44 VERDEFLOR, SOPHIA MARIE D.
BSAC2
CHAPTER 16: ERROR CORRECTION
Prior period errors
Definition: Omissions and misstatements in
the entity’s financial statements for one or
more periods arising from a failure to use or
misuse of reliable information that:
a. Was available when financial
statements for these periods were
authorized for issue
b. Could reasonably be expected to
have been obtained and taken into
account in the preparation and
presentation of those financial
statements
Treatment: by retrospective restatement –
if comparative statements are presented, the
prior year statements are restated to correct
the error
Note: Correction of prior period error is an
adjustment of the beginning balance of retained
earnings of the earliest period presented.
Statement of financial position errors
 Affects the real accounts only –
improper classification of an asset,
liability and capital account
 Entry is simply made to reclassify
the account balances
Income statement errors
 Affects the nominal accounts only –
improper classification of revenue
and expense accounts
 Reclassifying entry is necessary only
if the error is discovered in the same
year it is committed
 If error is discovered in a
subsequent year, no reclassifying
entry is necessary because the
nominal accounts for the current year
are correctly stated
Combined statement of financial position
and income statement errors
 Affect both the statement of financial
position and income statement
because they result in a
misstatement of net income
 Classified as counterbalancing
errors and noncounterbalancing
errors
Counterbalancing errors
Definition: These are errors which, if not
detected, are automatically counterbalanced
or corrected in the next accounting period.
Effects:
a. The income statements for two
successive periods are incorrect
b. The statement of financial position at
the end of the first period is
incorrect
c. The statement of financial position at
the end of the second period is
correct
Examples: Misstatement of the following:
a. Inventory, including purchases and
sales
b. Prepaid expense
c. Accrued expense
d. Deferred income
e. Accrued income
44 VERDEFLOR, SOPHIA MARIE D. BSAC2

Noncounterbalancing errors

Definition: These are errors which, if not

detected, are not automatically
counterbalanced or corrected in the next
accounting period.

Effects:

1. The income statement of the period

in which the error is committed is
incorrect but the succeeding income
statement is not affected.
2. The statement of financial position
of the year of error and succeeding
statement of financial position are
incorrect until the error is corrected.

