NEW GOVERNMENT ACCOUNTING SYSTEM (NGAS)

No money shall be paid out of the Treasury except in pursuance of an appropriation made by law.

Introduction

Article IX-D, Section 2, par. 2 of the 1987 Constitution provides, that: The Commission on Audit shall
have exclusive authority, subject to the limitations in this Article, to define the scope of its audit and
examination, establish the techniques and methods required therefore and promulgate accounting
and auditing rules and regulations, including those for the prevention and disallowance of irregular,
unnecessary, excessive, extravagant, or unreasonable expenditures, or uses of government funds and
property.

Pursuant to this mandate, the Commission on Audit (COA) revised the existing government accounting
system. The New Government Accounting System (NGAS) took effect last January 1, 2002. The shift to
the new accounting system was prompted by the need to simplify the government accounting system,
which was about half a century old, in order to facilitate the process of recording transactions and the
preparation of financial reports, and ultimately, to computerize the entire government accounting
system. In addition, the new system includes responsibility accounting.

Government Accounting

It encompasses the processes of analyzing, recording, classifying, summarizing and communicating all
transactions involving the receipt, disposition and utilization of government funds and property and
interpreting the results thereof. It also includes:
Bookkeeping referred to as analysis, recording and journalizing.
Posting/grouping/classifying of similar items.
Preparation of periodic financial reports.
Analysis of reports to determine their accuracy and adequacy, as well as the efficiency of agency
operations.

Distinguishing characteristic of government accounting is the requirement of a budget which shall be the
basis for all expenditures. Budgeting is performed on a basis consistent with the revenue and
appropriation system. The appropriation system provides for the control and ultimate disbursement of
funds.

Objectives

1. Provide information concerning past operation and present conditions.

2. Provide basis as guidance for future operation.
3. Provide control for the acts of public bodies and offices regarding receipts, disposition, and
utilization of government funds and property.
4. Report and provide information on the financial condition and results of operation of government
agencies to all persons concerned.

Government Business vs. Private Business

Business Government Private
As to purpose Render public service Accumulate profit
As to ownership No defined ownership Defined ownership
Governed by specific laws and
As to management Few limitations
regulations
From services rendered and
As to income From collection of taxes and fees
commodities sold

New Government Accounting System (NGAS)

Is a simplified set of accounting concepts, guidelines and procedures designed to ensure correctness,
completeness, and timeliness in the recording of government financial transactions, and production of
financial reports.
Objectives

1. Simplify government accounting.

2. Conform to international accounting standards.
3. Generate periodic and relevant financial reports for better monitoring of performance.

Subjects

1. National Government departments, bureaus, commissions, boards, state colleges and universities
2. Local Government - LGUs
3. Government-owned or controlled corporations - GOCCs

Components
1. Basic Features 5. Accounting Records
2. Coding Structure 6. Accounting Reports
3. Chart of Accounts 7. Accounting Forms
4. Books of Accounts

Basic Features

Modified ACCRUAL ACCOUNTING

Under this method, all expenses shall be recognized when incurred. Income shall be on accrual basis
except for transactions where accrual basis is impractical or when other methods may be required by
law.

RESPONSIBILITY CENTERS
The NGAs and LGUs, as well as the GOCCs provide for responsibility centers.

ONE-FUND CONCEPT
Under a one-fund concept, all government agencies shall maintain only one fund. To provide each
government agency accessibility to cost information and to properly control and monitor cost incurred,
responsibility centers and cost centers, with assigned codes, shall be set for each agency and its regional
offices, including their programs, projects, and activities.

Separate fund accounting shall be done only when specifically required by law or by a donor agency or
when otherwise necessitated by circumstances subject to prior approval of the Commission.

BOOKS OF ACCOUNT
All national agencies shall maintain two sets of books: Regular Agency (RA) and National Government
(NG) books.

Regular Agency Books (Whole Agency) shall be used to record the receipt and utilization of Notice of
Cash Allocation (NCA) and other income/receipts which the agencies are authorized to use.
Journals Ledgers
Cash Receipts Journal (CRJ)* General Ledger (GL)
Cash Disbursements Journal (CDJ)* Subsidiary Ledger (SL) for: Cash, Receivables,
Check Disbursements Journal (CkDJ)* Inventories, Investments, PPE, Construction-in-
General Journal (GJ) Progress, Liabilities, Income, Expenses

*Collecting and Disbursing Officers shall maintain for Agencys respective sub-unit:
Cash Receipts Record
Cash Disbursement Record
Check Disbursement Record

National Government Books shall be used to record cash receipts/collections which are required to be
remitted to the Bureau of Treasury and Authorized Government Depositary Bank (AGDB).
Journals Ledgers
Cash Journal (Receipts and Remittances) General Ledger
General Journal
NEW CHART OF ACCOUNTS AND ACCOUNT CODES
A new chart of accounts and coding structure (COA Circular No. 2003-01 as amended by COA Circular No.
2008-01) with a three-digit account numbering system shall be adopted.

NOTICE OF CASH ALLOCATION (NCA)

Receipt of NCA by an agency shall be recorded in the regular books of accounts:
Dr Cr
Cash National Treasury, Modified Disbursement System xx
Subsidy Income from National Government xx

ALLOTMENTS AND OBLIGATIONS

Receipt of budgetary allotments from the DBM, as well as incurrence of obligations shall not be recorded
in the regular books of accounts. Instead, they shall be separately recorded in the four (4) Registries of
Allotments and Obligations (RAO), namely:
- RAOCO - Registry of Allotments and Obligations Capital Outlay
- RAOMO - Registry of Allotments and Obligations Maintenance and Other Operating
Expenses
- RAOPS - Registry of Allotments and Obligations Personal Services
- RAOFE - Registry of Allotments and Obligations Financial Expenses

RECOGNITION OF LIABILITY
Liability shall be recognized at the time the goods and services are accepted or rendered and
supplier/creditor bills are received in accordance with the International Accounting Standards.

FINANCIAL EXPENSES
Financial expenses such as bank charges, interest expense, commitment fees, and other related
expenses shall be separately classified from Maintenance and Other Operating Expenses (MOOE).

REGISTRY OF PUBLIC INFRASTRUCTURES

For agencies that construct public infrastructures, such as roads, bridges, plazas, monuments, etc.,
separate registries shall be maintained, such as:
- RPI Bridges
- RPI Roads
- RPI Parks, Plazas, etc.

During construction, the above properties shall be recorded in the regular books of the concerned
agency as Construction-in-Progress. Upon completion, they shall be transferred to appropriate RPI and
removed from the agencys regular books of accounts.

CONSTRUCTION OF ASSETS
For assets under construction, liability shall be recognized as bills are received, based on Percentage of
Completion. The construction period theory shall be applied for costing purposes.

DEPRECIATION
The straight-line method of depreciation shall be used. The COA shall issue separate guidelines
indicating, among others, the depreciable lives and residual or scrap values of various assets.

For Leasehold Improvements, it shall be depreciated over the period of the lease or the life of the
improvement whichever is shorter.

ALLOWANCE FOR DOUBTFUL ACCOUNTS

AFDA shall be set-up for estimated uncollectible receivables. This will allow for a fair valuation of
receivables prior to write-off.

INTEREST ACCRUAL
Whenever applicable and appropriate, interest income and/or expense shall be accrued and recognized
in the books of accounts.

CONTINGENT ACCOUNTS
Contingent assets/liabilities are off-book items and shall be shown only in the notes to financial
statements. However, if it has reasonable assurance of maturing into an actual liability, such amount
shall be recognized in the books and the appropriate journal entry shall be made

ADJUSTING/REVERSING ENTRIES
Corrections of erroneous journal entries shall not be affected by negative journal entries but by making
the necessary reversing/adjusting entries, all in positive amounts.

