Colegio de Dagupan

School of Business and Accountancy Financial Management 2

Module 1: An Overview of Financial Management

Learning Objectives:
At the end of this module, the students are expected to:
1. Know and explain the evolution of finance as a recognized field of study
2. Know and explain the goals and functions of Financial Management

Lesson Proper: Lecture on what financial management is, its goals, forms of
business organization and agency relationships

Goals of Financial Management

1. Maximization of the value of the firm (valuation approach)

Valuation Approach refers to the maximization not only of profit but also of the
overall value of the firm. To achieve these goals, the following concerns need to be
considered when selecting investment proposals:
 Risks attached to the investment proposal
 Time design as to when and how the profits will flow into the company;
 The quality and reliability of the profits reported by the firm

2. Maximization of shareholders wealth – is considered to be the expansive goal of

the firm

3. Social responsibility and ethical behaviour

The firm, by using measures that would maximize wealth and company market,
would be able to draw more capital, help diminish unemployment and give services
to the community.

Financial Manager’s Responsibilities

1. Forecasting and Planning

The financial manager works together with other managers in formulating strategic
as well as operative plans necessary. It is forming the company’s desired positions.

2. Making Crucial Investment and Financing Decisions

Increasing sales or increasing demand for services from companies require
investing money for acquisition of property, plant and equipment (PPE) and
inventory.

3. Coordinating and Controlling

Financial manager works and coordinates with other executives to guarantee
efficient operation of the firm. Financial managers must carefully take into account
how their decisions and actions affect other factors like fund availability, inventory
requirements, and plant acquisition, capacity and utility.

4. Trading in Financial Markets

The financial managers are tasked to trade the equity securities of the firm in the
financial market.

5. Risk Management
A well skilled financial manager can deter the effects of risks by availing of the
appropriate and adequate insurance for the firm by hedging into the derivatives
market. The risks may come in terms of financial risks where prices of commodities,
currency exchange rates; and interest rates fluctuate; or the risks may even come
in terms of natural calamities.

Forms of Business Organization

1. Sole Proprietorship
This is a form of business organization is characterized by: it has only one owner,
owner is separable from the business, simplicity in decision making, easy and

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

inexpensive to form, subject to few government regulations, and unlimited personal

liability.

2. Partnership
This form of business organization exists when two or more persons combine their
resources to conduct business, earn profit, and distribute among themselves the
results of their operations. The contract evidencing its existence is called articles of
partnership. Is characterized by: low cost and ease of formation, unlimited liability,
limited life, difficulty of transferring ownership, and difficulty of amassing large
amount of capital.

3. Corporation
A corporation is a legal business entity created by the government. It is considered
as separate and distinct from its owners and executives. The contract evidencing
the existence of a corporation is called articles of incorporation. Is characterized by:
unlimited life, ease of transferability of ownership, changes in ownership or death of
owners do not dissolve the corporation, transfers ownership through buying and
selling of stocks, and limited liability.

4. Limited Liability Partnership

It is composed of at least one general partner and the rest are limited partners. Is
characterized by: limited partners are liable only for their amount of investment,
and although a partnership it has the benefit of a corporation.

Agency relationship
It exists when a person or group of persons (principal) employs another person or
group of persons (agency) to render service(s) and delegate decision making
authority to the agent. It exists between the company’s shareholders and
managers, and between creditors and owners.

Agency conflict
It exists when the manager is also the partial owner of the same firm, if the
manager stabilizes job security for himself and for all the employees of the firm, and
if the manager increases his position, status, prerequisites and salary.

Agency cost
In order to prevent agency conflicts, managers can be persuaded to maximize the
company’s stock price or maximize wealth and act for the shareholders best
interest but this would entail costs. These costs are called the agency costs. The
more control measures employed by management gearing towards stockholder’s
benefits, the higher would be the agency costs.

Control Mechanisms (to encourage managers to perform for the interest of

shareholders)
1. Provide performance-based incentive plans
2. Straight involvement by shareholders (Institutional)
3. Takeovers

Exercises:

Multiple Choice Questions

1. The following are the financial manager's responsibilities EXCEPT
a. Preparation of Financial Statements
b. Forecasting and Planning
c. Coordinating and Controlling
d. Risk Management

2. The long-run objective of financial management is to

a. Maximize total company profit
b. Maximize the value of the firm's common stock
c. Maximize return on investment

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

d. Maximize market share

3. This means that the main goal of financial management is to maximize not profit
alone, but the maximization of the overall value of the firm.
a. Financial Management Approach
b. Valuation Approach
c. Maximization Approach
d. Non-profit Approach

4. It refers to meeting the needs of the present without compromising the ability of
the future generations to meet their own needs.
a. Social Responsibility
b. Sustainability
c. Convergence
d. Green Economics

5. The goals of financial management includes all of the following EXCEPT

a. Make crucial investments and financial decisions
b. Maximization of the value of the firm
c. Maximization of shareholder wealth
d. Social responsibility and ethical behaviour

6. In this type of partnership, there is at least one general partner and the rest are
limited partners
a. General Partnership
b. Semi-limited Partnership
c. Limited Liability Partnership
d. Unlimited Liability Partnership

Essay Questions:
1. Enumerate and explain the goals of financial management.
2. Enumerate and explain the financial manager’s responsibilities.

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

Module 2: Financial Statements

Learning Objectives:
At the end of this module, the students are expected to:
1. Know and explain the definition and components of the financial statements
2. Know and explain the relationship of the components of financial statements
3. Prepare the basic financial statements

Lesson Proper: Lecture on what are the financial statements, its components and
how to prepare the basic financial statements

Statement of Financial Position

The statement of financial position presents the company’s financial position at a
given time. The three elements of the Statement of Financial Position are: assets,
liabilities and equity.

Assets are resources controlled by an entity as a result of past transactions and

events from which future economic benefits are expected to flow in the entity.

Classifications of Assets:
1. Current assets – according to PAS # 1, assets are considered to be current when:
it is cash or cash equivalent, the company intends to hold the asset for the purpose
of trading it, the company expects to realize the asset within 12 months, and the
company expects to realize the asset or intends to sell or use it within the entity’s
normal operating cycle.
2. Non-current assets – if the asset does not fall under current asset then it must be
non-current.

Liabilities are present obligations of the firm from past transactions or events, the
payment of which is expected to result in an outflow of economic resources or
assets.

Classifications of Liabilities:
1. Current liabilities – according to PAS # 1, liabilities are considered to be current
when: the firm is expected to pay the liability within it normal operating cycle, the
firm holds the liability primarily for the purpose of trading, and the liability can be
paid within 12 months.
2. Non-current liabilities – liabilities not considered as current are non-current.

Shareholder’s equity is the excess of the firm’s assets over the firm’s liabilities.

Three basic components:

1. Share capital consists of the issuance of the company’s own share at their par or
stated value.
2. Reserves consist of the company’s own share above par/stated value or
additional paid in capital or sometimes called premium on the share capital.
3. Retained earnings consist of various comprehensive income, revaluation surplus
and appropriated retained earnings.

