Conceptual Frameworks and

Accounting Standards

Rosalie D. Tiu, CPA, MBA

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 Table of Contents

Module 5: Statement of Cash Flows

Introduction 123
Learning Objectives 123
Lesson 1. What is a Statement of Cash Flows? 124
Lesson 2. Cash and Cash Equivalents 124
Lesson 3. Classification of Cash Flows 125
Lesson 4. Presentation of Operating Activities 129
Assessment Task 130
Summary 136
References 136

Module 6: Accounting Policies, Estimates and Errors / Events After

the Reporting Period / Related Party Disclosures
Introduction 139
Learning Objectives 139
Lesson 1. Accounting Policies 140
Lesson 2 Accounting Estimates 143
Lesson 3. Prior Period Errors 145
Lesson 4. Types of Events After the Reporting Period 146
Lesson 5. Related Party 147
Assessment Task 149
Summary 156
References 156

Module 7: Property, Plant and Equipment (PAS 16) and Borrowing

Costs (PAS 23)
Introduction 160
Learning Objectives 160
Lesson 1. Property, Plant and Equipment 161
Lesson 2. Borrowing Costs 170
Assessment Task 178
Summary 178
References 179

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 MODULE 5
STATEMENT OF CASH FLOWS
PAS 7

Introduction

This module covers the discussion on Statement of Cash Flows as governed by

Philippine Accounting Standard No.7.

Learning Outcomes
At the end of this module, students should be able to:

1. Explain the primary purpose of a statement of cash flows.

2. Comprehend the nature and purpose of a statement of cash flows.
3. Understand the concept and components of cash and cash equivalents.
4. Differentiate operating activities, investing activities and financing activities
5. Solve accounting problems related to cash flows.

Lesson 1. What is a Statement of Cash Flows ?

A statement of cash flows is a component of financial statements summarizing the

operating, investing and financing activities of an entity. It provides information about the cash
receipts and cash payments of an entity during a period. The primary purpose of a statement
of cash flows is to provide relevant information about cash receipts and cash payments of an
entity during a period Valix, C., Peralta, and Valix, C.A. (2020.

An entity shall prepare a statement of cash flows and present it as an integral part of
the financial statements for each period for which financial statements are presented (Valix et
al, 2020).

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Lesson 2. Cash and Cash Equivalents

According to Valix et al., (2020), the statements of cash flows is designed to provide
information about the change in an entity’s cash and cash equivalents.

Cash comprises cash on hand and demand deposits whereas Cash equivalents are
short-term highly liquid investments that are readily convertible to known amount of cash and
which are subject to an insignificant risk of change in value (Valix et al, 2020).

PAS 7, paragraph 7, provides that an investment normally qualifies as a cash equivalent only
when it has a short maturity of three months or less from date of acquisition. In other words,
the investment must be acquired three months or less before the date of maturity.

Examples of cash equivalents (Valix et al, 2020)

a. Three-month BSP treasury bill
b. Three-year BSP treasury bill purchased three months before date of maturity.
c. Three-month time deposit
d. Three-month money market instrument or commercial paper

Lesson 3. Classification of Cash Flows (Valix et al, 2020)

The statement of cash flows shall report cash flows during the period classified as operating,
investing and financing activities (Valix et al, 2020).

1. Operating activities

Operating activities are the cash flows derived primarily from the principal revenue producing
activities of the entity. In other words, operating activities generally result from transactions
and other events that enter into the determination of net income or loss.

Examples of cash flows from operating activities are:

• Cash receipts from sale of goods and rendering of services
• Cash receipts from royalties, rental, fees, commissions and other revenue

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• Cash payments to suppliers for goods and services
• Cash payments for selling, administrative and other expenses
• Cash receipts and cash payments of an insurance entity for premiums and claims,
annuities and other policy benefits
• Cash payments or refunds of income taxes unless specifically identified with financing
and investing activities
• Cash receipts and payments for securities held for trading

Trading securities

Cash flows arising from the purchase and sale of dealing or trading securities are classified
as operating activities (PAS 7, paragraph 15)

Similarly, cash advances and loans made by a financial institution are usually classified as
operating activities since they relate to the main revenue producing activity of that entity.

2. Investing activities

Investing activities are the cash flows derived from the acquisition and disposal of long-term
assets and other investments not included in cash equivalent.

Investing activities include cash flows from transactions involving non operating assets.

Examples of cash flows from investing activities

• Cash payments to acquire property, plant and equipment, intangible and other long-term
assets.
• Cash receipts from sales of property, plant and equipment, intangible and other long-term
assets.
• Cash payments to acquire equity or debt instruments of other entities (current and long-
term investments)
• Cash receipts from sales of equity or debt instruments of other entities
• Cash advances and loans to other parties other than advances and loans made by
financial institution.

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• Cash receipts from repayment of advances and loans made to other parties
• Cash payments for futures contract, forward contract, option contract and swap contract
• Cash receipts from futures contract, forward contract, option contract and swap contact

3. Financing activities

Financing activities are the cash flows derived from the equity capital and borrowings of the
entity. These activities are the cash flows that result from transactions:

• Between the entity and the owners – equity financing

• Between the entity and the creditors – debt financing

As a simple guide, financing activities include the cash flows from transactions involving
nontrade liabilities and equity of an entity.
Examples of cash flows from financing activities
• Cash receipts from issuance of ordinary and preference shares
• Cash payments to acquire treasury shares
• Cash receipts from issuing debentures, loans, notes, bonds, mortgages, and other short
or long term borrowings
• Cash payments for amounts borrowed
• Cash payments by a lessee for the reduction of the outstanding principal lease liability

Cash payments to settle such obligations as trade accounts and notes payable, income tax
payable, accrued expenses are operating activities, not financing activities.
Noncash transactions
Investing and financing transactions that do not require use of cash or cash equivalents shall
be excluded from the statement of cash flows (PAS 7, paragraph 43).
Noncash investing and financing transactions shall be disclosed elsewhere in the financial
statements either in the notes to financial statements or in a separate schedule or in a way
that provides all relevant information about these transactions.
The statement of cash flows is strictly a cash concept. Accordingly, the following noncash
transactions are disclosed separately:
• Acquisition of asset by assuming directly related liability

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• Acquisition of asset by issuing share capital
• Acquisition of asset by issuing bonds payable
• Conversion of bonds payable into share capital
• Conversion of preference shares into ordinary shares

Interest

Interest paid and interest received shall be classified as operating cash flows because such
items enter into the determination of net income or loss (PAS 7, paragraph 33).

Alternatively, interest paid may be classified as financing cash flow because it is a cost
obtaining financial resources.

Alternatively, interest received may be classified as investing cash flow because it is a return
on investment.

For a financial institution, interest paid and interest received are usually classified as
operating cash flows.

Dividends

Dividend received shall be classified as operating cash flow because it enters into the
determination of net income (PAS 7, paragraph 33).

Alternatively, dividend received may be classified as investing cash flow because it is a

return of investment.

Divided paid shall be classified as financing cash flow because it is a cost of obtaining
financial resources (PAS 7, paragraph 34).

Alternatively, dividend paid may be classified as operating cash flow in order to assist users
to determine the ability of the entity to pay dividends out of operating cash flows.

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Income taxes

Cash flows arising from income taxes shall be separately disclosed as cash flows from
operating activities unless they can be specifically identified with investing and financing
activities (PAS 7, paragraph 35).

Tax cash flows are often difficult to match to the originating underlying transactions, so most
of the time all tax cash flows are classified as arising from operating activities.

Lesson 4. Presentation of Operating Activities

(Deloitte Touche Tomatsu, 2000)

The operating activities section of the cash flow statement can be presented using the
direct method and the indirect method (Deloitte Touche Tomatsu, 2000).

