total of profit or loss and other
c. Expenses of general executives comprehensive income
d. Expenses of general accounting and
credit department The following items shall be disclosed on the
e. Office supplies used face of the income statement and statement
f. Certain taxes of comprehensive income
g. Contribution a. Profit or loss for the period attributable to
h. Professional fees non-controlling interest and owners of the
i. Depreciation of office building and office parent
equipment b. Total comprehensive income for the
j. Amortization of intangible assets period attributable to non-controlling
other expenses interest and owners of the parent

 Are those expenses which are not directly

related to the selling and administrative  PAS 1, paragraph 99, provides that an entity shall
function present an analysis of expenses recognized in
a. Loss on sale of trading investments profit or loss using a classification based on
b. Loss on disposal of PPE either the function of expenses or their nature
c. Loss on sale of noncurrent investment within the entity, whichever provides information
d. Casualty loss – flood, earthquake, fire that is reliable and more relevant
 The income statement may be presented in two
ways:
No more extraordinary income
a. FUNCTIONAL PRESENTATION
PAS 1, paragraph 87, specifically mandates that  Classifies expenses according to their
on entity shall not present any items of income functions as part of goods sold, distribution
and expenses as extraordinary either on the face costs, administrative expenses and other
of the income statement or statement of expenses
comprehensive income or in the notes  Also known as the cost of goods sold
method
Line items  An entity classifying expenses by function
shall disclose additional information on the
PAS 1, paragraph 82, provides that as a minimum, nature of expenses, including
the income statement and statement of depreciation, amortization and employee
comprehensive income shall include the benefit costs
following: b. NATURAL PRESENTATION
a. Revenue  Referred to as the nature of expense
b. Gain and loss from the depreciation of method
financial asset measured at amortized cost  Expenses are aggregated according to
as required by PFRS 9. their nature and not allocated among the
c. Finance cost various functions within the entity
d. Share in income or loss of associate and joint  Expenses are no longer classified as cost of
venture accounted for using the equity goods sold, distribution costs,
method administrative expenses and other
e. Gain of loss on the reclassification of expenses
financial asset from amortized cos to fair  the expenses which are the same nature
value profit or loss are grouped or aggregated and
f. Gain of loss on the reclassification of presented as one item
financial asset from fair value other

31 | M i k e e P .
Chapter 10
STATEMENT OF CASH FLOW – PAS 7

STATEMENT OF CASH FLOWS EXAMPLES:

a. Cash receipts from sale of goods and
 A component of financial statements rendering of services
summarizing the operating, investing and b. Cash receipts from royalties, rental, fees,
financing activities of an entity commissions and other revenue
 PRIMARY PURPOSE: Provides information about c. Cash payments to suppliers for goods and
the cash receipts and cash payments of an d. Cash payments for selling, administrative
entity during a period and other expense
 An entity shall prepare a statement of cash e. Cash receipts and cash payments of an
flows and present it as an integral part of the insurance entity for premiums and claims,
financial statements for each period for annuities and other policy benefits
which financial statements are presented f. Cash payments or refunds of income taxes
unless specifically identified with financing
CASH AND CASH EQUIVALENTS and investing activities
g. Cash receipts and payments for securities
 CASH – comprises cash on hand deposits held for trading
 CASH EQUIVALENTS – short-term
highly liquid investments that are readily
convertible to known amount of cash and  PAS 7, paragraph 15, provides that cash flows
which are subject to an insignificant risk of arising from the purchase and sale of dealing
change in value or trading securities are classified as
 PAS 7, paragraph 7, provides that an OPERATING ACTIVITIES
investment normally qualifies as a cash  Cash advances and loans made by a
equivalent only when it has a short maturity financial institution are usually classified as
of three months or less from date of operating activities since they relate to the
acquisition main revenue producing activity of that
 The investments must be acquired three entity.
months or less before the date of acquisition
investing activities
EXAMPLES
a. Three-month BSP treasury bill  are the cash flows derived from the
b. Three-year BSP treasury bill purchased acquisition and disposal of long-term assets
three months before date of maturity and other investments not included in cash
c. Three-month time deposit equivalent.
d. Three-month money market instrument  investing activities include transactions
or commercial paper involving non-operating assets.

EXAMPLES:
 Cash flows are inflows outflows of cash and a. Cash payments to acquire property, plant
cash equivalents and equipment, intangibles and other
 The statement of cash flows shall report cash long-term assets
flows during classified as operating, investing b. Cash receipts from sales of property, plant
and financing and equipment, intangibles and other
long-term assets
Operating activities c. Cash payments to acquire equity or debt
instruments of other entities (current and
 are the cash flows derived primarily from the long-term investments)
principal revenue producing activities of an d. Cash receipts from sales of equity or debt
entity instruments of other entities
 operating activities generally result from and e. Cash advances and loans to other parties
other events that enter into the determination other than advances and loans made by
of net income or loss financial institution

32 | M i k e e P .
f. Cash receipts from repayment of THE FOLLOWING NONCASH TRANSACTIONS ARE DISCLOSED
advances and loans made to other parties
SEPARATELY:
g. Cash payments for futures contract,
a. Acquisition of asset by assuming directly
forward contract, option contract and
related liability
swap contract
b. Acquisition of asset by issuing share capital
h. Cash receipts from futures contract,
c. Acquisition of asset by issuing bonds
forward contract, option contract and
payable
swap contract
d. Conversion of bonds payable into share
capital
Financing activities e. Conversion of preference shares into
ordinary shares
 are the cash flows derived from the equity
capital and borrowings of the entity
 are the cash flows that result from transaction
a) Between the entity and the owners –  PAS 7, paragraph 33, provides that interest
EQUITY FINANCING paid and interest received shall be classified
b) Between the entity and the creditors – as operating cash flows because such items
DEBT FINANCING enter into the determination of net income
 financing activities include the cash flows or loss
transactions involving nontrade liabilities and  Alternatively, interest paid may be classified
equity of an entity as financing cash flow because it is a cost of
obtaining financial resources.
EXAMPLES:  Alternatively, interest received may be
classified as investing cash flow because it is
a. Cash receipts from issuance of ordinary a return on investment.
and preference shares  For a financial institution, interest paid and
b. Cash payments to acquire treasury interest received are usually classified as
shares operating cash flows.
c. Cash receipts from issuing debentures,
loans, notes, bonds, mortgages, and
other short or long-term borrowings
d. Cash payments for amounts borrowed  PAS 7, paragraph 33, provides that dividend
e. Cash payments by a lessee for the received shall be operating cash flow
reduction of the outstanding principal because it enters into the determination of
lease liability net income.
Cash payments to settle such obligations Alternatively, dividend received may be

as trade accounts and notes payable, classified as investing cash flow because it
income tax payable, accrued expenses are is a return on investment.
operating activities, not financing activities.  PAS 7, paragraph 34, provides that dividend
paid shall be financing cash flow because it
is a cost of obtaining financial resources.
 Alternatively, dividend paid may be classified
 PAS 7, paragraph 43, provides that investing
as operating cash flow in order to assist users
and financing transactions that do not
to determine the ability of the entity to pay
require use of cash or cash equivalents shall
dividends out of operating cash flows.
be excluded from the statement of cash
flows
 Noncash investing and financing
transactions shall be disclosed elsewhere in  PAS 7 paragraph 35, provides that cash
the financial statements either in the notes flows arising from income taxes shall be
to financial statements or in a separate separately disclosed as cash flows from
schedule or in a way that provides all operating activities unless they can be
relevant information about these specifically identified with investing and
transactions. financing activities.
 The statement of cash flows is strictly a cash  Tax cash flows are often difficult to match
concept. to the originating underlying transaction,
so most of the time all tax cash flows are
classified as arising from operating
activities.
33 | M i k e e P .
Chapter 11
Accounting Policies, Estimate and Errors (PAS 8)

c. The initial adoption of policy to carry assets at

revalue amount is a change in accounting
 Are the specific principles, bases, policy to be dealt with as revaluation.
conventions, rules and practices d. Change from cost model to fair value model
applied by am entity in preparing and in measuring investment property.
presenting financial statements e. Change to a new policy resulting from the
requirement of a new PFRS.
 Essential for a proper understanding of
the information contained in the
financial statements
 An entity is required to outline all
significant accounting policies applied A change in accounting policy required
in preparing financial statements by a standard or an interpretation shall be
 Under accounting standards, applied in accordance with the transitional
provisions therein.
alternative treatments are possible
 It becomes all the more important for an If the standard or interpretation contains
entity to clearly state the accounting no transitional provisions or if an accounting
policies used in preparing financial policy is changed voluntarily, the change shall
statements be applied retrospectively or retroactively.
 The entity shall select and apply the
same accounting policies each period Retrospective application
in order to achieve comparability of
financial statements or to identify trends  means that any resulting adjustment from the
change in accounting policy shall be
in the financial position, performance
reported as an adjustment to the opening
and cash flows of the entity balance of retained earnings.
 The amount of the adjustment is determined
as of the beginning of the year of change
Accounting policies must be applied  If comparative information is presented, the
consistently for similar transactions and events financial statements of the prior period
presented shall be restated to conform with
A change accounting policy shall be made the new accounting policy.
only when:

a. Require by an accounting standard

b. The change will result in more relevant and  PAS 8, paragraph 10. provides that in the
faithfully represented information about the absence of an accounting standard that
financial position, financial performance specifically applies to a transaction event,
and cash flows of the entity management shall use judgment in selecting
and applying an accounting policy that
EXAMPLES OF CHANGE IN results in information that is relevant to the
economic decision-making need of users
ACCOUNTING POLICY and faithfully represented.

A change in accounting policy arises Paragraphs 11 & 12 specify the following

when an entity generally adopts a accepted hierarchy of guidance which management may
accounting principle which is a the one use when selecting accounting policies in such
previously used by the entity. circumstances:
a. Requirements of current standards dealing
a. Change in the method of inventory pricing with similar
from FIFO to weighted average method. b. matters
b. Change in the method of accounting for long c. Definition, recognition criteria and
term construction contract from cost measurement concepts for assets, liabilities,
recovery method to percentage of income and expenses in the Conceptual
completion method. Framework for Financial Reporting

34 | M i k e e P .
d. Most recent pronouncements of other  A change in an accounting estimate shall not
standard-setting bodies that use a similar be accounted for by restating amounts
Conceptual Framework, other accounting reported in financial statements of prior
literature and accepted industry practices. periods.
 Changes in accounting estimates are to be
handled currently and prospectively, if
necessary,
 A change in accounting estimate is a normal  Prospective recognition of the effect of a
recurring correction or adjustment of an asset change in accounting estimate means that
or liability which is the natural result of the use the change is applied to transactions, her
of an estimate. events and conditions from the date of
 An estimate may need revision if changes change in estimate.
occur regarding the circumstances on which
the estimate was based or as a result of new Illustration
information, more experience or subsequent
development For example, a depreciable asset costing
 By very nature, the revision of the estimate P500,000 is estimated to have a life of 5 years. At
does not relate to prior periods and is not a the beginning of the third year, the original life is
correction of an error changed to 8 years. Thus, the asset has a
 Sometimes it is difficult to distinguish a remaining life of 6 years.
change in accounting estimate and a
The procedure is not to correct past
change in accounting policy.
depreciation.
 The change is treated as a change in
accounting estimate, with appropriate Instead, the remaining carrying amount of
disclosure. P300,000 (P500,000 minus P200,000 depreciation
for 2 years) is now allocated over 6 years or a
EXAMPLES OF ACCOUNTING subsequent annual depreciation of P50,000.
ESTIMATE Thus, the entry to record the annual
depreciation, starting the third year is:
 As a result of the uncertainties in business
activities, many items in financial statements Depreciation 50,000
cannot be measured with precision but can Accumulated depreciation 50,000
only be estimated
 Estimation involves judgment based on the
latest available and reliable information. PRIOR PERIOD ERRORS
ESTIMATES MAY BE REQUIRED FOR THE FOLLOWING: are omissions and misstatements in the financial
statements for one or more periods arising from
a. Doubtful accounts a failure to use or misuse of reliable information.
b. Inventory obsolescence
Errors may occur as a result of mathematical
c. Useful life, residual value and expected
mistakes, mistakes in applying accounting
pattern of consumption of benefit of
policies, misinterpretation of facts, fraud or
depreciable asset
oversight.
d. Warranty cost
e. Fair value of asset and liability

Prior period errors shall be corrected

retrospectively by adjusting the opening
balances of retained earnings and affected
The effect of a change in accounting estimate
assets and liabilities.
shall be recognized currently and prospectively
by including it in income or loss of: If comparative statements are presented, the
financial statements of the prior period shall be
a. The period of change if the change affects
restated so as to reflect the retroactive
that period only
application of the prior period errors as a
b. The period of change and future periods if
retrospective restatement.
the change affects both.

