CHAPTER 1 FINANCIAL STATEMENTS ‘TECHNICAL KNOWLEDGE To identify the components of financial statements | To know the objective of financial statements. To know the objective of financial reporting: ‘To understand the primary responsibility for the preparation financial statements. ‘To identify the general features in the preparation of financial statements. ‘Sanne with ComSeanneeFINANCIAL STATEMENTS il stotements are the means by which the informag, Zane ieltnnd processed in financial accounting ® periodically communicated to the users. ‘nancial statements are a structured financig preventation of the financial position and finer performance of an entity. General purpose financial statements General purpose financial statements are those statements intended to meet the needs of usera who are not in a position to require an entity to prepare reports tailored to their particular information needs. Reports prepared at the request of an entity's management or bankers are not general purpose financial statements because they are prepared specifically to meet the needs of management or bafikers. Components of financial statements A complete set of financial st: following components: 1. Statement of financial position Income statement +3. Statement of comprehensive income 4. Statement of changes in equity 5: Statement of eath flows ‘otes, comprising a summaty of significant i Policies and other explanatory information» weounting ‘Mauny entities also preset reports and statements environmental reports and value added statement” Helga ndarer in teste ene “Entoortend when employes are reurdedon ane user group. 3 _ “se ‘atements comprises the However, such statements and reports are not of financial statements, ro ‘Sconned wih CamSconner|objective of financial statements ‘The objective of general purpose financi Tiesie information abot the sae none performance and cash flows of an entity that i ‘efi perye range of users in making economic decisions. i Financial statements also show the results ; if management of the resources entrusted oe sonar ‘To meet this objective, financial sta dei i Ce ene {ements provide information a. Assets b. Liabilities ¢. Equity d. Income and expel yy and distributions to owne .nses, including gains and losses e. Contributions b; vrs in their capacity as owners £ Cash flows ‘Such information, along with other information in the notes, orf nancial statements in predicing the ir timing and certainty. However, financial statements do not provide all the Hower tion that users may need ake economic decisions. ‘The reason is that the financial » financial effects of past events and nonfinancial information. tatements largely portray the do not necessarily provide| Vom v Wiighign vo ae) —+ Financial position ial positic ises the assets, liabilitie, financial position comprises t ts, I i nag eae of an entity at a particular moment in time, pecificlly, financial position pertains tothe liquidity, solveny, en Gatececiae entity for additional financing. ‘his information is pictured in the statement of financial position, Financial performance ‘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 tse of its resources, ‘The financial performance of an entity is also known as results of z orerations and is portrayed in the income statement and Statement of comprehensive income. Cash flows Cash flows are the cash receipts and cash Payments arising from the operating, investing and financing activities of the entity, proanformation about cash receipts and cash Payments i Presented in the statement of cash Nowe, ene, Cash flow information is useful in assessing the abjji entity to generate cash and eash equivalents, “MY of theFinancial reporting The principal way of providing financial i users is through the annual financial aint exer However, financial reporting encom ipasses not only financial statements but also other means onimatsarng Ueerten that relates directly or indirectly to the financial accounting process. Financial reports include not only financial statements but also other information such as financial highlights, summary of important financial figures, analysis of financial statements and significant ratios. Financial reports also include nonfinancial information such as description of major products and a listing of corporate officers and directors: Objective of financial reporting r ic wrting, the Under the Conceptual Framework for Financial Reporting, i ject vat reporting isto provide financial information ecto of financial repr ng al eng ond petal Tetealors, lenders and cater cretilors maine DEC SGPa Oo providing resources (0 the entity. jective of financial reporting is Simply stated, the overall objective of Prarie Ot Rane ea i tio need tan ONE ‘Scanned with Camscanner‘Target users of tinanciat reporung xpoee financial reporting is directed primagy Sores ca evaidasl nvestere anaes aa cies cai which compose the primary user group. The reason is that existing and potential investors, lenders ne ather creditors have the most critical and immediate neq, ‘or information in financial reports. ‘\s a matter of fact, the primary users of financial information we the parties that provide resources to the entity. Yoreover, information that meets the needs of the specified vrimary users is likely to meet the needs of other users such as mployees, customers, governments and their agencies, ‘he management of a reporting entity is also interested in ‘nancial information about the entity. fowever, management need not rely on general purpose nancial reports because it is able to obtain or access additional nancial information internally. 