The direct method shows each major class of gross cash receipts and gross cash
payments. The operating cash flows section of the statement of cash flows under the direct
method would appear something like this:

Cash receipts from customers xx,xxx

Cash paid to suppliers xx,xxx
Cash paid to employees xx,xxx
Cash paid for other operating expenses xx,xxx
Interest paid xx,xxx
Income taxes paid xx,xxx
Net cash from operating activities xx,xxx

The indirect method adjusts accrual basis net profit or loss for the effects of non-cash
transactions. The operating cash flows section of the statement of cash flows under the
indirect method would appear something like this:

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 Profit before interest and income taxes xx,xxx
Add back depreciation xx,xxx
Add back impairment of assets xx,xxx
Increase in receivables xx,xxx
Decrease in inventories xx,xxx
Increase in trade payables xx,xxx
Interest expense xx,xxx
Less Interest accrued but not yet paid xx,xxx
Interest paid xx,xxx
Income taxes paid xx,xxx
Net cash from operating activities xx,xxx

Illustration: amounts are assumed

Cash and cash equivalents- January 1 2,500,000

Net cash provided by operating activities

Cash received from customers 15,000,000
Rent received 2,000,000
Interest received 500,000
Dividend received 1,000,000
Cash paid to suppliers -6,500,000
Salaries paid -4,500,000
Insurance paid -180,000
Utilities paid -825,000
Interest paid -300,000
Income tax paid -2,200,000 3,995,000

Net cash used in investing activities

Cash paid for land -2,500,000
Cash paid for tools and equipments -750,000
Cash received from sale of equipment 500,000
Cash received from sale of investment 1,800,000 -950,000

Net cash provided by financing activities

Cash received from issuance of shares 1,800,000
Cash received from bank loan 3,000,000
Cash paid for dividend -2,200,000
Cash paid for treasury shares 2,000,000 4,600,000

Cash and Cash equivalents - December 31 10,145,000

Cash receipts are cash provided and therefore increase cash and cash equivalents.
Cash payments are cash used and therefore decrease cash and cash equivalent

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 Assessment Tasks 5-1

A. Multiple Choice: Theory 1

1. The primary purpose of a statement of cash flows is to provide relevant information about
a. Difference between net income and associated cash receipts and disbursement.
b. An entity’s ability to generate positive net cash flows.
c. The cash receipts and cash disbursements of an entity during a period
d. An entity’s ability to meet cash operating needs
2. Cash equivalents are;
a. Treasury bills and money market funds.
b. Investments with original maturities of three months or less.
c. Readily convertible to known amount of cash.
d. All of these are features of cash equivalents.
3. Cash advances and loans made by a financial institution are usually classified as
a. Operating activities
b. Investing activities
c. Financing activities
d. Compound of cash and cash equivalents
4. Under IFRS, an entity can report interest paid on bank loan in the statement of cash
flows
a. operating activities
b. Either in operating activities or financing activities
c. In financing activities
d. In investing activities or financing activities
5. Cash flows relating to asset held for rental to others are classified as
a. Operating
b. Investing
c. Financing
d. Either operating or investing
6. Cash receipts from royalties and commissions are
a. Cash outflows for operating activities
b. Cash inflows from operating activities

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 c. Cash inflows from investing activities
d. Cash outflows for financing activities.
7. All can be classified as cash and cash equivalents, except
a. Time deposit due in 60 days
b. Treasury bills due for repayment in 90 days
c. Equity investments
d. Bank overdraft
8. Cash flows arising from trading securities are
a. Classified as operating activities
b. Classified as investing activities
c. Classified as financing activities
d. Not reported in the cash flow statement
9. Noncash investing and financing activities are
a. Reported only if the direct method is used.
b. Reported only if the indirect method is used.
c. Disclosed in a note or separate schedule.
d. Not reported.
10. Interest payments to lenders are classified as
a. Operating activities
b. Borrowing activities
c. Lending activities
d. Financing activities
11. Which of the following is not considered as a cash equivalent?
a. A three-year treasury note maturing on January 31 of next year purchased by the
entity
on December 1 of the current year.
b. A three-year treasury note maturing on January 31, of next year purchased by the
entity
on December 1 of the current year
c. A 90-day Treasury bill
d. A 60-day money market placement
12. Cash payments to acquire equity investments are
a. Cash outflows for financing activities

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 b. Cash inflows from investing activities
c. Cash outflows for investing activities
d. Cash inflows from financing activities
13. Cash receipts from issuing shares are
a. Cash inflows from investing activities
b. Cash outflows for investing activities
c. Cash inflows from financing activities
d. Cash outflows for financing activities
14. Which classification of the cash flow arising from the proceeds from an earthquake
disaster
settlement would be most appropriate?
a. Cash flow from operating activities
b. Cash flow from investing activities
c. Cash flow from financing activities
d. Does not appear in the statement of cash flows
15. Dividend payments to shareholders are classified as
a. Cash outflows for investing activities
b. Cash inflows from investing activities
c. Cash inflows from financing activities
d. Cash outflows for financing activities
16. Under IFRS the dividend received from share investments can be classified as
a. Either an operating activity or a financing activity
b. Either an operating activity or investing activity
c. Only as an investing activity
d. Only as operating activity
17. When an entity purchased a three month Treasury bill, how would the purchase be
treated in preparing the statement of cash flows?
a. Not reported
b. An outflow for financing activities
c. An outflow for lending activities
d. An outflow for investing activities
18. Interest received is classified as cash flow from
a. Operating activities

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 b. Investing activities
c. Financing activities
d. Revenue activities
19. Bank overdrafts that are repayable on demand and the bank balance often fluctuates
from positive to overdrawn shall be classified as
a. Operating activities
b. Investing activities
c. Financing activities
d. Component of cash and cash equivalents
20. Under IFRS, dividend paid can be classified
a. Either as financing activity or operating activity
b. Either as operating activity or investing activity
c. Only as financing activity
d. Only as operating activity

B. Multiple Choice with Computation

1. Ribbon Company provided the following information during the current year:
Dividend received 500,000
Dividend paid 1,000,000
Cash received from customers 9,000,000
Proceeds from issuing share capital 1,500,000
Interest received 200,000
Proceeds from sale of long term investments 2,000,000
Cash paid to suppliers and employees 6,000,000
Interest paid on long term debt 400,000
Income taxes paid 300,000
Cash balance January 1 1,800,000

1a. What is the net cash provided by operating activities?

a. 3,000,000 b. 3,300,000 c. 2,700,000 d. 2,000,000

1b. What is the net cash provided by investing activities?

a. 2,500,000 b. 2,000,000 c. 2,200,000 d. -0-

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1c.. What is the net cash provided by financing activities?
a. 1,500,000 b. 1,000,000 c. 500,000 d. -0-
1d. What is the cash balance on December 31?
a. 6,300,000 b. 5,500,000 c. 4,800,000 d. 7,300,000
2. On December 31, 2020, Kale Company had the following balances in the accounts
maintained at First Bank.
Checking account #101 1,750,000
Checking account #201 ( 100,000)
Time deposit 250,000
Money market placement 1,000,000
90-day treasury bill, due February 28, 2021 500,000
180-day treasury bill, due March 15, 2021 800,000
The entity classified investments with original maturities of three months or less as cash
equivalents.
On December 31, 2020, what amount should be reported as cash and cash
equivalents?
a. 3,400,000 b. 2,000,000 c. 2,400,000 d. 3,200,000

3. Oakwood Company provided the following data for the year

Cash balance, beginning of year 1,300,000
Cash flow from financing activities 1,000,000
Cash flow from operating activities 400,000
Cash flow from investing activities (1,500,000)
Total shareholders’ equity, beginning of year 2,000,000
What is the cash balance at the end of current year?
a. 1,200,000 b. 1,600,000 c. 1,400,000 d. 1,700,000
4. Alpha Company had the following activities during the current year:
• Acquired 2,000 shares as investment for P2,600,000
• Sold an investment for P3,500,000 when the carrying amount was P3,300,000
• Acquired a P5,000,000, 4-year certificate of deposit from a bank. During the year,
interest of P375,000 was paid to Alpha.
• Collected dividends of P120,000 on share investments.

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In the statement of cash flows, what amount should be reported as net cash used in
investing activities?
a. 3,725,000 b. 3,805,000 c. 3,980,000 d. 4,100,000

5. Kollar Company provided the following data for the current year:

Purchase of real estate for cash 5,500,000

Cash was borrowed from bank to purchase real 5,500,000
estate
Sale of investment for cash 5,000,000
Dividend paid 6,000,000
Issuance of ordinary shares for cash 2,500,000
Purchase of patent for cash 1,250,000
Payment of bank loan 1,500,000
Issuance of bonds payable for cash 3,000,000

5a. What is the net cash provided by financing activities?

a. 5,000,000 b. 3,500,000 c. 4,500,000 d. 5,500,000

5b. What is the net cash used in investing activities?