35 | M i k e e P .
Chapter 12
Events After the Reporting Period (PAS 10)
proceeds from asset sold before the end of
 PAS 10, paragraph 3, defines events after the reporting period.
reporting period favorable or unfavorable, e. The determination after the reporting
that occur between the end of reporting period of the profit sharing or bonus
period and the date on which the financial payment if the entity has the present
statements are authorized for issue. obligation at the end of reporting period to
 Events after reporting period are also known make such payment.
as subsequent events. f. The discovery of fraud or errors that show
 Such events may require either the financial statements were incorrect.
adjustment or disclosure
NONADJUSTING EVENTS
1. Business combination after the reporting
period
a. Adjusting events after the reporting period
2. Plan to discontinue an operation
are those that provide evidence of conditions
3. Major purchase and disposal of asset or
that exist at the end of reporting period
expropriation major asset by government
b. Nonadjusting events after reporting period
4. Destruction of a major production plant by a
are those that are indicative of conditions
fire after the reporting period
that arise after the end of reporting period.
5. Major ordinary share transactions and
potential ordinary share transactions after the
 It is appropriate to adjust the financial
reporting period
statements for all events that offer clarity
6. Announcing or commencing the
concerning the conditions that existed at the
implementation of a major restructuring
end of reporting period and that occur prior
7. Abnormally large changes after the reporting
to the date the financial statements are
period in asset prices or foreign exchange
authorized for issue.
rates
 an entity must adjust the amounts recognized
8. Entering into significant commitments or
in the financial statements for adjusting
contingent liabilities, for example, by issuing
events that provide evidence of conditions
guarantees
that existed at the end of reporting period.
9. Commencing major litigation arising solely
 an entity does not recognize events after the
from events that occurred after the reporting
reporting period that relate to conditions that
period
only arose after the reporting period.
10. Change in tax rate enacted or announced
 The entity is required only to disclose
after the end of reporting period that has a
significant nonadjusting events.
significant effect on current and deferred tax
asset and liability
ADJUSTING EVENTS
Examples of adjusting events after the
reporting period which require the entity to
adjust the financial statements are:
 Financial statements are authorized for issue
a. Settlement after the reporting period of a when the board of directors reviews the
court case because it confirms that the financial statements and authorizes them
entity already had a present obligation at issue.
the end of reporting period.  In some cases, an entity is required to submit
b. Bankruptcy of a customer which occurs the financial statements to the shareholders
after the reporting period. for approval after the financial statements
c. Sale of inventories after the reporting have been issued.
period may give evidence about the net  In such cases, the financial statements are
realizable value at reporting date. authorized for issue on the date of issue by the
board of directors and on the date when
d. The determination after the reporting shareholders approve the financial
period of the cost of asset purchased or the statements.
36 | M i k e e P .
CHAPTER 13
Related Party Disclosures - PAS 24

 The term "associate" includes the

Parties are considered to be related if subsidiary or subsidiaries of the
one party has: associate.
 The ability to control the other party. 3) in a joint venture
 The ability to exercise significant influence  A joint venture includes the subsidiary or
over the other party. subsidiaries of the joint venture.
 Joint control over the reporting entity. 4) - are
those persons having authority and
CONTROL responsibility for planning, directing and
 Is the power over the investee or the power controlling the activities of the entity, directly
to govern the financial and operating or indirectly, any executive director or
policies of an entity so as to obtain nonexecutive director.
benefits. 5)
 is ownership directly or indirectly through
subsidiaries of more than half of the voting are those family members who
power of an entity. may be expected to influence or be
influenced by that individual in their dealings
SIGNIFICANT INFLUENCE with the entity.
 is the power to participate in the financial
and operating policy decision of an entity, Close family members of an individual
include:
but not control of those policies.
 The individual's spouse and children
 may be gained by share ownership of 20%
 Children of the individual's spouse
or more.
 Dependents of the individual or the
 If an investor holds, directly or indirectly individual's spouse.
through subsidiaries, 20% or more of the voting 6) owning directly or indirectly an
power of the investee, it is presumed that the interest in the voting power of the reporting
investor has significant influence, unless it can entity that gives them significant influence
be dearly demonstrated that this is not the over the entity, and close family members of
case. such individuals.
 Beyond the mere 20% threshold of ownership,
7) for the
the existence of significant influence is usually
evidenced by the following factors: benefit of employees.

a. Representation in the board of Examples of

directors
b. Participation in policy making process related party transaction
c. Material transactions between the
investor and the investee A RELATED PARTY TRANSACTION is a
d. Interchange of managerial personnel transfer of resources or obligations between
e. Provision of essential technical related parties, regardless of whether a price is
information charged.
PAS 24, paragraph 20, provides the
JOINT CONTROL  is the contractually following examples of related party transaction:
agreed sharing of control over an economic
activity.  Purchase and sale of goods
 Purchase and sale of property and other asset.
Examples of related parties  Rendering or receiving services
 Leases
 Transfer of research and development
1)  License agreement 7. Finance arrangements,
 meaning the parent, the subsidiary and including loans and equity contributions in
fellow subsidiaries cash or in kind
2)  Guarantee and collateral
 meaning the entities over which one  Settlement of liabilities on behalf of the entity
party exercises significant influence or by the entity on behalf of another party.

37 | M i k e e P .
● PAS 24, paragraph 12, requires disclosure of
related party relationships where control PAS 24, paragraph 16, provides that an
exists irrespective of whether there have been entity shall disclose key management personnel
transactions between the related parties. compensation in total and for each of the
● In other words, relationships between parents following categories:
and subsidiaries shall be disclosed regardless
of whether there have been transactions  Short-term employee benefits
between those related parties.  Postemployment benefits, for example,
● An entity shall disclose the name of the retirement pensions
entity's parent and if different, the ultimate  Other long-term benefits
controlling party.  Termination benefits
● If neither the entity's parent nor the ultimate  Share based payment transactions, for
controlling party produces financial example, share options
statements available for public use, the name
of the next most senior parent that does so RELATED PARTY DISCLOSURES NOT REQUIRED
shall also be disclosed.
● PAS 24, paragraph 3, requires disclosure of
related party transactions and outstanding
balances in the separate financial statements
of a parent, subsidiary, associate or venturer.
● PAR 24, paragraph 17, provides that if there ● However, Paragraph 4 provides that
have been transactions between related intragroup related party transactions and
parties, an entity shall disclose the nature of outstanding balances are eliminated in the
the related party relationship as well as preparation of consolidated financial
information about the transactions and statements of the group.
outstanding balances necessary for an
understanding of the financial statements.
● As a minimum, the disclosures of related party
UNRELATED PARTIES
transaction shall include:
Unrelated parties include the following:
 The amount of the transaction
 Two entities simply because they have a
 The amount of outstanding balance,
director or key management personnel in
terms and conditions, whether secured or
common.
unsecured, and nature of consideration
 Providers of finance, trade unions, public
to be provided in settlement.
utilities and government agencies in the
 The allowance for doubtful accounts
course of their normal dealings with an
related to the outstanding balance.
entity by virtue only of those dealings.
 The doubtful accounts expense
 A single customer, supplier, franchisor or
recognized during the period in respect
general agent with whom an entity
of amount due from related parties.
transacts a significant volume of business
merely by virtue of the resulting economic
dependence
 Two venturers simply because they share
joint control over a joint venture.

38 | M i k e e P .
CHAPTER 14
Inventories ( PAS 2)

 Trade discounts, rebates and other similar

items are deducted in determining the
 are assets held for sale in the ordinary course cost of purchase.
of business, in the process of production for 2) COST OF CONVERSION
such sale or in the form of materials or
 The cost of conversion of inventories
supplies to be consumed in the production
includes cost directly related to the units
process or in the rendering of services.
of production such as direct labor.
 Inventories encompass goods purchased
 It also includes a systematic allocation of
and held for resale, for example:
fixed and variable production overhead
 Merchandise purchased by a retailer
that is incurred in converting materials
and held for resale
into finished goods.
 Land and other property held for
 FIXED PRODUCTION OVERHEAD is the indirect
resale by a subdivision entity and real
estate developer. cost of production that remains relatively
 Inventories also encompass finished goods constant regardless of the volume of
produced, goods in process and materials production.
and supplies awaiting use in the production  Examples are depreciation and
process. maintenance of factory building
and equipment, and the cost of
factory management and
administration.
● Inventories are broadly classified into two,  VARIABLE PRODUCTION OVERHEAD is the
namely inventories of a trading concern and
indirect cost of production that varies
inventories of manufacturing concern directly with the volume of production.
● A trading concern is one that buys and sells
 Examples are indirect labor and
goods in the same form purchased. indirect materials.
● The term "merchandise inventory" is generally
3) OTHER COST
applied to goods held by a trading concern.
● A manufacturing concern is one that buys  Is included in the cost of inventories only
goods which are altered or converted into to the extent that it is incurred in bringing
another form before they are made available the inventories to their present location
for sale. and condition.
The inventories of a manufacturing  For example, it may be
concern are: appropriate to include the cost of
 Finished goods designing products for specific
 Goods in process customers in the cost of
 Raw materials inventories.
 Factory or manufacturing supplies  excluded from the cost of inventories and
recognized as expenses in the period
when. incurred:
COST OF INVENTORIES
(a) ABNORMAL amounts of wanted
1) Cost of purchase materiale, labor and other
2) Cost of conversion production costs.
3) Other cost incurred in bringing the (b) STORAGE COSTS, unless necessary in
inventories to their present location and the production process prior to a
condition further production stage. Thus,
1) COST OF PURCHASE storage costs on goods in process
 The cost of purchase of inventories are capitalized but storage costs
comprises the purchase price, import on finished goods are expensed.
duties and irrecoverable taxes, freight, (c) ADMINISTRATIVE OVERHEADS
handling and other costs directly (d) DISTRIBUTION OR SELLING COSTS
attributable to the acquisition of finished
goods, materials and services.

