BATCH 2021: INTERMEDIATE ACCOUNTING 1
SAN BEDA UNIVERSITY - BS ACCOUNTANCY
Ora et Labora
PROFESSOR: Ma’am Pauline Fulgencio, CPA, MBA, CrFA
OUTLINE
COMBINED NOTES AND ANNOTATIONS FROM ROBLES, EMPLEO, VALIX, & The Students
I.
II.
III.
IV.
V.
CASH AND CASH EQUIVALENTS
RECEIVABLES
INVENTORIES
EQUITY & DEBT INVESTMENTS
A. INVESTMENTS IN DEBT SECURITIES AND OTHER NON-CURRENT FINANCIAL ASSETS
B. INVESTMENT IN EQUITY SECURITIES
C. FINANCIAL LIABILITIES
INVESTMENT IN ASSOCIATES
INTRODUCTION
INTERMEDIATE ACCOUNTING 1 is all about ASSETS
- ASSETS: economic resources controlled by the entity as a result of a past event
- ECONOMIC RESOURCE: a right that has the potential to produce economic benefits.
(a) used singly or with other assets in the production of revenues
(b) - used to acquire other assets
- settle liability
- distribute to the enterprise owners
- The nature of Financial Assets are Financial Instruments
- The NATURE is a factor to determine which accounting standards are applicable to its measurement
and recognition
NATURE OF FINANCIAL INSTRUMENTS
-
-
-
-
IAS 32 (FINANCIAL INSTRUMENTS PRESENTATION)
- a FINANCIAL INSTRUMENT is any contract that gives rise to a financial asset of one entity and a
financial liability or equity of another entity
IAS 32 PARA. 33
- HOLDER’S POV- the instrument is a financial asset
- ISSUER’S POV- the same instrument represents a financial liability or a component of the shareholder’s equity
FINANCIAL ASSET arises from a contract that entitles the holder to receive cash or another financial asset
Examples of Financial Assets are:
* Cash and Cash Equivalents
* Investments in equity instruments of other entities
* Contractual rights to receive cash from another entity cash or another financial asset
- trade receivables
- loans and other receivables
* Investments in debt instruments of another entity classified by the latter entity as financial liabilities.
- investments in bonds and commercial papers
FINANCIAL ASSETS also include derivatives held by an entity
- DERIVATIVE: is a financial instrument that meets the ff. characteristics:
(a) its value changes in response to the change in
- specified interest rate,
- commodity price,
- financial instrument price,
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- foreign exchange rate,
- price index,
- credit rating/credit index,
- or other variables
(b) it requires no initial investment or initial net investment smaller than that required in similar
contracts
(c) it is settled at a future date
Example
options and warrants that enable holders to acquire equity shares of other entities
RECOGNITION OF FINANCIAL ASSETS
The recognition of financial statement elements depends on the attributes of relevance and faithful representation.
- likelihood of inflow
- intention of acquiring
- environment affecting the inflow of economic benefits
FINANCIAL ASSETS
-
NON FINANCIAL ASSETS
CASH
CASH EQUIVALENTS
ACCOUNTS RECEIVABLE
DEBT INVESTMENTS AT FAIR VALUE
DEBT INVESTMENTS AT AMORTIZED COST
EQUITY INVESTMENTS AT FAIR VALUE
INVESTMENT IN ASSOCIATE
INVESTMENT IN SUBSIDIARY COMPANY
ADVANCES TO EMPLOYERS AND
EMPLOYEES
DEPOSITS ON UTILITY CONTRACTS
CASH SURRENDER VALUE OF LIFE
INSURANCE POLICY
CLAIMS FOR INCOME TAX REFUND
I.
-
INVENTORIES
UNUSED SUPPLIES
PROPERTY PLANT AND EQUIPMENT
FRANCHISE
INVESTMENT PROPERTY
PATENTS
GOODWILL
DEFERRED TAX ASSET
CASH AND CASH EQUIVALENTS
CASH / MONEY
-
The standard medium of exchange; Measured @ Face Value
currency and coins that are in circulation and legal tender
To qualify as cash presented as a current asset, IT MUST BE GENERALLY UNRESTRICTED: available
immediately for use in current operations.
First asset item listed on the face of the SFP or Balance Sheet
Cash such as checks, bank deposits, and money orders must be ACCEPTABLE by the BANK for deposit
and
immediate encashments
In ACCOUNTING, Cash includes the money and other negotiable instruments that are payable in money and
ACCEPTABLE by the BANK for deposit and immediate encashments
Cash and cash equivalents are always a current asset
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it is the most significant ASSET because:
Has the ability to settle
Acquire another
an obligation
asset
Pay operating costs
Provide returns to
enterprise owners
UNRESTRICTED CASH
-
“Walang Pinaglalaanan”
It must be readily available in payment of current obligations
It must not be subjected to any restrictions. contractual or otherwise
COMPOSITIONS OF CASH
(1) CASH IN HAND
(A) UNDEPOSITED CASH COLLECTION
- Currencies: Bills and coins
- Bank drafts
- Money orders
CHECKS:
(B) WORKING/(2) CASH FUNDS- For current use
- EX: Petty cash fund, Change fund, Payroll fund.
Dividend fund, Tax fund, Interest fund
- Cash segregated for a specific use or purpose
- Dividend into category: (1) cash fund for current
operation; (2) cash fund not for the current
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-
-
-
-
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Certified Check
Manager’s checks
Personal Check
Traveler’s checks
Cashier’s checks
Customer’s checks
Customer’s postdated check – NOT
CASH, included as a component of
receivables
Customer’s stale check – NOT CASH,
included as a component of receivables
(if exceeds 6 months)
- Kapag di mo parin naeencash
yung check na binigay sayo
Customer’s NSF/DAUD/DAIF check NOT CASH, included as a component of
receivables
Company’s postdated check – should be
added back to cash in the bank
Company’s stale check – should be
added back to cash in the bank
- Kapag di pa naeencash ng
payee yung check mo
The company’s unreleased/undelivered
check – should be added back to cash in
the bank
operation
Further classifications:
a. Cash fund for the current operation
i. Petty cash fund
ii. Payroll fund
iii. Revolving fund
iv. Travel fund
v. Tax fund
vi. Interest fund
vii. Dividend fund
viii. Change fund
b. Cash fund for not for current operation – NOT
CASH, with exception
i. Segregated for payment of the noncurrent liability
- Sinking fund
- Pension fund
- Preference share redemption fund
- (1) Cash, if the related noncurrent liability
becomes a current liability
- Classification of cash fund as
current or noncurrent should be
parallel to the classification of the
related liability.
- (2) Long-Term Investments (other NCA),
general rule, or SILENT.
ii. Segregated for payment of noncurrent asset
- PPE acquisition fund
- Fund for construction of PPE
- Depreciation fund
- Insurance fund
- Contingency fund
- (1) NOT CASH, included as part of the
investment (other NCA) forever
regardless of the year of disbursement.
(3) CASH IN BANK
- Demand Deposit or Checking Account
- Savings Account
a. Current account/checking account/demand deposit
b. Saving account
c. Time deposit – NOT CASH:
(1) cash equivalent, if it can be withdrawn within 3 months from the date of purchase. SILENT
(2) other current assets, if it can be withdrawn within 12 months from reporting date.
(3) other non-current assets, if it can be withdrawn beyond 12 months from reporting date.
d. Deposit in closed bank – NOT CASH, included as part of other non-current assets.
e. Deposit in foreign bank
(1) cash in bank, if not restricted. SILENT
(2) other non-current assets, if restricted
f. Compensating balance / compensatory balance/maintaining balance
(1) cash in bank, if not legally restricted. SILENT
(2) other current assets, if legally restricted and related to short term loans
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(3) other non-current assets, if legally restricted and related to long term loans
g. Bank overdraft
(1) cash in bank, if happen in the same bank with a positive balance (included as a deduction)
(2) current liability, if it happens in a different bank. SILENT
Other Important Notes
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-
The usual distractions encountered in the problems:
(1) IOU from employees, NOT CASH, included as a component of receivables.
(2) Postage stamps, NOT CASH, included as components of supplies.
(3) Credit memo from suppliers, NOT CASH, contra-account of purchases, and deduction to accounts
payable
(4) Cash surrender value, NOT CASH, included as a component of investments
If the question is what is the amount of “cash”? do not include the cash equivalents.
If the question is what is the amount of cash and cash equivalents? Include the cash equivalents.
PRESENTATION AND MEASUREMENT OF CASH IN THE STATEMENT OF
FINANCIAL POSITION
-
If there is no special purpose, just note the other cash details in the notes to financial statements
(1.) FOREIGN CURRENCY
- is subject to immediate and unrestricted withdrawal
- should be translated into Philippine currency using the exchange rate (current) @ the end of the reporting
period.
- Cash deposits in foreign banks that are subject to foreign exchange restrictions should be classified separately
among non-current assets and the restriction clearly indicated.
(2.) CASH IN CLOSED BANKS/ BANKRUPTCY
- Should be reclassified as receivable and should be written down to its recoverable amount
(3.) CUSTOMER’S POST-DATED CHECKS, NSF CHECKS, & IOUs
- Should not be reported as receivables rather than cash.
- IOUs- “I owe you notes”
- NSF Checks- No Sufficient Fund Checks- cannot be covered by funds in the debtor’s bank account
- NSF checks in the Philippines are oftentimes described as DAIF checks or DAUD checks
- DAIF- “drawn against insufficient funds”
- DAUD- “drawn against unclear deposits”
(4.) POSTAGE STAMPS & EXPENSE ADVANCES
- Are not cash
- But are reported as prepaid expenses in the current assets section.
(5.) BANK OVERDRAFT THAT CANNOT BE OFFSET AGAINST ANOTHER ACCOUNT
- Is reported as a liability
- BANK OVERDRAFT occurs when a depositor has written checks for a sum greater than the amount in the
depositor’s bank account, resulting in a credit balance in that cash account.
- An overdraft happens when the cash in bank account has a credit balance
- Resulting from the issuance of checks in excess of deposits.
- Issue ng check (labas ng pera) > deposit (pasok ng pera)
CLASSIFICATION OF BANK OVERDRAFTS
CASH
If the net amount
represents
an
-
LIABILITY
If the net amount represents an excess of overdrawn account over
the cash balance
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excess of cash
balance over the
credit balance
-
VALIX (2020), A bank overdraft is classified as a current liability and
should NOT be offset against other bank accounts with debit
balances.
Illustration: An entity maintains 2 accounts
a. Cash in Bank- 1st bank, which is overdrawn by P10,000.
b. Cash in Bank- 2nd bank, with a debit of P100,000
The net cash balance is P90,000
Proper statement classification:
Current Asset:
Cash in Bank- Second Bank
100,000
Current Liability
Bank Overdraft-First Bank
10,000
Note: it is not necessary to adjust and open a bank overdraft account in the
ledger. The Cash in Bank-First Bank account is maintained in the ledger with a
credit balance.
-
According to VALIX (2020), overdrafts are generally not permitted in the Philippines.
- EXCEPTION: When an entity maintains 2 or more accounts in one bank and one account results in an
overdraft, such overdraft can be offset against the other bank account with a debit balance in order to
show cash, net of bank overdraft or bank overdraft, net of other bank accounts.
- An overdraft can be offset against the other bank account if the amount is not material.
- OFFSET: With offsetting, you show your company's assets and liabilities on the balance sheet
on a net basis (netting). In offset accounting, you decrease the total, or net, of a different
account balance to create a net balance. Offsetting is purely a presentation method, not a type
of accounting.
- IFRS: You can offset overdrafts against other banks when PAYABLE ON DEMAND and OFTEN
FLUCTUATES from positive to negative as integral parts of CASH MANAGEMENT.
- A bank overdraft may be offset against a positive balance in another bank account with the same bank if
a right of offset exists between the bank and the depositor. In such a case, the depositor reports the
net positive amount as “Cash”.
(6.) UNDELIVERED OR UNRELEASED CHECKS
- These are the company’s checks drawn and recorded as disbursed but are not actually issued or delivered to
the payees as of the reporting date.
- Check na ginawa ng company pero di pa naman ibinibigay sa payee.
- Technically, checks drawn by a company should not be deducted from the company’s cash balance until they
have been mailed or otherwise delivered.
- Don’t deduct sa cash balance kase hindi pa naman ito na rerelease pa. Kaya JUST REPORT IT AS
Current payable.
- Therefore these checks should be reverted to the cash balance. As a result, liabilities that the checks are
intended to liquidate still exist and should be reported as current payables.
(7.) COMPANY’S POSTDATED CHECK
- A POST DATED CHECK DELIVERED is a check drawn, recorded, and already given to the payee but it bears
a date subsequent to the end of the reporting period.
- The company’s postdated check, which has been recorded and delivered to the payee before or at the end of
the reporting period- should be reverted to cash, and the corresponding liability shall continue to be recognized
because there is no actual payment yet, as of that date.
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-
Such a check cannot possibly be cleared with the bank until the date is indicated in the check.
The original entry recording a delivered postdated check shall also be reversed and therefore restored to the
cash balance.
Cash
xxx
AccPay. Or Appropriate Account
-
xxx
The reason is that there is no payment until the check can be presented to the bank for
encashment or deposit.
- Ex: You end the reporting period on Dec 31, 2020 but the check that you drew is post
dated to Jan 15, 2021. Therefore, SAYO PA YUNG CASH NA YON -> Balik/Revert it
back as cash in bank @ the end of the reporting period. As far as 2020 is concerned,
sayo pa rin yung cash.
- SAME GOES IF THE COMPANY WILL RECEIVE A POST DATED CHECK. Hindi pa
sayo yun so it is not yet a part of your cash.
(8.) COMPENSATING BALANCES
- The minimum accounts that the company agrees to maintain in a bank checking account as support to collateral
for a loan by the depositor.
- UNRESTRICTED COMPENSATING BALANCES: Maintain it in the account and include it in cash
Effects of compensating balances:
a. Reduces the amount of cash available to the borrower
b. Increases the effective interest rate to the borrower
c. They must not be disclosed in the financial statement footnotes
Compensating Balances IF RESTRICTED May Be:
NOT LEGALLY RESTRICTED (INFORMAL)
- short-term loan
- part of cash
- informal compensating balance agreement
LEGALLY RESTRICTED (depending on nature of loan) (FORMAL)
- Classify separately as SHORT-TERM INVESTMENT under the current asset section if
the loan is related to short-term. “Cash held for compensating balances”
- classify separately as LONG-TERM INVESTMENT under the non current asset section
if the loan is related to long-term.
- Basta kapag legally restricted, ibawas mo sya!!!
- If the loan is related to long-term, it is classified as NON-CURRENT INVESTMENT.
- Example: An entity borrows P5,000,000 from a bank and agrees to maintain a 10% or P500,000 minimum
compensating balance in a demand deposit account.
- In effect, this arrangement results in a reduction of the amount borrowed
because the compensating balance provides a source of funds to the bank as
partial compensation for the loan extended.
- DEMAND DEPOSIT ACCOUNT: is just a different term for a checking account.
... Most demand deposit accounts (DDAs) let you withdraw your money without
advance notice, but the term also includes accounts that require six days or less
of advance notice.
(9.) CASH SET ASIDE FOR LONG-TERM SPECIFIC PURPOSE/ACQUISITION OF A NON-CURRENT ASSET
- ex: Sinking fund, plant expansion fund
- reported as Non-Current Financial Asset
(10.) STALE CHECK
- STALE CHECK or Check Long Outstanding: is a check not encashed by the payee within a relatively long
period of time.
- How long must the check remain outstanding?
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Negotiable Instruments Law provides that where the instrument is payable on demand, presentment
must be made within a reasonable time after issue.
In determining what is a reasonable time, consideration should be made regarding the nature of the
instrument, the usage of trade or business, if any, with respect to such instrument and the facts of the
particular case.
- The law does not specify a definite period within which checks must be presented for
encashment. Reference is made to usage of trade or business practice.
- In banking practice, a check becomes stale if not encashed within six months from the date of
issuance. This is a matter of entity policy.
- Thus, even after three months only, the entity may issue a stop payment order to the
bank for the cancellation of a previously issued check.
If the amount of the stale check is IMMATERIAL- it is accounted
for as MISCELLANEOUS EXPENSE
Dr. Cash
XXX
Cr. Miscellaneous Expense
XXX
However, if the amount is MATERIAL and LIABILITY IS
EXPECTED TO CONTINUE, the cash is restored and the liability
is again set up.
Dr. Cash
XXX
Cr. A/P or Appropriate Account
XXX
CASH MANAGEMENT AND INTERNAL CONTROL
-
Businesses must use and manage cash efficiently
- Too much cash or an excessive cash balance indicates that resources are not efficiently managed and this
represents unproductive assets.
- This must be converted into productive resources to generate more inflow of resources and
eventually cash back to the business.
(1) SEGREGATION OF DUTIES FOR HANDLING CASH AND RECORDING CASH TRANSACTIONS
- No person should be in complete control of a transaction
- The employee handling cash receipts should not have access to the accounting records for cash.
- PREVENTS simultaneous misappropriation or manipulation of accounting records to cover up stolen cash.
(2) IMPREST SYSTEM
- Characterized by a daily deposit of all cash receipts intact to the bank and making disbursements through the
issuance of checks.
- PREVENTS the presence of a significant amount of cash balance within the business vicinity.
- Expenditures involving small amounts are made from petty cash funds.
(3) VOUCHER SYSTEM
- A system to control cash disbursements.
