Conceptual Framework PDF

CONCEPTUAL FRAMEWORK FRSC definition (formerly ASC) Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities, that is intended to be useful in making economic decision. Committee on Accounting Terminology (AICPA)...

CONCEPTUAL FRAMEWORK FRSC definition (formerly ASC) Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities, that is intended to be useful in making economic decision. Committee on Accounting Terminology (AICPA) Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are in part at least of a financial character and interpreting the results thereof. American Accounting Association Accounting is the process of identifying, measuring and communicating economic information to permit informed judgment and decision by users of the information. ACCOUNTING 1. Identifying – analytical component 2. Measuring – technical component 3. Communicating – formal component The basic purpose of accounting is TO PROVIDE QUANTITATIVE FINANCIAL INFORMATION ABOUT A BUSINESS THAT IS USEFUL TO STATEMENT USERS PARTICULARLY OWNERS AND CREDITORS, IN MAKING ECONOMIC DECISIONS. REPUBLIC ACT NO. 9298, also known as PHILIPPINE ACCOUNTANCY ACT OF 2004 is the law regulating the practice of accountancy in the Philippines. BOARD OF ACCOUNTANCY – is the body authorized by law to promulgate rules and regulation affecting the practice of the accountancy profession in the Philippines.  Public Accounting  Private Accounting  Government Accounting *Research and Education Single practitioners and partnerships for the practice of public accountancy shall be registered certified public accountants in the Philippines. Certificate of accreditation shall be issued to CPA in public practice – registrant has acquired a minimum of three years of meaningful experience in any of the areas of public practice including taxation. SEC shall not register any corporation organized for the practice of public accountancy. Accreditation to practice public accountancy a) CPAs, firms and partnerships of CPAs including partners and staff members are required to register with BOA and PRC b) Upon favorable recommendation of BOA, PRC shall issue certificate of registration which shall be valid for 3 years and renewable every 3 years upon payment of required fees. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) – encompass conventions, rules and procedures to define what is accepted accounting practice. They represent the rules, procedures, practice and standards followed in the preparation and presentation of financial statements. ACCOUNTING STANDARDS COUNCIL (ASC) – is the body established on November 18, 1981 by PICPA to promulgate suitable financial accounting standards (Philippine Accounting Standards – PAS and Philippine Financial Reporting Standards – PFRS) in the Philippines. FINANCIAL REPORTING STANDARDS COUNCIL (FRSC) – now replaces the ASC, which will continue to function until the creation FRSC. INTERNATIONAL ACCOUNTING STANDARDS COMMITTEE (IASC) – founded in 1973, is an independent private sector body, with the objectives of achieving the uniformity in the accounting principles, which are used by business and other organizations for financial reporting around the world. The objectives of IASC: a. To formulate and publish in the public interest accounting standards to be observed in the presentation of the financial statements and to promote their worldwide acceptance and observance. b. To work generally for the improvement and harmonization of regulations, accounting standards and procedures relating to the presentation of financial statements. IASC’s approved statements International Accounting Standards – IAS Factors considered in using the IAS: a. Support of IASC standards by Philippine organizations, such as SEC, BOA and PICPA. b. Increasing internalization of business which has heightened interest in a common language for financial reporting. c. Improvement of international accounting standards or removal of free choices of accounting treatments. d. Increasing recognition of international accounting standards by World Bank, ADB and World Trade Organizations. INTERNATIONAL ACCOUNTING STANDARDS BOARD (IASB) now replaces the International Accounting Standards Committee (IASC). It publishes its standards in a series of pronouncements called INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS). The IFRS is a global phenomenon intended to bring about greater transparency and a higher degree of comparability in financial reporting, both of which will benefit the investors and are essential to achieve the goal of one uniform and globally accepted financial reporting standards. The IASB’s objective is to raise the quality and consistency of financial reporting and to have a platform of high quality and improved standards. ACCOUNTING ASSUMPTIONS are the basic notions or fundamental premises on which the accounting process is based. Accounting assumptions are the “givens” and they exist without saying. Accounting assumptions serve as the foundation or bedrock of accounting in order to avoid misunderstanding but rather enhance the understanding and usefulness of the financial statements. Accounting