Chapter 3 and 4

CHAPTER 3
STATEMENT OF
COMPREHENSIVE
INCOME
3.1 DEFINITION
• A statement of comprehensive income (new title for

income statement) is a structured financial statement that
shows the financial performance of business entity for a
given period. A period covered by an income statement
may be monthly,quarterly, semi-annually or annually.
• The two accounting elements comprising the statement of
comprehensive income are the income and expenses.The
difference between these two accounting elements can
either be profit or loss.
• Income is increases in economic benefits during the
accounting period in the form of inflows or enhancement
of assets or decreases of liabilities that result in increases
in equity other than those relating to contributions from
equity participants.
• Expenses are decreases in economic benefits during the

accounting period in the form of outflows or depletion of
assets or incurrences of liabilities that result in decrease
in equity,other than those relating to distribution to equity
participants.
• The definition of income and expenses identify their
essential features but do not attempt to satisfy the criteria
that would need to be met before they are recognized in
the income statement. Thus, item of income and expense
will be included in the statement of comprehensive
income if it meets the criteria for recognition.
Differences between Statement of Financial Position
and Statement of Comprehensive Income
Statement of Financial Statement of
Position Comprehensive
Income
As to the accounting Assets,liabilities and equity Income and expenses
elements presented
As to the nature of the Presents the financial position Presents the result of operation
Statement
As to financial data needed Liquidity,solvency,financial structure Profitability of the business entity
for decision making and capacity for adaptation
As to to date of the financial As a given date(one day only) For a given

Statement period(month,quarter,semi-annual
or annual)
As to the nature of the Real accounts Nominal accounts
3.2 RECOGNITION PRINCIPLE
• Recognition is the process of incorporating in the

statement of comprehensive income an item that meets
the definition of income and expense and satisfies the
criteria for recognition.
• An item that meets the definition of income and expenses
should be recognized if:
a.It is profitable that any future economic benefit associated
with the item will flow to or from the entity; and
b.the item has a cost or value that can be measured with
reliability
• Recognition involves the depiction of the item in words
and by monetary amount and the inclusion of that amount
in the statement of comprehensive income. Items that
satisfy the recognition criteria should be recognized in the
statement.
• The failure to recognize an income or expense is not

rectified by disclosure of the accounting policies
used nor by notes or explanatory materials.
Recognition of Income
• Income is recognized in the statement of comprehensive
income when an increase in future economic benefit
related to an increase in an asset or a decrease of a
liability has arisen that can be measured reliably.
• This means, in effect that recognition of income occurs
simultaneously with the recognition of increases in assets
or decreases in liabilities, for example, the net increase in
assets arising on a sale of goods or services or the
decrease in liabilities arising from the waiver of a debt
payable.
• Generally,income is recognized when revenue has been
earned already where it can be measured reliably and has
some sufficient degree of certainty.
Recognition of Expenses
• Expenses are recognized in the income statement when a

decrease in future economic benefits related to a
decrease in assets or an increase of a liability has arisen
that can be measured reliably.
• This means in effect, that recognition of expenses occurs

simultaneously with the recognition of an increase in
liabilities or a decrease of assets, for example,the accrual
of employees salary or the depreciation of machinery.
Methods of Recognizing Expenses
• An item that meets the recognition criteria of expense is

recognized in the income statement on the following
basis:
1.Matching costs with revenues;

2.Systematic and rational allocation; and
3.Immediate recognition
Matching Costs with Revenues
• Expenses are recognized in the statement of

comprehensive income on the basis of a direct
association between costs incurred and the earning of
specific items of income.
• This process involves the simultaneous or combined
recognition of revenues and expenses that result directly
and jointly from the same transactions or events.
• For example, the various components of expense making
up the cost of goods sold are recognized in the same time
as the income derived from the sale of goods.
• Systematic and rational allocation. When economic
benefits are expected to arise over several accounting
periods and the association with income can only be
broadly or indirectly determined, expenses are recognized
in the statement of comprehensive income of the basis of
systematic and rational allocation procedures.
• This allocation procedure is intended to recognize

expenses in the accounting periods in which the
economic benefits associated with the item is consumed
or expired.
• For example, the expenses associated with the using up
of assets such as property, plant and equipment ,
goodwill, patents or trademarks (depreciation and
amortization) is an application of the systematic and
rational allocation procedure.
Immediate Recognition
• Under this recognition procedure, an expense is

recognized immediately in the statement of
comprehensive income when expenditure produces no
future benefits or when the future economic benefits do
not qualify for recognition in the statement of financial
position as an asset.
• An expense is also recognized in the statement of
comprehensive income in those cases when a liability is
incurred without the recognition of an asset, as when a
liability under product warranty arises
EXERCISES
1.Define the following:

a. Statement of comprehensive income
b.Income
c.Expenses
2.Differentiate statement of financial position from
statement of comprehensive income.
3.State the criteria for income and expenses to be
recognized in the statement of comprehensive income.
4. Discuss the concept of recognition of income and
expenses.
5. Describe the following methods of recognizing
expenses:
a.Matching of costs with revenues
b.Systematic and rational allocation
c.Immediate recognition
3.3 DETERMINATION OF PROFIT
• Profit is frequently used as a measure of performance or
as the basis for other measures such as return on
investment or earnings per share
• Profit or net income is generally the expression of the
financial performance of a business entity. It is the excess
of the income over cost or expenses for a particular
period.
• There are two methods of determining the net income or
profit of a business entity:
1.Capital maintenance approach; and
2.Transaction approach
3.4 CAPITAL MAINTENANCE APPROACH
• The concept of capital maintenance as the term suggests

is concerned with how an entity defines the capital it
seeks to maintain. Under this approach, only inflows of
assets in excess of amounts needed to maintain capital
may be regarded as profit.
• In other words, profit under the capital maintenance
approach is measured by simply comparing the capital at
the end of the period against the capital at the beginning
of the period. The term ‘’capital’’ refers to the excess of
assets over liabilities or net assets.
• In general terms, an entity has maintained its capital if it
has as much capital at the end of the period as it had at
the beginning of the period. Any amount over and above
that required to maintain the capital at the beginning of
the period is considered profit.
The Framework mentioned two concepts of capital

maintenance,namely:
1.financial capital maintenance;and
2.physical capital maintenance
Financial Capital Maintenance
• Under this concept, a profit is earned only if the financial
amount of the net assets at the end of the period exceeds the
financial amount of net assets at the beginning of the period,
after excluding any distributions to, and contributions from,
owners during the period.
• Financial capital maintenance can be measured in either
nominal monetary units or units of constant purchasing power.
Since capital is defined in terms of nominal monetary units
under the concept of financial capital maintenance, profit
represents the increase in nominal money capital over the
period.
• Thus, increase in the prices of assets held over the
period conventionally referred to as holding gains, are not
recognized until the assets are disposed of in an
exchange transaction.
• Under the concept of financial capital maintenance, the

net assets are defined in terms of constant purchasing
units.
• The financial capital maintenance does not require the
use of a particular basis of measurement. The basis of
measurement selected is dependent on the type of
financial assets that the entity is seeking to maintain.
Physical Capital Maintenance
• Under the concept, a profit is earned only if the physical
productive capacity of the entity at the end of the period
exceeds the physical productive capacity at the beginning
of the period after, excluding any distribution to and
contributions from owners during the period.
• Since capital is defined in terms of the physical
productive capacity, profit represents the increase in that
capital over the period.
• This concept requires the adoption of the current cost
basis of measurement
Differences Between The Two Concepts of
Capital Maintenance
• The principal difference between the two concepts of
capital maintenance is the treatment of the effect of
changes in the prices of assets and liabilities of the entity.
• Under the financial capital maintenance, the effect of
the changes in the prices of assets and liabilities are
disregarded. The net assets therefore are measured
using the historical cost.
• Under the physical capital maintenance, the effect of
the changes in the prices of assets and liabilities are
considered. Hence, the net assets are measured using
the current costs.
Formulas to Compute the Net Income Using thee
Capital Maintenance Approach
Formula 1- Net assets at the beginning and end of the period are given
Under this formula, the net income is computed by comparing the net assets at
the end of the period against the net assets at the beginning of the period by
excluding distribution to our contributions frow the owners.
Net assents – end xxxxxx

Less: Net assets beginning xxxxxx
Income before adjustments capital distribution/contribution xxxxxx
Add: Distribution to owners xxxxxx
Total xxxxxx
Less: Additional contributions from owners xxxxxx
Net Income xxxxxx
An alternative formula may appear as follows:
Net assets, end of the period xxxxxx

Add: Withdrawals made xxxxxx
Total xxxxxx
Less: Net assets,beginning of the period xxxxxx
Additional investment xxxxxx xxxxxx
Net income xxxxxx
Formula ll -Only changes in the assets and
liabilities are given
Under this formula, the net income is computed by
determining the effect of changes in assets and liabilities on
the net assets of the business entity.
The points to remember are;

1.increase in assets will increase net assets;
2.decrease in assets will decrease net assets;
3.increase in liability will decrease net assets; and
4.decrease in liability will increase net assets
The net increase in net assets (increase in net assets
minus decrease in net assets) will then be adjusted by
contributions from or distributions to owners
Net increase in net assets xxxxxx

Add:withdrawal mode xxxxxx
Total xxxxxx
Less: Additional investment xxxxxx
Net income xxxxxx
Illustration 1 -Determining of Income Using Capital
Maintenance Approach
JENNY Company provides the following data for the

current year.
January 1 December 31
Total assets 1,800,000 2,600,000
Total liabilities 1,200,000 1,500,000
Withdrawals made during the year 600,000
Additional investment 400,000
By reason of changes in prices and inflation rates, the total
assets and liabilities on January 1 had a current cost of
P2,100,000 and P1,400,000 respectively.
REQUIRED: Determine the amount of net income under the

capital maintenance approach using:
1.Financial capital maintenance;and
2.Physical capital maintenance
Answer 1. Since the net assets at the beginning and the end can be
determined, the first formula can be applied.
The net assets on January 1 and December 31 amounted
to P600,000 (P1,800,000 - 1,600,000) and P1,100,000 (P2,600,000
- 1,500,000 ) respectively.
Net assets, December 31 1,100,000

Less: Net assets , January 1 600,000
Income before withdrawal and additional investment 500,000
Add: Withdrawal 600,000
Total 1,100,000
Less: Additional investment 400,000
Net income 700,000
Using the alternative formula, the net income is
computed as follows:

Add: Withdrawal 600,000
Total: 1,700,000
Less: Net assets , January 1 600,000
Additional investment 400,000 1,000,000
Net income 700,000
Answer 2. The net assets on January 1 using the current
cost amounted to P700,000 (P2,100,000 - 1,400,000)
The net income is computed as follows:

