ACC-106: Conceptual Framework and Accounting Standards PDF

ACC-106: CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS LESSON 1: 1st SEMESTER | A.Y. 202Y – 202Y LECTURER: SIR/MS. THE NEED FOR FINANCIAL REPORTING (3) Potential Investors  They must see...

ACC-106: CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS LESSON 1: 1st SEMESTER | A.Y. 202Y – 202Y LECTURER: SIR/MS. THE NEED FOR FINANCIAL REPORTING (3) Potential Investors  They must see the FS to know if their investments can grow, for them to see if they THE FINANCIAL REPORT AND ITS USERS should invest or not, and they use your FS to  It provides information about economic entities to see if you are able to give them dividends at be used as basis for future economic decisions to some point internal and external stakeholders.  To see of the company is profitable  It is a tool for transparency (4) Regulatory Agencies and Taxing Authorities o All transactions are captured in the financial  They rely on FS to determine whether statements to make sound economic business entities comply with prescribed rules decisions and regulations  They are dependent on the FS to collect the INTERNAL USERS right amount of taxes, to determine taxation policies, and to set basis for national income ─ the active owners and internal management that use and similar statistics the financial reports for internal decisions. (5) Employee ─ Active owners and managers use financial  They evaluate the financial status of the information to evaluate the entity’s performance, enterprise to assess the latter’s ability to make financial and operational plans, and implement provide remuneration, retirement benefits business decisions and employment benefits EXTERNAL USERS (6) Financial Advisers and Consultants/Lawyers  They need the company’s FS to give them ─ the inactive owners, creditors, lenders, suppliers, advice regarding the performance of the potential investors, regulatory agencies, employee company, legalities of contract, transactions, and employee unions, financial advisers, consultants etc. and the general public that rely heavily on this (7) General Public reports  They are interested in financial information ─ Users other than the management of the entity do about the trends and the range of business not have ready access to financial reports entities’ economic activities ─ Rely heavily on negotiations and regulations to obtain information about a business enterprise --------------- Based on the interest of the user ---------- DIRECT USERS (1) Inactive Owners  The difference of active and inactive owners ─ users with direct interest use financial information as is the participation a tool to protect their own interest in the enterprise.  Inactive owner (e.g., silent owner) do not ─ They include the owners, managers, creditors, actively participate in managing the business, suppliers, customers, employees, and taxing while active owner is vice versa authorities  They don’t have an involvement in the daily ─ Taxing authorities – its primary goal is to get the tax operations in the business, but they have a ─ Customers – have an interest in information about stake the continuance of an enterprise (long-term  They use the financial statements to keep involvement) track of the company’s financial condition and performance INDIRECT USERS (2) Creditors, Lenders, & Suppliers ─ those who use accounting information to provide  Through the FS, they will be able to assess advice to protect the interest of the direct user. the ability of the enterprise to pay its loans ─ They include regulatory agencies, labor unions, and the interesting attaching to such loans financial and legal consultants  They will be able to determine whether the ─ Regulatory Agencies – protect the interest of the cost of such goods and services will be paid investors and the public when due ─ Labor Unions (DOLE) – protect the interest of the  They will look at the balance sheet (because employees of current assets and current liabilities) 1|Page ─ Financial and Legal Consultants – provide advice and o Were you able to maximize as a business all assistance to their clients who may be customers, your economic resources to produce profits? lenders, or suppliers  Operating and Financial Flexibility NOTE: o Company’s ability to adjust to unexpected o Internal and external users can use the same set economic downturns or take advantage of of financial statement – the general-purpose business opportunities that arises within the financial statement environment in which they operate o The concern of upper management is also the concern of other branches of accounting o How flexible and agile is your business? o Internal users have more access to other o Adjust in case of economic downturn information than external users  Information about a business’ economic resources and claims MONETARY UNIT o Information about an entity’s economic o Stable monetary unit principle resource and claims (financial position) o It is generally the unit of measure used in o What resources does the company have and communicating accounting information what are the claims that need to be settled? o Home currency of reporting entity is used How well does the company put these resources to good use? Example: Pru Life UK o Primarily provided in the statement of financial o Pru Life UK Philippines is a subsidiary of Pru Life UK position Hong Kong o What are our resources? It’s in the ASSET o Parent-Subsidiary relationship section o Parent = HK o What are the claims need to be settled? It’s in Subsidiary = PH the LIABILITY section o If ever it reported in the Philippines, PESO is the currency to be used  Information on changes on a business’ economic o If ever it reported the consolidated earnings of resources and claims Hong Kong and Philippines, HK dollar is the o How well did the company do during the currency to be used business year? o Consolidated earnings = currency of the parent to o Did we acquire or dispose something this year? be used o Information about an entity’s financial o Figures in peso will be converted to HK dollar for uniformity performance reflected by accrual accounting o Primarily provided in the statement of comprehensive income WHAT DO THE USERS WANT TO KNOW? o Financial Performance = income statement, cash flows, notes to FS, and changes in equity No matter the classification of the users, all of them have common information needs, which is to evaluate the organization’s… FOUR SECTORS OF ACCOUNTING PROFESSIONS  Liquidity 1. Commerce and Industry o Refers to the availability of cash in the near o ACPACI - Association of CPAs in Commerce and future after taking into account of financial Industry commitments over the current period o Private firms o Short-term financial obligation 2. Public Practice o Liquid = current assets > current liabilities o ACPAPP - Association of CPAs in Public Practice (have enough fund to cover liabilities) 3. Government o GACPA – Government Association of CPAs  Solvency 4. Education o The availability of cash over the long term to o nACPAE – National Association of CPAs in meet financial commitments as they fall due Education o Long-term financial obligation o Academe  Profitability o It is the ability of the enterprise to generate THE FINANCIAL REPORT AND ITS USERS cash flows from its existing resource base (1) FINANCIAL ACCOUNTING o It refers to the effectiveness with which the entity has employed its resources ─ The broadest branch of accounting, it focuses on o How effective are they in doing business? the needs of external users. 