The Environment of Financial Accounting and Reporting Chapter 1

Introduction

• Accounting is an information system, designed to identify, collect, measure, and communicate

economic information about a business entity (firm) to those having interest in the financial affairs of
the entity.

Objective of Financial Reporting

• User’s decisions involve decisions about

• Buying, selling or holding equity or debt instruments

• Providing or settling loans and other forms of credit
• Voting, or otherwise influencing management’s actions

To make these decisions, users assess

• Prospects for future net cash to the entity

• Management’s stewardship of the entity’s economic resources

• To make both these assessments, users need information about both

• The entity’s economic resources, claims against the entity and changes in those resources and
claims
• How efficiently and effectively management has discharged its responsibilities to use the entity’s
economic resources

Accounting Information Users and Their Needs

• External decision makers

• Investors
• Employees
• Lenders
• Suppliers and other trade creditors
• Customers
• Governments and their agencies
• Public

• Internal decision makers

The Need to Develop Standards

• Accounting standards help accountants meet the information demands of users by providing
guidelines and limits for financial reporting. Accounting standards also improve the
 comparability of financial reports among different companies. These are many different ways to
account for the same underlying economic events, and users are never satisfied with the
amount of financial information they receive – they always want to know more.

Development and Sources of Financial Reporting Standards

• Accounting Variations among Countries

• Implications of Differences in Accounting Among Nations
• Calls for Global Harmonization of Accounting Standards
• Accounting Standard-Setting in the Philippines

Sources of Accounting Standards

• International Accounting Standards Board (IASB)

• Financial Reporting Standards Council (FRSC)
• Securities and Exchange Commission (SEC)
• Philippine Institute of Certified Public Accountants (PICPA)
• Other professional associations
• Bureau of Internal Revenue (BIR)

Financial Reporting Framework

• A financial reporting framework is vital to financial governance of entities. This is a set of accounting
principles, standards, interpretations and pronouncements that must be adopted in the preparation and
submission of the annual financial statements of a particular class of entities. It includes, but not limited
to the Philippine Financial Reporting Standards.

Major Challenges in Financial Reporting Environment

• IFRS/PFRS in a Political Environment

• The Expectation Gap

• Financial Reporting Issues

• Nonfinancial measurements
• Forward-looking information
• Soft assets
• Timeliness

• The Constraints on Useful Financial Reporting

• Cost-Benefit Balancing
• Balance Between Qualitative Characteristics
• True and Fair View Presentation
Enhancing the Existing System of Financial Reporting

• One-size-fits-all financial reports do not meet the needs of the spectrum of investors
• When preparing financial reports, it is difficult to ensure compliance with the voluminous and
complex requirements contained in SEC reporting rules
• We may want to consider a more comprehensive business reporting model, including both
financial and nonfinancial key performance indicators
• How to deliver all of this information in a timelier manner

Ethics in the Accounting Environment

• Ethics is a term that refers to a code or moral system that provides criteria for evaluating right
and wrong. One of the elements that many believe distinguishes a profession from other
occupations is the acceptance by its members of a responsibility for the interests of those it
serves.

The Role of External Auditors

• An external auditor, a CPA is an independent professional who conducts the audit in accordance
with the Standards on Auditing. When the audit is completed, the auditor makes no claim as to
the accuracy of the financial statements he has audited.
 Conceptual Framework and Theoretical
Structure of Financial Accounting and
Reporting, Part I
Chapter 2

Introduction

• The conceptual framework plays a vital role in the development

of new standards and in the revision of previously issued
standards. Recognizing the importance of this role, the
standards setters (International Accounting Standards Board)
stated that “fundamental concepts guide the Board in
developing accounting and reporting standards by providing… a
common foundation and basic reasoning on which to consider
merits of alternatives.”

Overview of Conceptual Framework

• The conceptual framework outlines the objectives of financial

reporting and the qualities of good accounting information,
precisely defines commonly used terms such as asset and
revenue, and provides guidance about appropriate recognition,
measurement, and reporting.

Purposes of the Conceptual Framework

• To assist the Board in the development of future IFRSs and in

its review of existing IFRSs;
• To assist the Board 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 IFRSs;
• To assist national standard-setting bodies in developing national
standards;
• To assist preparers of financial statements in applying IFRSs
and in dealing with topics that have yet to form the subject of an
IFRSs;
• To assist auditors in forming an opinion on whether financial
statements comply with IFRSs;
• To assist users of financial statements in interpreting the
information contained in financial statements prepared in
 compliance with IFRS; and
• To provide those who are interested in the work of IASB with
information about its approach to the formulation of IFRSs.