Income Statement presents the results of a firm’s operation or performance for a

given time. The elements of income statement include revenue and expenses.

Income Statement Presentation Approaches:

1. Functional presentation follows the function of expenses. Here expenses are
classified in accordance with their function namely; cost of sales, operating
expenses, etc.
2. Natural approach totals all revenue and all expenses. The sum of expenses are
deduction from the sum of revenues to get the income before tax.

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

Statement of Comprehensive Income consists of recognized gains and losses that

are not included in the income statement but are found in the equity section of the
statement of financial position or more clearly at the statement of changes in
equity. Other gains and losses can be presented separately or as an extension of
the income statement.

Statement of Changes in Equity includes the following: total or net comprehensive

income, the effects brought about by the changes in accounting policies or
corrections of errors, investment transactions of owners and dividends paid to
owners, and beginning balance of each component in the statement of changes in
equity and the movements under them that brought about the ending balances.

Statement of Cash Flow presents the summary of the operating, investing and
financing activities of the firm. It reconciles the beginning and ending balances of
the cash and cash equivalents in the Statement of Financial Position. It shows the
movement (receipts and disbursements) of cash for one whole period, generally one
year.

Cash Flow Activities:

1. Operating Activities – are activities related in the generation of the principal
revenue or main source of revenue of the firm or company. Example would be the
main source of revenue of a barbershop is from haircut services.
2. Investing Activities – are cash flows from purchasing or selling long-term assets
or long-term investments. An example would be cash disbursement used to buy
buildings, plants and equipment, furniture and other fixed expenses.
3. Financing Activities – are the company’s cash inflows or outflows involving its
owners (equity financing) and creditors (debt financing). The borrowings under this
category are non-trade payables. Non-trade payables are those we get from
borrowings from bank or other financial institutions. An example would be cash
receipts from issuance of the company’s ordinary shares.

Notes to the Financial Statements are sets of information that cannot be disclosed
on the face of the financial statements. These information may either be
quantitative or qualitative. The notes may include the following: corporate /
company information, basis of preparing the financial statements and the statement
of compliance, and a summary of significant accounting policies.

Sample Income Statement

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

Sample Statement of Changes in Equity

Sample Statement of Financial Position

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

Exercises:
Multiple Choice Questions
1. This statement presents the results of firm's operation or performance for a given
time.
a. Statement of Financial Position
b. Statement of Comprehensive Income
c. Income Statement and Its Forms
d. Statement of Retained Earnings

2. These are bits or sets of information that cannot be disclosed on the face of the
financial statements. This information may either be quantitative or qualitative in
nature and may have a bearing on how the financial statements may be
interpreted.
a. Company Information
b. Notes to the Financial Statements
c. Additions to the Financial Statements
d. Auditor's Report

3. A complete set of financial statement would include each of the following EXCEPT
a. Forecast for next year
b. Statement of Financial Position
c. Income Statement
d. Statement of Cash Flows

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

4. These are cash flows from purchasing or selling of long-term assets and other
long-term investments.
a. Operating Activities
b. Financing Activities
c. Disbursing Activities
d. Investing Activities

5. These are the company's cash inflows or outflows involving its owners (equity
financing) and creditors (debt financing).
a. Operating Activities
b. Financing Activities
c. Disbursing Activities
d. Investing Activities

6. This is a component of shareholders equity that consists of issuance of the

company's own share above par / stated value or additional paid in capital or
sometimes called premium on share capital.
a. Share capital
b. Reserves
c. Retained earnings
d. Drawings

7. This component of shareholders equity contains the accumulated earnings of the

company
a. Share capital
b. Reserves
c. Retained earnings
d. Income statement

8. According to the Philippine Accounting Standards (PAS) the ways in presenting

the Income statement are
I. Functional Approach (Cost of Sales Method)
II. Natural Approach
III. Nature of Income Approach
a. I only
b. I and II only
c. I and III only
d. I, II and III
Preparation of Financial Statements

The following items were taken from the accounting records of a company. Prepare
the Statement of Financial Position (SFP).

Accounts Payable 57,000.00 Long-term Investments 35,000.00

Accounts Receivable 32,000.00 Trademarks 6,000.00

Building 255,000.00 Accrued Expenses 9,000.00

Cash 15,000.00 Short-term Notes Payable 35,000.00

Equipment 76,000.00 Common Stock 1,000.00

Retained Earnings ??? Interest Income 2,000.00

Prepaid Expenses 12,000.00 Inventory 82,000.00

Sales Dividends paid

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

123,000.00 25,000.00

Salary Expense 22,000.00 Cost of Goods Sold 62,000.00

Module 3: Financial Statement Analysis

Learning Objectives:
At the end of this module, the students are expected to:
1. Know and explain the various ways financial statements are analyzed
2. Know and explain the objectives of financial statement analysis
3. Know the steps in doing financial statement analysis
4. Know and explain the limitations of financial statement analysis
5. Perform the steps in doing financial statement analysis by applying the different
techniques, interpretations, conclusions, and draw the implications based on results
of the applications.

Lesson Proper: Lecture on the objectives of financial statement analysis,

limitations of financial statement analysis, steps in analyzing financial statements,
and approaches in analyzing financial statements.

Objectives of Financial Statement Analysis

The financial analysis aims to probe the company’s:
1. Profitability – the ability of the firm to yield a sufficient amount of return on
company sales, assets and invested capital.
2. Liquidity and Stability – the ability of the firm to meet its current or short-term
maturing obligations.
3. Asset utilization or activity – measures how efficient the company is in managing
its resources.

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

4. Debt-utilization or leverage – measures the overall debt status of the company.

The primary purpose of financial statement is to examine the present, as well as the
past, financial position (statement of financial position) and results of operation
(income statement) of the firm in order to: determine the best suitable estimate and
predict the future state and performance of the company.

Limitations of Financial Statement Analysis:

1. Its failure to consider changes in the purchasing power, inconsistencies, as well
as dissimilarities in the accounting principles, policies, and procedures used by the
firms in the industry.
2. Its failure to consider changes in the purchasing power of currencies.
3. The age of financial statements is a limitation. The older it gets, the less reliable
it becomes.
4. Failure to read and understand the information in the notes to the financial
statements may obscure managers in evaluating the degree of risk.
5. The usage of financial statements that have not undergone external auditing
procedures may lead to erroneous analysis, and ultimately erroneous decisions.
6. The usage of financial statements that have not undergone external auditing
procedures results to financial measurements that are not dependable and not
conclusive.
7. Audited statements do not guarantee accuracy.

Practical Steps Proposed in Analyzing Financial Statements

1. Determine which of the objectives discussed would be the coverage of the
analysis
2. Learn about the retrospective, current, as well as the prospective conditions of
the industry
3. Get to know the firm you are analyzing
4. Assessment / analysis
5. Interpret the results
6. Draw conclusions from the interpretations

Approaches in Analyzing Financial Statements

1. Horizontal Analysis of Comparative Statements – the balance of the accounts in
the financial statements of the previous year is subtracted from that of the current
year. This would result to a change, either a growth or a reduction. The percentage
of change is then computed by dividing the change in balance of the accounts by
the previous balance of the account.