- All disbursements must be supported by properly approved vouchers, which must be recorded in the voucher
register.
- Actual payments are recorded in the check register.
- USE: Provides for review and authorization of disbursements.
(4) INTERNAL AUDITS AT IRREGULAR INTERVALS
- Cash counts conducted by the internal control department are made WITHOUT advance notice to the custodian,
such that the cash custodian is always conscious of his accountability keeping the cash on hand intact.
- Surprise internal audits ensure that internal controls over an entity’s assets are properly implemented.
- CASH COUNT involves test checking of transactions and record keeping.
- PREVENTS connivance among employees and manipulation of cash records.
(5) PERIODIC RECONCILIATION OF BANK STATEMENT BALANCE AND CASH BALANCE IN THE COMPANY’S
ACCOUNTING RECORDS
- Aka “bank reconciliation”
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Regular reconciliation of bank balance and book balance for cash uncovers immediately any error or
irregularities in recording cash transactions.
Any error or irregularity is, therefore, immediately rectified.
PETTY CASH FUND-IMPREST FUND SYSTEM
-
Cash set aside to pay a small amount of disbursements where issuance of a check to pay these are not
possible/practical.
Follows the imprest system.
The amount should not be too small that may require frequent replenishment of the fund nor should it be too
large that the person in charge of the fund may be tempted to use the funds for other purposes.
Small
Insignificant amount is relative in nature
Initially nakalagay lahat sa cash in bank
- Savings account- passbook/atm
- Current- checking account | checkbook
ESTABLISHMENT OF PETTY CASH FUND
- Established by the issuance of checks by the general cashier to the custodian.
- A check is drawn payable to petty cash is encashed, and then, the petty cash custodian places the money in the
petty cash fund (locked box)
- Estimated to last from 2-4 weeks.
- Nililipat mo lang sya, the balance of your cash is not affected, yung cash in bank lang yung mababawasan.
ENTRY TO ESTABLISH:
Dr. Petty Cash Fund
Cr. Cash in Bank
XXX
XXX
DISBURSEMENT OF PETTY CASH FUND
- Payment of cash coming from the petty cash fund requires preparation of a voucher, but no entry is
necessary.
- No formal entry is made but the petty cashier generally requires a signed petty cash voucher for such payments
and simply prepares memorandum entries in the petty cash journal.
- Upon the authorization of a responsible officer.
- To request- a petty cash voucher must be prepared by the petty cash custodian.
- Petty cash vouchers record the payments made from the petty cash fund.
- They are sequentially numbered to be easily accounted for.
- Upon payment- the payee signs the voucher and returns it to the petty cash custodian.
- Any receipt or invoice supporting the payment must be attached to the signed voucher.
REIMBURSEMENT / REPLENISHMENT OF PETTY CASH FUND
- In event that the petty cash is low, it will be replenished
- The petty cash custodian submits the signed petty cash vouchers and accompanying receipts to the general
cashier to request reimbursement.
- The amount of the replenishment check is the difference between the remaining petty cash and the imprest
balance.
Amount of remaining petty cash – xx
Imprest balance of petty cash – (xx)
Amount of replenishment check – xx
ENTRY TO REPLENISH:
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Dr. Expenses (Various)
Cr. Cash in Bank
-
XXX
XXX
It is to be pointed out that petty cash disbursements should be replenished by only means of check and not from
undeposited collections.
INCREASING and DECREASING FUND BALANCE
-
Imprest balance is the amount of petty cash when it was established plus any subsequent increase or decrease
because of board resolution.
An INCREASE of fund balance happens when the amount of petty cash fund is deemed inadequate to satisfy
the company’s needs.
ENTRY TO INCREASE THE IMPREST BALANCE:
Dr. Petty Cash Fund
Cr. Cash in Bank
XXX
ENTRY TO DECREASE THE IMPREST BALANCE:
Dr. Cash in Bank
Cr. Petty Cash Fund
XXX
XXX
XXX
ADJUSTING ENTRIES-PETTY CASH FUND
- The imprest balance should be maintained all throughout the accounting period, the “petty cash fund” account
should not be affected by disbursement and subsequent replenishment, but at year-end, and the balance of the
imprest account and the remaining petty cash is not equal, year-end adjustment is necessary.
- An adjusting entry is made to recognize the payments from the fund that are not replenished and to
state the correct petty cash balance.
- Updates and brings the petty cash fund general ledger account to an amount equal to the actual cash
balance in the petty cash fund as of the end of the reporting period.
- This would avoid understatement of expenses and overstatement of cash.
- The adjustment is to be reversed at the beginning of the next accounting period.
- The reversal is made in order that the normal replenishment procedures may be followed by
simply debiting the expenses and crediting cash in bank without distinguishing whether the
expenses pertain to the current period or prior period.
YEAR-END ADJUSTMENT FOR FS PREPARATION:
Dr. Expenses (Various)
XXX
Cr. Petty Cash Fund
XXX
CASH SHORT AND OVER
- CASH SHORT AND OVER
- The cash short or over account is only a temporary/suspense account. When Financial statements are prepared,
the same should be adjusted.
- Account that is debited or credited in the petty cash fund:
- DEBITED- for SHORTAGES
- Should be reported as a miscellaneous expense
- Cash Count < Recorded Cash
- However, a material cash shortage resulting from a non-negligible cause (theft or
misappropriation) should be charged to be a receivable account if it is probable that the
shortage is to be recovered.
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A Petty cash voucher should be prepared for covering the shortage, for transmission to the
general cashier, together with other petty cash vouchers, for reimbursement. This is to maintain
the petty cash balance at its imprest balance.
Where the cash count shows cash which is less than the balance per
book, a cash shortage is to be recorded. (Entry to record cash
shortage if detected at replenishment)
Dr. Cash short or over
XXX
Cr. Cash in bank
XXX
Entry to record cash shortage if detected at year-end:
Dr. Cash Short or Over
xx
Cr. Petty Cash Fund
xx
Hence, if the cashier or cash custodian is held responsible for
the cash shortage, the adjustment should be:
Dr. Due from cashier
XXX
Cr. Cash short or over
XXX
However, if reasonable efforts fail to disclose the cause of the
shortage, the adjustment is:
Dr. Loss from cash shortage
XXX
Cr. Cash short or over
XXX
-
CREDITED- for OVERAGES
- Should be reported as a miscellaneous revenue
- Cash Count > Recorded Cash
- To document the existence of material cash overage, an official receipt may be prepared by the
company.
- Note that whenever it is a cash short or cash overage, the offsetting account is cash short or
over account. Such accounts should be adjusted when statements are made.
Where the cash count shows cash which is more than the balance
per book, a cash overage is to be recorded. Entry to record cash
overage if detected at replenishment:
Dr. Cash in bank
XXX
Cr. Cash Short or over
XXX
Entry to record cash overage if detected at year-end:
Dr. Petty Cash Fund
XXX
Cr. Cash Short or over
XXX
The cash overage is treated as Miscellaneous income if there is
no claim on the same.
Dr. Cash short or over
XXX
Cr. Miscellaneous Income
XXX
But where the cash overage is properly found to be the money
of the cashier, the journal entry is:
Dr. Cash short or over
XXX
Cr. Payable to cashier
XXX
DEPOSIT OF CASH OVERAGE
Dr. Cash in Bank
Cr. Miscellaneous Income
reason/cause:
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XXX
XXX
-
Usually results from errors in making change or failure to obtain receipts for very small amounts.
Receipts may have been written for an incorrect amount
Money from the fund may have been lost or stolen.
Illustration (empleo pg. 13-15):
Assume that the petty cash fund was originally established at P10,000 on December 1. 2020. To record this
transaction, the entry is:
Petty Cash Fund
Cash in Bank
P10,000
P10,000
From December 1 through December 20, payments were made from petty cash fund for the following items:
Transportation
P2,300
Representation expenses
3,400
Office Supplies
4,200
No entry is taken up to record the above payments.
On December 21, petty cash vouchers were submitted to request reimbursement for the above expenditures. A check
for P9,900 was issued to replenish the petty cash fund. The entry for replenishment is
Transportation Expense
Representation Expense
Office Supplies Expense
Cash in Bank
P2,300
3,400
4,200
P9,900
Case 1: On December 31, no replenishment of the petty cash was made. A count and review of the fund revealed
the following composition:
Bills and Coins
Petty cash vouchers for
Transportation
Office Supplies
An employee advance
Representation
P2,200
1,500
2,500
3,000
720
The total of Bills and coins counted and paid vouchers above, which is P9,920 is less than the amount of the imprest
petty cash balance of P10,000. Thus, the difference of P80 is missing cash, which is reported as cash shortage. The
adjusting entry on December 31 to remove the non-cash items from the petty cash fund and to show the correct
amount of the petty cash fund in the statement of financial position is
Transportation expense
Office Supplies Expense
Advances to Employees
Representation Expense
Cash short or over
Petty Cash Fund
1,500
2,500
3,000
720
80
7,800
Case 2: Assume that instead of the following was the composition was the fund on December 31.
Bills and Coins
Petty cash vouchers for
Transportation
Office Supplies
An employee advance
Representation
P2,400
1,500
2,500
3,000
720
The total of Bills and coins counted and paid petty cash vouchers of P10,120 exceeds the amount of the imprest petty
cash balance of P10,000. This excess of the items counted over the petty cash fund balance is to be recorded as
12 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
cash overage or miscellaneous income. The adjusting entry on December 31 is:
Transportation expense
Office Supplies Expense
Advances to Employees
Representation Expense
Petty Cash Fund
1,500
2,500
3,000
720
7,720
Proper internal control suggests that the amount of cash representing the overage of P120 be taken out of fund, for
deposit to the general cash account of the company. This will bring the remaining balance of Bills and Coins equal to
P2280 (P2,400 - P120 cash overage). The ENTRY FOR THE DEPOSIT OF CASH OVERAGE is:
Cash in Bank
Miscellaneous Income
120
120
After the deposit of the cash overage, the total composition of the fund would be P10,000 (P2,280 bills and coins and
petty cash vouchers of P7,720), which is the amount at which the petty cash fund is originally established.
Illustration (valix pg. 13-14):
2020
Nov. 10 The entity established an imprest fund of P10,000
Petty cash fund
Cash in bank
10,000
10,000
Nov 29 Replenished the fund. The petty cash items include the following:
Currency and coin
Supplies
Telephone
Postage
2,000
5,000
1,800
1,200
Dec 31 The fund was not replenished
The fund is composed of the following:
Currency and coin
7,000
Supplies
Postage
Miscellaneous Expense
Petty cash fund
1,500
1,200
1,000
3,000
2021
Jan 1 The adjustment made on December 31 is reversed.
Petty cash fund
Supplies
Postage
Miscellaneous Expense
3,000
1,500
1,200
1,000
Feb 1 The fund is replenished and increased to P15,000.
The composition of the fund:
Currency and coin
1,000
Supplies
4,500
Postage
3,000
13 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
Misc. Expense
1,500
Total
`10,000
Journal Entry:
Petty cash fund
5,000
Supplies
4,500
Postage
3,000
Miscellaneous Expense
1,500
Cash in Bank
14,000
The total amount of the check drawn is P14,000 representing the petty cash disbursements of P9,000 and the fund
increase of P5,000.
PETTY CASH FUND-FLUCTUATING FUND SYSTEM
-
It is called the “fluctuating fund system” because the checks drawn to replenish the fund do not necessarily equal
the petty cash disbursements.
The replenishment checks are simply drawn upon the request of the petty cashier.
The petty cash disbursements are immediately recorded resulting in a fluctuating petty cash balance in the per
book from time to time
ESTABLISHMENT OF PETTY CASH FUND
ENTRY TO ESTABLISH:
Dr. Petty Cash Fund
Cr. Cash in Bank
XXX
XXX
PAYMENT OF EXPENSES OUT OF THE PETTY CASH FUND
- Under this system, the disbursements from the petty cash fund are immediately recorded in contradistinction
with the imprest fund system where the disbursements are recorded upon replenishment of the fund.
Dr. Expenses
Cr. Cash in Bank
XXX
XXX
REPLENISHMENT OR INCREASE OF THE PETTY CASH FUND
- The replenishment check may or may not be the same as the petty cash disbursements.
Dr. Petty Cash Fund
Cr. Cash in Bank
XXX
XXX
At the end of the reporting period, NO ADJUSTMENTS is necessary because the petty cash expenses are
recorded outright.
DECREASE OF THE PETTY CASH FUND is reverted to the general cash.
Dr. Cash in Bank
Cr. Petty cash fund
XXX
XXX
Illustration (valix pg. 16):
Nov 10 The entity established a petty cash fund of P10,000.
Petty cash fund
14 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
10,000
Cash in bank
10,000
Nov 11-28 Petty cash disbursements amounted to P8,000.
Expenses
8,000
Petty cash fund
8,000
Nov 29 Issued a check for P10,000 to replenish the fund
Petty cash fund
Cash in bank
10,000
10,000
At this point, the petty cash balance per book is P12,000
Dec 1-30 Petty cash expenses amounted to P9,000
Expenses
9,000
Petty cash fund
9,000
Dec 31 Issued check for P15,000 to replenish the fund.
Petty cash fund
Cash in bank
15,000
15,000
At this point, the petty cash balance per book is P18,000
This is the difference between accountability and accounted.
ACCOUNTABILITY
ACCOUNTED
Diff
Imprest Balance
Remaining currency and coins
Undeposited Cash Balance
Envelope containing employee contribution (a)
Undeposited Check Collections (b)
Customers checks accounted (b)
Unclaimed Salary
Paid expense voucher
Excess of advance travel
Replenishment checks (c)
Employee contributions
IOUs
Accommodation check (d)
Total
xx
xx
xx
shortage
NOTES:
(a) – will only be included in the accounted if the envelope still contains the cash contribution.
(b) – will only include withdrawable checks, (exclude stale, nsf, postdated)
(c) – clue, addressed to the custodian
(d) – include all accommodation check whether withdrawal or not
(e) – checks issued by the company should be ignored and not be included in the computation
-
COMPUTATION OF ADJUSTED PETTY CASH BALANCE
The adjusted petty cash balance is the amount to be presented in the year-end financial statements.
15 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
-
The difference between the adjusted petty cash balance and the imprest balance is the net adjustment to the
petty cash fund.
- Net debit if the adjusted is higher than the imprest balance.
- Net credit if the adjusted is lower than the imprest balance.
Currencies and coins at the date of cash count
xxxx
plus: vouchers or payments from January 1 up to date of cash
count
xxxx
minus: any cash collections to whoever from January 1 up to
date of cash count
(xxxx)
Currencies and coins at December 31 after workback
xxxx
minus: currencies and coins that do not belong to petty cash
but included in the count
a. Unclaimed salary (only if in the form of currencies and
coins)
xxxx
b. Excess of advance travel (only if in the form of
currencies and coins)
xxxx
c. Employee contributions (only if the envelope contains
nothing/open)
xxxx
d. Undeposited cash collections
xxxx
Total
(xxxx)
xxxx
plus: petty cash fund not in the form of currencies and coins
a. Accommodation checks (a)
xxxx
b. Replenishment checks
xxxx
Adjusted petty cash fund at December 31
xxxx
xxxx
NOTES: (a) – will only include withdrawable checks, (exclude stale, nsf, postdated)
BANK RECONCILIATION
-
-
-
A schedule prepared to bring the depositor’s cash and the related bank’s cash balance into agreement. It shows
the items causing discrepancies between the balance per bank and the balance per book. (Ong & Gomendoza,
2017)
Is a monthly prepared statement that balances books and bank Record
It shows the following information
(a) Beginning of month cash balance
(b) Total deposits made by the depositor and other bank credits during the month
(c) Total checks paid by the bank and other bank charges during the month
(d) End of month cash balance
to determine causes of difference between the bank balance and book balance as a form of internal control.
to compute the adjusted bank balance to be presented in the year-end statement of financial position.
to serve as a basis of adjusting journal entry.
“PUT IT WHERE IT ISN’T”- Mam Dani
16 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
BANK RECONCILING ITEMS
Recorded in
Where will
you reconcile
in order to
correct the
cash balance
Outstanding
checks
- Outstanding checks (-) are checks that have
already been recorded by the depositor but not yet
reflected in their bank statement.
- Checks issued by the business during the period
that have not been presented to the bank for
payment before the statement is prepared.
- Checks written by the company, issued to the
payees, and deducted from the company’s cash
balance but they have not been reflected in the
bank statement since they have not been
presented yet to the bank for payment.
- The amount of the outstanding checks is
determined by comparing the checks written
during the month as reflected in the company’s
check register or cash disbursements journal with
the cancelled checks included in the bank
statement.
- The amounts of the checks issued (as reflected in
the check register or cash disbursements journal)
but have not been presented for payment (as
reported in the bank statement) are then totaled
and referred to as outstanding checks.
- Outstanding checks at month-end result in an
overstatement of the bank balance.
- CORRECTION OF OVERSTATEMENT: The
amount of the outstanding checks should be
deducted from the bank balance.
book
(-) In bank
Deposits in
transit
- Deposit in Transit (+) are collections that have
yet to be reflected in the bank statement but
already is recorded in the books of the depositor
- Deposits made by the business that have not
reached or recorded by the bank before the
statement is prepared.