'pecific objectives of financial reporting Pecifically, the Conceptual Framework for Financial ‘Sporting states the following objectives of financial 2porting: To provide informatior n useful in making investing and credit decisions about : ei Providing resources to the entity. + To provide information Prospects of the entity. + To provide information a ‘useful in assessing the cash flow about entity resources, claims and in resources and claims. taina. General purpose finan 9 and other red ay sd ote » Sree mtr provide information to helt neon but Risser aports the value of the entity,“ ‘M® Primary users estimate investors, lende; c. General purpose financi e financial report intende provide common information to users ani cannot cone late every specific request for information. d, Toa large extent, financial reports and judgment rather than oact depitons Responsibility for financial statements ‘The management of an. entity has the primary ity for the preparation and presentation of financial statements. ‘The Board of Directors in discharging its respon: reviews and authorizes the financial statements for issue before these are submitted to the shareholders of the entity. Management is accountable for the safekeeping of the Mrourees and their proper, efficient and profitable use, Shareholders are interested in information that helps them SharelPow effectively management has fulfilled this role te assess het nt to the decision concerning their investment this ig relexppointment or replacement of management General features of financial statements pliance with PFRS 1. Fair presentation and com Going concern Materiality and aggregation Oretting rrequency rative information Comparativs of presentation ene eT 7Fair presentation ‘The financial statements shall present fairly the financ position, financial performance and cash flows of ar enti Virtually, in all circumstances, fair presentation is achieve if the financial statements are prepared in accordance with the Philippine Financial Reporting Standards which represent the GAAP in the Philippines, ‘The application of Philippine Financial Reporting Standards, with additional disclosure when necessary, is presumed to resultin financial statements that achieve a fair presentation, An entity whose financial statements comply with PFRS shalt make an explicit and unreserved statement of such compliance in the notes. Fair presentation is defined as faithful representation of the effects of transactions and other events in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses laid down in the Conceptual Framework. Fair presentation requires an entity: a. To select and apply accounting policies in accordance with . PERS. i b. To present information, including accounting policies, in a manner that provides relevant and faithfully represented financial information. © To provide additional disclosures nocossary for the users to understand the entity's financial statements An entity cannot rectify inappropriate accounting policies either by disclosure of the accounting policies used or by notes or explanatory information.Doparture from standard In the extremely rare eireumstan 1 cires concide tht snptinne with rege mi misleading, the entity shall depart trom thot quiroment provided the rele Conceptual Framework requires, or otherwine doce doparture, rex, oF otherwise does not probibie a in which management ment in a standard ‘Thu, an entity in permitted to depart from a standard: 8, In oxtromely rare circumstances, b, Whon management conclu iance wit standard would be eae aan When the departure from the standard is necessary achieve fair presentation. a ae following: 1. ‘The management has concluded that the financial statements present fairly the financial position, performance and cash flows of the entity. 2 ‘That the entity has complied with applicable standards crrapt that it has departed from a particular requirement to achieve a fair presentation. 2 ‘The ttle ofthe standard from which the entity has departed, the nature of the departure, including the treatment that the standard would require, ‘the reason why that treatment ‘would be so misleading ‘and the treatment adopted. 4. For each period presented, m Teberture'on each item in the Bosnia at would have been reported in complying requirement. the financial impact of the itements that with theGoing concern Going concern means that the accounting entity ig continuing in operation indefinitely in the absence coe to the conirary. my Going concern is also known as continuity assumption, In other words, financial statements are prepared gn the assumption that the entity shall continue in opera for the foreseeable future. _ ‘Thus, assets are normally recorded at original acquis cost. As a rule, market values are ignored. “sition However, some standards require measurement of certain assets at fair value. Going concern is particularly relevant when management shall make an estimate of the expected outcome of future