MODULE 1

BASIC FINANCIAL STATEMENTS

CONCEPTUAL FRAMEWORK
➢ the summary of concepts and terms which serves as the theoretical foundation for the
development of accounting principles and standards.
➢ it describes the objective of, and the concepts for, general purpose financial reporting.
The purpose of the Conceptual Framework is to:
a. assist the International Accounting Standards Board (Board) to develop IFRS
Standards (Standards) that are based on consistent concepts;
b. assist preparers to develop consistent accounting policies when no Standard
applies to a particular transaction or other event, or when a Standard allows a
choice of accounting policy; and
c. assist all parties to understand and interpret the Standards.
➢ it is not a Standard. Nothing in the Conceptual Framework overrides any Standard or
any requirement in a Standard.

FINANCIAL REPORTING is the provision of financial information about an entity that is useful
to different users for making economic decisions.
➢ the objective of general purpose financial reporting forms the foundation of the
Conceptual Framework. The objective of general purpose 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 relating to providing
resources to the entity.
➢ specific objectives of financial reporting are as follows:
a. to provide information useful in making investing and credit 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 the entity’s resources, claims and changes in resources
and claims.

➢ Financial reports include the following:

a. Financial information – primarily the financial statements (FS) and the other
informations such as financial highlights, summary of important financial figures, FS
analysis and significant ratios.
b. Non-financial information such as description of major products and list of corporate
officers and directors.

➢ Financial reports are primarily intended for an entity’s fund providers (owners and
creditors) which are the primary external users but it can also be used by the
management (internal user), customers, employees and the government and its
agencies.

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 ➢ Conceptual framework covers the following:
A. OBJECTIVES of FINANCIAL STATEMENTS (FS)
Financial Statements are the means by which the information accumulated and
processed in financial accounting is periodically communicated to the users.
• the complete set of FS and their specific objectives are as follows:
1. Statement of FINANCIAL POSITION (Balance Sheet) – to show the financial position of
the entity
a. liquidity – ability of the entity to meet currently maturing obligations
b. solvency - ability of the entity to meet long term obligations
c. capacity for adaptation – ability of the entity to raise cash when needed
d. financial structure

2. Statement of COMPREHENSIVE INCOME

a. INCOME Statement – to show the results of financial performance, expressed by the
level of net income or loss, which measures the level of success or failure of
operations for the period.
b. other comprehensive income (OCI)

3. Statement of CASH FLOWS – to show the company’s capability to generate cash

(inflow) in order to finance its operations and the movement of cash to assess the
investing, financing and operating activities of the company.

4. Statement of CHANGES IN EQUITY - to show the movements in the elements of equity.

5. NOTES to FS – to provide the summary of significant accounting policies and other
information that are helpful in explaining the data found in the face of FS.

• the entity’s management has the primary responsibility for the preparation and
presentation of FS.

General Features of FS
1. Fair Presentation – the FS are prepared in accordance with the Philippine Financial
Reporting Standards (PFRS) which represent the GAAP in the Philippines.

2. Going concern (Continuity Assumption) - the life of business is indefinite, EXCEPT if

there is evidence to the contrary (like large persistent losses, bankruptcy). Thus assets
are valued at cost. if the firm is under liquidation concern, all assets will be valued at
fair value.
• If the FS are not prepared on a going concern basis, such fact shall be disclosed
together with the measurement basis and the related reasons.
3. Accrual Basis – revenue and expense recognition principle
Accrual Basis Cash Basis
Revenue When earned , not when received When received, not when earned
Expense When incurred, not when paid When paid , not when incurred

4. Materiality and aggregation – an entity shall present separately each

a. material class of similar items.
b. Item of dissimilar nature or function unless they are immaterial.

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 Materiality: Information is material if omitting, misstating or obscuring it could
reasonably be expected to influence decisions that the primary users of general
purpose financial reports (see paragraph 1.5) make on the basis of those reports,
which provide financial information about a specific reporting entity.
• An entity need not provide disclosure required by PFRS if the information is immaterial.