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

Liquidity and Solvency – The increase in receivables and inventory is much higher
than the increase in sales. This can be interpreted to mean that the inventory and
receivables had a slow conversion into cash. The increase in inventory could be
related to the marked increase in cost of goods (12.4%). It implies that the purchase
cost of inventories have increased.

Stability or Long-term Financial Position – The growth in total liabilities (1.57%) is

much lower than the growth of the firm’s retained equity (10.23%). This growth in
the retained earnings could be attributed to the firm’s net income growth of 7.57%.
It could be inferred that Riel Corporation has established its long-term financial
position.

Operating Efficiency and Profitability – There is a marked favourable increase in

sales (10.07%), however this is further negated by the increase in the cost of goods
sold (COGS) (12.4%). The decrease in administrative expenses is noteworthy (-
2.82%). This may be interpreted to mean that the company may efficiently and
successfully control its expenses. The decrease in notes payable (-17.78%) may
indicate early payment of debt, which resulted in a decreased interest expense (-

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

4.66%). In general, it can be inferred that the operating performance of Riel

Corporation has proven to be favourable as supported by the increase in the net
income of 7.57%.
2. Vertical Analysis Using Common Size Statements – uses percentages / ratios that
present the relationship of the different accounts or items in the financial
statements. For the statement of financial position, the base used is the total
assets. For the income statement, the base is net sales or net revenue. The
common-size statements are sometimes called component percentage or 100%
statements. This statement aids management to assess their financial position as
well as the results of operation by comparing their statement with other companies
belonging in the same industry.

Statement of Financial Position

Majority of the current assets is made of inventory (33.02%) seconded by
receivables (32.31%). Decrease in the allocation for property, plant and equipment

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

must also be noted. Total liability percentage (59.06%) is also higher than the total
shareholder’s equity percentage (40.94%), which means that most assets were
financed by borrowings. Decrease of liabilities in 2014 (61.04%) to 2015 (59.06%)
indicates that the firm is shifting its dependence of financing from borrowing to
using more of the owner’s investment.

Income Statement
High percentage of Cost of Goods Sold (COGS) to sales is not favourable. This
indicates that most of sales revenue is used to cover the cost of selling. Gross profit
(26.58%) in 2015 has decreased comparing it with the gross profit ratio (28.1) in
2014. This is due to marked increase in cost of goods sold ratio. Net income ratio
(3.86%) is favourable as this indicates that the company earned during the year.

3. Trend Analysis – is longitudinal and a modification of the horizontal and vertical

analysis. Under this method, the percentage changes are determined for several
successive periods instead of the typical two year period horizontal analysis. This
method is more thorough than the two-year period horizontal analysis because it
presents a view in the long-run of the company’s progression or regression as the
case maybe. In computing the trend, the base period (oldest year) amounts are
written as 100%.

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

Liquidity and Solvency

The trend analysis matrix shows the improving net capital (current assets – current
liabilities) status of Nico Corporation. The upward trend of the firm’s current assets
and downward trend of the current liabilities evidence this. The matrix also reveals
that cash as well as other current assets showed an upward trend. The consistent
increase of the trade and other receivables is supported by the upward trend sales
revenue.

Exercises
Complete the Comparative Financial Statements below

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

Multiple Choice
1. A Statement of financial position which reports percentages of total assets
instead of peso amounts is referred to as
a. Percentages statement of financial position
b. Financial ratio presentation of financial position
c. Balance sheet
d. Common-size statement of financial position

2. Under this method, the percentage changes are determined for several
successive periods instead of the typical two-year period horizontal analysis
a. Vertical analysis
b. Trend analysis
c. Horizontal analysis
d. Financial ratio analysis

3. This involves the comparison and measurement of financial statements of two or

more periods
a. Diagonal Analysis
b. Horizontal Analysis
c. Circular Analysis
d. Vertical Analysis

4. Also know as static measure or structural ratios

a. Horizontal Analysis
b. Diagonal Analysis
c. Circular Analysis
d. Vertical Analysis

Module 4: Financial Ratio Analysis

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

Learning Objectives:
At the end of this module, the students are expected to:
1. Know and explain what financial ratio is
2. Know and explain the objectives of financial ratio analysis
3. Know and explain the limitations of financial ratio analysis
4. Perform the steps in doing financial ratio analysis, interpretations, conclusions,
and draw the implications based on the results of the applied ratios

Lesson Proper: Discussion on the various financial ratios and how they are
computed

Ratio represents relationships between two variables. Financial ratio refers to the
relationships between financial statement items or accounts expressed in
mathematical terms. Basis for standard financial ratios are: company budget for the
same period, those used by the industry to which the firm belongs, those used by
the firm’s successful competitors, those used by the firm using prior periods, and
those used by the analysts in the past.

Industry ratios are averages developed by a group of experts involved in research.

Industry experts developed ratios that are suitable for particular industry. Analysts
resort to readily available ratios of competitors.

Results of financial ratios are: subject to limitation, indicators of a firm’s weakness

or strength, and presented as a percentage, a fraction, a peso amount or a relative
ratio.

There are two ways of comparing ratios: examine the ratios across time or compare
ratios between firms.

Liquidity ratio – pertains to the firm’s ability to pay any immediate and incoming
cash disbursements like payment of payables and operating costs and expenses.

1. Current ratio = current assets__

current liabilities

2. Acid test ratio / Quick ratio = quick assets (cash + trading securities +
receivables)
current liabilities

Asset utilization – it measures how often is the turn-over of accounts receivable,

inventory and long-term assets.

1. Accounts receivable

Accounts receivable turn-over = net sales_________

average accounts receivable

Days’ sales in average receivables or average collection period = 365 days_____

receivable turnover

2. Inventory

Inventory turnover ratio refers to the average inventory sold (finished goods &
merchandise), or used (raw materials), or processed (work in process).

Raw materials inventory turnover = raw materials used_______

average raw materials inventory

Work in process inventory turnover = cost of goods manufactured___

average work in process inventory

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

Finished goods inventory turnover = cost of goods sold_______

average finished goods inventory

Merchandise inventory turnover = cost of goods sold_______

average merchandise inventory

Number of days in inventory or average sale period = 365 days_____

Inventory turnover

3. Long term assets

Fixed asset turnover = net sales___

average net PPE

Total asset turnover = net sales_____

average total assets

Debt utilization / leverage ratios – allows the analyst to ascertain how efficient the
company manages its financial obligations. It measures the degree of company
financing in terms of borrowings and investment or equity.

Debt to equity ratio = total liabilities_____

total stockholders’ equity

Debt ratio = total liabilities

total assets

Number of times interest earned = net income before interest and income tax
annual interest expense

Profitability ratios measure the firm’s capacity to earn sufficient return on sales,
total assets and owner’s investment.