COROLLARY/NEGATIVE JOURNAL ENTRIES

The following shall no longer be used in the new accounting system. Acquisition of inventory, fixed assets
and other assets shall be recognized as capital expenditures in the regular books of accounts, eliminating
the need for corollary journal entries.

ACCOUNTING REPORTS
The ff. reports shall be prepared:
Report Frequency

Trial Balance Monthly

Balance Sheet Quarterly

Statement of Income and Expenses Quarterly

Cash Flow Statement Quarterly
- Balance Sheet Approach
- Income Statement Approach

The NATIONAL BUDGET

The national budget is the government estimate of its income and expenditure. It is what the
government plans to spend for its programs and projects. It is based on what the government thinks it
will spend during the year and the sources of what it hopes to have as funds, either from revenues or
from borrowing, with which to finance such expenditure.

Kinds of Budget

As to Nature
a. Annual Budget - basis of an annual appropriation.
b. Supplemental Budget - purports to supplement/adjust a previous budget which is deemed
inadequate for the purpose for which it is intended. This is the basis for supplemental
appropriation.
c. Special Budget - generally submitted in special forms on account on the fact that
itemizations are not adequately provided in the Appropriation Act.
As to Basis
a. Performance Budget - budget emphasizing the programs/services conducted and based on
functions, activities, and projects which focus attention upon the general character and nature of
the work to be done, or upon services to be rendered, rather than upon the things to be
acquired, such as personal services, supplies and equipment. It is a management-oriented which
measure actual and estimated results in the basis, terms of benefits accruing to the public and
their costs.
b. Line-Item Budget - basis of which are the objects of expenditures such as salaries and
wages, traveling expenses, freight, supplies, materials, equipment, etc.
As to Approach and Techniques
a. Zero-Base Budgeting - process which requires systematic consideration of all programs,
projects and activities with the use of defined ranking procedures. Activities are analyzed and
presented in decision packages or key budgetary inclusions.
b. Incremental Approach - focuses analysis of incremental changes in the budget and may be
done within the context of performance and program budgeting.

Other forms
 a. Regional Budgeting - is prepared consistent with the regional organization of the national
government, wherein the DBM identifies by region the expenditures of government agencies
and releases funds also on a regional basis.
b. Long-term Budget - longer-range estimate of revenue and expenditures requirements.
c. Key Budgetary Inclusions refer to financial commitments of agencies pertaining to a budget
year. KBIs are a maintained for the purpose of:
1. Controlling major financial commitments so that funds are not misappropriated or to
prevent juggling funds.
2. Disclose the funds and have a clear picture of expenditures.
3. Track down mandatory obligations and insure funding of priority projects.

The Budget Process

a. BUDGET PREPARATION
This begins with the issuance of a budget call issued by the DBM. This document outlines the priority
areas of government activity applicable to the budget year. It likewise reiterates the fiscal limits and
approximate rate of increase in government ceilings applicable to the budget year and appearing in the
developing plan, as updated in the long-term fiscal projection appearing in the latest Budget Message.

Regional basis is explicit in the budget process which requires the participation of agency regional
offices/units, coordinated at the regional level under various Regional Development Councils (RDC) or
autonomous regions.

After the regional phase, budget proposals are submitted to the Central Offices where they are collated
and received prior to submission to the DBM.

Zero-Base Budgeting
It is a process which requires systematic consideration of all programs, projects and activities with the
use of defined ranking procedures. This approach has been adopted to correct traditional budgeting
practices, strengthen performance budgeting and to maximize the use of available funds thru systematic,
analytical and creative method of allocating resources. The term zero-base refers to the yearly analysis,
evaluation and justification of each activity, project or program, starting from a zero performance and
budgeting level.

b. LEGISLATIVE AUTHORIZATION
Refers to the second phase of the budget process relative to the enactment of General Appropriations
Bill as based on the budget of Receipts and expenditures submitted by the President, i.e., the
enactment of the Bill into an Appropriation Act pursuant to the provision of Section 29 (() of Article VII of
the 1987 Constitution. To comply with this constitutional timetable, the Presidents Budget is submitted
to the legislature within 30 days from the opening of its regular session, as the basis of the general
appropriation bill.

The General Appropriation Bill presents the proposals of the President for the coming year. The
proposals are listed by the agency or lump sum fund and are detailed by budgetary function activities
project. Each function is briefly described in the so-called appropriations language. Any conditions
governing agency expenditures are presented as Special Provisions applicable to the agency, which also
identify the amount intended for the most significant activities of the agency. General Provisions are also
provided in the Bill, representing the expenditure rules and conditions applicable to all agencies or to
group of agencies.

Budget briefings are conducted whereby the various heads of agencies would explain to the Congress
the details of their respective budgets.

No bill passed by either House shall become a law unless it has passed three readings on separate days,
and printed copies thereof in its final form have been distributed to its Members three (3) days before its
passage, except when the President certifies to the necessity of its immediate enactment to meet a
public calamity or emergency. Upon the last reading of a bill, no amendment thereto shall be allowed,
and the vote thereon shall be taken immediately thereafter, and the yeas and nays entered in the
Journal. (Sec. 26 (2), Art. VI)
Every bill passed by the Congress shall, before it becomes a law, be presented to the President. If he
approves the same, he shall sign it; otherwise, he shall veto it and return the same with his objection to
the House where it originated, which shall enter the objections at large in its Journal and proceed to
reconsider it. If, after such reconsideration, two-thirds of all Members of such House shall agree to pass
the bill, it shall be sent, together with the objections of the other House by which it shall likewise be
reconsidered, and if approved by two-thirds of all Members of that House, it shall become a law. In all
such cases, the votes of each House shall be determined by yeas and nays, and the names of the
Members voting for or against shall be entered in its Journal. The President shall communicate his veto
of any bill to the House where it originated within thirty (30) days after the date of receipt thereof;
otherwise, it shall become a law as if he had signed it. (Sec. 27 (1), Art. VI)

Appropriations are approved by the legislative body in the form of General Appropriations Law covering
most of the expenditures of the government; Continuing Appropriations for various public works
projects; Supplemental Appropriation laws which are passed from time to time, to adjust or correct an
already existing appropriation; and certain automatic appropriations intended for fixed and specific
purpose.

c. BUDGET EXECUTION
This covers the various operational aspects of budgeting, thus making budgeting serves as one of the
principal tools of management control to ensure that public funds are spent only for specific purposes
for which they are appropriated. The responsibility for monitoring of this phase is the Department of
Budget and Management (DBM).

The main objectives of budget execution are: (1) preserving legislative intent; (2) observing financial
limitations; and (3) maintaining flexibility in governmental operations. Other requirements comprise of
the following: establishment of obligational authority ceilings, the evaluation of work and financial plans
for individual activities, the continuing review of governmental fiscal position, regulation of fund release,
implementation of cash payment schedules and other related activities such as up-to-date planning and
scheduling of activities.

This phase covers the operational aspects of budgeting composed of:

1. Submission, evaluation and approval of Agency Budget Matrix and subsequent issuance of NCA
based on the Agencys Annual Cash Program.
2. Continuous monitoring and review of the government fiscal policies.
3. Cash management and monitoring and generally seeing to it that funds are available to support the
approved agency functions and projects.

The principal budget execution and control techniques used in the Philippines are the release of
allotments to governmental agencies, the institution of positive retrenchment measures (including the
outright slashing of appropriations in the event that actual revenues do not come up to anticipated
levels), the mandatory setting up of reserves, and the institution of accounting and auditing requirement
in public spending.

d. BUDGET ACCOUNTABILITY
The significance of this reporting process is clear, as only with it can the budget cycle be completed. Data
on funds use evidences the implementation of the legislative and appropriations intention and is a
major basis of budget preparation and evaluation for the succeeding year.

This phase consists of:

1. Periodic reporting by the agencies of performances under their approved budgets.
2. Top management review of government activities and the fiscal and policy implications thereof.
3. The action of the Commission on Audit is assuring the fidelity of officials and employees by carrying
out of the intent of the National Assembly in regard to their handling of receipts and expenditures.

