CFAS_The Conceptual Framework for Financial Reporting.pdf

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...

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 even more onerous—it  Whatever remains after I depreciate the means that it increases interest rates or part of the laptop is now the shortening of the term or some other carrying/book value of the laptop contractual changes that will affect the value of the liability must be reflected (b) Payments received that extinguish part or all of the asset (d) Accrual of interest to reflect any financing component Example: o Like in the asset, we must also recognize  I sold a particular asset. That asset is no the related accrued interest on a liability longer part of my business. And so, I that remains unpaid have to derecognize this.  The measurement of financial assets and financial (c) Impairment liabilities initially at historical cost and subsequently o When an asset is impaired, there is a considering subsequent changes due to interest, right down happening in the value of an receipts or payments and impairment, is in effect asset because probably there has been applying and arriving at the financial asset's or changes that renders the price of an financial liability's amortized cost. asset to lower o This is because we’ve been adjusting the value 10 | P a g e  o We recognize a liability or an asset at historical  It is not derived, even in part, from the price of the cost, but as we adjust, we arrived at the transaction or other event that gave rise to the asset amortized cost or carrying value of the asset or or liability. liability  Current value measurement includes the following  The amortized cost of a financial asset or financial basis: liability reflects estimates of future cash flows, o fair value discounted at a rate determined at initial recognition. o value in use (for assets) and fulfillment value (for liabilities)  Historical cost is likely to provide useful information o current cost for assets that produce cash flows indirectly, by being used singly or in combination with other resources to produce and market goods and services. FAIR VALUE  As the asset or part of the asset is consumed, sold, or impaired, that asset (or portion of it) is recognized  It is the price that would be received to sell an asset, as expense in profit or loss. or paid to transfer a liability, in an orderly transaction between market participants to which the entity has Example: access at the measurement date.  As the economic benefit is derived from the use of o How much did you buy it in the market today property, plant and equipment, a portion of its cost at an arms length transaction? is transferred to profit or loss in the form of o How much you paid for a liability at the depreciation. measurement date or date when the  The cost of a portion of inventory is transferred to transaction occurred? expense in the period that the goods are sold.  It reflects the perspective of market participants  Because as you consume your asset, you consume (buyer and seller) acting in their economic best it to generate sale—for you to generate sale, you interest. must incur cost and that cost of asset is found in o The seller would always want to sell the item depreciation or asset at price he wants, while the buyer  The cost of a portion of the inventory, which is the would want a cheaper price—when there is a asset will eventually transfer to expense in the meeting of the minds between the 2 and it period that the goods are sold. becomes at an arm’s length transaction, there  From inventory which was already sold, you will is now a sale, as they acted on their best see the corresponding amount in cost of goods interests. sold account.  Fair value may be observed directly for assets and  Debit = COGS | Credit = Inventory liabilities with active market, or indirectly if the asset or liability does not have active market.  For financial assets and liabilities that are managed o Being sold in the market right now principally to collect contractual cash flows consisting o Fair value may be observed directly using solely of principal and interest, the use of amortized market prices of the asset/liability in an active cost may provide relevant information that can be market. used to derive the interest earned or interest  In the latter case, some measurement techniques will incurred. have to be applied, such as cash-flow measurement  Historical cost is a measurement basis that may be techniques, that reflect the following factors: readily verified; however, it may not support (a) Estimates of future cash flows comparability of information across enterprises as the (b) Possible variations in amounts or timing carrying amounts of assets with identical economic (c) The time value of money benefits may be measured at amounts based on (d) Risk premium or risk discount (the price of prices at different acquisition dates. bearing uncertainty in the cash flows) o You may use historical cost but lose the (e) Other factors, such as enterprise liquidity. comparability, especially when you purchase same type of asset at different acquisition Example: dates  The fair value of the glass is P35—because it is an o As we know price of these financial asset that has active market instruments, they also update over time  If it is an asset or liability that doesn’t have directly active market, you have to go to collectors, or sell it in museums or galleries. CURRENT VALUE  Even the valuation of that specific asset is actually dependent on the factors that you have described  It is a measurement basis that uses information and not just the condition of the item. updated to reflect conditions at the measurement date. 11 | P a g e  Fair value is not increased or decreased by  They consider estimates of future cash flows, possible transaction costs and does not consider the variations in amounts or timing, time value of money, transaction costs on the disposal of asset or risk premium or risk discount, and such other factors settlement of the liability. that reflect entity-specific assumptions. o In historical cost, there is an adjustment for o Value in use and fulfillment are very entity- transaction cost. specific o But in fair value, we do