- Because it is not yet received by the
bank as of the cut-off time (Deposit in
transit) or it has not been deposited
as of the end of the month
(undeposited collection)
- The amount of the deposit in transit or the
undeposited collection can be determined
by comparing the receipts as reflected in the
company’s accounting records with the
deposits as reflected in the bank statement
- The amounts reflected in the accounting
records but not in the bank statement are
totaled as either deposits in transit or
undeposited collections.
- The deposits in transit or undeposited
collections understate the bank balance.
- CORRECTION OF UNDERSTATEMENT: the
collections awaiting deposit or are in transit
book
(+) in bank
(undeposited
collection)
17 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
should be added to the bank balance in
arriving at the correct cash balance.
Collections
- Collections of promissory notes (credit memos) or
charge accounts made by the bank on behalf of
the depositor.
banks
(+) in book
DEBIT
MEMOS
- Bank charges for services such as
- check printing and processing.
- If these deductions have not yet been recorded by
the depositor at month end, the balance per book
is overstated.
- Debit memos charged directly by the bank should
be deducted from the balance per books in
determining the correct cash balance.
- Causes the cash balance per ledger to be higher
than that reported by the bank, all other things
being equal.
banks
(-) in book
- An item that was originally deposited into the
company’s account (usually a customer check)
and later bounced because the drawer did not
have sufficient funds. (Kristin, 2019)
- Customer’s check that has been deposited in the
company’s bank account but has not been paid by
the customer’s bank because there is insufficient
funds in the customer’s bank account.
- Ideally, the bank should immediately inform the
company of each NSF check to enable the latter to
update its accounting records.
- In such a situation, the balances per books and
per bank statement are in agreement, thereby
requiring no adjustment.
- However, there may be some NSF checks
included in the bank statement that have not been
recorded by the company.
- Thus, the balance per books is
apparently
overstated.
- DEPOSIT IN TRANSIT OR DEPOSIT OF
CUSTOMER
- Pwedeng NSF if walang laman
- “Checks cleared” if received ng bank
book
(-) in book
- These are deposits made directly by the bank to
the company’s account.
- EXAMPLES:
- Notes or drafts collected by the bank
in order to favor the depositor
- Proceeds of bank loan credited
directly to the account of the
depositor
- Interest earned on the company’s
checking account
- A bank often acts as a collecting agent for its
depositors on items such as notes receivable.
When a note is collected, the bank records the
principal and interest as an increase in the
depositor’s bank account. Generally, the bank
immediately informs the company of the deposit to
Bank
(+) in book
(a) Service
charges
DEBIT
MEMOS
(b) NSF (Not
sufficient
fund)
Checks |
DAIF | DAUD
CREDIT
MEMOS
18 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
enable the depositor to update its records.
Otherwise, the cash balance per book does not
reflect this collection of notes receivable.
- Many checking accounts nowadays earn interest.
The company, however, does not know the amount
of interest earned by them until it receives the
bank statement. The interest on this checking
account is directly credited by the bank to the
depositor’s account.
- These credits made by the bank increased the
bank statement balance and therefore should be
added to the cash balance per book in order to
correct the cash balance.
Errors
- Errors made by the bank or the depositor/company
in recording cash transactions. (Cabrera, BBA,
MBA, CPA, CMA & Cabrera, 2017)
Book
error-books
(-/+)
In book
Bank errorbank
(-/+)
In bank
OTHER ITEMS/NOTES:
CERTIFIED
CHECKS
- A certified check is one drawn by the bank upon
itself.
- a form of check for which the bank verifies that
sufficient funds exist in the account to cover the
check, and so certifies, at the time the check is
written.
- Those funds are then set aside in the bank's
internal account until the check is cashed or
returned by the payee.
TYPES OF BANK RECONCILIATION STATEMENT
- Bank reconciliation may be prepared in either of these types:
(1) SINGLE DATE BANK RECONCILIATION
- reconciliation of ending balances, where the balance per bank and the balance
per company's records are reconciled as of the end of the period.
(2) PROOF OF CASH | FOUR COLUMN RECONCILIATION | RECONCILIATION OF RECEIPTS,
DISBURSEMENTS, AND BANK BALANCES
- reconciliation of beginning cash balances, receipts and disbursements during
the period, and ending cash balances.
FORMS OF BANK RECONCILIATION STATEMENT
- A bank reconciliation statement may be prepared using any of the following forms:
(1) Both bank and book balances are reconciled to a correct balance
- This form is prepared in two sections: the bank statement balance being adjusted to the correct
cash balance in the first section, and the book balance being adjusted to the same corrected
cash balance in the second section.
- ADVANTAGE- Clearly identify items that require adjustments in the depositor’s accounting
records. In addition, it develops a corrected cash balance that is reported in the SFP.
- 1st section (BANK SECTION)
- Reflects items not yet recognized by the bank (e.g. deposits in transit or outstanding
checks) as well as corrections for any errors made by the bank
- 2nd section (BOOK SECTION)
19 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
-
-
Contains items that the depositor has not yet recognized (e.g. debit and credit memos
by bank for direct deposits, NSF, bank service charges, notes and drafts collected by
the bank in behalf of the depositor and repayment of loans) and any corrections for
errors made on the depositor’s books.
(2) Bank balance reconciled with book balance
- This form reconciles the bank balance to the unadjusted balance of the depositors cash
account in the general ledger. This is the form frequently used by many auditors to trace the
accounting entries taken up by the company's bookkeeper.
(3) Book balance reconciled with bank balance
- this form starts with the cash balance per ledger and reconciled to the balance per bank
statement
BALANCES
- BANK < CORRECT CASH BALANCE : Bank balance is less than the correct cash balance, if there is
no error in both the depositor/entity and bank,
- There must be DEPOSITS IN TRANSIT
- BOOK < CORRECT CASH BALANCE : Book balance is less than the correct cash balance, if there is
no error in both the depositor/entity and bank,
- There must be deposits credited by the bank but not yet recorded by the depositor
(CREDIT MEMOS)
PROOF OF CASH
-
Proof of Cash is a two-date bank reconciliation which is used to find and fix the ending balance of the book and
bank statement.
It balances the book and bank statement’s beginning, receipts, disbursements and ending balance of the period.
It is also an expanded reconciliation in that it includes proof of receipts and disbursements.
DEPOSIT IN TRANSIT AND OUTSTANDING CHECKS
- The determination of deposits in transit and outstanding checks were described earlier, and this is done in an
actual scenario by comparing the company's accounting records with the data provided in the bank statement. If
there were no errors existing in the records of both the depositor and the bank, the computations for
deposit in transit and outstanding checks, respectively, maybe as follows:
To compute deposits in transit:
Deposits in transit, beginning of the month
Pxx
Add cash receipts reflected in the company’s records during the month
(Excluding credit memos issued by the bank in previous month but recorded by
the depositor only this month)
xx
Total
Pxx
Less deposits as reflected in the bank statement during this month
(Excluding credit memorandum in the bank statement, if any, during this month)
xx
Deposits in transit, end of the month
Pxx
Mam pau’s formula:
DIT-Beginning + Receipts(Book) - Deposits(Bank) = DIT-Ending
To compute for the amount of outstanding checks:
20 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
Outstanding checks, beginning of the month
Pxx
Add checks drawn by the company during the month
(Excluding debit memos for bank charges last month)
xx
Total:
Pxx
Less checks paid by the bank during the month
(Excluding debit memos for bank charges this month)
xx
Outstanding checks, end of the month
Pxx
Mam pau’s formula:
OC-Beginning + Disbursements(Book) - Checks Cleared(Bank) = OC-Ending
-
To compute for the Adjusted Per Book
Balance
To compute for the Adjusted Per Bank
Balance
Unadjusted Per Book-Previous Month
Add: Receipts(Books)-Present/current month
Less: Disbursements(Books)-Present month
= Unadjusted Current Month (Per Books)
Unadjusted Per Bank-Previous Month
Add: Receipts/bank deposit-current month
Less: Disbursements-current month
= Unadjusted Current Month
Unadjusted Current Month (PerBooks)-Present
Add:CM-Note Collected
Less: DM-NSF Check
Less: DM-Service Charge
= Adjusted per book-CURRENT
Unadjusted Current Month-Present
ADD: DEPOSIT IN TRANSIT
Less: OUTSTANDING CHECKS
= Adjusted per bank-CURRENT
There are three forms of proof of cash:
-
Adjusted balance method
ADJUSTED BALANCE METHOD
Company X
PROOF OF CASH
For the month of February
January
31
Receipts
Disbursments
February
28
Balance per book
xxx
xxx
xxx
xxx
Note collected:
January
February
xxx
(xxx)
xxx
NSF check:
January
February
(xxx)
Service charge:
21 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
xxx
(xxx)
xxx
(xxx)
January
(xxx)
(xxx)
Adjusted book balance
xxx
xxx
xxx
xxx
Balance per book
xxx
xxx
xxx
xxx
Deposits in transit:
January
February
xxx
(xxx)
xxx
Outstanding checks:
January
February
(xxx)
Adjusted bank balance
xxx
xxx
(xxx)
xxx
(xxx)
xxx
xxx
xxx
January
31
Receipts
Disbursments
February
28
Balance per book
xxx
xxx
xxx
xxx
Note collected:
January
February
xxx
(xxx)
xxx
NSF check:
January
February
(xxx)
BOOK TO BANK METHOD
Company X
PROOF OF CASH
For the month of February
Service charge:
January
(xxx)
xxx
(xxx)
Deposits in transit:
January
February
(xxx)
Outstanding checks:
January
February
(xxx)
Balance per bank
xxx
BANK TO BOOK METHOD
Company X
PROOF OF CASH
22 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
xxx
(xxx)
(xxx)
xxx
(xxx)
xxx
(xxx)
xxx
(xxx)
xxx
xxx
xxx
For the month of February
January
31
Receipts
Disbursments
February
28
Balance per bank
xxx
xxx
xxx
xxx
Deposits in transit:
January
February
xxx
(xxx)
xxx
Outstanding checks:
January
February
(xxx)
Note collected:
January
February
xxx
NSF check:
January
February
xxx
Service charge:
January
xxx
Balance per book
xxx
xxx
(xxx)
xxx
(xxx)
(xxx)
xxx
(xxx)
xxx
(xxx)
xxx
xxx
xxx
xxx
xxx
CASH EQUIVALENTS
NATURE AND COMPOSITION OF CASH EQUIVALENTS
-
-
-
IAS 7 Paragraph 6 defines cash equivalents as short-term and highly liquid investments that are readily
convertible into cash and so near their maturity date that they present an insignificant risk of changes in
value because of the changes in interest rates.
- The standard further states that only highly liquid investments that are acquired three months before
maturity can qualify as cash and cash equivalents.
- Highly liquid short-term investments.
- Subject to an insignificant risk of changes in value.
To be included as part of the cash equivalent, the investment should possess a maturity date (date where your
investment will return to you without selling it). Thus shares are automatically excluded because they don't have
a maturity date with the exception to preference shares with specific redemption date, the maturity date, in this
case, is the redemption date.
Short term means 3 months, the counting of 3 months as from the date of purchase up to date of maturity.
Composed of four securities usually encountered in the problems:
i. Time deposit/certificate of deposit
ii. Commercial paper/money market placement
iii. Treasury bill, treasury warrants, treasury bonds
iv. Preference shares with a specific redemption date
Examples of Cash Equivalents
a. Three-month BSP Treasury bill
23 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
b. Three-year BSP Treasury bill purchased three months before the maturity date
c. Three-month time deposit
d. Three-month money market instrument or commercial paper
-
-
Equity securities (temporary investments in equity shares) cannot qualify as cash equivalents because shares
don’t have a maturity date.
- They are appropriately classified as either equity investments at FVPL or equity investments at FVOCI,
subject to the entity’s intention for holding the shares and on the guidelines provided by the IFRS 9.
- However, redeemable preference shares with specified redemption date and acquired three
months before the redemption date can qualify as cash equivalents.
Note that what is important is the date of purchase which should be three months or less before the maturity
date.
REGARDLESS of management’s policy, the determination of the maturity date starts from the date of
acquisition of the instrument and not from the date indicated in the face of the instrument.
- Thus a BSP Treasury bill that was purchased one year ago cannot qualify as a cash equivalent
even if the remaining maturity is three months or less.
INVESTMENT OF EXCESS CASH
-
The control and proper use of cash is an important aspect of cash management- the entity must maintain
sufficient cash funds for use in current operations.
Any cash accumulated in excess of that need for current operations should be invested even temporarily in
some type of revenue earning investment.
Accordingly, excess cash may be invested in:
(1) Time deposits
(2) Money market instruments
(3) Treasury bills
- The mentioned accounts are used for the purpose of earning interest income.
CLASSIFICATIONS IN INVESTMENT OF EXCESS CASH
Cash and
Cash Equivalents
Short term Financial
Assets or Temporary
Investments
(presented separately as
current assets)
Non-current or Long-term Investments
Classify
the
instrument as cash
and cash equivalents
if the term is three
months or less
Classify investments here if
the term is more than three
months but within one
year.
- Classify investments here if the term is
more than one year
- However, if such investments
become due within one year
from the end of the reporting
period, they are reclassified as ↓
Current or Temporary Investments
24 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
DISCLOSURE RELATING TO CASH AND CASH EQUIVALENTS
-
-
IAS 1 Presentation of Financial Statements requires “Cash and Cash Equivalents” (either combined or
separate account titles) as a separate line presentation on the face of the statement of financial position.
Furthermore, the entity shall disclose its policy in determining which financial instruments shall qualify to be
reported as cash equivalents.
An example of such disclosure is as follows:
On the face of the statement of financial position of a bank:
2020
2019
Pxx
Pxx
xxx
xxx
Due from Bangko Sentral ng Pilipinas
xxx
xxx
Due from other banks
xxx
xxx
Securities purchased under resale agreements
xxx
xxx
Pxx
Pxx
Cash and other cash items
Cash equivalents:
Total cash and cash equivalents
-
Cash and cash equivalents:
- For purposes of reporting cash flows, cash and cash equivalents include cash and other cash items, due
from BSP and other banks, and securities purchased under resale agreement (SPURA) that are
convertible to known amounts of cash which have original maturities of three months or less from dates
of placements and that are subject to an insignificant risk of changes in value. Due from BSP includes
the statutory reserves required by the BSP which the entity considers as cash equivalents wherein
withdrawals can be made to meet the entity’s cash requirements as allowed by the BSP.
CASH FRAUD
(1) WINDOW DRESSING
- It is a practice of opening the books of accounts beyond the close of the accounting period for the
purpose of showing a better financial position and performance.
- It is usually perpetrated as follows:
- By recording as of the last day of the accounting period collections made subsequent to the
close of the period.
- By recording as of the last day of the accounting period payments of accounts made
subsequent to the close of the period
(2) LAPPING
- It consists of misappropriating a collection from one customer and concealing this defalcation when
collection is made from another customer.
A deficiency in cash control that may occur when the cashier performs the bookkeeping function
(3) KITING
- It is a transfer of cash from one bank to another bank. It is usually employed at the end of the month.
25 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
-
It occurs when a check is drawn against the first bank and depositing the same check in a second bank
to cover the shortage in the latter bank.
II.
RECEIVABLES
- Receivables are financial assets because they represent a contractual right to receive cash or another financial asset
from another entity.
TRADE RECEIVABLES AND RELATED ALLOWANCES
Trade Receivables
Refer to claims arising from sale of merchandise or services in the ordinary course of business. Trade
receivables include accounts receivable and notes receivable.
Those that are expected to be realized in cash within the normal operating cycle or one year, whichever is
longer, are classified as current assets.
Non-trade Receivables
represent claims arising from sources other than the sale of merchandise or services in the ordinary course
of business.
Those that are expected to be realized in cash within one year, the length of the operating cycle
notwithstanding, are classified as current assets.
-
IF collectible beyond one year, non-trade receivables are classified as non-current assets.
Examples of non-trade receivable
1. Advances to or receivables from shareholders, directors, officers or employees. If collectible in one year such
advances or receivables should be classified as current assets. Otherwise, they are classified as non-current
assets.
2. Advances to affiliates are usually treated as long-term investments.
3. Advances to Supplier for the acquisition of merchandise are current assets
4. Subscriptions Receivable are current assets if collectible within one year. Otherwise, they are shown preferably
as a deduction from subscribed share capital.
5. Creditors’ accounts may have debit balances as a result of overpayment or returns and allowances. These are
classified as current assets.
6. Special deposits on contract bids normally are classified as other non-current assets because they are likely to
remain outstanding for a considerable, long period of time.
7. Accrued income such as dividends receivable, accrued rent income, accrued royalties income and accrued
interest on bond investment are usual current items.
8. Claims receivable such as claims against common carriers for losses or damages, claim for rebates and tax
refunds, claims from insurance companies, are normally classified as current assets.
26 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
Initial Recognition
-
Trade receivables are initially recognized at the transaction price.
Transaction price - Amount to which an entity expects to be entitled in exchange for transfer of
goods and services.
Trade Discounts
Trade discounts (volume or quantity discounts) are means of converting a catalog list price to the prices
actually charged to the buyer.
-
Commonly quoted in percentage or series of percentages.
-
Are not recognized for financial accounting purposes
-
Deducted from list price prior to recording the accounts receivable arising from a credit sales transaction.
-
Both accounts receivable and the related revenue are always recorded net of trade discounts.
-
For example:
Example #1
List price
P100,000
Less 10% x 100,000
10,000 .
Less 10% x 90,000
Less 5% x 81,000
Invoice price
P90,000
9,000 .
