Advanced Financial Accounting and Reporting :)(:, CPA, CTT, CMA

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Table of Contents
Title I: Accounting for Special Business Organizations
Theories of Equity .................................................................................................... 1
Consolidation Theories .............................................................................................. 1
Partnership Formation ............................................................................................... 2
Valuation of the Contributions .................................................................................... 2
Procedural Layout ................................................................................................... 3
Other Notes on Partnership Formation ........................................................................... 3
Partnership Operations .............................................................................................. 4
Profit Distribution Arrangements ................................................................................. 4
Valid Profit Distribution Bases..................................................................................... 4
Procedural Layout ................................................................................................... 6
Other Notes on Partnership Operations .......................................................................... 6
Partnership Dissolution .............................................................................................. 7
Dissolution by Admission of a New Partner ...................................................................... 7
Dissolution by Retirement or Death of a Partner ............................................................... 8
Dissolution by Incorporation ....................................................................................... 8
Procedural Layout – Dissolution by Admission................................................................... 8
Procedural Layout – Dissolution by Retirement ................................................................. 9
Partnership Liquidation ........................................................................................... 10
General Liquidation Procedures: ................................................................................. 10
Lump-sum and Installment Liquidation ......................................................................... 11
Schedule of Safe Payments ....................................................................................... 12
Cash Priority Program ............................................................................................. 13
Corporate Liquidation ............................................................................................. 14
Statement of Affairs and Estate Equity ......................................................................... 14
Statement of Realization and Liquidation ...................................................................... 15
Notes on Corporate Liquidation .................................................................................. 15
Home Office, Branch, Agency Accounting ..................................................................... 16
Summary of Home Office-Branch Transactions ................................................................ 16
Some Considerations for Journal Entries ....................................................................... 17
Inter-branch Transactions......................................................................................... 17
Reconciliation of Home Office Books and Branch Books ...................................................... 17
Control Procedures of Home Office and Branch Accounting ................................................. 18
True Branch Income ............................................................................................... 18
Cross-charge Accounting .......................................................................................... 19
Combined Financial Statements ................................................................................. 19
Business Combinations (PFRS 3) ................................................................................. 20
The Concentration Test ........................................................................................... 20
Accounting for Business Combinations: ......................................................................... 20
Notes – Business Combinations ................................................................................... 21
Consolidated Balance Sheet – Date of Acquisition ............................................................. 29
Separate & Consolidated Financial Statements (PAS 27, PFRS 10) ........................................ 30
PAS 27 – Separate Financial Statements ........................................................................ 31
Consolidation Procedure (PFRS 10) .............................................................................. 31
Goodwill Allocation ................................................................................................ 31
Consolidated Income Statement ................................................................................. 32
Working Paper Eliminating Entries............................................................................... 32
Procedural Approach .............................................................................................. 33
Formulas ............................................................................................................. 33
Reconstructive Problems in Consolidation ...................................................................... 34
Consolidated Balance Sheet – Establishing Reciprocity ....................................................... 34
Notes for Separate and Consolidated Financial Statements ................................................. 34
Joint Arrangements (PFRS 11, PAS 28) ......................................................................... 40
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Joint Operations (PFRS 11) ....................................................................................... 40

General Accounting for Joint Operations ....................................................................... 40
Investments of Non-Monetary Assets in the Joint Arrangement ............................................. 41
Joint Operation as a Partnership or Unincorporated Venture (PFRS 11) ................................... 42
Joint Ventures (PFRS 11, PAS 28) ................................................................................ 43
Joint Arrangements for SMEs ..................................................................................... 44
Equity Method (PAS 28) ........................................................................................... 44
Intercompany Transactions ....................................................................................... 45
Step Acquisitions ................................................................................................... 45
Discontinuance of the Equity Method ........................................................................... 45
Foreign Exchange Transactions & Translation (PAS 21, PAS 29) ........................................... 46
Definition of Terms ................................................................................................ 46
FOREX Trading ...................................................................................................... 46
FOREX Transactions (PAS 21) ..................................................................................... 47
FOREX Translation (PAS 21, PAS 29) ............................................................................. 48
Functional Currency vs Presentation Currency (Steps 2 and 3) .............................................. 48
Hyperinflationary Economies PAS 29 – Constant Peso Approach ............................................ 49
Steps in Restatement and Translation .......................................................................... 50
Determining The Translation Reserve ........................................................................... 50
Hyperinflationary Economies – Current Cost Accounting Approach ......................................... 51
Derivatives & Hedge Accounting (PAS 39, PFRS 9) ........................................................... 52
Definition of Terms ................................................................................................ 53
Hedge Accounting .................................................................................................. 54
Forwards and Futures Contracts ................................................................................. 55
Interest Rate Swaps ................................................................................................ 56
Options Contracts .................................................................................................. 57
PAS 39 vs PFRS 9 ................................................................................................... 58
Hedge Effectiveness in PFRS 9 ................................................................................... 58
Other Notes on Hedging and Derivatives ....................................................................... 58
Not-for-profit Accounting ......................................................................................... 59
Special Considerations for NPOs ................................................................................. 59
Generic NGOs and Some Considerations ........................................................................ 60
Government Accounting ........................................................................................... 61
Budget Cycle ........................................................................................................ 61
Government Accounting Manual ................................................................................. 61
Basic Government Accounting and Budget Reporting Principles ............................................ 62
Financial Reporting System ....................................................................................... 62
Responsibility Center Code Structure/ Unified Account Code Structure ................................... 62
Revenues and Receipts ............................................................................................ 63
Disbursements ...................................................................................................... 63
Fund Release Documents .......................................................................................... 63
Common Journal Entries .......................................................................................... 64
PPSAS Summary .................................................................................................... 68
Title II: Special Transactions on Revenues
PFRS 15 Revenue Recognition .................................................................................... 69
Definition of Terms ................................................................................................ 69
Five-step Model for Revenue Recognition ...................................................................... 69
Step One: Identifying the Contract/s with the Customer .................................................... 70
Step Two: Identify the Performance Obligations in the Contract ........................................... 70
Step Three: Determining the Transaction Price ............................................................... 70
Step Four: Allocating the Transaction Price to the Performance Obligations ............................. 70
Step Five: Recognize Revenue ................................................................................... 71
Contract Costs and Modifications ................................................................................ 71
Financial Statement Presentation ............................................................................... 72
Other Revenue Recognition Concepts (PFRS 15) ............................................................. 72
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Sales with a Right of Return ...................................................................................... 72

Sales with Warranties ............................................................................................. 73
Consignment Sales (Principal-Agent Relationship) ............................................................ 73
Pacto de Retro Sales (Repurchase Agreements/Repos) ....................................................... 73
Bill and Hold Arrangement ........................................................................................ 73
Other Revenue Issues .............................................................................................. 74
Construction Contracts (PAS 11, PFRS 15) ..................................................................... 74
Profit Realization Methods: ....................................................................................... 75
Journal Entries ..................................................................................................... 76
Impact of PFRS 15 .................................................................................................. 76
Procedural Layout .................................................................................................. 77
Combination of Construction Contracts ......................................................................... 78
Unbundling for Construction Contracts ......................................................................... 79
Financing Arrangements - Upfront Fees for Construction Contracts under IFRS 15 ....................... 79
Financing Arrangements - Customer Pays in Arrears .......................................................... 80
Contract Modifications under IFRS 15 ........................................................................... 80
Construction Contracts with Variable Consideration .......................................................... 81
Tender Costs for Construction (Contract Acquisition Costs) ................................................. 83
Under the Old PAS 11 .............................................................................................. 84
PIC 2020 – 03 Percentage of Completion in advance of Billings ............................................. 84
Licenses & Franchise Contracts (PFRS 15, PAS 18) ........................................................... 85
Impact of PFRS 15 .................................................................................................. 85
When to Use US GAAP on Franchises? ........................................................................... 86
Formulas ............................................................................................................. 86
Revenue (PAS 18) ................................................................................................... 87
Installment Sales Method (US GAAP/PFRS for SMEs) .......................................................... 87
Insurance Contracts (PFRS 4/PFRS 17) .......................................................................... 88
Definition of Terms ................................................................................................ 88
Unbundling .......................................................................................................... 89
Liability Adequacy Test ........................................................................................... 89
Discretionary Participation Feature ............................................................................. 89
24th Method of Revenue Recognition for Insurance Contracts ............................................... 90
Service Concession Arrangements (IFRIC 12) .................................................................. 90
Consideration Given by the Grantor (Government) ........................................................... 90
Title III: Cost Accounting
Cost Accounting ..................................................................................................... 91
Cost Accumulation Methods ...................................................................................... 91
Job-order Costing ................................................................................................... 91
Scraps, Spoilages and Reworks ................................................................................... 92
Other Considerations .............................................................................................. 92
Service Cost Allocation ............................................................................................ 93
Service Cost Allocation - Illustration ............................................................................ 93
Process Costing ...................................................................................................... 94
Considerations for Process Costing: ............................................................................. 95
Increases in Units and Losses ..................................................................................... 96
Absorption of Losses ............................................................................................... 97
Quick Tips ........................................................................................................... 97
Joint and By-product Costing ..................................................................................... 98
Cost Allocation Methods for Joint Products .................................................................... 98
Cost Allocation for By-products .................................................................................. 98
Procedural Layouts:................................................................................................ 99
Journal Entries for By-product Costing........................................................................ 100
Just-in-time Management and Backflush Costing ............................................................ 100
Procedural Layout ................................................................................................ 101
Activity-based Costing ............................................................................................ 101
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Overhead Allocation ............................................................................................. 101

Procedural Layout ................................................................................................ 102
Appendix: Other Journal Entries in Cost Accounting ....................................................... 102
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Title I: Accounting for Special

Business Organizations
Theories of Equity
The various theories of equity set the tone for most topics under AFAR. These tackle issues concerning
as to how to properly attribute resources to owners; in this, assets to which aspects of equity.
Proprietary Entity Theory Enterprise Residual Equity Fund/Fiduciary
Theory Theory Theory Theory
Description The business is The business is A business is a The business is Neither the
an agent or alter separate and social consisted of business nor its
ego of its distinct from its institution only the estate owners are
investors investors operated for the or corpus of emphasized. A
benefit of assets after fund is its own
various social debts are paid juridical person
groups
Accounting The Owners of The Business The Economic The Estate The Fund (Not a
Emphasis the group Value-added business)
Emphasized Balance Sheet Income Value-added or Statement of Statement of
Financial Statement Tripple Bottom Affairs (Changes Activities
Statement Line in Equity) (**Cashflows)
Accounting Assets Assets Market Value Assets Assets
Equation – = of Net Assets – –
Liabilities Liabilities – Liabilities Liabilities
= + Cost of Capital – =
Equity Equity = Pref. Equity Funds
Economic =
Value-added Residual Equity
Business NCINAS is NCINAS is Corporate Corporate NPOs, Gov’t
Manifestations ignored in CFS accounted Valuation Liquidation Acctg, Pensions
Consolidation Theories
Consolidation Theories deal with how the financial statements should best provide a faithfully-
represented attribution of control. There are 3 main theories to consider: (in grey are those in practice)
Manifestations Proprietary Theory Parent Theory Entity Theory
Owners keep title in income Owners keep equity
In Partnerships and Joint
& net assets Not Applicable interests in the entity and
Operations:
(Under the parent theory, shares in income
Applies Equity Method of the investor/acquirer does Dividends are considered
In Joint Ventures and Accounting and does one-line not own, but controls, the Returns of Capital
Investments in Associates consolidation of net net assets of the acquiree.)
investments.
The Consolidated FS is The Consolidated FS is The Consolidated FS is
In Business Combinations generated for the Acquirer generated for the acquirer generated for the
only and acquiree Consolidated Entity
NCINAS is ignored or not NCINAS is a Liability at Book NCINAS is part of Equity at
NCINAS on acquisition
recorded on consolidation Value Fair Value initially
Investment in Subsidiary is at Investment in Subsidiary is at Investment in Subsidiary is at
Initial Measurement -
FVNA (Net Asset Purchase) FVNA (Net Asset Purchase) Consideration Given
Separate Books
(Stock Acquisition)
Subsequent Measurement – Cost Model or Equity Model Cost Model or Equity Model Cost Model or Equity Model
Separate Books
Only Controlling Interest Net Only Controlling Interest Net Subsidiary NI is allocated to
Consolidated Net Income
Income Income CI and NCI
Eliminate pro-rata in Eliminate downstream 100%; Eliminate 100% Unrealized
upstream and downstream Sale of PPE and Long-term gains and losses in
Elimination Entries
entries debt require special determining CNI.
treatment
Not Allowed, except for
Pushdown Accounting Allowed Allowed
Foreign Subsidiaries IAS 21
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Partnership Formation
Partnership – a contract of two or more persons who bind themselves to contribute money, property, or
industry to a common fund with the intention of dividing profits among themselves
• It is worthy to recall that the partners are separate entities from the partnership that they form.
There are transactions that apply to the partners that do not concern the partnership.
• The pooled fund for which the partnership derives its substance is subject to stipulations of
valuation among the partners
o The partners may agree as to the value of their contributions; be it through the actual
investment or withdrawal of contributions or, merely stipulating that such contributions
are worth what they are agreed (Land may be agreed to be given a value of P325,000
instead of a value of P300,000, despite having the latter be the actual current value)
• Similarly, the capital interest in the fund may be set into agreement among the partners
• Also, the interest in the profits and losses may be stipulated by the partners
o In the absence of any agreements as to the profit ratio, the partners must use the
Relative Capital Interests in the partnership.
o In the absence of any agreements as to the loss ratio, the partners may follow the profit-
sharing ratio, and if there is still no profit-sharing ratio, the partners must use their
relative capital interests
Formation through Business Combination
The formation of partnership through business combination is allowed, provided it meets the
requirements of IFRS 3 (Concentration Test).
Valuation of the Contributions
• Cash – Face Value; Non-cash Assets – Agreed Value, Fair Market Value, Book Value, in that order
• Liability Assumed by the Partnership – at Present Value/Fair Value
• Labor – Memorandum Entry
• TCC – Total Contributed Capital, TAC – Total Agreed Capital
• If the partners come from sole proprietorships, their separate books are updated and closed.
**These capital contributions are adjusted depending on the agreed capital ratios or capital balances.
This causes differences in the amount contributed and the amount agreed-upon by the partners.
***If a partner invests property, and then later resells the same, the property’s selling price is actually
the Fair Value. (Not unless an agreed value is imposed.)
• Net Investment Method – The partnership will simply recognize whatever the partners invest in
it as their respective capital balance. In this method, if the contributed capital does not match
the agreed capital, the partner simply invests or draws out contributions in order to match the
agreed capital.
𝑶𝒗𝒆𝒓𝒂𝒍 𝑷𝒂𝒓𝒕𝒏𝒆𝒓𝒔𝒉𝒊𝒑: 𝑻𝑪𝑪 = 𝑻𝑨𝑪; 𝑰𝒏𝒅𝒊𝒗𝒊𝒅𝒖𝒂𝒍 𝑷𝒂𝒓𝒕𝒏𝒆𝒓𝒔: 𝑻𝑪𝑪 = 𝑻𝑨𝑪
• Bonus Method – The partners agree that whatever the contributions are, shall be the total capital
of the partnership. However, the partners may disagree as to the capital contribution ratio. This
means that the funds are pooled first, and then redistributed among the partners.
𝑶𝒗𝒆𝒓𝒂𝒍 𝑷𝒂𝒓𝒕𝒏𝒆𝒓𝒔𝒉𝒊𝒑: 𝑻𝑪𝑪 = 𝑻𝑨𝑪; 𝑰𝒏𝒅𝒊𝒗𝒊𝒅𝒖𝒂𝒍 𝑷𝒂𝒓𝒕𝒏𝒆𝒓𝒔: 𝑻𝑪𝑪 ≠ 𝑻𝑨𝑪
• Revaluation Method – The partners agree to base the partnership’s total capital on the capital
contributions and capital ratio of one of the partners. This means that the partnership will either
increase or decrease in value, based on an identifiable asset, and that these changes in value
will be shared by the other partners. The partners may take a Revaluation Up (Highest Capital
Basis) or Revaluation Down (Lowest Capital Basis)
𝑶𝒗𝒆𝒓𝒂𝒍 𝑷𝒂𝒓𝒕𝒏𝒆𝒓𝒔𝒉𝒊𝒑: 𝑻𝑪𝑪 ≠ 𝑻𝑨𝑪; 𝑰𝒏𝒅𝒊𝒗𝒊𝒅𝒖𝒂𝒍 𝑷𝒂𝒓𝒕𝒏𝒆𝒓𝒔: 𝑻𝑪𝑪 ≠ 𝑻𝑨𝑪
• If the problem is silent as to which method is used, take the Net Investment Method
• If the problem is silent whether the revaluation is revalued up or down, take a Revaluation Up
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Procedural Layout
Partner A Partner B Partner C Total
Cash XX XX XX XX
Non-Cash Assets XX XX XX XX
Liabilities Assumed by the Partnership (XX) (XX) (XX) (XX)
Contributed Capital XX XX XX XX
Agreed Capital (XX) (XX) (XX) (XX)
Revaluation XX XX XX XX
Bonus to and from Partners XX (XX) (XX) -
Capital Balances XX XX XX XX

Partner’s Capital Contribution XX Total Contributed Capital XX

Divided by: Partner’s Capital Ratio X% Multiply by: Partner’s Capital X%
Ratio
Implied Partnership Capital/Agreed Capital XX Partner’s Agreed Capital Balance XX
Total Contributed Capital (XX) Partner’s Contributed Capital (XX)
Revaluation Up (Down) XX Bonus from (to) Other Partners XX
Other Notes on Partnership Formation
• PPE, after being closed in the Sole Proprietorship’s books, should be invested into the partnership at
Fair Value, as if a newly purchased asset
• If there is no mention of the partnership assuming an attached liability, the liability is not recorded.
• A revaluation is done in order to approximate a firm’s overall fair value; hence, any under or
overvaluation in a firm’s asset/s will result in using the revaluation method
• The basis for revaluation will always follow a certain order of priority. If the Agreed Capital Balance is
stipulated by the partners, it prevails. Otherwise, one of the partners’ capital investments have to be
the basis for the agreed capital
• Take the partner whose capital will yield the largest total agreed capital unless the contrary is
stated. This is because any partnership with a large secret reserve of equity can increase the
debt leverage of all partners.
• If a problem refers to one of the partner’s capital balances as the required, under the revaluation
model, the other partner’s capital balance will be the basis for the revaluation; given that there are
only two of them. If there are three or more of them, take the partner that yields the largest capital
• If the problem does not specify which method to use in allocating the capital balances, the Net
Investment Method is used
• Always remember that a Bonus is simply a transfer of capital. Its net effect to the total capital will not
change, but the individual balances will
• The Profit or Loss Ratio is used to represent movements of capital, in this case, income or loss,
revaluations, and even transfers of capital
• The Capital Ratio is used to represent stakes over the partnership, as a setting for a partner’s capital
• Cash Settlement between partners – worded this way, this actually refers to the amount of capital
transfer between partners, in other words, the bonus to and from partners
o Settlement through Bonus reallocation – The bonus method of reallocating capital will reveal
which partner takes the larger portion of capital by agreement. Inevitably, other partners may
have contributed too much property prior to allocation. To settle accounts, the partner who
receives an increase in capital via bonus must pay their co-partner that same amount in cash.
• If a partner assumes a mortgage for another and decides that they should be credited for that amount,
the mortgage is assumed by the partnership first, then paid-off by the partner, increasing their capital.
• Partnership Formation through Business Combination – Apply IFRS 3, record Goodwill at proportional
method only; Each partner is entitled to their own share of goodwill to the extent of interest in the
newly formed partnership.
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Partnership Operations
Partnership operations are much the same with any other form of business organization. Of particular
interest is the allocation of profits and losses among the partners.
Profit Distribution Arrangements
Capitalist Partner Industrial Partner
On Profit Division: Any stipulation in the partnership Any stipulation in the partnership
contract contract
In the Absence of a Profit- Sharing will be based on the Sharing will be based on whatever
sharing Agreement capital contribution, share is just and equitable. If the
proportionately partners cannot decide, the
courts will determine this value;
In principle, this is equal to the
capitalist’s interest with the
smallest share in profits.
On Loss Division: Any stipulation in the partnership Any stipulation in the partnership
contract contract, but generally do not
share in losses
In the Absence of a Loss- The Profit-sharing Ratio will be The Industrial Partner shall not
sharing Agreement used, if none exist, the capital Share in Losses
contribution will be used
For Capitalist-Industrialist Partners, they will share entirely in profits and losses in these two separate
capacities. This means that the partner has a share to the extent as a capitalist, and another as an
industrialist. In a template, it would be as if the partner in multiple capacities were two different
persons. The headings of the template would be: X, Capitalist Share | X, Industrialist Share| Y,
Capital | Z, Capital
Valid Profit Distribution Bases
• Equally; On Arbitrary Ratio; or Capital Ratio (in order of priority, top to bottom)
o Original Capital Balance
o Beginning of the Period Capital Balance
o End of the Period Capital Balance
o Average Capital for the Period
Beginning Capital+Ending Capital
▪ Simple Average Capital Balance
2
▪ Weighted Average Capital Balance
Date Investment (Drawing) Peso-weight Weighted Average
January 1 XX 12/12 XX
February 28 XX 10/12 XX
September 1 (XX) 4/12 (XX)
December 1 (XX) 1/12 (XX)
December 31 XX 0/12 XX
Balance XX XX
• Interest – Returns on capital contributed
• Enforced entirely even in the case of losses, unless there is a stipulation to the contrary
(This is always given priority, since capital is always in use in business even in the case of losses.)
• Pro-rated based on the number of months funds are invested and withdrawn
• Annual Weighted Average Capital vs Weighted Average Capital
o In the schedule for WAC computation, the unannualized version would be based on
number of months that the partnership began operating (for instance, the start of
operations is April, the peso-weight would be based on 10 instead of 12)
o In the schedule for WAC Computation, the WAC the annualized version would still apply
the entire year for allocating interest.
Operations for March 1 to December 31 (10 Months); The interest rate is 10%, Solve for:
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Annual WAC Conversion Factor Adjusted WAC

12/10 →
10%  10/12 12%
Assume a partner’s capital movements, operations began on March 1. The Fiscal Y/E is December 31:
Annual WAC WAC
Date Amount Factor Capital Amount Factor Capital
3/1/20X1 75,000 10/12 62,500 75,000 10/10 75,000
9/1/20X1 (30,000) 4/12 (10,000) (30,000) 4/10 (12,000)
12/1/20X1 (12,000) 1/12 (1,000) (12,000) 1/10 (1,200)
12/31/20X1 5,000 0/12 - 5,000 0/10 -
Total Annual WAC 51,500 WAC 61,800
Interest Rate 10% 10%
Annual Interest 5,150 Adjusted 6,180
Interest
Adjusted Interest 6,180 Annual Interest 5,150
***The Annual Interest is used for Capital Computation. The reason why the annual capital is taken
is because the capital was not productive for the entire year. The returns should only be in
proportion as to when the capital is in actual use, regardless of profit or loss. Thus, if operations
were to temporarily cease, the capital is still deemed to be based on an annual basis in order to
account for the unproductive use of capital during the year.
• Salaries – compensation to the partners for labor
o Fixed, and enforced, unless there is a stipulation to the contrary
o Generally, Salaries are allocated even in the case of a loss. This is because the efforts
of each partner are not assumed to be lacking and are in good faith.
o Except if a stipulation to the contrary is provided. These may be limited only to the
extent of earnings only if expressed. If the earnings cannot cover salaries, the salaries
are prorated on the total salaries each partner is entitled to.
• Guarantees/ Minimum Shares – Promises by the partnership to compensate partners upon the
fulfillment of any contractual condition, enforced even with losses, unless there are stipulations
to the contrary. These are the amounts ensured to the partners as stipulated. It may or may not
be a sum of the remainders and other allowances.
o In the case of Guarantees and Minimum Shares, do not be limited to accommodating
the balance strictly. Take the choice that satisfies all conditions (the income share
may exceed the guarantee. This is usually the case when a regularly sharing partner
receives a share of income; in case of a share of a loss, then the guarantee should
be prioritized.)
o Guarantees and Minimum Shares will sometimes require the absorption of losses in terms
of the P/L ratio in order to make a partner’s share comply with the profit distribution
scheme; (The guarantee is the minimum ending capital balance.)
• Bonuses – Incentives provided to the managing partner for managerial expertise, based on the
partnership’s performance/net income. No Bonuses are given if the basis for the bonus is
negative (Basis being, Net Income before or after Other Allowances)
Case 1 Case 2 Case 3 Case 4
NI before All NI after Bonus, before NI before Bonus, after NI after All Allowances
Allowances other Allowances other allowances
B%
B% (NI − OA) ∗ B% = (NI − OA) ∗
NI ∗ B% = Bonus NI ∗ = Bonus 1 + B%
1 + B% Bonus
= Bonus
Not an Expense Not an Expense An Expense An Expense
**NI – Net Income, OA – Other Allowances
o Remainders – Based on any arbitrary Ratio
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Procedural Layout
Partner Partner Partner Total Net Income
A% B% C% Remaining
Capital Balance AA BB CC ABC DD
Interest II II - II DD-II
Salaries SS SS SS SS DD-II-SS
Bonus NN - NN DD-II-SS-NN
Total Share in Net Income YY YY YY YY -
Beginning Capital Balances AA BB CC ABC
Additional Investments AA BB CC ABC
Temporary Drawings (AA) (BB) (CC) (ABC)
Permanent Drawings (AA) (BB) (CC) (ABC)
Ending Capital Balance AA BB CC ABC
Other Notes on Partnership Operations
• In the absence of distribution bases, the weighted average method is used to compute for interest
• If average capital balance is computed at the beginning of the month, regardless of any
subsequent changes during that month, the peso-weight of the investment or drawing is 1-month
less. (Ignore the 15-day = 1 month ended rule.) e.g., the partners’ capital transactions during
the year are as follows:
X’s Transactions Y’s Transactions
Date
Dr Cr WAC Amt. Dr Cr WAC Amt.
1/1/20X1 P500,000 12/12 P500,000 P650,000 12/12 P500,000
4/1/20X1 85,000 8/12 (56,667)
4/15/20X1 1,000 8/12 (667) 1,500 8/12 (1,000)
4/16/20X1 15,000 8/12 10,000 45,000 8/12 30,000
4/30/20X1 52,000 8/12 41,333 13,000 8/12 8,667
12/1/20X1 4,000 0/12 - 3,000 0/12 -
12/31/20X1 123,000 0/12 - 123,000 0/12 -
Total 494,000 537,667
• Salary is only a method for distributing income among partners. If a problem treats salaries
as a part of operating expense, the salaries are not allocated into the partner’s balances.
o Allocation of Net Income – worded this way, the net income is allocated, ignoring the
salaries first, and then adding it to the balance after the remainder is distributed. The
result is not the actual capital balance, instead it is the consequence of distributing
income earned
• If income is worded as allocated to the extent available, the profit has to honor the
availability of income over the general profit-sharing agreement.
o For instance, the salaries of both X and Y are greater than the income for the period.
Instead of allocating the income per agreement, and allocating deficiencies
proportionately as usual, income is distributed on the proportion of available salaries.
o If the income can accommodate the Interest first but not the Salaries, the salaries are
allocated based on proportion, and the Interest on the basis of their agreement.
o If the income cannot accommodate either, the interest is enforced even at a loss, while
the salaries may be enforced proportionately on what each partner receives instead of
the usual full enforcement.
• Temporary withdrawals (Drawings done on a regular basis, or if so expressed) will not be used
for computing Average Capital. Only Permanent Drawings are used.
• Temporary Withdrawals are only deducted at year-end, while Permanent Withdrawals are
deducted at the time that it is done.
• For accounting errors, any prior period, non-counterbalancing and counterbalancing errors
apply the correction effect to the new partner’s capital balance and share in income.
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Partnership Dissolution
Dissolution – the change in the relation of the partners caused by any partner ceasing to be associated
in the carrying on as distinguished from the winding-up of business.
Dissolution by Admission of a New Partner
• A new contract is formed as among the new and old partners
• Profit or Loss is closed to the capital accounts of the old partners
• Errors are identified and corrected
• Assets and Liabilities are Revalued at Fair Value (Exit Value from the Old Partnership)
• Books are closed, and Revalued Net Assets are invested into the new partnership
• Loans to and from partners are ignored in Dissolution by Admission
Admission by Purchase of Interest – A simple transfer of capital from the old partners to the new
partners. Any gains or losses from the sale of the interest is not recorded in the partnership books since
the partners dispose of their interest in their personal capacities, as if interest were personal property.
Old Partners will allocate the sold stake on the partnership based on their Old Profit or Loss Ratios.
Old Capital XX
New Capital XX
Admission by Investment – A new partner is admitted by investing assets into the partnership. The value
of the partnership is first determined by asset revaluation, and then the partnership capital is reallocated
to match the new capital ratios. (Bonus and Revaluation may or may not be used simultaneously)
• The basis for revaluation will always be the Agreed Capital vs Contributed Capital of the Partnership
• The basis for the bonus will always be the Agreed Capital vs Contributed Capital of the New Partner
• In order of priority, this information is used: Agreed Capital, Revaluation Balance, Implied Capital
• The Implied Capital is based on the investment a new partner places into the partnership, since this
should theoretically approximate the Partnership’s Fair Value.
• If a specific Asset is determined to be under or overvalued, then this shall be the difference between
the Total Agreed Capital and Total Contributed Capital.
• If no Asset is identified as over or undervalued, but the partnership insists on using the Revaluation
Method, then the Debit Balance of the Revaluation will be recognized as Goodwill (No longer allowed
under PFRS 3)
o Goodwill may only be recognized if two partnerships merge or consolidate into one, or if
two sole proprietors merge or consolidate their businesses into one. The business must first
qualify with the Concentration Test of PFRS 3 (See Business Combinations). Goodwill is
allowed to be allocated on a proportionate basis (full basis is not allowed.)
**Conceptually, under both Bonus and Revaluation Model, the Assets structure of the firm changes.
However, it is the issue of when that increase in assets is recorded. Take note, that ALL the Methods of
Accounting for Partnership Dissolution can be combined because these are merely indicators of value.
Net Assets XX
Old Capital XX
New Capital XX
Combination of Purchase of Interest and Investment – the Revaluation is performed first, if any, and
the same rules apply. However, the Partner’s Contributed Capital through Investment, may not be the
same with the Agreed Capital after Revaluation, hence a Bonus is required to set the balances according
to the Capital Distribution Agreement.
• A Newly Admitted Partner’s Capital is the same as the price they offered under Revaluation
Model, when there are no bonuses applied to their contribution, because technically, a partner
‘purchased’ the interest. It is a simulation of Purchase of Interest, only with the Fair Value being
distributed instead of the Book Value
The Indifference Point between Goodwill/Revaluation and Bonus Method – is done by writing-off
goodwill in Goodwill method and determining the adjusted capital balance after; the same is compared
with the Bonus Method Capital. Under Revaluation Model, allocate the secret reserves to the old partners
first, then determine the bonus to be given to the incoming partner.
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Dissolution by Retirement or Death of a Partner

A retiring Partner or their Estate may sell the stake at the partnership to:
Outsiders Other Partners The Partnership
No changes in capital; only a Merely a transfer of capital A revaluation is required.
change in name/attribution. among partners.
Retiree, Capital XX Retiree, Capital XX
Assignee, Capital XX Partner, Capital XX
In all cases, the financial statement close process is the same:
• Profits and Losses are closed • Assets and Liabilities are • Settlement of Debt and
• Error Corrections are done Revalued Capital Interest of the
• Debt Interest may be Retiring Partner
accrued from the payable to • Close Partnership Books
the retiring partner/estate
o Transfer to the Partnership
▪ The partnership may return the retiree’s interest in cash or in kind, or recognize a payable
to the retiring partner or their estate, in case the partnership cannot pay immediately
▪ The retiring partner may receive an amount larger or smaller than their capital interest;
instead of merely capital changing, net assets will change instead. (Asset Revaluation is done
in this arrangement)
Retiree, Capital XX
Other Partner, Capital XX
Net Assets XX
**Same as the procedure in Admission of Partners, the partnership is revalued first, and then the assets
are ‘sold’ to the partner, and finally, capital balances are reallocated. The partnership may offer a
price at equal, higher, or lower than the capital interest of the retiree.
𝐑𝐞𝐭𝐢𝐫𝐞𝐦𝐞𝐧𝐭 𝐏𝐫𝐢𝐜𝐞 𝐨𝐫 𝐒𝐞𝐭𝐭𝐥𝐞𝐦𝐞𝐧𝐭 𝐏𝐫𝐢𝐜𝐞 > 𝐑𝐞𝐭𝐢𝐫𝐞𝐞′ 𝐬 𝐈𝐧𝐭𝐞𝐫𝐞𝐬𝐭 → 𝐁𝐨𝐧𝐮𝐬 𝐭𝐨 𝐑𝐞𝐭𝐢𝐫𝐞𝐞
𝐑𝐞𝐭𝐢𝐫𝐞𝐦𝐞𝐧𝐭 𝐏𝐫𝐢𝐜𝐞 𝐨𝐫 𝐒𝐞𝐭𝐭𝐥𝐞𝐦𝐞𝐧𝐭 𝐏𝐫𝐢𝐜𝐞 < 𝐑𝐞𝐭𝐢𝐫𝐞𝐞′ 𝐬 𝐈𝐧𝐭𝐞𝐫𝐞𝐬𝐭 → 𝐁𝐨𝐧𝐮𝐬 𝐭𝐨 𝐎𝐥𝐝 𝐏𝐚𝐫𝐭𝐧𝐞𝐫𝐬
• A Retiree’s Interest may include their Loans to the Partnership, which increases their stake, and
their Loans from the Partnership, which decreases their stake
Dissolution by Incorporation
• Incorporation of a partnership is simple, and merely includes recording corporate accounts in
place of the partnership accounts. The partners’ capital accounts are no longer used and share
capital that are issued are the entries that remain.
• In the like manner as with retirement, the FS Close process applies, except that Share Capital
Accounts are now opened.
Number of SH Par Value
Total Partnership Capital XX
Capital Allocated to Preferred Shares (XX) XX XX
Capital Allocated to Ordinary Shares Issued (XX) XX XX
Additional Paid-in Capital (PS & OS on a Par value allocation Basis) XX
Stock issue Costs (XX)
APIC Balance XX
Procedural Layout – Dissolution by Admission
Purchase of Interest (1) TCC TAC (4) Difference
Old Partners: **PAC – Partner’s Agreed
Capital,
A (XX) PCC - (1) PAC (3) + (2)
B (XX) PCC - (1) PAC (3) + (2) **PCC – Partner’s
C PCC PAC (3) + (2) Contributed Capital
New Partners:
D XX PCC + (1) PAC (3)
E PCC PAC (3) Bonus to (from) (3)
Total - TCC TAC XX Revaluation (2)
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1. If there are any indicators for purchase of interest, transfer the capital first before revaluation
In theory, the Revaluation happens first, this is because the post-revalued purchased interest should
be the same as the agreed capital of the partner which results in a proportionate interest in the agreed
capital. In the procedural layout, the purchased interest is a pre-revaluation interest, which only affects
Contributed Capital (It becomes the theoretical book value of the incoming partner’s capital, becoming
the basis for bonus later on).
In case an incoming partner purchases interest from the old partners for x% and invests other
properties for y% in the partnership, these are combined to form an implied valuation of the partnership’s
value as a whole. It is actually the premium the incoming partner places into the partnership believing
that the partnership possesses an unidentifiable benefit to him. This is still tenable since a purchase of
interest is a mere reallocation of existing book values which will be revalued in the same manner as in
the usual case.
2. Compute for the revaluation amount allocated to each partner
• Follow the order of priority used: TAC, then Revaluation amount, then Implied Capital
3. Any differences in the individual balances should be reallocated in the form of bonuses
4. The net difference in the capital of the partners is combined with their contributed capital to
solve for the agreed capital
• This is especially true if the Individual Agreed Capital does not match the partner’s
Individual Contributed Capital, even if the Total Agreed Capital now equals the Total
Contributed Capital
5. In case the problem mentions that a purchase of interest is instituted, however, the investment
for a given capital ratio goes directly to the other partners, goodwill/revaluation method is
applied; as such:
Consideration Transferred (given directly to partners, not partnership) XX **this is not the same
Book Value of the Partnership acquired (BVNAS * Capital Ratio offered) (XX) as acquisition by
investment. In this
Excess over Book Value acquired XX case, no investment
Undervalued Assets (XX) actually went to the
Overvalued Assets XX partnership.
Full Goodwill XX
**This is actually prohibited under IFRS 3. This is not a business combination, for which goodwill may be
recognized, unless the partnership contract is in fact, in consideration for a business combination.
Procedural Layout – Dissolution by Retirement
Sale of Interest Adjusted Capital Balances Bonus
Remaining Partners:
A XX XX XX(XX)
B XX XX XX(XX)
C XX XX(XX)
Retiring Partners:
D (XX) (RP) XX(XX)
E (XX) (RP) XX(XX)
Total - XX -
6. When a partner retires, observe that a similar procedure is done. Interest is sold first and
then revalued. After which, the partnership may pay the partner or their estate in cash or in
kind, otherwise, the partnership must recognize a liability to the partner or to their estate.
7. If a problem provides information from partnership formation until dissolution, focus your
attention to the nominal accounts as these will certainly affect the allocation of net income
• If no nominal accounts are given, but the Capital Balances are, Net income is solved as:
Beginning Capital XX ***If the data given is from the post-closing trial balance, the Adjusted
Ending Capital (XX) N/I is already closed. Revaluation is not yet done as of this step in the
Drawings XX accounting process.
***If the unadjusted trial balance is given, the N/I is not yet determined
Additional Investments (XX) since adjusting entries must be recorded.
Share in Net Income XX
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Partnership Liquidation
Liquidation – the termination of business operations. Partnership assets are sold, the partnership’s
creditors are paid, and any remaining cash is distributed among the partners.
• Since partners are generally liable to creditors up to the extent of their personal assets, any
deficiencies in the partnership’s assets in paying-off debt must be invested into the partnership
in order to satisfy obligations.
• A Limited Partner who leaves the partnership does not dissolve the partnership.
• Since the partnership is at a quitting concern, it must first satisfy external debt, followed by the
partnership’s debt to its partners in their capacity as creditors, and then finally to the partners
their capital balances.
o If the cash remaining is not enough to cover the capital balances, any deficiencies are
distributed at their profit or loss agreements. (Cash Deficits are losses, and are
considered changes in capital)
Asset Marshalling – Partnership Assets are assured for the Partnership’s Creditors; any remaining assets
will be given for the partners to pay personally to their personal creditors. When the partnership is
insolvent, and the personal funds of any of the partners are insolvent, other partners in able capacity to
cover the liabilities of the partnership shall assume the other partners’ shares in the outstanding
obligation.
• Among the partners, the debt assumed by one for another, will be part of their personal undertakings
Set-off of Obligations – A partner having loaned to the partnership, in their capacity as a creditor, may
set-off this debt with their own share in the partnership’s outstanding obligations.
• Limited Partners are not allowed to set-off their loan interests in the partnership with their capital
interest.
• Limited Partners are not allowed to encumber partnership property for their own benefit
(2) (1)
Partnership Assets XX Partner’s Free Personal Assets XX
Partnership Obligations (XX) Partner’s Obligations (XX)
(Deficit) or Cash Distributed
to Partners (XX) Partner’s Marshalled Assets XX
Partner’s Share in Cash Remaining or
(Outstanding Partnership Obligations) (3) (XX)
Balance XX
Personal Obligations to Partners for Absorbing Losses and
Partnership Obligations (XX)
Assets Remaining XX
Asset Realization – The process of converting Non-cash Assets into Cash.
• Inventory is marked down significantly and Sales Discounts are significantly larger than usual
• Accounts Receivable is collected
o Large discounts are given to secure cash collection
o Sometimes, Accounts Receivable are Factored
• Fixed Assets and Other Assets are usually sold at a loss or written-off entirely
• Cash Balances are ALWAYS MAINTAINED, especially for Installment Liquidation
Beginning Cash XX
Proceeds from Realization XX
Liabilities and Liquidation Expenses (XX)
Cash for Distribution (Installment and Lump-sum) XX
General Liquidation Procedures:
1. Assets and Liabilities are Revalued to reflect the Realizable Amounts, and Income from
Operations are closed to the Partners’ Capital Accounts
2. Assets are Realized, and losses and gains on realization are allocated among the partners using
their Profit or Loss Ratios
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3. Expenses are usually incurred to process liquidation. These are usually legal, administrative, and
tax obligations incurred. At this stage, only Liquidation Expenses are paid, and no other Expenses
are recognized.
4. Partnership Obligations are paid. Any balances remaining after all partnership assets are
exhausted are covered by the partners’ personal assets, unless the partner is a limited partner
a. Always exercise a partner’s right of set-off first
b. If they are solvent, they must invest more cash, unless the partner is a limited partner
c. If they are insolvent or if the insolvent partner has exhausted their capital balance, then
the other partners should absorb the deficiency
d. Loan from Partners and their Capital Accounts are paid with any remaining cash
**If the problem remains silent as to a partner’s solvency, they are considered insolvent
**Limited partners with loan balances are not afforded their right of offset, unless stated otherwise.
Lump-sum and Installment Liquidation
Lump-sum Liquidation – A one-time liquidation process where all of business activities end within a short
period of time
A = L + C (If the problem is silent, the maximum loss is assumed; as if all NCA were written-off
**Liquidation Exp are included in Max Loss). Cash Non-Cash Assets Liabilities Capital
Pre-liquidation bal. XX XX XX XX
Realization XX (XX) (XX)
Payment of Liabilities (XX) (XX)
Additional Investments XX XX
Payment of Liabilities (XX) (XX)
Absorption of Deficits XX(XX)
Balance - - - -
• There should be no negative balance in the capital column. To eliminate this, the other
partners have to invest additional cash in order to maintain the statement’s balance,
sharing in their proportionate profit or loss ratio.
• If no partner can absorb any more losses (i.e., they are now insolvent), the solvent partners
must invest more property to pay creditors. The partnership’s creditors have no other choice but
to incur a loss if all the personal assets of all general partners are exhausted.
• Outside of the partnership, the partners who have absorbed the deficit of their co-partners are
entitled to a just payment of the deficit absorbed.
• Limited Partners do not share in capital absorption. The creditors may claim only to the extent
of the Limited Partner’s invested capital only. Their Personal Assets are not claimed by
partnership creditors.
Installment Liquidation – A series of cash realizations is done repetitively over a long-period of time,
which is the actual real-world case. Since this liquidation process occurs over a long period of time:
• It may recognize more liabilities and incur liquidation expenses every time cash is ready for
distribution as the partnership finalizes its operations, usually taking months
• Future possible losses are estimated & apportioned in based on a cash distribution program
• Capital Deficiencies are only eliminated at the time before the final payment
Installment Liquidation follows a few assumptions in order to ensure equitable distribution of cash.
1. All Non-cash Assets are worthless. Losses are equal to their carrying values; the Accounting
Equation will only be composed of Cash = Liabilities + Capital (Net of Losses)
2. If, due to the hypothetical losses from the above assumption, a partner suffers a deficit, that
partner will no longer be able to contribute to make additional contributions to absorb further
losses, regardless of the partner’s personal solvency. Equity here is purely based on contributions
to the partnership.
3. This deficit will be allocated to the partners with remaining credit balances; repeated until all
deficits are eliminated.
4. The partner with the largest capital absorption capacity gets the priority over cash.
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Schedule of Safe Payments

