Financial Assets

Chapter 6
Learning Objectives
1. Define a financial asset and give examples
2. Account for cash and cash equivalents
3. Account for receivables
4. Account for investments
Financial Instrument
Financial instrument - is any contract that gives rise to both , a
financial asset of one entity and a financial liability or equity the
instrument of another entity. (PPSAS 28.9)
Financial Asset
Financial asset - is any asset that is:
a. Cash
b. An equity instrument of another entity
c. A contractual right to receive cash or another financial asset
from another entity
d. A contractual right to exchange financial instruments with
another entity under conditions that are potentially favorable
e. A contract that will or may be settled in the entity's own equity
instruments
Financial Liability
Financial liability - is any liability that is:
a. A contractual obligation to deliver cash or another financial
asset to another entity
b. A contractual obligation to exchange financial assets or
financial liabilities with another entity under conditions that
are potentially unfavorable to the entity
c. A contract that will or may be settled in the entity’s own equity
instruments.
Equity Instrument
Equity instrument - is any contract that evidences a residual
interest in the assets of an entity after deducting all of its
liabilities.

The issuer of a financial instrument shall classify the instrument,

or its component parts, on initial recognition as a financial asset,
a financial liability or an equity instrument in accordance with the
substance of the contractual arrangement and the definitions of a
financial asset, a financial liability and an equity instrument. (GAM
for NGAs, Chapter 7, Sec. 23)
Financial Instrument
Example:

Bank deposit is a financial instrument. It is a contract that gives rise to both a

financial asset (i.e., Cash in bank) on the part of the depositor and a financial
liability (i.e., Deposit liability) on the part of the bank. The depositor has a
contractual right to withdraw his cash while the bank has a contractual
obligation to deliver cash when the depositor withdraws.

Cash is the most basic financial instrument because it is the medium of

exchange and the basis of measurement of all financial statement elements
Initial Recognition
A financial asset is recognized when an entity becomes a party to
the contractual provisions of the instrument. (PPSAS 29.16
Initial Measurement
Financial assets are initially measured at fair value plus
transaction costs, except for financial assets at fair value through
surplus or deficit whose transaction costs are expensed.

Transaction costs are incremental costs that are directly

attributable to the acquisition, issue, or disposal of a financial
instrument. An incremental cost is one that would not have been
incurred if the entity had not acquired, issued or disposed the
financial instrument.
Initial Measurement
Transaction costs include:
(a) fees and commissions paid to agents, advisers, brokers and
dealers
(b) levies by regulatory agencies and securities exchanges
(c) transfer taxes and duties
Cash & Cash Equivalents
Cash - comprises

 cash on hand
 cash in bank
 cash treasury accounts.
Adjustments for Unreleased
Commercial Checks
Unreleased checks are checks drawn but not yet given to the
payees as of the end of the period.

Unreleased checks are reverted back to cash as follows:

Cash in Bank, Local Currency-Current XX

Accounts Payable (or other liability account) XX
Adjustments for Unreleased
Commercial Checks
Unreleased checks are not physically cancelled. At the start of the following year, the
adjusting entry above is reversed to recognize the availability of the checks for
release.

This procedure does not apply to the "Cash-Modified Disbursement System (MDS)"
account because there is no actual cash with the Government Servicing Bank.

Recall that any unused NCA is reverted back to the National Government, and
therefore, the balance of the "Cash-Modified Disbursement System MDS) account is
zeroed-out at the end of each period.
Accounting for Cancelled Checks
Checks are cancelled when they become stale, voided or spoiled.

A check is considered stale if it has been outstanding for over 6

months from its date.

Replacement checks may be issued for cancelled checks that

were already released to payees, upon submission of the
cancelled checks to the Accounting Unit.
Accounting for Cancelled Checks
Cancelled checks are reverted back to cash as follows:

Current year Prior period

Cash-MDS, Regular xx Accumulated Surplus (Deficit) xx
Accounts Payable xx Accounts Payable xx

To recognize the cancellation of stale/ voided/ spoiled MDS To recognize the cancellation of stale/ voided/ spoiled MDS
checks checks in prior year
Accounting for Cancelled Checks
For prior period MDS checks, the "Accumulated Surplus/(Deficit)" account
is debited.