The Budgetary Accounts and other definitions:

Appropriation refers to an authorization made by law or other legislative enactment for payments to be
made with funds of the government under specified conditions and/or for specified purposes.

Allotment is an authorization issued by the DBM to an agency, which allows it to incur obligations within
specified amount that is within a legislative appropriation.
Obligations are commitments by a government agency arising from an act of a duly authorized official
which bind the government to the immediate or eventual payment of a sum of money.

Agency Budgetary Matrix (ABM) refers the document that shows the desegregation of agency
expenditures into components like, among others, by Source of appropriation, by Allotment Class, and
by Need of Clearance.

Notice of Cash Allocation is an authorization issued by the DBM to an agency to withdraw cash from
Bureau of Treasury to pay expenses incurred; purchase of materials, and property, plant and equipment;
payment of payables; and other authorized disbursements thru the issuance of MDS checks and other
modes of disbursements.

The agency is authorized to incur obligations only in the performance of activities which are in pursuit of
its functions and programs authorized in appropriations acts/laws within the limit of the Allotment
Release Order (ARO).

ACCOUNTING RECORDS MAINTAINED by:

DEPARTMENT OF BUDGET AND MANAGEMENT

A. Registry of Appropriations and Allotments (RAPAL) shall be maintained for each agency/bureau to
monitor the balance of appropriations at any given time. The total appropriation of the agency
appearing in the GAA or other appropriations act shall be posted in the RAPAL at the beginning of
each year or upon approval of the appropriation act by allotment class (PS,MOOE,CO,FE).
B. Registry of Allotments and NCA Issued (RANCAI) shall also be maintained to ensure that the NCA
issued for the current years operations will not exceed the allotments released.

NATIONAL GOVERNMENT AGENCIES

A. Registry of Allotments and Obligations (RAO) shall be maintained by national government agencies
by allotment class, particularly by Budget Unit to monitor allotments available for obligations. The
registries maintained by the agencies are as follows:
RAOPS - Personal Services
RAOMO - Maintenance and Other Operating Expenses
RAOCO - Capital Outlay
RAOFE - Financial Expenses

ACCOUNTING FOR BUDGETARY ACCOUNTS:

Budgetary Accounts System encompasses the processes of:

1. Recording of appropriations
2. Preparing of ABM
3. Monitoring and recording of allotments received by the agency from the DBM
4. Releasing of Sub-Allotment Release Order (SARO) to Regional Offices by the Central Office
5. Issuance of Sub-SARO to Operating Units by the RO; and
6. Recording and monitoring obligations

TREATMENT OF OBLIGATIONS AND ACTUAL LIABILITY:

Obligation Accounting is modified such that obligation are now recorded in the appropriate Registry
Allotments and Obligations (RAO) maintained by allotment class.
The actual liability of government arising from financial transaction is recognized by a direct credit to
the payable account.

ACCOUNTING FOR INCOME, COLLECTIONS, DEPOSITS, AND RELATED TRANSACTIONS

Revenues/Income refer to the annual or periodic yield of taxes, fines and penalties, charges for services,
charges for use of money and property and other charges which the government collects or receives into
its treasury for public use.
Taxes
Fines/Penalties
 Income from Government Service
Income from Government Business Operation
Rent Income

Receipts include all cash actually received from all sources/accounts during a given fiscal period.

Notes:
a. Proceeds from loans/borrowings are no longer recorded as Income but directly credited to Long-
Term Liabilities such as:
Loans Payable Long term, domestic Bonds Payable Long term, domestic
Loans Payable Foreign Bonds Payable Foreign
b. Trust Receipts are now presented as Payables:
Withholding tax payable
GSIS payable
Pag-ibig payable
Philhealth payable
Due to NGAs

Books of Accounts (For Receipts)

Regulatory Agency Books record the regular transactions of the agency like the receipt and
utilization of the Notice of Cash Allocation; and collection of income and other receipts which can be
used by the Agency.

National Government Books record collections or income which the agency cannot use and are
required to be remitted to the Bureau of Treasury.

Accounting Policies for Regulatory Books:

1. Without authority to use the collection shall be recorded in the NG books and for deposit with
National Treasury.
2. With authority to use - the collections shall be recorded in the RA books and for deposit either
to the AGDB or the National Treasury.
3. Authority with limitations - any excess of collection shall be remitted to the National Treasury, such
as collections for seminar and convention fees.
4. Income from sale of equipment - proceeds is deemed automatically appropriated for the
purchase of new ones and/or for the repair of existing equipment. Collections however shall be first
remitted to BTr and upon receipt of SARO and NCAS, may be used to purchase another one.
5. Grants and donations - shall be remitted to the National Treasury. In case with authority to
use, a special budget shall be approved by the DBM to be covered by NCA.
6. Miscellaneous collections - refund of cash advance paid thru Cash-National Treasury, MDS and
collection of Performance/Bidders/Bail Bonds shall be recorded in the RA books and remitted to the
National Treasury.

ACCOUNTING FOR DISBURSEMENTS AND RELATED TRANSACTIONS

Disbursements constitute all cash paid out during a given period. They represent movement of cash
either from the BTr or AGDB or from an authorized disbursing officer to the final recipient. They refer to
the settlement of government payable/obligations by cash or by check.

Expenditures include the amount actually expended for goods delivered or services rendered whether
paid or not.

Modes of Disbursements by:

Cash (thru Disbursing Officer)

Cash disbursements out of cash advances of regular and special disbursing officers for personal
services, petty expenses and MOOE for field operating requirements.
Check
a. MDS checks for disbursements covered by NCA
MDS checks issued by NGAs chargeable against the account of the Treasurer of the Philippines
maintained with different MDS-Government Servicing Banks (BSBs)
 b. Commercial checks for disbursements covered by income/receipt authorized to be deposited
with AGDBs; for ROs/OUs disbursements out of Funding Checks received from Cos/ROs.
NCAA (Non-Cash Availment Authority) Disbursements are non-cash disbursements thru JEV by
availing/implementing agency; adopted to account for the cash equivalent of the loan proceeds
availed of through suppliers credit/constructive cash.
ADA (Advice to Debit the Account) issued by national government agencies which serves as notice
to the bank to debit the agencys MDS account for payments made for accounts payable and
retirement gratuity/ terminal leave benefit.
TRA (Tax Remittance Advice) refers to the accountable document issued by NGA to record the
remittance of all taxes with the BIR. The same document shall be the basis for the BIR and the BTr to
record the tax collection and deposit in their respective books of accounts.

Basic Requirements Applicable to All Types of Disbursements

1. Existence of a lawful and sufficient allotment and amount duly obligated and certified by the Budget
Officer.
2. Validity of Obligation certified by the Chief Accountant.
3. Legality of the transactions and conformity with existing rules and regulations.
4. Submission of proper evidence to establish the claim.
5. Approval of the disbursement by the Chief of Officer or by his duly authorized representative.

PERSONAL SERVICES
Payroll Fund in the hands of the Disbursing Officer as cash advance. Payments are made in cash to
the employees.
Payroll Fund deposited in an authorized depositary bank. Withdrawal is thru ATM.
Direct payments are made thru check.

MAINTENANCE AND OTHER OPERATING EXPENSES

Asset method will be followed in recording disbursements when expenditures apply to more than just
the accounting period. Examples are:
Insurance Rent
Interest Supplies and materials

Perpetual Inventory method

Purchase of supplies and materials for stock, regardless of whether or not they are consumed within
the accounting period, shall be recorded as Inventory following the Perpetual Inventory Method.
Supplies and materials purchased for immediate use or on emergency shall be taken up as an
expense.
Petty cash hall not be used to purchase supplies for stock.

