FINANCIAL MANAGEMENT 1 FINANCIAL MANAGEMENT 1

LECTURE HANDOUT 1 OROSEO TUY II LECTURE HANDOUT 1 OROSEO TUY II

UNDERSTANDING OF FINANCIAL STATEMENTS FREQUENCY OF REPORTING PERIOD

 Financial statements shall be presented at least annually. When an entity’s end of reporting period changes
and financial statements are presented for a period longer or shorter than one year, an entity shall disclose,
LEARNING OBJECTIVES: in addition to the period covered by the financial statements:
1) Reason for using a longer or shorter period
At the end of this topic, the student should be able to: 2) Fact that amounts presented in the financial statements are not entirely comparable
1) Identify the basic financial statements
2) Explain the contents of: STATEMENT OF FINANCIAL POSITION (balance sheet)
a) Balance sheet statement  A formal statement showing the three elements comprising financial position, namely assets, liabilities and
b) Income statement
c) Statement of changes in equity
equity.
3) Prepare the different types of financial statements most especially income statement and balance sheet  Investors, creditors and other statement users analyze the statement of financial position to evaluate such
_________________________________________________________________________________________ factors as liquidity, solvency, financial structure and capacity for adaptation

Financial statements ASSETS – resources controlled by the entity as a result of past transactions and events and from which future
 Means by which the information accumulated and processed in financial accounting. economic benefits are expected to flow to the entity.
 Periodically communicated to the users. Classification of assets:
 The end product (main output) of the financial accounting process.  Current Assets
Paragraph 66 of revised PAS 1 provides that an entity shall classify an asset as current when:
COMPONENTS OF FINANCIAL STATEMENTS: a) Asset is cash or cash equivalent unless the asset is restricted from being exchanged or used to settle a
1) Statement of Financial position (balance sheet) liability for at least twelve months after the reporting period
2) Income statement b) The entity holds the asset primarily for the purpose of trading
3) Statement of comprehensive income (statement of recognized gains and losses) c) The entity expects to realize the asset within twelve months after the reporting period
4) Statement of changes in equity d) The entity expects to realize the asset or intends to sell or consume it within the entity’s normal
5) Statement of cash flows operating cycle
6) Notes, comprising a summary of significant accounting policies and other explanatory notes
 Non-current assets – an entity shall classify all other assets not classified as current as non-current. Included in
the noncurrent assets are the following:
The revisions under PAS 1 include the changes in the titles of the financial statements to reflect 1) Property plant and equipment (fixed assets) 3) Intangible assets
their function more clearly: 2) Long-term investments 4) Other noncurrent assets
Old name New name
Balance sheet Statement of financial position PAS 1 provides that “when an entity presents current and noncurrent assets as separate classification
Income statement Statement of comprehensive income on the face of the statement of financial position, it shall NOT classify deferred tax assets as current
Cash flow statement Statement of cash flows assets”

Paragraph 81 of revised PAS 1 provides that an entity shall present all items of income and expense LIABILITIES – present obligations of an entity arising from past transactions or events, the settlement of which is
and components of other comprehensive income in EITHER of the following: expected to result in an outflow from the entity of resources embodying economic benefits.
1) Two separate statements: (a) income statement displaying the components of net income
or loss; (b) statement of comprehensive income beginning with net income or loss and Essential characteristics of a liability:
displaying components of other comprehensive income 1) The liability is the present obligation of a particular entity – the entity liable must be identified. It is not necessary
2) Single statement of comprehensive income. that the payee or the entity to whom the obligation is owed be identified
2) Liability arise from past transaction or event – liability is not recognized until it is incurred
Paragraph 10 of revised PAS 1 provides that an entity may use titles for the statements other than 3) Settlement of liability requires an outflow of resources embodying economic benefits – obligation of the entity is
those in the standards. Accordingly, the new names are used in accounting standards BUT ARE to transfer cash and non-cash resources or provide services at some future time
NOT MANDATORY FOR USE IN FINANCIAL STATEMENTS.
Classification of liabilities:
PURPOSE OF FINANCIAL STATEMENTS: “to provide information about the financial position,  Current liabilities
performance and cash flows of an entity that is useful to a wide range of users in making economic PAS 1 provides that an entity shall classify a liability as current when:
decisions.” a) Entity expects to settle the liability within the entity’s normal operating cycle
b) Entity holds the liability primarily for the purpose of trading
 Financial statements also show the results of the management’s stewardship of the resources entrusted to it. c) Liability is due to be settled within twelve months after the reporting period
To meet the objective, financial statements provide information about an entity’s: d) The entity does not have an unconditional right to defer settlement of the liability for at least twelve
1) Assets 5) Contributions by and distributions to months after the reporting period
2) Liabilities owners in their capacity as owners
3) Equity 6) Cash flows  Long-term debt falling due within one year – A liability which is due to be settled within twelve months
4) Income and expenses, including gains after the reporting period is classified as CURRENT, even if:
and losses 1) The original term was for a period longer than twelve months
2) An agreement to refinance or to reschedule payment on a long-term basis is completed after the
reporting period and before the financial statements are authorized for issue
However, this rule does not apply if the entity has the discretion to refinance (or roll over) an
obligation for at least 12 months after reporting period under an existing loan facility. In other words,
such obligation is classified as noncurrent even if it would otherwise be due within a shorter period
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LECTURE HANDOUT 1 OROSEO TUY II LECTURE HANDOUT 1 OROSEO TUY II