Add: Withdrawals 600,000
Total: 1,700,000
Less: Net assets, January 1 700,000
Additional investments 400,000 1,100,000
Net income 600,000
Illustration 2. Determining of Income Using Capital Maintenance
Approach
The following information were provided by YVONE Company during the
current year:
Increase in cash 300,000
Decrease in accounts receivable 80,000
Increase in inventories 400,000
Decrease in prepaid expenses 20,000
Increase in land 800,000
Decrease in motor vehicle 200,000
Increase in accounts payable 300,000
Decrease in mortgage payable 200,000
Additional Investment 600,000
Temporary withdrawal of capital 150,000
Required: Determine the net income during the period using the
capital maintenance approach.
• Answer: Since the net assets at the beginning and at the end of
the period are not provided, the second formula will apply.
Effects on the net assets
Increase Decrease
Increase in cash 300,000
Increase in inventories 400,000
Decrease in prepaid expenses 20,000
Increase in land 800,000
Decrease in motor vehicles 200,000
Decrease in mortgage payable 200,000 -
Total 1,700,000 600,0000
3.5 TRANSACTION APPROACH
• The transaction approach is the traditional method of determining net income
or profit in accordance with the Philippine Accounting Standards.
• Under the transaction approach, the elements directly related to the
measurements of profit are income and expenses.
The basic formula to compute the net income will appear as follows:
Income xxxxxx
Less: Expenses xxxxxx
Net income (loss) xxxxxx
The framework defines income as follows:
Income is increases in economic benefits during the

accounting period in the form of inflowsor enhancement of
assets or decreases of liabilities that result in increases in
equity other than those relating to contributions from
equality participants.
The definition of income encompasses both revenue and

gains.
Revenue arises in the course of the ordinary activities of
an entity and is referred ti by a variety of different names
includes sales,fees,interests, dividends,royalties and rent.
Gains represent other items that meet the definition of

income and may , or may not, arise in the course of the
ordinary activities of an entity. Gains represent increases in
economic benefits and as such are not different in nature
from revenue. Gains may arise from the disposal of non-
current assets.
• When gains are recognized in the income statement, they
are usually presented separately because knowledge of
them is useful for the purpose of making economic
decisions.
Gains are often reported in the income statement net of

related expenses.
Expenses
• The Framework defines expenses as follows:
Expenses are decreases in economic benefits during the
accounting period in the form of outflows or depletion of
assets or incurrences of liabilities that result in decrease in
equity, other than those relating to distribution to equity
participants.
The definition of expenses encompasses losses as
well as those expenses that arise in the course of the
ordinary activities of the entity. Expenses usually take the
form of an outflow or depletion of assets such as cash and
cash equivalents , inventory, property, plant and equipment.
The definition also includes unrealized losses, for
those arising from the effects of increase in the rate of
exchange for a foreign currency in respect of borrowings of
an entity in that currency.
Examples of expenses that arise in the course of

the ordinary activities of the entity are costs of
sales,wages,supplies used and depreciation.
Losses represent other items that meets the
definition of expenses and may, or may not, arise in the
course of the ordinary activities of an entity. Losses
represent decreases in economic benefits and as such they
are no different in nature from other expenses. Losses
include, for example,those resulting from disasters such as
fire and flood as well as those arising on the disposal of
non-current asset.
When losses are recognized in the income
statement, they are usually displayed separately because
knowledge of them is useful for the purpose of making
economic decisions.
PROFIT
Profit is the residual amount that remains after

expenses,including capital maintenance adjustment where
appropriate have been deducted from income. If expenses
exceed income, the residual amount is called loss.
3.6 METHODS OF PRESENTING THE
STATEMENT OF COMPREHENSIVE INCOME
An entity shall present an analysis of expenses
using a classification based on either the nature of expense
or their function within the entity,whichever provides
information that is reliable and more relevant.
Entities are encouraged to present the analysis on
the face of the statement of comprehensive income.
Expenses are subclassified to highlight components of
financial performance that may differ in terms of
frequency,potential for gain or loss and predictability.
PAS 1 mentioned two methods of presenting the statement
of comprehensive income, namely
1.Nature of expense;and
2.function of expense or cost of sales method
The choice between the function of expense

and the nature of expense method depends on historical
and industry factors and the nature of entity.Both methods
provide an indication of those cost that might vary,directly or
indirectly,with the level of sales or production of the entity.
Because each method of presentation has merit for
different types of entities,management is required to select
the most relevant and reliable
presentation.However,because information on the nature of
expense is useful in predicting the future cash
flows,additional disclosure is required when the function of
expense classification is used.
NATURE OF EXPENSE METHOD
Under the nature of expemse method,the expenses
are aggregated in the statement of comprehensive income
according to their nature.For example,the aggregation will
be depreciation,purchases of materials,transport
costs,employee benefits and advertising costs.
The expenses are not allocated among the various
function within the entity.This method may be simple to
apply because no allocations of expenses to functional
classifications are necessary.
The statement of comprehensive income using the nature of
expense method of presentation will appear as follows:
Revenue xxxxx
other income xxxxx
Change in inventories of finished goods and works in process xxxxx
Total income xxxxx
Expenses
Raw materials or inventory purchases xxxxx
Employee benefit costs xxxxx
Depreciation and amortization xxxxx
Other expenses xxxxx xxxxx
Net income xxxxx
FUNCTION OF EXPENSE OR COST OF SALES
METHOD
This method of presenting the statement of comprehensive
income classifies expenses according to their function as part of cost of
sales,distribution or administrative activities.
At a minimum,an entity discloses the cost of sales under this
method separately from other expenses.This method can provide more
relevant information to users than classification of expense by nature,but
allocating costs to function may require arbitrary allocations and involve
cinsiderable judgement.
Entities classifying expenses by function shall disclose additional
information on the nature of expenses,including depreciation and
amortization expenses and employee benefit expense.
The statement of comprehensive income using the
function of expenses method may appear as follows:
Revenue xxxxx
Less of cost sales xxxxx
Gross income xxxxx
Less:Selling or distribution expenses xxxxx
Administrative expenses xxxxx
Finance cost xxxxx
Other expenses xxxxx xxxxx
Net income xxxxx
ILLUSTRATION 3- Preparation of Statement of
Comprehensive Income
NICANOR trading provided the following information for
the year 2018 as follows:
Sales 7,800,000
Sales return and allowances 180,000
Sales discounts 120,000
Merchandise inventory, January 1 800,000
Merchandise inventroy, December 31 1,200,000
Purchases 4,500,000
Freight in 150,000
Purchase returns and allowances 110,000
Purchase discount 140,000
Rent income 250,000
Dividend income 150,000
Interest income 100,000
Doubtful account 50,000
Distribution expenses
Sales salaries 300,000
SSS contribution 15,000
PAG-IBIG contribution 5,000
Salesmen's commission 100,000
Depreciation expenses-Delivery Vehicle 40,000
Administrative expenses:
Officer and staff salaries 500,000
Depreciation-Office furniture 50,000
Advertising expenses 20,000
Office supplies 10,000
Store supplies 15,000
Interest expense on bank loan 20,000
The applicable tax rate is 30%.
REQUIRED: Prepare a statement of comprehensive.
income for the year using the following methods:
1.Nature of expense with supporting notes;and

2.Function of expense with supporting notes
ANSWER 1.The statement of comprehensive income of

blue sky company using the nature of expense method will
appear as follows:
NICANOR TRADING
Statement of comprehensive income
Year ended December 31,2018
Net sales revenue (Note 1) 7,500,000
Other income (Note 2) 500,000
Increase in inventory (Note 3) 400,000
Total Income 8,400,000
Expenses:
Net purchase (Note 4) 4,400,000
Employee benefit costs (Note 5) 850,000
Doubtful Accounts 50,000
Salesmen's commision 100,000
Depreciation (Note 6) 90,000
Advertising 20,000
Supplies expense (Note 7) 25,000
Finance costs (Note 8) 20,000 5,555,000
Net income before tax 2,845,000
Income tax- 30% 853,500
Net income 1,991,500
Note 1- Net sales revenue

Sales 7,800,000
Sales return and allowances (180,000)
Sales discounts (120,000)
Net sales revenue 7,500,000
Note 2- Other income
Rent income 250,000
Total 500,000
Note 3- Increase in Inventory

Merchandise inventory, December 31 1,200,000
Merchandise inventory,January 1 800,000
Increase in inventory 400,000
Note 4- Net purchases
Purchases 4,500,000
Freight-in 150,000
Purchase returns and allowances (110,000)
Purchase discounts (140,000)
Net purchases 4,400,000
Note 5-Employee benefit cost
SSS contribution-distribution 15,000
PAG-IBIG contribution-distribution 5,000
Officer and staff salaries 500,000
Total 850,000
Note 6- Depreciation
Depreciation expenses-Delivery Vehicle 40,000
Total 90,000
Note 7-Supplies
Total 25,000
Note 8-Finance cost
Answer 2.The statement of comprehensive income of

NICANOR TRADING using the function of expense method
will appear as follows:
NICANOR TRADING
Statement of comprehensive income
Year ended December 31,2018
Net sales revenue (Note 1) 7,500,000
Less:Cost of sales (Note 2) 4,000,000
Gross income 3,500,000
Other income (Note 3) 500,000
Total income 4,000,000
Expenses:
Distribution expenses(Note 4) 495,000
Administrative expenses(Note 5) 640,000
Finance costs (Note 6) 20,000 1,155,000
Income before tax 2,845,000
Income tax 853,500
Note 1- Net sales revenue
Sales 7,800,000
Sales returns and allowances (180,000)
Sales discounts (120,000)
Net sales revenue 7,500,000
Note 2-Cost of sales
Purchases 4,500,000
Freight-in 150,000
Total 4,650,000
Purchase returns and allowances (110,000)
Purchase discounts (140,000) 4,400,000
Good available for sale 5,200,000
Less:Merchandise Inventory,December 31 1,200,000
Cost of sales 4,000,000
Note 3- Other income

Rent income 250,000
Total 500,000
Note 4- Distribution expense

Salesmen's commission 100,000
Depreciation expenses-Delivery vehicle 40,000
Advertising expenses 20,000
Total 495,000
Note 5- Administrative expense
Office and staff supplies 500,000
Doubtful accounts 50,000
Total 640,000
Note 6-Finance costs

3.7 DISCLOSURE OF INFORMATION ON THE
STATEMENT OF COMPREHENSIVE INCOME
Significant information need to be shown on the

statement of comprehensive income may be presented
either:
a.On the face of the statement;or

b.an additional notes
Information to be Presented on the Face of the
Statement of Comprehensive Income
Normally all items of income amd expenses
recognized in a period are included or profit.This includes
the effect of changes in accounting estimates.
All items of income and expenses recognized in
a period shall be included in profit or loss unless a
Standard or an interpretation requires otherwise.
However,circumstances may exist when particular
items maybe excluded from profit or loss for the current
period.The following items are excluded from profit or loss.
However,circumstances may exist when particular items
maybe excluded from profit or loss for the current
period.The following items are excluded from profit or loss.
1.revaluation surplus;
2.gains and losses arising on translating the financial
statements of a foreign operation;
3.gains or losses on remmesuring available-for-sale
financial assets;
4.correction of errors;and
5.effect of changes in accounting policies
As a minimum,the face of the statement of comprehensive
income shall include line items that present the following
amounts for the period.
1. revenue
2. finance costs
3. share of the profit or loss of associates and joint ventures
accounted for using the equity method
4. tax expense
5. single amount comprising the total of post-tax profit or
loss on the disposal of assets from discontinued operation
6. profit or loss
The following items shall be disclosed on the face of the
statement of comprehensive income as allocations of profit or
loss for the period.
1. profit or loss attributable to minority interest;and
2. profit and loss attributable to equoty holders of the parent
Additional line items, headings and subtotals shall be
presented on the face of the income statement when such
presentation is relevant to an understanding of the enity's
financial performance.
In adding additional line items, headings and subtotals,
the factors to be considered include materiality and the nature
and function of the components of income and expenses.
Generally, income and expense items are not offset.
An entity shall not present any items of income

and expenses as extraordinary items,either on the face
of the income statement or in the notes.
When items of income and expenses are material,

their nature and amounts shall be disclosed separately.
Information to be Disclose Separately on the
Notes
Circumstances that would give rise to the
separate disclosure of items of income and expenses
include.
1.Write down of inventories to net realizable value or of
property,plant and equipment to recoverable amount,as well
as reversal of such write down
2.Restructuring of the activities of an entity and reversals of
any provisions for the cost of restructuring.
3.Disposal of items of property,plant and equipment.
4.Disposals of investments
5.Discontinued operations
6.Logation settlements;and
7.other reversal of provision
EXERCISES
1.Give the two methods of determining net income.
2.Discuss the following capital maintenance approach:
a.financial capital maintenance
b.physical capital maintenance
3.Describe the formula used to compute net income using
the capital maintenance approach.
4.Discuss the transaction approach of determining net
income.
5.State the methods of presenting the statement of
comprehensive income.
6.Describe the nature of expenses method.
7.Describe the concept of the function of expense method.
8.What are the items enumerated in PAS 1 to be excluded
from the statement of the comprehensive income for the
period?
9.State the minimum line items thats should be presented
on the face of the statement of comprehensive income.
3.1 TRUE OR FALSE
Write true if the statement is correct. If you believe
otherwise,write false and state your reason briefly.
1.Profit or loss refers to the change in equity during a period
resulting from transactions and other events other than those
changes resulting from transaction with owners.
2.Other comprehensive income comprises item of income and
expense,including reclassification adjustments that are not
recognized in profit and loss as required by the standards.
3.A business entity that classifies expenses by function are required
to disclose additional information on the nature of expenses
including depreciation,amortization expense and employee benefit
costs.
4.The PFRS requires an entity to present all items and
expenses in a period using either a single statement of
comprehensive income or a two separate statements one of
which displays the component of profit and loss and the
ither statements begins with profit and loss and displays
components of other comprehensive income.
5.In the nature of expense method,expenses are calssified

