MMCO Continuing Professional Development Training Center (CPDTC)

2F MMCO Building, 8000 Lakeview Ph3 Angela Street, Halang Calamba City Laguna, Philippines
Tel No. (02) 330-8617, (049) 523-6031; (02) 330-6057
CPA REVIEW (May 2019 Batch)
FAR Theory Cedrick Zapanta, CPA
Module 1
1. Overview of Accounting
2. Accounting Standard-setting Process and Institutions
3. Conceptual Framework

OVERVIEW OF ACCOUNTING
1. History of Accounting
Historical records show that the beginnings of record keeping or storing information dates back some 76,000 years ago in the
Blombos caves of Africa.

Accounting In Ancient Egypt, China, Greece and Rome

• Government accounting records in Egypt show “in kind” tax payments.
• China used Accounting as a means of evaluating the efficiency of governmental programs
• Legislation on financial matters in Greece (5th century BC) included control of receipts and expenditures of public monies
through the oversight of “public accountants” chosen by lot
• In its thousand years of existence, these records showed simple list-making only, similar to single-entry bookkeeping
• Early financial records in the Roman Empire include the Account, (listed public revenues); the Treasury, (which listed
amounts of cash in the provincial tax officials and in the hands of the public contractors). The records included not only cash
and commodities but also the names of freed men and slaves, especially the records Roman army.
• Medieval Europe (13th century) –introduction of double-entry bookkeeping. The chief objective was to keep track of
amounts owed by customers (debtors) and amounts owed to creditors. Debit is Latin for 'he owes' and credit is Latin for 'he
trusts'.
• The Messari (Italian for Treasurer’s accounts, of the city of Genoa 1340) is the oldest discovered record of a complete
double-entry system. These accounts contain debits and credits journalized in a bilateral form.

Luca Pacioli and Double-entry System of Bookkeeping

• Luca Pacioli's "Summa de Arithmetica, Geometria, Proportioni et Proportionalità," published in Venice in 1494, included a
27-page, 36 short chapters on bookkeeping.
• Books of accounts used by Luca Pacioli
o The memorandum (a daybook) – for chronological recording of business transactions as they occurred
o The journal – the merchant's private account book
o The ledger – the money and date columns were almost identical to those in modern ledgers, with entries
consisting of brief paragraphs
• The trial balance is the end of Pacioli's accounting cycle. Debits from the old ledger are listed on the left side of the balance
sheet and credits on the right. If the two totals are equal, the old ledger is considered balanced. If not (in balance), says
Pacioli, "that would indicate a mistake in your ledger, which mistake you will have to look for diligently with the industry and
intelligence God gave you."
• The objective of Luca Pacioli’s keeping records is to give traders prompt information as to his assets and liabilities.
• The Summa is the first known printed treatise on bookkeeping and was translated into different languages. It is widely
believed to be the forerunner of modern bookkeeping practice.
• Thus, it can be said that Luca Pacioli systematized record keeping through the double-entry bookkeeping system.

Professional Accountancy Travels across the Globe

• 1880: Institute of Chartered Accountants in England and Wales (ICAEW) brought together all the accountancy organizations
in those countries
• 1887: the first national accounting society of the United States was formed, the American Association of Public Accountants
(predecessor of the AICPA)
Accounting in the Internet Era
• The act of accounting is usually defined as the act of collecting information on resource usage for the purpose of trend
analysis, auditing, billing, or cost allocation.
o For example when a user uses a connectivity service paid with a pay-per-view approach the accounting process is
based on a metering of the resource usage by the user (usually time spent with an active connection or the
amount of data transferred using that connection). The accounting is hence the recording of this connectivity
service consumption for subsequent charging of the service itself.

Recent Trends and Developments in Accounting

• Cloud Accounting
• Automation (Artificial Intelligence)
• Data Analytics
• Environmental Accounting
• Standardization and Harmonization
2. Definition, Nature, and Purpose of Accounting
 Definition: Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about
economic entities that is intended to be useful in making economic decisions.

Accounting is the art of recording, classifying, summarizing in a significant manner and in terms of money, transactions and events
which are, in part at least, of a financial character and interpreting the results thereof.

Nature:
• Accounting as Science and Art – Accounting is a social science with a body of knowledge which has been systematically
gathered, classified, and organized. It is influenced by, and interacts with, economic, social and political environments.
Accounting is a practical art which requires the use of creative skill and judgment.
• Accounting as an Information System – Accounting identifies and measures economic activities, processes information into
financial reports and communicates these reports to decision makers.

Purpose: To provide quantitative information1 about economic entities2 intended to be useful in making economic decisions.

1 – Types of information provided by accounting

• Quantitative information – expressed in numbers, quantities or units
• Qualitative information – expressed in words or descriptive form
• Financial information – expressed in terms of money

2 – Economic entity vs business entity

• Economic entity – is a separately identifiable combination of persons and property that uses or controls economic or scarce
resources to achieve certain goals or objectives. Scarce resources have one significant characteristic: because of their
limited nature, they command a price.
o Business entity is an economic entity that produces and distributes goods or services primarily for profit.
o Not-for-profit or non-profit entity is one that carries out some socially desirable needs of the community or its
members whose activities are not directed towards making profit.

3. Functions of Accounting
a. Identification – the accounting process of recognition or non-recognition of business activities as “accountable events” or
whether they have accounting relevance.
b. Measurement – the accounting process of assigning of peso amounts or numbers to the economic transactions and events. The
unit of measure of accounting is money, expressed in prices.
c. Communication – the accounting process of preparing and distributing accounting reports to potential users of accounting
information and interpreting the significance of this processed information. The three aspects of communicating are:
i. Recording – the process of systematically committing to writing business transactions and events in books of account in
a systematic and chronological manner according to accounting rules and regulation.
ii. Classifying – the grouping of similar and interrelated items into their respective classes.
iii. Summarizing – expressing in condensed or brief form the recorded and classified information in financial statements.

4. Branches of Accounting
a. Financial Accounting – the recording of transactions, preparation of financial statements and communication of financial
information to external user groups. (Focus: general purpose reports)
b. Auditing – the examination of financial statements by independent certified public accountant for the purpose of expressing an
opinion on the fairness of presentation of financial statements. (Focus: audit report)
c. Management Accounting (or Management Services) – the accumulation and communication of information for use by internal
parties or management. This includes services to clients on matters of accounting, finance, business policies, organization
procedures, product costs, distribution, and many other phases of business conduct and operations. (Focus: advisory services;
consultancy)
d. Government Accounting – accounting for the national government and its instrumentalities, focusing attention on the custody of
public funds and the purpose or purposes to which such funds are committed.
e. Tax Accounting – involves the preparation of tax returns and rendering of tax advice, such as determination of tax consequences
of certain proposed business endeavors. (Focus: Tax advisory services)
f. Fiduciary Accounting – handling of accounts managed by a person entrusted with the custody and management of property for
the benefit of another.
g. Social Responsibility Accounting – reporting of programs and projects that have to do with the upliftment of the welfare of the
people of a community or of the nation.
h. Environmental Accounting – the area of accounting that focuses on programs, activities and projects that are focused on care for
Mother Earth. One example is carbon accounting which is a process of encouraging reductions in greenhouse gas emissions.
i. Price-level Accounting (Accounting for Hyperinflationary Economies) – is accounting that recognizes in the financial statements
changes in the purchasing power of money. This is in contrast to traditional accounting which assumes a stable monetary unit
when it reports financial information.

5. Financial Accounting vs. Management Accounting

Financial Accounting Management Accounting
o Basically concerned with income o Basically concerned with decision-making
determination and asset valuation o Prepares statements in accordance with
o Prepares statements in accordance with management needs
GAAP o Prepares special purpose reports for
o Prepares general purpose statements internal users
 that can be used by external and internal
users o Future-oriented
o Historical in nature o Makes use of subjective data as long as it
o Emphasizes objective data is relevant

6. Areas of Professional Accounting Practice

a. Public Accounting – composed of individual practitioners, accounting firms and large multinational organizations that render
independent expert financial services to the public on a professional fee basis. Public accountants usually offer three kinds of
services: assurance and audit, taxation, and management advisory services.
b. Private Accounting – composed of individuals employed in business enterprises on salary basis. The major objective of private
accounting is to assist management in planning and controlling the enterprise’s operations.
c. Government Accounting – composed of accountants employed in the different branches of government, such us the BIR, COA,
SEC, and GBEs. The focus of government accounting is custody and administration of public funds.
d. Accounting Education – composed of CPAs who are professors of accounting in various colleges and universities. Their task is to
prepare entrants into the accountancy profession.

7. Environment of Accounting
Financial accounting is shaped to a significant extent, by the environment, and in particular, all of the following:
• The economic activities in society
• The means of measurement of economic activity
• The financial statement users and their information needs

Economic Activities and their Classification

a. Production – the process of converting economic resources into outputs of goods and services that are intended to have
greater utility than the required inputs
b. Exchange – the process of trading resources or obligations for other resources or obligation
c. Income distribution – the process of allocating rights to the use of output among individuals and groups in society
d. Consumption – the process of using the final output of the production process
e. Investment – the process of using current inputs to increase the stock of resources available for output as opposed to
immediately consumable output
f. Savings – the process by which individuals and groups set aside rights to present consumption in exchange for rights to
future consumption

Accountable Events – are events that are quantifiable and has an effect on assets, liabilities and equity. Also known as economic
activities, these are the subject matter of accounting.
• Only economic activities are emphasized and recognized in accounting. Sociological and psychological matters are not
recognized.
• Criteria for an accountable event
o It must affect a financial element of accounting (increasing or decreasing asset, liability or equity (probability
criterion)
o It is a result of a past activity
o Its cost can be measured reliably (measurability criterion)

Types of Accountable Events

1. External Events – events wherein another party participates
a. Transfers – there is flow of economic resources
i. Exchanges – two-way
ii. Non-reciprocal Transfers – one-way
b. External Events other than Transfers – no flow of economic resources
2. Internal Events – those wherein only the entity participates
a. Production
b. Casualties

Measurement of Accountable Events (to be discussed in Conceptual Framework)

1. Historical Cost
2. Current Cost
3. Realizable (Settlement) Value
4. Present Value

QUIZZER 1 – OVERVIEW OF ACCOUNTING

History of Accounting
1. Are the following statements about the history of Accounting true or false?
I. According to the history of accounting, debit means “he owes” and “credit” means “he trusts”.
II. Frater Luca Bartolomes Pacioli did not invent accounting but his treatise, “De Computis et Scripturis is said to have laid the
foundation for double-entry bookkeeping as it is practiced today.
III. The earliest accounting records date back to the 14th Century and were found in the Roman Empire.
Statement I Statement II Statement III
a. True False True
b. False True False
 c. True True False
d. False False True

2. Which of the following statements pertaining to Luca Pacioli’s bookkeeping system is (are) true?
I. The books of accounts included a Memorandum, a Journal and a Ledger
II. The objective of Luca Pacioli’s keeping records is to give traders prompt information as to his assets and liabilities.
III. Luca Pacioli’s accounting cycle is basically the same as the accounting cycle as practiced today.
a. Statements I and II are true c. Statements II and III are true
b. Statements I and III are true d. All statements are true

3. Which of the following statements is (are) true?

I. Accountancy is a communication service profession.
II. Financial accounting is the process of identifying, measuring, analyzing, and communicating financial information needed by
management to plan, evaluate, and control an organization's operations.
III. Financial statements are the principal means through which financial information is communicated to those outside an
enterprise.
a. Statements I and II only c. Statements II and III only
b. Statements I and III only d. Statements I, II and III

4. Which of the following statements is not a proper description of accounting as a communication profession?
a. Financial statements can be expressed in any national language.
b. Financial statements can be expressed in any dialect of a country.
c. Financial statements should use terminology within the level of understanding of the statement user.
d. Financial statements, as far as possible, should show information that can be verified from documentary evidence in order
to gain the confidence of statement users

5. Which of the following statements about accounting information is (are) true?

I. Accounting provides quantitative and financial information only.
II.Accounting provides quantitative, qualitative and financial information
III. Information in the financial statements are sourced only from the books of account.
a. I and II only b. II and III only c. II and III only d. I, II and III

6. Which of the following statements is not an objective of financial reporting?

a. Provide information that is useful in investment and credit decisions.
b. Provide information about enterprise resources, claims to those resources, and changes to them.
c. Provide information on the liquidation value of an enterprise.
d. Provide information that is useful in assessing cash flow prospects.

7. How does accounting help the capital allocation process attract investment capital?
a. Provides timely, relevant information c. Promotes productivity
b. Encourages innovation d. (a) and (b)

8. The information provided by financial reporting pertains to

a. Individual business enterprises, rather than to industries or an economy as a whole or to members of society as consumers.
b. Business industries, rather than to individual enterprises or an economy as a whole or to members of society as consumers.
c. Individual business enterprises, industries, and an economy as a whole, rather than to members of society as consumers.
d. An economy as a whole and to members of society as consumers, rather than to individual enterprises or industries.

9. Which of the following represents a form of communication through financial reporting but not through financial statements?
a. Statement of financial position c. Income statement
b. President's letter d. Notes to financial statements

10. Qualitative information is found

a b c d
Only in the face of the financial statements yes no yes no
In the face of the financial statements and
the accompanying notes yes yes no no

11. In which of the following situations is the science aspect of accounting demonstrated?
I. The accountant makes use of the rules of debit and credit in recording transactions of the business
II.Transactions and events are processed using the steps of the accounting cycle.
III. A provision for doubtful accounts was estimated by the accountant on the basis of recorded data and the collection
experience of the company
a. I only b. I and II only c. II and III only d. I, II and III

12. The art aspect of accounting is applied in which of the following circumstances?
I. The accountant records a purchased equipment at cost plus expenses in acquisition and putting it available for use.
II.The external auditor gives an unqualified opinion that the financial statements are fairly presented in conformity with
generally accepted accounting principles.
III. The accountant selects the reliable fair value at which a consumable biological asset will be recognized and measured in
the books of account.
 a. Statement I only c. Statements II and III
b. Statements I and II d. Statements I, II and III

13. Which of the following statements is (are) true?

I. Not all quantitative information is also financial in nature.
II.Measurement is the process of assigning numbers to objects such as inventories or plant assets and to events such as
purchases or sales.
III. Management decisions are oriented to the future whereas the decisions of external users are oriented to the past.
a. I and II only c. I and III only
b. II and III only d. I, II and III

14. Which of the following features of an asset closely links its definition to the science of Economics?
a. An asset is controlled by an entity c. An asset can command a price
b. An asset can provide future benefits to an entity d. An asset is exclusively owned by an entity

15. Which of the following is not an economic entity?

a. Aldo, Baldo, Calvo & Associates, a law office c. Polytechnic University of the Philippines
b. Luna Sangre Group of Companies d. Janet, a filipino citizen who owns JLN Piggery

16. Which of the following is an economic entity but not a business entity?
a. Golden Acres, a charitable institution c. Rustan’s supermarket
b. Consolidated Foods Corporation d. ABC Co., a stock corporation

17. It is the process of recognition and non-recognition of business activities as “accountable events” or whether they have
accounting relevance
a. Identification c. Communication
b. Measurement d. Summarization

18. The accounting process of assigning peso amounts or numbers to relevant objects and events is known as
a. Identification c. Communication
b. Measurement d. Summarization

Branches of Accounting / Areas of Professional Practice

19. Which of the following branches of accounting focuses on general purpose reports on financial position and results of
operations, known as financial statements?
a. Financial accounting c. Management advisory services
b. Auditing d. Bookkeeping

20. The process of analyzing, recording, classifying, summarizing and communicating all transactions involving state funds and
property is known as
a. government accounting c. fiduciary accounting
b. estate accounting d. receivership accounting

21. An independent appraisal function established within an organization to examine and evaluate its activities as a service to the
organization.
a. external auditing c. fiduciary accounting
b. internal auditing d. management accounting

22. The process of identifying, measuring and communicating financial information used for planning , evaluation, and control
within the organization
a. financial accounting c. social responsibility accounting
b. estate accounting d. management accounting

23. Handling of accounts for fiduciaries who wind up the affairs of a deceased person.
a. estate accounting c. receivership accounting
b. fiduciary accounting d. macro accounting.

24. The process of measuring and disclosing the performance of a firm in terms of community involvement and related criteria.
a. macro accounting c. social responsibility accounting
b. enterprise accounting d. community accounting

25. Accounting for not-for-profit entities other than the government

a. Estate accounting c. Receivership accounting
b. Institutional accounting d. Enterprise accounting

26. The practice of accounting by one whose principal employment is confined to a single enterprise
a. single-proprietorship accounting c. estate accounting
b. enterprise accounting d. private accounting

27. Branch of accounting which deals with rendering of services to the public for compensation.
a. Private Accounting c. Public Accounting
b. Government Accounting d. Enterprise Accounting
28. It is an independent examination intended to support the expression of an impartial, professional opinion on the reliability of
the financial statements
a. External Auditing c. Internal auditing
b. Management accounting d. Fiduciary accounting

29. Which of the following applies to financial accounting?

a b c d
Information meets specific needs of particular statement users yes no yes no
Emphasizes objective data yes yes no no
Basically concerned with income determination and asset valuation no yes no yes
Primarily historical in nature no yes yes yes

30. Accounting that recognizes changes in the purchasing power of money is known as
a. Price-level accounting c. Current value accounting
b. Historical accounting d. Traditional accounting

QUIZZER 2 – ENVIRONMENT OF ACCOUNTING

The Environment of Accounting / Economics Concepts

1. Financial accounting is shaped to a significant extent, by the environment, and in particular, all of the following, except:
a. The economic activities in society
b. The financial statement users and their information needs
c. The means of measurement of economic activity
d. The characteristics and limitations of financial accounting and financial statements

2. Which of the following is not a fundamental economic activity in society?

a. Consumption c. Income recognition
b. Income distribution d. Investment

3. This is an economic activity which involves trading resources and obligations for other resources or obligations.
a. Production c. Non-reciprocal transfer
b. Exchange d. Distribution

4. This is the process of converting economic resources into outputs of goods and services that are intended to have greater utility
than the required inputs.
a. Production c. Investment
b. Exchange d. Distribution

5. The process of using the final output of the production process is

a. Investment c. Distribution
b. Savings d. Consumption

6. It is the process of using current inputs to increase the stock of resources available for future output as opposed to immediately
consumable output
a. Exchange c. Consumption
b. Investment d. Savings

Economic Resources/Economic Obligations/Residual Equity

7. These are the scarce means (limited in supply relative to desired uses) available for carrying on economic activities of a business
enterprise:
a. Economic resources c. Production resources
b. Economic obligations d. Property

8. Economic resources include

a. Money c. Products
b. Claims to receive money d. All of these

9. Productive resources include all of the following except

a. tangible productive resources of the enterprise
b. intangible productive resources of the enterprise
c. contractual rights to the use of resources of other entities
d. ownership interests in other enterprises

10. Which of the following is not among the economic resources of a business enterprise?
a. Money c. Obligations to pay money
b. Products or output of the entity d. Ownership interest in other enterprises

11. These represent an enterprise’s present responsibilities to transfer economic resources or provide service to other entities in the
future:
a. Economic resources c. Residual interest in resources
 b. Economic obligations d. None of these

12. The interest in the economic resources of an enterprise that remains after deducting economic obligations is called
a. Residue c. Residual Interest
b. Stockholders’ Equity d. Owners’ Equity

13. The economic activities of a business enterprise increase or decrease its (the)
Assets Liabilities Owner’s Equity
a. Yes No Yes
b. Yes Yes Yes
c. Yes No No
d. No No No

Events and Transactions / Accountable Events

14. These are events and transactions that affect the enterprise and in which other entities participate.
a. External events c. Exchange transactions
b. Internal events d. Production

15. These are events in which only the entity participates

a. External event c. Non-reciprocal event
b. Internal events d. Accountable event

16. These are reciprocal transfers of resources or obligations between the enterprise and other entities in which the enterprise
either sacrifices resources or incurs obligations in order to obtain other resources or satisfy other obligations
a. Exchanges c. Manufacturing
b. Production d. Investment

17. These are changes in economic resources by actions of other entities that do not involve transfers of enterprise resources and
obligations
a. Transfers c. Internal events
b. External events other than transfers d. Production

18. Some events involve the transfer of resources in only one direction, either from the enterprise to other entities, or from other
entities to the enterprise. These are called
a. Nonmonetary transactions c. Nonreciprocal transfers
b. Arms-length exchanges d. Executory contracts

19. External events are those that affect the enterprise and in which other entities participate. One example is when
a. A manufacturing company transfers goods from one production department to another
b. The expired portion of prepaid insurance is taken up as expense
c. Loss of inventory due to fire
d. Issuance of promissory note in settlement of an account
e. Manufacture of a product out of raw materials

20. The following are classified as external events except

a. Payment of money borrowed c. Government grant
b. Purchase of supplies d. Casualty loss

21. Safe Corp. discovered a material amount of loss from theft. The value of the loss should be classified as
a. A non-reciprocal transfer c. An exchange
b. A reciprocal transfer d. A casualty

22. Purchases or sale of merchandise on account is classified as

a. Exchanges c. Production
b. External events other than transfers d. Nonreciprocal transfer

23. These are sudden, substantial, unanticipated reductions in enterprise resources not caused by other entities
a. Internal events c. Casualties
b. Production d. Exchanges

24. Fire, tornado, and volcanic eruption are examples of accountable events classified as
a. Production c. Events other than transfers
b. Exchange d. Casualties

25. Which of the following is (are) classified as nonreciprocal transfer?

I. Imposition of fines
II. Loss from theft
III. Declaration of dividends
a. I only c. II and III only
b. I and II only d. I, II and III
26. Which of the following is (are) classified as external events other than transfers
I. Exchange of assets with no commercial substance
II. Transfer of materials from one stage of production to another
III. Technological changes caused by other entities
IV. General price level changes
a. I and II only c. II, III and IV only
b. III and IV only d. I, III and IV only

27. In the classification of accountable events, vandalism is an event that

a. is classified as an external event other than transfer
b. cannot be recorded
c. is classified as a nonreciprocal transfer
d. is classified as a casualty

28. Which of the following criteria should be met before a particular action, condition, or set of circumstances qualifies as an
accountable event?
a. It has already happened.
b. It affects the financial position of individual business entities.
c. It can be measured in monetary terms with a reasonable degree of precision.
d. All of the above.

29. Which of the following will not qualify as an accountable event in financial statements according to current generally accepted
accounting principles (assume all amounts are material)?
a. Receipt of a stock split
b. Decline in market value of trading securities held
c. Increase in market value of investment property
d. Revaluation of property

30. Which of the following is not a transaction in a strict sense?

a. Enterprise’s charitable contributions to flood victims
b. Loss of assets due to theft
c. Additional investment by owner
d. Depreciation of property and equipment

QUIZZER 3 – ENVIRONMENT OF ACCOUNTING

Measuring Economic Activity

1. Which accounting process is the assigning of peso amounts to the accountable economic transactions and events?
a. Identifying c. Summarizing
b. Measuring d. Communicating

2. This is usually the primary basis of measurement of assets upon initial recognition
a. Historical cost c. Realizable or settlement value
b. Current cost d. Present value
3. Applied to assets, this is usually are measured by the cash or cash equivalent paid, or the fair value of the consideration given to
acquire them at the time of acquisition. value
a. Historical Cost c. Realizable (settlement) value
b. Current cost d. Present value
4. Under this measurement base, assets are carried at the amount of cash or cash equivalents that would have to be paid if the
same or an equivalent asset was acquired currently
a. Historical cost c. Realizable or settlement value
b. Current cost d. Present value
5. This represents the present discounted value of future net cash inflows that the item is expected to generate in the normal
course of business.
a. Historical cost c. Realizable or settlement value
b. Current cost d. Present value

6. “Historical cost” is another name for

Past Input Price Past Output Price Past Input price Past Output Price
a. Yes No c. No No
b. Yes Yes d. No Yes

7. Which of the following is price based on a future exchange?

a. Discounted cash flow c. Present value of future net cash receipts
b. Net realizable value d. All of these

8. Historical cost is a measurement base currently used in financial accounting. Which of the following measurement bases is (are)
also currently used in financial accounting?
Fair value or current value Discounted Cash Flow Net Realizable Value
a. Yes Yes Yes
 b. No Yes Yes
c. Yes No Yes
d. Yes No No

9. Proponents of the use of historical cost (or price in past purchase exchange) as a measurement of resources in financial
accounting advance that compared with other types of money prices used for measuring resources in financial accounting,
statements using this type are more
a. Indicative of the entity’s purchasing power c. Conservative
b. Relevant d. Objective

10. Which of the following types of acquisition of asset and measurement base is (are) properly and logically matched?
Mode of acquisition Measurement base
1. Acquisition asset by purchase 1. Historical cost
2. Acquisition of machinery by long-term credit 2. Net realizable value
3. Acquisition of land invested by the owner 3. Fair value
a. 1 only b. 1 and 2 only c. 1 and 3 only d. 1, 2 and 3

Users of Accounting Information

11. The investors or providers of risk capital and their advisers are concerned with the following information except
a. The need to determine whether they should buy, hold, or sell their investment
b. The need to assess the ability of the enterprise to pay dividends
c. The need to assess the ability of the enterprise to provide retirement benefits and employment opportunities
d. The need to assess the risk inherent in, and return provided by their investments

12. Customers are interested in information

a. That enables them to determine whether amounts owing to them will be paid when due
b. About the continuance of an enterprise, especially when they have long-term involvement with or are dependent on the
enterprise
c. About the stability and profitability of the enterprise
d. In order to regulate the activities of the enterprise

13. Lenders are interested in information that enables them to determine

a. Whether the entity has the capacity to pay its short-term obligation
b. Whether their loans and the interest attaching to them will be paid when due
c. Whether the enterprise is making a substantial contribution to the local economy
d. Whether the enterprise will continue to operate as a going concern

14. Which of the following is an internal user of a company’s financial information?

a. A member of the board of directors
b. A creditor with long-term contracts with the company
c. A holder of the company’s bonds
d. A stockholder of the company

15. Which of the following groups use financial accounting information to assess the nature and extent of financing needs,
evaluate results of past economic decisions, set dividend policy and project future potential position and income?
a. management c. financial analysts
b. owners d. potential owners

16. These financial statement user group is interested in information that enables them to determine if amounts owing to them,
generally over a shorter period of time, will be paid when due
a. Suppliers & trade creditors c. Investors
b. Lenders d. Stockholders

17. Which of these statements about users of financial information is (are) true?
I. The public need information about the trends and recent developments in the prosperity of the enterprise
II. Employees and their representative groups are interested in information about the stability and profitability of the
enterprise
III. The providers of risk capital and their advisers are concerned with the risk inherent in and return provided by their
investments
IV. Government and their agencies have an interest in information about the continuance of an enterprise, especially when
they have long-term involvement or are dependent on the enterprise
a. Only I is true c. I, II and III are true
b. I and II are true d. All statements are true

Ethics and Challenges of the Accounting Profession

18. Financial statements in the early 2000s provided information related to
a. nonfinancial measurements c. forward-looking data
b. hard assets (inventory & PPE) d. none of these

19. Which of the following is not a major challenge facing the accounting profession?
 a. Nonfinancial measurements c. Accounting for hard assets
b. Timeliness d. Forward-looking information

20. Which of the following is an ethical concern of accountants?

a. Earnings manipulation c. Industry practices
b. Conservative accounting d. None of the above

Numbers 21 to 25 pertain to ethical issues, some procedures and practices by Sara Corp. For each of the situations described in
these numbers, identify what assumption, principle, qualitative objective or constraint is violated
21. Sara Corporation switched from accelerated depreciation method to straight line method because the company's income is
low this year
a. Comparability c. Understandability
b. Neutrality d. Relevance

22. The president of Sara Corp. believes it is foolish to report financial information on a yearly basis. Instead, the president believes
that financial information should be disclosed only when significant new information is available related to the company's
operations.
a. Going Concern c. Periodicity
b. Economic Entity d. Money measurement

23. Sara Corp. decides to establish a large loss and related liability this year because of the possibility that it may lose a pending
patent infringement lawsuit. The possibility of loss is considered remote by its attorneys
a. Measurement Principle c. Revenue recognition Principle
b. Matching Principle d. Disclosure Principle

24. An officer of Sara Corp. purchased a new home computer for personal use with company money, charging this to miscellaneous
expense.
a. Materiality c. Relevance
b. Economic or separate entity d. Verifiability

25. A bookkeeper discovered an omitted sales invoice of P500 while she was preparing the draft financial statements the year.
Since the total sales for the year amount to P5,080,000, she did not correct the error anymore as she reasoned that the amount
anyway is not material. This is
a. An application of the materiality concept
b. A violation of the materiality concept
c. An application of the initial recognition principle
d. A violation of the initial recognition principle

CONCEPTUAL FRAMEWORK OF FINANCIAL ACCOUNTING

Definition: A conceptual framework is a coherent system of interrelated basic concepts and propositions that prescribe objectives,
limits, and other fundamentals of financial accounting and serves as a basis for developing and evaluating accounting principles and
resolving accounting and reporting controversies (FASB).

Preface to the Philippine Financial Reporting Standards

1. Institutions, Professional Bodies and Standard-Setting Due Process
The FRSC
The Financial Reporting Standards Council (FRSC) was established by the Board of Accountancy (BOA or the Board) in 2006 under the
implementing Rules and Regulations of the Philippine Accountancy Act of 2004 to assist the Board in carrying out its power and
function to promulgate accounting standards in the Philippines.

Composition: Appointed by BOA

A Chairman and members that include sectoral representatives from the Philippine Institute of Certified Public Accountants (PICPA),
the Board of Accountancy, the Securities and Exchange Commission, (SEC), Bangko Sentral ng Pilipinas (BSP), Financial Executives
Institute of the Philippines (FINEX) and Philippine Institute of Certified Public Accountants (PICPA), Commission on Audit (COA) and
Bureau of Internal Revenue (BIR)

The FRSC is the successor of the Accounting Standards Council (ASC), which was created on November 18, 1981 by the Philippine
Institute of Certified Public Accountants to establish generally accepted accounting principles in the Philippines.

Responsibility of FRSC: The approval of Philippine Financial Reporting Standards (PFRSs), Philippine Interpretations and related
documents such as the Framework for the Preparation and Presentation of Financial Statements, exposure drafts, and other
discussion documents.
• Once it was established, the FRSC resolved that all Standards and Interpretations issued by the ASC continue to be
applicable unless and until they are amended or withdrawn by the FRSC.
• The Philippine Interpretations Committee (PIC) was formed by FRSC in November 2006 to assist the FRSC in establishing
and improving financial reporting standards in the Philippines. The role of the PIC is principally to issue implementation
guidance on PFRSs. The PIC replaced the former Interpretations Committee created by the ASC in 2000.
Objectives of the FRSC:
(1) The main function of the FRSC is to establish generally accepted accounting principles in the Philippines. In achieving the
objective the FRSC considers Standards issued by the IASB.
(2) The FRSC carries on the decision made by the ASC to converge Philippine accounting standards and international accounting
standards issued by the IASB. The objectives of FRSC in this respect are:
a) To develop, in the public interest a single set of high quality, understandable and enforceable accounting standard that
require, high quality, transparent and comparable information in financial statements and other financial reporting to
help participants in the various capital markets and other users of the information to make economic decisions
b) To promote the use and rigorous application of those standards; and
c) To work for the convergence of Philippine accounting standards with international Financial Reporting Standards
(PFRSs) issued by the IASB.