• 6,750,000 b. 3,750,000 c. 1,750,000 d. 500,000

Summary

 A statement of cash flows is a component of financial statements summarizing the

operating, investing and financing activities of an entity.
• The statements of cash flows is designed to provide information about the change in
an entity’s cash and cash equivalents.
• The statement of cash flows shall report cash flows during the period classified as
operating, investing and financing activities.

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• Operating activities are the cash flows derived primarily from the principal revenue
producing activities of the entity. The operating activities section of the cash flow
statement can be presented using the direct method and the indirect method.
• Investing activities are the cash flows derived from the acquisition and disposal of long-
term assets and other investments not included in cash equivalent.
• Financing activities are the cash flows derived from the equity capital and borrowings
of the entity.
• Investing and financing transactions that do not require use of cash or cash
equivalents shall be excluded from the statement of cash flows.

References

Valix, C.T., Peralta, J.F., Valix, C. A. M.(2020). Conceptual Framework and

Accounting Standards. Manila City, Phils. GIC Enterprises & Co., Inc.

https://www.iasplus.com/en/standards/ias/ias7

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 MODULE 6
ACCOUNTING POLICIES, ESTIMATE AND
ERRORS (PAS 8) / EVENTS AFTER THE
REPORTING PERIOD (PAS 10) / RELATED
PARTY DISCLOSURES (PAS 24)

Introduction

This module discusses the requirements for when events after the end of the
reporting period should be adjusted in the financial statements and the accounting for changes
in estimates and the treatment for corrections of prior period errors. It also outlines the various
classes of entities and people as related parties and sets out the disclosures required in
respect of those parties.

Learning Outcomes

At the end of this module, students should be able to ;

1. To differentiate the concept of a change in accounting policy and change in accounting
estimates.
2. To differentiate the recognition and reporting of a change in accounting policy. and
accounting estimates.
3. To discuss the concept of prior period errors and how it is recognized and reported.
4. To discuss the concept and types of event s after the reporting period.
5. To differentiate the recognition of adjusting and non adjusting events.
6. To understand the concept of related parties.
7. To know the requirements for disclosure of related party relationship.

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Lesson 1. Accounting Policies (Valix et al., 2020)

Accounting policies are the specific principles, bases, conventions, rules and practices
applied by an entity in preparing and presenting financial statements. They are essential for a
proper understanding of the information contained in the financial statements.

An entity is required to outline all significant accounting policies applied in preparing

financial statements. Alternative treatments are possible under the accounting standards,
hence it becomes all the more important for an entity to clearly state the accounting policies
used in preparing financial statements.

The entity shall select and apply the same accounting polices each period in order to
achieve comparability of financial statements or to identify trends in the financial position,
performance and cash flows of the entity.

Change in accounting policy (Valix et al, 2020)

Accounting policies, once selected, must be applied consistently for similar

transactions and events. A change in accounting policy shall be made only when:

• Required by accounting standard.

• The change will result in more relevant and faithfully represented information about
the financial position, financial performance and cash flows of the entity.

A change in accounting policy arises when an entity adopts a generally accepted

accounting principle which is different from the one previously used by the entity.

Examples of change in accounting policy are:

• Change in method of inventory pricing from the FIFO to weighted average method.
• Change in the method of accounting for long term construction contract from cost
recovery method to percentage of completion method.

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 • The initial adoption of policy to carry assets at revaluated amount is a change in
accounting policy to be dealt with are revaluation.
• Change from cost model to fair value model in measuring investment property.
• Change to new policy resulting from the requirement of a new PFRS.

How to report a change in accounting policy

A change in accounting policy required by a standard or an interpretation shall be

applied in accordance with the transitional provisions therein. If the standard or interpretation
contains no transitional provisions or if an accounting policy is changed voluntarily, the change
shall be applied retrospectively or retroactively.

Retrospective application

Retrospective application means that any resulting adjustment from the change is accounting
policy shall be reported as an adjustment to the opening balance of retained earnings.

The amount of the adjustment is determined as of the beginning of the year of change.

If comparative information is presented, the financial statements of the prior period presented
shall be restated to conform with the new accounting policy.

Illustration
An entity has used the FIFO method of inventory valuation since it began operation in 2020.

The entity decided to change to the weighted average method for determining inventory cost
at the beginning of 2021.

FIFO Weighted
average
December 31, 2020 1,000,000 750,000
December 31, 2021 1,500,000 1,200,000

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 FIFO inventory – January 1, 2021 1,000,000
Weighted average inventory – January 1, 2021 750,000
Decrease in beginning inventory 250,000

Adjustment of the decrease in beginning inventory

Retained earnings 250,000
Inventory – January 1 250,000

The computation of the cost of goods sold for 2021 would then show beginning inventory at
P750,000 and ending inventory at P1,200,000 to conform with the weighted average method.

The statement of changes in equity for the year ended December 31, 2021 would show the
effect of the change of P250,000 net of tax as deduction from the beginning balance of
retained earnings.

Absence of accounting standard

In the absence of an accounting standard that specifically applies to a transaction or event,

management shall use judgement in selecting and applying an accounting policy that results
in information that is relevant to the economic decision making needs of users and faithfully
represented (PAS 8, paragraph 10).

Paragraph 11 and 12 specify the following hierarchy of guidance which management may use
when selecting accounting policies in such circumstances:

• Requirements of current standards dealing with similar matters

• Definition, recognition criteria and measurement concepts for assets, liabilities, income
and expenses in the Conceptual Framework for Financial Reporting
• Most recent pronouncement of other standard -setting bodies that use a similar
Conceptual Framework, other accounting literature and accepted industry practices.
Lesson 2. Accounting Estimate

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 A change in accounting estimate is a normal recurring correction or adjustment of an
asset or liability which is the natural result of the use of an estimate. An estimate may need
revision if changes occur regarding the circumstances on which the estimate was based or as
a result of new information, more experience or subsequent development. (Valix et al, 2020)

By very nature, the revision of the estimate does not relate to prior periods and is not a
correction of an error. Sometimes it is difficult to distinguish a change in accounting estimate
and a change in accounting policy. In such a case, the change is treated as a change in
accounting estimate, with appropriate disclosure (Valix et al, 2020).

Examples of accounting estimate

As a result of the uncertainties in business activities, many items in financial statements
cannot be measured with precision but can only be estimated. Estimation involves judgment
based on the latest available and reliable information.

Estimates may be required for the following:

• Doubtful accounts
• Inventory obsolescence
• Useful life, residual value and expected pattern of consumption of benefit of
depreciable asset
• Warranty cost
• Fair value of asset and liability

How to report change in accounting estimate

The effect of a change in accounting estimate shall be recognized currently and prospectively
by including it in income or loss of:

• The period of change if the change affects that period only.

• The period of change and future periods if the change affects both.
A change in an accounting estimate shall not be accounted for by restating amounts reported
in financial statements of prior periods. Changes in accounting estimates are to be handled
currently and prospectively, if necessary.

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Prospective recognition of the effect of a change in accounting estimate means that the
change is applied to transactions, other events and conditions from the date of change in
estimate.

Illustration
A depreciable asset costing P500,000 is estimated to have a life of 5 years. At the beginning
of the third year, the original life is changed to 8 years. Thus the asset has a remaining life of
6 years.

The procedures is not to correct past depreciation.

Instead, the remaining carrying amount of P300,000 (P500,000 minus P200,000) depreciation
for 2 years) is now allocated over 6 years or a subsequent annual depreciation of P50,000.

Thus, the entry to record the annual depreciation, starting the third year is:

Depreciation 50,000
Accumulated depreciation 50,000

Lesson 3. Prior Period Errors (Valix et al., 2020)

Prior period errors are omissions and misstatements in the financial statements for
one or more periods arising from a failure to use or misuse of reliable information. Errors may
occur as a result of mathematical mistakes, mistakes in applying accounting policies,
misinterpretation of facts, fraud or oversight (Valix et al, 2020).

How to treat prior period errors

Prior period errors shall be corrected retrospectively by adjusting the opening balances of
retained earnings and affected assets and liabilities.