5. Offsetting – assets and liabilities, income and expenses, shall not be offset against
each other when they are material. Offsetting may be done when it is required or
permitted by another PFRS.
Examples
a. gains on trading securities (TS) are netted against loss on TS.
b. selling expenses are deducted from the selling price to get the net proceeds
which is compared to carrying amount to get the gain or loss on disposal of asset.
c. a bank overdraft can be deducted from the other accounts In the same bank to
determine the cash in bank balance of an entity.

6. Frequency of reporting – an entity shall present a complete set of FS at least annually.

• when an entity changes its accounting period and presents FS longer than or
shorter than one year, it shall disclose the period covered by the FS, the reason for
using that period and the fact that the FS are not entirely comparable.

7. Comparative Information – except when permitted or required otherwise by

standard, an entity shall disclose comparative information in respect of the previous
period for all amounts reported in the current period’s FS.
8. Consistency of presentation – accounting methods and practices shall be applied on
a uniform basis from period to period to allow comparability of information.

B. QUALITATIVE CHARACTERISTICS (QC)

➢ attributes that must be possessed by the F/S for it to be useful in decision making
I. FUNDAMENTAL QC - related to the content of F/S
a. RELEVANCE – “ability to influence decision” of user
1. predictive value – allows an accurate forecast of future outcomes
2. confirmatory value - gives feedback about (confirms or changes) previous
evaluation. It allows the user to verify the forecast (expectation)
3. timeliness – information must be available when needed for decision making.
MATERIALITY – magnitude of an information to affect decision (judgment) of user.
• it can be determined based on amount (% of major FS account) or nature, or both,
of the items to which the information relates in the context of an individual entity’s
financial report.

b. FAITHFUL REPRESENTATION – “actual effects of transaction are accounted for and

reflected in the financial statements. It is primarily obtained thru correct journal
entries. Faithful representation has these 3 major characteristics:
1. COMPLETENESS – all relevant information must be included in the FS.
• provides adequate disclosure for contingent assets, liabilities, subsequent
events and other information not disclosed in the FS. It is primarily attained
thru the Notes to FS.

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 2. NEUTRALITY – FS must serve the common users, not favor a specific user; no bias
• Neutrality is supported by the exercise of prudence. Prudence is the exercise
of caution when making judgements under conditions of uncertainty. The
exercise of prudence means that assets and income, liabilities and expenses
are not overstated or understated.
• Conservatism means that when in doubt about the measurement of
transaction, the least effect on equity must be taken.

3. FREE FROM ERROR – no error or omission on the description of transaction or

process used to produce the reported information.
* SUBSTANCE OVER FORM – the economic form, not legal form, of transaction, must
be reflected. Ex: X rented the machine from Y for P 5, 000 a month for 5 years. After
5 years, machine will be owned by X. In form, it is an ordinary rental agreement
(operating lease) but in substance, it is an installment purchase (Capital lease)

➢ Under the old conceptual framework, reliability represents faithful representation.

RELIABILITY is the “degree of confidence” that users place on the FS.

II. ENHANCING QC - Related to the presentation of F/S

a. COMPARABILITY – points of likeness or difference
1. INTERcomparability – between 2 firms of the same industry
2. INTRAcomparability – between 2 accounting periods of the same firm.
- look for trends in financial position, performance and cash flows of business.
➢ Implicit for comparability is the principle of consistency which states that same
accounting methods and practices must be applied from period to another.

b. UNDERSTANDABILITY – F/S must be presented in a manner that is comprehensible

to users. Users are assumed to have sufficient knowledge in basic accounting and
commerce.
c. VERIFIABILITY – “implies consensus”. Financial information is supported by evidence
such that people who would look into the same evidence would arrive at the
same conclusion or economic decision.

d. TIMELINESS - information must be available when needed for decision making.