The schedule of safe payments is so named because it assumes the worst possible case for cash
distribution (i.e., the largest possible losses incurred); if the schedule presents a positive balance for
capital interest of the partners, it means that cash is sufficient to cover both liabilities, and still have
cash for distribution of capital. This statement accompanies the Statement of Liquidation and presents
how a cash balance is distributed.
1. Determine Total Interest of Each Partner
Partner A Partner B Partner C
Adjusted Capital Balance AA BB CC
Loan to(from) Partnership BB
Total Interest AA BB CC
2. Determine the Possible Loss
Other Unsold Assets XX The Cash withheld must only be for Liquidation
Cash withheld for Liquidation XX Expenses and Unrecorded Liabilities. Any other cash
Expenses and Liabilities withheld is ultimately used for distribution even if
Total Possible Loss XX these are held for other purposes
3. Compute for the Payments to the Partners with the Cash Priority Program
a. If a problem requires or gives data on the cash distribution to EACH PARTNER, use the
CPP. Otherwise, use the schedule below.
b. If absorption is done (there is a debit balance given), use the schedule below.
Partner A Partner B Partner C
Adjusted Capital Balance AA BB CC
Loan to(from) Partnership BB
Total Interest AA BB CC
Total Possible Loss (Use P/L Ratio) (AA) (BB) (CC)
Balance (AA) BB CC
Absorption of Loss AA (AA) (AA)
Payments to Partners - BB CC
4. Update the Partners’ Capital Balances and the Statement of Liquidation
a. If the loans are paid, these are no longer included in further computation of interest
b. The total possible loss is not used to distribute losses in the formal statement. It is merely
a tool used to make safe assumptions for payment
c. If there are any new liquidation expenses incurred as well as liabilities discovered, these
are shared by the partners and new balances are used for preparation of the next
schedule
5. Repeat the Process until all Non-cash assets are liquidated, and all cash is distributed
6. Only Eliminate Capital Deficiencies when the Final Payment is about to be in order
a. Capital Balances may persist to be negative until the final payment is due. Absorption
only happens at the last payment.
b. Deficient Partner still absorbs possible losses
The Schedule of Safe Payments is NO LONGER REQUIRED when the Capital Balances are in proportion
to their Profit or Loss Ratio
• This comes from the assumption that only cash net of liabilities remains as distributable to the
partners, and all non-cash assets are worthless. The loss equivalent of the non-cash assets will
either be larger or smaller than the total equity of the partnership
• For instance, a partner having a 25% stake at the partnership that shares in 20% of profits and
losses will make their Capital large enough to absorb 20% losses, however, this means that the
other partners may only have a 75% stake at the partnership while absorbing 80% of its losses;
meaning the capital of the other partners will not be enough to absorb losses.
• Therefore, a capital balance proportionate to the profit or loss ratio will indicate that all partners
are able to get safe-to-pay amount until all non-cash assets are liquidated.
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Cash Priority Program

Cash Priority Program – A program that permits its partners to project a cash distribution arrangement,
under the same principles of the Schedule for Safe Payments for future periods until all assets are
liquidated.
1. Compute for the Cash Balances per installment:
1st Installment 2nd Installment Final
Installment …
Cash, beginning XX XX XX
Proceeds from Realization XX XX XX
Liquidation Expenses Paid XX XX XX
Liabilities paid (XX) (XX) (XX)
Cash Withheld for Future Expenses (XX) (XX) -
Cash Withheld for Future Remaining Liabilities (XX) (XX) -
Total Cash Available to partners XX XX XX
2. Compute for the Loss Absorption Potential Other Notes:
Partner Partner Partner C **The CPP and the
A B Schedule of Safe
Capital Balance XX XX XX Payments may be used
Loan to(from) Partnership XX XX XX even for lump-sum
Total XX XX XX liquidation. If any
Divide by: P/L Ratio A% B% C% priority of payment is
Loss Absorption Potential AA BB CC larger than the actual
3. Determine a Partner’s Priority in payments balance of cash
Partner A Partner B Partner C available, the balance is
Loss Absorption Potential AA BB CC simply prorated
Priority 1 (Largest – Next Priority) CC-BB according to the P/L.
Balance AA BB CC-BB
Priority 2 (Next Priority – Last BB-AA CC-BB- **In a CPP, if the priority
Priority) AA payment was not fully
Balance AA AA AA covered, the balance is
carried over to the next
4. Compute for cash to be paid in each priority month.
Partner A Partner B Partner C
Priority 1 * C% CC **Use Schedule of Safe
Priority 2 * C%, Priority 2* B% BB CC Payments for P/L
Safe Payments - BB CC requirements; use CPP
Cash in Excess of Safe Payments for cash balance
(A%, B%, C%) AA BB CC requirements.
Total Cash Allocation AA BB CC
5. Prepare a Schedule of Safe Payments
a. The cash priority program is a projection of the worst possible outcome, without any
allowance for future positive changes, it is a convenient basis for Safe Payments
b. Do note that the Schedule of Safe Payments will not be affected by any additional
investments by the partners. Only Statement of Liquidation reflects this transaction
c. Additional Unrecorded Liabilities are immediately paid, and capital is adjusted
6. Update the Statement of Liquidation
7. Interruptions in the CPP
If a Partner instead receives property instead of cash, the drawing of property is debited to the capital
of the partner at agreed value or fair value. This changes their capital balance and requires a
reassessment of the Loss Absorption Potential. Any Cash distributed prior to this interruption is
applied to the balance as usual, however it is after this interruption that the capital balances are
reassessed for absorption capacity. Furthermore, there is also a possibility that the priority orders
change.
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Corporate Liquidation
Corporate Liquidation – the winding-up of business for corporations. The entire process is handled by a
trustee who shall manage the realization of assets and payment of obligations for the estate of the
corporation.
Accounting for Corporate Liquidation follows a Quitting-concern, hence:
• Assets are valued at the Net Realizable Value or Fair Value if the former is not given
• Assets Pledged with Fully Secured Creditors
• Assets Pledged with Partially Secured Creditors
• Free Assets – Assets not pledged to any liability
i. Unsecured Portion of Assets partially pledged
ii. Other Assets
• Liabilities are valued at their Maturity Values or Fair Value if the former is not given
• Unsecured Liabilities with Priority
i. Liquidation Expenses first, then Salaries and Employee Benefits, then Taxes,
because generally upon liquidation, the expenses on liquidation and pension
expenses can be claimed to reduce tax liabilities pending a business closure.
• Fully Secured Liabilities
• Partially Secured Liabilities
• Unsecured Liabilities without Priority (USWP)
i. Any Loss not absorbed by total SHE is absorbed by USWP. Hence, absorption is
identified as: (Total Loss – SHE – Unsecured Liabilities w/o Priority = Payment)
• Estimated Recovery Percentage is required so as to provide the unsecured creditors an
expectation over the collectability of their receivables.
𝑁𝑒𝑡 𝐹𝑟𝑒𝑒 𝐴𝑠𝑠𝑒𝑡𝑠
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑅𝑒𝑐𝑜𝑣𝑒𝑟𝑦 𝑅𝑎𝑡𝑒 (𝐸𝑅%) =
𝑈𝑛𝑠𝑒𝑐𝑢𝑟𝑒𝑑 𝐶𝑟𝑒𝑑𝑖𝑡 𝑤𝑖𝑡ℎ𝑜𝑢𝑡 𝑃𝑟𝑖𝑜𝑟𝑖𝑡𝑦
𝑃𝑎𝑟𝑡𝑖𝑎𝑙𝑙𝑦 𝑃𝑙𝑒𝑑𝑔𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 + (𝑈𝑛𝑠𝑒𝑐𝑢𝑟𝑒𝑑 𝑃𝑜𝑟𝑡𝑖𝑜𝑛 𝑜𝑓 𝐶𝑟𝑒𝑑𝑖𝑡𝑠 × 𝐸𝑅%)
𝐸𝑅% 𝑜𝑓 𝑃𝑎𝑟𝑡𝑖𝑎𝑙𝑙𝑦 𝑆𝑒𝑐𝑢𝑟𝑒𝑑 𝐶𝑟𝑒𝑑𝑖𝑡 =
𝑃𝑎𝑟𝑡𝑖𝑎𝑙𝑙𝑦 𝑆𝑒𝑐𝑢𝑟𝑒𝑑 𝐶𝑟𝑒𝑑𝑖𝑡
Statement of Affairs and Estate Equity
A financial statement showing the Net Realizable Value of the Corporation; it presents the assets at Net
Realizable Value and is arranged in such a way that shows how each asset is pledged to liquidate
obligations. It omits Contra-asset accounts and refers to the Net Assets at NRV as the Estate Equity. It
is the Balance Sheet of a Quitting Concern, and is prepared ONLY at the beginning of liquidation, as such
is based on estimates.
Assets Pledged to Fully Secured XX Share Capital (OSC+SP) XX
Liabilities Retained Earnings/(Deficit) (XX)
Fully Secured Liabilities (XX) Estimated Net Gain (Loss) (XX)
Excess Assets Pledged XX Estate Equity/Deficit XX
Assets not Pledged XX
Total Free Assets XX Estate Deficit or Estate Equity
Unsecured Credit with Priority (XX) Loss on Realization Gain on Realization
Net Free Assets XX Increase in Liability Increase in Assets
Unsecured Credit without Priority: Estd. Gross Loss Estd. Gross Gain
Partially Secured Liabilities XX Estimated Net Loss
Assets Partially Pledged (XX) (XX) Absorbed by Absorbed by
Unsecured Liabilities without Priority (XX) Unsecured Creditors** Stockholders
Estimated Deficiency to Unsecured Estate Deficit = Negative SHE
Creditors/Estate Deficit, beg. XX Deficit = Negative R/E
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Statement of Realization and Liquidation

A financial statement that shows how the trustee accomplishes the liquidation of the corporation. It is
prepared every period-end under a quitting concern, in other words, it is the Cashflow and Income
Statement of Liquidating Corporations. In contrast to the Statement of Estate Equity (Deficit), it
presents the actual results of realization and liquidation. Generally, a trustee has within 3 years to
fully liquidate a corporation under the Financial Rehabilitation & Insolvency Act.
Statement of Realization and Liquidation
Assets, beginning or to be realized Liabilities, beginning or to be liquidated
Assets Acquired Liabilities Assumed
Liabilities PAID Assets REALIZED
Liabilities, end or not liquidated Assets, end or not realized
Supplemental Charges Supplemental Income
Gain on Realization Loss on Realization
• The balances are flipped for Gains or Losses because the statement is an actual results statement
rather than an estimation of gains or losses; the total debits and credits must always be equal.
• Observe that there are ending balances for Assets and Liabilities, this shows that realization and
liquidation is rarely an instant procedure. These ending balances are continued into the next
period, and are considered beginning balances by then.
• Observe also that the only movement in equity may only come from net income/loss
• Cash Balance from Estate Liquidation:
Cash, beginning XX SHE, end (XX)
Assets to be Realized XX Liabilities not Liquidated XX
Liabilities to be Liquidated (XX) Assets not Realized (XX)
SHE, Beginning XX Cash, end XX
Gain (Loss) on Realization (XX) SHE is usually at a deficit**
SHE, end (XX)

Notes on Corporate Liquidation

• The Estimated Recovery Percentage changes depending on the class of liability.
• Partially secured Liabilities may have different recovery rates than Unsecured Liabilities
with Priority, however, the general percentage of the entire class will be still be applied
• Unsecured portions will still be multiplied by the general class recovery rate, the result
being used for computation of a new rate
• Some partially secured liabilities will have different recovery rates than others (i.e.
bonds may have different recovery rates than loans or notes.)
• Sales on Account – Dr. Asset Acquired; Credit Supplemental Credits
• Purchase on Account – Dr. Supplemental Debits; Credit Liabilities Assumed
• Cash Receipts – Dr. Asset Realized; Credit Supplemental Credits
• Cash Disbursements – Dr. Liabilities Liquidated; Credit Supplemental Debits
• Pre-petition interest – Allowed to the creditor, whether secured or not (interest expenses that
have been pleaded by the creditor to be paid)
• Post-petition interest – Unsecured Credits will not have additional interest for payment (interest
expenses that have not been recorded yet, but are falling due as the corporation is liquidating)
• Secured Credits will be allowed this extra payment if:
i. The Collateral exceeds the principal and interest (THE DEBT IS FULLY SECURED)
• Accrued Interest is Secured so long as the principal is Secured, absent any other facts.
• Dividend rate at liquidation is the recovery rate.
• The only time Equity receives dividends still, is if the liquidation returns a gain. This means
that the corporation’s book value can return at or above par after paying all its debts.
• Prepayments are non-refundable and are valued at zero; worthless.
• Goodwill and Intangibles in general are unrecoverable in a quitting concern; worthless.
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Home Office, Branch, Agency Accounting

Agencies – Simple extensions of a Home Office’s Operations. These do not maintain their own accounting
records as these rely on the discretions of the Home Office. A fund is maintained and updated by the
Main Office for the Agency to carry-out its transactions assigned to it by the home office.
Branches – Not separate entities with a company but have a degree of autonomy to maintain its own
records and accounts distinct from the Home Office. At the end of the Accounting Period, the Accounts
of the Home Office and the Branch are offset through the consolidation of records
Home Office Books = Branch Books
Investment in Branch/Branch Current Home Office Current
• Debit • Credit
• Asset Account • Equity Account
Shipment to Branch Shipment from Home Office
• Credit • Debit
• Nominal Account • Nominal Account
• Deducted from Total Goods Available for • Added to Goods Available for Sale of
Sale/ Goods Available for Sale in the HO Branch
Summary of Home Office-Branch Transactions
Transaction Journal Entry – Home Office Journal Entry – Branch
Investment in Branch
Shipment to Branch
Shipment from Home Office
Shipment of Merchandise Allowance for Branch
Home Office Current
Overval.
Cash (Freight Charges)
Allowance for Branch Overval.
Return Merchandise to Home Home Office Current
Shipments to Branch
Office Shipment from Home Office
Investment in Branch
Investment in Branch
Home Office A/R collected by Cash
Sales Discount
Branch (A/P; Paid) Home Office
Accounts Receivable
Home Office
Branch A/R collected by Home Cash
Sales Discount
Office (A/P; Paid) Investment in Branch
Accounts Receivable
Home Office acquired PPE for
Equipment – Branch
the Branch, Home Office NO ENTRY
Cash
records in own acquisition*
Investment in Branch Depreciation Expense
Depreciation*
Accumulated Depreciation Home Office Current
Branch acquired PPE for Home Home Office Current
Equipment
Office, Home Office records Cash
Investment in Branch
acquisition**
Depreciation Expense
Depreciation** NO ENTRY
Accumulated Depreciation
Cash Home Office Current
Remittance to Home Office
Investment in Branch Cash
Allocation of Expenses to Investment in Branch Expenses
Branch Expenses Home Office Current
Investment in Branch Income Summary
Branch Reports Net Income
Branch Income Home Office Current
Allowance for Overvaluation
Realized Gross Profit
Branch Income
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Some Considerations for Journal Entries

Assets maintained in HO books Property, Plant, Equipment Depreciation
Not an intercompany transaction Treat as Allocation of Expense
HO acquires for Branch
(Only HO records the PPE) (Increase Reciprocal Accounts)
Treated as a Remittance Treat as Allocation of Expense
Branch acquires for itself
(Decrease Reciprocal Accounts) (Increase Reciprocal Accounts)
Treated as a Remittance Not an Intercompany Transaction
Branch acquires for HO
(Decrease Reciprocal Accounts) (Only HO records DEPEX)
Assets independently recorded (if Silent)
Treat like Merchandise Shipment Not an Intercompany Transaction
HO acquires for Branch
(Increase Reciprocal Accounts) (Only Branch records DEPEX)
Treat like Return of Merchandise Not an Intercompany Transaction
Branch acquires for HO**
(Decrease Reciprocal Accounts) (Only HO records DEPEX)
Each acquires for themselves Own Books Own Books
**The Branch does not typically record assets for the home office
• A Debit/Credit Memo refers to the Account that it comes from and if it is sent to the
counterparty, the other party is instructed to apply the same change in its reciprocal account.
DM from HO = Increase HOC DM from BC = Decrease Investment in Branch
CM from HO = Decrease in HOC CM from BC = Increase Investment in Branch
Inter-branch Transactions
• These transactions will still require the home office’s notice from one branch to another
Transaction Home Office Branch 1 Branch 2
Branch 2 Home Office Cash
Cash Transfer
Branch 1 Cash Home Office
Branch 2 Home Office Cash
Collection in behalf
Branch 1 Sales Discount Home Office
(Affects Sales)
Accounts Receivable
Branch 2 Home Office Shipments-in
Expenses -Excess freight Shipments-in Freight-in HO to B2
Branch 1 Freight-in HO to B1 Home Office
Branch 1 to Branch Gain or Savings - Freight Cash (Prepaid) Cash (Collect)
2 Shipment
(Affects COGS) Shipment-out 1 **The Home Office absorbs the excess or (savings)
Allowance for Overval. 1 in freights as it is a result of its accountability in
Shipment-out 2 deciding to ship its goods directly to Branch 2
Allowance for Overval 2
Reconciliation of Home Office Books and Branch Books
Home Office Books Branch Books
Unadjusted Investment Balance AA Unadjusted Home Office Equity BB
Unrecorded Income XX Unrecorded Income XX
Unrecorded Expense (XX) Unrecorded Expense (XX)
Erroneous Charges to Branch XX Erroneous Charges to Home Office XX
Erroneous Remittance (XX) Erroneous Remittance (XX)
Debit Memo from Branch (XX) Debit Memo from Home Office XX
Credit Memo from Branch XX Credit Memo from Home Office (XX)
Adjusted Balance XX Adjusted Balance XX
Reconciling the Home Office Books and Branch Books is a matter of identifying where the differences lie;
this is because the Investment in Branch Account (Asset) and Home Office Current (Equity) are reciprocal
accounts that are expected to be equal at the end of the period, as well as at the beginning of the period
(Although this may not be the case when there are Overvaluations that the Home Office has yet to
adjust.) The usual sources of the discrepancies are usually unrecorded balances due to timing
differences, transposition errors, and outright misstatements in Bookkeeping and Footing of the Ledger
.
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Control Procedures of Home Office and Branch Accounting

The need to decentralize into profit/investment centers requires that intracompany accounts be
maintained.
• As the branches operate with enough autonomy, they may come into deals with different
departments to negotiate prices (Negotiated Transfer Pricing) for acquiring goods at a
significantly lower price rather than buying from outsiders.
• The act of placing markups on goods sold to a cohort imposes internal control over cost-pushing;
as the billed price is actually only limited to standard variable cost plus some markup; this is
called Dual Pricing as the Sender Office charges at Full markup while maintaining inventory (or
any shared service (see service cost allocation)) only at variable cost; and the Receiving Office
maintains at the sender office’s Full Markup.
• The Home Office does this to force the branches to minimize costs incurred, and maximize sales
in the interest of goal congruence, simulating a perfect competition market inside the
company. As such, any branch receiving from the home office, or a cohort branch will have no
awareness as to the true cost of the shipment to it.
• The profit is not a true profit; however, it is still maintained in order to account for proper
disposals and to leave audit trails.
True Branch Income
Cost Billed Price Allowance Purchased Outside
Beginning XX XX XX XX Prior Yr. Profit
Inventory
Net Shipments XX XX XX - Current Yr. Profit
Purchases, net XX XX - XX *** Allowance is
Freight in XX XX - XX also known as
TGAS XX XX XX XX Branch Loading for
Ending Inventory (XX) (XX) (XX) (XX) Perpetual Inventory
Cost of Goods Sold XX XX XX or RGP XX
• Reconciled income from branches will be the aggregate of all Branch & Inter-branch transactions
• Sometimes, a Reconciled Income Report will not have accounted for in-transit inventory, these
are adjusted later on in determining true branch net income
• This will mean that the Shipments from Home Office or Shipments-in are understated
• Be especially aware that freight on any line-item of inventory does not usually share in the
gross profit rate. Remove freight first before applying the GP rate, then return the freight
to the balance
• Goods in Transit, although being recorded in the books of the home office, will find no
equivalent in the branch books. In this case, the information to use should be the home
office records.
• Net Income solved for at Billed Price is the Branch’s Reported Net Income
• Net Income solved for at Cost is the True Net Income from the Branch
Total Sales Revenue XX Allowance for OV, Beg. Inventory XX
Total Cost of Goods Sold (Billed Price) (XX) Allowance for OV, Shipments-in XX
Gross Profit XX Allowance for OV, End Inventory (XX)
Total Operating Expenses (XX) OR Realized Gross Profit XX
Total Net Income XX Net Income Reported XX
Allowance for Overvaluation in COGS (XX) Unrecorded Expenses (XX)
Total True Net Income of All Branches XX True Branch Net Income XX
Home Office Own Net Income XX
Total True Net Income of the Entity XX
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Cross-charge Accounting
Cross-charging is the act where departments, business units, or projects under a single economic entity
provide shared services to each other. This may consist of Intercompany transactions or Intracompany
transactions. Multiple reasons are considered as to why cross-charging (or chargebacks) are done:
• To realize business synergies between affiliated companies
• To maximize labor and tax arbitrages locally as well as between multinational affiliates
• To maximize available professional skills and workforces between affiliates
• To capitalize on intangible assets between affiliates
• To be able to manage contracts on favorable terms based on an affiliate’s existing advantage
• To perform overhead splitting and maximizing economies of scale
• To simulate an external market with very minimal information asymmetry within the same entity
• To track shared costs between departments accurately and reliably thereby minimizing the risk
of assigning indirect/uncontrollable costs (and to some extent, revenues) that cause Slack
• As a function of cost control, cross-charging is applicable to Cost Centers, Profit Centers, and
Company Projects ranging from advertising campaigns, as well as capital projects to
acquire/create assets.
• As a function of accounting compliance, it imposes an audit trail of the existence of transactions
when these would normally be expected to offset anyway (on the Financial Statements, the
transaction would have no effect if it offset anyway.)
Borrowed and Lent Accounting
• A method of cross-charging that transfers costs between affiliates/projects without the need for
formal invoicing methods. At the very least, these will go through immediate billing between
affiliates/departments and a memorandum is created between the departments/projects
• This is more prominent for agency accounting and interdepartmental service rendering
Invoiced Cross-charges
• A method of cross-charging that transfers costs between affiliates/projects by using formal
invoicing. The invoice is maintained and undergoes typical procurement procedures, including
price screening.
• This is prominent for multinational entities and for intercompany transactions that must meet
compliance requirements such as branch profit remittance taxes, indirect taxes, related-party
considerations, and the like
For both methods of cross-charge accounting, the following considerations should be taken note of:
• The cross-charge is cleared of any Foreign Exchange Differences, withholding obligations, & taxes
• An approval between the dealing affiliates is required before the cross-charges are done
• The cross-charge is only eliminated as part of period-close and consolidation
• Overvaluation Allowances or Loading accounts are reconciled at period-end
Combined Financial Statements
• These are the financial statements of entities who have sub-units that do not qualify as associates,
joint ventures or operations, or subsidiaries. These are more appropriate for branches or relatively
independent operating segments of the company.
• Like Consolidation, Combined Financial Statements also perform intragroup eliminations
• There is no affiliation between the branches and the home office as these are already one and the
same, unlike in consolidation, there is initially a distinct separability among the affiliates.
• If any information reveals nominal accounts, the Reciprocal Accounts are UNADJUSTED. Absence of
the same indicate an Adjusted balance, however, it has no certainty as to whether some errors were
committed.
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Business Combinations (PFRS 3)

Business Combination – A transaction or other even in which an acquirer obtains control of one or more
businesses. The definition and standard also apply to true mergers or mergers of equals.
• Transferring cash or other assets • Issuing Equity Securities
• Incurring liabilities that are payable to the • Providing more than one consideration
previous owners of the acquiree’s equity • By Contract alone
Business – an integrated set of activities and assets that is capable of being conducted and managed for
the purpose of providing a return directly to investors, other owners, members or participants.
It consists of: Inputs and Processes; it is not necessary for it to have any outputs, although it is usually a
consequence of being in one.
There are two types of Business Combination:
Net Asset Acquisition – an acquirer offers the owners of the acquiree some consideration in exchange of
substantially all of its net assets.
o Statutory Mergers – two or more entities consolidate into one of either
o Statutory Consolidations – two or more entities consolidate to establish another entity
Stock Acquisition – a parent acquires majority or all of the common equity interests/voting rights of
another subsidiary entity/entities, thereby attaining control
PFRS 3 does not cover:
• Joint Ventures and Joint Operations
• Acquisition of Assets/Group of Assets that do not constitute a business
• Entities under common control i.e., Subsidiaries as among each other, are not in business
combinations. Only a Parent-Subsidiary relationship is covered by the scope of PFRS 3.
• Gain on Sale of Business = Consideration Transferred – Book Value of Net Assets of Acquiree
The Concentration Test
This is an optional test to see whether the asset or group of assets acquired is indeed a business. It
qualifies that a thing is indeed a business if the fair value of the gross assets acquired is concentrated in
a single identifiable asset or group of similar identifiable assets. This means if the acquirer somehow
acquires substantially all rights to the assets in a net asset acquisition; and control in a stock acquisition
(in the latter case, the rights are concentrated in the investment). The Gross assets for the purpose of
this test only excludes cash, deferred tax assets (these are typically not absorbable by an acquirer), and
Goodwill arising from Deferred Tax Liabilities. Gross assets however include the Goodwill from the
Acquisition.
Accounting for Business Combinations:
• Pooling of Interest Method – Applied for companies under common control (Subsidiaries under
the same parent undergo business combination)
• Purchase Method – Applied for SMEs
• Acquisition Method – Applied as the General Rule in Business Combinations
Transactions Purchase Method (SMEs) Acquisition Method (Full PFRS)
Directly Attributable Costs Capitalized Separate FS – Capitalized
Consolidated FS – Expensed
Indirectly Attributable Costs Expensed Expensed
Bond Issue Costs Apply PFRS 9 – Bond Premium Apply PFRS 9 – Bond Premium
Stock Issue Costs, net of Tax Apply PAS 32 – Share Premium Apply PAS 32 – Share Premium
Non-controlling Interest Partial Goodwill Method only Full or Partial Goodwill is
allowed
Goodwill Amortized for 10 years Not Amortized
There are Four Steps required in order to accomplish a business combination:
Identifying the Acquirer – the acquirer is usually:
o the one who issues cash/ other assets/equity instruments and or incurs liabilities
o the one who holds large minority interest in a combined entity
o the entity who holds decision-making powers
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o the entity whose senior management is likely to manage affairs after combination
o the entity that usually issues a control premium upon acquisition
Determining the Acquisition Date, and the Consideration Transferred
o The acquisition date is the date the entity acquires formal control over the acquiree; however,
the substantial acquisition may not yet be accomplished immediately or at once because of
logistical reasons i.e., not all identifiable assets have been identified after acquiring formal
control. This period may only last up until one year or until it is certain that all identifiable
assets are identified
o The acquisition date is the date that Goodwill is initially recognized
Recognizing and Measuring the Net Identifiable Assets acquired, Liabilities assumed and Non-
Controlling Interest in the Acquiree
o Measure assets and liabilities at Fair Value, or based on relevant PFRS/PAS
o Non-controlling Interest is taken-up at Fair Value or at Partial Basis
o Contingent Consideration may be given, and thus, increase the Consideration Transferred
Recognizing and Measuring Goodwill or Gain on Bargain Purchase

Consideration Transferred XX
Non-Controlling Interest XX
Previously Held Interest XX
Fair value of Net Assets of Subsidiary (XX)
Goodwill (Gain on Bargain Purchase) XX
Notes – Business Combinations
Note 1 – Relevant PFRS and PAS will be used to account for considerations at fair value some, exceptions
include, but are not limited to:
• Assets Held for Sale – Fair Value less Cost to Sell PFRS 5 (deduct Cost to Sell from total FV)
• Deferred Tax Assets and Liabilities are not offset and are carried at Historical Cost; hence
the FV of the Assets and FV of Liabilities of the Subsidiary is determined separately before FVNA.
N.B. DTA = Tax Rate * Overstated Asset or Understated Liability; DTL = Tax Rate* Understated Asset or
Overstated Liability (IAS 12.66) DTL adds to Goodwill; DTA is reduced from Goodwill. NCI does not share
in Deferred Taxes under Partial Method.
• Employee Benefits – measured following PAS 19
o Restructuring Provision Liability – generally must be planned and communicated to the
stakeholders; (This is actually a termination employee benefit) it is not recognized if the
problem is silent
• Share-based Payments – measured following PFRS 2
• Contingent Assets and Contingent Liabilities – Contingent Assets are not recognized, but
Contingent Liabilities are Recognized, regardless of likelihood of the condition to occur. PAS 37
• Identifiable Intangible Assets – measured and recognized following PAS 38**
o Research and Development Expenses are capitalized once arising from business combinations
o Any asset meeting Separability and Contractual-legal criterion are recognized
• Indemnification Assets – recognized on a consistent basis (only on indemnification value)
• Leases where the Acquiree is the Lessee – apply PFRS 16
Exceptions as to Measurement: - PFRS 5, PAS 38, PFRS 2
Exception as to Recognition: PAS 37
Exception as to Recognition, Measurement – PAS 12, PAS 19, PFRS 16, Indemnification Assets (PFRS 4/17)
Net Assets under Pre-existing relationships – Accounted separately from Business Combination, thus
Gains or Losses are recognized
**(IFRS 3.18-44), (IFRS 3.22-31,54-57)

Note 2 – Consideration Transferred is Retained in the Consolidated Entity by the Acquiree

• When a consideration is transferred to the acquiree, but the acquiree still holds interests in the
entity, it may decide to allow the consideration be kept within the consolidated entity, that is,
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the previous equity holders of the subsidiary decide to let the asset be kept in the business. If
this is the case, the consideration transferred does not include the retained asset, and it is
carried at cost with no gain or loss recognized.
Parent owns pieces of land costing P2,000,000. The parent transfers 50% of the land; this is further
distributed by the subsidiary as follows: the first half was retained in the consolidated entity by the
previous equity holders of the subsidiary, while the rest were sold to the equity holders of the subsidiary
for cash at 120% of the original cost which is the fair value at the time.
• 50% of 50% of the Land will be retained, hence the 25% of P2,000,000 should be carried at
Historical Cost, and no gain or loss on disposal is recorded. The other 25% will be sold and
recognized as a consideration transferred at Fair Value (120%) of historical cost. Consolidated
Land is at P1,500,000

Note 3 – Acquisition-related Expenses are generally expensed outright, with some notable nuances:
• Share Issuance Costs – Charged against Share Premium, or Retained Earnings if the balance of
share premium is lacking, net of any TAX. (On a per Balance Basis i.e., so long as an APIC balance
is available); although Share Issue Costs are required to be paid outright under current SEC
memoranda.
• Bond Issuance Costs – These are either bond premiums or discounts depending on whoever
shoulders the cost. Regardless of whoever shoulders the cost, these are NOT included in the
consideration transferred, and are only either additions or deductions to the consolidated
liabilities of the entity. Similarly, Bond Issue Costs are also paid outright under current SEC
memoranda and EO 226 rules.
• Liquidation Expenses – are part of the Consideration Transferred only if the Acquirer shoulders
the payments for it, and not merely provides an estimate or a provision for such, otherwise, if
the acquiree pays for or assumes the liquidation expenses, it is ignored
• Direct Acquisition Costs – Expensed in the Consolidated FS, capitalized in the Separate FS
• Indirect Acquisition Costs – Expensed; observe terminology as to payment; no mention of
payment implies a Liability incurred

Note 4 – Assets and Liabilities not initially recognized/undiscovered until Business Combination are
included in the FVNA of the Subsidiary, and are retroactively adjusted; this affects Goodwill and FVNA.
• This is because the closing date/date of acquisition is not the same with the date the combination
is consummated.
• This is allowed only for within 1 year after the acquisition date; this is called the
Measurement/Acquisition Period, lasting only until the earlier of the Combination is
accomplished or one year from the transaction date
• Any transaction performed to accompany the Business Combination but occur after the
measurement period are treated as separate transactions from the Business Combination.

Note 5 – Contingent Considerations are reassessed to see whether:

• The Condition for which the contingent consideration was met; or
o These are recognized regardless of the probability of occurrence**
o These conditions may include any valid condition, but the usual ones are:
i. Meeting Profit Targets
ii. Reaching a Specified Market Value Price per share
iii. Reaching a Milestone for Research and Development
o These are NOT RETROACTIVE
i. Adjustments within measurement period will restate Consideration Transferred
ii. Adjustment outside of the measurement period are charged thru Profit or Loss
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o For Equity Considerations (Share issuances) – Not Remeasured, and are accounted for as
transfers within equity for shares of different classes, and mere increases in the number of
shares of the same class (NO EFFECT TO CONSIDERATION TRANSFERRED)
A Contingency Clause provides that the Acquirer shall issue additional shares of stock upon the
occurrence of Condition A. Regardless of whether Condition A is met, its initial measurement is
maintained, this means that the Contingency will only increase or decrease the number of shares sharing
in the initial fair value of the Contingent Consideration.
Recognition of Contingency Settlement of Contingency Non-occurrence of
Contingency
Goodwill XX Share Premium Contingency XX Share Premium Contingency XX
Share Premium Contingency XX Ordinary Share Capital XX Share Premium Ordinary XX
Share Premium Ordinary XX
Change in Estimated Contingency
Memorandum
o For Liability Considerations – These are Remeasured in accordance with PFRS 9 or with any
other appropriate Liability Standard, as such, the happening of the contingency results in a
gain or loss in the transaction
Recognition of Contingency Settlement of Contingency Non-occurrence of Contingency
Goodwill XX Provision for Contingency XX Provision for Contingency XX
Provision for Contingency XX Loss on Contingency XX Gain on Contingency XX
Cash XX
Gain on Contingency XX
Chance in Estimate (Stock Change in Estimate after Change in Estimate (Net Asset
Acquisition) Provisional Measurement Period Acquisition) Provisional
Investment in Subsidiary XX Loss on Contingency XX Goodwill XX
Provision for Contingency XX Provision for Contingency XX Provision for Contingency XX
• There were facts and circumstances that were undiscovered within the measurement period as
per Note 4 (The only time a Contingent Consideration is adjusted through Goodwill/Retained
Earnings)
• Adjustments occur in the Consolidated FS and are journalized in the Working Paper.
**(IFRS 3.22-23), ***(IFRS3.58)
Note 6 – Business Combinations Under Common Control
These arrangements are akin to corporate
restructuring. For instance, a Parent having two
subsidiaries relinquishes interest in one subsidiary
to the other. In these cases, other notes in this
text shall apply only that these shall use Book
Values of Net Assets.