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If comparative statements are presented, the financial statements of the prior period shall be
restated so as to reflect the retroactive application of the prior period errors as the
retrospective restatement.

Lesson 4. Types of Events After The Reporting Period (PAS 10)

PAS 10, paragraph 3, defines events after the reporting period as those events,
whether favorable or unfavorable, that occur between the end of reporting period and the
date on which the financial statements are authorized for issue. They are also known as
subsequent events. Such events may require either adjustment or disclosure (Valix et al,
2020).

Types of events after the reporting period.

• Adjusting events after the reporting period are those that provide evidence of conditions
that exist at the end of reporting period. Accordingly, an entity must adjust the amounts
recognized in the financial statements for adjusting events that provide evidence of
conditions that existed at the end of reporting period.

• Non adjusting events after reporting period are those that are indicative of conditions that
arise after the end of reporting period. An entity does not recognize events after the
reporting period that relate to conditions that only arose after the accounting period. But
the entity is required to disclose significant nonadjusting events.

Examples of adjusting events

• Settlement after the reporting period of a court case because it confirms that the entity
already had a present obligation at the end of reporting period.
• Bankruptcy of a customer which occurs after reporting period.
• Sale of inventories after the reporting period may give evidence about the net realizable
value at reporting date.
• The determination after the reporting period of the cost of asset purchased or the
proceeds from asset sold before the end of reporting period.

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• The determination after the reporting period of the profit sharing or bonus payment if the
entity has the present obligation at the end of reporting period to make such payment.
• The discovery of fraud or errors that show the financial statements were incorrect.

Examples of nonadjusting events

• Business combination after the reporting period
• Plan to discontinue an operation
• Major purchase and disposal of asset or expropriation of major asset by government
• Destruction of a major production plant by a fire after the reporting period
• Major ordinary share transactions and potential ordinary share transactions after the
reporting period.
• Announcing or commencing the implementation of a major restructuring.
• Abnormally large changes after the reporting period in asset prices or foreign exchange
rates
• Entering into significant commitments or contingent liabilities, for example, by issuing
guarantees
• Commencing major litigation arising solely from events that occurred after the reporting
period.
• Change in tax rate enacted or announced after the end of reporting period that has a
significant effect on current and deferred tax asset and liability

Financial statements authorized for issue

Financial statements are authorized for issue when the board of directors reviews the financial
statements and authorizes their issuance.

In some cases, an entity is required to submit the financial statements to the shareholders for
approval after the financial statements have been issued. In such cases, the financial
statements are authorized for issue on the date of issue by the board of directors and not on
the date when shareholders approve the financial statements.

Lesson 5. Related Party Disclosures (PAS 24) (Valix et al, 2020)

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 Related Party Disclosures requires disclosures about transactions and outstanding
balances with an entity's related parties. The standard defines various classes of entities and
people as related parties and sets out the disclosures required in respect of those parties,
including the compensation of key management personnel (Valix et al, 2020).

RELATED PARTY
Parties are considered to be related if one party has:
• The ability to control the other party.
• The ability to exercise significant influence over the other party.
• Joint control over the reporting entity.

Control is the power over the investee or the power to govern the financial and operating
policies of an entity so as to obtain benefits.

Control is ownership directly or indirectly through subsidiaries of more than half of the voting
power of an entity.

Significant influence is the power to participate in the financial and operating policy decision
of an entity, but not control of those policies.

Significant influence may be gained by share ownership of 20% or more.

If an investor holds, directly or indirectly through subsidiaries, 20% or more of the voting power
of the investee, it is presumed that the investor has significant influence, unless it can be
clearly demonstrated that this is not the case.

Beyond the mere 20% threshold of ownership, the existence of significant influence is usually
evidenced by the following factors:

• Representation in the board of directors

• Participation in policy making process
• Material transactions between the investor and the investee

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• Interchange of managerial personnel
• Provision of essential technical information

Joint control is the contractually agreed sharing of control over an economic activity.

Examples of related parties

Affiliates – meaning the parent, the subsidiary and fellow subsidiaries
• Associates – meaning the entities over which one party exercises significant influence
The term “associate” includes the subsidiary or subsidiaries of the associate.
• Venturer in a joint venture
A joint venture includes the subsidiary or subsidiaries of the joint venture.
• Key management personnel are those persons having authority and responsibility for
planning, directing and controlling the activities of the entity, directly or indirectly,
including any executive director or nonexecutive director.
• Close family members of an individual are those family members who may be
expected to influence or be influenced by that individual in their dealings with the entity.

Close family members of an individual include:

• The individual’s spouse and children
• Children of the individual’s spouse
• Dependents of the individual or the individual’s spouse.

• Individuals owning directly or indirectly an interest in the voting power of the reporting
entity that gives them significant influence over the entity, and close family members
of such individuals.
• Postemployment benefit plan for the benefit of employees.
Examples of related party transaction

A related party transaction is a transfer of resources or obligations between related parties,

regardless of whether a price is charged.

PAS 24, paragraph 20, provides the following examples of related party transaction:
• Purchase and sale of goods

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• Purchase and sale of property and other asset
• Rendering or receiving services
• Leases
• Transfer of research and development
• License agreement
• Finance arrangements, including loans and equity contributions in cash or in kind.
• Guarantee and collateral
• Settlement of liabilities on behalf of the entity or by the entity on behalf of another party.

Related party disclosures

PAS 24, paragraph 12, requires disclosure of related party relationships where control exists
irrespective of whether there have been transactions between the related parties.

In other words, relationships between parents and subsidiaries shall be disclosed regardless
of whether there have been transactions between those related parties.

An entity shall disclose the name of the entity’s parent and if different, the ultimate controlling
party.

If neither the entity’s parent nor the ultimate controlling party produces financial statements
available for public use, the name of the next most senior parent that does so shall also be
disclosed.

Disclosures of related party transaction

PAS 24 paragraph 17 provides that if there have been transactions between related parties,
an entity shall disclose the nature of the related party relationship as well as information about
the transactions and outstanding balances necessary for an understanding of the financial
statements.

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As minimum, the disclosures of related party transaction shall include:
• The amount of the transaction.
• The amount of outstanding balance, terms and conditions, whether secured or
unsecured, and nature of consideration to be provided in settlement.
• The allowance for doubtful accounts related to the outstanding balance.
• The doubtful accounts expense recognized during the period in respect of amount due
from related parties.

Key management personnel compensation

PAS 24, paragraph 16, provides that an entity shall disclose key management personnel
compensation in total and for each of the following categories:
• Short-term employee benefits
• Postemployment benefits, for example, retirement pensions
• Other long-term benefits
• Termination benefits
• Share based payment transactions, for example, share options
Related party disclosures not required
PAS 24, paragraph 3, requires disclosure of related party transactions and outstanding
balances in the separate financial statements of a parent, subsidiary, associate or venturer.
However, Paragraph 4 provides that intragroup related party transactions and outstanding
balances are eliminated in the preparation of consolidated financial statements of the group.

Unrelated parties
Unrelated parties include the following:
• Two entities simply because they have a director or key management personnel in
common.
• Providers of finance, trade unions, public utilities and government agencies in the
course of their normal dealings with an entity by virtue only of those dealings.
• A single customer, supplier, franchisor, or general agent with whom an entity transacts
a significant volume of business merely by virtue of the resulting economic dependence.
• Two venturers simply because they share joint control over a joint venture.

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 Assessment Task 6-1

I. Multiple Choice – ( Accounting Policies, Estimates and Errors)

1. Which is the first step within the hierarchy of guidance when selecting accounting
policies?
a. Apply a standard from IFRS if it specifically relates to the transaction.
b. Apply the requirements in IFRS dealing with similar and related issue.
c. Consider the applicability of the definitions, recognition criteria and measurement
concepts in the Conceptual Framework.
d. Consider the most recent pronouncement of other standard setting bodies.
2. In the absence of an accounting standard that applies specifically to a transaction,
what is the most authoritative source in developing and applying an accounting policy?
a. The requirement and guidance in the standard or interpretation dealing with similar
and related issue.
b. The definition, recognition criteria and measurement of asset, liability, income and
expense in the Conceptual Framework
c. Most recent pronouncement of other standard-setting body
d. Accounting literature and accepted industry practice
3. A change in accounting policy shall be made when
I. Required by law.
II. Required by an accounting standard.
III. The change will result in more relevant or reliable information about the
financial position, financial performance and cash flow of the entity.
a. I and III only
b. II and III only
c. I and II only
d. I, II and III
4. Why is an entity permitted to change an accounting policy?
a. The change would allow the entity to present a more favorable profit picture.