Scope of the Conceptual Framework

• The objective of financial reporting;

• The qualitative characteristics of useful financial information;
• The definition, recognition and measurement of the elements
from which financial statements are constructed; and
• Concepts of capital and capital maintenance.

Objective of General Purpose Financial Reporting

• The objective of general purpose financial reporting is to

provide financial information that is useful to users in making
decisions relating to providing resources to the entity.

Types of Useful Information

• Financial Flexibility
• Liquidity and Solvency
• Operating Capability
• Investing, Financing and Operating Activities

Limitations of General Purpose Financial Reporting

• They do not and cannot provide all the information that existing
and potential investors, lenders and other creditors need such
as general economic conditions and expectations, political
events and political climate and the industry and company
outlooks;
• They are not designed to show the value of a reporting entity
but they provide information to the users to estimate the value
of such entity;
• General purpose reports may not meet the needs of individual
primary users because of the difference and sometimes
conflicting information needs and desires of such users; and
• To a large extent, financial reports are based on estimates,
judgments and models rather than exact depictions. The
 conceptual framework however, establishes the concepts that
underlie those estimates, judgments and models for better
understanding acceptance and implementation by the users.

Fundamental Qualitative Characteristics of Financial Information

• Relevance

• Predictive Value
• Confirmatory Value
• Materiality

• Faithful Representation

• Completeness
• Neutrality
• Free from Errors
• Measurement Uncertainly

Applying the Fundamental Qualitative Characteristics

• Identify an economic phenomenon or activity that has the

potential to be useful to users of the reporting entity’s financial
information;
• Identify the type of information about the phenomenon that
would be most relevant if it is available and can be faithfully
represented; and
• Determine whether that information is available and can be
faithfully represented.

Enhancing Qualitative Characteristics

• Comparability
• Verifiability
• Timeliness
• Understandability

Underlying Assumption: Going Concern

• The financial statements are normally prepared on the

assumption that an enterprise is a going concern and will
continue in operation for the foreseeable future. Hence, it is
assumed that the enterprise has neither the intention nor the
need to liquidate or curtail materially the scale of its operations;
is such an intention or need exists, the financial statements may
have to be prepared on a different basis and, if so, the basis
used is disclosed.
 Conceptual Framework and Theoretical
Structure of Financial Accounting and
Reporting, Part II
Chapter 3

Financial Statements

• Financial statements are the principal means through which a company

communicates its financial information to those outside it. These
statements provide a company’s history quantified in money terms. They
are a particular form of financial reports that provide information about
the reporting entity’s assets, liabilities, equity, income and expenses.

Reporting Entity

• A Reporting Entity is an entity that chooses or is required to prepare

financial statements and is not necessarily a legal entity. It could take
many form, e.g., portion of an entity. If a reporting entity does not have
typical legal form, the boundary of reporting is determined by the
information that is relevant and representationally faithful.

Forms of Financial Statements

Consolidated financial statements

Provide information about

assets, liabilities, income and
expenses of both the parent
and its subsidiaries as a single
reporting entity.

Unconsolidated financial statements

Provide information about

assets, liabilities, equity, income
and expenses of the parent
only.
combined financial statements

Provide information about

assets, liabilities, equity, income

and expenses of two or more

entities that are not linked by a

parent-subsidiary relationship.

Statement of Financial Position

• This statement shows the resources of a company (the assets), the

company’s obligations (the liabilities), and the net difference between its

assets and liabilities, which represents the equity of the owners.

Statement of Profit or Loss and Other Comprehensive Income

• This reflects the net assets generated through business operations

(revenues), the net assets consumed (expenses), and the difference,

which is called net income as well as other comprehensive income.

Statement of Cash Flows

• The amount of cash generated and consumed by a company through the

following three types of activities: operating, investing, and financing.

Considered as the most objective, this statement is insulated from the

accounting estimates and judgments needed to prepare a statement of

financial position and statement of profit or loss.

Statement of Changes in Equity

• Summarizes the changes in each item of equity for a period of time.

