Conceptual Framework And

Accounting Standards

Marian G. Magcalas, CPA, MBA

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 MODULE 1

OVERVIEW OF ACCOUNTING

Lesson 1 Definition of Accounting (Millan, 2018)

Accounting is the “process of identifying, measuring and communicating

economic information to permit informed judgments and decisions by users of the
information.” (American Association of Accountants)

Three important activities included in the definition of accounting:

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 1. Identifying
2. Measuring
3. Communicating

Identifying
Identifying is the process of analyzing events and transactions to determine
whether or not they will be recognized (Millan, 2018).
 Recognition refers to the process of including the effects of an accountable event
in the statement of financial position or the statement of comprehensive income
through a journal entry.
Only accountable events are recognized (journalized). An accountable event is
one that affects the assets, liabilities, equity, income or expenses or an entity. It is
also known as economic activity, which is the subject matter of accounting.
Non-accountable events are not recognized but disclosed only in the notes, if
they have accounting relevance. The disclosure only in the notes is not an
application of the recognition process.

Types of events or transaction(Millan, 2018)

A. External events- are events that involve an entity and another external
party.
Types of external events:
1. Exchange (reciprocal transfer)- an event wherein there is a reciprocal giving and
receiving of economic resources or discharging of economic obligations between an
entity and an external party.
Ex. Sale, purchase, payment of liabilities, receipt of notes receivable in
exchange for accounts receivable, collection of receivables, etc.

2. Non-reciprocal transfer- is a “one way” transaction in that the party giving something
does not receive anything in return while the party receiving does not give anything in
exchange.
Ex. Donations, gifts or charitable contributions, payment of taxes, imposition of
fines, theft, provision of capital by owners,etc. and the like.

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 3. External events other than transfer- an event that involves changes in the economic
resources or obligations of an entity caused by an external party or external source but
does not involve transfers of resources or obligations.
Ex. Changes in fair values and price levels, obsolescence, technological
changes, etc.

A. Internal events– are events that do not involve an external party.

Types of internal events

1. Production- the process by which resources are transformed into finished

goods. Ex conversion of raw materials into finished products, production of
farm products, etc.
2. Casualty- an unanticipated loss from disasters and other similar events. Ex
loss from fire, flood, earthquakes and other catastrophes.

Measuring
Measuring involves assigning numbers, normally in monetary terms, to the
economic transactions and events.
Several measurement bases used in accounting, include, but not limited
to(Millan, 2018):
1. Historical cost
2. Fair value
3. Present value
4. Realizable value
5. Current cost
6. Sometimes inflation-adjusted cost

The most commonly used is historical costs, which is usually combined with the
other measurement bases. Accordingly, financial statements are said to be prepared using
mixture of costs and values.
Costs include historical cost and current cost while values include the other
measurement bases.

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 Valuation by fact or opinion(Millan, 2018)
The use of estimates is essential in providing relevant information. Thus, financial
statements are said to be a mixture of fact and opinion.
When measurement is affected by estimates, the items measured are said to
be valued by opinion. Examples:
1. Estimates of uncollectible amounts of receivables.
2. Depreciation and amortization expenses, which are affected by
estimates of useful life and residual value.
3. Estimated liabilities, such as provisions.
4. Retained earnings, which is affected by various estimates of
income and expenses.

When measurement is unaffected by estimates, the items measured

are said to be valued by fact. Examples:
1. Ordinary share capital at par value
2. Land stated at acquisition cost
3. Cash measured at face amount

Communicating
Communicating is the process of transforming economic data into
useful accounting information, such as financial statements and other
accounting reports, for dissemination to users. It also involves interpreting the
significance of the processed information (Millan, 2018).

The communicating process of accounting involves three aspects:

1. Recording- refers to the process of systematically committing into writing the

identified and measured accountable events in the journal through journal
entries.
2. Classifying- involves the grouping of similar and interrelated items into their
respective classes through posting in the ledger.

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 3. Summarizing- putting together or expressing in condensed from the recorded
and classified transactions and events. This includes the preparation of
financial statements and other accounting reports.

Interpreting the processed information involves the computation of financial

statement ratios. Some regulatory bodies, such as the Bangko Sentral ng Pilipinas
(BSP), require certain financial ratios to be disclosed in the notes to the financial
statements.

Lesson 2. Basic Purpose of Accounting (Millan, 2018)

The basic purpose of accounting is to provide information that is useful in

making economic decisions. The financial statements are one of the sources of
information used when making economic decisions. Other sources may include
current events, industry publications, internet resources, professional advices, expert
systems, etc.

Economic entities use accounting to record economic activities, process data,

and disseminate information intended to be useful in making economic decisions. An
economic entity is separately identifiable combination of persons and property that
uses or controls economic resources to achieve certain goals or objectives. An
economic entity may either be:
a. Not-for-profit entity- one that carries out some socially desirable needs of
the community or its members and whose activities are not directed
towards making profit; or
b. Business entity- one that operates primarily for profit.

Economic activities are activities that affect the economic resources (assets)
and obligations (liabilities), and consequently, the equity of an economic entity.
Economic activities include (Millan, 2018):

1. Production- process of converting economic resources into outputs of goods and

services that are intended to have greater utility than the required inputs.
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 2. Exchange- the process of trading resources or obligations for other resources or
obligations.
3. Consumption- the process of using the final output of the production process.
4. Income distribution- the process of allocating rights to the use of output among
individuals and groups in society.
5. Savings- the process of setting aside rights to present consumption in exchange for rights
to future consumption.
6. Investment- the process of using current inputs to increase the stock of resources
available for output as opposed to immediately consumable output.

Types of information provided by accounting (Millan, 2018)

1. Quantitative information- information expressed in numbers, quantity, or units.
2. Qualitative information- information expressed in words or descriptive form. Qualitative
information is found in the notes to financial statements as well as on the face of the other
financial statements.
3. Financial information- information expressed in money. Financial information is also quantitative
information because monetary amounts are normally expressed in numbers.

Types of accounting information classified as to users’ needs Millan, 2018)

1. General purpose accounting information- designed to meet the common needs of most
statement users. This information is provided under financial accounting. General purpose
information is governed by generally accepted accounting principles (GAAP) represented by
the Philippine Financial Reporting Standards (PFRSs).
2. Special purpose accounting information- designed to meet the specific needs of particular
statement users. This information is provided by other types of accounting other than
financial accounting, e.g., managerial accounting, tax basis accounting.

Sources of information in financial statements (Millan, 2018)

Information in the financial statements is not obtained exclusively from the entity’s
accounting records. Some are obtained from external sources. For example, fair value
measurements, resolutions of uncertainties, future lease payments, and contractual
commitments are only a few of the information presented in the financial statements that are
derived from external sources.

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 Accounting as science and art (Millan, 2018)
1. As a social science, accounting is a body of knowledge which has been
systematically gathered, classified and organized.
2. As a practical art, accounting requires the use of creative skills and judgment.

Accounting as an information system (Millan, 2018)

Accounting indentifies and measures economic activities, processes
information into financial reports, and communicates these reports to decision
makers.

Accounting as a language of business (Millan, 2018)

Accounting is often referred to as a “language of business” because it is
fundamental to the communication of financial information.

Creative and critical thinking in accounting (Millan, 2018)

The practice of accountancy requires the exercise of creative and critical thinking.
a. Creative thinking- involves the use of imagination and insight to solve problems by finding new
relationships (ideas) among items of information. It is most important in identifying alternative
solutions.
b. Critical thinking- involves the logical analysis of issues, using inductive or deductive reasoning to
test new relationships to determine their effectiveness. It is most important in evaluating alternative
solutions.

Creative skills and judgment are exercised in problem solving. The following are the
steps in problem solving:
1. Recognizing the problem
2. Identifying alternative solutions
3. Evaluating the alternatives
4. Selecting a solution from among the alternatives
5. Implementing the solution
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 Lesson 3. Accounting Concepts (Millan, 2018)

Accounting concepts refer to the principles upon which the process of accounting
is based. The term “accounting concepts” is used interchangeably with the following
terms:

• Accounting assumptions (Accounting postulates)- are the fundamental concepts or

principles and basic notions that provide the foundation of the accounting process.
• Accounting theory- is logical reasoning in the form of a set of broad principles that
1). Provide a general frame of reference by which accounting practice can be
evaluated and
2). Guide the development of new practices and procedures.

It is the organized set of concepts and related principles that explain and guide the
accountant’s action in identifying, measuring, communicating accounting information.
Accounting theory comprises the Conceptual Framework and the Philippine Financial Reporting
Standards (PFRSs).

Most accounting concepts are derived from the Conceptual Framework and the
Philippine Financial Reporting Standards (PFRSs). However, some accounting concepts are
implicit, meaning they are not expressly stated in the framework or PFRSs but are generally
accepted because of their long-time use in the profession.

Examples of accounting concepts (Millan, 2018):

1. Double-entry system- each accountable event is recorded in two parts- debit and credit.

2. Going concern assumption- the entity is assumed to carry on the operations for an
indefinite period of time. Meaning, the entity does not expect to end its operations in the
foreseeable future. The measurement basis involving mixture of costs and values is
appropriate only when the entity is a going concern. If the entity is a liquidating concern,

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 the appropriate measurement basis is realizable value, i.e., estimated selling price less
estimated costs to sell for assets and expected settlement amount for liabilities.

3. Separate entity (Accounting entity/Business entity concept/Entity concept- the entity is

viewed separately from its owners. Accordingly, the personal transactions of the owners
among themselves or with other entities are not recorded in the entity’s accounting
records. This concept defines the area of interest of the accountant.

4. Stable monetary unit (Monetary with assumption)

a. Assets, liabilities, equity, income and expenses are stated in terms of a
common unit of measure, which is the peso in the Philippines.
Accounting information should be stated in a common denominator.
Amounts in foreign currency shall be translated into peso.
b. The purchasing power of the peso is regarded as stable or constant
and that its instability is insignificant and therefore ignored.

5. Time period (Periodicity/Accounting period)- the life of the entity is divided

into series of reporting periods. An accounting period is usually 12 months
and may either be a calendar year or a fiscal year period. A calendar year
period starts on Janunary 1 and ends on December 31 of that same year.
A fiscal year period also covers 12 months but starts on a date other than
January 1.

6. Materiality concept- information is material if its omission or misstatement

could influence economic decisions. Materiality is a matter of professional
judgment and is based on the size and nature of an item being considered.

7. Cost-benefit (Cost constraint/Reasonable assurance)- the cost of

processing and communicating information should not exceed the benefits
to be derived from it.
8. Accrual basis of accounting- the effects of transactions and other events
are recognized when they occur (and not as cash is received or paid) and

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 they are recorded in the accounting records and reported in the financial
statements of the periods to which they relate.
Under accrual basis, income is recognized when earned rather
than when cash is collected and expenses are recognized
when incurred rather than when cash is paid.

9. Historical cost concept (Cost principle)- the value of an asset is determined

on the basis of acquisition cost.
This concept is not always maintained. Some PFRSs require
the departure from this concept, such as when inventories are
measured at net realizable value (NRV) rather than at cost
when applying the “lower of cost and NRV” measurement.

10. Concept of articulation- all of the components of a complete set of financial

statemens are interrelated. The preparation of a worksheet (and the
eventual completion of the financial statements) recognizes that the
financial statements are fundamentally interrelated and interact with each
other. Accordingly, when users use the financial statements in making
decisions, they need to use each financial statement in conjunction with
the other financial statements.
For example, when evaluating an entity’s ability to generate
future cash flows, all financial statements should be used and
not only the statement of cash flows.
- Receivables and payables in the statement of financial position provide
information on expected cash receipts and cash disbursements in future
periods.
- Information on income and expenses in the statement of profit or loss and other
comprehensive income provides information on the entity’s ability to generate
cash flows from its operations.
- Information on issued and unissued shares in the statement of changes in
equity provides information on the availability of equity financing.
- Information on historical changes in cash and cash equivalents in the statement
of cash flows helps users assess future resources and uses of funds.

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- The notes to financial statements provides information on the quality of
earnings, e.g. whether income or expenses are realized or unrealized or
whether they are recurring or non-recurring.

12. Full disclosure principle- this principle recognizes that the nature and
amount of information included in the financial statements reflect a series
of judgmental trade-offs. The trade-offs strive for:
a. Sufficient detail to disclose matters that make a difference to users, yet
b. Sufficient condensation to make the information understandable
keeping in mind the costs of preparing and using it.

13. Consistency concept- the financial statements are prepared on the basis
of accounting principles that are applied consistently from one period to
the next. Changes in accounting policies are made only when required or
permitted by the PFRSs or when the change results to more relevant and
reliable information. Changes in accounting policies are disclosed in the
notes.

14. Matching (Association of cause and effect)- costs are recognized as

expenses when the related revenue is recognized.

15. Entity theory- the accounting objective is geared towards proper income
determination. Proper matching of costs against revenues is the ultimate
end. This theory emphasizes the income statement and is exemplified by
the equation: “Assets = Liabilities + Capital”
16. Proprietary theory- the accounting objective is geared towards the proper
valuation of assets. This theory emphasizes the importance of the balance
sheet and is exemplified by the equation:
“Assets – Liabilities = Capital”

17. Residual equity theory- this theory is applicable when there are two
classes of shares issued, i.e., ordinary and preferred. This equation is

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 “Assets – Liabilities – Preferred Shareholders’ Equity = Ordinary
Shareholders’ Equity”.
This theory is applied in the computation of book value per share
and return on equity.

18. Fund theory- the accounting objective is neither proper income

determination nor proper valuation of assets but the custody and
administration of funds. The objective is directed towards cash flows,
exemplified by the formula “cash inflows minus cash outflows equals
fund”. This concept is used in government accounting and fiduciary
accounting.

19. Realization- the process of converting non-cash assets into cash or claims
for cash. It is also the concept that deals with revenue recognition.
For example, realization occurs when goods are sold for cash or in
exchange for accounts receivable or notes receivable. The goods are
noncash assets and they are converted into cash or, in the case of
receivables, claims for cash.

20. Prudence (Conservatism)- is the use of caution when making estimates

under conditions of uncertainty, such that assets or income are not
overstated and liabilities or expenses are not understated. In other words
when exercising prudence, the one which has the least effect on equity is
chosen.

Lesson 4. Common branches of accounting (Millan, 2018)

1. Financial Accounting- is the branch of accounting that focuses on general purpose

financial statements.
• General purpose financial statements are those statements that cater to the common needs
of a wide range of external users.
• External users are those who do not have the authority to demand financial reports tailored
to their specific needs.
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 Financial accounting is governed by the Philippine Financial Reporting
Standards. (PFRSs)

Financial accounting vs Financial reporting

The term “financial accounting” is often used interchangeably with the term “financial
reporting”. Although, both financial accounting and financial reporting focus on general purpose
financial statements, the latter endeavors to promote principles that are also useful in “other
financial reporting”.
Other financial reporting comprises information provided outside the financial statements that
assists in interpretation of a complete set of financial statements or improves users’ ability to make
efficient economic decisions.

Financial statements vs Financial report

Financial statements are the structured presentation of an entity’s financial position and
results of its operations. They are the end product of the accounting process and the means by
which information gathered and processed are periodically communicated to users (Millan, 2018).
A complete set of financial statements consists of the following:
1. Statement of financial position
2. Statement of profit or loss and other comprehensive income
3. Statement of changes in equity
4. Statement of cash flows
5. Notes
6. Additional statement of financial position (required only when certain instances occur).

A financial report includes the financial statements plus other information provided outside the
financial statements.

Financial reporting involves the provision of financial information about an entity that is useful
in making economic decisions by external users and assessing management’s stewardship.

Primary objectives of financial reporting:

a. To provide information about economic resources, claims to those resources,
and changes in those resources.
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 b. To provide information that is useful in making investment and credit decisions.
c. To provide information that is useful in assessing the amounts and timing of
future cash flows.

Secondary objectives of financial reporting:

d. To provide information useful in assessing management’s stewardship or the
effectiveness of the entity’s management.

2. Management accounting- refers to the accumulation and communication of information for use
by internal users or management. An offshoot of management accounting is management
advisory services which includes services to clients on matters of accounting, finance, business
policies, organization procedures, product costs, distribution, and many other phases of
business conduct and operations.
3. Cost accounting- is the systematic recording and analysis of the costs of materials, labor, and
overhead incident to production.
4. Auditing- is the process of evaluating the correspondence of certain assertions with established
criteria and expressing an opinion thereon.
5. Tax accounting- the preparation of tax returns and rendering of tax advice, such as the
determination of the tax consequences of certain proposed business endeavors.
6. Government accounting- refers to the accounting for the government and its instrumentalities,
placing emphasis on the custody of public funds, the purposes for which those funds are
committed, and the responsibility and accountability of the individuals entrusted with those
funds.
7. Fiduciary accounting- refers to the handling of accounts managed by a person entrusted with
the custody and management of property for the benefit of another.
8. Estate accounting- refers to the handling of accounts for fiduciaries who wind up the affairs of a
deceased person.
9. Social accounting (social and environmental accounting or social responsibility reporting)- the
process of communicating the social and environmental effects of an entity’s economic actions
to the society.
10. Institutional accounting- the accounting for non-profit entities other than the government.
11. Accounting systems- the installation of accounting procedures for the accumulation of financial
data and designating of accounting forms to be used in data gathering.