39 | M i k e e P .
COST OF INVENTORIES OF A Illustration - FIFO

SERVICE PROVIDER
UNITS UNIT TOTAL TOTAL
COST COST COST
 The cost of inventories of a service provider
consists primarily of the labor and other costs
Jan. 1 Beg. Bal
of personnel directly engaged in providing 800 200 160,000
the service, including supervisory personnel
and attributable overhead. Sale 500
8
 Labor and other costs relating to sales and
general administrative personnel are not Purchase
included but are recognized as expenses in 700 210 147,000
18
the period in which they incurred.
Sale 800
22
Cost formulas
Purchase 500 220 110,000
PAS 2, paragraph 25, expressly provides 31
that the cost of inventories shall be determined
by using either:
. ,
. UNITS UNIT TOTAL
 The standard does not permit anymore the COST COST
use of the last in, first out (LIFO) as an
alternative formula in measuring cost of Fr. Jan 18 200 210 42,000
inventories. Purchase

Fr. Jan 31 500 220 110,000

1) FIRST IN, FIRST OUT (FIFO) Purchase
 The FIFO method assumes that "the goods
first purchased are first sold" and 700 152,000
consequently the goods remaining in the
inventory at the end of the period are
those most recently purchased or Cost of Good Sold
produced.
 In other words, the FIFO is in accordance
Inventory - Jan 1 160,000
with the ordinary merchandising
Purchases 257,000
procedure that the goods are sold in the
Goods Avail for Sale 417,000
order they are purchased.
Inventory - Jan 31 (152,000)
 The rule is " , ".
COGS 265,000
 The inventory is thus expressed in terms of
recent or new prices while the cost of
Jan 18 Purchases 147,000
goods sold is representative of earlier or old
31 Purchases 110,000
prices.
Total Purchases 157,000
 This method favors the statement of
financial position in that the inventory is
stated at current replacement cost.
2) WEIGHTED AVERAGE
 The objection to the method is that there is
 The cost of the beginning inventory plus
improper matching of cost against
the total cost of purchases during the
revenue because the goods sold are
period is divided by the total units
stated at earlier or older prices resulting in
purchased plus those in the beginning
understatement of cost of goods sold.
inventory to get a weighted average unit
 Accordingly, in a period of inflation or rising
cost.
prices, the FIFO method would result to the
 Such weighted average unit cost is then
highest net income.
multiplied by the units on hand to derive
 However, in a period of deflation or
the inventory value. In other words, the
declining prices, the FIFO method would
average unit cost is computed by dividing
result to the lowest net income.
the total cost of goods available for sale by
the total number of units available for sale

40 | M i k e e P .
The preceding illustrative data are used.  The objection of the LIFO is that the inventory
is stated at earlier or older prices and
therefore there may be a significant lag
UNITS UNIT TOTAL between inventory valuation and current
COST COST replacement cost.
Jan. Beg. Bal 800 200 160,000  In a period of RISING PRICES, the LIPO method
1 would result to the lowest net income.
 In a period of DECLINING PRICES, the LIFO
Purchase 700 210 147,000
18 method would result to the highest net
income.
Purchase 500 220 110,000
31 Illustration - LIFO

Total Goods 2,000 417,000 UNITS UNIT TOTAL

Available for Sale COST COST
Weighted average unit cost (417,000 / 2,000) From Jan 1 balance 700 200 140,000
= 208.50
Inventory - Jan 1 160,00
Inventory cost (700 x 208.50)
= 145, 950 Purchases 257,00

Cost of Good sold Goods Avail for Sale 417,000

Inventory - Jan 1 160,000 Inventory - Jan 31 (140,000)

Purchases 257,000
Goods Avail for Sale 417,000 COGS 227,000
Inventory - Jan 31 (145,950) Specific identification
COGS 271,050
● means that specific costs are attributed to
 The argument for the weighted average identified items of inventory.
method is that it is relatively easy to apply, ● The cost of the inventory is determined by
especially with computers. simply multiplying the units on hand by the
 Moreover, the weighted average method actual unit cost.
produces inventory valuation that ● PAS 2, paragraph 23, provides that this
approximates current value if there is a rapid method is appropriate for inventories that
turnover of inventory. are segregated for a specific project and
 The argument against the weighted average inventories that are not ordinarily
method is that there may be a considerable interchangeable.
lag between the current cost and inventory
valuation since the average unit cost involves
Measurement of inventory
early purchases.
● PAS 2, paragraph 9, provides that
LAST IN, FIRST OUT (LIFO) inventories shall be measured at the lower of
 The LIFO method assumes that the goods cost and net realizable value.
last purchased are first sold and ● The cost of inventory is determined using
consequently the goods remaining in the either FIFO cost or average cost.
inventory at the end of the period are those ● The measurement of inventory at the lower
first purchased or produced. of cost and net realizable value is known as
 The inventory is thus expressed in terms of LCNRV.
earlier/old prices and the cost of goods sold
is representative of recent/new prices. Net realizable value
 The LIFO favors the income statement
because there is matching of current cost ● Net realizable value or NRV is the estimated
against current revenue, the cost of goods selling price in the ordinary course of
sold being expressed in terms of current or business less the estimated cost of
recent cost completion and the estimated cost of
disposal.

41 | M i k e e P .
The cost of inventories may not be recoverable Illustration - Inventory Data on Dec. 31, 2020
under the following circumstances:
INVENTORY TOTAL NRV LCRNV
a. The inventories are damaged
ITEM COST
b. The inventories have become wholly or
partially obsolete. A 2,000,000 1,900,000 1,900,000
c. The selling prices have declined
d. The estimated cost of completion or the B 1,500,000 1,550,000 1,500,000
estimated cost of disposal has increased.
 Inventories are usually written down to net C 2,500,000 2,100,000 2,100,000
realizable value on an item by item or
individual basis. D 3,000,000 3,200,000 3,200,000

Total 9,000,000 8,750,000 8,500,000

Accounting for inventory writedown
The measurement of the inventory at LCNRV is
● If the cost is lower than net realizable applied on an item by item or individual basis or
value, there is no accounting problem P8,500,000
because the inventory is stated at cost
and the increase in value is not Total Cost 9,000,000
recognized. LCNRV 8,500,000
● If the net realizable value is lower than Inventory Writedown 500,000
cost, the inventory is measured at net
realizable value.
● In this case, the problem is the proper
The inventory on December 31, 2020 is recorded
treatment of the writedown of the
at cost.
inventory to net realizable value.
● The writedown of inventory to net Inventory-December 31, 2020 9,000,000
realizable value is accounted for using Income summary 9,000,000
the allowance method.
The loss on inventory writedown is accounted for
separately.
 The inventory is recorded at cost and any loss Loss on inventory write down 500,000
on inventory writedown is accounted for Allowance for inventory writedown 500,000
separately.
 This method is also known as loss method  The loss on inventory write down is included in
because the computation of cost of goods sold.
 "loss on inventory
writedown" is debited & The allowance for inventory write down is presented
 "allowance as a deduction from the inventory.
for inventory writedown" is credited.
 In subsequent years, this allowance account Inventory- December 31, 2020, at cost 9,000,000
is adjusted upward or downward depending Allowance for inventory writedown (500,000)
on the difference between the cost and net Net realizable value 8,500,000
realizable value of the inventory at year-end
 If the required allowance increases, an
additional loss is recognized.
 If the required allowance decreases, a
gain on reversal of inventory writedown
is recorded.
 However, the gain is limited only to the extent
of the allowance balance.
 The allowance method is used in order that
the effects of writedown and reversal of
writedown can be clearly identified.
 As a matter of fact, PAS 2, paragraph 36,
requires disclosure of the amount of any
inventory writedown and the amount of any
reversal of inventory writedown.

42 | M i k e e P .
Chapter 15
Property, Plant, and Equipment (pas 16)

 Are intangible assets that are held for used  Purchase price, including imp[ort duties and
in production or supply of goods or nonrefundable purchase taxes, after
services, for rental to others, or for deducting trade discounts and rebates
administrative purposes;  Cost directly attributable to bringing the
 are expected to be used during more than assets to the location and condition
one period. necessary for it to be capable of operating in
the manner intended by management.
 Initial estimate of the cost of dismantling and
removing the item and restoring the site on
 The PPE are intangible assets with physical
which it is located for which an entity has a
substance
present obligation.
 The PPE are used in business (use in
production or supply of goods or services, for Directly attributable costs that qualify for
rental to others, & for administrative purposes)
recognition
 The PPE are expected to be used over a
period or more than 1 year. a. Cost of employee benefit arising directly
from the construction or acquisition of the
item of PPE
b. Cost of site preparation
.
. c. Initial delivery and handling cost
. d. Installation and assembly cost
. e. Professional fee
. f. Cost of testing whether the asset is
. functioning properly.
.
. Cost not qualifying for recognition
.
. , - Costs that are expensed rather than
. recognized as element of PPE
. a. Cost of opening a new facility
b. Cost of introducing a new product of
Recognition of PPE service, including cost of advertising and
promotion
An item of PPE shall be recognized as an asset c. Cost of conducting business in a new
when: location or with a new class of customer,
including cost of staff training
 It is probable that future economic d. Administration and other general
benefits associated with the asset will overhead cost
flow to the entity e. Cost incurred while an item capable of
 The cost of the asset can be measured operating in the manner intended by
reliably management has yet be brought into use
of is operated less than full capacity
MEASUREMENT AT RECOGNITION f. Cost of relocating or recognizing aprt or
all of an entity’s operations.
An item of PPE that qualifies for recognition as
an asset shall be measured at cost. MEASUREMENT AFTER RECOGNITION
● COST is the amount of cash or cash ➢ After initial recognition, an entity shall choose
equivalent paid and the fair value of the either the cost model or the revaluation
other consideration given to acquire an model as the accounting policy for PPE
asset at the time of acquisition or ➢ The entity shall apply such accounting policy
construction to an entire class of PPE
❖ The cost model means that PPE are
carried at cost less any accumulated

