CHAPTER 1

CASH AND CASH EQUIVALENTS

Cash

In accounting, cash not just includes money in the form of currency and coins, but also
negotiable instruments in the form of checks and money orders acceptable by the bank for
immediate credit and bank deposits whether in a savings or current account.

Dealing with cash – no specific standards

PAS 1, paragraph 66, stated that an entity shall classify an asset as current when the
asset is cash or a cash equivalent unless it is restricted to settle a liability for more than twelve
months after the end of the reporting period.

To be reported as “cash”, an item must be unrestricted in use.

Cash includes the following items plus adjustments:

 Undeposited currency and coins

 Checks and money orders held unless the checks are postdated, defective or stale because
these items shall still be included as receivables.

 Unrestricted bank deposits, however checks that have been recorded as payments that
have not been delivered or postdated must be restored back to the bank deposits’ balance
with a corresponding liability for the payment that was made.

 Funds on hand and deposits that are for current use and have been restricted for a liability
that is classified as “current”. As mentioned in PAS 1, this includes petty cash fund,
payroll fund and funds for taxes and dividends.

Items included in cash: Items not included in cash:

 Checks x Sinking Fund

 Bank Drafts Cash on hand x Preferred Redemption Fund
 Money Orders x Plant Expansion Fund
 Petty Cash Fund x Insurance Fund
 Payroll Fund Cash fund x Postdated Checks
 Dividend Fund x Restricted cash
 Demand deposit
 Saving deposit Cash in bank
Special Items of Cash

A. Bank Overdraft – a credit or negative balance in the bank account of the depositor
resulting from an issuance of a check that exceeds the amount of the deposit.

 As a rule, an overdraft shall be classified as a current liability and not offset

against current accounts with a positive or debit balance.
 As an exception, if the overdraft is in a bank where there are other accounts that
have a positive balance and those accounts are sufficient to cover the overdraft,
the total cash shall be shown net of the overdraft. There can be an offset if the
entity maintains two or more accounts in one bank and also if the amount is
immaterial an overdraft can be offset against the other bank account – integral
part of cash management.

For example, an entity maintains three bank accounts:

a. Cash in bank – First Bank, with a debit balance of P50,000
b. Cash in bank – Second Bank, which is overdrawn by P10,000
c. Cash in bank – Third Bank, with a debit balance of P80,000
The net cash balance is P120,000.

The proper statement classification of the three accounts is as follows:

Current asset:
Cash in bank – First Bank 50,000
Cash in bank – Third Bank 80,000
Current liability:
Bank overdraft – Second Bank 10,000

Note:*Not necessary to adjust and open a bank overdraft account in the ledger.

In other words, the Cash in Bank – Second Bank account is maintained in a ledger
with a credit balance. It is to be stated also that generally bank overdrafts are not
permitted in the Philippines.

B. Compensating Balance Agreement – deposits that a bank can use to offset an existing
loan. It can also describe as a minimum amount of the deposit that a depositor agrees to
maintain in order to guarantee future credit availability.

 In the case of deposits that a bank can use to offset a loan, the assumption is that
this amount is legally restricted to withdrawal and therefore excluded from cash,
however in cases that it still remains to be unrestricted, the compensating balance
shall be part of cash. If the compensating balance is legally restricted the
following rules shall be followed:

a) The related loan is short-term:

If the deposit is legally restricted as to withdrawal by the borrower
because of a formal compensating balance agreement, the compensating
 balance is classified separately as “cash held as compensating balance”
under current assets.

b) The related loan is long-term:

The compensating balance is classified as noncurrent investment.

 An informal agreement to maintain a minimum amount of deposit will not be

legally restricted and therefore included in cash.

C. Undelivered or Unreleased Check – merely drawn and recorded but not given to the
payee before the end of reporting period.

 When the check is pending delivery to the payee at the end of reporting period,
there is no payment because it is still subject to the entity’s control and may thus
be canceled any time before delivery at the discretion of the entity.

Adjusting entry is recorded as follows:

Cash xx

Accounts payable or appropriate account xx

 In practice, it is not very substantial and no evidence of actual cancelation of the

check that’s the reason why the foregoing adjustment is sometimes ignored.

D. Postdated Check Delivered – check drawn, recorded and already given to the payee but
it bears a date subsequent to the end of reporting period.

Adjusting entry is recorded as follows:

Cash xx
Accounts payable or appropriate account xx

 There is no payment until the check can be presented to the bank for encashment
or deposit.

E. Stale Check or Check Long Outstanding – check not encashed by the payee within a
relatively long period of time.

 According to Negotiable Instruments Law, presentment must be made within

reasonable time after issue if the instrument is payable on demand.

 In banking practice, a check becomes stale if not encashed within six months from
the time of issuance. But, even after three months only, the entity may issue a
“stop payment order” to the bank for the cancelation of a previously issued check.
  Amount of stale check is immaterial: Accounted for as miscellaneous income.

It is simply accounted as follows:

Cash xx
Miscellaneous Income xx

 Amount of stale check is material and liability is expected to continue: Cash is

restored and the liability is again set up.

It is simply accounted as follows:

Cash xx
Accounts payable or appropriate account xx

Restoration of Cash Balance from: Check as payment Check as receipt

Unreleased Check ↑Cash ↓Account Payable ↓Cash ↑Account Receivable
Postdated Check ↑Cash ↓Account Payable ↓Cash ↑Account Receivable
Stale Check ↑Cash ↓Account Payable ↓Cash ↑Account Receivable

Cash Equivalents

These are short-term and highly liquid investments that are readily convertible into cash
and so near their maturity that they present insignificant risk of changes in value because of
changes in interest rates. According to PAS 7, paragraph 6, only highly liquid investments that
are acquired three months before maturity can qualify as cash equivalents.

The three important characteristics for cash equivalents as mentioned in PAS 7 are short-
term, highly liquid and near maturity. In other words, short-term debt instruments with low
risk (also low yield) and acquired 3 months or less from maturity date shall be considered as cash
equivalents.

Items included in cash equivalents:

 3-month BSP Treasury Bill

 BSP Treasury Bill purchased 3 months before maturity date
 3-month Time Deposit
 3-month Money Market Instrument or commercial paper
 Preference shares with specified redemption date purchased 3 months before redemption
date
Items not included in cash equivalents:

x Equity securities because shares do not have maturity date.

Financial Statement Presentation

Aggregate cash and cash equivalents should be shown as the 1st line item among the
current assets. The details comprising the cash and cash equivalents should be disclosed in the
notes to financial statements.

Financial Statement Classification

Classified as Cash and Cash Equivalents Classified as a separate line item

1. Unrestricted/Current Use Restricted/Noncurrent Use → Long-term

Investment

Note: Classification of cash fund as current or noncurrent should parallel the classification of the
related liability. If material, foreign bank deposits subject to foreign exchange restriction shall
be classified separately among noncurrent assets and restriction clearly indicated.

2. Excess cash should be invested in revenue-earning investment.

e.g. Investment in Time Deposit, Money Market Instrument and Treasury Bills

If Term ≤ 3 months 3 months < Term ≤ 1 year → Short-term Investment

Term > 1 year → Long-term Investment

Note: There is an assumption of 3 month-term when the problem does not specify.

Measurement of Cash - cash is measured at face value. Cash in foreign currency is measured at
current exchange rate.

In Local Currency In Foreign Currency* If Recoverable Value < Face Value*

= Face Value = Current Exchange Rate = Estimated Realizable Value

Note:*Deposit in foreign bank which are subject to foreign exchange restriction, if material,
should be classified separately among noncurrent assets and the restriction is clearly indicated.

*Cash in bank or in financial institutions having financial difficulty or in bankruptcy should be

shown at its estimated realizable value, if the recoverable value is estimated to be lower than the
face value.
Details comprising cash and cash equivalents should be disclosed in the notes to financial
statements.

Accounting for cash shortage – Cash < Balance per book

It is to be recorded as follows:
Cash short or over xx
Cash xx

Cash short or over account is only a temporary or suspense account. It should be adjusted
in preparation of financial statements.

If the cashier or cash custodian is held responsible for the cash shortage, the adjustment should
be:
Due from cashier xx
Cash short or over xx

Accounting for cash overage – Cash > Balance per book

It is to be recorded as follows:
Cash xx
Cash short or over xx

The cash overage is treated as miscellaneous income if there is no claim on the same.

Cash short or over xx

Miscellaneous Income xx

But where the cash overage is properly found to be the money of the cashier, the journal entry
is:

Cash short or over xx

Payable to cashier xx

Note:*Whether it is cash shortage or cash overage, the offsetting account is cash short or over
account. It should be adjusted when statements are made.

Petty Cash Fund – money set aside to pay small expenses which cannot be paid conveniently by
means of check.

There are two methods of handling the petty cash:

 1. Imprest Fund System – system of control of cash which requires that all cash receipt
should be deposited intact and all cash disbursements should be made by means of
check. In this system, payment of expenses requires no formal entries. Petty cashier
generally requires a signed petty cash voucher for such payments and prepares memo
entry in the petty cash journal.

 Petty cash disbursement should be replenished only by means of check and not
from undeposited collection.
 If not replenished, the entry is to state the correct cash fund is:
Expenses xx
Petty cash fund xx

Petty cash expenses are recorded upon replenishment.

Replenishment amount = Petty cash disbursements

2. Fluctuating Fund System - checks drawn to replenish the fund do not necessarily equal
the petty cash disbursement. Expenses are immediately recorded and petty cash fund
fluctuates from to time.

Petty cash expenses are immediately recorded.

Replenishment amount = or > or < Petty cash disbursements

Misstatement Practices Concerning Cash Balance:

1. Window Dressing - 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.

2. Lapping - consists of misappropriating a collection from one customer and concealing this
defalcation when collection is made from another customer.

3. Kiting - is a transfer of cash from one bank to another bank usually employed at the end of the
month.
PROBLEM 1-1

DLF Company reported the checkbook balance on December 31, 2019 at P8,000,000. In
addition, the entity held the following items in the safe on that date:

Check payable to the entity, dated January 2, 2020 in payment of a sale,

not  included in December 31 check book balance 1,000,000
Check payable to the entity, deposited December 15 and included in
December 31 checkbook balance, but returned by bank on
      December 30 stamped “NSF”. The check was redeposited on
January 2, 2020 and cleared on January 5, 2020 3,000,000
Check drawn on the entity’s account, dated and recorded on
      December 31, 2019 but not mailed until January 15, 2020 2,500,000
Coins and currencies on hand 800,000
Three-month money market instruments 1,500,000

What is the correct amount of “cash” on December 31, 2019?

a. 7,500,000
b. 9,300,000
c. 8,300,000
d. 9,800,000

Problem 1-1 Answer C

Checkbook balance 8,000,000

NSF check (3,000,000)
Undelivered check drawn 2,500,000
Coins and currencies 800,000
Total cash 8,300,000

The check payable to the entity is properly not included because it is postdated January 2, 2016.

Technically, the three-month money market instruments are cash equivalents but not cash.

PROBLEM 1-2

On December 31, 2019, an entity showed the following current assets:

Cash 500,000
Accounts receivable 2,500,000
 Inventory 2,000,000
Prepaid expenses 100,000
Total current assets 5,100,000

Cash on hand including customer postdated check of P20,000 and

employee IOU of P10,000 130,000
Cash in bank per bank statement (outstanding checks on December
31, 2019, P70,000) 370,000
Total cash 500,000

Customers’ debit balances, net of customer deposit of P50,000 1,900,000

Allowance for doubtful accounts (150,000)
Sale price of goods invoiced to customers at 150% of cost on December 29,
2019 but delivered on January 5, 2020 and excluded from reported 
Inventory 750,000
Total accounts receivable 2,500,000

What is the adjusted cash balance?

a. 500,000
b. 470,000
c. 430,000
d. 400,000

PROBLEM 1-2 Answer D

Cash on hand 130,000

Customer postdated check ( 20,000)
Employee IOU ( 10,000)
Adjusted cash on hand 100,000
Cash in bank per bank statement 370,000
Outstanding checks ( 70,000) 300,000
Adjusted cash balance 400,000

PROBLEM 1-3

On December 31, 2019, the cash account of SDG Company showed the following details:

Undeposited collections 60,000

Cash in bank – PCIB checking account 500,000
Cash in bank – PNB (overdraft) (50,000)
Undeposited NSF check received from the customer, dated Dec. 1, 2019 15,000
Undeposited check from a customer, dated Jan. 15, 2020 25,000
Cash in bank – PCIB (fund for payroll) 150,000
Cash in bank – PCIB (saving deposit) 100,000
Cash in bank – PCIB (money market instrument, 90 days) 2,000,000
Cash in foreign bank (restricted) 100,000
IOUs from officers 30,000
Sinking fund cash 450,000
Listed shares held as trading investment 120,000
Petty cash fund (all funds were reimbursed on 12/31/2019) 50,000
Time deposit (due February 1,2020) 250,000
Treasury bills 1,000,000
Traveler’s check 50,000

What is the total cash and cash equivalent on December 31, 2019?
a. 4,100,000
b. 4,200,000
c. 4,080,000
d. 4,160,000

PROBLEM 1-3 Answer D

Undeposited collections 60,000

PCIB checking account 500,000
PCIB payroll fund 150,000
PCIB saving deposit 100,000
Petty cash fund 50,000
Time deposit 250,000
Treasury bills 1,000,000
Traveler’s check 50,000
PCIB money market 2,000,000
Total cash and cash equivalents 4,160,000

PROBLEM 1-4

Dion Company had the following balances on December 31, 2019:

Cash in bank – current account 4,000,000

Cash in bank – payroll account 500,000
Cash in bank – restricted account for building
construction to be disbursed in 2020 1,500,000
Cash on hand 100,000
Time deposit 2,000,000

The cash on hand included P30,000 check payable to Dion, dated January 15, 2020.

What total amount should be reported as cash and cash equivalents on December 31, 2019?
 a. 6,600,000
b. 6,630,000
c. 6,570,000
d. 4,600,000

PROBLEM 1-4 Answer C

Cash in bank – current account 4,000,000
Cash in bank – payroll account 500,000
Cash on hand (100,000 – 30,000 postdated customer check) 70,000
Time deposit 2,000,000
Total cash and cash equivalents 6,570,000
PROBLEM 1-5

Mayumi Company reported the following information at year-end:

 Share investment of P500,000 that are very actively traded in the stock market.
 Government treasury bills of P1,000,000 with a 10-year term but purchased on December
31 at which time they had two months to go until maturity.
 Cash of P2,500,000 in the form of coin, currency, saving account and checking account.
 Commercial papers of P700,000 with term of nine months but purchased on December 31
at which time they had three months to go until maturity.

What total amount should be reported as cash?

a. 3,500,000
b. 2,500,000
c. 3,000,000
d. 3,200,00

What total amount should be reported as cash equivalents?

a. 1,700,000
b. 1,500,000
c. 2,200,000
d. 3,500,000

PROBLEM 1-5 Question 1 Answer B Question 2 Answer A

Cash - coin, currency, saving and checking 2,500,000

Government treasury bills 1,000,000

Commercial papers 700,000
Total cash equivalents 1,000,000

PROBLEM 1-6
Maliksi Company had the following account balances at year-end:

Cash in bank 3,150,000

Cash on hand 100,000
Cash restricted for addition to plant and
expected to be disbursed next year 1,400,000

Cash in bank included P500,000 of compensating balance against short-term borrowing

arrangement.

The compensating balance is not legally restricted as to withdrawal.

What total amount of cash should be reported under current assets at year-end?
a. 3,150,000
b. 3,250,000
c. 1,400,000
d. 4,550,000

PROBLEM 1-6 Answer B

Cash in bank 3,150,000

Cash on hand 100,000
Total cash 3,250,000

PROBLEM 1-7

On December 31, 2019, Malakas Company provided the following information:

Petty Cash Fund 50,000

Current account – First Bank 4,000,000
Current account – Second Bank (overdraft) (250,000)
Money market placement – Third Bank 500,000
Time deposit – Fourth Bank 2,100,000

 A check for P100,000 was drawn against First Bank current account dated and recorded
December 29, 2019 but delivered to payee on January 15, 2020.
 The Fourth Bank time deposit is set aside for land acquisition in January 2020.

What total amount should be reported as cash and cash equivalents on December 31, 2019?
a. 4,050,000
b. 4,000,000
c. 4,650,000
d. 4,500,000
PROBLEM 1-7 Answer C

Petty Cash Fund 50,000

Current account – First Bank (4,000,000 + 100,000) 4,100,000
Money market placement – Third Bank 500,000
Total cash and cash equivalents 4,650,000

PROBLEM 1-8

Jill Company provided the following information with respect to its cash and cash equivalents on
December 31, 2019.

Checking account at First Bank (200,000)

Checking account at Second Bank 2,500,000
Treasury bonds 2,000,000
Payroll account 500,000
Value added tax account 400,000
Foreign bank account – restricted 100,000
Postage stamps 50,000
IOU from president’s sister 350,000
Credit memo from a vendor for a purchase return 80,000
Traveler’s check 300,000
NSF check 100,000
Petty cash fund (P20,000 in currency and expense
receipts for P30,000) 50,000
Money order 150,000

What amount should be reported as unrestricted cash on December 31, 2019?

a. 3,500,000
b. 4,600,000
c. 4,000,000
d. 3,870,000

PROBLEM 1-8 Answer C

Checking account at Second Bank 2,500,000

Payroll account 500,000
Value added tax account 400,000
Traveler’s check 300,000
Petty cash fund 20,000
Money order 150,000
Total unrestricted cash 3,870,000

PROBLEM 1-9

The cash account in XX Company’s ledger showed a balance at December 31, 2019 of
P4,415,000 which consisted of the following:

Petty cash fund 24,000

Undeposited receipts, including a postdated
customer check for P70,000 1,220,000
Cash in Allied Bank, per bank statement, with
a check for P40,000 still outstanding 2,245,000
Bond sinking fund 850,000
Vouchers paid out of collections, not yet recorded 43,000
IOU’s signed by employees, taken from collections 33,000
4,415,000

What amount should be reported as cash in the December 31, 2019 statement of financial
position?
a. 3,389,000
b. 3,379,000
c. 3,489,000
d. 3,449,000

PROBLEM 1-9 Answer B

Petty cash fund 24,000

Undeposited receipts (1,220,000 - 70,000) 1,150,000
Cash in Allied Bank (2,245,000 – 40,000) 2,205,000
3,379,000

PROBLEM 1-10
Rold Company reported petty cash fund which compromised the following:

Coins and currency 4,960

Paid vouchers:
Transportation 300
Gasoline 750
Office supplies 900
Postage stamps 870
Due from employees 455 3,275
 Manager’s check returned by bank marked “NSF” 4,560
Check drawn by the entity to the order
of petty cash custodian 3,890

What is correct amount of petty cash fund for statement presentation purposes?
a. 8,850
b. 8,235
c. 10,735
d. 7,460

PROBLEM 1-10 Answer C

Coins and currency 4,960
Check drawn by the entity to the order
of petty cash custodian 3,890
Correct amount of petty cash 8,850

PROBLEM 1-11

The cash account in the current assets section of the statement of financial position of Eva
Company consisted of the following:

Bond sinking fund 1,000,000

Checking account in FEBTC (A P320,000 check is
still outstanding per bank statement 3,155,000
Currency and coins waiting deposit 1,135,000
Deposit in a bank closed by BSP 700,000
Petty cash fund (10 000 is in the form of paid vouchers) 50,000
Receivables from officers and employees 175,000
6,215,000

What is the amount of cash to be reported under current assets?

a. 4,440,000
b. 4,830,000
c. 4,330,000
d. 5,830,000

PROBLEM 1-11 Answer C

FEBTC 3,155,000
Currency and coins 1,135,000
Petty cash fund (50,000 – 10,000) 40,000
Total 4,330,000

PROBLEM 1-12
On December 31, 2019, Remy Company had the following cash balances:

Cash in bank – current account 4,000,000

Cash in bank – sinking fund 2,000,000
Petty cash fund 50,000
Cash on hand 500,000
Cash in bank – restricted account for plant addition,
Expected to be disbursed in 2020 1,500,000
Treasury bills 1,000,000

The petty cash fund includes unreplenished December 2019 petty cash expense vouchers of
P10,000 and employee IOU of P5,000. The cash on hand includes a P100,000 check payable to
Remy dated January 15, 2020. In exchange for a guaranteed line of credit, Remy has agreed to
maintain a minimum balance of P200,000 in its unrestricted current bank account. The sinking
fund is set aside to settle a bond payable that is due on June 30, 2020.

What total amount should be reported as “cash and cash equivalents” on December 31, 2019?
a. 7,435,000
b. 5,435,000
c. 4,435,000
d. 5,535,000

PROBLEM 1-12 Answer A

Petty cash fund (50,000 – 15000) 35,000
Cash in bank – current account 4,000,000
Cash on hand (500,000 – 100,000) 400,000
Cash in bank – sinking fund 2,000,000
Treasury bills 1,000,000
Total cash and cash equivalents 7,435,000

PROBLEM 1-13
The statement of financial position of Rosie Company shows cash of 330,820. The following
items were found to comprise this total amount:

Checking account in Metrobank (outstanding checks as of

year-end totaled 15,200) 105,200
Savings account is Far East bank 30,800
Petty cash fund (including expense receipts for 250) 1,500
Cash on hand (undeposited sales receipts) 4,200
Sinking fund cash 35,000
Cash in foreign bank (in equivalent pesos) 65,000
Customers' check on hand
Traveler's Check 14,000
Manager's Check 23,120
Short term treasury bills 52,000

What is the correct amount of cash?

a. 143,570
b. 143,000
c. 144,770
d. 243,570

PROBLEM 1-13 Answer D

Checking account in Metrobank (outstanding checks as of
year-end totaled 15,200) 105,200
Savings account is Far East bank 30,800
Petty cash fund (1500 - 250) 1,250
Cash on hand (undeposited sales receipts) 4,200
Cash in foreign bank (in equivalent pesos) 65,000
Customers' check on hand
Traveler's Check 14,000
Manager's Check 23,120
Total amount of cash 243,570

PROBLEM 1-14
Green Company’s general ledger showed a balance of 3,000,000 in its cash account on
December 31, 2019. Included in this balance are the following items:

DAIF checks returned by bank 30,000

Savings account 750,000
IOUs 1,500
 Postage Stamps 2,000
Bank draft 10,000
Cash on hand 50,000
Cash in sinking fund 700,000
Customers’ check dated January 2020 5,400
Travel advances 4,000
Traveler’s check 8,000

What is the correct balance of cash?

a. 2,256,000
b. 2,300,000
c. 2,257,100
d. 2,260,000

PROBLEM 1-14 Answer C

Balance per ledger 3,000,000
Non-cash items: Customer’s NSF check (30,000)
IOUs (1,500)
Postage stamps (2,000)
Cash in sinking fund (700,000)
Customers’ postdated checks (5,400)
Travel advances (4,000)
Correct cash balance 2,257,100

PROBLEM 1-15
Jose Company had the following account balances at December 31, 2019:

Cash in Bank 5,000,000

Cash restricted for bond payable due on June 30, 2021 2,000,000
Time Deposit 6,000,000
Saving deposit set aside for dividend payable on June 30, 2020 1,000,000

In the December 31, 2019 statement of financial position, what total amount should be reported
as “cash and cash equivalents”?
a. 12,000,000
b. 14,000,000
c. 11,000,000
d. 13,000,000

PROBLEM 1-15 Answer B

Cash in bank 5,000,000
Time Deposit 6,000,000
 Saving deposit 1,000,000
Total cash and cash equivalents 12,000,000

PROBLEM 1-16
In the course of your audit of the Virgilio Corporation, its controller is attempting to determine
the amount of cash to be reported on its December 31, 2019 balance sheet. The following
information is provided:

 Commercial savings account of P1,200,000 and a commercial checking account balance

of P1,800,000 are held at PS Bank.
 Travel advances of P360,000 for executive travel for the first quarter of the next year
(employee to reimburse through salary deduction).
 A separate cash fund in the amount of P3,000,000 is restricted for the retirement of a long
term debt.
 Petty cash fund of P10,000.
 An I.O.U. from a company officer in the amount of P40,000.
 A bank overdraft of P250,000 has occurred at one of the banks the company uses to
deposit its cash receipts. At the present time, the company has no deposits at this bank.
 The company has two certificates of deposit, each totaling P1,000,000. These certificates
of deposit have maturity of 120 days.
 Virgilio has received a check dated January 2, 2020 in the amount of P150,000.
 Virgilio has agreed to maintain a cash balance of P200,000 at all times at PS Bank to
ensure future credit availability.
 Currency and coin on hand amounted to P15,000.

Based on the above information and the result of your audit, how much will be reported as cash
and cash equivalent at December 31, 2019?
a. 3,025,000
b. 2,825,000
c. 2,575,000
d. 5,025,000

PROBLEM 1-16 Answer A

Savings account at PS Bank 1,200,000
Checking account at PS Bank 1,800,000
Petty cash fund 10,000
Currency and coin 15,000
Total 3,025,000
PROBLEM 1-17
De Guzman Company reported petty cash fund which compromised the following:

Coins and currency 5,000

Paid vouchers:
Transportation 400
Gasoline 600
Office supplies 850
Postage stamps 460
Due from employees 900 3,210
Manager’s check returned by bank marked “NSF” 2,500

Check drawn by the entity to the order

of petty cash custodian 3,450

What is correct amount of petty cash fund for statement presentation purposes?
a. 8,210
b. 10,710
c. 8,450
d. 7,500

PROBLEM 1-17 Answer C

Coins and currency 5,000
Check drawn by the entity to the order
of petty cash custodian 3,450
Correct amount of petty cash 8,450

PROBLEM 1-18
You noted the following composition of Felix Company’s “cash account” as of December 31,
2019 in connection with your audit:
Demand deposit account 2,000,000
Time deposit – 30 days 1,000,000
NSF check of customer 40,000
Money market placement (due June 30, 2020) 1,500,000
Savings deposit in a closed bank 100,000
IOU from employee 20,000
Pension fund 3,000,000
Petty cash fund 10,000
Customer’s check dated January 1, 2020 50,000
Customer’s check outstanding for 18 months 40,000
Total 7,760,000

Additional information follows:

a) Check of P200,000 in payment of accounts payable was recorded on December 31, 2019 but
mailed to suppliers on January 5, 2020.
b) Check of P100,000 dated January 15, 2020 in payment of accounts payable was recorded and
mailed on December 31, 2019.
c) The company uses the calendar year. The cash receipts journal was held open until January
15, 2020, during which time P400,000 was collected and recorded on December 31, 2019.

What is the total amount of cash and cash equivalents to be shown on the December 31, 2019
balance sheet?
a. 3,310,000
b. 2,910,000
c. 1,910,000
d. 4,410,000

PROBLEM 1-18 Answer B

Demand deposit account as adjusted:

Demand deposit account per books 2,000,000

Undelivered check 200,000

Postdated check issued 100,000

Window dressing of collection (400,000) 1,900,000

Time deposit - 30 days 1,000,000
Petty cash fund 10,000
Cash and cash equivalents 2,910,000

PROBLEM 1-19
You were able to gather the following from the December 31, 2019 trial balance of Hidalgo
Corporation in connection with your audit of the company:
Cash on hand 500,000
Petty cash fund 10,000
BPI current account 1,000,000
Security Bank current account No. 01 1,080,000
 Security Bank current account No. 02 (80,000)
PNB savings account 1,200,000
PNB time deposit 500,000

Cash on hand includes the following items:

 Customer’s check for P40,000 returned by bank on December 26, 2019 due to
insufficient fund but subsequently redeposited and cleared by the bank on January 8,
2020.
 Customer’s check for P20,000 dated January 2, 2020, received on December 29, 2019.
 Postal money orders received from customers, P30,000.

The petty cash fund consisted of the following items as of December 31, 2019.
Currency and coins 2,000
Employees’ vales 1,600
Currency in an envelope marked “collections for charity”
with names attached 1,200
Unreplenished petty cash vouchers 1,300
Check drawn by Hidalgo Corporation, payable to the petty cashier 4,000
10,100

Included among the checks drawn by Hidalgo Corporation against the BPI current account and
recorded in December 2019 are the following:
a. Check written and dated December 29, 2019 and delivered to payee on January 2, 2020,
P80,000.
b. Check written on December 27, 2019, dated January 2, 2020, delivered to payee on December
29, 2019, P40,000.

The credit balance in the Security Bank current account No. 2 represents checks drawn in excess
of the deposit balance. These checks were still outstanding at December 31, 2019.

The savings account deposit in PNB has been set aside by the board of directors for acquisition
of new equipment. This account is expected to be disbursed in the next 3 months from the
balance sheet date.

Based on the above and the result of your audit, what is the adjusted balances of cash and cash
equivalents?
a. 2,917,200
b. 3,052,000
 c. 3,074,900
d. 3,066,000

PROBLEM 1-19 Answer D

Unadjusted cash on hand 500,000
NSF check (40,000)
Postdated check received (20,000)
Adjusted cash on hand 440,000

Petty cash fund per total 10,100

Employees' vales (IOU) (1,600)
Currency in envelope marked "collections for charity" (1,200)
Unreplenished petty cash vouchers (1,300)
Petty cash fund, as adjusted 6,000

Unadjusted BPI current account 1,000,000

Unreleased check 80,000
Postdated check delivered 40,000
Adjusted BPI current account 1,120,000

Security Bank current account (net of overdraft of P80,000) 1,000,000

PNB time deposit 500,000
Cash and cash equivalents, as adjusted 3,066,000

PROBLEM 1-20
Batchy Company reported petty cash fund which compromised the following:

Coins and currency 7,680

Paid vouchers:
Transportation 870
Gasoline 950
Office supplies 430
Postage stamps 200
Due from employees 950 3,400
Manager’s check returned by bank marked “NSF” 9,750
Check drawn by the entity to the order
of petty cash custodian 10,500
What is correct amount of petty cash fund for statement presentation purposes?
a. 17,430
b. 11,080
c. 20,830
d. 18,180

PROBLEM 1-20 Answer D

Coins and currency 7,680
Check drawn by the entity to the order
of petty cash custodian 10,500
Correct amount of petty cash 18,180
 Chapter 2

Bank Reconciliation

Bank deposits

Demand deposits Saving deposit Time Deposit

 Also known as current  An interest-bearing  An interest-bearing
or checking account. deposit account held bank deposit with a
 Non- Interest bearing at a bank or other specified period of
 Very liquid and can financial institution. maturity. It is a money
be accessed using Though these deposit at a banking
checks, automated accounts typically pay institution that cannot
teller machines, and a modest interest rate, be withdrawn for a
electronic debits, their safety and specific term or
among other methods. reliability make them period of time. When
 Often allows for a great option for the term is over, it can
numerous withdrawals parking cash you want be either withdrawn or
and unlimited available for short- held for another term.
deposits, whereas term needs.
savings accounts
sometimes limit both.

Bank reconciliation is the process of matching the information held by bank in the form
of a bank statement in the information in the entity’s book. The cash balance per book and the
cash balance per bank must equal after the process of bank reconciliation which lead us to the
main goal of bank reconciliation which is to ascertain the differences between the bank statement
and the books of the entity. (Bragg, 2018).

Reconciling items

Book reconciling items

 (1) Credit memo- a document issued by the seller of goods or services to the buyer, reducing
the amount that the buyer owes to the seller under the terms of an earlier invoice.

(2) Debit memo- a document that records adjustments for three general cases: reduction in a
bank customer's account balance, under-billing of goods or services, or an internal offset
to a minor credit balance in a customer account.

(3) Errors- these are errors committed by the entity in recording in the books.

Bank reconciling items

(1) Deposit in Transit- money that has been received by a company and sent to the bank, but
has yet to be processed and posted to the account by the bank.
(2) Outstanding checks- a company has issued and recorded in its general ledger accounts,
but the check has not yet cleared the bank account on which it is drawn. This means that
the bank balance will be greater than the company's true amount of cash.

(3) Bank errors- these are errors made by the bank

Forms of Bank Reconciliation

(a.) Adjusted balance method- is an accounting method that bases finance charges on the
amount(s) owed at the end of the current billing cycle after credits and payments have
been posted.
(b.)Book to bank method- the book balance is reconciled with the bank balance.
(c.) Bank to book balance- the bank balance is reconciled with the book balance.

Bank Reconciliation Procedure

 The following bank reconciliation procedure assumes that you are creating the bank
reconciliation in an accounting software package, which makes the reconciliation process
easier:
  Enter the bank reconciliation software module. A listing of uncleared checks and
uncleared deposits will appear.
 Check off in the bank reconciliation module all checks that are listed on the bank
statement as having cleared the bank.
 Check off in the bank reconciliation module all deposits that are listed on the bank
statement as having cleared the bank.
 Enter as expenses all bank charges appearing on the bank statement, and which have not
already been recorded in the company's records.
 Enter the ending balance on the bank statement. If the book and bank balances match,
then post all changes recorded in the bank reconciliation and close the module. If the
balances do not match, then continue reviewing the bank reconciliation for additional
reconciling items. Look for the following items:
 Checks recorded in the bank records at a different amount from what is recorded in the
company's records.
 Deposits recorded in the bank records at a different amount from what is recorded in the
company's records.
 Checks recorded in the bank records that are not recorded at all in the company's records.
 Deposits recorded in the bank records that are not recorded at all in the company's
records.
 Inbound wire transfers from which a lifting fee has been extracted.

PROBLEMS

1. In preparing the bank reconciliation on December 31, 2020, Baretto Company provided
the following data:

Balance per bank statement P4,000,000

Deposit in transit 720,000

Amount erroneously credited by bank to Baretto’s Account 240,000

Bank Service charge for December 5,000

Outstanding checks 875,000

What is the adjusted cash in bank on December 31, 2020?

a. P2,005,000

b. P3600,000

c. P3,605,000

d. P2,000,000

2. On April 30, 2019, Casio Company received its bank statement. However, the closing
balance of the account was unreadable. Attempt to contact the bank after hours did not
secure the desired information. The following data are available in preparing the bank
reconciliation:

March 31, 2019 book balance P1,480,000

Note collected by bank 120,000
Interest earned on note 10,000
NSF check of customer 130,000
Bank service charge on NSF check 2,000
Other bank service charges 3,000
Outstanding checks 222,000
Deposit on march 31 placed in night 85,000
depository
Checked issued by Icarus Company charged 20,000
to Daedalus Company

What is the cash balance per bank statement?

a. P1,475,000
b. P1,592,000
c. P1,470,000
d. P1,350,000

3. The following information was included in the bank reconciliation for Hephaestus
Company for April 30,2020:

Balance per bank statement P1,240,000

Balance per ledger 750,000
Deposit of July 30 not recorded by bank 300,000
Debit memo-service charges 15,000
Credit memo- collection of notes by bank for Hephaestus Company 350,000
Outstanding checks ?

An analysis of the cancelled checks returned with the bank statement reveals the following:

 Checks for purchase of supplies was drawn for P60,000 but was recorded as P90,000
 The manager wrote a check for travelling expenses of P145,000 while out of town. the
check was not recorded.

What is the amount of outstanding checks on July 31?

(a.) 600,000
(b.) 570,000
(c.) 550,000
(d.) 610,000

4. The book keeper in Lyka Company recently prepared the following bank reconciliation
on December 31, 2019:

Balance per bank statement P2,800,000

Deposit in Transit 195,000
Checkbook Printing Charge 5,000
 Error made by Lyka Company in recording 35,000
Check No. 02 (issued in December)
NSF Check 110,000
Outstanding Check 100,000
Note Collected by bank (includes P15,000 215,000
interest)
Balance per book 2,830,000

Lyka Company has P200,000 cash on hand on December 31, 2019.

What amount should be reported by Lyka Company as “cash” in the statement of financial
position on December 31, 2019?
a. P2,930,000
b. P3,095,000
c. P2,895,000
d. P3,130,000

5. Casio Company’s reconciling items for the month of March included the following
information:

Balance per book P920,000

Bank service charge for March 20,000
Checks deposited by Casio during March was 40,000
not collectible
Deposits made but not yet recorded by bank 140,000
Checks written and mailed but not yet 100,000
recorded by bank

All deposits in transit and outstanding checks have been properly recorded in Casio’s books.
Casio Company found a check for P35,000, payable to Casio Company that had not yet been
deposited and had not been recorded in Casio’s books.

What is the adjusted cash in bank on April 30?

a. P895,000
b. P900,000
c. P920,000
d. P955,000

6. Cash data related to Home Corporation for the month of February of the current year are
as follows:

Balance per book, February 28 P3130,000

Balance per bank, February 28 3500,000
Undeposited collections 550,000
NSF check received from a customer returned 50,000
by the bank on March 5 with the February
bank statement
Outstanding checks 650,000
Bank debit memo for safety deposit box rental 5,000
not recorded by depositor
A creditor’s check for P30,000 was 300,000
incorrectly recorded in the depositor’s book
as
A customer’s check for P200,000 was 20,000
recorded by the depositor as
Neglected entry of the depositor to a check 125,000
drawn

What is the adjusted cash in bank on February 28?

a. P3,130,000
b. P3,500,000
c. P3,400,000
d. P2,950,000

7. Piattos Company’s newly hired assistant prepared the following bank reconciliation on
December 31:
 Book Balance P1,405,000
Deposit in transit 750,000
Collection of Note 2,500,000
Interest on note 150,000
Debit memo 1,145,000
Error on Check No.173 45,000
NSF Check 220,000
Preauthorized payments for water bills 205,000
Outstanding Check 1,650,000

Piattos authorized the bank to automatically pay its water bills as submitted directly to the bank.

What is the adjusted cash in bank on March 31?

a. P1,500,000
b. P1,405,000
c. P3,630,000
d. P2,500,000

8. On March 31,2019, the bank statement of GQ Company had an ending balance of

P3.735,000. The following data were assembled in the course of reconciling the bank
balance:
 The bank erroneously credited GQ Company for P21,000 on March 22.
 During the month, the bank charged back NSF checks amounting to P23,000 of which
P8,000 had been redeposited by March 25.
 Collection for March 31 totaling P103,000 was deposited the following month.
 Checks outstanding on March 31 amounted to P302,000.
 Note collected by the bank for GQ Company was P80,000 and the corresponding bank
charge was P5,000.

What is the unadjusted cash in bank per ledger on March 31, 2019?
a. P3,515,000
b. P3,557,000
c. P3,455,000
d. P3, 497,000

9. The following data pertain to the cash transactions and bank account of Quinn Company
for August of the current year:

Cash Balance per book P1,719,000

Cash balance per bank statement 3,195,000
Bank service charge 10,000
Debit memo 12,000
Outstanding Checks 685,000
Undeposited colletions 500,000
Proceeds of loan (net of interest, P30,000) 570,000
Erroneous credit 90,000
Bank error 80,000
NSF Check 77,000

What is the adjusted cash in bank?

a. P3,080,000
b. P2,910,000
c. P3,000,000
d. P2,990,000

10. The cash account in the ledger of Blue Company shows a balance of P1,652,000 at
December 31. The bank statement, however, shows a balance of P2,090,000 at the same
date, The only reconciling items consist of a bank service charge of P2,000, a large
number of outstanding checks totaling P590,000 and a deposit in transit.

What is the deposit in transit in the December 31 bank reconciliation?

a. P150,000
b. P440,000
c. P154,000
d. P592,000

11. Elsa Company keeps all its cash in a checking amount. An examination of the entity’s
accounting records and bank statement for the month ended December 31,2019 revealed
a bank statement balance of P8,649,000 and a book balance of P8,524,000.

A deposit of P950,000 placed in the bank’s night depository on December 29 does not appear on
the bank statement. Checks outstanding on December 31 amount to P270,000.

The bank statement shows that on December 25, the bank collected a note for Elsa Company
and credited the proceeds of P935,000 to the entity’s account. The proceeds included P35,000
interest, all of which Elsa Company earned during the current period. Elsa Company has not yet
recorded the said collection.

Elsa Company discovered that check no. 0906 written in December for P183,000 in payment of
an account had been recorded in the entity’s records as P138,0000.

Included with the December 31 bank statement was an NSF Check for P250,000 that Elsa
Company had received from Ana Company on December 20. Elsa Company has not yet
recorded the returned check. The bank statement shows a P15,000 service charge for December.

What is the journal entry to adjust the cash in bank on December 31, 2019?
a. Net debit to cash in bank of P625,000
b. Net credit to cash in bank of P625,000
c. Debit to cash in bank of P935,000
d. Credit to cash in bank of P310,000
 12. In preparing the September 30, 2019 bank reconciliation, Helen Company provided the
following information

Balance per bank statement P2,000,000

Deposit in transit 415,000
Return of customer’s check for insufficient 150,000
fund
Outstanding checks 365,000
Bank service charge for September 10,000

On September 30, 2019, what is the adjusted cash in bank?

a. P1850,000
b. P1,855,000
c. P1,220,000
d. P2,000,000

13. The following information was included in the bank reconciliation for Ceres Company
for January and February 2020:

Checks and charges recorded by bank in P550,000

February, including a February service charge
of P8,000 and NSF check of P24,000
Service charge made by bank in January and 2,000
recorded by depositor in February.
Total credits to cash in all journals during 620,000
February
Customer’s NSF check returned in January 40,000
and redeposited in February (no entry made
by depositor in either January or February).
Outstanding checks on January 31, 2020 that 230,000
cleared in February
What is the amount of outstanding checks on February 28, 2020?

(a.) 282,000
(b.) 302,000
(c.) 518,000
(d.) 322,000\

14. In an audit of Troy Company on December 31, 2023 the following data are gathered:

Balance per book P1,000,000

Bank charges 3,000
Outstanding checks 235,000
Deposit in transit 300,000
Customer note collected by bank 375,000
Interest on customer note 15,000
Customer check returned NSF 62,000
Depositors note charged to account 250,000

What is the adjusted cash in bank on December 31, 2023?

a. P1,254,000
b. P1,257,000
c. P1,078,000
d. P1,075,000

15. While checking the cash account of Clarissa Company on December 31, 2019, the
following information is discovered:

Balance per book P6,776,000

Balance per bank statement (outstanding 6,532,000
checks of P987,000
Deposit in bank closed by BSP 1,850,000
 Deposit in Transit 1,245,000
Currency and Coins counted 950,000
Petty cash fund (of which P10,000 is in the 50,000
form of paid vouchers)
Bank Charges not yet taken up in the book 8,000
Bond sinking fund 1,200,000
Receivables from employees 70,000
Error in recording a check in the book. The 9,000
correct amount as paid by the bank is P89,000
instead of P98,000 as recorded in the book, or
a difference of

What is the adjusted cash in bank on December 31, 2019?

a. P6,776,000
b. P6,777,000
c. P6,769,000
d. P6,789,000

16. Marvin Company’s reconciling items for the month of December included the following
information:

Ending balance, December 31 P2,890,000

Bank Service Charge for December 12,000
Interest paid by bank to Marvin Company for 10,000
December
Deposits made but not yet recorded by the 350,000
bank
Checks written and mailed but not yet 650,000
recorded by the bank

In addition, Marvin Company discovered that it had drawn and erroneously recorded a check for
46,000 that should have been recorded for P64,000
What is the cash balance per ledger on December 31?
a. P2,890,000
b. P2,590,000
c. P2,610,000
d. P2,580,000

17. Evans Company keeps all its cash in a checking account. An examination of the entity’s
accounting records and bank statement for the month ended June 30, 2019 revealed the
following information:

Balance per book on June 30 P8,550,000

Undeposited Collections 1,200,000
Note Collections 950,000
Outstanding Checks 350,000
NSF Check 250,000
Service Charge 25,000

Evans discovered that a check written in June for P200,000 in payment of an account payable,
had been recorded in the entity’s records as P20,000.

What is the cash in bank to be reported in the statement of financial position on June 30,
2019?
a. P9,045,000
b. P8,300,000
c. P9,360,000
d. P9,180,000

18. The accounts of Erobos company showed the following facts on August 31, 2023.

Balance of cash in bank account P1,300,000

Balance of bank statement 1,200,000
Outstanding checks, august 31:
Number 555 2,000
 861 55,000
862 35,000
863 30,000
864 66,000
865 70,000
Receipts of August 31, deposited September 1 275,000
Service charge for August 3,000
NSF check received from a customer 80,000
The cashier bookkeeper had misappropriated P30,000 and an additional P10,000 by
charging sales discounts and crediting accounts receivable.

The stub for check number 865 and the invoice relating thereto show that it was for P50,000. It
was recorded incorrectly in the cash disbursement journal as P70,000. This check was drawn in
payment of an account payable.

Payment has been stopped on check number 555 which was drawn in payment of an account
payable. The payee cannot be located.

What is the adjusted cash in bank on August 31, 2023?

(a.) 1,240,000
(b.) 1,230,000
(c.) 1,239,000
(d.) 1,235,000

19. Steve Company provided the following data for the purpose of reconciling the cash
balance per book with the balance per bank statement on December 31, 2019:

Balance per bank statement P2,000,000

Outstanding Checks 400,000
Deposit in transit 200,000
NSF Checks (P50,000 had been redeposited 150,000
and cleared by December 27)
Erroneous credit to Steve’s account, 300,000
representing proceeds of loan granted to
another company
 Proceeds of note collected, net of service 750,000
charge of P20,000

What is the cash in bank to be reported in the December 31, 2019 statement of financial
position?
a. P1,500,000
b. P1,400,000
c. P1,800,000
d. P1,450,000

20. In reconciling the cash balance on December 31, 2023 with that shown in the bank
statement, the following facts are gathered from the records of Jupiter Company:

Balance per bank statement P4,000,000

Balance per book 2,700,000
Outstanding checks 600,000
Deposit in transit 500,000
Service charge 10,000
Proceeds of bank loan, December 1, discounted for 6 965,000
months at 12%, not recorded on Jupiter Company’s
books
Customer’s check charged back by bank for absence 50,000
of counter signature
Deposit of P100,000 incorrectly recorded by bank as 15,000
Check of Neptune Company charged by bank against 150,000
Jupiter account
Customer’s note collected by bank in favor of Jupiter
company
Face P400,000
Interest 40,000
Total 440,000
Collection fee 5,000 465,000
Erroneous debit memo of December 28, to charged 225,000
Jupiter account with settlement of bank loan
Deposit of Neptune company credited to Jupiter 300,000
company
Prepare a bank reconciliation for Jupiter company on the month of December?
 SOLUTIONS

Problem 1. Answer: C
Solution:

Balance per bank statement P4,000,000

Deposit in Transit 720,000

Outstanding Checks (875,000)

Bank Error (240,000)

Adjusted Bank Balance P3,605,000

Problem 2. Answer: B
Solution:
March 31, 2019 book balance P1,480,000
Note collected by bank 120,000
Interest earned on note 10,000
NSF Check (130,000)
Bank Service Charges (2,000+3,000) (5,000)
Adjusted book balance P1,475,000

Balance per bank statement (SQUEEZE) P1,592,000

Deposit in Transit 85,000
Bank Error- erroneous charge 20,000
Outstanding Checks (222,000)
Adjusted Bank Balance P1475,000

Problem 3. Answer: C

Solution:

Balance per ledger P750,000

Add:
Collection of note 350,000
Book error (90,000-60,000) 30,000
Less:
Service charges 15,000
Unrecorded check for travelling expenses 145,000
Adjusted book balance 970,000
 Balance per bank P1,240,000
Add:
Deposit in transit 300,00
Less:
Outstanding checks 570,000
Adjusted bank balance 970,000

Problem 4. Answer: B
Solution .
Balance per bank P2800,000
Deposit in transit 195,000
Outstanding Check (100,000)
Adjusted cash in Bank P2,895,000
Cash on hand 200,000
Total Cash P3,095,000

Problem 5. Answer: A
Solution:
Balance per book P920,000
Unrecorded customer check 35,000
Bank Service Charge (20,000)
NSF Check (40,000)
Adjusted book balance P895,000

Problem 6. Answer: C
Solution
Balance per book P3130,000
Overstatement of creditor’s check 270,000
Understatement of customer’s check 180,000
NSF Check (50,000)
Bank Debit Memo for safety deposit box (5,000)
Unrecorded check (125,000)
Adjusted book balance P3,400,000

Balance per bank P3,500,000

Undeposited Collections 550,000
Outstanding Checks (650,000)
Adjusted Bank Balance P3,400,000

Problem 7. Answer: C
Solution
Book balance P1,405,000
Collection of Note 2,500,000
Interest on Note 150,000
Book error on Check No. 173 45,000
Bank service charge (45,000)
Water bills (205,000)
NSF Check (220,000)
Adjusted book balance P3,630,000

Problem 8. Answer: C
Solution.
Balance per bank P3,735,000
Erroneous bank credit (21,000)
Deposit in transit 103,000
Outstanding checks (302,000)
Adjusted bank balance P3,515,000

Balance per book (SQUEEZE) P3,455,000

NSF Check (15,000)
Note Collected by bank 80,000
Service Charge (5,000)
Adjusted book balance P3,515,000
 Problem 9. Answer: C
Solution
Balance per book P1,719,000
Service Charge (10,000)
Debit memo (12,000)
Proceeds of bank loan 570,000
Proceeds of customer’s note 810,000
NSF Check (77,000)
Adjusted book balance P3,000,000

Balance per bank P3,195,000

Outstanding checks (685,000)
Deposit in transit 500,000
Erroneous credit (90,000)
Bank error 80,000
Adjusted bank balance P3,000,000

Problem 10. Answer: A

Solution

Balance per book P1,652,000

Service Charge (2,000)
Adjusted book balance P1,650,000

Balance per bank P2,090,000

Deposit in transit (SQUEEZE) 150,000
Total P2,240,000
Outstanding Checks (590,000)
Adjusted bank balance P1,650,000
 Problem 11. Answer: A

Solution:
Book Balance P8,254,000
Note Collected 935,000
Total P9,459,000
Book Error (183,000-138,000) (45,000)
NSF Check (250,000)
Service Charge (15,000)
Adjusted book balance P9,149,000

Debit to cash in bank P935,000

Credit to cash in bank 310,000
Net debit to cash in bank P625,000

Problem 12. Answer: C

Solution:

Balance per bank 2,000,000

Deposit in Transit 415,000
Total 1,585,000
Outstanding Checks (365,000)
Adjusted bank balance 1,220,000

Problem 13. Answer: C

Solution.

Checks and charges by bank in November P550,000

Service charge in November (8,000)
NSF check in February (24,000)
Checks paid by bank in February 518,000
 Total credits to cash in all journals during February P620,000
Service charge in January recorded in February (2,000)
Checks issued by depositor in February 618,000
Outstanding Checks— January 31 230,000
Total checks to be paid by bank 848,000
Checks paid by bank in February (518,000)
Outstanding checks— February 28 330,000

Problem 14. Answer: D

Solution:

Balance per book P1,000,000

Bank charges (3,000)
Note collected by bank 375,000
Interest on Note 15,000
NSF (62,000)
Note Charged to account (250,000)
Adjusted Book Balance P1,075,000

Problem 15. Answer: B

Solution:
Balance per book P6776,000
Bank Charges (8,000)
Book error in recording check 9,000
Adjusted cash in bank P6,777,000

Problem 16. Answer: C

Solution.
Balance per bank P2890,000
Deposit in transit 350,000
Outstanding Checks (650,000)
Adjusted bank balance P2,590,000
Balance per ledger (SQUEEZE) P2,610,000
Interest Income 10,000
Service Charge (12,000)
Book error (64,000-46,000) (18,000)
Adjusted book balance P2,590,000

Problem 17. Answer: A

Solution.

Balance per book P8,550,000

Note collected by bank 950,000
Total P9,500,000
Book error (200,000-20,000) (180,000)
NSF Check (250,000)
Service charge (25,000)
Adjusted book balance P9,045,000

Problem 18. Answer: C

Solution

Balance per book P1,300,000

Add:
Overstatement of check 20,000
number 765
Check number 555 stopped 2,000 22,000
for payment
Less:
Service Charge 3,000
NSF check 80,000 83,000
Adjusted book balance 1,239,000
Balance per bank 1,200,000
Add:
Undeposited collections 275,000
Less:
 Outstanding checks
Number 861 55,000
862 35,000
863 30,000
864 66,000
865 50,000 236,000
Adjusted bank balances 1,239,000

Problem 19. Answer: A

Solution

Balance per bank P2,000,000

Deposit in transit 200,000
Total P2,200,000
Outstanding Checks (400,000)
Erroneous bank credit (300,000)
Adjusted bank balance P1,500,000

Problem 20. Solution:

Balance per book P2,700,000

Add:
Proceeds of bank loan P965,000
Note collected by bank 465,000 1,430,000
Less:
Service charge 15,000
Customer’s check charged 50,000 65,000
back
Adjusted book balance 4,065,000

Balance per bank P4,000,000

Add:
Deposit in transit 500,000
Incorrect deposit 90,000
Erroneous bank charge 150,000
Erroneous debit memo 225,000 965,000
Less:
Outstanding checks 600,000
Erroneous bank credit 300,000 900,000
Adjusted bank balance 4,065,000
CHAPTER 3 Proof of Cash

Proof of cash is a more detailed four-column bank reconciliation consisting of the beginning
balance, receipts, disbursements and the ending balance. Compared to a simple bank
reconciliation, a proof of cash also reconciles the receipts and disbursements of the bank and the
depositor. It can be noted that the combined balances of beginning date and receipts is equal to
the combined amount of disbursements and ending date. Preparing a proof of cash is suitable in
determining discrepancies in the cash balance of an entity.

The preparation of a proof of cash may become complicated due to the omission of one or
combination of the beginning and ending balance of the following: book, bank, deposits in transit
and outstanding checks. The omission of such information gives rise to the necessity of
computing them.

Computation of Book Balance

Balance per book

Add: Book debits – current month

Total

Less: Book credits – current month

Balance per book – end of month

Book debits are receipts or increases in cash in bank recorded per book

Book credits are disbursements or decreases in cash in bank recorded by book.

Computation of Bank Balance

Balance per bank

Add: Bank credits – current month

Total

Less: Bank debits – current month

Balance per bank– end of month

Bank debits are decreases in the account of the depositor which include debit memos such
service charges and NSF checks and checks paid by the bank.

Bank credits are increases in the account of the depositor which includes credit memos such as
notes collected by bank and proceeds of bank loans and deposits acknowledged by the bank.

Computation of Deposits in Transit

Deposits in transit – Beginning of month

Add: Cash receipts deposited during the month

Total deposits to be acknowledged by bank

Less: Deposits acknowledged during the month

Deposits in transit – end of the month

Computation of Outstanding Checks

Outstanding checks – Beginning of month

Add: Checks drawn during the month

Total checks to be paid

Less: Checks paid by the bank during the month

Outstanding checks – end of the month

Illustration

The following information pertains to BTS Corporation for the months of September and
November 2019:

Balance per ledger

September 30 P 600,000
 October 31 780,000

Bank Balance

September 30 P 617,400

October 31 758,200

Book debits – October 2,580,000

Book credits – October 2,400,000

Bank debits – October 2,413,600

Bank credits - October 2,554,400

Deposits in Transit

September 30 P 240,000

October 31 305,000

Outstanding Checks

September 30 P 223,000

October 31 198,000

Bank service charges

September 30 1,200

October 31 800

NSF (recorded by the company the following month)

September 30 25,000

October 31 14,000

Bank credit memo for customer’s note collected by bank in September

Face value – 60,000; interest – 600 60,600

Credit Memo for bank loan granted by bank on October 30 100,000

Book

Sep. 30 Receipts Disbursements 0ctober 31

Unadjusted book balance 600,000 2,580,000 2,400,000 780,000
Bank service charge – Sept. (1,200) (1,200)
Bank service charge – Nov. 800 (800)
NSF- Sept. (25,000) (25,000)
NSF – Nov. 14,000 (14,000)
Credit memo - Note Collected 60,600 (60,600)
Credit memo - Proceeds of Loan 100,000 100,000

Adjusted book balance 634,400 2,619,400 2,388,600 865,200

Bank

Sep. 31 Receipts Disbursements October 30

Unadjusted bank balance 617,400 2,554,400 2,413,600 758,200
Deposits in Transit– Sept. 240,000 (240,000)
Deposits in Transit– Nov. 305,000 305,000
Outstanding Checks - Sept. (223,000) (223,000)
Outstanding Checks – Nov. 198,000 (198,000)
Adjusted book balance 634,400 2,619,400 2,388,600 865,200
COMMENTS

A. Bank service charges are book reconciling items. September service charge is deducted to
beginning balance because it is a disbursement not deducted in the previous month
therefore it is also deducted to current month disbursement because it is not a
disbursement of October. October service charge is added to disbursement and deducted
to ending balance because it is a disbursement of the current month. NSF checks were
also treated the same in this problem.
B. Bank credit memo for notes collected in September is added to Beginning balance and
deducted to October receipts because it is an addition made by the bank to the depositors
account in September. Bank credit memo for proceeds of loan granted in October is
added to receipts and ending balance because it is an increase in the cash balance for the
current month.
C. September NSF check is deducted to beginning balance and disbursement because it was
recorded as a receipt in previous month hence beginning balance is overstated. It is
deducted from disbursement because it is a disbursement of September and not the
current month.
 D. September deposits in transit is added to beginning balance and deducted to receipt
because it is a receipt that was not recorded previously therefore understating the
beginning balance. October DIT is a receipt of current month therefore it is added to
receipt and ending balance.
E. September Outstanding check is deducted to beginning balance and disbursements
because this is a disbursement of the previous month not recorded. October outstanding
check is a disbursement of the current month hence it decreases the ending balance.