2|Page  ─ Its main concern is the recognition,  The main use of the report is to help measurement and communication of economic management in forming plans and implement resources and economic obligations short-term/long-term plans ─ These are communicated in a complete set of  Some of the information that is not disclosed in financial statements. the public (like calculations) are part of ─ Both internal and external users can use management accounting—it will only help to financial accounting make decisions because it contains classified  External users have common information needs information that only that only mangers have (i.e., to evaluate the business entity's access to profitability, liquidity and stability) ─ Decisions are based on:  Internal users use FS as it communicate  Financial accounting disclosed to external users substantial information (i.e., to evaluate an and general public entity’s performance and financial condition to  Management accounting that are more detailed better perform their planning and control and helpful functions) ─ Financial accounting should conform to the (3) COST ACCOUNTING accounting standards as developed by standard ─ It is concerned with measurement and setting bodies. recognition of cost of services provided or  They follow a standard products manufactured  Philippine Accounting Standards (PAS) ─ This is a sub-branch of management accounting  Philippine Financial Reporting Standards ─ It is more ordinarily associated with (PFRS)—these two are our codexes when manufacturing companies as a tool of both preparing FS financial accounting and management ─ In financial accounting, we make an implicit accounting statement of 100% compliance to PFRS ─ We are the ones preparing FS for and in behalf (4) TAX ACCOUNTING of the company—financial accountants ─ It is concerned with the computation of taxes PHILIPPINE ACCOUNTING STANDARDS (PAS) and preparation of tax returns submitted to a o Accounting adopted in the Philippines by FRSC and taxing authority. ASC—the originated from the works of the IASC ─ We are the ones making the ITR (income tax return) PHILIPPINE FINANCIAL REPORTING STANDARDS ─ The financial statements for reporting, SEC, or (PFRS) other users are different to the BIR because it o Comprised the specific PFRS as adopted from doesn’t use accrual basis specific International Financial Reporting ─ It is cash basis accounting Standards  This does not use actual basis in financial statements for tax purposes (2) MANAGEMENT ACCOUNTING (5) GOVERNMENT ACCOUNTING ─ Also called managerial accounting ─ It encompasses the process of analyzing, ─ Serves the information needs of the internal classifying, summarizing, and communicating all users for making and implementing short-term transactions involving the receipt and disposition and long-term plans for the enterprise as well as of government funds and property and routine and major economic decisions. interpreting the results thereof. ─ Internal users access to both financial ─ It has separate rules—NGAS (New Government accounting prepared by financial accounts and Accounting System) management accounting prepared by ─ It is similar to financial accounting, but they make management separate FS of three different funds (fund ─ The information provided is not structured and is accounting) not necessarily conforming to the accounting  Trust Fund – funds that are not used in day-to- standards day operations of government  Doesn’t follow any standard (no set of rules to  Special-Education Fund – funds used for qualified follow) projects (like for schools)  Because information required by the  General Fund – funds that LGUs use in every day management may vary based on the specific operations needs at a particular time  Free-form = own way/format to present the Bookkeeping report and calculations that will be understood o Refers only to one phase—recording phase o While accounting, consist of all phases—recording, classifying, summarizing, & interpreting 3|Page   His winnings are subject to the US taxation (as it Auditing part of their conditions) o Refers to an independent examination of the  If you are a Filipino citizen and residing in the financial statements conducted by a certified public Philippines, you are called resident citizen. If you accountant for the purpose of rendering an opinion are a Filipino resident citizen with income from as to the fairness of the presentation of the other countries and your income in those financial statements countries will be taxable to your home country, regardless where it came from. (6) FINANCIAL MANAGEMENT  Kahit san siya lumaban, he will be taxed by the BIR ─ No accounting involved  There are treaties—Law of Reciprocity—US has ─ Financial management involves the management its own set of tax rules and the Philippines has its of finances of an organization to achieve financial own set of tax rules objectives of the entity  Non-resident contractor (pumunta ng US para ─ It covers investment decisions, financing lang magtrabaho) is tax exempt and the rest decisions, distributing back to investors, and risk need to follow the 1040r (tax form for non- management resident aliens)—and Manny Pacquiao is a non- ─ The management relies on us to give them a resident alien decent and sound recommendation (7) ACCOUNTING EDUCATION FINANCIAL REPORTING AND STANDARD – SETTING PROCESS ─ It aims to produce competent and professional accountants capable of making a positive contribution over their lifetime to the profession THE PROBLEM OF GLOBALIZATION and to society in which they work  In this era of globalization, it has become increasingly ─ For those in academe apparent that we live in a borderless world. (8) ACCOUNTING RESEARCH Businesses have also become global and business transaction has become more complex. Therefore, ─ Accounting research is often time associated with there was a need to bring into a common basis the accounting education system of measurement and communication of ─ It is the systematic process of collecting and economic activities. analyzing information to increase one’s o International accounting was born because of understanding of the function of a professional globalization accountant and contribute to the solutions of the o The rise of globalization in business give rise problems that be setting of the practice of the also to one set of standards we adapt today profession  There was a need to bring into common basis system of measurement and communication of economic (8) FORENSIC ACCOUNTING activities o Through the creation of International ─ Forensic accounting is all about detection of Accounting Standards Committee (IASC) in fraud, the prevention of fraud, business 1973 valuations, and expert witness services, and  From 1971 to 2001, IASC developed a set of uniform other investigating services. global accounting standards and promote the use of ─ In case there were accusation in the court, the this standards—International Accounting Standards forensic accountant can vouch for the books (IAS) (litigation support) o IAS was adopted in the Philippines setting ─ Forensic accounting becomes third party expert (PAS) (9) INTERNATIONAL ACCOUNTING  IAS Committee reconstituted in 2001 as the International Accounting Standards Board (IASB) ─ It is