events, such as the recoverability of accounts receivable and the useful life of noncurrent assets. This postulate is the very foundation of the cos¢ principle. Financial statements shall be prepared on a going concern basis unless management intends to-liquidate the entity or Cease trading or has no realis:ie option but to do so. When upon assessment it besomes evident that there are material uncertainties regarding the ability of the entity to Continue as a going concern, those uncertainties shall be fully disclosed, In making the assessment about the going concert assumption, management shall take into account all available information about the future which is at least twelve months from the end of reporting period. If the financial statements are not prepared on a goiné ‘concern basis, such fact shall bo disclosed together with the ‘measyrement basis and the reason therefor. iat AQ a ‘Scanned with Comcannee|Accrual basis An entity shall p, accrual basis of pes’, the fina ancial at : CoOAnLing ANCA otatements, using the ‘for can flow : Under accrual basis, the effects : pee cri re ona tg of act wd nh eauivalent ty rescued hee fd ota ath of and reported in the financial dats halen which they relate, ments of the periods to In the simplest langua, i Be, accrual basis are reeggnized whon recive rather than when Piya when actually paid. |” “nized payable rather than Accrual accounting means that income is recognized when earned regardless of when received and expense fe recoguived when incurred regardless of when paid, The essence of accrual accounting is the recognition of accounts receivable, accounts payable, prepaid expenses, accrued expenses, deferred income, and accrued income. Materiality and aggregation ‘An entity shall present separately each material class of similar items. An entity shall present separately items of dissimilar nature or function unless they are immaterial. inancial its result from processing large number of Financial statoment® qvents hat are aggregated into classes according to their nature or function. final i ification | i wrocess of aggregation and classi Th Sal stage inh Prac ata Wc line idemas in the financial statements y ish fund, cash in bank on hand, petty cash fund, cet ad ‘example, cash For example: ‘alent shall be presented ha ae \w materials and Fini ds, goods i Pre and presented as one inished goods. plies are agereeste manufacturing 94? ‘item “inventories” iL ‘Scanned with CamSeanner|ine item is not individually materia, it is Ua lier items either in those statements or in the Sted Je, an investor's share in the net income of para iF presented as a separate line item in the incase statement. However, if this amount is not individually material, i m, be aggregated with other income. ” Materiality dictates that “an entity need not provide a specie disclosure required by PFRS if the information is nor material". 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 judgment, 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. Information is material if the omission or misstatement could influence the economic decision that users make on the basis, of the financial statements. For example, small expenditures for tools are often expensed immediately rather than depreciated over their useful life to save on clerical costs of recording depreciation. In such a case, the effect on the financial statements is not large enough to affect economic decision. Another example is the common practice of lurge entities of rounding amounts to the nearest thousand pesos in theit financial statements. ‘Small entities may round off to the nearest peso, 12Materiality is a relativity Materiality of an it Materiality ofan item depends on relative size rather than What is material for one entity may be immaterial for another. An error of P100,000 in multinational entity may the financial statements of & critical for a small entity. portant but may be s0 Factors of materiality In the exercise of judgment in determining material 1c Ae SRG epee * ‘a. Relative size of the item in relation to the total of the group to which the item belongs. For example, the amount of advertising in relation to total distribution costs, the amount of office salaries to total Gdiinistrative expenses, the amount of prepaid expenses ae total current assets and the amount of leasehold improvements to total property, plant and equipment. ~ An item may be inherently material b. Nature of the item ture it affects economic decision. because by its very nal For example, the discovery of a P20,000 bribe isa material event even for a very large entity. Offsetting ‘Aseets and lnbilties, and income and expenses, when material, setts ape offset against each other- Offsetting may be done when it is required or permitted by another PFRS. 18Examples of offsetting Gains and losses on disposal of noncurrent agsg reported by deducting from the proceeds the carrying amg? of the assets and the related selling expenses, n, Expenditure related to a provision and reimbursed wy contractual arrangement with a third party may be ean, against the related reimbursement. In other words, the expenditure related to a provision ang fny reimbursement from a third party ean be offiet, and ont the net expenditure is presented as exponse. In addition, gains and losses