2019 Edition

CPA

Examination
in
Advanced Financial
Accounting and
Reporting

(Theories and Problems)

Antonio Jaramillo Dayag, CPA, PhD (CAR)

CPA Reviewer, The Review School of Accountancy (ReSA)

Faculty Member, University of Santo Tomas (UST)
 Copyright 2019

by
Antonio Jaramillo Dayag

Any copy of this book not bearing the

signature of the author on this page is
unauthorized and shall be considered as
proceeding from an illegal source.

All rights Reserved

ISBN: 978-621-416-060-0

Published & Printed by:

GIC ENTERPRISES & CO., INC.

“National Book Development Board Registered
2017 C.M. Recto Avenue, Sampaloc
Manila, Philippines
 This book is dedicated to
my beloved wife, Jennifer,
daughters, Kim Dorothy
and Drei Cerise,
and son, Antonio Jr.
to my dearly departed parents,
my dearest brothers & sister, nieces,
and my students, and reviewees

A failure is not always a mistake.

It may simply be the best one
can do under the circumstances,
real mistake is to stop trying.
- B. F. Skinner —

A person who never made a mistake

never tried anything new.
- Albert Einstein —
 Preface
The best way for most CPA reviewees to learn Advanced Financial Accounting and Reporting is
to read textbook relative to the topic involved since there was already a prior knowledge of the
subject matter. But, such is not the case for a student - you need to read at a glance importance
topics in the textbook such as the procedural approach then solve the CPA Examination book.
Then, after solving the multiple-choice problem in the examination book, read the discussion of
the solution at end of each chapter and it is time to read the textbook comprehensively.

The key strengths of this book are the clear and readable discussions of concepts ‘And the
detailed demonstrations of these concepts through illustrations and explanations. The result is a
text that ties procedures in its application that develops understanding in an incremental depth.
The sequential approach used in this book is undoubtedly effective in the learning process of
each student

and the CPA reviewee.

I observed reviewees'/students'’ skills vary widely. As a result, they should strengthen their
knowledge on theory and concepts and transform this knowledge in a problem-solving
approach.

This 2019 edition includes discussions on PFRS 9, PFRS 15, the Government Accounting Manual,
PFRIC 16 and PFRIC 22. There are also certain issues the author raised on some theoretical rules
which the author firmly resolve and justify.

The author wishes to thank his fellow ReSA CPA Reviewers (Elerie Aranas, Atty. Marceliano S.
Bonafe, Gerardo C. Caiga, Atty. Andrix Domingo. Atty. James Christopher D. Domingo,
Christopher Espenilla, Shirley Cordova-lreneo, Jose M. Ireneo,, Charlwin “Aljon” P. Lee, Atty.
Christian Lovie U. Lim, Gorgonio S. Macariola, Kenneth Glenn L. Manvel, Mark Alyson B. Ngina,
Atty. Ronn Robby BD: Rosales, Asser S. Tamayo, Florenz Tugas, Conrado O. Uberita, Nico B.
Vailderama and Fermin Antonio D. Yabut) for their untiring support, the ReSA staft (Mytene B.
Ponce, Cynthia E. Ponce and Rhea Bajaro) for their usual help and coordination reviewees for
their intelligent questions, former reviewees and UST students, Ms. Jhoanna Feliza Caw Go
(ReSA reviewee and UST graduate, 1" Placer – May 2005 CPA Board Examination, now an SGV
Partner) for her inputs on some topics. and most of all to my dearest wife, Jennifer Basilio-
Dayag for her helpful comments and suggestions and to my children - Kim Dorothy and Drei
Cerise in editing this 2019 edition. Again, thank you for patronizing this book and for your usual
consideration.
Accounting Standards and Pronouncements Cited in this Edition
PAS No. 16 Property, Plant and Equipment