not consider o When we calculate them, it varies per entity transaction cost as an adjustment that arose depending on the factors that the entity when you dispose of the asset of settle the established that applies to them liability VALUE IN USE AND FULFILLMENT VALUE CURRENT COST  The value in use of an asset is the present value of  The current cost of an asset is the cost of an the cash flows or other economic benefits that an equivalent asset at the measurement date plus the entity expects to derive from the use and eventual transaction costs that would be incurred at that date. cost of the assets. o It is the cost of an equivalent asset at the o Value in Use = Asset measurement date comprising the transaction o As long as it’s in your possession or the value cost of that particular asset as you use it or as you o e.g., the book’s current cost or market value is derive it—entity specific value. P800. I have incurred an additional P55 to the o Value in use (or fulfilment value) is defined as book shipped to me. The current cost of the an entity-specific value, and remains as the book P55. My current cost will become my present value of the cash flows that an entity historical cost at measurement date. I’m expects to derive from the continuing use of an reviewing that as time goes by as I use this, or asset and its ultimate disposal. if this book is still relevant to me—that value is o Current cost is different from fair value and going to be considered in subsequent value in use, as current cost is an entry value. measurement periods o If you really want to measure the asset to your  The current cost of a liability is the consideration that company, then you estimate it—how long is it would be received minus the transaction costs that serviceable? How long it will be useful to me?— would be incurred for an equivalent liability at the estimate the future value that it will bring to measurement date. the company and discount it in the present  We use current value when the value of the asset is value. sensitive to market factors or other risks, the most o Therefore, whatever is the present value of the relevant information is provided by measuring the total benefits you can possibly get from this asset or liability at fair value if such can be directly particular asset—the value in use observable, or value in use or current cost if the value  The fulfillment value of a liability is the present value cannot be directly observed. of cash or other economic resources that an entity o If the asset or liability we have is very expects to be obliged to transfer to the counterparty susceptible to market factors (Konting galaw and other parties as it fulfills the liability. lang, nagbabago) o Fulfillment Value = Liability o e.g., You own a gasoline station. Your o If you have a debt and you want to settle. The inventory evaluation will fluctuate because settlement of debts spans years. The value of later on, there are market factors that will the money changes because the value of P10M affect the value of crude oil and coal. So you today is different value with P10M 10 years use fair value if you can directly observe or from now. obtain the price. If you cannot do so, you use o What you have to pay up to the time we the value in use or current cost. extinguish the asset must also be discounted  This type of measurement basis is applicable for to the present value in order for us to get the assets and liabilities that produce cash flows directly fulfillment value of the liability as of the (those that can be sold independently). recording date, and later on change it—  Thus, financial assets that are held for trading, because the value of asset and liability financial assets that are held for sale, and assets that changes. are held for capital appreciation or for leasing out to others based on market rentals, are preferably  Value in use and fulfillment value include the present measured at current value. value of transaction costs relating to ultimate o e.g., If you buy stocks from trading, how will disposal of asset or fulfilling the liability. you measure? The current cost of that 12 | P a g e  particular stock is the price when you actually  At initial recognition, the cost of an asset acquired or bought it. of a liability incurred is normally like fair value at that o e.g., If your market rental building is located in date, unless transaction costs are significant. BGC, what is the prevailing price of that o You will always initially measure at fair value building when you bought it. whatever asset have acquired—how much did  The use of fair value involves low cost as the fair you pay for to acquire the asset. And you add value can be directly observed and can enhance both depending on the significance of transaction comparability from period to period for a reporting cost to the initial measurement/fair value entity and comparability for a single period across  The measurement basis after initial recognition is entities. normally the same measurement basis at initial o There is no much cost in determination of asset recognition—because you want to use uniform basis and liability and try to use it in fair value. Since  Using uniform basis at initial recognition and it is readily available, you can get it in the subsequent measurement avoids recognizing income market, and it is comparable to your own or expense at the time of the first subsequent internal financial data. measurement solely because of a change in  On the other hand, value in use and fulfillment value measurement basis. could provide different measures for identical assets o If we measure our asset and liability at fair and liabilities of different entities, because such value—we can no longer change it because it measures are entity-specific rather than market- will result to inconsistency, therefore you based, thus the information may not be comparable. cannot compare. o The measurement will depend per entity o The change in measurement basis does not because the estimation is up to the entity and merit the recognition of an additional income they will have to adjust depending the entity or expenses has establish that needs to incorporate and the o We want to preserve the uniformity of the data