The Impact of Inadequate Source Documents and

Disclosures on the Fair Presentation of

Aroroy, Masbate’s 2020 Annual
Financial Statements:
A Case Study

Prepared by:

BALLERAS, MARIA CHRISTY ALDE M.

ESPINOLA, RONALYN MAE D.
ESQUILLO, HANNAH V.
KING, ALEXIS
PASAHOL, JOLINA C.

BSA - 4
A.Y 2021 - 2022
INTRODUCTION

The municipality of Aroroy is a coastal and first-class municipality in the

island province of Masbate. Aroroy has 41 barangays and is known for Kalanay
Cave which is one of the most important sites in Masbate Province. Its total
population was 88,351 representing 9.72% of the total population of the province
of Masbate. Aroroy denotes a positive growth rate as its population grew from 9,
836 in 1918 to 88, 351 in 2020.
The GOVPH Cities and Municipalities Competitive Index shows the annual
ranking of cities and municipalities based on the sum of their scores on the 4
Pillars: Economic Dynamism, Government Efficiency, Infrastructure and,
Resiliency. The provincial rankings are based on population and income
weighted averages of the overall scores of cities and municipalities under a
province. According to the competitive index for 2020, Aroroy ranked as 43rd
place in terms of resiliency as they rank first on indicators such as strong
land-use plan, disaster risk reduction plan, annual disaster drill, early warning
system, and local risk assessments. In terms of infrastructure they ranked 180th,
under this pillar their highest ranked indicator was distance to port (12th) and
their lowest ranked indicator was their information technology capacity wherein it
was ranked under 407th. In terms of economic dynamism they are ranked 391st,
their local economy growth was the indicator with the highest ranked (9th) and
their lowest ranked indicator under this pillar was their cost of doing business
(483rd). Lastly, in terms of government efficiency they are ranked 398th, they
ranked 1st in the compliance to National Directiveness but they had the lowest
rank of 483rd when it comes to social protection.
The Municipal Government of Aroroy implemented the following
programs/projects/activities (PPAs) under the 20% Growth Fund (DF) for
Calendar Year (CY) 2020 to promote its social and economic development,
namely:
1. Road Opening (FTMR) Junction, Mataba-Matongog-Sawang;
2. Road Opening (FTMR) Junction, Sawang to Mataba;
3. Road Rehabilitation, Cabangcalan to Tinigban;
4. Road Rehabilitation, Tinigban to Mariposa;
5. Seaport Development, Construction of Pier, Bugui, Gumahang Pier;
6. Seaport Development, Expansion of Pier, Amotag;
7. Installation of Street Lights at AMC, Ambolong;
8. Construction of 10 Unit Multi-Purpose Drying Pavement (MPDP) of 10
Barangays;
 9. Construction of two units Covered Court;
10. Construction of Riprap Wall at Sanitary Landfill;
11. Construction of Multi-purpose Building at Brgy. Tinigban; and
12. Livelihood Program.
The LGU also completed in CY 2020 the implementation of its Philippine
Rural Development Projects (PRDP) under I-BUILD and I-REAP Sub-projects.

PROBLEM

In the 2020 Annual Report issued by the Commission on Audit (COA), the
municipality of Aroroy in Masbate has received a qualified opinion on the fairness
of the presentation of the financial statements. A Qualified Opinion is given to an
institution that has inadequate disclosures in the footnotes to the financial
statements, which is one of the problems on the municipalities’ financial
statements. The inadequacy of the LGU’s prior years record and supporting
documents cast a difficulty on auditors to verify and determine the validity,
accuracy, and correctness of the amounts and items recorded.
According to the reports, the following are the significant issues
concerning the municipality's annual financial report in terms of the supporting
documents and records:
1. The unreconcile counts on LGU’s PPE;
2. Donated properties were not documented;
3. The LGU's records still included several PPEs that were already in the
hands of the schools.;
4. There was still no final reconciliation on property and accounting records;
5. Numerous assets and liabilities have anomalous and unreconciled
balances;
6. Other balances lacked a subsidiary ledger and supporting documents, and
payables had been outstanding for more than two years but had not been
reverted to government equity.; and
7. The procurement of goods and services has deficient information.

DISCUSSION

Based on the Notes to Consolidated Financial Statement of the

Municipality of Aroroy for the year ended December 31, 2020, from the
Commission on Audit, their financial statements are prepared on an accrual basis
in accordance with the policies and guidelines of the International Public Sector
Accounting Standards (IPSAS). The LGU followed the following accounting rules
and policies with regard to the measurements of their accounts:

Consolidation of Financial Statements

During consolidation, inter-group transactions, balances, and
unrealized profits and losses on transactions between entities and funds are
completely eliminated. Market Administration, Slaughterhouse, and Aroroy
Municipal College are among the LGU's economic entities that have special
accounts under the General Fund.