Scope and Authority of PFRSs

1) The FRSC issues its Standards in a series of pronouncements called Philippine Financial Reporting Standards (PFRSs). These
consist of:
(a) Philippine Financial Reporting Standards (PFRSs) (these correspond to the International Financial Reporting Standards
(IFRSs)
(b) Philippine Accounting Standards (PASs) (these correspond to International Accounting Standards (IASs); and
(c) Philippine Interpretations (these correspond to Interpretations of the IFRIC and the Standing Interpretations Committee
(SIC) of the IASC. (These also include Interpretations developed by the PIC)

2) The FRSC achieves its objectives primarily by developing and issuing Philippine Financial Reporting Standards (PFRSs) and
promoting the use of these standards in general purpose financial statements and other financial reporting.

3) PFRSs sets out the recognition, measurement, presentation and disclosure requirements dealing with transactions and
events that are important in general purpose financial statements. They may also set out such requirements for the
transactions and events that arise mainly in specific industries. The Framework also provides a basis for the use of judgment
in resolving accounting issues.

4) PFRSs are designed to apply the general purpose financial statements and other financial reporting of all profit-oriented
entities. Profit-oriented entities include those engaged in commercial, industrial, financial and similar activities, whether
organized in corporate or any other forms. They include organizations such as mutual insurance companies and other
mutual cooperative entities that provide dividends or other economic benefits directly and proportionately to their owners,
members or participants. Although PFRSs are not designed to apply to not-for profit activities in private sector, public
sector or government, entities with such activities may find them appropriate

5) PFRSs apply to all general purpose financial statements. These financial statements are directed towards the common
information needs of a wide range of users, for example, shareholders, creditors, employees and the public at large.

The objective of financial statements is to provide information about the financial position, performance and cash flows of
an entity that is useful to those users in making economic decisions.

6) A complete set of financial statements include a statement of financial position (or balance sheet), a statement of
comprehensive income , a statement showing either all changes in equity or changes in equity other than those arising from
capital transactions with owners and distribution to owners, a cash flow statement, and accounting policies and
explanatory notes.

7) Interpretations of PFRSs are intended to give authoritative guidance on issues that are likely to receive divergent or
unacceptable treatment in the absence of such guidance.

Philippine Due Process in Accounting Standard-Setting

PFRSs are developed through a due process that includes members of PICPA, financial executives, regulatory authorities, academics,
and other interested individuals and organizations. Due process for projects normally, but not necessarily includes the following
steps:
a) Consideration of pronouncements of the IASB;
b) Formation of a task force, when deemed necessary, to give advice to the FRSC;
c) Issuing for comment an exposure draft approved by a majority of the FRSC members, comment period will be at least 60 days
unless a shorter period (not less than 30 days) is considered appropriate by FRSC.
d) Consideration of all comments received within the comment period and, when appropriate, preparing a comment letter to
the IASB; and
e) Approval of the standard or an interpretation by a majority of the FRSC members.
f) Approval of the Standard by majority of the members of the Board of Accountancy.
g) Final approval of the Accounting standard or Interpretation by the Professional Regulation Commission
h) Publication in the PRC Official Gazette

FRAMEWORK FOR THE PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS

CONCEPTUAL FRAMEWORK LEVEL 1

1. Purpose and Status

The FRSC Framework for the Preparation and Presentation of Financial Statements identifies the following purposes:
a) Assists the FRSC in the development of future Philippine Financial Reporting Standards and its review of existing Philippine
accounting standards.
b) Assists preparers of financial statements in applying the Statements of Financial Accounting Standards and in dealing with
topics that have yet to form the subject of a Philippine Financial Reporting Standard
c) Assists auditors in forming an opinion as whether financial statements conform with Philippine Financial Reporting Standards.
d) Assists users of financial statements in interpreting the information contained in financial statements prepared in conformity
with Philippine Financial Reporting Standards, and
e) Provides those who are interested in the work of FRSC with information about its approach to the formulation of Statements
of Philippine Financial Accounting Standards.

This framework is not a PFRS. However, when developing an accounting policy in the absence of a standard or an Interpretation that
specifically applies to an item, an entity’s management is required to refer to, and consider the applicability of the concepts of the
Framework. (see PAS 8, Accounting Policies, Changes in Accounting Estimates and Errors).

In a limited number of cases where there may be a conflict between the Framework and the requirements within the Standard or
Interpretation, the Standard or Interpretation should prevail over those of framework.

. Scope
1) The framework deals with:
(a) The objective of financial statements:
(b) The qualitative characteristics that determine the usefulness of information in financial statements.
(c) The definition, recognition and measurement of the elements from which financial statements are constructed; and
(d) Concepts of capital and capital maintenance

A complete set of financial statements normally include:

• A statement of financial position
• A statement of comprehensive income
• A statement of changes in financial position (which could be presented in many ways, like a statement of cash flows), and
• Those notes and other statements and explanatory material that are an integral part of the financial statements. They may
also include supplementary schedules and information based on, or derived from and expected to be read with such (ex:
financial information about industrial and geographical segment, and disclosures about the effects of changing prices.

3. Special purpose financial statements are outside of the scope of this Framework.

4. Applicability: Financial statements of all commercial, industrial, and business reporting enterprises whether public or private
sector. A reporting enterprise is an enterprise for which there are users who rely on the financial statements as their major
source of financial information about the enterprise.

5. Users and their Information Needs

Users of the financial statements have different needs for the information which are as follows:
a. Investors – The provider of risk capital and their advisers are concerned with the risk inherent in, and return provided by their
investments. They need information:
• to help them determine whether they should buy, hold or sell
• to assess the ability of the enterprise to pay dividends
b. Employees – Employees and their representative groups need information about the stability and profitability of their
employers. They need information that will enable them:
• to assess the ability of the enterprise to provide remuneration, retirement benefits and employment opportunities.
c. Lenders – Lenders are interested in the information that enables them:
• to determine whether their loans, and the interest attaching to them will be paid when due.
d. Suppliers and other trade creditors – They are interested in information that enable them:
• to determine whether the amounts owing to them will be paid when due.
• Trade creditors are likely to be interested in an enterprise over a shorter period of time than lenders unless they are
dependent upon the continuation of the enterprise as a major customer.
e. Customers – They need information that enable them to:
• to know about the continuance of the enterprise, especially when they have a long term involvement with, or are
dependent on, the enterprise.
f. Government and their agencies – They are interested in the allocation of resources and activities of the enterprise. They require
information:
• to regulate the activities of the enterprises,
• to determine taxation policies and as the basis for national income and similar statistics.
g. Public – Enterprises affect the members of the public in a variety ways. For example the enterprises may make a substantial
contribution to the local economy in many ways, including the number of people they employ and their patronage of the local
suppliers. The public need financial statements in order to assists them
• to determine trends and recent developments in the prosperity of the enterprise and the rank of its activities.

The basic financial statements are designed to meet the common needs of all users. As investors are providers of risk capital to
the enterprise, the provision of financial statements that meet their needs will also meet most of the needs of other users.

6. Responsibility for the Financial Statements

 The management of an enterprise has the primary responsibility for the preparation and presentation of the financial
statements of the enterprise.

7. Objective of Financial Statements

The objective of financial statements is to provide information about the financial position, performance and changes in
financial position of an enterprise that is useful to a wide range of users in making economic decisions.
Financial statements prepared for this purpose:
• Meet the common needs of most users.
• Also show the results of the stewardship of management, or accountability of management for the resources entrusted to
it.
• Do not, however provide all the information that users may need to make decisions since they largely portray the financial
effects of past events and do not necessarily provide non-financial information.

A. Financial position – The financial position of an enterprise is affected by the economic resources it controls, its financial structure,
it liquidity and solvency, and its capacity to adapt to changes in the environment in which it operates. This is primarily provided in
the Statement of Financial Position (or Balance Sheet). It answers the following questions:
• What assets does the entity own?
• What does it owe?
• What are the residual equity interests in the entity’s net assets?

Other important information provided by the statement of financial position are as follows:
• Financial structure – is the source of financing for the assets of the enterprise. It indicates what amount of assets has been
financed by creditors, which is borrowed capital, and what amount of assets has been financed by owners, which is
invested capital.
Significance: (1) Useful in predicting future borrowing needs and how future profits and cash flows will be distributed
among those with an interest in the enterprise
(2) Useful in predicting how successful the enterprise is likely to be raising further finance.
• Liquidity – refers to the availability of cash in the near future after taking account of financial commitments over this
period.
Significance: Useful in predicting the ability of the enterprise to meet its short-term financial commitments as they fall
due
• Solvency – refers to the availability of cash over the longer term to meet financial commitments as they fall due
Significance: Useful in predicting the ability of the enterprise to meet its long-term financial commitments as they fall
due
• Capacity for adaptation – the ability of the enterprise to use its available cash for unexpected requirements and investment
opportunities. This is also known as financial flexibility. It can be accomplished by raising cash at a short notice either
through borrowing or issuance of securities or by disposal of assets without disrupting normal operations.
Significance: Information about the economic resources controlled by the enterprise and its capacity for adaptation is
useful in predicting the ability of the enterprise to generate cash and cash equivalents in the future

B. Financial performance reflected by accrual accounting

Performance of an enterprise – comprises its revenue, expenses, net income or loss for a period of time. It is the level of income
earned by the enterprise through efficient and effective use of its resources. Information about the performance of an enterprise, in
particular its profitability, is important in assessing potential changes in the economic resources that it is likely to control in the
future. Information about performance is primarily provided in a statement of comprehensive income.

Accrual accounting recognizes transactions and other events of a reporting entity in the periods in which those effects occur, even if
the resulting cash receipts and payments occur in a different period.

Current financial reporting standards provide that all increases and decreases in equity other than from owner – related
transactions, that is, income, expense, realized and unrealized gains and losses should be reported in the overall performance
report.

Changes in financial position – refers to the changes in the economic resources and obligation of an enterprise. In constructing a
statement of changes in financial position, funds can be defined in various ways, such as all financial resources, working capital,
liquid assets or cash. .

Information about changes in financial position is provided in the financial statement by means of a separate statement.
Significance: (1) Useful in assessing investing, financing and operating activities during the reporting period.
(2) Useful in providing the user with a basis to assess the ability of the enterprise to generate cash and cash
equivalents and the needs of the enterprise to utilize those cash flows.

Fundamentally related financial statements – The component parts of the financial statements interrelate because they reflect
different aspects of the same transactions or other events. Although each statement provides information that is different from the
others, none is likely to serve only a single purpose or provide all the information necessary for particular needs of users.
Notes and Supplementary Schedules
The financial statements also contain notes and supplementary schedules and other information. For example, they may contain
additional information that is relevant to the needs of users about the items in the balance sheet and income statement. They may
include:
• Disclosures about risks and uncertainties affecting the enterprise and
• Any resources and obligations not recognized in the balance sheet (mineral reserves)
• Information about geographical and industry segments and the effect on the enterprise of changing prices

CONCEPTUAL FRAMEWORK LEVEL 2

Qualitative Characteristics of Financial Statements

If financial information is to be useful, it must be relevant and faithfully represent what it purports to represent. The usefulness of
financial information is enhanced if it is comparable, verifiable, timely and understandable.

A. Fundamental Qualitative Characteristics

The fundamental qualitative characteristics are
1. relevance and
2. faithful representation

(1) Relevance
Relevant financial information is capable of making a difference in the decisions made by users. Information has the quality of
relevance when it influences the economic decisions of users by helping them to evaluate, past, present, or future events or
confirming, or correcting, their past evaluations.

Financial information is capable of making a difference in decisions if it has predictive value or confirmatory value, or both.
(a) Predictive value - Financial information has predictive value if it can be used as an input to processes employed by users to
predict future outcomes. Thus, the information can help users increase the likelihood of correctly predicting or forecasting
outcome of events. For instance, information about financial position and past performance is frequently used in predicting
dividend and wage payments, and the ability of the enterprise to meet maturing commitments
(b) Confirmatory value (or feedback) - Financial information has confirmatory value if it provides feedback about (confirms or
changes) previous evaluations. Information with feedback value enables users to confirm or correct expectations.
The predictive value and confirmatory value of financial information are interrelated.

Materiality
Materiality is an entity-specific aspect of relevance based on the nature or magnitude, or both, of the items to which the information
relates in the context of an individual entity’s financial report. Materiality provides a threshold or cut-off point rather than being a
primary qualitative characteristic which information must have to be useful. The relevance of information is affected by its nature
and materiality. Information is material if its omission or misstatement could influence the economic decisions.

(2) Faithful Representation

Financial reports represent economic phenomena in words and numbers. To be useful, financial information must not only
represent relevant phenomena, but it must also faithfully represent the phenomena that it purports to represent.

Characteristics of faithful representation:

a) Completeness - A complete depiction includes all information necessary for a user to understand the event or information
being presented, including all necessary descriptions and explanations.
b) Neutrality - A neutral presentation of information is one without bias. A neutral information is one that is not manipulated to
increase the probability that financial information will be received favorably or unfavorably by users.
c) Freedom from error - means there are no errors or omissions in the description of the phenomenon, and the process used to
produce the reported information has been selected and applied with no errors in the process.

Faithful representation does not mean accurate in all respects. In this context, free from error does not also mean perfectly accurate
in all respects. For example, an estimate of an unobservable price or value cannot be determined to be accurate or inaccurate.
However, a representation of that estimate can be faithful if the amount is described clearly and accurately as being an estimate, the
nature and limitations of the estimating process are explained, and no errors have been made in selecting and applying an
appropriate process for developing the estimate.

B. Enhancing Qualitative Characteristics

The usefulness of information that is relevant and faithfully represented is enhanced by the qualitative characteristics of
comparability, verifiability, timeliness and understandability
(1) Comparability - is the qualitative characteristic that enables users to identify and understand similarities in, and differences
among, items. Unlike the other qualitative characteristics, comparability does not relate to a single item. A comparison
requires at least two items.

Users’ decisions involve choosing between alternatives, for example, selling or holding an investment, or investing in one reporting
entity or another. Consequently, information about a reporting entity is more useful if it can be compared with similar information
about other entities and with similar information about the same entity for another period or another date.

Consistency, is not the same as comparability. Consistency refers to the use of the same methods for the same items, either from
period to period within a reporting entity or in a single period across entities.

Comparability is the goal; consistency helps to achieve that goal.

(2) Verifiability – means that different knowledgeable and independent observers could reach consensus, although not necessarily
complete agreement, that a particular depiction is a faithful representation. Verifiability helps assure users that information
faithfully represents the economic phenomena it purports to represent.

Verification can be direct or indirect. Direct verification means verifying an amount or other representation through direct
observation, for example, by counting cash. Indirect verification means checking the inputs to a model, formula or other
technique and recalculating the outputs using the same methodology.

(3) Timeliness – means having information available to decision-makers in time to be capable of influencing their decisions.
Generally, the older the information is the less useful it is. However, some information may continue to be timely long after the
end of a reporting period because, for example, some users may need to identify and assess trends.

(4) Understandability – means classifying, characterizing, and presenting information clearly and concisely. Some phenomena are
inherently complex and cannot be made easy to understand. However, excluding this information from the financial reports
may render these reports be incomplete and therefore potentially misleading.

Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review
and analyze the information diligently. At times, even well-informed and diligent users may need to seek the aid of an adviser to
understand information about complex economic phenomena.

C. Cost Constraint
Cost is a pervasive constraint on the information that can be provided by financial reporting. Reporting financial information
imposes costs, and it is important that those costs are justified by the benefits of reporting that information.

Providers of financial information expend most of the effort involved in collecting, processing, verifying and disseminating financial
information, but users ultimately bear those costs in the form of reduced returns. Users of financial information also incur costs of
analyzing and interpreting the information provided. If needed information is not provided, users incur additional costs to obtain
that information elsewhere or to estimate it.

In applying the cost constraint, there is a need to assess whether the benefits of reporting particular information are likely to justify
the costs incurred to provide and use that information.

VI. The Elements of Financial Statements

Financial statements portray the financial effects of transactions and other events by grouping them into broad classes according to
their economic characteristics. These are termed the elements of financial statements. Elements directly related to measurement of
financial position are Assets, Liabilities and Equity while elements directly related to measurement of performance are Income and
Expenses.

The statement of changes in financial position usually reflects income statement elements and changes in balance sheet elements;
accordingly, this Conceptual Framework identifies no elements that are unique to this statement. The presentation of these
elements in the balance sheet and the income statement involves a process of sub-classification. For example, assets and liabilities
may be classified by their nature or function in the business of the entity in order to display information in the manner most useful
to users for purposes of making economic decisions.

QUIZZER 4 CONCEPTUAL FRAMEWORK LEVELS 1 and 2

The IASB, FASB, FRSC AND “DUE PROCESS”

1. The IASB conceptual framework is intended to establish
a. Generally accepted accounting principles in financial reporting by business enterprises
b. The meaning of “present fairly in accordance with generally accepted accounting principles”
c. The objectives and concepts for use in developing standards of financial accounting and reporting
d. The hierarchy of sources of generally accepted accounting principles.

2. The purpose of the International Accounting Standards Board is to

a. Issue enforceable standards which regulate the financial accounting and reporting of multinational companies
b. Develop a uniform currency in which the financial transactions of companies throughout the world would be
measured
c. Develop a single set of high quality IFRS.
d. Arbitrate accounting disputes between auditors and international companies

3. Which of these statements regarding the IFRS and US GAAP is correct?

a. US GAAP is considered to be “principles-based” and more detailed than IFRS
b. US GAAP is considered to be “rules-based” and less detailed than IFRS
c. IFRS is considered to be “principles-based” and less detailed than US GAAP
d. Both US GAAP and IFRS are considered “rules-based”, but US GAAP tends to be more complex
4. Which of the following is not included in the scope of the IASB’s conceptual framework?
a. Qualitative characteristics of useful financial accounting information
b. Definition, recognition & measurement of the elements
c. Concepts of capital and capital maintenance
d. Generally accepted accounting principles
 5. What is due process in the context of standard setting at the IASB?
a. IASB and FASB operates in full view of the public
b. Public hearings are held on proposed accounting standards
c. Interested parties can make their views known
d. All of these

6. The following published documents are part of the “due process” system used by the IASB in the evolution of a typical IASB
Standard
1. Exposure Draft
2. IASB Standard
3. Discussion Paper
The chronological order in which these items are released is as follows:
a. 1, 2, 3 b. 1, 3, 2 c. 2, 3, 1 d. 3, 1, 2

7. Which one of the following bodies is responsible for reviewing accounting issues that are likely to receive divergent or
unacceptable treatment in the absence of authoritative guidance with a view to reaching a consensus as to the appropriate
accounting treatment?
a. International Financial Reporting Interpretations Committee (IFRIC)
b. Standards Advisory Council (SAC)
c. International Accounting Standards Board (IASB)
d. International Accounting Standards Committee Foundation (IASCF)

8. Which of the following are parts of the “due process” of the IASB in issuing a new International Financial Reporting
Standard?
(1) Establishing an advisory committee to give advice
(2) Reviewing compliance and enforcement procedures
(3) Issuing an interpretation as authoritative interim guidance
(4) Developing and publishing a discussion document for public comment
a. (1) and (4) b. (2) and (3) c. (2) and (4) d. ( 1) and (3)

The Financial Reporting Standards Council

9. The main function of this body is to establish and improve accounting standards that will be generally accepted in the
Philippines
a. Board of Accountancy c. Professional Regulation Commission
b. Philippine Institute of CPAS d. Financial Reporting Standards Council

10. You are given the following statements relating to the FRSC and standard setting process in the Philippines. Which of these
is (are) true?
I. All members of the FRSC should be CPAs.
II. The Financial Reporting Standards Council (FRSC) Board of Accountancy (BOA) and Professional Regulation
Commission (PRC) are all involved in the standard setting process, with PRC as the final approving authority.
a. Only I is true c. I and II are true
b. Only II is true d. I and II are false

11. Which of the following is a characteristic of the Financial Reporting Standards Council (FRSC)?
a. FRSC members must come from CPA firms
b. FRSC members are required to render service on full-time basis
c. All four sectors of the Accountancy profession are represented in the FRSC
d. All members should be CPAs

12. Which of the following are parts of the “due process” of the IASB in issuing a new International Financial Reporting
Standard?
(1) Establishing an advisory committee to give advice
(2) Reviewing compliance and enforcement procedures
(3) Issuing an interpretation as authoritative interim guidance
(4) Developing and publishing a discussion document for public comment
a. (1) and (4) b. (2) and (3) c. (2) and (4) ( 1) and (3)

13. Which of the following is (are) part of the financial reporting standard setting process in the Philippines?
I. Consideration of pronouncements of the IASB;
II. Creation of a task force by the standard setting body to study the proposed accounting standard
III. Distribution of the exposure draft for comment to CPA professionals and other interested parties.
IV. Approval by the Financial Reporting Standards Council and eventually by the Professional Regulation Commission
V. Publication in the Official Gazette and in a newspaper of general circulation
a. I and IV only c. I, II, III and IV only
b. II, III and V only d. I, II, III, IV and V

14. Once the FRSC has established an accounting standard

a. The standards are continually reviewed to see if modifications or amendments are necessary
 b. The standards are not reviewed unless the SEC makes a complaint
c. The task of reviewing the standard to see if modification is necessary is given to PICPA
d. The standard should never be modified to conform with the principle of consistency

15. As an assistance to the FRSC, Philippine Accountancy profession and the public it serves, which of the following should the
Philippine Interpretations Committee (PIC) consider issuing an interpretation?
I. Newly identified financial reporting issues in the Philippines not specifically Addressed in PFRSs
II. Narrow industry-specific issues arising in the international business scene
III. Philippine accounting and reporting issues when unsatisfactory or conflicting interpretations have developed or seem
likely to develop
a. I and II only c. II and III only
b. I and III only d. I, II and III

Nature/Purpose/Scope
16. A conceptual framework is
a. An International Financial Reporting Standard
b. An underlying accounting assumption
c. A theoretical foundation which guides the accounting standard-setters, the prepares and users of financial accounting
information in the preparation and presentation of financial statements
d. A financial statement

17. Which is not a basic purpose of a conceptual framework?

a. Assist preparers of financial statements in applying FRSC accounting standards
b. Assist accounting standard-setting body in reviewing and adopting International Accounting Standards
c. Assist accounting standard setting body in developing accounting standards
d. A assist the Board of Accountancy in promulgating rules and regulations affecting the practice of accountancy in the
Philippines

18. A soundly developed conceptual framework of concepts and objectives should

a. Increase financial statement users’ understanding of and confidence in financial reporting
b. Enhance comparability among companies’
c. Allow new and emerging practical problems to be more quickly solved
d. All of these

19. In the conceptual framework for financial reporting, what provides the “why” – the goals and purposes of accounting?
a. Measurement and recognition concepts such as assumptions principles and constraints
b. Qualitative characteristics of accounting information
c. Elements of financial accounting
d. Objective of financial reporting

20. The underlying theme of the conceptual framework is

a. Decision usefulness c. Reliability
b. Understandability d. Comparability

21. The accounting standard setting body in the Philippines is currently known as
a. The Accounting Standards Council
b. The Financial Reporting Standards Council
c. The Auditing Standards and Practices Council of the Philippines
d. The Auditing and Assurance Standards Council

22. The conceptual framework applies to all financial statements of reporting enterprises described as
a. Industrial enterprise c. Business enterprise
b. Commercial enterprise d. All of these

23. Which of the following statements regarding the Conceptual Framework of accounting is (are) correct?
I. The Framework deals with the qualitative characteristics of financial statements
II. The Framework normally prevails over International Accounting Standards where there is a conflict between the two
III. The Framework deals with the objectives of financial statements and the users of financial information
a. Only I is true c. I and III are true
b. I and II are true d. All statements are true

Users of Financial Information

24. Which users need financial information to enable them to assess the ability of the enterprise to pay dividends?
a. Employees c. Suppliers
b. Lenders d. Investors
25. Which users need financial information to assess trends and recent developments in the prosperity of an enterprise?
a. Customers c. Government & their agencies
b. Public in general d. Employees
 26. Which of the following financial statement users need to determine whether obligations due them, usually over a short
period of time, will be paid when due?
a. Employees c. Suppliers and other trade creditors
b. Lenders d. Customers

27. Which of the following users will need financial information to regulate activities of an enterprise and determine taxation
policies?
a. Lenders c. Management
b. Government and their agencies d. Public

28. Which of the following statement users will use financial information to anticipate price changes, seek alternative sources of
supply, and assess ability of enterprise to operate as a going-concern?
a. Public in general c. Lenders
b. Customers d. Employees

29. Which of the following statement users need to determine whether the obligations due them for loans granted and the
related interest will be paid when due?
a. Lenders c. Suppliers and other trade creditors
b. Customers d. Investors
30. Which users need financial information to enable them to assess the ability of the enterprise to provide remuneration and
retirement benefits and employment opportunities?
a. Employees c. Customers
b. Government and its agencies d. Investors

Basic Features/Assumptions of Accounting

31. According to FRSC Conceptual Framework, the following may be considered among the basic features of accounting that
have a direct relationship with preparation and presentation of financial statements.
a. Accounting Entity and Time Period c. Going Concern and Exchange Price
b. Accrual and Going Concern d. Timeliness and Neutrality

32. The following statements, are applications of the basic features of financial accounting except
a. A parent corporation and its subsidiaries are treated as a single enterprise.
b. Estimates used in accounting are based on informed judgment.
c. Economic activities that can be quantified are emphasized in financial accounting.
d. Financial information should be presented in a way that facilitates understanding and avoids erroneous implications.

33. Clarence, Inc. is a company whose securities are traded on over-the-counter market. It controls Sherwin Corp. Consolidated
financial statements are prepared in recognition of the accounting concept of
a. Economic entity c. Legal entity
b. Materiality d. Flexibility

34. The following statements relate to basic assumptions of financial accounting. Which is false?
a. An enterprise is not viewed as a going concern if liquidation appears imminent.
b. The life of an enterprise is divided into equal time segments at the end of which financial statements are prepared.
c. The basic financial statements contain the same underlying data and made use of the same measurement rules, and
are therefore fundamentally related.
d. Financial accounting measurements are primarily based on current values.

35. This assumption states that the determination of periodic income and financial position depends on the measurement of
economic resources and obligations and changes in them as the changes occur rather than simply on receipt or and
payments of cash.
a. Accrual c. Monetary Unit
b. Going concern d. Time period

36. When a parent company and subsidiary relationship exists, consolidated financial statements are prepared in recognition of
a. Legal entity c. Stable monetary unit
b. Economic entity d. Time period

37. Which underlying concept serves as the basis for preparing financial statements at regular intervals of time?
a. Accounting entity c. Accounting period
b. Going concern d. Stable monetary unit

38. Past experience indicates that continuation of operations is highly probable for most enterprises although continuation
cannot be known with certainty.
a. Going concern c. Periodicity
b. Accounting entity d. Monetary unit
39. The accounting function is to account for nominal pesos only and not for changes in purchasing power
a. Accrual c. Separate entity
b. Monetary unit d. Time period
 40. The concept that justifies the classification of assets and liabilities in the balance sheet as to current and non-current is
a. Going concern c. Monetary postulate
b. Accounting entity d. Periodicity

Basic Financial Statements

41. The general objective of financial statements is
a. To provide financial information to assist users make economic decisions
b. To disclose the market value of the firm’s assets and liabilities
c. To determine compliance with tax laws
d. To make forecasts about the economy

42. Financial statements include a statement of financial position, a statement of cash flows and a statement of changes in
equity. Which TWO of the following are also included in basic financial statements?
(1) A statement of comprehensive income (3) Accounting policies
(2) A statement of retained earnings (4) An income statement
a. (1) and (2) c. (1) and (3)
b. (3) and (4) d. (2) and (4)

43. It is generally referred to as the financial flexibility of an enterprise

a. Liquidity c. Financial structure
b. Solvency d. Capacity for adaptation

44. It is the level of income earned by an enterprise through efficient and effective utilization of resources.
a. Financial position c. Positive cash flows
b. Performance d. Negative cash flows

45. This statement shows information about the operating, investing and financing activities of the enterprise during a period of
time.
a. Statement of Receipts and Disbursements c. Statement of Cash Flows
b. Statement of Financial Position d. Statement of Changes in Owner’s Equity

46. This refers to the availability of cash over a long term to meet financial commitments when they fall due.
a. Liquidity c. Financial flexibility
b. Solvency d. Financial structure

47. This indicates what amount of assets has been financed by creditors (borrowed capital) and how much has been financed by
owners (equity/invested capital)
a. Solvency c. Financial position
b. Financial structure d. Financial flexibility

48. Which of the following statements about the financial statements is true?
a. A prediction of events and transactions that will give rise to cash inflows and cash outflows is best seen in the
Statement of Cash Flows.
b. A statement of Comprehensive Income shows only realized gains and losses for the period.
c. The Statement of Changes in Equity shows information about owner-related transactions and events as well as results
of profit – directed activities including realized and unrealized gains and losses for a time-period.
d. Notes to financial statements are necessary because there are significant transactions and events that are non-
quantifiable but are important in making economic decisions.

Qualitative Objectives/Constraints
49. Which of the following is not considered a qualitative objective of financial accounting or aspect of these objectives?
a. Objectivity c. Consistency
b. Freedom from bias d. Conservatism

50. Which one of the following is not a fundamental qualitative objective of financial accounting?
a. b. c. d.
Relevance yes yes no no
Comparability yes no no yes
Faithful representation no yes yes no

51. Which of these are not enhancing qualitative characteristics?

a. Relevance and prudence c. Timeliness and verifiability
b. Understandability and comparability d. Comparability and timeliness

52. Which of the following is (are) an attribute of the fundamental qualitative characteristic of relevance?
a b. c. d.
Timeliness Yes No No Yes
Predictive value Yes No Yes No
Confirmatory value Yes No Yes No
 53. Comparability of financial information depends on
a. b. c. d.
Consistency Yes Yes No No
Regular reporting periods No Yes No Yes

54. It is the capacity of information to make a difference in decision by helping users form predictions about outcome of past,
present and future events or conform and correct prior expectations.
a. Relevance c. Comparability
b. Understandability d. Reliability

55. Which of the following is (are) the quality of information that assures readers that the information is representationally
faithful?
a b. c. d.
Freedom from error Yes No Yes No
Freedom from bias Yes Yes No No
Completeness Yes No No Yes

56. It is the ability to bring together for the purpose of noting similarities and dissimilarities.
a. Relevance c. Reliability
b. Understandability d. Comparability

57. Some accounting measures are more easily verified than others. Which of the following is the least verifiable measure?
a. Cost of machinery c. Salaries paid for the period
b. Amount of cash d. Net realizable value of accounts receivable

58. Objectivity is assumed to be achieved when an accounting transaction

a. Is recorded in a fixed amount of pesos
b. Involves the payment or receipt of cash
c. Involves an arm’s length transaction
d. Allocate revenues or expenses in a rational manner

59. If accounting information is neutral, complete, and free from error, then such information is
a. Relevant c. Comparable
b. Representationally faithful d. Understandable

60. The consistency standard of reporting requires that

a. Expenses are charged against the period in which they are incurred.
b. Whenever there is a change in an accounting method from one that was previously used by an enterprise, such change
must be justifiable and must be disclosed in the financial statements.
c. Extraordinary gains and losses should not appear in the income statement
d. Accounting procedures be adopted which give a consistent rate of net income

61. Which of the following terms are least properly matched?

a. Comparability and consistency c. Neutrality and freedom of bias
b. Verifiability and objectivity d. Neutrality and prudence

62. Which of the following is the threshold of recognition as to what information is relevant to be displayed in the balance sheet
or the income statement
a. Materiality c. Prudence
b. Timeliness d. Understandability

63. This accounting concept means that in case there is a conflict between economic substance and legal form, the economic
substance should prevail
a. Substance and form c. Form over substance
b. Substance over form d. Faithful representation

64. What is meant by comparability when discussing financial information?

a. Information has predictive or feedback value
b. Information is reasonably free from error
c. Information that is measured and reported in similar fashion across companies
d. Information is timely

65. What is meant by consistency when discussing financial accounting information?

a. Information that is measured and reported in a similar fashion across points in time.
b. Information is timely
c. Information is measured similarly across the industry
d. Information is verifiable
66. Which of the following is not a proper condition for comparability within a single enterprise?
a. The contents of the statements are identical
b. Accounting principles should not be changed, or if they are changed, the financial effects need not be disclosed.
c. The presentation of the financial statements are in the same form
d. Changes in the circumstances or in the nature of underlying transactions are disclosed.