FINANCIAL EXPENSES
These are the expenses which are not used in the actual operation of the agency. Examples are:
Bank Charge Interest Charge

CAPITAL OUTLAYS (Purchase/Construction of Fixed Assets)

Fixed assets are charged against allotment for capital outlay. The purchase is immediately recorded as
asset. Construction Period Theory shall be followed in recording fixed assets where all expenses during
the construction period shall be capitalized, e.g., interest and licenses.

Bonus paid to the contractor for completing the work ahead of schedule shall be added to the total cost
of the project.

However, liquidated damages charged to the contractor for delayed completion should be deducted
from total cost.
 NGAS for LOCAL GOVERNMENT UNITS

GENERAL ACCOUNTING PLAN shows the overall accounting cycle in the LGU.

TRANSACTIONS shall emanate from different offices/departments which will provide the source
documents and other accounting forms which will lead to the perfection of the transaction.

SOURCE DOCUMENTS shall be the basis of the reports of the OFFICE OF THE TREASURER.

OFFICE OF THE ACCOUNTANT shall Record the transactions to the registries or to the corresponding
books of original entry including Posting to the books of final entry, and preparation of Financial Reports.

BUDGET CYCLE (LGU):

BUDGETARY ACCOUNTS are composed of appropriations, allotments and obligations.

Local SANGGUNIAN approves the annual budget thru issuance of APPROPRIATION ORDINANCE.

Allotments are released quarterly based on the WORK and FINANCIAL PLAN and REQUEST FOR RELEASE
OF ALLOTMENT.

Upon receipt of the ADVICE OF ALLOTMENT, the Accountant shall enter in the REGISTRY OF
APPROPRIATIONS, ALLOTMENTS AND OBLIGATIONS (RAAO).

For each OBLIGATION, the requesting department/office shall prepare the ALLOTMENT AND OBLIGATION
SLIP (ALOBS) signed by the department/office head as the requesting official and forward this together
with the supporting documents to the BUDGET OFFICER to certify the existence of appropriation.
Obligations shall be taken up in the registries as they incurred.

The CHIEF ACCOUNTANT shall record paid disbursement vouchers in the Status of Obligation portion of
the ALOBS, and adjust the amount of recorded obligations in the RAAO.

THE NEW BARANGAY ACCOUNTING SYSTEM (2007)

MAJOR FINANCIAL TRANSACTION

1. Appropriations and Commitments

General fund
20% Development fund
Calamity fund
Sangguniang Kabataan fund
Gender and Development fund
2. Receipts and Deposits
3. Disbursements by:
Check
Cash
4. Supplies and Materials, PPE, Public Infrastructure/Reforestation Project

FINANCIAL STATEMENTS AND SUPPORTING SCHEDULES

Financial Statements
1. Balance Sheet (Detailed and Condensed)
2. Statement of Income and Expenses (Detailed and Condensed)
3. Statement of Cash Flows (Direct Method)
4. Statement of Changes in Government Equity
5. Notes to Financial Statements
Schedules
1. Schedule of Public Infrastructures and Reforestation Projects
2. Schedule of Accounts Payable
3. Schedule of Accounts Receivable

BASIC FEATURES AND POLICIES

ACCOUNTING METHOD
Modified Accrual accounting is used.
- Income shall be recorded when earned except when impractical or when law requires other
method.
- Expenses shall be recorded when incurred irrespective of their time of payment.
- Income and expenses shall be reported in the FS in the period they relate.
BARANGAY ACCOUNTS shall be kept within the framework of NGAS chart of accounts.
CERTIFIED REGISTERS
1. Cash Receipt Register
2. Cash on Hand and in Bank Registers
3. Petty Cash Fund Register
4. Cash and Check Disbursement Registers
E-NGAS is encouraged to facilitate the recording of transactions and to hasten the consolidation of
all barangay financial statements.
PROCESSING OF TRANSACTION AND RECORDING IN THE BOOKS
- Processing shall be done at the barangay level.
- Recording in the books thru Journal Entry Voucher shall be done by the City/Municipal
accountant.
RECOGNITION OF LIABILITY
- Liabilities shall be taken only for goods actually delivered and accepted or services rendered, or
upon receipt of bills from suppliers/creditors.
- All borrowings and secured loans shall be recorded using the appropriate liability account.
- Cash received to guaranty faithful performance of an activity shall be recorded as liability.
- Surety bond shall not be recorded.
PURCHASE OF SUPPLIES, MATERIALS AND SMALL ITEMS with serviceable life of more than one year,
shall be directly charged to expense account. Cost of transporting supplies and materials shall be
charged to DELIVERY EXPENSE account.
CASH ADVANCES
- Charged to PAYROLL FUND as payment for personal services.
- Charged to ADVANCES TO OFFICERS AND EMPLOYEES if granted for travel and other special time-
bound undertaking.
 AUDIT DISALLOWANCES shall be recorded only when final and executory.
TRIAL BALANCE, two money column shall be used.
NOT-FOR-PROFIT ORGANIZATIONS

INTRODUCTION

Presently, there are two schools of thought on accounting for not-for-profit organizations. One school
believes that there is little difference between business and not-for-profit accounting, and therefore
NPOs, its advocates believe, with little exceptions; make use of principles applicable to business
accounting. A well-known authority, Prof. Robert N. Anthony even commented that . nonbusiness
accounting is going to be essentially like business accounting. Nonbusiness organizations will prepare
operating statements, balance sheets and funds flow statement. The primary focus will be on the
operating statement, and its principles will be governed by the same principles that now apply in
business accounting.

The other school of thought believes that fund accounting, as it is currently practiced, will remain in
vogue. The advantages of fund accounting were extolled from the legal point of view and from
management control viewpoint. The advocates of this thought believe that funds have legal restrictions
or discretionary restrictions, and accordingly, they must be segregated between restricted and
unrestricted funds.

The four major NPOs include:

COLLEGES/UNIVERSITIES;
HOSPITALS;
VOLUNTARY HEALTH AND WELFARE ORGANIZATIONS; and
Other organizations such as museum, country clubs, and religious organizations.

The international accounting unit for many NPOs is the fund, which is defined as a fiscal and accounting
entity with a self-balancing set of accounts recording cash and other financial resources with all related
liabilities and residual equities, or balances, and changes therein which are segregated for the purpose of
carrying on specific activities or attaining certain objectives in accordance with special regulations,
restrictions, or limitations: Different type of funds is necessary to distinguish between assets that may be
used as authorized by the board of directors/trustees and assets whose use is restricted by donors.
Funds commonly used by some of NPOs were as follows:
UNRESTRICTED FUND/UNRESTRICTED CURRENT FUND/GENERAL FUND/CURRENT
UNRESTRICTED FUND
RESTRICTED FUND/RESTRICTED CURRENT FUND/CURRENT RESTRICTED FUND
ENDOWMENT FUND/PURE ENDOWMENT/TERM ENDOWMENT
AGENCY FUND/CUSTODIAN FUND
ANNUITY FUND/LIFE INCOME FUND/LIVING TRUST FUND
LOAN FUND
PLANT FUND/LAND, BUILDING, AND EQUIPMENT FUND

FUND ACCOUNTING has been used to organize and manage resources for various purposes in
accordance with regulations, restrictions, or limitations imposed by the parties outside the institution, or
with discretions issued by the governing board. A clear distinction of funds that are externally restricted
and those that are internally designated by action of the governing board has been maintained in the
accounts and disclosed on the financial reports.

ACCRUAL BASIS OF ACCOUNTING

Depreciation is applied even if they arise from gifts or donations.
Works of Art and Historical Treasures that meet the definition of collections need not be
capitalized or depreciated.

CLASSIFICATION OF NET ASSETS is totally dependent on the existence or absence of donor-imposed

restrictions. The three classes are:

PERMANENTLY RESTRICTED NET ASSETS are the portion of net assets whose use is limited by
donor-imposed stipulations that do not expire and cannot be removed by action of the NPO.
Examples may be donor restricted gift, such as:
 - An artwork that must be used for certain purpose and may not be sold.
- An asset to be invested, with the principal preserved and the income available for
expenditure.

