Break the chain of COVID19 Infection

 Wear face mask

 Frequent hand washing
 Proper hygiene
 Use alcohol and sanitizer
 Always observe physical distancing
 Cover your mouth when coughing and sneezing

Finals

University Vision
A synergistic multi-campus university producing competent, value laden and globally competitive
graduates who are proactive in promoting the socio-economic prosperity of the country.

University Mission
The University shall primarily provide advanced education, higher technological professional instruction and
training in the fields of agriculture, arts and sciences, business and industry, computer and information
technology, education, engineering, environmental sciences, fisheries, forestry, law and criminal justice,
medicine and allied sciences and other related fields of study. It shall intensify its research, extension and
production functions and provide progressive leadership in its areas of specialization.

Core Values
Excellence
Integrity
Accountability

Quality Policy
We commit to provide quality instruction, research, extension and production grounded on excellence,
integrity and accountability as we move towards exceeding stakeholders’ satisfaction in compliance with relevant
requirements and well-defined continual improvement measures

“Dekalidad na edukason, Kinabuhi na mainuswagon”

Subject Teacher’s Contact Details

Name : FRANCES JOSIE P. GILBER, CPA

Contact No. : 09357654215
Email Address : [email protected]

Preliminary Activity:

A. Vision and Mission

 What personal and professional qualities should you possess to become globally competitive
graduate?
 How will the University prepare you to become professional in your chosen field of
specialization?
B. Course Content, Requirements and Marking System (Please read the course guide)

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Name: ___________________________________________ Course & Year: _______________ Date of Submission: __________
Course Code: AIS 122 Descriptive Title: Intermediate Accounting 1

Lesson 6. Accounting for Inventories (REVIEW)

Introduction
Inventories are the core of merchandising and manufacturing companies whose main source of income is via sales.
In lay man’s terms, we identify inventories as the grocery items, the clothes, shoes, and all other items that can be bought
in the hypermarket. In accounting, however, inventories are defined in a broader sense. To add, the Philippine Accounting
Standards provides the guidelines applied when accounting for inventories.
In this lesson, we will discuss inventories, how businesses record inventories, different costing systems used in
accounting for inventories, various inventory estimation methods in case of loss, presentation and disclosure requirements
in reporting inventories in the financial statements and the internal controls placed to regulate and safeguard company
inventories.
Learning Outcomes:
At the end of this lesson, you are expected to:
1. define and classify inventories,
2. apply recognition and measurement criteria in recording inventories,
3. record inventories under the perpetual inventory system and the periodic inventory system,
4. determine inventory costs under the different inventory costing systems,
5. determine estimates of inventory losses using the gross profit method and the retail inventory method, and
6. cite internal control policies for inventories.

LESSON PROPER
A. Definition, Recognition, and Measurement
Definition
PAS 2 defines inventories as “assets held for sale in the ordinary course of business, in the process of production for
such sale or in the form of materials or supplies to be consumed in the production process or in the rendering of service.”
The PAS 2 definition provides the criteria of what assets classify as inventories.
For example, the inventories of a merchandising company engaged in the buying and selling of grocery items are
the grocery items (as this is the ordinary course of business of the company). When this company sells their warehouse, the
warehouse sold is not considered as inventory as the company’s ordinary course of business does not involve the buying
and selling of warehouses. On the other hand, for a real estate company engaged in the trade of real properties, real
properties are their inventories. Another example would be the food industry. Inventories of companies belonging in the
food industry includes not just the food they sell but also the raw materials purchased by the business.
*Note: Inventories are then comprised of goods purchased and held for resale, finished goods (goods that have completed
production and are ready for sale), goods in process (goods that have undergone processing but are only partially
completed), and raw materials (goods that are to be used in production).
Initial Recognition
Inventories are initially recorded at cost. Below are the costs recorded for inventories:
a. Cost of purchase – comprises the “purchase price, import duties and irrecoverable taxes, freight, handling and other
costs directly attributable to the acquisition of finished goods, materials, and services.” Furthermore, “trade discounts,
rebates and other similar items are deducted in determining the cost of purchase.”
b. Cost of conversion – includes cost directly attributed to the goods processed such as direct materials, direct materials
and their allocated share on the overhead costs.
c. Other costs – included in the cost of inventories only to the extent that said expenses were incurred to bring the
inventories in their present location and condition.
Subsequent Measurement
PAS 2, paragraph 9, provides that “inventories shall be measured at the lower of cost and Net Realizable Value
(NRV).” This means that inventories are subsequently recorded (normally at year-end) or adjusted to the lower of cost and
NRV. Cost pertains to the initial recorded amount whereas the NRV refers to the “estimated selling price in the ordinary
course of business less the estimated cost of completion and the estimated cost of disposal.” The NRV simply means the
price by which the inventory can be sold in the market less the costs to sell. As the value of inventories sometimes move
down depending on market factors, adjusting the cost of inventories to NRV makes the information reported in the financial
statements more accurate. The LCNRV will be discussed more below (on section E).

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B. Inventory Recording Systems
Companies record inventories under two systems – the perpetual inventory system and the periodic inventory
system. The two systems yield out the same cost of sales and the same ending inventory.
a. Perpetual Inventory System
The perpetual inventory system does not make use of purchase accounts. Rather, this system makes use of inventory
accounts and records a journal entry for cost of sales and the responding deduction to inventory for every sale recorded.
Ideally, the inventories recorded under the perpetual system matches the physical count of current inventories kept by
the company. Hence, conducting physical counts although encouraged are not required. The company’s ending
inventory balance is based on company records. In addition, this system is preferable for companies with large-peso
investments.
b. Periodic Inventory System
Unlike the perpetual inventory system, the periodic inventory system makes use of purchase, freight in and purchase
returns accounts. Conversely, the cost of sales is determined when the company conducts periodic inventory counts (in
order to determine the ending inventory balance). Inventory counts are a must under this system as the ending balance
of inventories are determined during the physical count. In addition, this system is mostly used to account for small
peso investments.
See pro-forma journal entries below prepared under both systems for varying inventory transactions.
Transaction Perpetual Inventory System Periodic Inventory System
Purchase of goods Merchandise Inventory xxx Purchases xxx
Accounts Payable or Cash xxx Accounts Payable or Cash xxx
Payment of freight Merchandise Inventory xxx Freight in xxx
Cash xxx Cash xxx
Return of merchandise to Accounts Payable xxx Accounts Payable xxx
supplier Merchandise Inventory xxx Purchase Returns xxx
Sale of goods Accounts Receivable xxx Accounts Receivable xxx
Sales xxx Sales xxx
Cost of Sales xxx No entry for Cost of Sales
Merchandise Inventory xxx
Return of merchandise Sales Return xxx Sales Return xxx
from customers Accounts Receivable xxx Accounts Receivable xxx
Merchandise Inventory xxx No entry for Cost of Sales
Cost of Sales xxx
Adjustment of ending Merchandise Inventory – End xxx
No entry
inventory Income Summary xxx
In addition, cost of sales is determined in the periodic inventory system using the following formula:
Beginning Inventory Pxxx
Add: Purchases xxx
Freight in xxx
Less: Purchase Returns (xxx)
Purchase Allowances (xxx)
Net Purchases xxx
Cost of goods available for sale xxx
Less: Ending Inventory (xxx)
Cost of Sales xxx

C. Inventory Costing System

Inventories, especially small-peso value inventories, are ordered and stored in bulk. Keeping track of inventory costs
becomes challenging. Hence, companies use various inventory costing methods to assign costs to their inventories.
PAS 2 expressly states that the cost of inventories can be determined by using either the FIFO method, average cost
method, moving average method, and specific identification. In addition, the standard expressly states that the Last in,
First out (LIFO) method is no longer permitted to be used in inventory costing as this method permits income
manipulation.
a. First in, First out (FIFO)
Under this inventory costing method, inventories that are bought first are sold first. Under this method,
inventory cost using either periodic method or perpetual method yields the same value.

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 Example:
Tonks Co. sells mountain bikes. The beginning balance of inventory and purchases made by the company for
the month of November are as follows:
October 31 500 units @ PHP6,000 per unit
Purchases:
November 4 300 units @ PHP5,400 per unit
November 10 300 units @ PHP6,200 per unit
November 20 700 units @ PHP5,200 per unit
Sold:
November 3 400 units @ PHP8,000 per unit
November 5 200 units @ PHP8,000 per unit
November 18 300 units @ PHP8,000 per unit
November 20 500 units @ PHP8,000 per unit
Solve for the following:
(1) How much is the company’s total sales for the month of November?
(2) How much is it’s ending inventory in units and in peso?
(3) How much is its total cost of goods available for sale (or COGAS)?
(4) How much is its cost of sales?

