Selling Expenses and General and Administrative

Expenses
• Selling expenses are expenses that contribute to selling products. Selling
expenses can include marketing, advertising, promotions, window displays,
delivery costs, and any other cost that is directly associated with making
sales like salesman salaries.

• General and administrative expenses include all of the non-selling expenses.

General and administrative expenses are costs that contribute to the overall
operations of the company and can’t really be directly related back to selling
or making sales. (Rent, Utilities, Insurance, Executives wages and benefits,
The depreciation on office fixtures and equipment, Legal counsel and
accounting staff salaries.
Ms. Misericordia, the CPA of Arnisto Trading, must categorize the ff. expenses
according to Selling or General Administrative:

Salaries Exp. Store Staff – 100,000, Depreciation Exp. – Office Bldg. – 200,000,
Depreciation Exp. – Store Furniture – 100,000, Utilities Expense (66.66% office,
33.33% store) – 300,000, Salaries Exp. – Office Staff – 200,000, Rent Expense – Store
– 100,000, Freight-out – 100,000, Office supplies Expense – 200,000 Advertising
expense – 100,000

Solution:

Selling expenses:

100K+100k+100k+100k+100k+100k=600,000

General Administrative expense:

200k+200k+200K+200K=800,000
INCOME STATEMENT OF MERCHANDISING BUSINESS

Schedule 1: Net Sales Schedule 3: Cost of Goods Sold

Gross Sales P xxx Merchandise Inventory, beg P xxx
Net Purchases xxx
Sales Discounts (xxx)
Cost of Goods Available for Sale xxx
Sales Returns and Allowances (xxx)
Merchandise Inventory, end (xxx)
Net Sales Pxxx Cost of Goods Sold Pxxx

Schedule 2: Net Purchases Schedule 4: Gross Profit

Gross Purchases P xxx
Net Sales P xxx
Freight-in xxx
Purchase Discounts (xxx) Cost of Goods Sold (xxx)
Purchase Returns and Allowances (xxx)
Gross Profit Pxxx
Net Purchases Pxxx
Schedule 5: Total Operating
Expenses
Selling Expenses P xxx
General and Administrative Expenses xxx
Total Operating Expenses P xxx
Schedule 8: Net Income
Net Income before Taxes P xxx
Schedule 6: Operating Income Income Tax Expense (xxx)
(Loss)
Net Income After Taxes P xxx
Gross Margin P xxx
Total Operating Expenses (xxx)
Operating Income (Loss) P xxx

Schedule 7: Net Income (Loss) before

Taxes
Operating Income P xxx
Other Income/ Revenue xxx
Other Expenses/ Losses (xxx)
Net Income before Taxes P xxx
Sales:10,000,000-Sales Discount: (?)- Sales Returns and Allowances: 100,000 =Net
Sales: 9,700,000

Beginning Inventory: 1,000,000+ Purchases:7,200,000+Freight in:200,000- Purchase

discounts:(?) -Purchase Returns and allowances: 180,000 = TGAFS:7,500,000

TGAFS:7500,000-Inventory Ending:500,000= Cost of Good Sold (?)

Net Sales: 9700,000- COGS: (?)= Gross Profit (?)

Gross Profit (?) –(Freight out: 350,000+Depreciations expenses: 80,000+Bad debt

expense:60,000+Utilities Expense:150,000+advertising expense 100,000+Salaries
expense:140000+ Other Expenses (?))=Net income before tax:1,000,000

Questions:
Sales Discount=
Purchase discounts=
COGS=
GP=
Other Expenses=
Sales:10,000,000-Sales Discount: (?)- Sales Returns and Allowances: 100,000 =Net
Sales: 9,700,000

Beginning Inventory: 1,000,000+ Purchases:7,200,000+Freight in:200,000- Purchase

discounts:(?) -Purchase Returns and allowances: 180,000 = TGAFS:7,500,000

TGAFS:7500,000-Inventory Ending:500,000= Cost of Good Sold (?)

Net Sales: 9700,000- COGS: (?)= Gross Profit (?)

Gross Profit (?) –(Freight out: 350,000+Depreciations expenses: 80,000+Bad debt

expense:60,000+Utilities Expense:150,000+advertising expense 100,000+Salaries
expense:140000+ Other Expenses (?))=Net income before tax:1,000,000

Answers:
Sales Discount= 200,000
Purchase discounts=720,000
COGS=7000,000
GP: 2700,000
Other Expenses: 820,000
 Comprehensive income

is the change in equity during a period resulting from

transactions and other events, other than changes
resulting from transactions with owners in their
capacity as owners.