Business Combinations under Common Control

shall apply especially if there are no Shareholders
outside the group that are affected AND if the
Parent remains to be in control. As such, NO
Goodwill nor Bargain Purchase is recorded.

Accounting for these types of arrangement is

called the Pooling of Interests Method under IAS
22 (Superseded by IFRS 3).

Note 7 – Valuation of the Non-controlling Interest

• Non-controlling Interest/Minority Interest – An equity account within Retained Earnings
representing the balance of interest not acquired by the parent. In other words, it is Interest
that holds no control. (Interest may be more than 50% but holds no control in substance)
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• The Acquirer has the option to record non-controlling interest at either Full Fair Value or at
Proportional Fair Value reflected within Equity (Retained Earnings). The effect is that Non-
controlling Interest either Shares in Goodwill or not, depending on the Approach**
• The Full Fair Value Approach/ Full Goodwill Approach attributes the Goodwill proportionately
between Controlling and Non-controlling Interest.
• The Proportional Goodwill Approach attributes the Goodwill only to the holders of the Parent
o Full Goodwill Method is NOT allowed for instruments that attain control other than by Common
Stock (by Contract, Preferred Shares that grant control, etc.)
• The decision to value Goodwill separately or not will matter:
o in Liquidation Procedures, since it affects the Return on Equity
o in Impairment Losses of Goodwill, and how much appears on the Consolidated Income
Statement
• The above two methods, however, apply only to Business Combination Equity, and not to other
forms of Equity under some other standard i.e., IFRS 2 Share-based Payments/Compensation
If the problem is silent as to the Method, take the HIGHER between Fair Value Method or Partial Goodwill
Method. If the Fair Value Method Amount is not Given, it is implied, so in this case, compare Implied
Goodwill against Partial Goodwill.
Check for: Assessed FV (Given) → Implied Goodwill → Partial Goodwill
𝑁𝑜𝑛-𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑙𝑖𝑛𝑔 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
𝐼𝑚𝑝𝑙𝑖𝑒𝑑 𝐺𝑜𝑜𝑑𝑤𝑖𝑙𝑙 = ∗ 𝐶𝑜𝑛𝑠𝑖𝑑𝑒𝑟𝑎𝑡𝑖𝑜𝑛 𝑇𝑟𝑎𝑛𝑠𝑓𝑒𝑟𝑟𝑒𝑑
𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑙𝑖𝑛𝑔 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
𝑃𝑎𝑟𝑡𝑖𝑎𝑙 𝐺𝑜𝑜𝑑𝑤𝑖𝑙𝑙 = 𝑁𝑜𝑛-𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑙𝑖𝑛𝑔 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 ∗ 𝐹𝑉𝑁𝐴𝑆
Problems are usually explicit as to which method it uses to value Goodwill and Non-controlling Interest.
**IFRS 3.19
The Floor Test – The floor test imposes a requirement for NCI to be valued at a minimum which is the
NCI share of FV of the Net Assets of the Subsidiary. This is because only the Parent can only truly share
in the Gain on Bargain Purchase, whereas the NCI transfers no consideration therefor, thus precluding
the NCI from the gain. This means that if there is no GBP, there can be no goodwill if the NCI is valued
in its minimal amount.

Note 8 – Control Premiums and Control Discount

• A Control Premium is an additional payment given by the acquirer for obtaining control over the
acquiree. This is always a part of the Consideration Transferred.
• Control Premiums only affect the Computation for Non-controlling Interest under Implied Method
o At Assessed Fair Value, there is no further computation needed
o At Implied Goodwill, the Consideration Transferred should exclude the Control Premium since
the premium is not intended to acquire the subsidiary and is not intrinsically valuable to the
acquiring entity as it has no business synergies peculiar to it; thus, including it in the
computation for implied goodwill will overstate Non-controlling Interest.
𝑁𝑜𝑛-𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑙𝑖𝑛𝑔 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
𝐼𝑚𝑝𝑙𝑖𝑒𝑑 𝐺𝑜𝑜𝑑𝑤𝑖𝑙𝑙 = ∗ (𝐶𝑜𝑛𝑠𝑖𝑑𝑒𝑟𝑎𝑡𝑖𝑜𝑛 𝑇𝑟𝑎𝑛𝑠𝑓𝑒𝑟𝑟𝑒𝑑 − 𝑃𝑟𝑒𝑚𝑖𝑢𝑚 + 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡)
𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑙𝑖𝑛𝑔 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
o At Proportional Goodwill, Non-controlling interest is computed independently.

Note 9 – Business Combinations Achieved in Stages**

• For investments that acquired control over stages, beginning with either nominal interest,
significant influence, or joint control, the investments are adjusted first to Fair Value:
o Existing Fair Value Model Investments (P/L or OCI) will be restated at the new fair value, and
OCI will be entirely recycled in the books of the Parent
o Existing Equity Model Investments (Associates or Joint Ventures) will be restated to fair value,
and Existing OCI is entirely recycled in the books of the Parent. The approach used to restate
these investments will be the Fair Value Model under PFRS 3
o The Equity Method or Cost Method is continued for use in the Separate Books of the Parent
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• Additional Considerations are added

• Existing Goodwill is adjusted to bring it to the new balance***
Example 1 - Acquirer initially held Joint Control with Entity A over Entity Z, holding 70% Interest over
Entity Z. Entity A decides to withdraw from the Joint Venture with the consent of the Acquirer. This
Arrangement will result in the Acquirer gaining Control, and thus requiring a Business Combination with
the Joint Venture, Entity Z.
Example 2 - Acquirer Co. initially held a portfolio of 10% Common Stock Investments over Entity A,
irrevocably holding it as Available-for-Sale. It had done so over five years and had a balance of
Unrealized Holding Gains thru OCI. After acquiring Control on April 1, 20XX, it must remeasure its old
Balance to Fair Value and add the Fair Value of the Consideration Transferred to the Owners of Entity
A. All of its OCI balances from equity is transferred thru Retained Earnings and its Goodwill Balance, if
any, will be adjusted accordingly. In its Separate Books, it MUST account for the investment using the
Fair Value model only since the option to record at FVOCI is exercised. Regardless, in the Consolidated
Financial Statements, the Investment balance is eliminated, and the OCI Reserve is reclassified.
The following Information pertain to Acquirer Co. and Entity A at the Date of Acquisition:
Initial Acquisition Cost (10%) P2,000,000 Fair Value of the Net Assets of P17,750,000
Entity A
Additional Interest Acquired (80%) P15,000,000 NCI at Fair Value P2,675,000
Provision for Contingent P500,000 Subsumed Goodwill of Acquirer P250,000
Consideration
OCI in Changes in Equity P150,000

Existing Interest: Effect to Profit or Loss:

Additional Interest P15,000,000 Gain (Loss) on Reclassification
from FVOCI to Consolidation
Method P/L
Provision – 500,000 (P1,937,500 -P2,000,000) (P62,500)
Contingency
Total Consideration P15,500,000 P15,500,000
Transferred
Divided by: Acq’d 80% Adjustments to Goodwill
Interest
Fair Value of Subsidiary P19,375,000 Subsumed Goodwill P -
Multiply by: Old 10% 1,937,500 Required Balance (FVS – FVNA) 2,362,500
Interest
Fair Value of Total 17,437,500 Adjustment to Goodwill*** 2,362,500
Interest
NCI at Fair Value 2,675,000
Total (FVS) 20,112,500 Transfer within Equity (OCI-R/E) P150,000
***Amount is debited to Goodwill, Credited against Investment in Subsidiary upon elimination
**(IFRS 3.42) ***(IFRS 3.32)

Business Synergies – Some problems provide different bases of fair values. Some incorporate business
synergies, and others do not. This is the case for Non-controlling Interest and the old balance of the
investment through the equity model. To some degree, the NCI, old Investment, and Newly Acquired
Shares are valued differently. This is because Old Interest is not originally acquired to generate goodwill,
unlike in acquiring control in the subsidiary. The event that causes the significant shift in intent are the
transactions that may only be accessible if control was acquired, something that Non-controlling Interest
does not possess.
In the Example above, the Fair Value of NCI is already valued independently from the Old and the New
Considerations; in interest of clarity, assume that the Fair Value of A Co. Shares in the Open Market of
P18,000,000. After Due Diligence, an independent appraisal values the Subsidiary at P20,000,000, and
Acquirer Co. deems it proper to attribute business synergies any premium over the market price. Apply
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Partial and Full Goodwill Method. Assume that the Consideration transferred infused with synergies
is still unknown.
Partial Full** **The Full Goodwill
Consideration Transferred P15,000,000 P15,025,000 Method in this
Old Interest (10%) 1,800,000 1,800,000 illustration does not
Provision for Contingency 500,000 500,000 deliberately
Fair Value of the NCI 1,775,000 2,675,000 maximize NCI for
Fair Value of the Subsidiary 19,075,000 20,000,000 the sake of
Fair Value of Net Assets of Subsidiary (17,750,000) (17,750,000) illustrating the next
Goodwill (Gain on Bargain Purchase) 1,325,000 2,250,000 instance.

IF for instance, the NCI was not available:

Partial Minimal NCI (10%) P1,775,000
Consideration Transferred P15,000,000 Share in Full
Goodwill 925,000
Old Interest (10%) Full NCI at Fair
1,800,000 Value 2,700,000
Provision for Contingency 500,000 ***The Fair Value of the Subsidiary
Fair Value of the NCI 1,775,000 less FVNA gives the Full goodwill
Fair Value of the Subsidiary 19,075,000 always.
Fair Value of Net Assets of **If the FVS is given, the Implied
Subsidiary (17,750,000) Method cannot be used, since the FV
Goodwill (Gain on Bargain of NCI and CT is inherent in the
Purchase) 1,325,000 amount.
Observe that Partial Method always attributes the Minimal Value versions of all the items in the case.

Note 10 – Business Combinations without Transfers of Considerations occur when:

• Control is acquired by contract alone
• Protective Rights of Minority Interest to Veto the Acquirer’s ability to Control expires; or
• Retention Rights and or removal rights by minority interest

Example 1 - In the Stockholders ‘Annual Meeting, the Board agrees to provide veto powers to
shareholders holding Significant Influence over the Acquiree after responding to competitive pressure
from the Acquirer holding Control currently. The veto rights shall lapse after five fiscal years, meaning,
the Acquirer holds no full control and is not required to consolidate. If after the five years, the Acquirer
still holds control over the subsidiary, then it shall regain control and will need to Consolidate the
Financial Statements of the Entities.
• The acquiree repurchases/transfers to treasury, shares that allows an existing shareholder to
gain control (in other words, the Existing Share of an investor becomes saturated with control)
• In all of the circumstances above, the ‘Acquirer’ has no proactive involvement in the business
combination, therefore, it transfers no considerations to the acquiree; hence only minimal NCI
is allowed unless the contrary is apparent.
• In some cases where no dilution is involved, Minority Interests will actually be the Controlling
Interest in the Consolidated Financial Statements depending on the substance of the
contract/transaction. In this case, the Non-controlling Interest is above 50%.

Example 2 - Entity A accounts for its investment in Entity B using the Equity Method as it holds 45%
interest in Entity B’s 100,000 shares, par P20 Common Stock. On April 1, 20XX, Entity B earned P150,000
in Net Income from January 1 of the same year. Entity B also declared P1.00 Cash Dividends to all
existing shareholders at that time, to be paid the following quarter. Entity B decides to repurchase
40,000 shares from its other stockholders. This will result in Entity A holding 45,000 shares out of 60,000
shares, requiring Entity A to consolidate. Data pertaining to the Business Combination at the date of
the acquisition are as follows:
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Existing Interest P1,350,000

Fair Value of the Net Assets of B P7,000,000
Fair Value of NCI P1,625,000
1. Adjust the Balance of the Investment to Carrying Value using PFRS 9, PAS 28, depending on the
Investment held. In this case, apply PAS 28.
Beginning Balance P1,350,000
Share in Net Income 67,500
Dividends (45,000)
Balance P1,372,500
2. Since there is no change in the actual number of shares held by Entity A before and after the
combination, no change in Fair Value is applied to the Existing interest for Goodwill computation,
hence: (This is unique to no-consideration-transferred questions)
Consideration Transferred (CI%*FVNA) P5,250,000
Non-controlling Interest 1,625,000
Fair Value of Net Assets (7,000,000)
Goodwill (Gain on Bargain Purchase) (P125,000)
**If NCI is measured in Proportionate basis, there is neither Goodwill nor Gain on Acquisition.
**Although there is actually no consideration transferred, the Acquiree essentially ‘sold’ control to the
acquirer through its treasury, in this case, for 75% of its Fair Value on its Net Assets.
3. In the separate financial statements of the parent, the Investment is updated to follow PFRS 3
hence:
Investment in Subsidiary P5,250,000
Investment in Associates P1,372,500
Gain on Remeasurement P3,877,500

Example 3 – Entity C accounts for its investment in Entity D using PFRS 9, and irrevocably elects to
measure it using FVTOCI holding 15% of the 100,000 share, par P30 common stock in the investee entity.
In a sudden spur of events, the Board of Directors had elected most of Entity C’s representatives to
handle management and business policy through a management contract. There is sufficient evidence
to declare that Entity C holds control over Entity D, as no other investor singly holds above 50% interest
in D. Entity C assented and is now required to consolidate. The following are available:
Nominal Interest (P36/sh.) P540,000 Consideration Transferred P0.00
Fair Value of the D Shares on Non-controlling Interest
Acquisition Date P45/sh. (85%*FVNAS) P3,412,962.50
FVNA of D P4,015,250 FVNAS (4,015,250.00)
NCI is valued proportionately *** Goodwill (Gain on Acquisition) (P602,287.50)
Accumulated Unrealized Gain OCI P375,000
Investment in Subsidiary P3,412,962.50
Investment Equity Securities -OCI P540,000.00
Gain on Remeasurement P2,872,962.50

Unrealized Gain through OCI P375,000

Retained Earnings P375,000
In both the above examples, the Method used is only the Partial Method since there is actually no active
intent to acquire the Subsidiary or Synergies of the Combination. A special exception can be made if the
acquisition is apparently intended by the parties. The tenor of the transaction/contract must be stated
explicitly in order to impose a value to goodwill, however, there are some clues as to whether the intent
to acquire is present, which would be the valuation of NCI on a full or due diligence basis i.e., if NCI is
given at fair value. (In the first example on anti-dilution, NCI is fairly valued. This is most likely because
non-controlling interest assented to the reacquisition of shares by the subsidiary in order to transfer
the rights to policy to the acquiring entity. By assenting to the transfer, the NCI holders can actually
sell their existing interest to the acquirer of some other diverse 3 rd parties at a premium than when the
treasury shares were outstanding.)
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Note 11 – Reverse Acquisitions

• When the Legal Acquirer issues Equity Instruments as a Consideration to the Legal Acquiree,
enough so that the Legal Acquiree acquires Control, the Acquiree becomes the True/Accounting
Acquirer, and the Acquirer becomes the True/Accounting Acquiree
• The Accounting Acquirer usually issues no Consideration to the Accounting Acquiree. Accordingly,
the Fair Value of the Consideration Transferred by the Accounting Acquiree to the Accounting
Acquirer is based on the number of Equity Interest the Legal Acquiree would have had to issue
to give owners of the Legal Acquirer the same percentage equity interest in the combined entity.
• The transaction is usually done by a Publicly-listed Entity with a Non-listed one. The Legal
Acquirer is usually the Publicly-listed Entity, this is done so that the Non-listed Entity will not
have to undergo Public Listing and Initial Public Offerings.
• Consolidate as usual (Accounting Acquirer consolidates, acquiree eliminates equity)
Entity A acquires Entity B by issuing 3.5 shares for each share of Entity B. Entity B currently has 50,000
Common Shares Issued and Outstanding, while Entity A has 75,000 Common Shares Issued and
Outstanding. The Market Value for Entity A Shares is P42.50, while the Market Value for Entity B Shares
is P62.75. Entity A is valued at P1,000,000, while Entity B is valued at P3,500,000.
Accounting Acquiree & Legal Parent Entity % Ownership Accounting Acquirer & Legal Subsidiary
A over A Entity B
Entity A – Shares 75,000 30% Entity B – Shares 50,000
Shares Issued to Entity B (1) 175,000 70% (2) Implied Consideration (4) 21,429
Total Shares B Shares at Controlling Interest
250,000 100% (50,000/70%) = 100% (3) 71,429
**The Implied Consideration only appears in the Consolidated Financial Statements at Fair Value: Par
Value for Share Capital, and residue in Share Premium; this means that this is Implied FV of Acquiree.
Consideration Transferred (Acquisition Cost)
1,344,643
(21,429 shares at P62.75)
Book Value of the Net Assets of the Subsidiary A (1,000,000)
Goodwill 344,643
Observe that the reverse acquisition presupposes that the shares of both A and B are actually equivalent
to the extent of the new shares issued by A. This means that the 50,000 shares of B are equal, at
least in intrinsic value, to 175,000 A Shares (70% of A), rendering control to the Equity Holders of B
(or Entity B itself). The Consideration Transferred by B is exactly the Business Synergies and ‘control’
that A sees in B less B’s existing share capital (the 50,000 shares were purchased, but A insisted on
purchasing B at a premium, which is 50,000/70%. The premium is B’s “consideration in terms of intrinsic
value” to A i.e., 50,000*30%/70%)
Accordingly, if there are Interests that dissent with the Reverse Acquisition in Entity B, they shall
constitute the Non-Controlling Interest. As such, the Consideration Transferred will be PRORATED
between assenting and dissenting interests of the Accounting Acquirer. (Although this is usually not the
case as those exercising dissent are afforded their appraisal rights prior to the business combination.)

Note 12 – Push-down Accounting

Push-down accounting is the act where the acquirer entity does not record the changes in the fair value
of the net assets of the subsidiary, and instead, pushes down the fair value changes to the subsidiary’s
books. This means that instead of recognizing an excess over book value, that which will be subsequently
amortized, the subsidiary records these changes in its own books, making the consolidation easier.
This also means that the subsidiary recognizes its own goodwill (the parent in this case, has nil goodwill
in its own books), and adjusts all assets and liabilities to fair value. Any changes thereto are credited to
Push-down Capital that replaces Retained Earnings in the subsidiary books in the case of a Push-down
acquisition. Upon Consolidation, the Subsidiary goodwill is then reported in the Consolidated Statements.

Acquirer's Books Acquiree’s Books Eliminating Entry

Investment in Subsidiary XX -no entry- Share Capital – Subs. XX
Acquisition
Consideration Transferred XX APIC XX
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Goodwill XX Push-down Capital XX

Retained Earnings XX Investment in Subs. XX
Adjust to
-no entry- FVNAS Increase XX NCINAS XX
FV
Push-down Capital XX
FVNAS Decrease XX ***NCINAS is minimized.
• On the date of the acquisition, there is no unusual change as to the effects of the transactions
other than the acquiree reporting goodwill instead of the parent; however, after the date of the
acquisition, the Fair Value amortization will not happen because the amounts are carried in the
acquiree’s books instead of the consolidated financial statements. In this case, all the assets
have been presented at ‘book value’ as far as the consolidation process is concerned.
• The choice to apply pushdown accounting is irrevocable, and is only allowed (at least for US
GAAP), when the parent acquires not less than 80% ownership. It is totally not allowed in the
IFRS due to the sunken Fair Values in the subsidiary; the absence of Fair Value Amortization will
not correctly state consolidated financial statements as a result of departing from Entity Theory.
Note 13 – IFRS 3 for SMEs
Full Consolidation Method SMEs Purchase Method
Consideration Direct Cost – Expensed Direct Cost – Capitalized
NCI Full or Partial Partial only
Goodwill Indefinite Life 10 Years or less
Reacquired right to an Favorable – Intangible No distinction
Operating Lease Unfavorable – Liability
Contingent Consideration P/L or APIC Adjust only to GW (No GBP)
Contingency Provisions after No Adjustment to Goodwill Fair Value adjustment
remeasurement period
Intangibles IAS 38 Control & Separability At Fair Value if reliably measured

Note 14 - Nature of Acquisition-related Fees in Business Combinations:

Legal Fees Expense
Audit Fees for SEC Registration and Stock Issuance Share Issue Costs / Debit Share Premium
Advisory Fees and Audit Fees in General Expense
Costs of Stock Certificates Share Issue Costs / Debit Share Premium
Broker’s Fees Expense
Other Direct Costs of Acquisition Expense
General and Allocated Expenses Expense
Listing Fees (no equities are issued, hence expense) Expense
All Indirect Costs Expense
Consolidated Balance Sheet – Date of Acquisition
Total Assets Total Liabilities Total Equity
Acquirer’s Book Value Book Value Book Value
Acquirees’ Fair Value Fair Value -0-
Consideration Transferred (XX) XX XX
Stock Issue Costs (XX) XX (XX)
Bond Issue Costs (XX) XX -0-
Directly Attributable Costs (XX) XX (XX)
Indirectly Attributable Costs (XX) XX (XX)
Contingent Considerations – Cash (XX) XX -0-
Contingent Considerations – Stocks XX - XX
Goodwill/Bargain Purch. XX = GW -0- XX = BP
Total XX XX XX
• Create a separate goodwill computation for each subsidiary; one subsidiary may have goodwill and
the other may have a Gain on Bargain purchase
• Consolidated Papers are understood to be after adjustments and elimination entries
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Separate & Consolidated Financial Statements (PAS 27, PFRS 10)

Entities engaged in Business Combination are generally required to consolidate their financial
statements. In comparison to Net Asset Acquisitions, Stock Acquisitions present the going-concern of the
consolidated entity only on report dates. This means that in between the report dates, the affiliated
entities still prepare their separate financial statements as a general rule. Hence, Net Asset
Acquisitions will continue only the going-concern of the combined entity indefinitely; while Stock
Acquisitions will continue both the separate and consolidated entity’s going-concern for as long as control
over the acquiree entity is manifested.
Net Asset Acquisition Stock Acquisition

Entity A Entity A 70% Entity A Going-concern

Consolidated Consolidated Entity

Consolidated A, Subsequent to
Going-concern Entity A, Date
Entity C Acquisition Date
of Acquisition

Entity B Entity B Entity B Going-concern

Consolidated Financial Statements – The financial statements of a group in which the assets, liabilities,
equity, income, expenses, and cashflows of the parent and its subsidiaries are presented as those of a
single economic entity (PFRS 10)
Control – An investor controls an investee when the investor is exposed to, or has rights to, variable
returns from its involvement with the investee and has the ability to affect those returns through its
power over the investee. Control is manifested by expressing all three characteristics:
• Power over an investee
• Exposure, rights, to variable returns from its involvement with the investee; and
• The ability to use its power over the investee to affect the amount of the investor’s returns
The responsibility to consolidate rests with the entity that exercises control over another entity. The
Parent is required to assess and reassess whether it controls a Subsidiary or not.
Power – Existing rights that give the current ability to direct the relevant activities of the group; i.e.:
• Protective Rights – Rights designed to protect the interest of the party holding those rights
without giving that party power over the entity to which those rights relate to (e.g., Stock Rights
Issued to prevent share dilution)
• Removal Rights – Rights that enable the holder to deprive the decision-making capability of an
authority (e.g., Veto powers to vote out a policy by a controlling majority)
Who are not required to consolidate?
• Investment Entities – these are entities that obtain funds from investors for the purpose of
providing returns to those investors through investment management services. As such, it is
within their nature to acquire investments, and as a consequence, acquire interests in firms. The
investments they hold are measured using PFRS 9; presenting only separate financial statements;
should they discontinue being investment entities, they may account for investments at either
Cost or Equity Model prospectively. And:
Any parent who meets all the below criteria: (They are required to present using Separate FS.)
• Parents of any subsidiary who elects to or does not object to parent not consolidating the F/S
• Parents whose debt or equity instruments are not issued in a public exchange
• Any parent who is not filing, nor is in the process of filing its financial statements to any securities
commission or regulatory body for issuing any class of securities
• It is the ultimate or intermediate parent of a parent that already produces consolidated FS
Parent Theory – the NCINAS is an external party, and that the Parent records the NCI as a liability as it
falls under its ‘custody’
Proprietary Theory – Consolidation does not recognize NCINAS, and therefore, only the Parent and its
controlling interest in the subsidiary is consolidated; the NCINAS is also its own entity.
Entity Theory – The NCINAS is a remnant of the subsidiary, not acquired by the parent. IFRS 10 imposes
this view upon the interest that the parent does not control.
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PAS 27 – Separate Financial Statements

If an entity elects, or is mandated by law to apply accounting for Investments in Subsidiaries, Joint
Ventures, and Associates under PAS 27, the Controlling Entity must prepare Separate Financial
Statements for each affiliate and for itself. Affiliated entities are accounted for either under Cost Model,
Fair Value Model, or Equity Model. Cost Model is covered by PAS 27; Fair Value Model is covered by
PFRS 9; Equity Method thru PAS 28.
• Initially, Equity Method under PAS 27 was not allowed, however, an update on the standard on
August 2014, applicable January 2016 onwards, reinstated the Equity Method to accommodate
countries that were required by law to use Equity Method under and within SFS.
• Held for sale or disposal investments are accounted for under PFRS 5, not in the scope of PAS 27.
Transaction/Amount Cost Model Equity Model Fair Value Model
OCI – Capitalized
Transaction Costs Capitalized Capitalized
PL – Expensed
Share in Net Income N/A PL N/A
Share in OCI/OCL N/A OCI N/A
Return of Capital or
Dividend Income PL PL
deduct from Investment
Impairment Test Yes, PL Yes, PL No
Change in Fair Value No No OCI or PL
Consolidation Procedure (PFRS 10)
Consolidation is performed on the date of acquisition because it serves as a starting point for the merged
entities for subsequent period.
• A parent shall prepare Consolidated Financial Statements using Uniform Accounting Policies for like
transactions and other events in similar circumstances
o This is adjusted only on the Consolidated Financial Statement, and thus applying PAS 8
o For practicality, the Parent may follow the policies of the Subsidiary
• As much as possible, Parents and Subsidiaries must have the same report date
o In case the report dates are not the same, the standard allows at most, a 3-month difference in
value between the Parent’s report date and Subsidiary’s report date; adjusting balances for
significant transactions by the subsidiary
• Consolidation shall begin from the date the investor obtains control of the investee and shall cease
when the investor loses control of the investee
• Aggregate all like items of assets, liabilities, equity, income, expense, cashflows of the parent & its
subsidiaries
• Eliminate the Investment Account in each Subsidiary & the parent’s portion of equity in each subsidiary
• Eliminate Intragroup transactions
o Intragroup Losses will require an impairment test, Goodwill is usually written-off
o Deferred Tax Assets will arise from Intragroup Sales that will be eliminated, presented in the
Consolidated Financial Statements and Separate Financial Statements
Goodwill Allocation
Subsequent to the Date of the Acquisition, a Consolidated Entity electing to account for NCI through the
Full Goodwill method (Expressly or Impliedly) shall allocate goodwill based on the Fair Value on a
prorated basis. Impairment Losses, as determined, will be shared in the same manner.
Total (ab) Parent (a/ab) Subsidiary (b/ab)
Cost: XX XX i.e., Consideration Transferred XX i.e., NCINAS, beg.
FVNAS (XX) (XX) i.e., CI%*FVNAS (XX) i.e., NCI%*FVNAS
Goodwill XX XX XX
Impairment Loss is based on the Balances of Goodwill
For Entities electing to use the Proportionate Method of NCI Valuation, the goodwill is attributable only
to the parent, thus the NCI does not share any impairment losses.
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Consolidated Income Statement

NIATOP NCINIS
Net Income – Parent XX -
Dividend Income from Subsidiary (XX) - In some other
Net Income – Subsidiary XX XX sources, the CNI
Amortization of Overvaluation Allowance XX XX is the total net
Amortization of Undervaluation Allowance (XX) (XX) income
Unrealized Gross Profit (XX) (XX) attributable to
Realized Gross Profit XX XX the equity
Unrealized Gains (XX) (XX) holders of the
Realized Gains XX XX parent, following
Bargain Purchase XX - the Entity
Total XX XX Concept in IFRS
Share in Net Income XX (XX) 10.
Goodwill Impairment (XX)* (XX)**
Final Share in Net Income XX XX
*Full Goodwill & Partial Goodwill – for Full Goodwill, the NCI will share in Goodwill Impairment, the
opposite is also true.
Working Paper Eliminating Entries
Dividend Income XX Sales XX
Non-controlling Interest XX Cost of Sales XX
1 Dividends Payable XX 5 To eliminate XX
To record Elimination of Intercompany Sales. XX
Dividend Income.
Share Capital - Subsidiary XX Gain on Sale
Retained Earnings -Subsidiary XX PPE, net
Investment in Subsidiary XX To Eliminate
2 6
Non-controlling Interest (always) XX Intercompany Sale of PPEs.
To record elimination of
Subsidiary Equity, and to recognize NCI.
Equipment XX Cost of Sales XX
Inventory XX Inventory, end XX
Direct Acquisition Expenses XX To eliminate Unrealized
Goodwill XX Profits from Ending Inventory.
Investment in Subsidiary XX
3 Non-controlling Interest XX 7 Retained Earnings – Parent XX
Provision for Contingency XX Non-controlling Interest XX
To record the Excess over Book Cost of Sales XX
Value or Undervaluation of Identifiable To Realize Profits from
Assets and Goodwill (Reverse the Beginning Inventory.
Accounts for Overvaluation).
Depreciation Expense XX PPE, net XX
PPE, net XX Depreciation Expense XX
To Realize Gains
Cost of Sales XX from Amortizing the
Inventory XX Depreciation Allowance.
4 8
Impairment Loss – Goodwill XX
Goodwill XX
To record the amortization of
the Allowances and Goodwill
Impairment
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Procedural Approach
1. Determine the Considerations Transferred
2. Determine the NCINAS
3. Determine the FVNAS of the Subsidiary at the Date of the Acquisition.
a. Fair Value of the Subsidiary is entirely different from the FVNAS. FV of the Subsidiary is all of the
Considerations Transferred
b. FVNAS is based on the Subsidiary’s SHE, accordingly, any data presented through the Separate
Financial Statements will have included in the balance these effects in Retained Earnings:
(1) Net Income Closed to Retained Earnings
(2) Dividends Declared
(3) Intercompany Transactions
(4) At this state, the SHE should be at Book Value at the Date of the Acquisition by reversing the
above effects. However, the Fair Value Excess have not been eliminated yet.
c. After applying the adjusting events, Apply Fair Value adjustment reversals and their Respective
Amortization, and deduct Goodwill, beg. to state the Subsidiary SHE to Book Value at the DoA.
4. Allocate any Net Income, Impairment Losses, and Dividend Income Eliminations to the Beg. Balances
d. With both the Subsidiary’s Beginning and Ending Balances Available, the NCINAS, end and
Consolidated Retained Earnings, end may now be computed
5. Determine the Goodwill, beginning, and apply Impairment Losses to get Goodwill, end.
Formulas
NCINAS, Beginning XX Parent Retained Earnings, adj. XX
NCINIS XX Parent Share Retroacted Subsid. Equity XX
Dividend Share in Subsidiary (XX) CNI – Parent XX
NCINAS, end XX Dividends Declared by Parent (XX)
Consolidated Retained Earnings XX
Share Capital – Parent XX **Amortization of Underval’n, normal bal. (XX)
Share Premium – Parent XX **Amortization of Overval’n, normal bal. XX
Consolidated Retained Earnings XX
Non-controlling Interest XX Consolidated Equity XX
Consolidated Equity XX Net Income of Subsidiary (XX)
Dividends of Subsidiary XX
Sales – Parent XX SHE at Book Value XX
Sales – Subsidiary XX Net Over (Under)Valuation Allowance XX
Intercompany Sales at Selling Price (XX) Net Assets at Fair Value XX
Consolidated Sales XX

Cost of Sales – Parent XX Operating Expense – Parent XX

Cost of Sales – Subsidiary XX Operating Expense – Subsidiary XX
Intercompany Sales at Selling Price (XX) Realized Losses thru Depreciation XX
Unrealized Profit – EI XX Realized Gains thru Depreciation (XX)
Realized Profit – BI XX Impairment Losses XX
Amortization of Over (Under) Inventory XX Amortization of Under (Over) Valuation XX
Consolidated Cost of Sales XX Consolidated Operating Expenses XX

Gross Profit – Parent XX Inventory at Book Value – Parent XX

Gross Profit -Subsidiary XX Inventory at Book Value – Subsidiary XX
Unrealized Profit EI (XX) Under (Over) Valued Inventory XX
Realized Profit BI XX Amortization of Over (Under) Inventory (XX)
Amortization of Over (Under)Valuation XX Unrealized Profit in EI (XX)
Consolidated Gross Profit XX Consolidated Inventory XX
When performing consolidation, the target result for Real Accounts would be to present the account
as if the intercompany transaction had never occurred.
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Reconstructive Problems in Consolidation

Retrospective Approach
Conso. R/E Adjustments to Subsidiary Data NCINAS
XX Subsidiary SHE XX
(XX) Upstream Transactions (RPBI, RGOS, etc.) (XX)
(XX) Subsidiary Net Income (XX)
XX Dividends XX
XX Subsidiary SHE, Beginning XX
XX Current Year Subsidiary Net Income XX
(XX) Current Year Subsidiary Dividends (XX)
XX Acc. Earnings to Parent/NCINAS XX
XX Goodwill beginning (if full) XX
XX Adjustment to CRE XX
Prospective Approach
Conso. R/E Adjustments to Subsidiary Data NCINAS
XX Subsidiary SHE XX
XX Upstream Transactions (UPEI, UGOS, etc.) XX
XX Subsidiary Net Income w/ Imp Loss GW XX
(XX) Dividends (XX)
XX Adjusted Subsidiary SHE XX
XX Acc. Earnings to Parent/NCINAS XX
XX Goodwill end (if full) XX
XX Adjustment XX
Parent’s Data
Retrospective Adjustments to Parent Data Prospective
- Current Year Net Income XX
(XX) Prior Year Net Income -
- Current Year Dividends (XX)
XX Prior Year Dividends -
- Downstream Transactions (RPBI, RGOS) (XX)
(XX) Downstream Transactions (UPEI, UGOS)
XX End Adjustment to Parent R/E Beg. XX
XX End Goodwill Beg. XX
XX Adjustment to CRE XX
Consolidated Balance Sheet – Establishing Reciprocity
The consolidated balance sheet subsequent to the date of the Acquisition should present all items in the
books of the parent and subsidiary under normal accounting. Only intercompany transactions shall be
eliminated, hence the working paper elimination entries in order to present the items as if belonging to
a single entity. As such, Goodwill is presented in the consolidated financial statement, but not in the
separate financial statements of the parent or subsidiary. The subsidiary net assets remain to be recorded
at fair value & NCINAS is recognized every consolidation since the consolidated entity does not have its
own journals. This also means that any changes in the subsidiary shareholders’ equity will make the
eliminating entries from the date of the acquisition different in terms of amounts. To close this
difference, an additional entry to eliminate the parent’s share in the changes of the subsidiary’s equity
is made. This is essentially eliminating the subsidiary’s post-acquisition earnings (Income and Dividends).
WPEE (9) Investment in Subs XX WPEE (9) R/E Parent XX
R/E Parent XX (Parent share) OR NCINAS XX (NCI Share)
Based on Beginning Equity of Subs. Based on Subsequent Date Sub. Equity
Notes for Separate and Consolidated Financial Statements
Note 1 – Consolidation at the Date of Acquisition
• The Investment Account is eliminated and Net Assets of the Subsidiary are presented at Fair
Value at acquisition date (amortizing the FV difference). The balance after Investment Account
is eliminated is attributable to Goodwill & NCINAS.
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Note 2 – Consolidation After the Date of Acquisition

• The Subsidiaries still prepare their separate financial statements, however, every period-end,
the Parent consolidates all the records into one financial statement.
• The consolidation of records involves the elimination of the investment account and intragroup
transactions, but are never entered into the books. These are prepared in a working paper.
• The Investment in Subsidiary Account is carried at either Cost, Fair Value, or Equity Model in the
Separate Books and then Consolidated. The change in Method from Cost or Equity into
Consolidated will apply PAS 8 Change in Accounting Policies
Cost Model – No changes in Fair Value or Shares in Net Income are recorded in the separate
books. Any further purchase or disposal of investment will result in NO GAIN/LOSS or ADJUSTMENTS TO
GOODWILL. Using this model, the Acquirer and the Acquiree are entirely independent, as if transacting
in the usual course i.e., seller-buyers for intercompany sales, debtor-creditors for intercompany loans.
They merely return to the Consolidation Model to reflect the actual business combination and exercise
of control. The only reversals for computing retained earnings beginning, in this case would be on
intercompany sales and dividend income
Equity Model – There is simply a one-line consolidation in the separate financial statements of the
parent; the shares in net income and dividends have already been included in the balance of the
investment in subsidiary account. However, the equity method does not recognize any impairment loss
the separate books. Impairment Losses may only be recognized in the Consolidated Financial Statements
since the Goodwill and the Investment Account are not accounted for separately; (PAS 28 refers to this
as Implied Goodwill which is not presented in the Separate Financial Statements)
Accordingly, the Eliminating Entries would be simplified due to the consistent updating in the Separate
Books of the Parent
Fair Value Model – Changes in Fair Value are recognized in the Separate F/S; likewise, any
dividends arising from the subsidiary is directly recorded as dividend income. Consolidation will simply
involve the elimination of the unrealized gains and losses through Fair Value, as well as any Dividend
Income; furthermore, any intercompany transactions and NCINAS are recognized as they should in the
like manner as in the cost model. (Although Fair Value through P/L Investments are typically not
construed to be imbued with synergy, thus there should be no control.)