Solution:
(1) Total sales:
November 3 (400 units @ PHP8,000 per unit) = PHP 3,200,000
November 5 (200 units @ PHP8,000 per unit) = 1,600,000
November 18 (300 units @ PHP8,000 per unit) = 2,400,000
November 20 (500 units @ PHP8,000 per unit) = 4,000,000
11,200,000

(2) Ending Inventory:

Units: PHP:
Beg. Inventory 500 Beg. Inventory PHP 3,000,000
Purchases: Purchases:
Nov. 4 300 Nov. 4 1,620,000
Nov. 10 300 Nov. 10 1,860,000
Nov. 20 700 Nov. 20 3,640,000
COGAS 1,800 COGAS 10,120,000
Less: Less:
Sales (1,400) Sales (8,040,000)
Endg. Inventory 400 units Endg. Inventory 2,080,000

Or, 400 units multiplied by the latest price (400 x 5,200 = 2,080,000).
(3) COGAS:
Beg. Inventory 500 @ PHP 6,000 = PHP 3,000,000
Purchases:
Nov. 4 300 @ PHP 5,400 = 1,620,000
Nov. 10 300 @ PHP 6,200 = 1,860,000
Nov. 20 700 @ PHP 5,200 = 3,640,000
COGAS 1,800 units PHP 10,120,000
(4) COS:
Beg. Inventory PHP 3,000,000
Net Purchases 7,120,000
COGAS 10,120,000
Less:
Endg. Inventory (2,080,000)
Cost of Sales 8,040,000

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 b. Average cost method
Under this method, the cost of inventory per unit is computed by dividing COGAS by the total number of units
available for sale. Also called average cost method for periodic inventory system.
Example:
Tonks Co. sells mountain bikes. The beginning balance of inventory and purchases made by the company for
the month of November are as follows:
October 31 500 units @ PHP6,000 per unit
Purchases:
November 4 300 units @ PHP5,400 per unit
November 10 300 units @ PHP6,200 per unit
November 20 700 units @ PHP5,200 per unit
Sold:
November 3 400 units @ PHP8,000 per unit
November 5 200 units @ PHP8,000 per unit
November 18 300 units @ PHP8,000 per unit
November 20 500 units @ PHP8,000 per unit
Solve for the following:
(1) How much is it’s ending inventory in units and in peso?
(2) How much is its total cost of goods available for sale (or COGAS)?
(3) How much is its cost of sales?
Solution:
First, compute for the unit cost of inventory:
Beginning Inventory 500 units @ PHP6,000 per unit = 3,000,000
Purchases:
November 4 300 units @ PHP5,400 per unit = 1,620,000
November 10 300 units @ PHP6,200 per unit = 1,860,000
November 20 700 units @ PHP5,200 per unit = 3,640,000
COGAS 10,120,000
Divided by total number of inventory (units) ÷ 1,800
Unit cost 5,622.22

(1) Ending Inventory:

Beg. Inventory 500
Purchases:
Nov. 4 300
Nov. 10 300
Nov. 20 700
COGAS 1,800
Less:
Sales (1,400)
Endg. Inventory 400 units x 5,622.22 = 2,248,888
(2) COGAS = 10,120,000 (see computation above)
(3) COS: 1,400 units sold x 5,622.22 = 7,871,108
c. Moving average cost method
Under this method, “a new weighted average unit cost must be computed after every purchase and purchase
return. This method is also called average cost method for perpetual inventory system.
Example:
Tonks Co. sells mountain bikes. The beginning balance of inventory and purchases made by the company for
the month of November are as follows:
October 31 500 units @ PHP6,000 per unit
Purchases:
November 4 300 units @ PHP5,400 per unit
November 10 300 units @ PHP6,200 per unit
November 20 700 units @ PHP5,200 per unit
Sold:
November 3 400 units @ PHP8,000 per unit
November 5 200 units @ PHP8,000 per unit

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 November 18 300 units @ PHP8,000 per unit
November 20 500 units @ PHP8,000 per unit
Solve for the following:
(1) How much is it’s ending inventory in units and in peso?
(2) How much is its total cost of goods available for sale (or COGAS)?
(3) How much is its cost of sales?
Solution:
Date Transaction Units Price Details Amount Unit Cost
Oct. 31 Beg. Balance 500 units @ PHP 6,000 per unit PHP 3,000,000
Nov. 3 Sale (400 units) (400 units x 6,000) (2,400,000)
Total Cost 100 units 600,000
Nov. 4 Purchase 300 units @ PHP 5,400 per unit 1,620,000
Total Cost 400 units PHP 2,220,000
Cost per unit (PHP 2,220,000/400 units) 5,550.00
Nov. 5 Sale (200 units) (200 units x 5,550) (1,110,000)
Total Cost 200 units 1,110,000
Nov. 10 Purchase 300 units @ PHP 6,200 per unit 1,860,000
Total Cost 500 units 2,970,000
Cost per unit (PHP 2,970,000/500 units) 5,940.00
Nov. 18 Sale (300 units) (300 units x 5,940) (1,782,000)
Total Cost 200 units 1,188,000
Nov. 20 Purchase 700 units @ PHP 5,200 per unit 3,640,000
Total Cost 900 units 4,828,000
Cost per unit (PHP 4,828,000/900 units) 5,364.44
Nov. 20 Sale (500 units) (500 units x 5,364.44) (2,682,220)
Endg. Inventory 400 units 2,145,780

(1) See computation above. Endg. Inventory units = 400 units; in PHP = 2,145,780.
(2) See computation above. Cost of goods available for sale = PHP 10,120,000.
(3) See computation above. Cost of sales = PHP 7,947,220.

d. Specific identification
Under this method, specific costs are attributed to identified items of inventory. The cost of inventory, just like
the FIFO method, is determined by multiplying the units on hand by their actual unit cost. As the actual unit
costs are used in the determination of inventory costs, this method requires strict record-keeping of purchase
orders, invoices, and official receipts to determine the value of inventory on hand, cost of goods sold, and cost
of goods available for sale. This method can be used in either the periodic or perpetual method. In addition,
inventory cost flow corresponds with the actual flow of goods. PAS 2 provides that this “method is appropriate
for inventories that are segregated for a specific project and inventories that are ordinarily interchangeable.”

D. Inventory Estimation Method

Valix, et.al. provides three main reasons why companies estimate inventories. They are as follows:
1. Inventory loss due to fire or other catastrophe and theft. Amount of inventory loss must be provided for insurance
purposes.
2. Necessary to test correctness or reasonableness of physical count of goods on hand.
3. Company prepares interim financial statements and physical count of goods is costly to conduct, hence, the need
for the estimate.
Furthermore, there are two methods to estimate inventories:
a. Gross profit method
The gross profit method is only applicable when it is reasonable to assume that the company’s gross profit rate
(GPR) is relatively constant. (Gross Profit is the difference between sales and cost of sales.) The formula used to
estimate ending inventory is: 𝐸𝑁𝐷𝐼𝑁𝐺 𝐼𝑁𝑉𝐸𝑁𝑇𝑂𝑅𝑌 = 𝐶𝑂𝐺𝐴𝑆 − 𝐶𝑂𝑆 . In addition, the GPR is used to compute
for COS. Note that the GPR can either be based on sales or based on COS. Moreover, sales allowance and sales
discount is not deducted from sales when determining the cost of sales rather sales return is deducted as this
causes actual movement of the inventory.

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 Example (Adapted):
On December 31, 2020, a fire destroyed most of the merchandise inventory of a company. All goods were
completely destroyed except for partially damaged goods that normally sell for PHP150,000 and had an
estimated net realizable value of PHP50,000 and undamaged goods that normally sell for PHP500,000.
Inventory, 01/01/2020 400,000
Net Purchases for 2020 5,200,000
Net Sales for 2020 6,000,000
Total 2019 2018 2017
Net sales 10,000,000 5,000,000 3,000,000 2,000,000
Cost of goods sold 7,500,000 3,750,000 2,250,000 1,500,000
Gross profit 2,500,000 1,250,000 750,000 500,000
What is the estimated amount of fire loss on December 31, 2020?
Solution:
First, compute for the company’s gross profit rate:
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 𝑅𝑎𝑡𝑒 = ((𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 − 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑))/(𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠)
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 𝑅𝑎𝑡𝑒 = ((10,000,000 − 7,500,000))/10,000,000
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 𝑅𝑎𝑡𝑒 =. 𝟐𝟓 𝒐𝒓 𝟐𝟓%
Next, compute for COGAS:
𝐶𝑂𝐺𝐴𝑆 = 𝐵𝑒𝑔. 𝐼𝑛𝑣𝑡𝑦. +𝑁𝑒𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
𝐶𝑂𝐺𝐴𝑆 = 400,000 + 5,200,000
𝐶𝑂𝐺𝐴𝑆 = 𝟓, 𝟔𝟎𝟎, 𝟎𝟎𝟎
Then, compute for COS:
𝐶𝑂𝑆 = 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 𝑥 (1 − 𝐺𝑃𝑅)
𝐶𝑂𝑆 = 6,000,000 𝑥 75%
𝐶𝑂𝑆 = 𝟒, 𝟓𝟎𝟎, 𝟎𝟎𝟎
Fourth, compute for the Ending Inventory:
𝐸𝑛𝑑𝑔. 𝐼𝑛𝑣𝑡𝑦. = 𝐶𝑂𝐺𝐴𝑆 − 𝐶𝑂𝑆
𝐸𝑛𝑑𝑔. 𝐼𝑛𝑣𝑡𝑦. = 5,600,000 − 4,500,000
𝐸𝑛𝑑𝑔. 𝐼𝑛𝑣𝑡𝑦. = 𝟏, 𝟏𝟎𝟎, 𝟎𝟎𝟎
Lastly, compute for the Inventory Loss:
𝐼𝑛𝑣𝑡𝑦. 𝐿𝑜𝑠𝑠 = 𝐸𝑛𝑑𝑔. 𝐼𝑛𝑣𝑡𝑦. −𝑁𝑒𝑡 𝑅𝑒𝑎𝑙𝑖𝑧𝑎𝑏𝑙𝑒 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐷𝑎𝑚𝑎𝑔𝑒𝑑 𝐺𝑜𝑜𝑑𝑠
𝐼𝑛𝑣𝑡𝑦. 𝐿𝑜𝑠𝑠 = 1,100,000 − 50,000 − (500,000 𝑥 75%)
𝐼𝑛𝑣𝑡𝑦. 𝐿𝑜𝑠𝑠 = 𝟔𝟕𝟓, 𝟎𝟎𝟎
*Note that the undamaged goods were reduced to cost as the value given in the problem represents inventory
at selling price (“…normally sell…”).