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12. Accounting research- pertains to the careful analysis of economic events and other variables
to understand their impact on decisions. Accounting research includes a broad range of topics,
which may be related to one or more of the other branches of accounting, the economy as a
whole, or the market environment.

Bookkeeping and Accounting

Bookkeeping refers to the process of recording the accounts or transactions of
an entity. Bookkeeping normally ends with the preparation of the trial balance.
Unlike accounting, bookkeeping does not require the interpretation of the
significance of the processed information.

Accountancy
Accountancy refers to the profession or practice of accounting. The practice of
accounting can be broadly classified into two:
1. Public practice- public practice does not involve an employer
employee relationship.
2. Private practice- involves an employer-employee relationship,
meaning the account is an employee.

Lesson 5. Four sectors in the practice of accountancy (Millan, 2018)

Under RA 9298 also known as “Philippine Accountancy Act of 2004”, the practice of
accounting is sub-classified into the following:
1. Practice of Public Accountancy- involves the rendering of audit or accounting related services
to more than one client on a fee basis.
2. Practice in Commerce and Industry- refers to the employment in the private sector in a
position which involves decision making requiring professional knowledge in the science of
accounting and such position requires that the holder thereof must be a certified public
accountant.
3. Practice in Education/Academe- employment in an educational institution which involves
teaching of accounting, auditing, management advisory services, finance, business law,
taxation, and other technically related subjects.
4. Practice in the Government- employment or appointment in a position in an accounting
professional group in the government or in a government-owned and/ controlled corporation,
including those performing proprietary functions where decision making requires professional
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 knowledge in the science of accounting, or where civil service eligibility as certified public
accountant is a prerequisite.

Accountants practicing under numbers 2 to 4 are considered in private practice.

Lesson 6 Accounting Standards (Millan, 2018)

The Philippine Financial Reporting Standards (PFRSs) represent the generally
accepted accounting principles (GAAP) in the Philippines.
The PFRSs are Standards and Interpretations adopted by the Financial
Reporting Standards Council (FRSC). They comprise:
a. The Philippine Financial Reporting Standards (PFRSs)
b. Philippine Accounting Standards (PASs)
c. Interpretations

PFRSs are accompanied by guidance to assist entities in applying their

requirements. A guidance states whether it is an integral part of the PFRSs. A
guidance that is an integral part of the PFRSs is mandatory.

The need for reporting standards

For financial statements to be useful, they should be prepared using reporting
standards that are generally acceptable. If each entity will develop its own standards,
the financial statements would not be comparable, the risk of fraudulent reporting will
be heightened, and economic decisions based on these financial statements would
be grossly incorrect. For this reason, entities should follow a uniform set of reporting
standards when preparing and presenting financial statements.

The term “generally acceptable” means that either:

1. The standard has been established by an authoritative accounting role
making body, e.g., the PFRSs adopted by the FRSC, or
2. The principle has gained general acceptance due to practice over time and
has been proven to be most useful, e. g., double-entry recording and other
implicit concepts.

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 The process of establishing financial accounting standards is a democratic
process in that a majority of practicing accountants must agree with a standard before
it becomes implemented.

Hierarchy of Reporting Standards (Millan, 2018)

When selecting the accounting policies, an entity considers the following in descending
order:
1. Philippine Financial Reporting Standards (PFRSs)
2. In the absence of a PFRSs that specifically applies to a transaction or event, management
shall use its judgment in developing and applying an accounting policy that results in
information that is relevant and reliable.

In making the judgment:

1. Management shall refer to, and consider the applicability of, the following sources in
descending order:
a. The requirements in PFRSs dealing with similar and related issues.
b. The Conceptual Framework.
2. Management may also consider the following:
a. Pronouncements of other standard-setting bodies.
b. Accounting literature and accepted industry practices.

Although the selection of appropriate accounting policies is the responsibility

of the entity’s management, the proper application of accounting principles is most
dependent upon the professional judgment of the accountant.

Accounting standard setting bodies and other relevant organizations (Millan, 2018)
1. Financial Reporting Standards Council (FRSC)- is the official accounting standard
setting body in the Philippines created under the Philippine Accountancy Act 2004
(R.A. No. 9298)
The FRSC us composed of fifteen (15) individuals- a chairperson who
had been or presently a senior accounting practicioner in any of the scope of
accounting practice and fourteen (14) representative members.
Chairperson 1

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 Fourteen representative members from:
Board of Accountancy (BOA) 1
Commission on Audit (COA) 1
Securities and Exchange Commission (SEC) 1
BangkoSentral ng Pilipinas (BSP) 1
Bureau of Internal Revenue (BIR) 1
A major organization composed of preparers
and users of financial statements 1
Accredited National Professional Organization
Of CPAs (i.e. PICPA)
Public Practice 2
Commerce and Industry 2
Academic/Education 2
Government 2 8 1
4

Total 1
5

(Rules and Regulations Implementing R.A. 9298, Sec 9(A).)

2. Philippine Interpretations Committee (PIC)- is a committee formed by the

Accounting Standards Council (ASC), the predecessor of FRSC, with the role of
reviewing the interpretations of the International Financial Reporting
Interpretations Committee (IFRIC) for approval and adoption by FRSC.

3. Board of Accountancy (BOA)- is the professional regulatory board created under

R.A. No. 9298 to supervise the registration, licensure and practice of accountancy
in the Philippines. The BOA consists of a chairperson and six(6) members
appointed by the President of the Philippines. The Board shall elect a vice
chairperson from among its members for a term of one (1) year.

4. Securities and Exchange Commission (SEC)- is the government agency tasked in

regulating corporations and partnerships, capital and investing markets, and the
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 investing public. Some SEC rulings affect the accounting requirements of entities
and the adoption and application of accounting policies.

5. Bureau of Internal Revenue (BIR)- administers the provisions of the National

Internal Revenue Code. These provisions do not always reflect the goals of
financial reporting. However, they do at times influence the choice of accounting
methods and procedures.

6. Bangko Sentral ng Pilipinas (BSP)- influences the selection and application of

accounting policies by banks and other entities performing banking functions.

7. Cooperative Development Authority (CDA)- influences the selection and

application of accounting policies by cooperatives.

Accounting policies prescribed by a regulatory body (e.g. BSP, CDA)

are sometimes referred to as regulatory accounting principles.

International Accounting Standards

The International Accounting Standards Board (IASB) is the standard-setting
body of the IFRS Foundation with the main objectives of developing and promoting
global accounting standards.
The IASB was established in April 1, 2001 as part of the International
Accounting Standards Committee (IASC) Foundation. The IASC Foundation is a
nonprofit organization based in Delaware, USA and is the parent of the IASC
Foundation was renamed to International Financial Reporting Standards Foundation
or IFRS Foundation.
The standards issued by the IASB are the International Financial Reporting
Standards (IFRSs), composed of the following (Millan, 2018):
1. International Financial Reporting Standards (IFRSs)
2. International Accounting Standards (IASs)
3. Interpretations

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 The IFRSs are standards issued by the IASB after it replaced its predecessor,
the International Accounting Standards Committee (IASC) in April 1, 2001. The IASs
are standards issued by the IASC, which were adopted by the IASB. The PFRSs and
PASs are based on these standards.
The IASC was founded in June 1973. It was established as a result of an
agreement by accountancy bodies in ten national jurisdictions which constituted the
original board, namely Australia, Canada, France, Germany, Japan, Mexico, the
Netherlands, the UK, Ireland and the US.

Due process
The IFRSs are developed through an international due process that involves
accountants and other various interested individuals and organizations from around
the world. Due process normally involves the following steps:
1. The staff identifies and reviews issues associated with a topic and considers the application of
the Conceptual Framework in the issues.
2. Study of national accounting requirements and practice, including consultation with national
standard-setters.
3. Consulting the Trustees and the Advisory Council about the advisability of adding the topic to
the IASB’s agenda.
4. Formation of an advisory group to give advice to the IASB on the project.
5. Publishing a discussion document for public comment.
6. Publishing an exposure draft for public comment.
7. Publishing with an exposure draft a basis for conclusions and the alternative views of any IASB
member who opposes publication.
8. Consideration of all comments received.
9. Holding a public hearing and conducting field tests, if necessary, and
10. Publishing standard, including (a) a basis for conclusions, explaining among other things, the
steps in the IASBs due process and how the IASB dealt with public comments on the exposure
draft, and (b) the dissenting opinion of any IASB member.

Other relevant international organizations (Millan, 2018):

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 1. International Financial Reporting Interpretations Committee (IFRIC)- is a committee that
prepares interpretations of how specific issues should be accounted for under the application of
IFRS where:
a. The standards do not include specific authoritative guidance, and
b. There is a risk of divergent and unacceptable accounting practices.

The IFRIC is composed mostly of technical partners in audit firms but also includes preparers
and users. In 2002, IFRIC replaced the former Standing Interpretations Committee (SIC) which
had been created by the IASC. All of the SIC Interpretations have been adopted by the IASB.

2. IFRS Advisory Council (previously known as the Standards Advisory Council ‘SAC’)- is a
group of organizations and individuals with an interest in international financial reporting. The
Advisory Council’s role includes advising on priorities within the IASB’s work program. The
IASB is required to consult with the Advisory Council in advance of any board decisions on
major projects that it wishes to add to the agenda.
Members of the Advisory Council are appointed by the IFRS Foundation which also appoints
members to the IASB. These members are drawn from different geographic locations and have
a wide variety of backgrounds, including users, preparers, academicians, auditors, analysts,
regulators and professional accounting bodies.

3. International Federation of Accountants (IFAC)- is a non-profit, non-governmental, non-

political organization of accountancy bodies that represents the worldwide accountancy
profession. Its mission is to develop and enhance the profession to provide services of
consistently high quality in the public interest. Membership to the IFAC is open to all
accountancy bodies recognized by law or consensus within their countries.

4. International Organization of Securities Commissions (IOSCO)- is an international body

of security commissions. The Philippines SEC is a member of IOSCO.

Move to IFRSs
Prior to the full adoption of the IFRSs in 2005, the accounting standards used in the
Philippines were previously based on US GAAP, i.e., the Statements of Financial Accounting
Standards issued by the Federal Accounting Standards Boaard (FASB), the US national
standard setting body.
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 The move to IFRSs was primarily brought about by the increasing acceptance of
IFRSs worldwide and increasing globalization of businesses thereby increasing the need for a
common financial reporting standards that minimize, if now eliminate, inconsistencies of
financial reporting among nations.

The future of IFRSs

A significant milestone towards achieving the goal of having one set of global
standards was reached in October 2002 when the FASB and the IASB entered into a
memorandum of understanding called the “Norwalk Agreement”.
In this Agreement, the FASB and the IASB formalized their commitment to the
convergence of US GAAP and IFRSs by agreeing to use their best efforts to (Millan,
2018):
a. Make their existing financial reporting standards fully compatible as soon
as practicable, i.e., minimize differences, and
b. Coordinate their future work programs to ensure that once achieved,
compatibility is maintained.

Changes in reporting standards

Once established, financial reporting standards are continuously reviewed,
revised or superseded. Changes to reporting standards are primarily made in
response to users’ needs. Users’ needs for financial information change and so must
financial reporting standards in order to continually provide useful information. Legal,
political, business and social environments also influence changes in reporting
standards. Regulatory bodies, lobbyists, laws and regulations, and changes in
economic environments affect the choice of accounting treatment provided under the
reporting standards.

22
 ASSESSMENT

Discussion questions:
1. Discuss the 3 important activities included in the definition of accounting.
2. Explain the different types of events or transactions.
3. Enumerate the measurement bases used in accounting.
4. Discuss the 3 aspects of communicating process of accounting.
5. Give examples of accounting concepts.
6. Discuss the common branches of accounting.
7. What are the four sectors in the practice of accountancy?
8. Why is there a need for reporting standards?
9. Name the accounting setting bodies and other relevant organizations.

Problem 1: True of False

1. All events and transactions of an entity are recognized in the books of

accounts.
2. The accounting process of assigning numbers, commonly in monetary
terms, to the economic transactions and events is referred to as
classifying.
3. The basic purpose of accounting is to provide information about economic
activities intended to be useful in making economic decisions.
4. Financial accounting is the branch of accounting that focuses on general
purpose reports of financial position and operating results known as the
financial statements.
5. General purpose financial statements are those statements that cater to
the common and specific needs of a wide range of external users.
6. The financial statements are the only source of information when making
economic decisions.
7. All information presented in the financial statements are sourced from the
accounting records of the entity.

23
 8. Entity A’s accounting period starts on July 1 and ends on June 30 of the
following year. Entity A uses a fiscal year period.
9. Once promulgated, accounting standards are never changed.
10. The entity’s management is responsible for the selection of appropriate
accounting policies, not the accountant.

MODULE 2

CONCEPTUAL FRAMEWORK FOR FINANCIAL

REPORTING

Lesson 1. Purpose of the Philippine Conceptual Framework (Millan, 2018)

The purpose of the Philippine Conceptual Framework is to:

1. Assist the Financial Reporting Standards Council (FRSC) in developing
accounting standards and in reviewing and adopting existing IFRSs;
2. Assist preparers of financial statements in applying the Standards and in dealing
with topics that have yet to form the subject of an FRSC Standard;
3. Assist auditors in forming an opinion as to whether financial statements conform
with the Standards;
24
4. Assist users of financial statements in interpreting the information contained in
financial statements; and
5. Provide those who are interested in the work of FRSC with information about its
approach to the formulation of the Standards.

Authoritative Status of the Conceptual Framework

The Conceptual Framework is not a PFRS and therefore does not prescribe any
measurement or disclosure requirements. If there is a conflict between a PFRS and
the Conceptual Framework, the requirement of the PFRS will prevail.
As standard-setters will be guided by the Conceptual Framework in developing
or reviewing the Standards, conflicts between these two will diminish through time.
Moreover, the Conceptual Framework will be revised from time to time based on the
standard setters’ experience of working with it.
The authoritative status of the Conceptual Framework is depicted in the
hierarchy of guidance shown below (Millan, 2018):

Hierarchy of reporting standards

1. PFRSs
2. Judgment
When making the judgment:
 Management shall consider the following:
a. Requirements in other PFRS’s dealing with similar
transactions.
b. Conceptual Framework
 Management may consider the following:
a. Pronouncements issued by other standard-setting
bodies
b. Other accounting literature and industry practice

The hierarchy guidance above means that in the absence of a PFRS that
specifically applies to a transaction, management shall consider the applicability of

25
 the Conceptual Framework in developing and applying an accounting policy that will
result in information that is relevant and reliable.

Scope
The Conceptual Framework deals with the following:
a. Objective of financial reporting
b. Qualitative characteristics of useful information
c. Definition, recognition and measurement of financial statement elements, and
d. Concepts of capital and capital maintenance

Lesson 2.Objective of financial reporting (Millan, 2018)

“The objective of general purpose financial reporting is to provide financial
information about the reporting entity that is useful to existing and potential investors,
lenders and other creditors to making decisions about providing resources to the
entity.”
The objective is the foundation of the Conceptual Framework. All other aspects of the
Framework revolve around this objective.

Primary users
The objective of financial reporting refers to the following, so called the primary
users:
1. Existing and potential investors; and
2. Lenders and other creditors

These users cannot demand information directly from reporting entities and
must rely on general purpose financial reports for much of their financial information
needs. Accordingly, they are the primary users to whom general purpose financial
reports are directed.
Lenders normally refer to those who extend loans (e.g., banks) while other
creditors normally refer to those who extend forms of credit (e.g., supplier).
The Conceptual Framework is concerned with general purpose financial
reporting. General purpose financial reporting (or simply “financial reporting”) deals
with providing information that caters to the common needs of the primary users.
Therefore, general purpose financial reports do not and cannot provide all the
26
information needs of primary users. These users will need to consider other sources
for their other information needs.
The information needs of individual primary users may differ and possibly
conflict. Accordingly, financial reporting aims to provide information that meets the
needs of the maximum number of primary users. Focusing on common needs,
however, does not prohibit the provision of additional information that is most useful to
a particular subset of primary users.
Other users, such as the entity’s management, regulators, and the public may
find general purpose financial reports useful. However, these reports are not primarily
directed to these users.
General purpose financial reports do not directly show the value of a reporting
entity. However, they provide information that helps users in estimating the value of
an entity.
Providing useful information requires making estimates and judgments. The
Conceptual Framework establishes the concepts that underlie those estimates and
judgments.

Information on Economic resources, Claims, and Changes

The primary users’ decisions about providing resources to the entity involve
decisions on buying, selling or holding investments, or providing or settling loans or
other forms of credit. All these decisions are based on the assessment of an entity’s
prospects for future net cash inflows.
To assess an entity’s prospects for future net cash inflows, primary users need
information about the entity’s resources, claims to those resources, and how
efficiently and effectively the entity’s management has discharged its responsibilities
to use those resources (Millan, 2018):

General purpose financial reports provide information on a reporting entity’s:

a. Financial position- information on economic resources (assets) and claims
against the reporting entity (liabilities and equity); and
b. Changes in economic resources and claims- information on financial
performance and other transactions and events that lead to changes in
financial position.

27
 Collectively, all these information are referred to under the Conceptual
Framework as the economic phenomena.

Economic resources and claims

Information on economic resources and claims helps users assess the
entity’s (Millan, 2018):
a. Financial strengths and weaknesses
b. Liquidity and solvency
c. Needs for additional financing and how successful it is likely to be in
obtaining that financing.

