Module in Financial Accounting and Reporting

THE ACCOUNTACY PROFESSION

TECHNICAL KNOWLEDGE

To understand the definition of accounting

To identify the overall objective of accounting

To describe the practice of the accountancy profession in the Philippines

To understand the Continuing Professional Development in the field of accounting

To know the meaning of generally accepted accounting principles

To identify the standards –setting body in the Philippines

To describe the creation of the International Accounting Standards Board

To know the meaning of IFRS

Lesson 1 THE ACCOUNTANCY PROFESSION

DEFINITION OF ACCOUNTING

The Accounting Standards Council provides the following definition:

Accounting is a service activity.

The accounting function is to provide quantitative information, primarily financial in nature, about economic
entities, that is intended to be useful in making economic decision.

The Committee on Accounting Terminology of the American Institute of Certified Public Accountants defines
accounting as follows:

Accounting is the art of recording, classifying, and summarizing in a significant manner and in terms of
money, transactions and events which are in part at least of a financial character and interpreting the result
thereof.

The American Accounting Association in its Statement of Basic Accounting Theory defines accounting as
follows:

Accounting is the process of identifying, measuring and communicating economic information to permit
informed judgment and decision by users of the information.

Important points

The following important points made in the definition of accounting should be noted:

One – Accounting is about quantitative information.

Two – The information is likely to be financial in nature.

Three – The information should be useful in decision making.

The definition that has stood the test of time is the definition given by the American Accounting Association.
This definition states that the very purpose of accounting is to provide quantitative information to be useful in
making an economic decision.

The definition also states that accounting has a number of components, namely:

a. Identifying as the analytical component.

b. Measuring as the technical component.
c. Communicating as the formal component.

Identifying

This accounting process is the recognition or non-recognition of business activities as “accountable” events.

Not all business activities are accountable.

For example, the hiring of employees, the death of the entity president and the entering into a contract are all
business activities but such events are not accountable because they cannot be quantified or expressed in terms
of a unit of measure.

An event is accountable or quantifiable when it has an effect on assets, liability and equity.

In other words, the subject matter of accounting is economic activity or the measurement of economic
resources and economic obligations.

Only economic activities are emphasized and recognized in accounting.

Sociological and psychological matters are beyond the province of accounting.

External and Internal transactions

Economic activities of an entity are referred to as transactions which may be classified as external and internal.

External transactions or exchange transactions are those economic events involving one entity and another
entity.

Examples of external transactions are:

a. Purchase of goods from a supplier
b. Borrowing money from a bank
c. Sale of goods to a customer
d. Payment of salaries to employees
e. Payment of taxes to the government

Internal transactions are economic events involving the entity only.

Internal transactions are the economic activities that take place entirely within the entity.

Production and casualty loss are examples of internal transactions.

Production is the process by which resources are transformed into productions.

Casualty is any sudden and unanticipated loss from fire, flood, earthquake and other event ordinarily termed as
an act of God.
Measuring

This accounting process is the assigning of peso amounts to the accountable economic transactions and events.

If accounting information is to be useful, it must be expressed in terms of a common financial denominator.

Financial statements without monetary amounts would be largely unintelligible or incomprehensible.

The Philippine peso is the unit of measuring accountable economic transactions.

The measurement bases are historical cost and current value.

Historical cost is the most common measure of financial transactions.

Current value includes fair value, value in use, fulfillment value and current cost.

Communicating

Communicating is the process of preparing and distributing accounting reports to potential users of accounting
information.

Identifying and measuring are pointless if the information contained in the accounting records cannot be
communicated in some form to potential users.

Actually, the communicating process is the reason why accounting has been called the “universal language of
business”.

Implicit in the communication process are the recording, classifying and summarizing aspects of accounting.

Recording or journalizing is the process of systematically maintaining a record of all economic business
transactions after they have been identified and measured.

Classifying is the sorting or grouping of similar and interrelated economic transactions into their respective
classes.

Classifying is accomplished by posting to the ledger.

The ledger is a group of accounts which are systematically categorized into asset accounts, liability accounts,
equity accounts, revenue accounts and expense accounts.
Summarizing is the preparation of financial statements which include the statement of financial position,
income statement, statement of comprehensive income, statement of changes in equity and statement of cash
flows.

Accounting as an information system

Accounting is an information system that measures business activities, processes information into reports and
communicates the reports to decision makers.

A key product of this information system is a set of financial statements – the documents that report financial
information about an entity to decision makers.

Financial reports tell us how well an entity is performing in terms of profit and loss and where its stands in
financial terms.
Overall objective of accounting

The overall objective of accounting is to provide quantitative financial information about a business that is
useful to statement users particularly owners and creditors in making economic decision.

An accountant’s primary task is to supply financial information so that the statement users could make
informed judgment and better decision.

The essence of accounting is decision-usefulness.

Investors and other users are interested in financial accounting information necessary in making important and
significant economic decisions.

THE ACCOUNTANCY PROFESSION

At present, Republic Act no. 9298 is the law regulating the practice of accountancy in the Philippines.

This law is known as the “Philippine Accountancy Act of 2004”

Accountancy has developed as a profession attaining a status equivalent to that of law of medicine.

In the Philippines, in order to qualify to practice the accountancy profession, a person must finish a degree in
Bachelor of Science in Accountancy and pass a very difficult government examination given by the Board of
Accountancy.

The Board of Accountancy is the body authorized by law to promulgate rules and regulations affecting the
practice of the accountancy profession in the Philippines.

The Board of Accountancy is responsible for preparing and grading the Philippine CPA examination.

This computer-based examination is offered twice a year, one in May and another one in October, in
authorized testing centers around the country.

Limitation of the practice of public accountancy

Single practitioners and partnerships for the practice of public accountancy shall be registered certified public
accountants in the Philippines.

A certificate of accreditation shall be issued to certified public accountants in public practice only upon
showing in accordance with rules and regulations promulgated by the Board of Accountancy and approved by
the Professional Regulation Commission that such registrant has acquired a minimum of three years of
meaningful experience in any of the areas of public practice including taxation.

The Securities and Exchange Commission shall not register any corporation organized for the practice of
public accountancy.

Accreditation to practice public accountancy

Certified public accountants, firms and partnerships of certified public accountants, including partners and staff
members thereof, are required to register with the Board of Accountancy and Professional Regulation
Commission for the practice of public accountancy.
The Professional Regulation Commission upon favorable recommendation of the Board of Accountancy shall
issue the Certificate of Registration to practice public accountancy which shall be valid for 3 years and
renewable every 3 years upon payment of required fees.

Certified Public Accountants generally practice their profession in three main areas, namely:

a. Public accounting
b. Private accounting
c. Government accounting

PUBLIC ACCOUNTING

The field of public accounting or public accountancy is composed of individual practitioners, small accounting
firms and large multinational organizations that render independent and expert financial services to the public.

Public accountants usually offer three kinds of services, namely auditing, taxation and management advisory
services.

As a matter of fact, large multinational accounting firms have separate division for each of these services.

Auditing

Auditing has traditionally been the primary service offered by most public accounting practitioners.

Auditing or external auditing is the examination off financial statements by independent certified public
accountant for the purpose of expressing an opinion as to the fairness with which the financial statements are
prepared.

Actually, external auditing is the attest function of independent CPAs.

The Bureau of Internal Revenue requires audited financial statements to accompany the filing of annual
income tax return.

Banks and other lending institutions frequently require an audit by an independent CPA before granting a loan
to the borrower.

Creditors and prospective investors place considerable reliance on audited financial statements on making
economic decision.

Taxation

Taxation service includes the preparation of annual income tax returns and determination of tax consequences
of certain proposed business endeavors.

The CPA not infrequently represents the client in tax investigations.

To offer this service effectively and efficiently, the public accountant must be thoroughly familiar with the tax
laws and regulations and updated with changes in taxation law and court cases concerned with interpreting
taxation law.

Management advisory services

Management advisory services have become increasingly important in recent years although audit and tax
services are undoubtedly the mainstay of public accountants.

The term management advisory services has no precise coverage but is used generally to refer to services to
clients on matters of accounting, finance, business policies, organization procedures, product costs, distribution
and many other phases of business conduct and operations.

Specifically, management advisory services include:

a. Advice on installation of computer system
b. Quality control
c. Installation and modification of accounting system
d. Budgeting
e. Forward planning and forecasting
f. Design and modification of retirement plans
g. Advice on mergers and consolidation

PRIVATE ACCOUNTING

Many Certified Public Accountants are employed in business entities in various capacity as accounting staff,
chief accountant, internal auditor and controller.

The highest accounting officer in an entity is known as the controller.

The major objective of the private accountant is to assist management in planning and controlling the entity’s
operations.

Private accounting includes maintaining the records, producing the financial reports, preparing the budgets and
controlling and allocating the resources of the entity.

The private accountant has also the responsibility for the determination of the various taxes the entity is
obliged to pay.

GOVERNMENT ACCOUNTING

Government accounting encompasses the process of analyzing, classifying, summarizing and communicating
all transactions involving the receipt and disposition of government funds and property and interpreting the
results thereof.

The focus of government accounting is the custody and administration of public funds.

Many Certified Public Accountants are employed in many branches of the government, more particularly:
a. Bureau of Internal Revenue
b. Commission on Audit
c. Department of Budget and Management
d. Securities and Exchange Commission
e. Bangko Sentral ng Pilipinas

CONTINUING PROFESSIONAL DEVELOPMENT (CPD)

Republic Act No. 10912 is the law mandating and strengthening the continuing professional development
program for all regulated professions, including the accountancy profession.
All certified public accountants shall abide by the requirements, rules and regulations on continuing
professional development to be promulgated by the Board of Accountancy, subject to the approval of the
Professional Regulation Commission, in coordination with the accredited national professional organization of
certified public accountants or any duly accredited educational institutions.

Continuing professional development refers to the inculcation and acquisition of advanced knowledge, skill
proficiency, and ethical and moral values after the initial registration of the Certified Public Accountant for
assimilation into professional practice and lifelong learning.

Continuing professional development raises and enhances the technical skill and competence of the Certified
Public Accountant.

CPD credit units

The CPD credit units refer to the CPD credit hours required for the renewal of CPA license and accreditation
of a CPA to practice the accountancy profession every three years.

Under the new BOA Resolution, all Certified Public Accountants regardless of area or sector of practice shall
be required to comply with 120 CPD credit units in a compliance period of three years.

However, the initial implementation of the 120 CPD credit units is gradual in the following period:
2017 80 credit units
2018 100 credit units
2019 120 credit units

Excess credit units earned shall not be carried over to the next three-year period, except credit units earned for
masteral and doctoral degrees.

It is to be emphasized that the Continuing Professional Development has become mandatory for Certified
Public Accountants.

The Continuing Professional Development is required for the renewal of CPA license and accreditation of
CPA to practice the accountancy profession.

Exemption from CPD

A CPA shall be permanently exempted from CPD requirements upon reaching the age of 65 years.

However, this exemption applied only to the renewal of CPA license and not for the purpose of accreditation to
practice the accountancy profession.

Accounting versus auditing

In a broad sense, accounting embraces auditing.

Auditing is one of the areas of accounting specialization.

In a limited sense, accounting is essentially constructive in nature. Accounting ceases when financial
statements are already prepared.

On the other hand, auditing is analytical. The work of an auditor begins when the work of the accountant ends.

After the financial statements are prepared, the auditor will begin to perform the task of auditing.
The auditor examines the financial statements to ascertain whether they are in conformity with generally
accepted accounting principles.

Accounting versus bookkeeping

Bookkeeping is procedural and largely concerned with development and maintenance of accounting records.

Bookkeeping is the “how” of accounting.

Accounting is conceptual and is concerned with the why, reason or justification for any action adopted.

Bookkeeping is a procedural element of accounting as arithmetic is a procedural element of mathematics.

Accounting versus accountancy

Broadly speaking, the two terms are synonymous because they both refer to the entire field of accounting
theory and practice.

Technically speaking, however accountancy refers to the profession of accounting practice.

Accounting is used in reference only to a particular field of accountancy such as public accounting, private
accounting and government accounting.

Financial accounting versus managerial accounting

Financial accounting is primarily concerned with the recording of business transactions and the eventual
preparation of financial statements.

Financial accounting is the area of accounting that emphasizes reporting to creditors and investors.

Managerial accounting is the accumulation and preparation of financial reports for internal users only.
In other words, managerial accounting is the area of accounting that emphasizes developing accounting
information for use within an entity.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

Accounting has evolved through time changing with the needs of society. As new types of transactions occur
in trade and commerce, accountants develop rules and procedures for recording them.

These accounting rules, procedures and practices came to be known as generally accepted accounting
principles or simply GAAP.

The principles have developed on the basis of experience, reason, custom, usage and practical necessity.

Generally accepted accounting principles represent the rules, procedures, practice and standards followed in
the preparation and presentation of financial statements.

Generally accepted accounting principles are like laws that must be followed in financial reporting.

The process of establishing GAAP is a political process which incorporates political actions of various
interested user groups as well as professional judgment, logic and research.
Purpose of accounting standards

The overall purpose of accounting standards is to identify proper accounting practices for the preparation and
presentation of financial statements.

Accounting standards create a common understanding between preparers and users of financial statements
particularly the measurement of assets and liabilities.

A set of high –quality accounting standards is a necessary to ensure comparability and uniformity in financial
statements based on the same financial information.

FINANCIAL REPORTING STANDARDS COUNCIL

Is the Philippines, the development of generally accepted accounting principles is formalized initially through
the creation of the Accounting Standards Council or ASC.

The Financial Reporting Standards Council or FRSC now replaces the Accounting Standards Council.

The FRSC is the accounting standard setting body created by the Professional Regulation Commission upon
recommendation of the Board of Accountancy to assist the Board of Accountancy in carrying out its powers
and functions provided under R.A. Act No. 9298.

The main function is to establish and improve accounting standards that will be generally accepted in the
Philippines.

The accounting standards promulgated by the Financial Reporting Standards Council constitute the highest
hierarchy of generally accepted accounting principles in the Philippines.

The approved statements of the FRSC are known as Philippine Accounting Standards or PAS and Philippine
Financial Reporting Standards or PFRS.

Composition of FRSC

The FRSC is composed of 15 members with a Chairman who had been or is presently a senior accounting
practitioner and 14 representatives from the following:

Board of Accountancy 1
Securities and Exchange Commission 1
Bangko Sentral ng Pilipinas 1
Bureau of Internal Revenue 1
Commission on Audit 1
Major organization of preparers and users of financial statements –
Financial Executives Institute of the Philippines or FINEX 1
Accredited national professional organization of CPAs:
Public Practice 2
Commerce and Industry 2
Academic or Education 2
Government 2
-----
Total 14

The Chairman and members of the FRSC shall have a term of 3 years renewable for another term. Any
member of the ASC shall not be disqualified from being appointed to the FRSC.
Philippine Interpretations Committee

The Philippine Interpretation Committee or PIC was formed by the FRSC in August 2006 and has replace the
Interpretation Committee or IC formed by the Accounting Standards Council in May 2000.

The role of the PIC is to prepare interpretations of PFRS for approval by the FRSC and to provide timely
guidance on financial reporting issues not specifically addressed in current PFRS.

In other words, interpretations are intended to give authoritative guidance on issues that are likely to receive
divergent or unacceptable treatment because the standards do not provide specific and clear cut rules and
guidelines.

The counterpart of the PIC in the United Kingdom is the International Financial Reporting Interpretations
Committee or IFRIC which has already replaced the Standing Interpretation Committee or SIC.

INTERNATIONAL ACCOUNTING STANDARDS COMMITTEE

The International Accounting Standards Committee or IASC is an independent private sector body, with the
objective of achieving uniformity in the accounting principles which are used by business and other
organizations for financial reporting around the world.

It was formed in June 1973 through an agreement made by professional accountancy bodies from Australia,
Canada, France, Germany, Japan, Mexico, the Netherlands, the United Kingdom and Ireland, and the United
States of America. The IASC is head quartered in London, United Kingdom.

Objectives of IASC

a. To formulate and publish in the public interests accounting standards to be observed in the
presentation of financial statements and to promote their worldwide acceptance and observance.
b. To work generally for the improvement and harmonization of regulations, accounting standards and
procedures relating to the presentation of financial statements.

INTERNATIONAL ACCOUNTING STANDARDS BOARD

The International Accounting Standards Board or IASB now replaces the International Accounting Standards
Committee or IASC.
The IASB publishes standards in a series of pronouncements called International Financial Reporting
Standards or IFRS.

However, the IASB has adopted the body of standards issued by the IASC.

The pronouncements of the IASC continue to be designated as “International Accounting Standards” or IAS.

The IASB standard –setting process includes in the correct order research, discussion paper, exposure draft and
accounting standards.

Move toward IFRS

In developing accounting standards that will be generally accepted in the Philippines, standards issued by other
standard setting bodies such as the USA Financial Accounting Standards Board (FASB) and the IASB are
considered.
In the past years, most of the Philippine standards issued are based on American accounting standards.

At present, the FRSC has adopted in their entirety all International Accounting Standards and International
Financial Reporting Standards.

The move toward IFRS is essential to achieve the goal of one uniform and globally accepted financial
reporting standards.

The Philippines is fully compliant with IFRS effective January 2005, a process which was started back in 1997
in moving from USA GAAP to IFRS.

The following factors are considered in deciding to move totally to international accounting standards.
a. Support of international accounting standards by Philippine organizations, such as the Philippine SEC,
Board of Accountancy and PICPA.
b. Increasing internationalization of business which has heightened interest in a common language for
financial reporting,
c. Improvement of international accounting standards or removal of free choices of accounting
treatments.
d. Increasing recognition of international accounting standards by the World Bank, Asian Development
Bank and World Trade Organization.

Philippine Financial Reporting Standards

The Financial Reporting Standards Council issues standards in a series of pronouncements called “Philippine
Financial Reporting Standards” or PFRS.

The Philippine Financial Reporting Standards collectively include all of the following:

a. Philippine Financial Reporting Standards which correspond to International Financial Reporting

Standards.

The Philippine Financial Reporting Standards are numbered the same as their counterpart in
International Financial Reporting Standards
b. Philippine Accounting Standards which correspond to International Accounting Standards.
The Philippine Accounting Standards are numbered the same as their counterpart in International
Accounting Standards.
c. Philippine Interpretations which correspond to Interpretations of the IFRIC and the Standing
Interpretations Committee, and Interpretations developed by the Philippine Interpretations
Committee.