(SCI = P/L + OCI)

4-7 LO 1
 Income Statement

Usefulness
 Evaluate past performance.

 Predicting future performance.

 Help assess the risk or uncertainty of

achieving future cash flows.

4-8 LO 1
 Income Statement

Limitations
 Companies omit items that cannot be
measured reliably.

 Income numbers are affected by the

accounting methods employed.

 Income measurement involves judgment.

4-9 LO 1
 Income Statement

Components of Profit or Loss:

a. Income – an inflow of future economic benefit that increases equity, other
than contribution by owners.

(Sales of merchandise to customers, Rendering of services, Use of entity

resources, and Disposal of resources other than products)

b. Expense – an outflow of future economic benefit that decreases equity,

other than distribution or dividend paid to owners.

(Cost of sales, Distribution costs, Administrative expenses, Other expenses,

and Income tax expense)

4-10 LO 1
 Content and Format of the LEARNING OBJECTIVE 2
Describe the content and format of
Income Statement the income statement.

Elements of the Income Statement

Income – Increases in economic benefits during the accounting period in the
form of

 inflows or enhancements of assets or

 decreases of liabilities

that result in increases in equity, other than those relating to contributions

from shareholders.

Income includes both revenues and gains.

 Revenues - ordinary activities of a company

4-11
 Gains - may or may not arise from ordinary activities LO 2
 Elements of the Income Statement

Expenses represent decreases in economic benefits during the

accounting period in the form of
 outflows or depletions of assets or

 incurrences of liabilities

that result in decreases in equity, other than those relating to

distributions to shareholders.

4-12 LO 2
 Elements of the Income Statement

Expenses include both expenses and losses.

 Expenses - ordinary activities of a company
 Losses - may or may not arise from ordinary activities.

Expense Accounts Loss Accounts

 Cost of goods sold  Losses on restructuring charges
 Depreciation  Losses on to sale of long-term
 Interest assets
 Rent Salary and wages  Unrealized losses on trading
 Taxes securities

4-13 LO 2
 1. Sales or Revenue
Income
2. Cost of Goods Sold
Statement
Gross Profit
3. Selling Expenses
Intermediate
4. Administrative or General Expenses
Components
5. Other Income and Expense
Companies generally Income from Operations
present some or all of these 6. Financing costs
sections and totals within
Income before Income Tax
the income statement.
7. Income Tax
Income from Continuing Operations
8. Discontinued Operations
Net Income
9. Non-Controlling Interest
10. Earnings Per Share
4-14
 Format of the
Income 1

Statement 2

Includes all of the

major items in
previous list, except
4
for discontinued
operations.

ILLUSTRATION 4.2 9
Income Statement 10
4-15
 Condensed
Income
Statement

More representative of the

type found in practice.

ILLUSTRATION 4.3
Condensed Income
Statement

Company prepares
supplementary
schedules to support
the totals. ILLUSTRATION 4.4
Sample Supporting
Schedule
4-16
 Reporting Various Income LEARNING OBJECTIVE 3
Discuss how to report various
Items income items.

Gross Profit
 Computed by deducting cost of goods sold from net sales.

 Provides a useful number for evaluating performance and

predicting future earnings.

Unusual or incidental revenues are disclosed in other income and

expense.

4-17 LO 3
 Reporting Various Income Items

Income from Operations

 Determined by deducting selling and administrative expenses
as well as other income and expense from gross profit.

 Highlights items that affect regular business activities.

 Used to predict the amount, timing, and uncertainty of future

cash flows.

4-18 LO 3
 Income From Operations
Expense Classification

Nature Function

 Cost of materials used  Employee benefits

 Direct labor incurred  Depreciation expense
 Delivery expense  Amortization expense
 Advertising expense

4-19 LO 3
 “You can think of it this way: functional
expenses describe the purpose of an expense by
its category, while natural classifications explain
what the money was spent on.”

4-20
 Income From Operations
Expense Classification

Nature Function

 Cost of goods sold

 Selling expenses
 Administrative
expenses

4-21 LO 3
 Income From Operations

Expense Classification
Illustration: The firm of Telaris Co. performs audit, tax, and consulting
services. It has the following revenues and expenses.

