Chapter 6
Financial Assets
Learning Objectives
1. Define a financial asset and give examples. 2. Account for cash and cash equivalents.
3. Account for receivables.
4. Account for investments.
Chapter 6
Introduction
Financial instrument - is any contract that gives rise to both a financial asset of one entity and a
financial liability or equity instrument of another entity. (PPSAS 28.9)
Financial asset - is any asset that is:
a. Cash;
b. An equity instrument of another entity;
c. A contractual right to receive cash or another financial asset from another entity;
d. A contractual right to exchange financial instruments with another entity under conditions
that are potentially favorable;
or
e. A contract that will or may be settled in the entity's own equity instruments.
Financial liability - is any liability that is:
a. A contractual obligation to deliver cash or another financial asset to another entity;
b. A contractual obligation to exchange financial assets or financial liabilities with another entity
under conditions that are potentially unfavorable to the entity; or
c. A contract that will or may be settled in the entity's equity instruments.
own equity instruments.
Equity instrument - is any contract that evidences a residual interest in the assets of an entity
after deducting all of its liabilities.
The issuer of a financial instrument shall classify the instrument, or its component parts, on
initial recognition as a financial asset, a financial liability or an equity instrument in accordance
with the substance of the contractual arrangement and the definitions of a financial asset, a
financial liability and an equity instrument. (GAM for NGAS, Chapter 7, Sec. 23)
Example:
Bank deposit is a financial instrument. It is a contract that gives rise to both a financial asset
(i.e., Cash in bank) on the part of the depositor and a financial liability (i.e., Deposit liability) on
the part of the bank. The depositor has a contractual right to withdraw his cash while the bank
has a contractual obligation to deliver cash when the depositor withdraws.
Cash is the most basic financial instrument because it is the medium of exchange and the basis
of measurement of all financial statement elements.
Initial Recognition
A financial asset is recognized when an entity becomes a party to the contractual provisions of
the instrument. (PPSAS 29.16)
Initial Measurement
Financial assets are initially measured at fair value plus transaction costs, except for financial
assets at fair value through surplus or deficit whose transaction costs are expensed.
Transaction costs are incremental costs that are directly attributable to the acquisition, issue, or
disposal of a financial instrument. An incremental cost is one that would not have been incurred
if the entity had not acquired, issued or disposed the financial instrument. Transaction costs
include: (a) fees and commissions paid to agents, advisers, brokers and dealers; (b) levies by
regulatory agencies and securities exchanges; and (c) transfer taxes and duties.
Our succeeding discussions on financial assets are subdivided into the following:
a. Cash and cash equivalents
b. Receivables
c. Investments
d. Derivatives
Cash and Cash Equivalents
Cash - comprises cash on hand, cash in bank and cash treasury accounts.
Adjustments for Unreleased Commercial Checks
Unreleased checks are checks drawn but not yet given to the payees as of the end of the period.
Unreleased checks are reverted back to cash as follows:
Date Cash in Bank, Local Currency-Current XX
Accounts Payable (or other liability account) XX
Unreleased checks are not physically cancelled. At the start of the following year, the adjusting
entry above is reversed to recognize the availability of the checks for release. This procedure
does not apply to the "Cash-Modified Disbursement System (MDS)" account because there is no
actual cash with the Government Servicing Bank. Recall that any unused NCA is reverted back to
the National Government, and therefore, the balance of the "Cash-Modified Disbursement
System (MDS)" account is zeroed-out at the end of each period.
Accounting for Cancelled Checks
Checks are cancelled when they become stale, voided or spoiled. A check is considered stale if it
has been outstanding for over 6 months from its date. Replacement checks may be issued for
cancelled checks that were already released to payees, upon submission of the cancelled checks
to the Accounting Unit. Cancelled checks are reverted back to cash as follows:
The cancelled check pertains to:
Current year Prior period
Cash-Modified Disbursement System (MDS), Accumulated Surplus/ (Deficit). XX
Regular XX Accounts payable XX
Accounts payable XX To recognize the cancellation of
To recognize the cancellation of stale/voided/spoiled MDS checks in prior yr.
stale/voided/spoiled MDS checks
For prior period MDS checks, the "Accumulated Surplus/(Deficit)" account is debited. This is
because, again, the "Cash-Modified Disbursement System (MDS)" account is zeroed- out at the
end of each period.
For cancelled commercial checks, the "Cash in Bank-Local Currency, Current" account is debited
for both current year and prior period.