Multiple choice

1. Accounting is a service activity and its function is to provide quantitative information, primarily
financial in nature, about economic entities, that is intended to be useful in making economic decision.
This accounting definition is given by
a. Accounting Standards Council
b. AICPA Committee on Accounting Terminology
c. American Accounting Association
d. Board of Accountancy
2. All of the following describe accounting, except
a. A service activity
b. An information system
c. A universal language of business
 d. An exact science rather than an art
3. The important points made in the definition of accounting include all of the following, except
a. Accounting information is quantitative.
b. Accounting information is both quantitative and qualitative
c. Accounting information is financial in nature.
d. Accounting information is useful in decision making.
4. This accounting process is the recognition or non-recognition of business activities as accountable
events.
a. Identifying
b. Measuring
c. Communicating
d. Reporting
5. The events that affect the entity and in which other entities participate are known as
a. Internal events
b. External events
c. Current events
d. Obligating events

EVALUATING

DEFINE ACCOUNTING

CHAPTER 2

CONCEPTUAL FRAMEWORK

Objective of financial reporting

TECHNICAL KNOWLEDGE

To know the nature of the revised Conceptual Framework.

To describe the purpose and usefulness of a Conceptual Framework.

To understand the Authoritative status of a Conceptual Framework.

To understand the objective of financial reporting.

To know the limitations of financial reporting.

CONCEPTUAL FRAMEWORK

The Conceptual Framework for Financial Reporting is a complete, comprehensive and single document
promulgated by the International Accounting Standards Board.

The Conceptual Framework is a summary of the terms and concepts that underlie the preparation and
presentation of financial statements for external users.

In other words, the Conceptual framework describes the concepts for general purpose financial reporting.
The Conceptual Framework is an attempt to provide an overall theoretical foundation for accounting.

The Conceptual Framework is intended to guide standard-setters, preparers and users of financial information
in the preparation and presentation of statements.

It is the underlying theory for the development of accounting standards and revision of previously issued
accounting standards.

The Conceptual Framework will be used in future standard setting decision but no changes will be made to the
current IFRS.

The Conceptual Framework provides the foundation for Standards that:

a. Contribute to transparency by enhancing international comparability and quality of financial

information.
b. Strengthen accountability by reducing information gap between the providers of capital and the
people to whom they have entrusted their money.
c. Contribute to economic efficiency by helping investors to identify opportunities and risks across the
world.

Purposes of Revised Conceptual Framework

a. To assist the International Accounting Standards Board to develop IFRS Standards based on
consistent concepts.
b. To assist preparers of financial statements to develop consistent accounting policy when no Standard
applies to a particular transaction or other event or where an issue is not yet addressed by an IFRS.
c. To assist preparers of financial statements to develop accounting policy when a Standard allows a
choice of an accounting policy.
d. To assist all parties to understand and interpret the IFRS Standards.

Authoritative status of Conceptual Framework

If there is a standard or an interpretation that specifically applies to a transaction, the standard or interpretation
overrides the Conceptual Framework.

In the absence of a standard or an interpretation that specifically applies to a transaction, management shall
consider the applicability of the Conceptual framework in developing and applying an accounting policy that
results in information that is relevant and reliable.

However, it is to be stated that the Conceptual framework is not an International Financial reporting standard.

Nothing in the Conceptual Framework overrides any specific International Financial Reporting Standards shall
prevail over the Conceptual Framework.

Users of financial information

Under the Conceptual framework for Financial Reporting the users of financial information may be classified
into two, namely:
a. Primary users
b. Other users

The primary users include the existing and potential investors, lenders and other creditors.
The other users include the employees, customers, governments and their agencies, and the public.

Primary users

The primary users of financial information are the parties to whom general purpose financial reports are
primarily directed.

Such users cannot require reporting entities to provide information directly to them and therefore must rely on
general purpose financial reports for much rely on general purpose financial reports for much of the financial
information they need.

Existing and potential investors

Existing and potential investors are concerned with the risk inherent in and return provided by their
investments.

The investors need information to help them determine whether they should buy, hold or sell.

Shareholders are also interested in information which enables them to assess the ability of the entity to pay
dividends.

Lenders and other creditors

Existing and potential lenders and other creditors are interested in information which enables them to
determine whether their loans, interest thereon and other amounts owing to them will be paid when due.

Other users

By residual definition, “other users” are users of financial information other than the existing and potential
investors, lenders and other creditors.

Other users are so called because they are parties that may find the general purpose financial reports useful but
the reports are not directed to them primarily.

Employees

Employees are interested in information about the stability and profitability of the entity.

The employees are interested in information which enables them to assess the ability of the entity to provide
remuneration, retirement benefits and employment opportunities.

Customers

Customers have an interest information about the continuance of an entity especially when they have a long-
term involvement with or are dependent on the entity.

Governments and their agencies

Governments and their agencies are interested in the allocation of resources and therefore the activities of the
entity.

These users require information to regulate the activities of the entity, determine taxation policies and as a
basis for national income and similar statistics.

Public

Entities affect members of the public in a variety of ways.

For example, entities make substantial contribution to the local economy in many ways including the number
of people they employ and their patronage of local suppliers.
Financial statements may assist the public by providing information about the range of its activities.

Scope of Revised Conceptual Framework

a. Objective of financial reporting

b. Qualitative characteristics of useful financial information
c. Financial statements and reporting entity
d. Elements of financial statements
e. Recognition and DE recognition
f. Measurement
g. Presentation and disclosure
h. Concepts of capital and capital maintenance

OBJECTIVE OF FINANCIAL REPORTING

The objective of financial reporting forms the foundation of the Conceptual Framework.

The overall objective of financial reporting is to provide financial information about the reporting entity that
is useful to existing and potential investors, lenders and other creditors in making decisions about providing
resources to the entity.

The objective of financial reporting is the “why” purpose or goal of accounting.

Financial reporting is the provision of financial information to external users is through the annual financial
statements.

However, financial reporting encompasses not only financial statements but also other information such as
financial highlights, summary of important financial figures, analysis of financial statements and significant
ratios.

Financial reports also include non-financial information such as description of major products and a listing of
corporate officers and directors.

Targets users

Financial reporting is directed primarily to the existing and potential investors, lenders and other creditors
which compose the primary user group.

The reason is that existing and potential investors, lenders and other creditors have the most critical and
immediate need for information in financial reports.
As a matter of fact, the primary users of financial information are the parties that provide resources to the
entity.

Moreover, information that meets the needs of the specified primary users is likely to meet the needs of other
users such as employees, customers, governments and their agencies.

The management of a reporting entity is also interested in financial information about the entity.
However, management need not rely on general purpose financial reports because it is able to obtain or access
additional financial information internally.

Specific objectives of financial reporting

The overall objective of financial reporting is to provide information that is useful for decision making.

The Conceptual Framework places more emphasis on the importance of providing information needed to
assess the management stewardship of the entity’s economic resources.

According, the specific objectives of financial reporting are:

a. To provide information useful in making decisions about providing resources to the entity.
b. To provide information useful in assessing the cash flow prospects of the entity.
c. To provide information about entity resources, claims and changes in resources and claims.

Economic decisions

Existing and potential investors need general purpose financial reports in order to enable them in making
decisions whether to buy, sell or hold equity investments.

Existing and potential lenders and other creditors need general purpose financial reports in order to enable
them in making decisions whether to provide or settle loans and other forms of credit.

Assessing cash flow prospects

Decisions by existing and potential investors about buying, selling or holding equity instruments depend on the
returns that they expect from an investment, for example, dividends.

Similarly, decisions by existing and potential lenders and other creditors about providing or settling loans and
other forms of credit depend on the principal and interest payments or other returns that they expect.

Consequently, financial reporting should provide information useful in assessing the amount, timing and
uncertainty of prospects for future net cash inflows to the entity.

Economic resources and claims

General purpose financial reports provide information about the financial position of a reporting entity.

Financial position is information about the entity’s economic resources and the claims against the reporting
entity.

The economic resources are the assets and the claims are the liabilities and equity of the entity.

In order words, the financial position comprises the assets, liabilities and equity of an entity at a particular
moment in time.
Information about the nature and amounts of an entity’s economic resources and claims can help users identify
the entity’s financial strength and weakness.

Otherwise stated, information about financial position can help users to assess the entity’s liquidity, solvency
and the need for additional financing.

Liquidity is the availability of cash in the near future to cover currently maturing obligations.

Solvency is the availability of cash over a long term to meet financial commitments when they fall due.

Information about priorities and payment requirements of existing claims can help users to predict how future
cash flows will be distributed among those with a claim against the reporting entity.

Changes in economic resources and claims

General purpose financial reports also provide information about the effects of transactions and other events
that change the economic resources and claims.

Changes in economic resources and claims result from financial performance and from other events or
transactions, such as issuing debt or equity instruments.

The financial performance of an entity comprises revenue, expenses and net income or loss for a period of
time.

In other words, financial performance is the level of income earned by the entity through the efficient and
effective use of its resources.

The financial performance of an entity is also known as results of operations and is portrayed in the income
statement and statement of comprehensive income.

Usefulness of financial performance

Information about financial performance helps users to understand the return that the entity has produced on
the economic resources.

Information about the return the entity has produced provides an indication of how well management has
discharged its responsibilities to make efficient and effective use of the economic resources.

Information about past financial performance is usually helpful in predicting the future returns on the entity’s
economic resources.

Information about financial performance during a period is useful in assessing the entity’s ability to generate
future cash inflows from operations.

Accrual accounting

Accrual accounting depicts the effects of transactions and other events and circumstances on an entity’s
economic resources and claims in the periods in which those effects occur even if the resulting cash receipts
and payments occur in a different period.

In other words, under the accrual basis, the effects of transactions and other events are recognized when they
occur and not as cash is received or paid.
Simply stated, accrual accounting means that income is recognized when earned regardless of when received
and expense is recognized when incurred regardless of when paid.

Information about financial performance measured in accordance with accrual accounting provides a better
basis for assessing past and future performance than information solely about cash receipts and payments
during a period.

Limitations of financial reporting

a. General purpose financial reports do not and cannot provide all of the information that existing and
potential investors, lenders and other creditors need.

These users need to consider pertinent information from other sources, for example, general economic
conditions, political events and industry outlook.
b. General purpose financial reports are not designed to show the value of an entity but the reports
provide information to help the primary users estimate the value of the entity.
c. General purpose financial reports are intended to provide common information to users and cannot
accommodate every request for information.
d. To a large extent, general purpose financial reports are based on estimate and judgment rather than
exact depiction.

Management stewardship

Information about how efficiently and effectively management has discharged its responsibilities to use the
entity’s economic resources helps users to assess management stewardship of those resources.

Such information is also useful for predicting how management will use the entity’s prospects for future net
cash flows.

For example, management can decide not to dispose or sell investments when prices are declining in order to
avoid realized losses.

Multiple choice

1. Which statement is true about the Conceptual framework for financial Reporting?
a. The Conceptual Framework is not a Standard.
b. The Conceptual Framework describes the concepts for general purpose financial reporting.
c. In case of conflict, the requirements of the IFRS prevail over the Conceptual Framework.
d. All of these statements are true about the Conceptual Framework.
2. Which is a purpose of the Conceptual Framework?
a. To assists the IASB to develop IFRS based on consistent concepts.
b. To assists preparers to develop consistent accounting policy when no Standard applies to a
particular transaction or when Standard allows a choice of accounting policy
c. To assists all parties to understand and interpret the Standards.
d. All of these can be considered a purpose of the Conceptual Framework
3. Which is not a purpose of the Conceptual Framework?
a. To assists users of financial statements in interpreting the standards.
b. To assists preparers of financial statements in applying the Standards.
 c. To assists preparers of financial statements in developing an accounting policy
choice.
d. To assists the Board of Accountancy in promulgating rules and regulations affecting
the accountancy profession.
4. The Conceptual Framework provides the foundation for Standards that
a. Contribute to transparency by enhancing information.
b. Strengthen accountability of the people entrusted with the economic resources of the
entity.
c. Contribute to economic efficiency by helping investors to identify opportunities and risks
across the world.
d. All of these are the result of Standards developed based on consistent concepts.

EVALUATION:

WHAT IS THE MEANING OF CONCEPTUAL FRAMEWORK?

CHAPTER 3 CONCEPTUAL FRAMEWORK – Qualitative characteristics

TECHNICAL KNOWLEDGE

To identify the qualitative characteristics of accounting information.

To identify the fundamental qualitative characteristics.

To identify the enhancing qualitative characteristics.

To understand the cost constraint on useful information.

QUALITATIVE CHARACTERISTICS

Qualitative characteristics are the qualities or attributes that make financial accounting information useful to
the users.

In deciding which information to include in financial statements, the objective is to ensure that the information
is useful to the users in making economic decisions.

Under the Conceptual Framework for Financial Reporting, qualitative characteristics are classified into
fundamental qualitative characteristics and enhancing qualitative characteristics.
Fundamental qualitative characteristics

The fundamental qualitative characteristics relate to the content or substance of financial information.

The fundamental qualitative characteristics are relevance and faithful representation.

Information must be both relevant and faithfully represented if it is to be useful.

Neither a faithful representation of an irrelevant phenomenon nor an unfaithful representation of a relevant

phenomenon helps users make good decisions.

Application of qualitative characteristics

The most efficient and effective process of applying the fundamental qualitative characteristics would usually
be:

First, identify an economic phenomenon that has the potential to be useful.

Second, identify the type of information about the phenomenon that would be most relevant and can be
faithfully represented.
Third, determine whether the information is available.

Relevance

In the simplest terms, relevance is the capacity of the information to influence a decision.

To be relevant, the financial information must be capable of making a difference in the decisions made by
users.

In other words, relevance requires that the financial information should be related or pertinent to the economic
decision.

Information that does not bear on an economic decision is useless.

To be useful, information must be relevant to the decision making needs of users.

For example, broadly, the statement of financial position is relevant in determining financial position, and the
income statement is relevant in determining performance.

More specifically, the earnings per share information is more relevant than book value per share in determining
attractiveness of an investment.

Ingredients of relevance

Financial information is capable of making a difference in a decision if it has predictive value and
confirmatory value.

Financial information has predictive value if it can be used as an input to processes employed by users to
predict future outcome.
In other words, financial information has predictive value when it can help users increase the likelihood of
correctly or accurately predicting or forecasting outcome of events.

For example, information about financial position and past performance is frequently used in predicting
dividend and wage payments and the ability of the entity to meet maturing commitments.

The net cash provided by operating activities is valuable in predicting loan payment or default.

Financial information has confirmatory value if it provides feedback about previous evaluations.

In other words, financial information has confirmatory value when it enables users confirm or correct earlier
expectations.

For example, a net income measure has confirmatory value if it can help shareholders confirm or revise their
expectation about an entity’s ability to generate earnings.

Often, information has both predictive and confirmatory value. The predictive and confirmatory roles of
information are interrelated.

An example is an interim income statement which provides feedback about income to date and serves as a
basis for predicting the annual income.

The interim income statement for the first quarter shows net income of P2,000,000. This is the confirmatory
value.

If this trend continues for the entire year, it is logical to assume that the net income after four quarters or one
year would be P8,000,000. This is the predictive value

Materiality

Materiality is a practical rule in accounting which dictates that strict adherence to GAAP is not required when
the items are not significant enough to affect the evaluation, decision and fairness of the financial statements.

The materiality concept is also known as the doctrine of convenience.

Materiality is really a quantitative “threshold” linked very closely to the qualitative characteristic of relevance.

The relevance of information is affected by its nature and materiality.

In other words, materiality is a sub-quality of relevance based on the nature or magnitude or both of the items
to which the information relates.

The Conceptual framework does not specify a uniform quantitative threshold for materiality or predetermine
what could be material in a particular situation.

Materiality is a relatively

Materiality of an item depends on relative size rather than absolute size.

What is material for one entity may be immaterial for another.

An error of P100,000 in the financial statements of a multinational entity may not be important but may be so
critical for a small entity.
When is an item material?

There is no strict or uniform rule for determining whether an item is material or not.

Very often, this is dependent on good judgment, professional expertise and common sense.

However, a general guide may be given, to wit:

“ An item is material if knowledge of it would affect or influence the decision of the informed users of the
financial statements.”

Information is material it its omission or misstatement could influence the economic decision that the users
make on the basis of the financial information about an entity.
For example, small expenditures for tools are often expensed immediately rather than depreciated over their
useful lives to save on clerical costs of recording depreciation because the effect on the financial statements is
not large enough to affect economic decision.

Another example of the application of materiality is the common practice of large entities of rounding amounts
to the nearest thousand pesos in their financial statements.

Small entities may round off to the nearest peso.

Factors of materiality

In the exercise of judgment in determining materiality, the relative size and nature of an item are considered.

The size of the item in relation to the total of the group to which the item belongs is taken into account.

For example, the amount of advertising in relation to total selling expenses, the amount of office salaries to
total administrative expenses, the amount of prepaid expenses to total current assets and the amount of
leasehold improvements to total property, plant and equipment.

The nature of the item may be inherently material because by its vary nature it affects economic decision.

For example, the discovery of a P20,000 bribe is a material event even for a very large entity.

Faithful representation

Faithful representation means that financial reports represent economic phenomena or transactions in words
and numbers.

Stated differently, the descriptions and figures must match what really existed or happened.

Simply worded, faithful representation means that the actual effects of the transactions shall be properly
accounted for and reported in the financial statements.

For example, if the entity reports purchases of P5,000,000 when the actual amount is P8,000,000, the
information would not be faithfully represented.

To record a sale of merchandise as miscellaneous income would not also be a faithful representation of the sale
transaction.
Ingredients of faithful representation

To be a perfectly faithful representation, a depiction should have three characteristics, namely:

a. Completeness
b. Neutrality
c. Free from error

Completeness

Completeness requires that relevant information should be presented in a way that facilitates understanding
and avoids erroneous implication.

Completeness is the result of the adequate disclosure standards or the principle of full disclosure.

A complete depiction includes all information necessary for a user to understand the phenomenon being
depreciated, including all necessary descriptions and explanations.

For example, a complete depiction of a group of assets would include description of the assets, numerical
depiction and description of the numerical depiction, such as cost, current cost or fair value.

Standard of adequate disclosure

The standard of adequate disclosure means that all significant and relevant information leading to the
preparation of financial statements shall be clearly reported.

Adequate disclosure however does not mean disclosure of just any data.

The accountant shall disclose a material fact known to him which is not disclosed in the financial statements
but disclosure of which is necessary in order that the financial statements would not be misleading.

In other words, the standard of adequate disclosure is best described by disclosure of any financial facts
significant enough to influence the judgment of informed users.

Notes to financial statements

Actually, to be complete, the financial statements shall be accompanied by “notes to financial statements”

The purpose of the notes is to provide the necessary disclosures required by Philippine Financial Reporting
Standards.

Notes to financial statements provide narrative description or disaggregation of the items presented in the
financial statements and information about items that do not qualify for recognition.