 Liquidity refers to an entity’s ability to pay short-term obligations while solvency refers to an
entity’s ability to meet its long-term obligations.

All these information help users assess the entity’s prospects for the future cash flows. For example:
- Information on receivables, current investments, inventory, and other assets helps users assess
the entity’s ability to convert non-cash assets into cash.
- Information on obligations helps users assess the timing of cash outflows.
- Information on liquidity and solvency helps users assess the entity’s ability to obtain additional
financing. Overleverage (use of too much debt) may cause difficulty in obtaining additional
financing.

Changes in economic resources and claims

Changes in economic resources and claims result from (Millan, 2018):
a. Financial performance, and
b. Other events and transactions.
Information on financial performance helps users assess the entity’s ability to produce return
from its economic resources.
Information on the variability of the return helps users in assessing the uncertainty of future
cash flows. For example, significant fluctuations in reported profits may indicate financial instability
and uncertainty on the entity’s ability to generate cash flows from its operations.

28
 Information based on accrual accounting provides a better basis for assessing an entity’s
financial performance than information based solely on cash receipts and payments during the
period.
Information past cash flows helps users assess the entity’s ability to generate future cash flows
by providing users a basis in understanding the entity’s operating, investing and financing activities,
assessing it liquidity or solvency, and interpreting other information about its financial performances.
Economic resources and claims may also change for reasons aside from financial
performance, such as issuing debt or equity instruments. Information on these types of changes is
necessary for a complete understanding of the entity’s changes in economic resources and claims
and the possible impact of those changes in the entity’s future financial performance.

Lesson 3. Qualitative Characteristics (Millan, 2018)

The qualitative characteristics of useful financial information identify the types
of information that are likely to be most useful to the primary users in making
decisions using an entity’s financial report. Qualitative characteristics apply to
information in the financial statements as well as to financial information provided in
other ways.

The Conceptual Framework classifies the qualitative characteristics into the

following:
1. Fundamental qualitative characteristics- these are the characteristics that
make information useful to users. They consist of the following:
a. Relevance
b. Faithful presentation
2. Enhancing qualitative characteristics- these are the characteristics that
enhance the usefulness of information. They consist of the following:
a. Comparability
b. Verifiability
c. Timeliness
d. Understandability

Relevance

29
 Information is relevant if it is capable of making a difference in the decisions
made by users. Relevant information has the following (Millan, 2018):
a. Predictive value- the information can be used to make predictions.
b. Confirmatory value (feedback value)- the information can be used in
confirming previous predictions.

Predictive value and confirmatory value are interrelated. Information that has
predictive value is likely to also have confirmatory value. For example, revenue in the
current period can be used to predict revenue in a future period and at the same time
can also be used in confirming a past prediction.

Materiality
Information is material if omitting, misstating or obscuring it could reasonably
be expected to influence decisions that the primary users of a specific reporting
entity’s general purpose financial statements make on the basis of those financial
statements.
The Conceptual Framework states that materiality is an entity-specific aspect
of relevance, meaning materiality depends on the facts and circumstances
surrounding a specific entity. Accordingly, the Conceptual Framework and the
Standards do not specify a uniform quantitative threshold for materiality. Materiality is
a matter of judgment.
IFRSs Practice Statement 2 Making Materiality judgments provides a
nonmandatory guidance that entities may follow in making materiality judgments.

The guidance consists of a four-step process called the “materiality process”

Step 1- Identify information that has the potential to be material.

The starting point in making the identification is the
requirements of the Standards. This is because, when developing
Standards, the IASB identifies the information needs of a wide range of
primary users and considers the balance between the benefits to be
derived from the information and the cost of producing it.

30
 However, cost is not a factor when making materiality
judgments.
The entity also considers the common information needs of its
primary users, in addition to those specified in the PFRS2.

Step 2- Assess whether the information identified in Step 1 is, in fact,

material.
In making this assessment, the entity considers the following:
a. Whether the information could influence the users’
decisions on the basis of the financial statements as a
whole.
b. The item’s nature or size, or both.
c. Quantitative and qualitative factors.
• Quantitative factors include the size of the impact of the
item. The size of an item can be assessed in relation to
a percentage of another amount (e.g., percentage of
total assets or total revenues or a threshold amount.)
• Qualitative factors are characteristics of the item or its
context. These are:
-entity specific qualitative factors, e.g.,
involvement of a related party or rarity of the
item.
-external qualitative factors, e.g., the entity’s
industry sector or the state of the economy
Step 3- Organize the information within the draft financial statements in
a way that communicates the information clearly and concisely to
primary users.
The entity exercises judgment on how to present
information in a manner that maximizes understability to the primary
users.
Step 4 Revise the draft financial statements to determine whether all material
information has been identified and materiality considered from a wide

31
 perspective and in aggregate, on the basis of the complete set of financial
statements.
The review allows the entity to “step-back” and get a
wider perspective of the information provided. This is necessary
because an item might not be material on its own, but it might
be material if used in conjunction with the other information in
the complete set of financial statements.

Figure 1. The Four-Step Materiality Process

Faithful representation
Faithful representation means the information provides a true, correct and
complete depiction of what it purports to represent. Faithfully represented information
has the following characteristics:
a. Completeness- all information necessary for users to understand the phenomenon being
depicted are provided. These include description of the nature of the item, numerical depiction
(e.g., monetary amount), description
of the numerical depiction (e.g., historical cost or fair value) and explanation of significant facts
surrounding the item.

32
 b. Neutrality- information is selected or presented without bias. Information is not manipulated to
increase the probability that users will receive it favorably or unfavorably.
c. Free from error- this does not mean that the information is perfectly accurate in all respects. Free
from error means there are no errors in the description and in the process by which the
information is selected and applied. If the information is an estimate, that fact should be
described clearly, including an explanation of the process used in making the estimate.

Comparability
Information is comparable if it helps users identify similarities and differences between one
information and another information that is either provided by the same entity but in another period
(intra-comparability) or by other entities (intercomparability).unlike the other qualitative
characteristics, comparability does not relate to only one item because a comparison requires at least
two items.
Comparison is not uniformity, meaning like things must look alike and different things must look
differently. It would be inappropriate to make different things look alike, or vice versa.
Although related, consistency and comparability are not the same. Consistency refers to the use
of the same methods for the same items. Comparability is the goal while consistency is the means of
achieving the goal (Millan, 2018).

Verifiability
Information is verifiable if different users could reach an agreement as to what the
information purports to represent (Millan, 2018).
Verification can be direct or indirect. Direct verification involves direct observation (e.g., counting
of cash). Indirect verification means recalculating using the same formula (e.g., checking the inputs in
the cash ledger and recalculating the ending balance.)

Timeliness
Information is timely if it is available to users in time to be able to influence their decisions.

Understandability
Information is understandable if it is presented in a clear and concise manner.
Understandability does not mean that complex matters should be excluded to make information
understandable to users because this would make information incomplete and potentially misleading.
Accordingly, financial reports are intended for users (Millan, 2018):

33
 a. Who have reasonable knowledge of business activities, and
b. Who are willing to analyze the information diligently.

Summary of Qualitative characteristics

1. Fundamental qualitative characteristics
a. Relevance (predictive value and confirmatory value
 Materiality (entity-specific aspect of relevance)
b. Faithful representation (completeness, neutrality, and free
from error)
2. Enhancing qualitative characteristics
a. Comparability
b. Verifiability
c. Timeliness
d. understandability

Applying the qualitative characteristics (Millan, 2018)

The fundamental qualitative characteristics are essential to the usefulness of information;
meaning, information must be both relevant and faithfully represented for it to be useful. For example,
neither a relevant information that is erroneous nor a correct information that is irrelevant helps users
make good decisions (Millan, 2018). The enhancing qualitative characteristics only enhance the
usefulness of information that is both relevant and faithfully represented but cannot make information
that is irrelevant or erroneous to be useful. Accordingly, the enhancing qualitative characteristics should
be maximized to the extent possible. There is no prescribed order in applying the enhancing qualitative
characteristics. Sometimes, one enhancing qualitative characteristic may have to be sacrificed to
maximize another qualitative characteristic.

The Cost Constraint

Cost is a pervasive constraint on the entity’s ability to provide useful information.
Providing information entails cost and this can only be justified by the benefits expected to be
derived from using the information. Accordingly, an optimum balance between costs and benefits is
desirable such that costs do not outweigh the benefits (Millan, 2018).

Underlying Assumption

34
 The underlying assumption in financial reporting is going-concern. It is assumed that the
entity has neither the intention nor the need to end its operations in the foreseeable future. If this
is not the case, the entity’s financial statements are prepared on another basis
(e.g., measurement at realizable values rather than mixture of costs and values.)

Lesson 4. The Elements of Financial Statements (Millan, 2018)

Financial statements portray the effects of transactions and events by grouping them into
broad classes called the elements of financial statements.

Financial Position
The Elements directly related to the measurement of financial position are assets, liabilities and
equity.

Asset
“An asset is a resource controlled by the entity as a result of past events and from which future
economic benefits are expected to flow to the entity.

Essential elements in the definition of asset

a. Control- means the entity has the exclusive right over the benefits of an asset or the ability to
prevent others from accessing those benefits.
Control normally stems from ownership or possession. However, ownership or possession is not
always necessary for control to exist because control can arise from other rights. For example, Entity A
acquires a vehicle through bank financing. Although the bank retains legal title over the vehicle until full
payment, the vehicle is nonetheless an asset of Entity A. This is because Entity A has the exclusive right
to use the vehicle and therefore controls the benefits from it.
Physical form is also not necessary for an asset to exist. For example, receivables and intangible
assets are considered assets even if they do not have physical form.
The presence or absence of expenditure is also not necessary in determining the existence of an
asset. For example, assets can arise from donations.
When determining whether an item meets the definition of an element, the entity considers the
substance of the transaction rather than merely its legal form (i.e., substance over form concept).

35
 b. Past events- the control over a resource have resulted from a past event or transaction.
Therefore, resources for which control is yet to be obtained in the future do not qualify as assets in the
present. For example, the mere intention of acquiring a vehicle in the future does not of itself give rise to
an asset at present.

c. Future economic benefits- “Future” means the resource is expected to provide economic benefits
over more than one accounting period. A resource that provides economic benefits only in the current
period is an expense rather than an asset.
“Economic benefits” means the potential of the resource to provide the entity, directly or indirectly,
with cash and cash equivalents. Such potential may be:
i. Productivity- e.g. assets used in the entity’s operations.
ii. Convertibility into cash or cash equivalent- e.g., receivables and inventories
iii. Capability to reduce cash outflows- e.g., the asset lowers the costs of production or provides cost-
saving.

The future economic benefits of an asset may flow to the entity in many ways. For example, the
asset may be:
i. Sold or exchanged for other assets.
ii. Used singly or in combination with other assets to produce goods for sale.
iii. Used to settle liability; or
iv. Distributed to the owners.

Liability
“A liability is a present obligation of the entity arising from past events, the settlement of which is
expected to result in an outflow from the entity of resources embodying economic benefits”.

Essential elements in the definition of liability (Millan, 2018):

a. Present obligation arising from past events- means that at the reporting date, the entity has the
responsibility to perform some act because of an obligating event that has already transcribed.
An obligating event is an event that creates either:
1) Legal obligation- an obligation that results from a contract, legislation, or other operation of Law;
or
36
 2) Constructive obligation- an obligation that results from an entity’s actions 9e.g., past practice or
published policies0 that create a valid expectation from others that the entity will accept and
discharge certain responsibilities.

Examples:

1. Entity A intends to acquire inventories in the future on credit.

Analysis: Entity A has no present obligation. An obligation arises only when Entity A actually makes
the purchase and receives the inventories.

2. Entity A enters into an irrevocable commitments with Entity B to acquire inventories in the future
on credit.
Analysis: A non-cancellable future commitment gives rise to a present obligation when it becomes
burdensome. For example, the inventory becomes obsolete before the delivery but Entity A cannot cancel
the contract without paying substantial penalty.
Unless it becomes burdensome, no present obligation normally arises from a future commitment.
3. Although not stated in the sales contract, Entity A has a publicly known policy or providing free
repair services for the goods it sells. Entity A has consistently honored this implicit policy in the past.
Analysis: Entity A has a constructive obligation to provide free repair services for the goods it has
already sold because its past practice created a valid expectation from others that it will accept and
discharge such responsibility.
b. Outflow of economic benefits- settling an obligation normally requires the entity to;
a) Pay cash
b) Transfer other non-cash assets
c) Render a service
d) Replace the obligation with another obligation’
e) Convert the obligation to equity
The Conceptual Framework’s definition of a liability encompasses a broad approach to identifying the
existence of a liability, such that liability may exist:
a) Even if the oblige (payee) is not specifically known (the obligee can be the public at large, e.g.,
liability for environmental damages).
b) Even if the amount of the liability is not definite, e.g., estimated liability or provision.

Equity

37
 “Equity is the residual interest in the assets of the entity after deduction all its liabilities.”
The definition of equity applies to all entities regardless of form (i.e., sole proprietorship,
partnership, cooperative, corporation, non-profit entity, or government entity). Although, equity is
defined as a residual, it may be sub-classified in the statement of financial position. For example, for
a corporation, equity arising from contributions by owners is presented separately from retained
earnings, reserves and other components of equity.
Reserves may refer to amounts set aside by the entity as protection for its creditors or
stakeholders from losses. For some entities (e.g., cooperatives), the creation of reserves is
required by law. Transfers to such reserves are appropriations of retained earnings rather than
expenses.

Performance

The elements directly related to the measurement of performance are income and expenses
(Millan, 2018).

Income
“Income is increases in economic benefits during the accounting period in the form of
inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other
than those relating to contributions from equity participants.”

Income includes both revenue and gains (Millan, 2018):

a. “Revenue arises in the course of the ordinary activities of an entity and is referred to by a
variety of different names including sales, fees, interest, dividends, royalties, and rent”.
b. “Gains represents other items that meet the definition of income and may, or may not,
arise in the course of the ordinary activities of an entity.”

Most gains do not arise from the entity’s ordinary course of activities. However, some do. For
example, gain on sale of equipment does not arise from an entity’s ordinary course of activities but
a gain from the increase in the fair value of a biological asset (animals) do not arise from a farming
entity’s ordinary course of agricultural activities.

38
Revenues and gains are normally presented separately in the financial statements as knowledge
of them is useful in making economic decisions.
Gains are often reported net of related expenses.

Expenses
“Expenses are decreases in economic benefits during the accounting period in the form
of outflows or depletions of assets or incurrences of liabilities that result in decreases in
equity, other than those relating to distributions to equity participants.”

Expenses include both expenses and losses:

a. “Expenses that arise in the course of the ordinary activities if the entity include, for
example, cost of sales, wages and depreciation.”
b. “Losses represent other items that meet the definition of expenses and may, or may
not, arise in the course of the ordinary activities of the entity.”

The definition of income and expenses are opposites.

- Income results from enhancements of assets (e.g., a sale increases cash) while
expenses result from depletion of assets (e.g., paying an expense decreases cash).
- Income results from decreases in liabilities (e.g., unearned income becomes earned)
while expenses result from increases in liabilities (e.g, accrual of salaries payable).
- Income increases equity while expenses decrease equity.
- However, transactions with the entity’s owners do not normally result to income or
expenses (e.g., contributions by and distribution to, the owners increase, and decrease
assets, but these are not income, and expenses, but rather direct adjustments to equity.

Income and expenses may be reported in a variety of ways. One common method is to
make distinctions between those that arise in the entity’s ordinary course of activities and
those that do not. This helps users identify items that are recurring and non-recurring,
thereby, allowing them to better assess the entity’s prospects for future net cash inflows.
Income less expenses equals profit or loss. Profit or loss is customarily used as a
measure of performance.

Summary: Elements of Financial Statements

39
 Financial Position Definitions
a. Assets -resource controlled arising from past events and
expected to provide inflows of future economic benefits.

b. Liabilities -present obligation arising from past events and

expected to cause outflows of future economic benefits.

c. Equity -assets minus liabilities

Performance
d. Income -enhancements of assets or decreases in liabilities
-depletion of assets or increases in liabilities
e. Expenses

Recognition
Recognition is “the process of incorporating in the balance sheet or income
statement an item that meets the definition of an element and satisfies the criteria for
recognition.”

Recognition involves recording an item in words and in monetary amount and

including that amount to the balance sheet or income statement totals.
An item is recognized if all of the following are satisfied:
1. The item meets the definition of an element.
2. It is probable that any future economic benefit associated with the item will
flow to or from the entity; and
3. The item has a cost or value that can be measured with reliability.

Before an item is recognized, it should meet first the “definition” of an element

and then satisfy both the recognition criteria of “probable’ and “measured reliably.” If
any one of these is not met, the item is not recognized, however, it may be disclosed
in the notes if it has an accounting relevance (Millan, 2018).

Failure to recognize an item that meets all the requirements above is not
rectified by note disclosure.
Meets the definition

40
 The item must meet first the definition of an element, for example, if it relates to liability, it must
be present obligation arising from past events.

Probable inflows or outflows of future economic benefit

The concept of probability refers to the degree of uncertainty that the future economic benefits
associated with the item will flow to or from the entity.