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 b. The change would result in the financial statements providing more reliable and
relevant information about financial position, financial performance and cash flows.
c. The change is made by the internal auditor.
d. The change is made by the CPA.
5. A change in accounting policy requires what kind of adjustment to the financial
statements?
a. Current period adjustment
b. Prospective adjustment
c. Retrospective adjustment
d. Current and prospective adjustment
6. How should the effect of a change in accounting estimate be accounted for?
a. By restating amounts reported in financial statements of prior periods
b. By reporting pro forma amounts for prior periods
c. As a prior period error
d. In the period of change and future periods if the change affects both
7. When it is difficult to distinguish between a change in accounting estimate and a
change in accounting policy, the change is treated as
a. Change in accounting estimate with appropriate disclosure
b. Change in accounting policy
c. Correction of an error
d. Change in accounting estimate with no appropriate disclosure

8. Which of the following is the proper time period to record the effect of a change in
accounting estimate?
a. Current period and prospective
b. Current period and retrospectively
c. Retrospectively
d. Current period
9. Why is retrospective treatment of change in accounting estimate prohibited?
a. A change in accounting estimate is a normal recurring correction or adjustment.
b. The retrospective treatment is not allowed.
c. Retrospective treatment of change in accounting estimate is required by IFRS.

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 d. IFRS is silent on the issue.
10. Which is required for a change from sum of years’ digits to straight line depreciation?
a. Reported in the statement of retained earnings
b. Retrospective restatement
c. Recomputation of depreciation for current and future years
d. All of these are required.

Multiple Choice – Events after the Reporting Period

1. Financial statements are authorized for issue

a. When the board of directors reviews and authorizes the financial statements for issue.
b. When the shareholders approve the financial statements at their annual meeting.
c. When the financial statements are filed with the regulatory agency.
d. When a supervisory board made solely of nonexecutives approves the financial
statements.
2. Which event after the reporting period would require adjustment?
a. Loss of plant as a result of fire
b. Change in the market price of investment
c. Loss on inventory resulting from flood loss
d. Loss on a lawsuit the outcome of which was deemed uncertain at year-end
3. Events that occur after the current year-end but before the financial statements are
issued and affect the realizability of accounts receivable should be
a. Discussed in the management annual report.
b. Disclosed in the notes to financial statements.
c. Used to record an adjustment to bad debt expense.
d. An adjustment directly to retained earnings.

4. Nonadjusting events include all, except

a. A major business combination after reporting period
b. Announcing a plan to discontinue an operation
c. Expropriation of major asset after reporting period
d. Destruction of a major production plant by a fire before the end of the reporting period
5. Nonadjusting events include all, except

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 a. The entity announced the discontinuation of an operation.
b. The entity entered into an agreement to purchase the leased building.
c. Destruction of a major production plant by fire.
d. A mistake in the calculation of allowance for uncollectible accounts receivable.
6. Which event after the end of reporting period would generally require disclosure?
a. Retirement of key management personnel
b. Settlement of litigation when the event that gave rise to the litigation occurred in a
prior period
c. Strike of employees
d. Issue of a large amount of ordinary shares
7. An entity build a new factory building during the current year. Subsequent to the current
year-end and before issuance of financial statements, the building was destroyed by fire
and the claim against the insurance entity proved futile because the cause of the fire
was negligence on the part of the caretaker of the building. What should be reported at
the current year-end?
a. Write off the carrying amount of the building
b. Make a provision for one-half of the carrying amount of the building
c. Make a provision for three-fourths of the carrying amount of the building
d, Disclose the non adjusting event in the notes to financial statements

Multiple Choice – Related Party Disclosure

1. A related party transaction is a transfer

a. Between related parties when a price is charged.
b. Between related parties, regardless of whether a price is charged.
c. Between unrelated parties when a price is charged.
d. Between unrelated parties, regardless of whether a price is charged.
2. Which of the following is not a required minimum disclosure about related party
transaction?
a. The amount of related party transaction
b. The amount of the outstanding balance
c. The amount of similar transaction with unrelated parties to establish that comparable
related party transaction has been entered at arm’s length

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d. Doubtful debt related to the outstanding balance
3. Related party transactions include all, except
a. A venturer sold goods to the joint venture.
b. Sold a car to the uncle of the entity’s finance director.
c. Sold goods to another entity owned by the daughter of the entity’s managing
director.
d. All of these are related party transactions.
4. All of the following are related party transactions, except
a. Transferred goods from inventory to a subsidiary
b. Sold an entity car to the wife of the managing director
c. Sold an asset to an associate
d. Took out a huge bank loan
5. An entity that entered into a related party transaction would be required to disclose all
of the following, except
a Nature of the relationship between the parties.
b. Nature of any future transactions planned between the parties and the terms
involved.
c. Peso amount of the transaction.
d. Amount due from or to related parties at the end of reporting period.
6. Which is not required as a related party disclosure?
a. The son of the chief executive officer of the entity
b. The parent of the entity
c. An entity that has a common director with the entity
d. Joint venture in which the entity is a venturer
7. All of the following are related parties, except
a. Joint venture in which the entity is a venturer
b. A postemployment benefit plan for the employees
c. An executive director of the entity
d. The partner of a key manager is a major supplier of the entity
8. Which of the following is not a related party of an entity?
a. A shareholder owning twenty percent
b. An entity providing banking facilities to the entity
c. An associate of the entity

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 d. Key management personnel of the entity

II. Multiple Choice Computation - ( Accounting Policies, Estimates and Errors)

1. On January 1, 2017, Flax Company purchased a machine for P5,280,000 and

depreciated it by the straight line method using an estimated useful life of eight years with
no residual value.

On January 1, 2020, the entity determined that the machine had a useful life of six years
from the date of acquisition and the residual value was P480,000.

An accounting change was made in 2020 to reflect this additional information.

What is the accumulated depreciation for the machine on December 31, 2020?

a. 2,920,000 b. 3,080,000 c. 3,200,000 d. 3,520,000

2. Samar Company reported the following events during the year ended December 31,
2020:

• A counting error relating to the inventory on December 31, 2019 was discovered.
This required a reduction in the carrying amount of inventory at that date of
P280,000.
• The provision for uncollectible accounts receivable on December 31, 2019 was
P300,000.
During 2020, an amount of P500,000 was written off related to the December 31,
2019 accounts receivable.
What adjustment is required to restate retained earnings on January 1, 2020?
a. 280,000 b. 300,000 c. 580,000 d. 0

3. Dean Company acquired 100% of Morey Company in the prior year. During the current
year, the individual entities included in their financial statements the following:

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 Dean Morey
Key officers’ salaries 750,000 500,000
Officers’ expenses 200,000 100,000
Loans to officers 1,250,000 500,000
Intercompany sales 1,500,000

What total amount should be reported as related party disclosures in the notes to Dean
Company’s consolidated financial statements for the current year?
a. 1,500,000 b. 1,550,000 c. 1,750,000 d. 3,000,000

4. Gibson Company reported the following remuneration and other payments made to the
entity’s chief executive officers during the current year:
Annual salary 2,000,000
Share options and other salary-based payments 1,000,000
Contributions to retirement benefit plan 500,000
Reimbursement of travel expenses for business trips 1,200,000

What total amount should be disclosed as compensation to key management personnel?

a. 3,500,000 b.4,700,000 c. 3,000,000 d. 2,500,000

Summary
• Accounting policies are the specific principles, bases, conventions, rules and practices
applied by an entity in preparing and presenting financial statements.

• An entity is required to outline all significant accounting policies applied in preparing

financial statements.

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 • Prior period errors are omissions and misstatements in the financial statements for
one or more periods arising from a failure to use or misuse of reliable information.
• Prior period errors shall be corrected retrospectively by adjusting the opening
balances of retained earnings and affected assets and liabilities.