according to their function as part of cost of sales,marketing
costs,administrative activities and other operating activities.
6.Actuarial gain on define benefit plan that is fully
recognized,unrealized gain on forward contract designated
as cash flow hedge and dividend paid to stock holders are
included as part of other comprehensive income.
7.In the transaction approach of measuring

income,adjustment of inventory to lower or net realizable
value when net realizable value is lower than cost and
exchange of inventory valued at regular selling price for a
machinery are considered business transaction.
8.Under financial concept of capital,a profit is earned only if
the monetary amount of net assets at the end of the period
exceeds the monetary amount of the net assets at the
beginning of the period,after excluding any distribution to
and contributions from owners.
9.A decrease of equity arising from distribution to owners,a
loss onthe dislosal of machinery and a reduction in incone
for the accounting period are examples of expense.
10.By measuring the change of owners' equity or by
applying the value added concept,income for the period can
be determined.
3.2 TRUE OR FALSE

otherwise,write false and state your reason briefly.
1. The new name for income statement is statement of
2.The statement of comprehensive income shows the
income,expenses,liabilities and assets of a business entity.
3. A statement of comprehensive income usually covers a
certain period.
4. An income usually results to decrease in economic benefits
in the form of outflow of resources.
5. An income basically increases the equity of the owners.
6. When the equity of the owners increases, it is attributable
only to income realized.
7. Expenses basically result to depletion of assets or
incurrence of liabilities.
8. Expenses will result to reduction of the owners’ equity
9. Reduction in owners’ equity is attributable solely to
expenses incurred by an entity.
10. The financial position of a business entity is reflected in te
statement of comprehensive income.
3.3 – TRUE OR FALSE

otherwise, write false and state you reason briefly.
1. The statement of comprehensive income presents the
results of entity’s financial performance.
2. Both the liquidity and profitability status of an entity can
be determined in the statement of comprehensive
income.
3. An item that meets the definition of income or expense is
immediately recognized in the statement of
4. Recognition of income or expense item means inclusion in
the statement of comprehensive income.
5. An income or expense item that was not recognized would
be corrected by disclosure in the notes or explanatory
materials.
6. An income is recognized if is possible that future
economic benefits that can be measured reliably will flow to
the entity.
7. Income is recognized when cash has been collected
already.
8. Expenses usually involve payment of cash.
9. Cost of sales increases the equity of the owners.
10. Under the matching of cost with revenue principle,
expenses are recognized only once revenues have been
realized already.
3.4 - TRUE OR FALSE
1. The recognition of salaries and wages as an expense is
an example of systematic and rational allocation principle.
2. Depreciation or amortization is an application of
systematic or rational allocation.
3. Under the capital maintenance approach, profit is the
excess of income over expenses.
4. The financial capital maintenance approach uses the
historical cost in valuing net assets.
5. The physical capital maintenance approach differs from
the financial capital maintenance approach because the
former uses current cost to measure net assets.
6. When the net assets at the beginning of the period
exceed the net assets at the end of the period, the
difference is net income after excluding capital
contributions and distributions of owners.
7. The net income cannot be determined under the capital
maintenance approach, if the net assets at the beginning
and at the end of the period are not provided.
8. An increase in liability will result to increase in net assets.
9. When the assets of the company decreased, its net
assets would also decrease.
10. Under the capital maintenance approach, dividend
payments to shareholders are deducted from net assets to
compute the net income.
3.5 – TRUE OR FALSE
Write true if the statement is correct, if you believe
1. When there are no capital contributions or distribution to or
from the owners, the excess of net assets at the end over the
net assets at the beginning of the period is equal to net
income.
2. A decrease in bank loan payable will increase the net assets
of an entity.
3. Only changes in current assets and current liabilities are
accounted in computing the net income under the capital
maintenance approach.
4. The income or loss under the traditional approach is computed in
accordance with the generally accepted accounting principles.
5. The excess of income over expenses in the traditional approach is equal
to net income.
6. Revenues include income and gains realized or earned by the entity.
7. An inflow of economic resources arising from the ordinary activities of a
business entity is called revenue.
8. Usually, gains realized are presented separately in the statement of
9. The definition of expenses includes the concept of losses.
10. The term profit refers to the residual amount after expenses have been
deducted from income.
3.1 – MULTIPLE CHOICE
Select the best answer.
1. A structure financial statement that shows the financial

performance of business entity for a given period is called
______________.
A. Statement of financial position
B. Statement of comprehensive income
C. Statement of cash flow
D. Statement of changes in equity
2. The accounting elements that comprise the statement of
comprehensive income are :
2. The accounting elements that comprise the statement of
comprehensive income are :
I. Income and expenses
II. Assets, liabilities and equity
III. Assets, liabilities, equity, income and expenses
a. I only c. III only

b. II only d. Cannot be determined
3. An item that meets the definition of income and expense
should be recognized if:
I. It is probable that any future economic benefit associated
with the item will flow to or from the entity
II. It is possible that any future economic benefit associated
with the item will not flow to or from the entity
III. The item has a cost or value that can be measured with
reliability
A. I only C. I and III
B. I and II D. II and III
4. The process of incorporating in the statement of
cosmprehensive income an item that meets the definition of
income and expense the criteria for inclusion is called ________.
A. Identification C. interpretation
B. Measurement D. recognition
5. The following methods are adopted in recognizing expenses in

the income statement, except
A. Systematic and rational allocation
B. Correlation analysis
C. Immediate recognition
D. Matching of cost with revenue
6. _________ is an expense recognition principle where
expenses are recognized in the statement of comprehensive
income on the basis of a direct association between costs
incurred and the earnings realized.
7. When the costs of the items are considered as expenses
in the same period as the income realized from the sale of
goods. It is an example of _________.
8. What expense recognition principle is applied when
depreciation and amortization are recognized as expense?
9. It is used to measure the financial performance of a business
entity.
A. Assets
B. Income
C. Expense
10. Statement 1 The definition of income and
expense simply identifies their essential features but
do not satisfy the criteria for recognition
Statement 2 The failure to recognize an
income or expense is not corrected by disclosure
procedure of the accounting policies used
A. Only the first statement is correct
B. Only the second statement is correct
C. Both statement is correct
D. Neither statement is correct
1. In this method of determining income, only inflows of

assets in excess of amounts needed to maintain the capital
may be considered.
A. Transaction approach
B. Capital maintenance approach
C. Year-end adjustment approach
D. Comparison approach
2. Under this concept of determining income, profit
represents the increase in nominal money capital over the
period.
B. Financial capital maintenance only
C. Physical capital maintenance only
D. Both financial capital and physical capital maintenance
3. The concept of determining income where net assets are
defined in terms of constant purchasing units is
___________.
4. Under the concept, capital is defined in terms of the
productive capacity of net assets.
5. The concept of determining net income where I adopts
the current cost as a basis of measuring the net assets is
___________.
6. To compute the net income under the capital
maintenance approach, the amount distributed to owners in
the form of dividends or withdrawal of capital is
A. Added to the net assets at the end of the period
B. Deducted from the net assets at the end of the period
C. Added to or deducted from the net assets at the end of
the period depending on the materiality of the amount
involved
D. Disregarded in the computation
7. Statement 1 an increase in liabilities will give
rise to a decrease in net assets.
Statement 2 an increase in assets will result to an
increase in net assets
8. The concept of determining profit, where income and
expenses are the elements directly related to its
measurement is _________.
9. Which of the following statement is false?
A. The definition of income encompasses both revenue and
gains
B. The definition of revenue encompasses both income and
gains
C. Revenue usually arises in the course of the ordinary
activities of a business entity
D. Gains are not different in nature from revenue
10.Statement 1 Gains when recognized are usually
presented separately in the income statement
Statement 2 Gains are often reported in the income
statement net of related expenses.
Select the best answer

1. The following information are separately disclose in the
notes to the financial statements, except
A. Provision for doubtful accounts
B. Disposal of investment
C. Discontinued operation
D. Restructuring of the activities of an entity
2. Statement 1 When items of income and expenses
are immaterial their nature and amounts shall be disclosed
separately.
Statement 2 An entity shall not present any
items of income and expenses as extraordinary items,
either on the face of the statement of comprehensive
income or in the notes.
3. The following items shall be disclosed on the face of the
statement of comprehensive income as allocation of profit or
loss for the period
I. Profit or loss attribute to minority interest.
II. Profit or loss attribute to equity holders of the parent.
III. Profit or loss attribute to major prospective investors.
A. I only C. I and III
B. I and II D. II and III

4. When presentation becomes relevant to an
understanding of the entity’s financial performance,
additional line items, headings and subtotals shall be made
on the fact of the statement of comprehensive income.
A. The statement is true
B. The statement is false
C. The statement is partly true but most of the time is false
D. The statement is partly false but most of the time is true
• 5. As a minimum, the face of the statement of
comprehensive income shall include the following line items,
except:
A. Revenue C. profit or loss
B. Finance cost D. disposal of investment
6. The effects of changes in accounting estimates are not
recognized in the statement of comprehensive income but
should be properly presented to the accompanying notes.
A. The statement is true
B. The statement is false
C. The statement is partly true but most of the time is false
D. The statement is partly false but most of the time is true
7. The following items are excluded in the determination of
profit or loss, except:
A. Correction of errors C. provision for
amortization
B. Revaluation surplus D. effect of changes in
accounting principles
8. Which of the following statement is false?
A. Gains or losses arising or translating the financial
statements of a foreign operation are excluded from profit
or loss
B. Share of profit or associates accounted using the equity
method is one line item in the statement of comprehensive
income.
C. Write down of property, plant and equipment to recoverable
amount is included in the determination of profit or loss.
D. The factor of materiality and the nature and the function of
the components of income and expenses shall be
considered in adding line items.
9. Statement 1 The excess amount of the beginning
inventory over the ending inventory
represents income
Statement 2. Finance costs include interest paid on bank
loans and interest payment of bonds issuance
10. Statement 1 The nature of expense method of
presenting income statement is
preferred over the function of expense
method.
Statement 2 The function of expense method of
presenting income statement is preferred
over the nature of expense method.
3.1 – PROBLEM
Jenny trading presented the following data for year 2018.
Total assets 7,000,000 9,000,000
During the year, there were no capital contributions from
or capital distribution to owners.
The net income for year 2018 would be.
A. 1,000,000 C. 3,000,000
B. 2,000,000 D. 4,000,000
3.2 PROBLEM
YVONE Merchandising presented the following data for year
2018.
Total assets 4,200,000 6,300,000
During the 2018, YVONE made additional
investment of P600,000 and temporary withdrew P400,000.
The net income for the year 2018 would be:
a. 800,000 c. 400,000
b. 600,000 d. 200,000
3.3-PROBLEM
During 2018, the changes that take place on the statement of
financial position accounts of NICANOR Trading are given below:
• Cash – increase 600,000
• Accounts receivable – increase 250,000
• Notes receivable – decrease 300,000
• Merchandise inventory – decrease 100,000
• Prepaid expense – decrease 20,000
• Building – increase 800,000
• Investment in stocks- increase 500,000
• Accounts payable- increase 300,000
• Bank loan payable- increase 400,000
• Accrued expense- decrease 30,000
Nicanor withdrew P250,000 and made additional
investments of P600,000 during the year.The net income for
the year 2018 would be
A. 1,410,000 C. 710,000
B. 1,310,000 D. 1,060,000
3.4 PROBLEM
Angel Company provided the following information for year 2018:
Purchases 5,250,000
Freight in 150,000
Freight out 100,000
Purchases discount 280,000
Sales 9,000,000
Sales returns and allowances 200,000
Sales discounts 100,000
Merchandise inventory, January 1 2,000,000
The goods available for sale would be
A. 7,000,000 C. 6,700,000
B. 7,100,000 D.6,800,000
3.5 – PROBLEM
You are provided by the following information for year 2018:
Finished goods 500,000 300,000
Goods in process 600,000 850,000
Raw materials 350,000 480,000
Additional information:
Raw materials purchased 4,200,000
Direct labor incurred 2,400,000
Factory overhead 1,900,000
The total manufacturing cost during the year 2018 would

be:
A. 4,070,000 C. 6,470,000
B. 5,970,000 D. 8,370,000
3.6- PROBLEM
An analysis of the records of Princess Merchandising
revealed the following information during the current year:
Disbursement for purchases 6,500,000