necessary for us accountants to be aware of under the umbrella of the International Financial the standards and guidelines, as well as the rules Reporting Standards (IFRS) Foundation of accounting, auditing, and tax that exist within o IASB is the governing body that develops and other countries—since we now operate global promotes accounting standards business internationally up to today ─ We need to hone our skills in knowing standards o IASB is responsible for IFRS in other place for us to comply with them in the  The IFRS Foundation is a not-for-profit, public event of international ops interest organization established to develop a single set of high-quality, understandable, enforceable and Example: Manny Pacquiao is a Filipino that went to globally accepted accounting standards—IFRS Las Vegas for a competition and won. Standards 4|Page  After its reconstitution, the IASB took the initiative to  the lASB’s main vehicle to consult the interested undertake an improvements project in the light of public queries and criticisms raised in relation to the AS—  It is a proposed standard or a proposed the convergence project amendment to a standard o IASB’s work is to enhance and develop the  The comment period for major projects is usually accounting standards more (eliminate 120 days, and for IFRIC Interpretations is alternatives, redundancies, ad conflicts within usually 60 days, but may be less in urgent cases. IAS)  The IASB makes revisions on the draft after  IAS Committee’s work was revised by IASB and the considering the comments on the exposure draft collective revisions became IFRS and make new standards 5. Developing And Publishing The Standard  Upon reaching conclusion on the issues covered International Accounting Standards (IAS) in the exposure draft, the pre-ballot IFRS is sent o Accounting standards originated from the IAS to selected parties for review; after which, a near Committee, even improved/revised by IASB final draft is posted on the IASB's website International Financial Reporting Standards (IFRSs) 6. Afterwards, The Standard Is Issued o The standards that originated from the works of  The approved pronouncement is posted to the the IASB IASB’s limited access website for an initial period of about ten days, after which the draft is freely available online. THE WORKS OF THE IAS COMMITTEE IFRS include the following: THE STANDARD SETTING PROCESS IN THE PHILIPPINES a.) Specific International Financial Reporting Standards;  Before 1981, the Philippines did not have a formal b.) Interpretation made by the International process for the development of accounting Financial Reporting Interpretation Committee practices. (IFRIC), the body interpreting the work of the  In late November 18, 1981, Philippine Institute of IASB. Certified Public Accountants (PICPA), the accredited c.) International Accounting Standards; and professional organization of certified public d.) Interpretations made by the Standing accountants in the Philippines, organized the Interpretations Committee (SIC), the body that Accounting Standards Council (ASC) that formalized interprets the work of the IAS Committee. the standard setting process in the country o The main function of the ASC was to establish  Overall objective is the objective of financial and improve generally accepted accounting reporting—to communicate financial information that principles in the Philippines achieves transparency, accountability, and efficiency  The Standards developed by the ASC was called the Statements of Financial Accounting Standards (SFAS), based on existing practices, research and THE STANDARD SETTING PROCESS OF THE IASB studies done by the council, international The IASB follows a due process in the development of accounting literature, statements by then financial reporting standards. The due process involves International Accounting Standards Committee and interested individual and organizations around the world the Financial Accounting Standards Board of the and comprises the following stages: United States.  In 1997, the ASC decided to move fully to the 1. Setting The Agenda International Accounting Standards (IAS) and a  the IASB identifies an issue item to its agenda transition was made gradually. after considering the relevance of information to  From 1997 to 2000, the ASC developed accounting the users and the reliability of the information standards that were already based on IAS. that could be provided  In 2001, it adopted most of the standards that had 2. Planning The Project been developed by the IASC. The ASC set the year  the IASB decides whether to conduct the project 2005 for the full adoption of the International alone or jointly with another standard-setter Accounting Standards in the Philippines. 3. Developing And Publishing The Discussion Paper  In 2006, the Board of Accountancy established the  the discussion of the working group Financial Reporting Standards Council (FRSC) to  not mandatory replace and take over the functions of the ASC.  includes a comprehensive overview of the issue, o The Board of Accountancy is the body that possible approaches in addressing the issue regulates the practice of accountancy in the 4. Developing And Publishing The Exposure Draft Philippines. 5|Page  THE FINANCIAL REPORTING STANDARDS COUNCIL  Securities and Exchange Commission  Bangko Sentral ng Pilipinas The FRSC formed the Philippine Interpretations  Bureau of Internal Revenue Committee (PIC) in November 2006 to provide the  Financial Executives of the Philippines Council assistance in establishing and improving financial  Commission on Audit reporting standards in the Philippines. The PIC issues  2 members from each of the four sectors implementation guidelines on Philippine Financial (Public Practice, Commerce and Industry, Reporting Standards (PFRS). The PFRS is composed of: Government and Education) of the accredited professional organization of CPAs in the  Specific Philippine Financial Reporting Standards Philippines (which is presently the Philippine (PFRS) adopted from the International Financial Institute of Certified Public Accountants or Reporting Standards (IFRS); PICPA).  Philippine Accounting Standards (PAS), adapted from the International Accounting Standards (IAS);  Philippine Interpretations, adopted from the interpretations of IFRIC and the SIC and the Interpretations of the PIC. The PFRSs set out the recognition, measurement, presentation, and disclosure requirements dealing with transactions and events that are important in general purpose financial transactions. THE DEVELOPMENT PROCESS OF PFRS The PFRSs are developed through a due process that involves members of PICA, financial executives, regulatory authorities, members of the academe and other interested individuals and organizations. Due process for projects, normally, but not necessarily involves the following steps (Preface to PFRSs, paragraph 19):  Consideration of the pronouncements of the IASB;  Formation of a task force, when deemed necessary that will give advice to the FRSC;  Issuing for a comment an exposure draft approved by a majority of the FRSC members; comment period will be at least 60 days, unless a shorter period is considered (not less than 30 days).  