CBACTG01-CHAPTER 1 MODULE PDF

CHAPTER 1 OVERVIEW OF ACCOUNTING Objectives: Define the meaning of accounting Identify and learn the PAS 1 to PAS 23 Definition of Accounting Accounting is “the process...

CHAPTER 1 OVERVIEW OF ACCOUNTING Objectives: Define the meaning of accounting Identify and learn the PAS 1 to PAS 23 Definition of Accounting Accounting is “the process of identifying, measuring, and communicating economic information to permit informed judgment and decisions by users of information.” Three important activities 1. Identifying - the process of analyzing events and transactions to determine whether or not they will be recognized. Only accountable events are recognized. 2. Measuring - involves assigning numbers, normally in monetary terms, to the economic transactions and events. 3. Communicating - the process of transforming economic data into useful accounting information, such as financial statements and other accounting reports, for dissemination to users. 1 Types of Events 1. External events – events that involve an external party. a. Exchange (reciprocal transfer) – reciprocal giving and receiving b. Non-reciprocal transfer – “one way” transaction c. External event other than transfer – an event that involves changes in the economic resources or obligations of an entity caused by an external party or external source but does not involve transfers of resources or obligations. 2. Internal events – events that do not involve an external party. a. Production – the process by which resources are transformed into finished goods. b. Casualty – an unanticipated loss from disasters or other similar events. Measurement The several measurement bases used in accounting include, but not limited to, the following: - historical cost, - fair value, - present value, - present value, - current cost, and - sometimes inflation-adjusted costs. The most commonly used is historical cost. This is usually combined with the other measurement bases. Accordingly, financial statements are 2  said to be prepared using a mixture of costs and values Types of accounting information classified as to users’ needs 1. General purpose accounting information - designed to meet the common needs of most statement users. This information is governed by the Philippine Financial Reporting Standards (PFRSs). 2. Special purpose accounting information - designed to meet the specific needs of particular statement users. This information is provided by other types of accounting, e.g., managerial accounting, tax basis accounting, etc. 3 - Double-entry system – each accountable event is recorded in two parts – debit and credit - Going concern - the entity is assumed to carry on its operations for an indefinite period of time. - Separate entity – the entity is treated separately from its owners, - Stable monetary unit - amount in the financial statements are stated in terms of a common unit of measure; changes in purchasing power are ignored. - Time Period – the life of the business is divided into series of reporting periods. - Materiality concept – information is material if its omission or misstatement could influence economic decisions. - Cost-benefit – the cost of processing and communicating information should not exceed the benefits to be derived from it - Accrual Basis of accounting – effects of transactions are recognized when they occur (and not as cash is received or paid) and they are recognized in the accounting periods to which they relate - Historical cost concept – the value of an asset is determined on the basis of acquisition cost. - Concept of Articulation – all of the components of a complete set of financial statements are interrelated. - Full disclosure principle – financial statements provide sufficient detail to disclose matters that make a difference to users, yet sufficient condensation to make the information understandable, keeping in mind the costs of preparing and using it. 4  - Consistency concept – financial statements are prepared on the basis of accounting policies which are applied consistently from one period to the next. - Matching – costs are recognized as expenses when the related revenue is recognized. - Residual equity theory – this theory is applicable where there are two classes of shares issued, ordinary and preferred. The equation is “Assets – Liabilities – Preferred Shareholders’ Equity = Ordinary Shareholders’ Equity.” - Fund theory – the accounting objective is the custody and administration of funds - Realization – the process of converting non-cash assets into cash or claims for cash - Prudence (Conservatism) – the inclusion of a degree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainty , such that assets or income are not overstated and liabilities or expenses are not understated Common branches of accounting 5 1. Financial accounting - focuses on general purpose financial statements 2. Management accounting – focuses on special purpose financial reports for use by an entity’s management. 3. Cost accounting - the systematic recording and analysis of the costs of materials, labor, and overhead incident to production. 4. Auditing - the process of evaluating the correspondence of certain assertions with established criteria and expressing an opinion thereon 5. Tax accounting - the preparation of tax returns and rendering of tax advice, such as the determination of tax consequences of certain proposed business endeavors 6. Government accounting - refers to the accounting for the government and its instrumentalities, placing emphasis on the custody of public funds, the purposes for which those funds are committed, and the responsibility and accountability of the individuals entrusted with those 6  funds. Four sectors in the practice of accountancy 1. Practice of Public Accountancy - involves the rendering of audit or accounting related services to more than one client on a fee basis. 2. Practice in Commerce and Industry - refers to employment in the private sector in a position which involves decision making requiring professional knowledge in the science of accounting and such position requires that the holder thereof must be a CPA. 3. Practice in Education/Academe – employment in an educational institution which involves teaching of accounting, auditing, management advisory services, finance, business law, taxation, and other technically related subjects. 4. Practice in the Government – employment or appointment to a position in an accounting professional group in the government or in a government–owned and/or controlled corporation where decision making requires professional knowledge in the science of accounting, or where civil service eligibility as a CPA is a prerequisite Conceptual Framework for Financial Reporting The Conceptual Framework sets out the concepts that underlie the preparation and presentation of financial statements for external users Objective of general-purpose financial reporting - The objective of general-purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity. A secondary objective of financial statements is to show the results 7  of the stewardship of management - The objective of general-purpose financial reporting forms the foundation of the Conceptual Framework. Other aspects of the Conceptual Framework flow logically from the objective. Users and their Needs Primary users – those to whom general purpose financial reports are directed: (a) Existing and potential investors (b) Lenders and other creditors Only the common needs of primary users are met by the financial statements Qualitative Characteristics 1. Qualitative Characteristics (1) Relevance (a) Predictive value (b) Feedback value  Materiality – entity-specific aspect of relevance (2) Faithful representation (a) Completeness (b) Neutrality (c) Free from error 2. Enhancing qualitative characteristics (3) Comparability (4) Verifiability (5) Timeliness (6) Understandability 8 Elements of Financial Statements Financial Position 1. Asset - resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. 