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SAMCIS CMPC 131 MODULE v1

The document outlines a module in accounting for special transactions, focusing on partnership accounting, joint arrangements, and revenue recognition principles. It includes course learning outcomes, a cover letter to students, and detailed instructions on managing course activities and discussions. The module emphasizes ethical considerations, practical applications, and specialized accounting problems relevant to partnerships and other special topics.

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0% found this document useful (0 votes)

189 views92 pages

SAMCIS CMPC 131 MODULE v1

Uploaded by

Lea Jane Zorca

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MODULE IN

ACCOUNTING FOR SPECIAL

TRANSACTIONS
CMPC
131

Department of Accountancy
SCHOOL OF ACCOUNTANCY, MANAGEMENT,
COMPUTING, AND INFORMATION STUDIES

COURSE LEARNING
OUTCOMES

At the end of the module, the would-

be Accountants are expected to:
Understand the concepts and apply
knowledge regarding partnership
dissolution and liquidation.
Understand the nature, forms and
structure of a Joint Arrangement and
prepare journal entries and reports
(PFRS 11).
Account for the different revenue
recognition principles pertaining to,
Long-term construction contracts and
franchise accounting, consignment
sales (PFRS 15).
Comprehend nature and
ACCOUNTING FOR
characteristic and apply knowledge
SPECIAL
on the accounting of Instalment
sales.
TRANSACTIONS
Understand and have basic
knowledge in special topics of
accounting for insurance contracts by
insurers (PFRS 4/PFRS 17) and other
special issues such as build-operate-
transfer (BOT) (PFRIC 12).
Develop the value of honesty,
objectivity, and perseverance in the
preparation of financial statements
and reports as individuals imbibed
with the Christian spirit and to be
socially involved in the crusade for
social awareness.

Dear Students,

Greetings!

This course will guide you through the what, why and how of intermediate accounting in
today’s business world. At the beginning of each topic, you are shown what, why, how
framework through a presentation of concepts and procedures blended with examples and
solved exercises that can ensure your success.

The What provides you with a concise explanation of accounting principles without
sacrificing topical coverage or quantity of examples.

Understanding Why a financial concept is important, why it is necessary and why it is done
the way it is allows you to be fully engaged with the topic. Instead of memorizing
equations, you will be challenged to think conceptually and consider how accounting
relates to the business world. The need for you to be able to analyze business situations
and make informed, ethical decisions is essential in today’s world. Ethical considerations
are woven throughout the course.

After you have learned the conceptual meaning behind a topic and have seen how it
relates to the real world, you need to be able to complete calculations and apply what you
have learned in a practical sense. The actual repetition and practice of accounting close the
gap, solidifying your knowledge of accounting principles.

My role as facilitator is to serve as a guide on the side, to establish routines, and to manage
the pacing of course. Your knowledge and skills in all the different topics are needed. To
keep ourselves on track, actively engaged and guided, kindly read and be mindful of the
following reminders:

1. Schedule and manage your time to read and understand every part of the module.
Read it over and over until you understand the point. Please note that due to the
problems on erratic internet connections and to be able to cooperate with the
government in observing the GCQ protocols, this online course will be delivered
asynchronously.
2. Study how you can manage to do the activities of this course in consideration of
your other modules from other courses. Be very conscious with the study schedule.
Post it on a conspicuous place so that you can always see. Do not ask your course
facilitator about questions that are already answered in the guide.
3. Log in to the course site at least thrice a week (if you can log in daily, do so) and as
scheduled to keep abreast of important announcements, discussions, and other class
activities. Check the STREAM page every time you log in for possible
announcements.
4. Do not procrastinate. Remember, it is not others who will be short-changed if you
will not do your work on time.
5. Before you start doing your tasks, read and understand the assessment tools
provided. Do not settle with exceptionally low standards, target the highest
standards in doing your assigned tasks. I know you can.
6. You are free to browse and read the different materials even prior to doing the tasks

a. Your post should be composed of complete and grammatically correct sentences.

Do not use abbreviations and acronyms unless these are introduced in the
readings, and do not write in text-speak. Avoid writing in all caps.
b. post appropriate and well-thought rejoinders. Avoid merely approving or
disapproving with your classmates and course facilitators. You need to support
your inputs in the discussions from reliable information and resources. Do not
post uninformed opinions.
c. Read and analyze the contributions made by your classmates in the discussion
forums. Respond appropriately and courteously. Always use proper language.
d. Be polite and respectful in arguing a point and in defending your opinions. Do not
be rude and do not make remarks that may be construed as a personal attack.
Refer to ideas/statements, not the person. Remember that the objective of
academic discussion is to develop your critical and analytical thinking skills apart
from contributing to the wealth of knowledge.
e. Do not post lengthy contributions. Stick to the point. Be clear what your main
point is and express it as concisely as possible. Do not let the discussion stray.
f. Quote your sources in the online discussion by mentioning the last name of the
author and the year. No need to use a particular style.
g. Protect your privacy. Ponder before you post. If you wish to share something
private, do it by email or private chat.

9. Do not plagiarize and do not patch write. Patchwriting is still a form or plagiarism. It
refers to the act of making small changes and substitutions to copied source
material (Merriam-Webster, 2020).
10. Follow the schedule of course activities. Always remind yourself of deadlines. Read in
advance. Try to anticipate possible conflicts between your personal schedule and the
course schedule and make the appropriate adjustments. Try your best to inform
through any means your course facilitator for any unavoidable delays or "absences"
or "silences" of more than a week's duration or other concerns.
11. Note that our Google Classroom is a virtual learning environment, not a social
networking site. Use recent and appropriate ID photo on your profile page for proper
identification.
12. Lastly, you are the learner; hence, you do the module on your own. Your family
members and friends at home will support you but the activities must be done by
you. As a Louisian, we always need to demonstrate our core values of competence,
creativity, social involvement and Christian spirit.

Sincerely,

CONRADO B. CHAN JR., CPA, MBA

Course Facilitator
cbchan@slu.edu.ph

This course includes specialized problems in partnership accounting; accounting for

joint arrangement(Philippine Financial Reporting Standards 11); PFRSS 15, Revenue
Contract with Customers which includes accounting for long-term construction
contracts, franchise and consignment sales; accounting for fire insurance accounting
(PFRS 4/PFRS 17); and other special issues such as build-operate-transfer (BOT) (PFRIC
12). This course also included accounting for instalment sales.

MODULE 1: PARTNERSHIP ACCOUNTING

Topic Learning Outcome:
 Understand and apply knowledge of the concepts relating partnership formation,
operation, dissolution, and liquidation.

Unit 1: Partnership Formation

Learning Objectives:
 Differentiate between the accounting for partnerships , sole proprietorships, and
corporations.
 State the valuation of contributions of partners.
 Account for the initial investments of the partners to the partnerships.
 State the peculiar accounts used in a partnership and identify the transactions
that affect these accounts.

When two or more individuals engage in an enterprise as co-

owners, the organization is known as a partnership. This form
of organization is popular among personal service enterprises,
as well as in the legal and public accounting professions.
Partnerships are also particularly common in the service
professions, especially law and medicine. These professions
have generally not adopted the corporate form of business
because of their long-standing tradition of close professional
association with clients and the total commitment of the
ENGAGE professional’s association with clients and the total commitment
of the professional’s business and personal assets to the
property of the advice and service given to clients.

Partnerships are popular forms of businesses because they are easy to form and
because they allow several individuals to combine their talents and skills in a particular
business venture. In addition, partnerships provide a means of obtaining more capital
than a single individual can obtain and allow the sharing of risks for rapidly growing
businesses.

A summary of the topic is presented via power point presentation to

explain further the information from the materials in the context
that you would understand. Additional assignments and lecture
notes via Google classroom may also be given.

Note: A copy of the power point presented in the google classroom.

EXPLORE

Articles of partnership is a contract that forms an agreement

among business partners to pool labor and capital and share in
profit, loss, and liability. Such a document acts as a rule book for
limited partnerships by outlining all the conditions under which
parties enter into a partnership.

To be able to fully understand the role of Articles of Partnership,

explain the importance of a written
EXPLAIN partnership agreement? Also, identify the
important provisions that should be incorporated in the
Articles of Partnership? Provide an answer to this question by writing your answer
in
the box provided:

Requirement: Using the bonus method, provide the journal entry to

record the initial investments of the partners.
EVALUAT
Activity 2 – Cash settlement between partners
A, B and C formed a partnership. Their contributions are as follows:

A B C
Cash 80,0 20,00 200,00
00 0 0
Equipmen 160,0
t 00
Totals 80,0 180,0 200,00
00 00 0

Additional information:

 Although C has contributed the most cash to the partnership, he did not have the
full amount of P200,000 available and was forced to borrow P80,000.
 The equipment contributed by B has an unpaid mortgage of P40,000, the
repayment of which, is assumed by the partnership.
 The partners agreed to equalize their interest. Cash settlements among the partners
are to be made outside the partnership.

Requirements:
a. Which partner(s) shall receive cash payment from the other partner(s)?
b. Provide the entry to record the contributions of the partners.

Activity 3 – Capital credits equal to an agreed stipulation

A and B agreed to form a partnership. The partnership agreement stipulates the
following:
 Initial capital of P280,000.
 A 60:40 interest in the equity of the partnership.

A contributed P200,000 cash while B contributed P80,000 cash.

Requirement: Which partner should provide additional investment (or withdraw part of
his investment) in order to bring the partners’ capital credits equal to their respective
interests in the equity of the partnership?

Unit 2: Partnership Operation

Operation of the partnership usually entails problems involving

the computation of correct net income after adjustment for
unrecorded items. It also involves questions about the
distribution of profit and losses among the partners after
consideration of factors such as salaries, interest, and bonuses
to partners.

Net income is computed in the usual manner, that is matching

revenues and expenses, then credited to the individual capital
accounts. However, the treatment
becomes more complex because of the differences in
capital contributions, ENGAGE in abilities and talents of individual
partners, and in time spent on partnership duties by the
individual partners.

Since a partnership is composed of two or more persons, there should be a clear

indication on how the partnership profit or loss be equitably divided among the
partners. The method of division to be used in any given situation is generally the
method specified in the partnership agreement. This agreement should be consulted
first since it is legally binding on the partners.

Two partners in a new firm failed to make an agreement about

how their profits and losses would be divided. At the end of
the first year, one partner argued that the division should be
based on the balance of the capital accounts. The other
argued that there should be an equal division. Which partner
was correct? What advice would you give to the partners
about the importance of a definite agreement about the
division of profits and losses? Provide an
answer to this EXPLAIN question by writing your answer in the box
provided:

Note: A copy of the power point presented in the google classroom.

EXPLORE

Activity 4 – Computation of adjusted profit

Abe, Bert, and Carl are partners sharing profit on a 7:2:1 ratio. On
January 1, 2005, Dave was admitted into the partnership with
15% share in profits. The old partners continue to participate in
profits in their original ratios.

For the year 2005, the partnership showed a

profit of P15,000. However, it was discovered
that the following items were omitted in the firm’s book:
EVALUAT
2004 2005
Accrued expense P 1,050
Accrued income 875
Prepaid expenses P 1,400
Unearned income P 1,225

The share of partner Bert in the 2005 net profit is?

Activity 5 – Distribution of partnership loss

FF, GG and HH form a partnership and agree to maintain average investments of
P2,500,000, P1,250,000, and P1,250,000, respectively. Interest on the excess or
deficiency in a capital contribution is to be computed at 6% per annum. After the
interest allowances, FF,GG, and HH are to share any balance in the ratio of 5:3:2.
Average amounts invested during the first six months were as follows: FF, P3,000,000.
GG, P1,375,000; and HH, P1,000,000. A loss from operations of P62,500 was incurred
for the first six months. How is this loss distributed among the partners?

Activity 6 – Computation of partnership net income

A, a partner in the ABC Partnership, has a 30% participation in partnership profits and
losses. A’s capital account has a net decrease of P 60,000 during the calendar year
20x1. During 20x1, A withdrew P130,000 (charged against his capital account) and
contributed property valued at P 25,000 to the partnership. What was the net income
of the ABC Partnership for 20x1?

Activity 7 – Computation of capital balances of partners

The salary was to be withdrawn by each partner in monthly installments. The

partnership’s net profit for 2005 is P120,000.

What are the capital balances of the partners on December 31, 20x1?

Unit 3: Partnership Dissolution

Learning Objectives:
 State the causes of partnership dissolution.
 Account for the effects of partnership dissolution on the partnership equity.

Partnerships rest on contractual foundations, creating an

uncertainty in terms of lifespan, which depends on the
relationships of the partners. Circumstances causing the
technical termination of a partnership may lead to the
partnership’s permanent dissolution and liquidation if the
partners so agree. Partnership dissolution and partnership
liquidation are not the same with each other. Art. 1825 of the
Civil Code of the Philippines defines dissolution as the change in
the relationship of the partners caused by any partner ceasing
ENGAGE to be associated in the carrying out of the business.
Liquidation on the other hand refers to the termination of the
activities carried on by the partnership and the winding up of partnership affairs
preparatory to going out of business. Situations like: admission of a new partner,
retirement of a partner, death of a partner and incorporation of a partnership will result
to partnership dissolution by change in ownership structure.
When changes in the ownership of a partnership occurs, the market values of individual
partnership assets and liabilities most of the time are different from their book values.
These differences can be accounted for by recording them on the partnership books
either by adjusting the assets and liabilities or by adjusting the partners’ capital
accounts.

The following are major considerations in the accounting for partnership dissolutions:

Property of and for the exclusive use of SLU. Reproduction, storing in a retrieval system, distributing, uploading or posting online, or transmitting in any form or by any
means, electronic, mechanical, photocopying, recording, or otherwise of any part of this document, without the prior written permission of SLU, is strictly prohibited. 10
1. ADMISSION OF A NEW PARTNER
An existing partnership may admit a new partner as a primary source of additional
capital or needed business expertise but with the consent of all the partners. When
a new partner is admitted, the partnership is automatically dissolved, and a new
partnership is formed, and an Articles of Co-Partnership is drawn by all the partners.
The admission of a new partner may occur in either of two ways, namely:
a. Purchase of all or part of the interest of one or more of the existing partners.
b. Investment of assets in the partnership by the incoming partner.
2. RETIREMENT/WITHDRAWAL OF A PARTNER
When a partner retires or withdraws from the partnership, the partnership is legally
dissolved, but the remaining partners may continue operating the business. The
retiring/withdrawing partner may receive a settlement equal to his interest, more
than his interest, or less than his interest. The interest of the retiring or withdrawing
partner is usually measured by his capital balance before his retirement or
withdrawal, adjusted by the following:
a. Profit or loss from operations from the last closing date to the date of his
retirement or withdrawal;
b. Changes in the valuation (fair market value versus book value) of all assets
and liabilities; and
c. Errors in the net income in prior years which should be corrected before
determining the interest of the retiring or withdrawing partner.
3. DEATH OF A PARTNER
In the event of the death of a partner, the estate of the deceased partner is entitled
to receive the amount of his interest in the partnership at the date of his death. The
deceased partner’s capital is adjusted using his profit and loss share percentage for
changes in asset values arising from revaluation of assets, and for the profit from
the date the books were last closed. The balance of his capital account after
considering the necessary adjustments should be transferred to a liability account
pending settlement.
4. INCORPORATION OF A PARTNERSHIP
When a partnership is converted into a corporation, the corporation takes over the
assets and assumes the liabilities of the partnership in exchange for shares of
stocks. The shares received by the partnership are distributed to the partners in
settlement of their interest. The partners now become shareholders of the newly
formed corporation.

A summary of the topic is presented via power point presentations

to explain further the information from the materials in the
context that you would understand. Additional assignments and
lecture notes via Google classroom may also be given.

Note: A copy of the power point presented in the google

classroom.

EXPLORE

Provide an answer to this question by writing your answer in the box provided:

Activity 8 – Admission of a partner by investment

The following is the condensed balance sheet of the partnership
Jo, Li and Bi who share profits and losses in the ratio of 4:3:3.

Cash P 180,000 Accounts, payable P 420,000

Other assets 1,660,000 Bi, Loan 60,000
Jo, receivable 40,000 Jo, Capital 620,000
Li, Capital
400,000
EVALUAT __ Bi, Capital
380,000
Total P 1,880,000 Total P 1,880,000

Assume that the assets and liabilities are fairly valued on the balance Sheet and the
partnership decides to admit Mac as a new partner, with a 20% interest. No goodwill or
bonus is to be recorded. How much Mac should contribute in cash or other assets?

Activity 9 – Admission of a partner by investment using bonus method

Fernando and Jose are partners with capital balances of P30,000 and P70,000,
respectively. Fernando has a 30% interest in profits and losses. All assets of the
partnership are at fair market value except equipment with book value of P300,000 and
fair market value of P320,000.

At this time, the partnership has decided to admit Rosa and Linda as new partners.
Rosa contributes cash of P55,000 for a 20% interest in capital and a 30% interest in
profits and losses. Linda contributes cash of P10,000 and an equipment with a fair
market value of P50,000 for a 25% interest in capital and a 35% interest in profits and

Activity 10 – Admission of a partner by purchase

The capital accounts of the partnership of Nakpil, Ortiz, and Perez on June 1, 2005 are
presented below with their respective profit and loss ratios:

Nakpil P 139,200 1/2

Ortiz 208,800 1/3
Perez 96,000 1/6
P 444,000

On June 1, 2005, Quizon is admitted to the partnership when he purchased, for P

132,000, a proportionate interest from Nakpil and Ortiz in the net assets and profits of
the partnership. As a result of a transaction, Quizon acquired a one-fifth interest in the
net assets and profits of the firm. Assuming that implied goodwill is not to be recorded,
what is the combined gain realized by Nakpil and Ortiz upon the sale of a portion of
their interest in the partnership to Quizon?