PAS No. 21 The Effect of Changes in Foreign Exchange Rates

PAS No. 27 Separate Financial Statements

PAS No. 28 Investment in Associates and Joint Ventures

PAS No.29 Reporting in Hyperinflationary Economies

PAS No 31 Financial Reporting of Interests in Joint Ven

PAS No. 32 Financial Instruments: Disclosures and Presentation

PAS No. 37 Provisions, Contingent Liabilities and Contingent Assets

PAS No. 38 Intangible Assets

PFRS No. 3 Business Combinations

PFRS No. 4 Insurance Contracts

PFRS No. 9 Financial Instruments: Recognition and Measurement

PFRS No. 10 — Consolidated Financial Statements

PFRS No. 11 = Joint Arrangements

PFRS No, 13 - Fair value Measurement

PFRS No, 15 - Revenue from Contracts with Customers

PFRS No, 17 = Insurance Contracts (effective January 1, 2021)

PFRS for SMEs

PFRIC 12 Service Concession Arrangement

PFRIC 16 Hedges on a Net Investment in Foreign Operations

PFRIC 22 Foreign Currency Transactions and Advance Consideration

FASB No.52 Foreign Currency Translation

FASB No.116 Accounting for Contributions Received and Contributions Made

FASB No.117 Financial Statements of Not-for-Profit Organizations

FASB No.133 Accounting for Derivative and Instruments and Hedging Activities

FASB No.138 Accounting for Certain Derivatives Instruments and Certain Hedging Activities – An
Amendment of FASB No. 133

Government Accounting Manual

Antonio Jaramillo Dayag

August 28, 2018

 TABLE OF CONTENTS

Dedication

Preface

Contents

Chapter 1: Partnership- Formation, Operation, Dissolution and Liquidation………………………….1

Chapter 2: Corporate Liquidation……………………………………………………………………………………….

Chapter 3: Revenue Recognition — Contracts with Customers………………………………………….

Chapter 4: Revenue Recognition - Contract with Customers:

Construction Accounting…………………………………………………………………………………

Appendix: SMEs — Construction Contracts………………………………………………………………….

Chapter 5: Revenue Recognition — Contract with Customers:

Franchise and Consignment……………………………………………………………………………

Appendix: SMEs — Franchise…………………………………………………………………………………….

Chapter 6: Home Office, Branch, and Agency Accounting……………………………………………….

Chapter 7: Business Combinations — Statutory Merger and

Statutory Consolidations…………………………………………………………………………….

Appendix: SMEs — Business Combinations……………………………………………………………

Chapter 8: Consolidation Financial Statements — Stock Acquisition………………………..

Appendix: SMEs — Consolidations………………………………………………………………………

Chapter 9: Joint Arrangements………………………………………………………………………………

Chapter 10: Accounting for Foreign Currency Transactions, Contract (Hedging)

Transactions, Foreign Currency Financial Statement Translation,

and Financial Reporting in Hyperinflationary Economies………………………

Appendix: SMEs — Foreign Currency and Hyperinflation………………………………..

Chapter 11: Derivatives as Hedging Instruments in Managing Foreign Currency

Exposures ………………………………………………………………………………………

Appendix: SMEs — Hedging…………………………………………………………………………….

Chapter 12: Not-for-profit Organizations — Hospitals, Colleges and Universities,

Voluntary Health and Welfare Organizations and Other Not-for-Profit

Organizations………………………………………………………………………………..

Chapter 13: Insurance Contracts and Service Concession Arrangement

(Accounting for Build-Operate and Transfer) ……………………………….

Chapter 14: Government Accounting Manual - General Fund………………………..

Chapter 15: Job Order Costing - Costing of Product, Service Cost Allocation,

Overhead Allocation, Accounting for Scrap, Waste, Spoilage,

and Rework………………………………………………………………………………

Chapter 16: Process Costing — Equivalent Units and Cost Allocation,

Accounting for Normal and Abnormal Lost Units………………………….

Chapter 17: Joint and By-Products …………………………………………………………………

Chapter 18: Standard Costing………………………………………………………………………….