If a replacement check is issued, the replacement check is recorded in the regular manner, i.e.,
debit to accounts payable and credit to cash.
Petty Cash Fund
Petty Cash Fund (PCF) refers to the amount granted to duly designated Petty Cash Fund
Custodian for payment of authorized petty or miscellaneous expenses which cannot be
conveniently paid through checks or ADA.
(GAM for NGAS, Chapter 6, Sec. 2)
Guidelines:
a. The Head of Agency shall approve the amount of PCF to be established, which shall be
sufficient to defray recurring petty expenses for 1 month.
b. The PCF Custodian shall be properly bonded) whenever the established amount of PCF
exceeds #5,000.
(a). "Bonded" means an insurance shall be taken on the custodian. In the event that the
custodian misuses the funds, the entity can claim from the insurance company, and the
insurance company in turn will go after the custodian.
c. The PCF shall be maintained using the Imprest System. At all times, total cash on hand and
unreplenished expenses shall be equal to the PCF ledger balance.
d. The PCF shall be kept separately from other advances or collections and shall not be used to
pay for regular expenses, such as rentals, electricity, water, and the like.
e. PCF payments shall not exceed $15,000 for each transaction, except when otherwise
authorized by law or by the COA. Splitting of transactions to avoid exceeding the ceiling is
prohibited.
f. A canvass from at least 3 suppliers is required for purchases amounting to $1,000 and above,
except for purchases made while on official travel.
g. PCF disbursements shall be supported by properly accomplished and approved Petty Cash
Vouchers, invoices, ORs, or other evidence of disbursements.
h. Replenishment shall be made as soon as disbursements reach at least 75% or as needed.
i. At the end of the year, the PCF Custodian shall submit all unreplenished Petty Cash Vouchers
to the Accounting Unit for recording in the books of accounts.
j. The unused balance of the PCF shall not be closed at year-end. It shall be closed only upon the
termination, separation, retirement or dismissal of the PCF Custodian, who in turn shall refund
any balance to close his/her cash accountability.
Illustration:
After careful estimates of recurring monthly petty expenses, the Head of Entity A approves the
establishment of a $50,000 petty cash fund.
Date Petty Cash 50,000
Cash-Modified Disbursement System (MDS), Regular 50,000
To record the establishment of PCF
Just like the accounting by business entities, no journal entries are made as disbursements are
made out of the PCF. Journal entries will be made when the PCF is (a) replenished or (b)
adjusted at the end of the period for unreplenished expenses.
A cash count of the PCF reveals the following:
Coins and Currencies 12,500
Vouchers:
Office Supplies Expenses 10,000
Fuel, Oil and Lubricants 15,000
Postage and Courier Expenses 8,000
Other Maintenance and Operating Expenses 4,500 37,500
Total per count 50,000
Accountability 50,000
Shortage (Overage) –
Case 1: The PCF is replenished.
Date Office Supplies Expenses 10,000
Fuel, Oil and Lubricants 15,000
Postage and Courier Expenses 8,000
Other Maintenance and Operating Expenses 4,500
37,500
Cash-Modified Disbursement System (MDS), Regular
To record the replenishment of the PCF
Case 2: The PCF is not replenished.
Date Office Supplies Expenses 10,000
Fuel, Oil and Lubricants 15,000
Postage and Courier Expenses 8,000
Other Maintenance and Operating Expenses 4,500
37,500
Petty Cash
To adjust the PCF for unreplenished disbursements
Case 3: The PCF Custodian retires and the PCF is closed.
Date Cash-Collecting Officer 12,500
Petty Cash 12,500
To record the return of unused PCF upon retirement of the
Petty Cash Custodian
Accounting for Cash Shortage/Overage of Disbursing Officer The disbursing officer is liable for
any cash shortage while any cash overage that he cannot satisfactorily explain to the auditor is
forfeited in favor of the government.