ACCOUNTING CONSTRAINTS – the limitations in obtaining or providing financial information

a. COST constraint – the cost of obtaining or providing the information must not exceed
the benefit to be derived from it.

b. TIMELINESS – balancing the merits of relevance vs reliability of information

c. MATERIALITY

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 C. Definition, Recognition & Measurement of Accounting Elements
Criteria Assets & Liabilities &
Revenues Expenses
1. Flow of future economic benefits (usually cash) Inflow Outflow
2. Amount can be measured Reliably Reliably

Results to either: Revenue Recognition Expense Recognition

1. Assets Ex: Cash sale; Ex: Cash expenses
accrual of income Adjustment of prepayments

2. Liabilities Ex: adjustment of unearned income Ex: Accrual of expenses

INCOME recognition Principle

➢ income is recognized when earned regardless of when cash is received. It encompasses
both
a. REVENUE - arise from ordinary regular activities
➢ generally recognized at point of sale. Exceptions are the following revenue
recognition methods: installment, cost recovery, cash, % of completion, and
production method.
b. GAINS - arises from activities other than ordinary regular activities

EXPENSE Recognition: Matching Principle

➢ expenses are recognized when incurred regardless of when paid.
1. Associating Cause & Effect – expense is directly related to revenue
Ex: sales commission, delivery expense, cost of sale ---all related to sales revenue

2. Systematic and Rational Allocation – cost of an asset is allocated to all periods benefited
Ex: depreciation of PPE, amortization of intangibles, consumption of prepaid expenses
3. Immediate Recognition – expenses incurred are expensed outright; no future benefits is
expected Ex: utilities expense, salaries expense, worthless assets

➢ expense encompasses both:

a. expenses- arise from ordinary regular activities
b. losses - arises from activities other than ordinary regular activities

MEASUREMENT of Accounting Elements

Measurement is the process of determining the monetary value of the accounting
elements that would appear in the financial statements.
a. HISTORICAL Cost – value of consideration given to acquire an asset at time of acquisition.
b. CURRENT Cost – value to be paid to replace the asset or acquire the same (equivalent) asset
c. REALIZABLE Value – value of consideration to be received if the asset is disposed (sold).
d. PRESENT Value – the discounted value of all future net cash inflows to be generated by the
asset.

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 D. Concepts of Capital and Capital Maintenance
CAPITAL MAINTENANCE (well offness) – means that a firm earns profit (net income) only
after the capital beginning is maintained.
1. FINANCIAL Capital – absolute monetary value of net assets (Assets - Liabilities) with
the assets valued at historical costs.
• a profit is earned only if the financial (or money) amount of the net assets at the
end of the period exceeds the financial (or money) amount of net assets at the
beginning of the period, after excluding any distributions to, and contributions from,
owners during the period.
Capital – end Pxx
Drawings (dividends paid) xx
Additional investments (xx)
Capital – beg (xx)
Net income (net loss) Pxx

2. PHYSICAL capital – the quantitative measure of the physical productive capacity of

the asset to produce goods and services. It is the value of net assets using current cost.

STATEMENT OF FINANCIAL POSITION (BALANCE SHEET)

➢ a formal statement showing the 3 elements (assets, liabilities, equity) comprising financial
position. It can be presented in the following forms:
a. REPORT Form – the 3 major elements are shown downwards
b. ACCOUNT Form – assets presented at the left; liabilities and equity at the right

PRO – FORMA: REPORT Form

ABC Company
Statement of Financial Position
December 31, 2020

Current Assets Note

Cash and cash equivalents (1) xx
Financial assets at fair value (2) xx
Trade and other receivables (3) xx
Inventories (4) xx
Prepaid expenses (5) xx
Total current assets xx

Noncurrent Assets
Property, plant and equipment (6) xx
Investment in associate at equity (7) xx
Long term investments (8) xx
Intangible assets (9) xx
Other non-current assets (10) xx
Total noncurrent assets xx
Total Assets xx

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 Current Liabilities
Trade and other payables (11) xx
Short term note payable xx
Current portion of bonds payable xx
Provisions (12) xx
Total current liabilities xx

Noncurrent Liabilities
Bonds payable – noncurrent portion xx
Note payable – long term xx
Deferred tax liability (13) xx
Total noncurrent liabilities xx