This is because, again, the "Cash-Modified Disbursement System (MDS)"

account is zeroed-out at the end of each period.

For cancelled commercial checks, the "Cash in Bank-Local Currency,

Current" account is debited for both current year and prior period.

If a replacement check is issued, the replacement check is recorded in the

regular manner, i.e., debit to accounts payable and credit to cash.
Petty Cash Fund
Petty Cash Fund (PCF) refers to the amount granted to duly
designated Petty Cash Fund Custodian for payment of authorized
petty or miscellaneous expenses which cannot be conveniently
paid through checks or ADA. (GAM for NGAs, Chapter 6, Sec. 2)
Guidelines
a. The Head of Agency shall approve the amount of PCF to be established,
which shall be sufficient to defray recurring petty expenses for 1 month.

b. The PCF Custodian shall be properly bonded*) whenever the established

amount of PCF exceeds P5,000.

*"Bonded" means an insurance shall be taken on the custodian. In the event

that the custodian misuses the funds, the entity can claim from the insurance
company, and the insurance company in turn will go after the custodian”
Guidelines
c. The PCF shall be maintained using the Imprest System. At all
times, total cash on hand and unreplenished expenses shall be
equal to the PCF ledger balance.

d. The PCF shall be kept separately from other advances or

collections and shall not be used to pay for regular expenses,
such as rentals, electricity, water, and the like.
Guidelines
e. PCF payments shall not exceed P15,000 for each transaction,
except when otherwise authorized by law or by the COA.
Splitting of transactions to avoid exceeding the ceiling is
prohibited.

f. A canvass from at least 3 suppliers is required for purchases

amounting to P1,000 & above, except for purchases made
while on official travel.
Guidelines
g. PCF disbursements shall be supported by properly
accomplished & approved Petty Cash Vouchers, invoices, Ors
or other evidence of disbursements.

h. Replenishment shall be made as soon as disbursements reach

at least 75% or as needed.
Guidelines
i. At the end of the year, the PCF Custodian shall submit all
unreplenished Petty Cash Vouchers to the Accounting Unit for
recording in the books of accounts.

j. The unused balance of the PCF shall not be closed at year-end.

It shall be closed only upon the termination, separation.
retirement or dismissal of the PCF Custodian, who in turn shall
refund any balance to close his/her cash accountability.
Illustration
After careful estimates of recurring monthly petty expenses, the Head of
Entity A approves the establishment of a P50,000 petty cash fund.

Petty Cash 50,000

Cash-MDS, Regular 50,000

To recognize the cancellation of stale/ voided/ spoiled MDS

checks

Just like the accounting by business entities, no journal entries are made
as disbursements are made out of the PCF.

Journal entries will be made when the PCF is (a) replenished or (b)
adjusted at the end of the period for unreplenished expenses.
Illustration
Illustration
Case 1: The PCF is replenished.

Office Supplies Expenses 10,000

Fuel, Oil, Lubricants 15,000
Postage & Courier Expenses 8,000
Other Maintenance & OPEX 4,500
Cash-MDS, Regular 37,500

To record the replenishment of the PCF

Illustration
Case 2: The PCF is not replenished.

Office Supplies Expenses 10,000

Fuel, Oil, Lubricants 15,000
Postage & Courier Expenses 8,000
Other Maintenance & OPEX 4,500
Petty Cash 37,500

To adjust the PCF for unreplenished disbursements

Illustration
Case 3: The PCF retires and the PCF is closed.