Gross profit ratio = gross profit

net sales

Net profit ratio or profit margin = net profit

net sales

Return on assets (ROA) = net income____

average total assets

Return on equity (ROE) = net income______

average stockholders’ equity

Sample application

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

1. Liquidity
Current ratio = 0.64 in the year end 2015
2. Asset utilization
Accounts receivable turnover = 1.59 times
Day’s sales in average receivables = 243 days
3. Debt utilization
Debt ratio = 0.41 in the year end 2015

Exercises

Multiple choice
1. Cost of goods solds DIVIDED BY average merchandise inventory
a. Finished goods inventory turn-over
b. Merchandise inventory turn-over
c. Net worth ratio
d. Receivable turn-over ratio

2. The quick ratio EXCLUDES which of the following

a. Accounts receivable
b. Cash
c. Trading securities
d. Inventory

Use the following items to answer items 3 & 4

Cash 10,000
Accounts Receivable 30,000
Inventory 80,000
Prepaid Insurance 6,000
Long-term Assets 200,000
Accounts Payable 30,000
Notes Payable due in 10 months 25,000
Wages Payable 5,000
Long-term Liabilities 70,000

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

Stockholder's Equity 196,000

3. The company's current ratio is

a. 1.0 : 1
b. 2.0 : 1
c. 2.1 : 1
d. 2.5 : 1

4. The company's quick ratio is

a. 0.67 : 1
b. 1.0 : 1
c. 2.1 : 1
d. 2.5 : 1

5. Net income DIVIDED BY average total assets

a. Return on equity
b. Return on assets
c. Earnings per share
d. Profit margin on income

6. Ratios that measure the ability of the company to pay its short-term debts are
called
a. Debt ratios
b. Cover ratios
c. Liquidity ratios
d. Profitability ratios

7. Gross profit ratio, return on assets and return on equity are examples of
a. Liquidity ratios
b. Profitability ratios
c. Debt ratios
d. Efficiency ratios

Use the following items to answer items 8 & 9

Minden company has sales of PHP500,000, operating profit of PHP50,000, interest
expense of PHP10,000, tax expense of PHP20,000, average equity of PHP125,000
and average debt of PHP275,000.

8. The return on assets is?

a. 5%
b. 8%
c. 12.5%
d. 16%

9. The return on equity is?

a. 8%
b.10%
c. 12.5%
d. 16%

10. Debt to equity ratio is an example of a/an

a. Profitability ratio
b. Liquidity ratio
c. Leverage ratio
d. Asset utilization

11. Profitability ratio includes all of the following EXCEPT

a. Number of times interest earned
b. Gross profit ratio
c. Return on assets
d. Return on equity

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

12. Determine what would happen to current ratio if notes payable are paid off with
cash
a. Current ratio does not change
b. Current ratio decreases
c. Current ratio increases
d. None of the above

13. Determine what would happen to current ratio if inventory is sold on account
a. Current ratio does not change
b. Current ratio decreases
c. Current ratio increases
d. None of the above

14. Tater's Corporation reported sales for 2008 of PHP23,000,000. Tater's listed
PHP5,600,000 of inventory in its statement of financial position. Calculate the
number of days in inventory
a. 4.11
b. 4.00
c. 87.98
d. 88.87

15. You are considering a stock investment in one of two firms X and Y, both of
which operate in the same industry. X finances its PHP25,000,000 in assets with
PHP24,000,000 in debt and PHP1,000,000 in equity. Y finances its PHP25,000,000 in
assets with PHP1,000,000 in debt and PHP24,000,000 in equity. What is CORRECT
regarding the debt to equity ratio of X and Y firms
a. X is 96%, Y is 4%
b. X is 25 times, Y is 1.04 times
c. X is 24 times, Y is 0.04 times
d. X is 24 times, Y is 1.04 times

Calculation: Use the Statement of Financial Position and Income Statement of Lake
Egypt Marina to calculate the ratios. Show your computations.

Lake of Egypt Marina, Inc.

Statement of Financial Position December 31, 2013 and 2014
(in millions of dollars)

Assets 2007 2008

Current Assets
Cash and Marketable Securities 65 75
Accounts Receivable 110 115
Inventory 190 200
Total 365 390

Non-Current Assets
Gross Plant and Equipment 471 580
Less: Depreciation 100 110
Net Plant and Equipment 371 470
Other Long Term Assets 49 50
Total 420 520

Total Assets 785 910

Liabilities & Equity 2007 2008

Current Liabilities

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

Accrued Wages and Taxes 43 40

Accounts Payable 80 90
Notes Payable 70 80
Total 193 210

Non-current Liabilities 280 300

Stockholders' Equity
Preferred Stock (5 million
shares) 5 5
Common Stock (65 million
shares) 65 65
Retained Earnings 242 330
Total 312 400

Total Liabilities and Equity 785 910

Lake of Egypt Marina, Inc.

Income Statement for Years Ending December 31, 2013 and 2014
(in millions of dollars)

2007 2008
Net Sales (all credit) 432 515
Less: Cost of Goods Sold 200 260
Gross Profits 232 255
Less: Operating Expenses 20 22
Earnings before interest and taxes
(EBIT) 212 233
Less: Interest 30 33
Earnings before taxes (EBT) 182 200
Less: Taxes 55 57
Net Income 127 143

Less: Preferred Stock Dividends 5 5

Net Income Available to Common
Stockholders 122 138
Less: Common Stock Dividends 65 65
Addition to Retained Earnings 57 73

Calculate the following ratios:

Current Ratio
Quick Ratio
Inventory Turn-over Ratio
Number of Days in Inventory
Accounts Receivable Turn-over
Average Collection Period
Fixed Asset Turn-over
Total Asset Turn-over
Debt Ratio
Debt to Equity Ratio
Number of Times Interest Earned
Gross Profit Ratio
Profit Margin
Return on Assets
Return on Equity

Prepared by: Maureen P. Abulencia, CPAPage 24

Colegio de Dagupan
School of Business and Accountancy Financial Management 2

Module 5: Financial Forecasting, Corporate Planning and Budgeting

Learning Objectives:
At the end of this module, the students are expected to:
1. Know and explain the basic concepts involving financial forecasting, corporate
planning and budgeting
2. Know and explain what are the pro-forma financial statements and percent of
sales method
3. Construct pro-forma statements in designing a financial forecast
4. Apply percent of sales method in designing a financial forecast

Lesson Proper: Discussion on corporate planning and its three forms, budgeting
and its importance, and construction of pro-forma financial statements

Corporate planning is a formal, systematic, managerial process that is organized by

responsibility, time and information to assure that strategic planning, project
planning and operational planning are carried out regularly to enable top
management to direct and control the future of the company.