67. Under the revised Conceptual Framework of 2010, which of the following is a constraint when implementing accounting
procedures to achieve the qualitative objectives of relevance and reliability as set forth in the FRSC conceptual framework?
a. Cost c. Materiality
b. Timeliness d. Balance between qualitative characteristics

68. Financial reporting is concerned only with information that is significant enough to affect evaluation or decision.
a. Timeliness c. Materiality
b. Cost and benefit d. Comparability

69. Which of the following is not an element of faithful representation?

a. Influence on the economic decisions of users
b. Neutral presentation of financial information
c. Freedom from material error
d. Completeness of information

70. Which of the following situations violates the concept of reliability?

a. Financial statements were issued nine months late
b. Report on segments having the same expected risks and growth rates to analysts estimating future periods
c. Financial statements included property with a carrying amount increased to management’s estimate of market value
d. Management reports to stockholders regularly refer to new projects undertaken, but the financial statements never
report project results.

END OF MODULE 1
 MMCO Continuing Professional Development Training Center (CPDTC)
2F MMCO Building, 8000 Lakeview Ph3 Angela Street, Halang Calamba City Laguna, Philippines
Tel No. (02) 330-8617, (049) 523-6031; (02) 330-6057
CPA REVIEW (May 2019 Batch)
FAR Theory Cedrick Zapanta, CPA
Module 2
1. Bookkeeping Systems
2. Review of the Accounting Process
3. Income Recognition Bases
BOOKEEPING SYSTEMS

Definition: Bookkeeping is the systematic and chronological recording of transactions and events in books of account. It is also known as
the recording phase of accounting.

Systems of Bookkeeping
1. Single Entry Bookkeeping – a system of bookkeeping whereby, as a general rule only cash and personal accounts are recognized.

2. Double Entry Bookkeeping – a system of bookkeeping which views a transaction as having two-fold effect on accounting values, (i.e., a
value received and a value parted with and which reflects these two-fold effects in the accounting record).

Single Entry Bookkeeping System

Single entry bookkeeping is usually adopted by organizations with relatively few and simple transactions such that they do not employ
the services of a bookkeeper.

Books of account used in single-entry system include:

• Day Book or General Journal – records transactions in chronological order and in narrative form
• Cash Book and Subsidiary Ledgers (debtors and creditors)
o The cash book records all transactions affecting cash (no account titles are maintained)
o The subsidiary ledgers record transactions with debtors and creditors

Single-entry formula in arriving at profit or loss for the period:

Equity, end of the year P xx
Equity, beginning of the year xx
Total increase (decrease in equity) xx
Add: Amounts withdrawn by owners xx
Less: Additional investments by owners (xx)
Profit (loss) for the year P xx

Distinctions between Double Entry and Single Entry

A. Principles involved
1. Duality (VR / VPW) Recognizes only one phase of a transaction
2. Equilibrium (or equality)
B. Transactions and events recorded
Records every type of accountable event (transactions Records only transactions involving cash and personal
approach) accounts

C. Accounts recognized
Assets, Liabilities, Equity, Income, and Expenses Cash, Accounts Receivable, Accounts Payable, and Equity
D. Books used
Journals and Ledgers Cash Book, Subsidiary Ledgers
E. Financial statement preparation
Financial statements are prepared using a systematic Income (Loss) is determined using the Net Assets Method,
processing of data known as the accounting process. Income sometimes known as Analysis Approach / Residual or
(Loss) is computed using the direct matching approach. Indirect Approach.
F. Financial statements
Statement of Financial Position Statement of Assets, Liabilities and Net Worth (SALN)
Statement of Comprehensive Income Summary of Changes in Equity
Statement of Cash Flows
Statement of Changes in Equity
Notes to Financial Statements

REVIEW OF THE ACCOUNTING PROCESS

Broad Steps of Operation in the Financial Accounting Process under Double-Entry System of Bookkeeping

These are the series of steps undertaken in one accounting period to identify, record, store and report accounting information
contained in accountable events.
1. Selecting the event (or Identification of accountable events) – an event or transaction is selected for recording if it complies with
the criteria for accountable events set under double–entry principles
2. Analyzing the events – events are analyzed to determine their effects on the financial position of the enterprise
3. Measuring the effects – effects of the events on the financial position of the enterprise are measured and represented by money
amounts.
4. Classifying the measured effects – the effects are classified according to the individual assets and liabilities, owners’ equity items ,
revenue and expenses affected
5. Recording the measured effects – the effects are recorded according to the asset, liability, equity, revenue and expense items
affected (journalizing and posting)
6. Summarizing the recorded effects – the amount of changes for each asset, liability, equity item, revenue and expenses are
summed and related data are grouped (trial balance preparation)
7. Adjusting the records – re-measurements, new data, corrections or other adjustments are often required after the events have
been initially recorded, classified, and summarized of financial statements (preparation of adjusting entries including worksheet
preparation)
8. Communicating the processed information – the information is communicated to users in the form (Preparation of Financial
Statements)

The accounting cycle is a series of well-defined steps leading to the communication of the effects of a business transaction.

The accounting cycle implements the accounting process from period to period.

Steps in the Accounting Cycle

1. Identifying and analyzing transactions and events to be recorded – gathering of information from source documents and
determining the impact of the transaction or event on the financial position using the equation “Assets equals Liabilities + Owners’
Equity”.
2. Journalizing the transactions and events – act of recording transactions in the business forms to appropriate journals.
3. Posting – act of transferring peso amounts and other information from the journal to the ledger.
4. Preparing the unadjusted trial balance – balances of the general ledger accounts are proved as to the equality of debits and credits
and to serve as a basis for adjusting entries.
5. Journalizing and posting the adjusting entries – made to take up accruals, expiration of deferrals, estimations and other events
often not signaled by new source documents.
6. Preparing the adjusted trial balance (or preparing the worksheet) – checking the equality of debits and credits after adjustments
and to facilitate the preparation of financial statements.
7. Preparing the financial statements – the means by which the processed information is communicated to external decision-makers.
8. Closing the books – involves journalizing and posting closing entries and ruling and balancing real accounts in the ledger.
Temporary capital accounts (or nominal accounts) are closed and the resulting net income or loss is transferred to the capital
account or retained earnings account.
9. Taking a post-closing trial balance – this is done to prove equality of debits and credits in the ledger after the closing process.
10. Preparing, entering and posting of reversing entries – this is done to facilitate the recording of certain transactions in the
succeeding accounting period.

Accounting Records of a Business Enterprise

1. Business or source documents – these are the original source materials evidencing a transaction. Examples are purchase invoice,
official receipts, vouchers, debit or credit memoranda, miscellaneous bills for expenses.
2. Books of original entry – these refer to the journals such as the General Journal and the special journals (sales journal, purchase
journal, cash receipts journal, cash disbursement journal, or voucher register and check register.
3. Books of final entry – these refer to the Ledgers: General Ledger and subsidiary ledgers.

Step 1: Identifying and Analyzing Transactions and Events – the process of selecting a transaction or event and analyzing its impact
on the financial position.
1.1 The “dual effects principle” of the double-entry system of bookkeeping is used. Each recorded event affects at least two
items in the financial accounting records.
1.2 The account is used as the storage unit of information in double-entry system. It is composed of three parts, the name of
the account, (or account title), the left side (or debit) the right side (or credit).

Step 2: Journalizing – the process of recording transactions by means of a journal entry in the journal.
2.1 Types of journal entries as to the time prepared:
• Opening entry – entry beginning a new system of accounting for enterprises
• Current entries – entries to record transactions completed by the business during a given period
• Adjusting entries – entries made at the end of the accounting period to update certain amounts so that they reflect
correct balances at a designated time
• Closing entries – entries made at the end of the accounting period after adjustments, by means of closing nominal
accounts to a summary account transferring the balances to capital
• Reversing entries – entries made at the start of the subsequent accounting period to reverse certain adjusting entries
made in the immediately preceding accounting period
• Correcting entries – entries made to correct entries made in error
• Reclassification entries – entries that transfer an item from one account to another that may clearly describe the nature
of the item transferred

2.2 Journal – a formal record or book of original entry where transactions are recorded for the first time. The following are
the types of Journals:
• simple journal – a book of original entry used to record all transactions
 general journal – simple journal with two money columns
 combination journal – simple journal with several money columns
 • special journal – multi-column book to record transactions of a similar nature

2.3 Types of Special Journals:

• Cash Receipts Journal • Voucher Register
• Cash Disbursement Journal • Check Register
• Sales Journal • Requisition Journal
• Purchase Journal .

2.4 Voucher System – a special method of accounting for business transactions which involves the payment of cash
immediately or in the future. It is one of the means of establishing internal control over the expenditures of the
business. A voucher is a document that carries the authorization to pay cash either immediately or in a future date,
and to journalize the transaction. Thus, one of the most important parts of a voucher is the signature(s) of the
authorizing officials of the economic entity.

Two basic principles in voucher system:

1. All cash payments, immediately or in the future, must be properly authorized through a voucher.
2. No voucher can be presented for payment twice.

Books of Accounts used in a Voucher System

1. voucher register – records vouchers issued
2. check register – records all purchases of merchandise
3. sales register – records all sales of merchandise
4. cash receipts journal – records all receipts of cash
5. general journal – records transactions not accommodated in special journal

Advantages of the Voucher System

1. Better control over disbursements
2. Facility in taking cash discount
3. Elimination of accounts payable subsidiary ledger

Disadvantages of the Voucher system

1. Lacks flexibility
2. May result in duplication of work and increased bookkeeping expenses

Step 3: Posting – it is the process of transferring data from the journal to the appropriate accounts in the ledger.
Purpose: it serves to classify the effects of transactions on specific asset, liability, proprietorship, revenue and expense accounts.
3.1 Ledger – a systematic compilation of a group of accounts
3.2 Kinds of Ledger
1. General ledger – contains all accounts appearing in the financial statements
2. Private ledger – contains confidential information of accounts
3. Subsidiary ledger – a supporting ledger consisting of a group of accounts of similar nature, the total of which is
in agreement with a controlling account in the general ledger
3.3 Accounts – are accounting devices used to summarize change in asset, liability or proprietorship.
3.4 Kinds of Accounts
1. Real account 6. Suspense account
2. Nominal account 7. Reciprocal account
3. Mixed account 8. Auxiliary account
4. Clearing account 9. Summary account
5. Controlling account

Step 4: Preparing the Trial Balance – this is the next step of the bookkeeping cycle which is the listing down of accounts with
open balances in order to prove the mathematical accuracy of the debits and credits in the ledger.
4.1 Types of Trial Balance
4.1.1 As to Form
1. Trial Balance of Balances – contains accounts with open balances only
2. Trial Balance of Totals – contains all accounts in the ledger, both open and closed
4.1.2 As to time of preparation
1. Periodic or Unadjusted Trial Balance – this is prepared before the preparation of adjusting entries.
Contents: Real, Nominal, and Mixed Accounts
2. Adjusted Trial Balance – one prepared after adjusting entries.
Contents: Real and Nominal Accounts
3. Post-closing Trial Balance – one prepared after the closing process.
Contents: Real Accounts only
4.2 Examples of errors revealed by a Trial Balance:
1. Error of Transplacement (sliding error; decimal point)
2. Error of Transposition
3. Error in posting one side of an entry
4. Omission in posting one side of an entry
4.3 Examples of errors not revealed by a Trial Balance:
1. Wrong computation
2. Wrong classification of account (wrong account used)
3. Double-posting both sides of an entry
 4. Omission in posting both sides of an entry
5. Omission in journalizing a transaction

Step 5: Preparation of Adjusting Entries – These are entries made at the accounting period to update or bring to their correct
balances certain asset, liability, revenue or expense accounts.
5.1 Concepts Involved
• Accrual – revenue must be recognized when earned, even if cash is not yet received. Expenses must be recorded
when benefits are received, even if cash is not yet paid.
• Matching of Costs Against Revenue – to have a fair measurement of revenue in a given period of time, all costs and
expenses incurred in generating that revenue must be deducted therefrom.
• Accounting period – a transaction is recorded on the basis of business papers. Certain transactions, however,
remain “unfinished” at the time of reporting financial information. Estimates and updating entries therefore
become necessary in order to reflect more fairly the status of certain accounts.
5.2 Purpose of Adjusting Entries (7 adjusting entries)
1. To take up unrecorded income and expenses of the period
a. Accrued expense
b. Accrued income
2. To split mixed accounts into their real and nominal elements:
a. Deferred or prepaid expenses
b. Deferred, unearned, or pre-collected income
c. Bad debts
d. Inventory
e. Depreciation

Step 6: Preparing Adjusted Trial Balance or a Worksheet

6.1 Definition: A worksheet is an analytical device used in accounting to facilitate the gathering of data for adjustment, the
preparation of financial statements, and closing entries.

Step 7: Preparing Financial Statements

7.1 Definition: Financial statements are the means by which the information accumulated and processed in financial
accounting is periodically communicated to the users.
7.2 Components of the Basic Financial Statements (details to be discussed in PAS 1 – Presentation of Financial
Statements):
1. Statement of Financial Position (Balance Sheet) – a formal statement showing assets, liabilities, capital or the
financial position of an enterprise as of a given date.
2. Statement of Comprehensive Income – presents the revenue, expenses, gains, losses, both realized and
unrealized, that are the result of the enterprise’s profit-directed activities during a given period of time.
3. Statement of Changes in Equity – shows the movements in the elements of the components of stockholders’
equity which includes the net income and items such as dividends, appropriations and adjustments of net
income of prior periods.
4. Statement of Cash Flows – is a statement that summarizes the cash inflows and outflows arising from
operating, financing and investing activities of the enterprise for a given period of time.
5. Notes – contain explanatory material, and disaggregation of certain items in the face of the financial
statements, as well as other significant quantifiable and non-quantifiable information that are necessary in
making economic decisions.

Step 8: Closing the Books

8.1 Definition: Closing the books is the process of preparing closing entries and ruling and balancing real accounts.
8.2 Closing entries – are entries prepared at the end of the accounting period to “empty” or bring to zero all nominal
accounts in the ledger.
8.3 Steps in preparing closing entries:
1. Close all nominal accounts to Income and Expense Summary account
2. Close Income and Expense Summary account to Drawing (if single proprietorship or partnership), or to Retained
Earnings (if corporation)
3. Close Drawing to Capital

Step 9: Preparing the Post-Closing Trial Balance

9.1 Definition: A post-closing trial balance is a trial balance prepared after closing the books.
9.2 Purpose: To prove the equality of the debits and credits in the ledger after the closing process.
9.3 Contents : Real accounts only

Step 10: Reversing Entries

10.1 Definition: Reversing entries are entries made on the first day of the succeeding accounting period to reverse certain
adjusting entries done in an immediately preceding period.
10.2 Purpose:
1. For convenience in recording accruals
2. For consistency in recording deferrals
10.3 Adjustments requiring reversal:
1. Accrued expense
2. Accrued income
 3. Prepaid expense, if expense method is used
4. Unearned income, if income method is used

QUIZZER 1 BOOKKEEPING SYSTEMS

Bookkeeping Concepts/Accounting Equation/Rules of Debit and Credit

1. This is the means by which a reporting entity records and stores the financial and managerial information from its transactions or
economic events so that it can retrieve and report the information in an accounting statement
a. Accounting system c. Internal control system
b. Bookkeeping system d. Ledger system

2. The systematic and chronological recording of transactions and events in books of account is known as
a. Accounting c. Recordkeeping
b. Bookkeeping d. Auditing

3. Accounting records of an enterprise include which of the following?

a b c d
Source documents of accountable events yes no yes no
Journals and ledgers yes yes no no

4. Which of the following phrases are descriptive of bookkeeping?

a b c d
Routine, mechanical and repetitive yes yes no no
Creative, analytical, judgmental no yes yes no
Follows method prescribed by accounting yes yes no yes

5. Which one of the following is among the conditions that will qualify a situation, particular action or set of circumstances as an
accountable event?
a. It has happened or will happen within a short period of time
b. It affects an accounting element (s) either increasing and decreasing it
c. It involves an exchange of values between the business enterprise and a third party
d. It can be measured accurately in monetary terms

6. The system of bookkeeping that recognizes the two-fold effect of an accountable event is known as
a. Double-entry c. Cash basis
b. Single-entry d. Accrual basis

7. The system of bookkeeping whereby, as a general rule, only cash and personal accounts are recognized and is deemed to be
incomplete bookkeeping
a. Double-entry c. Cash basis
b. Single-entry d. Hybrid accounting

8. Which of the following statements about bookkeeping systems is (are) true?

I. Single-entry bookkeeping is the same as cash basis of accounting
II. In both single-entry bookkeeping and cash basis of accounting, receipt and payment of cash is used as the basis for
recording transactions.
III. Single-entry bookkeeping offers a better internal control than double-entry bookkeeping
a. Only I is true c. Both II and III are true
b. Only II is true d. All statements are true

9. Which of the following statements about single-entry bookkeeping is (are) true?

I. Single-entry bookkeeping uses the net assets approach or indirect approach in determining net income for a period.
II. The single-entry or net assets formula in determining net income or loss cannot be used in a corporate form of organization
III. There are certain instances when a trial balance can be prepared from a single-entry set of books
a. Only I is true c. II and II are true
b. I and II are true d. All statements are true

10. The following books of account are used in single-entry bookkeeping

a. Cashbook and subsidiary ledger
b. Cash receipts book and general ledger
c. Cash receipts book , cash disbursements book, general ledger and subsidiary ledger
d. Cashbook and general ledger

11. Which of the following transactions are recognized in single-entry bookkeeping?

a b c d
Purchase of office supplies for cash yes yes no no
Collection on accounts receivable no yes no yes
Unsold merchandise at the end of the year yes no yes no
12. Which one of the following bases of income and expense recognition is used in accounting for revenue and expenses under
single-entry bookkeeping?
a. Cash basis c. Modified cash basis
b. Accrual d. None of these is used
13. The two basic concepts or theories underlying double-entry bookkeeping are
a. Value received and value parted with c. Debit and credit
b. Duality and equilibrium d. Check and balance

14. Which of the following should be recognized as an accountable event in financial accounting according to GAAP?
a. LMN Corporation declares an issuance of stock rights to its stockholders
b. OP Inc. increases its recorded goodwill due to good customer relations and high employee morale.
c. The estimated recoverable value of an intangible asset becomes lower than its carrying value
d. RST’s building, which is carried in the books using the cost model, has increased in fair value at year-end

15. The primary characteristic that distinguishes double-entry bookkeeping from single-entry is
a. It recognizes the two-fold effect of each event affecting the enterprise
b. A complete set of journals and ledgers is maintained
c. A trial balance is periodically prepared
d. Accrual basis accounting is used

16. Double entry bookkeeping requires that

a. Every transaction affects both an asset account and either a liability or owner’s equity account
b. The number of ledger accounts with debit balance is equal to the number with credit balances
c. The total peso amount of debit entries posted to the ledger is equal to the total peso amount of the credit entries
d. The number of debit entries posted to the ledger equals the number of credit entries

17. The basic classification category and storage unit for information in a double-entry system is the
a. Business document c. Ledger
b. Journal d. Account

18. Which of the following statement is false concerning double-entry bookkeeping?

I. The duality and equilibrium principles in double – entry are expressed through an accounting equation, “ Assets = Liabilities +
Equity”
II. If an economic entity has no liabilities, the assets will be equal to equity unless some assets are impaired.
III. In double entry bookkeeping, an accountable event always has an effect on assets and / or liabilities or capital account
a. Only I is false c. I and II are false
b. Only II is false d. All statements are false

19. Given the dual effects of accountable events, an increase in an asset cannot possibly be accompanied by a (an)
a. Decrease in another asset c. Increase in a liability
b. Decrease in owner’s equity d. Increase in revenue

20. A transaction caused a P60,000 increase in both assets and total liabilities. This transaction could have been
a. Purchase of office supplies for P60,000 cash
b. Exchange of assets with no commercial substance , at carrying amount, P60,000
c. Purchase of a piece of ornate office furniture for P100,000 paying P40,000 cash and issuing a note payable for the balance
d. Repayment of a P30,000 bank loan

21. Owner’s equity was understated and liabilities were overstated. Which of the following errors could have been the cause?
a. Making the adjustment entry for depreciation expense twice
b. Failure to record interest accrued on a note payable
c. Failure to make the adjusting entry to record revenue which had been earned but not yet billed to customers
d. Failure to record the earned portion of rent received in advance

22. Which is false concerning the rules of debit and credit?

a. The left side of an account is always the debit side and the right side is always the credit side.
b. The normal balance of any account appears on the side used for recording increases.
c. The rules of debit and credit cannot be amended over time.
d. The word “debit” means to increase and the word “credit” means to decrease.

23. Which of the following explains the debit and credit rules relating to the recording of revenue and expenses
a. Expenses appear on the left side of the balance sheet and are recorded by debits; revenue appears on the right side of the
balance sheet and is recorded by credits
b. Expenses appear on the left side of the income statement and are recorded by debits; revenue appears on the right side of
the income statement and is recorded by credits
c. The effects of revenue and expenses upon owner’s equity
d. The realization principle and the matching principle

24. All of the following are disadvantages of the single-entry bookkeeping system except
a. Accounting records are incomplete.
 b. Accrual basis financial statements cannot be prepared.
c. Internal control is inadequate.
d. Financial statements are not likely to be fairly presented in accordance with GAAP.

25. Which of the following is a book of account utilized in both a single-entry bookkeeping system and a double-entry bookkeeping
system?
a. cash receipts book c. general journal
b. subsidiary ledger d. sales journal

26. Which of the following statements about bookkeeping systems is (are) true?
I. Net income or loss under single entry bookkeeping is computed using an approach that directly matches cost with revenue.
II. Double-entry bookkeeping is sometimes known as transactions approach of accounting for Assets, liabilities, equity,
revenue and expenses.
III. Double-entry bookkeeping is the generally acceptable method of bookkeeping because it offers an accurate and more
complete income measurement than single-entry.
a. Only III is true c. I and II are true
b. Only II is true d. I, II, and III are true

27. In double-entry bookkeeping system which of the following may be used as basis for recognizing income and expenses?
a. b. c. d.
Cash basis yes no yes no
Modified cash basis yes yes no no
Accrual basis yes no no yes

QUIZZER 2 ACCOUNTING PROCESS

Accounting Process/Accounting Cycle

1. Which of the following statements is true?
a. “Accounting process” and “accounting cycle” may be used interchangeably as they have exactly the same meaning.
b. The accounting cycle represents the steps taken to accomplish the accounting process.
c. The accounting process implements the steps of the accounting cycle.
d. The steps of the accounting process culminates in the preparation of reversing entries.

2. The series of well-defined steps followed and completed within an accounting period to record transactions and prepare
financial statements under the double-entry bookkeeping system is
a. Operating cycle c. Accounting cycle
b. Business cycle d. Accounting process

3. Which of the following operations in the financial accounting process determine how events affect the assets, liabilities, owners’
equity, revenue, and expenses of the enterprise?
a. Selecting the events c. Measuring the effects
b. Analyzing the events d. Classifying the measured effects

4. Which of the following operations involves the assignment of peso amounts to accountable events?
a. Analyzing the events c. Recording the measured effects
b. Measuring the effects d. Classifying the measured effects

5. Which of the following operations can be performed by a computer without requiring an accountant’s judgment?
a. Selecting the events c. Summarizing the recorded effects
b. Measuring the effects d. Adjusting the records

6. Identify the following as pertaining to the recording phase (RP) and summarizing phase (SP) of an accounting cycle
(1) Analyzing each event (3) Posting to ledger accounts
(2) Preparing a trial balance (4) Preparing the financial statements
a. RP, RP, RP, SP c. RP, SP, RP, SP
b. SP, RP, RP, RP d. SP, RP, SP, SP

Journalizing
7. The first step in the accounting cycle is
a. Record transactions in the journal c. Post journal entries to general ledger accounts
b. Analyze transactions from source documents d. Adjust the general ledger accounts

8. At what step in the accounting cycle is GAAP typically applied?

a. Journalizing c. Trial balance preparation
b. Posting d. All of these

9. Transactions and events are analyzed according to the rules of debit and credit
a. After selecting the event and before an entry is recorded in the journal.
b. After the entry is recorded in the journal and before it is posted in the ledger
c. When adjusting entries are prepared.
 d. After adjusting entries and before preparation of the financial statements and closing entries

10. Which of the following documents does not initiate an entry to be made in the books of accounts?
a. Sales invoice c. Purchase order
b. Purchase invoice d. Credit memorandum

11. A firm’s chart of accounts is

a. A flowchart of all transactions
b. A list of names of all account titles used by an economic entity
c. An accounting procedures manual
d. A journal

12. Which of the following statements the primary purpose of a general journal?
a. The general journal provides a continuing balance of the amount to date in each of the temporary accounts
b. The general journal provides an organized summary, in chronological order, of the transactions of the entity.
c. The general journal directly provides the data for a trial balance.
d. The general journal eliminates the need for control accounts in the ledger

13. Which is false concerning use of special journals?

a. Sale of merchandise is recorded in the sales journal and sale of any item for cash is recorded in the cash receipts journal.
b. Only cash sales are recorded in the cash receipts journal
c. Investment of non-cash asset by the owner of the entity is recorded in the general journal
d. Purchase of property and equipment on account is recorded in the general journal.

14. One of these is not an advantage of using special journals:

a. Division of labor is possible
b. Possibility of error is minimized
c. Number of postings is reduced
d. Space and effort in recording transactions is reduced

15. A company uses the periodic inventory system and records purchases net of discounts. On April 1, the company purchased
merchandise worth P20,000 under terms 2/10, n/30. The journal entry to be made to record the purchase on April 1 will include
a
a. credit to accounts payable of P 20,000
b. credit to accounts payable of P 19,600
c. debit to purchases of P 20,000
d. debit to allowance for purchase discounts of P 400

16. Which of the following pertaining to the use of special journals is (are) true?
Statement 1 – Transactions that cannot be appropriately recorded in a special journal are recorded in the general journal.
Statement 2 – If entity is using a one-column Sales Journal, sale of merchandise on account are recorded in the sales journal
while cash sales are recorded in the cash receipts journal.
Statement 3 – Voucher register and check register are also classified as special journals.

a. Only statement 1 is true c. Statements 1 and 2 are true

b. Only statement 2 is true d. All of the statements are true
17. Which of the following statements pertaining to the voucher system is incorrect?
a. A voucher system is used in connection with transactions involving payment of cash.
b. When installments or other payments are made on an invoice, a separate voucher is prepared for the amount of each check
issued
c. A file of unpaid vouchers shows only the total amount of outstanding liabilities for merchandise purchased.
d. Payments of purchases with discounts is recorded in the check register by a debit to vouchers payable at gross and
appropriate credits to cash and purchase discounts.

18. The voucher system strengthens internal accounting control by requiring that a voucher be prepared to authorize payment of the
liability at the time the liability is
a. Paid c. Planned
b. Incurred d. Audited

19. Which of the following best describes a voucher?

a. A supporting document prepared for each cash receipt or disbursement
b. A promise to pay an amount owed within a discount period
c. A written authorization prepared for each check written
d. A written record sent to a payee along with the signed check

20. Which of the following statements about the voucher system is (are) true?
I. A voucher need not be prepared for a purchase on account since it will not require an immediate cash payment.
II. Since the voucher system is costly to apply, repetitive and time-consuming, it is not recommended for use in accounting for
cash disbursements.
 III. The voucher system offers a more effective internal control than the non- voucher system.
a. I only c. I and III only
b. III only d. I, II and III

Posting
21. A systematic compilation of account titles of asset, liability, equity, revenue and expense accounts which is also called a “book of
secondary entry” is known as
a. Journal c. Worksheet
b. Ledger d. Trial balance

22. Which of the following statements is incorrect?

a. Accounts are arranged in the general ledger following the “financial statement order”.
b. The ledger is more important than the journal.
c. Posting is the process of transferring debit and credit changes in account balances from the ledger to the journal.
d. A ledger account shows in one place all the information about changes in a specific asset or liability, or owners’ equity.
23. A listing of the components of account balances which relieves the general ledger of detail thereby facilitating the preparation of
a trial balance is known as
a. Subsidiary ledger c. Worksheet
b. Private ledger d. Register

24. Which of the following types of accounts measure economic flows over a period of time?
a. Real accounts c. Mixed accounts
b. Nominal accounts d. Summary accounts

25. An auxiliary account that has the same balance as the principal account is a
a. Contra account c. Offset account
b. Adjunct account d. Controlling account

26. Which of the following best defines a controlling account?

a. A summary account in the general ledger that is supported by detailed accounts in a subsidiary ledger
b. A listing of the balances in all accounts
c. An account which increases due to sale of goods or services during the normal operations of a business
d. A chronological listing of all transactions for a specific time period.

27. You are given the following statements. Which one is true?
I. A mixed account involves a mixture of asset and income elements
II. Transactions are posted only at the end of the month when special journals and controlling accounts are used.
III. The “Share Premium” account is both an auxiliary and adjunct account
a. Only I is true c. I and II are true
b. II and III are true d. Only III is true

28. Which of the following statements is false?

a. Before year-end adjustments are prepared, a building account is a mixed account
b. Offset accounts are neither assets nor liabilities
c. Contra accounts appear only in the balance sheet
d. A principal account is an account that can stand alone

29. A notation entered in a journal or ledger, not intended to be formally incorporated in the accounts, which describes a situation
or event, with or without money values is known as
a. a footnote c. a memorandum entry
b. a negative entry d. a reciprocal entry

Trial Balance
30. Which of the following statements regarding a trial balance is incorrect?
a. A trial balance should always balance.
b. A trial balance is a test of the equality of the debits and credits in the ledger.
c. A trial balance that is in balance proves that no error of any kind has been made in the accounts during the accounting
period.
d. A trial balance is useful in the preparation of the income statement and the balance sheet.

