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OVERVIEW
Objective of FSs: To provide information that enables the user to make decisions
Primary users of FSs: Management, potential investors, lenders, other creditors
Qualitative Characteristics of Accounting Information -attributes that make the information presented in the FS useful
to users.
 Fundamental Qualitative Characteristics:
1. Relevance – capable of making difference in the decisions made by users
a) Confirmatory Value -quality that confirms earlier expectation
b) Predictive Value -enables the users to make forecast and plan their future actions.
c) Materiality -provides threshold or cut-off for recognition.

2. Faithful Representation – means representation of the substance of an economic phenomenon instead

of representation of its legal form only.
-to maximize the underlying characteristics of completeness, neutrality, and freedom from
error.
 Enhancing Qualitative Characteristics:(VCUT)
1. Verifiability -helps to assure users that information represents faithfully the economic phenomena it
purports.
 Means that different knowledgeable and independent observers could reach consensus,
although not necessarily complete agreement. That a particular depiction is a faithful
representation.

2. Comparability – Information about a reporting entity is more useful if it can be compared with a similar
information about other entities and with similar information about the same entity for another period.
 Enables user to identify and understand similarities and differences.

3. Understandability -Classifying, characterizing and presenting information clearly and concisely makes it
understandable. Financial reports are prepared for users who have a reasonable knowledge of business
and economic activities

4. Timeliness -means that information is available to decision-makers in time to be capable of influencing

their decisions.

Elements of FSs – are grouping, into broad classes, of the financial effect of transactions and other events according to
economic benefits
1. Statement of Financial Position: Assets, Liability and Equity
2. Statement of Profit or Loss and Other Comprehensive Income: Income and Expense
Equity -residual interest in the assets after deducting all liabilities of the company
Income – Increase in economic benefits that results increase in equity
Expense – Decrease in economic benefits that results decrease in equity

Recognition Principle:
Recognition -process of capturing for inclusion in the Statement of Financial Position or Statement of Financial
Performance an item that meets the definition of assets, liability, equity, income, and expenses.
Carrying Amount -amount at which asset, a liability or equity is recognized in statement of financial position.
Recognition Criteria:
1. It is probable that there is an inflow or outflow of economic benefits
2. The element has a cost or value that could be reliably measured.
Process of recognition requires assigning value to the FS element, called measurement
1. Historical Cost
2. Current Cost (or Fair Value)
3. Realizable Value
4. Present Value

Classification of Assets and Liabilities:

PAS 1, requires an entity to present CA, NCA, CL, NCL, as separate classification of Statement of Financial Position
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An entity shall classify an asset as current when:
 Expected to realize in normal operating cycle
 Holds primarily for the purpose of trading
 Expects to realize within twelve months
 The asset is a cash or cash equivalent unless the asset is restricted from being exchange or used to settle a
liability for at least 12 months after the reporting period.
An entity shall classify a liability as current when:
 Expects to settle liabilities in normal cycle
 Holds the liability primarily for the purpose of trading
 Liability is due to settled within 12 months after the reporting period
 It does not have an unconditional right to defer settlement of the liability for at least 12 months after reporting
period.
CHAPTER 1: CASH AND CASH EQUIVALENTS
Cash – item must be unrestricted and must be immediately available for use in current operation
Cash items to be included in cash:
1. Cash on hand
 Undeposited cash collection
 Cash items awaiting deposit

2. Cash in bank
 Demand deposits/Saving/ Current
3. Working fund
 Petty cash fund
 Change fund
 Payroll fund
 Dividend fund
 Tax fund
 Interest fund
 Revolving fund
Cash items not included in cash but part of non-current asset:

1. Pension fund 5. Insurance fund

2. Preferred redemption fund 6. Sinking fund

3. Acquisition of PPE

4. Contingent fund

Treated as receivable: Postdated checks-checks dated at future date, IOU, advance to employees
Treated as asset specifically prepaid supplies: Unused postage stamp
Treated as other asset: depreciation fund
Stale check- checks delivered to payees are not encashed within a relatively long period of time, normally 6mos or
more.
Unused credit line- not included in cash but disclosed only to notes. Difference of line credit and amount borrowed.
If compensating balance is unrestricted then included in cash.
Cash equivalents – 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.

Short period of time, normally 3 months or less, from the date of acquisition

Only debt instruments acquired within 3 months or less before maturity date can qualify as cash equivalents.
Example of cash equivalents:
 Time deposit- form of bank deposit normally made in fixed denomination with higher interest.
 Money markets instruments- investment in portfolios of short-term securities
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 commercial paper – consist of short-term, unsecured, notes payable issued in large denominations by large
companies with high credit rating. Maturity date normally less 270 days
 Treasury bills, note, or bonds acquired 3mos before maturity date
 Redeemable preference shares with mandatory redemption acquired 3 months before maturity. Recognize as
debt instrument rather than equity instrument if matures 3mos or less.
Equity securities (investment in stocks) can’t qualify as cash equivalent because share of stocks don’t have maturity date.
Restricted cash is excluded in cash and presented either current or non-current assets.
Presentation and measurement of cash in the SFP:
GR: Cash is generally measured at face value, which is its fair value.
Following scenarios that need further consideration:
1. Foreign Currency – cash should be translated to PH currency using the exchange rate at the reporting period.