P81,000
May simply be computed as
100,000 x .90 x .90 x .95
4,050 .
P76,950
P76,950
Cash Discounts
-
Reductions from the sales price as an inducement for prompt payment of an account.
27 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
-
Expressed in terms which may read as:
2/10, n/30 (2% discount is granted if account is paid within 10 days from the invoice date, gross
amount due in 30 days)
3/15, n/60 (3% discount is granted if account is paid within 15 days from the invoice date, gross
amount due in 60 days).
The timing of the recognition of cash discounts is based on the method of accounting adopted by the
company for sales and the related accounts receivable:
Assume that on July 16, 2020, ABC Manufacturing sells merchandise on account with a list price of
P100,000 less trade discounts of 10%, 10% and 5%. The invoice price of the merchandise is computed earlier
as P76,950. Assume further that the credit terms were 2/10; n/30, FOB shipping point and freight paid to the
shipper by ABC Manufacturing amounted to P2,000. The sale on July 16, 2020 is recorded as follows under the
gross method:
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GROSS PRICE METHOD
Accounts Receivable
Sales
Cash
78,950
76,950
2,000
If customer pays on or before July 26 (within discount period
of 10 days)
77,411
Cash
1,539
Sales Discount
78,950
Accounts receivable
If customer pays after July 26 (beyond the discount period)
78,950
Cash
78,950
Accounts receivable
To recognize anticipated sales discounts must be prepared at
year-end
Sales discount
xx
Allowance for Sales Discount
xx
NET PRICE METHOD
Accounts Receivable
Sales
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77,411
75,411
Cash
2,000
If customer pays on or before July 26 (within discount period
of 10 days)
Cash
77,411
Accounts receivable
77,411
If customer pays after July 26 (beyond the discount period)
Cash
78,950
Sales Discount Forfeited
1,539
Accounts receivable
77,411
To recognize anticipated sales discounts must be prepared at
year-end
xx
Accounts receivable
xx
Sales Discount Forfeited
ALLOWANCE METHOD
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Accounts Receivable
78,950
Allowance for Sales Discounts
1,539
Sales
75,411
Cash
2,000
If customer pays on or before July 26 (within discount period
of 10 days)
Cash
77,411
Allowance for Sales Discounts
1,539
Accounts receivable
78,950
If customer pays after July 26 (beyond the discount period)
Cash
78,950
Allowance for Sales Discounts
1,539
Sales Discount Forfeited
1,539
Accounts receivable
78,950
To recognize anticipated sales discounts must be prepared at
year-end
Allowance for Sales Discounts
Sales Discount Forfeited
31 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
xx
xx
Credit Card Sales
-
Involving a national credit card company results in accounts receivable in the name of the card-issuing company.
-
Credit card fees range from 1% to 5% of net credit card sales, reducing the value of the accounts receivable.
-
Credit Card Service Charge would be reported as an operating expense in profit or loss.
Assume that MS Department Store has Citibank Visa drafts/receipts that total P1,200,000 on December 20. The
entry to record the Citibank Visa sales would be:
Credit Card Sales
Accounts Receivable – Citibank Visa
1,200,000
Sales
1,200,000
Assuming a 2% service fees by the bank, recognized by SM
as a selling expense, the entry would be:
Cash
1,176,000
Credit Card Service Charge
24,000
Accounts Receivable – Citibank Visa
1,200,000
Assuming that the credit card company allowed the retailer to
deposit credit card drafts/receipts directly to a current
account:
Cash
Credit Card Service Charge
Sales
32 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
1,176,000
24,000
1,200,000
NOTES RECEIVABLE
These are claims supported by formal promises to pay usually in the form of notes.
- The basic issues in accounting for notes receivable are the same as those for accounts receivable: recognition,
valuation, and disposition.
Negotiable promissory note
Is an unconditional promise in writing made by one person to another, signed by the maker, engaging to pay on
demand or at fixed or determinable future time a sum certain in money to order or to bearer.
–
It is a written contract in which one person, known as the maker, promises to pay another person, known as the
payee, a definite sum of money.
Interest-bearing notes receivable
-
The initial measurement of long-term notes will depend on whether the notes are interest-bearing or noninterest
bearing.
-
Interest-bearing long-term notes are measured at face value which is actually the present value upon issuance.
Non Interest-bearing notes receivable
-
Noninterest-bearing long-term notes are measured at present value which is the discounted value of the future cash
flows using the effective interest rate.
-
Actually, the term "noninterest-bearing" is a misnomer because all notes implicitly contain interest.
-
It is simply a case of the "interest being included in the face amount" rather than being stated as a separate rate.
*Standing alone, the term “notes receivable” represents only claims arising from sale of merchandise or service in the
ordinary course of business.
Initial Measurement
Conceptually, it is initially measured at present value.
However, short-term notes receivable are measured at face value. While the initial measure of long-term notes will
depend on whether the notes are interest-bearing or non-interest bearing.
Interest bearing long-term notes are measured at face value which is actually the present value upon issuance.
Non Interest bearing long-term notes are measured at present value which is the discounted value of the future cash
flows using the effective interest rate.
Subsequent Measurement
• Subsequent to initial recognition, long term notes receivable shall be measured at amortized cost using
effective interest method.
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• For long-term non-interest-bearing notes receivable, the amortized cost is the present value plus
amortization of the discount, or the face value minus the unamortized unearned interest income.
Meaning of amortized cost
-
The "amortized cost" is the amount at which the note receivable is measured initially:
a. Minus principal repayment
-
-
b. Plus or minus cumulative amortization of any difference between the initial carrying amount and
the principal maturity amount.
-
c. Minus reduction for impairment or uncollectibility.
-
For long-term non-interest-bearing notes receivable, the amortized cost is the present value plus amortization of the
discount, or the face value minus the unamortized unearned interest income.
-
Accordingly, only long-term notes receivable will be discussed in conjunction with the present value concept under
the following situations:
-
a. Interest bearing note
b. Noninterest bearing note
Dishonored Notes
•
A promissory note matures, and it is not paid, it is said to be dishonored.
•
(Transfer to accounts receivable)
Illustration – Interest bearing note
An entity owned a tract of land costing P800,000 and sold the land for P1,000,000.
The entity received a 3-year note for P1,000,000 plus interest of 12% compounded annually.
When interest is "compounded", in the mathematical parlance, this means that any accrued
interest receivable also earns interest.
The selling price of P1,000,000 is reasonably assumed to be the present value of the note
because the note is interest bearing.
34 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
Journal entries
First year
Note receivable
1,000,000
Land
800,000
Gain on sale of land
200,000
Accrued interest receivable
120,000
Interest income
120,000
(12% x 1,000,000)
Second year
Accrued interest receivable
134,400
Interest income
Face value
Interest accrued for first year
Total
Interest for second year (12% x 1,120,000)
35 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
134,400
1,000,000
120,000
1,120,000
134,400
Third year
Cash
1,404,928
Note receivable
1,000,000
Accrued interest receivable
254,400
Interest income
150,528
Face value
1,000,000
Interest accrued:
120,000
First year
134,400
254,400
Second year
Total
1,254,400
Interest for third year (12% x1,254,400)
150,528
Cash received
1,404,928
Illustration 1 – Non interest bearing note
An entity manufactures and sells machinery. On January 1, 2017, the entity sold machinery costing P280,000 for
P400,000.
The buyer signed a non interest bearing note for P400,000, payable in four equal installments every December 31.
The cash sale price of the machinery is P350,000.
36 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
Face value of note
400,000
Present value cash sale price
350,000
Unearned interest income
50,000
Cash sale price
350,000
Cost of machinery
280,000
Gross income
70,000
Journal entries for 2017
To record the sale:
Note receivable
400,000
Sales
350,000
Unearned interest income
50,000
To record the first installment collection:
Cash
100,000
Note receivable
37 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
100,000
To recognize the unearned interest as income over the
term of the note:
Unearned interest income
20,000
Interest income
20,000
YEAR
(a)
(b)
(c)
Note
Fraction
Interest
receivable
income
2017
400,000
4/10
20,000
2018
300,000
3/10
15,000
2019
200,000
2/10
10,000
2020
100,000
1/10
5,000
1,000,000
-
50,000
The first installment was received on December 31, 2017.
-
Thus, for 2017 the note payable outstanding is P400,000 and decreased by P100,000 each
year.
-
The fractions are developed from the note receivable balance every year.
-
The fractions developed are multiplied by the total unearned interest of P50,000 to get the yearly interest
income.
-
Thus, for 2017, 4/10 x P50,000 equals P20,000 and so on.
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If a statement of financial position is prepared on December 31, 2017, the current portion of the note
receivable is classified as current asset.
Note receivable – current portion
100,000
Unearned interest income
(15,000)
Carrying amount or amortized cost
85,000
Total unearned interest income
50,000
Realized in 2017
(20,000)
Balance-December 31, 2017
30,000
Realizable in 2018 – current portion
15,000
Realizable beyond 2018 – noncurrent portion
15,000
Total
30,000
39 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
Presentation
The noncurrent portion of the note receivable is classified as a Noncurrent asset.
Note receivable noncurrent portion
200,000
Unearned interest income
(15,000)
Carrying amount or amortized cost
40 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
185,000
Illustration 2 – Non interest bearing note
On January 1, 2017, an entity sold equipment with a cost of P250,000 for P400,000.
The buyer paid a down of P100,000 and signed a non-interest bearing note for P300,000 payable in equal annual
installment of P100,000 every December 31.
The prevailing interest rate for a note of this type is 10%. The present value of an ordinary annuity of 1 for three
periods at 10% is 2.4869.
The present value of the note is computed by multiplying the annual installment of P100,000 by the present value
factor of 2.4869 or P248,690.
Computation
The unearned interest income and gain on sale of
equipment are computed as follows:
Face value of note
Present value of note (100,000. x 2.4869)
Unearned interest income
Present value of note
Cash received – down payment
Sale price
Cost of equipment
Gain on sale of equipment
41 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
300,000
248,690
51,310
248,690
100,000
348,690
250,000
98,690
Journal entries for 2017
To record the sale of equipment:
Cash
100,000
Note receivable
300,000
Equipment
250,000
Gain on sale of equipment
98,690
Unearned interest income
51,310
To record the first installment collection:
100,000
Cash
100,000
Note receivable
To record the interest income for 2017:
Unearned interest income
24,869
24,869
Interest income
In this case, the computation of the interest income is made using the effective interest method.
Date
Annual
Interest income
collection
42 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
Principal
Present value
Jan. 1, 2017
100,000
Dec. 31, 2017
100,000
24,869
75,131
173,559
Dec. 31, 2018
100,000
17,356
82,644
90,915
Dec. 31, 2019
100,000
9,085
90,915
-
248,690
The interest income is computed by multiplying the present value by 10%.
-
-
Thus, for 2017, 10% x P248,690 equals P24,869.
The principal payment is equal to annual collection minus interest income.
-
-
Thus, for 2017, P100,000 minus P24,869 equals P75,131.
The present value is equal to the preceding balance minus the annual principal payment.
-
-
Thus, on December 31, 2017, P248,690 minus P75,131 equals P173,559.
LOANS RECEIVABLE AND IMPAIRMENT LOSSES
-
Initial amount > principal amount = amortization of difference deducted to carrying amount
Origination fees
-
Lending activities likely precede actual disbursement of funds and generally include efforts to identify and attract
potential borrowers and to originate a loan.
-
Fees charged by the bank against the borrower for the creation of the loan are known as “origination fees”.
-
Origination fees include compensation for the ff:
-
Evaluating the borrower’s financial condition
-
Evaluating guarantees, collateral, and other security.
-
Negotiating the terms of the loan.
-
Preparing and processing the documents related to the loan.
-
Closing and approving the loan transaction.
Accounting for origination fees
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The origination fees received from the borrower are recognized as unearned interest income and amortized over the
term of the loan.
-
If origination fees are not chargeable against the borrower, fees are known as “direct origination costs”.
-
Direct origination costs are deferred and amortized over the term of the loan.
-
Preferably, they are offset directly against any unearned origination fees received.
If origination fees received exceed the direct origination costs = difference is charged to unearned interest income
and amortization will increase interest income.
If direct origination costs exceed the origination fees received = difference is charged to direct origination costs and
amortization will decrease interest income.
-
Origination fees received and direct origination costs are included in the measurement of the loan receivable.
Illustration: Global Bank granted a loan to a borrower on January 1, 2017. The interest on the loan is 12%
payable annually starting December 31, 2017. The loan matures in three years on December 31, 2019.
Principal Amount
5,000,000
Origination fees received from borrower
331,800
Direct origination costs incurred
100,000
44 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
Initial carrying amount of the loan
Principal Amount
5,000,000
Origination fees received
(331,800)
Direct origination costs incurred
100,000
Initial carrying amount of the loan
4,768,200
Journal entries on January 1, 2017
To record loan:
Loan receivable
5,000,000
Cash
5,000,000
To record the origination fees received from the borrower:
Cash
331,800
Unearned interest income
331,800
To record the direct origination fees incurred by the bank:
Unearned interest income
100,000
Cash
100,000
Unearned interest income (credit balance) of P231,800 to be amortized over term of the loan using effective interest
method.
-
A new effective rate must be computed because of the origination fees received and direct origination costs.
45 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
-
Computed thru trial and error or interpolation approach.
Initial carrying amount of loan receivable of P4,768,200 is lower than principal amount.
-
Meaning there is a discount and effective rate must be higher than nominal rate of 12%
Effective rate is the rate that would equate the present value of the future cash flows of the loan to the initial carrying
amount of loan receivable.
Using an effective rate of 13%, the present value of 1 for 3 periods is 0.693, and present value of
ordinary annuity of 1 for 3 periods is 2.361.
Present value of the cash flows:
ILLUSTRATION
PV of principal (5,000,000 x .693)
3,465,000
PV of interest (600,000 x 2.361)
1,416,600
Total present value of cash flows
4,881,600
Initial carrying amount is P4,768,200 which is lower than
P4,881,600. This means that effective rate is higher than 13%.
Another rate is used in the interpolation process, using 14%, the
present value of 1 for 3 periods is .675 and the present value of
ordinary annuity of 1 for three periods is 2.322.
PV of principal (5,000,000 x .675)
PV of interest (600,000 x 2.322)
3,375,000
1,393,200
Total present value of cash flows
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4,768,200
-
Initial carrying amount of P4,768,200 is now the same as the present value of the cash flows. Thus, the effective
rate is 14%.
ILLUSTRATION
Interest Received
Interest income
Amortization
Carrying amount
Jan. 1, 2017
600,000
667,548
67,548
4,768,200
Dec. 31, 2017
600,000
677,005
77,005
4,835,748
Dec. 31, 2018
600,000
687,247
87,247
4,912,753
Dec. 31, 2019
600,000
Date
Effective Interest Method
-
Interest received = Principal x nominal rate
-
Interest income = Carrying amount x effective rate
47 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
5,000,000
Effective Interest Method
December 31, 2017
Interest received (5,000,000 x 12%)
600,000
Interest income (4,768,200 x 14%)
667,548
Amortization
65,548
Carrying amount – January 1, 2017
4,768,200
Carrying amount – December 31, 2017
4,835,748
December 31, 2018
Interest received
600,000
Interest income (4,835,748 x 14%)
677,005
Amortization
77,005
Carrying amount – January 1, 2017
4,835,748
Carrying amount – December 31, 2018
4,912,753
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December 31, 2019
Interest received
600,000
Interest income (4,912,753 x 14% = P687,785 – P538)
687,247*
*Amount of P538 came from rounding off present value factors*
Amortization
87,247
Carrying amount – January 1, 2018
4,912,753
Carrying amount – December 31, 2019
5,000,000
Journal Entries on December 31, 2017
Cash
600,000
Interest income
Unearned interest income
Interest income
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600,000
67,548
67,548
Journal Entries on December 31, 2017
Cash
600,000
Interest income
Unearned interest income
600,000
77,005
Interest income
77,005
Journal Entries on December 31, 2017
Cash
600,000
Interest income
Unearned interest income
600,000
87,247
Interest income
Cash
Loan receivable
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87,247
5,000,000
5,000,000
Statement Presentation
If a statement of financial position is prepared on December 31, 2017, the loan
receivable is presented as follows:
Loan receivable
600,000
Unearned interest income (231,800 – 67,548)
(164,252)
Carrying amount – December 31, 2017
4,835,748
* Carrying amount is the amortized cost. *
Impairment of Loan
PFRS 9, paragraph 5.5.1, provides that an entity shall recognize a loss allowance for expected credit losses on
financial assets measured at amortized cost.
Paragraph 5.5.3 provides that an entity shall measure loss allowance for a financial instrument at an amount equal
to the lifetime expected credit losses if the credit risk on that financial instrument has increased significantly since initial
recognition.
-
Credit losses are the present value of all cash shortfalls.
-
Expected credit losses are an estimate of credit losses over the life of the financial instrument.
Measurement of Impairment
-
When measuring expected credit losses, an entity should consider:
-
The probability-weighted outcome
The estimate should reflect the possibility that a credit loss occurs and the possibility that
no credit loss occurs.
-
The time value of money
-
-
The expected credit losses should be discounted.
Reasonable and supportable information that is available without undue cost or effort.
PFRS 9 does not prescribe a particular method of measuring expected credit losses.
51 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
An entity may use various sources of data both internal or entity-specific and external in measuring
expected credit losses.
The amount of impairment loss can be measured as the difference between the carrying amount
and the present value of estimated future cash flows discounted at the original effective rate.