Activity 11 – Withdrawal/Retirement of a partner

On June 30, 1998, the balance sheet for the partnership of Coll, Maduro, and Prieto,
together with their respective profit and loss ratios, was as follows:

Assets, at cost P 180,000

Coll, loan P 9,000

Coll, capital (20%) 42,000
Maduro, capital (20%) 39,000
Prieto, capital (60%) 90,000
Total P 180,000

Coll decided to retire from the partnership. By mutual agreement, the assets are to be
adjusted to their fair value of P 216,000 at June 30, 1998. It was agreed that the
partnership would pay Coll P 61,200 cash for Coll’s partnership interest, including Coll’s
loan which is to be repaid in full. No goodwill is to be recorded. After Coll’s retirement,
what is the balance of Maduro’s capital account?

Unit 4: Partnership Liquidation

Learning Objectives:
 State the order of priority in the settlement of claims in cases of liquidation.
 Account for the liquidation of a partnership

Dissolution is a legal term indicating a change in the legal

relationship between or among partners. Termination is the end
of the normal business function of the partnership. Liquidation
is on the other hand, is winding-up of business affairs. In
liquidation, the association of the partners for purposes of

Liquidation of a partnership means winding-up the business

usually by selling the assets, paying the liabilities, and
ENGAGE distributing the remaining cash to the partners. A business
which is in the process of converting its assets into cash and
making settlement with creditors is said to be in liquidation. A term which is always
used by a business that is in the process of liquidation is realization, which means the
sale of assets.

In this chapter, emphasis will be placed on the accounting problems and procedures
involved in the winding up (liquidation) of the partnership affairs – from the dissolution
to the effective termination of partnership operations. When the business is to be
liquidated, the accounts must be adjusted and closed, and the resulting income or loss
in the final period is transferred to the capital accounts of the partners. This chapter
presents the concept that accountants must know if they offer professional services to
partnerships undergoing liquidation.

Methods of Partnership Liquidation:

When a partnership is to be liquidated by the sale of assets, the following methods may
be used:
1. Lump-Sum Liquidation otherwise called Total Liquidation or Single Distribution.
 A lump-sum liquidation of a partnership is one in which all the assets are
converted into cash within a noticeably short time, outside creditors are
paid, and a single, lump-sum payment is made to the partners for their
total interests.

2. Installment Liquidation, otherwise called Installment Distribution.

 Under the installment liquidation, non-cash assets are sold on a piece-
meal basis over an extended period of time. Cash realized is immediately
distributed to partners after fully satisfying creditor’s claims after setting
aside sufficient cash for these liabilities. When this happens, the partners
may prefer to receive the amounts due to them in a series of installments
rather than wait until all assets have been converted to cash.
There are certain rules that should be followed in the liquidation of the partnership,
namely:
1. Always allocate and close gains or losses to the partners’ capital accounts prior
to distributing any cash to the partners.
2. When the business is liquidated, the partner is entitled to an amount depending
upon his capital contribution, his drawing, his share in the net income or loss
from operations before liquidation, gains and losses on realization, and the
balance of his loan account, if any.

Each partner will receive in the final settlement the amount of his equity in the
business. The amount of a partner’s equity is increased by the positive factors such as
investment of capital and share in the profits. It is decreased by the negative factors

The priorities for creditors’ claim against the asset available to pay partnership
liabilities involve two concepts: the marshaling of assets and the right of offset. At
the point of liquidation, the assets and liabilities of the partnership are directly
intertwined with those of the individual partners’ personal assets and liabilities because
of the unlimited liability of each partner. Marshaling of assets involves the order of
creditors’ right against the partnership assets and personal assets of the individual
partners. The order in which claims against partnership assets will be marshaled is as
follows:

1. First, partnership creditors other than partners.

2. Second, partners’ claim other than capital and profits, such as loans payable and
accrued interest payable.
3. Third, partners’ claim to capital and profit, to the extent of credit balance in
capital account.

The order of claims against the personal assets of the individual partners is as follows:

1. Personal creditors of individual partners

2. Partnership creditors for unpaid partnership liabilities, regardless of a partner’s
capital balance in the partnership.

The rule indicating priority of partner’s loan over partner’s capital is supported by an
established legal doctrine called the right to offset. When a partner’s capital account
shows a debit balance (or even a potential debit balance depending on possible losses)
and said partner has a loan account, the law permits the exercise of the right of offset
by part or his entire loan against the capital deficiency. Although loans from partners
have a higher legal priority than amounts owed as capital and profits, the doctrine of
the right of offset sets aside this ranking in favor of procedural and economic
considerations that facilitate the actual liquidation process. As a result of the exercise
of the right of offset, payment to some partners can be made on their capital balances
even if there are loans payable to the other partners.

A debit balance in the partner’s capital account may be caused by losses incurred in
the realization of assets or by pro-rata absorption of an uncollectible deficit of a partner
whose combined capital and loan accounts is not enough to absorb the partner’s share
of total losses.

A summary of the topic is presented via power point presentations

to explain further the information from the materials in the context
that you would understand. Additional assignments and lecture
notes via Google classroom may also be given.

EXPLORE
Property of and for the exclusive use of SLU. Reproduction, storing in a retrieval system, distributing, uploading or posting online, or transmitting in any form or by any
means, electronic, mechanical, photocopying, recording, or otherwise of any part of this document, without the prior written permission of SLU, is strictly prohibited. 15
Note: A copy of the power point presented in the google classroom.

Assume that a partner had a loan account and a capital

account, and that the sum of the balances of both accounts
was less than his possible losses on future realization.
The other partner had only a capital account, but its balance
exceeded his possible loss. Would it be permissible to waive
the rule requiring payments of loans before capital and to
make a payment on the second partner's capital account
before making any payments on the first partner's loan
account? Provide an answer to this question by writing your
EXPLAIN answer in the box provided:

Activity 12 – Lump-sum Liquidation (Constructive Problem)

A, B, C, and D, are partners, sharing earnings in the ratio of 3/21,
4/21, 6/21 and 8/21, respectively. The balances of their capital
accounts on December 31, 2004 are as follows:

A………………………………………………………………………. P 1,000

EVALUAT
B……………………………………………………………………….. 25, 000
C………………………………………………………………………. 25, 000
D………………………………………………………………………. 9, 000
Total P 60,000

The partners decide to liquidate, and they accordingly convert the non-cash assets into
P23,200 of cash. After paying the liabilities amounting to P3,000, they have P22,000 to
divide. Assume that a debit balance of any partner’s capital is uncollectible.

Activity 13 – Installment Liquidation

The partnership of Jenson, Smith, and Hart share profits and losses in the ratio of 5:3:2,
respectively. The partners voted to dissolve the partnership when its assets, liabilities,
and capital were as follows:
Assets
Cash P 40,000
Other assets 210,000
P250,000

Liabilities and Capital

Liabilities P 60,000
Jenson, Capital 48,000
Smith, Capital 72,000
Hart, Capital 70,000
P250,000

The partnership will be liquidated over a prolonged period of time. As cash is available
it will be distributed to the partners. The first sale of noncash assets having a book
value of P120,000 realized P90,000. How much cash should be distributed to each
partner after this sale?

Activity 14 – Installment Liquidation (Preparation of Safe Payments)

On January 1, 20X2, the partners of Allen, Brown, and Cox, who share profits and losses
in the ratio of 5:3:2, respectively, decide to liquidate their partnership. The partnership
trial balance at this date is as follows:
Debit Credit
Cash P 18,000
Accounts receivable 66,000
Inventory 52,000
Machinery and equipment, net 189,000
Allen, loan 30,000
Accounts payable P 53,000
Brown, loan 20,000
Allen, capital 118,000
Brown, capital 90,000
Cox, capital ________ 74,000
P355,000 P355,000

The partners plan a program of piecemeal conversion of assets in order to minimize

liquidation losses. All available cash, less an amount retained to provide for future
expenses, is to be distributed to the partners at the end of each month. A summary of
the liquidation transactions is as follows:

January 20X2:
a. P51,000 was collected on accounts receivable; the balance is uncollectible.
b. P38,000 was received for the entire inventory.
c. P2,000 liquidation expenses were paid.

All partners are insolvent.

Required:
Compute for the safe installment to the partners as of January 31, 20x2. Show
supporting computations in good form.

MODULE 2: JOINT ARRANGEMENTS

Topic Learning Outcome:
 Understand the nature, forms and structure of a Joint Arrangement and prepare
journal entries and reports (PFRS 11).

Learning Objectives:
 Define a joint arrangement and state its characteristics.
 Differentiate between a joint operation and a joint venture.
 Account for joint operations.
 Describe the accounting requirements for joint ventures.

The core principle of PFRS 11 is that a party to a joint

arrangement determines the type of joint arrangement in which
it is involved by assessing its rights and obligations and
accounts for those rights and obligations in accordance with that
type of joint arrangement.

Joint arrangements
A joint arrangement is an arrangement of which two or more
parties have joint control. A joint arrangement has the following
characteristics:
ENGAGE
 the parties are bound by a contractual arrangement, and;
 the contractual arrangement gives two or more of those parties joint control of
the arrangement.

Contractual Arrangement
The contractual arrangement sets out the terms upon which the parties participate in
the arrangement. It generally addresses matters such as:

a. the objective and duration of the joint arrangement;

b. the specific activities undertaken by the joint arrangement;

Joint control
Joint control is the contractually agreed sharing of control of an arrangement, which
exists only when decisions about the relevant activities require the unanimous consent
of the parties sharing control. Before assessing whether an entity has joint control over
an arrangement, an entity first assesses whether the parties, or a group of the parties,
control the arrangement. After concluding that all the parties, or a group of the parties,
controls the arrangement collectively, an entity shall assess whether it has joint control
of the arrangement.

Joint control exists only when decisions about the relevant activities require the
unanimous consent of the parties that collectively control the arrangement. The
requirement for unanimous consent means that any party with joint control of the
arrangement can prevent any of the other parties, or a group of the parties, from
making unilateral decisions (about the relevant activities) without its consent.

Relevant Activities – are activities that significantly affect the returns of an

arrangement. Judgment is required when assessing what constitutes relevant activities.
It may include:

a. selling and purchasing of goods or services;

b. managing financial assets during their life (including upon default);
c. selecting, acquiring, or disposing of assets;
d. researching and developing new products or processes; and
e. determining a funding structure or obtaining funding.

A joint arrangement is either a joint operation or a joint venture.

1. JOINT OPERATION - is a joint arrangement whereby the parties that have joint
control of the arrangement have rights to the assets, and obligations for the
liabilities, relating to the arrangement. Those parties are called joint operators.
For example, the contractual arrangement gives the parties an interest in
individual assets and obligations for liabilities of the arrangement.

2. JOINT VENTURE - is a joint arrangement whereby the parties that have joint
control of the arrangement have rights to the net assets of the arrangement.
Those parties are called joint venturers. For example, the contractual
arrangement only gives the parties rights to a share of the net outcome
generated by an economic activity.

ACCOUNTING FOR JOINT OPERATIONS

Joint operators have rights to the assets, but must also bear obligations for the
liabilities, relating to the arrangement. Therefore, a joint operator has to recognize (in
relation to a joint operation):

Because of the risks involved and the relatively short period of duration of the joint
operation, conservatism dictates that no income is recognized until the joint operation
is completed. The computation and distribution of income to the joint operators are
made only upon the completion of the venture and not at regular or periodic intervals
except under specific circumstances.

No separate records are maintained

In this case, each joint operator will record transactions on behalf of the joint operation
in his own records, alongside with other business dealings. Under this approach, each
joint operator records all joint operation transactions in their own books using the “Joint
Operation” account, which is like the “income summary” account, hence, each joint
operator must inform on time the other joint operator of the joint operation
transactions made by him. In addition, personal accounts are used. A personal account
is a “receivable from”, or a “payable to”, a joint operator.

An account “Joint Operation” is maintained to take the place of all nominal accounts.
This account is debited for all costs and expenses and credited for all revenues
necessary in the computation of the joint operation profit or loss. The following
transactions that affect the account can be summarized as follows:

JOINT OPERATION
Merchandise contribution Merchandise withdrawal
Purchases Purchase returns & allowances
Freight-in Purchase discounts
Sales returns & allowances Sales
Sales discounts Other income
Expenses Unsold merchandise if any

If the joint operation is completed, the balance of the Joint Operation account
represents the profit or loss. Credit balance represents profit and a debit balance
represents loss.

If the joint operation is uncompleted, meaning there are still unsold merchandise, profit
or loss is a balancing figure between the balances of the Joint Operation account before
profit distribution and the cost of unsold merchandise.

Separate records are maintained

When separate records are maintained, the joint operation transactions are recorded in
those separate books in the regular manner, similar to an ordinary business. The joint
operators record only their own transactions in their respective books. Accordingly,
personal accounts and Joint Operation - Cash or similar accounts are not used.

ACCOUNTING FOR JOINT VENTURES

In contrast to joint operation, in a joint venture, a party has an interest in the net
assets and that party’s loss is limited to its investment. When a party in a joint venture
has an interest in net assets and any losses exceed the investment, the losses are not
recognized. Instead, such losses are recognized only to the extent that the party has a
legal or constructive obligation to make payments on behalf of the joint venture.

The investment in the joint venture will be shown as a separate line item on the
balance sheet. It is initially recognized at cost and subsequently adjusted by the share
of profit or loss and other comprehensive income of the joint venture. Any dividends
received are deducted from the carrying amount of the investment.

An overview of PAS/IAS 28 – Investment in Associate and Joint Venture

Objective of IAS 28
The objective of IAS 28 (as amended in 2011) is to prescribe the accounting for
investments in associates and to set out the requirements for the application of the
equity method when accounting for investments in associates and joint ventures.

Scope of IAS 28
IAS 28 applies to all entities that are investors with joint control of, or significant
influence over, an investee (associate or joint venture).

Significant influence
Where an entity holds 20% or more of the voting power (directly or through
subsidiaries) on an investee, it will be presumed the investor has significant influence
unless it can be clearly demonstrated that this is not the case. If the holding is less
than 20%, the entity will be presumed not to have significant influence unless such
influence can be clearly demonstrated. A substantial or majority ownership by another
investor does not necessarily preclude an entity from having significant influence.

The existence of significant influence by an entity is usually evidenced in one or more

of the following ways:

 representation on the board of directors or equivalent governing body of the

investee;
 participation in the policy-making process, including participation in decisions
about dividends or other distributions;
 material transactions between the entity and the investee;
 interchange of managerial personnel; or
 provision of essential technical information

The existence and effect of potential voting rights that are currently exercisable or
convertible, including potential voting rights held by other entities, are considered
when assessing whether an entity has significant influence. In assessing whether

An entity loses significant influence over an investee when it loses the power to
participate in the financial and operating policy decisions of that investee. The loss of
significant influence can occur with or without a change in absolute or relative
ownership levels.

The equity method of accounting

Basic principle. Under the equity method, on initial recognition the investment in an
associate or a joint venture is recognized at cost, and the carrying amount is increased
or decreased to recognize the investor's share of the profit or loss of the investee after
the date of acquisition.

Distributions and other adjustments to carrying amount. The investor's share of the
investee's profit or loss is recognized in the investor's profit or loss. Distributions
received from an investee reduce the carrying amount of the investment. Adjustments
to the carrying amount may also be necessary for changes in the investor's
proportionate interest in the investee arising from changes in the investee's other
comprehensive income (e.g. to account for changes arising from revaluations of
property, plant and equipment and foreign currency translations.)

Potential voting rights. An entity's interest in an associate or a joint venture is

determined solely on the basis of existing ownership interests and, generally, does not
reflect the possible exercise or conversion of potential voting rights and other
derivative instruments.

Interaction with IFRS 9. IFRS 9 Financial Instruments does not apply to interests in
associates and joint ventures that are accounted for using the equity method. An entity
applies IFRS 9, including its impairment requirements, to long-term interests in an
associate or joint venture that form part of the net investment in the associate or joint
venture but to which the equity method is not applied. Instruments containing potential
voting rights in an associate or a joint venture are accounted for in accordance with
IFRS 9, unless they currently give access to the returns associated with an ownership
interest in an associate or a joint venture.

Classification as non-current asset. An investment in an associate or a joint venture is

generally classified as non-current asset, unless it is classified as held for sale in
accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations.

Application of the equity method of accounting

Basic principle. In its consolidated financial statements, an investor uses the equity
method of accounting for investments in associates and joint ventures. Many of the
procedures that are appropriate for the application of the equity method are similar to
the consolidation procedures described in IFRS 10. Furthermore, the concepts
underlying the procedures used in accounting for the acquisition of a subsidiary are
also adopted in accounting for the acquisition of an investment in an associate or a
joint venture.

Note: A copy of the power point presented in the google classroom.