2. Cash in closed banks or bank having financial difficulty or bankruptcy -reclassified as receivable

3. Customers’ post dated checks and NSF check -should be reported as receivable

4. Expense advances -should be reported as prepaid expense

5. Bank overdraft -occurs when a depositor has written checks for a sum greater than in the depositors bank
account.

 Should be reported as current liability, except when the depositor has sufficient funds in
another account with the same bank

6. Undelivered or unreleased checks -company’s drawn and record but not actually issued for delivered to the
payees as of the reporting date.

7. Company’s post dated check -recorded as issued and delivered to payees before or at the reporting date.

8. Cash set aside for long-term specific purpose -non-current asset

9. Compensating balance – minimum amounts that a company agrees to maintain in a checking account

 When compensating balance is not legally restricted as to withdrawal —cash

 When compensating balance is legally restricted as to withdrawal —either current or non-
current asset

Cash short and over – a nominal account that is debited for shortage and credited for overage in the petty cash fund
 A debit balance in cash short or over account the end of the period should be reported as a
miscellaneous expense, while a credit balance is reported as miscellaneous income.

Cash shortage Cash overage

Cash short or over xx Cash xx
Cash xx Cash short or over xx
Adjustments if shortage due to cashier or cash custodian: Adjustments if cashier found properly the cash overage:
Due from cashier xx Cash short or over xx
Cash short or over xx Payable to cashier xx
Adjustments if shortage fail to disclose: Adjustments if there’s no claim on cash overage:
Loss from cash shortage xx Cash short or over xx
Cash short or over xx Miscellaneous income xx
Concealment of Cash shortage:
1. Lapping- occurs when collection of receivable from one customer is misappropriated and then concealed by
applying a subsequent collection from another customer.(nangungupit yung nagrerecord like d nya ineentryhan
or binabawasan nya ng amount)
2. Kitting- overstating the balance of cash in book pero shortage in actual

Cash management -segregation of duties for handling cash and recording cash transactions
 Imprest System – system cash control that requires all cash receipts should be deposited intact and all cash
disbursements should be made by means of check.
 Voucher System
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 Internal audit at irregular intervals
 Periodic reconciliation of bank statement balance and cash balance per company records
Petty cash fund:
IMPREST FUND SYSTEM FLUCTUATING SYSTEM

A. To establish the fund A. To establish the fund

Petty cash fund xx Petty cash fund xx
Cash in bank xx Cash in bank xx
B. Payment of expense B. Payment of expense
Memo entry Expense xx
Petty cash fund xx
C. Replenishment of petty cash payment C. Replenishment of petty cash payment
Expense xx Petty cash fund xx
Cash in bank xx Cash in bank xx
D. To adjust the unreplenished expense D. To adjust the unreplenished expense
Expense xx No adjusting entry
Petty cash fund xx
E. Increase in the fund E. Increase in the fund
Petty cash fund xx Petty cash fund xx
Cash in bank xx Cash in bank xx
F. Decrease in the fund F. Decrease in the fund
Cash in bank xx Cash in bank xx
Petty cash fund xx Petty cash fund xx

CHAPTER 2: BANK RECONCILIATION

Bank reconciliation – schedule prepared the accounts for the differences between cash balance per book and balance
per bank. It is only prepared for checking account/ demand deposit and is usually prepared monthly because the bank
provides the depositor with the bank statement at the beginning (normally first week) of the ff. month.

Forms of bank reconciliation: 2. Book to bank method

Book balance xx
1. Adjusted balance method Add: Credit Memos xx
Book balance xx Outstanding checks xx
Add Credit Memos xx Total xx
Total xx Less: Debit Memos xx
Less: Debit Memos xx Deposits in transit xx
Adjusted book balance xx Bank balance xx

Bank balance xx 3. Bank to book method

Add: Deposit in transit xx Bank balance xx
Total xx Add: Deposits in transit xx
Less: Outstanding checks xx Debit Memos xx
Adjusted bank balance xx Total xx
Add: Outstanding checks xx
BOOK reconciling items:
Credit Memos xx
 Credit Memo -collections or deposits made by Book balance xx
bank to the account of the company but not yet
recorded by the entity.
Examples:
Notes Receivable
Collection made by bank on behalf of the entity
Proceeds of bank loan credited to the account of the entity
Matured time deposits transferred by bank to the current account of the depositor