Notes to the Financial Statements

• The notes contain supplemental information as well as information about

items not included in the financial statements such as accounting

estimates.

Objective of Financial Statements

• The objective of financial statements is to provide information about the

financial position, performance, and changes in financial position of an

entity that is useful to a wide range of users in making economic

decisions (e.g., whether to sell or hold an investment in the entity).

Users and Their Needs

• Investors

• Decisions about buying, selling or holding equity and debt instruments.

• Lenders and other creditors

• Decisions about providing or settling loans and other forms of credit.

Elements of Financial Statements

• Assets
• Liabilities
• Equity
• Income
• Expenses
Measurement of Financial Position

• Assets

• Assets are present economic resources controlled by the entity as a result of past

events. An economic resource is a right that has the potential to produce economic

benefits.

• Liabilities

• Liabilities are present obligation of the entity to transfer an economic resource as a

result of past events. An obligation is a duty or responsibility that the entity has no

practical ability to avoid.

• Equity

• Equity is the residual interest in the assets of the entity after deducting all its liabilities.

Measurement of Performance

• Income

• Income is increases in assets, or decreases in liabilities, that result in increases in

equity, other than those relating to contributions from holders of equity claims.

• Expenses

• Expenses are decreases in assets, or increases in liabilities, that result in decreases

in equity, other than those relating to distributions to holders of equity claims.

Capital Maintenance Adjustments

• The revaluation or restatement of assets and liabilities gives rise to

increases or decreases in equity. While these increases or decreases meet

the definition of income and expenses, they are not included in the

income statement under certain concepts of capital maintenance. Instead

these items are included in equity as capital maintenance adjustments or revaluation reserves.
Recognition and Derecognition Concepts

• Unit of account

• Unit of account refers to the right(s) or obligation(s), or group of rights and

obligations, to which recognition criteria and measurement concepts are applied.

• Recognition of the Elements of Financial Statements

• Recognition is the process of capturing for inclusion in the statement of financial

position or the statement(s) of financial performance an item that meets the

definition of an asset, a liability, equity, income or expenses.

Recognition Criteria

• Relevance

• Low probability of a flow of economic benefits

• Existence uncertainty

• Faithful representation

• Measurement uncertainty
• Recognition inconsistency (accounting mismatch)
• Presentation and disclosure

Derecognition of the Elements of Financial Statements

• Derecognition is the removal of all or part of a recognized asset or liability

from an entity’s statement of financial position.

Measurements of the Elements of Financial Statements

• 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 statement of financial position and income statement.

Basis of Measurement

• Historical cost measurement basis

• Provide information derived, at least in part, from the price of the transaction or other event
that gave rise to the item being measured.

• Current value measurement basis

• Provide information updated to reflect conditions at the measurement date.

Current Value Measurement Basis

• Fair value

• The price that would be received to sell an asset, or paid to transfer a liability, in an

orderly transaction between market participants at the measurement date.

• Value in use (for assets) fulfilment value (for liabilities)

• Reflects entity-specific current expectations about the amount, timing and uncertainty

of future cash flows.

• Current cost

• Reflects the current amount that would be paid to acquire an equivalent asset and

received to take on an equivalent liability.

Selecting a Measurement Basis

• In selecting a measurement basis, it is necessary to consider the nature of

the information in both the statement of financial position and the

statement(s) of financial performance.

Factors to Consider in Selecting a

Measurement Basis

• Relevance

• Characteristics of the asset or liability

• Contribution to future cash flows

• Faithful representation
 • Measurement inconsistency
• Measurement uncertainty

Presentation and Disclosure

• The Revised Conceptual Framework

• Introduces concepts how information should be presented and disclosed in financial

statements

• Introduces the term “Statements of Financial Performance” to refer to the

statement of profit and loss (which includes all income and expenses) together with

the statement presenting OCI.

Concepts of Capital

• Financial concept

• Capital is synonymous with the net assets or equity of the enterprise.

• Physical concept

• Capital is regarded as the productive capacity of the enterprise based on, for

example, units of output per day.

Concepts of Capital Maintenance

• Financial capital maintenance

• A profit is earned only if the financial (or money) amount of the net assets at the end of

the period exceeds the financial (or money) amount of net assets at the beginning of the

period, after excluding any distributions to, and contributions from, owners during the

period.