Activity 1 – Accounting for Joint Operations

Alpha, B, and C formed a joint operation. The following were the

transactions:

a. A transferred EVALUAT inventory, costing $400, to C, the appointed

manager. A paid freight of $20 on the transfer.
b. B transferred $400 cash to C.
c. C purchased inventory worth $500. Of that amount, $400 were paid using the
joint operation’s cash and $100 were on account of C.
d. C made cash sales of $1,600.
e. C paid operating expenses of $110 using his personal cash.
f. The joint operation was completed and the unsold inventory worth $60 was
charged to C. The profit was divided equally

Requirements: Provide the (a) journal entries, (b) compute for the profit or loss, and (c)
determine the cash settlements under each of the following assumptions:
1. No separate books are maintained for the joint operation; and
2. Separate books are maintained for the joint operation.

Activity 2 – Accounting for Joint Venture

Entity X obtains control over a joint arrangement for an investment of $220,000. The
investment gives Entity X 40% interest on the net assets of the arrangement. The joint
arrangement earns a profit of $800,000 and distributes earnings of $500,000 to the
owners.

Requirement: Compute for the carrying amount of the investment at year-end.

Activity 3 – Accounting for Joint Venture

On January 1, 2020, two real estate companies (the parties – Packet Company and
Sacket Company) set up a separate vehicle (Harrison Company) for the purpose of
acquiring and operating a shopping center. The contractual arrangement between the
parties establishes joint control of the activities that are conducted in Harrison

As a result, Packet Company paid $1,600,000 for 50,000 shares of Harrison’s voting
common stock, which represents a 40% investment. No allocation to goodwill or other
specific account was made. The joint control over Harrison is achieved by this
acquisition and so Packet applies equity method. Harrison distributed a dividend of $2
per share during the year and reported net income of $560,000. What is the balance in
the Investment in Harrison account found in Packet’s financial records as of December
31, 2020?

Activity 4 – Accounting for Joint Venture

Ace Company purchases 40% of Basket Company on January 1 for $500,000 that carry
voting rights at a general meeting of shareholders of Basket Company. Ace Company
and Blake Company immediately agreed to share control (wherein unanimous consent
is needed to all the parties involved) over Basket Company. Basket reports assets on
that date of $1,400,000 with liabilities of $500,000. One building with a seven-year life
is undervalued on Basket’s books by $140,000. Also, Basket’s book value for its
trademark (10 year remaining life) is undervalued by $210,000. During the year,
Basket reports net income of $90,000, while paying dividends of $30,000. What is the
Investment in Basket Company balance in Ace’s financial records as of December 31?

Activity 5 – Accounting for Joint Venture

On January 1, 2020, Wilkins, Inc. acquired 20% of the outstanding common stock of
Bremm, Inc. for $700,000. This investment gave Wilkins the joint control over Bremm.
Bremm’s assets on that date were recorded at $3,900,000 with liabilities of $900,000.
Any excess of cost over book value of the investment was attributed to patent having a
remaining useful life of 10 years.

In 2020, Bremm reported net income of $170,000. In 2021, Bremm reported net
income of $210,000. Dividends of $70,000 were paid in each of these two years. What
is the equity method balance of Wilkin’s Investment in Bremm, Inc. at December 31,
2021?

MODULE 3: CORPORATE LIQUIDATION

Topic Learning Outcome:
 Comprehend nature and characteristic and apply knowledge on the
accounting of Instalment sales.

Learning Objectives:
 Describe the accounting for corporate liquidation and reorganization.
 Prepare statement of affairs.

Liquidity refers to a firm’s ability to meet its current or short-term obligations, while
solvency relates to the longer time span of obligation. These terms are interrelated. An
auditor who examines the financial statements of an enterprise with a history of losses
and financial difficulties and is in default of loan agreement covenants must, at some
point, assess the enterprise’s ability to continue as a going concern and survive
financially.

A debtor corporation is considered insolvent in the conventional (or equity) sense when
it is unable to pay off its liabilities as they become due. The debtor corporation is
insolvent in the legal sense when the financial condition is such that the sum of all its
debts is greater than all of its assets at fair valuation, as defined in Section 1045 of the
Insolvency Law. Thus, in the legal sense, a corporation remains solvent as long as the
fair value of its assets exceeds its liabilities, even if it cannot meet its current obligation
because of an insufficiency of liquid resources. A debtor corporation that is insolvent
has a large number of alternatives, such as liquidation, reorganization, or debt
restructuring.

Liquidation. When the financial position of the debtor corporation is such that it
cannot resolve its financial difficulties by any of the following quasi-reorganization,
troubled-debt restructuring, and dacion-en-pago accounting, the corporation will have
to resort to liquidation.

CORPORATE LIQUIDATION
This process may be initiated by the debtor filing a debtor’s voluntary petition or
creditor’s involuntary petition with the Securities and Exchange Commission (SEC).
The corporation is given three years from the date of approval within which to wind up
its affairs.

The Securities and Exchange Commission may appoint a receiver or a trustee following
the filing of a petition for liquidation or bankruptcy. The duties of the trustee are

Financial Reports
The focal point of accounting for a business in bankruptcy is that of a “quitting concern’
rather than a ‘going concern’, which is the usual assumption in accounting. A
corporation in liquidation prepares two classes of financial reports. The first class is the
initial report which shows the available asset values and liabilities of the debtor
corporation known as the Statement of Affairs. The second is the periodic report of the
trustee known as the Statement of Realization and Liquidation. This shows how the
trustee managed the assets of the debtor corporation on behalf of the creditors.

STATEMENT OF AFFAIRS
The Statement of Affairs which has been devised for the quitting concern can be
hypothetical or pro-forma in nature. It is an important planning report for the
anticipated liquidation of a company. This statement represents the best estimate on
the outcome of the liquidation of a debtor’s business. Normally, at the start of
liquidation, this statement is prepared for the corporation to provide information about
the current financial position of the company. Thus, assets shown in the statement of
affairs are valued at current fair values; carrying amounts are presented on a
memorandum basis and historical cost figures are not relevant. The various parties
concerned desire information that reflects (1) the net realizable value of the debtor’s
assets and (2) the ultimate application of these proceeds to specific liabilities.

The assets and liabilities are reported according to the classifications relevant to
liquidation. Consequently, assets are classified into three categories as follows:

1. Assets pledged to fully secured creditors. Certain assets may be pledged

as security for a particular liability and the estimated realizable value of the
assets equals or exceeds the amount of the liability. Such assets may also yield
resources to cover unsecured liabilities. The building with an estimated
realizable value of P3,000,000, which secures a P2,000,000 mortgage liability, is
an example of an asset pledged to a fully secured creditor. After the mortgage is
paid, P1,000,000 remains for unsecured creditors.

2. Assets pledged to partially secured creditors. Other assets are pledged as

security for a particular liability and the realizable value of the assets is less than
the amount of the liability. Partial payment of the liability will utilize the entire
asset value; nothing will be left for the unsecured liabilities. The equipment with
a realizable value of P30,000, which secures a P50,000 note payable, is an
example of an asset pledged to a partially secured creditor.

3. Free Assets. Assets are not pledged as security for any particular liability and
are available to meet the claims of priority liabilities and unsecured creditors.
Free assets also include the value of assets pledged to fully secured creditors in

The liabilities of the company are classified into four categories and listed in parallel
fashion as follows:

1. Unsecured Liabilities with Priority. When a creditor has no lien on specific

assets of the debtor corporation but its claims rank ahead of other unsecured
liabilities in the order of payment, the claims are considered unsecured liabilities
with priority. These liabilities, in order of priority are:
a. Administrative expenses of the trustee
b. Unpaid employees’ salaries and wages and benefit plans
c. Taxes

2. Fully Secured Creditors. For these liabilities, the creditor has a lien on
specific assets, whose estimated realizable value equal or exceeds the amount
of the liability. For example, a bank holds a P2,000,000 mortgage on a building
of a debtor corporation, and the building has an estimated realizable value of
P3,000,000. The mortgage is, therefore, fully secured, and the bank is referred
to as a fully secured creditor.

3. Partially Secured Creditors. All other liabilities for which the creditor has no
lien on any specific assets, but the estimated realizable value of those assets is
less than the amount of the liability. For example, a finance company holds a
P50,000 note secured by an equipment of a debtor corporation, but the
equipment has an estimated realizable value of only P30,000. This note is
partially secured, and the finance company is referred to as a partially secured
creditor.

4. Unsecured Creditors. All other liabilities for which the creditor has no lien on
any specific assets of the debtor corporation are unsecured. This includes the
unsecured portion of the liability to partially secured creditors. In the example
above, there is a note payable to the finance company for P50,000 secured by
the equipment worth P30,000; the difference of P20,000 is added to the
unsecured liabilities.

Illustration of Statement of Affairs

To illustrate the preparation of this statement, assume that Palugi Corporation has
experienced severe financial difficulties in recent times and is currently insolvent. The
corporation officials are trying to decide whether to seek liquidation, reorganization, or
debt restructuring. Consequently, they have asked their accountant to produce a
Statement of Affairs to assist them in formulating an appropriate strategy.

A current Statement of Financial Position for Palugi Corporation, prepared as if the

corporation were a going concern, is presented below:

ASSETS
Cash P
2,000
Marketable Securities 15,000
Accounts Receivable 23,000
Inventory 41,000
Prepaid Expenses 3,000 P
84,000
Property and Equipment (net)
Land P100,00
0
Building 110,000
Equipment 80,000 290,000
Intangible Assets 15,000
P389,00
Total Assets
0

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current Liabilities:
Notes Payable (secured by inventory) P
75,000
Accounts Payable 60,000
Accrued Expenses 18,000 P153,00
0
Long-term Liabilities:
Notes Payable (secured by lien on land and 200,000
building)
Ordinary Share P100,00
0
Accumulated Profits (Deficit) (64,000 36,000
)
P389,00
Total Liabilities and Shareholders’ Equity
0

Before the preparation of a Statement of Affairs, additional data must be ascertained

concerning the insolvent corporation and its assets and liabilities. Hence, the following
information has been accumulated about Palugi Corporation:

1. The marketable securities reported on the statement of financial position

have appreciated in value since being acquired and is now worth P20,000.
Dividends of P500 are currently due from this investment.
2. P12,000 of the company’s accounts receivable can still be collected.
3. The inventory held by the corporation can be sold for P43,000.
4. No refund will be received from the various prepaid expenses and the
corporation’s intangible assets have no resale value.

The following should be specifically noted in the Statement of Affairs:

a. The current and non-current classifications usually applied to assets and
liabilities are omitted. Since the company is on the verge of going out of
business, such classification is meaningless. Instead, the statement is designed
to separate the secured and unsecured balances.

b. Book values are presented on the left side of the schedule but only for
informational purposes. These figures are not relevant. All assets are reported
at net realizable value, whereas liabilities are shown at the amount required for
settlement.

c. The dividends receivable and interest payable are both included in the
statement, although neither has been recorded on the statement of financial
position. Currently, updated figures must be disclosed within the statement of
affairs.

d. Liabilities having priority are individually identified with the liability section (a)
because these claims will be paid before other unsecured creditors, the P35,500
total also is deducted directly from the free assets and (b) although not yet
incurred, estimated administrative expenses will be necessary or liquidation.

e. According to this statement, if liquidation occurs, Palugi Corporation expects to

have only P57,000 in free assets remaining after settling all liabilities with
priority (c). Unfortunately, the liability section shows unsecured claims with a
total of P95,000. These creditors, therefore, face a P38,000 loss (P95,000 –
P57,000) if the company is liquidated (d).

This final distribution is often converted into an expected recovery

percentage computed as follows:

Net Free Assets P 57,000

= ------------------------- =
---------------------------- --- 60%
Unsecured Claims P 95,000

Thus, unsecured creditors can anticipate receiving only 60 percent of their claims. An
unsecured creditor, for example, who is owed P1,000 by this corporation should
anticipate collecting only P600 (P1,000 x 60%) following liquidation. Fully secured
creditors, of course, receive the full amount owed to them, as well as those creditors
with priority claims.
Palugi Corporation

Estimate
Available
d
Book for
Assets Realizabl
Values Unsecured
e
Creditors
Values
Pledged to fully secured
P210,00 creditors:
0 Land and Building P231,000
Less: Payable (long-term) 200,000
Interest Payable 5,000 P 26,000
Pledged to partially secured creditors:
41,00 Inventory
0 43,000 -0-
2,00 Free Assets:
0 Cash 2,000
15,00
0 Marketable Securities 20,000
-
0- Dividends Receivable 500
23,00
0 Accounts Receivable 12,000
3,00
0 Prepaid Expenses -0-
80,00
0 Equipment 32,000
15,00
0 Intangible Assets -0- 66,500
Total Free Assets P 92,500
Less: Liabilities with priority (see b
a) 35,500
Net Free Assets P 57,000 c
Estimated deficiency (squeezed figure) 38,000 d
P389,00
P 95,000
0

Unsecured
Book Secured and Non-
Liabilities and Shareholders’
Values Priority priority
Equity
Claims Liabilities
P Liabilities with priority:
-0- Administrative Expenses P 20,500
12,00 Salaries Payable
0 12,000
3,00 Payroll Taxes Payable
0 3,000
Total P 35,500 a -0-
200,00 Fully secured creditors: P200,000

Accounting and Reporting for Trustee / Receiver

Normally, the trustee opens a new set of accounting records. The assets and liabilities
of the debtor corporation are recorded in the trustee’s books at book values, rather
than at their net realizable values. Contra-asset accounts are omitted because they
are not necessary in liquidation. These accounting procedures are used to keep the
trustee’s accounting records as simple as possible. The reports usually prepared by the
trustee are the Statement of Cash Receipts and Disbursements, and Statement of
Realization and Liquidation.

Illustration of the Accountability Technique

Cash 2,000
Marketable Securities 15,000
Accounts Receivable 23,000
Inventory 41,000
Prepaid Expenses 3,000
Land 100,000
Building 110,000
Equipment 80,000
Patent 15,000
Notes Payable 75,000
Accounts Payable 60,000
Accrued Expenses 18,000
Long-term Notes Payable 200,000
Estate Equity 36,000
To record custody of assets and liabilities of
Palugi Corporation at book values.
After the assumption of the estate, the trustee records gains, losses, and liquidation
expenses directly to the estate equity account. Any unrecorded assets or liabilities the
trustee discovers are likewise recorded in the estate equity account. All assets
acquired and liabilities incurred after the trustee takes charge of the estate are
identified as “new.”

The transactions and events during the first month of Palugi Corporation’s trusteeship
and the related journal entries to record them in the trustee’s books are illustrated
below:

1. The accounting records of Palugi Corporation are adjusted to correct the

balances as of June 30. Hence, the dividends receivable and interest payable
are recognized.

Estate Equity 4,500

Dividends Receivable – new 500
Interest Payable – new 5,000

2. The trustee spends P7,000 to sell the inventory at a price of P51,000. The net
cash is applied to the notes payable for which the inventory had served as
partial security.

Inventory 41,000
Estate Equity 3,000
Notes Payable – current 44,000

3. Collection is made of the P500 cash dividend accrued as of June 30. The related
investments reported at P15,000 are then sold for P19,600.

Cash 20,100

4. Accounts Receivable of P16,000 is collected. The remaining balance is written

off as bad debts.

Cash 16,000
Estate Equity 7,000
Accounts Receivable 23,000

5. The trustee determines that no refund is available from any of the company’s
prepaid expenses. The patent is removed from the accounting records because
they have no cash value.

Estate Equity 18,000

Prepaid Expenses 3,000
Patent 15,000

6. The land and building are sold for P208,000 with P205,000 of this money was
used to pay off the secured creditors.

Cash 208,000
Estate Equity 2,000
Land 100,000
Building 110,000

Long-term Notes Payable 200,000

Interest Payable – new 5,000
Cash 205,000

7. The equipment is sold for P42,000 cash.

Cash 42,000
Estate Equity 38,000
Equipment 80,000

8. Various administrative expenses of P24,900 are paid.

Estate Equity 24,900

Cash 24,900

9. Payment of Unsecured Liabilities with Priority (Accrued salaries of 12,000 plus

Accrued Taxes of 3,000).

Accrued Expenses 15,000

Cash 15,000

After the above entries are entered on the trustee’s books, financial statements are
prepared to show the progress of liquidation and the company’s financial position.

Cash
P P
Balance, July 1, 2021 2,000 Notes Payable 44,000
Inventory sold 44,000 Notes Payable and 205,000
interest
Dividends Receivable 500 Administrative 24,900
Expenses
Marketable Securities 19,600 Accrued Expenses 15,000
sold
Accounts Receivable 16,000
Land and Building sold 208,000
Equipment sold 42,000
P332,10 P288,90
0 0
P
Balance, July 31, 2021
43,200

The table below presents the trustee’s statement of cash receipts and disbursements
for the period July 1 to July 31, 2021.