 Debit Memo -these are charges and deductions made by the bank to the account of the company but not yet
recorded by the entity.
Examples:
Bank service charge
NSF or No sufficient fund checks- other name is DAIF- drawn against insufficient fund/
Technically defective checks
Payment of loan

 Errors
BANK reconciling items:
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 Deposits in transit -deposits already recorded in the cash books in one period but were taken up by the bank
only in the next period/ not yet reflected on the bank statement
Example:
Collection already forwarded to the bank for deposit but too late to appear in the bank statement
Undeposited collection or those still in the hands of the depositor. In effect, these are cash on hand awaiting
delivery to the bank for deposit

 Outstanding checks – these are check written and released to payees and are already recorded in the cash book
but not yet presented for encashment to the bank.
Certified check – checks that the bank already certified as having sufficiency of funds and thus technically
are no longer outstanding checks.
Example:
Check drawn
Certified check

 Error
Rules for errors assuming the company is using the adjusted balance method of presenting bank reconciliation
EFFECT OF THE ERRORS TREATMENT
Understatement of cash receipts Add on the unadjusted cash in bank balance
Overstatement of cash receipts Deduct from the unadjusted cash in bank balance
Understatement of cash disbursement Deduct from the unadjusted cash in bank balance
Overstatement of cash disbursement Add on the unadjusted cash in bank balance
3kinds of Bank Deposit:
1. Demand deposit- current/checking/commercial account deposit. Usually non-interest bearing.
2. Saving deposit-
3. Time deposit- similar to saving deposit in the sense that it is interest bearing.
PROCEDURES ON GETTING ADJUSTED BOOK BALANCE:
1. The unadjusted book balance will be used is the ENDING BALANCE of it.
2. To determine the UNADJUSTED BOOK BALANCE, Cash receipts less cash disbursement.
3. ADD: ALL under credit memos, tumingin ka sa bank statement sa part ng deposits hanapin ang Cr Memos like
notes receivable, proceeds/loans, collections.
4. LESS: ALL under debit memos, tumingin ka sa bank statement sa part ng withdrawals hanapin ang dr memos like
service charge, nsf. Note: the errors depend on the circumstance it can be added or deducted.
5. Get the total from no. 1-4.
Note; pagdating sa adjusting entries ang eentryhan lang ay yung lahat ng under sa book na adjustments.

PROCEDURES ON GETTING ADJUSTED BANK BALANCE:

1. The unadjusted bank balance will be used is the ENDING BALANCE of it.
2. To determine the UNADJUSTED BANK BALANCE, Deposits less withdrawals.
3. ADD: ALL under deposit in transit, ikocompare mo yung record ng book ni company sa record ni bank—cash
receipts at deposit, yung hindi mo nakitang nairecord ni bank na deposit ni company yun yung deposit intransit.
4. LESS: ALL under outstanding checks, ikocompare mo yung cash disbursement sa book ni company at
withdrawals recorded ng bank. Note: the errors depend on the circumstance it can be added or deducted.
5. Get the total from no. 1-4.

CHAPTER 3: PROOF OF CASH

Proof of cash or 4-column bank reconciliation or 2-date bank reconciliation – is an expanded reconciliation that
includes proof of receipts and disbursement.
Formula for DEPOSIT IN TRANSIT: Formula for OUTSTANDING CHECKS:
Deposit in transit, beg xx Outstanding checks, beg xx
Add: Deposit made by the company in this month xx Add: Check issued by the company in this month xx
Total deposits to be acknowledge by the bank xx Total checks to be paid by the bank this month xx
Less: Deposit acknowledge by the bank in this month xx Less: Checks paid by the bank this month xx
Deposit in transit, end xx Outstanding checks, end xx
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FORMULA: Book Balance

Rule: ALL reconciling items last month will be automatically corrected/recorded this month
Adjusted Balance Beg. Balance Receipts Disbursement Ending Balance
Method
Cash in bank per xx xx xx xx
books
Cr Memo – last xx (xx)
month
Cr. Memo -this xx xx
month
Dr. Memo – last (xx) (xx)
month
Dr. Memo – this xx (xx)
month
Adjusted balance

CHAPTER 4: ACCOUNTS RECEIVABLE

Receivables- is a financial asset that represents a contractual right to receive cash or another financial asset from
another entity. It represents the amount collectible from customers and others, most frequently arising from sale of
merchandise, claims for money lent, or the performance of services.
Accounts Receivable- a.k.a customer’s accounts, trade debtors, and trade account receivable
 Arising from sale of good or services in the ordinary course of business and not supported by
promissory ntoes.
Notes Receivable- supported by formal promises to pay
Classification of receivables:
A. As to source:
1. Trade receivables- claims arising from sales of merchandise or services in the ordinary course of business.
 Includes accounts receivable and note receivable.