Neutrality

A neutral depiction is without bias in the preparation or presentation of financial information.

A neutral depiction is not slanted, weighted, emphasized, de-emphasized or otherwise manipulated to increase
the probability that financial information will be received favorably or unfavorably by users.
In other words, to be neutral, the information contained in the financial statements must be free from bias.

The financial information should not favor one party to the detriment of another party.
The information is directed to the common needs of many users, and not to the particular needs of specific
users.

Neutrality is synonymous with the all-encompassing principle of fairness.

To be neutral is to be fair.

Prudence

The Revised Conceptual Framework has reintroduced the concept of prudence.

Prudence is the exercise of care and caution when dealing with the uncertainties in the measurement process
such that assets or income are not overstated and liabilities or expenses are not understated.

Neutrality is supported by the exercise of prudence.

Conservatism

Conservatism is synonymous with prudence.

Conservatism means that when alternatives exist, the alternative which has the least effect on equity should be
chosen.

In the simplest words, conservatism means “in case of doubt, record any loss and do not record any gain.”

For example, if there is a choice between two acceptable asset values, the lower figure is selected.

Accordingly, inventories are measured at the lower of cost and net realizable value.

Contingent loss is recognized as a “provision” if the loss is probable and the amount can be reliably measured.

Contingent gain is not recognized but disclosed only.

It is to be emphasized that conservatism is not a license to deliberately understate net income and net assets.

For example, if an entity has a cash of P500,000 and reports only P100,000, this is not conservatism but fraud
or inaccurate reporting.

Expressions of conservatism

“Anticipate no profit and provide for probable and measurable loss.”

“In the matter of income recognition, the accountant takes the position that no matter how sure the
businessman might be in capturing the bird in the bush, he the accountant, must see it in the hand.”

“Don’t count your chicks until the eggs hatch”.

Free from error

Free from error means there are no errors or omissions the description of the phenomenon or transaction.
Moreover, the process used to produce the reported information has been selected and applied with no errors in
the process.

In this context, free from error does not mean perfectly accurate in all respects.

For example, an estimate of an unobservable price or value cannot be determined to be accurate or inaccurate.

However, a representation of that estimate can be faithful if the amount is described clearly and accurate or
inaccurate.

Moreover, the nature and limitations of the estimating process are explained, and no errors have been made in
selecting and applying an appropriate process for developing the estimate.

Measurement uncertainty

Measurement uncertainty arises when monetary amounts in financial reports cannot be observed directly and
must instead be estimated.

Measurement uncertainty can affect faithful representation if the level of uncertainty in providing an estimate
is high.

However, the use of reasonable estimate is an essential part of providing financial information and does not
undermine the usefulness of the financial information.

As long as the estimate is clearly and accurately described and explained, even a high level of measurement
uncertainty does not affect the usefulness of the financial information.

Substance over form

If information is to represent faithfully the transactions and other events it purports to represent, it is necessary
that the transactions and events are accounted in accordance with their substance and reality and not merely
their legal form.

The economic substance of transactions and events are usually emphasized when economic substance differs
from legal form.

Substance over form is not considered a separate component of faithful representation because it would be
redundant.

Faithful representation inherently represents the substance of an economic phenomenon or transaction rather
than merely representing the legal form.

Representing a legal form that differs from the economic substance of the underlying economic phenomenon
or transaction could not result in a faithful representation.

Example of substance over form

An example is when the lessee property from the lessor.

The terms of the lease provide that the lease transfers ownership of the asset to the lessee by the end of the
lease term.

In form, the contract is a lease as popularly understood.

But in substance, in reality, if the “transfer of ownership provision” is to be considered, the real intent of the
parties is an installment purchase of an asset by the lessee from the lessor.

Accordingly, the lessee shall record an acquisition of right of use asset and set up a liability to the lessor.

The periodic rental is conceived as an installment payment representing interest and principal.

Enhancing qualitative characteristics

The enhancing qualitative characteristics relate to the presentation or form of the financial information.

The enhancing qualitative characteristics are intended to increase the usefulness of the financial information
that is relevant and faithfully represented.

The enhancing qualitative characteristics are comparability, understandability, verifiability and timeliness.

Relevant and faithfully represented financial information is useful but the information would be most useful if
it is comparable, understandable, verifiable and timely.

Comparability

Comparability means the ability to bring together for the purpose of noting points of likeness and difference.
Comparability is the enhancing qualitative characteristic that enables users to identify and understand
similarities and dissimilarities among items.
Comparability may be made within an entity or between and across entities.

Comparability within an entity is the quality of information that allows comparisons within a single entity
through time or from one accounting period to the next.

Comparability within an entity is also known as horizontal comparability or intracomparability.

Comparability between and across entities is the quality of information that allows comparisons between two
or more entities engaged in the same industry.

Comparability across entities is also known as intercomparability or dimensional comparability.

For information to be comparable, like things must look alike and different things must look different.

Comparability is not enhanced by making unlike things look alike or making like things look different.

Consistency

Implicit in the qualitative characteristic of comparability is the principle of consistency.

Consistency is not the same as comparability.

In a broad sense, consistency refers to the use of the same method for the same item, either from period to
period within an entity or in a single period across entities.

Comparability is the goal and consistency helps to achieve that goal.

In a limited sense, consistency is the uniform application of accounting method from period to period within an
entity.

On the other hand, comparability is the uniform application of accounting method between and across entities
in the same industry.

An entity cannot use the FIFO method of inventory valuation in one year, the average method in the next year,
again the FIFO method in succeeding year and so on.

If the FIFO method is adopted in one year, such method is followed from year to year. Consistency is
desirable and essential to achieve comparability of financial statements.

However, consistency does not mean that no change in accounting method can be made.

But there shall be full disclosure of the change and the peso effect thereof.

It is inappropriate for an entity to leave accounting policies unchanged when better and acceptable alternatives
exist.

Understandability

Understandability requires that financial information must be comprehensible or intelligible if it is to be most

useful.

Accordingly, the information should be presented in a form and expressed in terminology that a user
understands.

Classifying, characterizing and presenting information “clearly and concisely” makes it understandable.

An essential quality of the information provided in financial statements is that it is readily understandable by
users.

But the complex economic activities make it impossible to reduce the financial information to the simplest
terms.

Accordingly, the users shall have an understanding of the complex economic activities, the financial
accounting process and the terminology in the financial statements.

Financial statements cannot realistically be understandable to everyone.

Financial reports are prepared for users who have a reasonable knowledge of business and economic activities
and who review and analyze the information diligently.

At times, even well-informed and diligent users may need to seek the aid of an adviser to understand
information about complex phenomena or transactions.

Understandability is very essential because a relevant and faithfully represented information may prove useless
if it is not understood by users.

Verifiability
Verifiability means that different knowledgeable and independent observers could reach consensus, although
not necessarily complete agreement, that a particular depiction is a faithful representation.

In other words, verifiability implies consensus.

The financial information is verifiable in the sense that it is supported by evidence so that an accountant that
would look into the same evidence would arrive at the same economic decision or conclusion.

Verifiable financial information provides results that would be substantially duplicated by measurers using the
same measurement method.

Accordingly, verifiability helps assure users that information represents the economic phenomenon or
transaction it purports to represent.

Type of verification

Verification can be direct or indirect.

Direct verification means verifying an amount or other representation through direct observation, for example,
by counting cash.

Indirect verification means checking the inputs to a model, formula or other technique and recalculating the
inputs using the same methodology.

An example is verifying the carrying amount of inventory by checking the inputs in quantities and costs, and
recalculating the ending inventory using the same cost flow assumption, such as first-in, first-out.

Timeliness

Timeliness means that financial information must be available or communicated early enough when a decision
is to be made.

Relevant and faithfully represented financial information furnished after a decision is made is useless or of no
value.

For example, the most important attribute of quarterly or interim financial information is its timeliness.

Generally, the older the information, the less useful.

However, some information may continue to be timely long after the end of reporting period because some
users may need to identify and assess trends.

Timeliness enhances the truism that without knowledge of the past, the basis for prediction will usually be
lacking and without interest in the future, knowledge of the past is sterile.

What happened in the past would become the basis of what would happen in the future.

Cost constraint on useful information

Cost is a pervasive constraint on the information that can be provided by financial reporting.
Reporting financial information imposes cost and it is important that such cost is justified by the benefit
derived from the financial information.

In other words, the cost constraint is a consideration of the cost incurred in generating financial information
against the benefit to be obtained from having the information.

However, the evaluation of the cost constraint is substantially a judgmental process.

Assessing whether the cost of reporting outweighs or falls short of the benefit is difficult to measure and
becomes a matter of professional judgment.

Multiple choice

1. What are the attributes that make the information provided in the financial statements useful to the readers?
a. Qualitative characteristics of financial information
b. Quantitative characteristics of financial information
c. Elements of financial statements
d. Objectives of financial reporting
2. Qualitative characteristics
a. Are considered either fundamental or enhancing.
b. Contribute to the decision-usefulness of financial reporting information.
c. Distinguish better information from inferior information for decision –making purposes
d. All of the choices are correct.
3. The fundamental qualitative characteristics are
a. Relevance and faithful representation
b. Relevance, faithful representation and materiality
c. Relevance, and reliability
d. Faithful representation and materiality
4. Accounting information is considered relevant when it
a. Can be depended on to represent the economic conditions and events that it is intended to represent.
b. Is capable of making a difference in a decision.
c. Is understandable by reasonably informed users of accounting information.
d. Is verifiable and neutral
5. The ingredients of relevant financial information are
a. Predictive value and confirmatory value
b. Predictive value, confirmatory value and timeliness
c. Predictive value, confirmatory value and materiality
d. Predictive value, confirmatory value, timeliness and materiality

Evaluation:

What is the meaning of qualitative characteristics of financial information?

Chapter 4 CONCEPTUAL FRAMEWORK
Financial statements and reporting entity – Underlying assumptions

TECHINICAL KNOWLEDGE

To know the general objective of financial statements.

To define a reporting entity.

To explain the assumption underlying the preparation of financial statements.

GENERAL OBJECTIVE OF FINANCIAL STATEMENTS

Financial statements provide information about economic resources of the reporting entity, claims against the
entity and changes in the economic resources and claims.

Financial statements provide financial information about an entity’s assets, liabilities, equity, income and
expenses useful to users of financial statements in:

a. Assessing future cash flows to the reporting entity.

b. Assessing management stewardship of the entity’s economic resources.

The financial information is provided in the following:

1. Statement of financial position, by recognizing assets, liabilities and
equity.
2. Statement of financial performance, by recognizing income and expenses.
3. Other statements and notes by presenting and disclosing information
about:
a. Recognized assets, liabilities, equity, income and expenses
b. Unrecognized assets and liabilities
c. Cash flows
d. Contribution from equity holders and distribution to equity holders
e. Method, assumption and judgment in estimating amount presented
Types of financial statements

The Revised Conceptual Framework recognizes three types of financial statements.

1. Consolidated financial statements – These are the financial statements prepared when the reporting
entity comprises both the parent and its subsidiaries.
2. Unconsolidated financial statements – these are the financial statements prepared when the reporting
entity is the parent alone.
3. Combined financial statements – these are the financial statements when the reporting entity
comprises two or more entities that are not linked by a parent and subsidiary relationship.

Consolidated financial statements

Consolidated financial statements provide information about the assets, liabilities, equity, income and expenses
of both the parent and its subsidiaries as a single reporting entity.

The parent is the entity that exercises control over the subsidiaries.

Consolidated information is useful for existing and potential investors, lenders and other creditors of the parent
in their assessment of future net cash inflows to the parent.

This is because net cash inflows to the parent include distributions to the parent from its subsidiaries.

Consolidated financial statements are not designed to provide separate information about the assets, liabilities,
equity, income and expenses of a particular subsidiary.

A subsidiary’s own financial statements are designed to provide such information.

Unconsolidated financial statements

Unconsolidated financial statements are designed to provide information about the parent’s assets, liabilities,
income and expenses and not about those of the subsidiaries.

Such information can be useful to the existing and potential investors, lenders and other creditors of the parent
because a claim against the parent typically does not give the holder of that claim against subsidiaries.

Information provided in unconsolidated financial statements is typically not sufficient to meet the requirement
needs of primary users.

Accordingly, when consolidated financial statements are required, unconsolidated financial statements cannot
serve as substitute for consolidated financial statements.

Combined financial statements

Combined financial statements provide financial information about the assets, liabilities, equity, income and
expenses of two or more entities not linked with parent and subsidiary relationship.

Reporting entity

A reporting entity is an entity that is required or chooses to prepare financial statements.

The reporting entity can be a single entity or portion of an entity, or can comprise more than one entity.

A reporting entity is not necessarily a legal entity.

Accordingly, the following can be considered a reporting entity:

a. Individual corporation partnership or proprietorship

b. The parent alone
c. The parent and its subsidiaries as single reporting entity
d. Two or more entities without parent and subsidiary relationship as a single reporting entity
e. A reportable business segment of an entity

Reporting period
The reporting period is the period when financial statements are prepared for general purpose financial
reporting.

Financial statements may be prepared on an interim basis, for example, three months. Six months or nine
months.

Interim financial statements are not required but optional.

However, financial statements must be prepared on an annual basis or a period of twelve months.

Financial statements are prepared for a specified period of time and provide information about:
a. Assets, liabilities and equity at the end of the reporting period.
b. Income and expenses during the reporting period.

To help users of financial statements to identify and assess change in trends financial statements also provide
comparative information for at least one preceeding reporting period.
Financial statements may include information about transactions and other events that occurred after the end of
reporting period if the information is necessary to meet the general objective of financial statements.

UNDERLYING ASSUMPTIONS

Accounting assumptions are the basic notions or fundamental premises on which the accounting process is
based. Accounting assumptions are also known as postulates.

Like a building structure that requires a solid foundation to avoid or prevent future collapse and provide room
for expansion, and so with accounting.

Accounting assumptions serve as the foundation or bedrock of accounting in order to avoid misunderstanding
but rather enhance the understanding and usefulness of the financial statements.

The Conceptual framework for Financial Reporting mentions only one assumption, namely going concern.

However, implicit in accounting are the basic assumptions of accounting entity, time period and monetary unit.

Going concern

The going concern or continuing assumption means that in the absence of evidence to the contrary, the
accounting entity is viewed as continuing in operation indefinitely.

In other words, the financial statements are normally prepared on the assumption that the entity will continue
in operations for the foreseeable future.

The going concern postulate is the very foundation of the cost principle.

Thus, assets are normally recorded at cost. As a rule, market values are ignored.

However, some new standards require measurement of certain assets at fair value.

If there is evidence that the entity would experience large and persistent losses or that the entity’s operations
are to be terminated, the going concern assumption is abandoned.

In this case, the users of the statements will have a great interest in the amount of cash that will be generated
from the entity’s assets in the short term.
Accounting entity

In financial accounting the accounting entity is the specific business organization, which may be a
proprietorship, partnership or corporation.

Under this assumption, the entity is separate from the owners, managers, and employees who constitute the
entity.

Accordingly, the transactions of the entity shall not be merged with the transactions of the owners.

The reason for the entity assumption is to have a fair presentation of financial statements.

The personal transactions of the owners shall not be allowed to distort the financial statements of the entity.

For example, the cash invested by the proprietor is treated as an asset of the proprietorship.

If an enterprising entrepreneur owns department store, restaurant and bookstore, separate statements shall be
prepared for each business in order to determine which business is profitable.

Each business is an independent accounting entity.

When a major shareholder of a corporation borrows money from a bank on his own personal account, the loan
is a liability of the shareholders alone and not of the corporation.

The shareholder is not the corporation and the corporation is not shareholder.

However, where parent and subsidiary relationship exists, consolidated statements for the affiliates are usually
made because for practical and economic purposes, the parent and the subsidiary are a “single economic
entity”

The consolidation, however, does not eliminate the legal boundary segregating the affiliated entities.

Accounting will continue to be done separately for each entity.

Time period

A completely accurate report on the financial position and performance of an entity cannot be obtained until
the entity is finally dissolved and liquidated.

Only then can the final net income and networth of the entity be determined precisely.

However, users of financial information need timely information for making an economic decision.

It becomes necessary therefore to prepare periodic reports on financial position, performance and cash flows of
an entity.

The time period assumption requires that the indefinite life of an entity is subdivided into accounting periods
which are usually of equal length for the purpose of preparing financial reports on financial position,
performance and cash flows.

By convention, the accounting period or fiscal period is one year or a period of twelve months.
The “one – year period” is traditionally the accounting period because usually it is after one year that
government reports are required.

The accounting period may be a calendar year or a natural business year.

A calendar year is a twelve – month period that ends on December 31.

A natural business year is a twelve-month period that ends on any month when the business is at the lowest or
experiencing slack season.

Monetary unit

The monetary unit assumption has two aspects, namely quantifiability and stability of the peso.

The quantifiability aspect means that the assets, liabilities, equity, income and expenses should be stated in
terms of a unit of measure which is the peso in the Philippines.

How awkward to see financial statements without any common unit of measure. Such statements would be
largely unintelligible and incomprehensible.

The stability of the peso assumption means that the purchasing power of the peso is stable or constant and that
its instability is insignificant and therefore may be ignored.

The stable peso postulate is actually an amplification of the going concern assumption so much so that
adjustments are unnecessary to reflect any changes in purchasing power.

The accounting function is to account for nominal pesos only and not for constant pesos or changes in
purchasing power.

In today’s world, the assumption that the peso is a stable measure over time is not necessarily valid.

Consider an equipment which was imported 10 years ago from the United States for $100,000 when the
exchange rate was P35 to 1 or an equivalent of P3,500,000.

If the same equipment is purchased now and assuming there is no change in the $100,000 purchase price, the
replacement cost in terms of pesos would be in the vicinity of P5,400,000, considering a current exchange rate
of P54 to $1.

Obviously, there is a significant gap between historical cost and current replacement cost.

In this regard, an entity may choose the revaluation model as an accounting policy.