Probable means “more likely than not”, i.e., there is a higher chance that the item will cause
an inflow or outflow of future economic benefits than not. We may think of it as a “51% or more”
chance that the inflow or outflow will occur. If it is ‘50:50’, then it is not probable because there
are equal chance of occurrence and non-occurrence.
The opposite of probable is non-probable.
An item that does not meet the “probable” criterion is normally not recognized except when it
qualifies as another element. For example, a cost with an improbable inflow of future economic
benefits is not recognized as an asset but as an expense.
 Costs that provide future economic benefits, also called
“capitalizable costs” are recognized as assets.
 Costs that do not provide future economic benefits or provide economic benefits for the
current period only, also called “period costs” or “revenue expenditures”, are expensed
immediately in the period they are incurred.

Measured reliably (Millan, 2018)

The item must have a cost or value that can be measured reliably.
Cost normally refers to price or expenditure. The absence of cost, however, does not preclude
the recognition of an item if some other value (e.g., fair value) can be substituted for cost. For
example, an asset received as donation has no cost to the entity but is nonetheless recognized
and measured at fair value.
In many cases, cost or value must be estimated. The use of reasonable estimates is an
essential part of financial reporting and does not undermine the reliability of financial reports.
However, when a reasonable estimate cannot be made, the item is not recognized (Millan,
2018).
 The recognition of an element is usually co-dependent on the recognition of another
element. For example, the recognition of accounts receivable coincides with the recognition of
sales, the accrual of salaries payable coincides with the recognition of salaries expense.
41
  The recognition criteria above apply to assets, liabilities, income and expenses.
Equity, as a residual amount and necessarily dependent on the measurement of assets and
liabilities, does not require a separate recognition criteria.

Remember the following requirements for recognition:

a. Meets the definition of an element.
b. Probable future economic benefits
c. Measured reliably

Expense recognition principles (Millan, 2018)

The following principles are applied when recognizing expenses

1. Matching concept (Direct association of costs and revenues)- costs that are directly related
to the earning of revenue are recognized as expenses in the same period the related revenue is
recognized.
For example, the cost of inventory is initially recognized as asset and recognized as expense (i.e.,
cost of sales) when the inventory is sold. Other examples include freight-out and sales commissions;
these are expensed in the period the related sales are recognized.

2. Systematic and rational allocation- costs that are not directly related to the earning of
revenue are initially recognized as assets and recognized as expense over the periods their economic
benefits are consumed, using some method of allocation.
For example, the cost of equipment is initially recognized as asset and subsequently
recognized as depreciation expense over the periods the equipment is used. Other examples
include amortization, expensing of prepayments, and effective interest method of allocation.

3. Immediate recognition- costs that do not provide or cease to provide future economic
benefits are expensed immediately.
For example, a cost with an improbable inflow of future economic benefits is immediately
recognized as expense when incurred. Other examples include casualty losses and impairment
losses.

Measurement
42
 “Measurement is the process of determining the monetary amounts at which the elements of the
financial statements are to be recognized and carried in the balance sheet and income statement.”

As introduced in the previously, several measurement bases are used in accounting. Below are
some of these measurement bases (Millan, 2018):
1. Historical cost
 For assets- this the amount of cash paid of the fair value of the consideration given to
acquire them at the time of the acquisition.
 For liabilities- this the amount of proceeds received in exchange for the obligation or the
amount of cash expected to be paid to settle a liability.
2. Current cost
 For assets- this is the amount of cash that would have to be paid if the same asset was
acquired currently.
 For liabilities- this is undiscounted amount of cash that would be required to settle the
obligation currently.

3. Realizable value (Settlement value)

 For assets- this is the amount of cash that could currently be obtained by selling the asset
in an orderly disposal.
 For liabilities- this is the settlement value or the undiscounted amount of cash expected to
be paid to satisfy the liabilities in the normal course of business.

3. Present value
 For assets- this is the discounted value of the future net cash inflows expected to be
derived from the asset.
 For liabilities- this is the discounted value of the future net cash outflows expected to be
paid to settle the liability.

Lesson 5. Concept of Capital and Capital Maintenance (Millan, 2018)

The Conceptual Framework mentions two concepts of capital, namely:

a. Financial concept of capital- capital is regarded as the invested money or invested
purchasing power. Capital is synonymous with equity or net assets.

43
 b. Physical concept of capital- capital is regarded as the entity’s productive capacity,
e.g., units of output per day.

The choice of an appropriate concept is based on users’ needs. Thus, if users are primarily
concerned with the maintenance of nominal invested capital or purchasing power of invested capital,
the financial concept shall be used. On the other hand, if their primary concern is the entity’s
operating capability, the physical concept shall be used.

The concept chosen affects the determination of profit. In this regard, the concepts of capital
give rise to the following concepts of capital maintenance:

a. Financial concept maintenance- under this concept, profit is earned if the net assets at the
end of the period, exceeds the net assets at the beginning of the period, after excluding any
distributions to, and contributions from, owners during the period. Financial capital maintenance can
be measured in either nominal monetary units or units of constant purchasing power.

b. Physical capital maintenance- under this concept, profit is earned only if the entity’s
productive capacity at the end of the period exceeds the productive capacity at the beginning of the
period, after excluding any distributions to, and contributions from, owners during the period.

The concept of capital maintenance is essential in distinguishing between a return on capital

and a return of capital. Only inflows of assets in excess of the amount needed to maintain capital is
regarded as a return of capital or profit.

The physical capital maintenance concept requires the use of current cost. On the contrary, the
financial capital maintenance concept does not require any particular measurement basis. This would
depend on the type of financial capital that the entity seeks to maintain.

The main difference between the two concepts of capital maintenance is the treatment of the
effects of changes in the prices of assets and liabilities. This is summarized as follows (Millan, 2018):

Financial Capital Physical Capital

44
 Constant purchasing
Nominal cost power

Profit represents Profit represents the All price changes are treated
as capital maintenance
the increase in increase in invested
adjustments that are part of
nominal money purchasing power over equity and not as profit.
capital over the the period.
period.
Only the portion of the
Increases in the increase in prices in
excess of the increase
prices of assets
held over the in the general level of
period, also called
holding gains,
are, conceptually, profits but are remainder is treated as capital
recognized as such only when the maintenance adjustment
assets are disposed of. prices is (i.e., part of equity).
regarded as profit. The

The Conceptual Framework states that financial statements are most

commonly prepared in accordance with an accounting model based on recoverable
historical cost and the nominal financial capital maintenance concept. However, the
Conceptual Framework has been designed to apply to a range of accounting models
and concepts of capital and capital maintenance (Millan, 2018).

ASSESSMENT

Discussion Questions:
1. Discuss the purpose of the Conceptual Framework.
The purpose of the Conceptual Framework is to assist the IASB in the development of
future accounting standards and in its review of existing accounting standards, ensuring

45
consistency across standards. Conceptual framework need to assist the IASB in promoting
harmonization of regulations, accounting standards and procedures relating to the
presentation of financial statements by providing a basis for reducing the number of alternative
accounting treatments permitted by accounting standards. It also need to assist national
standard-setting bodies in developing national accounting standards. Conceptual framework
also assist preparers of financial statements in applying international financial reporting
standards and in dealing with topics that have yet to form the subject of an accounting
standard. Conceptual framework is also assisting users of financial statements in interpreting
the information contained in financial statements prepared in compliance with international
financial reporting standards. Conceptual framework has also this purpose to assist auditors in
forming an opinion on whether financial statements comply with international accounting
standards and to provide those who are interested in the work of the IASB with information
about its approach to the formulation of accounting standards.

2. Discuss the scope of the Conceptual Framework.

The Conceptual Framework deals with the objective of financial reporting where the
objective of general purpose financial reporting is to provide financial information about the
reporting entity that is useful to existing and potential investors, lenders and other creditors to
making decisions about providing resources to the entity. Conceptual framework also deals
with qualitative characteristics of useful information that identifying the types of information
that are likely to be most useful to the primary users in making decisions using an entity’s
financial report. Lastly, it also deals with definition, recognition and measurement of financial
statement elements, and Concepts of capital and capital maintenance.

3. State the objective of financial reporting.

The objective of financial reporting is to track, analyze and report your business’
income. The purpose of these reports is to examine resource usage, cash flow, business
performance and the financial health of the business. This helps you and your investors make
informed decisions about how to manage the business. Accordingly, financial reporting aims
to provide information that meets the needs of the maximum number of primary users.
Focusing on common needs, however, does not prohibit the provision of additional
information that is most useful to a particular subset of primary users. Financial reporting
analyze assets, liabilities and owner's equity by monitoring these, and any changes to them,

46
you can work out what to expect in the future, and what you can change now to prepare. This
also shows the availability of resources for future growth.

4. What are the economic information that are presented in the financial
reporting?
The economic information that are presented in the financial reporting are financial
position and changes in economic resources and claims. General purpose financial reports
provide information on a reporting entity’s financial position where it refers to information on
economic resources (assets) and claims against the reporting entity (liabilities and equity).
Lastly is the changes in economic resources and claims that refers to information on financial
performance and other transactions and events that lead to changes in financial position.

5. Explain briefly the qualitative characteristics of useful information and how

they are applied to financial reporting.

The qualitative characteristics of useful information are relevance and faithful

representation. In accounting, the term relevance means it will make a difference to a
decision maker. Relevant information is capable of making a difference in the decisions made
by users. It is capable of making a difference in decisions if it has predictive
value, confirmatory value or both. Predictive value helps users in predicting or anticipating
future outcomes. Confirmatory value enables users to check and confirm earlier predictions

or evaluations.  In order to have relevance, accounting information must be timely. Financial

statements issued three weeks after the accounting period ends will have more relevance
than financial statements issued several months after the period ends. Having timeliness and
relevance may mean sacrificing some precision or reliability. Materiality is an aspect of
relevance which is entity-specific. It means that what is material to one entity may not be
material to another. It is relative. Information is material if it is significant enough to influence
the decision of users. Materiality is affected by the nature and magnitude (or size) of the
item. 

Faithful representation is the second qualitative characteristic where the financial

reports represent economic phenomena in words and numbers. The financial information in
the financial reports should represent what it purports to represent. Meaning, it should show

47
what really are present and what really happened, as the case may be. There are three
characteristics of faithful presentation. First is completeness, where the depiction of all
necessary information for a user to understand the phenomenon being depicted. It includes
all necessary descriptions and explanations. Next is neutrality, it means that the depiction is
without bias in the selection or presentation of Financial information must not be manipulated
in any way in order to influence the decision of users. Lastly is free from error, means there
are no errors and inaccuracies in the description of the phenomenon and no errors made in
the process by which the financial information was produced. That does not mean no
inaccuracies can arise, particularly in case of making estimates. The standards expect that
the estimates are made on a realistic basis and not arbitrarily. 

6. Define the elements of financial statements.

There are five main elements of financial statements which are assets, liability, equity,
revenue and expenses. Assets are the property or legal rights owned by a business to which
money value can be attached. In other words, it is an item of economic value that is expected
to yield a benefit in the future. According to IFRS Framework, “A liability is a present
obligation of the enterprise arising from past events, the settlement of which is expected to
result in an outflow from the enterprise of resources embodying economic benefits”. In other
words, liability is the amount owed by the business to the proprietor and to the
outsiders. Equity represents an ownership interest in a firm in the form of stock. Being precise
in the accounting terms, it is the difference between the value of assets and the cost of
liabilities of something owned. It is mainly a residual amount adjusted by the assets against
liabilities. Revenue is the income that a business earns from its normal business activities. It
is an inflow of assets, which result in an increase in owner’s equity. Exchange of goods and
services for money consideration is an example of revenue. Expenses are the gross
outflows incurred by the business enterprise for generating revenues. An expense is charged
to Profit and Loss Account.

7. Discuss the recognition criteria for each of the elements of the financial
statements.
An asset is recognized in the balance sheet when it is probable that the future
economic benefits will flow to the entity and the asset has a cost or value that can be
measured reliably. The economic benefits contribute, directly or indirectly, in the form of cash
or cash equivalents. Even though many assets are in physical form, such as machinery, the
physical form is not essentials. For example, patents and intellectual property are assets

48
controlled by the entity and have future economic benefits. A liability is recognized in the
balance sheet when it is probable that an outflow of resources embodying economic benefits
will result from the settlement of a present obligation and the amount at which the settlement
will take place can be measured reliably. For example, accounts payables are present
obligations, which will result in an outflow of resources embodying economic benefits. Income
is recognized in the income statement when an increase in future economic benefits related
to an increase in an asset or a decrease of a liability has arisen that can be measured
reliably. In effect, the recognition of income occurs simultaneously with the recognition of
increases in assets or decreases in liabilities. For example, when a sale is made, it results in
a net increase in assets (cash). Income includes both revenues and gains, such as from sale
of assets that are not a part of the normal business activity. Expenses are recognized when a
decrease in future economic benefits related to a decrease in an asset or an increase of a
liability has arisen that can be measured reliably. In effect, the recognition of expenses occurs
simultaneously with the recognition of an increase in liabilities or a decrease in assets. For
example, the depreciation of an asset decreases the asset and the expense is recognized.
Expenses include both expenses and losses.

Multiple choice questions:

1. It is the body authorized by law to promulgate rules and regulations affecting the

practice of the accountancy profession in the Philippines.

a. Board of Accountancy

b. Philippine Institute of Certified Public Accountants

c. Securities and Exchange Commission

d. Financial Reporting Standards Council

2. What are the three main areas in the practice of the accountancy profession?

a. Public accounting, private accounting, and managerial accounting

b. Auditing, taxation, and managerial accounting

c. Financial accounting, managerial accounting and corporate accounting

d. Public accounting, private accounting, and government accounting

49
3. Accountants employed in entities in various capacity as accounting staff, chief
accountant or controller are said to be engaged in

a. Public accounting c. Government accounting

b. Private accounting d. Financial accounting

4. It is the area of accountancy profession that encompasses the prose of analyzing,

classifying, summarizing and communicating all transactions involving the receipt
and disposition of government funds and property and interpreting the results
thereof.

a. Internal auditing c. Private accounting

b. External auditing d. Government accounting

5. All of the following are represented in FRSC, except

a. Board of Accountancy

b. Securities and Exchange Commission

c. Commission on Audit

d. Department of Budget and Management

6. The International Accounting Standards Board was formed

a. To enforced IFRS in foreign countries

b. To develop a single set of high quality IFRS

c. To establish accounting standards for multinational entities

d. To develop accounting standards for countries that do not have their own

standard-setting bodies

7. What is the chronological order in the evaluation of a typical standard?

a. Exposure draft, Standard and Discussion paper

b. Exposure draft, Discussion paper and Standard

50
 c. Standard, Discussion paper and Exposure draft

d. Discussion paper, Exposure draft and Standard

8. The IASB employs a “due process” system which

a. Is an efficient system for collecting dues from members

b. Enables interested parties to express their views on issues under

consideration.

c. Identifies the most important accounting issues.

d. Requires that all CPA’s must receive a copy of IFRS.

9. Financial accounting standard-setting

a. Can be described as a social process which reflects political actions of various

interested user groups as well as a product of research and logic.

b. Is based solely on research and empirical findings.

c. Is a legalistic process.

d. Is democratic in the sense that a majority of accountants must agree with a

standard.

10. Financial accounting emphasizes reporting to

a. Management c. Internal auditors

b. Regulatory bodies d. Creditors and investors

11. Managerial accounting emphasizes

a. Reporting financial information to external users

b. Reporting to the Securities and Exchange Commission

c. Combining accounting with data processing

d. Developing accounting information for use within an entity

51
12. Which statement is true regarding managerial accounting and financial

accounting?

a. Managerial accounting is generally more precise.

b. Managerial accounting need not follow generally accepted accounting

principles while financial accountings must allow GAAP.

c. Managerial accounting has a future focus.

d. The emphasis on managerial accounting is relevance and the emphasis on

financial accounting is timeliness.

13. Proper application of accounting principles is most dependent upon

a. Existence of specific guidelines

b. Oversight of regulatory bodies

c. External audit function

d. Professional judgment of the accountant

14. What is the only underlying assumption mentioned in the Conceptual Framework

for Financial Reporting?

a. Going concern c. Time period

b. Accounting entity d. Monetary unit

15. The relatively stable economic, political and social environment supports

a. Conservatism c. Timeliness

b. Materiality d. Going concern

16. Which basic assumption may not be followed when an entity in bankruptcy

reports financial results?

a. Economic entity assumption

b. Going concern assumption

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 c. Time period assumption

d. Monetary unit assumption

17. The economic entity assumption

a. Is inapplicable to unincorporated businesses

b. Recognizes the legal aspects of business organizations

c. Requires periodic income measurement

d. Is applicable to all forms of business organizations

18. Which basic accounting assumption is threatened the by the existence of severe
inflation in an economy.

a. Monetary unit assumption

b. Periodicity assumption

c. Going concern assumption

d. Economic entity assumption

19. The concept of accounting entity is applicable

a. Only to the legal aspects of business organizations

b. Only to the economic aspects of business organizations

c. Only to business organizations

d. Whenever accounting is involved

20. When a parent and subsidiary relationship exist, consolidated financial

statements are prepared in recognition of

a. Legal entity

b. Economic entity

c. Stable monetary unit

d. Time period
53
21. In the Conceptual Framework for Financial Reporting, what provides the “why” of
accounting?

a. Measurement and recognition concept

b. Qualitative characteristic of accounting information

c. Element of financial statement

d. Objective of financial reporting

22. The underlying theme of the Conceptual Framework is

a. Decision usefulness

b. Understandability

c. Timeliness

d. Comparability

23. The primary focus of financial reporting has been on meeting the needs of which

of the following groups?

a. Management

b. Existing and potential investors, lenders and other creditors

c. National and local taxing authorities

d. Independent CPA’s

24. The overall objective financial reporting is to provide information

a. That is useful for decision making

b. About assets, liabilities and owners’ equity

c. About financial performance during a period

d. That allows owners to assess management performance

25. Which is an objective of financial reporting?

a. To provide information that is useful to those making investing and credit

54
 decisions.

b. To provide information that is useful to management.

c. To provide information about prospective investors.

d. To provide information about ways to solve internal and external conflicts

about the entity.