• Physical capital maintenance

• A profit is earned only if the physical productive capacity (or operating capability) of the
enterprise (or the resources or funds needed to achieve that capacity) at the end of the period
 exceeds the physical productive capacity at the beginning of the period, after excluding any
distributions to, and contributions from, owners during the period.

Preparation of Financial
Statements (PAS 1)
Chapter 4

PAS 1 Presentation of Financial

Statements

• Prescribes the basis for presentation of general-purpose financial

statements, in order to ensure comparability both with the
enterprise’s own financial statements of previous periods as well as
with the financial statements of other enterprises.

General-Purpose Financial Statements

• General-purpose 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 their particular information needs.

Financial Accounting

• Financial accounting is the information accumulation, processing

and communication system designed to satisfy the investment and
credit decision-making information needs of external users.

Purpose of Financial Statements

• The objective of general-purpose financial statements is to provide

information about the financial position, performance and cash
flows of an enterprise that is useful to a wide range of users in
making economic decisions.

Complete Set of Financial Statements

• A statement of financial position as at the end of the period;

• A statement of profit or loss and other comprehensive income for
the period or statement of comprehensive income or statement of
financial performance;
• A statement of changes in equity for the period;
• A statement of cash flows for the period;
• Notes, comprising a summary of significant accounting policies and
other explanatory information; and
• A statement of financial position as at the beginning of the earliest
comparative period when an entity applies and accounting policy
retrospectively or makes a retrospective restatement of items in its
financial statements, or when it reclassifies items in its financial
statements.

Overall Considerations for the Compliance with

PFRS and Fair Presentation of Financial
Statements

• Fair Presentation and Compliance with PRFS

• Accounting Policies
• Relevant
• Reliable
• Going Concern
• Accrual Basis of Accounting
• Materiality and Aggregation
• Offsetting
• Frequency of Reporting
• Comparative Information
• Consistency of Presentation

Identification of Financial Statements

• Financial statements shall be clearly identified and distinguished

from other information in the same published document.
• Each component of the financial statements should be clearly
identified.

Statement of Financial Position

a. Property, plant and equipment;

b. Investment property;
c. Intangible assets;
d. Financial assets (excluding amounts shown under (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. The total of assets classified as held for sale and assets included
in disposal groups classified as held for sale in accordance with
PFRS 5 Non-current Assets Held for Sale and Discontinued
Operations;
k. Trade and other payables;
l. Provisions;
m. Financial liabilities (excluding amounts shown under (k) and (l));
n. Liabilities and assets for current tax, as defined in PAS 12 Income
Taxes;
o. Deferred tax liabilities and deferred tax assets, as defined in PAS
12;
p. Liabilities included in disposal groups classified as held for sale in
accordance with PFRS 5;
q. Non-controlling interests, presented within equity; and
r. Issued capital and reserves attributable to owners of the parent.

Current/Non-current Distinction

• Each enterprise should determine, based on the nature of its

operations, whether or not to present current and non-current
assets and current and non-current liabilities as separate
classifications on the face of the statement of financial position.
When an enterprise chooses not to make this classification, assets
and liabilities should be presented broadly in order of their liquidity.

• Whichever method of presentation is adopted, an entity shall

disclose the amount expected to be recovered or settled after more
than twelve months for each asset and liability line item that
combines amounts expected to be recovered or settled:
• No more than twelve months after the reporting period; and
• More than twelve months after the reporting period.
•
Current Assets
• It expects to realize the asset, or intends to sell or consume it, in its
normal operating cycle;
• It holds the asset primarily for the purpose of trading;
• It expects to realize the asset within twelve months after the
reporting period; or
• The asset is cash or a cash equivalent (as defined in PAS 7) unless
the asset is restricted from being exchanged or used to settle a
liability for at least twelve months after the reporting period.

Non-Current Assets
• All other assets shall be classified all other assets as noncurrent.

Other Information to be Presented Either

in the Statement of Financial Position or
in the Notes

• An entity shall disclose, either in the statement of financial position

or in the notes, further subclassifications of the line items
presented, classified in a manner appropriate to the entity’s
operations.
• The detail provided in subclassifications depends on the
requirements of PFRSs and on the size, nature and function of the
amounts involved. An entity also uses the factors set out in
paragraph 58 to decide the basis of subclassification.
Current Liabilities

• It expects to settle the liability in its normal operating cycle;

• It holds the liability primarily for the purpose of trading;
• The liability is due to be settled within twelve months after the
reporting period; or
• It does not have an unconditional right to defer settlement of the
liability for at least twelve months after the reporting period.