Multiple Choice

1. Which best describes the term going concern?

a. When current liabilities exceed current assets.
b. The ability of the entity to continue in operation for the foreseeable future
c. The potential to contribute to the flow of cash and cash equivalents to the entity.
d. The expenses exceed income
2. Which is an implication of the going concern assumption?
a. The historical cost principle is credible.
b. Depreciation and amortization policies are justifiable and appreciate.
c. The current and non-current classification of assets and liabilities is justifiable and significant.
 d. All of these are an implication of going concern.
3. The relatively stable economic, political and social environment supports.
a. Conservatism
b. Materiality
c. Timeliness
d. Going concern
4. Which of the following is not a basic assumption underlying financial accounting?
a. Economic entity assumption
b. Going concern assumption
c. Periodicity assumption
d. Monetary unit assumption
5. Which basic assumption may not be followed when an entity in bankruptcy reports financial results?
a. Economic entity assumption
b. Going concern assumption
c. Periodicity assumption
d. Monetary unit assumption
6. The economic entity assumption
a. Is inappropriate to unincorporated businesses.
b. Recognizes the legal aspects of business organizations.
c. Requires periodic income measurement.
d. Is applicable to all forms of business organizations.
7. What is being violated if an entity provides financial reports in connection with a new product introduction?
a. Economic entity
b. Periodicity
c. Monetary unit
d. Continuity
8. Which underlying assumption serves as the basis for preparing financial statements at regular artificial
points in time?
a. Accounting entity
b. Going concern
c. Accounting period
d. Stable monetary unit
9. Which basic accounting assumption is threatened by the existence of severe inflation in the economy?
a. Monetary unit assumption
b. Periodicity assumption
c. Going concern assumption
d. Economic entity assumption
10. Inflation is ignored in accounting due to
a. Economic entity assumption
b. Going concern assumption
c. Monetary unit assumption
d. Time period assumption

Evaluation

What is the general objective of financial statements?

CHAPTER 5 CONCEPTUAL FRAMEWORK – Elements of financial statements

TECHNICAL KNOWLEGDE

To identify the elements directly related to the measurement of financial position and financial
performance.

To understand the concept of asset, liability and equity

To understand the concept of income and expenses

ELEMENTS OF FINANCIAL STATEMENTS

Financial statements portray the financial effects of transactions and other events by grouping them
into broad classes according to their economic characteristics.

These broad classes are termed the elements of financial statements.

The elements of financial statements refer to the quantitative information reported in the statement of
financial position and income statement.

The elements of financial statements are the “building blocks” from which financial statements are
constructed.

The presentation of these elements in the statement of financial position and the income statement
involves a process of classification and subclassification.

For example, assets and liabilities may be classified by their nature of function in the business of the
entity in order to display information in a manner most useful to users for purposes of making
economic decisions.

The elements directly related to the measurement of financial position are:

a. Asset
b. Liability
c. Equity
The elements directly related to the measurement of financial performance are:
a. Income
b. Expense

The Conceptual Framework identifies no elements that are unique to the statement of changes in
equity because such statement comprises items that appear in the statement of financial position and
the income statement.
Equity is the residual interest in the assets of the entity after deducting all of the liabilities.

ASSET

Under the revised Conceptual framework an asset is defined as a present economic resource controlled
by the entity as a result of past events.

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

The new definition clarifies that an asset is an economic resource and that the potential economic
benefits no longer need to be expected to flow to the entity.

Essential characteristics of asset

a. The asset is present economic resource.

b. The economic resource is a right that has the potential to produce economic benefits.
c. The economic resource is controlled by the entity as a result of past events.

Right

Rights that have the potential to produce economic benefits may take the following forms:
1. Rights that correspond to an obligation of another entity
a. Right to receive cash
b. Right to receive goods or services
c. Right to exchange economic resources with another party on favorable terms
d. Right to benefit from an obligation of another party if a specified uncertain future event
occurs
2. Rights that do not correspond to an obligation of another entity
a. Right over physical objects, such as property, plant and equipment or inventories
b. Right to intellectual property
3. Rights established by contract or legislation such as owning a debt instrument or any equity
instrument or owning a registered patent.

Potential to produce economic benefits

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

For the potential to exist, it does not need to be certain or even likely that right will produce benefits.

It is only necessary that the right already exists.

A right can meet the definition of an economic resource even if the probability that it will produce
economic benefit is low.

The economic resource is the present right that contains the potential and not the future economic
benefits that the right may produce.

An economic resource could produce economic benefits if an entity is entitled:

a. To receive contractual cash flows
b. To exchange economic resources with another party on favorable terms.
c. To produce cash inflows or avoid cash outflows.
d. To receive cash by selling the economic resource
e. To extinguish a liability by transferring an economic resource
Control of an economic resource

An entity controls an asset if it has the present ability to direct the use of the asset and obtain the economic
benefits that flow from it.

Control also includes the ability to prevent others from using such asset and therefore preventing others from
obtaining the economic benefits from the asset.

Control may arise if an entity enforces legal rights.

If there are no legal rights, control can still exist if an entity has other means of ensuring that no other party can
benefit from an asset.

For example, an entity has access to technical know-how and has the ability to keep this know-how secret.

LIABILITY

Under the revised Conceptual Framework, a liability is defined as present obligation of an entity to transfer an
economic resources as a result of past events.

The new definition clarifies that a liability is the obligation to transfer an economic resource and not the
ultimate outflows of economic benefits.

The outflow of economics no longer needs to be expected similar to the definition of an asset.

The new definition of liability to some extent is inconsistent with the definition of liability under IAS 37.

In case of conflict, the IASB stated that the requirements of a standard shall always prevail over the
Conceptual framework.

Essential characteristic of liability

a. The entity has an obligation
The entity liable must be identified. It is not necessary that the payee or the entity to whom the
obligation is owed be identified.
b. The obligation is to transfer an economic resource.
c. The obligation is a present obligation that exists as a result of past event.
This means that a liability is not recognized until it is incurred.

Obligation

An obligation is a duty or responsibility that an entity has no practical ability to avoid. Obligations can either
be legal or constructive.

Obligations may be legally enforceable as a consequence of a binding contract or statutory requirement.

This is normally the case, for example, with accounts payable for goods and services received.

Constructive obligations arise from normal business practice, custom and a desire to maintain good business
relations or act in an equitable manner.

For example, an entity decides as a matter of policy to rectify faults in the products even when these become
apparent after the warranty period.
Transfer of an economic resource

Obligations to transfer an economic resource include:

a. Obligation to pay cash

b. Obligation to deliver goods or non-cash resources
c. Obligation to provide services at some future time
d. Obligation to exchange economic resources with another party on unfavorable terms
e. Obligation to transfer an economic resource if specified uncertain future event occurs

Past event

An obligation exists as a result of past event if both of the following conditions are satisfied:

a. An entity has already obtained economic benefits.

b. An entity must transfer an economic resource.

Definition of income

Income is defined as increases in assets or decreases in liabilities that result in increases in equity, other than
those relating to contributions from equity holders.

The definition of income has changed to reflect the change in the definition of asset and liability.

The definition of income encompasses both revenue and gains.

Revenue arises in the course of the ordinary regular activities and is referred to by variety of different names
including sales, fees, interest, dividends, royalties and rent.

The essence of revenue is regularity.

Gains represent other items that meet the definition of income and do not arise in the course of the ordinary
regular activities.

Gains include gain from disposal of non-current asset, unrealized gain on trading investment and gain from
expropriation.

Statement of financial performance

The revised Conceptual Framework introduces the term statement of financial performance.

This statement refers to the statement of profit or loss and a statement presenting other comprehensive income.

The statement of profit or loss is the primary sources of information about an entity’s financial performance.
As a general rule, all income and expenses are included in profit or loss.

However, in developing accounting standards, there are some items of income and expenses that are included
in other comprehensive income and not in profit or loss if such representation would provide more relevant and
faithfully represented information about financial performance.

There are instances that an amount in other comprehensive income in one reporting period may be recycled to
profit or loss in another reporting period.
Such recycling is permitted as long as it would result to relevant and faithfully represented information about
financial performance.

Definition of expense

Expense is defined as decreases in assets or increases in liabilities that result in decreases in equity, other than
those relating to distributions to equity holders.

The definition of expense has changed to reflect the change in the definition of asset and liability.

Expenses encompasses losses as well as those expenses that arise in the course of the ordinary regular
activities.

Expenses that arise in the course of ordinary regular activities include cost of goods sold, wages and
depreciation.

Losses do not arise in the course of the ordinary regular activities and include losses resulting from disasters.

Examples include losses from fire, flood, storm surge, tsunami and hurricane, as well as those arising from
disposal of non-current assets.

Multiple choice
1. The elements directly related to the measurement of financial position are
a. Assets, liability and equity
b. Asset and liability
c. Income and expense
d. Asset, liability, equity, income and expense
2. The elements of financial position describe amounts of resources and claims
against resources
a. During a period of time
b. At a moment in time
c. During a period of time and at a moment in time
d. Neither during a period of time nor at a moment in time
3. The elements directly related to the measurement of financial performance are
a. Income and expenses
b. Asset, liability and equity
c. Assets and liability
d. Income, expense and equity
4. It is a present economic resource controlled by the entity as a result of past events.
a. Asset
b. Liability
c. Equity
d. Income
 5. It is a present obligation of the entity to transfer an economic resource as a result of
past events
a. Asset
b. Liability
c. Equity
d. Expense

Evaluation:

1. Define elements of financial statements

2. What are the elements directly related to the measurement of financial position?
3. Define an asset.
4. Define a liability.
5. Distinguish income from revenue

Chapter 6 CONCEPTUAL FRAMEWORK –Recognition and Measurement

TECHNICAL KNOWLEDGE

TO define recognition of the elements of financial statements.

To know the recognition criteria for asset, liability, income and expense.

To define measurement of the elements of financial statements.

To be aware of the various financial attributes for measuring asset, liability, income and expense

RECOGNITION

The revised Conceptual Framework defines recognition as the process of capturing for inclusion in the
financial statements an item that meets the definition of an asset, liability, equity, income or expense.

The amount at which an asset, a liability or equity is recognized in the statement of financial position is
reported as carrying amount.

Recognition links the elements to the statement of financial position and statement of financial performance.

The statements are linked because the recognition of an item in one statement requires the recognition of an
increase in asset or decrease in liability.

The recognition of expense happens simultaneously with the recognition of a decrease in asset or increase in
liability.
Recognition criteria

Only items that meet the definition of an asset, a liability or equity are recognized in the statement of financial
position.

Similarly, only items that meet the definition of income or expense are recognized in the statement of financial
performance.

In addition to meeting the definition of an element, items are recognized only when their recognition provides
users of financial statements with information that is both relevant and faithfully represented.

Recognition does not focus anymore on how probable economic benefits will flow to or from the entity and
that the cost can be measured reliably.

An asset or liability and any corresponding income or expense can exist even if the probability of inflow or
outflow of the benefits is low.

Point of sale income recognition

The basic principle of income recognition is that income shall be recognized when earned.

But the question is when is income considered to be earned?

With respect to sale of goods in the ordinary course of business, the point of sale is unquestionably the point of
income recognition.

The reason is that it is at the point of sale that the entity has transferred to the buyer the significant risks and
rewards of ownership of the goods.

Stated differently, legal title to the goods passes to the buyer at the point of sale.

However, under certain conditions, income may be recognized at the point of production, during production
and at the point of collection.

Expense recognition

The basic expense recognition means that expenses are recognized when incurred

But the question is when are expenses incurred?

Actually, the expense recognition principle is the application of the matching principle.

The generation of revenue is not without any cost. There has got to be some cost in earning a revenue.

There is no gain if there is no pain .

The matching principle requires that those costs and expenses incurred in earning a revenue shall be reported
in the same period.

The matching principle has three applications, namely:

a. Cause and effect association
b. Systematic and rational allocation
c. Immediate recognition
Cause and effect association

Under this principle, the expense is recognized when the revenue is already recognized.

The reason is the presumed direct association of the expense with specific items of income. This is actually
the “strict matching concept”.

This process, commonly referred to as the matching of cost with revenue, involves the simultaneous or
combined recognition of revenue and expenses that result directly and jointly from the same transactions or
events.

The best example is the cost of merchandise inventory.

Such cost is considered as an asset in the meantime that the merchandise is on hand.
When the merchandise is sold, the cost thereof is expensed in the form of cost of goods sold because at such
time revenue may be recognized.

Other examples include doubtful accounts, warranty expense and sales commissions.

Systematic and rational allocation

Under this principle, some costs are expensed by simply allocating them over the periods benefited.

The reason for this principle is that the cost incurred will benefit future periods and that there is an absence of a
direct or clear association of the expense with specific revenue.

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 on the basis of systematic and allocation
procedures.

Concrete examples include depreciation of property, plant and equipment, amortization of intangibles, and
allocation of prepaid rent, insurance and other prepayments.

Immediate recognition

Under this principle, the cost incurred is expensed outright because of uncertainty of future economic benefits
or difficulty of reliably associating certain costs with future revenue.

An expense is recognized immediately:

a. When an expenditure produces no future economic benefit.
b. When cost incurred does not qualify or ceases to qualify for recognition as an asset.

Examples include officers’ salaries and most administrative expenses, advertising and most selling expenses,
amount to settle lawsuit and worthless intangibles.

Many losses, such as loss from disposal of building, loss from sale of investments, and casualty loss, are
immediately recognized because they are not directly related to specific revenue.

De-recognition

The Revised Conceptual Framework introduced the term derecognition.

Derecognition is defined as the removal of all or part of a recognized asset or liability from the statement of
financial position.

Derecognition normally occurs when an item no longer meets the definition of an asset or a liability.

Derecognition of an asset occurs when the entity loses control of all or part of the asset.

Derecognition of a liability occurs when the entity no longer has a present obligation for all or part of the
liability.

MEASUREMENT

Measurement is defined as quantifying in monetary terms the elements in the financial statements.

The Revised Conceptual Framework mentions two categories:

a. Historical cost
b. Current value

HISTORICAL COST

The historical cost of an asset is the cost incurred in acquiring or creating the asset comprising the
consideration paid plus transaction cost.

The historical cost of a liability is the consideration received to incur the liability minus transaction cost.

Simply stated, historical cost is the entry price or entry value to acquire an asset or to incur a liability.

An application of the historical cost measurement is to measure financial asset and financial liability at
amortized cost.

The amortized cost reflects the estimate of future cash flows discounted at a rate determined at initial
recognition.

Historical cost updated

1. Historical cost of an asset is updated because of:

a. Depreciation and amortization
b. Payment received as a result of disposing part or all of the asset
c. Impairment
d. Accrual of interest to reflect any financing component of the asset
e. Amortized cost measurement of financial asset.
2. Historical cost of a liability is updated because of:
a. Payment made or satisfying an obligation to deliver goods
b. Increase in value of the obligation to transfer economic resources such that the liability becomes
onerous
c. Accrual of interest to reflect any financing component of the liability
d. Amortized cost measurement of financial liability

CURRENT VALUE

Current value includes:

a. Fair value
 b. Value in use for asset
c. Fulfillment value for liability
d. Current cost

Fair value

Fair value of an asset is the price that would be received to sell an asset in an orderly transaction between
market participants at measurement date.

Fair value of liability is the price that would paid to transfer a liability in an orderly transaction between market
participants at the measurement date.

Fair value is an exit price or exit value.

Fair value can be observed directly using market price of the asset or liability in an active market.

In cases where fair value cannot be directly measured, an entity can use present value of cash flows.

Fair value is not adjusted for transaction cost. The reason is that such cost is a characteristic of the transaction
and not of the asset or liability.

Value in use

Value in use is the present value of the cash flows that an entity expects to derive from the use of an asset and
from the ultimate disposal.

Value is use does not include transaction cost on acquiring the asset but includes transaction cost on the
disposal of the asset.

Value in use is an exit price or exit value.

Fulfillment value

Fulfillment value is the present value of cash that an entity expects to transfer in paying or settling a liability.

Fulfillment value does not include transaction cost on incurring a liability but includes transaction cost on
fulfillment of a liability.

Fulfillment value is an exit price or exit value.

Current cost

Current cost of an asset is the cost of an equivalent asset at the measurement date comprising the consideration
paid and transaction cost.

Current cost of a liability is the consideration that would be received less any transaction cost at measurement
date.

Similar to historical cost, current cost is also based on the entry price or entry value but reflects market
conditions on measurement date.

Selecting a measurement basis

In selecting a measurement basis for an asset or a liability and for the related income and expense, it is
necessary to consider the nature of the information that the measurement basis will produce.

In most cases, no single factor will determine which measurement basis should be selected.

The relative importance of each factor will depend on facts and circumstances.

The information produced by the measurement basis must be useful to the users of financial statements.

To achieve this, the information must be both relevant and faithfully represented.

Historical cost is the measurement basis most commonly adopted in preparing financial statements.

In many situations, it is simpler and less costly to measure historical cost than it is to measure a current value.

In addition, historical cost is generally well understood and verifiable.

The IASB did not mandate a single measurement basis because the different measurement bases could produce
useful information under different circumstances.

PROBLEMS

Problem 6-1 Multiple choice (conceptual framework)

1. It is the process of capturing for inclusion in the financial statements an item that meets the
definition of the elements of financial statements.
a. Recognition
b. Measurement
c. Classifying
d. Derecogntion
2. An item is recognized in the financial statement if
a. It is probable that economic benefits will flow to or from the entity.
b. It meets the definition of an asset, liability, equity, income and expense.
c. The entity has ownership of such item.
d. It is probable that economic benefits will flow to or from the entity and that the cost can be
measured reliably.
3. Recognition of an element is appropriate when information results in
a. Relevance
b. Faithful representation
c. Both relevance and faithful representation
d. Neither relevance nor faithful representation

4. It is the removal of all or part of a recognized asset or liability from the statement of financial
position.
a. Writeoff
b. Derecognition
c. Extinguishment
d. Retirement
5. Derecognition normally occurs when
a. An item no longer meets the definition of an asset or a liability.
b. The entity loses control of the asset.
 c. The entity no longer has a present obligation for the liability.
d. Under all of these circumstances.

Problem 6-2 Multiple choice (IAA)

1. Generally, revenue is recognized

a. At the point of sale
b. When cause and effect are associated
c. At the point of cash collection
d. At appropriate points throughout the operating cycle.
2. Which of the following is not an accepted basis for recognition of revenue?
a. Passage of time
b. Performance of service
c. Completion of percentage of a project
d. Upon signing of contract.
3. Normally, revenue is recognized
a. When the customer order is received.
b. When the customer order is accompanied by a check.
c. Only if the transaction will create an account receivable.
d. When the title to the goods changes.
4. Which of the following practices may not be an acceptable deviation from recognizing revenue at the
point of sale?
a. Upon receipt of cash
b. During production
c. Upon receipt of order
d. End of production
5. Which of the following represents the least desirable choice for the recognition of revenue?
a. Recognition of revenue during production
b. Recognition of revenue when a sale occurs
c. Recognition of revenue when cash is collected
d. Recognition of revenue when production is completed.