TEMPORARILY RESTRICTED NET ASSETS are the portion of net assets whose use is limited by
donor-imposed stipulations that either expire/time restrictions or can be removed by the NPO
fulfilling the stipulations/purpose restrictions. They may be donor restricted gift, such as:
- An asset to be invested for a certain period during which only the income may be expended,
but after a certain point in time, the principal may be expended as well.
- An asset that may only be expended for a special program or project.

UNRESTRICTED NET ASSETS are the portion that carry no donor imposed restrictions. Examples
include:
- Assets resulting from operations.
- Unrestricted gifts of cash or other assets.
- Governing board designated funds.
- Temporarily restricted assets released due to satisfaction of the donors provisions.

The division of NA is the focal point in presenting the FS for NPOs. Revenues, gains, and losses can be
reported in each NA class, but expenses are reported only in the Unrestricted NA class.

FINANCIAL STATEMENTS prepared in accordance with the present GAAP shift away from fund reporting
to put an emphasis on the organization as a whole. Under the present GAAP, the equity account balance
is replaced with the term NET ASSETS based on the existence/absence of donor imposed restriction.

The financial statements display three classes of Net Assets: UNRESTRICTED, TEMPORARILY RESTRICTED,
and PERMANENTLY RESTRICTED. Any changes of these three classes must be reported in the FS:

STATEMENT OF FINANCIAL POSITION (Balance Sheet) will report organization-wide total for assets,
liabilities and net assets. The focus is on the entity as a whole and should report total assets,
liabilities, and net assets.

Purpose: To provide relevant information about the organizations Assets, Liabilities, and NA. It
should also provide information about their relationships to each other as of the date of the
statement.

Principles:
- Cash and other assets having restrictions should be segregated from other assets that are
unrestricted.
- NA should be segregated into three classes within the statement.
- The nature and timing of donor restrictions should be disclosed. Voluntary restrictions may be
disclosed.

STATEMENT OF ACTIVITIES reports revenues, expenses, gains, losses, and reclassifications/changes in

NA. Minimum requirements are organization-wide totals, changes in NA for each class of assets, and
all expenses recognized only in the unrestricted classification. A display of a measure of operations in
the statement of activities is permitted. Its primary focus is to provide relevant information about:
- The effects of transactions and other events and circumstances that change the amount and
nature of the NA.
- The relationships of those transactions and other events and circumstances to each other.
- How the organizations resources are used in providing various programs or services.

STATEMENT OF CASH FLOWS is similar to a regular business enterprise. The organization may use
either the direct or indirect approach. The primary purpose of this statement is to provide relevant
information about cash receipts and cash payments of an organization during the period.

NOTES TO THE FINANCIAL STATEMENTS are necessary for disclosure purposes.

ACCOUNTING FOR HOSPITALS/HEALTH CARE PROVIDERS

Health care entities include hospitals, clinics, continuing care retirement communities, health
maintenance organizations, home health agencies and nursing homes. A modern health care provider
may be a complex entity with medical, surgical, research, teaching, and public service aspects. One very
unusual element about health care operation is the manner of payment for services; that is, when a
significant portion of the fees for health care services paid by a third party, like Medicare. Health care
entities employ two classes of funds, namely: GENERAL FUNDS, which account for resources available for
general purposes, and DONOR-RESTRICTED FUNDS, which account for temporarily and permanently
restricted resources, such as specific purpose funds, plant replacement and expansion funds,
endowment funds, and other donor-restricted funds.

Hospitals depends large part of its revenue on donations and grants, which often come with restrictions.
Fund accounting is required in order to maintain accountability over restricted resources. It also uses
normal Accrual Accounting, including the classification of costs as expenses rather than expenditures,
and will not record budgetary accounts/encumbrances on the books.

TYPES OF FUNDS:

A. GENERAL (UNRESTRICTED) FUND is not subject to outside restrictions and used for day-to-day
operations. Note that Board designated funds are unrestricted. Items in this category includes:
a. Assets whose use is limited include assets set aside by the governing board for identified
purpose.
b. Agency Funds as both an asset and liability. They are used to account for fees collected as an
agent of physicians who have private-practice patients coming to hospital offices provided to the
staff physicians.
c. Property and equipment used for general operations and the related liabilities.
DESIGNATION is an internal process which can be altered at the discretion of the BOT.
RESTRICTION is externally imposed and not subject to alteration by the board.

B. DONOR-RESTRICTED FUNDS are accounts for temporarily and permanently restricted resources. This
class is subdivided into:
a. Temporary Restricted Fund
Specific Purpose Fund is a restricted fund used by health care providers to account for
principal and income in accordance with donors specified restrictions.
Endowment Fund is used by hospital to account for a trust where the principal must be kept
intact and the income be expanded for either current operations or for a specific purpose in
accordance with grantors wish. An endowment may be in perpetuity, fixed term, or until a
specific event occurs.
Plant Replacement and Expansion Fund is a restricted fund used by hospitals and other
health providers to account for donors contributions that must be used to acquire PPE.
Annuity and Life Income Fund
b. Permanently Restricted Fund is also endowment fund but differs from term-endowment and the
principal must be maintained intact in perpetuity and only the income may be used in
accordance with the donors wishes.
c. PPE whose use is restricted.

ACCOUNTING FOR REVENUE AND EXPENSES

A. REVENUES AND GAINS

a. Patient Service Revenue are typically recorded at established Gross Rates as the services are
provided but are reported net of amounts that are considered deductions. The objective is to
report the amount that the hospital is entitled to collect which include room and board, nursing
services, and other professional services.

Excluded from gross and net patient service revenues:

Charity care services are provided free of charge to patients who qualify under a hospitals
charity care center.

Deductions from revenues include:

Courtesy allowances discounts to doctors and employees.
 Contractual adjustments - discounts arranged with third party payors (Philhealth, Health
Insurance Cos.) that frequently have agreements to reimburse at less-than-established rates.

Allowance accounts are used to reduce receivables for estimated deductions from revenues, as
well as estimated doubtful account.
b. Premium Fees/Subscriber Fees/Capitation Fees is a growing portion of hospital revenues in many
hospitals. They are reported separately from Patient Service Revenues. These are revenues from
agreements which a hospital provides any necessary patient services. The fees are earned
whether the services are actually rendered or not during the period.
c. Other Revenue and Gains is the account where Other Operating Revenues and Non-Operating
Revenue can be lump as one account.

Other Operating Revenues are revenues from services to patients other than health care, and
from sales/services provided to non-patients. This include tuition from schools operated by the
hospital; rentals of hospital space; charges for preparing/reproducing medical records; charges
for telephone calls/T.V.; and, proceeds from cafeterias, gift shops, snack bars, donated medicine,
linen and office supplies, etc.

Non-Operating Revenue records revenue not related directly to an entitys principal operations.
These are primarily financial in nature; and, include unrestricted and donor-restricted pledges,
gifts or grants, unrestricted income from endowment funds, income and gain from investments,
gain from sale f property. Further, Realized/Unrealized Gains from Investments are also included
in Non-Operating Revenue.

B. OPERATING EXPENSES are reported on accrual basis and normally include functional categories such
as:
Nursing services medical and surgical, intensive care, nurseries, operating
rooms;
Other profession services laboratories, radiology, anesthesiology, pharmacy;
General services housekeeping, maintenance, laundry;
Fiscal services accounting, cashier, credit and collection, data processing;
Administrative services personnel, purchasing, insurance, governing board;
Interest; and
Depreciation provisions.

Provision for Bad debts is an expense.