2. Non trade receivables- receivables that arise from sources other than from sales of goods or services in the
normal course of business.

B. As to SFP:
1. Current-
Trade receivables and non trade receivables—if expected to be realized within 12mos after
reporting period.
2. Non- current- non trade that are not reasonably expected to be realized in cash within 12mos.
Receivable measurement:
Receivables are recognized simultaneously with the recognition of revenue under PFRS 15. An entity shall recognize
revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration
to which the entity expects to be entitled in exchange for the good or services.
1. Under PFRS 9 financial instruments, financial assets are initially measured at fair value plus transaction cost.
2. Receivables are subsequent measured at amortized cost (net realizable value) using the effective interest rate
method.
Amortized cost- amount of receivable that is expected to be collected or estimate recoverable amount.
Accounts Receivable xx
Notes receivable Accrued interest on NR xx
Advances to officer and employees xx
Dividends receivable xx
Less: Allowance for doubtful accounts xx
Total Trade and Accounts Receivable xx

Example of Non Trade Receivables Treatment

Loss to officers, shareholders, directors and employee NCA if due more than 12mos from reporting date
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Advances to affiliates Long-term investment, unless collectible within one year
Advances to supplier for acquisition of merchandise CA
Accrued income receivables CA
Deposit to guarantee performance or payment or to CA
cover possible damages or losses
Claims receivable from common carriers for damaged or CA
lost of goods
Claim for tax refunds or rebates CA
Special deposit on contract bids NCA unless collectible within one year
Dr balance of creditors accounts that arise from CA if material, otherwise it may be netted against
overpayments or returns and allowance accounts payable with cr balance.

Short-term receivables:
Transaction price- initial measurement of short-term receivables.
Net realizable value- subsequent measurement of short-term receivables.
Face Amount xx
Less: Allowance for freight charge xx
Allowance for sales return xx
Allowance for sales discount xx
Allowance for doubtful account xx
Net realizable value xx

Trade Discount/ Volume Discount/ Quantity Discount

- Trade discount are deducted from the list price to arrive at the invoice price and never recognized in the
accounting record since the journal entry is based on the amount of sales invoice.
Cash Discount/ Settlement Discount
- Cash discount are reduction from invoice price an inducement for payment of an account within the discount
period.
Sales discount on POV of seller, purchase discount on POV of buyer.
1. Gross price method
2. Net price method
Freight Charges:
1. FOB- means “ free on board” or ‘freight on board”
2. FOB Destination- ownership of good will be transfer to the buyer upon receive of goods. Seller would shoulder
the freight.
3. FOB Shippin point- ownership of good will be transferred to buyer upon shipment. Buyer would shoulder the
freight.
4. Freight collect- charge on goods shipped is not yet paid by seller and common carrier shall collect the same
from buyer.
5. Freight prepaid- charge on the goods was already paid by the seller.
Accounting for bad debts:
1. Allowance method- requires recognition of a bad debts loss if the accounts are doubtful of collection.
- GAAP require the use allowance method because it conforms with the matching principle
Allowance for doubtful accounts is deduction from accounts receivable.
 If doubtful: Dr. Doubtful Accounts Cr. Allowance for Doubtful Accounts
 If the doubtful is uncollected or worthless: Dr. Allowance for Doubtful Accounts, Cr. Accounts
Receivable
 If the written off are unexpectedly recovered or collected: Dr. Account Receivable, Cr
Allowance for Doubtful Accounts then Dr. Cash, Cr. Account Receivable

2. Direct write off method- requires recognition of a bad debts loss only when the accounts proved to be
worthless or uncollectible.
 If doubtful: No entry
 If accounts proved worthless: Dr. Bad Debts, Cr. Accounts Receivable.
 If the written off are unexpectedly recovered or collected: Dr. Account Receivable, Cr Bad
Debts then Dr. Cash, Cr. Account Receivable
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Doubtful accounts in the income statement:

1. Distribution cost- If the granting of credit and collection of accounts are under the charge of the sales manager,
doubtful shall be considered as distribution cost. Also called selling expense
2. Administrative Cost- If the granting of credit and collection of accounts are under the charge of an officer than
sales manager, doubtful accounts shall be considered as administrative.
In the absence of any contrary statement, doubtful accounts shall be classified as administrative.