Cash-Collecting Officer 12,500

Petty Cash 12,500

To record the return of the unused PCF upon retirement of the

Petty Cash Custodian
Accounting for Cash Shortage/Overage
of Disbursing Officer
The disbursing officer is liable for any cash shortage while any
cash overage that he cannot satisfactorily explain to the auditor is
forfeited in favor of the government.
Relevant provision of law:
"The failure of a public officer to have duly forthcoming any
public funds or property with which he is chargeable, upon
demand by any duly authorized officer, shall be prima facie
evidence that he has put such missing funds or property to
personal use." (Revised Penal Code, Art: 217)
Cash Shortage
Due from Officers & Employees xx
Advances for/to … (Appropriate Account) xx

To recognize cash shortage of disbursing officer

Cash –Collecting Officers xx

Due from Officers & Employees xx

To recognize restitution of cash shortage

Cash-Treasury/Agency/Deposit, Regular xx
Cash –Collecting Officers xx

To recognize the remittance if restricted cash shortage to the BTr

Cash Overage
Cash –Collecting Officers xx
Miscellaneous Income xx

To recognize forfeiture of cash overage of the disbursing officer

Cash –Treasury/Agency Deposit, Regular xx

Cash –Collecting Officers xx

To recognize the remittance of forfeited cash overage to the BTr

Dishonored Checks
A dishonored check is a check that is not accepted when
presented for payment, e.g., a check returned by the bank
because of lacked sufficient funds – ‘bounced’ check.

The drawer of the dishonored check is liable for the amount of

the check and all penalties resulting from the dishonor, without
prejudice to his criminal liability for a 'bounced' check.
Dishonored Checks - Guidelines
a. When a check is dishonored, the Collecting Officer shall:
i. issue a Notice of Dishonored Checks to the drawer and any
endorser; and
ii. cancel the related OR.

b. If the Collecting Officer fails to issue the notice, the

dishonored check becomes his personal liability. The drawer
and any endorser not given the notice will be relieved from
any liability.
Dishonored Checks - Guidelines
c. A check refused by the drawee bank when presented within 90
days from its date is a prima facie evidence that the drawer has
knowledge about the insufficiency of his funds, unless the drawer
pays the check in full or makes arrangement with the drawee
bank for the full payment of the check within 5 banking days
after receiving the notice of the dishonor.

d. A dishonored check shall be settled by payment in cash or

certified check. The dishonored check shall not be returned to
the payor unless he returns first the previous OR therefor.
Dishonored Checks – Journal Entries
Dishonored checks are recorded to the “Other receivables” account as
follows:

Collections remitted to the BTr

Current year Prior period
Other receivables xx Other receivables xx
Cash-Treasury/Agency Deposit, Regular xx Accumulated Surplus/Deficit xx

To recognize the cancellation of current year’s deposited To recognize the cancellation of prior year’s deposited
collections due to dishonored checks collections due to dishonored checks
Dishonored Checks – Journal Entries

Collections remitted to Authorized Government Depository Bank

Current year Prior period
Other receivables xx Other receivables xx
Cash in Bank-Local Currency, Current Account xx Cash in Bank-Local Currency, Current Account xx
Bank Reconciliation
A bank reconciliation statement is a report that is prepared for
the purpose of bringing the balances of cash (a) per records and
(b) per bank statement into agreement.

A bank statement is a report issued by a bank which shows the

credits and debits to the depositor's account during a period, as
well as the account's cumulative balance.
Bank Reconciliation - Guidelines
a. Bank reconciliations shall be prepared as internal control to ensure
the correctness of cash records & as deterrent to fraud.

b. The Chief Accountant or designated staff shall prepare the separate

bank reconciliations for each bank account maintained by the entity
within 10 days from receipt of the monthly bank statement.

c. The Adjusted Balance Method shall be used. Under this method, the
unadjusted book & bank balances are brought to the adjusted
balance that is reported on the Statement of Financial Position.
Bank Reconciliation - Guidelines
d. Bank reconciliations shall be prepared in 4 copies to be
submitted within 20 days from receipt of bank statement to
the following:
1. COA Auditor
2. Head of Agency
3. Accounting Division
4. Bank, if necessary

e. A Journal Entry Voucher (JEV) shall be prepared to record

any reconciling items.
Cash Equivalents
Cash Equivalents - are short-term, highly liquid investments that
are readily convertible to known amounts of cash and which are
subject to an insignificant risk of changes in value. (PPSAS 2.8)