Shareholders’ Equity
Share capital, P10 par xx
Reserves (14) xx
Retained Earnings xx
Treasury shares xx
Total Shareholders’ Equity xx
Total Liabilities and Shareholders’ Equity xx

PRO – FORMA: ACCOUNT Form

ABC Company
Statement of Financial Position
December 31, 2020

Current Assets Note Current Liabilities Note

Cash and cash equivalents (1) xx Trade and other payables (11) xx
Financial assets at fair value (2) xx Short term note payable xx
Trade and other receivables (3) xx Current portion of bonds payable xx
Inventories (4) xx Provisions (12) xx
Prepaid expenses (5) xx Total current liabilities xx
Total current assets xx
Noncurrent Liabilities
Noncurrent Assets Bonds payable – noncurrent portion xx
Property, plant and equipment (6) xx Note payable – long term xx
Investment in associate at equity (7) xx Deferred tax liability (13) xx
Long term investments (8) xx Total noncurrent liabilities xx
Intangible assets (9) xx
Other non-current assets (10) xx Shareholders’ Equity
Total noncurrent assets xx Share capital, P10 par xx
Reserves (14) xx
Retained Earnings xx
Treasury shares xx
Total Shareholders’ Equity xx

Total Assets xx Total Liabilities and Shareholders’ Equity xx

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 NOTE:
a. Notes 1 – 14 will be presented in the notes to the FS to show the computation of the related
accounts of asset, liability or shareholders’ equity.

b. The presentation of accounts observed the following principles:

1. AGGREGATION – items of the similar nature are presented as 1 item. These are represented by
the cash and cash equivalents and other accounts with notes beside them.
2. LIQUIDITY – items shall be presented in the order of their period of convertibility (nearness) to
cash without impairment in value.
➢ the one presented above is generally in the Philippines setting where accounts are listed
from most liquid to least liquid. PAS 1 paragraph 57 provides that the standard does not
prescribe the order or format in which the items are to be presented.

INCOME STATEMENT
➢ a formal statement showing the financial performance of an entity for a period of time.
It can be presented in the following forms:
a. FUNCTIONAL Presentation (Cost of Sales Method) – the traditional or common form
of IS, where expenses are classified according to their function as part of cost of
sales, distribution costs, administrative activities and other activities.
b. NATURAL Presentation (Nature of Expense Method) – expenses are aggregated
according to their nature.

PRO – FORMA: FUNCTIONAL PRESENTATION

ABC Company
Income Statement
Year ended December 31, 2020

Note
Net Sales (1) xx
Cost of sales (2) xx
Gross income xx
Other income (3) xx
Investment income (4) xx
Total income xx

Expenses
Distribution costs (5) xx
Administrative expenses (6) xx
Other expenses (7) xx
Finance costs (8) xx (xx)
Income before Tax xx
Income tax expense (xx)
Net income (net loss) xx

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 PRO – FORMA: NATURAL PRESENTATION

ABC Company
Income Statement
Year ended December 31, 2020

Note
Net Sales (1) xx
Other income (2) xx
Investment income (3) xx
Total income xx

Expenses
Net purchases (4) xx
Increase in inventory (5) (xx)
Employee benefit costs (6) xx
Sales commission xx
Advertising xx
Supplies expense (7) xx
Delivery expenses xx
Depreciation expense (8) xx
Bad debts expense xx
Taxes and licenses xx
Other expenses (9) xx
Finance costs (10) xx (xx)
Income before Tax xx
Income tax expense (xx)
Net income (net loss) xx

NOTE:
a. Notes 1 – 8 (or 1-10 in natural presentation) will be presented in the notes to the FS to show the
computation of the related accounts of income and expenses.

b. TERMINOLOGIES: Distribution costs = selling expenses Net income = profit net loss = loss
Investment income normally refers to share in net income of associate to distinguish it from all other
sources of income which is included in “other income”.

Finance costs normally refers to interest expense, bank service charge and other costs associated
with financing activity.