4-22 LO 3
 Expense Classification

Nature-of-Expense Approach
ILLUSTRATION 4.5

4-23 LO 3
 Expense Classification

Function-of-Expense Approach
ILLUSTRATION 4.6

The function-of-expense method is generally used in practice although many

companies believe both approaches have merit.
4-24 LO 3
 Income From Operations

Gains and Losses

IASB takes the position that both

 revenues and expenses and

 other income and expense

should be reported as part of income from operations.

Companies can provide additional line items, headings, and subtotals when
such presentation is relevant to an understanding of the entity’s financial
performance.

4-25 LO 3
 Income From Operations

Gains and Losses

Additional items that may need disclosure:
 Losses on write-downs of inventories to net realizable value or of
property, plant, and equipment to recoverable amount, as well as
reversals of such write-downs.
 Losses on restructurings of the activities and reversals of any provisions
for the costs of restructuring.
 Gains or losses on the disposal of items of property, plant, and,
equipment or investments.
 Litigation settlements.
 Other reversals of liabilities.

4-26 LO 3
 Reporting Various Income Items

Net Income
Represents the income after all

 revenues and

 expenses

for the period are considered.

Viewed by many as the most important measure of a company’s

success or failure for a given period of time.

4-27 LO 3
 Reporting Various Income Items

Discontinued Operations
A component of an entity that either has been disposed of, or is
classified as held-for-sale, and:
1. Represents a major line of business or geographical area of
operations, or

2. Is part of a single, co-coordinated plan to dispose of a major line

of business or geographical area of operations, or

3. Is a subsidiary acquired exclusively with a view to resell.

4-28 LO 3
 Discontinued Operations

Companies report as discontinued operations

1. (in a separate income statement category) the gain or loss from
disposal of a component of a business.

2. The results of operations of a component that has been or will be

disposed of separately from continuing operations.

3. The effects of discontinued operations net of tax as a separate

category, after continuing operations.

4-29 LO 3
 Discontinued Operations

Illustration: KC Products, a highly diversified company, decides to

discontinue its electronics division. During the current year, the
electronics division lost P300,000 (net of tax). KC sold the division at
the end of the year at a loss of P500,000 (net of tax).

Income from continuing operations P20,000,000

Discontinued operations:
Loss from operations, net of tax 300,000
Loss on disposal, net of tax 500,000
Total loss on discontinued operations 800,000
Net income P19,200,000
ILLUSTRATION 4.10
Income Statement Presentation of
4-30
Discontinued Operations LO 3
 Discontinued Operations
ILLUSTRATION 4.11
A company that
reports a
discontinued
operation must
report per share
amounts for the
line item either on
the face of the
income statement
or in the notes to
the financial
statements.

4-31
 Reporting Various Income Items

Allocation to Non-Controlling Interest

When a company prepares a consolidated income statement, IFRS
requires that net income be allocated to the controlling and non-
controlling interest. This allocation is reported at the bottom of the
income statement, after net income.

ILLUSTRATION 4.15 (amounts given)

Presentation of Non-Controlling Interest

4-32 LO 3
 Reporting Various Income Items
BE4-3: Presented below is some financial information related to Volaire
Group. Compute the following: Other Income
and Expense

Revenues P800,000 P800,000

Income from continuing operations 100,000 100,000
Comprehensive income 120,000 120,000
Net income 90,000 90,000
Income from operations 220,000 - 220,000
Selling and administrative expenses 500,000 - 500,000
Income before income tax 200,000 200,000
P80,000

4-33 Rev-S-A-Oth. exp=Income from Op. LO 3

 Reporting Various Income Items
BE4-3: Presented below is some financial information related to Volaire
Group. Compute the following:
Financing
Costs
Revenues P800,000 P800,000
Income from continuing operations 100,000 100,000
Comprehensive income 120,000 120,000
Net income 90,000 90,000
Income from operations 220,000 220,000
Selling and administrative expenses 500,000 500,000
Income before income tax 200,000 - 200,000
P20,000

4-34 Rev-S-A-Oth. exp=Income from Op.-financing cost=NIBT LO 3

 Reporting Various Income Items
BE4-3: Presented below is some financial information related to Volaire
Group. Compute the following:

Income Tax

Revenues P800,000 P800,000

Income from continuing operations 100,000 - 100,000
Comprehensive income 120,000 120,000
Net income 90,000 90,000
Income from operations 220,000 220,000
Selling and administrative expenses 500,000 500,000
Income before income tax 200,000 200,000