arising from a group of similar transactions are reported on a net basis. For example, foreign exchange gains and losses or gains and losses arising from trading securities are netted against the other, However, if material, such gains and losses are reported separately. ‘The measurement of assets net of valuation allowance is permitted because technically this is not offsetting, ‘Thus, accounts receivable may be shown net of allowance for doubtful accounts. Frequency of reporting An entity shall present a complete set of financial statements at least annually. ‘When an entity changes the end of the reporting period and Presents financial statements for a period longer or shorter than one year, the entity shall disclose: 8. The period covered by the financial statements. ‘The reason for using a longer or shorter period, © The fact that amounts presented in the financial statements are not entirely comparable. 4 Scanned wih ComSeanne:Comparable inf; Egret wei previous periog’o7herative information ag Periods Financial staronensr"OU'S Feported in the cusrens was uncertain at the end ofthe eee ¢ to be resolved, are danced tn orang Dard and Users shall benefit from information that an uncertai ext a hod of inmediily peating reporting period, and s been taken dui to resolve the omnia ——— ‘Third statement of fi ‘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. e. Reclassifies items in the financial statements, i inces, an entity shall present three a 1. The end of the current period 2. ‘The end of the previous period — 8, The beginning of the earliest comparative period incial position 18 aisConsistency of presentation Implicit in the presentation of comparable informaty_. Principle of consistency. Parable information ig The principle of consistency requires that the methods and practices shall be applied not ening from period to period, m basis The presentation and classification of finan cial I be uniform from one accounting restatement Period to the ‘An entity cannot use the FIFO method of i in one year, the average method in the method in ‘succeeding year and so on. If the FIFO method is a i i ig from your te yeacPted in one year, such method i inventory valuation next year, another Gonsistency is desirable and essential to achieve comparability of financial statements. However, consistency does not mean that no change in accounting method can be made. Hf 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 eso effect of the change. A change in the presentation and classification of items in the financial statements is allowed: a. When it is required by another PFRS. 'b. When a significant change in the nature of the operations of the entity will demonstrate a more appropriate revised Presentation and classification, It is inappropriate for an entity to leave accounting policies unchanged when bllr and acceptable ornateIdentification of financial state ments Financial state distinguished from ert, Stall be clearly identified and document. information in the same published Bach component identified: ° the Sinancial statements shall be clearly In addition, the following i y displayed: lowing information shall be prominently a. The name ofthe reporting entity b. Whether the financial stat 6 Maher the financial statements cover the individual c. The end of the reporting peri if period or the period i pimp 4. The precontation currency. e. The level of rounding used in the 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 ie disclosed and relevant and material information is not lost or omitted. 7 ‘Scanned with CamScannerQUESTIONS 1 Define financial statements. 2. Explain general purpose financial statements, 3, What are the components of financial statements? 4. Explain the objective of financial statements, 5. To meet the objective of financial statements, wha: information is necessary? 6 Explain financial position, financial performance ang cash flows of an entity. 7. Explain financial reporting. 8, Explain the target users of financial reporting. 9. What is the objective of financial reporting under the Conceptual Framework for Financial Reporting? 10. What are the specific objectives of financial reporting? 11. What are the limitations of financial reporting? tion and 12. Explain the responsibility for the prepai presentation of financial statements. 13, What are the general features of financial statements? 14. Explain fair presentation of financial statements. 15. Specifically, what are the requirements of fair presentation? 16. Explain the requirements when there is a departure from an accounting standard. 18 ‘Scanned with Camscanner17, Explain going concern, 18, Explain accrual basis of accounting. 19. Explain materiality and aggregation. 90. When is an item material? ‘21, What are the factors in determining materiality? 22, Explain the rule on offsetting, 25, Bxplain the frequency of reporting financial statements 24, What are the necessary disclosures when an entity presents financial statements for a period longer oF shorter than one year? 495, Explain the requirement for comparable information 26; What are the circumstances when three statements of financial position are required? a7, What is consistency of presentation? in the presentation and cli ancial statements allowed? assification 28, When is @ change of items in the fin 9, What is identification of financial statements? 