Palugi Corporation
Statement of Cash Receipts and Disbursements in Trusteeship
From July 1 to July 31, 2021

Cash balance, July 1, 2021 P 2,000

Add: Cash receipts
Sale of inventory P 44,000
Collection of dividends receivable 500
Sale of marketable securities 19,600
Collection of accounts receivable 16,000
Sale of land and building 208,000
Sale of equipment 42,000 330,100
Total P332,100
Less: Cash disbursements
Notes Payable (partially secured) P 44,000
L/T notes payable and interest (fully 205,000
secured)
Administrative expenses (priority claim) 24,900
Accrued expenses (with priority) 15,000 288,900
Cash balance, July 31, 2021 P 43,200

Statement of Estate Deficit

Estate Equity (deficit)

Adjustments for dividends and P P36,00
interest 4,500 July 1, 2021 balance 0
Accounts Receivable written off 7,000 Inventory gain 3,000
Prepaid Expenses and Intangible Marketable securities
Assets 18,000 gain 4,600
Land and Building loss 2,000
Equipment loss 38,000
Administrative Expenses 24,900
P94,40 P43,60
0 0
P50,80
July 31, 2021 balance
0

The Statement of Estate Deficit for Palugi Corporation is presented below:

Palugi Corporation
Statement of Estate Deficit
From July 1 to July 31, 2021

Estate equity, July 1, 2021 P 36,000

Adjusted for dividends and interest ( 4,500)
Adjusted balance P 31,500
Net gain (loss) on realization:
Accounts Receivable written off P( 7,000)
Prepaid Expenses and Intangible Assets written off (18,000)
Land and Building ( 2,000)
Equipment (38,000)
Inventory 3,000
Marketable Securities 4,600
Total P(57,400)
Administrative Expenses paid (24,900) (82,300)
Estate deficit, July 31, 2021 P(50,800)

Statement of Financial Position

A Statement of Financial Position is prepared from the account balances taken from the
general ledger of the company and is presented below.

Palugi Corporation
Statement of Financial Position
July 31, 2021

Statement of Realization and Liquidation

This statement shows a complete record of the transactions of the trustee for a period
of time. It is an activity statement that is intended to show progress, that is, the actual
transactions toward the liquidation of the debtor’s estate. Its definite purpose is to
inform the bankruptcy court and interested creditors of the accomplishments of the
trustee. Its structure is similar to a T-account, and it is composed of three elements:
asset transactions, liability transactions, and income/loss transactions. The structure of
T-accounts for assets and liabilities with hypothetical figures appear as follows:

Asset account
Beginning Balance 100 70 Decreases
Increases 50 80 Ending Balance
150 150

Liability account
Decreases 40 60 Beginning Balance
Ending Balance 50 30 Increases
90 90

The above structure is to be applied to the activities of the trustee or the receiver. The
first duty of the trustee is to realize the assets, that is, to convert the non-cash assets
into cash so that creditors may be paid. The process of realization may be done in
several ways. Some assets may be realized by normal operations, such as the
continuing collection of receivables from customers. Other assets may be realized by
sale. During realization, gains and losses on asset sales may occur, expenses may be
incurred, and revenues may be earned. The gains on realization will decrease the
deficit while losses on realization will further increase the deficit. The realization
activities may be presented in a T-account format as follows:

Assets (except Cash)

Assets to be realized – Beg. Balance Assets realized – Decreases

Income Effect of Realization on Deficit

Gains on Realization Losses on Realization

The second task of the trustee is to liquidate the liabilities, that is, to make full or
partial settlement with the creditors. Again, gains or losses may occur in the process of
liquidation, as well as expenses or revenues. In such manner, the gains on liquidation
will decrease the deficit while losses on liquidation will increase the deficit. The
liquidation activities may also be presented in a T-account format as follows:

Liabilities
Liabilities liquidated – Decreases Liabilities to be liquidated – Beg.
Liabilities not liquidated – End Liabilities incurred - Increases

Income Effect of Liquidation on Deficit

Gains on Liquidation Losses on Liquidation

The traditional format of the statement of realization and liquidation is presented

below:

Palugi Corporation
Statement of Realization and Liquidation
July 1, 2021 to July 31, 2021

ASSETS
Assets to be Realized: Assets Realized:
Marketable Securities P 15,000 Marketable Securities P 19,600
Accounts Receivable 23,000 Accounts Receivable 16,000
Inventory 41,000 Inventory 44,000
Prepaid Expenses 3,000 Prepaid Expenses -0-
Land 100,000 Land and Building 208,000
Building 110,000 Equipment 42,000
Equipment 80,000 Intangible Assets -0-
Intangible Assets 15,000 Dividends Receivable 500
Total P387,000 Total P330,100

Assets Acquired (new) Assets Not Realized:

Dividends Receivable P 500 None

LIABILITIES
Liabilities Liquidated: Liabilities to be Liquidated:
Notes Payable P 44,000 Notes Payable P 75,000
Long-term Notes Payable 200,000 Accounts Payable 60,000
Interest Payable 5,000 Accrued Expenses 18,000
Accrued Expenses 15,000 Long-term Notes Payable 200,000

Liabilities Not Liquidated: Liabilities Incurred/Assumed (new)

Notes Payable P 31,000 Interest Payable P 5,000
Accounts Payable 60,000
Accrued Expenses 3,000
Total P 94,000

GAIN OR LOSS ON REALIZATION AND LIQUIDATION

Gain on Realization/Liquidation Loss on Realization/Liquidation
Inventory P 3,000 Account Receivable P 7,000
Marketable Securities 4,600 Prepayments and Intangibles 18,000
Land and Building 2,000
Equipment 38,000
Total P 7,600 Total P 65,000
P753,100 P753,100

Alternative Format of Statement of Realization and Liquidation

The traditional statement of realization and liquidation presented in the previous page
was a complex and not too understandable accounting presentation. A form that should
be more useful to the parties concerned than the traditional statement is presented in
the following page:

Palugi Corporation
Statement of Realization and Liquidation
For the Month Ended July 31, 2021

Estate Equity, June 30, 2021 P 36,000

Adjustments:
Dividends Receivable P 500
Interest Payable ( 5,000) ( 4,500)
Adjusted balance P 31,500
Assets Realized:
Book
Realization Gain
Value,
Proceeds (Loss)
June 30
Accounts Receivable P 23,000 P 16,000 P( 7,000)
Inventory 41,000 44,000 3,000
Marketable Securities 15,000 19,600 4,600
Land and Building 210,000 208,000 ( 2,000)
Equipment 80,000 42,000 (38,000)
Prepaid Expenses 3,000 -0- ( 3,000)
Intangible Assets 15,000 -0- (15,000) (57,400)
Liabilities Liquidated:
Notes Payable P 44,000
Long-term Notes Payable 200,000
Interest Payable 5,000

Closing the Books of the Trustee

The total remaining liabilities of P94,000 (all unsecured creditors) receive P.4596 on the
peso (P43,200 / P94,000) in final settlement of their claims. Entries to record the cash
distribution are as follows:

Notes Payable (P31 000 x .4596) 14,247

Accounts Payable (P60,000 x .4596) 27,575
Accrued Expenses (P3,000 x .4596) 1,378
Cash 43,200
To record payment of the unsecured creditors.

The estate is now fully administered by the trustee. The trustee makes the following
entry to close the books of Palugi Corporation.

Notes Payable 16,753

Accounts Payable 32,425
Accrued Expenses 1,622
Cash 50,800
To close the trustee’s books.

The Statement of Realization and Liquidation differs from the Statement of Affairs in
the following matters: (a) The statement of realization and liquidation shows the actual
liquidation results. In contrast, the statement of affairs is of a pro-forma nature and is
based on estimates rather than on actual results; (b) The statement of realization and
liquidation provides an ongoing reporting of the trustee’s activities and is updated
throughout the liquidation process. The statement of affairs is a summary of the
estimated results of a completed liquidation.

A summary of the topic is presented via power point presentations

to explain further the information from the materials in the context
that you would understand. Additional assignments and lecture
notes via Google classroom may also be given.

Note: A copy of the power point presented in the google classroom.

EXPLORE

Activity 1 – Computation of claims

Bontoc National Bank loaned P40,000 to Lepanto Company. The
loan is secured by inventory with a book and fair value of P50,000

EVALUAT
and P30,000 respectively. What amount will the bank receive if unsecured creditors
receive 25% of their claims?

Activity 2 – Computation of claims

Glympse Company owes P200,000 on a note payable plus P8,000 interest to its bank.
The note is secured by inventory with a book value of P160,000 and a fair value of
P120,000. What amount will the bank receive if unsecured creditors receive 75% of
their claims?

Activity 3 – Computation of claims

Karla Company owes P15,000,000 on the mortgage of its building to Sagada Rural
Bank. The building has a net book value of P20,000,000 and a fair value of
P18,000,000. When Karla Company filed for liquidation, it owed interest of P90,000;
when the building is sold for P18,000,000, the interest due on the mortgage is
P200,000. What amount will the bank receive if the unsecured creditors received 80%
of their claims?

Activity 3 – Computation of claims

Reine Alethea Company has had severe financial difficulties and is considering the
possibility of liquidation. At this time, the company has the following assets (stated at
net realizable value) and liabilities. Assets (pledged against debts of P70,000),
P116,000; Assets (pledged against debts of P130,000), P50,000; Other Assets, P80,000;
Liabilities with Priority, P42,000; Unsecured Creditors, P200,000. In liquidation, how
much would be paid to partially secured creditors?

Activity 4 – Computation of claims

The Statement of Affairs for Ivan Corporation shows that approximately P0.78 on the
peso probably will be paid to unsecured creditors without priority. The corporation
owes JICR Company P23,000 on a promissory note, plus accrued interest on P940.
Inventories with a current fair value of P19,200 collateralized the note payable.
Compute the amount that JICR Company should receive from Ivan Corporation
assuming that the actual payments to unsecured creditors without priority consist of
78% of total claims. (Round all amounts to the nearest peso).

Activity 5 – Computation of claims

Poypoy Co. has been forced into bankruptcy and liquidated. Unsecured claims will be
paid at the rate of P0.50 on the peso. Paul Alex Co. holds a non-interest bearing note
receivable from Poypoy Co. in the amount of P50,000, collateralized by machinery with
a liquidation value of P10,000. The total amount to be realized by Paul Alex Co. on this
note receivable is:

MODULE 4: LONG-TERM CONSTRUCTION

CONTRACTS

Learning Objectives:
 Apply PFRS 15 to account for revenues from, and costs of, construction
contracts.
 Account for onerous construction contracts.
 Account for changes in the transaction price of a construction contract.
 Account for uncertainty in the collectibility of contract revenue.

INTRODUCTION
Long-term construction contracts are construction projects that
stretch out for more than one accounting period. These
construction projects usually involve the construction of high-
rise buildings, highways, flyovers, and other projects in which
the government is usually involved.

An entity applies PFRS 15 Revenue from Contracts with

Customers to account for revenues from contracts with
ENGAGE customers. PFRS 15 supersedes PAS 11 Construction Contracts.

SUMMARY OF PFRS 15
PFRS 15 specifies how and when an PFRS reporter will recognize revenue as well as
requiring such entities to provide users of financial statements with more informative,
relevant disclosures. The standard provides a single, principles based five-step model
to be applied to all contracts with customers.

The objective of PFRS 15 is to establish the principles that an entity shall apply to
report useful information to users of financial statements about the nature, amount,
timing, and uncertainty of revenue and cash flows arising from a contract with a
customer.

Key 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.

Revenue Income arising in the course of an entity’s ordinary activities.

The Five-Step Model Framework

The core principle of PFRS 15 is that an entity will recognize revenue to depict the
transfer of promised goods or services to customers in an amount that reflects the
consideration to which the entity expects to be entitled in exchange for those goods or
services. This core principle is delivered in a five-step model framework:

Step 1: Identify the contract with the customer

If a contract with a customer does not yet meet all of the above criteria, the entity will
continue to re-assess the contract going forward to determine whether it subsequently
meets the above criteria. From that point, the entity will apply PFRS 15 to the contract.

The standard provides detailed guidance on how to account for approved contract
modifications. If certain conditions are met, a contract modification will be accounted
for as a separate contract with the customer. If not, it will be accounted for by
modifying the accounting for the current contract with the customer. Whether the latter
type of modification is accounted for prospectively or retrospectively depends on
whether the remaining goods or services to be delivered after the modification are
distinct from those delivered prior to the modification. Further details on accounting for
contract modifications can be found in the Standard.

Step 2: Identify the performance obligations in the contract

At the inception of the contract, the entity should assess the goods or services that
have been promised to the customer, and identify as a performance obligation:
 a good or service (or 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 is transferred to the customer in the same pattern
if both of the following criteria are met:
a. each distinct good or service in the series that the entity promises to transfer
consecutively to the customer would be a performance obligation that is
satisfied over time; and
b. a single method of measuring progress 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.

A good or service is distinct if both of the following criteria are met:

a. the customer can benefit from the good or services on its own or in conjunction
with other readily available resources; and
b. the entity’s promise to transfer the good or service to the customer is separately
identifiable from other promises in the contract.

Factors for consideration as to whether a promise to transfer goods or services to the

Step 3: Determine the transaction price

The transaction price is the amount to which an entity expects to be entitled in
exchange for the transfer of goods and services. When making this determination, an
entity will consider past customary business practices.

In a construction contract, the transaction price normally consists of the following:

a. the contract price; and
b. any subsequent variations in the contract price to the extent that it is probable
that they will result in revenue and they are capable of being measured reliably.

However, the transaction price may not be equal to the contract price if the
consideration in the contract is affected by any of the following:
a. variable consideration
b. constraining estimates of variable consideration
c. the existence of a significant financing component in the contract
d. non-cash consideration
e. consideration payable to a customer

Two Types of Construction Contract or Contract Price:

a. Fixed Price Contract - a construction contract in which the contractor agrees

to a fixed contract price, or a fixed rate per unit of output, which in some cases is
subject to cost escalation clauses. A cost escalation clause may provide for an
increase in the original contract price if prices of construction materials or costs
of labor increases by a certain percentage subsequent to the signing of the
contract.

b. Cost Plus Contract - a construction contract in which the contractor is

reimbursed for allowable or otherwise defined costs, plus a percentage of these
costs of a fixed fee. Some contracts, however, contain characteristics of both
types, such as a cost-plus-contract with an agreed maximum price

Step 4: Allocate the transaction price to the performance obligations in the

contracts
Where a contract has multiple performance obligations, an entity will allocate the
transaction price to the performance obligations in the contract by reference to their
relative standalone selling prices. If a standalone selling price is not directly
observable, the entity will need to estimate it. PFRS 15 suggests various methods that
might be used, including:
a. Adjusted market assessment approach
b. Expected cost plus a margin approach
c. Residual approach (only permissible in limited circumstances).

Any overall discount compared to the aggregate of standalone selling prices is

allocated between performance obligations on a relative standalone selling price basis.

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.

Step 5: Recognize revenue when (or as) the entity satisfies a performance
obligation
Revenue is recognized as control is passed, either over time or at a point in time.
Control of an asset is defined as the ability to direct the use of and obtain substantially
all of the remaining benefits from the asset. This includes the ability to prevent others
from directing the use of and obtaining the benefits from the asset. The benefits
related to the asset are the potential cash flows that may be obtained directly or
indirectly. These include, but are not limited to:
a. using the asset to produce goods or provide services;
b. using the asset to enhance the value of other assets;
c. using the asset to settle liabilities or to reduce expenses;
d. selling or exchanging the asset;
e. pledging the asset to secure a loan; and
f. holding the asset.

An entity recognizes revenue over time if one of the following criteria is met:
a. the customer simultaneously receives and consumes all of the benefits provided
by the entity as the entity performs;

b. the entity’s performance creates or enhances an asset that the customer

controls as the asset is created; or

c. 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.

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:
a. the entity has a present right to payment for the asset;
b. the customer has legal title to the asset;
c. the entity has transferred physical possession of the asset;
d. the customer has the significant risks and rewards related to the ownership of
the asset; and
e. the customer has accepted the asset.

Methods of Measuring Progress

The stage of completion of a contract may be determined in a variety of ways. The
enterprise uses the method that measures reliably the work performed. Depending on
the nature of the contract, the methods may include:

a. Cost-to-cost method. The proportion that contract costs incurred for work
performed to date bear to the estimated total contract costs. In other words, the
percentage of completion is determined as the ratio of total costs incurred to
date over the estimated total contract costs.

b. Efforts-expended method. Under this method, the percentage of completion is

based on “efforts expended” in completing the contract, normally in direct labor
hours, rather than on costs.

2. Output Measures. Output measures recognize revenue on the basis of direct

measurements of the value to the customer of the goods or services promised
under the contract. Examples would include:

a. Surveys of performance completed to date

b. Appraisals of results achieved, milestones reached, time elapsed and units

produced, or units delivered

Contract Costs
The incremental costs of obtaining a contract must be recognized as an asset if the
entity expects to recover those costs. However, those incremental costs are limited to
the costs that the entity would not have incurred if the contract had not been
successfully obtained (e.g. ‘success fees’ paid to agents). A practical expedient is
available, allowing the incremental costs of obtaining a contract to be expensed if the
associated amortization period would be 12 months or less.

Costs incurred to fulfil a contract are recognized as an asset if and only if all of the
following criteria are met:
a. the costs relate directly to a contract (or a specific anticipated contract);
b. the costs generate or enhance resources of the entity that will be used in
satisfying performance obligations in the future; and
c. the 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.

Presentation in financial statements

Contracts with customers will be presented in an entity’s statement of financial position
as a contract liability, a contract asset, or a receivable, depending on the relationship
between the entity’s performance and the customer’s payment.