Relevant provision of law:
"The failure of a public officer to have duly forthcoming any public funds or property with which
he is chargeable, upon demand by any duly authorized officer, shall be prima facie evidence that
he has put such missing funds or property to personal use." (Revised Penal Code. Art. 217)
❖ Cash shortage
Date Due from Officers and Employees XX
Advances for/to..(Appropriate account) XX
To recognize cash shortage of disbursing officer
Date Cash - Collecting Officers XX
Due from Officers and Employees XX
To recognize restitution of cash shortage
Date Cash-Treasury/Agency Deposit, Regular XX
Cash Collecting Officers XX
To recognize the remittance of restituted cash shortage to the
BTT
❖ Cash overage
Date Cash Collecting Officers XX
Miscellaneous Income XX
To recognize forfeiture of cash overage of the disbursing officer
Date Cash-Treasury/Agency Deposit, Regular XX
Cash - Collecting Officers XX
To recognize the remittance of forfeited cash overage to the BTr
Dishonored Checks
A dishonored check is a check that is not accepted when presented for payment, e.g., a check
returned by the bank because of lack of sufficient funds - 'bounced' check.
The drawer of the dishonored check is liable for the amount of the check and all penalties
resulting from the dishonor, without prejudice to his criminal liability for a 'bounced' check.
Guidelines:
a. When a check is dishonored, the Collecting Officer shall:
i. issue a Notice of Dishonored Checks to the drawer and any endorser; and
ii. cancel the related OR.
b. If the Collecting Officer fails to issue the notice, the
dishonored check becomes his personal liability. The drawer and any endorser not given the
notice will be relieved from any liability.
c. A check refused by the drawee bank when presented within 90 days from its date is a prima
facie evidence that the drawer has knowledge about the insufficiency of his funds, unless the
drawer pays the check in full or makes arrangement with the drawee bank for the full payment
of the check within 5 banking days after receiving the notice of the dishonor.
d. A dishonored check shall be settled by payment in cash or certified check. The dishonored
check shall not be returned to the payor unless he returns first the previous OR therefor.
Journal entries
Dishonored checks are recorded to the "Other receivables" account as follows:
➤ Collections remitted to BTr
Current year Prior period
Other receivables XX Other receivables XX
Cash-Treasury/Agency Accumulated Surplus/(Deficit) XX
Deposit, Regular XX To recognize the cancellation of prior year's
To recognize the cancellation of current year's deposited collections due to dishonored
deposited collections due to dishonored checks
checks
➤ Collections remitted to Authorized Government Depository
Current year Prior period
Other receivables XX Other receivables XX
Cash in Bank-Local Cash in Bank-Local
Currency, Current Account XX Currency, Current Account ΧΧ
Bank Reconciliation
A bank reconciliation statement is a report that is prepared for the purpose of bringing the
balances of cash (a) per records and (b) per bank statement into agreement.
A bank statement is a report issued by a bank which shows the credits and debits to the
depositor's account during a as well as the account's cumulative balance.
period, as well as the account’s cumulative balance.
Guidelines:
a. Bank reconciliations shall be prepared as internal control to ensure the correctness of cash
records and as deterrent to fraud.
b. The Chief Accountant or designated staff shall prepare separate bank reconciliations for each
bank account maintained by the entity within 10 days from receipt of the monthly bank
statement.
c. The Adjusted Balance Method shall be used. Under this method, the unadjusted book and
bank balances are brought to an adjusted balance that is reported on the Statement of Financial
Position.
d. Bank reconciliations shall be prepared in 4 copies to be submitted within 20 days from receipt
of bank statement to the following: COA Auditor, Head of Agency, Accounting Division, and
Bank, if necessary.
e. A Journal Entry Voucher (JEV) shall be prepared to record any reconciling items.
Cash Equivalents
Cash Equivalents - are short-term, highly liquid investments that are readily convertible to
known amounts of cash and which are subject to an insignificant risk of changes in value.
(PPSAS 2.8)
Only debt instruments acquired within 3 months before their scheduled maturity date can
qualify as cash equivalents.
Receivables
Receivables represent claims for cash or other assets from other entities.
Examples:
a. Accounts receivable - refers to amounts due from customers arising from regular trade and
business transactions.
b. Notes receivable - represents claims, usually with interest, for which a formal instrument of
credit is issued as evidence of debt, such as promissory notes.
c. Loans receivable - used in the BTr-NG books to recognize loans extended by the National
Government to Government Financial Institutions 'GFIs' or GOCCs, covered by loan agreements.
d. Other receivables, such as, interest receivable, due from employees/officers/ other NGAs,
lease receivables, dividends receivable, and the like. (GAM for NGAs, Vol. 3)
Receivables are initially measured at fair value plus transaction costs and subsequently
measured at amortized cost.