assumptions are also known as POSTULATES. CONCEPTUAL FRAMEWORK TWO ASSUMPTIONS: 1. ACCRUAL 2. GOING CONCERN UNDERLYING ASSUMPTIONS: ACCOUNTING ENTITY TIME PERIOD MONETARY UNIT – quantifiability and stability of the peso A CONCEPTUAL FRAMEWORK is a summary of the terms and concepts that underlie the preparation and presentation of financial statements. It is the underlying theory for the development of accounting standards and revision of previously issued accounting standards. The conceptual framework is an attempt to provide an overall theoretical foundation for accounting, which will guide standard-setters, preparers and users of financial information in the preparation and presentation of statements. Basic Purpose of Conceptual Framework a. Assists the FRSC in developing accounting standards that will represent Philippine GAAP. b. Assists preparers of financial statements in applying accounting standards and in dealing with issues not yet covered by GAAP. c. Assists the FRSC in its review and adoption of IFRS.  d. Assists users of financial statements in interpreting the information contained in the financial statements. e. Assists auditors in forming an opinion as to whether financial statements conform with Philippine GAAP. IMPORTANT NOTE: If there is a standard or an interpretation that specifically applies to a transaction, the standard or interpretation overrides the conceptual framework. In the absence of a standard or an interpretation that specifically applies to a transaction, management should consider the applicability of the conceptual framework in developing and applying an accounting policy that results in information that is relevant and reliable. NOTE: In case there is conflict, the requirements of the PFRS shall prevail over the conceptual framework. SCOPE OF CONCEPTUAL FRAMEWORK a. Objective of financial statements b. Qualitative characteristics that determine the usefulness of information in financial statements. c. Definition, recognition and measurement of the elements from which financial statements are constructed. d. Concepts of capital and capital maintenance STAKEHOLDERS  Investors  Employees  Lenders  Suppliers and trade creditors  Customers  Government  Public The objective of financial statements is to provide information about the financial position, performance, and cash flows of an enterprise that is useful to a wide range of users in making economic decisions. A Complete Set of Financial Statements: Balance Sheet – Statement of Financial Position Income Statement – Statement of Comprehensive Income Statement of Changes in Equity, showing either All changes in equity, or Changes in equity other than those arising from transactions with equity holders acting in their capacity as equity holders; Cash Flow Statement Notes, comprising a summary of significant accounting policies and other explanatory notes. FINANCIAL POSITION (BALANCE SHEET) Economic Resources Liquidity Solvency Financial Structure Capacity for Adaptation Performance of an Enterprise (INCOME STATEMENT STATEMENT OF CHANGES IN OWNERS’ EQUITY CASH FLOW STATEMENT CONCEPTS IN CONJUNCTION WITH THE OBJECTIVE OF FINANCIAL STATEMENTS Entity Theory (Assets = Liabilities + Capital)  Proprietary Theory (Assets – Liabilities = Capital) Residual Equity Theory (Assets – Liabilities – Preference Shareholders’ Equity = Ordinary Shareholders’ Equity) Fund Theory (Fund = Cash inflows – Cash outflows) FINANCIAL REPORTING – encompasses financial statements and other means of communicating information that relates directly and indirectly to the financial accounting process. FINANCIAL REPORTS – represent the main product of financial reporting, they include financial statements, other information such as financial highlights, summary of important figures, analysis of financial statements and significant ratios, and non financial information such as description of major products and a listing of corporate officers and directors. Objective of Financial Reporting The overall objective of financial reporting is to provide information that is useful for decision making. Specifically, the AICPA Financial Accounting Standards Board in its Statement of Financial Accounting Concepts enumerates the following objectives of financial reporting:  To provide information useful in investment, credit and similar decisions  To provide information useful in assessing cash flow prospects  To provide information about entity resources, claims to those resources and changes in them. QUALITATIVE CHARACTERISTICS are the qualities or attributes that make financial accounting information useful to the users. The ASC in its conceptual framework enumerates four principal qualitative characteristics, namely:  CONTENT of FINANCIAL STATEMENTS - Relevance & Reliability  PRESENTATION of FINANCIAL STATEMENTS - Understandability & Comparability RELEVANCE – capacity of information to make a difference in a decision by helping users form predictions about the outcome of past, present and future events, or confirm and correct prior expectations. It is the capacity of the information to influence a decision. Ingredients of Relevance  