31. The primary purpose of preparing a trial balance is to determine that

a. The ledger contains an equal peso amount of debit and credit entries
b. The ledger contains an equal number of debit and credit entries
c. The number of ledger accounts with debit balances is equal to the number of accounts with credit balances
d. Each transaction was recorded with equal amounts of debits and credits.
32. A trial balance will disclose that an error has been made in
a. a. Entering an amount on the wrong side of an account
b. b. Computing the interest expense on a note payable
c. c. Posting an amount to the wrong ledger account
 d. d. Double-posting two both sides of an entry
33. A trial balance that contains real accounts only is
a. an interim trial balance c. an adjusted trial balance
b. an unadjusted trial balance d. a post-closing trial balance

Adjusting Entries
34. Adjusting entries are needed
a. Whenever revenue is not received in cash
b. Whenever expenses are not paid in cash
c. Primarily to correct errors in the initial recording of business transactions
d. Whenever transactions affect the revenue or expenses of more than one accounting period

35. Which one of the following concepts is least related to adjusting entries.
a. Accrual c. Materiality
b. Approximation d. Matching of cost against revenue

36. Adjusting entries involve

a. Only real accounts c. Only capital accounts
b. Only nominal accounts d. At least one real and one nominal account

37. Which one of the following is a purpose of adjusting entries?

I. To apportion the proper amounts of revenue and expense to the current accounting period.
II. To establish the proper amounts of assets and liabilities in the balance sheet.
III. To accomplish the objective of offsetting the revenue of the period with all the expenses incurred in generating that
revenue.
IV. To prepare the revenue and expense accounts for recording transactions of the following period.
a. I and II only c. I, II and III only
b. II and III only d. All of these

38. The entry to record depreciation is an example of an adjusting entry

a. To apportion a recorded cost c. To record unrecorded expense
b. To apportion unearned revenue d. To record unrecorded revenue
39. Assume that a company’s fiscal year ends on December 31. Which of the following events involves an adjusting entry that would
be affected by how the event was originally recorded?
a. Sale of merchandise on account
b. Signing a one-year lease for a building
c. Salaries earned by employees this year will be paid next year.
d. Payment of rent for 6 months coverage starting October 1 of current year

40. If the advance payment of an expense was initially recorded in an expense account, the adjusting entry will involve
a. A debit to the asset account and a credit to the expense account in the amount of the unexpired portion.
b. A debit to the asset account and a credit to expense in the amount of the expired portion.
c. A debit to expense and a credit to the asset account in the amount of the unexpired portion.
d. A debit to expense and a credit to the asset account in the amount of the expired portion.

41. The entry to record merchandise inventory for goods unsold at the end of the accounting period is
a. An adjusting entry c. Both an adjusting and closing entry
b. A closing entry d. A regular entry

42. Rent revenue collected one month in advance should be accounted for as
a. Revenue in the month collected c. A separate item in equity
b. An accrued liability d. A current liability

Worksheet
43. An analytical device used by accountants to facilitate the gathering of data for adjustments, and the preparation of adjusting and
closing entries.
a. trial balance c. account
b. worksheet d. ledger

44. Which of the following is not a factor to consider in determining the money columns of a periodic worksheet?
a. the nature of the business
b. the concept or basis used in accounting for revenue and expenses
c. the amount of capital of the business
d. the type of ownership of the business

Closing Entries/ Post-closing Trial Balance/ Reversing Entries

45. The purpose of making closing entries is to
a. Prepare revenue and expense accounts for the recording of the next period’s revenue and expenses
b. Enable the accountant to prepare financial statements at the end of the accounting period
c. Establish new balances in the balance sheet accounts
 d. Reduce the number of revenue and expense accounts

46. The effect of closing entries is to

a. Change assets
b. Change liabilities
c. Change retained earnings
d. Change debit balances of all accounts into credits and vice-versa

47. The purpose of the post-closing trial balance is to

a. Provide the account balances for preparation of the balance sheet.
b. Ensure that the ledger is in balance for the start of the next period
c. Aid the journalizing and posting of the closing entries.
d. Ensure that the ledger is in balance for completion of the worksheet

48. Reversing entries are used

a. primarily to simplify the bookkeeping during the next accounting period
b. to adjust the inventory account under a periodic inventory system
c. to close the income summary account
d. to establish appropriate contra accounts

49. The following six adjusting entries were recorded by RNQ Corp. at the end of the fiscal year:
(1) Bank service charge expense xx (4) Wages expense xx
Cash xx Wages payable xx

(2) Unearned rent xx (5) Insurance expense xx

Rent revenue xx Prepaid insurance xx

(3) Bad debts expense xx (6) Prepaid rent xx

Allowance for bad debts xx Rent expense xx

If the firm reverses all adjusting journal entries that should be appropriately reversed, which of the six adjusting journal entries
would be reversed?
a. (3), (4), and (6) c. (4) and (6)
b. (1), (2), and (5) d. All six adjustments should be reversed

50. Which of the following steps in the accounting cycle are optional?
Adjusting entries Worksheet Closing Entries Reversing entries
a. NO NO NO NO
b. NO YES YES YES
c. NO YES NO YES
d. YES YES YES YES

INCOME RECOGNITION BASES

Principle: Determination of periodic net income depends on recognizing changes in assets and liabilities in the period in which the
changes occur, rather than simply on recording receipts and payments of money. (Accrual Concept)

1. Alternative Income-Recognition Bases (for recording of day-to-day transactions)

a. Accrual basis
b. Cash basis
c. Modified cash basis

2. Accrual basis
a. Underlying concept – Revenues are recognized when realized, i.e. when goods are sold are services provided. Expenses
are recognized when incurred, i.e. when assets are consumed to generate revenue. Net income (loss) for the period is the
difference between realized revenues and related expenses.
b. Advantages – Accomplishments (revenues) are related to efforts or sacrifices (expenses) so that reported net income
measures an enterprise’s performance during a period.
It is also more useful in predicting future earnings and cash flows of the enterprise. These are the primary reasons why
accrual accounting is preferred over cash-basis accounting.

3. Cash Basis
a. Underlying concept – Revenue is recognized when collected in cash, expenses when paid or settled in cash. Net income
(loss) for the period is the difference between cash received from, and cash disbursed for the firm’s profit-directed
activities.
b. Advantages – The claimed advantages of cash basis accounting are:
1. Simplicity and economy because transactions are recorded only when cash is received or paid.
2. Reliability because estimates and judgments are not required.
 c. Disadvantage – Cash basis is not useful in evaluating enterprise performance because it does not reflect the results of all
profit-directed activities which took place during the period. Cash receipts and payments and the accomplishments and
efforts often occur in different periods.
d. Acceptability – Cash basis accounting is not a generally accepted basis of recognizing net income. It is used only by
relatively small business firms and practicing professionals whose needs are satisfied by simple accounting records.
Moreover, strict cash basis accounting is often modified in practice.

4. Modified Cash Basis

a. Underlying concept – Modified cash basis is a hybrid system of recognizing net income. Items materially affecting net
income such as purchases and sales on account, inventories, long-lived assets and depreciation are accounted for on an
accrual basis; all other items are recognized on a cash basis.
b. Modified accrual basis - This term is sometimes used in place of “modified cash basis”, particularly in describing the basis
of accounting for governmental funds.
SAMPLE TRANSACTIONS AND ENTRIES USING DIFFERENT INCOME AND EXPENSE RECOGNITION BASES UNDER THE DOUBLE ENTRY
SYSTEM OF BOOKKEEPING

MODIFIED
CASH BASIS ACCRUAL BASIS
CASH BASIS

INCOME  when cash INCOME  INCOME  when earned

is received when cash is EXPENSE  when benefits
TRANSACTION EXPENSE  when paid received are received
EXPENSE 
when paid
 AR, AP,
Mdse Invty, PPE
1. Cash sales, P100,000 Cash 100,000 Same Cash 100,000
Sales 100,000 Sales 100,000
2. Account sales No entry Accrual view Accts Rec 200,000
P 300,000 Sales 200,000
3. Cash purchases, P 90,000 Purchases 90,000 Same Purchases 90,000
Cash 90,000 Cash 90,000
4. Collection on acct, P 150,000 Cash 150,000 Accrual view Cash 150,000
Sales 150,000 Accts Rec 150,000
5. Paid salaries, Salaries Exp.75,000 Same Salaries Exp. 75,000
P 75,000 Cash 75,000 Cash 75,000
6. Account purchases, P120,000 No entry Accrual view Purchases 120,000
Accts Pay 120,000
7. Payment on acct purchase, Purchases 60,000 Accrual view Accts Pay 60,000
P60,000 Cash 60,000 Cash 60,000
8. Purchased supplies, C.O.D P Supplies Exp. 10,000 Unused Supplies or
10,000 Cash 10,000 Cash view Supplies Exp. 10,000
Cash 10,000
9. Bought eqpt C.O.D P50,000 Eqpt Exp. 50,000 Accrual view Equipment 50,000
Cash 50,000 Cash 50,000
10. Interest income received, Cash 15,000 Same Cash 15,000
P15,000 Int. Inc. 15,000 Int. Inc. 15,000
11.. Rent collected in advance, Cash 60,000 Cash view Cash 60,000
P60,000 Rent Inc. 60,000 Rent Income/or
Unearned Rent 60,000
12. Unpaid advertising No entry Cash view Advert. Exp. 18,000
P 18,000 Advert. Pay. 18,000
13. Uncollected service income No entry Cash view Com. Rec. 30,000
P 30,000 Com. Income 30,000
14.. Unused supplies, P2,000 No entry Cash view Supplies Exp. 8,000
Unused Sup. 8,000
Unused Sup. 2,000
Supplies Exp. 2,000
15. One-third of advance No entry Cash view Rent Income 40,000
collection of rent is earned Unearned Rent 40,000
Unearned Rent 20,000
Rent Income 20,000
16. 10% of accounts receivable No entry Accrual view Bad Debts Exp. 5,000
outstanding is uncollectible Allow for BD 5,000

17.Unsold merchandise by No entry Accrual view Mdse. Invty. 35,000

physical count P 35,000 Inc. & Exp. Sum. 5,000
18. Equipment life, 5 years No entry Accrual view Dep. Exp. 10,000
Accum. Dep. 10,000

QUIZZER 3 INCOME RECOGNITION BASES

1. In double-entry bookkeeping system which of the following may be used as basis for recognizing income and expenses?
a. b. c. d.
Cash basis yes no yes no
Modified cash basis yes yes no no
Accrual basis yes no no yes
2. Under the cash basis revenue are recognized when they are
a. Collected c. Earned and collected
b. Earned d. Earned and become measurable

3. Under the accrual basis, revenue are recognized when they are
a. Collected c. Earned and collected
b. Earned d. Earned and become measurable

4. Under the cash basis, expenses are recognized when

a. they are paid by the entity
b. the costs expire or as assets are used
c. the revenues are recognized that the expenses helped to produce
d. cash is received from revenues that the expenses helped to produce

5. Which of the following transactions will not be recognized in cash basis accounting?
a. Unsold inventory at the end of the period c. Payment of utilities
b. Collection of account sales d. Purchase of equity shares in ABS Corporation

6. The recognition of expenses under accrual accounting is based on three principles: direct matching, systematic and rational
allocation and immediate recognition. The direct matching principle requires that expenses be recognized
a. when they are paid by the enterprise
b. in the same period that costs expire or assets are used
c. in the same period in which the revenues are recognized that the expenses help to
d. produce in the same period that the revenue is received that the expenses helped to produce

7. Which of the following books of accounts are used under cash basis of accounting?
a. Cash book only c. Cash receipts and disbursement books only
b. Journals and ledgers d. Day book and subsidiary ledgers only

8. Which of the following is (are) recognized in both modified cash basis and accrual basis of accounting?
a. Prepaid rent expense c. Accrued commission income
b. Bad debts expense d. Unearned rent revenue

9. Modified cash basis or hybrid basis differs from accrual basis in the computation of
a. Gross profit c. Depreciation
b. Expenses d. Bad debts expense

10. Which of the following statements is (are) false?

I. Purchase of equipment is recognized as outright expense under cash basis Accounting.
II. In both modified basis and accrual basis of accounting, the cost of long-lived assets is spread over the period of benefits in a
systematic and rational manner
III. There are no adjusting entries under modified cash basis of accounting
a. I only c. II and III only
b. III only d. I and III only

11. Which of the following statements about income and expense recognition is (are) true?
I. The gross profit on sales computed under modified cash basis is the same as that computed under accrual basis.
II. Both cash basis and modified cash basis will yield the same amount of operating expenses in the income statement.
III. In recording day-to-day transactions and events, all entities must follow accrual basis of accounting.
a. Only I is true c. II and III are true
b. I and II are true d. All statements are true

12. Which of the following is (are) recognized in both modified cash basis and accrual basis of accounting?
a. Prepaid rent expense c. Accrued commission income
b. Bad debts expense d. Unearned rent revenue

13. Which of the following items of income and expenses are given the same treatment in the books under both pure cash and
modified cash basis of accounting?
I. Income collected in advance
II. Doubtful accounts expense
III. Prepaid expenses
a. I only c. I and III only
b. II and III only d. I, II and III

14. Which of the following bases of accounting for income and expenses are currently in use by economic entities?
a. Cash basis c. Accrual basis
b. Modified cash basis d. All of these

15. Which of the following types of business is allowed to use cash basis in financial reporting in the Philippines?
a. Publicly accountable entities b. Medium-sized entities
 c. Small entities d. Micro entities

16. Which one of the following bases of income and expense recognition is acceptable for financial reporting under current GAAP?
a. cash basis c. modified cash basis
b. accrual d. All of these

END OF MODULE 2
 MMCO Continuing Professional Development Training Center (CPDTC)
2F MMCO Building, 8000 Lakeview Ph3 Angela Street, Halang Calamba City Laguna, Philippines
Tel No. (02) 330-8617, (049) 523-6031; (02) 330-6057
CPA REVIEW (May 2019 Batch)
FAR Theory Cedrick Zapanta, CPA
Module 3
1. Principles of Recognition and Measurement
a) Assets
b) Liabilities
c) Equity

PRINCIPLES OF RECOGNITION AND MEASUREMENT OF THE ELEMENTS OF FINANCIAL POSITION

1. Recognition
Definition – Recognition is the process of formally incorporating in the balance sheet or income statement an item that meets the
definition of an element and satisfies the criteria for recognition.
Criteria – An item that meets the definition of an element should be recognized if:
• It is probable that any future economic benefit associated with the item will flow to or from the enterprise (probability
criterion); and
• The item has a cost or value that can be measured with reliability (measurability criterion)
In assessing whether an item meets these criteria and therefore qualifies for recognition in the financial statement regard needs to be
given to the materiality considerations.

Recognition vs. Realization

Realization (assets) is the process of converting noncash resources and rights into money and is most precisely used in accounting and
financial reporting to refer to sales of assets for cash or claims to cash.

2. Measurement
Definition – Measurement is the process of determining the monetary amounts at which the elements of financial statements are to be
recognized and reported. It is also known as valuation.

Measurement Bases used in Accounting

A. Historical Cost
Assets – are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the
time of their acquisition.
Liabilities – are recorded at the amount of the proceeds received in exchange for the obligation, or in some circumstances, at the
amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business.

B. Current Cost
Assets – are carried at the amount of cash or cash equivalents that would have to be paid, if the same or an equivalent asset was
acquired currently.
Liabilities – are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently.

C. Realizable (Settlement) Value

Assets – carried at the amount of cash or cash equivalents that could currently be obtained by selling the asset in an orderly disposal.
Liabilities – are carried at their settlement values; that is, the undiscounted amounts of cash or cash equivalents expected to be paid to
satisfy the liabilities in the normal course of business.

D. Present Value
Assets – are carried at the present discounted value of the future net cash inflows that the item is expected to generate in the normal
course of business.
Liabilities – are carried at the present discounted value of the future net cash outflows that are expected to be required to settle the
liabilities in the normal course of business.

The initial measurement basis usually adopted by enterprises in recording transactions is historical cost. Subsequent measurement in
the financial statements may be at historical cost or fair market value depending on the nature of the asset. Historical cost is usually
combined with other measurement bases, such as lower of cost and net realizable values (for inventories), market value (for marketable
securities), present value (for pension liabilities) and current cost to recognize effects of changing prices of nonmonetary assets.
ACCOUNTING FOR ASSETS

Definition – An asset:
• is a resource controlled by the enterprise
• as a result of past events and
• from which future economic benefits are expected to flow to the enterprise

Characteristics – Assets have the following characteristics or attributes:

A. Future economic benefits – the potential to contribute, directly or indirectly, to the flow of cash and cash equivalents to the
enterprise. Future economic benefits embodied in an asset may flow to the enterprise as in several ways. It may be
• used singly or in combination with other assets in the production of goods or services to be sold by the enterprise
• exchanged for other assets
• used to settle a liability
• distributed to the owners of the enterprise

Physical form is not an essential to the existence of an asset. Most assets, however, have physical form.
 B. Controlled by a particular enterprise – the enterprise has the right to obtain and control the asset benefits expected. In
determining the existence of an asset, the right of ownership is not essential.

The capacity of an enterprise to control benefits is usually the result of legal rights. However, an item may satisfy the definition
of an asset even when there is no legal control.

C. Past transactions – arise from transactions and events which have occurred in the past.

D. Money measurement – the asset has a relevant attribute that can be measured in monetary units with sufficient reliability.

Valuation accounts – are reductions or increases in assets to reflect adjustments beyond historical cost or carrying amount. They are
part of the related asset and are neither assets nor liabilities in their own right.

1. Initial Recognition of Assets

An asset is recognized on the balance sheet when it is probable that the future economic benefits will flow to the enterprise and the
asset has a cost or value that can be measured reliably.

Broad Operating Principles

A. Financial assets – recognize when, and only when, the entity becomes a party to the contractual provisions of the instrument.
B. Assets acquired through Exchanges – Recognize assets when transfer of resources takes place or services provided.
C. Asset received through nonreciprocal transfers – Recognize the asset when acquired or when transfer occurs.
D. Executory contracts – The effects of executory contracts are generally not recognized until one of the parties, at least, partially
fulfills his commitment.
a. Executory contracts – is an agreement which neither party has fulfilled
b. Rationale for accounting treatment – this is a mere exchange of promises which are offsetting
c. Exception – some executory contracts (e.g., long-term leases) are recorded if their economic substance indicates that
substantially all the benefits and risks of ownership have been transferred to the enterprise.

Terms Associated with Asset Acquisition

• Expenditure (cost outlay) – payment of cash or property, or the incurrence of a liability to obtain an asset or service.
o Capital expenditure – a cost outlay whose benefits extend beyond the current accounting period, and which therefore,
is capitalized by charging an asset or a contra-asset account.
o Revenue expenditure – a cost outlay whose benefits do not extend beyond the current accounting period and which,
therefore is charged to expense.

2. Initial Measurement of Assets

Pervasive Principle: Assets are initially measured at the exchange price at which transfers take place. This measurement base is called
historical cost.
• Accounting measures the economic value of an asset.
• However, the true economic value cannot be determined, as it is a very subjective concept. It pertains to the preference or
“desirability” people have for one item as opposed to others.
• Accountants rely on exchange price to approximate the economic value. In an arms-length transaction, exchange price
approximates economic value at the time an asset is acquired. It has the advantage of objective and easy verifiability.

2.1 Exchanges – Assets acquired in exchanges are measured at the exchange price, i.e., at acquisition cost. Money or money claims
acquired are measured at face amount or sometimes at discounted amounts. This principle classifies assets into:
• Nonmonetary assets – measure at acquisition cost
• Monetary assets – measure at face amount or sometimes discounted amounts

2.2 Nonreciprocal transfers – Cost is generally measured by the face amount or discounted value or fair value of assets acquired. This is
because there is no exchange price since assets are acquired without giving up something of value in exchange. Thus:
• Monetary assets received are measured at their face value (fair value) or discounted amount
• Nonmonetary assets received are measured at their fair value on the date received

Monetary vs. Nonmonetary Assets

Assets may be classified according to ease or difficulty of measurement, into monetary and nonmonetary.
A. Monetary assets – are assets whose peso amounts are fixed by contract or law, regardless of changes in prices. They include (a)
Cash, and (b) claims to a fixed amount of money in the future such as accounts and notes receivable.
B. Nonmonetary assets – are assets whose price in terms of money may change over time. They include inventories, prepayments,
property, plant and equipment. In general, items that are not monetary assets are nonmonetary.

In the classification of assets as to monetary and nonmonetary, the rule “auxiliary follows principal” is observed.

3. Measurement of Monetary Assets

Monetary assets are measured at their fair value or sometimes at discounted amount.
A. Cash – should be measured at fair value (or face value)
B. Accounts receivable and other short-term money claims – are valued at the original exchange price between the firm and the
outside party, less adjustment for cash discounts, returns and allowances, yielding an approximation to fair value.
C. Short-term notes – are initially recorded at the present value of the future cash receipts on the date of issue. The present value of a
short-term interest-bearing note is equal to the face value of the note.
D. Long term receivables are measured at the face amount or they may be stated at present value (or discounted amount) when notes
bear no interest or stated rate is unreasonable.
E. Imputing interest – When face differs from discounted amount, discounted amount may be determined by imputing interest on the
note using an imputed interest rate, the rate that would be incurred in a similar arms-length transaction. Assume a P10,000 one-year
non-interest bearing note, if imputed rate is 10%, discounted amount is P9,091 (P10,000 divided by 1.10).

4. Measurement of Nonmonetary Assets

 Assets (other than financial instruments) acquired in exchanges are measured at the exchange price, that is, at acquisition cost.

Cost is often used as synonym for exchange price when nonmonetary assets are involved. The basic idea of cost is economic sacrifice,
something given up for economic benefits acquired or to be acquired.

A. Cash transactions – Acquisition cost is the net price of the asset acquired. It excludes any discounts, returns, allowances, and other
adjustments or partial cancellation of the list or billed price.

B. Credit transactions – Acquisition cost is the equivalent net cash price of the asset, i.e. the amount of cash required to immediately
settle the liability. The difference between cash and higher credit price represents interest and financing charges which are costs of
using or borrowing money rather than part of the cost of acquiring the asset.

C. Nonmonetary transactions - Acquisition cost is generally measured by the fair value of the asset given up. However, if the fair value
of the asset acquired is more clearly evident, cost is measured by that amount. If fair value of both asset given and received is not
reasonably determinable, carrying value of asset given up is used.
i. Exchange of assets with commercial value (or substance) – record at the fair value of the asset given or the asset received
whichever is more clearly determinable. If the fair value of both the asset received and the asset given up are determinable,
the asset received should be recorded at the fair value of the asset given up.
ii. Exchange of assets with no commercial value (or substance) – should be recorded at the carrying amount of the asset given
up.

Carrying value (CV) – the recorded amount of assets given up. Carrying (book) value is not used to measure cost unless:
• No other fair value amount is available, or
• Nonmonetary assets with no commercial substance are exchanged.

D. Nonreciprocal transfer – Cost is measured by monetary or fair value of asset received. In a strict sense, no cost is involved since
assets were acquired without sacrificing other assets or incurring liabilities. However, term “cost” is commonly used to refer to
amounts at which assets are initially recorded, regardless of how the amount is determined.

E. Auxiliary costs – Acquisition cost included expenditures necessary to prepare the asset for its intended use.
Special Cases
• Biological assets – should be valued at fair value less point of sale costs
• Financial assets at fair value through profit or loss – measured at fair value
• Financial assets not at fair value through profit or loss – measured at fair value plus transaction costs that are directly
attributable to the acquisition or issue pf the financial asset
• Lump-sum acquisition – Total exchange price is allocated to individual assets based on their relative fair values (relative sales
value method)
• Imputed costs – are hypothetical costs not involving actual expenditures, should not be recognized in accounting records

5. Accounting for Assets after Acquisition

The amounts at which assets are initially recorded may be carried without change, may be changed, for example, by amortization,
write-off, or may be shifted to other categories.
Changes in utility – The initial utility of an asset measured by exchange price when recognized may be changed by the following
subsequent events.
• External events other than transfers
• Production
• Casualties

Alternative Measurement Bases

When the initially recorded amount no longer measures expected asset benefits (utility), some other measurement basis must be used.
The following basis are used in current practice:
A. Acquisition cost adjusted for depreciation, depletion or impairment – Property, plant and equipment, and intangible assets are
reported at their acquisition cost, commonly adjusted after acquisition for amortization, depreciation, depletion or other
allocations.
B. Cost or net realizable value whichever is lower - Generally, inventories are reported at their cost or net realizable value (or
replacement cost). Net realizable value is computed as selling price less selling costs or expenses
C. Fair value – Some financial assets are valued at fair value (either through profit or loss or through equity)
D. Fair value less point of sale costs adjusted for changes in values – This specifically pertains to the valuation of biological assets.
E. Net realizable value – Short-term receivables and some inventories are reported at their net realizable value, which is the non-
discounted amount of cash, or its equivalent, into which an asset is expected to be converted in due course of business less direct
costs, if any, necessary to make that conversion.
F. Amortized cost – Loans and receivables as well as held to maturity instruments are reported at their amortized cost, using the
effective interest method.
G. Revalued amount less accumulated depreciation and accumulated impairment loss – Property, plant and equipment may be
written up to their appraised value, which is the current or fair value of an asset as established by an independent expert using
systematic procedures that include physical examination, pricing and often engineering estimates.

6. Asset Disposition
Once acquired, an asset continues as an asset of the enterprise until the enterprise collects it, transfers it to another entity, uses it, or
some other event or circumstance destroys the future benefit or removes the enterprise’s ability to obtain it.

Recognition – Decreases in assets are recorded when assets are disposed in exchanges.

Measurement – The decrease in assets is measured by the recorded amounts that relate to the assets. In partial dispositions,
measurement of the amount removed is governed by detailed principles (ex: FIFO, Average Cost, or Specific Identification for
inventories) that are based on the presumed flow of goods or the presumed flow of costs.
 When the service potential of an asset is no longer available to the enterprise whether transferred by sale dissipated by obsolescence or
damage, the acquisition cost of the asset, as modified by events subsequent to acquisition should be eliminated from the accounts and
a final gain or loss on disposition is recognized.

QUIZZER 1 ACCOUNTING FOR ASSETS

Recognition of Assets
1. According to the conceptual framework, the definition of asset includes which of the following descriptions?
a. b. c. d.
Resource exclusively owned by entity yes yes no no
Accounts with debit balances carried forward upon closing of the books no yes yes no
Resource controlled by the entity from which probable benefits will flow to entity yes no yes yes

2. One of the following is not an essential characteristic of an asset. Which one?

a. It is acquired at a cost and is exchangeable.
b. It provides the entity with probable future benefits.
c. The event giving rise to the enterprise’s right to the benefit has already happened.
d. A particular enterprise can obtain the benefit and control others’ access to it.
3. Which of the following statements is (are) true?
I. No asset can simultaneously be an asset of more than one entity.
II. An asset must produce future economic benefits and must have physical form.
III. At times, two or more entities, may share the benefits that an asset provides.
a. I and II are true c. I and III are true
b. II and III are true d. I, II, and III are true

4. Which of the following is an asset?

a. Corporation’s own shares reacquired for re-issue
b. Preference shares of another corporation acquired by the entity
c. Possible gain on lawsuit according to company lawyer’s opinion
d. Goodwill developed by the entity through extensive advertising and personnel development

5. Which of the following is considered an asset but not an economic resource?

a. Mango orchard c. Ownership interest in other enterprises
b. Deferred tax asset d. Productive resources

6. Which of the following is not an asset?

a. Delivery truck purchased by installment; legal title retained by seller until full payment of the purchase price.
b. Waiting shed in front of sales office built by the entity for its customers
c. Public highways used by company to transport its goods to customers
d. Advance payment for six months advertising of company products

7. According to conceptual framework, asset valuation accounts are

a. Assets c. Part of stockholders’ equity
b. Neither assets nor liabilities d. Liabilities

8. The appropriate basis for recognizing an asset is when a particular enterprise

a. Acquires the right to utilize and control access to the asset’s benefits
b. Acquires legal title to the asset
c. Obtains physical possession of the asset
d. Makes a cash disbursement for the asset

9. Which of the following is an appropriate basis for recognizing an asset?

a. The president of CDE Corporation signed a one-year, lease contract for office space in a new building. The lease contract is
renewable after one year.
b. A company issued a purchase order to a supplier for merchandise to be delivered next month under terms, FOB supplier’s
warehouse.
c. ABC, Inc. signed a non – cancellable, 40-year lease contract for the use of a building with a useful life of 50 years. The lease
contract does not transfer ownership to ABC, Inc. at the end of the lease term and there is no provision for a bargain purchase
option.
d. The Board of Directors of ELB Corporation approved a resolution authorizing the purchase of new machinery next year.

10. Which of the following statements about “executory contracts” is not true?
a. Executory contracts are viewed in accounting as a mere exchange of promises which are offsetting
b. Executory contracts should be recorded only when both parties have fully complied with the terms of the agreement.
c. Executory contracts are legally binding
d. Executory contracts are not recorded until one or both parties at least partially performs under the contract

11. Generally accepted accounting principles require that certain lease contracts be accounted for as credit purchases of plant assets. The
theoretical basis for this treatment is that a lease of this type
a. Effectively conveys all of the benefits and risks incident to the ownership of property.
b. Is an example of form over substance
c. Provides the use of the leased asset to the lessee for a limited period of time
d. Must be recorded in accordance with the concept of cause and effect

12. Which of the following is a monetary asset?

a. Inventories c. Furniture and equipment
b. Cash in bank d. Financial assets
13. All of the following are a non-monetary assets except
a. Patents c. Machinery
b. Land d. Accounts receivable, net

14. The initial recording principle for assets states that assets are initially recorded on the basis of events in which the enterprise acquires
resources from other entities. This principle does not apply to the acquisition of
a. Claims to receive money
b. Contractual rights to the use of resources of other entities
c. Produced or self-constructed assets
d. Ownership interests in other enterprises

Measurement/Valuation of Assets
15. Financial assets such as held for trading securities and available for sale securities are initially valued
a. Historical cost c. Net realizable value
b. Present value of future cash flows d. Fair market value

16. The ideal measure of short-term receivables in the balance sheet is the discounted value of cash to be received in the future. Failure to
follow this practice usually does not make the balance sheet misleading because
a. Cash can be raised through receivable financing
b. The allowance for uncollectible accounts include a discount element
c. Short-term receivables are normally non-interest bearing
d. The amount of the discount is not material.