Three forms of corporate planning:

1. Strategic planning involves the creation of strategies that are aimed in

maximizing the entity’s future position. A strategy is a design that integrates the
corporate objectives, policies and programs in a well-developed unified whole. It
involves the SWOT analysis (Strengths, Weaknesses, Opportunities and Threats).
a. Research strategies
b. Production strategies
c. Marketing strategies

2. Project planning entails detailed plan involving acquisition of new property, plant
and equipment; creation of new product; modification, acquisition or adaptation of
new systems; and acquisition of new entities. In evaluating acquisitions that involve
significant capital expenditures, systematic and scientific methods are used like:
a. Discounted cash flows (DCF)
b. Rate of return (ROR)
c. Cost of capital investment

3. Operational planning – is concerned on how to efficiently and effectively utilize

the entity’s resources to achieve the company’s short-term and long-term
objectives set up during strategic planning.

Budgeting involves quantifying of the plans in terms of monetary value. For

example, if the firm needs to increase revenue in order to maintain its current
market share, budgeting would say, increase sales revenue by Php1,200,000 and
decrease administrative expenses by Php200,000.

Budget is a formal statement of plan presented in quantitative terms. Management

compares the actual figures of company operations against the budgeted figures
and see if there are favourable or unfavourable difference.

Budgets are usually prepared for one year. The company may opt to present the
budget on a monthly or quarterly basis.

Reasons for budgeting

1. Planning in the development of operational and projects plans, proposed

activities should involve profit generation.

2. Coordination – budgeting tends to synchronize the firm’s operations, because the

budget serves as a guide as to what the company should achieve.

Prepared by: Maureen P. Abulencia, CPAPage 25

Colegio de Dagupan
School of Business and Accountancy Financial Management 2

3. Control – the differences or variance between the budget and actual results are
assessed so that adjustments be done if needed.

Components of the Master Budget

1. Operations budget / profit plan – is composed of a detailed presentation of

revenues, expenses and net profit. It takes the form of the pro-forma or budgeted
income statement. Formation of the budgeted income statement would include the
sales, production volume, cost of raw materials, number of raw materials units to be
purchased, cost of direct labor, factory overhead, cost of goods sold, selling
expenses, administrative expenses, and financing charges.

2. Financial resources budget – would include the cash budget, pro-forma or

budgeted Statement of Financial Position (SFP), and projected funds flow statement.

3. Capital expenditures budget – involves plans on material modification, acquisition

and disposal of property, plant and equipment or material modification, acquisition
or renewal of a firm’s computerized accounting information system, and budgeted
financial ratios. These are ratios taken from the pro-forma or prepared budgeted
financial statements.

Process in Preparing the Master Budget

1. Formulation of the corporate objectives, plans, policies, and assumptions, which
will give direction in the formulation of the budget estimates.
2. Establish or estimate sales projection or targeted sales which serves as basis in
determining the targeted number of units (volume) to be solved.
3. Individual budgets from the different functional areas as well as sub-units or
responsibility centers of the company. These are based on the planned volume of
units to be sold.
4. Consolidation of the individual budgets. This is done to create a draft master
budget. This is specifically the work of the corporate planning department.
6. Revision of the preliminary drafted master budget. This is done to come up with
the final draft subject to the approval of top management.
7. Approval and dissemination of the final master budget to department heads and
supervisors.

Process in Preparing Pro-forma Statements

Methods in Estimating or Forecasting Sales

1. Sales Trend Analysis – under this method, the product life cycle is utilized in
making the forecast. Product life cycle shows that the growth starts from the
introduction stage of the product and accelerates in the middle year and then
plateaus and finally declines.

2. Sales Force Composite Method – under this method, each salesman estimates the
sales in his particular territory. Historical sales may be used by each salesman as
basis for estimating the probable sales for the next period.

Prepared by: Maureen P. Abulencia, CPAPage 26

Colegio de Dagupan
School of Business and Accountancy Financial Management 2

3. Executive Opinion Method – Under this method, the vies of the top executives are
culled to arrive at the estimate.

4. Industry Trend Analysis Method – under this method, the relationship between
expected industry sales and the company sales in terms of market share is
determined. The growth statistics of the industry is assessed and a forecast is
made.

5. Correlation Analysis Method – This is a more scientific means of forecasting sales

using regression analysis. The regression equation is used to determine the cause
and effect relationship between sales and the factors affecting it.

6. Multiple Approach Method – This method utilizes a combination of the various

methods discussed.

Cash budgets are created because sales and income generation may not
necessarily mean that there is sufficient cash on hand to meet the financial debts of
the equity. Credit sales or charge sales generate revenue but does not generate
immediate cash. Because of this, the translation of the pro-forma income statement
into cash is necessary.

Exercises

Multiple Choice

1. The 3 forms of corporate planning include all of the following EXCEPT

a. Strategic planning
b. Project planning
c. Management planning
d. Operational planning

2. It entails detailed plan involving: acquisition of property, plant, and equipment;

creation of a new product; modification, acquisition or adaptation of new systems;
acquisition of new entities
a. Strategic planning
b. Project planning
c. Management planning
d. Operational planning

3. It involves quantifying of the plans in terms of monetary value

a. Budgeting
b. Financial analysis
c. Financing
d. Investing

4. Components of the master budget include:

a. Operations budget
b. Financial resource budget
c. Capital expenditure budget
d. All of the above

5. It is a component of the master budget that is composed of a detailed

presentation of revenues, expenses and net profit
a. Operations budget
b. Financial resource budget
c. Capital expenditure budget
d. Budgeted financial ratios

6. Budgeted income statement would include all of the following, EXCEPT

a. Sales
b. Cost of raw materials

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

c. Cash budget
d. Factory overhead

7. Under this method of estimating sales, each salesman estimates the sales in his
particular territory.
a. Sales trend analysis
b. Sales force composite method
c. Executive opinion method
d. Industry trend analysis method

8. Under this method of estimating sales, the product life cycle is utilized in making
the forecast
a. Sales trend analysis
b. Sales force composite method
c. Executive opinion method
d. Industry trend analysis method

9. Under this method of estimating sales, the relationship between expected

industry sales and the company sales in terms of market share is determined.
a. Sales trend analysis
b. Sales force composite method
c. Executive opinion method
d. Industry trend analysis method

10. This is concerned on how to efficiently and effectively utilize the entity's
resources to achieve the company's short-term and long-term objectives set up
during strategic planning.
a. Strategic planning
b. Project planning
c. Management planning
d. Operational planning

11. This involves the creation of strategies that are aimed in maximizing the entity's
future position taking into consideration the various elements and factors that may
pervade the company's internal and external environment.
a. Strategic planning
b. Project planning
c. Management planning
d. Operational planning

12. This is mainly made up of: Cash Budget, Pro-forma or budgeted Statement of
Financial Position, and Projected Funds Flow Statement.
a. Operations budget
b. Financial resource budget
c. Capital expenditure budget
d. Budgeted financial ratios

13. Budgeting is done for the following reasons, EXCEPT

a. The budgeted financial statement helps management in paving the way to
achieve the desired profit found in the budgeted income statement.
b. Budgeting tends to synchronize the firm's operations, because the budget serves
as a guide to what the company should achieve.
c. Budgeting helps to look for the best top executives to manage the company and
help to achieve the company towards success.
d. Budgeting provides the barometer or yardstick against which the firm can
measure and compare their actual results of operations.