Consideration of all comments received within the comment period and when appropriate, preparing a comment letter to the IASB; and  Approval of the standard or interpretation by a majority of the FRSC members. The FRSC continues to monitor the revisions of and the amendments to the IFRS to ensure that improvements made in the IFRS are being made effective in the Philippines. The Board of Accountancy also monitors the implementation of the PFRS. NOTE: o Under the Implementing Rules and Regulations of the Philippine Accountancy Act (Republic Act 9298), the FRSC shall be composed of a chairman and 14 members representing the following organizations:  Board of Accountancy 6|Page ACC-106: CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS LESSON 2: 1st SEMESTER | A.Y. 202Y – 202Y LECTURER: SIR/MS. THE CONCEPTUAL FRAMEWORK FOR FINANCIAL 3. Financial Statements and the Reporting Entity REPORTING 4. The Elements of Financial Statements 5. Recognition and Derecognition Conceptual Framework – skeletal system 6. Measurement PURPOSE AND STATUS OF THE CONCEPTUAL 7. Presentation and Disclosure FRAMEWORK 8. Concepts of Capital and Capital Maintenance It describes the objective of, and the concept for, the general-purpose financial statements. The purpose of the USEFUL FINANCIAL INFORMATION conceptual framework is to:  Assist the IASB to develop International Financial Reporting Standards (IFRS) that are based on consistent concepts. o The conceptual framework is the ancestor of the accounting standards o In order for the standards to be developed, there must me framework to be followed  Assist preparers to develop consistent accounting policies when no Standard applies to a particular transaction or other event, or when a Standard allows a choice or accounting policies; and, o When we are preparing FS and it so happens when a particular item does not have issued standard as of yet, the basis will be conceptual framework to be able develop a consistent How do we know if the financial information is useful? For accounting policy financial to be useful, it should have the qualitative  Assist all parties to understand and interpret the characteristics. These are generally divided into two Standard. groups: o Aside from the interpretations IASB prepared, a. the fundamental qualitative characteristics; and they may also supplement the interpretations b. the enhancing qualitative characteristics guide with the conceptual framework o The conceptual framework is not a Philippine Financial Reporting Standards (PFRS) and nor it is an International Financial Reporting Standard FUNDAMENTAL QUALITATIVE CHARACTERISTICS (IFRS) o Whenever there is a conflict between the RELEVANCE conceptual framework and an accounting ─ For financial information to be relevant, it should standard, the requirements of the accounting affect the decision or evaluation of the user. standards will prevail  Relevant is subjective o The conceptual framework will prevail if there  It is relevant if it is able to sway the user to were no accounting standards developed for a decide on something or change user’s mind on specific economic transaction previous decision ─ It should also have confirmatory or predictive value SCOPE OF THE CONCEPTUAL FRAMEWORK Confirmatory Value  The information that allow users to confirm or The Conceptual Framework of Financial Reporting is change their opinions on such evaluations consisted of eight (8) chapters, as follows:  This provides feedback on previous evaluations 1. The Objective of General-Purpose Financial Statements 2. Qualitative Characteristics of Useful Information 1|Page   It is relevant when the users enable to confirm earlier expectations about the enterprise FAITHFUL REPRESENTATION ─ The information contained in the financial reports Predictive Value must faithfully represent the transactions and other  The information that can be used to predict events it either purports to represent or reasonably future outcomes be expected to represent.  Financial information about the enterprise’s ─ For information to be faithfully represented, it must financial position and past performance helps be: users formulate more intelligible predictions about the future Complete  We are able to forecast intelligent projections  Requires the inclusion of all information using historical information necessary for a user to understand the phenomenon being depicted, including all ─ Financial reporting is concerned with information necessary depictions and explanations that is significant enough to influence the economic  A complete depiction of an account presented decisions of users on the face of the FS is necessary to achieve ─ Concept of materiality is connected to the concept faithful representation of relevance because an information is relevant if it is material Neutral  A neutral information is impartial and is not The Concept of Materiality biased towards the particular needs or  It is largely a matter of professional judgment desires of specific users based on identifiable circumstances.  The information presented in financial reports  Largely matter of professional judgment should not work for the advantage of one means that naka-depende sa tumitingin yung group of users but to detriment of another level of materiality group  It is also entity-specific.  Prudence affecting neutrality  Materiality depends on the following:  Prudence/Conservatism, which is the o the nature of the item; exercise of caution when making judgments o the magnitude of the items in which under conditions of uncertainty the information relates; and/or,  We have to be cautious to protect the interest o error judged circumstances of of the users omission or misstatement of information. Free From Error  An item is deemed material if its inclusion or  An information is free from error if there are disclosure would make a difference in the no errors in mathematical equations or evaluation or decision of the user. omissions in its description and that there is no error committed in the process of Example: Sari-Sari Store producing the information  Nawalan ng P1,000 ang sari-sari store.  If we rely on unreliable information, we  If you operate a small business and you loss inadvertently relied on erroneous data—it will P1,000, it is material also result in error judgments as users of FS  Nature of the item = cash (most liquid asset)  Magnitude of the item = P1,000 (huge amount) ENCHANCING QUALITATIVE CHARACTERISTICS  Error judged circumstances = money count mistake, computed mistakenly, or omit to list COMPARABILITY something ─ The quality of information that enables users to identify similarities and differences between at least Example: SM Hypermarket two sets of economic circumstances.  Nawalan ng P1,000 ang SM Hypermarket. ─ IAS 1 Presentation of Financial Statements  For SM, 1,000 is not as material prescribes the basis for the presentation of financial  Nature of the item = cash statements to ensure comparability with the  Magnitude of the item = P1,000 (small company’s financial statements from previous amount) periods as well as those of other entities.  