Example: Misstatement of depreciation

44 VERDEFLOR, SOPHIA MARIE D. BSAC2
CHAPTER 17: STATEMENT OF CASH
FLOWS
Definition: It is a component of financial
statements summarizing the operating,
investing and financing activities of an
entity. Simply, it provides information about
the cash receipts and cash payments of an
entity during a period.
Purpose: To provide relevant information
about cash receipts and cash payments of an
entity during a period.
Classifications of cash flows:
Cash flows – are inflows and outflows of
cash and cash equivalents
Bank overdrafts – which are repayable on
demand form an integral part of an entity’s
cash management
Operating activities
Definition: These are the cash flows derived
primarily from the principal revenue
producing activities of the entity.
Examples:
a. Cash receipts from sale of goods and
rendering of services
b. Cash receipts from royalties, rental,
fees, commissions and other revenue
c. Cash payments to suppliers for
goods and services
d. Cash payments for selling,
administrative and other expenses
e. Cash receipts and cash payments of
an insurance enterprise for premiums
and claims, annuities and other
policy benefits
f. Cash payments or refunds of income
taxes unless they can be specifically
identified with financing and
investing activities
g. Cash receipts and payments for
securities held for dealing or trading
purposes
Others:
 Cash flows arising from the purchase and
sale of dealing or trading securities (PAS 7,
paragraph 15)
 Cash advances and loans made by a
financial institution (since they relate to the
main revenue producing activity of that
entity)
Investing activities
Definition: These are cash flows derived
from the acquisition and disposal of long-
term assets and other investments not
included in cash equivalent.
Examples:
a. Cash payments to acquire property,
plant and equipment, intangibles and
other long-term assets
b. Cash receipts from sales of property,
plant and equipment, intangibles and
other long-term assets
c. Cash payments to acquire equity or
debt instruments of other entities and
interests in joint ventures (current
and long-term investments)
d. Cash receipts from sales of equity or
debt instruments of other entities and
interests in joint venture
e. Cash advances and loans to other
parties (other than advances and
loans made by financial institution)
44 VERDEFLOR, SOPHIA MARIE D.
f. Cash receipts from repayment of
advances and loans made to other
parties
g. Cash payments for future contract,
forward contract, option contract and
swap contract
h. Cash receipts from future contract,
forward contract, option contract and
swap contract
Financing activities
Definition: These are cash flows derived
from the equity capital and borrowings of
the entity. Simply, these are cash flows that
result from transactions:
a. Between the entity and the owners –
equity financing
b. Between the entity and the creditors
– debt financing
Note: It includes cash flows from transactions
involving nontrade liabilities and equity of an
entity.
Examples:
a. Cash receipts from issuing shares or
other equity instruments (ex:
issuance of ordinary and preference
shares)
b. Cash payments to owners to acquire
or redeem the enterprise’s shares (ex:
payment for treasury shares)
c. Cash receipts from issuing
debentures, loans, notes, bond,
mortgages, and other short or long
term borrowings
d. Cash payments for amounts
borrowed
BSAC2
e. Cash payments by a lessee for the
reduction of the outstanding
principal lease liability
Note: Cash payments to settle obligations such as
trade accounts and notes payable, income tax
payable, accrued expenses and similar items are
operating activities, not financing activities.
Noncash transactions (PAS 7, paragraph
43)
 Investing and financing transactions
that do not require use of cash or
cash equivalents shall be excluded
from the statement of cash flows
 Such transactions shall be disclosed
elsewhere in the financial statements
 Statement of cash flows is strictly a
cash concept
The following noncash transactions are
disclosed separately:
a. Acquisition of asset either by
assuming directly related liability
b. Acquisition of asset by means of
issuing share capital
c. Conversion of bonds payable to
share capital
d. Conversion of preference share to
ordinary share
Interest (PAS 7, paragraph 33)
 Interest paid and interest received
shall be classified as operating cash
flows because they enter into the
determination of net income or loss
 Alternatively, interest paid may be
classified as financing cash flow
because it is a cost of obtaining
financial resources.
44 VERDEFLOR, SOPHIA MARIE D. BSAC2
 Alternatively, interest received may
be classified as investing cash flow
because it is a return on investment
 For financial institution, interest
paid and interest received are
usually classified as operating cash
flows
Dividends
 Dividend received shall be
classified as operating cash flow
because it enters into the
determination of net income (PAS 7,
paragraph 33)
 Alternatively, divided received may
be classified as investing cash flow
because it is a return on investment
 Dividend paid shall be classified as
financing cash flow because it is a
cost of obtaining financial resources
(PAS 7, paragraph 34)
 Alternatively, dividend paid may be
classified as operating cash flow in
order to assist users to determine the
ability of the entity to pay dividends
out of operating cash flows
Income taxes
 Cash flows arising from income
taxes shall be separately disclosed
as cash flows from operating
activities unless they can be
specifically identified with investing
and financing activities
PAS 7, paragraph 18, provides that an
entity shall report cash flows from operating
activities using either the direct method or
indirect method
Direct method
 It shows in detail or itemizes the
major classes of gross cash receipts
and gross cash payments
 Cash receipts and cash payments are
listed one by one, and the difference
represents the net cash flow from
operating activities
 It is the “cash basis” income
statement
Indirect method
 It begins with the accrual basis net
income and applies a series of
adjustments to convert the income to
a cash basis
General guidelines to adjust net income to
cash basis:
1. All increases in trade noncash
current assets are deducted from net
income
2. All decreases in trade noncash
current assets are added to net
income
3. All increases in trade current
liabilities are added to net income
4. All decreases in trade current
liabilities are deducted from net
income
5. Depreciation, amortization and other
noncash expenses are added back to
net income to eliminate the effect
they had on net income
6. Any gain on disposal of property or
gain on early retirement of nontrade
liabilities is included in net income –
nonoperating item – deducted from
net income
44 VERDEFLOR, SOPHIA MARIE D. BSAC2

7. Any loss on disposal of property or

loss on early retirement of nontrade
liabilities is deducted from net
income – nonoperating item –
added back to net income
8. Other noncash income or gain is
deducted from net income and other
noncash expense or loss is added to
net income to eliminate the effect on
net income

Note: Direct method and indirect method are

applicable only to operating activities.

PAS 7, paragraph 21, provides that an entity shall

report separately major classes of gross cash receipts
and gross cash payments arising from investing and
financing activities using the direct method.

Basic guidelines

a. Operating activities include the

cash effects of transactions that enter
into the determination of net income
b. Investing activities include the cash
effects of transactions involving
nonoperating assets
c. Financing activities include the cash
effects of transactions involving
nontrade liabilities and equity