FINANCIAL ACCOUNTING & REPORTING 3

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Financial statements and conceptual framework for financial reporting

Module 001 Week001- FinAcct3 Financial

statements and conceptual framework for
financial reporting
Financial statements are the means by which the information accumulated
and processed in financial accounting is periodically communicated to the
users. It is a structured representation of the financial position and financial
performance of an entity. The objective of the 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. Financial statements that are intended to meet the needs
of users who are not in a position to require an entity to prepare reports
tailored to their particular information needs are called general purpose
financial statements. A complete set of financial statements comprises the
following components: statement of financial position, income statement,
statement of comprehensive income, statement of changes in equity,
statement of cash flows and notes. The main standard that will be considered
in this module is PAS 1 Presentation of Financial Statements. Per PAS 1,
financial statements shall present fairly the financial position, financial
performance and cash flows of an entity. Fair presentation requires the
faithful representation of the effects of transactions, other events and
conditions in accordance with the definitions and recognition criteria for
assets, liabilities, income and expenses set out in the IASB’s Conceptual
Framework for Financial Reporting (IASB Framework). PAS 1 applies to
general purpose financial statements.

At the end of this module, you will be able to:

1. Understand the nature, purpose and objective of financial statements
2. Identify and define each components of financial statements
3. Understand the responsibility and the accountability of management in
the financial statements
4. Enumerate and explain the general features of the financial statements
5. Define the elements of financial statements
6. Clearly identify financial statement and distinguish from other
information

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Financial statements and conceptual framework for financial reporting

Definition of financial statements

The published accounts of an entity are intended to provide a report to enable

shareholders to assess current year stewardship and management performance and to
predict future cash flows. In order to assess stewardship and management performance,
there have been mandatory requirements for standardized presentation, using formats
prescribed by Philippine Financial Reporting Standards and this is called financial
statements.
Financial statements are a structured representation of the financial position and financial
performance of an entity.
They are intended to be understandable by readers who have "a reasonable knowledge of
business and economic activities and accounting and who are willing to study the
information diligently.”
Elements of financial statements - broad classes of events or transactions that are grouped
according to their economic characteristics. The elements of financial statements are the
“building blocks” from which financial statements are constructed.
The elements directly related to the measurement of financial position are asset, liability and
equity.
The elements directly related to the measurement of financial performance are income and
expense.
Asset is defined as “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”
Liability is defined as “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”
Equity is the “residual interest in the assets of the entity after deducting all of the liabilities”
Income is “increase in economic benefit during the accounting period in the form of inflow
or increase in asset or decrease in liability that results in increase in equity, other than
contribution from equity participants”
Expense is “decrease in economic benefit during the accounting period in the form of
outflow or decrease in asset or increase in liability that results in decrease in equity, other
than distribution to equity participants”

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Financial statements and conceptual framework for financial reporting

General purpose financial statements

PAS 1 prescribes the basis for presentation of general purpose financial statements to
ensure comparability both with the entity's financial statements of previous periods and
with the financial statements of other entities. It sets out overall requirements for the
presentation of financial statements, guidelines for their structure and minimum
requirements for their content.
General purpose financial statements are those statements intended to meet the needs of
users who are not in a position to require an entity to prepare reports tailored to their
particular information needs.
However, it may be difficult or impossible to satisfy the needs of all users. For example,
users may have different time-scales – shareholders may be interested in the long-term
trend of earnings over three years, whereas creditors may be interested in the likelihood of
receiving cash within the next three months.
The information needs of the shareholders are regarded as the primary concern. The
government perceives shareholders to be important because they provide companies with
their economic resources. It is shareholders’ needs that take priority in deciding on the
nature and detailed content of the general-purpose reports.

Components of financial statements

A complete set of financial statements comprises:

a. a statement of financial position as at the end of the period;
b. a statement of profit or loss and other comprehensive income for the period;
c. statement of changes in equity for the period;
d. a statement of cash flows for the period;
e. notes, comprising significant accounting policies and other explanatory information;
f. comparative information in respect of the preceding period; and
g. a statement of financial position as at the beginning of the preceding period when an
entity applies an accounting policy retrospectively or makes a retrospective
restatement of items in its financial statements, or when it reclassifies items in its
financial statements.
Many entities also present reports and statements such as environmental reports and value
added statements, particularly in industries in which environmental factors are significant
and when employees are regarded as an important user group.

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Financial statements and conceptual framework for financial reporting

However, such statements and reports are not components of financial statements and
therefore outside of the scope of PFRS.