Collection on sales 9,000,000
Payment for freight in 100,000
Payment for freight out 80,000
Increase in merchandise inventory 300,000
Increase in trade accounts payable 600,000
The total purchase made during the year amounted to
a. 6,500,000 c. 7,180,000
b. 6,680,000 d. 7,200,000
3-7 PROBLEM
Using the same information in Problem 3-6, the cost of
sales of the company during the year would be
a. 6,200,000 c. 7,200,000
b. 6,900,000 d. 7,500,000
3.8- PROBLEM
Hazel Company provided the following information for the year 2018.
Sales 10,000,000
Purchases 6,000,000
Freight in 200,000
Office salaries 600,000
Depreciation-building 500,000
Depreciation-office equipment 200,000
Depreciation-store equipment 300,000
Sales discount 80,000
Purchases returns and allowances 140,000
Purchase discounts 100,000
Income tax expense 297,000
Required: Prepare the statement of comprehensive income for

the year using:
1. Nature of expense method with supporting notes.
2. Function of expense method with supporting notes.
3.9 PROBLEM
The record of Izzy Trading showed the following data for year 2018:
Sales 12,500,000
Sales discount 140,000
Purchases 7,300,000
Freight in 250,000
Purchases discounts 120,000
Rent income 300,000
Income tax expense 1,104,000
Freight out 120,000
Office salaries 900,000
Salesmen’s commission 400,000
Loss on sale of equipment 100,000
Depreciation-building 400,000
Depreciation-office equipment 150,000
Depreciation-store furniture 100,000
Depreciation-delivery truck 150,000
Required: Prepare the statement of comprehensive income
for the year using
1.Nature of expense method with supporting notes

2. Function of expense method with supporting notes.
4.1 OWNER’S EQUITY
The basic accounting is that asset is equal to equity. The

total equity of the business is broadly classified into the
equity of creditors and the equity of the owners. Technically,
the equity of the creditor is called liabilities. Hence the term
“equity” that stands alone refers to the equity of the owner.
The Framework defines equity as follows:

Equity is the residual interest in the asset of the entity after
deducting all its liabilities.
The equity of the owner is affected by several
items: hence, there is a need to prepare a statement
showing the different items affecting the equity of the owner.
This statement that will account for changes on the equity of
the owner is called statement of changes in equity.
4.2 STATEMENT OF CHANGES IN EQUITY
A Statement of changes in equity is a financial statement showing on the
face of the statement following;
a. net income or loss for the period
b. each item of income and expense for the period that is recognized
directly in equity and the total of these items as required by the PASS:
c. total income and expense for the period showing separately the total
amounts attributed to equity holders of the parent and to minority interest:
d. for each component of equity the effect of changes in accounting
policies and corrections of errors.
The statement of changes in equity, stated otherwise, is a statement that

reflects all the elements that caused changes in an entity’s equity between
two dates of the statement of financial position.
Sole Proprietorship and Partnership
The statement of changes in equity of a sole proprietorship

and a partnership, because of simplicity of operation, is
usually affected by the following:
a. net income or loss during the period:

b. additional investment: and
c. withdrawal or capital.
The pro-forma of the statement of changes in equity for sole

proprietorship and partnership may appear as follows:
JENNY Merchandising
Statement of Changes in Equity
December 31, 2018
Jenny , Capital January 1, 2018 xxxxx
Add: Net income xxxxx
Additional investment xxxxx xxxxx
Total xxxxx
Less: Net Loss xxxxx
Withdrawal xxxxx xxxxx
Jenny, Capital December 31, 2018 xxxxx
The concept of statement of changes in owner’s equity has been
discussed and illustrated in previous semester under the specialized
subject of Fundamentals of Accountancy Business and Management 1.
The concept of statement of changes in owner’s equity has
been discussed and illustrated in previous semester under
the specialized subject of Fundamentals of Accountancy
Business and Management 1.
Illustration 1 Statement of Changes in Equity of
Sole Proprietorship
The following balances of some accounts are presented by
YVONE Trading for the year ended December 31, 2018 prior
to the closing of income and expense summary account
(IESA):
Cash 125,000
Accounts receivable 90,000
Merchandise inventory 280,000
Accounts payable 80,000
Yvone , Capital 680,000
Yvone , Drawing 30,000
The income and expense summary account for the year
ended December 31, 2018 has a credit balance after the
closing of revenue and expense account of P128,000
During the year, Yvone made an additional investment of
P250,000.
Required: Prepare the statement of changes in equity of

YVONE Trading.
ANSWER: The statement of changes in equity appear as

follows:
YVONE Trading
December 31, 2018
Yvone Capital , January 1, 2018 (P680,000-250,000) 430,000
Add: Net income 128,000
Additional investment 250,000 378,000
Total: 808,000
Less: Yvone , Drawing 30,000
Yvone, Capital, December 31, 2018 778,000
The statement of changes in equity a partnership is basically similar to that
of a sole proprietorship. However, instead of having one capital account
only, there will be two or more capital accounts based on the number of
partners composing the partnership.
Corporation
For corporate entity, the equity of the shareholders in the
statement of financial position may be sub-classified as
follows:
a. share capital:
b. retained earnings : and
c. reserves.
The classifications can be relevant to the decision-making
needs of the users of financial statements when they
indicate legal or other restrictions on the ability of the entity
to distribute or otherwise apply its equity.
The classification may also reflect the fact that parties with
ownership interest in an entity have differing rights in relation to
the receipt of dividends or the repayment of contributed equity.
Share capital represents funds contributed by shareholders. An

entity’s shares capital may be in the form of ordinary shares
capital or preferences shares capital. Share capital has par value
indicated on the face of the share as authorized by the Securities
and exchange and commission. (SEC)
Shareholders holding ordinary shares capital have the
same rights and privileges and enjoy to preference over
each other. Shareholders holding preference shares capital
have preference over ordinary shareholders on the
dividends and net assets of an entity in the event of
liquidation.
The line item share capital also includes

subscriptions made by shareholders net of subscription
receivable.
Retained earnings is a line item in the equity that
represents the accumulated amount of net income or loss,
errors of prior periods, dividends distribution changes in
accounting policy and other equity adjustment other than
arising from contributions from shareholders.
Basically, the amount of retained earnings appearing
on the face of the statement of financial position is net
appropriations and available for dividend distributions to the
shareholders.
Reserves are line-item in the equity section that includes the

following:
1 .appropriation reserve;
2.shae premium;
3.revaluation adjustment; and
4.foreign currency translation reserve
Appropriation reserve. The appropriation reserve is a

transfer of an amount from the retained earnings. The creation
of reserves may be required by law in order to given the entity
and its creditors an added measure of protection from the
effect of losses, voluntary action of the management or
because of contractual obligations.
The transfers of amount to reserves are appropriations of
retained earnings rather than expenses.
Share premium. The share premium represents the excess

amount contributed by the shareholders over the par value.
The par value is the minimum issue price of the shares
appearing on the face of the certificates of stock
Revaluation adjustment. The revaluation adjustment

represent the excess of the depreciated replacement cost or
sound value of the revalued property, plant and equipment
over the book value.
There will be a revaluation adjustment only once the entity
adopts the revaluation model of measuring the property plant
and equipment after initial recognition and the fair values or
revalued values less any subsequent depreciation and
subsequent impairment losses are not equal to the net book
value of the assets.
Foreign currency translation reserve. This reserve arises

from the translation of financial elements of transactions in
foreign currency into the functional currency if an entity. The
translation may give arise to translation gain or translation
loss.
PAS 1 requires all items of income and expense
recognized in a period to be included in income or loss unless
another Standard or an Interpretation requires otherwise.
Other Standards require some gains and losses such

as revaluation increase and decreases, foreign exchanges
differences, gain or loss on measuring available-for-sale
financial asset and related amounts of current tax and
deferred tax to be recognize directly as changes in equity.
Because it is important to consider all items of
income and expense in assessing changes in an entity’s
financial position between two dates, PAS 1 requires the
presentation of a statement of changes in equity that
highlights an entity’s total income and expenses, including
those that are recognized directly in equity.
Items affecting the owner’s equity of corporate entity are

lengthily discussed in collegiate accounting subjects.
Illustration 2 Computation of Shareholder’s
Equity of a Corporation
The shareholders equity section YVONE Company included
the following information:
Ordinary shares, par P100 4,000,000
Share premium-ordinary 400,000
Preferences share, par P100 3,000,000
Share premium-preference 450,000
Bonds payable 2,000,000
Premium on bonds payable 100,000
Appropriation for insurance 300,000
Foreign translation loss 150,000
Required: Determine the following;
1.Amount of share capital
2.Amount of reserves
Answer 1: The amount of share capital is computed as
follows:
Ordinary shares 4,000,000
Preference shares 3,000,000
Total 7,000,000
Answer 2. The reserves amounted to P1,000,000
computed as follows:
Share premium-ordinary 400,000

Share premium-preference 450,000
Appropriation for insurance 300,000
Foreign translation loss 150,000
Total 1,000,000
Illustration 3 Statement of Changes in Equity of
a Corporation
The shareholders’ equity section of the balance sheet
of NICANOR Company on December 31, 2018 appears as
follows (all amounts are assumed)
NICANOR Company
Statement of Financial Position
Year ended December 31, 2018
Shareholders’ equity 12,000,000
Share Capital (Note 8) 5,000,000
Retained earnings 4,800,000
Total shareholders ‘ equity 21,800,000
The notes to the financial statements included the
following:
Note 8- Share capital

Ordinary shares, par P100 8,000,000
Preference shares, par P100 4,000,000
Total 12,000,000
Note 9 – Reserves
Share premium- preference 900,000

Appropriation for plant expansion 1,200,000
Appropriation for contingencies 900,000
Revaluation increment in property 500,000
Foreign currency translation gain 100,000
Total 4,800,000
Assume further that on January 1,2018 the beginning
balances of related accounts be follows:
Ordinary share 6,000,000

Preference shares 3,000,000
Share premium- ordinary 800,000
Share premium- preference 700,000
Appropriation for plant expansion 800,000
Appropriation for contingencies 600,000
Retained earnings 3,000,000
During the year, the following transactions affected
the quality of the company :
1.Net income for the period amounted to P2,900,000

2.The depreciation of year 2017 was incorrectly overstated
by P300,000
3.Dividends declared and paid amounted to P500,000
4.Additional issuance of 20,000 ordinary shares P100 par at
P120 per share and 10,000 preference shares P100 par at
P120 per share
5.Additional appropriations were provided during the year.
Required: Prepare the statement of changes in equity on
December 31, 2018
Answer: The statement of changes in equity appear as
follows:
NICANOR Company
Year ended December 31, 2018
Share Reserve Retained
Capital Earnings
Balances-January 1,2018 9,000,000 2,900,000 3,000,000
Net income for the period 2,900,000
Correction of prior-period 2014 300,000
overstatement of depreciation
Dividends payment (500,000)
Issuance of 20,000 ordinary
shares par P100 at P120 per share 2,000,000 400,000
Issuance of 10,000 preference shares, par P100
at P120 per share 1,000,000 200,000
Current appropriation for plant expansion 400,000 (400,000)
Current appropriation for contingencies 300,000 (300,000)
Revaluation increment 500,000
Foreign currency translation gain 100,000
.
Balances- December 31 12,000,000 4,800,000 5,000,000
Separate Disclosure
A business entity shall also present either on the face of
the statement of changes in equity or in the notes the
following:
1.Amounts of transactions with equity holders acting in their
capacity as equity holders showing separately distributions to
equity holders
2.Balance of retained earnings at the beginning of the period
and ate the balance sheet date, and the changes during the
period ;and
3.Reconciliation between the carrying amount of each class of
contributed equity and each reserve at the beginning and the
end of the period separately disclosing each change.
The disclosure requirements of the statement of
changes in equity may be met in various ways.
One method is using a columnar format in the