Where the entity has performed by transferring a good or service to the customer and
the customer has not yet paid the related consideration, a contract asset or a
receivable is presented in the statement of financial position, depending on the nature
of the entity’s right to consideration. A contract asset is recognized when the entity’s
right to consideration is conditional on something other than the passage of time, for
example future performance of the entity. A receivable is recognized when the entity’s
right to consideration is unconditional except for the passage of time.

Contract assets and receivables shall be accounted for in accordance with PFRS 9. Any
impairment relating to contracts with customers should be measured, presented, and
disclosed in accordance with PFRS 9. Any difference between the initial recognition of a
receivable and the corresponding amount of revenue recognized should also be
presented as an expense, for example, an impairment loss.

Disclosures
The disclosure objective stated in PFRS 15 is for an entity to disclose sufficient
information to enable users of financial statements to understand the nature, amount,
timing and uncertainty of revenue and cash flows arising from contracts with
customers. Therefore, an entity should disclose qualitative and quantitative information
about all of the following:

- its contracts with customers;

- the significant judgments, and changes in the judgments, made in applying the
guidance to those contracts; and
- any assets recognized from the costs to obtain or fulfil a contract with a
customer.

Entities will need to consider the level of detail necessary to satisfy the disclosure
objective and how much emphasis to place on each of the requirements. An entity
should aggregate or disaggregate disclosures to ensure that useful information is not
obscured.

A summary of the topic is presented via power point presentation

to explain further the information from the materials in the context
that you would understand. Additional assignments and lecture
notes via Google classroom may also be given.

Note: A copy of the power point presented in the google classroom.

EXPLORE

EVALUAT Activity 1 – True or False

1. Step 2 of the revenue recognition under
PFRS 15 is the allocation of the transaction price to the
performance obligations in the contract.
Answer:

2. According to PFRS 15, each promise to deliver a distinct good

or service in a contract is treated as a separate performance
obligation.
Answer:

3. The percentage of completion under a construction contract is always computed

based on the costs incurred to date as they bear to the expected total costs at
completion.
Answer:

4. Revenue from a performance obligation that is satisfied over time is recognized as

the entity progresses towards the complete satisfaction of the performance
obligation. Answer:

5. Entity X enters into a contract to build a house for a customer. The contract
identifies the customer as the owner and is entitled to any asset created in case the
contract is terminated before completion. Entity X's performance obligation is most
likely to be one that is satisfied at a point in time.

Activity 2 – Multiple Choice Questions

1. The primary issue in the accounting for construction contracts is:
A. the determination of the percentage of completion and revenue to be recognized
during the period
B. the allocation of contract revenue and contract costs to the accounting periods
in which construction work is performed
C. the determination of the rate at which physical performance has been made
during the reporting period and the future performance on which future revenues
will be allocated
D. the allocation of costs of a long-lived asset to permit the proper matching of
costs with revenues

2. According to PFRS 15, each contract is accounted for separately. However, two or
more contracts entered into at or near the same time with the same customer are
combined and accounted for as a single contract if any of the following conditions
are met, except:
A. The contracts are negotiated as a package with a single commercial objective
B. The amount of consideration to be paid in one contract depends on the price or
performance of the other contract
C. Some or all of the goods or services promised in the contracts are a single
performance obligation
D. At contract inception, the collectibility of the consideration is probable of
collection

3. Which of the following does not indicate that a promise to transfer a good or service
is separately identifiable?
A. The good or service is not an input to a combined output specified by the
customer
B. The good or service does not significantly modify another good or service
promised in the contract
C. The good or service is not highly interrelated with other goods or services
promised in the contract
D. The customer’s decision of not purchasing a good or service affects the other
promised goods or services in the contract

4. Which of the following precludes an entity from applying PFRS 15?

A. The contract is a long-term construction contract with a customer
B. The contract is a franchise contract with a customer
C. The contract is an installment sale contract with a customer
D. The contract is a sale contract with a non-customer, such as a participant in the
entity's activities who shares the related risks and benefits rather than a mere
recipient of the output of the entity's ordinary activities

5. According to PFRS 15, each promise to deliver a distinct good or service in a

contract is treated as a separate performance obligation. A promised good or
service is distinct if: (a) The customer can benefit from the good or service either on
its own or together with other resources that are readily available to the customer

Activity 2 – Overview of possible cases

Use the following information for the next three questions:
Information on Red Hot Co.’s construction contracts with customers which commenced
during 20x1 is shown below:

Contract Contract
1 2
Contract price 420,000 300,000
Costs incurred during the
year 240,000 280,000
Estimated costs to complete 120,000 40,000
Progress billings 150,000 270,000
Collections 90,000 250,000

1. At contract inception, Red Hot Co. assessed that its performance obligation in each
of Contract 1 and Contract 2 is satisfied over time. Red Hot Co. uses the ‘cost-to-
cost’ method in measuring its progress on the contract. How much total profit (loss)
is recognized from the two contracts in 20x1?

2. At contract inception, Red Hot Co. assessed that its performance obligation in each
of Contract 1 and Contract 2 is satisfied over time. However, Red Hot Co.
determined that the outcome of the performance obligation in each of the contracts
cannot be reasonably measured but contract costs incurred are recoverable. How
much total profit (loss) is recognized from the two contracts in 20x1?

3. At contract inception, Red Hot Co. assessed that its performance obligation in each
of Contract 1 and Contract 2 is satisfied at a point in time, that is, when the
construction is completed. How much total profit (loss) is recognized from the two
contracts in 20x1?

Activity 3 – Computation of revenue in year 1

On July 1, 20x1, Contractor Co. enters into a contract with a customer for the
construction of a building. At contract inception, Contractor Co. assesses the contract
in accordance with the principles of PFRS 15 and concludes that it has a single
performance obligation that is satisfied over time. Contractor Co. then determines that
the appropriate measure of its progress on the contract is input method based on costs
incurred. Information on the contract is shown below:

600,00
Contract price 0
120,00
Contract costs incurred during 20x1 0
Estimated remaining costs as of Dec. 31, 240,00

What amount of revenue is recognized on the contract in 20x1?

Activity 4 – Computation of revenue in year 2 and transaction price

Use the following information for the next two questions:
In 20x1, Gorgeous Too Co. enters into a fixed-price construction contract with a
customer. At contract inception, Gorgeous Too Co. assesses its performance obligations
in the contract and concludes that it has a single performance obligation that is
satisfied over time. Gorgeous Too Co. determines that the measure of progress that
best depicts its performance on the contract is input method based on costs incurred.
Information on the contract follows:

20x1 20x2
Cumulative contract costs 2,250,0 4,800,0
incurred 00 00
750,0 1,200,0
Cumulative profits recognized 00 00
2,400,0 3,600,0
Progress billings 00 00
2,000,0 4,000,0
Collections on progress billings 00 00

The contract is completed in 20x2.

1. What amount of revenue is recognized in 20x2?

2. How much is the transaction price in the contract?

MODULE 5: ACCOUNTING FOR FRANCHISE

Topic Learning Outcome:
 Account for the revenue recognition principles pertaining to accounting for
franchise using PFRS 15 Revenue from Contracts with Customers.

Learning Objectives:
 Define a franchise contract.
 Apply the general and specific principles of PFRS 15 in recognizing revenue from
franchise contracts.

INTRODUCTION
A franchise agreement involves the granting of business rights
by the franchisor to the franchisee that will operate the
franchise outlet in a certain geographical area or location. Each
party contributes resources.

An entity applies PFRS 15 Revenue from Contracts with Customers to account for
revenues from contracts with customers. PFRS 15 supersedes PAS 18 Revenue.

Key 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.

Revenue Income arising in the course of an entity’s ordinary activities.

The Five-Step Model Framework

Step 1: Identify the contract with the customer

A contract with a customer will be within the scope of PFRS 15 if all the following
conditions are met:
 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.

Step 2: Identify the performance obligations in the contract

A good or service is distinct if both of the following criteria are met:

Factors for consideration as to whether a promise to transfer goods or services to the

customer is not separately identifiable include, but are not limited to:
a. the entity does provide a significant service of integrating the goods or services
with other goods or services promised in the contract;
b. the goods or services significantly modify or customize other goods or services
promised in the contract;
c. the goods or services are highly interrelated or highly interdependent.

Paragraphs B52-B63 of PFRS 15 cover licensing of intellectual property such as:

 software and technology;
 motion pictures, music and other forms of media and entertainment;
 franchises; and
 patents, trademarks, and copyrights.

The main challenges in this area relate to determination whether licensing of

intellectual property constitutes a distinct good or service and if so, whether
related performance obligation is satisfied over time or at a point in time.

License that is distinct

A license is usually capable of being distinct, but sometimes a customer benefits only
from a combined entity’s output and therefore a license forms a part of wider
performance obligation. The following examples of licenses that are not distinct are
given in PFRS 15:

If a license is distinct, it can provide a customer with either:

a. a right to access the entity’s intellectual property as it exists throughout the
license period; or
b. a right to use the entity’s intellectual property as it exists at the point in time
at which the license is granted.

A license provides a right to access the entity’s intellectual property as it exists

throughout the license period, and therefore the related performance obligation is
satisfied over time, if the customer will essentially be using the most recent form of the
intellectual property during the license period. This is the case when all of the following
criteria are met:
a. the contract requires, or the customer reasonably expects, that the entity will
undertake activities that significantly affect the intellectual property to which the
customer has rights;
b. the rights granted by the license directly expose the customer to any positive or
negative effects of the entity’s activities identified above; and
c. those activities do not result in the transfer of a good or a service to the
customer as those activities occur (e.g. software updates that are treated as
distinct services).

If the criteria listed above are not met, the performance obligation is satisfied at a point
in time at which the license is granted to the customer. However, revenue cannot be
recognized before the beginning of the period during which the customer is able to use
and benefit from the license.

License that is not distinct

If a license is not distinct, entities should determine whether the license is a primary or
dominant component in the performance obligation. If so, the specific provision relating
to licensing of intellectual property should be applied. If the license is not a primary or
dominant component in the performance obligation, the general criteria for satisfaction
of performance obligations apply. PFRS 15 does not contain any specific criteria for
determining whether a license is a primary or dominant component in the performance
obligation.

Examples of licenses that are not distinct from other goods or services promised in the
contract:
a. A license that is integral to the functionality of a tangible good (e.g. software
embedded to a machine); and
b. A license that the customer can benefit from only in conjunction with a related
service (e.g. software with web hosting arrangement).

Step 3: Determine the transaction price

The transaction price is the amount to which an entity expects to be entitled in
exchange for the transfer of goods and services. When making this determination, an

Franchise fees come in the form of:

1. Initial franchise fee. The initial franchise fee is a consideration for the
establishment of franchise relationship providing some initial services. These
services are as follows:

a. Assistance in site selection (analyzing location and negotiating lease)

b. Evaluation of potential income
c. Supervision of construction activity (obtaining financing, designing building
and supervising contractor on the on-going construction)
d. Assistance in the acquisition of signs, fixtures, and equipment
e. Provision of bookkeeping and advisory services (setting up franchisee’s
records, advising on income, real estate, other taxes, local regulations, etc.)
f. Provision of employee and management training
g. Provision of quality control
h. Provision of advertising and promotion

2. Continuing franchise fee. Continuing franchise fee is a fee received in return for
the continuing rights granted by the franchise agreement, and providing such
services such as management fees, training and conference fees, advertising, and
promotion.

3. Sale of equipment and other tangible assets. In most franchise agreements,

the franchisor provides equipment and other tangible assets to the franchisee for a
separate fee. Also, the franchisor may purchase goods centrally and supplies
directly to franchisees. A markup, purchasing fee or handling fee may be charged
on tangible assets transferred to franchisees.

Step 4: Allocate the transaction price to the performance obligations in the

contracts
The transaction price is allocated to the performance obligations based on the relative
stand-alone prices of the distinct goods or services.

The stand-alone selling price is the price at which a promised good or service can be
sold separately to a customer. If there is only one performance obligation in a contract,
the transaction price is allocated only to that single obligation.

Step 5: Recognize revenue when (or as) the entity satisfies a performance
obligation

 If the performance obligation in the contract is satisfied over time, revenue is

recognized over time as the entity progresses towards the complete satisfaction
of the obligation.

 If the performance obligation in the contract is satisfied at a point in time,

the entity recognizes revenue when the performance is satisfied.

A summary of the topic is presented via power point presentation to

explain further the information from the materials in the context
that you would understand. Additional assignments and lecture
notes via Google classroom may also be given.

Note: A copy of the power point presented in the google classroom.

EXPLORE

EXPLAIN

EVALUAT
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Activity 1 – True or False
1. PFRS 15 does not address the accounting for revenue from
franchise agreements.
Answer:

2. Under the current PFRS, a franchisor recognizes the initial

franchise fee as revenue in full at the commencement of the
franchisee's business operations.
Answer:

3. If a promise to grant a license is not distinct, the entity shall apply the specific
principles to determine whether the license provides the customer a right to access
or a right to use the entity's intellectual property.
Answer:

4. If the intellectual property to which the customer has rights does not change over
the license period, the nature of the entity's promise to transfer the license is most
likely a right to access.
Answer:

5. According to PFRS 15, if, at contract inception, the entity determines that the
collectibility of the consideration in a franchise agreement is significantly uncertain,
the entity may recognize revenue from the contract using either the installment
sales method or the cost recovery method.
Answer:
Activity 2 – Multiple Choice Questions
1. State the correct sequence of the following steps of revenue recognition under PFRS
15. (I) Determine the transaction price; (II) Recognize revenue when (or as) the
entity satisfies a performance obligation; (III) Identify the performance obligations in
the contract; (IV) Allocate the transaction price to the performance obligations in
the contract; (V) Identify the contract with the customer.
A. V, IV, II, I, III
B. V, I, IV, III, II
C. V, III, I, IV, II
D. V, I, III, IV, II

2. Which of the following correctly relates to ‘Step 2’ in the recognition of revenue

under PFRS 15?
A. The entity shall assess the customer’s ability and intention to pay the
consideration in the contract when they become due.
B. The entity shall determine the transaction price and shall consider whether the
transaction price includes, among other things, a variable consideration or
significant financing.
C. The entity shall treat each promise to transfer a distinct good or service as a
performance obligation.

3. According to PFRS 15, a good or service is distinct if:

A. it is tangible
B. the customer can benefit from it, either on its own or together with other
resources that are readily available to the customer
C. the good or service is separately identifiable
D. b and c

4. If an entity’s promise to grant a license is not distinct:

A. the general principles of PFRS 15 are applied to determine whether the
performance obligation is satisfied over time or at a point in time.
B. the specific principles of PFRS 15 are applied to determine whether the
performance obligation is satisfied over time or at a point in time.
C. both the general and specific principles are used to determine whether the
performance obligation is satisfied over time or at a point in time and whether
the nature of the promise to grant the license is a ‘right to access’ or a ‘right to
use.’
D. US GAAP (FAS No. 45) is applied to determine whether there is substantial
performance of the initial services required in the contract.

5. An entity, a movie distribution company, licenses Movie XYZ to a customer. The

customer, an operator of cinemas, has the right to show the movie in its cinemas
for six weeks. In exchange for providing the license, the entity will receive a portion
of the operator’s ticket sales for Movie XYZ. Which of the following statements is
incorrect?
A. The only performance obligation in the contract is the promise to grant the
license.
B. The fact that the performance obligation in the contract is satisfied over time or
at a point in time is irrelevant when determining how revenue is recognized on
the contract.
C. The transaction price is a variable consideration.
D. The entity shall estimate the variable consideration, subject the estimate to the
“constraining’ principle of PFRS 15, and recognize the resulting amount at the
point in time when the license is transferred to the customer.

Activity 3 – Preparation of journal entries

On December 1, 2021, CAMOUFLAGE COMPANY granted a 5-year franchise right to
MILITARY INC. for an initial franchise fee of ₱400,000 and a 10% sales-based royalty.
The initial franchise fee is non-refundable and due upon signing of the contract.

At contract inception, CAMOUFLAGE COMPANY determines that the nature of its

promise to grant the license is to provide the customer with the right to access
CAMOUFLAGE COMPANY’s intellectual property as it exist throughout the license period.
As of December 31, 2021, CAMOUFLAGE COMPANY has no remaining obligation or
intent to refund any of the cash received, all the initial services necessary to setup the
contract have been performed, and MILITARY INC. started operating the franchise
business. MILITARY INC. reported sales of ₱800,000 for 2021.

MODULE 6: CONSIGNMENT SALES

Topic Learning Outcome:
 Account for the revenue recognition principles pertaining to consignment sales
using PFRS 15 Revenue from Contracts with Customers.

Learning Objectives:
 Define a consignment arrangement.
 Apply the principles of PFRS 15 in recognizing revenue from a consignment
arrangement.

INTRODUCTION
The word consignment can be generally defined as the act of
sending a quantity of goods by the manufacturers or producers
to their agents for the latter to sell the goods delivered to him.
Goods so sent are known as "consignment". The sender of the
goods is called the consignor. Generally the manufacturers or
producers are consignors. The person to whom goods are
forwarded for the purpose of sale is known as the consignee.

ENGAGE An entity applies PFRS 15 Revenue from Contracts with

Customers to account for revenues from contracts with
customers. PFRS 15 supersedes PAS 18 Revenue.