Objectives of financial statements

The objective of 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. Financial statements also show the results of management's
stewardship of the resources entrusted to it.
To meet this objective, financial statements provide information about an entity's:
a. Assets
b. Liabilities
c. Equity
d. Income and expenses, including gains and losses
e. Contributions by and distributions to owners in their capacity as owners, who are
holders of instruments classified as equity.
f. Cash flows
This information, along with other information in the notes, assists users of financial
statements in predicting the entity's future cash flows and, in particular, their timing and
certainty.
However, financial statements do not provide all the information that users may need to
make economic decisions since they largely portray the financial effects past events and
don not necessarily provide nonfinancial information.
The financial position comprises the assets, liabilities and equity of an entity at a
particular moment in time. Specifically, financial position pertains to the liquidity, solvency,
and the need of the entity for additional financing. This information is pictured in the
statement of financial position.
The financial performance comprises the revenue, expenses and net income or loss of an
entity for a period of time. Performance is the level of income earned by the entity through
the efficient and effective use of its resources. The financial performance of an entity is also
known as results of operations and is portrayed in the income statement and statement
of comprehensive income.
Cash flows are the cash receipts and cash payments arising from the operating, investing
and financing activities of the entity. This information is presented in the statement of
cash flows.

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Financial statements and conceptual framework for financial reporting

Responsibility of financial statements

The management of the entity is primarily responsible for the preparation and presentation
of the financial statements.
The Board of Directors in discharging its responsibilities reviews and authorizes the
financial statements for issue before these are submitted to the shareholders.

Accountability of management

Management is also accountable for the safekeeping of the resources and their proper,
efficient and profitable use.
Shareholders are interested in information that helps them assess how effectively
management has fulfilled this role as this is relevant to the decision concerning their
investment and the reappointment or replacement of management.

General features of financial statements

Fair presentation and compliance with IFRS

Financial statements shall present fairly the financial position, financial performance and
cash flows of an entity. Fair presentation requires the faithful representation of the effects
of transactions, other events and conditions in accordance with the definitions and
recognition criteria for assets, liabilities, income and expenses.
Virtually, in all circumstances, fair presentation is achieved if the financial statements are
prepared in accordance with the Philippine Financial Reporting Standards which represent
the GAAP in the Philippines. The application of PFRSs, with additional disclosure when
necessary, is presumed to result in financial statements that achieve a fair presentation.
An entity whose financial statements comply with PFRS shall make an explicit and unreserved
statement of such compliance in the notes.
Fair representation requires an entity:
a. To select and apply accounting policies in accordance with PFRS
b. To present information, including accounting policies, in a manner that provides
relevant, reliable, comparable and understandable information.
c. To provide additional disclosures when compliance with the specific requirements in
PFRSs is insufficient to enable users to understand the impact of particular transactions,
other events and conditions on the entity's financial position and financial performance.

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Financial statements and conceptual framework for financial reporting

In the extremely rare circumstances in which management concludes that compliance with
a requirement in an IFRS would be so misleading that it would conflict with the objective of
financial statements, the entity shall depart from that requirement if the relevant regulatory
framework requires, or otherwise does not prohibit, such a departure.
Going concern
Going concern means that the accounting entity is viewed as continuing in operation
indefinitely in the absence of evidence to the contrary. It is also known as continuity
assumption.
Thus, assets are normally recorded at original acquisition cost. As a rule, market values are
ignored.
This postulate is the very foundation of the cost principle.
When preparing financial statements, management shall make an assessment of an entity's
ability to continue as a going concern. An entity shall prepare financial statements on a going
concern basis unless management either intends to liquidate the entity or to cease trading,
or has no realistic alternative but to do so.
Accrual basis
An entity shall prepare its financial statements, except for cash flow information, using the
accrual basis of accounting.
When the accrual basis of accounting is used, an entity recognizes items as assets, liabilities,
equity, income and expenses (the elements of financial statements) when they satisfy the
definitions and recognition criteria for those elements.
This means that the effects of transactions and other events are recognized when they occur
and not as cash or cash equivalent is received or paid, and they are recorded and reported in
the financial statements of the periods to which they relate.
Materiality and aggregation
An entity shall present separately each material class of similar items. An entity shall
present separately items of a dissimilar nature or function unless they are immaterial.
Financial statements result from processing large numbers of transactions or other events
that are aggregated into classes according to their nature or function.
The final stage in the process of aggregation and classification is the presentation of
condensed and classified data, which form line items in the financial statements.
For example, cash on hand, petty cash fund, cash in bank and cash equivalent shall be
presented as one item “cash and cash equivalents”.

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Financial statements and conceptual framework for financial reporting

If a line item is not individually material, it is aggregated with other items either in those
statements or in the notes. An item that is not sufficiently material to warrant separate
presentation in those statements may warrant separate presentation in the notes.
For example, an investor’s share in the net income of an associate is presented as a separate
line item in the income statement.
When is an item material?
There is no strict or uniform rule for determining whether an item is material or not. Very
often, this is dependent on good judgement, professional expertise and common
sense.
However, a general guide may be given, to wit:
An item is material if knowledge of it would affect the decision of the informed users of the
financial statements.
An example is the common practice of large entities of rounding amounts to the nearest
thousand pesos in their financial statements while small entities may round off to the
nearest peso.
Factors of materiality
a. Relative size of the item in relation to the total of the group to which the item belongs.
b. Nature of the item – An item may be inherently material because by its very nature it
affects economic decision.
This means that the effects of transactions and other events are recognized when they occur
and not as cash or cash equivalent is received or paid, and they are recorded and reported in
the financial statements of the period s to which they relate.
Offsetting
An entity shall not offset assets and liabilities or income and expenses, unless required or
permitted by the standards.
An entity reports separately both assets and liabilities, and income and expenses. Offsetting
in the statement(s) of profit or loss and other comprehensive income or financial position,
except when offsetting reflects the substance of the transaction or other event, detracts from
the ability of users both to understand the transactions, other events and conditions that
have occurred and to assess the entity's future cash flows. Measuring assets net of valuation
allowances—for example, obsolescence allowances on inventories and doubtful debts
allowances on receivables—is not offsetting.