b. Retail inventory method

The retail inventory method is used mainly in the retail industry as inventories are voluminous and prices are
rapidly changing (making the GPR not relatively stable, hence, only this method is practical to use). However, there
are certain limitations when using this method. Particularly, the following information are required:
1. Beginning inventory at cost and at retail price
2. Purchases during the period at cost and at retail price
3. Adjustments to original retail price such as additional markup, markup cancellation, markdown and
markdown cancellation
4. Other adjustments such as departmental transfer, breakage, shrinkage, theft, damaged goods, and
employee discounts (Valix, 2020)
Similar to the GP method, the retail inventory method follows the same formula in estimating ending inventory
(with the exception, however, that the ending inventory under the retail method is stated at selling price rather
than cost).
Goods available for sale (at selling price) PHP xxxx
Less: Net Sales (only sales returns is deducted from sales) (xxx)
Ending inventory (at selling price) xxxx
Multiply: Cost Ratio x xx
Ending inventory (at cost) xxxx

𝐺𝑜𝑜𝑑𝑠 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝑠𝑎𝑙𝑒 𝑎𝑡 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒

𝐶𝑜𝑠𝑡 𝑟𝑎𝑡𝑖𝑜 =
𝐺𝑜𝑜𝑑𝑠 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝑠𝑎𝑙𝑒 𝑎𝑡 𝐶𝑜𝑠𝑡

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 Valix, et.al. further provides the treatment of the following items:
1. Purchase discount – deducted from purchases at cost only
2. Purchase return – deducted from purchases at cost and at retail
3. Purchase allowance – deducted from purchases at cost only
4. Freight in – addition to purchases at cost only
5. Departmental transfer in or debit – addition to purchases at cost and retail
6. Departmental transfer out or credit – deducted from purchases at cost and at retail
7. Sales discount and sales allowance – disregarded (not deducted from sales)
8. Sales return – deducted from sales (as this involves physical movement of inventory)
9. Employee discount – added to sales
10. Normal shortage, shrinkage, spoilage, breakage – deducted from goods available for sale at retail
(absorbed in the cost of goods sold)
11. Abnormal shortage, shrinkage, spoilage, breakage – deducted from goods available for sale at cost
and at retail (abnormal losses are recorded as loss)
In addition, the following items related to the retail method are:
1. Initial markup – original markup on the cost of goods
2. Original retail – sales price for which the goods are initially offered for sale
3. Additional markup – increase of sales price over original sales price
4. Markup cancellation – decrease in sales price that does not place the sales price over the original
sales price
5. Net additional markup or net markup – markup less markup cancellation
6. Markdown – decrease in sales price over original sales price
7. Markdown cancellation – increase in sales price that does not place the sales price over the original
sales price
8. Net markdown – markdown less markdown cancellation
9. Maintained markup – also called “mark-on”; the difference between sales price and cost after the
adjustment for all of the above items
Moreover, there are three approaches to the retail inventory method, namely, the conservative approach, average
cost approach, and the FIFO approach.
1. Conservative Approach (also called conventional or LCNRV approach)
- includes net markup and excludes net markdown in determining the cost ratio
2. Average Cost Approach
- includes both net markup and net markdown in determining the cost ratio
3. FIFO Retail Approach
- similar to the average cost approach as it includes both net markdown and net markup in
determining the cost ratio with the exception that the beginning inventory (at cost and at retail)
is not included
Example (Adapted):
Scabbers Co. used the retail inventory method to estimate the ending inventory. The following information is
available for the year:
Cost Retail
Beginning inventory 800,000 1,600,000
Purchases 13,250,000 26,500,000
Freight in 350,000
Purchase returns 450,000 800,000
Purchase allowances 100,000
Departmental transfer in 300,000 550,000
Net markups 1,000,000
Net markdowns 4,500,000
Sales 10,000,000
Sales discounts 250,000
Employee discounts 600,000
Estimated normal shoplifting losses 150,000
Estimated normal shrinkage 350,000
Given the data above, compute for the cost of the ending inventory using the (1) conservative approach, (2)
average cost approach, and (3) FIFO retail approach.

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 Solution:
(1) Conservative Approach
Cost Retail
Beginning inventory 800,000 1,600,000
Add: Purchases 13,250,000 26,500,000
Add: Freight in 350,000
Less: Purchase returns (450,000) 800,000
Less: Purchase allowances (100,000)
Add: Departmental transfer in 300,000 550,000
Add: Net markups 1,000,000
Cost Ratio (14,150,000/30,450,000 = 46.5%) – exclude markdown 46.5%
Less: Net markdowns (4,500,000)
Goods available for sale (GAS) 14,150,000 25,950,000
Less: Sales (10,000,000)
Add: Sales discounts 250,000
Add: Employee discounts 600,000
Less: Estimated normal shoplifting losses (150,000)
Less: Estimated normal shrinkage (350,000)
Ending inventory at retail 26,290,000
Multiply: Cost ratio x 46.5%
Ending inventory at cost 12,224,850

(2) Average Cost Approach

Cost Retail
Beginning inventory 800,000 1,600,000
Add: Purchases 13,250,000 26,500,000
Add: Freight in 350,000
Less: Purchase returns (450,000) 800,000
Less: Purchase allowances (100,000)
Add: Departmental transfer in 300,000 550,000
Add: Net markups 1,000,000
Less: Net markdowns (4,500,000)
Goods available for sale (GAS) 14,150,000 25,950,000
Cost Ratio ( 14,150,000/25,950,000 = 54.5% ) 54.5%
Less: Sales (10,000,000)
Add: Sales discounts 250,000
Add: Employee discounts 600,000
Less: Estimated normal shoplifting losses (150,000)
Less: Estimated normal shrinkage (350,000)
Ending inventory at retail 26,290,000
Multiply: Cost ratio x 54.5%
Ending inventory at cost 14,328,050

(3) FIFO Retail Approach

Cost Retail
Beginning inventory 800,000 1,600,000
Add: Purchases 13,250,000 26,500,000
Add: Freight in 350,000
Less: Purchase returns (450,000) 800,000
Less: Purchase allowances (100,000)
Add: Departmental transfer in 300,000 550,000
Add: Net markups 1,000,000
Less: Net markdowns (4,500,000)
Goods available for sale (GAS) 14,150,000 25,950,000

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 Cost Ratio (13,350,000/24,350,000 = 54.8%) – exclude beg. inventory 54.8%
Less: Sales (10,000,000)
Add: Sales discounts 250,000
Add: Employee discounts 600,000
Less: Estimated normal shoplifting losses (150,000)
Less: Estimated normal shrinkage (350,000)
Ending inventory at retail 26,290,000
Multiply: Cost ratio x 54.8%
Ending inventory at cost 14,406,920

E. Lower of Cost and Net Realizable Value

As discussed in section A, subsequent recognition, inventories shall be measured at the lower of cost and net realizable
value (LCNRV). Net realizable value is the estimated price by which the inventory can be sold at the market, in the
ordinary course of business, less the estimated cost to sell and the estimated cost of completion. Valix, et.al. elaborates
that the “practice of writing down inventories to their net realizable value (when cost is higher) is consistent with the
view that assets shall not be carried in excess of amounts expected to be realized from their sale or use.”
Determination of NRV. PAS 2 provides that “inventories are written down to NRV on an item by item or individual basis
and not based on a classification of inventory.” In addition, the “replacement cost of inventories may be the best
evidence of NRV.” Inventories whose cost is lower than its NRV are considered impaired. There are two ways to write
down inventories namely, the (1) direct method or cost of sales method and (2) allowance method or the loss method.
Example (Adapted):
On December 31, 2019, Marauders, Inc. reported the following information about their inventory:
Cost NRV LCNRV
Category 1:
A 1,250,000 1,500,000 1,250,000
B 5,000,000 4,250,000 4,250,000
Category 2:
A 3,750,000 3,000,000 3,000,000
B 2,000,000 2,640,000 2,000,000
Solution:
The Company’s inventory as of 12/31/2019 amounts to PHP 10,500,000 (add up the LCNRV column – reminder that
inventory’s LCNRV is determined on an item by item basis). The entry to record the impairment is as follows:
(1) If the direct method is used:
Cost of Sales 1,500,000
Inventory 1,500,000
(2) If the allowance method is used:
Loss on inventory write-down 1,500,000
Allowance for inventory write-down 1,500,000
Whatever method used, the company will still present the same cost of sales and same carrying amount of inventories.
The loss on inventory write-down is presented as a line item under the cost of sales. The allowance for inventory write-
down is used as a contra-account.