Non-Current Liabilities
• An entity shall classify all other liabilities as non-current.

Equity
• Equity capital and reserves are disaggregated into various classes,
such as paid-in capital, share premium and reserves.

Statement of Profit or Loss and Other

Comprehensive Income or Statement of Financial
Performance

• The statement of profit or loss and other comprehensive income

(statement of comprehensive income) shall present, in addition to
the profit or loss and other comprehensive income sections:

• Profit or loss;
• Total other comprehensive income;
• Comprehensive income for the period; being the total of profit or loss and
other comprehensive income.

• An entity shall present the following items, in addition to the profit or loss
and other comprehensive income sections, as allocation of profit or loss
and other comprehensive income for the period:

• Profit or loss for the period attributable to:

• Non-controlling interests, and
• Owners of the parent.
• Comprehensive income for the period attributable to:
• Non-controlling interests, and
• Owners of the parent.

Profit or Loss for the Period

• An entity shall recognize all items of income and expense in a

period in profit or loss unless a PFRS requires or permits
otherwise.
• Some PFRSs specify circumstances when an entity recognizes
particular items outside profit or loss in the current period.
 Other Comprehensive Income for the Period

• An entity shall disclose the amount of income tax relating to each

item other comprehensive income, including reclassification
adjustments, either in the statement of profit or loss and other
comprehensive income or in the notes.
• An entity shall disclose reclassification adjustments relating to
components of other comprehensive income.

Information to be Presented in the Statement(s) of

Profit or Loss and Other Comprehensive Income or
in the Notes

• When items of income or expense are material, an entity shall

disclose their nature and amount separately.
• Circumstances that would give rise to the separate disclosure of
items of income and expense include:
• 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;
• Restructuring of the activities of an entity and reversals of any provisions for
the costs of restructuring;
• Disposals of items of property, plant and equipment;
• Disposals of investments;
• Discontinued operations;
• Litigation settlements; and
• Other reversals of provisions.
• An entity shall present an analysis of expenses recognized in profit or
loss using a classification based on either their nature or their function
within the entity, whichever provides information that is reliable and more
relevant.

Statement of Changes in Equity

• Total comprehensive income for the period, showing separately the total
amounts attributable to owners of the parent and to non-controlling
interests;
• For each component of equity, the effects of retrospective application or
retrospective restatement recognized in accordance with PAS 8; and
• For each component of equity, a reconciliation between the carrying
amount at the beginning and the end of the period, separately disclosing
changes resulting from:
• Profit or loss;
• Other comprehensive income; and
• Transactions with owners in their capacity as owners, showing separately
contributions by and distributions to owners and changes in ownership
interests in subsidiaries that do not result in a loss of control.
Statement of Cash Flows

• Cash flow information provides users of financial statements with a

basis to assess the ability of the entity to generate cash and cash
equivalents and the needs of the entity to utilize those cash flows.
PAS 7 Statement of Cash Flows sets out requirements for the
presentation and disclosure of cash flow information.

Disclosure of Accounting Policies

• An entity shall disclose in the summary of significant accounting policies:

• The measurement basis used in preparing the financial statements, and
• The other accounting policies used that are relevant to an understanding of the
financial statements.
• An entity shall disclose, in the summary of significant accounting policies
or other notes, the judgments, apart from those involving estimations, that
management has made in the process of applying the entity’s accounting
policies and that have the most significant effect on the amounts
recognized in the financial statements.

Capital
• An entity shall disclose information that enables users of its
financial statements to evaluate the entity’s objectives, policies and
processes for managing capital.

Other Disclosures

• An entity shall disclose in the notes:

• The amount of dividends proposed or declared before the financial
statements were authorized for issue but not recognized as a distribution to
owners during the period, and the related amount per share; and
• The amount of any cumulative preference dividends not recognized.
• An entity shall disclose the following, if not disclosed elsewhere in
information published with the financial statements:
• The domicile and legal form of the entity, its country of incorporation and the
address of its registered office;
• A description of the nature of the entity’s operations and its principal
activities;
• The name of the parent and the ultimate parent of the group; and
• If it is a limited life entity, information regarding the length of its life