Note 3 – Intragroup Transactions

Outsider

Realization of Gross Profit

Parent s Books
Parent Parent

Downstream Sale Downstream Sale of PPE

Upstream Sale of Inventory Upstream Sale of PPE
Consolidation of Inventory Consolidation

Realization of Gain on Sale

through Depreciation

Subsidiary Subsidiary
Subsidiary s Books

Sale of Inventory – The sales transaction is recorded twice, and so, are offset once the records are
consolidated. The resulting profit will eventually be offset once the inventory is actually sold to third
parties. The realized and unrealized portions are allocated between CI% and NCI%
• Consequently, the ultimate value of Consolidated Sales, Consolidated Cost of Sales, and
Merchandise Inventory is the transaction that is consummated with outsiders.
• The eventual sale of the inventory to outsiders will be a REDUCTION TO COST OF SALES or
DECREASE IN RETAINED EARNINGS and NCINAS if from a prior year.
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• The remaining inventory unsold will be an ADDITION TO COST OF SALES and a reduction against
Merchandise Inventory since the intercompany profit had not been consummated
• Since these Inventories are not really at their true amounts, the effects have to be removed
from Net Income
• To normalize income, for inter-year acquisition and consolidation, i.e., a report period is due
within less than 12 months, the Unrealized and Realized Gross Profit must be PRORATED along
with the NET INCOME of the Subsidiary.
• For Inter-subsidiary sales, simply eliminate every instance of sale and resale, this is because
every time a new gross profit rate is applied, the sales in the separate books increase
Sale of PPE – The gains or losses from sale of PPE can be realized much like inventory in two ways:
• Disposal – the PPE is eventually sold to third parties, much like inventory in the group; thus,
the CONSOLIDATED GAIN ON SALE shall be the difference between the Original Cost and the
Price it was sold for to Outsiders.
• If the Property, upon consolidation was under or overvalued, the Fair Value shall be the True
Cost of the property for recognizing the Consolidated Gain
• Depreciation – the Realized Profit is said to be realized due to continuing use
• Unlike inventory, which are expected to be normally transacted, Sale of PPE should NOT BE
PRORATED if the sale occurred in an inter-year since these are unlikely to be usual.
Intercompany Loans, Receivables, and Leases – The Receivable on one end is the Payable to another,
much like the Interest Income and Interest Expenses, they offset equally.
Intercompany Bonds – Like Loans and Receivables, this should resemble the preceding transaction, but
upon bond disposal to third parties, the Gain or Loss is realized entirely, and allocated accordingly.
Bond Amortized Cost XX • Direct Indebtedness – Eliminate outright any related accounts
Retirement Price (XX) • Indirect Indebtedness – This is when the Subsidiary issues
Loss (Gain) on Retirement XX debts to a 3rd party; the 3rd party in turn, lends the same
object of debt to the parent. In this case, there is a
constructive bond retirement.
Deferred Tax Assets and Liabilities – In the consolidated Financial Statements, deferred tax items will
arise out of the non-taxability of intercompany transactions such as dividends, transfer pricing rules, etc.
This is because the consolidated entities are still taxed separately, and each enjoy the benefit of the
deduction. Applying PAS 12, the deferred tax assets and liabilities are NOT OFFSET.
These will appear in both the Consolidated Financial Statement and Separate Financial Statements.

Note 4 – Change of Ownership without Change in Control and Reorganizations

• Change (increase/decrease) in control is considered merely as an equity transaction, no gain or
loss is recorded and goodwill is not adjusted
• Changes in Non-controlling Interest (Consideration – FV of NCI) is attributed through Share
Premium to Controlling Interest
Increase in Interest
Consolidated FS Separate FS
NCINAS XX Investment in Subsidiary (Based on BVNAS) XX
Share Premium XX Cash or other account XX
Cash XX Gain or Loss on Purchase XX
The CFS considers this Cashflow as The SFS considers this Cashflow as an
a Financing Activity. Investing Activity
Decrease in Interest
Consolidated FS Separate FS
Share Premium or R/E XX Cash XX
Cash XX Investment in Subsidiary XX
NCINAS XX Gain or Loss on Disposal XX
The CFS considers this Cashflow as The SFS considers this Cashflow as a
an Investing Activity. Financing Activity
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• Any balance of OCI will be RECYCLED PROPORTIONATELY to the amount of the Investment
Disposed (Decrease) or Reclassified to Consolidation Method (Increase).
• If the parent owns preferred Shares in the Subsidiary – the Parent’s Preferred Shares are
eliminated, while the NCI’s Preferred Shares are not eliminated. Their Dividends are also
eliminated in the same manner as common shares
• If the Subsidiary Repurchases Stocks from the NCI – In this case, the Subsidiary entity reacquires
treasury shares from the NCI. This will result in the recognition of the issuance of new share
capital. In the Separate FS, the Gains or Losses in Anti-dilution are recognized thru R/E, and
eventually closed into APIC and NCINAS. Furthermore, the Repurchase Transaction is eliminated.
Subsidiary SHE XX
New Proportionate Shares X%
New Book Value of Investment XX
Book Value of Investment in Subsidiary XX
Gain or Loss on Anti-dilution XX

Note 5 – Group Consolidation

Case 1 Case 2

Parent Parent
Indirect Interest = 48% Indirect Interest 24%
When a Subsidiary holds interest in
80% 80%
another subsidiary, the ultimate
parent holds either direct or
Subsidiary Subsidiary Subsidiary Subsidiary
indirect control over the final
1
60%
2 1
30%
2 subsidiary. So long as there is
control in the interceding
Case 3 Case 4 subsidiary, the parent must
consolidate the final subsidiary or
Parent Parent
affiliate. This will provide an
Total Interest = 30% + 19.2% Total Interest = 60% Indirect Interest in the final
subsidiary.
80% 30% 100%

Subsidiary Subsidiary Subsidiary Subsidiary

24% 60%
1 2 1 2

• Parent acquires 80% Interest in Subsidiary 1 for P1,300,000 on January 1, 20XX.

• Subsidiary 1 acquired 60% Interest in Subsidiary 2 on July 1, 20XX for P800,000.
• NCI of Subsidiary 1 is fairly valued at P300,000, while NCI of Subsidiary 2 is fairly valued at
P400,000.
• The Book and Fair Values of the subsidiaries are equal on both dates of acquisition; Subsidiary
1 Net Assets are P1,800,000. Subsidiary 2 Net Assets are P600,000.
• On December 31, Goodwill is determined to be Impaired by P5,000 for Subsidiary 2.
• Parent reports a Net Income of P2,000,000. Subsidiary 1 reports Net Income of P520,000, while
Subsidiary 2 reports Net Income of P450,000 from Subsidiary 1’s Date of Acquisition.
Apply PFRS 10 to determine NCINAS and Goodwill on December 31, 20XX.
Subsidiary 1 Subsidiary 2 Control: Subsidiary 1 Subsidiary 2
Consideration Transferred P1,300,000 P800,000 Direct Int. 80% -
NCINAS 300,000 400,000 Indirect Int. - 48%
Indirect Holding - (160,000) NCINAS 20% 52%
Adjustment**
Total 1,600,000 1,040,000 Total 100% 100%
FVNAS (1,800,000) (600,000)
Goodwill (GBP) (200,000) 440,000
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Goodwill, end Total Parent Subsidiary 2

Computation: (48% = 80%*60%) (52% = 100%-48%)
Fair Value P1,040,000 P640,000 P400,000
FVNAS (600,000) (288,000) (312,000)
Goodwill P440,000 P352,000 P88,000
Impairment (5,000) (4,000) (1,000)
Goodwill, end P435,000 P348,000 P87,000

CNI NIATOP NCINIS 1 NCINIS 2

Parent N/I P2,000,000 P2,000,000 - -
NCINIS 1 520,000 416,000 104,000 -
NCINIS 2 450,000 216,000 - 234,000
Impairment (5,000) (4,000) - (1,000)
Balance P2,965,000 P2,628,000 P104,000 P233,000

Subsidiary 1 Subsidiary 2
NCINAS Beginning P300,000 P400,000
NCINIS 104,000 233,000
Dividends - -
Indirect Holdings Adjustment - (320,000)
NCINAS, end P404,000 P313,000

**The Indirect Holdings adjustment is a deduction to Consideration Transferred and NCINAS since the
indirect holdings imply that the parent did not acquire the final subsidiary entirely; rather, the parent,
along with the interceding subsidiary’s Minority Vote acquired the final subsidiary.
𝐼𝐻𝐴 = 𝐶𝑇𝐺𝑖𝑣𝑒𝑛 𝑏𝑦 𝑆𝑢𝑏𝑠𝑖𝑑𝑖𝑎𝑟𝑦 1 𝑡𝑜 𝑆𝑢𝑏𝑠𝑖𝑑𝑖𝑎𝑟𝑦 2 ∗ 𝑁𝐶𝐼𝑜𝑓 𝑆𝑢𝑏𝑠𝑖𝑑𝑖𝑎𝑟𝑦 1
**Given a case where the parent may hold direct interest, but not control over a final subsidiary, the
procedure will not change. Simply apply the Direct Interest that the parent directly holds to the accounts
of the indirectly acquired subsidiary. The same procedure is applied to indirectly held interests. The
direct and indirect interests are then added for consolidation.

**For purposes of computing NCINAS in a complex holding, the same process of consolidation is applied.
Although one may expect to have NCI that are near or even exceed 51%.

Note 6 – Deconsolidation and Loss of Significant Influence or Joint Control

• Upon Loss of Control, Loss of Significant Influence, or Joint Control (Down to Joint Control or
Significant Influence, or Nominal Interest), a Gain or Loss on disposal reported in PL is recognized
depending on the method used by the Entity. (Cost or Equity Model)
• Net Assets in the Subsidiary are Derecognized at Cost, and the Remaining Investment is
remeasured at Fair Value. The Procedure is called Cessation (See Cessation in Equity Method)
• Do note that any balance of OCI (Revaluation Surplus, FVOCI, Effective Portion of CF Hedge, etc.)
will be ENTIRELY RECYCLED upon loss of control, significant influence, or joint control.
Fair Value of Remaining Interest in Affiliate XX FV of Retained Interest XX
Carrying Value of NCINAS -R/E XX CV of Retained Interest:
Carrying Value of NCINAS – R/E, OCI XX BVNAS XX
Fair Value of Consideration Received XX CV of NCINAS (XX) (XX)
Total XX Intrinsic Gain XX
Carrying Value of the Net Assets of Former Affiliate (XX) Boot or Cash Received XX
Goodwill at Carrying Value (XX) Write-off of Goodwill (XX)
Gain or Loss on Disposal XX Loss on Deconsolidation XX
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Note 7 – Mutual Holdings

Mutual Holdings are when the subsidiary holds some nominal or significant interests in the parent. It is a
consolidation of Reciprocal Interests. (Normal Accounting for share issues is followed by the Parent
Company)
Treasury Shares Method – The consolidated entity will treat the mutual holding by the subsidiary as
treasury shares. Hence, unique eliminating entries are:
Separate Books of Subsidiary Working Paper
Investment in Parent Co. Treasury Shares
Cash Investment in Parent Co.
Cash Dividend Income
Dividend Income Retained Earnings
to eliminate intercompany dividends.
Conventional Method – The consolidated entity will treat the mutual holding as if it had never occurred,
hence, the shares issued to the subsidiary are conventionally retired.
Separate Books of Subsidiary Working Paper
Investment in Parent Co. Common Shares
Cash Additional Paid-in Capital
Retained Earnings
Investment in Parent Co.
to eliminate the investment accounts
Cash Dividend Income
Dividend Income Retained Earnings
to eliminate intercompany dividends.

Note 8 – Consolidation under Equity Method

Consolidation under Equity Method is easier. This is due to the fact that the Investment in Subsidiary
Balance is consistently adjusted every time an intercompany transaction is done.
1. Eliminate the Investment in Subsidiary Balance and reveal the subsumed Goodwill balance
2. Income, Intercompany Accounts, and Dividends are already aggregated within the Investment in
Subsidiary Balance, hence no more adjustments upon consolidation.
3. Eliminate Subsidiary Equity and recognize Consolidated Retained Earnings; since intercompany
transactions and dividends are already eliminated, whatever balance remaining multiplied by
the Controlling Interest is the Consolidated R/E, and whatever remains is the NCI.
Practically speaking, Equity Method consolidation is preferred as it captures the accounting information
upon occurrence. However, theoretically, this type of consolidation follows the Proprietary Theory of
Capital, not the Entity Theory of Capital. As a matter of consistency in accounting application (with
parent’s own equity which follows entity theory), Cost Method is theoretically correct.

Other Notes:
• Dividend Income is included in Net Income in CONTINUING OPERATIONS (i.e., Dividends - Cost PL
OCI)
• Dividend Income is excluded from Net Income from OWN OPERATIONS
• Mind the dates of acquisition and report dates so as to prorate net income appropriately
Necessary Adjustments to Consolidation
• Inconsistent Accounting Policies – If there is a member of a group that uses accounting policies
other than those adopted in the consolidated financial statements, adjustments are made to
ensure conformity with the group’s policies
• Report Period differences – If the reporting dates of the parent and subsidiaries are different,
the following shall be done in order:
i. Subsidiary prepares additional financial information for consolidation procedures
ii. Subsidiary prepares information using the most recent financial statements adjusted
for effects of significant transactions/events that occur between SFS and CFS issue.
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Joint Arrangements (PFRS 11, PAS 28)

Joint control – a contractually agreed sharing of control over an arrangement, which exists only when a
decision about the relevant activities require the unanimous consent of the parties sharing control as
per PFRS 11. PFRS 11 recognizes both JV’s & JO’s, furthermore, joint control over an asset is accounted
for as a JO.
• Obtained by contractual arrangement
• Financial and operating decisions requires consent of ALL parties concerned, regardless of
equity interests or ownership rights in the arrangement
• Joint Arrangements are not clear-cut. It is not clear whether an agreement or arrangement
between parties constitute with certainty, a Joint Operation or a Joint Venture, hence there is
a constant need to reassess, upon changes in a contract or terms, if the arrangement qualifies
as JO or JV. (Accounted for Prospectively)
• Potential Voting rights are not considered in determining consent; however, Veto powers and
Removal Rights are considered in determining joint control
Collective Control – When a contractual agreement to share control exists, however, unanimity is not
certain as to the enactment of policy, there is only collective control.
Income (4)
Assets, Liabilities, Income, Expenses (3) Returns on and of Equity Capital (5)

Entity A Joint Venture

Entity A Assets (2) (1) Assets
Assets and Liabilities Separate
(1) Assets and Liabilities
Vehicle Equity Interests
Joint Operation
(2) (3)
Assets and Liabilities
Assets and Liabilities Entity B
Liabilities (2) Liabilities
Entity B (1)
(1)
Returns on and of Equity Capital Income
Assets, Liabilities, Income, Expenses (3)

Joint Operations (PFRS 11)

Joint Operations – parties having joint control of the arrangement have rights to assets, and obligations
for the liabilities placed into the arrangement, and which the arrangement assumed. The Operators
maintain title to their own Assets and Obligations in the Joint Operation, in essence, a co-ownership and
agency is at hand.
Joint Operations may either maintain its own books of accounts, or not. If the joint operation does not
maintain their own books of account, there are two methods of accounting for the Joint Operation:
• Partial Accounting for Joint Operations – the Co-operators maintain only their transactions with
the Joint Operation, not taking into account the transactions of the other operators with respect
to the Joint Operation.
• Full Accounting for Joint Operations – All Co-operators maintain each other’s capital accounts
If the Joint Operation maintains its own books, it is accounted for like a Partnership.
The accounting for Joint Operations is only a matter of consolidating like items, depending on the tenors
of the Joint Operation agreement or contract. This standard also includes Jointly-owned Assets
accounted for in the same manner as partnerships.
General Accounting for Joint Operations
• Joint Operators may report any investment in the joint arrangement differently from the other
operators. The owner asset or liability in the Joint Operator will record these accounts at Book
Value, while the other operators will record the same assets and liabilities at Fair Value as far
as their interest is concerned, as if owning the property themselves, if the problem is silent.
o This is primarily because the Investments in Joint Operations are accounted for under
normal accounting, and Investments into the Joint Operation requires the
derecognition of the asset invested in the Operator’s own books.
o As regards the other operators, this constitutes an entry value, and must therefore be
recorded at FV
• The Operators may choose to agree to carry the accounts at Fair Value in each of their books.
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1. All operators will recognize an Asset in JO with a value corresponding their Share %
2. The assets in the Joint Operation are recognized as Investments, hence will be Amortized
• The Operator’s own investment is a Derecognition of the Asset in their own books
• In the books of the Co-operators, if the Asset is carried at Fair Value, any difference with the
Book Value is credited to ‘Realized Gain or Loss; The difference in value will be divided into:
1. Unrealized Gains (Joint Operator’s Share %) – This is not presented as a liability, but rather
a contra-asset to the Asset in Joint Operation, subsequently amortized over the life of the
asset.
2. Realized Gains (Total of Other Operators’ Share %)
(See Investments of Non-monetary Assets in Joint Arrangements.)
• Intercompany Sales and Transfers in Joint Operations are only recognized once the sale is
transferred to third parties; Gains are amortized, while losses are recognized immediately
as impairment losses (if silent) unless other facts determine the absence of impairment.
• If a party has a stake over the JO, but no joint control, it accounts for its share in the Joint
Operation in accordance with the appropriate PFRS (PFRS 9, Cost Model, Fair Value Model). This
is the case with Joint Operations coursed through a separate vehicle with equity interests.
**The Assets Cash in Joint Ops and Building in Joint Ops can be combined into a single account:
Investment in Joint Ops to further emphasize their status as investments rather than the actual nature
of their accounts as regards the operation.
**Bear in mind that the co-operators are separate entities and are not affiliated outside the joint
operations. Therefore, a separate sale to co-operators or co-investors are external transactions.
However, the Joint Operation if through a separate vehicle gains separate existence, is an affiliated
party of all operators.
Investments of Non-Monetary Assets in the Joint Arrangement
Because of the fair value amortization, and the effective realization of transactions as among the co-
investors, the non-cash asset investments are effectively disposed or technically, sold in the like manner
as in business combinations, with respect to the separate financial statements. This also applies to Joint
Ventures.
Investments in Kind into the Joint Arrangement must take into account the applicable standards
(i.e., PAS 16, PFRS 13, PAS 40, PAS 36, etc.)
o No Commercial Substance – the Entire unrealized gain is not realized until full disposal or
amortization.
o With Commercial Substance – with Fair Value = Unrealized and Realized Gains are recorded
Investment in Joint Arrangement contains a Return of Capital – this occurs when a joint investor invests
assets into the joint arrangement for a consideration from the other joint investors.
o The return of capital is also called ‘Boot’ or Proceeds from the Part sale-investment
transaction.
o The Boot is considered a partial sale since these come from the investment of other venturers
or from the other venturer’s shares in the Joint Operation’s Borrowings.
o As such, the gain or loss is said to be realized insofar as how much of the cost of the boot is
recovered.
𝐹𝑎𝑖𝑟 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐵𝑜𝑜𝑡
𝐶𝑜𝑠𝑡 𝑜𝑓 𝐵𝑜𝑜𝑡 = 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑖𝑛 𝐽𝑉 ×
𝑇𝑜𝑡𝑎𝑙 𝐹𝑎𝑖𝑟 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐶𝑜𝑛𝑠𝑖𝑑𝑒𝑟𝑎𝑡𝑖𝑜𝑛 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑
Fair Value of the Consideration Received XX
Cost or Book Value of the Investment (XX)
Unrealized Gain XX
Realized Gain on Sale:
Fair Value of Boot XX
Cost of Boot (XX) (XX)
Balance of Unrealized Gain subject to Amortization XX
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**Observe that the above transaction effectively resembles a sale to outsiders. This is a purchase where
the purchasing venturer ‘pays’ for the incoming venturer’s participation in the joint venture much like
a bonus to another partner in partnerships.
If the consideration received was from the share of a co-venturer’s debt, the realized gain will be:
Investment of Co-Venturers XX
Share of Co-venturers in Additional Debt (% of Debt) ** XX
Total Proceeds XX
Cost or Book Value of Boot (XX)
Realized Gain on Sale XX
𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑐𝑒𝑒𝑑𝑠
𝐶𝑜𝑠𝑡 𝑜𝑟 𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 =
𝑇𝑜𝑡𝑎𝑙 𝐹𝑎𝑖𝑟 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐶𝑜𝑛𝑠𝑖𝑑𝑒𝑟𝑎𝑡𝑖𝑜𝑛 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑
**The Investment of the Co-venturers effectively constitute a purchase, as such, any deficiency in the
capital balances of the co-venturers must be assumed through debt by the Joint Venture on their behalf.
As such, the debt is divided into the respective shares of all the venturers. Only the purchasing
venturers’ share in debt will be included in the total proceeds.
**Notice also that since the Joint Venture borrows in behalf of all the venturers, the selling venturer
has leveraged his own investment in the joint venture, having a return on equity.
A Co. and B Co. formed ABC Co. on January 1, 2020. A Co. Invested equipment with a carrying amount
of P750,000 and a fair value of P1,120,000 for a 40% interest in the separate vehicle. B contributed new
equipment having a fair value of P1,470,000 for the remaining interest in ABC. Both sets of equipment
have useful lives of 5 years.
Case 1 – If A’s transfer has no commercial substance, there is no Realized Gain and the entire difference
between carrying amount and fair value is unrealized but are amortized over 5 years.
Case 2 – If A’s transfer has commercial substance, there is a realized gain which is determined in the
same manner as investments from Joint Operations.
Case 3 – If A’s transfer was executed for a full consideration from B of P225,000:
Fair Value of the Consideration Received P1,120,000
Cost or Book Value of the Investment (750,000)
Unrealized Gain 370,000
Realized Gain on Sale:
Fair Value of Boot P225,000
Cost of Boot (750 * 225/1,120) (150,670) (74,330)
Balance of Unrealized Gain subject to Amortization 295,670
Case 4 – If A’s transfer was executed for a full consideration from B of P225,000 however, B’s cash is
insufficient to cover the sale by P75,000 requiring the venture to assume debt.
Investment of Co-Venturers P225,000
Share of Co-venturers in Additional Debt (% of Debt) 45,000
[75,000*60%]
Total Proceeds 270,000
Cost or Book Value of Boot (750*270/1,120) (180,804)
Realized Gain on Sale 89,196

Joint Operation as a Partnership or Unincorporated Venture (PFRS 11)

The same principles are applied as in the previous discussions on Partnerships; Income is distributed in
the same manner as with partnership accounting, and the final cash distribution of the Joint Operation
is determined in the like manner as with Partnership Liquidation.
• The Investment in Joint Operation is the Venturer’s own contribution in the JO plus Distribution
of Net Income.
Investment/Assets in Joint Operation (Operator’s Own Books)
Contributions Sales and Other Income
Expenses and Cost paid for Joint Operation Withdrawals
Share in the Profit of Joint Operations Share in the Loss of Joint Operations
Receivable from Joint Operation Payable to Joint Operation
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Co-Operator’s, Capital (Equity Account in Operator’s Own Books)

Receivable from Operator, beg. Contribution/Investment
Withdrawals of Contributions Costs and Expenses paid for Joint Operations
Share in the Loss of Joint Operations Share in the Profit of Joint Operations
Payable to Co-Operator Receivable from Co-Operator
• Profits or Losses are distributed according to any arrangement agreed-upon.
• If JO does not maintain its own books, the Operators must account for each other’s investments
in the JO. Accordingly, this means that the other operators recognize the Investment at Fair
Value, whereas the investing operator derecognizes an asset for their investment at book value.
The difference is accounted for as an Unrealized Gain or Loss in Joint Operations to be amortized
over the term of realization (Much like understated or overstated Inventories, PPEs, etc. in
Separate and Consolidated FS under IFRS 10.)
Trial Balance of Joint Operations
Assets in Joint Operation Liabilities in Joint Operation
Merchandise Contribution Merchandise Withdrawal
Purchases and Freight in Purchase Returns, Discounts, and Allowances
Sales Returns, Discounts and Allowances Sales and Other Income
Expenses (Paid by Operators or from own Cash) Ending Inventory
Loss on Joint Operations Profit from Joint Operations
Presentation of Joint Operations in the Separate Financial Statements
• Investments or Net Assets in Joint Operations are presented as a separate line-item in the
financial statement of each reporting operator. The Operator need not present nor disclose the
interests of his co-operators.
• The Investment Balance is net of any contra-asset to the investment such as the Unrealized Gain.
• All intercompany sales are eliminated. This includes only those between any operator and the
joint operation, if the operation maintains its own books.
• The Joint Operation is akin to a triple entry accounting system. The records of each operator
should reconcile with the records of others. This means, that if a transaction is recorded by A,
then both B and C must have that same transaction recorded if they maintain their own books.
Joint Ventures (PFRS 11, PAS 28)
Joint Ventures – parties that have joint control have rights to the equity of the arrangement, i.e., the
outcomes of the arrangement such as income, expenses, and liquidated assets. It is the same as with an
investor to a corporation, instead of owning the literal assets of the partnership that they invested in,
and owing the literal obligations in the venture. The Venture is totally distinct from the investors, i.e.,
the Venture actually owns or holds title to its own Rights, Properties, and Obligations.
**These will always require a separate vehicle to substantiate
• A separate vehicle is essentially a contract that makes it so that two entities may come together for
any undertaking, for instance, a contract specifying an agreement between two entities to cooperate
in developing national roads, specifying a pooling of funds, interests in their outcomes such as profits,
etc. would be considered the separate vehicle
• Two corporations agreeing to pool funds into forming another corporation can be considered a separate
vehicle for the joint venture. Though the spawned corporation maintains its own separate books of
accounts, the investor-corporations shall maintain an Account called Investment in Joint Venture if
their contract to incorporate, as well as the Articles of Incorporation and By-laws, satisfy PFRS 11.
• Be mindful however, that even if there may be a separate vehicle to form the arrangement, it may not
always be considered a JOINT VENTURE.
• It will be a JOINT OPERATION if the contract specifies for in both substance and form, the rights
over assets and assumptions of the liabilities accrued, instead of Equity Interest
• An entity that participates in the Joint Venture, but has no joint control shall account for this through
PFRS 9 or PAS 28 if the party has SIGNIFICANT INFLUENCE OR ‘CONTROL’ upon election.
• ACCOUNTED FOR UNDER EQUITY METHOD
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Joint Arrangements for SMEs

• In the full PFRS, Joint Ventures may only be accounted for using the Equity Model
• For SMEs, it may be accounted for using Fair Value Model, Cost Model, or Equity Model
• Technically, this includes the old standard which recognizes SME Joint Ventures as Jointly-controlled
Entities.
• Do also observe that SMEs opting to use the Equity Model will include Goodwill Amortization for 10
years.
Fair Value Model Cost Model
Initial Recognition Fair Value, excluding Transaction Cost Purchase Price plus Transaction
Cost
Subsequently Beginning Balance adjusted to Fair Value Beginning Balance + Impairment
at the End of the Period Loss – Impairment Reversal

FV Model Cost Model IFRS for SMEs identifies Joint Arrangements

Dividend Income XX XX through the Old standard IAS 31; Jointly
Unrealized Gain/Loss XX - controlled Assets and Operations are Joint
Transaction Cost (XX) - Operations, whereas Jointly controlled entities
Impairment Loss - (XX) are akin to Joint Ventures in IFRS 11.
Impairment Reversal - XX
Effect in P/L XX XX
**If the SME JV elects to record the investment at Equity Model, it follows the standards set by PAS 28
Equity Method (PAS 28)
Equity Method/One-line Consolidation - A method of accounting whereby the investment is initially
recognized at cost and adjusted thereafter for the post-acquisition change in the investor's share of the
investee's net assets. The investor's profit or loss includes its share of the investee's profit or loss and the
investor's other comprehensive income includes its share of the investee's other comprehensive income
Purchase Price XX Share in Net Income (N.I. * Equity Interest) XX
Transaction Cost XX Unabsorbed Impairment Loss XX
Beginning Balance XX Intercompany Sales/Transfers XX
Investment Income (A) XX Amortization of (UV) or OV of Net Assets XX
Share in OCI(L) XX Gain on Bargain Purchase XX
Dividend Income (XX) Investment Income (A) XX
Net Impairment Loss (XX) **Shares in OCI will still be subject to Recycling
Balance XX **SEE CESSATION AND DEEMED SALE in Auditing and FAR
Unabsorbed Impairment Loss – If the balance of an investment is smaller than an Associate/Joint
Venturer’s share in Net Loss, the investment is considered to be impaired, however, the standard
specifies that no investment under equity model may be carried at a balance below zero, hence the
standard permits this unabsorbed impairment loss to be netted against an investor’s share in the
investee’s net income in the subsequent periods until the investee starts to earn profits, this means that
the investor discontinues recognizing further any share in net loss until the investee’s share exceeds the
loss, otherwise, no share may still be recognized.
• Accounts Absorb the Losses in this Order:
o Carrying Amount of Investment in Joint Venture/Associate
o Investment in Preferred Shares over the Joint Venture/Associate
o Unsecured Long-term Receivables or Unsecured Loans
• An Unabsorbed Impairment Loss is kept (Non-current Liability), if it persists to exceed absorbing
balances
**The Joint Venture or Associate will have to adjust its financial statements to match that of its Investor.
Therefore, the equity accounts must be adjusted using the guidance of PAS 8 Changes in Acctg Policies
**For Joint Ventures, an investor will record the purchase price at the higher of Cost or FVNA, for
Associates and purchasers of interest in JV, the Investor will record at the Consideration transferred.
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Intercompany Transactions
The same core principles apply to any other arrangement such as for Subsidiaries, Associates, and Joint
Ventures accounted for under Equity Method. Elimination entries are prepared. Except that the Co-
venturer’s transaction with the Joint Venture is not recorded by the Venturer.
A Venturer B Venturer
Net Income of JV XX XX
Intercompany Profit to A XX -
Intercompany Profit to B - XX
Adjusted Net Income as far as the separate venturer is concerned XX XX
Share in JV A% B%
Share in Net Income XX XX
***A’s transaction to B is an external transaction as far as the Joint Venture is concerned
Step Acquisitions
• Fair Value Approach – the Existing Interest is restated at Fair Value, and the consideration
received are added to the existing interest at fair value. The restated fair value will yield a gain
or loss on reclassification of investment charged to P/L. Furthermore, the Gain or loss on
acquisition is also recognized. (Consideration Received – Book Value of Net Assets * % Interest)
𝐹𝑎𝑖𝑟 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐸𝑥𝑖𝑠𝑡𝑖𝑛𝑔 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 + 𝐶𝑜𝑛𝑠𝑖𝑑𝑒𝑟𝑎𝑡𝑖𝑜𝑛 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑 = 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝐵𝑎𝑙.
Discontinuance of the Equity Method
Loss of Significant Influence or Joint Control will require the 100% recycling of OCI balance. If there is
no loss of either Significant Influence or Joint Control, then OCI will only be recycled proportionately.
Be aware of where the OCI must be recycled too. Some Items of OCI are recycled to Retained Earnings
such as Unrealized Gains through OCI from Equity and Revaluation Surplus, and some are recycled
through Profit or Loss such as Unrealized Gains through OCI from Debt Securities and Cumulative Foreign
Translation Gains or Losses.
Cessation – The actual Disposal of the Investment will require a remeasurement of the amount of the
amount remaining. As such, the amount or portion of interest that is held for disposal must first be
restated at fair value and then must be accounted for under PFRS 5, as a Non-current Asset Held for Sale.
Fair Value of Remaining Investments XX
Net Proceeds XX
Carrying Amount of Investment at Date of Discontinuance of Equity Method (XX)
Total Gain or Loss (Sale and Reclass) XX

Realized (Sale) Unrealized (Reclass) Total

Proceeds from Portion Disposed XX - XX
FMV of Portion unsold and reclassed - XX XX
CV of Investment** (XX) (XX) (XX)
Gain or Loss before Recycling XX XX XX
OCI** XX XX XX
Gain or Loss on Cessation XX XX XX
Dilution/Deemed Sales – Dilution or Deemed Sale is an event where an investor fails to protect themself
from losing interest in the capital stock of the investee. This occurs if the investor does not exercise its
preemptive right against dilution from additional issuance of shares or from failing to acquire stock
dividends from the investee. This means that as other shareholders acquire shares from the investee,
the associate losses capital interest by virtue of the other investors improving their capital positions
(i.e., 20 from 100 (20%) is different from 20 from 120 (16.67%)).
Proceeds from Issuance of New Shares * % owned after Dilution XX
CV*(%Decrease in Interest/Original Interest) XX
Gain or Loss before Recycling XX
OCI XX
Dilution Gain/Loss XX
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Foreign Exchange Transactions & Translation (PAS 21, PAS 29)

Foreign Exchange – is the act of trading one currency for another. The Foreign Exchange Markets are
the largest, most liquid markets in the world, constantly exchanging monetary items. Monetary Items
such as Cash, Credits, Securities, Derivatives, and the exchanges thereof, enable entities to enter into
various markets internationally.
The main guidance on Foreign Transactions is provided by PAS 21, it applies to:
• Accounting for TRANSACTIONS and BALANCES in foreign currencies, except for those derivative
transactions and balances within the scope of PAS 39 Financial Instruments
o Embedded Derivatives, covered by PFRS 9, are included in the Scope of PAS 21 since PAS 39
does not cover Embedded Derivatives.
o PAS 21 does not cover Hedge Accounting. PAS 39 and PFRS 9 cover Hedge Accounting
o PAS 21 does not cover the presentation in the Statement of Cashflows of the Cashflows arising
from transactions in Foreign Currencies, or to the translation of cashflows of a foreign
operation (PAS 7 Statement of Cashflows)
• TRANSLATING the results and financial position of Foreign Operations that are included in the Financial
Statements of the entity by Consolidation, Proportionate Consolidation (Equity Method); and
• Translating an Entity’s result and financial position into a Presentation Currency
Definition of Terms
• Closing Rate – spot exchange rate at the end of the period
• Exchange Difference – the difference resulting from translating a given number of units of one
currency into another currency at different exchange rates
• Exchange Rate – the ratio of exchange for two currencies
• Functional Currency – currency of the primary economic environment in which the entity operates
• Presentation Currency – the currency in which financial statements are presented
• Spot Rate – indicates the number of units of a currency that would be exchanged for one unit of another
currency on a given date
• Forward Rate – specifies at a point in time, the number of units of one currency to be exchanged for
one unit of another at a future date
• Buying/Bid Rate – the rate at which a bank is willing to purchase a foreign currency
• Selling/Ask Rate – the rate at which a bank sells a foreign currency
• Direct Quote – Expresses the Functional Currency as the basis for the Local Currency i.e., 1$: P50
• Indirect Quote – Expresses the Local Currency as the basis for the Functional Currency i.e., $0.20: P1
FOREX Trading
The procedure for FOREX Trading begins with the transaction by a domestic entity with another entity
abroad. This requires the parties to transact at a common currency. In this case, a dealer of foreign
currencies ‘sells’ these currencies to the buyer to allow it to transact with the seller. The dealer is
usually a bank that has expanded foreign currency deposit units. When the buyer is contractually bound
to deliver at seller’s currency, the transaction is called an import; and thus, must purchase at the bank’s
selling rate. When the seller is contractually bound to accept the currency, it is called an export; and
thus, must convert the foreign currency at the bank’s buying rate to be able to use it as legal tender in
its country. When dealing with interest receivable or payable, these are converted at the spot rate being
monetary accounts. Additionally, to prevent the changes from affecting the financial statements
materially, either party may enter into Hedge Accounting and may invest in Derivatives.
Interaction with Fair Value Securities
• The standard does not require segregating changes due to fair value from changes due to forex
fluctuations. Regardless, some problems may require segregating these.
• The rate used by the FV Assets are the Revaluation Rate (which is usually also the current rate
at the end of the period.)
• Change in FV = Change in FV at FC * Historical Rate
• Change in Forex = Change in FX * FV, end
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FOREX Transactions (PAS 21)

Initial Recognition – A foreign currency transaction should be recorded initially at the rate of exchange
at the date of transaction
Subsequently:
• Amounts of Monetary Items are reported at the closing rate
• Non-monetary items that are carried at Historical Cost are stated using the rate in which these were
recognized
• Non-monetary items that are carried at Fair Value are restated at the rates in which the fair values
were determined
• Monetary Items – Any Item with a right to receive or an obligation to deliver a fixed or determinable
number of units of currency
• Non-monetary Items – All Items that are not monetary
Monetary Items Non-monetary Items
Cash and Cash Equivalents Prepaid Goods/Services
Financial Assets at Amortized Cost Goodwill
Notes and Accounts Receivables, and Allowances Intangibles
Advances to Employees Inventories
Prepaid Interest PPE and Depreciation
Lease Receivable and Lease Obligations Provisions settled in-kind
Cash Surrender Value Advances to and from suppliers
Pensions & Other Employee Benefits paid in cash Fair Value Investments and Securities (P/L or OCI)
Provisions settled in Cash Share Capital
Cash Dividends Payable Share Premium
Accounts, Notes, Bonds Payable Non-Controlling Interest
Financial Instruments that pay or receive a fixed Generally, Service Warranty Liabilities (IAS 37)
and exact amount of cash Deferred Tax Assets/Liabilities (generally)
Common Foreign Exchange Transactions
Buying and Selling Goods or Services, Lending Activities, Disposal of Assets/Extinguishing Liabilities using
Foreign Currencies, Investment Activities
Procedures in FOREX Transactions
• A change in exchange rates between the foreign currency and the functional currency increases or
decrease the expected amount of the functional currency. This is called a FOREX Gain or Loss/ FOREX
Translation Gain included in Net Income (Reported in Profit or Loss)
• A transaction gain or loss (also FOREX Gain or Loss) measured from the most recent intervening
balance sheet date or settlement date, whichever is later, realized from settlements/disposals should
be included in Net Income (Reported in Profit or Loss)
• For International Investing Activities: Net Foreign Operations
o At the transaction date, each asset, liability, revenue/gain, expense/loss arising from the
investment transaction should be measured and recorded in the functional currency of the
recording entity, using the exchange rate in effect on that date
o At each balance sheet date, recorded balances that are denominated in foreign currencies
other than the functional currency of the recording entity should be adjusted to reflect the
current exchange rate.
o Separate FS – Report Net Investment Operations Thru P/L
o Consolidated – Report Net Investment Operations in OCI, then reclassify to P/L upon
realization/settlement/depreciation
• For non-monetary items recognized in OCI, FOREX Changes shall be presented in OCI
• For non-monetary items recognized in P/L, FOREX Changes shall be presented in P/L
• For Changes in Functional Currency, these are applied prospectively from the date of change
**Purchasing Power Gain or Loss/Monetary Gain or Loss/Restatement Gain or Loss are also known as
Translation Gains or Losses (Strictly NOT for Transaction Gains or Loss)
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FOREX Translation (PAS 21, PAS 29)