F. Presentation and Disclosure in the Financial Statements

Inventories are classified as current assets as they are assumed to be sold in the next twelve months after year-end. The
following are the required disclosures for inventories:
1. accounting policy and the carrying amount of inventories by category,
2. the carrying amount of inventory carried at NRV and amount of any reversal of a write-down,
3. the carrying amount of inventory pledged as security for liabilities,
4. the cost of inventory charged to expense for the period.

ACTIVITY 1: Inventories
I. Directions: Write your answers on the space provided (3 points each).
1. Based on physical inventory taken on December 31, 2020, Adobo Co. determined its chocolate inventory on a FIFO basis
at P26,000 with a replacement cost of P20,000. Adobo estimated that, after further processing costs of P12,000, the
chocolate could be sold as finished candy bars for P40,000. Adobo normal profit margin is 10% 0f sales. Under the lower

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 cost or market rule, what amount should Adobo report as chocolate inventory in its December 31, 2020 balance sheet?
_____________
2. Coca Company’s inventory at December 31, 2020 was P1,200,000 based on physical count of goods priced at cost, and
before any necessary year-end adjustments relating to the following:
 Included in the physical count were goods billed to a customer FOB shipping point on December 30, 2020. The
goods had a cost of P25,000 and were picked up by the carrier on January 7, 2021.
 Goods shipped FOB shipping point on December 28, 2020, from a vendor to Coca were received on January 4,
2021. The invoice cost was P60,000.
What amount should Coca report as inventory in its December 31, 2007 balance sheet? _____________
3. MC Corp. uses FIFO retail method of inventory valuation. The following information is available:
Cost Retail
Beginning inventory P12,000 P30,000
Purchases 60,000 110,000
Net Additional Markups 10,000
Net Markdowns 20,000
Sales Revenue 90,000
If the lower of cost or market rule is disregarded, what would be the estimated cost of the ending inventory? _____________
II. Directions: In a separate sheet of paper, answer the following questions briefly (less than five sentences).
1. Is LIFO an acceptable inventory costing method? Why or why not? (5 points)
2. What principle of accounting governs the Lower of Cost or Net Realizable Value (LCNRV)? (10 points)

Lesson 7. Accounting for Agricultural Activities and Biological Assets

Introduction
Some companies in the food industry invest on livestock and plantations to spend less and earn more. These assets,
as long as they are not the items for sale, are treated as biological assets.
In this lesson, we will discuss biological assets and agricultural activities and how to account for them.
Learning Outcomes:
At the end of this lesson, you are expected to:
1. differentiate biological assets and agricultural produce,
2. apply the recognition and measurement criteria in recording biological assets, and
3. enumerate presentation and disclosure requirements of biological assets in the financial statements.

LESSON PROPER
A. Definition
Biological assets and agricultural produce
Biological assets are defined as the “living animals and living plants owned by a company.” In addition, accounting
for biological assets are governed by PAS 41. On the other hand, agricultural produce are the harvested products of
biological assets and are accounted for using PAS 2, Inventories.
Illustrated in the table below are examples of these two.
Biological Asset Agricultural Produce Processed Agricultural Produce
1. Sheep Wool Yarn, Carpet
2. Trees in plantation forest Felled trees Logs, lumber
3. Plant Harvested cane Sugar
4. Dairy cattle Milk Cheese
5. Pigs Carcass Sausage, Ham
Illustration 1. Examples of Biological Asset and Agricultural Produce
Source: Valix, C., Peralta, J., and Valix, C., (2020). Intermediate Accounting Volume 1. GIC Enterprises & Co., Inc.: Philippines.
Agricultural activity
The management of biological assets falls under agricultural activity. PAS 41 defines agricultural activity as the
“management by an entity of the biological transformation and harvest of biological assets for sale or for conversion
into agricultural produce or into additional biological assets.” Agricultural activity has the following features:
a. Capability to change.
Example: capable of physical change (from seedling to full-grown plants, from calf to a full-grown cow, etc.)
b. Management of change.

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 Example: irrigation, cattle housing, etc. (there must be management or human intervention in the growth
and development of biological assets for an activity to qualify as agriculture)
c. Measurement of change.
Examples: change in prices (change in quality or quantity must be measured and monitored)
The following activities qualify as agricultural activities:
1. Raising livestock
2. Annual or perennial cropping of plants
3. Cultivating orchards and plantations
4. Floriculture (for flowers)
5. Aquaculture (including fish farming)

Biological Transformation
PAS 41 defines biological transformation as the cycle that causes qualitative or quantitative changes in biological
assets. Hence, biological transformation results from the following outcomes:
1. Asset changes through:
a. Growth – an increase in quantity or improvement of quality of an animal or plant
b. Degeneration – a decrease in quantity or deterioration in quality of an animal or plant
c. Procreation – creation of additional living animal or plant
2. Production of agricultural produce.
B. Recognition and Measurement
PAS 41 provides that an entity shall recognize a biological asset or agricultural produce only when the entity controls
the asset as a result of past events, it is probable that future economic benefits will flow to the entity, and the fair value
or cost of the asset can be measured reliably.
Moreover, PAS 41 expressly states that:
 Biological assets shall be measured on initial recognition and at the end of each reporting period at fair
value less cost of disposal.
 Agricultural produce shall be measured at fair value less cost of disposal at the point of harvest.
PFRS 13 defines fair value as the “price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date.” The standard further sets out a hierarchy
used in fair value determination (this hierarchy also sets out the best evidences for fair value). The illustration below
summarizes the fair value hierarchy.
Fair Value Hierarchy

Illustration 2. Fair Value Hierarchy

Adapted: IFRS 13 – Fair Value Measurement. Deloitte. Retrieved from: https://www.iasplus.com/en/standards/ifrs/ifrs13
To understand better, let’s tackle an example.
Example:
At January 1, 2020, Finnigan Co. purchased 50 cows which are 2 years old for PHP 20,000 each for the
purpose of producing milk. On July 1, 2020, the cows gave birth to 30 calves. The active market provided the fair
value less cost of disposal of the biological assets as follows:
Newborn calf on July 1, 2020 PHP 5,000
Newborn calf on December 31, 2020 5,500
½ year old calf on December 31, 2020 7,500
2-year old cow on December 31, 2020 21,000
3-year old cow on December 31, 2020 23,000
Journal Entries:
1. Journal entry (or JE) to record the acquisition of milking cows:
Biological asset 1,000,000

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 Cash 1,000,000
2. JE to record the birth of 30 calves with a fair value of PHP 5,000 each (total of PHP 150,000):
Biological asset 150,000
Gain from change in fair value 150,000
3. To record the change in fair value of the cows and calves on 12/31/2020:
Biological asset 225,000
Gain from change in fair value 225,000
Computation:
Cows which are now 3 years old
(23,000 x 50) PHP 1,150,000
Cows which are now ½ year old
(30 x 7,500) 225,000
Fair value of biological assets, 12/31/2020 1,375,000
Less: Carrying amount of biological assets
(1,000,000 + 150,000) (1,150,000)
Change in fair value 225,000
C. Presentation and Disclosure in the Financial Statements
Biological assets are presented as a separate line item in the balance sheet and falls under the noncurrent
asset classification. PAS 41 provides the following required disclosures of biological assets:
1. aggregate gain or loss from the initial recognition of biological assets and agricultural produce and the
change in fair value less costs to sell during the period
2. description of an entity's biological assets, by broad group
3. description of the nature of an entity's activities with each group of biological assets and non-financial
measures or estimates of physical quantities of output during the period and assets on hand at the end
of the period
4. information about biological assets whose title is restricted or that are pledged as security
5. commitments for development or acquisition of biological assets
6. financial risk management strategies
7. reconciliation of changes in the carrying amount of biological assets, showing separately changes in
value, purchases, sales, harvesting, business combinations, and foreign exchange differences.

ACTIVITY 2: Bio Assets

Directions: In a separate sheet of paper, answer the following questions briefly (less than five sentences). In answering, refer
to PAS 41 or the discussion in the previous lesson.
1. Why are zoo animals not accounted for as biological assets?
2. In relation to number 1, how are zoo animals accounted for in the company’s books?
3. How are bearer plants accounted for?

Lesson 8. Accounting for Property, Plant and Equipment

Introduction
Companies usually own fixed assets such as land and building. These assets are treated and accounted for as
property, plant and equipment. Their values are initially recorded at costs and are periodically charged against income as
depreciation expense.
This topic provides the definition of property, plant and equipment, their recognition and measurement bases,
management and control and the presentation and disclosure of property, plant and equipment in the financial statements.
Learning Outcomes:
At the end of this lesson, you are expected to:
1. define property, plant and equipment,
2. cite and apply the measurement bases in recording property, plant and equipment,
3. determine depreciation expense for property, plant and equipment and its corresponding net book value,
4. apply presentation and disclosure of property, plant and equipment in the financial statements,
5. enumerate the different internal control measures for property, plant and equipment, and
6. account for investment property.