Only debt instruments acquired within 3 months before their

scheduled maturity date can qualify as cash equivalents.
Receivables
Receivables represent claims for cash or other assets from other
entities.
Examples:
a. Accounts receivable - refers to amounts due from customers
arising from regular trade and business transactions.
b. Notes receivable - represents claims, usually with interest, for
which a formal instrument of credit is issued as evidence of
debt, such as promissory notes.
Receivables
c. Loans Receivables – used in the BTr-NG books to recognize
loans extended by the National Government to Government
Financial Institutions 'GFIs or GOCCs, covered by loan
agreements
d. Other receivables, such as, interest receivable, due from
employees/officers/ other NGAs, lease receivables, dividends
receivable, and the like. (GAM for NGAs, Vol. 3)

Receivables are initially measured at fair value plus transaction

costs and subsequently measured at amortized cost.
Investments
Categories of Financial Assets
For purposes of subsequent measurement, financial assets are classified
as follows:
a. Financial asset at fair value through surplus or deficit - is one that
is either:
i. Held-for-trading
ii. Designated as at fair value through surplus or deficit on initial recognition.
Any financial asset can be classified in this category if its fair value can be
reliably measured.
b. Held-to-maturity investments - are non-derivative financial assets
with fixed or determinable payments and fixed maturity that an entity
has the positive intention and ability to hold until maturity.
Receivables
c. Loans and receivables - are non-derivative financial assets
with fixed or determinable payments and are not quoted in an
active market.

d. Available-for-sale financial assets – are non-derivative

financial assets that are designated as available for sale or are
not classifiable under the other categories
Summary of Measurements
Type of Financial Subsequent
Examples Initial Measurement
Asset Measurement
Financial asset at fair Investments in quoted Fair value Fair value; changes in
value through surplus stocks or bonds fair value are
or deficit recognized in
surplus/deficit
Held-to-maturity Investments in bonds Fair value plus Amortized cost (using
and other debt transaction costs the effective interest
securities to be held method)
until maturity
Loans and receivables Accounts, Notes, Loans Fair value plus Amortized cost (using
receivable transaction costs the effective interest
method)
Available-for-sale Investments in stocks or Fair value plus Fair value; changes in
financial assets bonds not classified transaction costs fair value are
under a to c above recognized in equity
Summary of Measurements
Investments in unquoted equity instruments whose fair value
cannot be reliably measured are measured at cost.
Illustration 1: Initial measurement
Entity A acquires an investment for P100,000. Transaction costs amount to
P10,000.

Case 1: The investment is classified as Financial Asset Held for Trading

Financial Asset Held for Trading 100,000

Other Financial Charges 10,000
Cash in Bank – Local Currency, Bangko Sentral ng Pilipinas 110,000
Illustration 1: Initial measurement
Entity A acquires an investment for P100,000. Transaction costs amount to
P10,000.

Case 2: The investment is classified as Held-to-Maturity investments

Investments in Treasury Bills-Local 110,000

Cash in Bank – Local Currency, Bangko Sentral ng Pilipinas 110,000
Illustration 1: Initial measurement
Entity A acquires an investment for P100,000. Transaction costs amount to
P10,000.

Case 3: The investment is classified as Available-for-sale assets

Investments in Stocks (Bonds) 110,000

Cash in Bank – Local Currency, Bangko Sentral ng Pilipinas 110,000
Illustration 2: Subsequent measurement
Assume the investment in Illustration 1 is investment in stocks. The fair value
at the end of the period is P120,000

Case 1: The investment is classified as Financial Asset Held for Trading

Financial Asset Held for Trading 20,000

Gain from Changes in Fair Value of Financial Instruments 20,000
(120K-100K)
Illustration 2: Subsequent measurement
Assume the investment in Illustration 1 is investment in stocks. The fair value
at the end of the period is P120,000