Journal Entry

Accounts Receivable 14,000

Cash in Bank 14,000

Bank Service Charge 800

Cash in Bank 800

Cash in Bank 100,000

Notes Payable – bank 100,000

PROBLEMS

1. Kish Company had the following data pertaining to the cash records for the months of October
and November.

October 31 November 30
Book balance ? 1,000,000
Cash receipts per book 1,500,000
Cash disbursements per book 2,500,000

Bank balance 2,200,000 ?

Bank disbursements 2,600,000
Bank receipts 1,300,000

NSF check 60,000 40,000

Collections of accounts receivable
not recorded by entity and
corrected in subsequent month 30,000 50,000
Overstatement of check in
Payment of salaries corrected
In subsequent month 90,000 120,000
Deposit in transit 130,000 260,000
Outstanding checks 270,000 30,000

Prepare a four-column bank reconciliation.

BOOK

Oct. 31 Receipts Disbursements November 30

Unadjusted book balance 2,000,000 1,500,000 2,500,000 1,000,000
NSF- Sept. (60,000) (60,000)
NSF – Nov. 40,000 (40,000)
Collection of Accounts 30,000 (30,000)
Receivable- October 31
Collection of Accounts 50,000 50,000
Receivable- November 30
Overstatement of Check - Oct. 31 90,000 (90,000)
Overstatement of Check - Nov. 31 (120,000) 120,000
Adjusted book balance 2,060,000 1,430,000 2,360,000 1,130,000

BANK

Oct. 31 Receipts Disbursements November 30

Unadjusted bank balance 2,200,000 1,300,000 2,600,000 900,000
Deposits in Transit– Oct.. 130,000 (130,000)
Deposits in Transit– Nov. 260,000 260,000
Outstanding Checks - Oct. (270,000) (270,000)
Outstanding Checks – Nov. 30,000 (30,000)
Adjusted book balance 2,060,000 1,430,000 2,360,000 1,130,000

2. Using data from item 1, what is the unadjusted book balance in October?
Unadjusted Cash Balance, Oct. 31(SQUEEZE) 2,000,000

Add: Receipts 1,500,000

Total 3,500,000

Less: Disbursements 2,500,000

Unadjusted Cash Balance, Nov. 30 1,000,000

3. Using data from item 1, what is the unadjusted bank balance in November?

Unadjusted Cash Balance, Oct. 31 2,200,000

Add: Receipts 1,300,000

Total 3,500,000

Less: Disbursements 2,600,000

Unadjusted Cash Balance, Nov. 30 900,000

4. Using data from item 1, what is the adjusted bank balance in October? 2,060,000

5. Using data from item 1, what is the adjusted bank balance in November? 1,130,000

6. The bank is responsible for the preparation of proof of cash. FALSE

7. Furball Company prepared the following bank reconciliation on July 31:

Balance per bank statement, July 31 4,500,000

Deposit in transit 400,000

Total 4,900,000
Outstanding checks (900,000)

Balance per book, July 31 4,000,000

The Bank statement for the month of August showed the following:

Deposits, including P200,000 note collected by the bank for furball 10,500,000
Disbursements, including P140,000 DAIF and
P10,000 service charge 8,500,000

All reconciling items on July 31 cleared through the bank in August.

August 30

Outstanding checks P600,000

Deposit in transit P1,000,000

What is the adjusted cash in bank on August 30?

a. 6,500,000
b. 6,700,000
c. 7,050,000
d. 6,900,000

Balance per bank statement, July 31 4,500,000

Deposits 10,500,000
Disbursements (8,500,000)
Balance per bank, August 30 6,500,000
DIT 1,000,000
OC (600,000)
Adjusted Balance 6,900,000

8. In the immediately preceding problem, what is the cash balance per book on August 30?

a. 6,900,000
b. 6,850,000
c. 7,050,000
d. 5,900,000

Balance per Book, August 30 (SQUEEZE) 6,850,000

Note Collected 200,000
DAIF ( 140,000)
Bank service charge ( 10,000)
Adjusted Book Balance 6,900,000

9. In the immediately preceding problem, what is the amount of cash receipts per book in
August?

a. 10,900,000
b. 11,100,000
c. 10,100,000
d. 11,300,000

Deposit per bank statement, June 10,500,000

Note Collected (200,000)

DIT, July (400,000)

DIT, August 1,000,000

Cash Receipts per Book, August 10,900,000

10. Beautiful Guel Company prepared the following bank reconciliation on November 30.

Balance per bank 9,000,000

Deposit in transit 800,000
Outstanding checks (1,200,000)
Balance per book ?

What is the balance per book?

a. 8,300,000
b. 7,900,000
c. 8,900,000
d. 8,600,000

11. Arnold Company prepared the following bank reconciliation on December 31.

Balance per bank ?

Deposit in transit 1,000,000
Outstanding checks (1,250,000)
Balance per book 4,400,000

What is the balance per bank?

a. 4,600,000
b. 4,400,000
c. 4,900,000
d. 4,650,000

12. The following are reconciling items that the entity journalizes, except:

a. Service charge

b. Collection of notes

c. NSF Check

d. Deposits in transit

13. The following are bank reconciling items, except:

a. Service charge

b. Collection of notes

c. NSF Check

d. Deposits in transit

14. Beginning deposits in transit is deducted to ___________.

a. Beginning balance

b. Ending balance

c. Receipts

d. Disbursements
15. The following are bank reconciling items, except:

a. Deposits in transit

b. Outstanding checks

c. Bank error

d. Collection of Notes

16. A proof of cash

a. proves the existence of a bank account

b. is a type of financial statement

c. is a four-column bank reconciliation

d. is prepared by the bank

17. Outstanding checks are reconciling items

a. deducted to bank balance

b. added to book balance

c. deducted to book balance

d. added to bank balance

18. Beginning deposits in transit is added to beginning balance and deducted to receipts. TRUE

19. Bank credit memo of the previous month is a bank reconciling item that must be added to
beginning balance and deducted to receipts. FALSE

20. Outstanding checks of current month are book reconciling items that must be deducted to
ending balance and added to disbursement. FALSE
CHAPTER 4:

ACCOUNTS RECEIVABLE

Introduction to Accounts Receivable

We often go to the grocery buy necessities such as foods, beverages supplies etc. in
which we usually pay in cash and then take possession of the product.

In companies however, they must be willing to accept cash or on credit in exchange of the goods.
This means that the entity would be willing to accept payment at a later date, and you (the buyer)
would incur an obligation towards the entity.

Transaction on credit usually results to:

a. Higher sales – since buyers are more willing to purchase on credit rather than pay on cash

b. Potential loss – the entity shoulders the risk of loss, which will happen if the buyer does not
pay the amount it owes.

If the buyer does not pay the seller will recognize

1. A bad debts expense which will be shown in the balance sheet.

2. A reduced amounts of accounts receivable shown in the balance sheet.

Example

Assume that on March 1 Petmalu Co. Sold 90000 worth of Laptops to clients with a
credit term of net 20 days.

Entry

Accounts Receivable 90000

Sales 90000

Under accrual basis income is recognized when earned regardless of whether paid or not. In this
case income is earned and recognized but payment of cash shall be recognized after 20 days.
(note: credit term net of 20 days represents the days the buyer may pay the full amount.)

SALES OF GOODS IN CREDIT

When a company sells goods on account, the transaction results to an increase in income
statement as a sales revenue and COGS, an increase and decrease in balance sheet as an
Accounts Receivable and Inventory. The final amount in the income statement of net profil (or
loss) on the sale shall be reported in the Statement of Stockholder’s Equity.

Shipping Terms and Freight Terms

Shipping terms can sometimes be confusing. Buyers need to be fully aware of its Shipping and
Freight terms before sendin away the good so that the buyer and seller can come to an agreement
on who shall shoulder the costs in shipping the goods.

Shipping terms can either be:

a. FOB Destination - the seller shall take ownership of the goods until the buyer has
received the product.
b. FOB Shipping point - the buyer takes ownership upon shipment of the goods. Freight

Freight Terms can be:

a. Freight prepaid – seller pays the cost of shipping.

b. Freight Collect – the buyer pays cost of shipping.

To further summarize the concept kindly look at the diagram below:

Transfer of
Ownersp
FOB Shipping Point
SELLER BUYER

Transfer of
Ownersp
FOB Destination

SELLER BUYER
Table 1

Example

Assume that in the illustration Above Petmalu Co. Shipped their Laptops FOB Destination,
freight collect that costs 1000.

Entry

Freight Out 10000

Allowance for freight Charge 10000
Now assume that Petmalu shipped their goods FOB Shipping point, freight collect.

Entry

None
(there shall be no entry to the selling entity’s perspective since the buyer owns and
shoulders transportation costs)

Credit Terms with discounts

When a seller gives a credit term net of 30 days the buyer is due to pay the entire amount within
30 days after sales invoice date.

But some companies find that they do not recieve payment on time even with long credit terms
so these companies offer discounts to customers who pays within a short amount of time. These
are called cash dicounts or early payment discount and the period of time to avail cash discount
is called the dicount period. For example 2/10 net of 30 days. The 2% dicscount on the entire
amount owed shall only apply within 10 days. If the customer does not pay withing the discount
period of 10 days, the net purchase amount without the idcount is payable within 30 days after
invoice date.

Example

Using the examples from above that on March 1 Petmalu Co. Sold 90000 Laptops with credit
terms 2/10 net 30 days

If the buyer is able to pay on or before March 11 (10 days) he/she may be able to deduct 1800
(0.02 x 90000) from the 90000 purchase price of the laptops

And thus the entry shall be

March 1
Accounts receivable 90000
Sales 90000

March 11
Cash 88200
Sales Discount 1800
Accounts Receivable 90000
If the customer fails to avail the 2% discount the entry shall be:

March 11
Cash 90000
Accounts Receivable 90000

Methods for Recording Credit Sales

a. Gross Method – The accounts receivable and Sales are recorded at gross amount
b. Net Method – The accounts receivables and sales are recorded ar net amount

Example – GROSS METHOD

Sale of Goods worth 5000 terms 2/15 net 20 days

Accounts Receivable 5000

Sales 5000

If payment is received within discount period

Cash 4900
Sales Discount 100
Accounts Receivable 5000

Is payment was received beyond the discount Period

Cash 5000
Accounts Receivable 5000

Example – NET METHOD

Sale of Goods worth 5000 terms 2/15 net 20 days

Accounts Receivable 5000

Sales 5000

If payment is received within discount period

Cash 4900
Accounts Receivable 4900

Is payment was received beyond the discount Period

 Cash 5000
Accounts Receivable 4900
Sales Discount forfeited 100

Note that in Gross method they used an account of Sales discount if payment was made within
discount period while Net method uses Sales dicount forfeited if collection was made beyond
dicsount period.

Allowance for Bad Debts

Accounts Receivable are dound in the entity’s balance sheet classified as current asset
since the account is highly liquid and can easily be converted to cash within a year. If not
collected the Accounts receivable account can easuly be overstated in the balance sheet.

To present the account accurately the entities usually estimate how much of the Accounts
Receivable are not collectible. This estimate is a contra asset-account found in the balance sheet
called Allowance for Bad Debts or Allowance for Doubtful Accounts. An increase or decrease
in this account are recorded in the income statement as Bad Debts Expense or Doubtful Account
Expense.

There are two method of accounting for bad debts namely

1. Allowance Method
2. Direct Writeoff Method

Allowance method for reporting Credit losses

To recognize doubtful account the entry shall be:

Doubtful Accounts
Allowance for Doubtful Accounts

If the account is sure to be uncollectible the Accounts Receivable shall be written-off and shall
be entries as follows:

Allowance for Doubtful Accounts

Accounts Receivable

Example

An Accounts Receivable of 10000 from the 50000 sale of Phones on credit are
considered doubtful of collection
 Doubtful Accounts Expense 10000
Allowance for Doubtful Accounts 10000

The accounts are subsequently discovered are proved to be uncollectible

Allowance for Doubtful Accounts 10000

Accounts Receivable 10000

Recovery of an account

After writing off the Acocunts receivable it is srill possible the seller has paid all or part
of the account that has been wrritten off.

Assume that in the previous example 10000 of Doubtful Account has been unexpectedly
collected

Steps to record a recovery of Account under allowance method:

1. Reinstate the account written off by reversing the entry

Accounts Receivable 10000

Allowance for D oubtful Accounts 10000

2. Record the Accounts Receivable as if collected normally

Cash 10000
Accounts Receivable 10000

Direct Writeoff Method

Under direct Writeoff method Doubtfull Accounts are only recognized when the accounts
are proved to be worthless or uncollectible.

Example

A 5000 Accounts receivable are doubted to be collected.

No entry

5000 Accounts receivable is sure to be worthless or uncollected

 Doubtful Accounts Expense 5000
Accounts Receivable 5000

Suddenly, 5000 of the Accounts receivable was collected

Accounts Receivable 5000

Doubtful Accounts Expense 5000

Cash 5000
Accounts Receuvake 5000

PROBLEMS: MULTIPLE CHOICE

1.On February 1 P222 woth of goods are sold with credit terms of 1/10 n/30. If the buyer paid
the goods on Fenruary 9. How much cash should the seller expect to receive?

a. 219.78
b. 200
c. 220.56
d. 199.30

2. On July 1, P800 of goods are sold with credit terms of 1/10. n/30. On July 5 the customer
returned P100 of the goods. How much should the seller expect to receive if the buyer pays on
June 8?

a. 692
b. 693
c. 700
d. 792

3. With credit terms of 2/10. n/30, the discount rate is

a. 2%
b. 10%
c. 30%
d. None of the above

4. The Buyer is responsible for the costs of shipping when goods are sold with the terms?
 a. FOB Destination
b. FOB Origin
c. FOB Shipping point
d. None of the Above

5. On which financial statement would you find the Allowance for Doubtful Accounts

a. Statement of Changes in Equity

b. Income Statement
c. Statement of Cash Flows
d. Balance Sheet

6. Which method of reporting losses on Accounts Receivable is used for Financial Reporting

a. Gross Method
b. Allowance Method
c. Direct Write-off Method
d. Net Methog

Allowance for Doubtful Accounts Expense has a credit balance of 50 000. It is discoverered hat
one of its account receivable amounting to 1800 is worthless and needs to be written off.

7. Which account should be debited for 1800 when writing off the account?

a. Allowance for Doubtful Accounts

b. Accounts Receivable
c. Accounts Payable
d. None of the above

8. Which account should be credited?

a. Allowance for Doubtful Accounts

b.Accounts Receivable
c. Accounts Payable
d. None of the Above

9. 4. The Seller is responsible for the costs of shipping when goods are sold with the terms?

a. FOB Destination
b. FOB Origin
c. FOB Shipping point
d. None of the Above

10. When the Allowance for Doubtful Accounts appears on a company’s financial statements, its
balance will be a _______ balance
 a. Debit
b. Credit
c. Added
d. Deducted

PROBLEM SOLVING

A sale of goods on june 1 credit terms 3/20, n/30 worth of 123450 has been sold by Etneb Co
FOB Shipping Point Freight Collect, with freight costing 3200. The full amount was collected on
June 21

11. Prepare Journal Entry on June 1 - June 21 using Gross Method

Accounts Receivable 123450

Cash 123450

Cash 119746.5
Sales Discount 3703.5
Accounts Receivable 123450

12. Prepare Journal Entry on June 1 – June 21 using Net Method

Accounts Receivable 119746.5

Sales 119756.5

Cash 119746.5
Accounts Receivable 119746.5

13. A company estimated that 700 of its 1000 Accounts receivable will be uncollectible. Its
Allowance for Doubtful Accounts presently has a credit balance of 200. The adjusting entry will
include a ______ to the Allowance for Doubtful Acocunts

Answer:

500 Credit

14. A company estimated that 400 of its 1000 of Accounts Receivable will be uncollectibe. Its
Allowance for Doubtful Accounts today has a debit balance of 300. The edjusting entry will
include a ____ to Allowance for Doubtful Accounts

Credit of 700
15. Ghosting Co. Sold Merchandise on account amounting to 32250000 on January 20. The
terms are 3/10, n/30. The freight charge amounted to 500. FOB Destination Freight Collect. The
amount was collected February 25

Prepare journal entries to record transactions under Net method.

Answer:

Accounts Receivable 3225000

Freight Out 500
Sale 3225000
Allowance for freight charge 500

Cash 3225000
Accounts Receivable 3160500
Sales Discount Forfeited 64500

16. On November 1 the following transactions occured in Enebenemen Co.

1. Sale of Merchandise on Accounr 5/10 n/30 1000000

2. Collection withing the discount period 250000
3. Collection beyond Discount period 100000
4. Sales Return granted 50000

Prepare journal Entries to record Transaction

Answer

Accounts Receivable 1000000

Sales 1000000

Cash 950000
Sales Discount 50000
Accounts Receivable 100000

Cash 1000000
Accounts receivable 1000000

Sales Return 50000

Accounts Receivable 50000
17. On October 15 KadenangTanso Co. Sold 5 refridgerators. The sale price for each fridge is
12000.

All sales are subject to term 2/10 n/30. The entity iused ross method of accounting for accounts
Receivable

Prepare journal entries to record sale

Answer:

Accounts Receivable 60000

Sales 60000

18. TugsTugs Co. Sold 600000 worth of merchandise on january 10 with credit terms 2/10 n/30.
The entity estimated sales and returns to be 100000

Prepare journal entry under Net method assuming the customer paid beyond ddeicount period

Answer:

Accounts Receivable 600000

Sales 600000

Sales Return 100000

Accounts receivable 100000

Cash 600000
Accounts Receivable 588000
Sales Discount Forfeited 12000

19. Dododoo Co. Provided the following information for the current year in relation to accounts
Receivable

Accounts receivable - beg 2600000

Credit Sales 1500000
Sales Return 50000
Account Written-off 10000
Estimated future return on Dec. 31 25000
Estimated uncollectible Accounts 1000

What amount should be reported as the net realiable value of the Accounts receivable on Dec 31
 Answer:

Accounts Receivable - beg 2600000

Credit Sales 1500000
Sales Return (50000)
Account Written-off (10000)
Accounts Receivable – end 4040000
Estimated future return (25000)
Estimated uncollectible Accouts (10000)
Net realizable Value 4005000

20. Inaantoknaako Co. Provided the following T-account summarizing the transactions affecting
accounts receivable for the current year

Accounts Receivable

Jan 1. Balance 100000 Collection from customers 200000

Charge Sales 50000 Writeoff 20000

IOU’s ffrom employees 20000 Collection from Carrier 1000

Claims

Compute the correct amount of the Accounts Recevable

Answer:

Accounts Receivable – beginning 1000000

Charge Sales 50000
Total 1050000
Less: Collection from custimers 200000
Writeoff 20000 220000
Total 830000
CHAPTER 5 Estimation of Doubtful Accounts

Methods of estimating doubtful accounts

The three methods of estimating doubtful accounts are:

1. Aging the accounts receivable

2. Percent of accounts receivable
3. Percent of sales

Aging of accounts receivable and percent of accounts receivable involves an account of financial
position hence they are “statement of financial position approach” and they will yield required
allowance for accounts receivable. While percent of sales involves an account of income
statement hence it is an “income statement approach” and the resulting amount would be the
doubtful accounts expense.
Aging of Accounts Receivable

This method classifies accounts receivables into not due or past due. Each classification is then
multiplied by the rate or percent of loss that the entity has experienced for every category. The
resulting amount represents the required allowance for doubtful accounts at the end of the period.
In order to determine whether the accounts are past due, the credit term is considered. For
example, if the credit term is 2/10, n/30 and the account is already at 40 days then it is already 10
days past due. This means that the maximum credit term has been exceeded by 10 days.

Illustration

Balance Experience rate Required Allowance

Not due 600,000 2% 12,000
1-30 days past due 500,000 4% 20,000
31-60 days past due 400,000 12% 48,000
61-90 days past due 350,000 20% 70,000
91-180 days past due 240,000 21% 50,400
181-365 days past 160,000 22% 35,200
due
More than one year 45,000 25% 11,250
Total 2,295,000 246,850

Percent of Accounts Receivable

This method is also a statement of financial position approach therefore the resulting amount
would be the required allowance for doubtful accounts. In this method, a rate or percentage
based on the past experience of the entity in its accounts is multiplied by the open accounts.

Illustration

Angeli Company reported the following account balance at year end:

Accounts Receivable 5,000,000

Allowance for Doubtful Accounts 20,000

Credit sales 3,050,000

Doubtful accounts are estimated at 2% of accounts receivable.

Journal Entry

Doubtful Accounts 80,000

Allowance for Doubtful Accounts 80,000

Required Allowance (5,000,000 * 2%) 100,000

Less: Credit balance of Allowance for doubtful accounts 20,000

Doubtful Accounts Expense 80,000

Percent of Sales

Doubtful accounts expense is obtained using this method by multiplying a rate to either credit
sales or total sales. This rate is calculated by dividing bad debt losses in the prior year by the
charge sales of the prior years.

Illustration

The following accounts are reflected in the ledger Andrew Co.

Accounts receivable 2,000,000

Allowance for doubtful accounts, Beginning 40,000

Sales 4,500,000

Sales return 50,000

Doubtful accounts expense is calculated as 2% of net sales

Sales 4,500,000

Sales return 50,000

Net Sales 4,450,000

Multiply by 2%

Doubtful Accounts Expense 89,000

Allowance for Doubtful accounts, Beginning 40,000

Doubtful Accounts Expense 89,000

Allowance for Doubtful Accounts, Ending 129,000

PROBLEMS

1. Bet Ty Inc. reported the following account information before adjustments at year end.
Compute for the required allowance of doubtful accounts using percent of accounts receivables
method. Doubtful accounts are estimated at 4% of accounts receivable.

Cash 500,000

Accounts receivable 525,000

Notes Receivable 350,000

Allowance for Doubtful accounts 20,000

Sales 3,000,000

Accounts receivable 525,000

Multiply: Rate 4%

Required Allowance 21,000

2. In the immediately preceding problem, compute for the doubtful accounts expense.

Allowance for Doubtful accounts, Beginning 20,000

Add: Doubtful accounts expense (SQUEEZE) 1,000

Required Allowance 21,000

3. The following information is reported by Alyssa Company:

Allowance for Doubtful accounts, Beginning 170,000

Recoveries 30,000

Write off 235,000

The company historically computed allowance account using percent of net sales. However, it
was decided that the doubtful accounts must be computed using aging of accounts receivable in
the year-end adjusting entry.

The following schedule was prepared for the aging of accounts receivable:

Balance Percent collectible

Not due 2,000,000

1-30 days past due 1,200,000 95

31-60 days past due 100,000 75

61-90 days past due 150,000 50

Over 90 days past due 120,000 0

Additional accounts to be written off 30,000

Compute for the required allowance at year end.

1-30 days past due 1,200,000*5% 60,000

31-60 days past due 100,000*25% 25,000

61-90 days past due 150,000*50% 75,000

Over 90 days past due 120,000*0% 120,000

Required allowance 280,000

4. In the immediately preceding problem, compute for the doubtful accounts expense.

Allowance for Doubtful accounts, Beginning 170,000

Recoveries 30,000

Doubtful Accounts Expense (SQUEEZE) 345,000

Total 545,000

Less: Write off 265,000

Required allowance at year end 280,000

5. In the immediately preceding problem, compute for the net realizable value of accounts
receivable.

Not due 2,000,000

1-30 days past due 1,200,000

31-60 days past due 100,000

61-90 days past due 150,000

Over 90 days past due 120,000

Accounts Receivable 3,570,000

Less: Allowance for doubtful accounts 280,000

NRV 3,290,000

6. Bonet Company reported the following balances at year year-end:

Debit Credit

Accounts receivable 4,000,000

Allowance for doubtful accounts 10,000

Credit sales 5,500,000

The entity estimates doubtful accounts using 4% of gross accounts receivable. Compute for
required allowance during the year.

a. 150,000

b. 160,000

c. 159,600

d. 220,000

7. In the immediately preceding problem, what is the doubtful accounts expense?

a. 220,000

b. 160,000

c. 159,600

d. 150,000

8. Ga Lang Corporation provided the following information for the current year:

Accounts Receivable 500,000

Allowance for doubtful accounts – January 1 50,000

Sales 5,500,000

The entity recorded doubtful accounts expense at the rate of 5% of credit sales. 40% of sales are
cash sales.

How much is the credit sales of the corporation?

a. 3,300,000

b. 2,200,000

c. 3,000,000

d. 3,150,000
9. Using the information in problem 8, what is the amount of doubtful accounts expense?

a. 160,000

b. 110,000

c. 165,000

d. 163,000

10. Using the information in problem 8, what is the required allowance?

a. 215,000

b. 213,000

c. 160,000

d. 210,000

11. Using the percent of sales method, there is a proper matching of cost and revenue. TRUE

12. Both the percent of sales and percent of accounts receivable are income statement approach.
FALSE

13. Both the percent of sales and percent of accounts receivable are statement of financial
position approach. FALSE

14. Percent of sales determine doubtful accounts based on accounts past due. FALSE

15. Percent of Accounts receivable and Aging of accounts receivable would both yield doubtful
accounts expense. FALSE

16. In order to determine accounts past due, discount period is considered. FALSE
17. An account receivable with a credit term of 2/10, n/60 which is currently held by the entity
for 40 days is already 10 days past due. FALSE

18. Aging receivables is a method of establishing allowance for uncollectible accounts based on
outstanding receivables. TRUE

19. The following are James Company’s unadjusted trial balance at year end:

Accounts receivable 2,000,000

Allowance for Bad debts 16,000

Net Credit Sales 6,000,000

James estimates that 3% of the gross accounts receivable outstanding will become uncollectible.

After adjustments, what is the balance of allowance for bad debts?

a. 180,000

b. 164,000

c. 76,000

d. 60,000

20. Using the same information from no. 19, what is the amount of uncollectible accounts
expense?

a. 180,000

b. 164,000

c. 76,000

d. 60,000
 CHAPTER 6
NOTES RECEIVABLE

A note receivable is a written promise to receive a specific amount of cash from another
party on one or more future dates. This is treated as an asset by the holder of the note.
Overdue accounts receivable are sometimes converted into notes receivable, thereby giving
the debtor more time to pay, while also sometimes including a personal guarantee by the
owner of the debtor.

The payee is the party who receives payment under the terms of the note, and the maker is
the party obligated to send funds to the payee. The amount of payment to be made, as listed
in the terms of the note, is the principal . The principal is to be paid on the maturity date of
the note.

INITIAL MEASUREMENT

Short-term notes receivable is measured at face value and is not discounted. Conversely,
long-term notes receivable is measured initially at present value which is the sum of all
future cash flows discounted using the effective interest rate for the same or similar notes.

INTEREST BEARING NOTES

These notes are measured at face value or the present value upon issuance.

ILLUSTRATION
On January 1, 2019, Kaze Company sold to Haya Company a land costing P2,000,000, for
P3,000,000. Ryoga Co. paid P1,000,000 down and signed a two-year promissory note for the
balance plus 10% interest that will be compounded annually. The note matures at the beginning
of 2021.

Journal entries:

2019
Jan. 1 Cash P1,000,000
Notes receivable P2,000,000
Land P2,000,000
Gain on sale of land P1,000,000
Dec. 31 Accrued interest receivable P200,000
Interest income P200,000
(P2,000,000*10%)
2020
Dec. 31 Accrued interest receivable P220,000
Interest income P220,000
 (P2,200,000*10%)
2021
Jan. 1 Cash P2,220,000
Notes receivable P2,000,000
Accrued interest receivable P220,000

NON-INTEREST BEARING NOTE

These notes are measured at present value or the discounted value of the future cash flows
using the effective interest rate. “Non-interest bearing” does not mean that it does not have
any interest. It simply means that the interest is already included in the face amount of the
note.

ILLUSTRATION (1)
Ichibi Company is a manufacturing company. On January 1, 2019, it sold a machinery costing
P200,000 for P300,000. The buyer signed a non-interest bearing note for P300,000 to be paid in
four equal installments every year-end. The cash selling price of the machinery is P250,000.

Face value of note P300,000

Present value (cash selling price) P250,000
Unearned interest income P 50,000 Journal entries for the
current year:
Selling price P250,000
To record
Cost the sale:
of machinery P200,000
Notes receivable
Gross income P300,000 P 50,000
Sales P250,000
Unearned interest income P 50,000

To record the first installment collection:

Cash P75,000
Note receivable P75,000

To recognize the unearned interest as income:

Unearned interest income P20,000
Interest income P20,000

Computation of interest income:

Notes receivable Fraction Interest income
2019 300,000 4/10 (50,000*4/10) = 20,000
2020 225,000 3/10 (50,000*3/10) = 15,000
2021 150,000 2/10 (50,000*2/10) = 10,000
2022 75,000 1/10 (50,000*1/10) = 5,000
750,000 50,000
ILLUSTRATION (2)
On January 1, 2019, Anime Company sold to Cartoons Company an equipment costing P500,000
for P750,000. Cartoons Company paid P150,000 as down payment and signed a non-interest
bearing note for P600,000 that is payable in three equal installment of P200,000 every year-end.
Prevailing interest rate for similar notes 10%
PV of an ordinary annuity of 1 at 10% for 3 periods 2.4869

Computation:
Face value of note 600,000
Present value (P200,000*2.4869) 497,380
Unearned interest income 102,620

Present value of note 497,380

Cash received 150,000
Sales price 647,380
Cost of equipment 500,000
Gain on sale of equipment 147,380

Date Annual Interest Principal Present Value

Collection Income
1/1/2019 497,380
12/31/2019 200,000 49,738 150,262 (497,380-150,262)
(497,380*10%) (200,000-49,738) 347,118
12/31/2020 200,000 34,712 165,288 (347,118-165,288)
(347,118*10%) (200,000-34,712) 181,830
12/31/2021 200,000 18,170 181,830 0

Journal entries for the current year:

To record the sale:
Cash P150,000
Notes receivable P600,000
Equipment P500,000
Gain on sale of equipment P147,380
Unearned interest income P102,620

To record the first installment collection:

Cash P200,000
Note receivable P200,000
To record the interest income:
Unearned interest income P49,738
Interest income P49,738

SUBSEQUENT MEASUREMENT
Long-term notes receivable are measured at amortized cost which is will be discussed in
the succeeding chapter.
PROBLEMS

On January 1, 2019, Naruto Company sold to Sasuke Company a land costing P2,500,000 for
P3,500,000.

Sasuke Co. paid P500,000 as down payment and signed a two-year promissory note for the
balance plus 12% interest that will be compounded annually. The note matures at the beginning
of 2021.

1. What is the interest income on 2019?

A. P300,000
B. P360,000 (P3,000,000*12%)
C. P403,200
D. P420,000
2. What is the interest income on 2020?

A. P300,000
B. P360,000
C. P403,200 (P3,360,000*12%)
D. P420,000
3. What is the amount of cash to be received on 2021?

A. P3,000,000
B. P3,763,200 (P3,000,000+P360,000+P403,200)
C. P3,720,000
D. P3,360,000

Kyubi Company manufactured and sold a machinery costing P400,000 for P500,000. The buyer
signed a non-interest bearing note for P500,000 to be paid in four equal installments every year-
end. The cash sale price of the machinery is P450,000.

4. What is the interest income on 2019?

A. P50,000
B. P20,000
C. P15,000
D. P12,500
5. What is the interest income on 2020?

A. P50,000
B. P20,000
C. P15,000
 D. P12,500

6. What is the interest income on 2021?

A. P15,000
B. P10,000
C. P5,000
D. P50,000
7. What is the interest income on 2022?

A. P15,000
B. P10,000
C. P5,000
D. P50,000
Computation (Items 4-7):

Face value of note P500,000

Present value (cash sale price) P450,000
Unearned interest income P 50,000

Notes receivable Fraction Interest income

2019 500,000 4/10 (50,000*4/10) = 20,000
2020 375,000 3/10 (50,000*3/10) = 15,000
2021 250,000 2/10 (50,000*2/10) = 10,000
2022 125,000 1/10 (50,000*1/10) = 5,000
1,250,000 50,000

Uchiha Company is a dealer in equipment and machineries. On December 31, 2019, the entity
sold an equipment in exchange for a non-interest bearing note requiring five annual payments of
P300,000. The first payment was made on December 31, 2020.

Market interest rate for similar notes 8%

PV of 1 at 8% for 5 periods 0.68
PV of an ordinary annuity of 1 at 8% for 5 periods 3.99

8. What is the carrying amount of the note receivable on December 31, 2019?
A. P1,020,000
B. P1,500,000
C. P1,197,000 (P300,000*3.99)
D. P1,200,000
9. What amount of interest income should be reported for 2020?
 A. P81,600
B. P120,000
C. P95,760 (P1,197,000*8%)
D. P96,000
K Company sold an equipment costing P400,000 which had a carrying amount of P250,000 on
January 1, 2019. During the same day, the company received P75,000 down payment and a
P300,000 non-interest bearing note due on January 1, 2022.

There was no established exchange price for the equipment and the note had no ready market.

Prevailing interest rate for a note of the same type at January 1, 2019 12%
PV of 1 at 12% for 3 periods 0.7118

10. What is the present value of the note on January 1, 2019?

A. P213,540
B. P239,165
C. P300,000
D. P375,000
11. What amount of interest income should be reported on January 1, 2019?

A. P36,000
B. P28,700
C. P25,625 (P213,540*12%)
D. 0
What is the present value of the note on December 31, 2019?

A. P213,540
B. P239,165
C. P300,000
D. P375,000
12. What amount of interest income should be reported on December 31, 2019?

A. P36,000
B. P28,700
C. P25,625
D. 0
13. What is the present value of the note on December 31, 2020?

A. P213,540
B. P267,865
C. P300,000
 D. P375,000
14. What amount of interest income should be reported on December 31, 2020?

A. P36,000
B. P28,700
C. P25,625
D. 0
15. What is the present value of the note on December 31, 2021?

A. P225,000
B. P250,000
C. P300,000
D. P375,000
16. What is the amount of cash received on January 1, 2019?

A. P0
B. P50,000
C. P75,000
D. P100,000
17. What is the amount of cash to be received on December 31, 2019?

A. P0
B. P50,000
C. P75,000
D. P100,000
18. What is the amount of cash to be received on December 31, 2021?

A. P300,000
B. P225,000
C. P450,000
D. P0

Computation (Items 10-18):

Face value of the note 300,000

Present value (P300,000*.7118) 213,540
Unearned interest income 86,460

Present value 213,540

Cash received 75,000
Sales price 288,540
Carrying amount 250,000
 Gain on sale of equipment 38,540

Date Interest income Unearned interest PV

1/1/2019 86,460 213,540
12/31/2019 (213,540*12%) 25,625 (86,460-25,625) 60,835 (213,540+25,625) 239,165
12/31/2020 (239,165*12%) 28,700 (60,835-28,700) 32,135 (239,165+28,700) 267,865
12/31/2021 (balancing figure) 32,135 (32,135-32,135) 0 (267,865+32,135) 300,000
19. Ryoma Company sold to Ryoga Company on January 1, 2019 a land costing P5,000,000 for
P6,500,000. Ryoga Co. paid a down of P1,000,000 and signed a two-year promissory note for
the remaining balance plus 12% interest that will be compounded annually. The note matures on
January 1, 2021.

Requirement: Prepare journal entries for 2019, 2020, and 2021.

Journal entries:
2019
Jan. 1 Cash P1,000,000
Notes receivable P5,500,000
Land P5,000,000
Gain on sale of land P1,500,000
Dec. 31 Accrued interest receivable P660,000
Interest income P660,000
(P5,500,000*12%)
2020
Dec. 31 Accrued interest receivable P739,200
Interest income P739,200
(P6,160,000*12%)
2021
Jan. 1 Cash P6,899,200
Notes receivable P5,500,000
Accrued interest receivable P1,399,200

20. On January 1, 2019, Tanaka Company sold to Mabuchi Company an equipment costing
P500,000 for P750,000. Mabuchi Company paid P150,000 as down payment and signed a non-
interest bearing note for P600,000 that is payable in three equal installment of P200,000 every
year-end.

Prevailing interest rate for similar notes 12%

PV of an ordinary annuity of 1 at 12% for 3 periods 2.4018

Requirement: Prepare journal entries for 2019, 2020, and 2021.

Journal entries:
2019
Jan. 1 Cash P150,000
Notes receivable P600,000
Equipment P500,000
Gain on sale of equipment P130,360
Unearned interest income P119,640
Dec. 31 Cash P200,000
Notes receivable P200,000
Unearned interest income P57,643
Interest income P57,643
2020
Dec. 31 Cash P200,000
Notes receivable P200,000
Unearned interest income P40,560
Interest income P40,560
2021
Dec. 31 Cash P200,000
Notes receivable P200,000
Unearned interest income P21,437
Interest income P21,437

Computation:

Face value of note 600,000

Present value (P200,000*2.4018) 480,360
Unearned interest income 119,640

Present value of note 480,360

Cash received 150,000
Sales price 630,360
Cost of equipment 500,000
Gain on sale of equipment 130,360

Date Annual Interest Principal Present Value

Collection Income
1/1/2019 480,360
12/31/2019 200,000 57,643 142,357 338,003
(480,360*12%) (200,000-57,643) (480,360-142,357)
12/31/2020 200,000 40,560 159,440 178,563
(338,003*12%) (200,000-40,560) (338,003-159,440)
12/31/2021 200,000 21,437 178,563 0
CAHPTER 7

LOANS RECEIVABLE
Loan Receivable

Loan receivable is a financial asset in the form of loan given by a bank or other financial
institutes to a borrower. The term of the loan may be classified as short-term but usually it is
long-term receivable.

Initial Measurement of Loan Receivable

At initial recognition, an entity shall measure a financial asset at Fair Value plus transaction cost
that are directly attributable to the acquisition of the financial asset.

However, if the financial asset is measured at fair value through profit or loss the transaction
cost directly attributable to the acquisition of the financial asset are expensed outright.(PFRS 9,
paragraph 5.1.1)

Loans receivable is financial asset not measured at fair value through profit or loss. Hence it
should be initially measured at fair value plus transaction cost directly attributed to the
acquisition of financial asset.

The fair value of the loan receivable at initial recognition is normally the transaction price, which
is the amount of the grated loan.

The transaction costs directly attributed to the acquisition of loan receivable include Direct
origination cost.

Indirect origination costs on the other hand are treated as outright expense.

Subsequent Measurement of Loan Receivable

After the initial measurement, the financial asset shall be measured at:

a. Fair value through profit or loss (FVPL)

b. Fair value through other comprehensive income (FVOCI)
c. Amortized cost

The method of measurement depends on the business model of managing the financial asset
which may be to realize fair value changes and to collect contractual cash flows. (PFRS 9,
paragraph 5.2.1)

If the business model is to hold the financial asset in order to collect contractual cash flows on
specified date and the contractual cash flows are solely payment of principal and interest, the
financial asset shall be measured at Amortized cost.(PFRS 9, paragraph 4.1.2)
Hence, a loan receivable is subsequently measured at amortized cost using the effective interest
rate method.

Amortized cost

The amortized cost is the initial measurement of loan receivable less/minus principal payment,
plus or minus cumulative amortization of any difference of initial carrying amount to the
principal maturity amount and minus impairment loss or uncollectibility.

If the initial amount recognized is lower than the principal amount, the amortization of the
difference is added to the carrying amount. If the initial amount is higher the amortization is
deducted to the carrying amount.

Origination Fees

The origination fees are fees charge by bank against the borrower. It’s a compensation of the
bank for the creation of the loan.

The origination fees are derived from the following activities:

1. Evaluation of collateral and security

2. Negotiation of the terms of the loan
3. Processing of the documents required
4. Evaluation of borrower’s financial condition

Treatment for origination fees

The origination cost received from the borrowers or clients are recognized as unearned interest
income and will be amortized over the term of the loan.

There are origination fees that are not chargeable against the borrower. These are fee are define
as “direct origination costs”. Direct origination costs are cost incurred by the bank and not
received from the borrower.

Direct origination costs are also amortized over the term of the loan.

The origination fee received and the direct origination costs incurred are included in the
measurement of the loan receivable’s carrying amount.

If the direct origination cost exceeds the origination fees received, the difference is charged to
“direct origination cost, the amortization will decrease the interest income.

However, if the origination fee is higher than the direct origination costs, the interest income will
increase and the difference of the two is recorded as unearned interest income.
Illustration

Smart Bank granted a 3-year loan to a borrower on January 1, 2020. The interest of the loan is
10% and payable annually starting December 21, 2020. The loan matures on December 31, 2022.

Principal amount 4,000,000

Origination fee received 302,100
Direct origination costs incurred 104,000
Indirect origination costs incurred 30,000

Initial measurement of the loan

Principal amount 4,000,000
Direct origination costs 110,000
Origination cost 302,100
Carrying amount 3,807,900

Note: the indirect origination costs are expense outright.

Journal entries on January 1, 2020

1. Recording of the loan
Loan receivable 4,000,000
Cash 4,000,000

2. To record origination fee received

Cash 302,100
Unearned interest income 302,100

3. To record the direct origination costs

Unearned Interest income 110,000
Cash 110,000

The origination fee exceeds the amount of direct origination cost. Thus, there is an unearned
interest income of P192,100 (302,100 – 110,000).

A new effective interest rate must be computed, because of origination fees received and the
direct origination costs incurred.

After consideration of the direct origination costs and origination fees received, the effective rate
is 12%. Since the initial carrying amount of the loan is lower than the principal amount the
effective rate should be higher than the nominal rate because of discount of the loan.
Amortization table effective interest method

Interest
Receivabl Interest Carrying
Date e Income Amortization Amount
3,807,90
1-Jan 2020 0
3,864,84
31-Dec 2020 400,000 456,948 56,948 8
3,928,63
31-Dec 2021 400,000 463,782 63,782 0
4,000,00
31-Dec 2022 400,000 471,370 71,370 0

Note: there is a difference of P65 because of rounding the PV.

Interest received = Principal x nominal interest rate

Interest income = Carrying amount x effective interest rate
Amortization = Interest received – interest income
Carrying amount = Beginning carrying amount (prior year) + amortization

Note: Since the carrying amount is lower than the principal amount, the amortization should be
added.

Journal entries – December 31, 2020

Cash 400,000
Interest income 400,000

Unearned interest income 56,948

Interest income 56,948

December 31, 2021

Cash 400,000
Interest income 400,000

Unearned interest income 63,782

Interest income 63,782
December 31 ,2022

Cash 400,000
Interest income 400,000

Unearned interest income 71,370

Interest income 71,370

On December 31, 2020’s statement of financial position, the loan receivable is presented at
amortized cost.

Loan Receivable 4,000,000

Unearned interest income (192,100 - 56,948) 135,152
Carrying amount- December 31, 2020 3,864,848

Impairment loss

There is a possibility that the issuer of the loan will not be able to collect some or even all the
amount of loan receivable due to borrower’s incapacity to pay (credit risk). If this happens, the
loan receivable is impaired.

According to the standards, an entity shall measure the loss allowance for a financial instrument
at an amount equal to the lifetime expected credit losses if the credit risk on the financial
instrument has increased significantly since initial recognition. (PFRS 9, 5.5.3)

Credit losses occur because of the credit risk, it is the loss on the uncollectible payments of the
borrower.

In measuring the credit loss, the entity should consider the probability-weighted outcome, the
time value of money and reasonable information. Any information, internally or externally are
can be used on measuring the expected credit losses.

The impairment loss amount is the difference of the carrying amount to the present value of
estimated future cash flows discounted at original effective interest rate. The loans receivable’s
carrying amount shall be deducted using either direct method or with allowance account.
Illustration

Sugar bank granted five year loan of P10,000,000 to Pepper company on January 1, 2020. The
terms require principal payment of P2,000,000 every year with interest of 10%, starting on
December 31, 2020.

On December 31, 2020 and December 31, 2021, Pepper Company made the required payments.

Unfortunately, Pepper Company was unable to make the required payments on December 31,
2022 because of weak financial condition of the company due to low revenue during year 2022.

After sugar bank assessed the collectability of the loan on December 31, 2022, the bank
determined that the remaining principal will be collected; however, the interest payments will not
be collected.

On December 31, 2022, the loan receivable has a P6,600,000 carrying amount including the
accrued interest of P 600,000.

The projected cash flow from the loan on December 31, 2022

December 31, 2023 1,000,000

December 31, 2024 2,000,000
December 31, 2025 3,000,000

Present value of 1 at 10%

For one period .91
For two periods .83
For three periods .75

Computation of present value cash flow

December 31, 2023 (1,000,000 x .91) 910,000

December 31, 2024 (2,000,000 x .83) 1,660,000
December 31, 2025 (3,000,000 x .75) 2,250,000
Total present value of cash flow 4,820,000

Computation of impairment loss

Carrying amount of the loan 6,600,000

Present value of cash flow 4,820,000
Impairment loss 1,780,000

Journal entry on December 31, 2022

Loan impairment loss 1,780,000

Accrued interest receivable 600,000
Allowance for loan impairment 1,180,000

Note: since the interest is uncollectible, the accrued interest receivable should be credited
directly.

Computation of carrying amount-December 31, 2022

Loan receivable 6,000,000

Allowance for loan impairment (1,180,000)
Carrying amount – December 31, 2022 4,820,000

December 31, 2023

* To record the collection of cash
Cash 1,000,000
Loan receivable 1,000,000
*To record the interest
Allowance for loan impairment 482,000
Interest income 482,000

Interest income (4,820,000 x 10%) = 482,000

Note: The interest income is charge against the allowance of impairment.

December 31, 2024

* To record the collection of cash
Cash 2,000,000
Loan receivable 2,000,000
*To record the interest
Allowance for loan impairment 430,200
Interest income 430,200

Computation of interest income:

Loan receivable – December 31, 2023 5,000,000
Allowance for loan impairment (1,180,000 – 482,000) (698,000)
Carrying amount – December 31, 2023 4,302,000
Original Effective interest rate x10%
Interest income 430.200

December 31, 2025

* To record the collection of cash

Cash 3,000,000
Loan receivable 3,000,000
*To record the interest
Allowance for loan impairment 267,800
Interest income 267,800

Computation of interest income:

Loan receivable – December 31, 2023 3,000,000
Allowance for loan impairment (698,000 – 430,200) (267,800)
Carrying amount – December 31, 2023 2,732,200
Original Effective interest rate x10%
Interest income 273.220

Note: there is a difference in interest income due to rounding of the PV factor.

Three stage impairment approach

Stage 1 – it covers debt instrument that have low credit risk. Under this stage 12-month expected
credit loss is recognized.

12-month expected credit loss is the portion of the lifetime expected credit loss from default
event within 12 months after reporting period.

Stage 2 – it covers debt instrument that have declined significantly but do not have evidence of
impairment. Lifetime expected credit loss is recognized under this stage.

Lifetime expected credit loss is the expected credit loss resulting from all default events over
the expected life of the debt instrument. It is measured for trade receivable using aging method,
percentage of receivable and percentage of sales.

Stage 3 – it covers debt instrument with evidence of impairment. Lifetime expected credit loss is
recognized.

Computation of interest income

Under stages 1 and 2 the interest income is based on face amount.

Interest income = Face amount x interest rate

Under stage 3 the interest income is based on net carrying amount.

Net carrying amount = Face amount – allowance for credit loss.

Interest income = Net carrying amount x interest rate

Multiple choice Theories

1. Which statement is true about the loan receivable?

a. Loan receivable is initially measured at fair value plus transaction cost directly
attributed to the acquisition of the loan.
b. Direct origination cost and origination fees are included in measurement of loan
receivable.
c. Indirect origination costs are expense outright.
d. All of the above
2. Which is true about subsequent measurement of loan receivable?
a. The loan receivable is subsequently measured at amortized cost.
b. The loan receivable is subsequently measured at fair value through profit or loss
c. The loan receivable is subsequently measured at fair value through other
comprehensive income.
d. None of the above.
3. What are the fees charges by bank against the borrower for creation of the loan?
a. Direct origination costs
b. Indirect origination costs
 c. Origination fees
d. None of the above
4. The possibility of loss resulting from the failure of borrower to meet the contractual
obligation is called?
a. Credit losses
b. Credit risk
c. Estimated credit losses
d. None of the above.
5. Which is considered in measuring the credit loss
a. The probability-weighted outcome
b. The time value of money
c. Reasonable and supportable information
d. All of the above

True or False

1. Direct origination cost is not included in the transaction cost directly attributed to the
acquisition of the loan. False
2. There is an accrued interest if the direct origination costs exceed the origination fees
received. False
3. Indirect origination costs on the other hand are treated as outright expense. True
4. If the initial amount recognized is lower than the principal amount, the amortization of
the difference is added to the carrying amount. True
5. If the initial amount is lower than the principal amount, the computed effective interest
rate should be higher than the nominal rate. True

Problem 1

On January 1, 2019 Piggy Bank granted a loan to an individual barrower, with 10% interest
payable annually. The loan matures in four years on December 31, 2022.

Principal 5,000,000
Direct origination cost 169,300
Origination fee charged against the borrower 340,500

After considering the direct origination cost and the origination fees, the effective rate on the
loan is 12%

Requirements:

1. Prepare the necessary journal entries on the year 2019, 2020, 2021, and 2022.
Problem 2

Fleck Company borrowed a loan to Wayne Bank amounting to P3,300,000 on January 1, 2018
with a stated interest rate of 8% payable annually. The term of the loan is three years.

Wayne Bank incurred P150,000 of direct origination cost and P50,000 indirect origination cost,

In addition, Wayne Bank charged Fleck Company an origination fee amounting to P 280,000.

The effective interest rate is 10%.

Requirements:

1. What is the initial carrying amount of the loan receivable to be recognized in January 1,
2018?
a. 3,300,000
b. 3,175,000
c. 3,343,000
d. 3,430,000
2. What amount should be reported as interest income for 2018?
a. 264,000
b. 330,000
c. 317,500
d. 254,000

Solutions

1. Answer B
Principal amount 3,300,000
Direct origination cost incurred 150,000
Origination cost received (280,000)
Carrying amount 3,175,000
2. Answer C
Carrying amount 3,175,000
Effective rate x10%
Interest income 317,500

Problem 3

Rich Bank granted a loan to a borrower on January 1, 2020. The loan has an interest rate of 8%
payable annually starting December 31, 2020. The maturity of the loan is on December 31, 2023.

Principal amount 4,400,000

Origination fee 130,000
Direct origination cost 370,000

After the consideration of direct origination cost and origination fee, the effective rate on the
loan is 6%.

1. What is the initial carrying amount of the loan receivable?

a. 4,640,000
b. 4,400,000
c. 4,259,700
d. 4,000,000
2. What amount should be recorded as interest income for 2020?
a. 362,000
b. 264,000
c. 255,582
d. 278,400
3. What is the carrying amount of the loan receivable on December 31, 2020?
a. 4,566,400
b. 4,400,000
c.4,640,000
d. 4,000,000
Solutions
1. Answer A
Direct origination cost 370,000
Origination fee received (130,000)
Net direct origination cost 240,000
Principal amount 4,400,000
Carrying amount of loan receivable 4,640,000
2. Answer A
Carrying amount 4,640,000
Effective interest rate x6%
Interest income 2020 278,400
3. Answer A
Interest income 2020 (278,400)
Interest received 2020 352,000
Amortization (73,600)
Carrying amount January 1, 2020 4,640,000
Carrying amount December 31, 2020 4,566,400

Problem 4
On January 1, 2021, Poor Bank granted a loan to a client with a 12% interest rate payable
annually starting December 31, 2021. The term of the loan is three years.
Principal amount 4,000,000
Direct origination cost incurred 144,000
Origination fee received 330,000
Indirect origination cost incurred 60,000

After considering the origination fee and direct origination cost, the effective interest rate is 14%.
1. What is the initial carrying amount of the loan receivable?
a. 4,186,000
b. 4,000,000
c. 3,814,000
d. 3,754,000
2. What is the interest income for 2021?
a. 480,000
b. 560,000
c. 533,960
d. 457,680
3. What is the carrying amount of the loan receivable on December 31, 2021?
a. 4,000,000
b. 3,814,000
c. 3,867,960
d. 3,754,000
Solutions
1. Answer C
Principal amount 4,000,000
Direct origination cost 144,000
Origination fee received 330,000
Carrying amount-January 1, 2021 3,814,000
2. Answer C
Carrying amount-January 1, 2021 3,814,000
Effective interest rate x14%
Interest income 2021 533,960
3. Answer C
Interest income 2021 533,960
Interest received 2021 (480,000)
Amortization 53,960
Carrying amount January 1, 2020 3,814,000
Carrying amount December 31, 2020 3,867,960

Problem 5
On January 1, 2019, Better Bank provides a loan to a client with. The loan has a 10% interest
rate payable annually that will start on December 31, 2021. The loan matures in four years.

Principal amount 3,350,000

Direct origination cost incurred 315,000
Origination fee received 140,000
Indirect origination cost incurred 40,000

After considering the origination fee and direct origination cost, the effective interest rate is 8%.
4. What is the initial carrying amount of the loan receivable?
a. 3,525,000
b. 3,350,000
c. 3,485,000
d. 3,175,000
5. What is the interest income for 2020?
a. 335,000
b. 282,000
c. 330,000
d. 277,760
6. What is the carrying amount of the loan receivable on December 31, 2020?
a. 3,414,760
b. 3,525,000
c. 3,175,000
d. 3,000,000
Solutions
1. Answer A
Direct origination cost 315,000
Origination fee received (140,000)
Net direct origination cost 175,000
Principal amount 3,350,000
Carrying amount of loan receivable 3,525,000
2. Answer D
3. Answer A
Interest
Receivabl Interest Carrying
Date e Income Amortization Amount
3,525,00
1-Jan 2019 0
3,472,00
31-Dec 2019 335,000 282,000 53,000 0
31-Dec 2020 335,000 277,760 57,240 3,414,76
 0

Problem 6

Bruce Bank grated a loan to a borrower on January 1, 2018 amounting to 10,000,000 with annual
interest of 8%. The terms of the loan require principal payment of P2,000,000 each year for 5
years plus the interest. The first payment is due on January 1, 2019

The borrower made the required payments on January 1, 2019 and 2020. Unfortunately, during
year 2019 the borrower experienced financial difficulties.

After the bank reassesses the collectability of the loan on December 31, 2020, the bank
determined that the remaining principal will be collected but the interests are not. The bank did
not accrue the interest for 2020.

The present value of 1 at 8%:

For one period 0.93

For two period 0.86
For three period 0.79

Requirements:

1. What is the amount of impairment loss on 2020?

a. 500,000
b. 420,000
c. 480,000
d. 400,000

Solutions

1. Answer B
January 1, 2021 (1 x 2,000,000) 2,000,000
January 1, 2022 (.93 x 2,000,000) 1,860,000
January 1, 2023 (.86 x 2,000,000) 1,720,000
Present value of loan 5,580,000

Loan receivable 6,000,000

Present value of loan (5,580,000)
Impairment loss 420,000

Problem 7
On December 31, 2020, Best Bank has a loan receivable to a borrower amounting to P2,500,000
with 10% interest rate payable annually. The loan matures on December 31, 2024.

However, the borrower experienced financial difficulties and will have hard time paying the
necessary payments.

The bank estimated that the entire principal will be paid at the maturity and 5% interest will be
paid annually of the next 4 years. The bank did not accrue an interest in December 31, 2020.