Rev-S-A-Oth. exp=Income from Op.-financing cost=NIBT- P100,000

tax=inc from continuing operation
4-35 LO 3
 Reporting Various Income Items
BE4-3: Presented below is some financial information related to Volaire
Group. Compute the following:
Discontinued
Operations
Revenues P800,000 P800,000
Income from continuing operations 100,000 100,000
Comprehensive income 120,000 120,000
Net income 90,000 - 90,000
Income from operations 220,000 220,000
Selling and administrative expenses 500,000 500,000
Income before income tax 200,000 200,000
P10,000
Rev-S-A-Oth. exp=Income from Op.-financing cost=NIBT-tax=inc from
cont.
4-36 operation-dis. Op=Net income LO 3
 Reporting Various Income Items
BE4-3: Presented below is some financial information related to Volaire
Group. Compute the following: Other
Comprehensive
Income
Revenues P800,000 P800,000
Income from continuing operations 100,000 100,000
Comprehensive income 120,000 120,000
Net income 90,000 - 90,000
Income from operations 220,000 220,000
Selling and administrative expenses 500,000 500,000
Income before income tax 200,000 200,000

Rev-S-A-Oth. exp=Income from Op.-financing cost=NIBT- P30,000

tax=inc from continuing operation-dis. Op=Net income
LO 3
4-37 (P&L)+OCI= Net income
 Income Statement

Summary ILLUSTRATION 4.16

Summary of Various Income Items

4-38 LO 3
 Income Statement

Summary ILLUSTRATION 4.16

Summary of Various Income Items

4-39 LO 3
 Related Equity
Statements

Retained Earnings Statement

Increase Decrease
 Net income  Net loss
 Change in accounting  Dividends
principle  Change in accounting
 Prior period adjustments principles
 Prior period adjustments

4-40 LO 5
A change in accounting principle is defined as:
“A change from one generally accepted accounting principle to
another generally accepted accounting principle when

(a) there are two or more generally accepted accounting principles that apply;
Note: (The change will result in more relevant and faithfully represented
information about the financial statements)

(b) the accounting principle formerly used is no longer generally accepted. A

change in the method of applying an accounting principle also is considered a
change in accounting principle.”

A change in accounting principle is applied for two types of changes:

(a) Mandatory changes required by a newly issued Accounting Standard

Update

(b) Voluntarily changes from one acceptable accounting principle to another on

the basis that it is preferable.
4-41
Examples:

1)different depreciation method or switching

(voluntary)

2) between LIFO to FIFO inventory valuation

methods. (mandatory way back 2003)
LIFO was prohibited to be used by International Accounting
Standards (IAS) after the revision of IAS in 2003 in preparation and
presenting financial statements.

4-42
Prior period adjustments are corrections of past errors that occurred and
were reported on a company's prior period financial statement. Likewise,
a prior year adjustment is a correction to a company's prior year financial
statement.

4-43
 Retained Earnings Statement

Restrictions on Retained Earnings

Disclosed
 In notes to the financial statements.

 As Appropriated Retained Earnings.

•Acquisitions.
•Stock Buyback.
•Marketing Campaigns.
•Research and Development.
•Reserve against lawsuits and future losses.
•Debt Reduction.
4-44 LO 5
 Related Equity Statements

Comprehensive Income
All changes in equity during a period except those resulting from
investments by owners and distributions to owners.

Includes:

 all revenues and gains, expenses and losses reported in net

income, and

 all gains and losses that bypass net income but affect equity.
(OCI)

4-45 LO 5
 Comprehensive Income
Net Income
Income Statement (in thousands)
Other Comprehensive
Sales
Cost of goods sold
$ 285,000
149,000
+ Income
Gross profit 136,000
 Unrealized gains and
Operating expenses:
Selling expenses 10,000 losses on non-trading
Administrative expenses 43,000 equity securities.
Total operating expense 53,000
 Translation gains and
Income from operations 83,000
Other revenue (expense):
losses on foreign currency.
Interest revenue 17,000  Plus others
Interest expense (21,000)
Total other (4,000)
Income before taxes 79,000
Income tax expense 24,000 Reported in Equity
Net income $ 55,000

4-46 LO 5
 Comprehensive Income

Companies must display the components of other comprehensive

income in one of two ways:

1. A single continuous statement (one statement approach) or

2. two separate, but consecutive statements of net income and

other comprehensive income (two statement approach).