Case 2: The investment is classified as Available-for-sale financial assets

Investment in Stocks 10,000

Unrealized Gain/(Loss) from Changes in Fair Value of Financial Assets 10,000
(120K-110K)
Illustration 2: Subsequent measurement
Interest income from debt instruments, other than those which are
classified as financial asset at fair value through surplus or deficit, is
recognized using the effective interest method.
Therefore, if the investment in the illustration above in is in the form of
bonds and is classified as available-for-sale financial assets, the
unrealized gain (loss) would have been computed as the difference
between the fair value at year-end and the carrying amount adjusted for
the amortization of bond discount or premium.
Only debt securities can be classified as held-to-maturity investments.
Thus, this category is omitted in Illustration 2 above. Held-to-maturity
investments are subsequently measured at amortized cost, and
therefore, changes in fair value are ignored.
Illustration 3: Held-to-maturity investments
On January 1, 20x1, Entity A acquires 5-year, 5%, P1,000,000 face amount
bonds for P957,876 & classifies them as held-to-maturity investments. The
issuer pays annual interest every December 31. The effective interest rate is
6%

1/1/x1

Investment in Bonds 957,876

Cash in Bank-Local Currency, Bangko Sentral ng Pilipinas 957,876
Illustration 3: Held-to-maturity investments
On January 1, 20x1, Entity A acquires 5-year, 5%, P1,000,000 face amount
bonds for P957,876 & classifies them as held-to-maturity investments. The
issuer pays annual interest every December 31. The effective interest rate is 6%
Amortization Table

Date Interest received Interest income Amortization Present value

1/1/x1 957,876

12/31/x1 50,000 57,473 7,473 965,349

12/31/x2 50,000 57,921 7,921 973,270

12/31/x3 50,000 58,396 8,396 981,666

12/31x4 50,000 58,900 8,900 990,566

12/31/x5 50,000 59,434 9,434 1,000,000

Illustration 3: Held-to-maturity investments
On January 1, 20x1, Entity A acquires 5-year, 5%, P1,000,000 face amount
bonds for P957,876 & classifies them as held-to-maturity investments. The
issuer pays annual interest every December 31. The effective interest rate is
6%

12/31/x1

Cash in Bank-Local Currency, Bangko Sentral ng Pilipinas 50,000

Investment in Bonds 7,473
Interest Income 57,473

To recognize interest income

Variation: Available-for-sale financial assets
Assume the bonds are classified as available-for-sale financial assets and the
fair value at year-end is P1,010,000. The unrealized gain that is recognized in
net assets would have been P44,651 (P1,010,000 fair value – P965,349
carrying amount adjusted for discount amortization).The same amount of
interest income would be recognized.
Impairment of Financial Assets
An entity shall assess at the end of each reporting period whether there is any
objective evidence that a financial asset or group of financial assets is impaired.

If any such evidence exists, the entity shall measure the amount of loss as the
difference between the carrying amount of the asset and the present value of
estimated future cash flows discounted at the financial asset's original effective
interest rate.

The carrying amount of the asset shall be reduced either directly or through the
use of an allowance account.

The amount of the loss shall be recognized in surplus or deficit.

Impairment of Financial Assets
In case of Accounts Receivable, the Allowance tor Impairment
shall be provided in an amount based on collectability of
receivable balances and evaluation of such factors as aging of
accounts, collection experiences of the agency, expected loss
experiences and identified doubtful accounts.
(GAM for NGAs, Chapter 7, Sec. 10)
Derecognition of Financial Assets
Derecognition is the process of removing a previously
recognized asset, liability or equity from the statement of financial
position.

A financial asset is derecognized when:

a. The contractual rights to the cash flows from the financial asset
expire or are waived
b. The financial asset is transferred and the transfer qualifies for
derecognition, such as when the risks and rewards of ownership and
control of the financial asset are relinquished
Derecognition of Financial Assets
The derecognition of financial assets is subject to the provisions
of the State Audit Code of the Philippines (P.D. No. 1445) on the
writing off of receivables and other policies issued by the COA.
(GAM for NGAs, Chapter 7, Sec. 10)
Illustration: Impairment & Derecognition
Entity A, a government hospital, receives promissory notes from several
patients amounting to P1,000,000

Notes Receivable 1,000,000

Hospital Fees 1,000,000

To recognize receipt of promissory notes

Illustration: Impairment & Derecognition
At year end, it was estimated that P300,000 notes are impaired.