26. An objective of financial reporting is to provide

a. Information about the investors in the entity.

b. Information about the liquidation value of the resources held by the entity

c. Information that is useful in assessing cash flow prospects.

d. Information that will attract new investors.

27. The fundamental qualitative characteristics are

a. Relevance and faithful representation

b. Relevance, faithful representation and materiality

c. Relevance and reliability

d. Faithful representation and materiality

28. Accounting information is considered relevant when it

a. Can be depended upon to represent the economic conditions and events that

it is intended to represent.

b. Is capable of making a difference in a decision.

c. Is understandable by reasonably informed user.

d. Is verifiable and neutral

29. Which of the following is the best description of faithful representation in relation

to information in financial statements?

a. Influence on the economic decision of users

b. Inclusion of a degree of caution

55
 c. Freedom from material error

d. Comprehensibility to users

30. The enhancing qualitative characteristics of financial information are

a. Comparability and understandability

b. Verifiability and timeliness

c. Comparability, understandability and verifiability

d. Comparability, understandability, verifiability and timeliness

31. An entity issuing the annual financial reports within one month at the end of
reporting period is an example of which enhancing quality of accounting
information?

a. Neutrality

b. Timeliness

c. Predictive value

d. Representational faithfulness

32. The overriding qualitative characteristics of accounting information is

a. Relevance

b. Understandability

c. Faithful representation

d. Decision faithfulness

33. What is meant by comparability when discussing financial accounting

information?

a. Information has predictive and confirmatory value.

b. Information is reasonably free from error.

c. Information is measured and reported in a similar fashion across entities.

d. Information is timely
56
34. Which of the following is not an enhancing qualitative characteristic?

a. Understandability

b. Profit-oriented

c. Timeliness

d. Comparability

35. The Conceptual Framework includes which of the following constraints?

a. Prudence

b. Substance over form

c. Cost

d. All of the choices are constraints

36. Conservatism is best described as selecting an accounting alternatives that

a. Understates assets and net income

b. Has the latest favorable impact on equity

c. Overstates liabilities

d. Is least likely to mislead users of financial information

37. Objectivity is assumed to be achieved when an accounting transaction

a. Is recorded in a fixed amount of pesos

b. Involves the payment or receipt of cash

c. Involves an arm’s length transaction between two independent parties

d. Allocate revenue or expense in a rational and systematic manner

38. Which statement is an argument against historical cost?

a. Fair value is more relevant.

57
 b. Historical cost is based on exchange transaction.

c. Historical cost is verifiable and reliable.

d. Fair value is subjective.

39. The usefulness of providing information in financial statements is subject to the

constraint of

a. Consistency

b. Cost-benefit

c. Reliability

d. Representational faithfulness

40. The elements directly related to the measurement of financial position are

a. Assets, liabilities, equity, income and expense

b. Assets, liabilities and equity

c. Income and expense

d. Assets and liabilities

41. The elements directly related to the measurement of financial performance are

a. Assets, liabilities, equity, income and expense

b. Assets, liabilities and equity

c. Income and expense

d. Sales and cost of goods sold

42. Which statement in relation to income is true?

a. Income encompasses both revenue and gain.

b. Revenue compasses both income and gain.

c. Gain encompasses both income and revenue.

d. Income is the same as revenue.

58
43. Asset measurements in financial statements

a. Are confined to historical cost

b. Are confined to historical cost and current cost

c. Reflect several financial attributes

d. Do not reflect output value

44. Which of the following should be considered a current value measure?

a. Replacement cost and exit value

b. Replacement cost and discounted cash flow

c. Exit value and discounted cash flow

d. Replacement cost, exit value and discounted cash flow

45. Which measurement basis is currently used in financial statements?

a. Present value

b. Present value and settlement value

c. Settlement value and fair value

d. Present value, settlement value and fair value.

46. Generally, revenue is recognized

a. At the point of sale.

b. When cause and effect are associated.

c. At the point of cash collection.

d. At appropriate points throughout the operating cycle

47. Which of the following is not an accepted basis for recognition of revenue?

a. Passage of time

b. Performance of service

c. Completion of percentage of a project

59
 d. Upon signing of contract

48. Income recognized using the installment method of accounting equals cash

collected multiplied by

a. Net profit rate

b. Net profit rate adjusted for uncollectible accounts

c. Gross profit rate

d. Gross profit rate adjusted for uncollectible accounts

49. The cost recovery method of revenue recognition

a. Is used only when circumstances surrounding a sale are so uncertain that

earlier recognition is impossible.

b. Is used in accounting for real estate sales.

c. Is similar to percentage of completion accounting.

d. Is never acceptable under GAAP.

50. Revenue may result from

a. A decrease in an asset from primary operations.

b. An increase in an asset from incidental transactions.

c. An increase in a liability from incidental transactions.

d. A decrease in a liability from primary transactions.

60
 MODULE 3

PAS 1 PRESENTATION OF FINANCIAL

STATEMENTS

INTRODUCTION

61
 Philippine Accounting Standards (PAS) 1 Presentation of Financial Statements
prescribes the basis for the presentation of general purpose financial statements, the
guidelines for their structure, and the minimum requirements for their content to ensure
comparability.

Comparability requires consistency in the adoption and application of accounting policies

and in the presentation of financial statements. PAS 1 applies to the preparation of general
purpose financial statements. The recognition, measurement and disclosure requirements
for specific transactions and other events are set out in other PFRSs.

The terminology used in PAS 1 is suitable for profit-oriented entities. If non-profit

organizations apply PAS 1, they may need to amend the line-item and financial statement
descriptions.

LEARNING OUTCOMES

At the end of the module, students should be able to:

1. Enumerate and describe the general features of financial statement
presentation;
2. Enumerate and describe the components of a complete set of financial
statements;
3. State the acceptable methods of presenting items of income and
expenses;
4. Differentiate between the statement of profit and loss and other
comprehensive income and the statement of changes in equity; and
5. State the relationship of the notes with the other components of a complete
set of financial statements.

Lesson 1. Financial Statements (Millan, 2018)

62
 “Financial statements are the “structured representation of an entity’s financial
position and results of its operations”.”

Financial statements are the end product of the financial reporting process
and the means by which the information gathered and processed is periodically
communicated to users. The financial statements of an entity pertain only to that
entity and not to the industry where the entity belongs or the economy as a whole.

General purpose financial statements (‘financial statements’) are “those

intended to meet the needs of users who are not in a position to require an entity to
prepare reports tailored to a particular information needs.”
General purpose financial statements cater to most of the common needs of
a wide range of external users. General purpose financial statements are the subject
matter of the Conceptual Framework and PFRSs.

Purpose of financial statements (Millan, 2018):

1. Primary objective: to provide information about the financial position, financial
performance, and cash flows of an entity that is useful to a wide range of users in
making economic decisions.
2. Secondary objective: to show the results of management’s stewardship over the
entity’s resources.

To meet the objective, financial statements provide information about

an entity’s
a. Assets (economic resources)
b. Liabilities (economic obligations)
c. Equity
d. Income
e. Expenses
f. Contributions by, and distributions to owners; and
g. Cash flows

63
 This information along with other information in the notes, helps users
assess the entity’s prospects for future net cash inflows.

Complete set of financial statements (Millan, 2018):

A complete set of financial statements consist of:
1. Statement of financial position
2. Statement of profit or loss and other comprehensive income.
3. Statement of changes in equity.
4. Statement of cash flows
5. Notes
(5a) comparative information; and
6. Additional statement of financial position (required only when
certain instances occur).

An entity may use other titles for the statements. For example,
an entity may use the title “balance sheet” in lieu of “statement of
financial position” or “statement of comprehensive income” instead of
“statement of profit and loss and other comprehensive income”.
However, an “income statement” is different from “statement of
profit and loss and other comprehensive income” or a “statement of
comprehensive income”.
Reports that are presented outside of the financial statements,
such as financial reviews by management, environmental reports and
value added statements are outside the scope of PFRSs.

Lesson 2. General features of financial statements (Millan, 2018)

1. Fair Presentation and Compliance with PFRSs

Fair presentation is faithfully representing, in the financial statements, the
effects of transactions and other events in accordance with the definitions and
recognition criteria for assets, liabilities, income and expenses set out in the
Conceptual Framework.

64
 Compliance with the PFRSs is presumed to result in fairly presented
financial statements.
Fair presentation also requires the proper selection and application of
accounting policies, proper presentation of information, and provision of
additional disclosures whenever relevant to the understanding of the financial
statements.
Inappropriate accounting policies cannot be rectified by mere disclosure.
PAS1 requires an entity whose financial statements comply with PFRSs
to make and explicit and unreserved statement of such compliance in the notes.
However, an entity shall not make such statement unless it complies with all the
requirements of PFRSs.

Example:
Statement of Compliance with Philippine Financial Reporting Standards

The financial statements of the Bank have been prepared in accordance with
Philippine Financial Reporting Standards (PFRSs), which are adopted by the
Financial Reporting Standards Council (FRSC) from the pronouncements
issued by the International Standards Board (IASB).

There may be cases wherein an entity’s management concludes that

compliance with a PFRS requirement is misleading. In such cases, PAS 1
permits a departure from PFRS requirement if the relevant regulatory
framework requires or allows such departure.

When an entity departs from a PFRS requirement, it shall disclose the

management’s conclusion as to the fair presentation of the financial
statements, that all other requirements of the PFRSs are complied with; the
title of the PFRS from which the entity has departed; and the financial effect
of the departure.

2. Going Concern

65
 Financial statements are normally prepared on a going concern basis
unless the entity has an intention to liquidate or has no other alternative but to
do so.
When preparing financial statements, management shall assess the
entity’s ability to continue as a going concern, taking into account all available
information about the future, which is at least, but not limited to, 12 months
from the reporting date.
If the entity has a history of profitable operations and ready access to
financial resources, management may conclude that the entity is a going
concern without detailed analysis.
If there are material uncertainties on the entity’s ability to continue as a
going concern, those uncertainties shall be disclosed.
If the entity is not a going concern, its financial statements shall be
prepared using another basis. This fact shall be disclosed, including the basis
used, and the reason why the entity is not regarded as a going concern.

3. Accrual Basis of Accounting

All financial statements shall be prepared using the accrual basis of
accounting except for the statement of cash flows which is prepared using
the cash basis.

4. Materiality and Aggregation

Each material class of similar items is presented separately. A class
of similar items is called a “line item”. Dissimilar items are presented
separately unless they are immaterial. Individually immaterial items are
aggregated with other items.

5. Offsetting
Assets and liabilities or income and expenses are presented separately
and are not offset, unless offsetting is required or permitted by PFRSs.
Offsetting is permitted when it reflects the substance of the transaction.
Examples of offsetting:

66
 a. Presenting gains or losses from sales of assets net of the related
selling expenses.
b. Presenting at net amount the unrealized gains and losses arising
from trading securities and from translation of foreign currency
denominated assets and liabilities, except if they are material.
c. Presenting a loss from a provision net of a reimbursement from a
third party.

Measuring assets net of valuation allowances is not offsetting. For

example, deducting allowance for doubtful accounts from
accounts receivables or deducting accumulated depreciation from
a building account is not offsetting.
6. Frequency of reporting
Financial statements are prepared at least annually. If an entity
changes its reporting period to a period longer or shorter than one year, it
shall disclose the following:
a. The period covered by the financial statements.
b. The reason for using a longer or shorter period; and
c. The fact that amounts presented in the financial statements are not
entirely comparable.

7. Comparative information
PAS 1 requires an entity to present comparative information in
respect of the preceding period for all amounts reported in the current
period’s financial statements, unless another PFRS requires otherwise.
As a minimum, an entity presents two of each of the statements and
related notes. For example, when an entity presents its 20x2 current year
financial statements, the 20x1 preceding year financial statements shall also
be presented as comparative information.
PAS 1 permits entities to provide comparative information in addition
to the minimum requirement. For example, an entity may provide a third
statement of comprehensive income. In this case, however, the entity need
not provide a third statement for the other financial statements, but must

67
 provide the related notes for that additional statement of comprehensive
income.

Additional Statement of financial position

Instances wherein an additional statement of financial statement shall
be presented.
a. The entity applies an accounting policy retrospectively, makes a
retrospective restatement of items in its financial statements, or
reclassifies items in the financial statements; and
b. The instance in (a) has a material effect on the information in the
statement of financial position at the beginning of the preceding
period.

For example, if any of the instances above occur, the entity

shall present three statements of financial statements as follows

Statement of financial statement

position Date
1. Current year As at December 31, 20x2
2. Preceding year As at December 31, 20x1
(comparative information)
3. Additional As at January 1, 20x1

8. Consistency of presentation
The presentation and classification of items in the financial statements
is retained from one period to the next unless a change in presentation:
a. Is required by a PFRS, or
b. Results in information that is reliable and more relevant.

A change in presentation requires the reclassification of items in the

comparative information. If the effect of a reclassification is material, the
entity shall provide the “additional statement of financial position”.
Summary: General features:
1. Fair presentation and compliance
68
 with PFRSs
2. Going concern
3. Accrual Basis
4. Materiality and Aggregation
5. Offsetting
6. Frequency of reporting period
7. Comparative information
8. Consistency of presentation

Lesson 3. Structure and contents of financial statements (Millan, 2018)

Each of the financial statements shall be presented with equal prominence

and shall be clearly identified and distinguished from other information in the same
published document. For example, financial statements are usually included in an
annual report, which also contains other information. The PFRSs apply only to the
financial statements and not necessarily to the other information.
The following information shall be displayed prominently and repeatedly
whenever relevant to the understanding of the information presented:
a. The name of the reporting entity
b. Whether the statements are for the individual entity or for a group of
entities.
c. The date of the end of the reporting period or the period covered b the
financial statements
d. The presentation currency
e. The level of rounding used (e.g., thousands, millions, etc.)

Illustration: A heading for a financial statement:

ABC Group

69
 Statement of Financial Position
As of December 31, 20x2
(in thousands of Philippine Pesos)

First line: Name of the reporting entity indicating that the financial
statement pertains to a group.
Second line: the title of the the Statement (i.e., Statement of Financial
Position
Third line: Date of the end of reporting period for Statement of
Financial Statement (i.e., As of December 31, 20X2)
Duration of the period covered by the statement for other
financial statements (i.e., for the year ended December
31, 20X2)
Fourth line: Level of rounding off and presentation currency (only if
necessary)

The statement of financial position is dated as at the end of the

reporting period while the other financial statements are dated for the period
that they cover.
PAS1 requires particular disclosures to be presented either in the notes
or on the face of the other financial statements (e.g., footnote disclosures).
Other disclosures are addressed by other PFRSs.

Management’s Responsibility over Financial Statements (Millan, 2018)

The management is responsible for an entity’s financial statements.
The responsibility encompasses:
a. The preparation and fair presentation of financial statements in accordance
with PFRSs;
b. Internal control over financial reporting;
c. Going concern assessment;
d. Oversight over the financial reporting process; and
e. Review and approval of financial statements

70
 The responsibilities are expressly stated in a document called “
Statement of Management’s Responsibility for Financial Statements,” which
is attached in the financial statements as a cover letter. This document is
signed by the entity’s:
a. Chairman of the Board, (or equivalent)
b. Chief Executive Officer (or equivalent), and
c. Chief Financial Officer (or equivalent)

Lesson 4. Statement of Financial Position (Millan, 2018)

The statement of financial position shows the entity’s financial condition (i.e.,
status of assets, liabilities and equity) as at a certain date. It includes line items that
present the corresponding amounts:
a. Property, plant and equipment
b. Investment property
c. Intangible assets
d. Financial assets (including (e), (h) and (i)
e. Investments accounted for using the equity method
f. Biological assets
g. Inventories
h. Trade and other receivables
i. Cash and cash equivalents
j. Assets held for sale, including disposal groups
k. Trade and other payables
l. Provisions
m. Financial liabilities (excluding (k) and (l))
n. Current tax liability and current tax assets
o. Deferred tax liabilities and deferred tax assets
p. Liabilities included in desposal groups

71
 q. Non-controlling interests, and
r. Issued capital and reserves attributable to owners of the parent

PAS 1 does not prescribe the order or format of presenting items in

the statement of financial position. The foregoing is simply a list of items that
are sufficiently different in nature or function to warrant separate
presentation.
Accordingly, an entity may modify the descriptions used and the
sequence of their presentation to suit the nature of the entity and its
transactions. Moreover, additional line items may be presented whenever
relevant to the understanding of the entity’s financial position.