43 | M i k e e P .
depreciation & any accumulated Issuance of bonds payable
impairment loss.
❖ The revaluation model means that PPE PFRS 9, paragraph 5.1.1, provides the asset
are carried at revalued carrying amount acquired by issuing bonds payable is measured
➔ REVALUED CARRYING AMOUNT - is in the following order:
the fair value at the date of
revaluation less any subsequent a. Fair value of bonds payable
accumulated impairment loss b. Fair value of asset received
c. Face amount of bonds payable
Acquisition on a cash basis
Exchange
 The cost of an item of PPE is the cash price
equivalent at the recognition date. ➢ PAS 16, paragraph 24, provides that the
 The cost of asset acquired on a cash basis cost of an item of PPE acquired in
simply includes the cash paid + directly exchange for a nonmonetary asset or a
attributable costs (as freight, installation combination of monetary and
cost and other cost necessary in bringing nonmonetary asset is measured at fair
asset to the location and condition for the value plus any cash payment.
intended use.) ➢ However, the exchange is recognized at
carrying amount if the exchange
Acquisition on account transaction lacks commercial substance.
● Commercial substance is a new
 When an asset is acquired on account notion and is defined as the event or
subject to a cash discount, the cost of the transaction causing the cash flows of
asset is equal to the invoice price minus the the entity to change significantly by
discount, (regardless of whether the reason of the exchange.
discount is taken or not) ➔ An exchange transaction has
 Cash discounts are generally considered commercial substance when the
as reduction of cost and not as income. cash flows of the asset received
differ significantly from the cash
Acquisition on installment basis flows of the asset transferred.
 When payment for item of PPE is deferred Construction
beyond normal credit terms, the cost is the
cash price equivalent. The cost of self-constructed asset is determined
 In other words, if an asset is offered at a using the same principles as for an acquired
cash price and at an installment price and asset.
is purchased at the installment price, the
asset shall be recorded at the cash price. 1) Direct cost of materials
 The excess of the installment price over the 2) Direct cost of labor
cash price is treated as an interest to be 3) Indirect cost and incremental overhead
amortized over the credit period. specifically identifiable or traceable to
the construction.
Issuance of share capital PAS 16, paragraph 22, provides that the cost of
abnormal amount of wasted material, labor or
 Philippine GAAP provides that if shares are overheard incurred in the production of self-
issued for consideration other than actual constructed asset is not included in the cost of
cash, the proceeds shall be measured by the asset.
the fair value of the consideration
received. Derecognition
 Accordingly, where a property is acquired
through the issuance of share capital, the
➢ means that the cost of the PPE together with
property shall be measured at an amount
the related accumulated depreciation shall
equal to the following in the order of
be removed from the statement of financial
priority:
position.
a. Fair value of the property received
➢ PAS 16, paragraph 67, provides that the
b. Fair value of the share capital
carrying amount of an item of PPE shall be
c. Par value or stated value of the
derecognized on disposal or when no future
share capital
economic benefits are expected from the use
or disposal.
44 | M i k e e P .
➢ The gain or loss from the derecognition of an DEPRECIATION PERIOD
item of PPE shall be included in profit or loss.
➢ The depreciable amount of an asset shall be
➔ Gains shall not be included in
allocated on a systematic basis over the
revenue but treated as other income.
useful life.
➢ The gain or loss arising from the derecognition
➢ Depreciation of an asset begins when it is
of an item of PPE shall be determined as the
available for use, meaning, when the asset
difference between the net disposal
is in the location and condition necessary for
proceeds and the carrying amount of the
the intended use by management.
item.
➢ Depreciation ceases when the asset is
derecognized.
Fully Depreciated Property
➔ Therefore, depreciation does not
➢ A property is said to be fully depreciated cease when the asset becomes idle
when the carrying amount is equal to zero, temporarily.
or the carrying amount is equal to the ➔ Temporary idle activity does not
residual value. preclude depreciating the asset as
➢ In such a case, the asset account and the future economic benefits are
related accumulated depreciation consumed not only through usage but
account are closed and the residual value also through wear and tear and
is set up in a separate account. obsolescence.
➢ However, it is not uncommon for an entity to
continue to use an asset after it has been
fully depreciated. ➢ In order to properly compute the amount of
➢ The cost of fully depreciated asset depreciation, 3 factors are necessary,
remaining in service and the related namely depreciable amount, residual value
accumulated depreciation ordinarily shall and useful life.
not be removed from the accounts.
1. DEPRECIABLE AMOUNT
➢ However, entities are encouraged but not
required to disclose fully depreciated ➔ is the cost of an asset or other amount
property. substituted for cost, less the residual
value.
➔ Each part of an item of PPE with a cost
that is significant in relation to the total
 defined as the systematic allocation of the cost of the item shall be depreciated
depreciable amount of an asset over the separately.
useful life. ★ For example, it may be
 not so much a matter of valuation. appropriate to depreciate
 is a matter of cost allocation in recognition separately the airframe,
of the exhaustion of the useful life of an item engines, fittings (seats and floor
of PPE. coverings) and tires of an
 OBJECTIVE: to have each period benefiting aircraft.
from the use of the asset bear an equitable ➔ The entity also depreciates separately
share of the asset cost. the remainder of the item and the
remainder consists of the parts of the
DEPRECIATION IN THE FINANCIAL STATEMENTS item that are individually not
➢ Depreciation is an expense. significant.
➢ Depreciation may be a part of the cost of 2. RESIDUAL VALUE
goods manufactured or an operating ➔ is the estimated net amount currently
expense. obtainable if the asset is at the end of
➢ The depreciation charge for each period the useful life.
shall be recognized as expense unless it is ➔ The residual value of an asset shall be
included in the carrying amount of another reviewed at least at each financial
asset. year-end and if expectation differs
from previous estimate, the change
shall be accounted for as a change in
an accounting estimate.
➔ The residual value of an asset may
increase to an amount equal to or
greater than the carrying amount.

45 | M i k e e P .
➔ If it does, the depreciation charge is  STRAIGHT LINE METHOD
zero unless and until the residual value
➔ Under the straight line method, the
subsequently decreases to an amount
annual depreciation charge is
below the carrying amount.
calculated by allocating the depreciable
➔ Depreciation is recognized even if the
amount equally over the number of years
fair value of the asset exceeds the
of useful life.
carrying amount as long as the residual
➔ In other words, straight line depreciation
value does not exceed the carrying
is a constant charge over the useful life of
amount.
the asset.
3. USEFUL LIFE ➔ The straight line method is adopted when
➔ Useful life is either the period over the principal cause of depreciation is
which an asset is expected to be passage of time.
available for use by the entity, or the ➔ The straight line approach considers
number of production or similar units depreciation as a function of time rather
expected to be obtained from the than as a function of usage.
asset by the entity.
 PRODUCTION METHOD
➔ The production or output method
A. EXPECTED USAGE OF THE ASSET - Usage is assumes that depreciation is more a
assessed by reference to the asset's function of use rather than passage of
expected capacity or physical output. time.
B. EXPECTED PHYSICAL WEAR AND TEAR - This ➔ The useful life of the asset is considered in
depends on the operational factors: terms of the output it produces or the
● no. of shifts the asset is used, number of hours it works.
● the repair and maintenance  Thus, depreciation is related to the
program, & estimated production capability of
● the care and maintenance of the asset and is expressed in a rate
the asset while idle. per unit of output or per hour of
C. TECHNICAL OR COMMERCIAL OBSOLESCENCE use.
- This arises from changes or improvements in ➔ The production method is adopted if the
production, or change in the market demand principal cause of depreciation is usage
for the product output of the asset.
D. LEGAL LIMITS for the use of the asset, such as  DIMINISHING BALANCE METHOD (accelerated
the expiry date of the related lease. methods)
➔ provide higher depreciation in the earlier
Depreciation method years and lower depreciation in the later
years of the useful life of the asset.
➢ The depreciation method shall reflect the  Thus, these methods result in a
pattern in which the future economic benefits decreasing depreciation charge
from the asset are expected to be consumed over the useful life.
by the entity. ➔ The accelerated depreciation is on the
➢ The depreciation method shall be reviewed philosophy that new assets are generally
at least at every year-end. capable of producing more revenue in
➢ If there has been a significant change in the the earlier years than in the later years.
expected pattern of economic benefits, the ➔ The accelerated methods include sum of
method shall be changed to reflect the years' digits method and double
changed pattern. declining balance method.
➔ Such change shall be accounted for as
a change in accounting estimate.
➢ A variety of depreciation methods can be
used.
➢ Depreciation methods include straight line,
production method and diminishing balance
method.

46 | M i k e e P .
CHAPTER 16
Government Grant (PAS 20)

 Grant in recognition of specific expenses shall

be recognized as income over the period of
 PAS 20, paragraph 3, defines government the related expense.
grant as assistante by government in the  Accordingly, the grant of P15,000,000 is
form of transfer of resources to an entity in allocated as income over three years in
return for part or future compliance with proportion to the costs incurred.
certain conditions relating to the operating
activities of the entity. Journal entries-first year

Cash 15,000,000
Deferred grant income 15,000,000
Government grant shall be recognized when
there is reasonable assurance that: Deferred grant income 3,000,000
 The entity will comply with the conditions Grant income 3,000,000
attaching to the grant.
 The grant will be received. Environmental expenses 2,000,000
Cash 2,000,000
Government grant shall not be recognized:
 on a cash basis -- as this is not consistent
First year (2/10 x 15,000,000) 3,000,000
with generally accepted accounting
Second year (3/10 x 15,000,000) 4,500,000
practice.
Third year (5/10 x 15,000,000) 7,500,000
15,000,000

Illustration 2
a. GRANT RELATED TO ASSET
➢ This is a government grant whose primary An entity received a grant of P50,000,000 from
condition is that an entity qualifying for the Australian government for the acquisition of
the grant shall purchase, construct or a chemical facility with an estimated cost of
otherwise acquire long-term assets. P80,000,000 and useful life of 6 years.
b. GRANT RELATED TO INCOME
➢ By residual definition, this is government  Grant related to depreciable asset shall be
grant other than grant related to asset. recognized as income over the periods and
in proportion to the depreciation of the
Accounting for government grant related asset
 Accordingly, the grant of P50,000,000 is
● Government grant shall be recognized as allocated an income over 5 years
income on a systematic basis over the depending on the method of depreciation.
periods in which an entity recognizes as  The straight line method is used.
expenses the related costs for which the
grant is intended to compensate. Journal entries for first year
● In other words, the grant is taken to income
over one or more periods in which the 1. Cash 50,000,000
related cost is incurred Deferred grant income 50,000,000

2. Building 80,000,000
Illustration 1
Cash 80,000,000
An entity received a grant of P15,000,000 from
3. Depreciation 16,000,000
the national government for the purpose of
Accumulated depreciation 16,000,000
defraying safety and environmental expenses
(80,000,000/5)
over the period of three years.
4. Deferred grant income 10,000,000
The safety and environmental expenses will be
Grant income 10,000,000
incurred by the entity as follows:
(50,000,000/5)
First year 2,000,000
Second year 3,000,000
Third year 5,000,000
10,000,000
47 | M i k e e P .
Illustration 3 Presentation of government grant
An entity is granted a large tract of land in
 Government grant related to asset shall be
Mindanao by the national government.
presented in the statement of financial position
 The fair value of the land is P60,000,000. in either of two ways:
 The grant requires that the entity shall  By setting the grant as deferred income.
construct a refinery on the site.  By deducting the grant in arriving at the
 The cost of the refinery is estimated to carrying amount of the asset.
be P100,000,000 and the useful life is 20
years.  Government grant related to income is
 Grant related to nondepreciable asset presented as follows:
requiring fulfillment of certain conditions  The grant is presented in the income
shall be recognized as income over the statement, either separately or under
periods which bear the cost of meeting the the general heading "other income."
conditions.  Alternatively, the grant is deducted from
 Accordingly, the grant of P60,000,000 is the related expense.
allocated over 20 years.
Illustration
Journal entries in the first year ● At the beginning of current year, an entity
purchased an equipment for P5,000,000
1. Land 60,000,000
and received a government grant of
Deferred grant income 60,000,000
P500,000 with respect to this asset.
2. Refinery 100,000,000 ● The equipment is to be depreciated on a
Cash 100,000,000 straight line basis over5 years. The estimated
residual value of the equipment is P200,000.
3. Depreciation 5,000,000
Accumulated depreciation 5,000,000
(100,000,000/20)
1. To record the acquisition of the equipment:
4. Deferred grant income 3,000,000
Grant income 3,000,000 Equipment 5,000,000
(60,000,000/20) Cash 5,000,000

Illustration 4 2. To record the government grant as deferred

income:
An entity received grant of P50,000,000 from the
USA government to compensate for massive Cash 500,000
losses incurred because of a recent Deferred grant income 500,000
earthquake..
3. To record annual depreciation:
A government grant that becomes receivable
Depreciation 960,000
as compensation for expenses or losses already
Accumulated depreciation 960,000
incurred or for the purpose of giving immediate
financial support to the entity with no further
related costs shall be recognized as income of Cost of equipment 5,000,000
the period in which it becomes receivable. Residual value (200,000)
Depreciable amount 4,800,000
Accordingly, the grant of P50,000,000 is
recognized as income immediately. Annual depreciation 960,000
(4,800,000 / 5 years)
Cash 50,000,000
Grant income 50,000,000 4. To recognize the income from government
grant for the current year:

Deferred grant income 100,000

Grant income 100,000
(500,000/5 years)

48 | M i k e e P .
1. To record the acquisition of the equipment:  The accounting policy adopted for
government grant, including the method of
Equipment 5,000,000 presentation adopted in the financial
Cash 5,000,000 statements.
 The nature and extent of government grant
2. To record the government grant as a deduction recognized in the financial statements and
from the cost of the asset: an indication of other forms of government
Cash 500,000 assistance from which the entity has directly
Equipment 500,000 benefited.
 Unfulfilled conditions and other
3. To record the annual depreciation: contingencies attaching to government
assistance that has been recognized.
Depreciation 860,000
Accumulated depreciation 860,000  It is not required to disclose the name of the
government agency that gave the grant
Acquisition cost 5,000,000 along with the date of sanction of the grant
Government grant ( 500,000) by such government agency and the date
Net cost 4,500,000 when cash was received in case of monetary
Residual value ( 200,000) grant.
Depreciable amount 4,300,000
Annual depreciation 860,000
(4,300,000/5 years)

Government assistance
● Government assistance is action by
government designed to provide an
economic benefit specific to an entity or
range of entities qualifying under certain
criteria. The essence of government
assistance is that no value can reasonably
be placed upon it

Examples of government assistance are:

 Free technical or marketing advice

 Provision of guarantee
 Government procurement policy that is
responsible for a portion of the entity's
sales.