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LESSON PROPER
A. Definition and Recognition
PAS 16 provides the guidelines in accounting for Property, Plant and Equipment (PPE). The standard defines PPE as
“tangible assets that are held for use in production or supply of goods or services, for rental to others, or for
administrative purposes, and are expected to be used during more than one period.”
The definition laid out the purposes by which business owners acquire PPE. First, they are either used in production
(e.g. warehouse, equipment, etc.), for rental (e.g. investment property), or for administrative purposes (e.g. land and
building). In contrast, companies who construct or purchase land, building or equipment for purposes of sale treat these
assets as inventories.
Moreover, the standard expressly states that for an asset to be considered PPE they must be expected to be used
for more than one period. Hence, assets that are expected to be consumed within one year are not accounted for as
PPE.
B. Recognition and Measurement
PAS 16 provides that “the cost of an item of property, plant and equipment shall be recognized as an asset if, and
only if: (a) it is probable that future economic benefits associated with the item will flow to the entity; and (b) the cost
of the item can be measured reliably.
PPE shall initially be measured at cost. The standard further provides that the cost of a PPE is comprised of:
(a) its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts
and rebates.
(b) any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable
of operating in the manner intended by management.
(c) the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is
located, the obligation for which an entity incurs either when the item is acquired or as a consequence of
having used the item during a particular period for purposes other than to produce inventories during that
period.
C. Initial Measurement and Capitalization of Costs
There are a lot of ways to acquire PPE. The following ways are used by companies to acquire PPE and their respective
measurement and capitalization of costs.
1. Cash basis: recorded at cost paid (cash paid plus directly attributable costs)
2. On account (or on credit): recorded at invoice price less discount (taken up or not)
3. On installment basis: recorded at cash price equivalent (or at present value of all cash payments)
4. Through issuance of stocks: cost recorded is determined using a hierarchy
i. Fair value of PPE received
ii. Fair value of share capital
iii. Par value of share capital
5. Through issuance of bonds: cost recorded is determined using a hierarchy
i. Fair value of bonds
ii. Fair value of PPE received
iii. Face amount of bonds
6. By exchange: recording of costs depends if acquisition is with or without commercial substance
i. With commercial substance:
a. If company is the payor of additional cash: fair value of PPE given + cash
b. If company is the payee of additional cash: fair value of PPE given – cash
ii. Without commercial substance:
a. Recorded at carrying amount (or book value)
7. By donation: recorded at fair value of PPE
8. Through government grants (will be discussed more in higher accounting subjects)
9. By construction (will be discussed more in higher accounting subjects)
D. Subsequent Measurement
Every year-end, the cost of PPE is subsequently measured using either the cost model or the revaluation model. The
standard provides that “an entity shall choose either the cost model or the revaluation model as its accounting policy
and shall apply that policy to an entire class of property, plant and equipment.”
 Cost Model - After recognition as an asset, an item of property, plant and equipment shall be carried at its cost
less any accumulated depreciation and any accumulated impairment losses.

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  Revaluation Model - After recognition as an asset, an item of property, plant and equipment whose fair value
can be measured reliably shall be carried at a revalued amount, being its fair value at the date of the revaluation
less any subsequent accumulated depreciation and subsequent accumulated impairment losses. (Will be
discussed more on the succeeding sections).
E. Depreciation
I. Definition, Nature and Causes
J.R. Batboi states that “…all fixed assets such as plant,
machinery, tools, buildings, leasehold, furniture etc.,
gradually diminish in value as they get older and become
worn out by constant use in the business.”
Weygandt, et.al. defines depreciation as a means of cost
allocation. It is one of the manifestations of the matching
principle in accounting wherein income is matched with the
expenses incurred to earn it. It is simply a means of
spreading asset costs to periods in which the assets
produce revenue. Weygandt further explains that
depreciation “involves allocating the cost of tangible assets
in a systematic and rational manner to periods expected to
benefit from use of its depreciable assets.” Only land does
not depreciate in value.
The causes of depreciation can be divided into internal
and external factors. See illustration below summarizing the
causes of depreciation.
Depreciation is the dimunition in the value of an
asset. This decrease in value may result from both internal
Illustration 3. Causes of Depreciation and external factors. Internal factors may be due to:
Adapted: Depreciation – Meaning, Characteristics, Causes, Objectives, 1. Wear and tear – especially for assets that are used
Factors Affecting Depreciation Calculation. Accountlearning.com. Retrieved
from: https://accountlearning.com/depreciation-meaning-characteristics- in production and day-to-day operations (e.g. equipment
causes-objectives-factors-affecting-depreciation-calculation/ and delivery vehicles)
2. Exhaustion – particular in production lines
3. Depletion – specially for mining companies (will be discussed more in the succeeding sections)
4. Deterioration – assets that deteriorate become more inclined for downtimes and may require higher repairs
and maintenance costs
Assets may also depreciate due to external factors such as:
1. Passage of time – Even though not in use or idle for a space of time, assets are still subject for
depreciation. Examples of these are buildings, equipments, machineries, vehicles, etc.
2. Obsolescence – Some assets (e.g. appliances, equipment, machinery, and vehicles) may go out of
market circulation leading to unavailability of spare parts necessary for maintenance and repairs.
3. Permanent fall in market value – Assets that go obsolete automatically suffers decreases in market
value.
4. Weather and accidental elements – Exposed assets to weather and accidental disruptions are prone to
breakage.

II. Factors affecting depreciation

The following factors affect depreciation and how depreciation is computed:
1. Cost – the cost of the PPE is used in depreciation. As the value changes, so does the depreciation charged
and the net book value. Because depreciation is an expense account, changes in cost have an income
effect. Cost can sometimes change due to repairs made.
2. Estimated useful life – working life is estimated by the company. Several factors that may affect useful life
estimation includes:
i. Legal or contractual limits such as the expiry dates of related leases.
ii. Extraction or consumption.
iii. Extent of use and physical deterioration on account of wear and tear which again depends
upon operational factors like number of shifts for which the asset is to be used, repair and
maintenance policy of the enterprise.

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 3. Salvage value – also called scrap value or residual value. This is an estimate of the company and is estimated
to be the value the asset can be sold for at the end of its useful life. The salvage value is deducted from
the cost of the asset to determine the depreciable value.

III. Methods of depreciation

There are a lot of ways to depreciate PPE; that it is up to company management to decide which method
suits them best. However, the company’s depreciation method should be reflective as to how company
operations affect PPE value. Simply put, the company’s depreciation method should be aligned with how the
company makes use of the asset.
Moreover, the goal of depreciation is to spread out the cost of the asset over its useful life. At the end of
its estimated useful life, the value of the asset should be equal to its salvage value.
Outlined in the illustration below are some of the different methods of depreciation.
The entry to record depreciation is as follows:
Depreciation expense xxx
Accumulated depreciation xxx

1. Fixed Depreciation Methods. Fixed depreciation methods

result to equal amounts of annual depreciation. There are two
methods that yield this result, namely, straight line and group
(composite) method.
a. Straight line. The straight line method is the most
commonly used depreciation method owing to its simplicity.
This method follows the concept that the passage of time is the
main cause of the asset’s reduction in value. In addition, this
method yields equal amounts of annual depreciation expenses
over its useful life. Depreciation is computed by deducting
residual value from PPE cost and then dividing the resulting
amount by the asset’s useful life.
Depreciation = (Cost – Residual Value)/Useful Life
b. Group/Composite. This depreciation method is
commonly used by companies with a large group of low cost
PPE that are either similar in nature or otherwise. Computation
Illustration 4. Depreciation Methods for this method is similar to straight line depreciation with the
Adapted: Whittington, O. (2016). 2016 Wiley CPAexcel Exam
Review Study Guide Financial Accounting and Reporting. John exception that the depreciation expense is computed on a
Wiley & Sons, Inc.: New Jersey group (composite) of assets rather than a single PPE.
Composite rate = total annual depreciation/total cost
Depreciation = cost x composite rate
2. Variable depreciation method. As the name dictates, this method yields variable amounts of depreciation expense
per period. This is also referred to as “Physical Usage Depreciation.” In contrast to the straight line method where
passage of time is believed to be the main driver of depreciation, under this method, asset activity is believed to be
the main cause of the reduction in asset value. Hence, the formula below.
Annual Depreciation = (Current activity/Total expected activity) x (Cost – Salvage value)
This method has two main subtypes.
a. Units of production method. Based on output (e.g. units of finished goods).
b. Working hours method. Based on input used (e.g. number of hours used for the period).
3. Diminishing balance method. Also called “Accelerated depreciation.” This method is justified when any of the
following factors are present:
 Increased productivity when asset is new
 Increasing maintenance charges with age as old assets are more susceptible to downtimes compared
to new assets.
 Risk of obsolescence is greater as time passes
There are two common methods under the diminishing balance method.
a. Sum of years’ digit (SYD) method.
Depreciation = (Cost – Salvage Value) x SYD rate
SYD rate = (Useful Life (Useful Life + 1))/2