Presentation of statement of financial position (Millan, 2018)

A statement of financial position may be presented in a “classified” or
an “unclassified” manner.
a. A classified presentation shows distinctions between current and
noncurrent assets and current and noncurrent liabilities.
b. An unclassified presentation (also called ‘based on liquidity’) shown
no distinction between current and noncurrent items.

A classified presentation shall be used except when an unclassified

presentation provides information that is reliable and more relevant. When
that exception applies, assets and liabilities are presented in order of liquidity
(this is normally the case for banks and other financial institutions.)
PAS 1 also permits a mixed presentation, i.e., presenting some
assets and liabilities using a current/non-current classification and others in
order of liquidity. This may be appropriate when the entity has diverse
operations.
Whichever method is used, PAS 1 requires the disclosure of items
that are expected to be recovered or settled (a) within 12 months and (b)
beyond 12 months, after the reporting period.
A classified presentation highlights an entity’s working capital and
facilitates the computation of liquidity and solvency ratios.
72
  Working capital = Current Assets – Current Liabilities

Current Assets and Current Liabilities (Millan, 2018)

Current Assets Current Liabilities

are assets that are liabilities that
are: are:
a. Expected to be realized, sold, or a. Expected to be settled in the
consumed in the entity’s normal entity’s normal operating cycle.
operating cycle.
b. Held primarily for trading b. Held primarily for trading.
c. Expected to be realized within 12 c. Due to be settled within 12 months
after the reporting months after the reporting period.
period; or
d. Cash or cash equivalent , unless d. The entity does not have an restricted
from being exchanged unconditional right to defer or used to settle a liability
for at settlement of the liability for at least twelve months after the least
twelve months after the reporting period. reporting period.
All other assets and liabilities are classified as noncurrent.
“The operating cycle of an entity is the time between the acquisition of assets
for processing and their realization in cash or cash equivalent. When the entity’s
normal operating cycle is not clearly identifiable, it is assumed to be 12 months.”
Assets and liabilities that are realized and settled as part of the entity’s
operating cycled (e.g., trade receivables, inventory, trade payables, and some
accruals for employees and other operating costs) are presented as current, even if
they are expected to be realized or settled beyond 12 months after the reporting
period.
Assets and liabilities that do not form part of the entity’s normal operating
cycle (e.g., non-operating assets and liabilities) are presented as current only when
they are expected to be realized or settled within 12 months after the reporting
period.

73
 Deferred tax assets and liabilities are always presented as noncurrent items
in a classified statement of financial position regardless of their expected dates of
reversal.
Examples

Current Assets Current Liabilities

• Cash and cash equivalent • Accounts payable
• Accounts receivable • Salaries payable
• Non-trade receivables collectible • Dividends payable
within 12 months • Income (current) tax
payable
• Held for trading securities
• Unearned revenue
• Inventory
• Portion of
• Prepaid assets
notes/loans/bonds payable
due within 12 months
Noncurrent Assets Noncurrent liabilities

  Portion of notes/loans/bonds
Property, plant and payable due beyond 12
equipment Non-trade

receivable collectible  months
beyond 12 months Deferred tax liability
• Investment in associate
• Investment property
• Intangible assets
• Deferred tax asset

Refinancing agreement (Millan, 2018)

A long-term obligation that is maturing within 12 months after the
reporting period is classified as current, even if a refinancing agreement to
reschedule payments on a long-term basis is completed after the reporting
period but before the financial statements are authorized for issue.
However, the obligation is classified as noncurrent if the entity
expects, and has the discretion, to refinance it on a long-term basis under an
existing loan facility.
If the refinancing is not at the discretion of the entity (for example, there
is no arrangement for refinancing), the financial liability is current.

74
  Refinancing refers to the replacement of an existing
debt with a new one but with different terms, e.g., an
extended maturity date or a revised payment
schedule. Refinancing normally entails a fee or
penalty. A refinancing where the debtor is under
financial distress is called “troubles debt
restructuring”.
 Loan facility refers to credit line.

Illustration:
Entity A’s current reporting date is December 31, 20x1. A bank loan taken
10 years ago is maturing on October 31, 20X2.
Analysis: a currently maturing obligation (i.e., due within 12 months
after the reporting date) is classified as current even if that obligation
used to be noncurrent. Therefore, the loan is presented as current
liability in Entity A’s December 31, 20x! statement of financial position.

On January 15, 20x2, Entity A enters into a refinancing agreement to

extend the maturity date of the loan to October 31, 20x7. Entity A’s
financial statements are authorized for issue on March 31, 20x2.
Analysis: continuing with the general rule, a currently maturing
obligation is classified as current even if a refinancing agreement, on
a long-term basis, is completed after the reporting period and before
the financial statements are authorized for issue. Accordingly, the
loan is nevertheless presented as a current liability.

Under the original terms of the loan agreement, Entity A has the unilateral
right to defer (postpone) the payment of the loan up to a maximum period
of 5 years from the original maturity date. Entity A expects to exercise this
right after the reporting date but before the financial statements are
authorized for issue.
Analysis: Entity A has the discretion (i.e., unilateral right) to
refinance the obligation on a long-term basis under an existing loan

75
 facility (i.e., the unilateral right is included in the original terms of the
loan agreement). Accordingly, the loan is classified as noncurrent.
In this situation, Entity A has an unconditional right to defer the
settlement of the loan for at least twelve months after the reporting
period. Therefore, condition ‘d’ above for current classification (i.e.,
“…does not have an unconditional right to defer settlement…’) is
inapplicable.

Liabilities payable on demand (Millan, 2018)

Liabilities that are payable upon demand of the lender are classified as
current.
A long-term obligation may become payable on demand as a result of
a breach of a loan provision. Such an obligation is classified as current even
if the lender agree, after the reporting period and before the authorization of
the financial statements for issue, not to demand payment. This is because
the entity does not have an unconditional right to defer settlement of the
liability for at least twelve months after the reporting period.
However, the liability is noncurrent if the lender provides the entity by
the end of the reporting period (e.g., on or before December 31) a grace
period ending at least twelve months after the reporting period, within which
the entity can rectify the breach and during which the lender cannot demand
immediate repayment.

Illustration
In 20x1, Entity A took a long-term loan from a bank. The loan agreement
requires Entity A to maintain a current ratio of 2:1. If the current ratio falls
below 2:1, the loan becomes payable on demand. On December 31, 20x1
(reporting date), entity A’s current ratio was 1.8:1, below the agreed level.
Entity A’s financial statements were authorized for issue on March 31, 20x2.

Case 1
On January 5, 20x2, the bank gives Entity A a chance to rectify the breach of
loan agreement within the next 12 months and promised not to demand
immediate repayment within the period.
76
Analysis: the loan is classified as current liability because the grace period is
received after the reporting date.

Case 2
On December 31, 20x1, the bank gives Aa chance to rectify the breach of
loan agreement within the next 12 months and promised not to demand
immediate repayment within this period.

Analysis: this loan is classified as noncurrent liability because the grace period
is received by the reporting date.

Illustration:
Classified Statement of financial position

Entity A
Statement of Financial Position
As of December 31, 20x2
(amounts in Philippine Peso)

Notes 20x2 20x1

ASSETS
Current assets
Cash and cash equivalents P698,020 P280,00
0
Trade and other receivables 500,000 100,0
00
Inventories 400,000 180,0
00
Total Current assets 1,598,020 560,0
00

Non-current Assets
Property, plant and equipment 2,750,000 2,800,0
00
Intangible assets 600,000 640,0
77
 00
Total non-current assets 3,350,000 3,440,0
00

Total Assets P4,948,020P4,000,000

LIABILITIES AND EQUITY

Current Liabilities
Trade and other payables P287,500 P200,00
0
Current Tax Payable 69,960 15,4
80
Current portion of long-term borrowings 40,000 40,0
00
Provisions 6,000 4,000
Total Current liabilities 403,460 259,4
80

Non-current liabilities
Long-term borrowings 120,000 160,0
00
Deferred tax liability 70,000 50,0
00
Total non-current liabilities 190,000 210,0
00

Equity
Share capital 2,000,000 2,000,0
00
Retained Earnings 2,354,560 2,530,5
20
Total Equity 4,354,560 4,530,5
20

Total Liabilities and Equity P4,948,020 P4,000,000

Lesson 5. Statement of Profit or Loss and Other Comprehensive Income (Millan, 2018)
Income and expenses for the period may be presented in either:

78
a. A Single statement of profit or loss and other comprehensive income
(statement of comprehensive income); or
b. Two statements- 1) a statement of profit of loss, and
2) a statement presenting comprehensive income.

These presentations have the following basic

formats: A. Single statement presentation:
Statement of profit or loss and other comprehensive income
Revenues P100
Expenses ( 80)
Profit or loss 20
Other comprehensive income 10
Comprehensive Income P 30

B. Two-statement presentation
1.
Statement of profit or loss/Income statement
Revenues P100
Expenses ( 80)
Profit of loss P 20

2.
Statement of other comprehensive income
Profit of loss P
2
0
Other comprehensive income
1
0
Comprehensive income P
3
0

PAS 1 requires the entity to present information on the following:

79
 a. Profit or loss
b. Other comprehensive income
c. Comprehensive income
Presenting a separate income statements is allowed as long as a
separate statement showing comprehensive income is also presented (i.e.,
“two-statement presentation”). Presenting only an income statement is
prohibited.

Profit or Loss (Millan, 2018)

Profit or loss is income less expenses, excluding the components of
other comprehensive income. The excess of income over expenses is profit,
while the deficiency is called loss. This method of computing for profit or loss
is called the “transaction approach”.
Income and expenses are usually recognized in profit or loss unless: a.
They are items of other comprehensive income; or
b. They are required by other PFRSs to be recognized outside of profit
or loss.

The following are not included in determining the profit or loss for the period:
Transaction Accounting
1. Correction of prior period error - Direct adjustment to
the
beginning balance of retained
earnings. The adjustment is
presented in the statement of
changes in equity.

2. Change in accounting policy - Similar treatment to

the

80
 correction of prior period error.

3. Other comprehensive income - Changes during the period are

presented in the “other
comprehensive income”
section of the statement of
comprehensive income.
Cumulative balances are
presented in the equity section
of the statement of financial
position.

4. Transactions with owners (e.g., - Recognized directly in equity. issuance of

share capital, Transactions during the period declaration of dividends, and
the are presented in the statement like) of changes in equity.

The profit or loss section shows line items that present the following
amounts for the period:
a. Revenue, presenting separately interest revenue;
b. Finance costs;
c. Gains and losses arising from the derecognition of financial assets
measured at amortized cost;
d. Impairment losses and impairment gains on financial assets;
e. Gains and losses on reclassifications of financial assets from
amortized cost or fair value through other comprehensive income to
fair value through profit or loss;
f. Share in the profit or loss of associates and joint ventures;
g. Result of discontinued operations.

Additional line items shall be presented whenever relevant to the

understanding of the entity’s financial performance. The nature and amount
of material items of income or expense shall be disclosed separately.

81
 Circumstances that would give rise to the separate disclosure of items
of income and expense include:
a. Write-downs of inventories to net realizable value or of property,
plant and equipment to recoverable amount, as well as reversals of
such write-downs;
b. Restructurings of the activities of an entity and reversals of any
provisions for restructuring costs;
c. Disposals of items of property, plant and equipment;
d. Disposals of investments;
e. Discontinued operations;
f. Litigation settlements; and
g. Other reversal of provisions.

PAS 1 prohibits the presentation of extraordinary items in the

statement of profit or loss and other comprehensive income or in the notes.

Presentation of Expenses (Millan, 2018)

Expenses may be presented using either of the following methods:
a. Nature of expense method- under this method, expenses are aggregated
according to their nature (e.g., depreciation, purchases of materials,
transport costs, employee benefits, and advertising costs) and are not
reallocated according to their functions within the entity.

b. Function of expense method- (Cost of sales method)- under this method,

an entity classifies expenses according to their function (e.g., cost of
sales, distribution costs, administrative expenses, and other functional
classifications). At a minimum, cost of sales shall be presented separately
from other expenses.

The nature of expense method is simpler to apply because it

eliminates considerable judgment needed in reallocating expenses according
to their function. However, an entity shall choose whichever method it deems

82
 will provide information that is reliable and more relevant, taking into account
historical and industry factors and the entity’s nature.
If the function of expense method is used, additional disclosures on
the nature of expenses shall be provided, including depreciation and
amortization expense and employee benefits expense. This information is
useful in predicting future cash flows.

Nature of Expense Method

Revenue xxx
Other income xxx
Changes in inventories of finished goods
and work in progress xx
Raw materials used xx
Employee benefits expense xx
Depreciation and amortization expense xx
Other expenses xx
Total expenses (xx)
Profit before tax xx
Income tax expense (xx) Profit after tax xx

Function of Expense Method

Revenue x
x
x
Cost of Sales (x
x)
Gross profit
x
x
Other income
x
x
83
 Distribution costs (x
x)
Administrative expenses (x
x)
Finance costs (x
x)
Other expenses (x
x)
Profit before tax
x
x
Income tax expense (x
x)
Profit after tax
x
x

Other Comprehensive Income (OCI) (Millan, 2018)

Other comprehensive income “comprises items of income and expense
(including reclassification adjustments) that are not recognized in profit or loss as
required or permitted by other PFRSs.”
The components of other comprehensive income include the following:
a. Changes in revaluation surplus;
b. Remeasurements of the net defined benefit liability (asset);
c. Gains and losses on investments designated or measured at fair value
through other comprehensive income (FVOCI);
d. Gains and losses arising from translating the financial statements of
foreign operations;
e. Effective portion of gains and losses on hedging instruments in a cash flow
hedge;
f. Changes in fair value of a financial liability designated at fair value through
profit or loss (FVPL) that are attributable to changes in credit risk;
g. Changes in the time value of option when the option’s intrinsic value and
time value are separated and only the changes in the intrinsic value is
designated as the hedging instrument;

84
 h. Changes in the value of the forward elements of forward contracts when
separating the forward element and spot element of forward contract and
designating as the hedging instrument only the changes in the spot
element; and changes in the value of the foreign currency basis spread of
a financial instrument when excluding it from the designation of that
financial instrument as the hedging instrument.

Amounts recognized in OCI are usually accumulated as separate

components of equity. For example, cumulative changes in revaluation
surplus are accumulated in a “Revaluation Surplus” account, which is
presented as a separate component of equity, cumulative gains and losses
from investments in FVOCI and from translation of foreign operation are also
accumulated in separate equity accounts.

Reclassification Adjustments
Items of OCI include reclassification adjustments (Millan, 2018).

 Reclassification adjustments “are amounts reclassified to profit or loss

in the current period that were recognized in other comprehensive
income in the current or previous periods.

Reclassification adjustments arise, for example, on disposal of a

foreign operation, derecognition of debt instruments measured ag FVOCI, or
when a cash flow hedge becomes ineffective or affects profit and loss.
On derecognition (or when the cash flow hedge becomes ineffective),
the cumulative gains and losses that were accumulated in equity on these
items are reclassified from OCI profit and loss. The amount reclassified is
called the reclassification adjustment.
A reclassification adjustment for a gain is a deduction in OCI and an
addition to profit or loss. This is to avoid double inclusion in total
comprehensive income. On the other hand, a reclassification adjustment for
a loss is an addition to OCI and a deduction from profit and loss.

85
 Reclassification adjustments do not arise on changes in revaluation
surplus, derecognition of equity instruments designated at FCOCI, and
remeasurements of the net defined benefit liability (asset).
On derecognition, the cumulative gains and losses that were
accumulated in equity on these items are transferred directly to retained
earnings, rather than to profit or loss as a reclassification adjustment.

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Presentation of OCI
The other comprehensive income section shall group items of OCI into
the following (Millan, 2018):
a. Those for which reclassification adjustment is allowed; and
b. Those for which reclassification adjustment is not allowed.

Those entity’s share in the OCI of an associate or joint venture

accounted for under the equity method shall also be presented separately
and also grouped according to the classification above.

Type of other comprehensive income Reclassification adjustment?

a. Changes in revaluation surplus No
b. Remeasurements of the net defined
benefit liability (asset) No
c. Fair value changes in FVOCI
- Equity instrument No

(election) Yes

- Debt instrument (mandatory)

d. Translation difference on foreign
operations Yes
e. Effective portion of cash flow hedges Yes

Items of OCI including reclassification adjustments, may be presented

at either net of tax or gross of tax.

Total Comprehensive Income

Total comprehensive income is “the change in equity during a period
resulting from transactions and other events, other than those changes
resulting from transactions with owners in their capacity as owners”. (PAS
1.7)

87
 Total comprehensive income is the sum of profit or loss and other
comprehensive income. It comprises all ‘non-owner’ changes in equity.
Presenting information on comprehensive income, and not just profit of loss,
helps users better assess the overall financial performance of the entity.