Problem 6-3 Multiple choice (AICPA adapted)

1. Revenue recognition conventionally refers to

a. The process of identifying transactions to be recorded as revenue in an accounting period.
b. The process of measuring and relating revenue and expenses during a period.
c. The earning process which gives rise to revenue realization.
d. The process of identifying those transactions that results in an inflow of assets to the entity.
2. Which of the following in the most precise sense means the process of converting non-cash resources
and rights into cash or claims to cash?
a. Allocation
b. Collection
c. Recognition
d. Realization
3. Gains on assets unsold are identified, in a precise sense, by the term
a. Unrecorded
b. Unrealized
c. Unrecognized
d. Unallocated
4. The term recognized is synonymous with the term
a. Recorded
b. Realized
 c. Matched
d. Allocated
5. Which statement conforms to the realization concept?
a. Depreciation was assigned to product unit cost.
b. Equipment was sold in exchange for a note receivable
c. Cash was collected on receivable
d. Product unit costs were assigned to cost of goods sold.

Problem 6-4 Multiple choice (AICPA adopted)

1. Which of the following is not a theoretical basis for the allocation of expense?
a. Immediate recognition
b. Systematic and rational allocation
c. Cause and effect association
d. Profit maximization
2. Costs that can be reasonably associated with specific revenue but not with specific product should be
a. Expensed in the period incurred.
b. Allocated to the specific product based on the best estimate of the product processing time.
c. Expensed in the period in which the related revenue is recognized.
d. Capitalized and then amortized over a reasonable period.
3. Which of the following is an example of the cause and effect association principle?
a. Sales commission
b. Allocation of insurance cost
c. Depreciation of property, plant and equipment
d. Officers’ salaries
4. Which of the following is an application of the systematic and rational allocation principle?
a. Doubtful accounts
b. Research and development cost
c. Warranty cost
d. Amortization of intangible asset
5. Which of the following would be matched with current revenue on a basis other than association of
cause and effect?
a. Goodwill
b. Cost of goods sold
c. Sales commission
d. Warranty cost
6. Why are certain costs of doing business capitalized when incurred and then depreciated or amortized
over subsequent accounting periods?
a. To reduce the income tax liability
b. To aid management in the decision-making process
c. To match the cost of production with revenue
d. To adhere to the accounting concept of conservatism
7. Which of the following principles best describes the conceptual rationale for the method of matching
depreciation with revenue?
a. Association cause and effect
b. Systematic and rationale allocation
c. Immediate recognition
d. Partial recognition
8. Which of the following should be expensed under the principle of systematic and rational allocation?
a. Salesmen’s monthly salaries
b. Insurance premiums
c. Transportation to customers
d. Electricity to light office building
 9. The writeoff of a worthless patent is an example of which of the following principles?
a. Associating cause and effect
b. Immediate recognition
c. Systematic and rational allocation
d. Objectivity
10. What is an example of cost that cannot be directly related to particular revenue but incurred to obtain
benefits that are exhausted in the period when the cost is incurred?
a. Sales commissions
b. Sales salaries
c. Freight in
d. Prepaid insurance

Evaluation ……………………………………………………..

CHAPTER 7 CONCEPTUAL FRAMEWORK-Presentation and disclosure concepts of capital

TECHNICAL KNOWLEDGE

To know the guideline in the presentation and disclosure of financial information.

To understand presentation and disclosure as an effective communication tool.
To define the two concepts of capital.
To determine net income under the financial capital and physical capital concept.

PRESENTATION AND DISCLOSURE

The presentation and disclosure can be an effective communication tool about the information in financial
statement.

A reporting entity communicates information its assets, liabilities, equity, income and expenses by presenting
and disclosing information in the financial statements.

Effective communication of information in financial statements makes the information more relevant and
contributes to a faithful representation of an entity’s assets, liabilities, income and expenses.

Effective communication of information in financial statements also enhances the understandability and
comparability of information in different parts of the financial statements.

Effective communication in financial statements is supported by not duplicating information in different parts
of the financial statements.

Duplication is usually unnecessary and can make financial statements less understandable.
Classification

Classification is the sorting of assets, liabilities, equity, income and expenses on the basis of shared or similar
characteristics.

Classifying dissimilar assets, liabilities, equity, income and expenses can obscure relevant information, reduce
understandability and comparability and may not provide a faithful representation of financial information.

For example, it could be appropriate to classify an asset or a liability into current and non-current.

It may be necessary to classify components of equity separately if such components are subjects to legal,
regulatory and other requirements.

Thus, ordinary share capital, preference share capital, share premium and retained earnings should be disclosed
separately.

Classification of income and expenses

Income and expenses are classified as components of profit loss and components of other comprehensive
income.

The Revised Conceptual Framework has introduced the term statement of financial performance to refer to the
statement of profit or loss together with the statement presenting other comprehensive income.

The statement of profit or loss is the primary source of information about an entity’s financial performance for
the reporting period.

As a default, all income and expenses should be appropriately classified and included in the statement of profit
or loss.

However, there are certain items of income and expenses that are presented outside of profit or loss but
included in other comprehensive income.

The components of other comprehensive income are subsequently recycled or reclassified to profit or loss or
retained earnings.

Aggregation

Aggregation is the adding together of assets, liabilities, equity, income and expenses that have similar or
shared characteristics and are included in the same classification.

Aggregation makes information more useful by summarizing a large volume of detail. However, aggregation
may conceal some of the detail.

Hence, a balance should be made so that relevant information is not obscured either by a large amount of
insignificant detail or by excessive aggregation.

Typically, the statement of financial position and the statement of financial performance provide summarized
or condensed information.
More detailed information is provided in the notes to financial statements.

CAPITAL MAINTENANCE

The financial performance of an entity is determined using two approach, namely transaction approach and
capital maintenance approach.

The transaction approach is the traditional preparation of an income statement.

The capital maintenance approach means that net income occurs only after the capital used from the beginning
of the period is maintained.

In other words, net income is the amount an entity can distribute to its owners and be as “well-off” at the end
of the year as the beginning.

The distinction between return of capital and return on capital is important to the understanding of net income.

Shareholders invest in entity to earn a return on capital or an amount in excess of their original investment.

Return of capital is an erosion of the capital invested in the entity.

The Conceptual Framework considered two concepts of capital maintenance or well-offness, namely financial
capital and physical capital.

Financial capital

Under a financial capital concept, such as invested money or invested purchasing power, capital is
synonymous with net assets or equity of the entity.

Financial capital is the monetary amount of the net assets contributed by shareholders and the amount of the
increase in net assets resulting from earnings retained by the entity.

Financial capital is the traditional concept based on historical cost and adopted by most entities.

Net income under financial capital

Under the financial capital concept, net income occurs “when the nominal amount of the net assets at the end
of the year exceeds the nominal amount of the net assets at the beginning of the period, after excluding
distributions to and contributions by owners during the period”.

Illustration

The following assets, liabilities and other financial data pertain to the current year:
January 1 December 31
Total assets 1,500,000 2,500,000
Total liabilities 1,000,000 1,200,000
Additional investments during the year 400,000
Dividends paid during the year 300,000

Computation of net income

Net assets – December 31 1,300,000

Add: dividends paid 300,000
Total 1,600,000
Less: Net assets – January 1 500,000
Additional investments 400,000 900,000
Net income 700,000
========
Note that the amount of net assets is “the excess of total assets over the total liabilities”.

This is the reason this approach is also known as the net asset approach.
Physical capital

Physical capital is the quantitative measure of the physical productive capacity to produce goods and services

The physical productive capacity may be based on, for example, units of output per day or physical capacity of
production assets to produce goods and services.

This concept requires that productive assets be measured at current cost, rather than historical cost.

Productive assets include inventories and property, plant and equipment.

The current costs for these productive assets must be maintained in order that physical capital is also
maintained.

Accordingly, physical capital is equal to the net assets of the entity expressed in terms of current cost.

The physical concept of capital should be adopted if the main concern of users is the operating capability of the
entity, meaning, the resource or fund needed to achieve that operating capability or capacity.

Under this concept, net income occurs “when the physical productive capital of the entity at the end of the year
exceeds the physical productive capital at the beginning of the period, also after excluding distributions to and
contributions from owners during the period.

Illustration

Assume in the previously given illustration, the net assets of P500,000 on January 1 had a current cost of
P800,000 by reason of inflationary condition.

Net assets – December 31 1,300,000

Add: Dividends paid 300,000
Total 1,600,000
Less: net assets at current cost, January 1 800,000
Additional investments 400,000 1,200,000
Net income 400,000
========
PROBLEMS

Problem 7-1 Multiple choice (conceptual framework)

1. The presentation and disclosure requirement achieves all of the following, except
a. An effective communication tool
b. More relevant and faithfully represented financial information
c. Understandability and comparability of information
d. Financial position, financial performance and cash flows
2. It is the sorting of assets, liabilities, equity, income and expenses with similar characteristics.
a. Classification
b. Summarization
c. Interpretation
d. Recognition
3. All of the following can considered appropriate classification, except
a. Current and non-current assets
b. Current and non-current liabilities
c. Ordinary share capital and preference share capital
d. Offsetting asset and liability
4. Income and expenses are classified as
a. Profit or loss and other comprehensive income
b. Profit loss and retained earnings
c. Retained earnings and other comprehensive income
d. Ordinary and extraordinary
5. What is the new term to describe the statement of profit or loss together with the statement showing other
comprehensive income.
a. Income statement
b. Statement of profit or loss.
c. Statement of other comprehensive income.
d. Statement of financial performance.

Problem 7-2 Multiple choice (conceptual framework)

1. Financial capital is defined as

a. Net assets in monetary terms.
b. Net assets in terms of physical productive capacity.
c. Legal capital.
d. Share capital issued and outstanding.
2. The physical capital maintenance concept requires the adoption of which measurement basis?
a. Historical cost
b. Current cost
c. Fair value
d. Present value
3. Which concept is applied to net income and other comprehensive income?
a. Financial capital
b. Physical capital
c. Legal capital
d. Borrowed capital

4. Which statement regarding the term profit is true?

a. Profit is any amount over and above that required to maintain the capital at the beginning of the
period.
 b. Profit is equal to income minus expenses.
c. Profit is the equivalent of net income under IFRS.
d. All of these statements are true about the term profit.
5. Under the financial capital concept, net income occurs when
a. The nominal amount of net assets at year-end increased.
b. The physical productive capital at year-end increased after excluding any distributions to and
contributions from owners.
c. The nominal amount of net assets at year-end increased after excluding distribution to and
contributions from owners.
d. The physical productive capital at year-end increased.

EVALUATION

CHAPTER 8 PAS 1 PRESENTATION OF FINANCIAL STATEMENTS

Statement of financial position

TECHNICAL KNOWLEDGE

To identify the components of financial statements.

To understand the objective of financial statements.
To know the preparation of a statement of financial position.
To identify the minimum line items to be presented in a statement of financial position as required by IFRS.
To understand the current and non-current classification of assets and liabilities.
To know the forms of presenting the statement of financial position.

FINANCIAL STATEMENTS

Financial statements are the means by which the information accumulated and processed in financial
accounting is periodically communicated to the users.

The financial statements are the end product or main output of the financial accounting process.

Financial statements are a structured financial representation of the financial position and financial
performance of an entity.

General purpose financial statements

An entity shall prepare and present general purpose financial statements in accordance with the International
Financial Reporting Standards.

General purpose financial statements or simply referred to as financial statements are those intended to meet
the needs of users who are not in a position to require an entity to prepare reports tailored to their particular
information needs.

In other words, general purpose financial statements are directed to all common users and not to specific users.

Components of financial statements

1. Statement of financial position

2. Income statement
3. Statement of comprehensive income
4. Statement of changes in equity
5. Statement of cash flow
 6. Notes, comprising a summary of significant accounting policies and other
Explanatory notes.

Objective of financial statements

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

Financial statements also show the results of the management’s stewardship of the resources entrusted to it.

To meet this objective, financial statements provide information about the following:
a. Assets
b. Liabilities
c. Equity
d. Income and expenses, including gains and losses
e. Contributions by and distributions to owners in their capacity as owners.
f. Cash flows

Frequency of reporting

Financial statements shall be presented at least annually.

When an entity’s end of reporting period changes and financial statements are presented for a period longer or
shorter than one year, an entity shall disclose:

a. The period covered by the financial statements.

b. The reason for using a longer or shorter period.
c. The fact that amounts presented in the financial statements are not entirely comparable.

Statement of financial position

A statement of financial position is a formal statement showing the three elements comprising financial
position, namely assets, liabilities and equity.

Investors, creditors and other statement users analyze the statement of financial position to evaluate such
factors as liquidity, solvency and the need of the entity for additional financing.

Definition of asset

An asset is an economic resource controlled by an entity as a result of past event.

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

Classification of assets

Assets are classified only into two, namely current asset and non-current assets.

When an entity supplies goods or services within a clearly identifiable operating cycle, the separate
classification of current and non-current assets is a useful information by distinguishing between net assets that
are continuously circulating as working capital from the net assets used in long-term operations.

The operating cycle of an entity is the time between the acquisition of assets for processing and their
realization in cash or cash equivalents.
When the entity’s normal operating cycle is not clearly identifiable, the duration is assumed to be twelve
months.

Current assets

PAS 1, paragraph 66, provides that an entity shall classify an asset as current when:
a. The asset is cash or cash equivalent unless the asset is restricted to settle a liability for more than
twelve months after the reporting period.
b. The entity holds the asset primarily for the purpose of trading.
c. The entity expects to realize the asset within twelve months after the reporting period.
d. The entity expects to realize the asset or intends to sell or consume it within the entity’s normal
operating cycle.

Presentation of current assets

Current assets are usually listed in the order of liquidity. PAS 1, paragraph 54, provides that as a minimum,
the line items under current assets are:
a. Cash and cash equivalents
b. Financial assets at fair value such as trading securities and other investments in quoted equity
instruments
c. Trade and other receivables
d. Inventories
e. Prepaid expenses

Non –current assets

The caption “ non-current assets” is a residual definition.

PAS 1, paragraph 66, simply states that “an entity shall classify all other assets not classified as current as non-
current”

In other words, what is not included in the definition of current assets is deemed excluded. All others are
classified as non-current assets. Accordingly, non-current assets include the following:

a. Property, plant and equipment

b. Long-term investments
c. Intangible assets
d. Deferred tax assets
e. Other non-current assets

Property, plant and equipment

PAS 16, paragraph 6, defines property, plant and equipment as “tangible assets which are held by an entity for
use in production or supply of goods and services, for rental to others, or for administrative purposes, and are
expected to be used during more than one period”.

Examples of property, plant and equipment include land, building, machinery, equipment, furniture, fixtures,
patterns, molds, dies and tools.

Most property, plant and equipment, except land, are presented at cost less accumulated depreciation.

Long-term investments
The international Accounting Standards Committee defines investment as “ an asset held by an entity for the
accretion of wealth through capital distribution, such as interest, royalties, dividends and rentals, for capital
appreciation or for other benefits to the investing entity such as those obtained through trading relationships”

Intangible assets

An intangible asset is simply defined as an identifiable nonmonetary asset without physical substance.
The common examples of identifiable intangible assets include patent, franchise, copyright, lease right,
trademark and computer software.

An example of an unidentifiable intangible asset is goodwill.

Other non-current assets

Other non-current assets are those assets that do not fit into the definition of the previously mentioned non-
current assets.

Examples of other non-current assets include long-term advances to officers, directors, shareholders and
employees, or abandoned property and long-term refundable deposit.

Definition of liability

A liability is a present obligation of an entity to transfer an economic resource as a result of past event.
An obligation is a duty or responsibility that an entity has no practical ability to avoid.

An obligation can either be legal or constructive.

A liability is classified as current and non-current.

Current liabilities

PAS 1, paragraph 69, provides that an entity shall classify a liability as current when:
a. The entity expects to settle the liability within the entity’s normal operating cycle.
b. The entity holds the liability primarily for the purpose of trading.
c. The liability is due to be settled within twelve months after the reporting period.
d. The entity does not have an unconditional right to defer settlement of the liability for at least twelve
months after the reporting period.

Presentation of current liabilities

PAS 1, paragraph 54, provides that as a minimum, the face of the statement of financial position shall include
the following line items for current liabilities:

a. Trade and other payables

b. Current provisions
c. Short-term borrowing
d. Current portion of long-term debt
e. Current tax liability

The term “trade and other payables” is a line item for accounts payable, notes payable, accrued interest on note
payable, dividends payable and accrued expenses.
No objection can be raised if the trade accounts and notes payable are separately presented.

Non –current liabilities

The term “non-current liabilities” is also a residual definition.

PAS 1, paragraph 69, provides that all liabilities not classified as current are classified as non-current.

a. Non-current portion of long-term debt

b. Finance lease liability
c. Deferred tax liability
d. Long-term obligations to company officers
e. Long-term deferred revenue

Currently maturing long-term debt

A liability which is due to be settled within twelve months after the reporting period is classified as current,
even if:
a. The original term was for a period longer than twelve months
b. An agreement to refinance or to reschedule payment on a long-term basis is completed after the
reporting period and before the financial statements are authorized for issue.

However, if the refinancing on a long-term basis is completed on or before the end of the reporting period,
the refinancing is an adjusting event and therefore the obligation is classified as non –current.

Discretion to refinance

If the entity has the discretion to refinance or roll over an obligation for at least twelve months after the
reporting period under an existing loan facility, the obligation is classified as non-current even if it would
otherwise be due within a shorter period.

The reason for this treatment is that such obligation is considered to form part of the entity’s long-term
refinancing because the entity has an unconditional right under the existing loan agreement to defer
payment for at least twelve months after the end of the reporting period.

Note that the refinancing or rolling over must be at the discretion of the entity.

Otherwise, if the refinancing or rolling over is not at the discretion of the entity, the obligation is classified
as a current liability.

Covenants

Covenants are often attached to borrowing agreements which represent undertakings by the borrower.

Covenants are actually restrictions on the borrower as to undertaking further borrowings, paying
dividends, maintaining specified level of working capital and so forth.

Under these covenants, if certain conditions relating to the borrower’s financial situation are breached, the
liability becomes payable on demand.

Effect of breach of covenants

PAS 1, paragraph 74, provides that the liability is classified as current even if the lender has agreed, after
the reporting period and before the statements are authorized for issue, not to demand payment as a
consequence of the breach.

This liability is classified as current because at reporting date the borrower does not have an unconditional
right to defer payment for at least twelve months after the reporting period.

However, Paragraph 75 provides that the liability is classified as non-current if the lender has agreed on or
before the end of the reporting period to provide a grace period ending at least twelve months after the end
of reporting period.

Definition of equity

The term equity is the residual interest in the assets of the entity after deducting all of its liabilities.
Simply stated, equity means “net assets” or total assets minus liabilities.

The terms used in reporting the equity of an entity depending on the form of the business organization are:
a. Owner’s equity in a proprietorship
b. Partners’ equity in a partnership
c. Stockholders’ equity or shareholders’ equity in a corporation

However, the term equity may simply be used for all business entities.