4-47 LO 5
 Comprehensive Income
ILLUSTRATION 4.21
One Statement Approach One Statement Format:
Comprehensive Income

Advantage – does
not require the
creation of a new
financial statement.
Disadvantage - net
income buried as a
subtotal on the
statement.

4-48 LO 5
 Comprehensive Income

Two Statement Illustration 4-19

Approach

ILLUSTRATION 4.22
Two Statement Format:
Comprehensive Income

4-49
 Other comprehensive income

comprises items of income and expense including reclassification adjustments.

(generally amounts should be reclassified to P/L in the period that these
should be recognized as P/L). OCI initially as current recognition (adjustments
and initial recognition).
Note: Only the adjustments for the period should reflect on SCI and the accumulated amount
should reflect in the SFP.
Some OCI accounts are being reclassified directly to other equity account like Retained
earnings
Example: Forex gain translation for the period is 200,000 gain adjustment and initially
(beg. Balance) a credit balance related to this is 1,200,000.
To be reflected:
SFP: PHP1400,000
SCI: PHP 200,000
4-50 LO 5
 Other comprehensive income
Components of Other Comprehensive Income
1. Gain or loss from translating the financial statements of a foreign operation
2. Unrealized gain or loss from derivative contracts designated as cash flow hedge
3. Unrealized gain or loss on investment in debt instrument measured at FV through OCI
4. Unrealized gain or loss on investment in equity instrument measured at FV through
OCI
5. Change in revaluation surplus
6. Remeasurements of defined benefit plan
7. Change in fair value attributable to credit risk of a financial liability designated at fair
value profit or loss

4-51 LO 5
Review IA1

4-52
 Other comprehensive income
Presentation of OCI
Line items of OCI subsequently reclassified to P/L
1. Gain or loss from translating the financial statements of a foreign operation
2. Unrealized gain or loss from derivative contracts designated as cash flow hedge
3. Unrealized gain or loss on investment in debt instrument measured at FV through OCI
Line items of OCI subsequently reclassified to Retained Earnings
1. Unrealized gain or loss on investment in equity instrument measured at FV through OCI
2. Change in revaluation surplus
3. Remeasurements of defined benefit plan
4. Change in fair value attributable to credit risk of a financial liability designated at fair value
profit or loss

4-53 LO 5
At the beginning of the current year, an entity provided the following information in connection with a
defined benefit plan:

Fair value of plan Asset: 10,000,000

Projected benefit obligation: (13,000,000)
Prepaid/accrued benefit cost: (3000,000)

The entity revealed the following transactions affecting the plan for the current year:

Current service cost: 2.5M

Past service cost- remaining vesting period of covered employees is 5 years: 1.2M
Contribution to the plan: 3.5M
Benefits paid to retirees: 3M
Actual return on plan assets: 1.5M
Decrease in projected benefit obligation due to change in actuarial assumptions: 400K
Discount rate: 10%

What is the net remeasurement gain for the current year? 900,000

1.5M-1M=500k (actual return vs interest income)

400k (decrease in obligation)
900K
Review:

PFRS 9 provides that an entity shall recognized a loss allowance for expected credit
losses on:

1) Debt investment at amortized cost

2) Debt at FVOCI

Standard provides that an entity shall measure the loss allowance for a financial
instrument at an amount equal to the lifetime expected credit losses if the credit
risk increase significantly since initial recognition.

Credit losses: PV of all cash shortfalls.

In estimation consider these:

Probability
Time value of money
Estimation cost

(standard do not have any guidelines for this. Impairment loss can be measured:
Carrying-PV expected cash flow discounted using effective interest rate.)
IFRS 9 requires gains and losses on financial liabilities designated as at
FVTPL to be split into the amount of change in fair value attributable to
changes in credit risk of the liability, presented in other comprehensive
income, and the remaining amount presented in profit or loss. The new
guidance allows the recognition of the full amount of change in the fair value
in profit or loss only if the presentation of changes in the liability's credit risk
in other comprehensive income would create or enlarge an accounting
mismatch in profit or loss. That determination is made at initial recognition
and is not reassessed. [IFRS 9, paragraphs 5.7.7-5.7.8]

Amounts presented in other comprehensive income shall not be

subsequently transferred to profit or loss, the entity may only transfer
the cumulative gain or loss within equity.
For example, IAS 21 The Effects of Changes in Foreign Exchange Rates (IAS 21),
is one example of a standard that requires gains and losses to be reclassified
from equity to P/L as a reclassification adjustment.