The PV of 1 at 10% for 4 periods is .68, and the present value of ordinary annuity at 10% for
four periods is 3.17

1. What is the amount of impairment loss of the loan?

a. 0
b. 443,300
c. 500,000
d. 403,750
2. What amount should be recorded as interest income for 2021?
a. 209,625
b. 250,000
c. 200,000
d. 220,000
3. What is the carrying amount of the loan receivable on December 31, 2021?
a. 2,096,250
b. 2,180,875
c. 2,500,000
d. 2,000,000

Solutions

1. Answer D
Present Value of Principal (2,500,000 x .68) 1,700,000
Present Value of Interest (125,000 x 3.17) 396,250
Total present value 2,096,250
Carrying amount (2,500,000)
Impairment loss 403,750

Interest (2,500,000 x 5%) = 125,000

2. Answer A
Interest income for 2021 (2,096,250 x 10%) 209,625
Interest Received (2,500,000 x 5%) (125,000)
Amortization of Impairment loss 84,625
3. Answer B
 Present value 2,096,250
Amortization of impairment loss 84,625
Carrying amount 2021 2,180,875

Problem 8
On December 31, 2019, Stark Bank has a 4-year loan receivable with face value of P7,000,000
dated January 1, 2018 that is due on December 31, 2020, the interest is payable at 10% every
year.

On December 31, 2017, the borrower was able to pay the interest due. However he informed the
bank that the accrued interest in 2019 will be paid at the maturity date.

After reassessing the collectability the bank determined that there is a high probability that the
remaining interest payment will not be collected because of financial difficulty of the borrower.

The PV of 1 for three periods is .75

1. What is the amount of impairment loss for 2019?
a. 0
b. 2,000,000
c. 1,925,000
d. 1,950,000
Solutions
1. Answer C
Loan receivable 7,000,000
Accrued interest receivable (7,000,000 x 10%) 700,000
Carrying amount 7,700,000
Present value (7,700,000 x .75) (5,775,000)
Impairment loss 1,925,000

Problem 9
Arthur Bank has a loan receivable of 3,000,000 from a borrower on December 31, 2019. The
loan’s carrying at face value and is due on December 31, 2023. The interest is payable at 9%
each December 31.
The interest due on December 31, 2019 was paid by the borrower but informed the bank that it
would miss the next year interest payment.

The borrower is expected to resume the payments of annual interest but the payment of the
principal will be late by one year, with interest paid for that additional year at the time of
principal payment.

The PV of 1 at 9% is:
For two periods .84
For three periods .77
For four periods .71
For five period .65

1. What is the loan impairment loss for 2019?

a. 270,000
b.0
c. 252,100
d. 248,100
Solution
1. Answer D
December 31, 2020 No payment of interest
December 31, 2021 Interest (3,000,000 x 9%) 270,000 x.84 = 226,800
December 31, 2022 Interest (3,000,000 x 9%) 270,000 x.77 = 207,900
December 31, 2023 Interest (3,000,000 x 9%) 270,000 x.71 = 191,700
December 31, 2024 Interest/principal (3,000,000 x 1.9) 3,270,000 x.65 = 2,125,500
Present Value of loan 2,751,900

Loan Receivable 3,000,000

Present value 2,751,900
Impairment loss 248,100

Problem 10

On January 1, 2020 Rogers Bank has a loan receivable from a borrower amounting to
P15,000,000 with interest rate of 8%. The borrower is required to pay principal of P3,000,000
annually plus the interest.

On the year 2020 and 2021, the borrower made the required payments but on year 2022 the
borrower’s financial condition is weak and will have a difficult time on making payments,
requiring the bank to reassess.

On year end 2022 the bank has determined that the remaining principals are collectable.
However, the interest payments are unlikely. The bank has accrued the interest for 2022.

The expected principal payments:

December 31, 2022 2,000,000

December 31, 2023 3,000,000
December 31, 2024 4,000,000
Present Value of 1 at 8%
For one period 0.93
For two period 0.86
For three period 0.79

Requirement:
1. What is the amount of impairment loss?
a. 2,110,000
b. 2,500,000
c. 2,120,000
d. 0
2. What is the carrying amount of the loan on year 2022?
a. 8,439,210
b. 9,000,000
c. 7,600,000
d. 8,350,330
Solutions
1. Answer C
December 31, 2022 (2,000,000 x .93) 1,860,000
December 31, 2023 (3,000,000 x .86) 2,580,000
December 31, 2024 (4,000,000 x .79) 3,160,000
Present value of loan 7,600,000

Carrying amount (9,000,000 x 1.08) 9,720,000

Present value of loan (7,600,000)
Impairment loss 2,120,000
2. Answer C
Loan receivable 9,000,000
Allowance for impairment (2,120,000 – 720,000) 1,400,000
Carrying amount 2022 7,600,000

.
Chapter 8

RECEIVABLE FINANCING

Pledge, assignment and factoring

Receivable financing

Receivable financing is the capability to raise money out of its receivable. The financing of
receivable occurs when an entity experienced financial difficulties due to business decline.

Because of weak financial condition, the receivables of an entity are used in payments of its
obligation or liabilities.

Common forms of receivable financing.

1. Pledging of account receivable

2. Assignment of account receivable
3. Factoring of account receivable
4. Discounting of notes receivable

Pledge of account receivable

Pledge of account receivable is a form of receivable financing in which an entity uses or pledged
its existing account receivable as collateral to secure the payment of the loan.

The collection of the pledge account receivable is normally done by the borrower but may be
required to turn over the collection to the bank.

The recognition of the loan is done by debiting the cash and discount on note payable if the loan
is discounted and crediting the note payable.

Illustration

On July 1, 2020, Lopez company borrowed P1,500,000 from a Bank and issued promissory note
for the loan.

The loan is discounted at 10% and it matures in one year. The Company pledged its account
receivable amounting to P2,000,000 as collateral for the loan.

Journal entry – July 1, 2020

Cash 1,350,000
Discount on notes payable 150,000
Note payable – bank 1,500,000
Note: There is no entry in the pledging of account receivable

The term discounted means that the interest is deducted from the loan in advance.

On December 31, 2020’s statement of financial position the note payable is presented follows:

Note payable – bank 1,500,000

Discount on note payable (150,000 – 75,000) (75,000)
Carrying amount 1,425,000
The discount on note payable must be amortized as an interest expense for 6 months from July 1
to December 31.

Interest expense (150,000 x 6/12) 75,000

Discount on note payable 75,000

July 1, 2020 journal entry

*Payment of the loan

Note payable – bank 1,500,000
Cash 1,500,000
*amortization of discount on notes payable

Interest expense 75,000

Discount on notes payable – bank 75,000

Assignment of account receivable

Assignment of account receivable is a more formal type of pledging of account receivable,

wherein the borrower (assignor) transfers the rights in some account receivable to a lender
(assignee) as collateral security for the loan.

Distinction of assignment and pledged

Pledge Assignment
*Less formal type *More formal type
*General *Specific

Pledge is general because all the account receivable serves as collateral.

Assignment is specific for the reason that it on assign specific account receivable as collateral for
the loan.
The assignment is recorded by debiting the “Accounts receivable – assigned” and crediting the
accounts receivable.

Notification and Non-notification basis

Notification and non-notification basis are two ways on assigning account receivable.

Notification basis Non-notification basis

*The customers are notified that their account *The customers are not aware of the
were assigned assignment of the account.
*the obligation to collect is still in the
*The collections will go directly to the assignee assignor side but later remits the collection
to the assignee
Illustration – Notification basis

Transactions

January

1 Coffee company assigned P2,000,000 of its account receivable to a bank. The bank loans 85%
minus bank charge of 5% on gross amount of accounts receivable assigned.

The company signed a promissory note with 2% interest of the unpaid loan balance per month.

31 The company receive notice from the bank that P1,000,000 of assigned account were
collected and 2% discount. The company made the payment of interest due.

February

31 The company receive notice from the bank that P900,000 of assigned account were collected.
Final settlement was made by the bank for excess collection and uncollectible accounts assigned
of P100,000.

Journal Entries

January 1

*To assign account receivable.

Accounts receivable- assigned 2,000,000
Accounts receivable 2,000,000

*To record the loan.

Cash 1,600,000
Service charge (2,000,000 x 5%) 100,000
Note Payable – bank (2,000,000 x 85%) 1,700,000

January 31

*To record Accounts assigned collection

Note payable – bank 980,000
Sales Discount (1,000,000 x 2) 20,000
Accounts receivable – assigned 1,000,000

*To record interest payment

Interest expense (1,700,000 x 2%) 34,000
Cash 34,000

February 28

*To record collection, excess collection and interest expense.

Cash 165,600
Interest expense (720,000 x 2) 14,400
Note payable – bank (1,700,000 – 980,000) 720,000
Accounts receivable – assigned 900,000

*To record uncollected assigned account

Accounts receivable 100,000
Account receivable – assigned 100,000

Illustration - Non-notification basis

January

1 Coffee company assigned P2,000,000 of its account receivable to a bank. The bank loans 85%
minus bank charge of 5% on gross amount of accounts receivable assigned.

The company signed a promissory note with 2% interest of the unpaid loan balance per
month.

6 Issued credit memo to a customer whose account was assigned for return of damaged
merchandise amounting to P50,000.

15 the company collected P1,000,000 of the assigned account less discount of 2%

31 the company remitted the collection of the assigned account to the bank plus the interest
payment for one month.

February

2 The company determined that P20,000 of the assigned account is uncollectible or worthless.

22 Collected P900,000 of the assigned account.

28 Remitted the amount due for the loan balance plus the monthly interest.

Journal Entries

January 1

*To assign account receivable.

Accounts receivable- assigned 2,000,000
Accounts receivable 2,000,000

*To record the loan.

Cash 1,600,000
Service charge (2,000,000 x 5%) 100,000
Note Payable – bank (2,000,000 x 85%) 1,700,000

January 6

*To record the sales return and allowances

Sales return
Account receivable – assigned

January 15

*To record the collection of assigned account

Cash 980,000
Sales Discount (1,000,000 x 2%) 20,000
Account receivable – assigned 1,000,000

January 31

*To record the remittance of the collection plus the interest

Note payable – bank 980,000
Interest expense (1,700,000 x 2%) 34,000
Cash 1,014,000
February 2

*To record the write off

Allowance for doubtful account 20,000
Accounts receivable – assigned 20,000

February 22

*To record collection

Cash 900,000
Accounts receivable – assigned 900,000

February 28

*To record the remittance of collection

Note payable – bank 720,000
Interest expense (720,000 x 2) 14,400
Cash 734,400

*To transfer the remaining balance of account receivable – assigned to account receivable.
Account receivable 10,000
Account receivable – assigned 10,000

Account receivable – assigned balance (2,000,000 -1,900,000 – 20,000 – 50,000 -20,000) =

10,000

Factoring
Factoring of account receivable is a form of finance receivable wherein an entity sells its
accounts receivable to the bank called the factor on a without recourse, notification basis.

A gain or loss is recognized as the difference between the proceeds received and the net carrying
amount of the account factored.

The difference of factoring and assigning is the ownership of the account receivable. In
assignment of account, the entity or the borrower retains the ownership of the receivable.

On the other hand, in factoring the ownership is actually transferred to the factor or the bank and
the customers whose account are factored are notified.
Casual Factoring
In times of financial distress an entity may factor some or all its account receivable to a bank to
gain cash.
Journal entry on factoring
Cash xxx
Allowance for doubtful account xxx
Accounts receivable xxx
Note: if there is gain on factoring, the gain is recognized by debiting” gain on factoring”. Loss is
recognized by crediting “Loss in factoring”

Factoring as a continuing agreement

In this agreement, before the shipment of the goods the seller (entity) requests credit approval to
the factor. If the request is approved, the account is sold to the factor at the time after the
shipment of the goods.

The factor may compensate a commission for the factoring services and he may also withhold an
amount for security in case of sales return and allowance occurs.

The amount withheld is called “factor’s holdback” that is recognized as receivable from factor
classified as current asset.

Illustration

Luck company factored account receivable amounting to P400,000 to a finance entity with a
term of 2/10, n/30.

The factor charged a 5% commission and withheld 10% of the accounts receivable to cover sales
return and allowances.

Journal entry
Cash 332,000
Sales Discount (400,000 x 2%) 8,000
Commission (400,000 x 5%) 20,000
Receivable from factor (400,000 x 10%) 40,000
Account receivable 400,000

If there is a sales return of P25,000, the entry would be:

Sales return and allowance 25,000
Sales Discount (25,000 x 2%) 500
 Receivable from factor 24,500

If all receivable factored are collected without further sales return, the entry would be:
Cash (40,000 – 24,500) 15,500
Receivable from factor 15,500

True or False

1. If the business model is to hold the financial asset in order to collect contractual cash
flows on specified date, the financial asset shall be measured at amortized cost. TRUE
2. Assignment of account receivable is more formal type of pledging. TRUE
3. Assignment of account receivable is general while pledge of account receivable is
specific. FALSE
4. Under the non-notification basis of assignment of account receivable, the payments of the
customers are directly to the assignee. FALSE
5. Under the notification basis of assignment of account receivable, the payments of the
customers are directly to the assignee. TRUE
6. There is no necessary entry in recognizing pledged account receivable. TRUE
7. In Assignment of account receivable, the entity transfers the ownership of the account
receivable to the assignee. FALSE
8. Factor’s holdback that is recognized as receivable from factor classified as noncurrent
asset. FALSE
9. In factoring, the factor assumes the responsibility for uncollectible factored account.
TRUE
10. If the loan is discounted, in the banking parlance this means that the interest for the term
of the loan is deducted in advance. TRUE

Multiple Choices

1. If the financial asset is held in order to collect contractual cash on specified date flow is
measured at
a. Amortized cost
b. Fair value
c. Net realizable value
d. None of the above
2. Which of the following is a form of receivable financing?
a. Pledge of account receivable
b. Assignment of accounts receivable
c. Factoring of the account receivable
d. All of the above.
3. In this form of receivable financing an entity actually transfers ownership of the account
receivable.
 a. Pledge of account receivable
b. Assignment of accounts receivable
c. Factoring of the account receivable
d. None of the above
4. Which statement is not true about Assignment of account receivable?
a. Assigning is general because all accounts receivable serves as collateral security
of the loan
b. Assigning specific because specific account receivable is assigned as collateral
security of the loan
c. Assignment may be done either notification or non-notification basis.
d. Assignment is more formal type of pledging account receivable.
5. Which is not true about notification and nonnotification basis?
a. Under notification basis, the payment of the customers are directly to the assignee
b. Under non-notification basis the collection of the accounts is in the side of assignor
c. Under non-notification basis the customers continue to make the payments to the
assignor.
d. None of the above
6. Royal company factored P5,000,000 of account receivable to a finance entity. The factor
charged a commission of 5% and retained a holdback equal to 10% of the account
receivable. What is the cash amount received by Royal Company from the factoring
a. 4,250,000
b. 5,000,000
c. 5,725,000
d. 4,000,000

Solution
Gross amount 5,000,000
Commission (250,000)
Factor’s holdback (500,000)
Cash received from factoring 4,250,000

7. On January 1, Brilliant Company assigned its accounts receivable to a bank as collateral

security of the loan amounting to P1,000,000 under non-notification basis. The bank
advances 80% less service charge of P15,000.
The loan was agreed to have a 3% interest per month. A promissory note was signed by
the company

On January 5, The Company issued a credit memo to a customer for return of damage
merchandise for P20,000. The account is a assigned account.
 On January 25, the company collected P500,000 on the assigned account less 3%
discount.

On January 31, the Company remitted the collection to the bank.

What is the balance of the account receivable – assigned at the end of the month?
a. 500,000
b. 465,000
c. 450,000
d. 1,000,000

Solution

Initial amount of account receivable- assigned 1,000,000

Collections (500,000)
Sales discount (15,000)
Sales return and allowance (20,000)
Balance 465,000

8. Bitter company factored P545,000 of account receivable with allowance for doubtful
accounts of P55,000 for P500,000. What is the amount of loss on factoring?
a. 50,000
b. 20,000
c. 10,000
d. 15,000
Solution
Account receivable 545,000
Allowance for doubtful accounts (55,000)
Cash received (500,000)
Loss on factoring (10,000)

9. Sweet company factored P880,000 of account receivable with allowance for doubtful
accounts of P88,000 for P930,500. What is the amount of loss or gain on factoring?
a. 138,500 gain
b. 140,000 gain
c. 138,500 loss
d. 140,000 loss
Solution
Cash 930,500
Allowance for doubtful account 88,000
Gain on factoring 138,500
Accounts receivable 880,000
 10. Night company began to experience a financial distress and have a critical cash position.
The Company was forced to factored P6,635,000 of account receivable to a finance entity
to obtain money.
The factor charged a commission of 20% based on the amount of the factored account. In
addition:
The factor withheld an amount equal to 10% of the account receivable in case of sales
return. What is the cash amount received by Royal Company from the factoring.
a. 4,644,500
b. 5,000,000
c. 5,308,000
d. 0

Solution

Gross amount 6,635,000

Commission (1,327,000)
Factor’s holdback (663,500)
Cash received from factoring 4,644,500
Chapter 9: Receivable Financing: Discounting of Note Receivable

INTRODUCTION

A discount on note receivable happens when he present value of the payment received
from the note are less than its face amount.

Notes are usually sold with or without recourse, meaning the company discounting the note
agrees to shoulder the cost if the maker dishonors the note. When notes receivables are sold with
recourse, the company shall recognize a contingent liability that must be disclosed in the notes to
financial statements.
Contingent Liability – obligation to pay an amount in the future if an uncertain event
occurs.

Terms:

a. Net proceeds – the value of the discounted note received from the endorsee (usually a
bank or financial institution)
b. Maturity Value – the value due on the note on time of maturity
c. Maturity date – date of which the note must be paid
d. Principal – amount that appears on the face of the note.
e. Interest – amount of interest on full term of the note
f. Interest rate – Interest rate shown on the face of the note

Example 1

To make computing easier follow the steps to computing each:

A 500000, 180-day 10% note dated March 30 was received from a customer and
discounted without recourse on May 30 at 12% discount rate

Step 1: Compute the Maturity Value

Principal 500000
Interest (500000 x 10% x 180/360) 25000
Maturity Value 5250000

Note that the interest is computed as for the entire 180 day of the note to determine the maturity
value

Stet 2: Compute the Discount

Discount (525000 x 12% x 120/360) 21000

Note that the discount period is the time remaining since March 30 – May 30 = 60 days and 180
days is the entire amount then: 180 – 60 = 120.
Step 3: Compute for net proceeds

Maturity Value 525000

Discount 21000
Net Proceeds 504000

Step 4: Compute for Carrying Amount of the note

Principal 500000
Accrued interest receivable (200000 x 10% x) 8333.33
60/360

Carrying Amount of Notes receivable 508333.33

Gain or Loss on Discounting

If Carrying amount > Net proceeds = Loss on note discounting

If Carrying amount < Net proceeds = Gain on note discounting

In this case:
Net proceeds 504000
Carrying Amount of Notes receivable 508333.33
Gain on Note discounting (4333.33)

Journal Entry

Since in the example there without recourse there shall be no contingent liability

Cash 504000
Loss on note receivable discounting 4333.33
Note Receivable 500000
Interest Income 8333.33

Now assume that in the previous example the note was discounted with recourse, the transaction
can either be accounted for either of the following

a. Conditional Sale
b. Secured Borrowing

Conditional Sale

If in the previous example the note is treated as a Conditional Sale the journal entry to
record transaction is
 Cash 504000
Loss on note receivable discounting 4333.33
Note Receivable discounted 500000
Interest income 8333.33

The note account title note receivable discounted is deducted from notes receivable in the
statement of financial position

If note is paid by maker in the date of maturity

Note receivable discounted 500000
Note Receivable 500000

If note is dishonored by the maker and the bank charged the company 5000
Accounts Receivable 530000
Cash 530000

Notes receivable discounted 500000

Note Receivable 500000

Note: The first entry is to record payment to the bank of the amount of the Maturity value plus
any bank charges. The second entry is to cancel the contingent liability since the company is
already paid and is no longer liable.

Secured borrowing

Assume again the example above except that the note is treated as secured borrowing the
entry shall be:

Cash 504000
Interest Expense 4333.33
Liability for note receivable discounted 500000
Interest income 8333.33

In secured borrowing, a liability is recorded equal to the amount of the face value of the note in
place of note receivable. No gain or loss shall be recognized on if note receivable is discounted
for as a Secured borrowing

Note Paid by the maker in the date of maturity

Liability for note receivable discounted 500000
Note Receivable 500000
The liability and Note Receivable is derecognized if the maker paid the bank

Note dishonored by maker

Accounts Receivable 530000
Cash 530000

Derecognition of liability and Note discounted

Liability for note receivable discounted 500000
Note receivable 500000

Problems:

1. Which of the following is true?

a. Maturity Value is the amount of interest deducted by bank in advance.
b. Net proceeds refer to the value discounted of the note received
c. Maturity date is the period of time from date of discounting to maturity date
d. None of the above

2. Which of the following is True?

a. Secured borrowing recognizes a contingent liability
b. Secured borrowing does not recognize a gain or loss
c. Note receivable discounted is added from the total notes receivable
d. If note is paid by maker the liability for note receivable and note receivable is
recognized
3. Which of the following is false?
a. The accounting for notes receivable discounting depends on whether the
discounting is with or without recourse
b. In the absence of any evidence, a note receivable is assumed to be with
recourse
c. A discount of note receivable may be without recourse which means that the
company or endorser shall pay the endorsee if the maker dishonors the note
d. None of the Above
4. Which of the following is false?
a. Under secured borrowing payment of note on maturity is an entry to a debit
of Notes receivable and credit to Liability for note receivable discounted
b. Under Conditional Sale an entry to record payment of note is to Debit Accounts
Receivable and Credit Cash
c. Under Conditional Sale an entry to cancel contingent liability is a debit to Note
receivable discounted and a credit to Note Receivable
 d. Under Secured Borrowing the entry to derecognize liability for note receivable is
a debit to liability for note receivable discounted and a credit to note receivable

Trulala Co. accepted from a customer a 1000000, 90-day, 12% note dated September 30, 2020.
On October 31, 2019 the entity discounted without recourse the note at 15%. However, the
proceeds were not received until November 1, 2019

5. What amount was received from the note receivable discounting?

a. 25750 Principal 1000000
b. 1030000 1000000 x 12% x 90/360 30000
c. 30000 Maturity Value 1030000
d. 1004250 1030000 x 15% x 60/360 50025750
1004250

6. What amount should be reported as gain on note receivable discounting?

a. 5750 1000000
b. 1000000 1000000 x 12% x 30/360 10000
c. 10000 Carrying Amount 1010000
d. 1010000 Net Proceeds 1004250
Gain on receivable discounting 5750

BangBang Co. received from a customer a 1 year, 600000 note with an annual interest rate of
8%. After holding the note for 6 months, the entity discounted the note at the bank at an interest
rate of 10%

7. What amount of cash was received from the bank?

a. 48000 Principal 600000
b. 600000 (600000 x 8%) 48000
c. 648000 Maturity Value 648000
d. 618000 (600000 x 10% x 6/12) 30000
e. None of the Above Net proceeds 618000

8. What is the loss on note receivable discounting?

a. 6000 Principal 600000
b. 24000 (600000 x 8% x 6/12) 24000
c. 18000 Carrying Amount 624000
d. 0 Net Proceeds 618000
e. None of the above loss on note receivable disc. 6000

9. What is the Carrying Amount of the note?

a. 600000
 b. 624000
c. 618000
d. None of the Amount
10. Statement 1: Contingent Liability – obligation to pay an amount in the future if an
uncertain event occurs.

Statement 2: Maturity Value – the value due on the note on time of maturity

a. Both statement is true

b. Both statement is false
c. Statement 1 is true while Statement 1 is false
d. Statement 1 is false while Statement 2 is true

Problem solving

11. On july 1, 2019 AllMight Co. Sold goods in exchange for 2000000, 8 moth, non-interest
bearing note receivable. At the time of the sale, the note’s market rate of interest was
12%. The note was discounted at 10% on September 1, 2019

What is the loss on note receivable discounting

Answer:

2000000 – 1900000 = 100000 loss

12. Sinagtala Co. Received from a customer a one-year 200000 note bearing annual interest
of 10%. Ater holding the note for 6 months, the entity discounted the note at the bank at
an eddective interest rate of 12%.

a. What amount of cash was received from the bank

b. What is the loss on the note receivable discounting

Answer: a.

Principal 2000000
Interest (200000 x 10%) 20000
Maturity Date 220000

Less: Discount ( 220000 x 12% x 6/12) 13200

Net Proceeds 206800
 b. Principal 200000
Accrued interest receivable 10000
Carrying Amount 210000

Net Proceeds 206800

Carrying Amount (210000)
Loss on note receivable (3200)

Co. provided the following transactions:

Jan 1 – The entity sold merchandise for 600000 accepting the note for 1000000
for six months with interest to be paid at maturity at 10%

March 1 – Hogwarts discounted the note without recourse at local bank at 20%

July 1 – The customer paid the bank in full

13. Compute for Carrying Amount and Net Proceeds

14. Prepare Journal Entries

Answer:

Principal 600000
Interest (600k x 10% x 6/12) 30000
Maturity Value 630000
Discount (106k x 20% x 2/12) (21200)
Net proceeds 608800

Principal 600000
Accrued Int. Rec. (600k x 12% x 2/12) 12000
Carrying Amount of NR 612000

Net Proceeds 608800

Carrying Amount (612000)
gain on note discounting (3200)

Journal Entries
 January 1
Notes Receivable 600000
Sales 600000

March 1
Cash 608800
Loss on Note discounting 3200
Notes receivable 600000
Interest Income 12000

July 1
No Entry

Unicorn Co. received from customer a 3000000 value note term, 90 days and carried at an
interest rate of 12%. On August 31 2019, the company discounted with recourse the note at the
bank with a rate of 15%.

The customer paid the note to the bank on October 30, 2019

15. Prepare Journal Entries assuming the discounting is accounted for as a secured borrowing
16. Compute for Carrying Amount and Net Proceeds

Answer

Principal 3000000
Interest (3M x 12% x 90/360) 90000
Maturity Value 3090000
Discount (3090k x 15% x 60/360) 77250
Net Proceeds 3012750

Principal 3000000
Accrued Int. Rec (3M x 12% x 30/360) 30000
Carrying Amount of NR 3030000

Net Proceeds 3012750

Carrying Amount 3030000
loss 17250

Journal Entry:

Cash 3012750
Interest expense 17250
Liability for note receivable disc. 3000000
Interest Income 30000
 Liability for note receivable discounted 3000000
Note Receivable 3000000

17. Moonlight Co. Discounted at the bank a customer’s 3000000, 6 month, 10% , note
receivable dated April 30, 2019 on June 30 2019. The bank discounted the note at 12%

a. What amount should be reported as et proceeds from the discounted notes

receivable
b. What is the lodd on the note receivable discounting?

Answer:

a. Principal 3000000
Interest (3M x 10% x 6/12) 150000
Maturity Value 3150000
Discount (3150000 x 12% x 4/12) (126000)
Net Proceeds 3024000

b. Principal 3000000
Accrued Interest (3m x 10% x 2/12) 50000
Carrying Amount 3050000

Net Proceeds 3024000

Carrying Amount 3050000
Loss on Note Receivable Discounting (26000)

Jhoto Co. Provided the ff. Data in the current year

June 1 – A 5000000, 12%, 90-day note received from Hoenn Co. From goods sold

July 1 - Rreceived from Sinnoh Co. A 6000000, 10%, 60-day note in full payment of an
account

1 – Discounted Hoenn Co. At a bank at 12%

1 – Discounted Sinnoh Co. Note at abank at 12%

Aug. 30 – The bank Notified Johto Co. That Sinnoh Co. Note has been paid
 30 – The bank told Jhoto Co. That Hoenn Co. Dishonored the note and charged the amount
of principal, interest and a fee of 20000 against Jhoto’s bank account

30 – Received payment in full from Aye Company for the dishonored note plus 12%
Annual interest on the total amount due for four months.

18. Prepare journal entries if the note receivable discounting is accounted for as a secured
borrowing.
19. Prepare journal entries if the note receivable discounting is accounted for as conditional
sale with recognition of contingent liability.

Answers: 18

June 1 Notes Receivable 5000000

Sales 5000000

July 1 Notes Receivable 6000000

Sales 60000000

Cash 5047000
Interest expense 3000
Liability for note receivable discounted 5000000
Interest income 50000

July 16 Cash 6008500

Interest Expense 16500
Liability for note receivable discounted 6000000
Interest Income 25000

August 30 Liability for note receivable discounted 6000000

Notes Receivable 6000000

Accounts Receivable 5170000

Cash 5170000

Liability for note receivable discounted 5000000

Note Receivable 6000000

Cash 5376000
Accounts Receivable 5170000
Interest Income 206800

Answers: 19
 June 1 Notes Receivable 5000000
Sales 5000000

July 1 Notes Receivable 6000000

Sales 60000000

Cash 5047000
Loss on discounting 3000
Note receivable discounted 5000000
Interest income 50000

July 16 Cash 6008500

Loss on discounting 16500
Note receivable discounted 6000000
Interest Income 25000

August 30 Note receivable discounted 6000000

Notes Receivable 6000000

Accounts Receivable 5170000

Cash 5170000

Note receivable discounted 5000000

Note Receivable 6000000

Cash 5376000
Accounts Receivable 5170000
Interest Income 206800

20. Frozen Co. Provided the following transactions:

March 14 – Sale of merchandise 2050000 to a customer, FOB Destination 2/10 net 30

April 7 – Receipt of 60-day, 12% note dated April 4 from the customer. The face of the note
was the amount of the invoice minus freight charge of 50000 paid by the customer in
connection with the marhc 14 sale.

20 – The note of the customer was dicounted with the bank at 15%

June 4 – Bank notified from the bank that the customer dishonored the note. Accordingly, the
entity paid the bank the amount due including protest fee and other charges of 10000
July 4 – Receipt of cash from the customer for the full amount of the idebtedness plus
interest on the original Face value

Prepare Journal Entries

Answer:

March 14 Accounts Receivable 2050000

Sales 2050000

April 7 Notes receivable 2000000

Freight Out 50000
Accounts Receivable 2050000

April 20 Cash 2001750

Loss on Discounting 8250
Notes receivable discounted 2000000
Interest Income 10000

June 4 Accounts Receivable 2050000

Cash 2050000

Notes Receivable Discounted 2000000

Notes Receivable 2000000

July 4 Cash 2070000

Accounts Receivable 2050000
Interest Income 20000
CHAPTER 10
INVENTORIES

Definition

According to IAS 2, Paragraph 6, inventories are assets held for sale in an ordinary
course of business, in the process of production, in the form of materials to be consumed in the
production or in rendering services.

Inventories encompass goods purchased and held for resale (Merchandise Inventory):
1.) Raw Materials - To be used in production
2.) Work – in – Process - Partially completed goods
3.) Finished Goods - Completed goods and available for sale

Inventories encompass service provider:

1.) Cost of service

Classes of Inventories

a.) Trading Concern – buys and sell goods

b.) Manufacturing Concern – buys raw materials or goods and converted into finished
goods available for sale.

Goods Includible in the Inventory

Economic control is the basic criteria for goods to be included in the inventory than
physical possession. In simple words, economic control means having the legal ownership or
title.

Basically, goods are included in inventory when received by the buyer and recorded sold
by the seller. However, Passing of Title serves as the determinant in classifying inventory.
Examples:

1. Goods in transit FOB Destination and FOB Shipping Point

2. Goods out on consignment/Consigned Goods -
3. Goods in the hands of salesmen or agents/Conditional Sales
4. Goods held by customers on approval or on trial

In relation to the concept of Passing of Title, Under FOB Shipping Point, legal title is
passes to buyer upon shipment of goods wherein seller should pay for the freight charge. On the
other hand, under FOB Destination, legal title is passes to the buyer at the point of destination
wherein buyer should pay for the freight charge.
 Furthermore, Freight Terms (Freight Collect and Freight Prepaid) determine the person
who actually paid the freight charge. In Freight Collect, buyer actually paid the freight charge
while in Freight Prepaid, seller actually paid the freight charge.

Maritime Shipping Terms

FAS or Free Alongside – Title passes to the buyer when the goods are in the carrier’s
possession in which the buyer is responsible for the charges.

CIF or Cost, Insurance, Freight – Title passes to the buyer upon delivery of goods to the
carrier in which the seller is responsible for the freight cost.

Ex-Ship – Title passes to the buyer when the goods are unloaded in which seller should paid for
the charges.

CONSIGNED GOODS

Goods that are in the possession of the agent or the one who sells it called consignee in
behalf of the owner which is the consignor. These goods are included in inventory at cost plus
freight and handling charges. The consignee earns commission (Commission Expense for the
consignor) when goods are sold and remitted to consignor.

ACCOUNTING FOR INVENTORIES

1.) PERIODIC SYSTEM – Physical counting of goods on hand at the end of

accounting period in which physical quantities are multiplied to its unit cost to obtain
the inventory value necessary in presenting Financial Statement.
2.) PERPETUAL SYSTEM – The entity maintains records of movements of inventory
called stock cards. However, physical count should be also made at least once a year.

PERIODIC SYSTEM PERPETUAL SYSTEM

Purchase merchandise on account costing 100,000
Purchases 100, 000 Merchandise Inventory 100, 000
Accounts Payable 100,000 Accounts Payable 100,000
Paid 3,000 for the freight charge
Freight in 3,000 Merchandise Inventory 3, 000
Cash 3,000 Cash 3,000
Return 30,000 worth of goods purchased to supplier
Accounts Payable 30, 000 Accounts Payable 30, 000
Purchase Return 30,000 Merchandise Inventory 30,000
Sold merchandise on account worth 45,000 at 20% Gross Profit Rate
Accounts Receivable 45, 000 Accounts Receivable 45, 000
Sales 45,000 Sales 45,000
Cost of Goods Sold 36,000
Merchandise Inventory 36,000
 (45,000 x 80%) = 36,000

Customer returns 5,000 worth of merchandise

Sales Return 5,000 Sales Return 5, 000
Accounts Receivable 5,000 Accounts Receivable 5,000
Merchandise Inventory 4 ,000
Cost of Goods Sold 4,000
(5,000 x 80%) = 4,000
To record ending Inventory
Merchandise Inventory 41,000 Merchandise Inventory 41,000
Income Summary 41,000 Income Summary 41,000
(100,000+3,000-30,000-36,000+4,000) (The balance of Merchandise Inventory)

INVENTORY SHORTAGE OR OVERAGE

In the preceding illustration, the entity has Merchandise Inventory – Ending costing
P41,000. Assume that the entity made physical count of inventory and shows that the on hand
inventory is P38,000. The journal entry should be:

Inventory Shortage (41,000-38,000) 3,000

Merchandise Inventory 3,000

In such case of Inventory Overage, the entry will be just reversed of the entry in
Inventory Shortage. If the Inventory Shortage is normal, it shall be closed to cost of goods sold,
on the other hand, if it is abnormal, it shall be charge to other expense.

TRADE DISCOUNT AND CASH DISCOUNT

Trade Discount is the deduction from the list price to arrive at the amount that the buyer should
pay and to encourage buyers to buy in a bulk of goods. Trade discount is not recorded.

Cash Discount is the deduction in the invoice price when payment is made within the discount
period. Cash discount encourages buyers to pay on time, thus, this is recorded as purchase
discount for the buyer and sales discount for the seller.

In determining the discount period, exclude the first day but include the last day.

METHODS OF RECORDING PURCHASES

1.) Gross Method

2.) Net Method

Gross Method Net Method

 On May 1, Jose purchased goods on account, P100,000, 2/10, n/30
Purchases 100,000 Purchases 98,000
Accounts Payable 100,000 Accounts Payable 98,000
(100,000 x 98% (2/10 or 2% discount within
10 days)
On May 10, Jose paid the purchased goods.
Accounts Payable 100,000 Purchases 98,000
Cash 98,000 Accounts Payable 98,000
Purchase Discount 2,000
Assume that Jose paid on May 13
Accounts Payable 100,000 Accounts Payable 98,000
Cash 100,000 Purchase Discount Lost 2,000
Cash 100,000

COST OF INVENTORIES

1.) Cost of Purchase – includes purchase price, import duties, irrecoverable taxes,
freight, handling and other costs directly attributable in purchasing of goods.
2.) Cost of Conversion – includes direct labor and overhead (Fixed and Variable)
3.) Other Costs – includes costs incurred in bringing the inventory to its present
condition. It may include costs incurred for special order.

Exclusion in Determining Cost of Inventories:

a.) Abnormal Amounts
b.) Storage Costs (If in Goods in Process, capitalized. If in Finished Goods,
expensed)
c.) Administrative Costs
d.) Distribution and Selling Costs
PROBLEMS

1.) Lee Company provided the following information at the end of 2018:
Materials in Transit, FOB Destination 100,000
Materials 2,000,000
Goods in process, at cost of materials and labor 1,440,000
Finished goods in storeroom, at cost including 4,000,000
20% overhead
Finished goods, FOB seller 500,000
Consigned Goods, at selling price, cost, P200,000 280,000
Defective Materials returned to suppliers 200,000
Machine Lubricants 50,000
What is the cost of Lee’s Inventory at year end?
a.) 7,440,000
b.) 8,000,000
c.) 8,570,000
d.) 8,050,000

2.) Arya Company has incurred the following costs during 2017.
Cost of Purchases from Friendship Company 3,000,000
Trade Discounts already deducted by Friendship 200,000
Company
Import Duties 180,000
Freight and insurance on purchases 700,000
Handling costs related to imports 40,000
After-sales warranty costs 140,000
Accounting Department salaries 700,000
What is the cost of Arya’s Inventory at year end?
a.) 3,920,000
b.) 4,960,000
c.) 4,260,000
d.) 3,860,000
 3.) What is the total amount of inventory to be measured based on the following:
Materials 1,000,000
Irrecoverable purchase taxes 100,000
Storage costs of finished goods 220,000
Goods out on consignment, cost, 100,000 400,000
Finished Goods, FOB Shipping point 150,000
a.) 1,870,000
b.) 1,720,000
c.) 1,200,000
d.) 1,420,000

On January 31, 2017, Jon Company consigned 30 ovens to Daenerys Company costing P8,000
each and to be sold for P12,000 each. Jon Company paid P1,000 transportation cost and P2,000
handling cost. On December 28, 2017, Daenerys Company reported that only 22 ovens are sold
and remitted P237,600, net of 10% agreed commission.
1.) What is the total amount of consignment sales revenue for 2017?
a.) 264,000
b.) 176,000
c.) 237,600
d.) 360,000
2.) What should be the amount of consigned goods in Jon Company’s Inventory?
a.) 360,000
b.) 240,000
c.) 243,000
d.) 240,600

Tyrion Merchandise is a regular buyer of Jamie Company which granted Tyrion trade discounts
of 30% from the list price. Tyrion purchased a merchandise and received an invoice with a list
price of P780,000, freight charge of P10,000, and the payment terms of 2/10, n/30.

1.) What is the net invoice price of Tyrion?

a) 540,000
b) 790,000
c) 780.000
d) 546,000
2.) What is the total cost of the purchase made by Tyrion?
a.) 780,000
b.) 556,000
c.) 546,000
d.) 790,000
 3.) Assume that Tyrion payment is within the discount period, what is the total cost of
purchase?
a.) 550,800
b.) 546,000
c.) 556,000
d.) 544,880

On March 1, Cersie Company recorded purchases of inventory of P500,000 and P700,000 under
credit terms of 2/15,net 30. The payment due on the P500,000 and P700,000 were remitted on
March 16 and March 31, respectively.

1.) What is the amount to be recorded as net purchase under Net Method?
a.) 1,000,000
b.) 1,200,000
c.) 1,176,000
d.) 1,190,000
2.) What is the net purchase under Gross Method?
a.) 1,190,000
b.) 1,000,000
c.) 1,200,000
d.) 1,176,000

On May 1, 2016, Dominic Company sold merchandise with a list price of P3,000,000 to Hobbs
on account in which Dominic allowed trade discounts of 20% and 10% and the credit terms is
2/10, n/30. The sale was made FOB Seller, Dominic paid P100,000 freight costs. On May 11,
2016 Hobbs paid in full amount.

1.) What amount should be reported as sales revenue?

a.) 2,160,000
b.) 3,000,000
c.) 2,400,000
d.) 2,900,000
2.) What amount was received by Dominic as payment by Hobbs?
a.) 2,216,800
b.) 2,160,000
c.) 2,380,200
d.) 2,840,800

TRUE OR FALSE

1.) Under gross method, purchase discount is deducted from purchases regardless of whether
taken or not. FALSE
 2.) Under net method, only purchase discount taken is deducted from purchases. FALSE
3.) Both trade discount and cash discount are recorded. FALSE
4.) Since Storage costs of finished goods in not an inclusion in the cost of inventory,
therefore, it is recognized as an expense. TRUE
5.) If the entity is using Perpetual Inventory system which maintains the inventory
transactions, then it is not necessary to do physical counting of inventories. FALSE
6.) Both normal and abnormal inventory shortage shall be expense outright. FALSE
7.) The journal entry for the sale of inventory under the Periodic and Perpetual is the same,
however, only in Perpetual system the entity Cost of Goods Sold and Merchandise
Inventory account is affected. TRUE

CHAPTER 11

INVENTORY COST FLOW

Learning Objectives:

 To identify the three cost formulas

 To determine the cost of inventory using the FIFO cost formula
 To determine the cost of inventory using the Weighted Average cost formula
 To determine the cost of inventory using the Moving Average cost formula
 To apply the specific identification method

First in, First out (FIFO)

The first in, first out method is a cost flow assumption that the goods are first purchased are also
the goods first sold. This results in the remaining items in inventory being accounted for at the
most recently incurred cost, so that the inventory asset recorded on the balance sheet contains
cost that are quite close to the most recent costs that can be acquired in the market.
This method also results in older historical costs being matched against current revenues that
reflect an improper matching of revenues and costs resulting understatement of cost of sales.

The FIFO method provides the same results under either the periodic or perpetual inventory
system.

Illustration

FIFO – Periodic

Units Unit cost Total cost Sales(in

units)

Dec. 1 Beginning balance 700 150 105,000

10 Sale 500

15 Purchase 800 200 160,000

20 Sale 500

31 Purchase 300 300 90,000

Ending inventory is 800 units.

Total
Units Unit cost cost
Dec. 15 Purchase 500 200 100,000
31 Purchase 300 300 90,000
800 190,000

Cost of Goods Sold

Inventory-December 1 105,000
Purchases
250,000
(160,000+90,000)
 Goods available for sale
355,000
Inventory-December 31 190,000
Cost of goods sold 165,000

FIFO – Perpetual

Purchases Sales Balance

Unit Total Unit Total Unit Total
Date Units cost cost Units cost cost Units cost cost
Dec. 1 700 150 105,000
10 500 150 75,000 200 150 30,000
15 800 200 160,000 200 150 30,000
800 200 160,000
20 200 150 30,000
300 200 60,000 500 200 100,000
31 300 300 90,000 500 200 100,000
300 300 90,000

Cost of goods sold determine from the stock card:

1
December 75,000
0
2 (30,000+60,00
90,000
0 0)
Cost of goods 165,00
sold 0

Weighted Average - Periodic

Using the weighted average method, the total cost of goods available for sale is divided by the
number of units available for sale which yields the weighted average cost per unit. The cost of
goods available for sale is calculated as the sum of the beginning inventory plus the net
purchases.

Inventory cost = Weighted average cost per unit x Ending inventory

Illustration

Units Unit cost Total cost Sales(in

units)

Dec. 1 Beginning balance 700 150 105,000

10 Sale 500

15 Purchase 800 200 160,000

20 Sale 500

31 Purchase 300 300 90,000

Ending inventory is 800 units.

Units Unit cost Total cost

Dec
. 1 Beginning balance 700 150 105,000
1
5 Purchase 800 200 160,000
3
1 Purchase 300 300 90,000
Total goods available for sale 1,800 355,000

Weighted average unit cost (355,000/1,800) 197.22

Inventory cost (800 x 197.22) 157,776

Cost of goods sold

Inventory-December 1 105,000
Purchases 250,000
Goods available for sale
355,000
Inventory-December 31 (157,776)
Cost of goods sold 197,224

Weighted Average – Perpetual

Weighted Average – Perpetual method is also known as the moving average method.

Under the moving average method, the average cost of each inventory item in the stock must be
computed after every inventory purchase and purchase return. This is done by dividing the total
cost of goods available after every purchase and purchase return by the total units available for
sale to get the new weighted average unit cost.

To get the inventory cost, the new weighted average unit cost is multiplied with the units on
hand.

Illustration

Units Unit cost Total cost Sales(in units)

Dec. 1 Beginning balance 700 150 105,000

10 Sale 500

15 Purchase 800 200 160,000

20 Sale 500

31 Purchase 300 300 90,000

Units Units cost Total cost

Decembe
r 1 Balance 700 150 105,000
1
0 Sale (500) 150 (75,000)
Balance 200 150 30,000
1 Purchas
5 e 800 200 160,000
Balance 1,000 190 190,000
2
0 Sale (500) 190 (95,000)
Balance 500 190 95,000
3 Purchas
1 e 300 300 90,000
Total 800 231.25 185,000

Cost of goods sold determine from the stock card:

December 1 75,000
 0
2
95,000
0
Cost of goods 170,00
sold 0

Specific Identification

Specific identification method relates to inventory valuation used to track specific items in the
inventory.

Computation:

Cost of inventory = Units on hand x actual unit cost

Relative sales price method

Relative sales price method is a technique used to allocate joint cost base on the prices at which
products will be sold. This is based on the philosophy that the cost is proportionate to selling
price.

Example:

Product X, Y and Z are purchased at basket price of 3,000,000.

Sales Price Fraction Allocated Cost

Product X 1,000,000 1/6 500,000
Product Y 2,000,000 2/6 1,000,000
Product Z 3,000,000 3/6 1,500,000
6,000,000 3,000,000
Problem 11-1

An entity provided the following information:

Units Unit cost Total cost

Jan
. 1 Beginning balance 10,000 150 1,500,000
5 Purchase 10,000 180 1,800,000
1
5 Sale 15,000
1
6 Sale return 1,000
2
5 Purchase 4,000 200 800,000
2
6 Purchase Return 2,000 200 400,000

1. Under FIFO, what amount should be reported as cost of goods sold?

a.2,900,000

b.2,620,000

c.2,220,000

d.2,500,000

2. Under the weighted average, what amount should be reported as ending inventory?

a.1,466,640

b.1,345,440

c.1,432,000
d.1,413,360

3. Under the moving average, what amount should be reported as ending inventory?

a.1,690,000

b.1,390,000

c.1,790,000

d.1,600,000

Solution 11-1

1. Answer d

8,000 x 200 = 1,600,000 Cost of ending inventory

Cost of goods sold

Inventory, beg 1,500,000

Purchases 2,600,000

Goods available for sale 4,100,000

Inventory, end 1,600,000

Cost of goods sold 2,500,000

2. Answer a

Unit Total
Units cost cost
Ja 10,00 180000
n 5 0 180 0
2 4,000 200 800000
 5
2
6 2,000 200 400000
12,00 220000
0 0

Weighted average unit cost (2,200,000/14,000) 183.33

Inventory cost (8,000 x 183.33) 1,466,640

3. Answer

Unit Total
Units cost cost
Ja Beginning
n 1 balance 10,000 150 1500000
5 Purchase 10,000 180 1800000
Balance 20,000 165 3300000
1 (15,00 (247500
5 Sale 0) 165 0)
Balance 5,000 165 825000
1
6 Sales return 1,000 165 165000
Balance 6,000 165 990000
2
5 Purchase 4,000 200 800000
Balance 10,000 179 1790000
2 Purchase
6 return (2,000) 200 (400000)
Balance 8,000 173.7 1390000
 5

Problem 11-2

Which of the following is not affected by the inventory valuation method used by an entity?

a.Cost of goods sold

b.Net income of the entity

c.Amounts owed for income taxes

d.Amounts paid to acquire merchandise

Answer: D

Problem 11-3

Ram Inc. is a wholesaler of office supplies. The activity for Model 2 calculators during August is
shown below:

Unit
Units cost
Augus
t 1 Inventory 2,000 36
7 Purchase 3,000 37.2
1
2 Sale 3,600
2
1 Purchase 4,800 38
2
2 Sales 3,800
2
9 Purchase 1,600 38.6

1. If Ram Inc. uses a FIFO perpetual inventory system, the ending inventory of Model 2
calculators at August 31 is reported as

a. 152,288

b.152,960

c.150,080
d.150,160

2. If Ram Inc. uses a weighted average cost periodic inventory system, the ending inventory of
Model 2 calculators at August 31 is reported as

a.150,080

b.152,960

c. 150,160

d. 146,400

Solution 11-3

1. Answer b

Purchases Sales Balance

Unit Total Unit Unit Total Unit Unit Total
Date Units cost cost s cost cost s cost cost
Aug 1 2,000 36 72000
7 3,000 37.2 111600 2,000 36 72000
3,000 37.2 111600
12 2,000 36 72000
1,600 37.2 59520 1,400 37.2 52080
21 4,800 38 182400 1,400 37.2 52080
4,800 38 182400
22 1,400 37.2 52080
2,400 38 91200 2,400 38 91200
29 1,600 38.6 61760 2,400 38 91200
1,600 38.6 61760

2. Answer a

Unit Total
Units cost cost
Au
g 1 2,000 36 72,000
111,60
7 3,000 37.2 0
 2 182,40
1 4,800 38 0
2
9 1,600 38.6 61,760
11,40 427,76
0 0

Weighted average unit cost (427,760/11,400) 37.52

Inventory cost (4,000 x 37.52) 150,080

Problem 11-4

The following information was available from the inventory records of Castaway Company for
January:

Unit
Units cost
Balance at
January 1 3,000 9.77
Purchases:
6-Jan 2,000 10.3
26-Jan 2,700 10.71
Sales:
7-Jan 2,500
31-Jan 3,200

Assuming that Castaway Company maintains a perpetual inventory records, what should be the
inventory at January 31, using the moving average inventory method, rounded to the nearest
peso?

a. 20,474

b. 20,520

c. 20,725

d. 21,010
Solution 11-14 Answer c

Unit Total
Date Units cost cost
1-Jan Balance 3,000 9.77 29,310
Purchas
6-Jan e 2,000 10.3 20,600
Balance 5,000 9.98 49,910
(24,950
7-Jan Sale (2,500) 9.98 )
Balance 2,500 9.98 24,960
Purchas
26-Jan e 2,700 10.71 28,917
Balance 5,200 10.36 53,877
(33,152
31-Jan Sale (3,200) 10.36 )
Balance 2,000 10.36 20,725

Problem 11-5

A company decided to change its inventory valuation method from FIFO to LIFO in a period of
rising prices. What was the result of the change on ending inventory and net income in the year
of the change?

Ending inventory Net Income

a. Increase Increase

b. Increase Decrease

c. Decrease Increase

d. Decrease Decrease

Answer: C

Problem 11-6

Elixir Development Corporation bought a 10 hectare land in Novaliches, to be improved,

subdivided into lots and eventually sold. Purchase price of the land was P58,000,000. Taxes and
documentation expenses on the transfer of the property amounted to P800,000. The lots were
classified as follows:

Lot Number of lots Selling price per lot Total clearing

 class costs
A 10 P1,000,000 None
B 20 800,000 P1,000,000
C 40 700,000 3,000,000
D 50 600,000 8,000,000

The cost per lot of class B lots under the relative sales price method of inventory valuation is?

a. 674,285

b. 610,000

c. 602,380

d. 560,000

Solution 11-6 Answer b

Allocated
Sales price Fraction cost
(10 x
A 1,000,000) 10,000,000 10/84 7,000,000
(20 x
B 800,000) 16,000,000 16/84 11,200,000
(40 x
C 700,000) 28,000,000 28/84 19,600,000
(50 x
D 600,000) 30,000,000 30/84 21,000,000
84,000,000 58,800,000

Allocated cost of class B 11,200,000

Clearing cost of class B 1,000,000
Total cost 12,200,000

12,200,000 / 20 = 610,000

Problem 11-7

Greece Company wholesales bicycles. It uses the perpetual inventory system. The company’s
repoting date id December 31. At December 31, inventory on hnd consisted of 350 bicycles at
P820 each and 43 bicycles at P850 each. During the month of Decembe the following inventoy
transactions took place (all purchase and sales transactions are on credit)
 2 Sold 300 bicycles for P1,200 each.
Five bicycles were returned by a customer. They had originally cost P820 each amd were
3 sold for P1,200 each.
9 Purchased 55 bicycles at P910 each.
13 Purchased 776 bicycles at P960 each.
15 Sold 86 bicycles for P1,350 each.
Returned one damaged bicycles to the supplier. This bicycle had been Purchased on
16 December 9

22 Sold 60 bicycles for P 1,250 each.

26 Purchased 72 bicycles at P980 each.
Two bicycles sold on December 22 were returned by a customer. The bicycles were
returned by a customer. The bicycles were badly damaged so it was decided to write
29 them off. they had original cost P910 each

1. The cost of goods sold for the month of December using moving average method is

a. 367,230

b. 365,410

c. 366,320

d. 372,725

Solution 11-7 Answer d

Unit Total
Date Units cost cost
1-Dec Balance 393 823 323,550
2-Dec Sale 300 823 246,900
3-Dec Sales Return 5 823 4,115
Balance 98 823 80,765
9-Dec Purchase 55 910 50,050
13-Dec Purchase 76 960 72,960
Balance 229 890 203,775
16-Dec Sale 86 890 76,540
Balance 143 890 127,235
Purchase
16-Dec Returns 1 910 910
Balance 142 890 126,325
22-Dec Sale 60 890 53,400
Balance 82 890 72,925
26-Dec Purchase 72 980 72,560
Balance 154 932 143,485

P246,90
Sales, Dec. 2 0
Sales return, Dec. 3 4,115
Sales, Dec. 15 76,540
Sales, Dec. 22 53,400
Cost of goods sold 372,725
 Chapter 12

Lower of Cost and Net Realizable Value

Generally accepted accounting principles require that inventory be valued at lesser

amount of its laid-down cost and the amount which it can likely be sold or its net realizable
value.

Net Realizable Value

Net Realizable Value or NRV is the estimated selling price of the goods, minus the cost
of sale or disposal. This valuation/measurement shall be used in determining the lower of cost or
market of on-hand inventory items. The cost of sale as deduction in the estimated selling price
are any reasonable costs of completing, transporting and disposing of inventory or any
expenditure incurred by the purchaser in order to place the merchandise in the business and
ready for sale.

In order to determine if the costs of the inventory should be reduced, the following
examinations are used:

A. Spoilage
B. Obsolescence
C. Reduced demand from Customers
If any of these were observed and happen in the inventory, the company will have to
write off the inventory. The practice of inventory write-down is based upon the view that the
inventory should not be recorded or carried higher than the amount the company is expecting to
gain form them.

Accounting for Inventory Write-down

An inventory write-off is the process of removing inventory that has no value in the
general ledger. When the market price of the inventory falls below its cost, accounting requires
that the company should reduce the value of the inventory reported. However, if the cost is
below its market price, there will be no problem because the increase in the value of the
inventory is not recognized.

Methods in Inventory Write-down

There are two methods in writing off inventory, they are the direct write-off method or
the direct method and the allowance method.

A. Direct write-off method

 In using the direct write-off method, the company will record a journal entry with a credit
to the inventory asset account and a debit to an asset expense account. There is no allowance
account, an asset is written off directly.

B. Allowance Method
In using the allowance method, a business will record a journal entry with a credit to contra
asset account, allowance for inventory write-down. An offsetting debit will be made to an expense
account. When the asset is actually disposed, the inventory account will be credited and the
allowance for inventory write-down account will be debited to reduce both. If the required
allowance for inventory write-down is lesser than the one recorded, there will be a gain and
reversal entry. However, the gain to be recorded should not excess the allowance balance.

Illustration

X company with P150,000 worth of inventory found out that P25,000 of it are damaged
due to poor storing of the inventory. The company will have to record the loss to reflect the
damaged goods.