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Financial statements and conceptual framework for financial reporting

Frequency of reporting
An entity shall present a complete set of financial statements (including comparative
information) at least annually.
When an entity changes the end of its reporting period and presents financial statements for
a period longer or shorter than one year, an entity shall disclose, in addition to the period
covered by the financial statements:
a. The reason for using a longer or shorter period, and
b. The fact that amounts presented in the financial statements are not entirely
comparable.
Normally, an entity consistently prepares financial statements for a one-year period.
However, for practical reasons, some entities prefer to report, for example, for a 52-week
period. This Standard does not preclude this practice.
Comparative information
Except when permitted or required otherwise by PFRS, an entity shall disclose comparative
information in respect of the previous period for all amounts reported in the current period’s
financial statements.
Comparative information shall be included for narrative and descriptive information when
it is relevant to an understanding of the current period’s financial statements.
An entity shall present, as a minimum, two statements of financial position, two statements
of profit or loss and other comprehensive income, two separate statements of profit or loss
(if presented), two statements of cash flows and two statements of changes in equity, and
related notes.
A third statement of financial position is required when an entity:
a. Applies an accounting policy retrospectively
b. Makes retrospective restatement of items in the financial statements
c. Reclassifies items in the financial statements
Under these circumstances, an entity shall present three statement of financial position as
at:
a. The end of the current period
b. The end of the previous period
c. The beginning of the earliest comparative period
Consistency of presentation
Implicit in the presentation of comparable information is the principle of consistency.
The principle of consistency requires that “the accounting methods and practices shall be
applied on a uniform basis from period to period”.
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Financial statements and conceptual framework for financial reporting

The presentation and classification of financial statement items shall be uniform from one
accounting period to the next.
Consistency is desirable and essential to achieve comparability of financial statements.
However, consistency does not mean that no change in accounting method can be made.
If the change will result to information that is faithfully represented and more relevant to
the users of financial statements, then such change should be made but there should be full
disclosure of the change and the peso effect of the change.
It is inappropriate for an entity to leave accounting policies unchanged when better and
acceptable alternatives exist.

Identification of financial statements

An entity shall clearly identify the financial statements and distinguish them from other
information in the same published document.
In addition, an entity shall display the following information prominently, and repeat it
when necessary for the information presented to be understandable:
 the name of the reporting entity or other means of identification, and any change in
that information from the end of the preceding reporting period;
 whether the financial statements are of an individual entity or a group of entities;
 the date of the end of the reporting period or the period covered by the set of
financial statements or notes;
 the presentation currency; and
 the level of rounding used in presenting amounts in the financial statements.
Financial statements are often made more understandable by presenting information in
thousands or millions of units of the presentation currency.
This is acceptable as long as the level of rounding in presentation is disclosed and relevant
and material transaction is not lost or omitted.

References and Supplementary Materials

Books and Journals

Valix, C., Peralta, J. & Valix, C.A; 2016; Financial Accounting Volume 3; Metro Manila,
Philippines; GIC Enterprises & Co., Inc.

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Financial statements and conceptual framework for financial reporting

Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield; 2013; Intermediate Accounting;

United States; John Wiley & Sons, Inc.

Barry Elliot, Jamie Elliot; 2011; Financial Accounting and Reporting; Essex CM20 2JE,
England; Pearson Education Limited

Online Supplementary Reading Materials

The Conceptual Framework;
http://www.fasb.org/jsp/FASB/Page/BridgePage&cid=1176168367774; October 29,
2017

The Conceptual Framework; http://www.ifrs.org/projects/work-plan/conceptual-

framework/; October 29, 2017

IASplus; https://www.iasplus.com/en/resources/ifrsf/iasb-ifrs-ic/iasb; October 29,

2017

IASplus; https://www.iasplus.com/en/standards/ias/ias; October 29, 2017

Online Instructional Videos

The Conceptual Framework Intermediate Accounting CPA Exam;
https://www.bing.com/videos/search?q=conceptual+framework&&view=detail&mid=222
050C98AACF518049E222050C98AACF518049E&FORM=VRDGARl; January 10, 2018

Financial Accounting Conceptual Framework (Financial Accounting Tutorial #12);

https://www.bing.com/videos/search?q=conceptual+framework&&view=detail&mid=8E
AF86DFB689D8DCF6278EAF86DFB689D8DCF627&FORM=VRDGAR; January 10, 2018

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