“When a group has an overseas subsidiary a group exchange difference will

arise on the re-translation of the subsidiary’s goodwill and net assets. In
accordance with IAS 21 such exchange differences are recognized in OCI and so
accumulate in OCI.

“On the disposal of the subsidiary, IAS 21 requires that the net cumulative
balance of group exchange differences be reclassified from equity to P&L as a
reclassification adjustment.”

4-57
Alternatively, IAS 16 PPE is an example of a standard that prohibits gains and
losses to be reclassified from equity to SOPL as a reclassification adjustment.

If we consider land that cost $10m which is treated in accordance with IAS 16
PPE. If the land is subsequently revalued to $12m, then the gain of $2m is
recognized in a revaluation reserve.

When in a later period the asset is sold for $13m, IAS 16 PPE specifically
requires that the profit on disposal recognized in the SOPL is $1m – ie the
difference between the sale proceeds of $13m and the carrying amount of
$12m. The previously recognized gain of $2m is not recycled/reclassified
back to P/L as part of the gain on disposal.

However the $2m balance in the revaluation surplus is now redundant as the
asset has been sold and the profit is realized. Accordingly, there will be a
transfer in the Statement of Changes in Equity, from the OCI of $2m into RE.

4-58
 Related Equity Statements

Statement of Changes in Equity

Required, in addition to a statement of comprehensive income.
 Generally comprised of
► Share capital—ordinary,
► Share premium—ordinary,
► Retained earnings, and the
► Accumulated balances in other comprehensive income.

4-59 LO 5
Legal capital is that amount of a company's equity that cannot
legally be allowed to leave the business; it cannot be distributed
through a dividend or any other means. It is the par value of
common stock and the stated value of the preferred stock that a
business has sold or otherwise issued to investors.

The legal capital concept does not apply to any stock that is
authorized for issuance but which has not yet been issued.

4-60
 Statement of Changes in Equity
Reports the change in each equity account and in total equity for the
period. Includes the following:
1. Accumulated comprehensive income for the period.

2. Contributions (issuances of shares) and distributions (dividends) to

owners.

3. Reconciliation of the carrying amount of each component of equity

from the beginning to the end of the period. (adjustments)

4-61 LO 5
 Statement of Changes in Equity

ILLUSTRATION 4.23
Statement of Changes in Equity

4-62 LO 5
 Statement of Changes in Equity

Regardless of the display format used, V. Gill reports the accumulated

other comprehensive income of P90,000 in the equity section of the
statement of financial position as follows.

ILLUSTRATION 4.24
Presentation of Accumulated Other Comprehensive Income in the Statement of Financial Position LO 5
4-63
 Accounting Changes
and Errors

Changes in Accounting Principle

 Retrospective adjustment.
 Cumulative effect adjustment to beginning retained earnings.

 Approach preserves comparability across years.

 Example include:
► Change from FIFO to average-cost.

4-64 LO 4
Retrospective means implementation new accounting policies for
transaction, event, or other circumstances as if it had been
implemented. ... While prospective means implementation new
accounting policies for transaction, event, or other circumstances
after new accounting policies or estimation has been implemented.

Cumulative effect equals the difference between the

actual retained earnings reported at the beginning of the year
using the old method and the retained earnings that would have
been reported at the beginning of the year if the new method had
been used in prior years.

4-65
 Changes in Accounting Principle

Change in Accounting Principle: Gaubert Inc. decided in March 2019

to change from FIFO to weighted-average inventory pricing. Gaubert’s
income before taxes, using the new weighted-average method in 2019, is
P30,000.
ILLUSTRATION 4.17
Pretax Income Data Calculation of a Change in
Accounting Principle

ILLUSTRATION 4.18
Income Statement
Presentation of a Change
in Accounting Principle (Based
on 30% tax rate)

4-66 LO 4
 Accounting Changes

Change in Accounting Estimates

 Accounted for in the period of change or the period of and the
future periods if the change affects both.
 Not handled retrospectively.
 Not considered errors.
 Examples include:
► Useful lives and residual values of depreciable assets.
► Uncollectible receivables.
► Inventory obsolescence.

4-67 LO 4
 Change in Accounting Estimates

Change in Estimate: Arcadia HS, purchased equipment for P510,000

which was estimated to have a useful life of 10 years with a residual
value of P10,000 at the end of that time. Depreciation has been
recorded for 7 years on a straight-line basis. In 2019 (year 8), it is
determined that the total estimated life should be 15 years with a
residual value of P5,000 at the end of that time.