Difference between:
CHARITY CARE BAD DEBTS
Results from Hospitals policy to extend Extension of credit.
health care to individuals who
meet certain financial criteria.
Cash flows Not intended to provide. Intended

FINANCIAL STATEMENTS
a. Statement of Activities present organization wide totals for changes in unrestricted, temporarily
restricted, and permanently restricted NA.
b. Statement of Financial Position
c. Statement of Cash Flows

ACCOUNTING FOR NOT-FOR-PROFIT UNIVERSITIES/COLLEGES

Colleges and universities are required to use fund accounting due to the large amount of restricted
resources under their control. Accrual accounting is used, but there are certain similarities to accounting
by governmental funds, especially in the reporting of expenditures rather than expenses.

Accounting for private colleges and universities is a shift away from the fund group focus to an
organization-wide focus, where there is no requirement for external financial statements to include fund
group reporting. Instead of fund balances, three net asset classes are used. Events that were previously
recorded as changes in fund balance will now be recorded as contributions, exchange transactions,
capital acquisitions, or expenses.

TYPES OF FUNDS:

A. CURRENT FUNDS will be used in carrying out the primary objectives of the institution: instruction,
research, extension, and public service.
Unrestricted Current Funds are not subject to outside restraints on usage.
Restricted Current Funds have been restricted by donors/grantors for specific purpose.

B. LOAN FUNDS are established for resources that are to be loaned to students, faculty, or staff. It is
designated to hold assets, not liabilities, and also not for loan to others. Fund balances should
separately report:
Restricted amounts which outside parties provided on the condition it will be used for loan; and
Unrestricted fund balances which were placed in the loan fund at the election of the institution
itself.

C. ENDOWMENT AND SIMILAR FUNDS are resources which outside parties contributed to the
university on the condition that they not be spent, but invested to yield earnings which may be
spent.
Occasionally, a donor will establish the fund and place it with an independent trustee, who will remit
the earnings to the university on a regular basis. Since the fund is not under the control of the
university, it will note the arrangement by memorandum only and disclose in the Notes.
Term Endowment funds may be spent after a specific period of time has passed or a certain
event has occurred.
Quasi-endowment funds are not actually restricted because they are designated by the
university to be retained and invested.

D. ANNUITY AND LIFE INCOME FUNDS

Annuity funds are resources given to the university on the condition that regular payments be
made to a specific person for a certain period of time, after which the principal is available to the
institution.
Life Income funds require distribution of all earnings to a specified person, upon whose death
the balance becomes expendable by the university.

E. PLANT FUNDS is used accounting for all assets and liabilities associated with fixed assets of the
university. The plant fund balances include:
Unexpended plant funds contain liquid assets which are to be used to acquire new plant assets
in the future.
Funds for renewals and replacements contain liquid assets which are to be used to replace
existing plant assets as needed.
Funds for retirement of indebtedness contain resources to make principal, as well as interest
payments on debts incurred to acquire plant assets.
Investment in plant consists of fixed assets themselves and any long term debt issued in
connection with the acquisition of these assets.
The first three funds should be subdivided further into restricted and unrestricted, based on external
requirements or internal designation.

F. AGENCY FUNDS are resources received by the institution which belong to others, such as student
body fees, with a liability equal to the assets collected.

ACCOUNTING FOR REVENUE AND EXPENSES

A. REVENUES include
Tuition and fees
Government appropriations
Government grants and contracts
Endowment income
Sales and services of educational activities (such as residence halls, food services, and,
intercollegiate athletics and college stores)
Sales and service of auxiliary enterprises
Other sources (such as expired term endowments, annuities, and life income agreements)
Independent operations (such as government research laboratories)

B. EXPENDITURES
Educational and General
Auxiliary enterprises
Hospitals, and independent operations

FINANCIAL STATEMENTS:
Public Universities Private Universities
Statement of Current Funds, Revenues, Statement of Activities
Expenditures, and other changes Balance Sheet
Balance Sheet Statement of Cash Flows
Statement of Changes in Fund Balance

ACCOUNTING FOR VOLUNTARY HEALTH AND WELFARE ORGANIZATION

To qualify as VHWO, the organizations primary source of revenue should be contributions from donors,
who do not benefit directly from the organization, and the program must be in the area of health,
welfare or community services. There are some instances where contributions received by an
organization specify the purpose for which they must be expended. To segregate resources with external
restrictions, the organization must report these items under the 3 classes of NA.
TYPES OF FUNDS

A. CURRENT FUND
- Unrestricted CF is used for operations that require only the discretion of the organizations BOD,
and include assets designated by the board for specific purposes.
- Restricted CF is used for operations, but only in accordance with a donor/grantors
specifications.

B. LAND, BUILDING, AND EQUIPMENT FUND is used to account for:

Land, Buildings and Equipment acquired by the organization;
Liabilities arising from the acquisition/improvement of plant assets; and
Current assets restricted by donors/grantors for future disposition.

C. ENDOWMENT FUND
- Permanently restricted is maintained intact in perpetuity.
- Temporarily restricted is maintained until a specific event/condition occurs.

D. CUSTODIAN FUND is similar to Agency Fund and thus does not belong to the organization. It is a fund
established to account for assets received by the organization to be held and disbursed only on the
instructions of the donor/grantor.

ACCOUNTING PRINCIPLES:

VHWO adhere to Accrual Basis of accounting. Revenues are generally recognized when earned and
expenses are shown when related services are provided.

A. REVENUES are inflows of resources resulting from a charge of service from financial activities or from
other exchange transactions, such as:
Membership dues
Program Service Fees
Sales of publications and supplies
Investment income e.g., interest, dividends, and other earnings

B. EXPENSES are reported on a functional basis and are classified as :

Program Services relate to expenses incurred in providing organizations social service activities.
- Research
- Public education
- Professional education
- Community services
Supporting Services consists of administrative expenses and fundraising costs.
- Management and general
- Fund raising

C. PUBLIC SUPPORT is the inflow of resources from voluntary donors who receive no direct, personal
benefit from the organizations usual programs. They include the ff:
Contributions
Special events support
Legacies and bequests
Proceeds from fund raisers

D. DONATIONS OF SERVICES should be charged to appropriate expense with an offsetting credit to

support.

E. DONATED PROPERTY should be recorded at FMV on the date of donation.

F. PLEDGES should be recognized net of uncollectible amounts, and those not spendable until a future
period should be shown as a Deferred Credit on the BS.

FINANCIAL STATEMENTS
a. Statement of Financial Position
b. Statement of Activities
c. Statement of Cash Flows
d. Statement of Functional Expenses is provided by VHWOs which supplements the operating
statement and presents the total of each functional expense to programs and supporting services.

OTHER NOT-FOR PROFIT ORGANIZATIONS

Organizations that have restricted resources may use fund accounting for internal control and
management reporting purposes in order to demonstrate compliance with externally imposed
restrictions.

Wide variety of organizations have the option of using fund accounting, such as research and scientific
organizations, social and country clubs, religious organizations, and museums. Great deal of flexibility is
permitted for these organizations.

All NPOs are required to present three general purpose FS, such as the Statement of Financial Position,
Statement of Activities, and Statement of Cash Flows.

DERIVATIVES
INTRODUCTION

Everyday companies face a variety of risks, for it is difficult to succeed without taking some chances. If
some action can lower risk without lowering returns too much, then the action can enhance the value.
One important tool for managing risk is the derivatives market. Derivatives can and should be used to
hedge against certain risks.

Derivatives are relatively new but becoming increasingly common. In the early 1990s, huge losses were
suffered by banks and other financial institutions because of too much exposure in derivative financial
instruments. The collapse of the Barings Bank, one of Londons oldest and prestigious financial
institutions, was caused by heavy trading of derivatives.

Trading in derivatives and accounting for them has been likened to a wild frontier where adventure and
danger is constant companion.

Companies need to manage their risks. Management has to develop a variety of financial instruments to
manage their business risks. Those companies operating internationally are subject not only to normal
business risks but are typically subject to additional risks from possible changes in currency exchange
rates because they are transacting in more than one currency. Multinational entities manage their
foreign currency risks by using one of several types of financial instruments: (1) foreign currency forward
contracts; (2) foreign currency options; (3) foreign currency futures; and (4) foreign currency swaps.