The carrying amount of the loan receivable shall be reduced either directly or through the use of an
allowance account.
Meaning of Credit Risk
Credit risk is the risk that one party to a financial instrument will cause a financial loss for the other party by failing to
discharge a particular obligation.
-
The risk contemplated is the risk that the issuer will fail to perform a particular obligation.
-
The risk does not necessarily relate to the credit worthiness of the issuer.
Illustration: International Bank loaned P5,000,000 to Bankard Company on January 1, 2015. The term of the loan
require principal payment of P1,000,000 each year for 5 years plus interest at 10%. The first principal and interest
payment is due on December 31, 2015. Bankard Company made the required payments on December 31, 2015
and December 31, 2016. However during 2017, Bankard Company began to experience financial difficulties and
was unable to make the required principal and interest payment on December 31, 2017.
On December 31, 2017, International Bank assessed the collectability of the loan and has determined that the
remaining principal payments will be collected but the collection of the interest is unlikely. The loan receivable has
carrying amount of 3,300,000 including the accrued interest of P300,000 on December 31, 2017. International
Bank projected the cash flows from the loan on December 31, 2017.
Date of cash flow
Amount projected
December 31, 2018
500,000
December 31, 2019
1,000,000
December 31, 2020
1,500,000
Using the original effective rate of 10%, the present value of 1 is .9091 for 1 period, .8264 for 2 periods and .7513
for 3 periods.
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Present value of the cash flows
December 31, 2018 (500,000 x .9091)
454,550
December 31, 2019 (1,000,000 x .8264)
826,400
December 31, 2020 (1,500,000 x .7513)
1,126,950
Total present value of cash flows
2,407,900
Computation of impairment loss
The impairment loss is the difference between the carrying
amount of loan and the present value of cash flows.
Carrying amount of loan
3,300,000
Present value of cash flows
2,407,900
Impairment loss
892,100
Journal entry on December 31, 2017
Loan impairment loss
892,100
Accrued interest receivable
300,000
Allowance for loan impairment
592,100
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The accrued interest receivable is credit directly because
the collection of interest is unlikely.
Statement presentation on December 31, 2017
Loan receivable
3,000,000
Allowance for loan impairment
(592,100)
Carrying amount
2,407,900
Journal entries on December 31, 2018
To record the cash collection:
Cash
500,000
Loan receivable
500,000
To record the interest income using the effective interest
method:
Allowance for loan impairment
240,790
Interest income
240,790
The interest income for 2018 is computed by multiplying
the carrying amount of loan by effective rate.
P2,407,000 x 10% = P240,790
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*Note that the recognition of interest income is charged
against allowance for loan impairment account*
Journal entries on December 31, 2019
To record the cash collection:
Cash
1,000,000
Loan receivable
1,000,000
To record the interest income using the effective interest
method:
Allowance for loan impairment
214,869
Interest income
214,869
Loan receivable – December 31, 2018
2,500,000
Allowance for loan impairment (592,100 – 240,790)
(351,310)
Carrying amount – December 31, 2018
2,148,690
Interest income for 2019 (10% x 2,148,690)
214,869
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Journal entries on December 31, 2019
To record the cash collection:
Cash
1,500,000
Loan receivable
1,500,000
To record the interest income using the effective interest
method:
Allowance for loan impairment
136,441
Interest income
136,441
Loan receivable – December 31, 2018
1,500,000
Allowance for loan impairment (592,100 – 240,790)
(136,441)
Carrying amount – December 31, 2018
1,363,559
Interest income for 2019 (10% x 2,148,690)
136,356
There is a difference of P85 between P136,441 and
P136,356 due to rounding of present value factors
56 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021
RECEIVABLE FINANCING
Concept of receivable financing
Receivable financing is the financial flexibility/capability of an entity to raise money out of its receivables.
Forms of receivable financing
The common forms of receivable financing are:
Pledge of accounts receivable
Assignment of accounts receivable
Factoring of accounts receivable
Discounting of notes receivable
Pledge of accounts receivable
Loans obtained from the bank or any lending institution, the accounts receivable may be pledged as collateral
security for the payment of the loan.
The loan is recorded by debiting cash and discount on note payable if loan is discounted, and crediting note
payable.
The subsequent payment of the loan is recorded by debiting note payable and crediting cash.
With respect to the pledged accounts, no entry would be necessary. It is sufficient that disclosure thereof is made in
a note to financial statement.
Illustration On November 1, 2017, an entity borrowed P1,000,000 from Philippine
National Bank and issued a promissory note for the same. The term of the loan is
one year and discounted at 12%. The entity pledged accounts receivable of
P2,000,000 to secure the loan.
On November 1, 2017, the journal entry to
record the loan is:
880,000
Cash
120,000
Discount on note payable
1,000,000
Note payable – bank
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If the loan is discounted, in the banking
parlance this means that the interest for the
term of the loan is deducted in advance.
1,000,000
Face value of loan
(120,000)
Less: Interest deducted in advance
(1,000,000 x 12%)
880,000
Net proceeds
Statement presentation
On December 31, 2017, using the
straight-line method, the discount on note
payable is amortized as interest expense for
two months from November 1 to December
31.
20,000
Interest expense (120,000 x 2/12)
20,000
Discount on note payable
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At this point, if a statement of financial
position is prepared on December 31, 2017,
the note payable-bank and the discount on
note payable are presented as follows:
Current liabilities:
Note payable – bank
1,000,000
Discount on note payable
(100,000)
Carrying amount
900,000
A note to financial statement may appear as
follows:
"The note payable to bank matures on
November 1, 2018, and is secured by
accounts receivable with face value of
P2,000,000.”
On November 1, 2018, the payment of the
bank loan is recorded.
Note payable-bank
1,000,000
Cash
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1,000,000
And the discount on note payable is finally
amortized.
100,000
Interest expense
100,000
Discount on note payable
Assignment of accounts receivable
-
Assignment of accounts receivable means that a borrower called the assignor transfers rights in some accounts
receivable to a lender called the assignee in consideration for a loan,
Assignment is a more formal type of pledging of accounts receivable. Assignment is secured
borrowing evidenced by a financing agreement and a promissory note both of which the assignor signs.
However, pledging is general because all accounts receivable serve as collateral security for the
loan. On the other hand, assignment is specific because specific accounts receivable serve as
collateral security for the loan.
-
Assignment may be done either on a non-notification or notification basis.
When accounts are assigned on a non-notification basis, customers are not informed that their
accounts have been assigned. As a result, the customers continue to make payments to the assignor,
who in turn remits the collections to the assignee.
When accounts are assigned on a notification basis, customers are notified to make their
payments directly to the assignee.
The assignee lends only a certain percentage (maybe 70%, 80%, or 90% depending on the quality
of the accounts) of the face value of the accounts assigned because the assigned accounts may not be
fully realized by reason of such factors as sales discount, sales return, and allowances and uncollectible
accounts quality of the accounts.
The assignee charges interest for the loan that it makes and requires a service or financing charge
or commission for the assignment agreement.
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Illustration – non notification basis
April
1
An entity assigned P700,000 of accounts receivable to a bank
under a non-notification arrangement. The bank advances 80% less a
service charge of P5,000.
The entity signed a promissory note that provides for interest of 1%
per month on the unpaid loan balance.
To
separate
the
assigned
accounts:
700,000
Accounts receivable-assigned
700,000
Accounts receivable
To record the loan:
555,000
Cash (560,000 - 5,000)
5,000
Service charge
560,000
Note payable – bank
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5 Issued a credit memo for
sales return to a customer
whose account was assigned,
P20,000.
20,000
Sales return
20,000
Accounts receivable-assigned
10 Collected P300,000 of
the assigned accounts less
2% discount.
Cash
Sales discount (2% x
294,000
6,000
300,000)
Accounts
300,000
receivable-assigned
30 Remitted the total
collections to the bank plus
interest for one month.
Note payable – bank
Interest expense (1% x
294,000
5,600
560,000)
Cash
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299,600
May
7 Assigned accounts of
P15,000 proved worthless.
15,000
Allowance for doubtful
15,000
accounts
Accounts
receivable-assigned
20 Collected P300,000 of
the assigned accounts.
300,000
Cash
Accounts
receivable-assigned
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300,000
30 Remitted the total amount
due the bank to pay off the
loan balance plus interest for
one month.
Note payable-bank (560,000 294,000)
Interest expense (1% x
266,000
2,660
266,000)
Cash
268,660
To transfer the remaining
balance of assigned accounts
to accounts receivable:
Accounts receivable
65,000
65,000
Accounts
receivable-assigned
Total accounts
700,000
receivable-assigned
Less: Collections (294,000 +
300,000)
594,000
6,000
Sales discount
20,000
Sales return
15,000
Worthless
635,000
accounts
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65,000
Balance
Illustration – notification basis
July
1
An entity assigned P1,000,000 of accounts receivable to a bank under a
notification arrangement. The bank loans 80% less 4% service charge on
the gross amount assigned.
The entity signed a promissory note that provides for 1% interest per month
on the unpaid loan balance.
1
Accounts receivable – assigned
1,000,000
Accounts receivable
1,000,000
Cash (800,000 - 40,000)
760,000
Service charge (4% x 1,000,000)
40,000
Note payable – bank
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800,000
31
Received notice from bank that P600,000 of
the assigned accounts were collected less 2%
discount. A check was sent to the bank for the
interest due.
Note payable – bank
588,000
Sales discount (2% x 600,000)
12,000
Accounts receivable – assigned
600,000
Interest expense (1% x 800,000)
8,000
Cash
8,000
August
31 Received notice from bank that P300,000
of the assigned accounts were collected. Final
settlement was made by the bank for the
excess
collections
together
with
the
uncollected assigned accounts of P100,000.
Cash
Interest expense
Note payable – bank
85,880
2,120
212,000
300,000
Accounts receivable – assigned
Accounts receivable
100,000
Accounts receivable – assigned
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100,000
Computation
Loan from bank
800,000
Less: July collection by bank
588,000
Balance due the bank
212,000
August collection by bank
300,000
Less: Loan balance
212,000
Excess collection
88,000
Less: Interest (1% x 212,000)
2,120
Remittance from bank
85,880
Statement presentation
An entity provided the following accounts at
year-end:
Accounts receivable-unassigned
4,000,000
Accounts receivable-assigned
1,000,000
Allowance for doubtful accounts
100,000
Note payable – bank (related to assignment)
400,000
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Accounts receivable-unassigned
4,000,000
Accounts receivable-assigned
1,000,000
Total
5,000,000
Allowance for doubtful accounts
(100,000)
Net realizable value
4,900,000
The net realizable value of P4,900,000 is
included in the caption "trade and other
receivables".
Equity in assigned accounts
Moreover, the entity shall disclose its equity in
the assigned accounts determined as follows:
Accounts receivable – assigned
Note payable – bank
Equity in assigned accounts
1,000,000
(400,000)
600,000
Factoring
-
Factoring is a sale of accounts receivable on a without recourse, notification basis.
In a factoring arrangement, an entity sells accounts receivable to a bank or finance entity
called a factor.
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Accordingly, a gain or loss is recognized for the difference between the proceeds received and the
net carrying amount of the receivables factored.
Factoring differs from an assignment in that an entity actually transfers ownership of the accounts receivable to
the factor.
Thus, the factor assumes responsibility for uncollectible factored accounts.
In assignment, the assignor retains ownership of the accounts assigned.
Because of the nature of the transaction, the customers whose accounts are factored are notified
and required to pay directly to the factor.
The factor has then the responsibility of keeping the receivable records and collecting the accounts.
Factoring may take the form of the following:
Casual factoring
Factoring as a continuing agreement
Casual factoring
If an entity finds itself in a critical cash position, it may be forced to factor some or all of its accounts receivable at a
substantial discount to a bank or a finance entity to obtain the much-needed cash.
EXAMPLE: An entity factored P100,000 of accounts receivable with an
allowance for doubtful accounts of P5,000 for P80,000.
Journal entry to record the sale:
Cash
80,000
Allowance for doubtful accounts
5,000
Loss on factoring
15,000
Accounts receivable
100,000
Factoring as a continuing agreement
-
Factoring may involve a continuing arrangement where a finance entity purchases all of the accounts
receivable of a certain entity.
- In this setup, before a merchandise is shipped to a customer, the selling entity requests
the factor's credit approval.
- If it is approved, the account is sold immediately to the factor after shipment of the goods.
- The factor then assumes the credit function as well as the collection function.
- For compensation, typically the factor charges a commission or factoring fee of 5% to 20%
for its services of credit approval, billing, collecting, and assuming uncollectible factored
accounts.
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-
Moreover, the factor may withhold a predetermined amount as a protection against customer returns and
allowances and other special adjustments.
- This amount withheld is known as the "factor's holdback".
- The factor's holdback is a receivable from the factor and classified as current asset.
- Final settlement of the factor's holdback is made after the factored receivables have been
fully collected.
Illustration
An entity factored accounts receivable of P500,000 with credit terms of 2/10,
n/30 immediately after shipment of the goods to the customer.
The factor charged a 5% commission based on the gross amount of the
receivables factored.
In addition, the factor withheld 20% of the amount of the receivables factored to
cover sales return and allowances.
Journal entry to record the factoring:
Cash
365,000
Sales discount
10,000
Commission
25,000
Receivable from factor
100,000
Accounts receivable
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500,000
Computation
Gross amount
500,000
Less: Sales discount (2% x 500,000)
10,000
Commission (5% x 500,000)
25,000
Factor's holdback (20% x
100,000
500,000)
135,000
Cash received from factoring
365,000
If the customer is subsequently allowed
a credit of P50,000 for
damaged merchandise, the journal entry
is:
Sales return and allowance
50,000
1,000
Sales discount (2% x 50,000)
49,000
Receivable from factor
When all the receivables factored are
collected by the factor
with no further returns and allowances,
the final settlement with the factor is
recorded as follows:
Cash (100,000 - 49,000)
51,000
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Receivable from factor
51,000
Credit card
A credit card is a plastic card which enables the holder to obtain credit up to a predetermined limit from the issuer of
the card for the purchase of goods and services.
The credit card has enabled retailers and other businesses to continue to sell goods and services where the
customers obtain possession of the goods immediately but do not have to pay for the goods for about one month.
-
The major credit cards in the Philippines are Diners Club, American Express, VISA and MasterCard.
These entities are generally responsible for approving the credit of customers and collecting the receivables for a
service fee from 1% to 5% of the credit card sales.
Generally, if a customer buys goods and uses a credit card, the credit card receipt must be forwarded by the retailer
to the card issuer who will then pay the retailer the appropriate amount minus the credit service charge.
Two entries are necessary, one entry at the time of sale and another entry when payment is received from the card
issuer.
Illustration #1
Credit card sales to customers using Diners Club amount to P200,000 for a
certain period.
The credit card receipts are forwarded to Diners Club and payment is
subsequently received from Diners Club minus a 3% service charge.
To record the credit card sales:
Accounts receivable-Diners Club
200,000
Sales
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200,000
To record the payment from Diners Club:
Cash
194,000
Credit card service charge (200,000 x 3%)
6,000
Accounts receivable-Diners Club
200,000
Illustration #2
There are some credit cards that allow the retailer business to deposit the credit
card receipts directly to a current account.
The bank accepts the credit card receipts and immediately increases the current
account of the retailer for the amount of credit card sales minus the credit card
service charge.
This arrangement is in effect a form of factoring of accounts receivable because
the credit card sales are treated as cash sales by the retailers.
For example, credit card sales amount to P200,000 with 5% service charge or
P10,000.
The journal entry to record the credit card
sales under this form of arrangement is:
Cash
190,000
Credit card service charge
10,000
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Sales
200,000
Concept of discounting
-
As a form of receivable financing, discounting specifically pertains to note receivable.
-
In a promissory note, the original parties are the maker and payee.
-
The maker is the one liable and the payee is the one entitled to payment on the date of maturity.
-
When a note is negotiable, the payee may obtain cash before maturity date by discounting the note at a bank or
other financing company.
-
To discount the note, the payee must endorse it.
Thus, legally the payee becomes an endorser, and the bank becomes an endorsee.
Endorsement
-
the transfer of right to a negotiable instrument by simply signing at the back of the instrument.
-
Endorsement may be with recourse which means that the endorser shall pay the endorsee if the maker dishonors
the note.
-
In the legal parlance, this is the secondary liability of the endorser.
In the accounting parlance, this is the contingent liability of the endorser.
-
Endorsement may be without recourse which means that the endorser avoids future liability even if the maker
refuses to pay the endorsee on the date of maturity.
-
In the absence of any evidence to the contrary, endorsement is assumed to be with recourse.
Terms related to discounting of note
1.
Net proceeds refer to the discounted value of the note received by the endorser from the endorsee.
a.
Net proceeds = Maturity value - Discount
2.
Maturity value is the amount due on the note at the date of maturity.
a.
Maturity value = Principal + interest
3.
Maturity date is the date on which the note should be paid.
4.
Principal is the amount appearing on the face of the note. It is also referred to as face value.
5.
Interest is the amount of interest for the full term of the note.
a.
Interest is computed as Principal x rate x time.
6.
Interest rate is the rate appearing on the face of the note.
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7.
Time is the period within which interest shall accrue. For discounting purposes, it is the period from date of note
to maturity date.
a.
In other words, the term “time” is the entire period or "full term” of the note.
8.
Discount is the amount of interest deducted by the bank in advance.
a.