Questions:

 Does prior years’ depreciation need to be restated?

 Calculate the depreciation expense for 2019.

4-68 LO 4
 After 7
Change in Accounting Estimates years

Equipment cost P510,000 First, establish NBV at

Residual value - 10,000 date of change in
Depreciable base 500,000 estimate.
Useful life (original) 10 years
Annual depreciation P 50,000 x 7 years = P350,000

Balance Sheet (Dec. 31, 2018)

Fixed Assets:
Equipment P510,000
Accumulated depreciation 350,000
Net book value (NBV) P160,000

4-69 LO 4
 After 7
Change in Accounting Estimates years

Net book value P160,000 Depreciation Expense

Residual value (new) 5,000 calculation for 2019.
Depreciable base 155,000
Useful life remaining 8 years
Annual depreciation P 19,375

Journal entry for 2019

Depreciation Expense 19,375

Accumulated Depreciation 19,375

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 Accounting Errors

Corrections of Errors
 Result from:
► mathematical mistakes.

► mistakes in application of accounting principles.

► oversight or misuse of facts.

 Corrections treated as prior period adjustments.

 Adjustment to the beginning balance of retained earnings.

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 Corrections of Errors

Illustration: In 2019, Tsang Ltd. determined that it incorrectly

overstated its accounts receivable and sales revenue by P100,000 in
2018. In 2019, Tsang makes the following entry to correct for this
error (ignore income taxes).

Retained Earnings 100,000

Accounts Receivable 100,000

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4-73
 2018
2019

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 Notes for counterbalancing errors: (matching
principle)

Notes for AFDA and BD reduction

* You have already reflected as an entry the
5M*2%=100,000 where in your new estimate it
should be just 5m*1.5%=75000.

Notes for machinery

Notes for unused portion of insurance : *the 12500 depreciation expense came from
*All are charged as expense in 2018 but 1/5 of it depreciable amount of 125000/10.
has been used during that period therefore net of *Portion of depreciation last year of 12500 and
4/5 should be removed in Equity. the total amount of 150k charged as an expense
*typical insurance expense adjustment for the instead of as non current asset net amount is
year 137500
*The 3/5 unused should reflect as an asset. *Accumulated depreciation reflects the two years
time already

If you are confused in compound entries, analyze the

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effects using single entries. 
 Entries 2019:

1) Prepaid Insurance 18600

Insurance expense 6200
Retained Earnings 24800

2) AFDA 25000
Bad debts expense 25000

3) Retained Earnings 75500

COGS 23500
Inventory 99000

4) Equipment 150000
Depreciation Exp. 12500
Retained Ear. 137500
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Accumulated Dep. 25000
 A counterbalancing error has occurred when an error is made that cancels
out another error.

An example of a counterbalancing error is expenses charged to year X that

should have been charged to year Y. The result is year X has an overstated
expense and an understated profit and year Y has an expense understated
and the profit overstated.

Yet when retained earning for year Z is correct, because the two previous
errors cancelled each other out. While the effects of the error are
corrected over a period of two years, the yearly net income figures for year
X and year Y were still misstated.

Non-counterbalancing errors are those that will not be automatically offset

in the next accounting period. It makes no difference whether the books are
closed or still open, a correcting journal entry is necessary.

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 Accounting Errors
ILLUSTRATION 4.19
Summary Summary of Accounting
Changes and Errors

Type of
Situation
Changes in Accounting Principle
Criteria Change from one generally accepted accounting principle to
another.

Examples Change in the basis of inventory pricing from FIFO to

average-cost.

Placement on Recast prior years’ income statements on the same basis as the
Income newly adopted principle.
Statement

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 Accounting Errors
ILLUSTRATION 4.19
Summary Summary of Accounting
Changes and Errors

Type of
Situation
Changes in Accounting Estimate
Criteria Normal, recurring corrections and adjustments.

Examples Changes in the realizability of receivables and inventories;

changes in estimated lives of equipment, intangible assets;
changes in estimated liability for warranty costs, income taxes,
and salary payments.

Placement on Show change only in the affected accounts (not shown net of
Income tax) and disclose the nature of the change.
Statement

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 Accounting Errors
ILLUSTRATION 4.19
Summary Summary of Accounting
Changes and Errors

Type of
Situation
Corrections of Errors
Criteria Mistake, misuse of facts.

Examples Error in reporting income and expense.

Placement on Restate prior years’ income statements to correct for error.