Predictive Value  Feedback Value  Timeliness RELIABILITY – is the degree of confidence users place upon the truthfulness of the representations in the financial statements. It is the quality of information that assures users that the information is free from bias and error, and faithfully represents what it purports to represent. The following factors enhance the reliability of financial statements:  Faithful Representation  Substance over form  Neutrality  Conservatism or Prudence  Completeness Faithful representation – actual effects of the transactions should be properly accounted and reported in the financial statements. Substance over form – the economic substance of transactions and events are usually emphasized when economic substance differs from legal form. Neutrality – information should be free from bias. It is synonymous with the all encompassing “principle of fairness.” Conservatism – under this when alternative exists, the alternative which has the least effect on equity should be chosen. Possible errors in measurement be in the direction of understatement rather than overstatement of net income and net assets. Prudence is the desire to exercise care and caution when dealing with the uncertainties in the measurement process. Contingent loss is recognized as a provision if the loss is probable and the amount can be reasonably estimated. Contingent gain is not recognized but disclosed only. Completeness is the result of the adequate disclosure standard or the principle of full disclosure  Standard of adequate disclosure The rule is that the accountant should disclose a material fact known to him which is not disclosed in the financial statements but disclosure of which is necessary in order that the statements would not be misleading.  Notes to financial statements The purpose is to provide the necessary disclosures required by the Philippine Financial Reporting Standards. They provide narrative description or disaggregation of the items presented in the financial statements and information about items that do not qualify for recognition. UNDERSTANDABILITY requires that information should be comprehensible or intelligible to be useful. Users are assumed to have a reasonable knowledge of the economic activities of accounting and a willingness to study the information with reasonable diligence. COMPARABILITY means the ability to bring together for the purpose of noting points of likeness and difference. Horizontal Comparability or Intracomparability – comparability within the entity. Dimensional Comparability or Intercomparability – comparability between and across entities. PRINCIPLE OF CONSISTENCY The accounting methods and practices should be applied on a uniform basis from period to period. Consistency does not mean that no change in accounting method can be made. If the change will result to more useful and meaningful information, then such change should be made. But there should be full disclosure of the change and the peso effect thereof. It is inappropriate for an entity to leave its accounting policies unchanged when more relevant and reliable alternative exist. ACCOUNTING CONSTRAINTS- are factors that may affect the relevance and reliability of financial accounting information.  Timeliness  Cost-Benefit  Materiality  Balance between relevance and reliability Timeliness – requires that the accounting information must be available or communicated early enough when a decision is to be made. Cost-benefit – the benefit derived should exceed the cost incurred in obtaining the information. Materiality – information is material if its omission or misstatement could influence the economic decision of the users taken on the basis of the financial statements. Factors of materiality: SIZE OF THE ITEM & NATURE OF THE ITEM Balance between relevance and reliability – in achieving a balance between relevance and reliability, the overriding consideration is how best to satisfy the economic decision making needs of the users. RECOGNITION is a term, which means the process of reporting an asset, liability, income or expense on the face of the financial statements of an enterprise. In other words, it involves the inclusion of peso amount in the enterprise’s financial statements. Elements of Financial Statements  Assets  Liabilities  Equity  Revenue  Expenses Assets are resources controlled by the entity as a result of the past transactions or events and from which future economic benefits are expected to flow to the entity. Liabilities are present obligations of the entity arising from past transactions or events the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. Equity is the residual interest in the assets of the entity after deducting all of its liabilities. Income is increase in economic benefit during the accounting period in the form of inflow or increase in asset or decrease in liability that results in increase in equity, other than contribution from equity participants. Expense is decrease in economic benefit during the accounting period in the form of an outflow or decrease in asset or increase in liability that results in decrease in equity, other than distribution to