ACCTG 121N CHAPTERS 5-11
description or disaggregation of items presented in
Financial Statements- are the means by which the
information accumulated and processed in financial
accounting is periodically communicated to the users
- the end product or main output of the
financial accounting process
General Purpose Financial Statements- directed to all
common users and not to specific users
Components of Financial Statements
1. Statement of Financial Position
2. Statement of Financial Performance
3. Statement of Comprehensive Income
4. Statement of Changes in Equity
5. Statement of Cash Flows
6. Notes to Financial Statement
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 shall be presented atleast
annually.
Investors, creditors, and other statement users analyze
the statement of financial position to evaluate factors
such as liquidity, solvency, and the need of the entity
for additional financing.
Asset- resources controlled by an entity as a result of
past events and from which future economic benefits
are expected to flow
Operating cycle- time between the acquisition of
assets for processing and their realization in cash or
cash equivalents
Accounts are usually listed according to liquidity.
Property, Plant, and Equipment- tangible assets
which are held by an entity for use in production or
supply of goods and services
Long-term Investments- as asset held by an entity for
the accretion of wealth through capital distribution
Intangible Assets- identifiable non-monetary assets
without physical substance
Goodwill- an example of an unidentifiable intangible
asset
Liability- present obligation of an entity arising from
past events
Covenants- often attached to borrowing agreements
which represent undertakings by the borrower
Equity- is the residual interest in the assets of the
entity after deducting all of its liabilities
Shareholders’ Equity- is the residual interest of
owners in the net assets of a corporation measured
by the excess of assets over liabilities
Notes to Financial Statements- provide narrative
the financial statements
Forms of Statement of Financial Position
1. Report Form- downward
2. Account Form- left and right side
Income Statement- a formal statement showing the
financial performance of an entity for a given period
of time
- Results of operations of the entity
Transaction Approach- traditional preparation of the
income statement in conformity with accounting
standards
Information about financial performance is useful in
predicting future performance and ability to generate
future cash flows
Comprehensive Income- change in equity during a
period resulting from transactions and other events,
other than changes resulting from transactions with
owners in their capacity as owners
Profit or Loss- total of income less expense, excluding
the components of other comprehensive income
- bottom line in the traditional income
statement
Other Comprehensive Income- comprises items of
income and expenses including reclassification
adjustments that are not recognized in profit or loss
Presentation of Comprehensive Income
1. Two Statements
a. An income statement showing the
components of profit or loss.
b. A statement of comprehensive income
beginning with profit or loss as shown in
the income statement plus or minus the
components of other comprehensive
income
2. Single Statement
This is the combined statement showing the
components of profit or loss and components
of other comprehensive income in a single
statement.
Sources of Income
a. Sales of merchandise to customers
b. Rendering of services
c. Use of entity resources
d. Disposal of resources other than products
Classification of Expenses
1. Cost of Goods Sold
2. Distribution Costs- constitute costs which are
directly related to selling, advertising, and
delivery of goods to customers
 3. Administrative Expenses- constitute cost of
administering the business
4. Other Expenses- those expenses which are
not directly related to the selling and
administrative function
5. Income Tax Expense
Forms of Income Statement
1. Functional Presentation- commonly used
2. Natural Presentation-does not recognize cost
of goods sold
Statement of Retained Earnings- shows the changes
affecting directly the retained earnings of an entity
and relates the income statement to the statement of
financial position
Statement of Changes in Equity- a basic statement
that shows the movements in the elements or
components of the shareholders’ equity
Statement of Cash Flows- a basic component of the
financial statements which summarizes the
operating, investing, and financing activities of an
entity
Inventories- 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
Class of Inventories
1. Trading Concern- one that buys and sells
goods in the same form purchased
2. Manufacturing Concern- one that buys goods
which are altered or converted into another
form before they are made available for sale
The inventories of a manufacturing concern are:
a. Finished Goods
b. Goods in Process
c. Raw Materials
d. Manufacturing Supplies
Cost of Inventories
a. Cost of Purchase- comprises the purchase
price, import duties and irrecoverable taxes,
freight, handling and other costs directly
attributable to the acquisition of finished
goods, materials, and services
b. Cost of Conversion- includes cost directly
related to the units of production such as
direct labor
- also includes a systematic allocation of fixed
and variable production overhead
Fixed Production Overhead- indirect cost of
production that remains relatively constant
regardless of the volume of production
Variable Production Overhead- indirect cost of
production that varies directly with the volume of
production
3. Other Cost- included on the cost of
inventories only to the extent that it is
incurred in bringing the inventories to their
present location and condition
Cost Formulas
1. First In, First Out (FIFO)- the goods first
purchased are first sold
2. Weighted Average- computed by dividing the
total costs of goods available for sale by the
total number of units available for sale
3. Last In, First Out (LIFO)- the goods last
purchased are first sold
Specific Identification- means that specific costs are
attributed to identified items of inventory
Low Cost Net Realizable Value (LCNRV)- the
measurement of inventory at the lower of cost and
net realizable value
Net Realizable Value- is the estimated selling price in
the ordinary course of business less the estimated
cost of completion and the estimated cost of disposal
Inventories are usually written down to net realizable
value on an item by item or individual basis.