Impairment Loss-Loans and Receivables 300,000

Allowance for Impairment – Notes Receivable 300,000

To recognize impairment of notes receivable

Illustration: Impairment & Derecognition
A subsequent audit reveals that P100,000 of the impaired notes cannot be
collected anymore. The COA authorizes the derecognition (write-off) of
these notes.

Allowance for Impairment – Notes Receivable 100,000

Notes Receivable 100,000

To recognize the derecognition of notes receivable

Derivatives
A derivative is a financial instrument or other contract that
derives its value from the changes in value of some other
underlying asset or other instrument.

Characteristics of a derivative
a. Its value changes in response to the change in an underlying
b. It requires no initial net investment (or only a very minimal
initial net investment)
c. It is settled at a future date.
Derivatives
An "underlying" is a specified price, rate, or other variable (e.g,
interest rate, security or commodity price, foreign exchange rate,
index of prices or rates, etc.), including a scheduled event (e.g., a
payment under contract) that may or may not occur.

Purpose of a derivative
The very purpose of derivatives is risk management. Risk
management is the process of identifying the desired level of risk,
identifying the actual level of risk and altering the latter to equal
the former. (GAM for NGAs, Chapter 7, Sec. 19)
Hedging
Hedging is a method of offsetting a potential financial loss or the
structuring of a transaction to reduce risk involving financial
instruments.

Hedge accounting recognizes the offsetting effects on surplus or

deficit of changes in the fair values of the hedging instrument and
the hedged item.
Hedging
Hedging Relationships
a. Fair value hedge - a hedge of the exposure to changes in fair value of a
recognized asset or liability or an unrecognized firm commitment, or an
identified portion of such an asset, liability of firm commitment, that is
attributable to a particular risk and could affect surplus or deficit.
b. Cash flow hedge - a hedge of the exposure to variability in cash flows
that
i. is attributable to a particular risk associated with a recognized asset or liability
(such as all or some future interest payments on variable rate debt) or a highly
probable forecast transaction
ii. could affect surplus or deficit.
c. Hedge of a net investment in a foreign operation.
Hedging
Components of a Hedging Relationship
a. Hedging Instrument - a designated derivative or a designated
non-derivative financial asset or non-derivative financial liability
whose fair value or cash flows are expected to offset changes in
the fair value or cash flows of designated hedged item.
b. Hedged Item - an asset, liability, firm commitment, highly
probable forecast transaction or net investment in a foreign
operation that
i. exposes that entity to risk of changes in fair value or future cash flows
and
ii. is designated as being hedged.
Chapter Summary
 Financial asset is any asset that is:
 cash or right to receive cash or other financial asset
 an equity instrument of another entity
 or contractual right to exchange financial instruments under potentially
favorable condition

Examples:
 cash and cash equivalents
 receivables
 investments in debt and equity securities
 derivative assets
Chapter Summary
 The Petty Cash Fund of a government entity is:

- maintained using the imprest system

- sufficient to defray recurring petty expenses for 1 month
- used for disbursements not exceeding ₽15,000 per transaction
- replenished as soon as disbursements reach at least 75% or as needed
Chapter Summary
 A government entity prepares monthly bank reconciliations
using the adjusted balance method

 Only debt instruments acquired 3 months or less before their

scheduled maturity date can qualify as cash equivalents

 Receivables are initially measured at fair value plus transaction

costs and subsequently measured at amortized cost.
Chapter Summary
 For subsequent measurement purposes, a government entity
classifies its financial assets into the following categories:

 Financial asset at fair value through surplus or deficit

 Held-to-maturity investments
 Loans and receivables
 Available-for-sale financial assets
End of Chapter 6.