2. Liability - present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. 3. Equity – assets less liabilities Performance 1. Income - encompasses both (a) revenues and (b) gains 2. Expense - encompasses both (b) expenses and (losses) PAS 1 Presentation of Financial Statements PAS 1 prescribes the basis for presentation of a general purpose financial statements to improve comparability both with the entity's 9 financial statements of previous periods (intra-comparability) and with the financial statements of other entities (inter-comparability). Complete set of financial statements 1. Complete set of financial statements 2. Statement of profit or loss and other comprehensive income 3. Statement of changes in equity 4. Statement of cash flows 5. Notes (5a) comparative information in respect of the preceding period; and 6. Additional statement of financial position (required only when certain instances occur) General features 1. Fair Presentation and Compliance with PFRSs - The application of PFRSs, with additional disclosure when necessary, is presumed to result in financial statements that achieve a fair presentation 2. Going concern - An entity is not a going concern if, as of the financial reporting date or prior to the date of authorization of the financial statements for issue, management either: a. Intends to liquidate the entity or to cease trading, or b. Has no realistic alternative but to do so. 3. Accrual Basis of Accounting - An entity shall prepare its financial statements, except for cash flow information, using the accrual basis of accounting 4. Materiality & Aggregation - Each material class of similar items must 10  be presented separately in the financial statements. 5. Offsetting - Assets and liabilities, and income and expenses, shall not be offset unless required or permitted by a PFRS 6. Frequency of reporting – An entity shall present a complete set of financial statements (including comparative information) at least annually 7. Comparative Information - An entity shall present comparative information in respect of the preceding period for all amounts reported in the current period’s financial statements, unless other standards permit or require otherwise 8. Consistency of presentation - An entity shall retain the presentation and classification of items in the financial statements from one period to the next unless: a. it is apparent that another presentation or classification would be more appropriate following a significant change in the nature of the entity’s operations or a review of its financial statements; or b. a PFRS requires a change in presentation Statement of financial position A statement of financial position may be presented as either a. Classified - showing distinctions between current and noncurrent assets and liabilities, or b. Unclassified (based on liquidity) - showing no distinction between current and noncurrent items Current Assets 11 An entity shall classify an asset as current when: 1. it expects to realize the asset or intends to sell or consume it, in its normal operating cycle 2. it holds the asset primarily for the purpose of trading 3. it expects to realize the asset within twelve months after the reporting period 4. the asset is cash or a cash equivalent unless the asset is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting period Current Liabilities An entity shall classify a liability as current when: 1. it expects to settle the liability in its normal operating cycle 2. it holds the liability primarily for the purpose of trading 3. the liability is due to be settled within twelve months after the reporting period 4. the entity does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting period Presentation of Deferred taxes 12  Deferred tax liabilities (assets) are presented as noncurrent items in a classified statement of financial position, irrespective of their expected dates of reversal Statement of profit or loss and other comprehensive income An entity shall present all items of income and expense recognized in a period 1. in a single statement of profit or loss and other comprehensive income 2. in two statements: (1) a statement displaying the profit or loss section only (separate ‘statement of profit or loss’ or ‘income statement’) and (2) a second statement beginning with profit or loss and displaying components of other comprehensive income Total comprehensive income Total comprehensive income comprises all components of Profit or loss; and Other comprehensive income Presentation of Expenses 1. Nature of expense method 13  2. Function of expense method PAS 2 Inventories Inventories are assets 1. Held for sale in the ordinary course of business (Finished Goods) 2. In the process of production for such sale (Work In Process) 3. In the form of materials or supplies to be consumed in the production process or in the rendering of services (Raw materials and manufacturing supplies) Financial statement presentation All items that meet the definition of inventory are presented on the statement of financial position as one line item under the caption “Inventories.” The breakdown of this line item (as finished goods, WIP and Raw materials) is disclosed in the notes Inventories are normally presented in a classified statement of 14 financial position as current assets Measurement a. Inventories are measured at the lower of cost and net realizable value (NRV) b. The cost of inventories comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition c. Net realizable value (NRV) is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale Cost Formulas 1. Specific identification - - shall be used for inventories that are not ordinarily interchangeable (i.e., used for inventories that are unique). Cost of sales is the cost of the specific inventory that was sold 2. FIFO - cost of sales is based on the cost of inventories that were purchased first. Consequently, ending inventory represents the cost of the latest purchases 3. Weighted Average Cost - cost of sales is based on the average cost of all inventories purchased during the period. Wtd. Ave. Cost = (TGAS in pesos ÷ TGAS in units) Recognition as an expense The carrying amount of an inventory that is sold is charged as expense (i.e., cost of sales) in the period in which the related revenue is recognized. Likewise, the write-down of inventories to NRV and all losses of inventories are recognized as expense in the period the write- 15 down or loss occurs For further discussion please refer to the link provided: Overview of Accounting https://www.youtube.com/watch?v=RlhHMzzMKwA For further discussion please refer to the link provided: Conceptual Framework https://www.youtube.com/watch?v=CaGife7RCnE For further discussion please refer to the link provided : PAS 1 – Presentation of FS https://www.youtube.com/watch?v=c54-lIDFqbk Reference Book: Conceptual Framework and Accounting Standards By: Zeus Vernon B. Millan, 2019 16