WHAT IS A DERIVATIVE?

A derivative is financial instrument that derives its value from the movement in commodity price,
foreign exchange rate and interest rate of an underlying asset or financial instrument.

It is an executory contract, meaning it is not a transaction but an exchange of promises about future
action.

On inception, derivative financial instruments give one party a contractual right to exchange financial
asset or financial liability with another party under conditions that are potentially favorable, while the
other party has a contractual obligation to exchange under potentially unfavorable conditions.

In laymans terms, parties are taking bets on what will happen to the underlying instrument in the
future.

Derivatives are financial instruments separate from the primary financial instruments or stand-alone
derivatives. They would not exist in their own right.

PURPOSE

Entities use derivatives to manage financial risk originating from sources, such as changes in commodity
price, cash flows and foreign currency exposure. The reduction of financial loss from financial risk is a
motivating factor for trading derivatives.

CHARACTERISTICS

PAS 39 defines a derivative as a financial instrument or other contract with all of the following
characteristics:
1. The value of the derivative changes in response to the change in an underlying variable. An
underlying may be a specified interest rate, commodity price, FOREX rate, price index or other
variable.
2. Requires either no initial investment or an initial net investment that is smaller than would be
required of other types of contracts that have similar response to changes in market factors.
3. Is readily settled at a future date by a net cash payment.

TYPES OF FINANCIAL RISK

1. Price Risk is the uncertainty about the future price of an asset, whether it be a trading security or an
asset to be acquired thru purchase commitments.
2. Credit Risk is the uncertainty whether a party to the contract will honor the terms of the contract
because there is always the possibility of nonpayment of loans.
3. Interest Rate Risk is the uncertainty of future interest rates and their impact on cash flows and the
fair value of the financial instruments.
A borrower or lender in a variable-rate or fixed-rate loan is exposed to this risk due to fluctuation of
interest rate or increase/decrease of interest rate in the future.
4. Foreign Currency Risk arises due to the volatility of the peso to dollar exchange rate. It is the
uncertainty of an increase/decrease in cash flow stemming from assets and liabilities denominated
in foreign currency.

CATEGORIES OF DERIVATIVES

1. Option-based derivatives have one-sided exposure. Only the downside risk on the hedged item is
counter-balanced. Ex. Option, Interest rate caps, Interest rate floors
2. Forward-based derivatives have two-sided exposure. The downside risk and the upside potential on
the hedged item are counterbalanced. Ex. Forwards, Futures, Swaps

TYPES OF DERIVATIVES

1. Interest rate swap is a contract whereby two parties agree to exchange cash flows for future interest
payments based on a contract of loan.

A swap is a contract in which two parties agreed to exchange payments in the future based on the
movement of some agreed-upon price or rate.

Swaps, forwards, and futures provide two-sided protection, they hedge against both increases and
decreases in prices or rates.

2. Forward contract is a commitment to purchase or sell a specified commodity on a future date at a

specified price. It is a private contract.

It is an agreement between a buyer and a seller that requires the delivery of some commodity at a
specified future date at price agreed today (exercise price).

A typical example is Foreign Currency Forward Contract. It is an agreement to buy or sell a foreign
currency at a:
a. Specified future date (usually within 12 months), and
b. Specified exchange rate (forward rate).

At the inception of the contract, the forward rate usually varies from the spot rate.
Discount = Forward Rate > Spot Rate; Premium = Forward Rate < Spot Rate

3. Futures contract is a contract to purchase or sell a specified commodity at some future date at a
specified price in a futures exchange market. Is a standard and a more formal contract.

Instead of being negotiated between two parties, the contract is a standard one that is sponsored by
an organized exchange.

4. Option is contract that gives the holder the right to purchase or sell an asset at a specified price
during a definite period at some future time. It is right, not an obligation to purchase or sell.

An option contract between two parties the buyer and the seller gives the buyer (option holder)
the right to purchase or sell something to the option seller (option writer) at a future date at a
specified price (strike price) agreed to at the time the option contract is exchanged.

There are two options, namely call option on the part of the buyer, and put option on the part of the
seller. A call option gives the right to purchase an asset, and a put option gives the holder the right to
sell an asset.

Unlike an interest rate swap, forward contract and futures contract, an option must be paid for. It
requires an initial small payment called option premium for protection against unfavorable
movement in price.
 A foreign currency option contract is a contractual agreement giving the holder the right to buy/sell
a given amount of currency at a specified price (Exercise Price/Strike Price) for a period of time or a
point in time.

Terminologies:
Call option to buy Holder party having the right
Put option to sell Writer party that grants the right
Purchased option the contract from the perspective of the holder
Written option - the contract from the perspective of the writer

Foreign Currency Option Situations

Option Call Put
Spot Price = Strike Price At the money
Spot Price > Strike Price In the money Out of the money
Spot Price < Strike Price Out of the money In the money
In the money favorable to holder
Out of the money unfavorable to holder

Accounting for Foreign Currency Option Premiums

Spot Price = Strike Price the entire premium is the Time Value. Amortize to income over the
life of the option.
FV Intrinsic Value = Time Value
Spot Price > Strike Price the difference between the spot price and strike price is the Intrinsic
Value. (Call)
Spot Price > Strike Price the difference between the spot price and strike price is the Intrinsic
Value. (Put)
(Time Value + Intrinsic Value) X Notional Amount = Total Value
American Option is where the option can be exercised anytime within the option period.
European Option is wherein the option can only be exercised at maturity.

5. Foreign currency forward contract

When foreign loans are obtained or when an asset is purchased from abroad by an entity, most often
than not, the loan or obligation is denominated in foreign currency. Thus, when foreign loans or
obligations must be repaid in foreign currency, a foreign currency risk always arises by reason of the
volatility of the exchange rate of the peso with a foreign currency.

As protection against foreign currency risk, the entity enters into a contract with a bank or any
financial institution to the effect that if the exchange rate proves unfavorable (FC > LC), the bank
shall pay the entity for the difference in the exchange rate. Conversely, if the exchange rate of the
peso decreases (FC < LC) the entity shall pay the bank the difference.

HEDGING

Under PAS 39, hedging means designating one or more hedging instruments so that their change in FV
or cash flow is an offset in net profit and loss, in whole or in part, to the change in FV or cash flow of a
hedged item.

Hedging is a means of protecting a financial loss or the structuring of a transaction to reduce risk.

A non-derivative financial instrument may also be designated hedging instrument, but only with respect
to hedge foreign currency risk.

The standard mentions three types of hedging relationship, namely FV hedge, cash flow hedge, and
hedge of a net investment in a foreign operation.

The designation must be in writing, up front, and be consistent with an established risk management
strategy. In essence, PAS No. 39 hedge accounting is not mandatory. If an enterprise does not want to
use hedge accounting, it simply does not designate a hedging relationship.
Hedge accounting recognizes symmetrically the offsetting effects on net profit or loss of changes in the
fair values of the hedging instrument and the related item being hedged.

It is allowed only when hedging instrument is a derivative other than a written option, written option
when used to hedged a purchased option, or non-derivative financial asset or liability when used to
hedged foreign currency risks.

The basic accounting issue for hedging is determining whether the gain or loss on the hedging
instrument can be reported in earnings in the same period in which the loss or gain on the hedged item
occurs. Two possibilities exist to achieve concurrent recognition: Immediate recognition, and Delayed
recognition.

A hedging instrument is the derivative whose FV or cash flows would be expected to offset changes in
the FV or cash flows of the hedged item.

A hedged item is an asset, liability, firm commitment, highly probable forecast transaction or net
investment in a foreign operation. To be designated as hedged item, it should expose the entity to risk of
changes in FV or future cash flows.