The Five-Step Model Framework

Step 1: Identify the contract with the customer

Step 2: Identify the performance obligations in the contract

ACCOUNTING FOR CONSIGNMENT

Goods sent on consignment do not become the property of the consignee since he has
not bought them. The ownership remains with the sender or the consignor. The
consignee tries to sell the goods according to the instructions of the consignor. When
the goods have been sold, he will deduct his expenses, commission, etc., from the sale
proceeds and the balance is remitted to the consignor.

The relationship between the consignor and the consignee is that of principal and
agent. The consignee is the agent. The consignee acts entirely on behalf of the
consignor. The consignee is entitled to his remuneration which is generally fixed on the
basis of a commission on sales.

The expenses incurred by the consignee must also be reimbursed by the principal. It is
important to remember that the consignee does not buy the goods; he merely receives
the possession of the goods.

Initially, the goods on consignment are valued at cost. Cost should not mean merely
the cost at which the consignor invoices the goods. If expenses that normally increase
the value of goods have been incurred, a proportionate of such expenses should be
included in the cost. These expenses include: shipping cost, freight and handling costs,
insurance on the consigned goods, among others.

As the goods sent on consignment by the consignor are not his sales, he must not
record consignment as sales and the consignee must not record them as purchases.
The consignor should not take up any profit on the transaction until the goods have
been actually sold by the consignee. Since the goods still belong to the consignor, any
unsold goods in the hands of the consignee at the end of the trading period should be
included in the consignor's inventory.

The valuation of inventory in the possession of the consignee at the time of final
closing of the account of the consignor is generally made at lower of cost and net
realizable value (LCNRV).

DISTINCTION BETWEEN CONSIGNMENT AND SALE

The following are the main points of the difference between consignment and sale.

1. Transfer of legal ownership of the goods. In case of sale, the legal

ownership of the goods sold is transferred to the purchaser of goods. Whereas in
case of a consignment of goods, the legal ownership of the goods is not
transferred to the consignee, but the ownership of the goods remains vested in
the consignor till the goods consigned are sold by the consignee.

2. Relationship between consignor and consignee. In case of a sale of goods,

the relationship between the seller and the purchaser of the goods is that of a
creditor and a debtor whereas in case of a consignment, the relationship

3. Expenses incurred. In consignment, expenses incurred by the consignee in

connection with the goods consigned to him are usually borne by the consignor
whereas in case of a sale, expenses incurred after sale of goods are born by the
purchaser.

4. Risk attached to the goods. In case of consignment, risk attached to the

goods sold lies with the consignor till the goods consigned are sold by the
consignee. But in case of a sale, risk attached to the goods sold is transferred to
the buyer of goods.

5. Return of goods. In case of consignment, return of goods is possible if the

goods are not sold by the consignee. But in case of sale, return of goods may or
may not be possible (e.g. if the goods sold are found to be defective)

6. Reportorial requirement. In case of consignment, the consignee periodically

reports (e.g. weekly, monthly, quarterly, depending on the arrangement) to the
consignor for goods sold on consignment. But in case of sales, no such report is
required to be submitted by the purchaser to the seller.

A summary of the topic is presented via power point presentation

to explain further the information from the materials in the context
that you would understand. Additional assignments and lecture
notes via Google classroom may also be given.

Note: A copy of the power point presented in the google classroom.

EXPLORE

EXPLAIN

2. A consignor recognizes revenue when the consigned goods are

transferred to the consignee.
Answer:

3. If another party is primarily responsible for fulfilling a contract with a customer, this
may indicate that the entity is an agent.
Answer:

4. Pinewood Co. agrees to create an artifact for Sagada Co. Pinewood is primarily liable
for the artifact's conformance with the customer's specifications. Pinewood does not
have the required expertise, so it subcontracts Saleng Co. to do the manufacturing.
If the entire manufacturing process is outsourced from Saleng Co., Pinewood would
be acting as an agent of Saleng.
Answer:

5. Fight Club Co. enters into a contract with Tough Co., a promoter of mixed martial
arts fights. Under the contract, Fight Club Co. purchases mixed martial arts event
tickets from Tough at a negotiated price and resells them to end customers at a
marked-up price. Fight Club bears the loss for unsold tickets. The arrangement
between Fight and Tough implies a principal-agent relationship whereby Fight is an
agent of Tough.
Answer:
Activity 2 – Multiple Choice Questions
1. Goods on consignment should be included in the inventory of:
A. The consignor but not the consignee
B. Both the consignor and the consignee
C. The consignee but not the consignor
D. Neither the consignor nor the consignee

2. In accounting for sales on consignment, sales revenue and the related cost of goods
sold should be recognized by the:
A. Consignor when the goods are shipped to the consignee
B. Consignor when the goods are shippedd to the third party
C. Consignor when notification is received that the consignee has sold the goods
D. Consignor when cash is received from the customer

3. The profit or loss on consignment is calculated after a careful analysis of expenses

to be allocated and not to be allocated between the sold and unsold units.
Examples of expenses that are to be allocated, except:
A. Packing expenses related to consigned goods
B. Freight paid by the consignee upon receipt of the shipment

4. Which of the following statements is false?

A. The consignee makes a journal entry for the receipt of the consigned inventory
B. No revenue is recognized by the consignor until the goods are sold by the
consignee to outside or third parties
C. Consignment expenses like freight paid by the consignor are added to the
inventory balance as added costs
D. Any reimbursable expense like freight paid by the consignee is added to the
inventory balance by the consignor

5. Beautiful, a consignee, paid the freight costs for goods shipped from Gorgeous, a
consignor. These freight costs are to be deducted from Beautiful’s payment to
Gorgeous when the consignment goods are sold. Until Beautiful sells the goods, the
freight costs should be included in Beautiful’s:
A. Cost of goods sold
B. Freight-out costs
C. Selling expenses
D. Receivable

Activity 3 – Determination of selling price

Use the following information for the next two questions:
On January 10, 2010, Fedex Corp. consigned 10 units of washing machines costing
$7,200 each to LBC Corp. Fedex Corp. paid the amount of $4,800 for freight on the
shipment. On January 31, LBC Corp. submitted a consignment liquidation report stating
that it had sold 6 washing machines and remitted $54,600 which is net of the following:
Additional freight cost paid upon receipt of consigned goods, $600; Advertising
expenses, $3,600; Delivery of items sold, $2,400; Commissions at 15% of selling price.

1. The six (6) washing machines were sold at a total of?

2. The consignor’s net profit from the sale of the consigned goods was?

Activity 4 – Computation of remittance and consignment profit

Use the following information for the next two questions:
Abanao Square consigned 10 dozen of fine men’s suits with a cost of P1,000 a suit to
Tiongsan Shop. Abanao Square incurred freight cost of P30 per dozen. A month later,
Tiongsan Shop reported sales of 7 dozen at P2,000 a suit and expenses of P3,000.
Tiongsan Shop remitted the proceeds to Abanao Square, net of the agreed 15%
commission on sales.

1. How much was remitted by Tiongsan Shop to Abanao Square?

2. Using the same information above, the consignment profit is?

Activity 5 – Computation of remittance, inventory, and consignment profit

Use the following information for the next three questions:

Nate Co. consigned 10 TV sets to Video Co. Manufacturing costs amount to P40,000
per set and consignment profits are not recorded separately by the company. At the

1. The cash remitted to the consignor amounts to?

2. The balance of the consignor’s inventory relative to consigned goods is
3. Net profit on consignment sales was

Activity 6 – Computation of selling price, commission, and consignor’s profit

Use the following information for the next three questions:
NCC Consigned 10 construction machines to Mitsu Co. The machines cost P450,000
each. Freight on the shipment, which was paid by NCC amounted to P300,000. Mitsu
Co. submitted an account sales stating that they had sold 6 units and remitted
P3,412,500 balance due to NCC after the following deductions:

Commission 15% of selling price

Marketing expenses P225,000
Delivery of items sold 150,000
Delivery cost paid upon receipt of consignment 37,500

1. The consignee sold the 6 construction machines for a total of:

2. The commission earned on the sale of the six machines by Mitsu Co. was
3. The consignor’s profit from the sale of the consigned goods was

Activity 6 – Computation of consignment profit and inventory

Use the following information for the next three questions:
On January 1, 2010, Ace Hardware received from Do-It-Yourself Shop 300 pieces of
microwave ovens. Ace Hardware was to sell these on consignment at 50% above cost
per piece, and to receive 15% commission on the selling price. After selling 200 units,
Ace Hardware had the remaining unsold units repaired for some electrical defects and
spent P2,000 for the said repairs. Do-It-Yourself Shop consequently increased the
selling price of the remaining units to P330 per unit. On January 31, Ace Hardware
remitted P64,980 to Do-It-Yourself Shop after deducting 15% commission, P850 for
delivery expenses of sold units, and P2,000 for the repair of 100 units. The consigned
goods cost Do-It-Yourself Shop P200 per unit and shipping costs of P900 had been paid
to ship to Ace Hardware. All expenses in connection with the consignment were
reimbursable to the consignee.
1. The consignment profit was?
2. The value of inventory on consignment was?

MODULE 7: INSURANCE CONTRACTS

Topic Learning Outcome:
 Understand and have basic knowledge in special topics of accounting for
contracts by insurers using PFRS 17 insurance Contracts.

Learning Objectives:
 State the scope and applicability of PFRS 17.

INTRODUCTION
PFRS 17 establishes the principles for the recognition,
measurement, presentation, and disclosure of insurance
contracts within the scope of the standard. The objective of
PFRS 17 is to ensure that an entity provides relevant information
that faithfully represents those contracts. This information gives
a basis for users of financial statements to assess the effect that
insurance contracts have on the entity's financial position,
financial performance, and cash flows.
ENGAGE
An entity applies PFRS 17 Insurance Contracts for the
recognition, measurement, presentation, and disclosure of insurance contracts. PFRS
17 supersedes PFRS 4.

SCOPE
An entity shall apply PFRS 17 Insurance Contracts to:
a. Insurance contracts, including reinsurance contracts, it issues;
b. Reinsurance contracts it holds; and
c. Investment contracts with discretionary participation features it issues, provided
the entity also issues insurance contracts.

Some contracts meet the definition of an insurance contract but have as their primary
purpose the provision of services for a fixed fee. Such issued contracts are in the scope
of the standard, unless an entity chooses to apply to them PFRS 15 Revenue from
Contracts with Customers and provided the following conditions are met:
a. the entity does not reflect an assessment of the risk associated with an
individual customer in setting the price of the contract with that customer;
b. the contract compensates the customer by providing a service, rather than by
making cash payments to the customer; and
c. the insurance risk transferred by the contract arises primarily from the
customer’s use of services rather than from uncertainty over the cost of those
services.

DEFINITION OF TERMS
Insurance contract - A contract under which one party (the issuer) accepts significant
insurance risk from another party (the policyholder) by agreeing to compensate the
policyholder if a specified uncertain future event (the insured event) adversely affects
the policyholder.

Portfolio of insurance contracts - Insurance contracts subject to similar risks and

managed together.

Contractual service margin - A component of the carrying amount of the asset or

liability for a group of insurance contracts representing the unearned profit the entity
will recognize as it provides services under the insurance contracts in the group.

Fulfilment cash flows – An explicit, unbiased and probability-weighted estimate (i.e.

expected value) of the present value of the future cash outflows less the present value
of the future cash inflows that will arise as the entity fulfils insurance contracts,
including a risk adjustment for non-financial risk.

Risk adjustment for non-financial risk – The compensation an entity requires for
bearing the uncertainty about the amount and timing of the cash flows arising from
non-financial risk as the entity fulfils insurance contracts.

SEPARATING COMPONENTS FROM AN INSURANCE CONTRACT

An insurance contract may contain one or more components that would be within the
scope of another standard if they were separate contracts. For example, an insurance
contract may include an investment component or a service component (or both).

The standard provides the criteria to determine when a non-insurance component is

distinct from the host insurance contract.

An entity shall:
a. Apply PFRS 9 Financial Instruments to determine whether there is an embedded
derivative to be separated and, if there is, how to account for such a derivative.
b. Separate from a host insurance contract an investment component if, and only
if, that investment component is distinct. The entity shall apply PFRS 9 to
account for the separated investment component.
c. After performing the above steps, separate any promises to transfer distinct non-
insurance goods or services. Such promises are accounted under PFRS
15 Revenue from Contracts with Customers.

LEVEL OF AGGREGATION
PFRS 17 requires entities to identify portfolios of insurance contracts, which comprises
contracts that are subject to similar risks and managed together. Contracts within a
product line would be expected to have similar risks and hence would be expected to
be in the same portfolio if they are managed together.

Each portfolio of insurance contracts issues shall be divided into a minimum of:
 A group of contracts that are onerous at initial recognition, if any;
 A group of contracts that at initial recognition have no significant possibility of
becoming onerous subsequently, if any; and
 A group of the remaining contracts in the portfolio, if any.

An entity is not permitted to include contracts issued more than one year apart in the
same group.

If contracts within a portfolio would fall into different groups only because law or
regulation specifically constrains the entity's practical ability to set a different price or
level of benefits for policyholders with different characteristics, the entity may include
those contracts in the same group.

MEASUREMENT
On initial recognition, an entity shall measure a group of insurance contracts at the
total of:
1. the fulfilment cash flows (“FCF”), which comprise:
a. estimates of future cash flows;
b. an adjustment to reflect the time value of money (“TVM”) and the financial
risks associated with the future cash flows; and
c. a risk adjustment for non-financial risk

2. the contractual service margin (“CSM”).

An entity shall include all the future cash flows within the boundary of each contract in
the group. The entity may estimate the future cash flows at a higher level of
aggregation and then allocate the resulting fulfilment cash flows to individual groups of
contracts.

The estimates of future cash flows shall be current, explicit, unbiased, and reflect all
the information available to the entity without undue cost and effort about the amount,
timing, and uncertainty of those future cash flows. They should reflect the perspective
of the entity, provided that the estimates of any relevant market variables are
consistent with observable market prices.

DISCOUNT RATES
The discount rates applied to the estimate of cash flows shall:
a. reflect the time value of money (TVM), the characteristics of the cash flows and
the liquidity characteristics of the insurance contracts;
b. be consistent with observable current market prices (if any) of those financial
instruments whose cash flow characteristics are consistent with those of the
insurance contracts; and
c. exclude the effect of factors that influence such observable market prices but do
not affect the future cash flows of the insurance contracts.

RISK ADJUSTMENT FOR NON-FINANCIAL RISK

The estimate of the present value of the future cash flows is adjusted to reflect the
compensation that the entity requires for bearing the uncertainty about the amount
and timing of future cash flows that arises from non-financial risk.

CONTRACTUAL SERVICE MARGIN

The CSM represents the unearned profit of the group of insurance contracts that the
entity will recognize as it provides services in the future. This is measured on initial
recognition of a group of insurance contracts at an amount that, unless the group of
contracts is onerous, results in no income or expenses arising from:

SUBSEQUENT MEASUREMENT
On subsequent measurement, the carrying amount of a group of insurance contracts at
the end of each reporting period shall be the sum of:
1. the liability for remaining coverage comprising:
a. the FCF related to future services and;
b. the CSM of the group at that date;
2. the liability for incurred claims, comprising the FCF related to past service
allocated to the group at that date.

ONEROUS CONTRACTS
An insurance contract is onerous at initial recognition if the total of the FCF, any
previously recognized acquisition cash flows and any cash flows arising from the
contract at that date is a net outflow. An entity shall recognize a loss in profit or loss for
the net outflow, resulting in the carrying amount of the liability for the group being
equal to the FCF and the CSM of the group being zero.

On subsequent measurement, if a group of insurance contracts becomes onerous (or

more onerous), that excess shall be recognized in profit or loss. Additionally, the CSM
cannot increase and no revenue can be recognized, until the onerous amount
previously recognized has been reversed in profit or loss as part of a service expense.

PREMIUM ALLOCATION APPROACH

An entity may simplify the measurement of the liability for remaining coverage of a
group of insurance contracts using the Premium Allocation Approach (PAA) on the
condition that, at the inception of the group:
a. the entity reasonably expects that this will be a reasonable approximation of the
general model, or
b. the coverage period of each contract in the group is one year or less.

Where, at the inception of the group, an entity expects significant variances in the FCF
during the period before a claim is incurred, such contracts are not eligible to apply the
PAA.

Using the PAA, the liability for remaining coverage shall be initially recognized as the
premiums, if any, received at initial recognition, minus any insurance acquisition cash
flows. Subsequently the carrying amount of the liability is the carrying amount at the
start of the reporting period plus the premiums received in the period, minus insurance
acquisition cash flows, plus amortization of acquisition cash flows, minus the amount
recognized as insurance revenue for coverage provided in that period, and minus any
investment component paid or transferred to the liability for incurred claims.

PRACTICAL EXPEDIENTS AVAILABLE UNDER THE PAA:

If insurance contracts in the group have a significant financing component, the liability
for remaining coverage needs to be discounted, however, this is not required if, at

In applying PAA, an entity may choose to recognize any insurance acquisition cash
flows as an expense when it incurs those costs, provided that the coverage period at
initial recognition is no more than a year.

The simplifications arising from the PAA do not apply to the measurement of the
group’s liability for incurred claims, measured under the general model. However, there
is no need to discount those cash flows if the balance is expected to be paid or
received in one year or less from the date the claims are incurred.