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 b. Double declining balance method.
In the first period: Depreciation = Cost x (1/Useful Life) x 2
In the succeeding period: Depreciation= Carrying amount x (1/Useful Life) x 2
4. Inventory method. These method is useful for companies that own many low-cost tangible assets (e.g. tools for a
manufacturing company, utensils for restaurants, etc.). In order to determine depreciation of these assets, companies
conduct physical count of these goods every period end.
Annual Depreciation = Beginning balance + Purchases – Ending balance

F. Depletion
Companies in the extractive industry (e.g. mining companies, oil exploration companies, etc.) capitalize on extraction
of mineral resources. Mineral resources are also called wasting assets that are characterized by physical consumption
and are irreplaceable. In this discussion, we will tackle how these companies account for their exploration and
evaluation costs. Our discussion will focus on the accounting guidelines provided by PFRS 6, Exploration for and
Evaluation of Mineral Resources. Determining depletion, tackled and guided by PFRS 6, is an essential activity for these
businesses. Depletion refers to “the process of recording the consumption of natural resources.” (Kieso, et.al., 2016)
Exploration and evaluation costs (E & E costs, for short) refers to the costs spent by companies to search for mineral
resources. Costs included in E & E pertains to costs incurred after obtaining the legal right to explore the area for resources
and prior to development for technical feasibility. These costs are initially recorded at cost and are subsequently measured
using the cost model or the revaluation model (same with PPE). We have established earlier that mineral resources are also
referred to as wasting assets. Listed below are the costs capitalized to wasting assets:
a. Acquisition cost
b. Exploration cost
c. Development cost (note: only intangible development costs are capitalized)
d. Estimated restoration cost (included only in the cost of the wasting asset if restoration cost is a present
obligation of the company)
This capitalized costs forms part of the Wasting Asset account of the company. Accounting for wasting asset
generally follows PPE accounting treatment. It is presented in the balance sheet as a noncurrent asset and at carrying amount
(cost less accumulated depletion and accumulated impairment losses). In the income statement, depletion is classified as a
part of cost of production or cost of sales. Likewise, we can infer that depletion is similar to depreciation as they are both
cost allocation methods with the exception that the method used to determine depletion expense for the period is the units
of production method and the straight line method. To elaborate, below are the definitions of depletion (Valix, 2020):
 Depletion is the removal, extraction, or exhaustion of a natural resource.
 Depletion is the systematic allocation of the depletable amount of a wasting asset over the period the natural
resource is extracted or produced.
Methods to compute for depletion:
 Units of production method
𝑢𝑛𝑖𝑡𝑠 𝑒𝑥𝑡𝑟𝑎𝑐𝑡𝑒𝑑
𝐷𝑒𝑝𝑙𝑒𝑡𝑖𝑜𝑛 = 𝑥 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑡ℎ𝑒 𝑤𝑎𝑠𝑡𝑖𝑛𝑔 𝑎𝑠𝑠𝑒𝑡
𝑡𝑜𝑡𝑎𝑙 𝑢𝑛𝑖𝑡𝑠 𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑡𝑜 𝑏𝑒 𝑒𝑥𝑡𝑟𝑎𝑐𝑡𝑒𝑑
 Straight line method
𝐶𝑜𝑠𝑡 − 𝑆𝑎𝑙𝑣𝑎𝑔𝑒 𝑉𝑎𝑙𝑢𝑒
𝐷𝑒𝑝𝑙𝑒𝑡𝑖𝑜𝑛 =
𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠 𝑜𝑓 𝑢𝑠𝑒𝑓𝑢𝑙 𝑙𝑖𝑓𝑒

Note: Depletion will be discussed more in your higher accounting subjects.

G. Revaluation Model
As discussed earlier, PPE and Wasting Assets are initially measured at cost and are subsequently measured using
either the cost model or the revaluation model. Under the revaluation model, the asset is remeasured at its fair value
less accumulated depreciation and accumulated impairment losses. There is no guidance as to when revaluation must
be made but the PAS 16 dictates that revaluation should be made with sufficient regularity so that the carrying amount
does not differ materially from the asset’s fair value at the end of the reporting period. The difference between the
carrying amount and the fair value of the asset is recorded as revaluation surplus which forms part of the OCI (part of
equity). Note: Revaluation model will be discussed more in your higher accounting subjects.
H. Impairment of PPE
PAS 36, Impairment of Assets, is applied when determining impairment. The standard provides that an asset (e.g.
PPE) is impaired when its carrying amount is higher than its recoverable amount. Recoverable amount can either be
based on two measurements, namely, (1) Fair value less cost of disposal or (2) Value in use (equal to the present value

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 of cash flows the asset is expected to generate over its useful life). When the asset is impaired, the company records
impairment loss either the direct method or the allowance method. See proforma entry below.
Direct Method: Impairment loss xxx
Accumulated impairment - PPE xxx
Allowance Method: Impairment loss xxx
Allowance for accumulated impairment xxx
Note: PPE impairment will be discussed more in your higher accounting subjects.
I. Retirements and Disposals
The carrying amount of an item of property, plant and equipment shall be derecognized:
(a) on disposal; or
(b) when no future economic benefits are expected from its use or disposal.
The gain or loss arising from the derecognition of an item of property, plant and equipment shall be determined as
the difference between the net disposal proceeds, if any, and the carrying amount of the item. The gain or loss shall be
included in profit or loss when the item is derecognized. Gains shall not be classified as revenue. The proforma entry
below is used in recording disposals or retirement of PPE.
If there is gain: Accumulated depreciation xxx
PPE xxx
Gain on sale/retirement xxx
If there is loss: Accumulated depreciation xxx
Loss on sale/retirement xxx
PPE xxx
J. Presentation and Disclosure in the Financial Statements
PPE is presented in the balance sheet under noncurrent assets at carrying amount. Carrying amount is equal to the
cost of the PPE less accumulated depreciation and accumulated impairment losses.
The following are required to be disclosed in the notes to financial statements for each class of PPE:
1. the measurement bases used for determining the gross carrying amount;
2. the depreciation methods used;
3. the useful lives or the depreciation rates used;
4. the gross carrying amount and the accumulated depreciation (aggregated with accumulated impairment
losses) at the beginning and end of the period; and
5. a reconciliation of the carrying amount at the beginning and end of the period showing:
• additions;
• assets classified as held for sale or included in a disposal group classified as held for sale and other disposals;
• acquisitions through business combinations;
• increases or decreases resulting from revaluations and from impairment losses recognized or reversed in
other comprehensive income;
• impairment losses recognized in profit or loss;
• impairment losses reversed in profit or loss;
• depreciation;
• the net exchange differences arising on the translation of the financial statements from the functional
currency into a different presentation currency, including the translation of a foreign operation into the
presentation currency of the reporting entity; and
• other changes.
The company’s financial statements shall also disclose:
1. the existence and amounts of restrictions on title, and property, plant and equipment pledged as security for
liabilities;
2. the amount of expenditures recognized in the carrying amount of an item of property, plant and equipment
in the course of its construction;
3. the amount of contractual commitments for the acquisition of property, plant and equipment; and
4. if it is not disclosed separately in the statement of comprehensive income, the amount of compensation from
third parties for items of property, plant and equipment that were impaired, lost or given up that is included
in profit or loss.
If items of property, plant and equipment are stated at revalued amounts, the following shall be disclosed in addition
to the disclosures required by IFRS 13 Fair Value Measurement:
1. the effective date of the revaluation;
2. whether an independent valuer was involved;

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 3. for each revalued class of property, plant and equipment, the carrying amount that would have been
recognized had the assets been carried under the cost model; and
4. the revaluation surplus, indicating the change for the period and any restrictions on the distribution of the
balance to shareholders.
The company may also disclose the following information when relevant to their needs:
1. the carrying amount of temporarily idle property, plant and equipment;
2. the gross carrying amount of any fully depreciated property, plant and equipment that is still in use;
3. the carrying amount of property, plant and equipment retired from active use and not classified as held for
sale; and
4. when the cost model is used, the fair value of property, plant and equipment when this is materially different
from the carrying amount.

K. Accounting for Investment Property

PAS 40, Investment Property, provides guidelines on how to account for investment property. The standard defines
investment property as “property (land or building or part of a building or both) held by an owner or by the lessee under
a finance lease to earn rentals or for capital appreciation.” It is important to note that only land and building can qualify
as investment property (meaning, machinery cannot be considered). It is also relevant to point out that under the
definition provided by the standard, investment property is land and/or building held for rental purposes and capital
appreciation (meaning, increases in market value). This excludes property owned for administrative purposes or for
production (e.g. factory cannot be investment property). Likewise, land and building held for sale in the ordinary course
of business do not qualify as IP.
Recognition: recognized as an asset when:
1. It is probable that future economic benefits that are associated with the investment property will flow to the
entity.
2. The cost of the investment property can be measured reliably.
Initial Measurement: originally recorded at purchase price plus directly attributable costs (e.g. professional fees, property
taxes and other transaction costs that are necessary to bring the property to its location and present condition)
Subsequent Measurement: Similar to PPE (except that no depreciation is recorded for investment property) either the
cost model or the revaluation model.