Foreign Exchange Translation can only occur once there is an extension of the main entity to international
operations (either a stand-alone associate/subsidiary, joint venture, or branches), therefore, entities
merely transacting with foreign counterparts do not need to engage with FOREX Translation.
Steps in FOREX Translation
• Step 1 – Determine the Functional Currency – there are some factors to consider:
o The functional currency is usually the one that influences SALES of Goods and Services
o The country whose competitive forces and regulations mainly determine sales prices
o The currency that mainly influences costs of production will often be the basis for the markup
o The currency in which funds from financing activities are generated
o The currency from which receipts from operations are retained
o Whether or not the extension has a significant degree of autonomy
i. Its transactions comprise a majority of the reporting entity’s operations
ii. Cashflows are significant relative to the main entity
iii. Cashflows are sufficient to service its own debt obligations
o Currency determined by professional judgment
• Step 2 – Apply that currency to the various accounts in the financial statements, either at the
Functional Currency or Presentation Currency
• Step 3 – Report the Effects of the Translation in accordance to the standard.
Functional Currency vs Presentation Currency (Steps 2 and 3)
Functional to Presentation Functional
Closing/Current Rate/Net Temporal Method/ Remeasurement
a.k.a.
Investment/Translated Method Method/ Historical Cost Accounting
Foreign Operations are independent Foreign Operations are significant to
Used when:
from the Parent/Main Office; not the Parent/Main Office; is integral to
integral to Parent’s strategy Parent’s Strategy
The Foreign Operation is treated as The Foreign Operation is not a net
a Net Investment. As if the entire investment, and functions as active
operation was a Separate extension of the parent’s operations.
Investment Asset, hence the Fair There is no Push-down accounting
Values are applied and Pushed- applied since the Local Office retains
Accounting Treatment down to the Foreign Operation. control over Net Assets as if these
The differential between the Net were part of Parent’s Operations.
Assets and Existing Equities The translation adjustments are not
attributed to the foreign operation treated as a reserve, so these are
is treated as OCI translation reserve reported in Profit or Loss, unless the
Revaluation Model is used (OCI).
Functional Currency is The LCU of the extension or if it is a The Parent’s Currency
Translated into: 3rd country’s currency (TCC)
The Functional Currency is NOT The Functional Currency may or may
PAS 29
HYPERINFLATED not be HYPERINFLATED
Monetary Items Current Rate Current Rate/Closing Rate
Non-monetary Items Current Rate Historical Cost
Invst. Ppty & Eqty Sec. Current Rate or Revaluation Rate Current Rate or Revaluation Rate
Shareholders’ Equity Historical Cost Historical Cost
Beginning R/E Equal to Ending Balance last year Equal to Ending Balance last year
Dividends Historical Cost at Declaration Historical Cost at Declaration
Historical Rates/Fair Value or Related to Non-monetary – Same
Average Rates (Prefer Average) rule as Current Method
Revenues and Expenses Related to Monetary – Historical
Rate or Average Rate, take average
unless fluctuations are significant
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ENTIRELY Reported in OCI, until Reported in P/L, but if the income

ultimate disposal due to recycling in item is designated at OCI, in then
Translation Gain/Loss
the Consolidated FS. (SFS of that portion is reported in OCI
foreign investee in P/L)
• Goodwill arising from Acquisition of Foreign Subsidiaries – Translated as Closing rate, since these
are attributable to the foreign operations of the parent (Foreign Subsidiary Investments are
typically pushed-down, hence goodwill is applied on a current method basis.)
• Upon disposal of a foreign operation, the cumulative amount of OCI is recycled into Profit or loss,
proportionately or entirely, depending on the degree of control or influence lost; IMPAIRMENT
OR WRITEDOWNS ARE NOT TREATED AS DISPOSALS.
• The steps to translating consolidated financial statements: Restate, Translate, then Consolidate
• Revaluation Rate or Current Rate is applied at whichever rate is the latest available.
Foreign Curr -> Functional Curr = Temporal Only Functional Curr -> Report Curr = Current only
Functional Curr = Report Currency = Temporal Functional =/= Report Currency = Current
Hyperinflationary Economies PAS 29 – Constant Peso Approach
The financial statements of an entity that reports in the currency of a hyperinflationary economy should
be stated in terms of the measuring unit current at the balance sheet date. Comparative figures for prior
periods should be restated into the same current measuring unit. Operations in Hyperinflationary
Economies require the entity to adjust some of its accounts to reflect the effects of inflation. This is
done by RESTATING THE ACCOUNTS at the General Price Index.
𝐆𝐞𝐧𝐞𝐫𝐚𝐥 𝐏𝐫𝐢𝐜𝐞 𝐈𝐧𝐝𝐞𝐱 = (Current Year Index − Base Year Index)/(Base Year Index)
• The base year index is usually the first year an entity begins to operate in a hyperinflationary economy,
otherwise, the base year will have to be mentioned by the problem; if it is still silent, take the last 3
years. The current year is hyperinflated if the general price index is larger than 100%.
• Monetary Items are NOT ADJUSTED TO THE GENERAL PRICE INDEX
o UNLESS the monetary item is expressly made to be valued at the Index
• Non-monetary items are generally adjusted to the GPI (Asset*Current Index/Historical Index), except:
o If the Non-monetary item is restated at Fair Value or Net Realizable Value, they are NOT
RESTATED
o If the Non-monetary items are acquired mid-year, then the GPI for 2 years is used, and
averaged; the index is applied proportionately.
o Sometimes, the index is not applied exactly proportionately. If the problem is silent on the
inter-year indexes, the index increases proportionately
• Income Statement Items are expressed at their restated forms, restated at the price index used on the
date these were recorded
o Gains or Losses on the Net Monetary Position is included in Net Income; disclosed separately.
For entities whose FUNCATIONAL CURRENCIES ARE HYPERINFLATED:
• All amounts in the financial statements shall be translated at the closing rate at the date of the
most recent statement of financial position EXCEPT:
• When amounts are translated into the currency of a non-hyperinflationary economy, comparative
amounts shall be those that were presented as current year amounts in the relevant prior year
financial statements. (Comparative Amounts for the previous year are not to be adjusted for
price index changes, while Comparative Amounts for current year are adjusted by the index)
• When the economy ceases to be hyperinflationary and the entity no longer restates its statements
under the standard, it shall use historical costs for translation into the presentation currency the
amounts restated to the price level at the date the entity ceased restating its financial
statements. (The adjusted amounts will be carried on prospectively as new historical cost)
PAS 29 provides no guidance to determine when an entity is objectively hyperinflationary, so the
question should imply hyperinflation; this also means that it is a matter of professional judgment
(i.e., indexes increase significantly)
For Translation – The Retained Earnings is strictly a residual account.
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Translation Reserves – Translation Reserves are the accumulated differences in the Retained Earnings
Balance arising from the differing application of forex rates.
• Furthermore, the Translation Reserves are also RECYCLED TO P/L upon disposal of a Foreign
Investment, whereas as when an entity is transitions into a hyperinflationary economy, the entire
reserve to is recycled within equity.
• Translation Reserve have both Cumulative Balances and Income Statement Balances, and follow
the Account they proceed from when recycled (i.e., if FVOCI from a foreign investment, these
are recycled into equity; if from a Revaluation Surplus, recycled into P/L)
FCU Rate Functional Amt. Current Rate Amt.
Beg. R/E XX A XX* AA
Net Income XX B BB BB
Dividends (XX) C (CC) (CC)
Ending R/E XX D ZZ* YY*
Ending RE, Current (DD) (DD)
Balance Dr (Cr) Translation Reserve Translation Adjustment
*do not apply any rate on these amounts
Translation Gains or Losses
No FOREX Gains or Translation G/L are recognized from operations in Hyperinflationary Economies
Steps in Restatement and Translation
• Compute monthly inflation, if available
𝐶𝑃𝐼 𝑎𝑡 𝑌𝑒𝑎𝑟 𝑒𝑛𝑑 − 𝐶𝑃𝐼 𝑎𝑡 𝑌𝑒𝑎𝑟 𝑜𝑝𝑒𝑛𝑖𝑛𝑔
𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑒 =
12
• For non-monetary assets, (multiply monthly inflation times the day in account) that is, from the
acquisition date to the year end
• Deduct the inflation applied from the CPI at Year-end = a.k.a. CPI at transaction date
• CPI at transaction date * FC Units * Closing Rate = Restated and Translated Amount
Purchasing Power Parity
In periods of Inflation: Monetary Asset > Monetary Liab. Monetary Asset < Monetary Liab.
Purchasing Power Purchasing Power Loss Purchasing Power Gain
Constant Peso Net Income (Squeezed XX Net Monetary Assets, beginning XX
from R/E) Restated Peso Net Income (XX)
Restated Peso Net Income (Net Income (XX) Restated Peso Dividends XX
Items applying Restatement) Net Monetary Assets, ending (XX)
Purchasing Power Loss (Gain) XX Purchasing Power Gain (Loss) XX
***Goodwill Translation – always at the Current Rate because Goodwill is always acquired from business
combination. IFRS 3 requires goodwill on a net foreign operation to be pushed-down to the foreign
subsidiary.
Determining The Translation Reserve
Non-hyperinflationary Hyperinflationary
Peso, non-restated Retained Earnings XX Restatement Debits XX
Translated Net Debits (Credits) XX Restatement Credits (Includes SHE, N/I, Divs) (XX)
Translation Reserve XX Restated R/E XX
Or Closing Rate X
Translated Net Assets at Current Rate XX Translated R/E XX
Translated SHE at Historical Rate (XX)
Translation Reserve XX
The Translation Reserve and other OCI Reserves under Economies determined to be hyperinflationary are
recycled entirely directly to retained earnings. The realization of these reserves is manifested in the
economy transitioning into a hyperinflationary one, wherein the cash value of a non-monetary asset
vanishes due to sharp rises in fair values, effectively, the inflated prices is literally the price any buyer
would pay for the asset (including its reserves/stocked-up value) since there is too much cash flowing
towards too few goods; as if all the stocked-up value had been accumulated only in a short span of time.
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Hyperinflationary Economies – Current Cost Accounting Approach

Current Cost Accounting – a valuation method whereby assets and goods used in production are valued
at their actual or estimated current market prices at the time the production takes place. The reason
why controllers use current cost accounting is that it captures the effect of gross value-added, and hence,
GDP. This implies that goods withdrawn from inventories must be valued at the prices prevailing at the
times the goods are withdrawn and not at the price at which they were initially recognized.
This method is particularly useful when the Stable Peso assumption no longer holds true (under
hyperinflationary economies), however, it becomes difficult to distinguish which gains come from
currency inflation versus those imposed by other market valuation forces.
Most often, current cost accounting is simply used to append the constant peso to financial reporting, as
it is made as a reference for value adjustments for estimates as comments on annual reports.
Steps in restatement:
1. Items stated at current cost in the statement of financial position are no longer restated.
a. Cash, Receivables, Payables, Share Capital, Share Premium
2. Items not stated at current cost must be restated:
a. Inventories and Land – Stated at Current Cost at the end of the period
b. Depreciable Property and Equipment – Stated at Current Cost less Accumulated Depreciation
based on Current Cost at Year-end.
3. Retained Earnings – treated as a balanced-figure
4. Statement of Comprehensive Income Items
a. Sales and other expenses, including income taxes, are recorded at money amounts as they
have occurred, and are NOT restated
b. Cost of Sales and Depreciation Expenses – Recorded at current cost at the time of
consumption
(1) Cost of Sales – restated at the average unit cost multiplied by the units sold during the
period
(2) Depreciation – based on the average current cost of property, plant, and equipment

Realized Holding Gains Unrealized Holding Gains

COGS, Average Current Cost XX Invty. Or Land at Current Cost this year XX
COGS, Nominal Cost (XX) Invty. Or Land at Current Cost prior year (XX)
Realized Holding Gains (Losses) XX Unrealized Holding Gains (Losses) XX

DEPEX, Average Current Cost XX PPE, net Current Cost this year XX
DEPEX, Nominal Cost (XX) PPE, net Current Cost prior year (XX)
Realized Holding Gains (Losses) XX Unrealized Holding Gains (Losses) XX

Other Assets, at Current Cost (date of sale) XX **Computation of Accumulated Depreciation is

Other Assets, Current Cost (prior year) (XX) like how revaluation of depreciable PPE is
Realized Holding Gains (Losses) XX determined. It is done through assessment of
remaining useful life, and how much is already
depreciated.

As the current cost accounting method does not distinguish between inflationary effects and other market
effects, it does not segregate the Unrealized Holdings between PL and OCI. As such, these are reported
as supplementary figures to disclosures in the income statement and may also be used to support
disclosures relating to Equity.
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Derivatives & Hedge Accounting (PAS 39, PFRS 9)

The guidance on Derivatives and Hedge Accounting are governed by both PAS 39 and PFRS 9; both of the
standards share the same principles and definition in recognizing Derivatives, however differ in a few
respects.
Derivative – a financial instrument or other contract that have the following characteristics:
• Its value changes in response to a change in an ‘underlying’. (Interest Rates, Commodity Rates,
Forex Rates, Credit Index, or some other variable not specific to a party to the contract)
• It requires no initial net investment or an initial net investment that is smaller than would be
required for other types of contracts that would be expected to have similar changes due to
market factors
• It is settled at a future date OR it is acquired or incurred for the purpose of generating a
profit from short-term fluctuations in market factors (Derivatives for Speculation or Trading)
There are two types of derivatives:
• Options-based Derivatives – These have a one-sided exposure wherein only one party can
potentially have a favorable outcome for which it pays a premium at inception; the other party
can have only an unfavorable outcome for which it is paid the premium at inception. Only the
Downside risk on the hedged item is counterbalanced, and the possible loss is only to the extent
of the premium paid. (E.g., Options, Interest Caps and Floors)
• Forwards-based Derivatives – These have a two-sided exposure, wherein either party, but not
both simultaneously, can potentially have a favorable outcome and either party can have an
unfavorable outcome, but not both simultaneously. In other words, one party wins, while the
other loses. Both the Upside and Downside Risks of the Hedged Item are counterbalanced by the
derivative. (E.g., Forwards, Futures, Interest Rate Swaps)
Hedging – A risk management strategy employed to offset losses of an investment, typically involving
derivatives such as Forwards and Options, but also may use investments that are not derivatives.
Hedging Accounting – designating derivative financial instrument as an offset in the net profit or loss,
in whole or in part, to the change in fair value or cashflow of a hedged item. A non-derivative financial
instrument may also be a designated hedging instrument i.e., FVPL/OCI Investments but only with respect
to hedge foreign currency risks. The standards require the following procedures be met in order to
perform Hedge Accounting:
• Sufficient Documentation outlining the hedging strategy applied in managing various risks
• Hedges must be highly effective, and hedge effectiveness is measured reliably
• The Hedge is assessed on an ONGOING BASIS until final settlement of the Host Contract
• Hedge Accounting is OPTIONAL and an entity may opt not to apply hedge accounting, therefore,
must apply instead only PFRS 9 for derivative as an Investment thru P/L if it chooses not to
There are three types of Hedges:
• Fair Value Hedge – the derivative is applied against the risks in changes in the fair value of the
asset/liability or firm commitment, or portions thereof. Changes in BOTH the Hedged Item and
Hedging Instrument charged in P/L, offsetting each other until the event is realized. This may
apply to exposed net assets or liabilities as well as firm commitment to buy or sell.
• Cashflow Hedge – the derivatives are applied against the risk of changes in expected cashflows
attributable to future interest payments or receipts (Variable interest payments) and Highly
probably future transactions (Forecasted Sales or Purchases that will change in fair value). The
exposed cashflow (Hedged Item) is anticipated, and the same anticipated event is temporarily
presented in OCI. OCI will be Recycled as per PAS 39 upon the happening of the Forecasted event.
As there is mere anticipation, it would be incorrect to present the anticipation as a consummated
event in Profit or Loss, hence it must be presented in OCI until the event passes. This is to prevent
misstatement in profits.
o As to Hedging Instrument (Derivative) – Valued at the lower of the cumulative G/L on
Hedging Instr. & cumulative G/L from Hedged Cashflows from Inception of the Hedging
Activity
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o As to Hedged Item (Anticipated Cashflow; Receivable/Payable) – Valued as to the

effect of Hedge Effectiveness/Ineffectiveness PFRS 9/PAS 39
• The Hedge of a Net Investment in a Foreign Operation (PAS 21) – Accounted for as a Cashflow
Hedge; the partial disposal of the Net Investment in the Foreign Operation will make any changes
in OCI be Recycled to Profit or Loss as per PAS 39. Do note that the Dividends from the investment
are not considered part of the Net Investment Operation. Hence, any FOREX Gains or Losses are
applied and are not eliminated in the Consolidated Financial Statements.
Definition of Terms
• Exposed Net Asset/Liability – a Forex Transaction exposed to foreign currency exchange risk.
Hedging is applicable (i.e., offsetting of losses), but Hedge Accounting is not applicable since
the transaction is already actualized (recognition of Derivative Accounts).
• Firm Commitment – a binding agreement for the exchange of a specified quantity of resources
(currencies, commodities, etc.) at a specified price on a specified future date or dates. Common
for Forwards-based derivatives. These are applied at the FORWARD RATE at the date the
transaction was entered into.
o Applying a Fair Value Hedge: Hedge Accounting allows the early recognition of the
transaction ahead of actual delivery of goods/services; thus, both the hedged item &
instrument are at forward rates.
o Applying a Cashflow Hedge: Hedge Accounting does not allow the early recognition of
the hedged item. As such, only the Hedging Instrument and its changes are recognized,
and is parked under OCI; actualization of the Firm Commitment will prompt recycling
from OCI to the asset/liability recognized.
o In effect, both FVH and CFH recognize the asset received/given at the forward rate at
the inception of the firm commitment, they simply differ in recognition and use of the
Hedged Item (FVH - Firm Commitment closed to Asset; CFH – URG/L OCI closed to Asset)
• Highly Probable Future Transaction – an uncommitted, but anticipated future transaction.
Common for Options-based derivatives. These are applied at the FORWARD RATE at inception of
the projection when the forecast transaction actualizes. Hedge Accounting does not allow the
early recognition of the hedged item. As such, only the Hedging Instrument and its changes are
recognized, and is parked under OCI; actualization of the Forecast Transaction will prompt
recycling from OCI to P/L.
o Its difference with a Committed Transaction will be the degree of the hedge. A Firm
Commitment is always a perfect hedge while a forecast transaction may be an imperfect
hedge.
• Hedging Instrument – a designated derivative or non-derivative financial asset/liability whose
fair value or cashflows are expected to offset changes in the fair value or cashflows of a
designated hedged item; it is where the “transaction date value” is locked in at until the hedged
item is delivered.
• Hedged Item – an asset, liability, firm commitment, highly probable future transaction, or net
investment in a foreign operation that:
o Exposes the entity to risks of changes in fair value or future cashflows
o And is designated as being hedged
• Hedge Effectiveness – the degree to which changes in the fair value or cashflows of the hedged
item that are attributable to a hedged risk are offset by the changes in fair value or cashflows
of the hedging instrument.
o PAS 39 provides that a Hedge is effective if it absorbs 80-125% of the Hedged Item’s Value
changes, this is a rebuttable presumption at the inception of the contract. This is also
known as the Bright Line Test.
o An instrument passing the Bright Line Test will have the Effectively Hedged portion of
the Hedged Item be reported at Other Comprehensive Income
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o An instrument failing the Bright Line Test will entirely apply Ineffective Portion to P/L
Change in Hedged Item Change in Hedging Instrument Bright Line Test
100% 80% 80% - OCI
100% 125% 100% - OCI; 25% P/L
100% 70% 70% - P/L
o PFRS 9 now provides for a more qualitative measure of hedging effectiveness but it still
allows using the Bright Line Test in absence of objective evidence of hedge effectiveness
• Recycling – The treatment for recycling under PAS 39 and PFRS 9 are different. As to the Hedged
Item, OCI are certainly recycled for both standards. The Hedging Instrument, on the other hand,
may or may not be Recycled under PAS 39 (The entity may opt to apply a basis adjustment;
wherein the Hedged Instrument absorbs the change in value; i.e., for non-financial assets, use
basis adjustment; for financial instruments, use reclassification adjustments in other words,
recycle to profit or loss upon final realization). Under PFRS 9, the Hedging Instrument must apply
a basis adjustment only
o Basis Adjustment – A basis adjustment is applied to non-financial assets. This means that
any OCI from a cashflow hedge is applied to the cost of the asset acquired (i.e., PPE or
Inventory). Under IAS 39, the option to apply the reclassification adjustment to non-
financial instruments are manifested through recycling OCI to Cost of Sales or DEPEX.
o Reclassification Adjustment – A reclassification is applied to financial instruments. This
means that the OCI goes directly onto P/L through realization of Interest Income, Sales,
Realized Gains or Losses on Disposal.
Hedge Accounting
Hedge Accounting is simply accounting for instruments that offset the risks to a transaction. In the case
of forex transactions, these are exposed to foreign currency risks. The hedge is applied such that either
effects in the SCI or SCF are offset by these instruments in the future through derivatives.
Transaction/Hedged Items Hedge Type Remarks
Firm Commitment Fair Value Hedge, generally Cashflows will not change
Highly Probable Future Transaction Cashflow Hedge Cashflows will change
Fixed to Floating Rate Fair Value Hedge Cashflows will not change
Floating to Fixed Rate Cashflow Hedge Cashflows will change
• The Transaction will follow the Hedged Item, not the Hedging Instrument
• Undesignated Hedges WILL NOT apply Hedge Accounting
Designation - Fair Value Designation - Cashflow
Hedging Instr. P/L Gain OCI Gain or Loss Depends on cash
Hedged Items P/L Loss Normal Accounting outlay
• If the Instrument reports a gain, the hedged item reports a loss ALWAYS.
**Do note that both derivatives & non-derivatives can be designated for offsetting risk exposure.
Stand-alone Derivative – it is a separate contract e.g., Share Warrants from the Principal Contract
Embedded Derivative – a clause in a contract pertains to the Hedging Instrument/Activity along with
the Contractual basis for which the derivative is acquired (Host Contract)
o e.g., Convertible Bonds – Bond Issuance (Host Contract), Bond Conversion (Embedded
Derivative) or Stock Rights attached to any form of Issuance (Leases, Bonds, Shares, etc.)
o The term used to account for the derivative and the host separately is called Bifurcation
• If both the Derivative and the Host Contract qualify as assets in PFRS 9, they are not accounted
for separately, and are recognized as one as Financial Assets thru Profit or Loss ONLY
• If only the Derivative qualifies for PFRS 9 Recognition, then the host and the derivative are
accounted for separately, as if different contracts with the same terms.
• If the Host Contract does not qualify for PFRS 9, and the Derivative does not qualify for Hedge
Accounting, then different accounting standards shall apply instead to the entire contract
Notional Amount – The number of units that is specified in the derivative clause/instrument. It
determines the total peso value of a derivative, traceable to movements or changes in the underlying.
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Forwards and Futures Contracts

Forwards Contract – an agreement between a buyer and a seller that requires the delivery of a
commodity or a currency at a specified future date at a price agreed to today (Price agreed to today –
Exercise Price or Forward Rate).
The difference between the spot rate at inception and the forward rate is called a discount when the
Forwards are larger than the Spot, and premium for the opposite case.
Futures Contract – Essentially the same as a Forwards contract, however, these contracts are traded at
an organized exchange; the exchange handles the cash settlements between the parties and almost never
directly to each other.
For Designated Hedges
Transaction Balance Sheet Date Settlement Date
Foreign Currency Asset/Liability Difference between Transaction Difference between Balance
(a.k.a. Undesignated Hedge) Date and Balance Sheet Date Sheet Date and Settlement Date
DO NOT APPLY HEDGE ACCTG Forward Rates – P/L Forward Rates- P/L
Unrecognized Firm Commitment Difference between Transaction Difference between Balance
– Local Transaction Date and Balance Sheet Date Sheet Date and Settlement Date
APPLY HEDGE ACCTG Forward Rates – P/L Forward Rates - P/L
Unrecognized Firm Commitment Difference between Transaction Difference between Balance
– Foreign Transaction Date and Balance Sheet Date Sheet Date and Settlement Date
APPLY HEDGE ACCTG Forward Rates –OCI or P/L Forward Rates – OCI or P/L
Difference between Transaction Difference between Transaction
Forecasted Transaction
Date and Balance Sheet Date Date and Balance Sheet Date
APPLY HEDGE ACCTG
Forward Rates –OCI Forward Rates –OCI
Net Investment Foreign Difference between Transaction Difference between Transaction
Operation Date and Balance Sheet Date Date and Balance Sheet Date
APPLY HEDGE ACCTG Forward Rates –OCI Forward Rates –OCI
Speculation Difference between Transaction Difference between Transaction
(a.k.a. Derivatives for Trading) Date and Balance Sheet Date Date and Balance Sheet Date
DO NOT APPLY HEDGE ACCTG Forward Rates – P/L Forward Rates – P/L
**All Transactions that APPLY Hedge Accounting, designated as OCI, will have to recycle the OCI upon
actual realization of the hedged item.
i.e., Inventory Sold will recycle OCI into P/L based on the ratio of the quantity sold over the total
quantity; the same principles apply for PPE Sold, upon recycling occurs once PPE is depreciated or sold.
Date (Seller POV) Hedged Item Hedging Instrument Total Effect to PL/OCI (Inverse for Buyer)
Transaction Date 0 0 0
Report Date XX (XX)** XX(XX)**a.k.a. Derivative Asset/(Liab.)
Settlement Date XX(XX) (XX)XX XX(XX)
Net Effect XX XX XX(XX) a.k.a. Prem/(Disc.)
Another format:
FORWARD or FUTURES CONTRACT Transaction Date Balance Sheet Date Settlement Date
Variable Currency (A) AA BB CC
Fixed Currency (B) XX XX XX
Derivative Asset (Liability) [A vs. B] A-X B-X C-X
Prior Balance (0) (A-X) (B-X)
Gain or Loss (PL or OCI) Prem/(Disc.) 0 A-B C-B
**To Buy (Peso is fixed while FC is variable); **To Sell (Peso is variable while FC is fixed)
If the problem is silent, use the Net Position (i.e., Fair Value of Derivative Instrument is presented as a
net amount); if the problem uses Forward/Futures Contract Receivable/Payable, gross position is used.
Apply a discount factor if an interest rate is given. (Note: rate must be expressed in terms of months.)
• A Forward purchased and designated as a Fair Value Hedge is always a perfect hedge,
whether or not it is designated P/L OCI, if hedged transaction is a Firm Commitment.
o This is because the rate of the hedged item applies the same forward rate as the bank.
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• A forward purchased and designated as a Cashflow Hedge may be an imperfect hedge if the
hedged transaction is a Forecast Transaction.
o The Hedged item will be traded at the spot rate in the future, and the Hedging
Instrument is applied at the forward rate. However, the books will record the Differential
in OCI upon settlement of the transaction. The OCI will be eventually recycled as either
a basis adjustment or reclassification adjustment depending on the type of asset.
Split Accounting for Forwards
Hedge effectiveness based on Δ in spot rates: Hedge effectiveness based on Δ in forward rates:
o OCI component – to the extent of G/L of o OCI Component – to the extent of G/L oat Balance
Hedged Item (Applied at Intrinsic Value) Sheet Date
o P/L – any excess over Hedged Item at Y/E ▪ Recycled to G/L of Hedged Item at Settlement
(Applied at Time Value) ▪ Amortization of any Excess over the Hedged
▪ Amortization of excess over hedged item Item upon Settlement to P/L
on settlement o P/L Component – zero at balance sheet date
Interest Rate Swaps
• Determine the Host Contract/Primary Financial Instrument (interest rate swaps, loans)
o Determine if the interest rate is a Floating/Variable Rate or Fixed Rate
• Determine the Derivative Contract
o Keep in mind the salient contractual conditions of the swap
• Net Cash payment is the Basis for whether the Derivative is classified as an Asset/Liability
• Valuation of Interest Rate Swaps:
o PV of All Cashflows from entry into Primary Contract until Settlement Date
o Settlement Date is the date where interest is paid on the Loan
o At the end of the Host Contract, the balance of the derivative will also be zero
Essentially, it is the Incremental Interest Paid or Received multiplied by a PV Factor if applicable (If less
than one year, no PV; if only for a year PV of 1; if for multiple years, PV OA of 1)
Inception Δ Accrual Δ Accrual Δ Settlement
Fixed Cashflow F F F F
Variable Cashflow (V1) (V2) (V3) (V4)
Net Cashflow XX XX XX XX
PV OA at Effective Rate A1% *SQZ B2% *SQZ C3% *SQZ D4%
Dvtv Asset (Liab.) XX XX* XX XX* XX XX* XX
Interest Amortization A (AA) B (BB) C (CC)
FV Change in Dvtv XX XX XX

Inception Interest Payment Recycling

Derivative X Interest X URG X URG X
URG X Expense X Interest X Interest X
Cash Expense Expense
• The real interest expense is applied using the (Hedge Accounting)
original contract’s terms. When the favorability of
• The hedging loan (speculator’s loan) is applied to Cash X the Swap changes, the
follow the hedge arrangement; Receive Variable, OCI balance is recycled
Unrealized Gain X
Pay Fixed/ Receive Fixed, Pay Variable into profit or loss
Derivative (SQZ) X through a reclass
• Interest amortization is applied to the beginning
balance at the effective rate determined at (Interest Amort.) adjustment.
period-end.
Interest Rate Swap
Beginning Balance Int. Inc (Exp) Amort.
Unrealized Gain (SQZ) (SQZ) Unrealized Loss
Ending Bal. Receivable Ending Bal. Payable
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Options Contracts
Option Contracts – gives the holder of the contract a right (never an obligation) to buy or sell something
(commodities or currencies) to the seller at a date in the future at a price agreed to at the date of the
Call/Bid Price – Option to buy Put/Asking Price – Option to Sell
Strike Price – price set to exercise the option
Option Premium – is the amount of money that the option holder pays to the option seller to obtain the
right in the option, this means that there is never an obligation in an Option Contract i.e., no entity will
ever exercise Option Contracts unless these are in favorable positions.
Call Option Put Option Time Value = Strike
Out the Money Strike Price > Market Price Strike Price < Market Price Price or FV at Trade
In the Money Strike Price < Market Price Strike Price > Market Price date
At the Money Strike Price = Market Price Strike Price = Market Price
Intrinsic Value Market Price – Strike Price Strike Price – Market Price Intrinsic Value = FV-TV
‘Applying Split Accounting’ means to designate only the Intrinsic Value as the Hedging Instrument
 = amounts reported in P/L or OCI; Net Gain = IV, end – Option Premium
Procedure:
• Step 1 – Identify the Role of the Holder, as either a buyer or seller
• Step 2 – Check the Option Position
• Favorable Position means that there is an Intrinsic Value
• Unfavorable Position means that the Intrinsic Value of the Option is ZERO
• Step 3 – Compute for the Fair Value of the Option
• Intrinsic Value at the Inception of the Option is ZERO (Options are useless if the value of
the stock is known or is depressed.)
• Time Value of the Option is ZERO upon EXPIRATION of the Option Contract
• Time Value = Option Premium – Intrinsic Value, unless other amounts are provided.
Intrinsic Value of the Option XX Intrinsic Value of the Option, Yr.2 XX
Time Value of the Option XX Time Value of the Option, Yr. 1 XX
Fair Value of the Option in B/S XX Fair Value of the Option Yr. 2 XX
Option Premium initially at B/S (XX) Fair Value of the Option Yr. 1 (XX)
Changes in Net Income (P/L or OCI) XX Changes in Net Income (P/L or OCI) XX
• Step 4 – Decide to Apply Split Accounting or not (asking for P/L amount despite being a CFH)
Split Accounting – Accounting separately for changes in Intrinsic Value and Time Value of Options; Split
Accounting is applied when only the Intrinsic Value is designated as the Heding Instrument. In this case,
the Option Premium is not used to hedge any cashflows. Therefore, the Time Value is always at OCI, and
will be recycled accordingly at the end of the contract term. Apply a discount rate if applicable.
Trans.  Report  Settled
Time Value (OCI) 30,000 -10,000 20,000 -20,000 0
Intrinsic Value (P/L) 0 50,000 50,000 -20,000 30,000
Fair Value 30,000 40,000 70,000 -40,000 30,000
Designated as Fair Value Hedge Designated as Cashflow Hedge
Increase in Intrinsic Value Unrealized/FOREX Gain – P/L Unrealized/FOREX Gain – OCI
Decrease in Intrinsic Value Unrealized/FOREX Loss – P/L Unrealized/FOREX Loss – OCI
Increase in Time Value Unrealized/FOREX Gain – P/L Unrealized/FOREX Gain – P/L
Decrease in Time value Unrealized/FOREX Loss – P/L Unrealized/FOREX Loss – P/L
• **Non-split Accounting – All charged to OCI in a Cashflow Hedge
• When the Option is held for speculation, do not apply hedge accounting. However, the Option
Positions will change. As the holder, (the one with the right, not obligation) will have a short
position; while the issuer (one with obligation to deliver upon exercise) will have a long position.
• Split accounting is done to specifically attribute only certain aspects of an instrument as part of
a hedge. This is due to the fact that a security may be held for multiple purposes, especially if
it is exposed to multiple types of risk (A Bond holds both credit risk and interest rate risk, of
which separate sources of change in values are expected, for example). Rather than holding the
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entire change in aggregate, it may make sense to exploit an increase in value specifically, when
an instrument performs poorly overall or in other aspects in terms of risk exposure.
Intrinsic Value
Transaction Date Report Date Settlement Date
Strike Price (Fixed) XX XX XX
Spot Price (A) (B) (C)
In the Money (OUT) (X) X X
Notional XX XX XX
Intrinsic Value 0 XX XX
• If the Time Value is included in the assessment of the changes in Fair Value, there is no split
account because the Time Value is mixed with the Intrinsic Value of the option. There is split
accounting if the opposite is stated. (Time Value is excluded)
PAS 39 vs PFRS 9
Hedging Instruments – PAS 39 is restrictive as to what can be considered as hedging instruments.
Either they take derivatives or alternatively, use a non-derivative financial asset or liability in a hedge
of a foreign currency risk. PFRS 9 allows the use of a broader range of hedging instruments, the use of
any non-derivative financial asset or liability measured at fair value through profit or loss
Hedged Items – PAS 39 allows hedging only a non-financial item in its entirety, and not just a
component of it (Split Accounting); PFRS allows split accounting as long as it is separately identifiable
and measurable
Testing Hedge Effectiveness – PAS 39 uses the bright line test (80-125%); it is significantly simplified
under IFRS 9. IFRS 9 enables an entity to use information produced internally for risk management
purposes and stopped forcing to perform complex analysis required only for accounting purposes. The
requirement is more principles based in application.
Rebalancing – This is the modification of hedges. PAS 39 required the termination of hedging activities
to rebalance the transaction. The documentation and analysis required would be performed all over
again. Under IFRS 9, it is easier because it allows certain changes to the hedge relationship without
necessity to terminate it and to start the new one.
Discontinued Hedges – PAS 39 allows discontinuing on a discretionary basis. PFRS 9 does not allow
termination on a discretionary basis.
Other Differences:
• Possibility to apply hedge accounting to exposures that give rise to two risk positions that are
managed by separate derivatives over different periods (Split Accounting)
• Less profit or loss volatility when using options and forwards
• Option to account for own use contracts to buy or sell a non-financial item
• More alternatives for hedges of credit risk using credit derivatives
Hedge Effectiveness in PFRS 9
• Assess the economic relationship between hedged items and hedging instruments
• Effect of credit risk does not dominate value of changes that result from economic relationship
• The hedge ratio of the relationship is the same as that actually used in the economic hedge.
Other Notes on Hedging and Derivatives
• Some problems will give choices that are deliberately designed to confuse the examinee. When
a problem requires the balance of the derivative account presented in the balance sheet at
the settlement of the principal contract, the answer should always be zero applying IAS 1.
• If the problem requires the balance of the derivative account, the question should clarify if the
balance in question is after recycling and settlement are applied, or if the balance is before the
contract is settled. These multiple-choice questions are unfair, and must be inquired for clarity;
or at least, provide at least one of either zero or the balance immediately before settlement,
but not both.
• It is essential to account for both changes in values of both the hedged item and hedging
instrument since some problems ask for the overall effect of the hedge.
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Not-for-profit Accounting
Not-for-Profit Organization – is a legal and accounting entity that is operated for the benefit of the
public as a whole, rather than for the benefit of its owners. NPOs include civic organizations, colleges,
universities, hospitals, private foundations, religious organizations, and social and country clubs.
• There is an absence of ownership interest to report to
• There is a mission to provide services, but not at a profit
• There is a dependence on significant amounts of contributions
• There is a restriction of donated assets as to their use
• Private NPOs are tax-exempt; Public NPOs are exempt from income taxes
• Instead of an Income Statement, these prepare a Statement of Activities because these do not
organize activities for profits
Fund Accounting – is an accounting system for recording resources whose use has been limited by the
donor, grant authority, governing agency, or other individuals or organizations or by law. It
emphasizes accountability rather than profitability, and is used by Nonprofit organizations and by
governments. In this method, a fund consists of a self-balancing set of accounts and each are reported
as either unrestricted, temporarily restricted or permanently restricted based on the provider-imposed
restrictions.
Unrestricted Fund Temporarily Restricted Fund Permanently Restricted Fund
Assets assigned to this fund are Assets available for use, but These are composed of assets
available for use for any purpose expenditures are restricted by maintained indefinitely in
by virtue of authority granted by conditions imposed by their revenue-producing investments.
the board donors. These are transferred to Both the Donor’s and Board’s
the unrestricted fund once the Approval is required to expend
expenditure is authorized by the the fund.
donor
Special Considerations for NPOs
• Works of Art, Historical Treasures, and similar assets may not be capitalized as assets, except if
all conditions are met:
o Held for public exhibition, education/research in furtherance of public service instead of
financial gain
o These are protected, unencumbered, are cared for and preserved
o These are subject to an organizational policy that requires the proceeds from sales of
collection items to be used to acquire other items for collections
• All contributions are recorded at Fair Value
• Donated/Contributed Services are only recognized only if:
• These create or enhance nonfinancial assets
• The services require specialized skills
• Anything else cannot be recognized
• Pledges – Unconditional promises to give in cash or in kind in the future shall be recognized when
the promise to give is received from the donor in Temporarily Restricted Contribution, net of
uncollectible accounts
• Conditional Promises – recognized only when the future event to bind the promisor will have
the conditions be substantially met thru the Refundable Advance (Deferred Revenue/Liability)
• The statement of financial position presents the fund accounts as above mentioned instead of
equity accounts
• Instead of the Income Statement, NPOs present a Statement of Activities
• Expenses come in two forms:
• Program Expenses – Expenses arising from the conduct of the NPOs purposes
• Supporting Expenses – All other activities other than Program Expenses, in other words,
these expenses make the program expenses happen
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Generic NGOs and Some Considerations