calculation. presented in a FS o Information may not be comparable  When an asset or liability is measured at cost, no  In addition, the use of valuation techniques may be income or expenses arise at initial recognition, unless costly and more complex, using inputs that may be income and expenses arise from the derecognition of subjective and arbitrary, thus also reducing the transferred asset or liability (through sale or verifiability. exchange), or unless the asset is impaired, or the o The information when we speak of use in value liability is onerous. or fulfillment value is quite subjective o “at cost” = cost price/without profit to seller depending in what the company feels or other o Whatever is the price in active market that is factors they feel should be integrated or what your cost. valuation technique should be use. o The time we actually recognize gains or losses  Therefore, the use of value in use and fulfillment  In some instances, an asset or liability does not have value reduces verifiability. a "cost" because they are acquired or incurred as a  Entry values are measurement bases on the date of result of condonation, donation, legislation or acquisition, creation or incurrence. Following this regulation, or penalty. definition, historical cost and current cost are entry o If the debt is too onerous and condone, the values. company has decided to extinguished the debt o Historical cost and current cost are considered by condonation—they are not claiming on the entry values. liability o Pagkagawa ng pagkagawa ng liability or  In such cases, the fair value or its equivalent pagkabili na pagkabili—that is the entry point determined through measurement techniques, is its of the transaction (the recording of the asset deemed cost. Any difference between this deemed or the liability) cost and any consideration given or received (which o Entry value is using historical cost or current presumably is nominal or zero), is recognized as cost income or expense.  Exit values are measurement bases on the date of o If you have received an asset that has been measurement or the date after acquisition or donated or acquired through legislation—there incurrence, disposal or settlement. Thus, per is no concrete basis fair value or cost, you will definition, value in use and fulfillment values are exit use fair value. values. o e.g., Farmland given by DAR and acquired it by o The reporting date legislation. In particular land, how much it o Value in use and fulfillment values = exit usually sell for? If you don’t want to canvas the values prices of similar lands, you can use a measurement technique that is established, therefore, you determine the deemed cost. INITIAL AND SUBSEQUENT MEASUREMENT 13 | P a g e  In some cases, there may be differences in (b) Achieving comparability within an enterprise measurement bases used in presenting information for two different reporting periods and in the statement of financial position and in the comparability across enterprises for a single recognized income and expenses in profit or loss. reporting period o For example, financial assets held for sale are  It is not just about following the rules or the measured at fair value in the statement of prescribed presentation. We want to give the entities financial position, because fair value is the the flexibility to choose and provide the relevant most relevant measurement basis. information that we want to highlight to the users.  e.g., You bought a glass for sale, you capital for that  But they also must also consider the comparability of asset is just the fair value—kung magkano mo siya the financial reports that they are making, because nabili—that is your measurement basis the financial statements must serve the purpose of  The total income relating to the asset during the many different users—general purpose reporting period is separated and classified into: (a) The statement of profit or loss on the basis of amortized cost. CLASSIYING INFORMATION (b) The statement of other comprehensive  It is necessary to classify the FS elements based on income for the remaining component of shared characteristics, such as nature of the item, its income. functions within the business activities, and how it is  It depends on what portion you will report it. There measured. are cases that the proceeds of the sale of the glass,  Classification is the sorting od assets, liabilities, a portion of it will be shown in your income statement equity, income, or expenses on the basis of shared as current gains. While the rest, it will be shown in characteristics for presentation and disclosure another portion of the statement of comprehensive purposes income.  Classifying dissimilar assets, liabilities, equity, income, and expenses can obscure relevant PRESENTATION AND DISCLOSURE information, reduce understandability and comparability, and may not provide a faithful  This tackles the details on how we should be representation of financial information presenting and disclosing information that do not  Classification of assets and liabilities: merit the recognition on the face of the financial (a) Current statements. (b) Non-Current  An entity reports its financial position and financial performance and other financial information in its  Income and expenses are classified and presented financial statements. either in:  Such information must both be relevant and faithfully (a) Profit or loss OR represented and requires: (b) Other comprehensive income (1) Focusing on presentation and disclosure objectives and principles rather than on rule  If it is related to the main business line, it is  you must focus on the presentation or the included in the statement of profit and loss things significant to the decision making  If it is not related to the main business line, it is that these users of the financial included in other comprehensive income statements will make (2) Classifying information in a manner that  The statement of profit or loss is the primary source groups similar items and separate dissimilar of information about an entity’s financial items performance.  