Government assistance does not include the

following indirect benefits or benefits not
specific to an entity:

 Infrastructure in development areas such as

improvement to the general transport and
communication network.
 Imposition of trading constraints on
competitors.
 Improved facilities such as irrigation for the
benefit of an entire local community.

49 | M i k e e P .
Chapter 17
Borrowing Cost (PAS 23)

Accounting for borrowing cost

➢ (Under PAS 23, prg 5) borrowing costs are
- PAS 23, paragraph 8, mandates the
defined as interest and other costs that an
following rules on borrowing cost:
entity incurs in connection with borrowing of
funds. 1. If the borrowing is directly attributable to the
➢ Parag 6 provides that borrowing costs acquisition, construction or production of a
specifically include: qualifying asset, the borrowing cost is
a. Interest expense calculated using the required to be capitalized as cost of the
effective interest method. asset.
b. Finance charge with respect to a  In other words, the capitalization of
finance lease. borrowing cost is mandatory for a
c. Exchange difference arising from qualifying asset.
foreign currency borrowing to the  Borrowing cost can be capitalized
extent that it is regarded as an when the asset is a qualifying asset
adjustment to interest cost. and it is probable that the borrowing
cost will result to future economic
benefit and the cost can be
➢ A qualifying asset is an asset that necessarily measured reliably.
takes a substantial period of time to get
2. All other borrowing costs shall be expensed
ready for the intended or sale.
as incurred
Examples include the following:  In other words, if the borrowing is not
directly attributable to a qualifying
. asset, the borrowing cost is expensed
. immediately.
.
.
Asset financed by specific borrowing
➢ PAS 23, paragraph 12, provides that if the
funds are borrowed specifically for the
- PAS 23 does not require capitalization of purpose of acquiring a qualifying asset, the
borrowing costs relating to the following: amount of capitalizable borrowing cost is the
actual borrowing cost incurred during the
A. Asset measured at fair value, such as period less any investment income from the
biological asset temporary investment of those borrowings.
B. Inventory that is manufactured in large
quantity on a repetitive basis, such as Illustration
maturing whisky, even if it takes a At the beginning of the current year, an entity
substantial period of time to get ready for
obtained a loan of P4,000,000 at an interest rate
sale of 10%, specifically to finance the construction
C. Asset that is ready for the intended use or
of new building. The building was completed at
sale when acquired. the current year-end.

Availments from the loan were made quarterly

in equal amounts. Total borrowing cost incurred
amounted to P250,000 for the current year.

50 | M i k e e P .
Prior to their disbursement, the proceeds of the Average carrying amount of the building
borrowing were temporarily invested and
earned interest income of P40,000. (a)
(b)
MONTHS
date EXPENDITUR (a x b) AMOUNT
OUTSTANDI
Actual borrowing cost 250,000 ES
NG
Interest income from investment of proceeds(40,000)
Jan.1 400,000 12 4,800,000
Capitalizable borrowing cost 210,000
March 31 1,000,000 9 9,000,000
Asset financed by general borrowing
June 30 1,200,000 6 7,200,000
➢ PAS 23, paragraph 14, provides that if the
funds are borrowed generally and used for Sept. 30 1,000,000 3 3,000,000
acquiring a qualifying asset, the amount of
capitalizable borrowing cost is equal to the Dec. 31 400,000 0 –
average carrying amount of the asset during
the period multiplied by a capitalization rate 24,000,000
or average interest rate.
Average carrying amount 2,000,000
- However, the capitalizable borrowing
(24,000,000 / 12)
cost shall not exceed the actual
interest incurred. >>> Another Approach <<<
➢ The capitalization rate or average interest
rate is equal to the total annual borrowing date
(a) (b) (a x b)
cost divided by the total general borrowings EXPENDITURES FRACTION AMOUNT
outstanding during the period.
Jan. 1 400,000 12 / 12 400,000
➢ No specific guidance is provided for general
borrowing with respect to investment income.
March 31 1,000,000 9 / 12 750,000
➢ Accordingly, any investment income from
general borrowing is not deducted from June 30 1,200,000 6 / 12 600,000
capitalizable borrowing cost.
Sept. 30 1,000,000 3 / 12 250,000
Illustration
Dec.31 400,000 – –
An entity had the following borrowings on
January 1 of the current year. The borrowings Average carrying amount 2,000,000
were made for general purposes and the
proceeds were partly used to finance the  The capitalization rate is computed by dividing
construction of a new building. the total annual borrowing cost by the total
Principal Borrowing cost general borrowings.
10% bank loan 3,000,000 300,000 - Thus, P760,000 divided by P8,000,000
12% short-term note 1,500,000 180,000 equals 9.5%.
8% long-term loan 3,500,000 280,000 .
8,000,000 760,000  The amount of capitalizable borrowing cost is
the average carrying amount of the building
The construction of the building was started on
multiplied by the capitalization rate.
January 1 and was completed on December 31
of the current year. - Thus, P2,000,000 x 9.5% equals P190,000.

January 1 400,000  The capitalizable borrowing cost shall not

March 31 1,000,000 exceed the actual borrowing cost.
June 30 1,200,000  The amount of P190,000 is the proper
September 30 1,000,000 capitalizable borrowing cost because it is less
December 31 400,000 than the actual borrowing cost of P760,000.
Total expenditures on the building 4,000,000
 The excess of P760,000 over P190,000 or
P570,000 is charged to interest expense.

51 | M i k e e P .
Asset financed both by specific COMMENCEMENT OF CAPITALIZATION
and general borrowing
The capitalization of borrowing costs as part of
the cost of a qualifying asset shall commence
At the beginning of the current year, an entity
borrowed P1,500,000 at an interest of 10% when the following three conditions are present:
specifically for the construction of a new
building. The actual borrowing cost on this loan A. When the entity incurs expenditures for
is P150,000. the asset.
B. When the entity incurs borrowing costs.
The entity had also outstanding during the year C. When the entity undertakes activities that
a 5-year 8% general borrowing of P7,000,000.
are necessary to prepare the asset for the
The construction of the building started on intended use or sale.
January 1 and was completed on December 31
of the current year. ACTIVITIES NECESSARY TO PREPARE
January 1 500,000
➢ The activities necessary to prepare the asset
April 1 1,000,000
May 1 1,500,000 for the intended use or sale encompass
September 1 1,500,000 more than the physical construction of the
December 31 500,000 . asset.
Total Cost 5,000,000 ➢ These include technical and administrative
work prior to the commencement of
date (a) (b) (A x B)
EXPENDITURES FRACTION AMOUNT physical construction, such as drawing up
plans and obtaining permits for a building.
Jan. 1 500,000 12 / 12 500,000 ➢ However, merely holding assets for use or
April 1 1,000,000 9 / 12 750,000 development without any associated
development activity does not qualify for
May 1 1,500,000 8 / 12 1,000,000 capitalization.
★ For example, borrowing costs incurred
Sept.1 1,500,000 4 / 12 500,000
while land is under development are
Dec. 31 500,000 – – capitalized during the period in which
development activities are being
Average carrying amount 2,750,000
undertaken.
➢ But borrowing costs incurred while land
Specific borrowing (1,500,000)
acquired for building purposes is held
without any associated development
Applicable to general borrowing 1,250,000
activity do not qualify for capitalization.

CAPITALIZABLE INTEREST
Suspension of capitalization
➢ Capitalization of borrowing costs shall be
Specific Borrowing 150,000
suspended during extended periods in
(10% X 1,500,000)
which active development is interrupted
General Borrowing 100,000  However, capitalization of borrowing
(8% X 1,250,000) costs is not normally suspended during
TOTAL CAPITALIZABLE INTEREST 250,000 a period when substantial technical
and administrative work is being
carried out.
➢ Capitalization of borrowing costs is not also
suspended when a temporary delay is a
necessary part of the process of getting an
asset ready for its intended use or sale.

52 | M i k e e P .
★ For example, capitalization continues
during the extended period that high
water levels delay the construction of
a bridge, if such high water levels are
common during the construction
period in the georgraphical region
involved.

Cessation of capitalization
➢ Capitalization of borrowing costs shall cease
when substantially all the activities
necessary to prepare the qualifying asset for
the intended use or sale are complete.
➢ An asset is normally ready for the intended
use or sale when the physical construction
of the asset is complete even though routine
administrative work might still continue.

Disclosures related to borrowing

costs
 The amount of borrowing costs capitalized
during the period.
 The capitalization rate used to determine
the amount of borrowing costs eligible for
capitalization.

~ Segregation of assets that are "qualifying

assets" from other assets in the statement of
financial position is not required to be disclosed.

53 | M i k e e P .
CHAPTER 18
Investment in Associates (PAS 28)

 Associate is simply defined as an entity over

which the investor has significant influence. ● The investment in associate is measured using
 Significance influence is the power to the equity method of accounting.
participate in the financial and operating ● The equity method is based on the economic
policy decisions of the associate but not relationship between the investor and the
control or joint control over those policies. investee.
 The assessment of significant influence is a ● The investor and the investee are viewed as a
single economic unit. The investor and the
matter of judgment.
investee are one and the same.
 However, PAS 28, paragraph 5, provides a ● The equity method is applicable when the
practical guidance to assist management in investor has a significance influence over the
making such assessment. investee.
 If the investor holds, directly or indirectly
through subsidiaries, 20% or more of the ACCOUNTING PROCEDURES
voting power of the investee, it is presumed - EQUITY METHOD -
that the investor has significant influence,
unless it can be clearly demonstrated that (a) The investment is initially recognized at cost.
this is not the case. (b) The carrying amount is increased by the
 Conversely, if the investor holds, directly or investor's sharo of the profit of the investee
indirectly through subsidiaries, less than 20% and decreased by the investor's share of the
of the voting power of the investee, it is loss of the investee.
presumed that the investor does not have
➢ The investor's share of the profit or loss of
significant influence, unless such influence the investee is recognized as investment
can be clearly demonstrated.
income.
 A substantial or majority ownership by (c) Dividends received from an equity investee
another investor does not necessarily
reduce the carrying amount of the
preclude an investor from having significant investment.
influence
(d) Note that the investment must be in ordinary
Beyond the mere 20% threshold of ownership, shares
PAS 28, paragraph 6, provides that the existence ➢ If the investment is in preference shares,
of significant influence is usually evidenced by the equity method is not appropriate
the following factors: regardless of the percentage because
the preference share is a nonvoting
a. Representation in the board of directors equity.
b. Participation in policy making process (e) Technically, if the investor has significant
c. Material transactions between the influence over the investee, the investee is
investor and the investee said to be an associate
d. Interchange of managerial personnel. ➢ Accordingly, under the equity method,
e. Provision of essential technical the investment in ordinary shares should
information be appropriately described as
investment in associate.
(f) The investment in associate accounted for
using the equity method shall be reported as
noncurrent asset.