CHAPTER 5: ESTIMATION OF DOUBTFUL ACCOUNTS

Methods of estimating bad debt expense under allowance method:
1. Percentage of Sales (Income Statement approach): Bad debt expense estimated directly by multiplying to NET
sales account.
The following accounts are gathered from the ledger:

A/R 1,000,000
Sales 5,050,000
Sales Return 50,000
Allowance for doubtful accounts 20,000

Solution:
Sales 5,050,000 Entry:
Less:Sales Return 50,000 Doubtful accounts 50k
Net Sales 5,000,000
multiply by percentage 0.01 Allowance for doubtful accounts 50k
Allowance for doubtful accounts 50,000

2. Percentage of A/R (Balance Sheet Approach) -has an advantage of presenting the accounts receivable at
estimated net realizable value.
a. First, the required ending balance in the allowance for doubtful accounts is estimated the multiplying a
percentage times the ending outstanding receivables.
b. Then, bad debt expense is equal to the difference between the required ending balance and the existing
balance in the allowance account.
Illustration: The balance of A/R is P2M and the credit balance in the allowance for doubtful accounts is P10k. Doubtful
accounts are estimated at 3% of accounts receivable.
Required allowance (2M*3%) 60,000 Entry:
Less: Allowance balance b4 adjustments 10,000 Doubtful accounts 50k
Doubtful accounts expense 50,000 Allowance for doubtful accounts 50k

3. Aging the A/R (Balance Sheet Approach) – this is the same procedure in the percentage of receivables; the only
difference is the percentage use for each term in the aging schedule.
-This method has an advantage of presenting fairly the accounts receivable in the statement of financial
position at net realizable value. However, the objection is that it violates the matching process.
Illustration:
Required
Balance Experience rate Allowance
Not due 500,000 1% 5,000
1-30 days past due 300,000 2% 6,000
31-60 days past due 200,000 4% 8,000
61-90 days past due 100,000 7% 7,000
91-180 days past due 50,000 10% 5,000
181-365 days past due 30,000 30% 9,000
More than one year 20,000 50% 10,000
1,200,000 50,000
Thus, if the allowance for doubtful accounts has a credit balance of P10,000 before adjustment, the doubtful accounts
expense is determined as follows:
Entry:
Doubtful accounts 40k
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Required allowance 50,000
Less: Allowance balance b4 adjustments 10,000
Doubtful accounts expense 40,000
Past due- credit period beyond the maximum credit term

Chapter 6: Notes Receivable

Notes Receivable

 Claims supported by formal promises to pay usually in the form of notes.

 Represent only claims arising from sale of merchandise or service in the ordinary course of business.

*Notes Received from officers, employees, shareholders, and affiliates shall be designated separately.

Negotiable Promissory Note

 Is an unconditional promise in writing made by one person to another, signed by the maker, engaging to pay on
demand or at a fixed determinable future time a sum certain in money to order or to bearer.
 A written contract in which one person, knowns as the maker, promises to pay another person, known as the
payee, a definite sum of money.

*The note may be payable on demand or at a definite future date.

Dishonored Notes

 Promissory note matures and is not paid.

 Should be removed from the notes receivable account and transferred to accounts receivable (should include
the face amount, interest, and other charges).

Initial Measurement of Notes Receivable

 Notes Receivable should be measured initially at present value.

 The present value is the sum of all future cash flows discounted using prevailing market rate of interest for
similar notes.
 The prevailing market rate of interest is actually the effective interest.

*Short-term notes receivable should be measured at face amount.

*Cash flows relating to short-term notes receivable are not discounted because the effect of discounting is usually not
material.

Interest-Bearing Notes Receivable

 The initial measurement of long-term notes receivable will depend on whether the notes are interest-bearing or
noninterest bearing.
 Interest-bearing long-term notes are measured at face amount which is actually the present value upon
issuance.

Noninterest-Bearing Notes Receivable

 Is measured at present value which is the discounted value of the future cash flows using the effective interest
rate.
 A misnomer because all notes implicitly contain interest.
 The interest being included in the face amount rather than being stated as a separate rate.

Subsequent Measurement

 Subsequent to initial measurement, long-term notes receivable shall be measured at the amortized cost using
the effective interest method. (in accordance with PFRS 9, prgph. 5.2.2)

*Amortized cost is measured initially:

(a) Minus principal Payment

(b) Plus, or minus cumulative amortization of any difference between the initial carrying amount and the principal
maturity amount.

(c) Minus reduction for impairment or uncollectibility.

 For Long-term noninterest-bearing notes receivable, the amortized cost is the present value plus amortization of
the discount, or the face amount minus the unamortized unearned interest income.
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*Only long-term interest bearing and noninterest-bearing notes receivable will be discussed in the conjunction with the
present value concept.

Additional info:

 The principal payment is equal to annual collection minus interest income.

 The present value is equal to the preceding balance minus the annual principal payment.
 The unearned interest income is arrived at by deducting the interest income from the preceding balance or face
amount of note minus unearned interest income.

Chapter 7: Loan Receivable

Loan Receivable

 A financial asset arising from a loan granted by a bank or other financial institution to a borrower or client.

*May be short-term, but in most cases, the repayment periods cover several years.