• A change in accounting estimate is a normal recurring correction or adjustment of an

asset or liability which is the natural result of the use of an estimate.
• When it is difficult to distinguish a change in accounting estimate and a change in
accounting policy, the change is treated as a change in accounting estimate, with
appropriate disclosure.

References

Valix, C.T., Peralta, J.F., Valix, C. A. M.(2020). Conceptual Framework and

Accounting Standards. Manila City, Phils. GIC Enterprises & Co., Inc.

https://www.iasplus.com/en/standards/ias/ias10

MODULE 7
PROPERTY PLANT AND EQUIPMENT (PAS 16) /
BORROWING COSTS (PAS 23)

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 Introduction

This module outlines the accounting treatment for most types of property, plant and
equipment. The measurement, depreciation and derecognition of property, plant and
equipment were likewise discussed.

This module also discusses the accounting treatment for borrowing costs.

Learning Outcomes

After studying this module, students should be able :

1. explain the definition of property plant and equipment..
2. calculate the measurement of property , plant and equipment.
3. identify the methods of depreciating property plant and equipment.
4. describe the derecognition of property, plant and equipment.
5. determine the concept of qualifying asset for purposes of capitalization of borrowing
costs.
6. demonstrate the proper accounting treatment of borrowing costs.
7. distinguish specific borrowing and general borrowing in relation to capitalization of
borrowing costs.
8. point out the necessary disclosures related to borrowing costs.

Lesson 1. Property, Plant and Equipment (Valix et al, 2020)

Valix et al., (2020) stated the definition of property, plant and equipment as tangible
assets that are held for use in production or supply of goods or services, for rental to others,
or for administrative purposes, and are expected to be used during more than one period.

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Accordingly, the major characteristics in the definition of property, plant and equipment are:

• The property, plant and equipment are tangible assets, meaning with physical substance.

• The property, plant and equipment are used in business, meaning used in production or
supply of goods or services for rental purposes and for administrative purposes.

• The property, plant and equipment are expected to be used over a period of more than
one year.

Examples of property, plant and equipment

• Land g. Motor vehicle
• Land improvements h. Furniture and fixtures
• Building i. Office equipment
• Machinery j. Patterns, molds and dies
• Ship k. Tools
• Aircraft l. Bearer plants

Recognition of property, plant and equipment

An item of property, plant and equipment shall be recognized as an asset when:

• It is probable that future economic benefits associated with the asset will flow to the
entity.
• The cost of the asset can be measured reliably.

Measurement at recognition

An item of property, plant and equipment that qualifies for recognition as an asset shall be
measured at cost.

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Cost is the amount of cash or cash equivalent paid and the fair value of the other
consideration given to acquire an asset at the time of acquisition or construction.

Elements of cost

The cost of an item of property, plant and equipment comprises:

• Purchase price, including import duties and nonrefundable purchase taxes, after
deducting trade discounts and rebates.
• Cost directly attributable to bringing the assets to the location and condition
necessary for it to be capable of operating in the manner intended by management.
• Initial estimate of the cost of dismantling and removing the item and restoring the site
on which it is located for which an entity has a present obligation.

Directly attributable costs

Examples of directly attributable costs that qualify for recognition include:

• Cost of employee benefit arising directly from the construction or acquisition of the item
of property, plant and equipment.
• Cost of site preparation
• Initial delivery and handling cost
• Installation and assembly cost
• Professional fee
• Costs of testing whether the asset is functioning properly.

Cost not qualifying for recognition

Examples of costs that are expensed rather than recognized as element of cost of property,
plant and equipment are:
• Cost of opening a new facility
• Cost of introducing a new product or service, including cost of advertising and
promotion
• Cost of conducting business in a new location or with a new class of customer,
including cost of staff training

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 • Administration and other general overhead cost
• Cost incurred while an item capable of operating in the manner intended by
management has yet to be brought into use or is operated at less than full capacity
• Initial operating loss
• Cost of relocating or reorganizing part or all of an entity’s operations

Measurement after recognition

After initial recognition, an entity shall choose either the cost model or the revaluation model
as the accounting policy for property, plant and equipment.

The entity shall apply such accounting policy to an entire class of property plant and
equipment.

The cost model means that property, plant and equipment are carried at cost less any
accumulated depreciation and any accumulated impairment loss.

The revaluation model means that property, plant and equipment are carried at revalued
carrying amount.

The revalued carrying amount is the fair value at the date of revaluation less any subsequent
accumulated depreciation and subsequent accumulated impairment loss

Acquisition on cash basis

The cost of an item of property, plant and equipment is the cash price equivalent at the
recognition date.

The cost of asset acquired on a cash basis simply includes the cash paid plus directly
attributable costs such as freight, installation cost and other cost necessary in bringing the
asset to the location and condition for the intended use.

Acquisition on account

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When an asset is acquired on account subject to a cash discount, the cost of the asset is
equal to the invoice price minus the discount, regardless of whether the discount is taken or
not.

Cash discount are generally considered as reduction of cost and not as income.

Acquisition on installment basis

When payment for item of property, plant and equipment is deferred beyond normal credit
terms, the cost is the cash price equivalent.

In other words, if an asset is offered at a cash price and at an installment price and is
purchased at the installment price, the asset shall be recorded at the cash price.

The excess of the installment price over the cash price is treated as an interest to be amortized
over the credit period.

Issuance of share capital

Philippine GAAP provides that if shares are issued for consideration other than actual cash,
the proceeds shall be measured by the fair value of the consideration received.

Accordingly, where a property is acquired through the issuance of share capital, the property
shall be measured at an amount equal to the following in the order of priority.

• Fair value of the property received

• Fair value of the share capital
• Par value or stated value of the share capital

Issuance of bonds payable

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PFRS 9, paragraph 5.1.1. provides the asset-acquired by issuing bonds payable is
measured in the following order:

• Fair value of bonds payable

• Fair value of asset received
• Face amount of bonds payable

Exchange

PAS 16, paragraph 2, provides that the cost of an item of property, plant and equipment
acquired in exchange for a nonmonetary asset or a combination of monetary and
nonmonetary asset is measured at fair value plus any cash payment.

However, the exchange is recognized at carrying amount if the exchange transaction lacks
commercial substance.

Definition of commercial substance

Commercial substance is a new notion and is defined as the event or transaction causing the
cash flows of the entity to change significantly from the cash flows of the asset transferred.

Construction
The cost of self-constructed asset is determined using the same principles as for an
acquired asset.
The cost of self-constructed property, plant and equipment includes:
• Direct cost of materials
• Direct cost of labor
• Indirect cost and incremental overhead specifically identifiable or traceable to the
construction.
PAS 16, paragraph 22, provides that the cost of abnormal amount of wasted material, labor
or overhead incurred in the production of self-constructed asset is not included in the cost of
the asset.

Derecognition

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Derecognition means that the cost of the property, plant and equipment together with the
related accumulated depreciation shall be removed from the statement of financial position.

PAS 16, paragraph 67, provides that the carrying amount of an item of property, plant and
equipment shall be derecognized on disposal or when no future economic benefits are
expected from the use or disposal.

The gain or loss from the derecognition of an item of property plant and equipment shall be
included in profit or loss.

Gain shall not be included in revenue but treated as other income.

The gain or loss arising from the derecognition of an item of property, plant and equipment
shall be determined as the difference between the net disposal proceeds and the carrying
amount of the item.

Fully depreciated property

A property is said to be fully depreciated when the carrying amount is equal to zero, or the
carrying amount is equal to the residual value.

In such a case, the asset account and the related accumulated depreciation account are
closed and the residual value is set up in separate account.
However, it is not uncommon for an entity to continue to use an asset after it has been fully
depreciated.

The cost of fully depreciated asset remaining in service and the related accumulated
depreciation ordinarily shall not be removed from the accounts.

However, entities are encouraged but not required to disclose fully depreciated property.

Concept of depreciation

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Depreciation is defined as the systematic allocation of the depreciable amount of an asset
over the useful life.

Depreciation is not so much as a matter of valuation.

Depreciation is a matter of cost allocation in recognition of the exhaustion of the useful life of
an item of property, plant and equipment.

The objective of depreciation is to have each period benefiting from the use of the asset bear
an equitable share of the asset cost.