Hospitals/Health Care Organizations-------------------------------------------------------------------------------
Gross Patient
XX
Rooms, boarding, professional services Revenues
Discounts to doctors, employees, direct relatives, etc. Courtesy Allowance (XX)
Contractual
XX(XX)
Discounts and Insurance Claims and changes in insurance policies Adjustments
Net Patient Service
XX
Revenue
Revenue from third parties other than patients (availing medical
Premium Revenues XX
services by private companies) a.k.a. Capitation Agreements
Other Revenues and
XX
Interest, Gains on Disposal, etc. Gains
Other Operating
XX
From canteens, tuitions, etc. Revenues
Other Non-Operating
XX
Endowments, donations, grants Revenues
Total Hospital
XX
Revenues
**Charity Care Services – Services provided by hospitals to those eligible patients under charity care
policies; excluded both from Gross and Net Patient Service Revenues; IF the problem mentions TOTAL
PATIENT SERVICES RENDERED, the charity care service is actually included in that amount, and must be
removed.
Colleges and Universities-----------------------------------------------------------------------------------------------
Educational and General Revenue Tuition Fees XX
Tuition Fee Refunds (XX)
Net Revenue from Tuition XX
Dorms, Canteens, etc. Auxiliary Revenue XX
Transfers of Endowments to the Unrestricted Fund Expired Term Endowments XX
Total Revenue XX
Endowment Fund of Colleges and Universities
• Permanent Endowments – Principal is permanent, but interest is expendable; classified as
Permanently Restricted Asset and Revenue
• Term Endowments – Principal and Interest are expendable but only after a passage of time;
classified as Temporarily Restricted Asset and Revenue that will eventually expire
• Quasi-endowment – Established by the Board under its control; Principal and Interest is
expendable, classified as Unrestricted Assets and Revenues
• If the condition attached to the endowment is not fulfilled within the specified period, the
revenue is not recognized and the liability to comply extinguishes along with the restricted fund
Tuition Fee Discounts, Scholarships, and Student Aid in general are considered Expenses
All Donations from Trustees to the NPO are considered Agency Transactions
Annuity Funds – Payments of specified amounts periodically to recipients. At the end of the term, these
are transferred to the unrestricted fund
Life Income Fund – Used to pay beneficiaries over their lifetime. Only income attributable to this fund
may be expended
Loan Funds – Funds set-up to loan to students, staff, faculty which generally revolve & get repaid
Plant Funds – These are akin to Retained Earnings Appropriation for Plant Expansion, Redemption Funds
ALL EXPENSES FALL UNDER CHANGES IN UNRESTRICTED FUNDS
All donations and endowments that are restricted or conditional fall under Financing Cashflows;
unrestricted and unconditional donations and endowments fall under Operating Cashflows. Incidentally,
any funds used falls under Investing Cashflows (This includes the transfer from Restricted to Unrestricted,
having 0 net effect)
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Government Accounting
Government Accounting – Encompasses the proves of analyzing, recording, classifying, summarizing,
and communicating all transactions involving the receipt and disposition of government funds and
property, and interpreting the results thereof. (Sec. 109, P.D. 1445)
Budget Cycle
• Budget Preparation – the preparation of the national budge regulated by law. The DBM issues a
budget call to all secretaries of the departments and State Universities and Colleges, to provide
an estimation of their budget for the next fiscal year
• DBM reviews the budget proposals by the agencies and prepares recommendations
• Recommendations are presented to an evaluation board and then deliberated upon
considering national goals
• The DBM then consolidates all the budgets, to be submitted to the president and cabinet
for further refinements and prioritization
• After the president’s and cabinet’s approval, the report is then passed onto Congress
within 30 days before opening of regular session
• Budget Legislation (Authorization) – Receipt of the house speaker of the budget and ends with
enactment of the General Appropriations Act.
• The Budget is assigned to the House Appropriation Committee to schedule the conduct
of hearings on the budgets of different departments, agencies, and their respective
programs and projects to craft the General Appropriations Bill
• Committee will sponsor, present and defend the bill in a plenary session, after approval
here, it is passed onto the Senate
• The Senate conducts its own hearings and deliberations.
• The Senate and the House of Representatives will constitute a Bicameral Conference
Committee that seeks to harmonize their versions of the Bill
• Budget Execution – DBM issues guidelines on the release and use of funds
• Each agency is required to submit a Budget Execution Document that outline the agency
plan and performance targets
• The DBM prepares an Allotment Release Program to set limits for allotments issued to
agencies to ensure that these coincide with the Government’s fiscal program
• The DBM then issues an NCA to different agencies to cover cash requirements for projects
and obligations
• Budget Accountability – This happens alongside Budget Execution. The DBM monitors the
efficiency and fund utilization, assess the performance of agencies, and provide evaluations and
recommendations to inform new policies and budgets.
• Each agency submits a Budget Accountability Report on monthly and quarterly bases to
show fund use as well as physical accomplishments of projects, to which the DBM
compares it with the agency’s predetermined plans
• The Commission of Audit audits the agencies use of government funds, the DBM then uses
the audit reports in confirming the agency’s performance
Government Accounting Manual
The Government Accounting Manual provides general provisions from existing laws, rules, and
regulations; and basic standards/fundamental accounting principles for financial reporting by national
government agencies.
• prescribed by COA pursuant to Article IX-D, Section 2 par. (2) of the 1987 Philippine Constitution
• Aimis to update the following: Standards, Policies, Guidelines, and Procedures in accounting for
Government Funds and Property, Coding Structure and Accounts, Accounting Books, Registries,
Records, Forms, Reports, and Financial Statements
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Basic Government Accounting and Budget Reporting Principles

• GAAP in accordance with PPSAS, laws, rules, and regulations
• Accrual Basis of Accounting
• Budget Basis for Presentation of Budget Information in the Financial Statements - PPSAS 24
• Revised Chart of Accounts Prescribed by COA
• Double Entry Bookkeeping
• Financial Statements based on Accounting and Budgetary Records
• Fund Cluster Accounting
Financial Reporting System
• NGAs, Bureau of Treasury, Department of Budget and Management, and COA are responsible
• Each Entity shall maintain a complete set of accounting books by fund cluster which is reconciled
with the records of cash transactions maintained by the BTr
• The BTr Accounts for the Cash Allocation, Public Debt, and related transactions
• Each entity maintains budget registries which are reconciled with the budget records maintained
by the DBM, Government Accountancy Sector (GAS), and COA
• The COA through the GAS:
• Maintains budget records showing the overall approved budget of the government and its
execution/implementation
• Consolidates the FS and Budget Accountability Reports of all agencies and the BTr with
COA records to come up with the Annual Financial Report
• Prepares other financial reports required by law for submission to oversight agencies
• Responsibility over the Financial Statements:
• Individual Entity/Department – Head of entity or their authorized representative jointly
with the head of the finance/accounting division/unit
• For department/Entity as a single entity – the head jointly with the head of the finance
unit
• Book of Accounts and Registries
• Cash Receipts, Disbursements and Check Disbursements Journal
• General and Subsidiary Ledgers
• Registry of Revenue and Other Receipts (RROR) – Receipts from Fees and Licenses issued
• Registry of Appropriations and Allotments (RAPAL) – Receipts from the BTr
• Registry of Allotments, Obligations, and Disbursements (RAOD) – Debt incurred thru
Obligation Request Status (ORS) supported by payroll, job orders, etc.
i. PS – Personnel Services,
ii. MOOE – Maintenance and Other Operating Expenses,
iii. FE – Financial Expenses,
iv. CO – Capital Outlay
• Registry of Budget, Utilization, and Disbursements (RBUD) – same sub-registries as RAOD
Think of the Registries as journals for memoranda or remarks of transactions.
ORS memorandum is akin to a purchase order, while the RAOD memorandum is akin to the purchase
invoice
Responsibility Center Code Structure/ Unified Account Code Structure
00 000 0000000 000

Additional Code for Major Office/Department

Lower Level/Operating Unit
Agency
Department
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Revenues and Receipts

• Sale of Goods/Services
• Service Revenues – Any form of Licenses and Fees for Administrative Purposes
• Business Income – Fees coming from operations and use of Public Property
• Use of Assets yielding interest, royalties or dividends, and other similar distribution
• Revenue from non-exchange transactions
• Tax Revenues • Trust Liabilities (Conditional Grants)
• Gifts, Donations • Deferred Credits and Unearned Revenues
• Penalties and Fines
• Credit the Respective Revenue Account, and Debit Cash – Collecting Officer or Cash in Bank –
Local Currency BSP, etc.
• Cash MDS is replenished by: DR: SUBSIDY FROM NAT. GOV CR: CASH IN BANK
• Cash from Trust Funds: DR: CASH MDS – TRUST CR: CASH – AGENCY DEPOSIT
Disbursements
• Disbursements by Checks - Drawn only on duly approved disbursement vouchers or payroll. Used
for payment of regular expenses that cannot be paid using ADA (Authority to Debit Accounts
Payable) or not authorized to be paid using Petty Cash Fund or advances for OPEx.
• MDS Checks – drawn out of the Account of the Treasurer of the Philippines
• Commercial Checks – Chargeable against the Agency’s Checking Account
• Disbursements by Cash – granted to special and regular disbursing officers for personal services,
petty expenses, MOOE, etc. covered by duly approved disbursement vouchers, payroll, etc. Cash
advances are allowed
• Disbursements by LDDAP-ADA (List of Due and Demandable Accounts Payable – Authority to
Debit) – Mode of settling accounts payable
• Disbursements through Tax Remittance Advice – NGAs usually withhold taxes for BIR and BOC,
hence must remit the cash it withholds from its clients through this authority (5%)
• Disbursements by Foreign-based Agencies (Cash Disbursement Ceiling)– authority allowed to
DFA and DOLE to cover operating requirements by using operating revenues collected from
Foreign Service Posts, not exceeding allotment provided
• Disbursements by Direct Payment Method – Covered by an NCAA. Done thru a Journal Entry
Voucher issued by the Treasury Bureau to record payment of goods directly by the lending
institution to the supplier or contractor (government underwriting
Fund Release Documents
• ALL ENTRIES RELATING WITH FUND RELEASE WILL BE A CREDIT TO THE ACCOUNT
• “SUBSIDY FROM NATIONAL GOVERNMENT” DEBIT CASH – MDS (SPECIAL/REGULAR)
• In the Books of BTr, it is “SUBSIDY TO NATIONAL AGENCIES”
• Assets/Cash (most of the time) are assigned to either Special Allotments/General
Allotments
• No Journal Entries are made upon APPROPRIATIONS, but a REGISTRY ENTRY IS MADE IN THE
RAPAL
• No Journal Entries are made upon ALLOTMENTS by DBM – Posted in RAOD
• Incurrence of ORS – No Entries, Posted in RAOD
• Obligational Authorities/Allotments – allows the agency to incur obligations for its proposed
programs
• General Appropriations Act Release Document (GAARD) – For Comprehensive Release
(FCR) of Budgetary Items appropriated in the GAA.
• Special Allotment Release Order (SARO) – For Later Release (FLR) in the entity’s Budget
Execution Documents, subject to compliance of required documents/clearances.
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(Calamity Funds, Contingency Funds, Feasibility Studies Funds, Miscellaneous Personnel

Benefits Funds, etc.) – CASH MDS SPECIAL
• General Allotment Release Order (GARO) – A comprehensive authority issued to all
national government agencies in general to incur obligations not exceeding an authorized
amount during a specified period and purpose. It covers automatically appropriated
expenditures common to most – CASH MDS GENERAL
• Disbursement Authorities – Allows the agency to release funds into disbursements and
expenditures
• Notice of Cash Allocation (NCA) – Authority released to agencies to cover cash needs
• Non-cash Availment Authority (NCAA) – Authority issued by DBM to agencies to cover
the liquidation of obligations incurred against available allotments for availment of
proceeds from loans/grants through supplier’s credit/constructive payment
• Cash Disbursement Ceiling (CDC) – Issued to DOLE and DFA to use income to cover
operations
• Notice of Transfer Allocation (NTA) – Authority by Central Office to Regionals and
Operating Units to cover the latter’s cash requirements
• Any unused Balance in the Subsidy from National Government Account Is reversed, hence Cash –
MDS Regular and Special are Credited if their disbursements were not accomplished for the period
• Tax Remittance – CR: Due to BIR upon incurrence, offset against Cash – MDS when paid
Common Journal Entries
Revenues from Exchange Transaction
Note Receivable Cash - Collecting Officers
Sales Revenue Notes Receivable
Recognize sale Interest Income
Recognize collection

Grant with Condition

Books of BTr Books of NGA
Cash in Bank - Local/Foreign Currency, Bank Cash - MDS Special
Other Deferred Credits Subsidy from National Government
Receipt of Grant Receipt of NCA from construction

Other Deferred Credits Construction in Progress

Income from Grants Cash- MDS Special
Recognize Income from Grant Recognize Construction Costs

Subsidy from National Government

Cash in Bank - Local Currency, Bank
Replenishment of MDS
Check

Railway or PPE
Construction in Progress
Recognize completion of
construction
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Other Receipts

Receipt of NCA
Cash - MDS Regular Cash - MDS Trust
Subsidy from National Cash - Treasury/Agency Deposit
Government Trust
Receipt of NCA Receipt of NCA for Trust
Receipts
Cash - MDS Special
Cash - Treasury/Agency Deposit Non-cash Availment Authority
Special Accounts Payable
Receipt of NCA for Special Subsidy from National
Purpose Government
Receipt of NCAA

Cash Disbursement Ceilings Cash - Constructive Income Remittance

Books of DFA/DOLE Subsidy from National Government
Cash - Collecting Officers Receipt of CDC from DBM
Passport and Visa Fees
Recognize Revenue Collection Expenses
Cash in Bank - Foreign Currency
Cash in Bank - Foreign Currency Current Current
Cash - Collecting Officers Payment of Expenses charged
to CDC
Deposit to Bank

BTr Books
Subsidy to National Government Agencies
Cash - Constructive Income
Remittance
Constructive Receipt of
Income
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Tax Remittance Advice

Withholding Tax Customs Duties
NGA NGA
Cash - Tax Remittance Advice PPE/ Inventory
Subsidy from National Government Cash MDS - Regular
Receipt of NCA for TRA Due to BOC (Customs Duties)
Purchase by NGA
Due to BIR
Cash - Tax Remittance Advice Cash - Tax Remittance Advice
Remittance to
BIR Subsidy from National Government
NCA Receipt for Customs Duties
BIR Books
Cash - Tax Remittance Advice Due to BOC
Income Tax Cash - Tax Remittance Advice
Recognize Income Tax Remittance to BOC

BTr Books BOC Books

Subsidy to NGAs Cash - Tax Remittance Advice
Cash - Tax Remittance Advice Customs Duties
Recognize Constructive
Payment Recognize Customs Duties

BTr Books
Subsidy to NGAs
Cash - Tax Remittance Advice
Recognize Constructive
Payments
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Disbursements by Checks
Expenses Disbursements by Cash Advance
Cash - MDS Regular Salaries & Wages
Payment of Bills PERA
Due to BIR
Advances to Officers and Employees Due to GSIS
Cash - MDS Regular Due to PAG-IBIG
Granting allowances to employees Due to PhilHealth
Other Payables
Due from NGAs Due to Officers and Employees
Cash - MDS Regular Recognize Salaries, Wages, and
Payment of advances to the Withholdings
Government Procurement Service
Advances for Payroll (Payroll Fund)
Petty Cash Fund Cash - MDS Regular
Cash - MDS Regular Payment of Advances to Employees
Establish PCF
Due to Officers and Employees
Expenses Advances for Payroll
Cash - MDS Regular Liquidation of Payroll Fund
Replenish PCF
Advances for Operating Expenses
Cash - Collecting Officer Cash - MDS Regular
Petty Cash Fund Grant of Cash Advance to field units
Return of PCF upon retirement of without books
Custodian
Expenses
Expenses Advances for Operating Expenses
Petty Cash Fund Liquidation of cash advance upon
Adjusting the PCF balance at year- receipt of Disbursement vouchers
end
Advances to Special Disbursing Officer
Retirement and Life Insurance Premiums Cash MDS - Regular
(GSIS) Grant of cash advance to SDO
PAG-IBIG Contribution
PhilHealth Contributions Expenses
Cash MDS - Regular Advances to SDO
Remittance of Government's Share Liquidation of Cash advance

Due to GSIS
Due to PAG-IBIG
Due to PhilHealth
Other Payables
Cash MDS - Regular
Remittance of Withheld Salary
Contributions
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Remittance to BIR

LDDAP-ADA BIR Books

Inventory Cash - TRA
Accounts Payable Income Tax
Recognize payable Recognize Tax Revenue

Accounts Payable BTR Books

Cash - MDS Regular Subsidy to NGA
Payment through ADA Cash - TRA
Recognize Remittance by NGA to BIR
Payment through Agent Bank
Cash in Bank - Local Currency, Current Direct Payment Method through NCAA
Cash MDS - Regular Agency Books

Due to Officers and Employees PPE

Cash in Bank - Local Currency, Current Accounts Payable
Receipt of Procurement
Disbursement through TRA
Agency Books Accounts Payable
Constructive Receipt of NCA for TRA Subsidy from National Government
Cash - TRA Receipt of NCAA
Subsidy from National Government
Constructive Receipt of NCA for TRA BTR Books
Subsidy to NGA
Due to BIR Loans Payable - Foreign
Cash - TRA Replenishment made to Agency Bank

PPSAS Summary
• PPSAS 1 – Present FS using Accrual Basis of Accounting
• PPSAS 2 – Cashflows are reported using the Direct Method; exclude movements of cash equiv.
• PPSAS 4 – Use Functional Currency, at the Spot Rate
• PPSAS 5 – Borrowing Costs are generally expensed (Benchmark Treatment) if borrowed by National Government, but
may be capitalized if these are for the account of the local government and NGAs
• PPSAS 9 – Apply IAS 18, not IFRS 15
• PPSAS 12 – Inventories are recorded at Lower of Cost and Replacement Cost; using only Specific
Identification/Moving Average Approach; write-downs are expensed, excluded in COGS
• PPSAS 13 – Apply IAS 17 Leases, not IFRS 16
• PPSAS 16 – Investment Property only uses Cost Model; Fair Value Model is only allowed when
acquired through a non-exchange transaction
• PPSAS 17 - PPE
o Minimum Capitalization of P15,000.00; if Below Minimum or equal, then treat as Inventory or
Expense
o Above Capitalization of P15,000.00 – PPE
o Residual Value at a Minimum of 5% of the Cost
• PPSAS 27 -Bearer Plants are considered Biological Assets, not PPE
• PPSAS 28,29,30 – Financial Instruments follow PAS 39, not PFRS 9
• PPSAS 32 – Service Concession Arrangements follows Deferred Liability Approach
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Title II: Special Transactions on

Revenues
PFRS 15 Revenue Recognition
PFRS 15 provides guidance on Revenue Recognition for contracts with Customers. It augments and
replaces some provisions of other Revenue Standards such as PAS 11 Construction Contracts and PAS 18
Revenue, and made other specific standards govern special revenue cases such as for Interest and
Dividends to PAS 27, 28, 39/PFRS 9 Financial Instruments, Rent Income to PFRS 16 Leases, Income from
Government Grants to PAS 20 Government Grants, and others.
PFRS 15 PAS 11 PAS 18
Revenue from Customers (Goods Revenue from Construction Revenue from Sale of Goods,
and Services in General) Contracts (A Service) Services, Interest, Dividends
In PFRS 15, all revenue contracts with customers, are harmonized and are provided guidance.
Definition of Terms
• Customer – A party that has contracted with the entity to obtain goods or services that are an
output of the entity’s ordinary activities in exchange for a consideration
• Contract – An agreement between two or more parties that creates enforceable rights and
obligations
• Performance Obligation – A promise in a contract with a customer to transfer to the customer
either: goods or services (a bundle of both) that is distinct; or a series of distinct goods or services
that are substantially the same and that have the same pattern of transfer to the customer
• Income – Increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities that result in an increase in equity, other than
those relating to contributions from equity participants
• Revenue – Income arising in the course of an entity’s ordinary activities
• Transaction Price – The amount of consideration to which an entity expects to be entitled in
exchange for transferring promised goods or services to a customer, excluding amounts collected
on behalf of third parties
Comment:
Observe how the standard defines both revenue and income, at first glance, these may seem to be the
same, however, one has to entertain the possibility of why these two seemingly identical terms are given
distinction. Income and Revenue are distinguishable, even if it may not seem like it per standard (PFRS
15 and PAS 18), because Income refers to the OVERALL NET BENEFIT received from being in business, and
Revenue refers to a single organized activity that the business engages in. Income is broader than
Revenue.
Five-step Model for Revenue Recognition
Sales of Goods and Services may seem straightforward, however, nothing in the current laws of the
Philippines or anywhere in the world for that matter, prevents the contracting parties from agreeing to
special modifications to the usual course. How then should revenue be recognized if the distinct
obligations that it arises from, are complex and differently valued? Previous standards had struggled with
this issue as their definitions of revenue were rigid, and could not accommodate the flexible nature of
sales.
1. Identify the Contract/s with the Customer
2. Identify the Performance Obligations in the Contract
3. Determine the Transaction Price
4. Allocate the Transaction Price to each of the Performance Obligations in the Contract
5. Recognize Revenue when (or as) the entity satisfies a performance obligation
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Step One: Identifying the Contract/s with the Customer

PFRS 15 sets out criteria for contracts to qualify for its application; A contract must exhibit ALL of the
following:
• Parties to the contract has approved the contract and are committed to perform;
• Each Party’s rights to the goods/services transferred are identified;
• The Payment terms are identified;
• The contract has Commercial Substance; and
• It is probable that an entity will collect the consideration – an INTENTION and ABILITY to pay
upon inception of the contract
Commercial Substance – risk, timing or amount of an entity’s future cash flow is expected to change as
a result of the contract.
• There is no commercial substance when a company engages in an intercompany sale or transfer
marked at prices other than the market.
Contract Combination – When multiple contracts have to be accounted as a single contract and not
separately
• For instance, in an arrangement with a construction firm, there may be separate contracts signed
for materials acquisition, labor agreements, and equipment leasing. These may be treated as a
single contract to construct property.
• Allowed only when all three conditions are met:
o For those of the same customer or to a customer with its related party
o Consideration depends on 3rd parties
o Goods or Services are part of a single performance obligation
Step Two: Identify the Performance Obligations in the Contract
Stated simply, whatever is due for transfer to the customer is the Performance Obligation. This may
either be in the form of distinct goods, services, or both, at once or in a series of deliveries.
• Performance Obligations are DISTINCT or Separately Identifiable and that the performance
obligations are of separate utility or benefit – that is, you know for a fact that you can do a
specific task without confusing it for another. In case that these are not distinct, these must be
combined into one
• Since Performance Obligations are distinct, it is important that performance obligations must
refer to those owed to the customer and not some other party
Step Three: Determining the Transaction Price
The transaction price is what you expect to receive after delivering the performance obligations of the
contracts, it is not always simply the Contract Price. The Transaction Price is actually Estimated
depending on these considerations:
• Variable Consideration – Discounts, bonuses, rebates, penalties, etc. These are only considered
upon high likelihood (Expected Value or Most Likely Outcome)
• Constraints – Likelihoods and estimates on the ability to keep specific terms within set criteria
i.e., delays in construction progress will make a certain percentage of the transaction price
forfeit
• Significant Financing Component – If the customer is willing but not able to pay right now, and
may only do so in the future, should there be Time value? An insignificant financing component
will not bear on the contract. Otherwise, a significant component will be accounted for
separately (PFRS 9)
• Consideration in Kind – Fair Value of Non-cash Items
• Payable to the Customer – Reimbursements, coupons, vouchers, etc.
Step Four: Allocating the Transaction Price to the Performance Obligations
The transaction price is split according to the performance obligations in the contract. This is done on
the basis of the stand-alone selling price for each performance obligation, unless:
• There are Considerations with Variable Amounts, for which each obligation will be adjusted.
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Stand-alone Selling Price – a price at which an entity would sell a promised good or a service separately
to a customer. This is to say that each performance obligation would have a ready market price, and
would be allocated on that basis. Problems will usually give these for each performance obligation.
• Although there are stand-alone selling prices to each performance obligation, adding these together
is not the transaction price. It is not the price you would agree to when performing the obligations
altogether.
Stand-alone Price Ratio Allocated Contract Price
Selling Price XX X/XYZ AX
Discounts XX Y/XYZ (AX)
Penalties XX Z/XYZ (AX)
Variable Consideration XX W/XYZ AX
Others XX O/XYZ AX
Total Contract Price XX
If the Stand-alone selling price is unavailable, other approaches are appropriate:
• Adjusted Market Assessment Approach or Market Value; Expected Cost plus a Margin; or
• Residual Approach
𝐓𝐫𝐚𝐧𝐬𝐚𝐜𝐭𝐢𝐨𝐧 𝐏𝐫𝐢𝐜𝐞 − 𝐓𝐨𝐭𝐚𝐥 𝐑𝐞𝐥𝐚𝐭𝐢𝐯𝐞 𝐒𝐭𝐚𝐧𝐝-𝐚𝐥𝐨𝐧𝐞 𝐒𝐞𝐥𝐥𝐢𝐧𝐠 𝐏𝐫𝐢𝐜𝐞 = 𝐒𝐭𝐚𝐧𝐝-𝐀𝐥𝐨𝐧𝐞 𝐒𝐞𝐥𝐢𝐧𝐠 𝐏𝐫𝐢𝐜𝐞
Step Five: Recognize Revenue
This is concerned of when ‘transfer’/delivery of control happens.
• Revenue Over time – Control is passed onto the customer over some period of time/contract term
• For construction contracts, although there is no technical passing of control when an asset is
not yet completed, revenue is recognized over time as a consequence of delivering the
necessary progress into making the asset in question
• There are criteria to recognize revenue over time: (Comply with at least one)
i. Customer receives and consumes the benefits provided by performance simultaneously
(the period is resolutory; or the benefits cease at the happening of an event.)
ii. Entity creates benefits or enhances the value of the assets/resources controlled by the
customer
iii. The performance obligation does not create an asset with alternative use to the entity and
the entity has an enforceable right to payment for the performance completed to date
iv. If none of the above are present, the entity recognizes revenue at a point in time
• Revenue at a Point in time – Control is passed only until performance is accomplished; indicators
include those usual in consummating a contract of sale or service.
• Under PAS 18, the criteria for revenue recognition were the transfer of significant risks & rewards.
Contract Costs and Modifications
The standard also provides guidance on how to account for contract costs (Whether capitalized or not)
• Cost to Obtain a Contract – Costs incurred in order to make contracting with a customer possible in
the first place; without these costs, there would have been no contract at all. These Costs are
recognized as Contract Assets if these are expected to bring control over benefits for more than 12
months, otherwise, these costs are expensed (shorter than 12 months). If the attempt is unsuccessful
this is considered an expense.
• Costs to Fulfill a Contract – Apply normal accounting and the appropriate standards (PAS 2, 16, 38, 40,
41), otherwise, it falls under PFRS 15 as cost of contract asset if all three criteria are met: The cost
is directly related to the contract, the cost is recoverable (refundable), and it enhances or creates
resources for the customer.
Contract Modification – A change in the contract’s scope, price or both.
• Not in the same manner as a contract novation. The standard does not identify contracts in the same
manner as the law. A contract may be novated but may still refer to the same engagement under the
standard.
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Does the price change affect

Is there a distinct change of the stand-alone selling
scope? prices? Remark
Yes Yes There is a new, separate contract
along with the old contract
Yes No There is a new contract, the old
one is cancelled
No Yes The old contract is simply
revised, and Catch-up adjustment
is done
Financial Statement Presentation
• Contract Asset –Presented as net of the receivable; it is recognized after performance, and before
payment
• Receivable – The receivable is usually the billing of the G/S. it is recognized after performance or if
there is an unconditional right to receive payment (only passage of time being the condition for receipt)
• Contract Liability – it is the same as unearned revenue
• All the above are Presented in the Current Portion of the Financial Statements. Contract Assets and
Contract Liability presented separately from other account aggregates.
• Impairment under PFRS 15 – when the Carrying Value (Contract Asset less Receivable), is larger than
the Recoverable Amount, net of Cost of contract the Impairment Loss is recorded in Profit or Loss.
• Applicability – PFRS 15 should either be applied fully retrospectively, from the inception of the business
or the earliest retrospective application possible adjusting to the Beginning Equity balance, as far as
available information permits. These adjustments are presented with comparative amounts.
Other Revenue Recognition Concepts (PFRS 15)
Sales with a Right of Return
An arrangement in which an entity transfers control of a product to a customer and also grants the
customer the right to return the product for various reasons. (Dissatisfaction, for instance) and receive
any combination of the following:
• A Full/Partial Refund of any consideration paid (Sales Returns and Allowances)
• A credit that can be applied against amounts owed (Set-off of obligations)
• Another Product in Exchange
If the Goods are not Expected to be Returned: If the Goods are Expected to be Returned:
Recognize Revenue according to PFRS 15 Do not recognize Revenue, but DERECOGNIZE M/I
Contract Asset Cash/Contract Asset/Receivable
Sales Revenue Returns Liability
Cost of Sales Asset with Right of Return
Merchandise Inventory Merchandise Inventory
Upon Return of the Asset:
Revenue
Contract Asset
No Entry
Merchandise Inventory
Cost of Sales
Upon Expiration of Return Period
Returns Liability
Sales Revenue
No Entry
Cost of Sales
Asset with Right of Return
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Sales with Warranties

Sales with Warranties are generally final sales, only that a warranty liability is estimated just in case a
return of the goods i.e., a right of warranty is exercised. Upon exercise, the customer is entitled to the
benefits determined in the warranty clause of the sale.
Service-type Warranties Assurance-type Warranty
If the customer has an option to purchase the In the absence of a Separate Warranty Option and
warranty separately; or if the warranty provides an additional service upon exercise, it is an
an additional service, the sale is accounted for assurance-type warranty; accounted for under
under PFRS 15; PAS 37. If the warranty is required by law, it falls
under this arrangement.
Cash Warranties Expense
Contract Liability Estimated Warranty Liability
Contract Liability Estimated Warranty Liability
Revenue from Service-type Warranty Various Credits
Consignment Sales (Principal-Agent Relationship)
Transfers of property to a consignee who is assigned to sell in behalf of a consignor. Even if there is a
physical transfer of property, there is no sale recorded. The ultimate sale will be recorded only once the
consignee actually transfers the property to third parties
Transaction Control
Goods Unsold Consignor
Goods Sold Buyer
Reimbursed Freight and Expenses – to Consignee Consignor/Principal (Consignment Out Account)
Remittances, Freight, and Expenses – to Buyer Consignee/Agent (Consignment in Account)
Sales Revenue Consignor/ Principal (Gross of Commissions)
Commissions Revenue Consignee/Agent (Net of Remittances)
Pacto de Retro Sales (Repurchase Agreements/Repos)
A seller Sells an Asset to a Customer and reserves a right to repurchase the thing sold at a later date.
These may be manifested thru:
Forward Contracts Call Options Put Options
Obligation to Repurchase, with Right to Repurchase with Obligation to Repurchase upon
no Expiration of term Expiration of Term exercise of Customer’s Option
with Expiration of Term
The customer does not obtain The Customer does not obtain The customer may or may not
control; hence no sale control; hence no sale obtain control
If the Repurchase Price > Original Price = the transaction is a Park If the Repo > Orig S.P. see if:
Sale (Inventory Financing) The difference is Interest Expense • Customer holds significant
Cash economic incentive;
Contract Liability Accounted for under PFRS 16,
(RP > FMV)
Interest Expense
• otherwise, this is a Sale with
Contract Liability
Right of Return (RP < FMV)
Contract Liability If the Repo < Orig. S.P. see if:
Cash • Customer holds significant
economic incentive;
Contract Liability Accounted as Park Sale, (RP >
Revenue (Upon Expiration of Call Option) FMV)
If the Repurchase Price < Original Price = the transaction is a • otherwise, this is a Sale with
Lease (PFRS 16) Right of Return (RP < FMV)
Bill and Hold Arrangement
A seller sells an asset to a customer, whereby the asset remains in the possession of the seller for a
specified period. The customer obtains control upon the meeting of all the criteria:
• The reason for bill-and-hold is substantive
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• The product is distinct/separately identifiable

• The product is ready for physical transfer/is completed
• The entity has no obligation to use the product or to transfer it to another customer (No Right of
Lien, Stoppage in Transitu, Right of Resale, or Repurchase Obligation)
Other Revenue Issues
Customer Incentives (Recognized in a Point in Time)
• Bundled Sales – Allocate the Bundled Price to all the Goods Sold (Buy 2 get 1 free)
• Loyalty Programs – Premiums Liability (FAR) Allocate Price to Sale and to Loyalty Program at
Exercise
• Discount Coupons – Upon exercise of Coupons, a Discount is recorded (Sales Discount offered,
Provisions are set-up)
Generally, all the above pertain to other performance obligations aside from the delivery of the thing
sold. Thus, the price is allocated to each performance obligation.
Gift Cards/Certificates (Recognized in a Point in Time)
• Upon Sale of the Gift Cards or Certificates, recognize a Contract Liability
• Upon availment, Debit Contract Liability; Credit Revenue
Stages of Pre-selling (Recognized Over Time)
• Reservations – No Sale, but a Contract Liability is recognized; upon expiration eliminate the
Contract Liability against Revenue
• Contract to Sell – Option Money is paid at this stage. There is no formal sale yet.
• Deed of Absolute Sale – Upon issuance of the Deed of Absolute Sale, there is now a sale, subject
to some limitations by the Law (Recto Law for Chattels/Moveable’s and Maceda Law for Realties)
Construction Contracts (PAS 11, PFRS 15)
Construction Contracts – Contracts specifically negotiated for the construction of an asset or
combination of assets that are closely interrelated or interdependent depending in the terms of their
design, technology or function, or their ultimate purpose or use.
• Fixed Price Contract – the contractor agrees to a fixed price or fixed rate per unit of output, subject
to cost escalation cost (Based on Estimated Costs to Complete, thus the price here is called Bid Price)
• Cost-plus Contract – the contractor is reimbursed for allowable or other defined costs plus a
percentage of these costs or a fixed rate (Based on actual cost incurred)
Construction contracts may be segmented i.e., a single contract be subdivided into multiple contracts
or combined, where multiple contracts are treated as a single contract; or combined into one
Fixed Price Clause XX Construction Costs (DM, DL, OH) XX Selling Costs XX
Escalation Clause XX Directly Attributable Costs XX General & Admin Cost XX
De-escalation Clause (XX) Indirectly Attributable Costs XX Dep’n of Idle PPE XX
Incentives Clause XX Reimbursable Costs XX R&D XX
Penalty Clause (XX) Total Construction Cost XX Total Expenses XX
Change Orders X(X) Gain on Sale of Scrap (XX)
Claims XX Cost Incurred to Date XX
Total Revenue XX
• For Change Orders it is included in the Total Contract Price only upon approval of both parties (All
Clauses in the Contract)
• While for Claims, these are included in the Total Contract Price only upon reaching an advanced stage
of negotiation
• Materials acquired in Advance/Unused Materials – Current Assets; if Materials are specialized,
Capitalized.
• Advances to Subcontractors – Current Assets; Receivable
• Any cost not specified to be capitalizable in the construction contract is considered an expense (i.e.,
wastage); Reimbursable Costs incurred (even if not related to construction) are included in Cost
Incurred to Date.
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• Under PAS 11, Materials Acquired in Advance and Advances to Subcontractors are excluded in the
Cost Incurred to Date, but are included in the Estimated Cost to Complete. Furthermore, if the
Materials acquired in advance have no alternative use, these are included in the Cost incurred to date
and estimated cost to complete; otherwise include only in Estimated Cost to Complete.
• Under PFRS 15, regardless of alternative use, the above are excluded in Cost Incurred to Date,
and included in Estimated Cost to Complete. Before use, these are presented as Assets then
transferred to Construction in Progress/Contract Asset upon use.
Profit Realization Methods:
• Percentage of Completion Method – used only when there is a reliable estimate as to the
contract revenue and costs. (Contract Revenue, Stage of Completion, and Estimated Cost to
Complete)
• Stage of Completion determines how much of the profit is actually earned
• Input Measures: (If a cost is incurred, but not used, these will be deducted from
computation)
i. Cost to Cost – based on Proportions of Contract Cost incurred.
Cost Incurred to Date Construction in Progress
Percentage of Completion = ; Percentage of Completion =
Total Estimated Cost to Complete Total Contract Price
ii. Effort Expended – prepared by costing measures and work performed
• Output Measures – based on architect’s or engineer’s estimates
i. Proportional Costs Approach – Cost incurred may not equal actual costs
(preferred)
ii. Actual Costs Approach – Costs incurred should be equal to actual costs
Work deemed Complete Output Units Completed
Percentage of Completion = ; Percentage of Completion =
Total Expected Production or Usage Total Units per Contract
• Profit is only realized to extent of actual progress; Losses are recognized entirely
• If Cost Incurred to Date > Contract Revenue →begin using Zero-Profit Method
• When Prior Year Revenue is larger than Revenue to date, this is not yet considered a loss
• If Cumulative Cost is larger than Cumulative Revenue, POC will no longer be used
• Zero Profit Method – Outcomes of the contract cannot be reliably measured (Revenue, Stage of
Completion, Total Cost to Complete)
• Revenue is only realized when it starts to overtake costs
• Contract costs are recognized as expenses when no revenue could be recognized
Other Issues and Formulas:
• Anticipated Losses – Expensed immediately, unconditionally, even if using POC
• Costs for Future Activity – Exclude from Cost incurred to date, include once used
Cost incurred to Date XX
Cumulative Realized Gross Profit (Loss) XX
Construction in Progress or Inventory XX
CIP = Contract Price ∗ POC = Revenue to Date; Revenue to Date − Loss to Date = CIP
CIP (treated as Current Asset) = Total Cost ∗ POC + GP to Date or − Loss to Date
Accounts Receivable or (Advances from Customer) XX Progress Billings XX
Progress Billings (Contra-asset Account) XX Additional Billings XX
Collections (XX) Total Progress Billings XX
Ending Balance XX
• Construction in Progress and Progress Billings are Offset. CIP is larger, Asset; PB is larger, Liability
• Contract Retention – Included in the Billing, but not paid to the contractor due to some elements in
the agreement not yet being accomplished; has no income element
• Mobilization Fee – A Liability, is deducted from bills, but added to back later; has no income element
• Cost Incurred to Acquire the Construction Contract – If the contract is acquired, it is included in the
Costs Incurred to Date, otherwise, it is simply expensed
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Journal Entries
PAS 11/PFRS SMEs PFRS 15
Construction in Progress Assets (DM, DL, OH) Purchase of Materials, Labor, Overhead,
Cash Various Credits and other Costs
Cost of Construction
Cost of Construction
Assets (DM, DL, OH)
Construction in Progress Recognizing progress
Contract Asset
Construction Revenue
Construction Revenue
Accounts Receivable Accounts Receivable
Progress Billings Contract Asset Recognizing billings
Contract Liability
Cash Cash
Collecting billings
Accounts Receivable Accounts Receivable
Recognizing unearned revenue at Year-
No entry Contract Asset end,
Contract Liability The existing balance of CA is transferred
to CL if the CL > CA.
Progress Billings Contract Liability (A/R) Accomplishing the construction contract
Construction in Progress Contract Asset that INCLUDED unearned Revenue
Accounts Receivable Accounts Receivable Client withholds cash until certain
Contract Retention Contract Asset conditions are met (Retention Policy);
Cash Cash Netting the A/R from Cont. Asset is
allowed
Cash Cash
Payment by customer of retention fee
Contract Retention Contract Asset
after meeting conditions
Accounts Receivable Accounts Receivable
Cash Cash
Mobilization Fee to initiate construction
Advances from Customer Contract Liability
Progress Billings Recognizing billings, with reduced A/R
Contract Liability
Advances from Customer against Progress Billings/Contract
Accounts Receivable
Accounts Receivable Liability
Impact of PFRS 15
• Generally, construction contracts under PFRS 15 take the same procedures under PAS 11 if the revenue
qualifies to be recognized OVER TIME regardless of the use of Zero-Profit or Percentage of Completion.
• However, if the revenue qualifies to be recognized AT A POINT IN TIME, the entire revenue and costs
directly related to the contract are recognized only when the construction contract is accomplished,
or when the retention fee from the customer is paid regardless of the use of ZPM or POC.
• If a Construction Contract is finished within 12 months from contract inception, Accrual Method may
be used
• Penalties, Incentive pays, Cost escalation clauses, and litigation claims are lumped together as
variable considerations measured at the Most Likely Outcome or Expected Value along with
Contract Price.
• Direct Cost of Contracts, Allocated Costs of Contracts, and Extra charges are lumped together as the
Costs to fulfill the Contract Obligation, which must follow the criteria set by PFRS 15. They are added
as part of Contract Assets.
• Recognize a RECEIVABLE when an UNCONDITIONAL RIGHT to receive payment is acquired. Recognize a
CONTRACT ASSET, when a CONDITIONAL RIGHT is acquired. A Progress Billing is a CONTRA-ASSET
• Recognize a CONTRACT LIABILITY when PB > CIP.
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Procedural Layout
Year 1 Year 2 Year 3 Year 4
Contract Price XX XX XX XX
Revenue for the Year XX XX XX XX
Revenue Earned in Prior Years - XX XX XX
Revenue to Date XX XX XX XX
Cost Incurred for the Year XX XX XX XX
Cost Incurred in Prior Years - XX XX XX
Cost Incurred to Date XX XX XX XX
Estimated Costs to Complete XX XX XX -
Total Estimated Cost XX XX XX XX
Gross Profit XX XX XX XX
Percentage of Completion X% X% X% X%
Realized Gross Profit to Date XX XX XX XX
Realized Gross Profit in Prior Years - (XX) (XX) (XX)
Realized Gross Profit for the Year XX XX XX XX
• For Percentage of Completion, this would be the usual way to compute the RGP.
• For Zero-Profit or Cost Recovery Method, it is recommended to compute for the Gross Profit first to
see when the project starts to earn revenue throughout the project.
• For as long as the Cost is not recovered yet, the Revenue to date should equal Cost incurred to date
• Although not usual, it is possible for a problem to present costs larger than revenues, this will mean
that the project will start to recognize in full the losses for that year, but will then recompute the
percentage of completion once the project starts to earn again (Change in Accounting Estimate)
Year 1 Year 2 Year 3
Total Cost incurred to Date XX XX XX
Revenue to Date (XX) (XX) (XX)
Balance XX XX (XX)
Realized Gross Profit - - XX
• There are NO estimated Costs for Zero-profit Method. Since estimating costs carried at a loss is
useless, and if no reliable measure of costs or percentage of completion could be made.
• Some problems will also ask about the status of the contract whether the contracting party has a
contract asset/due from customer or a contract liability/ due to customer.
• Note: The Contract Liability is extinguished upon COMPLETION of the project & its other conditions.
Billings (A/R or PB) XX
Mobilization Fee (XX)
Contract Asset (Contract Liability) under IFRS 15 XX

