Reviewer – Valix’s Conceptual Framework (Ch.
5 & 6)
Elements of Financial Statements
1. Assets
Definition: Economic resources controlled by the entity because of past events, expected to
bring future economic benefits.
Key Points: Must be controlled, must give future benefits, must come from a past
transaction.
Examples: Cash, machinery, prepaid rent.
2. Liabilities
Definition: Present obligation to transfer resources due to past events.
Types:
- Legal obligation → enforceable by law (e.g., loan payable, tax payable).
- Constructive obligation → arises from business practice (e.g., warranties, refund policy).
Examples: Accounts payable, bank loans, taxes payable.
3. Equity
Definition: Residual interest in assets after deducting liabilities.
Formula: Assets – Liabilities = Equity.
Example: If assets = ₱1,000,000 and liabilities = ₱600,000 → Equity = ₱400,000.
4. Income
Definition: Increases in assets or decreases in liabilities that increase equity.
Types:
- Revenue → from normal business (e.g., sales of goods, service fees).
- Gains → from outside normal business (e.g., profit on sale of old land).
Example: Grocery store earns sales revenue; also earns a gain from selling an old truck.
5. Expenses
Definition: Decreases in assets or increases in liabilities from operations.
Examples: Cost of goods sold, salaries, utilities, depreciation.
6. Losses
Definition: Decrease in economic benefits not from normal operations.
Examples: Damage from typhoon, loss on sale of equipment, theft.
Recognition Principles
Recognition
Definition: Process of including an item in the financial statements.
Criteria:
1. Meets definition of element.
2. Probable inflow or outflow of benefits.
3. Can be measured reliably.
Example: Lawsuit with certain ₱200,000 liability → recognize; uncertain → disclose only.
Carrying Amount
Definition: Value of an item in the financial statements.
Example: Equipment ₱500,000 – depreciation ₱100,000 = ₱400,000 carrying amount.
Income Recognition
General rule: Recognize income when earned (point of sale).
Exceptions:
- During production → e.g., long-term construction projects.
- Upon collection → if uncertain to collect.
- Agricultural produce → recognized at harvest.
Example: Sold ₱10,000 goods on credit → record income when sold, not when paid.
Expense Recognition
Based on Matching Principle: Record expenses in same period as related income.
Methods:
1. Cause-and-effect → COGS matched with sales, warranty expense with product sold.
2. Systematic allocation → spreading cost, e.g., depreciation, amortization.
3. Immediate recognition → if future benefit is uncertain, e.g., salaries, advertising.
Key Takeaways
- Assets = controlled resources with future benefits.
- Liabilities = present obligations (legal or constructive).
- Equity = residual claim after liabilities.
- Income increases equity, expenses and losses decrease it.
- Recognition = include items only if definition, probability, and measurability are met.
- Matching principle = expenses must align with revenues.