Cash and Cash Equivalents, and Inventories

The cash and cash equivalents of the LGU include cash on hand and
cash in bank. For inventories, upon initial recognition, the value is at cost. The
cost of inventory is its fair value at the time of purchase if it was acquired
through non-exchange transactions (for no cost or for a nominal cost).
Furthermore, when inventories are used or consumed in the usual course of
the LGU's business, they are recorded as an expense.

Property, Plant and Equipment

All the property, plants, and equipment of the LGU are all measured at
cost, less accumulated depreciation and impairment losses. The cost of an
item includes all expenditures that are directly related to its acquisition. The
LGU recognizes key elements of property, plant, and equipment as discrete
assets with definite useful lifetimes and depreciates them proportionately
when they must be replaced at intervals. Similarly, if the recognition
conditions are met, the cost of a major inspection is recognized in the carrying
amount of the plant and equipment as a replacement. All other repair and
maintenance costs are recorded as incurred in the surplus or deficit. When an
asset is acquired for no or nominal consideration in a non-exchange
transaction, it is originally measured at its fair value. Depreciation is
calculated on a straight-line basis throughout the asset's useful life.
Depreciation is computed at rates to allocate the asset's cost or
valuation less any estimated residual value over the asset's remaining useful
life. The LGU will not recognize impairment on its assets in the first year of
implementation of the PPSAS.
Vehicles and machines are examples of leased assets. At the end of
each reporting period, the residual values and useful lives of the assets are
examined and, if necessary, prospectively updated. If the carrying amount of
an asset exceeds its projected recoverable amount or recoverable service
amount, the carrying amount is immediately written down to the recoverable
amount or recoverable service amount.

Measurements of Financial Instruments

Financial liabilities are classified at fair value through surplus or deficit,
or loans and borrowings, as required, within the framework of IPSAS 29. At
the time of initial recognition, the LGU determines the classification of its
financial liabilities. All financial liabilities are recognized at face value at first,
with the exception of loans and borrowings, which are recorded at fair value.
Trade and other payables, bank overdrafts, loans, and borrowings are among
the financial liabilities of the LGU Group.
Interest-bearing loans and borrowings are measured at amortized cost
utilizing the effective interest method after initial recognition. When obligations
are derecognized, as well as through the effective interest method
amortization process, gains and losses are recognized as surplus or deficit.
Any acquisition discount or premium, as well as fees or costs that are an
integral part of the effective interest rate, are included in the computation of
the amortized cost.
When a financial responsibility's obligation is discharged, annulled, or
expires, the financial liability is derecognized. Moreover, once an existing
financial liability is replaced by another from the same lender on substantially
different terms, or the terms of an existing liability are substantially modified, it
is viewed as a derecognition of the previous liability and the recognition of a
new liability.

Revenue Recognition
When the asset recognition criteria are met, revenues from taxes and
fines are recognized by the LGU upon the occurrence of a transaction.
Liability is recognized instead of income to the degree that there is a related
condition attached that would result in a liability to repay the amount. Other
non-exchange revenues are recognized when it is unlikely that the asset's
future economic benefit or service potential would flow to the entity and the
asset's fair value can be accurately measured. Revenues from non-exchange
transactions with other government entities are measured at fair value and
recognized when the assets such as cash, goods, services, and property, are
transferred to the LGU and the economic benefits or service potential
associated with the asset is likely to flow to the LGU and can be measured
 reliably. Furthermore, for the recognition of Tax Revenue - Real Property and
Special Education Tax, the LGU took advantage of the 5-year transitional
provision. There will be no change in policy regarding the recognition of the
aforementioned tax income for the first year. Rental income from operating
leases on investment properties is accounted for in revenue on a straight-line
basis over the lease duration.
The financial statements filed by the Municipality of Aroroy contain
some discrepancies in accounts such as Property Plants and Equipments and
Payables,based on the findings of COA auditors. The lack of supporting
documentation and reports makes it difficult to verify the accuracy and
correctness of these accounts.

Source Documents
Every day, numerous business transactions occur in an entity, and these
transactions are recorded and controlled by several sources of papers. For
operational reporting, some of these papers are recorded and reported. Some of
them are accounting records that are used to keep track of financial data. Every
time a business does a financial transaction, it leaves a paper trail. This paper
trail is referred to as a source document or documents by accountants. These
documents are critical to the bookkeeping and accounting process since it
establishes the existence of a financial transaction. During an accounting or tax
audit, source papers serve as a transaction trail that backs up the accounting
journals and general ledger.
The amount of the transaction, to whom the transaction was made, the
purpose of the transaction, and the transaction date are all described in detail in
a source document. Official cash receipts, Credit memos, Invoices, Deposit slips,
Computer-generated receipts, Purchase orders are only a few examples of
source documents. Any data obtained from source documents should be
appropriately recorded in the company's journal, accounting software, or financial
records. Following the initial recording, all documents should be saved, sorted,
and stored in a manner that allows them to be retrieved at any time. It's also
crucial to keep track of general internal control procedures that define who in the
company has access to and can authorize payments, orders, and other
transactions.