Illustration 2, that reconciles the opening and closing
balances of each element within equity
An alternative method is to present only the items

set out in the definition of the statement of changes in equity.
Under this approach, the items described in the separate
disclosure above are shown in the notes.
EXERCISES
1.Define statement of changes in equity
2.What are the line items that subdivide the shareholders
equity?
3.Discuss the following:
a.Share capital
b.Retained earnings
c.Appropriation reserve
d.Share premium
e.Revaluation statement
4.State the items that are disclose in the notes of the
statement of changes in equity.
4.3 STATEMENT OF CASH FLOWS
A statement of cash flows is a financial statement that
provides information about the historical changes, inflows and
outflows, in cash and cash equivalents of an entity during the
period from operating, investing and financing activities.
In the preparation of the statement of cash flows, it is
necessary to have clear understanding of the concept of cash.
The terms “cash” in the statement of cash flows refers to cash
and cash equivalents.
The basic question that is resolved in the preparation of
the statement of cash flows is –How much was received and
disbursed during the period?
Cash- comprise on hand and demand deposits.
Cash equivalents -are short-term, highly liquid investments
that are readily convertible to known amounts of cash and
which are subject to an insignificant risk of changes in value.
Operating activities- are the principal revenue-producing
activities of the entity and other activities that are not
investing or financing activities.
Investing activities- are the acquisition and disposal of long-
term assets and other investments not included in cash
equivalents.
Financing activities- are activities that result in changes in
the size and composition of the contributed equity and
borrowings of the entity.
Information about the cash flows of an entity is
useful in providing 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. The economic decisions that are taken by users
require an evaluation of the ability of an entity to generate
cash and cash equivalents and the timing and certainty of
their generation.
The statement of the cash flow therefore is a mere
accounting of the cash flows of a business entity.
Cash flows are inflows and outflows of cash and

cash equivalent.Cash flows excludes movements between
items that constitute cash or cash equivalents because
these components are parts of the cash management of an
entity rather than part of its operating, investing, and
financing activities. Cash management includes the
investment of excess cash in cash equivalents.
Cash equivalents are held for the purpose of meeting
short-term commitments rather than for investment or other
purposes.For an investment to qualify as a cash equivalent it
must be readily convertible to a know amount of cash and be
subject to an insignificant risk of changes in value.
Therefore, an investment normally qualifies as cash

equivalent when it has a short maturity of, say, three months or
less from the date of acquisition. Equity investment are excluded
from cash equivalents unless the are, in substance, cash
equivalents, for example in the case of preference shares
acquired within a short period of their maturity and with a
specified redemption date.
Examples of cash equivalents are:
1. three-month time deposit.
2. three-month money market placement
3. three-month BSP treasury bill; and
4. three-month BSP treasury bill acquired three months
before maturity date.
An investment in classified therefore as short-term when it

was acquired within three months or less before the date of
maturity.
All entities are required to present cash flow statement.

An entity shall prepare a cash flow statement in
accordance with the requirement of PAS 7 and shall present it
as an integral part of its financial statement for each period for
which financial statements are presented.
Illustration 4 Computation of Cash Composition

Angel Merchandising had the following balances at December
31,2018
Cash on hand awaiting deposit 100,000

Petty cash fund 10,000
Sinking fund 500,000
Current account-PNB 2,100,000
Cash in money market account 500,000
Required: determine the amount of cash and cash equivalent
on December 31,2018.
Answer: the amount of cash and cash equivalent as of

December 31,2018 is computed as follows:
Cash on hand awaiting deposit 100,000

Petty cash fund 10,000
Current account-PNB 2,100,000
Cash in money market account 500,000
Cash and cash equivalents 2,710,000
The sinking fund is classified as long-term investment.

The treasury bill is not classified as cash equivalent,
although it will mature within two-months from the date of the
statement of financial position, since it was acquired beyond
the three-month requirement reckoned from the maturity.
Benefits of Statement Cash Flows
A statement of cash flows, when used in conjunction with the
rest of the financial statements, will provide the following benefits:
1. It furnishes information that enable users to evaluate the

changes in the assets of an entity, its financial
structure including its liquidity and solvency and its ability to effect
the amounts and timing of cash flows in order to adapt to
changing circumstances and opportunities.
2. It is useful in assessing the ability of the entity to generate
cash and cash equivalents.
3. It enables users to develop models to assess and compare the
present value of the future cash flows of different entities.
4. It enhances the comparability of the reporting of operating
performance by different entities because it eliminates the
effects of using different accounting treatments for the same
transactions and events.
5. It is used as an indicator of the amount, timing and certainty
of the future cash flows.
6. It is useful in checking the accuracy of past assessments of
the future cash flows.
7. It is helpful in examining the relationship between profitability
and net cash flows and the impact of changing prices.
4.4 PRESENTATION OF THE STATEMENT OF
CASH FLOWS
The statement of cash flows shall report cash ( inflows and
outflows) during the period classified by operating, investing and
financing activities as shown in figure 5.
Operating Activities Financing Activities
Cash Flows Activities Classification
Investing Activities
Figure 5. Classification of Cash in Statement of Cash Flows

Classification by activity provides information that
allows users to assess the impact of those activities on the
financial position of the entity and the amount of the cash and
cash equivalents.
The presentation of cash flows from operating,
investing and financing activities may also be used to evaluate
the relationships among those activities.
In certain cases, a single transaction may include cash
flows that are classified differently. For example, when the
cash repayment of a loan includes both interest and principal,
the interest element may be classified as an operating activity
and the principal element is classified as a financing activity.
Operating Activities
The amount of cash flows arising from operating activities is
a key indicator of the extent to which the operations of the entity
have generated sufficient cash flows to repay loans, maintain the
operating capability of the entity, pay dividends and make new
investments without recourse to external sources of financing.
Also, information about the specific components of
historical cash flows is useful in conjunction with other
information, in forecasting future operating cash flows.
Cash flows from operating activities are primarily derived
from the principal revenue-producing activities of the entity.
Therefore, they general result from the transactions and other
events that enter into determination of income or loss.
Cash inflows from operating activities include the following:
a. Cash receipts from sale of goods;

b. Cash receipts from rendering of s
c. Cash receipts from royalties, fees , commissions and other
revenues;
d. Cash receipts from insurance entity for claims, annuities,
and other policy benefits;
e. Cash refunds of income taxes unless they can be
specifically identified with financing and investing activities;and
f. Cash receipts from contracts held for dealing or trading
purposes.
Cash outflows from operating activities include the following:
a. Cash payment to suppliers for goods and services;

b. Cash payment to and on behalf of employees;
c. Cash payment for operating expenses;
d. Cash payment for insurance premiums; and
e. Cash payment of income taxes unless they can be
specifically identified with financing and investing activities.
Illustration 5 Cash from Operating Activities of a
Sole Proprietorship
The records of Princess Services showed the following
information for the year ended December 31, 2018.
Sales revenue (60% represents cash sales) 8,000,000

Collections received from costumers 1,000,000
Rental income (80% cash collected) 500,000
Employees salaries fro the year (90% paid) 3,000,000
Payment to suppliers 800,000
Other operating expenses (10% accrued) 700,000
Required: Determine the net cash provided used by operating
activities fro year 2018.
Answer: The net cash from operating activities is computed as
follows:
Cash inflows
cash sales(60% × P8,000,000) 4,800,000
collections from costumers 1,000,000
rental income( 80% × P500,000) 400,000 6,200,000
Cash outflows
Salaries(90% × P3,000,000) 2,700,000
Payment to suppliers 800,000
Other operating expenses(90%×P700,000) 630,000 4,130,000
Net cash provided by operating activities 2,070,000
Investing Activities
Cash flows from investing activities arise from the acquisition
and disposal of long-term assets and other investments not
included in cash equivalents.
The separate disclosure of cash flows arising from

investing activities is important because cash flows
represents the extent to which expenditures have been made
for resources intended to general future income and cash
flows.
Cash inflows from investing activities will include the

following:
a. Cash receipts from sale of property, plant and equipment,
intangibles and other long-term assets;
b. Cash receipts from sales of equity or dept instruments of
other entities and interest in joint ventures;
c. Cash receipts from the repayment of advances and loans
made to other parties other than advantages and loans of a
financial institution; and
d. Cash receipts from future contracts, forward contracts,
option contracts and swap contracts except when the contracts
are held for dealing or trading purposes, or the receipts are
classified as financing activities.
Cash outflows from investing activities will include the
following:
a. Cash payments to acquire property, plant and equipment,

intangibles and other long-term assets;
b. Cash payments to acquire equity to debt instruments of
other entities and interest in joint ventures;
c. Cash advances and loans made to other parties other than
advances and loans made by a financial institution;
d. Cash payments from future contracts, forward contracts,
option contracts and swap contracts except when the
contracts are held for dealing or trading purposes, or the
receipts are classified as financing activities.
When a contract is accounted for as a hedge of an
identifiable position,the cash flows of the contract are
classified in the same manner as the cash flows of the
position being hedge.
At the end of the year 2018, Hyzel Trading provided the
following selected comparative
information:
1 12/31/2018 12/31/2017
Short-term investment classified 2,000,000 1,200,000
as cash and cash equipments
Investment in bonds 3,000,000 4,000,000
Investment in stocks 2,000,000 1,000,000
Patent 300,000 -
Property , plant and equipment 8,000,000 6,200,000
Accumulated depreciation 3,900,000 3,100,000
Trade accounts receivable 3,400,000 4,800,000
Trade notes receivable 2,500,000 1,000,000
The investment in bonds was sold during the year at gain of
P400,000.
Required: Determine the following for the year 2018

1. Cash flows provided by investing activities
2. Cash flows used by investing activities
3. Net cash flows provided (used) by investing
activities
Answer 1. The cash flows provided by investing activities
would be:
Investment in bonds (P4,000,000 – 3,000,000) + 400,000 1,400,000
Answer 2. The cash flows used by investing activities would be:

Investment in stocks (P2,000,000 – 1,500,000) 500,000
Acquisition of patent 300,000
Property , plant and equipment (P8,000,000 – 6,200,000) 1,800,000
Cash used by investing activities 2,600,000
Answer 3. The net cash provided (used) by investing activities would
be.
Cash provided by investing 1,400,000

Cash used by investing activities 2,600,000
Net cash used by investing activities 1,200,000
Financing Activities
Cash flows from financing activities are the result in
changes in the size and composition of the contributed
equity and borrowing of the entity.
Otherwise stated, cash flows activities between

the entity and the owners or between the entity and the
entity creditors are classified as financing activities.
The separate disclosure of cash flows arising from

financing activities is important because it is useful in
predicting claims on future cash flows by providers of capital
to the entity.
Cash inflows from financing activities will include
the following:
a. Cash proceeds from issuing entity’s own equity instruments;
b. Cash proceeds from issuing debentures, loans, notes, bonds,
mortgages and other short or long-term borrowings
Cash outflows from financing activities will include the

following:
a. Cash payments of amount borrowed;
b. Cash payments to owners to acquire or redeem the entity’s
shares; and
c. Cash payment by a lessee for the reduction of the outstanding
liability relating to a finance lease.
Illustration 7 Cash from Financing Activities
of a Sole Proprietorship
Izzy Merchandising provided the following information:
1 12/31/2018 12/31/2017
Trade accounts payable 2,500,000 3,000,000
Trade notes payable 1,200,000 800,000
Bank loan payable 2,000,000 -
due 12/31/2021
Bonds payable 1,000,000 3,000,000
Premium on bonds payable 100,000 300,000
Izzy, Capital 5,000,000 3,000,000
Izzy, Drawing 300,000 -
Required: Determine the amount of net cash flows provided
(used) by financing activities for the year 2018.
Answer: The net cash flows provided (used) by financing

activities is computed as follows:
Cash inflows
Bank loan 2,000,000
Izzy, Capital (5,000,000−3,000,000) 2,000,000 4,000,000
Cash outflows
Bonds payable (3,000,000 2,000,000
−1,000,000)
Izzy, Drawing 300,000 2,300,000
Net cash flows provided by financing activities 1,700,000
The trade accounts payable and trade notes payable
are not considered in the determination of cash flows
provided by financing activities since they arise from
operating activities.
The change in premium on bonds payable does not

involve cash flow.
EXERCISES
1. Define the following:
a. Statement of cash flows
b. cash
c. Cash and cash equivalents
d. Operating activities
e. Investing activities ; and
f. Financing activities
2. What are the benefits of statement of cash flows?
3. Describe the presentation of the cash flows.
4. Give examples of cash flows that are classified as:
a. Operating activities
b. Investing activities; and
c. Financing activities
4.5 TREATMENT OF DIVIDENDS, INTEREST AND
TAX ON INCOME
Cash flows from interest, dividends, and taxes on