17. Nonmonetary assets should initially be recorded at their acquisition cost which is best described as
a. The price paid to acquire the asset
b. All costs incurred to finance the acquisition of the asset and place it in a location and condition ready for use.
c. The invoice price of the asset plus all expenditures related to its acquisition
d. The cash or cash-equivalent outlay required to obtain the asset and place it in a condition and location ready for its intended use

18. ABS Company purchased certain plant assets under a deferred payment contract on December 31, Year 1. The agreement was to pay
P20,000 at the time of purchase and P20,000 at the end of the next five years. The plant assets should be valued at
a. The present value of a P20,000 ordinary annuity for five years
b. P120,000
c. P120,000 plus imputed interest
d. P120,000 less imputed interest

19. Assets acquired in a long-term credit transaction are measured at

a. Invoice price c. Installment price
b. Equivalent net cash price d. Exchange price

20. In non-monetary exchanges with commercial substance, the asset acquired is generally measured at the
a. Fair value of the asset given up or fair market value of the asset received whichever is clearly evident
b. Market value of the asset acquired even if the fair market value of the asset given is likewise clearly evident
c. Fair value of the asset given
d. Appraised value of the asset given up

21. In nonmonetary exchange with no commercial substance, the asset acquired is measured at
a. Fair market value of the asset given up c. Carrying value of the asset received
b. Fair market value of the asset received d. Carrying value of the asset given

22. Nonmonetary assets acquired in nonreciprocal transfers are measured at the

a. Fair value of the asset acquired
b. Carrying value of the asset acquired
c. Fair value of the asset given up or of the asset received, whichever is more clearly determinable
d. Assessed value of the asset acquired

23. In which two of the following asset acquisitions may a gain be recognized?
A. Acquisition by exchange of non-monetary assets with no commercial substance
B. Acquisition by exchange of non-monetary assets with commercial substance
C. Acquisition by donation
D. Acquisition by investment
a. A and B c. B and C
b. A and C d. B and D

24. Which of the following statements is (are) true?

I. When an asset is acquired through an exchange transaction, a gain or loss is recognized
II. When an asset is acquired through a non-monetary exchange with no commercial value, a gain or loss is recognized
III. When an asset is acquired through a non-monetary exchange with commercial value, a gain or loss may be recognized
IV. There may be instances when a gain may be recognized when an asset is received in a non-reciprocal transfer
a. I and II only c. I, II, and III
b. III and IV only d. I, II, III, and IV

25. Which of the following expenditures may be properly capitalized?

a. Extensive costs incurred in the inauguration and blessing of the building which is the primary place of business of Assert Enterprise
b. Cost of repairing damage on glass top of a table which was accidentally dropped upon delivery to the administrative office.
c. Cost of extraordinary repairs on building which did not prolong its life nor increase its operating capacity
d. Insurance on plant during construction
26. Which of the following is not an auxiliary cost that should be added to the purchase price of a new machine?
a. Freight to bring machine to the place of business
b. Installation cost of machine
c. Cost of test runs on the machine
d. Cost of dismantling old machine replaced by new machine

27. When a group of assets is acquired in an exchange, the fair values of the assets acquired is used
a. To determine total cost to the enterprise c. As the measurement basis of the basis
b. As a device for allocating total cost d. Both (b) and (c)

28. Theoretically, cash discounts permitted on purchased equipment should be

a. Excluded from asset cost if taken c. Excluded from asset cost whether taken or not
b. Excluded from asset cost if not taken d. Included in asset cost

29. Which of the following assets should be recorded initially at historical cost
a. Held for trading securities c. Newly hatched chicks
b. Available-for-sale securities d. Investment Property

30. The local government of Global City donated a factory site suitable for Expensaver Corporation. This donation may be reflected in the
company books at
a. Nominal value or market value at management’s option
b. At current market value
c. Cost of titling the property
d. Actual cost of relocating the factory

31. Which of the following is not a generally accepted basis for valuing an asset after acquisition?
a. Acquisition cost c. Nominal value
b. Net realizable value d. Current replacement cost

32. Which of the following events or circumstances would justify reporting an asset above its acquisition cost under present GAAP?
a. An investment in common stock is accounted for under the equity method and the investee reports a net income for the year.
b. The market value of an investment in common stock accounted for under the equity method is higher than the acquisition cost
c. The market value of an investment in debt securities is higher than acquisition cost and the investment is classified as a non-
current asset
d. The market value of inventories is higher than its cost

33. All of the following may be used to determine the “fair value” of an asset except
a. Quoted market prices c. Firm cash offers for the asset
b. Independent appraisals d. Book values

34. In an arms-length transaction, Company A and Company B exchanged nonmonetary assets with no monetary consideration involved.
The exchange can be classified as “with commercial value” and the fair value of the assets exchanged are both clearly evident. The
accounting for the exchange should be based on the
a. Fair value of the asset surrendered c. Carrying amount of the asset surrendered
b. Fair value of the asset received d. Carrying amount of the asset received

35. Company X and Company Y exchanged nonmonetary assets with no monetary consideration involved and no commercial value. The
accounting for the exchange should be based on
a. Carrying amount of the asset received c. Fair value of the asset received
b. Carrying amount of the asset relinquished d. Fair value of the asset relinquished

36. If the cost of a depreciable asset is incorrectly recorded as a revenue expenditure

a. Assets and owners’ equity for the first year will be understand
b. Assets and owners’ equity for the succeeding year will be overstated
c. Net income for the first year will be overstated
d. Net income in the succeeding year will be understated

37. For a manufacturing company, which of the following is an example of a period rather than a product cost?
a. Depreciation on factory equipment c. Wages of machine operators
b. Wages of salespersons d. Insurance on factory equipment

38. Present GAAP require recognition of all of the following unfavorable events except
a. Decline in market value of inventory below cost
b. Decline in market value of plant assets below cost
c. Reductions in the utility of productive facilities due to obsolescence
d. Future operating losses

39. Under present GAAP, which of the following items may not be initially measured at cost?
a. A constructed building
b. A machinery acquired by purchase
c. A one year old piglet acquired by purchase
d. A patent developed by the company and registered with the Philippine Patents Office

ACCOUNTING FOR LIABILITIES

Definition – A liability:
 • is a present obligation of the enterprise
• arising from past events
• the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits

Characteristics – Liabilities have the following characteristics:

A. Present obligation of a specific enterprise – an obligation is a duty or responsibility to act or perform in a certain way. The
enterprise has little or no discretion to avoid the future sacrifice.
• An obligation may be legally enforceable as a consequence of a binding contract or statutory requirement. However,
obligations also arise from normal business practice, custom and a desire to maintain good business relations or act in
an equitable manner.
• Present obligation vs. future commitment – An obligation normally arises only when the asset is delivered or the
enterprise enters into an irrevocable agreement to acquire the asset.

• The irrevocable nature of the agreement means that the economic consequences of failing to honor the obligation
leave the enterprise with little, if any discretion to avoid the outflow of resources to another party.
• A commitment is a decision by management of an enterprise to acquire assets in the future. It does not, of itself give
rise to a present obligation.

B. Requires sacrifice or transfer of assets – embodies obligation that requires payment or settlement by a probable future
sacrifice of assets.

Modes of settlement of a present obligation

• Payment of cash
• Transfer of other assets
• Provision of services
• Replacement of that obligation with another obligation; or
• Conversion of the obligation to equity

C. Past transactions or events – the obligation results from transactions or events that have already happened.

D. Monetary measurement – the amount can be measured in money with reasonable accuracy.
• Some liabilities can be measured only by using a substantial degree of estimation. These liabilities are usually
described as provisions. When the provision involves a present obligation and satisfies the rest of the definition of a
liability, it is a liability even if the amount has to be estimated.

E. Other matters
i. Identity of the payee – a liability may exist even if the identity of the payee is not immediately known provided it can be
determined before the settlement date of the obligation.
ii. Settlement date – liabilities may be payable at a specific or determinable future date, upon occurrence of a specified event,
or on demand.
iii. Valuation accounts – these may increase or decrease the carrying amount of a liability, and are therefore part of the related
liability. Examples are Premium on Bonds and Discount on Bonds.
iv. Gross profit on installment sales – is not a liability. The enterprise is not obligated to pay cash or provide goods or services
to the customer. It is conceptually an asset valuation account.
v. Legal enforceability – not all liabilities are legally enforceable claims. Legal enforceability is not a prerequisite for an
obligation to qualify as a liability if the future sacrifice of assets is otherwise probable. Thus liabilities may arise from
“equitable” or “constructive” obligations. (Ex. Estimated Warranty Payable; Estimated Premiums Payable)
1. Classification of Liabilities
A. As to nature of obligation
i. Legal obligation – arises from contracts and other agreements that are legally enforceable of from governmental actions
that have the force of law.
ii. Equitable obligation – arises from ethical and moral constraints, rather than legal requirements.
Examples: (1) A company obligates itself to pay for damages sustained when there is no legal requirement for it do so, or (2)
refunds damaged merchandise when there is no legal obligation for such refunds.
iii. Constructive obligation – Obligation created, inferred or construed from the facts in a particular situation rather than
contracted by agreement with another entity or imposed by the government
Example: An enterprise may create a constructive obligation to employees for vacation pay or year –end bonuses by paying
them every year even if it is not contractually bound to do so and has not announced a policy to do so.
B. As to amount of obligation
i. Determinable liability – a liability whose amount is specified or can be determined from the conditions of a contract.
ii. Estimated liability – A liability whose amount is dependent upon future events and must be measured by estimates of a
definitive character. These are sometimes known as provisions
C. As to existence of obligation
i. Actual liability – A liability whose existence is certain
ii. Contingent liability – A potential obligation that is dependent upon the occurrence or nonoccurrence of one or more future
events to confirm its existence.

2. Recognition of Liabilities
Recognition Principle – A liability is recognized in the balance sheet when it is probable that an outflow of resources embodying
economic benefits will result from the settlement of a present obligation and the amount at the settlement will take place can be
measured reliably.
• Liabilities from exchanges are recognized when the corresponding money, goods or services are received.
• Some liabilities are the result of non-reciprocal transfers which obligate the enterprise to make a future sacrifice of assets
without receiving in exchange. Examples: imposition of fines, damages and penalties, tax obligations and declaration of cash or
property dividends. These types of liabilities are recognized when the obligation is established.
 Liabilities should be given accounting recognition in the period in which money, goods or services are received, or when a legally
enforceable claim exists against the company is established. In general, liabilities are recorded when the corresponding assets, expenses
or losses are recognized.

Special Problems
• Commitment – A commitment to acquire goods and services in the future does not give rise to a liability because the mere
signing of a contract or the issuance of a purchase order does not result in a completed transaction.
• Contingent liabilities – The accounting treatment of a contingent liability and the corresponding loss contingency depends on
the likelihood that the related future event will occur and confirm the incurrence of the loss and the liability.

3. Measurement of Liabilities
Recognition Principle – A liability is recognized in the balance sheet when it is probable that an outflow of resources embodying
economic benefits will result from the settlement of a present obligation

Pervasive Principle: Liabilities are measured at exchange prices at which transfers take place.
• Liabilities are measured at amounts established in exchanges, usually the amounts to be paid, sometimes discounted.
• Liabilities imposed in nonreciprocal transfers are measured at the amount to be paid, sometimes discounted.

Monetary vs. Nonmonetary Liabilities

Like assets, liabilities may be classified as monetary and nonmonetary for the purpose of applying the measurement principle.
A. Monetary assets – obligations payable in a fixed amount of pesos at a definite future date. Conceptually, monetary liabilities should
be measured at discounted value. Most short-term liabilities are simply measured at the amount to be paid. Discounted present
values are often used if the obligation require payments at dates that are relatively far in the future.
B. Nonmonetary assets – obligations that will be settled by delivering goods or services.
• Estimated accrued liabilities - Reasonably probable obligations to deliver goods or services upon the occurrence of a related
future event or events. These are stated at net settlement value measured by estimated cost of goods to be delivered or
services to be provided in the future. Example: Estimated Liability for product warranties
• Deferred revenues - Obligations created by advance payment from customers for goods or services to be delivered in the
future. These are reported at historical proceeds, which is the amount of cash or its equivalent, advanced by customers,
adjusted after acquisition for amortization or other allocations.

4. Discharge of Liabilities
Broad Operating Principle: Decreases in liabilities are recorded when they are discharged through payments, through substitution of
other liabilities, or otherwise, the decreases are measured by the recorded amounts that relate to the liabilities. A partial discharge of
liabilities is measured at a proportionate part of the recorded amount of the liabilities.
Most liabilities are discharged by cash payments. Others are settled by the enterprise’s transferring of assets or providing services to
other entities, and some involve performance to earn revenues (ex: liabilities to provide magazines under a prepaid subscription
agreement. Liabilities are also sometimes eliminated by:
• Forgiveness
• Compromise
• Incurring another liabilities
• Changed circumstances

Accounting: A discharge of liabilities is accounted for by removing the recorded amount of the liability from the accounts. In some
cases, the amount of net assets required to settle a liability may be more or less than its recorded amount. Any difference is recognized
as a gain or loss.

ACCOUNTING FOR EQUITY

Definition – Equity is the residual interest of owners in the assets of the enterprise, after deducting all its liabilities.

Characteristics:
A. Owners’ rights – represents the rights of owners in the assets of a business enterprise.
B. Residual interest – residual interest ranks after liabilities as a claim to enterprise assets and significantly.
C. Indefinite repayment date – it has no definite repayment date except upon liabilities
D. Measurability – it is not independently measurable, its amount depends on the value assigned to assets and liabilities.

Owners’ Rights – “Equity” in the broad sense, refers to any recognized rights to, or interest in the assets of a business enterprise. Equity
interests are of two principal groups: liabilities and owner’s equity. Liabilities are the rights of creditors; owners’ equity represents the
rights of owners.

Residual Interest – Equity is a residual interest because the claims of creditors must first be satisfied, or not jeopardized, before assets
can be distributed to owners.

Indefinite Repayment Date – The claim of owners on assets of the enterprise has no specific maturity date except upon liquidation.
Generally, an enterprise is not obligated to transfer assets to owners, except upon liquidation and when the enterprise itself formally
acts to effect such transfer, for example, by declaring a cash dividend.

In contrast, the maturity date of creditors’ claims is generally fixed or determinable from written agreements or provisions of law, and
the enterprise has little or no discretion to avoid payment of these claims.

Measurability of Equity – Equity cannot be measured separately from other elements of financial position because it is the excess of
assets over liabilities. As such, its amount depends on the measurement of assets and liabilities.

1. Events Increasing/Decreasing Owners’ Equity

Increases in owners’ equity arise from
• Investments in an enterprise by its owners
 • The net result of all revenue and expenses recognized during a period (net income)
• External events other than transfers (revaluation of property and equipment)
• Owners’ equity may also be increased by prior period adjustments
Decreases in owners’ equity arise from
• Transfers from an enterprise to its owners (ex: dividends, treasury stock acquisitions)
• Net losses for the period
• Owners’ equity may also be decreased by prior period adjustments and by adjustment arising from quasi-reorganization

2. Recognition and Measurement of Owners’ Equity

Classification of transactions – Owners’ equity transactions are of two types:
• Capital transactions – represent the direct contributions or withdrawals of assets by owners.
• Income-related transactions – represent income statement transactions and prior period adjustments that pertain to income of
previous periods.
This section deals only with capital transactions. Income-related transactions are discussed in other sections.

Recognition of Changes in Owners’ Equity

a. Principle – Transfers of assets or liabilities between an enterprise and its owners are recorded when they occur.
b. Fundamental relationships – Assets, liabilities and owners’ equity are fundamentally related as expressed in the equation: A = L
+ C. Because of this relationship, recognition of changes in owners’ equity depends upon recognizing changes in assets and
liabilities that affect owners’ equity.
c. Events Affecting Owners’ Equity - Not all changes in assets and liabilities affect owners’ equity. Furthermore, changes may take
place within owners’ equity that do not affect asset or liabilities.

Measurement of Changes in Owners’ Equity

Changes in owners’ equity are measured by the values of related assets acquired or transferred, or related liabilities incurred or
discharged.

QUIZZER 2 ACCOUNTING FOR LIABILITIES

1. Which of the following is an essential characteristic of a liability?

a. The obligation should be paid in cash or non-cash asset
b. The obligation should arise from a past transaction of the enterprise
c. The obligation must have a definite amount.
d. The specific party to whom payable should be clearly identifiable at the balance sheet date.

2. Which of the following is not an essential characteristic of a liability?

a. Legal enforceability c. Involves future sacrifice of economic benefits
b. Present obligations to third parties d. Past activity

3. An example of an item which is not a liability is

a. The portion of a long-term debt due within one year
b. Estimated warranty costs
c. Dividends payable common shares of the issuing corporation
d. Customers’ deposits

4. Which of the following situations creates a liability for Bro Company?

a. The Bro Company signs a letter of intent to purchase goods worth P 5,200 from Santino Corporation. The goods will be delivered
in six months
b. Mara Trading pays Bro Company in advance for goods to be delivered throughout the year
c. Clara invests P 5,000,000 in Bro, expecting to earn a profit on her investments as stockholder
d. Bro’s company lawyers estimate that it is probable that Bro will have to pay damages on account of a patent infringement suit
although the amount cannot yet be ascertained.

5. When accountants record a liability for income taxes, they are

a. Measuring the current and future outcomes of accounting decisions
b. Measuring the present effect of a future cash outflow to the government
c. Reflecting a past exchange as a basis of accounting measurement
d. Using a present exchange price as the basis for their accounting measurement

6. Conceptually, “Deferred Gross Profit on Installment Sales is a (an)

a. Liability c. Element of owners’ equity
b. Asset valuation account d. Deferred credit

7. Which of the following statements relating to the recognition of liabilities is false?

I. Liabilities are recognized when obligations to transfer assets or provide services in the future are incurred in exchanges.
II. Liabilities arising from non-reciprocal transfers are recognized when the corresponding money, goods, or services are received.
III. Mutually unexecuted contracts are generally not recognized as accounting liabilities.
a. I only c. I and II only
b. II only d. I, II and III

8. All of the following are appropriate bases for recognizing a liability except
a. When money goods or services are acquired
b. When GMA promotes Pure Foods products on TV programs this month, but payment is not due until next month
c. When a check for P 60,000 is received by Time Magazine for a two year subscription.
d. When stock dividends are declared by Ayala land

9. A legal obligation that is not reported in the balance sheet but is disclosed in notes to financial statements is a
 a. Fixed amount – estimated payment date obligation
b. Estimated amount – estimated payment date obligation
c. Partially executed contract
d. Mutually unexecuted contract

10. Goods were ordered by Maranao Company from Malinao Company on December 20, 2017. The terms of sale were FOB destination.
Malinao Company shipped the goods on December 29, 2017 and Maranao received them on January 4, 2018. When should Maranao
record the accounts payable?
a. December 20, 2017 c. December 31, 2017
b. December 29, 2017 d. January 4, 2018
11. From the viewpoint of the declaring corporation, liability for cash dividend is established
a. Date of payment c. Date the dividend checks are released
b. Date of declaration d. Date of record

12. Which of the following would be an example of an executory contract?

a. A customer places an order for merchandise to be picked up and paid for in one week
b. A company sold a one year subscription to its publication and received the subscription price in cash
c. A company sold an appliance and gave a warranty to replace defective parts within one year after sale.
d. A company borrowed money from a bank to purchase a delivery truck.

13. The following statements relate to the measurement of liabilities. Which is true?
a. Liabilities are measured at amounts established in exchanges, usually the amounts to be paid, sometimes discounted.
b. A long-term noninterest bearing note payable should be recorded at its face amount
c. All monetary liabilities should be stated at their present discounted value
d. Liabilities created by advance payments from customers are measured in terms of the cost of goods be delivered or services to
be provided on the future

14. The following statements relate to liabilities. Which statement is true?

I. Liabilities may also be measured by estimates of a definitive character when the amount of the liability cannot be measured
precisely.
II. A long term, non-interest bearing note payable should be recorded at present discounted value.
III. All monetary liabilities should be stated at their present (discounted) value.
a. I & II c. II & III
b. I & III d. I, II, & III

15. Most short-term liabilities are measured at the

a. Amount to be paid c. Discounted amount
b. Amount incurred d. Exchange price

16. Which of the liabilities below would be accounted for at the present value of future cash payments?
a. Accounts payable c. Income taxes payable
b. Bonds Payable d. Unearned revenue

17. Obligations arising from advances from customers on unexecuted contracts (e.g., magazine subscriptions) should be valued at
a. Present value of goods or services to be delivered
b. Estimated cost of goods or services to be delivered
c. Amount of cash received
d. None of the above

18. The difference between the recorded amount of a liability and the amount to be paid is
a. Recognized as a financing expense when the liability is incurred
b. Amortized to interest expense over the periods to maturity
c. Added to the recorded amount of the liability to show its present discounted value
d. Reported as deferred charge

19. Potential obligations involving uncertainty as to possible losses are known as

Estimated liabilities Contingent liabilities Estimated liabilities Contingent liabilities
a. YES YES c. NO YES
b. YES NO d. NO NO

20. An estimated liability is an obligation which is uncertain as to

Amount Existence Amount Existence
a. YES YES c. NO YES
b. YES NO d. NO NO

21. Which of the following is an “estimated liability”?

a. Product warranties payable c. Liability for unclaimed checks
b. Accommodation endorsement d. Unearned rental income

22. Estimated liabilities are presented in the financial statements by

a. Footnote to the balance sheet
b. Showing the amount among the liabilities but not extending it to the liability total
c. An appropriation of retained earnings
d. Appropriately classifying them as regular liabilities in the balance sheet

23. Which of the following should not be classified as a contingent liability?

 a. Accommodation endorsement of liability
b. Premium offers to customers for labels or box tops
c. Pending lawsuits
d. Taxes that are in dispute

24. Which of the following statements is (are) true?

I. Liabilities where the amount is an estimate and the parties to whom payment will be made is uncertain are considered actual
liabilities and should be shown in the balance sheet as such
II. Estimated liabilities are not different from contingent liabilities and are disclosed in financial statements by footnote to the
statements
a. Only I is true c. I & II are true
b. Only II is true d. I & II are false

QUIZZER 2 ACCOUNTING FOR OWNER’S EQUITY

25. Which of the following statements pertaining to equity is false?

a. The term “net assets” is synonymous with “capital” or “owners” equity
b. Equity of a reporting entity represents the excess of total assets over total liabilities
c. Measurement of equity is affected by the measurement of assets and liabilities
d. Claims on or interest in assets are referred to as “equities” and is referred to as owner’s equity in the statement of financial
position

26. Which of the following statements is (are) true?

I. Owner’s equity represent the interest of owners in specific assets of a business enterprise
II. All increases in assets also increase owners’ equity
III. Changes in owners’ equity cannot be measured separately from changes in assets and liabilities
a. I only c. I and II only
b. III only d. I, II, and III

27. Which of the following can be best described as “residual equity”?

a. Unsecured loans payable c. Common or ordinary shares issued
b. Debenture bonds d. Preference shares issued

28. Increases in owners’ equity can arise from

a. Treasury stock acquisition c. Government grants
b. Transfers from a business to its owners d. Net losses for a period

29. Decreases in owners’ equity arises from

a. Investments in an enterprise by its owners
b. Nonreciprocal transfers to an enterprise from other than owners
c. Transfers from an enterprise to its owners
d. Net income

30. Which of the following events has no effect on total owners’ equity?
a. Increase in fair value of asset due to revaluation c. Sale of goods on account
b. Rent revenue collected in advance d. Prior period adjustment

31. A nonmonetary asset is invested in a corporation. Assuming all of the following values are equally reliable, the best measure of the
increase in owners’ equity is
a. Fair value of the stock issued c. Book value of the stock issued
b. Fair value of the nonmonetary asset invested d. Assessed value of nonmonetary asset invested

32. In which of the following cases may nonmonetary assets transferred to a corporation be measured at their costs to the transferor,
rather than at their face value on the date of transfer?
a. When the transfer is made by principal stockholders or founders of the corporation
b. When a nonmonetary asset is donated to the corporation
c. When the shares issued in exchange have no readily determinable market value
d. When the shares issued in exchange have no par value

33. Under of the rules of debit and credit which of the following situations cannot justify an increase in equity?
a. Decrease in bonds payable c. Increase in depreciation
b. Increase in cash d. Increase in value of land through revaluation

END OF MODULE 3
 MMCO Continuing Professional Development Training Center (CPDTC)
2F MMCO Building, 8000 Lakeview Ph3 Angela Street, Halang Calamba City Laguna, Philippines
Tel No. (02) 330-8617, (049) 523-6031; (02) 330-6057
CPA REVIEW (May 2019 Batch)
FAR Theory Cedrick Zapanta, CPA
Module 4
1. Principles of Recognition and Measurement
a) Net Income
b) Revenue
c) Expenses
2. Revenue Recognition Standards
a) PAS 18
b) PFRS 15

PRINCIPLES OF RECOGNITION AND MEASUREMENT OF THE ELEMENTS OF FINANCIAL PERFORMANCE

ACCOUNTING FOR NET INCOME

Definition – Net income (or net loss) is the excess (or deficit) of revenue over expenses for an accounting period, which is the net
increase (net decrease) in owners’ equity (assets minus liabilities) of an enterprise for an accounting period from profit-directed
activities that is recognized and measured in conformity with generally accepted accounting principles.

Characteristics
1. Net concept – Income is a net concept determined by deducting expenses from revenues.
2. Change in net assets – Net income (net loss) is the increase (decrease) in net assets of a business enterprise resulting from its
profit-directed activities.
3. Change in owners’ equity – Net income (net loss) increases (decrease) owners’ equity.
4. Periodicity and tentativeness – Net income is measured for stated periods of time and the resulting measurements are
tentative before the life of the business is terminated.

Related Terms
A. Profit – profit is frequently used as a measure of performance or as the basis for other measures, such as return on investment
or earnings per share. The elements directly related to the measurement of profit are income and expenses. The recognition
and measurement of profit (income and expenses) depends in part on the concepts of capital and capital maintenance used by
the enterprise in preparing financial statements.
B. Income – is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or
decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.
C. Gains – represent other items that meet the definition of income and may, or may not, arise in the course of the ordinary
activities of the enterprise. Gains represent economic benefits. It includes those arising on the disposal of noncurrent assets.
The definition of income also includes unrealized gains, for example, those arising on the revaluation of marketable securities
and those resulting from increases in the carrying amount of long-term assets.
When gains are recognized in the income statements, they are usually displayed separately because knowledge of them is
useful for the purpose of making economic decisions. Gains are often reported net of related expenses.
D. Earnings – earnings is a general term embracing revenue, profit and income. The term is commonly used as a synonym for net
income, particularly over a period of years.

1. Net Concept
Income has positive and negative elements consisting of revenues and expenses. Net income is the excess of total revenues over
total expenses during a period. An excess of total expenses over total revenues is a net loss.

Revenues and expenses can be combined in various ways to obtain several intermediate measures or sub-totals of income with
varying degrees of inclusiveness. Thus” income” may mean “operating income”, “income from continuing operations”, income
before extraordinary items” etc. To avoid confusion, an appropriate qualifying word or phrase should accompany the term “income”
to explain what is presented.
2. Changes in Net Assets
The elements of income describe changes in assets and liabilities resulting from the profit-directed activities of an enterprise during
a period. Revenues are gross increases in assets or gross decreases in liabilities. Expenses are gross decreases in assets or gross
increases in liabilities. Net income is the increase in net assets of an enterprise, measured by the excess of revenues over expenses.

Since net income measures the change (or part of the change) in net assets during a period, its determination is inseparably linked to
the recognition and measurement of assets and liabilities. The point in time at which revenues and expenses are recognized is also
the point at which changes in the amounts of net assets are recognized.

3. Changes in Owner’s Equity

Net income (net loss) is the change in net assets of an enterprise resulting from its profit-directed activities during a period. Since
net assets is equal to assets less liabilities, it is synonymous with owners’ equity. From the fundamental accounting equation (Assets
– Liabilities = Owners’ Equity), we know that an increase (decrease) in net assets is always accompanied by a corresponding increase
(decrease) in owners’ equity.
 Although net income changes owners’ equity, not all changes in owners’ equity are caused by net income. Owners’ equity can also
change as a result of (a) transfers between the business enterprise and its owners and (b) events that are accounted for as directed
changes in owners’ equity rather than as elements of net income such as appraisal write-ups of property and quasi-organizations.

4. Periodicity and Tentativeness

Unlike the elements of financial position which related to a point of time, net income and its elements relate to a period of time. Net
income cannot be conclusively measured until the end of the life of the enterprise. However, users cannot wait indefinitely for
information about an entity’s operating results. Accordingly, relatively short time periods of equal length, usually one year, are used
to measure and report net income.

To determine net income, revenues and expenses must be assigned to appropriate time periods during the life of the enterprise.
This requires the use of estimates and judgments because business activities do not come to a complete stop at the end of each
accounting period and because assumptions must be made as to future events which may be invalidated by experience. For
example, periodic depreciation expense is necessarily an estimate based on assumptions and judgments about the useful life and
salvage value of the asset and the amount to be recognized as expense in each period. Thus, attempts to measure net income for
short time periods are necessarily tentative. The shorter the time period, the more difficult it is to determine net income.

5. Recognition of Net Income

Principle – Determination of periodic net income depends on recognizing changes in assets and liabilities in the period in which the
changes occur, rather than simply on recording receipts and payments of money.

Alternative Income Recognition Bases

• Accrual Basis
• Cash Basis
• Modified Cash Basis

Accrual Basis
Revenues are recognized when realized, i.e. when goods are sold are services provided. Expenses are recognized when incurred, i.e.
when assets are consumed to generate revenue. Net income (loss) for the period is the difference between realized revenues and
related expenses.
• Advantages – Accomplishments (revenues) are related to efforts or sacrifices (expenses) so that reported net income
measures an enterprise’s performance during a period. It is also more useful in predicting future earnings and cash flows of
the enterprise. These are the primary reasons why accrual accounting is preferred over cash-basis accounting.

Cash Basis
Revenue is recognized when collected in cash, expenses when paid or settled in cash. Net income (loss) for the period is the
difference between cash received from, and cash disbursed for the firm’s profit-directed activities.
• Advantages – Simplicity and economy because transactions are recorded only when cash is received or paid and reliability
because estimates and judgments are not required.
• Disadvantages – Cash basis is not useful in evaluating enterprise performance because it does not reflect the results of all
profit-directed activities which took place during the period. Cash receipts and payments and the accomplishments and
efforts often occur in different periods.
• Acceptability – Cash basis accounting is not a generally accepted basis of recognizing net income. It is used only by relatively
small business firms and practicing professionals whose needs are satisfied by simple accounting records. Moreover, strict
cash basis accounting is often modified in practice.
Modified Cash Basis
Modified cash basis is a hybrid system of recognizing net income. Items materially affecting net income such as purchases and sales
on account, inventories, long-lived assets and depreciation are accounted for on an accrual basis; all other items are recognized on a
cash basis.

6. Measurement of Net Income

Principle – Net income (loss) for a period is measured by the excess (deficiency) of revenues over expenses recognized in accordance
with accrual accounting during the period. Net income should include all items of revenues and expenses given accounting
recognition during the period, with the sole exception of prior period adjustments.

Transaction Approach – Net income (net loss) is the excess (deficiency) of revenues over expenses recognized on an accrual
accounting basis during the period. This is the preferred approach because it shows not only the amount of net income or loss but
also the nature and amounts of revenues and expenses included in net income. The amount of net income or loss will be the same
under either approach because financial statements articulate.

Steps in Income Measurement

Under the transactions approach, the income measurement process involves three basis steps:
a. Revenue – Identify and measure revenues realized during the reporting period
b. Expenses – Measure the expenses incurred to directly or indirectly generate the realized revenues
c. Net income (loss) – Deduct expenses from revenues to arrive at the net income/loss for the period.

Comprehensive Income – Comprehensive income comprises all recognized changes in equity (net assets) of an entity during a
period from transactions and other events and circumstances except those resulting from investments by and distributions to
owners. Total comprehensive income and profit and loss are usually used as a measure of the total performance of the firm.
Performance is the relationship of the income and expenses (both realized and recognized) of an entity during a reporting period.
7. Contemporary Income Issues
A. Capital vs. Income
 Capital distinguished from income – Capital in its most general sense may be thought of as a “store of wealth” from the use
of which the owner hopes to obtain additional wealth. Income is the increment in wealth arising from the use of capital. It is
a return on capital as distinguished from a return of a capital.
 Importance of distinction – Capital should be distinguished from income so that charges and credits which should be made
directly to capital are not included in net income, and vice versa.

B. Capital Maintenance Concepts – Capital maintenance holds that a firm’s beginning capital should be maintained intact before
any income can be recognized. There are three concepts about the nature of capital that should be maintained.
• Nominal financial capital
• Physical capital
• Constant-peso capital

Nominal financial capital - Nominal financial capital is the money amount of net financial resources invested by owners in the
business, measured in terms of nominal pesos. Nominal pesos are actual pesos without adjustments for changes in the general
purchasing power of money. This concept underlies present generally accepted accounting principles.

Physical capital – Physical capital is the amount of capital need to replace existing assets of the enterprise and preserve its capacity
to produce a constant supply of goods and services at previous levels of output. Advocates of this concept believe that net income
should be measured on the basis of current values instead of historical costs.

Constant-peso capital – Constant peso capital (sometimes called “real capital” is the money amount of capital measured in constant
pesos. Constant pesos are units of money with the same (constant) general purchasing power. This concept is advocated by those
who believe that changes in the general purchasing power of money should be recognized in measuring net income.