Investments
Categories of Financial Assets
For purposes of subsequent measurement, financial assets are classified as follows:
a. Financial asset at fair value through surplus or deficit - is one that
is either:
a. Held-for-trading, or
b. Designated as at fair value through surplus or deficit on initial recognition. Any
financial asset can be classified in this category if its fair value can be reliably
measured.
b. Held-to-maturity investments - are non-derivative financial assets with fixed or determinable
payments and fixed maturity that an entity has the positive intention and ability to hold until
maturity.
c. Loans and receivables - are non-derivative financial assets with fixed or determinable
payments and are not quoted in an active market.
d. Available-for-sale financial assets - are non-derivative financial assets that are designated as
available for sale or are not classifiable under the other categories
Summary of Measurements:
Type of Examples Initial Subsequent
Financial Asset Measurement Measurement
a. Financial asset at > Investments in Fair value Fair value;
fair value through quoted stocks or changes in fair
surplus or deficit bonds. value are
recognized in
surplus/deficit
b. Held-to-maturity > Investments Fair value plus Amortized cost
in bonds and transaction (using the
costs securities to
other debt securities effective interest
to be held until method)
maturity
c. Loans and > Accounts, Notes, Fair value plus Amortized cost (using
receivables Loans receivable transaction costs the effective interest
method)
d. Available-for-sale > Investments in Fair value plus Fair value; changes in
financial assets stocks or bonds not transaction costs fair value are
classified under (a) to recognized in equity
(c) above.
Investments in unquoted equity instruments whose fair value cannot be reliably measured are
measured at cost.
Illustration 1: Initial measurement
Entity A acquires an investment for #100,000. Transaction costs amount to 10,000.
Case 1: The investment is classified as Financial Asset Held for Trading.
Date Financial Assets Held for Trading 100,000
Other Financial Charges 10,000
Cash in Bank-Local Currency, Bangko Sentral ng
Pilipinas 110,000
Case 2: The investment is classified as Held-to-maturity investments.
Date Investments in Treasury Bills-Local 110,000
Cash in Bank-Local Currency, Bangko Sentral ng
Pilipinas 110,000
Case 3: The investment is classified as Available-for-sale assets.
Date Investments in Stocks (or Bonds) 110,000
Cash in Bank-Local Currency, Bangko Sentral ng
Pilipinas 110,000
Illustration 2: Subsequent measurement
Assume the investment in Illustration 1 is investment in stocks. The fair value at the end of the
period is 120,000.
Case 1: The investment is classified as Financial Asset Held for Trading.
Date Financial Assets Held for Trading 20,000
Gain from Changes in Fair Value of Financial
Instruments (120K - 100K) 20,000
Case 2: The investment is classified as Available-for-sale financial assets.
Date Investments in Stocks 10,000
Unrealized Gain/(Loss) from Changes in Fair Value of
Financial Assets (120K - 110K) 10,000
Interest income from debt instruments, other than those which are classified as financial asset
at fair value through surplus or deficit, is recognized using the effective interest method.
Therefore, if the investment in the illustration above in is in the form of bonds and is classified
as available-for-sale financial assets, the unrealized gain (loss) would have been computed as
the difference between the fair value at year-end and the carrying amount adjusted for the
amortization of bond discount or premium.
Only debt securities can be classified as held-to-maturity investments. Thus, this category is
omitted in Illustration 2 above. Held-to-maturity investments are subsequently measured at
amortized cost, and therefore, changes in fair value are ignored.
Illustration 3: Held-to-maturity investments
On January 1, 20x1, Entity A acquires 5-year, 5%, $1,000,000 face amount bonds for $957,876
and classifies them as held-to-maturity investments. The issuer pays annual interest every
December 31. The effective interest rate is 6%.
1/1/x Investment in Bonds 957,876
1 Cash in Bank-Local Currency, Bangko Sentral ng Pilipinas
To recognize investment in bonds 957,876
Amortization Table:
Date Interest received Interest income Amortization Present value
1/1/x1 957,876
12/31/x1 50,000 57,473 7,473 965,349
12/31/x2 50,000 57,921 7,921 973,270
12/31/x3 50,000 58,396 8,396 981,666
12/31/x4 50,000 58,900 8,900 990,566
12/31/x5 50,000 59,434 9,434 1,000,000
12/31/x1 Cash in Bank-Local Currency, Bangko Sentral ng Pilipinas 50,000
Investment in Bonds 7,473
Interest income 57,473
To recognize interest income
Subsequent journal entries follow the same pattern.