30, What information shall be prominent] Msi ging financial statements? ly displayed in 19 Samed with CamScannerPROBLEMS Problem 1-1 Multiple choice (PAS 1) 1. A complete set of financial statements includes aj) following components, except of the a. Statement of financial position b. Statement of changes in equity. ¢, Notes to financial statements d. Environmental reports and value added statement, 2. What is the objective of financial statements? 8, To provide information about the financial positon financial performance and changes in financis| position useful to a wide range of users b. To prepare a statement of financial position ang statement of comprehensive income c. To present relevant, reliable, comparable and understandable information 4. To prepare financial statements in accordance with all applicable standards 3. The primary responsibility for the preparation of the financial statements is reposed in a. Management of the entity b. Internal auditor c. External aucitor d. Controller 4. The major financial statements include all, except a. Statement of financial position b. Income statement ¢. Statement of cash flows d. Statement of retained earnings 5. The major financial statements include all, exeept a. Statement of financial position b. Statement of changes in financial position €. Statement of comprehensive income d. Statement of changes in equityWeobtow to Nate vw 1 OHHAEY hay ne eae td fomgor ‘Ave al of the ¥ sin n imo ta 3, Whieh finan nA ata oment with local b. (Loaf changer in equity ; ti nts of position for. five ow 4. Which of the following ts statements? a. A statement of retained enrnings b, Accounting, Po cc. An auditor's report {Board of directors’ report early identify each financial states the following, except ment 5. An entity shall eh and display all of Name of the reporting entit)- Names of major sharebollers of the entity. b. be Mhe presentation CUrToney: 7 a. Whether the fin a siaeinent cover te individual lof entities. entity or # BrouP aSs meerning ty, Problem 1-8 Multiple choice (PAS 1) ch statement is Incorrect eo 1 Mpaslabon of aera oteeaaisy a. Fair presentation requires the faithfl representa * Geodon of tranncong and ther sece meng nancial statements shall present ity the fing, Position, financial performance and cash fo. oan entity. © Jn virtually all circumstance, a fir presentation achieved by compliance with applisable PPS’ 4 An entity whose financial statements comply iq PERS shall not make an explict! and unteron statement of such compliance in notes, h of the following cannot be considered fair Presentation of financial statements? 4. To present information in a manner that provides relevant and faithfully represented financial information, b. To provide additional disclosures when compliance with specific PIRS is insufficient to understand the financial position and financial performance, © To select and apply accounting policies in accordance with applicable PFRS. d. To rectify inappropriate accounting policies either by disclosure of the accounting policies used or by notes or explanatory information. 3. Which statement indicates a going concern? a. Management intends to liquidate the entity. b, Management intends to cease the operations of the entity. ¢ Management has no realistic alternative but to cease the operations of the entity. 4. None of these would indicate going concern lca —4.An entity is standard if all of ete to d of the a depart from a parti except singh from a particular nditions are satisfied, Reporting prohibits o_o oo for Financial e Tie ameto of transactions and other events on economie laces effects Cater in the periods in which paras en aes ir a. Accrual accounting b, Cash accounting ¢. Modified accrual accounting d. Modified cash accounting 6, Financial statements must be prepared at least Annually 1 Quarterly Semiannually Every two years pose ‘ting in financial statements is 7.Technically, off accomplished when ‘a. The allowance for doubtful accounts receivable. ; b. The accumulated depreciation is deducted from it and equipment The wal Plamties are deducted from total assets. The tote from disposal of noncurrent nese) reported by deducting from the, proceeds the carrying reportsrof the ascet and the Felnted disposal cost. ‘accounts is deducted from ee ‘Scanned with Camsconneresentation and classification of items ;, <4 re at aataments shall be retained from one secon period to the next. a. Consistency of presentation b. Materiality ¢. Aggregation d. Comparability 8. A third statement of financial position as at beginning the earliest comparative period presented is requing When an entity applies an accounting policy retrospectively. b, When an entity makes a retrospective restatement ¢ items in the financial statements. ¢. When an entity reclassifies items in the financial atements. . Under all of these circumstances 10. Which statement in relation to financial statements in incorrect? @. General purpose financial statements do not and cannot provide all of the information that primary users need. b. General purpose financial statements are designe! to show the value of the reporting entity. © General purpose financial statements are intended to provide common information to users. 