C. Holding Gains and Losses – Holding gains and losses are changes in the value of assets and liabilities held by a firm during a
period as a result of technological advances, movements in price levels, and other events and circumstances not directly
influenced by managerial decisions.
 Present practice – Holding gains and losses are recognized to the extent that they are allowed by particular accounting
standards (IFRSs), such as available-for-sale securities, (PAS 39), property and equipment carried at revalued amounts (PAS
16), Biological Assets (PAS 41)
 Holding gains and losses are recognized in the accounts and reported in the statement of comprehensive income separately
from profit and loss for the period. This will make net income more significant and facilitate prediction of future earnings
and cash flows.
QUIZZER - NET INCOME

1. The process of identifying, measuring, and relating revenue and expenses of an enterprise for an accounting period is known as
a. Revenue recognition c. Realization
b. Income determination d. Expense recognition

2. The excess of revenue over expenses for an accounting period, which is the net increase in owners’ equity of an enterprise from
profit-directed activities that is recognized and measured in conformity with GAAP is
a. Net income c. Net loss
b. Net gain d. Net margin

3. Which of the following statements is true?

I. Net loss is the decrease in net assets of a business resulting from its profit-directed activities.
II. Income is a net or partially net concept determined by deducting expenses from revenues
III. The income or loss which is shown as the final amount in the income statement reflects the success or failure of the business in
its profit-directed activities.
a. Only I is true c. II and III are true
b. I and II are true d. I, II, and III are true

4. Which of the following best describes “net income” of a business enterprise for an accounting period?
a. The increase in net assets resulting from all its activities during the period, except transfers between the enterprise and its
owner, that is recognized and measured in conformity with GAAP
b. The excess of revenues over expenditures during the period
c. The increase in net assets resulting from all its activities during the period
d. The increase in owner’s equity resulting from profit-directed activities during the period

5. “Profit-directed activities” generally refer to all activities of an enterprise

a. That give rise to revenue and expenses
b. That affect its earning potential
c. Except transfers between the enterprise and its owners
d. Except transfers between the enterprise and its owners and prior period adjustments

6. Which of the following terms is commonly used as a synonym for net income particularly over a period of years?
a. Earnings c. Revenue
b. Profit d. Proceeds
7. The computed figure which represents the difference between sales or other revenues and the sum of costs expired and expenses
incurred during the year is considered as the
a. Economic measurement of profit c. Return on investment
b. Accounting concept of income d. Return on total assets

8. The term “realized income” refers to

a. The recording of revenue at the time cash is received from the sale of a commodity of service
b. The accounting for income in the period in which it is actually earned
c. The recognition of revenue when there is sufficient objective evidence to determine with a fair degree of certainty that final
amount to be received from operations
d. The recognition of gain when there is good evidence that an asset has changed in value

9. Which of the following statements is incorrect?

a. Accrual basis financial statements may be prepared from single entry records.
b. Single entry accounting is synonymous with cash basis accounting.
c. No adjusting entries are necessary when accounting records are kept on a pure cash basis.
d. Over entire life of the business, there would be no difference between income on cash basis and income on an accrual basis.

10. Why is accrual accounting the generally accepted basis for recognizing and measuring net income?
a. It recognizes non-cash transactions and events affecting net income
b. Data needed for preparing the income statement is more readily available from accounting records
c. The information is more readily understood by users
d. It provides a better indication of enterprise performance than information about current cash receipts and payments

11. Which of the following phrases is associated with the cash basis, rather than the accrual basis of accounting?
a. Generally accepted accounting principle c. Matching efforts and accomplishments
b. Flexibility in determining timing of expenses d. Minimum amount or record keeping

12. Under modified cash basis accounting, which of the following would most likely be accounted for on an accrual basis (rather than a
cash) basis?
a. Interest income and expense c. Rent expense
b. Salaries and wages d. Long-lived assets and depreciation

13. Under the modified-cash basis accounting, bad debts are

a. Recognized in the books because sales on account are recognized as revenue even if not yet collected
b. Disregarded because sales on account are not recognized until collected in cash
c. Disregarded because sales on account are only allowed when total collection is ascertained
d. Answer not given

14. Compared to the accrual basis of accounting, the cash basis of accounting overstates income by the net increase during the
accounting period of the
Accounts Receivable Accrued Expenses Payable
a. NO NO
b. NO YES
c. YES YES
d. YES NO

15. Periodic net earnings are conventionally measured by a

a. Transactions approach
b. Transactions approach including recognition of unrealized gains and losses
c. Capital maintenance approach
d. Market value approach including recognition of all realized gains and some unrealized losses

16. The transactions approach to income measurement is superior to the capital maintenance approach because
a. It is simpler and easier to implement
b. All changes in asset values are recognized
c. It emphasizes articulation of the financial statements
d. It provides information on the components of net income

17. The method of income determination which measures the results of enterprise transactions and involves the determination of the
amount of revenue earned by an entity during a given period and the amount of expenses applicable to that revenue is known as
the
Transactions approach Economic approach
a. YES NO
b. NO YES
c. NO NO
d. YES YES

18. An income measurement approach based on the difference between capital values at two points in time is the
 a. Transactions approach c. Economic approach
b. Direct approach d. Comprehensive approach

19. Under GAAP

a. Income and expenses, assets and liabilities are measured based on the occurrence of changes in the economic resources and
obligations
b. Assets and liabilities are measured on the basis of their liquidation values
c. Income and expenses are recognized on the basis of cash receipts and payments, including depreciation of fixed assets
d. Financial position and results of operations are measured on the basis of cash received and cash paid.

20. The asset/liability view of earnings

a. Regards the balance sheet as a link between two successive income statements
b. Leads to balance sheet recognition of “deferred charges’ and “deferred credits” which are not economic resources and
obligations
c. Holds that revenues and expenses result only from changes in assets and liabilities
d. Asserts that changes in assets and liabilities are merely the consequences of revenues and expenses

21. Total comprehensive income includes all changes in equity during a period except
a. Sale of assets other than inventory
b. Those resulting from investments by or distributions to owners
c. Sales to a particular entity where ultimate payment by the entity is doubtful
d. Those resulting from revenue generated by a totally owned subsidiary

22. This type of losses is excluded from the determination of current period net income
a. Material losses resulting from unusual sales of assets not acquired for resale
b. Material losses resulting from the write-off of intangibles
c. Material losses resulting from adjustments specifically related to operations of prior years
d. Material losses resulting from transactions in the company’s own bonds payable

23. The occurrence that most likely would have no effect on 2017 net income under present GAAP is the
a. Sale in 2017 of an office building contributed by a stockholder in 1980
b. Collection in 2017 of a dividend from an investment acquired in 2011
c. Correction of an error in the financial statements of a prior period discovered subsequent to their issuance
d. Stock purchased in 2008 was deemed worthless 2017

24. Which one of the following types of losses is excluded from the determination of net income under present GAAP?
a. Material losses resulting from transactions in the company’s own capital stock
b. Material losses resulting from unusual sales of assets not acquired for resale
c. Material losses resulting from the write-offs of intangibles
d. Material losses of a type not usually insured against, such as those resulting from wars, riots, and similar calamities

25. The distinction between capital and income is illustrated by

a. Treating gains on sale of treasury stock as additional paid-in capital
b. Excluding corrections of prior years’ profits from current period net income
c. Adopting the current operating performance concept of net income
d. Recognizing income on an accrual basis

26. What concept is critical in distinguishing an enterprise’s return on investment from return of its investment?
a. Comprehensive income concept
b. Current operating performance concept
c. Capital maintenance concept
d. Return on investment concept

27. The capital maintenance concept followed under present GAAP is

a. Economic capital c. Real capital
b. Financial and physical capital d. Physical capital

ACCOUNTING FOR REVENUES

Basic Concepts
• Income is defined in the Conceptual Framework as increases in economic benefits during the accounting period in the form
of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to
contributions from equity participants. Income encompasses both revenue and gains.
• Revenue is income that arises in the course of ordinary activities of an entity and is referred to by a variety of different
names including sales, fees, interest, dividends and royalties.

Characteristics
1. Asset inflows – Revenue is the stream of inflowing assets resulting from the ongoing operations of a business enterprise (or
from those types of profit-directed activities that can change owner’s equity).
 2. Increases Owners’ Equity – Revenues increase owners’ equity because they represent rewards for enterprise efforts and
sacrifices in providing goods and services to others.
3. Gross Concept – In contrast to income, revenue is a gross rather than a net concept. The entire selling price of goods and
services is considered revenue, even though part of the sales price is required to cover the cost of producing and selling the
goods and services.

Sources of Revenue
Activities generating revenue
• Sale of goods
• Rendering services
• Permitting others to use enterprise assets which result in interest, rent, royalties and dividends
• Disposing of resources other than products, for example, plant and equipment or investments in other entities
• Receipt of government grants and similar transactions
• Forgiveness of indebtedness

Events giving rise to revenue – Revenue arises primarily from exchanges. Occasionally, revenue arises from production, and rarely
from non-reciprocal transfers and from external events other than transfers.

Non-revenue events – Revenue does not include:

• Collection on behalf of third parties like:
 Sales taxes, goods and services taxes and value added tax
 In an agency relationship: collections on behalf of the principal
• Receipts of assets purchased
• Proceeds from borrowing
• Investment by owners
• Adjustments of revenue of prior periods
No revenue is recognized when goods and services similar in nature (or of no commercial substance) are exchanged.
No revenue is recognized where an enterprise is a part of an agency relationship. In this case, the following should apply:
• Amounts collected on behalf of and passed on to the seller are not revenue of agent. The principal in an agency relationship
recognizes as revenue the gross amount charged to the customer. Commission paid is accounted for as expense.

Related Terms
A. Proceeds – is a general term used to designate the total amount realized or received in a transaction. Both proceeds and
revenue are gross concepts but proceeds, is a broader term.
B. Gains – are increases in owners’ equity (net assets) from peripheral or incidental transactions of an entity, and from all other
transactions and other events and circumstances affecting the entity during a period except those that result from revenues or
investment by owners.
C. Cost savings – is an economy or reduction in cost made possible because of fortunate purchases or efficient operations. Savings
reduce costs and eventually increase net income but they are not revenue because there is no inflow of assets into the firm.
D. Cost offsets - are adjustments of the gross amounts of recorded costs and are reported as direct deductions therefrom. Cost
offsets are not revenue.

Recognition of Revenue
Recognition Principle – Revenue is recognized when it is probable that future economic benefits will flow to the entity and these
benefits can be measured reliably. (Conceptual Framework)
• Pervasive Principle Revenue is generally recognized when both of following conditions are met:
o the earning process is complete or virtually complete, and
o an exchange has taken place.
• Broad operating principle – Revenue from exchanges is recorded when products are sold, services provided, or enterprise
resources are used by others.

Realization principle – Revenue is conventionally recognized as specific point in the earning process of a business enterprise, usually
when assets are sold and services are rendered. This conventional recognition is the basis for the “realization principle,” i.e., the
principle governing recognition of revenue. Two conditions or requirements must be met before revenue can be considered
realized:
a. Earning requirement – the first condition of realization is that the earning process must be complete or virtually complete.
b. Exchange requirement – the exchange determines both the time at which to recognize revenue and the amount at which to
recognize it. The existence of an exchange transaction provides reasonable assurance that revenue exists and is relatively
permanent since cash or some other asset has been received for goods delivered or services performed. Furthermore, the
exchange price provides an objective basis for measuring the amount of revenue to be recorded in the accounts.

Philippine Accounting Standard No. 18: Revenue

1. Objectives
• To prescribe the accounting treatment of revenue arising from certain types of transactions and events.
• The primary Issue is determining when to recognize revenue. This Standard identifies the circumstances in which these
criteria will be met and, therefore, revenue will be recognized. It also provides practical guidance on the application of
these criteria.
2. Scope
This Standard shall be applied in accounting for revenue arising from the following transactions and events:
• the sale of goods
• the rendering of services
• the use by others of entity assets yielding interest, royalties and dividends

a. “Goods” include goods produced by the entity for the purpose of sale and goods purchased for resale, such as merchandise
purchased by a retailer or land and other property held for resale.

b. Rendering of services involves the performance by the entity of a contractually agreed task over an agreed period of time. The
services may be rendered within a single period or over more than one period. Some contracts for the rendering of services are
directly related to construction contracts, for example, those for the services of project managers and architects. Revenue arising
from these contracts is not dealt with in this Standard but is dealt with in accordance with the requirements for construction
contracts PAS 11 Construction Contracts.

c. The use by others of entity assets gives rise to revenue in the form of:
• interest – charges for the use of cash or cash equivalents or amounts due to the entity
• royalties – charges for the use of long-term assets of the entity, for example, patents, trademarks, copyrights and computer
software
• dividends – distributions of profits to holders of equity investments in proportion to their holdings of a particular class of
capital

Excluded from PAS 18 are revenue arising from:

• lease agreements (see IAS 17 Leases)
• dividends arising from investments which are accounted for under the equity method (see IAS 28 Investments in Associates)
• insurance contracts within the scope of IFRS 4 Insurance Contracts
• changes in the fair value of financial assets and financial liabilities or their disposal (see IAS 39 Financial Instruments:
Recognition and Measurement)
• changes in the value of other current assets
• initial recognition and from changes in the fair value of biological assets related to agricultural activity (see IAS 41 Agriculture)
• initial recognition of agricultural produce (see IAS 41)
• the extraction of mineral ores

3. Definitions
A. Revenue is the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity
when those inflows result in increases in equity, other than increases relating to contributions from equity participants.
B. Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in
an arm's length transaction.

4. Measurement of Revenue
Revenue shall be measured at the fair value of the consideration received or receivable.

Measurement of revenue takes into account the amount of any trade discounts and volume rebates allowed by the entity. The
consideration is usually in the form of cash or cash equivalents.

Credit transactions
When the inflow of cash or cash equivalents is deferred, the fair value of the consideration may be less than the nominal amount of
cash received or receivable.
• Example: An entity may provide interest free credit to the buyer or accept a note receivable bearing a below-market
interest rate from the buyer as consideration for the sale of goods. When the arrangement effectively constitutes a
financing transaction, the fair value of the consideration is determined by discounting all future receipts using an imputed
rate of interest.
• The imputed rate of interest is the more clearly determinable of either:
o the prevailing rate for a similar instrument of an issuer with a similar credit rating; or
o a rate of interest that discounts the nominal amount of the instrument to the current cash sales price of the goods
or services.
The difference between the fair value and the nominal amount of the consideration is recognized as interest revenue in accordance
with paragraphs 29 and 30 and in accordance with IAS 39 Financial Instruments: Recognition and Measurement.

Exchange of goods or services of a similar nature and value – the exchange is not a revenue transaction.

Goods sold or services rendered in exchange for dissimilar goods or services – Revenue is measured at the fair value of the goods or
services received, adjusted by the amount of any cash or cash equivalents transferred.
• When the fair value of the goods or services received cannot be measured reliably, the revenue is measured at the fair
value of the goods or services given up, adjusted by the amount of any cash or cash equivalents transferred.

5. Identification of the Transaction

The recognition criteria in this Standard are usually applied separately to each transaction. However, in certain circumstances, it is
necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the
substance of the transaction. Examples:
 • When the selling price of a product includes an identifiable amount for subsequent servicing defer the amount, and
recognize revenue over the period during which the service is performed.
• Conversely, apply recognition criteria to two or more transactions together when they are they are linked in such a way that
the commercial effect cannot be understood without reference to the series of transactions as a whole
o An entity may sell goods and, at the same time, enter into a separate agreement to repurchase the goods at a later
date, thus negating the substantive effect of the transaction. In such a case, the two transactions are dealt with
together.

6. Revenue from Sale of Goods

Revenue from the sale of goods shall be recognized when all the following conditions have been satisfied:
a. the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;
b. the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective
control over the goods sold;
c. the amount of revenue can be measured reliably;
d. it is probable that the economic benefits associated with the transaction will flow to the entity; and
e. the costs incurred or to be incurred in respect of the transaction can be measured reliably.

In most cases, the transfer of the risks and rewards of ownership coincides with the transfer of the legal title or the passing of
possession to the buyer as in the case for most retail sales. In other cases, the transfer of risks and rewards of ownership occurs at a
different time from the transfer of legal title or the passing of possession.

Entity retains significant risks of ownership – the transaction is not a sale and revenue is not recognized.
a. when the entity retains an obligation for unsatisfactory performance not covered by normal warranty provisions
b. when the receipt of the revenue from a particular sale is contingent on the derivation of revenue by the buyer from its sale
of the goods
c. when the goods are shipped subject to installation and the installation is a significant part of the contract which has not yet
been completed by the entity
d. when the buyer has the right to rescind the purchase for a reason specified in the sales contract and the entity is uncertain
about the probability of return

Entity retains only an insignificant risk of ownership – the transaction is a sale and revenue is recognized.
a. Seller retains legal title to the goods solely to protect the collectability of the amount due. If the entity has transferred the
significant risks and rewards of ownership, the transaction is a sale and revenue is recognized.
b. A retail sale when a refund is offered if the customer is not satisfied – Revenue is recognized at the time of sale provided
the seller can reliably estimate future returns and recognizes a liability for returns based on previous experience and other
relevant factors.

Revenue is recognized only when it is probable that the economic benefits associated with the transaction will flow to the entity. In
some cases, this may not be probable until the consideration is received or until an uncertainty is removed.
• Example: It may be uncertain that a foreign governmental authority will grant permission to remit the consideration from a
sale in a foreign country. When the permission is granted, the uncertainty is removed and revenue is recognized. However,
when an uncertainty arises about the collectability of an amount already included in revenue, the uncollectible amount or
the amount in respect of which recovery has ceased to be probable is recognized as an expense, rather than as an
adjustment of the amount of revenue originally recognized.

Revenue and expenses that relate to the same transaction or other event are recognized simultaneously – This process is commonly
referred to as the matching of revenues and expenses. Expenses, including warranties and other costs to be incurred after the
shipment of the goods can normally be measured reliably when the other conditions for the recognition of revenue have been
satisfied. However, revenue cannot be recognized when the expenses cannot be measured reliably; in such circumstances, any
consideration already received for the sale of the goods is recognized as a liability.

7. Revenue from Rendering of Services

When the outcome of a transaction involving the rendering of services can be estimated reliably, revenue associated with the
transaction shall be recognized by reference to the stage of completion of the transaction at the balance sheet date. The outcome of
a transaction can be estimated reliably when all the following conditions are satisfied:
a. the amount of revenue can be measured reliably;
b. it is probable that the economic benefits associated with the transaction will flow to the entity;
c. the stage of completion of the transaction at the balance sheet date can be measured reliably; and
d. the costs incurred for the transaction and the costs to complete the transaction can be measured reliably

The recognition of revenue by reference to the stage of completion of a transaction is often referred to as the percentage of
completion method. Under this method, revenue is recognized in the accounting periods in which the services are rendered. The
recognition of revenue on this basis provides useful information on the extent of service activity and performance during a period.

Revenue is recognized only when it is probable that the economic benefits associated with the transaction will flow to the entity.
However, when an uncertainty arises about the collectability of an amount already included in revenue, the uncollectible amount, or
the amount in respect of which recovery has ceased to be probable, is recognized as an expense, rather than as an adjustment of the
amount of revenue originally recognized.

An entity is generally able to make reliable estimates after it has agreed to the following with the other parties to the transaction:
 • each party's enforceable rights regarding the service to be provided and received by the parties;
• the consideration to be exchanged; and
• the manner and terms of settlement.

It is also usually necessary for the entity to have an effective internal financial budgeting and reporting system. The entity reviews
and, when necessary, revises the estimates of revenue as the service is performed. The need for such revisions does not necessarily
indicate that the outcome of the transaction cannot be estimated reliably.

The stage of completion of a transaction may be determined by a variety of methods. An entity uses the method that measures
reliably the services performed. Depending on the nature of the transaction, the methods may include:
a. surveys of work performed;
b. services performed to date as a percentage of total services to be performed; or
c. the proportion that costs incurred to date bear to the estimated total costs of the transaction. Only costs that reflect services
performed to date are included in costs incurred to date. Only costs that reflect services performed or to be performed are
included in the estimated total costs of the transaction.

Services performed by an indeterminate number of acts over a specified period of time – revenue is recognized on a straight-line
basis over the specified period unless there is evidence that some other method better represents the stage of completion. When a
specific act is much more significant than any other acts, the recognition of revenue is postponed until the significant act is
executed.

When the outcome of the transaction involving the rendering of services cannot be estimated reliably, revenue shall be recognized
only to the extent of the expenses recognized that are recoverable.

Outcome of the transaction cannot be estimated reliably (as in the early stages of production:
• If it is probable that the entity will recover the transaction costs incurred. Therefore, revenue is recognized only to the
extent of costs incurred that are expected to be recoverable.
• As the outcome of the transaction cannot be estimated reliably, no profit is recognized.

Outcome of a transaction cannot be estimated reliably and it is not probable that the costs incurred will be recovered:
• Do not recognize revenue.
• Costs incurred are recognized as an expense. When the uncertainties that prevented the outcome of the contract being
estimated reliably no longer exist, revenue is recognized in accordance with paragraph 20 rather than in accordance with
paragraph 26.

8. Interest, Royalties and Dividends

Revenue arising from the use by others of entity assets yielding interest, royalties, and dividends, shall be recognized on the basis set
out in par. 30 when
a. it is probable that the economic benefits associated with the transaction will flow to the entity, and
b. the amount of revenue can be measured reliably

Revenue shall be recognized on the following bases:

a. interest shall be recognized using the effective interest method as set out in IAS 39, paragraphs 9 and AG5–AG8;
b. royalties shall be recognized on an accrual basis in accordance with the substance of the relevant agreement; and
c. dividends shall be recognized when the shareholder's right to receive payment is established.

Unpaid interest that has accrued before the acquisition of an interest-bearing investment, the subsequent receipt of interest is
allocated between pre-acquisition and post-acquisition periods.

Only the post-acquisition portion is recognized as revenue.

Dividends on equity securities are declared from pre-acquisition profits –these dividends are deducted from the cost of the
securities. If it is difficult to make such an allocation except on an arbitrary basis, dividends are recognized as revenue unless they
clearly represent a recovery of part of the cost of the equity securities.

Royalties accrue in accordance with the terms of the relevant agreement and are usually recognized on that basis unless, having
regard to the substance of the agreement, it is more appropriate to recognize revenue on some other systematic and rational basis.

9. Disclosure
An entity shall disclose:
a. the accounting policies adopted for the recognition of revenue, including the methods adopted to determine the stage of
completion of transactions involving the rendering of services;
b. the amount of each significant category of revenue recognized during the period, including revenue arising from:
i. the sale of goods;
ii. the rendering of services;
iii. interest;
iv. royalties;
v. dividends; and
c. the amount of revenue arising from exchanges of goods or services included in each significant category of revenue.
10. Special Issues in Measuring Revenue

A. Non-cash transactions: Barter arrangements

Barter of advertising space on the web pages, in magazines and TV programs. Many internet companies recognize revenue
from barter transactions.
SIC 31: Revenue: Barter Transactions involving Advertising Services
• Revenue from a barter transaction involving advertising services cannot be measured reliably at fair value of the
advertising services received:
• A seller can reliably measure revenue at the fair value of the advertising services it provides in a barter transaction by
reference only to non-barter transactions that:
o involve advertising similar to the advertising in a barter transaction;
o occur frequently
o represent a predominant number of transactions and amount to provide advertising that is similar to the
advertising in the barter transaction.
o involve cash and/or another form of consideration (e.g. : marketable securities, non-monetary assets, and
other services) that has a reliably measurable fair value; and
o do not involve the same counterparty as in the barter transaction

B. Bill and Hold Sales (in which delivery is delayed at the buyer's request but the buyer takes title and accepts billing)
Revenue is recognized when the buyer takes title, provided:
a. it is probable that delivery will be made;
b. the item is on hand, identified and ready for delivery to the buyer at the time the sale is recognized;
c. the buyer specifically acknowledges the deferred delivery instructions; and
d. the usual payment terms apply.
Revenue is not recognized when there is simply an intention to acquire or manufacture the goods in time for delivery.

C. Goods Shipped Subject to Conditions

i. Installation and inspection – recognize revenue when buyer accepts delivery and installation and completion are
complete. However, revenue is recognized immediately upon the buyer's acceptance of delivery when:
• the installation process is simple in nature (ex: installation of a factory tested television receiver
• the inspection is performed only for purposes of final determination of contract prices (ex: shipments of iron
ore, sugar or soya beans)
ii. On approval when the buyer has negotiated a limited right of return – if there is uncertainty about the possibility of
return, revenue is recognized when the shipment has been formally accepted by the buyer or the goods have been
delivered and the time period for rejection has elapsed.
iii. Consignment sales under which the recipient (buyer) undertakes to sell the goods on behalf of the shipper (seller) –
revenue is recognized by the shipper when the goods are sold by the recipient to a third party.
iv. Cash on delivery sales – revenue is recognized when delivery is made and cash is received by the seller or its agent.

D. Lay Away Sales (the goods are delivered only when the buyer makes the final payment in a series of installments)
Revenue is recognized when the goods are delivered. However, when experience indicates that most such sales are
consummated, revenue may be recognized when a significant deposit is received provided the goods are on hand, identified
and ready for delivery to the buyer.

E. Orders when payment (or partial payment) is received in advance of delivery for goods not presently held in inventory, for
example, the goods are still to be manufactured or will be delivered directly to the customer from a third party – Revenue is
recognized when the goods are delivered to the buyer.

F. Sale and Repurchase Agreements (other than swap transactions) under which the seller concurrently agrees to repurchase the
same goods at a later date, or when the seller has a call option to repurchase, or the buyer has a put option to require the
repurchase, by the seller, of the goods.
For a sale and repurchase agreement on an asset other than a financial asset, the terms of the agreement need to be analyzed
to ascertain whether, in substance, the seller has transferred the risks and rewards of ownership to the buyer and hence
revenue is recognized. When the seller has retained the risks and rewards of ownership, even though legal title has been
transferred, the transaction is a financing arrangement and does not give rise to revenue. For a sale and repurchase agreement
on a financial asset, IAS 39 Financial Instruments: Recognition and Measurement applies.

G. Installment Sales – Revenue attributable to the sales price, exclusive of interest, is recognized at the date of sale. The sale price
is the present value of the consideration, determined by discounting the instalments receivable at the imputed rate of interest.
The interest element is recognized as revenue as it is earned, using the effective interest method.

H. Real Estate Sales – Revenue is recognized when legal title passes to the buyer. However, in some jurisdictions the equitable
interest in a property may vest in the buyer before legal title passes, in which case, provided that the seller has no further
substantial acts to complete under the contract, it may be appropriate to recognize revenue.
In either case, if the seller is obliged to perform any significant acts after the transfer of the equitable and/or legal title,
revenue is recognized as the acts are performed. An example is a building or other facility on which construction has not been
completed.
In some cases, real estate may be sold with a degree of continuing involvement by the seller such that the risks and rewards of
ownership have not been transferred. Examples are sale and repurchase agreements which include put and call options, and
agreements whereby the seller guarantees occupancy of the property for a specified period, or guarantees a return on the
 buyer's investment for a specified period. In such cases, the nature and extent of the seller's continuing involvement
determines how the transaction is accounted for. It may be accounted for as a sale, or as a financing, leasing or some other
profit sharing arrangement. If it is accounted for as a sale, the continuing involvement of the seller may delay the recognition of
revenue.
A seller also considers the means of payment and evidence of the buyer's commitment to complete payment. For example,
when the aggregate of the payments received, including the buyer's initial down payment, or continuing payments by the
buyer, provide insufficient evidence of the buyer's commitment to complete payment, revenue is recognized only to the extent
cash is received.

QUIZZER - REVENUE and PAS 18

1. These are gross increases in assets or gross decreases in liabilities recognized and measured in conformity with generally accepted
accounting principles that result from those types of profit-directed activities that can change owners’ equity
a. Income c. Revenue
b. Expense d. Profit

2. One of these activities does not generate revenue. Which one is it?
a. Permitting others to use enterprise resources
b. Sale of merchandise
c. Adjustment of revenue of prior periods
d. Disposing of investment in other entities.

3. Which of the following statements is false?

I. Revenue is the difference between the selling price of a service and the cost of providing such service.
II. Revenue is synonymous with proceeds.
III. Revenue is the change in net assets of an entity during a period that is attributable to profit-directed activities.
a. I and II only c. II and III only
b. I and III only d. I, II, and III

4. Which of the following is not a characteristic of revenue?

a. Revenue always increases owner’s equity
b. Revenue represents an inflow of assets into the enterprise
c. Revenue is a gross rather than a net concept
d. Revenue is always accompanied by an increase in cash.

5. According to the conceptual framework, an entity’s revenue may result from

a. A decrease in an asset from primary operations
b. An increase in an asset from incidental transactions
c. An increase in a liability from incidental transactions
d. A decrease in a liability from primary operations

6. An example of revenue derived from a non-reciprocal transfer is

a. Sale of products subject to warranty c. Land acquired by donation
b. Appreciation of property d. Settlement of a liability at less than its book value

7. Rent collected one month in advance should be accounted for as

a. Revenue in the month collected c. A separate item in stockholders’ equity
b. A current liability d. An accrued liability

8. The term “revenue recognition” conventionally refers to

a. The process of identifying transactions to be recorded a revenue in an accounting period.
b. The process of measuring and relating revenue and expenses of an enterprise for an accounting period.
c. The earning process which gives rise to revenue realization
d. The process of identifying those transactions that result in an inflow of assets from customers

9. Generally, revenue should be recognized at a point when

a. Management decides it is appropriate to do so
b. The product is available for sale to the ultimate consumer
c. An exchange has taken place and the earning process is complete or virtually complete
d. An order for a definite amount of merchandise has been received for shipment FOB destination.