Depreciation in the financial statements

Depreciation is an expense.

Depreciation may be a part of the cost of goods manufactured or an operating expense.

The depreciation charge for each period shall be recognized as expense unless it is included
in the carrying amount of another asset.

Depreciation period

The depreciable amount of an asset shall be allocated on a systematic basis over the useful
life.
Depreciation of an asset begin when it is available for use, meaning, when the asset is in the
location and condition necessary for the intended use by management.
Depreciation ceases when the asset is derecognized.

Therefore, depreciation does not cease when the asset becomes idle temporarily.

Temporary idle activity does not preclude depreciating the asset as future economic benefits
are consumed not only through usage but also through wear and tear and obsolescence.

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Factors of depreciation
In order to properly compute the amount of depreciation, three factors are necessary, namely
depreciable amount, residual value and useful life.

Depreciable amount

Depreciable amount is the cost of an asset or other amount substituted for cost, less the
residual value.

Each part of an item of property, plant and equipment with a cost that is significant in relation
to the total cost of the item shall be depreciated separately.

For example, it may be appropriate to depreciate separately the airframe, engines, fittings
(seats and floor coverings) and tires of an aircraft.

The entity also depreciates separately the remainder of the item and the remainder consists
of the parts of the item that are individually not significant.

Residual value

Residual value is the estimated net amount currently obtainable if the asset is at the end of
the useful life.

The residual value of an asset shall be reviewed at least at each financial year-end and if
expectation differs from the previous estimate, the change shall be accounted for as a change
in an accounting estimate.

The residual value of an asset may increase to an amount equal to or greater than the carrying
amount.

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If it does, the depreciation charge is zero unless and until the residual value subsequently
decreases to an amount below the carrying amount.

Depreciation is recognized even if the fair value of the asset exceeds the carrying amount as
long as the residual value does not exceed the carrying amount.

Lesson 2. Borrowing Costs (PAS 23) (Valix et al, 2020)

Under PAS 23, paragraph 5, borrowing costs are defined as interest and other costs
that an entity incurs in connection with borrowing of funds (Valix et al , 2020).

Paragraph 6, provides that borrowing costs specifically include:

• Interest expense calculated using the effective interest method.
• Finance charge with respect to a finance lease.
• Exchange difference arising from foreign currency borrowing to the extent that it is
regarded as an adjustment to interest cost.

Qualifying asset

A qualifying asset is an asset that necessarily takes a substantial period of time to get ready
for the intended use or sale.

Examples include the following

• Manufacturing plant
• Power generation facility
• Intangible asset
• Investment property

Excluded from capitalization

PAS 23 does not require capitalization of borrowing costs relating to the following:

• Asset measured at fair value, such as biological asset

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• Inventory that is manufactured in large quantity on a repetitive basis, such as maturing
whisky, even if it takes a substantial period of time to get ready for sale.
• Asset that is ready for the intended use or sale when acquired

Accounting for borrowing cost

PAS 23, paragraph 8, mandates the following rules in borrowing cost:
• If the borrowing is directly attributable to the acquisition, construction or production of a
qualifying asset, the borrowing cost is required to be capitalized as cost of the asset.

In other words, the capitalization of borrowing cost is mandatory for a qualifying asset.

Borrowing cost can be capitalized when the asset is a qualifying asset and it is probable
that the borrowing cost will result to future economic benefit and the cost can be
measured reliably.

• All other borrowing costs shall be expensed as incurred .

In other words, if the borrowing is not directly attributable to a qualifying asset, the
borrowing cost is expensed immediately.

Asset financed by specific borrowing

PAS 23, paragraph 12, provides that if the funds are borrowed specifically for the purpose of
acquiring a qualifying asset, the amount of capitalizable borrowing cost is the actual borrowing
cost incurred during the period less any investment income from the temporary investment of
those borrowings.

Illustration

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At the beginning of the current year, an entity obtained a loan of P4,000,000 at an interest
rate of 10%, specifically to finance the construction of new building. The building was
completed at the current year-end.
Availments from the loan were made quarterly in equal amounts. Total borrowing cost
incurred amounted to P250,000 for the current year.
Prior to their disbursement, the proceeds of the borrowing were temporarily invested and
earned interest income of P40,000.
Actual borrowing cost P250,000
Interest income from investment of proceeds (40,000)
Capitalizable borrowing cost 210,000

Asset financed by general borrowing

PAS 23, paragraph 14, provides that if the funds are borrowed generally and used for
acquiring a qualifying asset, the amount of capitalization borrowing cost is equal to the
average carrying amount of the asset during the period multiplied by a capitalization rate or
average interest rate.

However, the capitalizable borrowing cost shall not exceed the actual interest incurred.

The capitalization rate or average interest rate is equal to the total annual borrowing cost
divided by the total general borrowings outstanding during the period.

No specific guidance is provided for general borrowing with respect to investment income.

Accordingly, any investment income from general borrowing is not deducted from capitalizable
borrowing cost.

Illustration

An entity had the following borrowings on January 1 of the current year. The borrowing were
made for general purposes and the proceeds were partly used to finance the construction of
a new building.

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 Principal Borrowing cost
10% bank loan 3,000,000 300,000
12% short-term loan 1,500,000 180,000
8% long-term loan 3,500,000 280,000
8,000,000 760,000

December 31, of the current year.

January 1 400,000
March 31 1,000,000
June 30 1,200,000
September 30 1,000,000
December 31 400,000
Total expenditures on the building 4,000,000

Average carrying amount of the building

Date Expenditures Months outstanding Amount
(a) (b) (a x b)
January 1 400,000 12 4,800,000
March 31 1,000,000 9 9,000,000
June 30 1,200,000 6 7,200,000
September 1,000,000 3 3,000,000
December 31 400,000
24,000,000

Average carrying amount (24,000,0000 / 12)

2,000,000

Another approach
Date Expenditures Fraction Average
(a) (b) (a x b)
January 1 400,000 12/12 400,000
March 31 1,000,000 9/12 750,000

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 June 30 1,200,000 6/12 600,000
September 1,000,000 3/12 250,000
December 31 400,000
2,000,000

The capitalization rate is computed by dividing the total annual borrowing cost by the total
general borrowings.

Thus, P760,000 divided by P8,000,000 equals 9.5%.

The amount of capitalizable borrowing cost is the average carrying amount of the building
multiplied by the capitalization rate.

Thus, P2,000,000 x 9.5% equals P190,000.

The capitalizable borrowing cost shall not exceed the actual borrowing cost.

The amount of P190,000 is the proper capitalizable borrowing cost because it is less than
the actual borrowing cost of P760,000.

The excess of P760,000 over P190,000 or 570,000 is charged to interest expense.

Asset financed both by specific and general borrowing

At the beginning of the current year, an entity borrowed P1,500,000 at an interest of 10%
specifically for the construction of a new building. The actual borrowing cost on this loan is
P150,000.

The entity had also outstanding during the year a 5 year 8% general borrowing of P7,000,000.

The construction of the building started on January 1 and was completed on December 31,
of the current year.

January 1 500,000
April 1 1,000,000

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 May 1 1,500,000
September 1 1,500,000
December 31 500,000
Total cost 5,000,000

Date Expenditures Fraction Average

(a) (b) (a x b)
January 1 500,000 12/12 500,000
April 1 1,000,000 9/12 750,000
May 1 1,500,000 8/12 1,000,000
September 1 1,500,000 4/12 500,000
December 31 500,000
Ave. Expenditure 2,750,000

Average expenditures 2,750,000

Specific borrowing (1,500,000)
Applicable to general borrowing 1,250,000

Capitalizable interest
Specific borrowing (10% x 1,500,000) 150,000
General borrowing ( 8% x 1,250,000) 100,000
Total capitalizable interest 250,000

Commencement of capitalization

The capitalization of borrowing costs as part of the cost of a qualifying asset shall
commence when the following three conditions are present:

• When the entity incurs expenditures for the asset.

• When the entity incurs borrowing costs.

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 • When the entity undertakes activities that are necessary to prepare the asset for the
intended use or sale.

Activities necessary to prepare

The activities necessary to prepare the asset for the intended use or sale encompass more
than the physical construction of the asset.