equity participants. Four Main Recognition Principles ASSET RECOGNITION PRINCIPLE LIABILITY RECOGNITION PRINCIPLE EVENUE RECOGNITION PRINCIPLE EXPENSE RECOGNITION PRINCIPLE Asset Recognition Principle: Asset is recognized when it is probable that future economic benefits will flow to the entity and the asset has a cost or value that can be measured reliably. Inherent in asset recognition is the COST PRINCIPLE, which means that assets should be recorded initially at original acquisition cost. Liability Recognition Principle: Liability is recognized when it is probable that an outflow of resources embodying economic benefits will be required for the settlement of a present obligation and the amount of the obligation can be measured reli Income Recognition Principle: The basic principle is that income should be recognized when earned. Income is recognized when it is probable that an increase in an asset or a decrease in a liability has arisen and that the increase in economic benefits can be measured reliably. Revenue arises in the course of the ordinary regular activities of an entity and is referred to by a variety of different names. Gains represent other items that meet the definition of income and do not arise in the course of the ordinary regular activities of an entity. Revenue from Sale of Goods PAS 18 on revenue provides the ff. conditions:  The entity has transferred to the buyer the significant risks and rewards of ownership of goods  The entity retains neither continuing managerial involvement nor effective control over the goods sold  The amount of revenue can be measured reliably  It is probable that economic benefits associated with the transactions will flow to the entity.  The costs incurred or to be incurred in respect of the transaction can be measured reliably. Exceptions to the Point of Sale  Installment method – point of collection. Amount of revenue equals gross profit rate times amount of collections.  Cost recovery or sunk cost method – point of collection, all collections are first applied to the costs of merchandise sold.  Cash method – revenue is recognized when received regardless of when earned.  Percentage of completion method – when the outcome of a construction contract can be estimated reliable, contract revenue and contract costs associated with the construction contract shall be recognized as revenue and expenses respectively, by reference to the stage of completion of the contract activity.  Production method – point of production. Expense Recognition Principle: This means that expenses are recognized when incurred. Expenses are recognized when it is probable that a decrease in future economic benefits related to decrease in an asset or an increase in liability has occurred and that the decrease in economic can be measured reliably. Expenses encompass losses as well as those expense that arise in the course of the ordinary regular activities of the entity. Matching principle requires that those costs and expenses are incurred in earning a revenue should be reported in the same period. There should be simultaneous or combined recognition of the revenues and expenses that result directly from the same transactions and events. THREE APPLICATIONS OF MATCING PRINCIPLE  Cause and Effect Association Principle – expense is recognized when the revenue is already recognized.  Systematic and Rational Allocation Principle – some costs are expensed by simply allocating them over the periods benefited.  Immediate Recognition Principle – costs are expensed outright. MEASUREMENT OF ELEMENTS Measurement is the process of determining the monetary amounts at which the elements of financial statements are to be recognized and carried in the balance sheet or statement of financial position and income statement. DIFFERENT MEASUREMENT BASES a. Historical Cost – amount of cash or cash equivalents paid or fair value of the consideration given to acquire an asset at the time of acquisition b. Current Cost – amount of cash or cash equivalent that would have to be paid if the same or equivalent asset was acquired currently c. Realizable Value – amount of cash or cash equivalent that could currently be obtained by selling the asset in an orderly disposal. d. Present Value – is the discounted value of future net cash inflows that the item is expected to generate in the normal course of business. CAPITAL MAINTENANCE The performance of an entity is determined using two approaches, namely:  Transaction approach – traditional preparation of income statement  Capital maintenance approach – net income occurs only after the capital used from the beginning of the period is maintained. Net income is the amount an entity can distribute to its owners and be as well off at the end of the year as at the beginning. 2 CONCEPTS OF CAPITAL MAINTENANCE 1. Financial Capital (based on historical cost) – absolute monetary value of the net assets contributed by shareholders and the value of the increase in net assets resulting from earnings retained by the entity. 2. Physical Capital (measured at current cost) – quantitative measure of the physical productive capacity to produce goods and services.