INVESTMENT CONTRACTS WITH A DPF

An investment contract with a DPF is a financial instrument and it does not include a
transfer of significant insurance risk. It is in the scope of the standard only if the issuer
also issues insurance contracts. The requirements of the Standard are modified for
such investment contracts.

REINSURANCE CONTRACTS HELD

The requirements of the standard are modified for reinsurance contracts held.

In estimating the present value of future expected cash flows for reinsurance contracts,
entities use assumptions consistent with those used for related direct insurance
contracts. Additionally, estimates include the risk of reinsurer’s non-performance.

The risk adjustment for non-financial risk is estimated to represent the transfer of risk
from the holder of the reinsurance contract to the reinsurer.

On initial recognition, the CSM is determined similarly to that of direct insurance

contracts issued, except that the CSM represents net gain or loss on purchasing
reinsurance. On initial recognition, this net gain or loss is deferred, unless the net loss
relates to events that occurred before purchasing a reinsurance contract (in which case
it is expensed immediately).

Subsequently, reinsurance contracts held are accounted similarly to insurance

contracts under the general model. Changes in reinsurer’s risk of non-performance are
reflected in profit or loss, and do not adjust the CSM.

MODIFICATION AND DERECOGNITION

 Modification of an insurance contract
If the terms of an insurance contract are modified, an entity shall derecognize
the original contract and recognize the modified contract as a new contract if there
is a substantive modification, based on meeting any of the specified criteria.

The modification is substantive if any of the following conditions are satisfied:

1. if, had the modified terms been included at contract’s inception, this would
have led to:
a. exclusion from the Standard’s scope;
b. unbundling of different embedded derivatives;
c. redefinition of the contract boundary; or

DERECOGNITION
An entity shall derecognize an insurance contract when it is extinguished, or if any of
the conditions of a substantive modification of an insurance contract are met.

PRESENTATION IN THE STATEMENT OF FINANCIAL POSITION

An entity shall present separately in the statement of financial position the carrying
amount of groups of:
a. insurance contracts issued that are assets;
b. insurance contracts issued that are liabilities;
c. reinsurance contracts held that are assets; and
d. reinsurance contracts held that are liabilities.

RECOGNITION AND PRESENTATION IN THE STATEMENT(S) OF FINANCIAL

PERFORMANCE
An entity shall disaggregate the amounts recognized in the statement(s) of financial
performance into:
a. an insurance service result, comprising insurance revenue and insurance service
expenses; and
b. insurance finance income or expenses.
Income or expenses from reinsurance contracts held shall be presented separately
from the expenses or income from insurance contracts issued.

INSURANCE SERVICE RESULT

An entity shall present in profit or loss revenue arising from the groups of insurance
contracts issued, and insurance service expenses arising from a group of insurance
contracts it issues, comprising incurred claims and other incurred insurance service
expenses. Revenue and insurance service expenses shall exclude any investment
components. An entity shall not present premiums in the profit or loss, if that
information is inconsistent with revenue presented.

INSURANCE FINANCE INCOME OR EXPENSES

Insurance finance income or expenses comprises the change in the carrying amount of
the group of insurance contracts arising from:
a. the effect of the time value of money and changes in the time value of money;
and
b. the effect of changes in assumptions that relate to financial risk; but
c. excluding any such changes for groups of insurance contracts with direct
participating insurance contracts that would instead adjust the CSM.

An entity has an accounting policy choice between including all of insurance finance
income or expense for the period in profit or loss or disaggregating it between an
amount presented in profit or loss and an amount presented in other comprehensive
income (“OCI”).

Under the VFA, for direct par insurance contracts, only where the entity holds the
underlying items, disaggregating means presenting in profit or loss as insurance
finance income or expenses an amount that eliminates the accounting mismatches
with the finance income or expenses arising on the underlying items. On derecognition
of the groups, the amounts previously recognized in OCI remain there.

DISCLOSURES
An entity shall disclose qualitative and quantitative information about:
a. the amounts recognized in its financial statements that arise from insurance
contracts;
b. the significant judgements, and changes in those judgements, made when
applying PFRS 17; and
c. the nature and extent of the risks that arise from insurance contracts.

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EXPLORE

EXPLAIN

2. Under an insurance contract, the party

that has the right to compensation if the
EVALUAT insured event occurs is referred to as the
insurer.
Answer:

3. Ms. Banana obtains a health insurance from Monkey Insurance Co. Monkey cedes
the insurance contract with Ms. Banana to Bacchus Insurance Co. The contract
between Monkey and Bacchus is referred to as a reinsurance contract .
Answer:
4. Ms. Banana obtains a health insurance from Monkey Insurance Co. Monkey cedes
the insurance contract with Ms. Banana to Bacchus Insurance Co. Ms. Banana is
referred to as the cedant.
Answer:
5. Ms. Banana obtains a health insurance from Monkey Insurance Co. Monkey cedes
the insurance contract with Ms. Banana to Bacchus Insurance Co. Monkey is referred
to as the reinsurer.
Answer:
Activity 2 – Multiple Choice Questions
1. The significant risk that is transferred from the policyholder to the issuer of an
insurance contract is:
A. lapse or persistency risk
B. financial risk
C. expense risk
D. insurance risk

2. Entity A obtains life insurance for its key employee from Entity B (an insurance
company). Entity B cedes the insurance contract with Entity A to Entity C, another
insurance company. The contract between Entity B and Entity C is a(an):
A. direct insurance contract
B. indirect insurance contract
C. reinsurance contract
D. retrocession

3. Entity A obtains life insurance for its key employee from Entity B (an insurance
company). Entity B cedes the insurance contract with Entity A to Entity C, another
insurance company. How should Entity C account for the insurance contract with
Entity B?
A. using the general model or the premium allocation approach

4. Which of the following statements is incorrect regarding the level of aggregation of

insurance contracts under PFRS 17?
A. insurance contracts are combined into portfolios and each portfolio is subdivided
into groups
B. each group may form a separate unit of account for purposes of applying the
recognition and measurement principles of PFRS 17
C. contracts that are onerous at initial recognition from a separate group
D. insurance contracts issued more than one year apart can be included in the
same group if they have similar risks

5. This refers to the legal principle that the insured must be benefited by the insured
property's existence and prejudiced by its destruction. It is a requisite in the
enforceability of an insurance contract.
A. Principle of insurable interest
B. Principle of utmost good faith
C. Principle of contribution
D. Principle of indemnity

6. This refers to the legal principle that all material facts concerning an insurance
contract must be made known to the contracting parties.
A. Principle of full disclosure
B. Principle of utmost good faith
C. Principle of contribution
D. Principle of indemnity

7. Mr. Pyromaniac obtained fire insurance for his house. During the year, Mr.
Pyromaniac's house was burned. The legal principle that prohibits Mr. Pyromaniac
from earning profit from the loss event is:
A. Principle of loss minimization
B. Principle of utmost good faith
C. Principle of insurable interest
D. Principle of indemnity

8. Mr. Pyromaniac obtained two fire insurances for his house. During the year, Mr.
Pyromaniac's house was burned. The legal principle that prohibits Mr. Pyromaniac
from collecting twice from his insurers in respect of the same loss event is:
A. Principle of subrogation
B. Principle of utmost good faith
C. Principle of contribution
D. Principle of indemnity

9. Afternoon Insurance Co. issues a group of insurance contracts on Dec. 19, 20x1. The
coverage period of the group starts on Jan. 1, 20x2 and the first premium from a

10.Which of the following does not form a separate presentation in the statement of
financial position?
A. reinsurance contracts issued that are liabilities
B. insurance contracts issued that are assets
C. insurance contracts issued that are liabilities
D. Reinsurance contracts held that are assets

MODULE 8: BUILD, OPERATE AND TRANSFER

Topic Learning Outcome:
 Understand and have basic knowledge in special issues such as build-operate-
transfer (BOT) using IFRIC 12 Service Concession Arrangements.

Learning Objectives:
 Define a build-operate-transfer arrangement that is within the scope of the
PFRSs.
 Account for build-operate-transfer arrangements.

INTRODUCTION
A service concession arrangement is an arrangement
whereby a government or other public sector body contracts
with a private operator to develop (or upgrade), operate and
maintain the grantor's infrastructure assets such as roads,
bridges, tunnels, airports, energy distribution networks, prisons,
or hospitals. The grantor controls or regulates what services the
operator must provide using the assets, to whom, and at what
price, and also controls any significant residual interest in the
ENGAGE assets at the end of the term of the arrangement.

The objective of IFRIC 12 is to clarify how certain aspects of existing IASB literature are
to be applied to service concession arrangements.

Two types of service concession arrangements

IFRIC 12 draws a distinction between two types of service concession arrangement.

1. the operator receives a financial asset, specifically an unconditional

contractual right to receive a specified or determinable amount of cash or
another financial asset from the government in return for constructing or

This category includes guarantees by the government to pay for any shortfall
between amounts received from users of the public service and specified or
determinable amounts.

2. The operator receives an intangible asset – a right to charge for use of a public
sector asset that it constructs or upgrades and then must operate and maintain
for a specified period of time.

A right to charge users is not an unconditional right to receive cash because the
amounts are contingent on the extent to which the public uses the service.

IFRIC 12 allows for the possibility that both types of arrangement may exist within a
single contract: to the extent that the government has given an unconditional
guarantee of payment for the construction of the public sector asset, the operator has
a financial asset; to the extent that the operator has to rely on the public using the
service in order to obtain payment, the operator has an intangible asset.

ACCOUNTING – FINANCIAL ASSET MODEL

The operator recognizes a financial asset to the extent that it has an unconditional
contractual right to receive cash or another financial asset from or at the direction of
the grantor for the construction services. The operator has an unconditional right to
receive cash if the grantor contractually guarantees to pay the operator
a. specified or determinable amounts or
b. the shortfall, if any, between amounts received from users of the public service
and specified or determinable amounts, even if payment is contingent on the
operator ensuring that the infrastructure meets specified quality or efficiency
requirements.

 The operator measures the financial asset at fair value.

ACCOUNTING – INTANGIBLE ASSET MODEL

The operator recognizes an intangible asset to the extent that it receives a right (a
license) to charge users of the public service. A right to charge users of the public
service is not an unconditional right to receive cash because the amounts are
contingent on the extent that the public uses the service.

 The operator measures the intangible asset at fair value.

Operating revenue
The operator of a service concession arrangement recognizes and measures revenue in
accordance with PFRS 15 for the services it performs.

Accounting by the government (grantor)

IFRIC 12 does not address accounting for the government side of service concession
arrangements. IFRSs are not designed to apply to not-for-profit activities in the private
sector or the public sector. However, the International Public Sector Accounting
Standards Board (IPSASB) has started its own project on service concession

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EXPLORE

EXPLAIN

Activity 1 – True or False

1. According to IFRIC 12, the grantor in a service concession
arrangement is usually a private entity.
Answer:

3. The operator recognizes a financial asset if the consideration in a service

concession arrangement is the right to collect fees from users of the public service.
Answer:

4. According to PFRS 15, a non-cash consideration in a contract is measured at fair

value.
Answer:

5. The operator in a build-operate-transfer contract can capitalize borrowing costs only

if the consideration in the contract is a financial asset.
Answer:

Activity 2 – Multiple Choice Questions

1. According to IFRIC 12, the services that an operator may be obliged to provide
under a service concession arrangement are:
A. Manufacturing services
B. Construction or upgrade services
C. Operation services
D. b and c

2. Build-Operate-Transfer contracts in the Philippines are governed by the Philippine

BOT Law or:
A. Republic Act No. 9298
B. Republic Act No. 7718
C. Republic Act No. 8424
D. Republic Act No. 1234

3. How should an operator subsequently measure a financial asset arising from a

service concession arrangement?
A. At amortized cost
B. At fair value through other comprehensive income
C. At fair value through profit or loss
D. Any of these

4. How should an operator in a BOT contract recognize the infrastructure asset before
it is handed over to the government?
A. As property, plant and equipment
B. As investment property
C. As a biological asset
D. Not recognized

Activity 3 – Computation of financial/intangible asset and revenue

Use the following information for the next three questions:
Bailey Sok, the operator, enters into a service concession agreement with Ken San
Jose, the grantor, for 10 years. The terms of the arrangement require an operator to
construct a road, completing construction within two years and maintain and operate
the road to a specified standard eight years (i.e. years 3-10). At the end of year 10, the
arrangement will end. The operator estimates that the costs it will incur to fulfill its
obligations will be:

Contract Costs Year Amount

Construction services 1 $500
2 500
Operation services 3-10 10

The terms of the arrangement require the grantor to pay the operator $200 per year
in years 3-10 for making the road available to the public. The total consideration
reflects the fair values for each services, which are:

Fair values of the consideration received or receivable:

Construction services Forecast cost + 5%
Operation services Forecast cost + 20%
Effective interest rate 6.18% per year

1. How much is the financial asset/intangible asset at end of year 2?

2. How much is the financial asset/intangible asset at end of year 3?
3. How much is the total revenue, excluding interest income in year 3?

MODULE 9: BUILD, OPERATE AND TRANSFER

Topic Learning Outcome:
 Comprehend nature and characteristic and apply knowledge on the accounting
of Instalment sales

Learning Objectives:
 State the applicability of the installment sales method of recognizing revenues.
 Apply the installment sales method.

The instalment sales method is a special case of revenue

recognition that deviates from the revenue recognition principles
ENGAGE of PFRS 15. This method may be used for taxation purposes or
when an entity is a micro entity and has opted to use the
income tax basis of accounting.

Installment sales contracts are unique types of credit transactions which provide the
buyer terms and conditions for a chain of payments over a period of time, usually in
months or even years. These types of sales are typical for real estate properties,
jewelry, automobiles, and appliances. Due to the considerable time involved on the
collection of the full amount for these types of sales, interest on the unpaid balance are
usually charged by the seller to the buyer.

INSTALLMENT SALES METHOD

Under the installment sales method of accounting, the difference between the selling
price and the cost of sale is recorded as deferred gross profit or unrealized gross profit.
This account is decreased every so often for the amount recognized as revenue in
proportion to the cash collection made on the sales price. Simply stated, the amount of
gross profit realized in a given period depends upon the gross profit rate on the sale
and the cash collections of installment receivables. At the end of each period, a
balance of deferred gross profit account may appear in the books. This balance is equal
to the gross profit rate multiplied by the balance of installment receivables as of this
date.

ILLUSTRATION:
Assume that on July 31, 2020 an installment sale of an appliance costing $120,000 was
made. The selling price was $150,000. A down payment of $50,000 was required, the
balance payable in twenty monthly payments of $5,000 at the end of each month.

The gross profit on this sale is $30,000 ($150,000 – $120,000) hence, the gross profit
rate is 20% ($30,000 / $150,000) of sales price. Using the installment method, the
computations of annual realized gross profit and deferred gross profit are shown below.

Realized Gross Deferred Gross

Profit Profit
Collection Rat Receivable Rat
Year s x e = RGP Balance, end x e = DGP
202 *$ 20% $12,00 $ 90,000 20% $18,00
0 60,000 0 0
202 60,000 20% 12,000 30,000 20% 6,000

*$50,000 down payment plus $10,000 ($5,000 x 2 months) installment collections.

Repossession
At times, customers default on installment contracts and collections could no longer be
made. In such instances, the seller has the option of repossessing the property sold to
discharge any remaining indebtedness.

When goods are acquired in second-hand condition as a result of repossessions and

trade-ins, they should be recorded at their estimated cash purchase prices. In some
companies, these prices are defined and made available to dealers.

The condition of the merchandise repossessed, the cost of reconditioning, and the
market for second-hand merchandise of that particular type must all be considered.
The objective should be to put any acquired asset on the books at its fair
value or, when the fair value is not ascertainable, at the best possible
approximation of fair value.

Some contend that repossessed merchandise should be entered at a valuation that will
permit the company to make its regular rate of gross profit on resale. If it is entered at
its approximate cost to purchase, the regular rate of gross profit could be provided for
upon its ultimate sale, but that is only a secondary consideration. It is more important
that the asset acquired by repossession be recorded at its fair value is in accordance
with the general practice of carrying assets at acquisition price as represented by the
fair market value at the date of acquisition.

The following procedures to record repossession may be used:

1. Record the repossessed merchandise in an appropriate inventory account at
“fair value.” For purposes of applying the installment method, fair value is
either:
a. The appraised value of the repossessed merchandise; or
b. Net realizable value (estimated selling price of the repossessed
merchandise minus reconditioning costs and selling costs) less normal
profit margin, at the date of repossession.
2. Write-off the balance of the deferred gross profit relating to the receivable.
3. Recognize any resulting gain or loss on repossession.
- Ordinarily, however, conservatism would suggest that no more than
unrecovered cost, the difference between the receivable balance and the
deferred gross profit balance, be assigned to repossessed merchandise. No
gain, then, would be reported at the time of repossession. Recognition of any
gain would await the sale of the repossessed merchandise.
4. Cancel the uncollected installment receivable balance of the defaulted contract.