Other expenses are those expenses which are not directly related to distribution and
administrative functions and financing activity.

c. The standard does not prescribe format to be used in preparing Income statement.
PAS 1 paragraph 105 states that because each method of presentation has merit for different
types of entities, the management is required to select the presentation that is more relevant
and reliable.

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 STATEMENT OF COMPREHENSIVE INCOME
➢ a formal statement prepared in addition to income statement, in order to provide a more
comprehensive information on the financial performance of the entity.

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. It includes the following:
1. Net income (profit) or net loss (loss) – the bottom line in the income statement.
2. Other Comprehensive Income (OCI) – items of income and expenses including
reclassification adjustments that are not recognized in profit or loss as required or
permitted by PFRS.
• PAS 1 paragraph 82 provides that OCI shall be classified by nature, as follows:
a. OCI that will be reclassified subsequently to profit or loss
1. unrealized gain or loss on debt investment measured at fair value through OCI
2. Unrealized gain or loss on derivative contracts designated as “cash flow hedge”
3. gain or loss from translating financial statements of foreign operation

b. OCI that will be reclassified subsequently to Retained Earnings

1. unrealized gain or loss on equity investment measured at fair value through OCI.
2. Change in revaluation surplus
3. Remeasurement of a defined benefit plan
4. Gain or loss attributable to credit risk of a financial liability designated at fair value
through profit or loss.

➢ PAS 1 paragraph 81 provides these options of presenting comprehensive income:

a. Two statement approach – two separate statements are prepared, namely:
1. income statement
2. Statement of comprehensive income – begins with net income (net loss) followed
by components of OCI.

b. Single statement approach – a combined statement showing the components of

both profit or loss and OCI.

PRO – FORMA: TWO STATEMENT Approach

ABC Company
Statement of Comprehensive Income
Year ended December 31, 2020

Net income xx
OCI to be reclassified to profit or loss
Foreign currency translation gain xx
Unrealized loss on debt investment accounted as FV OCI (xx) xx
OCI to be reclassified to retained earnings
Unrealized gain on equity investment accounted as FV OCI xx
Change in revaluation surplus (xx) xx
Comprehensive income xx

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 PRO – FORMA: SINCLE STATEMENT Approach
ABC Company
Statement of Comprehensive Income
Year ended December 31, 2020
Note
Net Sales (1) xx
Cost of sales (2) xx
Gross income xx
Other income (3) xx
Investment income (4) xx
Total income xx

Expenses
Distribution costs (5) xx
Administrative expenses (6) xx
Other expenses (7) xx
Finance costs (8) xx (xx)
Income before Tax xx
Income tax expense (xx)
Net income (net loss) xx
OCI to be reclassified to profit or loss
Foreign currency translation gain xx
Unrealized loss on debt investment accounted as FV OCI (xx) xx
OCI to be reclassified to retained earnings
Unrealized gain on equity investment accounted as FV OCI xx
Change in revaluation surplus (xx) xx
Comprehensive income xx

STATEMENT OF CHANGES IN EQUITY – a financial statement showing the movements in the

elements of shareholders’ equity.
TRANSACTIONS Share
Capital R/E (OCI) Total
UNADJUSTED (beg.) balances xx xx Pxx Pxx
1. Issuance of Preference Shares and Ordinary Shares xx xx
2. Acquisition of treasury shares (TS) (xx) (xx)
3. Net income (Net loss) xx xx
4. Unrealized gain (loss) on FA FVOCI (AFS securities) xx xx
5. Change in FV attributable to credit risk - FV PL xx xx
6. Foreign currency translation gain (loss) xx xx
7. Unrealized gain (loss) on derivative contracts xx xx
designated as cash flow hedge
8. Actuarial gain (loss) in a defined benefit plan xx xx
9. Share dividends xx (xx) xx
10. Other types of Dividends (xx) xx
ADJUSTED (end) balance xx xx Pxx Pxx

NOTE: R/E = Retained Earnings OCI = Other Comprehensive Income

The column of Share Capital can be replaced by 2 separate columns for Ordinary Share Capital
and Preference Share Capital.

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