 Breach of covenants – if certain conditions relating to the borrowing agreement are breached or violated,
the liability becomes payable on demand. EQUITY (net assets) – the residual interest in the assets after deducting all of its liabilities. It is increased by
profitable operations and contribution by owners. It is decreased by unprofitable operations and distributions to
owners.
In this case, the standard states that “such a liability is classified as current even if the lender has
agreed, after the end of the reporting period and before the statements are authorized for issue, not The terms used in reporting the equity of an entity depending on the form of the business organization
to demand payment as a consequence of the breach. However, the liability is classified as are:
NONCURRENT if the lender has agreed on or before the end of the reporting period to provide a Business organization Term to be used
grace period ending at least twelve months after the end of the reporting period.  Proprietorship Owner’s equity
 Partnership
 Shareholders’ Partner’s
equity (stockholders’ equity) – the residual equity
interest of owners in the net assets of a corporation
measured by the excess of assets over liabilities. Generally
 Corporation the elements
Shareholders’ constituting
equity stockholders’
/ stockholders’ equity equity with
Presentation of current liabilities: their equivalent IAS term are:
Under PAS 1, as a minimum, the face of the statement of financial position shall include the following line items
for current liabilities:
a. Trade and other payables d. Current portion of long term debt Philippine term IAS term Philippine term IAS term
b. Current provisions e. Current tax liability Capital stock Share capital Retained earnings (deficit) Accumulated profits (losses)
c. Short-term borrowings Subscribed capital stock Subscribed share capital Retained earnings Appropriation reserve
appropriated
 Non-current liabilities – all liabilities not classified as current. Preferred stock Preference share capital Revaluation surplus Revaluation reserve
Common stock Ordinary share capital Treasury stock Treasury share
 Estimated liabilities – obligations which exist at the end of the reporting period although their amount is not Additional paid in capital Share premium
definite. (e.g. estimated liability for premiums and warranties)
 Reserves – Generally, it represents those items of equity other than the aggregate par or stated value of share
 Contingent liability capital and retained earnings unappropriated. Specifically, reserves include the following:
PAS 37 defines a contingent liability in two ways: a) Share premium reserves (additional paid in capital)
 A contingent liability is a possible obligation that arises from past event and whose existence will be b) Appropriation reserves (retained earnings appropriated)
confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly c) Asset revaluation reserve (revaluation surplus)
within the control of the entity d) Foreign currency translation reserve (accumulated translation gain or loss)
 A contingent liability is a present obligation that arises from past event but is not recognized because it is e) Equity contra reserve (e.g. cumulative unrealized loss on available for sale securities)
not probable that an outflow of resources embodying economic benefits will be required to settle the
obligation or the amount of the obligation cannot be measured reliably. NOTES TO FINANCIAL STATEMENTS – used to report information that does not fit into the body of the
statements in order to enhance the understandability of the statements. It contain information in addition to that
Types of contingent liability: presented in the statement of financial position, income statement, statement of comprehensive income, statement
1) Probable – future event is likely to happen 3) Remote – future event is least likely to of changes in equity and statement of cash flows. It provide narrative description or disaggregation of items
2) Possible – future event is less likely to happen presented in the financial statements and information about items that do not qualify for recognition.
happen
In general, the purpose of the notes to financial statements is “ to provide the necessary disclosure required
Treatment of contingent liability: by Philippine Financial Reporting Standards”.
1) Possible – disclosure
2) Remote – no disclosure
3) Probable and the amount is measured reliably – contingent liability should be recognized as a provision FORMS OF STATEMENT OF FINANCIAL POSITION
(expense and an estimated liability is recorded) 1) Report form – this form set forth the three major sections in a downward sequence of assets, liabilities and
equity
 Contingent assets 2) Account form – as the title suggests, the presentation follows that of an account, meaning, the assets are
PAS 37 defines contingent asset as a “possible asset that arises from past event and whose existence will be shown on the left side and the liabilities and equity on the right side of the financial position
confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within
the control of the entity. Actually, the statement of financial position is an expansion of the accounting equation “assets equals
liability plus equity”
Treatment of contingent asset:
A contingent asset is not recognized because this may result to recognition of income that may never be
realized. However, when the realization of income is virtually certain, the related asset is no longer contingent COMPREHENSIVE INCOME – includes the components of net income or loss and the components of other
asset and its recognition is appropriate. comprehensive income during the period.
A contingent asset is only disclosed when it is probable. If the contingent asset is only possible or remote,
no disclosure is required.  Components of net income (loss) – income and expenses that are recognized in profit or loss