54 | M i k e e P .
Illustration - equity method

1) On January 1, 2020, an investor purchased ● An accounting problem arises if the investor

20,000 shares of the 100,000 outstanding pays more or less for an investment than the
ordinary shares of another entity at P200 per carrying amount of underlying net assets.
share ● For example, if the earning potential of the
investee is: abnormally high, the current
The investment represents a 20% equity value of the investee's net assets is
interest and the investor has a significant frequently higher than their carrying
influence over the investee. amount.

Investment in associate 4,000,000 If the investor pays more than the carrying
Cash 4,000,000 amount of the net Assets acquired, the
difference is commonly known as "excess of cost
2) The investee reported net income of over carrying amount" and may be attributed to
P5,000,000 for 2020. the following:

The investor recognized a share of the net a. Undervaluation of the investee's assets,
income of the investee equal to 20% of such as building land and inventory.
P5,000,000 or P1,000,000. b. Goodwill

Investment in associate 1,000,000 ● If the assets of the investee are fairly valued,
Investment income 1,000,000 the excess of cost over carrying amount of
the underlying net assets is attributable to
3) Received a 25% share dividend from the goodwill
investee on December 31, 2020 ● If the excess is attributable to
undervaluation of a depreciable asset, it is
Memo-Received 5,000 ordinary shares as 25% amortized over the remaining life of the
share dividend on 20,000 original shares. depreciable asset.
Shares now held, 25,000 shares ● If the excess is attributable to
undervaluation of land, it is not amortized
Note that the 20% equity interest is not because the land is nondepreciable
affected by the share dividend. The equity ● The amount is expensed when the land is
interest is the same before and after the share sold
dividend ● If the excess is attributable to inventory, the
amount is expensed when the inventory is
already sold
4) The investee reported a net loss of P1,000,000 ● If the excess is attributable to goodwill, it is
for 2021 included in the carrying amount of the
investment and not amortized
The investor recognized a share in the net loss ● However, the entire investment in associate
of the investee equal to 20% of P1,000,000 or including the goodwill is tested for
P200,000. impairment at the end of each reporting
period.
Loss on investment 200,000
Investment in associate 200,000 Illustration

5) The investee declared and paid a cash At the beginning of the current year, an investor
dividend P2,500,000 on ordinary shares on purchased 20% of the outstanding ordinary
December 31, 2021. shares of an investee for P5,000,000.

● The net assets of the investee on the date

The investor recognized a share in the cash of acquisition are fairly valued. Any excess
dividend paid by the investee equal to 20% of is attributable to goodwill.
P2,500,000 or P500,000. ● The carrying amount of the investeo's not
Cash 500,000 assets was P20.000.000 equal to fair value.
Investment in associate 500,000 The investor therefore paid P1,000,000 in
excess of the carrying amount of net
Under the equity method, cash dividend is not assets.
an income but a REDUCTION OF INVESTMENT.

55 | M i k e e P .
Acquisition cost 5,000,0000  Since goodwill is not separately recognized
Carrying amount of net assets acquired from the investment amount, the impairment
(20% x 20,000,000) 4,000,000 loss recognized is applied to the investment
Excess of cost over carrying 1,000,000 as a whole.
amount - goodwill  The recoverable amount of an investment in
an associate is assessed for each individual
Excess of fair value over cost
associate.
PAS 28, paragraph 32, provides that any excess
of the investor's share of the net fair value of the  Investee with cumulative preference shares
associate's identifiable assets and liabilities over
the cost of the investment is included as income ➢ When an associate has outstanding
in the determination of the investor's share of the cumulative preference shares, the investor
associate's profit or loss in the period in which the shall compute its share of earnings or losses
investment is acquired. after deducting the preference dividends,
whether or not such dividends are
Illustration declared

At the beginning of the current year, an investor  Investee with noncumulative preference shares
purchased 40% of the ordinary shares
outstanding of an investee for P10,000,000 when ➢ When an associate has outstanding
the net assets of the investee amounted to noncumulative preference shares, the
P30,000,000. investor shall compute its share of earnings
after deducting the preference dividends
At acquisition date, the carrying amounts of the only when declared.
identifiable assets and liabilities of the investee
were equal to fair value. Discontinuance of equity method
Acquisition cost 10,000,000
● PAS 28, paragraph 22, provides that an
Fair value of net assets acquired investor shall discontinue the use of the equity
(40% x 30,000,000) 12,000,000 method from the date that it ceases to have
Excess fair value 2,000,000 significant influence over an associate,
Consequently, the investor shall account for the
The excess fair value is included in investment investment as follows:
income of the investor on the date of
acquisition.  Financial asset at fair value through profit
or loss
Investment in associate 2,000,000  Financial asset at fair value through other
Investment income comprehensive income.
 Nonmarkeble investment at cost or
investment in unquoted equity
instrument.
 If there is an indication that an investment in
associate may be impaired, an impairment PAS 28, Basis for Conclusion 18, requires an
loss shall be recognized whenever the investor that continues to have significant
carrying amount of the investment in influence over an associate to apply the equity
associate exceeds recoverable amount. method even if the associate is operating under
 The recoverable amount is measured as the severe long-term restrictions that significantly
higher between fair value less cost of disposal impair the ability to transfer funds to the investor.
and value in use.
 Fair value is the price that would be received Significant influence must be lost before the
to sell an asset in an orderly transaction equity method ceases to be applicable.
between market participants at the
measurement date. Measurement after loss of significant
 Value in use is the present value of the influence
estimated future cash flows expected to arise
from the continuing use of an asset and from ● PAS 28, paragraph 22, provides that on the
the ultimate disposal. date the significant influence is lost, the
investor shall measure any retained
investment in associate at fair value.

56 | M i k e e P .
● The fair value of the investment at the date it
ceases to be an associate shall be regarded
as the fair value on initial recognition as a
financial asset.
● The difference between the carrying amount
of the retained investment at the date the
significant influence is lost and the fair value
of the retained investment shall be included
in profit or loss.
● Of course, the difference between the net
proceeds from disposal of part of the
investment and the carrying amount of the
investment sold is recognized as gain or loss
on disposal of investment.

Equity method not applicable

PAS 28, paragraph 17, provides that an
investment in associato shall not be accounted
for using the equity method if the investor is a
parent that is exempt from preparing
consolidated financial statements or if all of the
following apply:

 The investor is a wholly-owned subsidiary,

or a partially owned subsidiary of another
entity and the other owners do not object
to the investor not applying the equity
method
 The investor's debt and equity instruments
are not traded in a public market or "over
the counter" market.
 The investor did not file or is not in the
process of filing financial statements with
the SEC for the purpose of issuing any class
of instruments in a public market.
 The ultimate or any intermediate parent of
the investor produces consolidated
financial statements available for public
use that comply with Philippine Financial
Reporting Standards.

In these circumstances, the investment is

accounted for as follows:

a) Financial asset at fair value through profit

or loss
b) Financial asset at fair value through other
comprehensive income.
c) Nonmarketable investment at cost or
investment in unquoted equity instrument.

57 | M i k e e P .
CHAPTER 19
Impairment of Assets (PAS 36)

● Impairment is a fall in the market value of an EXTERNAL SOURCES

asset so that the recoverable amount is now
less than the carrying amount in the a. Significant decrease or decline in the market
statement of financial position. value of the asset as a result of passage of
● The carrying amount is the amount at which time or normal use or a new competitor
an asset is recognized in the statement of entering the market.
financial position after deducting b. Significant change in the technological,
accumulated depreciation and market, legal or economic environment of
accumulated impairment loss. the business in which the asset is employed.
➢ This could be as simple as a change in
customer taste.
c. An increase in the interest rate or market rate
● The basic principle underlying impairment of of return on investment which will likely affect
asset is relatively straightforward. the discount rate used in calculating the
● There is an established principle that an asset value in use.
shall not be carried at above the recoverable d. The carrying amount of net assets of the entity
amount. is more than the "market capitalization."
● An entity shall write down the carrying ➢ In other words, the carrying amount
amount of an asset to the recoverable exceeds the fair value of the net
amount if the carrying amount is not assets.
recoverable in full. ➢ The market capitalization simply
● If the carrying amount is higher than the means the fair value of the net assets
recoverable amount, the asset is judged to of the entity.
have suffered an impairment loss.
● The asset shall therefore be reduced by the INTERNAL SOURCES
amount of the impairment loss.
a. Evidence of obsolescence or physical
ACCOUNTING FOR IMPAIRMENT damage of an asset.
b. Significant change in the manner or extent in
In this regard, there are three main accounting which the asset is used with an adverse effect
issues to consider, namely: on the entity. For example, the asset is part of
 Indication of possible impairment a restructuring or held for sale or the asset is
 Measurement of the recoverable amount idle.
 Recognition of impairment loss c. Evidence that the economic performance of
an asset will be worse than expected.
INDICATION OF IMPAIRMENT  For example, the undiscounted not
cash flows from the asset are
 An entity shall assess at each reporting date significantly worse than those
whether there is any indication that an asset budgeted.
may be impaired.  The external and internal sources of
 If any such indication exists, the entity information are not exhaustive. An entity may
shall estimate the recoverable amount of identify other indications that an asset may
the asset. be impaired.
 However, irrespective of whether there is any
indication of impairment, an entity shall test Measurement of recoverable amount
an intangible asset with an indefinite useful
life or an intangible asset not yet available for ● After establishing evidence that an asset has
use for impairment annually by comparing been impaired, the next step is to determine
the carrying amount with the recoverable the recoverable amount preparatory to the
amount. recognition of an impairment loss.
 The events and changes in circumstances ● The recoverable amount of an asset is the fair
that lead to an impairment of assets may be value less cost of disposal or value in use,
classified as external and internal sources of whichever is higher.
information.
58 | M i k e e P .
Fair value less cost of disposal Estimates of future cash flows do not
● FAIR VALUE is the price that would be received include:
to sell an asset in an orderly transaction a. Future cash flows relating to restructuring to
between market participants at the which the entity is not yet committed.
measurement date. b. Future costs of improving or enhancing the
● Cost of disposal is an incremental cost directly asset's performance.
attributable to the disposal of an asset, c. Cash inflows or outflows from financing
excluding finance cost and income tax activities.
expense. d. Income tax receipts or payments.
 Examples of cost of disposal include
legal cost, stamp duty and similar RECOGNITION OF IMPAIRMENT LOSS
transaction tax, cost of removing the
asset, and direct cost in bringing the ● If the recoverable amount of an asset is less
asset into condition for sale. that the carrying amount, an impairment
● In simple terms, fair value less cost of disposal loss has occurred.
is equal to the exit price or selling price of an ● The impairment loss shall be recognized
asset minus cost of disposal. immediately by reducing the asset's
carrying amount to its recoverable amount.
● The impairment loss is recognized in profit or
loss and presented separately in the income
● Value in use is measured as the present
statement.
value or discounted value of future net
cash flows expected to be derived from an Illustration
asset.
● The cash flows are pretax cash flows and At year-end, an entity has a machinery with the
pretax discount rate is applied in following cost and accumulated depreciation:
determining the present value.
Machinery 5,000,000
Accumulated depreciation 2,000,000
(5-year life, 2 years expired)
Calculating a value in use calls for estimates of Carrying amount 3,000,000
future cash flows and there is the possibility that
an entity might come up with "overoptimistic" Due to obsolescence and physical damage,
estimates of cash flows. the machinery is found to be impaired.
a. Cash flow projections shall be based on The entity has determined the following
reasonable and supportable assumptions. information with respect to the machinery at
b. Cash flow projections shall be based on year-end:
the most recent budgets on financial
forecasts, usually up to a maximum period Fair value less cost of disposal 2,400,000
of 5 years, unless a longer period can be Value in use 2,200,000
justified.
c. The discount rate used in estimating future Journal entry
cash flows is the current pretax rate.
Impairment loss 600,000
Composition of estimates of future cash Accumulated depreciation 600,000