Direct method

Inventory cost P150,000

Damaged inventory 25,000

Net realizable Value P125,000

Inventory – December 31, 2019 125,000

Income summary 125,000

Allowance Method

Loss on inventory write-down 25,000

Allowance for inventory write-down 25,000

 However, if the inventory in 2020 has a net realizable value of P130,000 and cost of
145,000 the gain on reversal should be recorded as:

Direct Method

Inventory – December 31, 2020 130,000

Income summary 130,000

Allowance Method

Cost in 2020 P145,000

NRV 130,000

Required allowance for 2020 P15,000

Required Allowance in 2019 (25,000)

Decrease in Allowance (P10,000)

Allowance for inventory writedown 10,000

Gain on inventory writedown 10,000

Purchase commitments

Purchase commitments are commitments by the buyer to purchase some goods or

services at some future date at a fixed price. A business will agree to purchase a commitment in
order to fix its prices over a period of time. For example, a business will contract to purchase 100
units of goods at a fixed price of P25 each after 7 months.

Businesses enter into purchase commitment to protect them from price increase.
However, sometimes, before the maturity of the fixed date or on the fixed date of the purchase
commitment, the price falls. Especially when the contract is not cancellable, the business will
have to pay the product higher that its market value.

Illustration
 Suppose a business enter into a purchase commitment with a supplier to purchase 100
units of goods with a contract price of P25 each within six months. At the year end, none of the
product was delivered and the price per unit has fallen into P20. Since the purchase commitment
is non-cancellable, the business is contracted to purchase the 100 units at a price higher that its
market value and therefore should recognize a loss.

The purchase commitment loss is computed as follows.

Contracted price 100*P25 = P2,500

Market value 100*P20 = (P2,000)

Purchase commitment loss P500

Journal entry

Loss on purchase commitments 500

Purchase commitments liability 500

The debit represents the loss recorded in the income statement of the business in the
period in which the decline in price occurred. The credit represents the liability in the purchase
commitments.

Further decline in the Product Price

Suppose that 7 months has passed, the business completes its contract and takes the
delivery of the 100 units and adds them to its inventory. However, at the time of the delivery the
price has declined even further to P18 a unit.

Contract price 100*P25 = 2,500

Market value 10*P18 = (1,800)

Purchase commitments loss P700

Inventory 1,800

Purchase commitments liability 500

Loss on purchase commitments 200

Accounts payable 2,500

Gain on purchase commitments

Gain on purchase commitments occurs when at the date of the actual purchase or before
the actual purchase, the market price of the product increases, the company will record a gain.
However, if the increase in the product occurred after the decline, the gain to be recorded should
be limited to the loss first recorded.

PROBLEMS

Theory question-MC 12-1

Any write-down of the inventory to the net realizable value and all losses of the inventory shall
be

a. Recognized as operating expense on the period the write-down or loss occurs

b. Recognized as other expense in the period the write-down or loss occurs
c. Recognized as component of cost of goods sold in the period the write-down or loss
occurs
d. Deferred until the related inventory is sold
Answer: C

Theory question-MC 12-2

What is the accounting principle which supports the inventories being valued at lower of cost or
net realizable value?

a. Revenue recognition principle

 b. Expense recognition principle
c. Conservatism
d. Lower of cost principle
Answer: C

Problem 12-3

By the end of the year the entity had 100 units in warehouse of Sung-gyi Co. Units are reported
at 10,000 total cost.

Recently a fire broke out and damaged the outer casing of units. Engineers have confirmed that
product can still fetch full selling price if outer cover is replaced. Currently Sung-gyi is selling
P110 per unit and cost of repair is estimated to P5 per unit. Additionally, entity will have to pay
P2,000 in total towards the carrying cost to move the repaired goods form workshop to
warehouse.

Compute the value to which inventory should be reported.

a. 10,000
b. 11,000
c. 8,500
d. 0
12-4 From the preceding problem, what is the net realizable value of the entity?

a. 10,000
b. 11,000
c. 8,500
d. 0
12-5 What amount is the loss from the inventory writedown?

a. 0
b. 1,000
c. 500
d. 1,500
Answers: B, B, D

Total cost of units 10,000

Total sales price (100*P110) 11,000

Less: Repair cost (100*5) 500

Carriage cost 2,000 (2,500) ( 8,500)

Loss on inventory write-down 1,500

NRV (8,500) < cost (10,000) therefore, inventory will be valued at 8,500 and recognize a loss of
1,500

Problem 12-6

Suzy Inc. makes miniature models of anime characters and Kpop Idols. Cost of year-end
inventory is 7,388. However, recent sales has fall in prices. Therefore its NRV is now 5,300
only.

Prepare the journal entry to record the write-down loss using:

1. Direct method
2. Allowance method
Answers:

1. Direct method

Inventory 5,300
Income summary 5,300

2. Allowance method

Loss on inventory write-down 2,088

Allowance for inventory write-down 2,088

(7,388-5,300 = 2,088)

Problem 12-7

Grams Company is a retailer of authentic furniture and fixtures. At year end, the entity have the
following inventory:

Total costs NRV

Dining tables 100,000 125,000

Rocking chairs 55,000 35,000

Sofas 70,000 62,000

Utensils cabinet 15,000 17,000

What is the inventory at year end?

a. 212,000
b. 239,000
c. 240,000
d. 251,000
Answer: A

LCNRV

Dining tables 100,000

Rocking chairs 35,000

Sofas 62,000

Utensils cabinet 15,000

212,000

Theory question-MC 12-8

What method might be used in the accounts to record a loss due to a price decline in the
inventory?

a. Record the inventory at net realizable value and then reduce it to cost, thereby reflecting a
loss in the current period.
b. Record the inventory at cost and then reduce it to net realizable value, thereby reflecting a
loss in the current period.
c. Record the inventory at selling price and then reduce it to cost, thereby reflecting a loss in
the current period.
d. Record the inventory at cost and then reduce at selling price, thereby reflecting a loss in
the current period.
Answer: B
Theory question-MC 12-9

What factors might call for inventory valuation at net realizable value?

a. When the cost of the inventory is higher than its net realizable value.
b. When there is no threat of obsolescence of the inventory.
c. When the company has able to protect the inventory from damages caused by typhoon.
d. When the cost of the inventory is lower than its net realizable value.
Answer: D

Problem 12-10

Presented below is the information related to Leesi Inc.’s inventory

(per unit) Skis Boots Parkas

Historical cost 190 106 53

Selling price 212 145 73.75

Cost to sell 19 8 2.5

Cost to complete 32 29 21.25

Determine the net realizable value for each item.

Problem 12-11 Determine the carrying value of each item under LCNRV.

Answer:

Item Cost NRV LCNRV

Skis 190 161 161

Boots 106 108 106

Parkas 53 50 50

Problem 12-12

Floyd Corporation has the following four items in its ending inventory

Item Cost NRV

Jokers 2,000 2,100

 Penguins 5,000 4,950

Riddlers 4,400 4,625

Scarecrows 3,200 3,830

Determine the total cost of the LCNRV

Problem 12-13 The amount written down, if any using an item-by-item LCNRV.

Problem 12-14 The amount of write-down using the total-group LCNRV valuation.

Solution:

Item Cost NRV LCNRV

Jokers 2,000 2,100 2,000

Penguins 5,000 4,950 4,950

Riddlers 4,400 4,625 4,400

Scarecrows 3,200 3,380 3,200

Total 14,600 15,505 14,550

Answers:

12-12 14,550

12-13 (14,600 – 14,550) 50

12-14 0, NRV>Cost

Problem 12-15

Kufal Inc. uses a perpetual inventory system. At January 1, 2011, inventory was P214,000,000 at
both cost and net realizable value. At December 31, 2011, the inventory was P286,000,000 at
cost and P265,000,000 at net realizable value.

Prepare the necessary December 31entry under the direct write-off method.

Answer:

Inventory-December 31, 2011 265,000,000

Income summary 265,000,000

Problem 12-16 Based on the preceding problem, prepare the necessary journal entries under the
allowance method.

Loss on inventory write-down 21,000,000

Allowance for inventory write-down 21,000,000

Problem 12-17

Dover Company began operations in 2010 and determined its year ending inventory at cost and
LCNRV at December 3, 2010 and December 31, 2011. This information is presented below.

Cost NRV

12/31/10 346,000 322,000

12/31/11 410,000 390,000

Determine the LCNRV for December 31, 2010 and 2011.

Answer:

LCNRV

12/31/10 322,000

12/31/11 390,000

Problem 12-18

From the preceding problem, prepare the journal entries required at December 31, 2010, and
December 31, 2011, assuming that the inventory is recorded at LCNRV, and a perpetual
inventory system using the cost-of-goods-sold method.

Answers:

12/31/10 Cost of Goods Sold 24,000

Allowance to Reduce Inventory to NRV 24,000

12/31/11 Allowance to Reduce Inventory to NRV 4,000

Cost of Goods Sold 4,000

Problem 12-19
Prepare journal entries required at December 31, 2010, and December 31, 2011, assuming that
the inventory is recorded at cost, and a perpetual system using the loss method.

Answers:

13/31/10 Loss Due to Decline of Inventory to NRV 24,000

Allowance to Reduce Inventory to LCNRV 24,000

13/31/11 Allowance to Reduce Inventory to NRV 4,000

Recovery of Inventory Loss 4,000

Cost of inventory at 12/31/10 346,000

LCNRV at 13/31/10 (322,000)

Allowance amount needed to reduce inventory to NRV 24,000

Cost of inventory at 13/31/11 410,000

LCNRV 12/31/11 (390,000)

Allowance amount needed to reduce inventory to NRV 20,000

Recovery of previously recognized loss 24,000

(20,000)

4,000

Problem 12-20

Which of the two methods above provide the higher net income in each year?

Answer: Both methods of recording lower-of-cost-or-NRV adjustments have the same effect on
net income.
 CHAPTER 13
Gross Profit Method

Valuing Inventory

An inventory valuation allows a company to provide a monetary value for items that make up
their inventory. Inventories are usually the largest current asset of a business, and proper
measurement of them is necessary to assure accurate financial statements. If inventory is not
properly measured, expenses and revenues cannot be properly matched and a company could
make poor business decisions.

A company will chose an inventory accounting system, either perpetual or periodic. In perpetual
inventory the accounting records must show the amount of inventory on hand at all times.
Periodic inventory is not updated on a regular basis.

Definition of Gross Profit Method

The gross profit method is a technique for estimating the amount of ending inventory. The gross
profit method might be used to estimate each month's ending inventory or it might be used as
part of a calculation to determine the approximate amount of inventory that has been lost due to
theft, fire, or other reasons.

The gross profit method assumes that a company’s gross profit rate in the current period is
similar to that of the previous periods. It estimates the cost of ending inventory by using the
relationship between cost of goods available for sale, cost of goods sold, and ending inventory in
the cost of goods sold model.

The gross profit method includes the following steps:

Step 1. Calculate the historical gross profit rate, as shown below,

¿
Historical Gross Profit Rate=Gross Profit ¿ prior Periods Net sales ¿ prior Periods ¿

Step 2. Calculate the cost of goods available for sale in the current period, as shown below,

Cost of Goods Available for Sale = Beginning Inventory + Net Purchases

Step 3. Estimate the gross profit for the current period, as shown below,
 Estimated Gross Profit= Historical Gross Profit Rate x Net Sales Revenue (current
period)

Step 4. Estimate the cost of goods sold for the period

Estimate Costs of Goods Sold= Net Sales Revenue (current period) – Estimated Gross
Profit

Step 5. Determine the estimated cost of the ending inventory

Ending Inventory= Cost of Goods Available for Sale – Estimated Cost of Goods Sold

Example: Gross Profit Method

Hardin Company has the following information related to its inventory:

Net Sales for the period 130,000

Beginning inventory, cost 10,000

Net purchases for the period 90,000

Estimated historical gross profit rate on net sales 40%

Solution:

Estimated gross profit rate (given) 40%

Beginning inventory, at cost 10,000

Net purchases 90,000

Cost of goods available for sale 100,000

Less: Estimated cost of goods sold:

Net sales 130,000

Gross profit rate x 0.40

Estimated gross profit 52,000

Sales 130,000

Estimated gross profit ( 52,000)

Cost of goods sold (130,000 – 52,000) (78,000)

Estimated cost of ending inventory 22,000

PROBLEMS

PROBLEM 1
How is the gross profit method used as it relates to inventory valuation?

a. Verify the accuracy of the perpetual inventory records.

b. Verity the accuracy of the physical inventory.
c. To estimate cost of goods sold.
d. To provide an inventory value of LIFO inventories.

PROBLEM 2
Which of the following is not a basic assumption of the gross profit method?

a. The beginning inventory plus the purchases equal total goods to be accounted for.
b. Goods not sold must be on hand.
c. If the sales, reduced to the cost basis, are deducted from the sum of the opening inventory plus
purchases, the result is the amount of inventory on hand.
d. The total amount of purchases and the total amount of sales remain relatively
unchanged from the comparable previous period.

PROBLEM 3
The gross profit method of inventory valuation is invalid when

a. a portion of the inventory is destroyed.

b. there is a substantial increase in inventory during the year.
c. there is no beginning inventory because it is the first year of operation.
d. none of these.

PROBLEM 4
Which statement is not true about the gross profit method of inventory valuation?

a. It may be used to estimate inventories for interim statements.

b. It may be used to estimate inventories for annual statements.
c. It may be used by auditors.
d. None of these.

PROBLEM 5
The following information is available for October for Barton Company.

Beginning inventory $ 50,000

Net purchases 150,000
Net sales 300,000
Percentage markup on cost 66.67%

A fire destroyed Barton’s October 31 inventory, leaving undamaged inventory with a cost of
$3,000. Using the gross profit method, the estimated ending inventory destroyed by fire is
a. $17,000.
b. $77,000.
c. $80,000.
d. $100,000.

ANSWER: a ($50,000 + $150,000) – ($300,000 ÷ 5/3) – $3,000 = $17,000.

PROBLEM 6
The following information is available for October for Norton Company.

Beginning inventory $100,000

Net purchases 300,000
Net sales 600,000
Percentage markup on cost 66.67%

A fire destroyed Norton’s October 31 inventory, leaving undamaged inventory with a cost of
$6,000. Using the gross profit method, the estimated ending inventory destroyed by fire is

a. $34,000.
b. $154,000.
c. $160,000.
d. $200,000.

ANSWER: a ($100,000 + $300,000) – ($600,000 ÷ 5/3) – $6,000 = $34,000.

PROBLEM 7
Miles Company, a wholesaler, budgeted the following sales for the indicated months:
June July August
Sales on account $1,800,000 $1,840,000 $1,900,000
Cash sales 180,000 200,000 260,000
Total sales $1,980,000 $2,040,000 $2,160,000

All merchandise is marked up to sell at its invoice cost plus 20%. Merchandise inventories at the
beginning of each month are at 30% of that month's projected cost of goods sold.

The cost of goods sold for the month of June is anticipated to be

a. $1,440,000.
b. $1,500,000.
c. $1,520,000.
d. $1,650,000.

ANSWER: d (1 +0 .2)C = 1,980,000

1.2 1.2
C = $1,650,000.
Merchandise purchases for July are anticipated to be
a. $1,632,000.
b. $2,076,000.
c. $1,700,000.
d. $1,730,000.

ANSWER: d COGS: July = $2,040,000 ÷ 1.2 = $1,700,000

Aug. = $2,160,000 ÷ 1.2 = $1,800,000
July's purchase = ($1,700,000 × .7) + ($1,800,000 ×0 .3) = $1,730,000.

PROBLEM 8
Reyes Company had a gross profit of $360,000, total purchases of $420,000, and an ending
inventory of $240,000 in its first year of operations as a retailer. Reyes’s sales in its first year
must have been

a. $540,000.
b. $660,000.
c. $180,000.
d. $600,000.

ANSWER: a $360,000 + ($420,000 – $240,000) = $540,000.

PROBLEM 9
On January 1, 2010, the merchandise inventory of Glaus, Inc. was $800,000. During 2010 Glaus
purchased $1,600,000 of merchandise and recorded sales of $2,000,000. The gross profit rate on
these sales was 25%. What is the merchandise inventory of Glaus at December 31, 2010?

a. $400,000.
b. $500,000.
c. $900,000.
d. $1,500,000.

ANSWER: c COGS = $2,000,000 × .75 = $1,500,000

$800,000 + $1,600,000 – $1,500,000 = $900,000.

PROBLEM 10
For 2010, cost of goods available for sale for Tate Corporation was $900,000. The gross profit
rate was 20%. Sales for the year were $800,000. What was the amount of the ending inventory?

a. $0.
b. $260,000.
c. $180,000.
d. $160,000.
ANSWER: b $900,000 – ($800,000 × .80) = $260,000.

PROBLEM 11
On April 15 of the current year, a fire destroyed the entire uninsured inventory of a retail store.

The following data are available:

Sales, January 1 through April 15 $300,000
Inventory, January 1 50,000
Purchases, January 1 through April 15 250,000
Markup on cost 25%

The amount of the inventory loss is estimated to be

a. $60,000.
b. $30,000.
c. $75,000.
d. $50,000.

ANSWER: a $50,000 + $250,000 – ($300,000/1.25) = $60,000.

PROBLEM 12
The sales price for a product provides a gross profit of 25% of sales price. What is the gross
profit as a percentage of cost?

a. 25%.
b. 20%.
c. 33%.
d. Not enough information is provided to determine.

ANSWER: c 25% ÷ (100% – 25%) = 33%.

PROBLEM 13
Gamma Ray Corp. has annual sales totaling $650,000 and an average gross profit of 20% of cost.
What is the dollar amount of the gross profit?

a. $130,000.
b. $97,500.
c. $108,333.
d. $162,500.

ANSWER: c $650,000 – ($650,000 ÷ 1.20) = $108,333.

PROBLEM 14
On August 31, a hurricane destroyed a retail location of Vinny's Clothier including the entire
inventory on hand at the location. The inventory on hand as of June 30 totaled $320,000. Since
June 30 until the time of the hurricane, the company made purchases of $85,000 and had sales of
$250,000. Assuming the rate of gross profit to selling price is 40%, what is the approximate
value of the inventory that was destroyed?

a. $320,000.
b. $181,500.
c. $205,000.
d. $255,000.

ANSWER: d ($320,000 + $85,000) – [$250,000 × (1 – 0.40)] = $255,000.

PROBLEM 15
On October 31, a fire destroyed PH Inc.'s entire retail inventory. The inventory on hand as of
January 1 totaled $680,000. From January 1 through the time of the fire, the company made
purchases of $165,000 and had sales of $360,000. Assuming the rate of gross profit to selling
price is 40%, what is the approximate value of the inventory that was destroyed?

a. $680,000.
b. $673,000.
c. $485,000.
d. $629,000.

ANSWER: d ($680,000 + $165,000) – [$360,000 × (1 – 0.40)] = $629,000.

PROBLEM 16
On March 15, a fire destroyed Interlock Company's entire retail inventory. The inventory on
hand as of January 1 totaled $1,650,000. From January 1 through the time of the fire, the
company made purchases of $683,000, incurred freight-in of $78,000, and had sales of
$1,210,000. Assuming the rate of gross profit to selling price is 30%, what is the approximate
value of the inventory that was destroyed?

a. $2,048,000.
b. $1,486,000.
c. $1,564,000.
d. $2,411,000.

ANSWER: c $1,650,000 + $683,000 + $78,000 – [$1,210,000 × (1 – 0.30)] = $1,564,000.

PROBLEM 17
Keen Company's accounting records indicated the following information:

Inventory, 1/1/10 $ 600,000

Purchases during 2010 3,000,000
Sales during 2010 3,800,000

A physical inventory taken on December 31, 2010, resulted in an ending inventory of $700,000.
Keen's gross profit on sales has remained constant at 25% in recent years.
Keen suspects some inventory may have been taken by a new employee. At December
31, 2010, what is the estimated cost of missing inventory?

a. $50,000.
b. $150,000.
c. $200,000.
d. $250,000.

ANSWER: a $3,800,000 × 0.75 = $2,850,000 (COGS)

$600,000 + $3,000,000 – $2,850,000 – $700,000 = $50,000

PROBLEM 18
An inventory taken the morning after a large theft discloses $60,000 of goods on hand as of
March 12. The following additional data is available from the books:

Inventory on hand, March 1 $ 84,000

Purchases received, March 1 – 11 63,000
Sales (goods delivered to customers) 120,000

Past records indicate that sales are made at 50% above cost.

Instructions
Estimate the inventory of goods on hand at the close of business on March 11 by the gross profit
method and determine the amount of the theft loss. Show appropriate titles for all amounts in
your presentation.

Solution

Beginning Inventory $ 84,000

Purchases 63,000
Goods Available 147,000
Goods Sold ($120,000 ÷ 150%) 80,000
Estimated Ending Inventory 67,000
Physical Inventory 60,000
Theft Loss $ 7,000

PROBLEM 19
On January 1, a store had inventory of $48,000. January purchases were $46,000 and January
sales were $90,000. On February 1 a fire destroyed most of the inventory. The rate of gross profit
was 25% of cost. Merchandise with a selling price of $5,000 remained undamaged after the fire.
Compute the amount of the fire loss, assuming the store had no insurance coverage. Label all
figures.

Solution
Beginning Inventory $ 48,000
Purchases 46,000
Goods available 94,000
Cost of sale ($90,000 ÷ 125%) (72,000)
Estimated ending inventory 22,000
Cost of undamaged inventory ($5,000 ÷ 125%) (4,000)
Estimated fire loss $18,000

PROBLEM 20
Utley Co. prepares monthly income statements. Inventory is counted only at year end; thus,
month-end inventories must be estimated. All sales are made on account. The rate of mark-up on
cost is 20%. The following information relates to the month of May.

Accounts receivable, May 1 $21,000

Accounts receivable, May 31 27,000
Collections of accounts during May 90,000
Inventory, May 1 45,000
Purchases during May 58,000

Instructions
Calculate the estimated cost of the inventory on May 31.

Solution

Collections of accounts $ 90,000

Add accounts receivable, May 31 27,000
Deduct accounts receivable, May 1 (21,000)
Sales during May $ 96,000

Inventory, May 1 $ 45,000

Purchases during May 58,000
Goods available 103,000
Cost of sales ($96,000 ÷ 120%) (80,000)
Estimated cost of inventory, May 31 $ 23,000
 Chapter 14

Retail Inventory Method

Retail inventory method is a method of estimating the value of the entity’s inventory
that are large in size which is stated in PAS 2, paragraph 22. It also provides the ending
inventory balance of an entity by measuring the cost of inventory relative to the price of the
goods.

Treatment of items under Retail Inventory Method

Cost Retail
Purchase Discount ✓
Purchase Returns ✓ ✓
Purchase Allowance ✓ (deductions from
purchases)
Departmental transfer out (credit) ✓ (deductions from ✓ (deductions from
purchases) purchases)
Departmental transfer in (debit) ✓ (addition to ✓ (addition to purchases)
purchases)
Sales discount
Disregarded
Sales allowance
Sales return Deducted from sales
Freight in ✓ (addition)
Employee Discounts Addition to sales
Normal shortage, shrinkage, spoilage, ✓ (deductions from
and breakage GAFS)
Abnormal shortage, shrinkage, spoilage, ✓ (deductions from ✓ (deductions from
and breakage GAFS) GAFS)

There are three approaches that can be used under the retail inventory method:

(1) Conservative or conventional or lower of cost and net realizable value approach
(2) Average cost approach
(3) FIFO approach
Illustration

Cost Retail
Beginning inventory P650,000 P1,000,000
Purchases 4,130,200 6,310,000
Net markup 400,000
 Net markdown 350,000
Sales 6,720,000
Normal Shoplifting Loss 120,000

Conservative and Average Cost

Cost Retail

Beginning inventory P650,000 P1,000,000

Purchases 4,130,200 6,310,000

Net markup . 400,000

GAS Conservative P4,780,200 P7,710,000

Cost Ratio (4,780,200/7,710,000) 62%

Net markdown . (350,000)

GAS Average P4,780,200 P7,360,000

Cost Ratio (4,780,200/7,360,000) 64.95%

Less: Sales (P6,720,000)

Normal Shoplifting Loss (P120,000)

Ending inventory at retail P520,000

Conservative cost (520,000*62%) P322,400

Average cost (520,000*64.95%) P337,740

PROBLEMS

1. SeaGod Company used the average retail inventory method to account for inventory. The
company gathered the following information:
Cost Retail
Beginning inventory P200,000 P704,000
Purchases 2,030,000 3,750,000
Purchase returns 35,000 32,000
Purchase discounts 40,000 80,000
Markup 150,000
Markup cancellation 72,000
Net markdown 120,000
Normal shoplifting losses 30,000
Sales 4,000,000

What amount should be reported as COST OF GOODS SOLD?

(a.) 1,987,380
(b.)1,880,000
(c.) 1,992,000
(d.)1,900,000
2. In the preceding problem what is the cost of inventory under lower of cost and net
realizable value?
(a.) 168,000
(b.)172,620
(c.) 150,000
(d.)186,000

3. Thalia Company used the conventional retail inventory method to account for inventory.
Thalia Company has the following information:
Cost Retail
Beginning inventory P800,000 P1,720,000
Purchases 4,320,000 7,750,000
Purchase returns 100,000 120,000
Purchase discounts 50,000 45,000
Markup 200,000
Markup cancellation 50,000
Net markdown 100,000
Employee discounts 50,000
Sales 6,350,000

1. What amount should be reported as COST OF GOODS SOLD?

(a.) 4,730,000
(b.) 4,370,000
(c.) 4,970,000
(d.) 4,900,000
4. Hokage Company had always measured finished goods at selling price and prepared the
following statement on this basis:

Sales P1,200,000
Raw materials used at cost 450,000
Labor 475,000
 Overhead 110,000
Total 1,035,000
Goods in process at cost
January 1 545,000
December 31 600,000 55,000
Cost of goods manufactured 980,000
Finished goods at selling price
January 1 300,000
December 31 800,000 500,000 500,000
Gross income 700,000

1. What is the amount of goods manufactured at retail?

(a.) 1,700,000
(b.)1,165,850
(c.) 2,000,000
(d.)300,000

5. Thief Company uses the average retail inventory method. On December 31, 2020 the
following information relating to the inventory was gathered:
Cost Retail
Inventory, January 1 P190,000 450,000
Purchases 2,990,000 4,750,000
Purchase Discounts 40,000
Freight-in 150,000
Markups 300,000
Markdowns 50,000
Sales 4,400,000
Sales return 100,000
Sales discount 50,000
Sales allowance 30,000

1. What is the estimated cost of inventory on December 31, 2020?

6. If the thief company uses the conventional method of retail inventory what is the cost of
ending inventory on December 31?
(a.) 368,500
(b.) 372,295
(c.) 347,215
(d.) 378,500

7. TS Company used the conventional retail inventory method to account for inventory
 Cost Retail
Beginning inventory P550,000 P1,500,000
Purchases 5,450,000 7,700,000
Net markup 400,000
Net markdown 100,000
Sales 6,500,000

1. What is the conventional cost ratio for TS Company?

(a.) 62%
(b.)63.83%
(c.) 63%
(d.)62.5%
2. What is the cost of ending inventory under conventional approach?
(a.) 343,750
(b.) 351,065
(c.) 333,750
(d.)434,750
8. What amount should be reported as cost of goods sold?
(a.) 5,648,000
(b.) 5,565,250
(c.) 5,656,250
(d.) 5,500,000

9. ADA Company uses the average cost retail inventory method:

Cost Retail
Beginning inventory P250,000 P470,000
Net purchases 1,200,000 3,000,000
Departmental transfer- credit 100,000 145,000
Net markup 150,000
Inventory shortage- sales price 94,000
Employee discounts 78,000
Net markdown 132,000
Sales 2,700,000

1. What is the estimated cost of ending inventory?

(a.) 182,936
(b.)190,189
(c.) 182,277
(d.)180,000
10. What is the estimated cost of ending inventory under conservative method?
(a.) 182,936
(b.)190,189
(c.) 182,277
(d.)180,000
 11. On December 31, 2018, the following information was available from Percy Company’s
accounting records:
Cost Retail

Inventory, January 1 P645,000 P1,015,000

Purchases 4,165,000 5,300,000

Additional markups ----- 210,000

4,810,000 6,525,000

Sales for the year totaled P5,035,000. Markdowns amounted to P70,000. Under the
conventional approach, what is the ending inventory on December 31, 2018?

(a.) 975,682
(b.) 1,420,000
(c.) 4,810,000
(d.) 795,282

12. Festus Company uses the conservative cost retail inventory method. The following
information is available for the year ended December 31, 2019.
Cost Retail
Inventory- January 1 P1,700,000 P2,250,000
Net Purchases 3,700,000 4,900,000
Net markup 250,000
Inventory shortage 100,000
Employee discounts 120,000
Sales (including sales of P400,000 of items which 4,000,000
were marked down from P500,000

1. What is the estimated cost of inventory on December 31, 2019?

(a.) 1,955,596
(b.)2,097,368
(c.) 1,555,596
(d.)2,997,368

13. What is the estimated cost of inventory under average method on December 31, 2019?
(a.) 2,097,368
 (b.)1,555,596
(c.) 2,997,368
(d.)1,955,596

14. Apollo Company used the conventional retail inventory method to account for inventory.
Cost Retail
Beginning inventory P750,000 P1,250,000
Purchases 5,350,000 7,240,000
Markup 145,000

Sales for the year totaled P6,500,00. Markdown amounted to P130,000.

1. Under the average cost approach what amount should be reported as cost of goods sold?
(a.) 4,700,000
(b.) 4,475,700
(c.) 4,745,000
(d.) 4,574,700

15. Athena Company provided the following data:

Beginning inventory

Cost P400,000

Selling price 675,000

Purchases

Cost P3,040,000

Selling price 4,535,000

Transportation in 45,000

Purchase discount 40,000

Purchase return:

Cost 25,000

Selling price 40,000

Sales return 60,000

Sales discount 20,000

Markup 75,000

Markdown 50,000

Cancellation of markup 25,000

Cancellation of markdown 15,000

Sales 4,000,000

a. What is the estimated cost of ending inventory using the lower of average cost and net
realizable value approach?
(a.) 609,472
(b.)582,200
(c.) 614,100
(d.)596,400

b. What is the estimated cost of ending inventory using the average cost approach?
(a.) 614,100
(b.) 616,859
(c.) 850,000
(d.) 616,589
16. Hypnos Company obtained the following information about the business:
2022 Cost Retail
Beginning Inventory P90,000 P132,000
Purchases 196,000 311,000
Purchase return 2,000 6,000
Net Markup 5,000
Net Markdown 2,600
Sales 500,000
Normal Spoilage and 12,000
Breakage
Departmental transfer out 5,000 8,000

1. Determine the ending inventory using the FIFO approach under the retail inventory
method?
(a.) 57,240
(b.)307,400
(c.) 217,200
(d.) 164,664
17. What is the cost of goods sold of Hypnos Company?
(a.) 57,240
 (b.)307,400
(c.) 217,200
(d.)164,664
18. Acolus company gathered the following information from its records in the year 2025
Cost Retail
Beginning inventory P70,000 P126,000
Purchases 340,000 438,000
Purchase returns (20,000) (20,000)
Purchase allowances (2,000)
Purchase discounts (1,000)
Freight in 4,000
Net markup 24,000
Net markdown (10,000)
Abnormal losses (22,000)
Departmental transfer out (9,000) (12,000)
P264,000 P524,000

19. Determine the cost of inventory on December 31, 2025 under the FIFO retail approach if
the company has a sale of P520,000? Janus supermarket uses the retail method of
inventory. At the end of May, the records provide the following:

Purchases during May: at cost P2,400,000; at retail P4,000,000

Sales during May: P3,200,000
Inventory, May 1: at cost P450,000; at retail P800,000
Markup: 40,000
Markdown: 20,000
Abnormal losses: 12,300
Inventory shortage: 14,000

Estimate the inventory and the cost of goods sold under the FIFO approach of retail inventory
method?

20. In the preceding problem what is the cost of goods sold to be recorded by the company?
 SOLUTIONS

Problem 1. ANSWER: A
Cost Retail
Beginning inventory P200,000 P704,000
Purchase 2,030,000 3,750,000
Purchase returns (30,000) (32,000)
Purchase discounts (40,000)
Markup 150,000
Markup cancellation . (72,000)
GAFS 2,160,000 4,500,000
Cost ratio- conservative 48%
(2,165,000/4,506,000)
Net markdown . (120,000)
GAFS 2,160,000 4,380,000
Cost ratio- average (2,160,000/4,380,000) 49.32 %
Less:
Sales (4,000,000)
Normal shoplifting losses (30,000)
Ending inventory 350,000
Average cost (350,000*49.32%) 172,620
GAFS 2,160,000
Less:
Ending Inventory (172,620)
COGS 1,987,380

Problem 2. ANSWER: A
Problem 3. ANSWER: B
Cost Retail
Beginning inventory P800,000 P1720,000
Purchase 4,320,000 5,750,000
Purchase returns (100,000) (120,000)
Purchase discounts (50,000)
Markup (200,000)
Markup cancellation . (50,000)
GAFS 4,970,000 7,100,000
Cost ratio- conservative 70%
(4,970,000/7,100,000)
Net markdown . (100,000)
GAFS 4,970,000 7,000,000
Cost ratio- average (4,970,000/7,000,000) 71%
Less:
Sales (6,350,000)
 Employee Discounts (50,000)
Ending inventory 600,000
Average cost (600,000*70%) 420,000
GAFS 4,970,000
Less:
Ending Inventory (600,000)
COGS 4,370,000

Problem 4. ANSWER: A

Cost Retail

Finished goods- January 1 172,950 300,000

Cost of goods manufactured 165,850 1,700,000

GAFS 338,800 2,000,000

Less: Finished Goods- December 31 461,200 800,000

COGS 800,000 1,200,000

Cost ratio: goods manufactured at cost/ goods manufactured at retail
(980,000/1,700,000) =57.65%
Finished Goods
January 1- 300,000*57.65% = 172,950
December 31- 800,000*57.65% = 461,200

Problem 5. ANSWER: B
Cost Retail
Inventory, January 1 190,000 450,000
Purchase 2,987,000 4,750,000
Purchase discounts (40,000)
Freight in 145,000
Markup . (300,000)
GAFS 3,283,000 4,900,000
Cost ratio- conservative 67%
(3,283,000/4,900,000)
Net markdown . (50,000)
GAFS 3,283,000 4,850,000
Cost ratio- average (3,283,000/4,850,000) 67.69%
Less:
Sales (4,400,000)
Sales return 100,000
 Ending inventory 550,000
Conservative cost (550,000*67%) P368,500

Average cost (550,000*67.69%) P372,295

Problem 6. ANSWER: A
Problem 7. ANSWER: D
Cost Retail
Beginning inventory P550,000 P1,500,000
Purchases 5,450,000 7,700,000
Net markup . 400,000
GAFS 6,000,000 9,600,000
Cost ratio- conservative (6,000,000/9,600,000) 62.5%
Net markdown . 100,000
GAFS 6,000,000 9,100,000
Cost ratio- average (6,000,000/9,100,000) 63.83%
Less:
Sales 8,550,000
Ending inventory 550,000
Average cost (550,000*62.5%) 343,750
GAFS 6,000,000
Less:
Ending Inventory (343,750)
COGS 5,656,250

Problem 8. ANSWER: C
Problem 9. ANSWER: B
Problem 10. ANSWER: A
Cost Retail
Beginning inventory P250,000 P470,000
Net purchases 1,200,000 3,000,000
Departmental transfer- credit (100,000) (145,000)
Net markup . 150,000
GAFS 1,350,000 3,475,000
Cost ratio- conservative 38.84%
(1,350,000/3,475,000)
Net markdown . (132,000)
GAFS 1,350,000 3,343,000
Cost ratio – average 40.38%
(1,350,000/3,343,000)
Less:
Sales (2,700,000)
 Inventory shortage- sales price (94,000)
Employee discounts (78,000)
Ending inventory 471,000
Conservative cost (471,000*38.84%) P182,936.4 or 182,936

Average cost (471,000*40.38%) P190,189.8 or 190,189

Problem 11. ANSWER: A

Cost Retail
Available for sale 4,810,000 6,525,000
Markdowns (70,000)
Sales (5,035,000)
Inventory – December 31 1,420,000
Conservative cost ratio (4,810,000/7,000,000) 68.71%
Inventory – December 31 at cost 975,682

Problem 12. ANSWER: A

Problem 13. ANSWER: A
Cost Retail
Inventory- January 1 P1,700,000 P2,250,000
Net Purchases 3,700,000 4,900,000
Net markup 250,000
GAFS 5,400,000 7,400,000
Cost ratio- conservative 72.97%
(5,400,000/7,400,000)
Net markdown . (100,000)
GAFS 5,400,000 6,900,000
Cost ratio- average (5,400,000/6.900,000) 78.26%
Less:
Sales (4,000,000)
Inventory shortage (100,000)
Employee discounts (120,000)
Ending inventory 2,680,000
Conservative cost (2,680,000*72.97%) P1,955,596

Average cost (2,680,000*78.26%) P2,097,368

Problem 14. ANSWER: D

Cost Retail
Beginning inventory P746,000 P1,354,800
Purchases 5,350,100 7,240,000
 Net markup . 145,200
GAFS 5,996,100 8,690,000
Cost ratio- conservative (5,996,100/8,690,000) 69%
Net markdown . 130,000
GAFS 5,996,100 8,560,000
Cost ratio- average (5,996,100 /8,560,000) 70.05%
Less:
Sales 6,500,000
Ending inventory 2,060,000
Average cost (2,060,000*69%) 1,421,400
GAFS 5,996,100
Less:
Ending Inventory (1,421,400)
COGS 4,574,700

Problem 15. ANSWER: C

ANSWER: B

Cost Retail

Beginning inventory 400,000 675,000

Purchases 3,070,000 4,300,000

Transportation in 45,300

Purchase return (25,000) (40,000)

Purchase discount (30,000)

Markup 75,000

Cancellation of markup . (25,000)

GAFS 3,430,600 4,985,000

Cost ratio – conventional 69%

(3,450,000/4,985,000)

Markdown (50,000)

Cancellation of markdown . 15,000

GAFS 3,430,600 4,950,000

Cost ratio – average 69.31%

(3,430,600/4,950,000)
 Less:

Sales 4,000,000

Sales return (60,000)

Ending inventory at selling 890,000

price
Conservative cost (890,000*69%) P614,100

Average cost (890,000*69.31%) P616,859

Problem 16. ANSWER: A

2022 Cost Retail
Beginning Inventory P90,000 P300,000
Purchases 186,480 311,000
Purchase return (2,040) (6,000)
Net Markup 5,000
Net Markdown . (2,600)
(184,440/307,400) 60% 184,440 307,400
GAFS 274,440 607,400
Sales (500,000)
Normal Spoilage and (12,000)
Breakage
Ending inventory at retail 95,400

FIFO cost (95,400*60%) = 57,240

GAFS 274,440

Ending inventory (57,240)

217,200

Problem 17. ANSWER: C

Problem 18. Solution
Cost Retail
Beginning inventory P70,000 P126,000
Purchases 347,000 450,000
Purchase returns (20,000) (20,000)
Purchase allowances (2,000)
Purchase discounts (1,320)
 Freight in 5,000
Departmental transfer out (9,000) (12,000)
Net markup 24,000
Net markdown . (10,000)
(319,680/432,000) 74% 319,680 432,000
GAFS 389,680 558,000
Less:
Sales (520,000)
Abnormal losses (22,000)

16,000

FIFO cost (16,000*74%) = 11,840

Problem 19.
Cost Retail
Beginning inventory P450,000 P800,000
Purchases 2,371,800 4,002,830
Net markup 37,170
Net markdown . (20,000)
(2,371,800/4,020,000) 59% 2,371,800 4,020,000
GAFS 2,821,800 4,820,000
Less:
Sales (3,200,000)
Abnormal losses (12,300)
Inventory shortage (14,000)
Ending inventory at retail 1,593,700

FIFO cost (1,593,700*59%) = 940,283

GAFS 2,821,800

Ending inventory (1,593,700)

COGS 1,228,100

Problem 20. ANSWER: P1,228,100

CHAPTER 15

FINANCIAL ASSET VALUE AT FAIR VALUE

Learning Objectives:

 To define a financial asset

 To know the three classifications of financial asset in accordance with the PFRS 9
 To determine the initial and subsequent measurement of financial asset
 To understand the measurement of financial asset at FVPL,FVOCI and at amortized cost
of equity and debt investments

Definition of financial asset

Financial asset refer to assets that arise from contractual agreements on future cash flows or from
owning equity instruments of another entity.

Financial assets include:

 Cash
 Equity instruments of an entity- for example a share certificate
 A contractual right to receive a financial asset from another entity-known as receivable
 The contractual right to exchange financial assets for liabilities with another entity under
favorable conditions
 A contract that will settle in an entity’s own equity instruments

Not considered financial assets

 Property, plant and equipment

 Inventory
 Intangible assets
 Prepaid expenses
 Leased assets
 Intellectual properties

Classification of financial assets

In accordance PFRS 9, paragraph 4.1.1, financial assets are to be classified in the following three
categories:

1. Financial asset at fair value through profit and loss- including both equity securities and
debt securities.
 2. Financial asset at fair value through other comprehensive income- including both equity
securities and debt securities.
3. Financial asset at amortized cost – including only the debt securities.

What is an equity security?

Equity security is a financial instrument that representing an ownership of shares and right,
warrants or options in a corporation.

Examples:

 Common stock
 Preferred stock
 Put and call options

What is a debt security?

Debt security is a financial asset the relationship between the issuer and an investor.

Examples:

 Corporate bonds
 Commercial papers
 BSP treasury bills
 Government securities
 Redeemable preferred stock

Initial measurement of financial asset

In accordance to the PFRS 9, at initial recognition, an entity shall measure financial asset at its
fair value plus the transaction cost directly attributable to the acquisition of the financial asset in
the case of financial asset at fair value through profit or loss.

At the time of initial recognition, the financial asset held for trading are recognized at fair value
through profit or loss, not including the transaction cost which are expensed outright.

Subsequent measurement

After the initial recognition, the entity classifies it based on the entity’s business model for
managing the asset and the asset’s contractual cash flows, as follows:

 Fair value through profit or loss

 Fair value through other comprehensive income
  Amortized cost

Financial assets at fair value through profit or loss

Financial asset measured at “fair value through profit or loss” are the following:

 Financial asset held specifically for trading purposes

-financial assets held for trading purposes are also known as trading securities. It is held
for trading if the entity acquired it for the purpose of selling it in the near future.
 Financial asset to be measured at fair value under the fair value option at designation
- The fair value option is applicable to all financial investments which can be
irrevocably designated as fair value through profit or loss although it can satisfy the
financial asset at fair value through other comprehensive income and amortized cost.

Gain or loss – Financial asset at fair value

Gains and losses on “Financial assets at fair value through profit or loss” are immediately
booked to the Income Statement.

Illustration

To record the acquisition

Trading securities xx

Cash xx

To record the increase in fair value

Trading securities xx

Unrealized gain- TS xx

To record the decrease in fair value

Unrealized loss xx

Trading securities xx

Sale of trading securities

 Gain

Cash xx

Trading securities xx

Gain on sale of trading securities xx

  Loss

Cash xx

Loss on sale of trading securities xx

Trading securities xx

Equity investment at fair value through other comprehensive income

Illustration

To record the acquisition

Financial asset-FVOCI xx

Cash xx

FVOCI – it means the financial asset is measured at fair value through OCI

To record the increase in the market value

Financial asset-FVOCI xx

Unrealized gain-OCI xx

To record the decrease in the market value

Unrealized loss- OCI xx

Financial asset- FVOCI xx

Sale of equity investment

 Gain

Cash xx

Financial asset-FVOCI xx

Retained earnings xx

 Loss

Cash xx
Retained earnings xx

Financial asset-FVOCI xx

The gain or loss in the equity investment at fair value through OCI is recognized in the retained
earnings.

Debt investment at amortized cost

Amortized cost classification applies predominantly to debt investment which meets the
following criteria:

 The business model of the company which owns such financial assets is to collect the
contractual cash flows rather than sell the asset to realize any capital gains.
 The contractual cash flows of specific financial asset under consideration are on account
of repayment of principal and interest and they occur on specified dates.

Debt investment at fair value through OCI

Financial asset are classified and measured at fair value through other comprehensive income if
the following criteria are met:

 The business model whose objective is achieved by both collecting contractual cash
flows and selling financial assets.
 The contractual cash flows of specific financial asset under consideration are on account
of repayment of principal and interest and they occur on specified dates.
TRUE or FALSE

________1.The fair value option is applicable to all financial instruments.

________2.The gain or loss in the equity investment at fair value through OCI is not recognized
in the retained earnings.

________3.The financial asset-FVOCI is normally classified as current asset.

________4.Financial asset is recognized initially at fair value.

________5.Intangible assets, physical assets, prepaid expenses and leased expenses are
considered as financial assets.

________6.The unrealized loss is reported in the income statement as other income.

________7.The unrealized gain is reported in the income statement as other income.

________8.The gain or loss in the sale of trading securities is reported in the income statement.

________9.If the fair value is higher than the carrying amount the difference is an unrealized
loss.

________10. If the fair value is higher than the carrying amount the difference is an unrealized
gain.

Answer key

1. TRUE
2. FALSE
3. FALSE
4. TRUE
 5. FALSE
6. FALSE
7. TRUE
8. TRUE
9. FALSE
10. TRUE

Problem 15-1

At the beginning of the year , Gem company purchased marketable equity securities as a trading
investment.

For the year ended December 31,2019, the company recognized an unrealized loss of P300,000

There were no security transactions during 2020. The entity provided the following information
on December 31, 2020:

Security Cost Market value

A 3,000,000 2,400,000
B 1,800,000 2,200,000
4,800,000 4,600,000

In the 2020 income statement, what amount should be reported as unrealized gain or loss?

a. Unrealized gain 100,000

b. Unrealized loss 150,000

c. Unrealized gain 150,000

d. Unrealized loss 100,000

Solution 15-1 Answer a

Market value-December 4,600,00

31,2020 0
Carrying amount equal to market value
4,500,00
on December 31,2019 0
Unrealized gain in 2020 100,000

4,800,00
Cost 0
Unrealized loss-2019 300,000
Market value- December 4,500,00
31,2019 0

Problem 15-2

On December 31,2019, Kayos Company appropriately reported a P200,000 unrealized loss

Securit Market value (December

y Cost 31,2020)
3,000,00
A 0 2,400,000
1,800,00
B 0 2,100,000
2,000,00
C 0 1,500,000
6,800,00
0 6,000,000

1.What is the market value of the investment on December 31,2019?

a.6,700,000

b.6,600,000
c.6,800,000

d.6,500,000

2.What amount of loss on these securities should be included in the statement of comprehensive
income for the year ended December 31, 2020 as component of other comprehensive income?

a.0

b.500,000

c.600,000

d.800,000

3.What cumulative amount of loss on these securities should be reported in the statement in
changes of equity for the year ended December 31,2020 as component of other comprehensive
income?

a.0

b.500,000

c.600,000

d.800,000

Solution 15-2

1. Answer b

6,800,00
Total cost 0
Unrealized loss in 2019 (200,000)
6,600,00
Market value - December 31,2019 0

2. Answer c

Market value-December 31,2020 6,000,000

Market value-December 31,2019 (6,600,000
 )
Unrealized loss in 2020 (600,000)

3. Answer d

Market value-December 31,2020 6,000,000

(6,800,00
Original historical cost 0)
Cumulative unrealized loss- December
31,2020 (800,000)

Problem 15-3

At te beginning of the current year, Magma Company purchased marketable equity securities to
be held as trading for P3,000,000. The entity also paid transaction cost amounting to P500,000.

The securities has a market value of P3, 300,000 at the year end and the transaction cost that
would be incurred on sale is estimated at P100,000. No securities were sold during the current
year.

What amount of unrealized gain or loss on these securities should be reported in the income
statement for the current year?

a.300,000 loss

b.300,000 gain

c.200,000 loss

d.200,000 gain

Solution 15-3 Answer b

3,300,00
Fair value 0
3,000,00
Acquisition cost-Trading 0
Unrealized gain- included in profit or loss 300,000
CHAPTER 16
EQUITY INVESTMENTS
Dividends, Share split and Share Right

Definition
 Investments are assets acquired to earn additional profit aside from the revenue
producing activities or the ordinary course of business. Thus, Investments can be equity or debt
securities.

Acquisition of Investments Measurement

According to PFRS 9 which takes place the requirement of PAS 39 (Recognition and
Measurement), financial asset shall be initially recognized at fair value which is considered as
the transaction price plus transaction cost directly attributable to the acquisition.

Note that directly attributable transaction cost of financial asset must be capitalized
except when the financial asset acquired is held for trading which must be expense outright.

Acquisition by Exchange Measurement in order of priority

1.) Fair Value of asset given

2.) Fair Value of asset received
3.) Carrying amount of asset given

If more than two financial assets are acquired in a lump sum or at a single cost, the cost must be
allocated based on the fair value of each financial asset.

The single cost of financial asset must be allocated to the one that has known market value and
the remainder shall be allocated to those financial assets that do not have market value.

Classification of Investments in Equity

1. Financial Asset at fair value through profit or loss (FVPL)

2. Financial Asset at fair value through other comprehensive income (FVOCI)
3. Investment in Associate
4. Investment in Subsidiary
5. Investment in unquoted equity instrument (measured at cost if fair value is cannot be
determined)

Sale of Equity Shares

According to Paragraph 3.2.12 of PFRS 9, the difference between net proceeds from sale
and the carrying amount of the investment measured at fair value through profit or loss shall be
taken as gain or loss.

In case of sale of same class equity share acquired on different dates at different costs,
FIFO or Average Cost Approach must be used in determining the cost of shares sold.

DIVIDENDS

Significant dates in dividends distribution

 a. Date of Declaration – when Board of Directors declares the distribution of dividends and
approved the payment.
b. Date of Record – the entity will provide the actual list of shareholders who are entitled to
receive dividends. (NO ENRTY)
c. Date of Payment – dividends are distributed and paid to the shareholders.

Shares Selling: Shares Selling:

Date of Date of Record Date of
“Dividend-on” “Ex-Dividend”
Declaration Payment
Shares sold are Only shares are sold,
carrying the right the right to receive
to receive dividends are still in the
dividends. original shareholder.

Dividends shall be recognized as income when right to receive payment is established. However,
dividends shall be recognized as income at the date of declaration because at that date legal
liability to the corporation arises.

CASH DIVIDENDS

Accordingly, cash dividends are recognized as income as when received or becomes

receivable if securities are measured at fair value through profit or loss, or at fair value though
other comprehensive income. However, cash dividends do not affect investment account.

Illustration
Assume that Aries Corporation acquired 2,000 shares of Mary Corporation at P100 per share. If
Aries received P15 per share cash dividend, the entry is:

Cash (2000x15) 30,000

Dividend Income 30,000

In case Aries sells the investment for 180,000, the entry will be:

Cash 180,000
Loss on sale of Investment 50,000
Investment in shares (2,000x100) 200,000
Dividend Income (2,000x15) 30,000

PROPERTY DIVIDENDS

Dividends distributed in the form of non-cash asset which are considered income and
recorded at fair value by the investor.
Illustration
Assume that Mary Corporation distributes 2,000 shares of Conor Corporation which are held as
investment by Mary Corporation with a fair market value of P120 per share as a property
dividend in Aries Corporation, the entry in Aries Corporation is:

Investment in shares (2,000x120) 240,000

Dividend Income 240,000

LIQUIDATING DIVIDENDS

When the entity have the intention to close the business believing that it can no longer
generate profit, liquidating dividends are distributed and paid either in the form of cash or non-
cash assets as a return of invested capital but not an income.

Note the when liquidating dividends exceeds the cost of investment, the difference is credited to
gain on investment. In contrast, when investment greater than the liquidating dividend received,
the balance is written off as a loss.

Illustration
Assume that a shareholder of Aries Corporation receives P80,000 dividend as an equal amount to
his investment, the entry in Aries Corporation is:

Cash or other appropriate account 80,000

Investment in shares 80,000

SHARE OR STOCK DIVIDENDS

Shares dividend in which the entity issues its own shares and is also known as bonus
issue. Share dividends can be same class held by shareholder or different from the class held by
the shareholder. Share dividends in whatever class are not an income.

SHARE DIVIDENDS OF SAME CLASS

Share dividends are recorded as memorandum entry. Share dividends affect the carrying
value per share held by the investor without affecting the total cost of investment.

Illustration
Assume that a shareholder of Aries Corporation acquired 500 shares costing P60,000 or P120 per
share. Shareholder receives 100 share dividends. The entry is:

Memo Entry: Received 100 new shares of Aries Company representing share dividend on 500
original held. Shares new held, 600 shares.
However, the cost per share now is P100 computed as P60,000 total cost divided by 600 new
shares.

SHARE DIVIDENDS DIFFERENT FROM THOSE HELD

Original cost of the investment is allocated between the original shares and the share
dividends on the basis of market value of each at the date of receipt.

Illustration
Assume that a shareholder of Aries Corporation acquired 500 ordinary shares costing P60,000.
Shareholder receives 100 share dividends (preference share). The market value of ordinary and
preference share is P110 and 90, respectively. The entry is:

Investment in Preference Share

Investment in Ordinary Share

Original Cost: P60,000

Allocated Cost
Share Dividend: 100 shares Fraction
20,000 (Market
Ordinary Shares: 100 shares x 110 = 11,000 11/20x60,000 33,000
Value)
Preference Shares: 100 shares x 90 = 9,000 9/20x60,000 27,000

SHARES RECEIVED IN LIEU OF CASH DIVIDEND

Considered as income at fair value of the shares received, if fair value is cannot be
determined, the income shall be equal to the cash dividends that would have been received.

To record receipt of shares

Investment in Shares xxx
Dividend Income (Number of shares x fair value per share) xxx

CASH RECEIVED IN LIEU OF SHARE DIVIDEND

A.) AS-IF APPROACH

The share dividends are assumed to be received and subsequently sold at the cash
received. Thus, there can be gain or loss to be recognized.

Illustration
Assume that a shareholder of Aries Corporation acquired 500 ordinary shares costing P60,000.
Shareholder receives P15,000 cash in lieu of 100 share dividends. The P60,000 cost will be
applied to 600 new shares and the cost per share will be P100.

Cash 15,000
Investment in Share (100 shares x 100) 10,000
Gain on Investment 5,000
 B.) BIR APPROACH
The cash received will be recognized as income, as is.

Cash 15,000
Dividend Income 15,000

SHARES SPLIT

Shares split do not affect the equity (retained earnings). Only memorandum entry is
necessary in share split. Share split can be:

A.) Split Up – original shares are replaced by a larger number of shares which results to a
decrease in par value per share.
Example:
A shareholder owns 1,000 shares and the share split up 5-for-1. The shareholder
receives 5,000 new shares (1000 x 5).
B.) Split Down – original shares are replaced by a smaller number of shares which
results to an increase in par value per share.
Example:
A shareholder owns 1,000 shares and the share split up 1-for-5. The shareholder
receives 200 new shares (1,000/ 5).

SPECIAL ASSESSMENTS

Additional capital contribution of the shareholders and recorded as additional cost of the
investment through debiting to Investment in shares account and crediting cash account.

REDEMPTION OF SHARES

Only Preference Share can be called for redemption, thus, it is recorded the same way as
sale of share.

SHARE RIGHT

Share rights are intact to every share, which means that the number of share rights is
equal to the number of shares held. However, in such cases, there can be specified number of
rights required in acquiring a share. PFRS 9 stated that investment in equity instruments must be
measured at fair value.

Three important dates in issue of rights:

a.) Date of declaration of rights

 b.) Date of issue of rights
c.) Date of rights expiration

ACCOUNTING FOR SHARE RIGHTS

1.) Accounted for separately

2.) Not Accounted for separately

Between the Date of Declaration and Date Between the Date of Record and
of Record Expiration Date
 Shares that are selling are right-on  Shares that are selling are ex-right
which means that shares and rights are which means that shares and rights are
treated as one. treated separately.
 Shares and rights cannot be sold  Shares and rights can be sold
separately. separately.

Illustration:
Toto Lee purchased 6,000 shares worth P750,000 and received 6,000 share rights to subscribe
for new shares at P120 per share for every 3 rights held. The market value per share and right is
P140 and 8, respectively.