The Consequences of Inadequate Source Documents

Proper source documentation maintenance is an important but sometimes
overlooked aspect in ensuring that proper and accurate transactions are
recorded to the Book of an entity. This is something that the Aroroy Municipality
in Masbate failed to manage properly. Several accounts were misstated in regard
to this matter, according to the COA report for their 2020 Financial Statements.
Some of the accounts lacking source documents include accounts payable and
procurement of goods and services.
According to the findings of an independent audit, about ₱10.79 million in
accounts payable from the general fund and the Special Education fund had
been unpaid for more than two years. Furthermore, these transactions are not
supported by subsidiary ledgers or source documents. Likewise, lack of source
documents in the acquisition of goods and services also leads to the deficiencies
in the utilization of about 96.15 percent of the ₱23.09 million budget for the
Bayanihan Grant.
As a result, it is clear that the Municipality of Aroroy failed to follow the
essential feature that the LGU must have when it comes to the management of
subsidiary ledger and source documents.They did not conform to the rules of
several government policies stated below.
● The Government Accounting Manual for Local Government Units - Volume
1 states in Chapter 2, Section 4(g), that LGUs must keep complete
subsidiary records for all accounts (assets, liabilities, and equity) for public
utilities and economic businesses. All other special accounts must have
subsidiary records for receipts, transfers, and expenditures.
● The GPPB issued Circular No. 01-2020, titled "Guidelines for Emergency
Procurement under Republic Act No. 11469 or the Bayanihan to Heal as
One Act," which listed the required supporting documentation.
● "Claims against government funds shall be backed with thorough
documentation," according to Section 4(6) of Presidential Decree 1445,
which applies to all LGUs.
The balance of the accounts payable was regarded as unreliable as a
consequence of the insufficient documentation and subsidiary ledger. Also, the
validity, propriety, and legality of the aforementioned disbursements could not be
verified.

Reasons for Inadequacy of Source Documents

The true reason behind each LGU’s inadequacy of reports will never be
known unless otherwise, they disclose it themselves, which is a very rare case.
However, we have compiled a list of plausible explanations for insufficient
reports, to mention a few.
 Accountability Issue. Accountability in terms of ethics and governance is
equated with answerability, blameworthiness, liability, and the expectation of
account-giving. To carry out its activities, the local government requires a lot of
funds. Any use of these funds should be recorded, reported in the financial
statements, and accountable to the public.
Minimal performance. In carrying out its affairs, local governments should
not limit their performance of activities. The budget or funds of the LGU’s should
be reflected on the quality of performance of each employee and the LGU
themselves.
Low Absorption Budget. Because of the frequent occurrence of official
legal issues, implementing activities are uncertain. Many giddy public officials to
carry out their actions, many frightened and alarmed public officials to carry out
their activities eventually seek safety by not doing so. It has a negative influence
on the budget because of the low absorption rate. The organizers of the local
government's realization budget absorb spending that is internal, such as staff
expenses and goods and services, while capital expenditures, as well as
development, are generally minimal. Currently, there is a trend of avoiding local
government organizers who do not achieve their budgets for fear of getting into
issues with law enforcement.
Corruption, Collusion, and Nepotism. The subject of corruption has long
been a problem for local government organizers. Today, the head area, board
members, employers, and local politicians are frequently mentioned in the media
as being complicit in the corruption problem. Today, corruption affects a large
number of people at all levels and throughout the system's life cycle. Hundreds of
regional heads, hundreds of members of the House of Representatives, and
thousands of state administrations are all active in legal matters.