10. Revenue is generally recognized when the earning process is virtually complete and an exchange has taken place. What principle is
described by this statement?
a. Consistency c. Realization
b. Matching d. Conservatism

11. Which of the following, in the most precise sense, means the process of converting noncash resources and rights into cash or claims
to cash?
a. Allocation c. Recognition
b. Recording d. Realization
12. Gains on assets unsold are identified, in a precise sense, by the term
a. Unrecorded c. Unrecognized
b. Unrealized d. Unallocated

13. Revenues are considered to have been earned when

a. Goods are shipped, not yet received by buyer, under terms “ sale on trial”
b. Goods are sold under “lay-away” terms, where goods are delivered only when buyer makes the final payment in a series of
installments.
c. Goods are shipped, not yet received by buyer, where the buyer has the right to rescind the purchase if the goods are not
within the specifications in the contract
d. The entity ships goods subject to installation which is a significant part of the contract and the entity has completed such
installation

Revenue Recognition Bases

14. Given the proper circumstances, each of the following is an acceptable basis for recognizing revenue except
a. After all costs have been recovered in cash collections
b. As cash is collected from a customer
c. After cash is collected but before goods are delivered to a customer
d. Upon completion of the production process but before a sale has taken place

15. Revenue, under proper circumstances, may be recognized at all of the following moments in time except
a. After the earning process has been completed and an exchange has taken place
b. Upon the receipt of cash from the customer
c. As certain stages of completion of production are attained
d. When goods are shipped under terms “sale on approval”

16. Arguments supporting revenue recognition at the point of sale include all of the following except
a. The significant risks and rewards of ownership have been transferred
b. For most concerns, the sale is usually the most critical event in the earning process
c. Most of the costs related to the manufacture or acquisition of the product and the costs of disposal are now readily
determinable
d. Uncertainties regarding the final measurement of revenue have been eliminated

17. Which of the following approaches to revenue recognition does not depend on the receipt of cash?
a. Installment sales c. Cash sale
b. Cost recovery d. Accrual basis

18. The following statements relate to the two methods of accounting for long-term construction contracts. Which statement is true?
I. The completed contract method recognized revenues at the point of sale
II. When work to be done and costs to be incurred on a long-term construction contract can be estimated dependably, the
percentage of completion method of revenue recognition should be used
a. Only I is true c. I and II are true
b. Only II is true d. I and II are false

19. The justification for recognizing revenue on a long-term construction contract as construction contract progresses is
a. To conform with established industry practices c. To provide better measure of periodic results
b. To comply with the realization principle d. To associate cause and effect

20. Under what condition is it proper to recognize revenues prior to the sale of the merchandise?
a. When the ultimate sale of the goods is at an assured sales price
b. When the concept of internal consistency (of amounts of revenue) must be complied with
c. When the revenue is to be reported as an installment sale
d. When management has a long established policy to do so

21. According to the installment method of accounting, the gross profit on an installment sale is recognized in income
a. On the date of sale
b. On the date the final cash collection is received
c. After cash collections equal to the cost of sales have been received
d. In proportion to the cash collections received

22. Income recognized using the installment method of accounting generally equals cash collected multiplied by the
a. Net operating profit percentage
b. Net operating profit percentage adjusted for expected uncollectible accounts
c. Gross profit percentage
d. Gross profit percentage adjusted for expected uncollectible accounts

23. One method employed to defer revenue recognition is the cost recovery method. Under the cost recovery method, profit is not
recognized until
a. The entire sales price is collected
b. The seller is convinced that collection is assured beyond a reasonable doubt
 c. The buyer formally accepts delivery of the merchandise involved in the sale
d. Cash payments by the buyer exceed the seller’s cost of the merchandise sold

24. Laguna Lands, Inc. is engaged in extensive exploration for water in Mt. Makiling. If upon discovery of water the corporation does not
recognized any revenue from water sales until the sales exceed the costs of exploration, the basis of revenue recognition being
employed is the
a. Production basis c. Sales (or accrual) basis
b. Cash (or collection) basis d. Sunk cost (or cost recovery) basis

25. Wilson Co. produces expensive equipment for sale on installment contract. When there is doubt about eventual collectability, the
income recognition method least likely to overstate income is
a. At the time the equipment is completed c. Cost recovery method
b. The installment method d. At the time of recovery

26. A real estate broker engaged in the sale of real estate on commission basis should recognize revenue on the basis of
a. Cash collections c. Specific performance
b. Completed performance d. Proportional performance

27. According to the cost recovery method of accounting, gross profit on an installment sale is recognized
a. After cash collections equal to the cost of sales have been received
b. In proportion to the cash collections
c. On the date the final cash collection is received
d. On the date of sale

28. Which of the following methods of service revenue recognition usually would be most appropriate for a business engaged in
packing, loading, transporting, and delivering freight?
a. Specific performance method c. Proportional performance method
b. Collection method d. Completed performance method

29. Which of the following methods of service revenue recognition is appropriate for use by a real estate broker engaged in the sale of
real estate on a commission basis?
a. Specific performance method c. Completed performance method
b. Proportional performance method d. Collection method

30. One of the conditions that must be satisfied in order to recognize revenue in a transaction involving the rendering of services is that
the stage of completion of the transaction at the end of the reporting period can be measured reliably. Which of the following
methods for determining the stage of completion of a contract involving the rendering of services are specifically referred to in
PAS18 Revenue, as acceptable?
I - Costs incurred to date as a percentage of the estimated total costs of the transaction
II - Advances received to date as a percentage of the total amount receivable
III - Surveys of work performed
IV - Revenue to date divided by total contract revenue
a. I and II c. II and III
b. I and III d. III and IV

31. According to PAS18 Revenue, which of the following conditions apply to the recognition of revenue for transactions involving the
rendering of services?
A – The significant risks and rewards of ownership have been transferred to the buyer
B – The amount of revenue can be measured reliably
C – The entity retains neither continuing managerial involvement nor effective control over the transaction
D – The costs incurred for the transaction and the costs to complete the transaction can be measured reliably
a. A and B c. C and D
b. B and D d. B, C, and D

32. According to PAS 18 Revenue, which two of the following criteria must be satisfied before revenue from the sale of goods should be
recognized in profit or loss?
A – Ownership has been transferred to the buyer
B – The outcome of the transaction is certain
C – Revenue can be reliably measured
D – Managerial control over the goods sold has been relinquished
a. A and B c. C and D
b. B and C d. A and D

33. The Odessa Corp. sells goods to a third party via an agent. During 2017, Odessa supplies the agent with goods with a sales value of P
200,000. The agent charges a commission of 15%. Under PAS18 Revenue, how much revenue should each of Odessa and the agent
recognize in profit or loss for 2017?
Odessa Corp. Agent
a. P 170,000 P 25,500
b. P 200,000 P 25,500
c. P 170,000 P 30,000
 d. P 200,000 P 30,000

34. The Karlo Company sells merchandise for P8,000 to Kim Corp. on December 31, 2016. The terms of the sale agreement state that
payment is due in one year's time. Karlo has an imputed rate of interest of 9%. Under PAS18, how much revenue should Karlo
recognize in profit or loss for the year ended 31 December 2016?
a. P 7,339 c. P 8,720
b. P 8,000 d. Nil

35. Heavy Company placed an order with Light Company for new specialist machinery. The order was non-cancellable once signed and
Heavy agreed to pay for the machinery at the time the order was signed on January 31, 2016. Light held the machinery to Heavy's
order from June 1, 2016, the date on which it was completed. Heavy commenced using the machinery on July 31, 2016 when Light
complete the installation process. Light had staff on standby to deal with any operating problems until the warranty period ended on
December 1, 2016. Under PAS 18 Revenue, Light should recognize the revenue from the sale of this specialist machinery on
a. January 31, 2016 c. July 31, 2016
b. June 1, 2016 d. December 1, 2016

36. The Marjo Company provides service contracts to customers for maintenance of their electrical systems. On October 1, 2016, it
agrees to a four year contract with a major customer for P 154,000. Costs over the period of the contract are reliably estimated at P
51,333. Under PAS 18 Revenue, how much revenue should the company recognize in profit or loss in the year ended December 31,
2016?
a. P 3,208 c. P 12,833
b. P 9,625 d. P 38,500

37. On January 1, 2016 Viola Company signs a four-year fixed-price contract to provide services for a customer. The contract value is P
550,000. On December 31, 2016, the contract is thought to be 30% complete. Costs to complete the contract cannot be reliably
estimated and costs incurred to date of P 152,000 are recoverable from the customer. What is the revenue to be recognized in profit
or loss for the year ended December 31, 2016, according to PAS 18 Revenue?
a. P 13,000 c. P 152,000
b. P 137,500 d. P 165,000

38. On July 1, 2016, Pyrex Company, a manufacturer of office furniture, supplied goods to Nacho Company for P 120,000 on condition
that this amount was paid in full on July 1, 2017. Nacho had earlier rejected an alternative offer from Pyrex whereby they could have
bought the same goods by paying cash of P108,000 on July 1, 2016. Under PAS 18 Revenue, how much relating to this transaction
should Pyrex recognize in profit or loss in respect of revenue and interest income for the year ended June 30, 2017?
Revenue Interest income
a. P 108,000 P 12,000
b. P 120,000 Nil
c. P 108,000 Nil
d. P 120,000 P 12,000

39. On July 1, 2017, The Osamis Company handed over to a client a new computer system. The contract price for the supply of the
system and aftersales support for 12 months was P 800,000. Osamis estimates the cost of the after-sales support at P 120,000 and it
normally marks up such costs by 50% when tendering for support contracts. Under PAS 18 Revenue, the revenue Osamis should
recognize in its financial year ended December 31, 2017 is
a. Nil c. P 710,000
b. P 620,000 d. P 800,000
Philippine Financial Reporting Standard No. 15
Revenue from Contracts with Customers

Effective Date: mandatory for annual reporting periods starting from 1 January 2018 onwards, with earlier application permitted.
Supersedes the following: PAS 11, PAS 18, IFRIC 13, IFRIC 15, IFRIC 18, SIC 31

The Need for a Change in the Revenue Standards

• Significant diversity in revenue recognition practices
• Limited guidance on many important topics, such as accounting for arrangements with multiple elements
• Difficult for investors and analysts (‘investors’) to understand and compare a company’s revenue
• Difficult to apply to complex transactions due to lack of basis for conclusions
• Numerous industry and transaction specific requirements, which often resulted in economically similar transactions being
accounted for differently.
• New types of transactions emerges

Overview
IFRS 15 establishes a comprehensive framework for recognition of revenue from contracts with customers based on a core principle
that an entity should recognize revenue representing the transfer of promised goods or services (PERFORMANCE OBLIGATION) to
customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or
services.
 IAS 18 / IAS 11 IFRS 15
Separate models for: Single model for performance obligations:
• Construction contracts • Satisfied over time
• Sale of goods • Satisfied at a point in time
• Rendering of services
Focus on risks and rewards Focus on control
Limited guidance on: More guidance on separating elements, allocating the
• Multiple element arrangements transaction price, variable consideration, repurchase
• Variable consideration arrangements…

Scope
IFRS 15 applies to all entities and all contracts with customers to provide goods or services in the ordinary course of business, except
for the following contracts, which are specifically excluded:
 Lease contracts ( IAS 17 or IFRS 16)
 Insurance contracts (IFRS 4 or IFRS 17)
 Financial instruments and other contractual rights or obligations (IAS 27, IAS 28, IAS 39, IFRS 9, IFRS 10, IFRS 11)
 Non-monetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers

Definitions
 Contract – An agreement between two or more parties that creates enforceable rights and obligations
 Customer – A party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary
activities in exchange for consideration.
 Performance obligation – A promise in a contract with a customer to transfer to the customer either:
o a good or service (or a bundle of goods or services) that is distinct; or
o a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the
customer.
 Transaction price – The amount of consideration to which an entity expects to be entitled in exchange for transferring
promised goods or services to a customer, excluding amounts collected on behalf of third parties.

The New Revenue Model under PFRS 15

The standard describes the principles an entity must apply to measure and recognize revenue and the related cash flows. The core
principle is that an entity will recognize revenue at an amount that reflects the consideration to which the entity expects to be
entitled in exchange for transferring goods or services to a customer.

1. Identify the contract(s) with a customer

An entity must first identify the contract, or contracts, to provide goods and services to customers. A contract with a customer
(which may be written, oral, or implied) will be within the scope of IFRS 15 if all the following conditions are met (PRACC):
 the contract has been Approved by the parties to the contract;
 each party’s Rights in relation to the goods or services to be transferred can be identified;
 the Payment terms for the goods or services to be transferred can be identified;
 the contract has Commercial substance; and
 it is probable that the consideration to which the entity is entitled to in exchange for the goods or services will be Collected.

These criteria are assessed at the inception of the arrangement. If the criteria are met at that time, an entity does not reassess these
criteria unless there is an indication of a significant change in facts and circumstances.

The model is to be applied on an individual contract basis, with a practical expedient available.
As a practical expedient, an entity may apply this Standard to a portfolio of contracts (or performance obligations) with similar
characteristics if the entity reasonably expects that the effects on the financial statements of applying this Standard to the portfolio
would not differ materially from applying this Standard to the individual contracts (or performance obligations) within that portfolio.

Contracts should be accounted for separately. However, contracts should be combined if:
 they are negotiated as a package with a single commercial objective;
 the amount of consideration to be paid in one contract depends on the goods or services to be delivered in another contract;
or
 the goods or services promised in the contracts are considered to be a single performance obligation

Contract Modification
Parties to an arrangement frequently agree to modify the scope or price (or both) of their contract. If that happens, an entity must
determine whether the modification is accounted for as a new contract or as part of the existing contract.

Is the contract modification for additional

NO goods and services that are distinct and at YES
their stand-alone selling price?*

Are the remaining goods and services Account for the new goods and services as
distinct from those already provided? a separate contract.
 Treat the modification as a termination of the existing contract and the creation
YES of a new contract. Allocate the total remaining transaction price (unrecognized
transaction price from the existing contract plus additional transaction price
from the modification) to the remaining goods and services (both from the
existing contract and the modification).

NO Update the transaction price and measure of progress for the single
performance obligation (recognize change as a cumulative catch-up to revenue).

Update the transaction price and allocate it to the remaining performance

obligations (both from the existing contract and the modification). Adjust
YES and NO revenue previously recognized based on an updated measure of progress for the
partially satisfied performance obligations. Do not adjust the accounting for
completed performance obligations that are distinct from the modified goods or
services.

In accordance with IFRS 15.20, an entity may make appropriate adjustments to the stand-alone selling price to reflect the
circumstances of the contract and still meet the criteria to account for the modification as a separate contract.

2. Identify the performance obligations in the contract

At contract inception, an entity shall assess the goods or services promised in a contract with a customer and shall identify as a
performance obligation each promise to transfer to the customer either:
 a good or service (or a bundle of goods or services) that is distinct; or
 a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer

A series of distinct goods or services has the same pattern of transfer to the customer if both of the following criteria are met:
 each distinct good or service in the series that the entity promises to transfer to the customer would meet the criteria to be a
performance obligation satisfied over time; and
 the same method would be used to measure the entity’s progress towards complete satisfaction of the performance obligation
to transfer each distinct good or service in the series to the customer

Unbundling Performance Obligations

Principal / Agent Considerations

When more than one party is involved in providing goods or services to a customer, the standard requires an entity to determine
whether it is a principal or an agent in these transactions by evaluating the nature of its promise to the customer.

An entity is a principal (and, therefore, records revenue on a gross basis) if it controls a promised good or service before transferring
that good or service to the customer.

An entity is an agent (and, therefore, records as revenue the net amount that it retains for its agency services) if its role is to arrange
for another entity to provide the goods or services.

Indicators that an entity is an agent:

 another party is primarily responsible for fulfilling the contract;
 the entity does not have inventory risk at any point during the contract;
 the entity does not have discretion in establishing prices for the other party’s goods or services and, therefore, the benefit that
the entity can receive from those goods or services is limited;
 the entity’s consideration is in the form of a commission; and
 the entity is not exposed to credit risk for the amount receivable from a customer in exchange for the other party’s goods or
services.
3. Determine the transaction price
An entity shall consider the terms of the contract and its customary business practices to determine the transaction price. The
transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised
goods or services to a customer, excluding amounts collected on behalf of third parties (for example, some sales taxes). The
consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both.

The nature, timing and amount of consideration promised by a customer affect the estimate of the transaction price. When
determining the transaction price, an entity shall consider the effects of all of the following:
 variable consideration
 constraining estimates of variable consideration
 the existence of a significant financing component in the contract
 non-cash consideration
 consideration payable to customer

Variable Consideration
If the consideration promised in a contract includes a variable amount, an entity shall estimate the amount of consideration to
which the entity will be entitled in exchange for transferring the promised goods or services to a customer.
Example: discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, penalties or if an entity’s
entitlement to the consideration is contingent on the occurrence or non-occurrence of a future event (sale with a right to return)

An entity shall estimate an amount of variable consideration by using either of the following methods, depending on which method
the entity expects to better predict the amount of consideration to which it will be entitled:
 The expected value (large number of contracts with similar characteristics)
 The most likely amount (only two possible outcomes)

Constraining Estimates of Variable Consideration

An entity shall include in the transaction price some or all of an amount of variable consideration estimated to the extent that it is
highly probable (i.e., significantly more likely than probable) that a significant reversal in the amount of cumulative revenue
recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. In assessing this,
an entity shall consider both the likelihood and the magnitude of the revenue reversal. Factors that could increase the likelihood or
the magnitude of a revenue reversal include, but are not limited to, any of the following:
 the amount of consideration is highly susceptible to factors outside the entity’s influence (volatility in a market, the judgement
or actions of third parties, weather conditions and a high risk of obsolescence of the promised good or service)
 the uncertainty about the amount of consideration is not expected to be resolved for a long period of time
 the entity’s experience (or other evidence) with similar types of contracts is limited, or that experience (or other evidence) has
limited predictive value
 the entity has a practice of either offering a broad range of price concessions or changing the payment terms and conditions of
similar contracts in similar circumstances
 the contract has a large number and broad range of possible consideration amounts

Significant Financing Component

In determining the transaction price, an entity shall adjust the promised amount of consideration for the effects of the time value of
money if the timing of payments agreed to by the parties to the contract (either explicitly or implicitly) provides the customer or the
entity with a significant benefit of financing the transfer of goods or services to the customer. In those circumstances, the contract
contains a significant financing component. A significant financing component may exist regardless of whether the promise of
financing is explicitly stated in the contract or implied by the payment terms agreed to by the parties to the contract.
Objective: to recognize revenue at an amount that reflects the cash selling price of those goods or services

A contract with a customer would not have a significant financing component if any of the following factors exist:
 the customer paid for the goods or services in advance and the timing of the transfer of those goods or services is at the
discretion of the customer
 a substantial amount of the consideration promised by the customer is variable and the amount or timing of that consideration
varies on the basis of the occurrence or non-occurrence of a future event that is not substantially within the control of the
customer or the entity
 the difference between the promised consideration and the cash selling price of the good or service arises for reasons other
than the provision of finance to either the customer or the entity, and the difference between those amounts is proportional to
the reason for the difference

Non-cash Consideration
Customer consideration may be in the form of goods, services or other non-cash consideration (e.g., property, plant and equipment,
a financial instrument). When an entity (i.e., the seller or vendor) receives, or expects to receive, non-cash consideration, the fair
value of the non-cash consideration is included in the transaction price. An entity will likely apply the requirements of IFRS 13 Fair
Value Measurement or IFRS 2 Share-based Payment when measuring the fair value of any non-cash consideration.

Consideration Payable to Customer

Consideration payable to a customer includes cash amounts that an entity pays, or expects to pay, to the customer (or to other
parties that purchase the entity’s goods or services from the customer). Consideration payable to a customer also includes credit or
other items (for example, a coupon or voucher) that can be applied against amounts owed to the entity (or to other parties that
purchase the entity’s goods or services from the customer). An entity shall account for consideration payable to a customer as a
 reduction of the transaction price and, therefore, of revenue unless the payment to the customer is in exchange for a distinct good
or service that the customer transfers to the entity.

Classification of the different types of consideration paid or payable to a customer

 payment for a distinct good or service
 reduction of the transaction price
 combination of both

Forms of consideration paid or payable to a customer

 slotting fees
 co-operative advertising arrangements
 price protection
 coupons and rebates
 ‘pay-to-play’ arrangements
 purchase of goods or services

4. Allocate the transaction price to the performance obligations in the contract

The objective when allocating the transaction price is for an entity to allocate the transaction price to each performance obligation
(or distinct good or service) in an amount that depicts the amount of consideration to which the entity expects to be entitled in
exchange for transferring the promised goods or services to the customer.

Once the separate performance obligations are identified and the transaction price has been determined, the standard generally
requires an entity to allocate the transaction price to the performance obligations in proportion to their stand-alone selling prices
(relative stand-alone selling price basis).

IFRS 15 indicates the observable price of a good or service sold separately provides the best evidence of stand-alone selling price.
However, if a standalone selling price is not directly observable, the entity will need to estimate it. The standard suggests various
methods that might be used, including:
 adjusted market assessment approach – benchmarking with adjustment of costs and margins
 expected cost plus a margin approach – forecasting expected costs of satisfying a performance obligation and adding an
appropriate margin
 residual approach – total transaction price less the sum of the observable stand-alone selling prices of other goods or services
promised in the contract (only permissible when selling price is highly variable or uncertain)

Where consideration is paid in advance or in arrears, the entity will need to consider whether the contract includes a significant
financing arrangement and, if so, adjust for the time value of money. A practical expedient is available where the interval between
transfer of the promised goods or services and payment by the customer is expected to be less than 12 months.

5. Recognize revenue when (or as) the entity satisfies a performance obligation
Under IFRS 15, an entity only recognizes revenue when it satisfies an identified performance obligation by transferring a promised
good or service to a customer. A good or service is considered to be transferred when the customer obtains control.

IFRS 15 states that “control of an asset refers to the ability to direct the use of and obtain substantially all of the remaining benefits
from the asset”. The key terms in this definition are explained as follows:
 ability – a customer must have the present right to direct the use of, and obtain substantially all of the remaining benefits
from, an asset for an entity to recognize revenue
 direct the use of – refers to the customer’s right to deploy or to allow another entity to deploy that asset in its activities or to
restrict another entity from deploying that asset
 obtain the benefits from – the ability to obtain substantially all of the remaining benefits from an asset for the customer to
obtain control of it, directly or indirectly in many ways, such as:
o using the asset to produce goods or services (including public services);
o using the asset to enhance the value of other assets;
o using the asset to settle a liability or reduce an expense;
o selling or exchanging the asset;
o pledging the asset to secure a loan; or holding the asset

Revenue is recognized as control is passed, either over time or at a point in time.

Control Transferred Over Time

An entity recognizes revenue over time if one of the following criteria is met:
 the customer simultaneously receives and consumes all of the benefits provided by the entity as the entity performs;
 the entity’s performance creates or enhances an asset that the customer controls as the asset is created; or
 the entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right
to payment for performance completed to date

Measuring Progress
Appropriate methods of measuring progress include output methods and input methods. In determining the appropriate method for
measuring progress, an entity shall consider the nature of the good or service that the entity promised to transfer to the customer.
Output Methods
Output methods recognize revenue on the basis of direct measurements of the value to the customer of the goods or services
transferred to date relative to the remaining goods or services promised under the contract and include:
 surveys of performance completed to date  time elapsed
 appraisals of results achieved  units produced
 milestones reached  units delivered

The disadvantages of output methods are that the outputs used to measure progress may not be directly observable and the
information required to apply them may not be available to an entity without undue cost. Therefore, an input method may be
necessary.

Input Methods
Input methods recognize revenue on the basis of the entity’s efforts or inputs to the satisfaction of a performance obligation, such
as:
 resources consumed  time elapsed
 labor hours expended  machine hours used
 costs incurred

If the entity’s efforts or inputs are expended evenly throughout the performance period, it may be appropriate for the entity to
recognize revenue on a straight-line basis.

Control Transferred at a Point in Time

If an entity does not satisfy its performance obligation over time, it satisfies it at a point in time. Revenue will therefore be
recognized when control is passed at a certain point in time. Factors that may indicate the point in time at which control passes
include, but are not limited to:
 the entity has a present right to payment for the asset;
 the customer has legal title to the asset;
 the entity has transferred physical possession of the asset;
 the customer has the significant risks and rewards related to the ownership of the asset; or
 the customer has accepted the asset

Other Topics
Warranties
The standard identifies two types of warranties:
 warranties that promise the customer that the delivered product is as specified in the contract (assurance-type)
 warranties that provide a service to the customer in addition to assurance that the delivered product is as specified in the
contract (service-type) – considered a performance obligation

Onerous Contracts
If an entity has a contract that is onerous, the present obligation under the contract shall be recognized and measured as a provision
in accordance with IAS 37. An onerous contract as a contract in which the unavoidable costs of meeting the obligations under the
contract exceed the economic benefits expected to be received under it. The unavoidable costs under a contract reflect the least net
cost of exiting from the contract, which is the lower of the cost of fulfilling it and any compensation or penalties arising from failure
to fulfil it.

Customer Options for Additional Goods or Services

Many sales contracts give customers the option to acquire additional goods or services. These additional goods and services may be
priced at a discount or may even be free of charge. Options to acquire additional goods or services at a discount can come in many
forms, including sales incentives, volume-tiered pricing structures, customer award credits (e.g., frequent flyer points) or contract
renewal options (e.g., waiver of certain fees, reduced future rates).
When an entity grants a customer the option to acquire additional goods or services, that option is only a separate performance
obligation if it provides a material right to the customer that the customer would not receive without entering into the contract
(e.g., a discount that exceeds the range of discounts typically given for those goods or services to that class of customer in that
geographical area or market). If the option provides a material right to the customer, the customer has, in effect, paid in advance for
future goods or services. As such, the entity recognizes revenue when those future goods or services are transferred or when the
option expires.
Breakage and Prepayments for Future Goods or Services
Entities may collect non-refundable payments from customers for goods or services that the customer has a right to receive in the
future. However, a customer may ultimately leave that right unexercised (breakage). Retailers, for example, frequently sell gift cards
that are not completely redeemed and airlines sometimes sell tickets to passengers who allow the tickets to expire unused.

When an entity receives consideration that is attributable to a customer’s unexercised rights, the entity recognizes a contract
liability equal to the amount prepaid by the customer for the performance obligation to transfer, or to stand ready to transfer, goods
or services in the future. Revenue would normally be recognized when the entity satisfies its performance obligation.

Non-refundable Upfront Fees

In certain circumstances, entities may receive payments from customers before they provide the contracted service or deliver a
good. Upfront fees generally relate to the initiation, activation or set-up of a good to be used or a service to be provided in the
future. Upfront fees may also be paid to grant access or to provide a right to use a facility, product or service. In many cases, the
upfront amounts paid by the customer are non-refundable. Examples include fees paid for membership to a health club or buying
club and activation fees for phone, cable or internet services.

Entities must evaluate whether a non-refundable upfront fee relates to the transfer of a good or service. If it does, the entity is
required to determine whether to account for the promised good or service as a separate performance obligation.

Repurchase Agreements
Some agreements include repurchase provisions, either as part of a sales contract or as a separate contract that relates to the goods
in the original agreement or similar goods. These provisions affect how an entity applies the requirements on control to affected
transactions.

A repurchase agreement is a contract in which an entity sells an asset and also promises or has the option (either in the same
contract or in another contract) to repurchase the asset. The repurchased asset may be the asset that was originally sold to the
customer, an asset that is substantially the same as that asset, or another asset of which the asset that was originally sold is a
component. Repurchase agreements generally come in three forms:
 an entity’s obligation to repurchase the asset (a forward);
 an entity’s right to repurchase the asset (a call option); and
 an entity’s obligation to repurchase the asset at the customer’s request (a put option)

Forward or Call Option

Repurchase price < Original selling price = Lease

Repurchase price ≥ Original selling price = Financing

Put Option

Repurchase price < Original selling price = Lease

(with significant economic incentive)
Repurchase price < Original selling price = Sale with a
right to return
(without significant economic incentive)

Repurchase price ≥ Original selling price and

Repurchase price > Expected market value of asset = Financing

Repurchase price ≥ Original selling price and

Repurchase price ≤ Expected market value of asset = Sale with a
right to return
Consignment Arrangements
Entities frequently deliver inventory on a consignment basis to other parties (e.g., distributor, dealer). By shipping on a consignment
basis, consignors are better able to market products by moving them closer to the end-customer. However, they do so without
selling the goods to the intermediary (consignee).

Indicators that an arrangement is a consignment arrangement include, but are not limited to, the following:
 the product is controlled by the entity until a specified event occurs, such as the sale of the product to a customer of the dealer
or until a specified period expires;
 the entity is able to require the return of the product or transfer the product to a third party (such as another dealer); and
 the dealer does not have an unconditional obligation to pay for the product (although it might be required to pay a deposit)

Bill-and-hold Arrangements
In some sales transactions, the selling entity fulfils its obligations and bills the customer for the work performed, but does not ship
the goods until a later date. These transactions, often called bill-and-hold transactions, are usually designed this way at the request
of the purchaser for a number of reasons, including its lack of storage capacity or its inability to use the goods until a later date.

For a customer to have obtained control of a product in a bill-and-hold arrangement, all of the following criteria must be met:
 the reason for the bill-and-hold arrangement must be substantive (for example, the customer has requested the arrangement)
 the product must be identified separately as belonging to the customer;
 the product currently must be ready for physical transfer to the customer;
 the entity cannot have the ability to use the product or to direct it to another customer

Contract costs
Two types of contract costs (costs of obtaining or fulfilling a contract)
 Costs of obtaining a contract – costs to be capitalized are those costs that entities would not have incurred had the contract
not been obtained (e.g., selling and marketing costs, bid and proposal costs, sales commissions, and legal fees)
• To be recognized as an asset, the entity must expect to recover such
• Practical expedient available
 Costs of fulfilling a contract – follow a two-step process:
 • Determine whether the accounting for such costs is addressed by other standards (e.g., IAS 2 Inventories) and, if so,
apply that guidance.
• Fulfillment costs not addressed by other standards should be capitalized if all the following criteria are met:
• costs relate directly to a contract or to an anticipated contract the entity can specifically identify (e.g., costs relating
to services to be provided under renewal of an existing contract or costs of designing an asset to be transferred
under a specific contract not yet approved)
• costs generate or enhance resources of the entity that will be used in satisfying (or in continuing to satisfy)
performance obligations in the future
• costs are expected to be recovered

These include costs such as direct labor, direct materials, and the allocation of overheads that relate directly to the contract. The
asset recognized in respect of the costs to obtain or fulfil a contract is amortized on a systematic basis that is consistent with the
pattern of transfer of the goods or services to which the asset relates.

Financial Statement Presentation

When either party to a contract has performed, an entity shall present the contract in the statement of financial position as a
contract asset or a contract liability, depending on the relationship between the entity's performance and the customer's payment.
An entity shall present any unconditional rights to consideration separately as a receivable.

If a customer pays consideration, or an entity has a right to an amount of consideration that is unconditional (i.e., a receivable)
before the entity transfers a good or service to the customer, the entity shall present the contract as a contract liability when the
payment is made or the payment is due (whichever is earlier). A contract liability is an entity's obligation to transfer goods or
services to a customer for which the entity has received consideration (or an amount of consideration is due) from the customer.

If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is
due, the entity shall present the contract as a contract asset, excluding any amounts presented as a receivable. A contract asset is an
entity's right to consideration in exchange for goods or services that the entity has transferred to a customer. An entity shall assess a
contract asset for impairment in accordance with IFRS 9. An impairment of a contract asset shall be measured, presented and
disclosed on the same basis as a financial asset that is within the scope of IFRS 9.

A receivable is an entity's right to consideration that is unconditional. A right to consideration is unconditional if only the passage of
time is required before payment of that consideration is due. For example, an entity would recognize a receivable if it has a present
right to payment even though that amount may be subject to refund in the future. An entity shall account for a receivable in
accordance with IFRS 9. Upon initial recognition of a receivable from a contract with a customer, any difference between the
measurement of the receivable in accordance with IFRS 9 and the corresponding amount of revenue recognized shall be presented
as an expense (for example, as an impairment loss).

Case A – Cancellable contract

On 1 January 20X9, an entity enters into a cancellable contract to transfer a product to a customer on 31 March 20X9. The contract
requires the customer to pay consideration of CU1,000 in advance on 31 January 20X9. The customer pays the consideration on 1
March 20X9. The entity transfers the product on 31 March 20X9. The following journal entries illustrate how the entity accounts for
the contract:
a. The entity receives cash of CU1,000 on 1 March 20X9 (cash is received in advance of performance)
Cash CU1,000
Contract liability CU1,000
b. The entity satisfies the performance obligation on 31 March 20X9
Contract liability CU1,000
Revenue CU1,000

Case B – Non-cancellable contract

The same facts as in Case A apply to Case B except that the contract is non-cancellable. The following journal entries illustrate how
the entity accounts for the contract:
a. The amount of consideration is due on 31 January 20X9 (which is when the entity recognizes a receivable because it has an
unconditional right to consideration)
Receivable CU1,000
Contract liability CU1,000
b. The entity receives the cash on 1 March 20X9
Cash CU1,000
Receivable CU1,000
c. The entity satisfies the performance obligation on 31 March 20X9
Contract liability CU1,000
Revenue CU1,000

If the entity issued the invoice before 31 January 20X9 (the due date of the consideration), the entity would not present the
receivable and the contract liability on a gross basis in the statement of financial position because the entity does not yet have a
right to consideration that is unconditional.