Income
Statement

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 Change in Accounting Estimate

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

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

b. The period of change and future period if the change
affects both.

Prospective recognition of the effect of a change in accounting

estimate means that the change is applied to transactions, other events
and conditions from the date of change in estimate.

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Accounting Policies
A change in accounting policy shall be made only when:
a. Required by an accounting standard or an interpretation of the
standard.
b. The change will result in more relevant and faithfully represented
information about the financial statements

The following are not changes in accounting policy:

a. The application of an accounting policy for events or transactions
that differ in substance from previously occurring events or
transactions

b. The application of a new accounting policy for events or

transactions which did not occur previously or that was immaterial

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 Change in Accounting Policies

Accounting Treatment
With transitional provision: A change in accounting policy
required by a standard or an interpretation shall be applied
in accordance with transitional provisions therein.
Without transitional provision: If the standard or interpretation
contains no transitional provisions or if an accounting policy is
changed voluntarily, the change shall be applied retrospectively or
retroactively.
PAS 8, paragraph 22, provides that “an entity shall adjust the
opening balance of each affected component of equity for the earliest
period presented and the comparative amounts disclosed for each prior
period presented as if the new policy had always been applied.”

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 Change in Accounting Policies
Limitation of Retrospective Application
Retrospective application of a change in accounting policy is not required if
it is impractical to determine the cumulative effect of change.

For a particular prior period, it is impractical to apply a change in

accounting policy when:
a. The effects of the retrospective application are not determinable.
b. The retrospective application requires assumptions about what management’s
intentions would have been at that time.
c. The retrospective application requires significant estimate, and it is impossible
to distinguish objectively information about the estimate that:
1. Provides evidence of circumstances that existed at that time, and
2. Would have been available at that time

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 Change in Accounting Policies
Prospective Application
When it is impractical to apply a new accounting policy retrospectively
because it cannot determine the cumulative effect of applying the policy to all prior
periods, the entity shall apply the new policy prospectively from the earliest period
practicable.
Change in Reporting Entity
A change in reporting entity is a change whereby entities change their
nature and report their operations in such a way that the financial statements are in
effect those of a different reporting entity.

A change in reporting entity is actually a change in accounting policy and

therefore shall be treated retrospectively or retroactively to disclose what the
statements would have looked like if the current entity had been existing in the prior
year. Thus, the financial statements of all prior periods presented shall be restated to
show financial information for the new reporting entity.

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 Change in Accounting Policies
Absence of Accounting Standard
PAS 8, paragraph 10, provides that in the absence of an accounting standard
that specifically applies to a transaction or event, management shall use its judgment
in selecting and applying an accounting policy that results in information that is
relevant to the economic decision making needs of users and faithfully represented.

Paragraphs 11 and 12 specify the following hierarchy of guidance which

management may use when selecting accounting policies in such circumstances:
a. Requirements of current standards dealing with similar matters.
b. Definition, recognition criteria and measurement concepts for assets,
liabilities, income and expenses in the Conceptual Framework for Financial
Reporting
c. Most recent pronouncements of other standard-setting bodies that use
similar Conceptual Framework, other accounting literature and accepted industry
practices.

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 Prior Period Errors

Prior period errors are omissions from and misstatements in the

financial statements for one or more periods arising from a failure to
use or misuse of reliable information that:

a. Was available when financial statements for those periods

were authorized for issue.

b. Could reasonably be expected to have been obtained and

taken into account in the preparation and presentation of those
financial statements.

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

This is known as retrospective restatement which is “correcting the recognition,

measurement and disclosure of amounts of elements of financial statements as if the
prior period error had never occurred.

In other words, the net income, its components, retained earnings and other affected
balances for the prior period presented shall be adjusted accordingly. If the error
occurred before the earliest period presented, the opening balances of assets,
liabilities and equity for the earliest period presented shall be restated.

When it is impractical to determine the cumulative effect at the beginning of the

current period of an error on all prior periods, the entity shall restate the comparative
information to correct the error prospectively from the earliest date practicable.
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 Prior Period Errors
Disclosures of Prior Period Errors
An entity shall disclose the following:
1. The nature of prior period error
2. The amount of correction for each prior period presented to the
extent practicable:
a. For each financial statement line item affected
b. For basic and diluted earnings per share
3. The amount of correction at the beginning of the earliest prior
period presented
4. If retrospective restatement is impracticable for a particular prior
period, the circumstances that led to the existence of that condition and
a description of how and from when the error has been corrected

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