Chapter 19: Backflush Costing and Activity- Based Costing…………………………………

I. Introduction A partnership is defined as an association of two or more persons who contributes
money, property or industry to a common fund with the intention of dividing the profits among
themselves. Accounting for partnerships should comply with the legal requirements as set forth
by the Partnership Law as well as complying with the partnership agreement itself.
II. Partnership Formation and Capital Accounts All assets contributed to the partnership are
recorded by the partnership at their agreed values (or fair market values, in the absence of
agreed values). All liabilities that the partnership assumes are recorded at their net present
values. Thus, if a partner contributes a noncash asset to the partnership (e.g., land or
equipment) subject to mortgage, the contributing partner's capital account is credited for the
agreed value (or fair values) of the noncash asset less the mortgage assumed by the partnership.
The capital account is an equity account similar to the shareholders' equity accounts in a
corporation. It is used to account for permanent withdrawals and additional contributions. Other
important accounts include a drawing account and loans to or from partners. The drawing
account is used to account for net income or loss and personal or normal withdrawals, i.e., share
against net income. It is closed at the end of the period into the capital account. Loan accounts
are set up for amounts intended as loans, rather than as additional capital investments. In
liquidation proceedings, a loan to or from a partner is in essence treated as an increase or
decrease in a partner's capital account.
III. Division of Profits and Losses As a rule profits and losses are allocated based on agreement.
Methods Various methods exist for the division of partnership profits and losses, including the
following:
1. Equally,
2. Arbitrary ratio,
3. Capital contribution ratio:
a. Original Capital or initial investment
b. Beginning Capital of each year
c. Average Capital
d. Ending Capital of each year
4. Interest on capital balance and/or loan balances and the balance on agreed ratio,
5. Salaries to partners and the balance on agreed ratio,
6. Bonus to partners and the balance on agreed ratio,
α. Bonus as an "expense" in computing the bonus amount. Here, bonus is
computed based on net income after bonus.
b. Bonus as a distribution of profit. Here, the bonus is computed based on
net income before deducting the bonus.
7. Interest on capitals and/or loan balances, salaries to partners, and bonus to partner
and the balance on agreed ratio.
The method of division to be used in any given situation is generally the method specified in the
partnership agreement. This agreement must always be consulted first, since it is legally binding
on the partners. If no profit and loss sharing arrangement is specified in the partnership
agreement, the partnership requires that profits and losses be shared according to capital
contribution. Capital contribution should be interpreted to be original capital/beginning capital
of each year in the absence of original capital; similarly, if the agreement specifies how profits
are to be shared but is silent as to losses, losses are to be shared in the same manner as profits.
Notice that the profit and loss sharing ratio is totally independent of the partners' ownership
interests. Thus, two partners may have ownership interests of 70% and 30% but share profits
and losses equally.
IV. Dissolution
A. Admission of a New Partner
 A new partner may be admitted to the partnership by purchasing the interest of one or more
of the existing partners or by contributing cash or other assets (i.e.. investment of additional
capital). These two situations are discussed below.

1. Purchase of interest - When a new partner enters the partnership by purchasing the
interest of an existing partner, the price paid for that interest is irrelevant to the
partnership accounting records because it is a private or personal transaction between
the buyer and seller. The assets and liabilities of the partnership are not affected. The
capital account of the new partner is recorded by merely reclassifying the capital
account of the old partner.
2. Admission by Investment of Additional Assets - A new partner may be granted an
Interest in the partnership in exchange for contributed assets and/or goodwill (e.g..
business expertise, an established clientele, etc.). The admission of the new partner and
contribution of assets may be recorded on the basis of the bonus method.
Bonus method This method is based upon the historical cost principle. Admittance of a new
partner Involves debiting cash or other assets for the FMV of the assets contributed and
crediting the new partner's capital for the agreed (i.e., purchased) percentage of total capital.
Total capital equals the book value of the net assets prior to admittance of the new partner, plus
the FMV of the assets contributed by the new partner, A difference between the FMV of the
assets contributed and the Interest granted to the new partner results in the recognition of a
bonus.
α. No bonus recognized - When an Incoming partner's capital account (ownership Interest)
is to be equal to his purchase price, the partnership books merely debit cash or other
assets and credit capital,
b. Bonus granted to the old partners When the FMV of the assets contributed by an
Incoming partner exceeds the amount of ownership Interest to be credited to his capital
account, the old partners recognize a bonus equal to this excess. This bonus is allocated
on the basis of the same ratio used for income allocation (unless otherwise specified in
the partnership agreement). Recording Involves crediting the old partners' capital
accounts by the allocated amounts.
c. Bonus granted to new partner - An Incoming partner may contribute assets having a
FMV smaller than the partnership interest granted to that new partner. Similarly, the
new partner may not contribute any assets at all. The incoming partner is therefore
presumed to contribute an intangible asset, such as managerial expertise or personal
business reputation. In this case, a bonus is granted to the new partner, and the capital
accounts of the old partners are reduced on the basis of their profit and loss ratio.
Goodwill method. In PFRS No. 3, goodwill represents the excess of the cost of the business
combination over the fair value of the Identifiable net assets obtained. Therefore, the standard
provides that goodwill attaches only to a business as a whole and is recognized only when a
business is acquired. This provision of PFRS No. 3 outlawed the use of the goodwill method in
partnership accounting particularly admission and retirement of a partner because there is no
business involved. The term "business" is defined in the Appendix A of PFRS No. 3 as:
An integrated set of activities and assets conducted and managed for the purpose of
providing:
(a) a return to investor; or
(b) lower costs or other economic benefits directly and proportionately to
policyholders or participants.
A business generally consists of inputs, processes applied to those inputs, and resulting
outputs that are, or will be, used to generate revenues. If goodwill is present in a
transferred set of activities and assets, the transferred set shall be presumed to be a
business.
Refer to Appendix of this chapter for further discussion and Illustration.
B. Withdrawal of a Partner

Admission of a new partner is not the only manner by which a partnership con undergo a
change in composition. Over the life of any partnership, partners may leave the
 Organization. Thus, some method of establishing an equitable settlement of the withdrawing
partner's interest in the business property is necessary.
For a partner to withdraw or retire from the partnership, the total interest of o partner
should be properly determined which includes the following.
1. Share in the profit and loss of the partnership.
2. Adjustments in assets and liabilities to reflect fair market values.
3. Loans to and from partnership.
4. Drawing accounts, and
5. Capital interest / accounts.
Withdrawal or retirement from the partnership may either be:
1 Selling of an interest to an outsider. This is similar to admission by purchase.
2 Selling of an interest to an existing partner. The interest of the retiring partner will be
purchased with the personal assets of existing partners rather than with the assets of
the partnership.
3 Selling of an interest to the partnership/payment from partnership fund. Under this
approach, the withdrawal of a partner maybe treated as:
a. Payment at book value
b. Payment at less than book value - bonus method
c. Payment at more than book value - bonus method
Incorporation of a Partnership For a variety of reasons, including legal and/or tax reasons, the partners of
o partnership may choose to incorporate. Two approaches of opening the corporate books are in general
use. One is to retain the books of the partnership and to record all assets and liabilities at fair market
value concomitant with the closing of the partners’ capital accounts and the opening of a Common Stock
account. The other approach to close out the partnership books completely and to open с new of books
for the corporation. In this case, the fair market values are used as the basis for recording all assets and
liabilities with the balancing amount credited to Common Stock. Occasionally, additional cash or other
assets may be invested corporation.
V. Liquidation
Liquidation is the process of converting partnership assets into cash and distributing the cash to
creditors and partners. Frequently, the sale of assets will not provide sufficient cash to pay both
creditors and partners. The creditors have priority on any distribution. The basic rule is that no
distribution is made to any partner until all possible losses and liquidation expenses have been
paid or provided for. An individual prematurely distributing cash to a partner whose capital
account later shows a deficit maybe held personally liable if the insolvent partner is unable to
repay such a distribution. The proceeds of a liquidation may be distributed in a lump sum after
all assets have been sold and all creditors satisfied, or the proceeds may be distributed to
partners in installments as excess cash becomes available.
A. Lump Sum Distribution The first step in the liquidation process is to sell all noncash
assets and allocate the resulting gain or loss to the capital accounts of the partners in
accordance with their profit and loss sharing ratio. The second step is to satisfy the
liabilities owing to creditors other than partners. The third step is to satisfy liabilities
owing to partners other than for capital and profits. The final step is to distribute any
Cash remaining to the partners for capital and finally for profits. Any deficiency (i.e..
debit balance) in a solvent partner's capital will require that partner to contribute cash
equal to the debit balance. If the deficient partner is insolvent, the debit balance must
be absorbed by the remaining partners (usually in accordance with their profit and loss
sharing ratio). Note, however, that in order to achieve an equitable distribution, a
partner's loan to the partnership will first be used to offset a debit balance in his capital
account. Therefore, under this so-called right of offset doctrine, a partner's loan to the
partnership will have distribution priority only to the extent it exceeds a debit balance in
the partner's capital account.
B. Installment Distributions The liquidation of a partnership may take place over a period of
several months. Installment distributions may be made to partners on the basis of a
Schedule of Safe Payments or Cash Priority Program, in conjunction with a Liquidation
Schedule similar to the one used for lump sum liquidations. The Schedule of Safe
Payments takes a conservative approach to the distribution by assuming that noncash
assets are worthless; thus, distribution may be made to partners on the basis of the
value of partnership assets, until the assets are sold.
 MULTIPLE CHOICE PROBLEMS
Note to the Examinees:
According to PFRS No. 3, goodwill represents the excess of the cost of the business combination over the
fair value of the identifiable net assets obtained. Therefore, the standard provides that goodwill attaches
only to a business as a whole and is recognized only when a business is acquired. This provision of PFRS
No. 3 outlawed the use of the goodwill method in partnership particularly admission and retirement of a
partner because there is no business involved. But, goodwill method (sometimes known as adjustment
or revaluation method) will still be discussed for purposes of concept illustration and comparison with
bonus (book value) method.
The Goodwill (Adjustment/Revaluation) Method
Under PFRS No. 3, goodwill represents the excess of the cost of the business combination over the fair
value of the identifiable net assets obtained. Therefore, the standard provides that goodwill attaches
only to a business as a whole and is recognized only when a business is acquired. This provision of PFRS
No. 3 outlawed the use of the goodwill method in partnership particularly admission and retirement of a
partner because there is no business involved. The term "business" is defined in the Appendix A of PFRS
No. 3 as:
An integrated set of activities and assets conducted and managed for the purpose of providing:
(a) a return to investor; or
(b) lower costs or other economic benefits directly and proportionately to policyholders
or participants.
A business generally consists of inputs, processes applied to those inputs, and resulting outputs
that are, or will be, used to generate revenues. If goodwill is present in a transferred set of
activities and assets, the transferred set shall be presumed to be a business.
This view of recognizing goodwill attaches only to the business as a whole was supported by E.
John Larsen in his book Modern Advanced Accounting, 9th Edition (2003) invoking FASB
Statement No. 142, "Goodwill and Other Intangible Assets," par. F1. In other words, recognizing,
goodwill on the admission of a partner (or even retirement of a partner) in partnership is not
considered to be in accordance with GAAP.
In cases of sole proprietor (or partnership) joining business either with sole proprietor or
partnership, then goodwill should be appropriately recognized.
The author firmly believes that accounting pronouncements of the IASB, FASB and its
predecessor organizations are intended primarily for publicly owned corporations, which must
follow GAAP. Most partnerships, however choose to ignore GAAP, the will of the partners may
prevail. Such a departure usually falls into one of the following categories:
1. Cash basis instead of accrual basis. Related titles
2. Prior-period adjustments
3. Current values instead of historical cost.
4. Recognition of goodwill.
Problems in this chapter discusses also the topic regarding goodwill (or adjustments in asset)
method despite the provision of PFRS 3 outlawing the use of goodwill method when no business
is involved in partnership formation and dissolution.
Partnership Formation:
1.On December 1, 20x5, EE and FF formed a partnership, agreeing to share for profits and losses
in the ratio of2:3 respectively. EE invested a parcel of land that cost him P25,000. FF invested
P30.000 cash. The land was sold for P50,000on the same date, three hours after formation of the
partnership. How much should be the capital balance of EE right after formation?
a.25,000 b. 30,000 c. P 60,000 d.50,000 (AICPA)
Answer: (d)
In the formation of a partnership, one or more of the partners will contribute noncash assets to
the business such as inventory, land or equipment, etc. retaining the recorded cost for such asset
would be inequitable to any partners investing appreciated property. Therefore, the contribution
of noncash assets to a partnership should be recorded based on fair values. In this case, the fair
value of the land would be measured by its sales price on the date of sale, P50,000. 2. On March
1, 20x5, Il and JJ formed a partnership with each contributing the following assets:
II JJ
Cash. P300,000 P700,000
Machinery and equipment. 250,000 750,000
Building. - 2,250,000
Furniture and fixtures.100,000 -