Case C – Contract asset recognized for the entity's performance

On 1 January 20X8, an entity enters into a contract to transfer Products A and B to a customer in exchange for CU1,000. The contract
requires Product A to be delivered first and states that payment for the delivery of Product A is conditional on the delivery of
 Product B. In other words, the consideration of CU1,000 is due only after the entity has transferred both Products A and B to the
customer. Consequently, the entity does not have a right to consideration that is unconditional (a receivable) until both Products A
and B are transferred to the customer.

The entity identifies the promises to transfer Products A and B as performance obligations and allocates CU400 to the performance
obligation to transfer Product A and CU600 to the performance obligation to transfer Product B on the basis of their relative stand-
alone selling prices. The entity recognizes revenue for each respective performance obligation when control of the product transfers
to the customer.
a. The entity satisfies the performance obligation to transfer Product A
Contract asset CU400
Revenue CU400
b. The entity satisfies the performance obligation to transfer Product B and to recognize the unconditional right to
consideration:
Receivable CU1,000
Contract asset CU400
Revenue CU600

QUIZZER - PFRS 15

1. To address inconsistencies and weaknesses, a comprehensive revenue recognition model was developed entitled the
a. Revenue Recognition Principle c. Rules-based Revenue Accounting
b. Principle-based Revenue Accounting d. Revenue from Contracts with Customers

2. The converged standard on revenue recognition

a. reduces the number of disclosures required for revenue reporting
b. increases the complexity of financial statement preparation
c. recognizes and measures revenue based on changes in assets and liabilities
d. simplifies revenue recognition practices across entities and industries
3. The first step in the process for revenue recognition is to
a. determine the transaction price
b. identify the contract with the customer
c. allocate the transaction price to the separate performance obligations
d. identify the separate performance obligations in the contract

4. A contract
a. must be in writing to be an enforceable contract
b. is an agreement that creates enforceable rights and obligations
c. is enforceable if each party can unilaterally terminate the contract
d. does not need to have commercial substance

5. Revenue from a contract with a customer

a. is recognized when the customer receive the rights to receive consideration
b. is recognized even if the contract is still wholly unperformed
c. can be recognized even when a contract is still pending
d. cannot be recognized until a contract exists

6. Signing of the contract by the two parties is

a. not recorded until one or both parties perform under the contract
b. recorded at the time the contract is approved by both parties
c. not recorded until both parties perform under the contract
d. recorded immediately after the contract is signed

7. On January 15, 2014, Bella Vista Company enters into a contract to build custom equipment for ABC Carpet Company. The contract
specified a delivery date of March 1. The equipment was not delivered until March 31. The contract required full payment of
P75,000 30 days after delivery. This contract should be
a. recorded on January 15, 2014 c. recorded on March 31, 2014
b. recorded on March 1, 2014 d. recorded on April 30, 2014

8. A performance obligation exists when

a. a company receives the right to receive consideration
b. a contract is approved and signed
c. a company provides a distinct product or service
d. a company provides interdependent product or service

9. New Age Computers manufactures and sells pagers and radio paging systems which include a 180 day warranty on product defects.
It also sells an extended warranty which provides an additional two years of protection. On May 10, it sold a paging system for
P3,850 and an extended warranty for another P1,200. The journal entry to record this transaction would include
a. a credit to Service Revenue of P5,050
b. a credit to Service Revenue of P1,200
c. a credit to Sales of P3,850 and a credit to Service Revenue of P1,200
 d. a credit to Unearned Service Revenue of P1,200

10. Consideration paid or payable to customers

a. includes volume rebates which increases the cost to the customer
b. includes discounts which reduces the cost of purchases to the company
c. reduces the consideration received and the revenue to be recognized
d. includes prompt settlement discount which increases revenues

11. The transaction price for multiple performance obligations should be allocated
a. based on selling price from the company’s competitors
b. based on what the company could sell the goods for on a standalone basis
c. based on forecasted cost of satisfying performance obligation
d. based on total transaction price less residual value

12. A company has satisfied its performance obligation when the

a. company has received payment for goods or services
b. company has significant risks and rewards of ownership
c. company has legal title to the asset
d. company has transferred physical possession of the asset

13. When a customer purchases a product but is not yet ready to accept delivery, this is referred to as
a. a repurchase agreement c. a principal-agent relationship
b. a consignment d. a bill-and-hold arrangement

14. The role of the agent in a Principal-Agent relationship is to

a. arrange for the principal to provide goods or services to a customer
b. provide the goods or services for a customer
c. market the principal goods and services to prospective customers
d. develop and maintain goodwill of the principal’s customers

15. Marle Construction enters into a contract with a customer to build a warehouse for P850,000 on March 30, 2016 with a
performance bonus of P50,000 if the building is completed by July 31, 2016. The bonus is reduced by P10,000 each week that
completion is delayed. Marle commonly includes these completion bonuses in its contracts and, based on prior experience,
estimates the following outcomes:

Completed by Probability
July 31, 2016 65%
August 7, 2016 25%
August 14, 2016 5%
August 21, 2016 5%

The transaction price for this transaction is

a. P895,000 c. P552,500
b. P850,000 d. P585,000

16. On June 1, 2017, Johnson & Sons sold equipment to James Landscaping Services. In exchange for a zero-interest bearing note with a
face value of P55,000, with payment due in 12 months. The fair value of the equipment on the date of sale was P50,000. The total
revenue to be recognized on this transaction in 2017 is
a. P55,000 c. P50,000
b. P5,000 d. P52,917

17. Meyer & Smith is a full-service technology company. They provide equipment, and installation services as well as training. Customers
can purchase any product or service separately or as a bundled package. Container Corporation purchased computer equipment,
installation and training for a total cost of P120,000 on March 15, 2016. Estimated standalone fair values of the equipment,
installation, and training are P75,000, P50,000, and P25,000 respectively. The transaction price allocated to equipment, installation
and training is
a. P75,000, P50,000, P25,000 respectively c. P120,000 for the entire bundle
b. P40,000, P40,000, P40,000 respectively d. P60,000, P40,000 and P20,000 respectively

18. On August 5, 2016, Famous Furniture shipped 20 dining sets on consignment to Furniture Outlet, Inc. The cost of each dining set was
P350 each. The cost of shipping the dining sets amounted to P1,800 and was paid for by Famous Furniture. On December 30, 2016,
the consignee reported the sale of 15 dining sets at P850 each. The consignee remitted payment for the amount due after deducting
a 6% commission, advertising expense of P300, and installation and setup costs of P390. The total profit on units sold for the
consignor is
a. P11,295 c. P6,045
b. P4,695 d. P9,945
Seasons Construction is constructing an office building under contract for Cannon Company. The contract calls for progress billings
and payments of P1,240,000 each quarter. The total contract price is P14,880,000 and Seasons estimates total costs of P14,200,000.
Seasons estimates that the building will take 3 years to complete, and commences construction on January 2, 2015.
19. At December 31, 2015, Seasons estimates that it is 30% complete with the construction, based on costs incurred. What is the total
amount of Revenue from Long-Term Contracts recognized for 2015 and what is the balance in the Accounts Receivable account
assuming Cannon Company has not yet made its last quarterly payment?
Revenue Accounts Receivable Revenue Accounts Receivable
a. P 4,960,000 P 4,960,000 c. P 4,464,000 P 1,240,000
b. P 4,260,000 P 1,240,000 d. P 4,260,000 P 4,960,000

20. At December 31, 2016, Seasons Construction estimates that it is 75% complete with the building; however, the estimate of total
costs to be incurred has risen to P14,400,000 due to unanticipated price increases. At December 31, 2016, Seasons estimated it was
30% complete. What is the total amount of Construction Expenses that Seasons will recognize for the year ended December 31,
2016?
a. P 10,800,000 c. P 6,390,000
b. P 6,300,000 d. P 6,540,000

21. At December 31, 2016, Seasons Construction estimates that it is 75% complete with the building; however, the estimate of total
costs to be incurred has risen to P14,400,000 due to unanticipated price increases. What is reported in the balance sheet at
December 31, 2016 for Seasons as the difference between the Construction in Process and the Billings on Construction in Process
accounts, and is it a debit or a credit?
Difference between the accounts Debit/Credit Difference between the accounts Debit/Credit
a. P 3,380,000 Credit c. P 880,000 Debit
b. P 1,240,000 Debit d. P 1,240,000 Credit

22. Seasons Construction completes the remaining 25% of the building construction on December 31, 2017, as scheduled. At that time
the total costs of construction are P15,000,000. At December 31, 2016, the estimates were 75% complete and total costs of
P14,400,400. What is the total amount of Revenue from Long-Term Contracts and Construction Expenses that Seasons will recognize
for the year ended December 31, 2017?
Revenue Expenses Revenue Expenses
a. P 14,880,000 P 15,000,000 c. P 3,720,000 P 4,200,000
b. P 3,720,000 P 3,750,000 d. P 3,750,000 P 3,750,000

ACCOUNTING FOR EXPENSES

Basic Concepts
• Expenses – are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets
or incidences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.
(Conceptual Framework)
• Expenses are outflows or other using up of assets of an entity or incurrences of liabilities (or a combination of both) during
a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing
major or central operations. (FASB SFAC 3).

Discussion: The definition of expenses encompasses losses as well as those expenses that arise in the ordinary activities of the
enterprises. Expenses that arise in the ordinary activities of the enterprise include, for example, cost of sales, wages and
depreciation. They usually take the form of an outflow of assets such as cash and cash and cash equivalents, inventory, property,
plant and equipment.

Losses represent other items that meet the definition of expenses and may, or may not, arise in the course of the ordinary activities
of the enterprise. Losses represent decreases in economic benefits and as such, they are different in nature from other expenses.
They include, for example, those resulting from disasters such as fire and flood, as well as those arising on the disposal of non-
current assets.

The definition of expenses also includes unrealized losses, such as those arising from the effects of increases in the rate of exchange
for a foreign currency in respect of the borrowings of an enterprise in that currency.

When losses are recognized in the income statement, they are usually displayed separately because knowledge of them is useful for
the purpose of making economic decisions. Losses are often reported net of related income. (Conceptual Framework)

Characteristics
1. Relation to assets – A business entity never acquires expenses as such. It always acquires assets, although, for convenience,
an expenditure may be immediately recorded as an expense if acquisition and consumption of benefits take place in the
same accounting period.
2. Assets Outflows – Expenses are asset outflows (decreases in assets) that result from carrying out activities constituting the
entity’s ongoing major or central operations. In the earning process, asset outflows (expenses) are made to generate asset
inflows (revenue).
3. Decreases in Owners’ Equity – Expenses decrease owners’ equity because they represent sacrifices or efforts made to
generate revenue.
4. Gross Concept – Like revenue, expense is a gross rather than a net concept. It is measured by the gross decreases in assets
or gross increases in liabilities.
 Related Terms
A. Loss – Losses are decreases in equity (net assets) from peripheral or incidental transactions of an entity and from all other
transactions and other events and circumstances affecting the entity during a period except those that result from expenses or
distribution to owners (FASB).
B. Revenue offsets – Revenue offsets are adjustments of the recorded amount of revenue representing amounts that will not be
collected or realized. They are shown as direct deductions from gross revenue. Examples are sales discounts, returns and
allowances.

Expenses vs. Costs

Accountants customarily use the term “cost” to describe assets and expenses. Expenses are the costs that are associated with the
revenue of the period. Costs to be associated with future revenue or otherwise to be associated with future accounting periods are
deferred to future periods as assets. Costs associated with past revenue or otherwise associated with prior periods are adjustments
of the expenses of those prior periods.

Expenses vs. Losses

The term “expense’ has both broad and narrow meaning. Broadly defined, it refers to all expired costs which are deducted from
revenue to determine net income. Under this concept, losses are part of expenses. In a narrow sense, expense is distinguished from
loss. Accountants use the term “loss” in two ways:
• to describe the excess of expenses over revenue for a period, such as “net loss:” if expenses exceed revenue, and
• to describe unfavorable events not related to normal operations of the entity, such as “loss on sale of plant assets” or “loss
on inventory market decline.”

Both expenses and loss (in the second sense) are expired costs. They differ as follows:
Expenses Losses
1. Result from ongoing major operations Result from incidental activities or unfavorable effects of the
environment
2. Contribute to the production of revenue Do not provide any economic benefits and are not directly or
indirectly associated with revenue.
3. Normal and recurring Irregular, nonrecurring and unplanned.
4. Voluntary incurred Involuntary

Other Matters
A. Events giving rise to expenses
• Exchanges • Production
• Reciprocal transfers with others owners • Casualties
• External events other than transfers

B. Important classes of expenses

• Costs of assets used to produce revenue (for example, cost of goods sold, selling and administrative expenses and
interest expense).
• Expenses from nonreciprocal transfers and casualties, for example, taxes, fires and thefts).
• Costs of assets other than products (for example, plant and equipment or investments in other companies) disposed of,
• Costs incurred in unsuccessful efforts, and
• Certain declines in market prices (such as in inventories held for sale).

C. Expenses do not include

• Repayments of borrowings
• Expenditures to acquire assets
• Distributions to owners (including acquisition of treasury stock)
• Adjustments of expenses of prior periods

1. Recognition of Expenses
Expenses are recognized in the income statement when a decrease in future economic benefits related to a decrease in an asset or
an increase of a liability has arisen and can be measured reliably.

Discussion: Recognizing expenses is essentially a problem of directly or indirectly relating expired economic benefits with revenues
recognized during an accounting period. We call this the “matching process”.

Matching involves finding a satisfactory basis of associating efforts or sacrifices (expenses) with rewards or accomplishments
(revenues). In the matching process, accountants first recognize the revenue realized in a given period and then relate to these the
expenses representing efforts or sacrifices made to earn the recognized revenues. The result of this process is the net income or loss
for the period.

2. Pervasive Expense Recognition Principles

The pervasive expense recognition principles specify the bases for recognizing the expenses that are deducted from revenue to
determine the net income or loss of a period. They are as follows:
 A. Associating Cause and Effect
Expenses are recognized in the income statement on the basis of a direct association between the costs incurred and the
earning of specific items of income.

Discussion: Associating cause and effect is the ideal way of matching revenues and expenses. This involves the simultaneous or
combined recognition of revenues and expenses that result directly and jointly from the same transactions or other events.

Examples
• The various components of expense making up the cost of goods sold are recognized at the same time as the income
derived from the sale of goods.
• Commissions paid to personnel can be traced to specific sales revenue.

B. Systematic and Rational Allocation

When economic benefits are expected to arise over several accounting periods, and the association with income can only be
broadly or indirectly determined, expenses are recognized in the income statement on the basis of systematic and national
allocation procedures.

Discussion: When costs cannot be associated with revenue on the basis of cause and effect, systematic and rational allocation
should be attempted. This form of expense recognition matches revenues and expenses indirectly. Many assets yield their
benefits to an enterprise over several accounting periods. Expenses and revenues are presumed to be indirectly associated
because economic benefits were consumed in the same period in which revenues were realized.

Example
• The using up of assets such as property, plant and equipment, patents and trademarks. The expense referred to as
depreciation or amortization.

C. Immediate Recognition
An expense is recognized immediately in the income statement when an expenditure produces no future economic benefits or
when, and to the extent that, future economic benefits do not qualify or, cease to qualify for recognition in the balance sheet
as an asset.

Discussion: When costs cannot be associated with revenue on the basis of cause and effect, systematic and rational allocation
should be attempted. This form of expense recognition matches revenues and expenses indirectly. Many assets yield their
benefits to an enterprise over several accounting periods. Expenses and revenues are presumed to be indirectly associated
because economic benefits were consumed in the same period in which revenues were realized.

An expense is also recognized in the income statement in those cases when a liability is incurred, without the recognition of an
asset, as when a liability under a product warranty arises.

Example: Some costs are associated with the current accounting period as expenses because
• Costs incurred during the period provide no discernible future benefits
o When incurred in nonreciprocal transfers to outside parties – example, amounts paid to settle lawsuits
o When benefits fail to materialize at the time costs are incurred – example, cost of resources used in
unsuccessful efforts
• Costs recorded as assets in prior periods no longer provide discernible benefits
o When costs carried as assets in prior periods expire without any benefits, a loss should be recognized in the
period in which the cost expiration too place or is discovered – examples are patents determined to be
worthless and long-lived assets destroyed by fire, flood or other casualty.
• Allocating costs either on the basis of association with revenue or among several accounting periods is considered to
serve no useful purpose
o Even if future periods are benefited, it may not be worthwhile to match costs with future revenues on the
basis of cause and effect association or rational and systematic allocation. In such cases, the costs are
immediately charged to expense as a practical expedient.
o Officers’ salaries are charged to expense when incurred even though part of the officers’ time and efforts are
devoted to production activities or planning for future periods.
o Advertising expenditures are accorded a similar treatment because the expected future benefits are difficult
to ascertain, measure, and allocate.

3. Measurement of Expenses
Expense is measured by the proportionate cost or other recorded amount of expired asset benefits given accounting recognition
during the period.

Discussion: Since expenses are the expired service potential of assets, the basis for measuring expenses is the amount at which
assets are valued. Assets are stated primarily at acquisition costs, therefore expenses are measured primarily in terms of the
acquisition cost of assets whose service potential has expired.

When assets are written up to appraised values, the basis for measuring expenses should be the appraised value of the asset, rather
than its acquisition cost.
 QUIZZER - EXPENSES

Nature and Characteristics

1. These are decreases in economic benefits during the accounting period in the form of outflows or depletion of assets or incidences
of liabilities that result in decreases in equity, other those relating to distributions to equity participants
a. Cost c. Loss
b. Expense d. Expenditure

2. Expenses may be best described as

a. Costs which have no discernible benefit to future operations
b. The consideration given to acquire goods or services
c. Costs that are associated with revenues of a given period
d. Gross decreases in owner’s equity

3. Which of the following statements is (are) true?

I. Expenses are synonymous with expenditures
II. All expenses are expired costs
III. All expired costs are expenses
IV. Expense in the broadest sense, includes expired costs and losses that are deducted from revenue, in a narrow sense,
expense is distinguished from loss
a. I and III are true c. III and IV are true
b. II and IV are true d. All statements are true

4. Which of the following is not a characteristic of expenses?

a. Expense is a gross rather than a net concept
b. Expenses decrease owners’ equity
c. They are gross increases in assets or gross decreases in liabilities resulting from the firm’s profit-directed activities
d. They involve acquiring assets and using goods and services to obtain revenue

5. The term “expired costs” means

a. Excess of all expenses over revenue for one accounting period
b. Cost which is deductible from revenue
c. Cost having no discernible benefit to future operations
d. The amount of the consideration measured in money given in order to acquire goods or services

6. An expired cost arising from using or consuming goods or services in the process of obtaining revenue is identified as
a. Expense c. Disbursement
b. Expenditure d. Obligation

7. Costs which are not applicable to production of future revenue and for that reason are treated as deductions from current revenue
or are charged against retained earnings are
a. Expired costs c. Revenue expenditure
b. Expenses d. Cost outlay

8. An expiration of cost which is incurred without compensation or return and is not absorbed as costs of revenue is called
a. Deferred charge c. Indirect costs
b. Deferred credit d. Loss

9. The expense of a period include all the following except

a. Costs directly associated with the revenue of the current period
b. Costs directly associated with past revenues
c. Costs associated with the current period on some basis other than a direct relationship with revenue
d. Costs that cannot, as a practical matter, be associated with any other period.

10. Which of the following involves recognizing an expense?

a. Factory supplies are consumed in production
b. Office supplies are consumed in operations
c. A sales discount is granted to customer who pays within the discount period
d. Previously unrecorded wages are paid to laborers engaged in constructing a building for company’s own use

11. Which of the following transactions would require the recording of an expense?
a. Cash paid to a supplier in settlement of a previously recorded promise to pay when some advertising supplies were
purchased
b. Cash paid to office employees for services rendered during the month
c. Cash paid to acquire a new truck to be used in the business
d. Cash paid to settle an unrecorded liability for factory supplies received and already consumed.

12. Which of the following is not a loss or an expense?

a. Shrinkage in the net realizable value of accounts receivable as measured by an estimate for uncollectible accounts
b. The cost of radio/TV time announcing a new product
 c. Depreciation on trucks used to construct a building for the company’s own use
d. A drop in the net realizable value of inventory below cost

13. The following statements relate to expenses. Which statement is true?

a. The fact that an expense is recognized on the income statement indicates that an equivalent outlay of cash has been made in
the same period
b. Losses are asset expirations that are incurred voluntarily to produce revenue
c. Expense accounts usually have debit balances and show the cost associated with producing revenue during an accounting
period
d. The price paid for a plant asset is actually a prepayment of an expense

14. Management reported P 30,000 as imputed costs for last month. These should be taken up as
a. A capital expenditure c. Offset against stockholders’ equity
b. A revenue expenditure d. None of these

15. In expense recognition principle, which of the following is not an important class of expense?
a. Expenditures to acquire assets
b. Expenses from non-reciprocal transfers and casualties
c. Cost of assets other than products disposed of
d. Declines in market prices of inventories held for sale

16. In accordance with Pervasive Measurement Principles, which of the following items accurately belong to the important classes of
expenses?
A. Expenditures to acquire assets
B. Distribution to owners
C. Costs of assets other than products disposed of
D. Costs incurred in unsuccessful efforts
a. A, B, and C only c. B and D only
b. C and D only d. All of these

17. An example of expense that arises from production is

a. Abnormal spoilage c. Taxes on factory building
b. Salary of plant superintendent d. All of the above

18. Expenses cannot arise from

a. External events other than transfers c. Production
b. Nonreciprocal transfers to owners d. Casualties

19. Losses on writing down inventory from cost to market are usually considered to be
Operating Losses Non-operating losses
a. Yes No
b. No Yes
c. Yes Yes
d. No No

20. Which of the following describes the distinction between expenses and losses?
a. Losses are reported net-of-related-tax-effect whereas expenses are not reported net-of-tax
b. Losses are extraordinary changes whereas expenses are ordinary charges
c. Losses are material items whereas expenses are immaterial items
d. Losses result from peripheral or incidental transactions whereas expenses result from ongoing major or central operations of
the entity.

Capital vs. Revenue Expenditures

21. The primary factor that distinguishes a capital from a revenue expenditure is
a. The period in which the expenditure was made
b. Whether or not the expected benefit will extend beyond the current accounting period
c. The account to be charged
d. The materiality of the expenditure

22. Which of the following is not a capital expenditure?

a. Purchased typewriter for office use
b. Repaired roof damaged by typhoon
c. Replaced major part of a machine which increased its production capacity
d. Paid for the services of engineers to test a new high-speed lather recently acquired.

23. The best general criterion for deciding whether a cost should be included in the value of a new asset is to determine
a. If the cost was necessarily incurred in the process of getting the asset to a usable state.
b. If the cost was optional or a part of the base model price
c. If the cost was incurred before or after the asset arrived at the ultimate place for use
d. All of the above
24. Which of the following expenditures may be properly capitalized?
a. Expenditure for massive advertising campaign
b. Insurance on plant during construction
c. Research and development related to a long-term asset which is giving the company a competitive advantage
d. Title search and other legal costs related to a piece of property which was not acquired

Matching Concept
25. After the revenues for an accounting period have been determined, the costs directly or indirectly associated with these revenues
must be deducted to measure net income. This is called
a. Income statement preparation c. Matching process
b. Profit and loss preparation d. Bookkeeping process

26. The following statements relate to the income determination process. Which statement(s) is (are) true?
I. Revenue for a period is generally determined independently by applying the realization principles
II. Expenses are determined by applying the expense recognition principles on the basis of the relationships between acquisition
costs and either the independently determined revenue of accounting periods
III. The term matching is used in accounting to describe the entire process of income determination, or in a more limited sense,
to the process of expense recognition.
a. I and II only c. I and III only
b. II and III only d. I, II, and III

27. The accounting concept of matching is best demonstrated by

a. Not recognizing any expense unless some revenue is realized
b. Associating effort (cost) with accomplishment (revenue)
c. Recognizing prepaid rent received as revenue
d. Establishing a Reserve for Possible Future Market Decline in Inventory Account

28. The term “matching costs and revenues” means

a. That all expenses should be allocated to accounting periods on the basis of the effect on net income
b. That costs should be carried forward to future accounting periods if they have not resulted in revenue during the current
accounting period
c. That if costs are charged off as expenses in the accounting period when they are actually incurred, they will be matched
properly with the revenues actually earned during that accounting period
d. That costs which can be associated directly with specific revenue should be carried forward in the balance sheet until the
associated revenue is recognized

29. Why are certain costs of doing business capitalized when incurred and then depreciated or amortized over subsequent accounting
periods?
a. To reduce the income tax liability
b. To aid management in the decision-making process
c. To match the costs of production with revenues as earned
d. To adhere to the accounting concept of conservatism

30. Current accounting practice does not strictly apply the matching principle to
a. Wasting assets c. Trademarks
b. Research and development d. Equipment

31. Costs should be charged against revenue in the period the costs are incurred except
a. For manufacturing overhead costs for a product manufactured and sold in the same accounting period
b. When the costs will not benefit any future
c. For costs from idle manufacturing capacity resulting from an unexpected plant shutdown
d. For costs of normal shrinkage and scrap incurred for the manufacture of a product in inventory

32. If losses and prior period adjustments are ignored, an exception to the general rule that costs should be charged to expense in the
period incurred is
a. Depreciation charges on equipment used in the construction of a new building for the company’s own use
b. Factory overhead costs on a product manufactured and sold during the accounting period
c. Idle manufacturing capacity costs when a plant is closed unexpectedly due to a strike
d. The cost of abnormal shrinkage and scrap incurred in the manufacture of a product included in ending inventory

33. The matching concept is least relevant to accounting for a

a. Manufacturing corporation with a three-month production cycle
b. Manufacturing corporation with a fifteen-month production cycle
c. Joint venture organized to subdivide and market lots in a large realty development
d. Joint venture organized to market this year’s mango crop from 20 hectares of trees

34. Which of the following items is NOT important in the matching of expenses revenues under the accrual basis of accounting?
a. Amortization of patent costs c. Beginning and ending inventory accounts
b. Estimated allowance for uncollectible accounts d. Cash receipts
35. The determination of expenses of an accounting period is based largely on the application of the
a. Cost principle c. Realization principle
b. Matching principle d. Consistency principle

Expense Recognition Principles

36. The following are theoretical basis for recognition of expenses except
a. Associating effort with accomplishment c. Ensuring maximum profits
b. Recognizing expense at the earliest possible time d. Allocating cost to all periods benefited

37. Which of the following is the rationale for deducting unsold inventory at the end of the period from goods available for sale in order
to determine the cost of sales to be matched against revenue from sales?
a. Associating cause and effect c. Immediate recognition
b. Systematic and rationale allocation d. Partial recognition

38. The following costs were charged to expense in the current period
1) Loyalty rewards expense
2) Patent amortization
3) Cost of sales
4) Insurance premiums
5) Utilities expense
6) Loss on inventory write-down
7) Doubtful accounts expense
8) Research and Development expense
9) Depreciation of building – leased asset
10) Impairment loss

Required: Indicate how many items were recognized as expense under each of the following principles:
Associating Cause & Effect Systematic & Rational Allocation Immediate Recognition
a. 3 items 4 items 3 items
b. 3 items 3 items 4 items
c. 5 items 2 items 3 items
d. 4 items 3 items 3 items

39. Which of the following is not an example of the expense recognition principle of associating cause and effect?
a. Freight out c. Product guaranty expense
b. Salesmen’s commission d. Repairs and maintenance

40. Which of the following is a deferred cost that should be amortized over the periods estimated to be benefited?
a. Three years’ prepayment on an operating lease contract for the use of a building.
b. Security deposit representing two-months’ rent on leased office space
c. Advance from customer to be returned when sale is completed
d. Property tax for this year payable next year

41. Which of the following is expensed under the principle of systematic and rational allocation?
a. Salesmen’s monthly salaries c. Insurance premiums
b. Transportation to customers d. Electricity to light the office building

42. Whenever costs or expenses cannot be reasonably associated with specific products but can be associated with specific revenues,
the cost should be
a. Expensed in the period in which the related revenue is recognized
b. Charged to expense in the period incurred
c. Allocated to specific products based on the best estimate of the production processing time
d. Capitalized and amortized over a period not to exceed 24 months

43. Some costs cannot be directly related to particular revenues but are incurred to obtain benefits in the period in which the costs are
incurred. An example of such cost is
a. Electricity used to light offices c. Cost of merchandise sold
b. Transportation to customers d. Sales commission

44. What is the underlying concept that supports the immediate recognition of a loss?
a. Consistency c. Judgement
b. Matching d. Conservatism

45. Sean Company purchased in patent at the beginning of 2008 and amortizes it over a life of ten years. At the end of year 2010, the
patent was determined to be worthless and was thus written off from the books. Which of the following expense recognition
principle was applied by Sean Company in 2010 on the derecognition of patents from the books?
a. Cause and effect association c. Immediate recognition
b. Systematic and rational allocation d. Materiality
46. Which of the following cost items would be matched with current revenues on a basis other than association of cause and effect?
a. Goodwill c. Cost of goods sold
b. Sales Commission d. Purchase on account

47. The current method of accounting for research expense is best described by
a. Associating cause and effect c. Immediate recognition
b. Income minimization d. Systematic and rational allocation

48. What method allocates costs to expense in proportion to elapsed time?

a. Unit output method c. Appraisal or inventory method
b. Straight line method d. Replacement method

49. This is a method of allocating costs whereby the earliest current costs are charged out first to expense of the period and the units
remaining on hand are reported at the current costs.
a. First-in, first-out c. Last-in, first-out
b. Moving weighted average d. Last invoice price

50. An investment in shares of stock a company that has dissolved due to bankruptcy has to be written off as expense (loss) according to
which of the following principles?
a. Associating cause and effect c. Immediate recognition
b. Systematic and rational allocation d. Conservatism

51. Simultaneous recognition of both revenue and an expense may result from certain transactions or events. An example of an expense
so recognized may be
a. Expired portion of prepaid insurance c. Transportation to customers
b. Salesperson’s monthly salaries d. Electricity used to light offices

52. When should an indicated loss on a long-term construction contract be recognized under the completed contract method and the
percentage of completion method, respectively?
Completed-contract Percentage-of-completion
a. Immediately Immediately
b. Immediately Over the life of the project
c. Completion of contract Over the life of the project
d. Completion of contract Immediately

53. If losses and prior period adjustments are ignored, an exception to the general rule that costs should be charged to expense in the
period incurred is
a. Depreciation charged on equipment used in the construction of a new building for the company’s own use.
b. Salaries paid to corporate officers
c. Idle manufacturing capacity costs when a plant is closed unexpectedly due to strike
d. Unabsorbed factory overhead incurred in the manufacture of a product included in ending inventory

54. Advertising costs are typically treated as expenses of the period in which incurred under the expense recognition principle of
a. Matching c. Immediate Recognition
b. Cause and Effect Association d. Systematic allocation

55. Depreciation of a long-lived asset is a process of

a. Providing for its eventual replacement c. Allocating its cost over its estimated useful life
b. Recognizing the effect of wear and tear d. Partial recognition

END OF MODULE 4