flows includes Carrying amount 3,000,000

Fair value less cost of disposal 2,400,000
a. Projections of cash inflows from the (recoverable amount)
continuing use of the asset. Impairment loss 600,000
b. Projections of cash outflows necessarily
 Note that the fair value less cost of disposal is
incurred to generate the cash inflows from
considered the recoverable amount and used
the continuing use of the asset. in computing the impairment loss because it is
c. Net cash flows received or paid on the higher than the value in use.
disposal of the asset at the end of its useful  After the recognition of an impairment loss, the
life in an arm's length transaction. depreciation charge for the asset shall be
adjusted in future periods to allocate the
59 | M i k e e P .
revised carrying amount less residual value on Reversal of an Impairment Loss
a systematic basis over the remaining useful
life. ● PAS 36, paragraph 114, provides that an
impairment loss recognized for an asset in
Another illustration prior years shall be reversed if there has been
a change in the estimate of the recoverable
On December 31, 2020, an entity has a amount.
machinery with the following cost and ● In other words, if the recoverable amount of
accumulated depreciation: an asset that has previously been impaired
turns out to be higher than the current
Machinery 60,000,000
carrying amount, the carrying amount of the
Accumulated depreciation 20,000,000
asset shall be increased to new recoverable
Carrying amount 40,000,000
amount.
● However, PAS 36, paragraph 117, provides
 The entity believes that there has been an that the increased carrying amount of an
impairment of the machinery and asset due to a reversal of an impairment loss
accordingly determines the fair value less shall not exceed the carrying amount that
cost of disposal and value in use. would have been determined, had no
 The fair value cost of disposal is determined to impairment loss been recognized for the asset
be P33,000,000. in prior years.
 The machinery has a remaining life of 5 years ● The reversal of the impairment loss shall be
and is expected to generate an annual recognized immediately in the income
undiscounted net cash inflow of P9,000,000, statement as gain on reversal of impairment
 The appropriate discount rate is 8%. The loss.
present value of an ordinary annuity of 1 at ● But any reversal of an impairment loss on a
5% for 5 periods is 3.99. revalued asset shall be credited to income to
 The value in use is the discounted net cash the extent that it reverses a previous
inflow computed by multiplying the annual revaluation decrease and any excess
undiscounted cash inflow of P9,000,000 by credited directly to revaluation surplus.
the present value factor of 3.99 or
Illustration
P35,910,000.
 The value in use is the recoverable amount On December 31, 2020, the statement of
because it is higher than the fair value less financial position shows the following balances:
cost of disposal.
Machinery 8,000,000
Computation of Impairment Loss Accumulated depreciation 1,000,000
(10-year life, 2 years expired)
Carrying amount 40,000,000 Carrying amount 6,400,000
Recoverable amount 35,910,000
Impairment loss 4,090,000  On the same date, the recoverable amount
of the machinery is determined to be
Journal entries P5,200,000,

1. To record the impairment loss on December 31, Journal entry to record impairment loss
2020:
Impairment loss 1,200,000
Impairment loss 4,090,000 Accumulated depreciation 1,200,000
Accumulated depreciation 4,090,000 (6,400,000 - 5,200,000)

2. To record depreciation for 2021: ➢ On December 31, 2021, the recoverable

amount of the machinery is P6,000,000,
Depreciation 7,182,000 indicating a reversal of impairment loss.
Accumulated depreciation 7,182,000 ➢ In this case, the "maximum" carrying amount
(35,910,000/5 years) of the machinery should be equal to the
carrying amount that would have been
determined had there been no impairment.

60 | M i k e e P .
Would have been carrying amount on
December 31, 2021
● A cash generating unit is the smallest
Machinery 8,000,000 identifiable group of assets that generate
Accumulated depreciation 2,400,000 cash inflows from continuing use that are
(8,000,000 / 10 x 3 years) largely independent of the cash inflows from
Carrying amount - 5,600,000 other assets or group of assets
December 31, 2021, no impairment ● Simply stated, a cash generating unit is a
segment of business that generates revenue
➢ Accordingly, the carrying amount of the and cash inflows independently.
machinery cannot exceed P5,600,000. ● In practice, a cash generating unit may be a
➢ Therefore, the carrying amount of P5,600,000 department, a product line or a segment of
is the basis of the impairment reversal and not business.
the recoverable amount of P6,000,000 ● As a basic rule, the recoverable amount of an
➢ As a simple guide, the increased carrying asset shall be determined for the asset
amount is the carrying amount assuming individually.
there was no impairment or the recoverable ● However, if it is not possible to estimate the
amount, whichever is lower. recoverable amount of the individual asset,
an entity shall determine the recoverable
Carrying amount with impairment on
amount of the cash generating unit to which
December 31, 2021
the asset belongs.
Machinery 8,000,000
Accumulated depreciation-Dec. 31, 2010 2,800,000 Illustration
(1,600,000 + 1,200,000)
Adjusted carrying amount-Dec. 31, 2020 5,200,000 An entity has determined that a cash
Depreciation for 2021 (5,200,000 / 8) 650,000 generating unit is impaired. The assets of the
Carrying amount-Dec. 31, 2021 per book 4,550,000 cash generating unit at carrying amount are:
with Impairment Building 2,100,000
Land 1,800,000
Journal entries on December 31, 2021
Equipment 1,500,000
1. To record the depreciation for 2021: Inventory 300,000
Carrying amount of CGU 6,000,000
Depreciation 650,000
Accumulated depreciation 650,000  Most often, the recoverable amount of a
cash generating unit. is equal to the value in
2. To record the impairment reversal: use because the unit is not to be disposed of.
 The entity calculated the value in use of the
Accumulated depreciation 1,050,000 cash generating unit to be P4,500,000.
Gain on reversal of impairment 1,050,000
Computation of Impairment Loss
Carrying amount-no impairment 5,600,000
Carrying amount- with impairment 4,550,000 Carrying amount of CGU 6,000,000
Value in use 4,500,000
Gain on reversal of impairment 1,050,000
Impairment loss 1,500,000
3. To record depreciation for 2022:
PAS 36, paragraph 104, provides that when an
Depreciation 800,000 impairment loss is recognized for a cash
Accumulated depreciation 800,000 generating unit, this loss shall be allocated to the
assets of the unit in the following order:
Adjusted carrying amount- Dec. 31, 2021 5,600,000
Divide by remaining life 7 years a. First, to the goodwill, if any.
b. Then, to all other noncash assets of the unit
Annual depreciation for 2022 800,000 pro rata based on their carrying amount.

Since there is no goodwill, the impairment loss is

allocated across the assets based on carrying
amount.

61 | M i k e e P .
Illustration
CARRYING FRACTION LOSS
AMOUNT A cash generating unit reported the following
assets at carrying amount at year-end:
Building 2,400,000 24/60 600,000
Property, plant and equipment 3,000,000
Land 1,800,000 18/60 450,000
Patent 2,000,000
Equipment 1,500,000 15/60 375,000 Goodwill 1,000,000
Carrying amount of CGU 6,000,000
Inventory 300,000 3/60 75,000
 An annual impairment review is required as
6,000,000 1,500,000 the cash generating unit contains goodwill.
 The most recent review assesses the value in
use of the cash generating unit to be
Journal entry to record an P4,500,000.
Impairment Loss
Carrying amount of CGU 6,000,000
Impairment loss 1,500,000 Value in use – recoverable amount 4,500,000
Accumulated depreciation - bldg. 600,000 Impairment loss 1,500,000
Land 450,000
Accumulated depreciation – equip 375,000 ALLOCATION OF IMPAIRMENT LOSS
Inventory 75,000
Impairment loss 1,500,000
Cash generating unit with goodwill Applicable to goodwill 1,000,000
Excess impairment loss 500,000
● Goodwill does not generale cash flows
independently from other assets or group of The excess impairment loss is allocated to the
assets, and therefore, the recoverable other noncash assets pro rata based on carrying
amount of goodwill as an individual asset amount.
cannot be determined.
● As a consequence, if there is an indication Carrying Amount Fraction Loss
that goodwill may be impaired, a PPE 3,000,000 ⅗ 300,000
recoverable amount is determined for the Patent 2,000,000 ⅖ 200,000
cash generating unit to which goodwill 5,000,000 500,000
belongs.
Journal entry to recognize the
DETERMINATION OF IMPAIRMENT impairment loss
PAS 36, paragraph 90, provides that a cash Impairment loss 1,500,000
generating unit to which goodwill has been Goodwill 1,000,000
allocated shall be tested for impairment at least Accumulated depreciation. 300,000
annually by comparing the carrying amount of Patent 200,000
the unit, including the goodwill, with the
recoverable amount.  PAS 36, paragraph 105, provides that the
carrying amount of an asset shall not be
a. If the recoverable amount of the unit reduced below the highest of fair value less
exceeds the carrying amount of the unit, cost of disposal, value in use and zero.
the unit and the goodwill allocated to  The amount of impairment loss that would
that unit shall be regarded as not otherwise have been allocated to the asset
impaired. shall be allocated prorata to the other assets
b. If the carrying amount of the unit exceeds of the cash generating unit.
the recoverable amount of the unit, the
entity must recognize an impairment loss. Reversal of impairment loss on goodwill

● PAS 36, paragraph 124, explicitly provides

that an impairment loss recognized for
goodwill shall not be reversed in a
subsequent period.

62 | M i k e e P .
CHAPTER 20
Intangible Assets (PAS 38)

C. FUTURE ECONOMIC BENEFITS

➢ An intangible asset is simply defined as an ➢ Future economic benefits may include
identifiable nonmonetary asset without revenue from the sale of products or
physical substance. services, cost savings or other benefits
➢ The intangible asset must be controlled by the resulting from the use of the asset by the
entity as a result of past event and from which entity.
future economic benefits are expected to ★ For example, the use of intellectual
flow to the entity. property in a production process or
the legal right to use a new
3 ESSENTIAL CRITERIA OF AN INTANGIBLE technology, may reduce future
- Identifiability, Control, & Future Economic production costs rather than increase
benefits (ICFe) future revenue.

A. IDENTIFIABILITY Recognition of an intangible asset

➢ The definition of an intangible asset requires
An intangible asset shall be recognized if the
that an intangible asset must be identifiable
following conditions are present:
in order to distinguish it clearly from goodwill.
➢ With nonphysical items, there may be a a. It is probable that future economic
problem with identifiability. benefits attributable to the asset will flow to
An asset is identifiable when: the entity.
a. It is separable. b. The cost of the intangible asset can be
➔ This means that the asset is capable of measured reliably.
being separated from the entity and Initial measurement of intangible asset
sold, transferred, licensed, rented or
exchanged, either individually or PAS 38, paragraph 24, provides that an
together with a related asset or liability. intangible asset shall be measured initially at
b. It arises from contractual or other legal cost.
rights.
➔ This is regardless of whether these rights ➢ If an intangible asset is acquired
are transferable or separable from the separately, the cost of the intangible asset
entity or from other rights and can be measured reliably, particularly so if
obligations. the purchase consideration is in the form of
cash or other monetary asset.
B. CONTROL
➢ Another element in the definition of an The cost of a separately acquired intangible
intangible asset is that it must be under the asset comprises:
control of the entity as a result of a past
event. a. Purchase price
➢ CONTROL is the power of the entity to obtain b. Import duties and nonrefundable
the future economic benefits flowing from purchase tax
the intangible asset and restrict the access c. Directly attributable costs of preparing the
of others to those benefits. asset for the intended use
- In other words, the entity must be able
Directly attributable costs include the following:
to enjoy the future economic benefits
from the asset and prevent others from a. Cost of employee benefit arising directly
enjoying the same benefits. from bringing the asset to its working
➢ The capacity of an entity to control the condition.
future economic benefits from an intangible b. Professional fee arising directly from
asset normally would stem from legal rights bringing the asset to its working condition.
that are enforceable in a court of law. c. Cost of testing whether the asset is
➢ The capacity to control future economic functioning properly
benefits is much pronounced in the case of
trademark, copyright and patent.
➢ In the absence of legal rights, it is more
difficult to demonstrate control.
63 | M i k e e P .
Costs which are not capitalizable ❖ PAS 38, paragraph 48,
 provides that internally generated
Examples of costs that are not included in the goodwill shall not be recognized as an
cost of an intangible asset but expensed asset.
immediately are:  Accordingly, such expenditures shall be
expensed when incurred.
● Cost of introducing a new product or
service, including cost of advertising and
promotional activity
● Cost of conducting business in a new 1. An expenditure on an intangible item that
location or with a new class of customer, does not meet the recognition criteria for an
including cost of staff training intangible asset shall be expensed when
● Administration and other general overhead incurred.
cost 2. Examples of expenditures that are expensed
● Cost incurred while an asset capable of when incurred include:
operating in a manner intended by ● Start up costs
management has yet to be brought into use ➔ Start up costs may consist of
● Initial operating loss organization costs such as legal and
secretarial costs incurred in
Internally generated intangible asset establishing a legal entity.
➔ Start up costs also include
➢ The cost of an internally generated preopening costs or expenditures to
intangible asset comprises all directly open a new facility or business, and
attributable costs necessary to create, preoperating costs or expenditures
produce and prepare the asset to be for commencing new operation or
capable of operating it in the manner launching new product.
intended by management. ● Training costs
● Advertising and promotional costs
Examples of directly attributable costs are: ● Business relocation or reorganization
● Cost of materials and services used or costs
consumed in generating the intangible
asset. Subsequent expenditure
● Cost of employee benefit arising from the
generation of the intangible asset. ➢ As a rule, a subsequent expenditure on an
● Fee to register a legal right. intangible asset shall be recognized as
● Amortization of patent used to generate expense.
the intangible asset. ➔ The reason is that most subsequent
expenditures are likely to maintain only
Expenditures that are not components of the cost of the expected future economic
an internally generated intangible asset: benefits embodied in the intangible
asset.
● Selling, administrative and other general ➢ Subsequent expenditure may be capitalized
overhead or added to the cost of the intangible asset if
● Clearly identified inefficiency and initial the following recognition criteria for an
operating loss intangible asset are met:
● Expenditure on training staff to operate the ● It is probable that future economic
asset benefits that are attributable
specifically to the subsequent
❖ PAS 38, paragraph 63, expenditure will flow to the entity.
 explicitly provides that internally ● The subsequent expenditure can be
generated brand, masthead, publishing measured reliably.
title, customer list and other items similar in
substance shall not be recognized as Identifiable intangible assets (PAS 38)
intangible assets.
 Such items cannot be identified separately ➢ If the intangible asset is acquired through
from the cost of developing the business as purchase, there is a transfer of legal right that
a whole. would make the asset identifiable.
- Instead, such items are seen as being ➢ Moreover, if the asset could be sold,
component of internally generated transferred, licensed, rented or sold
goodwill. separately, the intangible asset is identifiable.
64 | M i k e e P .
Examples of identifiable intangible assets are: IMPAIRMENT OF INTANGIBLE ASSETS
❖ Patent ➢ Intangible assets with finite useful life are
❖ Copyright. tested for impairment whenever there is an
❖ Franchise indication of impairment at the end of
❖ Trademark or brandname reporting period.
❖ Customer list ➢ Intangible assets with indefinite useful life are
❖ Computer software tested for impairment at least annually and
❖ Broadcasting license, airline right and whenever there is an indication of
fishing right impairment.
➢ An impairment loss on an intangible asset is
Unidentifiable intangible asset recognized if the recoverable amount is less
than the carrying amount.
➢ An intangible asset is unidentifiable if it
cannot be sold, transferred, licensed, rented
Amortization
or exchanged separately. ➢ Amortization is the systematic allocation of
➢ The intangible asset is inherent in a the amortizable amount of an intangible
continuing business and can only be asset over the useful life.
identified with the entity as a whole. ➢ The amortizable amount is the cost of the
➢ This unidentifiable intangible asset squarely intangible asset less residual value.
describes a goodwill. ➢ The amortization is recorded by debiting
amortization expense and crediting the
Measurement after Recognition intangible account.
An entity shall choose either the cost model or ➔ Normally, the intangible asset account
revaluation model as an accounting policy. is credited directly for the periodic
amortization but an accumulated
1. COST MODEL amortization account may be
- An intangible asset shall be carried at maintained.
cost, less any accumulated
amortization and any accumulated
impairment loss.  The amortizable amount of an intangible
2. REVALUATION MODEL asset shall be amortized on a systematic
- An intangible asset shall be carried at a basis over the useful life.
revalued amount, less any subsequent  Amortization shall begin when the asset is
amortization and any subsequent available for use, meaning, when the asset
accumulated impairment loss. is in the location and condition for the
- The revalued amount is the fair value at intended use.
the date of revaluation and is  Amortization shall cease when the
determined by reference to an active intangible asset is derecognized.
market.
- Thus, an intangible asset can only be
carried at revalued amount if there is an
The useful life of an intangible asset must be
active market for the asset.
assessed as either indefinite or finite.
AMORTIZATION OF INTANGIBLE ASSETS ● - the useful life may be
expressed in terms of years or the number
PAS 38 provides the following on the of units to be produced.
amortization of Intangible assets: ● - when there is no
● Paragraph 97 states that intangible assets foreseeable limit to the period over which
with limited or finite life are amortized the asset is expected to generate net
over their useful life. cash flows.
● Paragraphs 107 and 108 state that - the useful life is indefinite when
intangible assets with indefinite life are there are no legal, contractual,
not amortized but are tested for competitive and other factors that
impairment at least annually and would limit the useful life of the
whenever there is an indication that the intangible asset.
intangible asset may be impaired. ~ The major problem for an intangible asset is
determining useful life. the

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Factors affecting useful life Research and development
● PAS 38, paragraph 52,
● Technical, technological, commercial or ➔ provides that to assess whether an
other type of obsolescence internally generated intangible asset
● Expected action by competitors or potential meets the criteria for recognition, an
competitors entity classifies the generation of the
● Expected usage of the asset by the entity asset inte a research phase and a
● Typical product life cycle for the asset development phase.
● Stability of the industry in which the asset ● PAS 38, paragraph 53,
operates ➔ provides that if an entity cannot
● Level of maintenance expenditure required distinguish the research phase from the
to obtain the expected future economic development phase the entity treats the
benefits from the asset expenditure as if it were incurred in the
● The useful life of the asset may be dependent research phase only.
on the useful life of other assets of the entity
● Period of control over the asset and legal or
similar limits on the use of the asset, such as ➢ Research is an original and planned
expiry dates of related leases. investigation undertaken with the prospect
of gaining scientific or technical knowledge
AMORTIZATION METHOD and understanding.
➢ The method of amortization shall reflect ➢ Otherwise stated, a research activity is
the pattern in which the future economic undertaken to discover new knowledge
benefits from the asset are expected to be that will be useful in developing new
consumed by the entity product.
➢ However, if such pattern cannot be
determined reliably, the straight line EXAMPLES OF RESEARCH ACTIVITIES
method of amortization shall be used. ● Laboratory research aimed at
obtaining or discovering new
RESIDUAL VALUE knowledge.
The residual value of an intangible asset shall be ● Searching for application of research
presumed to be zero, except: finding and other knowledge.
● Conceptual formulation and design of
I. When a third party is committed to buy possible product or process alternative.
the intangible asset at the end of the ● Testing in search for product or process
useful life. alternative.
II. When there is an active market for the
intangible asset so that the expected
residual value can be measured and it is ➢ Development is the application of research
probable that there will be a market for findings or other knowledge to a plan or
the asset at the end of the useful life. design for the production of new or
substantially improved material, device,
❖ The residual value is reviewed at each product, process, system or service, prior to
financial year-end. the commencement of commercial
❖ A change in the residual value is accounted production.
for as a change in accounting estimate. ➢ Simply stated, a development activity
involves the application of research findings
to develop a new product.
Derecognition of an intangible asset EXAMPLES OF DEVELOPMENT ACTIVITIES
● Design, construction, and testing of
a. On disposal of the asset.
preproduction prototype and model.
b. When no future economic benefits are ● Design of tools, jigs, molds and dies
expected from its use and disposal. involving new technology.
Gain and loss arising from the derecognition of ● Design, construction and operation of a
an intangible asset shall be determined as the pilot plant that Is not of a scale
difference between the net disposal proceeds economically feasible to the entity for
and the carrying amount of the asset commercial production.
● Design, construction and testing of a
chosen alternative for new or improved
product or process.
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ACTIVITIES NOT CONSIDERED RESEARCH Criteria for recognition
AND DEVELOPMENT (R&D)
Development cost may qualify as intangible
➢ Research and development activities asset if and only if the entity can demonstrate all
typically occur prior to the beginning of of the following:
commercial production and distribution of a
product or process. ● The technical feasibility of completing the
➢ Accordingly, activities that relate to intangible asset so that it will be available for
commercial production do not result to use or sale.
research and development cost. ➔ This is achieved when a prototype or
model is produced.
ACTIVITIES NOT CONSIDERED R&D ➔ The entity has completed the testing
of the model and it is now convinced
● Engineering follow through in an early phase that it has a product to sell or use that
of commercial production. is significantly better than any other
● Quality control during commercial product available on the market.
production including routine testing. ➔ The entity plans to file a patent
● Trouble shooting breakdown during application for the product.
production. ● The intention to complete the intangible
● Routine on-going effort to refine, enrich or asset and use or sell it.
improve quality of an existing product. ● The ability to use or sell the intangible asset.
● Adaptation of an existing capability to a ● How the intangible asset will generate
particular requirement or customer need. probable future economic benefits.
● Periodic design changes to existing ➔ Among other things, the entity shall
products. demonstrate the existence of a
● Routine design of tools, jigs, molds and dies. market for the output of the
● Activity, including design and construction intangible asset or the intangible
engineering related to construction, asset itself.
relocation, rearrangement or start-up of ● Availability of resources or funding to
facilities and equipment. complete development and to use or sell
Accounting for Research Cost the asset.
● The ability to measure reliably the
➢ PAS 38, paragraph 54, provides that expenditure attributable to the intangible
expenditure on research or on the asset during its development.
research phase of an internal project shall
be recognized as expense when incurred. Capitalizable expenditures
➔ The reason is that at the research
phase of a project, an entity cannot ➢ Expenditures for research and development
be certain that future economic which have alternative future use, either in
benefits would probably flow to the additional research project or for
entity. productive purposes, can be capitalized.
➢ At the research stage, there is too much ➢ This means that costs incurred for materials,
uncertainty about the likely success of the equipment and intangible asset related to
project. research and development activities which
➢ In the research phase, an entity cannot have an alternative future use can be
demonstrate that an intangible asset exists capitalized.
that will generate probable future ➢ Subsequently, the following should be
economic benefits. charged to research and development
expense:
Accounting for Development Cost ● Cost of materials used
● Depreciation of equipment used in
➢ In contrast with research cost, research and development
development cost is incurred at a later
● Amortization of intangible asset used
stage in a project and the probability of
success may be more apparent. in research and developmen
➢ Development cost may or may not be
recognized as an intangible asset
depending on very strict criteria.

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