 Other comprehensive income – comprises items of income and expenses that are not recognized in profit or
loss but are recognized directly in equity as required or permitted by accounting standards. examples of
components of other comprehensive income are:
a. Unrealized gains and losses on available for sale financial assets
b. Gains and losses arising from translating the financial statements of a foreign operation
c. Changes in revaluation surplus
d. The effective portion of gains and losses on hedging instruments in a cash flow hedge. (e.g. unrealized gain
or loss on interest swap, forward contract, futures contract and option)
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LECTURE HANDOUT 1 OROSEO TUY II LECTURE HANDOUT 1 OROSEO TUY II

Presentation of comprehensive income: STATEMENT OF COMPREHENSIVE INCOME

The entity has two options of presenting comprehensive income, namely:
 Two statements :
1) An income statement showing the components of income and expenses that are recognized in profits or
loss
2) Statement of comprehensive income beginning with the net income or loss as shown in the income
statement plus or minus the components of other comprehensive income
 A single statement of comprehensive income showing all components of net income or loss and all components
of other comprehensive income. this single statement is a combined income statement and statement of
comprehensive income
As stated earlier, in addition to the income statement, a statement of comprehensive income is also prepared in
order to shown the total comprehensive income. The statement of comprehensive income is formerly the statement
of recognized gains and losses.
The statement of comprehensive income starts with the net income or loss as shown in the income statement
plus or minus the components of other comprehensive income that are not currently presented in the income
statement but are recognized directly in equity as required or permitted by accounting standards.
The purpose of this statement is to provide a more comprehensive information on performance measured
more broadly than the income as traditionally computed.

TRANSACTION APPROACH– the conventional (traditional) preparation of income statement in conformity
with GAAP. This requires the determination of how much income was earned during the year and how much
expense is incurred in earning the revenue. the difference between the income and the expense is net income or net
loss. It is the direct result of the application of the principle of matching costs with revenue that is why, this
procedure is called MATCHING APPROACH.
Sources of income:
a) Sales of merchandise to customers – income from sales should include all sales to customers during the period.
Sales returns, allowances and discounts should be deducted from gross sales to arrive at net sales
b) Rendering of services – income from rendering of services, among others, includes professional fees, media
advertising commissions, insurance agency commissions, admission fees for artistic performance and tuition
fees
c) Use of entity resources – includes interest, rent, royalty and dividend income
d) Disposal resources other than products – examples include gain on sale of investments, gain on sale of property,
plant and equipment and gain on sale of intangible assets
Components of expense:
a) Cost of sales d) Other expenses
b) Distribution costs or selling expenses e) Income tax expense
c) Administrative expenses
PAS 1 specifically mandates that “an entity shall not present any items of income and expense as
extraordinary items, either on the face of the income statement or statement of comprehensive
income or in the notes”.
UNUSUAL and INFREQUENT items of income and expense are now considered component of
income from continuing operations.
Comprehensive income for a period includes the net income or loss for the period plus or minus the
components of other comprehensive income.
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. The important data affecting the
retained earnings that should be clearly disclosed in the statement of retained earnings are:
a. Net income (loss) for the period d. Effect of change in accounting policy
b. Prior period errors e. Appropriation of retained earnings
c. Dividends declared and paid to stockholders
STATEMENT OF CHANGES IN EQUITY – it is a basic statement that shows the movements in the elements
or components of the shareholders’ equity.
The statement of retained earnings is NO LONGER a required basic statement BUT IT IS A PART OF THE
STATEMENT OF CHANGES IN EQUITY
An entity shall present a statement of changes in equity showing the following:
a) Total comprehensive income for the period
b) For each component of equity, the effects of changes in accounting policies and correction of errors
c) The amounts of transactions with owners in their capacity as owners, showing separately contributions by
and distributions to owners
d) For each component of equity, a reconciliation between the carrying amount at the beginning and end of
the period, separately disclosing each change.
STATEMENT OF CASH FLOWS – it is a basic component of the financial statements which summarizes the
operating, investing and financing activities of an entity. It provides information about the cash receipts and cash
payments of an entity during a period.

Forms of Income Statement

END OF LECTURE
PAS 1 provides that an entity shall present an analysis of expenses recognized in profit or loss using a
classification based on either the FUNCTION of expense or their NATURE within the entity, whichever provides
information that is reliable and more relevant.

 Functional presentation (cost of sales method) – classifies expenses according to their function as part of
cost of sales, selling activities, administrative activities and other activities.

 Natural presentation – expenses are aggregated according to their nature and not allocated among the
various functions within the entity.

PAS 1 does not prescribe any format. The standard simply states “because each method of
presentation has merit for different types of entities, management is required to select the most
relevant and reliable information.”

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