The Consequences of Inadequate Disclosures

While a company's financial statements contain all of the company's
significant financial data, that data is frequently in need of more explanation.
That's where the financial statement's disclosures come in useful. To a
company's stakeholders, a financial statement disclosure will communicate
relevant information not reflected in the statement itself. All pertinent information
must be disclosed. Generally, any context that may have an impact on the
reliability of a financial statement is considered "relevant." This could include
details on accounting techniques, dependencies, or changes in amounts or
projections.
 Section 269 of the Government Accounting Manual for Local
Governments states that the subsidiary ledger cards for each group of PPEs,
such as work and other animals, are maintained by the Local Accountant. Land
and Land Improvements; Ledger Cards for land and land improvements; Local
Road Network Ledger Card for road network; Other Public Infrastructure Ledger
Cards for public infrastructures other than the road network; Building and
Structure Ledger Cards for buildings and structures; Equipment Ledger Cards for
equipment; and Other Property Ledger Cards for other property not provided with
special ledger cards are the subsidiary ledger cards.
The Report on the Physical Count of Property, Plant, and Equipment is
also included in the list of required forms and reports. This form is used to report
the physical count and condition of PPE by type as of a specific date, including
those that are unrecorded or cannot be accounted for. It displays the PPE
balance per property card and per count, as well as any shortages or overages. It
will be provided by the Inventory Committee during its annual physical count of
the LGU's properties.
Based on the audit results, the Municipality of Aroroy's report on its PPE
was incomplete in this case. The independent accountant uncovered the
₱418.23 million discrepancy, and numerous reasons were given. Such reasons
are:
● There are donated properties that have not been recorded in the books
● Several PPEs have been transferred to the authority of schools but remain
in the books of the LGU
● Some Public Infrastructures have not been recorded back from the
Registry to the books following the adoption of the IPSAS
● There is still no reconciliation between properties and accounting books.

Furthermore, there are other factors that contribute to the Municipality's

failure to disclose. Because of the large number of PPEs, it is difficult for the
inventory officer to account for all of the PPE handled by the municipality.Time
constraints also present difficulties; because the municipality has a high number
of PPEs, time constraints make it more difficult for them to adequately and
accurately account for all of them. Finally, the inadequacy of records and other
source documents from previous years contributes to the value of PPE being
inaccurate. Because there is insufficient documentation to support the
deficiencies, the Municipality will find it difficult to implement all of the auditors'
recommendations because they lack a basis for the transactions of their PPEs.
 It's worth noting that these inconsistencies are all linked to the core reason
of insufficient source documents and disclosures. Moreover, based on the
findings, it is clear that the effects of these are continuous and difficult to reverse.
All of the deficiencies, no matter how minor, have a significant impact if they go
unrecognized, and they will continue to accumulate as time goes by.
The fair presentation of the Municipality of Aroroy's Financial Statements
is affected as a result of the accumulated overlooked inaccuracies with regard to
insufficient source documents and disclosures.Unfortunately, if the Municipality of
Aroroy does not act promptly to address their fundamental problem and limit the
potential impacts of their mistakes, it will continue to build up for the following
years.

The Municipality of Aroroy's Audited Balances of Accounts for 2020 are

shown below. All transactions involving inventories, PPE, and accounts payable
that have insufficient source documentation and disclosures are excluded from
the balances.

INVENTORIES
PROPERTY, PLANT AND EQUIPMENT
ACCUMULATED DEPRECIATION/AMORTIZATION
LIABILITIES
CONCLUSIONS
The aforementioned conclusions were drawn based on the
research findings:
1. Every type of business transaction necessitates the use of supporting
documentation. It serves as proof that a transaction took place, and
whatever happens, these records can be used to show the authenticity
and validity of account adjustments.
2. The results indicate that even minor errors,when accumulated and left
unnoticed, such as missing records have a significant influence on the fair
presentation of Local Government Units' financial statements.
3. Supporting documents are the required documentation for a transaction to
establish the claim. In the LGU’s case, it failed to provide the necessary
documents that would support the financial statement, particularly on the
property, plant & equipment (PPE). As a consequence, the inadequacy
and incomplete documents affect the fair presentation of PPE’s account in
the financial statement.
4. Payables with no subsidiary ledgers and supporting documents rendered
the reported balances unreliable and affected the fair presentation of
financial statements.
5. The deficiencies on the information of the procurement of goods and
services acquired from a supplier who does not offer such items, as
submitted, affected the validity, proprietary, and legality of the recorded
items or amounts.
6. Generally, the main problem of the Municipality of Aroroy, Masbate is the
inadequacy of source documents which results in the unreliability of their
2020 Financial Statements.

RECOMMENDATIONS

1. Improve the internal control over the receipt, acceptance and issuance of
items purchased and released, which must also conform to standards and
policies. Example, the inventory control account must be maintained in the
general ledger on a current basis, and the issuance of items should be
immediately recorded in the appropriate account.
2. For monitoring purposes and future references, the subsidiary ledgers
must be always updated.
3. The Inventory Committee should conduct an extensive review on the
physical counts of LGU’s property to ensure the detailed and complete
presentations of the accounts.
4. Proper allocation of the budget helps in managing the money effectively
thus avoiding any discrepancies and inadequacies in financial reports.
5. Transparency of the activities and expenditures must be practiced to avoid
possibility of corruption and allows detection and increases the
accountability of the employees.
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