Allowance Method- the inventory is recorded at cost
and any loss on inventory writedown is accounted for
separately
The primary purpose of a statement of cash flows is to
provide relevant information about cash receipts and
cash payments of an entity during a period.
Cash Flows- inflows and outflows of cash and cash
equivalents
Operating Activities- are the cash flows derived
primarily from the principal revenue producing
activities of the entity
Investing Activities- are the cash flows derived from
the acquisition and disposal of long-term assets and
other investments not included in cash equivalent
Financing Activities- are the cash flows derived from
the equity capital and borrowing of the entity
Tax cash flows are often difficult to match to the
originating underlying transaction, so most of the time
all tax cash flows are classified as arising from
operating activities.
Accounting Policies- are the specific principles, bases,
conventions, rules, and practices applied by an entity
in preparing and presenting financial statements
The entity shall select and apply the same accounting The financial statements are authorized for issue on
policies each period in order to achieve comparability the date of issue by the board of directors and not on
of financial statements. the date when shareholders approve the financial
statements.
Change in Accounting Policy
a. Required by an accounting standard
Accounting Income- net income for the period before
b. Will result in more relevant and faithfully
deducting income tax expense
represented information
Taxable Income- income for the period determined in
A change in accounting policy required by a standard
accordance with the rules established by the taxation
or an interpretation shall be applied in accordance
authorities upon which income taxes are payable or
with the transitional provisions therein.
recoverable
If the standard or interpretation contains no
Differences between accounting and taxable income
transitional provisions or if an accounting policy is
changed voluntarily, the change shall be applied 1. Permanent Difference- items of revenue and
retrospectively or retroactively. expense which are included in either
accounting income or taxable income but will
Retrospective Application- means that any resulting
never be included in the other
adjustment from the change in accounting policy
- pertain to nontaxable revenue and
shall be reported as an adjustment to the opening
nondeductible expenses
balance of retained earnings
Examples:
In the absence of accounting standard that specifically
applies to a transaction, management shall use Interest Income on Deposits Dividends Received
judgment in selecting and applying an accounting
Life Insurance Premium Tax Penalties
policy that results in information that is relevant to the
economic decision making needs of users and faithfully 2. Temporary Differences- items of income and
represented. expenses which are included in both
accounting income and taxable income but at
Change in Accounting Estimate- is a normal recurring
different time periods
correction or adjustment of an asset or liability which
is naturally result of the use of an estimate Temporary differences give rise either to a deferred tax
liability or deferred tax asset.
- not a correction of an error
Deferred tax liability- is the amount of income tax
The effect of a change in accounting estimate shall be
payable in future periods with respect to a taxable
recognized currently and prospectively by including it
temporary difference
in income or loss.
A deferred tax liability arises when accounting income
Changes in accounting estimates are handled currently
is higher than taxable income because of future taxable
and prospectively, if necessary.
amount.
Prospective Recognition- the change is applied to
Operating loss carryforward- an excess of tax
transactions, other events and conditions from the
deductions over gross income in a year that may be
date of change in estimate
carried forward to reduce taxable income in a future
Prior period errors- omissions and misstatements in year
the financial statements for one or more periods
Deferred Tax Asset- deferred tax consequence
arising from a failure to use or misuse of reliable
attributable to a future deductible amount and
information
operating loss carryforward
Prior period errors shall be corrected retrospectively
A deferred tax asset arises when taxable income is
by adjusting the opening balances of retained earnings
higher than accounting income because of future
and affected assets and liabilities.
deductible amount.
Current Tax Liability- current tax expense or the
Subsequent Events- events after the reporting period
amount of income tax actually payable
Types of Events after the Reporting Period
Under our income tax law, income tax for corporations
1. Adjusting Events- provide evidence of is payable very quarter.
conditions that exist at the end of reporting
A current tax liability or current tax asset shall be
period
measured using the tax rate that has been enacted and
2. Nonadjusting Events- indicative of conditions
effective at the end of the reporting period.
that arise after the end of reporting period
A deferred tax asset or liability shall not be discounted.