Variation: Available-for-sale financial assets
Assume the bonds are classified as available-for-sale financial assets and the fair value at
year-end is 1,010,000. The unrealized gain that is recognized in net assets would have been
#44,651 (P1,010,000 fair value #965,349 carrying amount adjusted for discount amortization).
The same amount of interest income would be recognized.
Impairment of Financial Assets
An entity shall assess at the end of each reporting period whether there is any objective
evidence that a financial asset or group of financial assets is impaired. If any such evidence
exists, the entity shall measure the amount of loss as the difference between the carrying
amount of the asset and the present value of estimated future cash flows discounted at the
financial asset's original effective interest rate. The carrying amount of the asset shall be
reduced either directly or through the use of an allowance account. The amount of the loss shall
be recognized in surplus or
deficit.
In case of Accounts Receivable, the Allowance for Impairment shall be provided in an amount
based on collectability of receivable balances and evaluation of such factors as aging of
accounts, collection experiences of the agency, expected loss experiences and identified
doubtful accounts. (GAM for NGAS, Chapter 7, Sec. 10)
Derecognition of Financial Assets
Derecognition is the process of removing a previously recognized asset, liability or equity from
the statement of financial position.
A financial asset is derecognized when:
a. The contractual rights to the cash flows from the financial asset expire or are waived; or
b. b. The financial asset is transferred and the transfer qualifies for derecognition, such as
when the risks and rewards of ownership and control of the financial asset are
relinquished.
The derecognition of financial assets is subject to the provisions of the State Audit Code of the
Philippines (P.D. No. 1445) on the writing off of receivables and other policies issued by the
COA. (GAM for NGAS, Chapter 7, Sec. 10)
Illustration: Impairment and Derecognition
Entity A, a government hospital, receives promissory notes from several patients amounting to
$1,000,000.
Date Notes Receivable 1,000,000
Hospital Fees 1,000,000
To recognize receipt of promissory notes
At year-end, it was estimated that 300,000 notes are impaired.
Date Impairment Loss-Loans and Receivables 300,000
Allowance for Impairment-Notes Receivable 300,000
To recognize impairment of notes receivable
A subsequent audit reveals that #100,000 of the impaired notes cannot be collected anymore.
The COA authorizes the derecognition (write-off) of these notes.
Date Allowance for Impairment-Notes Receivable 100,000
Notes Receivable 100,000
To recognize the derecognition of notes receivable
Derivatives
A derivative is a financial instrument or other contract that derives its value from the changes in
value of some other underlying asset or other instrument.
Characteristics of a derivative
a. Its value changes in response to the change in an underlying;
b. It requires no initial net investment (or only a very minimal initial net investment); and
c. It is settled at a future date.
An "underlying" is a specified price, rate, or other variable (e.g., interest rate, security or
commodity price, foreign exchange rate, index of prices or rates, etc.), including a scheduled
event (e.g., a payment under contract) that may or may not occur.
Purpose of a derivative
The very purpose of derivatives is risk management. Risk management is the process of
identifying the desired level of risk, identifying the actual level of risk and altering the latter to
equal the former. (GAM for NGAS, Chapter 7, Sec. 19)
Hedging
Hedging is a method of offsetting a potential financial loss or the structuring of a transaction to
reduce risk involving financial
instruments.
Hedge accounting recognizes the offsetting effects on surplus or deficit of changes in the fair
values of the hedging instrument and the hedged item.
Hedging Relationships
a. Fair value hedge - a hedge of the exposure to changes in fair value of a recognized asset or
liability or an unrecognized firm commitment, or an identified portion of such an asset, liability
or firm commitment, that is attributable to a particular risk and could affect surplus or deficit.
b. Cash flow hedge - a hedge of the exposure to variability in cash flows that (i) is attributable to
a particular risk associated with a recognized asset or liability (such as all or some future interest
payments on variable rate debt) or a highly probable forecast transaction and (ii) could affect
surplus or deficit.
c. Hedge of a net investment in a foreign operation.
Components of a Hedging Relationship
a. Hedging Instrument - a designated derivative or a designated non-derivative financial asset or
non-derivative financial liability whose fair value or cash flows are expected to offset changes in
the fair value or cash flows of designated hedged
item.
b. Hedged Item an asset, liability, firm commitment, highly probable forecast transaction or net
investment in a foreign operation that (a) exposes that entity to risk of changes in fair value or
future cash flows and (b) is designated as being hedged.