Initial Measurement of Loan Receivable

 Loan receivable should be measure at fair value plus transaction costs that are directly attributable to the
acquisition of the financial asset.
 The fair value of the loan receivable at initial recognition is normally the transaction price , meaning, the amount
granted.
 Transaction costs that are directly attributable to the loan receivable include direct origination costs.
 Direct origination costs should be included in the initial measurement of the loan receivable
 Indirect origination cost should be treated as outright expenses.

Subsequent Measurement of Loan Receivable

 PFRS prgph. 4.1.2, if the business model in managing financial asset is to collect contractual cash flows on
specified dates and the contractual cash flows are solely payments of principal and interest, the financial asset
shall be measured at amortized cost.
 A loan receivable is measured at amortized cost using the effective interest method.

*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 recognized is higher than the principal amount, the amortization of the difference is deducted from
the carrying amount

Origination Fee

 Lending activities usually precede the actual disbursement of funds and generally include efforts to identify and
attract potential borrowers and to originate a loan.
 The fees charged by the bank against the borrower for the creation of the loan are known as origination fees.

Origination Fees include compensation for the following activities:

(a) Evaluating the borrower’s financial condition.

(b) Evaluating guarantees, collateral, and other security.
(c) Negotiating the terms of the loan.
(d) Preparing and processing the documents related to the loan
(e) Closing and proving the loan transaction.

Accounting for Origination Fees

 The origination fees received from the borrower are recognized as unearned interest income and amortized
over the term of the loan.
 If the origination fees are not chargeable against the borrower, the fees are known as direct origination cost.
 The direct origination costs are deferred and also amortized over the term of the loan.
 The direct origination costs are offset directly against any unearned origination fees received.
 If the origination fees received exceed the direct origination costs, the difference is unearned interest income
and the amortization will increase interest income.
 If the direct origination costs exceed the origination fees received, the difference is charge to “direct origination
costs” and the amortization will decrease interest income.

*The origination fees received and the direct origination costs are included in the measurement of the loan receivable.

Effective Interest Method

Interest Received = Principal times nominal rate

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Interest Income = Carrying amount times effective rate

Impairment of Loan

 PFRS 9 prgph 5.5.1, An entity shall recognize a loss allowance for expected credit losses on financial asset
measured at amortized cost,
 PFRS 9prgph 5.5.3, an entity shall measure the loss allowance for financial instrument at an amount equal to the
lifetime expected credit losses if the credit risk on that financial instrument has increased significantly since
initial recognition.
 Credit losses are the present value of all cash shortfalls.

*Expected Credit Losses are an estimate of credit losses over the life of the financial instrument.

Measurement of Impairment

When measuring expected credit losses, an entity should consider:

(a) The probability-weighted outcome

The estimate should reflect the possibility that a credit loss occurs and the possibility that no credit loss occurs.
(b) The time value of money. The expected credit losses should be discounted
(c) Reasonable and supportable information that is available without undue cost or effort.

*PFRS 9 does not prescribe particular method of measuring expected credit losses.

An entity may use various source of data both internal or entity-specific and external in measuring expected sales.

The amount of impairment loss can be measured as the difference between the carrying amount and the present value
of estimated future cash flows discounted at the original effective costs.

The carrying amount of the loan receivable shall be reduced either directly or through the use of an allowance account.

Meaning of Credit Risk

 Credit risk is the risk that one party to a financial instrument will cause a financial loss for the other party by
failing to discharge an obligation.
 The risk contemplated is the risk that the issuer will fail to perform a particular obligation.
 The risk does not necessarily relate to the credit worthiness of the issuer.
 If an entity issued a collateralized liability and noncollateralized liability that are otherwise identical, the credit
risk of the two will be different.
The credit risk of the collateralized liability is surely less that the credit risk of the noncollateralized liability. The
credit risk for a collateralized liability may be zero.

Computation for Impairment Loss

 The impairment loss is the difference between the carrying amount of the loan and the present value of the cash
flows.

*If the accrued interest receivable is credited directly, the collection of interest is unlikely.

*The recognition of interest income is charged against the allowance for loan impairment account.

Three-Stage Impairment approach

Stage 1: This stage covers debt instruments that have not declined significantly in credit equally since initial recognition
or that have low credit risk.

Under this is the 12-month Expected Credit. It is defined as the portion of the lifetime expected credit loss from default
events that are possible within 12 months after the reporting period.

Stage 2: This stage covers debt instruments that have declined significantly in credit equally since initial recognition but
do not have objective evidence of impairment.

Under this is the Lifetime Expected Credit loss. It is defined as the expected credit loss that results from all default
events over the expected life of the instrument.

There is rebuttable presumption that there is a significant increase in credit risk if the contractual payments are more
than 30 days past due.

Stage 3: This stage covers debt instruments that have objective evidence of impairment at the reporting date.