income shall each be disclosed separately. Each shall be
classified in a consistent manner from period to period as
either operating, investing or financing activities.
PAS 7 provides the guidelines on how to handle cash

flows arising from interest , dividends and taxes on income.
Dividends
Dividends received. Dividends received are handled in the

following manner.
1. Preferential treatment. Dividends received are usually

classified as operating cash flow because they enter into the
determination of income or loss.
2. Alternative treatment. Dividends received may be classified as

investing cash flows because they are returns on investment.
Dividends payment. Dividends paid are presented in the
cash flow statements follows:
1. Preferential treatment. Dividends paid may be classified

as a financing cash flow because they are a cost of
obtaining financial resources.
2. Alternative treatment. Dividends paid may be classified

as cash flows from operating activities in order to assist
users to determine the ability of an entity to pay dividends
out of operating cash flows.
Interest
Interest received or paid. The interest received or paid
are presented in the cash flow statement as follows:
1. Preferential treatment. Interest paid or received are

usually classified as operating cash flows because they
enter into the determination of income or loss.
2. Alternative treatment. Interest paid may be classified as

financing cash flow because they are cost of obtaining
financial resources. Interest received maybe classified as
investing cash flows because they are return on investment.
Taxes on Income
While tax expense may be readily identifiable with
investing or financing activities, the related tax flows are often
impracticable to identify and may arise in a different period
from the cash flows of the underlying transaction. Therefore,
taxes paid are usually classified as cash flows from operating
activities.
However , when it is practicable to identify the tax cash
flow with an individual transaction that gives rise to cash flows
that are classified as investing or financing activities, the tax
cash flow is classified as an investing or financial activity as
appropriate.
Illustration 8 Statement of Cash Flows of a
Sole Proprietorship
ROLLY Merchandising, owned and managed by Rolly ,
presented the following information for the year ended
December31,2018.
Proceeds from sale of short-term investment 1,500,000

classified as cash equivalents
Purchase of bonds from domestic company 3,200,000
(face value, P3,000,000)
Collections from customers 4,000,000
Proceeds from sale of machinery 500,000
Interest received on bonds 150,000
Rolly, Drawing 400,000
Collected dividends on stock investment 100,000
Payment to suppliers 1,500,000
Taxes on income paid 200,000
Borrowings from the bank 2,500,000
Additional investment of Rolly 1,500,000
Acquisition of equipment 400,000
Required: Perform the following:
1. Determine the cash flows provided(used)using the

preferential treatment by the following:
a. Operating activities
b. Financing activities
c. Investment activities
2. Prepare the statement of the cash flows
Answer 1a. The net cash provided(used) by operating
activities is computed as follows:
Cash inflows
Collections from customers 4,000,000
Interest received on bonds 150,000
Collected dividends on stock 100,000 4,250,000
investment
Cash outflows
Taxes on income paid 200,000 1,700,000
Net cash flow provided by operating activities 2,550,000
Answer 1b. The net cash provided (used) by
financing activities would be:
Cash inflows
Borrowings from the bank 2,500,000
Additional investment 1,500,000 4,000,000
Cash outflows
Rolly , drawing 400,000
Net cash flow provided by financing activities 3,600,000
Answer 1c. The net cash provided (used) by
investing activities its computed as follows :
Cash inflows
Proceeds from sale of machinery 500,000
Cash outflows
Purchase of bonds 3,200,000
Acquisition of equipment 400,000 3,600,000
Net cash flow used by investing activities 3,100,000
Answer 2. The statement of cash flows of
supersonic company will appear as follows:
ROLLY Merchandising
Statement of Cash Flows
December 31,2018
Cash provided by operating activities
Cash inflows
Collection on customers 4,000,000
Interest received on bonds 1 50,000
Collected dividends on stock 100,000 4,250,000
investment
Cash outflows
Taxes on income paid 200,000 1,700,000
Net cash flow provided by 2,550,000
operating activities
Cash provided by financing activities
Cash inflows
Borrowing from the bank 2,500,000
Additional investment 1,500,000 4,000,000
Cash outflows
Rolly drawing 400,000
Net cash flow provided by 3,600,000
financing activities
Cash used in financing activities
Cash inflows
Proceeds from sale of 500,000
machinery
Cash outflows
Purchase of bonds 3,200,000
Acquisition of equipment 400,000 3,600,000
Net cash flow used by 3,100,000
investing activities
Net increase in cash 3,050,000
It can be observed that when the amount of cash
inflows in greater than the amount of cash outflows the
difference is labeled as “the net cash provided” . Hence, in
both the operating and financing activities of the statement of
cash flows shown above, the difference between the outflows
and the inflows has been labeled as net cash flows provided
by the activity .
However, if the cash outflows in different activities are
more than the inflow,the difference is labeled as “net cash
used”. Thus, in third section of statement of cash flows above
,the difference has been labeled as net cash used by
investing activities because the outflows are more than the
inflows.
There is a net increase in cash of P2,050,000
representing the sum of the cash flows and inflows from the
operating ,investing and financing activities broken down as
follows:
Net cash flow provided by operating activities 2,550,000

Net cash flow provided by financing activities 3,600,000
Net cash flow used by investing activities 3,100,000
Net increase in cash 3,050,000
The net increase in cash should to the difference
between the cash balance at the beginning and end of the
period.
For example,if the cash balance of the business on
January 1, 2018 is P3,500,000 as shown in the statement of
financial position ,then the cash balance on December
31,2018 would be P6,550,000(P3,500,000+P3,050,000)
The statement of cash flows,therefore accounts the
sources and uses of cash during the period it is a statement
that answers the simply query- what caused changes in cash .
4.6 NON-CASH TRANSACTONS
Investing and financing activities that do not require

the use of cash or cash equivalents shall be excluded from
a cash flow statement.
Such transactions shall be disclosed elsewhere in the
financial statements in a way that provides all the relevant
information about these investing and financing activities .
The exclusion of non cash transactions from the
cash flow statement is consistent with the objective of a
cash statement as these items do not involve cash flow in
the current period.
The following transactions are classified as non
cash-transactions and should be disclosed property.
1. Acquisition of assets by assuming directly related liabilities;

2. Acquisition of assets by mean of finance of lease;
3. Acquisition of assets by insurance of shares capital or
tends payable;
4. Acquisition of an entity by means of an equity issue;
5. Conversion of debt to equity (from bonds payable to
ordinary share); and
6. Conversion of share capital (from preference share to
ordinary share).
EXERCISES
1. Discuss the treatment of the following

a . Interest paid and received
b. Dividends paid and received
c. Income taxes paid
2. Discuss the treatment of investing and financing activities

that do not require the use of cash.Give examples
4.7 METHODS OF COMPUTING CASH FROM
OPERATING ACTIVITIES
An entity shall report cash flows from operating activities using

either the :
1.Direct method and
2.Indirect method
DIRECT METHOD
Using the direct method ,information about the major
classes of gloss cash receipts and gross cash payments are
disclosed which may be obtained either:
a. from the accounting records of the entity; or

b. by adjusting sales,cost of sales ,operating expenses and
other income from accrual basis to cash basis.
The direct method provides information which may be

useful in estimating future cash flows and which is not
available under the indirect method.
Entities are encouraged to report cash flows from operating
activities using direct method.
The major classes of gross cash receipts and gross cash
payments that should be separately disclosed and reported using
the direct method are:
1. Cash inflows
a. cash collection from customers
b. dividends received ,interest ,fees and royalties
c. other operating cash receipts
2. Cash outflows
a. cash payments to suppliers of merchandise
b. operating expenses paid (salaries,advertising ,insurance )
c. interest paid
d. income taxes paid
The information shown in the statement of financial

position and the statement of comprehensive income are
needed in determining the cash inflows provided by operating
activities using the direct method.
Since,the statement of financial position and
statement of comprehensive income are prepared under the
accrual concept, some of the items in the statement of
comprehensive income shall be converted to cash basis to
determine the amount of cash receipts and cash payments.
The following formulas are used to determine the amount of
cash receipts and cash payments:
1. Computation of collection from sales on account
Accounts and notes receivable, beginning (trade) xxxxxx

Add: sales on account during the period xxxxxx
Total xxxxxx
Less: Accounts and notes receivable ,end (trade) xxxxxx
Collection from sales on account xxxxxx
2.Computation of cash payments to suppliers of
merchandise
Accounts and notes payable, beginning (trade) xxxxxx
Add: Purchases on account during the period xxxxxx
Total xxxxxx
Less: Accounts and notes payable ,end (trade) xxxxxx
Payment to suppliers on account xxxxxx
3. Computation of payment of expenses
Expenses (accrual) xxxxxx

Add: prepaid expenses - end xxxxxx
Accrued expense - beginning xxxxxx xxxxxx
Total xxxxxx
Less : prepaid expenses - beginning xxxxxx
Accrued expenses - end xxxxxx xxxxxx
Cash payment for expenses xxxxxx
4. Computation of collection of other income
Other income (accrual) xxxxxx

Add: unearned income -end xxxxxx
Accrued income - beginning xxxxxx xxxxxx
Total xxxxxx
Less: unearned income - beginning xxxxxx
Accrued income -end xxxxxx xxxxxx
Cash collection of other income xxxxxx
Illustration 9-Computation of cash from operating
activities using direct method of sole
proprietorship
RYVEN Company provided the following comparative
selected accounts of the statement of financial position.
12/31/2018 12/31/2017
Trade accounts receivable 1,200,000 800,000
Merchandise inventory 1,000,000 650,000
Prepaid advertising 20,000 40,000
Trade accounts payable 700,000 550,000
Accrued salaries payable 80,000 60,000
Unearned net income 30,000 50,000
The statement of comprehensive income showed the
following information:
Sales 9,000,000
Purchases 4,500,000
Rent income 120,000
Salaries 1,200,000
Advertising 90,000
Other expenses 600,000
During the period, 60% of the salaries and 70% of the
purchases where made on account.
Required: Determine the net cash flows provided (used)

by operating activities using the direct method.
Answer: The following computations are made to compute

the net cash flows provided by operating activities using
the direct method:
1. Collections from sales on account
Accounts received beginning 800,000

Add: Credit sales (P9,000.000×60%) 5,400,000
Total 6,200,000
Less: Accounts receivable ,end 1,200,000
Collection from sales on account 5,000,000
2. Payment to suppliers of merchandise
Accounts payable beginning 550,000

Add: Purchases on account (P4,500,000×70%) 3,150,000
Total 3,700,000
Less: Accounts payable, end 700,000
Cash payment suppliers on account 3,000,000
3.Payment for salaries
Salaries 1,200,000
Add: Accrued salaries -beginning 60,000
Total 1,260,000
Less: Accrued salaries -end 80,000
Cash payment for salaries 1,180,000
4. Payment for advertising
Advertising 90,000
Add: Prepaid advertising -end 10,000
Total 110,000
Less: Prepaid advertising - beginning 40,000
Cash payment for advertising 70,000
5. Collection for rent income
Rent income 120,000