HEDGING and HEDGE ACCOUNTING:

Hedging Hedge Accounting
Changes - risks accounting for gains and losses
Decision - business accounting
Both optional activities.

ACCOUNTING FOR FOREIGN CURRENCY DERIVATIVES AND HEDING ACTIVITIES

A hedging operation is the purchase or sale of foreign currency contracts to offset the risks of holding
receivables and payables denominated in foreign currency. The usual way of avoiding foreign exchange
risks is thru forward contracts.

For derivatives to qualify as hedging instrument, two criteria must be met:

a. Sufficient documentation must be provided at the beginning of the term to identify the objective
and strategy of the hedge, the hedging instrument, the hedged item, and how the hedges
effectiveness will be assessed on an ongoing basis.
b. Hedge must be highly effective. Effectiveness is viewed as the instruments ability to offset changes
in FV or cash flows of the hedged item within the range between 80 and 125 percent of the change
in value of the hedged item.

ASSESSING HEDGE EFFECTIVENESS

Changes in Fair value of the cash

flows of the hedged item Changes in the fair value or cash
HIGHLY
flows of the hedging instrument
OFFSET
(80% to 125%)

1. Hedge is highly effective if there will be an approximate offset.

2. Initial expectation must be that they almost fully offset.
3. Actual offsetting within the range of 80% to 125%.
4. Depends on documented risk management strategy.
5. No single method is prescribed.
SPLIT ACCOUNTING IN ASSESSING/MEASURING HEDGE EFFECTIVENESS

PAS 39 requires all derivatives to be valued at their fair values. Thus, both time value and intrinsic value
are valued at fair value. Accordingly, the need to breakdown of total fair value (time value and intrinsic
value) occurs only if split accounting is used.
Carving out the time value element and reporting its gain and loss separately from the manner of
reporting the intrinsic value elements gain or loss is referred to as split accounting.

Intrinsic value is the incremental premium paid. (Difference between spot price and exercise price.)

Time value is the entire premium to be amortized over the life of the option period.

PAS 39 permits an entity to exclude all or part of a derivatives time value element in assessing hedge
effectiveness. Thus, split accounting is permitted.

For forward contracts purposes, time value element applies to premium and discounts on forward rates.
If hedge effectiveness were assessed excluding time value element, the change in FV of foreign exchange
commitment would be based on the change in spot rate not forward rate. Thus, only foreign currency
forwards intrinsic value change with, the change in foreign currency commitments FV using the change
in spot rate.

MEASUREMENT OF DERIVATIVES

PAS 39 requires that an entity shall recognize all derivatives as either assets or liabilities. All derivatives
are measured at FV. Both FV and the Notional Amount shall be fully disclosed. Again or loss is
recognized when there is change in FV.

The Notional Amount is the number of currency units, number of shares, number of bushels of
commodity, pounds, or other units specified in the financial instrument, it may also refer to the principal
amount of debt.

Whether the change in FV is recognized in profit or loss or in equity depends whether the derivative is:

a. Not designated as a hedging instrument

In this case, the derivative can be thought of as speculation. Changes in FV of the hedging
instrument shall be recognized in profit or loss.

b. Designated as Cash Flow Hedge

CFH is a derivative that offsets in whole or in part the variability in cash flows from a probable
forecast transaction. A forecast transaction is an uncommitted but anticipated future transaction.
The ff. are observed:
Derivative is measured at FV.
Change in FV is recognized as component of Other Comprehensive Income, to the extent hedge
is effective.
Ineffective portion is recognized in profit or loss.
Hedged item is not adjusted to conform with FV.

c. Designated as a Fair Value Hedge

FVH is a derivative that offset in whole or in part the change in FV of an asset or a liability. The ff. are
followed:
Derivative is measured at FV.
Hedged item is not adjusted.
Changes in FV are recognized in profit or loss.

CASH FLOW Hedge vs. FAIR VALUE Hedge

HEDGE CASH FLOW FAIR VALUE

Hedging Instrument (Forward

Carried at FV on Balance Sheet
Contract)

Gain/Loss on Hedging
Instrument
Gain/Loss on Hedged Item
Gain/Loss in OCI Section is
transferred to P/L
Effective Portion of Gain/Loss
recognize in OCI
Ineffective Portion of Gain/Loss
Recognized immediately in P/L
reported immediately in P/L
Not applicable (Forecasted
Transactions are not recognized)
If the Hedged Item is forecasted:
a.Purchase of Inventory
reclassified to earnings (P/L)
when sold.
Not applicable
b.Purchase of Equipment
reclassified to earnings (G/L)
as the equipment is
depreciated.

d. Hedge of a net investment in a foreign operation, including a hedge of monetary item that is
accounted for as part of the net investment, shall be accounted for as cash flow hedges.
Derivative is measured at FV.
Change in FV is recognized as component of Other Comprehensive Income, to the extent hedge
is effective.
Ineffective portion is recognized in profit or loss.
Hedged item is not adjusted to conform with FV.

HEDGE ACCOUNTING SUMMARY FOR FOREIGN EXCHANGE GAINS AND EFFECTIVENESS

Purpose of FOREX Hedge Accounting Accounting
Type of Hedge Accounting Result
Derivatives Applies Treatment
Recognition in P/L
To speculate None
currently
To hedge a No Concurrent
Recognize
receivable/payabl Undesignated recognition in P/L
immediately in P/L
e
To hedge a firm
Fair Value
commitment
To the extent Concurrent
hedge is: recognition in P/L
Effective on a delayed basis
To hedge a
recognize as OCI
forecasted foreign Cash Flow
Ineffective
transaction Yes
reported
immediately in
P/L
Recognize in OCI. Concurrent
To hedge an
Realize in P/L upon recognition on a
investment in a Net Investment
disposal of the delayed basis
subsidiary
investment.

Foreign Currency Firm Commitment

PAS 39, par. 87 states that When an entity enters into a firm commitment to acquire an asset or assume
a liability that is a hedged in a fair value hedge, the initial carrying amount of the asset or liability that
results from the entity meeting the firm commitment is adjusted to include the cumulative change in the
fair value of the firm commitment attributable to the hedged risk that was recognized in the balance
sheet.

What is an EMBEDDED DERIVATIVE?

PAS 39, par. 10, defines an embedded derivative as a component of a hybrid or combined contract that
also include a non-derivative host contract with the effect that some cash flows of the combined
contract vary in a way similar to a stand-alone derivative.
The derivatives previously discussed such as interest rate swap, option, forward and futures are stand-
alone derivatives, meaning separate contracts from the principal contract.

An embedded derivative is not a separate contract. Both the derivative and the host contract re
contained in one combined contract.

Examples of EMBEDDED DERIVATIVES

1. Equity conversion option

Principal Contract Bond; Accessory Contract Equity conversion feature
2. Redemption option
Principal Contract Preference share; Accessory Contract Redemption option
3. Investment in bond whose interest or principal payment is linked to the price of gold or silver
Principal Contract Investment in Bond; Accessory Contract Commodity derivative

Application of PFRS 9 to Embedded Derivative

If Host Contract Within Scope Outside Scope
Derivative Not separated Determine if separated or not
Measured In its entirety, at amortized cost If separated:
or FV depending on business a.Host Contract appropriate
model in managing FA PFRS
b.Derivative accounted at FV
Not separated same as
within the scope

An EMBEDDED DERIVATIVE is ACCOUNTED FOR SEPARATELY

Bifurcation is the process of separating an embedded derivative from the host contract.

PAS 39, par. 11, as consequentially amended by PFRS 9, provides that an embedded derivative shall be
separated from the host contract and accounted for as a derivative if the ff. conditions are met:

a. A separate instrument meets the definition of a derivative.

b. Host contract is outside the scope PFRS 9.
c. Economic characteristic and risk of the derivative is different from that of the host contract.
d. Combined contracts change in FV is not recognized in P/L.