Under PAS 1, paragraph 7, the holders of instruments classified as equity are simply known as owners.

Shareholders’ equity

Shareholders’ equity is the residual interest of owners in the net assets of a corporation measured by the
excess of assets over liabilities.

Generally, the elements constituting shareholders’ equity with their equivalent IAS term are:

Philippine term IAS term

Capital stock share capital
Subscribed capital stock subscribed share capital
Preferred stock preference share capital
Common stock ordinary share capital
Additional paid capital share premium
Retained earnings (deficit) accumulated profits (losses)
Retained earnings appropriated appropriation reserve
Revaluation surplus revaluation reserve
Treasury stock treasury shares

Notes to financial statements

Notes to financial statements provide narrative description or disaggregation of items presented in the
financial statements and information about items that do not qualify for recognition.

Notes contain information in addition to that presented in the statement of financial position, income
statement, statement of comprehensive income, statement of changes in equity and statement of cash
flows.
 In other words, notes to financial statements are used to report information that does not fit into the body
of the financial statements in order to enhance the understandability of the financial statements.

The purpose of the notes to financial statements is “ to provide the necessary disclosures required by
Philippine Financial Reporting Standards”.

Forms of statement of financial position

In practice, there are two customary forms in presenting the statement of financial position, namely:

a. Report form
This form sets forth the three major sections in a downward sequence of assets, liabilities and equity.

b. Account form
As the title suggests, the presentation follows that of an account, meaning, the assets are shown on the
left side and the liabilities and equity on the right side of the statement of financial position.

The following is an illustration of the two forms of statement of financial position.

Report form
SAMPLAR COMPANY
Statement of Financial Position
December 31, 2021

ASSETS
Note
Current assets:
Cash and cash equivalents (1) 500,000
Financial assets at fair value 200,000
Trade and other receivables (2) 700,000
Inventories (3) 900,000
Prepaid expenses (4) 50,000
Total current assets 2,350,000
Non-current assets:
Property, plant and equipment (5) 5,000,000
Investment in associate, at equity 1,000,000
Long-term investments (6) 5,100,000
Intangible assets (7) 2,000,000
Other non-current assets (8) 100,000
Total non-current assets 13,200,000
Total assets 15,550,000
=========
LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities:
Trade and other payables (9) 750,000
Note payable-short-term debt 400,000
Current portion of bonds payable 200,000
Warranty liability 50,000
Total current liabilities 1,400,000
Non-current liabilities:
Bonds payable-remaining portion 1, 800,000
Note payable-due July 1, 2023 600,000
 Deferred tax liability 100,000
Total non-current liabilities 2,500,000

Shareholders’ equity
Share capital, P100 par 5,000,000
Reserves (10) 3,000,000
Retained earnings 3,650,000
Total shareholders’ equity 11,650,000
Total liabilities and shareholders’ equity 15,550,000
=========

Note 1- Cash and cash equivalents

Cash on hand 40,000

Cash in bank 300,000
Petty cash fund 10,000
BSP Treasury bill, purchased on December 1, 2019
And due March 1, 2020 150,000
Total cash and cash equivalents 500,000
======
Note 2-Trade and other receivables
Accounts receivable 580,000
Allowance for doubtful accounts (20,000)
Notes receivable 100,000
Accrued interest on notes receivable 10,000
Advances to employees, collectible currently 30,000
Total trade and other receivables 700,000
======
Note 3 – Inventories
Finished goods 300,000
Goods in process 400,000
Raw materials 150,000
Manufacturing supplies 50,000
Total inventories 900,000
======
Note 4 – Prepaid expenses
Office supplies unused 30,000
Prepaid insurance 20,000
Total prepaid expenses 50,000
=======
Note 5 – Property, plant and equipment
Land 1,500,000
Building 4,500,000
Machinery and equipment 1,000,000
Furniture and fixture 300,000
Patterns, molds, dies and tools, net 100,000
Total 7,400,000
Accumulated depreciation (2,400,000)
Carrying amount 5,000,000
========

Accumulated depreciation:
 Building 1,900,000
Machinery and equipment 350,000
Furniture and fixtures 150,000
Total accumulated depreciation 2,400,000
========
Note 6 – Long-term investments
Plant expansion fund 2,000,000
Investment in bonds 3,000,000
Cash surrender value 100,000
Total other long-term investments 5,100,000
========
Note 7 – Intangible assets
Patent 500,000
Franchise 1,500,000
Total intangible assets 2,000,000
========
Note 8 – Other noncurrent assets
Long-term refundable deposit 20,000
Long – term advances to officers 80,000
Total other non-current assets 100,000
=======
Note 9-Trade and other payables
Accounts payable 350,000
Notes payable 150,000
Accrued interest on note payable 15,000
Income tax payable 50,000
Dividends payable 100,000
Accrued expenses 85,000
Total trade and other payables 750,000
======
Note 10 – Reserves
Share premium 2,000,000
Retained earnings appropriated for contingencies 1,000,000 total
reserves 3,000,000
========

Account form
SAMPLAR COMPANY
Statement of Financial Position
December 31, 2019

ASSETS LIABILITIES AND

EQUITY

Current assets: Current liabilities:

Cash and cash equivalents 500,000 Trade and other payables 750,000
Financial assets at fair value 200,000 Note payable-short-term 400,000
Trade and other receivables 700,000 current portion of bonds
Inventories 900,000 Payable 200,000
Prepaid expenses 50,000 Warranty liability 50,000
Total current assets 2,350,000 total current liabilities 1,400,000
======= ========
Non-current assets: Non- current liabilities
Property, plant and equip. 5,000,000 Bonds payable-remaining
Portion 1,800,000
Investment in associates 1,000,000 Note payable-due
July 1, 2021 600,000
Long-term investments 5,100,000 deferred tax liability 100,000
Intangible assets 2,000,000 Total non-current liabilities 2,500,000
Other non-current assets 100,000 ========
Total non-current assets 13,200,000
========
Equity:
Share capital, P100 par 5,000,000
Reserves 3,000,000
Retained earnings 3,650,000
Total Equity 11,650,000
Total assets 15,550,000 total liab. Equity 15,550,000
======== =========

Line items in statement of financial position

PAS 1, paragraph 54, states that as a minimum, the face of the statement of financial position shall include the
following line items:

1. Cash and cash equivalents

2. Financial assets (other than 1, 3 and 6)
3. Trade and other receivables
4. Inventories
5. Property, plant and equipment
6. Investment in associates accounted for by the equity method
7. Intangible assets
8. Investment property
9. Biological assets
10. Total of assets classified as held for sale and assets included in disposal group classified
as held for sale
11. Trade and other payables
12. Current tax liability
13. Deferred tax asset and deferred tax liability
14. Provisions
15. Financial liabilities (other than 11 and 14)
16. Liabilities included in disposal group classified as held for sale
17. Non-controlling interest
18. Share capital and reserves

In the Philippines, the common practice is to present current assets before non-current assets, current liabilities
before non-current liabilities, and equity after liabilities. Other formats may be equally appropriate provided
the distinction is clear. This is in accordance with paragraph 7 of the Preface to PAS 1.
PAS 1, paragraph 57, provides that “the standard does not prescribe the order or format in which items are to
be presented in the statement of financial position”.

Note that the format of the statement of financial position as illustrated in the appendix to IAS 1 presents non-
current assets before current assets, equity before liabilities, and non-current liabilities before current
liabilities. This may be the practice in other jurisdiction, like the United Kingdom.

PROBLEMS
Problems 8-5 Multiple choice (PAS 1)

1. The major financial statements include all, except

a. Statement of financial position
b. Statement of changes in financial position
c. Statement of comprehensive income
d. Statement of changes in equity
2. What is the objective of financial statements?
a. To provide information about the financial position, financial performance and changes in
financial position of an entity that is useful to a wide range of users in making economic
decisions.
b. To present a statement of financial position and a statement of comprehensive income.
c. To present relevant, reliable, comparable and understandable information to investors.
d. To present financial statements in accordance with all applicable standards.
3. To meet the objective of financial reporting, financial statements should provide information about all of
the following, except
a. Assets, liabilities and equity
b. Income and expenses, including gains and losses.
c. Contributions by and distribution to owners in their capacity as owners.
d. Nature of business activities.
4. Financial statements must be prepared at least
a. Annually
b. Quarterly
c. Semi-annually
d. Every two years
5. When entity changed the end of reporting period longer or shorter than one year, the entity shall disclose
all, except
a. Period covered by the financial statements.
b. The reason for using a longer or shorter period.
c. The fact that amounts presented are not entirely comparable
d. The fact that similar entities have done so

Problem 8-6 Multiple choice (PAS) 1

1. When there is much variability, the operating cycle is measured at

a. The mean value
b. The median value
c. Twelve months
d. Three years
2. The operating cycle of an entity
a. Is the time between the acquisitions of materials entering into a process and their realization in
cash.
b. Is the period of time normally elapsed in converting trade receivables back into cash.
c. Is a period of one year.
 d. Refers to the seasonal variation experienced by entities.
3. An entity shall classify an asset as current under all of the following conditions, except
a. The entity expects to realize the asset or intends to sell or consume it within the entity’s normal
operating cycle.
b. The entity holds the asset for the purpose of trading.
c. The entity excepts to realize the asset within twelve months after the reporting period.
d. The asset is cash or a cash equivalent that is restricted to settle a liability for more than twelve
months after the reporting period.
4. An entity shall classify a liability as current when under all of the following conditions, except
a. The entity expects to settle the liability within the entity’s normal operating cycle.
b. The entity holds the liability primarily for the purpose of trading.
c. The liability is due to be settled within twelve months after the reporting period.
d. The entity has an unconditional right to defer settlement of the liability for at least twelve months
after the reporting period.
5. Which obligations are classified as current even if there are due to be settled after more than twelve months
from the end of the reporting period?
a. Trade payables and accruals for employee and other operating cost.
b. Current portion of interest-bearing liabilities
c. Bank overdrafts
d. Dividends payable
6. Current and non-current presentation of assets and liabilities provides useful information when the entity
a. Supplies goods or services within a clearly identifiable operating cycle.
b. Is a financial institution
c. Is a public utility
d. Is a non-profit organization

7. A presentation of assets and liabilities in increasing or decreasing order of liquidity provides information
that is reliable and more relevant than a current and non-current presentation for
a. Financial institution
b. Public utility
c. Manufacturing entity
d. Service provider
8. In the Philippines, the common practice is to present in the statement of financial position
a. Current assets before non-current assets, current liabilities before non-current liabilities and
equity after liabilities.
b. Non-current assets before current assets, non-current liabilities before current liabilities and
equity after liabilities.
c. Current assets before non-current assets, noncurrent liabilities before current liabilities and equity
after liabilities
d. Non-current assets before current assets, current liabilities before non-current liabilities and
equity after liabilities.
9. A financial liability due within twelve months after the reporting period shall be classified as non-current
a. When it is refinanced on a long-term basis before the issue of financial statements.
b. When the entity has no discretion to refinance for at least twelve months.
c. When it is refinanced on a long-term basis after the end of reporting period.
d. When it is refinanced on a long-term basis on or before the end of reporting period.
10. When an entity breaches under a long –term loan agreement on or before the end of the reporting period
with the effect that the liability becomes payable on demand, the liability is classified as
a. Current under all circumstances
b. Non-current under all circumstances
c. Current if the lender has agreed after the reporting period and before the issuance of the
statements not to demand payment as a consequence of the breach.
 d. Non-current if the lender agreed after the reporting period to provide a grace period for at least
twelve months after the reporting period.

Problem 8-7 Multiple choice (IFRS)

1. In presenting a statement of financial position, an entity
a. Must make the current and non-current presentation.
b. Must present assets and liabilities in order of liquidity.
c. Must choose either the current and non-current or the liquidity presentation, meaning free choice
of presentation.
d. Must make the current and non-current presentation, except when a presentation based on
liquidity provides information that is reliable and more relevant.
2. Assets to be sold, consumed or realized as part of the normal operating cycle are
a. Current assets
b. Non-current assets
c. Classified as current or non-current in accordance with other criteria.
d. Non-current investments.
3. Liabilities that an entity expects to settle within the normal operating cycle are classified as
a. Non-current liabilities
b. Current or non-current liabilities in accordance with other criteria
c. Current liabilities
d. Equity
4. In which section of the statement of financial position should cash that is restricted for the settlement of a
liability due 18 months after the reporting period be presented?
a. Current assets
b. Equity
c. Non-current liabilities
d. Non-current assets
5. In which section of the statement of financial position should employment taxes that are due for settlement
in 15 months’ time be presented?
a. Current liabilities
b. Current assets
c. Non-current liabilities
d. Non-current assets
6. An entity has a loan due for repayment in six months’ time but the entity has the option to refinance for
repayment two years later. The entity plans to refinance this loan. In which section of the statement of
financial position should this loan be presented?
a. Current liabilities
b. Current assets
c. Non-current liabilities
d. Non-current assets
7. Which of the following must be included on the face of the statement of financial position?
a. Investment property
b. Number of shares authorized
c. Contingent asset
d. Shares in an entity owned by that entity
8. Which of the following is not required to be presented as minimum information on the face of the statement
of financial position?
a. Investment property
b. Investment accounted under the equity method
c. Biological asset
d. Contingent liability
Chapter 9 PAS 1 PRESENTATION OF FINANCIAL STATEMENTS
Statement of comprehensive income

TECHNICAL KNOWLEDGE

To understand the objective and usefulness of an income statement.

To understand the concept of comprehensive income, profit or loss and other comprehensive.

To identify the components of other comprehensive income.

To know the minimum line items in the statement of comprehensive income.

To know the natural and functional presentation of the income statement.

INCOME STATEMENT

An income statement is a formal statement showing the financial performance of an entity for a given period of
time.

The financial performance of an entity is primarily measured in terms of the level of income earned by the
entity through the effective and efficient utilization of its resources.

The financial performance is also known as the results of operations of the entity.

The transactions approach is the traditional preparation of the income statement in conformity with accounting
standards.

The income statement for a period presents the income, expenses, gains, losses and net income or loss
recognized during the period.

Information about financial performance is useful in predicting future performance and ability to generate
future cash flows.

Comprehensive income
Comprehensive income is the change in equity during a period resulting from transactions and other events,
other than changes resulting from transactions with owners in their capacity as owners.

Accordingly, comprehensive income includes:

a. Components of profit or loss

b. Components of other comprehensive income

Profit or Loss

The term profit or loss is the total of income less expenses, excluding the components of other comprehensive
income.
In other words, this is the “bottom line” in the traditional income statement.

An entity may use “net income” or “net loss” to describe profit or loss.

Other comprehensive income (OCI)

Other comprehensive income comprises items of income and expenses including reclassification adjustments
that are not recognized in profit or loss as required or permitted by Philippine Financial Reporting Standards.

The components of “other comprehensive income” include the following:

1. Unrealized gain or loss on equity investment measured at fair value through other
comprehensive income.
2. Unrealized gain or loss on debt investment measured at fair value through other
comprehensive income.
3. Gain or loss from translation of the financial statements of a foreign operation.
4. Revaluation surplus during the year.
5. Unrealized gain or loss from derivative contracts designated as cash flow hedge
6. “Remeasurements” of defined benefit plan, including actuarial gain or loss
7. Change in fair value attributable to credit risk of a financial liability designated at fair
value through profit or loss.

Presentation of other comprehensive income

PAS 1, paragraph 82A, provides that the statement of comprehensive income shall present line items for
amounts of other comprehensive income during the period classified by nature.

The line items for amounts of OCI shall be grouped as follows:

a. OCI that will be reclassified subsequently to profit or loss when specific conditions are met.
b. OCI that will not be reclassified subsequently to profit or loss but to retained earnings.

OCI that will be reclassified to profit or loss

a. Unrealized gain or loss on debt investment measured at fair value through other comprehensive
income.
b. Gain or loss from translating financial statements of a foreign operation.
c. Unrealized gain or loss on derivative contracts designated as cash flow hedge.

OCI that will be reclassified to retained earnings

 a. Unrealized gain or loss on equity investment measured at fair value through other comprehensive
income.

The Application Guidance of PFRS 9, paragraph B5.7.1, provides that such unrealized gain or loss is
reclassified to retained earnings upon disposal of the investment.
b. Revaluation surplus during the year

The realization of the revaluation surplus is through retained earnings.

c. Remeasurements of defined benefit plan, including actuarial gain or loss.

The remeasurements are not reclassified subsequently but are permanently excluded from profit or
loss.

However, the remeasurements may be transferred within equity or retained earnings.

d. Change in fair value attributable to credit risk of a financial liability designated at fair value through
profit or loss.

Such gain or loss from change in fair value attributable to credit risk of a financial liability may be
transferred within equity or retained earnings.

Presentation of comprehensive income

An entity has two options of presenting comprehensive income, namely:

1. Two statements:

a. An income statement showing the components of profit or loss.

b. A statement of comprehensive income beginning with profit or loss as shown in the income
statement plus or minus the components of other comprehensive income.
2. Single statement of comprehensive income

This is the combined statement showing the components of profit or loss and components of other
comprehensive income in a single statement.

The Revised Conceptual Framework calls this single statement as statement of financial performance.

Sources of income

a. Sales of merchandise to customers

The income from sales shall include all sales to customers during the period.

Sales returns, allowances and discounts shall be deducted from gross sales to arrive at net sales.
b. Rendering of services

Income from rendering of services, among others, includes professional fees, media advertising
commissions, insurance agency commissions, admission fees for artistic performance and tuition fees.
c. Use of entity resources

This income category includes interest, rent, royalty and dividend income.
d. Disposal of resources other than products
Examples include gain on sale of investments, gain on sale of property, plant and equipment and gain
on sale of intangible assets.
Components of expense

a. Cost of goods sold or cost of sales

b. Distribution costs or selling expenses
c. Administrative expenses
d. Other expenses
e. Income tax expense

Cost of goods sold of merchandising concern

Beginning inventory 500,000

Net purchases 2,000,000
Goods available for sale 2,500,000
Ending inventory ( 300,000)
Cost of goods sold 2,200,000
========

Gross purchases 1,900,000

Freight in 150,000
Total 2,050,000
Purchase returns, allowances and discounts ( 50,000)
Net purchases 2,000,000
========

Cost of goods sold of manufacturing concern

Beginning raw materials 500,000

Net purchases 2,000,000
Raw materials available for use 2,500,000
Ending raw materials (300,000)
Raw materials used 2,200,000
Direct labor 3,000,000
Factory overhead 1,300,000
Total manufacturing cost 6,500,000
Beginning goods in process 900,000
Total cost of goods in process 7,400,000
Ending goods in process (1,000,000)
Cost of goods manufactured 6,400,000
Beginning finished goods 1,600,000
Goods available for sale 8,000,000
Ending finished goods (1,500,000)
Cost of goods sold 6,500,000
========
Classifications of expenses

Distribution costs constitute costs which are directly related to selling, advertising and delivery of goods to
customers.
Distribution costs ordinarily include:
a. Salesmen’s salaries
b. Salesmen’s commissions
c. Traveling and marketing expenses
d. Advertising and publicity
 e. Freight out
f. Depreciation of delivery equipment and store equipment

Administrative expenses ordinarily include all operating expenses not related to selling and cost of goods sold.