4. Financial statements are largely based on estimate and judgment rather than exact depiction. 24 ‘Scanned wih CamSeannera b . a. 2 oe must disclose comparative information for . The previous comparable poriod for all amoun b ‘The previous comparsle perio! forall amouats and for all narrative and descriptive information. ¢. The previous comparable period for all amounts and for all narrative and descriptive information when it is relevant to an understanding ofthe current period's financial statements. . The previous two comparable periods for all amounts. 4,When the classification of items in the financial statements is changed, the entity a. Must not reclassifiy the comparative amounts. b. Can choose whether or not to reclassify. ; e Mfust reclassify the comparative amounts unless i impracticable to do £0. a. Must reclassify the current year amounts only. 5. An entity shall present re prominent. nt of cash flows more promine™ a. The statement ten pont ore premen 2 it ‘statement more Pp inently. a ‘The income al statement or equal prominence. 25 ‘Scanned with CmScannerProblem 1-5 Multiple choice (IAA) 1. The overall objective of financial reporting i8 t0 pry information = “ ‘a. That is useful for decision making D, About assets, liabilities and equity ¢. About financial performance during a period . That assesses performance of management 2. The objective of financial reporting is based on a. The need for conservatism }. Reporting on management stewardship ¢, Generally accepted accounting principles 4. The needs of the users of the information 3, Which is an objective of financial reporting? useful in mal a. Tq provide information that investing and credit decision: b. To provide information thet is useful to management, ¢. To provide information to investors. 4. To provide information about internal and external conflicts. 4, Which is an objective of financial reporting? ‘a. To provide information useful to management. b. To identify nonfinancial transactions. ¢. To provide information useful to assess the amount, timing and uncertainty of prospective cash receipts 4, To provide information that excludes claims, to provide 5. An objective of financial reporting. a. Information about the investors in the entity. b. Information about the liquidation value of the entit’: . Information useful in assessing cash flow prospect d. Information that will attract new investors. Scanned wih CamscannerProblem 1-6 Multiple choice (AICPA Adapted) Meetieae. is under the direction of divectly peavite magement, financial reporting will a. Entity performance and management performance ee PAapeaae ne but not entity performance d. Neither entity nor management Sereeerae 2, Financial reporting pertains to a. Individual business entities, ra industri or an economy orto members of covey as consumers b. Individual business entities and an economy or to members of society as consumers c. Individual business entities and an economy rather than to industries or to consumers d. Individual business entities, industries and an economy rather than to members of society as consumers 3, Which is not an objective of financial reporting? a. Financial reporting shall provide information about resources, claims against resources and changes in them. b. Financial reporting shall provide information useful jin evaluating stewardship of management. ¢. Financial reporting shall provide in‘ormation useful in investment, credit and similar decision. 4. Financial reporting shall provide in‘ormation useful in assessing cash flow prospects. 4. Which is not an objective of financial reporting? a. To provide information about assets and claims against those assets b. To provide informatio ¢. To provide informal investing decisions ae a. Ty etovide information about the Liquidation value of an entity in assessing cash flows yn useful it in lending and tion useful i 27 ‘Scand wih CamSeanner1-7 Multiple choice (IAA) Which would likely prepare the most accurate 1. Which wala entity based on empirical evidences =" ‘a. Investors using statistical models b, Corporate management ¢. Financial analysts, d. Independent certified public accountants Problem 2. What is the most useful information in predicting fy cash flows? aos a. Information about current cash flows b. Current earnings based on accrual accounting ¢. Information regarding the accounting policies seq 4, Information regarding the results obtained by ising ‘a wide variety of accounting policies 8. The accrual basis of accounting is most useful for a. Determining the amount of income tax liability b. Predicting short-term financial performance. ¢. Predicting long-term financial performance. 4. Determining the amount of dividends to shareholders. 4, In measuring financial performance, accrual accounticg is used because ‘a. Cash flows are considered less important. b. It provides a better indication of ability to generate cash flows than cash basis. c. It recognizes revenue when cash is received and ses when cash is paid. d. It is one of the implicit assumptions. 6. The financial statements prepared under GAAP ‘a. Do not articulate with one another. b. Reflect a single measurement which is historical €. Are not highly precise because estimate and j ‘must be made. - d. Contain a limited number of future projections. i | 28 }