Accounted for Separately Not Accounted for Separately

Original Investment in Shares 750,000 Investment in Shares 750,000
Investment Cash 750,000 Cash 750,000
Receipt of (6,000 rights x 8) Memorandum Entry:
Share Right Share rights 48,000 Received 6,000 share rights to subscribe for
Investment in shares 48,000 new shares at P120 per share for every 3
rights held, or a total of 2,000 new shares.
Exercise of (6,000 / 3 x 120) = 240,000 (2,000 new shares x 120) = 240,000
Share Rights Investment in shares 288,000 Investment in shares 240,000
Cash 240,000 Cash 240,000
Share rights 48,000
Share Rights Cash 48,000 Cash xxx
are not Share rights 48,000 Share rights xxx
exercised
but sold Note: There can be gain or loss on sale. Note: There is NO gain or loss on sale. The
amount debited and credited is the amount
of sale.
Expiration Loss on share rights xxx
of share Share rights xxx
rights Memorandum Entry
Note: The amount debited and credited is
the amount expired or not exercised.
 If there is no fair value the theoretical or parity value based on market value of the
share shall be used.

When the share is selling right-on When share is selling ex-right

Market value of share right on Market value of share ex-right
minus subscription price Value of one minus subscription price Value of one
= =
Number of rights to purchase right Number of rights to purchase right
one share plus 1 one share

PROBLEMS

During 2019, Jack Company acquired shares of Jill Company.

April 1 15,000 shares @ P90 P1,350,000
August 1 25,000 shares @ P100P2,500,000

Transactions for 2019

February 15 Received 20% share dividend.
May 20 Received cash dividend of P20 per share
November 10 Sold 20,000 shares @ P100 per share
1.) What is the gain on the sale of shares under FIFO approach?
a.) 483,333
b.) 652,400
c.) 450,000
d.) 553,667
2.) What is the gain on sale of share if Average method is used?
a.) 495,667
b.) 395,833
c.) 555,000
d.) 552,847
3.) What is the dividend income for the year?
a.) 900,000
b.) 800,000
c.) 960,000
d.) 1,200,000

Floor Company owns 15,000 shares of 150,000 Luna’s Company shares. On July 1 of 2018,
Luna Company declared and paid P2,000,000 dividends.

1.) What is the dividend income to be reported by Floor Company?

 a.) 300,000
b.) 200,000
c.) 400,000
d.) 150,000

On September 2019, Josh Company acquired 20,000 shares at 90 per share. Subsequently, Josh
Company received 20,000 share rights to purchase 1 share for 5 share rights at P80 per share. On
December 1, the market value of each shares and share rights are P88 and 10, respectively.

1.) What should be the amount to be recorded as Investment in share rights on December 1?
a.) 90,000
b.) 100,000
c.) 120,000
d.) 200,000
2.) What should be the amount to be recorded as Investment in shares through the exercise of
share rights?
a.) 880,000
b.) 900,000
c.) 200,000
d.) 520,000

Amanda Company issued share rights to subscribe to its stock, the ownership of 5 shares
entitling the shareholders to subscribe for 1 share at P110. Dawson Company owns 20,000 shares
of Amanda Company costing P2,200,000. The share is quoted right-on at P130. What is the cost
of the new investment in shares if all of the share rights are exercised?

a.) 605,500
b.) 500,400
c.) 506,600
d.) 500,000

TRUE OR FALSE

1.) The single cost of investment acquired or in a lump sum is allocated based on its par
value or stated value. FALSE
2.) The order of priority is not necessary in determining the cost of investment acquired by
exchange. FALSE
3.) Ana received cash dividend of P10 per share. Her share was determined to be 50,000,
therefore, Ana received P500,000 dividend income. In such case, cash dividend received
by Ana affects her investment account. FALSE
4.) When the shares are sold after the date of declaration but before the date of record, the
shares sold carry the right to receive dividends. TRUE
 5.) When the shares are sold after the date of record but before the date of payment, original
shareholder has still the right to receive dividends. TRUE
6.) Property Dividend can be in the form of Merchandise. TRUE
7.) When liquidating dividend received the amount will be debited to cash or other
appropriate account (other non-cash asset account), which should be considered and
recorded as income. FALSE
8.) Danica has an original share of 5,000 at P50 per share or P250,000. On July 30, Danica
received 500 share dividends. The total share of Danica as of July 30 is 5,500, therefore,
the total cost of her share is P275,000. FALSE
9.) Share dividend increases the total number of shares while maintaining the total cost
which results to a reduction in cost per share. TRUE
10.) Split up increases both number of shares and cost per share. FALSE
11.) Split down decreases number of shares and maintaining the total cost of shares. TRUE
12.) Since Share split reduces or increases the number of shares, therefore, it has a direct
effect to the total cost of shares held. FALSE
13.) There can be a loss or gain in upon receiving of liquidating dividends. TRUE

CHAPTER 17
INVESTMENT IN ASSOCIATE
Basic Principles

Types of Investments
Through the concept of “intercorporate share investment”, an entity may have a
significant influence or may control the financial and operating activities of another entity by
purchasing its equity shares.

Below 20%
Financial Asset at Fair 20% to 50% Above50%
Value Significant Influemce Control

Outstanding Ordinary Shares of an Investee

Ownership of less than 20% of outstanding ordinary shares of an investee does not
manifest significant influence over the investee entity. In order to have the power to participate
in the financial and operating policy decisions, an investor must own 20% to 50% of the
outstanding ordinary shares.

With such investment, an investor can be said to have a significant influence over the
investee entity and it is so-called “investment in associate”. Such influence carries on potential
voting rights which should be currently exercisable or convertible.
 On the other hand, having beyond 50% of the equity shares demonstrates power to
govern or control over the entity and known as “investment in subsidiaries”.

Investment in Associate

The existence of significant influence is usually based on meeting the required rate of 20-
50% ownership of outstanding ordinary shares. However, PAS 28 paragraph 6 states that this
threshold does not always demonstrate it. There are some factors that evidence significant
influence which includes:

 Material transactions between parties involved

 Representation in the board of directors
 Partaking in policy making

Meanwhile, an investor may lose its significant influence over an investee through:

 Contractual agreement
 Control of the government, court or regulator against the associate

This results to loss of the power to participate in the financial and operating policy
decisions of the investee.

Accounting Procedures for Investment in Associate

Equity Method
 Follows the movement of the equity of the associate
 Economic relationship wherein the investor and the investee are viewed as a
single economic unit
 Under this method, investment is classified as noncurrent asset and cash dividend
is not treated as an income but a return of investment
 Dividend distributions reduce the carrying amount of the investment

Illustration

1. At the beginning of the year, C Company acquired 30,000 shares which represent 30% of
outstanding ordinary shares of D Company for P100 per share. The acquisition cost
equaled the carrying amount of net assets acquired.
Investment in associate P3,000,000
Cash P3,000,000
2. D Company reported net income of P6,000,000 for the current year. C Company
recognized 30% share of the net income.
Investment in associate P1,800,000
Cash P1,800,000
3. D Company issued 10% share dividend.
 MEMO ENTRY: Received 3,000 ordinary shares representing 10% share dividend on
30,000 shares. (The share dividend will not affect the equity interest.)
4. On the following year of operation, D Company reported a net loss of P2,000,000.
Loss on investment P600,000
Investment in associate P600,000
5. On the same year, the investee declared and paid cash dividend of P2,000,000.
Cash P600,000
Investment in associate P600,000

Treatment of Heavy Losses

PAS 28, paragraph 38, provides that if an investor’s shares of losses of an associate
equals or exceeds the carrying amount of an investment, the investor discontinues recognizing its
share of further losses.

When the associate reports income, the investor resumes until its share in the net income
covered unrecognized share in losses.

Impairment Loss

PAS 28, paragraph 40, requires that an impairment loss shall be recognized whenever the
carrying amount of the investment in associate exceeds recoverable amount.

Recoverable amount must be determined between fair value less cost of disposal and
value in use, whichever is higher. The impairment loss recognized applies wholly to the
investment.

Preference Shares

In case an investee has outstanding cumulative preference shares:

 Investor computes its share of earnings or losses after deducting the preference dividends,
regardless of when there is a declaration of dividends or none.

In case an investee has outstanding noncumulative preference shares:

 Investor computes its share of earnings after deducting the preference dividends only
when it was declared.

Other Changes in Equity

A change in the investor’s proportionate interest is inevitable due to changes in the

investee’s equity such as revaluation of property, plant and equipment and differences arising
from foreign exchange translations. The share of the investor in these changes is recognized
directly in equity.

True or False

1. If an investor company owns 52% of the outstanding ordinary shares of an investee

company, the investor company merely has a significant influence over the other. F
2. Due to a possible neglect of corporate duty, Shai Company was subjected to government
control. If Bossing Company has a significant influence on Shai Company, Bossing
Company losses the power to partake in the financial decisions of Shai Company due to
the incident. T
3. The sole way to have a significant influence over an investee company, an investor must
acquire more than 20% but not more than 50% of the outstanding ordinary shares. F
4. The investor’s share of the profit or loss of the investee is recognized as investment
income. T
5. The goodwill is not included in the carrying amount of the investment. F
6. The excess of cost attributable to goodwill is amortized. F
7. The entire investment in associate excluding goodwill is tested for impairment at the end
of each reporting period. F
8. Dividend distributions reduce the carrying amount of the investment. T
9. Under the equity method, the investor and the investee are not one and not the same but
they are viewed as single economic unit. F
10. The equity method is applicable even if the investor does not have a significant influence
over the investee. F

Problems

1. Paul Company acquired 20% of the outstanding ordinary shares of Mich Company for
P8,000,000. The carrying amount of the acquired net assets was P7,200,000. The excess
cost over carrying amount was attributed to an undervalued equipment on the investee’s
balance sheet. The asset had a remaining useful life of 5 years.

For the current year, Mich Company reported net income of P2,000,000 and paid cash
dividend of P750,000.

What is the carrying amount of the investment in associate at year end?

a. P7,840,000
 b. P8,000,000
c. P8,090,000
d. P8,690,000

2. On January 1, 2020, Fallen Grace Company purchased 10% of Willford Company’s

outstanding ordinary shares for P3,000,000. Fallen Grace Company is the largest single
shareholder of Willford. Majority of Willford company’s board of directors are Fallen
Grace’s officers.

The investee reported net income of P4,000,000 for the current year and paid cash
dividend of P1,500,000.

What amount should be reported as investment in Willford Company at year end?

a. P400,000
b. P3,250,000
c. P3,400,000
d. P3,690,000

For items 3-5, refer to this problem.

At the beginning of the current year, Halterground Company purchased 40% of the
outstanding ordinary shares of Fantasia Company, paying P6,400,000 when the carrying
amount of the net assets of Fantasia Company equaled P12,500,000.

The difference was attributed to equipment which had a carrying amount of P3,000,000
and fair market value of P5,000,000 and to building which had carrying amount of
P2,500,000 and a fair value of P4,000,000. The remaining useful life of the equipment
and building was 4 years and 12 years, respectively.

During the current year, Fantasia Company reported net income of P5,000,000 and paid
cash dividend of P2,500,000.

3. What is the excess of cost over the carrying amount of assets acquired?
a. P 0
b. P1,400,000
c. P3,000,000
d. P5,000,000
4. What amount should be reported as investment income for the current year?
a. P1,000,000
b. P1,750,000
c. P1,800,000
d. P2,000,000
 5. What is the carrying amount of the investment in associate at year-end?
a. P6,400,000
b. P7,150,000
c. P7,400,000
d. P8,150,000
6. On April 1, 2020, Zach Company purchased 40% of the outstanding ordinary shares of
Luck Warm Company for P10,000,000. On the same date, Luck Warm net assets were
P20,000,000 and Zach cannot attribute the excess of the cost of its investment in Luck
Warm over its equity in Luck Warm’s net assets to any particular factor. The investee’s
net income for 2020 is P5,000,000.

What amount should be reported as investment income for 2020?

a. P1,400,000
b. P1,500,000
c. P1,850,000
d. P2,000,000
7. On July 1, 2020, Angel Company purchased 25% of Devine Company’s outstanding
ordinary shares and no goodwill resulted from the purchase. Angel appropriately carried
this investment at equity and the balance in Angel’s investment account was P1,900,000
on December 31, 2020.

Devine Company reported net income of P1, 200,000 for the year ended December 31,
2020, and paid cash dividend totaling P480,000 on December 31, 2020.

How much did Angel pay for 25% interest in Devine?

a. P1,720,000
b. P1,870,000
c. P2,020,000
d. P2,170,000

For items 8-10, refer to this problem.

On January 1, 2020, Jenica Company acquired 30% of the outstanding ordinary

shares of Erika Company for an amount of P5,000,000. On this date, Erika Company net
assets had a carrying amount of P12,000,000. The equity method is used by Jenica Company
in accounting for this investment.

A machinery with an average remaining life of 5 years had a fair value that was
P2,500,000 in excess of its carrying amount. The remaining difference between the purchase
price and the carrying amount of the underlying equity cannot be attributed to any asset.
Hence, the remaining difference is allocated to goodwill.
 At the end of the year, Erika Company reported net income of P4,000,000 and paid
cash dividend of P1,000,000.

8. What amount should be reported as investment income for 2020?

a. P920,000
b. P1,050,000
c. P1,200,000
d. P1,350,000
9. What is the implied goodwill from the acquisition?
a. P0
b. P650,000
c. P750,000
d. P1,400,000
10. What is the carrying amount of the investment in associate at year end?
a. P5,000,000
b. P5,400,000
c. P5,750,000
d. P5,900,000
 CHAPTER 18
INVESTMENT IN ASSOCIATE
Other Accounting Issues

Upstream and Downstream Transactions

Upstream transactions involve the selling of an associate’s assets such as inventory and
noncurrent assets to the investor. This transaction results to the elimination of unrealized profit in
determining the investor’s share in the profit or loss of the associate.

Illustration
Camille Company acquired 25% of the outstanding ordinary shares of Dinah Company. During
the year, Dinah Company reported a net income of P3,000,000. It also sold inventory amounting
to P400,000 for P500,000 to Camille Company. Te inventory remained unsold by Camille
Company at the end of the year and Dinah Company paid no dividend.
Computation of the share of Camille Company in the profit Dinah Company:
Net income P3,000,000
Unrealized profit (100,000)
Adjusted net income P2,900,000

Camille Company’s share in the profit= P2,900,000 x 25%= P725,000

*If the inventory was sold by Camille Company on the following year. The company will realize
its share in the profit equal to P25,000 (P100,000 x 25%). In recognizing its share, the journal
entry would be a debit to Investment in Associate account and a credit to Investment Income.

On the other hand, downstream transactions involve the selling of an investor’s assets
to the associate. Like in upstream transactions, unrealized profit must also be eliminated in
determining the investor’s share in the profit or loss of the associate.

Investment Having No Significant Influence

In the previous chapter, the equity method in accounting for investment in associate was
discussed. The equity method is not applicable when the investor fails to have a significant
influence due to either investment of less than 20% or contractual agreement or government
control.
However, PAS 28 paragraph 17 states that the equity method cannot be also used when
the investor:
 Is a parent corporation that is exempt from preparing consolidated FS
 Is a wholly-owned or partially-owned subsidiary
 Debt and equity instruments are not traded

Fair Value Method and Cost Method

 Fair value method and cost method are methods used in accounting for investment of less
than 20% interest. Fair value method is used when financial asset is measured at fair value
through profit or loss and through other comprehensive income. Meanwhile, cost method is used
in unquoted equity instruments.
In applying these methods, dividends received by the investor from the investee are
accounted for as dividend income. The investor and investee are independent entities and the
investor does not share in the profit or loss of the investee.

Illustration
Cost Method
o At the beginning of the year, an investor acquired 20,000 shares of the 200,000
outstanding ordinary shares of another company at P150 each.
Investment in shares 3,000,000
Cash 3,000,000
o During the year, the investee reported net income of P2,000,000.
NO ENTRY
o The investor received 10% share dividend at the end of the year.
Memo entry: Received 2,000 ordinary shares as 10% share dividend. Shares now held,
22,000 shares.
o On the following year, the investee had a net loss of P1,000,000.
NO ENTRY
o Nonetheless, the investee declared and paid a cash dividend of P1,000,000 at the end of
the year.
Cash 100,000
Dividend income 100,000
o The investor sold 1,000 ordinary shares at P200 each.
Cash 200,000
Investment in shares 136,364
Gain on sale of investment 63,636
Computation:
Sale price (1,000x200) 200,000
Cost of shares sold (1,000/22,000x3,000,000) 136,364
Gain on sale of investment 63,636

True or False

1. Unlike in upstream transaction, profit in downstream transaction must not be eliminated.

F
 2. When an investor ceases to have a significant influence over an investee, the use of
equity method is no longer applicable. T
3. The profit on the sale of an associate’s inventory to the investor must be realized by the
investor immediately. F
4. The investor and the investee are independent of the other under the equity method. F
5. Fair value method is applied with nonmarketable equity investment. F
6. Under the fair value and cost methods, dividends received by the investor are accounted
for as dividend income. T
7. An investment in associate can always be accounted for using the equity method. F
8. Fair value method is applicable when a legal relationship exists between the investor and
the investee. T
9. Under the cost method, the financial asset is measured at fair value through profit or loss
or through other comprehensive income. F
10. When an investor is a wholly-owned subsidiary, it can always use the equity method in
accounting for an investment in associate. F

Problems

For items 1-5, refer to this problem.

At the beginning of the year 2020, an investor acquired 20% of the outstanding ordinary
shares of an investee. The assets and liabilities of the investee are recorded at fair value.
At the middle of the year, the investee company sold inventory with a cost of P100,000
for P150,000 to the investor. It was sold by the investor on February 10, 2021.
The investee reported net income of P2,000,000 and P2,500,000 on 2020 and 2021,
respectively. It paid no dividend.

1. How much is the investor’s share in the profit for 2020?

a. P350,000
b. P390,000
c. P400,000
d. P450,000

2. How much is the investor’s share in the unrealized profit in 2020?

a. P10,000
b. P20,000
c. P30,000
d. P0
3. What is the entry to record the investor’s share in the profit of the associate in 2020?
a. Cash P350,000
Investment in associate P350,000
 b. Cash P390,000
Investment income P390,000

c. Investment income P400,000

Investment in associate P400,000

d. Investment in associate P390,000

Investment income P390,000

4. How much is the investor’s share in the profit for 2021?

a. P490,000
b. P500,000
c. P510,000
d. P520,000
5. If the investor was able to sell the inventory on December 31, 2020, what is the amount
to be recognized by the investor as share in the profit of the investee on 2021?
a. P490,000
b. P500,000
c. P510,000
d. P520,000

For items 6-8, refer to this problem.

Mathhew Company has a 30 % equity interest on Michelle Company. The significant
influence of Matthew Company over the investee was acquired when it purchased 30% of the
outstanding ordinary shares of Michelle Company on January 1, 2020 for P 3,000,000.
During 2020, Michelle Company earned P1,200,000 and paid dividends of
P600,000. It also reported earnings of P 900,000 for the six months ended June 30,
2021, and P3,000,000 for the year ended December 31, 2021 but paid dividends of
P1,500,000 on October 1, 2021.
Mathhew Company sold half of the investment in Michelle Company for P3,000,000
cash. On this date, the investment is measured at fair value through profit or loss.
The fair value of the retained investment is P3,200,000 on July 1,2021 and
P3,400,000 on December 31,2021.

6. What amount should be recognized as investment income for 2020 as a result of the
investment?
a. P180,000
b. P270,000
c. P360,000
d. P540,000
7. In December 31, 2020 balance sheet, what is the carrying amount of the investment?
 a. P3,000,000
b. P3,360,000
c. P2,760,000
d. P3,180,000
8. What total amount of income should be reported for 2021?
a. P3,245,000
b. P3,445,000
c. P3,220,000
d. P3,175,000

For items 9-10, refer to this problem.

Tin Co. purchased 10% of the total ordinary shares outstanding of Ange Company. for
P3,000,000 at the beginning of the year 2019. On January 12, 2020, it purchased an additional
15% for P6,750,000. The investments were accounted through the use of the cost method.
During the time of the second acquisition of interest, the fair value of the ten percent interest was
P4,500,000 and Ange Company’s net assets had a carrying amount equaled to P36,000,000.
Currently, the net assets of Angge Company has a fair value tantamount to the carrying amount,
except for a machinery which had a fair value increased by P4,000,00 and remaining useful life
of five years.

Additional data for 2020 were as follows:

Net income P8,000,000

Cash dividend P5,000,000
9. What is the carrying amount of the investment in associate at end of 2020?
a. P10,500,000
b. P11,550,000
c. P11,800,000
d. P12,000,000
10. How much gain should be recognized on remeasurement?
a. P0
b. P1,500,000
c. P2,250,000
d. P4,500,000
CHAPTER 19

FINANCIAL ASSET AT AMORTIZED COST

Bond Investment

Definition of Bond

Bond is a written and signed promise to pay a certain amount of money on a certain date, with
periodic interest payment at a stated rate.

A bond in a simple sense is a result of an investor lending money to the bond issuer in exchange
for interest payment.

Types of Bond

 Serial Bonds - bonds that mature in installments

 Term Bonds - bonds that mature on single date

 Convertible Bonds - bonds that can be exchange for share capital

 Callable Bonds - bonds that can be redeemed prior to their maturity date

 Secured Bonds - bonds that have security , such as mortgage or pledge of other collateral

 Debenture Bonds/Unsecured Bonds - bonds that are not protected by any collateral.

Acquisition of Bonds

a. Acquired on interest date

When bonds are acquired on interest date, there is no premium or discount nor any accrued
interest at the date of acquisition.

Illustration:

On March 1 of the current year, Akigami Company purchased 100, P1,000 12% bonds. Bonds
pay interest semiannually on March 1 and September 1 and mature on January 1, 2024.
Mar. 1 Acquisition of the bonds

Investment in bonds 100,000

Cash (100 x 1,000) 100,000
Sept. 1 Receive semiannual interest

Cash (100,000 x 12% x 6/12) 6,000

Interest income 6,000
Dec. 31 Adjustments for accrued interest

Accrued interest receivable 4,000

Interest income 4,000
(100,000 x 12% x 4/12)

b. Acquired between interest dates

When bonds are acquired between interest dates, adjustment is necessary for the interest accrued
between the last interest payment date and the acquisition date.

Illustration:

On May 1, 2019, Fabio company purchased 12% P1,000,000 face amount bonds plus accrued
interest. Interest is payable semiannually on June 1 and December 1. Bonds are dated June 1,
2018 and mature on June 1, 2023.

May 1 Acquisition of bonds

Investment in bonds 1,000,000

Interest income 50,000

Cash 1,050,000

June 1. Receive semiannual interest

Cash 60,000
 Interest income 60,000

Dec. 1. Receive semiannual interest

Cash 60,000

Interest income 60,000

Dec. 31 Adjustment for accrued interest

Accrued interest income 10,000

Interest income 10,000

Bonds Acquired at a Discount

When bonds are acquired below the prevailing market rate, the bonds are at a discount. It occurs
when the investors are only willing to pay less than the face amount of the bond because its
stated rate is lower than the market rate.

Bonds Acquired at a Premium

When bonds are acquired above the prevailing market rate, the bonds are at a premium. It occurs
at the time that the investors are willing to pay more than the face amount of the bonds.

Amortization of Premium or Discount

a. Effective Interest Method - Effective interest method uses constant rate to determine the
amount to be amortize.
b. Straight-Line Method - Straight-line method provides recognition for an equal amount
of discount or premium amortization each period. The amount of monthly amortization is
determined by dividing the discount or premium at purchase or acquisition date to the
number of months remaining to the bonds maturity date.

Illustration 1: Amortization of Discount

On May 1, 2020, Shikeku company purchased P200,000 face amount 12% bonds at 96. Bonds
pay interest semiannually on May 1 and November 1 and mature on May 1, 2025.
Dec. 31 Amortization of the bond discount for 8 months from May1 to December 31, 2020.

Investment in bonds 800

Interest income 800

Face amount 200,000

Cost (200,000 x 97%) (194,000)

Discount 6,000

Annual amortization (6,000/5 years) 1,200

Amortization for 8 months (1,200 x 8/12) 800

Illustration 2: Amortization of Premium

On February 1, 2020, Takai purchased 12% 500,000 face amount bonds at 105 on February 1,
2020. Interest is payable semiannually on April 1 and October 1. Bonds are dated April 1, 2019
and mature on April 1, 2024.

Dec. 3 Amortization of the bond premium for 11 months from February 1 to December 31, 2020

Investment in bonds 500

Interest income 500

Face amount 500,000

Cost (500,000 x 1.05) (525,000)

Premium (25,000)

Life of bonds (from February 1, 2020 to April 1, 2024) 50 months

Monthly amortization (25,000/50) 500

Sales of Bonds
On the sale of bonds, it is necessary to determine the carrying amount of the bonds. Carrying
amount is used to determine the gain or loss on the sale. Thus, the total amount of amortization
of discount and premium from acquisition date up to the date of sales should be recognized.

Illustration:

On February 1, 2021, Akki Company sold bonds at 103.

The company acquired the bonds last August 1, 2019 with face amount of P1,000,000, 12%
interest at 91. Interest are payable semiannually on May 1 and November 1 and mature May 1,
2023.

Sale price (1,000,000 x 103) 1,030,000

Accrued interest

(Nov. 1, 2020 – February 1, 2021

1,000,000 x 12% x 3/12) 30,000

Total cash received 1,060,000

Original cost (1,000,000 x .91) 910,000

Amortization

(August 1, 2019 - February 1,2021)

((90,000/45) x 18) 36,000

Carrying amount of bonds, February 1, 2021 946,000

Sale price (1,000,000 x 103) 1,030,000

Gain on sale of bonds 84,000

Journal entries

Update first the amortization of discount

Investment in bonds 2,000

Interest income (90,000/45 x 1 month) 2,000

Record the sale of the bonds

Cash 1,060,000
 Investment in bonds 946,000

Interest income 30,000

Gain on sale of bond investment 84,000

Problem 1

Sadara Company acquired 1,500, P5,000 12% bonds at 97 plus accrued interest on June 1, 2020
to be held as financial asset at amortized cost.

The bonds pay interest semiannually on March 1 and September 1. Bonds are dated March 1,
2019 and mature on March 1, 2024.

Required:

Prepare journal entries for the year 2020.

Answer:

June 1. Investment in bonds (7,500,000 x .97) 7,275,000

Interest income (7,500,000 x 12% x 3/12) 225,000

Cash 7,500,000

Sept. 1. Interest income (7,500,000 x 12% x 3/12) 225,000

Cash 225,000

Dec. 31. Accrued interest receivable 300,000

(7,500,000 x 12% x 4/12)

Interest income 300,000

Dec. 31. Investment in bonds 35,000

 Interest income 35,000

Face amount 7,500,000

Cost (7,275,000)

Discount 225,000

Life of bonds 45 months

Monthly amortization (225,000/45) 5,000

Amortization for 8 months (5,000 x 7) 35,000

Problem 2

On April 1, 2019, Lihiko Company purchased bonds with face amount of P5,000,000 at 91 plus
accrued interest. Bonds pay interest of 12% semiannually on January 1 and July 1. Bonds are
dated January 1, 2018 and mature on January 1, 2023.

1. What is the amount of the accrued interest at the date of acquisition?

a. 273,000
b. 150,000
c. 300,000
d. 0
Answer: B (5,000,000 x 12% x 3/12)
2. What is the total amount of cash paid?
a. 4,700,000
b. 5,000,000
c. 5,047,000
d. 4,550,000
Answer: A
Cost (5,000,000 x 91%) 4,550,000
Accrued interest 150,000
 Total cash paid 4,700,000
3. What is the amount to be recorded as amortization for the year ended December 31,
2019?
a. 450,000
b. 10,000
c. 90,000
d. 100,000
Answer: C (10,000 x 9 months)
Face amount 5,000,000
Cost (4,550,000)
Discount 450,000
Life of bonds 45 months
Monthly Amortization (450,000/45) 10,000

Problem 3

At the beginning of the year, Flabio Company purchased P1,500,000 face amount 12% bonds at
110 plus accrued interest. Bonds pay interest semiannually on Febraury 1 and August 1 and
mature on February 1, 2021.

Required:

Prepare journal entries for the current year.

Answer:

Jan. 1 Investment in bonds 1,650,000

Interest income (1,500,000 x 12% x 5/12) 75,000

Cash 1,1725,000

Feb. 1 Cash 15,000

Interest income (1,500,000 x 12% x 1/12) 15,000

Aug. 1 Cash 90,000

Interest income (1,500,000 x 12% x 6/12) 90,000

Dec. 31 Accrued interest income 75,000

Interest income (1,500,000 x 12% x 5/12) 75,000

Dec. 31 Interest income (6,000x12) 72,000

Investment in bonds 72,000

Face amount 1,500,000

Cost (1,650,000)

Premium (150,000)

Monthly amortization (150,000/25) 6,000

Problem 4

Chisu Company purchased a 12% P2,500,000 face amount bonds at 92 plus accrued income on
July 1,2020. The bonds pay semiannually on May 1 and November 1 and mature on November
1, 2023.

Required:

Prepare a journal entry for the acquisition of bonds.

Answer:

Investment in bonds (2,500,000 x .92) 2,500,000

Interest income (2,500,000 x 12% x 2/12) 50,000

Cash 2,550,000
Problem 5

Konch Company purchased a 12% P900,000 face amount bonds at 106 plus accrued income on
November 1, 2020. The bonds pay semiannually on May 1 and November 1 and mature on
November 1, 2023.

1. What is the amount to be amortized at December 31, 2020?

a. 1,500
b. 3,000
c. 1,350
d. 4,500

Answer: B (18,000 x 2/12)

2. What is the amount to be amortized at December 31, 2021?

a. 15,000
b. 16,200
c. 27,000
d. 18,000

Answer: D

Face amount 900,000

Cost (954,000)

Premium (54,000)

Annual amortization (54,000/3 years) 18,000

Problem 6

On May 1, 2019, Khila Company purchased bonds with face amount of P3,000,000 at 95 plus
accrued interest. Bonds pay interest of 12% semiannually on January 1 and July 1. Bonds are
dated July 1, 2018 and mature on July 1, 2023.

What is the amount of accrued interest?

 a. 120,000
b. 150,000
c. 360,000
d. 180,000

Answer: A (3,000,000 x 12% x 4/12)

Problem 7

On June 1, 2019, Lalite Company purchased bonds with face amount of P2,500,000 at 105 plus
accrued interest. Bonds pay interest of 12% semiannually on February 1 and August 1 and
mature on August, 2023.

What is the total cash paid?

a. 2,500,000
b. 2,625,000
c. 2,725,000
d. 2,400,000

Answer: C

Cost (2,500,000 x 1.05) 2,625,000

Accrued interest (2,500,000 x 12% x 4/12) 100,000

Total cash paid. 2,725,000

Problem 8

Kataa Company acquired 1,000, P6,000, 12% bonds at 103 plus accrued interest on May 1, 2020
to be held as financial asset at amortized cost.

The bonds pay interest semiannually on February 1 and August 1. Bonds are dated February 1,
2019 and mature on February 1, 2024.

Required:

Prepare all necessary journal entries for year 2020.

Answer:

May 1. Investment in bonds (6,000,000 x 1.03) 6,180,000

Interest income (7,500,000 x 12% x 3/12) 180,000

Cash 6,360,000

Aug. 1. Interest income (7,500,000 x 12% x 3/12) 180,000

Cash 180,000

Dec. 31. Accrued interest receivable 300,000

(6,000,000 x 12% x 5/12)

Interest income 300,000

Dec. 31. Interest income 32,000

Investment in bonds 32,000

Face amount 6,000,000

Cost (6,180,000)

Premium (180,000)

Life of bonds 45 months

Monthly amortization (225,000/45) 4,000

Amortization for 8 months (5,000 x 8) 32,000

Problem 9

Haya Company purchased a 12% P1,500,000 face amount bonds at 92 plus accrued income on
July 1,2020. The bonds pay semiannually on May 1 and Nobember 1 and mature on November
1, 2023.

Required:

Determine the amount of premium or discount.

Answer: Discount of P120,000

Face amount 1,500,000

Cost (1,500,000 x .92) (1,380,00)

Discount 120,000

Problem 10

Mitsi Company provides the following transactions in bonds held for trading during the current
year.

May 1 Purchase 1,500, P1,000, 12% bonds of Sheti Company at 105 plus accrued interest. The
bonds pay interest annually on December 1.

Dec. 31 Purchase 1,000, P5,000, 12% bonds of Latti Company at 98 plus accrued interest.
Semiannual payment of interest is on April 30 and October 31.

Dec. 31 The following quotations were obtained:

Sheti Company 102

Latti Company 99

Required:

a. Prepare journal entries to record the transactions.

b. Present the investment on December 31.

Answer:

Requirement A

May 1 Trading securities ( 1,500,000 x 1.05) 1,575,000

Interest income (1,500,000 x 12% x 5/12) 75,000

Cash 1,650,000

Dec. 1 Trading securities (5,000,000 x .98) 4,900,000

 Interest income (5,000,000 x 12% x 1/12) 50,000

Cash 4,950,000

Dec. 31 Cash 180,000

Interest income (1,500,000 x 12%) 180,000

Accrued interest income 50,000

Interest income (5,000,000 x 12% x 1/12) 50,000

Trading securities 5,000

Unrealized gain – TS 5,000

Requirement B

Carrying amount Fair market

Sheti bonds 1,575,000 1,530,000

Latti bonds 4,900,000 4,950,000

6,475,000 6,480,000

Problem 11 (Multiple Choices: Part 1)

1. It provides an equal amount of premium or discount amortization each accounting period.

a. Straight line method
b. Effective interest method
c. Accrued interest method
 d. Interest income method
2. A bonds that can be redeemed prior to the date of maturity.
a. Callable bonds
b. Convertible bonds
c. Serial bonds
d. Term bonds
3. It gives the bondholders the right to exchange their bonds for share capital.
a. Callable bonds
b. Convertible bonds
c. Secured bonds
d. Serial bonds
4. A bonds issued with collateral.
a. Debenture bonds
b. Secured bonds
c. Serial bonds
d. Term bonds

Answer: 1. A 2. A 3. B 4. B

Problem 12(True or False)

1. When bonds are acquired on interest date, there no accrued interest at the date of
acquisition.
2. When bonds are acquired below the fair market value, the bonds are at a premium.
3. Premium occurs when the investor is willing to pay more than the face value of the bonds

Answer: 1. True 2. False 3. True

Problem 13

Akati acquired convertible bonds and wants to redeem it prior to the date of maturity. Can Akati
redeem it before the maturity date?
 a. Yes, because convertible bonds can be redeemed before the maturity date.
b. No, because only callable bonds can be redeemed prior to the date of acquisition.
c. Yes, since Akati is the bondholder, he can redeem it anytime he wants.

Answer: B

Problem 14

Sahta company acquired 12% bonds with face amount of 3,000,000 at 98 including accrued
interest of P90,000. Bonds are held for trading.

Required:

Prepare journal entries for the acquisition.

Answers:

Trading securities 2,940,000

Accrued interest 90,000

Cash 3,030,000

Problem 15

On November 30, 2019, Hatakki Company purchased 100, P10,000, 12% interest at 89 including
accrued interest. Interest are payable annually on June 31 and mature June 31, 2024.

Required:

Prepare entries for the amortization of discount for the year ended 2019.

Answer:

Interest income 2,000

 Investment in bonds 2,000

Face amount 1,000,000

Cost (1,000,000 x .89) (890,000)

Discount 110,000

Life of bonds 55 months

Monthly amortization (110,000/55) 2,000

Problem 16

Mitsuki Company purchased 1,000, 1,000, 12% interest at 109 including accrued interest on
October 1, 2019. Interest are payable annually on July 1 and mature July 1, 2024.

1. What amount should be recorded as accrued interest?

a. 30,000
b. 40,000
c. 50,000
d. 60,000

Answer: A (1,000,000 x 12% x 3/12)

2. What is the total amount of premium?

a. 100,000
b. 90,000
c. 120,000
d. 0

Answer: B

Face amount 1,000,000

Cost (1,000,000 x 1.09) (1,090,000)

Premium (90,000)

3. What is the total amount of discount?

a. 100,000
b. 90,000
c. 120,000
d. 0

Answer: D ;There is no discount since it is acquired above the prevailing market rate.

Problem 17

On October 1, of the current year, Watabe Company purchased 1,500, 1,000, 12% interest at 106
including accrued interest. Interest are payable semiannually on January 1 and July 1 and mature
July 1, 2023.

What is the amount of premium amortization at the year end?

Answer: P 6,000 (2,000 x 3)

Face amount 1,500,000

Cost (1,500,000 x 1.06) (1,590,000)

Premium (90,000)

Life of bonds 45 months

Monthly amortization (90,000/45) 2,000

Problem 18

Judha purchased 12% bonds with face amount of 300,000 at 102 including accrued interest of
P12,000. Bonds are held for trading.

Required:

Prepare journal entry to record the acquisition.

Answer:

Trading securities 306,000

Interest income 12,000

Cash 318,000

Problem 19

Makira Company sold bonds at 103 on January 1, 2021

The company acquired the bonds last August 1, 2019 with face amount of P1,000,000, 12%
interest at 91. Interest are payable semiannually on May 1 and November 1 and mature May 1,
2023.

Required:

a. Determine the total amount of cash received

b. Determine the gain or loss on the sale of bond investment
c. Prepare a journal entry for the sale of bond investment
Answer:

Requirement A

Sale price (1,000,000 x 103) 1,030,000

Accrued interest (Nov. 1, 2020 – Jan 1, 2021)

(1,000,000 x 12% x 2/12) 20,000

Total cash received 1,050,000

Requirement B

Original cost (1,000,000 x .91) 910,000

Amortization

(August 1, 2019 - January 1,2021)

((90,000/45) x 17) 34,000

Carrying amount of bonds, February 1, 2021 944,000

Sale price (1,000,000 x 103) 1,030,000

Gain on sale of bonds 86,000

Requirement C

Journal entries

Cash 1,050,000

Investment in bonds 944,000

Interest income 20,000

Gain on sale of bond investment 86,000

Problem 20

On May 1,2019, Biskus Company acquired P2,000,000 12% bonds at 98 plus accrued interest.
Interests are payable January 1 and July 1 and mature July 1 2023. The bonds are held for
trading.

What is the correct entry to record the acquisition of bond?

a. Investment in bonds 1,960,000

Interest income 60,000
Cash 2,020,000
b. Trading securities. 1,960,000
Interest income 60,000
Cash 2,020,000
c. Both A and B are correct
d. Neither A nor B

Answer: D ;The amount of interest income is wrong

 CHAPTER 20
Effective Interest Method
(Amortized cost, FVOCI and FVPI)

Effective Interest Method

The effective interest method is a technique for calculating the actual interest rate in a period
based on the amount of a financial instrument's book value at the beginning of the accounting
period. Thus, if the book value of a financial instrument decreases, so too will the amount of
related interest; if the book value increases, so too will the amount of related interest. This
method is used to account for bond premiums and bond discounts.
The effective interest method is preferable to the straight-line method of charging off
premiums and discounts on financial instruments, because the effective method is
considerably more accurate on a period-to-period basis. However, it is also more difficult to
compute than the straight-line method, since the effective method must be recalculated
every month, while the straight-line method charges off the same amount in every month.
Thus, in cases where the amount of the discount or premium is immaterial, it is acceptable
to instead use the straight-line method. By the end of the amortization period, the amounts
amortized under the effective interest and straight-line methods will be the same.
Under PFRS 9, bond discount and bond premium shall be amortized using the effective
interest rate
Effective interest method is also known as scientific method or simply “interest method”
This method distinguishes two kinds of interest rate, namely nominal rate and effective
rate. The effective rate is the yield rate or market rate which is the actual or true rate of
interest which the bondholder earns on the bond investment.
Effective rate versus nominal rate
-Effective Rate is the rate that exactly discounts estimated future cash payments through the
expected life of the bond or when appropriate, a shorter period to the net carrying amount of
the bond. The Nominal Rate is the coupon rate or stated rate appearing on the face of the
bond.
-The effective rate and the nominal rate are the same if the cost of the bond investment is
equal to the face value.
-When the bonds are acquired at a premium, the effective rate is lower than the nominal
rate. The reason is that the premium is a loss on the part of the bondholder.
-On the other hand, when the bonds are acquired at a discount, the effective rate is higher
than the nominal rate. The reason is that the discount is a gain on the part of the
bondholder.
-Both of them, the effective rate and nominal rate are necessary in applying the effective
interest method.
A bond premium occurs when investors are willing to pay more than the face value of a bond,
because its stated interest rate is higher than the prevailing market interest rate. A bond discount
occurs when investors are only willing to pay less than the face value of a bond, because its
stated interest rate is lower than the prevailing market rate.
The difference between the interests earned or interest income and the interest received
represents the premium or discount amortization.
Interest earned or interest income= effective rate multiply to the carrying amount of the bond
investment
Interest received= nominal rate multiply to the face amount of the bond.
The carrying amount of the bond investment is the initial cost gradually increased by periodic
amortization of discount or gradually reduced by periodic amortization of premium.
Illustration. Effective interest method-Discount

On January 2020, an investor acquired for a 5-year 9% 100,000 bond issued in a 10% market for
96,149, let's highlight a few points:

1. The bond discount of 3,851 must be amortized to Interest Expense over the life of the
bond. The amortization will cause the bond's book value to increase from 96,149 on
January 1, 2020 to 100,000 just prior to the bond maturing on December 31, 2024.
2. The corporation must make an interest payment of 4,500 (100,000 x 9% x 6/12) on each
June 30 and December 31 that the bonds are outstanding. The Cash account will be
credited for 4,500 on each of these dates.
3. The effective interest rate is the market interest rate on the date that the bonds were
issued. In our example the market interest rate on January 1, 2020 was 5% per semi-
annual period for 10 semi-annual periods.
4. The effective interest rate is multiplied times the bond's book value at the start of the
accounting period to arrive at each period's interest expense.
5. The difference between Item 2 and Item 4 is the amount of amortization.

Date Interest Interest income Discount Carrying amount

received amortization
January 1,2020 4500 96149
June 30,2020 4500 4807 307 96456
December 31,2020 4500 4822 322 96778
June 30,2021 4500 4839 339 97117
December 31,2021 4500 4856 356 97473
June 30,2022 4500 4874 374 97847
December 31,2022 4500 4892 392 98239
 June 30,2023 4500 4912 412 98651
December 31,2023 4500 4933 433 99084
June 30,2024 4500 4954 454 99538
December 31,20204 4500 4962 462 100000
Totals 45000 48851 3851

Illustration. Effective interest rate method for amortizing the bond premium pertaining to a 5-
year 9% 100,000 bond issued in an 8% market for 104,100 on January 1, 2020, let's outline a few
concepts:

1. The bond premium of 4,100 must be amortized to Interest Expense over the life of the
bond. This amortization will cause the bond's book value to decrease from 104,100 on
January 1, 2018 to 100,000 just prior to the bond maturing on December 31, 2024.
2. The corporation must make an interest payment of 4,500 (100,000 x 9% x 6/12) on each
June 30 and December 31. This means that the Cash account will be credited for 4,500 on
each interest payment date.
3. The effective interest rate method uses the market interest rate at the time that the bond
was issued. In our example, the market interest rate on January 1, 2020 was 4% per semi-
annual period for 10 semi-annual periods.
4. The effective interest rate is multiplied times the bond's book value at the start of the
accounting period to arrive at each period's interest expense.
5. The difference between Item 2 and Item 4 is the amount of amortization.

The following table illustrates the effective interest rate method of amortizing the 4,100 premium
on a corporation's bonds payable:

Date Interest Interest income Premium Carrying

received amortization amount
January 1,2020 104100
June 30,2020 4500 4164 336 103764
December 31,2020 4500 4151 349 103415
June 30,2021 4500 4137 363 10305
December 31,2021 4500 4122 378 102674
June 30,2022 4500 4107 393 102281
December 31,2022 4500 4091 409 10187
June 30,2023 4500 4075 425 101447
December 31,2023 4500 4058 442 101005
June 30,2024 4500 4040 460 100545
December 4500 3955 545 1000
31,20204
Totals 4500 40900 4100
PROBLEMS
PROBLEM 1
The present value factor at 8% for one period is 0.92593, for two periods is 0.85734, for three
periods is 0.79383, for four periods is 0.73503, and for five periods is 0.68058. Given these
factors, what amount should be deposited in a bank today to grow to $100 three years from now?
a.$100/0.79383
b. $100/(0.92593/3)
c. ($100/0.92593 + $100/0.85734 + $100/0.79383)
d. $100 X 0.79383
PROBLEM 2
Bonds payable should be disclosed on the balance sheet.
a. At their face value minus any unamortized premiums.
b. At their face value plus any unamortized premiums.
c. At their maturity value.
d. d. At their face value.

PROBLEM 3
When the contract interest rate for a bond exceeds the effective interest rate of the bond, then:

a. The price of the bond will be equal to the future cash flow associated with the bond.
b. The bond will be issued at a premium.
c. The bond will be issued at a discount.
d. The face value of the bond will fluctuate over its life.

PROBLEM 4
On April 1, 20X1, German Corporation issued $100,000 of 7%, 5-year bonds dated April 1,
20X1, at 101. Interest is paid on March 31 and September 30. The proper entries to record bond
interest expense for the (entire) year ended 20X1 would include a decrease in interest expense
for premium amortization in the amount of (round to the nearest dollar and assume straight-line
amortization):
a. $0
b. $117
c. $150
d. $200
PROBLEM 5
Jeske Company issued $1,000,000 of 8% bonds at a time when the market rate of interest was
10%. If the bonds were issued at a $50,000 discount and interest was paid annually, how much
was interest expense for the first full year of the bond issue (utilize the effective-interest
amortization technique)?
a. $76,000
b. $80,000
c. $95,000
d. $100,000
Solution: $95,000. The bonds’ carrying value ($1,000,000 – $50,000) times the effective
interest rate (10%) yields the total interest expense.
PROBLEM 6
Billings Corporation retired $1,000,000 face of bonds payable. At the time of the retirement, the
bonds had unamortized discount of $20,000, and all interest accruals and payments were current.
Under the outstanding covenants, Billings was required to pay the bond holders 103.

a. The transaction caused Billings to recognize a loss of $50,000.

b. The transaction caused Billings to recognize a gain of $50,000.
c. The transaction caused Billings to recognize a loss of $30,000.
d. The transaction caused Billings to recognize a gain of $20,000.
PROBLEM 7
You are thinking of borrowing $250,000 to buy a new house. If you are going to finance this
purchase at 12% interest per annum, and make 360 level monthly payments to pay off the loan,
how much will your payments be?

a. $250,000/360
b. $250,000/present value factor for lump sum at 360 months and 1% per period
c. $250,000/present value factor for annuity of 360 months at 1% per period
d. $250,000 X present value factor for annuity of 360 months at 1% per period
PROBLEM 8
Assume that Kamchatny Vladimir borrowed $100,000 on January 1 of Year 1, at 5% interest per
annum. On December 31, of Year 1, an $8,000 payment is made. On December 31, of year 2,
another $8,000 payment is made. Using normal assumptions about interest and principal
reduction, how much is the unpaid balance of Vladimir’s loan after the second payment?

a. $100,000
b. $94,000
c. $93,850
d. $84,000
Solution: $93,850. The first payment is $5,000 of interest ($100,000 X .05) and $3,000
principal reduction. The resulting principal balance for Year 2 is $97,000; which accrues
interest of $4,850 ($97,000 X .05). The $8,000 payment in Year 2 therefore reduces the
principal by $3,150 ($8,000 – $4,850) to $93,850.

PROBLEM 9
On July 1, 2011, Alloeh-V Company paid P 1,198,000 of 10%,20-year bonds with a face value
amount of P 1,000,000. Interest is paid on December 31 and June 30. The bonds were purchased
to yield 8%. Alloeh-V uses the effective interest method to recognize interest income from this
long term investment.
What should be reported as the carrying amount of tge bonds u te December 31,2011 statement
of financial position?
a.1,207,900
b. 1,198,000
c. 1,195,920
d. 1,193,050

Solution

Date Interest Interest Premium Carrying

received income amortization amount
July 1,2011 1,198,000
December 31,2011 50,000 47,920 2,080 1,195,920

Interest received =1,000,000 x 10% x 6/12

=50,000
Interest income = 1,198,000 x 8% x 6/12
=47,920
PROBLEM 10
On July,2013, East Company purchased as a long-term investment P500,000 face
amount,8%bonds of Rand Company for P4,615,000 to yield 10% per year. The bonds pay
interest semiannually on January 1 and July 1. On December 31,2011,what amount should be
reported as interest receivable?
a. 184,600
b. 200,000
c. 230,750
d. 250,000
Solution:
Accrued interest receivable from July 1 to December 31,2011 (5000000 x 8% x 6/1)

200;000
PROBLEM 11
On July 2011, Pell Company purchased Green Company ten-year,8% with a face amount of
5000000 for 200,000. The bonds mature on June 30.2019 and pay interest semiannually on June
30 and December 31. Using the interest method, Pell recorded bond discount amortization of
P18000 for the six months ended December 31,2011. What amount should be reported as interest
income for 2011?
a. 168,000
b. 182,000
c. .200,000
d. 218,000
Solution
Interest received from July 1 to December 31,2011
(5,000,000 x 8% x 6/12) 200,000
Bond discount amortization for six months 18,000
______
Interest income for 2011 18,000

PROBLEM 12
On January 1,2012, Russia Company purchased 5-year bonds with face value of p8000000 and
stated interest of 10% per year payable semiannually January 1 and July 1. He bonds were
acquired to yield 8%. Present value factors are:
Present value of an annuity of 1 for 10 periods at 5% 7.72
Present value of an annuity of 1 for 10 periods at 4% 8.11
Present value of 1 for 10 periods at 4% 0.6756
What is the purchase price of the bonds?
a. 7,382,400
b. 8,617,600
c. 8,648,800
d. 7,351,200

Solutions
PV of principal (8,000,000 x .6756) 5,404,800
PV of semiannual interest payments (400,000 x 8.11) 3,244,000
Purchase price or present value of the bonds 8,648,800

PROBLEM 13
With connection to the above problem, what is the carrying amount of the bond investment on
December 31,2012?
a. 8,594,752
b. 8,540,704
c. 8,538,542
d. 8,302,848

Date Interest Interest Premium Carrying

received income amortization amount
January 1,2012 8,648,800
July 1,2012 400,000 345,952 54,048 8,594,752
December 31,2012 400,000 343,790 56,210 8,538,542

PROBLEM 14
On July 1,2013, Bukang Liwayway Company purchased bonds with face value of P2,000,000.
The bonds are dated January 1,2012 and mature on January 1, 2017. The interest on the bonds is
10% payable semiannually every June 30 and December31. The prevailing market rate of
interest on the bonds is 12%. The present value of 1 at 6% for 8 periods is .63, and the present
value of an ordinary annuity of 1 at 6% for 8 periods is 6.21. What is the present value of the
bonds on January 1,2013?

a. 1,881,000
b. 1,888,000
c. 1,360,000
d. 1,480,000

Solution
PV of principal (2,000,000 x .63) 1,260,000
PV of semiannual interest payments (100,000 x 6.21) 621,000
Present value or market price of bonds 1,881,000
PROBLEM 15
On Ajnuary 2014,Dean Company purchased ten-year bonds with a face value of P1,000,000 and
a stated interest rate of 8% per yearpyable semiannually July 1 nad January 1. The bonds were
acquired to yield 10%. Present value factors are as folloes:
Present value of 1 for 10 periods at 10% .386
Present value of 1 for 20 periods at 5% .377
Present value of an annuity of 1 for 10 periods at 10% 6.145
Present value of an annuity of 1 for 20 periods at 5% 12.462
What is the purchase price of the bonds?
a. 1,124,620
b. 1,100,000
c. 1,000,000
d. 875,380
Solution
PV of principal (1,000,000 x .377) 377,000
PV of semiannual interest payments (40,000 x 12.462) 498,480
Total present value 875,480

PROBLEM 16
On January 2020, Arabian Company purchased serial bonds with face value of P3,000,000 and
stated 12% interest payable annually every December 31. The bonds are to be held as financial
asset at amortized cost with a 10% effective yield. The bonds mature at an annual instalment of
P1,000,000 every December 31. The rounded present value of 1 at 10% for:
One period 0.91
Two periods 0.83
Three periods 0.75
What is the present value of the serial bonds on January 1,2020?
a. 3,106,800
b. 3,060,000
c. 3,045,000
d. 3,149,400
Solution
Principal payment 1,000,000
Interest payment (3,000,000 X 12%)
360,000
Total payments on December 31,2020 1,360,000

Principal payment 1,000,000

Interest payment (3,000,000 X 12%)
240,000
Total payments on December 31,2021 1,240,000

Principal paymet 1,000,000

Interst payment (3,000,000 X 12%)
120,000
Total paymets on December 31,2022 1,120,000
December 31,2020 payment (1,360,000 x .91) 1,237,600
December 31,2021 payment (1,240,000 x .83) 1,029,200
December 31,2022 payment (1,120,000 x .75) 840,000
Total present value on January 1,2020 3,106,800

PROBLEM 17
On January 1,2020, Krungkrung Company purchased bonds with face value of P5,000,000 at a
cost of P4,700,000 to be held as financial asset at amortized cost. The stated interest is 10%
payable annually every December 31. The bonds mature in 4 years or January 1,2024.
What amount of interest income should be reported by Krungkrung Company for the year ended
December 31,2020 under the effective interest method?
a. 500,000
b. 470,000
c. 5,170,000
d. 562,590
Solution :
Interest income (4,700,000 x 11.97%) 562,590
PROBLEM 18
Under ____________, an equal amount of discount is allocated to each interest period, whereas,
under the ____________ method of amortization, interest expense is calculated as a constant
percentage of the bond carrying value.

Answer: (straight-line amortization, straight line amortization),(effective interest)

PROBLEM 19
An ____________ is a series of equal cash flows.
Answer: (annuity)

PROBLEM 20
The set amount to be repaid on a bond’s maturity date is known as ____________, whereas, the
bond payable amount less any unamortized discount or plus any unamortized premium is known
as ____________.

Answer: (face value), (carrying value)

Chapter 21
 CHAPTER 22
Investment Property

Definition and initial recognition of investment property

Investment property is property (land or a building, or part of a building, or both) held by the
owner or by the lessee under a finance lease to earn rentals or for capital appreciation or both,
rather than for:

(a) use in the production or supply of goods or services or for administrative purposes, or
(b) sale in the ordinary course of business.

Notes
Property held for the purposes described above are inventories.

Provided that the owner-occupied property described in paragraph 16.2(a) is expected to be used
during more than one period, it is property, plant and equipment.

Investment property generates cash flows largely independently of the other assets held by an
entity. This distinguishes investment property from owner-occupied property.
The production or supply of goods or services (or the use of property for administrative
purposes) generates cash flows that are attributable not only to property, but also to other assets
used in the production or supply process.

Judgement is sometimes needed to determine whether a property qualifies as investment

property. For example, when an entity provides ancillary services to the occupants of a property
it holds, it treats the property as investment property if the services are insignificant to the
arrangement as a whole.

Examples – investment property

Ex 1 An entity owns a building that it rents out to independent third parties under
operating leases in return for rental payments.

The building is classified as an item of investment property by the entity (lessor). It is a property
held to earn rentals.

Ex 2 An entity owns a building that it rents out to independent third parties under
operating leases in return for rental payments. The entity provides cleaning, security and
maintenance services for the lessees of the building.

If the services provided by the entity are insignificant to the arrangement as a whole, then the
property is investment property. In most cases cleaning, security and maintenance services will
be insignificant and hence the building would be classified as investment property.
When the services provided are significant the property should be classified as property, plant
and equipment. For example, if an entity owns and manages a hotel, services provided to guests
are significant to the arrangement as a whole.

Ex 3 An entity owns a building that it rents out to an independent third party (the lessee)
under an operating lease in return for fixed rental payments. The lessee operates a hotel
from the building including a range of services commonly provided by boutique hotels. The
entity does not provide any services to hotel guests and its rental income is unaffected by
the number of guests that occupy the hotel (ie the entity is a passive investor).

The building is an investment property of the entity. The entity is not engaged in the business of
operating a hotel business (ie the entity is a passive investor).

Ex 4 An entity (parent) owns a building that it rents out to its subsidiary under an
operating lease in return for rental payment. The subsidiary uses the building as a retail
outlet for its products.

In the consolidated financial statements of the parent the building is not classified as an item of
investment property. The consolidated financial statements present the parent and its subsidiary
as a single entity. The consolidated entity uses the building for the supply of goods. Therefore
the building is accounted for by the consolidated group as an item of property, plant and
equipment.
In the separate financial statements of the parent the building is classified as investment property.
It is a property held to earn rentals.