Error judged circumstances = money count ─ To achieve comparability, users should be able to mistake, computed mistakenly, or omit to list identify similarities and differences arising from something actual similarities and differences in economic 2|Page  transactions, and not merely because there are  checking the inputs to a model, formula or differences in accounting treatment other technique and recalculating the outputs ─ It is achieved by adhering to the principle of using the same methodology consistency  e.g., checking the figures if there are no ─ Consistency is the application of the same mistakes or omissions, checking the formula accounting policies and procedures from period to if they add first before subtracting, and period recalculating the same technique Intracomparability ─ Verifiable information need not be a single point  Comparability internally estimate, as estimates may be within a range of  Comparability within the reporting entity possible amounts  Consistency applies to your own financial ─ To add to information’s verifiability, the underlying information and for your own comparison assumptions, methods of compiling the information,  It is not appropriate for enterprise to leave its the measurement techniques that is used in arriving accounting policy unchanged when another at the figure presented in FS must be disclosed method of accounting would result to a more  Because this will be the basis of the audit to relevant of the results of the transaction verify information completed by the entity  If the accounting policy changes— TIMELINESS retrospective application—we need to restate FS before as if we are using the new standard ─ For information to be relevant, it must be available all along (for the comparability won’t be to the users early enough to be used to make compromised) with proper disclosure in the economic decisions, with which the information Notes to FS might influence.  Early enough or on time for users to make Intercomparability decisions  Comparability of entity to entity ─ The relevance of the information might be lost if  Comparability between and among there is undue delay in reporting the information. enterprises  It is more difficult to achieve than intracomparability—because you cannot UNDERSTANDABILITY compare your own accounting policies to the ─ The linkage between the information and economic accounting policies of another entity decision made by the user.  Entities have different accounting policies as ─ If the user does not understand the presented long as in compliance with standards information, it becomes useless.  To achieve this, IASB tries, as much as ─ Understandability of information is dependent on possible, to limit alternative treatments in a two factors: minimum number  the quality of the user  the quality of information VERIFIABILITY ─ Terminologies used in expressing the information must be adapted to the users’ range of ─ To be verifiable, information must be replicated understanding. using the same methods and applying the same ─ Information should be presented in a form that process. facilitates the evaluation of the users. This is the ─ You must have the ability to verify the said reason why financial statements are organized a information certain way. ─ Verifiability of information, therefore, enhances the  Assets and liabilities are classified as current faithful representation of information and non-current  Revenues are separated from gains; and Direct Verification expenses are separated from losses  applying techniques and methods to achieve ─ Users have the responsibility to understand the the same result contents of the financial statements.  you apply sort of techniques to see if you ─ Complex matters should not be excluded from the achieve financial statements simply because the users can’t  e.g. performing cash count, requesting bank understand it. statements to validate cash balance ─ It is therefore assumed that users have reasonable knowledge of accounting, business and economic Indirect Verification activities. 3|Page  ─ The users should also have a willingness to study  Financial statements are prepared for a specified the financial information with reasonable diligence. period called reporting period, with comparative ─ They may seek assistance of financial adviser, information for at least one preceding reporting analysts and other professionals if they find some period. information that is too difficult to understand.  Information on transactions and other events that have occurred after the reporting period is also THE COST CONSTRAINT OF USEFUL FINANCIAL provided in the financial statements if such REPORTING information is necessary to meet the objective of the financial statements  A constraint is a practical exception to the o Forward-looking information is included in the application of sound accounting theory. FS if it relates to the entity's assets, liabilities  The benefits derived from the information should or equity at the end of the reporting period or exceed the cost of providing it to income and expenses for the reporting o Cost-Benefit Principle period, and such information is useful to users o Not all useful information is actually reported of financial statements. because the cost of acquiring it outweighs the benefit of having that information o The presentation of relevant information is GOING CONCERN constrained by the cost of obtaining information  This is an underlying assumption used in generating o Financial information provides certain the financial statements. benefits to its users AND involves cost to  This assumes that the enterprise is a going concern provide and use and will continue to operate for the foreseeable future. o Assuming that your business will continue to THE FINANCIAL STATEMENTS AND THE REPORTING operate for a long period of time and you are not ENTITY seeing any changes to this  This provides a useful frame of reference for OBJECTIVE AND SCOPE OF FINANCIAL STATEMENTS accounting measurements where assets are carried at going concern values instead of liquidation values. The information presented in the financial statements  If there is an intention or need to liquidate, the pertain to: financial statements may have to be prepared on a different basis and, if so, the basis used is disclosed a. the entity’s financial position with recognized assets,  In general, if we don’t have reasons to believe that a liabilities and equity; business will be liquidating, then we continue to use b. the entity’s financial performance with recognized going concern for financial reporting income and expenses; c. information about (1) Going Concern Assumption o Recognized assets, liabilities, income and  Accrual Basis expenses including the nature and risks arising  Revenues are recognized when it is earned from those recognized assets and liabilities; regardless when payment is received  In the Notes to FS  Expenses are recognized when incurred o Assets and liabilities that have not been regardless when payment is paid recognized, including the nature and risks  matching principle arising therefrom;  Accounts Receivables will continue to be  Deferred assets and liabilities receivable or there is a chance to collect them  We still need to disclose including the  Expenses that are not yet paid will continue to nature and risks be liabilities o Cash flows  Going concern means that we must still be  Separate statement conservative with our estimates and o Contributions from and distributions to accounting policies enterprise owners  Changes in owner’s equity (2) Liquidating Concern Assumption o The methods, assumptions and judgments in  Cash Basis estimating amounts presented or disclosed, and  Recognizes income and expenses only when changes in those methods, assumptions and cash is exchanged judgments.  