Discount = maturity value x discount x discount period.
9.
Discount rate is the rate used by the bank in computing the discount. The discount rate should not be confused
with the nterest rate. The discount rate and interest rate are diterent rom each other.
a.
If no discount rate is given, the interest rate is safely assumed as the discount rate.
10. Discount period is the period of time from date of discounting to maturity date.
a.
Discount period = term of the note – expired portion up to the date of discounting
b.
Discount period is the unexpired term of note.
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Illustration - discounting without recourse
A P1,000,000, 180-day, 12% note dated July 1 was received from a customer and
discounted without recourse on August 30 at 15% discount rate.
Computation
Maturity value which is equal to the
principal plus interest
Principal
Interest (1,000,000 x 12% x 180/360)
Maturity value
1,000,000
60,000
1,060,000
Discount which is equal to the "maturity
value times discount rate times discount
period".
Discount (1,060,000 x 15% x 120/360)
The discount period is the remaining
53,000
term of the note on the date of
discounting.
Term of note
180 days
Less: Days expired from July 1 to
August 30
60 days
Discount period-remaining term
120 days
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In counting, "exclude the first day but
include the last day."
Net proceeds from discounting
Maturity value
Discount
Net proceeds
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1,060,000
(53,000)
1,007,000
Carrying
amount
of
the
note
receivable
1,000,000
Principal
20,000
Accrued interest receivable (1,000,000 x
12% x 60 /360)
1,020,000
Carrying amount of note receivable
The
accrued
interest
receivable
is
interest earned from July 1 to the date of
discounting on August 30, or 60 days.
Gain or loss on note discounting
Net proceeds
1,007,0000
Carrying amount of note receivable
1,020,000
Loss on note discounting
(13,000)
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Accounting
for
note
receivable
discounting
The accounting for note receivable
discounting depends on whether the
discounting is with or without recourse.
In the illustration, the discounting is
without recourse, meaning, the sale of
the note receivable is absolute and
therefore there is no contingent liability.
Journal entry
Cash
Loss on note receivable discounting
1,007,000
Note receivable
13,000
Interest income
1,000,000
20,000
The note receivable account is credited
directly because the sale of the note
receivable
is
without
recourse
or
absolute.
The interest income is credited for the
actual interest earned on the date of
discounting.
Illustration - discounting with recourse
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A P2,400,000, 6-month, 12% note dated February l is received from a
customer by an entity and discounted by First Bank on March 1 at 15%
Principal
Interest (2,400,000 x 12% x 6/12)
2,400,000
144,000
Maturity value
2,544,000
Discount (2,544,000 x 15% x 5/12)
(159,000)
Net proceeds
2,385,000
Term of note
6 months
Less: Age of note (February 1 to March
1 month
1)
Discount period
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5 months
Since the term of the note is expressed
in "months', the counting is by months
regardless of the number of days in a
month.
2,400,000
Principal
24,000
Accrued interest receivable (2,400,000 x
12% x 1/12)
2,424,000
Carrying amount of note receivable
The accrued interest receivable is for
one month from February 1 to the date
of discounting on March 1.
Net proceeds
Carrying amount of note receivable
Loss on note receivable discounting
If the discounting is with recourse, the
transaction is accounted for as either of
the following:
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2,385,000
2,424,000
(39,000)
a)
Conditional sale of note
receivable recognizing a contingent
liability
b)
Secured borrowing
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Conditional sale
If the discounting is treated as a
conditional sale of note receivable, the
journal entry to record the transaction on
March 1 is as follows:
Cash
2,385,0000
Loss on note receivable
39,000
Note receivable discounted
2,400,000
Interest income
24,000
The note receivable discounted account
is
deducted
from
the
total
notes
receivable when preparing the statement
of financial position with disclosure of
the contingent liability.
Note is paid by maker on maturity
On August 1, date of maturity, the note
is paid by the maker to the First Bank.
The contingent liability 1s extinguished
as follows:
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Note receivable discounted
2,400,000
Note receivable
2,400,000
Note is dishonored by maker
The note is dishonored by the maker
on August 1, and the entity pays the
First Bank the maturity value of the note,
P2,544,000, plus protest fee and other
bank charges of P6,000.
The
total
payment
is
charged
to
accounts receivable.
Journal entries
To record the payment to First Bank:
Accounts receivable
2,550,000
Cash
2,550,000
To cancel the contingent liability:
Note receivable discounted
2,400,000
Note receivable
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2,400,000
Secured borrowing
If the discounting is treated as a secured
borrowing, the note receivable is not
derecognized but instead an accounting
liability is recorded at an amount equal
to
the
face
amount
of
the
note
receivable discounted.
Journal entry
Cash
2,385,000
Interest expense
39,000
Liability for note receivable discounted
Interest income
24,000
There is no objection if the interest
expense is "netted" against the interest
income or a net interest expense of
P15,000
because
the
discounting
transaction is a borrowing.
There is no gain or loss on discounting if
the
note
receivable
2,400,0000
discounting
is
accounted for as secured borrowing.
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Note is paid by maker on maturity
If the note is paid by the maker to the
First Bank, the liability for note
receivable discounted and note
receivable are derecognized.
Liability for note receivable discounted
2,400,0000
Note receivable
2,400,000
Note is dishonored by maker
The note is dishonored by the maker
on August 1, and the entity pays the
First Bank the maturity value of the note,
P2,544,000 plus protest fee and other
bank charges of P6,000.
Journal entries
To record the payment to First Bank:
Accounts receivable
2,550,000
Cash
2,550,000
To derecognize the liability for note
receivable discounted and note
receivable:
Liability for note receivable discounted
2,400,000
Note receivable
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2,400,000
Conditional sale or secured borrowing
IFRS 9, paragraph 3.2.3, provides that an entity shall derecognize a financial asset when either one of the following
criteria is met:
a)
The contractual rights to the cash flows of the financial asset have expired.
b)
The financial asset has been transferred and the transfer qualifies for derecognition based on
the extent of transfer of risks and rewards of ownership.
-
The first criterion is usually easy to apply.
The contractual rights to the cash flows may expire, for example, when a note receivable from a customer is fully
collected.’
-
The application of the second criterion is often complex.
-
It relies on the assessment of the extent of the transfer of risks and rewards of ownership.
-
IFRS 9, paragraph 3.2.6, provides the following guidelines for derecognition based on transfer of risks and rewards:
1.
If the entity has transferred substantially all risks ana rewards, the financial asset shall be derecognized.
2.
If the entity has retained substantially all risks and rewards, the financial asset shall not be derecognized.
3.
If the entity has neither transferred nor retained substantially all risks and rewards, derecognition depends on
whether the entity has retained control of the asset.
a.
If the entity has lost control of the asset, the financial asset is derecognized in its entirety.
b.
If the entity has retained control over the asset, the financial asset is not derecognized.
Discounting own note
-
In the previous discussion, the maker of the discount was a customer.
In other words, the party discounting is the payee and a mere endorser and therefore only a person secondarily
liable. There is then a contingent liability on the note discounted.
-
Where the note discounted is made by the party discounting, a primary liability, not a contingent liability, exists.
-
In effect, the party discounting is entering into a contract of loan with the endorsee.
Illustration #2
For example, an entity discounted at the bank its own note of P500,000 at
126 for one year on September 1, 2017.
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Journal entry
Cash
440,000
Discount on note payable
60,000
Note payable – bank
500,000
Principal
500,000
Discount (500,000 x 12%)
(60,000)
Net proceeds
440,000
On
December
31,
2017,
using
the
straight-line method, the discount on note
payable is amortized as interest expense
for four months from September 1 to
December 31.
Interest expense (60,000 x 4/12)
Discount on note payable
20,000
20,000
In the December 31, 2017, statement of
financial position, the note payable minus
the discount on note payable is presented
as current liability.
Note payable – bank
Discount on note payable
Carrying amount
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500,000
(40,000)
460,000
III.
INVENTORIES
Inventories
➢ are assets held for sale in the ordinary course of business, in the process of production for such sale in the form
of materials or supplies to be consumed in the production process or in the rendering of services
➢ It encompasses goods purchased and held for resale, for example:
- Merchandise purchases by a retailer in a merchandising business held for resale
- Land and other property held for resale by a subdivision entity and real estate developer
➢ In a manufacturing business, inventories also encompass finished goods produced, goods in process, and
materials and supplies awaiting use in the production process
Classes of Inventories
I.
II.
Inventories of a trading concern
- A trading concern is one that buys and sells goods in the same form purchased
- ‘Merchandise inventory’ is used
Inventories of a manufacturing concern
- A manufacturing concern is one that buys goods which are altered or converted into another form before
they are made available for sale
- A manufacturing concern maintains 4 types of inventory, namely:
(1) Finished Goods - Completed products which are ready for sale
(2) Goods in process- Also known as ‘work-in-process’, these are partially completed products
which require further process or work before they can be sold
(3) Raw Materials - goods that are to be used in the production process and can be directly
attributed to the end product
(4) Factory or Manufacturing Supplies- also referred to as ‘indirect materials’. These are
materials which are used in the manufacturing process but cannot be directly attributed to each
product practically.
Goods included in Inventory
- General rule: All goods to which the entity has title shall be included in inventory, regardless of location.
- Applying this principle, the following are included in inventory:
(1) Goods ownded and on hand
(2) Goods in transit and sold FOB destination
(3) Goods in transit and purchased FOB shipping point
(4) Goods out on consignment
(5) Goods in the hands of salesmen or agents
(6) Goods held by customers on approval or on trial
- Exception to the rule: Installment contracts which provide retention of the seller’s title until selling price is fully
paid
Cost of Inventories
-
The cost of inventories shall comprise:
a.Cost of purchase - comprises the purchase price, import duties and irrecoverable taxes, freigh,
handling and other costs directly attributable to the acquisiont of finished
goods, materials and services .
- Trade discounts, rebates and other items of similar nature are deducted.
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b.Cost of conversion- include costs of direct labor and systematic allocation of fixed and variable
production overhead
c.Other costs incurred in bringing the inventories to their present location and condition
- costs of bringing the inventories to their present location and condition except
the following:
a. Abnormal amounts of wasted materials, labor and other production
costs.
b. Storage costs, unless they are necessary before a further
improvement on the thing as part of the production process may be
employed
c. Administrative overheads that do not contribute to bringing the
inventories to their present location and condition
d. Distribution or selling costs
Consigned Goods
-
Consigned goods shall be included in the consignor’s inventory and excluded from the consignee’s
inventory .
Consignment is a method of marketing goods in which the owner (consignor) transfers PHYSICAL
POSSESSION to an agent (consignee)
Freight and other handling costs are part of cost of goods consigned (costs must be attributable to goods
consigned)
Cost Formulas
(1) First-in, First -out (FIFO)
- Goods first purchased are first sold
- Goods subsisting are assumed to be most recently purchased
- Note that cost application is the main concern not distribution per se
- Cost of goods issued is based on cost of goods first purchased
- The OBJECTION TO THE METHOD is that there is an improper matching of cost against revenue because the
-
goods sold are stated at earlier or old prices resulting in an understatement of the cost of goods sold
In a period with rising prices or inflation, FIFO results in Highest Income, Highest Tax and highest cost of ending
inventory.
Illustration II: (Problem based on Practical Financial Accounting- Valix 2019 edition Vol. 1)
Jayson Company uses FIFO perpetual costing system
The following information has been extracted from the records about one product:
Units
Unit Cost
Total Cost
January 1
Beg. Balance
8,000
70.00
560,000
January 6
Purchase
3,000
70.50
211,500
February 5
Sale
10,000
March 5
Purchase
11,000
73.50
808,500
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March 8
Purchase return
800
April 10
Sale
7,000
April 30
Sale Return
300
73.50
58,800
What is the cost of inventory sold on Feb. 5, April 10 and Sales Return on April 30?
UNITS
COST APPLICATION
TOTAL COST
February 5
10,000 units
(8,000 units * 70.00)
(2,000 units * 70.50)
701,000
April 10
7,000
(1,000 units * 70.50)
(6,000 units * 73.50)
511,500
April 30
300
(300 units * 73.50)
22,050
What is the cost of inventory on April 30?
March 5 inventory 11,000 units @ 73.50
April 10 Sale
(6,000 units)
April 30 return
300 units
March 8 Purch. Ret, (800 units)
4,500 units * 73.50 = 330,750
(2) Weighted Average Method
-
The cost of the beginning inventory plus the total cost of purchases During the period is divided by the total units
purchased plus those in the beginning inventory to get a weighted average unit cost.
Such weighted average unit cost is then multiplied by the units on hand to derive the inventory value.
In other words, the average unit cost is computed by dividing the total cost of goods available for sale by the total
number of units available for sale.
Weighted average is easy to apply
Illustration II: (Problem based on Practical Financial Accounting- Valix 2019 edition Vol. 1)
Lane Company provided the following inventory card during February:
Purchase
Jan. 10
Price
Untis
100
20,000
Jan. 31
110
Returns
Feb. 28
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Bal. Units
20,000
10,000
Feb. 8
Feb 9.
Units Used
30,000
10,000
40,000
(1,000)
41,000
11,000
30,000
Using the Weighted Average Method, what is the cost of inventory on February 28?
January 10
20,000 @ unit cost of 100 = 2,000,000
February 8
30,000 @ unit cost of 110 = 3,300,000
Total Units = 20,000 +30,000 = 50,000
Total Costs = 2,000,000 + 3,300,000 = 5,300,000
WAV COST = 5,300,000/50,000 = 106 per unit
February inventory = 30,000 units * 106 = 3,180,000
(3) Last-In , First-out (LIFO)
-
Goods last purchased are sold first
Goods subsisting are goods purchased first
Price of inventory issued or sold is based on the last purchase price
The LIFO favors the income statement because there is a matching of current cost against current revenue, the cost
of goods sold being expressed in terms of current or recent cost
-
The objection of the LIFO is that the Inventory is stated at earlier or older prices and therefore there may be a
significant lag between inventory valuation and current replacement cost.
In a period of rising prices or inflation, LIFO results in lowest income, lowest tax and lowest cost of ending inventory
Note that the standard does not allow use of LIFO as a formula for costing.
-
Illustration:
UNITS
UNIT COST
TOTAL COST
JAN 1
Beginning balance
800
200
160,000
18
Purchase
700
210
147,000
31
Purchase
500
220
110,000
From January 1 balance
UNITS
UNIT COST
TOTAL COST
700
200
140,000
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Inventory-January 1
160,000
Purchases
257,000
Goods available for sale
417,000
Inventory-January 31
(140,000)
Cost of goods sold
277,000
(4) Specific Identification (specific costing)
Specific costs are attriuted to specific inventories (items of inventory)
Makes use of actual unit cost
The cost of inventory is determined by simply multiplying the units on hand by their actual unit cost
Requires records that will clearly determine the actual cost of goods on hand
According to PAS 2, this method is appropriate for inventories that are segregated for a specific project and for
inventories that are ordinarily not interchangeable
The flow of inventory cost corresponds directly to actual physical flow of goods
There is actual determination of cost of units sold and on hand
This method is very costly to implement
(5) Relative Sales Price Method
When different commodities are purchased at lump sum, the single cost is distributed/ apportioned among the
commodities based on their respective sales price
Based on the philosophy that cost is proportionate to selling price
Illustration: ( Problem from Intermediate Accounting - Valix Vol. 1 2020 Edition )
Products A, B and C are purchased at a “Basket Price “ of P3,000,000. Assume that the said products have the
following sales price: A P500,000, B P1,500,000, and C P3,000,000
Compute for the cost of each product
Product A
500,000
500,000/ 5,000,000 * 3,000,000 = 300,000
Product B
1,500,000
1,500,000/ 5,000,000 *3,000,000 = 900,000
Product C
3,000,000
3,000,000/5,000,000 * 3,000,000 = 1,800,000
Total
5,000,000
3,000,000
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Measurement of Inventory
-
According to PAS 2, Paragraph 9, Inventories shall be measured at the lower of cost and net realizable value
(LCNRV).
Writing down to LCNRV is consistent with the principles that assets must not be carried in excess of amounts
expected to be realized from their sale or use.
Net Realizable Value
- It is the estimated selling price in the ordinary course of business less the estimated cost of completion
and the estimated cost of disposal
- Cases when the cost of inventories may not be recoverable
a. The inventories are damaged
b. The inventories have become wholly or partially obsolete
c. The selling prices have declined
d. The estimated costs of completion or the estimated cost of disposal has increased.
Inventory Writedown
- Writedown occurs when the net realizable value is lower than cost.
- Is applied on an item by item basis
- There are two (2) methods of writedown:
a. Direct method or cost of goods sold method
b. Allowance method or loss method
Direct Method or Cost of Goods Sold Method
-
Any Loss of inventory writedown or gain on reversal of inventory writedown is not accounted for separately but
“buried” in the cost of goods sold.
Loss on inventory writedown is not separately accounted for
The loss on inventory writedown (NRV is lower than cost) increases cost of goods sold
Allowance Method
-
Inventory is recorded at cost and any loss on inventory writedown is accounted for separately.
Also known as “loss method”
Loss account is debited and valuation account “allowance for inventory writedown” is credited
Allowance method is used in order that the effects of writedown and reversal of writedown can be clearly
identified
In subsequent years, allowance for writedown is adjusted upwards or downward depending on the difference
between the cost and net realizable value of the inventory at year-end.