In the individual financial statements of the subsidiary the arrangement is accounted for as an
operating lease in accordance with Section 20 Leases.

Ex 5 An entity acquired a tract of land as a long-term investment because it expects its

value to increase over time. No rentals are expected to be generated from the land in the
foreseeable future.

The land is classified as investment property. It is property held for capital appreciation.
The land is not held for sale in the ordinary course of business.

Ex 6 An entity holds land for an undetermined future use.

Notes
In accordance with Section 20 Leases, a lessee under an operating lease does not
recognize a leased asset and does not recognize the related lease obligation in its statement of
financial position (see Section 20). Furthermore, if the lessee makes an upfront payment relating
to a property interest held under an operating lease, the lessee accounts for that payment as a
prepaid expense, not as an item of property.
However, paragraph 16.3 allows for such an entity (as the lessee) to elect, on a property-
by-property basis, to account for the operating lease of investment property as if it were a finance
lease in accordance with Section 20, provided that the property would otherwise meet the
definition of an investment property and the lessee can measure the fair value of the property
interest without undue cost or effort on an ongoing basis.

A property interest that is held by a lessee under an operating lease may be classified and
accounted for as investment property using this section if, and only if, the property would
otherwise meet the definition of an investment property and the lessee can measure the fair value
of the property interest without undue cost or effort on an ongoing basis. This classification
alternative is available on a property-by-property basis.

MIXED USED PROPERTY

Mixed use property shall be separated between investment property and property, plant
and equipment. However, if the fair value of the investment property component cannot be
measured reliably without undue cost or effort, the entire property shall be accounted for as
property, plant and equipment in accordance with Section 17.

Measurement at initial recognition

An entity shall measure investment property at its cost at initial recognition. The cost of a
purchased investment property comprises its purchase price and any directly attributable
expenditure such as legal and brokerage fees, property transfer taxes and other transaction costs.
If payment is deferred beyond normal credit terms, the cost is the present value of all future
payments.

Measurement after recognition

Investment property whose fair value can be measured reliably without undue cost or effort shall
be measured at fair value at each reporting date with changes in fair value recognized in profit or
loss. If a property interest held under a lease is classified as investment property, the item
accounted for at fair value is that interest and not the underlying property

An entity shall transfer a property to, or from, investment property only when the property first
meets, or ceases to meet, the definition of investment property.
PROBLEMS

Question 1
Investment property is defined as:

a. property (land or a building, or part of a building, or both) held for sale in the ordinary course
of business.
b. property (land or a building, or part of a building, or both) held to earn rentals.
c. property (land or a building, or part of a building, or both) held for capital appreciation.
d. property (land or a building, or part of a building, or both) held to earn rentals or for
capital appreciation or both.

Question 2
A property interest that is held by a lessee under an operating lease may be classified and
accounted for as investment property if, and only if,

a. the property would otherwise meet the definition of an investment property and the lessee can
measure the fair value of the property interest without undue cost or effort on an ongoing basis.
Furthermore, the entity accounts for all its qualifying operating leasehold property interests as
investment property.

b. the property would otherwise meet the definition of an investment property and the
lessee can measure the fair value of the property interest without undue cost or effort on an
ongoing basis (irrespective of whether other qualifying operating leasehold property
interests are accounted for as investment property (ie the election is available to the entity
on a property-by-property basis)).

c. the property would otherwise meet the definition of an investment property and the lessee
accounts for all of its investment property (and qualifying operating leasehold property interests)
at fair value with the change in fair value recognized in profit or loss.

d. the property would otherwise meet the definition of an investment property and the lessee
accounts for all of its investment property (and qualifying operating leasehold property interests)
using a cost-amortization-impairment model set out in Section 17. Property, Plant and
Equipment.

Question 3
An entity operates a bed and breakfast from a building it owns. The entity also provides its
guests with other services including housekeeping, satellite television and broadband internet
access. The daily room rental is inclusive of these services. Furthermore, upon request, the entity
conducts tours of the surrounding area for its guests. Tour services are charged for separately.

The entity should account for the building as:

a. inventory
b. investment property
c. property, plant and equipment
Question 4
An entity must measure its investment property after initial recognition:

a. either at fair value or using the cost-depreciation-impairment model (same accounting policy
for all investment property).
b. either at fair value or using the cost-depreciation-impairment model (elected item by item).
c. at fair value.
d. at fair value, for those properties that fair value can be measured reliably without undue
cost or effort on an ongoing basis, with all other investment property accounted for using
the cost-depreciation-impairment model in Section 17.

Question 5
Investment property whose fair value cannot be measured reliably without undue cost or effort
on an ongoing basis is accounted for after initial recognition:

a. as inventory in accordance with Section13.

b. as property, plant and equipment in accordance with Section 17.
c. as a financial asset in accordance with Section 11.
d. as an intangible asset with a finite useful life in accordance with Section 18.

Question 6
A building is owned by a subsidiary (lessor) to earn rentals under an operating lease from its
parent (lessee). The parent manufactures its products in the rented building. The fair value of the
building can be measured reliably without undue cost or effort on an ongoing basis.
The building is:

a. accounted for as an item of property, plant and equipment by the subsidiary and an investment
property by the group.
b. accounted for as an investment property by the subsidiary and as an item of property,
plant and equipment by the group.
c. accounted for as an investment property by both the subsidiary and the group.
d. accounted for as an item of property, plant and equipment by both the subsidiary and the
group.

Question 7
On 1 January 2011 an entity acquired a building for CU95,000, including CU5,000 non-
refundable purchase taxes. The purchase agreement provided for payment to be made in full on
31 December 2011. Legal fees of CU2,000 were incurred in acquiring the building and paid on 1
January 2011.

The building is held to earn lease rentals and for capital appreciation.
An appropriate discount rate is 10 per cent per year.
The entity shall measure the initial cost of the building at:

a. CU88,364
b. CU97,000
c. CU102,000
d. CU107,000

Question 8
On 1 January 2011 an entity acquired an investment property (building) in a remote location for
CU100,000. After initial recognition, the entity measures the investment property using the cost-
depreciation-impairment model, because its fair value cannot be measured reliably without
undue cost or effort on an ongoing basis.

At 31 December 2011 management:

 assessed the building’s useful life at 50 years from the date of acquisition
 presumed the residual value of the building to be nil (given that the fair value cannot be
determined reliably)
 assessed that the entity will consume the building’s future economic benefits evenly over
50 years from the date of acquisition
 declined an unsolicited offer to purchase the building for CU130,000. This is a ‘one-off’
offer that is unlikely to be repeated in the foreseeable future.

The entity should measure the carrying amount of the building on 31 December 2011 at:

a. CU98,000
b. CU100,000
c. CU130,000
d. CU127,400

Question 9
On 31 December 2012 the entity reassessed the remaining useful life of the investment property
described in Question 8 as 73 years. The revised assessment is supported by new information
that became available in late 2012.

The entity should measure the carrying amount of the building on 31 December 2012 at:

a. CU130,000
b. CU96,676
c. CU126,533
d. CU97,333

Question 10
On 1 January 2011 an entity acquired a tract of land for an undetermined purpose.
On 1 January 2014 the entity started constructing a building on the land for use as its
administrative headquarters.
On 1 January 2015 the entity’s administrative staff moved into that building.
Three years later (on 1 January 2018) the entity’s administrative staff moved into newly acquired
premises. The old building was immediately rented to an independent third party under an
operating lease.
On 31 December 2019 the entity accepted an unsolicited offer from the tenant to purchase the
building from the entity with immediate effect.
The fair value of the property (land and related buildings) can be measured reliably without
undue cost or effort on an ongoing basis.

The entity shall account for the tract of land and the related building as:

a. investment property from 1 January 2011 to 31 December 2019.

b. investment property during 2011–2013 and 2018–2019 and as property, plant and
equipment during 2014–2017.
c. investment property during 2011–2013 and as property, plant and equipment during
2014–20110.
d. property, plant and equipment during 2011–2017 and as investment property during
2018–2019.

Question 11
Which of the following is not an example of investment property?

  Land held for undetermined future use

  Property leased to another entity under a finance lease

  Property leased to another entity under an operating lease

  Property being constructed for future use as an investment property

Question 12
If an entity uses part of a building for their own use, and rents the remainder. How should this be
treated?

  All as investment property under IAS 40 – Investment Property

  Account for separately under ‘IAS - 16 Property, Plant and Equipment’ and
‘IAS - 40 Investment Property’

  All under IAS 16 – Property, Plant and Equipment

  None of these

Question 13
If an entity uses the cost model for investment property, it must also disclose the fair value of the
investment property.

  True
  False

Question 14
A parent leases an office building to a subsidiary. In which financial statements will the property
appear as investment property?

  Parent company

  Subsidiary

  Consolidated financial statements

  None of these

Question 15
Under IAS 40 – Investment Property, where should a gain or loss on disposal be recognized?

  Income Statement

  Statement of Changes in Equity

  Statement of Financial Position

  None of these

Question 16
Property being constructed on behalf of third parties is an investment property under IAS 40 –
Investment Property until the contract is complete.

  True
  False

Question 17
An investment property should initially be measured at ___

  Market value
   Fair value

  Net realizable value

  Cost

Question 18
If an entity wishes to change from a cost model to fair value model under IAS 40 – Investment
Property, when may it do so?

  When the board of directors approves a change

  When a change will result in a more appropriate presentation

  When the value of the assets will improve with a revised model
  When the market for these properties is fluctuation

Question 19
Mega Corp owns a field near an industrial estate. The company has not decided what to do with
this land. Is it an investment property under IAS 40?

  Yes
  No

Question 20
Which of the following is not a transfer from or to investment property under IAS 40?

  Commencement of owner occupation

  Transfer from undetermined use to an operating lease

  Commencement of development with a view to sale

  End of construction of development
Chapter 23
Chapter 24
Chapter 25

Property, Plant and Equipment

Property, plant, and equipment (PP&E) are long-term assets vital to business
operations and not easily converted into cash. Property, plant, and equipment are tangible assets,
meaning they are physical in nature or can be touched. The total value of PP&E can range from
very low to extremely high compared to total assets. It is important to note when calculating
equity.

Characteristics of PPE

a. Tangible assets or one with physical substance

b. PPE are expected to be used over a period of more than one year

c. PPE are used in business operations.

Companies list their net PP&E on their financial statements. Potential investors
and analysts look at a company's PP&E to determine the kinds of capital expenditures it's making
and how it raises funding for its projects.

Examples of property, plant, and equipment (PP&E) include:

a. Vehicles like trucks

b. Office furniture

c. Machinery

d. Buildings

e. Undeveloped land

f. Land

g. Land Improvements
Recognition

An item of PPE should be recognised as an asset, if it is probable that future

economic benefits associated with the asset will flow to the entity and the cost of the item can be
measured reliably. Future economic benefits occur when the risks and rewards of the asset's
ownership have passed to the entity. PPE is initially recognised at its cost, which is the fair value
of the consideration given.

Elements of cost

a. Purchase price, including import duties, non-refundable purchase taxes.

b. All the directly attributable costs necessary to bring the asset into working condition should be
capitalised: these costs include delivery and installation costs and architects' fees.

After initial recognition, the asset should be measured at cost less

accumulated depreciation and impairment losses or at a revalued amount, which is its fair value
less subsequent depreciation and impairment losses. In this case, fair value must be reliably
measurable. Revaluations must be made with sufficient regularity to ensure that the carrying
amount is not materially different from fair value.

However, if an asset is revalued, then the entire class of asset must be

revalued. The fair value of property is its market value. A professionally qualified valuer
normally undertakes the valuation. IAS 16 does not use the value to the business model. As a
consequence, IAS 16 is not prescriptive in requiring such things as non-specialised properties to
be valued at existing use value (EUV), at depreciated replacement cost and properties surplus to
requirements to be valued at open market value.

Acquisition of Property

The following are the ways of acquiring a property

1. Cash basis

2. On account subject to cash discount

3. Installment basis

4. Issuance of share capital

5. Issuance of bonds payable

6. Exchange

7. Donation

8. Government grant

9. Construction

Cash basis acquisition of PPE

If item of property, plant and equipment is acquired on cash basis then its a simple transaction of
one asset increasing and the other decreasing.

For example entity bought a machinery of $100,000 paying by cash then journal entry will be as
follows:

Machinery a/c 100,000

Cash a/c 100,000

Similarly, if asset is bought paying by cheque then bank account will be credited. For example if
entity bought printer to be used in head office for $2,000 and paid the supplier via cheque then
journal entry will be:

Office equipment a/c 2,000

Bank a/c 2,000

PPE acquired on Lump-sum basis

If multiple assets are acquired as part of one deal for which a single payment is made it is called
lump-sum purchase.

For example entity has acquired land, building and installed machinery for 200,000. Although all
assets are acquired under one deal, we still have to recognize the assets separately in the
statement of financial position thus we need to know the values of each individual assets.
To allocate the purchase consideration entity use relative fair values of asset and divide the total
consideration on pro-rata basis. If it is not possible to determine the fair values of assets then
there are other allocation basis available like future income basis, replacement cost basis. Entity
is required to use such basis of allocation that render true and fair values of assets.

Example – Lump-sum purchase of property, plant and equipment

PPE acquired on account

Entity may acquire an asset on credit basis meaning that payment will be made at a later date.
This will create a liability at the time of acquisition which is recorded by crediting an account
with appropriate title which is usually the name of supplier.

For example a building is acquired by business worth $20,000 and promised to pay the full
amount in 2 months time to Momhil Plc. This will be recorded as follows:

Building a/c 20,000

Accounts Payable a/c 20,000

Acquisition on installment basis

Entities may acquire asset on such contracts where payment has been delayed for significant
period of time. Unlike credit basis purchase where payment is made in few months time, in
deferred payment contracts actual cash outflow may occur after 5 years or 10 years of actual
purchase.

Under such contracts, the deferred portion of consideration will be recorded on present value
basis in the cost of assets. However, unwinding charge will be treated as finance cost for the
period and recorded in the income statement instead of being capitalized as cost of the asset.

To make proper calculations, discount rate to be used for present value calculation must be
known and the period over which payment is deferred must also known with certainty. Usually it
is written as part of contract or a separate instrument is used like bond.
Issuance of Share Capital

Philippine GAAP states that if shares are issued for consideration other than actual cash, the
proceeds shall be measured at the fair value of the consideration received. Whereas, when a
property is acquired through the issuance of share capital, the property shall be measured at the
following order of priority:

a. Fair value of the property received

b. Fair value of the share capital

c. Par value or stated value of the share capital

Issuance of bonds payable

Acquisition of a property by issuing a bonds payable, PFRS 9 provides that the entity shall
measure the financial liability at fair value plus transaction costs that are directly attributable to
the issue of the financial liability.

Property acquired shall be measured in the following order:

a. Fair value of bonds payable

b. Fair value of asset received

c. Face amount of bonds payable

PPE acquired on exchange basis

Sometimes entity acquires a new asset in exchange of old one. As new asset is coming in and old
asset is going out therefore it is acquisition and disposal of asset at the same time.

The exchange is recognized at carrying amount when:

a. Measurement of asset received or given is not reliable.

b. The exchange lacks commercial substance.

Commercial Substance happens when the cash flows of the asset received differ
significantly from the cash flows of asset transferred.

For example a new asset worth 10,000 is acquired and no payment is made to supplier except
that entity gave and old asset in exchange. In this case disposal consideration of old asset is
10,000

Another example can be where entity acquired new asset that has a fair value of 15,000. Entity
paid 7,500 in cash and also gave a used asset as part of purchase consideration. In this case the
disposal value of old asset can be found using this simple formula:

New asset value = Cash + Old asset sales value

15,000 = 7,500 + Old asset sales value

15,000 – 7,000 = Old asset sales value

Old asset sales value = 7,500

Donation

Commission on Audit provides the following section for the accounting treatment of donation in
the following situations.

Sec. 9. Non-exchange Transaction. PPE acquired through a non-exchange transaction, such as

donation, presidential proclamation, taxes, transfers and grants, its cost shall be measured at its
fair value as at the date of acquisition. However, this does not constitute revaluation. If the fair
value cannot be determined, the asset should be recorded at a nominal value (the value that is
stated on currency or face value).

Sec. 10. Donation without Condition. Cost of PPE acquired through donation without
condition shall be taken up at its fair value at the date it is acquired. All expenses incurred in
connection with the donated asset, such as delivery and installation costs, shall be included in the
amount recognized as asset. The fair value of the PPE shall be recognized as Income from Grants
and Donations.

Sec. 11. Donation with Condition. Where a PPE is acquired thru donation with conditions
or restrictions, a liability account shall be recognized until the conditions or restrictions have
been fulfilled.

PROBLEMS

For number 1-4

January 1, 2017, an entity disclosed the following balances:

Land 4,000,000
Land improvements 1,300,000
Buildings 20,000,000
Machinery and equipment 8,000,000

During the current year, the following transactions occurred:

* A tract of land was acquired for P2,000,000 cash as a building site.

* A plant facility consisting of land and building was acquired in exchange for 200,000 shares
of the entity. On the acquisition date, each share had a quoted price of P45 on a stock
exchange. The plant facility was carried on the seller’s books at P1,600,000 for land and
P5,400,000 for the building at the exchange date. Current appraised values for the land and
the building, respectively, are P2,000,000 and P8,000,000. The building has an expected life
of forty years with a P200,000 residual value.

* Items of machinery and equipment were purchased at a total cost of P4,000,000. Additional
costs incurred were freight and unloading P100,000 and installation P300,000. The
equipment has a useful life of ten years with no residual value.

* Expenditures totaling P1,200,000 were made for new parking lot, street and sidewalk at the
entity’s various plant locations. These expenditures had an estimated useful life of fifteen
years.

* Research and development costs were P1,100,000 for the year.

* A machine costing P200,000 on January 1, 2010 was scrapped on June 30, 2017. Straight
line depreciation had been recorded on the basis of a 10-year life with no residual value.
* A machine was sold for P500,000 on July 1, 2017. Original cost of the machine sold was
P700,000 on January 1, 2014, and it was depreciated on the straight line basis over an
estimated useful life of eight years and a residual value of P50,000.

1. What is the total cost of land on December 31, 2017?

7,800,000
7,600,000
8,000,000
6,800,000

2. What is the total cost of land improvements on December 31, 2017?

1,200,000
3,600,000
1,300,000
2,500,000

3. What is the total cost of buildings on December 31, 2017?

28,000,000
25,400,000
27,200,000
27,000,000

4. What is total cost of machinery and equipment on December 31, 2017?

12,400,000
11,500,000
11,000,000
11,700,000

SOLUTION

Question 1 Answer A

Land – January 1 4,000,000

Land acquired for cash 2,000,000
Land acquired by issuing shares (2/10 x 9,000,000) 1,800,000
Land – December 31 7,800,000

Quoted price of shares issued for land and building (200,000 x P45) 9,000,000
 Current appraized value :

Land 2,000,000

Building 8,000,000
Total 10,000,000

The total cost of the land and building is equal to the quoted price of the shares which is
allocated prorata to the land and building based on the current appraised value.

Question 2 Answer D

Land improvements – January 1 1,300,000

Expenditures for parking lot, street and sidewalk 1,200,000
Balance – December 31 2,500,000

Question 3 Answer C

Buildings – January 1 20,000,000

Building acquired by issuing shares (8/10 x 9,000,000) 7,200,000
Balance – December 31 27,200,000

Question 4 Answer B

Machinery and equipment - January 1 8,000,000

Machinery and equipment purchased 4,000,000
Freight and unloading 100,000
Installation 300,000
Machinery scrapped ( 200,000)
Machinery sold ( 700,000)
Machinery equipment – December 31 11,500,000

5. October 1, 2005, Tonya Company purchased a machine for P250,000 that was placed in
service on November 30, 2005. Tonya incurred additional costs for this machine, as follows:
Shipping 10,000 Installation 15,000 Testing 35,000 In Tonya’s December 31, 2005 balance
sheet, the machine’s cost should be reported at

a.250000

b.295,000

c.300,000

d.310,000

6. On August 1, 2006, Bamco purchased a new machine on a deferred payment basis. A down
payment of P100,000 was made and the balance is payable in P100,000 annually for 4 years.
The current interest is 12%.The present value of an annuity at 12% for 5 years is 3.04 and the
present value of an amount at the end of 5 th year at 12% is .064. The same machine could be
acquired on cash basis at P400,000. Bamco should record the machine at

a. 500,000

b. 400,000

c. 403,735

d. 303,735

7. To save transportation costs, X acquired its needed equipment in exchange of its inventory
located in the supplier’s business place. The equipment acquired has cash price of P650,000. The
inventory of X has cost of P550,000, and X paid P80,000 cash for the difference in fair value of
the two assets in exchange. In the books of X, the exchange is to be accounted as resulting to

a. gain of 20,000

b. loss of 20,000

c. gain of 30,000

d. loss of 30,000

8. X issued 100,000 of its common shares in the treasury stocks, in exchange for a delivery truck.
The treasury stocks with P10 par were selling at P12 at date of exchange. The treasury shares
were previously acquired at cost of P11/share. The delivery truck has cash price of P1,250,000.
In the books of X, the exchange will result to

a. gain of P150,000

b. loss of P50,000

c. gain of P50,000

d. no gain/no loss

9. Residual value is specifically:

a. The gross cash amount that is received from the ultimate sale of the asset, at the end of its life

b. Scrap value

c. The net cash amount that is received from the ultimate sale of the asset, at the end of its life

10. Useful life of an asset refers to the life:

a. Of the asset whilst it is available for use in the firm

b. The average of A and C

c. Of the asset throughout its life, in the hands of any number of owners

11. Spare parts and servicing equipment are usually accounted for as:

a. Inventory

b. A separate class of fixed assets

c. Expenses written off to the profit or loss on buying

12. Repairs and maintenance costs are normally:

a. Capitalised

b. Expensed in the profit or loss as incurred

c. Recorded as deferred expenses

13. Recognition of costs (to be capitalised) ceases when:

a. Full production capacity has been reached

b. The accounting period ends

c. The item is in the location and capable of operating

14. Incidental income and expenses (such as using a site as a temporary car park) should be:

a. Capitalised into the asset

b. Taken to the profit or loss

c. Ignored
 CHAPTER 26
GOVERNMENT GRANT

Government Grants
These are assistance by the government in the form of transfers of economic resources to an
entity as a result of entity’s past or future compliance with certain specified conditions relating to
the operating activities of the entity. However, it does not include those forms of government
assistance which cannot be reliably measured in monetary terms and transactions with
government which are not distinguishable from the normal trading transactions of the entity.

Government Assistance
These are actions by the government undertaken to provide economic benefits to an entity or
range of entities which qualify certain conditions. These do not have exact value placed upon
them in monetary terms.

Grants related to Assets

The government grants which are available for the construction, acquisition or purchase of
certain assets are called grants related to assets. It may be having some certain conditions
attached to it regarding the nature, use or location of the asset.

Grants related to Income

These are government grants other than grants related to assets, and are normally available for
development or improvements. Such as grant for improvement in working conditions for
employees, grant for the creation of job vacancies, and grant for the training of the staff.

Recognition of Government Grants

Government grants are only permitted to be recognized when it is reasonably certain that:
a. Grant will be received and;
b. The entity will satisfy the predetermined conditions related to the government grant.

Approaches for the Recognition of Government Grant

There are two broad approaches to the accounting for government grants:
1. Deferred Income Approach
Under this approach, government grant is recognized in statement of profit or loss using
appropriate method over the periods in which the entity recognizes the related costs, for which
the grant is intended to compensate.
2. Deduction to Assets Approach
Under this approach, government grant is recognized outside the profit or loss because
government grants are not earned, so, it is not appropriate to recognize these in profit or loss.
Moreover, government grants are financing components, thus, it should be treated as such in the
statement of financial position as part of equity.

Illustration (1)
Tomoe Company received a government grant of P10,000,000 for the acquisition of research and
development facility with a cost of P50,000,000 and useful life of 5 years with no salvaged
value.

Journal entries:
Cash P10,000,00
0
Deferred grant income P10,000,000
Building P50,000,00
0
Cash P50,000,000
Depreciation P10,000,00
0
Accumulated depreciation P10,000,000
(P50,000,000/5 years)
Deferred grant income P2,000,000
Grant income P2,000,000
(P10,000,000/5 years)

Note: Grant related to non-depreciable asset, such as land, requiring fulfillment of certain
conditions shall be recognized as income over the periods which bear the cost of meeting the
conditions.

Illustration (2)
Kou Company received a grant of P30,000,000 from Korean government to compensate the
damages incurred from a massive cyclone.

Journal entries:
Cash P30,000,00
0
Grant income P30,000,000

Note: A government grant that becomes receivable as compensation for expenses or losses
already incurred or for the purpose of giving immediate financial support to the entity with no
further related costs shall be recognized as income of the period in which it becomes receivable.
Illustration (3)
On January 1, 2019, Naruse Company received a government grant of P8,000,000 for the
acquisition of equipment for P10,000,000. It is to be depreciated on a straight line basis over 10
years with a residual value of P500,000.

Journal entries for the current year

Using deferred income approach:
To record the acquisition of the asset:
Equipment P10,000,00
0
Cash P10,000,000

To record the government grant:

Cash P8,000,000
Deferred grant income P8,000,000

To record the annual depreciation:

Depreciation P950,000
Accumulated depreciation P950,000
(P10M-P500,000/10 years)

To recognize the income from government grant:

Deferred grant income P800,000
Grant income P800,000
(P8,000,000/10 years)

Using deduction from asset approach:

To record the acquisition of the asset:
Equipment P10,000,00
0
Cash P10,000,000

To record the government grant:

Cash P8,000,000
Equipment P8,000,000

To record the annual depreciation:

Depreciation P150,000
Accumulated depreciation P150,000*

Acquisition cost P10,000,000

Government grant ( 8,000,000)
Net cost P 2,000,000
Residual value ( 500,000)
Depreciable amount P 1,500,000
Annual depreciation (P1,500,000/10 years) P 150,000*
Illustration (4)

On January 1, 2019, an entity received P20,000,000 government grant related to a building that
is purchased on same date at a cost of P30,000,000. It has a useful life of 10 years with no
residual value.

On January 1, 2021, the full amount of the grant became repayable due to non-compliance of the
entity with the conditions attached in the government grant.

Using deferred income approach:

2019
Jan. 1 Building P30,000,00
0
Cash P30,000,000
1 Cash P20,000,00
0
Deferred grant income P20,000,000
Dec. 31 Depreciation P3,000,000
Accumulated depreciation P3,000,000
(P30,000,000/10 years)
Dec. 31 Deferred grant income P2,000,000
Grant income P2,000,000
(P20,000,000/10 years)
2020
Dec. 31 Depreciation P3,000,000
Accumulated depreciation P3,000,000
Dec. 31 Deferred grant income P2,000,000
Grant income P2,000,000
2021
Jan. 1 Deferred grant income P16,000,00
0
Loss on repayment of grant P4,000,000
Cash P20,000,000
Dec. 31 Depreciation P3,000,000
Accumulated depreciation P3,000,000

Building P30,000,000
Accumulated depreciation (P3,000,000*3 years) ( 9,000,000)
Carrying amount (December 31, 2021) P21,000,000

Using deduction from asset approach:

2019
Jan. 1 Building P30,000,000
 Cash P30,000,000
1 Cash P20,000,000
Building P20,000,000
Dec. 31 Depreciation P1,000,000
Accumulated depreciation P1,000,000
(P10,000,000/10 years)
2020
Dec. 31 Depreciation P1,000,000
Accumulated depreciation P1,000,000
2021
Jan. 1 Building P20,000,000
Cash P20,000,000
Dec. 31 Depreciation P7,000,000*
Accumulated depreciation P7,000,000

Depreciation on original carrying amount P1,000,000

Depreciation on increased carrying amount
(P20,000,000/10*3) P6,000,000
Total depreciation for 2021 P7,000,000*

Building (P10,000,000+ P10,000,000) P30,000,000

Accumulated depreciation
(P1,000,000+ P1,000,000+P7,000,000) ( 9,000,000)
Carrying amount (December 31, 2021) P21,000,000

Note: Whether the entity follows the deferred income approach or the deduction from asset
approach, the carrying amount after repayment of the grant is the same.
PROBLEMS:

1. Government grants should be recognized when there is:

A. Absolute certainty that the entity will comply with the conditions attaching to them and
the grant will be received.
B. Reasonable assurance that the entity will comply with the conditions attaching to
them and the grant will be received.
C. A probability that the entity will comply with the conditions attaching to them and the
grant will be received.
D. Some possibility that the entity will comply with the conditions attaching to them and the
grant will be received.

2. Which statement is not true about the recognition of government grant?

A. Government grants are recognized in profit or loss on a systematic basis over the periods
in which the entity recognizes as expenses the related costs for which the grants are
intended to compensate.
B. A government grant that becomes receivable as compensation for expenses or losses
already incurred or for the purpose of giving immediate financial support to the entity
with no future related costs is recognized in profit or loss of the period in which it
becomes receivable.
C. An entity recognizes government grants only when there is reasonable assurance that the
entity will comply with the conditions attached to them and the grants will be received.
D. An entity recognizes government grants even when there is no reasonable assurance
that the entity will comply with the conditions attached to them and the grants will
be received. 

3. IAS 20 deals with almost all types of government grants, except:

A. Grant related to income or reimbursement of expenditures
B. Grant related to agriculture
C. Grant for ecological measures
D. Grant for research and development

4. Which of the following is not covered by IAS 20?

A. Tax breaks
B. Employment grants
C. Subsidized loans
D. Forgivable loans

4. Which of the following can be considered a government grant?

A. Grant related to agriculture under IAS 41.
B. Government assistance in the form of tax reliefs, such as tax breaks, tax holidays, etc.
C. Government loan at a below-market rate of interest.
 D. Government assistance whose value cannot be reasonably measured, such as technical or
marketing advice.

5. Which of the following is not a correct treatment of government grants related to income?

A. Present as a separate credit under a general heading (eg. ‘Other income’)

B. Deduct from the related expense
C. Deduct from the cost of the asset
6. Which of the following is not a correct treatment of government grants related to an asset?

A. Deferred income
B. Credit to income in period received
C. Deducting the grant from the carrying amount of the asset

7. Which statement is not true under the income approach?

A. Government grant is recognized in statement of profit or loss using appropriate method

over the periods in which the entity recognizes the related costs.
B. Government grant is recognized in statement of profit or loss using appropriate method
over the periods for which the grant is intended to compensate.
C. Government grant should be recognized directly in equity because these are
received from an equity participant.
D. Government grant should not be recognized directly in equity because these are received
from a source other than equity participants.

8. If an entity receives a non-monetary asset as a grant, this is accounted for at?

A. Market value
B. Fair value
C. Present value
D. Discounted value

9. If a grant must be repaid it is

A. An error
B. A revision of an accounting policy
C. A revision of an accounting estimate
D. A new transaction
10. Which of the following disclosures is not a requirement of IAS 20?

A. Accounting policy adopted for grants

B. Nature and extent of grants recognised in the financial statements
C. Current grant applications in process
D. Unfulfilled conditions, contingencies attaching to recognised grants

11. An entity receives a forgivable loan from the local government. It does not expect to meet the
relevant terms for forgiveness. This loan should be treated as?
A. Government Grant
B. Liability

12. On January 1, 2019, Haru Company purchased a machine for P3,000,000. The entity
received a government grant of P600,000 in relation to the acquisition. The machine is to be
depreciated on a 20% declining balance over 5 years with a residual value of 150,000.

Using deferred income approach, what amount should be recorded as depreciation at the end of
the year?

A. P150,000
B. P90,000
C. P600,000 (P3,000,000*20%)
D. P480,000

13. Using the previous example, what amount should be recorded as depreciation at the end of
the year under the deduction from asset approach?

A. P150,000
B. P90,000
C. P600,000
D. P480,000 [P3,000,000-P600,000)*20%]

14. An entity received a P25,000 grant toward the purchase of new equipment that costs
P100,000. The equipment has a five-year life and is depreciated on a straight-line basis.

Prepare journal entries for the current year using deferred income approach and deduction from
asset approach.

Answer:

Deferred income approach:

Equipment P100,000
Cash P100,000

Cash P25,000
Deferred grant income P25,000

Depreciation (P100,000/5) P20,000

Accumulated depreciation P20,000

Deferred grant income P5,000

Grant income (P250,000/5) P5,000

Deduction from asset approach:

Equipment P100,000
Cash P100,000

Cash P25,000
Equipment P25,000

Depreciation (P75,000/5) P15,000

Accumulated depreciation P15,000

15. Kou Company received a grant of P20,000,000 from the Japanese government to compensate
for massive losses due to a recent earthquake.

Prepare the journal entries for the current year to record the grant.

Answer:

Cash P20,000,00
0
Grant income P20,000,000

16. On January 1, 2019, a foreign government granted Kazehaya Company a P11,000,000 loan
for acquiring land to be used as a building site.

The grant is a five-year zero-interest loan evidenced by a promissory note. The market rate of
interest is 6% and the present value of 1 for 5 periods at 6% is .7473.

Prepare journal entries for 2019 and 2020.

Answer:
 2019
Jan. 1 Cash P11,000,00
0
Discount on notes payable 2,779,700
Loan payable P11,000,000
Deferred grant income 2,779,700
Dec. 31 Interest expense 493,218
Discount on notes payable 493,218
31 Deferred grant income 493,218
Grant income 493,218
2020
Dec. 31 Interest expense 522,811.08
Discount on notes payable 522,811.08
31 Deferred grant income 522,811.08
Grant income 522,811.08

Computation:
Carrying amount, 1/1/2019 (P11,000,000*.7473) P8,220,300
Interest for 2019 (P8,220,300*6%) 493,218
Carrying amount, 1/1/2020 P8,713,518
Interest for 2020 (P8,713,518*6%) P522,811.08

17. On January 1, 2019, an entity received P10,000,000 government grant related to a building
that is purchased on same date at a cost of P20,000,000. It has a useful life of 10 years with no
residual value.

On January 1, 2021, the full amount of the grant became repayable due to non-compliance of the
entity with the conditions attached in the government grant.

Prepare journal entries for 2019, 2020 and 2021 using deferred income approach.

Answer:

2019
Jan. 1 Building P20,000,00
0
Cash P20,000,000
1 Cash P10,000,00
0
Deferred grant income P10,000,000
Dec. 31 Depreciation P2,000,000
Accumulated depreciation P2,000,000
(P20,000,000/10 years)
Dec. 31 Deferred grant income P1,000,000
Grant income P1,000,000
 (P10,000,000/10 years)
2020
Dec. 31 Depreciation P2,000,000
Accumulated depreciation P2,000,000
Dec. 31 Deferred grant income P1,000,000
Grant income P1,000,000
2021
Jan. 1 Deferred grant income P8,000,000
Loss on repayment of grant P2,000,000
Cash P10,000,000
Dec. 31 Depreciation P2,000,000
Accumulated depreciation P2,000,000

18. Using the same problem, determine the carrying amount after repayment of the grant using
deferred income approach.

Solution:

Building P20,000,000
Accumulated depreciation (P2,000,000*3 years) ( 6,000,000 )
Carrying amount (December 31, 2021) P14,000,000

19. Using the same problem, prepare journal entries for 2019, 2020 and 2021 using deduction
from asset approach.

2019
Jan. 1 Building P20,000,000
Cash P20,000,000
1 Cash P10,000,000
Building P10,000,000
Dec. 31 Depreciation P1,000,000
Accumulated depreciation P1,000,000
(P10,000,000/10 years)
2020
Dec. 31 Depreciation P1,000,000
Accumulated depreciation P1,000,000
2021
Jan. 1 Building P10,000,000
Cash P10,000,000
Dec. 31 Depreciation P4,000,000*
Accumulated depreciation P4,000,000

* Depreciation on original carrying amount P1,000,000

Depreciation on increased carrying amount
 (P10,000,000/10*3) P3,000,000
Total depreciation for 2021 P4,000,000

20. Using the same problem, determine the carrying amount after repayment of the grant using
deduction from asset approach.

Building (P10,000,000+ P10,000,000) P20,000,000

Accumulated depreciation
(P1,000,000+ P1,000,000+P4,000,000) ( 6,000,000 )
Carrying amount (December 31, 2021) P14,000,000
Chapter 27
 Chapter 28

Land and Building

Land is considered to be the asset with the longest term, it cannot be depreciated. Thus,
the life span of land is indefinite. Land is classified as long-term asset or a fixed asset on
business’ balance sheet, because it is not expected to convert cash in just a span of one year.

When acquiring a land, certain costs are ordinary and necessary that should be assigned
to land. These costs include the

a. cost of the land

b. title fees
c. legal fees
d. survey costs and zonal fees
e. site preparation costs like grading, clearing and draining
f. the costs to demolish an old structure
g. real estate commissions
h. title search and title transfer fees
i. title insurance premiums
j. existing mortgage not or unpaid taxes (back taxes) assumed by the purchaser
k. and other similar expenditures
All of these costs are directly attributed to get the land ready for intended use. The
account debits the entire costs to Land.

Land Improvements

The costs of the land improvements includes all expenditures associated with making the
improvements to the land for its intended use. This asset category includes the ff:

a. Parking lots
b. Sidewalks
c. Landscaping
d. Irrigation systems
e. And other similar expenditures
Land and land improvements have separate account for considering depreciation. Land have
an indefinite life and is not subject to depreciation. However, land improvements like parking
lots, irrigations and many more wear out throughout the years, hence, it is depreciated.

Building

Building, like land, is also a noncurrent long-term asset of the company. However, the
building is depreciated throughout the years because it is subject to wear and tear, damages like
calamity and so on and so forth. When acquiring or constructing a building, the costs that is
capitalize to the building would include all the expenses associated with purchasing or
construction of the building for its preparation for its intended use.

Like the case in the land, companies acquire or construct buildings for several purposes,
investment or for usage. The cost of the building must include:

a. Purchase price (includes the price paid to the seller for the old structure)
b. Closing costs (include professional fees paid to attorneys, agencies including title
searches, title insurance, survey costs, as well as fees paid to the government entities to
register the sale)
c. Construction costs (materials, labor, and overhead costs associated with the construction
of the building.
d. Fees (construction permits, architectural, and engineering services)
Generally, the cost of new building starts with the excavation of land to receive the new
structure. The cost of demolishing and removing the existing structure from the land, as well as
the cost for grading, clearing trees and levelling are costs attributable to the land and not to the
building.

Building Improvements

Building improvements are capital events that materially extends the life of the building
and/or increase the value of it. These improvements are capitalized and are recorded as an
addition of value to the existing building if the expenditure meets the capitalization threshold.
Unlike, land improvements these improvements are not accounted separately for a building is
also subject to depreciation.

Building fixtures, ventilating system, lighting system, elevator and others if put in within
the construction of the building and are immovable or attached to, the costs are capitalized to the
building account. However if such fixtures are movable, these are recorded to furniture and
fixtures account.

Cost Assignment

The correct amount of cost to allocate to a productive asset like land and building are
based on those expenditures that are ordinary and necessary to get the item in place and in place
for its intended use. Such amount include the purchase freight (less any negotiated amount),
permits, ordinary installation, and other normal costs associated with getting the property ready
for intended usage. These costs are termed capital expenditures and are assigned to the asset
account.

GAAP determines if the demolition costs are capitalized or expensed depending on the ff.
situations.
a. If the land and building are purchased with the intention to use the land and demolish the
building, the cost to demolish the old building is capitalized to Land improvements.
b. If land and building arte purchased with the intention to use the land, demolish the
building and build a new one, capitalize the cost to demolish the building as part of cost
of new building if demolition occurs thereafter.
c. If land and building are purchased with the initial intention to use the land and building,
expense the costs to demolish the existing building at a later date. The demolition cost are
an expense associated with the cost of using the existing asset as and are not capitalized
in the cost of the new asset.
PROBLEMS

Problem 28-1

Mi-len Co. purchased an old farm on the outskirts of Nueva Ecija to be used as a factory site.
The company paid P10,000,000 for the property. The company agreed to pay the unpaid taxes of
P300,000. Attorneys’ and other legal cost of P81,000. The company demolished the old
structures for P900,000. The company where able to sell some structure for P135,000.

What is the cost of the land?

a. P11,145,000
b. P11,146,000
c. P14,150,000
d. P16,146,000
Answer: B

Cost of Factory Site P10,000,000

Back taxes 300,000
Attorneys’ fees and other legal fees 81,000
Demolition 900,000
Sale of salvaged parts (135,000)
Total Land Cost P11,146,000

Problem 28-2

Anieting Co. decided to purchase a new land with the intention of constructing new building.
The following are the data for the acquisition of the land.

Land P20,500,000
Closing Costs 560,000
Costs of demolishing old warehouse 220,000

What is the cost of the land?

a. P21,600,000
b. P21.820,000
c. P21,060,000
d. P21,280,000
Answer: C

Land P20,500,000
Closing costs 560,000
Land cost P21,060,000

Problem 28-3 and 4

JR Inc. decided to acquire a land for the construction of a new resort to be used in
business. The following were incurred by JR Inc. in the acquisition of land.

Land P450,000
Razing Costs 42,000
Residual value 6,300
Legal Fees 1,850
Survey 2,200
Plans 65,000
Title Insurance 1,500
Liability Insurance 900
Construction 2,740,000
Interest 170,000

What is the cost of the land?

a. 589,000
b. 2,978,100
c. 489,500
d. 489,050
What is the cost of the building?

a. 589,000
b. 2,978,100
c. 489,500
d. 489,050
Answer: D, B

The allocation of costs is as follows:

Land Building

Land P450,000
Razing Costs 42,000
Residual value (6,300)
Legal Fees 1,850
Survey 2,200
Plans 65,000
Title Insurance 1,500
Liability Insurance 900
Construction 2,740,000
Interest 170,000

P498,050 P2,978,100

Problem 28-5 and 6

During the current year Johnny Company had the following transactions for the purchase of its
new building.

Purchase of land as a building site 500,000

Architect Fees 100,000
Legal Fees for the purchase of land 25,000
Demolition 75,000
Salvage sale 20,000
Construction of new building 1,800,000

What is the cost of the building?

a. 1,955,000
b. 1,980,000
c. 2,480,000
d. 525,000
What is the cost of the land?

a. 1,955,000
b. 1,980,000
c. 2,480,000
d. 525,000
Answers: A, D

Land Building

Purchase of land as a building site 500,000

Architect Fees 100,000
Legal Fees for the purchase of land 25,000
Demolition 75,000
Salvage sale (20,000)
Construction of new building 1,800,000

P525,000 P1,955,000

Problem 28-7

Lany Inc. acquired an existing building in exchange of 50,000 ordinary shares. The list price of
the building is P8,000,000 and the shares have affair value of P120. The entity also incurred the
following transactions.

Payment to tenants to vacate the building 65,000

Unpaid property taxes assumed by Lany 100,000
Assessment by city for sewerage project 10,000
Driveways and parking lot bays 550,000
Cost of grading and leveling 45,000
Cost of new wing attached to the building 750,000
Cost of new ventilation system 300,000
Remodeling costs prior to occupancy 200,000

What is the total cost of the building?

a. 9,115,000
b. 7,115,000
c. 7,415,000
d. 7,125,000
Answer: B

Cost of ordinary shares exchanged (50,000×120) P6,000,000

Payment to tenants to vacate the building 65,000
Unpaid property taxes assumed by Lany 100,000
Cost of new wing attached to the building 750,000
Remodeling costs prior to occupancy 200,000

P7,115,000

Problem 28-8

An entity purchased land and an old hotel on which it is located with the plan to tear down the
hotel and build a new hotel on the site. Any allocated cost to the old hotel should be:
 a. Depreciated over the period from the acquisition to the date the hotel is to be tear down
b. Written off as loss in the year the hotel was torn down
c. Capitalized as part of the cost of the land
d. Capitalized as part of the cost of the building
Answer: B

Problem 28-9

On January 2019. Flor Company purchased a track of land with an old building which is razed
shortly after acquisition to make room for the construction of new building. The costs incurred in
connection with the acquisition were:

Total purchase price (the old building has a fair value of P300,000) 3,000,000
Agent commission 100,000
Legal fees for the purchase contract 50,000
Guarantee insurance 10,000
Cost of razing the old building 150,000
Salvaged values of old building materials 25,000

What is the cost of the land?

a. 2,865,000
b. 3,165,000
c. 2,860,000
d. 2,990,000
Answer: A

Total purchase price (3000,000 – 300,000) 2,700,000

Agent commission 100,000
Legal fees for the purchase contract 50,000
Guarantee insurance 10,000
2,860,000

Problem 28-10

In the preceding problem, the construction of the building was started right after the razing of the
old building. The following costs are incurred by the company:

Construction of new building 16,000,000

Furniture and Fixtures attached to the building 260,000
Ventilation and other equipment acquired later on after the construion 350,000

What is the total cost of the building?

a. 16,385,000
b. 10,385,000
c. 16,260,000
d. 16,735,000
Answer: A

Cost of razing the old building 150,000

Salvaged values of old building materials (25,000)
Construction of new building 16,000,000

Furniture and Fixtures attached to the building 260,000

16,385,000

Problem 28-11

Reddhots Inc. purchased a track of land as a factory site for 3,200,000. The company demolished
the old building and sold the materials it salvaged.

Demolition of old building 180,000

Legal fees for purchase contract 160,000
Guarantee insurance 22,000
Sale of salvaged materials 70,000

What is the initial carrying amount of the land?

a. 3,632,000
b. 3,562,000
c. 3,382,000
d. 3,458,000
Answer: B

Land 3,200,000
Legal fees for purchase contract 160,000
Guarantee insurance 22,000
3,382,000

Problem 28-12 and 13

On Januray 2019, Jeff Company decided to expand its operations and had purchased land and an
old building for construction of a new manufacturing plant, the following costs were incurred in
purchasing the property and constructing the new building.

Purchase price (the old building has no fair value) 2,500,000

Payment of property and taxes 100,000
Title search and insurance 50,000
Special assessment for city improvements on water and sewer 150,000
Building permit 30,000
Cost to demolish old building 60,000
Contract cost of new building 7,000,000
Architect fee 200,000
Sidewalk and parking lot 100,000
Fire insurance on building 40,000

What is the cost of the land?

a. 2,860,000
b. 2,810,000
c. 2,800,000
d. 2,750,000
Answer: D

Purchase price (the old building has no fair value) 2,500,000

Payment of property and taxes 100,000
Title search and insurance 50,000
Sidewalk and parking lot 100,000

2,750,000

Problem 28-13

In the preceding problem, what is the cost of the building?

a. 7,440,000
b. 7,290,000
c. 7,390,000
d. 7,330,000
Answer: B

Building permit 30,000

Cost to demolish old building 60,000
Contract cost of new building 7,000,000
Architect fee 200,000
7,290,000

Problem 28-14

Grace Inc. acquired an existing building in exchange of 20,000 ordinary shares. The list price of
the building is P3,500,000 and the shares have affair value of P150. The entity also incurred the
following transactions.

Payment to tenants to vacate the building 65,000

Unpaid property taxes assumed by Grace 100,000
Assessment by city for sewerage project 10,000
Driveways and parking lot bays 550,000
Cost of grading and leveling 45,000
Cost of new wing attached to the building 750,000
Cost of new ventilation system 300,000
Remodeling costs prior to occupancy 200,000

What is the total cost of the building?

a. 6,115,000
b. 4,115,000
c. 4,415,000
d. 4,125,000
Answer: B

Cost of ordinary shares exchanged (20,000×150) P3,000,000

Payment to tenants to vacate the building 65,000
Unpaid property taxes assumed by Grace 100,000
Cost of new wing attached to the building 750,000
Remodeling costs prior to occupancy 200,000

P4,115,000

Problem 28-15

On January 2019. Just Company purchased a track of land with an old building which is razed
shortly after acquisition to make room for the construction of new building. The costs incurred in
connection with the acquisition were:

Total purchase price (the old building has a fair value of P200,000) 6,000,000
Agent commission 120,000
Legal fees for the purchase contract 50,000
Guarantee insurance 10,000
Cost of razing the old building 200,000
Salvaged values of old building materials 50,000

What is the cost of the land?

a. 5,980,000
b. 6,200,000
c. 6,080,000
d. 5,200,000
Answer: A

Total purchase price (6,000,000 – 200,000) 5,800,000

Agent commission 120,000
Legal fees for the purchase contract 50,000
Guarantee insurance 10,000
5,980,000

Problem 28-16

In the preceding problem, the construction of the building was started right after the razing of the
old building. The following costs are incurred by the company:

Construction of new building 14,000,000

Furniture and Fixtures attached to the building 260,000
Ventilation and other equipment acquired later on after the construion 350,000

What is the total cost of the building?

a. 14,410,000
b. 14,140,000
c. 10,140,000
d. 11,140,000
Answer: A

Cost of razing the old building 200,000

Salvaged values of old building materials (50,000)
Construction of new building 14,000,000
Furniture and Fixtures attached to the building 260,000
14,410,000

Problem 28-17

Alexis Co. decided to purchase a new land with an old warehouse. The old warehouse was
eventually razed after the acquisition by Alexis. The following are incurred by the company.
Land 11,000,000
Closing Costs 350,000
Costs of demolishing old warehouse 250,000
Sale of salvaged materials from the warehouse 50,000
Legal fees in purchase contract of the land 10,000

What is the cost of the land?

a. P11,600,000
b. P11.820,000
c. P11,360,000
d. P11,280,000
Answer: C

Land 11,000,000
Closing Costs 350,000
Legal fees in purchase contract of the land 10,000
11,360,000

Problem 28-18

EXO Inc. decided to acquire a land for the construction of a new resort to be used in business.
The following were incurred by EXO Inc. in the acquisition of land.

Land P520,000
Razing Costs 55,000
Residual value 6,300
Legal Fees 1,850
Survey 2,200
Plans 77,000
Title Insurance 10,000
Liability Insurance 5,000
Construction 2,850,000

What is the cost of the building?

a. 2,589,000
b. 2,540,000
c. 3,600,000
d. 2,934,200
Answer: D

Survey 2,200
Plans 77,000
Liability Insurance 5,000
Construction 2,850,000
2,934,200

Problem 28-19 and 20

During the current year Miggy Company had the following transactions for the purchase of its
new building.

Purchase of land as a building site 15,000,000

Architect Fees 200,000
Legal Fees for the purchase of land 125,000
Demolition 110,000
Salvage sale 85,000
Construction of new building 17,500,000
Furniture and fixtures attached to the Building 620,000
Ventilation purchased within the construction of the building 60,000
Agent Commission 1,500,000

What is the cost of the building?

a. 18,405,000
b. 15,550,000
c. 16,650,000
d. 16,625,000
What is the cost of the land?

a. 18,405,000
b. 15,550,000
c. 16,650,000
d. 16,625,000
Answers: A, D

Land Building

Purchase of land as a building site 15,000,000

Architect Fees 200,000
Legal Fees for the purchase of land 125,000
Demolition 110,000
Salvage sale (85,000)
Construction of new building 17,500,000
Furniture and fixtures attached to the Building 620,000
Ventilation purchased within the
construction of the building 60,000
Agent Commission 1,500,000
16,625,000 18,405,000
CHAPTER 29- Machinery

Machinery is a noncurrent or long-term asset account which reports the cost of the
machinery. Machinery will be depreciated over its useful life by debiting the income statement
account Depreciation Expense and crediting the balance sheet account Accumulated
Depreciation (a contra asset account).

Cost(s) to Capitalize:

a. Purchase price including import duties and non-refundable purchase taxes after deducting
trade discounts and rebate.
b. Cost directly attributable to bringing the asset to the location and condition necessary for
it to be capable of operating in the manner intended by the management.
c. Insurance on machinery while in transit.
d. Cost of special foundations if required.
e. Assembling and installation cost.
f. Cost of conducting trial runs.
Costs to capitalize are mainly all expenditures incurred in acquiring the machinery and the
preparation for its intended use.

Self-Constructed Machinery:

In cases where the entity constructs its own machinery, there would be an issue in
determining cost of such machinery. Without a purchase price, the company must allocate costs
and expenses incurred to determine the cost to capitalize for the machinery such as:

a. Direct Material
b. Direct Labor
c. Overhead, which includes; heat, light, insurance, property taxes on factory buildings and
equipment, factory supervisory labor, depreciation of fixed assets, and supplies.
Equipment

Equipment includes delivery and transportation equipment, office equipment, machinery,

furniture and fixtures, furnishings, factory equipment, and similar fixed assets.

Cost(s) to Capitalize:

a. Purchase price including other necessary costs, such as broker’s commissions and non-
refundable purchase taxes.
b. Freight, handling charges, and insurance on the equipment while in transit
c. Cost of necessary special foundations or platforms
d. Assembling and installation costs
e. Initial estimate of decommissioning and restoration costs for which the entity has a
present obligation
Cost(s) NOT included:

a. Cost of relocating the equipment after it has been put to the location and condition
originally intended by management.
b. Cost of training personnel who will be responsible in operating the equipment
c. Cost of dismantling and removing an old equipment belonging to the entity prior to the
installation of a new equipment
PROBLEMS:

1. In testing for unrecorded retirements of equipment, to verify this assumption you will most
likely to:
a. Select items of equipment from the accounting records and then locate them
during the plant tour.
b. Compare depreciation journal entries with similar prior-year entries in search of fully
depreciated equipment.
c. Inspect items of equipment observed during the plant tour and then trace them to the
equipment subsidiary ledger.
d. Scan the general journal for unusual equipment additions and excessive debits to
repairs and maintenance expense.
2. Additions to equipment are sometimes understated. Which of the following accounts
would be reviewed to gain reasonable assurance that additions are not
understated?
a. Accounts payable c. Depreciation expense
b. Gain on disposal of equipment d. Repair and maintenance expense

3. You obtain the following information pertaining to Puto Se Co. Machinery for 2020 in
connection with your audit of the company’s financial statements.
Blance as of December 31,2019:
Machinery and equipment 22,500,000
Accumulated depreciation –
Machinery and Equipment 6,250,000
Puto Se Co. uses straight line method over the ten-year useful life of the machinery and
equipment. On April 1, 2020, a machine purchased for P575,000 on April 1, 2015 was destroyed
by fire. Puto recovered P387,500 from its insurance company. On July 1, 2020, machinery and
equipment were purchased at a total invoice cost of P7,000,000; additional cost of P125,000 for
freight and P625,000 for installation were incurred.
How much is the Accumulated depreciation – Machinery and Equipment as of
December 31, 2020 where salvage value is immaterial?
a. P8,844,375 b. P8,614,375 c. P8,830,000 d. P8,556,875
4.
The following items relate to
the acquisition of a new
machine by Bongabon
Corporation in 2020:
Invoice price of machinery P2,000,000
Cash discount not taken 40,000
Freight on new machine 10,000
Cost of removing the old 12,000
machine
Loss on disposal of the old 150,000
machine
Gratuity paid to operator of 70,000
the old machine who was laid
off
Installation cost of new 60,000
machine
Repair cost of new machine 8,000
damaged in the process of
installation
Testing costs before machine 15,000
was put into regular operation
Salary of engineer for the 40,000
duration of the trial run
Operating cost during first 250,000
month of regular use
Cash allowance granted 100,000
because the new machine
proved to be of inferior
quality

How much should be recognized as cost of the new machine?

a. P1,985,000 c. P1,930,000
b. P1,993,000 d. P2,025,000

5. An improvement made to a machine which increased the fair value and production capacity
without extending the useful life of the machine should be

a. expensed immediately
b. debited to accumulated depreciation
c. capitalized in the machine account
d. allocated between accumulated depreciation
6. Which of the following would ordinarily be treated as a revenue expenditure rather than a
capital expenditure?

a. cost of servicing and overhaul to restore or maintain the originally assessed standard of
performance
b. the replacement of a major component of building
c. an addition to an existing building
d. cost of improvement that is expected to provide discernible future benefit

7. Which of the following costs should not be capitalized?

a. replacement of roof of building every 15 years

b. cost of site preparation
c. installation and assembly cost
d. replacement of small spare parts annually

8. Which of the following subsequent expenditure should be expensed immediately?

a. expenditure made to increase the efficiency or effectiveness of an existing asset

b. expenditure made to extend the useful life of an existing asset
c. expenditure made to maintain an existing asset in operating condition
d. expenditure made to add new asset

9. An expenditure made in connection wuth a machine being used by an entity shoul be

a. expensed if it merely extends the useful life but does not improve the quality
b. expensed if it merely improves the quality but does not extend the useful life
c. capitalized if it maintains the machine in normal operating condition
d. capitalized if it increases the quantity of units produced by the machine

10. On January 1, year 1, an entity acquires for $100,000 a new piece of machinery with an
estimated useful life of 10 years. The machine has a drum that must be replaced every five years
and costs $20,000 to replace. Continued operation of the machine requires an inspection every
four years after purchase; the inspection cost is $8,000. The company uses the straight-line
method of depreciation. Under IFRS, what is the depreciation expense for year 1?

a. $10,000
b. $10,800
c. $12,000
d. $13,200
11. Wilson Company maintains its records under IFRS. During the current year Wilson sold a
piece of equipment used in production. The equipment had been accounted for using the
revaluation method and details of the accounts and sale are presented below.
Sales price $100,000
Equipment book value (net) 90,000
Revaluation surplus 20,000
Which of the following is correct regarding recording the sale?
a. The gain that should be recorded in profit and loss is $30,000.
b. The gain that should be recorded in other comprehensive income is $10,000.
c. The gain that should be recorded in other comprehensive income is $30,000.
d. The gain that should be recorded in profit and loss is $10,000; the $20,000 revaluation surplus
should be transferred to retained earnings.