Under this, lifetime credit loss is recognized for trade receivables through aging, percentage of account receivable, and
percentage of sales.

CHAPTER 8: Receivable Financing - Pledge, Assignment and Factoring

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Receivable Financing – is the financial flexibility or capability of an entity to raise money out of its receivables.

 An entity may find itself in tight cash position because sales decreased and customers are not paying their
accounts on time.
 But the entity’s current accounts and notes payable must continue to be paid if its credit standing is not to
suffer.
 An entity would be in financial distress as collections of receivable are delayed cash payments for obligations
must be maintained.
 Under these circumstances, if the situation becomes very critical, the entity may be forced to look for cash by
financing its receivables.

FORMS OF RECEIVABLE FINANCING

Common forms of Receivable financing are:
a. Pledge of Accounts Receivable
b. Assignment of Accounts Receivable
c. Factoring of Accounts Receivable
d. Discounting of Notes Receivable
Pledge of Accounts Receivable – when loans are obtained from the bank or any lending institution, the accounts
receivable may be pledged as collateral security for the payment of the loan.

 Normally, the borrowing entity makes the collections of the pledged accounts but may be required to turn over
the collections to the bank in satisfaction for the loan.
 The loan is recorded y debiting CASH and DISCOUNT ON NOTES PAYABLE and crediting NOTES PAYABLE. The
subsequent payment of the loan is recorded by debiting NOTES PAYABLE and crediting CASH.
 With respect to the ledged account there is no entry necessary. It is sufficient that disclosure thereof is made in
a note to financial statement.
 If the loan is discounted, in the banking parlance this means that the interest for the term of the loan is
deducted in advance.

Assignment of Accounts Receivable – means that a borrower called the assignor transfers rights in some accounts
receivable to a lender called the assignee in consideration for a loan.

 Assignment is a more formal type of pledging of accounts receivable. Assignment is secured borrowing
evidenced by a financing agreement and a promissory note both of which the assignor signs.
 Pledging is general because all accounts receivable serve as collateral security for the loan.
 On the other hand, assignment is specific because specific accounts receivable serve as collateral security for the
loan.
 Assignment may be done either on notification or non-notification basis.
 Non-notification basis – means that customers are not informed that their accounts have been assigned.
 Notification basis – customers are notified to make their payments directly to the assignee.
 The assignee usually charges interest for the loan that it makes and requires a service or financing charge or
commission for the assignment agreement.
 In Assignment, the assignor retains ownership of the accounts assigned.

Factoring – is a sale of accounts receivable usually on a without recourse, notification basis.

 In a factoring arrangement, an entity sells accounts receivable to a bank or finance entity called a FACTOR.
 A gain or loss is recognized for the difference between the proceeds received and the net carrying amount of the
receivables factored.
 Factoring differs from an assignment in that an entity actually transfers ownership of the accounts receivable to
the factor.
 Because of the nature of the transaction, the customers whose accounts are factored are notified and required
to pay directly to the factor.
 The factor has then the responsibility of keeping the receivable records and collecting the accounts.
 Factoring may take the forms of the following:

1. Casual Factoring

2. Factoring as a continuing agreement

Casual Factoring – if an entity finds itself in a critical cash position, it may be forced to factor some or all of its accounts
receivable at a substantial discount to a bank or a finance entity to obtain the much needed cash.

Factoring as a Continuing Agreement – factoring may involve a continuing arrangement where a finance entity
purchases all of the accounts receivable of a certain entity.

 In this set-up, before a merchandise is shipped to a customer, the selling entity requests the factor’s credit
approval. If it is approved, the account is sold immediately to the factor after shipment of the goods. The factor
then assumes the credit function as well as the collection function.
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 Moreover, the factor may withhold a predetermined amount as a protection against customer returns and
allowances and other special adjustments. This amount withheld is known as the “factor’s holdback”.
 The factor’s holdback is actually a receivable from factor and classified as current asset.
 Final settlement of the factor’s holdback is made after the factored receivables have been fully collected.
- If the interest is computed on a weighted average time basis, the denominator is 365 days. In the absence of any
contrary statement, the simple interest is computed using 360 days as denominator.
- Recourse obligation is initially recorded as loss on factoring.

Credit Card – is a plastic card which enables the holder to obtain credit up to a predetermined limit from the issuer of
the card for the purchase of goods and services.

 The credit card has enabled retailers and other businesses to continue to sell goods and services where the
customers obtain possession of the goods immediately but do not have to pay for the goods for about one
month.
 Major credit cards in the Philippines are: Diners Club, American Express, VISA and MasterCard.

Chapter 9: Receivable Financing – Discontinuing of Note Receivable

 As a form of receivable financing, discontinuing specifically pertains to Notes Receivable.
 Maker and Payee – original parties in a promissory note.

Maker – the one liable

Payee – the one entitled to payment on the date of maturity.