These include technical and administrative work prior to the commencement of physical
construction, such as drawing up plans and obtaining permit for a building.
However, merely holding assets for use or development without any associated development
activity does not qualify for capitalization.

For example, borrowing costs incurred while land is under development are capitalized during
the period in which development activities are being undertaken.

But borrowing costs incurred while land acquired for building purposes is held without any
associated development activity do not qualify for capitalization.

Suspension of capitalization

Capitalization of borrowing costs shall be suspended during extended periods in which active
development is interrupted.

However, capitalization of borrowing costs is not normally suspended during a period when
substantial technical and administrative work is being carried out.

Capitalization of borrowing costs is not also suspended when a temporary delay is a

necessary part of the process of getting an asset ready for its intended use or sale.

For example, capitalization continues during the extended period that high water levels delay
the construction of a bridge, if such high water levels are common during the construction
period in the geographical region involved.

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Cessation of capitalization

Capitalization of borrowing costs shall cease when substantially all the activities necessary to
prepare the qualifying asset for the intended use or sale are complete.

An asset is normally ready for the intended use or sale when the physical construction of the
asset is complete even though routing administrative work might still continue.

Disclosures related to borrowing costs

• The amount of borrowing costs capitalized during the period.

• The capitalization rate used to determine the amount of borrowing costs eligible for
capitalization.

Segregation of assets that are “qualifying assets” from other assets which in the statement of
financial position is not required to be disclosed.

Assessment Task 7-1

Multiple Choice – Theory (PPE)

1. Which of the following is not a characteristic of property, plant and equipment?
a. The property, plant and equipment are tangible assets.
b. The property, plant and equipment are used in business.

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 c. The property, plant and equipment are expected to be used over a period of more
than a year.
d. The property, plant and equipment are subject to depreciation.
2. What valuation model should an entity use to measure property, plant and equipment?
a. Revaluation model and fair value model
b. Cost model and revaluation model
c. Cost model only
d. Cost model and fair value model
3. The cost of property, plant and equipment comprises all of the following, except
a. Purchase price
b. Import duties and nonrefundable purchase taxes
c. Any cost directly attributable in bringing the asset to the location and condition for
intended use
d. Initial estimate of the cost of dismantling the asset for which the entity has no
present obligation.
4. Which cost should be expensed immediately?
a. Cost of opening a new facility
b. Cost of introducing a new product including cost of advertising and promotional
activities
c. Cost of conducting business in a new location
d. All of these are expensed immediately

5. The cost of property, plant and equipment acquired in an exchange is measured at

the
a. Fair value of the asset given plus cash payment.
b. Fair value of the asset received plus cash payment.
c. Carrying amount of the asset given plus cash payment.
d. Carrying amount of the asset received plus cash payment.

Multiple Choice – Computation (PPE)

1. Disney Company recently acquired two items of equipment

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  Acquired a press at an invoice price of P3,000,000 subject to a 5% cash discount
which was taken.
Cost of freight and insurance during shipment were P50,000 and installation cost
amounted to P200,000.
 Acquired a welding machine at an invoice price of P2,000,000 subject to a 10% cash
discount which was not taken. Additional welding supplies were acquired at a cost of
P100,000.
What is the total increase in the equipment account as a result of the transactions?
a. 4,900,000 b. 5,000,000 c. 5,100,000 d. 5,200,000

2. Best Forwarding Company exchanged a delivery truck costing P1,000,000 for a parcel of
land. The truck had a carrying amount of P650,000 and a fair value of P500,000.

The entity gave P600,000 in cash in addition to the truck as part of this transaction.
It is expected that the cash flows from the assets will be significantly different. The previous
owner of the land had listed the land for sale at P1,200,000.

At what amount should the company record the land?

a. 1,100,000 b. 1,250,000 c. 1,150,000 d. 1,200,000

Multiple Choice – Theory (Borrowing Cost)

1. Borrowing cost can be capitalized as cost of the asset when

a. The asset is a qualifying asset.
b. The asset is a qualifying asset and it is not probable that the borrowing cost will
result in future economic benefit to the entity.
c. The asset is a qualifying asset and it is probable that the borrowing cost will
result in future economic benefit to the entity but the cost cannot be measured
reliably.
d. The asset is a qualifying asset and it is probable that the borrowing cost will
result in future economic benefit to the entity and the cost can be measured
reliably.

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 2. If the qualifying asset is financed by specific borrowing, the capitalizable borrowing
cost is equal to
a. Actual borrowing cost incurred
b. Actual borrowing cost incurred up to completion of asset
c. Actual borrowing cost incurred up to completion of asset minus any investment
income from the temporary investment of the borrowing
d. Zero
3. Which of the following could be treated as qualifying asset for the purpose of
capitalizing borrowing cost?
a. Investment property
b. Financial asset at fair value
c. Inventory that is manufactured in large quantity on a repetitive basis and takes a
substantial period of time to get ready for use or sale
d. Biological asset
4. If the qualifying asset is financed by general borrowing, the capitalizable borrowing
cost is equal to
a. Actual borrowing cost incurred
b. Total expenditures on the asset multiplied by a capitalization rate
c. Average expenditures on the asset multiplied by a capitalization rate or actual
borrowing cost incurred, whichever is lower
d. Average expenditures on the asset multiplied by a capitalization rate or actual
borrowing cost incurred whichever is higher
5. The period of time during which interest must be capitalized ends when
a. The asset is substantially complete and ready for the intended use.
b. No further interest is being incurred.
c. The asset is abandoned, sold or fully depreciated.
d. The activities that are necessary to get the asset ready for the intended use have
begun.

Multiple Choice – Computation (Borrowing Cost)

1. On January 1, 2020, Cagayan Company took out a loan of P24,000,000 in order to finance
specifically the renovation of a building. The loan carried annual interest at 10%

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The renovation work started on the same date. Work on the building was substantially
complete on October 31, 2020.
The loan was repaid on December 31, 20202 and P200,000 investment income was earned
n the period to October 31 on the proceeds of the loan not yet used for the renovation.
What amount of capitalizable borrowing cost should e included in the cost of the building?
a. 2,400,000 b. 2,200,000 c. 2,000,000 d. 1,800,000

2. During 2020 Joshua Company constructed asset costing P5,000,000. The weighted
average expenditures totaled P3,000,000.
To help pay for construction, P2,200,000 was borrowed at 10% on January 1, 2020.
Funds not needed for construction were temporarily invested in short-term securities yielding
P45,000 in interest revenue.
Other than the construction funds borrowed, the only other debt outstanding during the year
was a P2,500,000. 10-year, 9% note payable dated January 1, 2019.
What amount of interest should be capitalized during 2020?
a. 300,000 b. 150,000 c. 247,000 d. 472,000

Summary
 Property, plant and equipment are tangible assets that are held for use in production
or supply of goods or services, for rental to others, or for administrative purposes, and
are expected to be used during more than one period.
 An item of property, plant and equipment that qualifies for recognition as an asset shall
be measured at cost.
 An entity shall choose either the cost model or the revaluation model as the accounting
policy for property, plant and equipment after initial recognition.
 When an asset is acquired on account subject to a cash discount, the cost of the asset
is equal to the invoice price minus the discount, regardless of whether the discount is
taken or not.
 Philippine GAAP provides that if shares are issued for consideration other than actual
cash, the proceeds shall be measured by the fair value of the consideration received.

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 The carrying amount of an item of property, plant and equipment shall be
derecognized on disposal or when no future economic benefits are expected from the
use or disposal.
 Borrowing costs are defined as interest and other costs that an entity incurs in
connection with borrowing of funds.
 A qualifying asset is an asset that necessarily takes a substantial period of time to get
ready for the intended use or sale.
 The capitalization of borrowing cost is mandatory for a qualifying asset
 Capitalization of borrowing costs shall be suspended during extended periods in which
active development is interrupted.
 Capitalization of borrowing costs shall cease when substantially all the activities
necessary to prepare the qualifying asset for the intended use or sale are complete.

References

Valix, C.T., Peralta, J.F., Valix, C. A. M.(2020). Conceptual Framework and

Accounting Standards. Manila City, Phils. GIC Enterprises & Co., Inc.

https://www.iasplus.com/en/standards/ias/ias7

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