ACTIVITY 3: Property, Plant and Equipment

I. Directions: Write your answer on the space provided. (3 points each)
1. Yoo Co. determined that, due to obsolescence, equipment with an original cost of P 900,000 and accumulated
depreciation at January 1, 2007 of P420,000 had suffered permanent impairment, and as a result should have a
carrying value of only P300,000 as of beginning of the year. In addition, the remaining useful life of the equipment
was reduced from 8 to 3 years. In its December 31, 2008, balance sheet, what amount should be report as
accumulated depreciation? ____________________________
2. A natural resources property was purchased by Nge Wang Company for 6,000,000. The output was estimated to be
1,500,000 tons. Nge Wang Company purchased a mining equipment at a cost of 8,000,000 and has a useful life of
10 years but is capable of exhausting the resource in 8 years. Production is as follows:
1st Year 150,000 tons
2nd Year 225,000 tons
3rd Year None
4th Year 225,000 tons
What is the carrying amount of the mining equipment at the end of four years? ____________________________
II. Directions: In a separate sheet of paper, answer the questions briefly.
1. When should the company recognize PPE in its books? (5 points)
2. What is the difference between PPE, investment property, and wasting assets? (15 points)
3. Cite the required disclosures for PPE (refer to discussion on Lesson 3, section J) . (15 points)

Lesson 4. Accounting for Intangible Assets

Introduction
In the digital age, companies allocate funds to finance research and development expenditures to further their
competitive advantage in technological breakthroughs. Most of these expenses are accounted for as intangible assets.

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 In this lesson, we will discuss intangible assets, recognition and measurement basis in accounting for intangible
assets, presentation and disclosure in the financial statements and the internal control measures implemented to safeguard
these assets.
Learning Outcomes:
At the end of this lesson, you are expected to:
1. define and identify recognition of intangible assets in the financial statements,
2. cite and apply the measurement basis in recording different kinds of intangible assets,
3. determine amortization of intangible assets over their useful lives,
4. apply presentation and disclosure of intangible assets in the financial statements, and
5. enumerate internal control measures for intangible assets.

LESSON PROPER
Definitions
Intangible asset An identifiable nonmonetary asset without physical substance.
Amortization The systematic allocation of the depreciable amount of an intangible asset over its useful life.
Cost The amount of cash or cash equivalents paid or the fair value of other consideration given to acquire
an asset at the time of its acquisition or construction, or, when applicable, the amount attributed to
that asset when initially recognized in accordance with the specific requirements of other PFRSs.
Fair value The amount for which that asset could be exchanged between knowledgeable, willing parties in an
arm’s length transaction.
Monetary assets Money held and assets to be received in fixed or determinable amounts of money.
Research Original and planned investigation undertaken with the prospect of gaining new scientific or technical
knowledge and understanding.
Development The application of research findings or other knowledge to a plan or design for the production of new
or substantially improved materials, devices, products, processes, systems or services before the start
of commercial production or use.

Two important aspects of the definition of an Intangible Asset are:

I. Identifiability – Identifiable means
(a) Is separable, it is capable of being separated or divided from the entity and sold, transferred, licensed, rented
or exchanged, either individually or together with a related contract, asset or liability OR
(b) Arises from contractual or other legal rights, regardless of whether those rights are transferable or separable
from the entity or from other rights and obligations.
II. Inherent characteristics of assets are:
(a) Control - An entity controls an asset if the entity has the power to obtain the future economic benefits flowing
from the underlying resource and to restrict the access of others to those benefits.
(b) Future Economic Benefits - The future economic benefits flowing from an intangible asset may include
revenue from the sale of products or services, cost savings, or other benefits resulting from the use of the
asset by the entity.
(c) Cost – An asset shall only be recognized if its cost or value can be measured reliably.
KEY OBSERVATIONS
 Identifiability is the major reason why internally generated goodwill is not recognized as an asset. Aside from lacking
control and unmeasurable cost of goodwill.
 Control is the reason why internally generated brands and the skills of employees arising from training or experience
is not an asset. However, cost also plays a major role in its non recognition.
Recognition and Initial Measurement
 An enterprise to recognize an intangible asset, whether purchased or self-created AT COST if, and only if:
 It is probable that the future economic benefits that are attributable to the asset will flow to the enterprise; and
 The cost of the asset can be measured reliably.
Initial Measurement and Subsequent Expenditures
 Intangible assets are initially measured at cost.
 Subsequent expenditure on an intangible asset after its purchase or completion should be recognized as an
expense when it is incurred

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  However in very rare cases that it is probable that this expenditure will enable the asset to generate future
economic benefits in excess of its originally assessed standard of performance and the expenditure can be
measured and attributed to the asset reliably.
Internally Generated Intangible Assets
I. It is sometimes difficult to assess whether an internally generated intangible asset qualifies for recognition because
of problems in
(a) Identifying whether and when there is an identifiable asset that will generate expected future economic
benefits;
(b) Determining the cost of the asset reliably. In some cases, the cost of generating an intangible asset internally
cannot be distinguished from the cost of maintaining or enhancing the entity’s internally generated goodwill
or of running day-to-day operations.
II. To assess whether an internally generated intangible asset meets the criteria for recognition, an entity classifies the
generation of the asset into:
(a) A research phase (b) A development phase
III. If an entity cannot distinguish the research phase from the development phase of an internal project to create an
intangible asset, the entity treats the expenditure on that project as if it were incurred in the research phase only.
Research Phase
I. No intangible asset arising from research (or from the research phase of an internal project) shall be recognized.
Expenditure on research (or on the research phase of an internal project) shall be recognized as an expense when it
is incurred.
II. In the research phase of an internal project, an entity cannot demonstrate that an intangible asset exists that will
generate probable future economic benefits. Therefore, this expenditure is recognized as an expense when it is
incurred.
III. Examples of research activities are:
(a) Activities aimed at obtaining new knowledge
(b) The search for, evaluation and final selection of, applications of research findings or other knowledge
(c) The search for alternatives for materials, devices, products, processes, systems or services
(d) The formulation, design, evaluation and final selection of possible alternatives for new or improved materials,
devices, products, processes, systems or services.
Development Phase
I. An intangible asset arising from development (or from the development phase of an internal project) shall be
recognized if, and only if, an entity can demonstrate all of the following:
(a) The technical feasibility of completing the intangible asset so that it will be available for use or sale.
(b) Its intention to complete the intangible asset and use or sell it.
(c) Its ability to use or sell the intangible asset.
(d) How the intangible asset will generate probable future economic benefits. Among other things, the entity can
demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if
it is to be used internally, the usefulness of the intangible asset.
(e) The availability of adequate technical, financial and other resources to complete the development and to use or
sell the intangible asset.
(f) Its ability to measure reliably the expenditure attributable to the intangible asset during its development.
II. In the development phase of an internal project, an entity can, in some instances, identify an intangible asset and
demonstrate that the asset will generate probable future economic benefits. This is because the development phase
of a project is further advanced than the research phase.
III. Examples of development activities are:
(a) The design, construction and testing of pre-production or pre-use prototypes and models;
(b) The design of tools, jigs, moulds and dies involving new technology;
(c) The design, construction and operation of a pilot plant that is not of a scale economically feasible for commercial
production; and
(d) The design, construction and testing of a chosen alternative for new or improved materials, devices, products,
processes, systems or services.
IV. Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance shall
not be recognized as intangible assets.
V. Expenditure on internally generated brands, mastheads, publishing titles, customer lists and items similar in

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 substance cannot be distinguished from the cost of developing the business as a whole. Therefore, such items are
not recognized as intangible assets.

Measurement Subsequent to Acquisition

Cost model. After initial recognition the benchmark treatment is that intangible assets should be carried at cost
less any amortization and impairment losses.
Revaluation model. Intangible assets may be carried at a revalued amount (based on fair value) less any subsequent
amortization and impairment losses only if fair value can be determined by reference to an active market. Such active
markets are expected to be uncommon for intangible assets.
Classification of Intangible Assets Based on Useful Life
Intangible assets are classified as:
 Indefinite life: No foreseeable limit to the period over which the asset is expected to generate net cash inflows
for the entity.
 Finite life: A limited period of benefit to the entity.
Measurement Subsequent to Acquisition of Intangible Assets with Finite Lives
The cost less residual value of an intangible asset with a finite useful life should be amortized over that life:
 The amortization method should reflect the pattern of benefits.
 If the pattern cannot be determined reliably, amortize by the straight-line method.
 The amortization charge is recognized in profit or loss unless another PFRS requires that it be included in the cost of
another asset.
 The amortization period should be reviewed at least annually.
 The asset should also be assessed for impairment in accordance with PAS 36.
Measurement Subsequent to Acquisition of Intangible Assets with Indefinite Lives
 An intangible asset with an indefinite useful life should not be amortized.
 Its useful life should be reviewed each reporting period to determine whether events and circumstances continue
to support an indefinite useful life assessment for that asset. If they do not, the change in the useful life
assessment from indefinite to finite should be accounted for as a change in an accounting estimate.
 The asset should also be assessed for impairment in accordance with PAS 36.
Key Principles on Certain Intangible Assets
Patents
 An exclusive right granted by the government to an inventor to control the manufacture, use or sale of an invention
 Cost – Licensing and registration fees only for APPLIED AND REGISTERED patents and purchase price and any
directly attributable expenditure necessary in preparing the asset for its intended use for PURCHASED PATENTS.
 Principles on amortization:
 Amortization is based on the useful life or legal life (20 years), whichever is shorter.
 If a competing patent is acquired to protect an original patent. The cost of the new patent and the
carrying amount of the original patent is amortized over the remaining life of the original patent.
 If a related patent is acquired to extend the life of an existing patent. The cost of the new patent
and the carrying amount of the original patent is amortized over the extended period, unless if the
remaining life of the new patent is shorter than the extended period.
Goodwill
 An unidentifiable intangible asset that allows an enterprise to earn above normal income how
 It is only purchased goodwill that is recognized as an asset which is the cost in excess of the fair value of the net
assets acquired in a business combination. This the premium paid in acquiring another business or ordinary shares
when control is achieved. Countless of times goodwill is referred to as BADWILL because seemingly the purchaser
had gotten fleeced in the sale of the net assets of the seller.
 Internally generated goodwill shall not be recognized as an asset.
 Impairment of goodwill is discussed in Hand Out #22
 Methods of estimating goodwill
 Capitalization of “average excess earnings”
 Capitalization of “average earnings”
 Purchase or multiples of “average excess earnings”
 Present value of “average excess earnings”