ILLUSTRATION:
Assume the following data with respect to a default and repossession on July 31, 2020:

The loss on repossession may be computed as follows:

Estimated Selling Price of the Repossessed $12,00

Merchandise 0
Less: Reconditioning Costs $
2,500
Normal Profit Margin (30% x $12,000) 3,600 6,100
Market Value before Reconditioning Costs $
5,900
Less: Unrecovered Cost -
Installment Contracts Receivable $10,00
0
Less: Deferred Gross Profit (30% x $10,000) 3,000 7,000
Loss on Repossession ($1,10
0)

The entry to record the repossession on July 31, 2020, assuming a periodic inventory
system, is as follows:

Repossessed Merchandise 5,900

Deferred Gross Profit – 2020 3,000
Loss on Repossession 1,100
Installment Contracts Receivable – 2020 10,000

The entry to record the reconditioning cost amounting to $2,500, assuming a periodic
inventory system, is as follows:

Repossessed Merchandise 2,500

Cash or Accounts Payable 10,000

Notice that the reconditioning cost is capitalized as cost of the repossessed

merchandise. The repossessed merchandise amounting to $8,400 (market value
before reconditioning costs of $5,900 plus $2,500 reconditioning costs) is reported in
the income statement as addition to purchases to arrive at the total goods available for
sale. If the repossessed merchandise remains unsold, it is included as part of the
ending inventory in the statement of financial position and income statement.

Default by a customer followed by the repossession of the merchandise may occur in

the period of sale when the gross profit rate for the year is not yet known. Under these
circumstances, two steps may be used in recording the repossession, as follows:

1. On the date of repossession, record the repossessed merchandise in an

appropriate account with a corresponding credit to Loss on Repossession.

Using the same information above, except for the estimated selling price of the
repossessed merchandise amounted to $15,000, the procedures to record the
repossession will be as follows:

The loss on repossession may be computed as follows:

Estimated Selling Price of the Repossessed $15,00

Merchandise 0
Less: Reconditioning Costs $
2,500
Normal Profit Margin (30% x $12,000) 4,500 7,000
Market Value before Reconditioning Costs $
8,000
Less: Unrecovered Cost -
Installment Contracts Receivable $10,00
0
Less: Deferred Gross Profit (30% x $10,000) 3,000 7,000
Gain on Repossession $
1,000

The entry to record the repossession on July 31, 2020, assuming a periodic inventory
system, is as follows:

Repossessed Merchandise 8,000

Deferred Gross Profit – 2020 3,000
Gain on Repossession 1,000
Installment Contracts Receivable – 2020 10,000

If the repossessed merchandise is recorded at a value in excess of $7,000, the

difference between the balance in the installment contracts receivable account and the
deferred gross profit account, a gain will be reported on the repossession.

Ordinarily, however, conservatism would suggest that no more than unrecovered cost,
the difference between the receivable balance and the deferred gross profit balance, be
assigned to repossessed merchandise. No gain, then, would be reported at the time of
repossession. Recognition of any gain would await the sale of the repossessed
merchandise.

Any gain or loss on defaults and repossessions is normally recognized on the income
statement as an addition to or subtraction from the realized gross profit on installment
sales and the resulting balance is labeled as “Total Realized Gross Profit after Gain or
Loss on Repossession.”

Case 1: Trade-in value is equal to actual value. Normally, trade-in value allowed
to a customer is the amount charged to the asset traded-in provided the amount is
realistic and indicative of the fair market value or net realizable value of the item. Net
realizable value is the value of the old merchandise traded-in after the provisions of
expected costs to recondition, cost of disposal and a normal profit upon its resale are
taken into account.

No problem is encountered when the value assigned to the old merchandise traded-in
is equal to its net realizable value. Merchandise Inventory – Traded-In is debited for the
net realizable value of the traded-in merchandise (which, at this time, is equal to its
trade-in value), Cash is debited for any cash payment accompanying the trade-in,
Installment Contract Receivable is debited for the balance of the sales price, and
Installment Sales is credited for the full amount of the sales price.

Illustration:
Assume that on July 31, 2020, the Road Company sells a car for an installment price of
$870,000. The car costs $696,000. The customer trades-in his old car and is given a
trade-in value $270,000 for his old car. He makes a down payment of $240,000 and the
balance to be paid in twelve equal installments is $30,000 each. It is estimated that the
old car can be sold for $420,000 after incurring reconditioning expenses estimated at
$66,000. The company usually makes a gross profit of 20% on resale.

The computation below shows that the trade-in value is equal to its actual value.

Trade-in value allowed to customer $270,00

0
Less: Market value before reconditioning
costs
Estimated resale value $420,00
0
Less: Reconditioning cost $66,00
0
Normal profit margin (20%) 84,000 150,000 270,000
Difference -

The entry to record the sale of the new car is:

Case 2: Trade-in value is greater than net realizable value. At times, the trade-in
value given to the customer is greater than the realizable value of the item received
from him as a special inducement to the customer. Accounting problem arises if the
seller grants an over allowance on the used merchandise taken in. Over allowance is
the excess of the trade-in value granted over the net realizable value of the used
merchandise. The amount of the over allowance may be recorded either as a charge to
Over Allowance on Trade-In account or as a reduction from Installment Sales account to
arrive at a valid amount for the net sales price.

Illustration:
Assume the same example from Case 1 except that the trade-in value given for the car
amounted to $275,000. The net realizable value of the merchandise traded-in and the
amount of the over allowance may be computed as follows:

Trade-in value allowed to customer $275,00

0
Less: Market value before reconditioning
costs
Estimated resale value $420,00
0
Less: Reconditioning cost $66,00
0
Normal profit margin (20%) 84,000 150,000 270,000
Over allowance $
5,000

Assuming the over allowance is charged to Over Allowance on Trade-In account and the
perpetual inventory system is used, the journal entry to record the sale of the new
merchandise is:

Merchandise Inventory - traded-in 270,000

Over Allowance on Trade-In 5,000
Cash 240,000
Installment Contracts Receivable, 2020 360,000
Installment Sales 875,000

The gross profit rate on the installment sale is computed as follows:

Installment sales $875,000

Less: Over allowance 5,000
Net installment sales $870,000
Less: Cost of installment sales 696,000
Gross profit $174,000

Gross profit rate ($174,000/$870,000) 20%

Note: In instances where an under allowance would result from the trade-in transaction
(the trade-in value allowed to customer is less than the net realizable value of the
merchandise traded-in), the under allowance is treated as an addition to the selling
price of the new merchandise for which the old merchandise is traded-in.

Merchandise Inventory – Traded-In is presented in the Statement of Financial Position as

part of the ending inventory. When a periodic inventory system is used, trade-ins are
recorded in a separate nominal account, and this balance is added to purchases in
determining cost of goods sold at the end of the period.

Allocation of Cost of Goods Sold

Companies selling on installment basis typically also have cash sales and sales on
short-term credit. Employing the perpetual inventory system poses no problem as the
cost of each type of sale is determined and recorded at the same time with the
recording of the sales transaction. However, if the company uses the periodic or
physical inventory system in the determination of cost, proper allocation of the total
cost of goods sold among the different types of sales may cause problems. The
procedures to be followed in allocating the cost of goods sold would depend upon the
circumstances and information available.

ILLUSTRATION:
Beta Company sells merchandise for cash, charge and on installment basis. The
company employs the periodic inventory system in determining costs. At the end of
2020, the following information is available:

Cash sales $ 600,000

Charge sales 1,200,000
Installment sales 3,000,000
Merchandise inventory, January 1 480,000
Purchases 2,900,000
Freight-in 120,000
Repossessed merchandise 140,000
Merchandise inventory, December 31 520,000

Based on the above data, the cost of goods sold to be allocated is computed below:

Merchandise Inventory, January 1 $

480,000
Add: Purchases $
2,900,000

Case 1: If no additional facts are known other than the data given above, the cost of
goods sold must be allocated according to the ratio of each type of sale to total sales,
shown as follows:

Amount Allocated
Type of Sale of Sales Ratio to Cost
Total
Cash $ 600/4,800 $
600,000 390,000
Charge 1,200,000 1,200/4,800 780,000
Installment 3,000,00 3,000/4,800 1,950,00
0 0
$ $
4,800,000 3,120,000

The allocation would be fairly valued if the selling prices of the goods are the same
regardless of the type of sale. However, it is normal to have different selling prices for
every type of sale.

Case 2: Assume that the selling prices for charge and installment sales of Beta
Company are higher than the cash sales price by 20% and 25%, respectively. The
relevant sales figures must be expressed in terms of the cash sales price in order to
obtain a valid ratio. The allocation of the cost of goods sold should be based on cash
price as presented below:

Amount
Based
Amount of on Ratio to Allocated
Type of Sale Sales Cash Sales Total Cost
Cash $ $ 600,000 600/4,000 $
600,000 468,000
Charge 1,200,000 1,000,000a 1,000/4,000 780,000
Installment 3,000,00 2,400,000b 2,400/4,000 1,872,00
0 0
$ $ 4,000,000 $
4,800,000 3,120,000
a
$1,200,000 / 120% = $1,000,000
b
$3,000,000 / 125% = $2,400,000

Case 3: If the mark-up or gross profit percentage on cost price or sales price is known,
the allocation will be a simple matter. Assume that Beta Company’s gross profit rates

Amount of Gross Profit Gross Allocated

Type of Sale Sales Rate Profit Cost*
Cash $ 25% $ $
600,000 150,000 450,000
Charge 1,200,000 35% 420,000 780,000
Installment 3,000,00 37% 1,110,00 1,890,00
0 0 0
$ $1,680,00 $3,120,0
4,800,000 0 00
*Sales less Gross Profit

COST RECOVERY METHOD

Under this method gross profit is not recognized until collections are equal to the
amount of cost of goods sold. That is, all collections, both interest and principal
portions are treated first as recovery of the property costs. After the recovery of the full
cost, all collections are regarded as realization of gross profit. This deferral of gross
profit until cost is fully recovered is too conservative. This method is probably most
applicable in the sale of services or products of a nature which does not permit
repossessions and when the customers’ notes have no fair market value.

A summary of the topic is presented via power point presentation

to explain further the information from the materials in the context
that you would understand. Additional assignments and lecture
notes via Google classroom may also be given.

Note: A copy of the power point presented in the google classroom.

EXPLORE

EXPLAIN

2. Under the installment

sales method, the
EVALUAT deferred gross profit at
any given point in time may be determined by multiplying the
balance of receivable by the gross profit rate.
Answer:

3. Monkey Company uses the installment sales method. Monkey buys a banana for $2 and
sells it for $10. If Monkey collects $1 from the sale, Monkey's realized gross profit is $0.50.
Answer:

4. Monkey Company uses the installment sales method. Monkey buys a banana for $2 and
sells it for $10. If the ending balance of Monkey's installment receivable is $5, the deferred
gross profit is $4.
Answer:

5. Monkey Company uses the installment sales method. Monkey buys a banana for $2 and
sells it for $10. If the ending balance of Monkey's installment receivable is $3, the total
collections during the period must be $7.
Answer:

Activity 2 – Multiple Choice Questions

1. Groovy Co., a big corporation domiciled in the Philippines, enters into a 3-year
contract with a customer. At contract inception, Groovy assesses the customer's
ability and intention to pay the consideration in the contract and concludes that the
collectibility of the consideration is significantly uncertain. For financial reporting,
Groovy should do all of the following except:
A. not recognize any revenue until the criteria under PFRS 15 are met
B. recognize any consideration received from the contract as liability
C. reassess the contract in subsequent periods using the guidance in PFRS 15
D. apply the installment sales method

2. Which of the following methods of recognizing revenue is in accordance with the

principles of the PFRSs?
A. Installment sales method - Yes; Cost recovery method – Yes

3. Which of the following equations is incorrect regarding the installment sales

method?
A. Realized gross profit = gross profit rate x collection
B. Ending receivable = sales price – collection
C. Deferred gross profit = ending receivable x gross profit rate
D. Gross profit rate = ending receivable / deferred gross profit

4. Merchandise received as trade-in is recognized at:

A. trade-in value
B. fair value
C. current cost
D. original cost

5. Cash collection is a critical event for income recognition in the:

A. Installment sales method - Yes; Cost recovery method – Yes
B. Installment sales method - No; Cost recovery method – Yes
C. Installment sales method - Yes; Cost recovery method – No
D. Installment sales method - No; Cost recovery method - No

Activity 4 – Computation of realized gross profit

Pepe Company started operations on January 2, 2013. The following information is
gathered for 2013:

Installment accounts receivable, December 31 P5,250,000

Deferred gross profit, Dec. 31 (before adjustment) 3,675,000
Gross profit rate based on sales 25%

What is the realized gross profit on sales for 2013?

Activity 5 – Computation of realized gross profit

Gross profit rates of Baby Company were 35%, 33% and 30% for installment sales for
2011, 2012 and 2013, respectively. The following account balances are available at the
end of 2013.

Installment Deferred gross

Year of account profit (before
Sales receivable adjustment)
2011 P 21,000 P 25,305
2012 215,250 212,625
2013 682,500 420,525

What is the total realized gross profit to be reported in the Income Statement for the
year ended December 31, 2013?

Deferred gross profit balance (After Adjustment) P1,111,000

Total collections on installment sales 2,420,000
Gross profit rate based on cost 25%

Scooby, Inc. uses the installment method of accounting. What is Scooby’s total
installment sales for 2010?

Activity 7 – Computation of net income

Ram Corporation sells cars with a three-year installment sales contract. The December
31, 2010 results of Ram’s first year of operations, before adjustment are summarized
below:
Installment Sales P5,500,000
Cost of installment sales 3,850,000
Operating expenses 440,000

The total collections during the year, including interest and financing charges of
P550,000, is P2,750,000. What is the net income of Ram Corporation for the year
ended December 31, 2010?

Activity 8 – Computation of deferred gross profit

Bibingka, Inc. recently started operations. The company appropriately uses the
installment method of accounting. The following information pertains to Bibingka’s
operations for the year:

Installment sales P 6,500,000

Regular sales 3,900,000
Cost of installment sales 3,250,000
Cost of regular sales 1,950,000
Operating expenses 650,000
Collections on installment sales 1,300,000

In its December 31, current Statement of Financial Position, what amount should
Bibingka, Inc. report as deferred gross profit?

Activity 9 – Computation of deferred gross profit

Alien Company began operations on January 3, 2009 and appropriately used the
installment sales method of revenue recognition. The following information pertains to
Alien Company’s operations for 2009 and 2010:

2009 2010
Sales P750,00 P1,125,0
0 00

What amount should Alien Company report as deferred gross profit in its December 31,
2010 Statement of Financial Position for 2009 and 2010 sales?

Activity 10 – Computation of deferred gross profit

On January 2, 2010, Arrow Company sold a car to Mr. Reginales for P1,575,000. On this
date, the car cost P1,102,500. Mr. Reginales paid P225,000 as down payment and
signed a P1,350,000 interest bearing note at 10 percent. The note was payable in three
annual installments of P450,000 beginning January 1, 2011. Mr. Reginales made a
timely payment for the first installment on January 1, 2011 of P585,000 which included
interest of P135,000 to date of payment.

Arrow Company uses the installment method of accounting. In its December 31, 2011
Statement of Financial Position, what amount should Arrow Company report as deferred
gross profit?

Activity 11 – Computation of income using cost recovery method

The following information pertains to sale of real estate by Construction Corporation on

December 31, 2010:

Sales price:
Cash down-payment P 300,000
Mortgage Payable 2,700,000
Cost 2,000,000

The mortgage payable is to be paid in nine annual installments of P300,000 beginning

December 31, 2011 plus interest of 10 percent. The December 31, 2011 installment
was paid as scheduled, together with interest of P270,000. Construction Corporation
uses the cost recovery method of revenue recognition. What amount of income
(excluding interest) should Construction Corporation recognize in 2011 from the sale of
real estate?

Activity 12 – Computation of income using cost recovery method

On December 31, 2010, Clark Inc. sold construction equipment to Build Company for
P3,600,000. The equipment had a cost of P2,400,000. Build Company paid P600,000
cash on December 31, 2010 and signed a P3,000,000 interest bearing note at 10
percent payable in five annual installments of P600,000. Clark Inc. appropriately
accounted for the sale under the installment method.

Activity 13 – Computation of realized gross profit

The books of Power Co reflected following balances on December 31, 2010:

Accounts Receivable P942,250

Deferred Gross Profit (before adjustment) 114,000

Analysis and aging of the accounts receivable reveal the following:

Regular Accounts P622,500

2009 installment accounts 48,750
2010 installment accounts 270,000

Sales on an installment basis in 2009 were made at 30 percent above cost, in 2010, at
33 1/3 percent above cost. What is the total realized gross profit for the year ended
December 31, 2010?

REFERENCES
International Accounting Standards (IAS) and Philippine Accounting Standards (PAS)
International Financial Reporting Standards (IFRS) and Philippine Financial Reporting
Standards (PFRS) International Financial Reporting Interpretations Council (IFRIC) and
Philippine Financial Reporting Interpretations Council (PFRIC) / “Interpretations”

Dayag, A. J. (n.d.). Advanced Financial Accounting (A comprehensive and procedural

approach) (2018 ed., Vol. 1). Philippines: Lajara Publishing House.

Guerrero, P. P., & Peralty, J. F. (n.d.). Advanced Accounting Principles and Procedural
Applications (2017 ed., Vol. 1). Philippines: GIC Enterprises and Company.

Millan, Z. B. (2018). Accounting for Special Transactions (Advanced Accounting 1).

Baguio City: Bandolin Enterprise.

Electronic Sources International Financial Reporting Standards. (n.d.). IFRS. Retrieved

from IFRS.org: https://www.ifrs.org

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