Add: Unearned rent income -end 30,000
Total 150,000
Less : Unearned rent income - beginning 50,000
Cash collection of rent income 100,000
The cash flows provided by operating activities using the direct
method is computed then as follows:
Cash inflows
Cash collection from customers 5,000,000
Cash sales (P9,000,000×40%) 3,600,000
Rent income 100,000 8,700,000
Cash outflows
Cash payment to suppliers 3,000,000
Cash purchases (P4,500,000×30%) 1,350,000
Payment for salaries 1,180,000
Payment for advertising 70,000 5,600,000
Net cash flows provided by operating activities 3,100,000
Indirect Method
Under the indirect method ,the net cash flow operating
activities is determined by adjusting the income or loss for the
effect of the following :
1. Changes during the period in inventories and operating
receivables and payables or changes in current assets and
current liabilities except cash and cash equivalents and non trade
accounts
2. Non cash items such as depreciations, provisions deferred
taxes ,unrealized foreign currency gains and losses
,undestributed profits of associates and minority interest,
3. All other items for which the cash effects are investing or
financing cash flows.
Alternatively ,the net cash flow from operating activities
may be presented under the direct method by showing the
revenues and expenses disclosed in the income statement
and the changes during the period in inventories and
operating receivables and payable .
In other words, the net cash flow from operating
activities under the indirect method is computed by adjusting
the accrual net income to cash net income .
The following procedures may be observed in adjusting

the accrual net income:
1. Add the following items to the net income:
a. Provisions for doubtful accounts ,depreciation, depletion and
amortization of intangibles;
b. Amortization of discount on bonds payable
c. Amortization of premium on investments in bond ;
d. Decrease in current assets except cash and cash equivalents and non
trade accounts
e. Increase in current liabilities except financing accounts like bank loans
or current portion of long term liabilities
f. Loss on disposal of property;
g. Increase in deferred income taxes
h. Interest expense and income taxes paid (though classified under
operating expenses (these items are shown separately ) ;and
i. Loss on subsidiary using the equity method
2.Deduct the following items from the net income
a. Amortization of premium on bonds payable

b. Amortization of discount on investing in bonds
c. Increase in current assets except cash and cash equivalents
and non-trade accounts
d . Decrease in current liabilities except financing accounts like
bank loans or current portion of long term liabilities
e. Gain on disposal of property ;
f. Decrease in deferred income taxes; and
g. gain on subsidiary using the equity method
Alternatively, the interest expense and income tax
include in the income statement are not added back to the net
income but rather the changes(increase or decrease) on
interest payable and income tax payable are included in the
computation of net cash flow from operations.
The author, however ,adheres to the presentation that
interest expense and income tax should be added back to the
net income to arrive at the cash generated from operations .
The interests paid and income taxes paid are then shown
separately as deductions from cash generated from operation
to arrive at net cash from operating activities.
Illustration 10 Cash from operating activities
using direct and indirect method of sole
proprietorship
The income statement for the year ended December 31,
2015 of JENNY trading is presented as follows :
JENNY TRADING
Statement of Comprehensive Income
December 31, 2018
Sales 6,000,000
Cost of sales (note1) 2,400,000
Gain on sale equipment 80,000
Expenses
Administrative and selling salaries 1,800,000
Advertising 90,000
Depreciation 200,000
Amortization of patent 20,000
Interest expense 100,000 2,250,000
Income tax 440,000
Net income 990,000
Note 1 - Cost of Sales

Add: Purchases 2,650,000
Total goods available for sale 3,050,000
Less: Merchandise inventory, December 31 650,000
The following comparative related accounts
appeared as follows:
12/31/2018 12/31/2017
Accounts receivable 1,400,000 60,000
Accounts payable 700,000 850,000
Interest payable 90,000 70,000
Income tax payable 280,000 240,000
Required: Determine the cash flow from operating activities
using
1. Indirect method; and
2. Direct method
Answer 1:The changes in current assets and current

liabilities (except interest and income tax payable) are as
follows :
2015 2014 Increase(Decrease)
Accounts receivable 1,400,000 600,000 800,000

Inventory 650,000 400,000 250,000
Prepaid advertising 60,000 40,000 20,000
Accounts payable 700,000 550,000 150,000
The cash payment for interest is computed as follows:
Interest payable - January 1 70,000

Add: Interest expense for the period 100,000
Total 170,000
Less : Interest payable - December 31 90,000
Interest payable 80,000
The cash payment for income tax is computed as follows:
Income tax payable -January 1 240,000

Add: Income tax for the period 440,000
Total 680,000
Less: Income tax payable - December 31 280,000
Interest paid 400,000
The next cash flow provided by operating activities
using the indirect method is as follows:
Net income 990,000

Add: Income tax 440,000
Interest expense 100,000
Increase in accounts payable 150,000 950,000
Total 1,940,000
Less: Gain on sale of equipment 80,000
Increase in accounts receivable 800,00
Increase in prepaid advertising 20,000
Increase in inventory 250,000 1,150,000
Net cash flow from operation 790,000
Interest paid (80,000)
Income tax paid ( 400,000)
Net cash provided by operating activities 310,000
Alternative Presentation
Net income 990,000

Add: Doubtful accounts 40,000
Increase in interest payable 20,000
Increase in income tax payable 40,000 470,000
Total 1,460,000
Less: Gain on sale of equipment 80,000
Increase in accounts receivable 800,000
Increase in prepaid advertising 20,000
Increase in inventory 250,000 1,150,000
Net cash provided by operating activities 310,000
Answer 2: Using the direct method, the net cash
provided by operating activities appears as follows:
Cash inflow
Cash collection from customers
(P600,000 + 6,000,000 – 1,400,000) 5,200,000
Cash outflow
Cash payment for salaries 1,600,000
Cash payment for advertising
(P90,000 + 60,000 - 40,000) 110,000
Cash paid to supplier
(P550,000 + 2,650,000 – 700,000) 2,500,000 4,410,000
Cash generated from operations 790,000
Interest paid (60,000)
Income tax paid (400,000
Net cash flow provided by operating activities 310,000
Illustration 11 Statement of Cash Flow Using
Direct and Indirect Method of a Corporation
Princess Company presented the following information for the
year 2018
Balances as of
/ 12/31/2018 01/01/2018
Cash and cash equivalents 825,000 525,000
Accounts receivable 450,000 600,000
Inventory 990,000 750,000
Prepaid rent 90,000 60,000
Investment in equity securities, 900,000 1,500,000
at cost
Property, plant and equipment 8,235,000 5,085,000
Accumulated depreciation (1, 305,000) (900,000)
Total assets 10,185,000 7,620,000

Accrued interest payable 30,000 15,000
Salaries payable 270,000 260,000
Notes payable bank-short term 250,000 -
Bonds payable 2,000,000 1,000,000
Ordinary shares, P100 par 1,350,000 1,200,000
Share premium 2,910,000 2,400,000
Retained earnings 2,925,000 2,195,000
Treasury sales, at cost - ( 200,000)
Total liabilities and equity 10,185,000 7,620,000
The results of operations are presented as follows:
Sales 12,000,000
Gain on sale investment securities 120,000
Gain on sale of machinery 90,000
Expenses
Salaries 750,000
Other operating expenses 1,535,000
Rent expense 100,000
Interest expense 105,000 3,000,000
Income tax 576,000
The information on the earnings is as follows:
Retained earnings, January 1 2,195,000

Add: Net income 1,344,000
Total 3,539,000
Less: Cash dividends paid 614,000
Retained earnings , December 31 2,925,000
Additional information provided is as follows:
1. The treasury shares were reissued for P260,000.

2. The investment in equity securities for P720,000.
3. Machinery costing P3,780,000 was purchased for cash.
4. Land was purchased in 2009 by issuing 1,500 ordinary shares
when the stock was selling at a market price of P400 per share.
5. The company borrowed a 6-month loan of P250,000 from the
bank and issued 5-year bond for P1,000,000 at the end of the
year.
6. Machinery with a cost of P1,230,000 and a book value of
P1,125,000 was sold for P1,215,000 cash.
Required: Prepare the following for year ended December
31,2018
1. Statement of cash flows using the indirect method.
2. Statement of cash flows using the direct method.
Answer 1: The statement of cash flows simply accounts the

elements that caused change in cash and cash equivalent.
In the preparation of the formal statement of cash flows
the following procedures may be observed.
1. Determine first the amount of change in cash and cash
equivalents so that you have a working idea on the amount to
work on. The change in cash and cash equivalent would be:
Cash and cash equivalents – December 31 825,000
Cash and cash equivalents - January 2 525,000
Increase in cash and cash equivalents 300,000
2. Determine the cash flows from operating, investing, and
financing activities using a columnar format as a guide in the
preparation of a formal cash flow statement.
The columnar format for the given problem may
appear as follows:
Operating Investing Financing
Gain on sale-investment (120,000)
Gain on sale-machinery (90,000)
Payment of dividends (614,000)
Increase in inventory ( 240,000)
Increase in prepaid rent (30,000)
Decrease in accounts payable (300,000)
Increase in interest payable 15,000
Increase in salaries payable 10,000
Sale of treasury shares 260,000
Sale of investment 720,000
Acquisition of machinery (3,780,000)
Bank loan 250,000
Issuance of bonds 1,000,000
Sale of machinery 1,215,000 -
Net cash provided (used) 1,249,000 (1,845,000) 896,000
The columnar presentation gives net cash inflow of P300,000
as follows:
Cash flows provided by operating activities 1,249,000
Cash flows used by investing activities (1,845,000)
Cash flows provided by financing activities 896,000
Net cash flows 300,000
Princess Company
Year Ended December 31,2018
Cash flows from operating activities
Gain on sale-investment (120,000)
Gain on sale-machinery (90,000)
Increase in inventory (240,000)
Increase in prepaid rent (30,000)
Decrease in accounts payable (300,000)
Increase in salaries payable 10,000
Interest expense 105,000 Income
tax 576,000
Cash generated from operation 1,915,000
Interest paid ( 90,000)
Answer 2. The statement of cash flows using the direct
method will appear as follows:
Princess Company
Year Ended December 31,2018
Cash flows from operating activities 12,150,000