Examples include:
a. Doubtful accounts
b. Office salaries
c. Expenses of general executives
d. Expenses of general accounting and credit department
e. Office supplies used
f. Certain taxes
g. Contribution
h. Professional fees
i. Depreciation of office building and office equipment
j. Amortization of intangible assets

Other expenses are those expenses which are not directly related to the selling and administrative function.

Examples include:
a. Loss on sale of trading investments
b. Loss on disposal of property, plant and equipment
c. Loss on sale of non-current investment
d. Casualty loss- flood, earthquake, fire

No more extraordinary items

PAS 1, paragraph 87, specifically mandates that an entity shall not present any items of income and expense
as extraordinary either on the face of the income statement or statement of comprehensive income or in the
notes.

Line items

PAS 1, paragraph 82, provides that as a minimum, the income statement and statement of comprehensive
income shall include the following line items:

a. Revenue
b. Gain and loss from the derecognition of financial asset measured at amortized cost as required by
PFRS 9.
c. Finance cost
d. Share in income or loss of associate and joint venture accounted for using the equity method.
e. Gain or loss on the reclassification of financial asset from amortized cost to fair value profit or loss
f. Gain or loss on the reclassification of financial asset from fair value other comprehensive income to
fair value profit or loss.
g. Income tax expense
h. A single amount comprising discontinued operations
i. Profit or loss for the period
j. Total other comprehensive income
k. Comprehensive income for the period being the total of profit or loss and other comprehensive
income.

The following items shall be disclosed on the face of the income statement and statement of comprehensive
income.
 a. Profit or loss for the period attributable to non-controlling interest and owners of the parent.
b. Total comprehensive income for the period attributable to non-controlling interest and owners of the
parent.

Forms of Income statement

PAS 1, paragraph 99, provides that an entity shall present an analysis of expenses recognized in profit or loss
using a classification based on either the function of expenses or their nature within the entity, whichever
provides information that is reliable and more relevant.

Accordingly, the income statement may be presented in two ways, namely functional and natural.

Functional presentation

This form classifies expenses according to their function as part of cost of goods sold, distribution costs,
administrative expenses and other expenses.

The functional presentation is also known as the cost of goods sold method.

An entity classifying expenses by function shall disclose additional information on the nature of expenses,
including depreciation, amortization and employee benefit costs.

Natural presentation

The natural presentation is referred to as the nature of expense method.

Under this form, expenses are aggregated according to their nature and not allocated among the various
functions within the entity.

In other words, the expenses are no longer classified as cost of goods sold, distribution costs, administrative
expenses and other expenses.

The expenses which are of the same nature are grouped or aggregated and presented as one item.
For example, depreciation, purchases of raw materials, transport costs, employee benefit costs and advertising
costs are presented separately.

“Functional” income statement

EXAMPLAR COMPANY
Income Statement
Year ended December 31, 2019

Note
Net sales (1) 9,000,000
Cost of goods sold (2) (5,400,000)
Gross income 3,600,000
Other income 900,000
Investment income 500,000
Total income 5,000,000

Expenses:
Distribution costs (5) 1,350,000
 Administrative expenses (6) 1,000,000
Other expenses (7) 320,000
Finance cost (8) 200,000 2,870,000
Income before tax 2,130,000
Income tax expense 580,000
Net income 1,550,000
========

Note 1 – Net sales

Gross sales 9,300,000

Sales return and allowance (100,000)
Sales discount (200,000)
Net sales 9,000,000
========
Note 2 – Cost of goods sold

Inventory, January 1,500,000

Purchases 6,000,000
Freight in 300,000
Total 6,300,000
Purchases return and allowance ( 150,000)
Purchase discount ( 250,000) 5,900,000
Goods available for sale 7,400,000
Inventory, December 31 (2,000,000)
Cost of sales 5,400,000
========

Note 3 – Other income

Interest revenue 180,000

Dividend revenue 120,000
Rent revenue 100,000
Gain from expropriation 500,000
Total 900,000
======

Note 4 – Investment income

Share in net income of associate (25%) 500,000

======

Note 5 – Distribution costs

Sales salaries 600,000

SSS and Philhealth –sales 20,000
Sales commission 180,000
Advertising 100,000
Store supplies expense 50,000
Delivery expense 250,000
Depreciation – store equipment 150,000
Total distribution costs 1,350,000
========
Note 6 – Administrative expenses

Office salaries 650,000

SSS and Philhealth – office 30,000
Bonuses 100,000
Office supplies expense 70,000
Taxes and licenses 20,000
Doubtful accounts 40,000
Depreciation – office equipment 90,000
Total administrative expenses 1,000,000
========
Note 7 – Other expenses

Loss on sale of investment 30,000

Loss on sale of property 120,000
Casualty loss from earthquake 170,000
Total 320,000
======

Note 8 – Finance cost

Interest expense on bank loan 50,000

Interest expense on bonds payable 150,000
Total finance cost 200,000
======

“Natural” Income Statement

EXAMPLAR COMPANY
Income Statement
Year ended December 31, 2019
Note
Net sales (1) 9,000,000
Other income (2) 900,000
Investment income (3) 500,000
Total income 10,400,000

Expenses:
Increases in inventory (4) ( 500,000)
Net purchases (5) 5,900,000
Employees benefits costs (6) 1,400,000
Sales commission 180,000
Advertising 100,000
Supplies expense (7) 120,000
Delivery expense 250,000
Depreciation expense (8) 240,000
Taxes and licenses 20,000
Doubtful accounts 40,000
Other expenses (9) 320,000
Finance cost (10) 200,000 8,270,000
Income before tax 2,130,000
Income tax expense 580,000
Net income 1,550,000
=========
Note 1 – Net sales

Gross sales 9,300,000

Sales return and allowance ( 100,000)
Sales discount ( 200,000)
Net sales 9,000,000
========
Note 2 – other income

Interest revenue 180,000

Dividend revenue 120,000
Rent revenue 100,000
Gain from expropriation 500,000
Total 900,000
========
Note 3 – Investment income

Share in net income of associate (25%) 500,000

========

Note 4 – Increase in inventory

Inventory – December 31 2,000,000

Inventory – January 1,500,000
Increase in inventory 500,000
========
Note 5- Net purchases

Purchases 6,000,000
Freight in 300,000
Purchase return and allowances ( 150,000)
Purchase discount ( 250,000)
Net purchases 5,900,000
========

Note 6 – Employee benefit costs

Sales salaries 600,000

SSS and Philhealth – sales 20,000
Office salaries 650,000
SSS and Philhealth – office 30,000
Bonuses 100,000
Total employees costs 1,400,000
========

Note 7 – Supplies expense

Store supplies 50,000

Office supplies 70,000
Total supplies expense 120,000
=======
Note 8 – Depreciation

Depreciation –store 150,000

Depreciation – office 90,000
Total depreciation 240,000
========

Note 9 – Other expenses

Loss on sale of investment 30,000

Loss on disposal of property 120,000
Casualty loss from earthquake 170,000
Total 320,000
=======
Note 10 – Finance cost
Interest expense on bank loan 50,000
Interest expense on bonds payable 150,000
Total finance cost 200,000
=======
Which form of income statement?

PAS 1 does not prescribe any format.

Paragraph 105 simply states that because each method of presentation has merit for different types of entities,
management is required to select the presentation that is reliable and more relevant.

Statement of comprehensive income

As stated earlier, in addition to the income statement, a statement of comprehensive income is also prepared in
order to show the total comprehensive income.

The statement of comprehensive income starts with the profit or loss as shown in the income statement plus or
minus the components of other comprehensive.

The purpose of this statement is to provide a more comprehensive information on financial performance
measured more broadly than the income as traditionally computed.

Illustration

Using the data in the preceding illustration, the statement of comprehensive income may appear as follows:
EXAMPLAR COMPANY
Statement of Comprehensive Income
Year Ended December 31, 2019

Net income 1,550,000

Other comprehensive income to be reclassified to profit or loss:
Foreign currency translation gain 150,000
Unrealized loss on derivative contract
Designated as cash flow hedge (100,000) 50,000
Comprehensive income 1,600,000
 ========
Comprehensive income for a period includes the net income or loss for the period plus or minus the
components of other comprehensive income.

However, the comprehensive income of P1,600,000 is not carried to retained earnings. Only the net income of
P1,550,000 is included in the determination of retained earnings unappropriated.

The net other comprehensive income of P50,000 is carried to “reserves” or shown separately in the statement
of changes in equity.

Single statement of comprehensive income

Another option in presenting the components of profit or loss and components of other comprehensive income
is to prepare a single statement of comprehensive income.

Again, this single statement is the combined income statement and statement of comprehensive income.

Using the preceding data, the single statement of comprehensive income following the “functional
presentation” may appear as follows:

EXAMPLAR COMPANY
Statement of Comprehensive Income
Year Ended December 31, 2019

Net sales 9,000,000

Cost of goods sold (5,400,000)
Gross income 3,600,000
Other income 900,000
Investment income 500,000
Total income 5,000,000
Expenses:
Distribution costs 1,350,000
Administrative expenses 1,000,000
Other expenses 320,000
Finance cost 200,000 2,870,000
Income before tax 2,130,000
Income tax expense 580,000
Net income 1,550,000
Other comprehensive income to be reclassified to profit or loss:
Foreign currency translation gain 150,000
Unrealized loss on derivative contract
Designated as cash flow hedge (100,000) 50,000
Comprehensive income 1,600,000
========

Statement of retained earnings

The statement of retained earnings shows the changes affecting directly the retained earnings of an entity and
relates the income statement to the statement of financial position.

The important data affecting the retained earnings that should be clearly disclosed in the statement of retained
earnings are:
 a. Profit or loss for the period
b. Prior period errors
c. Dividends declared and paid to shareholders
d. Effects of change in accounting policy
e. Appropriation of retained earnings

Illustration – all amounts are assumed

EXAMPLAR COMPANY
Statement of Retained Earnings
Year Ended December 31, 2019

Retained earnings, January 1 1,000,000

Correction of error resulting
From prior year under-depreciation (100,000)
Change in accounting policy from weighted average
To FIFO inventory valuation resulting in an increase 300,000
Corrected beginning balance 1,200,000
Net income for the period 1,550,000
Dividends declared during the year ( 400,000)
Appropriated for contingencies ( 200,000)
Retained earnings, December 31 2,150,000
========

Statement of changes in equity

The statement of changes in equity is a basic statement that shows the movements in the elements or
components of the shareholders’ equity.

The statement of retained earnings is no longer a required basic statement but it is a part of the statement of
changes in equity.

An entity shall present a statement of changes in equity showing the following:

1. Comprehensive income for the period.

2. For each component of equity, the effects of changes in accounting policies and corrections of
errors.
3. For each component of equity, a reconciliation between the carrying amount at the beginning
and end of the period, separately disclosing changes from:
a. Profit or loss
b. Each item of other comprehensive income
c. Transactions with owners in their capacity as owners showing separately contributions by and
distributions to owners.

Illustration – all amounts are assumed

EXAMPLAR COMPANY
Statement of Changes in Equity
Year Ended December 31, 2019
 Share capital Reserves Retained earnings
Balance – January 1 5,000,000 2,000,000 1,000,000
Correction of error resulting
From prior year under
Depreciation ( 100,000)
Change in accounting policy
From weighted average
To FIFO –credit 300,000
Issuance of 10,000 ordinary shares
With P100 par at P150/share 1,000,000 500,000
Issuance of 5,000 preference shares
With P50 par at P100/share 250,000 250,000
Comprehensive income:
Net income 1,550,000
Other comprehensive income 50,000
Dividends paid during the year ( 400,000)
Current appropriation for
Contingencies 200,000 (200,000)
Balances – December 31 6,250,000 3,000,000 2,150,000
=========== ======== ========

Statement of cash flows

The statement of cash flows is a basic component of the financial statements which summarizes the operating,
investing and financing activities of an entity.

In simple language, the statement of cash flows and a more detailed discussion of the statement of financial
position, income statement, statement of comprehensive income and statement of changes in equity are taken
up exhaustively in Intermediate Accounting Volume Three.

Multiple choice (PAS 1)

1. It is change in equity during a period resulting from transactions and other events, other than
those changes resulting from transactions with owners in their capacity as owners.
a. Profit or loss
b. Comprehensive income
c. Other comprehensive income
d. Share capital
2. Comprehensive income includes
a. Profit or loss
b. Other comprehensive income
c. Both profit or loss and other comprehensive income
d. Neither profit or loss nor other comprehensive income
3. It is the total of income less expenses, excluding other comprehensive income.
a. Comprehensive income
b. Profit or loss
c. Accounting income
d. Economic income
4. It comprises items of income and expense, including reclassification adjustments that are not
recognized in profit or loss as required or permitted by PFRS.
a. Comprehensive income
b. Other comprehensive income
 c. Profit or loss
d. Retained profit
5. What is the two-statement approach of presenting comprehensive income?
a. A comparative statement of comprehensive income
b. A combined statement of comprehensive income and retained earnings
c. A combined income statement and a statement of changes equity
d. A separate income statement and a separate statement of comprehensive income.
6. Earnings
a. Include certain gains excluded from comprehensive income
b. Are the same as comprehensive income
c. Exclude certain gains and losses included in comprehensive income.
d. Include certain losses excluded from comprehensive income.
7. Other comprehensive income includes all, except
a. Gain and loss arising from translating the financial statements of a foreign operation.
b. Gain and loss from debt investment measured at fair value through OCI.
c. Gain and loss on hedging instrument in a cash flow hedge.
d. Dividend paid to shareholders.
8. All of the following components of OCI should be reclassified to profit or loss, except
a. Translation of financial statements of a foreign operation
b. Remeasurement of debt investment at FVOCI
c. The effective portion of gain or loss on hedging instrument in a cash flow hedge
d. Remeasurement of equity investment at FVOCI
9. Which of the following components of OCI should be reclassified to retained earnings
a. Revaluation surplus
b. Remeasurements of defined benefit plan
c. Gain or loss attributable to credit risk of a financial liability designated at FVPL
d. All of these components of OCI should be reclassified to retained earnings
10. Total comprehensive income for the period is presented
a. Showing separately the total amount attributable to owners of the parent and the non-
controlling interest.
b. Showing separately an analysis of expenses by function.
c. Showing separately an analysis of expenses by nature.
d. Showing separately profit or loss and the total of other comprehensive income.
11. Bangladesh Company provided the following information for the current year:
Sales 50,000,000
Cost of goods sold 30,000,000
Distribution costs 5,000,000
General and administrative expenses 4,000,000
Interest expense 2,000,000
Gain on early extinguishment of long-term debt 500,000
Correction of inventory error, net of income tax –credit 1,000,000
Investment income – equity method 3,000,000
Gain on expropriation 2,000,000
Income tax expense 5,000,000
Dividends declared 2,500,000
What is the income from continuing operations?

12. Corazon Company provided the following information for the current year:

Sales 7,000,000
Sales returns and allowances 100,000
Cost of goods sold 2,800,000
Utilities expense 1,000,000
 Interest revenue 150,000
Income tax expense 800,000
Casualty loss due to earthquake 50,000
Finance cost 200,000
Salaries expense 600,000
Loss on sale of investments 50,000

What amount should be reported as income from continuing operations?

13. Brock Company reported operating expenses in two categories, namely distribution and
administrative. The adjusted trial balance at year-end included the following expense and
loss accounts for current year. One-half of the rented premises is occupied by the sales
department.

Accounting and legal fees 1,200,000

Advertising 1,500,000
Freight out 800,000
Interest 700,000
Loss on sale of long-term investment 300,000
Officers’ salaries 2,250,000
Rent for office space 2,200,000
Sales salaries and commissions 1,400,000

What amount should be reported as distribution costs?

14. Lee Company reported the following data for the current year:

Legal and audit fees 1,700,000

Rent for office space equally shared by sales and accounting 2,400,000
Interest on inventory loan 2,100,000
Loss on abandoned data processing equipment 350,000
Freight in 1,750,000
Freight out 1,600,000
Officers’ salaries 1,500,000
Insurance 850,000
Sales representative salaries 2,150,000
Research and development expense 1,000,000

What amount should be classified as administrative expense?

Chapter 10 PAS INVENTORIES

TECHNICAL KNOWLEDGE

To understand the meaning of inventories.

To identify the items included in inventory cost.

To identify the cost formulas required by IFRS.

To know the measurement of inventory in the statement of financial position

 To apply the lower of cost and net realizable value basis of measurement.

INVENTORIES

Inventories are assets held for sale in the ordinary course of business, in the process of production for such
sale or in the form of materials or supplies to be consumed in the production process or in the rendering of
services.

Inventories encompass goods purchased and held for resale, for example:

a. Merchandise purchased by a retailer and held for resale

b. Land and other properly held for resale by a subdivision entity and real estate developer.

Inventories also encompass finished goods produced, goods in process and materials and supplies awaiting use
in the production process.

Classes of inventories

Inventories are broadly classified into two, namely inventories of a trading concern and inventories of
manufacturing concern.

A trading concern is one that buys and sells goods in the same form purchased.

The term “merchandise inventory” is generally applied to goods held by a trading concern.

A manufacturing concern is one that buys goods which are altered or converted into another form before they
are made available for sale.

The inventories of a manufacturing concern are:

a. Finished goods
b. Goods in process
c. Raw materials
d. Factory or manufacturing supplies

Cost of inventories

The cost of inventories shall comprise:

a. Cost of purchase
b. Cost of conversion
c. Other cost incurred in bringing the inventories to their present location and condition

Cost of purchase

The cost of purchase of inventories comprises the purchase price, import duties and irrecoverable taxes,
freight, handling and other costs directly attributable to the acquisition of finished goods, materials and
services.

Trade discounts, rebates and other similar items are deducted in determining the cost of purchase.
Cost of conversion

The cost of conversion of inventories includes cost directly related to the units of production such as direct
labor.

It also includes a systematic allocation of fixed and variable production overhead that is incurred in converting
materials into finished goods.

Fixed production overhead is the indirect cost of production that remains relatively constant regardless of the
volume of production.

Examples are depreciation and maintenance of factory building and equipment, and the cost of factory
management and administration.

Variable production overhead is the indirect cost of production that varies directly with the volume of
production.