12. On June 18, year 4, Dell Printing Co. incurred the following costs for one of its printing
presses:

Purchase of collating and stapling attachment $84,000

Installation of attachment 36,000

Replacement parts for overhaul of press 26,000

Labor and overhead in connection with overhaul 14,000

The overhaul resulted in a significant increase in production. Neither the attachment nor the
overhaul increased the estimated useful life of the press. What amount of the above costs should
be capitalized?

a. $0
b. $84,000
c. $120,000
d. $160,000

13. A building suffered uninsured fire damage. The damaged portion of the building was
refurbished with higher quality materials. The cost and related accumulated depreciation of the
damaged portion are identifiable. To account for these events, the owner should

a. Reduce accumulated depreciation equal to the cost of refurbishing.

b. Record a loss in the current period equal to the sum of the cost of refurbishing and the carrying
amount of the damaged portion of the building.
c. Capitalize the cost of refurbishing and record a loss in the current period equal to the carrying
amount of the damaged portion of the building.
d. Capitalize the cost of refurbishing by adding the cost to the carrying amount of the building.
14. Derby Co. incurred costs to modify its building and to rearrange its production line. As a
result, an overall reduction in production costs is expected. However, the modifications did not
increase the building’s market value, and the rearrangement did not extend the production line’s
life. Should the building modification costs and the production line rearrangement costs be
capitalized?
Building modification costs Production line rearrangement costs
a. Yes No
b. Yes Yes
c. No No
d. No Yes

15. Initial test batches are allowable as directly attributable cost of machine. FALSE

16. If a company purchased a land with an office building. The building has a useful life of 20
years and it should be depreciated over the useful life of the land. FALSE

17. An expenditure that benefits only the current period is a revenue expenditure and therefore
reported as an expense. TRUE

18. If a machinery is removed and retired to make room for the installation of a new one, the
removal cost not previously recognized as a provision is charged to expense. TRUE

19. Subsequent cost that maintains the existing level of standard performance should be
expensed when incurred. TRUE

20. Insurance of sold machinery can be capitalized either FOB destination or shipping point.
FALSE
 CHAPTER 30:

DEPRECIATION

Straight line and Variable Method

Depreciation-is the systematic allocation of the depreciable amount of an asset over its useful
life.

Depreciation of an asset begins when it is available for use and it ceases when held for sale (or
included in a disposal group that is classified as held for sale). Therefore, depreciation does not
cease when the asset becomes idle or retired from the active use unless the asset is fully
depreciated. However, under the usage methods of depreciation, the depreciation can be zero
while there is no production.

The residual value and the useful life of an asset shall be reviewed at least at each financial year-
end and, if expectations differ from previous estimates, the change shall be accounted for as a
change in an accounting estimate.

Depreciation is recognized even if the fair value of the asset exceeds its carrying value; as long
as the asset’s residual value does not exceed its carrying amount.

The depreciation amount of an asset is determined after deducting its residual value. In practice,
the residual value of an asset is often insignificant and therefore immaterial in the calculation of
the depreciable amount.

The residual value of an asset may increase to an amount equal to or greater than the carrying
value of an asset. If it does, the asset’s depreciation charge is zero unless and until its residual
value subsequently decreases to an amount below the asset’s carrying amount.

The depreciation method applied to an asset shall be reviewed at least at each financial year-end,
if there has been a significant change in the expected pattern of consumption of the future
economic benefits embodied in the asset, the method shall be changed to reflect the changed
pattern. Such a change shall be accounted for as a change in accounting estimate.

Derecognition- an item of property, plant and equipment should be derecognized when:

 a.) It is disposed
b.) No future economic benefit

Methods of Depreciation

1. Straight-line method

-Considers depreciation as a function of time rather than as a function of usage.

-Straight line rate is determined by dividing 100% by the life of the asset in years.

Formula: (Acquisition cost-Residual value)/ useful life

Journal entry: Depreciation Expense

Accumulated Depreciation

2. Composite and group method

-Under the composite method, assets that are dissimilar in nature or assets that have different
physical characteristics and vary widely in useful life, are grouped and treated as a single
unit,

-Under the group method, all assets that are similar in nature and in estimated useful life are
grouped
and treated as a single unit.

3. Working hours method

-Depreciation rate per hour is computed by dividing the depreciable amount by estimated
useful life in terms of service hours.

-Depreciation rate per hour is then multiplied by the actual hours worked in one period to get
the
depreciation for that period.
 4. Output or production method

-Depreciation rate per unit is computed by dividing the depreciable amount by the estimated
useful life in terms of units of output.

-Depreciation rate per unit is then multiplied by the yearly output to get the annual
depreciation.
PROBLEMS

1. On January 1,2019 Lodi Company bought machinery under a contract that required a
down payment of P100,000, plus 24 monthly payments of P50,000 each, for total cash
payments of P1,300,000. The cash price of the machinery was P1,100,000. The
machinery has a useful life of 10 years and residual value of P50,000. Lodi uses straight
line depreciation. What amount should Lodi report as depreciation for 2019?

Solution: (P1,100,000-P50,000)/10= P105,000

2. Justine Company purchased an asset with a useful life of 10 years on January 1, 2019 for
P6,500,000. On December 31, 2019, the amount the entity would receive from the
disposal of the asset if it was already of the age and in condition expected at the end of its
useful life was estimated at P700,000. Inclusive of inflation, the actual amount expected
to be received on disposal was estimated at P900,000. What is the depreciation charge for
2019?

Solution: (P 6,500,000-P700,000)/10= P580,000

3. The following information is taken from the statement of financial position of Petmalu
Company on December 31,2019 and December 31,2018.

2019 2018
Building cost P25,000,000
P25,000,000
Accumulated depreciation-buildings P5,000,000
P3,875,000

Petmalu did not acquire or dispose of any buildings during 2019. The straight
line method of depreciation is used. If residual value is assumed to be 10% of
asset cost, what is the average useful life of the buildings?
 Solution: Accumulated depreciation-2019
P5,000,000
Accumulated depreciation-2018
3,975,000
Annual depreciation
P1,125,000

Average life (25,000,000-2,500,000)/1,125,000 20

4. On January 1,2019, Jocelle Company acquired equipment for P1,000,000 with a 10-year
useful life and P100,000 residual value. The straight line method depreciation is used.
During 2023, after its 2010 financial statements has been issued, Jocelle determined that
this equipment’s remaining useful life was only four more years and its residual value
would be P40,000. What is the carrying amount of the equipment on December 31,2023?

Solution: Cost-January 1, 2019 P1,000,000

Accumulated depreciation on January 1,2023 360,000
(P900,000/10x4)
Carrying amount on January 1,2023 640,000
Depreciation for 2023 (640,000-40,000/4) 150,000
Carrying amount- December 31,2023 P490,000
5. Cardo Company’s depreciation policy on machinery is as follows:
 A full year’s depreciation is taken in the year of an asset’s acquisition.
 No depreciation is taken in the year of an asset’s disposition.
 The estimated useful life is five years.
 The straight line method is used.

On June 30,2019, Cardo sold for P2,300,000 a machine acquired in 2016 for P4,200,000. The
estimated residual value was P600,000.

What amount of gain on the disposal should Cardo record in 2019?

Solution: Sale Price P2,300,000

 Carrying amount of machine:

Cost-2016 P4,200,000

Accumulated depreciation-12/31/18

(4,200,000-600,000/5x3) 2,160,000 2,040,000

Gain on disposal 260,0000

No depreciation is recognized from January 1 to June 30,2019 because the depreciation policy is
that no depreciation is taken in the year of an asset’s disposition.

6. Hakdog Company acquired an aeroplane in 2019. At the time of acquisition, the cost of the jet
frame was P46,000,000 and the additional cost of the engine was P6,000,000. In 2022, the
engine was replaced with a new one costing P12,000,000. At the time of replacement, the
accumulated depreciation to date on the jet frame was P17,500,000 and on the engine was P
4000,000. What amount should be derecognized at the date of replacement?

Solution: Cost of old engine P6,000,000

Accumulated Depreciation 4,000,000
Carrying amount P2,000,000

7. Mimiyuh Company acquired a drilling machine on October 1,2019 at a cost of P2,500,000 and
depreciated it at 25% per annum on as straight line basis. On October 1,2021, the entity’s spent
P500,000 on upgrade to the machine in order to improve its efficiency and increase the inflow
of economic benefits over the machine’s remaining life. What depreciation expense should be
recognized for the year ended September 30,2021?

Solution: Original life (100%/25%) 4 years

Years, expired on October 1, 2021 2
Remaining life 2
 Depreciation on original cost (2,500,000x25%) P625,000
Depreciation on improvement (500,000/2) 250,000
Total depreciation for year ended September 30,2023 P875,000
8. Zeinab Company purchased a boring machine on January 1, 2019 for P8,100,000. The useful
life of the machine is estimated at 3 years with a residual value at the end of this period of
P600,000. During its useful life, the expected units of production are 12,000 units in 2019,
7000 units in 2020, and 5000 units in 2021, and P5,000 units in 2013. What is the depreciation
expense for 2020 using the most appropriate depreciation method?

Solution: Rate per unit (8,100,000-600,000) / 24,000 units 312.50

Depreciation for 2020 (7,000x312.50) P2,187,500

9. Jimbo Company acquired a machine in the first week of July 2019 and paid the following bills:

Invoice price P5,000,000

Freight in 50,000
Installation cost 150,000
Cost of removing the old machine preparatory
to the installation of the new machine 100,000

The estimated life of the machine is 8 years or a total of 100,000 working hours with no
residual .The operating hours of the machine totaled 5,000 hours in 2019 and 12,000 hours in
2020. The entity follows the working hours method of depreciation. On December 31,2020,
what is the carrying amount of the machine?

Solution: Cost (5,000,000+50,000+150,000) P5,200,000

Accumulated depreciation- December 31,2020 884,000
(17,000 hours x 52)
Carrying amount- December 31,2020 P4,316,000
 Rate per hour (5,200,000/100,000) 52

10. Micah Company uses the composite method of depreciation based on composite rate of 25%.
At the beginning of 2019, the total cost of equipment was P5,000,000 with a total residual
value of P600,000. The accumulated depreciation was P3,000,000 at the time. In January 2019,
Micah purchased an equipment for P2,500,000 with no residual value. At the end of 2019,
Micah sold an equipment with an original cost of P1,000,000 and a residual value P200,000
for P350,000. This asset was acquired on January 1,2017. What is the depreciation for 2019?

Solution: Total cost-January 1,2019 P5,000,000

Cost of new asset acquired 2,500,000
Cost of asset sold (1,000,000)
Remaining cost- December 31,2019 P6,500,000

Depreciation for 2019 (25%x6,500,000) P1,625,000

11. Jana Company purchased a depreciable asset for P100,000. The estimated salvage value is
P10,000, and the estimated useful life is 10 years. The straight-line method will be used for
depreciation. What is the depreciation base of this asset?

Solution: P100,000-P10,000= P90,0000

12. Faye Company purchased a depreciable asset for P200,000. The estimated salvage value is
P20,000, and the estimated useful life is 10 years. The straight-line method will be used for
depreciation. What is the depreciation base of this asset?

Solution: P200,000-P20,000=P180,000

13. Chechi Company purchased a depreciable asset for P200,000. The estimated salvage value
isP10,000,ang the estimated useful life is 10,000 hours. Chechi used the asset for 1,100 hours
in the current year. The activity method will be used for depreciation. What is the depreciation
expense on this asset?
 Solution: [(P200,000-P10,000)/10,000] x 1,100= P20,900

14. The first cost of a a machine is P1, 800,000 with a salvage value of P300,000 at the end of its
six years of life. Determine the total deprecation after three years using the straight line method
of depreciation.

Solution: (1,800,000-300,000)/6= P250,000

250,000 (3)= P750,000

15. A commercial building has a salvage value of P1000,000 after 50 years. Annual depreciation is
P2,000,000. Using the straight-line method, how many years after should you sell the building
for P30,000,000?

Solution: Annual depreciation=(FC-SV)/n Total depreciation=FC-BV

P2,000,000=(FC-1)/50 =P101,000,000-
P30,000,000
FC=P101,000,000 =P71,000,000

Total depreciation= Annual depreciation (n)

P71,000,000=2(n)
n=35.5 years

16. On January 1,2019, Chechi Company purchased a machine for P504,000 that was placed in
service on March 1,2019. Additional costs incurred to bring the asset to its location and prepare
for its intended use were: shipping,P4,000 and installation and testing cost,P6,000. The
estimated useful life of the asset was 10 years and has an estimated salvage value of P34,000.
What amount of depreciation should be recognized for the year ended December 31,2019?

Solution: Purchase Price P504,000

Add: Incidental and necessary costs:
Shipping P4,000
 Installation and Testing 6,000 10,000
Total Cost P514,000
Less: Estimated Salvage value 34,000
Depreciable cost P480,000
Divide: Estimated useful life 10 years
Annual depreciation P48,000

Depreciation for 2019 (from 03/01 to 12/31) P48,000 x 10/12 = P40,000

17. On January 2, 2019, Jang geun suk Corp. bought machinery under a contract that required a
down payment of P100,000, plus 24 monthy payments of P50,000 each, for total cash
payments of P1,300,000. The cash equivalent price of the machinery was P1,100,000. The
machinery has an estimated useful life of 10 years and estimated salvage value of P50,000.
Jang geun suk Corp. uses straight line depreciation. How much should Jang geun suk Corp.
report in its 2019 profit or loss as depreciation for the machinery?

Solution: Cost (cash price) P1,100,000

Salvage value ( 50,000)
Depreciable cost P1,050,000
Divide: Estimated useful life 10
Depreciation, 2019 P 105,000

18. On January 1,2019, Lili Corporation bought machinery under a contract that required a down
payment of P50,000, plus 24 monthly payments of P25,000 each, for total cash payments of
P650,000. The cash equivalent price of the machinery was P550,000. The machinery has an
estimated useful life of 10 years and estimated salvage value of P25,000. Lili uses the straight-
line method of depreciation. How much should Lili Corp. report in its 2019 profit or loss as
depreciation for the machinery?

Solution: Cost of the asset (cash price) P550,000

Less: Estimated salvage value 25,000
Depreciable cost P525,000
 Divide: Estimated useful life 10 years
Annual depreciation P 52,500

19. On January 2,2019, Shin hye Company purchased a transportation equipment costing
P2,400,000. The new asset has an estimated useful life of 8years with no salvage value. Shin
hye Company depreciates this type of asset using the straight line method. On January 2,2021,
Shin hye Company determined that the machine has a useful life of 6 years from the date of
acquisition with no salvage value. As a result of the change in the estimated useful life of the
asset, what is the carrying value of the transportation equipment as of December 31,2021?

Solution: Cost P2,400,000

Less: Accumulated depreciation
2019 & 2020 (P2,400,000x 2/8) 600,000
Book value as of date of change, January 2,2021 P1,800,000
Divide: Remaining new life
New life 6 years
Expired life( date of change) 2 years 4 years
Depreciation for 2021 P 450,000
Book value, January 1,2021 P1,800,000
Less: Depreciation-2021 450,000
Carrying value as of December 31,2021 P1,350,000

20. Jini Company uses straight line depreciation for its property, plant, and equipment, which
stated at cost, consisted of the following:

2019 2018
Land 250,000 250,000
Buildings 1,950,000 1,950,000
Machinery and equipment 6,950,000 6,500,000
Total 9,150,000 8,700,000
Less: Accumulated depreciation 4,000,000 3,700,000
5,150,000 5,000,000

The depreciation for 2019 and 2020 was P550,000 and P500,000,respectively. What amount
was debited to accumulated depreciation during 2019 because of plant, property, and
equipment retirements?

Solution: Accumulated depreciation-December 31,2018 P3,700,000

Add: Depreciation for 2019 550,000
Total 4,250,000
Less: Accumulated depreciation on property retirement (squeeze) 250,000
Accumulated depreciation-December 31,2019 P4,000,000
 DEPRECIATION
Sum of years’ digit and declining method

Accelerated Depreciation Methods

Under accelerated methods (decreasing-charge methods), depreciation charges decrease over the
useful life of the asset.
 Depreciation is higher in the early years of the asset’s useful life and lower in the later
years.
This depreciation method is based on the philosophy that the revenue-generating capacity of the
asset declines due to passage of time. Thus, higher depreciation should be recognized in the early
years of the asset’s useful life when higher revenues are generated.

The following are applications of accelerated depreciation:

1. Sum-of-the-years’ digits (SYD)
2. Declining Balance Method

Sum-of-the-years’ digits (SYD)

Sum-of-the-years’ digits (SYD) depreciation - depreciation is computed by applying a series of
fractions to the depreciable amount of the asset.
A fraction is derived by dividing the asset’s remaining useful life by the sum of digits in the life
of the asset.

For example, an asset with a 4-year useful life would have a sum of year’s digits of 10
(4+3+2+1). The series of fractions then would be 4/10,3/10,2/10,1/10, with 4/10 as the fraction
to be used in the first year of the asset’s useful life, 3/10 in the second year, and so on. These
decreasing fractions are multiplied to the depreciable amount of the asset to determine the
accelerated depreciation.

The formula below maybe used.

Life+1
SYD Denominator = Life x
2

Illustration: SYD
On January 1, 2019, APC Company acquired equipment with an estimated useful life of 4 years
and a residual value of P40,000 for a total purchase cost of P200,000.

Initial cost of equipment 200,000

Residual value (40,000)
Depreciable amount 160,000

Life+1 4+ 1
SYD Denominator = Life x =4x = 10
2 2

The depreciation table is prepared as follows:

 Date Depreciable SYD Depreciation Accumulated Carrying
amount Rate Depreciation Amount
a b c=axb d = cumulative e = historical
balance of c cost - d
1/1/19 200,000
12/31/19 160,000 4/10 64,000 64,000 136,000
12/31/20 160,000 3/10 48,000 112,000 88,000
12/31/21 160,000 2/10 32,000 144,000 56,000
12/31/22 160,000 1/10 16,000 160,000 40,000
160,000

Notice that SYD method results in decreasing periodic depreciation charges over the life
of the asset.

Declining Balance Method

Under this method, depreciation is computed by applying a fixed rate on the asset’s
carrying amount, rather than depreciable amount. Unlike the other depreciation methods, the
double declining method initially ignores the residual value. The residual value is considered
only at the latter part of the asset’s useful life by adjusting the depreciation charge(s) so that the
carrying amount does not fall below the residual value.
The double declining rate is computed as follows:
2
Double Declining rate =
Life
A variation of the double declining is the 150% declining balance method. The rate is
computed as follows:
1.5
150% Declining Rate =
Life

Illustration: Double-declining balance method

On Jan. 1, 2019, APC Company acquired equipment with an estimated useful life of 5 years and
a residual value of P40,000 for a total purchase cost of P200,000

The double declining rate is computed as follows:

2
Double declining rate = = 40%
5
The depreciation table is prepared as follows:
Date Double Carrying Depreciation Accumulated
Declining amount depreciation
rate
a b = hist. cost - c = a x b d = prev. balance
d +c
Jan. 1, 2019
Dec. 31, 2019 40% 200,000 80,000 80,000
Dec. 31, 2020 40% 120,000 48,000 128,000
Dec. 31, 2021 40% 72,000 28,800 156,800
 Dec. 31, 2022 n/a 43,200 - 3,200 160,000
40,000
Dec. 31, 2023 n/a 40,000 - 160,000
160,000

Notes:
 Depreciation equals double declining rate times carrying amount. The residual value is
initially ignored. This is a unique characteristic of the double declining balance method.
In other depreciation methods, residual value is not ignored.
 On December 31, 2022, double declining rate times the carrying amount equals P17,280
(405 x 43,200). Recognizing this amount would cause the carrying amount to fall below
the residual value. Thus, only P3,200 (43,200 – 40,000) is recognized as depreciation in
2022 in order to bring the carrying amount equal to the residual value.
 No depreciation is recognized in 2023 because the asset is now fully depreciated.

DEPRECIATION
Sum of years’ digit and declining method
PROBLEMS

Problem 1
On April 1, 2019, Escobio Company purchased new machinery for P3,300,000. The machinery
has an estimated useful life of five years with residual value of P300,000. Depreciation is
computed by the sum of the years’ digits method. What is the accumulated depreciation on
December 31, 2020?

a. 1,600,000
b. 1,800,000
c. 1,200,000
d. 1,000,000
Solution Answer a

SYD = 1+2+3+4+5

SYD = 15

April 1, 2019 to March 31,2020 (5/15 x 3,000,000) 1,000,000

April 1, 2020 to March 31,2021 (4/15 x 3,000,000) 800,000
Accumulated Depreciation – March 31, 2021 1,800,000

April 1,2019 – December 31,2019 (1,000,000 x 9/12) 750,000

January 1, 2020 – March 31, 2020 (1,000,000 x 3/12) 250,000

April 1, 2020 – December 31, 2020 (800,000 x 9/12) 600,000
Total 2020 depreciation 850,000
Accumulated Depreciation – December 31, 2020
(750,000 + 850,000) 1,600,000

Problem 2
On July 1, 2019, Galang Company purchased an equipment for P5,000,000. Residual value was
estimated at P200,000. The equipment is depreciated over ten years using the double declining
balance method. What is the depreciation expense for 2020?
a. 1,000,000
b. 900,000
c. 768,000
d. 960,000

Solution Answer b
Straight line rate (100% / 10 years) 10%
Fixed Rate (10 x 2) 20%

2019 depreciation (5,000,000 x 20% x 6/12) 500,000

2020 depreciation (5,000,000 – 5,000,000 x 20%) 900,000

Problem 3
Fajardo company purchased a machine on July 1, 2019 for P6,000,000. The machine has an
estimated useful life of five years and a residual value of P800,000. The machine is being
depreciated by the 150% declining balance method. For the year ended December 31, 2020, what
amount should Fajardo record as depreciation expense on the machine?
a. 1,530,000
b. 1,326,000
c. 1,040,000
d. 1,800,000

Solution Answer a
Straight line rate (100% / 5) 20%
Fixed rate (20% x 150%) 30%
Depreciation from July 1 to December 31, 2019
(6,000,000 x 30% x 6/12) 900,000
Depreciation for 2020 (6,000,000 – 900,000 x 30%) 1,530,000

Problem 4
Dimaunahan Company purchased a machine for P4,500,000 on January 1, 2019. The machine
has an estimated useful life of four years and a residual value of P500,000. The machine is being
depreciated using the sum of the years’ digits method. What is the carrying amount of the asset
on December 31, 2020?
a. 2,900,000
b. 2,700,000
 c. 1,700,000
d. 1,350,000

Solution Answer c
SYD = 1+2+3+4 = 10

Acquisition cost 4,500,000

Accumulated Depreciation
2019 (4/10 x 4,000,000) 1,600,000
2020 (3/10 x 4,000,000) 1,200,000 2,800,000
Carrying Amount – December 31, 2020 1,700,000

Problem 5
On January 1, 2019, Dinio Company acquired an equipment with useful life of 8 years and
residual value of P300,000. The depreciation applicable to this equipment was P900,000 for
2020, using the double declining balance method. What is the acquisition cost of the equipment?
a. 3,600,000
b. 4,500,000
c. 4,800,000
d. 5,100,000
Solution Answer c
Fixed rate (100% / 8 years x 2) 25%

Carrying amount – 1/1/2020 (900,000 / 25%) 3,600,000

Carrying amount – 1/1/2019 (3,600,000 / 75%) 4,800,000

Problem 6
In January 1, 2019, Del Mundo Company purchased equipment at a cost of P6,000,000. The
equipment has a useful life of eight years with residual value of P600,000. Del Mundo
considered various methods of depreciation and selected the sum of years’ digits method. On
December 31, 2020, what is the accumulated depreciation?
a. P750,000 less than under the straight line method
b. P750,000 less than under the double declining balance method
c. P900,000 greater than under the straight line method
d. P900,000 greater than under the double declining balance method

Solution Answer c
SYD = 1+2+3+4+5+6+7+8 = 36

2019 depreciation (5,400,000 x 8/36) 1,200,000

2020 depreciation (5,400,000 x 7/36) 1,050,000
Accumulated Depreciation – 12/31/2020 (SYD) 2,250,000
Accumulated Depreciation – 12/31/2020 (SL)
(5,400,000 / 8 x 2) 1,350,000
SYD greater than straight line 900,000
Problem 7
On January 1, 2019, Diamat Company purchased a large quantity of personal computers. The
cost of these computers was P6,000,000. On the date of purchase, the management estimated that
the computers would last approximately 4 years and would have a residual value at that time of
P600,000. The entity used the double declining balance method. During January 2020, the
management realized that technological advancements had made the computers virtually
obsolete and that they would have to be replaced. Management proposed changing the remaining
useful life of the computers to 2 years. What is the depreciation expense for 2020?
a. 3,000,000
b. 2,400,000
c. 1,500,000
d. 1,200,000
Solution Answer b
Fixed Rate (100% / 4 x 2)

Cost 6,000,000
Depreciation for 2019 (50% x 6,000,000) 3,000,000
Carrying amount – January 1, 2020 3,000,000
Residual Value (600,000)
Maximum depreciation in 2020 2,400,000

Fixed rate in 2020 (100% / 2 x 2) 100%

This means that the computers should be fully depreciated in 2020. Since there is a residual
value of P600,000, the maximum depreciation for 2020 is equal to the carrying amount of
P3,000,000 minus the residual value of P600,000 or P2,400,000.

Problem 8
On May 1, 2019, Fatty Company purchased a new machinery for P2,700,000. The machinery has
an estimated useful life of 7 years and depreciation is computed using the sum of the years’
digits method. Estimated salvage value of the machine is P180,000.
What is the total accumulated depreciation on December 31, 2020?
a. 900,000
b. 960,000
c. 990,000
d. 1,170,000

Solution Answer c
SYD = [7 x (7 + 1)] / 2 = 28
Acquisition cost 2,700,000
Less: Estimated salvage value 180,000
Depreciable cost 2,520,000

05/01/19 to 04/30/20 = (7/28 x 2,520,000) 630,000

05/01/20 to 04/31/20 = (6/28 x 2,520,000 x 8/12) 360,000
Total accumulated depreciation 990,000
Problem 9
On January 2, 2017, Sapporo Company acquired equipment to be used in its manufacturing
operations. The equipment has an estimated useful life of ten years and an estimated salvage
value of P50,000. The depreciation applicable to this equipment was P240,000 for 2019
computed under the sum of the years’ digits method.
What was the acquisition cost of the equipment?
a. 1,650,000
b. 1,700,000
c. 2,400,000
d. 2,450,00

Solution Answer b
SYD = [10 x (10+1)] / 2 55
Ratio for 2019 8/55
Depreciable cost [240,000 / (8/55)] 1,650,000
Add: Estimated salvage value 50,000
Acquisition cost 1,700,000

Problem 10
On October 1, 2018, PCC Company purchased machinery for P1,900,000. Salvage value was
estimated to be P100,000. The machinery will be depreciated over eight years using the sum of
the years’ digits method.
If depreciation is computed on the basis of the nearest full month, how much should PCC record
depreciation expense for 2019 on this machinery?
a. 350,000
b. 362,500
c. 387,500
d. 400,903

Solution Answer c
Acquisition cost 1,900,000
Less: Estimated salvage value 100,000
Depreciable cost 1,800,000
SYD = [8 X (8+1)] /2 36
1st year depreciation (10/01/18 to 09/30/19) = (1,800,000 x 8/36) 400,000
2nd year depreciation (10/01/19 to 09/30/20) = (1,800,000 x 7/36) 350,000

Depreciation for 2019 (January 1 to December 31)

From 1st year (400,000 x 9/12) 300,000
From 2nd year (350,000 x 3/12) 87,500
Total depreciation for 2019 387,500

Problem 11
On January 2, 2018, Nick Company purchased factory equipment for P4,000,000. Estimated
salvage value was P160,000. Estimated useful life of the equipment is 10 years and will be
depreciated using double-declining balance method.
What is the amount of depreciation to be recognized in year 2019?
a. 384,000
b. 614,400
c. 640,000
d. 768,000

Solution Answer c
Straight line rate (100% / 10 years) 10%
Double declining rate (10% x 2) 20%
2018 depreciation (4,000,000 x 20%) 800,000
2019 depreciation (4,000,000 – 800,000 x 20%) 640,000

Problem 12
Starla Company purchased on October 1, 2019 an equipment for P800,000. The equipment had
an estimated useful life of 8 years. The estimated salvage value was P50,000 at the end of the
useful life. The equipment is being depreciated using the double declining balance method.
What is the amount of depreciation to be charged against 2020 income?
a. 140,625
b. 175,000
c. 175,781
d. 187,500

Solution Answer d
Straight line rate (100% / 8 years) 12.5%
Double declining rate (12.5% x 2) 25%
2019 depreciation (800,000 x 25% x 3/12) 50,000
2020 depreciation (800,000 – 50,000 x 25%) 187,500

Problem 13
On march 1, 2018, De Luna Company bought an equipment costing P1,200,000. De Luna’s
depreciation policy is to depreciate long-lived assets using the double-declining balance method.
The equipment has an estimated useful life of ten years with a minimum amount of salvage value
at the end of its useful life.
What is the carrying amount of the asset as of December 31, 2020?
a. 480,000
b. 614,000
c. 640,000
d. 768,000

Solution Answer c
Double declining rate (100/10 x 2) 20%
Depreciation in –
2012 (1,200 x 20% x 10/12) 200,000
2013 (1,200,000 – 200,000 x 20%) 200,000
2014 (1,200,000 – 200,000 – 200,000 x 20%) 160,000
Total accumulated depreciation 560,000
Acquisition cost 1,200,000
Less: Accumulated depreciation 560,000
Carrying value as of December 31, 2020 640,000

Problem 14
IU Company purchased machinery that was installed and ready for use on January 2, 2019 at a
total cost of P960,000. Salvage value was estimated at P160,000. The machinery will be
depreciated over 5 years using the double declining balance method.
How much should be recorded as depreciation expense on this machinery for the year 2020?
a. 100,000
b. 192,000
c. 230,400
d. 384,000

Solution Answer c
Depreciation
2019 (960,000 x 40%) 384,000
2020 (960,000 – 384,000 x 40%) 230,400
Double declining rate (100% / 5 x 2) 40%

Problem 15
APC Company purchased a machine for P600,000 on January 2, 2019. The machine has an
estimated useful life of 5 years and salvage value of P60,000. Depreciation was computed by the
150% declining balance method.
How much should be the accumulated depreciation balance at December 31, 2020?
a. 216,000
b. 275,000
c. 294,000
d. 306,000

Solution Answer d
150% declining rate (100%/5 years) x 150% 30%
Depreciation in 2019 (600,000 x 30%) 180,000
Depreciation in 2020 (600,000 – 180,000 x 30%) 126,000
Total Accumulated Depreciation 306,000

Problem 16
Thoughtful Company purchased an equipment on January 2, 2018 for P3,000,000. The
equipment had an estimated useful life of 5 years. The company’s policy is o depreciate the asset
using the 200%-declining balance method in the first two years of the asset’s life and then switch
to the straight-line method for the remaining useful life of the asset.
What is the total accumulated depreciation as of December 31, 2020?
a. 1,800,000
 b. 2,280,000
c. 2,352,000
d. 2,520,000
Solution Answer b
Straight-line rate (100%/ 5 years) 20%
200%-declining rate (100%/5 years) x 2 40%
Depreciation in 2018 (3,000,000 x 40%) 1,200,000
Depreciation in 2019 (3,000,000 – 1,200,000 x 40%) 720,000
Total accumulated depreciation as of December 31, 2019 1,920,000
Add: Depreciation in 2020 using straight line method:
Cost 3,000,000
Less: Accumulated depreciation as of 12/31,2019 1,920,000
Book value 1,080,000
Divided by: Remaining useful life 3 years 360,000
Accumulated depreciation as of December 31,2014 2,280,000

Problem 17
On January 1, 2019, the Accumulated Depreciation – Machinery account of a particular
company showed a balance of P370,000. At the end of 2019, after the adjusting entries were
posted, it showed a balance of P370,000. During 2019, one of the machines which cost P125,000
was sold for P60,500 cash. This resulted in loss of P4,000.
Assuming that no other assets were disposed of during the year, how much was depreciation
expense for 2019?
a. 25,000
b. 60,000
c. 85,500
d. 93,500

Solution Answer c
Accumulated Depreciation, 12/31/19 395,000
Accumulated Depreciation on asset sold:
Cost of asset sold 125,000
Book value
Proceeds 60,500
Loss on sale 4,000 64,500 60,500
Total 455,500
Less: Accumulated Depreciation, 1/1/19 370,000
Depreciation during the year 85,500

Problem 18
On March 31, 2019, White, derecognized a machine used in manufacturing designer parts. The
machine was acquired on May 1, 2016. Straight-line depreciation method was used. The asset
had an estimated salvage value of P20,000 and a five-year life. On December 31, 2018, the
balance in the accumulated depreciation is P330,000. The machine was scrapped and the
company did not receive a single consideration.
How much would be the loss on derecognition?
 a. 250,000
b. 270,000
c. 277,812
d. 300,000

Solution Answer c
Accumulated Depreciation on 12/31/18 330,000.00
Divided by: Age of the asset 32 months
Monthly depreciation 10,312.50
Multiply by: Life of the asset 60 months
Depreciable cost 618,750.00
Salvage value 20,000.00
Cost of asset 638,750.00
Accumulated depreciation- from acquisition
To retirement (68,750 x 35/60) 360,938.00
Loss on derecognition 277,812.00

Problem 19
On July 1, 2019, Blue Corporation, a calendar year company received a condemnation award of
P3,000,000 as compensation for the forced sale of a plant located on company property that
stood in the path of a new highway. On this date, the plant building had a depreciated cost of
P1,500,000 and the land cost was P500,000. On October 1, 2019, Blue purchased a parcel of land
for a new plant side at a cost of P1,250,000.
Ignoring income taxes, how much gain should Blue report in its December 31, 2019 profit or
loss?
a. None
b. 250,000
c. 750,000
d. 1,000,000

Solution Answer d
Proceeds from a forced sale 3,000,000
Less: Book value-assets condemned:
Building 1,500,000
Land 500,000 2,000,000
Gain on condemnation of property 1,000,000

Problem 20
The following data are available from the book of Black Corporation:
Machinery Equipment
Cost of acquisition 560,000 140,000
Estimated salvage value 60,000 20,000
Date of acquisition January 1, 2011 July 1, 2011
Estimated life 10 years 5 years
On October 1, 2014, above machinery was sold for P400,000 while the equipment could no
longer be used on March 31,2014 and the company received P50,000 from the insurers in full
settlement of the claim.
What is the amount of net gain or loss on the disposal of the above assets?
a. 3,500
b. 23,500
c. 24,000
d. 27,500

Solution Answer a
Gain on sale of machinery 27,500
Less: Loss on disposal of equipment 24,000
Net gain 3,500

Year Mos. Days

Machinery
Selling Price 400,000 disposal 2014 10 01
Book value (560,000 – 187,500) 372,500 acquisition 2011 01 01
Gain on sale of machinery 27,500 expired life 3 09 00
X 12 36
Expired life in mos. 45

Cost 560,000
Salvage value 60,000
Depreciable cost 500,000
x Age of asset 45/120
Accumulated depreciation 187,500

Year Mos. Days

Equipment
Proceeds from insurance Co. 50,000 disposal 2014 03 31
Book Value (140,000-66,000) 74,000 acquisition 2011 07 01
Loss 24,000 expired life 2 08 30
x 12 24
32 + 1 = 33 mos.

Cost 140,000
Salvage value 20,000
Depreciable cost 120,000
x Age of asset 33/66
Accumulated depreciation 66,000
Chapter 32
Chapter 33
CHAPTER 34

IMPAIRMENT OF ASSET (Individual Asset)

LEARNING OBJECTIVES

After finishing this chapter, learners are expected to:

1. Know the basic principle in accordance with PAS 36

2. Define the fair value less cost to sell and value in use
3. Master the accounting for impairment
4. Account for the impairment of individual asset
PAS 36 (Impairment of Assets)

PAS 36 ensures that assets are carried at no more than their recoverable amount, and to define
how recoverable amount is determined.

PAS 36 applies to the following assets:

1. Property, plant and equipment

2. Investment property measured or carried at cost
3. Intangible assets
4. Investments in associates, joint ventures and subsidiaries carried at cost
Assets not subject to impairment:

1. Inventories
2. Deferred tax assets
3. Assets arising from employee benefits
4. Financial assets within the scope of PFRS 9
5. Investment property measured at insurance contracts, and non-current assets held for sale
6. Biological assets
7. Some assets arising from insurance contracts
8. Non-current assets held for sale
Basic Principle

PAS 36 defined that an asset must not be carried in the financial statements at more than the
highest amount to be recovered through its use or sale.

Accounting for Impairment

1. There is an indication of possible impairment

2. Measurement of recoverable amount
3. Recognition of impairment loss
4. Reversal of impairment loss
INDICATION OF POSSIBLE IMPAIRMENT

1. External sources
a. Market value of the asset declines
b. Negative changes in technology, markets, economy, or laws
c. Increases in market interest rates
d. Company stock price is below its book value
2. Internal sources
a. Obsolescence or physical damage of an asset
b. Asset is part of a restructuring or held for disposal
c. Worse economic performance than expected

MEASUREMENT OF RECOVERABLE AMOUNT

Under PAS 36, the recoverable amount of an asset is the higher of its fair value less cost to sell
or cost of disposal and value in use.

Fair value less cost to sell (or net selling price)

Fair value of an asset is “the price that would be received to sell the asset in an orderly
transaction between market participants at the measurement date.” (PAS 36 par. 6)

Cost of disposal is an “incremental cost directly attributable to the disposal of an asset of an

asset or cash generating unit excluding finance cost and income tax expense.” (PAS 36 par. 6)

Composition of cost of disposal:

a. Legal cost
b. Attributable stamp and transfer taxes
c. Cost of removing the asset
d. Any other cost to bring the asset into a “for-sale” condition
Rules in determining Fair Value:

1. If there is a binding sale agreement, use the agreed price or quoted price
2. If there is no binding sale agreement but there is an active market for that type of asset,
use the market price. Market price means current bid price, if available, or the price in
the most recent transaction.
3. If there's no binding sale agreement and the asset is not traded in an active market, the
fair value is the best estimate of price that willing parties might agree.
Value in Use (or the discounted future cash flows)

Rules in calculating projected cash flows:

a. Cash flow projections shall be based on reasonable and supportable assumptions.

 b. Projections shall be based on the latest budgets on financial forecast, usually up to
maximum period of 5 years, unless a longer period can be justified.
c. Projections beyond 5 years shall be estimated by extrapolating the 5-year projections
using a steady or declining growth rate each subsequent year, unless an increasing rate
can be justified.
Composition of estimates of future cash flows:

Includes:

a. Cash inflows of continuing use of the asset.

b. Cash outflows necessary to generate the inflows of cash from continuing use of the asset.
c. Net cash flows on the disposal of the asset at the end of its useful life.
Excludes:

a. Cash flows relating to restructuring to which the entity is not yet committed
b. Cash flows that arises from enhancing the performance of an asset
c. Cash flows from financing activities, and
d. Related income tax
In measuring value in use, the discount rate used should be the pre-tax rate that reflects current
market assessments of the time value of money and the risks specific to the asset. It is (based on
priority):

1. The current market rate the entity would pay in financing that specific asset or portfolio;

2. The entity's own weighted average cost of capital

3. The entity's incremental borrowing rate

4. Other market borrowing rates.

RECOGNITION OF IMPAIRMENT LOSS

 If the carrying amount is greater than recoverable amount, the asset is impaired. The
excess between carrying amount and recoverable amount is recognized as impairment
loss.
 If the carrying amount is equal to or less than the recoverable amount, the asset is not
impaired. There will be no accounting issue in this case.
Illustration 1:

On December 31, 2019, CJ Company determines that its equipment is impaired. The following
information is related to the equipment.

Equipment 5 000 000

Accumulated depreciation 2 000 000

Fair value less cost to sell (FVLCS) 2 500 000

Value in use (VIU) 2 000 000

Answer:

Recoverable amount (higher of FVLCS and VIU) 2 500 000

Less: Carrying amount (5 000 000 - 2 000 000) 3 000 000

Impairment loss (500 000)

Journal Entry:

Impairment loss 500 000

Accumulated depreciation 500 000

Illustration 2.

On December 31, 2020, EFG Company that its hotel building with a carrying amount of P800
000 has been impaired. In estimate, EFG Company’s hotel building has P500 000 fair value less
cost to sell.

In estimating the value in use, EFG Company determined the following information:

Year Future cash inflows Future cash outflows

2021 700 000 550 000
2022 680 000 400 000
2023 660 000 430 000
The discount rate is 10%.

Compute for the hotel building’s impairment loss.

Answer:

The future net cash flows are as follows:

Year Cash inflows (a) Cash outflows (b) Net cash flows (a-b)
2021 700 000 550 000 150 000
2022 680 000 400 000 280 000
2023 660 000 430 000 230 000

The value in use is computed as follows:

 Year Net cash flows PV of 1 factors Present value
2021 150 000 0.909091 136 367
2022 280 000 0.826446 231 405
2023 230 000 0.751315 172 816
540 588

The recoverable amount is determined as follows:

Fair value less cost to sell 500 000

Value in use 540 588

Recoverable amount (higher) 540 588

The impairment loss is computed as follows:

Recoverable amount 540 588

Less: Carrying amount 800 000

Impairment loss (259 412)

REVERSAL OF IMPAIRMENT LOSS

If the recoverable value of previously-impaired asset turns out to be higher than its current
carrying value, then the asset shall be increased to its new recoverable amount.

However, PAS 36 further provides that the increase in carrying amount of an asset due to a
reversal of an impairment loss shall not exceed the carrying amount as if the asset does not suffer
from impairment.

If the new recoverable amount is higher than the carrying value as if there is no previous
impairment recognized, the excess must be credited to revaluation surplus if the company elected
to use revaluation model and must be amortized over the remaining life of the asset. Needless to
say, the excess must be ignored if the company uses the cost model.

The reversal of the impairment loss shall be recognized immediately as income.

Determination of Revaluation Surplus:

New Recoverable Value xxx

Less: Carrying Value of an asset as if no previous impairment happened

xxx

Revaluation Surplus xxx

Proper Journal Entry

Appropriate Asset Account xxx

Accumulated depreciation xxx

Gain on reversal of impairment xxx

Revaluation surplus xxx

THEORIES: Part 1

TRUE OR FALSE

1. Asset shall be carried at above the recoverable amount.

2. Depreciation is a fall in the market value of an asset so that recoverable amount is now
less than the carrying amount in the statement of financial position
3. Fair value of an asset is the price that would receive to sell the asset in an orderly
transaction between market participants at the measurement date
4. The recoverable amount of an asset is the fair value less cost of disposal or value in
use, whichever is lower.
5. Value in use is measured as the present value or discounted value of future net cash
flows expected to be derived from an asset.
THEORIES: Part 2
MULTIPLE CHOICE
1. Estimates of future cash flows include the following except:
a. Projections of cash inflows from the continuing use of the asset.
b. Projections of cash outflows necessarily incurred to generate the cash inflows from
the continuing use of the asset.
c. Cash inflows or outflows from financing activities
d. Net cash flows received on the disposal of the asset at the end of the useful life in
an arm’s length transaction
2. The market participants are buyers and sellers in the principal market who are the
following except one:
a. Independent
b. Knowledgeable
c. Willing
d. Relevant
3. The reversal of the impairment loss shall be recognized as
a. Outright expense
b. Contra-asset account in the balance sheet
c. Deduction in the capital of the business
d. Immediately as income in the income statement
4. The journal entry to record impairment loss is to
a. Debit impairment loss and credit accumulated depreciation
b. Debit accumulated depreciation and credit impairment loss
c. Debit impairment loss and credit to asset related to the impairment
d. Debit to asset related to the impairment and credit to impairment loss
5. In the accounting for impairment the three accounting issues to consider except:
a. Indication of possible impairment
b. External and internal sources
c. Measurement of the recoverable amount
d. Recognition of impairment loss
PROBLEM 1

On December 31, 2019, MNL Company has an equipment with the following cost and
accumulated depreciation:

Equipment 5 000 000

Accumulated depreciation 3 150 000

Due to obsolescence and physical damage, the equipment is found to be impaired. On December
31,2019, MNL Company has determined the following related to the equipment

Fair value less cost to sell 1 500 000

Value in use or discounted net cash inflows 1 450 000

What amount should be reported as impairment loss in 2019?

A. 350 000
B. 400 000
C. 1 850 000
D. 0
PROBLEM 2

During December 2019, GIGI Company determined that there had been a significant decrease in
market value of its equipment used in its manufacturing process. On December 31, 2019, GIGI
compiled the following information:

Original cost of equipment 5 250 000

Accumulated depreciation 3 950 000

Expected undiscounted net future cash inflows related to the continued

use and eventual disposal of the equipment 1 750 000

Fair value of the equipment 1 150 000

What is the amount of impairment loss that should be reported in the income statement for the
year ended December 31,2019?

A. 750 000
B. 250 000
C. 150 000
D. 0
PROBLEM 3

Katie Company purchased four (4) convenience store buildings on January 1, 2015 for a total of

P15 000 000. The buildings have been depreciated using the straight line method with a 20-year
useful life and 10% residual value. On January 1, 2021, Katie has converted the buildings into a
hotel and restaurant. Because of the change in use of the buildings, Katie is evaluating the
buildings for possible impairment. Katie estimates that the buildings have a remaining useful life
of 10 years, that their residual value will be zero, that net cash inflows from the buildings will
total P1 500 000 per year and that the current fair value of the four (4) buildings totals P11 000
000. The appropriate discount rate is 12%. The present value of an ordinary annuity of 1 at 12%
for 10 periods is 5.65.

1. What impairment loss should be recognized for 2019?

a. 150 000
b. 250 000
c. 350 000
d. 950 000
2. What is the depreciation of the building for 2019?
a. 1 000 000
b. 1 200 000
c. 1 300 000
d. 0
PROBLEM 4

PIO Company purchased building on January 1, 2016 for P7 000 000. The building has been
depreciated using a straight line method with a 25-year useful life and no residual value. On
December 31, 2019, Elsa is evaluating for possible impairment. The building has a remaining
useful life of 15 years and is expected to generate cash inflows of P550 000 per year. The
applicable discount rate is 8%. Round off present value factor to two decimal places. The fair
value of the building on December 31, 2019 is P4 500 000.

What amount should be recognized as impairment loss on December 31, 2019?

a. 4 000 000
b. 1 120 000
c. 4 700 000
d. 1 172 000
PROBLEM 5

One of the cash generating units of Erika Company is the production of liquor. On December 31,
2019, Erika Company believed that the assets of the cash generating units (CGU) are impaired
based on an analysis of economic indicators.

The assets and liabilities of the CGU on December 31,2019 are:

Cash 4 550 000

Accounts Receivable 5 800 000

Allowance for doubtful account 2 000 000

Inventory 6 700 000

Property, plant and equipment 24 000 000

Accumulated depreciation 4 000 000

Goodwill 3 600 000

Accounts payable 2 500 000

Loans payable 1 300 000

The entity determined that the value in use of the CGU is P28 200 000. The account receivables
are considered collectible, except those considered doubtful.

What is the impairment loss to be allocated to property, plant and equipment?

a. 1 712 500
b. 5 137 500
c. 850 000
d. 1 850 000
PROBLEM 6

Mich Company has two cash generating units. On December 31, 2019, the carrying amounts of
the assets of one cash generating unit are:

Inventory 150 000

Accounts receivable 250 000

Plant and equipment 5 000 000

Accumulated depreciation 1 200 000

Patent 1 050 000

Goodwill 120 000

The accounts receivable are regarded as collectible and the inventory’s fair value less cost to sell
is equal to the carrying amount. The patent has a fair value less cost to sell of P1 650 000.

On December 31,2019, Mich Company undertook impairment testing of the cash generating unit
and determined the value in use of the unit at P4 550 000.

What is the impairment loss?

a. 625 000
b. 700 000
c. 850 000
d. 460 000
PROBLEM 7

Marijean Company acquired a machine for P4 500 000 on August 31, 2017. The machine has a
5-year life, P600 000 residual value and was depreciated using straight-line method. On May 31,
2020, a test for recoverability reveals that the expected net future undiscounted cash inflows
related to the continued use and eventual disposal of the machine total P1 800 000. The
machine’s fair value on May 31, 2020 is P1 450 000 with no residual value. If a loss on
impairment is recognized on May 31, 2020, what is the depreciation for June 2020?

a. 53 270
b. 50 050
c. 53 704
d. 65 000
PROBLEM 8

RMG Company had purchased equipment for P2 800 000 on January 1, 2017. The equipment
had an 8-year life and residual value of P400 000. RMG depreciated the equipment using straight
line method. In August 2020, RMG questioned the recoverability of the carrying amount of this
equipment. On August 31, 2020, the undiscounted expected net future cash inflows related to the
continued use and eventual disposal of the equipment amounted to P1 600 000. The equipment’s
fair value on August 31, 2020 is P1 500 000.

After any loss on impairment has been recognized, what is the carrying amount of the
equipment?

a. 1 500 000
b. 1 800 000
c. 1 550 000
 d. 1 700 000
PROBLEM 9

The following calculation refers to an impairment loss suffered by CJ Company on December

31,2019:

| Goodwill Net Assets

Carrying amount 3 000 000 9 000 000
Impairment loss (3 000 000) (2 000 000)
Adjusted carrying amount 0 7 000 000

There has been a favorable change in the estimate of the recoverable amount is now P8 000 000
on December 31, 2020. The carrying amount of the net assets would have been P7 200 000 on
December 31, 2020 if there was no impairment loss recognized on December 31, 2019. Assets
are depreciated at 20% of reducing balance. What gain on reversal of impairment should be
recognized in 2020?

a. 1 500 000
b. 5 600 000
c. 1 200 000
d. 1 600 000
PROBLEM 10

ROC company reported an impairment loss of P2 000 000 in its income statement for 2020. This
loss was related to an item of property, plant and equipment which was acquired on January 1,
2019 with a cost of P10 000 000, useful life of 10 years and no residual value. On December 31,
2020, ROC reported this asset at P6 000 000 which is the fair value on such date. On December
31, 2021, ROC determined that the fair value of its impaired asset had increased to P7 500 000.
The straight line method is used in recording depreciation of this asset.

What amount of gain on reversal of impairment should ROC report in its 2021 income
statement? Provide solution.
ANSWER KEY

TRUE OR FALSE

1. F
2. F
3. T
4. F
5. T
MULTIPLE CHOICE

1. C
2. D
3. D
4. A
5. B
PROBLEM 1. A

(1 500 000-1 850 000 = 350 000)

PROBLEM 2. C

5250 000-3 950 000=1 300 000-1 150 000=150 000

PROBLEM 3. D, A

1. FV= 10 000 000

PV= 1 500 000*5.65= 8 475 000
CA= 15 000 000*10%
=1 500 000
=15 000 000-1 500 000
=13 500 000/20
=675 000*6
=4 050 000
=15 000 000-4 050 000= 10 950 000
10 000 000(HIGHER)-10 950 000
=D. 950 000
2. 10 000 000/10
=A. 1 000 000

PROBLEM 4. D.

Annual cash inflows 550 000

Multiply by PV of an ordinary annuity of 1 at 8% for 15 periods 8.56

Value in use 4 708 000(higher)

Cost - January 1, 2016 7 000 000

Accumulated depreciation - December 31,2019

(7 000 000/25*4) 1 120 000

Carrying amount- December 31,2019 5 880 000

Recoverable amount 4 708 000

Impairment loss 1 172 000

PROBLEM 5. A

4 550 000+3 800 000+6 700 000+20 000 000+3 600 000

= CA 38 650 000-VIU 28 200 000

=10 450 000- 3 600 000

REMAINING IMPAIRMENT LOSS= 6 850 000

Carrying amount Fraction Loss

Inventory 6 700 000 67/267*6 850 000 1 712 500
Property, plant and 20 000 000 200/267*6 850 5 137 500
equipment 000
26 700 000 6 850 000

PROBLEM 6. B

150 000+250 000+3 800 000+1 050 000+120 000

=5 370 000-4 550 000

=820 000-120 000

= 700 000

PROBLEM 7. C

1 450 000/27= 53 704

PROBLEM 8. A
2 800 000-400 000

=2 400 000/96*44

=1 100 000

2 800 000-1 100 000

=1 700 000

1 700 000-1 500 000

=200 000

1 700 000-200 000 =1 500 000

PROBLEM 9. D

7 000 000- 1 400 000=5 600 000

7 200 000-5 600 000=1 600 000

PROBLEM 10.

Fair value- January 1,2021 6 000 000

Depreciation for 2019 (6 000 000/8) 750 000

Carrying amount- 12/31/2021- with impairment 5 250 000

Cost- January 1,2019 10 000 000

Accumulated depreciation- December 31,2021 (10 000 000/10*3) (3 000 000)

Carrying amount- 12/31/2021-assuming no impairment 7 000 000

Carrying amount-12/31/2021-with impairment 5 250 000

Gain on reversal of impairment 1 750 000

 CHAPTER 35

IMPAIRMENT OF ASSETS

CASH GENERATING UNIT

The standard requires an entity to recognize impairment when its asset are carried at more than
their recoverable amount. The standard prescribes procedures that an entity has to apply to
ensure assets are carried at no more than their recoverable amount illustrated below.

FAIR VALUE LESS

COST TO SELL

CARRYING RECOVERABLE HIGHER OF

EXCEEDS
AMOUNT AMOUNT

IMPAIRMENT OF VALUE IN USE

CASH-GENERATING
UNIT

Impairment- A loss in the future economic benefits or service potential of an asset, over and
above the systematic recognition of the loss of the asset’s future economic benefits or service
potential through depreciation.

Impairment loss of cash-generating asset- The amount by which the carrying amount of an
asset or cash-generating unit exceeds its recoverable amount.

Carrying amount- The amount at which an asset is recognized in the statement of financial
position, after deducting any accumulated depreciation and accumulated impairment losses
thereon.

Recoverable amount (of an asset or cash-generating unit)- The higher of an asset’s fair value
less costs of disposal and its value in use.

Fair value- The amount for which an asset could be exchanged, or a liability settled, between
knowledgeable, willing parties in arm’s length transaction.

Value in use- The present value of the future cash flows expected to be derived from an asset or
cash-generating unit.
So how do you apply requirements of IAS 36 to your entity?

At the end of each reporting period, an entity is required to assess whether there is an indication
that an asset may be impaired. A list of external and internal indicators of impairment are
prescribed by the standard. If there’s indication that the entity’s assets may be impaired then the
assets recoverable amount must be calculated.

The standard prescribes that goodwill acquired in a business combination is tested annually for
impairment and recoverable amounts determined whether or not there are any internal or external
indications of impairment. The same is true for intangible assets with an indefinite useful life and
intangible assets not yet available for use.

Fair value less costs of disposal

The best evidence of an asset’s fair value less costs to sell is the price in a binding sale
agreement in an arm’s length transaction, adjusted for incremental costs that would be directly
attributable to the disposal of the asset.

If there is no binding sale agreement but an asset is traded in an active market, fair value less
costs to sell in the asset’s market price less the costs of disposal.

If there is no binding sale agreement or active market for an asset, fair value less costs to sell is
based on the best information available that reflects the amount that an entity could obtain, at the
reporting date, from the disposal of the asset in an arm’s length transaction between
knowledgeable, willing parties, after deducting the costs of disposal.

Value in use

Estimating the value in use of an asset involves estimating the future cash inflows and outflows
to be derived from the continuing use of the asset and its ultimate disposal and applying an
appropriate discount rate to those future cash flows.

Illustration:

An entity has determined that one of its cash generating units is impaired. The calculated value
in use of the cash generating unit is P5,500,000

The asset of the cash generating unit at carrying amount are:

Building P2,400,000
Land 2,000,000
Equipment 1,400,000
Inventory 200,000
Carrying amount of CGU P6,000,000

Mostly, the recoverable amount of a cash-generating units is equal to the value in use because
the unit is not to be disposed of.

Carrying amount of CGU P6,000,000

Value in use 5,500,000
Impairment loss P 500,000

Allocation of impairment loss

Since there is no goodwill, the impairment loss is allocated across the assets based on carrying
amount.

Carrying amount Fraction

Loss

Building 2,400,000 24/60

200,000
Land 2,000,000 20/60
166,667
Equipment 1,400,000 14/60
116,667
Inventory 200,000 2/60
16,666
6,000,000
500,000

Journal entry to record the impairment loss

Impairment loss 500,000

Accumulated depreciation-building 200,000
Land 166,667
Accumulated depreciation-equipment 116,667
Inventory 16,666
Cash generating unit with goodwill

Goodwill does not generate cash flows independently from other assets or group of assets,
and therefore, the recoverable amount of goodwill as an individual asset cannot be
determined. Therefore, if there is an indication that goodwill may be impaired, recoverable
amount is determined for the cash generating unit to which goodwill belongs.

Recognition of an impairment

Recognizing an impairment asset for an individual asset other than goodwill:

 If, and only if, the recoverable amount of an asset is less than its carrying amount,
the carrying amount of the asset shall be reduced to its recoverable amount. That
reduction is an impairment loss; and
 an impairment loss shall be recognized immediately in surplus or deficit.

Illustration:

The assets of a cash generating unit at carrying amount at year-end are as follows:

Property, plant and equipment P4,000,000

Patent 1,000,000
Goodwill 1,000,000
Carrying amount of CGU 6,000,000

Annual impairment review is required as the cash generating unit contains goodwill. The
calculated value in use of the cash generating unit is P5,500,000
Carrying amount of CGU P6,000,000
Value in use 4,500,000
Impairment loss P 1,500,000

Allocation of impairment loss

Impairment loss P1,500,000

Applicable to goodwill 1,000,000
Excess impairment loss P 500,000

The excess impairment loss is allocated to the other noncash assets prorate based on
carrying amount.

Carrying amount Fraction

Loss
Property, plant and equipment P4,000,000 4/5
400,000
Patent 1,000,000 1/5
100,000
5,000,000
500,000

Journal Entry

Impairment loss 1500,000

Goodwill 1,000,000
Accumulated depreciation 400,000
Patent 100,000

Reversal of an Impairment Loss for a Cash-Generating Unit:

The reversal of an impairment loss for cash generating unit shall be allocated to the assets of the
unit, except for goodwill, on a pro rata based on the carrying amounts of those assets. These
increases in carrying amounts shall be treated as reversals of impairment losses for individual
assets and recognized in profit or loss, unless the assets are carried at revalued amount, that any
reversal of impairment on revalued asset or assets shall be treated as revaluation increase and
credited directly to equity.

In allocating a reversal of an impairment loss for a cash-generating unit, the carrying amount of
an asset shall not be increased above the lower of: (a)its recoverable amount(if determinable), (b)
the carrying amount that would have been determined (net of accumulated depreciation or
amortization) had no impairment loss been recognized for the asset in prior periods.

The amount of reversal of the impairment loss that would otherwise have been allocated to the
asset shall be allocated pro rata to the other assets of the unit, except for goodwill.

Re-designation of Assets

The re-designation of an asset from a cash-generating asset to non-cash generating asset or from
a non-cash-generating asset to a cash-generating asset shall only occur when there is clear
evidence that such a re-designation is appropriate. A re-designation, by itself, does not
necessarily trigger an impairment test or a reversal of an impairment loss.

a.
PROBLEMS

1. One of the cash generating units of Ivana Company is the production of liquor. On
December 31, 2019, Ivana Company believed that the assets of the cash generating unit
(CGU) are impaired based on an analysis of economic indicators.

The assets and liabilities of the cash generating unit on December 31, 2019 are:

Cash 4,000,000
Accounts Receivable 6,000,000
Allowance for doubtful accounts 1,000,000
Inventory 7,000,000
Property, plant and equipment 22,000,000
Accumulated depreciation 4,000,000
Goodwill 3,000,000
Accounts payable 2,000,000
Loans payable 1,000,000

The entity determined that the value in use of the cash generating unit is P30,000,000.
The accounts receivable are considered collectible, except those considered doubtful.
What is the impairment loss to be allocated to property,plant and equipment?

Solution:
Cash 4,000,000
Accounts Receivable-net 5,000,000
Inventory 7,000,000
Property, plant and equipment-net 18,000,000
Goodwill 3,000,000
Carrying amount of CGU P37,000,000
Value in use 30,000,000
Impairment loss 7,000,000
Impairment loss allocated to goodwill 3,000,000
Remaining impairment loss P4,000,000

Carrying amount Fraction Loss

Inventory 7,000,000 7/25 1,120,000
Property, plant and equipment 18,000,000 18/25 2,880,000
25,000,000 4,000,000
 The impairment loss is not allocated to the accounts receivable because the accounts are
considered collectible except those doubtful.

2. Mona Company operates a production line which is treated as a cash generating unit for
impairment review purposes. On December 31,2019, the carrying amounts of the
noncurrent assets allocated to this cash generating unit are as follows:

Intangibles-goodwill 1,100,000
Tangible-plant and machinery 2,200,000

On December 31,2019,the value in use of the production line is estimated at P2,700,000.

What are the revised carrying amounts of the intangible and tangible noncurrent assets
within this cash generating cash?

Intangibles Tangibles
a. 500,000 2,200,000
b. 900,000 1,800,000
c. 1,100,000 1,600,000
d. 800,000 1,900,000

Solution: Carrying amount of cash generating unit 3,300,000

Value in use 2,700,000

Impairment loss 600,000

The impairment loss is applied against the goodwill only. Thus, goodwill has an adjusted
balance

of P500,000 and the balance of the tangible noncurrent asset remains the same.

3. Justinius Company has various cash generating units. On December 31,2019, one cash
generating unit has the following carrying amount of assets:

Cash 600,000
Inventory 1,400,000
Land 2,500,000
Plant and equipment 9,000,000
Accumulated depreciation 1,500,000
Goodwill 1,000,000
 As part of the impairment testing procedure, the management of Justinius Company
determined the value in use of the cash generating unit at P8,500,000. The fair value less
cost to sell for the inventory is greater than the carrying amount. What is the impairment
loss to be allocated to plant and equipment?

Solution:
Cash P 600,000
Inventory 1,400,000
Land 2,500,000
Plant and equipment 7,500,000
Goodwill 1,000,000
Carrying amount of CGU 13,000,000
Value in use 8,500,000
Impairment loss 4,500,000
Impairment loss allocated to goodwill 1,000,000
Remaining impairment loss 3,500,000

Carrying amount Fraction Loss

Land 2,500,000 25/100 875,000
Plant and equipment 7,500,000 75/100 2,625,000
10,000,000 3,500,000

No impairment loss is allocated to inventory because the inventory’s fair value less cost
to sell is

higher that its carrying amount.

4. Tulfo Company has determined that its electronics division is a cash generating unit. The
entity calculated the value in use of the division to be P8,000,000. The assets of the cash
generating unit at carrying amount are as follows:

Building 5,000,000
Equipment 3,000,000
Inventory 2,000,000
10,000,000

Tulfo Company has also determined that the fair value less cost to sell the building
isP4,500,000. What is the impairment loss to be allocated to the equipment?

Solution:
Carrying amount of CGU 10,000,000
Value in use 8,000,000
 Impairment loss 2,000,000

Allocation of impairment loss

Building (5/10 x 2,0000,000) 1,000,000

Equipment (3/10 x 2,000,000) 600,000
Inventory (2/10 x 2,000,000) 400,000
2,000,000

Building Equipment Inventory

Allocated loss 1,000,000 600,000 400,000

Reallocated loss: (500,000)
(3/5 x 500,000) 300,000
(2/5 x 500,000) 200,000

Impairment loss 500,000 900,000 600,000

5. On January 1,2019, Duterte Company acquired all the assets and liabilities of another
entity.The acquire has a number of operating divisions, including one whose major
industry is the manufacture of toy train. The toy train division is regarded as a cash
generating unit. In paying P20,000,000 for the net assets of the acquiree, Duterte
calculated that it had acquired goodwill of P2,400,000. The goodwill was allocated to
each of the divisions, and the assets and liabilities acquired are measured at fair value at
acquisition date.
On December 31, 2019, the carrying amounts of the assets of the toy train division were:

Building 2,000,000
Inventory 1,500,000
Trademark 1,000,000
Goodwill 500,000

There is a declining interest in toy train because of the aggressive marketing of

computer-based
toys. Management of Duterte Company measured the value in use of the toy train
division on
December 31, 2019 at P3,600,000.

What is the impairment loss to be allocated to the building?

 Solution: Carrying amount of cash generating unit 5,000,000
Value in use 3,600,000
Impairment loss 1,400,000
Impairment loss allocated to goodwill 500,000
Remaining Impairment loss 900,000

Carrying amount Fraction

Loss

Building 2,000,000 20/45 400,000

Inventory 1,500,000 15/45
300,000
Trademark 1,000,000 10/45
200,000
4,500,000
900,000

6. Alex Company has two cash generating units. On December 31,2019, the carrying
amount of the assets of one cash generating unit are:

Inventory 200,000
Accounts receivable 300,000
Plant and equipment 6,000,000
Accumulated depreciation 2,600,000
Patent 850,000
Goodwill 100,000

The accounts receivable are regarded as collectible and the inventory’s fair value less
cost to sell is equal to the carrying amount. The patent has a fair value less cost to sell of
P750,000.

On December 31,2019, Brandy Company undertook impairment testing of the cash

generating unit and determined the value in use of the unit at P4,050,000.

What is the impairment loss to be allocated to the plant and equipment?

Solution:
Inventory 200,000
Accounts receivable 300,000
Plant and equipment-net 3,400,000
 Patent 850,000
Goodwill 100,000
Carrying amount of CGU 4,850,000
Value in use 4,050,000
Impairment loss
800,000
Impairment loss allocated to goodwill 100,000
Remaining impairment loss 700,000

Plant
Patent

Allocated loss
(3,400/4250 x 700,000) 560,000
(850/4250 x 700,000)
140,000
Reallocated loss 40,000
( 40,000)
600,000
100,000

7. Zebby Company has two cash-generating units, Gray and Pink. There is no goodwill
within the unit’s carrying values. The carrying values are Gray P10,000,000 and
Pink P15,000,000. Zebby Company has an office building that has not been included
in the above values and can be allocated to the units on the basis of their carrying
values. The office building has a carrying value P5,000,000. The recoverable
amounts are based on the value-in-use of P9,000,000 for Gray and P19,000,000 for
Pink. What amount of impairment loss should Zebby Company recognize on the
cash-generating-unit Gray?

Solution: Gray
Carrying value P10,000,000
Office Building(10:15 ratio) 2,000,000
Total P12,000,000
Fair value 9,000,000
Impairment loss P 3,000,000

8. Ginger Company’s cash-generating unit has been assessed for impairment and it has
been determined that the unit has incurred an impairment loss of P240,000. The
carrying amount of the asset were as follows:
 Building P6,000,000
Equipment 2,000,000
Land 3,500,000
Fittings 2,500,000

What amount of impairment loss should be allocated to the bulding?

Solution: Carrying Value Ratio

Impairment Loss
Building P6,000,000 6/14
P102,857

9. When should a reversal of goodwill impairment be recognized?

a. Immediately
b. At the end of the accounting period
c. At management’s discretion
d. Never

10. Under IAS 36, when it is not possible to calculate the recoverable amount of a single
asset, what should be done?
a. A rough estimate should be provided.
b. The recoverable amount of its cash generating unit.
c. A disclosure should be provided in the notes to the financial statements
d. The value should remain unchanged.

11. How often should a cash generating unit to which goodwill has been assigned be tested
for impairment?
a. At management’s discretion
b. Every six months
c. Every year
d. As often as practicable

12. The present value of expected future cash flows generated by an asset, plus its expected
disposal value is called…
a. Net present value
b. Value in use
c. Fair value
d. Market value

13. When should a reversal of an impairment loss be recognized?

a. Never
b. Immediately
c. When approved by the board of directors
 d. None of these

14. When the recoverable amount of an asset is less than its carrying value in the Statement
of Financial Position, the asset is…
a. In revaluation deficit
b. Impaired
c. Flawed
d. In negative equity

15. The smallest identifiable group of assets that generate cash inflows that are largely
independent of the cash inflows from the other group assets are called…
a. Division
b. Cash-generating unit
c. Department
d. Operating Segment
16. The asset is said to be impaired if…
a. Its carrying amount exceeds its net discounted cash inflows
b. Its recoverable amount exceeds its carrying amount
c. Its carrying amount exceeds its recoverable amount
d. Its carrying amount is less than its market value

17. Under IAS 36, what is the recoverable amount of an asset?

a. The lower of its cost and net realizable value
b. The higher of fair value less costs of disposal and value in use
c. The lower of net present value and cost
d. The higher of net present value and cost

18. The amount, which an asset is recorded in the Statement of Financial Position, less any
accumulated depreciation and impairment losses, is called…
a. Carrying amount
b. Present value
c. Fair value
d. Net Realizable Value

19. Goodwill and intangible assets with indefinite useful lives must be tested for impairment
at least every five years.
a. True
b. False

20. Which of the following is not permitted as a cost to sell under IAS 36?
a. Cost to dismantle machine
b. Auctioneers fees
c. Standard wages for employees
 d. Transport cost for machine

CHAPTER 36:

INTANGIBLE ASSETS

GOODWILL

LEARNING OBJECTIVES

After finishing this chapter, learners are expected to:

1. Know the basic principle of intangible assets in accordance with PAS 38

2. Define criteria of an intangible asset
3. Master the accounting for intangible asset (goodwill)
4. Understand the nature of goodwill as an intangible asset
5. Know the different approach in accounting goodwill
DEFINITION

PAS 38 defines intangible assets as identifiable monetary assets without physical substance.

Three essential criteria in determining whether an intangible asset must be recognized or not,
namely:

1. Identifiability - the ability of the asset to be separated from the entity and can be sold
2. Control – power of an entity over the future economic benefits to be provided by the
intangible assets
3. Future economic benefits- either in the form of revenue or cost savings
IDENTIFIABLE INTANGIBLE ASSETS

The following are the list of identifiable intangible assets:

a. Patent
b. Copyright
c. Franchise
d. Trademark
e. Customer list
f. Computer software
g. Broadcasting license
h. Airline right
i. Marketing rights
j. Fishing rights
RECOGNITION OF INTANGIBLE ASSET

An entity must recognize an intangible asset when:

1. It is probable that future economic benefits related to the intangible asset will flow to the
entity
2. The cost of intangible asset can be measured reliably.
INITIAL MEASUREMENT

1. Acquired separately- at cost plus any directly attributable cost of preparing the asset on
its intended use. (it should be capitalized)
 The cost of a separately acquired intangible asset comprises: (a) its purchase price,
including import duties and non-refundable purchase taxes, after deducting trade
discounts and rebates; and (b) any directly attributable cost of preparing the asset for
its intended use.

2. Part of business combination – fair market value at the date of acquisition

 In accordance with IFRS 3 Business Combinations, if an intangible asset is acquired
in a business combination, the cost of that intangible asset is its fair value at the
acquisition date. If an asset acquired in a business combination is separable or arises
from contractual or other legal rights, sufficient information exists to measure reliably
the fair value of the asset.
3. By way of government grant – either fair value or nominal amount (zero)
 Initially recognition at either fair value or normal value plus direct expenses to
prepare for use.
4. From exchange – fair market value
 Intangible assets may be acquired in exchange for a non-monetary asset or asset. The
cost is measured at fair value. If the acquired asset is not measured at fair value, its
cost is measured at the carrying amount of the asset given up.
5. Internally generated – all directly attributable costs necessary to create the asset will be
capitalized.
 Internally generated brands, mastheads, publishing titles, customer lists and items
similar in substance shall not be recognized as intangible assets.
MEASUREMENT AFTER RECOGNITION

An entity shall choose either the cost model or the revaluation model as its accounting policy.

1. Cost model - After initial recognition, an intangible asset shall be carried at its cost less
any accumulated amortization and any accumulated impairment losses.
2. Revaluation model - After initial recognition, an intangible asset shall be carried at a
revalued amount, being its fair value at the date of the revaluation less any subsequent
accumulated amortization and any subsequent accumulated impairment losses. For the
 purpose of revaluations under this Standard, fair value shall be measured by reference to
an active market.
 Revaluations shall be made with such regularity that at the end of the reporting period
the carrying amount of the asset does not differ materially from its fair value.
 When an intangible asset is revalued, the carrying amount of that asset is adjusted to
the revalued amount. At the date of the revaluation, the asset is treated in one of the
following ways:
 (a) the gross carrying amount is adjusted in a manner that is consistent with the
revaluation of the carrying amount of the asset.
 (b) the accumulated amortization is eliminated against the gross carrying amount of
the asset and the amount of the adjustment of accumulated amortization forms part of
the increase or decrease in the carrying amount.
 If an intangible asset in a class of revalued intangible assets cannot be revalued
because there is no active market for this asset, the asset shall be carried at its cost
less any accumulated amortization and impairment losses.
 If the fair value of a revalued intangible asset can no longer be measured by reference
to an active market, the carrying amount of the asset shall be its revalued amount at
the date of the last revaluation by reference to the active market less any subsequent
accumulated amortization and any subsequent accumulated impairment losses.
PRESENTATION AND DISCLOSURE

A. The financial statements shall disclose, for each intangible asset:

1. the whether the useful lives are indefinite or finite and, if finite, the useful
lives or the amortization rates used;
2. the amortization methods used for intangible assets with finite useful lives;
3. the gross carrying amount and any accumulated amortization (aggregated
with accumulated impairment losses) at the beginning and end of the
period;
4. the line item(s) of the statement of comprehensive income in which any
amortization of intangible assets is included;
5. a reconciliation of the carrying amount at the beginning and end of the
period
(b) The financial statements shall also disclose:

6. for an intangible asset assessed as having an indefinite useful life, the

carrying amount of that asset and the reasons supporting the assessment of
an indefinite useful life. In giving these reasons, the entity shall describe
the factor(s) that played a significant role in determining that the asset has
an indefinite useful life.
7. a description, the carrying amount and remaining amortization period of
any individual intangible asset that is material to the entity’s financial
statements.
 8. for intangible assets acquired by way of a government grant and initially
recognized at fair value
9. the existence and carrying amounts of intangible assets whose title is
restricted and the carrying amounts of intangible assets pledged as security
for liabilities.
10. the amount of contractual commitments for the acquisition of intangible
assets.

(c) If intangible assets are accounted for at revalued amounts, an entity shall disclose the
following:

11. by class of intangible assets

12. the amount of the revaluation surplus that relates to intangible assets at the
beginning and end of the period, indicating the changes during the period
and any restrictions on the distribution of the balance to shareholders.
GOODWILL

- unique asset presented in the financial statements.

- An intangible asset associated with the purchase of one company by another.
- Acquire when the purchase price is higher than the net fair value of all assets
acquired.
Characteristics of GOODWILL

- Most intangible of all intangible assets.

- Cannot be bought or sold
- Can only be identify by the entity as a whole
- Not specifically identifiable, has indeterminate life and inherent to business
FORMULA and CALCULATION OF GOODWILL

Goodwill = P – (A+L)

Where:

P= Purchase price

A= Fair market value of all assets acquired

L= Fair market value of all liabilities acquired

RECOGNITION OF GOODWILL

Developed or internal goodwill – should not be recognized as an asset hence, not recorded
Purchased goodwill – paid goodwill hence should be recognizing as an asset and is recorded to
the book of accounts.

MEASUREMENT OF GOODWILL

There are two approaches in measuring goodwill namely:

a. Residual approach
b. Direct approach
RESIDUAL APPROACH

Under this method, goodwill is measured by subtracting the net assets acquired (assets-liabilities)
to the purchase price for the entity.

Illustration:

A Company purchased B Company for P5 000 000 cash.

The assets and liabilities are of B Company is as follows:

Assets:

Cash P80 000

Merchandise inventory 500 000

Accounts receivable 250 000

Building 1 000 000

Land 1 500 000

Liabilities:

Accounts payable 250 000

Notes payable 300 000

Bonds payable 580 000

Net assets at fair value 2 200 000

Purchase price 5 000 000

Net assets at fair value (2 200 000)

Goodwill 2 800 000

JOURNAL ENTRY

Cash 80 000

Merchandise inventory 500 000

Accounts receivable 250 000

Building 1 000 000

Land 1 500 000

Goodwill 2 800 000

Accounts payable 250 000

Notes payable 300 000

Bonds payable 580 000

Cash 5 000 000

DIRECT APPROACH

Under this approach, goodwill is measure on the basis of future earnings. The value of the
anticipated excess earnings is essential component of goodwill.

This approach requires the following information:

1. Normal rate of return

2. Fair value of tangible assets
3. Estimated future normal earnings
4. Probable duration of any “excess earnings” attributable to goodwill.
Illustration:

The following data are available in relation to the computation of goodwill:

Shareholder’s equity P6 000 000

Normal rate of return in the industry 12%

Earnings for the past 5 years:

2016 800 000

2017 850 000

2018 980 000

2019 1 150 000

2020 1 175 000

4 955 000

Average earnings of the 5-year period (4 955 000/5) 991 000

Method 1 – Purchase of “average excess earnings”

The goodwill is measured at average excess earnings for 5 years.

Average earnings 991 000

Normal earnings (6 000 000*12%) 720 000

Average excess earnings 271 000

Goodwill (271 000*5) 1 355 000

The normal rate of 12% applies to the shareholder’s equity.

Method 2 – Capitalization of “average excess earnings”

The goodwill is measure at the average excess earnings capitalized at 15%.

Average excess earnings 271 000

Divided by capitalization rate 15%

Goodwill 1 806 667

Method 3 – Capitalization of “average earnings”

The goodwill is measured at average earnings capitalized at 10%.

Average 991 000

Divided by capitalization rate 10%

Net assets, including goodwill or purchase price 9 910 000

Less: Net assets excluding goodwill 6 000 000

Goodwill 3 910 000

Method 4 – Present value method

In this method, the goodwill is the present value of the average excess earnings that are expected
to become available in future periods.

Illustration:

In the preceding problem, if the average excess earnings of 271 000 are expected to be received
annually is 5 years, the goodwill, assuming a discount rate of 12% is computed as follows:

Average excess earnings 271 000

Multiply by PV of an ordinary annuity 3.605

Goodwill 976 955

IMPAIRMENT OF GOODWILL

PAS 38 mandates that goodwill shall not be amortized because the useful life is indefinite.
However, it shall be tested for impairment at least annually and whenever that there is an
indication that it may be impaired.

NEGATIVE GOODWILL

Negative goodwill occurs when the purchase price or consideration received for the entity is less
than the net fair value of the identifiable assets acquired and liabilities assumed.

Negative goodwill is recognized in the statement of profit or loss as gain on bargain purchase.
However, standards already dropped the term negative goodwill.

Illustration:

C entity purchased an ongoing business for P 5 000 000 cash.

The assets and liabilities of the acquired business at fair value is as follows:

Cash 2 000 000

Inventory 1 000 000

Building 3 500 000

Accounts payable 500 000

Bonds payable 600 000

Net assets at fair value 5 400 000

Purchase price 5 000 000

Less: Net assets at fair value 5 400 000

Negative goodwill ( 400 000)

Journal Entry

Cash 2 000 000

Inventory 1 000 000

Building 3 500 000

Accounts payable 500 000

Bonds payable 600 000

Gain on bargain purchase 400 000

Cash 5 000 000

TRUE OR FALSE

1. In recognition of an intangible asset it should always be probable and can be measure

reliably.
2. Judgement is always based on internal evidence
3. An intangible asset must be controllable in order to distinguish it from goodwill.
4. Identifiable means that the asset is capable of being separated from the entity.
5. The intangible asset must be controlled by the entity as a result of past event and from
which future economic benefits are expected to flow to the entity.
6. It is possible that the liabilities assumed by the entity will be greater than the asset
acquired
7. Amortization of goodwill is measured annually over its useful life.
 8. Under residual approach, the net assets acquired must be measured at fair value.
9. In direct approach, goodwill is measured on the basis of future earnings of the entity.
10. Developed or internal goodwill is the goodwill that has been paid for.
PROBLEM 1.

TIBS Company purchase another entity for P5 000 000 cash at the beginning of the current year.
The acquired entity’s assets and liabilities at fair value is as follows:

Cash 90 000

Trade and other receivables 680 000

Merchandise inventory 1 500 000

Land 3 000 000 5 270 000

Notes payable 750 000

Bonds Payable 900 000 1 650 000

Net assets at fair value 3 620 000

Required:

1. Determine the amount of goodwill

2. Prepare the journal entries
PROBLEM 2.

CINDY Company purchased for cash at P105 per share all 20 000 ordinary shares outstanding of
TIBS company. TIBS statement of financial position showed its net assets with the carrying
amount of P1 800 000 at the date of acquisition.

The fair value of its non-current asset on the same date was P150 000 in excess of carrying
amount.

Required:

Determine the amount of goodwill on the date of purchase.

PROBLEM 3.

RINDO Company purchased an entity for P 900 000 cash during its operating year. Given below
are the carrying amount and fair value of the assets:

Fair value
Cash 10 000
 Trade and other receivables 290 000
Inventory 1 600 000
Patent 260 000
Furniture and fixtures 900 000
Notes payable (long term 950 000
debt)
Bonds payable 1 850 000

Required:

Determine the amount of goodwill using residual approach.

PROBLEM 4.

Rain Company purchased an entity for P2 250 000 cash during its operating year. Given below
are the carrying amount and fair value of the assets:

Fair value
Cash 80 000
Trade and other receivables 900 000
Inventory 1 250 000
Patent 500 000
Building 1 500 000
Notes payable (long term 850 000
debt)
Bonds payable 1 500 000

Required:

1. Determine the amount of goodwill using residual approach.

2. Prepare necessary journal entries.
PROBLEM 5.

Kurt Company purchased for cash at P65 per share all 100 000 ordinary shares outstanding of
Joshua company. Joshua statement of financial position showed its net assets with the carrying
amount of P5 000 000 at the date of purchase

The fair value of its non-current asset on the same date was P500 000 in excess of carrying
amount.

Required:

Determine the amount of goodwill on the date of purchase.

PROBLEM 6.

Cy Company purchase John entity for P7 500 000 cash at the beginning of the current year. The
acquired entity’s assets and liabilities at fair value is as follows:

Cash 100 000

Trade and other receivables 800 000

In-process research and development 2 000 000

Building 5 000 000 7 900 000

Notes payable 500 000

Bonds Payable 2 000 000 2 500 000

Net assets at fair value 5 400 000

Required:

1. Determine the amount of goodwill

2. Prepare the journal entries
PROBLEM 7.

On December 31, 2019, Lind Company purchased for P50 per share all 150 000
outstanding ordinary share of Say Company. The following relates to Say company’s
assets acquired:

Carrying amount of assets acquired 6 350 000

Fair value of identifiable assets (excess of CA) 800 000

What amount should be reported as goodwill at year-end?

PROBLEM 8.

On January 1, 2019, AWARDS Company purchased Honor company at a cost that resulted in
recognition of goodwill of P3 250 000. During the first quarter of 2019, AWARDS spent an
additional P800 000 on expenditures designed to develop and maintain goodwill by training new
employees. Due to these expenditures, on December 31,2019, AWARDS estimated that the
benefit period of goodwill was indefinite. In it December 31, 2019 statement of financial
position, what amount should AWARDS report as goodwill?

PROBLEM 9.
The shareholders of JP Company mind to sell their business to new interest. For the past five
years, their cumulative net earnings amounted to P6 670 000 inclusive of expropriation gain of
P730 000. JP Company’s fair value of net assets was P8 000 000. If the goodwill is determined
by capitalizing average net earnings at 10%, what is the amount to be paid for goodwill?

PROBLEM 10.

Happy company is interested in computing the goodwill to be recognized in the purchase of Sad
Company in January 2020. Sad Company’s information is as follows:

Year Net Income Net Assets

2015 400 000 1 500 000
2016 500 000 1 700 000
2017 300 000 1 200 000
2018 800 000 1 500 000
2019 700 000 1 350 000
Totals 2 700 000 7 250 000

It is agreed that goodwill is measure by capitalizing excess earnings at 40%, with normal return
on average net assets at 10%.

What is the “purchase price” of Sad Company?

ANSWER KEY

TRUE OR FALSE

1. T
2. F
3. F
4. F
5. T
6. T
7. F
8. T
9. T
10. F
PROBLEM 1. ANSWER

1. 5 000 000-3 620 000=1 380 000(Goodwill)

2.
Cash 90 000

Trade and other receivables 680 000

Merchandise inventory 1 500 000

Land 3 000 000

Goodwill 1 380 000

Notes payable 750 000

Bonds payable 900 000

Cash 5 000 000

PROBLEM 2. ANSWER

105*20 000

=2 100 000-1 800 000-150 000

=150 000

PROBLEM 3. ANSWER

Net assets at fair value = 260 000

Purchase price= 900 000

900 000 – 260 000 =640 000(Goodwill)

PROBLEM 4. ANSWER

1. Net assets at fair value = 1 880 000

Purchase price= 2 250 000

2 250 000-1 880 000 =370 000(Goodwill)

2. Cash 80 000
Trade and other receivables 900 000
Inventory 1 250 000
Patent 500 000
Building 1 500 000
Goodwill 370 000
Notes payable 850 000
Bonds payable 1 500 000
Cash 2 250 000

PROBLEM 5. ANSWER

65*100 000

= 6 500 000-5 000 000 – 500 000

= 1 000 000(goodwill)

PROBLEM 6. ANSWER

1. 7 500 000-5 400 000=2 100 000(Goodwill)

2.
Cash 100 000

Trade and other receivables 800 000

In-process research and development 2 000 000

Building 3 000 000

Goodwill 2 100 000

Notes payable 500 000

 Bonds payable 2 000 000

Cash 7 500 000

PROBLEM 7. ANSWER

50*150 000

=7 500 000-6 350 000-800 000

=350 000 (goodwill)

PROBLEM 8. ANSWER

Cost of goodwill- January 1,2019 P3 250 000

PROBLEM 9. ANSWER

Cumulative earnings 6 670 000

Less: expropriation gain 730 000

Adjusted cumulative earnings 5 940 000

Average earnings (5 940 000/5) 1 188 000

Divide by capitalization rate 10% _

Net asset including goodwill 11 880 000

Less: net assets before goodwill 8 000 000

Goodwill 3 880 000

PROBLEM 10. ANSWER

Average net assets (7 250 000/5) 1 450 000

Average Earnings (2 700 000/5) 540 000

Less: Normal Earnings (10%*1 450 000) 145 000

Excess Earnings 395 000

Divide by capitalization rate 40%___

Goodwill 158 000

Net assets-2019 1 350 000

Goodwill 158 000

Total purchase price 1 508 000

 IDENTIFIABLE INTANGIBLE ASSETS

Identifiable Intangibles – can be identified apart from other assets of the enterprise and can be
sold separately.

Patent – an exclusive right granted by the government to an inventor enabling him o control the
manufacture, sale or other use of his invention for a specified period of time.

The cost of a purchased patent which is equal to its fair market value should be amortized over
its legal life (20 years) or useful life, whichever is shorter.
The cost of the developed patent which include only the licensing and other related legal fees in
securing the patent rights should be amortized the shorter of the legal life or useful life.
If a competitive patent was acquired to protect the old patent, the cost of the competitive patent
should be amortized over the remaining life of the old patent.

Legal fees and other costs of successfully prosecuting or defending a patent should be charged
outright as an expense. Any cost of unsuccessful litigation on patent should also be charged
outright as an expense including the unamortized cost of the patent.

If a new patent negates the old patent’s value, the cost of the new patent can be made by adding
the unamortized cost of the old patent; however, most business enterprises rely on the
conservatism constraint and immediately write-off the unamortized cost of the old patent.

Copyright – exclusive right granted by the government to the author, composer or artist
enabling to publish, sell or otherwise benefit from his literacy, musical and artistic work.

The costs which includes the expenses incurred in the production of the work including those
required to establish or obtain the right should be amortized over the period it is expected to
provide a revenue or legal life, whichever is shorter.

However, if revenues are expected to be received for an indefinite period of time and renewal
and registration can be done with minimal effort and cost, it should not be amortized but should
however be reviewed for impairment at each reporting date.

Franchise – an exclusive right granted by the franchisor (government or private companies) to a

franchisee to use the property or the rights (trademark, patent and process of the franchisor).

The cost of the franchise should be amortized or reviewed at each reporting period for
impairment:
 If the franchise has a definite period – it should be amortized over the definite period
(not exceeding 20 years) or useful life, whichever is shorter.
 If the franchise has an indefinite useful life – it is not amortized but tested for
impairment at each reporting date.

Trademark/ Tradename/ Brand name – is a symbol, sign, slogan or name used to mark a
product to distinguish it from other products. The cost of the intangible should include:
  When purchased – the purchase price or the cash price equivalent
 When developed – the expenditures required to establish including filing fees, registry
fees, and other expenses incurred in securing the trademark.

Under R.A No. 8293, the legal life of a trademark is 10 years and may be renewed for periods of
10 years each. The cost of a trademark is not amortized but tested for impairment at least
annually as a result of the almost automatic renewal. Trademark may be properly classified as an
intangible asset with an indefinite life.
However, if its life is no longer indefinite, it should be amortized over its remaining useful life.

Customer List – one of the customer-related assets result from interactions with outside parties.
 Cost of purchased customer list – includes the purchase price and any directly
attributable cost of preparing the asset for its intended use. The cost is amortized over the
asset’s useful life.
 Cost of an internally generated customer list – expensed in the period incurred.
Subsequent expenditures on customer lists are recognized as expense.

Web site costs

 Summary
Web site’s use Accounting treatment
1. Internal use Capitalize
2. External use (customers can place their orders Capitalize
on the web site)
3. External use (customers cannot place their Expensed
orders on the web site

 Summary
Web site development stage Treatment for costs incurred
1. Planning stage Expensed immediately
2. Application and Intangible asset if all conditions are met
infrastructure
3. Graphical design stage Intangible asset if all conditions are met
4. Content development stage Expensed to the extent that content is
developed to advertise products or services
5. Operating stage Expensed, unless recognition criteria are met
 IDENTIFIABLE INTANGIBLE ASSETS
PROBLEMS

Problem 1
Robin Company incurred P1,600,000 of research and development costs to develop a product for
which a patent was granted on January 1, 2019. Legal fees and other costs associated with
registration of the patent totaled P300,000. On March 31, 2019, Robin paid P450,000 for legal
fees in a successful defense of the patent. What is the total amount that should be capitalized for
the patent through March 31,2019?
a. 750,000
b. 300,000
c. 2,050,000
d. 2,350,000

Solution Answer b
Legal fees and other costs associated with registration 300,000
The cost of litigation whether successful or not, should be treated as outright expense because
such cost would only maintain and not enhance the originally assessed future economic benefits.
As a rule, expenditure on research and development should be recognized as an expense when it
is incurred.

Problem 2
On January 1, 2016, Coprade Company purchased a patent for P7,140,000. The patent is being
amortized over its remaining legal life of 15 years expiring on January 1, 2031. During 2019,
Coprade determined that the economic benefits of the patent would not last longer than ten years
from the date of acquisition.
What should be reported in the statement if financial position as carrying amoun of patent on
December 31, 2019?
a. 4,284,000
b. 4,896,000
c. 5,050,000
d. 5,236,000

Solution Answer b
Cost – January 1, 2016 7,140,000
Amortization for 2016, 2017, 2018
(7,140,000 / 15 x 3) (1,428,000)
Carrying amount – December 31, 2018 5,712,000
Amortization for 2019 (5,712,000 / 7) (816,000)
Carrying amount – December 31, 2019 4,896,000

Problem 3
On January 1, 2016, Dilan Company purchased a patent for a new customer product for P900,00.
At the time of purchase, the patent was valid for 15 years. However, the patent’s useful life was
estimated to be only 10 years due to competitive nature of the product. On December 31, 2019,
the product was permanently withdrawn from sale under governmental order because of a
potential health hazard in the product.
What amount should Dilan charge against income during 2019 if amortization is recorded at the
end of each year?
a. 90,000
b. 540,000
c. 630,000
d. 720,000

Solution Answer c
Acquisition cost 900,000
Amortization for 2016, 2017, 2018
(900,000 / 10 x 3) (270,000)
Carrying Amount – January 1, 2019 630,000

The remaining carrying amount on January 1, 2019 is entirely expensed in 2019 and this includes
the amortization of P90,000 for 2019.

Problem 4
Carmona Company acquired three patents in January 2019. The patents have different lives as
indicated in the following schedule:
Patent Cost Remaining Useful Remaining legal life
life
X 1,200,000 10 8
Y 2,000,000 5 10
Z 3,000,000 6 15
Patent Z is believed to be uniquely useful as long as the entity retains the right to use it. in June
2019, the entity successfully defended its right to Patent Y. Legal fees of P450,000 were incurred
in this action. The entity’s policy is to amortize intangible assets by the straight line method to
the nearest half year. The entity reports on a calendar-year basis. What amount of amortization
should be recognized for 2019?
a. 1,050,000
b. 1,100,000
c. 1,095,000
d. 1,020,000

Solution Answer a
Patent X (1,200,000 / 8) 150,000
Patent Y (2,000,000 / 5) 400,000
Patent Z (3,000,000 / 6) 500,000
Total Amortization 1,050,000

Problem 5
Pink Company was granted a patent on January 1, 2016, and appropriately capitalized P450,000
of related costs. Pink was amortizing the patent over its estimated life of 15 years. During 2019,
Pink paid P150,000 in legal costs in successfully defending an attempted infringement of the
patent. After the legal action was completed, Pink sold the patent to the plaintiff for P750,000.
Pink’s policy is to take no amortization in the year of disposal. In its 2019 income statement,
what amount should Pink report as gain from sale of patent?
a. 150,000
b. 240,000
c. 270,000
d. 390,000

Solution Answer d
Acquisition cost – January 1, 2016 450,000
Amortization for 2016, 2017, 2018 (450,000 / 15 x 3) (90,000)
Carrying amount – January 1, 2019 360,000

Sales Price 750,000

Remaining cost of patent (360,000)
Gain from sale of patent 390,000

Problem 6
On January 1, 2019, Serra Company bought a trademark from Kaba Company for P3,000,000.
Serra retained an independent consultant who estimated the trademark’s life to be indefinite. Its
carrying amount in Kaba’s accounting records was P1,500,000. On December 31, 2019, what is
the carrying amount of trademark?
a. 3,000,000
b. 1,500,000
c. 2,850,000
d. 0
Solution Answer a
The legal life of trademark is 10 years and may be renewed for periods of 10 years each.
Considering the almost automatic renewal of a trademark, the trademark can be classified as an
intangible asset with indefinite life. Accordingly, the cost of trademark is not amortized but
tested for impairment at least annually.

Problem 7
Narra Company has acquired a trademark relating to the introduction of a new manufacturing
process. The costs incurred were as follows:

Cost of trademark 3,500,000

Expenditure on promoting the new product 50,000
Employee benefits relating to testing of new process 200,000
What total cost should be capitalized as intangible noncurrent asset in respect of the new
process?
a. 3,750,000
b. 3,700,000
c. 3,500,000
d. 3,550,000

Solution Answer b
Total cost (3,500,000 + 200,000) 3,700,000

Problem 8
On January 1, 2019, Laderas Company showed patent of P1,920,000 with related accumulated
amortization of P240,000. The patent was purchased on January 1, 2017 at which date the legal
life is 16 years. On January 1, 2019, the useful life of the patent was determined to be only 8
years from the date of acquisition.
On January 1, 2019, in connection with the purchased of trademark from Ash Company, the
parties entered into a noncompetition agreement and a consulting contract. Laderas Company
paid Ash Company P800,000, of which three-fourths was for the trademark, and one-fourth was
for Ash Company’s agreement not to compete for a five-year period in the line of business
covered by the trademark. Laderas Company considers the life of the trademark to be indefinite.
Moreover, Laderas Company agreed to pay Ash Company P50,000 annually on January 1 of
each year for 5 years.
1. What is the carrying amount of intangible assets on January 1, 2019?
a. 2,280,000
b. 2,480,000
c. 1,880,000
d. 1,680,000
2. What is the total amortization of intangible assets for 2019?
a. 280,000
b. 440,000
c. 320,000
d. 160,000

Solution Question 1 Answer b Question 2 Answer c

Patent (1,920,000 – 240,000)1,680,000
Trademark (800,000 x ¾) 600,000
Noncompetition agreement (800,000 x 1/4) 200,000
Total intangible assets – January 1, 2019 2,480,000

Amortization of patent (1,680,000 / 6) 280,000

Amortization of noncompetition agreement (200,000 / 5) 40,000
Total amortization for 2019 320,000

Problem 9
On January 1, 2019, Love signed an agreement to operate as a franchise of Spade Company for
an initial franchise fee of P12,000,000. The same date, Love paid P4,000,000 and agreed to pay
the balance in four equal annual payments of P2,000,000 beginning January 1, 2020. The down
payment is not refundable and no future services are required of the franchisor. Love can borrow
at 14% for a loan of this type. Present and future value factors are as follows:

PV of 1 at 14% for 4 periods 0.59

Future amount of 1 at 14% for 4 periods 1.69
PV of an ordinary annuity of 1 at 14% for 4 periods 2.91
What is the acquisition cost of the franchise?
a. 13,520,000
b. 12,000,000
c. 9,820,000
d. 8,720,000

Solution Answer c
Down payment 4,000,000
PV of annual payment of P2,000,000
For 4 years (2,000,000 x 2.91) 5,820,000
Cost of franchise 9,820,000
The present value factor of an ordinary annuity of 1 is used in computing the present
value because the balance is payable equally by installment.

Problem 10
On January 1, 2017, Yan Company signed an eight-year lease for office space. Yan has the
option to renew the lease for an additional four-year period on or before January 1, 2024. During
January 2019, two years after occupying the lease premises, Yan made general improvements to
the premises costing P3,600,000 and having an estimated useful life of ten years. On December
31, 2019, Yan’s intentions as to exercise of the renewal option are uncertain. What is the
depreciation of leasehold improvements for 2019?
a. 300,000
b. 360,000
c. 450,000
d. 600,000

Solution Answer d (3,600,000 / 6) 600,000

The leasehold improvements are depreciated over the remaining lease term of 6 years because
this is shorter than the life of the improvements of 10 years.

Problem 11
On January 1, 2019, Rein Company leased land and building from an unrelated lessor for a ten-
year term. The lease has a renewal option for an additional ten years, but Rein has not reached a
decision with regard to the renewal option. In early January of 2019, Rein completed the
following improvements to the property:

Sales office 10 years 470,000

Warehouse 25 years 750,000
Parking lot 15 years 180,000
What is the depreciation of leasehold improvements for 2019?
a. 70,000
b. 89,000
c. 122,000
d. 140,000

Solution Answer d
Sales office (470,000 / 10) 47,000
Warehouse (750,000 / 10) 75,000
Parking lot (180,000 / 10) 18,000
Total 140,000
Leasehold improvements should be depreciated over the life of the improvement or life of the
lease contract, whichever is shorter.

Problem 12
Moon Company leases a building for its product showroom. The ten-year nonrenewable lease
will expire on December 31, 2024. In January 2019, Moon redecorated its showroom and made
leasehold improvement of P480,000. The estimated useful life of the improvement is 8 years.
Moon uses the straight line method of depreciation. What is the carrying amount of leasehold
improvement on June 30, 2019?
a. 456,000
b. 450,000
c. 440,000
d. 432,000

Solution Answer c
Leasehold improvement 480,000
Depreciation from January 1 to June 39, 2019
(480,000 / 6 x 6/12) (40,000)
Carrying amount – June 30, 2019 440,000
The remaining lease term from January 2019 to December 31, 2024 is six years which is shorter
than the life of the improvement of 8 years.

Problem 13
On January 1, 2018, Grey Company acquired a land lease for 21 years with no option to renew.
The lease required Grey to construct a building in lieu of rent. The building, completed on
January 1, 2019, at a cost of P8,400,000, will be depreciated using the straight line method. At
the end of the lease, the building’s estimated fair value is P4,200,000.
What is the carrying amount of the building in the December 31, 2019 statement of financial
position?
a. 7,980,000
b. 8,000,000
c. 8,190,000
d. 8,200,000
Solution Answer a
Building 8,400,000
Depreciation for 2019 (8,400,000 / 20) (420,000)
Carrying amount – December 31, 2019 7,980,000

The building was completed on January 1, 2019, one year from the date of the lease on January
1, 2018. Thus, the remaining term is 20 years.
The estimated fair value of the building at the end of the lease is ignored in computing
depreciation because legally, the building becomes the property of the lessor when the contract is
terminated.

Problem 14
On October 1, 2019, Mars, Inc. exchanged 2,000 shares of its P500 par value ordinary shares
held in treasury for a patent owned by Saturn Company. The treasury shares were acquired in
2018 at a cost of P800,000. At the time of exchange, Mar’s ordinary share was quoted at P550
per share and the patent had a net carrying value on Saturn’s books of P900,000.
At what amount should Mars record the patent?
a. 800,000
b. 900,000
c. 1,000,000
d. 1,100,000

Solution Answer d
FMV of shares issued (treasury)
At the time of exchange (2,000 x P550) P1,100,000

Problem 15
Constellation Company incurred P198,900 of research and development costs to develop a
product for which a patent was granted on January 2, 2016. Legal fees and other costs associated
with registration of the patent totaled P44,200. On January 2, 2019, Constellation paid P62,400
for legal fees in a successful defense of the patent. The patent has a useful economic life of 20
years.
What amount should Constellation record as amortization expense for 2019?
a. 2,210
b. 5,200
c. 7,800
d. 19,500

Solution Answer a
Historical cost 44,200
Divided by its legal life 20 years
Annual amortization 2,210

Cost to develop on intangible is recognized as an outright expense

Subsequent cost of defending the patent is charged outright to expense.
Problem 16
Pluto Company spent P288,000 in developing a new product with a patent being granted on
January 2, 2017. Due to a competitive nature of the product, the patent was estimated to have a
useful life of ten years. Cost of licensing and registering was P36,000. On July 1, 2019, a
competitor obtained rights to a patent, which made Pluto’s patent obsolete.
How much is the loss from patent obsolescence?
a. 6,000
b. 16,200
c. 27,000
d. 36,000

Solution Answer c
Cost of patent 36,000
Less: Total amortization from Jan. 2017 to July 1, 2019 9,000
(36,000 x 2.5/10)
Book value of patent as of July 1, 2019 27,000
The amount of loss on patent obsolescence is equal to the book value of the patent when it
became obsolete.

Problem 17
Earth Company bought a patent for P600,000 on January 2, 2016, at which time the patent had
an estimated useful life of ten years. On January 2, 2019, it was determined that the patent’s
useful life would expire at the end of 2022.
How much should Earth record as amortization expense for this patent on December 31, 2019?
a. 60,000
b. 105,000
c. 120,000
d. 140,000

Solution Answer b
Original cost 600,000
Less: Amortization from Jan.2, 2016 to
Jan. 2, 2019 (600,000 x 3/10) 180,000
Carrying value of patent- date of change in estimated life 420,000
Divided by: Remaining new life (Jan.2, 2019 to Dec.31, 2022) 4 years
Amortization expense, 2019 105,000

Problem 18
On January 1, 2015, Best Company bought a trademark for P400,000, having an estimated
remaining useful life of 16 years. After 16 years, revenues expected from these intangibles will
be zero. In January 2019, Best paid P60,000 for legal fees in a successful defense of the
trademark.
What amount of expense should Best Company recognize and charge against income during
2019?
a. 15,000
b. 25,000
 c. 30,000
d. 85,000

Solution Answer d
Amortization expense – original cost (400,000 / 16 years) 25,000
Cost of litigation 60,000
Total expense 85,000

Problem 19
Sang Company has a broadcasting license that expires in 5 years. As of January 1, 2016, the
license has a carrying amount of P1,800,000. The license is renewable and has already been
renewed twice in the past. During the current year 2016, the broadcasting authority has decided
that in the future it will auction the licenses when they came up for renewal. As a result of this
development the company’s renewal option is no longer assured. The license has a remaining life
of three years as of January 1,2016.
In the December 31, 2016 statement of financial position, how much should be reported as the
carrying value of the broadcasting license?
a. None
b. 1,200,000
c. 1,600,000
d. 2,000,000

Solution Answer b
Carrying value as of January 1, 2016 1,800,000
Amortization – 2016 (1,800,000 / 3 years) (600,000)
Carrying value as of Dec. 31, 2016 1,200,000

Problem 20
On July 1, 2019, Silk signed an agreement to operate as a franchise of Cream Company for an
initial franchise fee of P1,200,000. On the same date, Silk paid P400,000 and agreed to pay the
balance in four equal payments of P200,000 beginning July 1, 2020. The down payment is not
refundable and no future services are required of the franchisor. Silk can borrow at 14% for a
loan of this type. Present and future value factors are as follows:
PV of 1 at 14% for 4 periods 0.59
Future amount of 1 at 14% for 4 periods 1.69
PV of an ordinary annuity of 1 at 14% for 4 periods 2.91
How much should Silk record as acquisition cost of the franchise on July 1, 2019?
a. 872,000
b. 982,000
c. 1,200,000
d. 1,352,000

Solution Answer b
Down payment 400,000
Present value of future payments (200,000 x 2.91) 582,000
Cost of franchise 982,000
CHAPTER 38-Research and Development
Research activities are planned search or critical investigation aimed at discovery of new
knowledge.

Development activities are translation of research findings or other knowledge into a plan
or design for a new product or process or for a significant improvement to an existing product or
process whether intended for sale or use.

Research and development activities do not include routine or periodic alternatives to

existing products, production lines, manufacturing processes, and other ongoing operations even
though these alterations may represent improvements.

Accounting for R&D Costs:

1. Materials, Equipment, and Facilities- expense the entire cost unless the items have
alternative future uses, then carry as inventory and allocate as consumed, or capitalize
and depreciate as used.
2. Personnel- salaries, wages, and other related costs of personnel engaged research and
development should be expensed as incurred.
3. Intangibles- expense the entire cost unless the items have alternative future uses, then
capitalize and amortize.
4. Contract Services- cost of services performed by others in connection with the reporting
company’s R&D should be expensed as incurred.
5. Indirect costs- a reasonable allocation of indirect costs shall be included in R & D costs,
except for general and administrative cost which must be clearly related in order to be
included and expensed.
6. Only Development activity –related costs has the potential to be capitalized after a
market viability is established.
Other costs similar to Research and Development costs

Start-up cost

Start-up cost are costs incurred for one time activities to start a new operations. It
includes organizational costs which are incurred in organizing of a new entity. Start-up costs are
expensed as incurred with the expectation that future revenues will occur or increased
efficiencies will result.

Initial Operating Losses

Operating losses should not be capitalized during the early years for FASB concludes that
the accounting practices and reporting standards should be no different for an enterprise trying to
establish a new business than they are for other enterprise. The same GAAP that apply to the
established operating enterprises shall govern the recognition of revenue by a development stage
enterprise and shall determine whether a cost incurred by a development stage enterprise is to be
charged to expense when incurred or is to be capitalized or deferred.

Advertising Costs

These costs could be expensed in various of ways:

a. When advertising was completed

b. When first time advertising takes place
c. Over the estimated useful life of the advertising
d. In an appropriate fashion to each of the three periods identified above
e. Over the period revenues are expected to result

PROBLEMS

1. How should research and development costs be accounted for?

a. must be capitalized when incurred and then amortized over the useful life
b. must be expensed in the period incurred
c. may either be capitalized or expensed when incurred depending upon the materiality
d. must be expensed in the period incurred unless t can be clearly demonstrated that the
expenditure will have alternative future use or unless contractually reimbursable

2. Which of the following would be considered research and development?

a. routine effort to refine an existing product
b. periodic alteration to existing production lines
c. marketing research to promote a new product
d. construction of prototype
3. Which of the following costs should not be capitalized?
a. acquisition cost of equipment to be used on current and future research projects
b. engineering costs incurred to advance the product to the full production stage
c. cost incurred to file for patent
d. cost of testing prototype before economic feasibility has been demonstrated
4. Which of the following costs should be excluded from research and development
expense?
a. modification of the design of a product
b. acquisition of research and development equipment for use on a current project only
c. cost of marketing research for a new product
 d. engineering activity required to advance the design of a product to the manufacturing
stage
5. Which of the following should not be considered research and development activity?
a. adaptation of an existing capability to a particular requirement or customer need
b. application of research finding or other knowledge to a plan for a new product
c. laboratory research aimed at discovery of new knowledge
d. conceptual formulation and design of possible product alteration
6. Research activities include all of the following, except
a. search for application of research finding or other knowledge
b. search for product or process alternative
c. formulation and design of the possible product or process alternative
d. design, construction and testing of preproduction prototype and model
7. Development activities include all of the following except
a. design of tools, jigs, molds and dies involving new technology
b. design, construction and operation of a pilot plant
c. design, construction and testing of a chosen alternative for a new or improved product
or process
d. laboratory activities aimed at obtaining new knowledge
8. Which of the following is not one of the criteria which must be met before development
costs can be capitalized?
a. the entity has sufficient financial resources to complete the project
b. the entity intends to complete the project and either use or sell the intangible asset
c. the entity can reliably identify the research costs incurred to bring the project to
economic feasibility
d. the project has achieved technical feasibility

9. Which of the following costs should be capitalized?

a. acquisition cost of equipment to be used on current research project only
b. engineering cost incurred to advance the product to the full production stage
c. cost of research to determine whether a market for the product exists
d. salaries of research staff
10. Which statement is true about development cost?
a. development cost must be expensed
b. development cost is always deferred and expensed against future revenue
c. development cost may be capitalized as an intangible asset in very restrictive situations
d. development cost is recorded as component of other comprehensive income
11. Routine on-going effort to refine, enrich or improve quality of existing product is not a
considered a research and development activity. TRUE
12. Cost of testing equipment that will also be used in another separate research and
development project scheduled to begin next year should be capitalized and amortized
over current and future periods. TRUE
13. Internal-use software is considered to be software that is marketed as a separate product
or as part of a product or process. FALSE
14. A computer software purchased as an integral part of a computer controlled machine tool
that cannot operate without the specific software shall be treated as
a. intangible asset
b. property, plant, and equipment
c. inventory
d. expense
15. Preliminary cost should be expensed as incurred for internal-use software cost. TRUE
16. The proper accounting for costs incurred in creating computer software is to charge
research and development expense when incurred until technological feasibility has been
established for the product. TRUE
17. Design, construction and operation of a pilot plant would not be considered as a research
and development activity. FALSE
18. Application and development costs should be capitalized as incurred. TRUE
19. On December 31, year 3, Bit Co. had capitalized costs for a new computer software
product with an economic life of five years. Sales for year 4 were 30% of expected total
sales of the software. At December 31, year 4, the software had a net realizable value
equal to 90% of the capitalized cost. What percentage of the original capitalized cost
should be reported as the net amount on Bit’s December 31, year 4 balance sheet?
a. 70%
b. 72%
c. 80%
d. 90%

20. Cody Corp. incurred the following costs during year 4:

Design of tools, jigs, molds, and dies involving new technology $125,000
Modification of the formulation of a process 160,000
Troubleshooting in connection with breakdowns during commercial production

100,000
Adaptation of an existing capability to a particular customer’s need as part of a
continuing commercial activity 110,000

In its year 4 income statement, Cody should report research and development expense of
a. $125,000
b. $160,000
c. $235,000
d. $285,000