We will change accounting basis once there is  In the Notes to FS certainty that our business is no longer going concern 4|Page   We need to change the approach when o It is allowed to have separate FS on the liquidating concern because the valuation of subsidiaries assets, receivables, and inventories are not the o If there is a parent, it should also be same anymore as going concern recognized. The line that we will see in the  When a business decides to close or liquidate, books of parent (in the case of Smart and they will deplete is the inventory at a lower cost PLDT) is share in income of PLDT, non- (there is mark downs) controlling interest of PLDT, etc.  If a business is closing, (a) the business will try o If people would like to see the other details of to collect AR. If the efforts are worthless, (b) share in income, it is in Notes to FS and we write it off. ultimately lead to the FS of PLDT or Smart  One of the reasons why we are closing is  Meanwhile, the subsidiary’s own financial because majority of our capital is already tied statements are designed to provide separate to AR (huge portion of it is uncollectible) information about the assets, labilities, equity,  AR is no longer be recognized at face value income and expenses of that particular subsidiary.  What will appear in the books (liquidating o Parent and subsidiaries have their own FS concern) is Net Realizable Value— how much  Unconsolidated financial statements may also be can we recover out of the AR? prepared about the parent's assets, liabilities,  Equipment will be sold in Fair Market Value equity, income and expenses because they provide useful information to existing and potential Note: investors, lenders and other creditors of the parent o For tax purpose, we use cash basis accounting. about claims against the parent. o Accrual Basis = for general purpose o Three parts of consolidated FS: o Cash Basis = for tax returns (1) FS of the parent only (2) FS of the subsidiary (3) The consolidated financial statements of THE REPORTING ENTITY the two o If investors only want to know about parent,  Otherwise known as an accounting entity, may be a investors will only base on unconsolidated business enterprise, a government unit, a non-profit financial statement of the parent organization, an individual, a unit within an  Such information may also be provided in the notes enterprise, a group of entities, or any other unit to the consolidated financial statements. considered to have a separate personality than its o If you don’t want to prepare unconsolidated owners, members or employees. financial statement, you should provide o Entity concept information in the notes o The personality of the business is separate from  The unconsolidated financial statements cannot the members, owners, or employees substitute the consolidated financial statements, o Creation of Law = by registering your when the parent is required to present the latter. business/corporation, the law creates an o You cannot provide unconsolidated FS, if the artificial or a juridical person that has its own law regulating bodies are requiring to present assets other than assets of the owner of the consolidated FS business  These separate entities established for accounting can control its own economic resources and incur Combined Financial Statements economic obligations  The financial statements of a reporting entity comprising two or more entities that are not linked Consolidated Financial Statements by a parent-subsidiary relationship are called "combined financial statements.  Financial statements of a reporting entity  A reporting entity that is not a legal entity or does comprising both the parent and its subsidiaries are not comprise only legal entities linked by parent- called consolidated financial statements. subsidiary relationship shall present financial  A parent is an entity that exercises control over statements that reflect a complete depiction of the another entity, called the subsidiary. entity’s economic activities.  A parent may have one or more subsidiaries, and the consolidated financial statements are mainly for Example: the use of the owners of the parent because net o A reporting entity could be operation segment o Smart is a separate operation from PLDT cash flows to the parent include distributions to the o PLDT is a landline and internet service provider parent from its subsidiaries. o Smart and PLDT are owned by the same parent o The parent company is the only one who uses company consolidated financial statements 5|Page  o Smart and PLDT will prepare different FS as they o The rights embodied in an asset may are separate accounting units correspond to an obligation of another o Manny Pangilinan owns Smart and PLDT party o He will consolidate the financial statements o You have the right to the economic o Consolidation = data of Smart and PLDT will be resource combined, eliminate the related part o (e.g., rights to receive cash, transactions, and report in one FS along with goods/services) other businesses that Manny owns o His businesses is separate accounting entities (2) Potential to Receive Economic Benefits from that of his subsidiaries o An asset derives its value from a present potential to produce future economic THE ELEMENTS OF FINANCIAL STATEMENTS benefits, which may flow to the entity in any ways: The Basic Accounting Equation  Receiving cash or another economic A=L+E resource  Exchanging the resource with ─ The money I used to sell my assets for my business another party comes from two funding sources, either I borrow  Using the resource to produce (liability) or I invest (equity). goods/services ─ Element of financial statements are interrelated.  Enhance the value of another asset o The economic resource has the potential (1) Statement of Comprehensive Income to bring economic benefit by having that  Income statement is the first FS we right to the economic resource generate to get the Net Income/Loss  This contains nominal accounts, which (3) Control means that when we close the book, o You should also have control over the revenue/expense accounts will be zero out. assets o Control may arise if an entity enforces (2) Statement of Financial Position legal rights  Net Income/Loss will be zero out and o An entity controls an asset if it has the recognize in Equity account of balance sheet present ability to direct use of the asset  e.g., If there is partnership income, it will be transferred to the partners’ capital o e.g., If our parent let us borrow the car, accounts the ability to use the car does not absolutely give us the right to call our ─ Accounting equation encompasses both balance and asset income statement accounts ─ Income statement accounts are already embedded in LIABILITY equity section  A liability is a present obligation of an entity to transfer an economic resource as a result of past FINANCIAL POSITION events.  