Illustration: Statement of Comprehensive Income

(Single-statement presentation/function of expense method)

Entity A
Statement of Profit or Loss and Other Comprehensive Income
For the year ended December 31, 20x2 (amounts in
Philippine Pesos)

Note 20x2
s 20x1
Revenue 700,000 500,0
00
Cost of sales (200,000) (120,000)
Gross profit 500,000 380,000
Other income 22,000 12,000
Distribution costs (48,000) ( 39,000)
Administrative Expenses ( 92,000) ( 71,000)
Impairment of property, plant and equipment ( 10,000) -
Other expenses ( 6,000) ( 5,000)
Finance costs ( 15,000) ( 18,000)
Share in the profit of associates 35,000 30,000
Profit before tax 386,000 289,000
Income tax expense ( 86,000)
( 79,000)
Profit for the year from continuing operations 300,000 210,000
Loss for the year for discontinued operations - ( 10,000)
Profit for the year 300,000 200,000
Other comprehensive income, after tax:
Items that will not be classified subsequently to profit or loss:
Gains on property revaluation - 23,000
Remeasurement of defined benefit plan ( 1,000) 2,000
( 1,000) 25,000
Items that may be classified subsequently to profit or loss:
Gain on translation of foreign operations 53,000 20,000

88
 Cash flow hedges ( 2,000) ( 5,000)
51,000 15,000
Other comprehensive income for the year 50,000 40,000

Total Comprehensive Income for the Year 350,000 240,000

Lesson 6. Statement of Changes in Equity (Millan, 2018)

Statement in changes in equity shows the following information:

a. Effects of change in accounting policy (retrospective application) or
correction of prior period error (retrospective restatement);
b. Total comprehensive income for the period; and
c. For each component of equity, a reconciliation between the carrying
amount at the beginning and the end of the period, showing separately
changes resulting from:
1. Profit and loss
2. Other comprehensive income
3. Transactions with owners, e.g., contributions by and
distributions to owners.

Restrospective adjustments and retrospective restatements are

presented in the statement of changes in equity as adjustments to the
opening balance of retained earnings rather than as changes in equity during
the period.
Components of equity include for example, each class of contributed
equity, the accumulated balance of each class of other comprehensive
income and retained earnings. (PAS1.108)
PAS 1 allows the disclosure of dividends, and the related amount per
share, either in the statement of changes in equity or in the notes. “Non-
owner” changes in equity are presented in the statement of comprehensive
income while “owner” changes (e.g., contributions and distributions to owners)
are presented in the statement of changes in equity. This is to provide better

89
 information by aggregating items with shared characteristics and separating
items with different characteristics.

Entity A
Statement of Changes in Equity
For the year ended December 31, 20x2
(amounts in Philippine Pesos)

Share Retained Revaluation Total

Capital earnings surplus
equity
Balance, Jan. 1, 20x1 1,000,000 700,000 300,000 2,000,0
00
Changes in equity for 20x1:
Profit for the year 200,000
200,000
Other comprehensive income 20,000
20,000
Total comprehensive income
220,000
Balance, Dec. 31, 20x1 1,000,000 900,000 320,000 2,220,0
00
Changes in equity for 20x2:
Profit for the year 300,000
300,000
Other comprehensive income 50,000 50,000
Total comprehensive income
350,000
Issue of share capital 500,000
500,000
Dividends (100,000)
(100,00
0)
Balance, Dec. 31, 20x2 1,500,000 1,100,000 370,000 2,970,0
00

Statement of Cash Flows

PAS1 refers the discussion and presentation of statement of cash flows to
PAS 7 Statement of Cash Flows.

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Lesson 7. Notes (Millan, 2018)
The notes provided information in addition to those presented in the other
financial statements. It is an integral part of a complete set of financial statements.
All the other financial statements are intended to be read in conjunction with the
notes. Accordingly, information in the other financial statements shall be
crossreferenced to the notes.
PAS 1 requires an entity to present the notes in a systematic manner. Notes
are normally structured as follows (Millan, 2018):

1. General information on the reporting entity

This includes the domicile and the legal form of the entity, its country
of incorporation and the address of its registered office (or principal
place of business, if different from the registered office) and a
description of the nature of the entity’s operations and its principal
activities.

2. Statement of compliance with the PFRSs and Basis for preparation of

financial statements.

3. Summary of significant accounting policies.

This includes narrative descriptions of the line items in the other
financial statements, their recognition criteria, measurement bases,
derecognition, transitional provisions, and other relevant information.

4. Disaggregation (breakdown) of the line items in the other financial

statements and other supporting information.

5. Other disclosures required by PFRSs, such as (the list is not exhaustive)

a. Contingent liabilities and unrecognized contractual commitments.
b. Non-financial disclosures, e.g., the entity’s financial risk management
objectives and policies.
c. Events after the reporting date, if material.

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d. Changes in accounting policies and accounting estimates and
corrections of prior period errors.
e. Related party disclosures
f. Judgments and estimations
g. Capital management
h. Dividends declared after the reporting period but before the financial
statements were authorized for issue, and the related amount per
share.

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 i. The amount of any cumulative preference dividends not recognized.

6. Other disclosures not required by PFRSs but the management deems

relevant to the understanding of the financial statements.

Notes are prepared in a necessarily detailed manner. More often than

not, they are voluminous and occupy a bulk portion of the financial
statements. For that reason, only excerpts of notes to the financial
statements are provided below, sufficient to give you an idea on how the
concepts discussed above are presented in the notes.

Illustration 1: General information. Basis of preparation and Statement of

compliance.

Entity A
Notes
December 31, 20x2

1. General information
Entity A (the Company) is a stock corporation incorporated and
domiciled in the Philippines. The Company is engaged in the
manufacture and sale of security devices, fire prevention, and other
electronic equipment. The Company’s registered office is located at 123
ABC St., XYZ City, Philippines.

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The financial statements of the Company for the year ended December 31,
20x2 were authorized for issue in accordance with a resolution of the board of
directors on March 1, 20x3.

2.1 Basis of preparation

The financial statements have been prepared on a historical cost basis,
except for inventories which are measured at the lower of cost and net
realizable value, investment in equity securities which are measured at fair
value with changes in fair values recognized in other comprehensive
income, and lands and buildings measured at revalued amounts. The
Company’s financial statements are presented in Philippine peso (P),
which is the Company’s functional currency.
2.2 Statement of compliance
The financial statements of the Company have been prepared in
accordance with Philippine Financial Reporting Standards (PFRSs).
PFRSs are adopted by the Financial Reporting Standards Council (FRSC)
from the pronouncements issued by the International Accounting
Standards Board (IASB).

Illustration 2: Summary of significant accounting policies

2.3 summary of significant accounting policies
(f) Inventories
Inventories are stated at the lower of cost and net realizable value.
Cost comprises direct materials, direct labor costs and factory
overheads that have been incurred in bringing the inventories to
their present location and condition. Cost is calculated using the
weighted average method. Net realizable value represents the
estimated selling price less all estimated costs to complete and
costs to sell.

Illustration 3: Significant judgments, estimates and assumptions

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 3. Significant accounting judgments, estimates and assumptions The
key assumptions concerning the future and other key sources of
estimation uncertainty at the reporting date that have significant
risk of causing a material adjustment to the carrying amounts of
assets and liabilities within the next financial year are discussed
below:

Revaluation of property, plant and equipment

The Company measures land and buildings at revalued amounts
with changes in fair value being recognized in other comprehensive
income. The Company engaged independent valuation specialists
to determine fair value as of December 31, 20x1.

Illustration 4: Supporting information for a line item in the statement of financial

position
4. Cash and cash equivalents This
account consists of:
20x2 20x1
Cash on hand P 35,362 P 47,665
Cash in banks 642,510 206,780
Cash equivalents 20,148 25,555
Total cash and cash equivalents P 698,020 P 280,000

ASSESSMENT
Discussion Questions
1. Enumerate and describe the general features of financial statement
presentation.
The general features of financial statement presentation are fair presentation and
compliance with PFRS’s, going concern, accrual basis of accounting, materiality and
95
 aggregation, offsetting, frequency of reporting, comparative information and consistency of
presentation.

2. What comprises the complete set of financial statements?

Discuss the general features of financial statements.

Fair presentation is reliably representing, within the financial explanations, the impact of
transactions and other occasions in agreement with the definitions and recognition criteria for
resources, liabilities, salary and expenses set out within the conceptual framework. Financial
statements are normally prepared on a going concern basis unless the entity has an intention to
liquidate or has no other alternative but to do so. All financial statements shall be prepared using
the accrual basis of accounting except for the statement of cash flows which is prepared using
the cash basis. Each material class of similar items is presented separately. A class of similar
items is called a “line item”. Dissimilar items are presented separately unless they are
immaterial. Assets and liabilities or income and expenses are presented separately and are not
offset, unless offsetting is required or permitted by PFRSs. Financial statements are prepared at
least annually. PAS 1 requires an entity to present comparative information in respect of the
preceding period for all amounts reported in the current period’s financial statements, unless
another PFRS requires otherwise. The presentation and classification of items in the financial
statements is retained from one period to the next unless a change in presentation is required
by a PFRS, or results in information that is reliable and more relevant.

2. What is the responsibility of management over financial statements?

3. What is the purpose of the Statement of financial position?
4. What is an asset? a liability?
An asset is a resource with economic value that an individual, corporation,
or country owns or controls with the expectation that it will provide a future
benefit. Assets are reported on a company's balance sheet and are bought
or created to increase a firm's value or benefit the firm's operations. An
asset can be thought of as something that, in the future, can generate cash
flow, reduce expenses, or improve sales, regardless of whether it's
manufacturing equipment or a patent. A liability is something a person or
company owes, usually a sum of money. Liabilities are settled over time
through the transfer of economic benefits including money, goods, or
services. Recorded on the right side of the balance sheet, liabilities include
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 loans, accounts payable, mortgages, deferred revenues, bonds,
warranties, and accrued expenses. 
7. What are current assets?
Current assets are short-term economic resources that are expected to be
converted into cash within one year. Current assets include cash and cash
equivalents, accounts receivable, inventory, and various prepaid expenses.
8. What are current liabilities?
A current liability is an obligation that is payable within one year. The
cluster of liabilities comprising current liabilities is closely watched, for a business
must have sufficient liquidity to ensure that they can be paid off when due.
5. What is the purpose of the Statement of profit or loss and other
comprehensive income?
6. Discuss the methods of presenting expenses.
7. What are the components of comprehensive income?
8. What is the purpose of Statement of cash flows?

True or False
1. The primary objective of financial accounting is to provide general purpose
financial statements to help external users analyze and interpret an
organization's activities. true
2. External auditors examine financial statements to verify that they are prepared
according to generally accepted accounting principles. true
3. External users include lenders, shareholders, customers, and regulators. true
4. A partnership is a business owned by two or more people. true
5. Owners of a corporation are called shareholders or stockholders. true
6. In the partnership form of business, the owners are called stockholders. false
7. The balance sheet shows a company's net income or loss due to earnings
activities over a period of time. true
8. Generally accepted accounting principles are the basic assumptions,
concepts, and guidelines for preparing financial statements. The business
entity assumption means that a business is accounted for separately from
other business entities, including its owner or owners. true
9. The business entity assumption means that a business is accounted for
separately from other business entities, including its owner or owners. true
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 10. As a general rule, revenues should not be recognized in the accounting
records until it is received in cash. Revenues are increases in equity from a
company's earning activities. true
11. A net loss occurs when revenues exceed expenses. false
12. Net income occurs when revenues exceed expenses. true
13. Liabilities are the owner's claim on assets. false
14. Assets are the resources of a company and are expected to yield future
benefits. true
15. Owner's withdrawals are expenses. true

Multiple choice:
1. The accounting concept that requires financial statement information to be supported
by independent, unbiased evidence other than someone's belief or opinion is:
A. Business entity assumption.
B. Monetary unit assumption.
C. Going-concern assumption.
D. Time-period assumption.
E. Objectivity.

2. The accounting assumption that requires every business to be accounted for

separately from other business entities, including its owner or owners is known as the:
A. Time-period assumption.
B. Business entity assumption.
C. Going-concern assumption.
D. Revenue recognition principle.
E. Cost principle.

3. The rule that requires financial statements to reflect the assumption that the business will
continue operating instead of being closed or sold, unless evidence shows that it will not
continue, is the:
A. Going-concern assumption.
B. Business entity assumption.
C. Objectivity principle.
D. Cost Principle.
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E. Monetary unit assumption.

4. To include the personal assets and transactions of a business's owner in the records
and reports of the business would be in conflict with the:
A. Objectivity principle.
B. Monetary unit assumption.
C. Business entity assumption.
D. Going-concern assumption.
E. Revenue recognition principle.

5. The accounting principle that requires accounting information to be based on actual

cost and requires assets and services to be recorded initially at the cash or cash-
equivalent amount given in exchange, is the:
A. Accounting equation.
B. Cost principle.
C. Going-concern assumption.
D. Realization principle.
E. Business entity assumption

6. Which of the following accounting principles would require that all goods and
services purchased be recorded at cost?
A. Going-concern assumption.
B. Matching principle.
C. Cost principle.
D. Business entity assumption.
E. Consideration assumption.

7. Which of the following accounting principles prescribes that a company record

its expenses incurred to generate the revenue reported?
A. Going-concern assumption.
B. Matching principle.
C. Cost principle.

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D. Business entity assumption.
E. Consideration assumption.
8. Revenue is properly recognized:
A. When the customer's order is received.
B. Only if the transaction creates an account receivable.
C. At the end of the accounting period.
D. Upon completion of the sale or when services have been performed and the
business obtains the right to collect the sales price. E. When cash from a sale is
received.

9. Net Income:
A. Decreases equity.
B. Represents the amount of assets owners put into a business.
C. Equals assets minus liabilities.
D. Is the excess of revenues over expenses.
E. Represents owners' claims against assets.

10. Resources that are expected to yield future benefits are:

A. Assets.
B. Revenues.
C. Liabilities.
D. Owner's Equity.
E. Expenses.

11. Increases in equity from a company's earnings activities are:

A. Assets.
B. Revenues.
C. Liabilities.
D. Owner's Equity.
E. Expenses.

12. The difference between a company's assets and its liabilities, or net assets is:
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A. Net Income
B. Expense.
C. Equity.
D. Revenue.
E. Net loss.

13. Creditors' claims on the assets of a company are called:

A. Net losses.
B. Expenses.
C. Revenues.
D. Equity.
E. Liabilities.

14. Decreases in equity that represent costs of assets or services used to earn revenues
are called:
A. Liabilities.
B. Equity.
C. Withdrawals.
D. Expenses.
E. Owner's Investment.

15.The description of the relation between a company's assets, liabilities, and equity,
which is expressed as Assets = Liabilities + Equity, is known as the:
A. Income statement equation.
B. Accounting equation.
C. Business equation.
D. Return on equity ratio.
E. Net income

SUMMARY
• The objective of PAS1 is to prescribe the basis for presentation of general purpose
financial statements to ensure comparability.
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• General purpose financial statements are those statements that cater to the common
needs of a wide range of primary (external) users.
• The purpose of general purpose financial statements is to provide information about
the financial position, financial performance, and cash flows of an entity that is useful
to a wide range of users in making economic decisions.
• A complete set of financial statements consists of the following
1). Statement of financial position
2). Statement of profit or loss and other comprehensive income
3). Statement of changes in equity
4). Statement of cash flows
5). Notes
5a) Comparative information
6). Additional statement of financial position when an entity makes a retrospective
application, retrospective restatement, or reclassifies items- with material effect.
• The statement of financial position may be presented either showing
current/noncurrent distinction (classified) or based on liquidity (unclassified). PAS 1
encourages the classified presentation.
• Deferred tax assets and deferred tax liabilities are presented as noncurrent items in a
classified statement of financial position.
• PAS 1 does not prescribe the order or format in which an entity presents items.
• Income and expenses may be presented
a. In a single-statement of profit or loss and other comprehensive income, or
b. In two statements- an income statement and a statement presenting
comprehensive income
• Other comprehensive income (OCI) comprises items of income and expense
(excluding reclassification adjustments) that are not recognized in profit or loss as
required or permitted by other PFRSs. OCI include:
a. Changes in revaluation surplus
b. Remeasurements of the net defined benefit liability (asset)
c. Unrealized gains and losses on FVOCI investments
d. Translation gains and losses on foreign operations, and
e. Effective portion of gains and losses on hedging instruments in a cash flow
hedge.

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 • Reclassification adjustments ar amounts reclassified from OCI to profit or loss.
• OCI may be presented net or gross of related taxes.
• Total comprehensive income includes all non-owner changes in equity. It comprises
profit or loss and other comprehensive income.
• Presenting extra ordinary items in the financial statements, including the notes, is
prohibited.
• Expenses may be presented using either nature of expense or function of expense
method. Additional disclosure is required when the function of expense method is
used.
• Dividends are disclosed either in the statement of changes in equity or in the notes.
• Owner changes in equity are presented in the statement of changes in equity.
Nonowner changes are presented in the statement of comprehensive income.
• The notes is an integral part of the financial statements. It presents:
a. Information regarding the basis of preparation of financial statements
b. Information required by PFRSs, and
c. Other information not required by PFRSs but is relevant to users of
financial statements.

REFERENCES

Millan, Z.V. B. (2018). Conceptual Framework and Accounting Standards. Baguio

City, Phils. Bandolin Enterprises.