Year 1 Year 2 Year 3

Construction Cost XX XX XX
RGP – to Date XX XX XX
CIP, to Date XX XX XX
PB, to Date (XX) (XX) (XX)
Balance XX XX XX
Mobilization & Retention Fees XX XX XX
Contract Asset (Liability) XX XX XX
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Combination of Construction Contracts

• In the construction industry it is very
common for an entity to provide multiple
goods or services to one customer or
related parties of a customer.
• For example, a construction company can
be engaged to provide design and
engineering services as well as the actual
construction. Even the construction itself
could be seen as comprising many
component services such as site
clearance, foundations, procurement,
construction of the structure, piping and
wiring, etc. These activities can be dealt
with under one contract or be separated
into various sub-contracts.
IFRS 15 will require construction companies to consider whether these contracts should be accounted
for separately or as one combined contract.
The following decision should be used to determine whether multiple contracts are combined or not:
A customer engages Construction Co to provide construction services to build a house (contract price of
P500,000) and a garage (contract price of P50,000). There are separate contracts for each of these two
activities. They were negotiated together and a discount was given on the garage build as Construction
Co would already have the necessary equipment on site from the house construction, and could also
build the foundations simultaneously with the house. However, Construction Co has agreed with the
customer to first build and complete the house and then finish the garage within the next three months.
The standalone selling prices of the house and garage are P500,000 and P80,000 respectively.
The expected cost to construct the land and garage are P400,000 and P64,000 respectively. At 30 June
2019, the entity has incurred costs of P200,000 in for the house and P5,000 for the garage.
If the contracts were accounted for separately, revenue would be recognized as follows:
Estimated Costs incurred
Contract Contract Standalone Revenue recognized to 30 June
contract to 30 June
components price selling price 2019
costs 2019
House P500,000 P500,000 P400,000 P200,000 P250,000=
P500,000x(P200,000/P400,000)
Garage P50,000 P80,000 P64,000 P5,000 P3,906=
P50,000x(P5,000/P64,000)
Total P550,000 P580,000 P464,000 P205,000 P253,906
However, the entity needs to determine if the contracts for the building of the house and garage should
be accounted for separately or as one combined contract. The contracts were negotiated with the same
customer, at the same time and pricing on one contract is dependent on the other. Construction Co also
assesses that they have two separate performance obligations, because they will complete and handover
the house 3 months before the completion of the garage. Revenue on both performance obligations is
recognized over time, as construction is taking place on the customer’s land.
Therefore, the contracts should be combined and accounted for as one contract for the purposes of
IFRS 15. Revenue would be recognized as follows:
Components CP SSP RSP ECTC CITD Revenue as of 6/30/19
House P500,000 P500,000 P474,137= P400,000 P200,000 P237,068=
(P500,000/P580,000 P474,137x
x P550,000) (P200,000/P400,000)
Garage P50,000 P80,000 P75,863= P64,000 P5,000 P5,927=
(P80,000/P580,000 P75,863x
x P550,000) (P5,000/P64,000)
Total P550,000 P580,000 P550,000 P464,000 P205,000 P242,965
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Unbundling for Construction Contracts

In the construction industry it is very common for
an entity to provide multiple goods or services to
one customer.

For example, a construction company can be

engaged to provide design and engineering
services as well as the actual construction. Even
the construction itself could be seen as
comprising many different services such as site
clearance, foundations, procurement,
construction of the structure, piping and wiring,
etc. These activities can be dealt with as one
performance obligation or separated into various
separate performance obligations.

IFRS 15 will require construction companies to consider whether these goods and/or services should
be accounted for separately or as one performance obligation (bundling). Similarly, if there is one
contract that covers many different services then the entity will need to consider if the contract
contains multiple performance obligations that require the contract revenue to be split into separate
performance obligations (unbundling).
Construction Co is engaged by Customer A to design a building and also to construct the building once
the design has been approved. These activities are both within the same contract and the contract price
is for P100,000. Customer A could benefit from the design services by itself as they could engage another
construction company to perform the build with the design specifications made by Construction Co.
The standalone selling price for the design services is P30,000 and P80,000 for the building services.
Therefore, revenue is recognized for these two performance obligations as follows:
Obligations Standalone selling price Revenue
P100,000 is unbundled as
Design P30,000 P27,273=
separate obligations.
P30,000x(P100,000/P110,000)
Design and Construction
Construction P80,000 P72,727=
must be unbundled under
P80,000x(P100,000/P110,000)
IFRS 15.
P110,000
The revenue from the design services would potentially only be recognized when the design
specifications were approved by the customer, and the construction revenue would be recognized as the
construction services were provided (over time) because the second criterion in IFRS 15, paragraph
35(b), would be met, i.e., building on the customer’s land. Consideration should be given whether the
design services meet the third criterion in IFRS 15 paragraph 35(c).

Financing Arrangements - Upfront Fees for Construction Contracts under IFRS 15

In the construction industry, it is very common for a customer to be required to pay a deposit or portion
of the contract price upfront. There can also be cash receipts from customers which do not correspond
with the timing of the recognition of revenue. IFRS 15 requires the entity to consider if this represents a
financing arrangement. If a financing component is significant, IFRS 15 requires an adjustment to be
made for the effect of implicit financing. (From Time of Payment and Time of Transfer)
Construction Co enters into a contract with a customer to supply a new building. Control over the
completed building will pass to the customer in two years’ time (assuming the vendor’s performance
obligation will be satisfied at a point in time). The contract contains two payment options:
• The customer can pay P5 million in two years’ time when it obtains control of the building, or
• The customer can pay P4 million on inception of the contract.
The customer decides to pay P4 million on inception. Construction Co’s incremental borrowing rate is
determined to be 6%.
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Because of the significant period of time between the date of payment by the customer and the transfer
of the asset (the completed building) to the customer, together with the effect of prevailing market
rates of interest, there is a significant financing component in this arrangement.
The following journal entry is recognized at contract inception:
Dr Cash P4,000,000
Cr Contract Liability P4,000,000
Recognition of a contract liability for the payment received in advance
The following journal is recognized over the two-year construction period:
Dr Interest expense P494,400
Cr Contract Liability P494,400
Accretion of the contract liability at a rate of 6% (6% compound interest X P4 million for 2 years)
The following journal is recognized at the date of the transfer of the asset to the customer:
Dr Contract Liability P4,494,400
Cr Revenue P4,494,400
Recognition of contract revenue after performance obligation has been satisfied
Financing Arrangements - Customer Pays in Arrears
Construction Co enters into a contract with a customer to supply a new building. Control over the
completed building will pass to the customer in 12 months’ time (assuming the vendor’s performance
obligation will be satisfied at a point in time). The contract contains two payment options:
• The customer can pay P4.5 million in 12 months’ time when it obtains control of the building, or
• The customer can pay P5 million one year after control passes to the customer.
The customer decides to use the second payment option. Construction Co’s incremental borrowing rate
is determined to be 6%.
The following journal entry is recognized at the date the building is transferred to the customer:
Dr Trade receivable P4,716,981
Cr Revenue from sale of building P4,716,981
Recognition of revenue from sale of building at net present value of $5 million
payable in 12 months’ time at incremental borrowing rate of 6%.
The following journal entry is recognized over the one year until payment is received from the customer:
Dr Trade receivable P283,019
Cr Interest revenue P283,019
Accretion of the interest on the trade receivable at a rate of 6% compound interest for 1 year
The following journal is recognized when the customer settles the debt 12 months after delivery
Dr Cash P5,000,000
Cr Trade receivable P5,000,000
Recognition of cash received from customer.
• When a significant financing component is recognised, consideration is required of whether the
interest income or expense is required to be capitalised by IAS 23 Borrowing Costs.
Contract Modifications under IFRS 15
It is common for the scope and/or price of construction
contracts to be modified due to changes in the scope of
work (often termed contract variations) or because
additional goods or services are added to the
contract. IFRS currently has limited guidance for the
accounting consequences of these changes. In contrast,
IFRS 15 has detailed guidance to be applied in
determining whether, from an accounting perspective,
contract modifications result in changes to the existing
contract or the issue of a new contract. This links to
whether there is either an adjustment to the amount of
revenue recognized to date (resulting in a ‘true up’ in the
income statement) or to revenue to be recognized in
future. These new requirements may result in significant
changes to the pattern of revenue and profit recognition.
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Contract Modification for Distinct Goods or Services – On 1 January 2019, a customer engages
Construction Co to provide construction services to build a house for P500,000 (estimated cost
P300,000).
On 1 January 2020, Construction Co and the customer agree to modify the contract to include a
swimming pool for an additional P50,000 (estimated cost P40,000).
Construction Co regularly builds swimming pools on a standalone basis and the standard price for this
is P60,000. Construction Co has been recognizing revenue on a stage of completion basis and at 1
January 2020, 50% of the original contract value has been completed
The construction of the swimming pool is a distinct good that should be accounted for as a separate
performance obligation. As the contract price for the swimming pool is P50,000 which is less than the
standalone selling price of P60,000, the modification is treated as a termination of the original contract
and a new contract is created. This means that any unperformed work on the old contract is combined
with the new swimming pool contract. As such, total consideration on the ‘new contract’ is P300,000
(P250,000 + P50,000).
Revenue is then split between the two performance obligations as follows:
Contract components Contract price Standalone selling price Revenue
House P250,000 P250,000 P241,935=
P250,000x(P300,000/P310,000)
Swimming pool P50,000 P60,000 P58,065=
P60,000x(P300,000/P310,000)
Total P300,000 P310,000 P300,000
Revenue recognized prior to contract modification: P250,000 (P500,000 x 50%)
Revenue to be recognized based on contract modification:
• House P241,935
• Swimming pool P58,065
This means that for the remaining construction services to be performed in building the house, revenue
will be $241,935 rather than $250,000, due to the swimming pool discount allocated to both performance
obligations (i.e., the rest of the house and the new swimming pool).
Contract Modification for Indistinct Goods or Services - On 1 January 2019, a customer engages
Construction Co to provide construction services to build a house for P500,000 (estimated cost
P300,000). On 1 January 2020, Construction Co and the customer agree to modify the contract to
upgrade the kitchen for an additional P100,000 (estimated cost P50,000). Construction Co has been
recognizing revenue on a stage of completion basis and at 1 January 2020, 50% of the original contract
value has been completed.
End of Year 1
Total costs incurred to date P150,000 (50% x P300,000)
Updated total expected costs P350,000 (P300,000 + P50,000)
New % of completion 42.86% (P150,000/P350,000)
Revenue recognized based on modified contract P257,143 (P600,000 x 42.86%)
Revenue recognized to date P250,000 (P500,000 x 50%)
Cumulative catch-up adjustment. P7,143 (P257,143 – P250,000)
The following journal entry will be processed by Construction Co on 1 January 2020:
Dr Trade receivable P7,143
Cr Revenue P7,143
Construction Contracts with Variable Consideration
The amount of consideration specified in a construction contract may be fixed, variable, or a combination
of fixed and variable amounts.
When the consideration promised in a contract with a customer includes a variable amount, the
vendor estimates the amount of consideration to which it is entitled to in exchange for the transfer of
the promised goods or services. There are two possible estimation methods which can be used, namely
the expected value method or the most likely amount. Once a method has been selected, it must be
applied consistently throughout the term of each contract.
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Expected value method

The expected value is the sum of the probability-weighted amounts in a range of possible consideration
amounts. This may be an appropriate approach if the vendor has a large number of contracts which have
similar characteristics.
Most likely amount
The most likely amount is the single most likely amount in a range of possible consideration amounts
(i.e., the single most likely outcome of the contract). This may be an appropriate approach if a contract
has two possible outcomes, such as a performance bonus which will, or will not, be received.
The method chosen is not intended to be a free choice, but rather the one which is expected to provide
a better prediction of the amount of consideration to which a vendor expects to be entitled.
One of the key principles is that variable consideration can only be recognized if it is highly probable that
a significant reversal in the amount of the cumulative revenue recognized will not occur. There is no
specific guidance on what highly probable is but this is generally thought to be more than 75-80%.
Variable Consideration – Performance Bonuses
In the construction industry it is very common for there to be performance bonuses tied to completion
time to incentivize construction within a specified time frame. There can also be performance bonuses
tied to warranty and defect periods.
A customer engages Construction Co to build a warehouse for $1,000,000. If the warehouse is completed
on time, Construction Co will receive a performance bonus of $100,000. This amount reduces by $10,000
for every week Construction Co is late.
Estimated completion date Probability
On time 25%
One week late 25%
Two weeks late 20%
Three weeks late 20%
Four weeks late 10%
We would use the expected value method in this example because using the most likely amount would
violate the significant reversal principle (none of the above scenarios is in excess of 75-80% and hence
would most likely result in a reversal). Using the expected value method, we would use the probability-
weighted expected consideration to calculate the expected revenue.
Probability-weighted
Estimated completion time
Consideration (PHP)
On time 25% x (1,000,000 + 100,000) 275,000
One week late 25% x (1,000,000 + 90,000) 272,500
Two weeks late 20% x (1,000,000 + 80,000) 216,000
Three weeks late 20% x (1,000,000 + 70,000) 214,000
Four weeks late 10% x (1,000,000 +60,000) 106,000
Total transaction price 1,083,500
Variable Consideration – Penalties
Many construction contracts contain penalty clauses that are tied to completion date or warranty/defect
periods. These form part of variable consideration and need to be factored into the transaction price.
Construction Co enters into a contract to build an oil rig for P100,000. If the rig is not completed on
time, there will be a P20,000 penalty. Build Co has built similar oil rigs before and there is a 90% chance
that the oil rig will be completed on time.
There are only two possible amounts of consideration:
• P100,000 if the build is completed on time, or
• P80,000 if the build is not completed on time.
In this scenario, the ‘most likely amount’ method better predicts the amount of consideration. Therefore,
the transaction price is P100,000. Selecting this amount would mean it is highly probable that there
would not be a significant reversal in revenue because the historical compliance with the deadline is 90%
(in excess of 75-80%).
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Tender Costs for Construction (Contract Acquisition Costs)

In addition to the substantially more detailed guidance for revenue recognition, IFRS 15 contains
prescriptive criteria to be applied when determining whether costs associated with the acquisition of a
contract should be recognized as an asset or expensed as incurred. This extends to cover all contract
acquisition costs, such as bid costs incurred prior to the award of a contract.
IFRS 15 is restrictive in that it permits only incremental costs of obtaining a contract to be considered
for capitalization. Therefore, only those costs which would not have been incurred if the contract had
not been obtained are eligible to be considered.
• An example is a sales commission which is only payable in the event that a contract is
awarded. In contrast, ongoing costs of running the business, such as a legal department, are not
eligible to be considered because these costs would have been incurred regardless of whether a
specific contract had been obtained. Although it might be argued that the legal department
would not exist unless an entity was involved in obtaining sales contracts, IFRS 15 does not permit
those contracts to be analyzed on a portfolio basis. Instead, the focus is on whether costs
attributable to each individual contract are incremental.
Once incremental costs have been identified, these are recognized as an asset if there is an expectation
that they will be recovered, typically through profits to be generated from the related contract. This
asset is then amortized on a basis that is consistent with the transfer of the goods or services specified
in the contract. It will be necessary for judgement to be applied in determining an appropriate
amortization period and profile.
Construction Co wins a competitive tender to construct a warehouse for a customer. They incur the
following costs to obtain the contract:
• External legal fees for due diligence: P35,000
• Travel costs to deliver proposal: P5,000
• Commission to sales employee if tender is successful: P10,000
• External consulting costs incurred to assist Construction Co preparing the tender
documentation: P10,000
• Administrative costs incurred in preparing the tender document: P15,000.
The completion of this construction project is expected to take 2 years.
Amount
Cost Treatment Justification
(PHP)
Due diligence legal fees 35,000 Expense Expensed as incurred because these
would have been incurred whether or not
the tender was successful.
Travel costs to deliver proposal 5,000 Expense Expensed as incurred because these
would have been incurred whether or not
the tender was successful.
Commission to sales employee 10,000 Capitalize Recognize as an asset because these are
incremental costs of obtaining the
contract and the company expects to
recover them through future construction
fees.
External consulting costs incurred10,000 Expense Expensed as incurred because these
to assist Construction Co preparing would have been incurred whether or not
the tender documentation the tender was successful.
Administrative costs 15,000 Expense Expensed as incurred because these
would have been incurred whether or not
the tender was successful.
Total 75,000
Journal entries
Dr Tender costs (contract asset)P10,000
Dr Tender expenses P65,000
Cr Trade Payables P75,000
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Under the Old PAS 11

Combination of Contracts The common practice under IAS 11 would be to account for separately and
recognize the revenue on a percentage of completion basis. However,
timing of revenue recognition for each contract is not necessarily the
same. For example, if a garage is completed first, revenue would be
recognized earlier than for the house it was constructed with
Bundling and Unbundling Entities that currently do not ‘unbundle’ such contracts would recognize
Contracts revenue for the design services over time, together with the construction
services.
Financing Components – The common practice under IAS 11 would be to recognize revenue in n
Customer Deposit years’ time when control passes to the buyer, and not account for the
financing component.
Financing Components – It is likely that there is divergent current practice regarding the treatment
Payment in Arrears of payments in arrears. Some entities may recognize this as a financing
component but it is likely that many may not.
Contract Modification Account Modification as each separate contract
Variable Considerations Discretely the probable amount, and not weighted.
Tender Costs Little guidance, and usually capitalized
PIC 2020 – 03 Percentage of Completion in advance of Billings
PIC 2020-03 deals with the situation where the POC goes in advance of the billings. It settles the issue
as to how companies may account for this difference in timing.
Company A enters into a contract with a customer in June 2020 for the construction of condominium
units. The scheduled completion and delivery date is June 1, 2022. Revenue is recognized over time.
The transaction price (TP) is P1,000,000 and, as at 31 December 2020, the contract is 30% complete.
The financial reporting date of Company A is every December 31. As of December 31, 2020, Company A
recognizes revenue of 30% at P300,000.
Below are the payment terms, which indicate that the first instalment is due on January 1,2021.
30% (10% of TP every month) 1/1/21 to 3/1/21 70% of TP in June 1, 2022
If Company A fails to complete and deliver the asset, the customer will be entitled to a refund of any
consideration paid.
The Revenue Accounting does not change in this case. The PIC provides the guidance to account for the
debit side of the transaction. As such:
View 1 Company A recognizes a contract asset. PFRS 15.107 states that a contract asset is recognized if
an entity has the right to consideration in exchange for goods or services that the entity has
transferred to a customer. Company A recognizes a contract asset because as of December 31, 2020,
there is no unconditional right to a consideration (receivable) yet since the first instalment of 10% is
not due until January 1, 2021. This is consistent with Example 39 of PFRS 15.IE201-203.
Dr Contract Asset P300,000 Dr Accounts Receivable or Cash P300,000
Cr Construction Revenue P300,000 Cr Contract Asset P300,000
View 2 Company A recognizes a receivable. PFRS 15.108 states that a receivable is an entity’s right to
consideration that is unconditional. A right to consideration is unconditional if only the passage of time
is required before payment of that consideration is due. The required payment on 1 January 2021
arises from a contractually agreed payment term, and only the passage of time is required before
Company A has a right to consideration. The PIC has concluded that both Views above are acceptable
as long as this is consistently applied in transactions of the same nature. If presented as a contract
asset, the disclosures required under PFRS 15 should be complied with. If presented as a receivable,
the disclosures required under PFRS 15 should be followed.
Dr Accounts Receivable P300,000 Dr Cash P300,000
Cr Construction Revenue P300,000 Cr Accounts Receivable P300,000
The PIC settles that if services are rendered, but are contractually agreed to be paid in a later date,
the treatment can either be a Contract Asset or a Receivable.
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Licenses & Franchise Contracts (PFRS 15, PAS 18)

Franchise – a license that a party acquires to allow access to a business proprietary knowledge, processes
and trademarks in order to allow the party to sell a product or provide a service under the business name.
Impact of PFRS 15
The standard requires that the franchise or license thereto, be distinct since the standard provides
explicit guidance for distinct license agreements. The distinction manifests through the separability of
the promise to grant a license from other obligations in a franchising contract.
The separability clause is important because it means that the contracting parties can understand how
the license exactly works, as to whether the license grants a right to access intellectual property or a
right to use intellectual property which are differentiated in the standard. Accordingly, separability will
determine Separate Performance Obligations under PFRS 15, and therefore, different Contract
Liabilities. In the absence of separability, the license consists of only one Performance Obligation.
• Right to Access – The customer cannot direct or has no full control over the use of substantially
all of the remaining benefits from the license at a single point in time. Apparently because not
‘all’ benefits are available due to the assumption that further improvements could be made to
the use of the licensed good, hence this arrangement should recognize revenue over time.
• The franchisor is undertaking activities that significantly affects the intellectual property
while the customer has rights to it (i.e., incomplete training, construction/delivery of assets)
• The rights that the customer holds expose them to economic risks and rewards
• The franchisor’s activities to improve the license are not separate performance obligations
A shared economic interest is a good indicator for intention to undertake activities by the franchisor
• Right to Use – The customer can use and has full control over substantially all of the remaining
benefits from the license at a single point in time. No further benefits are expected to be
controlled/transferred to the customer (This is the usual case or if the problem is silent.)
• Sales-based or Usage-based Royalties (CFF) – An exception to the rule, the standard provides
that royalties should only be recognized at the later of two dates: Sale or Usage (Multiple Points
in Time) occurs OR Performance Obligations are satisfied (A Single Point in Time, or allocations
if these are more appropriate)
**If there are no distinctions in the performance obligations use 5-step Model
Franchise Fee Revenue ≠ Franchisor ′ s Revenue (includes Interest Income)
Allocate Revenue: Recognize Revenue when:
Initial Franchise Fee • Franchisor satisfies all performance obligations
• Over Time – for considerations with useful life with no refund period OR
(PPE, Intangibles delivered) • Control is transferred over the operation of the
• Point in Time – for those with infinite life/M.I. franchise
• Point in Time – Right to Use Arrangement
• If it represents a fair measure of SERVICES
already rendered with no refund period, use
Down Payment PFRS 15
• PFRS 15 allows only Accrual Method
• But the US GAAP is not prohibited
Continuing Franchise Fee (Allocable, if the • Sales already occurred AND
problem is silent, simply multiply the CFF Rate) • Performance Obligation on CFFs are satisfied in
• Points in Time - Date of Sale or if all full or partially
Performance Obligations are performed
Interest Income • Based on Amortized Cost
Non-refundable Upfront Fees Accounted as Promised G/S, Recognized in a Point
• Payment relates to Specific G/S transferred in Time upon transfer
• Payment not related to Specific G/S transferred Account for an Advanced payment for G/S,
Recognized in a Point in Time upon transfer
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When to Use US GAAP on Franchises?

• The problem mentions the collectability of any note issued for payment
• There is a refund period mentioned
• **If there are no distinctions in the performance obligations use 5-step Model
Use PFRS 15 if the problem is silent as to refund period, in which the assumption is that the down
payment is not refundable
• The problem mentions any form of performance or substantial performance
• The problem has no buyback or cancellation provisions (Certain – No Revenue if uncertain to exercise)
• All revenues are recognized in a Point in Time
• The entity is an SME
Initial franchise fee revenue is recognized thru Accrual method only when all of these are met:
• All initial services required under the contract had been performed or substantially performed
• Indicators include the Franchisee’s start or commencement of operations
• When Sales are Given
• If the services provide a fair measure of services performed, the down payment can be
recognized as revenue, with unearned interest if the note is non-interest bearing
• The refund period is expired or is non-refundable, and is explicitly stated as such
• Collectability of the receivables issued by the franchisee is reasonably assured
• There is NO Cancellation Provision/Buyback Provision
If at least one of the criteria are not met, then the entire Initial Franchise Fee becomes unearned until
met. (Deposit or Liability Method for Revenue)
EXCEPTION: If the down payment is non-refundable and it represents a fair measure of services
performed, recognize revenue to the extent of the down payment.
Furthermore, PAS 18 allows for the use of Accrual, Installment, and Cost-recovery Method for Franchises
• If the Collectability of the Note is:
• Reasonably Assured – Accrual Method
• Not Reasonably Assured – Installment Method
• Remote – Cost-recovery Method (NO REVENUES UNTIL THE COST IS COVERED)
**Cost of Franchise = Direct Costs of IFF ONLY; All Indirect Costs and Direct costs of CFF = OPEX Expense
Formulas
Accrual Method: PFRS 15 & PAS 18 Installment Method PAS 18 & US GAAP
Initial Franchise Fee XX Down Payment XX
Down Payment (XX) PV of Note XX
Balance XX Deferred Initial Franchise Fee XX
Divide by: No. of Periods X Cost of Initial Franchise Fee (XX)
Periodic Payment XX Deferred Gross Profit XX
Multiply by: PV of Ordinary Ann. X Divided by: Deferred Initial FF XX
PV of Note XX Gross Profit Rate XX
Multiply by: Cash Collection (Principal + PP) XX
Down Payment XX Realized Gross Profit XX
PV of Note XX Continuing Franchise Fee XX
Revenue from Initial Franchise Fee XX Interest Income XX
(determine if Over time/Point in Time)
Cost of Initial Franchise Fee (XX) Interest Income XX
Realized Gross Profit XX Bargain Purchase XX
Continuing Franchise Fee XX Option to Purchase the Franchise XX
Interest Income XX Operating Expenses (XX)
Bargain Purchase XX Net Income XX
Option to Purchase the Franchise XX
Operating Expenses (XX) **Always separate interest income, and
Net Income XX apply only the months/periods lapsed
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Revenue (PAS 18)

PAS 18 was the foundation of general revenue recognition, until it was superseded by PFRS 15, however,
PAS 18 still deserves to be studied in order to develop an appreciation of the salient changes added by
PFRS 15.
Revenue – the gross inflow of economic benefits arising from the ordinary operating activities of an
entity. It is measured at the Fair Value of the consideration received or receivable. Under deferred
arrangements, the Fair Value of the consideration is less than the nominal amount of cash to be received,
discounting is required.
Sale of Goods Rendering of Services
There is a transfer of significant risks and rewards
of ownership Reliability of measuring Revenue, Stage of
There is no managerial involvement or effective Completion, and Costs associated with generating
control associated with ownership remaining the said revenue
Reliable Measurement of Revenue and Costs
If no reliable measurement is available, then revenue is recognized only until cost is fully
recovered
Installment Sales Method (US GAAP/PFRS for SMEs)
Sales done in consideration of long-term solvency of a buyer, hence, no Bad Debts can be recognized.
This is if the collection of the balance is not reasonably assured, and the bad debts cannot be estimated.
• Consider each sales transaction for Trade-ins, repossessions and resales, etc.
• Compute the Gross Profit after adjustments to the above (Sales-COGS/Sales)
• Multiply the GPR to the Collections attributed to the sale for the period (May vary each year
Remarks Repossessions: RGP Regular Sales XX
Estimated Sales XX RGP – Instl. Sales XX
Normal Profit Margin (XX) G/L Repossession XX
Cost of Disposal (XX) G/L Resale XX
Add to Purchases/Inventory → Fair Value XX Operating Expenses (XX)
Reconditioning Cost (XX) Operating Income XX
Inst. A/R Defaulted – DGP Defaulted = Unrecovered Cost (XX) Interest Income XX
G/L on Repossession XX Net Income XX
Gross Profit is based on Cost Trade-ins: Resale:
Cost = 100%; Sales = 100+x% FV – Trade-in XX Resale Price XX
Allowance (XX) Cost of Resale (XX)
Deducted in Installment Sales → Under (Over) Allow. XX RGP - Resale XX
Add Acq. Cost to Cost of Sales → Original Selling Price XX Disposal Cost (XX)
New Selling Price XX G/L Resale XX
**GPR may vary for each class of inventory sold
**Separate Interest Income from Periodic Payment (Annual PP – PP @ PV=Interest Income from PP) if Non-
Interest-Bearing Note is used. Ignore if Interest-Bearing
Formulas for GPR • (Collection – Interest Income) *GP% = RGP
• DGP/Installment Sales = GP% • Change in Installment A/R * GP% = RGP
• DGP, beg/Installment A/R, beg = GP% • RGP from Regular Sales + RGP from Inst’t
Formula for DGP Sales = Total RGP
• Adjusted Installment A/R * GP% = DGP Total Cost of Sales
Installment Collections Beg. Inv XX
Installment Sales XX Net Purch XX
Trade in Allowance (XX) FMV of Repos. M/I + Reconditioning Cost XX
Down payment (XX) NRV of Trade in + Reconditioning Cost XX
Installment Receivable XX TGAS XX
Divided by: n collections X End Inv. (New + Repo +Trade-in (XX)
Installment Collection XX +Reconditioning)
Formulas on Computing Realized Gross Profit: Installment COGS XX
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Insurance Contracts (PFRS 4/PFRS 17)

Insurance Contracts – an arrangement under which one party line (the insurer) accepts significant
insurance risk by agreeing with another party (the policyholder) to compensate the policyholder or other
beneficiary if a specified uncertain future event (the insured event) adversely affects the policyholder or
other beneficiary.
• Risk here is limited to insurance risk and does not include other risks that are covered under PFRS
9 Financial Instruments and Derivatives.
• A contract creates sufficient insurance risk to qualify as an insurance contract only if there is a
reasonable possibility that an event effecting the policy holder or other beneficiary will cause a
significant change in the present value of the insurer’s net cash flows arising from that contract
• The standard on Insurance Contracts is currently governed by PFRS 4, and was scheduled to be
replaced by PFRS 17 on January 1, 2021 which was further pushed further out into January 1, 2023
due to the CoVid-19 Pandemic.
To foster a better understanding of insurance contracts, one has to understand the industry these belong
to. Insurance Companies are generally composed of safely-valued assets, hence, most of their investments
are debt securities, valued at amortized cost. These are generally safe investments that are secured
against market fluctuations. They also purchase shares of stocks valued at the market, which are more
common for property/casualty insurance (because these types of insurance companies issue policies that
last for less than a year) than it is for life insurance (policies lasting decades). To better their image of
safety, insurance companies also collect reinsurance recoverables (reinsurers are insurers of insurance
companies). The Right side of their balance sheets are mostly composed of Unearned Premium
Obligations, technically because the earnings of Insurance companies come from expirations of Insurance
policies; and Loss Reserves (Estimated Liabilities for when actual damages are compensated).
Definition of Terms
• Cedant – Policyholder of a reinsurance Contract
• Deposit Component – A contractual component that is not accounted for as a derivative under
PFRS 9/PAS 39, but would be within the scope of PFRS 9/PAS 39 if it were a separate instrument
• This is a clause in an insurance contract that would function as a derivative for hedging
against the usual financial risk over that which are covered by insurance
• Discretionary Participation Feature – A contractual right to receive as a supplement to
guaranteed benefits, additional ones at the option of the issuer:
• Likely to be a significant portion of the total contractual benefits
• Its amount or timing is contractually at the discretion of the insurer and;
• Has terms that are based on:
i. Performance of a pool of contracts or type of contracts;
ii. Realized and or unrealized investment returns on a specified pool of assets held
by the insurer; or
iii. The profit or loss of the company, fund, or other entity that issues the contract
• These are included in financial instruments to make the contract more
saleable/attractive, for which are purchased insurance policies for
• Financial Guaranteed Contract – requires the issuer to make specified payments to reimburse
the holder for a loss it incurs because a specified debtor fails to make payment when due in
accordance with the original or modified terms of a debt instrument
• Guaranteed Benefits – Payments or other benefits to which a particular policyholder or investor
has unconditional rights that is not subject to the contractual discretion of the issuer
• Guaranteed Element – An Obligation to pay guaranteed benefits, included in a contract that
contains a discretionary participation feature
• Insurance Assets – An insurer’s net contractual rights under an insurance contract
• Insurance Liability – An insurer’s net contractual obligations under an insurance contract
• Reinsurance Assets – A cedant’s net contractual rights under a reinsurance contract
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• Reinsurance Contracts – an insurance contract issued by one insurer to compensate another

insurer for losses on one or more contracts issued by the cedant
• Unbundling – accounting separately for the components of a contract
The scope of PFRS 4 not only covers virtually all insurance contracts, but also Financial instruments that
an entity issues with a discretionary participation feature
**The standard is notorious for being very flexible to changes in accounting policies. This means that
reporters are very likely to use this to their advantage without sufficient objective measure as to how
revenue should have been realized at all. The practice of abusing PAS 8 in this manner is called Shadow
Accounting
Unbundling
Since insurance contracts may contain both insurance clauses and deposit clauses as explained earlier,
the insurance company must account for these components separately, Deposit components fall under
derivatives under PFRS 9, while insurance components fall under this standard. It is required when:
• The deposit component can be measured separately without considering the insurance component
• The insurer’s accounting policies does not require it to recognize all obligations and rights arising
from the deposit component
• This is permitted, but not required if the insurer can measure the deposit component separately,
but its accounting policies require it to be recognized
• This is prohibited if the deposit component cannot be measured separately.
Liability Adequacy Test
The purpose of the LAT is to verify the adequacy of provisioning for insurance. The test consists of
comparing the number of provisions with the best estimates of the same provisions, arrived on at the basis
of the Present Value of the Best Estimate of Future Expected Contractual Cashflows (from premiums and
handling costs). This is performed for each separate contract while the results are aggregated based on
homogeneity of policies.
Present Value of Future Cashflows from XX Carrying Amount of Unearned XX
Premiums Premiums
Best Estimates for Handling Costs (XX) Other Insurance Liabilities XX
Best Estimate of Future Cashflows XX Deferred Acquisition Costs (XX)
Insurance Intangible Assets (XX)
Insurance Capacity XX
Best Estimate of Future Cashflows (XX)
**Deficiencies are presented as Current (Deficiencies) in P/L (XX)
Liability
• Some entities are not required to conduct a LAT, which may be the case for casualty/property
insurance companies. If this is the case:
Carrying Amount of Insurance Liabilities XX
Deferred Acquisition Costs (XX)
Insurance Intangible Assets (Acquired thru Bus. Combi or Portfolio Transfer) (XX)
Carrying Amount of Insurance Liabilities measured using PAS 37 (Contingent Liabilities) (XX)
Difference in P/L (XX)
• In a Business Combination, the insurer shall at the acquisition date, measure at FV the insurance
liabilities assumed and insurance assets acquired in the Business combination. It is permitted, but
not required to follow the split accounting for insurance contracts into two components:
• Liabilities measured under the Insurer’s accounting policies; and
• Intangible Assets = FV of Contractual Insurance Rights – Insurance Liabilities assumed
Discretionary Participation Feature
• Insurers of contracts with discretionary participation features may or may not, recognize the
guaranteed element (Obligation) separately from the DPF
• If the insurer chooses not to account for them separately, the whole contract is a Liability,
otherwise, only the guaranteed element is a Liability
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• The DPF can EITHER be presented as a Liability, or a Separate Component of Equity; using an
accounting policy for the split procedure since the standard does not specify one
• The insurer may recognize the premiums on the contract entirely as revenue without split
accounting. The change in the guaranteed element as equity and the DPF liability is recognized
in P/L. Profits or Losses attributable entirely to the equity component is treated only as an
allocation of P/L, not as an income or expense.
24th Method of Revenue Recognition for Insurance Contracts
It is a method for computing an unearned premium reserve. Premiums having the same term are
aggregated, and are assumed to have been written in the 15 th day of the month. This will make it so that
the premium coverage is for 15 days beyond closing date: 1/24 instead of 1/12. This would also mean that
if an insurance policy is applied on January 1 or January 31, only the second half of the month would be
insured, while the following months will have them entirely covered: 1/24 + 22/24 until December 31.
Gross Premium XX
Multiply by: 1/24 22/24
Earned Premium (Revenue); Unearned Premium (Liability) XX XX
• Marine Cargo Insurance is an exception. The Last two months of a year will have their revenue be
accrued in the following year.
Service Concession Arrangements (IFRIC 12)
Better known as Build-Operate-Transfer Arrangements, it is exactly what it is called. It is a contract
entered into by an operator with the government, whereby the concern of the contract involves the
construction (build) of public utilities and infrastructures, its maintenance and development both
administratively and financially (operate) is fostered until it may stand on its own, and is ultimately
conveyed back to the government (transfer) for little or no incremental consideration. The terms of the
contract are levied and regulated over the length of the service arrangement.
• Revenue Recognition by the Operator is governed by PAS 11, PAS 18, and PFRS 15
• The concern of this arrangement is the valuation of the consideration given by the government
• This standard applies when the grantor controls or regulates what services the operator must
provide with the infrastructure e.g., tolling plazas and the construction of national highways, and
the benefits or significant residual interest at the end of the arrangement.
Consideration Given by the Grantor (Government)
• Financial Assets (PFRS 9) at Fair Value
• These are equivalent to the specified amounts in the contract
• Shortfalls between amounts received by final consumers, even in conditions of needing to
meet quality standards
• Intangible Assets (Licenses under PAS 28) at Fair Value
• Borrowing Costs are expenses when the Operator receives a financial asset;
these are capitalized ONLY in the Construction Phase if the operator receives an intangible asset.
• Revenue may be earned during construction BUT may usually be collected during OPERATION
(Present an Amortization Table for Collections and Total Revenue Earned)
Year/Phase Collections Interest Amortization Total Fin. Asset (d-c)
(a) Income (b) (c); (a-b) Revenues
(d)
Y1 – Construction - - - XX XX
Y2- Construction - XX - XX XX
Y3 – Operations XX XX XX XX XX
Y4 – Operations XX XX XX XX XX
Construction Cost + Borrowing Cost – Amortization = Balance of Intangible Asset
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Title III: Cost Accounting