The financial effects of the transactions and other  Three criteria must be satisfied for a liability to events affecting the enterprise is reflected in the exist: financial statement (1) An Obligation Of The Entity The information presented in the financial statements o For a liability to exist, the entity must pertain to: have no practical ability to avoid obligation—a duty or responsibility ASSET o We don’t have the ability to actually  An asset is a present economic resource controlled delay or escape the payment of a liability by the entity, as a result of past events. o If we have the power to delay the  An economic resource controlled is a right that has liability—then it is not a liability, because the potential to produce economic benefits. it is already an optional not obligation  There are three aspects in the definition of assets: o However, for a liability to exist, it is not necessary to know the identity of the (1) Right person or entity to whom the obligation is owed. o We do not need to know to whom we will fulfill the obligation 6|Page  Examples: (2) The Obligation Is To Transfer an Economic (1) I own 20 million assets in 1 year, but I only made Resource 1 million in net income – the asset turnover was o The obligation to transfer an economic not that much, in which the company may not resource may be settled in the future by: have been maximizing its resources to generate  paying cash revenues.  delivering goods (2) I own 20 million assets in 1 year, but I made 60  providing services million in net income – with the 20 million assets  exchanging economic resource on I have, I was able to make triple the money out unfavorable terms of the assets.  creating another obligation in replacement of the old  Income and Expenses are transferred to owner’s  issue a financial instrument equity. equivalent to ownership interest. INCOME (3) The Present Obligation Arises From Past Events  Income refers to increases in assets or decreases o Liability arises from past event, that is, in liabilities that result in increases in equity, other when the entity has obtained economic than those relating to contributions from holders benefits or taken action that obliges it to of equity claims. transfer an economic resource o Liability decreases because you have o e.g., I ordered 12 pan of cakes to Tish. I performed services that will recognize gave my down payment of 12,000. At payments. that point, Tish has now a liability/an  Revenue is the income that arise from the obligation to transfer an economic principal operations of an entity resource o Income from main line  Gains are those that arise from incidental or peripheral transactions EQUITY o It does not necessarily relate to the  Equity is the residual interest in the assets of the operations of the business entity after deducting all its liabilities. o e.g., sale of equipment (not part of o E=A–L operations) o A=L–E o The accounting equation means that the EXPENSES creditors are the first one to get its claim in the economic resources. What was left will  Expenses are decreases in assets, or increases in be given to the capitalists, liabilities, that result in decreases in equity, other o Equity is what will be left after creditors go than those relating to distributions to holders of after the company. equity claims  It is what is left of its assets after satisfying its o Expenses is a deduction to income obligations o The net of income and expenses is the value  For single proprietorships and partnerships, equity added in changes in owner’s equity (net is generally called capital income)  For a corporate form of business organization,  Expenses are expenses that result from the equity accounts are broken down into components principal operations of an entity that reflect legal, regulatory or other requirements  Losses are those that result from incidental or or restrictions. peripheral transactions o Shareholders’ Equity o e.g., Impairment Loss – you bought a phone for 50,000. After 6 months you found out that the fair value of your phone is FINANCIAL PERFORMANCE 30,000. The value decrease in the fair value of phone while you are in a bakery business  Also called as Profit and Loss Statement or Statement is a loss because you are not in the business of Comprehensive Income of phones.  Assessing the ability of the company to generate o Impairment of Loss – market value is less revenue. than carrying value  The purpose of income statement is to assess o Expense – when you bought 3 sacks of flour management’s ability to use the assets to generate for your bakery business the revenue. 7|Page   Presenting separately income and expenses with o You will have to explain that this particular different characteristics can help users of financial amount is just an estimate statements to better understand the entity's  Recognition links the elements of financial financial performance statements. o Value received, value parted with o Recognition of expenses are matched with revenues RECOGNITION AND DERECOGNITION o e.g., Recording of sale transactions results in the recognition of the revenue RECOGNITION o By recognizing these transactions in a timely manner, we are matching revenues with  Recognition is the process of including in the face of expenses the financial statement an item that meets the o If we earn it now, the related expenses to earn definition of a financial statement element. that money should also be recorded in the o Recognition occurs the moment it qualifies as same period—matching principle a FS element o You recognize an asset once it made the Example: definition of assets I have a business and my supplier ran off my money. o Recognize = record I filed a lawsuit and demand for damages for loss of o Aside from the proper classification, it should income. also measurable  It involves giving a name to the financial statement Do I already need to report that I am charging element and assigning it a monetary amount, called damages? a carrying amount. o No. I don’t need to recognize yet in the face of the FS the amount damages I asked the court to grant o e.g., Phone – it is an asset because you a right against my supplier because of uncertainty. and control over it, and have the potential to o The information on the damages is not yet benefit from it relevant. o After giving an appropriate name or classification, you have to record the carrying Do I need to recognize the money I paid to the amount supplier?  For an item to be recognized in the financial o Yes. Because there is value received and value statement it must: parted with (A) Meet the definition of one of the elements of Inventory 5,000,000 financial position or performance Cash 5,000,000 (B) Provide useful information that is relevant and faithfully represented o I should not be reporting the damages I am asking the court to approve as income because it is still  If it doesn’t matter as of the moment, then uncertain, in which the court has yet to try to this piece of information may not be process on the lawsuit. recognized in the face of the FS o Notes to FS – We will make a disclosure in notes to  There are information that you choose not FS regarding the lawsuit until the results are not to recognize yet certain. (C) The benefit of providing the information to the o In the event that the court sides with us and users must justify the cost of obtaining and agreed that we should be paid Php 5,000,000 due providing and using the information to loss of income, there will be an increase in Non- (D) Be measurable Trade Receivable.  The process of recognition is governed by the Accounts receivable should be expected cash received as a result of business operations. qualitative characteristics of relevance and faithful representation. Non-Trade Receivable is a receivable that is not from  Some items of information at the date of the financial business operations. We may create a specific title on statements cannot yet be measured with certainty that particular front.  