Valix, C.T., Peralta, J.F., Valix, C. A. M.(2018). Conceptual Framework and

Accounting Standards. Manila City, Phils. GIC Enterprises & Co., Inc.

https://www.coursehero.com/file/11395228/Chapter-1-Introduction-to-
FinancialAccounting-pp-1-41/

https://www.coursehero.com/sg/introduction-to-finance/financial-statements/

MODULE 4

103
INTRODUCTION

INVENTORIES

PAS 2 prescribes the accounting treatment for inventories. PAS 2 recognizes

104
that a primary issued in the accounting for inventories is the determination of cost to be
recognized as asset and carried forward until it is expensed. Accordingly, PAS2 provides
guidance in the determination of cost of inventories, including the use of cost formulas, and
their subsequent measurement and recognition as expense (Millan, 2018).

LEARNING OUTCOMES
At the end of this module, students should be able to:
1. Define inventories.
2. Measure inventories and apply the cost formulas.
3. State the accounting for inventory write-down and the reversal thereof.

Lesson 1. Inventories
Inventories are assets held for sale in the ordinary course of business, in the
process of production for such sale or in the form of materials or supplies to be
consumed in the production process or in the rendering of services (Valix, Peralta &
Valix, 2019)

Inventories are as assets (Millan, 2018):

a. Held for sale in the ordinary course of business (finished goods);
b. In the process of production for such sale (work in process); or
c. In the form of materials or supplies to be consumed in the production
process or in the rendering of services (raw materials and manufacturing
supplies).
(PAS 2.6)

Examples of inventories:
a. Merchandise purchased by a trading entity and held for resale.
b. Land and other property held for sale in the ordinary course of business.
c. Finished goods, goods undergoing production, and raw materials and
supplies awaiting use in the production process by a manufacturing entity.
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 Ordinary course of business refers to the necessary, normal or usual
business activities of an entity.

Lesson 2. Application of PAS 2 (Millan, 2018)

PAS 2 applies to all inventories except for the following:

 Assets accounted for under other standards:
a. Financial instruments (PAS 32 and PFRS 9); and
b. Biological assets and agricultural produce at the point of harvest
(PAS 41).

 Assets not measured under the lower of cost or net realizable value
(NRV) under PAS 2
a. Inventories of producers of agricultural, forest, and mineral
products measured at net realizable value in accordance with well-
established practices in those industries.
b. Inventories of commodity broker-traders measured at fair value less
costs to sell.

Lesson 3 Measurement (Millan, 2018)

Inventories are measured at the lower of cost and net realizable value.]

Cost
The cost of inventories comprises the following:
a. Purchase cost- this includes the purchase price (net of trade discounts and
other rebates), import duties, non-refundable, or non-recoverable purchase
taxes and transport, handling, and other costs directly attributable the
acquisition of the inventory.
b. Conversion costs- these refer to the costs necessary in converting raw
materials into finished goods. Conversion costs include the costs of direct
labor and production overhead.

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c. Other costs necessary in bringing the inventories in their present location
and condition.

The following are excluded from the cost of inventories and are
expensed in the period in which they are incurred.
a. Abnormal amounts of wasted materials, labor or other production costs;
b. Storage costs unless those costs are necessary in the production process
before a further production stage (e.g., the storage costs of partly finished
goods may be capitalized as cost of inventory, but the storage costs of
completed goods are expensed).
c. Administrative overheads that do not contribute to bringing inventories to
their present location and condition; and
d. Selling costs.
(PAS 2.16)
When a purchase transaction effectively contains a financing element,
such as when payment of the purchase price is deferred, the difference
between the purchase price for normal credit terms and the amount paid is
recognized as interest expense over the period of the financing.

107
 Illustration:
Entity A acquires inventories and incurs the following costs:
Purchase price, gross of trade discount 100,000
Trade discount 20,000
Non-refundable purchase tax, not included
In the purchase price above 5,000
Freight-In (Transportation costs) 15,000
Commission to broker 2,000
Advertising costs 10,000
How much is the cost of inventories purchased?

Solution:
Purchase price, gross of trade discount 100,000
Trade discount (20,000)
Non-refundable purchase tax, not included
In the purchase price above 5,000
Freight-In (Transportation costs) 15,000
Commission to broker 2,000
Total costs of inventories 102,000

The advertising costs are selling costs. These are expensed in the
period in which they are incurred.
Cost formulas:

The cost formulas deal with the computation of cost of inventories that
are charged as expense when the related revenue is recognized (i.e., cost of
sales or cost of goods sold) as well as the cost of unsold inventories at the end
of the period that are recognized as asset (i.e, ending inventory). PAS 2
provides the following cost formulas:
Specific identification
Specific identification means that specific costs are attributed
to identified items of inventory. The cost of inventory is determined by
simply multiplying the units on hand by their actual unit cost. This

108
 requires records which will clearly determine the actual costs of goods
on hand (Valix, Peralta &Valix, 2019).
PAS 2, paragraph 23, provides that this method is
“appropriate for inventories that are segregated for specific project
and inventories that are not ordinarily interchangeable.

1. First-In, First-out (FIFO)

The FIFO method assumes that the goods first purchased are
first sold and consequently the goods remaining in the inventory at the
end of the period are those most recently purchased or produced
(Valix, Peralta &Valix, 2019).
In other words, the FIFO is in accordance with the ordinary
merchandising procedure that the goods are sold in the order they are
purchased.
The inventory is thus expressed in terms of recent or new
prices while the cost of goods sold is representative of earlier or old
prices (Valix, Peralta &Valix, 2019).

2. Weighted Average
Under this formula, cost of sales and ending inventory are
determined based on the weighted average cost of beginning inventory
and all inventories purchased or produced during the period. The average
may be calculated on a periodic basis, or as each additional purchase is
made depending upon the circumstances of the entity (Millan, 2018).
The cost formulas refer to the “cost flow assumptions”, meaning
they pertain to the flow of costs (i.e., from inventory to cost of sales) and
not necessarily to the actual physical flow of inventories. Thus, the FIFO
or Weighted Average can be used regardless of which item of inventory is
physically sold first.
PAS 2 does not permit the use of last-in, first –out (LIFO) cost
formula.

Illustration (Millan, 2018):

109
 Entity A, a trading entity, buys and sells Product A.Movements
in the inventory of Product A during the period are as follows:
Date Transaction Units Unit cost Total cost
Jan 1 Beginning Inventory 100 P10 P1,000
7 Purchase 300 12 3,600
12 Sale 320
21 Purchase 200 14 2,800

Case 1: FIFO
Compute the ending inventory and cost of sales using the FIFO cost
method:
Step 1: Compute for ending inventory in units.

Date Transactions Units

Jan 1 Beginning Inventory 100
7 Purchase 300
12 Sale (320)
21 Purchase 200
Ending inventory (in units) 280

Step 2: Compute for ending inventory at cost.

Units Unit cost Total cost
From Jan. 21 purchase 200 P14 P2,800
From Jan. 7 purchase 80 12 960
Ending inventory (at cost) P3,760

Step 3: Compute for cost of sales.

Date Transaction Units Unit cost Total cost
Jan 1 Beginning inventory 100 P10 P1,000
7 Purchase 300 12 3,6
00
2 Purchase 200 14 2,8
1 00

110
 Total goods available for 600 7,4
sale 00

Less: Ending inventory (280) (3,76

0)
Cost of sales 320 P3,6
40

Case 2: Weighted Average – Periodic (Millan, 2018)

Compute for the ending inventory and cost of sales using the Weighted
Average cost formula. The average is calculated on a periodic basis.
Step 1: Compute for the total goods available in units and at cost.
Date Transaction Units Unit cost Total cost
Jan Beginning inventory 100 P10 P1,000
1
7 Purchase 300 12 3,600
21 Purchase 200 14 2,800
Total goods available for sale 600 P7,400

Step 2: Compute for the weighted average unit cost.

Weighted average Total goods available for sale (TGAS) in

pesos
Cost = Total goods available for sale (TGAS) in units

Weighted average unit cost = P7,400÷ 600 = P12.33

Step 3: Compute for ending inventory at cost.

Ending inventory in units 280
Weighted average unit cost x P12.33
Ending inventory (at cost) P3,452.40

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 Step 4: Compute for cost of sales.
Total goods available for sale (at cost0 P7,400.00
Less: Ending inventory (at cost) (3,452.40)
Cost of sales P3,947.60

Case 3: Weighted Average- Moving Average (Millan, 2018):

Compute for the ending inventory and cost of sales using the Weighted
Average cost formula. The average is calculated as each additional purchase
is made (also called “moving average”).

Date Transaction Units Unit Total cost

cost
Jan 1 Beginning inventory 100 P10.00 P1,000.00
7 Purchase 300 12.00 3,600.00
400 11.50* 4,600.00
12 Sale (320) (3,680.00)
21 Purchase 200 14.00 2,800.00
Ending inventory 280 P3,720.00

*Moving average cost = TGAS at cost ÷ TGAS in units

= P4600 ÷ 400
= P11.50

Cost of sales = 320 units sold x P11.50 moving ave. cost

= P3,680

Net Realizable Value (NRV) (Millan, 2018)

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 Net realizable value is the estimated selling price in the ordinary
course of business less the estimated costs of completion and the estimated
costs necessary to make the sale (PAS 2.6).

NRV is different from fair value. Net realizable value refers to the net
amount that an entity expects to realize from the sale of inventory in the
ordinary course of business. Fair value reflects the price at which an orderly
transaction to sell the same inventory would take place between market
participants at the measurement date. The former is entity-specific value; the
latter is not. Net realizable value for inventories may not equal fair value less
costs to sell.

Measuring inventories at the lower of cost and NRV is in line with the
basic accounting concept that an asset shall not be carried at an amount that
exceeds its recoverable amount.

The cost of an inventory may exceed its recoverable amount if, for
example, the inventory is damaged, becomes obsolete, prices have declined,
or the estimated costs to complete or to sell the inventory have increased. In
these circumstances, the cost of the inventory is written-down to NRV. The
amount of write-down is recognized as expense.

If the NRV subsequently increases, the previous write-down is

reversed. However, the amount of reversal shall not exceed the original
writedown. This is so that the new carrying amount is the lower of the cost
and the revised NRV.

Write-downs of inventories are usually carried out on an item by item

basis, although in some circumstances, it may be appropriate to group similar
items. It is not appropriate to write down inventories on the basis of their
classification (e.g., finished goods or all inventories of an operating segment.)
Raw materials inventory is not written down below cost if the finished
goods in which they will be incorporated are expected to be sold at or above

113
 cost. If, however, this is not the case, the raw materials are written down to
their NRV. The best evidence of NRV for raw materials is replacement cost.

Illustration 1
Information on Entity A’s inventories is as follows:
Product A Product B
Cost 100,000 200,0
00
Estimated selling price 140,000 220,0
00
Estimated cost to sell 20,000 30,0
00

Requirement: Compute for the valuation of Products A and B in Entity

A’s Statement of financial position.

Solution:
Product A Product b
Cost 100,000 200,000

Estimated selling price 140,000 220,000

Estimated cost to sell (20,000) (30,000)
Net realizable value 120,000 190,000
Lower 100,000 190,000
Amount of write-down 10,000

Analysis
 Product A need not be written-down because it s cost is
lower than NRV.
 Product B must be written-down by P10,000 because its
cost exceeds its NRV.
 The total inventory to be shown in the statement of
financial position is P290,000. (A 100,000 + B 190,000)
 The P10,000 write-down is recognized as expense in
profit and loss.

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 Assume that in the subsequent period, the NRV of Product B increases
as follows:
Product B
Cost 80,000
Net realizable value 100,000
Analysis:
 The increase is P20,000 (100,000 – 80,000). However,
the amount of reversal that Entity A can recognize is
limited to P10,000, the amount of the original writedown.
 The amount of inventory to be shown in the statement of
financial position is P90,000 (80,000 cost + 10,000
reversal.)

Illustration 2
Information on Entity A’s inventories is as follows:
Raw materials Finished Goods
Cost 60,000 100,000
Replacement cost /NRV 50,000 120,000

Requirement: Compute for the valuation of the inventories in

Entity A’s statement of financial position.

Answer:
P160,000 total cost (60,000 + 100,000). The raw materials
need not be written-down to replacement cost because the NRV of
the finished goods exceeds the cost.

Lesson 4. Recognition as an expense (Millan, 2018)

The carrying amount of an inventory that is sold is charged as

expense (i.e., cost of sales) in the period in which the related revenue is
recognized. Likewise, the write-down of inventories to NRV and all losses of

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 inventories are recognized as expense in the period the write-down or loss
occurs.
“The amount of any reversal of any write-down of inventories arising
from an increase in net realizable value shall be recognized as a reduction in
the amount of inventories recognized as expense in the period in which the
reversal occurs (PAS 2.34).
Inventories that are used in the construction of another asset is not
expensed but rather capitalized as cost of the constructed asset. For
example, some inventories may be used in constructing a building. The cost
of those inventories is capitalized as cost of the building and will be included
in the depreciation of the building.

Lesson 5. Disclosures (Millan, 2018)

a. Accounting policies adopted in measuring inventories, including cost

formula used;
b. Total carrying amount of inventories and the carrying amount in
classifications appropriate to the entity;
c. Carrying amount of inventories carried at fair value less costs to sell;
d. Amount of inventories recognized as an expense in the period.
e. Amount of any write-down of inventories recognized as an expense in the
period;
f. Amount of any reversal of write-down that is recognized as a reduction in
the amount of inventories recognized as expense in the period;
g. Circumstances or events that led to the reversal of a write-down of
inventories; and
h. Carrying amount of inventories pledged as security for liabilities.
(PAS 2.36)

ASSESSMENT

Discussion Questions:
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 1. Define inventories and its characteristics. Give examples.
2. How are inventories measured?
3. Discuss the cost measurement.
4. Discuss the net realizable value.

True of False:

1. Merchandise inventory consists of products that a company acquires to resell to

customers.
2. A service company earns net income by buying and selling merchandise.
3. Gross profit is also called gross margin.
4. Cost of goods sold is also called cost of sales.
5. A wholesaler is an intermediary that buys products from manufacturers or other
wholesalers and sells them to consumers.
6. A retailer is an intermediary that buys products from manufacturers and sells them to
wholesalers.
7. Cost of goods sold represents the cost of buying and preparing merchandise for sale.
8. A merchandising company's operating cycle begins with the sale of merchandise
and ends with the collection of cash from the sale.
9. Merchandise inventory is reported in the long-term assets section of the balance
sheet. 10. Cash sales shorten the operating cycle for a merchandiser; credit sales
lengthen operating cycles.
11. Assets tied up in inventory are not productive assets.
12. A perpetual inventory system requires updating of the inventory account only at the
beginning of an accounting period.

13. A perpetual inventory system continually updates accounting records for inventory
transactions.
14. Beginning merchandise inventory plus the net cost of purchases is the merchandise
available for sale.
15. The Merchandise Inventory account balance at the end of the current period is equal
to the amount of beginning merchandise inventory for the next period.

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 16. Credit terms for a purchase include the amounts and timing of payments from a buyer
to a seller.
17. Purchase returns refer to merchandise a buyer acquires but then returns to the seller.
18. Purchase allowances refer to merchandise a buyer acquires but then returns to the
seller.
19. Under the perpetual inventory system, the cost of merchandise purchased is recorded
in the Merchandise Inventory account.
20. Credit terms of 2/10, n/30 imply that the seller offers the purchaser a 2% cash
discount if the amount is paid within 10 days of the invoice date. Otherwise, the full
amount is due in 30 days.
21. Sellers always offer a discount to buyers for prompt payment toward purchases made
on credit.
22. Purchase discounts are the same as trade discounts.
23. If a company sells merchandise with credit terms 2/10 n/60, the credit period is 10
days and the discount period is 60 days.
24. Sales discounts on credit sales can benefit a seller by decreasing the delay in
receiving cash and reducing future collections efforts.
25. Sales discounts is a contra revenue account, meaning that the Sales Discounts
account is added to the Sales account when computing a company's net sales.

SUMMARY

• Inventories include goods that are held for sale in the ordinary course of business,
in the process of production for such sale, and in the form of materials and
supplies to be consumed in the production.
• Inventories are measured at the lower of cost and net realizable value (NRV).
• The cost of inventories comprises all costs of purchase, cost of conversion and
other costs incurred in bringing the inventories to their present location and
condition.
• Trade discounts, rebates and other similar items are deducted in determining the
costs of purchase.

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 • The following are excluded from the cost of inventory: abnormal costs, storage
costs, unless necessary, administrative costs and selling costs.
• The cost formulas permitted under PAS 2 are specific identification, FIFO, and
weighted average.
• Specific identification shall be used for inventories which are not ordinarily
interchangeable.
• Net realizable value is the estimated selling price in the ordinary course of
business less the estimated costs of completion and the estimated costs
necessary to make the sale.
• Inventories are usually written-down to NRV on an item by item basis.
• Raw materials inventory is not written-down below cost if the finished goods in
which they will be incorporated are expected to be sold at or above cost.
• Reversals of inventory write-downs shall not exceed the amount of the original
write-down.

REFERENCES

Ballada, W., Ballada, S. (2019). Basic Accounting Made Easy. Manila. Domdane
Publishers.

Millan, Z.V. B. (2018). Conceptual Framework and Accounting Standards. Baguio

City, Phils. Bandolin Enterprises.

Valix, C.T., Peralta, J.F., Valix, C. A. M.(2018). Conceptual Framework and

Accounting Standards. Manila City, Phils. GIC Enterprises & Co., Inc.

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