ACTIVITY 4: Intangible Assets

Directions: Research on the “accounting for internally generated intangible assets”. Write your answer in a separate sheet of
paper.(15 points)

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ASSESSMENT
Directions: Encircle the letter of the correct answer.
1. The weighted average inventory costing method is particularly suitable to inventory where:
a. homogeneous products are mixed together.
b. goods have distinct use-by dates and the goods produced first must be sold earliest;
c. the entity carries stocks of raw materials, work-in-progress and finished goods;
d. dissimilar products are stored in separate locations;
2. When an inventory costing formula is changed, the change is required to be applied:
a. prospectively and the adjustment taken through the current profit or loss;
b. retrospectively and the adjustment recognised as an extraordinary gain or loss
c. prospectively and the current period adjustment recognised directly in equity;
d. retrospectively and the adjustment taken through the opening balance of accumulated profits;
3. The measurement rule for inventories, mandated by IAS 2 Inventories, is:
a. lower of fair value and selling price;
b. higher of completion costs and replacement costs.
c. higher of initial cost and realisable value;
d. lower of cost and net realisable value;
4. ‘Net realisable value’ of inventory is defined as the net amount that an enterprise expects to realise from the sale of
the inventory:
a. plus the estimated costs of completion
b. plus the estimated costs of completion plus the estimated costs necessary to make the sale;
c. in a forced sale;
d. in the ordinary course of operations less estimated costs of completion and costs necessary to make the sale;
5. Net realisable value of inventories may fall below cost for a number of reasons including:
I. Product obsolescence.
II. Physical deterioration of inventories.
III. An increase in the expected replacement costs of the inventory,
IV. An increase in the estimated costs of completion.
a. I, II and IV only; c. I, III and IV only;
b. II, III and IV only d. I and II only.
6. When determining the net realisable value of inventory, estimates must be made of the following:
I. Estimated costs of completion.
II. Expected replacement cost.
III. Expected selling price.
IV. Estimated selling price.
a. I, II, III and IV; c. I, II and III only;
b. II and IV only; d. I, III and IV only.
7. IAS 2 Inventories requires that when inventories are written down to net realisable value, they are written-down:
a. on a class-by-class basis; c. according to geographical segment within the entity.
b. on an item-by-item basis; d. on the basis of industry segment;
8. If the selling price of inventory that has been written down to net realisable value in a prior period, subsequently
recovers, the:
a. previous amount of the write-down can be reversed;
b. value adjustment can be recognised immediately in equity;
c. carrying amount of the inventory cannot be adjusted;
d. adjustment must be recognised in a ‘provision for future inventory write-downs’ account.
9. Where the net realisable value of inventory falls below cost, IAS 2 Inventories, requires that:
a. the difference be added to the carrying amount of the inventory.
b. no adjustment be made, but the difference between net realisable value and cost be disclosed in the notes to the
financial statements;
c. the inventory continue to be carried in the balance sheet at cost;
d. the inventory be written down to net realisable value;
10. When an entity allocates depreciation to the separate parts of an asset and each part is accounted for separately, the
entity is using which of the following approaches to depreciation?
a. periodic depreciation; c. segment depreciation
b. replacement cost depreciation; d. components depreciation

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11. When a balance is carried in an ‘asset revaluation surplus’ account in relation to an asset that has been derecognised,
it is acceptable under IAS 16 Property, Plant and Equipment, to:
a. transfer the balance to a provision account for future asset revaluations.
b. recognise the balance in profit or loss of the period in which the asset was derecognised;
c. transfer the balance to retained earnings;
d. transfer the balance to ‘share capital’ account;
12. If a reporting entity chooses to switch from the cost model to the revaluation model for property, plant and
equipment, the periodic depreciation charge will:
a. increase; c. no longer be required.
b. not be affected; d. decrease;
13. In relation to the amortisation of intangible assets, if an intangible asset has a finite useful life:
a. it must be amortised over a period not exceeding 40 years;
b. it must be amortised over that life.
c. it must be amortised across a period not exceeding 5 years;
d. it is not subject to an annual amortisation charge;
14. In relation to the amortisation of intangible assets, the general rule in IAS 38 Intangibles, is that unless demonstrated
otherwise:
a. the residual value is presumed to be zero
b. all intangible assets have a residual value at least equal to the amount of maintenance costs incurred;
c. the residual need no be reviewed at the end of each annual reporting period;
d. the residual value does not enter into the determination of the amortisation charge;
15. In relation to amortisation of intangible assets, IAS 38 Intangibles, requires that intangible assets with indefinite useful
lives:
a. should not be amortised in a period in which maintenance of the asset occurs.
b. are not subject to an amortisation charge;
c. must be amortised across a period of no more than 20 years;
d. are amortised by the straight-line method across their useful lives;
16. IAS 38 Intangibles, requires that the following items in relation to intangibles, each be disclosed separately:
a. all amounts of intangibles acquired during the period.
b. any impairment losses reversed in profit or loss during the period;
c. the closing balance of each intangible;
d. the opening balance of each intangible;
17. When an intangible asset is acquired by an exchange of assets, which of the following measures will need to be
considered in the determination of that cost? The:
a. Fair value of the asset given up; c. replacement cost of the asset received
b. carrying amount of the asset received; d. initial cost of the asset given up;
18. Internally generated goodwill is prohibited from recognition in the financial statements of an entity. The reason for
this treatment is that:
a. goodwill is not identifiable;
b. it is not comparable to any other intangible assets;
c. it is not prudent to recognise intangible assets.
d. goodwill is not measurable;
19. According to the definition provided in IAS 38 Intangibles, activities undertaken in the ‘research’ phase of the
generation of an asset may include:
a. original and planned investigation with the prospect of gaining new scientific knowledge;
b. using knowledge to materially improve a manufacturing device
c. the use of research findings to create a substantially improved product;
d. the application of knowledge to a design for the production of new materials;
20. According to IAS 38 Intangibles, in order to be able to capitalise ‘development’ outlays an entity must be able to
demonstrate the following:
I. Technical feasibility and intention of completing the asset so it will be available for use or sale.
II. Its ability to reliably measure the expenditure on the development of the asset.
III. Ability to use or sell the asset.
IV. How the asset will generate probable future economic benefits.
a. I, II and IV only; c. II, and IV only;
b. I, II, III and IV; d. II, III and IV only.

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References:
1. Valix, C., Peralta, J., and Valix, C., (2020). Intermediate Accounting Volume 1. GIC Enterprises & Co., Inc.: Philippines.
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/178-inventories-pas-2
3. IAS 16 Property, plant and equipment. (2017). Retrieved from: https://www.pkf.com/media/10033170/ias-16-property-
plant-and-equipment-summary.pdf
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affecting-depreciation-calculation/
5. Whittington, O. (2016). 2016 Wiley CPAexcel Exam Review Study Guide Financial Accounting and Reporting. John Wiley
& Sons, Inc.: New Jersey
6. Weygandt, J., et.al., (2009). Principles of Accounting 2 nd Edition. John Wiley & Sons Australia, Ltd.: Australia.
7. Kieso, D., Weygandt, J., and Warfield, T. (2016). Intermediate Accounting 16 th Edition. John Wiley & Sons Australia, Ltd.:
United States of America.
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industries
9. Elements of Internal Control over fixed assets. (2019). Real Asset Management. Retrieved from: https://www.realasse
tmgt.com/news-views/elements-of-internal-control-over-fixed-assets.html
10. Intangible Assets and its Types. (2020) eFinanceManagement.com. Retrieved from: https://efinancemanagement.com
/financial-accounting/intangib le-assets-and-its-types

Prepared by: Verified by: Approved by:

FRANCES JOSIE P. GILBER, CPA JAIRUS ISAIAS Q. CELIS TERESITA VILLA G. LACABA, D.M.
Lecturer Program Head, BSAIS Dean, CBMA

CBMA Page 25 of 25
Guiuan 6809
Eastern Samar, Philippines
[email protected]
https://essu.edu.ph