 To discount the note, the payee must endorse it. Thus, legally the payee becomes an endorser and the bank
becomes an endorsee.

Endorsement – is the transfer of right to a negotiable instrument by simply signing at the back of the instrument.

Endorsement with recourse – means that the endorser shall pay the endorsee if the maker dishonors the note. In the
legal parlance, this is the secondary liability of the endorser. In the accounting parlance, this is the contingent liability of
the endorser.

Endorsement without recourse – means that the endorser avoids future liability even if the maker refuses to pay the
endorsee on the date of maturity.

 In the absence of any evidence to the contrary, endorsement is assumed to be with recourse.

Terms related to discontinuing of Note

1. NET PROCEEDS - refer to the discounted value of the note received by the endorser from the endorsee. NET
PROCEEDS = MATURITY VALUE - DISCOUNT
2. MATURITY VALUE - is the amount due on the note at the date of maturity. MATURITY VALUE = PRINCIPAL +
INTEREST
3. MATURITY DATE - the date on which the note should be paid.
4. PRINCIPAL - is the amount appearing on the face of the note. It is also known as the FACE VALUE.
5. INTEREST - is the amount of interest for the full term of the note. INTEREST = PRINCIPAL x RATE x TIME
6. INTEREST RATE - is the rate appearing on the face of the note.
7. TIME - is the period within which interest shall accrue. For discounting purposes, it is the period from date of note to
maturity date. It is the entire period or full term of the note.
8. DISCOUNT - is the amount of interest deducted by the bank in advance. DISCOUNT = MATURITY VALUE x DISCOUNT
RATE x DISCOUNT PERIOD
9. DISCOUNT RATE - is the rate used by the bank in computing the discount. Interest rate and discount rate are
different form each other. But if there is no discount rate given, the interest rate is safely assumed as the discount
rate.
10. DISCOUNT PERIOD - is the period of time from date of discounting to maturity date. It is the unexpired term of the
note. DISCOUNT PERIOD = TERM OF NOTES - THE EXPIRED PORTION UPTO THE DATE OF DISCOUNTING.

ACCOUNTING FOR NOTE RECEIVABLE DISCOUNTING

 The accounting for note receivable discounting depends on whether the discounting is with or without recourse.
 If the discounting is without recourse, the sale of the notes receivable, is absolute and therefore there is no
contingent liability.
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 If the discounting is with recourse, the transaction is accounted for as either of the following:
1. CONDITIONAL SALE of the note receivable recognizing a contingent liability.
 The notes receivable discounted account is deducted from the total notes receivable when preparing the
statement of financial position with disclosure of the contingent liability.
2. Secured borrowing
 If the discounting is treated as a secured borrowing, the note receivable is not derecognized but instead an
accounting liability is recorded at an amount equal to the face amount of the note receivable discounted.
 There is no gain or loss on discounting if the note receivable discounting is accounted for as secured
borrowing.

Conditional sale or secured borrowing

 It states in PFRS 9, paragraph 3.2.3, provides that an entity shall derecognize a financial asset when either
one of the following criteria is met:

1. The contractual rights to the cash flows of the financial asset have expired.

 Is usually easy to apply.

 It may expire, example, when a note receivable from a customer is fully collected.

2. The financial asset has been transferred and the transfer qualifies for derecognition based on the extent of transfer
of risks and reward of ownership.

 Often complex.
 It relies on the assessment of the extent of the transfer of risks and rewards of ownership.

 It states in PFRS 9, paragraph 3.2.6, provides the following guidelines for derecognition based on transfer of risks
and rewards:

1. If the entity has transferred substantially all risks and rewards, the financial asset shall be derecognized.

2. If the entity has retained substantially all risks and rewards, the financial asset shall not be derecognized.

3. If the entity has neither transferred nor retained substantially all risks and rewards, derecognition depends on
whether the entity has retained control of the asset.

a) If the entity has lost control of the asset, the financial asset is derecognized in its entirety.
b) If the entity has retained control over the asset, the financial asset is not derecognized.

EVALUATION

 The first and second criterion does not apply to notes receivable with recourse and discounting of note with
recourse, respectively.
 The discounting transaction is a combination of the guidelines in the second criterion as follows:
a. The entity has substantially transferred all “”rewards”.
b. The Entity has retained substantially all “risks”.
c. The entity has lost control of the notes receivable.

CONCLUSION

 Premises considered, it is believed that the discounting of note receivable with recourse is to be accounted for
as a conditional sale with recognition of a contingent liability.
 The main justification is that upon discounting or endorsement of the note receivable, whether with or without
recourse, the transferor or endorser has lost control over the note receivable.

Accordingly, the transferee has complete control over the note receivable because the transferee has the practical
ability to sell the asset to a third party without attaching any restrictions to the transfe