Cash receipts from customer ( 7,830,000)
Cash payment to supplier ( 740,000)
Cash payment for salaries ( 1,535,000)
Cash payment for other expenses ( 130,000)
Cash generated from operations 1,915,000
Interest paid ( 90,000)
Cash flows from investing activities
Sale of investment 720,000
Acquisition of machinery ( 3,780,000)
Sale of machinery 1,215,000
Cash flows used by financing activities (1,845,000)
Cash flows from financing activities
Payment of dividends ( 614,000)
Sale of treasury share 260,000
Bank loan 250,000
Insurance of bonds 1,000,000
Cash flows provided by financing activities 895,000
Increase in cash and cash equivalents 300,000
Add: Cash and cash equivalents-January 1 525,000
Cash and cash equivalents- December 31 825,000
The following supporting computations are made for the cash
receipts and payments:
1.Cash receipts from customers
Accounts receivable-January 1 600,000
Add: Sales 12,000,000
Total 12,600,000
Less: Accounts receivable 450,000
Cash collections 12,150,000
2. Cash payment to suppliers
Add: Inventory-December 31 990,000
Goods available for sale 8,280,000
Less: Inventory- January 1 750,000
Purchases 7,530,000
Add: Accounts payable- January 1 750,000
Accounts payable- December 31 450,000
Cash payment to suppliers 7,830,000
3. Cash payment for salaries
Add: Salaries expense 750,000
Salaries payable- January 1 260,000
Total 1,010,000
Less: Salaries payable- December 31 270,000
Cash payment for salaries 740,000
4. Cash payment for rent
Rent expense 100,000
Add: Prepaid rent- December 31 90,000
Total 190,000
Rent expense- January 1 60,000
Cash payment for rent 130,000
EXERCISES
1. Discuss the method of determining cash flows from operating
activities.
2. State how to compute the following under the direct method.
a. Cash receipts from customers
b. Cash payments to suppliers or creditors
c. Cash payments of expense
d. Cash receipts of other income
CHAPTER REVIEW 4
4.1 TRUE OR FALSE
otherwise, write false and state your reason briefly.
1. Dividends payment to stockholders shall be classified as
cash outflows for investing activities in the statement of
cash flows.
2. The Standard requires the preparation of the statement of
cash flows as supporting schedule for the amount
appearing as cash and cash equivalents in the statement of
financial position.
3.The primary purpose of the statement of cash flows is to
assist investors or creditors in assessing the entity’s ability to
generate positive future net cash flows.
4.In the statement of cash flows, cash payments to acquire
equity instruments of other businesses and interest in joint
ventures are classified as cash outflows for financing
activities.
5.Noncash items like depreciation, deferred taxes and
unrealized foreign currency gains and losses are examples of
noncash investing and financing transactions.
6.Philippine Accounting Standard 7 requires entity to report
cash from operating activities using the direct method.
7.Cash equivalents refer to short and long term highly liquid
investments that are readily convertible to known amount of
cash and which are subject to an insignificant risk of changes
in value.
8.Cash flows arising from investing and financing activities are
reported in the statement of cash flows using either the direct
method or indirect method.
9.Interest received and dividends received are alternatively
classified in the statement of cash flows as cash from financing
activities
10.The Standard requires that cash flows arising from income
taxes shall be separately disclosed and classified as cash
flows from financing activities.
4.2 TRUE OR FALSE
1. The net income or loss for the period is only found in the
income statement but not in the statement of changes in
equity.
2. The statement of changes in equity presents all the items
that made changes in the equity between two statements of
financial position dates.
3. Equity represents the interest of the owners in the entity
after paying all the liabilities.
4. The line items appearing on the shareholders’ equity of a
business are share capital, net income or loss, reserves and
retained earnings.
5. The share capital represents funds contributed by the
shareholders and is considered as the legal capital of a
business entity.
6. The share subscription of the shareholders are part of the
share capital line item.
7. The balance of retained earnings represents prior period
errors, net income, dividends distributions, and changes in
accounting estimates and policy.
8.Appropriation reserves are deducted from retained earnings
balance and treated as expense
9.Appropriation for contingencies and appropriation for plant
expansion are examples of voluntary creation of reserve.
10.Share premium is the excess of the par value or stated
value over the issued price of the shares of stocks
4.3-TRUE OR FALSE
1. Revaluation increment in property arises from the cost model
of measuring property, plant and equipment.
2. Foreign currency translation gain or loss arises once the
company translates the items in the financial statements
from functional currency to foreign currency.
3. Cash dividends payments are deductions from the beginning
balance of the reserves.
4.When a business entity issued additional shares at a price
higher than par value share, the aggregate amounts are
shown as addition to share capital line item.
5.Current appropriations are transfers from the retained
earnings to the reserves.
6.A statement of comprehensive income is synonymous with
statement of changes in equity.
7.Cash includes cash on hand, petty cash fund, interest fund,
dividend fund and cash in bank not restricted for withdrawal.
8.Cash equivalents are short-term money market instruments
that are highly liquid and readily convertible to cash.
9.A time deposit with 120-day maturity period is classified as
cash equivalent.
10.A statement of cash flows is useful in providing users
information about the ability of the entity to generate and
utilize cash and cash equivalents.
4.4 TRUE OR FALSE
1. Short-term highly liquid investments are held for the
purpose of investment or capital appreciation.
2. Cash flows classified as operating activities arise from the
principal revenue producing activities of the entity.
3. The statement of cash flows will indicate the amount,
timing and certainty of past cash flows of an entity.
4. Cash payment of bank borrowings and interest are
classified as financing activities.
5.Cash flows classified as investing activities are attributable to
the acquisition and disposal of property, plant and equipment
and other investments.
6.Cash flows activities between the entity and the shareholders
or creditors are classified as financing activities.
7.Cash payment for patents and copyrights are shown under
operating activities as utilization of cash.
8.Issuance of notes and bonds payable are financing activities.
9.Dividends received are classified as operating activities.
10.Reissuance of treasury shares above cost represents gain
and the cash flow is classified as financing activity.
4.5-TRUE OR FALSE
Write true if the statement is correct. If you believe otherwise,
write false and state your reason briefly.
1. Conversion of preference shares to ordinary shares is classified as
financing activities.
2. Entities are encourage to present cash flows from operating activities
using the indirect method.
3. To compute for cash collections from customers, sales on account are
added to the accounts receivable end.
4. To convert the accrual net income to cash basis ,decrease in current
assets except cash and cash equivalents are added to the adjusted net
income.
5. Amortization of discount or bonds payable is deducted from the net
income under the indirect method.
6. Increase in trade accounts payable is added to the adjusted net income
under the indirect method.
7. The cost of sales is added back to the net income in computing cash
flows from operating activities.
8. The amount of income tax that appears on the income statement
represents the amount of income tax.
9.Gain on sale of investment securities or gain on sale of property, plant
and equipment are deducted from operating activities since these accounts
were added in the determination of net income but cash and cash
equivalents are not involved.
10. Depreciation and doubtful accounts are added to operating activities
since these accounts were deducted in determining net income for the
period but they did not involve cash and cash equivalents.
4.1-MULTIPLE CHOICE
1. A financial statement that reflects all the items that caused
changes in an entity’s equity between dates of two
statement of financial position.
a. statement of financial position
b. statement of comprehensive income
c. statement of changes in equity
d. statement of cash flow
2. The following line items are the sub-classification of the
shareholders' equity in the balance sheet, except
a. share capital c. retained earnings
b. reserves d. net income or loss
3.The classification of items in the shareholders' equity of the
business
I. indicates legal or other restrictions on the ability of the business
to distribute or apply its equity.
ll. reflects the fact that parties with interest in the entity have
differrent rights in dividends and repayment of contributed capital.
a. I only c. Both I and II
b.II only d.Neither I nor II
4.This is the net amount of accumulate net income or loss,prior
period adjustments, distribution of dividends and adjustments for
changes in accounting policy.
a. retained earnings c. revaluation reserve
b. share capital d. appropriation reserve
5. The line item reserves includes the following, except:

a. share premium c. revaluation adjustment
b. dividends paid d.appropriation reserve
6. Statement 1. Shares subscription of shareholder net of receivable is
included in share capital item
statements 2. Appropriations are transfer form retained earnings and
considered as expense
a. Only the first statement is correct b. Only the second statement iscorrect
c. Both statement are correct d.neither statements is correct
7. The following are the reasons for the creation of reserves except
A legal requirement C.contractual obligations
B.provision for uncollectible D. voluntary action of the management
8. The creation appropiation reserve for sinking fund is attributable to_____
A. legal requirement
B.provision for uncollectible
C.contractual obligations
D. voluntary action of the management
9. An early created appropriation reserve for treasury share as
_______
A. legal requirement
B.provision for uncollectible
C.contractual obligations
D. voluntary action of the management
10. In preparing of statement of changes in equity,cash
dividend payment is shown as _______
A. deduction from share capital
B. addition to share capital
C. deduction from retained earnings
D. addition to retained earnings
4.1- PROBLEM
The following accounts balances of JENNY Trading on December
31. 2018 presented is follows:
Party cash fund 30,000

Payment fund 100,000
Cash on hand awakening deposits 800,000
Cash in bank- PNB current account 5000,000
Cash in bank -sinking fund 1,500,000
Time deposits -90 days due February 1. 2019 2,000,000
Cash in bank- MBTC restricted for plant expansion 3,000,000
Analysis of the account revealed the following:
1. The party cash fund include unfinished party cash expense
vouchers of P 4000 and IOUs of employees of P 6000.
2. The cash on hand awakening deposit include P 200.000
customers check dates January 10,2019.
3. The cash in bank - PNB current is net of bank overdraft of P
500.000 with other bank
4. The cash in bank - sinking fund is inherited pay the bonds
payable that will mature on January 15, 2020.
5. The cash in bank - MBTC is expected to be utilized on
February 1, 2019.
The amount of cash and cash equivalents as of December

31 2018 that would be accounted in the statement of cash
flow would be.
A.7,720,000 C.9,720,000
B.8,220,000 D.1,243,000
4.2 PROBLEM
YVONNE Merchandising presented the following balances as of
December 31,2018:
Cash on hand 150,000
Money market account 1,000,000
Checking accounts No.50001 1,500,000
Checking accounts No.50002 (200,000)
BSP treasury bill, purchased 4/1/2018
maturing 1/31/2019 1,800,000
BSP treasury bill, purchased 12/15/2018
maturing 1/31/2019 1,000,000\
A. 3,450,000 C. 4,250,000
B.3,650,000 D.4,450,000
4.3 Problem
NICANOR company provided the following information for the year ended
December 31,2018:
Cash collection from customers 6,000,000
Cash payment to supplier 2,000,000
Cash payment to employees 800,000
Interest received 100,000
interest payment on bank Loan 300,000
Cash dividends received 300,000
Cash dividends paid 400,000
Income tax paid 200,000
Cash payment for equipment 1,500,000
The net cash provided by operating activities for 2018 would be:
A.2,700,000 B.3,000,000 C.3,100,000 D.1,200,000
4.4 Problem
The following comparative current accounts Angel Merchandising
for the year ended December 31. 2018 had been provided
Cash and cash equivalents 700,000 850,000
Accounts receivable 350,000 480,000
Allowance for doubtful accounts 10,000 15,000
Merchandise inventory 120,000 100,000
Bank loan payable -current 150,000 100,000
The net income for the year amounted P900,000 after
considering the following items:

Depreciation 80,000
Amortization of premium on bonds payable 10,000
The net cash provided by operating activities would be:

a. 898,000 c.975,000
b. 922,000 d. 878,000
4.5 Problem
Princess Merchandising presented the following balances for the
year 2018:
Accounts receivable 2,500,000 5,200,000
Allowance for doubtful account 200,000 400,000
The following information are related to the 2018 operation:

Total sales 8,750,000
Doubtful account recognized 500,000
Doubtful account written off 300,000
Fifteen percent of the total sales were cash sales. Using the
direct method, the total cash inflow from customers during
2018 would be:
a.4,437,500 c. 6,050,000
b.5,750,000 d. 9,937,500
4.6- PROBLEM
The following changes happened in some accounts of Hyzel
Trading as follows:
Increase in machinery 375,000

Increase in accumulated depreciation-machinery 600,000
Increase in notes payable 450,000
Increase in investment in bonds 500,000
Increase in bonds payable 1,000,000
1. The net income for the period was P4,000,000.
2.In November oof the current year, the company sold
machinery costing P375,000 with accumulated depreciation of
P180,000 at a loss of P25,000.
3.In the month of December, the company purchased
machinery costing P750,000 through the issuance of a 12%
note payable of P450,000 and P300,000 cash.
The net cash flows used by activities would be:

a. 630,000 c. 1,080,000
b.800,000 d. 605,000
4.7 PROBLEM
Izzy Merchandising had provided the statement of comprehensive
inome for the year ended December 31,2018 as follows:
Sales 6,750,000
Gross inome 2,250,000
Expenses:
Salaries 900,000
Advertising 30,000
Rent 375,000
Depreciation 75,000
Other expenses 150,000 1,530,000
Net income 720,000
Accounts receivable -trade 630,000 750,000
Merchandise inventory 1,125,000 900,000
Accounts payable- trade 240,000 420,000
Accrued salaries payable 120,000 75,000
Equipment 1,800,000 1,800,000
Accumulated depreciation 360,000 435,000
Required: Determine the cash flow from operating activities using :
1. indirect method; and
2.direct method

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Chapter 3 and 4

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CHAPTER 3

• A statement of comprehensive income (new title for

• Expenses are decreases in economic benefits during the

As to to date of the financial As a given date(one day only) For a given

• Recognition is the process of incorporating in the

• The failure to recognize an income or expense is not

• Expenses are recognized in the income statement when a

• This means in effect, that recognition of expenses occurs

• An item that meets the recognition criteria of expense is

1.Matching costs with revenues;

• Expenses are recognized in the statement of

• This allocation procedure is intended to recognize

• Under this recognition procedure, an expense is

1.Define the following:

• The concept of capital maintenance as the term suggests

The Framework mentioned two concepts of capital

• Under the concept of financial capital maintenance, the

Net assents – end xxxxxx

Net assets, end of the period xxxxxx

The points to remember are;

Net increase in net assets xxxxxx

JENNY Company provides the following data for the

REQUIRED: Determine the amount of net income under the

Net assets, December 31 1,100,000

Net assets, December 31 1,100,000

The net income is computed as follows:

Net assets, December 31 1,100,000

Income is increases in economic benefits during the

The definition of income encompasses both revenue and

Gains represent other items that meet the definition of

Gains are often reported in the income statement net of

Examples of expenses that arise in the course of

Profit is the residual amount that remains after

The choice between the function of expense

1.Nature of expense with supporting notes;and

ANSWER 1.The statement of comprehensive income of

Note 1- Net sales revenue

Note 3- Increase in Inventory

Answer 2.The statement of comprehensive income of

Note 3- Other income

Sales salaries 300,000

Note 6-Finance costs

Significant information need to be shown on the

a.On the face of the statement;or

An entity shall not present any items of income

When items of income and expenses are material,

5.In the nature of expense method,expenses are calssified

7.In the transaction approach of measuring

Write true if the statement is correct. If you believe

Write true if the statement is correct. If you believe

1. A structure financial statement that shows the financial

a. I only c. III only

5. The following methods are adopted in recognizing expenses in

1. In this method of determining income, only inflows of

Select the best answer

A. I only C. I and III

B. I and II D. II and III

The total manufacturing cost during the year 2018 would

Disbursement for purchases 6,500,000

Required: Prepare the statement of comprehensive income for

1.Nature of expense method with supporting notes

The basic accounting is that asset is equal to equity. The

The Framework defines equity as follows: