Financial Assets

Financial Instrument - is any contract that gives rise to both a financial asset of one entity and a
financial liability or equity instrument of another entity

Financial Asset - is a cash, contractual right to receive or exchange financial instruments with
another entity under potentially favorable conditions. Examples of financial assets include:

•Cash and cash equivalents: include physical currency, checking accounts, savings accounts, and
money market funds.

•Stocks (Equity Securities): Ownership shares in a corporation.

•Bonds are loans given to large organizations in exchange for periodic interest payments and the
return of the bond's face value upon maturity.

•Mutual Funds: Pooled funds from many investors to purchase securities.

•Derivatives: Financial contracts whose value is derived from the performance of an underlying
asset, index, or rate (e.g., options, futures, and swaps).

•Accounts Receivable: Money owed to a company by its customers for goods or services already
delivered.

•Certificates of Deposit (CDs): Time deposits offered by banks that pay a fixed interest rate for a
specified term.

Financial liabilities - are legal obligations to deliver assets or exchange financial instruments
under potentially unfavorable conditions, essentially debts or obligations that an entity must
settle over time. Examples of financial liabilities include:

• Loans and Borrowings: Borrowed money to be repaid with interest.

• Bonds Payable: Debt securities to be repaid with periodic interest.

• Accounts Payable: Money owed to suppliers for goods/services.

• Notes Payable: Written promises to pay future amount with interest.

• Mortgages Payable: Loans secured by property to be repaid over time.

• Lease Liabilities: Obligations to make lease payments.

• Derivative Liabilities: Obligations from derivative contracts causing net outflow of resources.
Equity Instrument - is any contract that evidences a residual interest in the assets of an entity
after deducting all of its liabilities.

Accounting for Financial Instruments

Initial Recognition

A financial asset is recognized when an entity becomes a party to the contractual provisions of
the instrument. (PPSAS 29.16)

Initial Measurement

Financial assets are initially measured at fair value plus transaction costs, except for financial
assets at fair value through surplus or deficit whose transaction costs are expensed.

Transaction Costs

Transaction costs are incremental costs incurred during financial instrument acquisition, issue, or
disposal, amortized using interest rate.

Cash and Cash Equivalents

Cash and cash equivalents include cash on hand, cash in bank, and treasury accounts.

Adjustments for Unreleased Commercial Checks

Unreleased checks are checks drawn but not yet given to the payees as of the end of the period.
Unreleased checks are reverted back to cash. Pro-forma entries to record as follows:

Date Cash in Bank, Local Currency-Current xx

Accounts Payable (or appropriate account) xx

Accounting for Cancelled Checks

Checks are cancelled if they become stale, voided, or spoiled, and replacement checks may be
issued for those already released to payees upon submission to the Accounting Unit. Cancelled
checks are reverted back to cash as follows:

Current Year:

Cash-Modified Disbursement System (MDS), Regular xx

Accounts Payable (or appropriate account) xx

Prior Period:

Accumulated Surplus/(Deficit) xx

Accounts Payable (or appropriate account) xx

Petty Cash Fund

A petty cash fund is a small cash account used for minor expenses, like office supplies or repairs,
replenished periodically based on receipts or records, and managed by keeping detailed records.

Petty Cash Fund (PCP) is a fund designated for small expenses. The Head of Agency approves
the amount, and the Custodian is bonded for amounts exceeding P5,000. It is maintained using
the Impress System and must be separate from other funds. Transactions are limited to P15,000.

Accounting for Cash Shortage/Overage of Disbursing Officer

The disbursing officer is liable for any cash shortage while any cash overage that he cannot
satisfactorily explain to the auditor, is forfeited in favor of the government.

Dishonored Checks

A dishonored check is a bank-returned check due to insufficient funds, resulting in the drawer
being liable for the amount and penalties.
Bank Reconciliation

Bank reconciliation is the process of comparing a bank statement with a company's financial
records to identify discrepancies, errors, and ensure accuracy.

A bank reconciliation statement reconciles cash balances per records and bank statement,
showing credits and debits to a depositor's account, and their cumulative balance.

Cash Equivalents

Cash equivalents are short-term, highly liquid investments that can be converted to known cash
amounts and are subject to minimal value change risk. Only debt instruments acquired within 3
months before their scheduled maturity date can qualify as cash equivalents.

Receivables

Receivables are claims for cash or other assets from other entities. Examples:

 Accounts receivable - refers to the amounts owed to customers from regular business
transactions.
 Notes Receivable - are claims, typically with interest, for which a formal credit
instrument, like promissory notes, is issued as proof of debt.
 Loans Receivable - refers to the loans granted by the National Government to
Government Financial Institutions (GFIs) or Government Agencies (GOCCs) under loan
agreements.
 Other receivables, such as, interest receivable, due from employees/officers/other NGAs,
lease receivables, dividend receivable, and the like.

Receivables are initially measured at fair value plus transaction costs and subsequently measured
at amortized cost.

Investments

Categories of Financial Assets:

• Financial asset at fair value through surplus or deficit – is one that is either:

 Held-for trading.
 Designated as at fair value through surplus or deficit on initial recognition.
• Held-to-maturity investments - are non-derivative financial assets with fixed payments and
maturity that an entity intends to hold until maturity.

• Loans and receivables - are non-derivative financial assets with fixed or determinable
payments, not quoted in an active market.

• Available-for-sale financial assets - are non-derivative assets that are either available for sale or
not classifiable under other categories.

Impairment of Financial Assets

Impairment of financial assets occurs when an asset's carrying value exceeds its recoverable
amount, requiring recognition in financial statements to reduce the asset's carrying amount to its
recoverable value. Entities must assess financial asset impairment at the end of each reporting
period, calculate loss using original interest rate, record profit or loss, and reduce asset value
through direct or allowance reduction.

Derecognition of Financial Assets

Derecognition is the process of removing a previously recognized asset, liability or equity from
the statement of financial position.

A financial asset is derecognized when:

a. The contractual rights to cash flows from the financial asset either expire or are waived.

b. The transfer of a financial asset qualifies for derecognition when ownership and control risks
and rewards are relinquished.

The derecognition of financial assets is subject to the provisions of the State Audit Code of the
Philippines (POD. No. 1445) on the writing off of receivables and other policies issued by the
COA. (GAM for NGAs, Chapter 7, sec. 10)

Derivatives

A derivative is a financial instrument or contract that is valued based on the changes in the value
of another underlying asset or instrument.
Characteristics of a derivative

a. Its value changes in response to the change in an underlying;

b. It requires no initial net investment (or only a very minimal initial net investment), and

c. It is settled at a future date.

An "underlying" refers to a specified price, rate, or other variable, including a scheduled event,
that may or may not occur.

Purpose of a derivative

Derivatives serve as a tool for risk management, identifying the desired and actual risk levels and
adjusting them accordingly.

Hedging

Hedging is a method of offsetting a potential financial loss or the structuring of a transaction to

reduce risk involving financial instruments.

Hedging is a financial risk management strategy that offsets potential losses by adjusting the fair
values of the hedging instrument and the hedged item.

Hedging Relationships

 Fair value hedge - is a financial instrument that protects against changes in the fair value
of an asset, liability, or firm commitment due to a specific risk.
 Cash flow hedge - is a financial instrument that protects against the risk of cash flow
variability due to a recognized asset or a highly probable forecast transaction.
 Hedge of a net investment in a foreign operation.

Components of a Hedging Relationship

 Hedging Instrument - is a financial asset or liability that is expected to offset changes in

the fair value or cash flows of a designated hedged item.
 Hedged Item - is an asset, liability, or investment in a foreign operation that exposes the
entity to potential changes in fair value or future cash flows.