14. The first step in preparing the master budget is?

a. Formulation of the corporate objectives, plans, policies and assumptions
b. Create the cash budget
c. Create the capital expenditures budget

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

d. Targeted sales are estimated

The sales of CBI Corporation are expected to be 8,000 units for the month, selling
price is 120. The company would like to maintain 20% of unit sales for each month
in ending inventory. Beginning inventory is 2,100 units, at a cost of 80. Use this
information for questions 15 and 18.

15. How many units should the company produce for the coming month?
a. 9,600
b. 1,600
c. 7,500
d. 8,000

16. What should be the forecasted ending inventory of CBI?

a. 9,600
b. 1,600
c. 7,500
d. 8,000

17. If production cost for the month is 90, assuming FIFO inventory method, what
would be your cost of goods sold?
a. 699,000
b. 675,000
c. 843,000
d. 531,000

18. Assuming operating expenses of 150,000, what would be your net profit?
a. 150,000
b. 261,000
c. 111,000
d. 100,000

Foster Company has forecasted credit sales for the fourth quarter of the year:
September (actual) 90,000.00
October (forecast) 100,000.00
November (forecast) 80,000.00
December (forecast) 120,000.00
Based on past experience, 30% are collected on the month of sales and 70% in the
following month. Use this information for questions 19 and 20.

19. What would be your cash receipts for the month of October?
a. 93,000
b. 94,000
c. 92,000
d.100,000

20. What would be your cash collection for the fourth quarter?
a. 90,000
b. 189,000
c. 279,000
d. 300,000
d. 100,000

Essay
Enumerate the 3 reasons for corporate planning and explain each.

Discuss and explain the three forms of corporate planning.

Prepared by: Maureen P. Abulencia, CPAPage 29

Colegio de Dagupan
School of Business and Accountancy Financial Management 2

Module 6: Fund Management

Learning Objectives:
At the end of this module, the students are expected to:
1. Set the parameters of what cash is all about
2. Use appropriate bank products for orderly management of fund
3. Understand the internal control measures adopted by persons handling the cash
and documents and evidence attached to it
4. Detect and resolve common misuses of cash
5. See cash as a potential use of additional income for the company

Lesson Proper: Discussion on what cash is, types of cash, kinds of cash
documents, and common misuses of cash.

Cash is defined as money and any other negotiable instrument that is payable in
money and acceptable by the bank for deposit and immediate credit.

Types of Cash

1. Cash on Hand – represents the cash collection waiting to be deposited the

following day.

2. Cash in Bank – represents the cash already deposited in the bank.

a. Savings account – an account where the money deposited will earn interest
income for the meantime while it is not yet used and is evidenced by a
savings passbook.
b. Demand deposit – is sometimes called checking account or current account.
This account normally does not earn interest and is evidenced by a check
book.
c. Combo account – is a combination of savings account and demand deposit
into one account. For this account the bank will require a bigger
compensation balance and the trade off will be the grant of interest on their
average daily balance. Compensating balances are maintaining balances
required by the bank whenever you open a bank account.

3. Cash Fund – is the company’s maintained cash to comply with the other fund
requirements of the company.
a. Petty cash fund – is the fund that will cater the small expenditures of the
company. The person handling this fund is called the petty cash custodian.
b. Change fund – is the fund used to maintain loose change to address the
concern for smaller bills and coins. Normally, this is being handled by the
company cashier.
c. Dividend fund – is the fund used to pay for the dividends which the board of
directors have declared and payable a time certain in the future. Normally,
this is being handled by the company cashier.

4. Cash Equivalent – are short term and highly liquid investments that are readily
convertible to cash.
Criteria set by the Philippine Accounting Standards (PAS) for proper evaluation of
cash equivalent:
 If the term is three months or less, such instrument is classified as cash
equivalent.
 If the term is more than three months but less than one year, such
investment is classified as short-term or temporary investment and should be
presented as separate current asset.
 If the term is more than one year, such item is classified as non-current or
long-term investment. However, if it will mature within a year, then it is
considered as current asset.

Kinds of Cash Document

Prepared by: Maureen P. Abulencia, CPAPage 30

Colegio de Dagupan
School of Business and Accountancy Financial Management 2

1. Provisional Receipt – is issued by collectors, whether cash or check collection.

These are surrendered by the collector to the office cashier every day. This receipt
is also issued by the office cashier in case of check payments. This is so because
check payments require three clearing days with the banking system.

2. Official Receipt – is issued by office cashier in case of cash payments. This will be
issued whenever the collector remits cash collection to the office cashier. This will
be issued also for check collections for which provisional receipt was issued having
passed the three-day clearing period. The official receipt must be in triplicate: the
original copy must be given to the person paying, the duplicate must be given to
the accounting department for recording, and the triplicate will be left on the
booklet for the cashier’s copy. When the booklet is fully used up, it must be
surrendered to the accounting department for filing and for audit purposes only.

3. Sales Invoices – are also considered cash sales invoices. However, some business
establishments use the sales invoice for credit sales or sales on account. When
sales invoices are used on credit sales, there is a notation that in case the account
is not settled within the prescribed credit period, a case will be filed. Sales invoice
must also be in triplicate the same will apply as the official receipt.

4. Daily Collectors Remittance Form – is the summary of the collection made by a

specified collector for the day. This will be submitted to the office cashier together
with the duplicate copy of the provisional receipt. The daily collectors remittance
form must be in duplicate. The original copy together with the duplicate will be
submitted to the office cashier. The duplicate copy will be furnished to the
accounting department for recording and audit purposes.

Policy on handling cash

The policy set up must feedback potential errors to management.

Sample policies on handling cash:

 The company should adopt the imprest system of handling cash.
 The company should maintain the combo account for easier tracking of
banking transaction.
 The company should place its money in various banking companies so as to
distribute the risk involved in banking.
 The following bank signatories will be observed:
o If the amount of the disbursement is Php50,000 the check signatories
will be the comprotroller or head of the accounting department and to
be countersigned by the treasurer or the vice president.
o If the amount of disbursement is more than Php50,000 the check
signatories will be the comptroller or head of the accounting
department and to be countersigned by the treasurer or president.
 Official receipt can only be issued when cash is received. Check payments
will be covered by provisional receipts.
 All funds should be kept and maintained by the office fund custodian. For the
petty cash fund, the custodian should request replenishment once the fund is
40% used to avoid disruption of operations due to insufficiency of the fund.

Sample procedure on handling cash

 The cashier upon receiving cash from the customer of the company collector
will issue an official receipt.
 The cashier will also issue an official receipt for cleared check deposits.
 The cashier will deposit the cash collection up to 12 noon of the current day
intact within the day and money collections after 12 noon will be deposited
intact the following day.
 The cashier will pay the daily cash position report.
 The official receipt issued together with the validated deposit slip and the
original copy of the daily cash position report will then be forwarded to the
accounting department.