Cost Accounting
Cost – a monetary measure of the amount of the resources given-up to attain some objective such as
acquiring goods and services.
Cost Accumulation – the collection of cost data in some organized way through an accounting system
Cost Accumulation Methods
• Job-order Costing – Costs are accumulated through job-orders. Job-orders are generally
dissimilar/heterogenous products based on specifications by customers. Each job is treated as a
separate profit center
• Process Costing – Costs are accumulated in different processes/departments to form a large
volume of identical/homogenous goods.
• Backflush Costing – A simplified method of cost accumulation that is used by firms that adopt a
Just-in-time lean environment. This method delays the costing process until the production of
goods are actually produced or completed. The costs are flushed back at the end of the production
and assigned to the goods. This is done to minimize/zero-out the inventory at the end of the
period
• Hybrid Costing – A combination of Job-order and Process Costing wherein direct materials are
accounting for under Job-order Costing, while Conversion Costs are accounted for using Process
Costing
• Activity-based Costing – A system where multiple overhead cost pools are allocated using
different bases that include one or more non-volume related factors
Cost Accumulation Systems
Historical Costing Standard Costing Normal Costing
Materials, Labor, Overhead are Materials, Labor, Overhead are Materials and Labor – ACTUAL
at ACTUAL AMOUNTS RECORDED at STANDARD AMOUNTS Overhead – STANDARD
Job-order Costing
Direct Materials: Work in Process: Finished Goods:
Beginning XX Prior Period Jobs: Job 1 (WIP-Beg.) XX Beginning Balance XX
Balance
Purchases XX Jobs Started: Jobs Finished – Job 1, Job XX
2
Materials Used (XX) Materials, Labor, & Overhead – Job 2 XX Jobs Sold – Job 1 (XX)
Ending Balance XX Materials, Labor, & Overhead – Job 3 XX Jobs Unsold – Job 2 XX
Jobs Finished: Job 1, Job 2 (XX)
Adjustments for Rework and Spoilage X(X)
Jobs Unfinished: Job 3 (WIP-End) XX
• Direct Materials and Labor are traced to particular jobs
• Costs that could not be directly traced are applied to each job using a predetermined OH rate
• Since Actual Overhead is still required to be reported and the data only becomes complete at the
end of the period, the Overhead using the predetermined rate (Applied Overhead) is ‘adjusted’
to bring the balance to the actual amounts (Usually, service costs of various departments are
allocated first, and then a new factory overhead rate is applied at the end of the period)
• Raw Materials ≠ Direct Materials; RM includes Indirect Materials; hence it must be deducted
from Raw Materials Available for Use to acquire the RMU and then added back to FOH to
compose the Cost of Goods Manufactured.
Actual Factory Overhead or Factory Overhead Control: Utilities, Wages, Depreciation XX
Applied Overhead (XX)
Underapplied/Debit/Unfavorable COGS (Overapplied/Credit/Favorable) Overhead XX
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Scraps, Spoilages and Reworks

Scrap Goods – fragments, or residue of materials removed during the production process having small
value. These are sold as is without any other additional costs from the production process. Costs incurred
to sell scraps are included in other operating expenses.
• Discovered at the time of Sale
• Scraps are considered as Scrap Revenue
• If the amount of revenue is significant:
i. The scrap is traceable to one job – Deduct from WIP – Job #
ii. The scrap is not traceable to one job – Deduct from FOH – Control
• Discovered during Production
• Charge to specific Job -Dr: Scrap Inventory; Cr: WIP – Job #
• Charge to overall production – Dr: Scrap Inventory; Cr: FOH – Control
Produced Units XX
Spoiled Goods – Goods damaged that either cannot be brought Spoiled Units (XX)
back to the original state or can be reworked into salable Defective but Reworkable Units (XX)
condition. Reworked Units XX
Good Units XX
Job Orders with Spoilage and Reworks
Internal Failure (Overhead) Job/Customer Specs (WIP)
𝐹𝑂𝐻 + 𝑅𝑒𝑤𝑜𝑟𝑘 𝐴𝑙𝑙𝑜𝑤𝑎𝑛𝑐𝑒 − 𝐸𝑠𝑡. 𝑆𝑉 𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝐹𝑂𝐻
= =
Predetermined OH % 𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦 𝐿𝑒𝑣𝑒𝑙 𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦 𝐿𝑒𝑣𝑒𝑙
**SV is Salvage Value
Deducted from Original Production Deducted at Salvage Value; ignore
Cost @ (Orig. Cost/Unit with salvage value or deduct the
Salvage Value/Spoilage Cost
Allowance); the Salvaged Units do not allowance for spoilage per unit if
affect unit cost. included.
Cash (Salvage Value) Cash (Salvage Value)
FOH – Control (Net) WIP (Salvage Value)
Journal Entry for Spoilages
WIP (Orig. Cost/U with Allowance
for Spoilage)
Actual Rework Costs Charged to FOH – Actual Rework Costs Charged to
Rework Cost
will not change Orig. Cost WIP – will change Orig. Cost
Cost per Unit Produced Units * OC/U with Allow. Produced Units * OC/U no Allow.
Formulas:
Original Production Cost XX XX
Salvaged Goods (XX) @ Orig. Cost/Unit with Allow. (XX) @ Salvage Value
Rework Costs - XX @ Actual Costs of Rework
Net Production Costs XX XX
Divided by: Good Units XX XX
New Cost per Unit XX XX
Other Considerations
• OT, Holidays – Generally, costs incurred during these days are charged FOH, Control as they are generally
expected anyway; except if the job is of a Rushed Nature, then these are charged to WIP
• Mandatory Employee Contributions by the EE’s have no effect on WIP/FG; however, fringe benefits
generally follow the employee’s classification (DL/OH) silently, these are indirect labor charges (FOH)
• Idle Time – Generally FOH, Control
• Make-up Pay – When the employee’s piecework wages are below minimum wage, the employer
compensates the difference. The Piecework Wages are charged to WIP, while the difference is charged to
FOH, Control
• Delay Allowances – When certain jobs are delayed out of any reason other than for the employee’s
actions, then these delay allowances are charged to Factory Overhead Control.
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Service Cost Allocation

Service Departments – these do not generate revenues but help or provide services to one or more
revenue producing/operating departments and also to other service departments. These costs of services
must be allocated to the departments that use those services
Direct Method Step Method Reciprocal Method
Costs of Service are allocated Costs of Services are allocated Costs of Services are allocated
only to the Operating to all other departments, to all departments
Departments only, pro-rata Service and Operating, but there simultaneously
is a ranking method
Service Cost Allocation - Illustration
Service Departments Operating Departments
A B C X Y
Costs 100,000 200,000 300,000
Services by A - 12% 33% 30% 25%
Services by B 13% - 27% 30% 30%
Services by C 8% 17% - 25% 50%
Cost Allocation, Direct Method (to Operations = 600,000)
From A 30/55 25/55
100,000 - - - 54,545.45 45,454.54
From B 30/60 30/60
200,000 - - - 100,000.00 100,000.00
From C 25/75 50/75
300,000 - - - 100,000.00 200,000.00
Allocated Costs 0 0 0 254,545.45 345,454.54

Cost Allocation, Step-down Method (to Operations = 600,000)

From A - - - 30/55 25/55
100,000+24,000+ 92,017.43 76,681.20
44,698.63 (68,969.63) (51,000.00)
From B 13/73 30/73 30/73
200,000+51,000 44,698.63 - - 103,150.68 103,150.68
From C 8/100 17/100 25/100 50/100
300,000 24,000.00 51,000.00 - 75,000.00 150,000.00
Allocated Costs 0 0 0 270,168.11 329,831.88

Cost Allocation, Algebraic Method (to Operations = 600,000)

From A 0% 12% 33% 30% 25%
173,307 (73,306.83) 20,796.84 57,191.31 51,992.10 43,326.75
From B 13% 0% 27% 30% 30%
295,063 38,358.19 (95,065.70) 79,667.01 88,518.90 88,518.90
From C 8% 17% 0% 25% 50%
436,858 34,948.64 74,265.86 (136,858.32) 109,214.50 218,429
Allocated Costs 0 0 0 249,724.50 350,274.65
A = 100,000+13%B + 8%C; A = 173,307
B = 200,000 +12%A + 17%C; B = 295,063
C = 300,000 +33%A + 27%B; C = 436,858
**In step method, it is assumed that the Service Department that covers more activity overall is given
allocation priority. If the levels of activities are normal, or if the problem is silent, the order of priority
is based on the amount of cost (largest given priority over others).
**Furthermore, the step method assumes that whatever cost a priority department incurs, already includes
the cost of the subsidiary departments, hence no reallocation is done from the subsidiary department to
the priority department.
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Process Costing
Equivalent Units of Production – the amount of production effort that if, concentrated on a single unit
of product, would result in a completed finished unit.
There are two ways a product could be finished under process costing:
• Sequential Processing – Costs and units would flow from one department to the next until completion
• Parallel Processing – Costs are incurred in different processes that do not follow in sequence; all the
costs would be accumulated in an assembly point from various departments
In process costing, A Cost of Production Report is always prepared. It shows the flow of inventories to be
accounted for, and how these units ‘flowed’ into the production process. It likewise applies this flow to
costs, considering the Equivalent Units of Production (EUP). It consists of the following schedules:
1. Quantity Schedule – Provides how effort was expended in the form of Physical Units.
Unit Accountability: Actual Units Accounted for as follows: Actual Applied Equivalent
Units in Process, Beginning XX Finished and Transferred:
Started in Process or XX In Process, Beginning XX A% AA
From Prior Dep’t XX Started in Process XX 100% XX
Accountability XX Unfinished and in process XX B% BB
Total Units Accounted XX XX (1)

Quantity Schedule for Work in Process Inventory

Beginning Balance Finished and Transferred
Started in Process or from Ending Inventory
Preceding Department Normal Loss
Abnormal Loss
Accountability Accounted for
**N.B. Some texts will actually include those goods which are finished and on-hand. For Exam purposes,
these amounts are ignored unless any express mention on their accounting is mentioned; and in that case,
are applied at 100%, only for the current period (ignore goods completed and on-hand, beginning).
2. Cost Schedule/ Costs to Account for/ Cost Accountability – Tracks how much cost is applied to
each component of Work-in Process inventory, how much cost is transferred to the department,
how much cost is from current production and how much cost is from previous production
Cost Accountability Total Cost (2) Cost per EUP (2)/(1)
Materials XX X
Labor XX X
Overhead XX X
Total Factory Cost XX XX
In Process, Beginning or Cost from Prior Dept. XX XX
Cost Accountability XX
3. Cost Reconciliation/ Cost Assignment/ Cost Accounted for – Accounts for the costs assigned to
the EUP that are completed and transferred to the next department, finished goods, work-in-
process, or spoiled units for disposal or rework. It is a Breakdown Report.
Units Cost
In process, Beginning XX XX
Last Month/Prior Department at EUP * Work Done XX XX
This Month XX XX
Started in Process: XX XX
Cost of Goods Transferred to Storage XX XX
Units Finished and Transferred (a) XX XX
Finished and On Hand (b) at EUP (always at 100%) XX XX
In Process, End (c) at EUP * Work Done XX XX
Cost Accounted for (a)(b)(c) XX XX
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Considerations for Process Costing:

• Work done – Work accomplished from the prior period will be continued in the current period,
hence, the percentage of work done for the current period would be (1-Work Done, prior period).
The fact is true for Ending Inventory, as the work done on ending inventory for the period is the
actual percentage of Materials or Conversion Costs applied.
• Beginning Inventory
• If Beginning Inventory exists, an issue presents itself: how should EUP be treated? Should the
progress be costed for this period or for the previous period?
• Under FIFO Costing, the Costs of Beginning Inventory is allocated as either coming from the
prior period or from the current period. Both Costs have to be accounted for.
i. This means that there will be different EUPs used for each cost applied to the units
accomplished, one coming from the previous period, and another from the current period.
• Under Average Costing, the Costs of Beginning Inventory from the previous period are
aggregated with Current Period Costs. There is only one EUP for the period. (FIFO if silent)
• Completed & transferred is actually composed of BWIP and Started & Transferred, separate
the two to apply the EUP Correctly. Separating them is no longer needed for Average Method.
FIFO WAVG
Cost of WIP, Beg. From Prior Period XX Total Manufacturing Cost XX
Cost of Beg. Inv. @ Current EUP= (a) * EUP XX WIP, Beg, XX
Cost of Beginning Inv. XX Total XX
Divided by: EUP XX
Cost per EUP XX
Multiply: Units in BI XX
Cost of Beg. Inv. XX
• EUP: Point of Application of Materials and Conversion Costs – Some production procedures apply
materials and conversion costs evenly, that is, at all stages of production, the degree of effort
and materials placed into producing goods are the same, as in the general illustration. In others,
these costs are applied unevenly, that is, on one stage of production, only materials are applied,
and in later stages, labor and machinery are applied to finish the products, in varying degrees.
Units Accounted for the period as Actual RM EUP CC EUP Trans. EUP
follows: Units In
Finished and Transferred:
In Process, Beginning XX A% AA C% CC 0% 0
Started in Process XX 100% XX 100% XX 100% XX
Finished and on-hand XX 100% XX 100% XX 100% XX
Unfinished and in process XX B% BB D% DD 100% XX
Total Units Accounted XX XX (1) XX (2) XX
IF COST IS: APPLIED AT BEGINNING, BI is 0%, EI is 100%; IF APPLIED AT END BI is 100%, EI is 0%
Total Cost (3) Cost per EUP Current Period
Materials XX X (3)/ (1)
Labor XX X (3)/ (2)
Overhead XX X (3)/ (2)
Total Factory Cost XX XX
In Process, Beginning or Cost from Prior Dept. XX XX
Cost Accountability XX
**N.B. When all the Materials or CC are applied at the Beginning of production, the mere fact that
there is a beginning inventory means that the materials are no longer applied at the current period.
When all the Materials or CC are applied at the End of production, currently, no manufacturing costs
are to be applied. Hence, when the percentage of completion is given, the percent to be completed
is taken for Beginning Inventory, while the percent completed as of the current period is taken for
Ending Inventory.
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• Goods Transferred-in – These are the goods from the prior department; in other words, they are
the Goods Completed and Transferred as regarded by the prior department, as such, these will
always have effort applied at 100% EUP in Ending WIP and Completed & transferred, and 0%
EUP in Beginning WIP. It is worthy to note that the Goods Transferred in are accounted for through
the Goods Started and Finished, the Losses, and through the WIP, end. Furthermore, the Cost
Assignment for these goods include costs carried over plus costs incurred for the current period.
Increases in Units and Losses
• Increases in units are caused by the increase in volume of product upon mixing in materials at
the same level of cost. For example, a product undergoes quick changes in design mid-production.
The packaging could accommodate less quantities of product than usual. This will result in a
significant change in the number of units manufacturable; more units could be made.
Unit Accountability: Actual Units
Units in Process, Beginning XX
Estimated Increase in Units XX
Started in Process XX
Accountability XX
• Apply the same procedure as with the previous illustration
• Evaporation is a form of loss of units that is expected in production. Usually this is caused by
natural processes inherent to producing the goods. For instance, dried fruits shrink in size over
time due to dehydration. The procedure of accounting for this type of loss is worked-back into
the cost schedule since the accounting for it/inspection may only be possible after the fact.
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐷𝑎𝑦𝑠 ∗ 𝐸𝑣𝑎𝑝𝑜𝑟𝑎𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑒
% 𝐸𝑣𝑎𝑝𝑜𝑟𝑎𝑡𝑒𝑑 =
𝐷𝑎𝑦𝑠 𝑖𝑛 𝑃𝑟𝑜𝑐𝑒𝑠𝑠 𝐸𝑣𝑎𝑝𝑜𝑟𝑎𝑡𝑖𝑛𝑔
𝑇𝑜𝑡𝑎𝑙 𝑈𝑛𝑖𝑡𝑠 𝐹𝑖𝑛𝑖𝑠ℎ𝑒𝑑 (𝐵𝑜𝑡ℎ 𝑆𝑡𝑜𝑟𝑒𝑑 𝑎𝑛𝑑 𝑇𝑟𝑎𝑛𝑠𝑓𝑒𝑟𝑟𝑒𝑑)
𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑉𝑜𝑙𝑢𝑚𝑒 =
% 𝐸𝑣𝑎𝑝𝑜𝑟𝑎𝑡𝑒𝑑
• Units Finished may still evaporate even as these are idle from department to department
• Normal Losses – the expected losses occurring during production such as waste, shrinkage, etc.
It will matter at what point the units are lost, and in which department did the loss occur.
• Method 1 – Theory of Neglect – assumes that if components to a product are lost over
production, the entire product could not be accounted for anymore, and thus, full cost is lost.
In another view, it supposes that spoiled units have never been placed into production.
• Method 2 – Theory of Constraint - assumes that effort expended for a lost product should still
be carried-over into further costs since the loss could have been anticipated anyway as being
part of a constraint in the process. Under this method, abnormal losses only come from true
case exceptions outside of the production process.
**Prefer Method 1 over Method 2 when the problem is silent
Method Applicability Initial Department Succeeding Department
Lost at the Equivalent Units are - Equivalent Units are zero
1 or 2 Start of zero, and no cost is - Cost of Lost Units is only from Prior Depts.
Process absorbed - Allocate Costs only to Remaining Good Units
Equivalent Units are - Equivalent Units are zero
Lost During
1 zero, and no cost is - Cost of Lost Units is only from Prior Depts.
the Process
absorbed - Allocate Costs only to Remaining Good Units
- Equivalent Units are zero
Equivalent Units are
Lost During - Cost of Lost Units is only from Prior Depts.
2 zero, and no cost is
the Process - Allocate Costs to Remaining Good Units based on
absorbed
% Completed or Applied
- Equivalent Units at 100%
Lost at the Equivalent Units are at
- Cost of Lost Units are from Prior Depts. and
1 or 2 End of the 100%, and full cost is
Current Dept.
Process absorbed
- Allocate Costs to Finished Units
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Method 1 Method 2
Adjustment for Lost Units: Adjustment for Lost Units:
Cost from Prior Dept. (Lost Units * Cost/EUP Cost from Prior Dept.: (Lost Units * Prior Cost/
Prior Dept.) XX Equiv. Units) XX
Cost from Current Dept. (Lost Units * Cost from Current Dept. (Lost Units *
Cost/EUP Current Department) XX Cost/EUP Current Department) XX
Total Cost Absorbed XX Total Cost Absorbed XX
Divided by: Total Finished and Good Units XX Divided by: Total Finished and Good Units XX
Adjusted Cost/EUP (d) XX Adjusted Cost/EUP (d) XX
**Always be aware that only Units Lost at the End of the Process will have their Current Cost be
absorbed. If the Units are LOST DURING or at the BEGINNING, NO CURRENT DEPARTMENT COSTS ARE
ABSORBED under the Theory of Neglect (this is the general rule).
**Do note that units lost at the beginning of the process, though will have no effect on the overall
cost, will still influence the Cost per EUP of the Good Units compared to when there would not have
been any loss. (Cost per EUP is larger due to loss not being allocated.)
Inspection Points and Discrete Losses – Normal and Abnormal Losses are discovered usually on inspection
points. This means that at a certain stage of completion, a loss may be detected, and may bear over cost
effects on the Cost per Good Unit, (having inspection points will certainly mean that the costs are incurred
UNEVENLY) (Also note that the inspection point is a stage of completion; in this case, the losses are
discretely incurred.)
• Abnormal Losses – These are losses incurred due to inefficiencies and are treated as expenses,
usually due to defective materials, labor and machine errors.
Stage of Process Initial Department Succeeding Department
Equivalent Production
Equivalent Production is zero, but the cost incurred is
Start is zero and no cost is
from the prior department
absorbed
Equivalent Production Equivalent Production is at Stage of Completion and
During and Cost is at Stage of Cost is both from Prior and This Department at Stage
Completion of Completion
Equivalent Production
Equivalent Production is at 100% and the Cost is both
End and Cost are fully
from Prior and Current Departments at 100% each
absorbed
**Abnormal losses will still bear over EUP Computations, therefore, will affect the cost absorption of
normal losses as well. (DR: ABNORMAL LOSS – OPEX CR: WIP or FOH-Control)
**Even Abnormal Lost Units share in Unit Costs under Normal Losses
Absorption of Losses
The Normal Loss is generally always absorbed if the Inspection is done continuously. In case of Discrete
Points in Production, Losses are only absorbed if they are detected past the inspection point. This means
that Ending WIPs may or may not share in the loss absorption (This depends on if the Inspection Point is
at 100%, or if it occurs after the Percentage of Work done for WIP, end).
Continuous Losses Normal Losses – EUP Abnormal Losses - EUP
DM or CC Cost applied At the Beginning 0% 0%
DM or CC Cost applied During 0% 100%
DM or CC Cost applied At the End 100% 100%
Abnormal Losses are charged to Cost of Goods Sold or Expense only, depending on the Company Policies.
Quick Tips
• The goal of Process Costing is to be able to locate the Cost per EUP. If the EUP is given, the cost allocation
is a matter of multiplying the EUP to the Units Accounted for as Completed and Transferred, WIP ending,
and the Losses.
• Cost Accounting is generally very explicit when it comes to problems. For Process Costing, the general
rule is to prefer FIFO since the costing method is more accurate. In any case where the Beginning
Inventory is not revealed, use the Weighted Average Method (Except if it is the First Year of Operations.)
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Joint and By-product Costing

Split-off Point – The point at which individual products are first identifiable in a joint process. This is a
step when a single pool of materials, labor, & overhead split-off to multiple product outputs.
Joint Process – A single process in which one product cannot be manufactured without producing others.
• Joint Costs – Costs incurred in the processing of two or more products from a common process
• Separate Costs – Costs incurred after the split-off point in a production process
In a Joint Process, multiple classes of products may be produced such as:
Joint Products By-products Scraps
**By-products differ from scraps in that the former requires additional processing to be able to be sold,
while the latter is sold as is.
Total Cost Allocated to Joint Product = Joint Costs + Separable Costs
Cost Allocation Methods for Joint Products
• Physical Measurement Approach – simply using physical bases such as quantities/averages
Quantitative Unit Method Average Unit Cost Method Weighted Average Method
– based on grams, units, etc. – Allocates total cost to each The same with the average Unit
quantitative unit used in the cost method, but some products
product hence, all Joint are given priority in sale over
Products will have taken joint others
**QUM costs proportionately **AUM **WAM
𝑇𝑜𝑡𝑎𝑙 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑎𝑖𝑣𝑒 𝑈𝑛𝑖𝑡𝑠 𝑜𝑓 𝑎 𝑃𝑟𝑜𝑑𝑢𝑐𝑡
𝐶𝑜𝑠𝑡 𝐴𝑙𝑙𝑜𝑐𝑎𝑡𝑒𝑑, 𝑄𝑈𝑀 = ∗ 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡
𝑇𝑜𝑡𝑎𝑙 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑎𝑡𝑖𝑣𝑒 𝑈𝑛𝑖𝑡𝑠 𝑜𝑓 𝐴𝐿𝐿 𝐽𝑂𝐼𝑁𝑇 𝑃𝑅𝑂𝐷𝑈𝐶𝑇𝑆
𝐶𝑜𝑠𝑡 𝐴𝑙𝑙𝑜𝑐𝑎𝑡𝑒𝑑, 𝐴𝑈𝑀 = 𝐽𝑜𝑖𝑛𝑡 𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡 𝑜𝑓 𝑎𝑙𝑙 𝑃𝑟𝑜𝑑𝑢𝑡𝑐𝑡𝑠 ∗ 𝐽𝑜𝑖𝑛𝑡 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 𝑈𝑛𝑖𝑡𝑠 𝑃𝑟𝑜𝑑𝑢𝑐𝑒𝑑
𝑇𝑜𝑡𝑎𝑙 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑎𝑖𝑣𝑒 𝑈𝑛𝑖𝑡𝑠 𝑜𝑓 𝑎 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 ∗ 𝑊𝑒𝑖𝑔ℎ𝑡 𝐼𝑛𝑑𝑒𝑥
𝐶𝑜𝑠𝑡, 𝑊𝐴𝑀 =
𝑇𝑜𝑡𝑎𝑙 𝑊𝑒𝑖𝑔ℎ𝑡𝑒𝑑 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑎𝑡𝑖𝑣𝑒 𝑈𝑛𝑖𝑡𝑠 𝑜𝑓 𝐴𝐿𝐿 𝐽𝑂𝐼𝑁𝑇 𝑃𝑅𝑂𝐷𝑈𝐶𝑇𝑆
∗ 𝐽𝑜𝑖𝑛𝑡 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 𝑈𝑛𝑖𝑡𝑠 𝑃𝑟𝑜𝑑𝑢𝑐𝑒𝑑
• Monetary Measurement Approach – considers the market impact of a joint product, matching
revenue with cost.
Method Formula for Joint Product Monetary Basis
Relative Sales Value Ratio * Units Produced Sales only; prefer if
Sales Value at Split-off
(Sold as is) silent
Net Realizable Value at Relative NRV * Units Produced Sales at Split-off
Split-off or Hypothetical (Cost of Disposal)
Market Value Approach (Sold as is method)
Relative Final NRV Ratio * Units Produced Final Sales
Approximated NRV, or (Further Process Cost)
Final NRV Method (Cost of Disposal)
(Processed further method) NRV
• Constant Gross Margin Approach – considers that each product shares on the same gross margin
Cost Allocation for By-products
By-products are valued at either:
• Replacement Cost Method – The cost of materials used resulted in the by-product is credited,
and the debited by-product is used as a different material for another department.
• Market Value or Reversal Cost Method – If a problem presents information about Market Values
or Average Profits of the By-products, these are treated like joint products that share in the costs
of the main product, as if the main product was the entire cost pool. Quite simply, the Reversal
Cost of the Byproduct is deducted from the Total Joint Cost.
Net Realizable Value Method Realized Value Method
Reduction to Cost of Goods Sold at NRV OR Increase in Other Income at NRV OR
Reduction in Joint Cost at NRV Increase in Other Revenue:
Selling Price is added to Revenue
Cost of By-product is added to Joint Cost
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Estimated Selling Price XX

Estimated Profit (XX)
Further Processing Costs if any (XX)
Selling and Administration Costs (XX)
Market Value or Reversal Cost XX
• Also recall from MAS, that Joint Costs are IRRELEVANT COSTS to decision making, hence, Joint
Costing is not useful for decision-making, however, it does provide insight as to cost allocation
• Process Costing may have Joint Costs and Further processing costs for jointly produced goods,
Scraps and Spoilages (Losses), but it may not have Reworks.
Procedural Layouts:
Via Measurement Approaches:
Product A Product B Product C Total
Revenue (SP * Units manufactured) XX XX XX XX
Separable Costs
(Based on whether to process further or sell as-is) (AA) (BB) (CC) (XX)
Product Margin AA BB CC XX
Total Joint Cost (JC)
By-products Reversed or By-products at NRV BP
Joint Cost Allocation
(Based on Physical/Monetary approaches) (JA) (JB) (JC) JC
Gross Margin AA BB CC XX
Via Constant Gross Margin Approach:
Product A Product B Product C Total
Revenue (SP * Units manufactured based on whether to
process further or sell as-is) XX XX XX XX
Separable Costs
(Based on whether to process further or sell as-is) (AA) (BB) (CC) (XX)
Product Margin AA BB CC XX
Total Joint Cost (JC)
By-products Reversed or By-products at NRV BP
Gross Margin GM
Divided by Total Revenue XX
Overall Gross Margin Percentage GM%
Multiply Product Revenue by Overall GM% GMA GMB GMC
Gross Margin per Product AA BB CC GM
Product Margin (AA) (BB) (CC) XX
Joint Cost Allocated JA JB JC JC
For each cost allocation method, the proper accounting should also consider how management maximizes
incremental profit, in this case, decision analysis is required.
Product A Product B Product C
SP if Sell as-is XX XX XX
Separable Cost if sell as-is (XX) (XX) (XX)
Sales Value at Split-off XX (XX) XX
SP if Process Further (a.k.a. Final Sales Value) XX XX XX
Separable Cost if Process further (XX) (XX) (XX)
Final NRV XX XX XX
Incremental Profit/Loss (XX) XX XX
Decision: (use this decision as basis for JC
Sell as-is Process Further Process further
allocation)
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Journal Entries for By-product Costing

NRV Reversal Method: Realized Value Reversal Method:
By-product Inventory XX By-product Inventory XX
Cost of Goods Sold or Joint Costs XX Other Income XX
Or
** The joint cost is not applied against COGS under Total Joint Cost or COGS (@ NRV) XX
Natural presentation of the Income Statement, Sales or Revenue (@ NRV) XX
under Functional method, it is applied.
Replacement Cost Method
Direct Materials – By-product XX
Direct Materials – Main Product XX
Just-in-time Management and Backflush Costing
• JIT Management – a management philosophy centered at manufacturing/production efficiency by
minimizing carried-over costs and maximizing customer satisfaction. It is a consequence of Total
Quality Management (TQM); hence it requires strengthening relationships with a select few
Suppliers to deliver quality goods on demand as well as to Customers for continued patronage.
• Handling Costs are minimized (storage costs) since there is a strong emphasis on meeting
customer satisfaction at the quickest possible time, from manufacturing until delivery.
• Inventory is projected to be kept at a minimum level or zero
• Backflush Costing – a costing system that assigns/recognizes costs of production after the sale of
goods. This is the consequence of a rapid production process. It does not follow GAAP.
• It is a simplified form of cost accounting adopted by companies that use JIT Management.
• There are NO Work-in-process accounts in this system; instead, it incorporates the WIP into
Raw Materials this is called Raw Materials in Process (RIP)
• Since there are no WIP accounts, it uses trigger points to keep track of fast-moving goods
• Conversion Costs are minor, unlike in a traditional costing system. Labor and Overhead are
combined into one account: Conversion Costs – Control, and Conversion Costs - Applied
• Trigger Points – stages in a cycle going from purchase of raw materials to the sale of finished goods.
• Journal entries should have been made at these points, however, since Backflush costing
assigns costs after sale, these entries will only be reflected in the books after the sale.
**Like any other costing system, the Backflush Costing System can still apply Historical Costing, Normal
Costing, or Standard Costing.
Transaction Tradition Method 1 Method 2 Method 3 Method 4
al Costing 3 entries 2 entries 2 entries 1 entry
RM Purch. RIP RIP
Purchase -- --
A/P A/P A/P
FG
FG FG
Completion -- A/P --
WIP RIP
Applied Cost
FG – end
COGS
COGS COGS COGS COGS
Sale RIP
FG FG FG RIP
Applied Cost
Applied Cost
WIP
Cost Control Cost Control Cost Control Cost Control
Apply Labor RM,
Salary, Salary Salary, Salary,
& OH DL,
DepEx DepEx DepEx DepEx
OH
AFOH Conv. Cost Ctrl Conv. Cost Ctrl Conv. Cost Ctrl Conv. Cost Ctrl
Underapplied
COGS COGS COGS COGS COGS
COGS COGS COGS COGS COGS
Overapplied
AFOH Cost Control Cost Control Cost Control Cost Control
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Trigger **In bold are the entries and costs that are
Method Stage in the Production Cycle
Points accumulated and ignored for backflush
I 3 Purchase, Completion, Sale costing. Backflushing exclusively uses
II 2 Purchase & Sale standard costs for cost capture. Raw
III 2 Completion & Sale Materials are not generally backflushed, this
IV 1 Sale includes indirect materials (The materials
**” COGS under Backflush Costing” simply means the from suppliers are usually the basis for the
total Costs Applied (RM, CC) demand-pull), since theoretically, Cost of
***Backflushing quite simply means working-back the Sales are predetermined from planning of JIT
missing records from the ones acquired. management.
Procedural Layout
Raw materials Conversion Costs Total
RIP, beginning XX XX XX
Purchases XX - XX
Conversion Costs - XX XX
Finished Goods, beginning XX XX XX
RIP, ending (XX) (XX) (XX)
Finished Goods, ending (XX) (XX) (XX)
Cost of Sales attributed to: XX XX XX
Activity-based Costing
• It is a tool for refining a costing system by focusing on individual activities as fundamental cost objects
• It is a two-stage product costing method that first assigns costs to activities and then allocates them to
products based on each product’s activity level
• Essentially, each product ‘consumes’ cost activities; and each activity consumes resources.
• It prevents distortion of cost by assigning overhead and other expenses to different activities
Steps in AB Costing Stages in AB Costing
1. Identify activities that use resources, assign • Stage 1 –Assign the Activities to their Cost Pools
costs to them, accumulate the costs • Stage 2 – Assign the Cost Data accumulated per
• Activities that use resources such activity (Cost Pool) to each product that
as utilities, supervision, or more benefitted in the activity
rigorous information capturing Cost Hierarchy
2. Identify the cost driver/s assigned to each • Volume-related Costs – Output-based costs
activity e.g., Indirect Materials
• Cost Driver – a factor that causes • Batch-related Costs – Common Costs incurred
changes in an activity’s costs, may for a batch e.g., fuel to run a Machine for
be based on: manufacturing
i. Causal Relation – e.g., • Product-related Costs – Costs of activities
Labor Hours incurred to support products/services regardless
ii. Benefits Received of outputs or batches e.g., Purchase of Software
iii. Reasonableness to enhance work efficiency
3. Compute the Cost Rate for each cost driver • Facility or Plantwide Costs – Activities that
4. Apply the Costs to products by multiplying cannot be traced to individual products or
the cost driver rate by the volume of cost services but to the entire organization e.g., Rent
driver units consumed by the unit Expenses

Overhead Allocation
• Single Rate Method – all overhead is allocated to products using only one overhead rate
• Multiple Rate Method/Department Rate – Different Overhead budgets are used by each
department
• AB Costing Method – Overhead is allocated based on the level of activity performed by each cost
driver to an activity
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𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦 % = 𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦 𝐶𝑜𝑠𝑡/𝑇𝑜𝑡𝑎𝑙 𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦 𝐵𝑎𝑠𝑒 𝑈𝑠𝑎𝑔𝑒

**As for any costing system, the general assumption is that the Cost System used is the Normal Costing
System, that may be applied for Job-order, Process, Backflush, and Activity-Based Costing. Essentially,
this means that Overhead is applied at the Budgeted Cost first before it is adjusted to the actuals.
Procedural Layout
Activity A Activity B Activity C
Overhead Cost XX XX XX
Divided by: Activity Driver for each Activity XX XX XX
Activity Rate for each Activity AA BB CC

Product X Product Y Product Z

Activity Driver Units (hours, headcounts, etc.) XX XX XX
For Activity A (Machine Hours) XX - XX
Activity Rate for A AA AA AA
AB Cost – Activity A XX - ZZ
For Activity B (Square feet) XX XX XX
Activity Rate for B BB BB BB
AB Cost – Activity B XX YY ZZ
For Activity C (Setup counts) XX XX -
Activity Rate for C CC CC CC
AB Cost – Activity C XX YY -
Total AB Cost XX XX XX
Direct materials XX YY ZZ
Direct Labor XX YY ZZ
Total Cost of Inventory XX YY ZZ
Divided by: Total Units of Product XX YY ZZ
Cost per Unit X Y Z
Appendix: Other Journal Entries in Cost Accounting
Overtime: Due to Rushed Nature of Work Delay Allowances:
Direct Labor XX Overhead Control XX
Wages Payable XX Wages Payable XX

Overtime: Due to inefficiencies Joint Cost Allocation:

Overhead Control XX WIP – A XX
Wages Payable XX WIP – B XX
WIP – C XX
Mandatory Withholdings (SSS, PAGIBIG, PHIC): Various Credits XX
Wages Expense (ER Contribution) XX (These are joint costs incurred such as
Withholding Items Payable XX depreciation, utilities, etc., …)

Wages Payable (EE Contribution) XX Goods Transferred In:

Withholding Items Payable XX WIP B XX
WIP C XX
Employee Idle Time: WIP A XX
Overhead Control XX
Wages Payable XX Loss Allocation:
Cost of Goods Sold – Abnormal Loss XX
Make-up Pay: Cost of Goods Sold – Normal Loss XX
Overhead Control XX WIP A, end XX
Direct Labor (Minimum Wage) XX Finished Goods (C&T) XX
Wages Payable XX Manufacturing Costs XX

Nothing follows