Examples are indirect labor and indirect materials.

Other cost

Other cost is included in the cost of inventories only to the extent that it is incurred in bringing the inventories
to their present location and condition.

For example, it may be appropriate to include the cost of designing product for specific customers in the cost
of inventories.

However, the following costs are excluded from the cost of inventories and recognized as expenses in the
period when incurred.

a. Abnormal amounts of wasted materials, labor and other production costs.

b. Storage costs, unless necessary in the production process prior to a further production stage.
Thus, storage costs on goods in process are capitalized but storage costs on finished goods are
expensed.
c. Administrative overheads
d. Distribution or selling costs

Cost of inventories of a service provider

The cost of inventories of a service provider consists primarily of the labor and other costs of personnel
directly engaged in providing the service, including supervisory personnel and attributable overhead.

Labor and other costs relating to sales and general administrative personnel are not included but are recognized
as expenses in the period in which they incurred.

Cost formulas

PAS 2, paragraph 25, expressly provides that the cost of inventories shall be determined by using either:

a. First in, First out

b. Weighted average
The standard does not permit anymore the use of the last in, first out (LIFO) as an alternative formula in
measuring cost of inventories.

First in, First out (FIFO)

The FIFO method assumes that “the goods first purchased are first sold and consequently the goods remaining
in the inventory at the end of the period are those most recently purchased or produced.

In other words, the FIFO is in accordance with the ordinary merchandising procedure that the goods are sold in
the order they are purchased.

The rule is “first come, first sold”.

The inventory is thus expressed in terms of recent or new prices while the cost of goods sold is representative
of earlier or old prices.

This method favors the statement of financial position in that the inventory is stated at current replacement
cost.

The objection to the method is that there is improper matching of cost against revenue because the goods sold
are stated at earlier or older prices resulting in understatement of cost of goods sold.

Accordingly, in a period of deflation or declining prices, the FIFO method would result to the lowest net
income.

Illustration – FIFO

The following data pertain to an inventory item:

Unit Sales (in units)

Units cost total cost
Jan 1 beginning balance 800 200 160,000
8 sale 500
18 Purchase 700 210 147,000
22 sale 800
31 Purchase 500 220 110,000

The ending inventory is 700 units.

Units unit costs total cost

From Jan. 18 Purchase 200 210 42,000
From Jan. 31 Purchase 500 220 110,000
700 152,000
=== ======
Cost of goods sold

Inventory –January 160,000

Purchases 257,000
Goods available for sale 417,000
Inventory – January 31 (152,000)
Cost of goods sold 265,000
======
Jan. 18 purchases 147,000
31 purchases 110,000
Total purchases 257,000
======

Weighted average

The cost of the beginning inventory plus the total cost of purchases during the period is divided by the total
units purchased plus those in the beginning inventory to get a weighted average unit cost.

Such weighted average unit cost is them multiplied by the units on hand to derive the inventory value.

In other words, the average unit cost is computed by dividing the total cost of goods available for sale by the
total number of units available for sale.

The preceding illustrative data are used.

Units unit cost Total cost
Jan. 1 Beginning balance 800 200 160,000
18 Purchase 700 210 147,000
31 Purchase 500 220 110,000
Total goods available for sale 2,000 417,000
Weighted average unit cost (417,000/2,000) 208.50
Inventory cost (700 x 208.50) 145,950

Cost of goods sold

Inventory – January 1 160,000
Purchases 257,000
Goods available for sale 417,000
Inventory –January 31 (145,950)
Cost of goods sold 271,050
=======

The argument for the weighted average method is that it is relatively easy to apply, especially with computers.

Moreover, the weighted average method produces inventory valuation that approximates current value if there
is a rapid turnover of inventory.

The argument against the weighted averaged method is that there may be a considerable lag between the
current cost and inventory valuation since the average unit cost involves early purchases.

Last in, First out (LIFO)

The LIFO method assumes that the goods last purchased are first sold and consequently the goods remaining in
the inventory at the end of the period are those first purchased or produced.

The inventory is thus expressed in terms of earlier or old prices and the cost of goods sold is representative of
recent or new prices.

The LIFO favors the income statement because there is matching of current cost against current revenue, the
cost of goods sold being expressed in terms of current or recent cost.

The objection of the LIFO is that the inventory is stated at earlier or older prices and therefore there may be a
significant lag between inventory valuation and current replacement cost.
Actually, in a period of rising prices, the LIFO method would result to the lowest net income. In a period of
declining prices, the LIFO method would result to the highest net income.
Illustration – LIFO
In the preceding illustration, the cost of 700 units under the LIFO is computed as follows:

Units unit cost total cost

From January 1 balance 700 200 140,000
==== === =======
Inventory – January 1 160,000
Purchases 257,000
Goods available for sale 417,000
Inventory – January 31 (140,000)
Cost of goods sold 277,000
=======
Specific Identification

Specific identification means that specific costs are attributed to identified items of inventory.

The cost of the inventory is determined by simply multiplying the units on hand by the actual unit cost.

PAS 2, paragraph 23, provides that this method is appropriate for inventories that are segregated for a specific
project and inventories that are not ordinarily interchangeable.

Measurement of inventory

PAS 2, paragraph 9, provides that inventories shall be measured at the lower of cost and net realizable value.

The cost of inventory is determined using either FIFO cost or average cost.

The measurement of inventory at the lower of cost and net realizable value is known as LCNRV.

Net realizable value

Net realizable value or NRV is the estimated selling price in the ordinary course of business less the estimated
cost of completion and the estimated cost of disposal.

The cost of inventories may not be recoverable under the following circumstances:

a. The inventories are damaged.

b. The inventories have become wholly or partially obsolete.
c. The selling prices have declined.
d. The estimated cost of completion or the estimated cost of disposal has increased.

Inventories are usually written down to net realizable value on an item or individual basis.

Accounting for inventory write-down

If the cost is lower than net realizable value, there is no accounting problem because the inventory is stated at
cost and the increase in value is not recognized.

If the net realizable value is lower than cost, the inventory is measured at net realizable value.
In this case, the problem is the proper treatment of the write-down of the inventory to net realizable value.

Allowance method

The inventory is recorded at cost and any loss on inventory write-down is accounted for separately.

This method is also known as loss method because a loss account “loss on inventory write-down” is debited
and a valuation account “allowance for inventory write-down” is credited.

In subsequent years, this allowance account is adjusted upward or downward depending on the difference
between the cost and net realizable value of the inventory at year-end.

If the required allowance increases, an additional loss is recognized.

If the required allowance decreases, a gain on reversal of inventory write-down is recorded.

However, the gain is limited only to the extent of the allowance balance.

The allowance method is used in order that the effects of write-down and reversal of write-down can be clearly
identified.

As a matter of fact, FAS 2, paragraph 36, requires disclosure of the amount of any inventory write-down and
the amount of any reversal of inventory write-down.

Illustration – Inventory data on December 31, 2019

Inventory total cost NRV LCNRV

A 2,000,000 1,900,000 1,900,000
B 1,500,000 1,550,000 1,500,000
C 2,500,000 2,100,000 2,100,000
D 3,000,000 3,200,000 3,000,000
TOTAL 9,000,000 8,750,000 8,500,000
======== ======== ========

The measurement of the inventory at LCNRV is applied on an items by items or individual basis or
P8,500,000.

Total cost 9,000,000

LCNRV 8,500,000
Inventory write-down 500,000
========
Journal entries

The inventory on December 31, 2019 is recorded at cost.

Inventory – December 31, 2019 9,000,000

Income Summary 9,000,000

The loss on inventory write-down is accounted for separately.

Loss on inventory write-down 500,000

Allowance for inventory write-down 500,000
The loss on inventory write-down is included in the computation of cost of goods sold

The allowance for inventory write-down is presented as a deduction from the inventory.
Inventory – December 31, 2019, at cost 9,000,000
Allowance for inventory write-down (500,000)
Net realizable value 8,500,000
========

Multiple choice questions

Problem 10-1 (IFRS)

Childish Company provided the following information in relation to an inventory:

Materials 700,000
Storage cost of finished goods 180,000
Delivery to customers 40,000
Irrevocable purchase taxes 60,000
At what figure should the inventory be measured?
a. 880,000
b. 760,000
c. 980,000
d. 940,000

Problem 10-2 (IFRS)

Parrot Company provided the following inventory data:

Materials 300,000
Production labor cost 330,000
Production overhead 120,000
General administration costs 100,000
Marketing cost 50,000

What is the value of the completed inventory?

a. 630,000
b. 850,000
c. 750,000
d. 900,000

Problem 10-3 (AICPA adapted)

Virtue Company provided the following data for the current year:

Merchandise purchased for resale 4,000,000

Freight in 100,000
Freight out 50,000
Purchases returns 20,000
Interest on inventory loan 200,000

What is the inventoriable cost of the purchase?

a. 4,280,000
b. 4,030,000
c. 4,080,000
 d. 4,130,000

Problem 10-4 (IFRS)

Eagle Company incurred the following costs in relation to a certain product:

Direct materials and labor 180,000

Variable production overhead 25,000
Factory –administrative cost 15,000
Fixed production cost 20,000

What is the correct measurement of the product?

a. 205,000
b. 225,000
c. 195,000
d. 240,000

Problem 10-5

1. Inventories are defined by all of the following, except

a. Held for sale in the ordinary course of business.
b. In the process of production for such sale.
c. In the form of materials or supplies to be consumed in the production process or the rendering
of services.
d. Used in the production or supply of goods and services for administrative purposes.
2. The cost of inventory is the sum of
a. Cost of purchase and cost of conversion.
b. Direct cost, indirect cost and other cost.
c. Cost of purchase, cost of conversion and other cost incurred in bringing the inventory to the
present location and condition.
d. Cost of conversion and other cost incurred in bringing the inventory to the present location
and condition.
3. The cost of purchase of inventory does not include
a. Purchase price
b. Import duty
c. Freight and handling cost
d. Trade discount and rebate
4. The costs of conversion of inventories include all, except
a. Direct labor
b. Systematic allocation of fixed production overhead
c. Systematic allocation of variable production overhead
d. Systematic allocation of administrative overhead
5. Fixed production overheads include all, except
a. Indirect materials and indirect labor
b. Depreciation of factory building
c. Maintenance of factory equipment
d. Cost of factory management and administration

CHAPTER 11 PAS 7 STATEMENT OF CASH FLOWS

TECHNICAL KNOWLEDGE
To understand the nature and purpose of a statement of cash flows.

To understand the concept and components of cash and cash equivalents.

To know the classifications of cash flows as operating, investing and financing.

STATEMENT OF CASH FLOWS

A statement of cash flows is a component of financial statements summarizing the operating, investing and
financing activities of an entity.

In simple language, the statement of cash flows provides information about the cash receipts and cash
payments of an entity during a period.

An entity shall prepare a statement of cash flows and present it as an integral part of the financial statements
for each period for which financial statements are presented.

The primary purpose of a statement of cash flows is to provide relevant information about cash receipts and
cash payments of an entity during a period.

Cash and cash equivalents

The statement of cash flows is designed to provide information about the change in an entity’s cash and cash
equivalents.

Cash comprises cash on hand and demand deposits.

Cash equivalents are short-term highly liquid investments that are readily convertible to known amount of cash
and which are subject to an insignificant risk of change in value.

PAS 7, paragraph 7, provides that an investment normally qualifies as a cash equivalent only when it has a
short maturity of three months or less from the date of acquisition.

In other words, the investment must be acquired three months or less before the date of maturity.

Examples of cash equivalents

a. Three-month BSP treasury bill

b. Three- year BSP treasury bill purchased three months before date of maturity.
c. Three- month time deposit
d. Three- month money market instrument or commercial paper.

Classification of cash flows

Cash flows are inflows and outflows of cash and cash equivalents.

The statement of cash flows shall report cash flows during the period classified as operating, investing and
financing activities.

Operating activities
Operating activities are the cash flows derived primarily from the principal revenue producing activities of the
entity.

In other words, operating activities generally result from transactions and other events that enter into the
determination of net income or loss.

Examples of cash flows from operating activities are:

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 entity for premiums and claims, annuities and other
policy benefits
f. Cash payments or refunds of income taxes unless specifically identified with financing and investing
activities
g. Cash receipts and payments for securities held for trading

Trading securities

PAS 7, paragraph 15, provides that cash flows arising from the purchase and sale of dealing or trading
securities are classified as operating activities.

Similarly, cash advances and loans made by a financial institution are usually classified as operating activities
since they relate to the main revenue producing activity of that entity.

Investing activities

Investing activities are the cash flows derived from the acquisition and disposal of long-term assets and other
investments not included in cash equivalent.

As a simple guide, investing activities include cash flows from transactions involving non-operating assets.

Examples of cash flows from investing activities

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 (current and long-term
investments)
d. Cash receipts from sales of equity or debt instruments of other entities (current and long-term
investments)
e. Cash advances and loans to other parties other than advances and loans made by financial institution.
f. Cash receipts from repayment of advances and loans made to other parties.
g. Cash payments for future contract, forward contract, options contract and swap contract.
h. Cash receipts from futures contract, forward contract, options contract and swap contract.

Financing activities

Financing activities are the cash flows derived from the equity capital and borrowings of the entity.

In other words, financing activities are the cash flows that result from transactions:
 a. Between the entity and the owners-equity financing
b. Between the entity and the creditors – debt financing

As a simple guide, financing activities include the cash flows from transactions involving nontrade liabilities
and equity of an entity.

Examples of cash flows from financing activities

a. Cash receipts from issuance of ordinary and preference shares

b. Cash payments to acquire treasury shares
c. Cash receipts from issuing debentures, loans, notes, bonds, mortgages, and other short or long term
borrowings
d. Cash payments for amounts borrowed
e. Cash payments by a lessee for the reduction of the outstanding principal lease liability

Cash payments to settle such obligations as trade accounts and notes payable, income tax payable, accrued
expenses are operating activities, not financing activities.

Noncash transactions

PAS 7, paragraph 43, provides that 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 either in the notes to financial
statements or in a separate schedule or in a way that provides all relevant information about these transactions.

The statement of cash flows is strictly a cash concept.

Accordingly, the following noncash transactions are disclosed separately:

a. Acquisition of asset by assuming directly related liability

b. Acquisition of asset by issuing share capital
c. Acquisition of asset by issuing bonds payable
d. Conversion of bonds payable into share capital
e. Conversion of preference shares into ordinary shares

Interest

PAS 7, paragraph 33, provides that 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 investing cash flow because it is a return on investment.

For a financial institution, interest paid and interest received are usually classified as operating cash flows.

Dividends

PAS 7, paragraph 33, provides that dividend received shall be classified as operating cash flow because it
enters into the determination of net income.

Alternatively, dividend received may be classified as investing cash flow because it is a return on investment.
PAS 7, paragraph 34, provides that dividend paid shall be classified as financing cash flow because it is a cost
of obtaining financial resources.

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

PAS 7, paragraph 35, provides that 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.

Tax cash flows are often difficult to match to the originating underlying transaction, so most of the time all tax
cash flows are classified as arising from operating activities.

Cash and cash equivalents – January 3,000,000

Net cash provided by operating activities

Cash received from customers 12,000,000
Rent received 1,000,000
Interest received 1,500,000
Dividend received 2,000,000
Cash paid to suppliers (8,000,000)
Salaries paid (2,900,000)
Insurance paid ( 100,000)
Interest paid ( 500,000)
Income tax paid (2,500,000) 2,500,000

Net cash used in investing activities

Cash paid for land (2,000,000)
Cash received from sale of equipment 800,000
Cash received from sale of investment 700,000 ( 500,000)

Net cash provided by financing activities

Cash received from issue of shares 3,000,000
Cash received from bank loan 4,500,000
Cash paid for dividends (3,500,000)
Cash paid for treasury shares (1,600,000) 2,400,000
Cash and cash equivalents – December 31 7,400,000
========

Cash receipts are cash provided and therefore increase cash and cash equivalents.

Cash payments are cash used and therefore decrease cash and cash equivalents.

Multiple choice questions

Problem 11-1 (AICPA adopted)

Lace Company provided the following information during the current year:
Dividend received 500,000
Dividend paid 1,000,000
Cash received from customers 9,000,000
Proceeds from issuing share capital 1,500,000
 Interest received 200,000
Proceeds from sale of long term investment 2,000,000
Cash paid to suppliers and employees 6,000,000
Interest paid on long term debt 400,000
Income taxes paid 300,000
Cash balance, January 1 1,800,000

1. What is the net cash provided by operating activities?

a. 3,000,000
b. 3,300,000
c. 2,700,000
d. 2,000,000
2. What is the net cash provided by investing activities?
a. 2,500,000
b. 2,000,000
c. 2,200,000
d. 0
3. What is the net cash provided by financing activities?
a. 1,500,000
b. 1,000,000
c. 500,000
d. 0
4. What is the cash balance on December 31?
a. 6,300,000
b. 5,500,000
c. 4,800,000
d. 7,300,000

Problem 11-2 (PAS 7)

1. The primary purpose of a statement of cash flows is to provide relevant information about
a. Difference between net income and associated cash receipts and disbursements
b. An entity’s ability to generate positive net cash flows
c. The cash receipts and cash disbursements of an entity during a period.
d. An entity’s ability to meet cash operating needs
2. Cash receipts from royalties and commissions are
a. Cash outflows for operating activities
b. Cash inflows from operating activities
c. Cash inflows from investing activities
d. Cash outflows for financing activities
3. Cash flows arising from trading securities are
a. Classified as operating activities
b. Classified as investing activities
c. Classified as financing activities
d. Not reported in the cash flow statement
4. Cash payments to acquire equity investments are
a. Cash outflows for financing activities
b. Cash inflows from investing activities
c. Cash outflows for investing activities
d. Cash inflows from financing activities
5. Cash receipts from issuing shares are
a. Cash inflows from investing activities
b. Cash outflows for investing activities
 c. Cash inflows from financing activities
d. Cash outflows for financing activities
6. Interest payments to lenders are classified as
a. Operating activities
b. Borrowing activities
c. Lending activities
d. Financing activities
7. Dividend payments to shareholders are classified as
a. Cash outflows for investing activities
b. Cash inflows from investing activities
c. Cash inflows from financing activities
d. Cash outflows for financing activities
8. Interest received is classified as cash flow from
a. Operating activities
b. Investing activities
c. Financing activities
d. Revenue activities
9. Bank overdrafts that are repayable on demand and the bank balance often fluctuates from positive to
overdrawn shall be classified as
a. Operating activities
b. Investing activities
c. Financing activities
d. Component of cash and cash equivalent
10. Cash advances and loans made by a financial institution are usually classified as
a. Operating activities
b. Investing activities
c. Financing activities
d. Component of cash and cash equivalents