Prepared by: Maureen P. Abulencia, CPAPage 31

Colegio de Dagupan
School of Business and Accountancy Financial Management 2

Common misuses of cash

1. Lapping – is a case of misappropriating a collection from one customer and

concealing this defalcation by applying a subsequent collection made from another
customer. This involves a series of postponement of entries on collection of a
receivable and is made possible because of poor internal control.

2. Kiting – happens when a check drawn from one depository bank is deposited in
another depository bank at the end of the month or year. There will be no entries
made on this drawing and depositing.

3. Fraudulent documents and evidence – some employees will make documents and
pieces of evidence which are not really true.

Examples of some good practices in handling cash

1. Establish good relationship with the bank officer
2. Identifying the various books where these cash transactions were recorded in
comparison with the various reports prepared
3. Routine audit procedures to countercheck the books and reports and employees
duties, so that there will be no overlapping of functions and strict adherence to
company’s policies and procedures.
4. The preparation of strategic plan, medium term development plan and long term
development plan

Exercises

Multiple Choice
1. This is a type of cash that represents collection waiting to be deposited the
following banking day
a. Cash on hand
b. Cash in bank
c. Petty cash fund
d. Change fund

2. This receipt will be issued by the office cashier in case of check payments. This is
so because check payments require 3 clearing days with the banking system.
a. Provisional receipt
b. Official receipt
c. Sales invoice
d. Daily collectors remittance form

3. Below are good practices in managing cash, EXCEPT

a. There is no need to control cash since it is not prone to theft and abuse anyway
b. Establishing a good relationship with the bank officer
c. Routine audit procedures to counter check the books and reports
d. Preparation of strategic plan, medium-term development plan and long-term
development plan

4. Below are common misuses of cash, EXCEPT

a. Lapping is a case of misappropriating a collection from one customer and
concealing this defalcation by applying a subsequent collection made from another
customer
b. Kiting happens when a check drawn from one depository bank and deposited in
another depository bank at the end of the month or year
c. Some employees will make fraudulent documents and pieces of evidence that will
conceal misuse of cash
d. Placing excess money in the bank during the day to an overnight placement and
terminate it the following day

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Colegio de Dagupan
School of Business and Accountancy Financial Management 2

5. Below are examples of short term time deposits, EXCEPT

a. Overnight placement
b. One week time deposit placement
c. 30 day short term investment
d. 2 year time deposit

6. This is the summary of the collection made by a specified collector for the day.
This will be submitted to the office cashier together with the duplicate copy of the
provisional receipt.
a. Provisional receipt
b. Official receipt
c. Sales invoice
d. Daily collector’s remittance form

7. These are short term highly liquid investments (those that are acquired three
months before maturity) and are readily convertible to cash and so near their
maturity that they present insignificant risk of changes in value.
a. Cash on hand
b. Cash in bank
c. Cash fund
d. Cash equivalent

8. It is sometimes called the checking account or current account. Normally doesn't

earn interest and is evidenced by a checkbook
a. Saving account
b. Time deposit account
c. Combo account
d. Demand deposit

9. Generally, if there is a bank overdraft:

a. This will be reported as a deduction from other bank deposits with other bank
accounts
b. This will be reported as a deduction from total quick assets
c. This will be reported as a deduction from total current assets
d. This will be reported as a current liability

10. Which is more likely not a duty of the cashier

a. To issue an official receipt for cash payment
b. To issue a provisional receipt for check payment from customer
c. To issue a sales invoice in the sales counter
d. To issue a warehouse slip

11. The process of misappropriating a collection of one customer and applying

subsequent collection from another customer to the former is:
a. Lapping
b. Kiting
c. Depending on another situation affecting the collection of the next customer
d. Depending on the other situation affecting the collection of the earlier customer

Essay:
Enumerate and give a brief description of the probable misuse of cash.

Give some examples of good practices in managing cash.

Prepared by: Maureen P. Abulencia, CPAPage 33

Colegio de Dagupan
School of Business and Accountancy Financial Management 2

Module 7: Inventory Management

Learning Objectives:
At the end of this module, the students are expected to:
1. Identify the components of inventory and its related terms
2. Identify the various forms and documents used to evidence an inventory account
3. Check the importance of human resources who handle the inventory
4. Methods of costing an inventory
5. Describe the EOQ model

Lesson Proper: Discussion on what an inventory is, the different types of inventory
accounts, the effects of mismanagement of inventory, the handlers of inventory,
how inventory is costed, and the EOQ model.

PAS 2 defined inventories as assets, which are held for sale in the ordinary course of
business in the process of production for such sale or in the form of materials or
supplies to be consumed in the production process or in the rendering of services.

Inventory accounts for the different types of business organization

1. Service concern – those that render service to earn income

For service concern the inventory account will only be for the supplies.

2. Trading concern – those that sell merchandise to earn income

For trading concern there will be two inventory accounts namely supplies and
merchandise inventory. Supplies will be the same as the service concern.
Merchandise inventory are those items which the company purchased and intended
for resale to its customers.

3. Manufacturing concern – those that convert raw materials into finished products
For the manufacturing concern there will be 3 more additional inventory accounts
under this type of business organization namely:
a. Raw materials inventory – these are the materials, which the company
purchased and is for use in the production
b. Work in process inventory – these are the partially finished products at the
end of the month
c. Finished goods inventory – these are products already finished, ready to be
sold to customers

Effects of mismanagement of inventory

1. Under-stocking – this is a serious problem as it can result to missed deliveries,
lost sales, unsatisfied customers, and production bottlenecks and worst, work
stoppage.
2. Overstocking – which results to holding costs that are too high, and funds could
have been used for a more productive venture.

Areas to consider in inventory management

1. Beginning inventory – must be enough until the next delivery of the raw
materials. We need to estimate the lead time, the lead time must be based on the
past experience of the company relating to traffic condition, supplier’s culture, and
distance of supplier’s warehouse to the company’s warehouse and of course the
company’s processing procedures and policies.

2. Purchases
 The accredited supplier of choice must be objectively selected by a
committee so that quality raw materials can be easily produced. In case no
committee is selected to handle the accredited supplier, the audit
department should work to protect the interest of the company. Protection

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School of Business and Accountancy Financial Management 2

would mean quality materials should be procured with the least price per
unit.

 Freight charges
o FOB Destination – this contract says the supplier will deliver the
merchandise inventory from the supplier’s warehouse to the buyer’s
warehouse free of charge.
o FOB Shipping Point – this contract says that the supplier will deliver the
merchandise inventory from the supplier’s warehouse to the shipping
point only. In this case legal title transfers the ownership from the
seller to the buyer when the delivery man of the seller has transferred
the merchandise from the delivery van / truck to the boat or plane or
the shipping point. In this case the buyer already pays for the freight
cost.
o CIF (Cost, Insurance, Freight) – under this agreement the buyer will pay
the lump sum amount of cost of goods sold, insurance and freight
charges.
o FAS (free alongside) – a seller who ships FAS must bear all expenses
and risks involved in delivering the goods to the dock next to or
alongside. The buyer will shoulder the cost of loading expenses and
shipment as the buyer takes possession of the merchandise when the
carrier takes possession of the merchandise.
o Ex-ship – a seller who delivers the goods ex-ship bears all expenses
and risks of loss until the goods are unloaded, at that time title and risk
of loss shall pass to the buyer.
 Total goods available for sale = beginning inventory + net purchases
TGAS account must be controlled well because too much goods in the
warehouse might result in over investment in inventory. Over investment in
inventory would result to losses on the part of the company because
investment on inventory could have been invested in other productive
activity of the company.

3. Merchandise inventory, end – are those merchandise that are left unsold at the
end of the year and is reflected on the balance sheet of the company. This should
be reported to the Bureau of Internal Revenue (BIR) 30 days after the end of the
company’s accounting period, to avoid using the account as an adjustment account
to the final net income of the company.

Goods on Consignment – are merchandise not owned by the enterprise but in its
physical possession. Although the merchandise is in the possession of the consignee
and for sale by the consignee in his store, the ownership of the merchandise is still
with the consignor if unsold at the end of the accounting period. Freight and
handling charges on the consigned goods will be part of the cost of the consigned
goods.

Purchase commitments – are obligations of the company to procure merchandise

inventory in the future which are already fixed by a contract as far as the price and
quantity are concerned. Should there be a decline in price after a purchase
commitment has been made; the company will record the loss on purchase
commitment.

4. Cost of Goods Sold

Merchandise Inventory, beginning
+Purchases
+Freight in
-Purchase discount
-Purchase returns and allowances
-Merchandise Inventory, ending

Handlers of the Inventory:

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School of Business and Accountancy Financial Management 2

1. Purchaser
2. Warehouseman
3. Stock card clerk
4. Bookkeeper
5. Auditor

Three Methods of Costing Inventory

1. FIFO (First in First out) – this means that the raw materials that were received
first are assumed to be the first to be issued.
2. LIFO (Last in First out) – this means that the last raw material that were received
by the warehouseman is assumed to be the first to be issued.
3. Weighted average – this means that we get the average cost of the raw materials
received and such cost will be the basis for those issued.

The Accounting Treatment for Returns and Allowances

1. Internal Returns – when returns are coming from the factory, it should be
recorded in the subsidiary ledger as a negative figure in the issued column. This will
increase the balance of the inventory.
2. Purchase Returns – when we return raw materials to the supplier, it should be
recorded at its original cost and will be posted in the subsidiary ledger or stock card
as a negative entry in the issued column. This decreases the inventory balance.

Economic Order Quantity – means the most economical order of raw materials that
the company can make.

Factors that affect the EOQ are:

1. Annual required units – this means the annual requirements of the company in
terms of units for a specific raw material. This can be estimated through
observation of the past years purchases.
2. Cost per order – this is the cost that will be incurred if the company will purchase
raw materials. This is driven by the number of orders placed during the year but not
the size of the order.
3. Cost per unit of materials – this represents the unit price of the raw materials.
4. Carrying cost – these are the costs incurred by the company for maintaining
inventory in the warehouse. These are driven by the size of the inventory held by
the company in the warehouse.

Prepared by: Maureen P. Abulencia, CPAPage 36

Colegio de Dagupan
School of Business and Accountancy Financial Management 2

Exercises

Multiple Choice

1. An inventory account that consists of products that are already finished, ready to
be sold to customers
a. Raw materials inventory
b. Work in process inventory
c. Finished goods inventory
d. Supplies

2. What will be the only inventory account for a service company

a. Raw materials inventory
b. Work in process inventory
c. Finished goods inventory
d. Supplies

3. This is the staff that records the purchases made by the purchaser and as
received by the warehouseman
a. Purchaser
b. Warehouseman
c. Stock card clerk
d. Bookkeeper

4. These are discounts availed by the company by paying early

a. Purchases
b. Purchase returns
c. Purchase allowance
d. Purchase discount

5. This is the staff that procures the inventory

a. Purchaser
b. Warehouseman
c. Stock card clerk
d. Bookkeeper

6. This is a result of mismanaging inventories that also results to holding costs that
are too high, and funds could have been used for a more productive venture thus
improving operating performance
a. Overstocking
b. Under-stocking
c. Purchasing
d. Manufacturing

7. Under this agreement involving freight charges, the seller bears all expenses and
risks involved in delivering goods to the dock next to or alongside
a. FOB destination
b. FOB shipping point
c. CIF (Cost, Insurance, Freight)
d. FAS (free alongside)

8. Total goods available for sales less ending inventory

a. Beginning inventory

Prepared by: Maureen P. Abulencia, CPAPage 37

Colegio de Dagupan
School of Business and Accountancy Financial Management 2

b. Total goods available for sale

c. Ending inventory
d. Cost of goods sold

9. This refers to a method of costing inventory wherein the raw materials received
first are assumed the first to be issued
a. FIFO - First in First out
b. LIFO - Last in First out
c. Weighted average
d. None of the above

10. The technical term used to denote discounts granted by the supplier for early
settlement of an account
a. Sales discount
b. Trade discount
c. Purchase discount
d. Commercial discount

11. The discount normally given to a customer for purchasing large volumes of
merchandise
a. Sales discount
b. Trade discount
c. Purchase discount
d. Size discount

12. The following items are to be included as part of inventory of the company at
the end of its accounting period although not physically counted
a. Goods on consignment to store A
b. Goods on consignment from store B
c. Goods in transit FOB destination
d. Choices a and c

13. Which ratio means the efficiency of the sales persons selling the merchandise of
the company
a. Current ratio
b. Number of days in inventory
c. Number of days in receivable
d. Ratio of commission earned by sales person to total sales

14. Which of the following costing method is not allowed by PAS 2?

a. FIFO - First in First out
b. LIFO - Last in First out
c. Weighted average
d. Specific identification

15. Assuming that Riel Corporation places its inventory at SM Makati on

consignment, the cost of inventory place at SM at the end of the accounting period
should be included in the inventory of:
a. The consignor but not on the consignee
b. Books of the consignor and the consignee
c. The consignee but not on the consignor
d. Neither the consignee not the consignor

16. Inventories encompass all of the following EXCEPT

a. Merchandise purchased by a retailer
b. Land and other property not held for sale
c. Finished goods produced
d. Materials and supplies awaiting use in the production process

Essay
Enumerate and give a brief description of the costing methods of inventories

Prepared by: Maureen P. Abulencia, CPAPage 38

Colegio de Dagupan
School of Business and Accountancy Financial Management 2

References:
Fundamentals of Financial Management (With Industry-Based Perspective)
By: Ma. Flordeliza Anastacio, Ph.D., CPA
Roberto C. Dacanay, CPA
Leonardo E. Aliling, CPA

Internet Sources:
[Link]

Prepared by: Maureen P. Abulencia, CPAPage 39