Illustration:
Using the preceding problem, the entries under allowance method are as follows:
Dec. 31, 2020 Inventory
8,000,000
Income Summary
8,000,000
Loss on inventory writedown
40,000
Allowance for inventory writedown
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40,000
Note that the loss on inventory writedown is included in the Cost of Goods Sold. The allowance
is disclosed as a deduction from the inventory
Inventory (12/31/20), at cost
8,000,000
Allowance for inventory writedown
(40,000)
Net realizable value
7,460,000
If at the end of the next year, the inventory is valued at a total cost of 8,020,000 and has a net
realizable value of 8,000,000. The following entries are required:
Dec 31, 2021
inventory
8,000,000
Income summary
Cost (12/31/21)
8,020,000
Net realizable value
8,000,000
Required Allowance
20,000
Less: Allow. (12/31/20)
40,000
Decrease in allowance
-20,000
8,000,000
To record dcrease in allowance:
Allowance for inventory writedown
20,000
Gain on reversal of inventory writedown
20,000
-
Estimation of Inventory Value
Use of estimating inventory:
- There are cases when physical count is not possible and sometimes although physical count is possible, it is
costly, inconvenient and difficult to do so.
- The following are some of the most common reasons for making an estimate of the cost of goods on hand:
a. Destruction of inventory and for insurance purposes, amount it required.
b. In order to check the validity/ correctness of a physical count (gross profit test)
c. For preparation of interim financial statements and making a physical count may take some time
There are two (2) methods for approximating the value of inventory:
(1) Gross Profit Method
(2) Retail Inventory Method
Gross Profit Method
-
Based on the assumption that gross profit rates remains approximately the same from period to period
Is so called the Cost of Goods Sold method because it uses the gross profit rate.
COGS is computed as follows:
a. If gross profit rate is based on sales,
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NET SALES * COST RATIO = COST OF GOOS SOLD
b. If gross profit rate is based on cost,
NET SALES/ SALES RATIO = COST OF GOODS SOLD
ILLUSTRATION:
Beginning inventory
100,000
Net purchases
500,000
Net Sales
700,000
GP rate based on sales of 40%
How much is the estimated Cost of Goods Sold?
Net Sales * Gp rate = cogs
700,000 * 0.6 = 420,000 = COGS
Note than 0.6 is because GP rate is based on sales..
100% - 40% = 60%
If Gross profit rate is based on cost, then:
700,000 / 1.40 = 500,000 = COGS
Retail Inventory Method
-
-
Inventory estimation method employed by department stores, supermarkets nad other retail concerns where
there is a wide variety of goods.
Selling price or retail price is tagged to each item
Requires that records be kept with regards to the following:
a. Beginning inventory @ cost and @ retail price
b. Purchases @ cost and @ retail price
c. Adjustments to the original retail price (Additional markup, markdown and markdown cancellation)
d. Other adjustments such as departmental transfer, breakage, shrinkage, theft, damaged goods and
employee discount
Ending inventory is expressed in terms of selling price
Important Terms
Purchase Discount
Deducted from purchases at cost only
Purchase Return
Deducted from purchases at cost and at retail
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Purchase Allowance
Deducted from purchases at cost only
Freight In
Addition to purchases at cost only
Departmental transfer-in or
debit
Addition to purchases at cost and at retail
Departmental transfer -out credit
Deduction from purchases at cost and at retail
Sales Discount and sales
allowance
Ignore and disregard
Sales return/ Sales returns and
allowances
Deducted from sales
Employee Discounts
Added to sales
Normal shortage, shrinkage,
spoilage, breakage
Deducted from Goods available for Sale at retail
Abnormal shortage, shrinkage,
spoilage, breakage
Deducted from goods available for sale at both cost and retail
Cost Ratio
Goods available for sale at cost divided by Goods available for sale
at selling price
Initial Mark-up
Original Mark-up on the cost of goods
Original Retail
The sales price at which the goods are first offered for sale
Additional Mark-up
Increase in sales price above the original sales price
Mark-up Cancellation
Decrease in sales price that does not decrease the sales price below
the original sales price
Net additional mark-up or net
markup
Markup minus mark-up cancellation
Markdown
Decrease in sales price below the original sales price
Markdown cancellation
Increase in sales price that does not increase the sales price above
the original sales prie
Net markdown
Markdown minus markdown cancellation
MAintained mark-up
Different between cost and sales price after adjustment for all the
above items. Sometimes called “markon”
Illustration: Retail inventory method without special items
Cost
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Retail
Beginnign Inventory
14,000
20,000
Purchases
63,000
90,000
GAS
77,000
110,000
Deduct: Sales
(85,000)
Ending inventory, at retail
25,000
Cost to retail ratio
77,000/110,000 = 0.7
Ending inventory at cost
IV.
0.7*25,000 = 17,500
EQUITY AND DEBT INVESTMENTS (IFRS 9)
Investment in Equity Securities
Financial Asset
- These assets are considered as investments.
- Investments of the company or entity provides benefits such as:
a. It increases their assets by collecting income or dividends
b. It provides them control over another entity (equity securities)
c. It opens a funding for future use or acquisition of other assets
Nature of Equity Securities
-
Equity Interest are represented by Certificates of Share Capital
Companies purchase equity securities for:
a. As temporary placements of excess cash and held primarily for sale in the near term to generate
income on short-term price fluctuations
b. To obtain long-term customer or supplier or creditor relationship to secure certain operating or
financing arrangements with these companies
c. To exercise significant influence or even control over the operating policies of another entity/
other entities.
Classification of Equity Investments
There are four (4) classifications of investments:
(1) Equity Investments @ Fair Value Through Profit or Loss
(2) Equity Investments @ Fair Value Through Other Comprehensive Income
(3) Investments in Associate or Investment in Joint Venture
(a) Investment in Associates - ability to participate but no control
(b) Investment in Joint Venture- investor that jointly controls the operation of another entity through
share capital ownership
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(4) Investment in Subsidiaries
Less than 20%
20% - 50%
More than 50%
Does not have significant
influence
Has Significant Influence
Has control over the investee
Fair value accounting
- FVOCI
- FVPL
Equity Method of Accounting
Consolidated Method of
Accounting
IFRS 9
IAS 28
IFRS 10
% of Ownership
Preference Shares
Ordinary Shares
<20%
FVPL or FVOCI
FVPL or FVOCI
20% to 50%
FVPL or FVOCI
INVESTMENTS IN ASSOCIATE
>50% - 100%
FVPL or FVOCI
INVESTMENT IN
SUBSIDIARIES
MEASUREMENT OF FINANCIAL ASSETS
In accordance with PFRS 9 (IFRS 9), we measure financial assets at :
a. Fair Value through Profit or Loss (FVPL)
- Equity Investments held for trading or Non-trading by irrevocable choice, Debt Securities held
for trading
b. Fair Value through Other Comprehnsive Income (FVOCI)
- Non-trading Equity Investments and Debt Investments held for trading and collection of
contractual cash flows that are payment of principal and interest
c. At Amortized Cost
- Debt Investments held for collection of contractual cash flows that are solely payments of
principal and interest
Measurement of Equity Investments
A.
FAIR VALUE THROUGH PROFIT OR LOSS (FVPL)
- FVPL can also be considered as ‘Trading Securities’ or ‘Current Assets held for Sale’ which represents
assets that are used by the entity for buying and selling.
- Equity Investments not held for trading purposes can also, by irrevocable election, be presented as
@FVPL
- Assets acquired at FVPL are also known to be irrevocably designated at the event that the asset has the
characteristics of FVOCI or at amortized cost
- Initial measurement of Equity Investments ar FVPL is at its Fair Value (Purchase Price at the date of
acquisition). Transaction costs incurred in the acquisition of the asset is not capitalized but rather treated
as an expense.
- Derecognition of FVPL is the same as acquiring it. However, gains or losses on changes in fair value
upon its sale must be acknowledged in the income statement.
CHARACTERISTICS OF EQUITY INVESTMENTS @FVPL
- These are assets primarily held for trading
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-
The entity states its nature as ‘held for sale’
The account titles to be used: ‘Financial Asset- FVPL’ or ‘Trading Securities’
Gains are acknowledged as part of other comprehensive income while losses are considered as part of
expense
Equity and Debt Securities can be considered as at FVPL
Illustration:
2019 – TVN Company bought 248 000 ordinary shares of S Company for P10 per share as an equity security
held for sale for P2 530 000 including transaction cost.
2020 – At this year the fair market value of the shares was P11 per share.
2021 – The current value of the ordinary shares this year is P2 627 000. TVN Company sold the following
shares for P2 550 000 to KBS Company.
Journal Entries:
2019
2020
2021
Financial Asset - FVPL
Transaction Cost
Cash
2,480,000
50,000
2,530,000
Financial Asset - FVPL
Unrealized gain- FVPL
((248,000sh * 11php/sh) - 2,480,000)
248,000
Unrealized Loss - FVPL
Financial Asset - FVPL
101,000
Cash
Loss on Sale of Financial Asset -FVPL
Financial Assets - FVPL
2,550,000
77,000
248,000
101,000
2,627,000
B. FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME (FVOCI)
- FVOCI is a non-current asset for it is held by the entity as a long-term investment.
- Classification of FVOCI depends on the irrevocable choice of the entity, if it is not assigned as FVOCI it
is measured to be measured at FVPL.
- In acquisition, both collecting contractual cashflows and selling financial asset is deemed to be
considered before recognizing as FVOCI thus, the contractual cashflows should be solely payments for
liabilities.
- Recognizing FVOCI is to be measured as Fair Value PLUS costs incurred in acquiring the said asset.
- Costs that are attributed in acquiring the financial asset should always be capitalized.
- Derecognition of FVOCI differs from FVPL; on sale of the financial asset, gains or losses in sale are
credited to Retained Earnings. In addition, accumulated gains or losses are to be closed to Retained
Earnings after sale.
Characteristics of FVPL
- These assets are not held for sale
- The entity clearly decided its nature as a FVOCI
- Account titles involve are: ‘Financial Asset-FVOCI’ and ‘Retained Earnings’
- Gains or losses per year are part of other comprehensive income
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-
While accumulated gains or losses held through time are consolidated in Statement of Changes in
Equity
Illustration:
2019 – SBU Company bought 425 000 ordinary shares of CEU Corp. worth P10 per share to be measured
as FVOCI; while acquiring the said asset, SBU Company incurred P22 000 as commission for the sale.
2020 – At this year the fair market value of the shares was P8.5 per share.
2021 – The current value of the ordinary shares this year is P13. A Company sold the following shares for
P5 850 000 to C Company.
Journal Entry
2019:
2020:
2021:
Financial Asset-FVOCI (4 250 000+22 000)
Cash
P4 272 000
Unrealized Loss -FVOCI [(425 000x8.5)-4 272 000]
Financial Asset-FVOCI
659 500
Financial Asset-FVOCI [(425 000x13)-3 612 500]
Unrealized Gain-FVOCI
1 912 500
Cash
5 850 000
P4 272 000
659 500
1 912 500
Retained Earnings
325 000
Financial Asset-FVOCI
5 525 000
Unrealized Gain-FVOCI (1 912 500-659 500)
Retained Earnings
1 253 000
1 253 000
TRANSACTIONS SUBSEQUENT TO INITIAL RECOGNITION
(refer to empleo book)
-
After acquisition, there may be miscellaneous transactions
(1) SHARE SPLIT
- Reduction in the par/stated value of share capital + proportionate increase in the number of shares
outstanding
- It does not affect the equity of a shareholder in the issuing corporation, nor does it affect the issuing
corporation’s total shareholder’s equity.
- No formal JE. Is necessary in the books of the investor. The investor records the receipt of the additional
shares through a MEMORANDUM ENTRY- indicating the change in the number of shares.
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(2) DIVIDENDS
A. CASH DIVIDEND
- Generally recognized as income when received or receivable
- If the dividends declared by the investee are to be paid in the ensuring accounting period a year
end adjustment is taken up by the investor for the accrual of dividends by charging dividends
receivable and crediting dividend revenue
- DISTRIBUTION OF DIVIDENDS (IMPORTANT DATES)
(a) DATE OF DECLARATION- BOD declares distribution of dividends
(b) DATE OF RECORD- Corporation draws a list naming the shareholders who are
entitled to the dividends. No JE
(c) DATE OF PAYMENT- Dividends are distributed to the shareholders
- DIVIDENDS-ON:
- From the date of declaration through the date of the record
- Market price of a share includes the amount of the dividend
- EX-DIVIDEND:
- After the record date
- Market price of a share does not include the amount of the dividend
- A shareholder selling his securities after the date of declaration but before the date of record
- Sells 2 types of financial assets (1) investment in shares and (2) dividend receivable
to be acquired by the BUYER.
LIQUIDATING DIVIDENDS
- A portion of the dividends received by an investor may have resulted from the investee’s
earnings prior to the acquisition of the shares by the investor.
- Dividends are treated as return of the investor’s cost of investment, as the investee’s
earnings prior to the date of the acquisition is logically considered by the original seller in
setting the selling price of the shares.
- There are instances when the dividends declared come from the balance of contributed
capital accounts of the issuing corporation
- In either case, Receipt by the investor of such dividends is not credited to an
income account but to an income account but to the investment account
B. BONUS/SHARE DIVIDEND
- Investee company distributes as dividends shares in the same class held by the shareholders.
- Distribution of bonus issue in the same class of share capital increases the number of shares,
held by each shareholder, without any charge in the total shareholder’s equity balance or net
assets of the distributing corporation.
- The equity of each shareholder after the receipt of the bonus is also unchanged
- Thus, an investor receiving a bonus issue record the transaction by a MEMO entry.
- The transaction merely adjusts the carrying amount per share held by the investor.
SPECIAL BONUS ISSUE
- Treated similarly with property dividends
- Shares received as bonus issue is recognized at fair value with a credit to dividend revenue.
C. PROPERTY DIVIDEND
- The investee distributes dividends in the form of non-cash assets
- The investor records the asset received as dividend revenue at the asset’s fair value.
(3) SHARE RIGHTS
-
Corporation issuing additional shares of capital = increases its capital
PREEMPTIVE RIGHT: enables the shareholders to maintain their ownership interest in the corporation.
SHARE WARRANT: Evidences a shareholder’s preemptive right
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-
-
-
-
Generally, the number of share warrants distributed is equal to the number of shares held by the
shareholder. However, a specified number of warrants may be necessary for a shareholder to purchase
a share of stock at a specified price, as stated in the share warrant.
An investor receives share rights without any cost
- Investor may either
- Sell the rights
- Use the rights to purchase additional shares
- Allow the rights to lapse
Because stock rights can be exercised or sold within a specific period.
They are considered securities held for trading
They are measured at fair value through profit or loss.
At the date the rights are received
- Share rights usually do not have a note fair value
- No entries made to Record its receipts other than a memorandum entry.
- Upon EXERCISE of rights- News your support shall be measured at the fair value of the shares.
The excess of this fair value over the exercise price or the subscription price is presumed to be
the fair value of the stock rights exercised to buy the shares.
- Any unexpired and unexercised share rights shall be recognized at fair value at the end of the
reporting period. A credit to an income account.
THEORETICAL FAIR VALUE OF SHARE RIGHTS
- In the absence of actual fair value of a share right,
FVof share ex-rights-subscription price
TVF = --------------------------------------------------------number of rights needed to buy one share
-
The unrealized gains on equity investments shall be taken to profit or loss or other
comprehensive income
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Illustration:
A company owns 2400 Ordinary shares Of the corporation acquired at 100 peso per share. The
shares represent less than 5% of ownership in B corporation.
a.
Receive cash dividend of P7.50 per share
Cash
18,000
Dividend Revenue
18,000
2,400 shares x 7.50
b.
Received a bonus issue of one ordinary share for every four shares held
Memo entry.
Received additional 600 shares of B Corp. ordinary shares as bonus
issue on 2,400 shares previously held.
c.
Received a preference share dividend of one share for every four ordinary shares held. Ordinary
share is selling ex-dividend at P125 one preference share is selling at P250
Equity Investments - A Preference
150,000
Dividend Revenue
150,000
600 x 250=150,000
d.
Ordinary shares our exchange in a 4-for-1 split.
Memo entry. Received additional shares of B Corp. ordinary shares on a 4-for-1 stock
split of the 2,400 shares previously held. Total shares now held: 9,600.
e.
Receive a property dividend of one ordinary share of C for every six shares of B held. Market
price of C’s ordinary share is P50 per share.
Equity Investments - C Ordinary.
20,000
Dividend Revenue
20,000
2,400/6 = 400 shares x 50
INVESTMENTS IN UNQUOTED EQUITY INSTRUMENTS
-
Oh investments in equity instruments except investment in associate and investments in subsidiaries and joint
ventures must be measured at fair value
Insufficient information to determine the fair value, also represents the best estimate a fair value, except that
when the following indicators are present that cost does not represent fair value (IFRS 9 par. B5.2.4)
a. significant change in the performance of the investee compared with budgets plans or milestones
b. Changes in expectation that the investees technical product milestones will be achieved
c. A significant change in the market for the investment is equity or its products or potential products
d. As significant change in the global economy or the economic environment in which the investee
operates
e. A significant change in the performance of comparable entities is in that always and supplied by the
overall market
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f.
-
Internal matters of the investee such as fraud, commercial disputes, litigations, changes in management
or strategy
g. Evidence from external transactions in the invest his equity either by the investee (such as fresh issue of
equity)
h. Or by transfers of equity instruments between third parties
In case it’s not equity investments held our uncoated and there is indication that the cost does not represent fair
value investor has the estimate the fair value of the investment using some measurement technique
FINANCIAL STATEMENT PRESENTATION
-
Financial Assets measured at FVPL – CURRENT ASSETS
Financial Assets measured at FVOCI- Generally classified as NON-CURRENT ASSETS
IMPAIRMENT OF EQUITY INVESTMENTS MEASURED AT FAIR VALUE
-
IFRS 9
-
Equity Investments at Fair Value
No longer tested for impairment
The measurement to fair value is sufficient to include such impairment, if any.
V.
INVESTMENT IN ASSOCIATES
ASSOCIATE
-
-
-
-
An entity over which the investor has significant influence
- A significant influence- the power to participate in the financial and operating policy decisions of the
associate but not control or joint control over these policies
- Representation on the board of directors or equivalent governing body
- Participation in the policy-making process
- Material transactions between the investor and the investee
- Interchange of managerial personnel
- Provision of essential technical information
- The assessment of significant influence is a matter of judgment
- Joint arrangement – an arrangement of which two or more parties have joint control.
- Joint venture – a joint arrangement whereby the parties that have joint control have rights to the net
assets of the arrangement.
However, PAS 28, paragraph 5- practical guidance to assist management in making such an assessment.
If the investor holds, directly or indirectly through subsidiaries, 20% or more of the voting power of the investee,
it is presumed that the investor has significant influence, unless it can be clearly demonstrated that this is not
the case.
Conversely, if the investor holds directly or indirectly through subsidiaries, less than 20% of the voting power of
the investee, it is presumed that the investor does not have a significant influence unless such influence
can be clearly demonstrated.
A substantial or majority ownership by another investor does not necessarily preclude an investor from having
significant influence is usually evidenced by the following factors:
-
Representation in the Board of Directors
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-
Participation in the policymaking process
Material transactions between the investors and investee
Interchange of managerial personnel
Provision of essential technical information.
MEASUREMENT OF INVESTMENT IN ASSOCIATE
-
-
Measured using the equity method of accounting- based on the economic relationship between the investor
and investee.
- Equity method is a method of accounting whereby the investment is initially recognized at cost and the
carrying amount is increased or decreased to recognize the investor’s share of the profit or loss of the
investee after the date of acquisition.
- The investor’s profit or loss includes its share of the investee’s profit or loss and the investor’s other
comprehensive income includes its share of the investee’s other comprehensive income.
- Distributions received from an investee reduce the carrying amount of the investment.
The investor and investee are viewed as a single economic unit- they are one on the same
The equity method is applicable when the investor has a significant influence over the investee.
ACCOUNTING PROCEDURES- EQUITY METHOD
a. The investment is initially recognized at cost.
b. The carrying amount is increased by the investor’s share of the profit of the investee and decreased by the
investor’s share of the loss of the investee.
- The investor’s share of the profit or loss is recognized as investment income.
c. Dividends received from an equity investee reduce the carrying amount of the investment.
d. Note the investment must be in ordinary shares
- If the investment is in preference shares, the equity method is not appropriate regardless of the
percentage because the preference share is a nonvoting equity.
e. Technically, if the investor has significant influence over the investee, the investee is said to be an associate
- Accordingly, under the equity method, the investment in ordinary shares should be appropriately
described as an investment in associates.
f. The investment in associate accounted for using the equity method shall be reported as a noncurrent asset
ILLUSTRATION- EQUITY METHOD
1. On Jan 1, 2020, an investor purchased 20,000 shares of the 100,000
outstanding ordinary shares of another entity at P200 per share. The
investment represents a 20% equity interest and the investor has a
significant influence over the investee
Investment in associate
4,000,000
Cash
4,000,000
2. The investee reported a net income of P5,000,000 for 2020. The
investor recognized a share of the net income of the investee equal to
20% of P5,000,000 or P1,000,000.
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Investment in associate
Cash
1,000,000
1,000,000
3. Received a 25% share dividend from the investee on December 31,
2020. Memo- received 5,000 ordinary shares as 25% share dividend on
20,000 original shares. Shares now held, 25,000 shares. Note that the
20% equity interest is not affected by the share dividend. The equity
interest is the same before and after the share dividend.
4. The investee reported a net loss of P1,000,000 for 2021. The investor
recognized a share in the net loss of the investee equal to 20% of
P1,000,000 or P200,000.
Loss on investment
200,000
Investment in associate
200,000
5. The investee declared and paid a cash dividend of P2,500,000 on
ordinary shares on December 31, 2021. The investor recognized a
share in the cash dividend paid by the investee equal to 20% of
P2,500,000 or P500,000.
Cash
500,000
Investment in associate
500,000
Under the equity method, the cash dividend is not an income but a
reduction of investment.
EXCESS OF FAIR VALUE OVER COST
-
PAS 28, paragraph 32- any excess of the investor’s share of the net fair value of the associate’s identifiable
assets and liabilities over the cost of the investment is included as income in the determination of the investor’s
share of associate’s profit or loss in the period in which the investment is acquired.
ILLUSTRATION
At the beginning of the current year, an investor purchases 40% of the ordinary shares
outstanding of an investee for P10,000,000 when the net assets of the investee
amounted to P30,000,000. At the acquisition date, the carrying amounts of the
identifiable assets and liabilities of the investee were equal to fair value.
Acquisition cost
10,000,000
Fair value of net assets acquired
(20% x 20,000,000)
12,000,000
Excess fair value
2,000,000
The excess of fair value is included in the investment income of the investor on the date
of acquisition
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Investment in associate
2,000,000
Investment income
2,000,000
IMPAIRMENT LOSS
-
-
If there is an indication that an investment in associate may be impaired, an impairment loss shall be recognized
whenever the carrying amount of the investment in associate exceeds the recoverable amount.
- The recoverable amount is measured as higher between fair value less cost of disposal and value in
use.
Fair value is the price that would be received to sell an asset in an orderly transaction between market
participants at the measurement date.
Value in use is the present value of the estimated future cash flows expected to arise from the continuing use of
an asset and from the ultimate disposal.
Since goodwill is not separately recognized from the investment amount, the impairment loss recognized is
applied to the investment as a whole.
The recoverable amount of an investment in an associate is assessed for each individual associate.
INVESTEE WITH CUMULATIVE PREFERENCE SHARES
-
When an associate has outstanding cumulative preference shares, the investor shall compute its shares of
earnings or losses after deducting the preference dividends, whether or not such dividends are declared.
INVESTEE WITH NON CUMULATIVE PREFERENCE SHARES
-
When an associate has outstanding non-cumulative preference shares, the investor shall compute its share of
earnings after deducting the preference dividends when declared.
DISCONTINUANCE OF EQUITY METHOD
PAS 28, paragraph 22- an investor shall discontinue the use of it from the date that it ceases to have significant
influence over an associate. Consequently, the investor shall account for the investment as follows:
a.
Financial assets at fair value through profit or loss.
b.
Financial asset at fair value through other comprehensive income
c.
Non Marketable investment at cost or investment in an unquoted equity instrument
PAS 28, Basis of Conclusion 18- requires an investor that continues to have significant influence over an associate to
apply the equity method even if the associate is operating under severe long-term restrictions that significantly impair the
ability to transfer funds to the investor. Significant influence must be lost before the equity method ceases to be
applicable.
MEASUREMENT AFTER LOSS OF SIGNIFICANT INFLUENCE
-
PAS 28, paragraph 22- on the date that the significant influence is lost, the investor shall measure any retained
investment in the associate at fair value.
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-
The fair value of the investment at the date it ceases to be an associate shall be regarded as a fair value on
initial recognition as a financial asset.
The difference between carrying amount of the retained investment shall be included in profit or loss.
Of course, the difference between the net proceeds from the disposal of part of the investment and the carrying
amount of the investment sold is recognized as a gain or loss on disposal of the investment.
EQUITY METHOD NOT APPLICABLE
PAS 28, paragraph 17- an investment in associate shall not be accounted for using the equity method if the investor is a
parent that is exempt from participating consolidated financial statements or if all of the following apply:
a. The investor is a wholly-owned subsidiary or a partially-owned subsidiary of another entity and the
owners do not object to the investor not applying the equity method.
b. The investor’s debt and equity instruments are not traded in a public market or “over the counter”
market.
c. The investor did not file or it is not the process of filing financial statements with the SEC for the purpose
of issuing any class of instruments in a public market.
d. The ultimate or any intermediate parent of the investor produces consolidated financial statements
available for public use that comply with PFRS.
In these circumstances, the investment is accounted for as long as follows:
a. Financial asset at fair value through profit or loss
b. Financial assets at fair value through other comprehensive income.
c. Non Marketable investment at cost of investment in an unquoted equity instrument.
DETERMINING SHARE OF PROFITS OR LOSSES
-
The most recently available financial statements of the associate or joint venture are used.
The share of the investor in profit or loss of the associate or joint venture shall be based on the date of the
financial statements of the investor.
Adjustments shall be made for any significant transactions that occurred between the date of the associate’s
financial statements and the date of the investor’s financial statements.
The difference between the reporting dates should not be more than 3 months.
The associate’s financial statements should be adjusted for any discrepancy in accounting policies.
OTHER ISSUES
-
-
When the investor’s interest in an associate or joint venture is reduced to zero (continuous loss recognized from
investment), additional losses are provided for and a liability is recognized only to the extent that the investor has
incurred obligations or made payments on behalf of the associate or joint venture.
If the associate or joint venture subsequently reports profits, the investor resumes recognizing its share of those
profits only after its share of the profits equals the share of losses recognized.
After the application of the equity method, the investor determines whether it is necessary to recognize
impairment loss. The entire carrying amount of the investment is tested for impairment by comparing its
recoverable amount with its carrying amount.
RECLASSIFICATION OF INVESTMENT IN ASSOCIATES
-
On the loss of significant influence, the investment in associate or joint venture is reclassified to equity
investments at fair value (irrevocable choice of designating at fair value through profit or loss or at fair value
through other comprehensive income)
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-
The securities shall be transferred at fair value at the date of reclassification and any difference between the fair
value and carrying value of the reclassified investment is reported in profit or loss.
REQUIRED DISCLOSURES FOR INVESTMENT IN ASSOCIATES AND JOINT
VENTURES
An entity shall disclose for each joint arrangement and associate that is material to the reporting entity:
- the name of the joint arrangement or associate
- the nature of the entity’s relationship with the joint arrangement or associate.
- the principal place of business of the joint arrangement or associate.
- the proportion of ownership interest held or proportion of voting rights, if different.
- fair value of investment in joint venture or associates for which there are published price quotations
- summarized financial information about the joint venture or associates, including aggregated assets, liabilities,
revenues and expenses.
- nature and extent of restrictions on the ability of the associate to distribute dividends to investor and to repay
loans to investors.
- unrecognized share of losses of an associate, cumulatively and for the period.
VI.
INVESTMENT IN DEBT SECURITIES
Debt Securities or Investments represents the creditor’s relationship with an entity. It also possesses three main
characteristics which are maturity value, maturity date, and percentage of rate. Certain measurement of debt
investments are:
a. at Amortized cost
b. Fair Value through Other Comprehensive Income
c. Fair Value through Profit or Loss
Measurements of Debt Investments
A. at Amortized cost
- These are debt investments held specifically for collecting contractual cashflows and selling the financial
asset.
- The measurement of this investment is at cost PLUS expenses incurred.
- Premium vs. Discount. Premium is acknowledged when cost is greater than its face value while
Discount is deemed to be recognized when its cost is lesser than its face value.
Illustration (Discount):
On January 1, 2020 Ceasar Corporation bought 14% bonds investment worth P2 022 500 from
Bellaman Company for P1 900 500 including commission expense of P85 000. The investment yields
for 16% interest rate and was classified to be at Amortized Cost. The bonds will mature on December
31, 2023 and payable of its interest is annually. On June 30, 2021, the bonds were quoted at 108 and
were sold.
Amortization Table:
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Date
Interest Received
Interest Income
Discount
Amortization
Jan 2020
Carrying Value
1 900 500
Dec. 2020
280 000
304 080
24 080
1 924 580
Dec. 2021
280 000
307 932.8
27 932.8
1 952 512.8
Dec. 2022
280 000
312 402.05
32 402.05
1 984 914.85
Dec. 2023
280 000
317 589.38
37 589.38
2 022 504.23
**Difference of 4.23 is immaterial.
✔Interest Received = Face Value x Nominal Interest
✔Interest Income = Carrying Value x Effective Interest
✔Discount/Premium Amortization = Interest Received – Interest Income
✔Carrying Value = add amortization (if discount)/ subtract amortization (if premium) to the
previous year’s Carrying Value
Journal Entry:
Jan 2020:
Dec 2020:
Jun. 2021:
Financial Asset-Amortized Cost
Cash
P1 900 500
Cash
Financial Asset-Amortized Cost
Interest Income
280 000
24 080
Interest Receivable (280 000/2)
Financial Asset-Amortized Cost (24 080/2)
Interest Income (304 080/2)
140 000
12 040
Cash
P1 900 500
304 080
2 324 300
Interest Receivable
Gain on Sale of Investment (2 184 300-1 936 620)
Financial Asset-Amortized Cost (1 924 580+12 040)
152 040
140 000
247 680
1 936 620
Key Takeaways:
✔Premium deducts its amortization on the investment while discounts adds its amortization
to the investment until it reached the face value amount at the maturity date.
✔When on sale of investment before maturity date, interest income and investment must be
adjusted.
B. Fair Value through Other Comprehensive Income
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-
These are debt investments held specifically for collecting contractual cashflows and selling the financial
asset unless it is said to be FVPL
The nature of this investment is still under FVOCI.
Interest Income is measured by multiplying the face value of bonds to its effective interest.
Illustration:
On January 1, 2020 A Company bought 10% bonds investment worth P4 000 000 from B
Company for P4 206 000 including commission expense of P85 000 that yields 8% interest rate
which was classified as FVOCI. The bonds will mature on December 31, 2022 and payable of its
interest is annually. On Dec. 31, 2020 the fair market value of the bonds was quoted at 106. On
January 2021, the bonds were quoted at 98 and were sold.
Amortization Table (Premium):
Date
Interest Received
Interest Income
Premium
Amortization
Carrying Value
Jan 2020
4 206 000
Dec. 2020
400 000
336 480
(63 520)
4 142 480
Dec. 2021
400 000
331 398
(68 602)
4 073 878
Dec. 2022
400 000
325 910
(74 090)
3 999 788/
4 000 000
**Difference of 212 is immaterial.
Journal Entry:
Jan 2020:
Dec 2020:
Financial Asset-FVOCI
Cash
P4 206 000
Cash
400 000
P4 206 000
Interest Income
Financial Asset-FVOCI
336 480
63 520
Financial Asset- FVOVI [(4 000 000x1.06)-4 142 780]
Unrealized Gain
Dec 2021:
Cash
97 220
400 000
Interest Income
Financial Asset-FVOCI
Jan 2021:
97 220
331 398
68 602
Unrealized Loss (97 220-153 878)
Financial Asset-FVOCI
56 658
Cash (4 000 000x0.98)
Unrealized Loss
3 920 000
153 878
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56 658
Financial Asset-FVOCI
Loss on Sale of Investment
Unrealized Loss
4 073 878
153 878
153 878
Key Takeaways:
✔Fair Value through OCI uses the effective rate for its interest income.
✔When realizing gains or losses, it is deemed to be compared to the current carrying
value of the investment based on the amortization table
✔When another adjustment arises, get the difference of the cumulative gains or losses
from the previous adjustment then subtract it to the current adjustment amount.
✔Unrealized gains or losses after sale should be closed.
C.
Fair Value through Profit or Loss
-
These are debt investments held specifically for trading.
This measurement prioritizes the fluctuations of the asset’s fair market value rather than to collect contractual cashflows.
The nature of this investment is still under FVPL
Interest Income is recognized by multiplying the face value of bonds to its nominal interest.
Illustration:
On January 1, 2020 A Company bought 10% bonds investment worth P2 500 000 from B Company for P2
400 000 including commission expense of P100 000 that yields 8% interest rate which was classified as
FVPL. The bonds will mature on December 31, 2022 and payable of its interest is semiannually every June
and December 31. On Dec. 31, 2020 the fair market value of the bonds was quoted at 116. On January
2021, the bonds were sold for P2 450 000.
Journal Entry:
Jan. 1, 2020:
Financial Asset-FVPL
P2 300 000
Commission Expense
100 000
Cash
Jun. 31, 2020:
Cash (2 500 000 x 5%)
P2 400 00
125 000
Interest Income
Dec. 31, 2020:
Cash (2 500 000 x 5%)
125 000
125 000
Interest Income
125 000
Financial Asset-FVPL
[(2 500 000 x 1.16) – 2 300 00]
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600 000
Unrealized Gain
Jan. 1, 2021:
600 000
Cash
2 450 000
Unrealized Gain
450 000
Financial Asset-FVPL
2 900 000
Key Takeaways:
✔Fair Value through PL only recognizes nominal interest for its interest income.
✔If the payment method is said to be semi-annually, interest rate may be split into half.
✔Interest income may be solved by PRT; P = as value of the bonds, R = nominal rate, T = length of
time of the interest divided by 12.
✔When realizing gains or losses, get the difference of the quoted price and cost.
✔In some cases, accrued interest is part of the sale of bonds.
114 | Intermediate Accounting 1 | FLORENDO, RAMIREZ, UNCIANO | BATCH 2021