FS must be organized (3) Aggregating information to make it not  Offsetting is deducting an item from another item of obscured either by unnecessary detail or by different kind to arrive at a net amount. excessive aggregation. o It occurs when, say, presenting a net amount for both an asset and a liability. o Offsetting is generally not appropriate because OBJECTIVES it classifies dissimilar items together. o e.g., You have receivable from ABC company  An entity must communicate effectively the information in financial statements to its intended worth P500,000. You also have a liability to company ABC worth P300,000. You believe users. that to arrive at the net amount, you will sum  In so doing, balance is needed between: (a) Giving entities flexibility to provide relevant them up. You offset it and so, you will only present P200,000 as receivable—because and faithfully represented financial statement elements 14 | P a g e  technically, based on the numbers, that is the  The physical productive capacity may be based only amount you will owe. on, for example, units of output per day or o Not Appropriate because “accounts receivable” physical capacity of productive assets to produce and “accounts payable” are different goods and services  This means that similar items should be classified  If you want to see the operating capacity or how together and dissimilar items should be separated far your business can operate, you view the  However, changes in the current value of recognized capital of the business as the operating assets or liabilities are also relevant and are capacity—because you can only operate up to the presented as part of other comprehensive income extent that you have in terms of capital, in terms until such time that such changes in value are of the asset that you have, or in terms of the realized and are, therefore, transferred to profit or money that you have infused in the business. loss.  It requires the use of current cost as o Unrealized gains and losses = statement of measurement basis. comprehensive income  The physical concept of capital is to be used when o Realized gains and losses = statement of profit the users of information are more concerned and loss about the operating capability of the enterprise.  There are certain exemptions, however, that the (the resource or fund needed to achieve that IASB considers it best not to subsequently recycle operating capability or capacity) other comprehensive income elements to profit or  Physical capital consists of tangible, human- loss made objects that a company buys or invests in  It may be necessary to present different components and uses to produce goods. of equity in the financial statements to provide useful o You view your capital as the machinery or information about the sources of equity components the things you buy (i.e. raw materials for and legal and regulatory requirements affecting such your product, investments to produce the components. goods and service)  Physical capital items, such as manufacturing equipment, also fall into the category of fixed AGGREGATION capital, meaning they are reusable, and not consumed during the production process.  Aggregation is the adding together of similar financial statement elements that have shared characteristics and are included in the same classification.  The process of aggregation summarizes large volumes of detail; hence information is not obscured by so many details. Financial Concept of Capital  Important details will reside in the notes to financial  Under this concept, capital is synonymous with statements. net assets or equity of the enterprise. o Aggregation is the totality of the line item. o Net Assets = assets less liability (= equity) o e.g., Cash line item – all cash accounts (cash  It does not require the adoption of a specific in the bank account, on hand, in petty cash, measurement basis, instead the measurement cash equivalents, etc.) basis used depends on the financial capital the o so if the users of the financial statement would entity seeks to maintain. like to see the details of that, they will go to  Under the financial concept of capital, financial the Notes to FS capital can be measured in either nominal monetary units or units of constant purchasing power. CONCEPTS OF CAPITAL o Nominal Monetary Units = what is the face value?  The reporting entity should select the appropriate o Units of Constant Purchasing Power = what cost of capital based on the information needs of the is the value of this particular asset or users. liability when you add inflation?  It may be viewed based on either of the following concepts:  The concept of capital shall be used when the Physical Concept of Capital users of financial statements are primarily concerned with the maintenance of nominal  The capital is viewed as the operating capacity of invested capital or the purchasing power of the enterprise. invested capital.  It is the quantitative measure of the physical o how much can my investment buy? productive capacity to produce goods and o How much is my actual investment in the services business? 15 | P a g e  o We adapt the financial concept of capital treated as a capital adjustment, hence taken to equity. o Purchasing Power Units = the difference CONCEPTS OF CAPITAL MAINTENANCE between the general inflation and increase in price in assets = profit  The capital maintenance concept views profits as excess of capital at the end of the accounting period o Capital Adjustment = changes due to purchasing power (the rest of the increase) = over the capital at the beginning of the period, after equity excluding the effects of contributions from and distributions to the owner’s during the reporting  This does not require the use of a particular basis of measurement period. o Profit = Equity (ending) – Equity (beginning)  It is concerned with how an entity defines the capital that it seeks to maintain PHYSICAL CAPITAL MAINTENANCE CONCEPT  What you used for the business and you made more than you actually infused in it—the excess is profits.  Under the physical capital maintenance concept, The profits is added to the equity section and exclude there is profits only if the physical productive capacity any drawings/distributions to the owner in the form (or operating capability) of the entity (or the of dividends. resources of funds needed to achieve that capacity)  It i