The use of reasonable estimates may be necessary to provide useful information o In the event that the court disapproved our case;  In such a case, information must be provided (1) we will show in the disclosure that we lose the describing the estimate and explaining the case uncertainties that affect it. (2) there is an adjustment in the inventory part, o If you are uncertain, you will not insist if it is we will write-it off because we have never receive part of the assets, liabilities, or equity any inventory 8|Page  (3) we need to reclassify the cash we paid as a o GAIN – There is an increase in value of asset. loss. What is recorded in the books is Php 30,000. But in the market, it is Php 50,000. We should Loss 5,000,000 recognize that portion of asset. Inventory 5,000,000 Asset 20,000 Revaluation Surplus 20,000 o LOSS – There is a decrease in value of asset. DERECOGNITION We have to derecognize that portion of asset.  It is the removal of all or part of a recognized asset, Impairment of Loss 20,000 or liability from an entity’s Statement of Financial Asset 20,000 Position. o If it is a revaluation, it could be gain from asset  It normally occurs when an item no longer meets the or loss due to impairment definition of an asset or a liability. o If you removed a part of asset, you cannot  Derecognition normally occurs when that item no recognize as profit or loss, unless the loss is longer meets the definition of an asset or of liability part of reclassification o e.g., (sale of) equipment – it is part of asset  In such a case, the income or expense results from before, from the time I sold this equipment, it the remeasurement or reclassification of the retained will no longer be part of my bakery’s portion will included in the statement of recognized assets comprehensive income o there is a need to update the records to show the disposal and therefore derecognize the portion of the equipment—I will only remove MEASUREMENT the value of the equipment that I disposed o derecognizes an asset—when it loses control  The financial statement elements is quantified in over that asset monetary terms that require the selection of a o derecognizing a liability—when the entity has measurement basis. no more present obligation o Quantifying the elements of in the FS in  We can derecognize an asset if dispose it completely. monetary terms o e.g., We derecognize the carrying amount of  The selected basis must be one that results to the computer, as well as the related provision of most relevant and faithfully represented accumulated depreciation by (1) selling – you information, considering the nature of the lose the computer but you gain cash. information that the measurement basis will provide. o e.g., We can also dispose an asset by (2)  The choice of the measurement basis is determined trading. Jam has iPhone 13, while Rose has by considering both: iPhone 10. They trade mobile phones so Jam o Initial measurement (at date of creation) – the will write it off her iPhone 13, and recognize the measurement of financial statement element iPhone 10. While Rose will recognize iPhone 13 at the time of its creation when asset is and derecognize iPhone 10 in here books. acquired, or liability has arise o e.g., We can also dispose an asset by (3) o Subsequent measurement (date of reporting) decreasing its value through use. At the  The characteristics of the asset or the liability as well beginning of 2023, we made an advance as how that asset or liability contributes to the future payment of P 120,000 in rent that is good for cash flows affect the choice of the measurement 1 year. Payment of it is every 30th of the basis. month.  The two general measurement bases are historical o As of February 16, Prepaid Rent is Php 110,000 cost and current cost and the Rent Expense is Php 10,000. – part of our asset is derecognized. The recognized portion of the asset was reclassified as HISTORICAL COST expense.  An entity derecognizing a part of an asset or liability  It is the cost based on the price of the transaction or and retaining another part of it shall NOT recognize event that gave rise to the financial statement in profit or loss an income or expense relating to the element. portion retained, unless the portion retained is o Historical cost is the cost at recording and the remeasured or reclassified. financial statement element is created o In the example above, there was no gain or  In some cases, the deemed historical cost of an asset loss—it is just a reclassification. or liability at initial recognition is its current value at that date, which is used as a starting point for subsequent measurement at historical cost 9|Page  o e.g., You bought a glass at P35—that was the value of glass at the time your purchase Example: o the current value at the time of creation of the  I bought a phone at P55,000. After 6 asset becomes its historical cost months, despite not being used, it is now o at the time of reporting (December 31), we P30,000 in the market. I just incurred an need to look at the glass and adjust any impairment of P20,000. I would need to changes what might have happened to it recognize the loss from the decrease of  Historical cost does not reflect changes in values, the value of my phone and reflect the except changes related to impairment of assets or adjusted amount. when a liability becomes onerous. (d) Accrual of interest o if we acquired an asset through a HISTORICAL COST OF AN ASSET liability, the related liability will be incurring interest—at that part of liability  The historical cost of an asset is the value of the costs will also form the value of the asset incurred in acquiring or creating the asset, including because it is considered transaction cost the consideration paid to acquire or create the asset in the acquisition of such asset plus transaction cost. o Original acquisition cost of an asset HISTORICAL COST OF A LIABILITY o e.g., the historical cost of a book should include the current price of the book on the time of  The historical cost of a liability is the value of the purchase online (P800) + shipping fee incurred consideration received to incur or take the liability to deliver to the owner (P55) = P855 is the minus transaction costs. total cost of the book o e.g., Bank loan for P100,000. They will deduct  The historical cost of an asset is updated over time if some amounts that relates to the processing applicable: fees, etc.—those transaction cost are not part (a) The consumption of a part or all of the of historical cost of the liability economic resource  The historical cost of the liability is updated over time o when the asset is no longer in the control to depict, if applicable: of the company—adjust the historical (b) Fulfillment of part or all of the liability cost to reflect how the asset is consumed o if you are paying loans monthly, every month the cost of the liability will be Example: updated to show the decrease in value  I bought a laptop at P55,000. As I corresponding to the principal payment I consumed the laptop, the value of it have been making towards the liability depreciates. From P55,000 at the beginning of 2021, I need to readjust the (c) The effect of events that increases its value, value of that laptop to reflect the current to the extent that the liability becomes value at the time of my review because onerous at the end of 2021, I need to be account o any changes in the terms of the liability for the depreciation of the laptop. that makes it eve